Company Quick10K Filing
Quick10K
Santander Holdings
10-K 2018-12-31 Annual: 2018-12-31
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
10-Q 2015-09-30 Quarter: 2015-09-30
10-Q 2015-06-30 Quarter: 2015-06-30
10-Q 2015-03-31 Quarter: 2015-03-31
10-K 2014-12-31 Annual: 2014-12-31
10-Q 2014-09-30 Quarter: 2014-09-30
10-Q 2014-06-30 Quarter: 2014-06-30
10-Q 2014-03-31 Quarter: 2014-03-31
10-K 2013-12-31 Annual: 2013-12-31
8-K 2019-03-21 Regulation FD, Exhibits
8-K 2018-11-28 Other Events, Exhibits
8-K 2018-11-16 Regulation FD, Exhibits
8-K 2018-11-01 Other Events
8-K 2018-09-14 Officers, Exhibits
8-K 2018-08-17 Regulation FD, Exhibits
8-K 2018-06-29 Other Events, Exhibits
8-K 2018-06-28 Other Events, Exhibits
8-K 2018-06-25 Other Events, Exhibits
8-K 2018-06-22 Other Events
8-K 2018-05-18 Regulation FD, Exhibits
8-K 2018-03-30 Regulation FD, Exhibits
8-K 2018-03-07 Other Events, Exhibits
8-K 2018-02-15 Regulation FD, Exhibits
8-K 2018-02-01 Regulation FD, Exhibits
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SOV 2018-12-31
Part I
Item 1 - Business
Item 1A - Risk Factors
Item 1B - Unresolved Staff Comments
Item 2 - Properties
Item 3 - Legal Proceedings
Item 4 - Mine Safety Disclosures
Part II
Item 5 - Market for The Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6 - Selected Financial Data
Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A")
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A - Quantitative and Qualitative Disclosures About Market Risk
Item 8 - Consolidated Financial Statements
Note 1. Basis of Presentation and Accounting Policies
Note 2. Recent Accounting Developments
Note 3. Investment Securities
Note 4. Loans and Allowance for Credit Losses
Note 5. Operating Lease Assets, Net
Note 6. Premises and Equipment
Note 7. Vies
Note 8. Goodwill and Other Intangibles
Note 9. Other Assets
Note 10. Deposits and Other Customer Accounts
Note 11. Borrowings
Note 12. Accumulated Other Comprehensive Income / (Loss)
Note 13. Stockholder's Equity
Note 14. Derivatives
Note 15. Income Taxes
Note 16. Fair Value
Note 17. Non-Interest Income and Other Expenses
Note 18. Stock-Based Compensation
Note 19.Other Employee Benefit Plans
Note 20. Commitments, Contingencies and Guarantees
Note 21. Related Party Transactions
Note 22. Regulatory Matters
Note 23. Business Segment Information
Note 24. Parent Company Financial Information
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A - Controls and Procedures
Item 9B - Other Information
Part III
Item 10 - Directors, Executive Officers and Corporate Governance
Item 11 - Executive Compensation
Part 1: Quantitative Score 95.3 %
Part 2: Qualitative Adjustment -1.4 %
Part 3: Santander Multiplier +3.0 %
Part 4: Exceptional Adjustment By Santander's Remuneration Committee +3.1 %
Item 12 - Security Ownership of Certain Beneficial Owners and Management Related Stockholder Matters
Item 13 - Related Party Transactions
Item 14 - Principal Accounting Fees and Services
Part IV
Item 15 - Exhibits and Financial Statement Schedules
Item 16 - Form 10-K Summary
EX-21.1 a10-k_2018exhibit211.htm
EX-23.1 a10-k_2018exhibit231.htm
EX-31.1 a10-k_4q18exhibit311.htm
EX-31.2 a10-k_4q18exhibit312.htm
EX-32.1 a10-k_4q18exhibit321.htm
EX-32.2 a10-k_4q18exhibit322.htm

Santander Holdings Earnings 2018-12-31

SOV 10K Annual Report

Balance SheetIncome StatementCash Flow

10-K 1 santanderholdings10-k2018.htm 10-K Document

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
þ
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     .
Commission File Number: 001-16581
SANTANDER HOLDINGS USA, INC.
 
(Exact name of registrant as specified in its charter)
  
Virginia
(State or other jurisdiction of
incorporation or organization)
 
23-2453088
(I.R.S. Employer
Identification No.)
 
 
 
75 State Street, Boston, Massachusetts
(Address of principal executive offices)
 
02109
(Zip Code)
(617) 346-7200
Registrant’s telephone number including area code
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    
Yes þ.   No o.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    
Yes o.   No þ.
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 þ. No o.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation ST (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit). Yes þ. No o.



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
 
Accelerated filer o
 
 
 
Non-accelerated filer þ
 
(Do not check if smaller reporting company)
 
 
 
 
 
Smaller reporting company o
 
 
 
 
 
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o. No þ.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class
 
Outstanding at February 28, 2019
Common Stock (no par value)
 
530,391,043 shares




INDEX

 
 
 
Page
 
 
 
 
 
 


3




FORWARD-LOOKING STATEMENTS
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

This Annual Report on Form 10-K of Santander Holdings USA, Inc. (“SHUSA” or the “Company”) contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 regarding the financial condition, results of operations, business plans and future performance of the Company. Words such as “may,” “could,” “should,” “looking forward,” “will,” “would,” “believe,” “expect,” “hope,” “anticipate,” “estimate,” “intend,” “plan,” “assume," "goal," "seek" or similar expressions are intended to indicate forward-looking statements.

Although SHUSA believes that the expectations reflected in these forward-looking statements are reasonable as of the date on which the statements are made, these statements are not guarantees of future performance and involve risks and uncertainties based on various factors and assumptions, many of which are beyond the Company's control. Among the factors that could cause SHUSA’s financial performance to differ materially from that suggested by forward-looking statements are:

the effects of regulation and/or policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the "FDIC"), the Office of the Comptroller of the Currency (the “OCC”) and the Consumer Financial Protection Bureau (the “CFPB”), and other changes in monetary and fiscal policies and regulations, including policies that affect market interest rates and money supply, as well as in the impact of changes in and interpretations of generally accepted accounting principles in the United States of America ("GAAP"), the failure to adhere to which could subject SHUSA to formal or informal regulatory compliance and enforcement actions and result in fines, penalties, restitution and other costs and expenses, changes in our business practice, and reputational harm;
SHUSA’s ability to manage credit risk that may increase to the extent our loans are concentrated by loan type, industry segment, borrower type or location of the borrower or collateral;
the slowing or reversal of the current U.S. economic expansion and the strength of the U.S. economy in general and regional and local economies in which SHUSA conducts operations in particular, which may affect, among other things, the level of non-performing assets, charge-offs, and provisions for credit losses;
inflation, interest rate, market and monetary fluctuations, which may, among other things, reduce net interest margins and impact funding sources and the ability to originate and distribute financial products in the primary and secondary markets;
Santander Consumer USA Inc.'s ("SC's") agreement with Fiat Chrysler Automobiles US LLC ("FCA") may not result in currently anticipated levels of growth, is subject to performance conditions that could result in termination of the agreement, and is also subject to an option giving FCA the right to acquire an equity participation in the Chrysler Capital portion of SC's business;
the pursuit of protectionist trade or other related policies, including tariffs by the U.S., its global trading partners, and/or other countries;
adverse movements and volatility in debt and equity capital markets and adverse changes in the securities markets, including those related to the financial condition of significant issuers in SHUSA’s investment portfolio;
SHUSA's ability to grow revenue, manage expenses, attract and retain highly-skilled people and raise capital necessary to achieve its business goals and comply with regulatory requirements;
SHUSA’s ability to effectively manage its capital and liquidity, including approval of its capital plans by its regulators and its ability to continue to receive dividends from its subsidiaries or other investments;
changes in credit ratings assigned to SHUSA or its subsidiaries;
the ability to manage risks inherent in our businesses, including through effective use of systems and controls, insurance, derivatives and capital management;
SHUSA’s ability to timely develop competitive new products and services in a changing environment that are responsive to the needs of SHUSA's customers and are profitable to SHUSA, the success of our marketing efforts to customers, and the potential for new products and services to impose additional unexpected costs, losses, or other liabilities not anticipated at their initiation, and expose SHUSA to increased operational risk;
competitors of SHUSA may have greater financial resources or lower costs, or be subject to different regulatory requirements than SHUSA, may innovate more effectively, or may develop products and technology that enable those competitors to compete more successfully than SHUSA and cause SHUSA to lose business or market share;
consumers and small businesses may decide not to use banks for their financial transactions, which could impact our net income;
changes in customer spending, investment or savings behavior;
loss of customer deposits that could increase our funding costs;
the ability of SHUSA and its third-party vendors to convert, maintain and upgrade, as necessary, SHUSA’s data processing and other information technology ("IT") infrastructure on a timely and acceptable basis, within projected cost estimates and without significant disruption to our business;
SHUSA's ability to control operational risks, data security breach risks and outsourcing risks, and the possibility of errors in quantitative models SHUSA uses to manage its business, including as a result of cyberattacks, technological failure, human error, fraud or malice, and the possibility that SHUSA's controls will prove insufficient, fail or be circumvented;
the ability of certain European member countries to continue to service their debt and the risk that a weakened European economy could negatively affect U.S.-based financial institutions, counterparties with which SHUSA does business, as well as the stability of global financial markets, including economic instability and recessionary conditions in Europe and the eventual exit of the United Kingdom from the European Union;
changes to income tax laws and regulations and the outcome of ongoing tax audits by federal, state and local income tax authorities that may require SHUSA to pay additional taxes or recover fewer overpayments compared to what has been accrued or paid as of period-end;
the costs and effects of regulatory or judicial proceedings, including possible business restrictions resulting from such proceedings;
adverse publicity, and negative public opinion, whether specific to SHUSA or regarding other industry participants or industry-wide factors, or other reputational harm; and
acts of terrorism or domestic or foreign military conflicts; and acts of God, including natural disasters.

1




GLOSSARY OF ABBREVIATIONS AND ACRONYMS
SHUSA provides the following list of abbreviations and acronyms as a tool for the readers that are used in Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Consolidated Financial Statements and the Notes to Consolidated Financial Statements.
ABS: Asset-backed securities
 
FASB: Financial Accounting Standards Board
ACL: Allowance for credit losses
 
FBO: Foreign banking organization
AFS: Available-for-sale
 
FCA: Fiat Chrysler Automobiles US LLC
ALLL: Allowance for loan and lease losses
 
FDIC: Federal Deposit Insurance Corporation
Alt-A: Loans originated through brokers outside the Bank's geographic footprint, often lacking full documentation
 
Federal Reserve: Board of Governors of the Federal Reserve System
ASC: Accounting Standards Codification
 
FHLB: Federal Home Loan Bank
ASU: Accounting Standards Update
 
FHLMC: Federal Home Loan Mortgage Corporation
Bank: Santander Bank, National Association
 
FICO®: Fair Isaac Corporation credit scoring model
BHC: Bank holding company
 
Final Rule: Rule implementing certain of the EPS mandated by Section 165 of the DFA
BOLI: Bank-owned life insurance
 
FINRA: Financial Industrial Regulatory Authority
BSI: Banco Santander International
 
FNMA: Federal National Mortgage Association
BSPR: Banco Santander Puerto Rico
 
FRB: Federal Reserve Bank
CBP: Citizens Bank of Pennsylvania
 
FVO: Fair value option
CCAR: Comprehensive Capital Analysis and Review
 
GAAP: Accounting principles generally accepted in the United States of America
CD: Certificate of deposit
 
GAP: Guaranteed auto protection
CEF: Closed-end fund
 
HFI: Held for investment
CET1: Common equity Tier 1
 
HTM: Held to maturity
CFPA: Consumer Financial Protection Act
 
IHC: U.S. intermediate holding company
CFPB: Consumer Financial Protection Bureau
 
IPO: Initial public offering
Change in Control: First quarter 2014 change in control and consolidation of SC
 
IRS: Internal Revenue Service
Chrysler Agreement: Ten-year private label financing agreement with Fiat Chrysler Automobiles US LLC, formerly Chrysler Group LLC, signed by SC
 
ISDA: International Swaps and Derivatives Association, Inc.
Chrysler Capital: Trade name used in providing services under the Chrysler Agreement
 
LCR: Liquidity coverage ratio
CIB: Corporate and Investment Banking
 
LHFI: Loans HFI
CLTV: Combined loan-to-value
 
LHFS: Loans held-for-sale
CMO: Collateralized mortgage obligation
 
LIBOR: London Interbank Offered Rate
CODM: Chief Operating Decision Maker
 
LTD: Long-term debt
Company: Santander Holdings USA, Inc.
 
LTV: Loan-to-value
Covered Fund: hedge fund or a private equity fund under the Volcker Rule
 
MBS: Mortgage-backed securities
CRA: Community Reinvestment Act
 
MD&A: Management's Discussion and Analysis of Financial Condition and Results of Operations
CRE: Commercial Real Estate
 
MSR: Mortgage servicing right
DCF: Discounted cash flow
 
MVE: Market value of equity
DFA: Dodd-Frank Wall Street Reform and Consumer Protection Act
 
NCI: Non-controlling interest
DOJ: Department of Justice
 
NPL: Non-performing loan
DRIVE: Drive Auto Receivables Trust
 
NYSE: New York Stock Exchange
DTI: Debt-to-income
 
OCC: Office of the Comptroller of the Currency
ECOA: Equal Credit Opportunity Act
 
OEM: Original equipment manufacturer
EPS: Enhanced Prudential Standards
 
OREO: Other real estate owned
ETR: Effective tax rate
 
OTTI: Other-than-temporary impairment
Exchange Act: Securities Exchange Act of 1934, as amended
 
 

2




Parent Company: the parent holding company of SBNA and other consolidated subsidiaries
 
SEC: Securities and Exchange Commission
REIT: Real estate investment trust
 
Securities Act: Securities Act of 1933, as amended
RIC: Retail installment contract
 
SFS: Santander Financial Services, Inc.
RV: Recreational vehicle
 
SHUSA: Santander Holdings USA, Inc.
RWA: Risk-weighted asset
 
SIS: Santander Investment Securities Inc.
S&P: Standard & Poor's
 
SSLLC: Santander Securities LLC
SAM: Santander Asset Management, LLC
 
TCJA: Tax Cut and Jobs Act of 2017
Santander: Banco Santander, S.A.
 
TDR: Troubled debt restructuring
Santander BanCorp: Santander BanCorp and its subsidiaries
 
TLAC: Total loss-absorbing capacity
Santander UK: Santander UK plc
 
Trusts: Securitization trusts
SBNA: Santander Bank, National Association
 
UPB: Unpaid principal balance
SC: Santander Consumer USA Holdings Inc. and its subsidiaries
 
VIE: Variable interest entity
SC Common Stock: Common shares of SC
 
VOE: Voting rights entity
SCF: Statement of cash flows
 
 
SCRA: Servicemembers' Civil Relief Act
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

3




PART I


ITEM 1 - BUSINESS

General

Santander Holdings USA, Inc. ("SHUSA" or the "Company") is the parent company of Santander Bank, National Association, (the "Bank" or "SBNA"), a national banking association, and owns a majority interest (approximately 69.9% as of February 21, 2019) of Santander Consumer USA Holdings Inc. (together with its subsidiaries, "SC"), a specialized consumer finance company focused on vehicle finance and third-party servicing. SHUSA is headquartered in Boston, Massachusetts and the Bank's main office is in Wilmington, Delaware. SC is headquartered in Dallas, Texas. SHUSA is a wholly-owned subsidiary of Banco Santander, S.A. ("Santander"). SHUSA is also the parent company of Santander BanCorp (together with its subsidiaries, “Santander BanCorp”), a holding company headquartered in Puerto Rico which offers a full range of financial services through its wholly-owned banking subsidiary, Banco Santander Puerto Rico; Santander Securities, LLC (“SSLLC”), a broker-dealer headquartered in Boston; Banco Santander International (“BSI”), an Edge Act corporation located in Miami which offers a full range of banking services to foreign individuals and corporations based primarily in Latin America; Santander Investment Securities Inc. (“SIS”), a registered broker-dealer located in New York providing services in investment banking, institutional sales, trading and offering research reports of Latin American and European equity and fixed-income securities; and several other subsidiaries.
 
The Bank's principal markets are in the Mid-Atlantic and Northeastern United States. At December 31, 2018, the Bank had 627 branches and 2,274 automated teller machines ("ATMs") across its footprint. The Bank uses its deposits, as well as other financing sources, to fund its loan and investment portfolios. The Bank earns interest income on its loan and investment portfolios. In addition, the Bank generates non-interest income from a number of sources, including deposit and loan services, sales of loans and investment securities, capital markets products and bank-owned life insurance ("BOLI"). The Bank's principal non-interest expenses include employee compensation and benefits, occupancy and facility-related costs, technology and other administrative expenses. The financial results of the Bank are affected by the economic environment, including interest rates and consumer and business confidence and spending, as well as the competitive conditions within the Bank's geographic footprint.

SC's primary business is the indirect origination of retail installment contracts ("RICs"), principally through manufacturer-franchised dealers in connection with their sale of new and used vehicles to retail consumers. SC also offers a full spectrum of auto financing products and services to Chrysler customers and dealers under the Chrysler Capital brand, the trade name used in providing services ("Chrysler Capital") under the ten-year private label financing agreement with Fiat Chrysler Automobiles US LLC ("FCA"), formerly Chrysler Group LLC, signed by SC in 2013 (the "Chrysler Agreement"). These products and services include consumer RICs and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile and recreational and marine vehicle portfolios for other lenders. Additionally, SC has several relationships through which it provides other consumer finance products.

Since its initial public offering (the “IPO”), SC has been consolidated with the Company and Santander for financial reporting and accounting purposes. If the Company directly, and Santander indirectly, owned 80% or more of SC’s common shares (“SC Common Stock”), SC could be consolidated with the Company and Santander for tax filing and capital planning purposes as well. Among other things, tax consolidation would (1) facilitate certain offsets of SC’s taxable income, (2) eliminate the double taxation of dividends from SC, and (3) trigger a release into SHUSA’s income the non-goodwill portion of the deferred tax liability established with respect to its ownership of SC. In addition, SHUSA and Santander would recognize a larger percentage of SC's net income. SC Common Stock is listed for trading on the New York Stock Exchange (the "NYSE") under the trading symbol "SC".

SC's Relationship with FCA

Since May 2013, SC entered into the Chrysler Agreement, pursuant to which SC became the preferred provider for FCA’s consumer loans and leases and dealer loans. Business generated under terms of the Chrysler Agreement is branded as Chrysler Capital. During 2018, SC originated more than $7.9 billion of Chrysler Capital retail installment contracts ("RICs") and more than $9.7 billion of Chrysler Capital vehicle leases.

The Chrysler Agreement requires, among other things, that SC bears the risk of loss on loans originated pursuant to the agreement, but also that FCA shares in any residual gains and losses from consumer leases. The agreement also requires that SC maintains at least $5.0 billion in funding available for dealer inventory financing and $4.5 billion of financing dedicated to FCA retail financing. In turn, FCA must provide designated minimum threshold percentages of its subvention business to SC.


4




The Chrysler Agreement has a ten-year term, subject to early termination in certain circumstances, including the failure by either party to comply with certain of their ongoing obligations. These obligations include, for SC, meeting specified escalating penetration rates for the first five years and, for FCA, treating SC in a manner consistent with comparable original equipment manufacturers' ("OEMs`") treatment of their captive providers, primarily regarding sales support. In addition, FCA may also terminate the agreement if, among other circumstances, (i) a person other than Santander or its affiliates or its other stockholders owns 20% or more of its common stock and Santander and its affiliates own fewer shares of common stock than such person, (ii) SC becomes, controls, or becomes controlled by, an OEM that competes with Chrysler, or (iii) certain of SC's credit facilities become impaired.

In connection with entering into the Chrysler Agreement, SC paid FCA a $150 million upfront, nonrefundable fee on May 1, 2013. This fee is considered payment for future profits generated from the Chrysler Agreement. Accordingly, the Company amortizes the Chrysler Agreement over the expected ten-year term as a component of net finance and other interest income. SC has also executed an equity option agreement with FCA, whereby FCA may elect to purchase, at any time during the term of the Chrysler Agreement, at fair market value, an equity participation of any percentage in the Chrysler Capital portion of SC's business.

For a period of 20 business days after FCA's delivery to SC of a notice of intent to exercise its option, SC is to discuss with FCA, in good faith, the structure and valuation of the proposed equity participation. If the parties are unable to agree on a structure and FCA still intends to exercise its option, SC will be required to create a new company into which the Chrysler Capital assets will be transferred and which will own and operate the Chrysler Capital business. If FCA and SC cannot agree on a fair market value during the 20-day negotiation period, each party will engage an investment bank and the appointed banks will mutually appoint a third independent investment bank to determine the value, with the cost of the valuation divided evenly between FCA and SC. Each party has the right to a one-time deferral of the independent valuation process for up to nine months. FCA will have a period of 90 days after a valuation has been determined, either by negotiation between the parties or by an investment bank, to deliver a binding notice of exercise. Following this notice, FCA's purchase is to be paid and settled within 10 business days, subject to a delay of up to 180 days if necessary to obtain any required consents from governmental authorities.

Any new company formed to effect FCA's exercise of its equity option will be a Delaware limited liability company unless otherwise agreed to by the parties. As long as each party owns at least 20% of the business, FCA and SC will have equal voting and governance rights without regard to ownership percentage. If either party has an ownership interest in the business of less than 20%, the party with less than 20% ownership will have the right to designate a number of directors proportionate to its ownership and will have other customary minority voting rights.

Because the equity option is exercisable at fair market value, SC could recognize a gain or loss upon exercise if the fair market value is determined to be different from book value. The Company believes that the fair market value of its Chrysler Capital financing business currently exceeds book value and therefore has not recorded a contingent liability for potential loss upon FCA's exercise.

Subsequent to the exercise of the equity option, SC's rights under the Chrysler Agreement would be assigned to the jointly-owned business. Exercise of the equity option would be considered a triggering event requiring re-evaluation of whether or not the remaining unamortized balance of the upfront fee SC paid to FCA on May 1, 2013 should be impaired.

In June 2018, SC announced that it was in exploratory discussions with FCA regarding the future of FCA's U.S. finance operations. FCA has announced its intention to establish a captive U.S. auto finance unit and indicated that acquiring Chrysler Capital is one option it would consider. In July 2018, FCA and the Company entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party in accordance with the Chrysler Agreement until December 31, 2018.

