SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 20-F
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
BANCO SANTANDER CENTRAL HISPANO, S.A.
(Exact name of Registrant as specified in its charter)Kingdom of Spain(Jurisdiction of incorporation)Ciudad Grupo Santander28660 Boadilla del Monte (Madrid), Spain(address of principal executive offices)
Securities registered or to be registered, pursuant to Section 12(b) of the Act
Guarantee of Non-cumulative Preferred Stock of BCH Capital Limited
Guarantee of Non-cumulative Guaranteed Preferred Stock of Santander Finance Preferred, S.A. Unipersonal
Banco Santander Central Hispano Shares are not listed for trading, but only in connection with the registration of the American Depositary Shares, pursuant to requirements of the New York Stock Exchange.
Securities registered or to be registered pursuant to Section 12(g) of the Act. None. (Title of Class) Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act None. (Title of Class) The number of outstanding shares of each class of Stock of Banco Santander Central Hispano, S.A. atDecember 31, 2004 was:Shares par value Euro 0.50 each: 6,254,296,579
The number of outstanding shares of each class of stock of BSCH Finance Limited benefiting from a guarantee of Banco Santander Central Hispano, S.A., at December 31, 2004 was:
12,000,000
The number of outstanding shares of each class of stock of BCH Capital Limited benefiting from a guarantee of Banco Santander Central Hispano, S.A., at December 31, 2004 was:
9,200,000
The number of outstanding shares of each class of stock of Santander Finance Preferred, S.A. Unipersonal benefiting from a guarantee of Banco Santander Central Hispano, S.A. at December 31, 2004 was:
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.
Indicate by check mark which financial statement item the registrant has elected to follow.
TABLE OF CONTENTS
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PRESENTATION OF FINANCIAL AND OTHER INFORMATION
Conversion to Euros
Accounting Principles
Except where we note otherwise, we prepared the financial information contained in this report according to Bank of Spain Circular 4/91, as amended (Spanish GAAP). As disclosed in note 28 to our consolidated financial statements, Spanish GAAP differs in some significant respects from U.S. GAAP.
We have formatted our financial information according to the classification format for banks used in Spain. We have not reclassified the line items to comply with Article 9 of Regulation S-X. Article 9 is a regulation of the U.S. Securities and Exchange Commission that contains formatting requirements for bank holding company financial statements. We have, however, included summary financial information that reflects the required reclassifications in note 28 to our consolidated financial statements.
Our auditors, Deloitte, S.L., have audited our consolidated financial statements in respect of the three years ended December 31, 2004 in accordance with Spanish GAAP and without qualification. The auditor’s report for December 31, 2004 does, however, include a reference relating to certain differences in our financial statements for the year ended December 31, 2004 as compared to the year ended December 31, 2003. These differences stem from the different accounting treatment accorded to pension commitments arising from early retirements in 2003 versus 2004. During 2003, with the express authorization of the Bank of Spain, the commitments arising from early retirements by the Bank and by other companies of the Group were charged against reserves. In 2004, the Bank of Spain did not grant such authorization to credit entities, including us, and subsequently the Bank charged such obligations against its income.
See page F-1 to our consolidated financial statements for the 2004 report prepared by our independent registered public accounting firm.
Acquisition of Abbey National plc.
In November 2004, we acquired 100% of the capital of Abbey National plc (“Abbey”). Under Spanish GAAP, our acquisition of Abbey has been reflected on our financial statements as if the acquisition had occurred on December 31, 2004. Accordingly, Abbey’s assets and liabilities were consolidated into our balance sheet as of December 31, 2004, but Abbey’s results of operations had no impact on our income statement for the year ended December 31, 2004.
Balance sheet and average balance sheet information in this Annual Report for the year ended December 31, 2004 includes the consolidation of Abbey line by line as of December 31, 2004 and renders such balances and average balances incompatible to the comparable data for the year ended December 31, 2003. In order to facilitate comparison of balances and average balances for these periods, we have provided in this report pro forma balance sheet and average balance sheet information for the year ended December 31, 2004 without consolidating Abbey. As a result, in the pro forma balance sheet, we are accounting for our investment in Abbey as if we did not have control over Abbey.
General Information
Our consolidated financial statements are in Euros, which are denoted “euro”, “euros”, EUR or “€” throughout this annual report. Also, throughout this annual report, when we refer to:
“one billion”, we mean 1,000 million.
When we refer to average balances for a particular period, we mean the average of the month-end balances for that period, unless otherwise noted. We do not believe that monthly averages present trends that are materially different from trends that daily averages would show. We included in interest income any interest payments we received on non-accruing loans if they were received in the period when due. We have not reflected consolidation adjustments in any financial information about our subsidiaries or other units.
When we refer to loans, we mean loans, leases, discounted bills and accounts receivable, unless otherwise noted.
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When we refer to non-performing assets, we mean non-performing loans, securities and other assets to collect.
When we refer to the allowances for credit-losses, we mean the statistical allowance for credit losses, the specific allowances for credit losses, and unless otherwise noted, the general allowance for credit losses including any allowances for country-risk. See “Item 4. Information on the Company—B. Business Overview—Selected Statistical Information—Classified Assets—Bank of Spain Allowance for Credit-Losses and Country-Risk Requirements”.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report contains statements that constitute “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include information regarding:
Forward-looking statements may be identified by words such as “expect,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “VaR,” “DCaR,” “ACaR,” “RORAC,” “target,” “goal,” “objective,” “estimate,” “future” and similar expressions. We include forward-looking statements in the “Operating and Financial Review Prospects,” “Information on the Company” and “Qualitative and Quantitative Disclosures About Market Risk” sections. Forward-looking statements are not guarantees of future performance and involve risks and uncertainities, and actual results may differ materially from those in the forward-looking statements.
You should understand that adverse changes in the following important factors, in addition to those discussed in “Risk Factors”, “Operating and Financial Review and Prospects,” “Information on the Company” and elsewhere in this Annual Report, could affect our future results and could cause those results or other outcomes to differ materially from those anticipated in any forward-looking statement:
Political and Governmental Factors
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The forward-looking statements contained in this annual report speak only as of the date of this annual report. We do not undertake to update any forward-looking statement to reflect events or circumstances after that date or to reflect the occurrence of unanticipated events.
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Selected Consolidated Financial Information
We have selected the following financial information from our consolidated financial statements. You should read this information in connection with, and it is qualified in its entirety by reference to, our consolidated financial statements.
We prepare our consolidated financial statements according to Spanish GAAP. Spanish GAAP differs in some significant respects from U.S. GAAP. In addition, our financial information is presented in Spanish format.
In the F-pages of this Form 20-F, audited financial statements for the years 2004, 2003 and 2002 are presented. Audited financial statements for the years 2001 and 2000 are not included in this document, but they can be found in our previous annual reports on Form 20-F.
In November 2004, we acquired 100% of the capital of Abbey National plc. Under Spanish GAAP, our acquisition of Abbey has been reflected on our financial statements as if the acquisition had occurred on December 31, 2004. Accordingly, Abbey’s assets and liabilities were consolidated into our balance sheet as of December 31, 2004, but Abbey’s results of operations had no impact on our income statement for the year ended December 31, 2004.
Balance sheet information in this Annual Report for the year ended December 31, 2004 includes the consolidation of Abbey line by line as of December 31, 2004 and renders such balances incompatible to the comparable data for the year ended December 31, 2003. In order to facilitate comparison of balances for these periods, we have provided in this report pro forma balance sheet information for the year ended December 31, 2004 without consolidating Abbey. As a result, in the pro forma balance sheet, we are accounting for our investment in Abbey as if we did not have control over Abbey. Our investment in Abbey is reflected in the pro forma balance sheet information under the item “Investments in Group and non-Group companies”.
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The following table shows net income, stockholders’ equity, total assets and certain ratios on a U.S. GAAP basis.
Exchange Rates
Fluctuations in the exchange rate between euros and dollars have affected the dollar equivalent of the share prices on Spanish Stock Exchanges and, as a result, are likely to affect the dollar market price of our American Depositary Shares, or ADSs, in the United States. In addition, dividends paid to the depositary of the ADSs are denominated in euros and fluctuations in the exchange rate affect the dollar conversion by the depositary of cash dividends paid on the shares to the holders of the ADSs. Fluctuations in the exchange rate of euros against other currencies may also affect the euro value of non-euro denominated assets, liabilities, earnings and expenses of Banco Santander Central Hispano.
Beginning January 1, 2002, most of the participating European Union member states, such as Spain, issued new euro-denominated bills and coins for use in cash transactions and withdrew the bills and coins denominated in their respective currencies.
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The following tables set forth, for the periods and dates indicated, certain information concerning the exchange rate for euros and dollars (expressed in dollars per euro), based on the Noon Buying Rate as announced by the Federal Reserve Bank of New York for the dates and periods indicated.
On June 24, 2005, the exchange rate for euros and dollars (expressed in dollars per euro), based on the Noon Buying Rate, was $1.2088.
For a discussion of the accounting principles used in translation of foreign currency-denominated assets and liabilities to euros, see Note 2(b) of our Consolidated Financial Statements.
B. Capitalization and indebtedness.
Not Applicable.
C. Reasons for the offer and use of proceeds.
D. Risk factors.
Risks Relating to Our Operations
Since our loan portfolio is concentrated in Continental Europe, the United Kingdom and Latin America, adverse changes affecting the Continental European, the United Kingdom or certain Latin American economies could adversely affect our financial condition.
Our loan portfolio is mainly concentrated in Continental Europe (in particular, Spain), the United Kingdom and Latin America. At December 31, 2004, Continental Europe accounted for approximately 49% of our total loan portfolio, while the United Kingdom and Latin America accounted for 40% and 10%, respectively. Therefore, adverse changes affecting the economies of Continental Europe (in particular Spain), the United Kingdom or the Latin American countries where we operate would likely have a significant adverse impact on our loan portfolio and, as a result, on our financial condition, cash flows and results of operations. See “Item 4. Information on the Company—B. Business Overview.”
Some of our business is cyclical and our income may decrease when demand for certain products or services is in a down cycle.
The level of income we derive from certain of our products and services depends on the strength of the economies in the regions where we operate and certain market trends prevailing in those areas. While we attempt to diversify our businesses, negative cycles may adversely affect our income in the future.
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Since our principal source of funds is short term deposits, a sudden shortage of these funds could increase our cost of funding.
Historically, our principal source of funds has been customer deposits (savings, demand and time deposits). At December 31, 2004 (including Abbey), 20.8% of these customer deposits are time deposits in amounts greater than $100,000. Time deposits have represented 59.5% and 51.7% of total customer deposits at the end of 2002 and 2003, respectively, and 49.4% at the end of 2004 (including Abbey). Large-denomination time deposits may be a less stable source of deposits than savings and demand deposits. In addition, since we rely heavily on short-term deposits for our funding, there can be no assurance that we will be able to maintain our levels of funding without incurring higher funding costs or liquidating certain assets.
A substantial percentage of our customer base is particularly sensitive to adverse developments in the economy.
Medium- and small-size companies and middle and lower-middle income individuals can be more adversely affected by adverse developments in the economy than large companies and high income individuals. As a result, our substantial lending to these segments of our existing and targeted customer base causes us to assume a relatively higher degree of risk than if we focused more heavily on the other, more economically stable groups.
Risks concerning borrower credit quality and general economic conditions are inherent in our business.
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. Adverse changes in the credit quality of our borrowers and counterparties or a general deterioration in Spanish, UK, Latin American or global economic conditions, or arising from systemic risks in the financial systems, could reduce the recoverability and value of our assets and require an increase in our level of provisions for credit losses. Deterioration in the economies in which we operate could reduce the profit margins for our banking and financial services businesses.
Increased exposure to real estate makes us more vulnerable to developments in this market.
The decrease in interest rates globally has caused an increase in the demand of mortgage loans in the last few years. This has had repercussions in housing prices, which have also risen significantly. As real estate mortgages are one of our main assets, comprising 50.9% of our loan portfolio at December 31, 2004 (including Abbey), we are currently highly exposed to developments in real estate markets. A strong increase in interest rates might have a significant negative impact in mortgage payment delinquency rates. An increase in such delinquency rates could have an adverse effect on our business, financial condition and results of operations.
The Group may generate lower revenues from brokerage and other commission- and fee-based businesses.
Market downturns are likely to lead to declines in the volume of transactions that the Group executes for its customers and, therefore, to declines in the Group’s non-interest revenues. In addition, because the fees that the Group charges for managing its clients’ portfolios are in many cases based on the value or performance of those portfolios, a market downturn that reduces the value of the Group’s clients’ portfolios or increases the amount of withdrawals would reduce the revenues the Group receives from its asset management and private banking and custody businesses.
Even the absence of a market downturn, below-market performance by the Group’s mutual funds may result in increased withdrawals and reduced inflows, which would reduce the revenue the Group receives from its asset management business.
Market risks associated with fluctuations in bond and equity prices and other market factors are inherent in the Group’s business. Protracted market declines can reduce liquidity in the markets, making it harder to sell assets and leading to material losses.
The performance of financial markets may cause changes in the value of the Group’s investment and trading portfolios. In some of the Group’s business, protracted adverse market movements, particularly asset price decline, can reduce the level of activity in the market or reduce market liquidity. These developments can lead to material losses if the Group cannot close out deteriorating positions in a timely way. This may especially be the case for assets of the Group for which there are not very liquid markets to begin with. Assets that are not traded on stock exchanges or other public trading markets, such as derivative contracts between banks, may have values that the Group calculates using models other than publicly quoted prices. Monitoring the deterioration of prices of assets like these is difficult and could lead to losses that the Group did not anticipate.
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Despite the Group’s risk management policies, procedures and methods, the Group may nonetheless be exposed to unidentified or unanticipated risks.
The Group has devoted significant resources to developing its risk management policies, procedures and assessment methods and intends to continue to do so in the future. Nonetheless, the Group’s risk management techniques and strategies may not be fully effective in mitigating the Group’s risk exposure in all economic market environments or against all types of risk, including risks that the Group fails to identify or anticipate. Some of the Group’s qualitative tools and metrics for managing risk are based upon the Group’s use of observed historical market behavior. The Group applies statistical and other tools to these observations to arrive at quantifications of its risk exposures. These tools and metrics may fail to predict future risk exposures. These risk exposures could, for example, arise from factors the Group did not anticipate or correctly evaluate in its statistical models. This would limit the Group’s ability to manage its risks. The Group’s losses thus could be significantly greater than the historical measures indicate. In addition, the Group’s quantified modeling does not take all risks into account. The Group’s more qualitative approach to managing those risks could prove insufficient, exposing it to material unanticipated losses. If existing or potential customers believe the Group’s risk management is inadequate, they could take their business elsewhere. This could harm the Group’s reputation as well as its revenues and profits.
Our recent acquisition of Abbey, and any future acquisitions may not be succesful and may be disruptive to our business.
We have acquired controlling interests in various companies, and more recently, we completed the acquisition of Abbey. Although we expect to realize strategic, operational and financial benefits as a result of the Abbey acquisition, we cannot predict whether and to what extent such benefits will be achieved. In particular, the success of the Abbey acquisition will depend, in part, on our ability to realize the anticipated cost savings from assuming the control of Abbey’s business. In addition, we will face certain challenges as we work to integrate Abbey’s operations into our businesses. Moreover, the Abbey acquisition increased our total assets by 51.7% as of December 31, 2004, thereby presenting us with significant challenges as we work to manage the increases in scale resulting from the acquisition. Our failure to successfully integrate and operate Abbey, and to realize the anticipated benefits of the acquisition, could adversely affect our operating, performing and financial results. See “Item 4. Information on the Company”. History and development of the company.” Additionally, we may consider other strategic acquisitions and partnerships from time to time. There can be no assurances that we will be successful in our plans regarding the operation of past or future acquisitions and strategic partnerships.
We can give you no assurance that our acquisition and partnership activities will perform in accordance with our expectations. Despite our due diligence efforts, we must necessarily base any assessment of potential acquisitions and partnerships on inexact and incomplete information and assumptions with respect to operations, profitability and other matters that may prove to be incorrect. We can give no assurance that our expectations with regards to integration and synergies will materialize.
Increased competition in the countries where we operate may adversely affect our growth prospects and operations.
Most of the financial systems in which we operate are highly competitive. Recent financial sector reforms in the markets in which we operate have increased competition among both local and foreign financial institutions, and we believe that this trend will continue. In particular, price competition in Europe and Latin America has increased recently. Our success in the European and Latin American markets will depend on our ability to remain competitive with other financial institutions. In addition, there has been a trend towards consolidation in the banking industry, which has created larger and stronger banks with which we must now compete. There can be no assurance that this increased competition will not adversely affect our growth prospects, and therefore our operations. We also face competition from non-bank competitors, such as brokerage companies, department stores (for some credit products), leasing companies and factoring companies, mutual fund and pension fund management companies and insurance companies.
Volatility in interest rates may negatively affect our net interest income and increase our non-performing loan portfolio.
Changes in market interest rates could affect the interest rates charged on interest-earning assets differently than the interest rates paid on interest-bearing liabilities. This difference could result in an increase in interest expense relative to interest income leading to a reduction in our net interest income. Income from treasury operations is particularly vulnerable to interest rate volatility. Since the majority of our loan portfolio reprices in less than one year, rising interest rates may also bring about an increasing non-performing loan portfolio. Interest rates are highly sensitive to many factors beyond our control, including deregulation of the financial sector, monetary policies, domestic and international economic and political conditions and other factors.
Foreign exchange rate fluctuations may negatively affect our earnings and the value of our assets and shares.
Fluctuations in the exchange rate between the euro and the U.S. dollar will affect the U.S. dollar equivalent of the price of our securities on the stock exchanges in which our shares and ADRs are traded. These fluctuations will also affect the conversion to U.S. dollars of cash dividends paid in euros on our shares.
In the ordinary course of our business, we have a percentage of our assets and liabilities denominated in currencies other than the euro. Fluctuations in the value of the euro against other currencies may adversely affect our profitability. For example, the appreciation of the euro against some Latin American currencies and the U.S. dollar will depress earnings from our Latin American operations, and the appreciation of the euro against the sterling will depress earnings from our UK operations. Additionally, while most of the governments of the countries in which we operate have not imposed prohibitions on the repatriation of dividends, capital investment or other distributions, no assurance can be given that these governments will not institute restrictive exchange control policies in the future. Moreover, fluctuations among the currencies in which our shares and ADRs trade could reduce the value of your investment.
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Changes in the regulatory framework in the jurisdictions where we operate could adversely affect our business.
A number of banking regulations designed to maintain the safety and soundness of banks and limit their exposure to risk apply in the different jurisdictions in which our subsidiaries operate. Changes in regulations, which are beyond our control, may have a material effect on our business and operations. As some of the banking laws and regulations have been recently adopted, the manner in which those laws and related regulations are applied to the operations of financial institutions is still evolving. Moreover, no assurance can be given generally that laws or regulations will be adopted, enforced or interpreted in a manner that will not have an adverse affect on our business.
Operational risks are inherent in our business.
Our businesses depend on the ability to process a large number of transactions efficiently and accurately. Losses can result from inadequate personnel, inadequate or failed internal control processes and systems, or from external events that interrupt normal business operations.
Different disclosure and accounting principles between Spain and the U.S. may provide you with different or less information about us than you expect.
There may be less publicly available information about us than is regularly published about companies in the United States. While we are subject to the periodic reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”), the disclosure required from foreign issuers under the Exchange Act is more limited than the disclosure required from U.S. issuers. Additionally, we present our financial statements under Spanish GAAP which differs from US GAAP. See note 28 to our consolidated financial statements.
In 2005, the Group will adopt International Financial Reporting Standards (“IFRS”), which will affect the financial results as IFRS differ in significant respects from Spanish GAAP.
Until December 31, 2004, the Group prepared its financial statements in accordance with Spanish GAAP. In June 2002, the Council of Ministers of the EU adopted new regulations requiring all listed EU companies, including Banco Santander, to apply IFRS (previously known as “International Accounting Standards” or “IAS”) in preparing their consolidated financial statements from January 1, 2005. Because IFRS emphasizes the measure of the fair value of certain assets and liabilities, applying these standards to our financial statements may have a considerable impact on a number of important areas, including, among others, goodwill and intangible assets, employee benefits and financial instruments, accounting for share-based payments, long-term assets and business combinations. Because our financial statements prepared in accordance with IFRS will differ from our financial statements prepared in accordance with Spanish GAAP, the me th ods used by the financial community to assess our financial performance and value our publicly-traded securities could be affected.
If we are not able to adequately implement the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and are the subject of sanctions or investigation, our results of operations and our ability to provide timely and reliable financial information may be adversely affected.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and related regulations implemented by the SEC are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. We will be evaluating our internal control over financial reporting to allow management to report on, and our registered independent public accounting firm to attest to, our internal controls over financial reporting. We will be performing the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, which we are required to comply with in ourannual report which we will file in 2007 for our 2006 fiscal year. As a result, we expect to incur substantial additional expenses and diversion of management’s time. While we anticipate being able to fully implement the requirements relating to internal controls and all other aspects of Section 404 by our deadline, we cannot be certain as to the timing of completion of our evaluation, testing and any remediation actions or the impact of the same on our operations since there is presently no precedent available by which to measure compliance adequacy. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities such as the SEC. Any such action could adversely affect our financial results or investors’ confidence in our company and could cause the price of our securities to fall. In addition, if we fail to develop and maintain effective controls and procedures, we may be unable to provide the financial information in a timely and reliable manner.
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Risks Relating to Latin America
Our Latin American subsidiaries’ growth, asset quality and profitability may be adversely affected by volatile macroeconomic conditions.
Additionally, the recent economic and political crisis in Argentina which led to the conversion by the Argentine government of all the U.S. dollar-denominated debt which was subject to Argentine laws and jurisdictions into Argentine peso-denominated debt had a negative impact on the Group’s Argentine banking subsidiaries. The negative effects on the Group’s operations in Argentina included losses generated by this forced conversion of U.S. dollar-denominated debt to Argentine pesos at below market rates, lower lending and deposit-making activities, increased restrictions on the transferability of funds and a larger number of defaults by Argentine customers. Although Argentina’s economy continued to recover in 2004, and the results of operations of the Group’s Argentine banking subsidiaries have also improved, it is possible that, despite its recent economic growth, Argentina could return to a period of economic and political instability. If this were to occur, the financial condition and results of operations of the Group’s Argentine subsidiaries could be materially and adversely affected.
Significant competition in some Latin American countries could intensify price competition and limit our ability to increase our market share in those markets.
Latin American economies can be directly and negatively affected by adverse developments in other countries.
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Item 4. Information on the Company
A. History and development of the company.
Banco Santander Central Hispano, S.A. is the parent bank of the Santander Group. It was established on March 21, 1857 and incorporated in its present form by a public deed executed in Santander, Spain, on January 14, 1875.
We are incorporated under, and governed by the laws of the Kingdom of Spain. We conduct business under the commercial name “Grupo Santander”. Our corporate offices are located in Ciudad Grupo Santander, Avda. de Cantabria s/n, 28660 Boadilla del Monte (Madrid), Spain. Telephone: (011) 34-91-259-6520.
Acquisitions, Dispositions, Reorganizations
Abbey National plc (“Abbey”). On July 25, 2004, our board of directors and the board of directors of Abbey announced that they had reached an agreement on the terms of a recommended acquisition by us of the total ordinary shares of Abbey by means of a scheme of arrangement under the United Kingdom Companies Act.
Polskie Towarzystwo Finansowe (“PTF”). In 2004, we acquired all the shares of PTF, a Polish consumer finance company (including the credit portfolio managed by it) for €524 million, of which €460 million represented the nominal value of the credit portfolio. This transaction generated goodwill of €70 million.
Abfin BV (“Abfin”). In September 2004, we acquired Abfin, a Dutch vehicle finance company, for €22 million. This transaction generated goodwill of €3 million.
Santander Central Hispano Previsión, S.A., de Seguros y Reaseguros (“Previsión”). In 2003, we reached an agreement for the sale of our entire investment in the capital stock of Previsión. Once all regulatory approvals were obtained, we completed the transaction in June 2004 for €162 million.
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Banco Español de Crédito, S.A. (“Banesto”). In 2002, Banesto carried out a monetary capital increase through the issuance of 81,670,694 new shares, carrying preemptive rights, at a ratio of 2 new shares issued at par for every 15 old shares. We sold the preemptive rights we received in this transaction (arising from our 99.04% holding in the capital stock of Banesto) for €443 million and reduced our ownership interest in Banesto to 88.57%. As of December 31, 2004, we had an 88.65% holding in the capital stock of Banesto.
The sale of the 24.9% stake was completed in the first quarter of 2003. As of December 31, 2003, we had a 74.0% holding in the capital stock of Serfin.
The shareholders, at the General Shareholders’ Meetings of Banco Santander Mexicano, S.A. (a 100% owned subsidiary of Serfin), Banca Serfin, S.A. (a 100% owned subsidiary of Serfin), Factoring Santander Serfin, S.A. de C.V. (a 98.8% owned subsidiary of Serfin) and Fonlyser, S.A. de C.V. (a 99.9% owned subsidiary of Serfin), held on November 29, 2004, agreed to the merger of these entities, with Banco Santander Mexicano, S.A. being the surviving entity. For accounting purposes, the merger was effective as of December 31, 2004. Banco Santander Mexicano, S.A. subsequently changed its legal name to Banco Santander Serfin, S.A.
Banco Santiago. Under the agreements between us and the Central Bank of Chile (as the second largest shareholder of Banco Santiago), on April 17, 2002, we acquired 35.45% of the Central Bank of Chile’s holding in the capital stock of Banco Santiago for $685 million (approximately €772 million). On August 1, 2002, Banco Santiago merged into Banco Santander Chile, with retroactive effect as of January 1, 2002, after the required resolutions were passed at their respective Shareholders’ Meetings and approval by the Chilean regulatory authorities. The name of the post-merger entity is Banco Santander Chile.
Banco Santander Colombia. As a result of a capital increase and of certain agreements reached in prior years, in 2002, we increased our holding in the capital stock of Banco Santander Colombia by 34.32% and paid €303 million. As of December 31, 2004, we held 97.64% of Banco Santander Colombia.
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Banco de Venezuela. On August 17, 2002, Banco de Venezuela and Banco de Caracas merged into the new Banco de Venezuela.
For a description of certain legal proceedings relating to the Cepsa tender offer, see “Item 8. Financial Information—A . Consolidated statements and other financial information—Legal Proceedings”.
As of December 31, 2003, following several purchases and sales made during the year, our holding in RBS was 5.05%. The sales gave rise to gains of €217 million.
In September 2004, we sold 79 million of our RBS shares, representing 2.51% of our holding, at a capital gain of approximately €472 million. As of December 31, 2004, our ownership interest in RBS was 2.54%.
Unión Eléctrica Fenosa, S.A. (“Unión Fenosa”). In 2002, we acquired several holdings in the capital stock of Unión Fenosa for a total amount of €465 million. In 2004, we sold 1% of our holding that as of December 31, 2004, was 22.02%.
Dragados y Construcciones, S.A. In 2002, we divested our 23.5% holding in Dragados y Construcciones, S.A. at a capital gain of approximately €521 million.
In 2004, we sold our entire holding in Sacyr-Vallehermoso for €92 million at a capital gain of €47 million.
Vodafone Airtouch plc (“Vodafone”). During 2002, we reduced our stake in Vodafone from 1.53% to 0.97%, realizing capital gains of €274 million. In 2003, we sold 0.67% of our holding, realizing capital gains of €369 million. In 2004, we sold the remainder of our holding in Vodafone, realizing capital gains of €242 million.
In January 2005, we acquired an additional 4.74% stake in Auna, thus increasing to 32.08% our total holding in this company.
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In addition to expanding our existing operations, we continually review possible acquisitions of, and investments in, businesses in markets in which we believe we have particular advantages.
As of December 31, 2001, our capital stock consisted of 4,659,362,499 fully subscribed and paid shares of €0.5 par value each.
AKB Holding Acquisition
As of December 31, 2002 and 2003, our capital stock consisted of 4,768,402,943 fully subscribed and paid shares of €0.5 par value each.
Abbey Acquisition
Recent Events
In April 2005, we, together with the other strategic partners of Auna, decided to open an orderly and competitive process for the sale of our holdings in Auna, or, as the case might be, its assets, submitting this option to the governance bodies of this telecommunications group.
B. Business overview.
Our principal operations are in Spain, the United Kingdom, Portugal, Germany, Italy and Latin America. We also have significant operations in New York and Paris as well as financial investments in San Paolo-IMI and Attijariwafa Bank (formerly, Banque Commerciale du Maroc). In Latin America, we have majority shareholdings in banks in Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, Puerto Rico, Uruguay and Venezuela.
As a result of the entry into force of the IFRS in 2005, we have redefined our business areas for financial reporting purposes. The new areas reflect the incorporation of Abbey, following our consolidation of its balance sheet at the end of 2004.
In accordance with the criteria established by the IFRS, the structure of the operating business areas has been segmented into two levels:
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Principal level (or geographic). The activity of our operating units is segmented by geographical areas. This coincides with our first level of management and reflects our positioning in the world’s three main currency areas. The reported segments are:
Secondary level (or business). This segments the activity of our operating units by type of business. The reported segments are:
In addition to these operating units, which cover everything by geographic area and business, we continue to maintain a separate Financial Management and Equity Stakes area. This area incorporates the centralized activities relating to equity stakes in industrial and financial companies, financial management of the structural exchange rate position and of the parent bank’s structural interest rate risk, as well as management of liquidity and of shareholders’ equity through issues and securitizations. As the Group’s holding entity, it manages all capital and reserves and allocations of capital and liquidity.
Business Areas in 2004
In 2004, our business was divided into five principal areas:
As noted above, in November 2004, we acquired 100% of the capital of Abbey National plc. Under Spanish GAAP, our acquisition of Abbey has been reflected on our financial statements as if the acquisition had occurred on December 31, 2004. Accordingly, Abbey’s assets and liabilities were consolidated into our balance sheet as of December 31, 2004, but Abbey’s results of operations had no impact on our income statement for the year ended December 31, 2004.
Abbey is a significant financial services provider in the United Kingdom, being the second largest residential mortgage lender, third largest savings brand, and operates across the full range of personal financial services serving approximately 18 million customers.
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Prior to the reorganization of Abbey’s structure following the completion of the acquisition, Abbey had two main business divisions: “Personal Financial Services” and the “Portfolio Business Unit”.
“Personal Financial Services” includes the following business areas:
(i) Banking and Savings: in addition to being the second largest provider of residential mortgages in the UK, Abbey also provides a wide range of retail savings accounts and offers a range of personal banking services including current accounts, unsecured loans and credit cards;
(ii) Investment and Protection: Abbey offers life and health protection, investment and pensions products primarily through its subsidiaries Abbey National Life, Scottish Mutual Assurance and Scottish Provident;
(iii) General Insurance: the range of non-life insurance products sold by Abbey includes buildings and contents insurance and payment protection insurance; and
(iv) Financial Markets: Abbey Financial Markets is responsible for the liquidity and capital management activities of the bank and it also incorporates derivatives and structured products and short term markets businesses.
The “Portfolio Business Unit” originally comprised a number of businesses, assets and portfolios that were deemed inconsistent with Abbey’s UK Personal Financial Services strategy. Accordingly, Abbey has reduced or exited these businesses and the remaining portfolio mainly corresponds to finance leases, operating leases (principally Porterbrook), Motor Financing and Litigation Funding.
Following the completion of the acquisition of Abbey, a new organizational structure has been created. Three new divisions were established by: (i) restructuring Abbey’s retail banking division, which integrates the former divisions of sales and marketing; (ii) restructuring Abbey’s insurance and asset management, which integrates both businesses and in doing so underscores the importance of these markets for Abbey and (iii) the creation of a new manufacturing division as a result of the merger of the former divisions of technology and operations with customers, which will be responsible for global management of costs and the bank’s operational efficiency.
Abbey is now organized as follows:
The Business and Support divisions are supported by five central units – Compliance, Communications, Legal, Secretariat and Tax, and Strategy and Planning.
European Retail Banking
This area covers the banking activities of the different networks and specialized units in Europe, principally with individual clients and small and medium sized companies (“SMEs”), as well as private and public institutions. During 2004 there were four units within this area: Santander Central Hispano Retail Banking, Banesto, Santander Consumer and Portugal.
Retail Banking Latin America
This area covers the banking activities in Latin America conducted through our subsidiary banks and finance companies.
Asset Management and Private Banking
Asset management includes pension and mutual funds and bancassurance. Private banking includes the activity carried out with clients via the specialized units in Spain and abroad.
Global Wholesale Banking
This area covers our corporate banking activities in Spain, the rest of Europe and New York, treasury activities in Madrid and New York, as well as investment banking businesses throughout the world.
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Financial Management and Equity Stakes
This area is responsible for the centralized activities relating to strategic or temporary equity stakes in industrial and financial companies, financial management related to the structural exchange rate position, the Group’s asset and liability portfolio and management of liquidity and capital through securities issuances and securitizations. It also manages all capital and reserves and allocations of capital and liquidity to the different business areas. The area also includes, on a temporary basis, businesses that are being wound down or closed in order not to distort the rest of the businesses. In exceptional circumstances, this area sometimes manages the launch of an activity of a strategic nature.
Our European retail banking activities include deposit taking, personal loans and consumer finance, mortgage lending, bill discounting, leasing, factoring, distribution of mutual and pension funds, life and non-life insurance distribution, credit and debit card operations, remote banking services, automobile financing and money transfers.
European Retail Banking is the largest business area of the Santander Group. At the end of 2004, it accounted for 56.4% of total customer deposits excluding Abbey (33.3%, including Abbey), 72.7% of loans excluding Abbey (43.0%, including Abbey) and 55% of net attributable income of the Group’s main business areas (excluding Abbey).
The area had 5,180 branches and 40,703 employees (direct and assigned) at the end of 2004.
The area experienced a 17.7% increase in net operating income, primarily due to increased revenue from commissions, lower operating costs, improved efficiency and growth in net interest income.
The efficiency ratio improved by 3.2 percentage points in 2004 from 45.7% in 2003 to 42.5%. Net attributable income increased 20.4% to €2,120.3 million. ROE in 2004 was 19.5%, the same as in 2003.
Santander Central Hispano Retail Banking
This activity is carried out through the branch network of Banco Santander Central Hispano, with support from an increasing number of automated cash dispensers, savings books updaters, telephone banking services, electronic and internet banking.
At the end of 2004, we had 2,571 branches and a total of 19,371 employees (direct and assigned) of which 791 employees were temporary, dedicated to retail banking in Spain. Compared to 2003, there was a net increase of 23 branches and a net reduction of 1,376 employees.
In 2004, Santander Central Hispano Retail Banking experienced growth of approximately 11.4% in lending, 12.2% in net operating income and 12.4% in net attributable income, an improved efficiency ratio from 45.4% in 2003 to 43.0% in 2004 and continued high standards of quality in credit risk.
Gross operating income from Santander Central Hispano Retail Banking was €3,639.3 million in 2004, as compared to €3,431.7 million in 2003.
In 2004, net attributable income from Santander Central Hispano Retail Banking was €1,041.4 million, 12.4% higher than net attributable income in 2003, while the ROE reached 20.8% (22.4% in 2003) and the efficiency ratio improved to 43.0% (45.4% in 2003).
The 11.4% growth in lending in 2004 versus 2003 came from both mortgages (+23%, mainly for individual customers) as well as other loans and credits (+13%), leasing and renting (+30%) and commercial bills (+9%).
Customer deposits increased slightly by 0.5%, while mutual and pension funds increased by 11.2% and 10.0%, respectively.
Banesto
At the end of 2004, Banesto had 1,683 branches and 9,801 employees (direct and assigned) (compared with 9,954 employees at the end of 2003), of which 612 employees were temporary.
In 2004, Banesto experienced growth of approximately 26.5% in lending, 8.2% in customer deposits and 11.6% in off-balance sheet customer funds.
In 2004, gross operating income from Banesto was €1,719.6 million, as compared to €1,578.4 million in 2003. Net attributable income from Banesto was €470.1 million, 23.7% higher than in 2003, while the ROE reached 16.8% (15.6% in 2003) and the efficiency ratio improved to 45.6% (48.5% in 2003).
Santander Consumer
Our consumer financing activities are conducted through our subsidiary Santander Consumer. Most of the activity is in auto financing, personal loans and credit cards. These consumer financing activities are mainly focused on Spain, Portugal, Germany and Italy (through Finconsumo). We are also present in Austria, Hungary, the Czech Republic, the Netherlands, Norway, Poland and Sweden.
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At the end of 2004, this unit had 256 branches (compared with 183 at the end of 2003) and 5,234 employees (direct and assigned) (compared with 3,991 employees at the end of 2003), of which 177 employees were temporary.
In 2004, this unit generated gross operating income of €1,306.8 million, 27.5% higher than in 2003. Net attributable income was €359.0 million, 44.9% higher than in 2003, while the ROE reached 22.0% (21.2% in 2003) and the efficiency ratio improved to 35.5% (39.9% in 2003).
Santander Consumer´s new lending amounted to €15,300 million, 30% more than in 2003 (including the new loans, acquired through our acquisitions of PTF, Elcon and Abfin). Excluding these acquisitions, growth would have been 23%. Total managed assets amounted to €26,800 milllion. Of note was the 24% organic growth in auto financing and the 36% increase in consumer finance and credit cards. The main traditional markets registered high lending growth: Spain and Portugal, 25%; Italy, 36% and Germany, 19%.
Portugal
Our Portuguese retail operations are conducted by Banco Santander Totta, and our Portuguese investment banking operations by Banco Santander de Negocios Portugal.
At the end of 2004, Retail Banking in Portugal operated 670 branches and had 6,297 employees (direct and assigned) (compared with 6,900 employees at the end of 2003), of which 32 employees were temporary.
In 2004, gross operating income from our Retail Banking activities in Portugal was €910.0 million, as compared to €852.3 million in 2003. Net attributable income was €249.9 million, 17.2% higher than in 2003, while the ROE reached 17.4% (16.9% in 2003) and the efficiency ratio improved to 44.4% (48.4% in 2003).
In 2004, net attributable income from our Group in Portugal (including Retail Banking, Asset Management and Global Wholesale Banking) was €289.5 million, 15.3% higher than in 2003.
At December 31, 2004, we had 3,874 offices and 52,107 employees (direct and assigned) in Retail Banking Latin America (compared with 3,894 offices and 52,229 employees, respectively, at December 31, 2003), of which 563 were temporary employees. Net attributable income from Retail Banking Latin America was €1,038.6 million, 2.4% lower than in 2003, while the ROE reached 26.9% (29.0% in 2003) and the efficiency ratio increased to 55.3% (54.9% in 2003). Our total Latin American activities (including Retail Banking, Asset Management and Global Wholesale Banking) accounted for €1,284.8 million of our net attributable income for the year ended December 31, 2004. Our Latin American banking business is principally conducted by the following banking subsidiaries:
We engage in a full range of retail banking activities in Latin America, although the range of our activities varies from country to country. We seek to take advantage of whatever particular business opportunities local conditions present. We engage in a wide array of deposit taking activities throughout Latin America, and other retail banking activities in Argentina, Brazil, Chile and Mexico. Our primary lending operations are in Chile, Mexico, Brazil and Puerto Rico. Our principal mutual fund operations are in Brazil, Mexico, Chile and Puerto Rico, and our main pension fund operations are in Chile, Mexico, Argentina, Peru and Colombia.
Our significant position in Latin America is attributable to our financial strength, high degree of diversification (by countries, businesses, products, etc), and breadth and depth of our franchise.
Detailed below are the performance highlights of the main Latin American countries in which we operate:
Brazil. Santander Banespa is one of the main financial franchises in Brazil. It has more than 1,800 branches and over 7,300 cash dispensers.
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In 2004, Santander Banespa focused on increasing customer business volumes, particularly loans development, capitalizing on the large number of clients after customer segmentation. This focus helped to increase total lending by 37% in line with the increase in loans to individual customers (credit cards, auto financing, consumer credit, etc.). Deposits plus mutual and pension funds increased by 17%.
Total net attributable income from Brazil in 2004 was €684.9 million, 2.3% lower than in 2003 (+2.6% excluding the exchange rate impact). The efficiency ratio was 48.0%, ROE was 38.8%, the ratio of non-performing loans (“NPL”) was 2.6% at the end of 2004 and the NPL coverage was 175%.
Mexico. Santander Mexicano is one of the leading financial services companies in Mexico. It is the third largest banking group in Mexico in terms of business volume and first in terms of profitability and credit risk quality. It has a network of 1,020 branches and 2,299 cash dispensers.
Net attributable income from Mexico declined 18.4% (-5.5% after eliminating the exchange rate impact) to €331.7 million. The year-on-year comparison was affected by the €17 million impact from the sale of 24.9% of Santander Serfin to Bank of America (February 28, 2003), the release of €51 million of loan-loss provisions in the first quarter of 2003 and the rise in the tax charge between the two periods. Net operating income, not affected by any of these factors, rose 29.4% after eliminating the exchange rate impact. The efficiency ratio was 45.6%, ROE was 24.2%, the ratio of non-performing loans was 0.7% at the end of 2004 and the NPL coverage was 401%.
