SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 20-F
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 Act None.(Title of Class)The number of outstanding shares of each class of Stock of Banco Santander Central Hispano, S.A. at December 31, 2003 was:Shares par value Euro 0.50 each: 4,768,402,943
BANCO SANTANDER CENTRAL HISPANO, S.A.
TABLE OF CONTENTS
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PRESENTATION OF FINANCIAL AND OTHER INFORMATION
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 have treated 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. 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.
Conversion to Euros
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.
Accounting Principles
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 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 goodwil l 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.
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The following table compares net attributable income between our consolidated financial statements included in this annual report and our Spanish statutory financial statements:
General Information
Our consolidated financial statements are in Euros, which are denoted “euro”, “euros”, EUR or “€” throughout this annual report. Also, throughout this annual report, when we refer to:
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 non-performing assets, we mean non-performing loans, securities and other assets to collect.
When we refer to the allowances for credit-losses, we mean the specific allowances for credit-losses and the general allowance for credit-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 Credit-Losses and Country-Risk Requirements”.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
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:
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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PART I
Item 1. Identity of Directors, Senior Management and Advisers
A. Directors and Senior Management.
Not applicable.
B. Advisers.
C. Auditors.
Item 2. Offer Statistics and Expected Timetable
A. Offer Statistics.
B. Method and Expected Timetable.
Item 3. Key Information
A. Selected financial data.
Selected Consolidated Financial Information
We have selected the following financial information from our consolidated financial statements. You should read this information in connection with, and it is qualified in its entirety by reference to, our consolidated financial statements.
We 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 year ended December 31, 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, 2002 and 2003. 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 2003, 2002 and 2001 are presented. Audited Financial Statements for the years 2000 and 1999 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 net income, stockholders’ equity, total assets and certain ratios on U.S. GAAP basis.
Exchange Rates
Fluctuations in the exchange rate between euros and dollars have affected the dollar equivalent of the share prices on Spanish Stock Exchanges and, as a result, are likely to affect the dollar market price of our American Depositary Shares, or ADSs, in the United States. In addition, dividends paid to the depositary of the ADSs are denominated in euros and fluctuations in the exchange rate affect the dollar conversion by the depositary of cash dividends paid on the shares to the holders of the ADSs. Fluctuations in the exchange rate of euros against other currencies may also affect the euro value of non-euro denominated assets, liabilities, earnings and expenses of Banco Santander Central Hispano.
Beginning January 1, 2002, most of the participating European Union member states, such as Spain, issued new euro-denominated bills and coins for use in cash transactions and withdrew the bills and coins denominated in their respective currencies.
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The following tables set forth, for the periods and dates indicated, certain information concerning the exchange rate for euros and dollars (expressed in dollars per euro), based on the Noon Buying Rate as announced by the Federal Reserve Bank of New York for the dates and periods indicated.
On July 12, 2004, the exchange rate for euros and dollars (expressed in dollars per euro), based on the Noon Buying Rate, was $1.2409.
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 “Consolidated Balance Sheet Data” in Item 3. “Key Information—A. Selected Financial Data.”
Not Applicable.
Risks Relating to Our Operations
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, 2003, 61.4% of our loans were made to Spanish resident borrowers and 17.3% 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.”
Some of our business is cyclical and our income may decrease when demand for certain products or services is in a down cycle.
The level of income we derive from certain of our products and services depends on the strength of the economies in the regions where we operate and certain market trends prevailing in those areas. While we attempt to diversify our businesses, negative cycles may adversely affect our income in the future.
Different disclosures and accounting principles between Spain and the U.S. may provide you with different or less information about us than you expect.
There may be less publicly available information about us than is regularly published about companies in the United States. While we are subject to the periodic reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”), the disclosure required from foreign issuers under the Exchange Act is more limited than the disclosure required from U.S. issuers. Additionally, we present our financial statements under Spanish GAAP which differs from US GAAP. See note 27 to our consolidated financial statements.
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Since our principal source of funds is short term deposits, a sudden shortage of these funds could increase our cost of funding.
Historically, our principal sources of funds have been customer deposits (savings, demand and time deposits). At December 31, 2003, 14.5% of these customer deposits are time deposits in amounts greater than $100,000. Time deposits have represented 57.8%, 59.5% and 51.7% of total customer deposits at the end of 2001, 2002 and 2003, 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 liquidating certain assets.
A substantial percentage of our customer base is particularly sensitive to adverse developments in the economy.
Medium- and small-size companies and middle and lower-middle income individuals can be more adversely affected by adverse developments in the economy than large companies and high income individuals. As a result, our substantial lending to these segments of our existing and targeted customer base causes us to assume a relatively higher degree of risk than if we focused more heavily on the other, more economically stable groups.
Increased competition in the countries where we operate may adversely affect our growth prospects and operations.
Most of the financial systems in which we operate are highly competitive. Recent financial sector reforms in the markets in which we operate have increased competition among both local and foreign financial institutions, and we believe that this trend will continue. In particular, price competition in Europe 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.
Volatility in interest rates may negatively affect our net interest income and increase our non-performing loan portfolio.
Changes in market interest rates could affect the interest rates charged on 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.
Foreign exchange rate fluctuations may negatively affect our earnings and the value of our assets and shares.
Fluctuations in the exchange rate between the euro and the U.S. dollar will affect the U.S. dollar equivalent of the price of our securities on the stock exchanges in which our shares and ADRs are traded. These fluctuations will also affect the conversion to U.S. dollars of cash dividends paid in euros on our shares.
In the ordinary course of our business, we have a percentage of our assets and liabilities denominated in currencies other than the euro. Fluctuations in the value of the euro against other currencies may adversely affect our profitability. For example, the appreciation of the euro against some Latin American currencies and the U.S. dollar will depress earnings from our Latin American operations. 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.
Changes in the regulatory framework in the jurisdictions where we operate could adversely affect our business.
A number of banking regulations designed to maintain the safety and soundness of banks and limit their exposure to risk apply in the different jurisdictions in which our subsidiaries operate. Changes in regulations, which are beyond our control, may have a material effect on our business and operations. As some of the banking laws and regulations have been recently adopted, the manner in which those laws and related regulations are applied to the operations of financial institutions is still evolving. Moreover, no assurance can be given generally that laws or regulations will be adopted, enforced or interpreted in a manner that will not have an adverse affect on our business.
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Our recent and future acquisitions and strategic partnerships may be disruptive.
We have acquired controlling interests in various companies and have 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 have 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.
Risks Relating to Latin America
Our Latin American subsidiaries’ growth, asset quality and profitability may be adversely affected by volatile macroeconomic conditions.
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 Retail Banking, Asset Management and Private Banking and Global Wholesale Banking) accounted for €1,318.5 million of our net attributable income for the year ended December 31, 2003 (a decrease of 4.6% from €1,382.7 million for the year ended December 31, 2002). (This figure does not include goodwill amortization of €1,979.8 million and €1,043.2 million and financing costs of €542.3 and €756.9 million -taking into account the euro long-term interest rate, net of taxes- at December 31, 20 03 and 2002, respectively). Negative and fluctuating economic conditions, such as a changing interest rate environment, impact our profitability by causing lending margins to decrease and leading to decreased demand for higher margin products and services.
Significant competition in some Latin American countries could intensify price competition and limit our ability to increase our market share in those markets.
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 are exposed to foreign exchange and, in some instances, political risks as well as other geographical risks related to the Latin American countries in which we operate, which could cause an adverse impact on our business.
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.
Latin American economies can be directly and negatively affected by adverse developments in other countries.
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.
Our subsidiaries in Argentina may be adversely affected by the current economic condition in Argentina.
At the end of 2001, Argentina suffered a deep political crisis that had at its roots the economic and social deterioration produced by four years of negative economic growth. Over a period of six weeks, four different presidents took office and subsequently resigned. Argentina imposed severe economic restrictions including (i) suspending payments on Argentina’s external debt; (ii) abrogating the convertibility of the Argentine peso; (iii) converting domestic U.S. dollar denominated bank-deposits into Argentine peso (ARP)-denominated deposits at an exchange rate of ARP1.40 per $1.00; (iv) converting domestic 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
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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 caused increased inflation, a volatile exchange rate and reduced economic activity as well as a deterioration of the liquidity, solvency and profitability of the Argentine financial system.