FCA has not delivered a notice to exercise its equity option, and the Company remains committed to the success of the Chrysler Capital business. Although the likelihood, timing and structure of any such transaction, and the likelihood that the Chrysler Agreement will terminate, cannot be reasonably determined, termination of the Chrysler Agreement, or a significant change in the business relationship between SC and FCA, could materially adversely affect SC's and SHUSA's operations, including the origination of receivables through the Chrysler Capital portion of SC's business and the servicing of Chrysler Capital receivables. Moreover, there can be no assurance that SC could successfully or timely implement any such transaction without significant disruption of its operations or restructuring, or without incurring additional liabilities, which could involve significant expense to the Company and have an adverse effect on its business, financial condition and results of operations.


5




Intermediate Holding Company ("IHC")

On July 1, 2016, due to both its global and U.S. non-branch total consolidated asset size, Santander became subject to both of the provisions of the FBO Final Rule discussed below under the "Regulatory Matters" section of Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations (the "MD&A"), of this Form 10-K. As a result of this rule, ownership of several Santander subsidiaries, including Santander BanCorp, BSI, SIS and SSLLC, were transferred to the Company, which became a U.S. intermediate holding company (an "IHC"). On July 1, 2017, an additional Santander subsidiary, Santander Financial Services, Inc. (“SFS”), a finance company located in Puerto Rico, was transferred to SHUSA, and on July 2, 2018, another Santander subsidiary, Santander Asset Management, LLC ("SAM"), an investment adviser located in Puerto Rico, was transferred to SHUSA. Refer to Note 1 to the Consolidated Financial Statements for additional details.

Segments

The Company's reportable segments are focused principally around the customers the Company serves. In 2018, the Company has identified the following reportable segments:

Consumer and Business Banking

The Consumer and Business Banking segment includes the products and services provided to Bank customers, including consumer deposits, business banking, residential mortgage, unsecured lending and investment services. This segment offers a wide range of products and services to consumers and business banking customers, including demand and interest-bearing demand deposit accounts, money market and savings accounts, certificates of deposit ("CDs") and retirement savings products. It also offers lending products such as credit cards, home equity loans and lines of credit, and business loans such as business lines of credit and commercial cards. In addition, the Bank provides investment services to its retail customers, including annuities, mutual funds, and insurance products. Santander Universities, which provides grants and scholarships to universities and colleges as a way to foster education through research, innovation and entrepreneurship, is the last component of this segment.

Commercial Banking

The Commercial Banking segment provides commercial lines, loans, letters of credit, receivables financing and deposits to medium and large commercial customers as well as financing and deposits for government entities, commercial loans to dealers and financing for equipment and commercial vehicles. This segment also provides financing and deposits for government entities and niche product financing for specific industries, including oil and gas, among others. Commercial Banking also includes Commercial Real Estate, which offers commercial real estate loans and multifamily loans to customers.

Corporate and Investment Banking ("CIB")

The CIB segment serves the needs of global commercial and institutional customers by leveraging the international footprint of Santander to provide financing and banking services to corporations with over $500 million in annual revenues. CIB's offerings and strategy are based on Santander's local and global capabilities in wholesale banking.

SC

SC is a specialized consumer finance company focused on vehicle finance and third-party servicing. SC’s primary business is the indirect origination of RICs, principally through manufacturer-franchised dealers in connection with their sale of new and used vehicles to retail consumers. In conjunction with a ten-year private label financing agreement with FCA that became effective May 1, 2013, SC offers a full spectrum of auto financing products and services to FCA customers and dealers under the Chrysler Capital brand. These products and services include consumer RICs and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile, recreational and marine vehicle portfolios for other lenders. In the third quarter of 2015, SC announced that it would exit personal lending, and such assets were accordingly classified as held-for-sale.

SC continues to hold the Bluestem portfolio, which had a carrying balance of approximately $1.1 billion as of December 31, 2018, and remains a party to agreements with Bluestem that includes obligations, among other things, to purchase new advances originated by Bluestem and existing balances on accounts with new advances, for an initial term ending in April 2020 and renewable through April 2022 at Bluestem’s option. Although a third party is being sought to assume this obligation, SC may not be successful in finding such a party, and Bluestem may not agree to the substitution. The Bluestem portfolio continues to be classified as held-for-sale. Significant lower-of-cost-or-market adjustments have been recorded on this portfolio and may continue as long as SC holds the portfolio, particularly due to the purchase commitments.


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SC has entered into a number of intercompany agreements with the Bank. All intercompany revenue and fees between the Bank and SC are eliminated in the consolidated results of the Company.

The financial results for each of these reportable segments are included in Note 23 of the Notes to Consolidated Financial Statements and are discussed in Item 7, "Line of Business Results" within the MD&A section of this Form 10-K. These results have been presented based on the Company's management structure and management accounting practices. The structure and accounting practices are specific to the Company and, as a result, the financial results of the Company's reportable segments are not necessarily comparable with similar information for other financial institutions.

Other

The Other category includes certain immaterial subsidiaries such as BSI, Banco Santander Puerto Rico, SIS, SSLLC, and SFS, the unallocated interest expense on the Company's borrowings and other debt obligations and certain unallocated corporate income and indirect expenses.

Subsidiaries

SHUSA has two principal consolidated majority-owned subsidiaries at December 31, 2018, the Bank and SC.

Employees

At December 31, 2018, the Company had approximately 16,700 employees among its subsidiaries. No Company employees are represented by a collective bargaining agreement.

Competition

The Bank is subject to substantial competition in attracting and retaining deposits and in lending funds. The primary factors in competing for deposits include the ability to offer attractive rates, the convenience of office locations, the availability of alternate channels of distribution, and servicing capabilities. Direct competition for deposits comes primarily from other national, regional, and state banks, thrift institutions, and broker-dealers. Competition for deposits also comes from money market mutual funds, corporate and government securities, and credit unions. The primary factors driving competition for commercial and consumer loans are interest rates, loan origination fees, service levels and the range of products and services offered. Competition for originating loans normally comes from thrift institutions, national and state banks, mortgage bankers, mortgage brokers, finance companies, and insurance companies.

The Company also provides investment management, broker-dealer and private banking services for its clients. We face competition in providing these services from trust companies, full-service banks, asset managers, investment advisors, securities dealers, mutual fund companies, and other financial institutions.

SC is also subject to substantial competition, particularly in the automobile finance industry. SC competes on the pricing it offers on its loans and leases as well as the customer service SC provides automobile dealer customers. SC, along with its competitors, provides pricing and other terms and conditions for loans and leases through web-based credit application aggregation platforms. When dealers submit applications for consumers acquiring vehicles, they can compare SC's terms and conditions against its competitors’ pricing. Dealer relationships are important in the automotive finance industry. Vehicle finance providers tailor product offerings to meet dealers' needs. SC's primary competitors in the vehicle finance space are national and regional banks, credit unions, independent financial institutions, and the affiliated finance companies of automotive manufacturers.

Supervision and Regulation

SHUSA is a bank holding company (“BHC”) pursuant to the Bank Holding Company Act of 1956 (the “BHC Act”). As a BHC, the Company is subject to consolidated supervision by the Federal Reserve. SBNA is a Federal Deposit Insurance Corporation (“FDIC”) insured national bank chartered under the National Bank Act and subject to supervision by the Office of the Comptroller of the Currency (the "OCC"). In addition, the Consumer Financial Protection Bureau (the "CFPB") has oversight over SHUSA, SBNA, and SHUSA’s other non-bank affiliates, including SC, for compliance with federal consumer protection laws.

Refer to the "Regulatory Matters" section within Item 7- MD&A for discussion of current regulatory matters impacting the Company.

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BHC Activity and Acquisition Restrictions

Federal laws restrict the types of activities in which BHCs may engage, and subject them to a range of supervisory requirements, including regulatory enforcement actions for violations of laws and policies. BHCs may engage in the business of banking and managing and controlling banks, as well as closely-related activities.

The Company would be required to obtain approval from the Board of Governors of the Federal Reserve System (the "Federal Reserve") if the Company were to acquire shares of any depository institution or any holding company of a depository institution, or any financial entity that is not a depository institution, such as a lending company.

Control of the Company or the Bank

Under the Change in Bank Control Act, individuals, corporations or other entities acquiring SHUSA's common stock may, alone or together with other investors, be deemed to control the Company and thereby the Bank. Ownership of more than 10% of SHUSA’s capital stock may be deemed to constitute “control” if certain other control factors are present. If deemed to control the Company, those persons or groups would be required to obtain the Federal Reserve's approval to acquire the Company’s common stock and could be subject to certain ongoing reporting procedures and restrictions under federal law and regulations.

Standards for Safety and Soundness

The federal banking agencies adopted certain operational and managerial standards for depository institutions, including internal audit system components, loan documentation requirements, asset growth parameters, information technology and data security practices, and compensation standards for officers, directors and employees.

Insurance of Accounts and Regulation by the FDIC

The Bank is a member of the Deposit Insurance Fund, which is administered by the FDIC. Deposits are insured up to the applicable limits by the FDIC, and such insurance is backed by the full faith and credit of the U.S. government. The FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the Deposit Insurance Fund. The FDIC also has the authority to initiate enforcement actions against banking institutions and may terminate an institution’s deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

The FDIC charges financial institutions deposit premium assessments to ensure it has reserves to cover deposits that are under FDIC-insured limits, which is currently $250,000 per depositor per ownership category for each ownership deposit account category.

FDIC insurance premium expenses were $53.3 million for the year ended December 31, 2018.

In addition to deposit insurance premiums, all insured institutions are required to pay a Financing Corporation assessment to fund the interest on bonds issued to resolve thrift failures in the 1980s. In 2018, the Bank paid Financing Corporation assessments of $2.5 million, compared to $4.0 million in 2017. The annual rate for all insured institutions dropped to $0.014 for every $1,000 in domestic deposits in 2018, compared to $0.046 in 2017. The assessments are revised quarterly and continue until the bonds mature between 2017 and 2019.

In March 2016, the FDIC finalized the rule to implement Section 334 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “DFA") to provide for a surcharge assessment at an annual rate of 4.5 basis points on banks with over $10 billion in assets to increase the FDIC insurance fund. The FDIC commenced this surcharge in the third quarter of 2016, which the FDIC estimated would take approximately two years. Under the rule, if the reserve ratio did not reach 1.35% by December 31, 2018, the FDIC would impose a shortfall assessment on larger depository institutions, including SBNA. The FDIC announced on November 28, 2018 that the reserve ratio had reached 1.35%, which ended the surcharge period.

Restrictions on Subsidiary Banking Institution Capital Distributions

Under the Federal Deposit Insurance Corporation Improvement Act (the “FDIA"), insured depository institutions must be classified in one of five defined tiers (well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized). Under OCC regulations, an institution is considered “well-capitalized” if it (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 8% or greater, (iii) has a common equity Tier 1 ("CET1") capital ratio of 6.5% or greater, (iv) has a Tier 1 leverage ratio of 5% or greater and (v) is not subject to any order or written directive to meet and maintain a specific capital level. As of December 31, 2018, the Bank met the criteria to be classified as “well capitalized.”

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If capital levels fall to significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and, in critically undercapitalized situations, appointment of a receiver or conservator. Critically undercapitalized institutions generally may not, beginning 60 days after becoming critically undercapitalized, make any payment of principal or interest on their subordinated debt. All but well-capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Pursuant to the FDIA and OCC regulations, institutions which are not categorized as well-capitalized or adequately-capitalized are restricted from making capital distributions, which include cash dividends, stock redemptions and repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the institution’s capital account.

Federal banking laws, regulations and policies limit the Bank’s ability to pay dividends and make other distributions to the Company. The Bank must obtain prior OCC approval to declare a dividend or make any other capital distribution if, after such dividend or distribution: (1) the Bank’s total distributions to the Company within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years; (2) the Bank would not meet capital levels imposed by the OCC in connection with any order, or (3) the Bank is not adequately capitalized at the time. In addition, the OCC's prior approval is required if the OCC deems it to be in troubled condition or a problem institution.

Any dividends declared and paid have the effect of reducing the Bank’s Tier 1 capital to average consolidated assets and risk-based capital ratios. The Company paid cash dividends on common stock of $410.0 million in 2018 while $10.0 million in dividends were declared or paid in 2017. The Company returned capital of $12.6 million in 2017, while no capital was returned in 2018.

Federal Reserve Regulation

Under Federal Reserve regulations, the Bank is required to maintain a reserve against its transaction accounts (primarily interest-bearing and non-interest-bearing checking accounts). Because reserves must generally be maintained in cash or in low-interest-bearing accounts, the effect of the reserve requirements is to reduce an institution’s asset yields.

The amount of total reserve requirements at December 31, 2018 and 2017 were $429.0 million and $294.2 million, respectively. At December 31, 2018 and 2017, the Company complied with these reserve requirements.

Federal Home Loan Bank ("FHLB") System

The FHLB system was created in 1932 and consists of 11 regional FHLBs. FHLBs are federally-chartered but privately owned institutions created by Congress. The Federal Housing Finance Agency is an agency of the federal government that is charged with overseeing the FHLBs. Each FHLB is owned by its member institutions. The primary purpose of the FHLBs is to provide funding to their members for making housing loans as well as for affordable housing and community development lending. FHLBs are generally able to make advances to their member institutions at interest rates that are lower than could otherwise be obtained by such institutions. As a member, the Bank is required to make minimum investments in FHLB stock based on its level of borrowings from the FHLB. The Bank is a member of and held investments in the FHLB of Pittsburgh which totaled $230.1 million as of December 31, 2018, compared to $116.1 million at December 31, 2017. The Bank utilizes advances from the FHLB to fund balance sheet growth, provide liquidity and for asset and liability management purposes. The Bank had access to advances with the FHLB of up to $17.7 billion at December 31, 2018, and had outstanding advances of $4.85 billion or 27% of total availability at that date. The level of borrowing capacity the Bank has with the FHLB of Pittsburgh is contingent upon the level of qualified collateral the Bank holds at a given time.

The Bank received $6.6 million and $12.9 million in dividends on its stock in the FHLB of Pittsburgh in 2018 and 2017, respectively.

Anti-Money Laundering and the USA Patriot Act

Several federal laws, including the Bank Secrecy Act, the Money Laundering Control Act, and the USA Patriot Act require all financial institutions to, among other things, implement policies and procedures relating to anti-money laundering, compliance, suspicious activities, currency transaction reporting and due diligence on customers. The USA Patriot Act substantially broadened existing anti-money laundering legislation and the extraterritorial jurisdiction of the U.S., imposed compliance and due diligence obligations, created criminal penalties, compelled the production of documents located both inside and outside the U.S., including those of non-U.S. institutions that have a correspondent relationship in the U.S., and clarified the safe harbor from civil liability to clients. The U.S. Treasury has issued a number of regulations that further clarify the USA Patriot Act’s requirements and provide more specific guidance on their application.

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Financial Privacy

Under the Gramm-Leach-Bliley Act (the "GLBA"), financial institutions are required to disclose to their retail customers their policies and practices with respect to sharing nonpublic customer information with their affiliates and non-affiliates, how they maintain customer confidentiality, and how they secure customer information. Customers are required under the GLBA to be provided with the opportunity to “opt out” of information sharing with non-affiliates, subject to certain exceptions.

Environmental Laws

Environmentally-related hazards are a source of high risk and potentially significant liability for financial institutions related to their loans. Environmentally contaminated properties owned by an institution’s borrowers may result in a drastic reduction in the value of the collateral securing the institution’s loans to such borrowers, high environmental cleanup costs to the borrower affecting its ability to repay its loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean-up costs, and liability to the institution for cleanup costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. To minimize this risk, the Bank may require an environmental examination of, and reports with respect to, the property of any borrower or prospective borrower if circumstances affecting the property indicate a potential for contamination, taking into consideration the potential loss to the institution in relation to the burdens to the borrower. Such examination must be performed by an engineering firm experienced in environmental risk studies and acceptable to the institution, and the costs of such examinations and reports are the responsibility of the borrower. These costs may be substantial and may deter a prospective borrower from entering into a loan transaction with the Bank. The Company is not aware of any borrower which is currently subject to any environmental investigation or clean-up proceeding or any other environmental matter that is likely to have a material adverse effect on the financial condition or results of operations of SHUSA or its subsidiaries.

Securities Regulation

The Company conducts its securities activities through its subsidiaries SIS and SSLLC. SIS and SSLLC are registered broker-dealers with the Securities and Exchange Commission (the “SEC”) and members of the Financial Industry Regulatory Authority, Inc. (“FINRA”). SIS’s activities include investment banking, institutional sales, trading and offering research reports of Latin American and European equity and fixed income securities. SIS, SSLLC and SAM are also registered investment advisers with the SEC, and BSI conducts certain securities transactions exempt from SEC registration on behalf of its clients.

Written Agreements and Regulatory Actions

See the “Regulatory Matters” section of the MD&A and Note 19 of the Consolidated Financial Statements in this Form 10-K for a description of current regulatory actions.

Corporate Information

All reports filed electronically by the Company with the SEC, including the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, as well as any amendments to those reports, are accessible on the SEC’s website at www.sec.gov. Our filings are also accessible through our website at https://www.santanderus.com/us/investorshareholderrelations. The information contained on our website is not being incorporated herein and is provided for the information of the reader and are not intended to be active links.


ITEM 1A - RISK FACTORS

The Company is subject to a number of risks that if realized could materially affect its business, financial condition, results of operations, cash flows and access to liquidity. As a financial services organization, certain elements of risk are inherent in our transactions and are present in the business decisions made by the Company. Accordingly, the Company encounters risk as part of the normal course of its business, and risk management processes are designed to help manage these risks.

Risk management and mitigation are important parts of the Company's business model and integrated into the Company's day-to-day operations. The success of the Company's business is dependent on management's ability to identify, understand, manage and mitigate the risks presented by business activities in light of the Company's strategic and financial objectives. These risks include credit risk, market risk, capital risk, liquidity risk, operational risk, model risk, investment risk, compliance and legal risk, and strategic and reputational risk. We discuss our principal risk management processes in the Risk Management section included in Item 7 of this Report.


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The following are the most significant risk factors that affect the Company. Any one or more of these could have a material adverse impact on the Company's business, financial condition, results of operations, or cash flows, in addition to presenting other possible adverse consequences, many of which are described below. These risk factors and other risks we may face are also discussed further in other sections of this Report.

Macro-Economic and Political Risks

Given that our loan portfolios are concentrated in the United States, adverse changes affecting the economy of the United States could adversely affect our financial condition.

Our loan portfolios are concentrated in the United States. Accordingly, the recoverability of our loan portfolios 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 the United States. A return to recessionary conditions in the United States economy would likely have a significant adverse impact on our loan portfolios and, as a result, on our financial condition, results of operations, and cash flows.

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

Global economic conditions deteriorated significantly between 2007 and 2009, and the United States fell into recession. Many major financial institutions, including some of the country's largest commercial banks, investment banks, mortgage lenders, mortgage guarantors and insurance companies, including us, experienced significant difficulties.

We face, among others, the following risks in the event of an economic downturn or another recession:

Increased regulation of our industry. Compliance with such regulation has increased our costs and may affect the pricing of our products and services and limit our ability to pursue business opportunities.
Reduced demand for our products and services.
Inability of our borrowers to timely or fully comply with their existing obligations.
The process we use to estimate losses inherent in our credit exposure requires complex judgments, including forecasts of economic conditions and how those 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 and lease loss allowances.
The value and liquidity of the portfolio of investment securities that we hold may be adversely affected.
Any worsening of economic conditions may delay the recovery of the financial industry and impact our financial condition and results of operations.
Macroeconomic shocks may impact the household income of our retail customers negatively and adversely affect the recoverability of our retail loans, resulting in increased loan and lease losses. 

Despite the long-term expansion of the U.S. economy, some uncertainty remains regarding U.S. monetary policy and the future economic environment. There can be no assurance that economic conditions will continue to improve. Such economic uncertainty could have an adverse effect on our business and results of operations. A downturn of the economic expansion or failure to sustain 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.

In addition, the global recession and disruption of the financial markets led to concerns over the solvency of certain European countries, affecting those countries’ capital markets access and in some cases sovereign credit ratings, as well as market perception of financial institutions that have significant direct or indirect exposure to these countries. These concerns continue even as the global economy is recovering, and some previously stressed European economies have experienced at least partial recoveries from their low points during the recession. If measures to address sovereign debt and financial sector problems in Europe are inadequate, they may delay or weaken economic recovery, or result in the further exit of member states from the Eurozone or more severe economic and financial conditions. If realized, these risk scenarios could contribute to severe financial market stress or a global recession, likely affecting the economy and capital markets in the United States as well.

Increased disruption and volatility in the 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 decrease in capital markets funding availability or increased costs or in deposit rates could have a material adverse effect on our net interest margins and liquidity.

If some or all of the foregoing risks were to materialize, they could have a material adverse effect on us.

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

While the United States economy has performed well overall, it has experienced volatility in recent periods, characterized by slow or regressive growth. This volatility has resulted in fluctuations in the levels of deposits at depository institutions and in the relative economic strength of various segments of the economy to which we lend.

Negative and fluctuating economic conditions, such as a changing interest rate environment, impact our profitability by causing lending margins to decrease and leading to decreased demand for higher margin products and services. Negative and fluctuating economic conditions 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 on public debt could cause to the banking system as a whole, particularly since commercial banks' exposure to government debt is high in certain Latin American and European 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, international ownership legislation, interest rate caps and tax policies. Growth, asset quality and profitability may be affected by volatile macroeconomic and political conditions.

The actions of the U.S. administration could have a material adverse effect on us.

There is uncertainty about how proposals and initiatives of the current U.S. presidential administration or the broader government could directly or indirectly impact the Company. Although certain proposals and initiatives, such as income tax reform or increased spending on infrastructure projects, could result in greater economic activity and more expansive U.S. domestic economic growth,
other initiatives, such as protectionist trade policies or isolationist foreign policies, could constrict economic growth. The continued uncertainty around these proposals and initiatives, could increase market volatility and affect the Company’s businesses directly or indirectly, including through the effects of such proposals and initiatives on the Company’s customers and/or counterparties.

Developments stemming from the U.K.’s referendum on membership in the EU could have a material adverse effect on us.

Implementing the results of the United Kingdom’s (“UK’s”) referendum on whether to remain part of the European Union (“EU”) has had and may continue to have negative effects on global economic conditions and global financial markets. The UK's decision to withdraw from the EU, and the UK's implementation of that referendum, means that the UK's EU membership will cease. The long-term nature of the UK’s relationship with the EU is unclear (including with respect to the laws and regulations that will apply as the UK determines which EU laws to replicate or replace) and, as negotiations continue, there is considerable uncertainty as to when the framework for any such relationship governing both the access of the UK to European markets and the access of EU member states to the UK’s markets will be determined and implemented. The result of the referendum has created an uncertain political and economic environment in the UK, and may create such environments in other EU member states. While the Company does not maintain a presence in the UK, political and economic uncertainty in countries with significant economies and relationships to the global financial industry have in the past led to declines in market liquidity and activity levels, volatile market conditions, a contraction of available credit, lower or negative interest rates, weaker economic growth and reduced business confidence on an international level, each of which could adversely affect our business. In addition, the Company has been working with its UK affiliates to expand their business; if the UK were to leave the EU, the results of those efforts could be impacted adversely.

