SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 20-F
Commission file number 001-12518 BANCO SANTANDER CENTRAL HISPANO, S.A.(Exact name of Registrant as specified in its charter)Kingdom of Spain(Jurisdiction of incorporation)Plaza de Canalejas, 128014 Madrid, Spain(address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act
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 ActNone.(Title of Class)The number of outstanding shares of each class of Stock of Banco Santander Central Hispano, S.A. at December 31, 2002 was:Shares par value Euro 0.50 each-4,768,402,943
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes No
Indicate by check mark which financial statement item the registrant has elected to follow.
Item 17 Item 18
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BANCO SANTANDER CENTRAL HISPANO, S.A.
TABLE OF CONTENTS
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Merger of Banco Central Hispanoamericano, S.A. into Banco Santander, S.A. and Presentation of Our Consolidated Financial Statements
On April 17, 1999, Banco Central Hispanoamericano merged into Banco Santander to create Banco Santander Central Hispano. For accounting purposes, we are treating the merger as if it had occurred on January 1, 1999. Therefore, our consolidated financial statements reflect the merger as follows:
The merger of Banco Santander and Banco Central Hispanoamericano was a merger-of-equals that created a new bank that is significantly different from either of the predecessor banks. As a result, our 2000 and 1999 consolidated financial statements are not comparable with our historical 1998 financial statements. In addition, because the businesses of Banco Santander and Banco Central Hispanoamericano were merged during 1999, we are unable to distinguish clearly between internal growth in 1999 and growth due to the merger. In order to address this problem and to facilitate an understanding of how our business evolved during 1999, we have provided supplemental pro forma 1998 information throughout this annual report. The pro forma 1998 information reflects the combination of Banco Santander with Banco Central Hispanoamericano as if the combination occurred on January 1, 1998, in the case of income statement information, and on December 31, 1998, in the case of balance sheet information. The pro forma adjustments are limited to those adjustments directly related to the transactions contemplated by the merger. The pro forma financial data are provided for illustrative purposes only and do not purport to represent what our actual financial position or results of operations would have been had the merger occurred on the dates assumed.
Effective January 1, 1999, Spain adopted the euro as its official currency. Our financial statements for fiscal years ending prior to December 31, 2000, which were prepared in Spanish pesetas, have been restated in euros using the fixed conversion rate of €1.00 to Pta.166.386. Our financial statements reported in euros reflect the same trends as if we had continued to present our financial statements in pesetas. However, our financial statements for periods prior to January 1, 1999, may not be comparable to the financial statements of other companies that have also restated their financial statements in euros.
Except where we note otherwise, we prepared the financial information contained in this report according to Spanish GAAP. As disclosed in note 27 to our consolidated financial statements, Spanish GAAP differs in some significant respects from U.S. GAAP. The most significant difference in the 1999 financial information relates to the merger described above that created Banco Santander Central Hispano. We accounted for this merger under the purchase method of accounting under U.S. GAAP while we accounted for it in 1999 in a manner that is similar to a “pooling of interests” under Spanish GAAP.
We have formatted our financial information according to the classification format for banks used in Spain. We have not reclassified the line items to comply with Article 9 of Regulation S-X. Article 9 is a regulation of the U.S. Securities and Exchange Commission that contains formatting requirements for bank holding company financial statements. We have, however, included summary financial information that reflects the required reclassifications in note 27 to our consolidated financial statements.
Differences Between Consolidated Financial Statements and Spanish Statutory Financial Statements — Accelerated Amortization of Goodwill
The auditor’s report on our Spanish statutory financial statements as of and for the year ended December 31, 1998 were qualified with respect to the accelerated amortization of goodwill during 1997. United States securities regulations do not allow the filing of financial statements with the Securities and Exchange Commission if they contain auditor’s opinions that are qualified with respect to a material departure from generally accepted accounting principles. Therefore, in order to avoid a qualification in the auditor’s report, we did not include the early amortization we recognized in 1997 in
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our consolidated financial statements included in the 1999 annual report on Form 20-F. As a result, net attributable income and net worth differ between these consolidated financial statements and our Spanish statutory financial statements for all of the years presented in our 1999 annual report due to the accelerated amortization of goodwill in 1997 and the effects the reduced balance of goodwill resulting from this early amortization had on ordinary amortization of goodwill in 1997, 1998 and 1999.
The following table compares net attributable income between our consolidated financial statements included in this annual report and our Spanish statutory financial statements:
Additionally, the differing amounts of net attributable income caused our net worth to differ between our Form 20-F consolidated financial statements and the Spanish statutory financial statements as follows:
Our consolidated financial statements are in Euros, which are denoted “euro”, “euros”, EUR or “€” throughout this annual report. Also, throughout this annual report, when we refer to:
When we refer to average balances for a particular period, we mean the average of the month-end balances for that period, unless otherwise noted. We do not believe that monthly averages present trends that are materially different from trends that daily averages would show. We included in interest income any interest payments we received on non-accruing loans if they were received in the period when due. We have not reflected consolidation adjustments in any financial information about our subsidiaries or other units.
When we refer to loans, we mean loans, leases, discounted bills and accounts receivable, unless otherwise noted.
When we refer to the allowances for loan-losses, we mean the specific allowances for loan-losses and the general allowance for loan-losses including any allowances for country risk, unless otherwise noted. See “Item 4. Information on the Company—B. Business Overview—Selected Statistical Information—Classified Assets—Bank of Spain Allowance for Loan-Losses and Country Risk Requirements”.
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We have made forward-looking statements in this annual report that are subject to risks and uncertainties. Forward-looking statements include information regarding:
Forward-looking statements may be identified by words such as “expect,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “VaR,” “DCaR,” “ACaR,” “RORAC,” “target,” “goal,” “objective,” “estimate,” “future” and similar expressions. We include forward-looking statements in the “Operating and Financial Review Prospects,” “Information on the Company” and “Qualitative and Quantitative Disclosures About Market Risk” sections.
You should understand that adverse changes in the following important factors, in addition to those discussed in “Operating and Financial Review and Prospects,” “Information on the Company” and elsewhere in this annual report, could affect our future results and could cause those results or other outcomes to differ materially from those anticipated in any forward-looking statement:
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The forward-looking statements contained in this annual report speak only as of the date of this annual report. We do not undertake to update any forward-looking statement to reflect events or circumstances after that date or to reflect the occurrence of unanticipated events.
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Not applicable.
We have selected the following financial information from our consolidated financial statements. You should read this information in connection with, and it is qualified in its entirety by reference to, our consolidated financial statements.
We prepared our consolidated financial statements according to Spanish GAAP. Spanish GAAP differs in some significant respects from U.S. GAAP. Our financial information is presented in Spanish format. The financial information at and for the years ended December 31, 1998 and 1999 reflects adjustments to the amortization of goodwill figures shown in our Spanish statutory financial statements. No adjustments have been made in the financial information for the years ended December 31, 2000, 2001 and 2002. See “Presentation of Financial and Other Information—Differences Between Consolidated Financial Statements and Spanish Statutory Financial Statements—Accelerated Amortization of Goodwill.”
In the F-pages of this Form 20-F, Audited Financial Statements for the years 2002, 2001 and 2000 are presented. Audited Financial Statements for the years 1999 and 1998 are not included in this document, but they can be found in our previous annual reports on Form 20-F.
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The following table shows income, stockholder’s equity, total assets and certain ratios on a U.S. GAAP basis.
Fluctuations in the exchange rate between pesetas and dollars have affected, and, after January 1, 1999, between euros and dollars will affect, the dollar equivalent of the share prices on Spanish Stock Exchanges and, as a result, are likely to affect the dollar market price of our American Depositary Shares, or ADSs, in the United States. In addition, dividends paid to the depositary of the ADSs will be denominated in euros and fluctuations in the exchange rate will affect the dollar conversion by the depositary of cash dividends paid on the shares to the holders of the ADSs. Fluctuations in the exchange rate of euros against other currencies may also affect the euro value of non-euro denominated assets, liabilities, earnings and expenses of Banco Santander Central Hispano.
The following table sets forth, at the dates and for the periods indicated, information regarding the Noon Buying Rate for pesetas expressed in pesetas per dollar.
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On January 1, 1999, the peseta became a member currency of the euro, at a fixed conversion rate of €1.00 to Pta. 166.386. Amounts stated in pesetas relating to dates subsequent to January 1, 1999, are accordingly translated into dollars following a two step procedure: first, the peseta amounts are converted into euros at the fixed conversion rate of €1.00 to Pta. 166.386; and second, such euro amounts are translated into dollars using the Noon Buying Rate of dollars per euro.
Beginning January 1, 2002, participating European Union member states such as Spain issued new euro-denominated bills and coins for use in cash transactions. The participating member states have withdrawn the bills and coins denominated in their respective currencies from circulation, and they are no longer legal tender for any transactions. Accordingly, Spain has withdrawn bills and coins denominated in pesetas.
The following table sets forth for the periods and dates indicated certain information concerning the exchange rate for euros and dollars (expressed in dollars per euro), based on the Noon Buying Rate for the dates and periods indicated.
On June 26, 2003, the exchange rate for euros and dollars (expressed in dollars per euro), based on the Noon Buying Rate, was $1.1429.
For a discussion of the accounting principles used in translation of foreign currency-denominated assets and liabilities to euros, see Note 2(b) of our Consolidated Financial Statements. See “Item 4. Information on the Company—B. Business Overview—Monetary Policy and Exchange Controls” for information concerning the peseta in the context of the European Monetary Union.
See “Consolidated Balance Sheet Data” in Item 3. “Key Information—A. Selected Financial Data.”
Not Applicable.
Since our loan portfolio is concentrated in Spain and Latin America, adverse changes affecting the Spanish or Latin American economies could adversely affect our financial condition.
Our loan portfolio is mainly concentrated in Spain and Latin America. At December 31, 2002, 55.9% of our loans were made to Spanish resident borrowers and 20.49% of our loans were made by our Latin American subsidiaries. Therefore, adverse changes affecting the Spanish or Latin America economies in which we operate would likely have a significant adverse impact on our loan portfolio and, as a result, on our financial condition, cash flows and results of operations. See “Item 4. Information on the Company—B. Business Overview.”
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The level of income we derive from certain of our products and services depends on the strength of the economies in the regions where we operate and certain market trends prevailing in those areas. While we attempt to diversify our businesses, negative cycles may adversely affect our income in the future.
There may be less publicly available information about us than is regularly published about companies in the United States. While we are subject to the periodic reporting requirements of the U.S. Exchange Act, the disclosure required from foreign issuers under the Exchange Act is more limited than the disclosure required from U.S. issuers. Additionally, we present our financial statements under Spanish GAAP which differs from US GAAP. See note 27 to our consolidated financial statements.
Historically, our principal sources of funds have been customer deposits (savings, demand and time deposits). At December 31, 2002, 19.7% of these customer deposits are time deposits in amounts greater than $100,000. Time deposits have represented 59.4%, 57.8% and 59.5% of total customer deposits at the end of 2000, 2001 and 2002, respectively. Large-denomination time deposits may be a less stable source of deposits than savings and demand deposits. In addition, since we rely heavily on short-term deposits for our funding, there can be no assurance that we will be able to maintain our levels of funding without incurring higher funding costs or the liquidation of certain assets.
Medium- and small-size companies and middle and lower-middle income individuals can be more adversely affected by adverse developments in the economy than large companies and high income individuals. As a result, our substantial lending to these segments of our existing and targeted customer base causes us to assume a relatively higher degree of risk than if we focused more heavily on the other groups.
Most of the financial systems in which we operate are highly competitive. Recent financial sector reforms in the markets in which we operate have increased competition among both local and foreign financial institutions, and we believe that this trend will continue. In particular, price competition in Europe has increased recently. Our success in the European markets will depend on our ability to remain competitive with other financial institutions. In addition, there has been a trend towards consolidation in the banking industry, which has created larger and stronger banks with which we must now compete. There can be no assurance that this increased competition will not adversely affect our growth prospects, and therefore our operations. We also face competition from non-bank competitors, such as brokerage companies, department stores (for some credit products), leasing companies and factoring companies, mutual funds and pension funds management companies, and insurance companies.
Changes in market interest rates could affect the interest rates charged on the interest-earning assets differently than the interest rates paid on interest-bearing liabilities. This difference could result in an increase in interest expense relative to interest income leading to a reduction in our net interest income. Income from treasury operations is particularly vulnerable to interest rate volatility. Since the majority of our loan portfolio reprices in less than one year, rising interest rates may also bring about an increasing non-performing loan portfolio. Interest rates are highly sensitive to many factors beyond our control, including deregulation of the financial sector, monetary policies, domestic and international economic and political conditions and other factors.
Fluctuations in the exchange rate between the euro and the U.S. dollar will affect the U.S. dollar equivalent of the price of our securities on the stock exchanges in which our shares are traded. These fluctuations will also affect the conversion to U.S. dollars of cash dividends paid in euros on our shares.
In the ordinary course of our business, we have a percentage of our assets and liabilities denominated in currencies other than the euro. Fluctuations in the value of the euro against other currencies may adversely affect our profitability. For example, the appreciation of the euro against some Latin American currencies and the U.S. dollar will depress earnings
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from our Latin American operations. Additionally, while most of the governments of the countries in which we operate have not imposed prohibitions on the repatriation of dividends, capital investment or other distributions, no assurance can be given that these governments will not institute restrictive exchange control policies in the future. Moreover, fluctuations among the currencies in which our shares and ADRs trade could reduce the value of your investment.
A number of banking regulations designed to maintain the safety and soundness of banks and limit their exposure to risk apply in the different jurisdictions in which our subsidiaries operate. Changes in regulations, which are beyond our control, may have a material effect on our business and operations. As some of the banking laws and regulations have been recently adopted, the manner in which those laws and related regulations are applied to the operations of financial institutions is still evolving. Moreover, no assurance can be given generally that laws or regulations will be adopted, enforced or interpreted in a manner that will not have an adverse affect on our business.
We acquired controlling interests in various companies and engaged in other strategic partnerships. See “Item 4. Information on the Company—A. History and development of the Company.” Additionally, we may consider other strategic acquisitions and partnerships from time to time. While we are optimistic about the acquisitions we made, there can be no assurances that we will be successful in our plans regarding the operation of these or other acquisitions and strategic partnerships.
We can give you no assurance that our acquisition and partnership activities will perform in accordance with our expectations. Despite our due diligence efforts, we must necessarily base any assessment of potential acquisitions and partnerships on inexact and incomplete information and assumptions with respect to operations, profitability and other matters that may prove to be incorrect.
The economy of the 11 Latin American countries where we operate has experienced significant volatility in recent decades, characterized, in some cases, by slow or regressive growth, declining investment and hyperinflation. This volatility has resulted in fluctuations in the levels of deposits and in the relative economic strength of various segments of the economies to which we lend. Latin America banking activities (including Commercial Banking, Asset Management and Private Banking and Global Wholesale Banking) accounted for €1,382.7 million of our net attributable income for the year ended December 31, 2002 (a decrease of 8.2% from €1,506.9 million for the year ended December 31, 2001) (This figure does not include goodwill amortization of €1,043.2 million and €1,648.4 million; financing costs of €756.9 million and €452.0 million -taking into account the euro long-term interest rate, net of taxes- at December 31, 2002 and 2001, respectively, and the special provision reserve for Argentina of €1,244 million made in 2001). Negative and fluctuating economic conditions, such as a changing interest rate environment, impacts our profitability by causing lending margins to decrease and leading to decreased demand for higher margin products and services.
Because some of the Latin American countries in which we operate only raise limited regulatory barriers to market entry, generally do not make any differentiation between locally or foreign-owned banks, have permitted consolidation of their banks and do not restrict capital movements, we face significant competition in Latin America from both domestic and foreign commercial and investment banks.
We operate in the banking business in Latin American countries and our overall success as a global business depends, in part, upon our ability to succeed in differing economic, social and political conditions. We are confronted with different legal and regulatory requirements in many jurisdictions, including different tax regimes and laws relating to the repatriation of funds or nationalization of assets. Our international operations also expose us to different local business risks and challenges, such as exchange rate risks, management and control of an international organization and other political risks, which could adversely affect our business.
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Financial and securities markets in Latin American countries where we operate are, to varying degrees, influenced by economic and market conditions in other countries in Latin America and beyond. Negative developments in the economy or securities markets in one country, particularly in an emerging market, may have a negative impact on other emerging market economies. These developments may adversely affect the business, financial condition and operating results of our subsidiaries in Latin America.
By the end of 2001, Argentina suffered a deep social and economic deterioration accompanied by political and economic instability. In reaction to these events, Argentina has imposed severe economic restrictions including (i) suspending payments on Argentina’s external debt; (ii) abrogating the convertibility of the Argentine peso (iii) converting U.S. dollar denominated bank-deposits into Argentine peso (ARP)-denominated deposits at an exchange rate of ARP1.40 per $1.00; (iv) converting U.S dollar denominated debts into ARP denominated debts at an exchange rate of ARP1.00 for each U.S. dollar (except internal federal and provincial government debt, which is converted at ARP1.40 per $1.00); (v) restricting bank withdrawals and transfers abroad; (vi) closing down the Argentine banking system for extended periods (vii) enacting changes in the bankruptcy law to protect debtors; (viii) amending the charter of the Argentine Central Bank to provide for increased money supply; and (ix) requiring the sale by all banks of all their foreign currency within Argentina to the Central Bank at an exchange rate of ARP1.40 per $1.00 (this requirement is currently suspended). The resultant shock of these events has caused increased inflation, a volatile exchange rate and reduced economic activity.
It is impossible to predict how the Argentine government will ultimately address the crisis that continues to affect the Argentine economy. The rapid and radical nature of the recent changes in the Argentine social, political, economic and legal environment, including with respect to tax regulations, and the absence of a clear political consensus or any particular set of economic policies, have created great uncertainty. Mr. Néstor Kirchner is the new president of Argentina; his presidential term began on May 25, 2003. How the new president of Argentina will affect the composition of the Argentine government, the laws it promulgates and the economy, and ongoing discussions with the International Monetary Fund regarding a restructuring of the Argentine government’s debt, add to the current unstable political and economic environment.
Within this framework, the Argentine banking sector and the Group (by virtue of its ownership of Banco Río and its other Argentine operations) have been affected, in particular, by losses generated by the forced conversion of dollar denominated debt to pesos at below market rates, lower lending and deposit-taking activities, the inability to manage our Argentine business due to forced extended holdings restrictions on transfer of money (including dividends) and a higher probability of our Argentine customers defaulting. We also face an increased potential for defaults among customers heavily invested in, or dependent upon, the Argentine economy and an increased risk based on guarantees and other instruments with recourse to Grupo Santander issued to or in support of their Argentine operations (See in Note 1 to our financial statements the accounting treatments given to this risk).
In light of the uncertainty prevailing in Argentina’s economic and political environment, our strategy in this country has been focused on preserving liquidity levels, decreasing sovereign risk exposure, strengthening credit risk control and optimizing the volume and structure of equity. In 2001, we established a special reserve amounting to €1,287.0 million. As of December 31, 2002, the special reserve amounted to €1,623.0 million that covers in full the net book value of and goodwill of our investments in companies located in Argentina, the risk arising from intercompany transactions, as well as the new regulatory requirements on provisions for country risk with third parties as a result of the change in the classification of Argentina. We expect that the deteriorated economic and political environment in Argentina will continue to have a negative impact on our financial condition and results of operations, including as a result of causing us to increase the coverage on our cross-border exposure to obligors in Argentina.
The Argentine government has historically exercised significant influence over the economy. In responding to the on-going crisis, the Argentine government has promulgated numerous, far-reaching and, at times, inconsistent laws and regulations affecting the economy.
We cannot assure you that laws and regulations currently governing the economy will not continue to change in the future or that any changes will not adversely affect our business, financial condition or results of our operations in the country, or with other counterparties located in the country.
Additional risks to investing in Argentina in light of the social and political crises include the potential for: (i) civil unrest, rioting, looting, nationwide protests, widespread social unrest and strikes; (ii) expropriation, nationalization and forced renegotiation or modification of existing contracts; (iii) additional restrictions on repatriation of investments and transfer of funds abroad; (iv) adverse changes to taxation policies, including retroactive tax claims; and (v) further changes in laws and policies of Argentina affecting foreign trade and investment.
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On January 15, 1999, the boards of directors of Banco Santander, S.A. and Banco Central Hispanoamericano, S.A. agreed to merge Banco Central Hispanoamericano into Banco Santander, and to change Banco Santander’s name to Banco Santander Central Hispano, S.A. The shareholders of Banco Santander and Banco Central Hispanoamericano approved the merger on March 6, 1999, at their respective general meetings. The merger and the name change were registered with the Mercantile Registry of Santander, Spain by the filing of a merger deed. Effective April 17, 1999, Banco Central Hispanoamericano shares were extinguished by operation of law and Banco Central Hispanoamericano shareholders received new Banco Santander shares at a ratio of three shares of Banco Santander for every five shares of Banco Central Hispanoamericano formerly held. On the same day, Banco Santander changed its legal name to Banco Santander Central Hispano, S.A. We are incorporated under, and governed by the laws of the Kingdom of Spain. We conduct business under the commercial name “Santander Central Hispano”. Our corporate offices are located in Plaza de Canalejas, 1, 28014 Madrid, Spain. Telephone: (011) 34-91-558-1111.
The principal holdings acquired by us in 2001 and 2002 and other significant corporate transactions were as follows:
Banco Español de Crédito, S.A. (“Banesto”). In 2002, Banesto carried out a monetary capital increase through the issuance of 81,670,694 new shares, carrying preemptive rights, at a ratio of 2 new shares issued at par for every 15 old shares. We sold the preemptive rights we received in this transaction (arising from our 99.04% holding in the capital stock of Banesto) for €443 million and reduced our ownership interest to 88.57%.
AKB Holding (“AKB”). In 2001, we reached an agreement with the Werhahn Group for the acquisition of AKB (a German group specialized in consumer finance). In May 2002, we issued 109,040,444 new shares of €0.5 par value each and share premium of €9.588 each for an effective amount of €1,100 million, which were paid in full through the contribution of shares representing all the capital stock of AKB, in accordance with the resolutions adopted by the Bank’s Special Shareholders’ Meeting on February 9, 2002.
Banco Santiago. Under the agreements between us and the Central Bank of Chile (as the second largest shareholder of Banco Santiago), on April 17, 2002 we acquired 35.45% of the Central Bank of Chile’s holding in the capital stock of Banco Santiago for $685 million (approximately €772 million). On August 1, 2002, Banco Santiago was merged into Banco Santander Chile, with retroactive effect as of January 1, 2002, after the required resolution of their respective Shareholders’ Meetings and approval by the Chilean regulatory authorities. The name of the post-merger entity is Banco Santander Chile.
Banco Santander Colombia. As a result of a capital increase and of certain agreements reached in prior years, in 2002, we increased our holding in the capital stock of Banco Santander Colombia by 34.32% and paid €303 million.
Banco del Río de la Plata, S.A. (Banco Río). As of December 31, 2001, we had an 80.3% controlling interest in Banco Río. Additionally, we had call options and were obliged by put options of third parties on the capital stock of Banco Río which affected 18.54% of Banco Rio’s capital stock (23% of the voting rights). On January 2002, we settled the exercise of the put option by its holder through the delivery of the Bank’s ordinary shares. The estimated cost of the investment was €395.0 million.
As of December 31, 2002, we had a 98.8% holding in the capital stock of Banco Río.
Grupo Financiero Santander Serfin (“Serfin”). In December 2002, we reached an agreement with Bank of America Corporation whereby the latter acquired 24.9% of Grupo Financiero Santander Serfin (“Serfin”) for $1,600 million, for which we recognized estimated capital gains of approximately €681 million. Under this agreement, Bank of America Corporation will maintain its share holding in Serfin for at least three years, and after this period it may use, if it deems it appropriate, several liquidity mechanisms, including the listing of its Serfín shares on the stock exchange and the right to sell its Serfin shares to us, at one time, at its book value at the time of the sale, calculated in accordance with international accounting standards.
The transaction was completed in March 2003. As of March 31, 2003, we had a 74.0% holding in the capital stock of Serfin.
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Patagon Group. In 2002, we restructured our Internet banking business, selling our holding in Patagon America, the Latin American financial portal, to the other shareholders for $9.84 million (approximately €10.7 million) and using the allowances recorded for the full amount of the investment that included €617 million of goodwill.
Banco de Caracas. On August 17, 2002, Banco de Venezuela and Banco de Caracas merged into the new Banco de Venezuela.
Banco do Estado de Sao Paulo (Banespa). In November 2000, we acquired a 33% holding investment (66.5% of the voting rights) in the capital stock of Banespa for 7,284 million Brazilian reais (approximately $3,802 million or €4,378 million). Finally, on April 2001 we acquired an additional 64.1% of the capital stock of Banespa (31.8% of the voting rights) for 2,275 million Brazilian reais (approximately $1,068 million or €1,203 million) after the successful tender offer for the remaining common and preferred shares owned by minority shareholders (67% of capital stock) approved by our board of directors on December 29, 2000.
As of December 31, 2002, we had a 98.01% holding in the capital stock of Banespa.
Compañía de Seguros de Vida Santander, S.A.(Vida Santander) and Compañia de Reaseguros de Vida Soince-Re, S.A. (Vida Soince). In November 2001, we sold to MetLife 100% of our shares in our two Chilean insurance subsidiaries, Vida Santander and Vida Soince, for a total price of approximately $258 million (€290 million), realizing capital gains of approximately $160 million (approximately €180 million).
The Royal Bank of Scotland Group, plc. (“RBS”). As of December 31, 2001, we had an 8.03% holding in the capital stock of RBS. In 2002 we made a net divestment of 3% of our holding in RBS, realizing capital gains of approximately €806 million.
As of December 31, 2002, we had a 5.04% holding in the capital stock of RBS.
Unión Eléctrica Fenosa, S.A. (Unión Fenosa). In 2002 we acquired several holdings in the capital stock of Unión Fenosa for a total amount of €465 million. As of December 31, 2002, we had a 23.35% holding in the capital stock of Unión Fenosa.
Grupo Financiero Bital. In 2002 we subscribed a capital increase and converted bonds into Grupo Financiero Bital shares for approximately €99 million, thus increasing our holding to 25.4% of the economic rights and 29.1% of the voting rights. Subsequently, we accepted the tender offer launched by Hong Kong and Shanghai Bank Corporation (“HSBC”) for the shares of Grupo Financiero Bital, realizing capital gains of approximately €113 million.
Dragados y Construcciones, S.A. In 2002 we divested our 23.5% holding in Dragados y Construcciones, S.A. (as of December 31, 2001, the holding was 20.19% of capital stock) at a capital gain of approximately €521 million.
Vallehermoso, S.A. In 2002 we divested 24.5% of our holding in Vallehermoso, S.A. (as of December 31, 2001, the holding was 25.14% of capital stock) at a capital gain of approximately €301 million.
Société Générale. As of December 31, 2000, we had a 5.93% holding in the capital stock of Société Générale. Following various divestments in 2001 (with realized gains of €185 million), we had a 1.5% holding in the capital stock of Société Générale as of December 31, 2001. This holding was divested in 2002 at a capital gain of €94 million.
Metropolitan Life Insurance Company (Metlife). In August 2001, we reduced our stake in MetLife from 4.00% to 0.67%, realizing capital gains of approximately €306 million. Subsequently, in January 2002 we sold our remaining 0.67% stake, realizing capital gains of approximately €76 million.
Previnter AFJP, S.A. (Previnter). In the first quarter of 2001, we merged Previnter and Origenes AFJP, our two pension fund subsidiaries in Argentina.
Vodafone. As of December 31, 2000 we had 1,842,641,757 shares of Vodafone, equivalent to 2.85% of its capital. During 2001 we divested 44% of our holding realizing capital gains of €1,713 million. As of December 31, 2001 we had a 1.53% holding. During 2002 we reduced our stake from 1.53% to 0.97%, realizing capital gains of €274 million.
Auna Operadores de Telecomunicaciones, S.A. (Auna). During 2001, we acquired a 9.77% of the capital stock of Auna, thus increasing to 10.87% our total holding in this company, the second largest Spanish telecommunications group. In December 2001, we announced that, together with other strategic partners, we will individually acquire a total stake of 26.89% in Auna. As a consequence of this transaction, and once all requirements pursuant to the sectorial regulations were met, in
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2002 we acquired a 12.62% stake in Auna, thus increasing to 23.49% our total holding in this company, although this stake could be increased by an additional 2.5%. The total price of the acquisition of the 26.89% stake in Auna was €2,000 million. The total price of the 12.62% stake acquired by us was €939 million. As of December 31, 2002, we had a 23.49% holding in the capital stock of Auna.
In addition to expanding our existing operations, we continuously review possible acquisitions of, and investments in, businesses in markets in which we believe we have particular advantages.
As of December 31, 2001, our capital stock consisted of 4,659,362,499 fully subscribed and paid shares of €0.5 par value each.
As of December 31, 2002, our capital had increased by 109,040,444 shares, or 2.34% of our total capital as of December 31, 2001, to 4,768,402,943 shares through the following transaction:
During March, April and May 2003 we announced the following transactions:
We are a financial group operating principally in Spain, other European countries and Latin America, offering a wide range of financial products. At December 31, 2002, we were one of the largest banking groups in the euro zone with a stock market capitalization of €31.2 billion, stockholders’ equity of €18.2 billion and total assets of €324.2 billion. We had an additional €93.3 billion in mutual funds, pension funds and other assets under management at that date. We also had 35,887 employees and 4,314 branch offices in Spain and 68,291 employees and 4,967 branches outside Spain at December 31, 2002.
Our principal operations are in Spain, Portugal, Germany, Italy, Belgium and Latin America. We also have significant operations in New York, London and Paris as well as strategic investments in The Royal Bank of Scotland Group, and financial investments in Commerzbank, San Paolo-IMI and Banque Commerciale du Maroc. In Latin America, we have majority shareholdings in banks in Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, Paraguay, Puerto Rico, Uruguay and Venezuela.
Our business is divided into five principal areas:
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This area covers the banking activities of the different networks and specialized units in Europe, chiefly with individual clients and small and medium companies (“SMEs”), as well as private and public institutions. There are five units within this area: Santander Central Hispano Commercial Banking, Banesto, Consumer Finance, Portugal and On-line Banking.
This area covers the universal banking activities in Latin America conducted through our subsidiary banks and finance companies.
Asset management includes pension and mutual funds and bancassurance. Private banking includes the activity carried out with clients via the specialized units in Spain and abroad.
This area covers our corporate banking activities in Spain and Europe, treasury activities in Madrid and New York and investment banking throughout the world.
This area is responsible for the centralized activities relating to strategic or temporary equity stakes in industrial and financial companies, financial management related to the structural exchange rate position, the Group’s asset and liability portfolio and management of issues and securitization. It also controls all capital and reserves and allocations of capital and liquidity to the different business areas. Lastly, the area also covers, on a temporary basis, businesses that are being wound down or closed in order not to distort the recurrent revenues of other businesses. In exceptional circumstances, it may include the launch of an activity of a strategic nature.
Our European commercial banking activities include deposit taking, personal loans and consumer finance, mortgage lending, bill discounting, leasing, factoring, distribution of mutual and pension funds, life and non-life insurance distribution, credit and debit card operations, remote banking services, automobile financing and money transfers.
European Commercial Banking is the most important business area for the Santander Central Hispano Group. Its share of total activity increased in 2002, both in terms of business volume and earnings. As of December 31, 2002, it accounted for 47% of total customer funds, 67% of total loans and credits and 49% of net attributable income of the Group.
The area had 5,027 branches and 42,856 employees (direct and assigned) at the end of 2002.
Income before taxes for European Commercial Banking increased 14.8% to €2,197.4 million in 2002 from €1,914.4 million in 2001. The main factors behind this increase were positive business performance, control of operating costs and, to some extent, the impact of the consolidation of AKB, which was not consolidated in 2001, on both the balance sheet and the income statement (the latter for the whole of the year).
The efficiency ratio improved by 3.4 percentage points, from 53.4% in 2001 to 50.0% in 2002. ROE was 19.07% as compared to 18.18% in 2001.
This activity is carried out through the branch network of Banco Santander Central Hispano, backed up by an increasing number of ATMs, savings books updaters, telephone banking services, electronic and Internet banking.
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At the end of 2002, we had 2,506 branches and a total of 21,267 employees (24,971 at the end of 2001), of which 239 were temporary, dedicated to commercial banking in Spain. In 2002 there was a net reduction of 328 branches and a net reduction of 3,704 employees mainly due to early retirements.
In 2002 Santander Central Hispano Commercial Banking experienced growth of approximately 9% in lending, 5% in deposits, 7.8% in net operating income and 6.3% in net attributable income, an improved efficiency ratio and continued high standards of quality in credit risk.
Net operating revenue from Santander Central Hispano Commercial Banking was €3,249.9 million in 2002, as compared to €3,231.8 million in 2001.
In 2002 net attributable income from Santander Central Hispano Commercial banking was €786.0 million, 6.3% higher than net attributable income in 2001, while the ROE reached 21.3% and the efficiency ratio improved to 50.0% (52.9% in 2001).
Santander Central Hispano Commercial Banking progressed on its management model based on customer segmentation, known as Project Da Vinci, in order to provide a differentiated range of products and services to each homogenous group and to develop innovative products.
The area set goals focused on achieving a strong business drive, defending customer spreads, improving efficiency with a significant cut in costs and control and quality of credit risk and non-performing loans. These general strategies were adapted to each customer segment and specified in plans, improvement measures and special projects with quantitative and qualitative targets, most of them focused on growth in net operating revenue, as a lever to improve the Group’s earnings.
The result was significant growth in the main customer business items. Lending rose on a sustained basis in items as varied as mortgages (+14.2%), mainly to individual customers, factoring and confirming (+71.1%) and secured loans (+9.8%).
Of note in funds was the 5.3% growth in deposits, both current accounts (+2.8%) as well as time deposits (+9.2%). Time deposits increased as a result of the strategy of placing structured products, which combine the guarantee of capital and a basic return, with profit expectations derived from the structures.
The performance of mutual funds, like that of the rest of the banking sector, was affected by the depressed state of stock markets. The asset value declined by more than €1,000 million, and growth capacity was limited by subscriptions because of the poor expectations. The combined impact of these circumstances was a drop of 8.5% in the balance, which was neutralized and overcome at the level of the Group in Spain (+ 6.5%) by institutional funds, deposited with us as coverage of the «Supersatisfacción» and «Super Rendimiento» Deposits.
Pension funds reaped the rewards of the promotion campaign at the end of 2001, consolidated in 2002. The balance rose 10.4% in 2002 and its return increased.
Bancassurance was more dynamic. Growth in new policies and income was 86% in 2002 as a whole and more than 100% in the last months of the year.
During 2002, the Banesto Group continued to achieve sustained growth in business and earnings. Income before taxes was 10.4% higher at €575.1 million (according to its published data, excluding adjustments for capital allocation and assignation of costs). This increase was due to a gradual increase in business, control of operating expenses and adequate management of customer spreads.
At the end of 2002, Banesto had 1,679 branches and 10,022 employees (compared with 10,750 at the end of 2001), of which 436 employees were temporary.
In 2002, net operating revenue from Banesto was €1,481.8 million, as compared to €1,447.2 million in 2001. Net attributable income from Banesto was €414.2 million, 0.7% higher than in 2001, while the ROE reached 17.3% (18.3% in 2001) and the efficiency ratio improved to 51.4% (53.2% in 2001).
These results were driven, in part, by the Bank’s different promotion campaigns aimed, in some cases, at strengthening the relationship with current customers, and in others at capturing new clients in target segments. The campaigns included the «present for a deposit», the continuation of the «DVD campaign» and the launch of the «Canal Satélite Digital» campaign.
Other noteworthy developments were:
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Our Portuguese operations are conducted by the Totta Group (“Totta”). Totta conducts its business through three brands in retail banking – Totta, Crédito Predial Português and Santander Portugal and, in investment banking with Banco Santander de Negocios Portugal.
At the end of 2002, Commercial Banking in Portugal operated 659 branches and had 7,175 employees (compared with 7,578 at the end of 2001), of which 157 employees were temporary.
In 2002, net operating revenue from our Commercial Banking activities in Portugal was €851.2 million, as compared to €887.0 million in 2002. Net attributable income was €191.2 million, 17.3% higher than in 2001, while the ROE reached 15.7% (13.8% in 2001) and the efficiency ratio improved to 49.4% (51.1% in 2001).
In 2002, net operating revenue from our Group in Portugal (including Commercial Banking, Asset Management and Global Wholesale Banking) was €921.9 million, as compared to €946.7 million in 2001. Net attributable income was €223.1 million, 16.8% higher than in 2001.
Our main consumer financing activities are focused on Spain and Portugal (through the Hispamer Group), Germany (through CC-Bank) and Italy (through Finconsumo). We are also present (through CC-Bank) in Austria, Hungary, the Czech Republic and Poland.
Under our business diversification strategy for Europe, we strengthened our position in Consumer Finance with the acquisition of the German entity AKB. Subsequently, we reorganized our shareholder structure and integrated in a single entity all our holdings in consumer finance in Europe (Santander Consumer Finance).
At the end of 2002, this area had 181 branches and 3,908 employees (compared with 2,866 at the end of 2001), of which 159 employees were temporary.
In 2002, this area generated net operating revenue of €831.9 million, as compared to €497.3 million in 2001. Net attributable income was €209.1 million, 89.4% higher than in 2001, while the ROE reached 24.7% (18.0% in 2001) and the efficiency ratio improved to 43.3% (50.7% in 2001). (The 2002 figures include the integration of AKB).
The noteworthy developments in the main markets where we operate are the following:
In Germany, the legal procedures for the merger of CC-Bank and AKB were completed. In 2002, the CC-Bank Group’s earnings rose significantly because of the incorporation of AKB. Net attributable income increased 236.6% to €114.4 million. The efficiency ratio improved from 54.8% in 2001 to 42.9% in 2002. ROE rose from 20.8% to 32.4%.
In Italy, Finconsumo Banca, jointly owned by CC-Bank and San Paolo-IMI, specializes in auto and consumer financing. Net attributable income doubled, the ROE increased from 7.4% to 11.2% and the efficiency ratio improved by 8.4 percentage points to 48.8%.
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In March 2003, we reached an agreement with San Paolo to buy its 50% stake in Finconsumo for €140.0 million. The transaction is subject to certain regulatory authorizations.
In Spain, the Hispamer Group specializes in consumer finance through agents. Net attributable income rose 22.2%, the ROE was 20.0% and the efficiency ratio improved by 3.1 percentage points to 42.3%.
We conduct our on-line banking activities through Patagon Spain and Germany.
At the end of 2002, this area had 2 branches and 484 employees (compared with 710 at the end of 2001), of which 10 employees were temporary.
In 2002, this area generated net operating revenue of €119.7 million, as compared to €99.4 million in 2001. Net attributable income was losses of €34.8 million, 9.3% higher than in 2001.
At December 31, 2002, we had 4,021 offices and 52,430 employees in Commercial Banking Latin America (compared with 4,266 and 58,814 respectively, at December 31, 2001), of which 422 were temporary employees. Net attributable income from Commercial Banking Latin America was €1,098.5 million, 8.9% lower than in 2001, while the ROE reached 22.9% (22.8% in 2001) and the efficiency ratio increased to 54.0% (52.7% in 2001). Our total Latin America activities (including Retail Banking, Asset Management and Global Wholesale Banking) accounted for €1,382.7 million1 of our net attributable income for the year ended December 31, 2002. The Group’s Latin American banking business is principally conducted by the following banking subsidiaries:
We engage in a full range of commercial banking activities in Latin America, although the range of our activities varies from country to country. We seek to take advantage of whatever particular business opportunities local conditions present. We engage in a wide array of deposit taking activities throughout Latin America, and other commercial banking activities in Argentina, Brazil, Chile and Mexico. Our primary lending operations are in Mexico, Chile, Puerto Rico and Brazil. Our principal mutual fund operations are in Brazil, Mexico, Chile and Puerto Rico, and our main pension fund operations are in Chile, Mexico, Argentina, Peru and Colombia.
In Latin America, the Group adapted its strategy to each country’s particular situation, while continuing to generate synergies and regional economies of scale.
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Our business growth objectives in Latin America are focused on four countries: Brazil, Chile, Mexico and Puerto Rico. The market shares in the aggregate of these four countries increased 0.6 points in lending in 2002 to 12.0% and 0.7 points in customer funds (deposits+mutual and pension funds) to 10.6%.
Detailed below are the main performance highlights, with particular emphasis on those countries which because of their relative importance are the most significant ones in the Group’s strategy.
Brazil. Santander Banespa is one of the four largest private-sector financial groups in Brazil. It has a very strong position in the south/southeast of the country where 100 million of the approximately total population of 175 million live, and which produces 76% of Brazil’s GDP. In this part of the country, Santander Banespa is the leader in the state of Sao Paulo, one of the three main banks in the city of Sao Paulo and the leader in the state of Rio Grande do Sul. Santander Banespa has 4.6 million customers, close to 2,000 branches and more than 7,500 ATMs. Its market shares are around 4-5% for the country as a whole, with more than double that in the south/southeast, the area of the greatest strategic importance for us.
Since the acquisition of Banespa at the end of 2000, we have focused on improving its efficiency through downsizing, modernizing technology and developing businesses, and with a continued improvement in credit risk quality. In 2002, the increased volatility in the markets led us to be even more vigilant in risks, reducing its portfolio of bonds and cross-border risks.
Income before taxes rose 14.7% in euros to €1,057.9 million (+34.9% at a constant exchange rate) and net attributable income rose 20.5% in Euro to €801.9 million (+41.6% excluding currency depreciation).
The indicators of profitability, efficiency and the degree of recurrent revenues improved in 2002. ROE was 45.3%; the efficiency ratio improved 7.2 points to 42.0% and the recurrence ratio rose from 51.9% in 2001 to 63.1% in 2002.
Mexico. We announced in September 2002 the business integration of Banco Santander Mexicano and Banca Serfin under the new brand name Santander Serfin. This completed a process begun two years earlier and which has led to the full integration of all the businesses and support areas of the two banks. The integration produced advantages in 2002 and will continue to do so in 2003, not only through cost savings and synergies, but also by making the bank stronger and more effective on the business front. More than 4 million customers and potential new ones will be tended to by a single network of more than 1,000 branches and 1,800 ATMs.