Although many of these restrictions have since been eliminated or relaxed, 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 Note 1 to our financial statements for a description of the accounting treatments given to this risk).
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, 2003, the special reserve amounted to €852.0 million and covered in full the net book value of and the 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. Goodwill was fully written off in 2003 with a charge to the special reserve.
Since 2002, a large number of cases has been brought in Argentine courts challenging the constitutionality of the required conversion of U.S. dollar denominated bank-deposits into ARP-denominated deposits and demanding the return of deposits in dollars or in pesos at the prevailing exchange rate at the time of payment. In at least one case, the Argentine Supreme Court stuck down the mandatory conversion to pesos of U.S. dollar deposits. This decision created uncertainty for the Argentine banking system as a whole and raises the possibility that a large number of depositors may seek to withdraw all of their deposits and convert their pesos into dollars in the future. If this happens, the Argentine government may be required to provide additional financial assistance to banks. If it is unable to provide this assistance and these withdrawals are significant, this could lead to the collapse of one or more large banks or even the Argentine financial system.
Throughout 2003, Argentina began to recover from the profound crisis that began at the end of 2001. The severe devaluation of the peso permitted the expansion of exporting activity and the decrease of imports. The manufacturing and construction industries have driven gross development product (“GDP”) growth of 8.7% in 2003. As a result of this recovery, inflation stabilized, at only 3.7% year-on-year in December 2003. In the currency markets, the peso appreciated relative to the U.S. dollar, in the context of the global downward trend of the U.S. dollar. In the political arena, the rise of President-elect Néstor Kirchner in May 2003 and the consolidation of his position throughout the year has led to a stabilized government which did not exist during the crisis. At the end of 2003, Kirchner’s political party, the Justicialismo, maintained a majority in both houses of Congress, and held the majority of the provincial governships.
Although general economic conditions have shown improvement and political protests and social disturbances have diminished considerably in 2003, the rapid and radical nature of the changes in the Argentine social, political, economic and legal environment and the absence of a clear political consensus in favor of any particular set of economic policies have given rise to significant uncertainties about the country’s economic and political future. It is currently unclear whether the economic and political instability experienced over the past few years will continue and it is possible that, despite recent economic growth, Argentina may return to a deeper recession, higher inflation and unemployment and greater social unrest. If this instability continues, there could be a material adverse effect on our business, financial condition or results of our operations in the country, or with other counterparties located in the country.
Further, the Argentine government is facing severe fiscal problems as a result of the devaluation of the peso. Specifically, its ability to honor its foreign debt obligations has been materially and adversely affected. It recently reached an agreement to postpone the maturity date of certain amounts of its debt owed to the International Monetary Fund, or IMF, and other international credit organizations. Due to a sustained lack of investor confidence in Argentina’s ability to make payments due on its sovereign debt and in the Argentine economy generally, Argentina’s opportunities to effectively raise capital in the international markets have been severely limited. This inability to obtain financing has and will continue to affect Argentina’s ability to implement any reforms and restore economic growth. In addition, the adoption of austere fiscal measures may be required to repay the debt and to balance the budget. These factors cou ld lead to deeper recession, higher inflation and unemployment and social unrest which would negatively affect our financial condition and results of operations.
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Item 4. Information on the Company
A. History and development of the company.
Introduction
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 Hisp ano, S.A. We are incorporated under, and governed by the laws of the Kingdom of Spain. We conduct business under the commercial name “Grupo Santander”. Our corporate offices are located in Plaza de Canalejas, 1, 28014 Madrid, Spain. Telephone: (011) 34-91-558-1111.
Principal Capital Expenditures and Divestitures
Acquisitions, Dispositions, Reorganizations
The principal holdings acquired by us in 2001, 2002 and 2003 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 in Banesto to 88.57%. As of December 31, 2003, we had an 88.60% holding in the capital stock of Banesto.
Previnter AFJP, S.A. (“Previnter”) and Orígenes AFJP, S.A. (“Orígenes”). In the first quarter of 2001, we merged Previnter and Orígenes, our two pension fund subsidiaries in Argentina. In 2003, we increased our ownership interest in Orígenes from 39.2% to 59.2%, in accordance with the agreements reached with Bank of Boston in 2000, for a total price of $150.0 million which was entirely provisioned for as of December 31, 2002 under our policy of coverage of Argentine risk.
Banco Santander Portugal, S.A. (“Banco Santander Portugal”). In 2003, we acquired a 12.74% ownership interest in the capital stock of Banco Santander Portugal for €106 million, thus increasing our holding to 97.95%.
Shinsei Bank. In 2003, we increased our holding in the capital stock of the Japanese bank Shinsei Bank from 6.5% as of December 31, 2002, to 11.4% as of December 31, 2003. The total cost of the investment at that date was approximately €144 million. Subsequently, in the first quarter of 2004, we sold 4.0% of our holding in Shinsei Bank at a capital gain of approximately €118 million. As a result, we currently hold 7.4% of the capital stock of Shinsei Bank.
Finconsumo Banca SpA (“Finconsumo”). In 2003, we resolved to acquire the remaining 50% of the capital stock of Finconsumo that we did not own and acquired 20% for €60 million in 2003 and the remaining 30% (paid in 2004) for €80 million.
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 Extraordinary Shareholders’ Meeting held on February 9, 2002. In 2002, AKB merged with CC-Bank Ag.
Banco Santiago. Under the agreements between us and the Central Bank of Chile (as the second largest shareholder of Banco Santiago), on April 17, 2002, we acquired 35.45% of the Central Bank of Chile’s holding in the capital stock of Banco Santiago for $685 million (approximately €772 million). On August 1, 2002, Banco Santiago merged into Banco Santander Chile, with retroactive effect as of January 1, 2002, after the required resolution of their respective
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Shareholders’ Meetings and approval by the Chilean regulatory authorities. The name of the post-merger entity is Banco Santander Chile.
Banco Santander Colombia. As a result of a capital increase and of certain agreements reached in prior years, in 2002, we increased our holding in the capital stock of Banco Santander Colombia by 34.32% and paid €303 million. As of December 31, 2003, we held 97.6% of the capital stock of Banco Santander Colombia.
Banco 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). In 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 98.9% holding in the capital stock of Banco Río and, as of December 31, 2003, a 99.1% holding following the conversion of the subordinated debt of Banco Río held by us into equity in 2003 .
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 in 2003 capital gains of €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. In June 2004, the shareholders of Serfin increased its capital by €163.4 million, of which we subsc ribed €122.5 million.
The sale of the 24.9% stake was completed in the first quarter of 2003. As of December 31, 2003, we had a 74.0% holding in the capital stock of Serfin.
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 Venezuela. 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, in 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, 2003 and 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).
Santander Central Hispano Previsión, S.A., de Seguros y Reaseguros (“Previsión”). In 2003, we reached an agreement for the sale of our entire investment in the capital stock of Previsión for €160 million.
Compañía Española de Petróleos, S.A. (“Cepsa”). In 2003, we launched a tender offer for up to 42,811,991 Cepsa shares. The offer was accepted by 32,461,948 shares, representing an investment by us of €909 million.
For a description of certain legal proceedings relating to the Cepsa tender offer, see “Item 8. Financial Information—A . Consolidated statements and other financial information—Legal Proceedings”.
The Royal Bank of Scotland Group, plc. (“RBS”). In 2001, we sold 1.53% of the capital stock of RBS, at a gain of approximately €400 million, thus reducing our investment in RBS to 8.03% as of December 31, 2001.
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In 2002, we made a net divestment of 3% of our holding in RBS, giving rise to gains of approximately €806 million. As of December 31, 2002, the ownership interest was 5.04%.