Uncertainty regarding the London interbank offered rate (“LIBOR”) may adversely affect our business

The UK Financial Conduct Authority, which regulates LIBOR, announced in July 2017 that it will no longer persuade or require banks to submit rates for the calculation of LIBOR after 2021. This announcement has resulted in uncertainty about the future of LIBOR and other rates used as interest rate “benchmarks,” and suggests that the continuation of LIBOR on the current basis will not be guaranteed after 2021, and that LIBOR could be discontinued or modified by 2021.

If LIBOR ceases to exist, or if new methods of calculating LIBOR are established, interest rates on our loans, deposits, derivatives and other financial instruments tied to LIBOR, as well as revenue and expenses associated with those financial instruments, may be adversely affected, and financial markets relevant to us could be disrupted. We could also incur further legal risks in the event of such changes, as changes to documentation for new and existing transactions may be required, as well as further operations risks due to the potential need to adapt information technology systems, trade reporting infrastructure, and operational processes and controls.

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Risks Relating to Our Business

Legal, Regulatory and Compliance Risks

We are subject to substantial regulation which could adversely affect our business and operations.

As a financial institution, the Company is subject to extensive regulation, which materially affects our businesses. The statutes, regulations, and policies to which the Company is subject may change at any time. In addition, regulators' interpretation and application of the laws and regulations to which the Company is subject may change from time to time. Extensive legislation affecting the financial services industry has been adopted in the United States, and regulations have been and 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. 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 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 affect us adversely.

Regulation of the Company as a BHC includes limitations on permissible activities. Moreover, the Company and the Bank are required to perform stress tests and submit capital plans to the Federal Reserve and the OCC on an annual basis, and receive a notice of non-objection to the plans from the Federal Reserve and the OCC before taking capital actions such as paying dividends, implementing common equity repurchase programs, or redeeming or repurchasing capital instruments. The Federal Reserve may also impose substantial fines and other penalties and enforcement actions for violations we may commit, and has the authority to disallow acquisitions we or our subsidiaries may contemplate, which may limit our future growth plans. Such constraints currently applicable to the Company and its subsidiaries and/or regulatory actions could have an adverse effect on our financial position and results of operations.

Other regulations which significantly affect the Company, or which could significantly affect the Company in the future, relate to capital requirements, liquidity and funding, taxation of the financial sector, and development of regulatory reforms in the United States.

In addition, the volume, granularity, frequency and scale of regulatory and other reporting requirements necessitate a clear data strategy to enable consistent data aggregation, reporting and management. Inadequate management information systems or processes, including those relating to risk data aggregation and risk reporting, could lead to a failure to meet regulatory reporting requirements or other internal or external information demands that may result in supervisory measures.

Significant United States Regulation

From time to time, we are or may become involved in formal and informal reviews, investigations, examinations, proceedings, and information gathering requests by federal and state government agencies, including, among others, the FRB, the OCC, the CFPB, the FDIC, the Department of Justice (the "DOJ"), the SEC, FINRA the Federal Trade Commission and various state regulatory and enforcement agencies.

The DFA will continue to result in significant structural reforms affecting the financial services industry. This legislation provided for, among other things, the establishment of the CFPB with broad authority to regulate the credit, savings, payment and other consumer financial products and services 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 engaging in certain proprietary trading activities, restrictions on ownership of, investment in or sponsorship of hedge funds and private equity funds and restrictions on interchange fees earned through debit card transactions.

The DFA provides for an extensive framework for the regulation of over-the-counter ("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 SEC, the U.S. Commodity Futures Trading Commission (the "CFTC") or both, and are or will be subject to new capital, margin, business conduct, record-keeping, clearing, execution, reporting and other requirements. We may register as a swap dealer with the CFTC.

In February 2014, the Federal Reserve issued the Final Rule to enhance its supervision and regulation of certain FBOs. Among other things, this rule required FBOs, such as the Company, with over $50 billion of United States non-branch assets to establish or designate a United States IHC and to transfer its entire ownership interest in substantially all of its United States subsidiaries to that IHC by July 1, 2016. United States branches and agencies were not required to be transferred to the IHC. As a result of this rule, Santander

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transferred substantially all of its equity interests in its U.S. bank and non-bank subsidiaries previously outside the Company to the Company, which became an IHC effective July 1, 2016. These subsidiaries included Santander BanCorp, BSI, SIS and SSLLC, as well as several other subsidiaries. On July 1, 2017, an additional Santander subsidiary, Santander Financial Services, Inc. (“SFS”), a finance company located in Puerto Rico, was transferred to SHUSA. The IHC is subject to an enhanced supervision framework, including enhanced risk-based and leverage capital requirements, liquidity requirements, risk/management requirements, and stress-testing requirements. A phased-in approach is being used for those standards and requirements. SHUSA's status as an IHC requires it to invest significant management attention and resources.

Within the DFA, the Volcker Rule prohibits “banking entities” from engaging in certain forms of proprietary trading or from sponsoring or investing in covered funds, in each case subject to certain exceptions. The Volcker Rule also limits the ability of banking entities and their affiliates to enter into certain transactions with such funds with which they or their affiliates have certain relationships. The final regulations implementing the Volcker Rule contain exclusions and certain exemptions for market-making, hedging, underwriting, and trading in United States government and agency obligations as well as certain foreign government obligations, and trading solely outside the United States, and also permit certain ownership interests in certain types of funds to be retained.

Our resolution in a bankruptcy proceeding could result in losses for holders of our debt and equity securities.

Under regulations issued by the Federal Reserve and the FDIC, and as required by Section 165(d) of the DFA, we must provide to the Federal Reserve and the FDIC a plan (a “Section 165(d) Resolution Plan”) for our rapid and orderly resolution in the event of material financial distress affecting the Company or the failure of the Company. The purpose of this provision of the DFA is to provide regulators with plans that would enable them to resolve failing financial companies that pose a significant risk to the financial stability of the United States in a manner that mitigates such risk. The most recently filed Section 165(d) Resolution Plan by Santander, dated as of December 31, 2018 (the “2018 Resolution Plan”), provides a roadmap for the orderly resolution of the material U.S. operations of Santander under hypothetical stress scenarios and the failure of one or more of its U.S. material entities (“U.S. MEs”). Material entities are defined as subsidiaries or foreign offices of Santander that are significant to the activities of a critical operation or core business line. The U.S. MEs identified in the 2018 Resolution Plan include, among other entities, the Company, the Bank and SC.

The 2018 Resolution Plan describes a strategy for resolving Santander’s U.S. operations, including its U.S. MEs and the core business lines that operate within those U.S. MEs, in a manner that would substantially mitigate the risk that the resolutions would have serious adverse effects on U.S. or global financial stability. Under the 2018 Resolution Plan’s hypothetical resolutions of the U.S. MEs, the Bank would be placed into FDIC receivership and the Company and SC would be placed into bankruptcy under Chapter 7 and Chapter 11 of the U.S. Bankruptcy Code, respectively.

The strategy described in the 2018 Resolution Plan contemplates a “multiple point of entry” strategy, in which Santander and the Company would each undergo separate resolution proceedings under European regulations and the U.S. Bankruptcy Code, respectively. In a scenario in which the Bank and SC were in resolution, the Company would file a voluntary petition under Chapter 7 of the Bankruptcy Code, and holders of our LTD and other debt securities would be junior to the claims of priority (as determined by statute) and secured creditors of the Company.
The Company, the Federal Reserve and the FDIC are not obligated to follow the Company’s preferred resolution strategy for resolving its U.S. operations under its resolution plan. In addition, Santander could in the future change its resolution strategy for resolving its U.S. operations. In an alternative scenario, the Company alone could enter bankruptcy under the U.S. Bankruptcy Code, and the Company’s subsidiaries would be recapitalized as needed, using assets of the Company, so that they could continue normal operations as going concerns or subsequently be wound down in an orderly manner. As a result, the losses incurred by the Company and its subsidiaries would be imposed first on the holders of the Company’s equity securities and thereafter on unsecured creditors, including holders of our LTD and other debt securities. Holders of our LTD and other debt securities would be junior to the claims of creditors of the Company’s subsidiaries and to the claims of priority (as determined by statute) and secured creditors of the Company. Under either of these scenarios, in a resolution of the Company under Chapter 11 of the U.S. Bankruptcy Code, holders of our LTD and other debt securities would realize value only to the extent available to the Company as a shareholder of the Bank, SC and its other subsidiaries, and only after any claims of priority and secured creditors of the Company have been fully repaid.

The resolution of the Company under the orderly liquidation authority could result in greater losses for holders of our equity and debt securities.

The ability of holders of our LTD and other debt securities to recover the full amount that would otherwise be payable on those securities in a resolution proceeding under Chapter 11 of the U.S. Bankruptcy Code may be impaired by the exercise of the FDIC’s powers under the “orderly liquidation authority” under Title II of the DFA.

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Title II of the DFA created a new resolution regime known as the “orderly liquidation authority” to which financial companies, including U.S. IHC of FBOs with assets of $50 billion or more, such as the Company, can be subjected. Under the orderly liquidation authority, the FDIC may be appointed as receiver to liquidate a financial company if, upon the recommendation of applicable regulators, the United States Secretary of the Treasury determines that the entity is in severe financial distress, the entity’s failure would have serious adverse effects on the U.S. financial system, and resolution under the orderly liquidation authority would avoid or mitigate those effects, among other things. Absent such determinations, the Company would remain subject to the U.S. Bankruptcy Code.

If the FDIC is appointed as receiver under the orderly liquidation authority, then the orderly liquidation authority, rather than the U.S. Bankruptcy Code, would determine the powers of the receiver and the rights and obligations of creditors and other parties who have transacted with the Company. There are substantial differences between the rights available to creditors under the orderly liquidation authority and under the U.S. Bankruptcy Code. For example, under the orderly liquidation authority, the FDIC may disregard the strict priority of creditor claims in some circumstances (which would otherwise be respected under the U.S. Bankruptcy Code), and an administrative claims procedures is used to determine creditors’ claims (as opposed to the judicial procedure utilized in bankruptcy proceedings). Under the orderly liquidation authority, in certain circumstances, the FDIC could elevate the priority of claims if it determines that doing so is necessary to facilitate a smooth and orderly liquidation without the need to obtain the consent of other creditors or prior court review. Furthermore, the FDIC has the right to transfer assets or liabilities of the failed company to a third party or “bridge” entity under the orderly liquidation authority.

Regardless of what resolution strategy Santander might prefer for resolving its U.S. operations, the FDIC could determine that it is a desirable strategy to resolve the Company in a manner that would, among other things, impose losses on the Company’s shareholder, unsecured debtholders (including holders of LTD) and other creditors, while permitting the Company’s subsidiaries to continue to operate. It is likely that the application of such an entry strategy in which the Company would be the only legal entity in the U.S. to enter resolution proceedings would result in greater losses to holders of our LTD and other debt securities than the losses that would result from the application of a bankruptcy proceeding or a different resolution strategy for the Company. Assuming the Company entered resolution proceedings and support from the Company to its subsidiaries was sufficient to enable the subsidiaries to remain solvent, losses at the subsidiary level could be transferred to the Company and ultimately borne by the Company’s securityholders (including holders of our LTD and other debt securities), with the result that third-party creditors of the Company’s subsidiaries would receive full recoveries on their claims, while the Company’s securityholders (including holders of our LTD) and other unsecured creditors could face significant losses. In addition, in a resolution under the orderly liquidation authority, holders of our LTD and other debt securities of the Company could face losses ahead of our other similarly situated creditors if the FDIC exercised its right, to disregard the strict priority of creditor claims described above.

The orderly liquidation authority also requires that creditors and shareholders of the financial company in receivership must bear all losses before taxpayers are exposed to any losses, and amounts owed by the financial company or the receivership to the U.S. government would generally receive a statutory payment priority over the claims of private creditors, including holders of our LTD and other debt securities. In addition, under the orderly liquidation authority, claims of creditors (including holders of our LTD and other debt securities) could be satisfied through the issuance of equity or other securities in a bridge entity to which the Company’s assets are transferred, as described above. If securities were to be delivered in satisfaction of claims, there can be no assurance that the value of the securities of the bridge entity would be sufficient to repay all or any part of the creditor claims for which the securities were exchanged.

Although the FDIC has issued regulations to implement the orderly liquidation authority, not all aspects of how the FDIC might exercise this authority are known, and additional rulemaking is possible.

United States stress testing, capital planning, and related supervisory actions

The Company is subject to stress testing and capital planning requirements under regulations implementing the DFA and other banking laws and policies. Effective January 2017, the Federal Reserve finalized a rule adjusting its capital plan and stress testing rules, exempting from the qualitative portion of the Comprehensive Capital Analysis and Review (“CCAR") certain BHCs and U.S.
IHCs of FBOs with total consolidated assets between $50 billion and $250 billion and total nonbank assets of less than $75 billion, and that are not identified as global systemically important banks. Such firms, including the Company, are still required to meet CCAR’s quantitative requirements and are subject to regular supervisory assessments that examine their capital planning processes. In 2017 and 2018, the Federal Reserve provided its non-objection to SHUSA’s capital plan; however, in 2015 and 2016, the Federal Reserve, as part of its CCAR process, objected on qualitative grounds to the capital plans the Company submitted. There is risk that the Federal Reserve could object to the Company’s future capital plans, which would limit the Company's ability to make capital distributions or take certain capital actions.

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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 institution’s activities. In many 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, certain U.S. subsidiaries’ regulators may advise certain U.S. 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 BHC Act, the Federal Reserve has the authority to disallow us and certain of our U.S. 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 certain of our U.S. 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.

We are subject to potential intervention by any of our regulators or supervisors, particularly in response to customer complaints.

As noted above, our business and operations are subject to increasingly significant rules and regulations relating to the banking and financial services business. These apply to business operations, affect financial returns, include reserve and reporting requirements, and conduct of business regulations. These requirements are set by the relevant central banks and regulatory authorities that authorize, regulate and supervise us in the jurisdictions in which we operate. The relationship between the Company and its customers is also regulated extensively under federal and state consumer protection laws. Among other things, these prohibit unfair, deceptive and abusive trading practices, require disclosures of the cost of credit, provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide financial privacy protections, and restrict our ability to raise interest rates.

In their supervisory roles, regulators seek to maintain the safety and soundness of financial institutions with the aim of strengthening, but not guaranteeing, the protection of customers and the financial system. Supervisors' continuing supervision of financial institutions is conducted through a variety of regulatory tools, including the collection of information by way of reports obtained from skilled persons, visits to firms and regular meetings with management to discuss issues such as performance, risk management and strategy. In general, regulators have an outcome-focused regulatory approach that involves proactive enforcement and penalties for infringement. As a result, we face increased supervisory intrusion and scrutiny (resulting in increasing internal compliance costs and supervision fees), and in the event of a breach of our regulatory obligations we are likely to face more stringent regulatory fines.

Some of the regulators focus strongly on consumer protection and on conduct risk and will continue to do so. This has included a focus on the design and operation of products, the behavior of customers and the operation of markets. Some of the laws in the relevant jurisdictions in which we operate give regulators the power to make temporary product intervention rules either to improve a company's systems and controls in relation to product design, product management and implementation, or address problems identified with financial products. These problems may potentially cause significant detriment to consumers because of certain product features, governance flaws or distribution strategies. Such rules may prevent institutions from entering into product agreements with customers until such problems have been solved. Some regulators in the jurisdictions in which we operate also require us to be in compliance with training, authorization and supervision of personnel, systems, processes and documentation requirements. Sales practices with retail customers, including incentive compensation structures related to such practices, have recently been a focus of various regulatory and governmental agencies. If we fail to be compliant with such regulations, there would be a risk of an adverse impact on our business from sanctions, fines or other actions imposed by regulatory authorities. Customers of financial services institutions, including our customers, may seek redress if they consider that they have suffered loss as a result of the mis-selling of a particular product, or through incorrect application of the terms and conditions of a particular product.

Given the inherent unpredictability of litigation and the evolution of judgments by the relevant authorities, it is possible that an adverse outcome in some matters could harm our reputation or have a material adverse effect on our operating results, financial condition and prospects arising from any penalties imposed or compensation awarded, together with the costs of defending such actions, thereby reducing our profitability.

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

As noted above, 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 reflects an increased supervisory focus on enforcement, combined with uncertainty about the evolution of the regulatory regime, and may lead to material

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operational and compliance costs. In general, amounts financial institutions pay in settlements of regulatory proceedings or investigations and the severity of terms of regulatory settlements have been increasing. In certain cases, regulatory authorities have required criminal pleas, admissions of wrongdoing, limitations on asset growth, managerial changes, and other extraordinary terms as part of such settlements, all of which could have significant economic consequences for a financial institution.

We are subject to civil and tax claims and party to certain legal proceedings incidental to the normal course of our business from time to time, including in connection with 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 when the claimants seek very large or indeterminate damages, or when the cases present novel legal theories, involve a large number of parties or are in the early stages of investigation or 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 established adequate reserves related to the costs anticipated to be incurred in connection with these various claims and legal proceedings. 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 we have currently accrued. As a result, the outcome of a particular matter may materially and adversely affect our financial condition and results of operations 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.

In addition, from time to time, the Company is, or may become, the subject of governmental and self-regulatory agency information-gathering requests, reviews, investigations and proceedings and other forms of regulatory inquiry, including by the SEC and law enforcement authorities.

Often, the announcement or other publication of claims or actions that may arise from such litigation and proceedings or of any related settlement may spur the initiation of similar claims by other clients or governmental entities. In any such claim or action, demands for substantial monetary damages may be asserted against us and may result in financial liability, changes in our business practices or an adverse effect on our reputation or client demand for our products and services. In regulatory settlements since the financial crisis, fines imposed by regulators have increased substantially and may in some cases exceed the profit earned or harm caused by the breach.

Our operations are subject to regular and ongoing inspection by our banking and other regulators, which may result in the need to enhance our regulatory compliance or risk management practices. Such remedial actions may entail significant costs, management attention, and systems development, and such efforts may affect our ability to expand our business until those remedial actions are completed. In some instances, we are subjected to significant legal restrictions on our ability to disclose these types of actions or the full detail of these actions publicly. Our failure to implement enhanced compliance and risk management procedures in a manner and timeframe deemed to be responsive by the applicable regulatory authority could adversely impact our relationship with that regulatory authority and lead to restrictions on our activities or other sanctions.

The magnitude and complexity of projects required to address the expectations of the Company’s regulators’ and legal proceedings, in addition to the challenging macroeconomic environment and pace of regulatory change, may result in execution risk and adversely affect the successful execution of such regulatory or legal priorities.

In many cases, we are required to self-report inappropriate or non-compliant conduct to regulatory authorities, and our failure to do so may represent an independent regulatory violation. Even when we promptly bring matters to the attention of appropriate authorities, we may nonetheless experience regulatory fines, liabilities to clients, harm to our reputation or other adverse effects in connection with self-reported matters.

We may not be able to detect money laundering and other illegal or improper 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 anti-money laundering, anti-terrorism and other laws and regulations in the jurisdictions in which we operate. These laws and regulations require us, among other things, to adopt and enforce “know-your-customer” policies and procedures and to report suspicious and large transactions to applicable regulatory authorities. These laws and regulations have become increasingly complex and detailed, require improved systems and sophisticated monitoring and compliance personnel, and have become the subject of enhanced government supervision.

While we have adopted policies and procedures aimed at detecting and preventing the use of our banking network for money laundering and related activities, those policies and procedures may not completely eliminate instances in which we may be used by other parties to engage in money laundering and other illegal or improper activities. Emerging technologies, such as cryptocurrencies and blockchain, could limit our ability to track the movement of funds. Our ability to comply with legal requirements depends on our ability to improve detection and reporting capabilities and reduce variation in control processes and oversight accountability.

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These require implementing and embedding effective controls and monitoring within our business and on-going changes to systems and operations. Financial crime is continually evolving and subject to increasingly stringent regulatory oversight and focus. Even known threats can never be fully eliminated, and there will be instances in which we may be used by other parties to engage in money laundering or other illegal or improper activities. To the extent we fail to fully comply with applicable laws and regulations, the relevant government agencies to which we report have the authority to impose fines and other penalties on us. In addition, our business and reputation could suffer if customers use our banking network for money laundering or other illegal or improper purposes.

While we review our relevant counterparties’ internal policies and procedures with respect to such matters, to a large degree we rely on our 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 counterparties’ services as conduits for money laundering (including illegal cash operations) or other illegal activities without our and our counterparties’ knowledge. If we are associated with, or even accused of being associated with, or become a party to, money laundering or other illegal activities, our reputation could suffer and/or we could become subject to fines, sanctions and/or legal enforcement (including being added to any “blacklists” 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.

An incorrect interpretation of tax laws and regulations may adversely affect 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 the United States 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 judgments, estimates, and assumptions we use in preparing our tax returns are subsequently found to be incorrect, there could be a material effect on our results of operations.

In addition, if the Company does not obtain ownership of 80% or more of SC Common Stock, the tax and other potential benefits described in Item 1 “Business - General” above may not be realized.

Changes in taxes and other assessments may adversely affect us.

The legislatures and tax authorities in the 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. Aspects of recent U.S. federal income tax reform such as the Tax Cuts and Jobs Act of 2017 limit or eliminate certain income tax deductions, including the home mortgage interest deduction and the deduction of interest on home equity loans. These limitations and eliminations could adversely affect demand for some of our retail banking products and the valuation of assets securing certain of our loans.

Credit Risks

If the level of our non-performing loans ("NPLs") increases or our credit quality deteriorates in the future, or if our loan and lease loss reserves are insufficient to cover loan and lease 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 negatively impacted and can continue to
negatively impact our results of operations. In particular, the amount of our reported NPLs may increase in the future as a result of growth in our total loan portfolio, including as a result of loan portfolios 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 the United States, the impact of political events, events affecting certain industries or events affecting financial markets. There can be no assurance that we will be able to effectively control the level of the NPLs in our loan portfolio.

Our loan and lease 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 last 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 there can be no assurance

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that our current or future loan and lease 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 an increase in lending to individuals and small and medium enterprises, a volume increase in our credit card portfolio or the introduction of new products, or if future actual losses exceed our estimates of incurred losses, we may be required to increase our loan and lease 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 also could have a material adverse effect on us.

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 low interest rate environment, prepayment activity increases, and this reduces the weighted average life 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 in our commercial activity, and an increase in prepayments could have a material adverse effect on us.