Santander Serfin is the third largest financial group in Mexico by business volume and the first in terms of profitability and growth.
In addition to the business integration effective as of the last quarter of 2002, our strategic focus was on developing business and on cutting costs. Net attributable income rose 16.4% to €681.4 million (+24.1% excluding currency depreciation). The efficiency ratio ended 2002 below 50% and the recurrence ratio increased by 7.1 points to 55.0%. ROE was 37.4%.
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An agreement was reached in December 2002 with Bank of America to sell 24.9% of Santander Serfin. The sale of this stake for $1,600 million at 2.9 times book value underscored the value of the Group’s investment in Mexico and in Latin America.
Chile. The merger of Banco Santander Chile and Banco Santiago was effective as of August 1, 2002. The two banks were the leaders in the domestic market and together create the largest bank by business volume, profitability and efficiency. With more than 350 branches and 1,100 ATMs, the new Banco Santander Chile has more than 1.9 million customers, market shares of 22.8% in deposits and 25.5% in loans and 11.1% and 21.2% respectively in pension and mutual funds.
An important development in 2002 was our acquisition on April 17, 2002 of the 35.45% of Banco Santiago held by Banco Central de Chile for $685 million.
Net attributable income was 20.6% lower at €228.9 million (-7.4% excluding the exchange rate effect). Although net attributable income benefited from the increased stake in Banco Santiago, it felt the impact of the sale of insurance companies at the end of 2001, the expiration of the tax credits of the former Banco Santiago and the recording of exceptional charges of €75 million gross relating to the merger.
Our efficiency ratio in Chile stood at 41.6%, 3.3 points better than in 2001, while the recurrence ratio increased 5.6 points to 46.3%. ROE was 19.4%.
Puerto Rico. We are one of the three largest financial groups in Puerto Rico, with 60 branches and 140 ATMs, 300,000 customers and market shares in deposits and loans of 12.0% and 11.0%, respectively, and a strong position in portfolio management.
We focused in 2002 on cleaning up loans and restructuring business, with greater emphasis on developing businesses that generate fees and commissions – mutual funds, cards, trade finance, and insurance – and in the generation of mortgages.
Net attributable income dropped 62.8% to €12.1 million.
Venezuela. In May 2002, Banco de Venezuela and Banco Caracas merged to form Banco de Venezuela, a leading bank by efficiency, profitability and business volume. Banco de Venezuela has 287 branches and 633 ATMs, around 2 million customers and market shares of more than 13%.
The management of Banco de Venezuela in 2002 was guided by criteria of maximum prudence, focusing on generation of liquidity, optimization of the balance sheet structure (reducing the volume of its lowest cost loans and highest cost deposits), risk control and cutting costs. Meanwhile the operational integration of the two banks generated cost savings and enhanced the competitive position of the new bank.
In a very volatile exchange rate environment, with the Venezuelan bolivar falling on average by 37% against the euro, we managed to increase net attributable income by 14.0% to €166.5 million. The efficiency ratio improved 9.1 points to 40.4%, the recurrence ratio rose 4.1 points to 41.1% and ROE reached 43.7% (+17.4 points).
The strategy in Peru, Colombia, Bolivia, Uruguay and Paraguay has focused over the past few years, and particularly in 2002, on three issues: resizing the Group’s installed capacity in these countries, reducing risks and generating liquidity.
As stated earlier, we sold to a Peruvian bank our retail business in Peru in order to concentrate on corporate banking, banking with SMEs, personal banking and pensions.
The net attributable income of these five countries was negative, amounting to -€15.6 million in 2002 as follows: €29.1 million in Peru, €12.0 million in Colombia, €11.6 million in Bolivia, a loss of €2.9 million in Paraguay and a loss of €65.4 million in Uruguay.
Developing our asset management activities has been, and in the foreseeable future will continue to be, one of our main priorities. It is also one of the activities that faces serious competition from other banking and asset management companies.
This area comprises all of our companies whose activity is the management of mutual and pension funds, private banking and bank assurance. At the end of 2002, this area had 195 branches and 6,149 employees (6,908 at the end of 2001), of which 27 were temporary.
In 2002, this area generated net operating revenue of €869.8 million, as compared to €1,032.2 million in 2001. Net attributable income was €327.0 million, down 8.3% from 2001.
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Asset Management in Spain: Over the last four years we have increased our market share in mutual funds from 23.9% in 1998 to 28.2% in 2002. The factors driving this improved performance have been active management of the product mix of our customers, moving them into more conservative risk profiles, leadership in management of higher value added products (real estate funds, alternative management and guaranteed funds) and the shared effort with our distributors in designing innovative and tailor-made products. There was strong growth in alternative management funds (+28% to more than $2,665 million under management). Our real estate funds management entity also registered significant growth (+37.7%).
Asset Management in Latin America: Pension funds under management amounted to €10,859 million (+19.5% excluding the exchange rate effect) and net attributable income (excluding Argentina) was 22.5% higher at €104.1 million. Of note was the effort made to improve the efficiency of this activity, with operating costs falling 26.9% (excluding Argentina). In mutual funds, revenue growth remained positive (+37.8% excluding Argentina), despite the depreciation of Latin American currencies and the volatility of the capital markets. Particularly noteworthy was the performance of our fund management entity in Mexico, which captured 25% of new customers and the success of Puerto Rico (gain of 2.4 percentage points in market share).
Private Banking: As a result of the negative performance of markets, Banif’s revenue declined. This made us focus our strategy on: a) segmentation and concentration in the segment with customers with more than €150,000 to invest (both for capturing new customers as well as service to existing customers), b) specialized advisory services and designing new products to suit the needs of each customer and c) cutting operating costs by more than 5% (-11% in general expenses).
Banif is the leading private bank in Spain with 63,000 customers, €18,100 million of managed funds and net capturing of €1,700 million in 2002.
In International Private Banking, net attributable income was 9% higher than in 2001 and managed funds rose 14% (excluding the exchange rate impact). Control of costs and the measures taken to offset the fall in net interest revenue pushed up net operating income by 9%.
Insurance: Bancassurance in Spain is growing significantly, both in terms of number of insurance policies as well as its contribution to earnings, due to a strategy focused on originating business linked to loans. Premium income in life-risk insurance grew 90% and 94% in household insurance, lifting their respective market shares by 3.0% and 3.4% according to the latest estimates of last year. Fees and commissions paid to the distributors increased 122.8% and net operating revenue rose 77.1%.
In Latin America, Bancassurance rose 53% at constant exchange rates, due to strict control of risks which improved the accident rate of portfolios, and a cost saving policy that produced a 45.5% fall in costs.
Net operating revenue from Global Wholesale Banking was €775.1 million in 2002, as compared to €1,018.4 million in 2001. Net attributable income was €176.3, 52.8% less than in 2001. One of the factors at play was the strong impact of the difficult situation of international markets on overall business and, in particular, on some treasury positions. In this difficult environment, the key elements of the strategy were the drive to generate more recurrent revenue, cost control and adequate use of capital.
At the end of 2002, we had 38 branches and 2,559 employees (2,769 at the end of 2001), of which 58 were temporary employees, dedicated to Global Wholesale Banking.
Our Group serves our large corporate, financial institutions and governments clients’ needs from our headquarters in Spain, our banking subsidiaries in Belgium, Portugal and Latin America, and our branches in London, Frankfurt, Paris, Milan, New York and Miami. The corporate banking unit provides a full range of banking services, among others, bill discounting, global cash management, treasury management services, risk mitigation products, trade finance, correspondent banking, etc.
Net operating income rose 8.2%, spurred by net interest revenue (+1.1%) and net fees and commissions (+12.5%). And with a 5.9% reduction in operating costs, the efficiency ratio improved 2.5% to 23.8%. However, the larger volume of provisions because of the deteriorated environment and prudent management of risks prevented these results from feeding through to income.
Our investment banking operations include brokerage, corporate finance, structured and project finance, and custody services. The corporate finance and structured finance units help our clients in their special financing needs such as, gaining access to the capital markets, acquisition and project finance advice, and mergers & acquisition advice. The brokerage unit
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provides securities execution, dealing and research services. In addition, we provide custody, settlement, and other value added securities related services, and engage in underwriting and dealing activities, mainly with equity and fixed income securities and instruments, in Spain, Portugal, our branch in New York and Latin America.
Investment Banking’s earnings declined because of the markets’ environment. Revenues generated at Santander Central Hispano Bolsa, the Group’s broker-dealer, declined in 2002 because of the reduced trading in stock markets. In Depository Business and Global Custody, Santander Central Hispano maintained its position as a leading bank in the Spanish market, taking over the custody activity in Spain of JP Morgan Chase.
Our treasury operations refer to money, foreign exchange and fixed-income trading in Spain and abroad (Portugal, New York and Latin America), using conventional instruments and derivatives, for our own account and for the account of customers, and for participating in fixed income capital market activities.
The Treasury area’s income declined in 2002 because of the impact of markets on business and strict management of risk, which made it close the more exposed positions in order to end the year with a lower level of market risk.
The Corporate Center acts as the Group’s holding, managing the Group’s capital and reserves and assigning capital and liquidity to the rest of the businesses. It also accounts for centrally managed businesses such as equity stakes, financial management, amortization of goodwill and country risk as well as businesses being launched or wound down.
As a result, this area covers a wide range of centralized activities, which can be divided into four areas:
Net operating loss from Corporate Center was €135.9 million in 2002, as compared to net operating loss of €484.4 million in 2001. Net attributable loss from Corporate Center was €920.4 million, 9.20% higher than in 2001.
At the end of 2002, this area had 184 employees (compared with 340 at the end of 2001), 154 employees were temporary.
We have alliances and financial investments in a number of banking companies, principally in Europe. The following summarizes our most important alliances and financial investments:
The Royal Bank of Scotland Group (“RBS”). We made a strategic alliance with RBS more than 15 years ago. The alliance provides for commercial collaboration between the two groups outside the United States, including, among others, in the areas of venture capital, technology development, and operational cooperation.
At December 31, 2002, we owned 5.0% of RBS, and RBS owned 2.8% of us and 12.7% of Banco Santander Portugal. RBS and we have each agreed to obtain the other’s consent before increasing the ownership or control of the voting securities of the other above certain levels. Each of us has the right, in certain circumstances, to purchase or place any of the shares that the other party (or any affiliate) wishes to dispose of. If such right is not exercised, the shares must be sold, subject to certain exceptions, in a widely dispersed public offering. In addition, we have agreed to vote our holding of shares of RBS in accordance with the directions of the board of directors of RBS. Similarly, RBS has agreed to permit the chairman of Banco Santander Central Hispano, or any other person who presides over a general meeting of shareholders at which a shareholder may vote, to vote RBS’s holding of our shares.
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As of December 31, 2001, we had an 8.0% holding in the capital stock of RBS. In 2002, we made a net divestment of 3% of our holding in RBS, giving rise to gains of approximately €806 million.
Commerzbank. At December 31, 2001, we owned 4.7% of Commerzbank. During 2002, we sold a 1% stake of our holding in Commerzbank. At December 31, 2002, we owned 3.7% of Commerzbank.
San Paolo-IMI. At December 31, 2002, we owned 5.2% of the capital stock of San Paolo-IMI, one of the largest banking groups in Italy in terms of assets. San Paolo-IMI controls Intereuropa Bank, a Hungarian bank in which we own a 10% stake. We also manage Finconsumo Banca S.p.A (Italy), the 50/50 joint venture between San Paolo-IMI and CC-Bank, as described above in “Consumer Financing in Europe.”
In March 2003, we increased our stake in San Paolo IMI from 5.38% to 6.36% for a total price of €124.9 million and we agreed to buy the 50% stake of Finconsumo owned by San Paolo-IMI.
Banque Commerciale du Maroc. At December 31, 2002, we had a 20.3% interest in Banque Commerciale du Maroc (Morocco), which engages mainly in trade finance and foreign investment activities. Together with Banque Commerciale du Maroc we have a 50% joint venture in Attijari International Bank, which specializes in trade finance in Tangier’s free trade zone.
The majority of our industrial holdings portfolio consists of investments in strategic sectors related to the growth of the Spanish economy. Through our investments in these areas, we aim to be present in these sectors as a long-term investor. Our investments in non-financial companies focus on long-term growth sectors, such as telecommunications.
The following table summarizes our main industrial holdings at December 31, 2002:
We continued our strategy of balancing the negative contribution from companies being developed with the positive contribution of companies generating income and distributing dividends. We realize capital gains from the sale of stakes when the circumstances are right.
As of December 31, 2002, the unrealized capital gains of our Central Portfolio were estimated at €2,600.0 million.
For a breakdown of our total revenues by category of activity and geographic market please see note 27 of our Consolidated Financial Statements.
The following tables show our selected statistical information.
The following table shows, by domicile of customer, our average balances and interest rates for each of the past three years. The differences between our average balances and interest rates in many cases reflect to some extent the different extent of consolidation of entities acquired by us in 2000 and 2001. See “Presentation of Information”.
You should read the following tables and the tables included under “Changes in Net Interest Income—Volume and Rate Analysis” and “Earning Assets—Yield Spread” in light of the following observations:
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The following table allocates, by domicile of customer, changes in our net interest income between changes in average volume and changes in average rate for 2001 compared to 2000 and 2002 compared to 2001. We have calculated volume and rate variances based on movements in average balances over the period and changes in interest rates on average interest-earning assets and average interest-bearing liabilities. We have allocated variances caused by changes in both volume and rate to volume. You should read the following tables and the footnotes thereto in light of our observations noted in the preceding sub-section entitled “Average Balance Sheets and Interest Rates”.
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The following table analyzes, by domicile of customer, our average earning assets, interest and similar income and dividends on equity securities and net interest income and shows gross yields, net yields and yield spread for each of the years indicated. You should read this table and the footnotes thereto in light of our observations noted in the preceding sub-section entitled “Average Balance Sheets and Interest Rates”, and the footnotes thereto.
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The following tables present our selected financial ratios for the years indicated as reported in our Spanish Statutory Financial Report.
The following table shows, by domicile of customer, the percentage mix of our average interest-earning assets for the years indicated. You should read this table in light of our observations noted in the preceding sub-section entitled “Average Balance Sheets and Interest Rates”, and the footnotes thereto.
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The following table shows our short-term funds deposited with other banks, at each of the dates indicated.
At December 31, 2002, the book value of our investment securities was €64.9 billion (representing 20.0% of our total assets). These investment securities had a yield of 7.16% in 2002, compared with a yield of 7.02% earned during 2001. €25.0 billion, or 38.5%, of our investment securities consisted of Spanish government and government agency securities, 14.72% of which consisted of Spanish Treasury bills that had a yield of 3.67% in 2002. For a discussion of how we value our investment securities, see note 2(d) to our consolidated financial statements.
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The following table shows the book values of our investment securities by type and domicile of counterparty at each of the dates indicated.
The following table analyzes the aggregate book value and aggregate market value of the securities of single issuers, other than the governments of the United States that exceeded 10% of our stockholders’ equity as of December 31, 2002.
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The following table analyzes the maturities and weighted average yields of our debt investment securities (before allowances for loan-losses and price fluctuations) at December 31, 2002. Yields on tax-exempt obligations have not been calculated on a tax-equivalent basis because we do not believe the effect of such a calculation would be material.
At December 31, 2002, our total loans equaled €167.9 billion (51.8% of our total assets). Net of allowances for loan-losses, loans equaled €163.0 billion (50.3% of our total assets). In addition to loans, we had outstanding at December 31, 1998, 1998 (proforma), 1999, 2000, 2001 and 2002 €21.8 billion, €34.5 billion, €44.2 billion, €54.3 billion, €49.6 billion and €49.1 billion of undrawn credit line commitments.
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The following table analyzes our customer loans (including securities purchased under agreement to resell), by domicile and type of customer, at each of the dates indicated.
At December 31, 2002, our loans to un-consolidated subsidiaries and associated companies amounted to €1,364.5 million (See “Item 7 —Major Shareholders and Related Party Transactions —B. Related Party Transactions”). Excluding government-related loans, the largest outstanding exposure at December 31, 2002 was €1.7 billion (1.0% of total loans, including government-related loans), and the five next largest exposures totaled €5.8 billion (3.4% of total loans, including government-related loans).
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The following table sets forth an analysis by maturity of our loans by domicile and type of customer at December 31, 2002.
The following table sets forth a breakdown of our fixed and variable rate loans having a maturity of one year or more at December 31, 2002.
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The following table sets forth, as of the end of the years indicated, the aggregate amount of our cross-border outstandings (which consist of loans, interest-bearing deposits with other banks, acceptances and other monetary assets denominated in a currency other than the home- country currency of the office where the item is booked) where outstandings in the borrower’s country exceeded 0.75% of our total assets. Cross-border outstandings do not include local currency loans made by subsidiary banks in other countries to the extent that such loans are funded in the local currency or hedged. As a result, they do not include the vast majority of the loans by our Latin American subsidiaries.
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The following table sets forth the amounts of our cross-border outstandings as of December 31 of each year by type of borrower where outstandings in the borrower’s country exceeded 0.75% of total assets.
Non-Performing Past-Due Assets.The Bank of Spain requires Spanish banks to classify as non-performing certain amounts of any loan, fixed-income security, guarantee and certain other extensions of credit on which any payment of principal or interest is 90 days or more past due (“non-performing past-due assets”). Banks must classify as non-performing the partial amount of any principal of or accrued interest on such asset that is 90 days or more past due until (1) this amount is more than 25% of the outstanding balance of the asset or (2) any installment of principal or interest is 12 months or more past due (6 months in case of loans to individuals not for purposes of financing business activities). When those conditions are met, banks must classify the entire outstanding principal of and accrued interest on the asset as non- performing. In relation with the joint risk exposure (including off-balance sheet risks) to one single obligor, if the amount of non-performing balances exceeds 25% of the outstanding risks (excluding non-accrued interests), then the bank must classify all outstanding risks as non-performing.
Once a partial amount of any loan is classified as non-performing, the entire loan is placed on a non-accrual status.
Other Non-Performing Assets. The Bank of Spain requires Spanish banks to classify any loan, fixed-income security, guarantee and certain other extensions of credit as non-performing if it has a reasonable doubt that the extension of credit will be collected (“other non- performing assets”), even if any past due payments have been outstanding for less than 90 days or the asset is otherwise performing. When a bank classifies an asset as non-performing on this basis, it must classify the entire principal amount of the asset as non-performing. The Bank of Spain also requires Spanish banks to classify as non-performing the entire outstanding principal of and accrued interest on any extension of credit to category 5 (very doubtful) countries or residents of category 5 countries to the extent it is not otherwise classified as non-performing. See “Country-Risk Outstandings”.
Once any of such assets is classified as non-performing, it is placed on a non-accrual status.
These classification criteria differs from US GAAP requirements. For an estimation of the amounts to be classified as non-performing under US GAAP see Note 16 to the Selected Consolidated Financial Information table on page 10 of this report.
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The Bank of Spain requires Spanish banks to classify as country-risk outstandings all loans, fixed-income securities and other outstandings to any countries, or residents of countries, that the Bank of Spain has identified as being subject to transfer risk or sovereign risk and the remaining risks derived from the international financial activity. The Bank of Spain has established six categories for classifying such countries, as shown in the following table:
The Bank of Spain allows each bank to decide how to classify the listed countries within this classification scheme, subject to Bank of Spain oversight. The classification is made based on criteria such as the risk global assessment according to the evolution of the balance of payments, the level of the outstanding debt and of the charges for debt services, the debt quotations in the international secondary markets and other indicators and factors of each country as well as all the criteria indicated by the Bank of Spain. It excludes from country-risk outstandings:
any interbank obligations of branches of foreign banks in the European Economic Space and of the Spanish branches of foreign banks;
some cases where securities are denominated in local currency;
With certain requirements, it treats guaranteed outstandings as outstandings to the guarantor.
The Bank of Spain requires Spanish banks to classify outstandings to countries or residents of countries in categories 1, 2, 3 and 4 on the basis of the criteria described below under “Item 4. Information on the Company—B. Business Overview Bank of Spain Allowances for Loan-Losses and Country Risk Requirements—Specific Provisions for Loan-Losses”. The Bank of Spain requires Spanish banks to classify as non-performing any loan in category 5, and to write-off the entire outstanding principal of and accrued interest on any outstandings to countries or residents of countries in category 6 (see the subsection below in this Item 4 entitled “Bank of Spain Charge-Off Requirements”).
The Bank of Spain requires Spanish banks to stop accruing interest on the entire principal amount of any asset that is classified as non-performing, even if only a portion of the asset is classified as non-performing, and on category 3 (transitory difficulties) and category 4 (doubtful) country-risk outstandings, whether or not they are non-performing. The banks must account for such collected interest on a cash basis, recording interest payments of the current year as interest income and interest payments of previous years as extraordinary income or recoveries of written-off assets, as appropriate.
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The following table shows the amount of interest owed on non-accruing assets and the amount of such interest that was received when due and when past due:
Non-Performing Past-Due Assets. Except for fully secured past-due mortgage assets and financial leases on certain types of properties, the Bank of Spain requires Spanish banks to set aside specific allowances for non-performing past-due assets. The amount of the required allowance is the product of the amount of the asset treated as non-performing (see “Bank of Spain Classification Requirements—Non-Performing Assets” above) times the percentages set forth in the following table. The allowance must be maintained for so long as the non-performing portion of the asset is carried as an asset on the banks’ balance sheets.
Fully-Secured Non-Performing Past-Due Mortgage Assets and financial leases on certain types of properties. If a non-performing asset is a fully secured non-performing past-due mortgage or a financial lease and certain conditions are met, the amount of the required allowance is the product of the amount of such asset times the percentages set forth in the following table instead of the preceding table. Such asset must satisfy three conditions: first, the asset is secured by a mortgage or a right of ownership (in case of a financial lease) on a finished residential property; second, such mortgage or right of ownership was placed on the property at the time the extension of credit was made; and third, the outstanding risk does not exceed 80% of the appraisal value of such mortgaged or leased property.
The only exception to these requirements is that when a bank treats otherwise performing assets to a single borrower as non-performing because of a non-performing 25% as set forth in “Bank of Spain Classification Requirements—Non-Performing Past Due Assets” above, the Bank of Spain does not require the bank to carry an allowance against any asset that has no overdue principal or interest payments.
Other Non-Performing Assets. If a non-performing asset is an other non-performing asset, see “Item 4. Information on the Company—B. Business Overview—Bank of Spain Classification Requirements—Non-Performing Assets—Other Non-Performing Assets”, the amount of the required allowance should not be less than 25% of the amounts treated as non-performing. When the treatment of such asset as a non-performing asset is due to, in management’s opinion, an inadequate financial or economical condition of the borrower, and the amount estimated as non-collectible is less than 25% of the outstanding debt, the amount of the required allowance will be at least 10% of the outstanding debt.
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Exceptions. The foregoing allowance requirements do not apply to any non-performing asset that is:
General Allowance
When calculating the general allowance for loan-losses on those investments in a bond fund that ranks behind unsubordinated securities on a winding up of the fund, the bank must include an amount equal to the coverage that the bank itself would have if the bank had a direct pro-rata interest in the underlying bond portfolio. If such provision is made, the bank is not required to make any other general allowance for securities issued by the bond fund.
Since July 1, 2000, the Bank of Spain has required Spanish banks to create an allowance for the statistical coverage of non-performing assets based on an estimation of future credit losses in the credit portfolio. This new allowance is in addition to the other allowances described above.
Spanish banks may estimate the provisions to be made to create this allowance using models based on their own credit loss experience and management’s estimation of future credit losses. In devising these models, which form a required part of a sound risk measurement and management system, management must take into consideration the quality of counterparties, the existence of guarantees or collateral, the term of the transactions and the expected evolution of the credit risk depending on medium and long term changes in the economic cycle. Furthermore, the models must use historical data covering at least a whole economic cycle and must be validated by the Bank of Spain.
As an alternative to the internal model referred to above (or as an alternative for some types of credit risk) Spanish banks may calculate the provisions to be made to create the allowance by applying to the amount of computable credit risk (loans, fixed income securities not included in the trading portfolio, contingent liabilities and non-performing assets exempted from the requirements for a specific allowance for insolvency or country-risk, and excluding risks with Spanish government entities and risks with credit institutions) in each of the categories set forth below the following coefficients:
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Assets in this category include risks described in paragraph “Exceptions” above.
Assets in this category include:
Assets in this category include financial leases and mortgages and pledges on tangible assets that are not included in other categories, provided that the estimated value of the financial leases and the collateral totally covers the outstanding risk.
Assets in this category include assets on Spanish residents or residents of countries classified in categories 1 or 2, provided that such assets are not included in other categories.
Assets in this category include loans to individuals for the acquisition of durable consumption goods or other goods or current services not for professional use, except those registered in the “Registro de Ventas de Bienes Muebles”; and risks with residents of countries classified in categories 3 to 6, to the extent not covered by country risk allowances.
Assets in this category include credit card balances; current account overdrafts and excesses in credit accounts (except those included in categories (a) and (b)), and doubtful assets not subject to a mandatory allowance not included in letter “a”.
Contingent liabilities will be weighted using the percentages set forth in the capital regulations of the Bank of Spain.
Provisions made to meet the statistical allowance requirements are charged quarterly against income in the amount of the positive difference between one fourth of the amount of the required statistical allowance and the amount of net provisions for the other allowances for loan-losses in that quarter. If the difference is negative, the amount is credited to income with a charge to the allowance, but only to the extent of the existing balance of that allowance.
Net provisions in net income statement include the provisions for the specific coverage of non-performing assets, plus provisions for the general coverage of non-performing assets, plus write-offs, less the recoveries of the specific allowance and foreclosed assets. It does not include country-risk provisions.
The amount of the allowance for the statistical coverage of loan-losses may be, at a maximum, three times the sum of the products of the amount of credit risk in each category multiplied by the risk coefficient of each such category.
The Bank of Spain requires Spanish banks to set aside an allowance for country risk on all country-risk outstandings. See the above sub-section entitled “Bank of Spain Classification Requirements—Country-Risk
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Outstandings”. The amount of the required provision is the product of the amount of the outstanding loans times the percentages set forth in the following table.
Under the recent Bank of Spain guidelines, as a result of the recent international economic crises, and the increasing presence of Spanish banks in Latin America and Southeast Asia, we are subject to more stringent information requirements. Banks that have risks in countries that do not fall within category 1, or banks that have subsidiaries abroad, or banks in which risks or liabilities with non-residents in Spain equal at least €5 million, must now complete new information statements when presenting their accounts.
The Bank of Spain requires some guarantees to be classified as non-performing in the following amounts:
The Bank of Spain requires Spanish banks to carry assets acquired on foreclosure at their net value (defined as the lower of (i) the face value of the loan secured (net of any related provision for non-performing asset) and (ii) the appraised market value of the foreclosed asset), reduced by allowances (expressed as a percentage of net value), as follows: if the asset is held between three and four years —25%; between four and five years —50%; more than five years —75%. In any event, net asset value can never exceed the market value of the asset. Bank of Spain regulations allow a release of allowances to the extent that the independently appraised value of the assets acquired upon foreclosure (appraised each year subsequent to the first date on which a provision would be required) exceeds the net value of such assets, but requires that a minimum allowance be maintained at all times equal to 25% of the outstanding principal of the underlying loan at the time of foreclosure and 100% of the outstanding interest at that time. Provisions made to this allowance are set forth as extraordinary loss in our consolidated financial statements.
The Bank of Spain requires Spanish banks to charge-off immediately only those extensions of credit that management believes will not be repaid at any time or that were made to category 6 (“bankrupt”) countries or residents of such category 6 countries. See the above sub- section entitled “Item 4. Information on the Company—B. Business Overview—Bank of Spain Classification Requirements—Country Risk Outstandings”. It requires Spanish banks to charge-off non-performing assets three years after they were classified as non-performing. They may carry fully secured past-due mortgage loans beyond this three-year deadline for up to six years if there are objective factors that indicate an improved likelihood of recovery.
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The following table analyzes movements in our allowances for loan-losses and movements, by domicile of customer, for the years indicated. See “Presentation of Information” for further discussion of movements in the allowances for loan-losses, see “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Net Provisions for Loan-Losses and Country Risk”.
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The table below shows a breakdown of charge-offs, recoveries and provisions by type of borrower for the years indicated.
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The following table shows our non-performing assets. We do not keep records classifying assets as non-accrual, past due, restructured or potential problem loans, as those terms are defined by the SEC. But we have estimated the amount of our assets that would have been so classified, to the extent possible, below.
We do not believe that there is a material amount of assets not included in the foregoing table and the table under “Country Risk Outstandings” below where known information about possible credit risk at December 31, 2002 (not related to transfer risk inherent in cross- border lending activities) gave rise to serious doubts as to the ability of the borrowers to comply with the loan repayment terms at such date.
The following table shows the quarterly movement in our non-performing assets (excluding country-risk, see “Country-Risk”) from December 31, 2000 until December 31, 2002.
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The following table shows the ratio of our non-performing assets to total computable credit risk and our coverage ratio at December 31, 2000, 2001 and 2002.
The following table sets forth our country-risk outstandings for the years shown.
As described above under “Item 4. Information on the Company—B. Business Overview—Bank of Spain Classification Requirements—Non-Performing Assets” and “Country Risk Outstandings”, we do not classify our loans to borrowers in countries with transitory difficulties (category 3) and doubtful countries (category 4) as non-performing. However, as described above under “Item 4. Information on the Company — B. Business Overview — Bank of Spain Provisions for Loan-Losses and Country Risk Requirements—Provisions for Country Risk” and “Bank of Spain Non-Accrual of Interest Requirements”, the Bank of Spain requires us to account for such loans on a cash basis (non-accruing) and to set aside certain allowances for such loans. We treat category 5 (very doubtful) country-risk outstandings as both non- accruing and non-performing. Total other non-accruing assets at December 31, 1998, 1998 (proforma), 1999, 2000, 2001 and 2002 were, €858.9 million, €1,085.4 million, €1,331.8 million, €1,313.7 million, €1,172.2 million and €259.5 million, respectively.
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We do not have any past-due loans 90 days or more that are accruing interest, in accordance with Spanish GAAP requirements.
As of December 31, 2002 the amount of “restructured loans” was €61.4 million.
The table below sets forth movements in our foreclosed assets for the years shown.
The principal components of our deposits are domestic demand, savings and time deposits, and international and domestic interbank deposits. Our retail customers are the principal source of its domestic demand, savings deposits and time deposits. For an analysis, by domicile of customer, of average domestic and international deposits by type for 2000, 2001 and 2002, see “Average Balance Sheets and Interest Rates—Liabilities”.
We compete actively with other commercial banks and with savings banks for domestic demand and savings deposits. Our share of customer deposits in the Spanish banking system (including Cajas de Ahorros) was 17.7% at December 31, 2002, according to figures published by the Spanish Banking Association (AEB) and the Confederación Española de Cajas de Ahorros (“CECA”). See “Item 4. Information on the Company—B. Business Overview—Competition”.
The following tables analyze our year-end deposits.
Deposits (Due to Credit Entities and Customer funds) by type of deposits
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The following table shows the maturity of time deposits (excluding inter-bank deposits) in denominations of $100,000 or more for the year ended December 31, 2002. Large denomination customer deposits may be a less stable source of funds than demand and savings deposits.
The aggregate amount of deposits held by non-resident depositors (banks and customers) in our domestic branch network was €16.7 million, €20.0 million and €19.7 million at December 31, 2000, 2001 and 2002, respectively.
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The following table analyzes our short-term borrowings as of December 31, 2000, 2001 and 2002.
We face strong competition in all of our principal areas of operation from other banks, savings banks, credit co-operatives, brokerage houses, insurance companies and other financial services firms.
Banks
Two Spanish banking groups dominate the commercial banking sector in Spain: Banco Bilbao Vizcaya Argentaria, S.A. and Banco Santander Central Hispano, S.A.
At the end of December 2002, these two Spanish banking groups accounted for approximately 63.6% of loans and 67.0% of deposits of all Spanish banks, which in turn represented 33.0% of loans and 33.2% of deposits of the financial system, according to figures published by the Spanish Banking Association (AEB) and the Confederación Española de Cajas de Ahorro (“CECA”). These banking groups also hold significant investments in the Spanish industry.
Foreign banks also have a presence in the Spanish banking system as a result of liberalization measures adopted by the Bank of Spain since 1978. At December 31, 2002, there were 59 foreign banks (of which 50 were from European Union countries) with branches in Spain.
Spanish law provides that any financial institution organized and licensed in another member state of the European Union may conduct business in Spain from an office outside Spain. They do not need prior authorization from Spanish authorities to do so. Once the Bank of Spain receives notice from the institution’s home country supervisory authority about the institution’s proposed activities in Spain, the institution is automatically registered and the proposed activities are automatically authorized.
The opening of a branch of any financial institution authorized in another member state of the European Union does not need prior authorization or specific allocation of resources. The opening is subject to the reception by the Bank of Spain of a notice from the institution’s home country supervisory authority containing, at least, the following information:
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Once the Bank of Spain receives the notice, it notifies the financial institution, thereby permitting the branch to be registered in the Mercantile Register and, then, in the Special Register of the Bank of Spain.
Spanish law requires prior approval by the Bank of Spain for a Spanish bank to acquire shares of a bank organized outside the European Union, create a new bank outside the European Union or open a branch outside the European Union. Spanish banks must provide prior notice to the Bank of Spain to conduct any other business outside the European Union.
In case of creation of a new bank, the following information has to be provided to the Bank of Spain:
The opening of branches outside Spain requires the prior application to the Bank of Spain attaching information about the State where the branch will be located, the address, program of activities and names of the branch’s managers. The opening of representative offices requires prior notice to the Bank of Spain, detailing the activities to perform.
Spanish savings banks (“Cajas de Ahorros”) are mutual organizations which engage in the same activities as banks, but primarily take deposits and make loans, principally to home buyers, public housing programs and small to medium-sized companies. The savings banks are influenced by regional and local governments. The Spanish savings banks provide strong competition for the demand and savings deposits which form an important part of our deposit base. Spanish savings banks, which traditionally were regional institutions, are permitted to open branches and offices throughout Spain. In the last four years, mergers among savings banks increased. The Spanish savings banks’ share of domestic deposits and loans were 53.9% and 46.4%, respectively, at December 31, 2001 and 55.9% and 48.5%, respectively, at December 31, 2002.
Credit co-operatives are active principally in rural areas. They provide savings bank and loan services, including financing of agricultural machinery and supplies.
We face competition in our brokerage activities in Spain from brokerage houses of other financial institutions.
Spanish law provides that any investment services company authorized to operate in another member state of the European Union may conduct business in Spain from an office outside Spain, once the Securities National Commission (Comision Nacional del Mercado de Valores – CNMV) receives notice from the institution’s home country supervisory authority about the institution’s proposed activities in Spain
However, Spanish law provides that beginning January 1, 2000, credit entities have access, as members, to the Spanish stock exchanges, in accordance with the provisions established by the Investment Services Directive.
We also face strong competition in our mutual funds, pension funds and insurance activities from other banks, savings banks, insurance companies and other financial services firms.
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The Bank of Spain, which operates as Spain’s autonomous central bank, supervises all Spanish financial institutions, including us. Until January 1, 1999, the Bank of Spain was also the entity responsible for implementing Spanish monetary policy. As of that date, the start of Stage III of the European Monetary Union, the European System of Central Banks and the European Central Bank became jointly responsible for Spain’s monetary policy. The European System of Central Banks consists of the national banks of the fifteen Member States belonging to the Euro zone and the European Central Bank. The European Central Bank is responsible for the monetary policy of the European Union. The Bank of Spain, as a member of the European System of Central Banks, takes part in the development of the European System of Central Banks’ powers including the design of the European Community’s monetary policy.
The European System of Central Banks is made up of three decision-making bodies:
The Governing Council is the body in charge of formulating monetary policy and adopting the guidelines and decisions necessary to perform the European System of Central Banks’ tasks. The Executive Board is the body in charge of implementing the monetary policy laid out by the Governing Council and providing the instructions necessary to carry out monetary policy to the national central banks.
The European Central Bank has delegated the authority to issue the euro to the central banks of each country participating in Stage III. These central banks will also be in charge of executing the European Community’s monetary policy in their respective countries. The countries that do not take part in Stage III will have a seat in the European System of Central Banks, but will not have a say in the monetary policy or instructions laid out by the governing council to the national central banks.
Notwithstanding the European Monetary Union, the Bank of Spain continues to be responsible for:
The Bank of Spain has the following supervisory powers over Spanish banks, subject to rules and regulations issued by the Ministry of Economy:
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European Central Bank regulations that came into force on January 1, 1999, require credit institutions in each member state that participates in the European Monetary Union, like us, to place a specific percentage of their “Qualifying Liabilities” with the respective central banks in the form of interest bearing deposits as specified below (the “Liquidity Ratio”).
The European Central Bank requires the maintenance of a minimum liquidity ratio at all credit institutions established in the member states of the European Union. Branches located in the euro zone of institutions not registered in this area are also subject to this ratio, while the branches located outside the euro zone of institutions registered in the euro zone are not subject to this ratio.
The European Central Bank can waive this obligation with respect to institutions that are in the process of winding-up or reorganization.
“Qualifying Liabilities” are broadly defined as deposits, debt securities issued and money market paper. The Liquidity Ratio is 2% over Qualifying Liabilities except in relation to deposits with stated maturity greater than two years, deposits redeemable at notice after two years, repos and debt securities with a stated maturity greater than two years, for which the ratio is 0%.
Liabilities of institutions subject to the Liquidity Ratio and liabilities of the European Central Bank and national central banks are not included in the base of “Qualifying Liabilities”.
The Spanish government has the power to require credit institutions to invest a portion of certain qualifying liabilities in certain kinds of public sector debt or public-interest financing (the “investment ratio”), and has exercised this power in the past. Although the investment ratio has been 0% since December 31, 1992, the law which authorizes it has not been abolished, and the Spanish government could reimpose the ratio, subject to EU requirements.
We and our Spanish bank subsidiaries are subject to Spanish capital adequacy requirements that implement the European Union Capital Adequacy Directive.
The Spanish capital adequacy requirements distinguish between “core” and “complementary” capital and require certain ratios of core and total capital to risk-weighted assets. Core capital generally includes voting equity, certain non-voting equity, most reserves and generic loan allowances less participations in other financial institutions exceeding certain thresholds, treasury stock and financing for the acquisition (by persons other than the issuer’s employees) of the issuer’s shares. Complementary capital generally includes certain non-voting equity, revaluation and similar reserves, subordinated debt and perpetual debt.
The computation of both core and complementary capital is subject to provisions limiting the type of stockholding and the level of control which these stockholdings grant to a banking group. The level of non-perpetual subordinated debt taken into account for the calculation of complementary capital may not exceed 50% of core capital and the total amount of complementary capital admissible for computing total capital may not exceed the total amount of core capital.
The consolidated total of core and complementary capital of a banking group calculated in the manner described above may not be less than 8% of the group’s risk-weighted assets net of specified provisions and amortizations. The calculation of total risk-weighted assets applies minimum multipliers of 0%, 20%, 50% and 100% to the group’s assets.
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Spanish regulations provide that, if certain requirements are met, Spanish banks may include the net credit exposure arising from certain interest rate -and foreign exchange- related derivative contracts (rather than the entire notional amount of such contracts) in their total risk- adjusted assets for purposes of calculating their capital adequacy ratios.
At December 31, 2002, our ratio of total capital to risk-weighted assets was 10.96%, which reflected a 34.27% (€5.5 billion) excess of stockholders’ equity over the applicable capital and reserve requirements. Our Spanish subsidiary banks were, at December 31, 2002, each in compliance with these capital adequacy requirements, and all our foreign subsidiary banks were in compliance with their local regulation.
Banks or consolidated banking groups should comunicate inmediately to Bank of Spain if they fail to satisfy minimum capital requirements, and within the next month should present a plan to recover the solvency. This plan could be modified by Bank of Spain. While the deficit persists, the payment of dividends by any of the entities of the banking Group must be approved by Bank of Spain, and will be limited to a maximum of 50% of net income. Payment of dividends could be forbidden if the deficit of capital is greater than 20% of minimum capital requirements. See “Item 4. Information on the Company-B. Business Overview-Restrictions on Dividends”.
The Basel Committee on Banking Regulations and Supervisory Practices, which includes the supervisory authorities of twelve major industrial countries, has adopted an international framework (the “Basel Accord”) for capital measurement and capital standards of banking institutions. The framework provides:
As described above, the capital adequacy of Spanish banks is regulated by European Union directives applicable to the Spanish banking system as well as to the banking systems of other European Union member states. Certain European Union member states are parties to the Basel Accord. Spain joined the Accord on February 1, 2001. Each national authority which is a party to the Basel Accord has implemented the Accord in a significantly different fashion. The capital requirements imposed by the Basel Accord are in many respects similar to those imposed by European Union directives, Spanish law and the Bank of Spain. Based purely on the capital framework itself, and making assumptions that we consider appropriate (but without including in Tier 2 capital any revaluation reserves), we estimate that at December 31, 2002, we had (1) a total capital to risk-weighted assets ratio of 12.64%, and (2) a Tier 1 capital to risk-weighted assets ratio of 8.01%.
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In January 2001, the Basel committee on Banking Supervision released the second Consultative Package of the New Basel Capital Accord which will replace the 1988 Accord. This Accord regulates the capital requirements for financial institutions. The final version is expected to be published in 2003, and to be implemented in 2006.
The New Accord introduces more emphasis on risk sensitivity, supervisory review and market discipline (through more extensive disclosures). The impact of the new regulation is not expected to increase the capital requirements, but will increase its volatility.
Spanish banks may not have exposure to a single person or group in excess of 25% (20% in the case of an affiliate) of the bank’s or group’s consolidated equity. Any exposure to a person or group exceeding 10% of a bank’s or group’s consolidated equity is deemed a concentration and the total amount of exposure represented by all of such concentrations must not exceed 800% of such equity.
Spanish banks are subject to legal and other restricted reserves requirements. In addition, we must allocate profits to certain other reserves as described under Note 21 to our consolidated financial statements.
For a discussion of Bank of Spain regulations relating to allowances for possible credit losses and country risk, see “Item 4. Information on the Company—B.Business Overview—Selected Statistical Information—Classified Assets—Bank of Spain Classification Requirements—Non-Performing Assets” and “Country-Risk Outstandings”.