As of December 31, 2003, following several purchases and sales made during the year, our holding was 5.05%. The sales gave rise to gains of €217 million.
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, 2003 and 2002, we had a 23.02% and a 23.35% holding, respectively, in the capital stock of Unión Fenosa.
Grupo Financiero Bital. In 2002, we subscribed to 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 of Grupo Financiero Bital. 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.
Grupo Sacyr-Vallehermoso, S.A. (“Sacyr-Vallehermoso”). In 2002, we divested 24.5% of our holding in Sacyr-Vallehermoso (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.
San Paolo IMI, S.p.A. (“San Paolo IMI”). In 2003, we increased our holding in San Paolo IMI, from 5.2% as of December 31, 2002, to 8.6% as of December 31, 2003, with a net investment of €525 million in 2003.
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 in Vodafone realizing capital gains of €1,713 million. As of December 31, 2001, we had a 1.53% holding in Vodafone. During 2002, we reduced our stake from 1.53% to 0.97%, realizing capital gains of €274 million. In 2003, we sold 0.67% of our holding in Vodafone, realizing capital gains of €369 million.
Auna Operadores de Telecomunicaciones, S.A. (“Auna”). During 2001, we acquired 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 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% which we did in 2004. 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 an d 2003, we had a 23.49% holding in the capital stock of Auna, with an investment of €1,696 million.
In addition to expanding our existing operations, we continually review possible acquisitions of, and investments in, businesses in markets in which we believe we have particular advantages.
Capital Increases
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:
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AKB Holding Acquisition
As of December 31, 2002 and 2003, our capital stock consisted of 4,768,402,943 fully subscribed and paid shares of €0.5 par value each.
Recent Events
In February 2004, we agreed to acquire all the shares of “Polskie Towarzystwo Finansowe”, a Polish consumer finance company, for €33 million.
In March 2004, we signed an agreement with DnB NOR to acquire its consumer finance unit ELCON Finans AS, the Norwegian leading vehicle finance company, for 3.44 billion Norwegian crowns (approximately €400 million). We intend to subsequently sell ELCON's equipment leasing and factoring businesses for approximately €160 million. We are presently in negotiations with Société Générale regarding the sale of these businesses. The resulting net cost to us is an estimated €240 million, generating goodwill of €102 million.
B. Business overview.
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, 2003, we were one of the largest banking groups in the euro zone with a stock market capitalization of €44.8 billion, stockholders’ equity of €18.4 billion and total assets of €351.8 billion. We had an additional €108.9 billion in mutual funds, pension funds and other assets under management at that date. We also had 34,956 employees and 4,369 branch offices in Spain and 68,082 employees and 4,830 branches outside Spain at December 31, 2003.
Our principal operations are in Spain, Portugal, Germany, Italy 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, Puerto Rico, Uruguay and Venezuela.
Our business is divided into five principal areas:
European Retail Banking
This area covers the banking activities of the different networks and specialized units in Europe, principally with individual clients and small and medium sized companies (“SMEs”), as well as private and public institutions. During 2003 there were five units within this area: Santander Central Hispano Retail Banking, Banesto, Consumer Finance, Portugal and On-line Banking.
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Retail Banking Latin America
This area covers the universal banking activities in Latin America conducted through our subsidiary banks and finance companies.
Asset Management and Private Banking
Asset management includes pension and mutual funds and bancassurance. Private banking includes the activity carried out with clients via the specialized units in Spain and abroad.
Global Wholesale Banking:
This area covers our corporate banking activities in Spain, the rest of Europe and New York, treasury activities in Madrid and New York, as well as investment banking throughout the world.
Financial Management and Equity Stakes
This area is responsible for the centralized activities relating to strategic or temporary equity stakes in industrial and financial companies, financial management related to the structural exchange rate position, the Group’s asset and liability portfolio and management of securities issuances 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 rest of the businesses. In exceptional circumstances, it may include the launch of an activity of a strategic nature.
Our European retail banking activities include deposit taking, personal loans and consumer finance, mortgage lending, bill discounting, leasing, factoring, distribution of mutual and pension funds, life and non-life insurance distribution, credit and debit card operations, remote banking services, automobile financing and money transfers.
European Retail Banking is the largest business area of the Santander Group. Its relative share of the total business volume increased during 2003, accounting at the end of December for 52% of total customer funds, 72% of loans and 52% of net attributable income of the Group.
The area had 5,096 branches and 41,644 employees (direct and assigned) at the end of 2003.
The area experienced an 18.5% increase in net operating income, primarily due to increased revenue from commissions, lower operating costs, improved efficiency and growth in net interest income.
The efficiency ratio improved by 4.3 percentage points in 2003 from 50.0% in 2002 to 45.7%. Net attributable income increased 12.5% to €1,761.6 million. ROE was 19.5% as compared to 19.0% in 2002.
Santander Central Hispano Retail Banking
This activity is carried out through the branch network of Banco Santander Central Hispano, backed up by an increasing number of cash dispensers, savings books updaters, telephone banking services, electronic and internet banking.
At the end of 2003, we had 2,548 branches and a total of 20,747 employees of which 528 were temporary, dedicated to retail banking in Spain. Compared to 2002, there was a net increase of 42 branches and a net reduction of 520 employees.
In 2003, Santander Central Hispano Retail Banking experienced growth of approximately 20.9% in lending, 19.8% in net operating income and 17.9% in net attributable income, an improved efficiency ratio and continued high standards of quality in credit risk.
Gross operating income from Santander Central Hispano Retail Banking was €3,431.7 million in 2003, as compared to €3,249.9 million in 2002.
In 2003, net attributable income from Santander Central Hispano Retail Banking was €926.5 million, 17.9% higher than net attributable income in 2002, while the ROE reached 22.4% (21.3% in 2002) and the efficiency ratio improved to 45.4% (50.0% in 2002).
The 20.9% growth in lending came from both mortgages (+30.8%, mainly for individual customers) as well as other loans (+12.9%), leasing and renting (+21.4%) and commercial bills (+10.9%).
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The different lines of customer funds also improved during 2003, albeit with more modest rates of growth (+6.3%). Customer deposits decreased by 0.4%, while mutual and pension funds increased by 14.6% and 12.9%, respectively.
Also noteworthy was the sale of life and household insurance. The volume of insurance premiums and revenues was more than double than that in 2002.
Banesto
Banesto's income before taxes was 11.2% higher than in 2002, at €639.8 million (according to its published data excluding adjustments for capital allocation and assignation of costs). The continued high volume of business with gains in market share, development of new projects and business plans, tight control of operating costs and adequate management of customer spreads produced higher revenues.
At the end of 2003, Banesto had 1,695 branches and 9,954 employees (compared with 10,022 at the end of 2002), of which 634 employees were temporary.
In 2003, gross operating income from Banesto was €1,578.4 million, as compared to €1,481.8 million in 2002. Net attributable income from Banesto was €379.9 million, 8.3% lower than in 2002, due to increased income taxes and minority interests, while the ROE reached 15.6% (17.3% in 2002) and the efficiency ratio improved to 48.5% (51.4% in 2002).
Other significant developments were:
Portugal
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 2003, Retail Banking in Portugal operated 670 branches (compared with 659 at the end of 2002) and had 6,900 employees (compared with 7,175 at the end of 2002), of which 122 employees were temporary.
In 2003, gross operating income from our Retail Banking activities in Portugal was €852.3 million, similar to the €851.2 million in 2002. Net attributable income was €213.2 million, 11.5% higher than in 2002, while the ROE reached 16.9% (15.5% in 2002) and the efficiency ratio improved to 48.4% (49.4% in 2002).
In 2003, net attributable income from our Group in Portugal (including Retail Banking, Asset Management and Global Wholesale Banking) was €251.0 million, 12.5% higher than in 2002.
Consumer Finance in Europe
Our consumer financing activities are conducted through our subsidiary Santander Consumer Finance. Most of the activity is in auto financing, personal loans and credit cards. These consumer financing activities are mainly focused on Spain, Portugal, Germany (through CC-Bank) and Italy (through Finconsumo). We are also present (through CC-Bank Group) in Austria, Hungary, the Czech Republic and Poland.
