As filed with the Securities and Exchange Commission on June 29, 2009
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008
Commission file number 001-15266
BANCO DE CHILE
(Exact name of Registrant as specified in its charter)
BANK OF CHILE
(Translation of Registrant’s name into English)
REPUBLIC OF CHILE
(Jurisdiction of incorporation or organization)
Banco de Chile
Ahumada 251
Santiago, Chile
(562) 637-1111
(Address of principal executive offices)
Pedro Samhan E.
Telephone: (562) 653-5150
Facsimile: (562) 653-5156
(Name, telephone, e-mail and/or facsimile number and address of company contact person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
New York Stock Exchange
(for listing purposes only)
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:
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:
Shares of common stock: 80,879,895,984
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP ¨ IFRS ¨ Other x
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.¨ Item 17 x Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
TABLE OF CONTENTS
Item 1.
Identity of Directors, Senior Management and Advisers
Item 2.
Offer Statistics and Expected Timetable
Item 3.
Key Information
Item 4.
Information on the Company
Item 4A.
Unresolved Staff Comments
Item 5.
Operating and Financial Review and Prospects
Item 6.
Directors, Senior Management and Employees
Item 7.
Major Shareholders and Related Party Transactions
Item 8.
Financial Information
Item 9.
The Offer and Listing
Item 10.
Additional Information
Item 11.
Quantitative and Qualitative Disclosures About Market Risk
Item 12.
Description of Securities Other than Equity Securities
Item 13.
Defaults, Dividend Arrearages and Delinquencies
Item 14.
Material Modifications to the Rights of Security Holders and Use of Proceeds
Item 15.
Controls and Procedures
Item 16.
[Reserved]
Item 16A.
Audit Committee Financial Expert
Item 16B.
Code of Ethics
Item 16C.
Principal Accountant Fees and Services
Item 16D.
Exemptions from the Listing Standards for Audit Committees
Item 16E.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Item 16F.
Change in Registrant’s Certifying Accountant
Item 16G.
Corporate Governance
Item 17.
Financial Statements
Item 18.
Index to Financial Statements
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THE MERGER
On January 1, 2008, Banco de Chile merged with Citibank Chile in a transaction in which Banco de Chile was the surviving corporate entity. As used in this annual report, unless the context otherwise requires, references to “Banco de Chile” relating to any date or period prior to January 1, 2008 (the effective date of the merger) are to Banco de Chile as it existed prior to the consummation of the merger, and such references relating to any date or period on or after January 1, 2008 are to Banco de Chile after the consummation of the merger.
PRESENTATION OF FINANCIAL INFORMATION
We prepare our audited consolidated financial statements in Chilean pesos and in accordance with generally accepted accounting principles in Chile, or Chilean GAAP, and the rules of the Superintendencia de Bancos e Instituciones Financieras, or the Chilean Superintendency of Banks. Together, these requirements differ in certain significant aspects from generally accepted accounting principles in the United States, or U.S. GAAP. References to “Chilean GAAP” in this annual report are to Chilean GAAP, as supplemented by the applicable rules of the Chilean Superintendency of Banks. See Note 34 to our audited consolidated financial statements contained elsewhere in this annual report for a description of the material differences between Chilean GAAP and U.S. GAAP, as they relate to us and our consolidated subsidiaries, and a reconciliation to U.S. GAAP of net income and equity.
The Chilean Superintendency of Banks, through its Circular No. 3,410 dated November 9, 2007, subsequently supplemented by Circular No. 3,443 dated August 21, 2008, introduced the new Compendium of Accounting Standards that banks must apply as a result of the IFRS convergence project developed by the Chilean Superintendency of Banks. The Compendium of Accounting Standards established a new format for the presentation of the annual financial statements starting in 2008. The application of this new format only affected the presentation of the financial statements and did not have an effect on the accounting criteria applied by the Bank. For comparative purposes, all the financial information from 2004 through 2007 in this annual report has been restated in accordance with the new presentation format, which presentation format was also used with respect to the 2008 financial information contained in this annual report.
Pursuant to Chilean GAAP, unless otherwise indicated, financial data for all full-year periods through December 31, 2008 included in our audited consolidated financial statements and in the other financial information contained elsewhere in this annual report have been restated in constant Chilean pesos as of December 31, 2008.
In this annual report, references to “$,” “U.S.$,” “U.S. dollars” and “dollars” are to United States dollars, references to “pesos” or “Ch$” are to Chilean pesos, and references to “UF” are to “Unidades de Fomento.” The UF is an inflation-indexed Chilean monetary unit of account with a value in Chilean pesos that is linked to and adjusted daily to reflect changes in the Consumer Price Index of the Instituto Nacional de Estadísticas, or the Chilean National Statistics Institute. As of December 31, 2008, one UF equaled U.S.$34.10 and Ch$21,452.57. See Note 1 to our audited consolidated financial statements. Percentages and certain dollar and peso amounts contained in this annual report have been rounded for ease of presentation.
This annual report contains translations of certain Chilean peso amounts into U.S. dollars at specified rates solely for your convenience. These translations should not be construed as representations that the Chilean peso amounts actually represent such U.S. dollar amounts, were converted from U.S. dollars at the rate indicated in preparing our audited consolidated financial statements or could be converted into U.S. dollars at the rate indicated. Unless otherwise indicated, such U.S. dollar amounts have been translated from Chilean pesos based on the observed exchange rate, as described in “Item 3. Key Information—Selected Financial Data—Exchange Rates,” reported by the Banco Central de Chile, or the Central Bank, for December 30, 2008 (the latest practicable date, as December 31, 2008 was a banking holiday in Chile). The observed exchange rate on June 26, 2009 was Ch$531.93 = U.S.$1.00. The rate reported by the Central Bank is based on the rate
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for the prior business day in Chile and is the exchange rate specified by the Chilean Superintendency of Banks to be used by Chilean banks in the preparation of their financial statements. The Federal Reserve Bank of New York does not report a noon buying rate for Chilean pesos.
Unless otherwise specified, all references in this annual report to loans are to loans and financial leases before deduction of allowances for loan losses, and all market share data presented in this annual report are based on information published periodically by the Chilean Superintendency of Banks. Non-performing loans include loans as to which either principal or interest is overdue and loans that do not accrue interest. Restructured loans as to which no payments are overdue are not ordinarily classified as non-performing loans. Past due loans include, with respect to any loan, the portion of principal or interest that is 90 or more days overdue; the entire outstanding balance of any loan is included in past due loans only after legal collection proceedings have been commenced. This practice differs from that normally followed in the United States, where the amount classified as past due would include the total principal and interest on all loans which have any portion overdue. See “Item 4. Information on the Company—Selected Statistical Information—Classification of Loan Portfolio Based on the Borrower’s Payment Performance.”
Certain figures included in this annual report and in our audited consolidated financial statements have been rounded for ease of presentation. Percentage figures included in this annual report have not in all cases been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding. For this reason, percentage amounts in this annual report may vary slightly from those obtained by performing the same calculations using the figures in our audited consolidated financial statements. Certain other amounts that appear in this annual report may similarly not sum due to rounding.
MACRO-ECONOMIC AND MARKET DATA
In this annual report, all macro-economic data relating to the Chilean economy is based on information published by the Central Bank. All market share and other data relating to the Chilean financial system as well as data on average return on equity are based on information published by the Chilean Superintendency of Banks. Information regarding the consolidated risk index of the Chilean financial system as a whole is not available. Prior to January 1, 2004, the Chilean Superintendency of Banks published the unconsolidated risk index for the financial system three times yearly in February, June and October. Since that date, this index is determined on a monthly basis by dividing allowances for loan losses by total loans, based on information provided by the Chilean Superintendency of Banks.
PART I
Not Applicable.
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SELECTED FINANCIAL DATA
The following table presents historical financial information about us as of the dates and for each of the periods indicated. The following table should be read in conjunction with, and is qualified in its entirety by reference to, our audited consolidated financial statements appearing elsewhere in this annual report. Our audited consolidated financial statements are prepared in accordance with Chilean GAAP and the rules of the Chilean Superintendency of Banks, which together differ in certain significant aspects from U.S. GAAP. Note 34 to our audited consolidated financial statements provides a description of the material differences between Chilean GAAP and U.S. GAAP and a reconciliation to U.S. GAAP of net income for the years ended December 31, 2006, 2007 and 2008 and equity at December 31, 2007 and 2008.
CONSOLIDATED STATEMENT OF INCOME DATA
Chilean GAAP:
Interest revenue
Interest expense
Net interest revenue
Net fees and commissions
Gains (losses) from trading and brokerage activities
Foreign exchange transactions, net
Other operating income
Provisions for loan losses
Total operating expenses
Income attributable to affiliates
Loss from price-level restatements
Income before income tax
Income tax
Net income for the year
Minority Interest
Net income
Earnings per share(1)
Dividends per share(2)
Weighted average number of shares (in millions)
U.S. GAAP(3):
Earnings per share on continuing operations
Earnings per share on discontinued operations
Weighted average number of total shares(4)
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CONSOLIDATED STATEMENT OF FINANCIAL SITUATION DATA
Cash and due from banks
Transactions in the course of collection
Trading securities
Securities purchased under resale agreement
Derivative instruments
Loans and advances to banks
Total loans to customer, net
Available for sale instruments
Held to maturity instruments
Investments in other companies
Intangible assets
Bank premises and equipment
Deferred tax assets
Other assets
Total assets
Current accounts and other demand deposits
Transactions in the course of payment
Securities sold under repurchase agreements
Saving accounts and time deposits
Borrowings from financial institutions
Debt issued
Other financial obligations
Currents tax liabilities
Deferred tax liabilities
Provisions
Other liabilities
Total liabilities
Total equity(12)
Financial investments
Loans, net
Total Equity
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CONSOLIDATED RATIOS
Profitability and Performance
Net interest margin(5)
Return on average total assets(6)
Return on average equity(7)
Capital
Average equity as a percentage of average total assets
Bank regulatory capital as a percentage of minimum regulatory capital
Ratio of liabilities to regulatory capital(8)
Credit Quality
Substandard loans as a percentage of total loans(9)
Allowances for loan losses as a percentage of substandard loans(9)
Allowances for loan losses as a percentage of total loans
Consolidated risk index
Operating Ratios
Operating expenses/operating revenue
Operating expenses/average total assets
U.S. GAAP:
Net interest margin(10)
Return on average total assets(11)
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Exchange Rates
As a general matter, prior to 1989, Chilean law permitted the purchase and sale of foreign exchange only in those cases explicitly authorized by the Central Bank. The Ley Organica Constitucional del Banco Central de Chile 18.840, or the Central Bank Act, liberalized the rules that govern the purchase and sale of foreign currency. The Central Bank Act empowers the Central Bank to determine that certain purchases and sales of foreign currency specified by law must be carried out in the Mercado Cambiario Formal, or the Formal Exchange Market. The Formal Exchange Market is formed by the banks and other entities so authorized by the Central Bank. The observed exchange rate for any given day equals the average exchange rate of the transactions conducted in the Formal Exchange Market on the immediately preceding banking day, as certified by the Central Bank. Even though the Central Bank is authorized to carry out its transactions at the rates it sets, it generally uses the spot rate for its transactions. Authorized transactions by other banks are generally carried out at the spot rate.
Purchases and sales of foreign exchange which may be effected outside the Formal Exchange Market can be carried out in the Mercado Cambiario Informal, or the Informal Exchange Market. There are no limits imposed on the extent to which the rate of exchange in the Informal Exchange Market can fluctuate above or below the observed exchange rate. On December 30, 2008 (the latest practicable date as December 31, 2008 was a banking holiday in Chile), the average exchange rate in the Informal Exchange Market was Ch$641.25 per U.S.$1.00, or 1.89% higher than the published observed exchange rate of Ch$629.11 per U.S.$1.00.
The following table sets forth the annual low, high, average and period-end observed exchange rate for U.S. dollars for each year beginning in 2004, as reported by the Central Bank:
Year
2004
2005
2006
2007
2008
December
2009
January
February
March
April
May
June(5)
Source: Central Bank.
The observed exchange rate on June 26, 2009 was Ch$531.93 = U.S.$1.00. The Federal Reserve Bank of New York does not report a noon buying rate for Chilean pesos.
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RISK FACTORS
The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties that we do not know about or that we currently think are immaterial may also impair our business operations. Any of the following risks if they actually occur, could materially and adversely affect our business, results of operations, prospects and financial condition.
We are subject to market risks that are presented both in this subsection and in “Item 11. Quantitative and Qualitative Disclosures About Market Risk.”
Risks Relating to our Operations and the Banking Industry
The growth of our loan portfolio may expose us to increased loan losses.
From December 31, 2004 to December 31, 2008, our aggregate loan portfolio, net of interbank loans (on a consolidated basis) grew by 113.8% in nominal terms and 72.8% in real terms to Ch$13,649,005 million. During the same period, our consumer loan portfolio grew by 150.2% in nominal terms and 102.2% in real terms to Ch$1,887,548 million, each calculated in accordance with the loan classification system of the Chilean Superintendency of Banks. Expansion of our loan portfolio (particularly in the retail market) may expose us to a higher level of loan losses and require us to establish higher levels of allowances for loan losses. For the year ended December 31, 2008, total allowances for loan losses accounted for Ch$227,202 million, or 1.66%, of total loans.
Our loan portfolio may not continue to grow at the same or similar rate.
We cannot assure you that in the future our loan portfolio will continue to grow at historical rates. According to the Chilean Superintendency of Banks, from December 31, 2004 to December 31, 2008, the aggregate amount of loans outstanding in the Chilean banking system grew by 103.2% in nominal terms and 64.3% in real terms to Ch$70,251,139 million. A slowdown or negative growth rate of the Chilean economy could adversely affect the rate of growth of our loan portfolio and our risk index and, accordingly, increase our required allowances for loan losses. See “Item 4. Information on the Company—Regulation and Supervision” and “Item 4. Information on the Company—Selected Statistical Information.”
Restrictions imposed by banking regulations may restrict our operations and thereby adversely affect our financial condition and results of operations.
We are subject to regulation by the Chilean Superintendency of Banks. In addition, we are subject to regulation by the Central Bank with regard to certain matters, including interest rates and foreign exchange transactions. See “Item 4. Information on the Company—Regulation and Supervision.” During the Chilean financial crisis of 1982 and 1983, the Central Bank and the Chilean Superintendency of Banks strictly controlled the funding, lending and general business matters of the Chilean banking industry.
Pursuant to the Ley General de Bancos, or the General Banking Law, all Chilean banks may, subject to the approval of the Chilean Superintendency of Banks, engage in additional businesses depending on the risk of the activity and the strength of the bank. The General Banking Law also applies to the Chilean banking system a modified version of the capital adequacy guidelines issued by the Basel Committee on Banking Regulation and Supervisory Practices, or Basel Committee, and limits the discretion of the Chilean Superintendency of Banks to deny new banking licenses. There can be no assurance that regulators will not impose more restrictive limitations in the future on the activities of banks, including us, than those that are currently in effect. Any such change could have a material adverse effect on our financial condition or results of operations.
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Increased competition and industry consolidation may adversely affect our operations.
The Chilean market for financial services is highly competitive. We compete with other Chilean private sector domestic and foreign banks, with Banco del Estado de Chile, a public sector bank, and with large department stores that make consumer loans to a large portion of the Chilean population. In 2002, two new private sector banks affiliated with Chile’s largest department stores began their operations, mainly as consumer and medium-sized corporate niche banks. In 2003, a new niche bank oriented at servicing corporations began its operations, and in 2004, two new retail banks commenced operations. The retail market (comprised of individuals and small- and medium-sized companies) has become the target market of several banks, and competition with respect to these customers is likely to increase. As a result, net interest margins (after credit risk) in these sub-segments are likely to decline.
We also face competition from non-bank competitors with respect to some of our credit products, such as credit cards and consumer loans. Non-bank competition from large department stores, private compensation funds and savings and credit associations has become increasingly significant in the consumer lending sector. In addition, we face competition from competitors such as leasing, factoring and automobile finance companies, with respect to credit products, and mutual funds, pension funds and insurance companies, with respect to savings products and mortgage loans. Currently, banks continue to be the main suppliers of leasing, factoring and mutual funds, and the insurance sales business has experienced rapid growth, but we cannot assure you that this will continue in the future. See “Item 4. Information on the Company—Business Overview—Competition.”
The increase in competition within the Chilean banking industry in recent years has led to, among other things, consolidation in the industry. For example, on August 1, 2002, Banco Santiago and Banco Santander-Chile, the then-second and third largest banks in Chile, respectively, merged to create Chile’s largest bank. In 2003, Banco del Desarrollo merged with Banco Sudameris; in 2004, Banco Security merged with Dresdner Banque Nationale de Paris; in 2005, Banco de Creditos e Inversiones merged with Banco Conosur; in 2007, Banco Itaú acquired Bank Boston unit in Chile, while Rabobank acquired HNS Bank and Scotiabank acquired Banco del Desarrollo; and in 2008, we merged with Citibank Chile and The Royal Bank of Scotland acquired ABN Amro Bank. We expect the trends of increased competition and consolidation to continue and result in the formation of new large financial groups. Consolidation, which can result in the creation of larger and stronger banks, may adversely affect our financial condition and results of operations by decreasing the net interest margins we are able to generate and by increasing our costs of operations.
Our exposure to certain segments of the retail market could lead to higher levels of past due loans and subsequent charge-offs.
Although we historically focused on banking for the wholesale market and high income individuals, an increasing proportion of our retail market consists of middle-sized and small companies (approximately 6.1% of the value of our total loan portfolio at December 31, 2008, including companies with annual sales of up to Ch$1,400 million) and, to a lesser extent, of lower income individuals (approximately 4.5% of the value of our total loan portfolio at December 31, 2008, including individuals with monthly incomes between Ch$100,000 and Ch$400,000). Our strategy includes increasing lending and providing other services to attract additional retail customers. These customers are likely to be more severely affected by adverse developments in the Chilean economy than large corporations and high-income individuals. Consequently, in the future we may experience higher levels of past due loans, which could result in higher allowances for loan losses. The levels of past due loans and subsequent write-offs may be materially higher in the future. See “Item 4. Information on the Company—Business Overview—Principal Business Activities.”
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Our affiliate may be obligated to sell shares of our stock in the public market if we do not pay sufficient dividends.
As of December 31, 2008, Sociedad Administradora de la Obligacion Subordinada S.A., or SAOS, our affiliate, holds 35.35% of our shares as a consequence of our 1996 reorganization. This reorganization was due in part to our 1989 repurchase from the Central Bank of certain non-performing loans that we had previously sold to the Central Bank and later exchanged for subordinated debt without a fixed term. Under the terms of a repayment obligation in favor of the Central Bank that SAOS assumed to replace the Central Bank subordinated debt, SAOS may be required to sell some of our shares to the public. See “Item 4. Information on the Company—History and Development of the Bank—History—The 1982-1983 Economic Crisis and the Central Bank Subordinated Debt.” See Note 34 to our audited consolidated financial statements.
In exchange for assuming the Central Bank indebtedness, SAOS received from SM-Chile S.A., a holding company that controls us and SAOS, 63.6% of our shares as collateral for this indebtedness. As a result of our merger with Banco de A. Edwards, the percentage of our shares held by SAOS decreased to 42.0%. As a result of the capital increase agreed upon in the Extraordinary Shareholders’ Meeting held in May 2007, the share dividend paid in May 2006, May 2007 and June 2009, and the merger with Citibank Chile in January 2008, the percentage of our shares held by SAOS further decreased to 34.6%. Dividends received from us are the sole source of SAOS’s revenue, which it must apply to repay this indebtedness. However, under SAOS’s agreement with the Central Bank, we have no obligation to distribute dividends to our shareholders. To the extent distributed dividends are not sufficient to pay the amount due on this indebtedness, SAOS is permitted to maintain a cumulative deficit balance with the Central Bank that SAOS commits to pay with future dividends. If the cumulative deficit balance exceeds an amount equal to 20% of our capital and reserves, the Central Bank may require SAOS to sell a sufficient number of shares of our stock owned by SAOS to pay the entire accumulated deficit amount. As of April 30, 2009, SAOS maintained a surplus with the Central Bank of Ch$86,819 million, equivalent to 6.58% of our capital and reserves. As of the same date, Ch$263,719 million would have represented 20% of our capital and reserves. If from time to time in the future our shareholders decide to retain and capitalize all or part of our annual net income in order to finance our future growth, and to distribute stock dividends among our shareholders, the Central Bank may require us to pay the portion of the net income corresponding to shares owned by SAOS in cash to SAOS. If we distribute stock dividends and the Central Bank does not require us to pay that portion in cash, the shares received by SAOS must be sold by SAOS within the following 12 months. The shareholders of SM-Chile will have a right of first refusal with respect to that sale.
We are unable to determine the likelihood that the Central Bank would require SAOS to sell shares of our common stock or that SAOS will otherwise be required to sell any stock dividends distributed by us, nor can we determine the number of such shares SAOS may be required to sell. If SAOS is required to sell shares of our stock in the public market, that sale could adversely affect the prevailing market price of our stock.
The results of our operations are affected by inflation and interest rate volatility.
The results of our operations depend to a great extent on our net interest revenue, which represented 70.9% of our operating revenue in 2008. Changes in inflation and in market interest rates could affect the interest rates earned on our interest-earning assets differently from the interest rates paid on our interest-bearing liabilities as well as in the derivative portfolio, resulting in a reduction in our net revenue. Inflation and interest rates are highly sensitive to many factors beyond our control, including the reserve policies of the Central Bank, deregulation of the financial sector in Chile, domestic and international economic and political conditions and other factors. Any volatility in interest rates could have a material adverse effect on our financial condition or results of operations. The average inflation rate was 3.40% in 2006, 4.39% in 2007 and 8.71% in 2008. The average annual short-term interest rate (based on the rate paid by Chilean financial institutions) for 90 to 360 day deposits was 2.83% in 2006, 2.20% in 2007 and 2.23% in 2008. The average long-term interest rate based on the Central Bank’s ten-year bonds was 2.98% in 2006, 2.9% in 2007 and 3.24% in 2008. See “Item 5. Operating and Financial Review and Prospects—Operating Results—Overview—Inflation” and “Item 5. Operating and Financial Review and Prospects — Operating Results—Overview—Interest Rates.”
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Operational problems or errors can have a material adverse impact on our business, financial condition and results of operations.
As all large financial institutions, we are exposed to many operational risks, including the risk of fraud by employees and outsiders, failure to obtain proper internal authorizations, failure to properly document transactions, equipment failures and errors by employees. Although we maintain a system of operational controls, there can be no assurance that operational problems or errors will not occur and that their occurrence will not have a material adverse impact on our business, financial condition and results of operations.
Complaint of Consejo de Defensa del Estado
On March 11, 2009, the Consejo de Defensa del Estado de la Republica de Chile filed a complaint against Banco de Chile in the United States District Court of the Southern District of Florida. The complaint alleges substantive civil violations of the Racketeer Influenced & Corrupt Organizations Act (“RICO”), RICO conspiracy, aiding and abetting RICO violations, and aiding and abetting a breach of fiduciary duty. The complaint seeks redress for funds allegedly misappropriated from the Chilean government by the former President of Chile, Augusto Pinochet, and it alleges that Banco de Chile participated in conduct related to a money laundering scheme. Damages being sought are $22 million, which amount is subject to trebling pursuant to RICO.
It is not possible to predict the outcome of this matter, or what impact, if any, it might have. As of the date of filing this annual report, Banco de Chile has not been served with the complaint, and it has not waived (and does not waive by virtue of filing this annual report) any of its rights with respect to service of process of the complaint. Banco de Chile believes it has meritorious defenses to the complaint, and it intends to defend this matter vigorously if and when it is served.
Risks Relating to our ADSs
Our principal shareholders may have interests that differ from those of our other shareholders and their significant share ownership may have an adverse effect on the future market price of our ADSs and shares.
As of June 17, 2009, LQ Inversiones Financieras S.A., a holding company beneficially owned by Quiñenco S.A., and Citigroup Chile S.A. beneficially owned approximately 61.7% of our outstanding voting rights. These principal shareholders are in a position to elect a majority of the members of our board of directors, direct our management and control substantially all matters that are to be decided by a vote of the shareholders, including fundamental corporate transactions.
Actions by our principal shareholders with respect to the disposition of the shares or ADSs they beneficially own, or the perception that such actions may occur, may adversely affect the trading price of our shares on the various stock exchanges on which they are listed and, consequently, the market price of the ADSs.
There may be a lack of liquidity and a limited market for our shares and ADSs.
While our ADSs have been listed on the New York Stock Exchange, or NYSE, since the first quarter of 2002, there can be no assurance that an active trading market for our ADSs will be sustained. During 2008, a daily average of 17,721 American Depositary Receipts, or ADRs, were traded on the NYSE. Although our shares are traded on the Santiago Stock Exchange, the Valparaiso Stock Exchange and the Chilean Electronic
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Stock Exchange, the market for our shares in Chile is small and illiquid. At December 31, 2008, approximately 11.78% of our outstanding shares were held by shareholders other than our principal shareholders, including SM-Chile and SAOS.
If an ADS holder withdraws the underlying shares from the ADR facility, the small size of the market and its low liquidity in general, and our concentrated ownership in particular, may impair the ability of the ADS holder to sell the shares in the Chilean market in the amount and at the price and time such holder desires, and could increase the volatility of the price of our ADSs.
You may be unable to exercise preemptive rights.
The Ley Sobre Sociedades Anonimas No. 18,046 and the Reglamento de Sociedades Anonimas, or the Chilean Corporations Law and its regulations, require that whenever we issue new common stock for cash, we grant preemptive rights to all of our shareholders (including holders of ADSs) to purchase a sufficient number of shares to maintain their existing ownership percentage. Such an offering would not be possible unless a registration statement under the Securities Act of 1933, as amended, or the Securities Act, were effective with respect to such rights and common stock or an exemption from the registration requirements thereunder were available.
We may elect not to make a registration statement available with respect to the preemptive rights and the common stock, in which case you may not be able to exercise your preemptive rights. If a registration statement is not filed, the depositary will sell such holders’ preemptive rights and distribute the proceeds thereof if a premium can be recognized over the cost of any such sale.
Developments in international financial markets may adversely affect the market price of the ADSs and shares.
The market price of the ADSs and shares may be adversely affected by declines in the international financial markets and adverse world economic conditions. The market for Chilean securities is, to varying degrees, influenced by economic and market conditions in other emerging market countries, especially those in Latin America. Although economic conditions are different in each country, investors’ reactions to developments in one country can affect the securities markets in other countries, including Chile. Developments in other countries may adversely affect the market price of the ADSs and shares.
In particular, since August 2007 to date, there has been significant volatility in worldwide financial markets due to the announcement, by several U.S. banks and financial institutions, of significant write-downs related to their exposure to mortgage-backed securities and other financial instruments. Although we, and our subsidiaries, are not directly exposed to the U.S. housing credit market and do not directly hold any assets related to such financial instruments, these write-downs, combined with other factors, have led to a tightening in the credit markets and to a downturn in the U.S. economy, which has impacted the Chilean economy. In fact, starting in late 2008 and continuing into 2009, many countries in Latin America, including Chile, are experiencing economic slowdowns or recessions. Any of these developments could adversely affect the market price of the ADSs and shares.
In the past, Chile has imposed controls on foreign investment and repatriation of investments that affected investments in, and earnings from, our ADSs.
Equity investments in Chile by persons who are not Chilean residents have historically been subject to various exchange control regulations that restrict the repatriation of the investments and earnings therefrom. In April 2001, the Central Bank eliminated most of the regulations that affected foreign investors, although foreign investors still have to provide the Central Bank with information related to equity investments and must conduct such operations within the Formal Exchange Market. Additional Chilean restrictions applicable to holders of our ADSs, the disposition of the shares underlying them, the repatriation of the proceeds from such disposition or the payment of dividends may be imposed in the future, and we cannot advise you as to the duration or impact of such restrictions if imposed.
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If for any reason, including changes in Chilean law, the depositary were unable to convert Chilean pesos to U.S. dollars, investors would receive dividends and other distributions, if any, in Chilean pesos.
We are required to withhold 35% tax from any dividend we pay to you.
ADSs owners are entitled to receive dividends on the underlying shares to the same extent as the holders of shares. Dividends received by ADSs owners will be paid net of foreign currency exchange fees and expenses of the depositary and will be subject to Chilean withholding tax of up to 35% of the dividend, which we will withhold and pay to the Chilean tax authorities. Any dividend distributions made in property (other than common stock) will be subject to the same Chilean tax rules as cash dividends. See “Item 10. Additional Information—Taxation—Chilean Tax Considerations.”
Risks Relating to Chile
Our growth and profitability depend on the level of economic activity in Chile.
A substantial amount of the transactions in which we participate are with customers doing business in Chile. Accordingly, our ability to increase the amount of business volume and our results of operations and financial condition, in general, are dependent to a significant extent on the level of economic activity in Chile. The global financial system has been experiencing difficulties since August of 2007 and the global financial markets have deteriorated very significantly since September of 2008. The recent global financial crisis has had significant consequences worldwide, including in Chile. It has generally caused capital markets volatility, unavailability of credit, volatile exchange rates and a general slowdown of the world economy. We cannot assure you that the Chilean economy will continue to grow in the future or that future developments in, or affecting, the Chilean economy will not materially and adversely affect our business, financial condition or results of operations.
Currency fluctuations could adversely affect the value of our ADSs and any distributions on the ADSs.
The Chilean government’s economic policies and any future changes in the value of the Chilean peso against the U.S. dollar could affect the dollar value of our common stock and our ADSs. The peso has been subject to large fluctuations in the past and could continue with this trend in the future. In the period from December 31, 2007 to December 31, 2008, the value of the U.S. dollar relative to the Chilean peso increased approximately 26.7%, as compared to a 7.2% decrease in value in the period from December 31, 2006 to December 31, 2007.
Chilean trading in the shares underlying our ADSs is conducted in pesos. Cash distributions with respect to our shares of common stock are received in Chilean pesos by the depositary, which then converts such amounts to U.S. dollars at the then-prevailing exchange rate for the purpose of making payments in respect of our ADSs. If the value of the Chilean peso falls relative to the U.S. dollar, the dollar value of our ADSs and any distributions to be received from the depositary will be reduced. In addition, the depositary will incur customary currency conversion costs (to be borne by the holders of our ADSs) in connection with the conversion and subsequent distribution of dividends or other payments. See “Item 10. Additional Information—Exchange Controls.”
Our results of operations may be affected by fluctuations in the exchange rates between the peso and the U.S. dollar despite our policy and Chilean regulations related to the general avoidance of material exchange rate mismatches. In order to reduce the effect of exchange rate mismatches we enter into foreign exchange derivative transactions. As of December 31, 2008, the net position of our foreign currency denominated assets and Chilean peso-denominated assets, which contain repayment terms linked to changes in
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foreign currency exchange rates, exceeded our foreign currency denominated liabilities and Chilean peso-denominated liabilities, which contain repayment terms linked to changes in foreign currency exchange rates, by Ch$51,114 million, or 4.2% of our paid-in capital and reserves.
We may decide to change our policy regarding exchange rate mismatches. Regulations that limit such mismatches may also be amended or eliminated. Greater exchange rate mismatches will increase our exposure to the devaluation of the peso, and any such devaluation may impair our capacity to service foreign-currency obligations and may, therefore, materially and adversely affect our financial condition and results of operations. Notwithstanding the existence of general policies and regulations that limit material exchange rate mismatches, the economic policies of the Chilean government and any future fluctuations of the peso against the U.S. dollar could adversely affect our financial condition and results of operations.
Inflation could adversely affect the value of our ADSs and financial condition and results of operations.
The level of inflation generally has moderated in recent years, especially in comparison to the periods of higher inflation in the 1980s and 1990s. High levels of inflation in Chile could adversely affect the Chilean economy and, indirectly, the value of our ADSs. The annual rate of inflation (as measured by changes in the Consumer Price Index and as reported by the Chilean National Institute of Statistics) during the last five years ended December 31, 2008 and the first five months of 2009 was:
2009 (through May 31)
Source: Chilean National Institute of Statistics
Although we benefit from inflation in Chile due to the structure of our assets and liabilities (i.e., we have a significant net asset position indexed to the inflation rate), our operating results and the value of our ADSs in the future may be adversely affected by changing levels of inflation, and Chilean inflation could change significantly from the current level. See “Item 5. Operating and Financial review and Prospects—Inflation.”
Chile has corporate disclosure and accounting standards different from those you may be familiar with in the United States.
The accounting, financial reporting and securities disclosure requirements in Chile differ from those in the United States. Accordingly, the information about us available to you will not be the same as the information available to shareholders of a U.S. company.
There are also important differences between Chilean and U.S. accounting and financial reporting standards. As a result, Chilean financial statements and reported earnings generally differ from those that would be reported based on U.S. accounting and reporting standards. See Note 34 to our audited consolidated financial statements.
As a regulated financial institution, as of December 2008, we are required to submit to the Chilean Superintendency of Banks unaudited consolidated and unconsolidated balance sheets and income statements, excluding any note disclosure, prepared in accordance with Chilean GAAP on a monthly basis. The Chilean Superintendency of Banks makes this information public and also makes summary financial information available within approximately three weeks of receipt. Such documentation is also published monthly in Banco de Chile’s website in both Spanish and in English.
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Such disclosure differs in a number of significant aspects from information generally available in the United States with respect to U.S. financial institutions.
Chilean disclosure requirements for publicly listed companies differ from those in the United States in some significant aspects. In addition, although Chilean law imposes restrictions on insider trading and price manipulation, the Chilean securities markets are not as highly regulated and closely supervised as the U.S. securities markets.
Chilean law provides for fewer and less well-defined shareholders’ rights.
Our corporate affairs are governed by our estatutos, or bylaws, and the laws of Chile. Under such laws, our shareholders may have fewer or less well-defined rights than they might have as shareholders of a corporation incorporated in a U.S. jurisdiction. For example, our shareholders would not be entitled to appraisal rights in the event of a merger or other business combination undertaken by us.
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FORWARD-LOOKING STATEMENTS
This annual report contains forward-looking statements. These statements appear throughout this annual report, including, without limitation, under “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and Prospects.” Examples of such forward-looking statements include:
projections of operating revenues, net income (loss), net income (loss) per share, capital expenditures, dividends, capital structure or other financial items or ratios;
statements of our plans, objectives or goals, including those related to anticipated trends, competition and regulation;
statements about our future economic performance or that of Chile or other countries in which we operate; and
statements of assumptions underlying such statements.
Words such as “believe,” “anticipate,” “plan,” “expect,” “intend,” “target,” “estimate,” “project,” “potential,” “predict,” “forecast,” “guideline,” “could,” “may,” “will,” “should” and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. These statements may relate to (1) our asset growth and financing plans, (2) trends affecting our financial condition or results of operations and (3) the impact of competition and regulations, but are not limited to such topics. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those described in such forward-looking statements included in this annual report as a result of various factors (including, without limitation, the actions of competitors, future global economic conditions, market conditions, foreign exchange rates and operating and financial risks), many of which are beyond our control. The occurrence of any such factors not currently expected by us would significantly alter the results set forth in these statements.
Factors that could cause actual results to differ materially and adversely include, but are not limited to:
changes in general economic, business, political or other conditions in Chile or changes in general economic or business conditions in Latin America;
changes in capital markets in general that may affect policies or attitudes towards lending to Chile or Chilean companies;
increased costs;
unanticipated increases in financing and other costs or the inability to obtain additional debt or equity financing on attractive terms; and
the factors discussed under “—Risk Factors.”
You should not place undue reliance on forward-looking statements, which speak only as of the date that they were made. This cautionary statement should be considered in connection with any written or oral forward-looking statements that we may issue in the future. We do not undertake any obligation to publicly release any revisions to such forward-looking statements after the filing of this annual report to reflect later events or circumstances or to reflect the occurrence of unanticipated events.
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HISTORY AND DEVELOPMENT OF THE BANK
Overview
We were founded in 1893, and we believe that we have been, for much of our recent history, among the largest and most profitable Chilean banks in terms of return on assets and equity. We are engaged primarily in commercial banking in Chile, providing general banking services to a diverse customer base that includes corporations and individuals.
Our legal name is Banco de Chile. We are organized as a banking corporation under the laws of Chile and are licensed by the Chilean Superintendency of Banks to operate as a commercial bank. Our principal executive offices are located at Ahumada 251, Santiago, Chile. Our telephone number is +56 (2) 637-1111 and our website is www.bancochile.cl.
We are a full-service financial institution providing, directly and indirectly through our subsidiaries and affiliates, a wide variety of credit and non-credit products and services to all segments of the Chilean financial market. Our operations are organized in four principal business segments:
wholesale market;
retail market;
treasury and money market operations; and
operations through subsidiaries.
Our banking services for corporate customers include commercial loans, including working capital facilities and trade finance, foreign exchange, capital market services, cash management and non-credit services such as payroll and payment services, as well as a wide range of treasury and risk management products. We provide our individual customers with credit cards, residential mortgage, auto and consumer loans, as well as traditional deposit services such as checking and savings accounts and time deposits.
As of December 31, 2008, we offered international banking services directly through our trade services subsidiary in Hong Kong, our representative offices in Sao Paulo and Beijing and a worldwide network of correspondent banks. In addition to our commercial banking operations, through our subsidiaries, we offer a variety of non-banking financial services including securities brokerage, mutual fund management, investment banking services, factoring, insurance brokerage, securitization, collection and sales services.
As of December 31, 2008, we had:
total assets of Ch$18,128,442 million (U.S.$28,816 million);
loans outstanding of Ch$13,649,005 million (U.S.$21,696 million);
deposits of Ch$11,479,851 million (U.S.$18,248 million); and
equity (including net income and minority interest) of Ch$1,297,743 million (U.S.$2,063 million).
According to information published by the Chilean Superintendency of Banks, as of December 31, 2008, we were the second largest private bank in Chile in terms of total loans (excluding interbank loans) with a market share of 19.4 %.
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We are headquartered in Santiago, Chile and, as of December 31, 2008, had 14,580 employees and delivered financial products and services through a nationwide network of 371 branches and 1,584 ATMs that form part of a network of 7,056 ATMs operated by Redbanc S.A., a company owned by us and 13 other private sector financial institutions.
History
We were established in 1893 as a result of the merger of Banco Nacional de Chile, Banco Agricola and Banco de Valparaiso, which created the largest privately held bank in Chile. We believe that we remained the largest private bank in Chile until 1996. Beginning in the early 1970s, the Chilean government assumed control of a majority of Chilean banks and all but one of the foreign banks operating at the time closed their branches and offices in Chile. Throughout this era, we remained privately owned, with the Chilean government owning participating shares which it sold to private investors in 1975. We developed a well-recognized name in Chile and expanded our operations in foreign markets where we developed an extensive network of correspondent banks. In the early twentieth century, we established a representative office in London, which we maintained until 1985, when our European operations were moved to Frankfurt. The Frankfurt office was closed in 2000, when our foreign operations were centralized at the New York branch. In 2008, we sold our US branches to Citigroup in connection with our merger with Citibank Chile. In 1987 and 1988, we established four subsidiaries to provide the full range of financial products and services permitted by the General Banking Law and in 1999, we established our insurance brokerage and factoring subsidiaries.
Merger with Banco de A. Edwards
On December 6, 2001, our shareholders approved the merger with Banco de A. Edwards, which became effective on January 1, 2002. Banco de A. Edwards had been listed on the NYSE since 1995, and in January 2002, we were listed on the NYSE under the symbol BCH. Since 2002, our shares have also been listed on the Latin American Stock Exchange of the Madrid Stock Exchange, or Latibex, and the London Stock Exchange, or LSE. We concluded the merger process at the end of 2002 with the consolidation of a new corporate structure and the integration of our technological platforms.
Merger with Citibank Chile
On December 27, 2007 our shareholders approved the merger of Citibank Chile into Banco de Chile, which became effective on January 1, 2008. In addition, we entered into a Global Connectivity Agreement with Citigroup Inc. to offer joint global financial services to customers in Chile. During 2008, we integrated Citibank Chile’s technological platforms with ours and also established a new organizational structure in order to satisfy our customers’ needs and to achieve important synergies. We concluded the merger process at the end of 2008 with the integration of Citibank Chile’s consumer business with ours.
Technological Projects
In 2003, we developed the groundwork for “Neos,” our technological innovation platform that provides information necessary for designing specific value proposals for every market subsegment and that simultaneously improves the quality of our service and increases efficiency. During 2004, we concluded the initial phases of “Neos,” which consisted of implementing a new management control platform that supports internal administration, a customer relationship management system, which manages client service requirements and global client information, a new core banking products system and a new accounting system.
During 2005, we successfully concluded the implementation of the Enterprise Resource Planning system, which, in its orientation towards self-service applications, provides human resources solutions. We also deployed a Customer Relationship Management, or CRM, service platform in all our retail branches and call centers. The CRM mainly allows for preventive functions, the management of commercial campaigns and the tracking of credit approvals. In addition, the new accounting system was deployed.
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During 2006, we expanded the CRM system and related processes to our corporate and private banking businesses, thus covering all of our segments and branch networks, with the exception of Credichile. We also introduced important improvements in this system, adding functionalities mainly related to the opportunity and post-sale modules. As part of the new core banking system, commercial and consumer loans were placed into the new loan module. In addition, we initiated the replacement of the teller system, which will enable faster and more accurate customer service. Also during 2006, a Customer Intelligence solution was implemented to improve customer acquisition, cross-selling, segmentation and retention.
During 2007, we achieved several milestones. We completed the migration of checking accounts, lines of credit and sight accounts into a new module as part of the new core banking system. In addition, the CRM platform and the teller solution were expanded to all of our networks. In addition, we implemented a new anti-money laundering program to increase the quality and efficiency of the operational follow-up and alerts.
During 2008, our priorities were focused on operational and technological stabilization after the merger with Citibank Chile. We have implemented critical initiatives such as the updating of the core database, which included hardware upgrades, the improvement of the batch process time and the performance of our front-end systems and middleware components.
The 1982-1983 Economic Crisis and the Central Bank Subordinated Debt
During the 1982-1983 economic crisis, the Chilean banking system experienced significant instability requiring that the Central Bank and the Chilean government provide assistance to most Chilean private sector banks, including us. During this period, we experienced significant financial difficulties. In 1985 and 1986, we increased our capital and sold shares representing 88% of our capital to more than 30,000 new shareholders. As a result, no single shareholder held a controlling stake in our company. In 1987, the Chilean Superintendency of Banks returned the control and administration of the bank to our shareholders.
Subsequent to the crisis, like most major Chilean banks, we sold certain of our non-performing loans to the Central Bank at face value on terms that included a repurchase obligation. The repurchase obligation was later exchanged for subordinated debt of each participating bank issued in favor of the Central Bank. In 1989, pursuant to Law No. 18,818, banks were permitted to repurchase the portfolio of non-performing loans for a price equal to the economic value of such loans, provided that the bank assume a subordinated obligation equal to the difference between the face value and economic value of such loans. In November 1989, we repurchased our portfolio of non-performing loans from the Central Bank and assumed the Central Bank’s subordinated debt relating to our non-performing loans.
The original repayment terms of our Central Bank subordinated debt, which at December 31, 1989 equaled approximately Ch$1,330,259 million, or U.S.$2,115 million, required that a certain percentage of our income before provisions for the subordinated debt be applied to repay this obligation. The Central Bank subordinated debt did not have a fixed maturity, and payments were made only to the extent that we earned income before provisions for the subordinated debt. In 1993 we applied 72.9% of our income before provisions for the Central Bank subordinated debt to the repayment of this debt. In 1994 we applied 67.6% and in 1995 we applied 65.8% of our income before provisions for the Central Bank subordinated debt to the repayment of this debt.
In November 1996, pursuant to Law No. 19,396, our shareholders approved a reorganization by which Banco de Chile was converted to a holding company named SM-Chile. In turn, SM-Chile organized a new wholly-owned banking subsidiary named Banco de Chile, to which it contributed all of its assets and liabilities other than the Central Bank subordinated debt. SM-Chile then created SAOS, a second wholly-owned subsidiary that, pursuant to a prior agreement with the Central Bank, assumed a new repayment obligation in favor of the Central Bank that replaced the Central Bank subordinated debt in its entirety.
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This Central Bank indebtedness, for which SAOS is solely responsible and for which there is no recourse to us or SM-Chile, was equal to the unpaid principal of the Central Bank subordinated debt that it replaced, but had terms that differed in some aspects. The most important of these included a rescheduling of the debt for a term of 40 years providing for equal annual installments and a pledge of our shares as collateral for such debt. The Central Bank indebtedness bears interest at a rate of 5.0% per year and is denominated in UF. See “Item 5. Operating and Financial Review and Prospects—Operating Results—Overview—Inflation—UF-denominated Assets and Liabilities” for a further explanation of UF.
In exchange for assuming the Central Bank indebtedness, SAOS received from SM-Chile, a holding company that beneficially owns SAOS and us, 63.6% of our shares as collateral for this indebtedness. As a result of our merger with Banco de A. Edwards, the percentage of our shares held by SAOS decreased to 42.0%. As a result of the capital increase agreed upon in the Extraordinary Shareholders’ Meeting held in May 2007, the share dividend paid in May 2006, May 2007, and June 2009, and the merger with Citibank Chile in January 2008, the percentage of our shares held by SAOS further decreased to 34.6%. Dividends received from us are the sole source of SAOS’s revenue, which it must apply to repay this indebtedness. However, under SAOS’s agreement with the Central Bank, we have no obligation to distribute dividends to our shareholders. To the extent distributed dividends are not sufficient to pay the amount due on this indebtedness, SAOS is permitted to maintain a cumulative deficit balance with the Central Bank that SAOS commits to pay with future dividends. If the cumulative deficit balance exceeds an amount equal to 20% of our paid-in capital and reserves, the Central Bank may require SAOS to sell a sufficient number of shares of our stock owned by SAOS to pay the entire accumulated deficit amount. As of April 30, 2009, SAOS maintained surplus with the Central Bank of Ch$86,819 million, equivalent to 6.58% of our paid-in capital and reserves. As of the same date, Ch$263,719 million would have represented 20% of our paid-in capital and reserves. See “Item 3. Key Information—Risk Factors—Risks Relating to our Operations and the Banking Industry.” Our affiliate may be obligated to sell shares of our stock in the public market if we do not pay sufficient dividends. See Note 34 to our audited consolidated financial statements.
If from time to time in the future our shareholders decide to retain and capitalize all or part of our annual net income in order to finance our future growth, and to distribute stock dividends among our shareholders, the Central Bank may require us to pay the portion of the net income corresponding to shares owned by SAOS in cash to SAOS. If we distribute stock dividends and the Central Bank does not require us to pay that portion in cash, the shares received by SAOS must be sold by SAOS within the following 12 months. The shareholders of SM-Chile will have a right of first refusal with respect to that sale.
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Capital Expenditures
The following table reflects our capital expenditures in each of the three years ended December 31, 2006, 2007 and 2008:
Computer equipment
Furniture, machinery and installations
Real estate
Vehicles
Subtotal
Software
Total
Our budget for capital expenditures in 2009 is Ch$41,480 million. Capital expenditures planned for 2009 consist mainly of expenditures for information technology and infrastructure, which are aimed at improving our efficiency and productivity.
Regarding technology capital expenditures, during 2009 we expect that the main disbursements will be related to:
the final stages of our new checking account system, including the integration with Citibank’s regional and global systems;
the roll-out of our new teller system as well as the Customer Relationship Management (CRM) sales platform in all CrediChile branches;
the upgrade of our internet customer authentication platform; and
the implementation of biometric solutions for customer transactions.
In terms of infrastructure, our 2009 capital expenditures are expected to involve the opening of new branches and ATMs, the refurbishment of some existing branches and the performance of maintenance in the ordinary course of our business.
BUSINESS OVERVIEW
Business Strategy
Our long-term strategy is to maintain and enhance our position as a leading bank in Chile by providing a broad range of financial products and services to corporations and individuals nationwide. As part of this strategy, we utilize a multi-brand approach to target diverse market segments and leverage our strongly positioned brand names: “Banco de Chile,” “Banco Edwards Citi,” “Banchile” and “Banco Credichile.” The key components of our strategy are described below.
Profitable Business Growth
Our banking strategy is focused on those businesses which make significant contributions and have risks that are bounded, and on retaining and strengthening the relationship with our customers. We seek a sustained growth, especially in higher-margin segments and in those business areas that provide a strong growth potential. Our focus on growth has been primarily placed on Retail segments, large companies and the Treasury segment, as we seek to achieve the same strong position in those areas that we have in the Large Corporations segment.
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Along with our traditional lending activities, we have increased our focus on other sources of revenue, such as foreign exchange derivative transaction, fee-based products and services. In this regard, our consolidated income from fees and other services has continued to be an important source of income in recent years, achieving Ch$187,773 million (U.S.$298 million or 23.9% of operating revenues) in 2007 and Ch$215,862 million (U.S.$ 343 million or 19.7% of operating revenues) in 2008. We seek to continue to increase our fee-based revenues by developing new services and by strategically cross-selling these services to our base of existing retail and wholesale banking customers. For our wholesale banking customers, we intend to actively market new and existing fee-based services such as receivables collection, payroll services, supplier payments, investment advisory services and cash management. For our retail banking customers, we intend to increase revenues from new and existing fee-based services such as general checking services, ATMs, credit cards, mutual funds, securities brokerage and insurance brokerage.
Continued Improvement of our Efficiency
Our efficiency approach is focused on seeking higher levels of productivity and cost control. We believe that a low-cost structure will become increasingly important to our ability to compete profitably. To achieve this goal, we have invested in (1) technology development, (2) developing business processes that are simpler and more manageable, and (3) secure and modern platforms that allow better time response and higher productivity.
We have invested heavily in technology during recent years (approximately Ch$99,350 million (U.S.$158 million) in the last three years) and we plan to continue focusing on technology in the future to achieve further improvements in customer service and operating efficiency.
In 2008, our consolidated operating expenses represented approximately 52.3% of our operating revenue. We intend to improve this ratio in the coming years by expanding the volume of our business and enhancing our internal processes, cost controls and monitoring.
High Standards of Service Quality
Given the importance of service quality to loyalty and retention of our customers, continuous improvement is required. We have developed and implemented a series of measures to improve our quality of service, such as: (1) the implementation of a new value proposition with emphasis on excellence service, (2) the strengthening of the quality service delivered to customers through an ongoing improvement plan that identifies the critical behaviors of our customers, developing an attention protocol for different kind of clients, (3) the transfer of business operation practices from high service quality branches to lower service quality branches, (4) the implementation of several enhancements to our Internet channel and business units in order to increase the processing capacity of information, allowing us to manage larger volumes of business with better time response to customers, (5) the development of a more effective call center platform and (6) the redistribution of our corporate portfolios among corporate executives, allowing us to obtain a deeper specialization and to improve the quality of our service.
Excellence in Human Resources Management
In order to succeed in the long term, we believe that it is essential to have highly qualified and motivated employees with a strong commitment to the goals and values of our institution. We seek to establish a distinctive culture among our employees fostering (1) a clear focus on the customer, (2) confidence and leadership, (3) meritocracy and high performance, (4) collaboration and teamwork, (5) accountability and empowerment, and (6) innovation and continuous improvement.
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We intend to make all necessary efforts to remain as one of the most respected companies at the occupational level, developing and fostering one of the most important assets of the Bank, represented by a team of excellence that is highly committed to our mission and the institutional values that represent us.
We cannot assure you that we will be able to realize our strategic objectives. For a discussion of certain risks applicable to our operations and to Chile that may affect our ability to meet our objectives, see “Item 3. Key Information—Risk Factors.”
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Ownership Structure
The following diagram shows the ownership structure as of June 17, 2009:
Principal Business Activities
We are a full-service financial institution providing, directly and indirectly through our subsidiaries and affiliates, a wide variety of credit and non-credit products and services to all segments of the Chilean financial market. The following diagram summarizes our principal business segments, which we conduct directly or, in the case of “Operations Through Subsidiaries,” through our subsidiaries:
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The following table provides information on the composition of our loan portfolio and our consolidated net income before tax for the year ended December 31, 2008, allocated among our principal business segments:
Retail market
Wholesale market
Treasury and money market operations
Operations through subsidiaries
Other (adjustments and eliminations)
The following table provides our consolidated operating revenues, for the period indicated, allocated among our principal business segments:
International banking(1)
The following table provides a geographic market breakdown of our operating revenues for the years indicated.
Chile
Banking operations
Foreign operations
New York
Miami
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Retail Market
Our retail market business segment serves the financial needs of individuals and middle market companies through our branch network comprised of 371 branches.
As of December 31, 2008, loans to our retail market represented 42.2% of our total loans outstanding and our retail market business segment accounted for approximately Ch$179,710 million of our net income before tax for the year ended December 31, 2008.
The following table sets forth the composition of our retail market business segment’s loan portfolio as of December 31, 2008:
Commercial loans
Residential mortgage loans
Consumer loans
The retail market business segment is served by two divisions: (i) the individuals and middle market division and (ii) the Banco CrediChile division.
Individuals and Middle Market Division
The individuals and middle market division is responsible for offering financial services to individuals with incomes of over Ch$400 thousand monthly (or Ch$4.8 million annually) and to small and medium-sized companies with annual sales of up to Ch$1,400 million. The individuals and middle market division manages that portion of our branch network that operates under the brand names Banco Chile and Banco Edwards/Citi. We had 227 such branches at December 31, 2008.
The individuals and middle market division has a range of management tools that measure returns, cross-sell products, track performance and the effectiveness of campaigns. Incentive systems have been gradually incorporated into the commercial targets, differentiated by segment, consequently permitting faster response times and a more efficient use of resources. This division also counts on the support of specialized call centers and internet banking services. The strategy followed in the individual and middle market division is mainly focused on subsegmentation and multi-brand positioning, on cross-selling of products and on quality of service.
At December 31, 2008, the individuals and middle market division served more than 571,000 individual customers and over 54,000 companies, resulting in outstanding loans to approximately 535,000 debtors, including approximately 60,109 residential loans, 46,018 commercial loans, 463,000 approved lines of credit, 256,967 other consumer loans and 658,871 credit card accounts. At the same date, we maintained 570,292 checking accounts, 163,939 savings accounts and 156,282 time deposits related to individuals.
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As of December 31, 2008, loans originated by our individuals and middle market division represented 37.7% of our total outstanding loans. The following table sets forth the composition of our portfolio of loans to individuals and middle market companies as of December 31, 2008:
Commercial Loans
Commercial credit
Leasing contracts
Other loans
Total Commercial Loans
Residential Mortgage Loans
Consumer Loans
Installment loans
Credit cards
Lines of credit
Total Consumer Loans
The principal financial services offered to individuals include checking accounts, automatic bill payment, debit cards, credit cards, revolving credit lines, housing loans, consumer loans, life insurance, general insurance (like home and vehicle insurance), savings instruments, mutual funds, stock trading and foreign currency services.
Installment Loans
Our consumer installment loans to individuals are generally incurred, up to a customer’s approved credit limit, to finance the cost of goods or services, such as cars, travel and household furnishings. Consumer loans are denominated in both pesos and UF, bear interest at fixed or variable rates of interest and are generally repayable in installments of up to 36 months.
At December 31, 2008, we had Ch$ 810,798 million in installment loans to individuals, which accounted for 43.2% of the retail market business segment consumer loans. A majority of installment loans are denominated in pesos and are payable monthly.
As of December 31, 2008, there were outstanding residential mortgage loans to individuals of Ch$2,236,897 million, which represented 43.5% of the retail market total loans and 16.4% of our total loan portfolio. A feature of our mortgage loans to individuals is that mortgaged property typically secures all of a mortgagor’s credit with us, including credit card and other loans.
Our residential mortgage loans generally have maturities between five and 30 years and are denominated in UF. To reduce our exposure to interest rate fluctuations and inflation with respect to our residential loan portfolio, a portion of these residential loans is currently funded through the issuance of mortgage finance bonds, which are recourse obligations with payment terms that are matched to the residential loans and which bear a real market interest rate plus a fixed spread over the rate of change in the UF. Chilean banking regulations limit the amount of a residential mortgage loan that may be financed with a mortgage finance bond to the lesser of 75% of the purchase price of the property securing the loan or the appraised value of such property. In addition, we generally require that the monthly payments on a residential mortgage loan not exceed 25% of the borrower’s household after-tax monthly income. This is mandatory for mortgage loans financed by mortgage bonds in which the assessment value of the property is less than UF3,000.
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We have promoted the expansion of Mutuos Hipotecarios, a mortgage-lending product, as an alternative form to traditional financing of mortgage loans with mortgage bonds. Whereas our traditional mortgage loans are financed by means of mortgage finance bonds, Mutuos Hipotecarios are financed with our general funds, especially long-term subordinated bonds. Mutuos Hipotecarios offer the opportunity to finance up to 100% of the lower of the purchase price or the appraised value of the property, as opposed to the 75% that a standard mortgage would allow.
As of December 31, 2008, we were Chile’s second largest private sector bank in terms of amount of mortgage loans, and, based on information prepared by the Chilean Superintendency of Banks, we accounted for approximately 14.1% of the residential mortgage loans in the Chilean banking system and approximately 18.7 % of such loans made by private sector banks.
Credit Cards
As of December 31, 2008, we issued Visa, MasterCard and Diners credit cards, and our product portfolio includes both personal and corporate cards. In addition to traditional cards, our credit card portfolio also includes co-branded cards (“Travel Club,” “Global Pass” and “Premium Club”), and 75 affinity card groups, most of which are associated with our co-branded programs.