The Bank of Spain requires Spanish bank pension funds to be fully funded. At December 31, 2002, our pension plans were all fully funded. See Note 2(j) to our consolidated financial statements.
We may only pay dividends (including interim dividends) if such payment is in compliance with the Bank of Spain minimum capital requirement (described under “Item 4. Information on the Company—B. Business Overview —Capital Adequacy Requirements”) and other limitations or, as described below, under certain circumstances when we have capital that is 20% or less below the Bank of Spain minimum capital requirements.
If a banking group meets this capital requirement, it may dedicate all of its net profits to the payment of dividends, although in practice Spanish banks nomally consult with the Bank of Spain before declaring a dividend. Even if a banking group meets the capital requirement as a group, any consolidated Spanish credit entity that is a subsidiary that does not meet the capital requirement on its own will be subject to the limitations on dividends described below. If a banking group or any Spanish credit entity subsidiary of the group has capital that is 20% or less below the Bank of Spain minimum capital requirement, it must devote an amount of net profits (at least 50%) determined by the Bank of Spain to reserves, and dividends may be paid out of the remainder only with the prior approval of the Bank of Spain. If the capital is 20% or more below the minimum requirement, it may not pay any dividends and must allocate all profits to reserves. In the case of a banking group failing to meet the capital requirement, however, consolidated subsidiaries in the group may pay dividends without restriction, so long as they are at least 90% owned by group companies and, if they are credit entities, independently comply with the capital requirement.
If a bank has no net profits, its board of directors may propose at the general meeting of the shareholders that a dividend be declared out of retained earnings. However, once the board of directors has proposed the dividend to be paid, it must submit the proposal to the Minister of Economy who, in consultation with the Bank of Spain, may in his discretion authorize or reject the proposal of the board.
Compliance with such requirements notwithstanding, the Bank of Spain is empowered to advise a bank against the payment of dividends on security and soundness grounds. If such advice is not followed, the Bank of Spain may require that notice of such advice be included in the bank’s annual report. In no event may dividends be paid from certain legal reserves.
Interim dividends may not exceed the net profits for the period from the closing of the previous fiscal year to the date on which interim dividends are declared. In addition, the Bank of Spain recommends that interim dividends not exceed an amount equal to one-half of all net income from the beginning of the corresponding fiscal year. According to the recommendations of the Bank of Spain, interim dividends may not be declared until the Bank of Spain has
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sufficient knowledge about the year’s profits. Although banks are not legally required to seek prior approval from the Bank of Spain before declaring interim dividends, the Bank of Spain has asked that banks consult with it on a voluntary basis before declaring interim dividends.
Spanish banks generally are not subject to any prohibitions on the types of businesses that they may conduct, although they are subject to certain limitations on the types of businesses they may conduct directly.
The activities that the credit institutions authorized in another member state of the European Union may conduct and which benefit from the mutual recognition within the European Union, are detailed in article 52 of Law 26/1988 (July 29, 1988).
The Deposit Guarantee Fund on Credit institutions, (“Fondo de Garantía de Depósitos”, or the “FGD”), which operates under the guidance of the Bank of Spain, guarantees (i) bank deposits up to €20,000 per depositor; and (ii) securities and financial instruments which have been relied to a credit institution for its deposit, register or for such other service, up to €20,000 per investor. Pursuant to regulations affecting the FGD, the FGD may purchase non-performing loans or may acquire, recapitalize and sell banks which experience difficulties.
The FGD is funded by annual contributions from member banks. The amount of such bank’s contributions is currently 0.6 per thousand (0.4 per thousand for savings banks and 1 per thousand for credit cooperatives) of the year-end amount of deposits to which the guarantee extends. For that purpose, the calculation basis will take into consideration the bank deposits, plus 5% of the market quotation (or nominal value or redemption value in case the securities are not traded in any secondary market) of the guaranteed securities at the end of the financial year. Nevertheless, the Minister of Economy may reduce the member bank contributions once the capital of the FGD resources exceeds its requirements, and suspend further contributions when the FGD’s funds exceed the requirement by 1% or more of the calculation basis.
At December 31, 2002, we and our other domestic bank subsidiaries were members of the FGD and thus obligated to make annual contributions to it.
The start of the European Monetary Union’s Stage III has influenced recent legislation in Spain, expressly Law 46/1998 (December 17, 1998), introducing the euro as national currency, ensuring the coexistence, from 1999 through 2002, of both the euro and the Spanish peseta, and providing that the Bank of Spain becomes fully integrated into the European System of Central Banks. See also “Item 4. Information on the Company—B. Business Overview—Bank of Spain and the European Central Bank” and “—Monetary Policy and Exchange Controls”.
Law 37/1998 amended Securities Markets Law 24/1988. This change to recent Legislation introduced several amendments to the original Securities Markets Law. See “Item 4. Information on the Company—B. Business Overview—Competition” and “Item 9. The Offer and Listing— C. Markets—Spanish Securities Market—Securities Market Legislation”.
Law 41/1998 (December 9, 1998), on taxation of non-resident individuals and companies, combined the legislation on non-residents that was previously divided between the Personal Income Tax (“IRPF”) and Corporate Tax (“IS”). A new Law on IRPF, Act 40/98, abolished the prior Act relating to taxation on individuals.
Law 1/1999 (January 5, 1999) regulates venture capital companies and their management companies.
Law 9/1999 (April 12, 1999) provides for a legal regime for cross-border credit transfer among members states in the European Union.
Royal Decree 664/1999 on Foreign Investment (April 23, 1999) provides for the free movement of capital for foreign investment in Spain, and for Spanish investment abroad.
Royal Decree 948/2001 regarding investors indemnity systems provides the establishment of the Investment Guarantee Fund and introduces changes to the regulations of the Deposit Guarantee Fund on credit institutions. See “Item 4. Information on the Company —B. Business Overview —Deposit Guarantee Fund”.
Law 44/2002 (November 22, 2002) on reform measures of the financial system, amended, among others, the Securities Market Law. See “Item 9. The Offer and Listing – C. Markets – Spanish Securities Market – Securities Market Legislation”.
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Law 46/2002 (December 18, 2002) amended Act 40/1998 of Personal Income Tax, Law 41/1998 on Taxation of Non-Resident individuals and companies and Law 43/1995 of Corporate Tax.
Also, please see our discussion of the New Basel Capital Accord (which we anticipate will be implemented in 2006) above under “Capital Adequacy Requirements”.
By virtue of the operation of our branches in New York City and our agencies in Miami, as well as our ownership of banks in New York and Puerto Rico, we are subject to the U.S. Bank Holding Company Act of 1956, as amended, and the U.S. International Banking Act of 1978, as amended. These statutes impose limitations on the types of business conducted by us in the United States and on the location and expansion of our banking business in the United States. We are subject to supervision and regulation by the Board of Governors of the Federal Reserve System.
The decisions of the European System of Central Banks influence conditions in the money and credit markets, thereby affecting interest rates, the growth in lending, the distribution of lending among various industry sectors and the growth of deposits. Monetary policy has had a significant effect on the operations and profitability of Spanish banks in the past and this effect is expected to continue in the future. Similarly, the monetary policies of governments in other countries in which we have operations, particularly in Latin America, affect our operations and profitability in those countries. We cannot predict the effect which changes in such policies may have in the future upon our operations but we do not expect it to be material.
The European Monetary Union has had a significant effect upon foreign exchange and bond markets and has involved modification of the internal operations and systems of banks and of inter-bank payments systems. Since January 1, 1999, the start of Stage III, see “Item 4. Information on the Company—B. Business Overview —Supervision and Regulation—Bank of Spain and the European Central Bank,” Spanish monetary policy has been affected in several ways. The euro became the national currency of the eleven initial participating countries and the exchange rates between the currencies of the eleven initial countries were fixed to the euro. Additionally, the European System of Central Banks became the entity in charge of the European Community’s monetary policy. On January 1, 2001 Greece also adopted the Euro as its national currency.
Pursuant to Law 46/1998, the peseta was a valid unit of account as a fraction of euro until December 31, 2001. In addition, the euro and the peseta, bank notes and coins have coexisted until February 2002.
Banco Santander Central Hispano, S.A., the Bank, is the parent company of the Group which was comprised at December 31, 2002 of 367 companies that consolidate by the global integration method and 169 companies that consolidate by the equity method.
See Exhibits I and II to our consolidated financial statements included in this Form 20-F, for details on our consolidated and non-consolidated companies.
During 2002 we and our bank subsidiaries either leased or owned premises in Spain and abroad, which at December 31, 2002 included 4,314 branch offices in Spain and 4,967 abroad. See Note 13 to our consolidated financial statements.
Notes 1 and 2 to our Consolidated Financial Statements contain a summary of our significant accounting policies. Certain of these policies require management to make difficult, complex or subjective judgements. Following our accounting procedures, these judgements are submitted to our Audit Committee and/or to our regulatory authorities and are always disclosed in the notes to our financial statements.
Management’s ability to make subjective decisions is more limited under Spanish GAAP than under U.S. GAAP. For example, U.S. GAAP requires financial instruments to be valued at fair value, which requires some subjective decisions to be made when there is not a ready market, while under Spanish GAAP such instruments are valued at cost which can be determined objectively.
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We believe that of our significant accounting policies, the following may involve a high degree of judgement:
Spanish GAAP requires the level of the allowance for loan-losses to be determined on the basis of specific rules rather than the subjective judgement involved under the US GAAP impairment process. Nevertheless, in addition to the minimum requirements established by the Bank of Spain, additional allowances are provisioned when management estimates probable losses on specific large exposures, such as corporate loans or sovereign risks.
We amortize goodwill on a straight-line basis over the period in which we estimate the investment would be recovered (maximum 20 years). Nevertheless, if management estimate that the investment may not be recovered during the foreseen period, goodwill is amortized on an accelerated basis, recognizing an impairment loss in the year. In 2001 and 2002, goodwill from our investment in Banespa of €1,229.2 million and €400.0 million, respectively, was partially amortized on an accelerated basis. Also, in 2002, goodwill from our investment in Banco Santander Colombia of €240.0 million was partially amortized on an accelerated basis. These decisions were coordinated with our regulatory authorities. (See Note 12 to our Consolidated Financial Statements).
These investments are accounted for by the equity method if the holdings are greater than 20% of voting rights (3% of voting rights if it is a listed entity), and if management considers that there is a lasting relationship and they are intended to contribute to the Group’s business activities. Otherwise, they are accounted for at the lower of cost or market. For this reason the Group always discloses its intentions with respect to each significant equity holding designating them as “financial” or “permanent”.
We have based the following discussion on our consolidated financial statements. You should read it along with these financial statements, and it is qualified in its entirety by reference to them. We prepare our financial statements according to Spanish GAAP. We have identified the significant differences between Spanish GAAP and U.S. GAAP in note 27 to our consolidated financial statements included in this report on Form 20-F. Note 27 also includes reconciliations to U.S. GAAP of net income and stockholders’ equity as reported in the consolidated financial statements. Note 27.5 (H) to our consolidated financial statements includes financial information for our main business segments.
We believe that the following factors had a significant impact on our results of operations and financial condition as of and for the year ended December 31, 2002.
First, the slow down of the world economy continued during 2002. The world economy grew less than approximately 2%, even though the US economy recovered to some extent (approximately 2.5% compared to 0.3% in 2001). The Latin American economy as a whole declined by almost 1%. The weakness in the world economy, aversion to risk among investors, the decrease in capital flows and the political uncertainty in some countries eroded Latin America’s economic growth and affected exchange rates. The Euro zone economy continued to slow down with a growth of 0.8% in 2002 (compared to 1.5% in 2001). Spain continued to grow at around 2% in 2002 (compared to 2.8% in 2001), above the Euro zone average rate.
Within this context of lower growth and uncertainty, our strategy has been focused on the improvement of our recurrent banking activities, cost controls, maintaining a prudent credit risk management policy, strengthening our balance sheet and improvement of our capital base.
Second, in Argentina, taking into account the uncertainty prevailing as a result of the changes in its financial system (sharp devaluation of the peso, conversion to pesos of certain foreign-currency denominated assets and liabilities in the balance sheets of Argentine entities and rescheduling of payment timing and method of customer deposits, among others), until final rules are issued to correct current asymmetries and in light of possible future events, the 2002 and 2001 consolidated financial statements were prepared as described below:
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In 2002, no cash contributions were made from other Group entities to the subsidiaries located in Argentina.
The changes in Argentina’s financial system, its lack of regulatory definition, the provisionality of the financial data and the devaluation of the Argentine peso, among other circumstances, are of such importance that some of the items presented in this section exclude Argentina in order to provide a more meaningful comparison with 2001.
Third, the impact of the euro’s rapid rise against the US dollar has magnified the effect of the depreciation of Latin American currencies against the US dollar and, consequently, against the euro. Over the year ended December 31, 2002, the Argentine peso fell 58% against the euro, the Brazilian real 45%, the Mexican peso 27%, the Chilean peso 24% and the Venezuelan Bolivar 54%. These depreciations reduced our lending and funds balances in euros by 11.1 percentage points. With regards to earnings in euros, the depreciation of the currencies at average exchange rates reduced the growth of our net attributable income by 11.6 percentage points.
Fourth, we have been active in management of our investments and divestments in attemping to maximize the return of our capital. Taking advantage of the opportunities created by the market, the following divestments took place during 2002:
The sale of 3.0% of the capital stock of Royal Bank of Scotland, with capital gains of €806.0 million.
Also we sold the preemptive rights we received in relation with the capital increase carried out by Banesto (and arising from our 99.04% holding in the capital stock of Banesto) for €443 million.
In addition, strategic transactions were made and completed during 2002, some of them relating to operations and options begun in previous years:
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As of December 31, 2002, our capital had increased by 109,040,444, or 2.34% of our total capital as of December 31, 2001, to 4,768,402,943 shares. The 109,040,444 shares were issued on May 14, 2002 and paid in full through the contribution of shares representing all the capital stock of AKB.
Net attributable income as reported in our consolidated financial statements for the year ended December 31, 2002 was €2,247.2 million, a decrease of 9.6% from €2,486.3 million in 2001 which was an increase of 10.1% from €2,258.1 million in 2000. The 2002 decrease reflected mainly decreases in net interest revenue, net fees and commissions, gains on financial transactions, income from equity-accounted holdings, earnings from group transactions and increased net provisions for loan-losses and net extraordinary losses, all of which were partially offset by decreases in operating expenses and goodwill amortization.
Excluding Argentina (because of its zero contribution in 2002), net attributable income for the year ended December 31, 2002 was 7.6% lower than in 2001.
Net interest revenue was €9,358.7 million in 2002, a 8.8% or €898.1 million decrease from €10,256.8 million in 2001, which was a 23.7% or €1,967.2 million increase from €8,289.6 million in 2000. Excluding dividends on equity-accounted holdings, net interest revenue was €9,005.6 million in 2002, a 8.4% or €827.5 million decrease from €9,833.1 million in 2001, which was a 23.0% or €1,836.9 million increase from €7,996.2 million in 2000.
Net interest revenue comparison with 2001 is affected by Argentina and the performance of exchange rates. Excluding Argentina (€705.5 million and €50.8 million in 2001 and 2002, respectively) and eliminating the impact of exchange rates (€892 million), net interest revenue in 2002 increased 6.8%. This growth was largely due to higher revenues from commercial businesses in Europe (due mainly to growth in average loan volume) and in the main countries of Latin America (except for Mexico, whose interest rates fell sharply in 2002). The overall decline in net interest revenue in 2002 mainly reflected a decrease in the average balance of earning assets and a decline in international yield spreads, which were partially offset by a shift in our volumes to assets classes where yield spreads were more favorable.
Average total earning total assets were €300,816.9 million for the year ended December 31, 2002, a 2.7% or €8,495.2 million decrease from €309,312.1 million for the same period in 2001. This decrease was mainly due to a decrease of €12,943.2 million in the average balances of our international total earning assets (mainly because of the effect of the weakening of nearly all the Latin American currencies against the euro, and particularly the effect of this on our international loan and leases and debt securities portfolios), partially offset by an increase of €4,448.0 million in the average balance of our domestic total earning assets (mainly due to an increase of €4,471.8 million in the average balance of our domestic loan and leases portfolio). Our loan and leases balance grew in Spain because of increased secured loans (mainly mortgage lending) resulting in part from continuing low and declining domestic interest rates.
The decrease in net interest revenue also resulted partly from the decline in overall yield spread from 3.22% in 2001 to 3.13% in 2002 (which mainly reflected a decline in international yield spread). Domestic yield spread decreased very slightly from 2.68% in 2001 to 2.67% in 2002: the decrease in the average rate of domestic total earning assets (from 6.16% to 5.46%) was very similar to the decrease in the average rate of domestic interest-bearing liabilities (from 3.48% to 2.79%). This reflected continued pressure on margins in Spain but was offset by adjusting our domestic asset mix. The margin pressure in Spain reflected continued low and declining domestic interest rates as well as the continued effects of competition. Expanded volumes in our domestic loan and leases portfolio, which yielded relatively higher returns, improved our domestic asset mix given existing conditions. International yield spread decreased from 4.04% in 2001 to 3.80% in 2002 primarily because the decrease in the average rate of international total earning assets (from 11.53% to 9.53%) was greater than the decrease in the average rate of international interest-bearing liabilities (from 7.49% to 5.73%). International yield spreads declined because of a decrease in interest rates in Portugal and in some Latin America countries (particularly in Mexico).
During 2002, we have expanded our volumes (assets and liabilities) where yield spread was maintained (domestic and European businesses) and decreased our volumes where yield spread was reduced (mainly Latin American
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businesses). This included expanding domestic deposit volumes, which pay significantly lower interest rates than international deposits, while contracting higher paying international deposit volumes.
The growth in net interest revenue in 2001 reflected a 10.9% or €30.3 billion increase in the average balance of earning assets, an increase in yield spread and an increased use of non-interest-bearing-liabilities and shareholders´ equity to fund assets.
The 10.9% increase in the average balance of our earning assets was mainly due to an increase of €25.7 billion in the average balance of our loan and debt securities portfolios. The increases in our average loan portfolio of €17.5 billion and our average debt portfolio of €8.2 billion reflects our continuing efforts to restructure our balance sheet in favor of higher yielding assets. Our average loan balances grew both in Spain and abroad. Domestic loan balances grew mainly because of increased mortgage lending due to the favorable interest rate environment. Average international loan balances grew mainly from the full consolidation of the acquisitions made during 2000. Taking into account year-end balance figures, domestic loans increased €3.1 billion and international loans increased €1.4 billion.
Our average domestic other debt securities portfolio increased €0.3 billion while our average international other debt securities portfolio increased €7.8 billion mainly due to the full year consolidation of our acquisitions made during 2000. Taking into account year-end balance figures our domestic other debt securities portfolio increased €0.08 billion and our international other debt securities portfolio decreased €4.4 billion.
Yield spread increased to 3.22% in 2001 from 2.57% in 2000. Domestic yield spread decreased to 2.68% in 2001 from 2.81% in 2000 primarily due to increased average rates in domestic total interest-bearing liabilities of 22 basis points from an average interest rate of 3.26% in 2000 to an average interest rate of 3.48% in 2001, in relation to the lesser increase of the average interest rate on our domestic total interest-earning assets of 2 basis points from 6.23% in 2000 to 6.25% in 2001. International yield spread increased to 4.04% in 2001 from 3.36% in 2000 primarily due to decreased average rates in international total interest-bearing liabilities of 356 basis points from 11.05% in 2000 to 7.49% in 2001, compared to a decrease in the interest earned on our international interest-earning assets of 295 basis points from 15.00% in 2000 to 12.05% in 2001.
We also increased net interest revenue in 2001 by using a greater percentage of non-interest-bearing liabilities to fund our earning assets. Non-interest bearing liabilities as a percentage of total earning assets increased to 22.0% in 2001 compared to 18.4% in 2000. See “Item 4. Information on the Company—B. Business Overview—Selected Statistical Information—Average Balance Sheets and Interest Rates” and “Earning Assets—Yield Spread”.
Net fees and commissions were €4,289.3 million in 2002, a 7.2% or €332.5 million decrease from €4,621.7 million in 2001, which was a 15.2% or €608.7 million increase from €4,013.0 million in 2000.
Net fees and commissions for 2002 and 2001 were as follows:
The €332.5 million decrease in 2002 primarily resulted from a €402.5 million or 72.7% decrease in total net fees and commissions from Argentina, a €12.0 million or 2.1% decrease in fees from securities services, partially offset by a €69.6 million or 3.0% increase in fees for services and a €12.4 million or 1.0% increase in mutual and pension fund management fees.
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The €402.5 million decrease in Argentina was mainly due to the negative impact of exchange rates and the general financial instability in that country. Net fees and commissions from securities and custody decreased as a result of decreased volume of activity in the stock markets (brokerage and custody activity). Within commissions for services, credit and debit cards commissions declined by 6.1% due to the impact of exchange rates, the sale of our credit and debit cards business in Venezuela and costs incurred in the launch of the “Serfin Light” card in Mexico which were charged against commissions. Insurance fees increased by 41.0% primarily due to the effect of the incorporation of AKB as well as an increase in volumes principally in Spain and Mexico and bill discounting fees increased by 4.7% mainly because of the incorporation of AKB.
Despite adverse market conditions, fees from mutual and pension funds remained relatively flat.
Average mutual funds under management in Spain rose 2.8% from €49.3 billion in 2001 to €50.7 billion in 2002 due to our marketing efforts. Average mutual funds abroad increased by 3.0% from €17.4 billion in 2001 to €17.9 billion in 2002 mainly due to an increase of average mutual funds in Portugal, partially offset by the negative impact of exchange rates in our Latin American fund management companies.
Average pension funds in Spain increased by 8.9% from €5.0 billion in 2001 to €5.5 billion in 2002, mainly due to increased activity in individual pension funds. Average pension funds abroad decreased by 13.6% from €14.3 billion in 2001 to €12.3 billion in 2002 primarily due to the negative impact of exchange rates in our Latin American pension management companies (mainly in Argentina).
Net fees and commissions for 2001 and 2000 were as follows:
The €608.7 million increase in 2001 primarily resulted from a €154.1 million or 11.0% increase in mutual and pension fund management fees, a €199.2 million or 69.0% increase in bill discounting fees, a €101.5 million or 79.1% increase in fees from insurance products and a 40.6 million or 8.1% increase in fees from credit and debit cards, partially offset by a €126.6 million or 17.5% decrease in fees from securities services. Excluding the acquisitions, net fees and commissions growth, on a “business alone” basis, would have been almost zero because of the small effect of decrease in fees from mutual and pension funds (-1.8%), with lower balances of mutual funds in the Spanish market, and a 20.9% fall in fees from securities services.
The decrease in fees from securities services principally reflected the weakness of the stock markets, both in Spain and abroad, and reduced activity. The increase in fees from mutual and pension funds under management principally reflected an increase in average mutual and pension funds under management from €77.6 billion in 2000 to €93.0 billion in 2001. This increase mainly resulted from a 23.3% increase in average pension funds under management and a 6.8% increase in average mutual funds under management, principally in Latin America. Most of the pension funds increase corresponds to fund management companies in Latin America, a market where we are implementing an expansion strategy both through internal business growth as well as acquisitions. Mutual funds under management in Spain increased slightly by 0.5% from €49.2 billion at December 31, 2000 to €49.5 billion at December 31, 2001 because of the sharp fall in the value of some funds following the decline in the stock markets and the withdrawals by some participants due to the bad performance of the equity funds. Mutual funds abroad increased by 20.8% from €15.8 billion at December 31, 2000 to €19.0 billion at December 31, 2001, mainly due to increased volumes in our Latin American subsidiaries and acquisitions. The increase in fees from bill discounting principally reflected increased financing activities of small and medium size businesses in Spain. The increase in fees from credit and debit cards reflected our credit and debit card marketing efforts, increased retail sales in Spain, and an increase in the number of our ATM machines.
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Net gains on financial transactions were €356.3 million, a 48.0% or €328.9 million decrease in 2002 from €685.1 million in 2001, which was a 2.4% or €17.0 million decrease from €702.1 million in 2000. Gains (losses) on financial transactions include gains and losses arising from the following: marking to market our trading portfolio and derivative instruments to market, including spot market foreign exchange transactions, and sales of investment securities and liquidation of our corresponding hedge or other derivative positions. See note 25(b) to our consolidated financial statements.
The €328.9 million decrease in 2002 was largely due to the volatility of the markets in Spain and abroad and the fall in debt prices on the main Latin American markets, which was reflected in a decrease in the value of our trading portfolios.
The Value at Risk (VaR) performance in 2002 reflects our policy of maintaining a medium/low market risk profile, while retaining the flexibility needed to adapt to the market’s changing circumstances. The average trading VaR in 2002 was $25.3 million compared to $27.0 million in 2001.
Net gains on financial transactions in 2002 includes net losses of €340.6 million on Spanish and foreign fixed-income securities (net gains of €236.2 million in 2001); net losses of €150.9 million on equity securities (net losses of €111.6 million in 2001); net gains of €417.0 million on exchange differences (net losses of €225.9 million in 2001) and net gains of €430.8 million in derivatives (net gains of €786.4 million in 2001). In the case of hedging transactions entered into to reduce market risk exposure, any gains and losses on exchange differences and derivatives are generally symmetrical to the gains (losses) recorded on Spanish and foreign fixed-income securities and equity securities.
Net gains on financial transactions in 2001 includes net gains of €236.2 million on Spanish and foreign fixed-income securities (net losses of €3.6 million in 2000); net losses of €111.6 million on equity securities (net losses of €374.3 million in 2000); net losses of €225.9 million on exchange differences (net gains of €283.2 million in 2000) and net gains of €786.4 million in derivatives (net gains of €796.8 million in 2000). In the case of hedging transactions, entered into to reduce market risk exposure, any gains and losses on exchange differences and derivatives are generally symmetrical to the gains (losses) recorded on Spanish and foreign fixed-income securities and equity securities.
The €17.0 million decrease is principally due to the negative impact of the Argentinean crisis in the valuation of our portfolio in such country, that offsets the favorable performance of the trading portfolios in Spain and other subsidiaries abroad. The Value at Risk (VaR) performance in 2001 reflects our policy of maintaining a medium/low market risk profile, while retaining the flexibility needed to adapt to the market’s changing circumstances. The average trading VaR in 2001 was $27.0 million compared to $32.4 million in 2000.
Other operating results generated a loss of €226.5 million in 2002, a 1.9% or €4.4 million decrease from a loss of €230.9 million in 2001, which was a 93.1% or €111.3 million increase from a loss of €119.6 million in 2000. Net other operating income consists mainly of other income and expenses income generated by our consolidated financial and non-financial consolidated subsidiaries and contributions we make to the Spanish Deposit Guarantee Fund and similar deposit guarantee programs abroad.
The €4.4 million decrease in 2002 was mainly due to a decrease in the contributions to the deposit guarantee programs (mainly in Spain) of €31.0 million partially offset by an increase in net other operating losses generated by our consolidated subsidiaries of €26.6 million.
The €111.3 million increase in 2001 was mainly due to a €53.3 million increase in the contributions to the deposit guarantee programs and a €58.0 million increase in net other operating losses generated by our consolidated financial and non-financial subsidiaries.
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Operating expenses were €7,322.1 million in 2002, a 12.8% or €1,078.9 million decrease from €8,401.0 million in 2001, which was a 15.1% or €1,104.6 million increase from €7,296.4 million in 2000.
Operating expenses for 2002 and 2001 were as follows:
The 12.8% decrease in operating expenses in 2002 reflected 14.0% decline in personnel expenses and a 10.9% decline in other expenses. There were reductions in expenses in almost all items, especially publicity, technical reports, building premises and printed and office material. Eliminating Argentina and the exchange rate effect, the reduction was 1.1%. Operating expenses fell in Spain, Portugal and Latin America.
The reduction in costs in Spain reflects the steps taken in previous years to reduce our employee base. This process continued in 2002 when 4,800 people left the Group in Spain.
The savings resulted principally from policies implemented for the whole Group as well as specific measures taken during the year, both at the general level as well as in Spain and Latin America including: more computerization, sending of unified statements to customers, reducing the use of paper, creation of a specific unit to control and coordinate logistics, etc.
The continued efforts in Latin America in optimization and savings also had a favorable impact, producing a 15.8% decrease excluding Argentina (22.7% decrease including it), and in this case favored by the depreciation of currencies. Eliminating the foreign exchange effect, expenses declined 0.8%.
Our efficiency ratio, measured by dividing operating expenses by ordinary income, improved by 1.7 percentage points to 52.3% in 2002 compared to 54.0% in 2001. Excluding Argentina our efficiency ratio in 2002 improved by 2.5 percentage points to 51.8% in 2002 compared to 54.3% in 2001.
Operating expenses for 2001 and 2000 were as follows:
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The €1,104.6 million increase in 2001 reflected a €807.3 million or 18.1% increase in personnel expenses and a €297.3 million or 10.5% increase in general administrative expenses. The rise in personnel and general expenses was largely the result of the incorporation of new entities and new projects undertaken. The trend, however, is favorable as in the second half personnel and general expenses decreased 4.1% and 4.0%, respectively, over the first half.
Excluding the effects of the incorporation of new entities (+19.4%) and exchange rate differences (-1.8%), expenses decreased by 2.4%. The reductions were in all business areas. Of note in Spain were the reductions in the parent bank, Banesto and Patagon Bank and in Latin America, Mexico, Brazil, Chile and Peru. The savings resulted principally from the global savings policy developed by the whole Group and specific measures taken during the year, both at general level as well as in Spain and Latin America including: joint management of purchases in Spain and Portugal through electronic auctions; optimization measures for travel and integration of the network with savings in production of information and delivery to customers.
Our efficiency ratio, measured by dividing operating expenses by ordinary income, improved to 54.0% in 2001 from 56.1% in 2000, despite the incorporation of new entities with larger efficiency ratios than that of the Group as a whole, towards which they will converge progressively.
Depreciation and amortization was €889.8 million in 2002, a 9.9% or €97.5 million decrease from €987.3 million in 2001, which was a 9.7% or €87.2 million increase from €900.1 million in 2000.
The €97.5 million or 9.9% decrease in 2002 was largely due to the effect of exchange rate fluctuations.
The €87.2 million or 9.7% increase in 2001 was largely due to the incorporation of new entities. Excluding the effect of new incorporations, depreciation and amortization increased by 1.4%.
Excluding dividends from equity-accounted holdings which are reflected under net interest income, income from equity-accounted holdings was €279.9 million in 2002, a 46.4% or €242.0 million decrease from €521.9 million in 2001, which was a 30.8% or €232.4 million decrease from €754.3 million in 2000. Including dividends from equity-accounted holdings, income from equity-accounted holdings was €633.0 million in 2002, a 33.1% or €312.5 million decrease from €945.5 million in 2001, which was a 9.8% or €102.2 million increase from €1,047.7 million in 2000.
The €242.0 million decrease in 2002 excluding dividends from equity-accounted holdings and the €312.5 millions including dividends, is mainly due to the lower contributions we received as a result of our divestments of certain of our holdings (Société Générale, MetLife, Dragados y Construcciones, Vallehermoso and Royal Bank of Scotland). See “—General.”
The entities providing a large portion of the contributions in 2002 include the following:
The €232.4 million decrease in 2001 is mainly due to non-recurrence of the €51.8 million obtained in 2000 from the sale of real estate by Agapsa, a Banesto subsidiary. Excluding this effect, of note was the higher contribution of Royal Bank of Scotland, because of the increase in the Bank’s size after the incorporation of NatWest (and the
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recording of its financial results of the previous year which were in many cases higher than those reflected during the year), and of the companies of the Industrial Group in Spain. On the other hand, the contribution of other European banks in which we have stakes was lower due to the impact of the economic environment on their earnings.
The entities providing a large portion of the contribution in 2001 and 2000 include the following:
Amortization of goodwill was €1,358.6 million in 2002, a 27.5% or €514.3 million decrease from €1,873.0 million in 2001, which was a 212.9% or €1,274.5 million increase from €598.5 million in 2000.
The €514.3 million decrease in 2002 is mainly due to less early amortization of goodwill. In 2001, early amortization of goodwill amounted to €1,230.6 million (relating mainly to Banespa, €1,229.2), while in 2002 early amortization of goodwill amounted to €702.9 million (relating mainly to Banespa, €400.0 million, Banco Santander Colombia, €240 million, and new economy companies).
In addition, and although it is not accounted for directly in this item of the income statement, €895 million of goodwill was amortized for divestments made in 2002. See Note 12 of the Consolidated Financial Statements.
In 2001 and 2002 amortization of goodwill (ordinary and early) charged directly to results and eliminations from dispositions reduced goodwill pending amortization by €4,560 million. This effort was mainly directed at Latin America and new economy investments, and was reflected in a reduction of Banespa goodwill from the initial €3,800 million to €1,770 million, and at the total elimination of the goodwill of Patagon, AOL Spain and BtoB Factory. This reduction is not fully reflected, because of the entries registered in 2002 (primarily AKB and acquisition of minority interests principally in Banco Santiago and Banco Río).
The €1,274.5 million increase in 2001 is due to increased stakes, the acquisitions of banks in Europe and Latin America and, largely, to the early amortization of goodwill amounting to €1,230.6 million (basically at Banespa, €1,229.2 million). The Group’s policy over the past few years has been to assign capital gains to extraordinary provisions. In this sense, an important portion of the capital gains have been applied to the early amortization of goodwill.
Consolidated goodwill as of December 31, 2001 was €9,868.7 million (€11,632.8 million, as of December 31, 2000). Our accelerated amortization policy is reflected in the fact that since December 2000 the goodwill balance has decreased in net terms by €1,764.1 million, due to the differences between new incorporations amounting to €558.0 million (basically relating to the Banespa tender offer) and amortizations and others of €1,873.0 million.
Earnings from Group transactions, which consist mainly of gains on the sale of securities of companies accounted for by the equity method, were €1,008.9 million in 2002, a 13.7% or €160.5 million decrease form €1,169.4 million in 2001, which was a 203.9% or €784.6 million increase from €384.8 million in 2000.
The amount of €1,008.9 million relates primarily to gains from the sale of a 3% stake in Royal Bank of Scotland (€806 million), and in Dragados and Vallehermoso (€520.9 million and €301.0 million, respectively).
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The amount of €1,169.4 million relates primarily to gains from our sales of a 1.53% stake in Royal Bank of Scotland, a 3.3% stake in MetLife, a 4.43% in Société Générale and our chilean insurance companies Vida Santander and Vida Soince-Re. These gains, however, were entirely offset by the accelerated amortization of goodwill and extraordinary provisions. It also includes losses of €5.5 million on transactions involving Banco Santander Central Hispano shares. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results —Amortization of Goodwill and Extraordinary Results—2001 Compared to 2000”.
Our net provisions for loan-losses were €1,648.2 million in 2002, a 3.9% or €62.2 million increase from €1,586.0 million in 2001,which was a 51.3% or €537.7 million increase from €1,048.3 million in 2000. Excluding Argentina, net provisions for loan-losses were €1,376.5 million for 2002, a 4.0% or €52.5 million increase from €1,324.0 million in 2001.
The €52.5 million increase in net provisions for loan-losses, excluding Argentina, reflected a €68.3 million decrease in provisions for loan-losses (provisions for loan-losses were €1,761.5 million in 2002 compared to €1,829.7 million), a €41.3 million decrease in release of provisions for country-risk (release of provisions for country-risk were €20.0 million in 2002 compared to release of provisions of €61.4 million in 2001), and a €79.5 million decrease in recoveries of written-off assets (recoveries totaled €364.9 million in 2002 compared to €444.4 million in 2001).
Net provisions for loan-losses in Argentina, according to Argentine local criteria, were €271.7 million in 2002, a 3.7% or €9.6 million increase from €262.0 million in 2001. These provisions for 2002 did not affect our income as earnings from Argentina are neutralized. See “—General.”
The €68.3 million decrease in provisions for loan-losses (excluding Argentina) reflects a €352.1 million decrease in provisions for statistical loan-losses partially offset by a €283.8 million increase in specific and general provisions for loan losses. (See “Item 4. Information on the Company—B. Business Overview—Classified Assets—Bank of Spain Classification Requirements—Statistical Allowance for Loan-Losses”). The overall decrease in provisions for loan-losses relates to decreased non-performing assets in Spain and abroad despite a relatively difficult economic environment (see explanation below).
We continue our policy of managing our country-risk exposure on a rigorous basis. Our total country-risk exposure, net of provisions, in accordance with Bank of Spain criteria decreased by €821.1 million to €72.0 million at December 31, 2002, compared to €893.1 million at December 31, 2001. This decrease was largely due to the reclassification in April 2002 of Mexico to Group 2 (not requiring provisions) and to reduced positions in Brazil and Colombia (which require provisions).
The €79.5 million decrease in recoveries of written-off assets reflects a €8.9 million decrease in recoveries from our subsidiaries in Spain and a €70.6 million decrease in recoveries from our subsidiaries outside Spain.
Our total allowances for loan-losses decreased by €418.6 million to €5,164.3 million at December 31, 2002, from €5,582.9 million at December 31, 2001, primarily as a result of the effect of exchange differences.
Excluding country-risk, non-performing assets decreased by €219.0 million to €3,676.5 million at December 31, 2002, compared to €3,895.5 million at December 30, 2001. Domestic non-performing assets decreased by €7.1 million to €1,003.9 million at December 31, 2002 from €1,011.0 million at December 31, 2001, while international non-performing assets decreased by €211.9 million to €2,672.6 million at December 31, 2002, from €2,884.5 million at December 31, 2001, due to our strong efforts to reduce our non-performing assets in Latin America and our conservative lending policy. This trend may not continue and may even reverse in the future.
Our coverage ratio (excluding country risk) was 139.9% at December 31, 2002, and 143.3% at December 31, 2001. See “Selected Statistical Information—Classified Assets”.
The €537.7 million increase in net provisions for loan-losses reflected a €621.6 million increase in provisions for loan-losses (provisions for loan-losses were €2,141.0 million in 2001 compared to €1,519.4 million in 2000), a €31.6 million decrease in release of provisions for country-risk (release of provisions for country risk totaled €61.4 million in 2001 compared to release of provisions of €93.0 million in 2000) and a €115.6 million increase in recoveries of written-off assets (recoveries totaled €493.6 million in 2001 compared to €378.1 million in 2000). See “Item 4.
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Information on the Company—B. Business Overview—Selected Statistical Information—Classified Assets—Movements in Allowances for Loan-Losses.”
The €2,141.0 million in provisions for loan-losses in 2001 includes €312.9 million arising from the Bank of Spain’s new regulations regarding provisions for statistical loan-loss coverage (€209.5 million in 2000). The €621.6 million increase in provisions for loan-losses reflects a €116.2 million increase in provisions for loan-losses in Spain and a €438.6 million increase in provisions for loan-losses in our Latin American subsidiaries (mainly Argentina, Brazil and Mexico). (See “Item 4. Information on the Company—B. Business Overview—Classified Assets—Bank of Spain Classification Requirements—Statistical Allowance for Loan-Losses”).
The €61.4 million release in provisions for country-risk reflected our policy of reducing this type of risk and the shift to borrowers in countries requiring lower levels of country risk provisions.
The €115.6 million increase in recoveries of written-off assets principally reflected continuing efforts to increase recoveries in 2001 and also reflects our increased charge-offs.
Our total allowances for loan-losses decreased by €67.6 million to €5,582.9 million from €5,650.5 million at December 31, 2000, primarily as a result of increased charge-offs against allowances for loan-losses and the effect of exchange differences.
Excluding country-risk, non-performing assets decreased by €631.9 million to €3,895.5 million at December 31, 2001, compared to €4,527.5 million at December 31, 1999. Domestic non-performing assets increased by €142.2 million to €1,011.0 million at December 31, 2001, from €868.8 million at December 31, 2000 due to the slowdown of the economy, while international non-performing assets decreased by €774.2 million to €2,884.5 million at December 31, 2001, from €3,658.7 million at December 31, 2000, due to increased charge-offs, primarily in our Latin American subsidiaries.
Our coverage ratio (excluding country risk) was 143.3% al December 31, 2001, and 123.0% at December 31, 2000.
We had an extraordinary net loss of €338.8 million in 2002, compared to extraordinary net income of €61.2 million in 2001 and extraordinary net loss of €406.2 million in 2000.
The net debit balance of €338.8 million in 2002 includes the gains or losses on disposal of property and equipment and long-term financial investments (net income of €443 million and net loss of €122 million); the collection of interest on doubtful and nonperforming loans earned in prior years (€76 million); losses from monetary adjustments (€69.5 million) (see note 2-b to our consolidated financial statements); provisions to pension allowances of €350.8 million (see note 2-j to our consolidated financial statements) and other net losses of €315 million, resulting mainly from the impact of writedowns of technological companies and other companies and businesses located outside Spain (including, those relating to the specific allowance recorded for Argentina indicated in “General” above).
The net income balance of €61.2 million in 2001 includes the gains and losses on disposal of property and equipment and long-term financial investments (extraordinary net income of €2,079.9 million – that includes the €1,713.0 million of capital gains from the divestment of Vodafone – and extraordinary net loss of €141.6 million); the collection of interest on doubtful and non-performing loans earned in prior years (€55.9 million); monetary losses of €41.8 million; provisions to pension allowances of €195.3 million (see notes 1 and 2-j to our consolidated financial statements) and other extraordinary losses amounting to €1,696.3 million that includes the charge of €1,244.0 million allocated to the establishment of a special reserve (for a total of €1,287.0 million) to cover the full amount of our capital investment in Argentina.
The net debit balance of €406.2 million in 2000 includes the gains and losses on disposal of property and equipment and long-term financial investments (extraordinary net income of €108.4 million and extraordinary net loss of €70.9 million); the collection of interest on doubtful and non-performing loans earned in prior years (€34.9 million); net monetary losses of €68.0 million related to adjustments for inflation in certain high-inflation countries (see note 2-b to our consolidated financial statements); provisions to pension allowances of €236.5 million (see notes 1 and 2-j to our consolidated financial statements) and a provision of €57.7 million to establish an allowance required by the Bank of Spain for payments to certain employees in connection with the special merger bonus to the employees of the Bank agreed upon in the framework agreement dated March 3, 1999 (see note 23 to our consolidated financial statement).