At the end of 2003, this area had 182 branches (compared with 181 at the end of 2002) and 3,847 employees (compared with 3,908 at the end of 2002), of which 61 employees were temporary.
In 2003, this area generated gross operating income of €995.3 million, as compared to €831.9 million in 2002. Net attributable income was €259.7 million, 24.2% higher than in 2002, while the ROE reached 22.3% (24.7% in 2002) and the efficiency ratio improved to 37.6% (43.3% in 2002). (The 2002 figures include the integration of AKB).
The noteworthy developments in the main markets where we operate are the following:
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In Spain and Portugal new business increased 17.5%, net operating income increased 40.7% and the efficiency ratio improved by 7.2 percentage points to 35.1%.
In Germany, CC-Bank Group's net interest income and net operating income increased by 40.0% and 28.1%, respectively. The efficiency ratio improved from 42.9% in 2002 to 38.3% in 2003.
In Italy, Finconsumo's new business increased 14%. Gross operating income was 36.1% higher and net operating income increased 63%. The efficiency ratio improved from 48.8% to 40.3%.
At December 31, 2003, we had 3,878 offices and 52,229 employees in Retail Banking Latin America (compared with 4,021 and 52,430, respectively, at December 31, 2002), of which 722 were temporary employees. Net attributable income from Retail Banking Latin America was €1,064.5 million, 3.1% lower than in 2002, while the ROE reached 29.0% (23.0% in 2002) and the efficiency ratio increased to 54.9% (54.0% in 2002). Our total Latin America activities (including Retail Banking, Asset Management and Global Wholesale Banking) accounted for €1,318.5 million1of our net attributable income for the year ended December 31, 2003. Our Latin American banking business is principally conducted by the following banking subsidiaries:
We engage in a full range of retail banking activities in Latin America, although the range of our activities varies from country to country. We seek to take advantage of whatever particular business opportunities local conditions present. We engage in a wide array of deposit taking activities throughout Latin America, and other retail banking activities in Argentina, Brazil, Chile and Mexico. Our primary lending operations are in Mexico, Chile, Brazil and Puerto Rico. Our principal mutual fund operations are in Brazil, Mexico, Chile and Puerto Rico, and our main pension fund operations are in Chile, Mexico, Argentina, Peru and Colombia.
Our significant position in Latin America is attributable to our financial strength, high degree of diversification (by countries, businesses, products, etc), and breadth and depth of our franchise.
The size of our franchise is underscored by our strong market shares, particularly in those areas and countries of strategic significance. Our market share in South-Southeast Brazil, which is the most attractive area in this country, is close to 10%, 13.1% in Mexico, 18.5% in Chile, 12.0% in Puerto Rico and 11.7% in Venezuela.
Detailed below are the performance highlights of the main Latin American countries in which we operate:
Brazil. Santander Banespa is one of the four largest private-sector financial groups in Brazil. It has more than 1,800 branches and over 7,000 cash dispensers. Our Group, with a market share of 4%-5% for the country as a whole, focuses on the south/southeast of Brazil, the richest and most developed part of the country where close to 100 million people live and which generates almost 75% of Brazil’s GDP. Our presence is particularly significant in the states of Sao Paulo (where it has 1,500 branches) and Rio Grande do Sul.
In 2003, Santander Banespa focused on business development, capitalizing on the large number of clients after customer segmentation.
Total net attributable income from Brazil in 2003 was €701.0 million, 12.6% lower than in 2002 (+11.2% excluding the exchange rate impact). Of this amount, 88% (€615.4 million) came from retail banking. The efficiency ratio was 43.0%, ROE was 45.3%, the ratio of non-performing loans was 2.68% at the end of 2003 and coverage was 190%.
Mexico.The Santander Serfin Group is one of the leading financial services companies in Mexico. It is the third largest banking group in Mexico in terms of business volume and first in terms of profitability. It has a 14.1% market share for loans and a 13.9% market share for deposits and mutual funds. It also has a pension fund management entity, which has an 8.8% market share. After the business integration of Santander Mexicano and Serfin in the fourth quarter of 2002, the Group operated under a single brand name in 2003 (Santander Serfin). It has a network of 1,000 branches and more than 1,800 cash dispensers in 225 cities and towns.
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Net attributable income declined 40.4% (-15.0% at constant exchange rates) to €406.4 million, of which 82% was generated by retail banking. This result reflected (in the last 10 months of 2003) the sale of 24.9% of the Santander Serfin Group to Bank of America. Net income before minority interests, not affected by this sale, dropped 27.3% in euros (-1.9% at constant exchange rates). The efficiency ratio was 50.2%, the recurrence ratio (calculated as the percentage of general administrative expenses divided by net fees) was 63.4% and ROE was 31.6%. We continued to have very solid levels of asset quality, underlined by both the lowest ratio of non-performing loans (1.33% using Spanish criteria) as well as the highest coverage (284%) of Mexico’s large banks.
Chile. The Santander Chile Group is a leader in the Chilean financial services industry, both in terms of business volume as well as earnings. The Group has a market share of 20.7% in deposits and 22.6% in loans, 11.3% in pensions and 21.1% in mutual funds.
We enjoy a strong competitive advantage in Chile, with 370 branches (the largest in Chile), 1,100 cash dispensers and a wide customer base.
In 2003, Santander Chile completed its operational and technological merger. The new bank (called Santander Santiago) has focused on optimizing the business base and market shares, improving the composition of assets (with a greater emphasis on the more profitable retail segments) and customer spreads and strengthening business capacity.
Net attributable income increased 6.4% to €243.5 million (+23.4% at constant exchange rates). Retail Banking generated 82% (€199.1 million) of this income. The efficiency ratio improved by 0.6 points to 41.0%, ROE was 22.6%, the NPL ratio was 4.70% and coverage was 103%.
Puerto Rico. We are one of the three largest financial entities in Puerto Rico, with a market share of 10.2% in loans and 9.1% in deposits. We have 70 branches and 140 cash dispensers. We are also the second largest player in asset management.
In 2003, we concentrated on repositioning Banco Santander Puerto Rico in order to achieve further growth in various activities, particularly in the segment of medium-sized companies and mortgages. Another priority area is the recovery of past due loans and bad debts.
Net attributable income was €28.1 million, 132.6% higher than in 2002 (149.2% excluding the exchange rate effect). The efficiency ratio was 61.5% and the recurrence ratio 36.1%. The NPL ratio was 2.66% and coverage 96%.
Venezuela. Banco de Venezuela is the country’s second largest bank by business volume (market shares of 12.4% in deposits and 14.9% in loans) and the first in asset quality among the country’s big banks. It has 250 branches and a large customer base.
Management in Venezuela, conditioned by the recession and political uncertainty, focused in 2003 on strengthening basic revenue through growth in the business volumes of existing customers, preserving credit risk quality, implementing an active pricing policy, boosting revenue from commissions, adjusting the number of branches and employees and containing costs.
Net attributable income decreased 35.2% to €107.9 million (+6.8% eliminating the exchange rate effect). Retail banking generated 90% of net attributable income. The efficiency ratio was 43.3%, the recurrence ratio 48.6%, and ROE 36.1%.
Colombia. The improved environment in Colombia has enabled us to re-focus on selective business growth. Net income in Colombia was €24.8 million, up from €12.0 million in 2002.
Other countries
The strategic focus on Bolivia and Uruguay continued to be risk reduction, downsizing and generating liquidity.
Bolivia’s net attributable income was €8.9 million (€11.6 million in 2002) and Uruguay incurred a net loss of €37.1 million (compared to a net loss of €65.4 million in 2002).
In the fourth quarter of 2002 we sold our retail banking business in Peru and in 2003 we concentrated on pensions, where our market share is 27%. This business generated net attributable income of €19.3 million in 2003 (€29.1 million in 2002).