As of December 31, 2008, we had 697,729 valid credit card accounts, with 883,536 credit cards to individuals. Total charges on our credit cards during 2008 amounted to Ch$ 1,139,510 million, with Ch$1,022,952 million corresponding to purchases and service payments in Chile and abroad and Ch$ 116,558 million corresponding to cash advances (both within Chile and abroad). These charge volumes represent a 34.5% market share in terms of volume of use of bank credit cards issued in Chile.
As of December 31, 2008, our credit card loans to individuals amounted to Ch$ 280,386 million and represented 14.9% of our retail market business segment’s consumer loans.
Two Chilean companies that are affiliated with us, Transbank S.A. and Nexus S.A., provide us with merchant acquisition and credit card processing services. As of December 31, 2008, Transbank S.A. had 15 shareholders and Nexus S.A. had seven shareholders, all of which are banks. As of December 31, 2008, our equity ownership in Transbank S.A. was 26.2% and our equity interest in Nexus S.A. was 25.8%.
We believe that the Chilean market for credit cards has a high potential for growth, especially among customers in the lower-middle and middle-income bracket, as the average merchant fees will continue to decline. We also believe that, in addition to the other banks that operate in Chile, our main competitors are department store cards and other non-banking businesses involved in the issuance of credit cards.
Debit Cards
We have different types of debit cards. Depending on their specifications, these cards can be used for banking transactions on the ATMs that operate on the local network, Redbanc, the Visa International PLUS network, the local network of merchants participating in the local Redcompra debit program or the international network of merchants associated with the Electron program. We have given these debit cards different names (Chilecard, Chilecard Plus, Chilecard Electron, Chilecard Empresas, Banjoven, Cheque Electronico, Multiedwards, Cuenta Directa, Cuenta Facil, Cuenta Familiar and Citicard) based on their specific functions and the relevant brand and target market to which they are oriented. As of December 31, 2008, we had a 43.8% market share of debit card transactions, with approximately 46.5 million transactions performed as of that date.
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Lines of Credit
We had approximately 463,458 approved lines of credit to individual customers as of December 31, 2008 and outstanding advances to 326,407 individuals totaling Ch$247,177 million, or 4.3% of the retail market total loans.
Our individual lines of credit are generally available on a revolving basis, up to an approved credit limit, and may be used for any purpose. Advances under lines of credit are denominated in pesos and bear interest at a rate that is set monthly. At the customer’s option, a line of credit loan may be renewed and re-priced for successive monthly periods, in each case subject to minimum monthly payments.
Deposit Products
We seek to increase our deposit-taking activities as a means of diversifying our sources of funding. We believe that the deposits of our individual customers provide us with a relatively low cost, stable funding source, as well as the opportunity to cross-market our other products and services. We offer checking accounts, time deposits and savings accounts to our individual customers. Checking accounts are peso-denominated and mostly non-interest bearing (approximately 0.1% of total checking accounts of the individual and middle market division are interest-bearing) and savings accounts are denominated in UF and bear interest at a fixed rate. Time deposits are denominated in pesos, UF and U.S. dollars. Most time deposits bear interest at a fixed rate with a term of 30 to 360 days.
While historically demand has been mainly for UF-denominated deposits during times of high inflation, demand for deposits denominated in pesos has increased in the current environment of lower and more stable inflation rates in Chile.
As of December 31, 2008, we administered 516,385 checking accounts for approximately 492,337 individual customers with an aggregate balance of Ch$708,620 million. At such date, our checking account balances totaled approximately Ch$2,534,753 million and represented 15.1% of our total liabilities.
The principal financial services offered to small and medium size companies with annual sales of up to Ch$1,400 million by the individuals and middle market division include a complete range of products, such as various financing options, support in import and export transactions, collection services, payments and collections, leasing agreements, factoring services, checking account services, investment management, insurance brokerage, currency trading, transfers and payments to and from abroad. As of December 31, 2008, we had approximately 51,020 middle market companies with checking accounts and 30,088 debtors.
Commercial Credits
Our individuals and middle market division’s commercial loans, which mainly consist of project financing and working capital loans, are denominated in pesos, UF or U.S. dollars. Commercial loans may have fixed or variable rates of interest and generally mature between one and three months from the date of the loan. As of December 31, 2008, our individuals and middle market companies had outstanding commercial loans of Ch$1,415,161 million, representing 24.6% of the retail market business segment’s total loans and 10.4% of our total loans at that date.
Leasing Contracts
Leasing contracts are financing leases for capital equipment and property. Leasing contracts may have fixed or variable rates of interest and generally mature between one and five years for equipment and between five and twenty years for property. Most of these contracts are denominated in UF. As of December 31, 2008, our individuals and middle market companies had outstanding leasing contracts of Ch$155,354 million, representing 2.7% of the retail market and 1.1% of our total loans at that date.
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Mortgage Loans
Mortgage loans granted to middle market companies are non-residential mortgage loans made to finance offices, land and other real estate. Mortgage loans are denominated in UF and generally have maturities of between eight and 12 years. As of December 31, 2008, middle market companies had outstanding mortgage loans of approximately Ch$178,284 million, representing 3.5% of the retail market business segment’s total loans and 1.3% of our total loans at such date.
Banco CrediChile Division, or Banco CrediChile
The Banco CrediChile division offers loans and other financial services to the lower-middle to middle income portions of the Chilean population, which historically have only been partially served by banking institutions. This bracket includes individuals whose monthly incomes fluctuate between Ch$100,000 and Ch$400,000 and small businesses. Banco CrediChile represents a distinct delivery channel for our products and services in this bracket, maintaining a separate brand and network of 144 Banco CrediChile branches. Banco CrediChile was established in 2004 from what was formerly our consumer banking division. In 2008, the business of Banco Credichile was combined with the consumer division of Atlas as part of the merger with Citibank Chile and thus became the leader in this segment in Chile.
Banco CrediChile offers our customers a range of products, including consumer loans, credit cards, auto loans and residential mortgage loans and a special demand deposit account (see “—Bancuenta” below) targeted at low-income customers. As of December 31, 2008, Banco CrediChile had approximately 450,709 customers and total loans outstanding of Ch$611,134 million, representing 4.5% of our total loan portfolio at that date.
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The following table sets forth the composition of our portfolio of loans to Banco CrediChile as of December 31, 2008:
Total consumer loans
Banco CrediChile focuses on developing and marketing innovative, targeted products to satisfy the needs of its customers while introducing them to the banking system. Banco CrediChile complements the services offered in our other business segments, especially our wholesale market, by offering services to employers such as direct deposit capabilities that stimulate the use of our services by employees.
The Chilean Superintendency of Banks requires greater allowances for loan losses for banks with lower credit classifications, such as Banco CrediChile. Banco CrediChile employs a specific credit scoring system, developed by our individual risk division, as well as other criteria to evaluate and monitor credit risk. Banco CrediChile seeks to ensure the quality of our loan portfolio through adherence to our loan origination procedures, particularly the use of our credit scoring system and credit management policies, including the use of credit bureaus and the services of the Chilean Superintendency of Banks. Banco CrediChile uses rigorous procedures for collection of past due loans through Socofin S.A., our specialized collection subsidiary. We believe that we have the necessary procedures and infrastructure in place to manage the risk exposure that Banco CrediChile introduces. These procedures allow us to take advantage of the attractive growth and earnings potential of this market while helping to manage the exposure to higher risk. See “Item 3. Key Information—Risk Factors—Risks Relating to our Operations and the Banking Industry—The growth of our loan portfolio may expose us to increased loan losses” and “Item 3. Key Information—Risk Factors—Risks Relating to our Operations and the Banking Industry—Our loan portfolio may not continue to grow at the same or similar rate.”
Consumer Lending
Banco CrediChile provides short- to medium-term consumer loans and credit card services. As of December 31, 2008, Banco CrediChile had approximately 371,371 consumer loans that totaled Ch$508,926 million outstanding. As of the same date, Banco CrediChile customers had 214,506 valid credit card accounts, with outstanding balances of Ch$30,428 million.
Bancuenta
Banco CrediChile introduced Bancuenta as a basic deposit product that provides consumers flexibility and ease of use, which allows us to tap a section of the consumer market that previously was not part of the banking system. The Bancuenta account is a non-interest bearing demand deposit account without checking privileges targeted at customers who want a secure and comfortable means of managing and accessing their money. The customer may use the ATM card linked to the Bancuenta account (which may include a revolving line of credit) to make deposits or automatic payments to other Banco CrediChile accounts through a network of 7,056 ATMs available through the Redbanc network.
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As of December 31, 2008, Banco CrediChile had approximately 655,179 Bancuenta accounts. Bancuenta account holders pay an annual fee, a fee related to the number of withdrawals on the Bancuenta line of credit and interest on any outstanding balance under the line of credit. All fees and interest due on a Bancuenta account are withdrawn automatically on a monthly basis from funds available in the account. Bancuenta allows us to offer our wholesale customers the ability to pay their employees by direct deposit of funds into the individual employee’s account at Banco CrediChile. We believe this product can lead to stronger long-term relationships with our wholesale customers and with the employees of such customers.
Wholesale Market
Our wholesale market business segment serves the needs of corporate customers with annual sales in excess of Ch$1,400 million. As of December 31, 2008, loans made by this business segment totaled approximately Ch$7,640,021 million and represented 56.0% of our total loan portfolio. Our wholesale banking business segment accounted for approximately Ch$146,708 million of our net income before tax for the year ended December 31, 2008.
The following table sets forth the composition of our portfolio of loans to the wholesale market as of December 31, 2008:
Commercial credits
Foreign trade loans
Leasing loans
Factoring loans
As of December 31, 2008, we had approximately 8,628 wholesale debtors. Our wholesale customers are engaged in a wide spectrum of industry sectors. As of December 31, 2008, this business segment’s loans were mainly related to:
financial services (approximately 29.5% of all loans made by this business segment);
trade (approximately 15.5% of all loans made by this business segment);
manufacturing (approximately 13.5% of all loans made by this business segment);
construction (approximately 11.5% of all loans made by this business segment);
agriculture, forestry and fishing (approximately 7.2% of all loans made by this business segment); and
community, social and personal services (approximately 5.6% of all loans made by this business segment).
In line with our strategy of identifying and differentiating market segments to provide value proposals for the specific needs of our customers, we have defined two divisions within the wholesale market based on companies’ annual sales, grouping them into (i) large corporations and (ii) large companies.
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Large Corporations Division
The large corporations division is oriented towards providing services to corporations that sell more than Ch$70 billion annually. This division’s customers include a large proportion of Chile’s publicly traded companies, subsidiaries of multinationals and conglomerates, including those in the financial, commercial, manufacturing, industrial and infrastructure sectors, as well as projects and concessions.
As of December 31, 2008, we had 606 large corporations debtors. Loans to large corporations totaled approximately Ch$3,923,232 million as of December 31, 2008, representing 28.7% of our total loans at that date.
The following table sets forth the composition of our portfolio of loans by the large corporations division as of December 31, 2008:
We offer our large corporation customers a wide variety of products that include short and long-term financing, working capital loans, mortgage loans, leasing, long-term syndicated loans and factoring, plus the investment banking services offered by our subsidiary, Banchile Asesoría Financiera S.A. Our investment banking services include the underwriting of public and private securities offerings. We also offer payment services (payrolls, suppliers, pensions, dividends, etc.), collection services and connection to international funds transfer networks, apart from the traditional deposit products, especially the checking account.
We are party to approximately 837 payment service contracts and approximately 210 collection service contracts with large corporations. We believe that cash management and payment service contracts provide a source of low-cost deposits and the opportunity to cross-market our products and fees to payees, many of whom maintain accounts with us. Under our collection contracts, we act as a collection agent for our large corporate customers, providing centralized collection services for their accounts receivable and other similar payments.
In order to provide a highly competitive service, our large corporation division has the direct support of our treasury and money market operations segment, which fulfills our corporate customers’ liquidity and short-term loans requirements directly. We have also improved our technological offerings to facilitate connection with customers and permit self-service. Similarly, we offer derivative products, which we believe have become increasingly important, especially peso-dollar and UF-dollar forward contracts and interest rate swaps.
The market for loans to large corporations in Chile in recent years has been characterized by reduced profit margins, due in part to the greater direct access of such customers to domestic and international capital markets and other sources of funds. As a result, we have been increasingly focused on margin growth and cross-selling fee generating services, such as the above mentioned payroll processing, dividend payments and billing services as well as computer banking services. This strategy has enabled us to maintain profitable relationships with our large corporate customers while preserving the ability to extend credit when appropriate opportunities arise.
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Large Companies Division
The large companies division provides a broad range of financial products such as electronic banking, leasing, foreign trade and financial consultancy to companies with annual sales between Ch$1,400 million and Ch$70 billion. Customers within this division are those related to commercial, manufacturing, the agriculture, forestry, fishing, infrastructure and real estate sectors, as well as projects and concessions.
As of December 31, 2008, we had 8,022 large companies debtors. Loans to large companies totaled approximately Ch$3,716,789 million as of December 31, 2008, representing 27.2% of our total loans at that date.
The following table sets forth the composition of our portfolio of loans by the large companies division as of December 31, 2008:
The products offered to these customers are mainly commercial loans, lines of credit, foreign trade and foreign currency transactions, factoring services, leasing, mortgage loans, syndicated loans, mergers and acquisitions and debt restructuring assistance, payments and collections services, checking accounts and related services, corporate credit cards, cash and investment management, forward contracts to hedge against currency fluctuations and insurance brokerage.
Our leasing segment is part of the large companies division and operates under the name of Banchile Leasing. Our factoring subsidiary, Banchile Factoring S.A., provides its services principally through the large companies division. The large companies division has introduced a new service model, centralizing the majority of business relations with its customers and eliminating intermediate reporting levels to provide faster response times. Account officers, which are organized by geographic region and by economic sector, are strongly sales-oriented and have a particular concern for service quality.
Our treasury and money market operations business segment provides a wide range of financial services to our customers including currency intermediation, forwards contracts, interest rate swaps, transactions under repurchase agreements and investment products based on bonds, mortgage notes and deposits.
In addition to providing services, our treasury and money market operations business segment is focused on managing currency, interest rate and maturity gaps, ensuring adequate liquidity levels and managing our investment portfolio. This business segment also performs the intermediation of fixed-income instruments, currencies and derivatives. Interest rate gap management is aimed at generating an adequate funding structure, prioritizing our capitalization and asset and liability cost structure and funding source diversification. This segment is also responsible for the issuance of short- and long-term bonds and the issuance of long-term subordinated bonds.
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The treasury and money market operations business segment is also in charge of monitoring compliance with regulatory deposit limits, technical reserves and maturity and rate matches, and monitors our adherence to the security margins defined by regulatory limits, as well as risk limits for interest rate, currency and investment gaps. The treasury and money market operations business segment continually monitors the funding costs of the local financial system, comparing them with our costs.
Our security portfolio as of December 31, 2008 amounted to Ch$1,071,438 million, of which 39.5% consisted of securities issued by the Central Bank and the Chilean Government, 9.6% consisted of securities from foreign issuers, 46.5% consisted of securities issued by local financial institutions and 4.4% consisted of securities issued by Chilean corporate issuers. Our investment strategy is designed with a view to supplementing our expected profitability, risks and economic variable projections. Our investment strategy is kept within regulatory limits as well as internal limits defined by our finance committee.
The international area, also part of the treasury and money market operations segment, manages relations with correspondent banks throughout the world, ensuring the fluent functioning of international payments and obtaining foreign currency financing for the Bank itself. As of December 31, 2008, we have established a network of approximately 900 correspondent banks, credit relations with approximately 250 correspondent banks and account relationships with approximately 42 correspondent banks.
Operations through Subsidiaries
We have made several strategic long-term investments in financial services companies, which are engaged in activities complementary to our commercial banking activities. Our principal goal in making these investments is to develop a comprehensive financial services group capable of meeting the diverse financial needs of our current and potential clients.
The following table sets forth information with respect to our financial services subsidiaries as of December 31, 2008:
Banchile Corredores de Bolsa S.A.
Banchile Administradora General de Fondos S.A.
Banchile Factoring S.A.
Banchile Corredores de Seguros Ltda
Socofin S.A.
Banchile Asesoría Financiera S.A.
Banchile Trade Services Limited
Banchile Securitizadora S.A.
Promarket S.A.
Citibank Agencia de Valores S.A(1).
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The following table sets out our ownership interest in our financial services subsidiaries as of December 31, 2008:
Banchile Trade Services Limited (Hong Kong)
Banchile Corredores de Seguros Ltda.
Each of these subsidiaries is incorporated in Chile, except for Banchile Trade Services Limited, which is incorporated in Hong Kong.
Securities Brokerage Services
We provide securities brokerage services through Banchile Corredores de Bolsa S.A. Banchile Corredores de Bolsa S.A. is registered as a securities broker with the Chilean Superintendency of Securities and Insurance, the regulator of Chilean open stock corporations, and is a member of the Santiago Stock Exchange and the Chilean Electronic Stock Exchange. Since it was founded in 1989, Banchile Corredores de Bolsa S.A. has provided stock brokerage services, fixed income investments and foreign exchange products to individuals and businesses through our branch network. During the year ended December 31, 2008, Banchile Corredores de Bolsa S.A. had an aggregate trading volume on the Santiago Stock Exchange and the Chilean Electronic Stock Exchange of approximately Ch$6,175,895 million. As of December 31, 2008, Banchile Corredores de Bolsa S.A. had equity of Ch$65,705 million and, for the year ended December 31, 2008, net income of Ch$10,016 million, which represented 3.7% of our consolidated net income for such period.
In addition, Citibank Agencia de Valores S.A., prior to its merger with and into Banchile Corredores de Bolsa S.A. referred to below, provided financial services as a securities broker, such as mutual funds management services. Citibank Agencia de Valores S.A. became a subsidiary of Banco de Chile as of January 1, 2008, as a result of the merger with Citibank Chile. As of December 31, 2008, Citibank Agencia de Valores S.A. had equity of Ch$6,746 million and, for the year ended December 31, 2008, a net loss of Ch$144 million. Effective January 1, 2009, Citibank Agencia de Valores S.A. merged with and into Banchile Corredores de Bolsa S.A.
Mutual and Investment Fund Management
Since 1980, we have provided mutual fund management services through Banchile Administradora General de Fondos S.A. (formerly Banchile Administradora de Fondos Mutuos S.A.). As of December 31, 2008, according to data prepared by the Chilean Superintendency of Securities and Insurance, Banchile Administradora General de Fondos S.A. was the largest mutual fund manager in Chile, managing
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approximately 24.0% of all Chilean mutual funds assets. As of December 31, 2008, Banchile Administradora General de Fondos S.A. operated 73 mutual funds and managed Ch$3,005,266 million in net assets on behalf of 250,930 corporate and individual participants. Banchile Administradora General de Fondos S.A. also operates four investment funds, Chile Small Cap, Banchile Inmobiliario I, II and III, and manages Ch$75,269 million in net assets on behalf of 938 participants.
During 2008, Banco de Chile acquired Legg Mason Chile, which channeled the business of Citibank Chile. Subsequently, during the same period, Legg Mason Chile merged with Banchile Administradora General de Fondos S.A.
The following table sets forth information regarding the various mutual funds managed by Banchile Administradora General de Fondos S.A. as of December 31, 2008:
Name of Fund
Type of Fund
Utilidades
Liquidez 2000
Deposito XXI
Corporativo
Estrategico
Corporate Dollar
Horizonte
Patrimonial
Performance
Banchile Acciones
Ahorro
Alianza
Disponible
Crecimiento
Inversion
Inversion 10
Inversion 20
Operacional
Capitalisa Accionario
Renta Futura
Euro Money Market Fund
Emerging Fund
Latin America Fund
Cobertura
Dolar Fund
U.S. Fund
Global
Asia Fund
Europe Fund
International Bond
Medical & Health-Care Fund
Inversion Dollar 30
Emerging Dollar
Global Dollar
U.S. Dollar Fund
Gestion Activa A
Gestion Activa Acciones
Gestion Activa B
Gestion Activa C
Gestion Activa D
Gestion Activa E
Bambu Garantizado
Brics Garantizado
Inversionista Calificado
Fronteras del Este
Marfil Garantizado
Verde Amarelo Garantizado
Consumo Estable
Energía y Materiales
Financiero
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Gigantes Garantizado
Industria y Consumo Cíclico
Liquidez Full
Tecnología y Telecomunicaciones
Tigres Garantizado
Potencias Garantizado
Fortalezas Garantizado
Wall Street 107 Garantizado
Inversión China
Inversión Brasil
Balance I
Asiatico Accionario
Inversión Dólar
Acciones Europa
Acciones USA
Cash
Inversión M.P.
Latina Accionario
Mid Cap
Inversión L.P.
Chile Accionario
Capital Financiero
Depósito Flexible
As of December 31, 2008, Banchile Administradora General de Fondos S.A. had equity of Ch$44,763 million and, for the year ended December 31, 2008, net income of Ch$5,758 million, which represented 2.1% of our consolidated net income for such period.
Factoring Services
We provide factoring services to our customers through Banchile Factoring S.A. Through this service, we purchase our customers’ outstanding debt portfolios, such as bills, notes, promissory notes or contracts, advancing them the cash flows involved and performing the collection of the related instruments. As of December 31, 2008, Banchile Factoring S.A. had net income of Ch$925 million, with a 2.8% return on equity and an estimated 12.3% market share in Chile’s factoring industry.
Financial Advisory Services
We provide financial advisory and other investment banking services to our customers through Banchile Asesoría Financiera S.A. The services offered by Banchile Asesoría Financiera S.A. are directed primarily to our corporate customers and include advisory services regarding mergers and acquisitions, restructuring, project finance and strategic alliances. As of December 31, 2008, Banchile Asesoría Financiera S.A. had equity of Ch$3,869 million and, for the year ended December 31, 2008, net income of Ch$4,744 million.
Insurance Brokerage
We provide insurance brokerage services to our customers through Banchile Corredores de Seguros Limitada. In 2000, we began to offer life insurance policies associated with consumer loans and non-credit related insurance to our individual clients and the general public. As of December 31, 2008, Banchile Corredores de Seguros Limitada had equity of Ch$11,256 million and, for the year ended December 31, 2008, net income of Ch$3,595 million. Banchile Corredores de Seguros Limitada had a 4.4% market share, measured by amount of policies (in Chilean pesos) sold by insurance brokerage companies during 2007, the latest year for which information is available for insurance brokerage companies.
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Securitization Services
We offer investment products to meet the demands of institutional investors, such as private pension funds and insurance companies, through Banchile Securitizadora S.A. This subsidiary securitizes financial assets, which involves the issuance of a debt instrument with a credit rating that can be traded in the Chilean marketplace, backed by a bundle of revenue-producing assets of the client company. As of December 31, 2008, Banchile Securitizadora S.A. had equity of Ch$407 million and, for the year ended December 31, 2008, a net loss of Ch$42 million. Banchile Securitizadora S.A. had a 11.3% market share measured by volume of assets securitized as of December 31, 2008.
Credits pre-evaluation services
Promarket S.A. provides credit pre-evaluation services to the Bank and its subsidiaries, and researches information about potential customers. As of December 31, 2008, Promarket S.A. had equity of Ch$934 million and, for the year ended December 31, 2008, net income of Ch$598 million.
Collection Services
We provide judicial and extra-judicial loan collection services on our behalf or on behalf of third parties through Socofin S.A. As of December 31, 2008, Socofin S.A. had equity of Ch$572 million and, for the year ended December 31, 2008, net income of Ch$112 million.
Trade Services
In November 2004, we began offering direct trade services to our customers through Banchile Trade Services Limited, which acts as our trade finance entity in markets such as China, Hong Kong, Taiwan and South Korea. As of December 31, 2008, Banchile Trade Services Limited had equity of Ch$695 million and, for the year ended December 31, 2008, net income of Ch$113 million.
Distribution Channels and Electronic Banking
Our distribution network provides integrated financial services and products to our customers through a wide range of channels. This network includes ATMs, branches, on-line banking and phone-banking devices. Our 1,584 ATMs (that form part of Redbanc’s 7,056 ATM system) allow our customers to conduct self-service banking transactions during banking and non-banking hours.
As of December 31, 2008, we had a network of 371 retail branches throughout Chile. The branch system serves as a distribution network for all of the products and services offered to our customers. Our full-service branches accept deposits, disburse cash, offer the full range of our retail banking products such as consumer loans, automobile financing, credit cards, mortgage loans and checking accounts and provide information to current and potential customers.
We offer electronic banking services to our customers 24 hours a day through our internet website, www.bancochile.cl, which has homepages that are segmented by market. Our individual homepage offers a broad range of services, including the payment of bills, electronic fund transfers, stop payment and non-charge orders, as well as a wide variety of account inquiries. Our corporate homepage offers services including our office banking service, Banconexion Web, which enables our corporate customers to perform all of their banking transactions from their offices. Both homepages offer our customers the sale of third-party products with exclusive benefits. We also have a homepage designed for our investor customers, through which they can perform transactions such as stock trading, time deposit taking and opening savings accounts. Our foreign trade customers can rely on our international business homepage, which enables them to inquire about the status of their foreign trade transactions and perform transactions such as opening letters of credit, recording import collection and hedging on instructions and letters of credit. In 2008, approximately 409,631 individual and corporate customers performed close to 16.6 million transactions monthly on our website, of which approximately 3.4 million were monetary transactions.
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In addition, we provide our customers with access to a 24-hour phone-banking call center that grants them access to account information and allows them to effect fund transfers and certain payments. This service, through which we receive approximately 605,703 calls per month, has enabled us to develop customer loyalty campaigns, sell financial services and products, answer specialized inquiries about our remote services and receive and resolve complaints by customers and non-customers.
In 2001, in association with Banco de Credito e Inversiones, we created a company called Comercio Electronico Artikos Chile S.A. with the purpose of providing Chilean companies with the opportunity to trade their products and services electronically through the internet. We supplement this service with a wide range of financial services and electronic payment means.
Involvement with the Transantiago Plan
Since June 2005, we have been a shareholder in Administrador Financiero de Transantiago (“AFT”), the company responsible for the financial management of the overhaul of Santiago’s public transit system (the “Transantiago Plan”). Other majority shareholders of the company include three major Chilean banks, a financial services company and a technology services company. We own 20% of AFT’s shares, which had an original capitalization of approximately U.S.$13.4 million as of June 8, 2005.
Although the Transantiago Plan has been beset with problems regarding its design, implementation and financing, certain transport agreements executed in March 2008 by and among the Secretary of Transportation and Telecommunications, the AFT and Toll Roads Companies sought to improve the Transantiago Plan. The Transantiago Plan is facing operational deficits that may be funded by means of permanent fiscal subsidies.
In 2007, as shareholders of AFT, we made extraordinary contributions for a total amount of U.S.$4,114,000 with the purpose of financing AFT’s expenses, which were capitalized as of December 31, 2007. Between January and April 2008, we made additional funds available to AFT in the amount of U.S.$358,000, to pay expenses arising from the Transantiago Plan. We have made no additional funds available after April 2008. AFT believes that it may continue to finance its operational expenses with revenue generated in the ordinary course of its business. However, if we had to incur additional payments, we do not expect that any such payments will materially affect our business.
Competition
The Chilean market for banking and other financial services is highly competitive, and we face significant competition in each of our principal segments of operation. The Chilean financial services market consists of a number of distinct sectors. The most important sector, commercial banking, includes 23 privately owned banks and one public sector bank, Banco del Estado. As of December 31, 2008, three banks together accounted for 53.5% of all outstanding loans by Chilean financial institutions, net of interbank loans: Banco Santander-Chile (20.8%), our bank (19.4%) and Banco de Credito e Inversiones (13.3%).
As a commercial bank offering a range of services to all types of businesses and individual customers, we face a variety of competitors, ranging from other large, privately owned commercial banks to more specialized entities like “niche” banks. We consider the principal commercial banks in Chile to be our primary competitors, namely, Banco Santander-Chile, Banco de Credito e Inversiones, Banco Bilbao Vizcaya Argentaria Chile, or BBVA, and Corpbanca. Nevertheless, we face competition to a lesser extent from Banco del Estado, which has a larger distribution network and larger customer base than we do. Banco del Estado,
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which operates under the same regulatory regime as Chilean private sector banks, was the fourth largest bank in Chile as of December 31, 2008, with outstanding loans, net of interbank loans, of Ch$9,322,591 million, representing a 13.3% market share, according to data published by the Chilean Superintendency of Banks.
In the wholesale market, we consider our strongest competitors to be Banco Santander-Chile, Banco de Credito e Inversiones, BBVA and Corpbanca. We also consider these banks to be our most significant competitors in the middle market companies business segment.
In the retail market, we compete with other private sector Chilean banks, as well with Banco del Estado. Among private banks, we consider our strongest competitors in this market to be Banco Santander-Chile, Banco de Credito e Inversiones and BBVA, as each of these banks has developed business strategies that focus on both middle market companies and lower-middle to middle income brackets of the Chilean population. In addition, with respect to high-income individuals, as of December 2008, we considered our strongest competitors in this market to be Banco Santander-Chile and Banco Itaú Chile.
The Chilean banking industry has experienced increased levels of competition in recent years, including from foreign banks, which has led to, among other things, consolidation in the industry. Consequently, strategies have, on an overall basis, been aimed at reducing costs and improving efficiency standards. Our income may decrease due to the extent and intensity of competition.
We expect the trend of increased competition and consolidation to continue, particularly in connection with the formation of new large financial groups and the creation of new niche banks. In this regard, in mid-1996, Banco Santander of Spain took control of Banco Osorno and merged it into its Chilean operations, changing its name to Banco Santander-Chile. In addition, Banco O’ Higgins and Banco de Santiago merged in January 1997, forming Banco Santiago. In 1999, Banco Santander of Spain took control of Banco Santiago. In August 2002, Banco Santiago and Banco Santander–Chile, then the second and fourth largest banks in Chile, respectively, merged and became Chile’s largest bank. In 2003, Banco del Desarrollo merged with Banco Sudameris, and in 2004, Dresdner Banque Nationale de Paris merged with Banco Security. In 2005, Banco de Credito e Inversiones merged with Banco Conosur. In 2007, Banco Itaú acquired Bank Boston unit in Chile, while Rabobank acquired HNS Bank. In addition, Scotiabank acquired Banco del Desarrollo. In the first quarter of 2008, we merged with Citibank Chile. In 2008, the Chilean Superintendency of Banks authorized the opening of a branch of the Norwegian bank DnB NOR and the acquisition of ABN Amro Bank by The Royal Bank of Scotland.
Although we believe that we are currently large enough to compete effectively in our target markets, any further consolidation in the Chilean financial services industry may adversely affect our competitive position.
Historically, commercial banks in Chile have competed in the retail market against each other, with finance companies and with department stores, the latter two having traditionally been focused on consumer loans to middle- and low-income subsegments. However, finance companies have gradually disappeared as most of them have been merged into the largest banks.
Non-bank competition from large department stores has become increasingly significant in the consumer-lending sector. Indeed, three new consumer-oriented banks, affiliated with Chile’s largest department stores, have been established during recent years. Although these banks had a market share of 1.5% as of December 31, 2008, according to the Chilean Superintendency of Banks, the opening of these banks is likely to make consumer banking more competitive.
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The following table provides certain statistical information on the Chilean financial system as of December 31, 2008:
Private banks
Banco del Estado
Total banking system
Source: Chilean Superintendency of Banks
Loans
The following table sets forth our market share in terms of loans (excluding interbank loans), and such of our principal private sector competitors, as of the dates indicated:
Banco Santander-Chile
Banco de Chile(2)
Citibank Chile
Banco de Credito e Inversiones
BBVA Bilbao Vizcaya
Banco Corpbanca
Total market share
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As of December 31, 2008, according to information published by the Chilean Superintendency of Banks, we had a ratio of allowances to total loans of 1.66%. This ratio was below the 1.79% posted by all banks in Chile as a whole. The following graph illustrates the five-year history of our allowances to total loan portfolio ratio as compared to the Chilean financial system’s ratio as of December 31 for each of the years indicated. Since 2008, the Chilean Superintendency of Banks has published financial statement information on a consolidated basis.
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The following table sets forth the ratio of allowances to total loans of the largest private sector banks and that of the financial system as a whole (including such banks) as of December 31 in each of the last five years:
Banco de Chile(1)
Banco Santander–Chile
Financial system
As of December 31, 2008, according to information published by the Chilean Superintendency of Banks, we had a ratio of past due loans to total loans of 0.60%. The following table sets forth the ratio of past due loans to total loans for the four largest private sector banks as of December 31 in each of the last five years on a consolidated basis:
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Deposits
We had deposits of Ch$11,482,449 million as of December 31, 2008 on a consolidated basis. In consolidated terms, our 18.8% of the market share for deposits, including borrowings from domestic financial institutions, placed us in second place among private sector banks. The following table sets forth the market shares in terms of deposits for the private sector banks with the largest market share as of December 31 in each of the last five years on a consolidated basis:
Equity
With Ch$1,216,008 million in equity (not including net income, minority interest and provision for minimum dividends), according to information published by the Chilean Superintendency of Banks, as of December 31, 2008, we were the second largest private sector commercial bank in Chile in terms of equity.
The following table sets forth the level of equity for the largest private sector banks in Chile as of December 31 in each of the last five years:
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Return on Average Equity
Our return on average equity, including net income for the year, was 20.1% for the year ended December 31, 2008, according to information published by the Chilean Superintendency of Banks. The following table sets forth our return on average equity and the returns of our principal competitors and the Chilean financial system, in each case as of December 31 in each of the last five years:
Financial system average
Efficiency
For the year ended December 31, 2008, our efficiency ratio (operating expenses as a percentage of our operating revenues) was 52.3% on a consolidated basis.(1)
The following table sets forth the efficiency ratios of the largest private sector Chilean banks as of December 31 in each of the last three years:
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REGULATION AND SUPERVISION
General
In Chile, only banks may maintain checking accounts for their customers, conduct foreign trade operations and, together with non-banking financial institutions, accept time deposits. The principal authorities that regulate financial institutions in Chile are the Chilean Superintendency of Banks and the Central Bank. Chilean banks are primarily subject to the Chilean General Banking Law and secondarily, to the extent not inconsistent with that law, the provisions of the Chilean Corporations Law governing public corporations, except for certain provisions that are expressly excluded.
The modern Chilean banking system dates back to 1925 and has been characterized by periods of substantial regulation and state intervention, as well as periods of deregulation. The most recent period of deregulation commenced in 1975 and culminated in the adoption of a series of amendments to the Chilean General Banking Law. In 2004, amendments to the General Banking Law granted additional powers to banks, including general underwriting powers for new issues of certain debt and equity securities and the power to create subsidiaries to engage in activities related to banking, such as brokerage, investment advisory, mutual fund services, administration of investment funds, factoring, securitization products and financial leasing services. Prior to 2006, banks had the option of distributing less than 30% of their earnings as dividends in any given year, subject to approval of the holders of at least two-thirds of the bank’s common stock. In 2006, however, the General Banking Law was amended to eliminate this option.
Following the Chilean banking crisis of 1982 and 1983, the Chilean Superintendency of Banks assumed control of banks representing approximately 51% of the total loans in the banking system. As part of the assistance that the Chilean government provided to Chilean banks, the Central Bank permitted banks to sell to it a certain portion of their problem loan portfolios at the book value of the loan portfolios. Each bank then repurchased such loans at their economic value (which, in most cases, was substantially lower than the book value at which the Central Bank had acquired the loans), with the difference to be repaid to the Central Bank out of future income. Pursuant to Law No. 18,818, which was passed in 1989, this difference was converted into subordinated debt.
The Central Bank
The Central Bank is an autonomous legal entity created by the Chilean Constitution. It is subject to its Ley Orgánica Constitucional, or Organic Constitutional Law, and the Chilean Constitution. To the extent not inconsistent with its Organic Constitutional Law or the Chilean Constitution, the Central Bank is also subject to private sector laws, but is not subject to the laws applicable to the public sector. It is directed and administered by a board of directors composed of five members designated by the President of Chile, subject to Senate approval.
The legal purpose of the Central Bank is to maintain the stability of the Chilean peso and the orderly functioning of Chile’s internal and external payment systems. The Central Bank’s powers include setting reserve requirements, regulating the amount of money and credit in circulation, and establishing regulations and guidelines regarding finance companies, foreign exchange (including the Formal Exchange Market) and bank deposit-taking activities.
The Chilean Superintendency of Banks
Banks are supervised and controlled by the Chilean Superintendency of Banks, a Chilean governmental agency. The Chilean Superintendency of Banks authorizes the creation of new banks and has broad powers to interpret and enforce legal and regulatory requirements applicable to banks and financial companies. Furthermore, in cases of noncompliance with its legal and regulatory requirements, the Chilean Superintendency of Banks has the ability to impose sanctions. In extreme cases, it can appoint, with the prior approval of the board of directors of the Central Bank, a provisional administrator to manage a bank. It must also approve any amendment to a bank’s bylaws or any increase in its capital.
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The Chilean Superintendency of Banks examines all banks from time to time, generally at least once a year. Banks are also required to submit unconsolidated unaudited financial statements to the Chilean Superintendency of Banks on a monthly basis and to publish their unaudited financial statements at least four times a year in a newspaper with countrywide coverage. Financial statements as of December 31 of any given year must be audited. In addition, banks are required to provide extensive information regarding their operations at various periodic intervals to the Chilean Superintendency of Banks. A bank’s annual financial statements and the opinion of its independent auditors must also be submitted to the Chilean Superintendency of Banks.
Any person wishing to acquire, directly or indirectly, 10.0% or more of the share capital of a bank must obtain the prior approval of the Chilean Superintendency of Banks. Without such approval, the holder will not have the right to vote such shares. The Chilean Superintendency of Banks may only refuse to grant its approval based on specific grounds set forth in the Chilean General Banking Law.
According to Article 35 bis of the Chilean General Banking Law, the prior authorization of the Chilean Superintendency of Banks is required for:
the merger of two or more banks;
the acquisition of all or a substantial portion of a bank’s assets and liabilities by another bank;
the control by the same person, or controlling group, of two or more banks; or
a substantial increase in the share ownership of a bank by a controlling shareholder of that bank.
Such prior authorization is required only when the acquiring bank or the resulting group of banks would own a market share in loans determined by the Chilean Superintendency of Banks to be more than 15.0% of all loans in the Chilean banking system. The intended purchase, merger or expansion may be denied by the Chilean Superintendency of Banks, or, if the acquiring bank or resulting group would own a market share in loans determined to be more than 20.0% of all loans in the Chilean banking system, the purchase, merger, or expansion may be conditioned on one or more of the following:
that the bank or banks maintain an effective equity higher than 8.0% and up to 14.0% of their risk-weighted assets;
that the technical reserve established in article 65 of the General Banking Law be applicable when deposits exceed one and a half times the resulting bank’s paid-in capital and reserves; or
that the margin for interbank loans be reduced to 20.0% of the resulting bank’s effective equity.
If the acquiring bank or resulting group would own a market share in loans determined by the Chilean Superintendency of Banks to be more than 15% but less than 20%, the authorization will be conditioned on the bank or banks maintaining an effective equity not lower than 10% of their risk-weighted assets for a period set by the Chilean Superintendency of Banks, which may not be less than one year. The calculation of risk-weighted assets is based on a five-category risk classification system applied to a bank’s assets that is based on the Basel Committee recommendations.
Pursuant to the regulations of the Chilean Superintendency of Banks, the following ownership disclosures are required:
banks must disclose to the Chilean Superintendency of Banks the identity of any person owning, directly or indirectly, 5.0% or more of its shares;
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holders of ADSs must disclose to the depositary the identity of beneficial owners of ADSs registered under such holders’ names;
the depositary must disclose to the bank the identity of beneficial owners of ADSs which the depositary has registered, and the bank, in turn, must disclose to the Chilean Superintendency of Banks the identity of the beneficial owners of the ADSs representing 5.0% or more of such bank’s shares; and
bank shareholders who individually hold 10.0% or more of a bank’s capital stock and who are controlling shareholders must periodically inform the Chilean Superintendency of Banks of their financial condition.
Limitations on Types of Activities
Chilean banks can only conduct those activities allowed by the General Banking Law, including making loans, factoring and leasing activities, accepting deposits and, subject to limitations, making investments and performing financial services. Investments are restricted to real estate for the bank’s own use, gold, foreign exchange and debt securities. Through subsidiaries, banks may also engage in other specific financial service activities such as securities brokerage services, mutual fund management, investment fund management, foreign capital fund management, financial advisory, securitization and factoring activities. Subject to specific limitations and the prior approval of the Chilean Superintendency of Banks and the Central Bank, Chilean banks may own majority or minority interests in foreign banks.
In March 2002, the Central Bank authorized banks to pay interest on checking accounts and the Chilean Superintendency of Banks published guidelines permitting banks to offer and charge fees for the use of a checking account product that pays interest. Under these guidelines, these accounts may be subject to a minimum balance and different interest rates depending on average balances held in the account. The Central Bank has imposed additional caps on the interest rate that can be charged by banks with a solvency score of less than A.
In June 2007, the Chilean Government passed Law No. 20,190, which amended various aspects of Chile’s capital markets regulatory framework, such as the General Banking Law, Securities, Insurance, Venture Capital and Tax law. Law No. 20,190 is aimed at improving the access to financing for start-up companies and small businesses in order to strengthen confidence in the stock market and to stimulate the development of the financial market in general. The General Banking Law was amended to achieve these ends by, among other things, revising regulations concerning demand deposits, increasing certain credit limits, and redefining the calculations to determine the proper amount for a bank’s reserves. In addition, the General Banking Law was amended to allow local banks to engage in derivatives such as options, swaps and forwards, thereby eliminating prior existing legal impediments to those practices.
Deposit Insurance
According to the Chilean General Banking Law, local or foreign currency denominated deposits at banks or financial companies are insured as described below.
The Chilean Government guarantees up to 100% of the principal amount of the following deposits held by individuals:
Deposits in current accounts;
Deposits in savings accounts;
Other demand deposits; and
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Deposits in savings accounts with unlimited withdrawals.
In addition, the Chilean Government guarantees up to 90.0% of the principal amount of time deposits held by individuals in the Chilean banking system. This guarantee covers obligations with a maximum value of UF108 per person (Ch$2,316,877.6 or U.S.$3,682.79 as of December 31, 2008).
Reserve Requirements
Deposits are subject to a reserve requirement of 9.0% for demand deposits and 3.6% for time deposits (with terms of less than one year). The Central Bank has statutory authority to increase these percentages to as much as 40% for demand deposits and as much as 20% for time deposits, to implement monetary policy.
In addition, Chilean banks must hold a certain amount of assets in cash or highly liquid instruments. This reserve requirement is equal to the amount by which the daily balance of deposits payable on demand, net of clearing, exceeds 2.5 times the amount of the bank’s effective equity. Deposits payable on demand include:
deposits in checking accounts;
other demand deposits or obligations payable on demand and incurred in the ordinary course of business;
saving deposits that allow unconditional withdrawals that bear a stated maturity; and
other deposits unconditionally payable immediately.
Chilean regulations also require that (1) gaps between assets and liabilities maturing within less than 30 days do not exceed a bank’s basic capital and (2) gaps between assets and liabilities maturing within less than 90 days do not exceed twice a bank’s equity.
Minimum Capital
Under the Chilean General Banking Law, a bank must have a minimum paid-in capital and reserves of UF800,000 (Ch$17,162 million or U.S.$27.3 million as of December 31, 2008). However, a bank may begin its operations with 50.0% of such amount, provided that it has an effective equity ratio (defined as effective equity as a percentage of risk-weighted assets) of not less than 12.0%. When such a bank’s paid-in capital reaches UF600,000 (Ch$12,872 million or U.S.$20.5 million as of December 31, 2008), the effective equity ratio requirement is reduced to 10.0%.
Capital Adequacy Requirements
According to the General Banking Law, each bank should have an effective equity of at least 8.0% of its risk-weighted assets, net of required allowances. Effective equity is defined as the aggregate of:
a bank’s paid-in capital and reserves, or net capital base;
its subordinated bonds, considered at the issue price (but reduced 20.0% for each year during the period commencing six years prior to maturity), but not exceeding 50.0% of its net capital base; and
its additional allowances for loan losses, up to 1.25% of risk-weighted assets to the extent these additional allowances exceed those that banks are required to maintain by law or regulation.
Banks should also have a net capital base of at least 3.0% of their total assets, net of required allowances.
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Market Risk Regulations
In September 2005, the Chilean Superintendency of Banks introduced new regulations for measuring market risks (e.g., price and liquidity risks). The Chilean Superintendency of Banks introduced standardized methodologies based on Basel Market Risk Measurement models for measuring and reporting price risks. These methodologies allow local banks to determine interest rate, foreign exchange (“FX”) and options risks (for FX and interest rate transactions) taken in both their trading and accrual books.
The trading book is comprised of the debt instruments portfolios that have a liquid secondary market and therefore their valuation at market prices (and the corresponding P&L) impact is representative of market conditions. In addition, all derivative transactions and the FX mismatches are also part of the trading book. The accrual book is comprised of all of the asset and liability balance sheet items that are not part of the trading book.
The new rules state that the price risk of the trading book plus 10% of the risk-weighted assets may not be greater than a bank’s effective equity (in this case, the effective equity is equivalent to equity plus subordinated debt and other minor adjustments). As of December 31, 2008, the price risk of our trading book totaled Ch$46,696 million.
The following table shows our regulatory risk availability, computed as the difference between the total risk (10% of the risk-weighted assets plus the trading book risk) and our effective equity, as of December 31, 2008:
(a) 10% risk-weighted assets
(b) Trading price risk
(c = a + b) Total risk
(d) Effective Equity
(e = d - c) Risk Availability
The guidelines for measuring liquidity risk are mainly focused on constructing a projected cash flow including behavioral run-off assumptions for some specific balance sheets items (for example, demand deposits).
In June 2006, the Chilean Superintendency of Banks introduced new regulations relating to (a) the valuation process of debt instruments and (b) the measurement and reporting of credit risk generated by derivative transactions.
Prior to June 2006, the Chilean Superintendency of Banks allowed banks to classify debt instruments for accounting and business purposes as either “Trading” or “Held-to-Maturity” only. Starting in June 2006, a new alternative classification was added (“Available-for-Sale”). With these three classifications now in place, the Chilean classification framework is in line with current international standards prevalent in all major financial centers. No changes to the classification system have occurred since June 2006.
Credit risk for derivative transactions, for regulatory purposes, must be measured and reported as:
Credit risk = Current Mark-to-Market (if positive) + Credit Risk Factor (%) * Notional Amount
The Current Mark-to-Market (or CMTM) of the transaction, if positive, reflects the amount of money owed by the customer today. In other words, the CMTM represents the amount the customer would pay us if the transaction was unwound today.
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As we are interested in measuring the amount of money that the customer would owe us at maturity, the potential future value of the transaction is added to the CMTM. This potential is measured as the Credit Risk Factor multiplied by the Notional Amount. The Credit Risk Factor reflects the potential fluctuation (under some specific confidence level) that the market factors involved in the transaction may have in the future until maturity, that positively (or negatively) impact the value (or risk) of the transaction for the bank. The regulator determines the Credit Risk Factor by considering market factors (interest rates, FX rates, etc.) and the types of transactions (FX forwards, interest rate swaps, etc.).
The formula detailed above does not completely capture the counterparty risk due to the derivative activities as the above methodology excludes transactions with a current negative value. This exclusion misstates the actual counterparty risk for the counterparties whose transactions are currently showing a negative current value for the bank. It is important to note that the fluctuation of market factors may lead to a positive expected value for the bank at maturity, although the above methodology does not capture such risk while it has a negative value.
Lending Limits
Under the General Banking Law, Chilean banks are subject to certain lending limits, including the following material limits:
a bank may not extend to any entity or individual, directly or indirectly, unsecured credit in an amount that exceeds 10.0% of the bank’s effective equity, or in an amount that exceeds 30.0% of its effective equity if the excess over 10.0% is secured by certain assets with a value equal to or higher than such excess. In the case of foreign export trade financing, the ceiling for unsecured credits is 10.0% and 30.0% for secured credits.
in the case of financing infrastructure projects built through the concession mechanism, the 10.0% ceiling for unsecured credits is raised to 15.0% if secured by a pledge over the concession, or if granted by two or more banks or finance companies which have executed a credit agreement with the builder or holder of the concession;
a bank may not extend loans to another financial institution subject to the General Banking Law in an aggregate amount exceeding 30.0% of its effective equity;
a bank may not extend to any individual or entity that is, directly or indirectly, related to the ownership or management of the bank, credit under more favorable terms with respect to repayment conditions, interest rates or collateral than those granted to third parties in similar transactions. The aggregate amount of such credits granted to related persons may not exceed 5.0% of the bank’s effective equity. The 5.0% unsecured ceiling is raised to 25.0% of the bank’s effective equity if the excess over 5.0% is secured by certain assets with a value equal to or higher than such excess. In any case, the aggregate amount of these credits granted by the bank may not exceed the bank’s effective equity.
a bank may not directly or indirectly grant a loan, the purpose of which is to allow an individual or entity to acquire shares of the lender bank;
a bank may not lend, directly or indirectly, to a director or any other person who has the power to act on behalf of the bank; and
a bank may not grant loans to related parties (including holders of more than 1.0% of its shares) on more favorable terms than those generally offered to non-related parties. Loans granted to related parties are subject to the limitations described in the first bullet point above. The aggregate amount of loans to related parties may not exceed a bank’s effective equity.
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In addition, the General Banking Law limits the aggregate amount of loans that a bank may grant to its employees to 1.5% of its effective equity and provides that no individual employee may receive loans in excess of 10.0% of this 1.5% limit. Notwithstanding these limitations, a bank may grant to each of its employees a single residential mortgage loan for personal use once during such employee’s term of employment.
Classification of Banks
The Chilean Superintendency of Banks regularly examines and evaluates each bank’s solvency and credit management process, including its compliance with loan classification guidelines. On the basis of this evaluation, it classifies banks into various categories.
Solvency and Management
In accordance with amended regulations of the Chilean Superintendency of Banks effective as of January 1, 2004, banks are classified into categories “I” through “V” based upon their solvency and management ratings. This classification is confidential.
A bank’s solvency rating is determined by its effective equity (after deducting accumulated losses during the financial year) to risk-weighted assets ratio. This ratio is equal to or greater than 10.0% for level A banks, equal to or greater than 8.0% and less than 10.0% for level B banks and less than 8.0% for level C banks.
With respect to a bank’s management rating, level A banks are those that are not rated as level B or C. Level B banks display some weakness in internal controls, information systems, response to risk, private risk rating or ability to manage contingency scenarios. Level C banks display significant deficiencies in internal controls, information systems, response to risk, private risk rating or ability to manage contingency scenarios.
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Allowances for Loan Losses
Chilean banks are required to evaluate their loan portfolio on a continuous basis using models and methods that follow guidelines established by the Chilean Superintendency of Banks that have been approved by our board of directors. This evaluation is conducted in order to determine the necessary allowances to cover loan losses adequately. Each bank is required to calculate and maintain, on a monthly basis, the following types of allowances:
allowances determined by individual analysis models (allowances for normal risk and above normal risk portfolios);
allowances determined by group analysis models; and
additional allowances for the loan portfolio.
Each year, a bank’s board of directors must examine the sufficiency of its level of allowances and provide an opinion stating whether the allowances are sufficient to cover all potential loan losses. The board must also obtain a report from the external auditors regarding compliance with required allowance levels. The opinion of the board of directors must be submitted in writing to the Chilean Superintendency of Banks and, if necessary, should state that additional allowances have been created as a result of the board’s examination.
The additional provisions up to an amount equal to 1.25% of the risk-weighted assets must be accounted for as effective equity in accordance with the Chilean Superintendency of Banks’ guidelines.
The Chilean Superintendency of Banks amended its guidelines effective as of January 1, 2004. Pursuant to the amended guidelines, Chilean banks are required to classify their loan portfolio on an ongoing basis for the purpose of determining the amount of allowances for loan losses. Although the Chilean Superintendency of Banks has established these guidelines, banks are given some latitude in devising more stringent classification systems within such guidelines. Prior to January 1, 2004, banks classified their loan portfolios and determined allowances for loan losses using different guidelines.
In order to create and maintain allowances, Chilean banks use models and methods to classify their portfolio by borrower and loan type. Loans are divided into:
consumer loans: comprised of all loans granted to individuals to be used for purchasing goods or services. This category include different types of loans (either installments or revolving), as well as balances from using credit cards or making overdrafts on current accounts belonging to individuals. Consumer loans also include consumer lease transactions and other accounts receivable;
mortgage loans: this category includes mortgage loans granted to individuals to acquire, expand, repair or build a home, issued as mortgage bonds, endorsable mortgage loans or other methods. It also includes supplementary loans for the same purposes and bridge loans granted during the period before the mortgage loan has been settled. This subcategory also includes residential real estate lease transactions and other accounts receivable; and
commercial loans: this category includes loans other than those described in the bullets above.
The models and methods a bank uses to classify its loan portfolio must comply with the following guidelines established by the Chilean Superintendency of Banks.
Models Based on the Individual Analysis of Borrowers
An individual analysis of the borrower is necessary if the borrower is a large or complex business, or one to which the bank has no previous exposure. Models based on the individual analysis of borrowers require that the bank assign a risk category level to each borrower and its respective loans. In making such a determination, a bank must consider the following risk factors with respect to the borrower: (i) its industry or sector; (ii) its owners or managers; (iii) its financial situation; (iv) its payment capacity; and (v) its payment behavior.
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Upon completion of this analysis, each borrower and loan must be classified by the following normal risk or above normal risk category levels:
Required Allowances. For loans in categories A1, A2, A3 or B, the board of directors of a bank is authorized to determine the levels of required allowances. Our Board of Directors has established the following levels of required allowances for loans classified as A1, A2, A3 and B:
Classification
Estimated range of loss
A1
A2
A3
B
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For loans in categories C1, C2, C3, C4, D1 or D2, we must have the following levels of allowances:
Category(1)
Allowance(2)
C1
C2
C3
C4
D1
D2
Models Based on the Group Analysis of Borrowers
A model based on the group analysis of borrowers should be used for the evaluation of borrowers whose individual loan amounts are relatively small, primarily loans to individuals and small companies. Each bank determines the level of required allowances depending on the estimated loss that may result from the loans, by classifying the loan portfolio using one or both of the following models:
A model based on the characteristics of the borrowers and their outstanding loans. Borrowers and their loans with similar characteristics will be placed into groups and each group will be assigned a risk level. Characteristics considered include payment behavior (with respect to the bank and other financial institutions), level of debt and financial stability.
A model based on the behavior of a group of loans. Loans with similar payment histories and characteristics will be placed into groups and each group will be assigned a risk level.
Additional Allowances
Under the Chilean Superintendency of Bank’s regulations, banks may create allowances in addition to those established pursuant to their model-based evaluation of the loan portfolio. However, a bank may create additional allowances only to cover specific risks that have been authorized by the board of directors. Our Board of Directors has established additional allowances to cover the unexpected deterioration of our loan portfolio.
Obligations Denominated in Foreign Currencies
Foreign currency denominated obligations of Chilean banks are subject to two requirements:
a reserve requirement of 9.0% for demand deposits and 3.6% for time deposits. See “—Reserve Requirements” above; and
a bank’s aggregate amount of net foreign currency liabilities having an original maturity of less than 30 days cannot exceed its net capital base, and the aggregate amount of net foreign currency liabilities having an original maturity of less than 90 days cannot exceed twice its net capital base.
Capital Markets
Under the General Banking Law, banks in Chile may purchase, sell, place, underwrite and act as paying agents with respect to certain debt securities. Likewise, banks in Chile may place and underwrite certain equity securities. Bank subsidiaries may also engage in debt placement and dealing, equity issuance advice and securities brokerage, as well as mutual fund and investment fund administration, factoring, investment advisory services and merger and acquisition services. The Chilean Superintendency of Banks generally regulates these subsidiaries. However, the Chilean Superintendency of Securities and Insurance regulates some of these subsidiaries. The Chilean Superintendency of Securities and Insurance is the regulator of the Chilean securities market and open stock corporations.
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Legal Provisions Regarding Banking Institutions with Economic Difficulties
The General Banking Law provides that if specified adverse circumstances exist at any bank, its board of directors must correct the situation within 30 days from the date of receipt of the relevant financial statements. If the board of directors is unable to do so, it must call a special shareholders’ meeting to increase the capital of the bank by the amount necessary to return the bank to financial stability. If the shareholders reject the capital increase, or if it is not effected within the 30-day period and in the manner agreed to at the meeting, or if the Chilean Superintendency of Banks does not approve the board of directors’ proposal, the bank will be barred from increasing its loan portfolio beyond that stated in the financial statements presented to the board of directors and from making any further investments in any instrument other than instruments issued by the Central Bank. In such a case, or in the event that a bank is unable to make timely payment in respect of its obligations, or if a bank is under provisional administration of the Chilean Superintendency of Banks, the General Banking Law provides that the bank may receive a two-year term loan from another bank. The terms and conditions of such a loan must be approved by the directors of both banks, as well as by the Chilean Superintendency of Banks, but need not be submitted to the borrowing bank’s shareholders for their approval. A creditor bank may not grant such interbank loans to an insolvent bank in an amount exceeding 25.0% of the creditor bank’s effective equity. The board of directors of a bank that is unable to make timely payment of its obligations must present a reorganization plan to its creditors in order to capitalize the credits, extend their respective terms, forgive debts or take other measures for the payment of the debts. If the board of directors of a bank submits a reorganization plan to its creditors and such arrangement is approved, all subordinated debt issued by the bank, whether or not matured, will be converted by operation of law into common stock in the amount required for the ratio of effective equity to risk-weighted assets to be no lower than 12.0%. If a bank fails to pay an obligation, it must notify the Chilean Superintendency of Banks, which shall determine if the bank is solvent.