Chile. Santander Santiago has the largest financial franchise in the country with substantial business in loans, deposits, mutual funds and pension funds. It has 346 branches and 1,191 cash dispensers.
In 2004, lending rose 19% and the total of deposits, mutual funds and pension funds increased 19%.
Net attributable income from Chile increased 11.3% to €271.0 million (+8.5% eliminating the exchange rate impact). The efficiency ratio stood at 41.5%, ROE was 23.2%, the ratio of non-performing loans was 3.3% and the NPL coverage was 116%.
Puerto Rico. Santander Puerto Rico is one of the largest financial entities in Puerto Rico. We have 71 branches and 149 cash dispensers in Puerto Rico.
In 2004, Santander Puerto Rico focused on growth in residential mortgages and loans to medium-sized companies, which produced an increase of 8% in lending in local currency. Deposits and mutual funds rose 19% in dollars.
Net attributable income from Puerto Rico was €45.7 million, 62.4% higher than in 2003 (78.4% excluding the exchange rate impact). The efficiency ratio was 58.8%, ROE was 11.0%, the ratio of non-performing loans stood at 2.3% and the NPL coverage was 131%.
Venezuela. Banco de Venezuela is one of the country’s largest banks. It has 242 branches and 656 cash dispensers.
The main focus of management in 2004 was growth in net basic revenue and the profitability of business, with selective growth in lending, a rise in transactional deposits, a very flexible pricing policy for loans and funds and the development of businesses that generate commissions.
Net attributable income from Venezuela grew 6.7% to €115.1 million (+33.6% excluding the exchange rate impact). The efficiency ratio was 43.6%, ROE stood at 39.6%, the ratio of non-performing loans was 2.2% and the NPL coverage was 346%.
Colombia. Colombia consolidated its economic recovery in 2004. The Group´s business model in Colombia is focused on selective growth and efficient management of costs, with excellent credit quality levels (the ratio of non-performing loans was 0.4% and coverage more than 1,000%).
Net attributable income from Colombia was €39.3 million, 58.2% higher than in 2003.
Other countries
Argentina made a positive contribution to Group earnings in 2004 (net attributable income was €38.9 million, compared to zero contribution in 2003). Growth in deposits was consolidated and lending began to slowly recover. Fees and commissions also increased.
Uruguay improved notably, generating net attributable income of €17.2 million in 2004 compared to a loss of €37.1 million in 2003.
Bolivia’s net attributable income was €8.0 million in 2004 (€8.9 million in 2003). Peru, where the Group focuses on pension funds, generated net attributable income of €17.8 million in 2004 (€19.3 million in 2003).
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In 2004, this area generated gross operating income of €871.0 million, as compared to €798.7 million in 2003. Net attributable income was €351.1 million, 9.9% higher than in 2003.
In Latin America, we managed €28,000 million of mutual and pension funds, 18% more than in 2003 (excluding the exchange rate impact). All group companies in Latin America increased their balances of mutual and pension funds in local currency. Of note was the growth of more than 30% in mutual funds in Mexico, Chile and Puerto Rico, as well as in pension funds in all countries (with an increase of approximately 15%, without the effect of exchange rates, with the exception of Argentina which had an increase of 9%).
In Latin America, the Group continued to focus on growth in the distribution of insurance via its banking network. Brazil, Mexico and Chile had an aggregate growth of 34% in premium income, excluding the exchange rate impact.
International Private Banking registered 20% growth in euros in net operating income and 35% in net attributable income. Average managed funds rose 25% in dollars terms.
Net attributable income was €331.1 million, 46.8% more than in 2003.
Global Corporate Banking
Global Investment Banking
Global Investment Banking increased revenues in 2004 24% over 2003. Revenues from our equities business increased 22%, consolidating our leadership in brokerage in Spain, Portugal and in ordinary Latin American shares.
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Treasury
• Equity Stakes: This area centralizes the management of equity stakes in financial and industrial companies.
• Projects underway/wound down: Also included, on a temporary basis, are businesses in the process of being wound down or closed in order not to distort the rest of our businesses. In exceptional circumstances, this area may manage the launch of a business of a strategic nature on a temporary basis. In 2004, this area managed the development of the Partenón project.
At the end of 2004, this area had 359 employees (direct and assigned) (271 employees at the end of 2003), of which 173 were temporary.
Equity Stakes
Alliances and Financial Investments
Commerzbank. At December 31, 2004, we owned 3.4% of Commerzbank.
Attijariwafa Bank (Morocco) (formerly, Banque Commerciale du Maroc). At December 31, 2004, we had a 14.5% interest in Attijariwafa Bank, which engages mainly in trade finance and foreign investment activities. Together with Attijariwafa Bank we have a 50% joint venture in Attijari International Bank, which specializes in trade finance in Tangier’s free trade zone.
Industrial Portfolio
The following table summarizes our main industrial holdings at December 31, 2004:
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As of December 31, 2004, our unrealized capital gains in industrial stakes were estimated at €2,400 million.
Total Revenues by Activity and Geographic Location
Selected Statistical Information
Average Balance Sheets and Interest Rates
You should read the following tables and the tables included under “Changes in Net Interest Income—Volume and Rate Analysis” and “Earning Assets—Yield Spread” in light of the following observations:
As stated above under “Item 4. Information on the Company – A. History and development of the company –Principal Capital Expenditures and Divestitures – Acquisitions, Dispositions and Divestitures”, on November 12, 2004, we completed the acquisition of Abbey. For consolidation purposes, Abbey´s assets and liabilities were consolidated into our balance sheet as of December 31, 2004, but Abbey’s results of operations had no impact on our income statement for 2004.
As noted above, in order to calculate average balance sheet information, we have utilized month-end balances. Because Abbey’s assets and liabilities were consolidated into our balance sheet as of December 31, 2004, the average balances including Abbey only reflect the impact of Abbey’s balances on one of the thirteen-month period ends used in calculating such averages. Accordingly, average balances including Abbey do not reflect the impact that Abbey’s assets will have on such balances following a full year of consolidation.
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Changes in Net Interest Income—Volume and Rate Analysis
The following tables allocate, by domicile of customer, changes in our net interest income between changes in average volume and changes in average rate for 2003 compared to 2002 and 2004 compared to 2003. We have calculated volume variances based on movements in average balances over the period and rate variance based on changes in interest rates on average interest-earning assets and average interest-bearing liabilities. We have allocated variances caused by changes in both volume and rate to volume. You should read the following tables and the footnotes thereto in light of our observations noted in the preceding sub-section entitled “Average Balance Sheets and Interest Rates”, and the footnotes thereto.
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Assets
Earning Assets—Yield Spread
The following table analyzes, by domicile of customer, our average earning assets, interest income and dividends on equity securities and net interest income and shows gross yields, net yields and yield spread for each of the years indicated. You should read this table and the footnotes thereto in light of our observations noted in the preceding subsection entitled “Average Balance Sheets and Interest Rates”, and the footnotes thereto.
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Return on Equity and Assets
The following table presents our selected financial ratios (excluding the effects of the Abbey acquisition, except where indicated) for the years indicated.
Interest-Earning Assets
The following table shows, by domicile of customer, the percentage mix of our average interest-earning assets for the years indicated. You should read this table in light of our observations noted in the preceding sub-section entitled “Average Balance Sheets and Interest Rates”, and the footnotes thereto.
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Due from Credit Institutions
The following table shows our short-term funds deposited with other banks at each of the dates indicated.
Investment Securities
At December 31, 2004, the book value of our investment securities, including Abbey, was €112.1 billion (representing 19.5% of our total assets). These investment securities had a yield of 5.11% in 2004, compared with a yield of 4.81% earned during 2003. €16.1 billion, or 14.4%, of our investment securities consisted of Spanish Government and government agency securities, 18.5% of which consisted of Spanish Treasury bills that had a yield of 2.2% in 2004. For a discussion of how we value our investment securities, see note 2(d) to our consolidated financial statements.
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The following table shows the book values of our investment securities by type and domicile of counterparty at each of the dates indicated.
The following table analyzes the aggregate book value and aggregate market value of the securities of single issuers, other than the Government of the United States, that exceeded 10% of our stockholders’ equity as of December 31, 2004 (including Abbey).
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The following table analyzes the maturities and weighted average yields of our debt investment securities (before allowances for credit losses and allowances for security price fluctuations) at December 31, 2004 (including Abbey). Yields on tax-exempt obligations have not been calculated on a tax-equivalent basis because we do not believe the effect of such a calculation would be material.
Loan Portfolio
At December 31, 2004, our total loans and credits, including Abbey, equaled €342.2 billion (59.5% of our total assets). Net of allowances for credit losses, loans and credits equaled €335.2 billion (58.3% of our total assets). In addition to loans, we had outstanding at December 31, 2000, 2001, 2002 and 2003 and with respect to 2004 (including Abbey), €54.3 billion, €49.6 billion, €49.1 billion, €48.6 billion and €64.3 billion, respectively, of undrawn balances available to third parties.
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Loans by Geographic Area and Type of Customer
The following table analyzes our customer loans and credits (including securities purchased under agreement to resell), by domicile and type of customer, at each of the dates indicated.
At December 31, 2004, our loans and credits to unconsolidated subsidiaries and associated companies, including Abbey, amounted to €1,579.5 million (See “Item 7 —Major Shareholders and Related Party Transactions —B. Related Party Transactions”). Excluding government-related loans and credits, the largest outstanding exposure at December 31, 2004, including Abbey, was €1.4 billion (0.4% of total loans and credits, including government-related loans), and the five next largest exposures totaled €5.2 billion (1.6% of total loans, including government-related loans).
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Maturity
The following table sets forth an analysis by maturity of our loans and credits by domicile and type of customer at December 31, 2004, (including Abbey).
Fixed and Variable Rate Loans
The following table sets forth a breakdown of our fixed and variable rate loans having a maturity of more than one year at December 31, 2004 (including Abbey).
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Cross-Border Outstandings
The following table sets forth, as of the end of the years indicated, the aggregate amount of our cross-border outstandings (which consist of loans, interest-bearing deposits with other banks, acceptances and other monetary assets denominated in a currency other than the home-country currency of the office where the item is booked) where outstandings in the borrower’s country exceeded 0.75% of our total assets. Cross-border outstandings do not include local currency loans made by subsidiary banks in other countries to the extent that such loans are funded in the local currency or hedged. As a result, they do not include the vast majority of the loans by Abbey or our Latin American subsidiaries.
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The following table sets forth the amounts of our cross-border outstandings as of December 31 of each year by type of borrower where outstandings in the borrower’s country exceeded 0.75% of total assets.
Classified Assets
In the following pages, we describe Bank of Spain requirements for classification of non-performing assets and credit loss recognition. Unlike under U.S. GAAP, Spanish GAAP establishes a credit loss recognition process that is independent of the process for balance sheet classification and removal of impaired loans from the balance sheet. In Note 28 to our consolidated financial statements, we include a summary of significant valuation and income recognition differences under Spanish and U.S. GAAP and a net income and stockholders’ equity reconciliation.
The description below sets forth the minimum requirements that are followed and applied by all of our Group’s subsidiaries. Nevertheless, if the regulatory authority of the country where a particular subsidiary is located imposes stricter or more conservative requirements, the more strict or conservative requirements are followed.
Bank of Spain Classification Requirements
Non-Performing Assets
Non-Performing Past-Due Assets. The Bank of Spain requires Spanish banks to classify as non-performing certain amounts of any loan, fixed-income security, guarantee and certain other extensions of credit on which any payment of principal or interest is 90 days or more past due (“non-performing past-due assets”). Banks must classify as non-performing the portion of any principal of or accrued interest on such asset that is 90 days or more past due until (1) this amount is more than 25% of the outstanding balance of the asset or (2) any installment of principal or interest is 12 months or more past due (6 months in case of loans to individuals not for purposes of financing business activities). When either of these conditions is met, banks must classify the entire outstanding principal of and accrued interest on the asset as non-performing. Accordingly, prior to the time that one of these conditions is met, a loan may be classified as non-performing with respect to a portion of its outstanding principal and interest, but performing with respect to the remainder of its principal and interest.
In relation to the aggregate risk exposure (including off-balance sheet risks) to a single obligor, if the amount of non-performing balances exceeds 25% of the total outstanding risks (excluding non-accrued interest on loans to such borrower), then the bank must classify all outstanding risks to such borrower as non-performing.
Once any portion of a loan is classified as non-performing, the entire loan is placed on a non-accrual status. Accordingly, even the portion of any such a loan which may still be identified as performing will be recorded on non-accrual status.
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Other Non-Performing Assets. The Bank of Spain requires Spanish banks to classify any loan, fixed-income security, guarantee and certain other extensions of credit as non-performing if it has a reasonable doubt that the extension of credit will be collected (“other non-performing assets”), even if any past due payments have been outstanding for less than 90 days or the asset is otherwise performing. When a bank classifies an asset as non-performing on this basis, it must classify the entire principal amount of the asset as non-performing. The Bank of Spain also requires Spanish banks to classify as non-performing the entire outstanding principal of and accrued interest on any extension of credit to category 5 (very doubtful) countries or residents of category 5 countries to the extent it is not otherwise classified as non-performing. See “Country - -Risk Outstandings”.
Once any of such assets is classified as non-performing, it is placed on a non-accrual status.
These classification criteria differ from U.S. GAAP requirements. For an estimation of the amounts to be classified as non-performing under U.S. GAAP, see Note 13 to the Selected Consolidated Financial Information table in this report.
Country-Risk Outstandings
The Bank of Spain requires Spanish banks to classify as country-risk outstandings all loans, fixed-income securities and other outstandings to any countries, or residents of countries, that the Bank of Spain has identified as being subject to transfer risk or sovereign risk and the remaining risks derived from the international financial activity. The Bank of Spain has established six categories for classifying such countries, as shown in the following table:
The Bank of Spain allows each bank to decide how to classify the listed countries within this classification scheme, subject to the Bank of Spain’s oversight. The classification is made based on criteria such as the risk global assessment according to the evolution of the balance of payments, the level of the outstanding debt and of the charges for debt services, the debt quotations in the international secondary markets and other indicators and factors of each country as well as all the criteria indicated by the Bank of Spain. It excludes from country-risk outstandings:
With certain requirements, it treats guaranteed outstandings as outstandings to the guarantor.
The Bank of Spain requires Spanish banks to classify outstandings to countries or residents of countries in categories 1, 2, 3 and 4 on the basis of the criteria described below under “Item 4. Information on the Company—B. Business Overview—Bank of Spain Allowances for Credit Losses and Country-Risk Requirements—Specific Provisions for Credit Losses”. The Bank of Spain requires Spanish banks to classify as non-performing any loan in category 5, and to write-off the entire outstanding principal of and accrued interest on any outstandings to countries or residents of countries in category 6 (see the subsection below in this Item 4 entitled “Bank of Spain Charge-Off Requirements”).
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Bank of Spain Non-Accrual of Interest Requirements
The Bank of Spain requires Spanish banks to stop accruing interest on the entire principal amount of any asset that is classified as non-performing, even if only a portion of the asset is classified as non-performing, and on category 3 (transitory difficulties) and category 4 (doubtful) country-risk outstandings, whether or not they are non-performing. The banks must account for such collected interest on a cash basis, recording interest payments of the current year as interest income and interest payments of previous years as extraordinary income or recoveries of written-off assets, as appropriate.
The following table shows the amount of interest owed on non-accruing assets and the amount of such interest that was received when due and when past due:
Bank of Spain Allowances for Credit Losses and Country-Risk Requirements
Specific Allowances for Credit Losses
The specific allowance is calculated based on the loan recovery expectations and, at a minimum, by application of the coefficients stipulated in the following tables.
Non-Performing Past-Due Assets. Except for fully secured past-due mortgage assets and financial leases on certain types of properties, the Bank of Spain requires Spanish banks to set aside specific allowances for non-performing past-due assets. The amount of the required allowance is the product of the amount of the asset treated as non-performing (see “Bank of Spain Classification Requirements—Non-Performing Assets” above) times the percentages set forth in the following table. The allowance must be maintained for so long as the non-performing portion of the asset is carried as an asset on the banks’ balance sheets.
Fully-Secured Non-Performing Past-Due Mortgage Assets and financial leases on certain types of properties. If a non-performing asset is a fully secured non-performing past-due mortgage or a financial lease and certain conditions are met, the amount of the required allowance is the product of the amount of such asset times the percentages set forth in the following table instead of the preceding table. Such asset must satisfy three conditions: first, the asset is secured by a mortgage or a right of ownership (in case of a financial lease) on a finished residential property; second, such mortgage or right of ownership was placed on the property at the time the extension of credit was made; and third, the outstanding risk does not exceed 80% of the appraisal value of such mortgaged or leased property.
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The only exception to these requirements is that when a bank treats otherwise performing assets to a single borrower as non-performing because non-performing assets exceed 25% of the bank´s total exposure to the borrower as set forth in “Bank of Spain Classification Requirements—Non-Performing Past Due Assets” above, the Bank of Spain does not require the bank to carry an allowance against any asset that has no overdue principal or interest payments.
Other Non-Performing Assets. If a non-performing asset is an other non-performing asset, see “Item 4. Information on the Company—B. Business Overview—Bank of Spain Classification Requirements—Non-Performing Assets—Other Non-Performing Assets”, the amount of the required allowance will be at least 25% and up to 100% of the amounts treated as non-performing, depending on management´s opinion of the loan recovery expectations. When the treatment of such asset as a non-performing asset is due to, in management’s opinion, an inadequate financial or economical condition of the borrower, and the amount estimated as non-collectible is less than 25% of the outstanding debt, the amount of the required allowance will be at least 10% of the outstanding debt.
Exceptions. The foregoing allowance requirements do not apply to any non-performing asset (non-performing past-due assets and other non-performing assets) that is:
In addition to the Bank of Spain specific allowance requirements, the Bank of Spain requires Spanish banks to set aside a general allowance equal to the sum of:
• 1% of the sum of loans (other than certain fully secured mortgage loans, certain financial leases and certain securitized mortgage bonds) and guarantees, private sector fixed-income securities other than those included in the trading portfolio, contingent liabilities and non-performing assets exempted from the specific allowances requirements described above of resident and non-resident sectors, except Spanish public authorities and credit entities; and
• 0.5% of the sum of fully secured mortgage loans, financial leases and securitized mortgage bonds when the following conditions are met:
first, the asset is secured by a mortgage or a ownership right on a finished residential property;
second, such mortgage or ownership right was placed on the property at the time the extension of credit was made; and
third, at the time the relevant portion of the asset first became non-performing, the outstanding principal of and accrued interest on the asset do not exceed 80% of the appraisal value of such mortgaged or leased property.
When calculating the general allowance for credit losses on those investments in a bond fund that ranks behind unsubordinated securities on a winding up of the fund, the bank must include an amount equal to the coverage that the bank itself would have if the bank had a direct pro-rata interest in the underlying bond portfolio. If such provision is made, the bank is not required to make any other general allowance for securities issued by the bond fund.
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Allowance for the Statistical Coverage of Credit Losses
Since July 1, 2000, the Bank of Spain has required Spanish banks to create an allowance for the statistical coverage of credit losses based on an estimation of future credit losses in the credit portfolio. This new allowance is in addition to the other allowances described above.
Spanish banks may estimate the provisions to be made to create this allowance using models based on their own credit loss experience and management’s estimation of future credit losses. In devising these models, which form a required part of a sound risk measurement and management system, management must take into consideration the quality of counterparties, the existence of guarantees or collateral, the term of the transactions and the expected evolution of the credit risk depending on medium and long term changes in the economic cycle. Furthermore, the models must use historical data covering at least a whole economic cycle and must be validated by the Bank of Spain.
As an alternative to the internal model referred to above (or as an alternative for some types of credit risk) Spanish banks may calculate the provisions to be made to create the allowance by applying to the amount of computable credit risk (loans, fixed income securities not included in the trading portfolio, contingent liabilities and non-performing assets exempted from the requirements for a specific allowance for insolvency or country-risk, and excluding risks with Spanish government entities and risks with credit institutions) in each of the categories set forth below the following coefficients:
Assets in this category include financial leases and mortgages and pledges on tangible assets that are not included in other categories, provided that the estimated value of the financial leases and the collateral totally covers the outstanding risk.
Assets in this category include assets on Spanish residents or residents of countries classified in categories 1 or 2, provided that such assets are not included in other categories.
Assets in this category include loans to individuals for the acquisition of durable consumption goods or other goods or current services not for professional use, except those registered in the “Registro de Ventas de Bienes Muebles”; and risks with residents of countries classified in categories 3 to 6, to the extent not covered by country-risk allowances.
Assets in this category include credit card balances; current account overdrafts and excesses in credit accounts (except those included in categories (a) and (b)), and doubtful assets not subject to a mandatory allowance not included in letter “a”).
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Contingent liabilities will be weighted using the percentages set forth in the capital regulations of the Bank of Spain.
Provisions made to meet the statistical allowance requirements are charged quarterly against income in the amount of the positive difference between one fourth of the amount of the required statistical allowance and the amount of net provisions for the other allowances for credit losses in that quarter. If the difference is negative, the amount is credited to income with a charge to the allowance, but only to the extent of the existing balance of that allowance.
Net provisions in the income statement include the provisions for the specific coverage of credit losses, plus provisions for the general and statistical coverage of credit losses, plus write-offs, less the recoveries of the specific allowance and foreclosed assets.
The amount of the allowance for the statistical coverage of credit losses, may be, at a maximum, three times the sum of the products of the amount of credit risk in each category multiplied by the risk coefficient of each such category.
Allowances for Country-Risk
The Bank of Spain requires Spanish banks to set aside an allowance for country-risk on all country-risk outstandings. See the above sub-section entitled “Bank of Spain Classification Requirements—Country-Risk Outstandings”. The amount of the required provision is the product of the amount of the outstanding loans and credits times the percentages set forth in the following table.
Under the recent Bank of Spain guidelines, as a result of relatively recent international economic crises, and the increasing presence of Spanish banks in Latin America and Southeast Asia, we are subject to more stringent information requirements. Banks that have risks in countries that do not fall within category 1, or banks that have subsidiaries abroad, or banks in which risks or liabilities with non-residents in Spain equal at least €5 million, must now complete new information statements when presenting their accounts.
Guarantees
The Bank of Spain requires some guarantees to be classified as non-performing in the following amounts:
• in cases involving past-due guaranteed debt: (i) for non-financial guarantees, the amount demanded by the beneficiary and outstanding under the guarantee; and (ii) for financial guarantees, at least the amount classified as non-performing of the guaranteed risk; and
• in all other cases, the entire amount of the guaranteed debt when the debtor has declared bankruptcy or has demonstrated serious solvency problems, even if the guaranteed beneficiary has not reclaimed payment.
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Bank of Spain Foreclosed Assets Requirements
The Bank of Spain requires Spanish banks to carry assets acquired on foreclosure at their net value (defined as the lower of (i) the face value of the loan secured (net of any related provision for non-performing asset) and (ii) the appraised market value of the foreclosed asset), reduced by allowances (expressed as a percentage of net value), as follows: if the asset is held between three and four years —25%; between four and five years —50%; more than five years —75%. In any event, net asset value can never exceed the market value of the asset. Bank of Spain regulations allow a release of allowances to the extent that the independently appraised value of the assets acquired upon foreclosure (appraised each year subsequent to the first date on which a provision would be required) exceeds the net value of such assets, but requires that a minimum allowance be maintained at all times equal to 25% of the outstanding principal of t he underlying loan at the time of foreclosure and 100% of the outstanding interest at that time. Provisions made to this allowance are set forth as extraordinary losses in our consolidated financial statements.
Bank of Spain Charge-off Requirements
Spanish GAAP does not permit non-performing assets to be partially charged-off.
The Bank of Spain requires Spanish banks to charge-off immediately those non-performing assets that management believes will never be repaid or that were made to category 6 (“bankrupt”) countries or residents of such category 6 countries. See the above sub-section entitled “Item 4. Information on the Company—B. Business Overview—Bank of Spain Classification Requirements—Country-Risk Outstandings”. Otherwise, the Bank of Spain requires Spanish banks to charge-off non-performing assets three years after they were classified as non-performing. Spanish banks may carry fully secured past-due mortgage loans beyond this three-year deadline for up to six years if there are objective factors that indicate an improved likelihood of recovery. Accordingly, even if allowances have been established equal to 100% of a non-performing asset (in accordance with the Bank of Spain criteria discussed above), the Spanish bank ma y maintain that non-performing asset, fully provisioned, on its balance sheet for the full three or six-year period if management believes based on objective factors that there is some possibility of recoverability of that asset. (See Note 28.1 to our consolidated financial statements for differences between Spanish and U.S. GAAP).
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Movements in Allowances for Credit Losses
The following table analyzes movements in our allowances for credit losses and movements, by domicile of customer, for the years indicated. See “Presentation of Information”. For further discussion of movements in the allowances for credit losses, see “Item 5. Operating and Financial Review and Prospects—A.Operating Results—Net Provisions for Credit Losses”.
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The table below shows a breakdown of charge-offs against income, recoveries, net provisions and charge-offs against credit loss allowance by type and domicile of borrower for the years indicated.
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The following table shows our non-performing assets, excluding country-risk. We do not keep records classifying assets as non-accrual, past due, restructured or potential problem loans, as those terms are defined by the SEC. However, we have estimated the amount of our assets that would have been so classified, to the extent possible, below.
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We do not believe that there is a material amount of assets not included in the foregoing table where known information about possible credit risk at December 31, 2004 (not related to transfer risk inherent in cross-border lending activities) gave rise to serious doubts as to the ability of the borrowers to comply with the loan repayment terms at such date.
Evolution of Non-Performing Assets
The following table shows the movement in our non-performing assets (excluding country-risk, see “Country-Risk Outstandings”) from December 31, 2002 until December 31, 2004.
Non-Performing Asset Ratios
The following table shows the ratio of our non-performing assets to total computable credit risk and our coverage ratio at December 31, 2002, 2003 and 2004.
The following table sets forth our country-risk outstandings with third parties for the years shown.
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Other Non-Accruing Assets
As described above under “Item 4. Information on the Company—B. Business Overview—Bank of Spain Classification Requirements—Non-Performing Assets” and “Country-Risk Outstandings”, we do not classify our loans to borrowers in countries with transitory difficulties (category 3) and doubtful countries (category 4) as non-performing. However, as described above under “Item 4. Information on the Company — B. Business Overview —Bank of Spain Allowances for Credit Losses and Country-Risk Requirements—Allowances for Country-Risk” and “Bank of Spain Non-Accrual of Interest Requirements”, the Bank of Spain requires us to account for such loans on a cash basis (non-accruing) and to set aside certain allowances for such loans. We treat category 5 (very doubtful) country-risk outstandings as both non-accruing and non-performing. Total other non-accruing assets at December 31, 2000, 2001, 20 02, 2003 and 2004 were, €1,313.7 million, €1,172.2 million, €259.5 million, €249.7 million and €717.5 million, respectively (including Abbey, with respect to 2004).
Includes the effects of the Abbey acquisition.
We do not have any loans past-due 90 days or more that are accruing interest, in accordance with the Bank of Spain’s requirements.
As of December 31, 2002, 2003 and 2004, the amounts of “restructured loans”, none of which were classified as non-performing, were €61.4 million, €147.6 million and €193.2 million, respectively (including Abbey, with respect to 2004).
Foreclosed Assets
The table below sets forth movements in our foreclosed assets for the periods shown.
Liabilities
Deposits
The principal components of our deposits are customer demand, savings and time deposits, and international and domestic interbank deposits. Our retail customers are the principal source of our demand, savings and time deposits. For an analysis, by domicile of customer, of average domestic and international deposits by type for 2002, 2003 and 2004, see “Average Balance Sheets and Interest Rates—Liabilities and Interest Expense”.
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We compete actively with other commercial banks and with savings banks for domestic demand and savings deposits. Our share of customer deposits in the Spanish banking system (including Cajas de Ahorros) was 15.3% at December 31, 2004, according to figures published by the Spanish Banking Association (AEB) and the Confederación Española de Cajas de Ahorros (“CECA”). See “Item 4. Information on the Company—B. Business Overview—Competition”.
The following tables analyze our year-end deposits.
Deposits (Due to Credit institutions and Customer deposits) by type of deposits
Deposits (Due to credit institutions and Customer deposits) by location of office
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The following table shows the maturity of time deposits (excluding inter-bank deposits) in denominations of $100,000 or more for the year ended December 31, 2004 (including Abbey). Large denomination customer deposits may be a less stable source of funds than demand and savings deposits.
The aggregate amount of deposits held by non-resident depositors (banks and customers) in our domestic branch network was €19.7 million, €31.9 million and €17.8 million at December 31, 2002, 2003 and 2004, respectively.
Short-term Borrowings
The following table analyzes our short-term borrowings as of December 31, 2002, 2003 and 2004.
Competition
We face strong competition in all of our principal areas of operation from other banks, savings banks, credit cooperatives, brokerage houses, insurance companies and other financial services firms.
Banks
Two Spanish banking groups dominate the retail banking sector in Spain. These two groups are headed by Banco Bilbao Vizcaya Argentaria, S.A. and Banco Santander Central Hispano, S.A.
At the end of December 2004, these two Spanish banking groups accounted for approximately 62.1% of loans and 63.5% of deposits of all Spanish banks, which in turn represented 30.7% of loans and 28.3% of deposits of the financial system, according to figures published by the Spanish Banking Association (AEB) and the Confederación Española de Cajas de Ahorro (“CECA”). These banking groups also hold significant investments in Spanish industry.
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Foreign banks also have a presence in the Spanish banking system as a result of liberalization measures adopted by the Bank of Spain since 1978. At December 31, 2004, there were 61 foreign banks (of which 53 were from European Union countries) with branches in Spain. In addition, there were 23 Spanish subsidiary banks of foreign banks (of which 17 were from European Union countries).
Spanish law provides that any financial institution organized and licensed in another member state of the European Union may conduct business in Spain from an office outside Spain. They do not need prior authorization from Spanish authorities to do so. Once the Bank of Spain receives notice from the institution’s home country supervisory authority about the institution’s proposed activities in Spain, the institution is automatically registered and the proposed activities are automatically authorized.
The opening of a branch of any financial institution authorized in another member state of the European Union does not need prior authorization or specific allocation of resources. The opening is subject to the reception by the Bank of Spain of a notice from the institution's home country supervisory authority containing, at least, the following information:
Program of activities detailing the transactions to be made and the corporate structure of the branch.
Once the Bank of Spain receives the notice, it notifies the financial institution, thereby permitting the branch to be registered in the Mercantile Register and, then, in the Special Register of the Bank of Spain.
Spanish law requires prior approval by the Bank of Spain for a Spanish bank to acquire shares of a bank organized outside the European Union, create a new bank outside the European Union or open a branch outside the European Union. Spanish banks must provide prior notice to the Bank of Spain to conduct any other business outside the European Union.
When a new bank is created, the following information has to be provided to the Bank of Spain:
amount of the investment,
The opening of branches outside Spain requires prior application to the Bank of Spain, including information about the State where the branch will be located, the address, program of activities and names of the branch's managers. The opening of representative offices requires prior notice to the Bank of Spain detailing the activities to perform.
In addition, we face strong competition outside Spain, particularly in Argentina, Brazil, Chile, Mexico, Portugal and the United Kingdom.
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Savings Banks
Spanish savings banks (“Cajas de Ahorros”) are mutual organizations which engage in the same activities as banks, but primarily take deposits and make loans, principally to individual customers and small to medium-sized companies. The savings banks are influenced by regional and local governments. The Spanish savings banks provide strong competition for the demand and savings deposits which form an important part of our deposit base. Spanish savings banks, which traditionally were regional institutions, are permitted to open branches and offices throughout Spain. In the last few years, mergers among savings banks increased. The Spanish savings banks’ share of domestic deposits and loans were 58.8% and 50.7%, at December 31, 2004.
Credit Co-operatives
Credit co-operatives are active principally in rural areas. They provide savings and loan services including financing of agricultural machinery and supplies.
Brokerage Services
We face competition in our brokerage activities in Spain from brokerage houses of other financial institutions.
Spanish law provides that any investment services company authorized to operate in another member state of the European Union may conduct business in Spain from an office outside Spain, once the Securities National Commission (Comisión Nacional del Mercado de Valores – “CNMV”) receives notice from the institution’s home country supervisory authority about the institution’s proposed activities in Spain.
However, Spanish law provides that credit entities have access, as members, to the Spanish stock exchanges, in accordance with the provisions established by the Investment Services Directive.
We also face strong competition in our mutual funds, pension funds and insurance activities from other banks, savings banks, insurance companies and other financial services firms.
Supervision and Regulation
Bank of Spain and the European Central Bank
The Bank of Spain, which operates as Spain’s autonomous central bank, supervises all Spanish financial institutions, including us. Until January 1, 1999, the Bank of Spain was also the entity responsible for implementing Spanish monetary policy. As of that date, the start of Stage III of the European Monetary Union, the European System of Central Banks and the European Central Bank became jointly responsible for Spain’s monetary policy. The European System of Central Banks consists of the national central banks of the twenty five member states belonging to the European Union, whether they have adopted the euro or not, and the European Central Bank. The “Eurosystem” is the term used to refer to the European Central Bank and the national central banks of the member states which have adopted the euro. The European Central Bank is responsible for the monetary policy of the European Union. The Bank of Spain, as a member of the Eu ro pean System of Central Banks, takes part in the development of the European System of Central Banks’ powers including the design of the European Union’s monetary policy.
The European System of Central Banks is made up of three decision-making bodies:
The Governing Council is the body in charge of formulating monetary policy for the euro area and adopting the guidelines and decisions necessary to perform the Eurosystem’s tasks. The Executive Board is the body in charge of implementing the monetary policy for the euro area laid out by the Governing Council and providing the instructions necessary to carry out monetary policy to the euro area national central banks.
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The European Central Bank has delegated the authority to issue the euro to the central banks of each country participating in Stage III. These central banks will also be in charge of executing the European Union’s monetary policy in their respective countries. The countries that have not adopted the euro will have a seat in the European System of Central Banks, but will not have a say in the monetary policy or instructions laid out by the governing council to the national central banks.
Notwithstanding the European Monetary Union, the Bank of Spain continues to be responsible for:
The Bank of Spain has the following supervisory powers over Spanish banks, subject to applicable laws, rules and regulations issued by the Spanish Government and the Ministry of Economy and Finance:
Liquidity Ratio
European Central Bank regulations require credit institutions in each member state that participates in the European Monetary Union, like us, to place a specific percentage of their “Qualifying Liabilities” with their respective central banks in the form of interest bearing deposits as specified below (the “Liquidity Ratio”).
The European Central Bank requires the maintenance of a minimum liquidity ratio at all credit institutions established in the member states of the European Monetary Union. Branches located in the euro zone of institutions not registered in this area are also subject to this ratio, while the branches located outside the euro zone of institutions registered in the euro zone are not subject to this ratio.
“Qualifying Liabilities” are broadly defined as deposits and debt securities issued. The Liquidity Ratio is 2% over Qualifying Liabilities except in relation to deposits with stated maturity greater than two years, deposits redeemable at notice after two years, repos and debt securities with a stated maturity greater than two years, for which the ratio is 0%.
Liabilities of institutions subject to the Liquidity Ratio and liabilities of the European Central Bank and national central banks of a participating member state of the European Monetary Union are not included in the base of "Qualifying Liabilities".
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Investment Ratio
The Spanish Government has the power to require credit institutions to invest a portion of certain “Qualifying Liabilities” in certain kinds of public sector debt or public-interest financing (the “investment ratio”), and has exercised this power in the past. Although the investment ratio has been 0% since December 31, 1992, the law which authorizes it has not been abolished, and the Spanish Government could reimpose the ratio, subject to EU requirements.
Capital Adequacy Requirements
The Bank and its Spanish bank subsidiaries are subject to Spanish capital adequacy requirements that implement the European Union Capital Adequacy Directive.
The Spanish capital adequacy requirements distinguish between “basic” and “complementary” capital and require certain ratios of basic and total capital to risk-weighted assets. Basic capital generally includes ordinary shares, non-cumulative preferred securities, most reserves and generic credit allowances less holdings in other financial institutions exceeding certain thresholds, treasury stock and financing for the acquisition (by persons other than the issuer’s employees) of the issuer’s shares. Complementary capital generally includes cumulative preferred securities, revaluation and similar reserves and dated and perpetual subordinated debt.
The computation of both basic and complementary capital is subject to provisions limiting the type of stockholding and the level of control which these stockholdings grant to a banking group. The level of dated subordinated debt taken into account for the calculation of complementary capital may not exceed 50% of basic capital, the level of non-cumulative preferred securities may not exceed 30% of basic capital and the total amount of complementary capital admissible for computing total capital may not exceed the total amount of basic capital.
The consolidated total capital of a banking group calculated in the manner described above may not be less than 8% of the group’s risk-weighted assets net of specified provisions and amortizations. The calculation of total risk-weighted assets applies minimum multipliers of 0%, 10%, 20%, 50% and 100% to the group’s assets.
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Spanish regulations provide that, if certain requirements are met, Spanish banks may include the net credit exposure arising from certain interest rate -and foreign exchange- related derivative contracts (rather than the entire notional amount of such contracts) in their total risk-adjusted assets for purposes of calculating their capital adequacy ratios.
At December 31, 2004, our eligible capital, including Abbey, exceeded the minimum required by the Bank of Spain by approximately €11.1 billion. Our Spanish subsidiary banks were, at December 31, 2004, each in compliance with these capital adequacy requirements, and all our foreign subsidiary banks were in compliance with their local regulation.
Banks or consolidated banking groups should communicate immediately to the Bank of Spain if they fail to satisfy minimum capital requirements, and within the next month should present a plan to recover the solvency. This plan could be modified by the Bank of Spain. While the deficit persists, the payment of dividends by any of the entities of the banking group must be approved by Bank of Spain, and will be limited to a maximum of 50% of net attributable income. Payment of dividends could be forbidden if the deficit of capital is greater than 20% of the minimum capital requirements. See “Item 4. Information on the Company-B. Business Overview-Restrictions on Dividends”.
The Basel Committee on Banking Regulations and Supervisory Practices, which includes the supervisory authorities of twelve major industrial countries, has adopted an international framework (the “Basel Accord”) for capital measurement and capital standards of banking institutions. The framework provides:
As described above, the capital adequacy of Spanish banks is regulated by European Union directives applicable to the Spanish banking system as well as to the banking systems of other European Union member states. Certain European Union member states are parties to the Basel Accord. Spain joined the Accord on February 1, 2001. Each national authority which is a party to the Basel Accord has implemented the Accord in a significantly different fashion. The capital requirements imposed by the Basel Accord are in many respects similar to those imposed by European Union directives, Spanish law and the Bank of Spain. Based purely on the capital framework itself, and making assumptions that we consider appropriate (but without including in Tier 2 capital any revaluation reserves), we estimate that, at December 31, 2004, we had (1) a total capital to risk-weighted assets ratio of 13.01%, and (2) a Tier 1 capital to risk-weighted assets ratio of 7.16%.
After continuing consultation, the Basel Committee has developed a new framework to replace the 1988 Capital Accord, which the European Union has adopted and issued as Capital Adequacy Directive Three. It is currently expected that the new Capital Accord will be implemented during 2007 and 2008, although implementation in the European Union will be dependent on the adoption of a directive amending the Banking Consolidation Directive and the Capital Adequacy Directives.
The New Accord introduces more emphasis on risk sensitivity, supervisory review and market discipline (through more extensive disclosures). The impact of the new regulation is not expected to increase the capital requirements, but will increase its volatility.
Concentration of Risk
Spanish banks may not have exposure to a single person or group in excess of 25% (20% in the case of an affiliate) of the bank’s or group’s consolidated equity. Any exposure to a person or group exceeding 10% of a bank’s or group’s consolidated equity is deemed a concentration and the total amount of exposure represented by all of such concentrations must not exceed 800% of such equity.
Legal Reserve And Other Reserves
Spanish banks are subject to legal and other restricted reserves requirements. In addition, we must allocate profits to certain other reserves as described under Note 21 to our consolidated financial statements.
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Allowances For Credit Losses And Country-Risk
For a discussion of Bank of Spain regulations relating to allowances for credit losses and country-risk, see “Item 4. Information on the Company—B.Business Overview—Selected Statistical Information—Classified Assets—Bank of Spain Classification Requirements—Non-Performing Assets” and “Country-risk Outstandings”.
Employee Pension Plans
The Bank of Spain requires Spanish banks’ pension funds to be fully funded. At December 31, 2004, our pension plans were all fully funded according to Bank of Spain requirements. See Note 2(j) to our consolidated financial statements.