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The provision for corporate income and other taxes was €723.1 million in 2002, a 20.6% or €187.3 million decrease from €910.4 million in 2001, which was a 27.3% or €195.5 million increase from €714.9 million in 2000. The effective tax rate was 20.6% in 2002, 21.5% in 2001 and 18.9% in 2000. For information about factors affecting effective tax rates, see note 22 to our consolidated financial statements.
Minority interests were €538.5 million in 2002, a 35.9% or €302.1 million decrease from €840.6 million in 2001, which was a 4.9% or €39.6 million increase from €801.0 million in 2000.
The €302.1 million decrease in 2002 reflected mainly a €202.5 million decrease in income attributable to minority shareholders, mainly related to our increased stakes in Banespa and Banco Santiago, and a €99.6 million decrease in dividends on preference shares of subsidiaries mainly as a result of the early amortization during the first quarter of 2002 of five issues of preferred shares amounting to $769 million of nominal value (€890 million, approximately).
The €39.6 million increase in 2001 reflected mainly a €57.8 million increase in dividends on preference shares of subsidiaries as a result of US$595 million (approximately €658 million) of new issuances made during 2000, the appreciation of the U.S. dollar against the euro and the incorporation of new companies, and an €18.1 million decrease in income attributable to minority shareholders, mainly related to our banks and fund management companies in Latin America.
Our consolidated financial statements have been prepared in accordance with Spanish GAAP. Spanish GAAP differs in certain significant respects from U.S. GAAP. For a summary of the most significant adjustments required to arrive at net income on a U.S. GAAP basis, see note 27 to our consolidated financial statements.
Our total assets were €324,208.1 million at December 31, 2002, a 9.5% or €33.9 million decrease from total assets of €358,137.5 million at December 31, 2001, an increase of 2.6% or €9,209.5 million from total assets of €348,928.0 million at the same date in 2000. Our gross loans to corporate clients, individual clients and government and public entities which include securities purchased from such clients under agreements to resell, decreased by 6.3% to €167,911.2 million at December 31, 2002 from €179,109.4 million at December 31, 2001 mainly due to the depreciation of the Latin American currencies and our prudent risk policy followed in Latin America. Customer liabilities, which are principally deposits from clients and securities sold to these clients under agreements to repurchase, decreased by 7.6% from €181,527.3 million at December 31, 2001, to €167,815.8 million at December 31, 2002. Other managed funds, including mutual funds, pension funds and other managed portfolios, decreased 2.0% from €95,246.5 million at December 31, 2001, to €93,337.9 million at December 31, 2002. The decreases in customer funds (customer liabilities and other managed funds) is mainly due to the depreciation of the Latin American currencies.
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Stockholders’ equity net of treasury stock at December 31, 2002, was €18,242.1 million, a decrease of €1,530.4 million or 7.7% from €19,772.5 million at December 31, 2001, mainly due to exchange rate differences.
At December 31, 2002, our ratio of total capital to risk-weighted assets under Bank of Spain regulations was 10.96%, which reflected a 34.27% or €5.5 billion excess. See “Item 4. Information on the Company—B. Business Overview—Supervision and Regulation—Capital Adequacy Requirements.”
We estimate that our Tier 1 capital ratios, calculated in accordance with Basel Committee guidelines, and our total capital ratios, which include Tier 1 and Tier 2 capital, at December 31, 2002 and 2001 were as set forth below.
As a financial group, our main source of liquidity is our customer deposits which consist primarily of demand, savings and customer time deposits. In addition, we complement our customer deposits through the access to the interbank market (overnight and time deposits) and to the domestic and international capital markets. For this purpose, we have in place a series of domestic and international programs for the issuance of commercial paper and medium and long term debt. Also we maintain a diversified portfolio of liquid assets and securitized assets throughout the year. In addition, another source of liquidity is the generation of cash flow.
We have raised significant funds in the domestic and international capital markets in order to finance our activities. In 2002 we implemented an Issues and Securitization Plan and obtained €9,523 million as follows: €1,100 million of subordinated debt; €4,166 million of senior debt and mortgage bonds and €4,257 million of securitizations. Additionally, we reduced our short term financing needs (commercial paper) from the markets by €5,000 million by substituting alternative short term funding sources.
At December 31, 2002, there were outstanding €20.5 billion of senior debt, of which €6.1 billion were mortgage bonds, €10.8 billion in promissory notes, €5.4 billion in preferred stock and €12.4 billion in subordinated debt issued or guaranteed by us.
The following table shows the average balances during the years 2001 and 2002 of our principal sources of funds:
The average maturity of the outstanding debt is the following:
Exhibits IV and V to our consolidated financial statements included herein show a detail of our senior and subordinated long-term debt, including the maturities.
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The cost and availability of debt financing are influenced by our credit ratings. A reduction in these ratings could increase the cost of, and reduce our market access to debt financing. At December 31, 2002, our credit ratings were as follows:
Our total customer deposits (excluding assets sold under repurchase agreements) totaled €130.5 billion at December 31, 2002. Our loans and credits (gross) totaled €167.9 billion at the same date. Including assets sold under repurchase agreements, customer deposits totaled €167.8 billion at December 31, 2002. Customer deposits increased mainly in the resident sector due to increased assets sold under repurchase agreements and time deposits, offset in part by a decrease in the non-resident sector mainly because of the depreciation of the Latin American currencies.
We are a diversified financial group operating in Spain and in a variety of other countries (mainly in Europe and in Latin America). Although, at this moment, except for Argentina, we are not aware of any legal or economic restrictions on the ability of our subsidiaries to transfer funds to the Bank (the parent company) in the form of cash dividends, loans or advances, capital repatriation and other forms, there is no assurance that in the future such restrictions could be adopted and how they could affect to our business. Nevertheless, the geographic diversification of our businesses limit the effect of any restrictions that could be adopted in any given country.
We believe that our working capital is sufficient for our present requirements and to pursue our planned business strategies.
As of December 31, 2002 and to the present date, we did not, and presently do not, have any material commitments for capital expenditures, except as disclosed in Item 4. “Information on the Company – Recent Events”.
In addition to loans, we had outstanding the following contingent liabilities and commitments:
We have significant holdings in companies whose business activity is not directly related to that of the Bank. According to Spanish GAAP, these holdings are not consolidated. (See a detail of these companies in Exhibit II to our Consolidated Financial Statements.)
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Transactions with these companies are made at market conditions and are closely monitored by our regulatory authorities. In Note 24 to our Consolidated Financial Statements there is a disclosure of the effect of these transactions on the income statement as well as on the balance sheet.
Also, we use special purpose vehicles in our securitization activity.
We do not have transactions with un-consolidated entities other than the aforementioned ones.
We do not currently conduct any significant research and development activities.
The European financial services sector is likely to remain competitive with increasing numbers of providers of financial services and alternative distribution channels. Further consolidation in the sector (through mergers, acquisitions or alliances) is likely as the other major banks look to increase their market share or combine with complementary businesses. It is foreseeable that regulatory changes will take place in the future that will diminish barriers in the markets.
Technological advances have strengthened the alliances between banking entities and other businesses (e.g., telephone companies) contributing to the blurring of the traditional division between businesses. This has facilitated the entry of new competitors that were not involved in the financing business until now.
The following are the most important trends, uncertainties and events that are reasonably likely to have a material adverse effect on the company or that would cause the disclosed financial information not to be indicative of our future operating results or our financial condition:
In June 2002, the European Parliament and Council of the European Union issued a regulation that will require all European listed companies to prepare their consolidated accounts in accordance with IFRS rather than existing national GAAP. The regulation takes effect from 2005, consequently the accounting framework under which we report will change. We will produce our consolidated accounts in accordance with IFRS for the year ended December 31, 2005.
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We are managed by our board of directors which currently consists of 21 members. In accordance with our By-laws (Estatutos), the board shall consist of at least 14 and not more than 30 members. Each member of the board is elected to a three-year term by our stockholders at a general meeting, with approximately one-third of the members being elected each year, but they can be reelected.
Our board of directors meets approximately eight or nine times per year. In 2002, it met 11 times. Our board of directors elects our Chairman and Vice Chairmen from among its members, as well as the Chief Executive Officer. Between board meetings, lending and other board powers reside with the Executive Committee (Comisión Ejecutiva) and with the Risk Committee (Comisión Delegada de Riesgos). Without detriment to the executive powers that in this regard belong to our Chairman, day to day supervision of our operations is carried out by the Executive Officers under the direct supervision and control of the Chief Executive Officer. Our board holds ultimate lending authority and it delegates such authority to the Risk Committee made up of board members, which generally meets twice a week. Executive officers are appointed and removed by the board.
The current members of our board of directors are:
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Our current Executive Officers are:
Following is a summary description of the relevant business experience and principal business activities performed by our current directors and executive officers both within and outside Banco Santander Central Hispano, S.A.:
Emilio Botín (Chairman of the Board of Directors and of the Executive Committee)
Born in 1934. He joined Banco Santander in 1958 and in 1986 he was appointed Chairman of the Board. He is also Director of Bankinter and Royal Bank of Scotland.
Jaime Botín (First Vice Chairman)
Born in 1936. Former Chairman of Bankinter, S.A. He is Chairman of Línea Directa Aseguradora, S.A., Cía de Seguros y Reaseguros.
Alfredo Sáenz (Second Vice Chairman and Chief Executive Officer)
Born in 1942. Former Vice Chairman of Banco Bilbao Vizcaya and Chairman of Banca Catalana until 1993. In 1994, he was appointed Chairman of Banesto and in February 2002, Second Vice Chairman and Chief Executive Officer of Banco Santander Central Hispano. He is also Vice Chairman of Cepsa and Director of Auna.
Matías R. Inciarte (Third Vice Chairman and Chairman of the Risk Committee)
Born in 1948. He joined Banco Santander in 1984 being appointed Executive Vice President and Chief Financial Officer in 1986. In 1988 he was appointed Director and in 1994 Second Vice Chairman. He is also Chairman of Unión de Crédito Inmobiliario, S.A., and Director of Banesto, S.A., Financiera Ponferrada, S.A., Grupo Corporativo Ono, S.A. and Cia. Operadora del Mercado Español de Electricidad, S.A.
Manuel Soto (Fourth Vice Chairman and Chairman of the Audit and Compliance Committee)
Born in 1940. He was appointed Director in April 1999. He is a Director and Vice Chairman of Indra Sistemas, S.A. and a Director of Campofrío Alimentación, S.A.; Cortefiel, S.A. and Corporación Financiera Alba, S.A.
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Juan Abelló
Born in 1941. He was appointed Director in June 2002. He is Chairman of Torreal, S.A., Nueva Compañía de Inversiones, S.A. and Inversiones Naira SIMCAVF, S.A.; Vice Chairman of Grupo Sacyr, S.A. and Director of Eurosar, S.A.
José Manuel Arburúa
Born in 1936. Former Director of Banco Central Hispanoamericano from 1991. He was appointed Director in April 1999.
Assicurazioni Generali, S.p.A.
An Italian insurance company represented by its Chairman, Mr. Antoine Bernhein. Former Director of Banco Central Hispanoamericano from 1994 to 1999. Assicurazioni Generali, S.p.A. was appointed Director in April 1999.
Fernando de Asúa
Born in 1932. Former Deputy Chairman of Banco Central Hispanoamericano from 1991 to 1999. He was appointed Director in April 1999. He is a Director of Cepsa, Técnicas Reunidas, S.A.; Energía e Industrias Aragonesas, EIA, S.A.; Air Liquide España, S.A.; Constructora Inmobiliaria Urbanizadora Vasco-Aragonesa, S.A. and Centro Asegurador, S.A.
Antonio Basagoiti
Born in 1942. Former Executive Vice President of Banco Central Hispanoamericano. He was appointed Director in July 1999. He is Chairman of Unión Fenosa, S.A., Vice Chairman of Golf La Moraleja, S.A. and of Fábrica Española de Productos Químicos y Farmacéuticos, S.A. and a Director of Pescanova, S.A. and Vallehermoso, S.A.
Ana P. Botín
Born in 1960. Former Executive Vice President of Banco Santander, S.A. and former Chief Executive Officer of Banco Santander de Negocios from 1994 to 1999. In February 2002, she was appointed Chairwoman of Banesto. She is also Chairwoman of Inmobiliaria Urbis, S.A.
Emilio Botín O.
Born in 1964. Former Executive Vice President of Banco Santander, S.A. He is the sole Administrator of Puente San Miguel, S.A. and of Jardín Histórico de Puente San Miguel, S.A.
Guillermo de la Dehesa
Born in 1941. Former Secretary of State of Economy, Secretary General of Commerce and Chief Executive Officer of Banco Pastor. He was appointed Director in June 2002. He is Chairman of Plus Ultra, Compañia Anónima de Seguros y Reaseguros, S.A. and a Director of Campofrío Alimentación, S.A.; Unión Fenosa, S.A. and Telepizza, S.A.
Rodrigo Echenique
Born in 1946. Former Director and Chief Executive Officer of Banco Santander, S.A from 1988 to 1994. He is Chairman of the Social Economic Council of the Carlos III University (Madrid) and a Director of NH Hoteles, S.A.
Antonio Escámez
Born in 1951. Former Director and Executive Vice President of Banco Central Hispanoamericano from 1988 to 1999. He was appointed Director in April 1999. He is also Chairman of Arena Communications España, S.A.; Vice Chairman of Banque Commerciale du Maroc and a Director of Banco Vitalicio, S.A.
Francisco Luzón
Born in 1948. He joined Banco Santander in 1996 as Executive Vice President, Adjoint to the Chairman. Former Chairman of Banco Exterior de España (from 1988 to 1996), Caja Postal (from 1991 to 1996), Corporación Bancaria de España (from 1991 to 1996) and of Argentaria (1996). He is also a Director of Industria de Diseño Textil, S.A.
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Elías Masaveu
Born in 1930. He is Chairman of Tudela Veguin, S.A. and Propiedades Urbanas, S.A. and a Director of Bankinter, S.A. and Hidroeléctrica del Cantábrico, S.A. and sole Administrator of Redonda, S.A.
George Matthewson
Born in 1940. Former Chief Executive Officer and Executive Deputy Chairman of The Royal Bank of Scotland, p.l.c (“RBSG”). He was appointed Chairman of RBSG in 2002. He is also Chairman of the British Banking Association.
Abel Matutes
Born in 1941. Former Foreign Minister and EU Commissioner (from 1989 to 1993). He is also Chairman of Global Dominios Access, S.A; Director of FCC Construcción, S.A., San Paolo IMI, SpA. and Instituto Sectorial de Promoción y Gestión de Empresas, S.A.
Luis Alberto Salazar-Simpson
Born in 1940. He is Chairman of Auna Operadores de Telecomunicaciones, S.A.; Endesa Diversificación, S.A.; Retevisión Móvil, S.A. and Constructora Inmobiliaria Urbanizadora Vasco-Aragonesa, S.A. and a Director of Saint Gobain Cristalería, S.A.
Antonio de Sommer Champalimaud.
Born in 1918. He was appointed Director in October 2002. He is owner of the Grupo Mundial Confiança.
David Arce
Born in 1943. He joined Banco Santander in 1964. In 1994 he was appointed Executive Vice President, Internal Audit of Banco Santander and Banesto. He is also a Director of Banesto.
José A. Aróstegui
Born in 1944. Former Executive Vice President, Resources of Banesto since November 1996. In February 2002 he was appointed Executive Vice President, Resources and Costs of Banco Santander Central Hispano, S.A.
Ignacio Benjumea
Born in 1952. He joined Banco Santander in 1987 as General Secretary of Banco Santander de Negocios. In 1994 he was appointed General Secretary and Secretary of the Board of Banco Santander. He is also a Director of Grupo Dragados, S.A., Iberclear and Sociedad Rectora de la Bolsa de Madrid, S.A.
Teodoro Bragado
Born in 1944. He joined the Bank in 1985. He was appointed Executive Vice President, Risk in March 2003. He is also a Director of Compañía Española de Seguros de Crédito a la Exportación (“CESCE”), COFIDES and of the Carlos III University (Madrid).
Juan Manuel Cendoya
Born in 1967. Former Manager of the Legal and Tax Departament of Bankinter, S.A. from 1999 to 2001. He joined the Bank on July 23, 2001.
José María Espí
Born in 1944. He joined the Bank in 1985 and in 1988 was appointed Executive Vice President, Human Resources. In 1999 he was appointed EVP, Risk Division. He is also a Director of Unión de Crédito Inmobiliario, S.A.
Enrique García
Born in 1953. He joined Banco Santander in 1975 and was appointed Senior Vice President in 1993. He was appointed Executive Vice President in January 1999. He is also a Director of Mobipay España, S.A.
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Francisco Gómez
Born in 1953. Former Chief Executive Officer of Banesto since 1996. In February 2002, he was appointed Executive Vice President, Finance of Banco Santander Central Hispano, S.A. He is also a Director of Avanza Internet Ventures, S.A.
Joan-David Grimá
Born in 1953. He joined Banco Central Hispanoamericano in 1993. He was appointed Executive Vice President Industrial Group in June 2001. He is also Vice Chairman and Chief Executive Officer of AUNA, Operadores de Telecomunicaciones, S.A, and a Director of Antena 3 Televisión, Teka Industrial, Banco Vitalicio de España and Grupo Dragados, S.A.
Juan Guitard
Born in 1960. Former General Secretary of the Board of Banco Santander de Negocios (from 1994 to 1999) and Manager of the Investment Banking Department of the Bank (from 1999 to 2000). He rejoined the Bank in 2002, being appointed Executive Vice President, Vice-Secretary General and of the Board. He is also Chairman of Narraganset, S.A. and Director of Megacuadro, S.A.
Antonio H. Osorio
Born in 1964. He joined Banco Santander in 1997 and was appointed Executive Vice President, Portugal in June 2001. He is Chairman of Banco Santander Portugal and Chairman of the Executive Committee of Banco Totta & Açores, Credito Predial Português and Banco Santander de Negocios Portugal.
Adolfo Lagos
Born in 1948. Former Chief Executive Officer of Grupo Financiero Serfin since 1996. He was appointed Executive Vice President, Latin America Division on October 2002 and Executive Vice President, Global Wholesale Banking in April 2003.
Gonzalo de las Heras
Born in 1940. He joined the Bank in 1990. He was appointed Executive Vice President in 1991 and supervises the North American business of the Bank.
Francisco Martín
Born in 1955. He joined the Bank in 1985 and in 1992 was appointed Executive Vice President, Head of the International Division. In 2002, he became Executive Vice President, Head of Global Corporate Banking.
Javier Peralta
Born in 1950. He joined the Bank in 1989 and in 1993 was appointed Executive Vice President. In 2002, he was appointed Executive Vice President, Credit Risks.
Marcial Portela
Born in 1945. He joined the Bank in 1998 as Executive Vice President in charge of operations, human resources and costs. In 1999, he was appointed Executive Vice President, Latin American Operations. He is also Vice Chairman of Comunitel Global, S.A. and Director of Best Global, S.A. and Unión Eléctrica Fenosa, S.A.
Juan R. Inciarte
Born in 1952. He joined Banco Santander in 1985 as Director and Executive Vice President of Banco Santander de Negocios. In 1989 he was appointed Executive Vice President and in 1991 Director of Banco Santander. He is also a Director of Compañía Española de Petróleos, S.A., Finanzauto, S.A., and The Royal Bank of Scotland, plc.
Jesús Mª Zabalza
Born in 1958. Former Executive Vice President of La Caixa (from 1996 to 2002). He joined the Bank in 2002, being appointed Executive Vice President, Latin America Branch Network.
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José Tejón
Born in 1951. He joined the Bank in 1989. In 2002 he was appointed Executive Vice President, Finance.
The following is a description of arrangements or understandings with major shareholders, customers, suppliers or others pursuant to which any person referred to above was appointed:
There are two directors that are or represent international financial institutions that have a holding in the Bank and have subscribed alliances or collaboration agreements with us: George Matthewson (Royal Bank of Scotland) and Assicurazioni Generali, S.p.A.
Article 37 of the Bank’s bylaws provides that the members of our board of directors shall receive, for performing their duties as such directors, an amount up to 5% of the Bank’s net income for any fiscal year.
For 2002, the Board of Directors, making use of the powers conferred on it, allocated 0.191% of the Bank’s net income (as compared to 0.254% for 2001 and 0.284% for 2000), as compensation (in the aggregate) for itself.
Consequently, the gross amount received by each director as compensation in 2002 (€65,000) is 10% lower than the compensation set for 2001 and 2000 (€72,000 in each of those years). Additionally, the Executive Committee members receive additional compensation, the gross amount of which was €141,000 in 2002 (also 10% below the €157,000 received in each of 2001 and 2000).
Finally, from 2002 onwards, the members of the Audit and Compliance Committee will receive additional compensation in the amount of €32,000 per year.
The detail of the salary compensation received by the Board members with executive duties, who as of December 31, 2002, were Mr. Emilio Botín, Mr. Alfredo Sáenz, Mr. Matías R.Inciarte, Ms. Ana P. Botín, and Mr. Francisco Luzón, is as follows:
The detail by director of the compensation earned by the Bank´s directors in 2002 as discussed above is as follows:
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The other compensation accrued to Board members amounted to €2.5 million in 2002, €3.2 million in 2001 and €5.3 million in 2000.
The compensation received in 2002 by the Bank’s directors who represent the Bank on the Boards of Directors of listed companies in which the Bank has a stake, at the expense of those companies, is as follows:
By resolution of the Executive Committee, the compensation for representation duties of this kind relating to appointments made after March 18, 2002, will accrue to the Group.
Additionally, as recommended by the Special Committee for the Fostering of Transparency and Security in the Markets and at Listed Companies (“Comisión Aldama”), following is a detail of the compensation paid to the Bank’s Executive Officers (*) in 2002:
The total balance of supplementary pension obligations assumed by the Group over the years for its current and retired employees, which amounted to €12,977 million (covered mostly by in-house allowances) as of December 31, 2002, includes the obligations to those who have been directors of the Bank during the year and who discharge (or have discharged) executive functions during the year. The total pensions accrued to these directors, together with the total sum insured under life insurance policies at that date and other items, amount to €256 million as of December 31, 2002, of which €108 million relate to the settlement of the pension rights referred to below (€209 million as of December 31, 2001, which did not include the extraordinary nonrecurring payment of €43.75 million paid in 2001, and €126 million as of December 31, 2000).
The following table provides information on the obligations undertaken and covered by the Group relating to pension commitments and other insurance to the Bank’s Executive Directors as of December 31, 2002:
Additionally, other directors benefit from life insurance policies at the Group’s expense, the related insured sum being €3 million as of December 31, 2002 (€3 million as of December 31, 2001, and €2 million as of December 31, 2000).
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At December 31, 2002, the pension benefits, together with the total guaranteed amounts for life insurance for our executive officers who are not directors, amounted to €113.3 million.
Following the decision of Mr. Ángel Corcóstegui to resign, for personal reasons, in February 2002 from his position as First Deputy Chairman of the Bank and Board member (which entailed his corresponding resignation from his position as Chief Executive Officer of the Bank and as member of the various Board Committees on which he sat), in settlement for the pension commitments undertaken, the Bank paid on his resignation a gross amount of €108 million for his pension rights. This amount had been fully provided for as of that date. Upon payment, a withholding of 48% was made, and the amount withheld was paid into the Spanish Treasury. Accordingly, the net amount paid to Mr. Corcóstegui in this connection was €56 million.
The detail of the Bank’s stock options granted to the Board members as of December 31, 2002, is as follows:
In recent years, the Bank has put in place compensation systems for its managers and employees linked to the market performance of the Bank’s shares based on the achievement of certain objectives. Below is a summary of the different stock option and compensation plans in effect as from January 1, 2002:
6 of our officers participate in an option plan known as “Plan Four”. Each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €7.84, and plan participants may exercise these options until December 30, 2005. Plan participants must hold the shares acquired through this plan for a period of twelve months following the date of exercise of the options. During 2002, 1,558,100 options were exercised and as of December 31, 2002, the balance of outstanding options under this plan was 264,000.
391 of our officers participate in an option plan known as the “Managers Plan 1999.” Each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €2.29, and plan participants may exercise these options from December 31, 2001 until December 30, 2004. Plan participants must hold the shares acquired through this plan for a period of twelve months following the date of exercise of the options. During 2002, 3,000,700 options were exercised and as of December 31, 2002, the balance of outstanding options under this plan was 1,992,324.
20 of our officers participate in an option plan known as the “Additional Managers Plan 1999”. Each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €2.41, and plan participants may exercise these options from April 1, 2002 until December 30, 2004. Plan participants must hold the shares acquired through this plan for a period of nine months following the date of exercise of the options. During 2002,
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78,440 options were exercised and as of December 31, 2002, the balance of outstanding options under this plan was 84,479.
61 of our officers from the Global Wholesale Banking Division participate in an equity incentive plan known as the “Investment Banking Plan”. The number of options received by plan participants under this plan is based on the extent to which certain business objectives are achieved, each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €10.25, and plan participants may exercise the first 50% of the options granted from June 16, 2003, and the remaining 50% from June 16, 2004. The exercise period ends in both cases on June 15, 2005. As of December 31, 2002, the balance of outstanding options under this plan was 6,440,000.
597 of our officers participate in an option plan known as the “Young Executives Plan”. Each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €2.29, and plan participants may exercise these options from July 1, 2003 until June 30, 2005. Plan participants must hold the shares acquired through this plan for a period of twelve months following the date of exercise of the options. As of December 31, 2002, the balance of outstanding options under this plan was 1,265,500.
1,039 of our officers participate in an option plan known as the “Managers Plan 2000”. Each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €10.55, and plan participants may exercise these options from December 30, 2003 until December 29, 2005. Plan participants must hold the shares acquired through this plan for a period of twelve months following the date of exercise of the options. As of December 31, 2002, the balance of outstanding options under this plan was 14,367,000.
26 of our officers participate in an incentive plan known as the “European Branches Plan”. Subject to the achievement of certain objectives, the beneficiaries of this plan will receive a payment in cash or in shares of Banco Santander Central Hispano. For purposes of the calculation of the number of shares to be delivered, the share price is calculated at the average quoted price of the month previous to the incorporation to the branch and plan participants may exercise the first 50% of the options granted from July 1, 2004, and the remaining 50% from July 1, 2005. The exercise period ends in both cases on June 30, 2008 although it can be postponed to June 30, 2009. As of December 31, 2002, the balance of outstanding shares to be delivered under this plan was 2,895,000.
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(i) Date of expiration of the current term of office of the directors and the period during which the directors have served in that office:
The period during which the directors have served in their office is shown in the table under Section A of this Item 6.
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The date of expiration of the current term of office is shown in the table below:
Certain of the Bank’s directors and members of its administrative, supervisory or management bodies have service contracts with the Bank which provide for benefits upon termination of employment in an amount equal to approximately three to five times their total annual compensation (including fixed compensation and variable compensation, and in certain cases, fees associated with Board participation). Additionally, certain of the Bank’s directors and members of its administrative, supervisory or management bodies, who were in the past or are presently employed by the Bank, have service contracts with the Bank, in the ordinary course of business, which provide for pension and other retirement benefits.
An Audit and Compliance Committee and an Appointments and Remuneration Committee operate as part of the Board of Directors. These committees consist exclusively of external Directors (6 and 5, respectively, of whom 5 and 4, respectively, are independent in accordance with the principles set forth in article 5 of the Board’s Regulations).
The Audit and Compliance Committee has the following functions:
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One of the meetings of this Committee will be devoted to evaluating the efficiency of and compliance with the rules and procedures of the company, and with preparing information for the Board´s approval and inclusion in the annual public documentation.
Following are the current members of the Audit and Compliance Committee:
The Appointments and Remuneration Committee has the following functions:
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Following are the members of the Appointments and Remuneration Committee:
At December 31, 2002, we had 104,178 employees (114,927 in 2001 and 129,640 in 2000) of which 35,887 were employed in Spain (40,741 in 2001 and 43,059 in 2000) and 68,291 were employed outside Spain (74,186 in 2001 and 86,581 in 2000). The terms and conditions of employment in the private sector banks in Spain are negotiated on an industry-wide basis with the trade unions. This process has historically produced collective agreements binding upon all the private banks and their employees. The most recent such agreement (which was executed in October 1999 and expired in December 2002) is currently under renegotiation.
The table below shows our employees by geographic area:
As of December 31, 2002, we had 1,662 temporary employees (3,035 at December 31, 2001).
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As of April 30, 2003, the direct, indirect and represented holdings of our current directors were as follows:
The options granted to the Bank´s directors, managers and employees are described in the table under “Section B Compensation” above.
All our shares are ordinary and of the same class.
At April 30, 2003 our current executive officers (not directors) referred to above under Section A of this Item 6 as a group beneficially owned, directly or indirectly, 2,404,110 ordinary shares, or 0.05% of our issued and outstanding share capital as of that date. Together with the options granted, no individual executive officer (not directors) beneficially owns, directly or indirectly, one percent or more of the outstanding share capital as of that date.
As of December 31, 2002, to our knowledge no person beneficially owned, directly or indirectly, more than 5% of our shares.
There has not been any significant change in the percentage ownership held by any major shareholder. All our ordinary shares have the same voting rights.
At December 31, 2002, a total of 422,912,446 shares, or 8.87% of our share capital, were held by 838 registered holders with registered addresses in the United States, including JPMorgan Chase, as depositary of our American Depositary Share Program. These shares were held by 778 record holders. Since certain of such shares and ADRs are
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held by nominees, the foregoing figures are not representative of the number of beneficial holders. Our directors and executive officers did not own any ADRs as of December 31, 2002.
To our knowledge, we are not controlled directly or indirectly, by any other corporation, government or any other natural or legal person. We do not know of any arrangements which would result in a change of our control.
B. Related party transactions.
Loans made to members of our Board of Directors and to our Executive Officers
Our direct or indirect risk exposure to the Bank’s directors as of December 31, 2002, amounted to €14.4 million (€7.8 million and €6.9 million as of December 31, 2001 and 2000, respectively) of loans and €1.2 million (€0.8 million and €1.2 million as of December 31, 2001 and 2000, respectively) of guarantees provided to them and entities controlled by them. These loans and guarantees were granted at market rates in all cases.
The detail by director as of December 31, 2002, is as follows:
(*) These positions were formalized prior to their appointment as directors of the Bank.
Additionally, the total advances and loans made by us and our consolidated subsidiaries to our executive officers, as of December 31, 2002, amounted to €4.5 million .
Loans extended to related parties were made in the ordinary course of business, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectibility or present other unfavorable features.
The companies of the Group engage, on a regular and routine basis, in a number of customary transactions among Group members, including:
and others within the scope of the ordinary course of the banking business, such as loans and other banking services to our shareholders, to employees of all levels, and the associates and the members of the families of all the above-
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mentioned, as well as those other businesses conducted by the companies of the Group. All these transactions are made:
As of December 31, 2002, an aggregate of €1,364.5 million in loans to non-consolidable and associated companies was outstanding (€1,476.7 million as of December 31, 2001). These loans represented 0.8% of our total net loans and 7.5% of our total stockholders´ equity at December 31, 2002 (0.9% and 7.5%, respectively, at December 31, 2001).
For more information, see Notes 3 and 24 to our Consolidated Financial Statements.
Not Applicable
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See Item 18 for our Consolidated Financial Statements.
The resolutions adopted at our general shareholders’ meetings held on January 18, 2000 and on March 4, 2000, approving the capital increases agreed in connection with the exchange offer made by The Royal Bank of Scotland Group plc. with National Westminster Bank plc., and in connection with our acquisitions of the Portuguese banks Banco Totta & Açores and Crédito Predial Portugués and the resolution adopted at our general shareholders’ meeting held on March 4, 2000 approving the capital increase necessary to carry out the exchange offers for shares of Banco Rio de la Plata, have been challenged under Spanish law. One plaintiff shareholder, in the case of the resolutions adopted in the first meeting and two plaintiff shareholders, in the case of the resolutions adopted in the second meeting, have challenged these resolutions on the grounds that, among other things, they were provided with insufficient information in connection with the vote on these resolutions and that the resolutions excluding the preemptive rights of shareholders were not validly adopted. In the proceedings, the plaintiffs have requested the court to declare that the above resolutions (and other ones adopted in the same meetings) are null and void. The first claim was rejected by the court in April 2001, and the plaintiff appealed the court’s rejection of his claim. The plaintiff´s appeal was then rejected by the court on December 2, 2002. The plaintiff has appealed for redress and the Bank has asked the court not to admit such appeal. The second claim was rejected by the courts of the city of Santander on November 29, 2002 and the plaintiffs have appealed such decision. The Bank has already answered the appeal. We cannot anticipate the outcome of these claims. Under Spanish law, if the claims were to prevail, the capital increase resolutions adopted on January 18, 2000, and on March 4, 2000, could be declared null and void. The effect under Spanish law of the declaration of nullity of a listed company’s share capital increase is highly uncertain and we are unable to anticipate what would be the outcome for us and our shareholders if these claims were to prevail.
The resolutions adopted at our shareholders’ meeting held on March 10, 2001, have been challenged under Spanish law by three shareholders who filed their claim before the courts of the city of Santander. These shareholders claim that the Bank has not complied with certain provisions of Spanish corporate law with respect to the resolutions adopted in said shareholders’ meeting. The challenged resolutions include the approval of the Bank’s annual accounts, the approval of a capital increase in exchange of cash, the approval of a capital increase in exchange of shares of Banco Rio de la Plata and BRS Investments and the approval of various issuances of bonds. In their complaints, the plaintiff shareholders ask the Court to declare the resolutions null and void and that the registration of the resolutions in the Commercial Registry are also annulled. The claim was rejected by the court in March 2002. The plaintiff shareholders have appealed such rejection. The Bank has already answered the appeals. The court then admitted the practice of new evidence. The court rejected the appeal of one of the shareholders and he has presented against the decision a motion to set aside such decision, which was also rejected and then subsequently appealed and again rejected.
The resolutions adopted at our shareholders’ meeting held on February 9, 2002, have been challenged under Spanish law by one shareholder who has filed his claim before the courts of the city of Santander. The challenged resolutions include the approval of the payment of an interim dividend, the reelection of Arthur Andersen y Cía, S. Com. as the external auditor of the Bank, the approval of a capital increase in exchange of shares of the German Company AKB Holding Gmbh and the approval of various issuances of bonds. Among other things, the plaintiff alleges the infringement of the shareholders’ rights of participating during the meeting and of receiving information regarding the different issues to be voted in the meeting; and that the resolutions excluding the preemptive rights of shareholders were not validly adopted. The plaintiff shareholder asked the Court to declare the above resolutions (and others adopted in the same meeting) null and void and that the registration of the resolutions in the Commercial Registry also be annulled . On September 9, 2002 the Court rejected the claim. The plaintiff has appealed such rejection and the Bank has answered the appeal.
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The resolutions adopted at our shareholders’ meeting held on June 24, 2002 have been challenged under Spanish law by one shareholder who filed his claim before the courts of the city of Santander. The challenged resolutions include the approval of the Bank’s annual accounts and the rejection by the shareholders meeting of the proposals made by the plaintiff shareholder and another shareholder to file a claim requesting the declaration of the Directors’ liability in connection with the investments made by the Bank in Argentina, as well as the proposal made by another shareholder for the severance of one of the Directors. The Bank responded to the claim on October 5, 2002. During the term to respond to this claim, the Bank was required to respond to another claim, filed by a different shareholder, challenging some of the resolutions adopted at the same meeting. The claim was admitted by the same court of the city of Santa nder that is in charge of the first proceeding and has been joined to this proceeding, so both proceedings will be carried out jointly. The Bank responded to this second claim on October 25, 2002. The hearing took place on April 21, 22 and 23, 2003, and the court dismissed the claim on May 29, 2003. The plaintiffs have appealed against such decision.
Since 1992, the Madrid Central Court number 3 has had preliminary court proceedings in progress to determine the liabilities which might arise in connection with certain credit assignment transactions (cesiones de crédito) carried out by Banco Santander, S.A. from 1987 to 1989. The Bank and our internal and external advisers anticipate that the final result of this litigation will be in our favor and that no additional specific provision is required. This opinion was confirmed by the dismissal order entered by the Madrid Central Court number 3 on July 16, 1996. The dismissal order was not appealed. However, the dismissal order was only partial, and therefore the proceedings remain open despite the partial dismissal order. The prosecutor and the Bank appealed the decision of June 27, 2002 which changed the cited proceedings to an Abbreviated Procedure. On June 23, 2003, the appeals court partially reversed the lower court’s decision, but certain of the proceedings against the Bank and three of its officers remain open.
In December 1995, the Spanish tax authorities issued an “Acta” (writ) requiring us to pay €26.2 million in back withholding taxes, interest and penalties relating to our alleged failure to comply with a purported obligation to withhold income tax on payments to clients with respect to cesiones de crédito held by such clients. Our appeal against this writ was rejected and we have filed a second appeal.
Lanetro, S.A. filed a suit against Banco Santander Central Hispano S.A., carried out before the Court of 1st Instance no. 34 of Madrid, Complaint of Plenary Suit no. 558/2002, principally alleging that the Bank breached its alleged obligation to subscribe to the increase in capital stock of the plaintiff in the amount of €30,050,605.22.
For informational purposes it is also mentioned, although this does not constitute litigation against the Bank, that one shareholder has filed a claim before the courts of the city of Madrid against the persons who were members of the Board of the Bank during 2001. The plaintiff claims that the Bank’s investments in Argentina were carried out by the defendants without due diligence, and that the losses derived from these investments have caused a direct damage to him that varies from euro 533.06 to euro 3,005.00. The plaintiff shareholder applies for the compensation of that amount against the Directors, as jointly and severally liable for his alleged damages. The claim was rejected by the court on April 2003, and the plaintiff has appealed the court’s decision. This claim is described for informational purposes only and does not constitute an implied representation that we have described all claims of equal or greater magni tude than this claim.
For the same purposes, it is also mentioned that several persons, who allegedly have funds deposited in Banco Río de la Plata, S.A., filed an application for conciliation before the courts of the city of Madrid against the Bank, the persons who were members of the Board of the Bank during 2001 and 2002 and others. According to Spanish Law, this application did not start proper judicial proceedings against the Bank. The claimants only intended that the defendants accept the reality of the facts alleged in their application, regarding the Bank and its directors’ claimed obligation to reimburse the funds deposited by the claimants in Banco Río de la Plata, S.A. The conciliation hearing was held on July 16, 2002. The Bank and the members of the Board refused to accept the facts and allegations of the application. This meant the termination of the conciliation.
For the same informational purposes, it is mentioned that the Madrid Central Court number 3 is carrying forward preliminary proceedings 352/2002 in connection with complaints filed by two shareholders against the chairman of the Bank, regarding the economic terms of the retirement in August 2001 of the former co-chairman, Mr. José María Amusátegui and the economic terms of the resignation in February 2002 of the former first vice-chairman and chief executive officer, Mr. Angel Corcóstegui.
The Bank of Spain has brought an administrative proceeding against Banesto and its former board of directors alleging, among other things, that Banesto maintained insufficient loan loss and securities fluctuation allowances, violated risk concentration limits, utilized deceptive accounting practices, and obstructed Bank of Spain inspections. The Bank of Spain may impose fines on a bank in connection with such a proceeding of up to 1% of the bank’s shareholders’ equity on the date of the violation. On February 6, 2003, the Ministry of Finance decided to impose a fine on the former members of the board of directors of Banesto and also to Banesto itself. The fine imposed on Banesto itself amounts to €120,202, and Banesto has appealed. Pursuant to the purchase contract under which we acquired our initial stake in Banesto, the “Fondo de Garantía de Depósitos” agreed, subject to certain conditions, to indemnify Banesto against, among other things, final judgments resulting from certain suits brought by shareholders between March 29, 1994 and March 29, 1996 and certain tax liabilities arising from occurrences before March 29, 1994.
In 1995 and 1996, the former directors of Banesto, who had been replaced by decision of the Bank of Spain’s Executive Council on December 28, 1993, filed claims challenging certain corporate resolutions adopted by the shareholders’ meetings held on March 26, and August 22, 1994 and February 15, 1995 approving, among other things,
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Banesto’s financial reorganization plan and the 1993 and 1994 financial statements of Banesto and the Banesto Group. In 2000, Madrid Appellate Court decisions rejected all the appeals filed by the plaintiffs in connection with the claim filed challenging the legality of the corporate resolutions approving the financial restructuring plan; the plaintiffs subsequently filed cassation appeals against these decisions. On March 5, 2002 the courts decided not to admit the cassation appeal against the Madrid Appellate Court’s decision rejecting the claims of some of the plaintiffs regarding the invalidity of the constitution of the shareholders’ meeting held on March 26, 1994. The claim filed against the resolutions adopted by the shareholders’ meeting held on August 22, 1994 approving the 1993 financial statements of Banesto was rejected by the Court of First Instance and the plaintiffs subsequently filed an appeal before the Madrid Appellate Court. The appeal was rejected in 2001 and the plaintiff has appealed in cassation. The claim filed against the approval by the shareholders’ meeting held on February 15, 1995 of the 1994 financial statements of Banesto was also rejected in 2000 by the Court of First Instance and was subsequently appealed by the plaintiffs. The appeal has been dismissed by judgment of the Court of Appeals of Madrid, rendered on May 20, 2003. The plaintiffs have announced their intention to appeal such judgment.
Additionally, in 1998 and 1999 claims were filed challenging certain resolutions adopted by the Shareholders’ Meeting of Banesto in 1997 and 1998 approving, among other things, the 1996 and 1997 financial statements of Banesto and of its Group. In 2000, these claims were also rejected by the courts and were subsequently appealed by the plaintiffs.
The appeals have been rejected by the Court of Appeals of Madrid through judgment rendered on September 26, 2002, subsequently appealed again by the plaintiffs and subsequently rejected again by the Court of Appeals of Madrid, who on March 31, 2003 declared the judgment final and definitive.
Banesto’s directors and legal advisers consider that these claims will not have any effect on the financial statements of Banesto and of its Group. The plaintiffs seek that the resolutions are declared null and void, not damages. It is very difficult to assess what would be the practical consequences of an adverse judgment.