Dissolution and Liquidation of Banks
The Chilean Superintendency of Banks may establish that a bank should be liquidated for the benefit of its depositors or other creditors when the bank does not have the necessary solvency to continue its operations. In such case, the Chilean Superintendency of Banks must revoke the bank’s authorization to exist and order its mandatory liquidation, subject to agreement by the Central Bank. The Chilean Superintendency of Banks must also revoke the bank’s authorization if the reorganization plan of the bank has been rejected twice. The resolution by the Chilean Superintendency of Banks must state the reason for ordering the liquidation and must name a liquidator, unless the Superintendent of Banks assumes this responsibility. When a liquidation is declared, all checking accounts, other demand deposits received in the ordinary course of business, other deposits unconditionally payable immediately or that have a maturity of no more than 30 days, and any other deposits and receipts payable within 10 days of its maturity date, are required to be paid by using the bank’s existing funds, its deposits with the Central Bank, or its investments in instruments that represent its reserves. If these funds are insufficient to pay these obligations, the liquidator may seize the bank’s remaining assets, as needed. If necessary, and in specified circumstances, the Central Bank will lend the bank the funds necessary to pay these obligations. Any such loans are preferential to any claims of other creditors of the liquidated bank.
Investments in Foreign Securities
Under current Chilean banking regulations, banks in Chile may grant loans to foreign individuals and entities and invest in certain foreign currency securities. Chilean banks may only invest in equity securities of foreign banks and certain other foreign companies which may be affiliates of the bank or which would support the bank’s business if such companies were incorporated in Chile. Banks in Chile may also invest in debt securities traded in formal secondary markets. Such debt securities shall qualify as (1) securities issued or guaranteed by foreign sovereign states or their central banks or other foreign or international financial entities, and (2) bonds issued by foreign companies. Such foreign currency securities must have a minimum rating as indicated in the table below:
Rating Agency
Moody’s
Standard and Poor’s
Fitch IBCA
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A Chilean bank may invest in securities having a minimum rating as follows, provided that if the total amount of these investments exceeds 20% (or 30% in certain cases) of the effective equity of the bank, an allowance of 100% of the excess shall be established by the bank:
If investments in these securities and certain loans referred to below exceed 70% of the effective equity of the bank, an allowance for 100% of the excess shall be established, unless the excess, up to 70% of the bank’s effective equity, is invested in securities having a minimum rating as follows:
Subject to specific conditions, a bank may grant loans in dollars to subsidiaries or branches of Chilean companies located abroad, to companies listed on foreign stock exchanges located in countries with an international risk rating not less than BB- or its equivalent and, in general, to individuals and entities residing or domiciled abroad.
In the event that the sum of the investments of a bank in foreign currency and the commercial and foreign trade loans granted to foreign individuals and entities exceeds 70.0% of the effective equity of such bank, the excess is subject to a mandatory reserve of 100.0%.
Convergence to IFRS
The Chilean Superintendency of Banks through Circular No. 3.410, dated November 9, 2007, subsequently complemented by Circular No. 3.443, dated August 21, 2008, introduced the new Compendium of Accounting Standards applicable as of January 1, 2009, as a result of the convergence project to International Financial Reporting Standards (IFRS). Since January 1, 2008, Chilean banks have begun to use the new Compendium of Accounting Standards in the preparation of their financial statements in accordance with the guidance provided by the Chilean Superintendency of Banks. The new Compendium of Accounting Standards differs in certain aspects from IFRS, such as the fact that banks (i) must provide for credit risk based on requirements such as expected losses on loan commitments (i.e., off-balance contingent risk such as authorized credit limits or letters of credit not yet negotiated) and (ii) are not allowed to designate assets or liabilities at fair value.
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The retroactive accumulated impact of the accounting changes at December 31, 2008 were directly recognized in equity by an increase equivalent to Ch$23.131 million at January 1, 2009.
The summary of the main accounting criteria changes that have been applied since January 1, 2009, include the following:
Price-level restatement
Until December 31, 2008, non-monetary assets, liabilities and equity accounts were restated according to the changes in the Consumer Price Index (CPI).
As of January 1, 2009, price-level restatement criteria was eliminated, considering Chile has a non- hyperinflationary economy as per the terms of the International Standard of Accountancy No. 29 (NIC 29).
Staff severance indemnities:
This liability is recorded at its present value, according with Technical Bulletin No. 8 of the Chilean Association of Accountants. As of January 1, 2009, the liabilities of this benefit plan are valued according to “projected unit of credit method,” including as variables: staff rotation rate, the salary growth expected and the probability of use of this benefit, discounted to the current rate for long term operations in accordance with the International Standard of Accountancy No. 19 (NIC 19) Benefits to Employees.
Fixed assets:
Until December 31, 2008, fixed assets were stated at acquisition cost net of accumulated depreciation restated by price-level restatement. As of January 1, 2009, the fixed assets value corresponds to historical cost or value of last appraisal required by the local regulator, with the price-level restatement applied until December 31, 2007. In the case of certain real estate items, according to the Compendium of Accounting Standards, the Bank chose to apply the reasonable value of these assets based on independent appraisals.
Impaired Portfolio:
The Impaired Portfolio concept was incorporated as of January 1, 2009. Impaired Portfolio corresponds to those customers where there is evidence that they will fail with any of their obligations in the payment conditions that were previously agreed.
In this context, the bank must incorporate these loans to impaired portfolio category and maintain them in that portfolio until a normalization payment’s conduct is observed.
Interest revenue:
(i) Until December 31, 2008, the loans and accounts receivable to customers were presented with their interests and accruals, according to the agreed rate. Loan origination costs were capitalized and amortized over the average life of the loan portfolio. As of January 1, 2009, loans and interest revenue are recorded using the effective interest rate method.
(ii) Suspension of recognition of revenue on an accrual basis
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Until December 31, 2008, interest revenue recognition factored in the suspension of accrual according to the following criteria:
From the date a loan, portion of the loan or installment is unpaid and 90 days overdue, while no payments or renegotiations apply on the delinquent amounts
Accrual suspended for loans classified in categories D1 and D2, from the classification date and so long as these loans are not reclassified in a risk category lower than C4.
For loans that were classified in category C4 during one year, the accrual is suspended one year after the credit was classified in this category (C4).
Starting on January 1, 2009, a portion of the loan portfolio classified as “impaired portfolio” (customers classified in the D1, D2, C3 and C4 credit risk categories) suspends the accrual of interest as described below:
Suspension Criteria
Suspension applies:
Individual Credit Evaluation (by debtor):
Loans classified in categories D1 and D2
Loans classified in category C3 and C4
Group Credit Evaluation (by group of debtors):
Loans with guaranties less than 80% of the outstanding
When the loan completes six months of
delinquency.
Charge-off loans:
Until December 31, 2008, the time requested by the Chilean Superintendency of Banks for recording charge-offs from loans was considered from its entrance to its past due portfolio. The past due portfolio is comprised of loans and loan installments whose principal or interest payments are 90 days or more past due.
As of January 1, 2009, charge-off loans apply on the current and past due installments, i.e., the charge-off should be recorded when the period of an unpaid installment or part of a credit completes the term indicated in the table below:
Types of Loan
Consumer loans with or without collateral
Other operations without collateral
Commercial loans with collateral
Residential real estate mortgage loans
Consumer leasing
Other non real estate leasing operations
Real estate leasing (commercial or residential)
Rewrite of charged-off transactions
Until December 31, 2008, at the moment of a renegotiation of a credit transaction previously written off, the accounting criteria applied treated it as loan recovery for the total amount renegotiated.
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Under the new rule, any renewal or renegotiation of charge–off credits is not considered recovery and only effective payments received from customers must be treated as loan recoveries.
Consequently, a previous credit write-off can only be recorded as an asset if the client maintains regular payments for at least six consecutive months.
Deferred taxes:
The effect of deferred taxes arising out of the temporary differences originating in the adjustment made due to the application of the new accounting criteria established by the Chilean Superintendency of Banks, were recognized in January 1, 2009.
The summary of retroactive impact on the financial statement due to these new accounting criteria, applicable as of December 31, 2008, is shown under Note 35 to the Consolidated Financial Statements.
Changes to Charging of Fees for Bank Services
On March 25, 2008, the Chilean Superintendency of Banks issued a circular (No. 3,429) which adopted a new rule to govern the charging of fees or commissions for services performed by banks. The new rule provides general criteria for the calculation of fees depending on which products or services are involved. The new rule seeks to increase transparency in fee and commission structures by improving the accuracy of information delivered to customers.
Under the new rule, banks will be required to provide adequate disclosure of financial services costs and will submit periodic information on fees effectively charged. In addition, banks must give 60 days’ notice to affected customers before implementing any changes related to the amount of fees and other charges and must provide full disclosure of any such fees or charges. In particular, the amended rule imposes a restriction on the ability of banks to collect fees for current accounts. Banks will only be permitted to charge annual administration fees for certain services (such as non-payment orders, check protests and non-authorized overdrafts, to name a few). The only fees that may be charged for services to current accounts are those that are either voluntarily accepted by the customer or those that relate to the maintenance of systems for providing such services (and not the transactions themselves).
We anticipate that the application of this new rule will have an impact on the Bank’s income, primarily due to our inability to charge certain fees which have historically been charged. The amended rule became fully effective as of March 1, 2009.
Procedures for the Management of Information of Interest to the Market
In order to ensure compliance with the provisions of the Chilean Securities Market Law and regulations, issued by the Chilean Superintendency of Securities and Insurance and the Chilean Superintendency of Banks, the Board of Directors of Banco de Chile approved, on October 24, 2008, the Manual for the Management of Information of Interest to the Market (the “Manual”).
The Manual’s main objective is to provide timely disclosure of Banco de Chile’s policies and internal regulations in connection with the disclosure of information to the public and the systems that have been implemented at the Bank.
In addition, these policies and internal regulations establish codes of conduct that Banco de Chile’s employees and other persons with access to certain information must comply with in order to protect information related to the Bank.
The Manual is available to the general public on Banco de Chile’s web page at www.bancochile.cl.
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Prevention of Money Laundering and the Financing of Terrorism
On March 6, 2006, the Chilean Superintendency of Banks issued regulations governing the requirements applicable to banks with respect to prevention of money laundering and terrorism financing. The regulations are aimed at incorporating international anti-money laundering (“AML”) and terrorism financing laws to the Chilean banking industry. Pursuant to the regulations, the Chilean Superintendency of Banks requires that banks implement an Anti-Money Laundering and Terrorism Financing system based mainly on the “know your customer” concept. Moreover, these policies and procedures must be approved by the board of directors and must take into account the volume and complexity of its operations and other related parties.
Based on these requirements, a Customer Identification Program (as part of the Anti-Money Laundering and Terrorism Financing) is needed to enable the Bank to reestablish the reasonable belief that it knows the true identity of its customers. In general, the program includes:
properly identifying customers, including their background, source and amount of funds, country of origin and other risk factors;
identifying what the Chilean Superintendency of Banks has defined as “persons politically exposed at the international level,” or PEPs, both within Chile and internationally;
establishing procedures to open accounts and products, with different documentation requirements needed for different types of accounts and products.
The Anti-Money Laundering and Terrorism Financing system required by local regulations must also include the following components:
AML policies and procedures aimed at preventing the Bank from being used as an intermediary to carry out money laundering operations;
Creation of a Compliance Officer on a senior management level who is responsible for coordinating and monitoring day-to-day AML compliance;
Establishment of an AML Committee, whose main function is planning and coordinating the fulfillment of AML policies and procedures. Our AML Committee gathers on a monthly basis and its membership includes the Chairman of the Board, the Chief Executive Officer, Legal Counsel, Operations and Technology Manager, CEO of Banchile Administradora General de Fondos S.A., the Risk Control Manager and the Global Compliance Head. In addition, we have also established a Transaction Analysis Committee, whose purpose is to analyze suspicious transactions, determine continuity of business with such clients and report these matters to the Financial Analysis Unit;
Use of software tools to detect, monitor and report unusual operations related to transactions made by customers on different products;
Implementation of personnel selection policies and a training program, in order to prevent money laundering issues;
Establishment of a Code of Conduct, in order to, among other things, guide employee behavior and prevent possible conflicts of interest; and
Independent testing in the Compliance area, which must be conducted by the Bank’s Internal Audit Department.
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ORGANIZATIONAL STRUCTURE
The following diagram presents our current corporate structure, including our subsidiaries and their respective ownership interests:
With the exception of Banchile Trade Services Limited, which was incorporated in Hong Kong, all of the subsidiaries presented above have their jurisdiction of incorporation in the Republic of Chile.
PROPERTY, PLANTS AND EQUIPMENT
We are domiciled in Chile and own the building located at Ahumada 251, Santiago, Chile that is approximately 76,500 square meters and serves as the headquarters for the Bank and its subsidiaries. In addition, we own an approximately 15,000 square meter building located at Huerfanos 740, Santiago, Chile where the remainder of our executive offices are located. As of, December 31, 2008, we owned the properties on which 165 of our full-service branches and other points of sale are located (approximately 110,000 square meters of office space). As of December 31, 2008, we had leased office space for our remaining 263 full-service branches and other points of sale, as well as for our representative offices. We also own properties throughout Chile for back office and administrative operations, as well as for storage of documents and other purposes. We believe that our facilities are adequate for our present needs and suitable for their intended purposes.
We also own approximately 135,000 square meters in mainly recreational physical facilities in Chile, which we use to assist our employees in maintaining a healthy work and life balance and which we use for incentive and integration activities.
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SELECTED STATISTICAL INFORMATION
The following information is included for analytical purposes and should be read in conjunction with our audited consolidated financial statements as well as “Item 5. Operating and Financial Review and Prospects.”
Average Balance Sheets, Interest Earned on Interest Earning Assets and Interest Paid on Interest Bearing Liabilities
The average balances for interest earning assets and interest bearing liabilities, including interest and readjustments received and paid, have been calculated on the basis of our daily balances and on the basis of monthly balances for our subsidiaries. These average balances are presented in Chilean pesos (Ch$), in UF and in foreign currencies (principally the U.S. dollar). The UF is an inflation-indexed Chilean monetary unit of account with a value in Chilean pesos which is linked to, and which is adjusted daily to reflect changes in, the Consumer Price Index of the Chilean National Institute of Statistics. See Note 1(b) to our audited consolidated financial statements.
The nominal interest rate has been calculated by dividing the amount of interest and principal readjustment gain or loss during the period by the related average balance, both amounts expressed in constant pesos. The nominal rates calculated for each period have been converted into real rates using the following formulas:
Where:
Rp = real average rate for peso-denominated assets and liabilities (in Ch$ and UF) for the period;
Rd = real average rate for foreign currency denominated assets and liabilities for the period;
Np = nominal average rate for peso-denominated assets and liabilities for the period;
Nd = nominal average rate for foreign currency denominated assets and liabilities for the period;
D = devaluation rate of the Chilean peso to the dollar for the period; and
I = inflation rate in Chile for the period (based on the variation of the Consumer Price Index).
The real interest rate can be negative for a portfolio of peso-denominated loans when the inflation rate for the period is higher than the average nominal rate of the loan portfolio for the same period. A similar effect could occur for a portfolio of foreign currency denominated loans when the inflation rate for the period is higher than the combined effect of the devaluation rate for the period and the corresponding average nominal rate of the portfolio.
The formula for the average real rate for foreign currency denominated assets and liabilities (Rd) reflects a gain or loss in purchasing power caused by the difference between the devaluation rate of the Chilean peso and the inflation rate in Chile during the period.
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The following example illustrates the calculation of the real interest rate for a U.S. dollar asset bearing a nominal annual interest rate of 10% (Nd = 0.10), assuming a 5% annual devaluation rate (D = 0.05) and a 12% annual inflation rate (I = 0.12):
In the example, since the inflation rate was higher than the devaluation rate, the real rate is lower than the nominal rate in dollars. If, for example, the annual devaluation rate were 15%, using the same numbers, the real rate in Chilean pesos would be 12.9%, which is higher than the nominal rate in dollars. Using the same numbers, if the annual inflation rate were greater than 15.5%, the real rate would be negative.
Due to the significant revaluation of the Chilean peso against the U.S. dollar in 2007, and the fact that nominal interest rates and the inflation rate were comparatively high in 2007, most real interest rates on foreign currency assets and liabilities shown in the tables in “—Selected Statistical Information” are negative in 2007.
Non-performing loans that are not yet 90 days or more overdue have been included in each of the various categories of loans, and therefore affect the various averages. Non-performing loans consist of loans for which either principal or interest is overdue (i.e., non-accrual loans) and restructured loans earning no interest. Non-performing loans that are 90 days or more overdue (i.e., past due loans) are shown as a separate category of loans. Interest and/or indexation readjustments received on all non-performing loans during the periods are included as interest revenue.
Included in interbank deposits are current accounts maintained in the Central Bank and overseas banks. Such assets have a distorting effect on the average interest rate earned on total interest earning assets because of balances maintained in:
the Central Bank, only the portion that is legally required to be held for liquidity purposes earns interest; and
overseas banks earn interest on certain accounts in certain countries.
Consequently, the average interest earned on such assets is comparatively low. These deposits are maintained by us in these accounts to comply with statutory requirements and to facilitate international business, rather than to earn income.
The monetary gain or loss on interest earning assets and interest bearing liabilities is not included as a component of interest revenue or interest expense because inflation effects are taken into account in the calculation of real interest rates.
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The following tables show, by currency of denomination, average balances and, where applicable, interest amounts, nominal and real rates for our assets and liabilities for the years ended December 31, 2006, 2007 and 2008:
Assets
Interest earning assets
Ch$
UF
Foreign currency
Financial Investments
Loans in advance to banks
Repurchase agreement
Total interest earnings assets
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Non–interest earning assets
Transaction in the course of collection
Allowances for loan losses
Derivatives
Investment in other companies
Fixed assets
Current tax assets
Total non–interest earning assets
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Liabilities
Interest bearing liabilities
Savings accounts
Repurchase agreements
Total interest bearing liabilities
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Non–interest bearing liabilities
Current account and demand deposit
Transaction in the course of payment
Current liabilities
Total non-interst bearing liabilities and equity
Total liabilities and equity
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Interest Earning Assets and Net Interest Margin
The following table analyzes, by currency of denomination, the levels of our average interest earning assets and net interest, and illustrates the comparative margins obtained, for each of the periods indicated.
Total average interest earning assets
Net interest earned(1)
Net interest margin, nominal basis(2)
Changes in Net Interest Revenue—Volume and Rate Analysis
The following tables compare, by currency of denomination, changes in our net interest revenue between 2007 and 2008 and between 2006 and 2007 caused by (i) changes in the average volume of interest earning assets and interest bearing liabilities and (ii) changes in their respective nominal interest rates. Volume and rate variances have been calculated based on movements in average balances over the period and changes in nominal interest rate, average interest earning assets and average interest bearing liabilities. The net change attributable to changes in both volume and rate has been allocated proportionately to the change in volume and the change in rate.
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Total interest earning assets
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Savings accounts and time deposits
Borrowing from financial institutions
Other financial obligation
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(a) Trading Securities:
The detail of instruments classified as trading securities is as follows:
(in millions of constant Ch$ as of December 31, 2008,
except for rate data)
Instruments issued by the Chilean Government and the Central Bank of Chile
Instruments issued by the Central Bank of Chile
Treasury bonds or notes payable
Other government instruments
Other instruments issued in Chile
Instruments issued by other banks
Bonds and commercial paper issued by companies
Instruments issued abroad
Instruments issued by foreign Governments or Central Banks
Instruments issued by other foreign banks
Other instruments issued abroad
Mutual fund investments
Funds managed by related companies
Instruments issued by the Chilean Government and the Central Bank of Chile include instruments sold under agreements to repurchase to customers and financial institutions, amounting to Ch$65,291 million, Ch$53,064 million and Ch$9,012 million as of December 31, 2006, 2007 and 2008, respectively. Other Financial Instruments include instruments sold under agreements to repurchase to customers and financial instruments, amounting to Ch$254,764 million, Ch$207,424 million and Ch$263,417 million as of December 31, 2006, 2007 and 2008, respectively.
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(b) Investment Portfolio:
The detail of instruments classified as available for sale instruments and as investments held to maturity is as follows:
(i) Available for sale
Instruments issued by the Chilean Government and Central Bank
Central Bank instruments
Other instruments issued abrod
As of December 31, the portfolio of available for sale instruments include a net unrealized loss of Ch$10 million, Ch$0 million and Ch$16,692 million in 2006, 2007 and 2008, respectively, recorded in equity.
(ii) Held to maturity
Instruments issued by Foreign Governments or Central Banks
(c) Maturity of Financial Investments:
The maturities of the securities trading, held to maturity and available for sale, as of December 31, 2008 was as follows:
Trading securities(1):
Held to maturity instuments
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The following table sets forth an analysis under U.S. GAAP of instruments held to maturity by type:
Instruments
The portfolio of instruments available for sale and held to maturity during 2006 corresponds entirely to the positions taken by our foreign branches. In anticipation of the sale of those operations to Citigroup as part of the merger with Citibank Chile, our foreign branches liquidated these positions during the last quarter of 2007. As a result, there are no securities reported under either category as of December 31, 2007, and as of December 31, 2008.
Loan Portfolio
The following table analyzes our loans by type of loan and risk classification. All loan amounts stated below are before deduction of allowances for loan losses.
Commercial loans:
General commercial loans
Subtotal commercial loans
Mortgage loans:
Mortgage bonds
Endorsable mortgage loans
Other Loans
Subtotal mortgage loans
Consumer loans:
Credit card
Subtotal consumer loans
Total loans
The loan categories are as follows:
“Commercial Loans” are loans and accounts receivable from clients not included within the mortgage or consumer loans categories.
“Mortgage Loans” include mortgage loans granted to individuals to acquire, expand, repair or build a home, issued as mortgage bonds, endorsable mortgage loans or by other methods. It also includes supplementary loans for the same purposes and bridge loans granted before the mortgage loan has been settled. This subcategory also includes residential real state lease transactions and other accounts receivable.
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“Consumer Loans” are all loans granted to individuals to be used for purchasing goods or services. These include different types of loans (either installments or revolving), as well as balances from credit card transactions or overdrafts on current accounts belonging to individuals. Consumer loans also include consumer lease transactions and other accounts receivable.
Consumer loans do not include loans granted to finance business activities that the debtor is developing or that it may develop.
Maturity and Interest Rate Sensitivity of Loans as of December 31, 2008
The following table sets forth an analysis by type and time remaining to maturity of our loans as of December 31, 2008:
Mortgage Loans:
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The following table presents the interest rate sensitivity of our outstanding loans due after one year as of December 31, 2008:
Variable rate
Fixed rate
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Loans by Economic Activity
The following table sets forth, at the dates indicated, an analysis of our loan portfolio based on the borrower’s principal economic activity. Loans to individuals for business purposes are allocated to their respective economic activity.
Agriculture, Livestock, Forestry, Agribusiness, Fishing:
Agriculture and livestock
Fruit
Forestry and wood extraction
Fishing
Mining and Petroleum:
Mining and quarries
Natural gas and crude oil extraction
Manufacturing:
Tobacco, food and beverages
Textiles, clothing and leather goods
Wood and wood products
Paper, printing and publishing
Oil refining, carbon and rubber
Production of basic metal, non-mineral, machine and equipment
Other manufacturing industries
Electricity, Gas and Water:
Electricity, gas and water
Construction:
Residential buildings
Other constructions
Commerce:
Wholesale
Retail, restaurants and hotels
Transport, Storage and Communications:
Transport and storage
Communications
Financial Services:
Financial and insurance companies
Holding companies and other financial services
Community, Social and Personal Services:
Community, social and personal services
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Foreign Country Outstanding Loans
Our cross-border outstanding loans are principally trade-related. These loans include loans to foreign financial institutions and foreign corporations, some of which are guaranteed by their Chilean parent company. The table below lists the total amounts outstanding to borrowers in certain foreign countries as of the end of the last three years, and thus does not include foreign trade-related loans to domestic borrowers.
Argentina
Australia
Austria
Belgium
Brazil
Canada
China
Colombia
Czech Republic
Dinamarca
El Salvador
Finland
France
Germany
Holland
Hong Kong
India
Israel
Island
Italy
Japan
Mexico
Netherlands
New Zealand
Norway
Oman
Panama
Paraguay
Perú
Portugal
Singapore
South Africa
South Korea
Spain
Switzerland
Sweden
Taiwan
United Arab Emirates
United Kingdom
United States
Uruguay
Venezuela
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We also maintain deposits abroad, as needed to conduct our foreign trade transactions and manage liquidity. The table below lists the largest amounts of foreign deposits by country as of the end of the past three years:
Denmark
Russia
Credit Review Process
Credit risk in Banco de Chile is managed with a global and unified strategy, oriented to the future, which recognizes the current and projected economic environment of the markets in which the Bank’s different businesses are developing. This strategy also establishes standardized criteria that take account of the policies that the Corporate Credit Risk and Market Risk Division and the Individual Credit Risk Division propose to the Board of Directors for approval.
The Bank’s credit policies and processes recognize the singularities of the different markets and segments, and grant appropriate credit treatment to each which, in general terms, translates into the implementation of the following three credit-risk approval models:
Automated Model: This model is directed to the individuals of the mass-market segment (i.e., not business-related) and is based on the integral automation of processes (admission, approval, follow-up and recovery) and scoring- and behavior-based approval systems. The Bank has also developed a broad level of intelligence in the selection of customers, with a significant capacity to discriminate between subjects of different credit bases. Therefore, different models, with different segments, exist for Individual Banking. Regarding lower-middle to middle income segment (i.e., Banco CrediChile), there are further distinctions for employed customers (separated into 5 sub-segments), and for independents. In the high income segment, there are sub-segments divided by activity and length of relationship with the Bank.
Parametric Model: This model is applied to small- and medium-sized enterprises and individuals in business. For analyzing these segments, a certain level of automation and limitation is used in evaluation. Automation currently provides a fundamental pillar of the pre-approval processes for small companies, and a support for the potential evaluation processes of medium companies.
Case-by-Case Model: This model is dedicated to the large companies and corporate market. Characterized by individual expert evaluation of risk level, operation amount, business complexity, etc.
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The evaluation of total customer credit risk takes into account the direct risk outstanding, the added risk involved in the proposed transaction, the indirect risks associated with guarantees or security given by the customer and the risk associated with other entities or individuals who have a direct or indirect affiliation with the customer. These include, in each case, outstanding principal (adjusted for inflation), interest and the balance of any unused lines of credit, and other credit transactions approved but not yet completed.
Transactions in which the total customer credit risk is more than UF 750,000 (approximately Ch$15,717 million) require approval by a credit committee, which includes three directors and our Chief Executive Officer. Transactions in which the total customer credit risk is equal to or less than UF 750,000 may be approved by other executives, depending on the amount involved, as follows:
Approved by
Credit committee, including members of the board of directors
Chief executive officer, chairman and senior credit risk officer
Chief executive officer, chairman or senior credit risk officer (any two of the three)
Chief executive officer and executive credit risk officers
Senior credit risk officers and executive vice president of corporate banking
Executive credit risk officers and Executive vice president of corporate baking
Other credit risk officers
Executive vice president of corporate banking
Other department heads
Other officers
In addition to reviewing the credit limit, the business segment extending the credit must review the terms of the loan, the interest rate and any security to be obtained.
To evaluate a customer’s credit risk, our commercial executives use various databases that provide information such as the customer’s profile, indebtedness to us, financial statements, monthly sales information, profitability reports, indebtedness to other Chilean financial institutions and payment history with other creditors. For this purpose, the Chilean Superintendency of Banks makes information regarding a customer’s indebtedness within the financial system available to banks.
The risk control division periodically reviews the quality of our loans, including the related loan classifications. Constant control and credit risk follow-up is the basis of proactive portfolio management and allows opportune risk recognition, identifying business opportunities and detecting eventual deteriorations in advance.
In the Companies market, control and follow-up is centered around a combination of revisions, the most relevant of which are the following:
Structured portfolio fast-revision schemes, according to the impact of specific macroeconomic fluctuations in sectors of activity, defining case-by-case actions plans.
Constant vigilance system for advance detection of those customers who show potential risks, and agreeing specific action plans for these customers with the commercial areas of the Bank.
Payment arrears management, backed by predictive indicators of risk level, with follow-up and action plans regarding the most important customers, plus management of differentiated strategies for early recovery.
Follow-up of the conditions, restrictions and covenants imposed by the credit committee to all operations requiring it due to their importance or complexity.
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Control of exposure and share guarantee coverage, monitoring fluctuations and preparing action plans in the event of the loss of minimum cover.
Follow-up schemes of credit behavior variables and financial figures of the companies.
Risk segmentation strategies in the collection processes and policies, achieving improvements in the integration of the approval and follow-up processes, aligned with a related vision of customers’ credit fundamentals.
Analysis of Our Loan Classification
The following tables provide statistical data regarding the classification of our loans at the end of each of the last five years. As discussed above, our risk analysis system requires that loans to all customers be classified:
IndividualAnalysisCategory
Subtotal classified loans
GroupAnalysisCategory
A
B–
C
D
Total classified loans
Percentage classified
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82
B-
83
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Classification of Loan Portfolio Based on the Borrower’s Payment Performance
Interest and indexation readjustments from overdue loans are only recognized when and to the extent effectively received. Overdue loans are classified in groups of one to 29 days overdue, 30 to 89 days overdue, and 90 or more days overdue, or past due loans.
The following table sets forth as of December 31 of each of the last five years the amounts that are current as to payments of principal and interest and the amounts that are overdue:
Current
Overdue 1-29 days
Overdue 30-89 days
Overdue 90 days or more (“past due”)
Overdue loans expressed as a percentage of total loans
Past due loans as a percentage of total loans
We suspend the accrual of interest on any loan when there is a high risk of unrecoverability or from the first day when it becomes past due. The amount of interest that would have been recorded on overdue loans if they had been accruing interest was Ch$3,965 million for the year ended December 31, 2008.
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Loans included in the previous table, which have been restructured and bear no interest, are as follows:
The amount of interest that we would have recorded on these loans for the year ended December 31, 2008 if these loans had been earning a market interest rate was Ch$255 million.
In addition, other loans that have been restructured, mainly through the extension of their maturities, and that bear interest are as follows:
Total other restructured loans
During the year ended December 31, 2008, interest recorded in income on these loans amounted to Ch$24,458 million.
Analysis of Substandard Loans and Amounts Past Due
The following table analyzes our substandard loans, past due loans and allowances for loan losses existing at the dates indicated. We have no restructured loans (troubled debt restructurings as defined in Statement of Financial Accounting Standards, or SFAS, No. 15 published by the Financial Accounting Standards Board, or FASB) that are not included in the following tables.
Substandard loans(1)
Substandard loans as a percentage of total loans
Amounts past due (2)
To the extent secured(3)
To the extent unsecured
Total amount past due
Amounts past due as a percentage of total loans
To the extent secured(2)
Allowances for loans losses as a percentage of:
Total amounts past due
Total amounts past due-unsecured
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Analysis of Allowances for Loan Losses
The following table analyzes our allowances for loan losses and changes in the allowances attributable to charge-offs, new allowances, allowances released and the effect of price-level restatement on allowances for loan losses:
Allowances for loan losses at beginning of period
Balance of allowances for loan losses from Citibank Chile S.A.(1)
Charge-offs
Allowances established
Allowances released(2)
Price-level restatement(3)
Allowances for loan losses at end of period
Ratio of charge-offs to average loans
Allowances for loan losses at end of period as a percentage of total loans
As a result of an improvement in economic conditions in 2005, 2006 and 2007, coupled with a more effective credit and collection policy, allowances and the risk index decreased in such period. Based on the information we have available about our debtors, we believe that our allowances for loan losses are sufficient to cover known potential losses and losses inherent in a loan portfolio of this size and nature.
As a result of the deterioration of the economic conditions during the second quarter of 2008, allowances as a percentage of total loans increased during 2008 at a higher rate than in prior years when economic conditions were more favorable.
Our policy with respect to charge-offs follows the regulations established by the Chilean Superintendency of Banks. Under these regulations, a consumer loan must be written off not more than six months after the loan is overdue and other unsecured loans, or parts thereof, must be written off not more than
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24 months after being classified as past due. Secured loans must be written off within 36 months after being classified as past due. However, the bank policies establish that a credit must be written-off before the 36 months if it is certain that the overdue loans will not be recovered.
The following table presents detailed information on write-offs and shows the charge-offs breakdown by loan category:
Mortgage loans
Loan recoveries by type of loan are shown in the table below:
Comercial loans
Recoveries and sales of loans reacquired from the Central Bank
Allocation of Allowances for Loan Losses
The following tables set forth, as of December 31 of each of the last five years, the proportions of our required minimum allowances for loan losses attributable to our commercial, consumer and residential mortgage loans at each such date.
Total allocated allowances
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The following table sets forth our charge-offs for 2006, 2007 and 2008 by major economic sector and provides further detail of charge-offs that have already been described in the previous discussion of allowances for loan losses:
Commercial:
Agriculture
Mining
Manufacturing
Construction
Commerce
Transport
Financial services
Community
Subtotal:
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Composition of Deposits and Other Commitments
The following table sets forth the composition of our deposits and similar commitments at December 31, 2006, 2007 and 2008. See “––Average Balance Sheets, Interest Earned on Interest Earning Assets and Interest Paid on Interest Bearing Liabilities” for the average rate paid on each of the following deposit categories.
Current accounts
Other demand deposits
Time deposits
Other term balance payables
Maturity of Deposits
The following table sets forth information regarding the currency and maturity of our deposits at December 31, 2008, expressed in percentages. UF-denominated deposits are similar to Chilean peso-denominated deposits in all aspects, except that the principal is readjusted periodically based on variations in the Consumer Price Index.
Demand deposits
Time deposits:
Maturing within three months
Maturing after three but within six months
Maturing after six but within 12 months
Maturing after 12 months
Total time deposits
Total deposits
The following table sets forth information regarding the currency and maturity of deposits in excess of U.S.$100,000 as of December 31, 2008:
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Minimum Capital Requirements
The following table sets forth our minimum capital requirements set by the Chilean Superintendency of Banks as of the dates indicated:
Banco de Chile’s regulatory capital
Minimum regulatory capital required
Excess over minimum regulatory capital required
Short-term Borrowings
Our short-term borrowings (other than deposits) totaled Ch$ 820,410 million as of December 31, 2006, Ch$ 698,357 million as of December 31, 2007 and Ch$ 1,966,901 million as of December 31, 2008.
The principal categories of our short-term borrowings are amounts borrowed under foreign trade lines of credit, domestic inter-bank loans and repurchase agreements. The table below presents the amounts outstanding at the end of each period indicated and the weighted average nominal interest rate for each period by type of short-term borrowing:
Investments sold under agreements to repurchase
Borrowings from domestic financial institutions
Foreign borrowings
Other obligations
Total short-term borrowings
The following table shows the average balance and the weighted average nominal rate for each short-term borrowing category during the periods indicated:
Central Bank borrowings
Sub-total
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The following table presents the maximum month-end balances of our principal sources of short-term borrowings during the periods indicated:
None.
OPERATING RESULTS
Introduction
The following discussion should be read together with our audited consolidated financial statements and the section entitled “Item 4. Information on the Company—Selected Statistical Information.” Certain amounts (including percentage amounts) that appear in this annual report may not total due to rounding.
We prepare our audited consolidated financial statements in accordance with Chilean GAAP (including the rules of the Chilean Superintendency of Banks related thereto), which differ in certain significant aspects from U.S. GAAP. Note 34 to our audited consolidated financial statements provides a description of the material differences between Chilean GAAP and U.S. GAAP as they relate to us. It also includes a reconciliation to U.S. GAAP of net income for the years ended December 31, 2006, 2007 and 2008 and equity at December 31, 2007 and 2008.
Pursuant to Chilean GAAP, the financial data presented in this section for all full-year periods are restated in constant pesos of December 31, 2008. See “Presentation of Financial Information” and Note 1 to our audited consolidated financial statements.
We are a leading bank in Chile providing a broad range of financial products and services to individual and corporate customers who are primarily located in Chile. Accordingly, and as described below, our financial condition and results of operations are largely dependent upon economic and political factors affecting Chile, as well as changes in interest rates and inflation rates. We also face a number of other risks, such as increased competition and changes in market conditions that could impact our ability to achieve our goals. See “Item 4. Information on the Company—Selected Statistical Information” for a description of risk characteristics associated with each type of loan in our loan portfolio and “Item 3. Key Information—Risk Factors” for a more detailed description of the specific risks that we believe to be material to our business operations.
After a period of accelerated growth between 1985 and 1997, when Chile’s gross domestic product grew at an average annual rate of 7.2%, Chile’s economic growth slowed to an average rate of 4.3% between 2000 and 2008. In 2008, Chile’s gross domestic product grew by 3.2%, following an increase of 4.7% in 2007. The slowdown in the Chilean economy during 2008, was due to the weakening of the global economy and internal demand deceleration. However, Chile has maintained a relatively stable financial condition as a result of the earlier accumulation of international reserves and fiscal restraint.
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Future changes in the Chilean economy may impair our ability to proceed with our strategic business plan. Our financial condition and results of operations could also be adversely affected by changes in economic or other policies of the Chilean government, which has exercised and continues to exercise a substantial influence over many aspects of the private sector, or other political and economic developments in Chile, as well as regulatory changes or administrative practices of Chilean authorities, over which we have no control. See “Item 3. Key Information—Risk Factors—Risks Relating to Chile—Inflation could adversely affect the value of our ADSs and financial condition and results of operations” and “Item 3. Key Information—Risk Factors—Risks Relating to Chile—Our growth and profitability depend on the level of economic activity in Chile.”
Inflation
Historically, Chile has experienced high levels of inflation that have significantly affected our financial condition and results of operations. Inflation has remained relatively low during much of the current decade. However, inflation in 2008 and 2007 has been relatively high (7.1% in 2008 and 7.8% in 2007), primarily as a result of the sharp increase in international oil and food prices. During the first five months of 2009, we experienced a negative inflation rate of 1.1% as a result of the turmoil of the global economy, which has involved lower prices of commodities and weaker demand.
An increase in inflation rates could adversely affect the Chilean economy and have an adverse effect on our business, financial condition and results of operations. Our results of operations reflect the effect of inflation in the following ways:
a substantial portion of our assets and liabilities are denominated in UFs, a unit that is indexed daily to reflect inflation recorded in the previous month, with the net gain or loss resulting from such indexation reflected in income;
Until December 31, 2008, our non-monetary assets, liabilities and capital and reserves were restated monthly to adjust for inflation, with the net gain or loss resulting from the adjustment reflected in income (See Item 5 — Changes in Accounting Principles — Standards that will be applicable starting 2009); and
the interest rates earned and paid on peso-denominated assets and liabilities to some degree reflect inflation and expectations regarding inflation.
UF-denominated Assets and Liabilities. The UF is revalued in monthly cycles. On each day in the period beginning the tenth day of the current month through the ninth day of the next month, the nominal peso value of the UF is indexed up (or down in the event of deflation) in order to reflect each day a pro rata amount of the prior calendar month’s change in the Consumer Price Index. One UF was equal to Ch$18,336.38 at December 31, 2006, Ch$19,622.66 at December 31, 2007 and Ch$21,452.57 (U.S.$34.1) at December 31, 2008. The effect of any changes in the nominal peso value of our UF-denominated assets and liabilities is reflected in our results of operations as an increase (or decrease, in the event of deflation) in interest revenue and expense. Our net interest revenue will be positively affected by inflation (and negatively affected by deflation) to the extent that our average UF-denominated assets exceed our average UF-denominated liabilities, while net interest revenue will be negatively affected by inflation (and positively affected by deflation) when average UF-denominated liabilities exceed average UF-denominated assets. Our average UF-denominated assets exceeded our average UF-denominated liabilities by Ch$1,795,251 million during the year ended December 31, 2006, Ch$1,771,864 million during the year ended December 31, 2007 and Ch$2,144,686 million (U.S.$ 3,409 million) during the year ended December 31, 2008. These numbers exclude capital and reserves and derivatives. See “Item 4. Information on the Company—Selected Statistical Information.”
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Peso-denominated Assets and Liabilities. Interest rates in Chile tend to reflect the rate of inflation during the relevant period and expectations regarding future inflation. The sensitivity of our peso-denominated interest earning assets and interest bearing liabilities to the inflation rate varies. See “—Interest Rates.” We maintain a substantial amount of non-interest bearing, peso-denominated current account and other demand deposits. The ratio of such deposits to average interest bearing peso-denominated liabilities was 52% during 2006, 51% during 2007 and 50% during 2008. Because a large part of such deposits are not sensitive to inflation, even a slight decline in the rate of inflation may adversely affect our net interest margin on assets funded with such deposits and even a slight increase in the rate of inflation may increase the net interest margin on such assets. See “Item 4. Information on the Company—Selected Statistical Information—Interest Earning Assets and Net Interest Margin.”
Interest Rates
Interest rates earned and paid on our assets and liabilities reflect in part inflation and expectations regarding future inflation, shifts in short-term interest rates related to the Central Bank’s monetary policies and movements in long-term real rates. The Central Bank manages short-term interest rates based on its objectives of balancing low inflation and economic growth. Accordingly, with the inflation increase in 2008, the Central Bank raised its reference interest rate five times, resulting in a final rate of 8.25% by the end of 2008. On the other hand, long-term rates showed a slight increase in 2008.
Because our liabilities generally re-price faster than our assets, changes in the rate of inflation or short-term interest rates are reflected in the rates of interest we pay on our liabilities before they are reflected in the interest rates we earn on our assets. Accordingly, our net interest margin on assets and liabilities is usually adversely affected in the short-term by increases in inflation or short-term interest rates and benefits in the short-term from decreases in inflation or short-term interest rates, although the existence of non-interest bearing peso-denominated demand deposits tends to mitigate both effects. See “—Inflation—Peso-denominated Assets and Liabilities.” In addition, because our peso-denominated liabilities have relatively short re-pricing periods, those liabilities generally are more responsive to changes in inflation or short-term interest rates than our UF-denominated liabilities. As a result, during periods when current inflation exceeds the previous month’s inflation, customers often switch funds from peso-denominated deposits to more expensive UF-denominated deposits, thereby adversely affecting our net interest margin.
The average real annual short-term interest rate based on the rate paid by Chilean financial institutions for 90- to 360-day Chilean peso-denominated deposits was 2.83% in 2006, 2.20% in 2007 and 2.23% in 2008. The average annual real long-term interest rate based on the Central Bank’s ten-year duration Chilean peso-denominated bonds was 2.98% in 2006, 2.90% in 2007 and 3.24% in 2008.
Foreign Currency Exchange Rates
A significant portion of our assets and liabilities are denominated in foreign currencies, principally U.S. dollars, and we have historically maintained and may continue to maintain gaps between the balances of such assets and liabilities. The gap between foreign currency denominated assets and foreign currency denominated liabilities was a net asset position of Ch$21,833 million at December 31, 2006, Ch$8,317 at December 31, 2007 and Ch$51,114 million at December 31, 2008. See Note 26 to our audited consolidated financial statements. This gap includes assets and liabilities denominated in foreign currencies and assets and liabilities denominated in Chilean pesos that contain repayment terms linked to changes in foreign currency exchange rates. Because foreign currency denominated assets and liabilities, as well as interest earned or paid on such assets and liabilities and gains (losses) realized upon the sale of such assets, are translated into pesos in preparing our audited consolidated financial statements, our reported income is affected by changes in the value of the peso with respect to foreign currencies, primarily the U.S. dollar. Adjustments to U.S. dollar-indexed assets are reflected as adjustments in net interest earnings and offset results in the foreign exchange position. The exchange rate variation over capital and reserves of our foreign branches, which were sold in January 2008, is adjusted against equity rather than against net income according to local accounting rules.
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Critical Accounting Policies
We prepare our consolidated financial statements in conformity with Chilean GAAP and the specific accounting rules of the Chilean Superintendency of Banks, which together differ in certain significant aspects from U.S. GAAP. The notes to our audited consolidated financial statements contain a summary of the accounting policies that are significant to us, as well as a description of the significant differences between these policies and U.S. GAAP. The notes include additional disclosures required under U.S. GAAP, a reconciliation between equity and net income to the corresponding amounts that would be reported in accordance with U.S. GAAP and a discussion of recently issued accounting pronouncements.
Both Chilean and U.S. GAAP require management to make certain estimates and assumptions, as some of the amounts reported in the financial statements are related to matters that are inherently uncertain. The following discussion describes those areas that require the most judgment or involve a higher degree of complexity in the application of the accounting policies that currently affect our financial condition and results of operations.
Chilean banks are required to maintain loan loss allowances in amounts determined in accordance with the regulations issued by the Chilean Superintendency of Banks. Under these regulations, we must classify our portfolio based on factors such as changes in the nature and volume of our loan portfolio, trends in forecasted portfolio credit quality and economic conditions that may affect the borrower’s payment capacity. The minimum amount of required loan loss allowances are determined based on fixed percentages of estimated loan losses assigned to each category.
Under U.S. GAAP, allowances for loan losses are made to account for estimated losses in outstanding loans for which there is doubt about the borrower’s capacity to repay the principal.
The classification of our loan portfolio for Chilean GAAP purposes and for allowances for loan losses under U.S. GAAP is determined through statistical modeling and estimates. Informed judgments must be made when identifying deteriorating loans, the probability of default, the expected loss, the value of collateral and current economic conditions. Even though we consider our allowances for loan losses to be adequate, the use of different estimates and assumptions could produce different allowances for loan losses, and amendments to the allowances may be required in the future due to changes in the value of collateral, the amount of cash to be received or other economic events.
On January 1, 2004, in accordance with Circular No. 3,246 issued by the Chilean Superintendency of Banks, we adopted a new methodology to determine our loan loss allowances. This new regulation did not adversely affect our financial position or results of operations. A detailed description of this accounting policy is discussed in “Item 4. Information on the Company—Regulation and Supervision—Allowances for Loan Losses” and in Notes 1 and 34 to our audited consolidated financial statements.
Fair value accounting
A portion of our assets and liabilities are carried at fair value. Under both Chilean GAAP and U.S. GAAP financial instruments are stated at fair value, except for those classified as “held-to-maturity” under U.S. GAAP, which are carried at amortized cost. Under U.S. GAAP, derivative financial instruments are recorded at fair value and assets received in lieu of payment are recorded at fair value less their estimated cost of sale. Fair values are based on quoted market prices or, if not available, on internally developed pricing models based on independently obtained market information. If market information is limited or in some instances not available, management applies its professional judgment. Other factors that may also affect estimates are incorrect model assumptions, market dislocations and unexpected correlations. Notwithstanding the level of subjectivity inherent in determining fair value, we believe our estimates of fair value are adequate. The use of different models or assumptions could lead to changes in our reported results.
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Statement of Financial Accounting Standards (SFAS) 157 defines “fair value” as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. To measure fair value, SFAS 157 has established a hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:
Level 1: Unadjusted quoted prices for identical assets or liabilities in an active market that Banco de Chile has the ability to access.
Level 2: Observable inputs other than Level 1, including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data.
Level 3: Prices or valuation techniques requiring inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would make in pricing the asset or liability.
Banco de Chile uses fair value to measure certain assets and liabilities on a recurring basis when fair value is the primary measure for accounting. This is done primarily for government and private securities classified as available for sale or trading account, forward transactions pending settlement and derivatives.
Chilean GAAP requires that financial statements be restated to reflect the full effects of loss in the purchasing power of the Chilean peso on the financial position and results of operations of reporting entities. The method prescribes that the historical cost of all non-monetary accounts be restated for general price-level changes between the date of origin of each item and the year-end. A bank’s net monetary asset position is determined by subtracting its net non-monetary liabilities from its non-monetary assets. As such, under Chilean GAAP, the gain (or loss) from price-level restatement in results of operations is determined by subtracting the price-level restatement adjustment of capital and reserves from the price-level restatement adjustment of non-monetary assets. The inflation rate used for purposes of such adjustments is the change in the Consumer Price Index during the 12 months ended November 30 of the reported year. The change in the Consumer Price Index used for price-level restatement purposes was 2.1% in 2006, 7.4% in 2007 and 8.9% in 2008. See Note 1(b) to our audited consolidated financial statements. The actual change in the Consumer Price Index was 2.6% in the year ended December 31, 2006, 7.8% in the year ended December 31, 2007 and 7.1% in the year ended December 31, 2008.
Our audited consolidated financial statements have been price-level restated in order to reflect the effects of the changes in the purchasing power of the Chilean peso during each year. All non-monetary assets and liabilities and all equity accounts have been restated to reflect the changes in the Consumer Price Index from the date they were acquired or incurred to year-end. Consistent with general banking practices in Chile, no specific purchasing power adjustments of income statement amounts are made. The purchasing power gain or loss included in net income reflects the effects of Chilean inflation on the monetary assets and liabilities held by us.
For comparative purposes, the historical December 31, 2007 and 2008 audited consolidated financial statements and their accompanying notes have been presented in constant Chilean pesos as of December 31, 2008.
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The price-level adjusted audited consolidated financial statements do not purport to represent appraised values, replacement cost, or any other current value of assets at which transactions would take place currently. Instead, they are intended to restate all nonmonetary consolidated financial statement components in terms of local currency of a single purchasing power and to include in the net result for each year the gain or loss in purchasing power arising from the holding of monetary assets and liabilities exposed to the effects of inflation. See the discussion of price-level restatement in Note 1(b) to our audited consolidated financial statements.
As of January 1, 2009, price-level restatement is no longer applicable. See “Item 4: Information on the Company — Regulation and Supervision.”
Goodwill
Under U.S. GAAP, we have significant intangible assets related to goodwill. We record all assets and liabilities acquired in purchase acquisitions, including goodwill and other acquired intangibles, at fair value as required by SFAS No. 141, published by FASB. These include amounts pushed down from our parent Quiñenco S.A. Under SFAS No. 142, goodwill must be allocated to reporting units and tested for impairment. On December 31, 2008, goodwill has been allocated according to the structure of our business segments in 2008.
We test goodwill for impairment annually or more frequently if events or circumstances, such as adverse changes in the business climate, indicate that there may be justification for conducting an interim test. Impairment testing is performed at the reporting-unit level, which is generally one level below the major business segments. The first part of the test is a comparison at the reporting unit level of the fair value of each reporting unit to its carrying amount, including goodwill. If the fair value is less than the carrying value, then the second part of the test is conducted to measure the amount of potential goodwill impairment. The implied fair value of the reporting unit goodwill is calculated and compared to the carrying amount of goodwill recorded in our financial records. If the carrying value of the reporting unit goodwill exceeds the implied fair value of that goodwill, then we would recognize an impairment loss in the amount of the difference, which would be recorded as a charge against net income.
The fair values of the reporting units are determined using discounted cash flow models based on each reporting unit’s internal forecasts.
We did not have any goodwill impairment charges in 2006, 2007 and 2008.
The initial goodwill and intangibles recorded and subsequent impairment analysis requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future using a discounted cash flow analysis. Additionally, estimated cash flows may extend beyond ten years and, by their nature, are difficult to determine. Events and factors that may significantly affect the estimates include competitive forces, customer behavior and attrition, changes in revenue growth trends, cost structures and technology and changes in interest rates and specific industry or market sector conditions. Impairment is recognized earlier whenever warranted. For a further discussion of accounting practices for goodwill under U.S. GAAP, see Note 34 to our audited consolidated financial statements.
Changes in Accounting Principles
On January 1, 2004, new principles for determining loan loss allowances became effective. The application of these new principles did not have a material effect on our financial condition or results of operations.
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In accordance with Circular No. 3,345 issued by the Chilean Superintendency of Banks, we adopted new accounting criteria for the measurement, classification and recording of trading and investment securities, derivative instruments, hedge accounting and asset derecognition beginning on June 30, 2006. The Circular required retroactive application as of December 31, 2005, recognizing the cumulative effect in equity during 2006. This resulted in a credit of Ch$960 million (in historical pesos) to a “Reserves” account within equity in 2006. On other hand, for the investment securities and derivatives portfolio held during 2006, the application of this new standard generated an income of Ch$910 million, which is included in the line item “Gains (losses) from trading and brokerage activities.”
The Chilean Superintendency of Banks, through its Circular No. 3,410 dated November 9, 2007, subsequently supplemented by Circular No. 3,443 dated August 21, 2008, and introduced the new Compendium of Accounting Standards that banks must apply as a result of the IFRS convergence project developed by the Chilean Superintendency of Banks. The main impact arising out of these new accounting criteria are described below:
Applicable accounting changes during 2008
In accordance with Chapters B-4 and E of the above mentioned Compendium of Accounting Standards, the Bank recorded a liability for an amount of Ch$190,698 million under “Provisions” as of December 31, 2008 related to the minimum dividends payment, reflecting a corresponding equity reduction for the same amount under “Retained earnings.” Until 2007, dividend obligations were recorded when declared by a Shareholders’ Meeting. This change did not generate effects on income.
New format for the presentation of financial statements applicable starting in 2008
Chapter C-3 of the Compendium of Accounting Standards established the new format for the presentation of annual financial statements. Chapter E requires that its application begin in 2008. The application of this new format has only affected the presentation of the 2008 financial statements, and has not had an effect on the accounting criteria applied by the Bank. For comparative purposes, financial information from 2004 through 2007 has been modified in accordance with the new presentation format and, therefore, the financial statements for the period 2004-2007 that are presented in this annual report differ, in terms of their presentation, from those reported in prior years for such period. This new presentation format has also been used with respect to the 2008 financial information contained in this annual report.
Standards that will be applicable starting in 2009
The Compendium of Accounting Standards establishes that starting January 1, 2009, banks must adopt the new accounting criteria established by the Chilean Superintendency of Banks, and apply IFRS for those matters not addressed by the Compendium. The changes in accounting criteria relate, among other things, to the following matters:
elimination of the price-level restatement;
option to revalue fixed assets as of the date of first time adoption;
accrual of loan interest during past due date;
accrual of loan interest at the effective rate; and
changes and incorporation of additional disclosures in notes to the financial statements.
The application of these new accounting criteria resulted in adjustments to the Bank’s equity accounts as of January 1, 2009, and will also affect the determination of income in future years. For comparison purposes with the financial statements that will be presented in 2009, the Bank must present financial statements for 2008 in accordance with the new accounting criteria, which will differ from those presented herein. See “Item 4 – Regulation and Supervision – Convergence to IFRS”
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Subsequent to the merger between Banco de Chile and Citibank Chile, which was effective on January 1, 2008, the Bank began to reconcile the criteria maintained by each bank for the classification of financial instruments, according to the different categories defined by the current applicable regulation. As a consequence of the reconciliation, on September 30, 2008, we reclassified certain financial instruments from “Trading Securities” to “Available for Sale Instruments” by an amount equivalent to Ch$244.827 million (historical pesos).
During the period ending December 31, 2008, there have not been other accounting changes that could significantly affect the consolidated financial statements presented in this annual report.
Differences between Chilean and United States Generally Accepted Accounting Principles
Chilean GAAP varies in certain important aspects from U.S. GAAP, including some of the methods that are used to measure the amounts shown in the audited consolidated financial statements, additional disclosures required by U.S. GAAP and the accounting treatment of the merger with Banco de A. Edwards and Citibank Chile. Those differences, as well as other significant differences between Chilean GAAP and U.S. GAAP, are described in greater detail in Note 34 to our audited consolidated financial statements.
Results of Operations for the Years Ended December 31, 2006, 2007 and 2008
The following section discusses the results of operations for the years ended December 31, 2006, 2007 and 2008. To the extent that it is available and is useful in analyzing our results, we have included information broken down by the business segments we use in internal reporting. We also present our results on a consolidated basis.
Net Income
The following table sets forth the principal components of our net income, as detailed in our audited consolidated financial statements for the years ended December 31, 2006, 2007 and 2008:
Other income (loss), net
Operating expenses
Loss from price-level restatement
Income before income taxes
Income taxes
2007 and 2008. The 3.2% increase in net income in 2008 as compared to 2007 was primarily attributable to a 51.5% increase in net interest revenue, fueled by (i) an 18.4% growth of the loan portfolio as a consequence of both the incorporation of Citibank Chile’s business as a result of the merger and organic expansion, (ii) higher income due to the proactive management of UF/Ch$ positions, (iii) higher contribution from demand deposits in an environment of higher interest rates, (iv) extraordinary income arising from both the sale of foreign branches during 2008 and the sale of stock of Visa Inc. as a result of its initial public offering on the New York Stock Exchange and, to a lesser extent, (v) an increase in net fees and commissions.
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These positive factors were partially offset by a 144.5% increase in provisions for loan losses and a 46.7% increase in our operating expenses, both of which also reflected the impact of the merger with Citibank Chile. In addition, provisions for loan losses also reflected the less dynamic macroeconomic scenario that has prevailed since the last quarter of 2007.
2006 and 2007. The 15.5% increase in net income in 2007 as compared to 2006 was primarily attributable to a 24.7% increase in net interest revenue, fueled by a 13.6% growth of the loan portfolio and higher earnings from assets funded by demand deposits as a consequence of higher nominal interest rates and, to a lesser extent, an increase in net fees and commissions. These positive factors were partially offset by a 31.9% increase in provisions for loan losses and by a 0.4% increase in our operating expenses. Higher net income mainly reflected our focus on expanding our customer base and improving our service quality.