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

The value of the collateral securing our loan portfolio may fluctuate or decline due to factors beyond our control, including macroeconomic factors affecting the United States. The value of the collateral securing our loan portfolio may be adversely affected by force majeure events such as natural disasters, particularly in locations in which 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 have an adverse impact on the economy of the affected region. We also may not have sufficiently recent information on the value of collateral, which may result in an inaccurate assessment of 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 on our loans, which may materially and adversely affect our results of operations and financial condition.

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 derivatives contracts under which counterparties have obligations to make payments to us or executing securities, futures, currency or commodity trades that fail to settle at the required time due to non-delivery by the counterparty or systems failure by clearing agents, clearinghouses 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. We rely on information provided by or on behalf of counterparties, such as financial statements, and we may rely on representations of our counterparties as to the accuracy and completeness of that information. 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 routine transactions we enter into expose us to significant credit risk in the event of default by one of our significant counterparties.

Liquidity and Financing Risks

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 become 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 these risks completely. Adverse and continued constraints in the supply of liquidity, including inter-bank lending, may materially and adversely affect the cost of funding our business, and extreme liquidity constraints may affect our current operations and our ability to fulfill regulatory liquidity requirements as well as limit growth possibilities.


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Our cost of obtaining funding is directly related to prevailing market interest rates and 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 be 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 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 depositors in the economy in general, and the financial services industry in particular, as well as competition among banks for deposits. Any of these factors could significantly increase the amount of deposit withdrawals in a short period of time, thereby reducing our ability to access deposit funding in the future on appropriate terms, or at all. If these circumstances were to arise, they could have a material adverse effect on our operating results, financial condition and prospects.

We anticipate that our customers will continue to make deposits (particularly demand deposits and short-term time deposits) in the near future, and we intend to maintain our emphasis on the use of banking deposits as a source of funds. The short-term nature of some deposits 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.

There can be no assurance 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.

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.

Any downgrade in our or Santander's debt credit ratings would likely increase our borrowing costs and require us to post additional collateral or take other actions under some of our derivatives 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 customers, particularly customers who need a minimum rating threshold in order to invest. In addition, under the terms of certain of our derivatives contracts, we may be required to maintain a minimum credit rating or terminate the 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.

We conduct a significant number of our material derivatives activities through Santander and Santander UK. We estimate that, as of December 31, 2018, if all of the rating agencies were to downgrade Santander’s or Santander UK’s long-term senior debt ratings, we would be required to post additional collateral pursuant to derivatives and other financial contracts. Refer to further discussion in Note 14 of the Notes to the Consolidated Financial Statements.

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 on numerous dynamic, complex and inter-related factors and assumptions, including market conditions at the time of any downgrade, whether any downgrade of a company's 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 on 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 the Company, the Bank, and SC.


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

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

Market Risks

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 rates, exchange rates or equity prices. Changes in interest rates affect the following areas, of our business, among others:

net interest income;
the volume of loans originated;
the market value of our securities holdings;
the value of our loans and deposits;
gains from sales of loans and securities; and
gains and losses from derivatives.

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. Variations in interest rates could affect our net interest income, which comprises the majority of our revenue, reducing our growth rate and potentially resulting in losses. This is a result of the different effect a change in interest rates may have on the interest earned on our assets and the interest paid on our borrowings. In addition, we may incur costs (which, in turn, will impact our results) as we implement strategies to reduce future interest rate exposure.

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.

In addition, we may experience increased delinquencies in a low interest rate environment when such an environment is accompanied by high unemployment and recessionary conditions.

We are 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.

Some of our investment management services fees are based on financial market valuations of assets certain of our subsidiaries manage or hold in custody for clients. Changes in these valuations can affect noninterest income positively or negatively, and ultimately affect our financial results. Significant changes in the volume of activity in the capital markets, and in the number of assignments we are awarded, could also affect our financial results.

We are also exposed to equity price risk in our 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 economic uncertainty and sovereign debt concerns has had a particularly strong impact on the financial sector. Continued volatility may affect the value of our investments in equity securities and, depending on their fair value and future recovery expectations, could become a permanent impairment which would be subject to write-offs against our results. To the extent any of these risks materialize, our net interest income and the market value of our assets and liabilities could be materially adversely affected.

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 recent years, financial markets have been subject to volatility and the resulting widening of credit spreads. We have material exposures to securities and other investments that are recorded at fair value and are therefore exposed to potential negative fair value

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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 also may translate into increased impairments. In addition, the value we ultimately realize on
disposal of the asset may be lower than its 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 and prospects.

In addition, to the extent 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 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. In addition, valuation models are complex, making them inherently imperfect predictors of actual results. Any resulting impairments or write-downs could have a material adverse effect on our operating results, financial condition and prospects.

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

We enter into derivatives 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).

The execution and performance of derivatives transactions depend 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 derivatives transactions continues to depend, to a great extent, on our information technology ("IT") systems. These factors further increase the risks associated with these transactions and could have a material adverse effect on us.

In addition, disputes with counterparties may arise regarding the terms or the settlement procedures of derivatives contracts, including with respect to the value of underlying collateral, which could cause us to incur unexpected costs, including transaction, operational, legal and litigation costs, or result in credit losses, all of which may impair our ability to manage our risk exposure from these products.

Risk Management

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. Although 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.

We rely on quantitative models to measure risks and estimate certain financial values. Models may be used in such processes as determining the pricing of various products, grading loans and extending credit, measuring interest rate and other market risks, predicting losses, assessing capital adequacy, and calculating economic and regulatory capital levels, as well as estimating the value of financial instruments and balance sheet items. Poorly designed or implemented models present the risk that our business decisions based on information incorporating models will be adversely affected due to the inadequacy of that information. Also, information we provide to the public or our regulators based on poorly designed or implemented models could be inaccurate or misleading.

Some of our qualitative tools and metrics for managing risk are based on 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 therefore could be significantly greater than the historical measures indicate. In addition, our quantified modeling does not take all risks into account. Our more qualitative approach to managing those risks could prove insufficient, exposing us to material unanticipated losses. We could face adverse consequences as a result of decisions based on models that are poorly developed, implemented, or used, or as a result of a modeled outcome being misunderstood or used of for purposes for which it was not designed. In addition, if existing or potential customers believe our risk management is inadequate, they could take their business elsewhere or seek to limit transactions with us. This could have a material adverse effect on our reputation, operating results, financial condition, and prospects.

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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 is to employ an internal credit rating system to assess the particular risk profile of a customer. Since this process involves detailed analyses of the customer, taking into account both quantitative and qualitative factors, it is subject to human and IT systems errors. In exercising their judgment on the current and future credit risk of our customers, our employees may not always assign an accurate credit rating, which may result in our exposure to higher credit risks than indicated by our risk rating system.

We have been refining 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 all possible risks before they occur or, due to limited tools available to us, our employees may not be able to implement them effectively, 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 NPLs and a higher risk exposure for us, which could have a material adverse effect on us.

General Business and Industry Risks

The financial problems our customers face could adversely affect us.

Market turmoil and economic recession could materially and adversely affect the liquidity, businesses and/or financial condition of our borrowers, which could in turn increase our NPL ratios, impair our loan and other financial assets and result in decreased demand for borrowings in general. In addition, our customers may further decrease their risk tolerance to non-deposit investments such as stocks, bonds and mutual funds significantly, which would adversely affect our fee and commission income. Any of the conditions described above could have a material adverse effect on our business, financial condition and results of operations.

We depend in part upon dividends and other funds from subsidiaries.

Some of our operations are conducted through our 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 pay dividends to us. Payment of dividends, distributions and advances by our subsidiaries will be contingent on our subsidiaries’ earnings and business considerations, and are limited by legal and regulatory 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.

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

We face substantial competition in all parts of our business from numerous banks and non-bank providers of financial services, including in originating loans and attracting deposits, and we expect competitive conditions to continue to intensify. Our 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.

There has been a trend towards consolidation in the banking industry, which has created larger and stronger banks with which we must now compete. Some of our competitors are substantially larger than we are, which may give those competitors advantages such as a more diversified product and customer base, the ability to reach more customers and potential customers, operational efficiencies, lower-cost funding and larger branch networks. Many competitors are also focused on cross-selling their products, which could affect our ability to maintain or grow existing customer relationships or require us to offer lower interest rates or fees on our lending products or higher interest rates on deposits. There can be no assurance that 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. These non-traditional providers of banking services currently have an advantage over traditional providers because they are not subject to the same regulatory or legislative requirements to which we are subject. 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.


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New competitors may enter the market or existing competitors may adjust their services with unique product or service offerings or approaches to providing banking services. If we are unable to successfully compete with current and new competitors, or if we are unable to anticipate and adapt our offerings to changing banking industry trends, including technological changes, our business may be adversely affected. In addition, our failure to effectively anticipate or adapt to emerging technologies or changes in customer behavior, including among younger customers, could delay or prevent our access to new digital-based markets, which would in turn have an adverse effect on our competitive position and business. Furthermore, the widespread adoption of new technologies, including cryptocurrencies and payment systems, could require substantial expenditures to modify or adapt our existing products and services as we continue to grow our internet and mobile banking capabilities. Our customers may choose to conduct business or offer products in areas that may be considered speculative or risky. Such new technologies and the rise in customer use of internet and mobile banking platforms in recent years could negatively impact our investments in bank premises, equipment and personnel for our branch network. The persistence or acceleration of this shift in demand towards internet and mobile banking may necessitate changes to our retail distribution strategy, which may include closing and/or selling certain branches and restructuring our remaining branches and workforce. These actions could lead to losses on these assets and increased expenditures to renovate, reconfigure or close a number
of our remaining branches or otherwise reform our retail distribution channel. Furthermore, our failure to keep pace with innovation or to swiftly and effectively implement such changes to our distribution strategy could have an adverse effect on our competitive position.

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

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

The success of our operations and our profitability depend, 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 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.

The introduction of new products and services can entail significant time and resources, including regulatory approvals. Substantial risks and uncertainties are associated with the introduction of new products and services, including technical and control requirements that may need to be developed and implemented, rapid technological change in the industry, our ability to access technical and other information from our clients and the significant and ongoing investments required to bring new products and services to market in
a timely manner at competitive prices. Our failure to manage these risks and uncertainties also exposes us to the enhanced risk of operational lapses, which may result in the recognition of financial statement liabilities. Regulatory and internal control requirements, capital requirements, competitive alternatives, vendor relationships and shifting market preferences may also determine whether initiatives can be brought to market in a manner that is timely and attractive to our clients. Failure to manage these risks in the development and implementation of new products or services successfully could have a material adverse effect on our business and reputation, as well as on our consolidated results of operations and financial condition.

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 in which 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 adequate to enable us to handle or manage such risks properly. 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.


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

We cannot ensure 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;
align our current IT systems adequately with those of an enlarged group;
apply our risk management policies 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 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.

Goodwill impairments may be required in relation to acquired businesses.

We have made business acquisitions for which it is possible that the goodwill which has been attributed to those businesses may have to be written down if our valuation assumptions are required to be reassessed as a result of any deterioration in the business’ underlying profitability, asset quality or other relevant matters. Impairment testing with respect to goodwill is performed annually, more frequently if impairment indicators are present, and includes a comparison of the carrying amount of the reporting unit with its fair value. If the carrying value of the reporting unit is higher than the fair value, the impairment is measured as this excess of carrying value over fair value. We recognized a $10.5 million impairment of goodwill in 2017 primarily due to the unfavorable economic environment in Puerto Rico and the additional adverse effect of Hurricane Maria. We did not recognize any impairments of goodwill in 2016. It is reasonably possible we may be required to record impairment of $4.5 billion of goodwill attributable to SC and SBNA in the future. There can be no assurance that we will not have to write down the value attributed to goodwill further in the future, which would not impact risk-based capital ratios adversely, but would adversely affect our results of operations and stockholder's equity.

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.

The financial industry in the United States has experienced 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. In addition, due to our relationship with Santander, we are subject to indirect regulation by the European Central Bank, which has recently imposed compensation restrictions that may apply to certain of our executive officers and other employees under the Capital Requirements Directive IV prudential rules. These restrictions may impact our ability to retain our experienced management team and key employees and our ability to attract appropriately qualified personnel, which could have a material adverse impact on our business, financial condition, and results of operations.

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 those 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, which could lead to reputational damage and regulatory investigations and intervention. Replacing these third-party vendors could also entail significant delays and expense. Further, the operational and regulatory risk we face as a result of these arrangements may be increased to the extent that we restructure them.  Any restructuring could involve significant expense to us and entail significant delivery and execution risk, which could have a material adverse effect on our business, financial condition and operations.


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If a third party obtains access to our customer information and that third party experiences a cyberattack or breach of its systems, this could result in several negative outcomes for us, including losses from fraudulent transactions, potential legal and regulatory liability and associated damages, penalties and restitution, increased operational costs to remediate the consequences of the third party’s security breach, and harm to our reputation from the perception that our systems or third-party systems or services that we rely on may not be secure.

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 and conducting business transactions with our counterparties. Damage to our reputation can therefore cause significant harm to our business and prospects. Harm to our reputation can arise from numerous sources including, among others, employee misconduct, litigation or regulatory outcomes, failure to deliver minimum standards of service and quality, dealing with sectors that are not well perceived by the public (e.g., weapons industries), dealing with customers on sanctions lists, ratings downgrades, compliance failures, unethical
behavior, and the activities of customers and counterparties. Further, adverse publicity, regulatory actions or fines, litigation, operational failures or the failure to meet client expectations or other obligations could materially and adversely affect our reputation, our ability to attract and retain clients or our sources of funding for the same or other businesses.

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 have caused public perception of us and others in the financial services industry to decline.

Preserving and enhancing our reputation also depends on maintaining systems, procedures and controls that address known risks and regulatory requirements, as well as our ability to timely identify, understand and mitigate additional risks that arise due to changes in our businesses and the markets in which we operate, the regulatory environment and customer expectations.

We could suffer significant reputational harm if we fail to identify and manage potential conflicts of interest properly. 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.

Fraudulent activity associated with our products or networks could cause us to suffer reputational damage, the use of our products to decrease and our fraud losses to be materially adversely affected. We are subject to the risk of fraudulent activity associated with merchants, customers and other third parties handling customer information. The risk of fraud continues to increase for the financial services industry in general. Credit and debit card fraud, identity theft and related crimes are prevalent, and perpetrators are growing more sophisticated. Our resources, customer authentication methods and fraud prevention tools may not be sufficient to accurately predict or prevent fraud. Additionally, our fraud risk continues to increase as third parties that handle confidential consumer information suffer security breaches and we expand our direct banking business and introduce new products and features. Our financial condition, the level of our fraud charge-offs and other results of operations could be materially adversely affected if fraudulent activity were to increase significantly. High-profile fraudulent activity could negatively impact our brand and reputation. In addition, significant increases in fraudulent activity could lead to regulatory intervention and reputational and financial damage to our brands, which could negatively impact the use of our products and services and have a material adverse effect on our business.

The Bank engages in transactions with its subsidiaries or affiliates that others may not consider to be on an arm’s-length basis.

The Bank and its subsidiaries have entered into a number of services agreements pursuant to which we render services, such as administrative, accounting, finance, treasury, legal services and others.

United States law applicable to certain financial institutions, including the Bank and other Santander entities and offices in the U.S., establish several procedures designed to ensure that the transactions entered into with or among our subsidiaries and/or affiliates do not deviate from prevailing market conditions for those types of transactions.

The Bank and its affiliates are likely to continue to engage in transactions with their respective affiliates. Future conflicts of interests among our affiliates may arise, which conflicts are not required to be and may not be resolved in SHUSA's favor.



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Our business and financial performance could be adversely affected, directly or indirectly, by disasters, natural or otherwise, terrorist activities or international hostilities.

Neither the occurrence nor potential impact of disasters (such as earthquakes, hurricanes, tornadoes, floods and other severe weather conditions, pandemics, dislocations, fires, explosions, or other catastrophic accidents or events), terrorist activities or international hostilities can be predicted. However, these occurrences could impact us directly (for example, by causing significant damage to our facilities or preventing us from conducting our business in the ordinary course), or indirectly as a result of their impact on our borrowers, depositors, other customers, suppliers or other counterparties. We could also suffer adverse consequences to the extent that disasters, terrorist activities or international hostilities affect the financial markets or the economy in general or in any particular region. These types of impacts could lead, for example, to an increase in delinquencies, bankruptcies and defaults that could result in our experiencing higher levels of nonperforming assets, net charge-offs and provisions for credit losses.

Our ability to mitigate the adverse consequences of such occurrences is in part dependent on the quality of our resiliency planning and our ability to anticipate the nature of any such event that may occur. The adverse impact of disasters, terrorist activities or international hostilities also could be increased to the extent that there is a lack of preparedness on the part of national or regional emergency responders or on the part of other organizations and businesses with which we deal.

Technology and Cybersecurity Risks

Any failure to effectively improve or upgrade our IT 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 IT on a timely and cost-effective basis. We must continually make significant investments and improvements in our IT infrastructure in order to remain competitive. There can be no assurance that we will be able to maintain the level of capital expenditures necessary to support the improvement or upgrading of our IT infrastructure in the future. Any failure to improve or upgrade our IT infrastructure and management information systems effectively and in a timely manner could have a material adverse effect on us.

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

Like other financial institutions with a large customer base, we have been subject to and are likely to continue to be the subject of attempted cyberattacks in light of the fact that we manage and hold confidential personal information of customers in the conduct of our banking operations, as well as a large number of assets. Our business depends on the ability to process a large number of transactions efficiently and accurately, and on our ability to rely on our digital technologies, computer and e-mail services, spreadsheets, 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 controls, accounting and other data collection and processing systems is critical to our businesses and our ability to compete effectively. Losses can result from inadequate personnel, inadequate or failed internal control processes and systems, or external events that interrupt normal business operations. We also face the risk that the design of our controls and procedures proves to be inadequate or is circumvented. Although we work with our clients, vendors, service providers, counterparties and other third parties to develop secure transmission capabilities and prevent information security risk, we routinely exchange personal, confidential and proprietary information by electronic means, which may be a target for attempted cyberattacks.

Many companies across the country and in the financial services industry have reported significant breaches in the security of their websites or other systems. Cybersecurity risks have increased significantly in recent years due to the development and proliferation of new technologies, increased use of the internet and telecommunications technology to conduct financial transactions, and increased sophistication and activities of organized crime groups, state-sponsored and individual hackers, terrorist organizations, disgruntled employees and vendors, activists and other third parties. Financial institutions, the government and retailers have in recent years reported cyber incidents that compromised data, resulted in the theft of funds or the theft or destruction of corporate information and other assets.

We take protective measures and continuously monitor and develop our systems to protect our technology infrastructure and data from misappropriation or corruption. We have policies, practices and controls designed to prevent or limit disruptions to our systems and enhance the security of our infrastructure. These include performing risk management for information systems that store, transmit or process information assets identifying and managing risks to information assets managed by third-party service providers through
on-going oversight and auditing of the service providers’ operations and controls. We develop controls regarding user access to software on the principle that access is forbidden to a system unless expressly permitted, limited to the minimum amount necessary for business purposes, and terminated promptly when access is no longer required. We seek to educate and make our employees aware of information security and privacy controls and their specific responsibilities on an ongoing basis.

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Nevertheless, while we have not experienced any material losses or other material consequences relating to cyberattacks or other information or security breaches, whether directed at us or third parties, our systems, software and networks, as well as those of our clients, vendors, service providers, counterparties and other third parties, may be vulnerable to unauthorized access, misuse, computer viruses or other malicious code, cyberattacks such as denial of service, malware, ransomware, phishing, and other events that could result in security breaches or give rise to the manipulation or loss of significant amounts of customer data and other sensitive information, disrupt, sabotage or degrade service on our systems, or result in the theft or loss of significant levels of liquid assets, including cash. As cybersecurity threats continue to evolve and increase in sophistication, we cannot guarantee the effectiveness of our policies, practices and controls to protect against all such circumstances that could result in disruptions to our systems. This is because, among other reasons, the techniques used in cyberattacks change frequently, cyberattacks can originate from a wide variety of sources, and third parties may seek to gain access to our systems either directly or by using equipment or passwords belonging to employees, customers, third-party service providers or other authorized users of our systems. In the event of a cyberattack or security breach affecting a vendor or other third party entity on whom we rely, our ability to conduct business, and the security of our customer information, could be impaired in a manner to that of a cyberattack or security breach affecting us directly. We also may not receive information or notice of the breach in a timely manner, or we may have limited options to influence how and when the cyberattack or security breach is addressed.

As financial institutions are becoming increasingly interconnected with central agents, exchanges and clearinghouses, they may be increasingly susceptible to negative consequences of cyberattacks and security breaches affecting the systems of such third parties. It could take a significant amount of time for a cyberattack to be investigated, during which time we may not be in a position to fully understand and remediate the attack, and certain errors or actions could be repeated or compounded before they are discovered and remediated, any or all of which could further increase the costs and consequences associated with a particular cyberattack. The perception of a security breach affecting us or any part of the financial services industry, whether correct or not, could result in a loss of confidence in our cybersecurity measures or otherwise damage our reputation with customers and third parties with whom we do business. Should such adverse events occur, we may not have indemnification or other protection from the third party sufficient to compensate or protect us from the consequences.

As attempted cyberattacks continue to evolve in scope and sophistication, we may incur significant costs in our attempts to modify or enhance our protective measures against such attacks to investigate or remediate any vulnerability or resulting breach, or in communicating cyberattacks to our customers. 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 or a cyberattack could result in our inability to recover or restore data that has been stolen, manipulated or destroyed, damage to our systems and those of our clients, customers and counterparties, violations of applicable privacy and other laws, or other significant disruption of operations, including disruptions in our ability to use our accounting, deposit, loan and other systems and our ability to communicate with and perform transactions with customers, vendors and other parties. These effects could be exacerbated if we would need to shut down portions of our technology infrastructure temporarily to address a cyberattack, if our technology infrastructure is not sufficiently redundant to meet our business needs while an aspect of our technology is compromised, or if a technological or other solution to a cyberattack is slow to be developed. Even if we timely resolve the technological issues in a cyberattack, a temporary disruption in our operations could adversely affect customer satisfaction and behavior, expose us to reputational damage, contractual claims, supervisory actions, or litigation.

U.S. banking agencies and other federal and state government agencies have increased their attention on cybersecurity and data privacy risks, and have proposed enhanced risk management standards that would apply to us. Such legislation and regulations relating to cybersecurity and data privacy may require that we modify systems, change service providers, or alter business practices or policies regarding information security, handling of data and privacy. Changes such as these could subject us to heightened operational costs. To the extent we do not successfully meet supervisory standards pertaining to cybersecurity, we could be subject to supervisory actions, litigation and reputational damage.

Financial Reporting and Control Risks

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.