Pursuant to the Brazilian labor regulations applicable to Banespa, this bank had recorded as of 31 December 2000, the pension allowances arising from the commitments to certain employees, which amounted approximately 4,000 million Brazilian reais. Since 1987, the Directors of Banespa, as advised by their tax advisers, treated these expenses as deductible expenses in calculating the Brazilian corporate income tax. However, in September 1999, the “Secretaria de Receita Federal” issued a decision according to which these expenses, in an amount of approximately Brazilian reais 2,867 million would not be tax deductible. In October 1999, the Board of Directors of Banespa filed an appeal challenging this decision together with an “acción cautelar” regarding fiscal years 1999 and 2000, posted a deposit of Brazilian reais 1,297 million and recorded a provision of Brazilian reais 2,600 million for this contingency. Such provision was recorded in 1999 with a charge to income, after recording the related deferred tax asset of Brazilian reais 1,200 million.
In this respect, the Board of Directors of Banespa has decided to accept the Medida Provisória nº 66 of the Secretaría da Receita Federal dated August 29, 2002 and to pay Brazilian reais 2,110 million in order to settle the proceedings. The company disputes any liability with respect to an additional amount of Brazilian reais 103 million relating to costs and surcharges imposed in connection with the dispute relating to the principal amount. The company has asked for a cautionary judicial action posting a deposit for an equivalent amount.
On May 19, 2003, the Secretaria de Receita Federal issued an “Auto de Infração” requiring from our Brazilian affiliate Santander Brasil DTVM, Ltda. the payment of Brazilian reais 290 million in taxes allegedly incurred in connection with certain cash management services rendered by such company to its clients which the company had treated during 2000, 2001 and the two first months of 2002 as exempt from the Tax on Financial Transactions, following the advice of its tax advisers. The Board of Directors of Santander Brasil DTVM, Ltda. appealed this decision in June 2003.
Also on May 29, 2003, the Secretaria de Receita Federal issued another “Auto de Infração” requiring from our Brazilian affiliate Banco Santander Brasil, S.A. the payment of Brazilian reais 290 million in taxes allegedly incurred in connection with certain clearing services rendered by such company to Santander Brasil DTVM, Ltda. pursuant to an agreement between these two companies. Following the advice of its tax advisers, Banco Santander Brasil, S.A. had treated during 2000, 2001 and the two first months of 2002 such services as exempt from the Tax on Financial Transactions. The Board of Directors of Banco Santander Brasil, S.A. appealed this decision in June 2003.
In addition to the above described matters, we and our subsidiaries are from time to time subject to certain claims and parties to certain legal proceedings incidental to the normal course of our business, including in connection with our lending activities, relationships with our employees and other commercial or tax matters. We believe we have made adequate reserves related to the costs anticipated to be incurred in connection with these various claims and legal proceedings and believe that liabilities related to such claims and proceedings are not likely to have, in the aggregate, a material adverse effect on our business, financial condition, or results of operations.
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We have normally paid an annual dividend in quarterly installments. The table below sets forth the historical per share and per ADS (each of which represents the right to receive one of our shares) amounts of interim, supplemental and total dividends in respect of each fiscal year indicated. All amounts below reflect all stock splits made in June and September 1998 and June 1999. Amounts for the years 1998 through 1999 have not been restated to reflect the merger of Banco Central Hispanoamericano and Banco Santander.
For a discussion of regulatory and legal restrictions on our payments of dividends, see “Item 4. Information on the Company—B.Business Overview—Supervision and Regulation—Restrictions on Dividends”.
For a discussion of Spanish taxation of dividends, see “Item 10. Additional information—E.Taxation—Spanish Taxation of Dividends”.
The dividends paid on the guaranteed non-cumulative preference stock of certain of our subsidiaries, see “Item 5. Operating and Financial Review and Prospects—A.Operating Results — Results of Operations—Capital”, are limited by our Distributable Profits in the fiscal year preceding a dividend payment. “Distributable Profits” with respect to any year means our reported net profits after tax and extraordinary items for such year as derived from our non-consolidated audited profit and loss account prepared in accordance with Bank of Spain requirements and guidelines in effect at the time of such preparation. Such requirements and guidelines may be expected to reflect the bank regulatory policies applicable to us, including without limitation those relating to the maintenance of minimum levels of capital. See “Item 4. Information on the Company—B. Business Overview—Supervision and Regulation—Capital Adequacy Requirements” and “Item 4. Information on the Company—B. Business Overview—Restrictions on Dividends”. According to our interpretation of the relevant Bank of Spain requirements and guidelines, Distributable Profits during the preceding five years were:
The portion of our net income attributable to our subsidiaries has increased steadily in recent years as our subsidiaries have grown and we have acquired new subsidiaries. Such profits are available to us only in the form of dividends from our subsidiaries and we are dependent to a certain extent upon such dividends in order to have Distributable Profits sufficient to allow payment of dividends on our-guaranteed preference stock of our subsidiaries as well as dividends on our shares (although the payment of dividends on the shares is limited in the event of the non-payment of preference share dividends). Please, see Note 3 to our Consolidated Financial Statements. We generally control a sufficient proportion of our consolidated subsidiaries’ voting capital to enable us it to require such subsidiaries to pay dividends to the extent permitted under the applicable law. As a result of our growth we, as the holding entity of the shares of our various companies, have added investments in our subsidiaries, the financial costs of which are borne by us.
For significant changes that have occurred since December 31, 2002, see our form 6-K relating to our first quarter 2003 results filed with the Securities and Exchange Commission on April 29, 2003.
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During the last year, our shares were the shares with the second highest trading volume on the Spanish stock exchanges. At December 31, 2002, our shares represented 14.40% of the IBEX 35 Stock Exchange Index, the first percentage among Spanish banks and the second of all Spanish issuers represented in this index. Our market capitalization of €31,185.4 million at 2002 year-end was the first largest of any Spanish bank and the second largest of any Spanish company, according to information published by the Sociedad de Bolsas.
At December 31, 2002, we had 1,092,193 registered holders of our shares and, as of such date, a total of 422,912,446 of our shares or 8.87% were held by 838 registered holders with registered addresses in the United States and Puerto Rico, including JP Morgan Chase, as depositary of our American Depositary Share program.
Our shares are traded on Spain’s automated “continuous market”, the national, centralized market which integrates by computer quotations originating in the four Spanish stock exchanges (Madrid, Barcelona, Valencia and Bilbao) (the “Automated Quotation Systems”). Our shares also are listed on the London, Paris, Frankfurt, New York (in the form of American Depositary Shares), Italian, Swiss, Lisbon and the Buenos Aires Stock Exchanges, respectively. On March 23, 2001, we delisted our shares from the Tokyo Stock Exchange. At December 31, 2002, 54.5% of our shares were held of record by non-residents of Spain.
The table below sets forth the high, low and last daily sales prices in euros for our shares on the continuous market for the periods indicated.
On June 24, 2003, the reported last sale price of our shares on the continous market was €7.62.
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Our ADSs have been listed and traded on the New York Stock Exchange since July 30, 1987. Each ADS represents one of our shares and is evidenced by an American Depositary Receipt, or ADR. The deposit agreement, pursuant to which ADRs have been issued, is among us, JP Morgan Chase, as depositary, and the holders from time to time of ADRs. At December 31, 2002, a total of 70,154,387 of our ADSs were held by 778 registered holders. Since certain of such of our shares and our ADSs are held by nominees, the number of record holders may not be representative of the number of beneficial owners.
The table below sets forth the reported high, low and last sale prices for our ADSs on the New York Stock Exchange for the periods indicated.
On June 24, 2003, the reported last sale price of our ADSs on the New York Stock Exchange was €8.90.
The Spanish securities market for equity securities (the “Spanish Stock Exchanges”) consists of the four stock exchanges located in Madrid, Barcelona, Bilbao and Valencia (the “local exchanges”). The majority of the transactions conducted on them are done through the Automated Quotation System (Sistema Interbancario Bursátil Español or “S.I.B.E.”). During the year ended December 31, 2002, the Automated Quotation System accounted for the majority of the total trading volume of equity securities on the Spanish Stock Exchanges. According to statistics of the CNMV (defined below), the shares of Spanish banks are among the most heavily-traded securities on the Spanish Stock Exchanges.
The Automated Quotation System was introduced in 1989 and links the four local exchanges, providing those securities listed on it with a uniform continuous market that eliminates most of the differences among the local exchanges. The principal feature of the system is the computerized matching of buy and sell orders at the time of entry of the order. Each order is executed as soon as a matching order is entered, but can be modified or canceled until executed. The activity
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of the market can be continuously monitored by investors and brokers. The Automated Quotation System is operated and regulated by the Sociedad de Bolsas, S.A. (the “Sociedad de Bolsas”), a corporation owned by the companies that manage the local exchanges. All trades on the Automated Quotation System must be placed through a bank, brokerage firm, an official stock broker or a dealer firm member of a Spanish stock exchange directly.
There is a pre-opening session held from 8:30 a.m. to 9:00 a.m. each trading day on which orders are placed at that time. The computerized trading hours are from 9:00 a.m. to 5:30 p.m. Each session will end with a 5 minute auction, between 5:30 and 5:35, with a random closedown of 30 seconds. The price resulting from each auction will be the closing price of the session.
From May 14, 2001, new rules came into effect regarding the maximum price fluctuations in the price of stocks. Under the new rules, each stock in the continuous market is assigned a static and a dynamic range within which the price of stocks can fluctuate. The price of a stock may rise or fall by its static range (which is published once a month and is calculated according to the stock’s average historic price volatility) above or below its opening price (which shall be the closing price of the previous session). When the stock trades outside of this range, the trading of the stock is suspended for 5 minutes, during which an auction takes place. After this auction, the price of the stock can once again rise or fall by its static range above or below its last auction price (which will be considered as the new static price before triggering another auction). Furthermore, the price of a stock cannot rise or fall by more than its dynamic price range (which is fixed and published once a month and is calculated according to the stock´s average intra-day volatility), from the last price at which it has traded. If the price variation exceeds the stock’s dynamic range a five minutes auction is triggered.
Between 5:30 p.m. and 8:00 p.m., trades may occur outside the computerized matching system without prior authorization of the Sociedad de Bolsas, at a price within the range of 5% above the higher of the average price and closing price for the day and 5% below the lower of the average price and closing price for the day, if there are no outstanding bids or offers, as the case may be, on the system matching or bettering the terms of the proposed off-system transaction, and if the trade involves more than €300,000 and more than 20% of the average daily trading volume of the stock during the preceding quarter. At any time before 8:00 p.m., trades may take place (with the prior authorization of the Sociedad de Bolsas) at any price if:
Information with respect to computerized trades between 9:00 a.m. and 5:30 p.m. is made public immediately, and information with respect to trades outside the computerized matching system is reported to the Sociedad de Bolsas and published in the Boletín de Cotización and in the computer system by the next trading day.
During 1998, the Block Market (el mercado de bloques) was implemented, allowing for block trades between buyers and sellers. Under certain conditions, this market allows cross-transactions of trades at prices different than at normal market sessions. Trading in the Block Market is subject to certain limits with regard to stocks and volumes.
Until April 1, 2003, transactions carried out on the regional Spanish stock exchanges and the continuous market were cleared and settled through the Servicio de Compensación y Liquidación de Valores, S.A. (the “SCL”). Since April 1, 2003, the settlement and clearance of all trades on the Spanish stock exchanges, the Public Debt Market (Mercado de Deuda Pública), the AIAF Fixed Income Market (Mercado AIAF de Renta Fija) and Latibex – the Latin American stock – exchange denominated in euros, are made through the Sociedad de Gestión de los Sistemas de Registro, Compensación y Liquidación de Valores (“Iberclear”), which was formed as a result of a merger between SCL and Central de Anotaciones del Mercado de Deuda Pública (CADE), which was managed by the Bank of Spain.
Ownership of shares listed on any Spanish stock exchange is required to be represented by entries in a register maintained by Iberclear, and transfers or changes in ownership are effected by entries in such register. Iberclear is
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responsible for maintaining the register of securities, held in book-entry form, of all trades from the Spanish stock exchanges, the Public Debt Market, the AIAF Fixed Income Market and Latibex.
The Spanish Securities Markets Act, which came into effect in 1989, among other things:
The Securities Markets Act was amended by Law 37/1998, which implemented two European Union directives into Spanish law. The first is Directive 93/22/CE, relating to investment services within securities, later amended by Directive 95/26/CE of European Parliament and Council. The second is Directive 97/9/CE of European Parliament and Council, relating to indemnity systems.
Law 37/1998 introduced some innovations to the Securities Markets Act. The first was the recognition that both Spanish and other European Union Member State companies authorized to provide investment services have full access to the official secondary markets, with full capacity to operate, thereby enabling the direct admission of banking entities into the stock exchange area. The second innovation was that the scope of the Securities Markets Act was enlarged to include a list of financial instruments, such as financial exchange contracts, or installment financial contracts, which expanded the category of securities.
Other modifications under Law 37/1998 include:
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The Securities Markets Act has been further amended by Law 44/2002 (November 22, 2002) on reform measures of the financial system, which introduced certain modifications to the laws governing financial markets and corporations, generally, including:
Some of our subsidiaries, in accordance with customary practice in Spain, and as permitted under Spanish law, have regularly purchased and sold our shares both for their own account and for the accounts of customers. Our subsidiaries have intervened in the market for our shares primarily in connection with customer transactions and, occasionally, in connection with transactions by non-customers that are undertaken for commercial purposes or to supply liquidity to the market when it is commercially reasonable to do so. Such trading activity also has provided a mechanism for accumulating shares that were used to meet conversions into our shares of bonds issued by us and other affiliated companies and to make offerings of shares. Prior to entering the continuous market, such trading took place mainly on the Madrid Stock Exchange during the trading session or in subsequent block trades. Entry into the continuous market has reduced the need for our subsidiaries to intervene in the market for the shares due to imbalances of supply and demand. We expect that our subsidiaries may continue to purchase and sell our shares from time to time.
Our trading activities in our shares are limited to those set forth above. No affiliated company acts as a “market maker” as that term is understood in the United States securities markets. The continuous market is driven by orders, which are matched by the market’s computer system according to price and time entered. Banco Santander Central Hispano’s and Banesto’s broker subsidiaries, Santander Central Hispano Bolsa, Sociedad de Valores, S.A., (“Santander Central Hispano-SVB”) and Banesto, Bolsa, S.A., S.V.B., and the other brokers authorized to trade on the continuous market (“Member Firms”) are not required to and do not serve as market makers maintaining independently established bid and ask prices. Rather, Member Firms place orders for their customers, or for their own account, into the market’s computer system. If an adequate counterparty order is not available on the continuous market at that time, the Member Firm may solicit counterparty orders from among its own clients and/or may accommodate the client by filling the client’s order as principal.
Under the Corporations Law of Spain, a company and its subsidiaries are prohibited from purchasing shares of the company in the primary market. However, purchase of the shares is permitted in the secondary market provided that: (1) the aggregate of such purchases (referred to as “treasury stock” or “autocartera”) and the shares previously held by the company and its subsidiaries does not exceed 5% of the total capital stock of the company, (2) the purchases are authorized at a meeting of the shareholders of the acquiring company and the acquiring company’s parent, if any, and (3) the acquiring company and its parent, if any, create reserves equal to the book value of the treasury stock included in its assets.
The law requires that the “Comisión Nacional del Mercado de Valores” (CNMV) be notified each time the level of treasury stock reaches 1% of the outstanding capital stock, regardless of any other preceding sales. Prior to adoption of the Corporations Law in 1989, treasury stock shares were considered to be outstanding for all purposes under Spanish law (except for calculating capital ratios pursuant to Bank of Spain requirements). The Corporations Law establishes, in relation to the treasury stock shares (held by us and our affiliates), that the exercise of the right to vote and other non-financial rights attached to them shall be suspended. Financial rights arising from treasury stock held directly by us, with the exception of the right to allotment of new bonus shares, shall be attributed proportionately to the rest of the shares.
The portion of trading volume in the shares represented by purchases by our subsidiaries has varied widely from day to day and from month to month and may be expected to do so in the future. In 2002, 14.9% of the volume traded of the shares was effected not as a principal by Santander Central Hispano-SVB and 2.3% was effected not as a principal by Banesto Bolsa, S.A., S.V.B. The portion of trading volume in the shares allocable to purchases and sales as principal by our companies was approximately 8.1% in the same period. The monthly average percentage of outstanding shares held by our subsidiaries ranged from 0.274% to 0.443% in 2002. Our consolidated subsidiaries held 3,851,465 of our shares (0.08% of our total capital stock) at December 31, 2002.
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The following summary of the material terms of our by-laws is not meant to be complete and is qualified by reference to our by-laws. Because this is a summary, it does not contain all the information that may be important to you. You should read our by-laws carefully before you decide to invest. Copies of our by-laws are incorporated by reference.
As of December 31, 2002, share capital is €2,384,201,471.50 represented by a single class of 4,768,402,943 book-entry Banco Santander Central Hispano shares with a nominal value of €0.50 each. Since that date, our share capital has not changed. All of our shares are fully paid and non-assessable. Spanish law requires that bank-listed equity securities be issued in book-entry form only.
Banco Santander Central Hispano is registered with the Commercial Registry of Santander (Finance Section). The Bank is also recorded in the Special Registry of Banks and Bankers with registration number 0049, and its fiscal identification number is A-39000013.
Article 12 of our by-laws states that the corporate objective and purpose of Banco Santander Central Hispano consist of carrying-out all types of activities, operations and services specific to the banking business in general and which are permitted under current legislation and the acquisition, holding and disposal of all types of securities.
As of the date of the filing of this report, Banco Santander Central Hispano’s capital is comprised of only one class of shares, all of which are ordinary shares and have the same rights.
Our by-laws do not contain any provisions relating to sinking funds.
Our by-laws do not specify what actions or quorums are required to change the rights of holders of our stock. Under Spanish law, the rights of holders of stock may only be changed by an amendment to the by-laws of the company that complies with the requirements explained below under “Meetings and Voting Rights.”
We hold our annual general shareholders meeting during the first six months of each fiscal year on a date fixed by the board of directors. Extraordinary meetings may be called from time to time by the board of directors whenever the Board considers it advisable in corporate interests, and whenever so requested by stockholders representing 5% of the outstanding share capital of Banco Santander Central Hispano. Notices of all meetings are published in the Official Gazette of the Mercantile Register and in one of the local newspapers having the largest circulation in the province where the registered office of Banco Santander Central Hispano, S.A. is located. Our last ordinary general meeting of shareholders was held on June 21, 2003 and our last extraordinary general meeting of shareholders was held on February 9, 2002.
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Each Banco Santander Central Hispano share entitles the holder to one vote, although only registered holders of at least 100 Banco Santander Central Hispano shares are entitled to attend stockholders meetings. Holders of fewer than 100 Banco Santander Central Hispano shares may aggregate their Banco Santander Central Hispano shares by proxy and select a representative to attend the stockholders meeting. Our by-laws do not contain provisions regarding cumulative voting.
As an exception to the general rule that entitles the holder of each Banco Santander Central Hispano share to one vote, our by-laws presently provide that, except when in representation of another shareholder or shareholders, none of which considered as a group or individually are casting a number votes greater than those corresponding to shares representing 10% of the share capital present at the meeting or represented therein, no shareholder may cast a number of votes greater than those corresponding to shares representing 10% of the share capital present at the meeting or represented therein. This provision is applicable to the aggregation of votes corresponding to shares held by companies pertaining to a same group of companies and to the aggregation of votes corresponding to shares held by an individual and the companies controlled by the same. The ordinary General Meeting held on June 21, 2003 passed a proposal by the Board of Directors to amend the by-laws to, among other things, remove this limitation on voting. This amendment, which is pending administrative authorization and official registration on the Mercantile Register, is more fully explained below.
Any Banco Santander Central Hispano share may be voted by proxy. Proxies may be given only to shareholders who are entitled to attend the shareholders meeting and are acting in their individual capacity, must be in writing and are valid only for a single meeting.
Only registered holders of Banco Santander Central Hispano shares of record at least five days prior to the day on which a meeting is scheduled to be held may attend and vote at such meeting. As a registered shareholder, the depositary will be entitled to vote the Banco Santander Central Hispano shares underlying the Banco Santander Central Hispano ADSs. The deposit agreement requires the depositary to accept voting instructions from holders of Banco Santander Central Hispano ADSs and to execute such instructions to the extent permitted by law.
In general, resolutions passed by a general meeting are binding upon all shareholders. In certain circumstances, Spanish law gives dissenting or absent shareholders the right to have their Banco Santander Central Hispano shares redeemed by us at prices determined in accordance with established formulae. Banco Santander Central Hispano shares held by our affiliates are counted for purposes of determining quorums but may not be voted by the affiliates.
In accordance with Spanish law, a quorum on first call for a duly constituted ordinary or extraordinary general meeting of shareholders requires the presence in person or by proxy of shareholders representing 25% of our subscribed voting capital. On second call there is no quorum requirement. Notwithstanding the above, a quorum of 50% of our subscribed voting capital is required on the first call to approve any of the following actions:
A quorum of 25% of the subscribed voting capital is required to vote on such actions on the second call.
Resolutions at general meetings are passed by a simple majority of the voting capital present or represented at the meeting. A two-thirds majority of our present or represented voting capital is required to approve the following actions when the shareholders meeting is held on second call and less than 50% of our subscribed voting capital are present:
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A 70% majority of our voting capital present or represented in the shareholders meeting on first or second call shall be necessary to approve the following:
The last ordinary General Meeting passed a proposal by the Board of Directors to amend our by-laws to, among other things, remove from them this 70% majority vote requirement to approve the actions described above. This together with the other changes in our existing by-laws discussed in this Item 10 are summarized in the paragraph below.
In order to guarantee equal treatment for all Banco Santander Central Hispano shareholders, and to reinforce their control of certain decisions of particular importance, the ordinary General Meeting held on June 21, 2003 passed a proposal by the Board of Directors to, among others, modify articles 17, 24, and 30 of our by-laws. Such modifications, which are pending administrative authorization and official registration on the Mercantile Register, will result in the elimination of: a) the limit on the maximum number of votes which a holder holding more than 10% of the capital present and represented at the shareholders meeting can cast; b) the requirement of a 70% majority of the capital present or represented in a shareholders meeting in order to approve certain actions by the Bank; and c) the requirement to hold, at least, 100 shares of the Bank for a minimum of three years prior to being eligible to serve as a director of the Bank.
Any increase or reduction in share capital must be approved at the general meeting in accordance with the procedures explained above in the section entitled “Meetings and Voting Rights.”
We normally pay a yearly dividend in advance in quarterly installments in July, October and January and a complementary dividend that is generally paid in April of the following year, upon approval at the shareholders meeting. We and our domestic banking subsidiaries are subject to certain restrictions on dividend payments, as prescribed by the Ministry of Economy and the Bank of Spain. See “Item 4. Information on the Company—B. Business Overview—Supervision and Regulation—Restrictions on Dividends”.
Our by-laws establish that any available profits shall be distributed in the following order: first, the legally required amounts are placed into the compulsory reserves. Next, our board of directors will assign such amounts it considers appropriate to voluntary reserves and pension funds. After separating the amount which should be carried forward, if the board deems it advisable, the remaining amount will be divided equally amongst our shareholders under the limitations imposed by Spanish law.
Our by-laws also dictate that non-voting shares shall receive a minimum annual dividend of 5% of the capital paid out in respect of each such share in accordance with the “Ley de Sociedades Anónimas” (Corporations Act).
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The amount, time and form of payment of the dividends, to be distributed amongst the shareholders in proportion to their paid-in capital will be established by resolutions adopted at the general meeting.
A shareholder’s dividend entitlement lapses five (5) years after the dividend payment date.
In the event of a capital increase, each shareholder has a preferential right by operation of law to subscribe for shares in proportion to its shareholding in each new issue of Banco Santander Central Hispano shares. However, this right may be excluded under certain circumstances by specific approval at the shareholders meeting and this right is deemed excluded in the relevant capital increase when the shareholders meeting approves:
If capital is increased by the issuance of new shares in return for capital from certain reserves, the resulting new Banco Santander Central Hispano shares will be distributed pro rata to existing shareholders.
Our by-laws do not contain any provisions relating to redemption of shares. Nevertheless, pursuant to Spanish law, redemption rights may be created at a duly held general shareholders’ meeting. Such meeting will establish the specific terms of any redemption rights created.
The Banco Santander Central Hispano shares are in book-entry form. We maintain a registry of stockholders. We do not recognize more than one person as the person entitled to vote each share in the shareholders meeting.
Under Spanish law and regulations, transfers of shares quoted on a stock exchange are normally made through a “Sociedad y Agencia de Valores”, credit entities and investment services companies, that are members of the Spanish stock exchange.
Transfers executed through stock exchange systems are implemented pursuant to the stock exchange clearing and settlement procedures of Iberclear. Transfers executed “over the counter” are implemented pursuant to the general legal regime for book entry transfer, including registration by Iberclear.
Upon a liquidation of Banco Santander Central Hispano, our shareholders would be entitled to receive pro rata any assets remaining after the payment of our debts, taxes and expenses of the liquidation. Holders of non-voting shares, if any, will receive reimbursement of the amount paid before any amount is distributed to the holders of voting shares.
Our by-laws do not contain any provisions that would have an effect of delaying, deferring or preventing a change in control of the company and that would operate only with respect to a merger, acquisition or corporate restructuring involving Banco Santander Central Hispano or any of our subsidiaries. Nonetheless, certain aspects of Spanish law described in the following section may delay, defer or prevent a change of control of the Bank or any of our subsidiaries in the event of a merger, acquisition or corporate restructuring.
Certain provisions of Spanish law require notice to the Bank of Spain prior to the acquisition by any individual or corporation of a substantial numbers of shares of a Spanish bank.
Any individual or corporation that wishes to acquire, directly or indirectly, a significant participation (participación significativa) in a Spanish bank must give advance notice to the Bank of Spain describing the size of such participation, its
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terms and conditions, and the anticipated closing date of the acquisition. “Significant participation” is defined as 5% of the outstanding share capital or voting rights of the bank or any lesser participation that gives the acquirer effective influence or control over the target bank.
In addition, advance notice must be given to the Bank of Spain of any increase, direct or indirect, in any significant participation at each of the following levels of ownership: 10%; 15%; 20%; 25%; 33%; 40%; 50%; 66% and 75%. Notice to the Bank of Spain is also required from anyone who, as a result of the contemplated acquisition, may attain sufficient power to control the credit entity.
Any acquisition mentioned in the preceding sentence to which the required notice was not given or even if given, a three month period after receipt of notice has not yet elapsed, or that is opposed by the Bank of Spain will have the following effects: (1) the acquired shares will have no voting rights, (2) the Bank of Spain may seize control of the bank or replace its board of directors and (3) a fine may be levied on the acquirer.
The Bank of Spain has three months after the receipt of notice to object to a proposed transaction. Such objection may be based on finding the acquirer unsuitable on the basis of its commercial or professional reputation, its solvency or the transparency of its corporate structure. If three months elapse without any word from the Bank of Spain, its authorization is deemed granted. However, absent objection by the Bank of Spain, it may extend the period for closing the proposed transaction.
Any individual or institution that plans to sell its significant participation, or reduce it to one of the above-mentioned levels of ownership, or because of any sale will lose control of the entity, must provide advance notice to the Bank of Spain indicating the amount of the transaction and its anticipated closing date. Failure to comply with these requirements may subject the offending party to penalties.
Credit entities must notify the Bank of Spain as soon as they become aware of any acquisition or transfer of significant shares of its stock capital that exceeds the above-mentioned percentages. In addition, credit entities are required to provide periodic reports to the Bank of Spain describing the composition of and significant alterations to the ownership of the capital stock of the credit entity. This information must also provide, the level of ownership, regardless of the amount, of any other financial entities in the capital stock of the credit entity.
If the Bank of Spain determines at any time that the influence of a person who owns a significant participation of a bank may adversely affect the bank’s financial situation, it may request that the Ministry of Economy: (1) suspend the voting rights of such person’s shares for a period not exceeding 3 years; (2) seize control of the bank or replace its board of directors; or (3) revoke the bank’s license.
The Bank of Spain also requires each bank to publish a list, dated on the last day of each quarter and during April, July, October and January of all its shareholders that are financial institutions and all other shareholders that own at least 0.25% of the bank’s total equity. Furthermore, banks are required to inform the Bank of Spain as soon as they become aware, and in any case not later than in 15 days after, of each acquisition by a person or a group of at least 1% of such a bank’s total equity.
Royal Decree 432/2003 of April 11, 2003 (“RD 432/2003”) modifies the current regulations on tender offers set forth by Royal Decree 1197/1991 of July 26, 1991 (“RD 1197/1991”) reinforcing the protection of minority shareholders and introducing certain changes intended to make the tender offer regime more flexible.
RD 432/2003 introduces additional scenarios which impose the mandatory launching of a tender offer. A person or entity must first launch a tender offer if it proposes to acquire a significant shareholding (25% or more) in the voting stock of the target company’s shares (or certain other equivalent securities that may directly or indirectly give the right to subscribe for shares) of a publicly-traded Spanish company. The tender offer must be for shares representing, at least, 10% and up to 100% of the target’s company capital ,contingent on the final percentage of the capital of such target company to be acquired (basically, 25% or more or 50% or more). Also, the launching of a tender offer is mandatory for the acquisition of shares representing 6% or more of the capital of the target company during any twelve-month period when the offeror holds a stake between 25% and 50% of the target’s company capital.
Tender offers are mandatory also, even without reaching the stake thresholds mentioned above, if such person or entity intends to appoint more than one third but less than half plus one of the target company’s Board or more than half of the directors of the target company’s Board.
These new cases also require the mandatory launching of a tender offer if, within two years from the date of the acquisition, the offeror nominates and appoints more than one third but less that half of the target company’s Board or more than one half of the target company’s Board.
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Finally, RD 432/2003 modifies the exceptions to the mandatory launching of a tender offer; it allows for conditional tender offers upon certain requirements being met and it substantially modifies the regime of competing tender offers.
The acquisitions or transfers of shares of any company listed on a Spanish Stock Exchange where, following the transaction, the acquiror’s ownership participation reaches 5% or any multiple of 5% of the capital stock of such company, or the seller’s participation is reduced from one of the above mentioned levels of ownership, must be reported, within 7 business days after such acquisition or transfer. The reporting must be made to the company that issued the traded shares, to the Governing Companies (Sociedades Rectoras) of the Spanish stock exchanges on which such company is listed, and to the Comisión Nacional del Mercado de Valores. This threshold percentage will be 1%, or any multiple of 1%, whenever the acquirer, or the person who acts on his/her behalf, is resident of a tax haven as defined in accordance with Royal Decree 1080/1991, or of a country or territory where there is no authority entrusted with the supervision of the securities markets, or when the designated authority declines to exchange information with the Comision Nacional del Mercado de Valores. The Minister of Finance is required to specify countries and territories in such cases, as proposed by the Comisión Nacional del Mercado de Valores.
In addition, any company listed on a Spanish stock exchange must report any acquisition by such company (or a subsidiary) of the company’s own shares if the acquisition, together with any acquisitions since the date of the last report, causes the company’s ownership of its own shares to exceed 1% of its capital stock. See “Item 9. The Offer and Listing—Banco Santander Central Hispano Shares—Trading by Banco Santander Central Hispano’s Subsidiaries in the Shares.”
The directors of any company listed on a Spanish stock exchange must report to the Comisión Nacional del Mercado de Valores, to the Governing Companies (Sociedades Rectoras) of the Stock Exchanges on which the company is listed, and to the company itself, the amount of shares or option rights over the company’s shares that they hold at the time of their appointment (or, if applicable, report that they own no shares or options) directly, through companies they control or any other intemediary, regardless of the amount, and must report all acquisitions or transmissions of shares in the company, regardless of the amount that they carry out by themselves or by means of either the companies they control or an intermediary. The directors must also report the acquisition or transfer of option rights over the company’s shares.
In addition, managers of any listed company must report to the Comision Nacional del Mercado de Valores the acquisition of shares and option rights over shares as a result of a compensation plan related to the shares’ price. Any change of the aforesaid plans must be also reported.
Our Board of Directors may be made up of a minimum of 14 and a maximum of 30 members, appointed by the general meeting of shareholders. Members of the Board of Directors are elected for an initial term of three years but can be re-elected. One third of the members of the Board are elected each year. The Board of Directors will endeavor for the external or non-executive directors to represent a majority of the members of the Board, and that a reasonable number of independent directors be part of the external ones.
The actions of the members of the board are limited by Spanish law and certain general provisions contained in our by-laws. For instance, Article 31 of our by-laws states that the directors will be liable to Banco Santander Central Hispano, to our shareholders and to our corporate creditors for any damages that they may cause by acts which are contrary to Spanish law or to the by-laws. Furthermore, the directors will be liable for any acts that are carried out without observing the formalities that would be followed by a responsible business person and a trustworthy representative.
The board of directors may pass resolutions in order to establish the amount of each payment of any capital call with respect to partially paid-in shares. The board will also establish the period within which the payments must be made and other details, all of which must be published in the “Boletín Oficial del Registro Mercantíl” (the Official Gazette of the Mercantile Register). Any delays in the payment of capital calls will bear interest starting from the day payment is due and without the need for any judicial or extra-judicial summons. We will also be able to take any action authorized by law to collect such sums.
Pursuant to our by-laws, our board of directors has the power to allocate up to 5% of our annual net income to its own compensation. See also “Item 6. Directors, Senior Management and Employees—B. Compensation”.
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There are no mandatory retirement provisions due to age for board members in our by-laws or in the regulations of our board of directors. These regulations contain provisions relating to the cessation of directorship for other reasons.
Only the following shall be eligible to hold the office as Directors of Banco Santander Central Hispano, S.A.:
The ordinary General Meeting held on June 21, 2003 passed the proposal by the Board of Directors to modify, among others, article 30 of our by-laws. Once administrative authorization is obtained and the amended by-laws are officially registered on the Mercantile Register, it will eliminate each of the two requirements described above so that, subject to legal limitations, any person will be eligible to serve as a Director of Banco Santander Central Hispano, S.A. without having to be a shareholder of the Bank. See “Item 9. Meeting and Voting Rights”.
During the past two years, the Bank was not a party to any contract outside its ordinary course of business that was material to the Group as a whole.
Under present regulations, foreign investors may transfer invested capital, capital gains and dividends out of Spain without limitation on the amount other than applicable taxes. See “Taxation”. The Spanish stock exchanges and securities markets are open to foreign investors. Royal Decree 664/1999, on Foreign Investments (April 23, 1999), established a new framework for the regulation of foreign investments in Spain which, on a general basis, will no longer require any prior consents or authorizations from authorities in Spain (without prejudice to specific regulations for several specific sectors, such as television, radio, mining, telecommunications, etc.). Royal Decree 664/1999 requires notification of all foreign investments in Spain and liquidations of such investments upon completion of such investments to the Investments Registry of the Ministry of Economy, strictly for administrative statistical and economical purposes. Only investments from “tax haven” countries (as they are defined in Royal Decree 1080/1991), shall require notice before and after performance of the investment, except that no prior notice shall be required for: (1) investments in securities or participations in funds of the investment that are registered with the CNMV and (2) investments that do not increase the foreign ownership of the capital stock of a Spanish company to over 50%. In specific instances, the Counsel of Ministers may agree to suspend, all or part of, Royal Decree 664/1999 following a proposal of the Minister of Economy, or, in some cases, a proposal by the head of the government department with authority for such matters and a report of the Foreign Investment Body. These specific instances include a determination that the investments, due to their nature, form or condition affect activities, or may potentially affect activities relating to the exercise of public powers, national security or public health. Royal Decree 664/1999 is currently suspended for investments relating to national defense. Whenever Royal Decree 664/1999 is suspended, the affected investor must obtain prior administrative authorization in order to carry out the investment.
The following is a discussion of the material Spanish and U.S. federal income tax consequences to you of the acquisition, ownership and disposition of the ADSs or shares.
This discussion only applies to you if you are a beneficial owner of shares or ADSs and are:
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The discussion of Spanish tax consequences below applies to you only if you are a non-resident of Spain and ownership of ADSs or shares is not effectively connected with a permanent establishment or fiscal base in Spain and only to U.S. residents entitled to the benefits of the Spanish-U.S. income tax treaty.
You should consult your own tax adviser as to the particular tax consequences to you of owning the shares or ADSs including your eligibility for the benefits of any treaty between Spain and the country of your residence for the avoidance of double taxation, the applicability or effect of any special rules to which you may be subject, and the applicability and effect of state, local, foreign and other tax laws and possible changes in tax law.
For purposes of the Spanish-U.S. income tax treaty and the U.S. Internal Revenue Code of 1986, as amended, United States holders of ADRs will generally be treated as the owners of the ADSs evidenced by the ADRs and of the shares represented by such ADSs.
The following is a summary of material Spanish tax matters and is not exhaustive of all the possible tax consequences to you of the acquisition, ownership and disposition of ADSs or shares. This discussion is based upon the tax laws of Spain and regulations thereunder, which are subject to change, possibly with retroactive effect.
Under Spanish law, if you do not reside in Spain for tax purposes, dividends paid by a Spanish resident company to you are subject to Spanish Non-Resident Income Tax at a 15% rate, which is also the rate to which you may be entitled to under the Spain-US Income Tax Treaty.
We will levy the withholding tax on the gross amount of dividends at a 15% tax rate, following the procedures set forth by the Order of April 13, 2000.
Under the Spanish law, any capital gains derived from securities issued by persons residing in Spain for tax purposes are considered to be Spanish source income and, therefore, are taxable in Spain. For Spanish tax purposes, income obtained by you if you are a U.S. resident from the sale of ADSs or shares will be treated as capital gains. Spanish non-resident income tax is currently levied at a 35% tax rate on capital gains obtained by persons not residing in Spain for tax purposes who are not entitled to the benefit of any applicable treaty for the avoidance of double taxation.
Notwithstanding the above, capital gains derived from the transfer of shares in an official Spanish secondary stock market by any holder who is resident in a country that has entered into a treaty for the avoidance of double taxation with Spain containing an “exchange of information” clause will be exempt from taxation in Spain. In addition, under the Spain-U.S. Income Tax Treaty, capital gains realized by you upon the disposition of ADSs or shares will not be taxed in Spain provided you have not held, directly or indirectly, 25% of our capital during the twelve months preceding the disposition of the stock. You may be required to establish that you are entitled to this exemption by providing to the relevant Spanish tax authorities an IRS certificate of residence in the United States, together with the appropriate Spanish tax form, not later than 30 days after the capital gain was realized.
Individuals not residing in Spain who hold shares or ADSs located in Spain are subject to the Spanish wealth tax (Spanish Law 19/1991), which imposes a tax on property located in Spain on the last day of any year. The Spanish tax authorities may take the view that all shares of Spanish corporations and all ADSs representing such shares are located in Spain for Spanish tax purposes. If such a view were to prevail, non-residents of Spain who held shares or ADSs on the last day of any year would be subject to the Spanish wealth tax for such year at marginal rates varying between 0.2% and 2.5% of the average market value of such shares or ADSs during the last quarter of such year.
Transfers of shares or ADSs upon death or by gift are subject to Spanish inheritance and gift taxes (Spanish Law 29/1987) if the transferee is a resident in Spain for tax purposes, or if the shares or ADSs are located in Spain at the time of gift or death, regardless of the residence of the beneficiary. In this regard, the Spanish tax authorities may determine that all shares of Spanish corporations and all ADSs representing such shares are located in Spain for Spanish tax purposes. The applicable tax rate, after applying all relevant factors, ranges between 0 and 81.6% for individuals.
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Gifts granted to corporations non-resident in Spain are subject to Spanish Non-Resident Income Tax at a 35% tax rate on the fair market value of the shares as a capital gain. If the donee is a United States corporation, the exclusions available under the Treaty described in the section “Taxation of capital gains” above will be applicable.
Transfers of ADSs or shares will be exempt from any transfer tax or value-added tax. Additionally, no stamp tax will be levied on such transfers.
The following summary describes the material United States federal income tax consequences of the acquisition, ownership and disposition of ADSs or shares, but it does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a particular person’s decision to acquire such securities. The summary applies only to U.S. Holders (as described below) that hold ADSs or shares as capital assets for tax purposes and does not address special classes of holders, such as:
The summary is based upon tax laws of the United States including the Internal Revenue Code of 1986, as amended to the date hereof (the “Code”), administrative pronouncements, judicial decisions and final, temporary and proposed Treasury Regulations, changes to any of which may affect the tax consequences described herein possibly with retroactive effect. In addition, the summary is based on the Convention Between the United States and the Kingdom of Spain for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (the “Treaty”) and is based in part on representations of the Depositary and assumes that each obligation provided for in or otherwise contemplated by the Deposit Agreement or any other related document will be performed in accordance with its terms. Prospective purchasers of the ADSs or shares are urged to consult their own tax advisers as to the United State s, Spanish or other tax consequences of the purchase, ownership and disposition of ADSs or Shares in their particular circumstances, including the effect of any U.S. state or local tax laws.
As used herein, a “U.S. Holder” is a beneficial owner of ADSs or shares that is, for United States federal income tax purposes:
For United States federal income tax purposes, U.S. Holders of ADSs will be treated as the holders of the underlying shares represented by those ADRs. Accordingly, no gain or loss will be recognized if a U.S. Holder exchanges ADSs for the underlying Shares represented by those ADSs.
The U.S. Treasury has expressed concerns that parties to whom ADSs are released may be taking actions that are inconsistent with the claiming of foreign tax credits for U.S. holders of ADSs. Accordingly, the analysis of the creditability of Spanish taxes described below could be affected by future actions that may be taken by the U.S. Treasury.
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To the extent paid out of our current or accumulated earnings and profits (as determined in accordance with United States federal income tax principles), distributions, including any Spanish withholding tax, made with respect to ADSs or shares (other than certain distributions of our capital stock or rights to subscribe for shares of our capital stock) will be includible in the income of a U.S. Holder as ordinary dividend income. Such dividends will not be eligible for the “dividends received deduction” generally allowed to corporations under the Code. To the extent that a distribution exceeds our current and accumulated earnings and profits, it will be treated as a nontaxable return of capital to the extent of the U.S. Holder’s tax basis in the ADSs or shares, and thereafter as capital gain. The amount of the distribution will equal the U.S. dollar value of the euros received, calculated by reference to the exchange rat e in effect on the date such distribution is received (which, for U.S. Holders of ADSs, will be the date such distribution is received by the Depositary), whether or not the Depositary or U.S. Holder in fact converts any euros received into U.S. dollars at that time. Any gains or losses resulting from the conversion of euros into U.S. dollars will be treated as ordinary income or loss, as the case may be, of the U.S. Holder and will be U.S. source. Dividends generally will constitute foreign source “passive” or “financial services” income for U.S. foreign tax credit purposes.