Net Interest Revenue
The tables included under the headings “—Interest Revenue” and “—Interest Expense” set forth information regarding our consolidated interest revenue and expenses and average interest earning assets and average interest bearing liabilities for the years ended December 31, 2006, 2007 and 2008. This information is derived from the tables included elsewhere in this annual report under “Item 4. Information on the Company—Selected Statistical Information” and is qualified in its entirety by reference to such information.
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Net interest margin(1)
2007 and 2008. Net interest revenue increased by 51.5% from 2007 to 2008, primarily as a result of a 17.5% growth in average interest earning assets and, to a lesser extent, due to a net interest margin increase of 115 basis points from 3.97% in 2007 to 5.12% in 2008. The increase in net interest margin was largely a result of the following:
A positive result associated with the management of UF/Ch$ gap positions coupled with an increase in the inflation rate, measured by the variation of the UF (which was 9.3% in 2008 as compared to 7.0% in 2007), implying that during 2008 we earned higher interest income on the portion of interest earning assets financed by non-interest bearing liabilities;
A higher contribution from demand deposits as a result of the increase in nominal interest rates (the average short-term interest rate was 7.24% in 2008 as compared to 5.47% in 2007);
A more favorable funding structure mainly as a consequence of the merger with Citibank Chile, which implied a higher proportion of checking accounts among the Bank’s liabilities. Accordingly, the ratio of interest-bearing liabilities to interest-earning assets improved to 76.9% in 2008 from 78.8% in 2007; and
An increase in average loan spreads as a result of higher credit risk as a consequence of a less dynamic economic scenario.
2006 and 2007. Net interest revenue increased by 24.7% from 2006 to 2007, primarily due to a 8.4% growth in average interest earning assets and, to a lesser extent, due to a net interest margin increase of 49 basis points from 3.48% in 2006 to 3.97% in 2007. The increase in net interest margin was largely a result of the following:
A higher inflation rate, measured by the variation of the UF, which was 7.0% in 2007 as compared to 2.0% in 2006, which implied that during 2007 we earned higher interest income on the portion of interest earning assets financed by non-interest bearing liabilities;
A higher contribution from demand deposits as a result of the increase in nominal interest rates (the average short-term interest rate was 5.31% in 2007 and 5.02% in 2006); and
A favorable funding structure as the ratio of interest-bearing liabilities to interest-earning assets improved to 78.8% in 2007 from 79.5% in 2006.
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However, these effects were partially offset by a lower lending spread attained during 2007 compared to the previous year as a consequence of increased competition.
Interest Revenue
The following table sets forth information regarding our interest revenue and average interest earning assets for the years ended December 31, 2006, 2007 and 2008:
Average interest earning assets:
Total Loans
Loans and Advance to Banks
Average rates earned on total interest earning assets: (1)
Average nominal rates
Average real rates
2007 and 2008. Interest revenue increased by 38.1% from 2007 to 2008, primarily as a result of a 17.5% increase in average interest earning assets and, to a lesser extent, an increase in average nominal interest rates earned from 9.30% in 2007 to 10.93% in 2008. The increase in average interest earning assets was the result of both the merger with Citibank Chile and the organic growth of our loan portfolio. The increase in average nominal interest rates was mainly the result of an increase in the Central Bank’s nominal reference rates (from an average of 5.47% in 2007 to 7.24% in 2008). In addition, the increase in the average real rate earned on interest earning assets from 0.72% in 2007 to 7.27% in 2008 reflected the large increase in the foreign exchange rate during that period.
2006 and 2007. Interest revenue increased by 42.4% from 2006 to 2007, primarily as a result of an increase in the average nominal interest rates earned from 7.04% in 2006 to 9.25% in 2007 and, to a lesser extent, a 8.4% growth in average interest earning assets which was driven by a 12.0% increase in average loans. The increase in average nominal interest rates was mainly the result of an increase in the inflation rate (from 2.6% in 2006 to 7.8% in 2007) and, to a lesser extent, to increases of the Central Bank’s nominal reference rates (from an average of 5.02% in 2006 to 5.31% in 2007). In addition, the decrease in the average real rate earned on interest earning assets from 5.71% in 2006 to 0.72% in 2007 can be explained by the relatively large decrease in the foreign currency rate during that period.
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Interest Expense
The following table sets forth information regarding our interest expense and average interest bearing liabilities for the years ended December 31, 2006, 2007 and 2008:
Average interest-bearing liabilities:
Saving accounts and time deposits(1)
Securities under agreements to repurchase
Debt Issued
Other Financial Obligations
Average rates paid on total interest bearing liabilities(2) :
Average (Chilean peso-denominated) non-interest bearing current account and demand deposits
2007 and 2008. Interest expense increased by 28.2% from 2007 to 2008, primarily as a result of a 17.4% increase in average interest-bearing liabilities and, to a lesser extent, to an increase in average nominal interest rates paid, from 7.16% in 2007 to 7.82% in 2008. The increase in average interest-bearing liabilities was primarily attributable to a 13.7% increase in savings accounts and time deposits and a 53.5% increase in borrowings from financial institutions. The average nominal rates increased primarily as a result of the Central Bank’s higher monetary policy rates during 2008.
2006 and 2007. Interest expense increased by 59.3% from 2006 to 2007, primarily as a result of an increase in average nominal interest rates paid, from 4.90% in 2006 to 7.16% in 2007 and also due to a 9.1% increase in average interest-bearing liabilities. The increase in the average nominal interest rate paid was primarily attributable to the higher inflation rate and an increase in the Central Bank’s monetary policy rate. The increase in average interest-bearing liabilities was mainly the result of a 9.2% increase in savings accounts and time deposits and a 11.7% increase in the issuance of debt (principally related to bonds and subordinated bonds).
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Net Fees and Commissions
The following table sets forth certain components of our fees and commissions (net of fees paid to third parties that provide support for those services, principally fees relating to services of pre-evaluations credit and receipts and collection services provided to us) for the years ended December 31, 2006, 2007 and 2008:
Insurance
Mutual funds
Checking accounts and overdrafts
Sight accounts and ATMs
Collection of over-due loans
Cash management services
Stock brokerage
Letters of credit, guarantees, collateral and other contingent loans
Credit lines
Financial advisory services
Foreign trade and currency exchange
Custody and trust services
Factoring
Collection services
Credits
Teller services expenses
Credit pre-evaluation services
Other
2007 and 2008. Net fees and commissions increased by 15.0% from 2007 to 2008, primarily as a result of an increase in fees generated by insurance, mutual funds, credit cards, financial advisory services and checking accounts and overdrafts, all of which increased as a result of a significant increase in our customer base and network expansion due to the merger with Citibank Chile and our long-standing efforts to cross-sell the Bank’s products. This increase was partially offset by lower fees posted by our stock brokerage subsidiary and higher credit pre-evaluation services expenses.
2006 and 2007. Net fees and commissions increased by 10.7% from 2006 to 2007. This annual increase in fees was primarily a result of an increase in fees generated by our mutual funds and stock brokerage businesses, as both businesses continued to deliver a diverse range of new services and products to address customer needs. To a lesser extent, higher fee income was also related to insurance and sight accounts and ATMs, largely as a result of an increase in the client base. These factors more than offset the lower fees generated by our financial advisory and foreign trade and currency exchange businesses.
Other Income (Loss), Net
Other income (loss), net, consists of net gains and losses from trading and brokerage activities, net gains and losses from foreign exchange transactions and other operating income. Trading and brokerage activities results include gains and losses realized on the sale of securities, gains and losses from the mark-to-market of securities and interest rate and currency derivatives at the end of the period. Net gains and losses from foreign exchange transactions include gains and losses realized upon the sale of foreign currency and foreign exchange derivatives and gains and losses arising from the period-end translation of foreign currency denominated assets and liabilities into pesos. Foreign exchange results also include net adjustments on U.S. dollar-indexed domestic currency transactions, or the exchange rate variation on foreign branches’ capital and reserves. Foreign exchange results include existing interest rate differences in currency derivatives.
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The following table sets forth certain components of our other income (loss), net, in the years ended December 31, 2006, 2007 and 2008:
Interest accrued on trading securities
Gains (losses) on sales and mark to market
Gains (losses) on derivatives contracts
Gains from sales of loans
Total gains (losses) from trading and brokerage activities
Other operating income, net
2007 and 2008. Other income (loss), net, increased from Ch$83,140 million in 2007 to Ch$103,077 million in 2008, largely as a result of a 185.6% increase in other operating income. The increase in other operating income was mainly due to non-recurring income arising out of both the sale of foreign branches (which amounted to Ch$38,459 million) and the sale of stock of Visa Inc. as a result of Visa Inc.’s initial public offering (which resulted in earnings of approximately Ch$10,352 million). The increase in gains from trading and brokerage activities was mainly due to a significant increase in gains on derivatives contracts, as a result of a higher net asset position in U.S.$/Ch$ forward contracts in an environment of rising exchange rates. However, this effect was more than offset by higher losses in foreign exchange transactions, which also reflect the impact of the Bank’s higher liabilities position in U.S. dollars.
2006 and 2007.Other income (loss), net, decreased from Ch$116,316 million in 2006 to Ch$83,140 million in 2007, primarily as a result of a 60.2% decrease in gains (losses) from trading and brokerage activities and, to a lesser extent, of a decrease in the amounts recovered from assets received in lieu of payments which were previously charged-off (this decrease was reflected in the other operating income line). The decrease in gains (losses) from trading and brokerage activities was a result of (i) losses in the value of the Bank’s securities portfolio related to Latin American countries as a consequence of the global financial instability during the second half of 2007, (ii) losses resulting from securities issued by Chilean companies booked in the Bank’s foreign branches due to an increase of 68 basis points in Chile’s country risk index during the second half of 2007, and (iii) losses in derivatives contracts due to meager results obtained in UF/$ forwards transactions, primarily as a result of a higher inflation rate, which was partially offset by higher interest income earned (which was reflected in the interest revenue line) as well as a higher profit arising from foreign exchange transactions.
Provisions for Loan Losses
Chilean banks are required to maintain allowances to cover possible credit losses in accordance with regulations issued by the Chilean Superintendency of Banks. For statistical information with respect to our substandard loans and allowances for loan losses, see “Item 4. Information on the Company—Selected Statistical Information” and Note 9 to our audited consolidated financial information. According to regulations of the Chilean Superintendency of Banks applicable to such periods, the amount of provisions charged to income in any period consists of net provisions for possible loan losses. Under Chilean regulations, additional allowances must be registered in the operating expenses line. See “Item 4. Information on the Company—Regulation and Supervision” and Note 9 to our audited consolidated financial statements.
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The following table sets forth information with respect to our provisions and allowances for loan losses and charge-offs for each of the years ended December 31, 2006, 2007 and 2008:
Provisions:
Total provisions for loan losses
Gross provisions for loan losses
Total loan loss recoveries
Charge-offs:
Total charge-offs
Net charge-offs
Other asset quality data:
Unconsolidated risk index
2007 and 2008. Our total provisions for loan losses sharply increased by 144.5% from 2007 to 2008, mainly as a result of an 18.4% increase in our loan portfolio as a result of our organic growth and the merger with Citibank Chile, and as a result of a higher level of risk due to lower dynamism in the local and international economy. The ratio of provisions for loan losses to average loans increased to 1.09% in 2008 from 0.54% in 2007. On a consolidated basis, our risk index increased from 1.27% in 2007 to 1.66% in 2008.
2006 and 2007. Our provisions for loan losses increased by 31.9% from 2006 to 2007, mainly as a result of an overall loan portfolio expansion and an increase in the level of risk mostly associated with our consumer portfolio. Higher provisions were partially offset by an increase of 16.4% in loan loss recoveries. The ratio of provisions for loan losses to average loans increased to 0.54% in 2007 from 0.45% in 2006. On a consolidated basis, our risk index decreased from 1.38% in 2006 to 1.27% in 2007.
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Operating Expenses
The following table sets forth information regarding our operating expenses for the years ended December 31, 2006, 2007 and 2008:
Staff expenses
Administrative expenses:
Advertising
Building maintenance
Rentals and insurance
Office supplies
Other expenses
Total administrative and other expenses
Depreciation and amortization
Other operating expenses
2007 and 2008. Our operating expenses increased by 46.7% from 2007 to 2008, primarily as a result of (i) the incorporation of Citibank Chile’s cost base, (ii) higher non-recurring charges (approximately Ch$44,700 million in 2008) related to the merger and integration with Citibank Chile, (iii) a higher level of business activity as a result of the Bank’s organic growth, (iv) higher other operating expenses during the fourth quarter of 2008, mainly related to the establishment of additional loan loss provisions of approximately Ch$17,000 million, and (v) non-recurring expenses of approximately Ch$13,500 million related to the collective bargaining agreements entered into by the Bank and some of its subsidiaries.
2006 and 2007. Our operating expenses increased by 0.4% from 2006 to 2007. Higher operating expenses resulted from our focus on expanding our business, transactional capabilities and service quality. We recorded an increase in personnel salaries, primarily related to additional employees for new branches and call centers, an increase in communication and technology expenses (including amortization expenses), in order to provide improved productivity and service quality, and larger rental expenses related to the expansion of the Bank’s branch network.
In addition, we incurred non-recurring expenses related to the merger with Citibank Chile and the sale of our foreign branches, which amounted to approximately Ch$3,920 million in 2007. However, the increase in these expenses was partially offset by a decrease in advisory expenses from the foreign branches related to the U.S. compliance requirements.
Loss from Price-Level Restatement
Chilean GAAP requires that adjustments be made to non-monetary assets (including fixed assets), liabilities and capital and reserves at the end of each reported period to reflect the effects of inflation during such period. The net effect of this inflation adjustment is reflected in our results of operations under “gain (loss) from price-level restatement.” See “—Overview—Inflation.”
2007 and 2008. The loss from price-level restatement increased from Ch$41,325 million in 2007 to Ch$77,789 million in 2008, primarily as result of the sharp increase in the inflation rate used for adjustment purposes from 7.4% in 2007 to 8.9% in 2008 and, also, due to the increase in net non-monetary liabilities as a result of the capital increase relating to the merger with Citibank Chile and, to a lesser extent, the capital increase carried out in the first semester of 2008.
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2006 and 2007. The loss from price-level restatement increased from Ch$9,972 million in 2006 to Ch$41,325 million in 2007, primarily as a result of the increase in the inflation rate used for adjustment purposes from 2.1% in 2006 to 7.4% in 2007 and, to a lesser extent, due to the increase in net non-monetary liabilities as a result of the partial capitalization of 2006 net income and a capital increase largely carried out in the third quarter of 2007.
Income Tax
The statutory corporate income tax rate in Chile was 17% in 2008, 2007 and 2006. We are also permitted under Law No. 19,396 to deduct dividend payments made to SAOS. Consequently, our effective tax rate is significantly lower than the statutory corporate income tax rate because of the deduction of such dividend payments from our taxable income. Additionally, but to a lesser extent, differences in the tax treatment for provisions on individual loans and for charge-offs for past-due loans have an impact on our effective tax rate. Finally, all real estate taxes paid on properties that are leased to customers are deductible from our taxable income.
2007 and 2008. In 2008, we recorded a tax expense of Ch$37,810 million as compared to a tax expense of Ch$ 29,316 million in 2007. This increase was primarily attributable to a higher effective tax rate, which increased from 10.0% in 2007 to 12.2% in 2008, mainly as a result of the dilution of the SAOS’s participation in the Bank as a consequence of the merger with Citibank Chile and, to a lesser extent, the higher income tax base in 2008 as a result of a 5.8% increase in net income before taxes.
2006 and 2007. In 2007, we recorded a tax expense of Ch$29,316 million as compared to a tax expense of Ch$28,182 million in 2006. This increase was primarily attributable to the higher income tax base in 2007 as a result of a 14.3% increase in net income before taxes.
Business Segments
We use a business segment-based profitability system to measure financial performance. This system allows us to extract income, balances, interest rate and expense information by client and also allows us to provide information by account officer, branch or business segment. In order to assess income per transaction, the system compares the interest rate agreed upon with the client with our own cost of funds. For various transactions, we use internal cost of funds tables, which are updated daily. From these tables we are able to determine operating costs per transaction or per client and these costs are then allocated to our various business segments. Developed internally, the system has been continuously refined resulting in cost re-allocations. Figures for the period 2004-2007 have been restated in accordance with the new presentation format required by the Chilean Superintendency of Banks. This new presentation format has also been used with respect to the 2008 figures contained in this section.
Our business has been organized into the following segments since 2008:
operations through subsidiaries
Prior to our merger with Citibank Chile, we also had an “International Banking” segment.
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Corporate and individual customers are assigned to account executives who work exclusively within one business segment. Some costs are allocated to one business segment, and others are split between two or more business segments based on a single transaction. Thereafter, any unallocated costs are included as “other” in order to arrive at the consolidated balance sheet and income statement.
The business segment information is subject to general internal auditing procedures to ensure the integrity of the information used in management decision-making. The business segment information presented has also been adjusted in order to tie results to the income statement, as presented in accordance with Chilean GAAP in our audited consolidated financial statements. The most significant differences in classification are as follows:
we measure the net interest margin of loans and deposits on an individual transaction and client basis, based on the difference between the effective customer rate and our related fund transfer price in terms of maturity, repricing and currency;
the results associated with our gap management (interest rate mismatches) have been fully allocated in the treasury and money market operations segment;
our management model, which measures the performance of our business segments, considers results that are directly related to performance and not to overhead expenses of corporate and support departments, additional allowances, merger costs, taxes and other operating income and other operating expenses; and
in addition to direct costs (consisting mainly of labor and administrative expenses), we allocate the majority of our indirect operating costs to each business segment based on the type and amount of the relevant transactions. These costs are mainly related to the use of office space, technology and computer equipment. Other indirect costs are allocated using activity-based costing methodology.
Net Income by Business Segment
The following table sets forth net income by business segment for each of the years ended December 31, 2006, 2007 and 2008. The line item “Other” includes the effect of conforming internal accounting policies to Chilean GAAP and a number of non-allocated costs, such as depreciation costs, additional provisions and merger-related expenses. For internal reporting purposes, we control and monitor these costs separately and do not include them in the determination of business segment profitability. Also included within “Other” are specific portions of income such as rental income.
Retail banking
Wholesale banking
International banking
Subsidiaries
Retail Banking. 2007 and 2008. The 25.7% increase in the retail banking business segment’s net income in 2008 was primarily attributable to a 35.5% increase in operating revenues, from Ch$403,951 million in 2007 to Ch$547,182 million in 2008. This increase was fueled by a 13.4% expansion in the loan portfolio, higher earnings from demand deposits and higher fee income. These factors were partially offset by an 80.7% increase in provisions for loan losses, mainly related to the consumer loan portfolio and, to a lesser extent, to commercial loans to small companies and by a 24.9% increase in operating expenses as a consequence of the merger with Citibank Chile.
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Retail Banking. 2006 and 2007. The 13.3% increase in the retail banking business segment’s net income in 2007 was primarily attributable to a 10.0% increase in operating revenues, from Ch$367,223 million in 2006 to Ch$403,951 million in 2007. This increase was mainly due to a 12.3% expansion in the loan portfolio, higher earnings from demand deposits and, to a lesser extent, higher fee income. These factors were partially offset by a 21.4% increase in provisions for loan losses mainly related to the consumer loan portfolio and, to a lesser extent, by higher operating expenses.
Wholesale Banking. 2007 and 2008. The 50.8% increase in the wholesale business segment’s net income in 2008 was mainly attributable to a 57.3% increase in operating revenues, from Ch$186,222 million in 2007 to Ch$293,016 million in 2008, primarily as a result of a 24.0% expansion in the loan portfolio, higher earnings from demand deposits and higher fee income. These factors were partially offset by higher provisions for loan losses, part of which were related to the fishing sector as a result of the outbreak of an infectious salmon virus that caused a substantial reduction in the exports of salmon.
Wholesale Banking. 2006 and 2007. The 5.2% increase in the wholesale business segment’s net income in 2007 was mainly attributable to a 15.1% increase in operating revenues, from Ch$161,787 million in 2006 to Ch$186,222 million in 2007, primarily as a consequence of a 20.0% expansion in loans and, to a lesser extent, a 6.3% decrease in operating expenses.
International Banking. 2007 and 2008. Banco de Chile sold its US branches (Miami and New York) to Citigroup as part of the merger with Citibank Chile.
International Banking. 2006 and 2007. The international banking business segment recorded a loss before taxes of Ch$2,370 million during 2007 as a consequence of mark-to-market losses in the securities portfolio of our foreign branches due to the global financial turbulence over the second half of 2007. In addition, during 2007, foreign branches registered non-recurring operating expenses related to the merger agreement with Citigroup, which led to the closing of these operations in 2008.
Treasury and Money Market Operations. 2007 and 2008. The treasury and money market operations business segment’s net income increased to Ch$108,664 million in 2008 from Ch$73,839 million in 2007 primarily as a result of higher interest income earned on the portion of UF denominated assets financed by nominal Chilean pesos denominated liabilities. This was due to an increase in the inflation rate and higher sales of forwards and derivative contracts to clients.
Treasury and Money Market Operations. 2006 and 2007. The treasury and money market operations business segment’s net income increased to Ch$73,839 million in 2007, from Ch$40,898 million in 2006 largely as a consequence of the sharp increase in the inflation rate, which resulted in higher interest income earned on the portion of UF denominated assets financed by non–UF denominated liabilities.
Operations through Subsidiaries. 2007 and 2008. The 15.4% decrease in net income from our subsidiaries in 2008 compared to 2007 was primarily attributable to a lower net income of our Mutual Fund subsidiary as a result of a rebalancing of our customers’ mutual funds portfolios from variable to fixed income structures, and a lower net income from our Factoring subsidiary as a result of a higher inflation rate during 2008, which affected the liability net position in UF of the Factoring subsidiary. This decrease offset the higher pre-tax income of our Financial Advisory, Insurance Brokerage and Security Brokerage subsidiaries.
Operations through Subsidiaries. 2006 and 2007. The 7.4% increase in net income from our subsidiaries in 2007 compared to 2006 was primarily attributable to higher fee income recorded by our Mutual Fund, Securities Brokerage and Insurance Brokerage subsidiaries. The positive performance of these subsidiaries offset the results obtained by our Financial Advisory subsidiary, which generated fewer transactions in 2007, and our Factoring subsidiary, which had a lower operating income as a consequence of a higher inflation rate as most of its Chilean peso-denominated loans were financed with funds denominated in UF.
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Chilean and U.S. GAAP Reconciliation
We prepare our audited consolidated financial statements in accordance with Chilean GAAP, which differs in certain significant aspects from U.S. GAAP. See Note 34 to our audited consolidated financial statements for a description of the material differences between Chilean GAAP and U.S. GAAP, as they relate to us and our consolidated subsidiaries, reconciliation to U.S. GAAP of net income and equity and a discussion of new accounting rules under U.S. GAAP. The following table sets forth net income and equity for the years ended December 31, 2006, 2007 and 2008 under Chilean GAAP and U.S. GAAP:
Net income (Chilean GAAP)
Net income (U.S. GAAP)
Equity (Chilean GAAP)(1)
Equity (U.S. GAAP)
Significant differences exist between our net income and equity under Chilean GAAP as presented in “Item 5. Operating and Financial Review and Prospects,” and our net income and equity under U.S. GAAP as presented in Note 34 to our audited consolidated financial statements.
Some differences are as follows:
Under Chilean GAAP, the merger with Banco de A. Edwards was accounted for as a “pooling of interests” on a prospective basis. As such, the historical financial statements for periods prior to the merger are not restated under Chilean GAAP and we are considered to be the surviving entity. Under U.S. GAAP, the merger of the two banks was accounted for as a merger of entities under common control, as L.Q. Inversiones Financieras, a holding company beneficially owned by Quiñenco S.A., controlled both banks since March 27, 2001. Consequently, U.S. GAAP requires that we restate our U.S. GAAP historical financial statements to retroactively reflect the merger as if both banks had been combined since March 27, 2001.
The pooling of interests method under Chilean GAAP eliminates any interbank balances and aggregates the results of both banks using their historical book values. Under U.S. GAAP, to the extent that we and Banco de A. Edwards were under common control, the assets and liabilities of Banco de A. Edwards were transferred into our accounts at their book value. However, as Quiñenco S.A. only owned 51.18% of Banco de A. Edwards, we effectively acquired from minority interest holders that portion that was not held by Quiñenco S.A. and so we applied purchase accounting. As a result, we calculated goodwill based on the difference between the purchase price (i.e., the market value of our shares) and the fair value of the proportion of assets and liabilities acquired from minority interest holders at the date of the merger. As part of this process, under U.S. GAAP, we were also required to value previously unrecorded intangible assets, such as the Banco de A. Edwards brand name, and to include these assets in our financial records. Such assets remain unrecorded under Chilean GAAP. The different basis of the assets and liabilities caused by this treatment has an effect on changes in depreciation and amortization in subsequent periods.
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In the same context, under Chilean GAAP the merger of Banco de Chile and Citibank Chile was accounted for as a pooling with no retroactive restatement of historical financial statements, while under U.S. GAAP the merger of the two banks was accounted for as a merger of entities under common control, as L.Q. Inversiones Financieras has controlled both banks since January 1, 2008. In this case, we were not required to restate our U.S. GAAP historical financial statements due the fact that common control was effective beginning on January 1, 2008.
Under U.S. GAAP, when accounting for a merger of entities under common control, the book value of the merged entities that are held in the books of the common parent must be pushed down to the merged entity. This means that any goodwill in the books of Quiñenco S.A. at the time that it acquired each bank and any fair value differences created from those purchases must be included in our U.S. GAAP accounting records. In practice this means that the goodwill and fair value adjustments created from Quiñenco S.A.’s purchases of Banco de A. Edwards shares in September, October and December 1999 and from Quiñenco S.A.’s purchase of our shares in March 2001 are pushed down to us. The same treatment applies with respect to the merger between Banco de Chile and Citibank Chile, where under local accounting principles the merger was recognized at book value and the goodwill and other intangibles were recognized at fair value in LQIF S.A. Pursuant to U.S. GAAP, these intangibles must be pushed down to the merged entity.
As there is no analogous accounting treatment under Chilean GAAP, there is a considerable difference in the asset and liability bases under each body of accounting principles.
Under Chilean GAAP, allowances for loan losses are calculated according to specific guidelines set by the Chilean Superintendency of Banks. Under U.S. GAAP, allowances for loan losses should be in amounts adequate to cover inherent losses in the loan portfolio at the respective balance sheet dates. If we had applied U.S. GAAP, our net income would have decreased by Ch$2,810 million in 2007 and increased by Ch$26,355 million in 2008, and equity would have increased by Ch$30,219 million in 2007 and increased by Ch$56,574 million in 2008.
Under Chilean GAAP, until December 31, 2005, forward contracts were recorded at the exchange rate in force at the close of each month and initial differences generated by this type of operations were recognized as deferred assets or liabilities and amortized over the term of the related contract. All other derivative instruments were reported at their market value.
Beginning in 2006, as a result of the adoption of Circular N°3,345, under Chilean GAAP all financial derivative contracts, which include foreign currency and UF forwards, interest rate forwards, currency and interest rate swaps, currency and interest rate options and other financial derivative instruments, are recorded in the balance sheet at cost (including transaction costs) at inception and subsequently measured at their fair value. Derivative contracts are reported as an asset when their fair value is positive and as a liability when negative under the line item “Derivative instruments.”
Under U.S. GAAP, all derivative instruments are recorded in the balance sheet at fair value. The standards also require formal documentation procedures for hedging relationships and effectiveness testing when hedge accounting is to be applied. If the derivative instrument does not qualify as a hedge, changes in fair value are reported in earnings when they occur. If the derivative instrument qualifies as a hedge, the accounting treatment varies based on the type of risk being hedged.
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Additionally, until 2005, Chilean accounting rules did not consider the existence of embedded derivatives and, therefore, such derivatives were not reflected in the financial statements. Beginning 2006, certain derivatives embedded in other financial instruments are treated as separate derivatives when their risk and characteristics are not closely related to those of the main contract and such derivatives are not recorded at their fair value with their unrealized gains and losses included in income. Circular N°3,345 did not include service-type contracts when evaluating for embedded derivatives. For U.S. GAAP purposes, we separately measure embedded derivatives included in certain contracts as freestanding derivative instruments at their estimated fair values, recognizing changes in earnings when they occur.
These differences are explained in greater detail in Note 34 to our audited consolidated financial statements.
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LIQUIDITY AND CAPITAL RESOURCES
Liquidity risk is technically categorized into in two types: trading liquidity risk and funding liquidity risk. Trading liquidity risk deals with the inability to defease cash positions (bonds, loans, etc.) or offset price risks generated by derivatives transactions; Funding liquidity risk is related to the inability of raising funds. Both lead to potentially adverse scenarios that might make the bank unable to meet its payment obligations and potential payment obligations as and when they become due.
These two risks are jointly managed but by using different tools.
Holding a minimum stake of debt instruments with deep secondary markets ensures trading liquidity. Central bank and government instruments show these characteristics; short-term bank’s time deposits do as well. These kinds of instruments are held in our trading portfolio and some portion of the AFS portfolio liquid instruments. In addition, mortgage bonds issued by banks resident in Chile and corporate bonds are also part of the AFS portfolio. Even though mortgage and corporate bonds show much less trading liquidity than other instruments, the former may be sold to the Central Bank under repurchase agreements. Government instruments and short-term bank time deposits are also permitted to be sold to the Central Bank under repurchase agreements.
Having diversified funding sources ensures funding liquidity. Diversification is ensured through establishing triggers that monitor concentrations by funding sources, by maturity, by currency, etc. The aggregation of significant fund providers by currency is monitored as a percentage of our third party liabilities; Concentration triggers by maturity date are also in place. Cross-currency funding is also watched in order to avoid the inability of converting Chilean Pesos back into U.S. dollars due to an absence of trading liquidity in the Foreign Exchange market.
Given our internal metrics and policies, we believe that our working capital is sufficient to meet our present needs. In addition to our own metrics in place to monitor liquidity, the local Central Bank and the Superintendency of Banks have established regulations regarding liquidity, which include: minimum reserve requirements for deposits, minimum “technical” reserve requirements and maximum expected outflow for the coming 30 and 90 days.
The Central Bank has established a minimum reserve of 9.0% for demand deposits and 3.6% for time deposits. The reserve requirement must be met separately by currency.
In addition, we are subject to a “technical” requirement applicable to all banks residing in Chile. The daily balance of deposits payable on demand, net of clearing, may not exceed 2.5 times the amount of the bank’s effective equity. Deposits payable on demand include:
Deposits in checking accounts;
Other demand deposits or obligations payable on demand and incurred in the ordinary course of business;
Savings deposits that allow unconditional withdrawals that bear a stated maturity; and
Other deposits unconditionally payable immediately.
Chilean regulations also require that the expected outflow within the coming 30 days may not exceed the amount of bank equity and the expected outflow within the coming 90 days may not exceed two times the amount of bank equity. Expected outflow may include behavioral assumptions. Measurements must be made by currency separately.
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Internal and regulatory metrics are prepared daily by specialized areas within the Treasury in charge of overseeing the liquidity. The ALCO also monitors the state of these metrics on a monthly basis.
Cash Flows
The tables below set forth our principal sources of cash. Our subsidiaries are not an important source of cash for us and therefore, do not significantly influence our ability to meet our cash obligations. No legal, contractual or economic restrictions exist on the ability of our subsidiaries to transfer funds to us in the form of loans or cash dividends as long as our subsidiaries abide by the regulations in the Chilean Corporations Law regarding loans to related parties and minimum dividend payments.
Net cash provided by operating activities
2007 and 2008. Cash provided by operating activities decreased to Ch$256,043 million in 2008 from Ch$417,124 million in 2007, primarily as a result of an increase in net interest accrued (which is reflected in the line item “net changes in interest and fee accruals”) as well as an increase in the fair value of derivatives (which is reflected in the line item “other credits which do not represent cash flows”).
2006 and 2007. Cash provided by operating activities increased to Ch$417,124 million in 2007 from Ch$386,534 million in 2006, primarily as a result of an increase in provisions for loan losses and of a 314.4% increase in loss from price-level restatement.
Net cash used in investing activities
2007 and 2008. Cash used in investing activities decreased to Ch$1,753,342 million in 2008 from Ch$2,184,418 million in 2007, primarily as a result of an increase in the amount of outstanding transfers in foreign currencies and to the establishment of provisions for minimum dividends.
2006 and 2007. Cash used in investing activities increased to Ch$2,184,418 million in 2007 from Ch$1,614,292 million in 2006, primarily as a result of a 14.2% increase in the volume of our loan portfolio.
Net cash provided by financing activities
2007 and 2008. The increase in cash provided by financing activities from Ch$1,214,799 million in 2007 to Ch$1,674,901 million in 2008 was primarily attributable to an increase in other long-term borrowings and, to a lesser extent, an increase in saving accounts and time deposits.
2006 and 2007. The decrease in cash provided by financing activities from Ch$1,788,415 million in 2006 to Ch$1,214,799 million in 2007 was primarily related to a decrease in saving accounts and time deposits as well as a decrease in short term borrowings.
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Other Borrowings
Our long-term and short-term borrowings are summarized below. In accordance with the guidelines established by the Chilean Superintendency of Banks, we do not present a classified balance sheet. Borrowings are described as short-term when they have original maturities of less than one year or are due on demand. All other borrowings are described as long-term, including the amounts due within one year on such borrowings.
Borrowing from financial institution:
Central Bank Credit lines for renegotiation of loans
Borrowings from foreign institutions
Debt Issued:
Bonds
Subordinated bonds
Mortgage finance bonds
Total other interest bearing liabilities
Central Bank borrowings include credit lines for the renegotiation of loans and other Central Bank borrowings. Credit lines were provided by the Central Bank for the renegotiation of mortgage loans due to the need to refinance debts as a result of the economic recession and crisis of the Chilean banking system from 1982 to 1985. The credit lines for the renegotiations of mortgage loans are linked to the UF index and carry an average real annual interest rate of 3.46 % as of December 31, 2008. The maturities of the outstanding amounts are as follows:
Due within 1 year
Due after 1 year but within 2 years
Due after 2 years but within 3 years
Due after 3 years but within 4 years
Due after 4 years but within 5 years
Due after 5 years
Total long-term (Credit lines for renegotiation of loans)
Total short-term (Other Central Bank borrowings)
Total Central Bank borrowings
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Borrowings from domestic financial institutions, which are used to fund our general activities, carried a weighted average annual real interest rate of 4.80% as of December 31, 2008 and had the following outstanding maturities as of December 31, 2008:
Total long-term
Total short-term
Total borrowings from domestic financial institutions
Borrowings from foreign financial institutions
We have short-term and long-term borrowings from foreign banks. The outstanding maturities of these borrowings as of December 31, 2008 were as follows:
Total foreign borrowings
Each of these loans is denominated in foreign currency and is principally used to fund our foreign trade loans and carry an average annual nominal interest rate of 2.76% as of December 31, 2008.
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Our bonds are linked to the UF Index and carry an average real annual interest rate of 3.50% as of December 31, 2008, with interest and principal payments due semi-annually. The bonds were originally intended to finance loans that had a maturity of greater than one year.
The maturities of outstanding bond amounts as of December 31, 2008 were as follows:
Total bonds
Bonds are linked to the UF Index and carry an average real annual interest rate of 3.33% as of December 31, 2008, with interest and principal payments due semi-annually. The bonds were originally intended to finance loans that had a maturity of greater than one year.
In 2008, Banco de Chile issued ordinary bonds in UF divided into two series, “Y” and “X.” The Y series was issued for an amount of Ch$79,400 million (historic pesos) with a maturity of five years and a coupon rate of 3.3%. The X series was issued for an amount of Ch$77,810 million (historic pesos) with a maturity of six years and a coupon rate of 2.5%.
Our currently outstanding subordinated bonds are linked to the UF index with interest and principal payments due semi-annually. The discount on the issuance of the currently outstanding subordinated bonds is amortized over the life of the bond. As of December 31, 2008, the effective real interest rate was 6.05% taking into consideration the discount on issuance.
The bonds are intended to finance loans having a maturity greater than one year. As of December 31, 2008 the outstanding maturities of the bonds, which are considered long-term, were as follows:
Total subordinated bonds
During 2008, Banco de Chile issued subordinated bonds with a 25-year maturity term. The subordinated bonds were issued in UF and for an aggregate amount of Ch$53,916 million (historic pesos). These subordinated bonds accrue interest at an annual rate of 4.5%.
Subordinated bonds are considered in the calculation of “effective equity” for the purpose of determining our minimum capital requirements.
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Mortgage finance bonds are used to finance the granting of mortgage loans. The outstanding principal amounts of the bonds are amortized on a quarterly basis. The range of maturities of these bonds is between five and twenty years. The bonds are linked to the UF index and carry a weighted average annual interest rate of 4.21% as of December 31, 2008.
The maturities of outstanding mortgage finance bond amounts as of December 31, 2008 were as follows:
Total mortgage finance bonds
Other long-term obligations:
Obligations with Chilean government
Total other long-term obligations
Other short-term obligations
Total other obligations
As of December 31, 2008, other financial obligations had the following maturities:
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Asset and Liability Management
Our asset and liability management policy is to maximize net interest revenue, return on assets and average equity in light of interest rate, liquidity and foreign exchange risks, within the limits of Chilean banking regulations and our internal risk management policies. Subject to these constraints, we may from time to time take mismatched positions as to interest rates or, in certain limited circumstances, foreign currencies when justified, in our view, by market conditions and prospects, and subject to our asset and liability management policies. Our board of directors determines our asset and liability policies. See “Item 11. Quantitative and Qualitative Disclosure About Market Risk.”
Funding
The following table sets forth our average daily balance of liabilities for the years ended December 31, 2006, 2007 and 2008, in each case together with the related average nominal interest rates paid thereon:
Current accounts and demand deposits
Other interest bearing liabilities
Other non-interest bearing liabilities
Our most important source of funding is our customer deposits, which consist primarily of peso-denominated, non-interest bearing current accounts and demand deposits and peso- and UF-denominated interest bearing time deposits and savings accounts. Current accounts and demand deposits represented 17.6% of our average total liabilities in 2008, and are our least expensive source of funding. Savings accounts and time deposit and debt issued represented 60.2% of our average liabilities in 2008 and 65.2% of our average liabilities in 2007, respectively.
A sound liquidity strategy ensures the necessary funding for attractive business opportunities and that we meet our financial obligations when they are due. To accomplish these goals, we take care of the trading liquidity held in our portfolios and the diversification of our funding sources.
In particular, our funding strategy aims to satisfy our customers’ needs and to enhance our product base offering while maintaining a prudent diversification of product, currency and maturity. We are focused on broadening the current core and diversified funding obtained through the retail banking business. In addition to this, we are continuously issuing either subordinated or mortgage bonds in order to match both the liquidity and the interest rate risk generated by the long-term mortgage loans. See “Item 4. Information on the Company—Business Overview—Principal Business Activities.”
Two limits are established to ensure the diversification of our funding sources. Both limits deal with large fund providers: (1) the funding obtained from an individual large fund provider may not exceed a certain percentage of the Bank’s current liabilities; and (2) the funding obtained by all large fund providers may not exceed a certain percentage of our current liabilities. The characteristics of large fund providers are established by the Superintendency of Banks.
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OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of business, we are a party to a number of off-balance sheet activities that contain credit, market and operational risk that are not reflected in our consolidated financial statements. These activities include commitments to extend credit not otherwise accounted for as contingent loans, such as overdrafts and credit card lines of credit, and long-term contractual obligations under operating leases or service contracts.
We provide customers with off balance sheet credit support through loan commitments. Such commitments are agreements to lend to a customer at a future date, subject to compliance with the contractual terms. Since substantial portions of these commitments are expected to expire without our having to make any loans, total commitment amounts do not necessarily represent our actual future cash requirements. The amounts of these loan commitments were Ch$3,875,345 million (U.S.$7,816 million) and Ch$3,113,239 million (U.S.$4,949 million) as of December 31, 2007 and 2008, respectively. The amounts of subscribed leasing contracts were Ch$104,725 million (U.S.$211 million) and Ch$105,325 million (U.S.$167 million) as of December 31, 2007 and 2008, respectively.
Interest rate and cross-currency swaps, which are entered into in order to hedge the foreign investment portfolio, are recorded at their estimated fair market values. See Note 6 to our audited financial statements.
The credit risk of both on- and off balance sheet financial instruments vary based on many factors, including the value of collateral held and other security arrangements. To mitigate credit risk, we generally determine the need for specific covenant, guarantee and collateral requirements on a case-by-case basis, depending on the nature of the financial instrument and the customer’s creditworthiness. The amount and type of collateral held to reduce credit risk varies, but may include real estate, machinery, equipment, inventory and accounts receivable, as well as cash on deposit, stocks, bonds and other marketable securities that are generally held in our possession or at another appropriate custodian or depository. This collateral is valued and inspected on a regular basis to ensure both its existence and adequacy. Additional collateral is requested when appropriate.
Financial Guarantees
The following is a summary of instruments that are considered financial guarantees in accordance with FASB Interpretation No.45:
(in millions of
constant Ch$ as ofDecember 31, 2008)
Performance bonds
Foreign office guarantees and standby letters of credit
Guarantees in the form of performance bonds, standby letters of credit and foreign office guarantees are issued in connection with agreements made by customers to counterparties. If the customer fails to comply with the agreement, the counterparty may enforce the performance bonds, standby letters of credit or foreign office guarantees as a remedy. Credit risk arises from the possibility that the customer may not be able to repay us for these guarantees.
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The expiration of guarantees per period is as follows:
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following tables set forth our contractual obligations and commercial commitments by time remaining to maturity. As of December 31, 2008, the scheduled maturities of our contractual obligations, including accrued interest, were as follows:
Contractual Obligations
Savings accounts and time deposits (1)
Bonds issued
Lease contracts
Services contracts
As of December 31, 2008, the scheduled maturities of other commercial commitments, including accrued interest, were as follows:
Commercial Commitments
Letters of Credit
Guarantees
Total other commercial commitments
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DIRECTORS AND SENIOR MANAGEMENT
Directors
Our administration is conducted by our Board of Directors, which, in accordance with our estatutos, or bylaws, consists of eleven Directors and two Alternate Directors. The entire Board of Directors is elected every three years. Our current Board of Directors was elected in March 2008 and its term expires in March 2011. Our Alternate Directors were appointed in March 2008. The current Chairman of the Board, Pablo Granifo, was elected in 2007.
Cumulative voting is permitted for the election of directors. Our Chairman and our Chief Executive Officer are appointed by our Board of Directors and hold their offices at its discretion. Scheduled meetings of our Board of Directors are held at least twice a month. Extraordinary Board of Directors meetings may be called by the Chairman, when requested by a majority of the Directors, or, in limited circumstances, when requested by one Director.
Our current Directors are as follows:
Director
Position
Pablo Granifo L. was elected as the Chairman of our Board of Directors in 2007. He was our Chief Executive Officer from 2001 to 2007. He was the Chief Executive Officer of Banco de A. Edwards from 2000 to 2001, a Commercial Manager at Banco Santiago from 1995 to 1999, and a Corporate Manager at Banco Santiago from 1999 to 2000. Mr. Granifo is Chairman of the Board of Directors of Banchile Asesoría Financiera S.A., Socofin S.A., Banchile Securitizadora S.A., Banchile Factoring S.A., and Banchile Administradora General de Fondos S.A., and Chairman of the Executive Committee of Banchile Corredores de Seguros Limitada. He holds a degree in Business from the Pontificia Universidad Católica de Chile.
Andrónico Luksic C. was reelected as Director and Vice Chairman of our Board of Directors in 2008, a position he has held every year since 2002. Mr. Luksic is Vice Chairman of Quiñenco S.A. and a member of the Board of Directors at Compañia Cervecerias Unidas S.A., Manufacturas de Cobre Madeco S.A., Industria Nacional de Alimentos S.A., Sociedad de Fomento Fabril (SOFOFA) and Bolsa de Comercio de Santiago. He also serves on the Chairman’s Advisory Council at the Council of the Americas, the Advisory Board to the Panama Canal Authority, the Asia-Pacific Economic Cooperation Business Advisory Council, and is a Triennium Participant in the Trilateral Commission and the International Business Leaders’ Advisory Council of Mayor Han Zheng of the Municipal Government of Shanghai. He is a member of the Board of Trustees at Babson College, the Advisory Committee to the David Rockefeller Center for Latin American Studies at Harvard University, and the Global Advisory Board of Harvard Business School. He was Chairman of the Board of Directors of Banco O’Higgins and subsequently Chairman of the Board of Directors of Banco Santiago until May 1999. Mr. Luksic was Director and Chairman of the Board of Directors of Banco de A. Edwards from September 1999 to December 2001. Mr. Andrónico and Mr. Guillermo Luksic are brothers.
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Jorge Awad M. has been a member of our Board of Directors since 1996. From 1989 to 1996, he was a member of the Board of Directors of Banco de Santiago. Mr. Awad has been the Chairman of the Board of Directors of Lan Airlines S.A. since 1994 and is a member of the Board of Directors of several other companies, including Envases del Pacifico S.A., Universidad de Talca, and Icare. Previously, Mr. Awad was a Director of Codelco Chile, Television Nacional de Chile, Laboratorio Chile S.A and other companies. He is also a Professor of Business Entrepreneurship at the Universidad de Chile, from which he holds a degree in Commercial Engineering.
Jacob Ergas E. has been a member of our Board of Directors since 2002. Mr. Ergas is also Director of Banchile Administradora General de Fondos S.A. He is Chairman of the Board of Directors of J. Ergas Inversiones y Rentas Limitada, Ever I BAE S.A., Ever II HNS S.A., Inmobiliaria Paidahue S.A., and INERSA S.A. He was Chairman of the Board of Directors of Banedwards S.A., Administradora de Fondos Mutuos, Banedwards S.A. Fondos de Inversion and Banedwards Corredora de Seguros Limitada. He was Director of Promarket S.A., Banedwards Compañia de Seguros de Vida S.A. and Banedwards Asesoría Financiera S.A. He was Director and Vice Chairman of Banco de A. Edwards from 1986 to 2001 and also Director of the Chilean Association of Banks and Financial Institutions. Presently, he is a member of the Board of Directors of Banchile Administradora General de Fondos S.A.
Fernando Quiroz is the ICG Head (Institutional Clients Group) for Citi in Latin America, Chairman of Acciones y Valores Banamex (Accival), and the CEO for ICG Banamex. He is a member of Citi’s Senior Leadership Committee and Citi’s ICG Management Committee. Prior to his current position, Mr. Quiroz was the Head of Strategy and Corporate Development of Banamex and Citi Latin America. He began his career at Banamex in 1979, holding various positions. He also served as Head Economist of Banamex.
Guillermo Luksic C. has been a member of our Board of Directors since 2001 and was previously the Vice Chairman of our Board of Directors from March 2001 to March 2002. Mr. Luksic is Chairman of the Board of Directors of Quiñenco S.A., Compañia Cervecerias Unidas S.A., Viña San Pedro Tarapacá S.A., CNT Telefonica del Sur S.A. and Madeco S.A. Since 2005, he has served as a member of the Board of Directors of Antofagasta PLC. Mr. Luksic is an active member of the Center of Public Studies and a member of the Board of Directors of Universidad Finis Terrae. Mr. Luksic is the brother of Mr. Andronico Luksic.
Raúl Anaya E. is Cluster Head for all Citigroup’s businesses in Central America and the Caribbean. He is responsible for all business within this region. Mr. Anaya was named to this position in July 2008. He previously served as Chief Executive Officer of Latin America, Citigroup Global Consumer Group since December 2005. Before that, he served as Retail Head for Latin America since February 2005. From August 2003 to January 2005, Mr. Anaya was Executive Director in Charge of Consumer Assets at Banamex in Mexico, responsible for Mortgages, Personal Loans and Auto Financing. Prior to this position, Mr. Anaya was the Divisional Director in Charge of the Center Metropolitan Retail Banking Division in Banamex. From May 1999 to January 2002, Mr. Anaya was Chairman and CEO of Banco Bansud S.A. (formerly a wholly owned subsidiary of Banamex) in Argentina. Mr. Anaya joined Citibank at the Banamex New York Agency in October 1987 and subsequently became General Manager of Banamex Los Angeles Agency, Executive VP of the Corporate and International Banking Division at California Commerce Bank, General Manager of Banamex Houston Agency and General Manager of Banamex New York Agency with responsibility for the U.S. and Canada offices. Mr. Anaya was a member of the Board of Directors of California Commerce Bank from 1996 to 2001.
Gonzalo Menendez D. has been a member of our Board of Directors since 2001. He is also the Chairman of the Board of Directors of Inversiones Vita S.A. and Banchile Corredores de Bolsa S.A., and a member of the Boards of Directors of several other companies, including Banchile Asesoría Financiera S.A., Banchile Seguros de Vida S.A., Compañia Nacional de Telefonos, Telefonica del Sur S.A., Minera El Tesoro, Compañia de Telefonos de Coyhaique S.A., Quiñenco S.A., Antofagasta PLC, Minera Michilla S.A., Mining
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Group Antofagasta Minerals S.A., Antofagasta Railway, Minera Los Pelambres, Aguas de Antofagasta S.A., Andsberg Investment Ltd. and Andsberg Limited. He is also Vice Chairman of Fundacion Andronico Luksic A. and Fundación Pascual Baburizza. Previously, Mr. Menendez served as Chief Executive Officer of Antofagasta Railway, Banco O’Higgins and Empresas Lucchetti. Since 1990, he has been a Director and is now the Chairman of the Board of Directors of the Latin American Export Bank. Mr. Menendez was a member of the Board of Directors and the Executive Committee of Banco Santiago and a member of the Board of Directors of Banco de A. Edwards. Mr. Menendez was a Professor of Finance and Chilean Economic and Business Policy at the Universidad de Chile. He holds a degree in Business Administration and Accounting from the Universidad de Chile
Juan Andrés Fontaine holds degrees in Economics from Pontificia Universidad Católica de Chile and the University of Chicago (MA). He has been a Research Director at the Central Bank of Chile, a Professor at some of the major universities in Chile, a visiting Professor at UCLA, an author of several publications and an international consultant. Currently, he is Partner and Chief Executive of Fontaine & Paúl Consultores, a firm that specializes in economic and financial consultancy in Chile and abroad. He is Chairman of the Board of Bolsa Electrónica de Chile, and a Board member of Quiñenco S.A., Socovesa S.A, and Transelec S.A. He is also an Associate Professor at Pontificia Universidad Católica de Chile.
Francisco Perez M. has been a member of our Board of Directors since 2001. Since 1998, Mr. Perez has been the Chief Executive Officer of Quiñenco S.A. He was formerly the Chief Executive Officer of Compañia Cervecerias Unidas S.A., of which he is still a Director. He is also a member of the Board of Directors of Banchile Corredores de Bolsa S.A. Prior to 1991, Mr. Perez was Chief Executive Officer of Citicorp-Chile and also was Vice President of Bankers Trust in Chile. Mr. Perez holds a degree in Business Administration from the Pontificia Universidad Católica de Chile and a Master’s Degree in Business Administration from the University of Chicago.
Jaime Estevez V. has been a member of our Board of Directors since 2007. Presently, he is also a member of the Board of Directors of Endesa Chile. Previously, Mr. Estevez served as the Chairman of Banco Estado, a state bank. Additionally, he has served as a Director on the boards of AFP Provida and AFP Proteccion, two Chilean private funds. Mr. Estevez served as Minister of Public Works and Minister of Transport and Telecommunications and was a Congressman and President of the Lower Chamber of Congress. Mr. Estevez holds a degree in Economics from the Universidad de Chile.
Rodrigo Manubens M. has been a member of our Board of Directors since 2001. Mr. Manubens was a member of the Board of Directors of Banco de A. Edwards from 1999 until 2001. From 1985 to 1999, Mr. Manubens was a member of the Board of Directors of Banco O’Higgins and continued in that role when it merged into Banco Santiago. From 1995 to 1999 he was Chairman of Banco Tornquist in Argentina and a member of the Board of Directors of Banco Sur in Peru and Banco Asuncion in Paraguay. Mr. Manubens also served as a Director and Chairman of Endesa Chile S.A. He is Chairman of Banchile Compañia de Seguros de Vida S.A., and the Director of the Center for International Management at the Adolfo Ibañez Graduate School of Business. Mr. Manubens holds a degree in Business from Universidad Adolfo Ibañez and a Master of Science from the London School of Economics and Political Science.
Thomas G. Fürst has been a shareholder and member of our Board of Directors since 2004. He is also a member of the Board of Directors of Banchile Administradora General de Fondos S.A. Previously, Mr. Fürst was Vice Chairman of the Board of Directors at Compañia Cervecerias Unidas S.A. and a member of the Board of Directors of several other companies, including Embotelladoras Chilenas Unidas S.A., Viña Dassault-San Pedro S.A, Southern Breweries Establishment, CCU Argentina S.A. and Compañia Industrial Cerveceria S.A. (CICSA). Mr. Fürst was a Founder and member of the Board of Directors of Parque Arauco. In addition, he is a Partner and member of the Board of Directors of Plaza S.A. and Nuevos Desarrollos S.A., the owners of eleven shopping centers around Chile and two in Peru. Mr. Fürst studied Civil Construction at Pontificia Universidad Católica de Chile.
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Senior Management
Our current Executive Officers are as follows:
Executive Officers
Chief Executive Officer
Chief Financial Officer
General Legal Counsel
Manager — Corporate Banking Division
Manager — Corporate Credit Risk Division
Manager — Individual Banking and Companies Division
Manager — Operations and Technology Division
Manager — Human Resources Division
Manager — Strategic Development Division
Manager — Marketing Division
Manager — Wholesale, Large Corporations and Real Estate Division
Manager — Consumer Division
Manager — Global Compliance Division
Manager — Investment Banking & Capital Markets Division
Manager — Treasury Division
Manager — Individual Credit Risk Division
Manager — Risk Control Division
Fernando Cañas B. was appointed our Chief Executive Officer in 2007. He was the Chairman of our Board of Directors from 2005 to 2007. Mr. Cañas began his financial services career at Banco Santiago in 1977, and participated in its development and management until 1983. Mr. Cañas returned to Banco Santiago in1997 as Vice Chairman of its Board of Directors and became Chief Executive Officer in 1998. Mr. Cañas was Chief Executive Officer at Banco O’Higgins until its merger with Banco Santiago. He served as Chairman of the Board of Directors at Banco Tornquist in Argentina, and as a Director on the Board of Directors of Banco del Sur in Peru. In 2001, Mr. Cañas became Chairman of the Board of Directors of MasterCard International for Latin America and the Caribbean. In 2002, he was Chief Executive Officer of Banco Santander Chile, and in 2003, he became the General Director and Head of Payment Methods for Latin America Banco Santander Central Hispano, based in Spain. Currently, Mr. Cañas is a member of the Board of Directors of Banchile Factoring S.A., Banchile Asesoría Financiera S.A., Banchile Securitizadora S.A., Socofin S.A. and of the Executive Committee of Banchile Corredores Seguros Limitada. Mr. Cañas has a degree in Business Administration from the Universidad de Chile.
Pedro Samhan E . was appointed our Chief Financial Officer on January 1, 2008. On August 21, 2008, he was appointed Director of Banchile Trade Services Limited. Prior to his appointment as Chief Financial Officer, Mr. Samhan was the Chief Financial Officer of Citigroup Chile for several years. He served as a Board member of Cruz Blanca Seguros de Vida (1994 – 1997), AFP Habitat (1996 – 2006) and Compañía Minera Las Luces (1994 – 1996). Mr. Samhan was Chief Financial Officer of Citicorp for Caribbean and Central America (1990 – 1993) and Investment Banking Head of Citicorp Chile (1988 – 1990). Mr. Samhan holds a degree in Civil Industrial Engineering from the Universidad de Chile.
Nelson Rojas P. has been our General Counsel and Secretary of our Board of Directors since 2004. In 2002, he joined us as Deputy General Counsel. Mr. Rojas joined Banco de A. Edwards in 1987 and was the General Legal Counsel and Secretary of the Board of Directors of Banco de A. Edwards from 1997 until 2002. He is also Vice President of the Legal Affairs Committee of the Chilean Bank Association. Mr. Rojas holds a degree in Law from the Universidad de Chile.
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Julio Guzman H. has managed our Corporate Division since 2002. He joined Banco de A. Edwards in 1992 and was appointed Finance and International Division Manager. From September 2001 to December 2001, he served as General Manager. Mr. Guzman is a member of the Board of Banchile Securitizadora S.A. He holds a degree in Business Administration from the Pontificia Universidad Católica de Chile.
Mauricio Baeza L. has been the Manager of the Credit Risk Division since December 2005. Mr. Baeza joined us in 1997 and was Manager of the Risk Division in Banco de A. Edwards during 2001. He was Risk Manager at Banco Santiago from 1993 to 1997 and a member of the Board of Directors of Santiago Administradora de Fondos de Inversion. He is Secretary to the Director’s Loan Committee, SOCOFIN SA Committee Advisor, Finance, International and Financial Risk Committee Advisor, and participates in the Portfolio Risk Committee. Mr. Baeza is also a member of the Investment Committee of Banchile Fondo Inmobiliario. Mr. Baeza holds a degree in Civil Engineering from the Pontificia Universidad Católica de Chile.
Alejandro Herrera A. has been the Manager of the Individual Banking and Branches Division since 2002. Since 2006, he has also been the Manager of Middle Market Banking. He served as Manager of the Individual Banking and Branches Division at Banco de A. Edwards from 2000 to 2001 and at Banco Sudamericano from 1996 to 1999. He also served as the Chief Executive Officer of Administradora de Fondos Mutuos Santiago S.A. from 1994 to 1995 and as Branch Manager at Banco Santiago for the Santiago region. Mr. Herrera is a member of the Board of Directors of Banchile Administradora General de Fondos S.A. and Socofin S.A. and a member of the Executive Committee of Banchile Corredores de Seguros Limitada. He holds a degree in Business from the Pontificia Universidad Católica de Valparaiso.