Restrictions on Dividends
We may only pay dividends (including interim dividends) if such payment is in compliance with the Bank of Spain’s minimum capital requirement (described under “Item 4. Information on the Company—B. Business Overview —Capital Adequacy Requirements”) and other requirements or, as described below, under certain circumstances when we have capital that is 20% or less below the Bank of Spain’s minimum capital requirements.
If a banking group meets this capital requirement, it may dedicate all of its net profits to the payment of dividends, although in practice Spanish banks nomally consult with the Bank of Spain before declaring a dividend. Even if a banking group meets the capital requirement as a group, any consolidated Spanish credit entity that is a subsidiary that does not meet the capital requirement on its own will be subject to the limitations on dividends described below. If a banking group or any Spanish credit entity subsidiary of the group has capital that is 20% or less below the Bank of Spain’s minimum capital requirement, it must devote an amount of net profits (at least 50%) determined by the Bank of Spain to reserves, and dividends may be paid out of the remainder only with the prior approval of the Bank of Spain. If the capital is 20% or more below the minimum requirement, it may not pay any dividends and must allocate all profits to rese rv es. In the case of a banking group failing to meet the capital requirement, however, consolidated subsidiaries in the group may pay dividends without restriction, so long as they are at least 90% owned by group companies and, if they are credit entities, independently comply with the capital requirement.
If a bank has no net profits, its board of directors may propose at the general meeting of shareholders that a dividend be declared out of retained earnings. However, once the board of directors has proposed the dividend to be paid, it must submit the proposal to the Minister of Economy and Finance who, in consultation with the Bank of Spain, may in his discretion authorize or reject the proposal of the board.
Compliance with such requirements notwithstanding, the Bank of Spain is empowered to advise a bank against the payment of dividends on security and soundness grounds. If such advice is not followed, the Bank of Spain may require that notice of such advice be included in the bank’s annual report registered before the Mercantile Register. In no event may dividends be paid from certain legal reserves.
Interim dividends of any given year may not exceed the net profits for the period from the closing of the previous fiscal year to the date on which interim dividends are declared. In addition, the Bank of Spain recommends that interim dividends not exceed an amount equal to one-half of all net income from the beginning of the corresponding fiscal year. Although banks are not legally required to seek prior approval from the Bank of Spain before declaring interim dividends, the Bank of Spain has asked that banks consult with it on a voluntary basis before declaring interim dividends.
Limitations On Types Of Business
Spanish banks generally are not subject to any prohibitions on the types of businesses that they may conduct, although they are subject to certain limitations on the types of businesses they may conduct directly.
The activities that credit institutions authorized in another member state of the European Union may conduct and which benefit from the mutual recognition within the European Union are detailed in article 52 of Law 26/1988 (July 29, 1988).
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Deposit Guarantee Fund
The Deposit Guarantee Fund on Credit Institutions (“Fondo de Garantía de Depósitos”, or the “FGD”), which operates under the guidance of the Bank of Spain, guarantees in the case of our Spanish banking subsidiaries: (i) bank deposits up to €20,000 per depositor; and (ii) securities and financial instruments which have been relied to a credit institution for its deposit, register or for such other service, up to €20,000 per investor. Pursuant to regulations affecting the FGD, the FGD may purchase non-performing loans or may acquire, recapitalize and sell banks which experience difficulties.
The FGD is funded by annual contributions from member banks. The amount of such bank’s contributions is currently 0.6 per thousand (0.4 per thousand for savings banks and 0.8 per thousand for credit cooperatives) of the year-end amount of deposits to which the guarantee extends. For that purpose, the calculation basis will take into consideration the bank deposits, plus 5% of the market quotation (or nominal value or redemption value in case the securities are not traded in any secondary market) of the guaranteed securities at the end of the financial year. Nevertheless, the Minister of Economy and Finance may reduce the member bank contributions once the capital of the FGD resources exceeds its requirements, and suspend further contributions when the FGD’s funds exceed the requirement by 1% or more of the calculation basis.
At December 31, 2004, the Bank and its domestic bank subsidiaries were members of the FGD and thus were obligated to make annual contributions to it.
Data Protection
Law 15/1999, dated December 13, 1999, establishes the requirements relating to the treatment of customers’ personal data by credit entities. This law requires credit entities to notify the Spanish Data Protection Agency prior to creating files with a customer’s personal information. Furthermore, this law requires the credit entity to identify the persons who will be responsible for the files and the measures that will be taken to preserve the security of those files. The files must then be recorded in the Data Protection General Registry, once compliance with the relevant requirements has been confirmed. Credit entities that breach this law may be subject to claims by the interested parties before the Data Protection Agency. The Agency, which has investigatory and sanctioning capabilities, is the Spanish Authority responsible for the control and supervision of the enforcement of this law.
Recent Legislation
Law 44/2002 (November 22, 2002) on reform measures of the financial system, amended, among others, the Credit Entities Discipline and Intermediation Law, the Private Insurance law and the Securities Market Law. See “Item 9. The Offer and Listing – C. Markets – Spanish Securities Market – Securities Market Legislation”.
On July 4, 2003, Law 19/2003 was approved. This law is an update to Spanish exchange control and money laundering prevention provisions. See “Item 10. Additional Information – D. Exchange Controls – Restrictions on Foreign Investments”. This law also introduces an additional rule to Law 13/1985 on requirements for the issuance of preferred securities.
On July 9, 2003, Law 22/2003 was approved, which implements certain reforms to the insolvency process, compiling all the material and formal aspects of the insolvency process into a single legal instrument.
Law 26/2003 (July 17, 2003) amended the Securities Market Law 24/1988 and the Corporations Law in order to reinforce the transparency of listed companies. See “Item 9. The Offer and Listing – C. Markets – Spanish Securities Market – Securities Market Legislation”.
Law 58/2003 (December 17, 2003), the General Tax Law, became effective on July 1, 2004 and superseded existing laws regulating this matter.
Royal Legislative Decree 3/2004, consolidated all the existing legislation regarding personal income tax into a single law and abolished existing law on the subject, including Law 40/1998 which was the primary source of regulation.
Royal Legislative Decree 4/2004, consolidated all the existing legislation regarding corporate income tax into a single law and abolished existing law on the subject, including Law 43/1995 which was the primary source of regulation.
Royal Legislative Decree 5/2004, consolidated all the existing legislation regarding taxation of non-resident individuals and entities into a single law and abolished existing law on the subject, including Law 41/1998 which was the primary source of regulation.
Royal Decree 1777/2004 which further developed Royal Decree Law 4/2004 relating to corporate income tax.
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On July 30, 2004, Royal Decree 1778/2004 was approved, introducing reporting obligations for (i) preferred participations and other debt instruments and (ii) certain income generated by individuals in the European Union.
Royal Legislative Decree 6/2004, consolidated the existing legislation regarding the regulation and supervision of private insurance.
Circular 4/2004 (December 22, 2004) of the Bank of Spain to financial institutions sets standards on public and restricted information and official forms for financial statements.
Law 3/2004 (December 29, 2004) establishes measures against non-performance of commercial transactions.
Royal Decree 54/2005 modifies the regulations on prevention of money laundering, to adapt to Law 19/2003, approved by Royal Decree 925/1995, and other standards to regulate the banking, finance and insurance systems.
Royal Decree Law 5/2005 (i) amends the Securities Market Law 24/1988 in order to implement the Directive 2003/71/EC of the European Parliament and of the Council on the prospectus to be published when securities are offered to the public or admitted to trading; and (ii) implements the Directive 2002/47/EC of the European Parliament and of the Council on financial collateral arrangements. See “Item 9. The Offer and Listing – C. Markets – Spanish Securities Market – Securities Market Legislation”.
Circular 1/2005 of the CNMV, which amends the official forms used to report periodic public information of the companies whose securities are traded on Spanish Stock Exchanges.
Law 6/2005 (April 22) on solvency and liquidation of credit entities.
Law 5/2005 (April 22) on supervision of financial conglomerates, amending other laws applicable to the financial sector.
Also, please see our above discussion of the New Basel Capital Accord under “Capital Adequacy Requirements”.
United Kingdom Regulation
General
By virtue of our acquisition of Abbey as well as the operation of our branch in the United Kingdom, we are subject to regulation by the Financial Services Authority in the United Kingdom. The Financial Services Authority is the single statutory regulator responsible for regulating deposit taking, mortgages, insurance and investment business pursuant to the Financial Services and Markets Act 2000. It is a criminal offense for any person to carry on any of the activities regulated under this Act in the United Kingdom by way of business unless that person is authorized by the Financial Services Authority or falls under an exemption.
The Financial Services Authority has authorized Abbey, as well as some of its subsidiaries, to carry on certain regulated activities. The regulated activities they are authorized to engage in depends upon permissions granted by the Financial Services Authority. The main permitted activities of Abbey and its subsidiaries are listed below.
Mortgages
Lending secured on land at least 40% of which is used as a dwelling by an individual borrower or relative has been regulated by the Financial Services Authority since October 31, 2004. Abbey is authorized to enter into, advise and arrange regulated mortgage contracts.
Banking
Deposit taking is a regulated activity that requires a firm to be authorized and supervised by the Financial Services Authority. Abbey has permission to carry on deposit taking as do several of its subsidiaries, including Abbey National Treasury Services plc, Cater Allen Limited and Cater Allen Premier Banking Limited.
Insurance
United Kingdom banking groups may provide insurance services through other group companies. Insurance business in the United Kingdom is divided between two main categories: long-term assurance (whole life, endowments, life insurance investment bonds) and general insurance (building and contents cover and motor insurance). Under the Financial Services and Markets Act, effecting or carrying out any contract of insurance, whether general or long-term, is a regulated activity requiring authorization. Life insurance mediation has been subject to regulation for many years. Brokering of long-term insurance (for example, critical illness) became regulated on October 31, 2004. General insurance mediation has been subject to regulation by the Financial Services Authority since January 14, 2005.
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Abbey has a number of subsidiaries which are authorized by the Financial Services Authority to effect contracts of insurance. Abbey also acts as a broker, receiving commissions for the policies arranged.
Investment business
Investment business such as dealing in, arranging deals in, managing and giving investment advice in respect of most types of securities and other investments, including options, futures and contracts for differences (which would include interest rate and currency swaps) and long-term assurance contracts are all regulated activities under the Financial Services and Markets Act and require authorization by the Financial Services Authority.
Abbey and a number of its subsidiaries have permission to engage in a wide range of wholesale and retail investment businesses including selling certain life assurance and pension products, unit trust products and Individual Savings Accounts (tax exempt saving products) and providing certain retail equity products and services.
United States Regulation
By virtue of the operation of our branch in New York City, our agency in Miami and Banesto’s branch in New York City, as well as our ownership of a bank in Puerto Rico, we are subject to the U.S. Bank Holding Company Act of 1956, as amended, and the U.S. International Banking Act of 1978, as amended. These statutes impose limitations on the types of business conducted by us in the United States and on the location and expansion of our banking business in the United States. We are subject to supervision and regulation by the Board of Governors of the Federal Reserve System.
Monetary Policy and Exchange Controls
The decisions of the European System of Central Banks influence conditions in the money and credit markets, thereby affecting interest rates, the growth in lending, the distribution of lending among various industry sectors and the growth of deposits. Monetary policy has had a significant effect on the operations and profitability of Spanish banks in the past and this effect is expected to continue in the future. Similarly, the monetary policies of governments in other countries in which we have operations, particularly in Latin America and, following the acquisition of Abbey, in the United Kingdom, affect our operations and profitability in those countries. We cannot predict the effect which any changes in such policies may have upon our operations in the future, but we do not expect it to be material.
The European Monetary Union has had a significant effect upon foreign exchange and bond markets and has involved modification of the internal operations and systems of banks and of inter-bank payments systems. Since January 1, 1999, the start of Stage III, see “Item 4. Information on the Company—B. Business Overview —Supervision and Regulation—Bank of Spain and the European Central Bank,” Spanish monetary policy has been affected in several ways. The euro has become the national currency of the twelve participating countries and the exchange rates between the currencies of these countries were fixed to the euro. Additionally, the European System of Central Banks became the entity in charge of the European Union’s monetary policy.
C. Organizational structure.
Banco Santander Central Hispano, S.A. (“the Bank”) is the parent company of the Group which was comprised at December 31, 2004 of 582 companies that consolidate by the global integration method and 185 companies that are accounted for by the equity method.
See Exhibits I, II and III to our consolidated financial statements included in this Form 20-F, for details on our consolidated and non-consolidated companies.
D. Property, plant and equipment.
During 2004, the Bank and its bank subsidiaries either leased or owned premises in Spain and abroad, which at December 31, 2004 included 4,384 branch offices in Spain and 5,589 abroad. See Note 13 to our consolidated financial statements.
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Item 5. Operating and Financial Review and Prospects
Critical Accounting Policies
Our primary financial statements are prepared in accordance with Spanish GAAP. Notes 1 and 2 to our Consolidated Financial Statements contain a summary of our significant accounting policies. Certain of these policies require management to make difficult, complex or subjective judgments that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of income and expenses during the reporting period. Following our accounting procedures, these judgments are submitted to our Audit and Compliance Committee and/or to our regulatory authorities and are disclosed in the notes to our financial statements.
Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions.
Management´s ability to make subjective decisions is more limited under Spanish GAAP than under U.S. GAAP. For example, U.S. GAAP requires financial instruments to be valued at fair value, which requires some subjective decisions to be made when there is not a readily available market for such instruments, while under Spanish GAAP, such instruments are valued at cost which can be determined objectively. For a summary of significant valuation and income recognition differences under Spanish and U.S. GAAP, see Note 28.1 to our Consolidated Financial Statements.
We believe that of our significant accounting policies, the following may involve a high degree of judgment:
Allowances for credit losses
Spanish GAAP requires the level of the allowance for credit losses (general, specific and statistical) to be determined in part on the basis of specific rules rather than the subjective judgment involved under the U.S. GAAP impairment process.
The general allowance is calculated by applying a coefficient to the outstanding sum of loans and other risks.
The specific allowance is calculated based on the minimum requirements (coefficients) established by the Bank of Spain. Additional allowances are provisioned when management estimates probable losses with respect to specific exposures.
Since July 1, 2000, the Bank of Spain has required Spanish banks to create an allowance for the statistical coverage of credit losses based on an estimation of future credit losses in the credit portfolio. This allowance is in addition to the other allowances described above.
As an alternative to the internal model referred to above (or as an alternative for some types of credit risk) Spanish banks may calculate the provisions to be made to create the allowance by applying a vector of coefficients (ranging from 0% to 1.5%) to each of the six categories in which the amount of computable credit risk is divided.
Amortization of goodwill
The book value of goodwill is stated at cost less accumulated amortization. We amortize goodwill on a straight-line basis over the period in which we estimate the investment would be recovered (maximum 20 years). Nevertheless, if management estimates that the investment may not be recovered during the foreseen period, goodwill is amortized on an accelerated basis, recognizing an impairment loss in that year. In 2002 and 2003, goodwill from our investment in Banespa of €400.6 million and €1,703.8 million, respectively, was amortized on an accelerated basis. Also, in 2002, goodwill from our investment in Banco Santander Colombia of €240.0 million was partially amortized on an accelerated basis and in 2003, goodwill of €775.7 million with respect to our operations in Argentina was fully written off with a charge to the allowances recorded in prior years for this purpose. Finally, in 2004 we amortized, on an accelerated basis, goodwill of €153.8 million (mainly related to our investments in Venezuela and Colombia, which had been adjusted in prior years for U.S. GAAP reconciliation purposes). These decisions were coordinated with our regulatory authorities (see Note 12 to our Consolidated Financial Statements).
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Management tests goodwill impairment against market quotations for listed investments, while unlisted investments are tested for impairment based on in-house valuations, according to the FAS 142 step one test criteria. In cases where events triggering the step two test occur, management supports impairment of goodwill with independent valuations or appraisals, in accordance with FAS 142.
Investment securities
Debt securities are classified as trading, available-for-sale investment or held-to-maturity securities, depending on the intent of the investment. Equity investments in listed companies owned less than 3% and non-listed companies owned less than 20% are classified as trading, available-for-sale investment or permanent investment securities, depending on the intent of the investment.
Trading securities are stated at market value, and differences between market value and book value are reported in the statement of income.
Held-to-maturity and permanent investment securities are stated at adjusted acquisition price.
Available-for-sale investment securities are measured either at lower of:
Unrealized losses are reported in an accrual account if deemed to be temporary or provisioned in the statement of income if deemed to be permanent creating a specific allowance. Releases from this allowance arise when unrealized losses disappear. Unrealized gains are not reported.
Under Spanish GAAP there are no general rules regarding the methodologies and factors that must be used or the period of time needed to consider an unrealized loss as “temporary” or “other than temporary”. Our management considers that an unrealized loss is “temporary” under Spanish GAAP if it believes that it will collect or recover all of the unrealized loss or when due to market conditions (volatility, interest rate evolution or macroeconomic variables) or future expectations, management considers that all or part of an unrealized loss will be recovered. Our management considers that an unrealized loss is “other than temporary” if it believes that it will not collect or recover all the unrealized loss (credit risk), or when due to market conditions (volatility, interest rate evolution, macroeconomic variables) or future expectations, management considers that all or part of an unrealized loss will not be recovered (market risk). Based on the foregoing factors, our management will conclude that an unrealized loss is “other than temporary” when a demonstrable recovery in the fair value of the security is not expected in the near future (one year). Our management performs this analysis at the end of each reporting period.
As described above, if an unrealized loss is classified as “other-than-temporary” we are required by Bank of Spain regulations to take a charge to our Consolidated Statement of Income.
If management’s assumptions and estimates concerning the probability that we will recover all or part of unrealized losses prove to be inaccurate, or if such assumptions and estimates are modified in light of the evolution of the factors described above, we may be required to change the classification of certain unrealized losses from “temporary” to “other than temporary” and, accordingly, take a corresponding charge to our Consolidated Statement of Income.
Additionally, for U.S. GAAP reconciliation purposes, an additional charge to income is recorded every time a “temporary loss” for a given security has been existing for the 6 months prior to the date of the financial statements.
After preparation of the primary financial statements as of December 31, 2004, during the first half of 2005 and Following IFRS 1 (first time adoption), management decided to discontinue classification of securities Held to Maturity in its IFRS financial statements as of December 31, 2003 and 2004. Accordingly, all securities Held to Maturity have been considered as reclassified to Available for Sale as of December 31, 2004 in its U.S. GAAP reconciliation and required disclosures (see Notes 28.2.e, 28.4 and 28.5.c).
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Significant equity investments
These investments are accounted for by the equity method if our holdings in the relevant entity represent more than 20% of the voting rights in such entity (3% of the voting rights if such entity is listed on a stock exchange) and if management considers that there is a lasting relationship between the Group and such entity and if such entity is intended to contribute to the Group’s business activities and over which the Group exercises significant influence. Otherwise, these investments are accounted for at the lower of cost or market. For this reason the Group always discloses its intentions with respect to each significant equity holding, designating them as “financial” or “permanent”.
As of December 31, 2003, we decided not to consider as “permanent” some of our equity holdings, among others, those of San Paolo-IMI and Commerzbank.
Derivative financial instruments
We use derivative financial instruments for both trading and non-trading activities. The principal types of derivatives used are: interest rate swaps, future rate agreements, interest rate options and futures, foreign exchange forwards, foreign exchange futures, foreign exchange options, foreign exchange swaps, cross currency swaps, equity index futures and equity options.
Macro hedges:
These transactions are carried out for hedging and overall management of the financial risks to which we are exposed and are aimed at eliminating or significantly reducing currency, interest rate or price risks on asset and liability positions. Similarly, we also treat as hedging transactions certain transactions which, although not specifically assigned to a specific hedged item, form part of global hedges or macro hedges used to reduce the risk to which we are exposed as a consequence of overall management of our assets, liabilities and other transactions. For this reason, the gains or losses arising from these hedging transactions are recorded symmetrically with the revenues and costs of the hedged items, and the collections or payments made in settlement of such hedging transactions are recorded with a balancing item under the “Other Liabilities” and “Other Assets” captions in the Consolidated Balance Sheets.
Non-hedging transactions valuation:
Non-hedging transactions, which are also known as trading transactions, are valued in accordance with Bank of Spain regulations based on the market on which they are traded:
Although Bank of Spain’s rules provide guidance regarding valuation of OTC derivative financial instruments, we are required to make estimates and assumptions, such as with respect to the futures quotations and its volatility, maturities and the effects of market risks.
Theoretical closings are the most reliable measure of fair value for derivative financial instruments. The determination of fair value requires us to make estimates and certain assumptions. If quoted market prices are not available, we have to calculate the fair value from commonly used pricing models that consider contractual prices for the underlying financial instruments, yield curves and other relevant factors. Our use of different estimates or assumptions in these pricing models could lead to materially different amounts being recorded in our Consolidated Financial Statements.
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Pension commitments
We participate directly and indirectly in defined benefit pension schemes for part of our employees. The pension cost for these schemes is assessed in accordance with the advice of a qualified external actuary. This cost is annually charged to the income statement. In determining this cost the actuarial value of the assets and liabilities of the scheme is calculated. This involves modeling their future growth and requires management and the external actuary to make assumptions as to factors such as:
There is an acceptable range established by management and the external actuary in which these estimates can validly fall. If different estimates within that range had been selected the cost recognized in the income statement could be significantly altered.
Significant accounting policies with respect to our reconciliation from Spanish to U.S. GAAP
We include a reconciliation of net income and shareholders' equity between Spanish GAAP and U.S. GAAP within Note 28 to the Consolidated Financial Statements. The preparation of this reconciliation requires management to consider accounting policies under U.S. GAAP to determine whether or not a difference in GAAP exists, and to quantify the amount of that difference where appropriate. These policies may also be based on difficult or subjective judgments, estimates based on past experience and assumptions determined to be reasonable and realistic based on the related circumstances.
Unless indicated otherwise, all of the significant accounting policies identified above, are equally critical to preparation of the U.S. GAAP reconciliation, and involve similar judgment and assumptions by management.
Business combinations and goodwill
Goodwill and intangible assets include the cost of acquired subsidiaries in excess of the fair value of the tangible net assets recorded in connection with acquisitions. Acquired intangible assets include core deposit, customer list, brand and asset under management. Accounting for goodwill and acquired intangible assets requires management's estimate regarding: (1) the fair value of the acquired intangible assets and the initial amount of goodwill to be recorded, (2) the amortization period and (3) the recoverability of the carrying value of acquired intangible assets.
To determine the initial amount of goodwill to be recorded upon acquisition, we have to determine the consideration and the fair value of the net assets acquired. We use independent appraisers and our internal analysis, generally based on discounted cash flow techniques, to determine the fair value of the net assets acquired and non-cash components of the consideration paid. The actual fair value of net assets acquired could differ from the fair value determined, resulting in an under- or over-statement of goodwill.
We test goodwill for impairment at the reporting unit level. We determine our reporting units one level below our business segment, based on our management structure. We keep those reporting units unchanged unless business segment reorganization occurs.
The useful lives of acquired intangible assets are estimated based on the period over which the assets are expected to contribute directly or indirectly to the future cash flows of the acquired entity.
The amortization period under U.S. GAAP is reviewed annually in light of the above factors for acquired intangible assets. In making these assumptions, we consider historical results, adjusted to reflect current and anticipated operating conditions. Because a change in these assumptions can result in a significant change in the recorded amount of acquired intangible assets, we believe the accounting for business combination is one of our critical accounting estimates.
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In the 2003 goodwill impairment test relating to our investment in Brazil, the valuation of this reporting unit was lower than its carrying value, triggering the need to perform the step two impairment test as required by FAS 142. As the purchase of this investment was done prior to the adoption of FAS 142, its intangible assets were not identified and recognized on acquisition. The step two impairment test led to the identification of intangibles that were in process of being valued when the 2003 form 20-F was filed. The identification of these intangibles had the effect of increasing the goodwill impairment.
The investment related to Brazil had a book value under U.S. GAAP of €4,427 million, of which €2,247 million was its net worth and €2,180 million goodwill. Management estimated intangibles in the customer portfolio between €1,000 and €1,500 million. An external appraisal valued this reporting unit in a range between €4,147 and €2,931 million, without identifying the value of any intangible asset. The methodology applied in the valuation was basically discounted cash-flows, multiple comparison, adjusted liquid stockholders’ equity and core results. For the impairment test, the Bank used the more conservative approach assuming the lower value of the valuation range of the reporting unit and that the value of non-registered intangible assets was, at minimum, €680 million. Based on these assumptions it registered a goodwill impairment charge of €2,180 million (€1,719 million in its primary financial statements plus €461 million in the reconciliation to U.S. GAAP). In order to complete the impairment test as required by FAS 142, the Bank demanded an appraisal from an external independent expert, to identify and value the intangibles not registered (see note 28.2.g). Such appraisal resulted in a report, dated November 2004, which identified intangibles that had a fair value of €1,350 million. Because such amount was above minimum management expectations as of the 2003 form 20F filing date (€680 million), once the Brazil reporting unit goodwill impairment test process was concluded, no additional impact has been recorded in the 2004 U.S. GAAP reconciliation. The valuation method used was the present value of future cash flows projected.
In 2004, we acquired Abbey. As a result of this transaction a significant amount of goodwill was registered (see Notes 12, 28.2.g and 28.5.o to our financial statements). As the business combination was performed close to the end of the year and because of the complexity of the process, the determination of goodwill for U.S. GAAP purposes as well as the identification and recognition of intangible assets is not yet concluded. Management has required independent appraisal for the intangible assets identification and valuation.
In the reconciliation to U.S. GAAP, the Group adjusts its investments and trading securities at fair value if they are considered to be available-for-sale or trading securities. For a substantial majority of the Group´s investments and trading account assets and liabilities, fair values are determined based upon quoted prices or validated models. Changes in values of available-for-sale securities are recognized in a component of stockholders' equity net of taxes, unless the value is impaired and the impairment is considered to be other than temporary. Impairment losses that are not considered temporary are recognized in earnings. The Group conducts reviews to assess whether other-than-temporary impairment exists. These reviews consist (i) on the identification of the securities that maintain impairments during the last six months, and (ii) on the determination of the value of the impairment that is not expected to be easily recovered. Changing global and regional conditions and conditions related to specific issuers or industries, could adversely affect these values. Changes in the fair values of trading securities are recognized in earnings.
In 2005, the Group is adopting IFRS (International Financial Reporting Standards). Among other decisions permitted in the rules of adoption of IFRS, the Company has decided to reclassify all its held to maturity portfolio to the available for sale portfolio. Consequently, even though the decision is taken in 2005 and statements under IFRS are not yet the Company’s primary financial statements, the Company has included this accounting change in its reconciliation to U.S. GAAP with effect on December 31, 2004 (see Note 28.2.e).
Variable Interest Entities
FIN 46-R defines and identifies “Variable Interest Entity” (VIE) if it has (1) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties (2) equity investor that cannot make significant decisions about the entity’s operations, or that do not absorb the expected losses or receive the expected returns of the entity or (3) equity investors that have voting rights that are not proportionate to their economic interests and substantially all the activities of the entity involved, or are conducted on behalf of, an investor with a disproportionately small voting interest. A VIE is consolidated by its primary beneficiary, which is the party involved with the VIE that has a majority of the expected losses or a majority of the expected residual returns or both. Adopting FIN 46-R required evaluating many Special Purposed Vehicles and in some cases to made s ome judgments. Note 28.1 shows differences between Spanish GAAP and U.S. GAAP consolidation procedures, the impact of the adoption of FIN 46-R is shown in notes 28.2.a and 28.4.
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We have based the following discussion on our consolidated financial statements. You should read it along with these financial statements, and it is qualified in its entirety by reference to them. We prepared our financial statements according to Spanish GAAP. We have identified the significant differences between Spanish GAAP and U.S. GAAP in note 28 to our consolidated financial statements included in this report on Form 20-F. Note 28 also includes reconciliations to U.S. GAAP of net income and stockholders’ equity as reported in the consolidated financial statements. Note 28.5 (J) to our consolidated financial statements includes financial information for our main business segments.
In November 2004, we acquired 100% of the capital of Abbey National plc. Under Spanish GAAP, our acquisition of Abbey has been reflected on our financial statements as if the acquisition had occurred on December 31, 2004. Accordingly, Abbey’s assets and liabilities were consolidated into our balance sheet as of December 31, 2004, but Abbey’s results of operations had no impact on our income statement for the year ended December 31, 2004. As a result, the following discussion of our operating results does not reflect the results of Abbey.
In a number of places in this report, in order to analyze changes in our business from period to period, we have isolated the effects of foreign exchange rates on our results of operations and financial condition. In particular, we have isolated the effects of depreciation of local currencies against the euro because we believe that doing so is useful to understand the evolution of our business. For these purposes, we calculate the effect of movements in the exchange rates by multiplying the previous period balances in local currencies by the difference between the exchange rate to the euro of the current and the previous period.
We are a financial group whose main business focus is retail banking, complemented by asset management and global wholesale banking businesses.
Our main source of income is the interest that we earn from our lending activities, by borrowing funds from customers and money markets at a rate and lending them to other customers at different rates. We also make money from the interest and dividends that we receive from our investments in fixed/variable income and equity securities and from our trading activities with such securities and derivatives, by buying and selling them to take advantage of current and/or expected differences between purchase and sale prices.
Another source of income is the commissions that we earn from the different banking and other financial services that we provide (credit and debit cards, insurance, account management, bill discounting, guarantees and other contingent liabilities, advisory and custody services, etc.) and from our mutual and pension funds management services.
In addition, an occasional source of income comes from the capital gains we can make from the selling of our holdings in Group´s companies and from the sale of treasury stock.
2004 Overview
We believe that the following factors had a significant impact on our results of operations and financial condition as of and for the year ended December 31, 2004.
First, we conducted our business in an environment in which the global economy continued its expansion. This expansion was present in many countries throughout the world, but in the United States and Asia, in particular.
The U.S. economy experienced a 4.4% growth in GDP in 2004. The Latin American economies were more buoyant; the region, as a whole, experienced economic growth of 5.8%. In the Euro zone, GDP growth slowed significantly in the second half of 2004, due to higher oil prices and the strengthening of the euro, leading to growth of 1.7% for the region during 2004. Spain´s economy experienced greater growth than the Euro zone as a whole (2.7% vs. 1.7% ), spurred by consumption, construction and recovery in investment in equipment.
Second, the year-on-year impact of exchange rates (mainly, the dollar’s fall against the euro and the depreciation of certain Latin American currencies against the euro) caused a decrease in net income and total assets by 4.4 percentage points and 1.5 percentage points, respectively.
In this environment, our strategy has been to increase income by strengthening our business with customers, while maintaining control of costs and improvement of credit quality. The result of this strategy was a strong increase in income and volume of business and the improvement in profitability, efficiency and credit quality ratios.
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Results of Operations
Summary
Net attributable income as reported in our consolidated financial statements for the year ended December 31, 2004 was €3,135.6 million, an increase of 20.1% from €2,610.8 million which was an increase of 16.2% from €2,247.2 million in 2002. The 2004 increase reflected mainly increases in net interest income, net fees and commissions and net income from companies accounted for by the equity method and decrease in goodwill amortization, all of which were partially offset by increases in net extraordinary losses, net provisions for credit losses and operating expenses, and decreased net gains on group transactions.
Net Interest Income
Net interest income was €8,635.7 million in 2004, a 8.5% or €677.4 increase from €7,958.3 million in 2003, which was a 15.0% or €1,400.3 million decrease from €9,358.7 million in 2002. Excluding dividends from companies accounted for by the equity method, net interest income was €8,270.2 million in 2004, a 8.1% or €621.4 million increase from €7,648.8 million in 2003, which was a 15.1% or €1,356.8 decrease from €9,005.6 million in 2002.
2004 Compared to 2003
The €677.4 million increase in net interest income is mainly due to the increased business volumes both in Spain and abroad and the steps taken by our business units to defend customer spreads that offset the fall in interest rates experienced in some countries. There was also an increase in the dividends received from our holdings of equity securities.
Average total earning assets (excluding Abbey) were €321,561.9 million for the year ended December 31, 2004, a 7.6% or €22,721.1 million increase from €298,840.8 million for the same period in 2003. This increase was mainly due to an increase of €11,037.6 million in the average balances of our domestic total earning assets (mainly due to an increase of €18,097.7 million in the average balances of our domestic loans and credits portfolio, partially offset by a decrease of €8,378.2 million in the average balances of our government debt securities portfolio) and an increase of €11,683.4 million in the average balance of our international total earning assets (mainly due to an increase of €7,749.1 million in the average balances of our debentures and other fixed income securities portfolio). Our loans and credits balance grew in Spain because of increased secured loans (mainly mortgage lending) and lo ans to companies resulting in part from continued low interest rates.
Our overall yield spread increased slightly from 2.63% in 2003 to 2.64% in 2004. Domestic yield spread decreased from 2.42% in 2003 to 2.38% in 2004. This change reflected continued pressure on margins in Spain which was offset by adjustments to our domestic asset mix. The margin pressure in Spain was due to continued low domestic interest rates as well as the continued effects of competition. Expanded volumes in our domestic loans and credits portfolio, which yielded relatively higher returns, improved our domestic asset mix. International yield spreads decreased from 3.17% in 2003 to 3.15% in 2004 due primarily to decreases in interest rates in some countries (Brazil, Chile and Venezuela).
2003 Compared to 2002
Net interest income comparison with 2002 is still greatly affected by the performance of exchange rates. Eliminating the impact of exchange rates (€1,284.3 million), net interest income only declined 1.2%. Another negative factor was the decrease in interest rates in Europe and Latin America. These negative factors were partly offset by the greater volume of business in Spain and by the steps taken by the Group’s different units to defend customer spreads. The overall decline in net interest income in 2003 mainly reflected a decrease in the average balance of earning assets as well as a decline in overall yield spreads.
Average total earning assets were €298,840.8 million for the year ended December 31, 2003, an 0.7% or €1,976.1 million decrease from €300,816.9 million for the same period in 2002. This decrease was mainly due to a decrease of €23,321.9 million in the average balances of our international total earning assets (mainly because of the effect of the weakening of nearly all the Latin American currencies against the euro, and particularly the effect of this on our international loans and credits portfolio), partially offset by an increase of €21,345.9 million in the average balance of our domestic total earning assets (mainly due to an increase of €10,640.1 million and €6,663.3 million in the average balances of our domestic loans and credits portfolio and debt securities portfolio, respectively). Our loans and credits balance grew in Spain because of increased secured loans (mainly mortgage lending) resulting in part from continuing low and declining domestic interest rates.
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The decrease in net interest income also resulted from the decline in overall yield spread from 3.13% in 2002 to 2.63% in 2003 (which mainly reflected a decline in international yield spread). Domestic yield spread decreased from 2.67% in 2002 to 2.42% in 2003. This change reflected continued pressure on margins in Spain but was offset by adjustments to our domestic asset mix. The margin pressure in Spain was due to continued low and declining domestic interest rates as well as the continued effects of competition. Expanded volumes in our domestic loans and credits portfolio, which yielded relatively higher returns, improved our domestic asset mix given existing conditions. International yield spreads declined because of a decrease in interest rates in Portugal and in some Latin America countries (Mexico, Brazil and Chile).
Net Fees and Commissions
Net fees and commissions were €4,609.3 million in 2004, a 10.5% or €438.7 million increase from €4,170.6 million in 2003, which was a 2.8% or €118.7 million decrease from €4,289.3 million in 2002.
Net fees and commissions for 2004 and 2003 were as follows:
The €438.7 million increase in 2004 primarily resulted from a €290.1 million or 22.4% increase in fees from mutual and pension funds due to higher volumes, a €164.3 million or 46.8% increase in fees from insurance due to increased activity and a €74.8 million or 15.4% increase in fees from credit and debit cards also due to increased activity, partially offset by a €105.9 million or 26.0% decrease in fees from bill discounting and a €75.4 million or 12.9% decrease in fees from securities services (due to lower fees from underwriting and placement).
Average balances of mutual funds under management in Spain rose 17.0% from €56.6 billion in 2003 to €66.2 billion in 2004. Average balances of mutual funds abroad (excluding Abbey) increased by 29.8% from €17.1 billion in 2003 to €22.2 billion in 2004 mainly due to increased activity in Mexico, Brazil and Chile.
Average balances of pension funds in Spain increased by 11.5% from €6.1 billion in 2003 to €6.8 billion in 2004, mainly due to increased activity in individual pension funds. Average balances of pension funds abroad (excluding Abbey) increased by 11.3% from €12.4 billion in 2003 to €13.8 billion in 2004 mainly due to increased activity in Chile, Colombia, Peru and Mexico.
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Net fees and commissions for 2003 and 2002 were as follows:
Excluding the impact of foreign exchange rates (€427.1 million), net fees and commissions in 2003 increased by 7.2%.
The €118.7 million decrease in 2003 primarily resulted from a €138.1 million or 24.7% decrease in fees from other operations and a €97.2 million or 19.3% decrease in fees from bill discounting, partially offset by a €93.6 million or 36.4% increase in fees from insurance (due to our marketing efforts, principally in Spain) and a €27.3 million or 4.9% increase in fees from securities services (due to commissions from underwriting and placement as those fees earned from the purchase and sale of securities continued to register moderate growth).
Fees from mutual and pension funds remained relatively flat, increasing €14.5 million or 1.1%.
Average mutual funds under management in Spain rose 11.6% from €50.7 billion in 2002 to €56.6 billion in 2003 due to our marketing efforts. Average mutual funds abroad decreased by 4.5% from €17.9 billion in 2002 to €17.1 billion in 2003 mainly due to the negative impact of exchange rates in our Latin American fund management companies, partially offset by an increase of average mutual funds in Portugal.
Average pension funds balances in Spain increased by 10.9% from €5.5 billion in 2002 to €6.1 billion in 2003, mainly due to increased activity in individual pension funds. Average pension funds abroad increased slightly by 0.8% from €12.3 billion in 2002 to €12.4 billion in 2003 mainly due to the increase of average mutual funds in our Latin American pension fund companies due to our marketing efforts, partially offset by the negative impact of exchange rates.
Gains (Losses) on Financial Transactions
Net gains on financial transactions were €952.7 million in 2004, a 4.6% or €46.1 million decrease from €998.8 million in 2003, which was a 180.4% or €642.6 million increase from €356.3 million in 2002. Gains (losses) on financial transactions include gains and losses arising from the following: marking to market our trading portfolio and derivative instruments, including spot market foreign exchange transactions, and sales of investment securities and liquidation of our corresponding hedge or other derivative positions. See note 25(b) to our consolidated financial statements.
The €46.1 million decrease in 2004 primarily reflects a lower contribution by our Latin American subsidiaries to our gains on financial transactions due to the negative impact of increasing interest rates on the trading portfolios of those subsidiaries, especially those in Mexico.
Net gains on financial transactions in 2004 includes net gains of €525.1 million on fixed-income securities (net gains of €392.1 million in 2003); net gains of €474.7 million on equity securities (net gains of €432.0 million in 2003); net gains of €282.9 million on exchange differences (net gains of €166.2 million in 2003) and net losses of €330.0 million in derivatives (net gains of €8.5 million in 2003). In the case of hedging transactions entered into to reduce market risk exposure, any gains and losses on exchange differences and derivatives are generally symmetrical to the gains (losses) recorded on fixed-income securities and equity securities.
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The €642.6 million increase in 2003 was mainly due to positive trading results and ALCO positions (due to interest rates and exchange rates), in clear contrast with the losses arising from the portfolio sales in Brazil (in order to reduce risk positions) during the second and third quarters of 2002 which made last year’s figure much lower than the Group’s average.
Net gains on financial transactions in 2003 includes net gains of €392.1 million on fixed-income securities (net losses of €340.6 million in 2002); net gains of €432.0 million on equity securities (net losses of €150.9 million in 2002); net gains of €166.2 million on exchange differences (net gains of €417.0 million in 2002) and net gains of €8.5 million in derivatives (net gains of €430.8 million in 2002). In the case of hedging transactions entered into to reduce market risk exposure, any gains and losses on exchange differences and derivatives are generally symmetrical to the gains (losses) recorded on Spanish and foreign fixed-income securities and equity securities.
Net Other Operating Income
Net other operating results generated a loss of €182.3 million in 2004, a 9.5% or €15.8 million increase from €166.5 million in 2003, which was a 26.5% or €60.0 million decrease from €226.5 million in 2002. Net other operating income consists mainly of other operating income and other operating expenses generated by our consolidated financial and non-financial consolidated subsidiaries and contributions we make to the Spanish Deposit Guarantee Fund and similar deposit guarantee programs abroad.
The €15.8 million increase in 2004 was mainly due to an increase in the contributions to the deposit guarantee programs (mainly in Latin America) of €6.6 million and an increase in net other operating losses generated by our consolidated subsidiaries of €9.2 million.
The €60.0 million decrease in 2003 was mainly due to a decrease in the contributions to the deposit guarantee programs (mainly in Latin America) of €32.0 million and a decrease in net other operating losses generated by our consolidated subsidiaries of €27.9 million.