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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 2003, this area had 189 branches and 6,606 employees (6,149 at the end of 2002), of which 7 were temporary.
In 2003, this area generated gross operating income of €798.7 million, as compared to €869.8 million in 2002. Net attributable income was €319.6 million, 2.3% lower than in 2002 because of the impact of the depreciation of Latin American currencies.
Asset Management in Spain:Two aspects defined asset management in Spain in 2003: leadership in capturing mutual funds and growth in revenues and market shares.
We captured more than €6,000 million in net terms, leading the growth in the mutual funds sector in Spain and consolidating our leadership (market share of 28%). This increase was due primarily to the success of campaigns for innovative guaranteed funds and the strong demand for high value added products (alternative management, real estate funds and controlled risk funds). We also remained the leader in real estate funds in Spain (close to €1,900 million), with two-thirds of the market.
Asset Management in Latin America: At the end of 2003, we managed more than €24,000 million of mutual and pension funds (+14.6% because of the strong growth in local currency). This growth, together with adequate management of revenues and costs, fueled the rise in earnings in local currency, but the sharp appreciation of the average exchange rate of the euro in 2003 reduced the area’s contribution to Group income.
Private Banking: In 2003, Banco Banif consolidated the strategy implemented at the end of 2002 which enabled it to reassert its leadership of Spain’s private banking market. Its position, focused on customers with more than €150,000, is based on global advisory services (financial, asset, corporate and real estate) and launching novel and high value added products. Advice and substantial specialization in mutual funds resulted in growth of 26% in balances. The business drive increased the number of targeted customers by 15%, with growth of 20% in balances. Along with containing costs, this increased net operating income and net attributable income by more than 50%.
The main development in International Private Banking was the acquisition of the Latin American business of the private banking arm of Royal Bank of Scotland – Coutts (USA) International and Coutts Securities Inc., resulting in more clients, bankers and managed assets. Furthermore, as a result of this acquisition and the performance of the business, net operating income increased by 29% in US dollar terms (+7.5% in euros).
Insurance: In Spain, we completed a reorganization, following the increased participation in individual insurance business (our stake in Santander Central Hispano Seguros y Reaseguros increased to 100%) and the sale of the portfolio of collective life insurance in the fourth quarter of 2003. This sale allows us to focus on selling individual insurance products through our banking network, channelling the business of collective retirement savings towards employment pension plans.
In 2003, Santander Central Hispano Seguros y Reaseguros increased its premium income by 122% to €172 million. Net income doubled to €30 million and the contribution to Group earnings (including commissions paid to the distribution networks) rose 142% to €98 million.
In Latin America, our insurance business continued to generate revenues. Brazil generated a high volume of premium income (€171 million) and Mexico increased its premium income in local currency by 30%.
Global Wholesale Banking
Net attributable income was €225.6 million, 27.9% more than in 2002.
At the end of 2003, we had 36 branches and 2,288 employees (2,559 at the end of 2002), of which 3 were temporary.
Global Corporate 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 and New York and our agency in 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.
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In 2003, Global Corporate Banking continued to perform well, despite the impact of lower interest rates. On the one hand, active management of prices increased the average spread on loans in Spain by 9.3 basis points in 2003 as compared to 2002 and, on the other, cross-selling of value added products spurred recurrent revenue. This, together with tight control of costs, prudence in granting loans and reduced needs for credit loss provisions, produced double digit growth in net attributable income.
Global Investment Banking
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 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.
Global Investment Banking took advantage of the difficult situation in the markets during 2003 to reinforce its leading position in the markets where it operates, improve revenues and significantly cut costs. As a result, net operating income and net attributable income increased by almost 100%.
Santander Central Hispano Bolsa continued to be the leader in equity brokerage in Spain with a market share of 11.2% (16.3% including Banesto Bolsa). In Custody, we strengthened our leadership in three main areas: resident clients, with an improved position as the depository entity of Collective Investment Schemes, both those linked to and separate to the Group; non-residents, with significant new clients; and in services to issuers, increasing the range of products provided to these customers.
Treasury
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.
Treasury had a good year both in the professional markets and also in customer related activity, the main source of revenue for this business, with new strategies integrated into the area’s new global management model.
This area acts as the Group’s holding company, managing all capital and reserves, and assigning capital and liquidity to the rest of the Group’s businesses. It also incorporates centrally managed businesses (such as equity stakes), financial management, allowances (such as amortization of goodwill and country-risk) and businesses being launched or wound down. As a result, this area covers a wide range of centralized activities, which can be divided into three sub areas:
Gross operating income from Financial Management and Equity Stakes was €116.2 million in 2003, as compared to gross operating loss of €135.9 million in 2002. Net attributable loss was €760.4 million, 17.4% less than in 2002.
At the end of 2003, this area had 271 employees (184 at the end of 2002), of which 95 were temporary.
Equity Stakes
Alliances and Financial Investments
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:
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The Royal Bank of Scotland Group (“RBS”). We have had a strategic alliance with RBS since 1988. 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, 2003, we owned 5.05% of RBS and RBS owned 2.83% of us. We have agreed with RBS 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.
Commerzbank. At December 31, 2003, we owned 3.38% of Commerzbank.
San Paolo-IMI. At December 31, 2003, we owned 8.60% 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.
Banque Commerciale du Maroc. At December 31, 2003, we had a 20.39% 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.
Industrial Portfolio
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, 2003:
In 2003, 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, 2003, the unrealized capital gains of Equity Stakes were estimated at €3,600.0 million.
Total Revenues by Activity and Geographic Location
For a breakdown of our total revenues by category of activity and geographic market please see note 27 of our Consolidated Financial Statements.
Selected Statistical Information
The following tables show our selected statistical information.
Average Balance Sheets and Interest Rates
The following tables show, by domicile of customer, our average balances and interest rates for each of the past three years.
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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Changes in Net Interest Income—Volume and Rate Analysis
The following tables allocate, by domicile of customer, changes in our net interest income between changes in average volume and changes in average rate for 2002 compared to 2001 and 2003 compared to 2002. We have calculated volume variances based on movements in average balances over the period and rate variance based on changes in interest rates on average interest-earning assets and average interest-bearing liabilities. We have allocated variances caused by changes in both volume and rate to volume. You should read the following tables and the footnotes thereto in light of our observations noted in the preceding sub-section entitled “Average Balance Sheets and Interest Rates”, and the footnotes thereto.
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Assets
Earning Assets—Yield Spread
The following table analyzes, by domicile of customer, our average earning assets, interest income and dividends on equity securities and net interest income and shows gross yields, net yields and yield spread for each of the years indicated. You should read this table and the footnotes thereto in light of our observations noted in the preceding subsection entitled “Average Balance Sheets and Interest Rates”, and the footnotes thereto.
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Return on Equity and Assets
The following table presents our selected financial ratios for the years indicated.
Interest-Earning Assets
The following table shows, by domicile of customer, the percentage mix of our average interest-earning assets for the years indicated. You should read this table in light of our observations noted in the preceding sub-section entitled “Average Balance Sheets and Interest Rates”, and the footnotes thereto.
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Due from Credit Institutions
The following table shows our short-term funds deposited with other banks at each of the dates indicated.
Investment Securities
At December 31, 2003, the book value of our investment securities was €85.4 billion (representing 24.3% of our total assets). These investment securities had a yield of 4.81% in 2003, compared with a yield of 7.16% earned during 2002. €31.1 billion, or 36.4%, of our investment securities consisted of Spanish Government and government agency securities, 6.1% of which consisted of Spanish Treasury bills that had a yield of 2.1% in 2003. For a discussion of how we value our investment securities, see note 2(d) to our consolidated financial statements.
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The following table shows the book values of our investment securities by type and domicile of counterparty at each of the dates indicated.
The following table analyzes the aggregate book value and aggregate market value of the securities of single issuers, other than the Government of the United States, that exceeded 10% of our stockholders’ equity as of December 31, 2003.