Patricio Melo was appointed Operations & Technology Division Manager at Banco Chile on July 1, 2008. He was CEO for Altec Brasil SA. from 2006 until June 2008, being the main person responsible for technological management of Banco Santander in Brazil. He was CEO for Altec Chile from 2001 until 2005. From 1992 until 2000 he joined Banco Santander in Chile and Perú as an Operations & Technology Manager. He has also been a member of various Boards of Directors such as that of Redbanc S.A., ALTEC México and ALTEC Chile. Mr. Melo majored in Electronic Engineering at Universidad Federico Santa María.
Jennie E. Coleman A. joined us as Manager of the Human Resources Division in March 2003. Previously, she was the Manager of the Human Resources Division, Manager of Organizational Development, and Training Chief Executive at Banco Santiago, where she worked for more than 23 years. Mrs. Coleman holds a degree in Public Administration from the Universidad de Chile.
Arturo Tagle Q. has been the Manager of the Strategic Development Division since 2008. From 2002 to 2007 Mr. Tagle was CFO of the Bank and from 1998 to 2001 he was Head of Internal Audit and Control. Mr. Tagle joined us in 1995. Previously he was General Manager of the Chilean Bankers Association (1990—1994) and Director of Research at the Chilean Superintendency of Banks (1984—1989). Mr. Tagle is the general manager of Sociedad Matriz del Banco de Chile S.A. and SAOS. He holds a degree in Business Administration from the Pontificia Universidad Católica de Chile and a Master’s Degree in Business Administration from the University of Chicago.
Gonzalo Rios D. has been the Manager of the Marketing Division since November 2005. He was the Marketing Manager of Falabella’s Financial Retail Division from 2002 to 2005 and Manager of Non-Store Retail Operations of Falabella Argentina from 2000 to 2002. He was a Business Consultant at McKinsey & Company from 1997 to 2000 and previously worked for IBM Argentina as a Sales Manager. Mr. Rios is a member of the Executive Committee of Banchile Corredores de Seguros Limitada. He holds a degree in Electrical Engineering from Instituto Tecnologico de Buenos Aires and an MBA from the Massachusetts Institute of Technology.
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Oscar Mehech C. was appointed head of our Risk Control Division in July 2008, after being Head of our Regulatory Policies Division since January 2008, and formerly our Global Compliance Head until December 2007. Mr. Mehech joined us in 2002 as a result of the merger with Banco de A. Edwards and since 2004 held the position of Deputy General Counsel of the Bank and Secretary of the Board of Banchile Asesoría Financiera S.A. Previously, he was the Deputy General Counsel of Banco de A. Edwards, which he joined in 1991. Mr. Mehech holds a law degree from Universidad de Chile.
Eduardo Ebensperger O. has been the Manager of the Wholesale, Large Companies and Real Estate Division since June 2005, and was previously the Chief Executive Officer of Banchile Factoring S.A. from 2002 to 2005. He joined Banco de A. Edwards in 1989. Mr. Ebensperger was Manager of the Medium Size Companies division and Manager of the regional branches of Banco de A. Edwards from 1997 to 2001. Presently, Mr. Ebensperger is the Chairman of the Board of Directors of Artikos S.A. He is also currently a member of the Board of Directors of Banchile Asesoría Financiera S.A., Banchile Factoring S.A. and Banchile Securitizadora S.A.Mr. Ebensperger holds a degree in Business from the Universidad de Chile.
Juan Cooper A. has been the Manager of the consumer division since 2003. He was the Chief Executive Officer of Altavida Santander Compañia de Seguros de Vida S.A. from 2001 to 2002 and the Manager of the Santiago Express division of Banco Santiago from 1993 to 2000. He is also currently a member of the Board of Directors of Socofin S.A., and a member of the Executive Committee of Banchile Corredores Seguros Limitada. Mr. Cooper has a degree in Business from the Universidad de Chile and a master’s degree in Business Administration from the Pontificia Universidad Católica de Chile.
Felipe Echaiz B. has been the Global Compliance Division Manager since January 2008. He joined us this year as a result of the merger with Citibank Chile. Mr. Echaiz worked at Citibank for ten years and was Citigroup’s Country Compliance Officer from 2006 to 2007. In 2003, he was the Deputy Director to the Anti-Money Laundering and Organized Crime Unit (Public Prosecutor’s Office). Mr. Echaiz is a member of the Executive Committee for Anti-Money Laundering of the Chilean Banks Association and holds a degree in Law from the Pontificia Universidad Católica de Chile, and a Master’s Degree in Finance and Economics from the Universidad de Chile.
Andres Bucher C. has 19 years of experience in investment banking and capital markets. He was Managing Director and Co-Head of Investment Banking and Capital Markets for Citibank Chile and currently is the Co-Head of Investment Banking & Capital Markets for Banco de Chile. Mr. Bucher has led and participated directly in a significant number of M&A and capital markets transactions with a number of local and international clients in a wide range of industries. Mr. Bucher holds an Industrial Engineering degree from the Universidad Católica de Chile and a Master’s Degree in Business Administration from the Wharton School, University of Pennsylvania.
Juan Carlos Cavallini has over 20 years of experience in investment banking, capital markets and corporate banking. He was Managing Director and Head of the Corporate Bank for Citibank Chile and currently is the Co-Head of Investment Banking & Capital Markets for Banco de Chile. Mr. Cavallini joined Citibank in 1986. From 1993 to 1996, he was based in New York in Citi’s International Corporate Finance Division. Mr. Cavallini also was Co-Head of the Investment Bank and Capital Markets Division in Citi and was appointed a Senior Securities Officer in 2003 and a Senior Credit Officer in 2005. Mr. Cavallini holds an Industrial Engineering degree from the Universidad Católica de Chile.
Mario Farren R. has been the Corporate and Investment Bank Head of Banco de Chile since September 1, 2008. Between January and September 2008 he was Head of the Treasury Division. Prior to serving in this position, Mr. Farren was the Country Treasurer for Citi Chile. In addition, Mr. Farren has held other positions in Citi Latin America and Citi New York, such as Country Treasurer and Investment Bank Head in Citi Uruguay, Treasury Products Sales Head in New York and Country Treasurer in Citi Colombia. He joined Citibank Chile in 1991 where he served as Derivative Head and General Manager of Citigroup Chile S.A. Corredores de Bolsa, among other positions. He holds a business degree from Universidad de Chile and a Master of Business Administration degree from the University of Chicago, Illinois.
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Julio Ramírez G. was appointed head of our Individual Credit Risk Division in January 2008. Mr. Ramírez joined us in 2002 as a result of the merger with Banco de A. Edwards, where he had been since 1990. From 2002 to 2007, Mr. Ramírez was Manager of the Individual Credit Risk Area, which was part of the Credit Risk Division. Mr. Ramírez is a member of the Board of Directors of Socofin S.A. He holds a degree in Business from the Universidad de Chile.
COMPENSATION
The table below presents the amount of compensation, as established by our shareholders, to the members of our Board of Directors for the year ended December 31, 2008. These amounts include remuneration for services, fees for attendance at Board meetings, committee meetings and subsidiary Board meetings and consulting and travel expenses.
Name of Director
Pablo Granifo Lavín
Andrónico Luksic Craig
Jorge Awad Mehech
Hernán Büchi Buc
Jacob Ergas Ergas
Jaime Estévez Valencia
Guillermo Luksic Craig
Rodrigo Manubens Moltedo
Gonzalo Menéndez Duque
Francisco Pérez Mackenna
Thomas Fürst Freiwirth
Jorge Ergas Heymann
Juan Andres Fontaine Talavera
Fernando Quiroz Robles
Raul Anaya Elizalde
Other subsidiary directors
Consistent with Chilean law, we do not disclose to our shareholders, or otherwise make public, information regarding the compensation of our senior management. For the year ended December 31, 2008, the aggregate amount of compensation paid to our senior management, including the senior management of our subsidiaries, was Ch$7,022 million. Pursuant to the Chilean Corporations Law, our Directors/Audit Committee must approve compensation plans, but we are not required to have a compensation committee. For the year ended December 31, 2008, no amounts were set aside or accrued by us to provide pension, retirement or similar benefits for our directors and officers.
Indebtedness of Directors and Executive Officers
The Chilean Corporations Law provides that the board of directors must previously approve any transaction in which a director has a personal interest or is acting on behalf of a third party. The transaction may be approved only when the board of directors has been informed of such director’s interest and the terms of such transaction are similar to those prevailing in the market. If the proposed transaction involves amounts considered material, the board of directors must previously determine that such transaction is consistent with conditions prevailing in the market. If it is not possible for the board of directors to reach such a judgment, the board may appoint two independent evaluators. The evaluators’ final conclusions must be made available to shareholders and directors for a period of 20 business days, during which shareholders representing 5% or more of the issued voting shares may request the board of directors to summon a shareholders’ meeting to resolve the matter, with the agreement of two-thirds of the issued voting shares required for approval.
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For purposes of this regulation, the law provides that the amount of a proposed transaction is material if (1) it exceeds 1% of the company’s paid-in capital and reserves (provided that it also exceeds 2,000 UF), or (2) it exceeds 20,000 UF. All resolutions approving such transactions must be reported to the company’s shareholders at the next annual shareholders’ meeting. Violations of this provision may result in administrative or criminal sanctions and civil liability to shareholders or third parties who suffer losses as a result of such violation.
Chilean law contains additional provisions restricting transactions with affiliates not involving directors or executive officers. The Chilean Corporations Law requires that our transactions with related parties be on market terms. We are required to compare the terms of any such transaction to those prevailing in the market at the date the transaction is to be entered into. Directors of companies that violate this provision are liable for losses resulting from such violation. As disclosed in Note 22 to our audited consolidated financial statements, we incurred an aggregate of Ch$26,044 million in expenses and Ch$650 million in income from transactions other than loans with related parties in 2008.
As authorized by the General Banking Law, and within applicable regulatory limits, we also hold several outstanding loans owed by different affiliated corporations. All such loans:
were made in the ordinary course of business;
were made on substantially the same terms, including interest rate 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.
We held an aggregate of Ch$318,422 million in loans to, including Ch$108,345 million in collateral pledged by, related parties as of December 31, 2008. See Note 22 to our audited consolidated financial statements for details concerning these transactions.
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BOARD PRACTICES
Governance Practices
The Board of Directors delegates certain functions and activities to our committees to research, evaluate and report to the Board of Directors regarding specific matters which may affect our businesses.
The Directors/Audit Committee
Prior to March 24, 2005, the Directors Committee and Audit Committee were separate committees performing independent functions for the Board of Directors. On March 24, 2005, the Board of Directors resolved to merge the Directors Committee with the Audit Committee, forming the Directors/Audit Committee. The Committee’s objectives are to seek the efficiency, maintenance, application and functioning of our internal control systems and compliance with the applicable rules and procedures governing our business; to identify our business risks; to supervise the functions of both the risk control division and the global compliance division, ensuring their independence from management; to serve as the link and coordinator of tasks between the internal audit work and the independent auditors; and to act as a link with our Board of Directors.
Our Directors/Audit Committee is composed of three members appointed by the Board of Directors. The Directors/Audit Committee is currently composed of the following individuals:
Jorge Awad M. (chair and financial expert);
Jaime Estevez V.; and
Fernando Quiroz R.
Mr. Awad was appointed as a member of the Directors/Audit Committee by the Board of Directors at the Board meeting held on April 12, 2007. Mr. Estevez was appointed to the Directors/Audit Committee at the meeting of the Board of Directors held on April 12, 2007. Mr. Quiroz was appointed to the Directors/Audit Committee at the meeting of the Board of Directors held on January 24, 2008.
Messrs. Awad and Estevez satisfy the independence requirements of both Chilean law and Rule 10A-3 under the Exchange Act and are full voting members of our Directors/Audit Committee.
Mr. Fernando Quiroz R. is exempt from the independence requirements of Rule 10A-3 pursuant to the exemption under Rule 10A-3(b)(1)(iv)(D). Pursuant to that exemption, Mr. Quiroz is a non-voting member of our Directors/Audit Committee with respect to all matters required to be addressed by our Audit Committee under U.S. federal securities laws.
The Directors/Audit Committee usually meets monthly and at least eight times a year. The budget of the Directors/Audit Committee is approved annually at the ordinary shareholders’ meeting. The Directors/Audit Committee satisfies the applicable requirements of the Chilean Superintendency of Banks and operates pursuant to a charter document. The Chilean Superintendency of Banks recommends that at least one of the members of the Committee be experienced with respect to the accounting procedures and financial aspects of banking operations. The Committee submits a report regarding its activities to our Board of Directors after each Directors/Audit Committee meeting and presents an annual report at our annual shareholder’s meeting. As established in the Committee’s bylaws, the Chief Executive Officer, the General Legal Counsel and the Controller, or their respective deputies, shall also attend meetings. The Committee may also invite other persons to attend meetings.
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The Committee may appoint independent personnel to carry out specific duties. The Committee’s objectives include:
Seeking efficiency, maintenance, application and functioning of the internal control systems, and compliance with rules and procedures;
Supervising compliance with the rules and procedures governing the banking business and identifying the business risks of the Bank and its subsidiaries;
Supervising the functions of the Corporate Credit Risk and Market Risk Division and Individual Credit Risk Division, ensuring their independence from the management;
Supervising the functions of the Compliance Division;
Serving as a link and coordinator of tasks between the internal audit work and the external auditors, and acting as a link between these and the Bank’s board;
Examining the fees budget for the external auditors and for the credit-rating agencies;
Analyzing the reports, content, procedures and scope of the revisions by the external auditors and credit-rating agencies;
Analyzing and generating information on the annual internal audit program and the results of internal audits and revisions;
Analyzing the interim and annual financial statements;
Analyzing the Bank’s financial statements included in Form 20-F, for presentation to the Securities and Exchange Commission (SEC);
Gathering information on accounting changes occurring during the year and their effects;
Reviewing of special cases affecting the internal control systems;
Analyzing the remuneration systems and compensation plans for managers and senior executives;
Analyzing the annual performance self-evaluation process carried out by the Bank;
Analyzing related party transactions, i.e. those referred to in clauses 44 and 89 of Chilean Corporations Law;
Analyzing policies relating to operational risk and progress in the risk-management process and SOX self-evaluation, in the context of Basel II;
Analyzing and informing on matters related to the Compliance Division, principally regarding the revision of policies for detecting and sanctioning money-laundering transactions; and
Reviewing customer reports made through the SBIF.
Portfolio Committee
The main function of the Portfolio Committee is to inform the Board of Directors of changes in the composition and risk of our loan portfolio from both a global perspective and from a sector point of view, and also segmented by lines of business. The Committee closely reviews the performance of our principal debtors, overdue loan ratios, past-due loan indicators, write-offs and allowances for loan losses.
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The Loan Portfolio Committee prepares proposals for discussion with, and approval by, the Board of Directors with respect to credit policies, portfolio evaluation methods and the calculation of allowances for expected loan losses. The Committee also performs analysis of the adequacy of allowances, authorizes extraordinary loan write-offs once recovery attempts have been exhausted and controls the disposal of assets acquired in lieu of payment.
This Committee meets on a monthly basis and is comprised of two directors in addition to our Chief Executive Officer, the Companies Credit Risk Manager, the Individual Credit Risk Manager and the Risks and Restructuring Control Manager.
Credit Committee of Directors
The Credit Committee of Directors provides the highest level of approval of credit proposals presented by our credit risk segment and commercial officers. The Committee evaluates proposals with respect to loans that would expose us to credit risks in excess of UF 750,000. It also evaluates proposals based upon certain qualitative aspects irrespective of approval amounts, such as the approval of customers whose eventual collections might adversely affect our corporate image or the approval of transactions with related parties. The Committee meets on a weekly basis and is comprised of the entire Board of Directors.
Finance, International and Market Risk Committee
The Finance, International and Market Risk Committee provides a forum for members to discuss and analyze the implementation of financial management policies. The Committee meets monthly and is comprised of four directors, our Chief Executive Officer, Corporate Credit Risk and Market Risk Division Manager, the Manager of Corporate and Investments Division, the Chief Financial Officer, and the Market Risk Area Manager. Committee members conduct analyses and make presentations to the Committee regarding certain matters, including:
The evolution and current status of the Bank’s financial positions and market risks – of price and liquidity – including both those that have been generated in the past and those currently being generated;
Knowledge of the current status of market risk, which permits forecasting potential future losses;
Validation of the estimation of results of the Bank’s financial position;
Analysis of the liabilities of the international financial exposure and major credit exposures generated by derivative transactions; and
The design of policies and procedures regarding the financial position limits and warning settings, as well as their control and reporting.
Asset Laundering Prevention Committee
The Asset Laundering and Financing of Terrorism Prevention Committee was set up in April 2006 with the purpose of defining the policies and procedures that would comprise the Asset Laundering and Financing of Terrorism Prevention System, as well as evaluating compliance and deciding on all matters related to these subjects.
This Committee includes the Chairman of the Board, the Chief Executive Officer, the General Legal Counsel, the Operations and Technology Division Manager and the General Manager of Banchile Administradora General de Fondos. The Corporate Credit Risk and Market Risk Division Manager, the Compliance Division Manager and the Prevention of Asset Laundering Area Manager also serve as members of the Committee with the right to speak.
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The Committee meets monthly and is charged to pursue with pursuing the following functions:
To approve the policies and procedures concerning knowledge of the Corporation’s customers and their activities, and the acceptance and monitoring of their accounts, products and operations;
To approve policies and procedures concerning unusual transaction detection systems; formal channels of information to senior levels; and monitoring, analysis and reporting mechanisms;
To approve policies and procedures concerning methods to improve vigilance and improve relations with correspondent banks;
To approve policies and procedures concerning staff selection, training programs and codes of conduct;
To revise and analyze the results of the revisions made to verify compliance with current policies and procedures;
To consider the transactions analyzed and decisions made by the Transactions Analysis Committee;
To consider and approve specific training plans proposed by the Global Compliance Division; and
To inform the Board of regulatory changes related to the prevention of asset laundering and financing of terrorism.
Disclosure Committee
In May 2003, we established the Disclosure Committee to check the accuracy and depth of the financial information given to the market. The members of the Disclosure Committee include the Chief Accountant, the Senior Lawyer for International Matters, the Controller’s Division Manager, the Financial Officer, the Research and Planning Area Manager, and the Investors Relations Manager. The members of the Disclosure Committee are involved in reviewing quarterly reports and in general all the financial information disclosed by the Bank prior to its disclosure.
Ethics Committee
The Ethics Committee was formed in 2005 to define, promote and regulate behavior of professional and personal excellence by all the staff of Banco de Chile, coherent with the company’s philosophy and values, in order to meet the expectations of trust granted by our customers.
To meet these objectives and promote a culture of ethical behavior, the Committee arranges activities regarding regulation, training and communications. The Committee sets policies on ethics and ensures their compliance, develops training plans related to ethics in our business, and reinforces positive behavior among our staff. The Committee also acts as a forum for resolving the various situations where there is a conflict between certain types of conduct and the values promoted by the Bank. This Committee is chaired by the Manager of the Human Resources Division and includes the General Legal Counsel and the Managers of the Controller’s, Compliance, Individuals, Middle Market Companies, Operations and Technology, and Corporate Divisions.
Citigroup and Banco de Chile Cooperation Agreements Committees
In order to control and review the evolution of the joint initiatives resulting from our strategic association between Banco de Chile and Citigroup, four committees have been set up to ensure the operation of the Direction Committee referred to in the Cooperation Agreement between both parties. These four
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committees are comprised of the Chairman of the Bank, the Chief Executive Officer and the two members of the Board representing Citigroup. Also taking part in these meetings are Division Managers related to each business and the Managers of the areas directly responsible for the respective business.
Global Transaction Services Committee (GTS)
The Global Transaction Services Committee was set up with the purpose of monitoring the overall performance of the banking transactions according to the Global Connectivity and Cooperation Agreements and in particular, the functioning of the local and international cash management, custody for foreign investors, and foreign trade services.
International Personal Banking and Private Banking Committee (IPB)
The main goal of the International Personal Banking and Private Banking Committee is to monitor the functioning of the Global Connectivity and Cooperation Agreements in relation to the services provided by Banco de Chile to Citibank with respect to its financial products and services offered abroad to residents of Chile.
Investment Banking Committee
The objective of the Investment Banking Committee is to favor the development of cross border merger and acquisition transactions, issuances and acquisitions of debt paper and capital markets for the Bank’s customers and customers of Citigroup doing business in Chile. This Committee is responsible for monitoring the execution of those transactions performed under the Global Connectivity Agreement and collaborating in the exploration of investment banking business opportunities, as well as ensuring that the Agreement signed regarding these matters is met.
Financial Control Committee of the Cooperation Agreement
The most important purpose of the this Committee is to monitor in detail the operative and financial performance of the Global Connectivity and Cooperation Agreements signed with Citigroup. This Committee checks that solutions are reached for all administrative and operative matters that permit the joint business to be carried out effectively, efficiently and profitably by both parties, ensuring compliance with the Agreements in the matters indicated above.
Approval of Policies and Procedures under the Merger Agreement
The Merger Agreement between Banco de Chile and Citibank Chile provided that the Board of Directors of Banco de Chile would approve and implement certain policies relating to the operation of the Bank. At the time of filing of this annual report, the following policies have been approved and implemented, among others:
Policy regarding Personal Investing and Use of Privileged Information;
Policy regarding Inter-company Transactions;
Policy regarding Expenditures and Investments;
Policy regarding Administration of Goods Received as Payment or Granted as Payment of Obligations;
Tax Policy;
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Policy that establishes prohibitions to condition products; and
Policy regarding Prevention of Improper Conduct.
In addition to the policies mentioned above, Banco de Chile is in the process of supplementing other policies currently in force at Banco de Chile to regulate issues of importance for our business, such as prevention of asset-laundering, credit risk, and market risk.
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EMPLOYEES
The following table shows the breakdown of our full-time, permanent employees at the dates indicated:
Overseas branches and representative offices
As of December 31, 2008, we had 14,580 employees (on a consolidated basis) of which approximately 5,519, or 37.9%, were unionized. All management positions are held by non-unionized employees. As of May 18, 2009, we were a party to five collective bargaining agreements covering our unionized employees. Four of the collective bargaining agreements were signed in May 2008 and will expire in April 2012. The other collective bargaining agreement was assumed as part of the merger with Citibank Chile and it has been in effect since September 2007 and is set to expire in September 2009. We have not experienced a strike in the last 10 years and consider relations with our employees to be satisfactory. During 2008, two of our subsidiaries, (Socofin S.A. and Promarket S.A.), entered into certain collective bargaining agreements.
We have a comprehensive personnel training and development program that includes internal courses on operational, technical and commercial matters as well as participation in external seminars. In 2008, the total cost of training programs was approximately 0.6% of total personnel salaries and expense. We do not maintain any pension or retirement programs for the vast majority of our employees. We do, however, pay certain long-serving key employees a severance payment upon retirement. Although we have, in the past, provided productivity bonuses to individual employees on a discretionary basis, we do not maintain a formal profit-sharing plan.
SHARE OWNERSHIP
Mr. Andronico Luksic and Mr. Guillermo Luksic, members of our Board of Directors since March 2002 and March 2001, respectively, together with members of their family, control Quiñenco S.A. As of June 17, 2009, Quiñenco S.A. owns 32.74% of our outstanding shares (directly and indirectly through LQ Inversiones Financieras S.A.). Additionally, Quiñenco S.A. holds 61.71% of the voting rights in Banco de Chile (directly and indirectly through shares of SM-Chile S.A. that are owned by LQ Inversiones Financieras S.A. and Inversiones LQ-SM S.A.).
In connection with the Framework Agreement executed between Citigroup, Inc. and Quiñenco S.A. in July 2007, which was amended on December 19, 2008, following the merger of Citibank Chile into Banco de Chile, Citigroup became a shareholder of LQ Inversiones Financieras S.A. (“LQIF”), the parent corporation of SM-Chile S.A. and Banco de Chile. As of June 17, 2009, Citigroup is the owner of 32.96% of LQIF and Quiñenco directly and indirectly owns 67.04% of LQIF. As part of the Framework Agreement, as amended on December 19, 2008, Citigroup may increase its ownership participation in LQIF to either 41.4778% or 50% subject to the terms set forth in such Amendment. Regardless of any increase in participation by Citi, however, the agreement provides that Quiñenco will remain in control of LQIF and the corporations that are directly or indirectly controlled by LQIF. Accordingly, Quiñenco will maintain the power to elect the majority of the directors of LQIF, SM-Chile and Banco de Chile.
Mr. Jacob Ergas, a member of our Board of Directors since January 1, 2002, controls Ever I Bae S.A., Ever Chile S.A. and Inversiones Aspen Limitada. As of June 17, 2009, these holding companies own 2.16%, 2.16% and 1.49% of our outstanding shares, respectively. Mr. Ergas holds 5.82% of the voting rights in Banco de Chile through these holding companies.
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None of our Directors or senior management (other than Mr. Andronico Luksic, Mr. Guillermo Luksic and Mr. Jacob Ergas) owns 1% or more of our outstanding common stock. Further, none of our Directors (including Mr. Andronico Luksic, Mr. Guillermo Luksic and Mr. Jacob Ergas) or senior management has preferential or different voting rights with respect to the shares they own.
We do not have any arrangements for involving employees in our capital, including any arrangements that involve the issue or grant of options of our shares or securities.
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MAJOR SHAREHOLDERS
The following table sets forth certain information regarding the ownership of outstanding shares as of June 17, 2009 for the following:
each person or entity who is known by us to own beneficially more than 5% of our outstanding share capital or voting power; and
our Directors and members of our executive management group, as a group.
Name
LQ Inversiones Financieras S.A. and SM Chile S.A.(2)
Jacob Ergas(3)
Directors and executive officers as a group (28 persons)
RELATED PARTY TRANSACTIONS
In the ordinary course of our business, we engage in a variety of transactions with certain of our affiliates and related parties. Financial information concerning these transactions is set forth in Note 22 to our audited consolidated financial statements. The Chilean Corporations Law requires that our transactions with related parties be on market terms or on similar terms to those customarily prevailing in the market. We are required to compare the terms of any such transaction to those prevailing in the market on the date the transaction is entered into. Directors of companies that violate this provision are liable for losses resulting from such violations.
In addition, the Chilean Corporations Law provides that any transaction in which a director has a personal interest or is acting on behalf of a third party must be previously approved by a majority of the disinterested directors on the company’s board of directors. The terms of such transaction must be similar to those prevailing in the market. If the proposed transaction involves amounts considered to be material, the disinterested directors must previously determine that the terms and conditions of the transaction are consistent with those prevailing in the market. If it is not possible for the board of directors to reach such a judgment on its own, the board may appoint two independent evaluators. The evaluators’ final conclusions must be made available to shareholders and directors for a period of 20 business days, during which shareholders representing 5% or more of the issued voting shares may request the board of directors to summon a shareholders’ meeting to resolve the matter, with the agreement of two-thirds of the issued voting shares required for approval. For purposes of this requirement, the Chilean Corporations Law considers that the amount of a proposed transaction is material if (1) it exceeds 1% of the company’s paid-in capital and reserves, (provided that it also exceeds UF2,000) or (2) it exceeds UF20,000.
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All resolutions approving such transactions must be reported to the company’s shareholders at the following annual shareholders’ meeting. Violations of this provision may result in administrative or criminal sanctions and civil liability to shareholders or third parties who suffer losses as a result of such violation. We believe that we have complied with the applicable requirements of the Chilean Corporations Law in all transactions with related parties and affirm that we will continue to comply with such requirements. See Note 22 to our audited consolidated financial statements for a more detailed accounting of transactions with related parties.
On July 19, 2007, Quiñenco S.A., Citigroup Inc. and Citibank Overseas Investment Corporation entered into a Master Joint Venture Agreement (the “Framework Agreement”) that set forth the parameters of a partnership between Quiñenco and Citigroup, including the eventual merger of Citibank Chile into Banco de Chile. The Framework Agreement provided that Citigroup would initially acquire a 32.96% equity interest in LQIF, the controlling shareholder of Banco de Chile, and would be entitled to increase its stake in LQIF to either 41.4778% or 50% through the exercise of several options. In this regard, Citigroup could also increase its stake in LQIF to 41.4778% if Quiñenco exercised its put option under the Framework Agreement. The acquisition by Citigroup of its initial interest in LQIF occurred, with effect on January 1, 2008, under the terms of the Framework Agreement and the corresponding Merger Agreement between Banco de Chile and Citibank Chile. For purposes of the Merger Agreement, the operations and businesses of Citibank Chile that were effectively contributed to Banco de Chile were deemed to represent 10.497% of the post-merger entity and, together with other assets and businesses contributed by Citigroup to LQIF, were the basis for issuance by LQIF to Citigroup of the 32.96% equity interest in LQIF. As consideration for the merger and as a result of the Extraordinary Shareholders’ Meeting held on December 27, 2007, we issued and conveyed to LQIF (and indirectly, the holders of Citibank Chile shares) 8,443,861,140 no-par value Banco de Chile S-Series shares.
Under the Framework Agreement, Quiñenco remains as the controlling shareholder of LQIF and therefore of Banco de Chile, while Citigroup is granted certain governance and other shareholder rights in LQIF. With respect to the governance of Banco de Chile, Citigroup has the right to name two directors to the eleven-member board of directors of Banco de Chile, while Quiñenco would maintain the right to appoint a majority of our board of directors. Citigroup also has the power to propose the appointment of certain officers of Banco de Chile (including the Chief Financial Officer) and at least one representative on each of our directors’ committees. Under this agreement, Citigroup was also granted certain veto rights over certain “fundamental strategic decisions” (as defined in the Framework Agreement), such as the delisting of Banco de Chile’s shares from the New York Stock Exchange or the Chilean stock exchanges, entry into new lines of business or large acquisitions, approval of related party transactions and changes to our bylaws or organizational documents. Furthermore, Citigroup agreed to purchase substantially all of the assets of the North American (i.e., Miami and New York) branches of Banco de Chile for US$130 million. In the event that Citigroup were to beneficially own 50% of LQIF, Citigroup would become entitled to name up to five of our 11 directors (such number to be reduced by the number of directors appointed by minority shareholders, provided that Citigroup always shall have the right to appoint at least one director), including the Vice-Chairman of our board of directors. However, even in this circumstance, Quiñenco would still be entitled to appoint a majority of our board of directors. The Framework Agreement also set forth a series of ancillary agreements proposed to be entered into by the parties to the Framework Agreement and their Affiliates.
On December 19, 2008, Quiñenco S.A., Citigroup Inc. and Citibank Overseas Investment Corporation amended the Framework Agreement, and through it the Shareholders’ Agreement mentioned below. The Amendment to the Framework Agreement provides that if Citigroup does not acquire 8.52% of LQIF’s shares (such that Citigroup holds a 41.4778% in LQIF) as provided in the Amendment as a consequence of the actions and decisions of any relevant authority in the United States, Quiñenco shall have the right to a compensation as provided in the Amendment, and Citigroup shall have the option of acquiring either a 41.4778% or a 50% share of LQIF. Furthermore, the Amendment provides that if for any reason Citigroup does not exercise any of the call options mentioned in the previous sentence, Quiñenco or its affiliates, as applicable, shall be entitled to require Citigroup that it sell to them an amount of shares of LQIF such that, after such sale, Quiñenco or its affiliates shall own an 80.1% stake in LQIF. If this occurs, Citigroup’s
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governance and other shareholder rights mentioned in the preceding paragraph shall be those provided in Clause Six of the Shareholders’ Agreement referred to below.
On December 27, 2007, Quiñenco S.A., Citigroup Chile S.A. and the minority shareholders of LQIF entered into a Shareholders’ Agreement that formalized the rights of Citigroup with respect to the governance of Banco de Chile as set forth in the Framework Agreement (and as discussed in the preceding paragraph). The Shareholders Agreement became effective on January 1, 2008.
On December 27, 2007, we entered into a Global Connectivity Agreement with Citigroup Inc. The purpose of this agreement is to enable Banco de Chile and its clients to become part of Citigroup’s Global Network and to provide a framework for Banco de Chile and Citigroup to direct new business to the partnership in order to generate wealth creation for both institutions. The agreement sets forth the terms upon which Banco de Chile, Citigroup and their affiliates will develop a relationship with respect to cross-border business and services being applied to Corporate and Investment Banking, International Personal Banking, Global Transactions Services, and other services and products. The parties agreed on the following principles with respect to implementing the terms of the agreement: (i) the promotion of global connectivity products among Chilean customers, (ii) the setup of a technology platform, (iii) the training of bank officers, and (iv) the construction of international support networks to carry out the transactions contemplated by the agreement. On February 27, 2009, Banco de Chile and Citigroup, Inc. amended the Global Connectivity Agreement. The purpose of the amendment was to clarify and supplement the terms of the original agreement with respect to the banking services to be provided in Chile and abroad.
On December 27, 2007, we also entered into a Trademark License Agreement with Citigroup Inc. in which Citigroup granted us a non-exclusive paid-up and royalty-free license to use certain Citi trademarks in Chilean territory. In addition, Citigroup granted us a license to use its domain name solely in connection with marketing and promoting authorized services in Chilean territory. On February 27, 2009 Banco de Chile and Citigroup amended the Trademark License Agreement. The amendment provides that Banco de Chile must deliver a certificate at least once a year that confirms Banco de Chile’s compliance with the standards set forth in the agreement. In addition, Banco de Chile must comply with certain additional quality control standards approved periodically by Citigroup relating to certain products, and Citigroup has the right to review and inspect all materials relating to the offer and sale of certain products.
On December 27, 2007, we entered into a Cooperation Agreement with Citigroup Inc. The purpose of this agreement is to provide a framework for regulating the interplay of issues created by the above mentioned Citibank Chile merger transaction agreements and to facilitate a successful relationship between Banco de Chile and Citigroup. In particular, this agreement establishes a communication mechanism between the parties to enhance the exchange of ideas and information related to the integration of our business with that of Citigroup in Chile and it also provides for certain specific areas of collaboration going forward (such as with respect to our hedging and derivatives strategies). On February 27, 2009, Banco de Chile and Citigroup amended the Cooperation Agreement to require the companies to define a more formal process for sharing information about regulatory changes in the United States and Chile that may have an impact on Banco de Chile.
On December 31, 2007, we entered into an Asset Purchase Agreement with Citibank, N.A., whereby we sold substantially all of the assets and operations of our banking businesses in Miami and New York to Citibank and Citibank agreed to offer employment to substantially all of the employees and to assume substantially all of the liabilities related to such assets and operations. In consideration for this sale, we were paid an aggregate purchase price of U.S.$130 million, in addition to the assumption of liabilities. Following the completion of the sale, the Miami and New York branches were placed in voluntary liquidation in January 2008. In March 2008, the banking licenses for both branches were surrendered to the appropriate banking regulator.
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On December 23, 2008, Banco de Chile and Compañía Nacional de Teléfonos, Telefónica del Sur S.A. (“Telsur”) agreed to enter into a Trade Agreement in order to optimize the placement and use of credit cards issued by the Bank. This commercial alliance seeks to implement a system linked to credit cards issued by the Bank and will provide discounts, benefits and incentives to be given to clients of both the Bank and Telsur.
On December 30, 2008 we entered into an agreement with Banchile Seguros de Vida S.A., an affiliated insurance brokerage company, setting forth the specific terms of the life insurance policies associated with customer loans contracted by us for its borrower portfolio on behalf of the borrowers. The conditions of this agreement are an integral part of all the life insurance policies that we offer our borrowers. The agreement can be automatically renewed for two additional one-year periods through December 31, 2011.
All the terms and conditions contained in the agreements mentioned above were previously reviewed and approved by our Board of Directors.
In addition, we are concluding negotiations of a Master Services Agreement with Citigroup Inc. This Agreement has the purpose of regulating and supplementing certain reciprocal services that, before the merger, had been provided pursuant to the terms of certain service level agreements then in effect between Citigroup Inc. (and certain of its affiliates) and Citibank Chile, which were assumed, after the merger, by Banco de Chile as legal successor to Citibank Chile. Furthermore, this Agreement seeks to foster global connectivity with respect to the banking and financial services referred to in the Global Connectivity Agreement and in the other agreements executed with Citigroup mentioned above. The Master Services Agreement is subject to approval by the Chilean Superintendency of Banks.
Loans to Related Parties
As authorized by the Chilean General Banking Law, and within the regulatory limits, we hold several outstanding loans owed by different corporations related to us. All such loans (i) were made in the ordinary course of business, (ii) were made on terms, including interest rates and collateral, substantially the same as those prevailing at the time for comparable transactions with other persons, and (iii) did not involve more than the normal risk of collectibility or present other unfavorable features. See Note 22 to our audited consolidated financial statements.
CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
Audited Consolidated Financial Statements
Please refer to “Item 18. Financial Statements.”
Legal Proceedings
We and our subsidiaries are subject to claims and are parties to legal proceedings in the normal course of business.
In September 2004, the Federal Agencies of the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Bank of Atlanta reviewed our New York and Miami branches respectively, in order to evaluate, among other matters, their compliance with the requirements of the U.S. Bank Secrecy Act and other U.S. regulations pertaining to the prevention of money laundering. On February 1, 2005, as a consequence of these reviews, we agreed with the OCC to the issuance of a Consent Order and with the Federal Reserve Bank of Atlanta to the issuance of a Cease and Desist Order. To comply with these orders, an action plan was developed to include the development and maintenance of programs designed to strengthen compliance with the aforementioned regulations.
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On March 12, 2008, the OCC Consent Order was terminated as a consequence of the voluntary liquidation of our New York branch. Likewise, on June 12, 2008, the Cease and Desist Order issued by the Federal Reserve Bank in Atlanta was terminated as a consequence of the voluntary liquidation of our Miami branch.
Dividends
We currently have two series of common shares, and the dividends on our shares are proposed by our Board of Directors and are approved by our shareholders at the annual ordinary shareholders’ meeting following the year with respect to which the dividends are proposed. Our annual ordinary shareholders’ meeting is held in the first three months of each year. Following shareholder approval, the dividends are declared and paid. Dividends are paid to shareholders of record on the fifth business day preceding the date set for payment of the dividend. The applicable record dates for the payment of dividends to holders of our ADSs are, to the extent practicable, the same. Under the Chilean Corporations Law and regulations issued thereunder, Chilean public corporations are generally required to distribute at least 30% of their earnings as dividends. Previously, a bank was permitted to distribute less than such minimum amount in any given year with approval of the holders of at least two-thirds of the bank’s outstanding stock. In 2006, however, this possibility was eliminated by law. Under the General Banking Law, a Chilean bank may only pay a single dividend per year (i.e., interim dividends are not permitted).
Our dividend policy is affected to some extent by the rights of SAOS, our affiliate, pursuant to its assumption of the Central Bank indebtedness discussed in “Item 5. Operating and Financial Review and Prospects—Overview—The 1982-1983 Economic Crisis and the Central Bank Subordinated Debt.”
We currently have two series of capital shares: Banco de Chile common shares and Banco de Chile S-series shares. We have a total of 82,551,699,423 outstanding shares with no par value, consisting of 73,834,890,472 ordinary shares and 8,716,808,951 ordinary shares of the series “Banco de Chile-S,” which resulted from the merger with Citibank Chile. All of our shares are duly subscribed and paid.
In March 2007, we paid a nominal dividend of Ch$1.9796 per share. At the Ordinary Shareholders Meeting on March 27, 2008, the shareholders agreed to the distribution and payment of dividend No. 196, in the amount of Ch$3.359690 per Banco de Chile common share, with a charge to the 2007 income of Banco de Chile, and the distribution and payment of a dividend of Ch$2.626161 per share of the “Banco de Chile-S” series. In March 2009, we paid a nominal dividend of Ch$2.357790 per share. At the Ordinary Shareholders Meeting held on March 26, 2009, the shareholders agreed to the distribution and payment of dividend No. 197, in the amount of Ch$2.357790 per Banco de Chile common share, with a charge to the 2008 income of Banco de Chile, and the distribution and payment of a dividend of Ch$2.357790 per share of the “Banco de Chile-S” series.
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During an Extraordinary Shareholders’ Meeting on December 27, 2007, our shareholders approved, among other things, (i) the merger with Citibank Chile and (ii) a capital increase in the amount of Ch$297,324,899,039, which was contributed and paid for as consideration for the acquisition of all of the assets and liabilities of Citibank Chile. It was further agreed that the Bank would issue 8,443,861,140 registered, ordinary no-par “Banco de Chile-S” series shares, which were to be delivered to the shareholders of Citibank Chile, in the proportion of 8,443.86114 shares of Banco de Chile-S for each Citibank Chile share. For a more detailed description of this Extraordinary Shareholders’ Meeting, see “Item 10. Additional Information—Memorandum and Articles of Association—Shareholders’ Meetings and Voting Rights.”
Dividends payable to holders of our ADSs are net of conversion expenses of the depositary and are subject to Chilean withholding tax currently at the rate of 35%, subject to certain credits. Owners of our ADSs are not charged any fees with respect to cash or stock dividends.
Pursuant to current Chilean foreign exchange regulations, a shareholder who is not a resident of Chile need not register as a foreign investor in order to receive dividends, sale proceeds or other amounts with respect to its shares remitted outside Chile, but the investor must inform the Central Bank about any such transactions and must remit foreign currency through the Formal Exchange Market. Under the foreign investment contract, the depositary, on behalf of our ADS holders, will be granted access to the Formal Exchange Market to convert cash dividends from Chilean pesos to U.S. dollars and to pay such U.S. dollars to ADS holders outside Chile.
The following table sets forth the cash dividends declared per common share and per ADS during the periods indicated:
Dividend payout ratio(1)
100.0%
Dividend per common share(2)
0.006
Whether future dividends will be paid will depend upon our earnings, financial condition, capital requirements, governmental regulations and policies and other factors. Accordingly, there can be no assurance that dividends in future years will be paid at a rate similar to dividends paid in past years.
SIGNIFICANT CHANGES
No significant changes in our financial condition have occurred since the date of the most recent audited consolidated financial statements included in this annual report.
Nature of Trading Market
Shares of our common stock are traded on the Chilean stock exchanges. They have been listed on the Santiago Stock Exchange since 1894, on the Electronic Stock Exchange since 1989 and on the Valparaiso Stock Exchange since 1894. The Santiago Stock Exchange is the principal trading market for our shares.
The Chilean securities markets are substantially smaller, less liquid and more volatile than major securities markets in the United States. The Santiago Stock Exchange, which is Chile’s principal exchange, had a market capitalization of approximately U.S.$134.1 billion as of December 31, 2008 and an average monthly trading volume of approximately U.S.$2,620 million for 2008. The Santiago Stock Exchange was established in 1893 and is a private company whose equity consists of 48 shares held by 45 shareholders. As of December 31, 2008, 300 series of shares were listed on the Santiago Stock Exchange.
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The Santiago Stock Exchange accounts, for approximately 87.2% of all amounts traded in Chile. The ten largest companies in terms of market capitalization represented, as of December 31, 2008, approximately 44.1% of the Santiago Stock Exchange’s aggregate market capitalization and during 2008 accounted for approximately 33.0% of its total volume. During 2008, 20.7% of the companies listed on the Santiago Stock Exchange had their shares traded on an average of 70% or more of the exchange’s trading days. Approximately 12.4% of equity trading in Chile is conducted on the Chilean Electronic Stock Exchange, an electronic trading market that was created by banks and non-member brokerage houses. The remaining 0.4% of equity is traded on the Valparaiso Stock Exchange.
ADSs, each representing 600 shares of common stock, without nominal (par) value, have been listed on the NYSE since January 2, 2002 under the symbol “BCH.” JPMorgan Chase Bank is our depositary for purposes of issuing the ADRs evidencing our ADSs. As of December 31, 2008, a maximum of 1,113,380 ADSs were outstanding (equivalent to 668,028,183 shares of common stock or 0.83% of the total number of issued shares of common stock). Since certain of our ADSs are held by brokers or other nominees, the number of direct record holders in the United States may not be fully indicative of the number of direct beneficial owners in the United States or of where the direct beneficial owners of such shares are resident.
We listed our shares on Latibex, and trading of our shares started on that exchange on October 8, 2002 under the code XBCH, grouped in trading units of 600 shares. In addition, since December 20, 2002, our shares are listed on the LSE.
The table below shows, for the periods indicated, the annual, quarterly and monthly high and low closing prices (in nominal Chilean pesos) of the traded shares of our securities on the Santiago Stock Exchange, the Electronic Stock Exchange, and the Valparaiso Stock Exchange:
Annual Price History
Quarterly Price History
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
Monthly Price History
December 2008
January 2009
February 2009
March 2009
April 2009
May 2009
Sources: Santiago Stock Exchange, Electronic Stock Exchange, Valparaiso Stock Exchange—Official Quotation Bulletin.
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The table below shows the annual, quarterly and monthly high and low closing prices in U.S. dollars and in Euros, respectively, as reported by the NYSE and Latibex:
Sources: Bloomberg.
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MEMORANDUM AND ARTICLES OF ASSOCIATION
Set forth below is a brief summary of the significant provisions of our bylaws, or estatutos and Chilean law. This description contains all material information concerning our shares, but does not purport to be complete and is qualified in its entirety by reference to our estatutos (a copy of which has been incorporated by reference into this annual report), the General Banking Law, the Chilean Corporations Law and the Securities Market Law.
We are an open stock (public) corporation. Open stock (public) corporations are those with 500 or more shareholders, or companies in which 100 or more shareholders own at least 10% of the subscribed capital (excluding those whose individual holdings exceed 10%), and all other companies that are registered in the Securities Registry of the Chilean Superintendency of Securities and Insurance. The Chilean Corporations Law sets forth the rules and requirements for establishing open stock corporations. Shareholder rights in a Chilean bank that is also an open stock corporation are governed by the bank’s estatutos, which effectively serve as both the articles of incorporation and the bylaws of a company incorporated in the United States. Article 137 of the Chilean Corporations Law provides that all provisions of the Chilean Corporations Law take precedence over any contrary provision in a corporation’s estatutos. Both the Chilean Corporations Law and our estatutos provide that legal actions by shareholders against us (or our officers or directors) to enforce their rights as shareholders or by one shareholder against another in their capacity as such are to be brought in Chile in arbitration proceedings.
The Chilean securities markets are principally regulated by the Chilean Superintendency of Securities and Insurance under the Securities Market Law and the Chilean Corporations Law. In the case of banks, compliance with these laws is supervised by the Chilean Superintendency of Banks. These two laws provide for disclosure requirements, restrictions on insider trading and price manipulation and protection of minority investors. The Securities Market Law sets forth requirements relating to public offerings, stock exchanges and brokers, and outlines disclosure requirements for companies that issue publicly offered securities.
Capitalization
There are currently two outstanding series of our capital stock. We have a total of 82,551,699,423 outstanding shares with no par value, consisting of 73,834,890,472 ordinary shares and 8,716,808,951 ordinary shares of the series “Banco de Chile-S,” which resulted from the merger of Citibank Chile with and into the Bank. For the avoidance of doubt, please note that there is no preferred class of shares and each series of our ordinary shares confer the same rights to shareholders. All of the shares are duly subscribed and paid. There are no legal restrictions on the payment of dividends from our net income, except that we may only pay a single dividend per year (i.e., interim dividends are not permitted). Chilean public corporations are generally required to distribute at least 30% of their earnings as dividends. Previously, a bank was permitted to distribute less than such minimum amount in any given year if the holders of at least two-thirds of the bank’s outstanding stock so determined, but in 2006 that possibility was eliminated by law. All of our shares have full voting rights.
Under Chilean law, the shareholders of a company, acting at an Extraordinary Shareholders’ Meeting, have the power to authorize an increase in the company’s capital. When an investor subscribes for issued shares, the shares are registered in such investor’s name, even if not paid for, and the investor is treated as a shareholder for all purposes except with regard to receipt of dividends and the return of capital. The investor becomes eligible to receive dividends or the return of capital once it has paid for the shares; if it has paid for only a portion of such shares, it is entitled to reserve a corresponding pro-rata portion of the dividends declared with respect to such shares unless the company’s bylaws provide otherwise. If an investor does not pay for shares for which it has subscribed on or prior to the date agreed upon for payment, the company is entitled under Chilean law to auction the shares on the stock exchange and collect the difference, if any, between the subscription price and the auction proceeds. However, until such shares are sold at auction, the subscriber
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continues to exercise all the rights of a shareholder (except the right to receive dividends or the return of capital). In the case of banks, authorized shares and issued shares that have not been paid for within the period fixed for their payment by the Chilean Superintendency of Banks are cancelled and are no longer available for issuance by the company.
The Chilean Corporations Law provides that the purchaser of shares of a company implicitly accepts its bylaws and any agreements adopted at shareholders’ meetings.
For a description of the provisions of our estatutos relating to our Board of Directors and our Directors/Audit Committee, see “Item 6. Directors, Senior Management and Employees.”
Ownership Restrictions
Under the Securities Market Law and the regulations of the Chilean Superintendency of Banks, shareholders of open stock corporations are required to report the following to the Chilean Superintendency of Securities and Insurance and the Chilean stock exchanges:
any direct or indirect acquisition or sale of shares that results in the holder’s acquiring or disposing of, directly or indirectly, 10% or more of an open stock corporation’s share capital; and
any direct or indirect acquisition or sale of shares or options to buy or sell shares, in any amount, if made by a holder of 10% or more of an open stock corporation’s capital or if made by a director, liquidator, main officer, general manager or manager of such corporation.
In addition, any person who acquires 10% or more of our shares must include in the report whether the purpose of the acquisition is to acquire control of the company or if the acquisition is just a financial investment. A beneficial owner of ADSs representing 10% or more of our share capital will be subject to these reporting requirements under Chilean law.
According to the regulations of the Chilean Superintendency of Banks, Chilean banks that issue ADSs are required to inform the Chilean Superintendency of Banks if any person, directly or beneficially, acquires ADSs representing 5% or more of the total amount of shares of capital stock issued by such bank.
Under the Securities Market Law and the regulations of the Chilean Superintendency of Banks, persons or entities intending to acquire control, directly or indirectly, of an open stock corporation are also required to inform the public of such intention at least 10 business days in advance but, in any case, as soon as negotiations regarding the change of control begin (i.e., when information and documents concerning the target are delivered to the potential acquirer) through a filing with the Chilean Superintendency of Securities and Insurance, the stock exchanges, companies controlled by and that control the target and through a notice published in two Chilean newspapers, which notice must disclose, among other information, the person or entity purchasing or selling, the price and the material conditions of any negotiations.
Prior to such publication, a written communication to such effect must be sent to the target corporation, to the controlling corporation, to the corporations controlled by the target corporation, to the Chilean Superintendency of Securities and Insurance and to the Chilean stock exchanges. Title XV of the Securities Market Law provides the definition of a controlling power, direct holding and related party.
The General Banking Law provides that, as a matter of public policy, no person or company may acquire, directly or indirectly, more than 10% of the shares of a bank without the prior authorization of the Chilean Superintendency of Banks, which may not be unreasonably withheld. The prohibition also applies to beneficial owners of ADSs. In the absence of such authorization, any person or group of persons acting in concert would not be permitted to exercise voting rights with respect to the shares or ADSs acquired. In determining whether to issue such an authorization, the Chilean Superintendency of Banks considers a number of factors enumerated in the General Banking Law, including the financial stability of the purchasing party.
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The General Banking Law also requires the prior authorization of the Chilean Superintendency of Banks for the following transactions:
the control by the same person or controlling group of two or more banks; or
a substantial increase in the share ownership by a controlling shareholder of a bank.
The above mentioned authorization is required when the acquiring bank or the resulting group of banks, after the transaction is consummated, would own a significant market share in loans, defined by the Chilean Superintendency of Banks to be more than 15.0% of all loans in the Chilean banking system. This authorization may be denied by the Chilean Superintendency of Banks only by means of a founded resolution and if the petitioner does not comply with certain requirements, such as financial stability and commercial soundness.
If a merger between two or more banks results in a market share greater than 15% but less than 20%, the authorization of the Chilean Superintendency of Banks is conditioned on the post-merger bank maintaining the percentage of paid-in capital and reserves to risk-weighted assets of not less than 10% for a period established by the Superintendency (but in no event less than one year).
When any of the aforementioned transactions results in a market share of 20% or greater for the resulting bank, the authorization may be conditioned on one or more of the following:
that the technical reserve requirements established by Article 65 of the General Banking Law be applicable when deposits exceed one and a half times the resulting bank’s paid-in capital and reserves; or
that the margin for interbank loans be diminished to 20% of the resulting bank’s paid-in capital and reserves.
The General Banking Law and the regulations issued by the Chilean Superintendency of Banks provide that individuals that are holders of shares and who beneficially own more than 1% of the shares may be considered related to the bank and imposes certain restrictions on the amounts and terms of loans to them made by the related bank. This rule also applies to beneficial owners of ADSs representing more than 1% of the shares.
Preemptive Rights and Increases of Share Capital
The Chilean Corporations Law provides that whenever a Chilean company issues new shares for cash, it must offer its existing shareholders the right to purchase a sufficient number of shares to maintain their existing ownership percentages in the company. Pursuant to this requirement, we must offer preemptive rights in connection with any future issue of shares to the depositary as the registered owner of the shares underlying the ADSs. However, the depositary will not be able to make the preemptive rights available to U.S. holders of ADSs unless a registration statement under the Securities Act, is effective with respect to the underlying shares or an exemption from the registration requirements thereunder is available.
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We intend to evaluate, at the time of any preemptive rights offering, the practicality under Chilean law and Central Bank regulations in effect at the time of making such rights available to our ADS holders, as well as the costs and potential liabilities associated with the registration of such rights and the related shares of common stock under the Securities Act, and the indirect benefits to us of thereby enabling the exercise by all or certain U.S. holders of ADSs of their preemptive rights and any other factors we consider appropriate at the time. There can be no assurance that any registration statement would be filed. If we do not file a registration statement and no exemption from the registration requirements under the Securities Act is available, the depositary will sell such holders’ preemptive rights and distribute the proceeds if a premium can be recognized over the cost of such sale.
In the event that the depositary is not able, or determines that it is not feasible, to sell such rights at a premium over the cost of any such sale, all or certain U.S. holders of ADSs may receive no value for such rights. Non-U.S. holders of ADSs may be able to exercise their preemptive rights regardless of whether a registration statement is filed. The inability of all or certain U.S. holders of ADSs to exercise preemptive rights in respect of shares of common stock underlying such ADSs could result in such holders not maintaining their percentage ownership of the common stock following a preemptive rights offering unless the holder made additional market purchases of ADSs or shares of common stock.
Under Chilean law, the preemptive right to subscribe new shares for cash must be exercised or transferred by shareholders within 30 days following the grant of such rights. For an open stock corporation during such period, and for an additional 30-day period thereafter, such corporation is not permitted to offer any unsubscribed shares for sale to third parties on more favorable terms than those offered to its shareholders. However, at the end of such additional 30-day period, a Chilean open stock corporation is authorized to sell unsubscribed shares to third parties on any terms, provided that they are sold on a Chilean stock exchange.
Shareholders’ Meetings and Voting Rights
An Ordinary Annual Meeting of Shareholders is held within the first three months of each year, generally in March. The Ordinary Annual Meeting of shareholders is the corporate body that approves the annual financial statements, all dividends in accordance with the dividend policy determined by our Board of Directors, elects our Board of Directors and any other matter that does not require an Extraordinary Shareholders’ Meeting. Extraordinary Meetings may be called by our Board of Directors when deemed appropriate, and Ordinary or Extraordinary Meetings must be called by our Board of Directors when requested by shareholders representing at least 10% of the issued voting shares or by the Chilean Superintendency of Banks.
Notice to convene the Ordinary Annual Meeting or an Extraordinary Meeting is given by means of three notices that must be published in a newspaper of our corporate domicile (currently Santiago, Chile) or in the Official Gazette in a prescribed manner, and the first notice must be published not less than 15 calendar days nor more than 20 calendar days in advance of the scheduled meeting. Notice must also be given to the Chilean Superintendency of Banks and the Santiago, Valparaiso and Electronic Stock Exchanges. Currently, we publish our official notices in the Diario El Mercurio.
The notice of a Shareholders’ Meeting must be mailed not fewer than 15 calendar days prior to the date of such meeting and, in the case of an Ordinary Annual Shareholders’ Meeting, shareholders holding a prescribed minimum investment must be sent an annual report of our activities which includes audited consolidated financial statements. Shareholders who do not fall into this category but who request it must also be sent a copy of our annual report. In addition to these requirements, we regularly provide, and management currently intends to continue to provide, together with the notice of shareholders’ meeting, a proposal for the final annual dividend.
The quorum for a Shareholders’ Meeting is established by the presence, in person or by proxy, of shareholders representing at least an absolute majority of the issued shares; if a quorum is not present at the first meeting on first call, the meeting can be reconvened (in accordance with the procedures described in the previous paragraph) and, upon the meeting being reconvened, shareholders present at the reconvened meeting are deemed to constitute a quorum regardless of the percentage of the shares represented.
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The Shareholders’ Meetings pass resolutions by the affirmative vote of an absolute majority of those voting shares present or represented at the meeting. Approval by a two-thirds majority of the issued shares, however, is required at any Shareholders’ Meeting to approve any of the following actions:
a change in corporate form, merger or spin-off;
an amendment to our term of existence or early dissolution;
a change in corporate domicile;
a decrease of corporate capital;
the approval of capital contributions in kind and a valuation of the assets contributed;
a modification of the powers of shareholders or limitations on the powers of our board of directors;
a reduction in the number of members of our board of directors;
the transfer of 50% or more of the corporate assets or the formation or amendment of any business plan that contemplates the transfer of 50% or more of our corporate assets;
any non-cash distribution in respect of the shares;
the granting of guarantees to secure third-party obligations in excess of 50% of our corporate assets, unless granted to a subsidiary; or
the repurchase of shares.