General Administrative Expenses
General administrative expenses were €6,735.2 million in 2004, a 4.0% or €257.5 million increase from €6,477.7 million in 2003, which was a 11.5% or €844.4 million decrease from €7,322.1 million in 2002.
General administrative expenses for 2004 and 2003 were as follows:
The 4.0% increase in general administrative expenses in 2004 reflected a 2.1% increase in personnel expenses and a 7.1% increase in other administrative expenses. This increase in other administrative expenses is mainly related to the re-launching of business in some countries and the development of corporate projects (Partenón, Altair, regional projects in Latin America). There was also a small increase in the amount of general administrative expenses resulting from Santander Consumer´s acquisitions of PTF, Elcon and Abfin (for more information, see “Item 4. Information on the Company—A. History and development of the company—Principal Capital Expenditures and Divestitures—Acquisitions, Dispositions, Reorganizations”).
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The performance of revenues and cost control improved the efficiency ratio, measured by dividing general administrative expenses by gross operating income, to 47.4%, 1.9 percentage points better than in 2003.
General administrative expenses for 2003 and 2002 were as follows:
The 11.5% decrease in general administrative expenses in 2003 reflected a 10.5% decline in personnel expenses and a 13.3% decline in other administrative expenses. These costs, like the rest of the income statement, were significantly impacted by changes in exchange rates. Eliminating the impact of exchange rates (€793.4 million), general administrative expenses declined 0.7%, with personnel expenses down 0.9% and other administrative expenses down 0.3%.
The reduction in personnel expenses reflects the effort made in 2002 to reduce the number of employees in Spain, Portugal and Latin America.
The Group’s purchasing and optimization of costs area continued to adopt measures to cut spending, while the organization and IT areas continued to improve processes in order to boost efficiency and productivity throughout the Group.
The performance of revenues and cost control improved the efficiency ratio, measured by dividing general administrative expenses by gross operating income, to 49.3%, 2.9 percentage points better than in 2002.
Depreciation and Amortization
Depreciation and amortization was €735.0 million in 2004, a 3.6% or €27.8 million decrease from €762.8 million in 2003, which was a 14.3% or €127.0 million decrease from €889.8 million in 2002.
The €27.8 million decrease in 2004 was largely due to the effect of exchange rate fluctuations.
The €127.0 million decrease in 2003 was largely due to the effect of exchange rate fluctuations.
Net Income from Companies Accounted for by the Equity Method
Excluding dividends from companies accounted for by the equity method which are reflected under net interest income, net income from companies accounted for by the equity method was €540.4 million in 2004, a 32.7% or €133.1 million increase from €407.3 million in 2003, which was a 45.5% or €127.4 million increase from €279.9 million in 2002. Including dividends from companies accounted for by the equity method, net income from companies accounted for by the equity method was €905.9 million in 2004, a 26.4% or €189.1 million increase from €716.8 million in 2003, which was a 13.2% or €83.8 million increase from €633.0 million in 2002.
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The €133.1 million increase in 2004 excluding dividends from companies accounted for by the equity method and the €189.1 million including dividends, is mainly due to the higher contributions of Royal Bank of Scotland, Cepsa, Inmobiliaria Urbis, Unión Fenosa and insurance companies.
The entities providing the largest portions of the contributions in 2004 include the following:
The €127.4 million increase in 2003 excluding dividends from companies accounted for by the equity method and the €83.9 million including dividends, is mainly due to the higher contributions of Cepsa, Sanpaolo IMI, Unión Fenosa, Urbis and insurance companies that was offset by the lower contributions from Royal Bank of Scotland, Dragados and Vallehermoso we received as a result of our divestments in these holdings.
The entities providing a large portion of the contributions in 2003 include the following:
Amortization of Consolidation Goodwill
Amortization of consolidation goodwill was €618.9 million in 2004, a 72.4% or €1,622.8 million decrease from €2,241.7 million in 2003, which was a 65.0% or €883.1 million increase from €1,358.6 million in 2002.
The €1,622.8 million decrease in 2004 is mainly due to less early amortization of goodwill. In 2003, early amortization of goodwill amounted to €1,719.2 million (mainly related to our investment in Banespa), while in 2004 early amortization of goodwill amounted to €153.8 million (of which €92.6 million related to our investment in Banco de Venezuela and €57.5 million related to our investments in Colombia).
Ordinary amortization of goodwill was €465.2 million in 2004, a 11.0% or €57.3 million decrease from €522.5 million in 2003.
The €883.1 million increase in 2003 is mainly due to the early amortization of €1,719.2 million (€1,016.3 million more than in 2002), relating mainly to Banespa (€1,703.8 million), whose goodwill was reduced to zero.
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For further information on the variations in the balances of “Consolidation Goodwill” see Note 12 of the Consolidated Financial Statements.
Gains (Losses) on Group Transactions
Gains on Group transactions were €466.2 million in 2004, a 51.2% or €489.4 million decrease from €955.6 million in 2003, which was a 5.3% or €53.4 million decrease from €1,008.9 million in 2002.
The €466.2 million gain in 2004 relates primarily to the gains generated from the sale of our 2.5% holding in Royal Bank of Scotland (€472.2 million) partially offset from losses in trading and in other purchases and sales of treasury stock (€31.9 million).
The €955.6 million gain in 2003 relates primarily to the gains generated in the first quarter of 2003 (€680.6 million) from the sale of 24.9% of Santander Serfin to Bank of America, and €216.9 million in the fourth quarter of 2003 from the sale of shares in Royal Bank of Scotland.
Net Provisions for Credit Losses
Our net provisions for credit losses were €1,647.7 million in 2004, a 10.2% or €152.0 million increase from €1,495.7 million in 2003, which was a 9.3% or €152.5 million decrease from €1,648.2 million in 2002.
The €152.0 million increase in net provisions for credit losses reflected a €209.0 million increase in gross provisions for credit losses (gross provisions for credit losses were €1,929.2 million in 2004 compared to €1,720.2 million in 2003), a €6.0 million decrease in provisions for country-risk (provisions for country-risk were €127.0 million in 2004 compared to €133.0 million in 2003), and a €51.1 million increase in recoveries of loans previously charged-off (recoveries totaled €408.6 million in 2004 compared to €357.5 million in 2003).
The €209.0 million increase in gross provisions for credit losses is mainly due to increased statistical credit loss provisions (€600.9 million allocated in 2004 compared to €328.8 million allocated in 2003) while specific and generic provisions decreased by €63.1 million. (See “Item 4. Information on the Company—B. Business Overview—Classified Assets—Bank of Spain Classification Requirements—Allowance for the Statistical Coverage of Credit Losses”).
The €6.0 million decrease in provisions for country-risk is mainly due to non-recurrence in 2004 of the increase in 2003 of the amount of coverage required by the Bank of Spain for country-risk in Argentina. Our total country-risk exposure with third parties, net of allowances, in accordance with Bank of Spain criteria increased by €529.2 million to €620.2 million at December 31, 2004, compared to €91.0 million at December 31, 2003. This increase was largely due to the reclassification of certain trade finance transactions longer than 1 year in Brazil.
Excluding Abbey, our total allowances for credit losses increased by €771.6 million to €6,186.0 million at December 31, 2004, from €5,414.4 million at December 31, 2003. Including Abbey, our total allowances for credit losses increased by €1,784.9 million to €7,199.3 million at December 31, 2004, from €5,414.4 million at December 31, 2003.
Excluding country-risk and Abbey, non-performing assets decreased by €204.7 million to €3,017.8 million at December 31, 2004, compared to €3,222.5 million at December 31, 2003. Domestic non-performing assets decreased by €62.6 million to €869.0 million at December 31, 2004 from €931.6 million at December 31, 2003, while international non-performing assets decreased by €142.1 million to €2,148.8 million at December 31, 2004 from €2,290.9 million at December 31, 2003, due to our strong efforts to reduce our non-performing assets in Latin America. This trend may not continue and may even reverse in the future. Including Abbey (€930.6 million), non-performing assets were €3,948.4 million at December 31, 2004.
Our coverage ratio (excluding country-risk and Abbey) was 208.0% at December 31, 2004, and 165.2% at December 31, 2003. Including Abbey (excluding country-risk), our coverage ratio was 184.6% at December 31, 2004. See “Selected Statistical Information—Non-Performing Asset Ratios”.
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The €152.5 million decrease in net provisions for credit losses reflected a €341.7 million decrease in gross provisions for credit losses (gross provisions for credit losses were €1,720.2 million in 2003 compared to €2,061.9 million in 2002), a €153.0 million increase in provisions for country-risk (provisions for country-risk were €133.0 million in 2003 compared to release of provisions for country-risk of €20.0 million in 2002), and a €36.2 million decrease in recoveries of loans previously charged-off (recoveries totaled €357.5 million in 2003 compared to €393.7 million in 2002).
The €341.7 million decrease in gross provisions for credit losses is mainly due to the positive effect of exchange rates, reduced provisions for loans to borrowers in Argentina, in accordance with Argentine local criteria, and lower needs for the rest of Latin America, offset by increased provisions for Spain, mainly because of increased statistical credit loss provisions (€328.8 million allocated in 2003 vs. a release €39.2 million in 2002) and generic provisions (from increased business). (See “Item 4. Information on the Company—B. Business Overview—Classified Assets—Bank of Spain Classification Requirements—Allowance for the Statistical Coverage of Credit Losses”).
The €153.0 million increase in provisions for country-risk is mainly due to the increase this year of the amount of coverage required by the Bank of Spain for country-risk in Argentina. Our total country-risk exposure with third parties, net of allowances, in accordance with Bank of Spain criteria increased by €19.0 million to €91.0 million at December 31, 2003, compared to €72.0 million at December 31, 2002. This increase was largely due to the application of stricter classification criteria in December 2003 to operations with political risk coverage by private agencies.
Our total allowances for credit losses increased by €250.1 million to €5,414.4 million at December 31, 2003, from €5,164.3 million at December 31, 2002.
Excluding country-risk, non-performing assets decreased by €454.0 million to €3,222.5 million at December 31, 2003, compared to €3,676.5 million at December 31, 2002. Domestic non-performing assets decreased by €72.3 million to €931.6 million at December 31, 2003 from €1,003.9 million at December 31, 2002, while international non-performing assets decreased by €381.7 million to €2,290.9 million at December 31, 2003 from €2,672.6 million at December 31, 2002, due to our strong efforts to reduce our non-performing assets in Latin America and our conservative lending policy. This trend may not continue and may even reverse in the future.
Our coverage ratio (excluding country risk) was 165.2% at December 31, 2003, and 139.9% at December 31, 2002. See “Selected Statistical Information—Non-Performing Asset Ratios”.
Extraordinary Results
We had an extraordinary net loss of €850.3 million in 2004, compared to an extraordinary net income of €668.7 million in 2003 and an extraordinary net loss of €338.8 million in 2002.
The net debit balance of €850.3 million in 2004 includes the gains or losses on disposal of property and equipment and long-term investments (gains of €550 million –that include the €242 million and €118 million of capital gains from the divestment of our holdings in Vodafone and Shinsei Bank, respectively- and losses of €83 million); the collection of interest on doubtful and nonperforming loans earned in prior years (€108 million); monetary adjustment (net gain of €2.8 million) (see note 2-b to our consolidated financial statements); provisions to pension allowances which increased mainly due to early retirements (€979.8 million) (see note 2-j to our consolidated financial statements); and other net losses of €448 million, relating mainly to writedowns made by different Group companies that include €155 million of non-recurring expenses related to t he Abbey acquisition (principally advisory fees).
The net credit balance of €668.7 million in 2003 includes the gains or losses on disposal of property and equipment and long-term investments (gains of €696 million and losses of €93 million); the collection of interest on doubtful and nonperforming loans earned in prior years (€92 million); monetary adjustment (€9.1 million) (see note 2-b to our consolidated financial statements); provisions to pension allowances (€120.1 million) (see note 2-j to our consolidated financial statements); and other net income of €103 million.
The net debit balance of €338.8 million in 2002 includes the gains or losses on disposal of property and equipment and long-term financial investments (gains of €443 million and losses of €122 million); the collection of interest on doubtful and nonperforming loans earned in prior years (€76 million); losses from monetary adjustments (€69.5 million) (see note 2-b to our consolidated financial statements); provisions to pension allowances of €350.8 million (see note 2-j to our consolidated financial statements) and other net losses of €315 million, resulting mainly from the impact of writedowns of technological companies and other companies and businesses located outside Spain (including, those relating to the specific allowance recorded for Argentina).
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Provision for Income Taxes
The provision for corporate income and other taxes was €766.8 million in 2004, an 11.8% or €102.7 million decrease from €869.4 million in 2003, which was a 20.2% or €146.3 million increase from €723.1 million in 2002. The effective tax rate was 17.3% in 2004, 21.2% in 2003 and 20.6% in 2002. For information about factors affecting effective tax rates, see note 22 to our consolidated financial statements.
Minority Interests
Minority interests were €532.3 million in 2004, a 14.3% or €88.9 million decrease from €621.2 million in 2003, which was a 15.4% or €82.7 million increase from €538.5 million in 2002.
The €88.9 million decrease in 2004 reflected mainly a €19.2 million increase in net income attributable to minority shareholders, principally related to increased minority interests of our subsidiaries in Chile and Mexico, and a €108.1 million decrease in dividends on preference shares of subsidiaries principally as a result of the early amortizations made during 2004 of six issues of preferred shares amounting to a total of €1,931.8 million and $850 million of nominal value.
The €82.7 million increase in 2003 reflected mainly a €168.9 million increase in net income attributable to minority shareholders, principally related to increased minority interests in Banesto and Santander Serfín, and a €86.2 million decrease in dividends on preference shares of subsidiaries principally as a result of the early amortizations made during 2003 and the dollar’s slide against the euro.
Net Income Information on U.S. GAAP Basis
Our consolidated financial statements have been prepared in accordance with Spanish GAAP. Spanish GAAP differs in certain significant respects from U.S. GAAP. For a summary of the most significant adjustments required to arrive at net income on U.S. GAAP basis, see note 28 to our consolidated financial statements.
Financial Condition
Assets and Liabilities
Excluding Abbey, our total assets were €379,250.8 million at December 31, 2004, a 7.8% or €27,460.3 million increase from total assets of €351,790.5 million at December 31, 2003, which was an 8.5% or €27,582.4 million increase from total assets of €324,208.1 million at December 31, 2002. Excluding Abbey, our gross loans and credits to corporate clients, individual clients and government and public entities which include securities purchased from such clients under agreements to resell, increased by 15.1% to €204,466.6 million at December 31, 2004 from €177,620.7 million at December 31, 2003, mainly due to increased business in Spain, Germany, Norway (as a result of the acquisition of Elcon) and Latin America (mainly in Brazil, Puerto Rico, Chile and Mexico). Excluding Abbey, customer liabilities, which are principally deposits from clients and securities sold to clients und er agreements to repurchase, increased by 9.1% from €159.335.6 million at December 31, 2003, to €173,842.2 million at December 31, 2004, mainly due to increased volumes in Spain, Germany and Latin America (mainly in Brazil and Chile). Excluding Abbey, other managed funds, including mutual funds, pension funds and other managed portfolios, increased by 15.2% from €108,903.0 million at December 31, 2003, to €125,454.0 million at December 31, 2004, mainly due to increased volumes of mutual funds, pension funds and managed portfolios both in Spain and abroad.
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Including Abbey, at December 31, 2004, our total assets were €575,397.9 million; our gross loans and credits were €342,177.0 million; our customer deposits were €293,845.7 million and our total managed funds were €139,994.7 million.
Capital
Stockholders’ equity, net of treasury stock, at December 31, 2004, was €32,584.3 million, an increase of €13,515.3 million or 70.9% from €19,069.0 million at December 31, 2003, mainly due to the capital increase of €12,540.9 related to the acquisition of Abbey.
At December 31, 2004, our eligible capital, including Abbey, exceeded the minimum required by the Bank of Spain by approximately €11.1 billion. See “Item 4. Information on the Company—B. Business Overview—Supervision and Regulation—Capital Adequacy Requirements.”
Including Abbey, we estimate that our Tier 1 capital ratios, calculated in accordance with Basel Committee guidelines, and our total capital ratios, which include Tier 1 and Tier 2 capital, at December 31, 2004 and 2003 were as set forth:
B. Liquidity and capital resources
Management of liquidity
For information about our liquidity risk management process, see Item 11. “Quantitative and Qualitative Disclosures About Market Risks — Part.6 Market Risk — Statistical Tools for Measuring and Managing Market Risk — Non Trading Activity — Liquidity Risk” and “—Quantitative analysis — C. Financial management —Management of structural liquidity”.
Sources of funding
As a financial group, our main source of liquidity is our customer deposits which consist primarily of demand, savings and time deposits. In addition, we complement our customer deposits through the access to the interbank market (overnight and time deposits) and to the domestic and international capital markets. For this purpose, we have in place a series of domestic and international programs for the issuance of commercial paper and medium and long term debt. We also maintain a diversified portfolio of liquid assets and securitized assets throughout the year. In addition, another source of liquidity is the generation of cash flow.
We have raised significant funds in the domestic and international capital markets in order to finance our activities. Under the 2004 Issues and Securitization Plan, we obtained (excluding Abbey) €35.0 billion from the capital markets, 71% of which was obtained through medium and long-term issues, including preference shares and subordinated debt. Securitization of medium and long-term assets amounted to €11.0 billion in 2004.
At December 31, 2004, including Abbey, we had outstanding €84.0 billion of senior debt, of which €17.5 billion were mortgage bonds and €26.1 billion promissory notes, as well as €20.2 billion in subordinated debt and €7.2 billion in preferred stock.
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The following table shows the average balances during the years 2004 (including Abbey) and 2003 of our principal sources of funds:
The average maturity of our outstanding debt as of December 31, 2004 is the following:
Exhibits V and VI to our consolidated financial statements included herein show a detail of our senior and subordinated long-term debt, including their maturities.
The cost and availability of debt financing are influenced by our credit ratings. A reduction in these ratings could increase the cost of, and reduce our market access to debt financing. Our credit ratings are as follows:
Including Abbey, our total customer funds (customer deposits, excluding assets sold under repurchase agreements, marketable debt securities and subordinated debt) totaled €355.5 billion at December 31, 2004. Including Abbey and assets sold under repurchase agreements, customer funds totaled €398.0 billion at December 31, 2004. Including Abbey, loans and credits (gross) totaled €342.2 billion at the same date.
We remain well placed to access various wholesale funding sources from a wide range of counterparties and markets, and the changing mix evident between customer deposits and repos, deposits by banks and debt securities in issue primarily reflects comparative pricing, maturity considerations and investor counterparty demand rather than any material perceived trend.
We use our liquidity to funding our lending and investment securities activities, for the payment of interest expense, for dividends paid to shareholders and the repayment of debt.
We, the Santander Group, are a European and Latin American financial group. Although, at this moment, except for Argentina and Venezuela, we are not aware of any legal or economic restrictions on the ability of our subsidiaries to transfer funds to the Bank (the parent company) in the form of cash dividends, loans or advances, capital repatriation and other forms, there is no assurance that in the future such restrictions will not be adopted or how they would affect our business. Nevertheless, the geographic diversification of our businesses limits the effect of any restrictions that could be adopted in any given country.
In prevailing economic conditions and with interest rates at relatively low historical levels in Spain, UK and the rest of Europe, it is anticipated that the growth in demand for further borrowing by customers may, in the medium term, continue to exceed customer deposits received, thus increasing net customer lending further and increasing gradually over time our dependence on the wholesale market for funding.
We believe that our working capital is sufficient for our present requirements and to pursue our planned business strategies.
As of December 31, 2004 and to the present date, we did not, and presently do not, have any material commitments for capital expenditures, except as disclosed in Item 4. “Information on the Company — Recent Events”.
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Other contingent liabilities and commitments
As of December 31, 2004 (including Abbey) and December 31, 2003, we had outstanding the following contingent liabilities and commitments:
Relationship with unconsolidated companies
We have significant holdings in companies whose business activity is not directly related to that of the Bank. According to Spanish GAAP, these holdings are not consolidated. (See a detail of these companies in Exhibit II to our Consolidated Financial Statements).
Transactions with these companies are made at market conditions and are closely monitored by our regulatory authorities. See Note 24 to our Consolidated Financial Statements for disclosure of the effect of these transactions on our income statement and balance sheet.
Also, we use special purpose vehicles (“fondos de titulización”) in our securitization activity. These vehicles are independent entities and are not consolidated in the Group´s financial statements. We are not required to repurchase assets or contribute additional assets to any of these special purpose vehicles. We do, however, provide in the ordinary course of business certain loans (amounting to €232.5 million to “fondos de titulización” in Spain) to some of these special purpose vehicles, which are provisioned in accordance with the risks involved. In 2004, the Group (excluding Abbey) securitized €11.0 billion of medium and long-term assets.
In the ordinary course of business, Abbey enters into securitization transactions using special purpose securitization companies which are consolidated and included in Abbey´s financial statements as quasi-subsidiaries. Except for some mortgage indemnity guarantees assigned to some transactions made before January 1, 2002, Abbey is under no obligation to support any losses that may be incurred by the securitization companies or the holders of the securities, and has no right or obligation to repurchase any securitized loan. Abbey has made some interest bearing subordinated loans to these securitization companies.
We do not have transactions with un-consolidated entities other than the aforementioned ones.
C. Research and development, patents and licenses, etc.
We do not currently conduct any significant research and development activities.
D. Trend information
The European financial services sector is likely to remain competitive with an increasing number of financial service providers and alternative distribution channels. Further, consolidation in the sector (through mergers, acquisitions or alliances) is likely to occur as the other major banks look to increase their market share or combine with complementary businesses. It is foreseeable that regulatory changes will take place in the future that will diminish barriers in the markets.
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The following are the most important trends, uncertainties and events that are reasonably likely to have a material adverse effect on the Bank or that would cause the disclosed financial information not to be indicative of our future operating results or our financial condition:
International Financial Reporting Standards (“IFRS”)
Under Regulation (EC) no. 1606/2002 of the European Parliament and of the Council of July 19, 2002, all companies governed by the law of an EU Member State and whose securities are admitted to trading on a regulated market of any Member State must prepare their consolidated financial statements for the years beginning on or after January 1, 2005 in conformity with the International Financial Reporting Standards (“IFRSs”) which have been previously ratified by the European Union. Therefore, we are required to prepare our consolidated financial statements for the year ending December 31, 2005 in conformity with the IFRSs.
Under IFRS 1, First-Time Adoption of International Financial Reporting Standards, our consolidated financial statements for 2005 must necessarily include, for comparison purposes, a consolidated balance sheet as of December 31, 2004, and a consolidated statement of income for the year then ended prepared in accordance with the methods established by the IFRSs in force as of December 31, 2005.
In order to adapt the accounting system of Spanish credit institutions to the new standards, on December 22, 2004, the Bank of Spain issued Circular 4/2004 on Public and Restricted Financial Reporting Standards and Model Financial Statements. We are completing a plan for transition to IFRSs which includes, inter alia, an analysis of the accounting criteria differences, the selection of the accounting criteria to be applied when alternative treatments are permitted and an assessment of the changes in reporting procedures and systems.
The approval of the IFRSs introduces changes in the financial statements by modifying general accounting principles, as well as changes in reporting (income statement and balance sheet). In addition, it regulates specific aspects of the business areas, such as their definition and disclosure levels, and introduces the mandatory auditing of the same.
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The following tables provide a detail of our unaudited consolidated income statement and balance sheet as of December 31, 2004, restated in accordance with new IFRSs criteria:
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E. Off-balance sheet arrangements
We have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
F. Tabular disclosure of contractual obligations
The following table summarizes our contractual obligations by remaining maturity at December 31, 2004 (including Abbey):
The maturity of deposits from credit institutions and from customer deposits, neither of which is reflected in the above table, is given in Notes 14 and 15 of the consolidated financial statements, respectively.
For a description of our futures transactions, which are not reflected in the above table, see Note 23 to our consolidated financial statements.
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Item 6. Directors, Senior Management and Employees
A. Directors and senior management.
We are managed by our board of directors which currently consists of 19 members. In accordance with our Bylaws (Estatutos), the board shall consist of at least 14 and not more than 30 members. Each member of the board is elected to a three-year term by our stockholders at a general meeting, with approximately one-third of the members being elected each year, but they can be re-elected.
Our board of directors meets approximately nine times per year. In 2004, it met 13 times. Our board of directors elects our Chairman and Vice Chairmen from among its members, as well as the Chief Executive Officer. Between board meetings, lending and other board powers reside with the Executive Committee (Comisión Ejecutiva) and with the Risk Committee (Comisión Delegada de Riesgos). The Chairman is the Bank’s most senior officer and, as a result, has delegated to him all such powers as may be delegated under Spanish Law, our By-laws and the Regulations of the Board. The Chairman leads the Bank’s management team, in accordance with the decisions made and the criteria set by our shareholders at the General Shareholders’ Meeting and by the Board.
The Chief Executive Officer by delegation and under the direction of the Board and of the Chairman (as the Bank’s most senior officer) leads the business and assumes the Bank’s highest executive functions.
Our board holds ultimate lending authority and it delegates such authority to the Risk Committee, which generally meets twice a week. Members of our senior management are appointed and removed by the board.
The current members of our board of directors are:
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Our current Executive Officers are:
Following is a summary description of the relevant business experience and principal business activities of our current Directors and executive officers performed both within and outside Banco Santander Central Hispano, S.A.:
Emilio Botín (Chairman of the Board of Directors and of the Executive Committee)
Born in 1934. He joined Banco Santander in 1958 and in 1986 he was appointed Chairman of the Board. He is also a Director of Shinsei Bank.
Fernando de Asúa (First Vice Chairman of the Board of Directors and Chairman of the Appointments and Remuneration Committee)
Born in 1932. Former Vice Chairman of Banco Central Hispanoamericano from 1991 to 1999. He was appointed Director in April 1999 and First Vice Chairman in July 2004. He is an Honorary Chairman of IBM España, S.A. and a Director of Cepsa, Técnicas Reunidas, S.A., Air Liquide España, S.A. and Constructora Inmobiliaria Urbanizadora Vasco-Aragonesa, S.A.
Alfredo Sáenz (Second Vice Chairman of the Board of Directors and Chief Executive Officer)
Born in 1942. Former Vice Chairman of Banco Bilbao Vizcaya and Chairman of Banca Catalana until 1993. In 1994, he was appointed Chairman of Banesto and in February 2002, Second Vice Chairman and Chief Executive Officer of Banco Santander Central Hispano. He is also Vice Chairman of Cepsa and a Director of San Paolo IMI SpA and Auna Operadores de Telecomunicaciones, S.A.
Matías R. Inciarte (Third Vice Chairman of the Board of Directors and Chairman of the Risk Committee)
Born in 1948. He joined Banco Santander in 1984 and was appointed Executive Vice President and Chief Financial Officer in 1986. In 1988 he was appointed Director and in 1994 Second Vice Chairman. He is also Chairman of Unión de Crédito Inmobiliario, S.A. and Director of Banesto, S.A., Financiera Ponferrada, S.A., Grupo Corporativo Ono, S.A. and Operador del Mercado Ibérico de Energía Polo Español, S.A. He was Minister of the Presidency of the Spanish Government (1981-1982).
Manuel Soto (Fourth Vice Chairman of the Board of Directors and Chairman of the Audit and Compliance Committee)
Born in 1940. He was appointed Director in April 1999. He is Vice Chairman of Indra Sistemas, S.A. and a Director of Inversiones Inmobiliarias Lar, S.A., Cortefiel, S.A. and Corporación Financiera Alba, S.A.
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Assicurazioni Generali, S.p.A. (“Assicurazioni”)
An Italian insurance company represented by its Chairman, Mr. Antoine Bernheim, who was born in 1924. Assicurazioni is a former Director of Banco Central Hispanoamericano from 1994 to 1999. Assicurazioni was appointed Director in April 1999.
Antonio Basagoiti
Born in 1942. Former Executive Vice President of Banco Central Hispanoamericano. He was appointed Director in July 1999. He is Chairman of Unión Fenosa, S.A., Vice Chairman of Golf La Moraleja, S.A. and of Faes Farma, S.A. and a Director of Pescanova, S.A. and Cepsa.
Ana P. Botín
Born in 1960. Former Executive Vice President of Banco Santander, S.A. and former Chief Executive Officer of Banco Santander de Negocios from 1994 to 1999. In February 2002, she was appointed Chairwoman of Banesto. She is also a Director of Inmobiliaria Urbis, S.A., Assicurazioni Generali, SpA. and Grupo Televisa, S.A.
Emilio Botín O.
Born in 1964. Former Executive Vice President of Banco Santander, S.A. He is the sole Administrator of Puente San Miguel, S.A. and Chairman of Swissrisk.
Javier Botín
Born in 1973. He was appointed Director in July 2004. He is also an executive Director of M&B Capital Advisers, Sociedad de Valores, S.A.
Lord Burns
Born in 1944. He was appointed Director in December 2004. He is also Chairman of Abbey and Glas Cymru (Welsh Water) and a non-executive Director of Pearson Group plc and British Land plc. He has been appointed as a non-executive director and deputy chairman of Marks and Spencer Group plc, which takes effect October 1, 2005. He was formerly Permanent Secretary to the UK Treasury and chaired the UK Parliamentary Financial Services and Markets Bill Joint Committee.
Guillermo de la Dehesa
Born in 1941. Former Secretary of State of Economy and Secretary General of Commerce of the Spanish Government and Chief Executive Officer of Banco Pastor. He was appointed Director in June 2002. He is Chairman of AVIVA Vida y Pensiones, S.A. and a Director of Campofrío Alimentación, S.A., Unión Fenosa, S.A., Tele Pizza, S.A., Goldman Sachs Europe Ltd. and AVIVA plc. He is also Chairman of the Centre for Economic Policy Research (CEPR) in London, member of the Group of Thirty of Washington, and Chairman of the Board of Trustees of the Instituto de Empresa.
Rodrigo Echenique
Born in 1946. Former Director and Chief Executive Officer of Banco Santander, S.A. from 1988 to 1994. He is Chairman of the Social Economic Council of the Carlos III University (Madrid) and a Director of Inversiones Inmobiliarias Lar, S.A.
Antonio Escámez
Born in 1951. Former Director and Executive Vice President of Banco Central Hispanoamericano from 1988 to 1999. He was appointed Director in April 1999. He is also Chairman of Santander Consumer, Patagon and Arena Communications España, S.A., and Vice Chairman of Attijariwafa Bank.
Francisco Luzón
Born in 1948. He joined Banco Santander in 1996 as Executive Vice President, Adjoint to the Chairman. Former Chairman of Banco Exterior de España (from 1988 to 1996), Caja Postal (from 1991 to 1996), Corporación Bancaria de España (from 1991 to 1996) and of Argentaria (1996). He is also a Director of Industria de Diseño Textil, S.A. and Chairman of the Social Council of the University of Castilla-La Mancha.
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Abel Matutes
Born in 1941. Former Foreign Minister of the Spanish Government and EU Commissioner (from 1989 to 1993). He is also a Director of Assicurazione Internazionale di Providenza, FCC Construcción, S.A. and Instituto Sectorial de Promoción y Gestión de Empresas, S.A.
Mutua Madrileña Automovilista
Spanish car insurance company represented on our board by Mr. Luis Rodríguez, who was born in 1941. Mr. Rodríguez is a Director of Mutua Madrileña Automovilista and Chairman of Mutuactivos SAU SGIIC.
Luis Ángel Rojo
Born in 1934. Former Head of Economics, Statistics and Research Department, Deputy Governor and Governor of the Bank of Spain. He has been a member of the Governing Council of the European Central Bank, Vice-Chairman of the European Monetary Institute, member of United Nations’ Development Planning Committee and Treasurer of the International Association of Economy. He is Professor of Economic Theory of the Complutense University of Madrid, Member of the Group of Wise Men appointed by the ECOFIN Council for the study of integration of the European financial markets, member of the Royal Academy of Moral and Political Sciences and of the Royal Academy of the Spanish Language.
Luis Alberto Salazar-Simpson
Born in 1940. He is Chairman of Auna Operadores de Telecomunicaciones, S.A. and Constructora Inmobiliaria Urbanizadora Vasco-Aragonesa, S.A., Joint Administrador of Auna Operadores de Telecomunicaciones, S.A. and Retevisión Móvil, S.A., a Director of Mutua Madrileña Automovilista and Saint Gobain Cristalería, S.A.
José A. Alvarez
Born in 1960. He joined the Bank in 2002. In 2004, he was appointed Executive Vice President, Financial Management.
David Arce
Born in 1943. He joined Banco Santander in 1964. In 1994, he was appointed Executive Vice President, Internal Auditing of Banco Santander and Banesto. He is also a Director of Banesto.
Ignacio Benjumea
Born in 1952. He joined Banco Santander in 1987 as General Secretary of Banco Santander de Negocios. In 1994 he was appointed General Secretary and Secretary of the Board of Banco Santander. In 1999, he was appointed Executive Vice President, Secretary General and of the Board of Banco Santander Central Hispano. He is also a Director of Bolsas y Mercados Españoles, Sociedad Holding de Mercados y Sistemas Financieros, S.A., Sociedad Rectora de la Bolsa de Madrid, S.A. and La Unión Resinera Española, S.A.
Teodoro Bragado
Born in 1944. He joined the Bank in 1985. He was appointed Executive Vice President, Risk, in March 2003. He is also a Vice Chairman of Compañía Española de Seguros de Crédito a la Exportación (“CESCE”) and a Director of Compañía Española de Financiación del Desarrollo, S.A., Consorcio Mexicano de Aseguradores de Crédito, S.A. and Consorcio Internacional de Aseguradores de Crédito, S.A.
Juan Manuel Cendoya
Born in 1967. Former Manager of the Legal and Tax Departament of Bankinter, S.A. from 1999 to 2001. He joined the Bank on July 23, 2001 as Executive Vice President, Communications and Research.
José María Espí
Born in 1944. He joined the Bank in 1985 and, in 1988, was appointed Executive Vice President, Human Resources. In 1999 he was appointed Executive Vice President, Risk. He is also Chairman of Unión de Crédito Inmobiliario, S.A., E.F.C. and Director of Unión de Crédito Inmobiliario, S.A.
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Enrique G. Candelas
Born in 1953. He joined Banco Santander in 1975 and was appointed Senior Vice President in 1993. He was appointed Executive Vice President, Retail Banking in January 1999. He is also a Director of Mobipay España, S.A.
Francisco G. Roldán
Born in 1953. Former Chief Executive Officer of Grupo Argentaria, Caja Postal and Banco Hipotecario from 1996 to June 2000, and of Banesto from June 2000 until March 2002. In March 2002, he was appointed Executive Vice President, Finance, of Banco Santander Central Hispano, S.A. and in October 2004, Chief Executive Officer of Abbey National plc. He is also a Director of Bolsas y Mercados Españoles, Sociedad Holding de Mercados y Sistemas Financieros, S.A. and AC Hoteles, S.A.
Joan-David Grimà
Born in 1953. He joined Banco Central Hispanoamericano in 1993. He was appointed Executive Vice President, Industrial Portfolio in June 2001. He is also Vice Chairman and Chief Executive Officer of Auna Operadores de Telecomunicaciones, S.A, and a Director of Antena 3 de Televisión, S.A., Teka Industrial, S.A. and ACS Actividades de Construcción y Servicios, S.A.
Juan Guitard
Born in 1960. Former General Secretary of the Board of Banco Santander de Negocios (from 1994 to 1999) and Manager of the Investment Banking Department of the Bank (from 1999 to 2000). He rejoined the Bank in 2002, being appointed Executive Vice President, Vice-Secretary General of the Board.
Gonzalo de las Heras
Born in 1940. He joined the Bank in 1990. He was appointed Executive Vice President in 1991 and supervises the North American business of the Group.
Antonio H. Osorio
Born in 1964. He joined Banco Santander in 1997 and was appointed Executive Vice President, Portugal, in June 2001. He is Chairman of Banco Santander Totta and Chairman of the Executive Committee of Banco Santander de Negocios Portugal.
Adolfo Lagos
Born in 1948. Former Chief Executive Officer of Grupo Financiero Serfin since 1996. He was appointed Executive Vice President, America, in October 2002 and Executive Vice President, Global Wholesale Banking, in April 2003.
Jorge Maortua
Born in 1961. Former Executive Vice President of Banesto since 2001, he joined the Bank in 2003 as Head of Global Treasury and was appointed Executive Vice President, Global Wholesale Banking, in 2004.
Francisco Martín
Born in 1955. He joined the Bank in 1985 and in 1992 was appointed Executive Vice President, Head of the International Division. In 2002, he became Executive Vice President, Head of Global Corporate Banking.
Pedro Mateache
Born in 1959. Former partner-manager of McKinsey & Co. He was appointed Executive Vice President, Resources and Costs in 2003.
Serafín Méndez
Born in 1947. He joined the Bank in 1964. He is the Manager of the Premises and Security Area and was appointed Executive Vice President, Resources and Costs in 2004.
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Jorge Morán
Born in 1964. He joined the Bank in 2002. He was appointed Executive Vice President, Asset Management and Insurance in 2004.
Javier Peralta
Born in 1950. He joined the Bank in 1989 and in 1993 was appointed Executive Vice President. In 2002, he was appointed Executive Vice President, Risk.
Marcial Portela
Born in 1945. He joined the Bank in 1998 as Executive Vice President in charge of operations, human resources and costs. In 1999, he was appointed Executive Vice President, America. He is also Vice Chairman of Comunitel Global, S.A. and Director of Best Global, S.A. and Unión Fenosa, S.A.
Juan R. Inciarte
Born in 1952. He joined Banco Santander in 1985 as Director and Executive Vice President of Banco Santander de Negocios. In 1989 he was appointed Executive Vice President and in 1991 Director of Banco Santander. He is also a Director of Cepsa, S.A.and Finanzauto, S.A.
José Tejón
Born in 1951. He joined the Bank in 1989. In 2002 he was appointed Executive Vice President, Financial Accounting.
Jesús Mª Zabalza
Born in 1958. Former Executive Vice President of La Caixa (from 1996 to 2002). He joined the Bank in 2002, being appointed Executive Vice President, America.
The following is a description of arrangements or understandings with major shareholders, customers, suppliers or others pursuant to which any person referred to above was appointed.
There are two Directors that are or represent international financial institutions that have a holding in the Bank: Assicurazioni Generali S.p.A. (represented by Mr. Antoine Bernheim), and Mutua Madrileña Automovilista (represented by Mr. Luis Rodríguez).
B. Compensation.
Directors’ compensation
By-law stipulated fees
Article 38 of the Bank’s by-laws provides that the members of our board of directors (together with our Executive Vice Presidents) may receive an amount up to 5% of the Bank’s net income for any fiscal year, for performing their duties as Directors.
The Board of Directors, making use of the powers conferred on it, applied 0.169% of the Bank’s income for 2004 (as compared to 0.196% for 2003 and 0.191% for 2002), as compensation for itself.
Consequently, the gross amount received by each Director as compensation in 2004 was €71,000 (€65,000 in 2003 and 2002). Additionally, the Executive Committee members received additional compensation, the gross amount of which was €155,000 in 2004 (€141,000 in 2003 and 2002).
Finally, the members of the Audit and Compliance Committee received additional compensation in 2004, the gross amount of which was €36,000 (€32,000 in 2003 and 2002).
Salary compensation
As provided by our by-laws, the members of the Board and of the Executive Committee are entitled to be remunerated for discharging duties within the Bank other than those duties performed in their capacity as a Director.
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Consequently, the Bank’s executive Directors (who as of December 31, 2004, 2003 and 2002 are Mr. Emilio Botín, Mr. Alfredo Sáenz, Mr. Matías R. Inciarte, Ms. Ana P. Botín, and Mr. Francisco Luzón) received the following salary compensation:
The remuneration and other compensation granted to the Directors in 2004 is as follows:
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Compensation to the Board Members as representatives of the Bank and to Senior Management
Representation on other boards
By resolution of the Executive Committee, all the compensation received by the Bank’s Directors who represent the Bank on the Boards of Directors of listed companies in which the Bank has a stake (at the expense of those companies) relating to appointments made after March 18, 2002, will accrue to the Group. The compensation received in 2004 in connection with representation duties of this kind, relating to appointments made after March 18, 2002, was as follows:
Additionally, other Directors received a total amount of €84,100 during 2004 for sitting on the boards of companies belonging to the Group.
Senior management
Additionally, below are the details of the aggregate compensation paid to the Bank’s Executive Officers (*) in 2004, 2003 and 2002:
Pension commitments, other insurance and other items
The total balance of supplementary pension obligations assumed by the Group over the years for its current and retired employees, which amounted to €19,109 million (covered mostly by in-house allowances) as of December 31, 2004, includes the obligations to those who have been Directors of the Bank during the year and who discharge (or have discharged) executive functions during the year. The total pension commitments for these Directors, together with the total sum insured under life insurance policies at that date and other items, amounted to €178 million as of December 31, 2004 (€162 million as of December 31, 2003 and €256 million as of December 31, 2002, of which €108 million related to the settlement of the pension rights referred to below).