Dividends paid to a non-corporate U.S. holder paid before January 1, 2009 will be taxed at a maximum rate of 15% if certain holding period requirements are met.
Subject to certain generally applicable limitations, a U.S. Holder will be entitled to a credit against its U.S. federal income tax liability, or a deduction in computing its U.S. federal taxable income, for Spanish withholding taxes. A U.S. Holder may be required to recognize ordinary income or loss attributable to currency fluctuations upon its receipt of a refund in respect of Spanish withholding tax to the extent that the U.S. dollar value of the refund differs from the U.S. dollar equivalent of the refund amount on the date the underlying dividend was received.
A U.S. Holder must satisfy minimum holding period requirements in order to be eligible to claim a foreign tax credit for foreign taxes withheld on dividends. U.S. Holders are urged to consult their own tax advisers to determine whether they are subject to any special rules that limit their ability to make effective use of foreign tax credits.
Subject to the discussion of the passive foreign investment company rules below, gain or loss realized by a U.S. Holder on the sale or exchange of ADSs or shares will be subject to United States federal income tax as capital gain or loss in an amount equal to the difference between the U.S. Holder’s tax basis in the ADSs or shares and the amount realized on the disposition. Gain or loss, if any, will be U.S. source for foreign tax credit purposes. The deductibility of capital losses is subject to limitations. Long-term capital gain of a non-corporate U.S. holder is generally taxed at a preferential rate.
We believe that we are not a “passive foreign investment company”, or “PFIC”, for United States federal income tax purposes for the taxable year 2002. However, since our PFIC status depends upon the composition of our income and assets and the market value of our assets (including, among others, less than 25 percent owned equity investments) from time to time, and based upon certain proposed Treasury Regulations that are not yet in effect but are generally proposed to become effective for taxable years after December 31, 1994, there can be no assurance that we will not be considered a PFIC for any taxable year.
In the event we are a PFIC, certain unintended tax consequences could apply to you.
Information returns will be filed with the Internal Revenue Service in connection with payments of dividends on, and the proceeds from a sale or other disposition of, ADSs or Shares. A U.S. Holder will be subject to United States backup withholding tax on these payments if the United States Holder fails to provide its taxpayer identification number to the paying agent and comply with certain certification procedures or otherwise establish an exemption from backup withholding. The amount of any backup withholding from a payment to a U.S. Holder will be allowed as a credit against the U.S. Holder’s U.S. federal income tax liability and may entitle the U.S. Holder to a refund, provided that the required information is furnished to the Internal Revenue Service.
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We are subject to the information requirements of the Exchange Act, except that as a foreign issuer, we are not subject to the proxy rules or the short-swing profit disclosure rules of the Exchange Act. In accordance with these statutory requirements, we file or furnish reports and other information with the SEC. Reports and other information filed or furnished by us with the SEC may be inspected and copied at the public reference facilities maintained by the SEC at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the SEC’s regional offices at 233 Broadway, New York, New York 10279 and Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. Copies of such material may also be inspected at the offices of the New York Stock Exchange, 11 Wall Street, New York, New York 10005, on which our ADSs are listed. In addition, the SEC maintains a Web site that contains information filed electronically with the SEC, which can be accessed over the internet at http://www.sec.gov.
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Our risk management activities involve the integrated qualification and quantification of the different types of risk (credit risk, operational risk, environmental risk and market risk) which are assumed by our business units in their activities.
We have divided this section, according to the primary risks faced by the Group, in the following five parts:
We regard risk management as one of our most important tasks in order to generate value on a sustained basis.
The model of management is the same for all of our units, without detriment to the adaptations that have to be made to local markets. As well as producing a better organization of risk admission, putting all units on the same footing enables comparisons to be properly made.
This approach allows the different risks to be identified, measured in homogeneous terms and integrated so that our global exposure is known and managed from different perspectives (products, groups of clients, segments, economic sectors, geographic areas, businesses, etc).
In 2002, we unified the areas of Latin America Commercial Banking Credit Risks, Recoveries, Corporate and Counterparty under the Credit Risks Area which, together with Market Risks and Integrated Risk Management, comprise the Risks Division. This division reports to the third Vice-Chairman of Santander Central Hispano and Chairman of the Risks Committee of the Board of Directors. This committee:
The approach is in line with the guidelines of the New Basle Accord, which ensure independence and the necessary capacity to supervise the development of general strategies of organization, as well as the consistency and coherence with the business plans established by senior management.
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Our management of credit risk is concerned with the identification, measurement, integration, control and evaluation of our different credit exposures and their risk-adjusted profitability from a global perspective as well as within each area of activity.
The organization of the risk management function in our different banks, both in Spain and abroad, is based on the principles and basic organizational structure of the parent bank in Spain.
At the end of 2002, 60.4% of our credit risk with clients (lending and guarantees) was with entities in Spain (including the parent bank). The rest of Europe accounted for 18.7% of our credit risk with clients. The subsidiaries in Latin America accounted for 18.8%; the rest of the Group accounted for 2.1% of the credit risk.
The following table shows the Group’s credit risk (loans and guarantees) with clients as of December 31, 2002.
The Group’s NPL ratio stood at 1.89% at the end of 2002, compared to 1.86% a year earlier, well below the 2.26% at the end of 2000.
The credit risk management process is carried out according to the type of customer, the product provided and the different phases of the lending process.
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The credit risk management with global clients (governments, companies and multinational financial groups) is done on a centralized basis, setting global limits of exposure for the Group as a whole.
Santander Central Hispano’s risk model makes a distinction between treatment of personalized and «global management» risks (large and medium-sized companies) and standardized treatment risks (small firms, businesses and individuals).
Company segment monitoring is backed up by a «special watch system» (FEVE) which determines the policy to be followed with companies or groups that are placed in the system. This system is applied, with the particular features of each market and entity, to our main banks in Spain and abroad.
At the end of 2002, the risks under special watch in the parent bank in Spain classified in the three more serious categories (reduce, secure and extinguish) amounted to €2,274 million, 4.7% if the managed portfolio and 22% less than in 2001. The most serious classification (extinguish) remained at around 1% of the balances.
Credit risk management incorporates, in its last phase, recoveries of loans which finally turned out to be unpaid.
Recovery of smaller unpaid loans is done, in a first phase, through telephone centers. These centers, equipped with powerful information and communications systems, lead to the recovery of a high percentage of this type of risks by telephoning clients a few days after non- payment. Specialized managers are used to recover larger and more complex amounts of unpaid loans.
Despite a less favorable economic environment in 2002 in Spain, net entries of non-performing loans (entries less recoveries) in Santander Central Hispano commercial banking in Spain were 22% lower than in 2001 at €176 million, well below the budgeted level. The level of recovery improved to 93.4% of entries (89.4% in 2001).
Risk management is carried out through our own scoring system, adapted for each specific customer segment, which enables us to measure the risk of each customer and transaction from the outset. The evaluation of the customer obtained after analyzing the relevant risk factors is then adjusted on the basis of the specific features of the transaction (such as its maturity, the presence of guarantees and type of transaction). The risk rating assigned in the admission phase is constantly reviewed during the subsequent risk monitoring stage.
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Each rating is assigned a certain probability of non-payment on the basis of historic experience which, together with the transaction’s features, enables the Group to determine the expected loss associated with the transaction and the client, a cost which is charged to the Return on Risk Adjusted Capital (RORAC) calculation.
The graph on the left shows the distribution by rating of the companies that compound Santander Central Hispano Spain’s credit risk portfolio. The graph on the right shows the distribution of credit risk to companies according to the ratings of such companies.
Santander Central Hispano has developed a computerized system that automatically qualifies or disqualifies clients applying for credit and enables us to anticipate the non-performing loan ratio in transactions with individuals. This system enables us to calculate expected losses in our portfolios, which in turn allows us to estimate the provisions needed for non-performing loans, in accordance with the recommendations of the regulatory authorities, as well as to set risk adjusted prices at the time of admission.
Each curve of the graph below shows NPLs as a percentage of the transactions made in a specific year («vintage»), where the performance over the life of the transaction of each «vintage» can be observed.
The historic record of our data base enables us to simulate future performances (as is the case for the 2003 results in the figure below).
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The Bank has a master scale used to conform the different ratings which are used in the various type of customers that we have (at given anticipated NPL ratios). In this way, the master scale creates a common language, translating any scoring system from different segments to a uniform risk management system which uses a scale of 0 to 9.3. In turn, this master scale is indexed to the values of the external rating agencies.
Santander Central Hispano continued to work in 2002 on matters concerning the New Basle Capital Accord.
Based on its commitment to the internal models promoted by the Bank of Spain in Circular 9/99, its Leadership Project and the Master Plan approved in 2002 to establish the BIS II internal models in the different units and geographic areas, the Group made the following progress in 2002:
These initiatives will require further substantial efforts to be made and possibly different models by countries, units and segments.
Santander Central Hispano continued to apply the RORAC (Return on Risk Adjusted Capital) methodology, both to portfolios as well as to specific clients, with the following aims:
The Bank regularly reviews the RORAC objective or the minimum threshold for its risk operations in order to ensure they create shareholder value. The RORAC target is currently 29%. This is roughly equivalent to a net return on economic capital of 15% after deducting the costs incurred.
The implementation of RORAC methodologies, like those described, is viewed in the upcoming regulations of the Basle Committee (BIS II) as one of the key points of internal risk models.
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Our policy is to maintain a medium to low risk profile both in credit and market transactions.
With regard to credit risk, this qualitative definition can be expressed in terms of the expected credit losses (average of credit losses throughout a whole economic cycle). Currently, our expected loss objective is a maximum of 0.40% of the Bank’s average balance of the risk portfolio and 1.00% for the consolidated Group as a whole, over a whole economic cycle (normally, between 5 and 10 years). In 2002 the annual cost of non-performing loans by the Group in Spain was 0.23%, and 0.84% for the Group as a whole (0.72% excluding Argentina).
There are different ways to measure the annual cost of bad debts, though they give the same result over the medium term. The first uses flow data relating to NPL entries and loan loss recoveries. In this case, one takes the algebraic sum of the change in doubtful loan balances plus write-offs during the period and 25% of foreclosed assets, less loan-loss recoveries. The second way, based on the income statement, is to deduct loan-loss recoveries (off-balance sheet) from specific provisions (net of recoveries). A third way would be computing net write-offs against average risk balances.
The following graphs show the annual cost, under the two different systems, by geographic areas and main countries in 2002 as compared to 2001, as well as the net write-offs by geographic areas in 2002 as compared to 2001.
The calculation of expected losses is important in order to be able to quantify the unrealized risks of our loan portfolio, recognize them and make provisions before there is a non-payment. This is the rationale behind the provisions established by the Bank of Spain in its Circular 9/99.
Two key factors are behind the calculation of the expected losses, the anticipated NPL ratio and the average rate of recoveries, isolated from the effect of the economic cycle. The anticipated NPL ratio refers to the ratio of new non-performing loans and the rate of recoveries refers to the percentage of initial non-payments that are expected to be recovered and to the percentage of non-performing loans which will not be recoverable by the Group.
The estimates as of December 31, 2002 of expected losses are set out in the following table, reflecting the credit exposure in Spain classified by homogeneous risk portfolios. The table shows that the level of annual expected losses for Santander Central Hispano Spain is equal to 0.40% of its total credit portfolio’s outstanding risk. The highest expected losses are in segments such as smaller companies and individuals which historically have a higher levels of NPLs.
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As well as the expected losses, the table below shows the capital at credit risk. Conceptually, capital at risk is the amount of capital that is needed to cover unexpected losses, which are losses that are not very likely to materialize but may have very negative consequences for any entity should they occur. The capital at risk reflected in the table isconsistent with that needed to endow Santander Central Hispano with an AA solvency rating.
Balances under management at December 31, 2002.
In order to verify the calculation model of the expected loss, the table below compares the specific loan-loss provisions, net of recoveries, actually made by Santander Central Hispano Spain over the last few years with the estimated expected loss.
Provisions declined substantially in 1995-99 and then grew again as a result of the slowdown in the Spanish economy, reflecting its cyclical nature.
Averaging out the provision figures and adjusting the average for the effects of the economic cycle, the resulting figure (0.41%) is practically the same as the estimated expected loss (0.40%).
The estimated customer credit loss at the Group level is 0.73% (1.71% for the Group in Latin America). Including counterparty credit risk and sovereign risk, the estimated loss for the Group is around 0.43%.
The distribution of capital at risk or Group economic capital by risk category, according to estimates as of December 31, 2002 is shown in the graph. In addition to trading portfolio risk, market risk also includes structural risk from the exchange and interest rates, and equity holdings.
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Our credit risk (lending and guarantees) exposure in Latin America stood at €36,689 million at the end of 2002, 18.8% of the consolidated portfolio. This was 33.9% lower than a year earlier, largely due to the depreciation of the region’s main currencies against the US dollar/euro.
Of the total credit risk exposure in Latin America 74.8% is in Mexico, Chile and Puerto Rico, countries with a low risk (investment grade) assigned by international rating agencies.
Three countries in the region where our activity is significant – Mexico, Brazil and Puerto Rico – reduced their NPL ratios. In Chile’s case the rise in NPLs was due to the application of stricter criteria in Banco de Santiago, after its merger, in line with the Group’s criteria. NPL coverage in Latin America, excluding Argentina, rose 7 percentage points to 140.1%.
In the context of a global economic slowdown, our NPL ratio, excluding Argentina, was slightly lower in 2002 (3.07% from 3.18% in 2001).
In Argentina, we concentrated our risk management policy on substantially reducing both the credit risk of our lending and country-risk portfolios, as well as liquidity and market risks.
On the lending side, we continued applying a very selective admission policy, which together with the impact of currency depreciation, resulted in a 34% decline in the portfolio during 2002.
We continued to implement the policy of maximum prudence in provisions, and their cost (net of recoveries) stood at 2.11%, 1.66% of average credit risk excluding Argentina, down from 1.71% in 2001.
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All of the risk teams in our different banks were consolidated in 2002. We continued to unify risk management systems (Altair-Garra project). This process should be completed for all countries by the middle of 2004. We also drew up a Master Plan, with specific measures and schedules for countries and portfolios and aimed at developing internal risk management models in line with the future capital requirements of the Basle agreement.
Our management of the risks assumed by the Group’s units in Latin America is based on the risk management principles common to the Group. The risk management principles applied are based on those of the parent bank: independence of the lending process, integrated management of the credit cycle in its different phases, high degree of specialization and efficient deployment, through the necessary training and investment in technology and technical and human resources. The organization of the risk function in each Latin American bank replicates the framework in Spain.
We continuously monitor the degree of concentration of credit risk portfolios under different categories: geographic areas and countries, economic sectors, products and customer groups.
The Board’s Risks Committee establishes the risk policies and reviews the exposure limits appropriate for adequate management of the degree of concentration of our credit risk portfolios.
At December 31, 2002, the 20 economic-financial groups with the largest volume of loans accounted for 10.7% of the Group’s total credit risk, a low degree of concentration.
The distribution by economic sectors of credit risk is set out in the following table:
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We control counterparty risk through an integrated system which provides information for each counterparty at each unit of the Group on the performance and available credit line, in any product and maturity. Risk is measured by its current as well as potential value (the value of the risk positions taking into account the future variation of the underlying market factors in contracts).
The Net Replacement Value of the portfolios of over-the-counter (“OTC”) derivative products that the Group maintained with its counterparties at December 31, 2002 amounted to $4,370.2 million, 0.6% of the nominal value of these contracts compared with 0.8% in 2001. The reduction was largely due to market conditions (interest rate movement, appreciation of the euro against the US dollar and fall in stock prices).
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The equivalent credit risk (that is, the sum of the net replacement value and the maximum potential value of these contracts in the future) was 14.4% lower than in 2001 at $20,436.1 million. This reduction was mainly due to the incorporation of collateral agreements which softened the risk of the portfolio of OTC derivative products.
Derivatives continue to be concentrated on excellent credit quality counterparties, to the extent that 96.6% of transactions have been contracted with entities with a rating equal to or higher than A-.
In terms of geographic distribution, the changes are marginal apart from a small rise in Spanish risk and North American risk. Latin American risk is mainly concentrated in the local operations of the Group’s subsidiaries in the region.
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The portfolio by type of counterparty was similar to that in 2001, with almost all risk in OECD countries (98.2%).
Part 3. Operational risk
The Group continued to develop and extend its project to identify, mitigate, manage and quantify operational risk. The following progress was made:
Analysis and accounting conciliation of losses in the Data Base of Losses, together with investigation of the anomalies observed and some revisions, enabled us to improve the controls and procedures with an immediate impact on reducing the losses derived from operational risk.
Analysis of the environmental risk of credit operations is part of the Strategic Plan of Corporate Social Responsibility.
The following steps were taken in 2002:
We are aware of the scope of our commitment in this sphere, as well as the need to act flexibly on the basis of each country’s legislation. We understand that socially responsible investment constitutes, in a general, a concept that will generate new business opportunities.
In any case, we have already been incorporating into our risk policies contingencies derived from a company damaging the environment in its activity, with the consequent possibility of fines, temporary stoppage of the company and rejection by society.
We are exposed to market risk mainly as a result of the following activities:
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The primary market risks to which we are exposed are interest rate risk, foreign exchange rate risk, equity price risk and liquidity risk. We are exposed to interest rate risk whenever there is a mismatch between interest rate sensitive assets and liabilities, subject to any hedging with interest rate swaps or other off-balance sheet derivative instruments. Interest rate risk arises in connection with both our trading and non-trading activities.
We are exposed to foreign exchange rate risk as a result of mismatches between assets and liabilities, and off-balance sheet items denominated in different currencies, either as a result of trading or in the normal course of business. We maintain non-trading open currency positions arising from our investments in overseas subsidiaries, affiliates and their currency funding. The principal non-trading currency exposures are the euro to the US dollar, the euro to the main Latin American currencies and the euro to the pound sterling. Trading foreign exchange rate open risk is not material compared to non-trading foreign exchange risk.
We are exposed to equity price risk in connection with both our trading and non trading investments in equity securities.
We are also exposed to liquidity risk. Market depth is the main liquidity driver in our trading portfolio, even though our policy is to trade the most liquid assets. Our liquidity risk also arises in non-trading activity due to the maturity gap between assets and liabilities in the commercial banking business.
Our board, through its Risk Committee, is responsible for establishing our policies, procedures and limits with respect to market risks, including which businesses to enter and maintain. The committee also monitors our overall performance in light of the risks assumed. Together with the local and global Assets and Liabilities Committees (“ALCO”), each Market Risk Unit measures and monitors our interest-rate and foreign-exchange risk, and provides figures for ALCO to use in managing such risks, as well as liquidity risk.
Our market risk policy is to maintain a low-medium risk profile in business units. The risk activity is regulated and controlled through certain policies, documented in our Market Risk Management Policies Manual (as described below), and through a limit structure on our exposure to these market risks which includes global limits for the entire Group (total risk limit unit) to specific portfolio limits; in addition, authorized products are listed and reviewed periodically.
These policies, procedures and limits on market risk are applicable to all units, businesses or portfolios susceptible to market risk.
The Market Risk Management Policies Manual is a compilation of policies that describe the control framework used by our Group to identify, measure and manage market risk exposures inherent to our activities in the financial markets. The Manual is employed for market risk management purposes at all involved levels in the Group and subsidiaries, providing a general and global action framework and establishing risk rules for all levels.
The Manual’s main objective is to describe and report all risk policies and controls our Board of Directors has established as well as its risk predisposition.
All Group managers must ensure that each business activity is performed in accordance with the policies established in the Manual. The Manual is applied to all business units and activities, directly or indirectly, related to market risk decision-taking.
All the functions developed by a risk manager are documented and regulated by different procedures, including measurement, control and reporting responsibilities. Internal and external auditors audit the compliance with this internal regulation control in order to ensure that our market risk policies are being followed.
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The market risk limit structure can be defined as the Board of Directors risk “appetite” and is managed by the Global Market Risk Function that accounts for all Group business units.
Its main functions are to:
The Global Market Risk Function defines the limit structure while the Risk Committee reviews and approves it. Business managers then administer their activities within these limits. The limit structure covers both our trading and non-trading portfolios and it includes limits on fixed income instruments, equity securities, foreign exchange and other derivative instruments.
Limits considered to be global limits refer to the business unit level. Local business managers set lower level limits, such as portfolio or trader limits. To date, system restrictions prevent intra-day limits.
Business units must always comply with approved limits. Potential excesses will require a range of actions carried out by the Global Market Risk Function unit including:
The Trading Portfolio is defined as proprietary positions in financial instruments held for resale and/or bought to take advantage of current and/or expected differences between purchase and sale prices. These portfolios also include positions in financial instruments deriving from market making, sale and brokering activity.
As a result of trading fixed income securities, equity securities and foreign exchange, we are exposed to interest rate, equity price and foreign exchange rate risks. We are also exposed to volatility when derivatives (options) are used.
Market risk arising from proprietary trading and market-making activities is actively managed through the use of cash and derivative financial instruments traded in OTC and organized markets.
Interest rate risk deriving from market-making books is typically hedged by buying or selling very liquid cash securities such as government bonds, or futures contracts listed in organised markets like Liffe, Eurex, Meff and CBOT.
Foreign exchange rate risk is managed through spot transactions executed in the global foreign exchange interbank market.
Equity price risk is hedged by buying or selling the underlying individual stocks in the organized equity markets in which they are traded, or futures contracts on individual stocks listed in organized markets like Meff and Liffe.
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In the case of equity indexes such as S&P 500, Euro STOXX , or IBEX-35, the hedging is done through futures contracts listed in the aforementioned organized markets.
Volatility risk arising from market-making in options and option-related products is hedged by, either buying and selling option contracts listed in organized markets like Eurex, Meff, and CBOT, or entering risk reversal transactions in the interbank OTC market.
We use VaR to measure our market risk associated with all our trading activity.
We use a variety of mathematical and statistical models, including value at risk (“VaR”) models, historical simulations, stress testing and evaluations of Return on Risk Adjusted Capital (“RORAC”) to measure, monitor, report and manage market risk. We call our VaR figures daily or annual “capital at risk” figures (“DCaR” or “ACaR”), depending on their time horizon, since we use them to allocate economic capital to various activities in order to evaluate the RORAC of such activities.
As calculated by us, DCaR is an estimate of the expected maximum loss in the market value of a given portfolio over a one-day time horizon at a 99% confidence interval. It is the maximum one-day loss that we estimate we would suffer on a given portfolio 99% of the time, subject to certain assumptions and limitations discussed below. Conversely, it is the figure that we would expect to exceed only 1% of the time, or approximately three days per year. DCaR provides a single estimate of market risk that is comparable from one market risk to the other.
The standard methodology used in the majority of the business units is based on historical simulation (520 days). In order to capture recent market volatility in the model, our DCaR figure is the maximum between the 1% percentile and the 1% weighted percentile of the simulated profit & loss distribution.
We use DCaR estimates to alert senior management whenever the statistically estimated losses in our portfolios exceed prudent levels. Limits on DCaR are used to control exposure on a portfolio by portfolio basis. DCaR is also used to calculate the RORAC for a particular activity in order to make risk-adjusted performance evaluations.
Our DCaR and VaR methodology should be interpreted in light of the limitations of our model, which include:
Because of these limitations in DCaR and VaR methodology, in addition to historical simulation, we use stress testing to analyze the impact of extreme market movements and to adopt policies and procedures in an effort to protect our capital and results of operation against such contingencies.
In order to calibrate our VaR model, we use backtesting processes. Backtesting is a comparative analysis between Value at Risk (VaR) estimates and the daily results actually generated. The purpose of these tests is to verify and measure the precision of the models used to calculate VaR.
The analyses of backtesting carried out by us comply at least with the BIS recommendations regarding the verification of the internal systems used to measure and manage market risks.
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Due to its nature, changes in strategic positions have to be approved by local/global functions in ALCO committee. Position limits with respect to these investments are established, although they will be measured under VaR and other methods which attempt to implement immediate action plans if a particular loss level is reached.
Our foreign exchange rate risk with respect to our non-trading activity can be either permanent or temporary. The permanent risk reflects the book value of investments net of the initial goodwill, while the temporary risk basically stems from purchase/sale operations made to hedge the exchange rate risk derived from dividend flows and expected results. The exchange rate differences generated for each position are recorded in reserves and in losses and gains respectively.
In order to manage the exchange rate risk of the book value of permanent investments, our general policy is to finance the investment in local currency provided there is a deep market which allows it and that the cost of doing so is justified by the expected depreciation. This is the case of investments in sterling and in some Latin American countries. Also, in 2002 we fully covered, using foreign exchange non-optional derivatives (swaps and forwards), the book value of our investments in Mexico and partially that of our investments in Chile, analyzing the specific allowances for each country and taking into account the interest rate differentials as well as the levels of depreciation expected.
The rest of our investments in foreign currency are financed in euros and so generate an exchange-rate risk. Certain one-off hedges of permanent investments are made when it is believed that a local currency could weaken against the euro more quickly than the market is discounting. Only in these cases does, for example, hedging in the face of a possible devaluation offset the cost of the coverage due to the interest rate differential. In addition, operations are carried out to hedge the currency risk of the Group’s results and dividends in Latin America.
Our equity price risk arises from our portfolio of investments in industrial and strategic shareholdings. Our strategic holdings in the industrial and financial equity portfolios are steady. Fluctuations in the market value of the shares in such portfolios do not have an effect on our operational results (as most of them are accounted for by the equity method) and their book value is much lower than their market value.
The Group analyzes the sensitivity of net interest revenue and net worth to changes in interest rates. This sensitivity arises from gaps in maturity dates and review of interest rates in the different asset and liability accounts. Certain repricing hypotheses are used for products without explicit contractual maturities based on the economic environment (financial and commercial).
The Group manages investments by determining a target range for each sensitivity and providing the appropriate hedge (mainly with government debt, interest rate swaps and interest rate options) in order to maintain these sensitivities within that range. The measures used to control interest rate risk are the interest rate gap and the sensitivity of net interest revenue and net worth to changes in interest rates, VaR and analysis of scenarios.
The interest rate gap is based on the analysis of the gaps between the maturities of the asset, liability and off-balance sheet items. Gap analysis provides a basic representation of the balance sheet structure and enables concentrations of interest rate risk by maturity to be identified. It is also a useful tool for estimating the possible impact of eventual interest rate movements on net interest revenue and net worth.
The sensitivity of net interest revenue measures the change in the short/medium term in the accruals expected over a particular period (12 months), in response to a parallel shift in the yield curve.
Net worth sensitivity measures in the long term (the whole life of the operation) the interest risk implicit in net worth (equity) on the basis of the effect that a change in interest rates has on the current values of financial assets and liabilities.
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The Value at Risk for balance sheet activity is calculated with the same standard as for trading: historic simulation with a confidence level of 99% and a time frame of one day.
Two scenarios for the performance of interest rates are established: maximum volatility and sudden crisis. These scenarios are applied to the balance sheet, obtaining the impact on net worth as well as the projections of net interest revenue for the year.
Liquidity risk is associated with our capacity to finance our commitments, at reasonable market prices, as well as to carry out our business plans with stable sources of funding. We permanently monitor maximum gap profiles.
We have a diversified portfolio of assets that are liquid or can be made so in the short term. We also have an active presence in a wide and diversified series of financing and securitization markets, limiting our dependence on specific markets and keeping open the capacity of recourse to alternative markets.
The measures used to control liquidity risk are the liquidity gap, liquidity ratios, stress scenarios and contingency plans.
The liquidity gap provides information on contractual and expected cash inflows and outflows for a certain period of time, for each of the currencies in which we operate. The gap measures the net need or excess of funds at a particular date, and reflects the level of liquidity maintained under normal market conditions.
The liquidity coefficient compares liquid assets available for sale or transfer (after applying the relevant discounts and adjustments) with total liabilities to be settled, including contingencies. This coefficient shows, for currencies that cannot be consolidated, the level of immediate response of the entity to firm commitments.
The coefficient of net accumulated illiquidity is defined as the ratio between the 30 day accumulated gap obtained from the immediate liquidity analysis already described and the amount of liabilities to be settled at 30 days. The modified contractual liquidity gap is drawn up on the basis of the contractual liquidity gap and placing liquid assets in the point of settlement or repos and not in their point of maturity. This coefficient reveals the level of short-term illiquidity.
Our liquidity management focus on preventing a crisis. Liquidity crises, and their immediate causes, cannot always be predicted. Consequently, our Contingency Plan concentrates on creating models of potential crises by analyzing different scenarios, identifying crisis types, internal and external communications and individual responsibilities.
The Contingency Plan covers the activity of a local unit and of central headquarters. Each local unit must prepare a Plan of Contingency Financing, indicating the amount it would potentially require as aid or financing from headquarters during a crisis. Each unit must inform headquarters of its plan at least every six months so that it can be reviewed and updated. These plans, however, must be updated more frequently if market circumstances make it advisable.
The process of setting limits is the instrument used by the Group to establish the level of equity that each activity has available. Setting the limits is conceived as a dynamic process which responds to senior management’s risk acceptance level.
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Our risk performance with regard to trading activity in financial markets during 2002, measured by daily VaR, is shown in the following graph.
As can be observed on the above graph, we have a low/medium risk profile, which was actively managed throughout the year. This active level of risk management allows for changes in strategy to take advantage of opportunities in an environment of uncertainty and high volatility.
The maximum risk level was reached on October 11 ($46.3 million in VaR terms), due to the Brazilian market volatility as a consequence of the pre-electoral period and the minimum on January 17 ($11 million), due to the crisis in Argentina. The average risk in 2002 was $25.3 million in VaR terms.
The risk histogram below shows the frequency distribution of average risk in daily VaR terms during 2002. The maximum and minimum risk levels were reached at specific moments; the daily VaR was higher than $40 million on only three occasions. The minimum levels were more frequent and the daily VaR was lower than $14 million on 20 occasions.
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The minimum, maximum, average and year-end 2002 values in VaR terms were as follows:
The average risk in Latin America in VaR terms was $17.9 million, ending December with a VaR of $20.4 million. Our risks were concentrated in fixed income (average daily VaR of $19.0 million, located in both Latin America and the US). The market risk in the US is generated by strategic and directional positions of Latin American fixed-income instruments denominated in US$ and whose markets are located in the US.
Observation of the daily VaR assists the Group in attaining a flexible and agile adaption of its risk profile on the basis of changes in strategy resulting from a different perception of market events and expectations.
The figures in the table below reflect in US$ million the net open position in each currency (i.e. the position subject to exchange risk). The long positions or assets are shown with a (+) and the short ones or liabilities with a (-). Forward operations and the equivalent Delta risk of currency options are also included.
The table shows that the greatest exchange risk concentration is in the main Latin American countries.
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During 2002, the main feature of the geographic distribution of the results of the Group’s trading activities was a greater concentration in Latin America, particularly in Brazil and Mexico, and to a lesser extent in Europe. Of note was Latin America’s contribution to the Group’s total VaR (53%). Europe contributes only 20% of risk in VaR terms, compared with 24% of results. This difference is due to the significant franchise of clients in Spain, which enables us to obtain high levels of revenue from low-risk profiles by intermediation, sales and market making. The US, on the other hand, does not have this franchise and so its average level of daily VaR is relatively higher than the accumulated result.
The geographic contribution, in percentage terms, both in risks as well as in results over the Group’s total daily VaR and annual net operating revenue from trading activity, is shown in the graph.
The minimum, average, maximum and year-end risk values in daily VaR terms, by geographic area, are shown in the table.
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The graph below shows that the level of risk was gradually increasing during the first half of 2002, which was reversed in the second half of the year. With regards to income, it can be seen that the differences with respect to the risk assumed intensified in the months of highest volatility (February, March, June and since September) when emerging markets became more unstable.
The histogram below details the distribution of daily Marked-to-Market (“MtM”) results on the basis of size. The most common yield interval was $0-$3 million, which occurred on 56 days of the year (22% of the days of the year). During 50% days of the year, the interval was between -$3 and $6 million.
Our structured derivatives activity (options outside of organized markets) is mainly focused on designing investment products and risk coverage for clients. These transactions include options on equities, fixed-income and currencies.
The units where this activity takes place are: Madrid, New York, Portugal, Brazil and Mexico. The average VaR was $1.4 million, the maximum $4.1 million and the minimum $0.65 million.
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The graph below shows on the y axis, the accumulated MtM result for the year and on the x-axis the return or risk-profitability ratio, expressed as the relationship between the accumulated MtM result for the year and the average daily VaR. A return of 20 signifies that the results achieved were 20 times higher than the average risk to which the Group was exposed in order to obtain them. The size of the circles represents the level of risk which in average terms a business unit maintained, expressed as average daily VaR.
This analysis measures the return of the different business units and enables one to make comparisons. Thus the greater or lower effectiveness in terms of risk adjusted return determines the position in the graph.
These are four differentiated zones: units in the quadrants on the right display high returns, with results equivalent to at least ten times the average risk incurred in VaR terms. In the quadrants on the left are units with a moderate or low profitability-risk, but making also a distinction between those units whose contribution to total MtM results is positive (upper quadrant), and those where the contribution was negative (lower quadrant).
Lastly, the different diameters of the circles allow one to compare the risk levels of the different business units. Venezuela is the unit that contributed the most risk to the Group due to economic and political instability in the country.
Different stress test scenarios were analyzed during 2002. A scenario of maximum volatility, applying six standard deviations to different market factors, with results as of December 31, 2002 is provided below.
The table below shows, at December 31, 2002, the maximum losses of value of each product (fixed-income, equities and currencies), in a scenario in which a volatility equivalent to six standard deviations in a normal distribution is applied.
The stress test shows that the Group would suffer an economic loss of $54.9 million, if this scenario materialized in the market.
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The following table of statistics is based on the aforementioned scenario. It shows the minimum, average, maximum and year-end loss of each scenario.
The graph on the evolution of balance sheet management risk shows that the level of interest rate risk in Latin America, measured by the sensitivity of net worth and net interest revenue to a parallel movement of 100 basis points, moved in a narrow band in 2002, with a significant reduction in risk over 2001.
At the end of December of 2002, risk consumption by region, measured by the sensitivity of net worth over equity to 100 basis points, was 2.27%, while that of net interest revenue at one year, measured by its sensitivity to 100 basis points on the budgeted revenue, was minimal at 0.6%. This risk profile corresponds to a reduction of 50% both in net interest revenue risk as well as net worth, mainly in Brazil and Puerto Rico.
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The gap tables below show the distribution by maturity of the risk in Latin America at December 31, 2002.
For the whole of Latin America net interest revenue budgeted for 2002 was $3,845.0 million, with the consumption at December 31, 2002 of $23.07 million (sensitivity measured to 100 basis points). This represented 0.6% of total net interest revenue budgeted for 2002.
81% of risk in net interest revenue is concentrated in Brazil, Chile, Mexico and Puerto Rico. Management of this area protected net interest revenue against the instability in markets. Compared with 2001, Brazil’s net interest revenue risk at the end of 2002 was 52%, Chile’s 47%, Mexico’s 53% and Puerto Rico’s 46%.
The net interest revenue positioning graph below, obtained from the sensitivity of net interest revenue to a parallel movement of 100 basis points in the yield curve, shows the positioning of countries with regard to NIR sensitivity. The two quadrants on the right signify an improvement in response to local currency interest rate increases, while those on the left assume an increased risk in the event of lower interest rates. The implications for the US$ are the same, but reflected in the upper and lower quadrants. The size of the circles represents the total sensitivity of the unit.
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Total local equity in Latin America in 2002 amounted to $6,233 million, with a risk consumption at December 31 of $141.32 million (sensitivity to 100 basis points), which represented 2.27% of total budget.
91% of net worth risk is concentrated in Chile, Mexico and Brazil.
Net worth risk was reduced in 2002 in Brazil and Puerto Rico. Brazil reduced it by 69% and Puerto Rico 89%.
The graph below shows that risk was concentrated in Mexico and Chile whose markets were less volatile.
The net worth sensitivity positioning graph below, obtained from the sensitivity of net worth to a parallel movement of 100 basis points in the yield curve, shows the positioning of countries with regard to MVE sensitivity. The two quadrants on the right signify an improvement in response to local currency interest rate rises, while those on the left assume an increase in the event of lower interest rates. The implications for the US$ are the same, but reflected in the upper and lower quadrants. The size of the circles represents the total sensitivity of the unit.
As the graph below shows, the risk of investment portfolios, (12 month equivalent as of December 2002), is concentrated in Chile, Brazil and Mexico. The investment portfolios largely consist of public sector risk (government or clearing house) with minimum risk in corporate securities. In 2002 we reduced our risk in Brazil and maintained our weighting of Mexico in the portfolio.
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Liquidity risk is controlled and analyzed in order to ensure that the Group maintains acceptable liquidity levels to cover its short- and long-term financing needs in normal market situations. Different scenarios reflecting the additional needs that could arise are also analyzed. All this enables the Group to anticipate a range of situations that, with varying degrees of probability, it may have to face in the future.
Santander Central Hispano actively manages the market risks inherent in commercial banking which is the core of its business. These risks of a structural nature come from our activity with customers and companies. Management of structural risk makes net interest revenue more stable and recurrent, maintaining adequate levels of liquidity and solvency.
The Financial Management Area, delegated by the Markets Committee, manages structural risk on a centralized basis. This allows the use of homogenous methodologies, adapted to each local market where we operate, as well as it ensures that all the risks assumed are managed together within the limits established.
Management of structural risks covers interest rate risk, liquidity risk and exchange rate risk. It is our policy not to operate in commodities.
The Financial Management Area manages structural interest rate risk derived from mismatches in maturity and revision dates for assets and liabilities. The gaps are calculated in repricing of interest rates and in maturity dates. They are calculated using the contractual maturities and repricing of the different equity and off-balance sheet items, both assets and liabilities. Certain repricing hypotheses are used for products without explicit contractual maturities based on the economic environment (financial and commercial).
These gaps reflect in a static way the Group’s position (long or short) in different maturities. The sensitivity of net interest revenue, the economic value and the duration of the structural balance sheet are also analyzed. At December 31, 2002, the Group’s balance sheet in euros had a net interest revenue sensitivity of less than 1.5% to a parallel shift in the yield curve.
There are two spheres of management: convertible currencies (mainly the euro and the US dollar) and non-convertible currencies (largely Latin American). The Markets Committee, through the Financial Management Area, directly manages convertible currencies and coordinates management of the local Asset and Liability Committees (ALCOs) of the banks in Latin America.
Structural exchange rate risk is largely derived from the Group’s currency operations, including permanent financial investments, collection of earnings/dividends from subsidiaries and purchase/sale of assets.
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In order to manage the exchange rate risk of the book value of permanent investments, our general policy is to finance it in local currency provided there is a profound market which allows it and that the cost of doing so is justified by the expected depreciation. This is the case of investments in sterling and some Latin American countries.
Throughout the year we significantly reduced our structural foreign exchange rate risk. This decrease was due to the full coverage of the book value of our investment in Mexico and the partial coverage of the book value of our investment in Chile, along with the reduction in positions as main Latin-American currencies depreciated against the euro.
The daily VaR reached its maximum level of $243.1 million at the end of July, as a result of the high volatility of Brazilian Real exchange rates after the negative sentiment of the local market related to new financial assistance to Brazil from IMF.
In the first six months, we reduced the risk of our industrial and strategic equity portfolio. The reduction of risk resulted from the combination of a general decline in the equity markets and the sale of certain large holdings (such as Dragados, Société Générale and Vallehermoso), thus decreasing the level of risk in the portfolio. These reductions were partially offset by increases in the share values of The Royal Bank of Scotland, Union Fenosa and Cepsa. In the second six months, we held positions, but, stress in the market increased the risk. In December, we sold 375 million of Vodafone shares. This fact reduced the level of risk in the portfolio to $534.3 million.
Our strategic holdings in the industrial and financial equity portfolios are steady. Fluctuations in the market value of the shares in such portfolios do not have an effect on our operational results (as most of them are accounted for by the equity method) and their book value is much lower than their market value.
The average daily VaR for the year, 2002, was $629.0 million, with a minimum of $534.3 million and a high of $740.3 million.
Management of structural liquidity enables assets to be financed in optimum conditions in terms of maturities and costs, preventing the assumption of undesired liquidity risks. We have a diversified portfolio of assets that are liquid or can be made so in the short term, adjusted to its positions. We also have an active presence in a wide and diversified series of financing markets or securitization of its assets, limiting our dependence on specific markets and keeping open the capacity of recourse to markets.
In 2002 we implemented an Issues and Securitization Plan and obtained €9,523 million as follows: €1,100 million of subordinated debt; €4,166 million of senior debt and mortgage bonds and €4,257 million of securitizations. Additionally, we reduced our short term financing needs (commercial paper) from the markets by €5,000 million by substituting alternative short term funding sources.
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Outstanding balance of securitized funds issued bythe Santander Central Hispano Group in Spain
Capital management aims to optimize its structure and cost from the regulatory and economic standpoints.
We have a targeted BIS ratio of 12%, although sometimes it can be lower than this because of strategic investments. In order to ensure our solvency we use different instruments and policies: capital increases and issues eligible for equity (preferred shares and subordinated debt), retained earnings, dividend policy and securitizations.
As well as managing our regulatory capital, we are undertaking various projects to optimize the return on the economic capital consumed by the businesses:
This focus of economic capital, in our case, goes beyond that of regulatory capital because of the combined effect of factors that are not eligible for equity (capital gains) or penalize the regulatory capital (goodwill), but which nevertheless form part of economic capital.
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Our total daily VaR at December 31, 2001 and our daily VaR estimates at December 31, 2002, broken down by trading and structural (non-trading) portfolios, were as follows (excluding our Argentine portfolios) at the dates below:
Activities in Argentina are not included so as to avoid distortion in risk that would not be generated given the special reserve we made. See note 1 to our consolidated financial statements.
Our daily VaR estimates of interest rate risk, foreign exchange rate risk and equity price risk, broken down by trading and structural (non-trading) portfolios, were as follows at and for the periods ended on the dates set forth below:
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(a) Evaluation of disclosure controls and procedures. Our chief executive officer and our chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c)) as of a date (the “Evaluation Date”) within 90 days of the filing date of this annual report, have concluded that as of the Evaluation Date, our disclosure controls and procedures were adequately designed and effective to ensure the gathering, analysis and disclosure of the information the Company is required to disclose in the reports it files under the Securities Exchange Act of 1934, within the time periods specified in the SEC’s rules and forms. The Company’s management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which by their nature can provide only reasonable assurance regarding management’s control objectives.