Shareholders may aggregate their votes for the election of directors and cast the same in favor of one person.
In general, Chilean law does not require a Chilean open stock corporation to provide the level and type of information that U.S. securities laws require a reporting company to provide to its shareholders in connection with a solicitation of proxies. Shareholders are entitled to examine the books of a company within the 15-day period before its Ordinary Annual Meeting.
The Chilean Corporations Law provides that whenever shareholders representing 10% or more of the issued voting shares so request, a Chilean company’s annual report must include, in addition to the materials provided by the board of directors to shareholders, any shareholders’ comments and proposals in relation to the company’s affairs. Similarly, the Chilean Corporations Law provides that whenever the board of directors of an open stock corporation convenes an ordinary meeting of the shareholders and solicits proxies for that meeting, or distributes information supporting its decisions or other similar material, it is obligated to include as an annex to its annual report any pertinent comments and proposals that may have been made by shareholders owning 10% or more of the company’s voting shares who have requested that such comments and proposals be included.
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Only shareholders registered as such with us on the fifth business day prior to the date of a meeting are entitled to attend and vote their shares. A shareholder may appoint another individual (who need not be a shareholder) as his proxy to attend and vote on his behalf. Every shareholder entitled to attend and vote at a shareholders’ meeting has one vote for every share subscribed.
An Extraordinary Shareholders’ Meeting was held on December 27, 2007 and the following issues were discussed and the following decisions were made:
Approval of the merger by absorption of Citibank Chile into Banco de Chile, under the terms set forth in the Merger Agreement executed by the parties on December 26, 2007. As a result of the merger, the Bank acquired all the assets and assumed all the liabilities of Citibank Chile, and it succeeded to all of the assets and all of the liabilities of the latter. The merger was approved by Citibank Chile’s Extraordinary Shareholders’ Meeting. In addition, the shareholders ratified the other agreements executed in connection with the Citibank Chile merger (i.e., the Asset Purchase Agreement, the License Agreement, the Cooperation Agreement and the Global Connectivity Agreement).
A capital increase was approved in the amount of Ch$297,324,899,039, which was contributed and paid for as consideration for the acquisition of the all of the assets and liabilities of Citibank Chile. It was resolved that the Bank would issue 8,443,861,140 registered, ordinary no-par “Banco de Chile-S” series shares, which were to be delivered to the shareholders of Citibank Chile, in the proportion of 8,443.86114 shares of Banco de Chile-S for each Citibank Chile share. The “Banco de Chile-S” series shares shall not be subject to the Exchange Agreement signed by the Central Bank of Chile and its subsequent modifications by virtue of the application of Agreements No. 1.167-03-041209 and No. 1.333-01-070510 of the Governing Council of the Central Bank of Chile.
It was agreed that the merger was to become effective as of January 1, 2008, and that the profits of each bank corresponding to the financial year 2007 were to correspond in to the shareholders of each respective institution in the manner and under the conditions determined by the Ordinary Shareholder’s Meeting of the post-merger bank.
Some modifications to the Articles of Incorporation of Banco de Chile were approved, as proposed by the Board of Directors (as detailed below). The issuance of a rewritten, coordinated and systemized text of the Articles of Incorporation of the Bank was also approved.
The modifications to the Articles of Incorporation are as follows:
Article Five was amended in order to establish the new capital of the Bank, the new amount of shares and the creation of a new series of ordinary shares (“Banco de Chile-S”);
Article Eight was modified in order to establish that, in the case of any vacancy of Alternate Directors, any replacement Director will be appointed by the Board so that the second Alternate Director will stand in the place of the first Alternate Director automatically;
Article Ten was modified to change the term during which a Board of Directors Meeting must be held when it has been convened by one or more Directors, to modify the term of any notice for such meetings, and the means by which these notices can be carried out;
Article Fifteen was amended to establish a new system for replacing the Chairman. Accordingly, in case of absence or incapacity of the Chairman of the Board, he shall be replaced in his functions by a Director appointed by the Board of Directors, and not by the Vice President;
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Article Nineteen was modified in order to change the system by which an election at a Shareholders’ Meeting is conducted. The existing viva vocemechanism was replaced by voting by slip of paper for shareholder votes. Additionally, the counting of votes can be carried out by a notary public, without prejudice to the resolutions adopted by the shareholders or by the Chilean Superintendency of Banks; and
New transitional articles were included to make reference to the merger between Banco de Chile and Citibank Chile and to the new capital of the Bank.
At the Ordinary Shareholders’ Meeting of the Bank, held on March 27, 2008, the Board of Directors was renewed, due to the end of the legal and statutory three-year terms for the Directors. Alternate Directors were also designated. In addition, the shareholders agreed to the distribution and payment of dividend No. 196, in the amount of Ch$3.359690 per Banco de Chile common share, with a charge to the 2007 income of Banco de Chile, and the distribution and payment of a dividend of Ch$2.626161 per share of the “Banco de Chile-S” series.
At the Ordinary Shareholders’ Meeting of the Bank, held on March 26, 2009, the shareholders agreed to the distribution and payment of dividend No. 197, in the amount of Ch$2.357790 per Banco de Chile common share, with a charge to the 2008 income of Banco de Chile, and the distribution and payment of a dividend of Ch$2.357790 per share of the “Banco de Chile-S” series.
At the Extraordinary Shareholders’ Meeting of the Bank, held on March 26, 2009, the shareholders agreed that 30% of the net income obtained during the fiscal year ending December 31, 2008, would be capitalized through the issuance of fully paid-in shares, of no par value, with a value of $31.26 per share, which would be distributed among the shareholders in the proportion of 0.032325 fully paid-in shares for each share held by shareholders at the date prescribed by law.
Dividend, Liquidation and Appraisal Rights
For a description of the provisions of our estatutos related to our dividends, see “Item 8. Financial Information—Consolidated Statements and Other Financial Information—Dividends.”
Under the Chilean Corporations Law, Chilean companies are generally required to distribute at least 30% of their earnings as dividends. Previously, the General Banking Law stated that banks were permitted to distribute less than such minimum amount in any given year with the approval of holders of at least two-thirds of the bank’s common stock. In 2006, however, this possibility was eliminated by law. In the event of any loss of capital or decrease in the legal reserve, no dividends can be distributed until the loss is recovered. Also, a bank cannot distribute dividends above the legal minimum if doing so would result in the bank exceeding its maximum indebtedness ratio or its lending limits. See “Item 8. Financial Information—Consolidated Statements and Other Financial Information—Dividends.”
Dividends that are declared but not paid by the date set for payment at the time of declaration are adjusted from the date set for payment to the date they are actually paid, and interest is accrued thereon. The right to receive a dividend lapses if it is not claimed within five years from the date the dividend is payable.
We may declare a dividend in cash or in shares. When a share dividend is declared above the legal minimum (which minimum must be paid in cash), our shareholders must be given the option to elect to receive cash. A U.S. holder of our ADSs may, in the absence of an effective registration statement under the Securities Act or an available exemption from the registration requirement thereunder, effectively be required to receive a dividend in cash. See “—Preemptive Rights and Increases of Share Capital.”
In the event of our liquidation, the holders of our fully paid shares would share equally and ratably, in proportion to the number of paid-in shares held by them, in our assets available after payment of all our creditors.
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In accordance with the General Banking Law, our shareholders would have no appraisal rights in the event of a business combination or otherwise.
Approval of Financial Statements
Our Board of Directors is required to submit our audited consolidated financial statements to the shareholders annually for their approval. The approval or rejection of the financial statements is entirely within our shareholders’ discretion. If our shareholders reject our financial statements, our Board of Directors must submit new financial statements not later than 60 calendar days from the date of the rejection. If our shareholders reject our new financial statements, our entire Board of Directors is deemed removed from office and a new Board of Directors is elected at the same meeting. Directors who individually approved our financial statements are disqualified from running for re-election for the ensuing period.
Registrations and Transfers
We act as our own registrar and transfer agent, as is customary among Chilean companies. In the case of jointly owned shares, an attorney-in-fact must be appointed to represent the joint owners in dealings with us.
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EXCHANGE CONTROLS
The Central Bank is responsible for, among other things, monetary policies and exchange controls in Chile. Appropriate registration of a foreign investment in Chile grants the investor access to the Formal Exchange Market. Foreign investments can be registered with the Foreign Investment Committee under Decree Law No. 600 or can be registered with the Central Bank under the Central Bank Act.
On April 16, 2001, the Central Bank agreed that, effective April 19, 2001:
the prior foreign exchange restrictions would be eliminated; and
a new Compendio de Normas de Cambios Internacionales, or Compendium of Foreign Exchange Regulations, would be applied.
The main objective of this change, as declared by the Central Bank, is to facilitate capital movements from and into Chile and encourage foreign investment.
The following specific restrictions were eliminated:
A reserve requirement with the Central Bank for a period of one year. This mandatory reserve was previously imposed on foreign loans and funds brought into Chile to purchase shares other than those acquired in the establishment of a new company or in the capital increase of the issuing company. This reserve requirement was decreased from 30% to 0% of the proposed investment on September 16, 1998;
The requirement for prior approval by the Central Bank for certain operations, such as repatriation of investments and payments to foreign creditors;
the mandatory return of foreign currencies to Chile; and
The mandatory conversion of foreign currencies into Chilean pesos.
Under the amended regulations, only the following limitations are applicable to these operations:
The Central Bank must be provided with information related to certain operations, such as foreign investments and foreign credits; and
Certain operations, such as money transfers to and from Chile must be conducted within the Formal Exchange Market.
The Central Bank also eliminated Chapter XXVI of the “Compendium of Foreign Exchange Regulations,” which regulated the establishment of an ADR facility by a Chilean company. According to the new rules, it is not necessary to seek the Central Bank’s prior approval in order to establish an ADR facility. The establishment of an ADR facility is now regarded as an ordinary foreign investment. The establishment of an ADR facility now simply requires that the Central Bank be informed of the transaction, and that the transaction be conducted exclusively through the Formal Exchange Market.
Foreign Investment Contract
We are a party, as legal successor of Banco de A. Edwards, to the currently existing foreign investment contract with the Central Bank and the depositary (a copy of which was filed as an exhibit to Banco de A. Edwards’ registration statement on Form F-1 (Registration No. 33-97594) filed with the Securities and Exchange Commission on September 29, 1995). Absent the foreign investment contract, under applicable Chilean exchange controls, investors would not be granted access to the Formal Exchange Market for the
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purpose of converting pesos to U.S. dollars and repatriating from Chile amounts received with respect to deposited shares or shares withdrawn from deposit on surrender of ADSs (including amounts received as cash dividends and proceeds from the sale in Chile of the underlying shares and any rights arising therefrom).
The following is a summary of the material provisions of the foreign investment contract. This summary does not purport to be complete and is qualified in its entirety by reference to the foreign investment contract. Under the foreign investment contract, the Central Bank agrees to grant to the depositary, on behalf of ADR holders, and to any investor not residing or domiciled in Chile who withdraws shares upon delivery of ADRs (we refer to such shares as withdrawn shares), access to the Formal Exchange Market to convert pesos to U.S. dollars (and remit such U.S. dollars outside of Chile) in respect of shares represented by ADSs or withdrawn shares, including amounts received as:
cash dividends;
proceeds from the sale in Chile of withdrawn shares (subject to receipt by the Central Bank of a certificate from the holder of the withdrawn shares (or from an institution authorized by the Central Bank) that such holder’s residence and domicile are outside Chile and a certificate from a Chilean stock exchange (or from a brokerage or securities firm established in Chile) that such withdrawn shares were sold on a Chilean stock exchange);
proceeds from the sale in Chile of rights to subscribe for additional shares;
proceeds from our liquidation, merger or consolidation; and
other distributions, including without limitation those resulting from any recapitalization as a result of holding shares represented by ADSs or withdrawn shares.
Transferees of withdrawn shares will not be entitled to any of the foregoing rights unless the withdrawn shares are redeposited with the depositary. Investors receiving withdrawn shares in exchange for ADRs will have the right to redeposit such shares in exchange for ADRs, provided that the conditions to redeposit are satisfied.
The foreign investment contract provides that a person who brings foreign currency into Chile to purchase shares with the benefit of the foreign investment contract must convert the foreign currency into pesos on the same date as the foreign currency is brought into Chile and then has five banking business days within which to invest the currency in shares in order to receive the benefits of the foreign investment contract. If the person decides within that period not to acquire shares, he or she can access the formal exchange market to reacquire dollars, provided that the applicable request is presented to the Central Bank within seven banking business days of the initial conversion into pesos. Shares acquired as described above may be deposited for ADSs and receive the benefits of the foreign investment contract, subject to:
receipt by the Central Bank of a certificate from the depositary that such deposit has been effected and that the related ADRs have been issued; and
receipt by the custodian of a declaration from the person making such deposit waiving the benefits of the foreign investment contract with respect to the deposited shares.
Access to the Formal Exchange Market under any of the circumstances described above is not automatic. Such access requires approval of the Central Bank based on a request presented through a banking institution established in Chile. The foreign investment contract provides that if the Central Bank has not acted on the request within seven banking days, the request will be deemed approved.
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Under current Chilean law, the foreign investment contract cannot be changed unilaterally by the Central Bank, and there are judicial precedents (which are not binding with respect to future judicial decisions) indicating that the foreign investment contract may not be abrogated by future legislative changes. On May 10, 2007, the Board of the Central Bank resolved to interpret the regulations regarding the previously established Chapter XXVI in connection with the access granted to the Formal Exchange Market. These regulations allow entities that endeavor to carry out capital increases by means of the issuance of cash shares before August 31, 2007 to apply the aforementioned regulation to their capital increases, but only once and only if those shares can be fully subscribed and paid by August 31, 2008, among other conditions. Consequently, capital increases carried out after August 31, 2007 (including, for example, the issuance of the “Banco de Chile-S” series shares in connection with our merger with Citibank Chile) will have no guaranteed access to the Formal Exchange Market. Furthermore, there is no assurance that (i) additional Chilean restrictions may be inapplicable to the holders of ADRs, (ii) the disposition of underlying shares or the repatriation of the proceeds from such disposition will be subject to restrictions in the future and (iii) we cannot assess the duration or impact of such restrictions if imposed.
TAXATION
Chilean Tax Considerations
The following discussion is based on certain Chilean income tax laws presently in force, including Ruling No. 324 of January 29, 1990 of theServicio de Impuestos Internos, or the Chilean Internal Revenue Service, and other applicable regulations and rulings. The discussion summarizes the principal Chilean income tax consequences of an investment in ADSs or shares of common stock by an individual who is not domiciled in, or a resident of, Chile or a legal entity that is not organized under the laws of Chile and does not have a permanent establishment located in Chile, which we refer to as a foreign holder. For purposes of Chilean tax law, an individual holder is a resident of Chile if he or she has resided in Chile for more than six consecutive months in one calendar year or for a total of more than six months, whether consecutive or not, in two consecutive tax years. An individual holder is domiciled in Chile if he or she resides in Chile with the purpose of staying in Chile (such purpose to be evidenced by circumstances such as the acceptance of employment within Chile or the relocation of his or her family to Chile). This discussion is not intended as tax advice to any particular investor, which can be rendered only in light of that investor’s particular tax situation.
Under Chilean law, provisions contained in statutes such as tax rates applicable to foreign holders, the computation of taxable income for Chilean purposes and the manner in which Chilean taxes are imposed and collected may be amended only by another statute. In addition, the Chilean tax authorities issue rulings and regulations of either general or specific application and interpret the provisions of Chilean tax law. Chilean taxes may not be assessed retroactively against taxpayers who act in good faith relying on such rulings and regulations, but Chilean tax authorities may change rulings and regulations prospectively. There is no general income tax treaty in force between Chile and the United States.
Cash Dividends and Other Distributions
Cash dividends paid by us with respect to ADSs or shares of common stock held by a foreign holder will be subject to a 35.0% Chilean withholding tax, which is withheld and paid over by us, which we refer to as the Chilean withholding tax. A credit against the Chilean withholding tax is available based on the level of corporate income tax, or first category tax, actually paid on the taxable income to which the dividend is imputed; however, this credit does not reduce the Chilean withholding tax on a one-for-one basis because it also increases the base on which the Chilean withholding tax is imposed. In addition, distribution of book income in excess of retained taxable income is subject to the Chilean withholding tax, but such distribution is not eligible for the credit. Under Chilean income tax law, for purposes of determining the level of the first category tax paid, dividends generally are assumed to have been paid out of oldest retained taxable profits. The effective rate of withholding tax to be imposed on dividends paid by us will vary depending upon the amount of first category tax paid by us on the earnings to which the dividends are attributed. In our case, the amount paid as first category tax is lower than it would be based on our income because the dividends paid to SAOS are accounted for as a cost to us. Presently, the first category tax rate is 17%. Whether the first category tax is imposed or not, the effective overall combined rate of Chilean taxes imposed with respect to our distributed profits is 35.0%.
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The foregoing tax consequences apply to cash dividends paid and dividend distributions made in property, other than shares of common stock. Share dividends are not subject to Chilean taxation.
Capital Gains
Gain realized on the sale, exchange or other disposition by a foreign holder of ADSs (or ADRs evidencing ADSs) will not be subject to Chilean taxation, provided that such disposition occurs outside Chile or that it is performed under the rules of Title XXIV of the Chilean Securities Market Law. The deposit and withdrawal of shares of common stock in exchange for ADRs will not be subject to any Chilean taxes.
Gain recognized on the sale or exchange of shares of common stock (as distinguished from sales or exchanges of ADSs representing such shares of common stock) by a foreign holder will be subject to both the first category tax and the Chilean withholding tax (the former being creditable against the latter) if (1) the foreign holder has held such shares of common stock for less than one year since exchanging ADSs for the shares of common stock, (2) the foreign holder acquired and disposed of the shares of common stock in the ordinary course of its business or as a regular trader of stock or (3) the sale is made to a company in which the foreign holder holds an interest (10.0% or more of the shares in the case of open stock corporations). In all other cases, gain on the disposition of shares of common stock will be subject only to the first category tax levied as a sole tax. However, if it is impossible to determine the taxable capital gain, a 5.0% withholding will be imposed on the total amount to be remitted abroad, without any deductions, as a provisional payment of the total tax due.
The tax basis of shares of common stock received in exchange for ADSs will be the acquisition value of such shares on the date of the exchange. The valuation procedure set forth in the deposit agreement, which values shares of common stock that are being exchanged at the highest price at which they trade on the Santiago Stock Exchange on the date of the exchange, generally will determine the acquisition value for this purpose. Consequently, the conversion of ADSs into shares of common stock and sale of such shares of common stock for the value established under the deposit agreement will not generate a capital gain subject to taxation in Chile.
The distribution and exercise of preemptive rights relating to the shares of common stock will not be subject to Chilean taxation. Amounts received in exchange for the shares or assignment of preemptive rights relating to the shares will be subject to both the first category tax and the Chilean withholding tax (the former being creditable against the latter to the extent described above).
There is an exemption for the payment of income tax by foreign institutional investors such as mutual funds, pension funds and others, that obtain capital gains in the sales through a Chilean stock exchange, a tender offer or any other system authorized by the Chilean Superintendency of Securities and Insurance, of shares of publicly traded corporations that are significantly traded in stock exchanges. The Chilean Internal Revenue Service has not enacted any rule nor issued any ruling about the applicability of this regulation to foreign holders of ADSs.
A foreign institutional investor is an entity that is either:
a fund that makes public offers of its shares in a country whose public debt has been rated investment grade by an international risk classification agency qualified by the Chilean Superintendency of Securities and Insurance;
a fund that is registered with a regulatory entity of a country whose public debt has been rated investment grade by an international risk classification agency qualified by the Chilean Superintendency of Securities and Insurance, provided that the investments in Chile, including securities issued abroad that represent Chilean securities, held by the fund represent less than 30.0% of its share value;
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a fund that holds investments in Chile that represent less than 30.0% of its share value, provided that it proves that no more than 10.0% of its share value is directly or indirectly owned by Chilean residents;
a pension fund that is exclusively formed by individuals that receive their pensions on account of capital accumulated in the fund;
a fund regulated by the Foreign Capital Investment Funds Law, Law No. 18,657, in which case all holders of its shares must reside abroad or be qualified as local institutional investors; or
another kind of institutional foreign investor that complies with the regulatory requirements of the prior report of the Chilean Superintendency of Securities and Insurance and the Chilean Internal Revenue Service.
In order to be entitled to the exemption, foreign institutional investors, during the time in which they operate in Chile, must:
be organized abroad and not be domiciled in Chile;
not participate, directly or indirectly, in the control of the issuers of the securities in which it invests and not hold, directly or indirectly, 10.0% or more of such companies’ capital or profits;
execute an agreement in writing with a Chilean bank or securities broker in which the intermediary is responsible for the execution of purchase and sale orders and for the verification, at the time of the respective remittance, that such remittances relate to capital gains that are exempt from income tax in Chile or, if they are subject to income tax, that the applicable withholdings have been made; and
register in a special registry with the Chilean Internal Revenue Service.
Also, the sale or disposition of shares of Chilean public corporations that are significantly traded on stock exchanges is exempted from Chilean taxes on capital gains if the sale or disposition was made:
on a local stock exchange or any other stock exchange authorized by the Chilean Superintendency of Securities and Insurance or in a tender offer process according to Title XXV of the Chilean Securities Market Law, so long as the shares (a) were purchased on a public stock exchange or in a tender offer process pursuant to Title XXV of the Chilean Securities Market Law, (b) are newly issued shares issued in a capital increase of the corporation, or (c) were the result of the exchange of convertible bonds (in which case the conversion price is considered to be the price of the shares). In this case, gains exempted from Chilean taxes shall be calculated using the criteria set forth in the Chilean Income Tax Law; or
within 90 days after the shares would have ceased to be traded in specified volumes on a stock exchange. In such case, the gains exempted from Chilean taxes on capital gains will be up to the average price per share of the last 90 days. Any gains above the average price will be subject to the first category tax.
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Capital gains subject to taxation in Chile may be generated in the case where the sale of the shares is made on a day other than the date in which the exchange is recorded. On October 1, 1999, the Chilean Internal Revenue Service issued Ruling No. 3708, allowing Chilean issuers of ADSs to amend the deposit agreements to which they are parties in order to include a clause that states that, in the case that the exchanged shares are sold by the ADSs’ holders in a Chilean stock exchange, either on the same day in which the exchange is recorded in the shareholders’ registry of the issuer or within the two prior business days to such date, the acquisition price of such exchanged shares shall be the price registered in the invoice issued by the stock broker that participated in the sale transaction. Consequently, should we include this clause in the deposit agreement, the capital gain that may be generated if the exchange date is different than the date in which the shares received in exchange for ADSs were sold, will not be subject to taxation.
Other Chilean Taxes
No Chilean inheritance, gift or succession taxes apply to the transfer or disposition of the ADSs by a foreign holder but such taxes generally will apply to the transfer at death or by a gift of shares of common stock by a foreign holder. No Chilean stamp, issue, registration or similar taxes or duties apply to foreign holders of ADSs or shares of common stock.
United States Federal Income Tax Considerations
The following discussion summarizes the principal U.S. federal income tax considerations relevant to an investment in the ADSs or shares of common stock by a holder that is a citizen or resident of the United States or a U.S. domestic corporation or that otherwise will be subject to U.S. federal income tax on a net income basis in respect of the ADSs or shares of common stock, who is referred to as a U.S. holder, but it does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a decision to purchase ADSs or shares of common stock. In particular, this discussion is directed only to U.S. holders that will hold ADSs or shares of common stock as capital assets and that have the U.S. dollar as their functional currency, and does not address the tax treatment of U.S. holders that are subject to special tax rules, such as banks, dealers in securities or currencies, regulated investment companies, real estate investment trusts, traders in securities electing to mark to market, financial institutions, insurance companies, tax-exempt entities, holders of 10% or more of our voting shares, certain short-term holders of ADSs or shares of common stock, persons holding ADSs or shares of common stock as a position in a “straddle” or conversion transaction, or as part of a “synthetic security” or other integrated financial transaction. Prospective purchasers who are U.S. holders are advised to consult their own tax advisors as to the overall United States federal, state and local tax consequences of their ownership of ADSs and the underlying shares of common stock.
The statements of United States tax laws set out below are based on the laws in force as of the date of this annual report and may be subject to any changes in United States law occurring after such date, including changes that may have retroactive effect.
ADRs
In general, U.S. holders of ADRs evidencing ADSs will be treated, for United States federal income tax purposes, as the beneficial owners of the underlying shares of common stock that are represented by those ADSs and evidenced by those ADRs.
The gross amount of cash dividends paid out of our current or accumulated earnings and profits (as determined for U.S. federal income tax purposes) with respect to the shares of common stock or ADSs, including the net amount of the Chilean withholding tax withheld on the distribution (after taking into account the credit for the first category tax), will be includable in the gross income of a U.S. holder as foreign source dividend income on the day the dividends are received by the U.S. holder, in the case of shares of common stock, or by the depositary, in the case of shares of common stock represented by ADSs, and will not be
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eligible for the dividends-received deduction allowed to corporations under the Internal Revenue Code of 1986, as currently in force. Dividends paid in Chilean pesos will be includable in the income of a U.S. holder in a U.S. dollar amount calculated by reference to the exchange rate in effect on the day they are received by the U.S. holder, in the case of shares of common stock, or the depositary, in the case of shares of common stock represented by ADSs. U.S. holders should consult their own tax advisors regarding the treatment of foreign currency gain or loss, if any, on any Chilean pesos received that are converted into U.S. dollars on a date subsequent to receipt.
Subject to certain exceptions for short-term and hedged positions, the U.S. dollar amount of dividends received by an individual prior to January 1, 2011 with respect to the ADSs will be subject to taxation at a maximum rate of 15% if the dividends are “qualified dividends.” Dividends paid on the ADSs will be treated as qualified dividends if (i) the ADSs are readily tradable on an established securities market in the United States and (ii) we were not, in the year prior to the year in which the dividend was paid, and are not, in the year in which the dividend is paid a passive foreign investment company, or PFIC. The ADSs are listed on the NYSE and will qualify as readily tradable on an established securities market in the United States so long as they are so listed. Based on our audited financial statements and relevant market and shareholder data, we believe that we were not treated as a PFIC for U.S. federal income tax purposes with respect to our 2008 taxable year. In addition, based on our audited financial statements and our current expectations regarding the value and nature of our assets, the sources and nature of our income, and relevant market and shareholder data, we do not anticipate becoming a PFIC for our 2009 taxable year.
Based on existing guidance, it is not entirely clear whether dividends received with respect to the common stock will be treated as qualified dividends, because the common stock is not itself listed on a U.S. exchange. In addition, the U.S. Treasury has announced its intention to promulgate rules pursuant to which holders of ADSs or common stock and intermediaries through whom such securities are held will be permitted to rely on certifications from issuers to establish that dividends are treated as qualified dividends. Because such procedures have not yet been issued, it is not clear whether we will be able to comply with them. Holders of ADSs and common stock should consult their own tax advisers regarding the availability of the reduced dividend tax rate in the light of their own particular circumstances.
The Chilean withholding tax (after taking into account the credit for the first category tax) will be treated as a foreign income tax that a U.S. holder may elect to deduct in computing its income tax or, subject to generally applicable limitations and conditions under the Internal Revenue Code, to credit against its U.S. federal income tax liability. For purposes of calculating the foreign tax credits, dividends paid on the common stock or ADSs will generally constitute foreign source passive income for U.S. tax purposes. Foreign tax credits will not be allowed for withholding taxes imposed in respect of certain short-term or hedged positions in securities and may not be allowed in respect of arrangements in which a U.S. holder’s expected economic profit is insubstantial. U.S. holders should consult their own advisors concerning the implications of these rules in light of their particular circumstances.
Distributions of additional shares of common stock (or rights to subscribe for shares of common stock) to U.S. holders with respect to the ADSs or shares of common stock that are made as part of a pro rata distribution to all of our shareholders generally will not be subject to U.S. federal income tax.
A non-U.S. holder, i.e., a holder of shares of common stock or ADSs that is a nonresident alien individual or a foreign corporation generally will not be subject to U.S. federal income or withholding tax on dividends received on shares of common stock or ADSs, unless that income is effectively connected with the conduct by the non-U.S. holder of a trade or business in the United States.
Gain or loss realized by a U.S. holder on the sale, exchange or other disposition of ADSs or shares of common stock will be subject to U.S. federal income taxation as a capital gain or loss in an amount equal to the difference between the holder’s adjusted basis in the ADSs or the shares of common stock and the amount realized on the disposition. The gain or loss generally will be a capital gain or loss. Capital gains realized by an individual U.S. holder are generally subject to a maximum tax rate of 15% with respect to property held for more than one year.
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Gains realized by a U.S. holder on a sale or other disposition of ADSs or shares of common stock generally will be treated as U.S. source income. Because a U.S. holder generally may not use a foreign tax credit to reduce its U.S. federal income tax liability in respect of its U.S. source income, in the case of a disposition of shares of common stock (which, unlike a disposition of ADSs, would be taxable in Chile), the U.S. holder generally would not be able to utilize foreign tax credits in respect of any Chilean tax imposed on such a disposition unless such holder has other income from foreign sources, in the appropriate category, for purposes of the foreign tax credit limitation rules. U.S. holders should consult their tax advisors regarding the application of the foreign tax credit limitation rules to their investment in, and disposition of, the ADSs and shares of common stock.
Deposits and withdrawals of shares of common stock by U.S. holders in exchange for ADSs will not result in the realization of gain or loss for U.S. federal income tax purposes.
A non-U.S. holder of shares of common stock or ADSs will not be subject to U.S. federal income or withholding tax on gain realized on the sale of shares of common stock or ADSs, unless (1) such gain is effectively connected with the conduct by the non-U.S. holder of a trade or business in the United States or (2) in the case of gain realized by an individual non-U.S. holder, the non-U.S. holder is present in the United States for 183 days or more in the taxable year of the sale and certain other conditions are met.
Backup Withholding and Information Reporting
In general, dividends paid to a U.S. holder and proceeds from a disposition of the ADSs or shares of common stock will be subject to information reporting requirements and the payments may be subject to U.S. backup withholding tax if the U.S. holder does not provide a taxpayer identification number or otherwise establish an exemption. Under certain circumstances, such payments made to a non-U.S. holder also may be subject to U.S. information reporting requirements and U.S. backup withholding tax, unless the holder certifies its non-U.S. status or otherwise establishes an exemption.
The foregoing discussion of Chilean and United States tax considerations is intended only to provide a general description of the principal relevant factors. The discussion is not intended as tax advice to any particular investor, which advice can be rendered only in light of that investor’s particular tax situation. Investors should consult their tax advisors about the federal, state, local and foreign tax consequences to them of the purchase, ownership and disposition of ADSs or shares of common stock.
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DOCUMENTS ON DISPLAY
The materials included in this annual report on Form 20-F, and exhibits thereto, may be inspected and copied at the Securities and Exchange Commission’s public reference room in Washington, D.C. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the public reference rooms. The Securities and Exchange Commission maintains a World Wide Web site on the Internet at http://www.sec.gov that contains reports and information statements and other information regarding us. The reports and information statements and other information about us can be downloaded from the Securities and Exchange Commission’s website.
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Background
The bank is exposed to market risks, such as price and liquidity risks, due to unmatched positions in both our trading and accrual portfolios.
The trading portfolio is comprised of the following: foreign exchange positions, local government bonds, time deposits holdings and the derivatives book. The latter is mainly comprised of FX forwards and swap transactions, a small number of FX options, bond forwards and FX futures transactions.
Cash balances that are not included in the trading portfolio are part of the accrual portfolio. The primary liability balances are: retail and corporate deposits (both DDA and time deposits); mortgage bonds (asset-backed securities matching mortgage loans); interbank borrowing, including trade-related facilities; and bonds issued for liquidity and interest rate hedging purposes. Asset balances include: corporate loans and trade facilities; consumer loans (including mortgage loans and cards activity); available-for-sale bonds holdings; interbank lending; trade loans; and all other asset balances such as fixed assets and accrued interests.
Accrual balances are mainly denominated in Ch$ and CLF terms (daily Chilean inflation index, which is published and computed by the Central Bank of Chile reflecting the previous month’s local inflation), though some trade-related transactions are denominated in U.S. dollars (“U.S.$”) and Japanese yen (“JPY”). Trading transactions are mainly denominated in Ch$, CLF and domestic U.S.$, with some transactions linked to offshore hard currencies yield curves.
Market Risk
Market risk is usually classified into two categories: price risk and liquidity risk. Price risk refers to the potential loss arising from unfavorable directional market movements of interest rates; FX rates or volatility levels, including the correlation among these market factors fluctuations. Liquidity risk refers to the inability to obtain funding (Funding Liquidity risk) or to the potential material impact of defeasing assets (Trading Liquidity risk). The following sections quantify the potential impact of these risks.
Price risk
Interest rate risk
We are exposed to interest rate risk in both the accrual and the trading portfolios. With respect to the trading portfolio, interest rate risk is the adverse change in the value of the portfolio due to the potential unfavorable fluctuations of interest rates.
Given the general accounting principles in place for trading portfolios, actual change in the value of this portfolio instantaneously impacts the Statement of Income.
In the case of the accrual portfolio, interest rate risk arises from holding assets and liabilities with different repricing tenors. However, actual adverse changes of interest rates impact the Statement of Income when assets/liabilities are effectively repriced and not when interest rates change.
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FX rate risk
We are exposed to FX rate risk given that we hold, for some specific currencies, unmatched balances. For FX positions calculation purposes, we aggregate all cash balance items and the net present value of off-balance cash flows we receive and pay in the future. Cash balance items are marked to prevailing FX rates regardless of whether the transaction itself is booked under trading or accrual accounting rules. Therefore, the difference in value of any cash balance item due to the change of any FX rate is reported in the Statement of Income.
We usually hold Ch$ positions against the U.S.$ and, to a lesser extent, Brazilian real, JPY and Euro positions against the U.S.$. Other FX positions are seldom significant.
Volatility risk
We are exposed to FX volatility (Ch$/U.S.$ volatility only) given that we hold an FX Options portfolio (short-term and plain vanilla transactions only). In addition to this, we are exposed (economically but not from an accounting standpoint) to interest rate volatility due to the holding of mortgage CLF loans for which the interest rate for the customer is capped. In any case, cap rates are currently deep OTM.
Liquidity risk
Funding Liquidity risk
Usually, our funding profile shows shorter tenors than those observed for our assets. Therefore, we are exposed to funding liquidity risk only in the event that our assets are not liquid enough to defease them in the corresponding secondary markets and the renewal of the funding is compulsory. The Bank is able to mitigate any contingency in this respect by diversifying its fund providers and by avoiding maturity concentration.
Trading Liquidity risk
We are exposed to trading liquidity risk whenever our loans may not be easily sold, or bonds not easily traded, in the secondary market. This may occur for a significant portion of our loans portfolio (however, a large stake of our mortgage loan portfolio is fully matched with asset-back securities issued by the Bank) since sale transactions involving loans are rare. Additionally, some of our holdings of corporate bonds, mortgage bonds and foreign Latin American bonds are exposed to a shallow secondary market.
The Price Risk Process
This process is segregated in the following steps:
Identification of the Treasury and non-Treasury transactions that may impact the P&L performance of the Treasury. The latter impact the Treasury P&L through a Transfer Pricing process.
Identification of the transactions categorized as trading transactions. The change of value due to changes in the market factors, within any interval of time, directly impacts the statement of comprehensive income. Conversely, those which are categorized as accrual transactions impact the State of Income according to their historical cost.
Identification of the market factors, such as FX rates, interest rates/yields or volatilities, involved in the above mentioned transaction.
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Distribution of the exposures generated by the positions held in the various market factors within the different Treasury desks or risk-taking units. The distribution is made taking into account the nature of the business (trading or accrual) but also subject to generally accepted accounting principles (derivatives always booked in trading accounts unless hedge-accounting programs are implemented, loans always booked in accrual accounts, etc.).
Setting process for each desk of exposures limits and actual/potential loss triggers. These are aligned with the budgeted revenues for the corresponding desk. This ensures that limits/triggers are set according to a risk/return rationale.
A strict and disciplined risk monitoring and reporting process, ensuring that the different relevant parties within the organization have a timely sense of the risks undertaken by the Treasury desks
These limits are reviewed at least annually by the Country Asset Liability Committee (“ALCO”) and approved by the Board of the Bank.
The Chairman of the Board and three other members of the Board of Directors, the Chief Executive Officer, the Chief Financial Officer, the Market Risk Manager, the Treasurer/Trading Head and the Corporate Credit Risk Head participate in the ALCO. The ALCO recommends price risk limits to the board for approval based on business strategy analysis, expected market volatility, trading liquidity of the products involved, management experience and our overall risk tolerance.
The frequency of monitoring and reporting the different exposures to market risks is based on the nature of each business. Price risk generated by the trading portfolio is monitored and reported on a daily basis. The reporting includes the regulatory price risk, its evolution across time, and risk concentrations by market factors and business units. This report is submitted on a daily basis to relevant Treasury officers and the Market Risk Manager, and to other members of the ALCO.
Price risk generated by accrual activities is monitored and reported on a monthly basis. The report includes interest rate risk exposure in Ch$, CLF and foreign currencies and is distributed to the same parties mentioned in the previous paragraph.
The Liquidity Risk Process
Generation of a behavioral cash-flow report, separated by currency, in order to estimate the cumulative outflow within the coming 1-month and 3-month period. This report includes the following main characteristics, among others:
Identification of the balances subject to be modeled under behavioral assumptions (this must be authorized by the Chilean banking regulatory entity).
Development of internal models that reliably reflect the behavior of time deposit balances, demand deposit accounts, etc., across time. Depending on the result, some portion of these balances may be modeled as stable or evergreen.
Development of internal models that reliably reflect the behavior of the loans, particularly focused on discovering the portion that may be considered not subject to renewal. Taking into account the size of the business for the bank, this analysis is made assuming a high level of confidence. Depending on the result, some portion of these balances may be modeled as a source of liquidity at the maturity date.
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Generation of additional reports that limit the funding concentration by either large fund providers or by maturity date
Liquidity risk is monitored and reported on a daily basis.
The Role of the Market Risk Management unit
The main responsibilities and duties of this unit include, among others:
Definition of internal (non-regulatory) market risk models;
Definitions of FX, interest rate and FX volatility positions reports;
Daily generation of regulatory accrual and liquidity risk reports;
Monthly generation of internal accrual risk report, based on gaps and Earnings at Risk analysis;
Daily internal price risks monitoring, including position limits, P&L and stress test triggers, and the generation of the corresponding limits excesses and triggers breach reports. The exposures and risks are checked against limits and/or triggers, the breaches and excesses are reported to the appropriate levels in a timely manner and the policy exceptions are managed;
Daily price and liquidity risk monitoring for regulatory models;
Definition and reporting of the price and liquidity stress tests;
Participation in the Transaction Valuation definitions, which is a task lead by the Product Control unit (this unit is a part of the Financial Control area; see below for details), in order to ensure that they are aligned with the risk reports linked to the corresponding transactions;
Participation in the Transfer Pricing definitions, which are the framework for regulating the way interest rates are transfer-priced from the Treasury to other units within the bank for the accrual business. These definitions must be aligned with the risk reports linked to the corresponding transactions;
Preparation of an adequate set of internal Price and Liquidity risk limits/triggers structure (in addition to those required by the local regulators) and the submission of the corresponding proposal to the ALCO;
Approval of the debt securities eligible list for trading portfolios;
Participation in the definition of the hedge-accounting programs, ensuring comprehensive alignment with market risk reporting;
Establishment and review of market risk policies and procedures;
Involvement in the development and release of new products, identifying new market factors and defining the risk aggregation process; and
Generation and maintenance of credit risk factors for derivative transactions.
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The Market Risk Management unit is responsible for reporting to the relevant Treasury units about the state of all risk limits in a timely fashion. In addition, the Treasury units and senior ALCO members are notified whenever a limit is exceeded.
Limit excesses are not permitted unless operational errors have occurred. If any risk limit is exceeded, the responsible Treasury unit must document the causes of the excess and it may require a permanent limit increase only after curing the excess. Temporary limit increases may be requested but such requests must be made prior to entering into any transactions that may generate excesses.
Limits are reviewed and approved annually unless market conditions or a business activity increase requires increased limits (in such a case, a risk-return analysis is implemented, taking the current conditions into consideration).
The Role of the Product Control Unit
This unit, which resides in the Financial Control area, supports the business and the Market Risk Management unit implementing the following tasks, among others:
Daily generation of regulatory trading risk reports;
Daily generation of trading positions for internal risk reporting purposes (DV01 for interest rate positions; FX delta for FX positions and vega for FX options positions);
Daily price verification process, in which prices, interest rates, derivatives yields, FX volatilities, etc. which have been previously inputted by the business for valuing portfolios are independently checked against public sources or internal price generation models;
Daily generation and maintenance of the market data set, which is used for valuing portfolios, valuing individual derivative transactions for credit risk purposes, etc.;
Fair Value Policy definition;
Daily P&L generation for trading portfolios, which are used for monitoring the state of the month-to-date P&L triggers;
Generation of interest rate regulatory reports;
Participation in the definition of the hedge-accounting programs and effectiveness modeling.
Effectiveness control for the hedge-accounting programs.
The main advantage of having this unit be part of the Financial Control area is to ensure data integrity for risk and positions reports. In fact, the data used for internal reporting purposes is reconciled with intra-month accounting records.
Moreover, the addition of the daily intra-month trading P&L estimated by this unit is reconciled with the end-of-month P&L obtained from the accounting records. This reconciliation process allows measuring granularity of the daily reports.
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Market Risk: Measurement and Reporting
Price Risk of the Trading Portfolio
We establish, for the trading portfolio: (a) positions limits, (b) triggers for actual month-to-date P&L (look back analysis), (c) triggers for potential losses (look forward analysis) and (d) regulatory price risk portfolio limit (mandatory). Potential losses are estimated utilizing two tools: VaR (95% confidence level) and directional stress tests. The reason why price risks are controlled by triggers rather than by limits is based on the fact that price risk depends on both position and volatilities/correlations. The traders may not control the latter and therefore it is possible that no limit would be established for a given variable that is not under our discretion.
Positions are expressed as the Greek letters embedded in any trading transaction. FX positions are expressed as the FX delta; interest rate positions as the rho (or also known as DV01 which is the change in value of the transaction due to 1 bp interest rate rise) and vega (which is the change in value of the transaction due to 1% FX volatility rise). The ALCO recommends risk limits for each market factor, which are approved by the Board of Directors if applicable.
Trading portfolios are subject to a close watching process in terms of P&L performance. In fact, daily performance is estimated allowing the determination of the month-to-date P&L for each trading desk. The result is compared with Stress Loss Triggers in order to alert the senior management in the case of abrupt unexpected losses.
We are in the process of developing a reliable parametric VaR. This will be computed utilizing a 95% confidence and historical volatilities of fluctuations of market factors and historical correlations among them. It is very likely that Risk Metrics will be the tool for computing parametric VaR and back testing.
As mentioned above, stress tests are made on a daily basis. Currently, four scenarios are modeled daily. Two of them reflect an adverse economic environment, one of which is referred to as “mild stress” and the other as “meltdown stress.” Mild stress is the result of an adverse fluctuation equal to 3.43 standard deviation of the market factors’ historical fluctuations. Meltdown stress is the result of an adverse fluctuation equal to 8 standard deviations. The other two scenarios reflect a positive economic environment, including positive fluctuations equivalent to 3.43 and 8 standard deviation. Stress tests under a positive economic scenario are made since the bank may be exposed to losses even in the case that market factors fluctuate in a positive direction (for example, the bank may hold a long U.S.$ position against CLP and would take a loss as the result of an appreciation of the CLP against the U.S.$).
The standard deviation for all market factors is computed as the standard deviation of a set of historical daily returns, assuming that the returns of the FX rates follow a lognormal distribution and the returns of the interest rates and volatilities follow a normal distribution. Therefore, the daily return for the FX rate between day i and day i+1 is computed as ln Si+1/Si, with Si being the closing FX spot rate observed on any day i. In the case of interest rates and volatilities, the daily return is computed as the difference between the observation on day i+1 and day i.
A regulatory price risk report is also generated on a daily basis. The regulatory report is based on the Market Risk Basel model, which includes embedded fixed and also large volatilities for the market factors’ fluctuations and fixed correlations, regardless of their actual behavior along the time. Therefore, it is more likely a stress test. In any case, it helps to follow the tendency and the evolution of the various risks generated by the trading portfolios.
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The following figure illustrates the pattern of the trading book price risk, utilizing the regulatory model, during 2008:
The following table summarizes by derivative type the notional outstanding of the derivatives portfolio as of December 31st, 2008:
Currency forwards
Interest rate swaps
Currency and rate swaps
Options
Price Risk of the Accrual Portfolio
The ALCO guidelines for the Accrual portfolio seek to protect the net revenues from funds (NRFF) on a pre-tax basis and the value of equity due to unexpected interest rate fluctuations. In order to achieve this purpose, a set of limits are jointly proposed by the business and Market Risk Management and approved, if applicable, by the Board of Directors.
Accrual interest rate risk or repricing risk arises from unfavorable fluctuations of either interest rates or the shape of the yield curves. Whenever balance sheet items held in the accrual portfolio include unmatched repricing tenors, the bank may be negatively impacted in the generating of net interest income.
The risk is estimated through the regulatory model, which includes standardized interest rate fluctuations and pre-defined tenor buckets. This model is based on the Basel accrual interest rate risk tables. Cash flows are separated by currency and loaded into the tenor buckets considering their repricing tenors. The difference between liability and asset items within given tenor buckets is referred as to the interest rate gap for each specific tenor bucket. A positive gap usually leads to a positive effect on the net interest revenue due to a rise in interest rates and vice versa.
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We currently control the interest rate risk for the accrual portfolio, on an aggregate basis (all currencies) and on month-end only, which is in line with the local regulator’s requirements. The Superintendency of Banks has also defined that two limits are to be observed and complied with:
The short-term interest rate risk plus the estimated negative impact of fees collection due to the interest rate rise may not exceed a percentage of the 12-month rolling net interest rate revenues plus the net fees that are sensitive to interest rates (and which were actually charged within the prior 12 months). The regulator allows banks to set this percentage. In our case, the limit is 25%.
The long-term interest rate risk may not exceed a percentage of the equity. The latter is the addition of capital, subordinated debt and retained earnings. The regulator allows banks to set the percentage. In our case, the limit is 25%.
Transactional balance sheet items (excluding debt securities classified as trading instruments) and hedge-accounted derivatives are part of this portfolio. Fixed assets, other assets and equity items are excluded from the analysis.
The Treasury is the unique area within the bank responsible for managing the interest rate gaps and therefore for holding interest rate risks. Additionally, the Treasury, in conjunction with Market Risk Management and Financial Control, is also responsible for proposing the internal transfer-pricing framework and then matching the schedule with the rest of the business units of the bank. The referred process is actually implemented through closing pseudo-transactions with non-Treasury business areas in order to leave the latter without interest rate exposures.
The Treasury usually holds a structural negative CLF full-life gap due to the placement of long-tenor loans and the holding of AFS portfolios, which are funded by short-tenor time deposits (less than two years). However, bonds and subordinated bonds denominated in CLF are issued from time to time in order to reduce the interest rate exposure and to manage the liquidity profile and the capital ratio within adequate ranges.
Tenors involved in transactions denominated in CLP are much shorter than in CLF terms; in fact, repricing tenors for CLP loans are not longer than two years since banks are not able to issue deposits or bonds to longer tenors. This is due to the low demand by institutional investors to hold CLP assets given that debt instruments denominated in CLP are exposed to negative real yields in the case of a high inflation environment. This is especially sensitive in the case of pension funds since Chilean workers are expecting a positive real yield for retirement. Therefore, interest rate gaps are not relevant for tenors longer than two years with the exception of the impact generated by DDAs. DDAs are modeled as a balance item considering permanent-maturity profiles. Volatile portions of DDAs are modeled in the shorter tenor buckets and stable portion are included in the back end of the tenor buckets framework (4-5 year tenor bucket). As a result of this modeling process, the CLP interest rate gap is usually negative for tenors shorter than three years and positive beyond that tenor.
The activity in the accrual U.S.$ book is mostly based on funding obtained from foreign banks (mostly U.S.$ denominated), which is placed through trade loans within the customer base. Additionally, DDAs and the U.S.$ 200 MM 10-year bullet subordinated bond issued by the bank in 2006 are other large balance sheet items and part of this book. The modeling process followed for DDAs, similar to that used for CLP DDAs, and the long tenor of the outstanding bonds generate a positive interest rate gap for this book.
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The pattern followed by the two metrics mentioned above during 2008 is illustrated below:
Stress tests for the Accrual book are made on a semi-annual basis. For this process, market factor fluctuations used are consistent with those utilized for the stress test of the trading portfolio. Additionally, the bank is in the process of reviewing the Price Risk policy for accrual portfolios. Monthly monitoring will therefore be in place shortly once policies are approved.
The following table summarizes the balance sheet structure of the bank classified by currency, as of December 31st, 2008:
Balance Sheet Structure
Assets(2):
Other assets(1)
Less than one year
From one to three years
More than three years
Total financial assets
Derivative operations
Allowance for loan losses
Percentage of total financial assets by currency
Liabilities and equity(2):
Non-interest bearing demand deposits
Other liabilities(1)
Total financial liabilities
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Equity (less provision for minimum dividends and net income)
Provision for minimum dividends
Percentage of total financial liabilities by currency
Asset/liability gap
Liquidity Risk
Trading Liquidity Risk
Trading liquidity risk is very low. In fact, after the merger with the former Citibank, N.A. branch in Chile, the Bank adopted a strict discipline in order to ensure that debt instruments booked under trading accounting rules have a deep secondary trading market. Therefore bank bonds, corporate bonds and mortgage bonds formerly booked under trading accounting rules were reclassified as AFS instruments. Central bank instruments (bonds and bills) and short-term time deposits issued by banks in Chile (either local institutions or local franchises of foreign banks) are currently the only instruments eligible to be booked under trading accounting rules since they have a reasonable liquid secondary market.
In any case, we expect to implement a formal trading liquidity analysis process even for AFS portfolios within year 2009.
Funding Liquidity Risk
The funding liquidity risk is controlled through the daily monitoring of various metrics. Expected available funding is estimated utilizing regulatory reports, which allow us to forecast the expected net cashflow by currency for the coming 30 and 90 days. These two reports are daily generated and controlled against regulatory limits, which are that the cumulative outflow for the coming 30 days may not exceed an amount equal to the capital of the bank and the cumulative outflow for the coming 90 days may not exceed an amount equal to two times the capital of the bank.
The reports, according to the regulator’s authorization, may include behavioral assumptions for customers’ liabilities runoffs, customers’ overdrafts, and loan repayments. The Bank was instructed by the Chilean Superintendency of Banks to utilize behavioral assumptions.
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The pattern followed for these two metrics during 2008 is the following:
The graphs above show a prudent management of the liquidity of the bank within year 2008. In fact, within the second quarter of 2008, the Treasury decided to increase funding tenors and maintain Cash & Due balance above Ch$ 1,200,000 million (equivalent to approximately U.S.$ 2 billion). The latter was executed by maintaining diversified overnight U.S.$ placements and by holding debt instruments that might be sold under repurchase agreements with the Central bank. This strategy was in place the whole year, and was not relaxed before the second quarter of 2009.
Additionally, there are other metrics defined by the Bank even though they are not required by the regulators to monitor and limit funding diversification. They consist of the following:
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The status of these metrics within 2008 is illustrated below:
Local Currency Large Fund Providers
as a % of Local Currency Current Liabilities
(Limit = 42%)
Individual Currency Large Fund Providers
(Limit = 8%)
The graphs above show a prudent approach to this topic. The excess of the Foreign Currency Large Fund Provider’s 20% limit was intentionally modified, given that foreign currency funding was preferred over concentration during the fourth quarter of 2008.
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Derivatives Credit Risk
We trade derivative transactions in order to meet our customers’ needs and to manage our exposures to fluctuations of FX volatility, interest, and FX rates.
We measure the risk of derivative transactions as the maximum expected value within the life of the transaction, under a certain interval of confidence. This is mathematically computed as the mark-to-market value of the transaction (i.e., the replacement cost of the transaction at the time the analysis is made) plus the maximum increase in value within the remaining period until maturity.
We are currently using internal models at inception and regulatory models for the remaining life of the transaction. Internal models are loaded with credit exposure factors calculated through a Montecarlo Simulation approach, considering a 95% confidence interval. Regulatory models follow the same approach but consider benevolent (i.e., more aggressive) credit exposure factors. A migration to measurement by fully internal models is expected to be implemented during 2009.
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PART II
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(a) Disclosure Controls and Procedures
We have evaluated, with the participation of our chief executive officer and chief financial officer, the effectiveness of our disclosure controls and procedures as of December 31, 2008.
There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon our evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The company’s internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on our assessment and those criteria, management believes that the company maintained effective internal control over financial reporting as of December 31, 2008.
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(c) Report of Independent Registered Public Accounting Firm on Internal Controls
Ernst & Young limitada, the independent registered public accounting firm that has audited our financial statements, has issued an attestation report on our internal control over financial reporting as of December 31, 2008. This attestation report appears on page F-3.
(d) Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Our Board of Directors has determined that Mr. Jorge Awad M., a member of our Audit Committee, qualifies as an “audit committee financial expert” and as independent within the meaning of this Item 16A.
We have adopted a new Code of Ethics, as defined in Item 16B of Form 20-F under the Exchange Act. In 2008, pursuant to the terms of the merger agreement with Citibank Chile, we modified our Code of Ethics to incorporate the key elements of Citigroup’s Code of Conduct. The Code of Ethics applies to our Chief Executive Officer, Chief Financial Officer, Principal Accounting Officer and persons performing similar functions, and to all other employees without exception. A current copy of the Code of Ethics is filed as Exhibit 11.1 to this Form 20-F.
Audit and Non-Audit Fees
The following table sets forth the fees billed to us by our independent auditors, Ernst & Young Limitada, during the fiscal years ended December 31, 2007 and 2008:
Audit fees
Audit-related fees
Tax fees
Other fees
Total fees
“Audit fees” in the above table are the aggregate fees billed by Ernst & Young Limitada in connection with the audit of our annual financial statements. This line item includes: (i) reviews and advisory services related to filings with the LSE and the Securities and Exchange Commission, (ii) the statutory audit required by local regulations, and (iii) the audit of the consolidated financial statements required by Item 18 of Form 20-F.
“Audit-related fees” in the above table are fees billed by Ernst & Young Limitada for other expenses related to review of our branches in Chile. This includes travel and subsistence expenses for the audit team.
“Tax fees” in the above table represent fees charged by Ernst & Young Limitada for tax-related services.
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“Other fees” in the above table are fees billed by Ernst & Young Limitada related to compensation for research studies during 2008, and services rendered in connection with the merger of Legg Mason Chile Mutual Funds with Banchile Mutual Funds.
We did not make any purchases of our previously issued shares during the fiscal year ended December 31, 2008.
Pursuant to Section 303A.11 of the Listed Company Manual of the NYSE, we are required to provide a summary of the significant ways in which our corporate governance practices differ from those required for U.S. companies under the NYSE listing standards. We are a Chilean bank with shares listed on the Santiago Stock Exchange, the LSE and the Latibex. Our corporate governance practices are governed by our bylaws, the General Banking Law, the Chilean Corporations Law, the Ley de Mercado de Valores No. 18,045 (the Securities Market Law), and the regulations issued by the Chilean Superintendency of Banks.
The table below discloses the significant differences between our corporate governance practices and the NYSE standards.
NYSE Standards
Our Corporate Governance Practice
Pursuant to the General Banking Law, we are not required to make a determination as to the independence of our Directors.
Pursuant to the Chilean Corporations Law, we must determine whether the members of our Directors/Audit Committee (all of whom are members of our Board of Directors) are independent.
The definition of independence applicable to us pursuant to the Chilean Corporations Law differs in certain aspects from the definition applicable to U.S. issuers under the NYSE rules.
Under the Chilean Corporations Law, a director is deemed to be an independent member of the Directors/Audit Committee if such member would have been elected as a director at the shareholders meeting after excluding the votes of any controller or party related to it. Under the regulations of the Chilean Superintendency of Banks, members of the Audit Committee must satisfy international independence criteria.
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the NYSE independence and other Audit Committee standards that are not prescribed by Rule 10A-3.
For a description of the duties of our Audit Committee under applicable Chilean law, see “Directors/Audit Committee Duties.”
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PART III
Our financial statements have been prepared in accordance with Item 18 hereof.
Our audited consolidated financial statements are included in this annual report beginning at page F-1.
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LIST OF EXHIBITS
Exhibit No.
Exhibit
1.1
2.1
2.2
2.3
3.1
3.2
3.3
4.1
4.2
4.3
4.4
183
4.5
4.6
4.7
4.8
8.1
11.1
12.1
12.2
13.1
Omitted from the exhibits filed with this annual report are certain instruments and agreements with respect to our long-term debt, none of which authorizes securities in a total amount that exceeds 10% of our total assets. We hereby agree to furnish to the Securities and Exchange Commission copies of any such omitted instruments or agreements as the Securities and Exchange Commission requests.