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The following table provides information on the obligations undertaken and covered by the Group relating to pension commitments and other insurance for the Bank’s executive Directors:
Additionally, other Directors benefit from life insurance policies at the Group’s expense, the related insured sum being €3 million as of December 31, 2004, 2003 and 2002.
In addition, the total pension commitments, together with the total sum insured under life insurance policies for the Bank’s Executive Officers (excluding executive Directors), amounted to €159 million as of December 31, 2004.
Pension settlement
Following the decision of Mr. Ángel Corcóstegui to resign, for personal reasons, in February 2002 from his position as First Vice Chairman of the Bank and Director (which entailed his corresponding resignation as Chief Executive Officer of the Bank and as member of the various Board Committees on which he sat), and in settlement for the pension commitments to him, the Bank paid on his resignation a gross amount of €108 million for his pension rights. This amount had been fully provided for as of that date. Upon payment, a withholding of 48% was made, and the amount withheld was paid into the Spanish Treasury. Accordingly, the net amount paid to Mr. Corcóstegui in this connection was €56 million. For more information, see “Legal Proceedings”.
Stock option plan
Our by-laws provide that Directors may also receive compensation in the form of shares of the Bank or options over the shares, or other remuneration linked to the share value following a resolution adopted by the shareholders at the General Shareholders’ Meeting (conducted in accordance with our by-laws and applicable Spanish legislation).
The details of the Bank’s stock options granted to the Board members as of December 31, 2004, are as follows:
The rights belonging to Ana P. Botín as beneficiary of the plan I-06 will be the ones that, by proposal of the Board of Directors of Banesto, the shareholders consent to at the Shareholders’ Meeting.
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Description of Stock Option and Compensation Plans
In recent years, the Bank has put in place compensation systems for its managers and employees linked to the market performance of the Bank’s shares based on the achievement of certain objectives. Below is a summary of the different stock option and compensation plans in effect as of January 1, 2004:
Plan Four
Five of our officers participate in an option plan known as “Plan Four”. Each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €7.84, and plan participants may exercise these options until December 30, 2005. Plan participants must hold the shares acquired through this plan for a period of twelve months following the date of exercise of the options. During 2004, 36,000 options were exercised and as of December 31, 2004, the balance of outstanding options under this plan was 228,000.
Managers Plan 1999
As of January 1, 2004, 243 of our officers participated in an option plan known as the “Managers Plan 1999”. Each option received under this plan granted its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan was €2.29, and plan participants could exercise these options from December 31, 2001 until December 30, 2004. Plan participants must hold the shares acquired through this plan for a period of twelve months following the date of exercise of the options. During 2004, 1,139,488 options were exercised.
Additional Managers Plan 1999
As of January 1, 2004, 14 of our officers participated in an option plan known as the “Additional Managers Plan 1999”. Each option received under this plan granted its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan was €2.41, and plan participants could exercise these options from April 1, 2002 until December 30, 2004. Plan participants must hold the shares acquired through this plan for a period of nine months following the date of exercise of the options. During 2004, 55,668 options were exercised.
Investment Banking Plan
56 of our officers from the Global Wholesale Banking Division participate in an equity incentive plan known as the “Investment Banking Plan”. The number of options received by plan participants under this plan is based on the extent to which certain business objectives are achieved. Each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €10.25, and plan participants may exercise the first 50% of the options granted from June 16, 2003, and the remaining 50% from June 16, 2004. The exercise period ended in both cases on June 15, 2005. During 2004, no options were exercised and as of December 31, 2004, the balance of outstanding options under this plan was 4,503,750.
Young Executives Plan
111 of our officers participate in an option plan known as the “Young Executives Plan”. Each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €2.29, and plan participants may have exercized the first 50% of the options granted from July 1, 2003 until June 30, 2005 and the remaining 50% from July 1, 2004 until June 30, 2005. Plan participants must hold the shares acquired through this plan for a period of twelve months following the date of exercise of the options. During 2004, 562,250 options were exercised and as of December 31, 2004, the balance of outstanding options under this plan was 364,000.
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Managers Plan 2000
970 of our officers participate in an option plan known as the “Managers Plan 2000”. Each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the options subject to this plan is €10.55, and plan participants may exercise these options from December 30, 2003 until December 29, 2005. Plan participants must hold the shares acquired through this plan for a period of twelve months following the date of exercise of the options. As of December 31, 2004, the balance of outstanding options under this plan was 13,341,000.
European Branches Plan
27 of our officers participate in an incentive plan known as the “European Branches Plan”. Subject to the achievement of certain objectives, the beneficiaries of this plan will receive a payment in cash or in shares of Banco Santander Central Hispano. For purposes of the calculation of the number of shares to be delivered, the share price is calculated at the average quoted price of the month previous to the incorporation to the branch and plan participants could exercise 1,615,000 of the options granted from July 1, 2004 until July 15, 2004, and may exercise the remaining options granted from July 1, 2005 until July 15, 2005. During 2004, 140,000 options were exercised and as of December 31, 2004, the balance of outstanding shares to be delivered under this plan was 2,690,000.
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Stock Option and Compensation Plans
(*) The average exercise price ranges from €5.65 to €10.15 per share.
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The option plans on shares of the Bank originally granted by management of Abbey to its employees (on Abbey shares) are as follows:
(*) The euro/pound sterling exchange rate was €1.4183 per pound as of December 31, 2004.
Lastly, on December 20, 2004, the Board of Directors decided to implement, pursuant to the approval of shareholders at our General Shareholders’ Meeting held on June 18, 2005, a new long-term incentive plan (I-06) in the form of stock options tied to the achievement of two objectives: a revaluation of the Bank’s share price and growth in earnings per share, in both cases above a sample of comparable banks. 2,750 officers are covered by this plan with a total of up to 103,050,000 options of Bank shares already granted at an exercise price of €9.07. The exercise period is from January 15, 2008 to January 15, 2009.
C. Board practices.
Date of expiration of the current term of office of the directors and the period during which the directors have served in that office:
The period during which the Directors have served in their office is shown in the table under Section A of this Item 6.
The date of expiration of the current term of office is shown in the table below:
The terms and conditions of the contracts which, following a report from the Appointments and Remuneration Committee and approval by the Board, have been entered into by the Bank with its executive Directors Alfredo Sáenz, Matías R. Inciarte, Ana P. Botín and Francisco Luzón, can be summarized (notwithstanding certain specific provisions for each of the Directors in question) as follows:
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(i) Exclusivity and non-competition
Executive Directors may not enter into other service contracts with other companies or institutions, unless prior authorization is obtained from the Board of Directors, an obligation of non-competition being established with respect to companies and activities of a nature similar to that of the Bank and its consolidated Group.
(ii) Code of Conduct
Mention is made of the obligation to strictly observe the provisions of the Grupo Santander’s General Code and Code of Conduct in Securities Markets, specifically with respect to rules of confidentiality, professional ethics and conflict of interests.
(iii) Remuneration
The remuneration for undertaking their executive responsibilities consists basically of a fixed amount, to be reviewed yearly, and a variable amount in terms of the criteria established by the Bank from time to time.
In addition, executive Directors are entitled to receive a pension supplement in the event of early retirement or retirement, which may be externalized by the Bank. The Bank may request executive Directors to take early retire, provided they have reached the age of 50 and have served more than 10 years in the Bank and/or other Group companies, although the Bank may order an extension of their professional duties for 6 months in order to arrange for another Director to take over their responsibilities. Likewise, executive Directors may to take early retirement at their own request if they are over 55 and have served the Bank and/or other Group companies for 10 years. In any event, any decision regarding retirement or early retirement should be presented with 60 days’ notice.
The right to a pension supplement is also applicable (with certain differences between some contracts and others) if the Director’s services are terminated due to the coincidence of different objective circumstances such as those affecting the functional and organic status of the executive Director.
Pension rights are also recognized in favor of the spouse (widow) and children (orphans) in cases of death and permanent disability of the executive Director.
Generally, the amount of such pension supplement consists of the amount necessary to reach an annual gross amount equivalent to 100% of the fixed salary received by the Director in question at the time when he or she actually ceased working, plus 30% of the average of the last three variable remuneration amounts received. In certain cases, if the early retirement occurs at the request of the Director, the amount resulting after applying the above criterion would be reduced by percentages ranging from 20% to 4% in terms of the Director’s age on early retirement.
Receipt of pension supplements will be incompatible with the rendering of services to competitors of the Bank or its Group, unless the Bank’s express authorization is received.
Remuneration for undertaking executive responsibilities is compatible with the receipt of amounts specified by the By-laws (participation in earnings) and an attendance fees applicable to them merely in their capacity as members of the Board of Directors, as expressly established by the By-laws and the Regulations of the Bank’s Board of Directors.
(iv) Termination
The duration of such contracts is indefinite. However, if a contract is terminated owing to breach of an executive Director’s responsibilities or of his or her own free will, he or she will not be entitled to any financial compensation.
Whenever termination is attributable to the Bank or due to objective circumstances, the Director will be entitled to receive the following items of remuneration: a) the pension supplements which in each case are recognized in his or her favor on changing to early retired or retired status; or b) in certain cases, indemnities which, for an amount up to 5 years’ fixed annual salary, are established in his or her contract depending on the date on which termination occurs.
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(v) Insurance
The Bank provides life and accident insurance to its executive Directors, with coverage varying in each case depending on the policy established by the Bank for its senior management, as well as health insurance consisting of reimbursement.
(vi) Confidentiality and return of documents
A strict confidentiality obligation is established throughout the duration of the Director’s relationship with the Bank and also following termination of such relationship, consisting of the obligation to return to the Bank all documents and objects in possession of the executive Director relating to his or her activity.
Compliance with NYSE Listing Standards on Corporate Governance
On November 4, 2003, the SEC approved new rules proposed by the New York Stock Exchange (NYSE) intended to strengthen corporate governance standards for listed companies. In compliance therewith, the following is a summary of the significant differences between our corporate governance practices and those applicable to domestic issuers under the NYSE listing standards.
Independence of the Directors on the Board of Directors
Under the NYSE corporate governance rules, a majority of the Board of Directors must be composed of independent directors, the independence of whom is determined in accordance with highly detailed rules promulgated by the NYSE. Spanish law does not contain any such requirements. The Board of Directors of Banco Santander Central Hispano has six independent directors (out of nineteen Directors total), as defined in Article 5 of the Regulations of the Board of Directors. We have not determined whether or not the directors on the Banco Santander Central Hispano Board would be considered independent under the NYSE rules. Article 5 of the Regulations of the Board of Directors defines the concept of an independent director as follows:
“Independent directors shall be deemed to be those external or non-executive Directors who: (i) are not, and do not represent, shareholders who have the power to influence the control of the Company; (ii) have not held executive positions therein in the last three years; (iii) are not connected to executive Directors by a family or professional bond; or (iv) do not maintain and have not maintained any relations with the Company or the Group which may impair their independence.”
Independence of the Directors on the Audit and Compliance Committee
Under the NYSE corporate governance rules, a majority of the audit committee must be composed of independent directors and by July 31, 2005, all members of the audit committee must be independent. Independence is determined in accordance with highly detailed rules promulgated by the NYSE.
The Audit and Compliance Committee of the Board of Directors of Banco Santander Central Hispano is composed of six Directors, five of whom are independent in accordance with the standards set forth in the previously mentioned Article 5 of the Regulations of the Board. These independence standards may not necessarily be consistent with, or as stringent as, the director independence standards established by the NYSE. Under Spanish law, a majority of the members and the chairman of the audit committee must be non-executive. All members of our Audit and Compliance Committee are non-executive Directors and its Chairman is independent in accordance with the standards set forth by the Regulations of the Board. The composition of the Audit and Compliance Committee is described under “Item 6. Directors, Senior Management and Employees—C. Board Practices—Audit and Compliance Committee and Appointments and Remuneration Committee”.
Independence of the Directors on the Appointments and Remuneration Committee
In accordance with the NYSE corporate governance rules, all U.S. companies listed on the NYSE must have a compensation committee and a nominations committee and all members of such committees must be independent in accordance with highly detailed rules promulgated by the NYSE. Under Spanish law, these committees are not required, though there is a non-binding recommendation for listed companies in Spain to have these committees and for them to be composed of non-executive directors. Banco Santander Central Hispano satisfies this non-binding recommendation. The composition of the Appointments and Remuneration Committee is described under “Item 6. Directors, Senior Management and Employees—C. Board Practices—Audit and Compliance Committee and Appointments and Remuneration Committee”.
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Separate Meetings for Non-Management Directors
In accordance with the NYSE corporate governance rules, non-management directors must meet periodically outside of the presence of management. Under Spanish law, this practice is not contemplated and as such, the non-management Directors on the Board of Directors of Banco Santander Central Hispano do not meet outside of the presence of the Directors who also serve in a management capacity.
Code of Ethics
Under the NYSE corporate governance rules, all U.S. companies listed on the NYSE must adopt a Code of Business Conduct and Ethics which contains certain required topics. In March 2000, Banco Santander Central Hispano adopted a “General Code of Conduct”, which applies to all members of the boards of the companies of the Group, to all employees subject to the Code of Conduct in the Securities Market, including the Bank’s Chairman, Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, and to all those employees designated by the Human Resources Division that have been specifically informed of their subjection to this General Code of Conduct. On July 28, 2003, the Board approved amendments to the General Code of Conduct to conform it to the requirements of Law 44/2002 (November 2, 2002) on reform measures of the financial system (see above ‘‘Recent Legislation’ 6; ). The new Code entered into force on August 1, 2003 and replaced the previous one. The General Code of Conduct establishes the principles that guide the actions of officers and Directors including ethical conduct, professional standards and confidentiality. It also establishes the limitations and defines the conflicts of interests arising from their status as senior executives or Directors.
As of December 31, 2004, no waivers with respect to the General Code of Conduct had been applied for or granted.
In addition, the Group abides by a Code of Conduct in the Securities Market, which was also updated on July 28, 2003. This code establishes standards and obligations in relation to securities trading, conflicts of interest and the treatment of price sensitive information.
Both Codes are available to the public on our website, which does not form part of this annual report on Form 20-F, at www.gruposantander.com under the heading “Corporate Governance – Internal Code of Conduct”.
Audit and Compliance Committee and Appointments and Remuneration Committee
An Audit and Compliance Committee and an Appointments and Remuneration Committee operate as part of the Board of Directors. The Audit and Compliance Committee consists exclusively of 6 external Directors (5 of whom are independent in accordance with the principles set forth in Article 5 of the Regulations of the Board). The Appointments and Remuneration Committee consists of 5 external Directors (4 of whom are independent in accordance with the principles set forth in Article 5 of the Regulations of the Board). These independence standards may not necessarily be consistent with, or as stringent as, the director independence standards established by the NYSE.
The Audit and Compliance Committee:
The Audit and Compliance Committee was created to provide support and specialization in the tasks of controlling and reviewing the accounts and compliance. Its mission, which has been defined and approved by the Board, is established in the by-laws and in the Regulations of the Board. Only non-executive Directors can be members of this Committee with independent Directors (as defined in the Regulations of the Board) having a majority representation. Its Chairman must always be an independent Director (as defined in the Regulations of the Board) and someone who has the necessary knowledge and experience of accounting techniques and principles. Currently, the Chairman of the Audit and Compliance Committee is Mr. Manuel Soto, the Fourth Vice-Chairman of the Board of Directors.
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Functions of the Audit and Compliance Committee:
Have its Chairman and/or Secretary report to the General Shareholders’ Meeting with respect to matters raised therein by shareholders regarding its powers.
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The Audit and Compliance Committee has issued a report which was distributed together with the Group’s 2004 Annual Report and which comprised a detailed account of the following points:
The Group’s 2004 Audit and Compliance Committee report is available on the Group’s website, which does not form part of this annual report on Form 20-F, at www.gruposantander.com under the heading “Information for Shareholders and Investors – Corporate Governance – Commitees Report”.
The following are the current members of the Audit and Compliance Committee:
Ignacio Benjumea also acts as Secretary to the Audit and Compliance Committee but is classified as a non-member.
The Appointments and Remuneration Committee:
The Regulations of the Board state that the members of this Committee must all be non-executive Directors with independent Directors (as defined in the Regulations of the Board) having a majority representation and an independent Director as Chairman (as defined in the Regulations of the Board).
Currently, the Chairman of the Appointments and Remuneration Committee is Fernando de Asúa, the First Vice Chairman of the Board of Directors.
Functions of the Appointments and Remuneration Committee
Establish and review the standards to be followed in order to determine the composition of the Board and select those persons who will be proposed to serve as Directors.
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The Appointments and Remuneration Committee issued a report which was distributed together with the Group’s 2004 Annual Report and which comprised a detailed account of the following points:
The Group’s 2004 Appointments and Remuneration Committee report is available on the Group’s website, which does not form part of this annual report on Form 20-F, at www.gruposantander.com under the heading “Information for Shareholders and Investors – Corporate Governance – Commitees Report”.
The following are the members of the Appointments and Remuneration Committee:
Ignacio Benjumea also acts as Secretary to the Appointments and Remuneration Committee but is classified as a non-member.
D. Employees.
At December 31, 2004, we had 126,488 employees (103,038 employees in 2003 and 104,178 in 2002) of which 33,353 were employed in Spain (34,956 in 2003 and 35,887 in 2002) and 93,135 were employed outside Spain (68,082 in 2003 and 68,291 in 2002), of which 24,361 were from Abbey. The terms and conditions of employment in the private sector banks in Spain are negotiated on an industry-wide basis with the trade unions. This process has historically produced collective agreements binding upon all the private banks and their employees. A new agreement was signed on May 11, 2005 and expires on December 31, 2006.
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The table below shows our employees by geographic area:
As of December 31, 2004, we had 2,739 temporary employees (2,172 at December 31, 2003 and 1,622 at December 31, 2002).
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E. Share ownership.
As of June 15, 2005, the direct, indirect and represented holdings of our current directors were as follows:
Emilio Botín has voting rights of 76,514,628 shares owned by Marcelino Botín Foundation (1.22% of share capital), of 8,096,742 shares the ownership of which corresponds to Jaime Botín, of 8,916,751 shares the ownership of which corresponds to Ana P. Botín, of 9,036,292 shares the ownership of which corresponds to Emilio Botín O., and of 8,793,481 shares the ownership of which corresponds to Javier Botín. Therefore, the table contains the number of shares of direct and indirect participation of each of the last three cited above who are Directors of the Board. However, under the column of percentage over the share capital, the participation of these three Directors is accounted together with the shares owned by Emilio Botín or for which he has proxy rights.
The options granted to the Bank´s Directors, managers and employees are described in the table under “Section B. Compensation” above.
Banco Santander Central Hispano’s capital is comprised of only one class of shares, all of which are ordinary and have the same rights.
As of June 15, 2005 our current Executive Officers (not Directors) referred to above under Section A of this Item 6 as a group beneficially owned, directly or indirectly, 2,523,727 ordinary shares, or 0.04% of our issued and outstanding share capital as of that date. Together with the options granted, no individual executive officer beneficially owns, directly or indirectly, one percent or more of the outstanding share capital as of that date.
Item 7. Major Shareholders and Related Party Transactions
A. Major shareholders.
As of December 31, 2004, to our knowledge no person beneficially owned, directly or indirectly, 5% or more of our shares.
At December 31, 2004 a total of 520,145,919 shares, or 8.32% of our share capital, were held by 794 registered holders with registered addresses in the United States and Puerto Rico, including JPMorgan Chase, as depositary of our American Depositary Share Program. These shares were held by 654 record holders. Since certain of such shares and ADRs are held by nominees, the foregoing figures are not representative of the number of beneficial holders. Our directors and executive officers did not own any ADRs as of December 31, 2004.
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To our knowledge, we are not controlled directly or indirectly, by any other corporation, government or any other natural or legal person. We do not know of any arrangements which would result in a change of our control.
B. Related party transactions.
Loans made to members of our Board of Directors and to our Executive Officers
Our direct or indirect risk exposure to the Bank’s Directors as of December 31, 2004, amounted to €10.8 million (€10.1 and €14.4 million as of December 31, 2003 and 2002, respectively) of loans and credits to such directors and €0.2 million (€0.4 and €1.2 million as of December 31, 2003 and 2002, respectively) of guarantees provided to them. These loans and credits and guarantees were granted at market rates in all cases.
The detail by director as of December 31, 2004, is as follows:
Additionally, the total amount of loans and credits and guarantees made by us to our Executive Officers who are not Directors, as of December 31, 2004, amounted to €6.8 million.
Loans extended to related parties were made in the ordinary course of business, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectibility or present other unfavorable features.
Loans made to other Related Parties
The companies of the Group engage, on a regular and routine basis, in a number of customary transactions among Group members, including:
overnight call deposits;
and others within the scope of the ordinary course of the banking business, such as loans and other banking services to our shareholders, to employees of all levels, and the associates and the members of the families of all the above-mentioned, as well as those other businesses conducted by the companies of the Group. All these transactions are made:
in the ordinary course of business;
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As of December 31, 2004, an aggregate of €1,579.5 million in loans and credits to non-consolidable and associated companies was outstanding (€1,445.5 and €1,364.5 million as of December 31, 2003 and 2002, respectively). These loans and credits represented 0.5% of our total net loans and credits and 4.9% of our total stockholders´ equity at December 31, 2004 (0.8% and 7.6%, respectively, at December 31, 2003, and 0.8% and 7.5%, respectively, at December 31, 2002).
For more information, see Notes 3 and 24 to our Consolidated Financial Statements.
C. Interests of experts and counsel.
Not Applicable
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Item 8. Financial Information
A. Consolidated statements and other financial information.
Financial Statements
See Item 18 for our Consolidated Financial Statements.
Legal Proceedings
Banco Santander Central Hispano
The resolutions adopted at the Bank’s general shareholders’ meetings held on January 18, 2000 and on March 4, 2000, approving the capital increases agreed in connection with the exchange offer made by The Royal Bank of Scotland Group plc. with National Westminster Bank plc., and in connection with the Bank’s acquisitions of the Portuguese banks Banco Totta & Açores and Crédito Predial Portugués and the resolution adopted the Bank’s general shareholders’ meeting held on March 4, 2000 approving the capital increase necessary to carry out the exchange offers for shares of Banco Rio de la Plata, have been challenged under Spanish law. One plaintiff shareholder, in the case of the resolutions adopted in the first meeting and two plaintiff shareholders, in the case of the resolutions adopted in the second meeting, have challenged these resolutions on the grounds that, among other things, they were provided with insufficient information in connection with the vote on these resolutions and that the resolutions excluding the preemptive rights of shareholders were not validly adopted. In the proceedings, the plaintiffs have requested the court to declare that the above resolutions (and other ones adopted in the same meetings) are null and void. The first claim was rejected by the court in April 2001, and the plaintiff appealed the court’s rejection of his claim. The plaintiff´s appeal was then rejected by the court on December 2, 2002. The plaintiff has appealed for redress and the Bank has asked the court not to admit such appeal. The second claim was rejected by the courts of the city of Santander on November 29, 2002 and the plaintiffs appealed. Such appeal was subsequently rejected by the court on July 5, 2004. The plaintiffs responded and the court admitted the response of one of the plaintiffs and dismissed the other. The Bank has requested that the appeals not be admitted. The Bank cannot anticipate the outcome of these claims. Under Spanish law, if the claims were to prevail, the capital increase resolutions adopted on January 18, 2000, and on March 4, 2000, could be declared null and void. The effect under Spanish law of the declaration of nullity of a listed company’s share capital increase is highly uncertain and the Bank is unable to anticipate what the outcome for it and its shareholders would be if these claims were to prevail.
The resolutions adopted at the Bank’s shareholders’ meeting held on March 10, 2001, have been challenged under Spanish law by three shareholders who filed their claim before the courts of the city of Santander. These shareholders claim that the Bank did not comply with certain provisions of Spanish corporate law with respect to the resolutions adopted in said shareholders’ meeting. The challenged resolutions include the approval of the Bank’s annual accounts, the approval of a capital increase in exchange of cash, the approval of a capital increase in exchange of shares of Banco Rio de la Plata and BRS Investments and the approval of various issuances of bonds. In their complaints, the plaintiff shareholders asked the Court to declare the resolutions null and void and that the registration of the resolutions in the Commercial Registry also be annulled. The claim was rejected by the court in March 2002. The plaintiff shareholders appealed such rejection and, although the court allowed the admission of new evidence, the claim was again rejected on April 13, 2004. One of the plaintiffs has appealed for redress and the Bank has asked the court that this appeal not be admitted.
The resolutions adopted at the Bank’s shareholders’ meeting held on February 9, 2002, have been challenged under Spanish law by one shareholder who has filed his claim before the courts of the city of Santander. The challenged resolutions include the approval of the payment of an interim dividend, the re-election of Arthur Andersen y Cía, S. Com. as the external auditor of the Bank, the approval of a capital increase in exchange of shares of the German Company AKB Holding Gmbh and the approval of various issuances of bonds. Among other things, the plaintiff alleges the infringement of the shareholders’ rights of participation during the meeting and of receipt of information regarding the different issues to be voted on in the meeting; and that the resolutions excluding the preemptive rights of shareholders were not validly adopted. The plaintiff shareholder asked the Court to declare the above resolutions (and others adopted in the same meeting) null and void and that the registration of the resolutions in the Commercial Registry also be annulled. On September 9, 2002 the Court rejected the claim. The plaintiff appealed the rejection but the court rejected the appeal on January 14, 2004. The plaintiff has appealed for redress and the Bank has asked the Court not to admit such appeal.
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The resolutions adopted at the Bank’s shareholders’ meeting held on June 24, 2002 have been challenged under Spanish law by one shareholder who filed his claim before the courts of the city of Santander. The challenged resolutions include the approval of the Bank’s annual accounts and the rejection by the shareholders meeting of the proposals made by the plaintiff shareholder and another shareholder to file a claim requesting the declaration of the Directors’ liability in connection with the investments made by the Bank in Argentina, as well as the proposal made by another shareholder for the dismissal of one of the Directors. The Bank responded to the claim on October 5, 2002. During the term to respond to this claim, the Bank was required to respond to another claim, filed by a different shareholder, challenging some of the resolutions adopted at the same meeting. The claim was admitted by the same court of the city of Sant an der that is in charge of the first proceeding and has been joined to this proceeding, so both proceedings will be carried out jointly. The Bank responded to this second claim on October 25, 2002. The hearing took place on April 21, 22, and 24, and the court dismissed the claim on May 29, 2003. The plaintiffs have appealed such decision and the Bank has already answered the appeal. On May 23, 2005, the court decided not to admit a new piece of evidence requested by one of the plaintiffs. Such plaintiff has requested the court’s decision to be redressed.
Since fiscal year 1992, the Madrid Central Pre-Trial Investigation Court No. 3 has maintained pre-trial investigative proceedings – now Summary Proceedings – in order to determine liabilities of the Bank, its Chairman and three of its Officers with respect to certain credit assignment transactions (operaciones de cesión de crédito) carried out by Banco Santander, S.A. between fiscal years 1987 and 1989. In the opinion of the Bank and its internal and external advisors, the final result of this litigation will be favourable to the Bank, its Chairman and three of its Officers, and does not require a specific additional reserve. On July 16, 1996, the Madrid Central Pre-Trial Investigation Court No. 3, pursuant to a request made to such effect by the Attorney General after having consulted the Spanish Tax Authority, dismissed certain but not all the claims against the Bank, its Chairman and three of its Officers. Thereafter, the Attorney General – representative of the Tax Authority – and the Office of the Public Prosecutor repeatedly requested the dismissal of the remaining claims and the removal of the case from the docket. However, on June 27, 2002, the court changed the cited proceedings into a Summary Proceeding. Such decision was appealed by the Office of the Public Prosecutor, the Bank, its Chairman and three of its Officers. On June 23, 2003, the Panel Two of the Criminal Division of the National Criminal and Administrative Court (Audiencia Nacional) admitted partially such appeals, explicitly acknowledging that the marketing of the credit assignment transactions with clients had been legal, and reducing the number of transactions under scrutiny – and with respect to which the Bank’s possible involvement is still being alleged – from 138 to 38, with respect to the remaining 38 transactions under scrutiny, the Attorney General and the Office of the Public Prosecutor have generally requested the dismissal of claims and their removal from the docket on the grounds that no crime had been committed. Following the conclusion of the indictment proceedings – with repeated requests by the the Office of the Public Prosecutor and the Attorney General for the dismissal of the proceedings and their removal from the docket, – and based on the complaint filed by the citizen complainant, Asociación para la Defensa de Inversores y Clientes (Investor and Customer Defense Association), the Court, in an order dated October 6, 2004, decreed the commencement of oral evidentiary proceedings against the Chairman of the Bank and three of its Officers for one continuing crime of falsification of an official document, three continuing crimes of falsification of a commercial document, and thirty crimes against the public finance, ordering that a bond be jointly posted for €67.8 million, which amount was later reduced to €40.1 million, as a fine and for costs. The order designated Panel One of the Criminal Division of the National Criminal and Administrative Court as the competent court to hear the oral evidentiary proceedings.
In December 1995, the Spanish tax authorities issued an ‘‘Acta’’ (writ) requiring Banco Santander, S.A. to pay €26.2 million in back withholding taxes, interest and penalties relating to the Bank’s alleged failure to comply with a purported obligation to withhold income tax on payments to clients with respect to certain credit assignment transactions held by such clients. Although a similar case in an amount of €3.8 million was successfully appealed by the Bank in June 2003 (and then appealed in turn by the Regional tax authorities), the Bank’s appeal against this writ was rejected. The Bank filed a second appeal which was partially admitted by the court on October 30, 2003. Both the Bank and the Attorney General have appealed such decision before the Supreme Court and are awaiting the Court’s decision with respect to the appeals.
The resolutions adopted at the Bank’s shareholders’ meeting held on June 21, 2003 have been challenged under Spanish law by three shareholders who filed their claims before the courts of the city of Santander. The three plaintiff shareholders challenged the resolution approving the annual accounts and the management of the Bank and of the Group for 2002. In addition, two out of the three plaintiff shareholders challenged the resolutions approving the profit allocation for 2002 and the Procedural Rules of the Bank’s Shareholders’ Meetings. On October 10, 2003, the Bank answered the claims. The preliminary hearing took place on January 21, 2004. On February 11, 2004 the Court decided to suspend the proceedings until the preliminary proceedings 352/2002 being carried out by the Madrid Central Court number 3 (referred to hereinbelow) are finalized. On September 29, 2004, the Bank also responded to a separate claim filed by another shareholder challenging the resolutions adopted at the same meeting. The preliminary hearing for this claim took place on January 19, 2005. The Court decided to carry out jointly all the proceedings related to the same meeting and to apply to all such proceedings the suspension ordered by the Court on February 11, 2004.
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The resolutions adopted at the Bank’s shareholders’ meeting held on June 19, 2004 have been challenged under Spanish law by three shareholders who filed their claims before the courts of Santander. The challenged resolutions include the approval of the Bank’s annual accounts, the profit allocation and the approval of the Procedural Rules of the Bank’s Shareholders’ Meetings. The Bank has already responded to the three claims and requested that all such claims be joined into one single proceeding. The Court granted the Bank’s request to carry out all the three proceedings jointly. The preliminary hearing took place on February 7, 2005 and the hearing occurred on May 9 and 10, 2005. The court’s decision is awaited.
Lanetro, S.A. filed a suit against the Bank, carried out before the Court of 1st Instance no. 34 of Madrid, Complaint of Plenary Suit no. 558/2002, principally alleging that the Bank breached its alleged obligation to subscribe to the increase in capital stock of the plaintiff in the amount of €30,050,605.22. The court rejected the claim on December 16, 2003, but the plaintiff has appealed. The Bank has answered the appeal and is presently awaiting the Court’s decision with respect to the appeal.
For informational purposes, it is also mentioned that several persons, who allegedly have funds deposited in Banco Río de la Plata, S.A., filed an application for conciliation before the courts of the city of Madrid against the Bank, the persons who were members of the Board during 2001 and 2002 and others. According to Spanish Law, this application did not start proper judicial proceedings against the Bank. The claimants only intended that the defendants acknowledge the facts alleged in their application, regarding the Bank and its Directors’ claimed obligation to reimburse the funds deposited by the claimants in Banco Río de la Plata, S.A. The conciliation hearing was held on July 16, 2002. The Bank and the members of the Board refused to accept the facts and allegations of the application. This meant the termination of the conciliation. In January 2004, there was a preliminary hearing in connection with a similar case, in which a person who allegedly deposited funds in Banco Río de la Plata, S.A. is claiming $8,365.71. The Court has not determined the date for the next hearing yet.
For the same informational purposes, it is mentioned that the Madrid Central Court number 3 is carrying forward preliminary proceedings 352/2002 in connection with complaints filed by two shareholders against the Chairman of the Bank, regarding the economic terms of the retirement in August 2001 of the former co-chairman, Mr. José María Amusátegui and the economic terms of the resignation in February 2002 of the former first vice-chairman and chief executive officer, Mr. Angel Corcóstegui. The prosecutor and the defendants requested the dismissal of the case, which was opposed by the plaintiff shareholders. On October 16, 2003 the Court decided to change the cited proceedings to a summary proceeding. The Office of the Public Prosecutor and the Chairman of the Bank and the other two accused appealed the decision. The hearing of the appeals took place on February 9, 2004, and on February 18, 2004 the Court decided not to admit such appeals without entering into the merits of the matter. The Chairman of the Bank then appealed to the Constitutional Court. The Office of the Public Prosecutor again requested the dismissal of the case. On April 26, 2004, the Madrid Central Court number 3 decided to commence oral evidentiary proceedings. On May 10, 2004, with two dissenting votes, and in spite of the favourable report of the Office of the Public Prosecutor, the Constitutional Court decided not to admit the appeal. At the oral hearing, the Office of the Public Prosecutor requested the acquittal of those accused on the grounds that the facts do not amount to a criminal offense. On April 13, 2005, the Court decided to acquit those accused since the facts do not amount to a criminal offense. A cassation appeal against such decision has been filed by the plaintiffs.
On September 25, 2003, the Bank announced that it would launch a public offering in Spain for the acquisition of up to 16% of the share capital of Compañía Española de Petróleos, S.A. (“Cepsa”), a Spanish oil and petrochemical company. On October 21, 2003, the Spanish National Securities Commission authorized the Bank to launch the offering. The acceptance term of the offering expired on November 24, 2003. The bid was accepted by shares representing 12.13% of Cepsa’s share capital.
The Bank decided to launch the bid for Cepsa once the agreements with the French group Total (“Total”), an oil and petrochemical group and major shareholder of Cepsa, to act in concert with respect to the parties’ investments in Cepsa had become ineffective after the enactment of Law 26/2003 of July 17, 2003 (“Ley de Transparencia”). These agreements included those related to the company Somaen Dos, S.L. (“Somaen Dos”), a holding company in which the Bank, Total and Unión Fenosa, S.A. (“Unión Fenosa”) have participations of approximately 60%, 25% and 15%, respectively. Somaen Dos owns shares representing 33.23% of Cepsa’s share capital, of which 19.92% belong to the Bank, 8.31% to Total and 5.00% to Unión Fenosa.
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After the Bank’s announcement to launch the public offering, Total requested a summary arbitral proceeding with the Netherlands Arbitration Institute seeking the adoption of certain injunctive measures. On November 25, 2003, that arbitration institute made public a ruling that, among other measures, imposed a temporary prohibition of the sale or encumbrance of the Cepsa shares owned by Somaen Dos as well as the Cepsa shares that the Bank had acquired in the bid. Furthermore, the ruling instructed both the Bank and Total to presently respect the supermajority rules contained in the agreements to act in concert in Cepsa and the rules, also established in those agreements, governing the right to appoint Directors of the boards of Cepsa and Somaen Dos.
Additionally, on October 20, 2003, the Total group filed a request for an arbitral proceeding with the Netherlands Arbitration Institute seeking a determination on the merits of its claim. The Bank responded that it was opposed to such request.
Currently, that arbitral proceeding remains open. In such proceeding, Elf and Odival (hereinafter, “Elf”) have requested the Netherlands Arbitration Institute inter alia to instruct the Bank: to return to the market the Cepsa shares that the Bank acquired in the bid, to declare that the conditions for Elf to exercise a call option for 4.35% of Cepsa’s share capital have been fulfilled, and to pay various indemnities, some of which have to be quantified during the course of the proceeding.
On October 15, 2004, the Bank answered the claim made by Elf. The Bank requested: (i) the dismissal of all the requests made by Elf in its claim, except for those related to the admission of Elf’s right to the restoration of its economic participation in Cepsa that Elf owns through Somaen, and to the Bank’s abstention from actions that could lead to the transfer or encumbrance of such participation, as these two requests have been repeatedly accepted by the Bank; (ii) the suspension of the presently existing injunctive measures described above; (iii) the declaration of ineffectiveness of the agreements signed by the Bank and Elf to act in concert with respect to their investments in Cepsa; (iv) the express declaration that irreconcible differences between the parties (“disputa insuperable”), within the meaning of the signed agreements, has not occurred between the Bank and Elf; (v) the impositio n to Elf of the obligation to negotiate in bona fide with the Bank the most favourable way for both parties and for Unión Fenosa to separate their economic participations in Cepsa and those that are owned by Somaen; and (vi) the sentence of Elf to indemnify the Bank for damages caused to the latter by the dispute between both parties and for damages derived from the adoption of the injunctive measures.
On November 30, 2004, Total answered the Bank’s pleadings and the Bank responded on January 21, 2005. After the hearings held by the Netherlands Arbitration Institute, the proceedings continue with a simultaneous submission of two conclusion filings by each party. As of May 31, 2005, both the Bank and Total submitted the first of such filings. The second filing must be submitted before June 30, 2005. Once these second conclusion filings are submitted, the proceedings will conclude with the issuance by the Institute of its ruling.
The decision to be adopted in this proceeding will not be conditioned by the above-mentioned injunctive ruling which is temporary and which does not constitute a pre-judgment on the merits.
In May 2004, Chadia Limited, S.A. filed a suit against the Bank, carried out before the Court of 1st Instance number 48 of Madrid, proceeding number 420/2004, alleging that the Bank breached an alleged agreement for the sale to the plaintiff of certain buildings and seeking damages in the amount of €133 million. The Court rejected the claim, Chadia Limited, S.A. appealed, and the Bank has already responded that is was opposed to such appeal.
In 1995 and 1996, the former directors of Banesto, who had been replaced by decision of the Bank of Spain’s Executive Council on December 28, 1993, filed claims challenging certain corporate resolutions adopted by the shareholders’ meetings held on March 26, and August 22, 1994 and February 15, 1995 approving, among other things, Banesto’s financial reorganization plan and the 1993 and 1994 financial statements of Banesto and the Banesto Group. In 2000, Madrid Appellate Court decisions rejected all the appeals filed by the plaintiffs in connection with the claim filed challenging the legality of the corporate resolutions approving the financial restructuring plan; the plaintiffs subsequently filed a cassation appeal against these decisions and Banesto has answered such cassation appeal. On March 5, 2002 the courts decided not to admit the cassation appeal against the Madrid Appellate Court’s decision rejecting the claims of some of the plaintiffs regarding the invalidity of the constitution of the shareholders’ meeting held on March 26, 1994. On July 22, 2003, the court admitted the cassation appeal filed by the remaining plaintiffs. Banesto filed its answer on September 20, 2003. On March 31, 2005, the parties were informed of a request made by some of the plaintiffs to bring the case to the European Court of Justice. Banesto has already opposed such request, and awaits the response of the Office of the Public Prosecutor. The claim filed against the resolutions adopted by the shareholders’ meeting held on August 22, 1994 approving the 1993 financial statements of Banesto was rejected by the Court of First Instance and the plaintiffs subsequently filed an appeal before the Madrid Appellate Court. The appeal was rejected in 2001 and the plaintiff has appealed in cassation. The claim filed against the approval by the shareholders’ meeting held on February 15, 1995 of the 1994 financial statements of Banesto was also rejected in 2000 by the Court of First Instance and was subsequently appealed by the plaintiffs. The appeal was dismissed by judgment of the Court of Appeals of Madrid, rendered on May 20, 2003. In September 2003, the plaintiffs’ appeal of this judgment was also dismissed. The plaintiffs have since appealed to the Supreme Court.
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Banesto’s directors and legal advisers do not believe that these claims will have any effect on the financial statements of Banesto or its Group. The plaintiffs seek that the resolutions be declared null and void, not damages. It is very difficult to assess what the practical consequences of an adverse judgment would be.
Abbey National Treasury Services plc
Abbey National Treasury Services plc has received a demand from the French Tax Authority relating to the repayment of certain tax credits and related charges. Following certain modifications to the demand its nominal amount now stands at 101 million Pounds sterling as compared with the original demand of 113 million Pounds sterling. As of December 31, 2004, additional interest in relation to the demand could amount to 16 million Pounds sterling. The amount of additional interest has been reduced from the amount disclosed by Abbey National plc as of December 31, 2003 of 36 million Pounds sterling due to certain modifications to the basis on which additional interest might be due. Abbey National Treasury Services plc has received legal advice that it has strong grounds to challenge the validity of the demand and accordingly no specific provision has been made.