(b) Changes in internal controls. There have been no significant changes in our internal controls or to our knowledge, in other factors that could significantly affect our internal controls subsequent to the Evaluation Date.
We have responded to Item 18 in lieu of this item.
Reference is made to Item 19 for a list of all financial statements filed as part of this Form 20-F.
We will furnish to the Securities and Exchange Commission, upon request, copies of any unfiled instruments that define the rights of holders of long-term debt of Banco Santander Central Hispano, S.A.
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SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
Date: June 30, 2003
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I, Alfredo Sáenz, certify that:
1. I have reviewed this annual report on Form 20-F of Banco Santander Central Hispano, S.A.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
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I, Francisco Gómez, certify that:
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INDEPENDENT AUDITORS’ REPORT
To the Shareholders ofBanco Santander Central Hispano, S.A.:
We have audited the accompanying consolidated balance sheets of BANCO SANTANDER CENTRAL HISPANO, S.A. (the “Bank”) and Companies composing, together with the Bank, the SANTANDER CENTRAL HISPANO GROUP (the “Group” – Notes 1 and 3) as of December 31, 2002, 2001 and 2000, and the related consolidated statements of income for the years then ended. These financial statements are the responsibility of the controlling company’s directors. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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.
Pursuant to Rule 13 of Bank of Spain Circular 4/1991 and after authorization by the Bank of Spain and by the respective Shareholders’ Meetings, the Bank and other Group entities recorded in 2002, 2001 and 2000 – with a charge to unrestricted reserves (approximately €856 million, €452 million and €496 million, respectively) and to the related deferred tax asset accounts (approximately €461 million, €244 million and €267 million, respectively) – the allowances required to cover the commitments to employees who took early retirement in those years through the date of effective retirement (Notes 2-j, 17 and 21).
As required by the Bank of Spain, the “Reserves” caption in the consolidated balance sheets as of December 31, 2002, 2001 and 2000, includes approximately €3,738 million for the difference between the market value of the investments in the capital stock of certain entities acquired in 2000 and the amount at which certain Bank shares were issued – pursuant to Article 159.1.c of the revised Spanish Corporations Law – for these acquisitions (Notes 20 and 21). This addition to the Group’s reserves gave rise to a corresponding increase in the acquisition cost of the investments acquired (Notes 10 and 11).
In our opinion, the 2002, 2001 and 2000 consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Santander Central Hispano Group as of December 31, 2002, 2001 and 2000, and of the consolidated results of its operations and of the consolidated funds obtained and applied by it for the years then ended in conformity with accounting principles generally accepted in Spain.
Accounting principles generally accepted in Spain vary in certain significant respects from accounting principles generally accepted in the United States of America. The application of the latter would have affected the determination of net income for each of the three years in the period ended December 31, 2002 and the determination of stockholders’ equity and financial position as of December 31, 2002 and 2001, to the extent summarized in Note 27.
DELOITTE & TOUCHE ESPAÑA, S.L.
Madrid-Spain, January 31, 2003, except for Note 27 as to which the date is June 16, 2003
F-1
BANCO SANTANDER CENTRAL HISPANO, SA AND COMPANIES COMPOSING THE SANTANDER CENTRAL HISPANO GROUPCONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2002, 2001 AND 2000 (NOTES 1, 2, 3 AND 4)(Currency - Thousands of Euros)
The accompanying Notes 1 to 27 and Exhibits I to V are an integral part of the consolidated balance sheets as of December 31, 2002, 2001 and 2000.
F-2
F-3
BANCO SANTANDER CENTRAL HISPANO, SA AND COMPANIES COMPOSING THE SANTANDER CENTRAL HISPANO GROUPCONSOLIDATED STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (NOTES 1, 2, 3 AND 4)(Currency - Thousands of Euros)
The accompanying Notes 1 to 27 and Exhibits I to V are an integral part of the consolidated statements of income for the years ended December 31, 2002, 2001 and 2000.
F-4
Banco Santander Central Hispano, S.A.and Companies composingthe Santander Central Hispano Group
Notes to Consolidated Financial Statementsfor the Years Ended December 31, 2002, 2001 and 2000
Banco Santander Central Hispano, S.A. (“the Bank”) is a private-law entity subject to the rules and regulations applicable to banks operating in Spain. The bylaws and other public information on the Bank can be consulted in the web page of the Bank (www.gruposantander.com) and in its registered office at Paseo de Pereda 9-12, Santander.
The consolidated financial statements of the Bank and of the companies which, together with it, compose the Santander Central Hispano Group (“the Group”) are presented in the formats stipulated by Bank of Spain Circular 4/1991 and subsequent amendments, and, accordingly, they give a true and fair view of the consolidated net worth, financial position and results of the Group. These consolidated financial statements, which were prepared by the Bank’s directors from the accounting records of the Bank and of each of the companies composing the Group, include the adjustments and reclassifications required to conform the accounting principles and presentation criteria followed by certain subsidiaries —mainly those abroad— with those applied by the Bank (Note 2).
The 2001 and 2000 consolidated financial statements were approved by the Shareholders’ Meetings of the Bank on June 24, 2002 and March 10, 2001, respectively.
The 2002 consolidated financial statements of the Group, the Bank and almost all the consolidated companies have not yet been approved by the respective Shareholders’ Meetings. However, the Bank’s Board of Directors considers that they will be approved without material changes.
The directors of the Bank and their legal advisers consider that the objection to certain resolutions adopted by the Bank’s Shareholders’ Meetings on June 24 and February 9, 2002, March 10, 2001 and January 18 and March 4, 2000, will have no effect on the financial statements of the Bank and the Group.
On April 25, 2001, the Santander Court of First Instance number 1 rejected in full a claim contesting the resolutions adopted at the Shareholders’ Meeting on January 18, 2000. The plaintiff filed an appeal against the judgment. On December 2, 2002, the Cantabria Provincial Appeal Court rejected the appeal. A cassation appeal has been filed against the judgment of the Cantabria Provincial Appeal Court.
On November 29, 2002, the Santander Court of First Instance number 2 rejected in full the claims contesting the resolutions adopted at the Shareholders’ Meeting on March 4, 2000. An appeal has been filed against the judgment.
On March 12, 2002, the Santander Court of First Instance number 4 rejected in full the claims contesting the resolutions adopted at the Shareholders’ Meeting on March 10, 2001. An appeal has been filed against the judgment.
On September 9, 2002, the Santander Court of First Instance number 5 rejected in full the claim contesting the resolutions adopted at the Shareholders’ Meeting on February 9, 2002. An appeal has been filed against the judgment.
The consolidated financial statements of the Group were prepared in accordance with the generally accepted accounting principles and valuation methods described in Note 2, which basically coincide with those established by Bank of Spain Circular 4/1991 and subsequent amendments thereto. All obligatory accounting principles and valuation methods with a material effect on the consolidated financial statements were applied in preparing them.
F-5
Consolidation principles
The companies whose business activity is directly related to that of the Bank and which are directly or indirectly 50% or more owned by the Bank or, if less than 50% owned, are effectively controlled by the Bank and constitute, together with the Bank, a single decision-making unit, were consolidated by the global integration method.
All significant accounts and transactions between consolidated companies were eliminated in consolidation. The equity of third parties in the Group is presented under the “Minority Interests”caption and in the “Consolidated Net Income for the Year — Minority Interests”account in the consolidated balance sheets (Note 19).
The investments in companies controlled by the Bank and not consolidable because their business activity is not directly related to that of the Bank (Note 11) and the investments in other companies with which the Group has a lasting relationship and which are intended to contribute to the Group’s business activities, in which the Group’s ownership interests are generally equal to or exceed 20% -3% if listed— (“associated companies” — Note 10), are carried at the fraction of the investees’net worth corresponding to such investments, net of the dividends collected from them and other net worth eliminations (equity method).
The income or loss generated by companies acquired in each year is consolidated by taking into account only the income or loss relating to the period between the acquisition date and the related year-end.
Determination of net worth
In evaluating the Group’s net worth, the balances of the following captions in the accompanying consolidated balance sheets should be taken into consideration:
Capital Adequacy Requirements
The entry into force of Law 13/1992 and Bank of Spain Circular 5/1993 and subsequent amendments introduced new regulations governing minimum equity requirements for credit institutions at both individual and consolidated group levels.
As of December 31, 2002, 2001 and 2000, the eligible equity of the Group was higher than the minimum requirements stipulated by the above-mentioned legislation.
Detail of risk provisions and coverage
In accordance with the Bank of Spain regulations, the risk provisions and coverage are presented as assigned to the related assets and/or in specific accounts. The detail of the aggregate risk provisions, coverage and guarantees, disregarding their accounting classification, is as follows:
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Argentina
Taking into account the uncertainty prevailing in Argentina as a result of the changes in its financial system (sharp devaluation of the peso, conversion to pesos of certain foreign-currency denominated assets and liabilities in the balance sheets of Argentine entities and rescheduling of customer deposits, among others), until final rules are issued to correct current asymmetries and in view of possible future events, the 2002 and 2001 consolidated financial statements were prepared as described below, in accordance with the Group’s traditional policy of prudence in valuation:
In 2002 no cash contributions were made from other Group entities to the subsidiaries located in Argentina.
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The accounting principles and valuation methods applied in preparing the consolidated financial statements were as follows:
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Depreciation is provided by the straight-line method at rates based on the years of estimated average useful life of the related assets. The annual depreciation expense is calculated basically at the following rates:
The provisions recorded with a charge to the “Extraordinary Loss” caption in the consolidated statements of income are presented as a reduction of the balance of the “Property and Equipment – Other Property“ caption (Note 13).
The balance of the “Treasury Stock” caption relates to Bank shares acquired and held by consolidated companies. These shares are reflected at cost, net of the required provision, if any, which is determined on the basis of the lower of the Group’s underlying book value or market price. The aforementioned provision is recorded with a charge to the “Losses on Group Transactions” caption in the consolidated statements of income.
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In-house allowances
The actuarial studies performed as of December 31, 2002, 2001 and 2000, to determine these commitments were made on an individual basis by independent actuaries, basically using the following assumptions:
External funds
In 2002 the Group adapted to the provisions of Royal Decree 1588/1999 certain insurance contracts, some of them made with non-consolidated companies of the group, covering the commitments undertaken subsequent to May 1996, and to employees hired after November 1999. Consequently, pursuant to Bank of Spain Circular 5/2000, they are deemed to be external funds and need not be recorded in the consolidated balance sheet as of December 31, 2002.
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Funded accrued commitments
Following are the main amounts disclosed in the aforementioned actuarial studies as well as those assumed by insurance companies as external funds:
(*) Including pensions to employees who took early retirement.
These commitments were funded as follows:
Plans for early retirement
In 2002, 2001 and 2000, the Bank, Banesto and Santander Consumer Finance, S.A. (formerly HBF Banco Financiero, S.A.) offered certain employees the possibility of taking early retirement before the age stipulated in the current collective labor agreement. Accordingly, in those years allowances were recorded to cover the supplementary liabilities to employees taking early retirement and the salary and other commitments to these employees from the time of early retirement to the date of effective retirement.
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Pursuant to Rule 13 of Bank of Spain Circular 4/1991, and after authorization from the Bank of Spain and from the respective Shareholders’ Meetings, these allowances were recorded as follows:
Companies abroad
Certain Group financial institutions abroad have entered into commitments with their employees that are similar to pensions.
The technical assumptions used by these entities (interest rates, mortality tables, cumulative annual CPI, etc.) are consistent with the socio-economic conditions prevailing in these countries.
As of December 31, 2002, 2001 and 2000, the total commitments accrued by these companies amounted to €3,002 million, €4,034 million, €3,541 million, respectively. Of these amounts, €1,390 million €2,395 million and €2,685 million, respectively, were covered by in-house pension allowances recorded under the “Provisions for Contingencies and Expenses – Pension Allowance” caption in the consolidated balance sheets. The remaining amount was covered by policies taken out with insurance companies.
Accrued cost and payments
The accrued pension cost at the Group and the payments for these commitments were as follows:
Assets and liabilities acquired or issued at a discount, except for marketable securities, are recorded at their redemption value. The difference between this value and the amounts paid or received are recorded under the liability and asset “Accrual Accounts” captions in the consolidated balance sheets.
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The premiums collected and paid for options sold or purchased, respectively, must be recorded under the “Other Assets” or “Other Liabilities” captions in the consolidated balance sheets through the maturity date.
Transactions whose purpose and effect was to eliminate or significantly reduce market risks and which are performed to reduce the risk to which the Group is exposed in its management of correlated assets, liabilities and futures transactions, were treated as hedging transactions. The gains or losses arising from hedging transactions were taken to income symmetrically to the revenues or expenses arising from the hedged items, with a balancing entry under “Other Assets” or “Other Liabilities” in the consolidated balance sheets.
Non-hedging transactions (also called trading transactions) arranged on organized markets were valued at market price, and market price fluctuations were recorded in full in the consolidated statements of income.
The gains or losses arising from trading transactions arranged outside organized markets are not recognized in income until they are effectively settled. However, provisions were recorded with a charge to income for potential net foreign exchange losses, if any, on each type of risk disclosed by the valuations of positions at the end of each year. The types of risks considered for these purposes are interest rate, share price and currency risks.
The expense for corporate income tax of each year is calculated on the basis of book income before taxes, increased or decreased, as appropriate, by the permanent differences from income for tax purposes. Permanent differences are defined as those arising between the taxable income and the book income before taxes which do not revert in subsequent periods, considering the income obtained by Group companies as a whole.
In this connection, certain timing differences which have a specific reversal period of less than ten years are recorded for accounting purposes; all other differences are treated for all purposes as permanent differences.
Tax relief and tax credits are treated as a reduction of the corporate income tax for the year in which they are taken (Note 22). Entitlement to these tax credits is conditional upon compliance with the requirements of current regulations.
The purpose of this structure, all of which is controlled by the Bank, is to optimize the international organization from a strategic, economic, financial and tax standpoint, since it makes it possible to define the most appropriate units to be entrusted with acquiring, selling or taking stakes in other international entities, the most appropriate financing method for these transactions and the most appropriate means of remitting the income obtained by the Group’s various operating units to Spain.
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The Exhibits provide relevant data on the Group companies (Exhibit I) and on the companies carried by the equity method (Exhibit II).
The principal equity investments acquired and sold by the Group in 2000, 2001 and 2002 and other significant corporate transactions were as follows:
Banco Español de Crédito, S.A. (“Banesto”)
In 2002, Banesto carried out a monetary capital increase through the issuance of 81,670,694 new shares, carrying preemptive rights, at a ratio of 2 new shares issued at par for every 15 old shares. The Group sold its preemptive rights (arising from its 99.04% holding in the capital stock of Banesto) for €443 million and reduced its ownership interest to 88.57% (Note 21).
AKB Holding (“AKB”)
In 2001 the Group reached an agreement with the Werhahn Group for the acquisition of AKB (a German group specializing in consumer finance). In 2002 the Bank issued 109,040,444 new shares of €0.5 par value each and share premium of €9.588 each (Note 20) for an effective amount of €1,100 million, which were paid in full through the contribution of shares representing all the capital stock of AKB, in accordance with the resolutions adopted by the Bank’s Special Shareholders’ Meeting on February 9, 2002.
Banco Santiago
Under the agreements between the Group and the Central Bank of Chile (as the second largest shareholder of Banco Santiago), on April 17, 2002, the Group acquired 35.45% of the Central Bank of Chile’s holding in the capital stock of Banco Santiago for US$685 million. On August 1, 2002, the merger of Banco Santiago and Banco Santander Chile was effectively executed, with retroactive effect as of January 1, 2002, after the required resolution of their respective Shareholders’ Meetings and approval by the Chilean regulatory authorities. The name of the post-merger entity is Banco Santander Chile.
Banco Santander Colombia
As a result of a capital increase and of certain agreements reached in prior years, in 2002 the Group increased its holding in the capital stock of Banco Santander Colombia by 34.32% and paid €303 million.
AFP Unión (Peru) and AFP Nueva Vida (Peru)
In 2000 the Group merged AFP Unión with AFP Nueva Vida, a Peruvian pension fund manager which was 97.29% owned by the Group as of December 31, 1999. As of December 31, 2001 and 2000, the Group had a 99.9% holding in the new entity (AFP Unión Vida).
Banco del Río de la Plata, S.A. (Banco Río)
As of December 31, 2002, the Group had a 98.85% interest in Banco Río (80.3% and 79.8% as of December 31, 2001 and 2000, respectively) after the merger in early 2000 of Banco Tornquist, S.A. and Banco Río de la Plata, S.A., the tender offer launched in 2000 to acquire the capital stock of Banco Río owned by minority shareholders, which was accepted by 94% of the minority shareholders, and the acquisition in 2002 (by virtue of the commitments assumed in prior years) of 18.54% of the capital stock (23% of the voting rights) for €395 million (Note 1).
Meridional Group
In January 2000, the Group acquired a 97% holding in the capital stock of the Brazilian Meridional Group, a finance group consisting of Banco Meridional and Banco de Inversiones Bozano Simonsen and subsidiaries, for approximately US$835 million.
Banco Totta & Açores, S.A. and Crédito Predial Portugués, S.A. (Totta Group)
In November 1999 the Bank reached certain agreements with the Champalimaud Group and with Caixa Geral de Depósitos, the final outcome of which was the acquisition by the Group of a 94.38% holding in the capital stock of Banco Totta & Açores, S.A. and of a 70.6% holding in the capital stock of Crédito Predial Portugués, S.A. This acquisition was paid in cash (Esc. 100,082 million) and through the delivery of the 252,892,250 Bank shares (Note 20) issued specifically for this transaction.
In April 2000, after the aforementioned purchase, the Group launched a tender offer for the acquisition of the remaining capital stock. As of December 31, 2002, the Group’s interest in both entities was 99.3%, with a total investment of approximately €2,145 million.
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Grupo Financiero Serfin and Grupo Financiero Santander Mexicano
In May 2000, the Group was the successful bidder in the call for tenders launched by Instituto de Protección al Ahorro Bancario de México on Grupo Financiero Serfin (the fourth largest Mexican financial institution), with an investment of 14,650 million Mexican pesos (equal to approximately US$1,535 million). Also, in 2000 the Group acquired a further 14.7% investment in the capital stock of Grupo Financiero Santander Mexicano.
In December 2002, the Group reached an agreement with Bank of America Corporation whereby the latter will acquire 24.9% of Grupo Financiero Santander Serfin for US$1,600 million, which will give rise to estimated capital gains, of approximately US$700 million. Under this agreement, Bank of America Corporation will keep its holding at least for three years, and after this period it may use, if it deems it appropriate, several liquidity mechanisms, including the listing of its holding on the stock exchange and the right to sell this holding to the Group, at one time, at its book value at the time of the sale, calculated in accordance with international accounting standards.
This transaction is subject to the obtainment of the relevant regulatory approvals and is expected to be implemented in the first half of 2003.
Patagon Group
In July 2000, the Group acquired a 97.62% holding in the capital stock of the Patagon Group (an American financial portal) for approximately US$607 million.
In 2002 the Group restructured its Internet banking business, sold its holding in the American financial portal to the other shareholders using the allowances recorded for the full amount of the investment.
Banco de Caracas
In October 2000, the Group made a tender offer for the acquisition of the capital stock of Banco de Caracas. The price offered to all the shareholders was US$0.57 per share, from which US$0.11 were deducted to cover any contingencies. The total investment amounted to approximately US$318 million and 93.1% of the bank’s capital stock was acquired in December 2000. On August 17, 2002, Banco de Venezuela and Banco de Caracas merged into the new Banco de Venezuela.
Banco do Estado de Sao Paulo (Banespa)
In November 2000, the Group acquired a 33% investment (66.5% of the voting rights) in the capital stock of Banespa for 7,284 million Brazilian reais. Additionally, on December 29, 2000, the Bank’s Board of Directors approved the launch of a tender offer for the remaining common and preferred shares owned by minority shareholders (67% of capital stock) at a price of 95 Brazilian reais for every 1,000 shares, to be paid in cash. This offer was accepted by the holders of 95% of the common shares and of 96% of the preferred shares, which enabled the Group to control 98.3% of the voting rights and 97.1% of the capital stock of Banespa. This transaction amounted to 2,275 million Brazilian reais.
Compañía de Seguros de Vida Santander, S.A. and Compañía de Reaseguros de Vida Soince-Re, S.A.
In 2001 the Group sold its holdings in these two Chilean companies for US$258 million, giving rise to capital gains of approximately US$160 million.
Other investments
The Royal Bank of Scotland Group, plc. (Royal Bank of Scotland)
In 2000 the Group subscribed to the capital increase carried out by Royal Bank of Scotland. Additionally, as part of the tender offer launched by this bank on National Westminster Bank, plc., the Group subscribed to €800 million of the capital increase carried out at Royal Bank of Scotland for this purpose.
Also, the Group made a net divestment on the stock exchange of 35 million shares of Royal Bank of Scotland in 2000 to avoid exceeding the applicable regulatory shareholding limits. In 2001, the Group made a divestment of 1.53% of the capital stock of Royal Bank of Scotland, at a capital gain of approximately €400 million, thus reducing its investment to 8.03% as of December 31, 2001.
In 2002 the Group made a net divestment of 3% of its holding in Royal Bank of Scotland, giving rise to capital gains of approximately €806 million.
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Unión Eléctrica Fenosa, S.A. (Unión Fenosa)
In 2002 several holdings were acquired in the capital stock of Unión Fenosa for a total amount of €465 million. The ownership interest was 23.35% as of December 31, 2002.
Grupo Financiero Bital
In 2002 the Group subscribed to a capital increase and converted bonds into Grupo Financiero Bital shares for approximately €99 million, thus increasing its holding to 25.4% of the economic rights and 29.1% of the voting rights. Subsequently, the Group accepted the tender offer launched by Hong Kong and Shanghai Bank Corporation (“HSBC”) on Grupo Financiero Bital, which gave rise to gains of approximately €113 million.
Dragados y Construcciones, S.A.
In 2002 the Group divested its holding in Dragados y Construcciones, S.A. (as of December 31, 2001, the holding was 20.19% of capital stock) at a capital gain of approximately €521 million.
Vallehermoso, S.A.
In 2002 the Group divested 24.5% of its holding in Vallehermoso, S.A. (as of December 31, 2001, the holding was 25.14% of capital stock) at a capital gain of approximately €301 million.
Inmobiliaria Urbis, S.A. (Urbis)
In 2000 the Group increased its holding in Urbis by 7.8% as a result of the capital increase carried out at this company in July 2000. As of December 31, 2001 and 2002, the Group had a 53.00% and 45.46% ownership interest in this company.
Somaen-Dos, S.L.
This company was 59.95% owned by the Group as of December 31, 2002, 2001 and 2000 (and was consolidated by the global integration method). Its main asset is a 33.23% holding in the capital stock of Cepsa. At those dates, the cost of the investment of Somaen-Dos, S.L. in Cepsa amounted to approximately euros 661 million.
Société Générale
As of December 31, 2000, the Group had a 5.93% holding in the capital stock of Société Générale. Following various divestments in 2001 (with realized capital gains of €185 million), the Group’s ownership interest was 1.5% as of December 31, 2001. This holding was divested in 2002 at a capital gain of €94 million.
Metropolitan Life Insurance Company (“Metlife”)
In 2000 the Group acquired a 3.9% holding in the capital stock of Metlife for euros 469 million. As of December 31, 2000, the negative difference in consolidation of this holding amounted to €132 million. In 2001 the Group realized the majority of its holding in Metlife at a gain of approximately €300 million.
San Paolo IMI-
At December 31, 2000, 2001 and 2002 the Bank had a 6.48%, 5.46% and 5.16% holding of its capital stock respectively.
Commerzbank, A.G. (Commerzbank)-
At December 31, 2000, 2001 and 2002 the Bank had a 4.84%, 4.72% and 3.72% holding of its capital stock respectively.
* * * * *
The cost, total assets and gross revenues of the other consolidated companies acquired and sold in 2002, 2001 and 2000 were not material with respect to the related consolidated totals.
F-18
The Board of Directors will submit for approval by the Shareholders' Meeting the following proposal for distribution of the Bank’s 2002 net income:
The provisional financial statements prepared by the Bank in accordance with legal requirements, to evidence the existence of sufficient funds for the distribution of the 2002 interim dividends were as follows:
Compensation and other benefits of the Bank’s directors and senior management
Directors’ compensation
Emoluments per the bylaws
Article 37 of the Bank’s bylaws provides that the share in the Bank’s income for the year to be received by members of the Board of Directors for discharging their duties will be up to 5% of such income.
The Board of Directors, making use of the powers conferred on it, set the related amount at 0.191% of the Bank’s income for 2002 (0.254% for 2001 and 0.284% for 2000).
Consequently, the gross amount to be received by each director in this connection in 2002 (€65 thousand) is 10% lower than that set for 2001 and 2000 (€72 thousand). Additionally, there is an annual emolument for the Executive Committee members, the gross amount of which was €141 thousand in 2002 (also 10% below the €157 thousand received in 2001 and 2000).
Finally, from 2002 onwards, the members of the Audit and Compliance Committee have been assigned a gross emolument of €32 thousand per year.
Salary compensation
The detail of the salary compensation received by the Board members with executive duties, who as of December 31, 2002, were Mr. Emilio Botín, Mr. Alfredo Sáenz, Mr. Matías R. Inciarte, Ms. Ana P.Botín, and Mr. Francisco Luzón, is as follows:
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Detail by director
The detail by director of the compensation earned by the Bank’s directors in 2002 as discussed above is as follows:
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Other compensation
The other compensation accrued to other Board members amounted to €2.5 million in 2002, €3.2 million in 2001 and €5.3 million in 2000.
Compensation to the Board members as representatives of the Bank and to senior management
Representation
Senior management
Pension commitments, other insurance and other items
The total balance of supplementary pension obligations assumed by the Group over the years for its serving and retired employees, which amounted to €12,977 million (covered mostly by in-house allowances) as of December 31, 2002, includes the obligations to those who have been directors of the Bank during the year and who discharge (or have discharged) executive functions during the year. The total pensions accrued to these directors, together with the total sum insured under life insurance policies at that date and other items, amount to €256 million as of December 31, 2002, of which €108 million relate to the settlement of the pension rights referred to in the following section of this Note (€209 million as of December 31, 2001, which did not include the extraordinary nonrecurring payment of €43.75 million paid in 2001, and €126 million as of December 31, 2000).
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Pension settlement
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Stock option planThe detail of the Bank’s stock options granted to the Board members as of December 31, 2002, is as follows:
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Loans
The Group’s direct or indirect risk exposure to the Bank’s directors as of December 31, 2002, amounted to €14.4 million (€7.8 million and €6.9 million as of December 31, 2001 and 2000, respectively) of loans and €1.2 million (€0.8 million and €1.2 million as of December 31, 2001 and 2000, respectively) of guarantees provided. These loans and guarantees were granted at market rates in all cases.
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Other information
As of December 31, 2002, 2001 and 2000, the market value of the available-for-sale and held-to-maturity portfolios did not differ materially from the acquisition cost, adjusted as indicated in Note 2-d).
The weighted average annual interest rate on the fixed-income securities portfolio as of December 31, 2002, was 10.2% (9.1% and 7.5% as of December 31, 2001 and 2000, respectively). The effect of discounting by the interest method the fixed-income securities whose interest rates are lower than the average cost of the Group’s borrowed funds is not material.
The balance as of December 31, 2002, of the “Public-Sector Issuers” account in the consolidated balance sheet includes €22,639 million relating to securities issued by non-resident public-sector entities (€31,991 million and €33,508 million as of December 31, 2001 and 2000, respectively).
€8,640 million of the Group's total fixed-income securities portfolio as of December 31, 2002, mature in 2003.
Security price fluctuation allowance
The variations in the balances of the “Security Price Fluctuation Allowance” account were as follows:
This caption includes basically the shares and securities representing holdings of less than 20% (less than 3% if listed) in the capital stock of companies which have no lasting relationship with the Group and are not intended to contribute to its activity, and units in mutual funds.
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Breakdown
The detail, by classification and listing status, of the balances of this caption is as follows:
Variations
The variations in the balances of this caption, disregarding the security price fluctuation allowance, were as follows:
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Airtel Móvil, S.A. (“Airtel”) and Vodafone Airtouch, plc. (“Vodafone”)
In July 2000, the Group accepted the offer made by Vodafone to exchange its investment in Airtel at that date for Vodafone shares. The 1,842,641,757 new shares received, which represented 2.85% of the capital stock of Vodafone, were recorded at the cost of acquisition of the Airtel shares exchanged.
In 2001 the Group divested 44% of its investment in the capital stock of Vodafone, generating a gross capital gain of €1,713 million.
Auna Operadores de Telecomunicaciones, S.A. (“Auna”)
Subsequent to the various corporate transactions that took place in 2001 and 2002, as of December 31, 2002, the Group had a 23.49% holding in the capital stock of Auna, with an investment of €1,696 million.
As of December 31, 2002, the Group had entered into certain agreements which would enable it, if they were exercised, to increase its holding by a further 2.5%.
Notifications on share acquisitions
The notifications on share acquisitions and sales by the Bank in compliance with Article 86 of the Spanish Corporations Law and Article 53 of Securities Market Law 24/1998 are listed in Exhibit III.
10. Investments in non-Group companies
This caption reflects the ownership rights in the capital of associated companies, i.e. companies which, although not forming part of the Group, have a lasting relationship with the Group and are intended to contribute to its activity. These companies (Exhibit II), which are not managed solely by the Group, are generally 50% or less owned but more than 20% owned in the case of unlisted companies (more than 3% if listed).
The breakdown, by company, of the balances of this caption (Note 3) in the consolidated balance sheets is as follows:
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The variations in the balances of this caption were as follows:
11. Investments in Group companies
This caption in the consolidated balance sheets reflects the investments in Group companies which were not consolidated (Exhibit II) because their business activities are not directly related with those of the Group. The breakdown, by company, of the balances of this caption is as follows:
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As of December 31, 2002, there were no capital increases in progress at any significant non-consolidable subsidiary.
12. Consolidation goodwill Breakdown
The breakdown, by company, of the balances of the “Consolidation Goodwill” caption (Note 3) is as follows:
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As of December 31, 2002 and 2001, the Group had recorded provisions (Notes 1 and 17) to cover the potential loss of value of certain of these assets. Also, based on the estimates and projections available to the Bank’s directors, the forecasted revenues attributable to the Group from these companies (after taking into consideration the matters shown in the preceding paragraph) are at least equal to the amounts of the respective goodwill balances yet to be amortized in the related periods.
The variations in the balances of the “Consolidation Goodwill” caption were as follows:
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Other property
The “Other Property” and “Furniture, Installations and Other” captions include, among other items, the assets acquired through foreclosure on non-recovered loans. These assets are recorded at foreclosure cost, which in no case exceeds the book value of the loan, net of the provisions recorded as a result of comparison with their market value. The provisions amounted to €395 million as of December 31, 2002, and accounted for 58% of the recorded value (€563 million and €624 million and 56% and 55% as of December 31, 2001 and 2000, respectively).
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As of December 31, 2002, the limit set by the Bank of Spain on the Bank and on the Banesto Group for the system of loans guaranteed by public-sector debt securities amounted to €1,209 million and €1,214 million, respectively (€1,683 million and €1,570 million on the Bank and on the Banesto Group, respectively, as of December 31, 2001, and €1,880 million and €1,363 million on the Bank and on the Banesto Group, respectively, as of December 31 2000).
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F-39
The exhibit IV list the detailed relation of bonds and debentures issued.
The variations in “Bonds and Debentures” accounts were as follows:
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Maturity
The detail, by maturity, of the balance of this caption as of December 31, 2002, is as follows:
Promissory notes and other securities
The detail, by maturity, of the balances of the “Promissory Notes and Other Securities” caption, issued basically by Banco Santander Central Hispano, S.A.; Santander Central Hispano International Ltd.; Santander Central Hispano Finance (Delaware), Inc.; Santander Consumer Finance, S.A.; Banca Serfin S.A.; Banco Santander Mexicano S.A.; and Banco Totta & Açores, Ltda., is as follows:
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17. Provisions for contingencies and expenses
The detail of the variations in the balances of the “Provisions for Contingencies and Expenses” caption is as follows:
Inclusion of companies in the Group
The company included in the Group in 2000 with the largest amount of recorded “Provisions for Contingencies and Expenses” was Banespa (Note 3).
In accordance with the applicable Brazilian labor regulations, Banespa had recorded as of December 31, 2000, the pension allowances arising from the commitments to certain employees, which amounted to approximately 4,000 million Brazilian reais.
Since 1987, the directors of Banespa, as advised by their tax advisers, treated these expenses as deductible expenses in calculating the Brazilian corporate income tax; however, in September 1999, the “Secretaria da Receita Federal” ruled that 2,867 million Brazilian reais of these expenses were not tax deductible. In October 1999, the Board of Directors of Banespa filed an appeal against this decision and paid the related deposit (1,450 million Brazilian reais) and recorded a provision of 2,600 million Brazilian reais for this contingency. This provision was recorded in 1999 with a charge to income, after recording the related deferred tax asset of 1,200 million Brazilian reais.
In 2002 the directors of Banespa availed themselves of “Medida Provisoria Nº 66”, and paid 2,110 million Brazilian reais to terminate the procedure. The company did not agree with a further 103 million Brazilian reais relating to expenses and surcharges, and, accordingly, a judicial action for injunctive relief was initiated and a deposit was placed for this amount.
Other provisions
The balances of the “Provisions for Contingencies and Expenses – Other Provisions” caption included the following items:
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18. Subordinated debt
The detail, by currency and interest rate, of the balances of this caption is as follows:
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These issues are subordinated and, therefore, for debt seniority purposes they are junior to the claims of all general creditors of the issuers. The issues of Santander Central Hispano Issuances, Ltd. are guaranteed by the Bank or are secured by restricted deposits at the Bank.
As of December 31, 2002, 2001 and 2000, the balance of this caption included €321,180 thousand relating to issues convertible into shares of the Bank at any time from January 1, 1999 through July 30, 2003 (Santander Central Hispano Finance B.V.) or September 23, 2003 (the Bank), at the holders’ option. The share value for conversion purposes is €16.53.
The detail, by maturity, of the balance of this caption in the consolidated balance sheet as of December 31, 2002, is as follows:
The interest on subordinated debt amounted to €736,364 thousand in 2002 (€750,778 thousand in 2001 and €660,056 thousand in 2000).
19. Minority interests
The detail, by Group company, of the balances of the “Minority Interests” caption is as follows:
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Preferred shares
In 2000, BSCH Finance, Ltd. issued shares amounting to US$ 300 million and US$ 295 million, with fixed annual dividends ranging from 8.625% to 9.40%.
These are non-cumulative non-voting shares. They were subscribed by third parties outside the Group and are fully or partially redeemable after five years, at the issuer’s discretion.
Additional information is disclosed in note 27.5.k
20. Capital stock
2000
As of December 31, 1999, the Bank’s capital stock consisted of 3,667,793,148 fully subscribed and paid shares of €0.5 par value each.
In accordance with a resolution of the Special Shareholders’ Meeting of January 18, 2000, on March 4, 2000, the Bank issued 151,846,636 shares of €0.5 par value each, of the same class and series as those then outstanding, plus an additional paid-in capital of €2.07 per share.
This capital increase was paid through a non-monetary contribution consisting of shares representing all the capital stock of the Portuguese company Foggia SGPS, S.A. (Foggia), the owner of a 51.8% holding in the capital stock of Sociedad Mundial Confiança, S.A.; of a 53.05% holding in Banco Pinto & Sotto Mayor, S.A.; of 94.38% of Banco Totta & Açores, S.A. and of 70.57% of Crédito Predial Portugués, S.A.
Additionally, the Bank recorded a reserve of €1,111,139,000 (the difference between the market value attributed to the shares contributed and the amount of the issue per the related public deed) as required by the Bank of Spain in order to record the goodwill embedded in the market value attributed to the contributed shares.
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Subsequently, Caixa Geral de Depósitos acquired from the Bank all its direct and indirect holdings in the Mundial Confiança Group as described in the preceding paragraphs. Then the Caixa Geral Group transferred to the Bank 94.38% of the capital stock of Banco Totta & Açores, S.A., the owner of 70.57% of Crédito Predial Portugués, S.A.
As a consideration for this acquisition and in accordance with the resolution of the Special Shareholders’ Meeting of the Bank of January 18, 2000, on April 7, 2000, the Bank issued 101,045,614 shares of €0.5 par value each, of the same class and series as those then outstanding, plus an additional paid-in capital of €3.41 per share. Additionally, the Group paid Esc. 100,082 million in cash and recorded a reserve of euros 702,265,000 (the difference between the market value of the shares contributed and the issue amount per the related public deed) as required by the Bank of Spain in order to record the goodwill embedded in the market value attributed to the contributed shares.
The new shares of the Bank conferred on their holders the same rights as the Bank shares outstanding at the issue date.
Royal Bank of Scotland - National Westminster Bank, plc.
In accordance with a resolution of the Bank’s Special Shareholders’ Meeting of January 18, 2000, on March 7, 2000, the Bank issued 179,615,243 shares of €0.5 par value each, of the same class and series as those then outstanding, plus an additional paid-in capital of €2.07 per share, as part of the tender offer made by The Royal Bank of Scotland for the acquisition of National Westminster Bank, plc.
This capital increase was paid thought a non-monetary contribution consisting of 144,334,856 new shares of The Royal Bank of Scotland, representing 5.90% of its capital stock at that date and was carried out after the divestment by the Group of 34,850,000 Royal Bank of Scotland shares (Note 3) to avoid exceeding the applicable regulatory shareholding limits.
Additionally, the Bank recorded a reserve of €1,499,068,000 (the difference between the market value of the shares contributed and the issue amount per the related public deed) as required by the Bank of Spain in order to record the goodwill embedded in the market value of the contributed shares.
Royal Bank of Scotland – Cash Payment.
In accordance with a resolution of the Bank’s Shareholders’ Meeting of March 4, 2000, in December 2000 the Bank issued 44,749,176 shares of €0.5 par value each, of the same class and series as those then outstanding, plus an additional paid-in capital of €10.53 per share.
These shares were subscribed and paid by a subsidiary of The Royal Bank of Scotland Group in December 2000.
This capital increase and that described above conferred on their holders the same rights as the Bank shares outstanding at the issue date.
Merger bonus
In accordance with a resolution of the Bank’s Shareholders’ Meeting of March 4, 2000, the Bank issued 6,736,590 shares of €0.5 par value each, of the same class and series as those then outstanding, plus an additional paid-in capital of €1.79 per share, to cater for the special merger bonus to the employees agreed upon in the Framework Agreement dated March 3, 1999.
These shares were subscribed and paid by Caixa d’Estalvis i Pensions de Barcelona (la “Caixa”), an entity with which the Bank arranged a Share Subscription and Purchase Option Agreement.
Additionally, the Bank recorded a reserve of €57,667,000 (the difference between the market value of the shares contributed and the issue amount per the related public deed) as required by the Bank of Spain in order to record this difference in income (Note 21).
To proceed with the first delivery of shares, on June 16, 2000, the Bank exercised its purchase option on a total of 1,914,900 shares (equal to 60 shares to each eligible employee under the Framework Agreement dated May 31, 2000, the date on which the employees’ right to receive this first delivery of shares vested).
Public Offer for the Subscription of Shares
In accordance with a resolution of the Bank’s Special Shareholders’ Meeting of June 1, 2000, the Bank issued 345,000,000 shares of €0.5 par value each, of the same class and series as those then outstanding, plus an additional paid-in capital of €10.5 per share addressed to minority shareholders (240 million shares) and of €10.75 per share addressed to other shareholders. These shares were subscribed and paid in July and August 2000 and since then confer on their holders the same rights as the shares outstanding.
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Banco Río
In accordance with a resolution of the Bank’s Shareholders’ Meeting of March 4, 2000, on July 20, 2000, the Bank issued 63,450,006 shares of €0.5 par value each, of the same class and series as those then outstanding, plus an additional paid-in capital of €1.75 per share.
This capital increase was paid through a non-monetary contribution consisting of 88,830,009 shares of Banco Río de la Plata, S.A. (Note 3); therefore, the Group’s holding in the capital stock of this bank then increased to 79.2%.
Additionally, the Bank recorded a reserve of €425,925,000 (the difference between the market value of the shares contributed and the issue amount per the related public deed) as required by the Bank of Spain in order to record the goodwill embedded in the market value of the contributed shares.
As of December 31, 2000, the Bank’s capital stock consisted of 4,560,236,413 fully subscribed and paid shares of €0.5 par value each.
2001
Young Executives Incentives Plan
On February 28, 1,300,000 new common shares (0.03% of the Bank’s capital stock) of €0.50 par value each and additional paid-in capital of €1.79 per share were issued within the framework of an incentive plan targeted at young executives.
To Finance Early Redemption of Preferred Stock
In December the Bank issued 97,826,086 new common shares (2.14% of the Bank’s capital stock) of €0.50 par value each and additional paid-in capital of €8.70 each. The net proceeds (€900 million) are destined to finance the early redemption of five issues of preferred shares in US$ issued by Group companies at rates that were considerably higher than current market rates (note 27.5.k and note19).
As of December 31, 2001, the Bank’s capital stock consisted of 4,659,362,499 fully subscribed and paid shares of €0.5 par value each.
2002
For acquisition of shares of AKB
The Group made one capital increase during the second quarter, issuing 109,040,444 new ordinary shares (2.3% of the Bank’s capital) of EUR 0.50 nominal value each and an issue premium of EUR 9.588 per share, which were fully subscribed and disbursed through shares representing all the capital of AKB, in accordance with the resolutions adopted by the Bank’s Special Shareholders’ Meeting on February 9, 2002. (notes 3 and 21)
After this operation and as of December 31, 2001, the Bank’s capital stock consisted of 4,768,402,943 fully subscribed and paid shares of €0.5 par value each.