184
SIGNATURE
The registrant, Banco de Chile, 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.
Date: June 29, 2009
185
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
Consolidated Statement of Financial Position as of December 31, 2007 and 2008
Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2008
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2008
Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period ended December 31, 2008
Notes to the Consolidated Financial Statements
Application of Constant Chilean Pesos
The December 31, 2006 and 2007 consolidated financial statements have been restated for general price-level changes and expressed in constant Chilean pesos of December 31, 2008 purchasing power.
F-1
Ernst & Young Chile
Huérfanos 770, piso 5
Santiago
Tel: 56 2 676 1000
Fax: 56 2 676 1010
www.ey.com/cl
To the Board of Directors and Shareholders of Banco de Chile:
We have audited the accompanying consolidated statements of financial position of Banco de Chile and its subsidiaries (the “Bank”) as of December 31, 2008 and 2007, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Banco de Chile and subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in Chile and regulations issued by the Chilean Superintendency of Banks and Financial Institutions, which differ in certain respects from U.S. generally accepted accounting principles (see Note 34 to the consolidated financial statements).
As explained in Note 2(a)(ii), the Bank adopted a new format for presentation of the financial statements, as required by Circular No. 3,410 and all prior periods were also modified for comparison purposes.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 26, 2009, expressed an unqualified opinion thereon.
ERNST & YOUNG LIMITADA
Santiago, Chile,
June 26, 2009
F-2
We have audited Banco de Chile and subsidiaries’ internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Banco de Chile’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
F-3
In our opinion, Banco de Chile maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2008 consolidated financial statements of Banco de Chile and our report dated June 26, 2009, expressed an unqualified opinion thereon.
F-4
BANCO DE CHILE AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(Restated for general price - level changes and expressed in millions of constant
Chilean pesos as of December 31, 2008 and thousands of U.S. dollars)
ASSETS
Derivate instruments
Loans and advances to Banks
Loans to customers, net
Loans to customers
Total loans to customers, net
TOTAL ASSETS
The accompanying notes 1 to 35 are an integral part of these consolidated financial statements
F-5
LIABILITIES
Securities sold under repurchase agreement
Current tax liabilities
TOTAL LIABILITIES
EQUITY
Reserves
Other comprehensive income
Retained earnings:
Retained earnings from previous periods
Income for the year
Provisions for minimum dividends
Minority interest in consolidated subsidiaries
TOTAL EQUITY
TOTAL LIABILITIES & EQUITY
F-6
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
A. STATEMENT OF INCOME
Income from fees and commissions
Expenses from fees and commissions
TOTAL OPERATING REVENUES
PROVISIONS FOR LOAN LOSSES
OPERATING REVENUES, NET OF PROVISIONS FOR LOAN LOSSES
Administrative expenses
Impairments
TOTAL OPERATING EXPENSES
NET OPERATING INCOME
INCOME BEFORE INCOME TAX
INCOME TAX
NET INCOME FOR THE YEAR
Attributable to:
Equity holders of the parent
Minority interest
NET INCOME
F-7
B. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
OTHER COMPREHENSIVE INCOME
Net unrealized gains (losses) on available for sale investments
Cumulative translation adjustment
Other comprehensive income before tax
Income tax related to other comprehensive income
Total other comprehensive income
TOTAL CONSOLIDATED COMPREHENSIVE INCOME
Comprehensive net income per share attributable to equity holders of the parent:
Basic net income
Diluted net income
F-8
CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES
Items that do not represent cash flows:
Fair value adjustments of trading securities
(Income) loss attributable to affiliates
Net gain on sales of assets received in lieu of payment
Gain on sales of bank premises and equipment
Write-offs of assets received in lieu of payment
Other credits which do not represent cash flows
Net changes in interest and fee accruals
TOTAL CASH FLOWS FROM OPERATING ACTIVITIES
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in loans to customers
Net increase in investments
Net decrease (increase) in investments purchased under agreements to resell
Purchases of bank premises and equipment
Proceeds from sales of bank premises and equipment
Dividends received from investments in other companies
Sale of investments in other companies
Proceeds from sale of assets received in lieu of payment
Net changes in other assets and liabilities
TOTAL CASH FLOWS FROM INVESTING ACTIVITIES
CASH FLOWS FROM FINANCIAL ACTIVITIES
Net increase in current accounts
Net increase in savings accounts and time deposits
Decrease in other demand or other deposits
Net increase (decrease) in investments sold under agreements to repurchase
Net increase (decrease) in short-term foreign borrowings
Increase mortgage finance bonds
Repayment of mortgage finance bonds
Decrease in other short-term borrowings
Borrowings from Central Bank (long-term)
Payments of borrowings from Central Bank (long-term)
Proceeds from bond issuances
Repayment of bond issuances
Long-term foreign borrowings
Payment of long-term foreign borrowings
Other long-term borrowings
Payment of other long-term borrowings
Subscription and payment of shares
Dividends paid
TOTAL CASH FLOWS FROM FINANCING ACTIVITIES
Effect of price-level restatement on cash and cash equivalent
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENT
Cash and cash equivalent at beginning of year
CASH AND CASH EQUIVALENT AT END OF YEAR
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest paid
Income taxes paid
F-9
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Chilean pesos as of December 31, 2008)
Balance as of January 1, 2006
Transfer to retained earnings
Capitalization of retained earnings (1)
Dividends paid (1)
Adjustment to fair value as result of adoption of Circular 3,345 (2)
Price – level restatement
Valuation adjustment on available for sale securities (*)
Cumulative translation adjustment (**)
Net Income for the year
Balance as of December 31, 2006
Balance as of December 31, 2006 restated in constant Chilean pesos as of December 31, 2008
Balance as of January 1, 2007
Capitalization of retained earnings (3)
Dividends paid (3)
Subscription and payment of shares (4)
Balance as of December 31, 2007
Balance as of December 31, 2007 restated in constant Chilean pesos as of December 31, 2008
Balance as of January 1, 2008
Capital increase as a result of the merger (5)
Dividends paid (6)
Subscription and payment of shares (7)
Price level restatement
Merger of subsidiaries
Provision form minimum dividends (8)
Balance as of December 31, 2008
F-10
As of December 31, 2007, 2,076,059,351 cash shares have been subscribed and paid amounting MCh$84,350 (historical).
F-11
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
(a) Basis of presentation
Banco de Chile (“Banco de Chile” or the “Bank”) is a Corporation organized under the laws of the Republic of Chile, regulated by the Superintendency of Banks and Financial Institutions (“SBIF”). Starting in 2001, Banco de Chile is regulated by the United States Securities and Exchange Commission (“SEC”), as the Bank is listed on the New York Stock Exchange (“NYSE”), through its American Depository Receipt (ADR) program, which is also registered in the London Stock Exchange. Banco de Chile’s shares are also listed on the Latinamerican securities market of the Madrid Stock Exchange (“LATIBEX”).
Banco de Chile offers a broad range of banking services to customers, ranging from individuals to large corporations. The services are managed in the following segment for internal reporting purposes: Wholesale Market, Retail Market, Treasury and Subsidiaries. The Bank's subsidiaries provide other services including securities brokerage, mutual fund management, factoring, insurance brokerage, financial advisory and securitization.
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in Chile and regulations of the Superintendency of Banks. Certain accounting practices applied by the Bank that conform to Chilean GAAP may not conform to generally accepted accounting principles in the United States (“US GAAP”) or International Financial Reporting Standards (“IFRS”). For the convenience of the reader, the consolidated financial statements have been translated into English and certain subtotals and clarifying account descriptions have been added.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. In certain cases generally accepted accounting principles require that assets or liabilities be recorded or disclosed at their fair values. The fair value is the amount at which an asset could be bought or sold or in the case of a liability could be transferred or settled in a current transaction between willing parties, other than in a forced or liquidation sale. Where quoted markets are not available, Banco de Chile has estimated such values based on the best information available, including using modeling and other valuation techniques.
The consolidated financial statements include the financial position and results of operations of Banco de Chile and its majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in the consolidation. The majority-owned subsidiaries of Banco de Chile as of December 31, 2007 and 2008 are as follows:
Subsidiary
Banco de Chile Sucursal Nueva York
Banco de Chile Sucursal Miami
Citibank Agencia de Valores S.A. (*)
F-12
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. Summary of Significant Accounting Policies (continued)
(a) Basis of presentation (continued)
For presentation purposes, the merger between Banco de Chile and Citibank Chile was accounted for as a “pooling of interest” in accordance to Technical Bulletin N° 72 on a prospective basis. Accordingly, financial statements for periods prior to January 1, 2008 are not restated and Banco de Chile is considered to be the continuing entity for legal and accounting purposes.
(b) Price-level restatement
The consolidated financial statements are prepared on the basis of general price-level accounting in order to reflect the effect of changes in the purchasing power of the Chilean peso for Banco de Chile and its Chilean subsidiaries during each year. At the end of each reporting period, the consolidated financial statements are stated in terms of the general purchasing power of the Chilean peso using changes in the Chilean consumer price index (“CPI”) as determined by the Chilean National Institute of Statistics as follows:
Non-monetary assets, liabilities, and equity accounts are restated in terms of year-end purchasing power using the “prior month rule”, as described below.
Consistent with general banking practices in Chile, no specific purchasing power adjustments are made to the income statement accounts.
Monetary items are not restated, as such items are, by their nature, stated in terms of current purchasing power in the consolidated financial statements.
The price-level restatement debit or credit in the income statement represents the monetary loss or gain in purchasing power from holding monetary assets and liabilities exposed to the effects of inflation.
For comparative purposes, the consolidated financial statements for periods through December 31, 2007 have been restated in Chilean pesos of general purchasing power as of December 31, 2008 (“constant pesos”), to reflect changes in the CPI from the financial statement dates to December 31, 2008. This updating does not change the prior year’s financial statements or information in any way except to update the amounts therein to constant pesos of similar purchasing power. Amounts previously presented in constant Chilean pesos as of each balance sheet date have been adjusted by the percentage changes in the Chilean CPI to December 31, 2008, as follows:
The general price-level restatements are calculated using the CPI, and are based on the “prior month rule”, in which the inflation adjustments are based on the CPI at the close of the month preceding the close of the respective period or transaction. The CPI is considered by the business community, the accounting profession, and the Chilean government to be the index that most closely complies with the technical requirement to reflect the variation in the general level of prices in the country and, consequently, is widely used for financial reporting purposes in Chile.
F-13
(b) Price-level restatement (continued)
The values of the CPI used for price-level restatement purposes are as follows:
The price-level adjusted consolidated financial statements do not purport to represent appraised values, replacement cost, or any other current value of assets at which transactions would take place currently and are only intended to restate all non-monetary financial statement components in terms of local currency of a single purchasing power and to include in the net result for each year the gain or loss in purchasing power arising from the holding of monetary assets and liabilities exposed to the effects of inflation.
The net charge to income for price-level restatement is comprised of the following restatements of non-monetary assets and liabilities. These figures are expressed in constant Chilean pesos of December 31, 2008.
Net loss from price-level restatement
(c) Index-linked assets and liabilities
Certain of Banco de Chile’s interest-bearing assets and liabilities are denominated in index-linked units of account.
The principal index-linked unit used in Chile is the Unidad de Fomento (“UF”), a unit of account, which changes daily to reflect changes in the CPI. The carrying amounts of such assets and liabilities change with the respective changes in the UF and serve to offset the monetary gains or losses from holding such assets and liabilities. As Banco de Chile’s UF-denominated assets exceed its UF-denominated liabilities, any increase in the Chilean CPI results in a net gain on indexation. Values for the UF are as follows (historical Chilean pesos per UF).
December 31,
F-14
(c) Index-linked assets and liabilities (continued)
The UF daily indexation adjustments from the 10th day of the month in question to the 9th day of the subsequent month are determined based on the previous month's changes in the Chilean CPI. The effect of changes in the UF index on interest earning assets and interest bearing liabilities is reflected in the income statement as an increase or decrease in interest income or expense.
(d) Interest revenue and expense recognition
Interest revenue and expense are recognized on an accrual basis using the effective interest method. Loans, investments and liabilities are stated at their cost, adjusted for accrued interest and the indexation adjustment applicable to such balances that are index-linked.
Banco de Chile suspends the accrual of interest and readjustments on loans when there is a high risk of unrecoverability or from the first day in which they become overdue. Accrued interest up to the suspension date remains on Banco de Chile’s assets and is considered a part of the loan balance when determining the allowance for loan losses.
(e) Foreign currency and derivative activities
Banco de Chile and its subsidiaries protect themselves against variations in the foreign exchange market by using forward contracts, currency futures contracts, currency swaps and interest rates swaps. These activities include hedging and treasury operations and help Banco de Chile and its subsidiaries provide financial products to their clients.
Financial derivative contracts, which include foreign currency and U.F. forwards, interest rate forwards, currency and interest rate swaps, currency and interest rate options and other financial derivative instruments, are recorded in the balance sheet at cost (including transaction costs) at inception and subsequently measured at their fair value. The fair value is obtained from market quotes, discounted cash flows models and options valuation models, as and where applicable. Derivative contracts are reported as an asset when their fair value is positive and as a liability when negative under the line item “Derivative instruments”.
Certain derivatives embedded in other financial instruments are treated as separate derivatives when their risk and characteristics are not closely related to those of the main contract and this contract is not recorded at its fair value with its unrealized gains and losses included in income.
At inception, a derivative contract must be designated by the Bank as a derivative instrument for investing or hedging purpose.
Changes in the fair value of derivative contracts maintained for investing purpose are included under “Gains (losses) from trading activities” in the Consolidated Statement of Income.
Should a derivative instrument be classified as a hedge, it can be: (1) a hedge of the fair value of existing assets or liabilities or firm commitments, or (2) a hedge of cash flows related to existing assets or liabilities or forecasted transactions. A hedge relationship for hedge accounting purpose must comply with all of the following conditions: (a) at the inception, the hedge relationship has been formally documented; (b) it is expected that the hedge would be highly effective; (c) the effectiveness of the hedge can be measured in a reasonable manner; and (d) the hedge is highly effective with respect to the hedged risk on an ongoing basis and throughout the entire hedge relationship.
F-15
(e) Foreign currency and derivative activities (continued)
Certain derivatives transactions which do not qualify for hedge accounting are treated and reported as derivatives for investing purposes even though they provide an effective hedge on the risk of net positions.
When a derivative instrument hedges the risk of changes in the fair value of an existing asset or liability, the hedged asset or liability is recorded at its fair value with respect to the specific hedged risk. Gains or losses from fair value adjustments, both the hedged item and the derivative instrument, are recognized in income.
Should the hedged item in a fair value hedge be a firm commitment, changes in the fair value of the commitment with respect to the hedged risk are recorded as an asset or liability against net income for the year. Gains or losses from fair value adjustments of the hedging derivative are recorded in income. When an asset or liability is acquired as a result of the commitment, the initial recognition of the asset or liability acquired is adjusted to incorporate the accumulated effect of the valuation at fair value of the firm commitment which was previously recorded in the balance sheet.
When a derivative hedges the risk of changes in the cash flows of existing assets or liabilities or forecasted transactions, the effective portion of changes in the fair value related to the hedged risk is recorded in equity net of taxes. Any ineffective portion is directly recorded in income. The accumulated amounts recorded in equity are transferred to income at the moment that the hedge item affects income.
When a interest rate fair value hedge is performed on a portfolio basis and the hedged item is an amount instead of individualized assets or liabilities, gains or losses from fair value adjustments, both the hedged portfolio and the derivative instrument, are recorded in income but the fair value adjustment of the hedged portfolio is reported in the balance sheet under “Other assets” or “Other liabilities”, according to the position of the portfolio hedged at a moment in time.
(f) Trading securities:
Trading securities are securities acquired having the intention of generating profits as result of short-term prices fluctuation or as result of brokerage activities, or are part of a portfolio on which a short-term profit generating pattern exists.
Trading securities are stated at their fair market value as of the balance sheet date. Gains or losses from their fair market value adjustments, as well as gains or losses from trading activities, are included in “Gains (losses) from trading activities” in the Consolidated Statement of Income. Accrued interest and readjustments are reported as “Interest revenue”.
All purchases and sales of trading securities that must be delivered within the period established by market regulations or conventions are recorded using the trade date, which is the date on which the purchase or sale of the asset is committed. Any other purchase or sale is treated as a derivative (forward) until liquidation occurs.
F-16
(g) Investments held to maturity and available for sale securities:
Investments held to maturity include only those securities for which the Bank has the ability and intention of keep them until maturity. The remaining investments are considered as available for sale securities.
At inception, both investments are recorded at cost, including transaction costs.
Available for sale securities are subsequently measured at their fair value based on market prices or valuation models. Unrealized gains or losses as result of fair value adjustments are recorded in equity, net of tax. When an available for sale securities is disposed of or impaired, the accumulated fair value adjustment recorded in equity is transferred to income and reported under the line item “Gains (losses) from trading activities” when applicable.
Investments held to maturity are recorded at their cost plus accrued interest and readjustments less impairment provisions made when the carrying amount exceeds the estimated recovery amount.
Interest and readjustments of investments held to maturity and available for sale securities are included under the line item “Interest revenue.”
Investment securities which are subject to hedge accounting are adjusted according to the rules for hedge accounting.
Purchases and sales of investment securities that must be delivered within the period established by market regulations or conventions are recorded using the trade date, that is the date on which the purchase or sale of the asset is committed. Any other purchase or sale is treated as a derivative (forward) until liquidation occurs.
As of December 31, 2008 and 2007, the Bank and subsidiaries do not hold held to maturity instruments.
(h) Transactions with repurchase and resale agreements:
The Bank and its subsidiaries enter into security repurchase agreements as a form of borrowing. Investments that are sold subject to a repurchase obligation and that serve as collateral for borrowings are reclassified as “Trading securities” or “Available for sale”. The liability to repurchase the investment is classified as “Securities sold under repurchase agreements”, which is valued in accordance with the agreed-upon interest rate.
The Bank and its subsidiaries also enter into resale agreements as a form of investment. Under these agreements, purchases securities, which are included as assets under the caption “Securities purchased under resell agreements”, which are valued in accordance with the agreed-upon interest rate.
F-17
(i) Loans to customers, allowances, charge-offs and loans recoveries:
The loans granted and acquired by Banco de Chile and its subsidiaries are initially recorded at cost (i.e. the original amount loaned). After this initial recording, the loans are valued at their amortized cost and disclosed net of allowances for loan losses.
In accordance with regulations of the Superintendency of Banks and Financial Institutions, Banco de Chile, its subsidiaries and foreign branches utilize models and methods, based on an individual and group analysis of the debtors, to constitute the allowances for loan losses.
Allowances for individual evaluations
An individual analysis of debtors is applied to individuals or companies with whom, due to size, complexity or level of exposure with the entity, Banco de Chile must be completely familiar. Likewise, it requires assigning a risk category to each debtor and its respective loans. This risk category should consider the following factors: industry or sector, partners, management and administration, financial situation, behavior and payment capacity.
One of the following categories must be assigned to each debtor and its loans after the analysis has been finalized:
In order to determine allowances for loan losses classified as A1, A2, A3 and B, Banco de Chile uses percentages approved by its Board of Directors. Allowance for debtors classified as C1, C2, C3, C4, D1 and D2 were determined, in conformity with regulations in place, as follows:
Category
Range of estimated loss
Allowances for group evaluations
The group analysis is used to analyze a large number of operations whose individual amounts are not significant and present similar risk characteristics. For this analysis, Banco de Chile uses models based on attributes of the debtors and their loans, and on the behavior of a group of loans. In the group evaluations, the allowances are always constituted in accordance with the estimated loss using the aforementioned models.
F-18
(i) Loans to customers, allowances, charge-offs and loans recoveries (continued):
Additional allowances
In conformity with regulations of the Superintendency of Banks and Financial Institutions, Banco de Chile has constituted additional allowances for its individually evaluated loan portfolio, taking into consideration the expected impairment of this portfolio. The calculation of this allowance is performed based on Banco de Chile’s historical experience and considering possible future adverse macroeconomic conditions or circumstances that could affect a certain sector, industry, groups of debtors or projects.
Loans are written-off when the collection efforts have been exhausted but not later than the maximum periods prescribed by the Superintendency of Banks, which are as follows:
- 24 months past due (3 months past due for consumer loans) for loans without collateral.
- 36 months past due for loans with collateral.
Loan loss recoveries
Cash recoveries on written-off loans including loans that were reacquired from the Central Bank of Chile, recorded in memorandum accounts (see Note 25), are recorded directly to income, as a reduction of the “Provision for loan losses” item.
(j) Leasing contracts
Banco de Chile leases certain property that meets the criteria for direct financing leases. At the time of entering into a direct financing lease transaction, Banco de Chile records the aggregate of the minimum lease payment receivable less unearned income. Generally, the lessee acquires the leased asset by remitting all lease payments due. There are no significant residual values assumed by Banco de Chile. Unearned income represents the excess of the minimum lease payments receivable plus any estimated residual value over the cost of the property acquired.
Unearned income is recognized in such a manner as to produce a constant periodic rate of return on the net investment in the direct financing lease. The net investment in financing leases is classified as “leasing contracts” in the accompanying consolidated balance sheets.
(k) Factoring transactions
Banco de Chile and its subsidiary Banchile Factoring S.A. carry out factoring transactions, where they receive invoices and other commercial instruments representative of credit, with or without recourse, and they advance to the assignor a percentage of the total amounts to be collected from the original debtor.
The caption “Loans to customers” includes MCh$483,904 (MCh$511,656 in 2007), corresponding to the amount advanced to the assigner plus accrued interest net of payments received.
F-19
(l) Investments in other companies
Shares or rights in other companies that are integral to the operations of Banco de Chile and where Banco de Chile holds a less than majority interest but has significant influence over the operating activities of the invested are accounted for under the equity method. Other minority investments are carried at cost restated for price-level changes.
(m) Intangibles assets:
This account includes goodwill, identifiable intangible assets and software, net of accumulated amortization and adjustments.
Intangible assets such as goodwill, assets generated in business combinations such as core deposit, software and trademark are valued at price-level restated cost and amortized using the straight-line method based on their estimated useful lives. The maximum amortization period for software is six years.
(n) Fixed assets, net
Fixed assets are stated at acquisition cost net of accumulated depreciation and have been restated for price-level changes. Depreciation is calculated using the straight-line method over the estimated useful lives of the underlying assets. Maintenance and repair costs are charged to income. The cost of significant renovations and improvements is capitalized.
Property, plant and equipment
Land and buildings
Furniture and fixtures
Machinery and equipment
Other equipment
(o) Assets received in lieu of payment
Assets received in lieu of payment are recorded at restated cost less regulatory charge-offs and presented net of a portfolio valuation allowance. The Superintendency of Banks and Financial Institutions requires regulatory charge-offs if the asset is not sold within one year of foreclosure.
(p) Deferred taxes and income taxes:
The deferred taxes effects of temporary differences between the financial and tax values of assets and liabilities are recorded in accordance with generally accepted accounting principles in Chile (“Chilean GAAP”) by using the liability method.
Income tax provision is determined based on current Chilean tax legislation.
The total impact of deferred and income taxes in showed under Note 27.
F-20
(q) Staff severance indemnities
Banco de Chile has recorded a liability for long-term severance indemnities in accordance with employment contracts it has with certain employees. The liability, which is payable to specified retiring employees with more than 30 years of service, is recorded at the present value of the accrued benefits, which are calculated by applying a real discount rate to the benefit accrued as of year-end over the estimated average remaining service period. For the years ended December 31, 2006, 2007 and 2008, the obligation has been discounted using the real interest rate of 6% per annum.
(r) Fees and expenses related to loans and services
Loan origination fees and expenses are considered to be adjustments to loan yield and are deferred and amortized as interest income over the term of the loan. Fees and expenses related to other financial products, including contingent loans, are generally deferred and recognized as income over the term of the products to which they relate. Fees related to financial advisory and other services are recognized on an accrual basis at the time services are provided.
(s) Consolidated statements of cash flows
Cash and cash equivalents corresponds to the account “Cash and bank deposits”, plus (minus) the net balance of transactions in the course of collection that are shown in the Statement of Consolidated Financial Position, plus highly-liquid trading and available-for-sale instruments with insignificant risk of changing value, maturing in no more than three months from the date of acquisition and repurchase agreements with similar conditions. It also includes investments in fixed-income mutual funds that are presented together with trading instruments in the Statement of Consolidated Financial Position. For the years ended December 31, 2006, 2007 and 2008 the consolidated statement of cash flows has been prepared in accordance with Technical Bulletin No.65 of the Chilean Association of Accountants.
(t) Convenience translation to U.S. dollars
Banco de Chile maintains its accounting records and prepares its consolidated financial statements in Chilean pesos. The U.S. dollar amounts disclosed in the accompanying financial statements are presented solely for the convenience of the reader at the observed exchange rate for December 31, 2008 of Ch$629,11 per US$1.00. This translation should not be construed as representing that the Chilean peso amounts actually represent or have been, or could be, converted into U.S. dollars at such a rate or, any other rate.
(u) Translation of financial statements of Banco de Chile’s foreign branches and subsidiaries
The Bank translates the accounting records of its subsidiary Banchile Trade Services Limited, Hong Kong to Chilean pesos from US dollars in accordance with guidelines established by the SBIF, which are consistent with Technical Bulletin No. 64, “Accounting for Investments Abroad”, issued by the Chilean Association of Accountants. All Comprehensive Income Statement and Financial Position Statement amounts are translated into Chilean pesos as of the exchange rate in effect as of the applicable balance sheet date. Under this standard the foreign investment recorded in the parent company’s books is price-level restated, the effects of which are reflected in income, while any foreign exchange gains or losses between the Chilean peso and the US dollar, net of the effects of Chilean inflation, is recorded in shareholders’ equity in the account “Other comprehensive income”.
As of December 31, 2007, Banco de Chile applied the same criteria for their New York and Miami branches.
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(v) Business combination
On January 1, 2008, the merger transaction between Banco de Chile and Citibank was effective. This business combination was deemed as a merger of entities under common control as both banks were controlled by the same parent company at the date of the merger transaction. The merger of entities under common control is prescribed by Technical Bulletin No. 72 (“BT 72”). BT 72 states that this type of transactions should be accounted using the pooling-of-interest method, whereby Citibank net assets acquired were recorded in the books of Banco de Chile at their previous carrying amount not recording any fair value adjustments or other identifiable net asset or intangible acquired.
2. Changes in Accounting Principles
In accordance with Chapters B-4 and E of the above mentioned Compendium of Accounting Standards, the Bank recorded a liability for an amount of MCh$190,698 under the line item “Provisions” as of December 31, 2008 related to the minimum dividends payment, reflecting as a counterpart an equity reduction for the same amount under “Retained earnings”. Until 2007, dividend obligations were recorded when declared by the Shareholders’ Meeting. This change did not generate effects on income.
Chapter C-3 of the above mentioned Compendium of Accounting Standards established the new formats for presentation of the annual financial statements, requiring in Chapter E, its application starting in 2008. The application of these new formats only affected the presentation of these financial statements, and did not have an effect on the accounting criteria applied by the Bank. For comparison purposes the 2007 and 2006 financial statements have been modified in accordance with the new presentation format, and therefore, the financial statements that are presented for this period differ, in terms of their presentation, from those reported the previous year.
In addition, the above-mentioned Compendium of Accounting Standards establishes that starting January 1, 2009, banks must begin with the application of the new accounting criteria established by the SBIF, and in those matters not addressed by the compendium, apply IFRS. The changes in accounting criteria are related, among other things, to the following matters: a) suspension of the price-level restatement mechanism; b) option to revaluate fixed assets as of the date of first time adoption; c) changes and incorporation of additional disclosures in notes to the financial statements; etc.
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2. Changes in Accounting Principles (continued)
The application of these new accounting criteria originated adjustments on the Bank’s equity accounts as of January 1, 2009, and will also affect the determination of income in future years. Likewise, and only for comparison purposes with the financial statements that will be presented in 2009, the Bank must present the financial statements for 2008 in accordance with the new accounting criteria, which will differ from those presented herein. As of the issuance date of these consolidated financial statements, the prepared the information that allow it to estimate, with reasonable objectivity, the final adjustments that must be recorded in 2009 and the effects on the statement of financial position and on the statement of comprehensive income for 2008 (See further details in note 35).
3. Cash and Cash Equivalent
Chilean Central Bank deposits
Deposits in other Domestic banks
Deposits abroad
Subtotal – Cash and due from banks
Net transactions in the course of settlement.
Highly liquid financial instruments
Total Cash and Cash equivalent
In accordance with guidelines established by the Superintendency of Banks, Banco de Chile must maintain certain non-interest bearing balances in its account with the Central Bank. The required balances are based upon specified financial criteria, including the level of Banco de Chile’s deposits, the amounts of its foreign borrowings and its average liabilities. These restricted cash amounts totaled MCh$318,030 and MCh$466,235 as of December 31, 2007 y 2008, respectively.
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3. Cash and Cash Equivalent (continued)
Transactions in the course of settlement are transactions for which the only remaining step is settlement, which will increase or decrease the funds in the Central Bank or in foreign banks, normally occurring within 12 to 24 business hours and are detailed as follows:
Documents drawn on other banks (clearing)
Funds receivable
Subtotal transactions in the course of collection
Funds payable
Subtotal transactions in the course of payment
Net transactions in the course of settlement
4. Trading Securities
The detail of securities classified as trading is as follows:
Instruments issued by the Central Bank
4.51%
6.22%
Instruments issued by the Chilean Government and Central Bank include instruments sold under agreements to repurchase to customers and financial institutions, equivalent to MCh$9,012 as of December 31, 2008 (MCh$53,064 in 2007).
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4. Trading Securities (continued)
Included in Other instruments issued in Chile and instruments issued abroad are instruments sold under agreements to repurchase to customers and financial instruments, equivalent to MCh$263,417 as of December 31, 2008 (MCh$207,424 in 2007).
Agreements to repurchase have an average expiration of 13 days as of year-end (9 days in 2007).
Additionally, the Bank holds financial investments in mortgage finance bonds issued by itself in the amount of MCh$113,127 (MCh$138,433 in 2007), which are presented as a reduction of the liability line item “Debt issued”.
5. Investments held to maturity and available for sale securities
Available for Sale
As of December 31, 2008, the portfolio of available for sale securities include a net unrealized loss of MCh$16,692 recorded in equity.
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6. Derivative Instruments
(a) The Bank uses derivative instruments for investing and hedging purposes
Derivatives held for hedging purposes
Total derivatives held for hedging purposes
Derivatives held for investing purposes
Currency Call options
Rate call options
Currency put options
Total derivatives held for investing purposes
Total derivative instruments
(b) Fair value of traded instruments
The table below sets forth the estimated fair value of derivative financial instruments held or issued by the Bank for trading and hedging purposes as of December 31, 2007 and 2008.
Contract to purchase and sell foreign exchange, net
Currency and interest rate swaps and options, net
For those instruments held by the Bank where no quoted market prices are available, fair values have been estimated using modeling and other valuation techniques.
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7. Loans and Advance to Banks
As of December 31, 2008 and 2007, amounts are detailed as follows:
Domestic Banks
Unavailable Central Bank Deposits
Other Central Bank credits
Interbank loans
Current account overdrafts
Foreign Banks
Loans to foreign banks
Other credits with foreign banks
Provisions and impairment of loans with foreign banks
8. Loans to customers, net
The loans and account receivable from clients included in the accompanying consolidated balance sheets are classified into subcategories as described below:
Comprised of loans and accounts receivable from clients not included in mortgage or consumer loans categories.
This includes mortgage loans granted to individuals to acquire, expand, repair or build a home, issued as mortgage bonds, endorsable mortgage loans or other methods. It also includes supplementary loans for the same purposes and bridge loans granted during the period before the mortgage loan has been settled. This subcategory also includes residential real state lease transactions and other accounts receivable.
Comprised of all loans granted to individuals to be used for purchasing goods or services. It includes different types of loans (either installments or revolving), as well as balances from using credit cards or making overdrafts on current accounts belonging to individuals. Consumer loans also include consumer lease transactions and other accounts receivable.
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8. Loans to customers, net (continued)
Commercial Loans:
Current account debtors
Factoring transactions
Leasing transactions
Other loans and accounts receivable
Other residential real state mortgage loans
Consumer Loans:
Consumer loans in installments
Credit card debtors
Lease transactions
Allowances:
Allowances for commercial loans
Allowances for mortgage loans
Allowances for consumer loans
Total Loans to Customers, Net
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The following table summarizes the most significant loan concentrations expressed as a percentage of total loans, excluding contingent loans and before allowance for loan losses:
Community, Social and Personal Services
Substantial portions of Banco de Chile’s loans are to borrowers doing business in Chile.
9. Allowance for Loan Losses
The changes in the allowance for loan losses for the periods indicated are as follows:
Balance as of January 1,
Balance from Citibank Chile
Price-level restatement (1)
Allowances released
Balance as of December 31,
The provisions for loan losses included in the results of operations for the periods indicated is as follows:
Other allowances established (1)
Net charges to income
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10. Leasing Contracts
Banco de Chile’s scheduled cash flows to be received from leasing contracts have the following maturities as of December 31, 2007 and 2008:
Maturity
Due within one year
Total leasing contracts
Leased assets consist principally of real estate, industrial machinery, vehicle, and computer equipment. The allowance for uncollectible lease receivable was MCh$8,753 and MCh$10,811 as of December 31, 2007 and 2008, respectively, which forms part of the allowance for loan losses.
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11. Investments in other companies
(a) As of December 31, 2006, 2007 and 2008, investments in other companies and Banco de Chile’s participation in those companies’ results of operations for each of the periods indicated, consist of the following:
Servipag Ltda.
Soc. Operadora de Tarjetas de Crédito Nexus S.A.
Redbanc S.A
Transbank S.A.
Bolsa de Comercio de Santiago (Stock Exchange)
Bolsa De Comercio de Santiago (Stock Exchange)
Soc. Operadora Cámara Compensación de Pagos de Alto Valor S.A. (1)
Centro de Compensación Automatizado S.A. (CCA S.A.)
Artikos Chile S.A. (2).
Sociedad Interbancaria de Depósito de Valores S.A
Bolsa de Valores de Chile (Stock Exchange)
Administrador Financiero de Transantiago S.A. (3)
Total investments in affiliates accounted for under the equity method
Other investments carried at cost
Total investments in other companies
On January 5, 2006, Banco de Chile decreased its participation to 11.52% as a result of not concurrence to a capital increase in “Sociedad Operadora Cámara Compensación de Pagos de Alto Valor S.A.”.
During December 2007, by agreement of the Extraordinary Shareholders’ Meeting of Administrdor Financiero de Transantiago S.A. the extraordinary contributions made by the partners were capitalized, whereby Banco de Chile capitalized MCh$2,040 (historical).
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11. Investments in other companies (continued)
(b) The reconciliation between opening and ending balance of investments in other companies that are no consolidated in 2008 and 2007 is detailed as follows:
Opening Balance
Acquisitions
Participation in net income
Dividends received
Impairment allowance
Ending Balance
12. Intangibles Assets
As of December 31, 2008 and 2007, Intangibles assets are detailed as follows:
Legg Mason
Share in stock exchange (Accival)
Software or computer programs
Legg Mason customer list
13. Fixed assets
The major categories of fixed assets net of accumulated depreciation are as follows:
Others
Fixed Assets, net
In accordance with rules of the Superintendency of Banks, bank premises and equipment are presented net of accumulated depreciation.
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14. Other Assets and Other Liabilities
(a) Other assets
Assets held for leasing
Pending transactions
Other account and notes receivable
VAT receivable
Commissions receivable
Assets received in lieu of payment
Prepaid expenses
Materials and supplies
Additional consideration paid in the purchase of mortgage bonds
Rental guarantees
Accounts receivable for asset received in lieu of payment sold
Lawsuits in collection process
Assets to be securitized
Total other assets
(b) Other liabilities
Accounts and notes payable
VAT payable
Leasing deferred gains
Deferred income
Total other liabilities
15. Currents Accounts and Other Demand Deposits
As of December 31, 2008 and 2007, currents accounts and other demand deposits are detailed as follows:
Other demand liabilities
Other demand deposits and accounts
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16. Saving Accounts and Time Deposits
As of December 31, 2008 and 2007, saving accounts and time deposits are detailed as follows:
Term savings accounts
Other term balances payable
17. Other Interest Bearing Liabilities
Banco de Chile’s long-term and short-term borrowings are summarized below. In accordance with the guidelines established by the Superintendency of Banks, Banco de Chile does not present a classified balance sheet. Borrowings are described as short-term when they have original maturities of less than one year or are due on demand. All other borrowings are described as long-term, including the amounts due within one year on such borrowings. None of the following financial liabilities are collateralized, except for investment sold under agreement to repurchase, nor are subject to covenants.
(a) Central Bank Credit lines for renegotiation of loans
(b) Borrowings from domestic financial institutions
(c) Borrowings from foreign institutions
Debt issued:
(d) Bonds
(e) Subordinated bonds
(f) Mortgage finance bonds
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17. Other Interest Bearing Liabilities (continued)
(a) Central Bank borrowings
Central Bank borrowings include credit lines for the renegotiation of loans and other Central Bank borrowings. Credit lines were provided by the Central Bank for the renegotiation of mortgage loans due to the need to refinance debts as a result of the economic recession and crisis of the Chilean banking system from 1982 to 1985. The credit lines for the renegotiations of mortgage loans are linked to the UF index and carry a real annual interest rate of 3.46%. The maturities of the outstanding amounts are as follows:
Borrowings from domestic financial institutions are used to fund Banco de Chile’s general activities, carry a weighted average annual real interest rate of 4.8% and have the following outstanding maturities as of December 31, 2008.
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(c) Borrowings from foreign financial institutions
Banco de Chile has short-term and long-term borrowings from foreign banks. The outstanding maturities of these borrowings as of December 31, 2008 are as follows:
Total borrowings from financial institutions
The maturities of outstanding bond amounts as of December 31, 2008 are as follows:
Bonds are linked to the UF Index and carried an average real annual interest rate of 3.33% as of December 31, 2008, with interest and principal payments due semi-annually. The bonds were originally intended to finance loans that had a maturity of greater than one year.
In 2008, Banco de Chile issued ordinary bonds in Unidades de Fomento divided into two series, “Y” and “X”. The Y series was issued for an amount of MCh$79,400 (historic pesos) with a maturity of 5 years and a coupon rate of 3.3%. The X series was issued for an amount of MCh$77,810 (historic) with a maturity of 6 years and a coupon rate of 2.5%.
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The bonds are intended to finance loans having a maturity greater than one year. As of December 31, 2008 the outstanding maturities of the bonds, which are considered long-term, are as follows:
During 2008, Banco de Chile issued subordinated bonds with a 25-year maturity. They were issued in Unidades de Fomento and the issuance totaled MCh$53,916 (historic pesos). They accrued interest at an annual rate of 4.5%.
These bonds are used to finance the granting of mortgage loans. The outstanding principal amounts of the bonds are amortized on a quarterly basis. The range of maturities of these bonds is between five and twenty years. The bonds are linked to the UF index and carry a weighted average annual rate of interest of 4.21% as of December 31, 2008.
The maturities of outstanding mortgage bond amounts as of December 31, 2008 are as follows:
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(g) Other financial obligations
As of December 31, 2008, other obligations had the following maturities:
18. Obligations Arising From Lease Commitments
Banco de Chile leases certain premises under operating leases. The following table shows the future minimum payments under the terms of the lease commitments, expressed in constant Chilean pesos as of December 31, 2008.
Total obligations arising from lease commitments
The rental expense on the premises was MCh$11,812, MCh$12,373 and MCh$15,829 for the years ended December 31, 2006, 2007 and 2008, respectively, and is included in the Consolidated Statements of Income under “Administrative expenses”.
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19. Other Provisions
Provisions included within liabilities are detailed as follows:
Provisions for personnel benefits and payroll
Additional loan allowance
Co-branding allowance
Allowance for contingent loan risks
Allowance for credit card risk fund
Civil lawsuit allowance
Country risk allowance
Total other provisions
20. Minimum Regulatory Capital Requirements
In accordance with the General Banking Law, the Bank must maintain a minimum ratio of Effective Equity to Consolidated Risk-Weighted Assets of 8%, net of required provisions and a minimum ratio of Basic Capital to Total Consolidated Assets of 3%, net of required provisions. However, because of the 2008 merger of Banco de Chile and Citibank Chile, the SBIF, through Resolution No. 209 dated December 26, 2007, established that the institution is obligated to maintain an Effective Equity to Consolidated Risk-Weighted Assets ratio no less than 10%.
The “Effective Equity” is defined as “net capital base” plus subordinated bonds, up to 50% of the capital and reserves, plus additional provisions of up to 1.25% of their risk-weighted assets. The value of the subordinated bonds that can be considered in the “effective equity” should decrease by 20% per year beginning six years prior to maturity.
Banco the Chile’s actual qualifying “net capital base” and “effective equity” used to support its “risk-weighted assets” as of December 31, 2008, are set forth in the following table:
Basic Capital
3% of total assets net of provisions
Excess over minimum required equity
Net capital base as a percentage of the total assets, net of provisions
Effective equity
8% of risk-weighted assets
Effective equity as a percentage of the risk-weighted assets (*)
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21. Dividends
Dividends are declared and paid during the year subsequent to that in which the related net income was earned.
Dividends declared and paid in 2006, 2007 and 2008 in constant Chilean pesos of December 31, 2008 are as follows:
Dividends relating to prior year net income
22. Transactions with Related Parties
In accordance with the rules of the Superintendency of Banks, related parties are defined as individuals or companies who are directors, officers, or shareholders who own more than 1% of Banco de Chile’s shares.
Entities in which a director, officer or shareholder of Banco de Chile holds more than a 5% interest as well as entities that have directors in common with Banco de Chile are also considered to be related parties. In the following tables, trading and manufacturing companies are defined as operating companies, and companies whose purpose is to hold shares in other companies are defined as investment companies.
(a) Loans granted to related parties
Loans to related parties, all of which are current, are as follows:
Operating companies
Investment companies
Individuals (1)
The activity in the balances of loans to related parties are as follows:
Balance as of January 1
New loans
Repayments
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22. Transactions with Related Parties (continued)
(b) Other transactions with related parties
During the years ended December 31, 2006, 2007 and 2008, Banco de Chile incurred the following expenses and income as a result of transactions with related parties equal to or greater than UF 5,000 equivalent to approximately MCh$107 as of December 31, 2008.
Empresa Nacional de Telecomunicaciones S.A.
Redbanc S.A.
Operadora de Tarjetas de Crédito Nexus S.A.
Consorcio Nacional de Seguros S.A.
Entel Telefonía Local S.A.
Entel PCS Telecomunicaciones S.A.
Depósito Central de Valores, Depósitos de Valores S.A.
Bolsa de Comercio de Santiago Bolsa de Valores
Banchile Cía de Seguros de Vida S.A
Plaza Oeste S.A.
Soc. Operadora de la Cámara Com. Pagos Alto Valor S.A.
Parque Arauco S.A.
Artikos S.A.
Empresa periodística La Tercera S.A.
Sonda S.A.
Asociación de Bancos e Instituciones Financieras
Plaza Antofagasta S.A.
Plaza El Trébol S.A.
Parque La Serena S.A.
Citicorp North America Inc.
CTI Inc.
Latin America Cash Settlement Unit
Diners Club Argentina
Citigroup Chile S.A.
Línea Aérea Nacional Chile S.A.
Transactions between 1,000 and 5,000 UF:
Services expenses
Rental income
Telephone expenses
Revenue from rentals
These expense and revenue items are for services received and rendered by Banco de Chile from and to related parties at market rates. Article 89 of the Chilean Corporations Law requires that Banco de Chile’s transactions with related parties be carried out on a market basis or on terms similar to those prevailing in the market.
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23. Fees and commissions
Banco de Chile’s fees and commissions from services for the years ended December 31, 2006, 2007 and 2008 are summarized as follows:
Card Services
Collection and payment
Investments in mutual funds and others
Lines of credit and overdrafts
Trading and securities management
Portfolio management
Guarantees and letters of credit
Credit card transactions
Services of pre-evaluation credits
Sale of mutual fund units
Fees for securities transactions
Others fees
Fees on mortgage finance loans operations are shown in the Consolidated Statements of Comprehensive Income under the line item “Interest Revenue”.
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24. Board of Directors Compensation
As agreed at the Shareholders Meeting, during 2007 and 2008 Banco de Chile and its subsidiaries have paid, and charged to income, the following compensation to their Directors:
Fernando Cañas Berkowitz
Jorge Díaz Vial
Segismundo Schulin-Zeuthen Serrano
Máximo Pacheco Matte
Juan Andrés Fontaine
Other subsidiaries directors
Travel and other related expenses amount to MCh$279 (MCh$270 in 2007).
25. Loan Loss Recoveries
Loan portfolio previously charged-off
Loans reacquired from Central Bank
Recovery of loans re-acquired from the Central Bank includes payments received on such loans, which at the date of their repurchase from the Central Bank were deemed to have no value and were recorded in memorandum accounts, are recorded directly to income, as a reduction of the “Provision for loan losses” item.
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26. Foreign Currency Position
The consolidated balance sheets include assets and liabilities denominated in foreign currencies, which have been translated to Chilean pesos at the Observed Exchange Rates as of December 31, 2007 and 2008 and assets and liabilities denominated in Chilean pesos but that contain repayment terms linked to changes in foreign currency exchange rates, detailed below:
Cash due from banks and transactions in the course of
Investment securities
Loans to customers and advance to banks
Held to maturity and available for sale
Other assets (1)
Deposits and transactions in the course of collection
NET (LIABILITIES) ASSETS
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27. Deferred and Current Tax
(a) Deferred tax
Banco de Chile and its subsidiaries have recorded in the Financial Statements the effects of deferred taxes and amortization of its complementary accounts, as provided by the Chilean Association of Accountants. The movements and effects from deferred taxes are shown on the following table:
Obligations with repurchase agreements
Leasing equipment
Assets at market value
Personnel provisions
Staff vacations
Accrued interest and indexation adjustments from past due loans
Staff severance indemnities
Other adjustments
Total deferred tax assets
Investments with repurchase agreements
Depreciation and price-level restatement of fixed assets
Transitory assets
Deferred taxes with an effect on equity
Valuation adjustment on available-for-sale investments
Total deferred tax on equity
Total deferred tax liabilities
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27. Deferred and Current Tax (continued)
(b) Current tax
As of December 31, 2008 and 2007, Current Tax is detailed as follows:
Income taxes, 17% rate
Less:
Monthly prepaid taxes (PPM)
PPM on accumulated losses
Credit for training expenses
Credit for purchase of fixed assets
“Income taxes” as presented in the Consolidated Statements of Income for the years ended December 31, 2006, 2007 and 2008 are summarized as follows:
Current income tax provision
Deferred tax effect for the year
Non-deductible expenses Art. 21
State tax for foreign branches
Income taxes expense
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28. Contingencies, Commitments and Fiduciary Activities
(a) Lawsuits and legal proceedings
In the ordinary course of business, Banco de Chile and its subsidiaries act as defendant or co-defendant in various litigation matters. Although there can be no assurances, Banco de Chile’s management believes, based on information currently available, that the ultimate resolution of these legal proceedings are not likely to have a material adverse effect on its results of operations, financial condition, or liquidity. Banco de Chile has established provisions for legal contingencies in the amount of MCh$1,109 and MCh$483 as of December 31, 2007 and 2008, respectively.
(b) Contingent loans
The following table details the contractual amounts of transactions that obligate the Bank to grant loans and the provisions established for the associated credit risk:
Immediate available lines of credit
Amounts available to credit card holders
Bank guarantees
Provision for bank guarantees
Provision for guarantees
Documented letters of credit
Provision for documented letters of credit
(c) Fiduciary activities
The following items are recorded in memorandum accounts by Banco de Chile and represent fiduciary safekeeping and custody services:
Securities held in safe custody
Amounts to be collected on behalf of domestic third parties
Amounts to be collected on behalf of foreign third parties
Total fiduciary activities
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28. Commitments and contingencies (continued)
(d) Guarantees granted
In compliance with article 226 and subsequent articles of Law 18,045, Banchile Administradora General de Fondos S.A., has designated Banco de Chile as the representative of the beneficiaries of the guarantees it has established and in that character the Bank has issued bank guarantees totaling UF 1,853,818, maturing January 9, 2009.
For the purposes of ensuring correct and complete compliance with all of its obligations as a broker-dealer entity, in conformity with the provisions of article 30 and subsequent articles of Law 18,045 on Securities Markets, the subsidiary established a guarantee in an insurance policy for UF 20,000, insured by Cía. de Seguros de Crédito Continental S.A., that matures April 22, 2010, whereby the Securities Exchange of the Santiago Stock Exchange was appointed as the subsidiary’s creditors representative.
Guarantees:
Shares to secure short-sale transactions in:
Securities Exchange of the Santiago Stock Exchange
Securities Exchange of the Electronic Stock Exchange of Chile
Money Market to Pershing Division of Donaldson, Lufkinn & Jenrette Securities Corporation
Bank guarantee
In conformity with the provisions of internal stock market regulations, and for the purpose of securing the broker’s correct performance, the company established a pledge on its share of the Santiago Stock Exchange in favor of that institution, as recorded in Public Deed on September 13, 1990, signed before Santiago public notary Mr. Raúl Perry Pefaur, and on its share in the Electronic Stock Exchange of Chile in favor of that institution, as recorded in a contract entered into by both parties on May 16, 1990.
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(d) Guarantees granted (continued)
Banchile Corredores de Bolsa S.A. keeps an insurance policy current with La Interamericana - Compañía de Seguros Generales S.A. that expires January 2, 2009, and that covers employee fidelity, physical losses, falsification or adulteration, and currency fraud with a coverage amount equivalent to US$ 5,000,000.
In accordance with article 58, letter D of D.F.L. 251, as of December 31, 2008 the company maintains two insurance policies that cover it in the case of possible damage as a consequence of infractions of the Law, regulations and supplemental standards that regulate insurance brokers, and especially when the noncompliance is related to acts, errors or omissions by the broker, its representatives, attorneys-in-fact or dependents that participate in brokerage activities.
The policies are detailed below:
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29. Concentrations of Credit Risk
Concentrations of credit risk (whether on or off-balance sheet) arising from financial instruments exist in relation to certain groups of customers. A group concentration arises when a number of parties have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. Pursuant to Chilean banking regulations, significant exposure exists when the concentration of any individual customer or counterparty exceeds ten percent of Banco de Chile’s effective equity. Banco de Chile does not have a significant exposure to any individual customer or counterparty.
Counterparty risk
Banco de Chile maintains a series of deposits, securities purchased under resell agreements, forward contract agreements and other financial instruments with institutions in the Chilean banking sector. The principal counterparties within the Chilean banking sector, excluding the Central Bank, and Banco de Chile’s related exposure to credit risk, as of December 31, 2007 and 2008 are as follows:
Bank
Banco Santander - Chile
BBVA Banco Bhif
Banco de Crédito e Inversiones
Corpbanca
Banco del Estado de Chile
BankBoston N.A.-ITAU
Deutsche Bank (Chile)
Banco Bice
Banco Security
ABN Amro Bank (Chile)
HSBC Bank Chile
Banco Penta
Banco Falabella
Citibank N.A.
Scotiabank Sud Americano
Banco Ripley
JP Morgan Chase Bank
Banco del Desarrollo
Banco Internacional
Banco Monex
Banco Paris
HNS Banco
Banco Do Brasil S.A.
Banco de Chile maintains a policy of placing deposits with a number of different financial institutions and does not believe that any one of these banks represents an unacceptable credit risk. Banco de Chile does not usually require collateral from these counterparties.
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30. Sales and Purchases of Loans
From time to time, Banco de Chile sells and purchases loans based on specific requirements from customers. During the years ended December 31, 2006, 2007 and 2008, Banco de Chile sold loans totaling MCh$33,058, MCh$4,367 and MCh$73,162, respectively, however, Banco de Chile does not generally originate loans for future sale. Banco de Chile did not retain servicing or any other interest in the loans sold or retains any risks in the event of non-collection by the purchaser. During the year ended December 31, 2007 and 2008, Banco de Chile purchased loans amounting to MCh$10,488 and M$114,442 respectively. Any gains or losses on such transactions are recognized in results of operations at the time of the transactions.
The aggregate gains on sales of loans were MCh$903, MCh$6 and MCh$711 for the years ended December 31, 2006, 2007 and 2008, respectively.
31. Maturity of Assets and Liabilities
The maturity dates of assets and liabilities are shown in the following table including accrued interest as of December 31, 2008.
Loans and advance to banks(*)
Loans to customers (*)
Currents accounts and other demand deposits
Saving accounts and time deposits(**)
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32. Merger Expenses:
During 2008, the following expenses were recorded as a result of the merger between Banco de Chile and Citibank Chile:
Staff severance indemnities and personnel bonuses
Write-off of fixed assets and intangibles assets
Computer development
Training and other personnel expenses
33. Relevant Events:
(a) On January 1, 2008, the merger of Banco de Chile with Banco Citibank Chile was effective, thus complying with the agreement reached in the respective Extraordinary Shareholders’ Meetings held on December 27, 2007. Consequently, beginning on that date, Banco de Chile is the legal successor entity of Citibank Chile.
The SBIF approved the merger by Resolution No. 3 dated January 8, 2008.
(b) On December 31, 2007, Banco de Chile and Citibank N.A. entered into a “Share Purchase Sale and Assumption of Liabilities Agreement” for its branches in Miami and New York, effective January 1, 2008, by which Citibank N.A. acquired their assets and assumed their liabilities with certain exclusions, subject to the authorization of the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Bank of Atlanta, paying to Banco de Chile a total price of US$130 million.
On January 3, 2008, the sale was effective, generating a gain, net of taxes, of MCh$35,593, recording MCh$38,459 in other operating income and MCh$2,866 in income taxes.
(c) In the Ordinary Board of Directors held on January 8, 2008, the Board of Directors accepted the resignation of Mr. Rodrigo Manubens Moltedo and Deputy Director Messrs. Thomas Fürst Freiwirth and Jorge Ergas Heymann as Alternate Directors.
Likewise, the Board of Directors appointed Mr. Raúl Anaya Elizalde as Director, Mr. Rodrigo Manubens Moltedo as First Deputy Director and Mr. Thomas Fürst Freiwirth as Second Deputy Director until the next Ordinary Shareholders’ Meeting.
Additionally, Mr. Jorge Ergas Heymann was appointed as Board advisor.
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33. Relevant Events (continued)
(d) In conformity with authorization from the Superintendency of Banks and Financial Institutions on February 1, 2008, Banco de Chile and its subsidiary Banchile Asesoría Financiera S.A. acquired all of the shares of the company Legg Mason (Chile) Administradora General de Fondos S.A. on February 8, 2008. Banco de Chile acquired 148,793 shares and Banchile Asesoría Financiera S.A. acquired 1 share. The total purchase price for the shares amounted to US$13,000,000. Therefore, Legg Mason (Chile) Administradora General de Fondos S.A. became a subsidiary of Banco de Chile.
(e) During March 2008, in accordance with the agreement reached in the Extraordinary Shareholders’ Meeting held May 17, 2007, 120,000,000 shares were subscribed and paid.
(f) In the Ordinary Shareholders’ Meeting of Banco de Chile held on March 27, 2008, the entire Board of Directors was renewed as the legal and statutory period for Directors of 3 years had expired. Alternate Directors were also appointed.
The following individuals were elected as Directors by shareholder vote at the aforementioned meeting for a new period of three years:
In the session of the Board of Directors held on March 28, 2008, the following appointments were agreed:
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(g) In the Ordinary Session of the Board of Directors held on April 24, 2008, the Board of Directors agreed to set a minimum auction price of Ch$38.80 per share for 319,951,628 new shares.
On May 5, 2008, Banco de Chile communicated that as a consequence of the full subscription and payment of 319,951,628 new shares of Banco de Chile, which were auctioned on April 30, 2008 at the Santiago Stock Exchange, the capital increase of 2,516,010,979 new shares, agreed upon by shareholders at the Extraordinary Shareholders’ Meeting held May 17, 2007, has been fully subscribed and paid.
In this way, Banco de Chile’s paid-in capital is divided into 80,879,895,984 nominative shares with no par value, fully subscribed and paid.
(h) In the Extraordinary Shareholders’ Meetings of the subsidiaries Banchile Administradora General de Fondos S.A. and Banedwards Administradora General de Fondos S.A., (formerly Legg Mason (Chile) Administradora General de Fondos S.A.) held on May 8, 2008, shareholders approved the merger between Banedwards Administradora General de Fondos S.A. and Banchile Administradora General de Fondos S.A., modifying the by-laws of the latter. This merger and by-law modification were approved by the Superintendency of Securities and Insurance through Exempt Resolution No. 371 and certified on June 12, 2008, and was recorded in the Commerce Registry of the Santiago Real Estate Registrar on page 26,455 No. 18,139 dated June 13, 2008 and published in the ”Diario Oficial” on June 14, 2008.
As a result of the above-mentioned merger, the subsidiary Banedwards Administradora General de Fondos S.A., (formerly Legg Mason (Chile) Administradora General de Fondos S.A.) was dissolved.
(i) On December 23, 2008, Banco de Chile and Compañía Nacional de Teléfonos, Telefónica del Sur S.A. (“Telsur”) agreed to enter into a Trade Agreement in order to optimize the placement and use of credit cards issued by the Bank. This commercial alliance to implement a system linked to credit cards issued by the Bank will provide discounts, benefits and incentives to be given to clients of both the Bank and Telsur.
The Bank’s Board of Directors approved the Trade Agreement as the conditions and benefits are favorable for Banco de Chile and reflect arm’s length conditions.