Banco do Estado de Sao Paulo (Banespa)
Pursuant to the Brazilian labor regulations applicable to Banespa, this bank had recorded as of December 31, 2000, the pension allowances arising from the commitments to certain employees, which amounted to approximately 4,000 million Brazilian reais. Since 1987, the Directors of Banespa, as advised by their tax advisers, treated these expenses as deductible expenses in calculating the Brazilian corporate income tax. However, in September 1999, the ‘‘Secretaria de Receita Federal’’ issued a decision according to which these expenses, in an amount of approximately Brazilian reais 2,867 million would not be tax deductible. In October 1999, the Board of Directors of Banespa filed an appeal challenging this decision together with an ‘‘acción cautelar’’ regarding fiscal years 1999 and 2000, posted a deposit of Brazilian reais 1,297 million and recorded a provision of Brazil ia n reais 2,600 million for this contingency. Such provision was recorded in 1999 with a charge to income, after recording the related deferred tax asset of Brazilian reais 1,200 million.
In this respect, the Board of Directors of Banespa has decided to accept the Medida Provisória nº 66 of the Secretaría da Receita Federal dated August 29, 2002 and to pay Brazilian reais 2,110 million in order to settle the proceedings. The company disputes any liability with respect to an additional amount of Brazilian reais 103 million relating to costs and surcharges imposed in connection with the dispute relating to the principal amount. The company has asked for a cautionary judicial action posting a deposit for an equivalent amount.
Santander Brasil DTVM, Ltda. and Banco Santander Brasil, S.A.
On May 19, 2003, the Secretaria de Receita Federal issued an “Auto de Infração” requiring from our Brazilian affiliate Santander Brasil DTVM, Ltda. the payment of Brazilian reais 290 million in taxes allegedly incurred in connection with certain cash management services rendered by such company to its clients which the company had treated during 2000, 2001 and the two first months of 2002 as exempt from the Tax on Financial Transactions, following the advice of its tax advisers. The Board of Directors of Santander Brasil DTVM, Ltda. appealed this decision in June 2003. The Tax Authorities confirmed the “Auto de Infrançao” and the Board of Directors appealed to “Conselho de Contribuintes” (final administrative court). The Court decision is pending. On December 31, 2004, the amount involved in the action was equivalent to reais 306 million.
Also on May 29, 2003, the Secretaria de Receita Federal issued another “Auto de Infração” requiring from our Brazilian affiliate Banco Santander Brasil, S.A. the payment of Brazilian reais 290 million in taxes allegedly incurred in connection with certain clearing services rendered by such company to Santander Brasil DTVM, Ltda. pursuant to an agreement between these two companies. Following the advice of its tax advisers, Banco Santander Brasil, S.A. had treated during 2000, 2001 and the two first months of 2002 such services as exempt from the Tax on Financial Transactions. The Board of Directors of Banco Santander Brasil, S.A. appealed this decision in June 2003. The Tax Authorities confirmed the “Auto de Infrançao” and the Board of Directors appealed to “Conselho de Contribuintes” (final administrative court). The Court decision is pending. On December 31, 2004, the amount involved in the action was equivalent to reais 306 million.
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Casa de Bolsa Santander Serfín, S.A. de C.V. (Grupo Financiero Santander Serfín)
An individual has filed an ordinary mercantile proceeding against Casa de Bolsa, Santander Serfin, S.A. de C.V. (Grupo Financiero Santander Serfín) in the thirty first court on civil law of the Federal District of Mexico in order to determine the liabilities of Casa de Bolsa, Santander Serfin, S.A. de C.V. (Grupo Financiero Santander Serfín) with respect to the alleged existence of irregular withdrawals at such entity made by a representative of the plaintiff and which were not carried out in accordance with various security brokerage agreements subscribed to by the parties. The plaintiff claims the restoration at market value of 2,401,588 shares of the company Mexico 1, of 11,219,730 shares of the company Mexico 4, and the payment of 15,025,730 Mexican Pesos in addition to the payment of interests calculated applying the CCP rate multiplied by four.
On July 6, 1999 the judgment against Casa de Bolsa became firm, and subsequently on November 5, 2004, the court rendered an execution ruling which quantified the amount of interests at 37,646.8 million Mexican Pesos ($3,408.4 million), and condemned Casa de Bolsa to deliver the claimed shares. Casa de Bolsa appealed, and on January 20, 2005, the court decided not to admit such appeal. Against this decision Casa de Bolsa asked for reddress and the court admitted its request and suspended the November 5, 2004 ruling temporarily first and subsequently granted a final suspension of such ruling which annulled it. The decision which turned into the annulment of the November 5, 2004 ruling has been, on its turn, appealed by the plaintiff and Casa de Bolsa. We are presently awaiting the court’s decision.
Other Litigation
In addition to the above described matters, the Bank and its subsidiaries are from time to time subject to certain claims and parties to certain legal proceedings incidental to the normal course of our business, including in connection with the Group’s lending activities, relationships with the Group’s employees and other commercial or tax matters. In view of the inherent difficulty of predicting the outcome of legal matters, particularly where the claimants seek very large or indeterminate damages, or where the cases present novel legal theories, involve a large number of parties or are in early stages of discovery, the Bank cannot state with confidence what the eventual outcome of these pending matters will be, what the timing of the ultimate resolution of these matters will be or what the eventual loss, fines or penalties related to each pending matter may be. The Bank believes that it has made adequate reserves related to the co sts anticipated to be incurred in connection with these various claims and legal proceedings and believes that liabilities related to such claims and proceedings should not have, in the aggregate, a material adverse effect on the Group’s business, financial condition, or results of operations. However, in light of the uncertainties involved in such claims and proceedings, there is no assurance that the ultimate resolution of these matters will not significantly exceed the reserves currently accrued by the Bank; as a result, the outcome of a particular matter may be material to the Bank’s operating results for a particular period, depending upon, among other factors, the size of the loss or liability imposed and the level of the Bank’s income for that period.
Dividend Policy
We have normally paid an annual dividend in quarterly installments. The table below sets forth the historical per share and per ADS (each of which represents the right to receive one of our shares) amounts of interim and total dividends in respect of each fiscal year indicated.
On August 1, 2005, we will pay the first dividend on account of the earnings for the financial year to December 31, 2005 for a gross amount of €0.09296 per share.
For a discussion of regulatory and legal restrictions on our payments of dividends, see “Item 4. Information on the Company—B.Business Overview—Supervision and Regulation—Restrictions on Dividends”.
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For a discussion of Spanish taxation of dividends, see “Item 10. Additional information—E.Taxation—Spanish Taxation of Dividends”.
The dividends paid on the guaranteed non-cumulative preference stock of certain of our subsidiaries are limited by our Distributable Profits in the fiscal year preceding a dividend payment. “Distributable Profits” with respect to any year means our reported net profits after tax and extraordinary items for such year as derived from the parent Bank’s non-consolidated audited profit and loss account prepared in accordance with Bank of Spain requirements and guidelines in effect at the time of such preparation. Such requirements and guidelines may be expected to reflect the Bank of Spain regulatory policies applicable to us, including without limitation those relating to the maintenance of minimum levels of capital. See “Item 4. Information on the Company—B. Business Overview—Supervision and Regulation—Capital Adequacy Requirements” and “Item 4. Information on the Company 15 1;B. Business Overview—Restrictions on Dividends”. According to our interpretation of the relevant Bank of Spain requirements and guidelines, Distributable Profits during the preceding five years were:
The portion of our net income attributable to our subsidiaries has increased steadily in recent years as our subsidiaries have grown and we have acquired new subsidiaries. Such profits are available to us only in the form of dividends from our subsidiaries and we are dependent to a certain extent upon such dividends in order to have Distributable Profits sufficient to allow payment of dividends on our guaranteed preference stock of our subsidiaries as well as dividends on our shares (although the payment of dividends on the shares is limited in the event of the non-payment of preference share dividends). We generally control a sufficient proportion of our consolidated subsidiaries’ voting capital to enable us to require such subsidiaries to pay dividends to the extent permitted under the applicable law. As a result of our growth, the Bank, as the holding entity of the shares of our various companies, has added i nvestments in our subsidiaries, the financial costs of which are borne by us.
B. Significant Changes.
For significant changes that have occurred since December 31, 2004, see our Form 6-K relating to our first quarter 2005 results filed with the Securities and Exchange Commission on May 12, 2005.
Item 9. The Offer and Listing.
A. Offer and listing details.
Market Price and Volume Information
Banco Santander Central Hispano’s Shares
During the last year, our shares were the shares with the second highest trading volume on the Spanish stock exchanges. At December 31, 2004, our shares represented 16.65% of the IBEX 35 Stock Exchange Index, the second highest percentage among all Spanish issuers and the first among all Spanish banks represented in this index. Our market capitalization of €57,101.7 million at 2004 year-end was the second largest of any Spanish company and the first of any Spanish bank, according to information published by the Sociedad de Bolsas.
At December 31, 2004, we had 2,685,317 registered holders of our shares and, as of such date, a total of 520,145,919 of our shares or 8.32% were held by 794 registered holders with registered addresses in the United States and Puerto Rico, including JP Morgan Chase, as depositary of our American Depositary Share program.
Our shares are traded on Spain’s automated “continuous market”, the national, centralized market which integrates by computer quotations originating in the four Spanish stock exchanges (Madrid, Barcelona, Valencia and Bilbao) (the “Automated Quotation Systems”). Our shares also are listed on the New York (in the form of American Depositary Shares), Milan, Lisbon and Buenos Aires Stock Exchanges. In 2001, we delisted our shares from the Tokyo Stock Exchange and in 2003 we delisted our shares from the London, Paris, Frankfurt and Swiss Exchanges. At December 31, 2004, 60.5% of our shares were held of record by non-residents of Spain. Following the acquisition of Abbey, we are currently in the process of obtaining a secondary listing of our ordinary shares on the London Stock Exchange.
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The table below sets forth the high, low and last daily sales prices in euros for our shares on the continuous market for the periods indicated.
American Depository Shares (ADSs)
Our ADSs have been listed and traded on the New York Stock Exchange since July 30, 1987. Each ADS represents one of our shares and is evidenced by an American Depositary Receipt, or ADR. The deposit agreement, pursuant to which ADRs have been issued, is among us, JP Morgan Chase, as depositary, and the holders from time to time of ADRs. At December 31, 2004, a total of 111,932,873 of our ADSs were held by 654 registered holders. Since certain of such of our shares and our ADSs are held by nominees, the number of record holders may not be representative of the number of beneficial owners.
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The table below sets forth the reported high, low and last sale prices for our ADSs on the New York Stock Exchange for the periods indicated.
On June 24, 2005, the reported last sale price of our ADSs on the New York Stock Exchange was $11.44.
B. Plan of distribution.
C. Markets.
Spanish Securities Market
The Spanish securities market for equity securities (the “Spanish Stock Exchanges”) consists of the four stock exchanges located in Madrid, Barcelona, Bilbao and Valencia (the “local exchanges”). The majority of the transactions conducted on them are done through the Automated Quotation System (Sistema Interbancario Bursátil Español or “S.I.B.E.”). During the year ended December 31, 2004, the Automated Quotation System accounted for the majority of the total trading volume of equity securities on the Spanish Stock Exchanges. According to statistics of the CNMV, the shares of Spanish banks are among the most heavily-traded securities on the Spanish Stock Exchanges.
Automated Quotation System
The Automated Quotation System was introduced in 1989 and links the four local exchanges, providing those securities listed on it with a uniform continuous market that eliminates most of the differences among the local exchanges. The principal feature of the system is the computerized matching of buy and sell orders at the time of entry of the order. Each order is executed as soon as a matching order is entered, but can be modified or canceled until executed. The activity of the market can be continuously monitored by investors and brokers. The Automated Quotation System is operated and regulated by the Sociedad de Bolsas, S.A. (the “Sociedad de Bolsas”), a corporation owned by the companies that manage the local exchanges. All trades on the Automated Quotation System must be placed through a bank, brokerage firm, an official stock broker or a dealer firm member of a Spanish stock exchange directly.
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There is a pre-opening session held from 8:30 a.m. to 9:00 a.m. each trading day on which orders are placed at that time. The computerized trading hours are from 9:00 a.m. to 5:30 p.m. Each session will end with a 5 minute auction, between 5:30 and 5:35 p.m., with a random closedown of 30 seconds. The price resulting from each auction will be the closing price of the session.
From May 14, 2001, new rules came into effect regarding the maximum price fluctuations in the price of stocks. Under the new rules, each stock in the continuous market is assigned a static and a dynamic range within which the price of stocks can fluctuate. The price of a stock may rise or fall by its static range (which is published once a month and is calculated according to the stock’s average historic price volatility) above or below its opening price (which shall be the closing price of the previous session). When the stock trades outside of this range, the trading of the stock is suspended for 5 minutes, during which an auction takes place. After this auction, the price of the stock can once again rise or fall by its static range above or below its last auction price (which will be considered as the new static price before triggering another auction). Furthermore, the price of a stock cannot rise or fall by more than its dynamic pri ce range (which is fixed and published once a month and is calculated according to the stock´s average intra-day volatility), from the last price at which it has traded. If the price variation exceeds the stock’s dynamic range a five minutes auction is triggered.
Between 5:30 p.m. and 8:00 p.m., trades may occur outside the computerized matching system without prior authorization of the Sociedad de Bolsas, at a price within the range of 5% above the higher of the average price and closing price for the day and 5% below the lower of the average price and closing price for the day, if there are no outstanding bids or offers, as the case may be, on the system matching or bettering the terms of the proposed off-system transaction, and if the trade involves more than €300,000 and more than 20% of the average daily trading volume of the stock during the preceding quarter. At any time before 8:00 p.m., trades may take place (with the prior authorization of the Sociedad de Bolsas) at any price if:
Information with respect to computerized trades between 9:00 a.m. and 5:30 p.m. is made public immediately, and information with respect to trades outside the computerized matching system is reported to the Sociedad de Bolsas and published in the Boletín de Cotización and in the computer system by the next trading day.
During 1998, the Block Market (“el mercado de bloques”) was implemented, allowing for block trades between buyers and sellers. Under certain conditions, this market allows cross-transactions of trades at prices different than at normal market sessions. Trading in the Block Market is subject to certain limits with regard to stocks and volumes.
Clearance and Settlement System
Until April 1, 2003, transactions carried out on the regional Spanish stock exchanges and the continuous market were cleared and settled through the Servicio de Compensación y Liquidación de Valores, S.A. (the “SCL”). Since April 1, 2003, the settlement and clearance of all trades on the Spanish stock exchanges, the Public Debt Market (Mercado de Deuda Pública), the AIAF Fixed Income Market (“Mercado AIAF de Renta Fija”) and Latibex - the Latin American stock - exchange denominated in euros, are made through the Sociedad de Gestión de los Sistemas de Registro, Compensación y Liquidación de Valores (“Iberclear”), which was formed as a result of a merger between SCL and Central de Anotaciones del Mercado de Deuda Pública (CADE), which was managed by the Bank of Spain.
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Book-Entry System
Ownership of shares listed on any Spanish stock exchange is required to be represented by entries in a register maintained by Iberclear, and transfers or changes in ownership are effected by entries in such register. Iberclear is responsible for maintaining the register of securities, held in book-entry form, of all trades from the Spanish stock exchanges, the Public Debt Market, the AIAF Fixed Income Market and Latibex.
Securities Market Legislation
The Spanish Securities Markets Act, which came into effect in 1989, among other things:
The Securities Markets Act was amended by Law 37/1998, which implemented two European Union directives into Spanish law. The first is Directive 93/22/CE, relating to investment services within securities, later amended by Directive 95/26/CE of European Parliament and Council. The second is Directive 97/9/CE of European Parliament and Council, relating to indemnity systems.
Law 37/1998 introduced some innovations to the Securities Markets Act. The first was the recognition that both Spanish and other European Union Member State companies authorized to provide investment services have full access to the official secondary markets, with full capacity to operate, thereby enabling the direct admission of banking entities into the stock exchange area. The second innovation was that the scope of the Securities Markets Act was enlarged to include a list of financial instruments, such as financial exchange contracts, or installment financial contracts, which expanded the category of securities.
Other modifications under Law 37/1998 include:
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The Securities Markets Act has been further amended by Law 44/2002 (November 22, 2002) on reform measures of the financial system, which introduced certain modifications to the laws governing financial markets and corporations, generally, including:
On July 17, 2003, the Securities Market law was amended by Law 26/2003 in order to reinforce the transparency of listed companies. It introduces:
On March 11, 2005 Royal Decree Law 5/2005 was approved, modifying the Securities Market Law in order to implement the Directive 2003/71/EC of the European Parliament and of the Council on the prospectus to be published when securities are offered to the public or admitted to trading. The Directive: (i) harmonizes the requirements for the process of approval of the prospectuses in order to grant to the issuer a single passport for such document, valid throughout the European Community; (ii) it incorporates the application of the country of origin principle by which the prospectus will be approved by the member states of the European Union where the issuer has its registered office but it also introduces as a new matter the possibility that in certain circumstances, such as issues with high minimum denominations (EUR 1,000 or more), the issuer may designate the relevant European Union competent authority for prospectus approval.
Finally, on April 22, 2005, the Securities Market Law was amended by Law 5/2005 on supervision of financial conglomerates in order to make the sectoral rules applicable to investment firms more consistent with other sectoral rules applicable to other groups with similar financial activities, such as credit institutions and insurance undertakings.
Trading by Banco Santander Central Hispano’s Subsidiaries in the Shares
Our trading activities in our shares are limited to those set forth above. No affiliated company acts as a “market maker” as that term is understood in the United States securities markets. The continuous market is driven by orders, which are matched by the market’s computer system according to price and time entered. Banco Santander Central Hispano’s and Banesto’s broker subsidiaries, Santander Central Hispano Bolsa, Sociedad de Valores, S.A., (“Santander Central Hispano-SVB”) and Banesto, Bolsa, S.A., S.V.B., and the other brokers authorized to trade on the continuous market (“Member Firms”) are not required to and do not serve as market makers maintaining independently established bid and ask prices. Rather, Member Firms place orders for their customers, or for their own account, into the market’s computer system. If an adequate counterparty order is not available on the continuous market at that time, the Member Firm may solicit counterparty orders from among its own clients and/or may accommodate the client by filling the client’s order as principal.
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The law requires that the “Comisión Nacional del Mercado de Valores” (CNMV) be notified each time the acquisitions of treasury stock made since the last notification reaches 1% of the outstanding capital stock, regardless of any other preceding sales. Prior to adoption of the Companies Law in 1989, treasury stock shares were considered to be outstanding for all purposes under Spanish law (except for calculating capital ratios pursuant to Bank of Spain requirements). The Companies Law establishes, in relation to the treasury stock shares (held by us and our affiliates), that the exercise of the right to vote and other non-financial rights attached to them shall be suspended. Financial rights arising from treasury stock held directly by us, with the exception of the right to allotment of new bonus shares, shall be attributed proportionately to the rest of the shares.
D. Selling shareholders.
E. Dilution.
F. Expense of the issue.
Item 10. Additional Information.
A. Share capital.
B. Memorandum and articles of association.
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Register
Corporate Object and Purpose
Certain Provisions Regarding Shareholder Rights
Our by-laws do not contain any provisions relating to sinking funds.
Meetings and Voting Rights
Each Banco Santander Central Hispano share entitles the holder to one vote. Registered holders of any number of shares who are current in the payment of capital calls will be entitled to attend shareholders’ meetings. Our by-laws do not contain provisions regarding cumulative voting.
In accordance with the Procedural Rules of the General Shareholders’ Meeting, the Group’s website includes from the date when the call of the General Shareholders’ Meeting is published, the details regarding the manner and procedures for shareholders to follow to confer representation on any other shareholder who is eligible to attend the General Shareholders’ Meeting in his own right and to vote by proxy. The manner and procedures for electronic delegation and voting via the Internet are also indicated.
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Only registered holders of Banco Santander Central Hispano shares of record at least five days prior to the day on which a meeting is scheduled to be held may attend and vote at such meeting. As a registered shareholder, the depositary will be entitled to vote the Banco Santander Central Hispano shares underlying the Banco Santander Central Hispano ADSs. The deposit agreement requires the depositary to accept voting instructions from holders of Banco Santander Central Hispano ADSs and to execute such instructions to the extent permitted by law.
Resolutions at general meetings are passed provided that, regarding the voting capital present or represented at the meeting, the number of votes in favor is higher than the number of votes against or in blank and abstentions.
In accordance with Spanish law, a quorum on first call for a duly constituted ordinary or extraordinary general meeting of shareholders requires the presence in person or by proxy of shareholders representing 25% of our subscribed voting capital. On second call there is no quorum requirement. Notwithstanding the above, a quorum of 50% of our subscribed voting capital is required on the first call to approve any of the following actions:
A quorum of 25% of the subscribed voting capital is required to vote on such actions on the second call. A two-third majority of our present or represented voting capital is required to approve all of the above listed actions when the shareholders’ meeting is held on second call and less than 50% of our subscribed voting capital is present.
Changes in Capital
Dividends
Our by-laws establish that any available profits shall be distributed in the following order: first, the legally required amounts are placed into the compulsory reserves. Next, our board of directors will assign such amounts it considers appropriate to voluntary reserves and ”fondos de previsión” (general allowances). After separating the amount which should be carried forward, if the board deems it advisable, the remaining amount will be divided equally amongst our shareholders under the limitations imposed by Spanish law.
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The amount, time and form of payment of the dividends, to be distributed amongst the shareholders in proportion to their paid-in capital will be established by resolutions adopted at the general meeting. The Board of Directors is entitled to distribute sums on account of future dividends; said distributions must be eventually approved by the general meeting.
Preemptive Rights
In the event of a capital increase, or the issuance of convertible debt, each shareholder has a preferential right by operation of law to subscribe for shares in proportion to its shareholding in each new issue of Banco Santander Central Hispano shares. However, this right may be excluded under certain circumstances by specific approval at the shareholders’ meeting and this right is deemed excluded in the relevant capital increase when the shareholders approve:
If capital is increased by the issuance of new shares in return for capital from certain reserves, the resulting new Banco Santander Central Hispano shares will be distributed pro rata to existing shareholders.
Redemption
Registration and Transfers
The Banco Santander Central Hispano shares are in book-entry form. We maintain a registry of shareholders. We do not recognize, at any given time, more than one person as the person entitled to vote each share in the shareholders meeting.
Transfers executed through stock exchange systems are implemented pursuant to the stock exchange clearing and settlement procedures of Iberclear. Transfers executed “over the counter” are implemented pursuant to the general legal regime for book entry transfer, including registration by Iberclear.
Liquidation Rights
Change of Control
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Legal Restrictions on Acquisitions of Shares in Spanish Banks
Any individual or corporation that wishes to acquire, directly or indirectly, a significant participation (participación significativa) in a Spanish bank must give advance notice to the Bank of Spain describing the size of such participation, its terms and conditions, and the anticipated closing date of the acquisition. “Significant participation” is defined as 5% of the outstanding share capital or voting rights of the bank or any lesser participation that gives the acquirer effective influence or control over the target bank.
Any acquisition mentioned in the preceding sentence to which the required notice was not given or even if given, a three month period after receipt of notice has not yet elapsed, or that is opposed by the Bank of Spain will have the following effects: (1) the acquired shares will have no voting rights, (2) the Bank of Spain may seize control of the bank or replace its board of directors, and (3) a fine may be levied on the acquirer.
Any individual or institution that plans to sell its significant participation, or reduce it to one of the above-mentioned levels of ownership, or because of any sale will lose control of the entity, must provide advance notice to the Bank of Spain indicating the amount of the transaction and its anticipated closing date. Failure to comply with these requirements may subject the offending party to penalties.
If the Bank of Spain determines at any time that the influence of a person who owns a significant participation of a bank may adversely affect that bank’s financial situation, it may request that the Ministry of Economy and Finance: (1) suspend the voting rights of such person’s shares for a period not exceeding 3 years; (2) seize control of the bank or replace its board of directors; or (3) revoke the bank’s license.
The Bank of Spain also requires each bank to publish a list, dated on the last day of each quarter and during April, July, October and January of all its shareholders that are financial institutions and all other shareholders that own at least 0.25% of the bank’s total equity. Furthermore, banks are required to inform the Bank of Spain as soon as they become aware, and in any case not later than in 15 days after, of each acquisition by a person or a group of at least 1% of such a bank’s total equity.
Tender Offers
Royal Decree 432/2003 of April 11, 2003 (“RD 432/2003”) modified previous regulations on tender offers set forth by Royal Decree 1197/1991 of July 26, 1991 (“RD 1197/1991”) reinforcing the protection of minority shareholders and introducing certain changes intended to make the tender offer regime more flexible.
RD 432/2003 introduces additional scenarios which impose the mandatory launching of a tender offer. A person or entity must first launch a tender offer if it proposes to acquire a significant shareholding (25% or more) in the voting stock of the target company’s shares (or certain other equivalent securities that may directly or indirectly give the right to subscribe for shares) of a publicly-traded Spanish company. The tender offer must be for shares representing, at least, 10% and up to 100% of the target’s company capital, contingent on the final percentage of the capital of such target company to be acquired (basically, 25% or more or 50% or more). Also, the launching of a tender offer is mandatory for the acquisition of shares representing 6% or more of the capital of the target company during any twelve-month period when the offeror holds a stake between 25% and 50% of the target’s company capital.
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Tender offers are mandatory also, even without reaching the stake thresholds mentioned above, if such person or entity intends to appoint more than one third but less than half plus one of the target company’s board or more than half of the directors of the target company’s board.
These new cases also require the mandatory launching of a tender offer if, within two years from the date of the acquisition, the offeror nominates and appoints more than one third but less than half plus one of the target company’s board or more than one half of the target company’s board.
Finally, RD 432/2003 modifies the exceptions to the mandatory launching of a tender offer; it allows for conditional tender offers upon certain requirements being met and it substantially modifies the regime of competing tender offers.
Reporting Requirements
The acquisitions or transfers of shares of any company listed on a Spanish Stock Exchange where, following the transaction, the acquiror’s ownership participation reaches 5% or any multiple of 5% of the capital stock of such company, or the seller’s participation is reduced from one of the above mentioned levels of ownership, must be reported, within 7 business days after such acquisition or transfer. The reporting must be made to the company that issued the traded shares, to the Governing Companies (Sociedades Rectoras) of the Spanish stock exchanges on which such company is listed, and to the CNMV. This threshold percentage will be 1%, or any multiple of 1%, whenever the acquirer, or the person who acts on his/her behalf, is a resident of a tax haven as defined in accordance with Royal Decree 1080/1991, or of a country or territory where there is no authority entrusted with the supervision of the securities markets, or when the designated authority declines to exchange information with the CNMV. The Minister of Finance is required to specify countries and territories in such cases, as proposed by the CNMV.
In addition, any company listed on a Spanish stock exchange must report any acquisition by such company (or a subsidiary) of the company’s own shares if the acquisition, together with any acquisitions since the date of the last report, causes the company’s ownership of its own shares to exceed 1% of its capital stock. See “Item 9. The Offer and Listing—Banco Santander Central Hispano Shares—Trading by Banco Santander Central Hispano’s Subsidiaries in the Shares.”
The directors of any company listed on a Spanish stock exchange must report to the CNMV to the Governing Companies (Sociedades Rectoras) of the Stock Exchanges on which the company is listed, and to the company itself, the amount of shares or option rights over the company’s shares that they hold at the time of their appointment (or, if applicable, report that they own no shares or options) directly, through companies they control or any other intemediary, regardless of the amount, and must report all acquisitions or transmissions of shares in the company, regardless of the amount that they carry out by themselves or by means of either the companies they control or an intermediary. The directors must also report the acquisition or transfer of option rights over the company’s shares.
In addition, managers of any listed company must report to the CNMV the acquisition of shares and option rights over shares as a result of a compensation plan related to the shares’ price. Any change of the aforesaid plans must be also reported.
Board of Directors
Our Board of Directors may be made up of a minimum of 14 and a maximum of 30 members, appointed by the general meeting of shareholders. Members of the Board of Directors are elected for an initial term of three years but can be re-elected. One third of the members of the Board are elected each year. Although there is no provision in Spanish law regarding the composition of a board of directors, the Regulation of the Board, following best corporate governance practices in Spain, provide that in exercising its powers to make proposals at the General Shareholders’ Meeting and to designate Directors by interim appointment to fill vacancies, the Board shall endeavour to ensure that the external or non-executive Directors represent a majority over the executive Directors and that the former include a reasonable number of independent Directors.
These independence standards may not necessarily be consistent with, or as stringent as, the director independence standards established by the NYSE. See “Item 6. Directors, Senior Management and Employees — C. Board Practices —Independence of the Directors on the Board of Directors”. The Bank currently complies with this requirement.
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Certain Powers of the Board of Directors
The actions of the members of the board are limited by Spanish law and certain general provisions contained in our by-laws. For instance, Article 32 of our by-laws states that the Directors will be liable to Banco Santander Central Hispano, to our shareholders and to our corporate creditors for any damages that they may cause by acts or omissions which are contrary to law or to the by-laws or by acts or omissions contrary to the duties inherent in the exercise of their office.
A Director’s power to vote on a proposal, arrangement or contract in which such Director is materially interested is not regulated by our by-laws. Conflicts of interest are regulated by Article 27 of the Regulations of the Board. Under Article 27, a Director is obliged to inform the Board of any direct or indirect conflict of interest which may exist with the Bank. If such a conflict relates to a particular transaction, then the Director (i) may not undertake the transaction without the Board’s authorization (such authorization can only be granted following a report of the Appointments and Remuneration Committee); and (ii) the Director may not take part in the discussion or voting regarding the transaction to which the conflict relates.
Our by-laws provide that the Directors may, by resolution of the Board, direct the subscription, acquisition, purchase, exchange, pledge and sale of public securities, shares, debentures, bonds and warrants. The Board is empowered to exercise borrowing powers without restriction as to limit or otherwise on behalf of the Bank, subject only to the power to authorize the issue of bonds, which is vested in the shareholders.
The board of directors may pass resolutions in order to establish the amount of each payment of any capital call with respect to partially paid-in shares. The board will also establish the period within which the payments must be made and other details, all of which must be published in the “Boletín Oficial del Registro Mercantil” (the Official Gazette of the Mercantile Register). Any delays in the payment of capital calls will bear interest starting from the day when the payment is due and without the need for any judicial or extra-judicial summons. We will also be able to take any action authorized by law to collect such sums.
Our by-laws provide that the members of the Board, and, if applicable, the Executive Committee (Comisión Ejecutiva) and the Bank’s Executive Vice Presidents, shall receive as a joint participation in the Bank’s annual results for performing their duties an aggregate amount equal to 5% of the Bank’s annual results, provided, however, that the Board may resolve that such percentage be reduced in those years in which the Board deems it justified. In practice, the amount so distributed is lower than the 5% limit mentioned above. In addition, the Board shall distribute the resulting payment among the participants in such manner and amount as may resolved annually by the Board with respect to each of them.
In order to set the specific amount corresponding to such participation, the percentage decided by the Board shall be applied to the year’s results.
In any event, before any payments in respect of the Directors’ participation can be made, the Bank must have made all allocations that have priority to such participation pursuant to applicable legislation.
Regardless of the foregoing, the members of the Board and of the Executive Committee are entitled to receive attendance fees, as well as such remuneration as may be applicable for the performance of their duties within the Bank other than their duties as a Director. These amounts are approved by the Board of Directors with the prior proposal from the Appointments and Remuneration Committee.
Directors may also receive compensation in the form of shares of the Bank or options over the shares, or other remuneration linked to share value following a resolution adopted by the shareholders at the General Shareholders’ Meeting (conducted in accordance with our by-laws and applicable Spanish legislation).
Board of Director Qualification
There are no mandatory retirement provisions due to age for board members in our by-laws or in the regulations of our board of directors. These regulations contain provisions relating to the cessation of directorship for other reasons.
Subject to legal limitations, any person will be eligible to serve as a Director of Banco Santander Central Hispano, S.A. without having to be a shareholder of the Bank.
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C. Material contracts.
During the past two years, the Bank was not a party to any contract outside its ordinary course of business that was material to the Group as a whole.
D. Exchange controls.
Restrictions on Foreign Investments
Under present regulations, foreign investors may transfer invested capital, capital gains and dividends out of Spain without limitation on the amount other than applicable taxes. See “Taxation”. On July 4, 2003, Law 19/2003 was approved which updates Spanish exchange control and money laundering prevention provisions, by recognizing the principle of freedom of the movement of capital between Spanish residents and non residents. The law establishes procedures for the declaration of capital movements for purposes of administrative or statistical information and authorizes the Spanish Government to take measures which are justified on grounds of public policy or public security. It also provides the mechanism to take exceptional measures with regard to third countries if such measures have been approved by the European Union or by an international organization to which Spain is a party. The Spanish stock exchanges and securities markets are open to foreign investors. Royal Decree 664/1999, on Foreign Investments (April 23, 1999), established a new framework for the regulation of foreign investments in Spain which, on a general basis, will no longer require any prior consents or authorizations from authorities in Spain (without prejudice to specific regulations for several specific sectors, such as television, radio, mining, telecommunications, etc.). Royal Decree 664/1999 requires notification of all foreign investments in Spain and liquidations of such investments upon completion of such investments to the Investments Registry of the Ministry of Economy, strictly for administrative statistical and economical purposes. Only investments from “tax haven” countries (as they are defined in Royal Decree 1080/1991), shall require notice before and after performance of the investment, except that no prior notice shall be required for: (1) investments in securities or participations in funds of the investment that are registered with the CNMV, and (2) investments that do not increase the foreign ownership of the capital stock of a Spanish company to over 50%. In specific instances, the Counsel of Ministers may agree to suspend, all or part of, Royal Decree 664/1999 following a proposal of the Minister of Economy, or, in some cases, a proposal by the head of the government department with authority for such matters and a report of the Foreign Investment Body. These specific instances include a determination that the investments, due to their nature, form or condition, affect activities, or may potentially affect activities relating to the exercise of public powers, national security or public health. Royal Decree 664/1999 is currently suspended for investments relating to national defense. Whenever Royal Decree 664/1999 is suspended, the affected investor must obtain prior administrative authorization in order to carry out the investment.
E. Taxation.
The following is a discussion of the material Spanish and U.S. federal income tax consequences to you of the acquisition, ownership and disposition of the ADSs or shares.
The discussion of Spanish tax consequences below applies to you only if you are a non-resident of Spain and ownership of ADSs or shares is not effectively connected with a permanent establishment or fiscal base in Spain and only to U.S. residents entitled to the benefits of the Convention Between the United States and the Kingdom of Spain for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (the “Treaty”).
You should consult your own tax adviser as to the particular tax consequences to you of owning the shares or ADSs including your eligibility for the benefits of any treaty between Spain and the country of your residence for the avoidance of double taxation, the applicability or effect of any special rules to which you may be subject, and the applicability and effect of state, local, foreign and other tax laws and possible changes in tax law.
Spanish tax considerations
Taxation of dividends
Under Spanish law, dividends paid by a Spanish resident company to a holder of ordinary shares or ADSs not residing in Spain for tax purposes and not operating through a permanent establishment in Spain are subject to Spanish Non-Resident Income Tax at a 15% rate, which is also the rate to which you may be entitled to under the Treaty.
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We will levy the withholding tax on the gross amount of dividends at a 15% tax rate, following the procedures set forth by the Order of April 13, 2000.
Taxation of capital gains
Under Spanish law, any capital gains derived from securities issued by persons residing in Spain for tax purposes are considered to be Spanish source income and, therefore, are taxable in Spain. For Spanish tax purposes, income obtained by you if you are a U.S. resident from the sale of ADSs or shares will be treated as capital gains. Spanish non-resident income tax is currently levied at a 35% tax rate on capital gains obtained by persons not residing in Spain for tax purposes who are not entitled to the benefit of any applicable treaty for the avoidance of double taxation.
Notwithstanding the above, capital gains derived from the transfer of shares on an official Spanish secondary stock market by any holder who is a resident at a country that has entered into a treaty for the avoidance of double taxation with Spain containing an “exchange of information” clause will be exempt from taxation in Spain. In addition, under the Treaty, capital gains realized by you upon the disposition of ADSs or shares will not be taxed in Spain provided you have not held, directly or indirectly, 25% of our stock during the twelve months preceding the disposition of the stock. You are required to establish that you are entitled to this exemption by providing to the relevant Spanish tax authorities an IRS certificate of residence in the United States, together with the appropriate Spanish tax form, not later than 30 days after the capital gain was realized.
Spanish wealth tax
Individuals not residing in Spain who hold shares or ADSs located in Spain are subject to the Spanish wealth tax (Spanish Law 19/1991), which imposes a tax on property located in Spain on the last day of any year. The Spanish tax authorities may take the view that all shares of Spanish corporations and all ADSs representing such shares are located in Spain for Spanish tax purposes. If such a view were to prevail, non-residents of Spain who held shares or ADSs on the last day of any year would be subject to the Spanish wealth tax for such year at marginal rates varying between 0.2% and 2.5% of the average market value of such shares or ADSs during the last quarter of such year.
Spanish inheritance and gift taxes
Transfers of shares or ADSs upon death or by gift are subject to Spanish inheritance and gift taxes (Spanish Law 29/1987) if the transferee is a resident in Spain for tax purposes, or if the shares or ADSs are located in Spain at the time of gift or death, or the rights attached thereto could be exercised or have to be fulfilled in the Spanish territory, regardless of the residence of the beneficiary. In this regard, the Spanish tax authorities may determine that all shares of Spanish corporations and all ADSs representing such shares are located in Spain for Spanish tax purposes. The applicable tax rate, after applying all relevant factors, ranges between 0 and 81.6% for individuals.
Gifts granted to corporations non-resident in Spain are subject to Spanish Non-Resident Income Tax at a 35% tax rate on the fair market value of the shares as a capital gain. If the donee is a United States corporation, the exclusions available under the Treaty described in the section “Taxation of capital gains” above will be applicable.
Expenses of transfer
Transfers of ADSs or shares will be exempt from any transfer tax or value-added tax. Additionally, no stamp tax will be levied on such transfers.
U.S. Tax Considerations
The following summary describes the material United States federal income tax consequences of the acquisition, ownership and disposition of ADSs or shares, but it does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a particular person’s decision to acquire such securities. The summary applies only to U.S. Holders (as defined below) that hold ADSs or shares as capital assets for tax purposes and does not address special classes of holders, such as:
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The summary is based upon tax laws of the United States including the Internal Revenue Code of 1986, as amended to the date hereof (the “Code”), administrative pronouncements, judicial decisions and final, temporary and proposed Treasury Regulations, changes to any of which may affect the tax consequences described herein possibly with retroactive effect. In addition, the summary is based on the Treaty and is based in part on representations of the Depositary and assumes that each obligation provided for in or otherwise contemplated by the Deposit Agreement or any other related document will be performed in accordance with its terms. Prospective purchasers of the ADSs or shares are urged to consult their own tax advisers as to the United States, Spanish or other tax consequences of the acquisition, ownership and disposition of ADSs or shares in their particular circumstances, including the effect of any U.S. state or local tax laws.
As used herein, a “U.S. Holder” is a beneficial owner of ADSs or shares that is, for United States federal income tax purposes:
In general, for United States federal income tax purposes, U.S. Holders of ADSs will be treated as the holders of the underlying shares represented by those ADSs. Accordingly, no gain or loss will be recognized if a U.S. Holder exchanges ADSs for the underlying shares represented by those ADSs.
Taxation of Distributions
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Subject to applicable limitations and the discussion above regarding concerns expressed by the U.S. Treasury, dividends paid to a non-corporate U.S. holder paid before January 1, 2009 will be taxed at a maximum rate of 15%. Non-corporate holders should consult their own tax advisers to determine the implications of the rules regarding this favorable rate in their particular circumstances.
A U.S. Holder must satisfy minimum holding period requirements in order to be eligible to claim a foreign tax credit for foreign taxes withheld on dividends. The rules governing foreign tax credits are complex and, therefore, U.S. Holders are urged to consult their own tax advisers to determine whether they are subject to any special rules that limit their ability to make effective use of foreign tax credits.
Subject to the discussion of the passive foreign investment company rules below, gain or loss realized by a U.S. Holder on the sale or exchange of ADSs or shares will be subject to United States federal income tax as capital gain or loss (and will be long-term capital gain or loss if the U.S. Holder held the shares or ADSs for more than one year) in an amount equal to the difference between the U.S. Holder’s tax basis in the ADSs or shares and the amount realized on the disposition. Gain or loss, if any, will be U.S. source for foreign tax credit purposes. The deductibility of capital losses is subject to limitations. Long-term capital gain of a non-corporate U.S. holder is generally taxed at a preferential rate.