The variations in the Bank’s capital stock summarizes as follows:
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The Bank’s shares are listed on the computerized trading system of the Spanish stock exchanges and on the New York, Milan, London, Paris, Lisbon, Buenos Aires, Frankfurt and Swiss stock exchanges, and all of them have the same features and rights. As of December 31, 2002, the only shareholders with an ownership interest in the Bank’s capital stock of over 3% were Chase Nominees Limited (with a 5.50% investment) and State Street Bank and Trust Company (with 3.46%).
Other considerations
As of December 31, 2002, the additional capital stock authorized by the Shareholders’ Meeting amounted to €1,464 million. The time periods that the Bank’s directors have to carry out capital increases up to this limit expire in February 2007.
On February 9, 2002, the Shareholders’ Meeting set the maximum amount of Bank shares that the Bank and/or any Group subsidiary may acquire at 5% of the capital stock outstanding at any time.
Also, the aforementioned Shareholders’ Meeting authorized the Bank’s Board of Directors to issue fixed-income securities not convertible to equity up to a maximum amount of €15,000 million over a period of five years and fixed-income securities convertible to equity for up to €1,000 million over a one-year period, and empowered the Board of Directors to execute the resolution to issue fixed-income securities convertible to shares without preemptive rights up to a maximum amount of €1,000 million over a one-year period, and, in addition, authorized the related capital increases to cater for the conversion, if any.
As of December 31, 2002, the shares of the following companies were listed on official stock markets: Banco Río de la Plata; Banco de Venezuela, S.A.C.A.; Banco Santander Colombia; Santander Bank Corporation (Puerto Rico); Grupo Financiero Santander Serfin, S.A. de C.V.; Banco Santander Chile; Bansaliber, S.A.; Central de Inversiones en Valores, S.A. (Ceivasa); Financiera Bansander, S.A. (Fibansa); Norteña de Valores, S.A. (Norvasa); Cartera Mobiliaria, S.A. (Carmosa); Santander Chile Holding; Inmuebles B de V 1985 C.A.; Banco do Estado de Sao Paulo; Banesto; Portada S.A. and Banco Totta & Açores.
As of December 31, 2002, the capital increases in progress at Group companies and the additional capital authorized by their Shareholders’ Meetings were not material at Group level.
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Additional paid-in capital, reserves and revaluation reserves
The breakdown of the balances of these captions, relating in full to the Bank, is as follows:
Legal reserve
Under the revised Corporations Law, 10% of Spanish companies’ net income for each year must be transferred to the legal reserve. These transfers must be made until the balance of this reserve reaches 20% of capital stock. The legal reserve can be used to increase capital provided that the remaining reserve balance does not fall below 10% of the increased capital stock amount.
Reserves for treasury stock
Under the revised Corporations Law, a restricted reserve was recorded for an amount equal to the book value of the Bank shares owned by subsidiaries. This reserve will become unrestricted when the circumstances which gave rise to its mandatory recording cease to exist. Additionally, this reserve includes the outstanding balance of the loans granted by the Group that are secured by Bank shares.
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Revaluation reserves Royal Decree-Law 7/1996
The balance of this account can be used, free of tax charges, to increase capital. From January 1, 2007, the balance of this account can be taken to unrestricted reserves, provided that the monetary surplus has been realized. The surplus will be deemed to have been realized in respect of the portion on which depreciation has been taken for accounting purposes or when the revalued assets have been transferred or retired from the accounting records.
If this balance were used in a manner other than that provided for in Royal Decree-Law 7/1996, it would be subject to tax.
Additional paid-in capital
The revised Corporations Law expressly permits the use of the additional paid-in capital balance to increase capital of the entities at which it is recorded and establishes no specific restrictions as to its use.
Early recording of voluntary reserves
As required by the Bank of Spain, the “Reserves” caption in the consolidated balance sheet as of December 31, 2002, includes “Voluntary Reserves Recorded Early”, of which approximately €3,277 million (€3,397 million and €3,738 million as of December 31, 2001 and 2000, respectively) relate to the difference between the amount at which certain Bank shares were issued – in accordance with Article 159.1.c of the revised Spanish Corporations Law – for the acquisition of investments in the capital stock of other entities and the market value of the shares received in exchange, net of the equivalent amortization of the goodwill arising in the acquisitions. This amount increased initially the acquisition cost of the investments acquired (Notes 12 and 20).
Reserves and accumulated losses at consolidated companies
The breakdown, by company, of the balances of these captions in the consolidated balance sheets, based on each company’s contribution to the Group (after considering the effect of consolidation adjustments), is as follows:
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Since 1992 the Madrid Central Court number 3 has had preliminary court proceedings in progress to determine the liabilities which might arise in connection with certain credit assignment transactions carried out by Banco Santander, S.A. from 1987 to 1989. The Bank and its internal and external advisers consider that the result of this litigation will finally be in its favor and that no additional specific provision is required. This opinion was corroborated by the dismissal order by the aforementioned Court on July 16, 1996, which signified a considerable advance in this connection. On June 27, 2002, it was decided to transform the aforementioned preliminary court proceedings into abridged proceedings, and the above–mentioned decision was appealed against by the Public Prosecutor’s Office and Bank management. The court has decided to stay the proceedings until the appeals filed are finally settled.
In any event, following its traditional prudent criteria, the Group has recorded reasonable provisions to cover any contingencies which might arise from the above–mentioned situations.
Reconciliation
The reconciliation of the corporate income tax expense calculated at the standard rate to the recorded corporate income tax expense is as follows:
The Bank and certain of the other Spanish consolidated companies have availed themselves of the tax credits available under corporate income tax legislation. Although the 2002 corporate income tax return has not yet been filed, the provision for 2002 corporate income tax shown in the consolidated balance sheet as of December 31, 2002, and the consolidated statement of income for the year then ended, is net of the related investment, dividend double taxation and international double taxation tax credits recorded in the balance of “Permanent Differences” in the foregoing reconciliation.
Other assets and other liabilities
The balance of the “Other Assets” caption in the consolidated balance sheets includes balances receivable from the tax authorities relating to prepaid corporate income tax. The balance of the “Other Liabilities” caption includes the liability for the various deferred taxes of the Group and the tax collection accounts.
The detail of the two balances is as follows:
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The aforementioned notional and/or contractual amounts of these transactions do not necessarily reflect the actual risk assumed by the Group, since the net position in these financial instruments is the result of offset and/or combination thereof. This net position is used by the Group basically to hedge the interest rate risk, the price of the underlying asset or the currency risk, the resulting gains or losses on which are included under the “Gains (Losses) on Financial Transactions” caption in the consolidated statements of income and, where appropriate, as an increase in, or offset of, the results on the investments for which these hedging contracts were arranged (Note 25).
Off-balance-sheet funds under management
The detail of the off-balance-sheet funds under management by the Group is as follows:
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The average number of employees at the Group, by professional category, was as follows:
Compensation systems based on the delivery of Bank shares
In recent years, the Bank has put in place compensation systems linked to the market performance of the Bank’s shares based on the achievement of certain objectives as shown below:
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Stock options plan
Other administrative expenses
The detail of the balances of this caption in the consolidated statements of income is as follows:
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Included in the “Other Expenses” balance are the annual audit fees paid by the Group companies (see Exhibits I and II) to their respective auditors, which amounted to €13.1 million, €13.2 million and €19.7 million in 2002, 2001 and 2000, respectively.
The detail of the 2002 expenses is as follows:
The net debit balance (€339 million) of these captions in the consolidated statement of income for the year ended December 31, 2002, includes the gains or losses on disposal of property and equipment and long-term financial investments (net income of €443 million and net loss of €122 million); the collection of interest on doubtful and non-performing loans earned in prior years (€76 million); monetary adjustments (Note 2-b); provisions to pension allowances (Note 2-j); and other net losses of €315 million, resulting mainly from the impact of write-downs of technology and other companies and of businesses located outside Spain (including, among others, those indicated in Note 1 relating to Argentina).
The net credit balance (€61 million) of these captions in the consolidated statement of income for the year ended December 31, 2001, includes the gains or losses on disposal of property and equipment and long-term financial investments (net income of €2,080 million – including the income obtained from the sale of Vodafone – and net loss of €142 million); the collection of interest on doubtful and non-performing loans earned in prior years (€56 million); monetary adjustments (Note 2-b); provisions to pension allowances (Note 2-j); and other results of €1,696 million, including most notably the recording of the special allowance for Argentina (Note 1).
The net debit balance of these captions in the consolidated statement of income for the year ended December 31, 2000 (€406 million), includes the gains or losses on disposal of property and equipment and long-term financial investments (net income of €108 million and net loss of €71 million); the collection of interest on doubtful and non-performing loans earned in prior years (€35 million); monetary adjustments (Note 2-b), provisions to pension allowances (Note 2-j) and the merger bonus (Note 23).
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As described in Note 1, the Consolidated Financial Statements of the Santander Central Hispano Group are presented in accordance with accounting principles generally accepted in Spain (“Spanish GAAP”) which vary in certain respects from those generally accepted in the United States (“U.S. GAAP”). This note includes relevant information about valuation differences, differences in Financial Statements presentation and different disclosure requirements.
The information included is classified as follows:
Following is a description of the most significant valuation and income recognition principles under Spanish and U.S. GAAP applicable to the financial statements of the Santander Central Hispano Group:
Consolidation procedures(See Note 1 and Note 27.2.a)-
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Treasury stock(See Note 2.i and Note 27.2.i)-
Gains or losses on transactions with Bank shares owned by dependent companies are accounted for as extraordinary results.Loans granted to shareholders, employees and other third parties for the acquisition of treasury stock are recorded in the consolidated balance sheets underLoans and Leases.
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General risk allowance (See Note 27.2.k)-
Pension plan and early retirements (See Note 2.j, Note 27.2.j and Note 27.2.l)-
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The gains or losses arising from trading transactions arranged outside organized markets are not recognized in income until they are effectively settled. However, provisions are recorded with a charge to income for unrealized net losses. These provisions are calculated independently for each risk (interest rate, equity price and currency), by grouping them by currency, then netting unrealized profits and losses for each group, and then adding only the net losses of each group.
The gains or losses arising from hedging transactions are accrued symmetrically to the revenues or expenses arising from the hedged items, with a balancing entry under “Other Assets” or “Other Liabilities” in the consolidated balance sheets.
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Depreciation is computed on the restated value using the straight-line method over the estimated useful life of the asset. The amount of depreciation and amortization charged to income is deductible for corporate income tax purposes. In addition, gains or losses on sales of the asset are determined as the difference between the selling price and the net restated value.
Fixed assets acquired and certain of those leased from both related and third parties through 1985, following the provisions of Spanish Royal Decree-Law 2/1985, were depreciated on an accelerated useful lives basis.
The tax expense for corporate income tax is calculated on the basis of book income before taxes, increased or decreased by permanent differences.Deferred tax assets and liabilities are recorded in respect of timing differences that are expected to result in a taxation asset or liability in the foreseeable future.
Income tax expense is comprised of two components: current tax payable or refundable and deferred tax expenses or benefits.
Income taxes currently payable for a particular year usually include the tax consequences of most events that are recognized in the financial statements for that year. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities, equity, revenues, expenses, gains, and losses, differences arise between:
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Following is a summary of the adjustments to consolidated net income and to consolidated Stockholders’ Equity which would be required if U.S. GAAP had been applied to the accompanying consolidated financial statements. These adjustments are explained in following notes A – O.
After the reconciliation, the Comprehensive Income reporting required by SFAS 130 is added. More information about it could be found in note P.
Finally, in note Q information about U.S. GAAP recent pronouncements is included.
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After reconciliation to U.S. GAAP, the consolidated statement of changes in stockholders’ equity would be as follows:
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Considering the adjustments included in the reconciliation, the Other Comprehensive Income information required in SFAS 130 is summarized in the table below:
Following are some explanations of the reconciliation items. All of them come from recurrent accounting differences except:
There is not adjustment related to accounting treatment of highly inflationary environments since a Securities Exchange Commission accommodation to foreign registrants permits the inclusion of comprehensive price-level adjusted financial statements as long as local GAAP requires them and Spanish GAAP allows it.
Other differences between Spanish and U.S. GAAP with respect to translation of foreign currency financial statements would only impact reclassification in stockholders’ equity, but not the total.
The accounting differences between Spanish and U.S. GAAP on the few stock option plans issued gives rise to no significant adjustment (see note 27.5.L).
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Globally managed clients, corporate, sovereign and other large balance loans are evaluated on an individual basis based on the borrower’s overall financial condition, resources, guarantees and payment record. Impairment is determined when there are doubts about collection, or when interest or principal is past due for 90 days or more.
Consumer mortgage, installment, revolving credit and other consumer loans are evaluated collectively, and its impairment is established when interest or principal is past due for 90 days or more.
Loan loss recognition under Spanish GAAP does not differ to losses that would have been recognized under U.S.GAAP except for the valuation of transfer risk of intercompany transactions and for the compensatory effects of the Allowance for Statistical Coverage. The reconciliation adjustment includes:
There are certain affiliates in which the Group holds an ownership interest of less than 20% and are accounted for by the equity method according to Spanish GAAP (see Exhibit II). Under U.S. GAAP, the Group’s investments in these companies should be accounted for as indicated by SFAS No. 115. In this adjustment we change the valuation of these holdings from the equity accounting method to lower of cost or market (Investment Securities under Spanish accounting classification). Afterwards the final adjustment to meet SFAS 115 is done, together with all other securities, in the Investment Securities adjustment described in the following note E). If the holdings were sold in the year, the adjustment corrects the gains or loss on sale.
The adjustment to net income reverses gains from affiliated companies of €1,378,285, €455,934 and €453,788 thousand, reverses goodwill amortization of €36,059, €64,140 and €316,926 thousand and includes gains from investment securities of €1,343,122, €215,421 and €199,037 thousand in 2002, 2001 and 2000 respectively.
In stockholder’s equity the adjustment also includes the negative net effect on reserves of €133,901, €326,211 and €358,799 thousand in 2002, 2001 and 2000 respectively.
After having adjusted the different criteria in equity holdings described in note D) above, the valuation adjustment of the investment securities was made in two steps:
In the calculations of the amounts to be adjusted we include the effect of investment portfolios of subsidiaries not consolidated under Spanish GAAP, but that should be consolidated under U.S.GAAP.
The net income reconciliation item reverses the net provisions made to the price fluctuation allowance in the year, and recognizes the loss on sale of securities that were charged against net income under Spanish GAAP in previous years (amounting €146,461, €139,837 and €41,464 thousand in 2002, 2001 and 2000 respectively). Net provisions of €108,295 and €248,981 thousand were reported in 2002 and 2000, while net releases amounted €36,716 thousand in 2001.
The Stockholders’ Equity reconciliation item amounting to €2,307,361, €6,497,154 and €10,992,277 thousand in 2002, 2001 and 2000, includes the reversion of the effect of the price fluctuation allowance and the unrealized gains of debt and equity securities included in the available for sale portfolio and in the equity securities mentioned in the previous note D, the related deferred tax liability is recorded under the “Other liabilities” caption.
See note P (comprehensive income) to find information about realized and unrealized gains on securities.
Certain expenses concerning basically capital increases are amortized over a five-year period according to Spanish GAAP. The U.S. GAAP criterion is to reflect them as a decrease inStockholders’ Equity. This adjustment also includes as an expense the cost of start-up activities, which under Spanish GAAP are activated and depreciated on a straight-line basis.
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In June 2001, the FASB issued Statement No. 141 (SFAS 141) “ Business Combinations” and No. 142 (SFAS 142) “Goodwill and Other Intangible Assets” which require that all business combinations initiated after June 30, 2001 be accounted for under the purchase method. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized, but will be subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives. The non-amortization provisions of the new rules are effective for fiscal years beginning after December 15, 2001 and immediately for any purchase business combinations completed after June 30, 2001. In relation with Intangible Assets, the company will not recognize Intangible Assets not allowed under Spanish GAAP, unless they represent a very significant amount and have a stable fair value.
As described in Note 2.g, under Spanish GAAP the Group generally amortizes goodwill arising on investments over a maximum period of twenty years. A description of the principal equity investments acquired and sold in 2002, 2001 and 2000 is disclosed in Note 3.
Up to December 31, 2001, for the purpose of reporting in accordance with U.S. GAAP, Santander Central Hispano Group’s accounting policy was to amortize goodwill on a straight-line basis by charges to income over periods estimated to be benefited. This amortization period is generally estimated to be between 2 and 20 years. An impairment test was realized if facts and circumstances indicated that unamortized goodwill may be impaired, the review was made to determine what amount, if any, was recoverable based on the estimated undiscounted cash flows of the entity acquired over the remaining period, the carrying amount of goodwill is reduced by the estimated shortfall of cash flows.
From June 30, 2001, reconciliation item was calculated applying FASB statement No. 141 (SFAS 141) “Business Combinations” and No. 142 (SFAS 142) “Goodwill and Other Intangible Assets”. As Spanish GAAP statements continue to include an amortization expense the reconciliation adjustment will always have the positive effect of eliminating this expense. An additional effect (positive or negative) could arise from the fact that two different impairment tests are conducted (both under Spanish and under U.S. GAAP) over different Goodwill balances. From June 30, 2001, to December 31, 2001, SFAS 142 stablished some provisions that had no effect on our reconciliation to U.S. GAAP.
The 2002 negative goodwill net income reconciliation figure of €15,459 thousand comes from the first application of SFAS 141, that states that negative goodwill should be recognized as extraordinary income.
Net income reconciliation figure of €526,715 thousand in year 2002 comes from the difference of:
Goodwill amortization under Spanish GAAP amounted to €1,358,616. In this adjustment we only adjust €1,322,557, as the remaining €36,059 were previously adjusted in the “Investments in affiliated companies” item of the reconciliation, see previous note 27.2.d)
For reconciliation to U.S. GAAP purposes the Group has decided not to recognize Intangible Assets not allowed under Spanish GAAP, unless it represents a very significant amount and have a stable fair value. The components of intangible assets under Spanish GAAP were as follows:
For reconciliation to U.S. GAAP purposes, additions of goodwill from business combinations are calculated using Spanish GAAP criteria to avoid expensive and laborious double bookkeeping. The effect on net income and on stockholder’s equity is not significant since the other reconciliation adjustments correct the impact. Changes in Goodwill during 2002 were as follows:
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The goodwill that arose under Spanish GAAP from the tender offer to purchase shares of Banesto (€2,544,271 thousand) was amortized in 1998 with a charge to the additional paid-in capital resulting from the capital increase carried out for that purpose. For U.S. GAAP purposes, the goodwill of this particular operation was amortized on a straight-line basis until December 31, 2001 (as stated in SFAS 142 goodwill should no longer be amortized).
The total goodwill related to our participation in Banesto, was adjusted as the Bank sold in November 2002 its preemptive rights on the capital increase operation of Banesto (see note 3). This particular adjustment corrects downward the Spanish GAAP profit on the sale of the preemtive rights, as the goodwill of Banesto under U.S. GAAP was bigger than under Spanish GAAP.
To determine fair values we used quoted market prices were possible. Other valuation techniques used were external appraisal and present value of future cash flows. To value our Mexican reporting unit we use the value of the agreement reached with Bank of America Corporation (see note 3).
As result of the impairment test, losses of €426,133 thousand euros were recognized. Significant amounts comes from:
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Had the Group been required to adopt SFAS 142 in pior years, reported Net income and Earnings per share would have been as follows:
H) REVALUATION OF PREMISES AND EQUIPMENT
Certain Spanish consolidated companies revalued in 1996 the cost and accumulated depreciation of premises and equipment following the relevant legislation. In addition, the premises and equipment of certain foreign companies have been restated pursuant to legislation enacted in their respective countries.
In 1999, this adjustment increased its effect on stockholders’ equity because in the Spanish GAAP books, the premises of former BCH were restated and it shouldn’t be under U.S. GAAP. The restatement of this premises comes from 1996 as the Spanish legislation permitted it and from the merger of Banco Central and Banco Hispanoamericano to create the BCH Group. After such restatement, an equivalent amount (€459,330 thousand) was deducted from Goodwill and allocated to premises and equipment (see note G) above). The effect of the revaluation of Banco Santander’s premises and equipment by €339,842 thousand, due to the merger (under Spanish GAAP) of Banco Santander and Banco Central Hispanoamericano also increased the adjustment in that year.
In summary, the adjustment to Stockholders’ Equity reflects the reversal of all unamortized revaluation surpluses. The adjustment to net income reflects the reversal of the additional depreciation on the revalued premises and equipment, net of the corresponding tax benefit attributable to such depreciation. The related deferred tax asset is being recorded in income in the years in which the relevant deductions are allowed for income tax purposes.
I) RESULTS ON TRANSACTIONS WITH PARENT COMPANY SHARES AND EMPLOYEE AND OTHER THIRD PARTY LOANS
Gains and losses from treasury stock have been reclassified from Net income to Other Stockholders’ Equity for U.S. GAAP purposes. Loans granted to the stockholders, employees and other third parties for the acquisition of the Bank shares have also been recorded as a reduction of Stockholders’ Equity.
J) PENSION PLAN
In 1991, the Group recalculated its actuarial liability for past service by changing certain assumptions. Gains and losses derived from this recalculation were covered with charges to reserves. SFAS No. 87 “Employers’ Accounting for Pensions” addressed that a net gain or loss arising from a change in actuarial assumptions should be amortized by the straight-line method, with charges to income, for a period not to exceed the average remaining service period of active employees or the average remaining life expectancy of retired employees.
Adjustments to net income for the years 2002, 2001 and 2000 relate primarily to the amortization of such gains and losses and the recognition of prepaid income taxes derived from pension plan liabilities. After such adjustments, unamortized net losses amounted to €55,227, €73,624 and €92,021 thousand in 2002, 2001 and 2000 respectively and are being amortized over a period of 15 years ending in 2005.
The Group has no significant post-retirement benefit obligations to its employees other than the pension commitments.
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K) GENERAL RISK ALLOWANCE
The Group recorded allowances amounting to €132,223 thousand to cover non-specific banking risks. Under U.S. GAAP, such allowances are not permitted. Therefore, the allowance is reversed with an adjustment to Stockholders’ Equity. Its balance has not change in past years.
L) EARLY RETIREMENTS
As explained in Note 2.j, in accordance to with Rule 13.4 of Bank of Spain Circular 4/1991 and with the authorization from the Bank of Spain, in 2002, 2001 and 2000 Santander Central Hispano, Banesto and Santander Consumer Finance, S.A. (formerly HBF Banco Financiero, S.A.) offered certain employees the possibility of taking early retirement before the age stipulated in the current collective labor agreement.
The total allowance created was €1,395,603, €695,845 and €763,818 thousand in 2002, 2001 and 2000 respectively, and was created against reserves and net income. The amount created against the reserves of each entity was €856,431, €452,298 and €496,480 thousand and generated deferred tax assets of €461,159, €243,547 and €267,338. In addition, the 1999 allowance was revised in year 2000 against reserves by €32,687 thousand.
Under U.S. GAAP, the costs incurred for early retirements should be recognized in net income. Therefore, each year the net charges to reserves are reversed recognizing the loss in net income and, were necessary the allocation to minority interest is done. No adjustment is needed for the tax effect of this allowance as it is already registered in “Other Assets – Prepaid Taxes” (see note 22).
Also U.S. GAAP requires the liability and the loss should be recognized when the employee accepts the offer and it can be reasonably estimated.
M) VALUATION OF DERIVATIVE INSTRUMENTS
Only for reconciliation between Spanish and U.S. GAAP purposes, the Group adopted SFAS 133 on January 1, 2001.
In order to conform to U.S. GAAP:
The transition adjustment as of January 1, 2001 increased net income by €132,409 thousand (net of related income taxes of €71,292 thousand), and an increase in equity (Other Comprehensive Income) of €60,191 thousand (net of taxes).
For more information about derivatives, see notes 23 and 27.5.F.
N) SALE OF PREEMPTIVE RIGHTS ON BANESTO SHARES
In 1998 the Bank launched a tender offer to purchase shares of Banesto. To finance that purchase it makes a capital increase.
The Bank, with authorization of Bank of Spain, immediately netted the goodwill arisen in the purchase from the additional paid-in capital resulting from the capital increase. The authorization of bank of Spain was conditioned to restore the reserves used if the Bank sells its stake in Banesto.
Under U.S. GAAP this goodwill wasn’t netted. Instead it was amortized with charge to net income by €127 millions a year, until SFAS No. 142 became effective (see note G above).
In November 2002 Banesto makes a capital increase which was not subscribed by the Bank. Instead the Bank sold its preemptive rights to the new shareholders, making a profit. Following the agreement with Bank of Spain, the Bank restores reserves by €271,805 thousand that were not included in Net Income.
The adjustment to U.S. GAAP recognizes the profit in Net Income.
Spanish and U.S. GAAP profit on the sale of the preemptive rights were different. See in note 27.2.g) above the related goodwill adjustment.
O) INCOME TAXES (SFAS NO. 109)
The previous adjustments to net income and Stockholders’ Equity do not include their related effects on corporate income tax, except for the adjustment mentioned in L), which are disclosed under “Cumulative tax effect of adjustments” item on the reconciliation statements.
As described in Note 2.n, under Spanish GAAP, only the timing differences arising from the recording of the non-specific banking risks allowance and those which have a specific reversal period of less than 10 years have been recorded. Of these, the timing differences originated by the non-specific banking risks allowance, amounting to €46,278 thousand, has been reversed (the above mentioned allowance is reversed in item K in the stockholder’s equity reconciliation). All other timing differences are deemed to be permanent differences for all purposes.
In addition to the aforementioned timing differences recorded under Spanish GAAP, as a result of application of SFAS No. 109, the Group has recorded deferred tax assets of €34,619, €47,480 and €74,916 thousand in 2002, 2001 and 2000, and deferred tax liabilities of €488,360, €1,322,040 and €2,414,440 thousand in 2002, 2001 and 2000 arising form valuation of
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investment securities adjustment in Spanish to U.S. GAAP reconciliation. Additionally, a valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized.
A reconciliation of the Group’s effective income tax expense to the Spanish statutory income tax expense has been disclosed in Note 22.
Following is a summary of the deferred tax assets and liabilities that should be recorded under SFAS No. 109, in addition to timing differences recorded under Spanish GAAP:
P) OTHER COMPREHENSIVE INCOME (SFAS 130)
SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The objective of the statement is to report a measure of all changes in Stockholders’ Equity that result from transactions and other economic events of the period from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
The accumulated balances of other comprehensive income for the years ended December 31, 2002, 2001 and 2000 were as follows:
The main reason for the reduction in year 2002 is the devaluation of Brazilian real and the reduction in unrealized gains on securities due to the market downturn.
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Taxes allocated to each component of other comprehensive income in 2002, 2001 and 2000 were as follows:
Foreign currency translation adjustment includes in 2002 the effect of the devaluation of the Brazilian real, and in 2001 the effect of the devaluation of the Argentinean peso. During 2002 the Group reduces significantly its exposure to currency changes thought the payment of dividends from operating entities and the hedging with derivatives products.
Net Gain on Derivatives: 2001 was the first year in which SFAS 133 Accounting for Derivative Instruments and Hedging Activities is effective.
Unrealized gains on securities: In 2002 the Group made some important divestments: 3% of Royal Bank of Scotland, 25,4% of Grupo Financiero Bital, 24,5% of Vallehermoso and 1,5% of Societe Generale. The reduction in unrealized gains also comes from the downturn of stock markets. The most important effect comes form our holding in Vodafone which losses 41% of its value (37% due to stock price and the rest due to the devaluation of the Sterling Pound against Euro).
In 2001, the Other Comprehensive Income was negative due to both the reductions of the unrealized gains on our holding in Vodafone and to some divestments:
In 2000, our holding of Royal Bank of Scotland common stock was the main source of the gains on securities: €2,434,790 thousand of which €384,095 thousand were realized and included in net income. At the end of year 2000 the total unrealized gain on this holding amounts €3,289,652 thousand (this unrealized gain is calculated under U.S. GAAP, the unrealized gain under Spanish GAAP is smaller as this holding is accounted by the equity method).
Also in 2000, taxes allocated to unrealized gains on securities include the impact of changes in tax legislation. In June 2000, the Royal Decree Law 3/2000, introduced a modification to requirements of a tax exemption clause on common stock holdings of non-Spanish companies by Spanish special legal vehicles (Known in Spain as ETV or “Empresas tenedoras de Valores”). The modified tax legislation exempts from tax payments the gains on these holdings if they are at least one year old. As a result, some of the taxes allocated to unrealized gains on securities in previous years were reversed from Accumulated Other Comprehensive Income.
Q) RECENT PRONOUNCEMENTS
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27. 3. Significant presentation differences between Spanish and U.S. GAAP
In addition to the differences in valuation and income recognition principles disclosed in Note 27.1, other differences relating to the financial statements presentation exist between Spanish and U.S. GAAP presentation following the formatting guidelines in Regulation S-X of the Securities and Exchange Commission of the United States. Although these differences do not cause differences between Spanish and U.S. GAAP reported net income and/or Stockholders’ Equity, it may be useful to understand them to better interpret the Group’s financial statements presented in accordance with U.S. GAAP. Following is a summary of the significant classification differences that pertain to the basic financial statements.
BALANCE SHEET-
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27.4. Consolidated Financial Statements
Following are the consolidated balance sheets and consolidated statements of income of the Group under Spanish GAAP reformatted to conform to the presentation guidelines for bank holding companies set forth in Regulation S-X of the Securities and Exchange Commission of the United States of America.
The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts and allocations of assets and liabilities and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates but any differences should not be material.
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (NOTES 1, 20 AND 21)
CHANGES IN STOCKHOLDERS’ EQUITY
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The difference between the fair value and book value reflects the unrealized gains net of the Security Price Fluctuation Allowance recorded following Spanish GAAP valuation criteria. Following U.S. GAAP valuation criteria, book value of the available for sale portfolio would be marked to market.
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The following table shows a disclosure of unrealized gains and losses at December 31, 2002 and 2001:
Under Spanish GAAP all unrealized losses are covered with a specific allowance, provisionedagainst profit and loss account (see reconciliation item in note 27.2.e)
The following table reflects the book and fair value of the debt securities portfolio by accounting categories exclusive of the allocation of security Price Fluctuation Allowance or the allowance for credit losses:
An analysis of the book value of investments, exclusive of valuation reserves, by contractual maturity and fair value of the debt securities portfolio is shown below:
Gross gains of €6,152,621, €6,856,821 and €4,797,351 thousand and gross losses of €6,582,568, €4,819,288 and €4,936,719 thousand have been realized during 2002, 2001 and 2000 on:
the revaluation at year-end of securities included in the trading portfolio, which are included, net, under “Gains (losses) from Investment Securities” in the consolidated statement of income.
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Spanish GAAP doesn’t require classifying the entire loan to non-performing, but only the amount unpaid. For this reason, the total allowance exceeds the amount of non-performing loans.
The roll-forward of allowances is shown in note 7 under Spanish GAAP. The reconciliation item to U.S. GAAP is in note 27.2.c.
An estimate of the effect of non-performing loans - net of charge-off - on interest revenue is presented in the following table:
Interest that would have been recorded if accruing represents €55,611, €52,900 and €48,716 thousand from borrowers in Spain and €288,332, €436,320 and €408,039 thousand from borrowers outside Spain in 2002, 2001 and 2000 respectively.
For the twelve months ended December 31, 2002, 2001 and 2000, the average recorded investments in impaired loans were €1,037,525, €867,211 and €848,701 thousand from borrowers in Spain, and €3,003,459, €3,553,096 and €3,117,179 thousand from borrowers outside Spain.
A summary of significant investments in affiliated companies, together with percentage of ownership and relevant financial information is shown in Exhibit II. Aggregated summarized financial information with respect to significant affiliated companies for the year ended December 31, 2002 and as of such date is presented below:
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This short-term indebtedness is denominated in different currencies, mostly Euro, US$ and Latin-American currencies. Interest rates of these currencies have not followed the same trend.
Spanish GAAP pension allowance includes some liabilities that under U.S. GAAP are presented separately (for example annuity contracts). This different balance sheet classification does not generate a net income or stockholders’ equity variantion.
Certain personnel employed in Spain are entitled to pension benefits, in addition to Social Security provided by the State. The benefits under the plans are based primarily on years of service and a final pay formula.
Benefits for retired employees are subject to annual adjustments (see Note 2.j). Non-consolidated insurance companies administer most of the plans. The funding policy of the plan is consistent with the requirements in Spain.
Under SFAS No. 87, the actuarial assumptions considered in 2002, 2001 and 2000 for U.S. GAAP disclosure purposes are the following:
Following is a disclosure of the aggregate amount of the estimated funded status for U.S. GAAP purposes of the plans of the Bank and the Banesto Group as of December 31, 2002, 2001 and 2000 as required by SFAS 132.
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The following table shows the differences between the total commitments accrued by Spanish companies and the projected benefit obligation (PBO) under U.S. GAAP of the plans of the Bank and the Banesto Group as of December 31, 2002.
Certain Group finance entities abroad have commitments to their employees that are similar to pensions.
The technical assumptions used by these entities (interest rates, mortality tables, cumulative annual CPI, etc.) are consistent with the economic conditions prevailing in those countries.
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As of December 31, 2002 and 2001, the total commitments accrued by these foreign companies amounted to €3,002, €4,034 and €3,541 million respectively. Of these amounts, €1,390, €2,395 and €2,685 million respectively, were covered by in-house pension allowances recorded under the “Provisions for Contingencies and Expenses – Pension Allowance” caption in the consolidated balance sheets. The remaining amount was covered by policies taken out with insurance companies.
Banespa is among the foreign entities the one with the biggest pension allowances. Its pension plans have been funded since the inclusion of Banespa in the Group (the acquisition in November 2000 of Capital Stock representing 66.5% of voting rights). In April 2001, the Bank acquired through a tender offer 67% of its Capital Stock, obtaining 98.3% of its voting rights (note 3). Then a previously planned voluntary redundancy program was launched and the bank reduced its employee role by approximately a third. In the process, assets allocated to plan assets were clearly defined. Banespa has 5 different Pension plans, some of them contributory plans, which are presented separately since they are different in nature. Some of the data on these plans are:
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Banco Santander Central Hispano, Banesto and Banespa jointly account for more than 90% of the pension allowances in the Consolidated statements.
The following table presents the components of the combined net periodic pension costs for the Bank, the Banesto Group and Banespa:
The Group has no significant post-retirement benefits obligations to its employees other than the pension commitments.
F) DERIVATIVE FINANCIAL INSTRUMENTS
Accounting principles-
The Group uses derivative financial instruments for trading purposes and to hedge asset and liability exposures. Derivatives accounted for as hedging operations include instruments that meet specific criteria required by Bank of Spain regulations. Derivatives accounted for as trading operations include instruments held for trading purposes and those that do not meet Bank of Spain requirements. A full description of the principles applied by the Group in accounting for derivative financial instruments is disclosed in Note 2.l. Spanish GAAP and U.S. GAAP differ in the accounting treatment of these transactions. See note in 27.1 a summary of the accounting criteria, and in note 27.2.m the impact on the reconciliation of net income and stockholders’ equity from Spanish GAAP to U.S. GAAP.
Fair value methods-
The following methods and assumptions were used by the Group in estimating its fair value disclosures for derivative financial instruments for which it is practicable to estimate such value.
Forward purchases/sales of foreign currency
Estimated fair value of these financial instruments is based on quoted market prices.
Forward purchase/sale of government debt securities
Estimated fair value of these financial instruments is based on quoted market prices since they are mostly traded in organized markets. On the other hand, the maturity of these operations is generally under fifteen days. Accordingly, no material unrecognized gains or losses can be found at closing.
Options and financial futures
Derivatives traded in organized markets are valued using the mark to market method so the fair value is based on quoted market prices.
For options and futures traded in OTC markets (mainly currency options), the fair value is estimated based on theoretical year-end closing prices. These year-end closing prices are calculated estimating the amounts the Group would receive or pay based upon the yield curve prevailing at year-end or prices.
As indicated above, the possible losses arising from the valuation of unhedged transactions are recognized by the Group and are recorded against income.
Forward rate agreements and interest rate swaps
Fair values of these contracts are estimated based on the discounted future cash flows related to the interest rates to be collected or paid, using for this purpose the yield curve prevailing at year-end.
The potential losses are recorded following the same procedure established for other OTC derivatives, which were described above.
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The disclosure of the notional principal amounts of the derivatives of the Group by trading or hedging operationsunder Spanish GAAP is as follows:
The aggregate credit exposure of each category of derivative financial instruments held by the Group is shown below:
The following table shows for each type of instrument in the trading derivative portfolio the year-end carrying amount, the average fair value during the year and the year-end fair value for the years 2002 and 2001:
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Other information-
The Group manages its exposures to market movements by modifying the asset and liability mix, either directly or through the use of derivative financial products including interest rate swaps, equity swaps, futures, forwards, purchased option positions (interest rate caps, floors, and collars) and foreign exchange contracts.
In the Group the use of derivatives for trading purposes is subject to limits clearly defined (trader, entity, business segment, country, etc.) and controlled using Value at Risk (VaR) methodology. Derivatives are also used for hedging purposes when a reduction of risk is desired. To qualify as an accounting hedge, the hedge relationship should be documented detailing the exposure to be hedged and the financial instrument that reduce the risk. The effectiveness of the hedging relationship should be tested.
Effective January 1, 2001 U.S. GAAP adopted SFAS 133 “Accounting for Derivative Instruments and Hedging Activities”, while Spanish GAAP keep unchanged. Differences affect especially the accounting of hedging derivatives, both on the criteria to qualify as a hedge and on its valuation (see note 27.1). The Group adopted SFAS 133 only for reconciliation of Stockholders’ equity and Net income purposes, but keeps its accounting records under Spanish GAAP.
To calculate the reconciliation item to U.S. GAAP, the following changes are made:
Since designation of derivative transactions as hedging or trading differs between Spanish and U.S. GAAP, we make these adjustments each time reconciliation to U.S. GAAP is calculated. The following table shows these adjustments and their change during the year:
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The transition impact of SFAS 133 was a credit of €60.2 million on Accumulated Other Comprehensive Income and an increase of net income of €132.4 million (an increase of €192.6 million in Stockholder’s equity). The positive effect on net income was reduced to €68.2 millions for the whole year 2001, and to a debit of €21.9 million on Accumulated Other Comprehensive Income (a net increase of €46.3 million in Stockholder’s equity).
G) FAIR VALUE OF FINANCIAL INSTRUMENTS
As required by SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”, the Group has estimated and disclosed the fair value information about financial instruments for which it is practicable to estimate that value. Fair value of a financial instrument is the amount for which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value is best determined by values quoted through active trading markets. Active trading markets are characterized by numerous transactions of similar financial instruments between willing buyers and willing sellers. Because no active trading market exists for various types of financial instruments, many of the fair values disclosed were derived using present value estimates or other valuation techniques. Therefore, the Group’s ability to actually realize these derived values cannot be assured.
The estimated fair values disclosed under SFAS No. 107 may vary significantly between institutions based on the estimates and assumptions used in the various valuations methods. Additionally SFAS No. 107 disclosures exclude goodwill, non-financial assets such as real state as well as certain financial instruments such as leases. Accordingly, the aggregate estimate fair values presented in the following tables do not represent the market value of the whole Group.
The following table presents the carrying value and fair value of the Group’s financial instruments as of December 31, 2002 and 2001:
Unused credit facilities granted to third parties are indexed to market interest rates at the moment of disposal, or to fixed interest rates well above the market (mostly credit cards). The positive fair value of them is not material.
The Group has used the following methods and assumptions in estimating its fair value disclosures for financial instruments for which it is practicable to estimate such value:
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Debt securities:
Listed securities: fair values are based on year-end quoted market prices.
Unlisted securities: fair values are estimated on the basis of quoted market prices of other listed debt securities of similar interest rate, credit risk and maturity. If no similar listed debt securities can be identified, the fair value is estimated by discounting future cash-flows using year-end rates based on market rates available on securities with similar credit and maturity characteristics of the Group’s.
Equity securities:
Listed securities with less than 3% ownership: fair values are based on year-end quoted market price.
Unlisted securities: fair values are determined based on the underlying book value of the investment considering latest investee’s financial statements (in some cases unaudited) and other information available.
Loans and leases
The fair values of the loan portfolio have been estimated as follows:
Deposits and short-term borrowings
For financial instruments maturing within three months, the carrying amount is a reasonable estimate of fair value. For financial instruments maturing in over three months, the fair value is estimated by discounting the expected future cash flows using rates currently offered for deposits of similar remaining maturities.
Long-term debt
Listed debentures: Fair values are based on year-end quoted market prices.
Unlisted debentures: Fair value is estimated by discounting the future cash flows over the remaining term to maturity of such debt. Discount rates are determined based on market rates available at year-end on securities with similar credit and maturity characteristics within the Group’s portfolio.
These segments are defined by management, and reflect the way business is conducted. Except for the Corporate Centrer, each business segment has an executive manager responsible for its performance. All financial information related to business segments is presented under Spanish GAAP.
The segregation of each of these areas is based on the financial statements of the different legally incorporated units. In all cases, the financial statements are adapted to Spanish regulations, reflecting both the adjustments for homogenization and/or the applicable consolidation adjustments.
The goodwill originated from all different investments made by the Group, as well as its amortization, is allocated to Corporate Center. The decisions related to acquisitions and prices offered in these purchases are taken in a centralized way. The others business segments present its net income without any charge derived from Goodwill and its performance is evaluated by management without any goodwill allocation.
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The criteria for the allocation of capital was changed from past years in order to be able to compare the returns on the different businesses. All the areas have been assigned the minimum regulatory capital for risk assets, except for two: Corporate Banking and Commercial Banking Latin America. Experience has shown that economic risk in Corporate Banking is lower than its regulatory risk weighting and it consumes less capital than assigned, while in Latin America it is higher. Management considers that it is therefore advisable to weight the regulatory capital for Corporate Banking downward (50%) and upward (50%) in Latin America. The Group’s institutional costs, traditionally in the Corporate Center, have been distributed among all businesses. The rest of costs attributed to support and control services continue to be distributed in accordance with the Group’s traditional criteria.
The 2001 and 2000 figures have been adjusted to apply the same management control criteria by business area adopted in 2002, following completion of the integration process. They also include changes, of little significance, to the consolidation perimeter and contain activity allocations to the business areas. These adjustments were made to facilitate year-on-year comparisons on a like-for-like basis of business area performance.
The business areas’ new definition and content are now as follows:
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