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For example, as noted in Note 2 to the Consolidated Financial Statements in this Form 10-K, in June 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. Effective January 1, 2020, this will substantially change accounting for credit losses on loans and other financial assets banks, financial institutions and other organizations hold. This standard will replace existing incurred loss impairment guidance and establish a single allowance framework for financial assets carried at amortized cost. Upon adoption of ASU 2016-13, companies must recognize credit losses on these assets equal to management’s estimate of credit losses over the assets’ full remaining expected lives. Companies must consider all relevant information when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts. In December 2018, the Federal Reserve, the OCC and the FDIC revised their regulatory capital rules to address this upcoming change to the treatment of credit expense and allowances. The final rule provides an optional three-year phase-in period for the Day One adverse regulatory capital effects upon adopting this standard. The impact of the final rule on the Company and the Bank will depend in part on whether we elect to phase in the impact of the standard over a three-year period. The standard is likely to have a negative impact, potentially materially, to the allowance and capital upon adoption in 2020; however, we are still evaluating its anticipated impact. It is also possible that our ongoing reported earnings and lending activity will be negatively impacted in periods following adoption of this ASU.

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 consolidated financial statements in conformity with GAAP requires management to make judgments, estimates and assumptions that affect our Consolidated Financial Statements and accompanying notes. 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 and provisions for liabilities.

The allowance for credit losses ("ACL") is a significant critical estimate. Due to the inherent nature of this estimate, we cannot provide assurance that the Company will not significantly increase the ACL or sustain credit losses that are significantly higher than the provided allowance.

The valuation of financial instruments measured at fair value can be subjective, in particular when models are used which include unobservable inputs. Given the uncertainty and subjectivity associated with valuing such instruments it is possible that the results of our operations and financial position could be materially misstated if the estimates and assumptions used prove inaccurate.

If the judgments, 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.

Disclosure controls and procedures over financial reporting and internal controls over financial reporting may not prevent or detect all errors or acts of fraud, and lapses in these controls could materially and adversely affect our operations, liquidity and/or reputation.

Disclosure controls and procedures over financial reporting are designed to provide reasonable assurance that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We also maintain a system of internal controls over financial reporting. However, these controls may not achieve, and in some cases have not achieved, their intended objectives. Control processes that involve human diligence and compliance, such as our disclosure controls and procedures and internal controls over financial reporting, are subject to lapses in judgement and breakdowns resulting from human failures. Controls can be circumvented by collusion or improper management override. Because of these limitations, there are risks that material misstatements due to error or fraud may not be prevented or detected, and that information may not be reported on a timely basis.

We have identified control deficiencies in our financial reporting process and for which remediation was still in process as of December 31, 2018. These control deficiencies contributed to the restatement of the audited Consolidated Financial Statements in our Form 10-K for the year ended December 31, 2015 and the unaudited financial statements included in certain of our previously

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filed Quarterly Reports on Form 10-Q. See Part II, Item 9A in this Form 10-K. We have initiated certain measures, including increasing the number of employees on, and the expertise of, our financial reporting team, and the enhancement of our model risk management framework and documentation process to remediate these weaknesses, and plan to implement additional appropriate measures as part of this effort. There can be no assurance that we will be able to fully remediate our existing material weaknesses. Further, there can be no assurance that we will not suffer from other material weaknesses in the future. If we fail to remediate these material weaknesses or fail to otherwise maintain effective internal controls over financial reporting in the future, such failure could result in a material misstatement of our annual or quarterly financial statements that would not be prevented or detected on a timely basis and which could cause investors and other users to lose confidence in our financial statements and limit our ability to raise capital. Additionally, failure to remediate the material weaknesses or otherwise failing to maintain effective internal controls over financial reporting may negatively impact our operating results and financial condition, impair our ability to timely file our periodic reports with the SEC, subject us to additional litigation and regulatory actions and cause us to incur substantial additional costs in future periods relating to the implementation of remedial measures.

Failure to satisfy obligations associated with public securities filings may have adverse regulatory, economic, and reputational consequences.

We filed our Annual Report on Form 10-K for 2015 and certain Quarterly Reports on Form 10-Q in 2016 after the time periods prescribed by the SEC’s regulations. Those failures to file our periodic reports within the time periods prescribed by the SEC, among other consequences, resulted in the suspension of our eligibility to use Form S-3 registration statements until we timely filed our SEC periodic reports for a period of 12 months. We timely filed our SEC periodic reports for 12 consecutive months as of November 13, 2017. If in the future we are not able to file our periodic reports within the time periods prescribed by the SEC, among other consequences, we would be unable to use Form S-3 registration statements until we have timely filed our SEC periodic reports for a period of 12 consecutive months. Our inability to use Form S-3 registration statements would increase the time and resources we need to spend if we choose to access the public capital markets.

Risks Associated with our Majority-Owned Consolidated Subsidiary

The financial results of SC could have a negative impact on the Company's operating results and financial condition.

SC historically has provided a significant source of funding to the Company through earnings. Our investment in SC involves risk, including the possibility that poor operating results of SC could negatively affect the operating results of SHUSA.

Factors that affect the financial results of SC in addition to those which have been previously addressed include, but are not limited to:
Periods of economic slowdown may result in decreased demand for automobiles as well as declining values of automobiles and other consumer products used as collateral to secure outstanding loans. Higher gasoline prices, the general availability of consumer credit, and other factors which impact consumer confidence could increase loss frequency and decrease consumer demand for automobiles. In addition, during an economic slowdown, servicing costs may increase without a corresponding increase in finance charge income. Changes in the economy may impact the collateral value of repossessed automobiles and repossession, and foreclosure sales may not yield sufficient proceeds to repay the receivables in full and result in losses.
SC’s growth strategy is subject to significant risks, some of which are outside its control, including general economic conditions, the ability to obtain adequate financing for growth, laws and regulatory environments in the states in which the business seeks to operate, competition in new markets, the ability to attract new customers, the ability to recruit qualified personnel, and the ability to obtain and maintain all required approvals, permits, and licenses on a timely basis
SC’s business may be negatively impacted if it is unsuccessful in developing and maintaining relationships with automobile dealerships that correlate to SC’s ability to acquire loans and automotive leases. In addition, economic downturns may result in the closure of dealerships and corresponding decreases in sales and loan volumes.
SC's business could be negatively impacted if it is unsuccessful in developing and maintaining its serviced for others portfolio. As this is a significant and growing portion of SC's business strategy, if an institution for which SC currently services assets chooses to terminate SC's rights as a servicer or if SC fails to add additional institutions or portfolios to its servicing platform, SC may not achieve the desired revenue or income from this platform.
SC has repurchase obligations in its capacity as a servicer in securitizations and whole loan sales. If significant repurchases of assets or other payments are required under its responsibility as a servicer, this could have a material adverse effect on SC’s financial condition, results of operations, and liquidity.
The obligations associated with being a public company require significant resources and management attention, which increases the costs of SC's operations and may divert focus from business operations. As a result of its initial public offering ("IPO"), SC is now required to remain in compliance with the reporting requirements of the SEC and the NYSE, maintain corporate infrastructure required of a public company, and incur significant legal and financial compliance costs, which may divert SC management’s attention and resources from implementing its growth strategy.

30




The market price of SC Common Stock may be volatile, which could cause the value of an investment in SC Common Stock to decline. Conditions affecting the market price of SC Common Stock may be beyond SC’s control and include general market conditions, economic factors, actual or anticipated fluctuations in quarterly operating results, changes in or failure to meet publicly disclosed expectations related to future financial performance, analysts’ estimates of SC’s financial performance or lack of research or reports by industry analysts, changes in market valuations of similar companies, future sales of SC Common Stock, or additions or departures of its key personnel.
SC's business and results of operations could be negatively impacted if it fails to manage and complete divestitures. SC regularly evaluates its portfolio in order to determine whether an asset or business may no longer be aligned with its strategic objectives. For example, in October 2015, SC disclosed a decision to exit the personal lending business and to explore strategic alternatives for its existing personal lending assets. Of its two primary lending relationships, SC completed the sale of substantially all of its loans associated with the LendingClub relationship in February 2016. SC continues to classify loans from its other primary lending relationship, Bluestem, as held-for-sale. SC remains a party to agreements with Bluestem that obligate it to purchase new advances originated by Bluestem, along with existing balances on accounts with new advances, for an initial term ending in April 2020 and which is renewable through April 2022 at Bluestem's option. Although SC is seeking a third party willing and able to take on this obligation, it may not be successful in finding such a party, and Bluestem may not agree to the substitution. SC has recorded significant lower-of-cost-or-market adjustments on this portfolio and may continue to do so as long as the portfolio is held, particularly due to the new volume it is committed to purchase.
SC's business could be negatively impacted if access to funding is reduced. Adverse changes in SC's ABS program or in the ABS market generally could materially adversely affect its ability to securitize loans on a timely basis or upon terms acceptable to SC. This could increase its cost of funding, reduce its margins, or cause it to hold assets until investor demand improves.
As with SHUSA, adverse outcomes to current and future litigation against SC may negatively impact its financial position, results of operations, and liquidity. SC is party to various litigation claims and legal proceedings. In particular, as a consumer finance company, it is subject to various consumer claims and litigation seeking damages and statutory penalties. Some litigation against it could take the form of class action complaints by consumers. As the assignee of loans originated by automotive dealers, it also may be named as a co-defendant in lawsuits filed by consumers principally against automotive dealers.

The Chrysler Agreement may not result in currently anticipated levels of growth and is subject to certain performance conditions that could result in termination of the agreement. If SC fails to meet certain of these performance conditions, FCA may seek to terminate the agreement. In addition, FCA has the option to acquire an equity participation in the Chrysler Capital portion of SC's business.

In February 2013, SC entered into the Chrysler Agreement with FCA through which SC launched the Chrysler Capital brand on May 1, 2013. Under the Chrysler Agreement, SC provides private-label loans and leases to facilitate the purchase of FCA vehicles by consumers and FCA-franchised automotive dealers. The financing services SC provides under the Chrysler Agreement include providing (1) credit lines to finance FCA-franchised dealers’ acquisitions of vehicles and other products FCA sells or distributes, (2) automotive loans and leases to finance consumer acquisitions of new and used vehicles at FCA-franchised dealerships, (3) financing for commercial and fleet customers, and (4) ancillary services. In addition, SC may facilitate, for an affiliate, offerings to dealers for dealer loan financing, construction loans, real estate loans, working capital loans, and revolving lines of credit. In May 2013, in accordance with the terms of the Chrysler Agreement, SC paid FCA a $150 million upfront, nonrefundable payment, to be amortized over ten years. The unamortized portion would be recognized as expense immediately if the Chrysler Agreement were terminated in accordance with its term.

Under and subject to the terms of the Chrysler Agreement, SC received limited exclusivity rights to participate in specified minimum percentages of certain of FCA's financing incentive programs, which include loan rate subvention and automotive lease residual support subvention. Among other covenants, SC has committed to certain revenue sharing arrangements. SC bears the risk of loss on loans originated pursuant to the Chrysler Agreement, while FCA shares in any residual gains and losses in respect of automotive leases, subject to specific provisions in the Chrysler Agreement, including limitations on SC’s participation in such gains and losses.

In connection with the Chrysler Agreement, SC and FCA entered into an option agreement pursuant to which FCA has the option to acquire, for fair market value, an equity participation in the business offering and providing the financial services contemplated by the Chrysler Agreement. FCA has announced its intention to establish a captive U.S. auto finance unit and indicated that acquiring Chrysler Capital is one option it will consider.

The equity option agreement does not specify the percentage of equity interests to be represented by the equity participation, but indicates that it can be greater than 80% and provides that FCA would specify the percentage to be purchased at the time of exercise of the option. The equity option agreement contains provisions that are designed to address a situation in which the parties disagree

31




on the fair market value of an equity participation interest. There is a risk that SC may ultimately receive less than what SC believes to be the fair market value for that interest, and the loss of SC's associated revenue and profits may not be offset fully by the proceeds for such interest. There can be no assurance that SC would be able to redeploy the immediate proceeds for such interest in other businesses or investments that would provide comparable returns, thereby reducing SC's profitability. Further, the likelihood, timing and structure of any such transaction cannot reasonably be determined at this time. There can be no assurance that SHUSA or SC could successfully or timely implement any such transaction without significant disruption of its operations or restructuring, or without incurring additional liabilities, which could involve significant expense to SHUSA and SC and have a material adverse effect on SHUSA's or SC's business, financial condition and results of operations.

The Chrysler Agreement is subject to early termination in certain circumstances, including the failure by either party to comply with certain of their ongoing obligations under the Chrysler Agreement. SC's obligations include SC meeting specified obligations in relation to escalating penetration rates for the first five years of the agreement, subject to FCA treating SC in a manner consistent with other comparable OEMs' treatment of their captive finance providers. Additional termination rights in favor of FCA include, among other circumstances, (i) a person other than Santander and its affiliates owns 20% or more of SC’s common stock and Santander and its affiliates own fewer shares of common stock than such person, (ii) SC becomes, controls, or becomes controlled by, an OEM that competes with FCA or (iii) certain of SC’s credit facilities become impaired.

SC’s ability to realize the full strategic and financial benefits of its relationship with FCA depends in part on the successful continued development of its Chrysler Capital business, which requires a significant amount of management's time and effort as well as continued cooperation from FCA. If FCA exercises its equity option, if the Chrysler Agreement (or FCA's limited exclusivity obligations thereunder) were to terminate, if FCA seeks to significantly change its business relationship with SC, or if SC otherwise is unable to realize the expected benefits of its relationship with FCA, there could be a materially adverse impact to SHUSA's and SC’s business, financial condition, results of operations, profitability, loan and lease volume, the credit quality of SHUSA's and SC’s portfolio, liquidity, funding and growth, and SHUSA's and SC's ability to implement its business strategy could be materially adversely affected. The Company has $1.0 billion of goodwill assigned to the SC reporting unit from the 2014 Change in Control of SC. It is possible that changes to the Chrysler Agreement may trigger a goodwill impairment evaluation, which could require the goodwill to be written down if SC's financial condition is materially adversely affected. In addition, the Company has a $65.0 million Chrysler relationship intangible, which may require an impairment evaluation if there are adverse changes to the Chrysler Agreement.

On July 11, 2018 FCA and SC entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party under the Chrysler Agreement until December 31, 2018. FCA has not delivered a notice to exercise its equity option, and the Company remains committed to the success of the Chrysler Capital business.


ITEM 1B - UNRESOLVED STAFF COMMENTS

None.


ITEM 2 - PROPERTIES

As of December 31, 2018, the Company utilized 787 buildings that occupy a total of 6.3 million square feet, including 196 owned properties with 1.5 million square feet, 469 leased properties with 3.4 million square feet, and 122 sale-and-leaseback properties with 1.5 million square feet. The executive and primary administrative offices for SHUSA and the Bank are located at 75 State Street, Boston, Massachusetts. This location is leased by the Company. SC's corporate headquarters are located at 1601 Elm Street, Dallas, Texas. This location is leased by SC.

Eleven major buildings serve as the headquarters or house significant operational and administrative functions, and are : Operations Center - 2 Morrissey Boulevard, Dorchester, Massachusetts-Leased; Call Center and Operations and Loan Processing Center-Santander Way; 95 Amaral Street, Riverside, Rhode Island-Leased; SHUSA/SBNA Administrative Offices-75 State Street, Boston, Massachusetts-Leased; Call Center and Operations and Loan Processing Center-450 Penn Street, Reading; Pennsylvania-Leased; Loan Processing Center-601 Penn Street; Reading, Pennsylvania-Owned; Operations and Administrative Offices-1130 Berkshire Boulevard, Wyomissing, Pennsylvania-Owned; Operations and Administrative Offices-1401 Brickell Avenue, Miami, Florida-Owned; Operations and Administrative Offices - San Juan, Puerto Rico-Leased; Computer Data Center - Hato Rey, Puerto Rico-Leased; SAM Administrative Offices-Guaynabo Puerto Rico-leased; and SC Administrative Offices-1601 Elm Street, Dallas, Texas-Leased.


32




The majority of these eleven properties of the Company identified above are utilized for general corporate purposes. The remaining 776 properties consist primarily of bank branches and lending offices. Of the total number of buildings, the Bank has 627 retail branches, and BSPR has 27 retail branches.

For additional information regarding the Company's properties refer to Note 6 - "Premises and Equipment" and Note 20 - "Commitments, Contingencies and Guarantees" in the Notes to Consolidated Financial Statements in Item 8 of this Report.


ITEM 3 - LEGAL PROCEEDINGS

Refer to Note 15 to the Consolidated Financial Statements for disclosure regarding the lawsuit filed by SHUSA against the Internal Revenue Service (“IRS”) and Note 20 to the Consolidated Financial Statements for SHUSA’s litigation disclosures, which are incorporated herein by reference.


ITEM 4 - MINE SAFETY DISCLOSURES

None.


PART II


ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company has one class of common stock. The Company’s common stock was traded on the NYSE under the symbol “SOV” through January 29, 2009. On January 30, 2009, all shares of the Company's common stock were acquired by Santander and de-listed from the NYSE. Following this de-listing, there has not been, nor is there currently, an established public trading market in shares of the Company’s common stock. As of the date of this filing, Santander was the sole holder of the Company’s common stock.

At February 28, 2019, 530,391,043 shares of common stock were outstanding. There were no issuances of common stock during 2018, 2017, or 2016.

During the year ended, December 31, 2018 and 2017, the Company declared and paid cash dividends of $410.0 million and $10.0 million, respectively, to its shareholder. The Company did not pay any cash dividends on its common stock in 2016.

Refer to the "Liquidity and Capital Resources" section in Item 7 of the MD&A for the two most recent fiscal years' activity on the Company's common stock.


33




ITEM 6 - SELECTED FINANCIAL DATA
 
 
SELECTED FINANCIAL DATA FOR THE YEAR ENDED DECEMBER 31,
(Dollars in thousands)
 
2018 (1)
 
2017 (1)
 
2016 (1)
 
2015
 
2014
Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
135,634,285

 
$
128,274,525

 
$
138,360,290

 
$
141,106,832

 
$
132,839,460

Loans HFI, net of allowance
 
83,148,738

 
76,795,794

 
82,005,321

 
83,779,641

 
81,961,652

Loans held-for-sale
 
1,283,278

 
2,522,486

 
2,586,308

 
3,190,067

 
294,261

Total investments (2)
 
15,189,024

 
16,871,855

 
19,415,330

 
22,768,783

 
18,083,235

Total deposits and other customer accounts
 
61,511,380

 
60,831,103

 
67,240,690

 
65,583,428

 
62,148,002

Borrowings and other debt obligations (2)(3)
 
44,953,784

 
39,003,313

 
43,524,445

 
49,828,582

 
40,381,582

Total liabilities
 
111,787,053

 
104,583,693

 
115,981,532

 
119,259,732

 
107,919,751

Total stockholder's equity (4)
 
23,847,232

 
23,690,832

 
22,378,758

 
21,847,100

 
24,919,709

Summary Statement of Operations
 
 
 
 
 
 
 
 
 
Total interest income
 
$
8,069,053

 
$
7,876,079

 
$
7,989,751

 
$
8,137,616

 
$
7,330,742

Total interest expense
 
1,724,203

 
1,452,129

 
1,425,059

 
1,236,210

 
1,087,642

Net interest income
 
6,344,850

 
6,423,950

 
6,564,692

 
6,901,406

 
6,243,100

Provision for credit losses (5)
 
2,339,898

 
2,759,944

 
2,979,725

 
4,079,743

 
2,459,998

Net interest income after provision for credit losses
 
4,004,952

 
3,664,006

 
3,584,967

 
2,821,663

 
3,783,102

Total non-interest income (6)
 
3,244,308

 
2,901,253

 
2,755,705

 
2,905,035

 
5,059,462

Total general, administrative and other expenses (7)
 
5,832,325

 
5,764,324

 
5,386,194

 
9,381,892

 
4,135,346

Income/(loss) before income taxes
 
1,416,935

 
800,935

 
954,478

 
(3,655,194
)
 
4,707,218

Income tax provision/(benefit) (8)
 
425,900

 
(157,040
)
 
313,715

 
(599,758
)
 
1,673,123

Net income / (loss) (10)
 
$
991,035

 
$
957,975

 
$
640,763

 
$
(3,055,436
)
 
$
3,034,095

Selected Financial Ratios (9)
 
 
 
 
 
 
 
 
 
 
Return on average assets
 
0.76
%
 
0.71
%
 
0.45
%
 
(2.18
)%
 
2.46
%
Return on average equity
 
4.11
%
 
4.10
%
 
2.88
%
 
(11.98
)%
 
12.95
%
Average equity to average assets
 
18.37
%
 
17.39
%
 
15.67
%
 
18.15
 %
 
18.99
%
Efficiency ratio
 
60.82
%
 
61.81
%
 
57.79
%
 
95.67
 %
 
36.59
%
(1)
On July 1, 2016, ownership of several Santander subsidiaries, including Santander BanCorp, BSI, SIS and SSLLC, were transferred to the Company. As these entities were and are solely owned and controlled by Santander prior to and after July 1, 2016, in accordance with Accounting Standards Codification ("ASC") 805, the transaction has been accounted for under the common control guidance, which requires the Company to recognize the assets and liabilities transferred at their historical cost of the transferring entity at the date of the transfer. Additionally, as this transaction represents a change in reporting entity, the guidance requires retrospective combination of the entities for all periods presented in these financial statements as if the combination had been in effect since inception of common control. On July 1, 2017, an additional Santander subsidiary, Santander Financial Services, Inc. (“SFS”), a finance company located in Puerto Rico, was transferred to the Company. On July 2, 2018, an additional Santander subsidiary, Santander Asset Management LLC ("SAM"), an investment adviser located in Puerto Rico, was transferred to the Company. SFS and SAM are entities under common control of Santander; however, their results of operations, financial condition, and cash flows are immaterial to the historical financial results of the Company on both an individual and aggregate basis. As a result, the Company has reported the results of SFS on a prospective basis beginning July 1, 2017 and the results of SAM on a prospective basis beginning July 1, 2018. Refer to Note 1 for additional information.
(2)
The decreases in Total investments and corresponding decreases in Borrowings and other debt obligations from 2016 to 2017 and 2015 to 2016 were primarily driven by the use of proceeds from the sales of investment securities to repurchase and pay off its outstanding borrowings.
(3)
The increase in Borrowings and other debt obligations from 2014 to 2015 was primarily a result of the Company funding the growth of the loan portfolio and operating lease portfolio.
(4)
The decrease in Stockholder's Equity from 2014 to 2015 reflects the goodwill impairment recorded of $4.5 billion in 2015.
(5)
The decrease in the Provision for credit losses from 2017 to 2018 was primarily due to lower net charge-offs on the RIC portfolio, accompanied by a recovery on the purchased RIC portfolio and lower provision on the originated RIC portfolio and a lower provision on the commercial loan portfolio. The decrease from 2015 to 2016 was primarily due to significantly lower provision on the purchased RIC portfolio, accompanied by slightly lower net charge-offs across the total loan portfolio. The increase from 2014 to 2015, was primarily due to the build up of the reserve on the growing originated RIC portfolio and increased net charge-offs.
(6)
The increase in Non-interest income from 2017 to 2018 is primarily attributed to an increase in lease income corresponding to the growth of the operating lease portfolio. Non-interest income in 2014 includes a one-time $2.4 billion gain on acquisition, which was related to the Change in Control.
(7)
General, administrative, and other expenses increased annually between 2016 and 2018, primarily due to growth in compensation and benefits and lease expense, driven by corresponding growth of the operating lease portfolio. In 2015, this line included a $4.5 billion goodwill impairment charge on SC.
(8)
Refer to Note 15 of the Notes to Consolidated Financial Statements for additional information on the Company's income taxes. The income tax benefit in 2017 was due to the impact of the TCJA, resulting in a tax benefit to the Company. The income tax benefit in 2015 was primarily the result of the release of the deferred tax liability in conjunction with the goodwill impairment charge. The higher income tax provision in 2014 was primarily attributable to the deferred tax expense recorded on the gain from the Change in Control.
(9)
For the calculation components of these ratios, see the Non-GAAP Financial Measures section of the MD&A.
(10)
Includes net income/(loss) attributable to non-controlling interest ("NCI") of $283.6 million, $405.6 million, $277.9 million, $(1.7) billion, and $464.6 million for the years ended December 31, 2018, 2017, 2016, 2015 and 2014, respectively.