We believe that we are not a “passive foreign investment company”, or “PFIC”, for United States federal income tax purposes for the taxable year 2004. However, since our PFIC status depends upon the composition of our income and assets and the market value of our assets (including, among others, less than 25 percent owned equity investments) from time to time, and based upon certain proposed Treasury Regulations that are not yet in effect but are generally proposed to become effective for taxable years after December 31, 1994, there can be no assurance that we will not be considered a PFIC for any taxable year.
In addition, if we were to be treated as a PFIC in a taxable year in which we pay a dividend or the prior taxable year, the 15% dividend rate discussed above with respect to dividends paid to non-corporate holders would not apply.
Payment of dividends and sales proceeds that are made within the United States or through certain U.S.-related financial intermediaries generally are subject to information reporting and to backup withholding unless (i) you are a corporation or other exempt recipient or (ii) in the case of backup withholding, you provide a correct taxpayer identification number and certify that you are not subject to backup withholding. The amount of any backup withholding from a payment to a U.S. Holder will be allowed as a credit against the U.S. Holder’s U.S. federal income tax liability and may entitle the U.S. Holder to a refund, provided that the required information is furnished to the Internal Revenue Service.
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F. Dividends and paying agents.
G. Statement by experts.
H. Documents on display.
I. Subsidiary information.
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Item 11. Quantitative and Qualitative Disclosures About Market Risks
Introduction
We have divided this section, according to the primary risks faced by the Group, in the following six parts:
Part 1. Organization of Risk Management
Our Risk Division reports directly to the third Vice-Chairman and Chairman of the Risk Committee.
This committee:
The committee deals with all types of risk, including: credit, market, operational and reputational.
Other principles that guide our risk management are:
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The Board's members and its subsidiary bodies have the necessary skills and independence to supervise development of the general strategy, as well as the decisions taken by senior management which, in turn, sets the business plans, supervises the daily decisions and ensures they are in line with the objectives and policies set by the Board.
The bodies for risk matters are the committees that have been assigned powers for making decisions, controlling and monitoring risks. The table below describes these committees by order of importance.
Name
The Group has been using a series of techniques and tools for many years, which are mentioned in other parts of this section. They include:
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The goal of the Risk Division is to establish, for the Group, a single and integrated risks function with a global mandate and multi-local execution which covers the different geographic areas where we operate. This division's mission is to provide an agile, effective and efficient service to clients, always maintaining the quality of risks.
The division is divided in two General Directorates:
The General Directorate of Risk is responsible for the executive functions of credit and market risk management and it is adapted to the structure of business, by type of client:
This structure strengthens the capacity to anticipate changes in the financial conditions of a client or a market, maintaining the quality and standards of the Group's risk and promoting dynamic and integrated management. In addition, under this General Directorate, there is an area that monitors use of the best practices in measurement and tools in order to be able to offer a large range of complex products, better analysis of risks and, in short, more efficient use of capital.
The General Directorate of Integral Management and Internal Control of Risk meets the requirements of organic independence established in the New Basel Capital Accord (BIS II). Its functions are to contribute a global view, measure risk, provide quality analysis and consistent methodologies for different risk exposures, as well as to provide adequate control and internal validation that ensure consistent and homogeneous processes and tools, via the following organisational structure:
Both directorates report directly to the head of the Risk Division and third Vice-Chairman, thereby ensuring adequate co-ordination mechanisms.
Our risk profile at December 31, 2004 by types of risk and business units, is shown below (excluding Abbey):
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By types of risk, credit continues to be the main source of our risk (48% of the global economic capital). The market risk of equity stakes was the second largest (23%). The balance of the risks (including structural interest or business) accounted for 29% of the capital.
The Integral Framework of Risks (MIR), developed in 2003, is the tool that we use to quantify, aggregate and assign economic capital and measure our risk adjusted return and that of our main business units. In accordance with this model, our diversification (the result of the multinational and multibusiness nature of its activity) results in a profit of 18%. In other words, our global risk, measured in terms of economic capital, is 18% less than the sum of the risk of our business units considered on their own. If Abbey were to be included in the calculations, we estimate this number would increase to 22%.
Our economic capital is calculated under the premise of supporting the risk of activity with a confidence level of 99.97%, equivalent to a rating of AA. Comparing economic capital figures with the capital funds available at December 2004, shows that the Group was sufficiently capitalised for an AA rating before and after the acquisition of Abbey.
The MIR results show a risk adjusted return for us in 2004 of 15.5%, which, with a cost of capital of 10.5%, means a high capacity to generate shareholder value.
This model was used to set, in the 2005 budget, the risk adjusted return objectives for our main business units, taking into account not only the return on the activity but also the risk incurred to achieve it and the return required by our shareholders.
We believe that this model will enable us to meet the new Basel regulatory requirements, specifically with respect to Pillar II.
Part 3. Credit Risk
Credit risk is the possibility of financial loss resulting from the failure of our clients or our counterparties to meet their obligations with us.
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Credit risk is our main source of risk (48% of the aggregate economic capital), and so identifying, measuring and managing such risk is vital in order to generate value on a sustained basis.
Our credit risk management not only identifies and measures the risk but also seeks the integration, control and mitigation of the different exposures and calculates the risk adjusted return.
The organization of the risks function is based on common principles and criteria shared by the different units. In order to develop it properly, we have a series of policies, procedures and management tools which, based on a common basic model, are adapted to the features of local markets and businesses.
The table below sets out our global credit risk exposure at December 31, 2004 (excluding Abbey):
Regarding the geographic distribution of credit exposure, Abbey's acquisition has significantly increased Europe's relative share in the Group to 85%. Spain, with 44%, still represents the largest credit risk exposure, followed by the UK (30%). Latin America's share has dropped to 12%, while that of non-investment grade countries is only 4% of the total.
The charts below show the distribution of the exposure (EaD), according to the equivalent external rating of the main groupings of credit risk and the expected loss for each tranche:
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The rating distribution in the portfolio of clients is a typical profile in retail banking. Most of the ratings below BBB are the portfolios of small and medium sized companies (“SMEs”), consumer loans and part of our mortgage portfolios. They have a high degree of fragmentation, lower proportional consumption of capital and levels of expected loss comfortably covered by the spread on the operations.
The table below shows the distribution of the Group´s exposure by type of customer:
3.1. Customer segmentation for credit risk management
Credit risk management is conducted according to customer segments and the features of products.
The Corporate Banking Risk Area treats customers on a global basis (large companies and multinational financial groups). For large companies, there is a pre-classification model (setting of a maximum internal limit on risk), based on a system of measurement and monitoring of risk capital. In addition, financial institutions have a specialized treatment and the technical monitoring and follow-up of structured finance has been optimized.
The Company Risk Area has strengthened the identification of business opportunities in order to improve business issues by setting common business-risk goals. Meanwhile, the underwriting process has been made more efficient by establishing pre-classifications under a more streamlined model and aimed at those companies which meet certain requirements (high knowledge, rating, etc.).
For its part, the Standardized Risk Area deals with retail clients (small companies, businesses and individuals). These risks are managed on a decentralized basis, following policies and measures that are designed centrally, and is supported by automatic systems for valuation and decision-making that produce effective risk management which is also efficient in terms of resources.
At the end of 2004, we published the Corporate Framework of Standardized Risk Management which aims to homogenize the main principles for managing this type of risk from the perspective of planning the credit cycle, the quality of decision-making models and control of management indicators.
3.2. Rating tools
We have been using internal ratings to assess and track risk for more than 10 years. The aim is to measure the degree of risk of a client or transaction. Each rating corresponds to a certain probability of default or non-payment, based on historical data and past experience.
In the case of corporate and company risks, the process for assigning ratings varies according to the segment. The weight of the view of the analyst is greater in the case of large clients, which involve more complex analysis, while the rating of clients and operations in retail segments is based more on pre-established rules of valuation where a more automatic treatment can be used. The process of assessment can differ depending on the business sector (financial entities, public institutions, industrial companies, real estate development, etc.).
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The table below shows our valuation tools:
During the tracking phase the ratings are regularly reviewed, at least once a year, and new financial information and the experience in the development of the banking relation are taken into account. The regularity of the reviews increases in the case of clients who reach certain levels in the automatic warning systems and in those classified as special watch.
The system for assessing companies is used for other of our subsidiaries both in Spain and abroad, including our banks in Portugal and Latin America. The depth of historical data available enables us to determine the probability of default associated with each rating. The tools to assign ratings used by the units abroad were improved during 2004 by introducing valuation models based on statistical models created with empirical data.
The table below on the left shows the distribution of the number of companies with outstanding risk by rating for Banco Santander Central Hispano, Spain. The table below on the right shows the distribution of outstanding risk balances by rating for Banco Santander Central Hispano, Spain.
In the case of standardized risks (retail), different automatic valuation systems are applied on the basis of the segment, product and channel (for example, mortgages via branches, consumer loans via agents, loans to businesses, etc). These admission systems are complemented by performance models on the basis of the available information in the Group in monitoring processes and pre-granting of risks.
Each of the yield curves of the charts below reflects the non-performing loans of operations with individuals granted in Spain every year (“vintages”) until maturity. The age of this base enables us to simulate future performances.
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3.3. Master scale or ratings
We have a Master Scale (see table below), whose purpose is to make comparable, at the same rate of anticipated default, the different ratings which are used in the various homogeneous segments of risk.
This scale is based on comparing the internally estimated probabilities of default for the Bank's portfolio with the history of defaults associated with each level of external rating, according to the publications of the rating agencies.
For purposes of comparison, the definition of default used for internal measurements for the purposes of the master scale is based on legal claim situations and not on 90 days of non payment. For the purposes of BIS II or statistical provisions, the probabilities of default are based on 90 days of non payment.
3.4. Concept of expected loss
As well as assessing the client, the analysis of transactions includes aspects such as the maturity, the type of product and the collaterals that exist, which is done through adjusting the initial rating. As a result, not only is the probability of default (PD) taken into account, but also the exposure at default (EaD) and the loss given default (LGD).
By estimating these three factors, the expected loss of each operation can be calculated. Its correct calculation is very important as it ensures that the price adequately reflects the resulting risk premium, and the expected loss is reflected as one of the costs of the activity.
The following charts, reflecting data on non-performing loans in Spain, include the distribution of defaulted consumer and mortgage loans since 1995, according to the percentage of recoveries, after deducting all costs -- including financial and opportunity-- incurred in recovery.
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In the international sphere, the proposal of the Basel Committee to reform the 1988 Capital Accord is also based on the concept of expected loss in order to determine the minimum levels of regulatory capital in the most advanced frameworks based on internal ratings.
3.5. Measurements of expected loss
Our expected credit risk loss (excluding Abbey), at the end of 2004, was €1,755 million (0.52% of the exposure, equivalent to 0.48% of the gross exposure and 0.76% of the risk balance of clients). The distribution of the expected loss by areas is as follows:
The provisional estimate of the expected loss of the whole Group, including Abbey, is €2,014 million (0.37% of exposure). The estimated expected loss of Abbey is 0.10%.
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While the estimates of expected losses at the units in Spain are the bottom-up result of internal measurement models, the estimates for other units - with some exceptions – are generally the result of top--down approximations, in so far as the measurements of the internal models in these units are consolidated.
3.6. Test of reasonableness in expected loss of the parent bank
To test the calculation model for expected loss, the following table compares specific provisions, net of recoveries, that were actually allocated for the portfolio of Banco Santander Central Hispano over the last few years with the estimated expected loss.
The allocations fell substantially during 1995-99, grew again in the subsequent years as a result of the slowdown in the Spanish economy, thereby reflecting their cyclical nature, and declined again in 2003 and 2004.
The average losses must be adjusted to the effect of the economic cycle. The average of 0.37% adjusted in terms of the cycle is close to the 0.38% envisaged in the model.
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3.7. Measurements of cost of credit (observed loss)
The following charts show the cost of credit risk at Grupo Santander (excluding Abbey) and our main business areas during 2004 and in comparison with previous years, measured through different approaches:
The cost of credit has been falling over the years, both in the Group as well as in our main units, particularly in Latin America.
3.8. Quantifying the risk premium
Our risk policy focuses on maintaining a medium-low risk profile, both in credit risk as well as market risk.
In credit risk, this qualitative objective can be quantified in terms of expected loss. The expected loss target for business in Spain must not exceed 0.40% of the outstanding balance of risk, while for the Group as a whole it should not be more than 1.00%.
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3.9. Concept of economic capital. RORAC methodology
Credit losses can surpass the level of expected loss for various reasons (economic cycle, concentration of exposure, errors in the model). The volatility of losses or unexpected loss is the real credit risk. While provisions are in response to the expected losses, institutions endow themselves with capital to cover the contingency of higher than expected credit losses. Just as the provisions, or the margin of operations, must be sufficient to cover the expected loss, the economic capital must be adequate to cover the unexpected losses, ensuring the continuity of business.
Conceptually, economic capital cannot cover with 100% probability all the losses that eventually could occur. The maximum loss, in credit risk, will be produced if all the assets are in default at the same time and nothing is recovered. Such an event, highly unlikely, is not fully covered by the economic capital, which nevertheless is allocated to cover very high losses (which are very unlikely but if they occur can threaten continued activity).
The Bank decides the level of losses it wants to cover with economic capital (the level of confidence with which it wants to ensure the continuation of its business). In our case, this confidence level is 99.97%, above the 99.90% assumed by the regulatory capital formulas proposed in the New Basel Capital Accord. The difference between both levels means assuming a default probability for the Group of 0.03% instead of 0.1%, three times lower than the proposal of BIS II.
In terms of external rating, a confidence level of 99.97% requires having sufficient capital to be rated AA, while 99.90% would only allow a rating of A-, given the higher probability of default associated.
Traditionally, the concept of economic capital has been contrasted with that of regulatory capital, as regulatory capital is required for the regulation of solvency and which, until its next reform, suffers from an insufficient sensitivity to risk. However, the reform of the 1988 Capital Accord is intended to bring both concepts closer together.
If one looks at each operation, the economic capital calculation is based on the same variables needed to calculate the expected loss (i.e., the client's rating, the maturity and the collaterals of the operation). By aggregation, the economic capital of the rest of the operations of this client can be calculated and, bearing in mind the appropriate factors of diversification/correlation of a portfolio of clients, of a business unit and of the bank as a whole.
For its part, the margin of operations must not only cover costs, including the expected loss or the risk cost, but also be sufficient to achieve an adequate return on the economic capital consumed.
The RORAC methodology enables an analysis of whether the return on a transaction covers the risk cost -- the expected loss -- and the cost of capital invested by an institution in the transaction.
Determining the cost of capital is closely linked to calculating the RORAC target, which means a minimum return threshold for risk operations. If an operation does not reach the RORAC target, it could be covering costs, but not making a return on the capital at the level required by us.
The Bank regularly reviews the RORAC target to ensure that the authorized operations generate shareholder value. It is calculated on the basis of two components, the return required by shareholders plus that needed to cover operating costs.
The return required by shareholders or the cost of capital (also called the hurdle rate) is calculated by adding up the free rate of long-term risk and the premium required for shareholders in order for them to invest in Santander shares. The cost of capital calculated at the end of 2004 was 10.5%.
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The chart below shows Banco Santander Central Hispano’s expected loss and RORAC by segments:
The target RORAC is 29%, slightly higher than the sum of the cost of capital plus operating costs and this is because we want to achieve an adequate return on our operations, higher than the minimum required by the average shareholder.
RORAC methodology enables the return on operations, clients, portfolios and businesses to be made on a homogeneous basis, identifying those that obtain a risk adjusted return higher than the cost of our capital, and so aligning risk and business management with the overall objective of creating value.
We have been using RORAC methodology in our credit risk management since 1993, with the following purposes:
3.10. Internal systems of risks
One of the main objectives of the New Basel Accord is to adopt rigorous risk management practices in line with the most advanced financial institutions.
One of our hallmarks is to be at the forefront of these practices. For example, when the Bank of Spain introduced in 1999 statistical or anti-cyclical provisions which anticipated the rules and discipline of BIS II, we were the pioneer among large Spanish banks in requesting and obtaining recognition of our internal credit models in line with the norms and disciplines included in Basel II.
The results have been positive for the following reasons:
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Experience in this field has confirmed the usefulness and necessity of independent functions of integrated management and risk, as is required by the New Basel Accord and which we have put into effect with the new organizational structure of the Risk Division.
As a continuation of this policy, we have requested recognition from the Bank of Spain of its new internal model for calculating coverage as referred to in Circular 4/2004.
3.11. Revised framework of international convergence of capital measures and capital standards
We are committed to the principles behind the Revised Framework of International Convergence of Capital Measurement and Capital Standards (Basel II). For this reason, we are actively involved in different forums on the issue, both Spanish and international. We have also stepped up contacts with the regulatory and supervisory authorities in different countries, contributing constructively to improving those technical aspects that could be asymmetric, unfavorable or far from the main objectives of the Basel II agreement.
We aspire for formal recognition, when the time comes, of our internal risk models, in accordance with the requirements of BIS II.
With this in mind, we developed an internal project that enabled our own calculation methods to be approved, under Bank of Spain Circular 9/99. In 2002, with the same goal, we launched our Master Plan to develop internal Basel II models.
The development of the Master Plan gave rise to a series of actions, many of which have been implemented, including:
For some time now, the measures needed in the Group regarding the Revised Framework have been channelled and developed via a Basel II Corporate Project, whose objective is to lead, coordinate, support and supervise the activities of our different areas affected by the new requirements, in order to adapt to them in the form and time required.
On the basis of the measures taken so far, as well as the estimates made for the whole Group in the quantitative impact studies, we can conclude that the impact on capital of the new agreement will be slightly favourable in its current state, even after incorporating the new requirements for operational risk.
The unit's management (General Directorate of Integral Management and Internal Control of Risk) which, in the sphere of the Risk Division, is responsible for developing and coordinating the necessary works for Basel, provides the necessary coverage which enables the principles of the New Agreement to be met, including:
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3.12. New Bank of Spain Circular
On December 22, 2004 the Bank of Spain published Circular 4/2004 on Credit Entities, which includes on Appendix IX the Analysis and Coverage of Credit Risk.
The most noteworthy aspect of this Circular was the toughening of the criterion for doubtful loans which will mean an increase in the balance of doubtful loans. However, this more conservative criterion for the recognition of doubtful loans is in line with our internal policy of risks and does not entail a need to change the internal risk management procedures, which are always focused on active and rapid management of risk as of its entry into a past due situation, and even before, via risk monitoring procedures.
3.13. Control and monitoring systems
Control is paramount in order to ensure adequate management of credit risk and maintain a risk profile within the parameters set by the Board and by senior management.
This function is carried out by various mechanisms inside and outside the Risk Division.
Within the Division, and independent of the business areas that characterize the Division, decision-making in the admission phase is subject to a system of powers delegated for risk authorization and management by the Risk Committee of the Board of Directors. The decisions in the admission phase are predominantly collective.
The 2005 Limits Plan was implemented against this background at the end of 2004 which, in synthesis, constitutes the formalization of a document that enables the balance sheet and the inherent risks to be fully managed, establishing the acceptable level of risk of the different factors measured.
The goals of this plan are to:
The Risk Area has the specific function of monitoring risks for which resources and responsible persons are identified. This function is based on permanent attention in order to ensure there is a punctual reimbursement of operations and anticipation of circumstances that could affect normal development.
We have a system called Companies in Special Watch (FEVE) which has four levels, categorized on the basis of the degree of concern arising from negative circumstances (track, reduce, secure, extinguish). The inclusion in these levels means automatically reducing delegated powers. Clients in FEVE are reviewed at least every six months, and every quarter for the most serious cases. A company can end up in special watch as a result of monitoring, a change in the rating assigned, a review conducted by internal auditing or automatic warnings.
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Ratings are reviewed at least every year, but if weaknesses are detected or on the basis of the rating, a review is done more regularly.
The table below shows our ratings of risk balances according to the FEVE monitoring system:
The units of control, analysis and consolidation also conduct control and monitoring tasks. The main functions are to obtain a global view of risk, analyze possible future scenarios and global treatment of information for management, as well as to promote and to follow-up on the common risk policies and to analyze their impact on the Group, ensuring fulfilment of local and Spanish legislation.
The General Directorate of Integral Management and Internal Control of Risk, under the principles of organic and functional independence from management of risk admission and monitoring as required by the New Basel Accord, performs specific tasks relating to control of credit risk internal models such as:
The recognition by the regulatory authorities of internal credit risk management models is a further guarantee of the degree of internal control because it is a requirement for the validation of these models.
3.14. Performance of the main magnitudes in 2004 (excluding Abbey)
Our ratio of non-performing loans (“NPLs”) was 1.27% at the end of 2004, 28 basis points lower than the 1.55% ratio at the end of 2003. NPL coverage rose by 43 points during the year to 208.0%. The specific provisions in 2004, net of recovered write off, dropped 11.2% to €693.6 million.
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The graphs below show our NPL ratio and coverage:
Our NPL ratio in Spain remained at a low and ended the year at 0.65%, 22 basis points lower than at the end of 2003. Coverage reached 329%, 105 points higher than in 2003.
In Portugal, where economic growth is weaker, the NPL ratio was 3.1% at the end of 2004, higher than the 2.3% recorded in December 2003. The high level of securitization activity had some bearing on this increase (taking secured balances into account, the ratio would be 2.3%.) Coverage was 111%, 14 points lower than at the end of 2003.
The NPL ratio of Santander Consumer, including Hispamer in Spain, CC Bank in Germany and Finconsumo in Italy, and the finance companies acquired in 2004 (PTF, Elcon and Abfin), rose to 2.2%, due to a rise in doubtful balances in Germany in a still unfavourable economic environment. Coverage increased to 153%, four points higher than in 2003.
Latin America's NPL ratio at the end of 2004 was 2.6%, 1.3 points lower than in 2003. Almost all countries reduced their NPL ratios. Coverage reached 162%, 37 points more than in 2003. Mexico, Chile and Puerto Rico, which are all rated investment grade countries by international agencies, account for 68% of the exposure with customers.
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The table below shows Latin America’s amount of risk, NPL and coverage ratios as of December 31, 2004 and 2003:
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Specific credit-loss provisions in Latin America, net of recovered write-offs, were 39% lower than in 2003 at €156.4 million. The cost against the average risk was 0.43% (0.75% in 2003).
The table below shows Latin America’s net specific credit-loss provisions as of December 31, 2004:
Our risk management in Latin America shares the common corporate culture. The principles that are the hallmark of the parent bank are applied in the region. The organization of the risks function in each Latin American bank is the same as the one in Spain, with the necessary adjustments made for the local markets.
Progress continued to be made in establishing the GARRA (our new common risk information system in Latin America) management models in Mexico and Chile. Furthermore, there was an increased use of the model for admission of companies in Puerto Rico. Our bank in Argentina became the first in Latin America to establish the existing risk information systems in the GARRA environment.
An initial study was also conducted in 2004 to establish GARRA in Venezuela and use the companies’ module during 2005. Of note in Brazil was the technology merger of the two networks which will enable GARRA to be fully established in Banespa.
3.15. Risk concentration
We continuously track the degree of concentration of its credit risk portfolios using various criteria: geographic areas and countries, economic sectors, products and groups of clients.
The Risk Committee of the Board of Directors establishes the policies and reviews the appropriate exposure limits for adequate management of the degree of concentration of credit risk portfolios.
The recent acquisition of Abbey has helped to diversify our risk by geographic area as it has reduced the relative share of Spain and Latin America.
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No sector accounts for more than 10% of the total exposure (excluding Abbey).
The table below shows the distribution by economic sector of total risk (expressed in percentages and excluding Abbey):
We are subject to Bank of Spain regulation on “large exposures” (those that exceed 10% of eligible shareholders’ equity). In accordance with Circular 5/93, no individual exposure, including all types of credit risks and equities, can exceed 25% of our shareholders’ equity. Also, the total of “large exposures” cannot be greater than eight times equity. At the end of 2004, the group with the largest risk was a Spanish telecom company and it accounted for 11.0% of eligible equity (well below the maximum legal limit). Only three groups were classified as “large risk” as they each slightly exceeded 10% of eligible equity.
At the end of 2004, the 20 largest economic and financial groups, excluding public entities and lending entities, represented 9.9% of the outstanding credit risk of our clients (9.7% in 2003), a low degree of risk concentration.
Within the framework of the MIR model for the measurement and aggregation of economic capital, particular importance is attached to the risk of concentration by wholesale portfolios (large companies, sovereign risks and counterparty). For this purpose we use as an additional reference the portfolio model of Moody’s-KMV, which is widely used by other banks.
Our Risk Division works closely with the Financial Division to actively manage credit portfolios. Its activities include reducing the concentration of exposures through various techniques such as using credit derivatives and securitization in order to optimize the risk-return relation of the whole portfolio.
3.16. Country-risk
Country-risk is a credit risk component in all cross-border credit operations. Its main elements are sovereign risk and transfer risk and, as a result of the last exchange-rate crises, the very strong risk of fluctuation of local currencies as it could produce a collective credit risk in economies with a high degree of foreign currency debt.
Country-risk management, part of the Risk Area, includes the analysis and assignment of country ratings, control of risk positions and the setting of limits, in accordance with the risk policies established.
A country rating is assigned on the basis of parameters of qualitative and quantitative valuation, which determine a country’s capacity to meet its external obligations. The country-risk limits are established on the basis of the credit quality or rating of the country and of the business opportunities, differentiating between different products and maturities.
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The degree of risk perception of emerging countries by markets continued to improve during 2004.
Our country-risk with third parties requiring provisions, in accordance with the Bank of Spain’s criteria, amounted to $1,254.9 million, 99% more than in 2003, of which 33% was covered by provisions.
The change in country-risk exposure was largely due to reclassification, following a criterion of maximum prudence in foreign trade operations of more than one year in Brazil (“pre-payments” of exports) as regulatory risk. This meant an increase of €421.5 million (67% of the overall rise).
There were also increases of €31.8 million and €25.2 million in Colombia and Venezuela, respectively, due to the larger demand produced by the area’s economic upturn and a reduction of €32.2 million in Argentina, partly due to the amortization of Argentine debt.
The reduction in provisions was due to the redistribution of the exposure towards countries of lower relative risk.
The principles of country-risk management continued to follow prudent criteria; country-risk is assumed very selectively in operations that are clearly profitable for the Bank and which enhance the global relationship with customers.
3.17. Environmental risk
Analysis of the environmental risk of credit operations is part of the Strategic Plan of Corporate Social Responsibility.
We have a standardized procedure for the validation of environmental risk. We believe that socially responsible investment is a concept that will continue to evolve and has to be taken into account both from the standpoint of the contingency of risks as well as business opportunities.
Since the beginning of 2004, we have been using an Environmental Risks Valuation System (VIDA), developed in collaboration with the Spanish Export Credit Insurance Company (CESCE) and Garrigues Medioambiental. It evaluates the environmental risk inherent in each company, whether they are current or future clients.
The operational and analysis focus of VIDA reflects the following:
Analyze the portfolio of customers and assign an initial level of basic risk (high, low, etc.). This level is established on the basis of activity data and size after examining all the necessary information.
Once the loan portfolio map is established, companies whose inherent risk/Group exposure binomial suggests the need for more detailed analysis are identified. For this purpose, additional information related to environmental factors is used, allowing a more thorough evaluation of the companies analyzed.
In those cases where, because of the risk level, a more thorough valuation is required, an analysis is made on the basis of electronic questionnaires by sectors.
The final result provides a rating scale (from 1 to 9), and the more thorough the valuation the more significant the rating.
This environmental rating will be gradually incorporated into our rating system. The rating serves, however, from the outset as an additional reference for making decisions.
3.18 Counterparty risk
Counterparty risk is a variant of credit risk. This includes all types of exposure with credit entities as well as the risk of solvency assumed in treasury operations (bonds and derivatives) with other types of clients.
Control is carried out in real time through an integrated system which provides information on the available credit line of any counterparty, in any product and maturity and at any of our branches.
Risk is measured by its current as well as potential value (the value of the risk positions taking into account the future variation of the underlying market factors in contracts).
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The Net Replacement Value (NRV) of the portfolios of OTC derivative products that we maintained with our counterparties at December 31, 2004 (excluding Abbey) amounted to $4,658.6 million, 0.71% of the nominal value of these contracts compared with 0.68% in 2003.
The table below sets forth our notional value of derivatives by maturity and their net replacement value:
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The Equivalent Credit Risk (that is, the sum of the NRV and the maximum potential value of these contracts in the future) was 22.2% less than in 2003 at $18,529.3 million. This reduction was mainly due to two factors: 1) the signing of new collateral agreements with the main financial institutions with risk and 2) a fine-tuning of the methodology for the valuation of credit derivatives and for calculating the potential risk in derivatives operations.
The table below sets forth our derivatives equivalent risk and average life as of December 31, 2004 (excluding Abbey).
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Our activity in credit derivatives continued to gain importance during 2004, both from the standpoint of trading as well as structural coverage of its credit positions.
Derivatives transactions continued to be carried out with counterparties that enjoy excellent credit quality, so that 91% of counterparty risk is at a rating equal to or superior to A-.
In terms of geographic distribution, the main changes over 2003 were the rise in Spanish risk (chiefly as a result of Santander Global Connect), a reduction in European Union risk, and a slight reduction in North American risk.
Lastly, the distribution of risk by type of counterparty shows 92.5 % in OECD banks, 6.4 % in companies and 1.1 % in non-OECD banks.
The tables below set forth our risk distribution by type of counterparty and by geographic areas (excluding Abbey):
Part 4. Operational Risk
4.1 Definition and objectives
We define operational risk as “the risk of losses from defects or failures in its internal processes, employees or systems, or those arising from unforeseen circumstances”. They are purely operational events, which makes them different from market or credit risks.
The objective is to identify, mitigate, manage and quantify this risk.
Our greatest need, therefore, is to identify and eliminate sources of risk, regardless of whether they produce losses or not. Measurement also helps management as it enables priorities to be established and a hierarchy to be created for making decisions.
We use the standard method for calculating operational risk under BIS II, but we do not rule out using an internal model in the future. We use the following valuations:
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4.2. Management model
The main principles of the organizational structure are:
This framework satisfies the qualitative criteria contained in the New Basel Capital Accord, both for standard methods and advanced measurement, as well as in the “Advance Notice of Proposed Rulemaking” of the U.S. Federal Reserve, regarding the independence of the global management unit, which is responsible for, among other things, designing and implementing policies, procedures and strategies, and information systems. Internal Auditing also keeps its independence with regard to management of operational risk, without detriment to its ability to review the management structure in this area.
We have adopted the following framework for representing the phases of the process for management of operational risk:
The main advantages of our management structure are:
4.3. Implementing the model: global initiatives and results
The independent management and control unit of operational risk, part of the Risk Division, has been operating since 2001. Its main functions, developed activities and global initiatives include:
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The project began to be installed in our different units in 2002. Almost all of our units have been incorporated to the project with a high degree of uniformity. Nonetheless, due to different paces of installation, stages, schedules and the historical depth of the relevant data bases, the degree of implementation varies from country to country.
Self-evaluation questionnaires are received and analyzed from nearly all of our units.
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4.4. BIS II Project – corporate operational risk tool
Within the general framework of the BIS II Project, our Operational Risk Department is working, together with Technology, on designing and establishing a corporate operational risk tool which, in an Internet environment, integrates the different management instruments used to date, via local applications, in the different units managing operational risk.
This tool is being developed in various phases and modules, beginning, from the onset, in satisfying the basic management requirements and, then, adding other more advanced functions.
The main modules are as follows:
The basic features of each model are as follows:
Data Base of Events. This is the model whose development is the most advanced. It is already installed in some of our entities. It enables the accounting systems to automatically capture operational risk events (SGO, for entities in the Partenón environment) as well as manual capturing of such risk events. It will also enable entities with non-Partenón environment common access via the website.
Self-Assessment Questionnaire. This model includes both general and specific questionnaires, as well as different types of qualitative and quantitative questions for evaluating present and future operational risk.
Risk Indicators. This model captures, via automatic or manual feeding, activity and control indicators (all of them managed under a common format) both for the present situation as well as for future expectations.
Mitigation. Its main use is centralized and integrated management of corrective measures. Questions, indicators or events/types of event are captured on the data base which exceed a certain threshold (scores or limits).
Financial Information Management Model. This allows dynamic management of the information model by selecting information, weightings, scenarios and impact of corrective measures.
Insurance. This incorporates basic information linked to insurance contracted by each unit, linking it to the data base of events.
Part 5. Reputational Risk
We regard, in all of our areas, the reputational risk function of its activities as being of the utmost importance. The management of this risk is conducted by:
5.1. Global Committee of New Products
All new products or services that any of our entities wants to market must be submitted to this committee for approval.
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The committee held 11 meetings in 2004 at which 70 products or families of products were analyzed.
A Local Committee of New Products is established in each country where we are present. Once a new product or service is ready, this committee must request permission for it to be marketed from the Global Committee. In Spain, the Local Committee falls within the Global Committee.
The areas that participate in the Global Committee are: Tax Advice, Legal Advice, Customer Attention, Internal Auditing, Retail Banking, Global Corporate Banking, International Private Banking, Auditing, Financial Operations and Markets, Operations and Services, Organization, Prevention of Money-laundering, Global Wholesale Banking Risk, Credit Risk, Financial Risk, Operational Risk, Technology, Global Treasury and, lastly, the unit proposing the new product or the Local Committee of New Products.
Before a new product or service is launched, these areas, as well as, where applicable, other independent experts considered necessary in order to correctly evaluate the risks incurred, exhaustively analyze the aspects that could affect the process, stating their opinion on each product or service.
The Global Committee, in the light of the documentation received, and after checking that all the requirements for approving the new product or service have been met and bearing in mind the risk guidelines set by the Board's Risk Committee approves, rejects or sets conditions for the new product or service.
The Global Committee gives particular consideration to the suitability of the new product or service to the area or segment where it is going to be marketed. Importance is attached to ensuring that:
5.2. Manual of Procedures for the Marketing of Financial Products
This manual is used by Banco Santander Central Hispano for the retail marketing of financial products in Spain.
The objective is to improve the quality of information made available to investors and ensure they understand the features, return and risk of the products.
The manual segments customers into three categories, which initially coincide with those of Private Banking, Personal Banking and Banking for Individuals. Products are also segmented into three categories: green, yellow and red, on the basis of their complexity and the guarantees they provide for recovering capital and obtaining a certain return.
The manual covers financial products sold to retail individuals, such as participations in mutual funds and shares in public placements. The Global Committee of New Products can include others in the sphere of the manual.
In 2004, 47 products covered by the manual were presented for approval. Most of them were mutual funds, but there were other categories such as warrants, hedging products, preferred shares and public offerings and/or subscriptions to securities.
Of the 47 products, 12 were new ones submitted to the Global Committee and 35 were not new and were submitted to the Office of the Manual (which was created to ensure enforcement of the Manual and is included in the Compliance Management Area). The 47 products were categorized as follows: 27 were green (57.5%), 11 yellow (23.5%) and 9 red (19%). The office reported on all the products approved to the National Securities Market Commission.
Implementing the manual requires: (1) rigorous use of business documentation and contracts, and (ii) paying attention to the segment to which the customer belongs before offering the product.
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5.3 The Board's Risk Committee
The Risk Committee, the ultimate body responsible for global risk management and all kinds of banking operations, evaluates reputational risk as part of its activities.
Part 6. Market Risk
Generally
Primary Market Risks and How They Arise
The primary market risks to which we are exposed are interest rate risk, foreign exchange rate risk, equity price risk and liquidity risk. We are exposed to interest rate risk whenever there is a mismatch between interest rate sensitive assets and liabilities, subject to any hedging with interest rate swaps or other off-balance sheet derivative instruments. Interest rate risk arises in connection with both our trading and non-trading activities.
We are exposed to foreign exchange rate risk as a result of mismatches between assets and liabilities, and off-balance sheet items denominated in different currencies, either as a result of trading or in the normal course of business. We maintain non-trading open currency positions arising from our investments in overseas subsidiaries, affiliates and their currency funding. The principal non-trading currency exposures are the euro to the US dollar and the euro to the main Latin American currencies. Trading foreign exchange rate open risk is not material compared to non-trading foreign exchange risk.
We are exposed to equity price risk in connection with both our trading and non-trading investments in equity securities.
We are also exposed to liquidity risk. Market depth is the main liquidity driver in our trading portfolio, even though our policy is to trade the most liquid assets. Our liquidity risk also arises in non-trading activity due to the maturity gap between assets and liabilities in the retail banking business.
We use derivatives for both trading and non-trading activities. Trading derivatives are used to eliminate, to reduce or to modify risk in trading portfolios (interest rate, foreign exchange and equity), and to provide financial services to clients. Our principal counterparties for this activity are financial institutions. The principal types of derivatives used are: interest rate swaps, future rate agreements, interest rate options and futures, foreign exchange forwards, foreign exchange futures, foreign exchange options, foreign exchange swaps, cross currency swaps, equity index futures and equity options.
Derivatives are also used in non-trading activity in order to manage the interest rate risk and foreign exchange risk arising from asset and liability management activity. Interest rate and foreign exchange non-optional derivatives are used in non-trading activity.
Procedures for Measuring and Managing Market Risk
Our board, through its Risk Committee, is responsible for establishing our policies, procedures and limits with respect to market risks, including which businesses to enter and maintain. The Committee also monitors our overall performance in light of the risks assumed. Together with the local and global Assets and Liabilities Committees (“ALCO”), each Market Risk Unit measures and monitors our market risks, and provides figures to ALCO to use in managing such risks, including liquidity risk.
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Our market risk policy is to maintain a medium to low risk profile in business units. The risk activity is regulated and controlled through certain policies, documented in our Market Risk Management Policies Manual (as described below), and through a limit structure on our exposure to these market risks which includes global limits for the entire Group (total risk limit unit) to specific portfolio limits; in addition, authorized products are listed and reviewed periodically.
These policies, procedures and limits on market risk are applicable to all units, businesses or portfolios susceptible to market risk.
1. Market Risk Management Policies Manual
The Market Risk Management Policies Manual is a compilation of policies that describe the control framework used by our Group to identify, measure and manage market risk exposures inherent to our activities in the financial markets. The Manual is employed for market risk management purposes at all involved levels in the Group and subsidiaries, providing a general and global action framework and establishing risk rules for all levels.
The Manual’s main objective is to describe and report all risk policies and controls that our Board of Directors has established as well as its risk predisposition.
All Group managers must ensure that each business activity is performed in accordance with the policies established in the Manual. The Manual is applied to all business units and activities, directly or indirectly, related to market risk decision-making.
2. Market Risk Management Procedures
All the functions developed by a risk manager are documented and regulated by different procedures, including measurement, control and reporting responsibilities. Internal and external auditors audit the compliance with this internal regulation control in order to ensure that our market risk policies are being followed.
3. Market Risk Limit Structure
The market risk limit structure can be defined as the Board of Directors risk “appetite” and is managed by the Global Market Risk Function that accounts for all Group business units.
Its main functions are to:
The Global Market Risk Function defines the limit structure while the Risk Committee reviews and approves it. Business managers then administer their activities within these limits. The limit structure covers both our trading and non-trading portfolios and it includes limits on fixed income instruments, equity securities, foreign exchange and other derivative instruments.
Limits considered to be global limits refer to the business unit level. Local business managers set lower level limits, such as portfolio or trader limits. To date, system restrictions prevent intra-day limits.
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Business units must always comply with approved limits. Potential excesses will require a range of actions carried out by the Global Market Risk Function unit including:
Statistical Tools for Measuring and Managing Market Risk
1. Trading activity
The Trading Portfolio is defined as proprietary positions in financial instruments held for resale and/or bought to take advantage of current and/or expected differences between purchase and sale prices. These portfolios also include positions in financial instruments deriving from market-making, sale and brokering activity.
As a result of trading fixed income securities, equity securities and foreign exchange, we are exposed to interest rate, equity price and foreign exchange rate risks. We are also exposed to volatility when derivatives (options) are used.
Market risk arising from proprietary trading and market-making activities is actively managed through the use of cash and derivative financial instruments traded in OTC and organized markets.
Interest rate risk derived from market-making is typically hedged by buying or selling very liquid cash securities such as government bonds, or futures contracts listed in organized markets like Liffe, Eurex, Meff and CBOT.
Foreign exchange rate risk is managed through spot transactions executed in the global foreign exchange inter-bank market, as well as through forward foreign exchange, cross currency swaps and foreign exchange options.
Equity price risk is hedged by buying or selling the underlying individual stocks in the organized equity markets in which they are traded or futures contracts on individual stocks listed in organized markets like Meff and Liffe.
In the case of equity indexes such as S&P 500, Euro STOXX, or IBEX-35, the hedging is done through futures contracts listed in the aforementioned organized markets.
Volatility risk arising from market-making in options and option-related products is hedged by, either buying and selling option contracts listed in organized markets like Eurex, Meff, and CBOT, or entering risk reversal transactions in the inter-bank OTC market.
We use VaR to measure our market risk associated with all our trading activity.