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The following table analyzes the maturities and weighted average yields of our debt investment securities (before allowances for credit losses and allowances for security price fluctuations) at December 31, 2003. 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, 2003, our total loans and credits equaled €177.6 billion (50.5% of our total assets). Net of allowances for credit losses, loans and credits equaled €172.5 billion (49.0% of our total assets). In addition to loans, we had outstanding at December 31, 1999, 2000, 2001, 2002 and 2003, €44.2 billion, €54.3 billion, €49.6 billion, €49.1 billion and €48.6 billion of undrawn balances available to third parties.
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Loans by Geographic Area and Type of Customer
The following table analyzes our customer loans and credits (including securities purchased under agreement to resell), by domicile and type of customer, at each of the dates indicated.
At December 31, 2003, our loans and credits to unconsolidated subsidiaries and associated companies amounted to €1,445.5 million (See “Item 7 — Major Shareholders and Related Party Transactions — B. Related Party Transactions”). Excluding government-related loans and credits, the largest outstanding exposure at December 31, 2003 was €1.6 billion (0.9% of total loans and credits, including government-related loans), and the five next largest exposures totaled €5.0 billion (2.8% of total loans, including government-related loans).
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Maturity
The following table sets forth an analysis by maturity of our loans and credits by domicile and type of customer at December 31, 2003.
Fixed and Variable Rate Loans
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, 2003.
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Cross-Border Outstandings
The following table sets forth, as of the end of the years indicated, the aggregate amount of our cross-border outstandings (which consist of loans, interest-bearing deposits with other banks, acceptances and other monetary assets denominated in a currency other than the home-country currency of the office where the item is booked) where outstandings in the borrower’s country exceeded 0.75% of our total assets. Cross-border outstandings do not include local currency loans made by subsidiary banks in other countries to the extent that such loans are funded in the local currency or hedged. As a result, they do not include the vast majority of the loans by our Latin American subsidiaries.
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The following table sets forth the amounts of our cross-border outstandings as of December 31 of each year by type of borrower where outstandings in the borrower’s country exceeded 0.75% of total assets.
Classified Assets
In the following pages, we describe Bank of Spain requirements for classification of non-performing assets and credit loss recognition. Unlike under U.S. GAAP, Spanish GAAP establishes a credit loss recognition process that is independent of the process for balance sheet classification and removal of impaired loans from the balance sheet. In Note 27 to our consolidated financial statements, we include a summary of significant valuation and income recognition differences under Spanish and U.S. GAAP and a net income and stockholders’ equity reconciliation.
Bank of Spain Classification Requirements
Non-Performing Assets
Non-Performing Past-Due Assets. The Bank of Spain requires Spanish banks to classify as non-performing certain amounts of any loan, fixed-income security, guarantee and certain other extensions of credit on which any payment of principal or interest is 90 days or more past due (“non-performing past-due assets”). Banks must classify as non-performing the portion of any principal of or accrued interest on such asset that is 90 days or more past due until (1) this amount is more than 25% of the outstanding balance of the asset or (2) any installment of principal or interest is 12 months or more past due (6 months in case of loans to individuals not for purposes of financing business activities). When either of these conditions is met, banks must classify the entire outstanding principal of and accrued interest on the asset as non-performing. Accordingly, prior to the time that one of these conditions is met, a loan may be classified as non-performing with respect to a portion of its outstanding principal and interest, but performing with respect to the remainder of its principal and interest.
In relation with the aggregate risk exposure (including off-balance sheet risks) to a single obligor, if the amount of non-performing balances exceeds 25% of the total outstanding risks (excluding non-accrued interest on loans to such borrower), then the bank must classify all outstanding risks to such borrower as non-performing.
Once any portion of a loan is classified as non-performing, the entire loan is placed on a non-accrual status. Accordingly, even the portion of such a loan which is identified as performing will be on 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
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Spain also requires Spanish banks to classify as non-performing the entire outstanding principal of and accrued interest on any extension of credit to category 5 (very doubtful) countries or residents of category 5 countries to the extent it is not otherwise classified as non-performing. See “Country-Risk Outstandings”.
Once any of such assets is classified as non-performing, it is placed on a non-accrual status.
These classification criteria differ from U.S. GAAP requirements. For an estimation of the amounts to be classified as non-performing under U.S. GAAP see Note 15 to the Selected Consolidated Financial Information table in this report.
Country-Risk Outstandings
The Bank of Spain requires Spanish banks to classify as country-risk outstandings all loans, fixed-income securities and other outstandings to any countries, or residents of countries, that the Bank of Spain has identified as being subject to transfer risk or sovereign risk and the remaining risks derived from the international financial activity. The Bank of Spain has established six categories for classifying such countries, as shown in the following table:
The Bank of Spain allows each bank to decide how to classify the listed countries within this classification scheme, subject to Bank of Spain’s oversight. The classification is made based on criteria such as the risk global assessment according to the evolution of the balance of payments, the level of the outstanding debt and of the charges for debt services, the debt quotations in the international secondary markets and other indicators and factors of each country as well as all the criteria indicated by the Bank of Spain. It excludes from country-risk outstandings:
With certain requirements, it treats guaranteed outstandings as outstandings to the guarantor.
The Bank of Spain requires Spanish banks to classify outstandings to countries or residents of countries in categories 1, 2, 3 and 4 on the basis of the criteria described below under “Item 4. Information on the Company—B. Business Overview—Bank of Spain Allowances for Credit Losses and Country-Risk Requirements—Specific Provisions for Credit Losses”. The Bank of Spain requires Spanish banks to classify as non-performing any loan in category 5, and to write-off the entire outstanding principal of and accrued interest on any outstandings to countries or residents of countries in category 6 (see the subsection below in this Item 4 entitled “Bank of Spain Charge-Off Requirements”).
Bank of Spain Non-Accrual of Interest Requirements
The Bank of Spain requires Spanish banks to stop accruing interest on the entire principal amount of any asset that is classified as non-performing, even if only a portion of the asset is classified as non-performing, and on category
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3 (transitory difficulties) and category 4 (doubtful) country-risk outstandings, whether or not they are non-performing. The banks must account for such collected interest on a cash basis, recording interest payments of the current year as interest income and interest payments of previous years as extraordinary income or recoveries of written-off assets, as appropriate.
The following table shows the amount of interest owed on non-accruing assets and the amount of such interest that was received when due and when past due:
Bank of Spain Allowances for Credit Losses and Country-Risk Requirements
Specific Allowances for Credit Losses
The specific allowance is calculated based on the loan recovery expectations and, at a minimum, by application of the coefficients stipulated in the following tables.
Non-Performing Past-Due Assets. Except for fully secured past-due mortgage assets and financial leases on certain types of properties, the Bank of Spain requires Spanish banks to set aside specific allowances for non-performing past-due assets. The amount of the required allowance is the product of the amount of the asset treated as non-performing (see “Bank of Spain Classification Requirements—Non-Performing Assets” above) times the percentages set forth in the following table. The allowance must be maintained for so long as the non-performing portion of the asset is carried as an asset on the banks’ balance sheets.
Fully-Secured Non-Performing Past-Due Mortgage Assets and financial leases on certain types of properties. If a non-performing asset is a fully secured non-performing past-due mortgage or a financial lease and certain conditions are met, the amount of the required allowance is the product of the amount of such asset times the percentages set forth in the following table instead of the preceding table. Such asset must satisfy three conditions: first, the asset is secured by a mortgage or a right of ownership (in case of a financial lease) on a finished residential property; second, such mortgage or right of ownership was placed on the property at the time the extension of credit was made; and third, the outstanding risk does not exceed 80% of the appraisal value of such mortgaged or leased property .
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The only exception to these requirements is that when a bank treats otherwise performing assets to a single borrower as non-performing because non-performing assets exceed 25% of the bank's total exposure to the borrower as set forth in “Bank of Spain Classification Requirements—Non-Performing Past Due Assets” above, the Bank of Spain does not require the bank to carry an allowance against any asset that has no overdue principal or interest payments.