34





ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ("MD&A")

EXECUTIVE SUMMARY

Santander Holdings USA, Inc. ("SHUSA" or the "Company") is the parent holding company of Santander Bank, National Association, (the "Bank" or "SBNA"), a national banking association, and owns approximately 69.9% (as of February 21, 2019) of Santander Consumer USA Holdings Inc. (together with its subsidiaries, "SC"), a specialized consumer finance company. SHUSA is headquartered in Boston, Massachusetts and the Bank's main office is in Wilmington, Delaware. SC is headquartered in Dallas, Texas. SHUSA is a wholly-owned subsidiary of Banco Santander, S.A. ("Santander"). SHUSA is also the parent company of Santander BanCorp (together with its subsidiaries, “Santander BanCorp”), a holding company headquartered in Puerto Rico which offers a full range of financial services through its wholly-owned banking subsidiary, Banco Santander Puerto Rico ("BSPR"); Santander Securities LLC (“SSLLC”), a broker-dealer headquartered in Boston; Banco Santander International (“BSI”), a financial services company located in Miami that offers a full range of banking services to foreign individuals and corporations based primarily in Latin America; Santander Investment Securities Inc. (“SIS”), a registered broker-dealer located in New York providing services in investment banking, institutional sales, trading and offering research reports of Latin American and European equity and fixed-income securities; and several other subsidiaries. SSLLC, SIS and another SHUSA subsidiary, SAM, are registered investment advisers with the Securities and Exchange Commission (the “SEC”).

The Bank's principal markets are in the Mid-Atlantic and Northeastern United States. The Bank uses its deposits, as well as other financing sources, to fund its loan and investment portfolios. The Bank earns interest income on its loan and investment portfolios. In addition, the Bank generates non-interest income from a number of sources, including deposit and loan services, sales of loans and investment securities, capital markets products and bank-owned life insurance ("BOLI"). The principal non-interest expenses include employee compensation and benefits, occupancy and facility-related costs, technology and other administrative expenses. The financial results of the Bank are affected by the economic environment, including interest rates and consumer and business confidence and spending, as well as the competitive conditions within the Bank's geographic footprint.

SC is a full-service, technology driven consumer finance company focused on vehicle finance and third-party servicing. SC's primary business is the indirect origination and securitization of retail installment contracts ("RICs"), principally through manufacturer-franchised dealers in connection with their sale of new and used vehicles to subprime retail consumers. Further information about SC’s business is provided below in the “Chrysler Capital” section.

SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile and recreational and marine vehicle portfolios for other lenders. Additionally, SC has several relationships through which it provides other consumer finance products.

SC has dedicated financing facilities in place for its Chrysler Capital business. SC periodically sells consumer RICs through these flow agreements and, when market conditions are favorable, it accesses the asset-backed securities ("ABS") market through securitizations of consumer RICs. SC also periodically enters into bulk sales of consumer vehicle leases with a third party. SC typically retains servicing of loans and leases sold or securitized, and may also retain some residual risk in sales of leases. SC has also entered into an agreement with a third party whereby SC will periodically sell charged-off loans.

Chrysler Capital

In conjunction with a ten-year private label financing agreement with Fiat Chrysler Automobiles US LLC ("FCA") that became effective May 1, 2013 (the "Chrysler Agreement"), SC offers a full spectrum of auto financing products and services to FCA customers and dealers under the Chrysler Capital brand ("Chrysler Capital"), These products and services include consumer RICs and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. RICs and vehicle leases entered into with FCA customers under the Chrysler Agreement represent a significant concentration of those portfolios and there is a risk that the Chrysler Agreement could be terminated prior to its expiration date. Termination of the Chrysler Agreement could result in a decrease in the amount of new RICs and vehicle leases entered into with FCA customers as well as dealer loans. Refer to Note 20 for additional details.

Under the terms of the Chrysler Agreement, certain standards were agreed to, including SC meeting specified escalating penetration rates for the first five years, subject to FCA treating SC in a manner consistent with comparable original equipment manufacturers ("OEMs'") treatment of their captive providers, primarily in regard to sales support. The failure of either party to meet its respective obligations under the Chrysler agreement, including SC's failure to meet target penetration rates, could result in the agreement being terminated. SC did not meet these penetration rates. Chrysler Capital continues to be a focal point of the Company's and SC's strategy,

35





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



and SC continues to work with FCA to improve penetration rates. SC's average penetration rate for the year ended December 31, 2018 was 30%, an increase from 18% in 2017.

In June 2018, SC announced that it was in exploratory discussions with FCA regarding the future of FCA's U.S. finance operations. FCA has announced its intention to establish a captive U.S. auto finance unit and indicated that acquiring Chrysler Capital is one option it would consider. Under the Chrysler Agreement, FCA has the option to acquire, for fair market value, an equity participation in the business offering and providing financial services contemplated by the Chrysler Agreement. In addition, in July 2018 FCA and the Company entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party under the Chrysler Agreement until December 31, 2018.

FCA has not delivered a notice to exercise its equity option, and the Company remains committed to the success of the Chrysler Capital business. Although the likelihood, timing and structure of any such transaction, and the likelihood that the Chrysler Agreement will terminate, cannot be reasonably determined, termination of the Chrysler Agreement, or a significant change in the business relationship between SC and FCA, could materially adversely affect SC's and SHUSA's operations, including the origination of receivables through the Chrysler Capital portion of SC's business and the servicing of Chrysler Capital receivables. Moreover, there can be no assurance that SC could successfully or timely implement any such transaction without significant disruption of its operations or restructuring, or without incurring additional liabilities, which could involve significant expense to the Company and have a adverse effect on its business, financial condition and results of operations.

As of December 31, 2018, the Company had a $65.0 million Chrysler relationship intangible. The intangible is related to the upfront fee paid to Chrysler in May 2013. A significant change to the Chrysler Agreement could potentially be considered a triggering event requiring re-evaluation of whether or not the remaining unamortized balance of the upfront fee should be deemed impaired.

In addition, the Company has $1.0 billion of goodwill allocated to the SC reporting unit. A significant change to the Chrysler Agreement could potentially be considered a triggering event requiring an interim goodwill impairment analysis. The Company will continue monitoring changes to the Chrysler Agreement that could lead to a potential impairment indicator in 2018. It is reasonably possible that impairment of the entire goodwill associated with the SC reporting unit could be recognized based on future changes to the Chrysler Agreement.

SC has dedicated financing facilities in place for its Chrysler Capital business. During the year ended December 31, 2018, SC originated more than $7.9 billion in Chrysler Capital loans, which represented 46% of its total RIC originations (unpaid principal balance ("UPB")), with an approximately even share between prime and non-prime, as well as more than $9.7 billion in Chrysler Capital leases. Since its May 2013 launch, Chrysler Capital has originated more than $53.1 billion in retail loans and $33.3 billion in leases, and facilitated the origination of $3.0 billion (excluding the SBNA RIC origination program) in leases and dealer loans for the Bank. As of December 31, 2018, SC's carrying value of its auto RIC portfolio consisted of $9.0 billion of Chrysler Capital loans, which represents 36% of SC's carrying value of its auto RIC portfolio.

SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile and recreational and marine vehicle portfolios for other lenders. Additionally, SC has several relationships through which it has provided other consumer finance products.

SC periodically sells consumer RICs through these flow agreements and, when market conditions are favorable, accesses the asset-backed securities ("ABS") market through securitizations of consumer RICs. SC typically retains servicing of loans and leases sold or securitized, and may also retain some residual risk in sales of leases. SC has also entered into an agreement with a third party whereby SC will periodically sell charged-off loans.

ECONOMIC AND BUSINESS ENVIRONMENT

Overview

During the fourth quarter of 2018, unemployment continued to decrease and the preliminary gross domestic product ("GDP") growth rate slowed slightly from the prior quarter. Year to date market results ended down overall, primarily driven by third quarter volatility which continued into the fourth quarter.

The unemployment rate at December 31, 2018 was down to 3.9% compared to 4.0% at September 30, 2018, and was lower compared to 4.1% one year ago. According to the U.S. Bureau of Labor Statistics, employment rose in professional and business services, healthcare, transportation, and warehousing.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



The Bureau of Economic Analysis ("BEA") initial estimate indicates that real GDP grew at an annualized rate of 2.6% for the fourth quarter of 2018, compared to 3.4% for the third quarter of 2018. Growth continued to be driven by increases in personal consumption expenditures, nonresidential fixed investment, exports, and federal government spending. This was offset by decreases to spending in residential fixed investment and state and local government, as well as increased imports.

Market year-to-date returns for the following indices based on closing prices at December 31, 2018 were:
 
 
December 31, 2018
Dow Jones Industrial Average
 
(5.6)%
Standard & Poor's ("S&P") 500
 
(6.2)%
NASDAQ Composite
 
(3.9)%

At its December 2018 meeting, the Federal Open Market Committee decided to raise the federal funds rate target to 2.25%-2.50%, reflecting that the labor market has continued to strengthen and that economic activity has continued to expand at a solid pace. Overall inflation remains below the targeted rate of 2.0%.

The ten-year Treasury bond rate at December 31, 2018 was 2.69%, up from 2.40% at December 31, 2017. Within the industry, changes within this metric are often considered to correspond to changes in 15-year and 30-year mortgage rates.

For the third quarter of 2018, mortgage originations increased approximately 1.1% over the prior quarter and 6.7% year-over-year. Mortgage originations for home purchases increased 3.6% quarter-over-quarter while they increased 3.4% from the third quarter last year. Mortgage originations from refinancing activity decreased 5.9% from the second quarter of 2018 and 28.5% from the third quarter of last year. These rates are representative of U.S. national average mortgage origination activity.

The ratio of nonperforming loans ("NPLs") to total gross loans for U.S. banks declined for six consecutive years, to just under 1.5% in 2015. NPL trends have remained relatively flat since that time. NPLs for U.S. commercial banks were approximately 0.98% of loans using the latest available data, which was as of the third quarter of 2018, compared to 1.17% for the prior quarter.

Changing market conditions are considered a significant risk factor to the Company. The interest rate environment can present challenges in the growth of net interest income for the banking industry, which continues to rely on non-interest activities to support revenue growth. Changing market conditions and political uncertainty could have an overall impact on the Company's results of operations and financial condition. Such conditions could also impact the Company's credit risk and the associated provision for credit losses and legal expense.

Credit Rating Actions

The following table presents Moody's Investors Service, Inc. (“Moody’s”), S&P and Fitch credit ratings for the Bank, and BSPR, SHUSA, Santander, and the Kingdom of Spain, as of December 31, 2018:
 
 
BANK
 
BSPR(1)
 
SHUSA
 
 
Moody's
S&P
Fitch (2)
 
Moody's
S&P
Fitch (2)
 
Moody's
S&P
Fitch
Long-Term
 
Baa1
A-
BBB+
 
Baa1
N/A
BBB+
 
Baa3
BBB+
BBB+
Short-Term
 
P-1
A-2
F-2
 
P-1/P-2
N/A
F-2
 
n/a
A-2
F-2
Outlook
 
Stable
Stable
Stable
 
Stable
N/A
Stable
 
Stable
Stable
Stable

 
 
 
SANTANDER
 
SPAIN
 
 
 
Moody's
S&P
Fitch
 
Moody's
S&P
Fitch
Long-Term
 
 
A2
A
A
 
Baa1
A-
A-
Short-Term
 
 
P-1
A-1
F-1
 
P-2
A-2
F-1
Outlook
 
 
Stable
Stable
Stable
 
Stable
Positive
Stable
(1)    P-1 Short Term Deposit Rating; P-2 Short Term Debt Rating.
(2) Short Term Debt and Short Term Deposit Ratings are both F-2.

SHUSA funds its operations independently of the other entities owned by Santander, and believes its business is not necessarily closely related to the business or outlook of other entities owned by Santander. Future changes in the credit ratings of its parent, Santander, or the Kingdom of Spain could impact SHUSA's or its subsidiaries' credit ratings, and any other change in the condition of Santander could affect SHUSA.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



At this time, SC is not rated by the major credit rating agencies.

Puerto Rico Economy

On May 3, 2017, the Financial Oversight and Management Board of Puerto Rico (“FOB”) submitted a request to the Federal District Court of Puerto Rico to apply Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”) to the Commonwealth of Puerto Rico. Title III of PROMESA allows the Commonwealth of Puerto Rico to enter into a debt restructuring process notwithstanding that Puerto Rico is barred from traditional bankruptcy protection under Chapter 9 of the U.S. Bankruptcy Code. On July 2, 2017, the Puerto Rican Electric Power Authority ("PREPA") submitted a request to the Federal District Court of Puerto Rico to apply Title III of PROMESA to PREPA.

During the fourth quarter of 2018, Puerto Rico’s economic conditions continued to improve, assisted by several proceedings under the PROMESA to restructure its outstanding obligations and those of certain of its instrumentalities. As part of the reconstruction process post-Hurricane Irma and Hurricane Maria, Puerto Rico is expected to receive $82 billion in federal relief fund and insurance payouts during the next 10-15 years. Access to this funding is instrumental to restore economic growth in the short term while the government works toward the implementation of structural reform to foster sustainable economic growth in the long term. So far, the partial disbursement of the federal relief funding and insurance is having a positive effect on the economy. The Economic Development Bank Economic Activity Index shows that the island’s economic activity increased 1.5% during 2018 when compared to 2017. The unemployment rate of 8.3% in December 2018 was one of the lowest in decades, while 6,700 jobs were created year-over-year. Other indicators are improving as well: the sale of housing units rose 23% in 2018 versus 2017, the sale of new automobiles continued increasing and tax revenue collections rose by $611.7 million to $3.5 billion from the second half of 2018 versus the same period in 2017.

On November 29, 2018, the Puerto Rico Fiscal Agency and Financial Advisory Authority and the Government Development Bank (“GDB”) announced the closing of the GDB restructuring process under Title VI of PROMESA, resulting in the first closure of a public debt restructuring process. During 2018, the U.S. District Court approved the adjustment plan for the Puerto Rico Urgent Interest Fund Corporation's debt restructuring process under Title III of PROMESA. The plan, already approved by the FOB and Puerto Rico’s legislature, contemplates the payment of $400 million annually in debt service in 2019 and up to $1,000 million annually in 2041.

On December 10, 2018, the Governor of Puerto Rico signed Act 257-2018 PR Tax Reform which includes, among the most significant changes to the Puerto Rico Internal Revenue Code, (i) a decrease in the corporate tax rate from 39% to 37.5, effective for taxable years beginning after December 31, 2018, (ii) a decrease from $500 to $25 on the amount paid or credited as interest subject to withholding, (iii) an increase to 90% of the limit on the deduction of net operating losses, (iv) an increase in the withholding rate on payments on account of services rendered from 7% to 10%, and (v) exemption of business-to-business retention to entities with business volume over $200,000.
Although as of the date hereof the FOB has sought to use the restructuring authority provided by PROMESA, limited to certain Commonwealth instrumentalities, the FOB may use the restructuring authority of Title III or Title VI of PROMESA for others, including its municipalities, in the future. Deterioration of the Commonwealth’s fiscal and economic situation, including any negative ratings implications, could further adversely affect the value of our Puerto Rico public sector exposure.
Although BSPR has a diversified loan portfolio, it continues with efforts to de-risk the portfolio, with credit risk indicators improving significantly year-over-year and surpassing budgeted targets. The lending strategy with respect to the public sector has been to enter into commitments with a short-term maturity, payment priority, and/or strong guarantees as well as with adequate profitability. Such commitments to the public sector amounted approximately to $265 million ($57 million of agencies and public corporations and $208 million of municipalities) and $293 million ($74 million of agencies and public corporations and $219 million of municipalities) as of December 31, 2018 and 2017, respectively, which represent 16% of BSPR's commercial loan portfolio for both periods. A substantial portion of BSPR’s credit exposure to the Government of Puerto Rico is either collateralized loans or obligations that have a specific source of income or revenues identified for their repayment, fixed income investment or real estate. For agencies and public corporations, guarantees are mainly mortgages, securities and standby letter of credits from low-risk multinational entities. In the case of municipalities, the main sources of income are from the Municipal Revenue Collection Center for property taxes and from the Secretary of the Treasury for sales and use taxes. In most cases, these are “general obligations” of a municipality, to which the municipality has pledged its good faith, credit and unlimited taxing power, or “special obligations” of a municipality, to which the applicable municipality has pledged other revenues. As of December 31, 2018 and 2017, $25 million, or 9%, and $40 million, or 13%, respectively, of commercial loans granted to the public sector mature in one year or less.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



Impact from Hurricanes

Our footprint was impacted by three significant hurricanes during 2017, Hurricane Harvey, which struck the State of Texas and the surrounding region, Hurricane Irma, which primarily struck the State of Florida, and Hurricane Maria, which struck the island of Puerto Rico. Each of these hurricanes resulted in widespread flooding, power outages and associated damage to real and personal property in the affected areas. SC, headquartered in Dallas, Texas, BSI, headquartered in Miami, Florida, and Santander BanCorp, BSPR and SSLLC subsidiaries in Puerto Rico were most directly affected by these hurricanes.  In Puerto Rico, there was significant damage to the infrastructure and the power grid on the entire island, which resulted in extended delays in BSPR returning to normal operations.

The Company assessed the potential additional credit losses related to its consumer and commercial lending exposures in the greater Texas, Florida and Puerto Rico regions. As a result, the Company's allowance for loan and lease losses (“ALLL") had approximately $25.0 million of reserves specifically related to the hurricanes at December 31, 2018 compared to $110 million at December 31, 2017. Approximately $50.0 million of the decrease in the qualitative allowance related to the hurricanes has been offset by an increase in model and specific reserves to other portfolios requiring additional allowance, including the municipality, commercial, and residential loan portfolios in Puerto Rico. The remaining hurricane reserve at December 31, 2018 is a specific reserve recorded for a commercial loan located in Puerto Rico.

See Note 20 to the Consolidated Financial Statement for a discussion of FINRA arbitration claims and class action litigation to which the Company and its affiliates are subject as a result of the sale of Puerto Rico bonds and closed-end funds.

REGULATORY MATTERS

The activities of the Company and its subsidiaries, including the Bank and SC, are subject to regulation under various U.S. federal laws and regulatory agencies which impose regulations, supervise and conduct examinations, and may affect the operations and management of the Company and its ability to take certain actions, including making distributions to our parent and shareholders. The Company is regulated on a consolidated basis by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), including the Federal Reserve Bank (the "FRB") of Boston, and the Consumer Financial Protection Bureau (the "CFPB"). The Company's banking and bank holding company subsidiaries are further supervised by the Federal Deposit Insurance Corporation (the "FDIC") and the Office of the Comptroller of the Currency (the “OCC”). As a subsidiary of the Company, SC is also subject to regulatory oversight by the Federal Reserve as well as the CFPB. Santander BanCorp and BSPR also are supervised by the Puerto Rico Office of the Commissioner of Financial Institutions.

Payment of Dividends

SHUSA is the parent holding company of SBNA and other consolidated subsidiaries, and is a legal entity separate and distinct from its subsidiaries. In addition to those arising as a result of the Comprehensive Capital Analysis and Review (“CCAR”) process described under the caption “Stress Tests and Capital Adequacy” below, SHUSA and SBNA are subject to various regulatory restrictions relating to the payment of dividends, including regulatory capital minimums and the requirement to remain "well-capitalized" under prompt corrective action regulations. As a consolidated subsidiary of the Company, SC is included in various regulatory restrictions relating to payment of dividends as described in the “Stress Tests and Capital Adequacy” discussion in this section. Refer to the Liquidity and Capital Resources section of this MD&A for detail of the capital actions of the Company and its subsidiaries during the period.

In addition, the following regulatory matters are in the process of being phased in or evaluated by the Company.

Foreign Banking Organizations ("FBOs")

In February 2014, the Federal Reserve issued the final rule implementing certain enhanced prudential standards (“EPS”) mandated by Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “DFA") (the “FBO Final Rule”). Under the Final Rule, FBOs with over $50 billion of U.S. non-branch assets, including Santander, were required to consolidate U.S. subsidiary activities under an intermediate holding company (an “IHC"). In addition, the FBO Final Rule required U.S. bank holding companies ("BHCs") and FBOs with at least $50 billion in total U.S. consolidated non-branch assets to be subject to EPS and heightened capital, liquidity, risk management, and stress testing requirements. Due to both its global and U.S. non-branch total consolidated asset size, Santander was subject to both of the above provisions of the FBO Final Rule. As a result of this rule, Santander has transferred substantially all of its U.S. bank and non-bank subsidiaries previously outside the Company to the Company, which became an IHC effective July 1, 2016. A phased-in approach is being used for the standards and requirements at both the FBO and the IHC. As a result of the phased-in approach, on July 1, 2017, Santander transferred ownership of Santander Financial Services, Inc. ("SFS") and on July 2, 2018, Santander transferred ownership of an additional entity, Santander Asset Management, LLC ("SAM") to the IHC. As a U.S. BHC with more than $50 billion in total consolidated assets, the Company became subject to the EPS on January 1, 2015.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



Economic Growth Act

In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the "Economic Growth Act") was signed into law. The Economic Growth Act scales back certain requirements of the DFA, primarily benefiting banks with $10 billion or less in assets, but also reducing regulatory requirements and modifying the enhanced supervision and EPS that may benefit certain mid-sized and larger BHCs and financial institutions. The Company applied the change during the fourth quarter of 2018, which impacted highly volatile acquisition, development and construction ("HVADC") loans and resulted in an insignificant impact to RWA and the risk-based ratios.