(j) On December 30, 2008, Banco de Chile and Banchile Seguros de Vida S.A. agreed to enter into a Mortgage Life Insurance Agreement that states the particular terms for mortgage life insurance contracted with Banchile Seguros de Vida S.A. by Banco de Chile for its debtor’s portfolio.
Banchile Seguros de Vida S.A. is a related company of Banco de Chile based on the provisions of article 44 of the Corporations Law and the Bank’s Board of Directors deemed the price and other terms to reflect arm’s length conditions.
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34. Differences between Chilean and United States Generally Accepted Accounting Principles
The following is a description of the significant quantitative differences between accounting principles as prescribed by the Superintendency of Banks and accounting principles generally accepted in Chile (collectively “Chilean GAAP”), and accounting principles generally accepted in the United States of America (“U.S. GAAP”).
References below to “SFAS” are to United States Statements of Financial Accounting Standards. Pursuant to Chilean GAAP, the Bank’s financial statements recognize certain effects of inflation. In addition, the Bank translates the accounting records of it subsidiary Banchile Trade Services Limited in Hong Kong to Chilean pesos from US dollars in accordance with guidelines established by the Superintendency of Banks, which are consistent with Technical Bulletin Nº64, “Accounting for Investments Abroad”, issued by the Chilean Association of Accountants. In the opinion of the Bank, this foreign currency translation methodology forms part of the comprehensive basis of preparation of price-level adjusted financial statements required by Chilean GAAP. Inclusion of inflation and the effects of translation in the accompanying consolidated financial statements under the Chilean accounting standards in the financial statements is considered appropriate under the inflationary conditions that have historically affected the Chilean economy even though the cumulative inflation rate for the last three years does not exceed 100% and, accordingly have not been eliminated in the reconciliation to U.S. GAAP included under paragraph (q) below.
(a) Merger of entities under Common Control Banco de Chile - Banco de A. Edwards
Under Chilean GAAP, the merger on January 1, 2002 between Banco de Chile and Banco de A. Edwards (the “Predecessor Banks”) was accounted for as a “pooling of interests” on a prospective basis. As such, the historical financial statements for periods prior to the merger were not restated and Banco de Chile was considered to be the continuing entity for legal and accounting purposes. Under U.S. GAAP, the merger of the two banks was accounted for as a merger of entities under common control, as LQ Inversiones Financieras, a holding company beneficially owned by Quiñenco, controlled both Banco de Chile and Banco de A. Edwards since March 27, 2001.
Under U.S. GAAP, when accounting for a merger of entities under common control, the book values of the merging entities that are held in the books of the common parent must be pushed down to the merged entity. This means that goodwill previously created in the books of Quiñenco, the transferring entity, at the time that it acquired each bank and also any fair value differences created from those purchases must be included in the U.S. GAAP accounting records of the Bank. In practice this means that the goodwill and fair value adjustments created from Quiñenco’s purchases of Banco de A. Edwards during September and October, 1999 and from Quiñenco’s purchases of Banco de Chile made during 1999, 2000 and March 2001 are pushed down to the merged entity. As this treatment does not apply in Chilean GAAP, there is a significant difference in the asset and liability bases under each body of accounting principles.
The effects of accounting for the push down of these purchase accounting adjustments, goodwill and any equity participation in the results of operations of the acquired banks into the accounting records of the Bank and their subsequent effects on net income is included in paragraph (q), below.
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34. Differences between Chilean and United States Generally Accepted Accounting Principles (continued)
(a) Merger of entities under Common Control Banco de Chile - Banco de A. Edwards (continued)
The parent company of the Bank, SM Chile S.A. (“SM-Chile”) has a subordinated debt that arose during and as a result of the economic crisis in 1982-1983. From 1984 through 1986, the predecessor entity, the former Banco de Chile, sold certain of its non-performing loans to the Chilean Central Bank at face value on terms that included a repurchase obligation. This was one of the mechanisms used by the Central Bank of Chile to deal with the economic crisis. In 1989, the repurchase obligation was exchanged for subordinated debt issued in favor of the Central Bank of Chile. In 1996, a reorganization took place by in which the former Banco de Chile was converted to a holding company named SM Chile, which in turn formed a new wholly-owned banking subsidiary named Banco de Chile to which SM Chile contributed all of its assets and liabilities other than the subordinated debt payable to the Central Bank. SM Chile then created a second wholly owned subsidiary named SAOS, which pursuant to a prior agreement with Central Bank, assumed a new repayment obligation which replaced the previous subordinated debt in its entirety.
In exchange for assuming the Central Bank indebtedness, SAOS received from SM Chile shares of the Bank as collateral for this indebtedness. As of December 31, 2008, SAOS holds 35.35% of the Bank shares as collateral for this subordinated debt obligation. As stated by the Law, in exchange for securing the subordinated debt by pledging the Bank shares held by SM-Chile, SM-Chile shareholders were granted the right of first refusal in the event that SAOS is required by Central Bank to sell all or a portion of the pledged shares to cover any unpaid balance. Additionally, the Law stated that voting rights of the pledged shares are to be held by SM-Chile shareholders. Dividends received from the Bank are the sole source of SAOS’s revenues and must be used to repay this indebtedness.
As of December 31, 2008 the outstanding subordinated debt balance held by SAOS amounted to MCh$920,227. During the years 2006, 2007 and 2008, SAOS paid to the Central Bank a total of MCh$90,539, MCh$91,308 and MCh$98,137, exceeding in all these three years the required minimum annual payment.
Pursuant to the law, SAOS and SM-Chile will be automatically dissolved upon extinction of the debt, either by full payment or execution of the collateral. Under the terms of SM-Chile’s bylaw and the Law, all the outstanding shares of the Bank held by SM-Chile and SAOS, as well as any other remaining asset, will be then distributed to SM-Chile shareholders.
As of December 31, 2008, major shareholders of SM-Chile are LQ Inversiones Financieras S.A. and Inversiones LQ-SM S.A., both subsidiaries of Quiñenco S.A., having a participation of 47.13% and 11.11% of total shares, respectively. Likewise, major shareholders of Banco de Chile are SAOS S.A., LQ Inversiones Financieras S.A. and SM-Chile having a participation of 35.35%, 32.11% and 15.01% of total shares, respectively.
SAOS is variable interest entity (VIE) as defined in FASB Interpretation No. 46(R) “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” (FIN 46R). In accordance with FIN 46R, the primary beneficiary is the party that consolidates a VIE based on its assessment that it will absorb a majority of the expected losses or expected residual returns of the entity, or both. The Bank has determined that it is not the primary beneficiary of SAOS and, therefore, it has not consolidated SAOS in the Consolidated Financial Statements of Banco de Chile.
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(b) Acquisition of Banco de A. Edwards
Under U.S. GAAP, to the extent that the Predecessor Banks were under common control, the assets and liabilities of Banco de A. Edwards were transferred into Banco de Chile using the U.S. GAAP carrying values of such assets and liabilities included in the records of the common parent. However, as Quiñenco only owned 51.18% of Banco de A. Edwards at the time of the merger, to the extent that the minority interest of Banco de A. Edwards was acquired through the issuance of Banco de Chile shares, Banco de Chile was considered the acquirer.
Therefore, Banco de Chile calculated goodwill based on the difference between the purchase price (i.e. the market value of the shares issued by Banco de Chile) and the fair value of the proportion of assets and liabilities acquired at the date of the merger. As part of this process, under U.S. GAAP, Banco de Chile was also required to value the interest acquired of previously unrecorded intangible assets, such as the Banco de Edwards brand name and core deposit intangibles, and to include these assets in the financial records of the Bank. Such assets were not required to be recorded under existing Chilean GAAP at that time.
As a consequence of the merger between Banco de Chile and Banco de A. Edwards, Banco de Chile issued 23,147,126,425 shares in exchange for all the outstanding common shares of Banco de A. Edwards using an exchange ratio of 3.135826295 Banco de Chile shares for each Banco de A. Edwards share. Under U.S. GAAP Banco de Chile was considered to have acquired 48.82% of the outstanding shares in Banco de A. Edwards, which corresponded to those shares that Quiñenco did not own as of that date. The acquisition of these shares has been accounted for using purchase accounting as described in the preceding paragraph. The consideration paid has been determined using an average of the market value of the publicly traded Banco de Chile shares, which at January 1, 2002 was Ch$25,110.17 (historical Chilean pesos) per share, plus merger expenses.
Under U.S. GAAP, purchase allocation of the 48.82% participation acquired from shareholders other than Quiñenco and its subsidiaries as of January 1, 2002 was as follows:
Net book value of Banco de A. Edwards
Incremental fair value of identified intangible assets (1)(2)
Fair value increment of identified net assets acquired
Fair value of Banco de A. Edwards
Purchase price
Market value of Banco de Chile shares issued
Direct costs of acquisition
Core deposits acquisition
Brand name intangibles
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(b) Acquisition of Banco de A. Edwards (continued)
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.
Intangibles
Total assets acquired
Total liabilities assumed
Net assets acquired
Of the MCh$39,892 of acquired intangible assets, MCh$35,525 was assigned to core deposits subject to amortization (using an estimated rate that the bank’s customers are expected to leave the bank in future years, based on a historical analyses performed by the Bank), and MCh$4,367 has been assigned to a registered trademark that is being amortized over a 10 year useful life.
The Bank does not amortize goodwill related to the acquisition of Banco de A. Edwards, following the provisions of SFAS No. 142, as described in paragraph (d) below.
(c) Merger of entities under Common Control Banco de Chile - Citibank Chile
In 2007, Quiñenco (parent company of Banco de Chile) and Citigroup Inc (including Citibank Overseas Investment Corporation (COIC)) signed a Master agreement, whereby a strategic association was established.
The final purpose of this association is to mutually leverage their local financial services business as result of being highly complementary businesses and for Banco de Chile get the benefits of becoming an associate of a globally known banking network such as Citibank.
On January 1, 2008, Banco de Chile successfully merged its operations with those of Citibank Chile, increasing its market participation by 1.7%, incorporating more than 50 thousand new clients, mainly multinational companies and consumer banking. The distribution network was also strengthened adding in January 2008, more than 100 branches and points of sale to the already existing ones.
A significant benefit to the operations of Banco de Chile was the strengthening of its Treasury, investment and private banking operations as result of the inclusion of Citibank well known financial know-how on these areas. Complementary to this, more robust and sophisticated processes and systems were implemented to control the enhanced management of financial and market risk.
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(c) Merger of entities under Common Control Banco de Chile - Citibank Chile (continued)
Under Chilean GAAP, the merger between Banco de Chile and Citibank Chile was accounted for as a “pooling of interest” in accordance to Technical Bulletin N° 72. (BT 72). As such, the historical financial statements for periods prior to the merger are not restated and Banco de Chile is considered to be the continuing entity for legal and accounting purposes. On January 1, 2008, Citigroup Inc. transferred its 100% interest in the net assets of Citigroup Chile II (Parent company of Citibank Chile) to LQ Inversiones Financieras (LQIF), a subsidiary of Quiñenco through which it controls Banco de Chile. In exchange, LQIF issued 220,558,398 series B shares to Citigroup Chile representing 32.9556% of its equity shares as consideration price. Additionally, pursuant to the terms of calls and put options Citigroup has the right to acquire up to an additional approximately 16% of LQIF at a pre-agreed upon price, and under certain conditions, Quinenco can force Citigroup to acquire approximately 8% of LQIF. The fair value of these financial instruments are part of the consideration exchanged and are included in the purchase accounting. Accordingly, as of this date LQIF took control of Citigroup Chile II net assets. Subsequently and as of the same date, LQIF transferred its 100% acquired interest in Citigroup Chile II (Citibank Chile and Subs) to Banco de Chile in exchange of Banco de Chile series S shares. In exchange a total of 8,443,861,140 no-par Banco de Chile S-Series shares were issued to LQIF.
As described above, under Chilean GAAP, the merger of Banco de Chile and Citibank Chile was accounted for as a pooling of interest beginning January 1, 2008 with no retroactive restatement of historical financial statements.
Under U.S. GAAP, when accounting for a merger of entities under common control, the entity that receives the net assets initially recognizes the assets and liabilities transferred at their carrying amounts in the accounts of the transferring entity. This means, the goodwill and purchase accounting adjustments previously created in the LQIF books, at the time that it acquired Citibank Chile, must be included in the U.S. GAAP accounting records of the merged Banks.
The effects of accounting for these purchase accounting adjustments into the accounting records of the Bank and their subsequent effects on net income is included in paragraph (q), below.
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Under U.S. GAAP, the purchase price allocation of above mentioned transaction as of January 1, 2008 was as follows:
Purchase consideration
Consideration paid
Less cash received
Less put option received
Net purchase consideration
Book value of Citibank Chile net assets
Incremental fair value of identified intangible assets
Deferred taxes on net assets acquired
Total net assets acquired
Core deposits intangible (1)
Brands (2)
Customer list(2)
Total incremental fair value of identified intangible assets acquired
Goodwill generated in this transaction by reportable business segment, which is also included under paragraph (d) below, is the following:
Treasury
Total goodwill
The Bank does not amortize goodwill related to the acquisition of Citibank Chile following the provisions of SFAS No. 142, as described in paragraph (d) below.
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Derivatives instruments
Net assets acquired, net of deferred taxes
(d) Amortization of Goodwill
The Bank adopted Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets”, (“SFAS 142”) as of January 1, 2002. SFAS 142 applies to all goodwill and identified intangible assets acquired in a business combination. Under this standard, beginning January 1, 2002, all goodwill, including that acquired before initial application of the standard, and indefinite-lived intangible assets are not amortized, but must be tested for impairment at least annually.
The Bank has performed the annual impairment test of goodwill required by the standard, which did not result in any impairment. As of December 31, 2008, under Chilean GAAP, the Bank presents only goodwill arose from the Legg Mason (Chile) acquisition. Under U.S. GAAP, the carrying value of goodwill, net of accumulated amortization, comprises goodwill arising from to push-down accounting as result of the above described merger of entities under common control , the acquisition of Banco de A. Edwards and Legg Mason (Chile), described in paragraphs (a), (b) and (c) and its total balance were MCh$409,981, MCh$13,717,MCh$239,298 and MCh$4,987, respectively.
The table below presents the allocation of the total carrying value of goodwill by segments of the Bank at the end of each year:
International
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(d) Amortization of Goodwill (continued)
As further described in paragraphs (p), Banco de Chile US Branches were sold on January 3, 2008. As a result of this transaction, the international segment has been discontinued and accordingly, goodwill allocated to this segment as of January 1, 2008 for an amount of MCh$50,803 has been derecognized. See the subsequent effects on net income included in paragraph (q), below.
(e) Deferred Income taxes
Under Statement of Financial Accounting Standard No. 109 (“SFAS 109”), “Accounting for Income Taxes”, income taxes are recognized using the liability method in a manner similar to Chilean GAAP.
Additional disclosures required under SFAS No. 109 are further described in paragraph (u) below.
(f) Investments in other companies
As shown in Note 11, certain long-term investments of less than 20% of the outstanding shares in other companies have been recorded using the equity method of accounting. Under U.S. GAAP these investments would generally be accounted for at cost less any non-temporary impairment in value. The effect of recording these assets in accordance with U.S. GAAP is included in the reconciliation of consolidated net income and equity in paragraph (q) below.
(g) Interest income recognition on non-accrual loans
The Bank suspends the accrual of interest on loans when it is determined to be a loss or when it becomes past due. Previously accrued but uncollected interest is not reversed at the time the loan ceases to accrue interest.
Under U.S. GAAP, recognition of interest on loans is generally discontinued when, in the opinion of management, there is an assessment that the borrower will likely be unable to meet all contractual payments as they become due. As a general practice, this occurs when loans are 90 days or more overdue. Any accrued but uncollected interest is reversed against interest income at that time.
In addition, under Chilean GAAP, any payment received on past due loans is treated as income to the extent that accrued interest is due, but has not been recorded because the status of the loan, after reducing any recorded accrued interest receivable. Any remaining amount is then applied to reduce the outstanding principal balance. Under U.S. GAAP, any payment received on loans when the collectibility of the principal is in doubt is treated as a reduction of the outstanding principal balance of the loan until such doubt is removed. The effect of the difference in interest recognition on non-accrual loans is not material to the Bank’s financial position and results of its operations.
(h) Contingent loans
Under Chilean GAAP, the Bank includes in off balance accounts financial guarantees. For guarantees, in accordance to FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The required FIN 45 disclosures have been incorporated into paragraph (z), below.
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(i) Allowance for loan losses
The determination of the allowance for loan losses and disclosure requirements under U.S. GAAP differs from that under Chilean GAAP in the following respects:
1) Allowance for loan losses
Under Chilean GAAP, the allowance for loan losses is calculated according to specific guidelines set out by the rules of the Superintendency of Banks, as described in Note 1 (i).
Under U.S. GAAP allowances for loan losses should be in amounts adequate to cover inherent probable losses in the loan portfolio at the respective balance sheet dates. The Bank has estimated its required reserve under U.S. GAAP in the following manner:
i) Commercial loans and leasing operations considered not impaired under Statement of Financial Accounting Standard No. 114, “Accounting by Creditors for Impairment of a Loan” (“SFAS No. 114”), were analyzed and adjusted, if necessary, to reflect the estimated losses not identified based on individual credit analysis. The estimations were performed using historical loan data, in order to estimate the inherent losses in the Bank’s loan portfolio, using patterns and trends based upon historical changes in loan classifications (“migration analysis”).
ii) Commercial loans and leasing operations considered impaired in accordance with the criteria established by SFAS No. 114, were valued at the present value of the expected future cash flows discounted at the loan’s effective contractual interest rate, or at market rates in the case of those loans that were considered to be collateral dependent.
iii) Allowance for loan losses for mortgage and consumer loans were determined using risk matrix models including historical loan charge-offs net of recoveries and other variables to adjust changes in trends and conditions.
Based on the preceding estimation process the Bank computed its allowance for loan losses under U.S. GAAP, and compared this estimate with the reported allowance determined in accordance with the guidelines established by the Superintendency of Banks.
U.S. GAAP loan loss reserve
Less: Chilean GAAP loan loss allowance as required by the Superintendency of Banks
U.S. GAAP adjustment
The effects of adopting SFAS No. 114 are included in the reconciliation included in paragraph (q) below.
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(i) Allowance for loan losses (continued)
2) Interest income and impaired loans – Additional disclosures
As of December 31, 2006, 2007 and 2008 the recorded investment in loans for which impairment had been recognized in accordance with SFAS No.114 totaled MCh$423,226, MCh$421,868 and MCh679,323 respectively, with a corresponding valuation allowance of MCh$80,324, MCh$78,234 and MCh$145,817, respectively. For the years ended December 31, 2006, 2007 and 2008 the average recorded investment in impaired loans was MCh$427,474, MCh$401,748 and MCh$563,188, respectively. For the years ended December 31, 2006, 2007 and 2008, the Bank recognized interest on impaired loans MCh$31,825, MCh$43,733 and MCh$42,533. The Bank recognizes interest on impaired loans on an accrual basis, except for past due loans for which the Bank recognizes interest on a cash basis, as described in paragraph (g) above. As of December 31, 2007 and 2008, the Bank had made provisions against all loans which it considered to be impaired.
The following presents an analysis under U.S. GAAP of the changes in the allowance for loan losses during the periods presented.
Allowance for loan losses in accordance with U.S. GAAP, as of January 1,
Allowances for loan losses established
Allowances for loan losses released
Balances as of December 31,
3) Charge-offs
As discussed in Note 1 (i) of these financial statements, under Chilean GAAP the Bank charges-off loans when collection efforts have been exhausted. Under the rules and regulations established by the Superintendency of Banks, charge-offs must be made within the following maximum prescribed limits:
- 24 months after a loan is past due (3 months after past due for consumer loans) for loans without collateral;
- 36 months after a loan is past due for loans with collateral.
Under U.S. GAAP, loans should be written-off in the period that they are deemed uncollectible. The Bank believes that the charge-off policies it applies in accordance with Chilean GAAP are generally the same as those required under U.S. GAAP.
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4) Loan Purchases
On a non-recurring basis, the Bank acquires non-impaired loans directly from the market of from other financial institutions, mainly to meet its customer requirements. Under Chilean GAAP, loans purchased are recorded at fair value (price paid) when acquired, classified and recorded in the loan portfolio line item to which it relates and any discount or premium is recognized as an adjustment to interest income using the effective interest rate method. Other than certain loans acquired from Citibank, as result of the merger transaction described above, the Bank does not purchase loans that are deemed impaired at the acquisition date.
Under US GAAP, the Bank applies the requirements of the Statement of Financial Accounting Standards No. 91 (“SFAS 91”), “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases to non-impaired loans”. When discounts or premiums are attributable to the credit quality of the purchased loan, the accounting treatment for this differences is prescribed by the Statement of Position (SOP) No. 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (SOP 03-3).
SFAS 91 states that any purchase premiums or discounts on loans shall be recognized as an adjustment of yield generally by the effective interest method based on the contractual terms of the loan. SOP 03-3 requires acquired loans to be recorded at fair value and prohibits carrying over valuation allowances in the initial accounting for acquired impaired loans. Furthermore SOP 03-3 limits the yield that may be accreted (accretable yield) to the excess of the undiscounted expected cash flows over the investor’s initial investment in the loan. The excess of the contractual cash flows over expected cash flows (nonaccretable yield) may not be recognized as an adjustment of yield, loss accrual or valuation allowance. Subsequent increases in cash flows expected to be collected are recognized prospectively through an adjustment of the loan’s yield over its remaining life. Decreases in expected cash flows are recognized as impairments. Considering that the Bank is not engaged, on a regular basis, in the purchase of impaired loans and the accounting treatment between Chilean and US GAAP for discounts or premiums as result of the acquisition of non-impaired loans does not differ, no significant differences arise.
During the years ended December 31, 2006, 2007, and 2008, Banco de Chile purchased non-impaired loans amounting to MCh$189,470, MCh$135,637 and MCh$114,442.
As mentioned above, the Bank acquired certain impaired loans from Citibank as result of the merger transaction. Under Chilean GAAP, these loans where recorded at their previous carrying amounts, including their related loan loss allowance. For US GAAP purposes, the Bank recorded these loans at fair value at the acquisition date, not carrying over any loan loss allowance as required by SOP 03-3.
(j) Reversal of additional Allowance for Loans Losses
Under Chilean GAAP, the Bank historically has followed the practice of maintain additional loan loss allowance as partof the determination of allowance for loan losses. From January 1, 2008 due to changes in format for the presentation of financial statements, this concept is recorded under Operating Expenses . For U. S. GAAP purposes, historically this item has not been considered in the determination of the reserve requirements under U.S. GAAP and, accordingly it have been eliminated in the reconciliation to U.S. GAAP included under paragraph (q) below.
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(k) Financial investments
Under Chilean GAAP, until December 31, 2005, financial investments were classified as permanent and non-permanent. Beginning 2006 the Bank adopted Circular No.3,345 (the “ Circular”), issued by the Superintendency of Banks. The Circular, which was based on International Accounting Standard N° 39 – “Financial Instruments-Recognition and Measurement”, established new accounting and classification criteria for investments securities and derivative instruments, among other. The new accounting criteria and classification rules are broadly similar to US GAAP, therefore, beginning 2006 no differences arise for financial investments. See Note 1(f) and 1(g) for further details on Chilean GAAP accounting rules on financial investments.
The following are required disclosures for investments classified as available-for-sale in accordance with SFAS Nº115 and the presentation requirements of Article 9 (see paragraph (s) below). The disclosures have been prepared using amounts determined in accordance with U.S. GAAP.
Realized gains and losses are determined using the proceeds from sales less the cost of the investment identified to be sold. For the years ended December 31, 2006 and 2007 no gains and losses realized on the sale of available-for-sale securities were recorded. For year ended December 2008 MCh$173 was recognized as gain.
The carrying value and market value of investments available-for-sale as of December 31, 2007 and 2008 are as follows:
Available-for-sale Instruments:
As of December 31, 2008, total carrying amount and fair value of the available-for-sale portfolio with unrealized losses amounted to MCh$503,705 and MCh$490,659, respectively. None of these securities have been in an unrealized loss position for more than 12 months.
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(k) Financial investments (continued)
The Bank evaluates all investments for declines in value that are considered other than temporary impairment (“permanent impairment”). The Bank charges-off to earnings any amounts which are deemed to be a permanent impairment of the value of that security.
Interest rate and foreign exchange valuation for securities issued in currencies different to the functional currency.
According to SFAS 115 the fair market value adjustment for Available for Sale portfolio is recognized in OCI (Other Comprehensive Income). These adjustments considered the interest rate and foreign exchange valuation when securities are issued in other currencies different to the functional currency. Under Chilean GAAP, the foreign exchange is directly recognized as income and only the interest rate effect is recognized in OCI. The effects of this adjustment is included in the reconciliation present in paragraph (q) below.
(l) Derivatives
The Bank enters into derivative transactions for its own account and to meet customers’ risk management needs. Banco de Chile and its subsidiaries protect themselves against variations in the foreign exchange and interest rate market by using forward contracts, currency swaps and interest rates swaps. These activities include hedging and treasury operations and help Banco de Chile and its subsidiaries provide financial products their clients.
Under Chilean GAAP all financial derivative contracts, which include foreign currency and U.F. forwards, interest rate forwards, currency and interest rate swaps, currency and interest rate options and other financial derivative instruments, are recorded in the balance sheet at cost (including transaction costs) at inception and subsequently measured at their fair value. The fair value is obtained from market quotes, discounted cash flows models and options valuation models, as and where applicable. Derivative contracts are reported as an asset when their fair value is positive and as a liability when negative under the line item “Derivative instruments”. The gains recognized in income associated with these contracts for the years ended December 31, 2006 and 2008 were MCh$29,476 and MCh$351,568 respectively, and the loss recognized in income associated with these contracts for the year ended December 31, 2007 was MCh$27,466.
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(l) Derivatives (continued)
Under Chilean GAAP, Circular 3,345, certain derivatives embedded in other financial instruments are treated as separate derivatives when their risk and characteristics are not closely related to those of the main contract and this is not recorded at its fair value with its unrealized gains and losses included in income. The above mentioned circular did not included service type contracts when evaluating for embedded derivatives.
See further details about the Chilean accounting treatment of derivate instruments in note 1(e).
Under U.S. GAAP, the Bank applies SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS No.138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities” and SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (collectively “SFAS 133”), which established comprehensive accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. The Standard required that all derivative instruments be recorded in the balance sheet at fair value. However, the accounting for changes in fair value of the derivative instrument depends on whether the derivative instrument qualifies as a hedge. The standards also require formal documentation procedures for hedging relationships and effectiveness testing when hedge accounting is to be applied. If the derivative instrument does not qualify as a hedge, changes in fair value are reported in earnings when they occur. If the derivative instrument qualifies as a hedge, the accounting treatment varies based on the type of risk being hedged.
As a result of the new accounting rules adopted in 2006, as set by the circular, no significant differences arise when applying SFAS 133 to derivatives accounting, other than the recognition of certain derivatives embedded in service type contracts.
Fair Value Hedge
During 2006, Banco de Chile has entered into an interest rate swap agreement for hedging its interest rate risk exposure related to the subordinated debt issued during 2006. The interest rate swap agreement modifies the Bank’s exposure to interest risk by converting its subordinated note’s fixed-rate debt to a floating interest. This agreement involves the payment of a fixed rate amount in exchange for floating rate interest payments over the life of the agreement without exchanging any underlying principal.
For the year ended December 31, 2007 and 2008 Banco de Chile recognized in the line item “Gains (losses) from trading and brokerage activities” a net loss of MCh$810 and MCh$667 related to the ineffective portion of its hedging instruments.
The effects of the differences in accounting for embedded derivatives between Chilean and U.S. GAAP on the consolidated net income and equity of the Bank are included in paragraph (q) below.
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(m) Mandatory dividend
As required by the Chilean General Banking Law, unless otherwise decided by a two-thirds vote of its issued and subscribed shares, the Bank must distribute a cash dividend in an amount equal to at least 30% of its net income for each year as determined in accordance with Chilean GAAP, unless and except to the extent the Bank has unabsorbed prior year losses.
Until 2007, dividend obligations were recorded when declared by the Shareholders’ Meeting and a reconciling item was recorded to recognize the minimum dividend liability.
The effects of this adjustment on the equity of the Bank until 2007 are included in paragraph (q) below.
Beginning 2008, as result of the new accounting rules prescribed by the Superintendency of Banks, the Bank is required to record a provision for minimum dividend. Accordingly, as of December 31, 2008 no difference exist between Chilean and U.S. GAAP.
(n) Assets received in lieu of payment
Under Chilean GAAP, assets received in lieu of payment are carried at cost and have been restated for price-level changes, less a portfolio valuation allowance if the total of the market value of those assets is lower than the carrying amount. Market value is determined based on appraiser valuations, as required by the Superintendency of Banks. If the asset is not sold within one year, then recorded asset amounts must be written-off on at least a straight-line basis over the following 12-month period.
Under U.S. GAAP, assets received in lieu of payment are initially recorded at fair value less any estimated costs to sell at the date of foreclosure, on an individual asset basis. The effect of recording these assets in accordance with U.S. GAAP is included in the reconciliation of consolidated net income and equity in paragraph (q) below.
(o) Staff severance indemnities
The provision for staff severance indemnities relates to a benefit payable to a defined number of employees, upon their retirement from the Bank, conditional upon having completed 30 years of continuous service. The Bank makes indemnity payments upon termination of the applicable employees, and has not set aside assets to fund its benefit obligation. Under Chilean GAAP, the related liability is calculated by discounting the benefit accrued using real interest rates, as described in Note 1(q), considering current salary levels of all employees eligible under the plan and the estimated average remaining service period. Under U.S. GAAP the corresponding liability is recorded using the shutdown method, consistent with the accounting criteria applied by its parent company, Quiñenco.
The effects of accounting for termination indemnity benefits under U.S. GAAP have been presented in paragraph (q), below.
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(p) Discontinued operations of US Branches
On December 31, 2007 the Bank and Citibank N.A. signed an “Agreement to Purchase the Assets and Assume the Liabilities” of the New York and Miami Branches, effective January 1, 2008, by which Citibank N.A. acquired the Bank’s branches assets and assumed liabilities, with certain minor exclusions, after receiving authorization from the federal agency Office of the Comptroller of the Currency (OCC) and the Federal Reserve Bank of Atlanta, for a total consideration price of US$130 million. The branches are included in the total purchase consideration and cash received in the transaction, refer to Note 34 ( c )
Under Chile GAAP, the disposal plan of the assets and liabilities of the New York and Miami Branches was not considered as a group of assets and liabilities held for sale and as discontinued operations for presentation purposes due to the immaterial contribution to the consolidated financial statements of the Bank as of December 31, 2007.
Under U.S. GAAP this group of assets and liabilities held for sale are accounted in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”. Accordingly, as of this date, the Miami and New York Branches of the Bank were considered as held for sale and were valued at the lower of its carrying amount and fair value less cost of sale for US GAAP purposes.
These subsidiaries were reported as part of the International Banking operating. The sale of these branches was effective on January 1, 2008.
Other than the derecognition of the related goodwill, as recorded for US GAAP purposes, there is no other significant difference between Chilean and US GAAP as result of this disposal. The effects of writing-off the above mentioned goodwill for U.S. GAAP purposes have been presented in paragraph (q), below.
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(q) Summary of Income Statement and Equity differences
The following is a reconciliation of consolidated net income under Chilean GAAP to the corresponding U.S. GAAP amounts:
Net income in accordance with Chilean GAAP
U.S. GAAP adjustments:
Push Down accounting Banco Edwards (Note 34 (a))
Fair value of intangibles
Fair value of loans
Fair value of premises
Fair value of other
Acquisition of Banco Edwards (Note 34 (b))
Fair value of other interest bearing liabilities
Fair value of premises and others
Acquisition of Citibank Chile (Note 34 (c))
Fair value of Loans
Derecognition of goodwill as result of US branches sale
Investments in other companies (Note 34 (f))
Allowance for loan losses (Note 34 (i))
Reversal of additional allowance for loan losses (Note 34 (j))
Derivatives (Note 34 (l))
Investment securities (Note 34 (k))
Assets received in lieu of payment (Note 34 (n))
Staff severance indemnities (Note 34 (o))
Deferred tax effect of the above U.S. GAAP adjustments (Note 34 (e))
Net income in accordance with U.S. GAAP
Other comprehensive income, net of tax (Note 34 (v))
Unrealized holding gains (losses) on available-for-sale securities, net of tax
Adjustment for translation differences
Comprehensive income in accordance with U.S. GAAP
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(q) Summary of Income Statement and Equity differences (continued)
The following is a reconciliation of consolidated equity differences under Chilean GAAP to the corresponding amounts under U.S. GAAP:
Equity in accordance with Chilean GAAP(1)
Goodwill accumulated amortization (Note 34 (d))
Amortization of fair value of intangibles
Amortization of fair value of premise
Amortization of fair value of premises
Amortization of fair value of loans
Minimum Dividend (Note 34 (m))
Equity in accordance with U.S. GAAP
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(q) Summary of Income Statement and’ Equity differences (continued)
The following summarizes the changes in equity under U.S. GAAP during the years ended December 31, 2007 and 2008:
Capital increase as a result of the merger
Mandatory dividends, previous date
Mandatory dividends, closing date
Unrealized gains on Available-for-sale investments, net of taxes
(r) Net income per share
The following disclosure of net income per share information is not generally required for presentation in the financial statements under Chilean GAAP but is required under U.S. GAAP. Earnings per share is determined by dividing combined net income by the weighted average number of total shares outstanding.
Earnings per share
Weighted average number of total shares outstanding (in millions)
Earnings per share on continued operations
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(s) Article 9 Presentation of Income Statements and Balance Sheets
The presentation of the consolidated financial statements differs from the format required by the Securities and Exchange Commission under Rules 210.9 to 210.9-07 of Regulation S-X (“Article 9”). The following financial statements are presented in constant Chilean pesos of December 31, 2008 and are presented in a format that complies with the requirements of Article 9 of Regulation S-X. The Income Statements presented for the years ended December 31, 2006, 2007 and 2008 disclose the Bank’s U.S. GAAP income statements in a format that complies with the requirements of Article 9 of regulation S-X.
The principal reclassifications and adjustments which were made to the basic Chilean GAAP consolidated financial statements in order to present them in the Article 9 format are as follows:
Presentation of Non-interest bearing net of cash clearing account(1)
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(s) Article 9 Presentation of Income Statements and Balance Sheets (continued)
The following income statements presented for the years ended December 31, 2006, 2007 and 2008 have been prepared in accordance with U.S. GAAP to disclose the Bank’s consolidated income statement related continued operations in accordance with the requirements of Article 9:
INTEREST INCOME:
Interest and fees on loans
Interest on investments
Interest on deposits with banks
Interest under agreements to resell
Total interest income
INTEREST EXPENSE:
Interest on deposits
Interest on investments sold under agreements to purchase
Interest on short-term debt
Interest on long-term debt
Price-level restatement1
Total interest expense
Net interest income
PROVISION FOR LOAN LOSSES
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
OTHER INCOME:
Other income
Total other income
OTHER EXPENSES:
Administration expenses
Total other expenses
INCOME BEFORE INCOME TAXES
INCOME TAXES
NET INCOME ON CONTINUED OPERATIONS
NET LOSS ON DISCONTINUED OPERATIONS, NET OF TAXES
The price-level restatement includes the effect of inflation primarily resulting from the loss in purchasing power on interest earning assets and interest bearing liabilities due to inflation. As the Bank does not maintain the price-level adjustment for separate categories of assets and liabilities, such adjustment is presented as a component of interest expense.
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The following balance sheets presented as of December 31, 2007 and 2008 have been prepared in accordance with U.S. GAAP to disclose the Bank’s consolidated balance sheets in accordance with the requirements of Article 9:
Balance Sheets
Interest bearing deposits in other banks
Unearned income
Fixed assets, net
Group of assets held for sale
LIABILITIES AND EQUITY
Deposits:
Non-interest bearing
Interest bearing
Short-term borrowings
Group of liabilities held for sale
Long-term debt
Common stock
Other Equity
TOTAL LIABILITIES AND EQUITY
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The following is a reconciliation of total assets presented in accordance with guidelines established by the Superintendency of Banks and the presentation prescribed by Article 9:
Total assets of the Bank under Chilean GAAP
Elimination of assets offset by liabilities:
Cash clearing account
Reclassification of deferred taxes
U.S. GAAP adjustments, net
Total assets as per Article 9 presentation
(t) Consolidated Statements of Cash Flows
As a result of the merger transaction, the Bank acquired assets and assumed liabilities, which are shown as non-cash investing transaction as follows:
Cash acquired
Financial investments and loans
Goodwill and intangibles
Capital increase (Note 34 (q))
For Chile GAAP purposes, cash and cash equivalent includes highly liquid instruments with insignificant risk of changing value, maturing in no more than three months from the date of acquisition and transactions in the course of settlement. For purposes US GAAP, these highly liquid instruments and transactions in the course of settlement are not considered as cash equivalent. Accordingly, cash and cash equivalent for US GAAP purposes is as follows:
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(t) Consolidated Statements of Cash Flows (continued)
Cash flow from operating activities under Chilean GAAP
Differences between Chilean GAAP and US GAAP:
Cash flow from operating activities under US GAAP
Cash flow investing activities Chilean GAAP
Net cash acquired from Citibank
Cash flow from investing activities under US GAAP
Financing cash flow activities Chilean GAAP and US GAAP
Cash flows from discontinued operations
Operating activities
Investing activities
Financing activities
Less total cash flows from discontinued operations
Net cash flow
Effect of price-level restatement and exchange rate difference
Total change of cash and cash equivalent
Cash equivalent at the beginning of the period
Cash equivalent at the beginning of the period – Discontinued operations
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(u) Income taxes
The reconciliation of the provision for income taxes charged to income under Chilean GAAP to the corresponding amounts under U.S. GAAP is as follows:
Tax expense for the year under Chilean GAAP
U.S. GAAP Adjustments:
Deferred tax effect of U.S. GAAP adjustments
Tax expense for the year under U.S. GAAP
Deferred tax assets (liabilities) are summarized as follows:
Deferred Tax Assets:
Deferred income taxes related to purchase accounting of Banco de
A. Edwards
Accrued interests and readjustments from risky loan portfolio
Total Deferred Tax Assets
Deferred Tax Liabilities:
Deferred income taxes related to push down accounting adjustments
Investments sold under repurchase agreements
Subtotal Deferred Tax Liabilities
NET DEFERRED TAX ASSETS
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(u) Income taxes (continued)
The provision (benefit) for income taxes under U.S. GAAP differs from the amount of income tax determined by applying the applicable Chilean statutory income tax rate to pretax income as a result of the following differences:
Chilean taxes due at the applicable statutory rate (1)
Increase (decrease) in rates resulting from:
Non-deductible expenses
Non-taxable income
Effect on tax and financial equity restatement (2)
At effective tax rate
Effective January 1, 2007, the Bank and its subsidiaries adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”. The Interpretation prescribes a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken within an income tax return. For each tax position, the enterprise must determine whether it is more likely than not that the position will be sustained upon examination based on the technical merits of the position, including resolution of any related appeals or litigation. A tax position that meets the more likely than not recognition threshold is then measured to determine the amount of benefit to recognize within the financial statements. No benefits may be recognized for tax positions that do not meet the more likely than not threshold. The benefit to be recognized is the largest amount that is more likely than not to be realized upon ultimate settlement.
The Bank did not record any effect as result of the adoption of the provisions of FIN 48 on the current period nor to retained earnings due to its tax positions did not meet the recognition threshold.
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(v) Comprehensive Income
The Bank presents comprehensive income and its components with the objective to report a measure of all changes in equity that result from transactions and other economic events of the period other than transactions with owners (“comprehensive income”). Comprehensive income is the total net income and other non-owner equity transactions that result in changes in net equity.
The following represents accumulated other comprehensive income balance, net of tax, for the years ended December 31, 2006, 2007 and 2008:
Beginning balance
Unrealized gains on investments available for sale:
Capital increase as a result of the merge.
Unrealized gains arising during the period
Less: reclassification adjustment for gains included in income
Net unrealized gains
Ending balance
Unrealized losses on investments available for sale:
Unrealized losses arising during the period
Less: reclassification adjustment for losses included in net income
Net unrealized losses
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(w) Segment information
The Bank presents information in accordance with Statement of Financial Accounting Standard No.131 “Disclosure about Segments of an Enterprise and Related Information,” which establishes standards for reporting information about operating segments and related disclosures about products and services and geographic areas. Operating segments are defined as components of an enterprise about which separate financial information is available that is regularly used by the Chief operating decision maker in deciding how to allocate resources and in assessing performance.
The Bank has strategically aligned its operations into four major segments of business (five for period prior to 2008) based on its market segmentation and the needs of its clients and trading partners. The Bank manages and measures the performance of its operations through these business segments using an internal profitability reporting system. The internally reported segments are as follows:
Wholesale Market,
The Wholesale market business segment serves the needs of corporate customers with annual sales in excess of Ch$1,400 million that are engaged in a wide spectrum of industry sectors. Services provided include depositing and lending in both Chilean pesos and foreign currency, trade and project financing, working capital financing, leasing, factoring, foreign trade financing, lines of credit, commercial mortgage loans and various non-credit services, such as financial consultancy, collections, supplier payments, payroll management and a wide array of treasury and risk management products, as well as electronic banking services. The Wholesale market business segment also includes international services, such as import and export financing, letters of credit, guarantees and other forms of credit support.
Retail Market,
The Retail market business segment serves the financial needs of individuals and middle-market companies (with annual sales of up to Ch$1,400 million) through the Bank’s branches network. The principal financial services offered include credit cards, debit cards, residential mortgage loans, consumer loans, commercial loans, leasing loans, as well as deposit services such as checking and savings accounts and time deposits.
Treasury,
The Treasury segment is responsible for the management of the Bank’s assets and liabilities and also offers financial services to other segments and external customers such as currency exchange and currency swaps, instruments developed for currency and interest rate risk hedging, transactions under repurchase agreements and investment products based on bonds, mortgage notes and deposits. The Treasury segment is also responsible for monitoring compliance with regulatory deposit limits, technical reserves and maturity and rate matches.
International Banking,
For periods prior to 2008, the International Banking segment included services offered through the Bank’s New York and Miami branches and its representative offices. As a consequence of the merger by absorption of Citibank Chile into Banco the Chile effective January 1st, 2008, US branches were sold to Citigroup.
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(w) Segment information (continued)
Subsidiaries,
The Subsidiaries segment includes non-banking financial services that are offered through separate legal entities. These include securities brokerage, mutual fund and investment fund management, financial advisory services, factoring, insurance brokerage, securitization, trade, collection and sales services.
The financial information used to measure the performance of the Bank’s business segments is not necessarily comparable with similar information from other financial institutions because it is based on internal reporting policies. The accounting policies are the same as those applied under Chilean GAAP as described in Note 1, except as noted below:
The net interest margin of loans and deposits is measured on an individual transaction and individual client basis, stemming from the difference between the effective customer rate and the related Bank’s fund transfer price in terms of maturity, re-pricing and currency.
The results associated with the gap management (interest rate mismatches) have been fully allocated in the treasury segment.
The performance of the business segments, measured by an internal profitability system considers results that are directly related to performance and not to overhead expenses of corporate and support departments, additional allowances, merger costs, taxes and other operating income and expenses.
The internal performance profitability system considers capital allocation in each segment in accordance to Basel guidelines.
Provisions for loan losses in each segment are measured on a client basis.
In addition to direct costs (consisting mainly of labor and administrative expenses), the Bank allocates the majority of its indirect operating costs to each business area, whenever there is a clearly defined business driver that links such costs to the business area.
The following tables show the results of the Bank by operating segments for the three years ended December 31, 2008:
Operating Revenues
Other income and expenses
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Information about geographic areas
The financial information presented below has been classified considering the country in which the related transactions were originated. Those transactions originated in the United States of America, through Banco de Chile’s operations in New York and Miami, U.S.A., are primarily completed with Chilean and Argentine citizens and enterprises, and are principally denominated in U.S. dollars.
A summary of activities by geographic area is as follows:
Total Interest Revenues
Republic of Chile
U.S.A.
Total Net Income
Income Taxes
Total Assets
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(x) Estimated Fair Value of Financial Instruments
The accompanying tables provide disclosure of the estimated fair value of financial instruments owned by the Bank. Various limitations are inherent in the presentation, including the following:
The data excludes non-financial assets and liabilities, such as bank premises and equipment and excludes values attributable to deposit and credit card relationships.
While the data represents management’s best estimates, the data is subjective, involving significant estimates regarding current economic and market conditions and risk characteristics.
The methodologies and assumptions used depend upon the terms and risk characteristics of the various instruments and include the following:
Cash and due from banks represents cash and short-term deposits which approximate fair value because of the short-term maturity of these instruments.
Most of the Bank’s securities are considered as trading or available for sale and therefore are generally carried at quoted market prices. Interest earning assets and liabilities with an original maturity of less than one year are considered to have a fair value, which is not materially different from their book value.
For interest earning assets and interest bearing liabilities which are contracted at variable interest rates, their book value is considered to be equivalent to their fair value.
For performing loans with fixed-rates and an original maturity of greater than one year, the fair values were calculated by discounting contractual cash flows, using the Bank’s current origination rates for loans with similar terms and similar risk characteristics.
For loans where the Bank’s management believes that the amounts outstanding will not be paid in accordance with contractual terms, the estimated cash flows arising from the liquidation of collateralized assets and other expected flows have been discounted at an estimated discount rate commensurate with the risk in the collection of these amounts.
For interest-bearing liabilities with fixed rates and an original contractual maturity of greater than one year, the fair values are calculated by discounting contractual cash flows at current market origination rates with similar terms.
The estimated fair value of foreign exchange forward contracts was determined using quoted market prices of financial instruments with similar characteristics.
The fair value of interest rate swaps represents the estimated amount the Bank would expect to receive or pay to terminate the contracts or agreements, taking into account current interest rates. As no quoted market prices are available for the interest rate swap and forward rate instruments held by the Bank, such estimates have been estimated using modeling and other valuation techniques.
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(x) Estimated Fair Value of Financial Instrument (continued)
The estimated fair values of financial instruments and derivatives financial instruments are as follows:
Accounts receivable under spot foreign exchange transactions (1)
Derivative instruments (1)
Accounts payable under spot foreign exchange transactions (1)
Short term and long term borrowings
Effective January 1, 2008, the Bank adopted SFAS No. 157, Fair Value Measurements. This Standards address the application of fair value accounting and reporting.
Fair Value Measurements
SFAS 157 defines fair value, establishes a consistent framework for measuring fair value, and enhances disclosures about fair value measurements. In February 2008, the FASB amended SFAS 157 with the issuance of FSP FAS 157-1, which excludes with certain exceptions SFAS No. 13,Accounting for Leases, from the scope of SFAS 157, and FSP FAS 157-2, which delayed the adoption of SFAS 157 for one year for the measurement of nonfinancial assets and nonfinancial liabilities. There was no material effect from the adoption of SFAS 157 on the Bank consolidated financial statements.
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(x) Estimated Fair Value of Financial Instruments (continued)
SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. To measure fair value, SFAS 157 has established a hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs. This hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:
Level 1 – Quoted prices in active markets for identical assets or liabilities; this category only includes certain derivatives (e.g. currency futures).
Level 2 – Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data; also includes derivative contracts whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data. This category generally includes certain Chilean Central Bank and corporate debt securities; certain securities sold, not yet purchased; and certain derivatives.
Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs for nonbinding single dealer quotes not corroborated by observable market data.
The Bank use fair value to measure certain assets and liabilities on a recurring basis when fair value is the primary measure for accounting. This is done primarily for available for sales and trading investment securities; securities sold, not yet purchased; and derivatives. Fair value is used on a nonrecurring basis to measure certain assets when applying lower of cost or market accounting or when adjusting carrying values, such as other real estate owned. Fair value is also used when evaluating impairment on certain assets, goodwill, and core deposit and other intangibles, long-lived assets, and for annual disclosures required by SFAS No. 107, Disclosures about Fair Value of Financial Instruments.
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Assets and liabilities measured at fair value on a recurring basis, are summarized as follows:
Subordinated bond
The following table reconciles the beginning and ending balances of assets for 2008 that are measured at fair value on a recurring basis using Level 3 inputs.
Total gains or losses in income
Foreign exchange (gains/losss)
Purchases
Sales and settlements
Transfer out of trading securities
Transfer difference due capitalization
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(y) Fixed assets, net
Assets under lease
Total fixed assets, net
In accordance with rules of the Superintendency of Banks, bank premises and equipment are presented net of accumulated depreciation. The accumulated depreciation at the end of December 31, 2007 and 2008 corresponds to MCh$138,852 and MCh$165,808, respectively. The expense recorded at the end of 2006, 2007 and 2008 was Ch$18,062, Ch$18,432 and Ch$23,480 in the same order.
(z) Other assets and other liabilities
(1) Other assets
Amounts receivable under spot foreign exchange transaction
Payments from counterparties to be settled
Deferred income tax assets, net
Intangibles (software and licenses for trademark use)
Accounts receivable for assets received in lieu of payment sold
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(z) Other assets and other liabilities (continued)
(2) Other liabilities
Derivative instruments, net
Provision for minimum dividend
Provision for personnel benefits and payroll
Allowance for contingent loans risk
Amounts payable under spot foreign exchange transaction
Current tax liability
Legal contingencies provision
(3) Contingent Loans
Contingent loans consist of open and unused letters of credit, together with guarantees granted by the Bank in Chilean pesos, UF and foreign currencies (principally U.S. dollars). The contingent loan represents the Bank’s obligations under such agreements. The Bank’s rights under these agreements are recognized as off balance account.
Foreign office guarantees and Standby letters of credits
Guarantees in the form of performance bonds, stand by letters of credit and foreign office guarantees are issued in connection with agreements made by customers to counterparties. If the customer fails to comply with the agreement, the counterparty may enforce the performance bond as a remedy. Credit risk arises from the possibility that the customer may not be able to repay the Bank for performance bonds. To mitigate credit risk, the Bank generally determines the need for specific covenant, guarantee and collateral requirements on a case-by-case basis, depending on the nature of the financial instrument and the customer’s creditworthiness.
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The expiration of guarantees, per period is as follows:
(aa) Other Interest Bearing Liabilities
In accordance with the guidelines established by the Superintendency of Banks, the Bank does not present a classified balance sheet. Borrowings are described as short-term when they have original maturities of less than one year or are due on demand. All other borrowings are described as long-term, including the amounts due within one year on such borrowings. For U.S. GAAP purposes, the total Other Interest Bearing Liabilities is higher for Debt issued in MCh$28,532 and MCh$24,212 as of December 2007 and 2008, respectively due to U.S GAAP adjustment from Acquisition of Banco Edwards (Note 34 (b)).
(ab) Equity
The Bank’s paid-in capital consists of 71,996,083,216 authorized shares with no fixed nominal value, issued and outstanding as of December 31, 2008. Dividends related to the year ended December 31, 2006 were paid-out based on the legal entities in existence as of the year end.
Dividends were declared and paid to shareholders based on prior year net income determined under Chilean GAAP for the years ended December 31, 2006, 2007 and 2008 (presented in constant Chilean pesos as of December 31, 2008) are as follows:
Dividends per share
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(ac) Pro Forma information related to the merger of Banco de Chile and Citibank Chile
The financial information under U.S. GAAP, as presented above, reflects the financial information the merger banks starting as of January 1, 2008. The following pro forma financial information gives effect to the merger of the banks as if it had occurred on January 1, 2007. These pro forma results from operations have been prepared only for information purposes and do not purport to be indicative of the actual results of operations.
The pro forma results and earning per share information, are as follows:
Earnings per Share ($)
(ad) Recent accounting pronouncements
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements” (“SFAS No. 160”). SFAS No. 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 defines “a noncontrolling interest, sometimes called a minority interest, is the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent”. The objective of SFAS No. 160 is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. It shall be applied prospectively as of the beginning of the fiscal year in which this Statement is initially adopted, except for the presentation and disclosure requirements. The presentation and disclosure requirements shall be applied retrospectively for all periods presented. Management is evaluating the impact, if any, of the adoption of SFAS No. 160.
In December 2007, the FASB issued FASB Statement No. 141(R), “Business Combinations” (“SFAS141(R)”). SFAS141(R) requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. SFAS141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date. SFAS141(R) applies to all transactions or other events in which an entity (the acquirer) obtains control of one or more businesses (the acquiree), including combinations achieved without the transfer of consideration. In April 2009, the FASB issued FASB Staff Position FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination that Arise from Contingencies. The FSP amends SFAS 141(R) to require that pre-acquisition contingencies be recognized at fair value if the fair value can be determined during the measurement period. Management is evaluating the potential impact of adopting SFAS141(R) on the Bank’s financial statements, if any.
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(ad) Recent accounting pronouncements (continued)
In February 2008, the FASB issued FASB Staff Position No. FAS 140-3 “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions”. It addresses whether there are circumstances that would permit a transferor and a transferee to evaluate the accounting for the transfer of a financial asset separately from a repurchase financing when the counterparties to the two transactions are the same. Transactions subject to this FSP involve the lender transferring a financial asset to the borrower and contemporaneously taking that asset back as security for the repurchase financing. The FSP presumes that the initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (a linked transaction) under SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS 140”). If the combined arrangement does not qualify for sale accounting, it generally will be accounted for as a forward sale of the financial asset, which may be subject to FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. However, if certain criteria specified in the FSP are met, the initial transfer and repurchase financing may be evaluated separately under SFAS 140. The FSP is effective for fiscal years beginning after November 15, 2008. At the issued date of financial statements, Banco de Chile and subsidiaries have not had any such transaction.
In March 2008, the FASB issued FASB statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB statement No. 133” (“SFAS161”). SFAS161 applies to all derivative instruments and non derivative instruments that are designated and qualify as hedging instruments pursuant to paragraphs 37 and 42 of SFAS133 and related hedged items accounted for under SFAS133. SFAS161 requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. SFAS161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. Comparative disclosures for earlier periods at initial adoption are encouraged but not required. Management does not expect the adoption of SFAS161 to have a material impact on the Bank’s financial statements.
In May 2008, the FASB issued FASB Statement No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS162”). SFAS162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles (GAAP) for nongovernmental entities. SFAS162 is effective 60 days following the United States Securities and Exchange Commission (SEC’s) approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles”. Management does not expect the adoption of SFAS162 to have a material impact on the bank’s financial statements.
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In April 2009, the FASB released FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. This FSP changes existing accounting requirements for other-than-temporary-impairment (OTTI) by:
Replacing the current recognition requirement
Requiring the OTTI to be separated into the amount representing the decrease in cash flows expected to be collected and the amount related to all other factors
Lowering the probability threshold for recognizing an OTTI from “probable” to “more likely than not”
Requiring the total OTTI to be presented in the statement of earnings with an offset in a separate line item for any amount of the total OTTI that is recognized in OCI
For securities classified as held-to-maturity, requiring the amount of the OTTI recognized in OCI to be amortized over the remaining life of the security
Extending disclosure requirements
FSP FAS 115-2 is effective for interim and annual periods ending after June 15, 2009. Management is evaluating the potential impact of this pronouncement on the Bank’s financial statements, if any.
In April 2009, the FASB issued FASB Staff Position No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”. This FSP amends SFAS 157 to provide additional guidance on estimating fair value when the volume and level of transaction activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability. The FSP also provides additional guidance on circumstances that may indicate that a transaction is not orderly. It also requires additional disclosures about fair value measurements in annual and interim reporting periods. The FSP is focused on assets and liabilities that have experienced a significant reduction in volume and activity in relation to normal market activity. The FASB believes there may be increased instances of transactions that are not orderly in these situations. In addition, uncertainty regarding when to make adjustments to observable data and when alternative valuation techniques should be used are more prevalent when the level of activity for an asset or liability has significantly decreased. Assets that historically traded in active markets (or in markets less inactive than they are today), were typically valued using a market approach given the availability and relevance of observable data. FSP FAS 157-4 provides additional guidance on when the use of multiple (or different) valuation techniques may be warranted and considerations for determining the weight that should be applied to the various techniques. This FSP is effective for interim and annual reporting periods ending after June 15, 2009. The impact of this FSP to a large degree depends on the market conditions prevailing at the next balance sheet date since this FSP only relates to fair value measurements in markets displaying significantly reduced transaction activity.
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In June 2009, the FASB has published Financial Accounting Statements No. 166, ‘Accounting for Transfers of Financial Assets’, and No. 167, ‘Amendments to FASB Interpretation No. 46(R)’, which change the way entities account for securitizations and special-purpose entities. Statement 166 is a revision to Statement No. 140, ‘Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities’, and will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a qualifying special-purpose entity, changes the requirements for derecognizing financial assets and requires additional disclosures. Statement 167 is a revision to FASB Interpretation No. 46(R), ‘Consolidation of Variable Interest Entities’, and changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based upon an entity’s purpose and design, and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. FAS 166 and FAS 167 are effective for the fiscal years beginning after November 15, 2009. Management is evaluating the potential impact of adopting FAS 166 and FAS 167 on the Bank’s financial statement, if any.
35. Subsequent Events
According to changes in accounting criteria informed under Note 2, during the first quarter of 2009, the Bank informed to the local Superintendency about the impact of the new accounting criteria application as of December 31, 2008. These adjustments will be made retroactive to December 31, 2008 and the Bank calculated to be an increase in equity of MCh$23,131, increase in assets of MCh$32,273 and increase on liabilities of MCh$9,142.
Total equity
Total minority interest
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