Other Non-Performing Assets. If a non-performing asset is an other non-performing asset, see “Item 4. Information on the Company—B. Business Overview—Bank of Spain Classification Requirements—Non-Performing Assets—Other Non-Performing Assets”, the amount of the required allowance will be at least 25% and up to 100% of the amounts treated as non-performing, depending on management's opinion of the loan recovery expectations. When the treatment of such asset as a non-performing asset is due to, in management’s opinion, an inadequate financial or economical condition of the borrower, and the amount estimated as non-collectible is less than 25% of the outstanding debt, the amount of the required allowance will be at least 10% of the outstanding debt.
Exceptions. The foregoing allowance requirements do not apply to any non-performing asset (non-performing past-due assets and other non-performing assets) that is:
General Allowance
In addition to the Bank of Spain specific allowance requirements, the Bank of Spain requires Spanish banks to set aside a general allowance equal to the sum of:
When calculating the general allowance for credit losses on those investments in a bond fund that ranks behind unsubordinated securities on a winding up of the fund, the bank must include an amount equal to the coverage that the bank itself would have if the bank had a direct pro-rata interest in the underlying bond portfolio. If such provision is made, the bank is not required to make any other general allowance for securities issued by the bond fund.
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Allowance for the Statistical Coverage of Credit Losses
Since July 1, 2000, the Bank of Spain has required Spanish banks to create an allowance for the statistical coverage of credit losses based on an estimation of future credit losses in the credit portfolio. This new allowance is in addition to the other allowances described above.
Spanish banks may estimate the provisions to be made to create this allowance using models based on their own credit loss experience and management’s estimation of future credit losses. In devising these models, which form a required part of a sound risk measurement and management system, management must take into consideration the quality of counterparties, the existence of guarantees or collateral, the term of the transactions and the expected evolution of the credit risk depending on medium and long term changes in the economic cycle. Furthermore, the models must use historical data covering at least a whole economic cycle and must be validated by the Bank of Spain.
As an alternative to the internal model referred to above (or as an alternative for some types of credit risk) Spanish banks may calculate the provisions to be made to create the allowance by applying to the amount of computable credit risk (loans, fixed income securities not included in the trading portfolio, contingent liabilities and non-performing assets exempted from the requirements for a specific allowance for insolvency or country-risk, and excluding risks with Spanish government entities and risks with credit institutions) in each of the categories set forth below the following coefficients:
Assets in this category include:
Assets in this category include financial leases and mortgages and pledges on tangible assets that are not included in other categories, provided that the estimated value of the financial leases and the collateral totally covers the outstanding risk.
Assets in this category include assets on Spanish residents or residents of countries classified in categories 1 or 2, provided that such assets are not included in other categories.
Assets in this category include loans to individuals for the acquisition of durable consumption goods or other goods or current services not for professional use, except those registered in the “Registro de Ventas de Bienes Muebles”; and risks with residents of countries classified in categories 3 to 6, to the extent not covered by country-risk allowances.
Assets in this category include credit card balances; current account overdrafts and excesses in credit accounts (except those included in categories (a) and (b)), and doubtful assets not subject to a mandatory allowance not included in letter “a”.
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Contingent liabilities will be weighted using the percentages set forth in the capital regulations of the Bank of Spain.
Provisions made to meet the statistical allowance requirements are charged quarterly against income in the amount of the positive difference between one fourth of the amount of the required statistical allowance and the amount of net provisions for the other allowances for credit losses in that quarter. If the difference is negative, the amount is credited to income with a charge to the allowance, but only to the extent of the existing balance of that allowance.
Net provisions in the income statement include the provisions for the specific coverage of credit losses, plus provisions for the general and statistical coverage of credit losses, plus write-offs, less the recoveries of the specific allowance and foreclosed assets.
The amount of the allowance for the statistical coverage of credit losses, may be, at a maximum, three times the sum of the products of the amount of credit risk in each category multiplied by the risk coefficient of each such category.
Allowances for Country-Risk
The Bank of Spain requires Spanish banks to set aside an allowance for country-risk on all country-risk outstandings. See the above sub-section entitled “Bank of Spain Classification Requirements—Country-Risk Outstandings”. The amount of the required provision is the product of the amount of the outstanding loans and credits times the percentages set forth in the following table.
Under the recent Bank of Spain guidelines, as a result of 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.
Guarantees
The Bank of Spain requires some guarantees to be classified as non-performing in the following amounts:
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Bank of Spain Foreclosed Assets Requirements
The Bank of Spain requires Spanish banks to carry assets acquired on foreclosure at their net value (defined as the lower of (i) the face value of the loan secured (net of any related provision for non-performing asset) and (ii) the appraised market value of the foreclosed asset), reduced by allowances (expressed as a percentage of net value), as follows: if the asset is held between three and four years —25%; between four and five years —50%; more than five years —75%. In any event, net asset value can never exceed the market value of the asset. Bank of Spain regulations allow a release of allowances to the extent that the independently appraised value of the assets acquired upon foreclosure (appraised each year subsequent to the first date on which a provision would be required) exceeds the net value of such assets, but requires that a minimum allowance be maintained at all times equal to 25% of the outstanding principal of the un derlying 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.
Bank of Spain Charge-off Requirements
Spanish GAAP does not permit non-performing assets to be partially charged-off.
The Bank of Spain requires Spanish banks to charge-off immediately those non-performing assets that management believes will never be repaid or that were made to category 6 (“bankrupt”) countries or residents of such category 6 countries. See the above sub-section entitled “Item 4. Information on the Company—B. Business Overview—Bank of Spain Classification Requirements—Country-Risk Outstandings”. Otherwise, the Bank of Spain requires Spanish banks to charge-off non-performing assets three years after they were classified as non-performing. Spanish banks may carry fully secured past-due mortgage loans beyond this three-year deadline for up to six years if there are objective factors that indicate an improved likelihood of recovery. Accordingly, even if allowances have been established equal to 100% of a non-performing asset (in accordance with the Bank of Spain criteria discussed above), the Spanish bank may maintain that non-performing asset, fully provided, on its balance sheet for the full three or six-year period if management believes based on objective factors that there is some possibility of recoverability of that asset. (See Note 27.1 to our consolidated financial statements for differences between Spanish and U.S. GAAP).
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Movements in Allowances for Credit Losses
The following table analyzes movements in our allowances for credit losses and movements, by domicile of customer, for the years indicated. See “Presentation of Information” for further discussion of movements in the allowances for credit losses, see “Item 5. Operating and Financial Review and Prospects—A.Operating Results—Net Provisions for Credit Losses”.
(2) The shift in “Other Movements” from 1999, to 2000, to 2001, to 2002 and to 2003 principally reflects foreign exchange differences.
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The table below shows a breakdown of charge-offs against income, recoveries, net provisions and charge-offs against credit loss allowance by type and domicile of borrower for the years indicated.
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The following table shows our non-performing assets, excluding country-risk. We do not keep records classifying assets as non-accrual, past due, restructured or potential problem loans, as those terms are defined by the SEC. 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 where known information about possible credit risk at December 31, 2003 (not related to transfer risk inherent in cross-border lending activities) gave rise to serious doubts as to the ability of the borrowers to comply with the loan repayment terms at such date.
Evolution of Non-Performing Assets
The following table shows the movement in our non-performing assets (excluding country-risk, see “Country-Risk Outstandings”) from December 31, 2001 until December 31, 2003.
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Non-Performing Asset Ratios
The following table shows the ratio of our non-performing assets to total computable credit risk and our coverage ratio at December 31, 2001, 2002 and 2003.
Allowances for non-performing assets as a percentage of non-performing assets.
The following table sets forth our country-risk outstandings with third parties for the years shown.