Regulatory Capital Requirements

In July 2013, the Federal Reserve, the FDIC and the OCC released final U.S. Basel III regulatory capital rules implementing the global regulatory capital reforms of Basel III that are applicable to both SHUSA and the Bank. The final rules established a comprehensive capital framework that includes both the advanced approaches for the largest internationally active U.S. banks, formerly known as Basel II, and a standardized approach that applies to all banking organizations with over $500 million in assets. Subject to various transition periods, this rule became effective for SHUSA on January 1, 2015.

The rules narrow the definition of regulatory capital and establish higher minimum risk-based capital ratios and prompt corrective action thresholds that, when fully phased in, require banking organizations, including the Company and the Bank, to maintain a minimum common equity Tier 1 ("CET1") capital ratio of 4.5%, a Tier 1 capital ratio of 6.0%, a total capital ratio of 8.0% and a minimum leverage ratio, calculated as the ratio of Tier 1 capital to average consolidated assets for the quarter, of 4.0%.

A capital conservation buffer of 2.5% above these minimum ratios was being phased in over three years starting in 2016, beginning at 0.625% and increasing by that amount on each subsequent January 1, until the buffer reached 2.5% on January 1, 2019. This buffer is required for banking institutions and BHCs to avoid restrictions on their ability to make capital distributions, including paying dividends.

The U.S. Basel III regulatory capital rules include deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights ("MSRs"), deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities are deducted from CET1 to the extent any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 for the Company and the Bank began on January 1, 2015 and was initially planned over three years, with a fully phased-in requirement of January 1, 2018. However, during 2017, the regulatory agencies finalized changes to the capital rules that became effective on January 1, 2018.  These changes extended the current treatment and will defer the final transition provision phase-in at non-advanced approach institutions for certain capital elements, and suspend the risk-weighting to 100 percent for deferred taxes and mortgage servicing assets not disallowed from capital, in lieu of advancing to 250 percent.  In addition, the regulatory agencies issued a secondary proposal in 2017 to further revise the capital rule by introducing new treatment of high volatility acquisition, development and construction loans, and by modifying the calculation for minority interest includible within capital, for which the regulators have not released a final decision.  In 2018, the regulatory agencies issued an additional proposal that would revise the definition of high volatility commercial real estate exposures.

See the Bank Regulatory Capital section of this MD&A for the Company's capital ratios under Basel III standards. The implementation of certain regulations and standards relating to regulatory capital could disproportionately affect the Company's regulatory capital position relative to that of its competitors, including those that may not be subject to the same regulatory requirements as the Company.

If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and, in critically undercapitalized situations, appointment of a receiver or conservator. Critically undercapitalized institutions generally may not, beginning 60 days after becoming critically undercapitalized, make any payment of principal or interest on their subordinated debt. All but well-capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Pursuant to the FDIA and OCC regulations, institutions which are not categorized as well-capitalized or adequately-capitalized are restricted from making capital distributions, which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of the institution. At December 31, 2018, the Bank met the criteria to be classified as “well-capitalized.”


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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



On April 10, 2018, the Federal Reserve issued a notice of proposed rulemaking ("NPR") seeking comment on a proposal to simplify capital rules for large banks.  If finalized as proposed, the NPR would eliminate the quantitative objection in CCAR and replace the capital conservation buffer. The capital conservation buffer would be replaced with a new stress capital buffer ("SCB"). The SCB is calculated as the maximum decline in CET1 in the severely adverse scenario (subject to a 2.5% floor) plus four quarters of dividends. The proposal would result in new regulatory capital minimums which are equal to 4.5% CET1 plus the SCB, any globally systemically important bank ("GSIB") surcharge, and any countercyclical capital buffer. The GSIB buffer is applicable only to the largest and most complex firms and does not apply to SHUSA. These new minimums would be firm-specific and would trigger restrictions on capital distributions and discretionary bonuses in the event a firm falls below their new minimums. Firms would still submit a capital plan annually and, absent prior Federal Reserve approval, would continue to be limited to the capital distributions included in their capital plan. Supervisory expectations for capital planning processes would not change under the proposal. The Company is still evaluating the impact this proposed rule would have on its financial position, results of operations and disclosures.

Stress Testing and Capital Planning

The DFA also requires certain banks and BHCs, including the Company, to perform a stress test and submit a capital plan to the Federal Reserve and receive a notice of non-objection before taking capital actions, such as paying dividends, implementing common equity repurchase programs, or redeeming or repurchasing capital instruments. In June 2018, the Company announced that the Federal Reserve did not object to the planned capital actions described in the Company’s capital plan through June 30, 2019. In February 2019, the Federal Reserve announced that SHUSA, as well as other less complex firms, would receive a one-year extension of the requirement to submit its capital plan until April 5, 2020. The Federal Reserve also announced that, for the period beginning July 1, 2019 through June 30, 2020, the Company would be allowed to make capital distributions up to the amount that would have allowed it to remain above all minimum capital requirements in CCAR 2018, adjusted for any changes in the Company’s regulatory capital ratios since the Federal Reserve acted on the 2018 Capital Plan. The Company continues to evaluate its planned capital actions.

Liquidity Rules

In September 2014, the Federal Reserve, the FDIC, and the OCC finalized a rule to implement the Basel III liquidity coverage ratio (the “LCR”) for certain internationally active banks and nonbank financial companies, and a modified version of the LCR for certain depository institution holding companies that are not internationally active. The LCR is designed to ensure that a banking entity maintains an adequate level of unencumbered high-quality liquid assets ("HQLA") equal to its expected net cash outflow for a 30-day time horizon. This rule implements a phased implementation approach under which the most globally important covered companies (more than $700 billion in assets) and large regional financial institutions ($250 billion to $700 billion in assets) were required to begin phasing-in the LCR requirements in January 2015. Smaller covered companies (more than $50 billion in assets), such as the Company, were required to calculate the LCR monthly beginning January 2016. In November 2015, the Federal Reserve published a revised final LCR rule. Under this revision, the Company was required to calculate the modified US LCR (the "US LCR") on a monthly basis beginning with data as of January 31, 2016 and is required to satisfy a minimum US LCR requirement of 100%. We are required to disclose elements under this final rule for quarterly periods ending after October 1, 2018, which can be found on our website at https://www.santanderus.com/us/investorshareholderrelations. At December 31, 2018, SHUSA's US LCR was above 100%.

In October 2014, the Basel Committee on Banking Supervision issued the final standard for the net stable funding ratio (the “NSFR”). The NSFR is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon The NSFR requires banks to maintain a stable funding profile in relation to their on- and off-balance sheet activities, thereby reducing the likelihood that disruptions to a bank's regular sources of funding will erode its liquidity in a way that could increase the risk of its failure and potentially lead to broader systemic stress. In May 2016, the Federal Reserve issued a proposed rule for NSFR applicable to U.S. financial institutions. The proposed rule has not been finalized, and the Company is currently evaluating the impact the proposed rule would have on its financial position, results of operations and disclosures.

Resolution Planning

The DFA requires all BHCs and FBOs with assets of $50 billion or more to prepare and regularly update resolution plans ("165(d) Resolution Plan"). The resolution plan must assume that the covered company is resolved under the U.S. Bankruptcy Code and that no “extraordinary support” is received from the U.S. or any other government. The most recent 165(d) Resolution Plan was submitted to the Federal Reserve and FDIC in December 2018. In addition, under amended Federal Deposit Insurance Act (“FDI Act”) rules, the Insured Depository Institution ("IDI") Resolution Plan rule requires that a bank with assets of $50 billion or more develop a plan for its resolution that supports depositors’ rapid access to their insured deposits, maximizes the net present value return from the sale
or disposition of its assets, and minimizes the amount of any loss realized by creditors in resolution. The most recent IDI Resolution Plan was submitted to the FDIC in June 2018. SHUSA and SBNA are currently awaiting feedback.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



Total Loss-Absorbing Capacity (“TLAC")

The Federal Reserve adopted a final rule in December 2016 that requires certain U.S. organizations to maintain a minimum amount of loss-absorbing instruments, including a minimum amount of unsecured long-term debt ("LTD") (the “TLAC Rule”). The TLAC Rule applies to U.S. GSIBs and to IHCs with $50 billion or more in U.S. non-branch assets that are controlled by a global systemically important FBO. The Company is such an IHC.

Under the TLAC Rule, companies are required to maintain a minimum amount of TLAC, which consists of a minimum amount of LTD and Tier 1 capital. As a result, SHUSA will need to hold the higher of 18% of its risk-weighted assets ("RWAs") or 9% of its total consolidated assets in the form of TLAC, of which 6% of its RWAs or 3.5% of total consolidated assets must consist of LTD. In addition, SHUSA must maintain a TLAC buffer composed solely of CET1 capital and will be subject to restrictions on capital distributions and discretionary bonus payments based on the size of the TLAC buffer it maintains. The TLAC Rule became effective on January 1, 2019.

Volcker Rule

The DFA added new Section 13 to the BHC Act, which is commonly referred to as the “Volcker Rule.” The Volcker Rule prohibits a “banking entity” from engaging in “proprietary trading” or engaging in any of the following activities with respect to a hedge fund or a private equity fund (together, a “Covered Fund”): (i) acquiring or retaining any equity, partnership or other ownership interest in the Covered Fund; (ii) controlling the Covered Fund; or (iii) engaging in certain transactions with the fund if the banking entity or any affiliate is an investment adviser or sponsor to the Covered Fund. These prohibitions are subject to certain exemptions for permitted activities.

Because the term “banking entity” includes an IDI, a depository institution holding company and any of their affiliates, the Volcker Rule has sweeping worldwide application and covers entities such as Santander, the Company, and certain of the Company’s subsidiaries (including the Bank and SC), as well as other Santander subsidiaries in the United States and abroad.

The Company implemented certain policies and procedures, training programs, recordkeeping, internal controls and other compliance requirements that were necessary to comply with the Volcker Rule. As required by the Volcker Rule, the compliance infrastructure has been tailored to each banking entity based on its size and its level of trading and Covered Fund activities. SHUSA's compliance program includes, among other things, processes for prior approval of new activities and investments permitted under the Volcker Rule, testing and auditing for compliance and a process for attesting annually that the compliance program is reasonably designed to achieve compliance with the rule.

In May 2018, the joint agencies responsible for administering the Volcker Rule released an NPR to revise the Volcker Rule. The NPR would tailor the Volcker Rule’s compliance requirements to the amount of a firm’s trading activity, revise the definition of a trading account, clarify certain key provisions in the Volcker Rule, and simplify the information companies are required to provide the banking agencies. The NPR would also replace the short-term intent test in the Volcker Rule with an accounting test. The Company is still evaluating the impact this proposed rule would have on its financial position, results of operations and disclosures.

Risk Retention Rule

In December 2014, the Federal Reserve issued its final credit risk retention rule, which generally requires sponsors of asset-backed securities ("ABS") to retain at least five percent of the credit risk of the assets collateralizing ABS. Compliance with the rule with respect to ABS collateralized by residential mortgages was required beginning in December 2015. Compliance with the rule with regard to all other classes of ABS was required beginning in December 2016. SHUSA, primarily through SC, is an active participant in the structured finance markets and began to comply with the retention requirements effective in December 2016.

Heightened Standards

In September 2014, the OCC finalized guidelines to strengthen the governance and risk management practices of large financial institutions commonly known as “heightened standards.” The heightened standards apply to insured national banks with $50 billion or more in consolidated assets. The heightened standards require covered institutions to establish and adhere to a written risk governance framework to manage and control their risk-taking activities. The heightened standards also provide minimum standards for the institutions’ boards of directors to oversee the risk governance framework.


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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



Transactions with Affiliates

Depository institutions must remain in compliance with Sections 23A and 23B of the Federal Reserve Act and the Federal Reserve's Regulation W, which governs the activities of the Company and its banking subsidiaries with affiliated companies and individuals. Section 23A imposes limits on certain specified “covered transactions,” which include loans, lines, and letters of credit to affiliated companies or individuals, and investments in affiliated companies, as well as certain other transactions with affiliated companies and individuals. The aggregate of all covered transactions is limited to 10% of a bank’s capital and surplus for any one affiliate and 20% for all affiliates. Certain covered transactions also must meet collateral requirements that range from 100% to 130% depending on the type of transaction.

Section 23B of the Federal Reserve Act prohibits a depository institution from engaging in certain transactions with affiliates unless the transactions are considered arms'-length. To meet the definition of arm's-length, the terms of the transaction must be the same,
or at least as favorable, as those for similar transactions with non-affiliated companies. As a U.S. domiciled subsidiary of a global parent with significant non-bank affiliates, the Company faces elevated compliance risk in this area.

Regulation AB II

In August 2014, the SEC adopted final rules known as Regulation AB II that, among other things, expanded disclosure requirements and modified the offering and shelf registration process for asset-backed securities (“ABS”). All offerings of publicly registered ABS and all reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for outstanding publicly-registered ABS were required to comply with the new rules and disclosures on and after November 23, 2015, except for asset-level disclosures. Compliance with the new rules regarding asset-level disclosures was required for all offerings of publicly registered ABS on and after November 23, 2016. SC must comply with these rules, which affects SC's public securitization platform.

Community Reinvestment Act ("CRA")

SBNA and BSPR are subject to the requirements of the CRA, which requires the appropriate federal financial supervisory agency to assess an institution's record of helping to meet the credit needs of the local communities in which it is located. BSPR’s current CRA rating is “Outstanding” and SBNA’s current CRA rating is "Satisfactory." The OCC takes into account the Bank’s CRA rating in considering certain regulatory applications the Bank makes, including applications related to establishing and relocating branches, and the Federal Reserve does the same with respect to certain regulatory applications the Company makes.

Other Regulatory Matters

On February 25, 2015, SC entered into a consent order with the Department of Justice (the "DOJ"), approved by the United States District Court for the Northern District of Texas, which resolves the DOJ’s claims against SC that certain of its repossession and collection activities during the period of time between January 2008 and February 2013 violated the Servicemembers’ Civil Relief Act (the “SCRA”). The consent order requires SC to pay a civil fine in the amount of $55,000, as well as at least $9.4 million to affected servicemembers, consisting of $10,000 per servicemember plus compensation for any lost equity (with interest) for each repossession by SC and $5,000 per servicemember for each instance where SC sought to collect repossession-related fees on accounts where a repossession was conducted by a prior account-holder. The consent order requires us to undertake additional remedial measures. The consent order also subjects SC to monitoring by the DOJ for compliance with the SCRA for a period of five years.

In February 2016, the CFPB issued a supervisory letter relating to its investigation of SC’s compliance systems, Board and senior management oversight, consumer complaint handling, marketing of guaranteed auto protection ("GAP") coverage and loan deferral disclosure practices. SC subsequently received a series of CIDs from the CFPB requesting information and testimony regarding SC’s marketing of GAP coverage and loan deferral disclosure practices. In November 2018, SC entered into a voluntary settlement with the CFPB under which the CFPB entered a consent order against SC in an administrative proceeding captioned In the Matter of Santander Consumer USA Holdings Inc., File No. 2018-BCFP-0008. In the consent order the CFPB found, among other things, that SC violated the Consumer Financial Protection Act of 2010 (the "CFPA") in its marketing of GAP coverage and in certain of its loan deferral disclosure practices. Without admitting or denying the findings, SC agreed to pay a civil penalty of $2.5 million to the CFPB and to provide remediation to certain impacted customers. The consent order also requires SC to submit a comprehensive plan to the CFPB demonstrating how it will comply with the CFPA and the terms of the consent order.  


43





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



In October 2014, SC received a subpoena from the SEC commencing an investigation into the SC’s securitization practices. In June 2016, the SEC served an additional subpoena on SC requesting documents related to SC’s securitization practices as well as SC’s financial restatements. SC has produced documents responsive to these subpoenas, and the SEC has taken testimony from certain of SC’s employees.  In December 2018, the SEC and SC reached a voluntary agreement to settle the SEC's investigation under which the SEC entered a cease-and-desist order against SC in an administrative matter captioned In the Matter of Santander Consumer USA Holdings Inc., File No. 3-18932.  According to the SEC’s order, among other things, SC failed to calculate and report its credit loss allowance for certain impaired loans in accordance with GAAP.  The SEC’s order also found that SC failed to maintain effective internal control over financial reporting, leading to SC’s financial restatements.    Without admitting or denying the findings, SC paid a civil penalty of $1.5 million in January 2019 and agreed to cease and desist from any future violations of the Exchange Act and the rules thereunder.

On March 21, 2017, SC and the Company entered into a written agreement with the FRB of Boston. Under the terms of that agreement, SC is required to enhance its compliance risk management program, board oversight of risk management and senior management oversight of risk management, and the Company is required to enhance its oversight of SC's management and operations.

In July 2015, the CFPB notified SC that it had referred to the DOJ certain alleged violations by SC of the Equal Credit Opportunity Act (the “ECOA”) regarding (i) statistical disparities in mark-ups charged by automobile dealers to protected groups on loans originated by those dealers and purchased by SC and (ii) the treatment of certain types of income in SC's underwriting process. In September 2015, the DOJ notified SC that it had initiated an investigation under the ECOA of SC's pricing of automobile loans based on the referral from the CFPB. SC resolved the DOJ investigation pursuant to a confidential agreement with the CFPB.

As of December 31, 2018, SSLLC had received 589 FINRA arbitration cases related to Puerto Rico bonds and Puerto Rico closed-end funds ("CEFs"). Most of these cases are based upon concerns regarding the local Puerto Rico securities market. The statements of claims allege, among other things, fraud, negligence, breach of fiduciary duty, breach of contract, unsuitability, over-concentration and failure to supervise. There were 420 arbitration cases that remained pending as of December 31, 2018.

As a result of Hurricane Maria impacting the Puerto Rico market including declines in Puerto Rico bond and CEF prices, it is possible that additional arbitration claims and/or increased claim amounts may be asserted in future periods.

In addition, SSLLC, Santander BanCorp, BSPR, the Company and Santander are defendants in a putative class action alleging federal securities and common law claims relating to the solicitation and purchase of more than $180 million of Puerto Rico bonds and $101 million of CEFs during the period from December 2012 to October 2013. The case is pending in the United States District Court for the District of Puerto Rico and is captioned Jorge Ponsa-Rabell, et. al. v. SSLLC, Civ. No. 3:17-cv-02243. The amended complaint alleges that defendants acted in concert to defraud purchasers in connection with the underwriting and sale of Puerto Rico municipal bonds, CEFs and open-end funds.


44





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



Disclosure Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act

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

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

Santander UK plc (“Santander UK”) holds two savings accounts and one current account for two customers. Both of the customers, who are resident in the UK, are currently designated by the U.S. under the Specially Designated Global Terrorist ("SDGT") sanctions program. Revenues and profits generated by Santander UK on these accounts in the year ended December 31, 2018 were negligible relative to the overall profits of Santander.
   
Santander UK holds one savings account with a balance of £1.24 as of December 31, 2018 and one current account with a balance of £1,884.53 as of December 31, 2018, for another customer resident in the UK who is currently designated by the U.S. under the SDGT sanctions program.  The United Nations and European Union removed this customer from their equivalent sanctions lists in 2008.  The customer relationship predates the designations of the customer under these sanctions.  After identifying the U.S. sanctions issue, Santander UK confirmed the absence of any U.S. dollar payments to or from the customer's accounts, determined to put a block on the accounts and the accounts were closed on January 14, 2019.  Revenues generated by Santander UK on these accounts in the year ended December 31, 2018 were negligible relative to the overall profits of Santander.

Santander UK holds two frozen current accounts for two UK nationals who are designated by the U.S. under the SDGT sanctions program. The accounts held by each customer have been frozen since their designation and remained frozen through 2018. The accounts are in arrears (£1,844.73 in debit combined) and are currently being managed by Santander UK's Collections and Recoveries Department. No revenues or profits were generated by Santander UK on these accounts through year ended December 31, 2018.

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

In the aggregate, all of the transactions described above resulted in gross revenues and net profits in the year ended December 31, 2018, which were negligible relative to the overall revenues and profits of Santander. Santander has undertaken significant steps to withdraw from the Iranian market, such as closing its representative office in Iran and ceasing all banking activities therein, including correspondent relationships, deposit- taking from Iranian entities and issuing export letters of credit, except for the legacy transactions described above. Santander is not contractually permitted to cancel these arrangements without either (i) paying the guaranteed amount (in the case of the performance guarantees), or (ii) forfeiting the outstanding amounts due to it (in the case of the export credits). As such, Santander intends to continue to provide the guarantees and hold these assets in accordance with company policy and applicable laws.


45





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



CRITICAL ACCOUNTING ESTIMATES

This MD&A is based on the Consolidated Financial Statements and accompanying notes that have been prepared in accordance with GAAP. The significant accounting policies of the Company are described in Note 1 to the Consolidated Financial Statements. The preparation of financial statements in accordance with GAAP requires management to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, accordingly, have a greater possibility of producing results that could be materially different than originally reported. However, the Company is not currently aware of any likely events or circumstances that would result in materially different results. Management identified accounting for ALLL and the reserve for unfunded lending commitments, accretion of discounts and subvention on RICs, estimates of expected residual values of leased vehicles subject to operating leases, goodwill, fair value measurements and income taxes as the Company's most critical accounting estimates, in that they are important to the portrayal of the Company's financial condition and results and require management’s most difficult, subjective and complex judgments as a result of the need to make estimates about the effects of matters that are inherently uncertain.

ALLL for Loan Losses and Reserve for Unfunded Lending Commitments

The ALLL and reserve for unfunded lending commitments represent management's best estimate of probable losses inherent in the loan portfolio. The adequacy of SHUSA's ALLL and reserve for unfunded lending commitments is regularly evaluated. This evaluation process is subject to several estimates and applications of judgment. Management's evaluation of the adequacy of the allowance to absorb loan and lease losses takes into consideration the risks in the loan portfolio, past loan and lease loss experience, specific loans that have loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. Management also considers loan quality, changes in the size and character of the loan portfolio, the amount of NPLs, and industry trends. Changes in these estimates could have a direct material impact on the provision for credit losses recorded in the Consolidated Statements of Operations and/or could result in a change in the recorded allowance and reserve for unfunded lending commitments. The loan portfolio represents the largest asset on the Consolidated Balance Sheets. Note 1 to the Consolidated Financial Statements describes the methodology used to determine the ALLL and reserve for unfunded lending commitments in the Consolidated Balance Sheets. A discussion of the factors driving changes in the amount of the ALLL and reserve for unfunded lending commitments for the periods presented is included in the Credit Risk Management section of this MD&A. 