1.1 VaR Model
We use a variety of mathematical and statistical models, including value at risk (“VaR”) models, historical simulations, stress testing and evaluations of Return on Risk Adjusted Capital (“RORAC”) to measure, monitor, report and manage market risk. We call our VaR figures daily or annual “capital at risk” figures (“DCaR” or “ACaR”), depending on their time horizon, since we use them to allocate economic capital to various activities in order to evaluate the RORAC of such activities.
As calculated by us, DCaR is an estimate of the expected maximum loss in the market value of a given portfolio over a one-day time horizon at a 99% confidence interval. It is the maximum one-day loss that we estimate we would suffer on a given portfolio 99% of the time, subject to certain assumptions and limitations discussed below. Conversely, it is the figure that we would expect to exceed only 1% of the time, or approximately three days per year. DCaR provides a single estimate of market risk that is comparable from one market risk to the other.
The standard methodology used in the majority of the business units is based on historical simulation (520 days). In order to capture recent market volatility in the model, our DCaR figure is the maximum between the 1% percentile and the 1% weighted percentile of the simulated profit and loss distribution.
We use DCaR estimates to alert senior management whenever the statistically estimated losses in our portfolios exceed prudent levels. Limits on DCaR are used to control exposure on a portfolio-by-portfolio basis. DCaR is also used to calculate the RORAC for a particular activity in order to make risk-adjusted performance evaluations.
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1.2 Assumptions and Limitations
Our DCaR and VaR methodology should be interpreted in light of the limitations of our model, which include:
1.3 Scenario Analysis and Calibration Measures
Because of these limitations in DCaR and VaR methodology, in addition to historical simulation, we use stress testing to analyze the impact of extreme market movements and to adopt policies and procedures in an effort to protect our capital and results of operation against such contingencies.
In order to calibrate our VaR model, we use back testing processes. Back testing is a comparative analysis between Value at Risk (VaR) estimates and the daily results actually generated. The purpose of these tests is to verify and measure the precision of the models used to calculate VaR.
The analyses of our back testing comply, at a minimum, with the BIS recommendations regarding the verification of the internal systems used to measure and manage market risks.
2. Non Trading activity
2.1 Foreign Exchange Risk and Equity Price Risk
Due to its nature, changes in strategic positions have to be approved by local/global functions in ALCO committee. Position limits with respect to these investments are established, although they will be measured under VaR and other methods, which attempt to implement immediate action plans if a particular loss level is reached.
Our foreign exchange rate risk with respect to our non-trading activity can be either permanent or temporary. The permanent risk reflects the book value of investments net of the initial goodwill, while the temporary risk basically stems from purchase/sale operations made to hedge the exchange rate risk derived from dividend flows and expected results. The exchange rate differences generated for each position are recorded in reserves and in profit and loss account respectively.
In order to manage the exchange rate risk of the book value of permanent investments, our general policy is to finance the investment in local currency, provided there is a deep market which allows it and that the cost of doing so is justified by the expected depreciation. If local markets are not deep enough, our investments in foreign currency will be financed in euros and therefore will generate an exchange-rate risk. Certain one-off hedges of permanent investments are made when it is believed that a local currency could weaken against the euro more quickly than the market is discounting. In addition, operations are carried out to hedge the currency risk of the Group’s results and dividends in Latin America.
Our equity price risk arises from our portfolio of investments in industrial and strategic shareholdings. Our strategic holdings in the industrial and financial equity portfolios are steady. Fluctuations in the market value of the shares in such portfolios do not have an effect on our operational results (as most of them are accounted for by the equity method) and their book value is much lower than their market value.
2.2 Interest Rate Risk
We analyze the sensitivity of net interest revenue and net worth to changes in interest rates. This sensitivity arises from gaps in maturity dates and review of interest rates in the different asset and liability accounts. Certain re-pricing hypotheses are used for products without explicit contractual maturities based on the economic environment (financial and commercial).
We manage investments by determining a target range for each sensitivity and providing the appropriate hedge (mainly with government debt, interest rate swaps and interest rate options) in order to maintain these sensitivities within that range.
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The measures used to control interest rate risk are the interest rate gap and the sensitivity of net interest revenue and net worth to changes in interest rates, VaR and analysis of scenarios.
a) Interest rate gap of assets and liabilities
The interest rate gap is based on the analysis of the gaps between the maturities of the asset, liability and off-balance sheet items. Gap analysis provides a basic representation of the balance sheet structure and enables concentrations of interest rate risk by maturity to be identified. It is also a useful tool for estimating the possible impact of eventual interest rate movements on net interest revenue and net worth.
b) Net interest revenue sensitivity (NIR)
The sensitivity of net interest revenue measures the change in the short/medium term in the accruals expected over a particular period (12 months), in response to a parallel shift in the yield curve.
c) Net worth sensitivity (MVE)
Net worth sensitivity measures in the long term (the whole life of the operation) the interest risk implicit in net worth (equity) on the basis of the effect that a change in interest rates has on the current values of financial assets and liabilities.
d) Value at Risk (VaR)
The Value at Risk for balance sheet activity is calculated with the same standard as for trading: historic simulation with a confidence level of 99% and a time frame of one day.
e) Analysis of scenarios
Two scenarios for the performance of interest rates are established: maximum volatility and sudden crisis. These scenarios are applied to the balance sheet, obtaining the impact on net worth as well as the projections of net interest revenue for the year.
2.3 Liquidity Risk
Liquidity risk is associated with our capacity to finance our commitments, at reasonable market prices, as well as to carry out our business plans with stable sources of funding. We permanently monitor maximum gap profiles.
We have a diversified portfolio of assets that are liquid or can be made so in the short term. We also have an active presence in a wide and diversified series of financing and securitization markets, limiting our dependence on specific markets and keeping open the capacity of recourse to alternative markets.
The measures used to control liquidity risk are the liquidity gap, liquidity ratio, stress scenarios and contingency plans.
a) Liquidity gap
The liquidity gap provides information on contractual and expected cash inflows and outflows for a certain period of time, for each of the currencies in which we operate. The gap measures the net need or excess of funds at a particular date, and reflects the level of liquidity maintained under normal market conditions.
b) Liquidity ratios
The liquidity coefficient compares liquid assets available for sale (after applying the relevant discounts and adjustments) with total liabilities to be settled, including contingencies. This coefficient shows, for currencies that cannot be consolidated, the level of immediate response of the entity to firm commitments.
c) Analysis of scenarios/Contingency Plan
Our liquidity management focuses on preventing a crisis. Liquidity crises, and their immediate causes, cannot always be predicted. Consequently, our Contingency Plan concentrates on creating models of potential crises by analyzing different scenarios, identifying crisis types, internal and external communications and individual responsibilities.
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The Contingency Plan covers the activity of a local unit and of central headquarters. Each local unit must prepare a Plan of Contingency Financing, indicating the amount it would potentially require as aid or financing from headquarters during a crisis. Each unit must inform headquarters (Madrid) of its plan at least every six months so that it can be reviewed and updated. These plans, however, must be updated more frequently if market circumstances make it advisable.
Control system
The process of setting limits is the instrument we use to establish the level of equity that each activity has available. Setting the limits is conceived as a dynamic process which responds to senior management’s risk acceptance level.
Quantitative analysis
A. Trading activity
Quantitative analysis of daily VaR in 2004
Our risk performance with regard to trading activity in financial markets during 2004 (excluding Abbey), measured by daily VaR, is shown in the following graph.
As the above graph shows, we have a medium to low risk profile, which was actively managed throughout the year. This level of management allows for changes of strategy to take advantage of opportunities in an environment of uncertainty and high volatility.
The maximum risk level was reached on August 12 ($22.5 million in VaR terms) and the minimum on March 23 ($15.6 million), due to the reduction of interest rate positions and currency risk in Brazil, Mexico and Spain. The levels of volatility in markets moved depending on the geopolitical situation and on the expectations of a slower than expected economic recovery. The average risk in 2004 was $19.2 million in terms of VaR.
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The risk histogram below shows the distribution of frequencies of average risk in terms of daily VaR during 2004 (excluding Abbey). The maximum risk levels were reached at specific moments and never surpassed $22.5 million.
Risk by product
The minimum, maximum, average and year-end 2004 values (excluding Abbey) in VaR terms were as follows:
The average risk in Latin America in terms of VaR was $18.4 million, ending the year with a VaR of $19.6 million. Our risks were concentrated in fixed income and currencies (average daily VaR of $15.6 million and $10.2 million, respectively, and were located in Latin America, Europe and North America).
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Historic VaR by product
Distribution of risks and results
• Geographic distribution
During 2004, excluding Abbey, Latin America’s contribution to the Group’s average total VaR was 71% and Europe’s contribution was 16.9%, meanwhile the contribution of Latin America to income (trading) was 51% and Europe’s was 40%. European treasury activities are more focused on client facilitation than other business units in the Group. The geographic contribution, in percentage terms, both in risks as well as in results over our total VaR and annual gross operating income from trading activity, is shown in the graph below.
The minimum, average, maximum and year-end risk values in daily VaR terms, by geographic area (excluding Abbey), are shown in the following table.
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Distribution by period
The table below shows the performance of risk versus monthly results for our trading activity, excluding Abbey.
Histogram of the frequency of daily marked-to-market results
The histogram below details the distribution of the frequency of daily Marked-to-Market (“MtM”) results on the basis of size. The most common yield interval was $0-$2.4 million, which occurred on 73 days of the year (27% of the days of the year) (excluding Abbey). During 67% of the days of the year, the interval was between ($2.4) and $4.9 million (excluding Abbey).
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Risk management of structured derivatives
Our structured derivatives activity (non-organized markets) is mainly focused on designing investment products and risk hedges for clients. These transactions include options on equities, fixed-income and currencies.
The units where this activity takes place are: Madrid, Portugal, Brazil and Mexico, and to some extent Chile, where we are beginning to develop this market.
Excluding Abbey, the average VaR was $1.9 million, the maximum $3.6 million and the minimum $1.0 million.
Stress Test
Different stress test scenarios were analyzed during 2004. Scenarios of maximum volatility, applying six standard deviations to different market factors, as of December 31, 2004, are provided below (excluding Abbey).
Maximum volatility scenario
The table below shows, at December 31, 2004, the maximum losses of value of each product (fixed-income, equities and currencies), in a scenario in which volatility equivalent to six standard deviations in a normal distribution is applied (decrease in prices, increases in local and external rates, devaluations of currencies against the U.S. dollar) (excluding Abbey).
Maximum volatility Stress
The stress test shows that we would suffer an economic loss of $31.5 million, if this scenario materialized in the market.
B. Asset and liability management in Latin America
Quantitative analysis of interest rate risk in 2004
The graph on the evolution of balance sheet management risk shows that the level of interest rate risk in Latin America, measured by the sensitivity of net worth and net interest revenue to a parallel movement of 100 basis points, moved in a narrow band in 2004.
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At the end of December of 2004, risk consumption by region, measured by the sensitivity of net worth to 100 basis points, was $495 million, and measured by the sensitivity of net interest revenue at one year to 100 basis points, was $95 million. This risk profile corresponds to a gradual taking of positions in order to guarantee the hedging of the margin in the face of possible cuts in interest rates, particularly in Mexico during the second quarter of 2004 and Chile in the last half of 2004.
Interest rate risk profile
The gap tables below show the distribution by maturity of the risk in Latin America at December 31, 2004.
Net interest revenue sensitivity
For the whole of Latin America, the consumption at December 2004 was $95 million (sensitivity to 100 basis points). The geographic distribution is shown below.
Brazil and Mexico accounted for more than 50% of the risk. The year 2004 was characterized by an increase in the net interest revenue risk, mainly due to the portfolio purchases in Mexico and Chile.
The positioning graph on the next page, obtained from the sensitivity of net interest revenue to a parallel movement of 100 basis points in the yield curve, shows the positioning of countries with regard to NIR sensitivity. Business units shown on the right side of the graph are exposed to losses in NIR in scenarios of local and U.S. interest rate reductions. Business units shown on the left side of the graph are exposed to losses in NIR in scenarios of local and U.S. interest rate increases. The size of the circles represents the total sensitivity of the unit.
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Net worth sensitivity
Consumption for all Latin America in 2004 amounted to $495 million (sensitivity to 100 basis points). The geographic distribution is shown below.
Approximately 75% of net equity risk is concentrated in Mexico, Chile and Brazil. The year was characterized by an increase in the net equity risk in two of the region´s main countries, Mexico and Chile, as positions were gradually taken to cover possible future losses in net interest revenue.
The net worth sensitivity positioning graph on the next page, obtained from the sensitivity of net worth to a parallel movement of 100 basis points in the yield curve, shows the positioning of countries with regard to MVE sensitivity. Business units shown on the right side of the graph are exposed to losses in MVE in scenarios of local and U.S. interest rate reductions. Business units shown on the left side of the graph are exposed to losses in MVE in scenarios of local and U.S. interest rate increases. The size of the circles represents the total sensitivity of the unit.
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C. Financial management
We actively manage the market risks inherent in retail banking, which is the core of our business. Management covers the structural risks of interest rates, liquidity, exchange rates and capital.
The purpose of financial management is to make net interest revenue from our commercial activities more stable and recurrent, maintaining adequate levels of liquidity and solvency.
The Financial Management Area manages structural risk on a centralized basis. This allows the use of homogenous methodologies, adapted to each local market where we operate.
In the euro-dollar area, the Financial Management Area directly manages the risks of the parent bank and coordinates management of the rest of the units that operate in convertible currencies. There are local teams in our banks in Latin America that manage balance sheet risks under the same frameworks, in coordination with the global area of Financial Management of the parent bank.
The Asset and Liability Committees (ALCOs) of each country and, where necessary, the Markets Committee of the parent bank are responsible for these risk management decisions.
Management of structural liquidity
The purpose of structural liquidity management is to finance the Group's recurrent business in optimum conditions in terms of maturities and costs, preventing the assumption of unwanted liquidity risks.
We have a diversified portfolio of assets that are liquid or can be made so in the short term, adjusted to its positions. It also has an active presence in a wide and diversified series of financing markets or securitization of its assets, limiting its dependence on specific markets and keeping open the capacity of recourse to markets. Management of structural liquidity involves planning the funding needs, structuring the sources of financing (optimizing diversification by maturities, instruments and markets) and drawing up contingency plans.
An annual liquidity plan is drawn up, based on the financing needs arising from the business budgets. On the basis of these needs and taking into account the limits of recourse to the short-term markets, an issuance and securitization plan is drawn up for the year. The real situation of financing needs is closely tracked during the year, resulting in changes to the plan when necessary.
The volume of convertible currencies captured under the financing plan during 2004 (excluding Abbey) amounted to €35.0 billion in the wholesale markets, 71% of which were medium- and long-term issues including preferred shares and subordinated debt which are included in the Group's eligible equity.
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Securitization of medium- and long-term assets amounted to €11.0 billion. Short-term recourse at the end of 2004 remained at the same levels as a year earlier.
Our banks in Latin America are autonomous in terms of liquidity, and do not resort to the lines of the parent bank for financing their activity. Each bank has its own liquidity and contingency plans without calling on the Group's financing. The cross-border and reputation risks arising from external financing are limited and authorized by the parent bank.
Unlike what generally happens in the euro-dollar area, the business activity of the Latin American banks has a surplus of funds and does not require structural financing from the markets.
Interest rate risk
The Financial Management Area analyzes structural interest rate risk derived from mismatches in maturity and revision dates for assets and liabilities in each of the currencies in which we operate. For each currency, the risk measured is the interest gap, the sensitivity of net interest revenue, the economic value and the duration of equity.
Depending on the position of the interest rates of the balance sheet and taking into account the market’s prospects, the necessary financial measures are adopted to adjust the position to that desired by the Bank. These measures include the taking of positions in markets to defining the interest rate features of products.
There are two spheres of management: convertible currencies (mainly the euro and the US dollar) and non-convertible currencies (largely Latin American). The Markets Committee, through the Financial Management Area, directly manages convertible currencies and coordinates management of the local ALCOs of the banks in Latin America.
This activity is particularly important in scenarios of low interest rates as is currently the case, when commercial banking margins are pressured down.
In these scenarios, adequate management of structural interest rate risk protects revenues via net interest revenue without exposing assets and liabilities to purely speculative positions.
Exchange rate risk
Structural exchange rate risk is largely derived from our currency operations, which mainly include our permanent financial investments, the collection of earnings and dividends from these investments and the purchases and sales of other assets.
In order to manage the exchange rate risk of the book value of permanent investments, our general policy is to finance it in local currency provided there is a deep market which allows it and the cost of doing so is justified by the expected depreciation. Also, certain one-off hedges of permanent investments are made when it is believed that a local currency could weaken against the euro more quickly than the market is discounting.
At December 2004, the only material open position in Latin America was our investment in Brazil, of approximately €2,100 million.
In addition, we manage the currency risk of our results and dividends in Latin America. The local units manage the exchange rate risk between their local currencies and the US dollar, which is the currency of the budget for this area. Financial Management, at the parent bank, is responsible for the management of the exchange rate risk between the US dollar and the euro.
Portfolio of industrial and strategic shareholdings
In the first semester of 2004, we reduced the risk of our industrial and strategic equity portfolios. The main stock positions remained with no significant changes until early June 2004, when stakes in Vodafone and Endesa Italia were sold to the market.
In the second half of the year, the main factors that explain the decrease of the risk of this portfolio were the significant changes in positions, with reductions and sales of large holdings such as Sacyr-Vallehermoso, Repsol and Royal Bank of Scotland.
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The average daily VaR for the year 2004 (excluding Abbey), was $549.8 million, with a minimum of $414.2 million and a maximum of $666.3 million.
Capital management
Capital management aims to optimize its structure and cost from the regulatory and economic perspectives. In order to ensure our solvency, we use different instruments and policies: capital increases and issues eligible for equity (preferred shares and subordinated debt), retained earnings, dividend policy and securitizations.
From a regulatory standpoint (BIS criteria), in 2004, including Abbey, we increased our eligible equity by €18,839 million. The BIS ratio rose from 12.43% to 13.01% and the excess of stockholders` equity over the regulatory minimum requirements increased from €9,101 million to €17,084 million.
In addition to managing the regulatory capital, we manage and try to optimize return on the economic capital. We assign economic capital to the business units in order to measure, on a homogeneous basis, the return of each unit and thus its contribution to the Group’s value.
We are progressively incorporating the creation of value as a tool to (i) measure the contribution of the different units that are part of the portfolio of business and (ii) assess the management of each unit.
D. Market Risk: VaR Consolidated Analysis
Our total daily VaR at December 31, 2003 and December 31, 2004 (excluding Abbey), broken down by trading and non-trading (structural) portfolios, were as follows at the dates below:
Our daily VaR estimates of interest rate risk, foreign exchange rate risk and equity price risk, broken down by trading and structural (non-trading) portfolios, were as follows at the dates below (excluding Abbey):
Interest Rate Risk
Foreign Exchange Rate Risk
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Equity Price Risk
Our daily VaR estimates by activity were as follows at the dates below (excluding Abbey):
The following tables show our daily VaR estimates of our trading portfolios (by region and by product), including Abbey, for the three months ended March 31, 2005
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Item 12. Description of Securities Other than Equity Securities.
A. Debt Securities.
B. Warrants and Rights.
C. Other Securities.
D. American Depositary Shares.
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PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies.
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds.
E. Use of proceeds.
Item 15. Controls and Procedures
(b) Changes in internal controls over financial reporting. There was no change in our internal control over financial reporting that occurred during the period covered by this annual report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 16. [Reserved]
The Audit and Compliance Committee has six members, all of whom are non-executive and five of whom are independent Directors (as defined by Article 5 of the Regulations of the Board). Our Regulations of the Board provide that the chairman of the Audit and Compliance Committee must be an independent director (as defined by Article 5 of the Regulations of the Board) and someone who has the necessary knowledge and experience of accounting techniques and principles. Currently, the chairman of the Audit and Compliance Committee is Mr. Manuel Soto, the Fourth Vice-Chairman of the Board of Directors. Our standards for director independence may not necessarily be consistent with, or as stringent as, the standards for director independence established by the NYSE.
Item 16B. Code of Ethics
This Code is available on our website, which does not form part of this Annual Report on Form 20-F, at www.gruposantander.com under the heading “Corporate Governance – Internal Code of Conduct”.
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Amounts paid to the firms belonging to the Deloitte worldwide organization, the Group’s principal auditor, for statutory audit and other services were as follows:
The Audit and Compliance Committee proposes to the Board the fees to be paid to the external auditor and the scope of its professional mandate.
If a new Group company is required to engage an auditing firm for audit and audit-related services, those services have to be pre-approved by the Audit and Compliance Committee.
The Audit and Compliance Committee is regularly informed of all fees paid to the auditing firms by the Group companies.
Not applicable.
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The following table shows the repurchases of shares made by the Bank or any of its Affiliated Purchasers during 2004:
Share repurchase program
Since the date when the Bank announced its offer to acquire Abbey on July 26, 2004, the Bank purchased its shares under the authorization described above through a repurchase program which was authorized by the Board aimed at reducing the Bank’s share capital by the net amount of the purchases and sales made under such program. The Repurchase Program was carried out according to the following terms:
the Repurchase Program expired on March 31, 2005.
The transactions undertaken under the Repurchase Program up to March 31, 2005 are summarized in the following table:
Sales
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PART III
Item 17. Financial Statements.
We have responded to Item 18 in lieu of this item.
Item 18. Financial Statements.
Reference is made to Item 19 for a list of all financial statements filed as part of this Form 20-F.
Item 19. Exhibits.
(b) List of Exhibits.
We will furnish to the Securities and Exchange Commission, upon request, copies of any unfiled instruments that define the rights of holders of long-term debt of Banco Santander Central Hispano, S.A.
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SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
By: /s/ José Antonio Álvarez
Date: June 30, 2005
INDEX TO FINANCIAL STATEMENTS
Index to Financial Statements
To the Board of Directors and Shareholders ofBanco Santander Central Hispano, S.A.:
We have audited the accompanying consolidated balance sheets of Banco Santander Central Hispano, S.A. (the “Bank”) and Companies composing, together with the Bank, the Santander Group (the “Group” – Notes 1 and 3), as of December 31, 2004, 2003 and 2002, and the related consolidated statement of income for the years then ended. These consolidated financial statements are the responsibility of the controlling Company’s directors. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States of America). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Bank is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Bank’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Banco Santander Central Hispano, S.A. and Companies composing the Santander Group as of December 31, 2004, 2003 and 2002, and the results of its operations and of the funds obtained and applied by them for the years then ended in conformity with accounting principles generally accepted in Spain.
As indicated in Notes 1 and 2-j to the consolidated financial statements referred to above, in 2003 and 2002, the Bank and other Group entities entered into early retirement agreements with certain employees and recorded these commitments, after receiving the related authorizations from the Bank of Spain pursuant to Rule 13 of Bank of Spain Circular 4/1991, with a charge to Reserves and simultaneously recorded the related deferred tax asset (€336 million and €181 million, respectively, in 2003, and €856 million and €461 million, respectively, in 2002). In 2004, the Bank of Spain did not grant such authorization to credit institutions and, accordingly, also in accordance with Rule 13 of Bank of Spain Circular 4/1991, the Bank and other Group entities recorded net provisions of €527 million with a charge to the consolidated statement of income to meet their commitments to the employees who took early retirement in that year (€810 million were charged to the "Extraordinary Loss" caption in the 2004 consolidated statement of income referred to above, and simultaneously the related deferred tax asset was recorded for €283 million).
Accounting principles generally accepted in Spain vary in certain significant respects from accounting principles generally accepted in the United States of America. The application of the latter would have affected the determination of net income for each of the three years in the period ended December 31, 2004, 2003 and 2002 and the determination of stockholders’ equity and financial position as of December 31, 2004, 2003 and 2002, to the extent summarized in Note 28.
/s/ Deloitte, S.L.Deloitte, S.L.
Madrid-Spain, March 29, 2005, except for Notes 27 and 28 as to which the date is June 30, 2005
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Banco Santander Central Hispano, SA and Companies Composing the Santander Group Consolidated Balance Sheets as of December 31, 2004, 2003 and 2002 (Notes 1,2,3 and 4)
The accompanying Notes 1 to 28 and Exhibits I to VIII are an integral part of the consolidated balance sheets as of December 31, 2004, 2003 and 2002.
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Consolidated Statements of Income for the Years Ended December 31, 2004, 2003 and 2002 (Notes 1,2,3 and 4)
The accompanying Notes 1 to 28 and Exhibits I to VIII are an integral part of the consolidated statements of income for the years ended December 31, 2004, 2003 and 2002.
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Banco Santander Central Hispano, S.A. and Companies composing the Santander Group
Notes to Consolidated Financial Statements for the year ended December 31, 2004
Description of the Bank, basis of presentation of the consolidated financial statements and other information
Basis of presentation of the consolidated financial statements
In view of the business activity carried on by the companies composing the Group, it does not have any environmental liability, expenses, assets, provisions or contingencies that might be material with respect to its consolidated net worth, financial position or results. Therefore, no specific disclosures relating to environmental issues are included in these notes to consolidated financial statements.
The 2003 and 2002 consolidated financial statements were approved by the Shareholders’ Meetings of the Bank on June 19, 2004 and June 21, 2003, respectively.
The 2004 consolidated financial statements of the Group and the financial statements of the Bank and of almost all the consolidated companies have not yet been approved by the respective Shareholders' Meetings. However, the Bank's Board of Directors considers that they will be approved without material changes.
Abbey National plc (Abbey)
On July 25, 2004, the respective Boards of Directors of the Bank and Abbey approved the terms on which the Board of Directors of Abbey recommended to its shareholders the tender offer launched by Banco Santander for all the common capital stock of Abbey under a Scheme of Arrangement subject to the British Companies Act.
After the related Shareholders’ Meetings of Abbey and the Bank were held in October 2004, and the other conditions of the transaction were met, on November 12, 2004, the acquisition was completed through the delivery of one new Banco Santander share for every Abbey common share. The capital increase performed to cater for the purchase amounted to €12,541 million (Notes 20 and 21), equal to 1,485,893,636 new shares of €0.5 par value, with additional paid-in capital of €7.94 each.
Information on Abbey
Abbey is a major financial services group in the United Kingdom, where it is the second-largest provider of residential mortgages. It is the sixth-largest bank in the UK in terms of assets, ranking sixteenth in Europe and thirtieth worldwide. Abbey has over 24,000 employees, approximately 730 branches and 18 million customers.
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On June 19, 2004, the Shareholders’ Meeting of Banco Santander authorized the Bank to purchase Banco Santander shares on terms substantially the same as those authorized at previous years’ Shareholders’ meetings.
Since the date on which the tender offer for Abbey shares was announced, Banco Santander acquired treasury stock under a share repurchase program authorized by the Board of Directors of Banco Santander for the purpose of reducing the Bank’s capital stock for the net amount of the purchases and sales carried out under such program, whose terms and conditions are as follows:
The summary of the transactions performed under this program through December 31, 2004, is as follows:
Objections to corporate resolutions
The directors of the Bank and their legal advisers consider that the objection to certain resolutions adopted by the Bank’s Shareholders’ Meetings on January 18, 2000, March 4, 2000, March 10, 2001, February 9, 2002, June 24, 2002, June 21, 2003 and June 19, 2004, will have no effect on the financial statements of the Bank and the Group.
On April 25, 2001, the Santander Court of First Instance number 1 rejected in full a claim contesting resolutions adopted at the Shareholders’ Meeting on January 18, 2000. The plaintiff filed an appeal against the judgment. On December 2, 2002, the Cantabria Provincial Appellate Court dismissed the appeal. A cassation appeal has been filed against the judgment of the Cantabria Provincial Appellate Court.
On November 29, 2002, the Santander Court of First Instance number 2 rejected in full the claims contesting resolutions adopted at the Shareholders’ Meeting on March 4, 2000. The plaintiffs filed an appeal against the judgment. On July 5, 2004, the Cantabria Provincial Appellate Court dismissed the appeal. One of the appellants has prepared and filed an extraordinary appeal on grounds of procedural infringements and a cassation appeal against the judgment.
On September 9, 2002, the Santander Court of First Instance number 5 rejected in full the claim contesting resolutions adopted at the Shareholders’ Meeting on February 9, 2002. The plaintiff filed an appeal against the judgment. On January 14, 2004, the Cantabria Provincial Appellate Court dismissed the appeal. The appellant has prepared and filed an extraordinary appeal on grounds of procedural infringements and a cassation appeal against the judgment.
On May 29, 2003, the Santander Court of First Instance number 6 rejected in full the claim contesting the resolutions adopted at the Shareholders’ Meeting on June 24, 2002. An appeal has been filed against the judgment.
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Despite the amount of time elapsed, the Santander Court of First Instance number 7 has yet to hand down its judgment on the objection to the resolutions adopted at the Shareholders’ Meeting on June 21, 2003, since it was agreed that the proceedings should be stayed on grounds of the need for an interlocutory decision in the criminal jurisdiction derived from the preliminary proceedings conducted at Central Examining Court number 3, which are currently being handled by the Criminal Chamber of the National Appellate Court, in respect of the amounts paid when Mr. Amusátegui and Mr. Corcóstegui retired from the Bank. A new claim has also been filed with the Santander Court of First Instance number 7 to contest the resolutions adopted at the same Shareholders’ Meeting on June 21. This proceeding has been joined with the foregoing proceeding, which means that it is subject to the effects of the stay on grounds of the need for an interl oc utory decision in the criminal jurisdiction.
The claims contesting the resolutions adopted at the Shareholders’ Meeting on June 19, 2004, are currently being processed before the Santander Court of First Instance number 8.
Accounting policies
The consolidated financial statements of the Group were prepared in accordance with the accounting principles and valuation methods described in Note 2, which coincide with those established by Bank of Spain Circular 4/1991 and subsequent amendments thereto. All obligatory accounting principles and valuation methods with a material effect on the consolidated financial statements were applied in preparing them.
Consolidation principles
The companies whose business activity is directly related to that of the Bank and which are directly or indirectly 50% or more owned by the Bank or, if less than 50% owned, are effectively controlled by the Bank and constitute, together with the Bank, a single decision-making unit, were fully consolidated.
All significant accounts and transactions between consolidated companies were eliminated in consolidation. The equity of third parties in the Group is presented under the "Minority Interests" caption and in the "Consolidated Net Income for the Year - Minority Interests" account in the consolidated balance sheets (Note 19).
The investments in companies controlled by the Bank and not consolidable because their business activity is not directly related to that of the Bank (Note 11) and the investments in companies which have a lasting relationship with the Group, which are intended to contribute to the Group’s business activities, in which the Group’s ownership interests are generally equal to or exceed 20% –3% if listed–, and over which the Group exercises significant influence –as evidenced by its representation in the associated company’s governing body, significant transactions between the other Group companies and the investee, or the exchange of management personnel, among others (“associated companies” - Note 10)–, are carried at the fraction of the investees' net worth corresponding to such investments, net of the dividends collected from them and other net worth eliminations (equity method).
The income or loss generated by companies acquired in each year is consolidated by taking into account only the income or loss relating to the period between the acquisition date and the related year-end.
Determination of net worth
In evaluating the Group's net worth, the balances of the following captions in the accompanying consolidated balance sheets should be taken into consideration:
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Capital adequacy requirements
The entry into force of Law 13/1992 and Bank of Spain Circular 5/1993 and subsequent amendments introduced new regulations governing minimum capital requirements for credit institutions at both individual and consolidated group levels.
As of December 31, 2004, 2003 and 2002, the Group’s eligible capital exceeded the minimum requirements stipulated by the aforementioned regulations by approximately €11,100 million, €5,700 million and €5,500 million, respectively.
Detail of risk provisions and coverage
In accordance with the Bank of Spain regulations, the risk provisions and coverage are presented as assigned to the related assets and/or in specific accounts. The detail of the aggregate risk provisions, coverage and guarantees, disregarding their accounting classification is as follows:
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Comparative information - early retirements
As indicated in Note 2-j, in 2003 and 2002, the Bank and other Group entities entered into early retirement agreements with certain employees and recorded these commitments, after receiving the related authorizations from the Bank of Spain pursuant to Rule 13 of Bank of Spain Circular 4/1991, with a charge to unrestricted reserves and simultaneously recorded the related deferred tax asset (€336 million and €181 million, respectively, in 2003 and €856 million and €461 million, respectively, in 2002). In 2004, the Bank of Spain did not grant such authorization to credit institutions and, accordingly, also in accordance with Rule 13 of Bank of Spain Circular 4/1991, the Bank and other Group entities recorded net provisions of €527 million with a charge to the consolidated statement of income to meet their commitments to the employees who took early retirement in that year (€810 million were charged to the "Extraordinary Loss" c ap tion in the accompanying 2004 consolidated statement of income, and simultaneously the related deferred tax asset was recorded for €283 million).
Transition to International Financial Reporting Standards
Under Regulation (EC) no. 1606/2002 of the European Parliament and of the Council of July 19, 2002, all companies governed by the law of an EU Member State and whose securities are admitted to trading on a regulated market of any Member State must prepare their consolidated financial statements for the years beginning on or after January 1, 2005 in conformity with the International Financial Reporting Standards (IFRSs) previously ratified by the European Union. Therefore, the Group is required to prepare its consolidated financial statements for the year ending December 31, 2005 in conformity with the IFRSs ratified by the European Union at that date.
Under IFRS 1, First-Time Adoption of International Financial Reporting Standards, the Group’s consolidated financial statements for 2005 must necessarily include, for comparison purposes, a consolidated balance sheet as of December 31, 2004, and a consolidated statement of income for the year then ended prepared in accordance with the methods established by the IFRSs in force as of December 31, 2005.
In order to adapt the accounting system of Spanish credit institutions to the new standards, on December 22 the Bank of Spain issued Circular 4/2004 on Public and Restricted Financial Reporting Standards and Model Financial Statements. However, although the Group is completing a plan for transition to IFRSs which includes, inter alia, an analysis of the accounting method differences, the selection of the accounting methods to be applied when alternative treatments are permitted and an assessment of the changes in reporting procedures and systems, sufficient information is not yet available to estimate with reasonable objectivity the extent to which the accompanying consolidated balance sheet and consolidated statement of income for 2004 will differ from those to be prepared in the future in accordance with the accounting methods contained in the IFRSs in force as of December 31, 2005.
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Detail by director
The detail by director of the compensation earned by the Bank’s directors in 2004 is as follows:
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The Group’s direct or indirect risk exposure to the Bank’s directors as of December 31, 2004, amounted to €10.8 million (€10.1 million and €14.4 million as of December 31, 2003 and 2002, respectively) of loans and credits and €0.2 million (€0.4 million and €1.2 million as of December 31, 2003 and 2002, respectively) of guarantees provided. These loans and guarantees were granted at market rates in all cases.
In accordance with the requirements of Article 127 ter.4 of the Spanish Corporations Law, in order to enhance the transparency of listed corporations, following is a detail of the directors’ investments in the capital stock of non-Group entities engaging in: (i) banking, financing or lending; (ii) insurance; (iii) management of Collective Investment Institutions; or (iv) securities brokerage; and of the management or governing functions, if any, that the directors discharge therein:
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The Annual Corporate Governance Report discloses information on the Bank’s directors ownership interests in and seats on the Board of Group companies.
None of the Board members perform, as independent professionals or as employees, any activities similar to those included in the foregoing table. Additionally, as required by Article 114.2 of the Securities Market Law, it is hereby stated that in 2004 the Bank’s directors did not perform, either directly or indirectly, any transaction with the Bank or with other Group companies other than in the ordinary course of operations or on an arm’s-length basis.
The breakdown of the balances of this caption, by term to maturity, disregarding the security price fluctuation allowance, is as follows:
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Based on the estimates, projections and assessments available to the Bank’s directors, the forecasted revenues attributable to the Group from these companies are at least equal to the amounts of the respective goodwill balances yet to be amortized in the related periods.
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The variations in the balances of the “Consolidation Goodwill” caption were as follows:
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The variations in the "Property and Equipment" accounts and in the related accumulated depreciation were as follows:
Of the total balances, approximately €5,210 million, €1,613 million and €2,602 million related to property and equipment abroad as of December 31, 2004, 2003 and 2002, respectively.
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Other property
The “Other Property” and “Furniture, Fixtures and Other” accounts include, among other items, the assets acquired through foreclosure on non-recovered loans. These assets are recorded at foreclosure cost which in no case exceeds the book value of the loan, net of the allowance recorded as a result of comparison with their market value. The allowance amounted to €293 million as of December 31, 2004, and represented 54% of the recorded value (€316 million and €395 million and 57% and 58% as of December 31, 2003 and 2002, respectively).
As of December 31, 2004, the limit set by the Bank of Spain for the Bank and for the Banesto Group in the system of loans guaranteed by public-sector debt securities amounted to €1,996 million and €817 million, respectively (€1,988 million and €1,017 million, and €1,209 million and €1,214 million as of December 31, 2003 and 2002 for the Bank and for the Banesto Group, respectively).
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The detail, by Group company, of the balances of the "Minority Interests" caption is as follows:
These are non-cumulative non-voting shares. They were subscribed by third parties outside the Group and are fully or partially redeemable after five years, at the issuer’s discretion. Prior to any redemption, the Group should receive the approval of the Bank of Spain and communicate such redemption to the local financial supervisor. There is no obligation that requires the Group to redeem them.
Additional information is disclosed in Note 28.5.k and Exhibit III.
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The variations in the balances of this caption were as follows:
As of December 31, 2001, the Bank’s capital stock consisted of 4,659,362,499 fully subscribed and paid shares of €0.5 par value each.
Capital increase for acquisition of AKB shares
On May 14, 2002, the Group made one capital increase, issuing 109,040,444 new ordinary shares (2.3% of the Bank’s capital) of €0.50 nominal value each and an issue premium of €9.588 per share, which were fully subscribed and disbursed through shares representing all the capital of AKB, in accordance with the resolutions adopted by the Bank’s Extraordinary Shareholders’ Meeting on February 9, 2002 (Notes 3 and 21).
After this operation and as of December 31, 2002 and 2003, the Bank’s capital stock consisted of 4,768,402,943 fully subscribed and paid shares of €0.50 par value each.
Capital increase for acquisition of Abbey
To complete the acquisition of Abbey, and after being approved in the Shareholders’ Meeting held in October 2004, the Bank increased, on November 12, 2004, its capital base by the issuance of 1,485,893,636 new shares of €0.5 par value, with additional paid-in capital of €7.94 each.
As of December 31, 2004, the additional capital stock authorized by the Shareholders’ Meeting of the Bank amounted to €1,492 million.
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The Bank’s shares are listed on the computerized trading system of the Spanish stock exchanges and on the New York, Milan, Lisbon and Buenos Aires stock exchanges and all of them have the same features and rights. As of December 31, 2004, the only shareholders with an ownership interest in the Bank’s capital stock of over 3% were E.C. Nominees Limited (with a 7.76% holding) and Chase Nominees Limited (with a 6.23% holding).
On June 19, 2004, the Shareholders’ Meeting resolved to increase capital by €300 million, and fully empowered the Board of Directors, for a period of one year, to set and establish the terms and conditions for this capital increase in all matters not already provided for by the Shareholders’ Meeting. In exercising these powers, the Board of Directors must determine whether the capital increase is to be performed through the issuance of new shares or by increasing the par value of the shares outstanding.
On June 19, 2004, the Shareholders’ Meeting set the maximum number of Bank shares that the Bank and/or any Group subsidiary may acquire at 5% of the capital stock, fully paid, the minimum price per share being the par value and the maximum price being up to 10% more than the market price on the Spanish stock exchanges on the acquisition date.
Also, the aforementioned Shareholders’ Meeting authorized the Bank’s Board of Directors to issue fixed-income securities for up to a maximum amount of €20,000 million or the equivalent amount in another currency, by any lawful means. On June 21, 2003, the Shareholders’ Meeting authorized the Bank’s Board of Directors to issue fixed-income securities convertible into new shares and/or exchangeable for outstanding shares for up to €4,000 million over a five-year period, and empowered the Board of Directors to increase capital by the required amount to cater for the requests for conversion.
As of December 31, 2004, the capital increases in progress at Group companies and the additional capital authorized by their Shareholders’ Meetings were not material at Group level.
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Early recording of voluntary reserves
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Other information
Off-balance-sheet funds under management
The detail of the off-balance-sheet funds under management by the Group is as follows:
Transactions with non-consolidable Group companies and with associated companies
See “Consolidation Principles” in Note 1 to find accounting criteria, Note 28.2.A to see the impact on net income and total assets and find a list of non-consolidable companies in Exhibit II.
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Following is certain relevant information in connection with the consolidated statements of income:
Geographical breakdown
The geographical breakdown of the balances of the main captions composing the Group’s revenues, by country of location of the Group companies giving rise to them, is as follows:
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The detail, by type of transaction, of certain captions in the consolidated statements of income is as follows:
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In recent years, the Bank has put in place compensation systems linked to the market performance of the Bank’s shares based on the achievement of certain objectives as shown below:
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