The ALLL includes: (i) an allocated allowance, which is comprised of allowances established on loans specifically evaluated for impairment and loans collectively evaluated for impairment, based on historical loan and lease loss experience adjusted for current trends general economic conditions and other risk factors, and (ii) an unallocated allowance to account for a level of imprecision in management's estimation process. Generally, the Company’s loans held for investment are carried at amortized cost, net of the ALLL. The ALLL includes the estimate of credit losses to be realized during the loss emergence period based on the recorded investment in the loan, including net discounts that are expected at the time of charge-off. In the case of loans purchased in a bulk purchase or business combination, the entire discount on the loan portfolio is considered as available to absorb the credit losses when determining the ALLL. For these loans, the Company records provisions for credit losses when incurred losses exceed the unaccreted purchase discount. Reserve levels are collectively reviewed for adequacy and approved quarterly.

The Company's allocated reserves are principally based on various models subject to the Company's Model Risk Management Framework. New models are approved by the Company's Model Risk Management Committee. Models, inputs and documentation are further reviewed and validated at least annually, and the Company completes a detailed variance analysis of historical model projections against actual observed results on a quarterly basis. Required actions resulting from the Company's analysis, if necessary, are governed by its Allowance for Loan and Lease Losses Committee.

The Company's unallocated allowance is no more than 5% of the overall allowance. This is considered to be reasonably sufficient to absorb imprecisions of models to otherwise provide for coverage of inherent losses in the Company's entire loan and lease portfolio. Imprecisions include loss factors in the loan portfolio that may not have been discreetly contemplated in the general and specific components of the allowance, as well as potential variability in estimates. Period-to-period changes in the Company's historical unallocated ALLL positions are considered in light of these factors.

46





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



Valuation of Automotive Lease Assets and Residuals

The Company has significant investments in vehicles in SC's operating lease portfolio. In accounting for operating leases, management must make a determination at the beginning of the lease contract of the estimated realizable value (i.e., residual value) of the vehicle at the end of the lease. Residual value represents an estimate of the market value of the vehicle at the end of the lease term, which typically ranges from two to four years. At contract inception, the Company determines the projected residual value based on an internal evaluation of the expected future value. This evaluation is based on a proprietary model using internally-generated data that is compared against third-party, independent data for reasonableness. The customer is obligated to make payments during the term of the lease for the difference between the purchase price and the contract residual value plus a finance charge. However, since the customer is not obligated to purchase the vehicle at the end of the contract, the Company is exposed to a risk of loss to the extent the value of the vehicle is below the residual value estimated at contract inception. Management periodically performs a detailed review of the estimated realizable value of leased vehicles to assess the appropriateness of the carrying value of leased assets.

To account for residual risk, the Company depreciates automobile operating lease assets to estimated realizable value on a straight-line basis over the lease term. The estimated realizable value is initially based on the residual value established at contract inception. Periodically, the Company revises the projected value of the leased vehicle at termination based on current market conditions and other relevant data points, and adjusts depreciation expense appropriately over the remaining term of the lease.

The Company periodically evaluates its investment in operating leases for impairment if circumstances, such as a systemic and material decline in used vehicle values occurs. These circumstances could include, for example, a decline in the residual value of our lease portfolio due to an event caused by shocks to oil and gas prices (which may have a pronounced impact on certain models of vehicles) or pervasive manufacturer defects (which may systemically affect the value of a particular brand or model). Impairment is determined to exist if the fair value of the leased asset is less than its carrying value and it is determined that the net carrying value is not recoverable. The net carrying value of a leased asset is not recoverable if it exceeds the sum of the undiscounted expected future cash flows expected to result from the lease payments and the estimated residual value upon eventual disposition. If our operating lease assets are considered to be impaired, the impairment is measured as the amount by which the carrying amount of the assets exceeds the fair value as estimated by discounted cash flows ("DCF"). No such impairment was recognized in 2018, 2017, or 2016.

The Company's depreciation methodology for operating lease assets considers management's expectation of the value of the vehicles upon lease termination, which is based on numerous assumptions and factors influencing used vehicle values. The critical assumptions underlying the estimated carrying value of automobile lease assets include: (1) estimated market value information obtained and used by management in estimating residual values, (2) proper identification and estimation of business conditions, (3) our remarketing abilities, and (4) automobile manufacturer vehicle and marketing programs. Changes in these assumptions could have a significant impact on the value of the lease residuals. Expected residual values include estimates of payments from automobile manufacturers
related to residual support and risk-sharing agreements, if any. To the extent an automotive manufacturer is not able to fully honor its obligation relative to these agreements, the Company's depreciation expense would be negatively impacted.

Accretion of Discounts and Subvention on RICs

Loans held for investment ("LHFI") include the RIC portfolio which consists largely of nonprime automobile loans, and which are primarily acquired individually from dealers at a nonrefundable discount from the contractual principal amount. The Company also pays dealer participation on certain receivables. The amortization of discounts, subvention payments from manufacturers, and other origination costs are recognized as adjustments to the yield of the related contracts. The Company applies significant assumptions, including prepayment speeds in estimating the accretion rates used to approximate effective yield.

The Company estimates future principal prepayments specific to pools of homogeneous loans which are based on the vintage, credit quality at origination and term of the loan. Prepayments in our portfolio are sensitive to credit quality, with higher credit quality loans experiencing higher voluntary prepayment rates than lower credit quality loans. The impact of defaults is not considered in the prepayment rate; the prepayment rate only considers voluntary prepayments. The resulting prepayment rate specific to each pool is based on historical experience and is used as an input in the calculation of the constant effective yield.

47





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



Goodwill

The acquisition method of accounting for business combinations requires the Company to make use of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value of the assets acquired and liabilities assumed. The excess of the purchase price of an acquired business over the fair value of the identifiable assets and liabilities represents goodwill. Goodwill and other indefinite-lived intangible assets are not amortized on a recurring basis, but rather are subject to periodic impairment testing.

As more fully described in Note 23 to the Consolidated Financial Statements, a reporting unit is an operating segment or one level below. The Company conducts its evaluation of goodwill impairment at the reporting unit level on an annual basis on October 1, and more frequently if events or circumstances indicate that the carrying value of a reporting unit exceeds its fair value. As of December 31, 2018, the reporting units with assigned goodwill were Consumer and Business Banking, Commercial Banking, CIB, and SC.

An entity's quantitative goodwill impairment analysis must be completed unless the entity determines, based on certain qualitative factors, that it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is greater than its carrying amount, including goodwill, and that no impairment exists. An entity has an unconditional option to bypass the preceding qualitative assessment for any reporting unit in any period and proceed directly to the quantitative analysis of the goodwill impairment test.

The quantitative analysis requires a comparison of the fair value of each reporting unit to its carrying amount, including its allocated goodwill. If the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and no further analysis is necessary. If the carrying value of the reporting unit is higher than the fair value, impairment is measured as the excess of the carrying amount over the fair value. A recognized impairment charge cannot exceed the amount of goodwill allocated to a reporting unit, and cannot subsequently be reversed even if the fair value of the reporting unit recovers. The Company utilizes the market capitalization approach to determine the fair value of its SC reporting unit, as it is a publicly traded company that has a single reporting unit. Determining the fair value of the remaining reporting units requires significant valuation inputs, assumptions, and estimates.

The Company determines the carrying value of each reporting unit using a risk-based capital approach. Certain of the Company's assets are assigned to a Corporate/Other category. These assets are related to the Company's corporate-only programs, such as BOLI, and are not employed in or related to the operations of a reporting unit or considered in determining the fair value of a reporting unit.

Goodwill impairment testing involves management's judgment, requiring an assessment of whether the carrying value of the reporting unit can be supported by its fair value. This is performed using widely-accepted valuation techniques, such as the guideline public company market approach (earnings and price-to-tangible book value multiples of comparable public companies), the market capitalization approach (share price of the reporting unit and control premium of comparable public companies), and the income approach (the DCF method). The Company uses a combination of these accepted methodologies to determine the fair valuation of reporting units. Several factors are taken into account, including actual operating results, future business plans, economic projections, and market data.

The guideline public company market approach ("market approach") includes earnings and price-to-tangible book value multiples of comparable public companies which were applied to the earnings and equity for all of the Company's reporting units. The market capitalization plus control premium approach was applied to the Company's SC reporting unit, as the SC reporting unit is a publicly traded subsidiary whose securities are traded in an active market.

In connection with the market capitalization plus control premium approach applied to the Company's SC reporting unit, the Company used SC's stock price as of the date of the annual impairment analysis. The Company also considered historical auto loan industry transactions and control premiums over the last three years in determining the control premium.

The DCF method of the income approach incorporates the reporting units' forecasted cash flows, including a terminal value to estimate the fair value of cash flows beyond the final year of the forecasts. The discount rates utilized to obtain the net present value of the reporting units' cash flows were estimated using a capital asset pricing model. Significant inputs to this model include a risk-free rate of return, beta (which is a measure of the level of non-diversifiable risk associated with comparable companies for each specific reporting unit), market equity risk premium, and, in certain cases, additional premium for size and/or unsystematic company-specific risk factors. The Company utilized discount rates that it believes adequately reflect the risk and uncertainty in the financial markets. The Company estimated expected rates of equity returns based on historical market returns and risk/return rates for similar industries of the reporting unit. The Company uses its internal forecasts to estimate future cash flows, so actual results may differ from forecasted results.

48





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



All of the preceding fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill impairment test will prove to be accurate predictions in the future. Examples of events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impacts the estimated fair value of the aforementioned reporting units include such items as:

a prolonged downturn in the business environment in which the reporting units operate;
an economic recovery that significantly differs from our assumptions in timing or degree;
volatility in equity and debt markets resulting in higher discount rates; and unexpected regulatory changes.
Specific to the SC reporting unit, a decrease in SC's share price would impact the fair value of the reporting segment.

Refer to the Financial Condition, Goodwill section of this MD&A for further details on the Company's goodwill, including the results of management's goodwill impairment analyses.

Fair Value Measurements

The Company uses fair value measurements to estimate the fair value of certain assets and liabilities for both measurement and disclosure purposes. Refer to Note 16 to the Consolidated Financial Statements for a description of valuation methodologies used to measure material assets and liabilities at fair value and details of the valuation models, key inputs to those models, and significant assumptions utilized. The Company follows the fair value hierarchy set forth in Note 16 to the Consolidated Financial Statements to prioritize the inputs utilized to measure fair value. The Company reviews and modifies, as necessary, the fair value hierarchy classifications on a quarterly basis. Accordingly, there may be reclassifications between hierarchy levels due to changes in inputs to the valuation techniques used to measure fair value.

The Company has numerous internal controls in place to ensure the appropriateness of fair value measurements, including controls over the inputs into and the outputs from the fair value measurements. Certain valuations are benchmarked to market indices when appropriate and available.

Considerable judgment is used in forming conclusions from observable market data used to estimate the Company's Level 2 fair value measurements and in estimating inputs to the Company's internal valuation models used to estimate Level 3 fair value measurements. Level 3 inputs such as interest rate movements, prepayment speeds, credit losses, recovery rates and discount rates are inherently difficult to estimate. Changes to these inputs can have a significant effect on fair value measurements. Accordingly, the Company's estimates of fair value are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange.

Income Taxes

The Company accounts for income taxes under the asset and liability method. Deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates that apply or will apply to taxable income in the years in which those temporary differences are expected to reverse or be realized. The effect of a change in tax rates on deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date. A valuation allowance will be established if the Company determines that it is more likely than not that a deferred tax asset will not be realized. This requires periodic analysis of the carrying amount of deferred tax assets and when the deferred tax assets will be realized in future periods. Consideration is given to all positive and negative evidence related to the realization of deferred tax assets. The critical assumptions used in the Company's deferred tax asset valuation allowance analysis are as follows: (a) the expectation of future earnings; (b) estimates of the Company's long-term annual growth rate, based on the Company's long-term economic outlook in the U.S.; (c) estimates of the dividend income payout ratio from the Company's consolidated subsidiary, SC, based on current policies and practices of SC; (d) estimates of book income to tax income differences, based on the analysis of historical differences and the historical timing of the reversal of temporary differences; (e) the ability to carry back losses to recoup taxes previously paid; (f) estimates of tax credits to be earned on current investments, based on the Company's evaluation of the credits applicable to each investment; (g) experience with operating loss and tax credit carryforwards not expiring unused; (h) estimates of applicable state tax rates based on current/most recent enacted tax rates and state apportionment calculations; (i) tax planning strategies; and (j) current tax laws. Significant judgment is required to assess future earnings trends and the timing of reversals of temporary differences.


49





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



The Company bases its expectations of future earnings, which are used to assess the realizability of its deferred tax assets, on financial performance forecasts of its operating subsidiaries and unconsolidated investees. The budgets and estimates used in these forecasts are approved by the Company's management, and the assumptions underlying the forecasts are reviewed at least annually and adjusted as necessary based on current developments or when new information becomes available. The updates made and the variances between the Company's forecasts and its actual performance have not been significant enough to alter the Company's conclusions with regard to the realizability of its deferred tax asset, including the effect of the SC transaction that occurred in 2011 and the Change in Control that occurred in the first quarter of 2014. The Company continues to forecast sufficient taxable income to fully realize its current deferred tax assets. Forecasted taxable income is subject to changes in overall market and global economic conditions.

In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of inherently complex tax laws in the U.S., its states and municipalities, and abroad. Actual income taxes paid may vary from estimates depending on changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. The Company reviews its tax balances quarterly and as new information becomes available. Interest and penalties on income tax payments are included within income tax expense in the Consolidated Statements of Operations.

The Company recognizes tax benefits in its financial statements when it is more likely than not the related tax position will be sustained upon examination by tax authorities. Such tax positions are initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the taxing authority assuming full knowledge of the position and all relevant facts. See Note 15 of the Consolidated Financial Statements for details on the Company's income taxes.


50





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



RESULTS OF OPERATIONS


RESULTS OF OPERATIONS FOR THE YEARS ENDED DECMEMBER 31, 2018 AND 2017
 
 
Year Ended December 31,
 
Year To Date Change
(dollars in thousands)
 
2018
 
2017
 
Dollar increase/(decrease)
 
Percentage
Net interest income
 
$
6,344,850

 
$
6,423,950

 
$
(79,100
)
 
(1.2
)%
Provision for credit losses
 
(2,339,898
)
 
(2,759,944
)
 
(420,046
)
 
(15.2
)%
Total non-interest income
 
3,244,308

 
2,901,253

 
343,055

 
11.8
 %
General, administrative and other expenses
 
(5,832,325
)
 
(5,764,324
)
 
68,001

 
1.2
 %
Income before income taxes
 
1,416,935


800,935

 
616,000

 
76.9
 %
Income tax provision/ (benefit)
 
425,900

 
(157,040
)
 
582,940

 
371.2
 %
Net income
 
991,035

 
957,975

 
33,060

 
3.5
 %
Net income attributable to non-controlling interest
 
283,631

 
405,625

 
(121,994
)
 
(30.1
)%
Net income attributable to SHUSA

$
707,404

 
$
552,350

 
$
155,054

 
28.1
 %

The Company reported pre-tax income of $1.4 billion for the year ended December 31, 2018, compared to pre-tax income of $800.9 million for the year ended December 31, 2017. Factors contributing to this change were as follows:

Net interest income decreased $79.1 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily due to an increase in interest expense on deposits and customer accounts as a result of higher interest rates overall and promotional rates offered during the year, and an increase in interest expense on borrowings due to higher borrowing rates, offset by an increase in interest income on loans driven by higher interest rates.
The provision for credit losses decreased $420.0 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily due to decline in the Company's net charge-offs, improved credit performance and stable recovery rates of the loan portfolio.
Total non-interest income increased $343.1 million for the year ended December 31, 2018 compared to 2017. This increase was primarily due to lease income associated with the continued growth of the lease portfolio and an increase in gain on sale of assets coming off lease.
Total general, administrative and other expenses increased $68.0 million for the year ended December 31, 2018 compared to 2017. This increase was primarily due to an increase in lease depreciation expense as a result of growth of the Company's leased vehicle portfolio, offset by lower compensation and benefits expenses and lower loss on debt repurchases for the year ended December 31, 2018.
Income tax provisions increased $582.9 million for the year ended December 31, 2018 compared to 2017. The income tax provision increased in 2018 primarily due to the enactment of the Tax Cuts and Jobs Act (“TCJA”) in 2017, which resulted in a significant benefit in 2017 to re-measure the net deferred tax liabilities due to the federal rate reduction.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

51





Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations



 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
CONSOLIDATED AVERAGE BALANCE SHEET / NET INTEREST MARGIN ANALYSIS
 
YEAR ENDED December 31, 2018 AND 2017
 
2018 (1)
 
2017 (1)
 
 
Change due to
(dollars in thousands)
Average
Balance
 
Interest
 
Yield/
Rate
(2)
 
Average
Balance
 
Interest
 
Yield/
Rate
(2)
 
Increase/(Decrease)
Volume
Rate
EARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
INVESTMENTS AND INTEREST EARNING DEPOSITS
$
21,342,992

 
$
522,677

 
2.45
%
 
$
26,251,822

 
$
498,734

 
1.90
%
 
$
23,943

$
(43,686
)
$
67,629

LOANS(3):
 
 
 
 
 
 
 
 
 
 
 
 



Commercial loans
31,416,207

 
1,325,001

 
4.22
%
 
32,897,457

 
1,216,958

 
3.70
%
 
108,043

(50,931
)
158,974

Multifamily
8,191,487

 
328,147

 
4.01
%
 
8,334,329

 
311,068

 
3.73
%
 
17,079

(5,054
)
22,133

Total commercial loans
39,607,694

 
1,653,148

 
4.17
%
 
41,231,786

 
1,528,026

 
3.71
%
 
125,122

(55,985
)
181,107

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgages
9,716,021

 
392,660

 
4.04
%
 
8,471,891

 
334,463

 
3.95
%
 
58,197

50,381

7,816

Home equity loans and lines of credit
5,602,240

 
261,745

 
4.67
%
 
5,902,819

 
233,477

 
3.96
%
 
28,268

(11,214
)
39,482

Total consumer loans secured by real estate
15,318,261

 
654,405

 
4.27
%
 
14,374,710

 
567,940

 
3.95
%
 
86,465

39,167

47,298

RICs and auto loans
27,559,139

 
4,570,641

 
16.58
%
 
26,881,782

 
4,603,561

 
17.13
%
 
(32,920
)
120,049

(152,969
)
Personal unsecured
2,362,910

 
630,394

 
26.68
%
 
2,500,670

 
619,053

 
24.76
%
 
11,341

(27,823
)
39,164

Other consumer(4)
526,170

 
37,788

 
7.18
%
 
698,654

 
58,765

 
8.41
%
 
(20,977
)
(13,174
)
(7,803
)
Total consumer
45,766,480

 
5,893,228

 
12.88
%
 
44,455,816

 
5,849,319

 
13.16
%
 
43,909

118,219

(74,310
)
Total loans
85,374,174

 
7,546,376

 
8.84
%
 
85,687,602

 
7,377,345

 
8.61
%
 
169,031

62,234

106,797

Intercompany investments
3,572

 
142

 
3.98
%
 
10,832

 
626

 
5.78
%
 
(484
)
(330
)
(154
)
TOTAL EARNING ASSETS
106,720,738

 
8,069,195

 
7.56
%
 
111,950,256

 
7,876,705

 
7.04
%
 
192,490

18,218

174,272

Allowance for loan losses(5)
(3,835,182
)
 
 
 
 
 
(3,954,133
)
 
 
 
 
 
 
 
 
Other assets(6)
28,346,465

 
 
 
 
 
26,526,834

 
 
 
 
 
 
 
 
TOTAL ASSETS
$
131,232,021

 
 
 
 
 
$
134,522,957

 
 
 
 
 
 
 
 
INTEREST-BEARING FUNDING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits and other customer related accounts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
$
9,116,631

 
$
40,355

 
0.44
%
 
$
10,138,818

 
$
23,560

 
0.23
%
 
$
16,795

$
(2,084
)
$
18,879

Savings
5,887,341

 
12,325

 
0.21
%
 
5,888,011

 
11,004

 
0.19
%
 
1,321

(1
)
1,322

Money market
25,308,245

 
248,683

 
0.98
%
 
25,403,882

 
132,993

 
0.52
%
 
115,690

(497
)
116,187

CDs
5,989,993

 
87,765

 
1.47
%
 
6,592,535

 
73,487

 
1.11
%
 
14,278

(5,603
)
19,881

TOTAL INTEREST-BEARING DEPOSITS
46,302,210

 
389,128

 
0.84
%
 
48,023,246

 
241,044

 
0.50
%
 
148,084

(8,185
)
156,269

BORROWED FUNDS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Federal Home Loan Bank ("FHLB") advances, federal funds, and repurchase agreements
2,066,575

 
53,674

 
2.60
%
 
4,258,450

 
65,294

 
1.53
%
 
(11,620
)
(18,987
)
7,367

Other borrowings
38,152,038

 
1,281,401

 
3.36
%
 
37,983,865

 
1,145,791

 
3.02
%
 
135,610

5,126

130,484

TOTAL BORROWED FUNDS (7)
40,218,613

 
1,335,075

 
3.32
%
 
42,242,315

 
1,211,085

 
2.87
%
 
123,990

(13,861
)
137,851

TOTAL INTEREST-BEARING FUNDING LIABILITIES
86,520,823

 
1,724,203

 
1.99
%
 
90,265,561

 
1,452,129

 
1.61
%
 
272,074

(22,046
)
294,120

Noninterest bearing demand deposits
15,117,229

 
 
 
 
 
15,629,718

 
 
 
 
 
 
 
 
Other liabilities(8)
5,490,385

 
 
 
 
 
5,239,268

 
 
 
 
 
 
 
 
TOTAL LIABILITIES
107,128,437

 
 
 
 
 
111,134,547

 
 
 
 
 
 
 
 
STOCKHOLDER’S EQUITY
24,103,584

 
 
 
 
 
23,388,410

 
 
 
 
 
 
 
 
TOTAL LIABILITIES AND STOCKHOLDER’S EQUITY
$
131,232,021

 
 
 
 
 
$
134,522,957

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NET INTEREST SPREAD (9)
 
 
 
 
5.57
%
 
 
 
 
 
5.43
%
 
 
 
 
NET INTEREST MARGIN (10)
 
 
 
 
5.95
%
 
 
 
 
 
5.74
%
 
 
 
 
NET INTEREST INCOME (11)
 
 
$
6,344,850

 
 
 
 
 
$
6,423,950

 
 
 
 
 
 
 
 
 
 
 
1.23x

 
 
 
 
 
1.24x

 
 
 
 
(1)
Average balances are based on daily averages when available. When daily averages are unavailable, mid-month averages are substituted.
(2)
Yields calculated using taxable equivalent net interest income.
(3)
Interest on loans includes amortization of premiums and discounts on purchased loan portfolios and amortization of deferred loan fees, net of origination costs. Average loan balances includes non-accrual loans and loans held-for-sale ("LHFS").
(4)
Other consumer primarily includes recreational vehicle ("RV") and marine loans.
(5)