Other Non-Accruing Assets
As described above under “Item 4. Information on the Company—B. Business Overview—Bank of Spain Classification Requirements—Non-Performing Assets” and “Country-Risk Outstandings”, we do not classify our loans to borrowers in countries with transitory difficulties (category 3) and doubtful countries (category 4) as non-performing. However, as described above under “Item 4. Information on the Company — B. Business Overview —Bank of Spain Allowances for Credit Losses and Country-Risk Requirements—Allowances for Country-Risk” and “Bank of Spain Non-Accrual of Interest Requirements”, the Bank of Spain requires us to account for such loans on a cash basis (non-accruing) and to set aside certain allowances for such loans. We treat category 5 (very doubtful) country-risk outstandings as both non-accruing and non-performing. Total other non-accruing assets at December 31, 1999, 2000, 2001, 2002 and 2003 were, €1,331.8 million, €1,313.7 million, €1,172.2 million, €259.5 million and €249.7 million, respectively.
Summary of non-accrual assets
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We do not have any loans past-due 90 days or more that are accruing interest, in accordance with Bank of Spain’s requirements.
As of December 31, 2003 and 2002, the amounts of “restructured loans”, none of which were classified as non-performing, were €147.6 million and €61.4 million, respectively.
Foreclosed Assets
The table below sets forth movements in our foreclosed assets for the periods shown.
Movement of foreclosed assets
Liabilities
Deposits
The principal components of our deposits are customer demand, savings and time deposits, and international and domestic interbank deposits. Our retail customers are the principal source of our demand, savings and time deposits. For an analysis, by domicile of customer, of average domestic and international deposits by type for 2001, 2002 and 2003, see “Average Balance Sheets and Interest Rates—Liabilities and Interest Expense”.
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 16.1% at December 31, 2003, according to figures published by the Spanish Banking Association (AEB) and the Confederación Española de Cajas de Ahorros (“CECA”). See “Item 4. Information on the Company—B. Business Overview—Competition”.
The following tables analyze our year-end deposits.
Deposits (Due to Credit institutions and Customer deposits) by type of deposits
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Deposits (Due to credit institutions and Customer deposits) by location of office
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, 2003. 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 €20.0 million, €19.7 million and €31.9 million at December 31, 2001, 2002 and 2003, respectively.
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Short-term Borrowings
The following table analyzes our short-term borrowings as of December 31, 2001, 2002 and 2003.
Competition
We face strong competition in all of our principal areas of operation from other banks, savings banks, credit cooperatives, brokerage houses, insurance companies and other financial services firms.
Banks
Two Spanish banking groups dominate the retail banking sector in Spain. These two groups are headed by Banco Bilbao Vizcaya Argentaria, S.A. and Banco Santander Central Hispano, S.A.
At the end of December 2003, these two Spanish banking groups accounted for approximately 62.7% of loans and 65.4% of deposits of all Spanish banks, which in turn represented 31.9% of loans and 30.6% 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, 2003, there were 57 foreign banks (of which 49 were from European Union countries) with branches in Spain. In addition, there were 24 Spanish subsidiary banks of foreign banks (of which 16 were from European Union countries).
Spanish law provides that any financial institution organized and licensed in another member state of the European Union may conduct business in Spain from an office outside Spain. They do not need prior authorization from Spanish authorities to do so. Once the Bank of Spain receives notice from the institution’s home country supervisory authority about the institution’s proposed activities in Spain, the institution is automatically registered and the proposed activities are automatically authorized.
The opening of a branch of any financial institution authorized in another member state of the European Union does not need prior authorization or specific allocation of resources. The opening is subject to the reception by the Bank of Spain of a notice from the institution's home country supervisory authority containing, at least, the following information:
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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.
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.
In addition, we face strong competition outside Spain, particularly in Argentina, Brazil, Chile, Mexico and Portugal.
Savings Banks
Spanish savings banks (“Cajas de Ahorros”) are mutual organizations which engage in the same activities as banks, but primarily take deposits and make loans, principally to individual customers and small to medium-sized companies. The savings banks are influenced by regional and local governments. The Spanish savings banks provide strong competition for the demand and savings deposits which form an important part of our deposit base. Spanish savings banks, which traditionally were regional institutions, are permitted to open branches and offices throughout Spain. In the last few years, mergers among savings banks increased. The Spanish savings banks’ share of domestic deposits and loans were 55.9% and 48.5%, respectively, at December 31, 2002 and 58.0% and 49.5%, respective ly, at December 31, 2003.
Credit Co-operatives
Credit co-operatives are active principally in rural areas. They provide savings and loan services including financing of agricultural machinery and supplies.
Brokerage Services
We face competition in our brokerage activities in Spain from brokerage houses of other financial institutions.
Spanish law provides that any investment services company authorized to operate in another member state of the European Union may conduct business in Spain from an office outside Spain, once the Securities National Commission (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.
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However, Spanish law provides that credit entities have access, as members, to the Spanish stock exchanges, in accordance with the provisions established by the Investment Services Directive.
We also face strong competition in our mutual funds, pension funds and insurance activities from other banks, savings banks, insurance companies and other financial services firms.
Supervision and Regulation
Bank of Spain and the European Central Bank
The Bank of Spain, which operates as Spain’s autonomous central bank, supervises all Spanish financial institutions, including us. Until January 1, 1999, the Bank of Spain was also the entity responsible for implementing Spanish monetary policy. As of that date, the start of Stage III of the European Monetary Union, the European System of Central Banks and the European Central Bank became jointly responsible for Spain’s monetary policy. The European System of Central Banks consists of the national central banks of the fifteen member states belonging to the European Union and the European Central Bank. The “Eurosystem” is the term used to refer to the European Central Bank and the national central banks of the member states which have adopted the euro. The European Central Bank is responsible for the monetary policy of the European Union. The Bank of Spain, as a member of the European System of Central Banks, takes part in t he development of the European System of Central Banks’ powers including the design of the European Union’s monetary policy.
The European System of Central Banks is made up of three decision-making bodies:
The Governing Council is the body in charge of formulating monetary policy and adopting the guidelines and decisions necessary to perform the Eurosystem’s tasks. The Executive Board is the body in charge of implementing the monetary policy 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 Union’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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Liquidity Ratio
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 their respective central banks in the form of interest bearing deposits as specified below (the “Liquidity Ratio”).
The European Central Bank requires the maintenance of a minimum liquidity ratio at all credit institutions established in the member states of the European 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”.
Investment Ratio
The Spanish Government has the power to require credit institutions to invest a portion of certain qualifying liabilities in certain kinds of public sector debt or public-interest financing (the “investment ratio”), and has exercised this power in the past. Although the investment ratio has been 0% since December 31, 1992, the law which authorizes it has not been abolished, and the Spanish Government could reimpose the ratio, subject to EU requirements.
Capital Adequacy Requirements
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 credit 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, the level of preferred securities may not exceed 30% of core capital and the total amount of complementary capital admissible for computing total capital may not exceed the total amount of core capital.
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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.
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, 2003, our total capital was €23,220.7 million, which reflected a 32.8% (€5.7 billion) excess of stockholders’ equity over the applicable capital and reserve requirements. Expressed as a percentage of risk-weighted assets, our total total capital ratio was 10.63%. Our Spanish subsidiary banks were, at December 31, 2003, each in compliance with these capital adequacy requirements, and all our foreign subsidiary banks were in compliance with their local regulation.
Banks or consolidated banking groups should communicate immediately to the Bank of Spain if they fail to satisfy minimum capital requirements, and within the next month should present a plan to recover the solvency. This plan could be modified by the Bank of Spain. While the deficit persists, the payment of dividends by any of the entities of the banking group must be approved by Bank of Spain, and will be limited to a maximum of 50% of net attributable income. Payment of dividends could be forbidden if the deficit of capital is greater than 20% of 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:
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• a requirement that banks engaged in international operations maintain Tier 1 capital of at least 4% of risk-weighted assets and “total” capital (Tier 1 capital plus up to an equal amount of Tier 2 capital) of at least 8% of risk-weighted assets.
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, 2003, we had (1) a total capital to risk-weighted assets ratio of 12.43%, and (2) a Tier 1 capital to risk-weighted assets ratio of 8.26%.
In April 2003, the Basel committee on Banking Supervision released the third 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 2004 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.
Concentration of Risk
Spanish banks may not have exposure to a single person or group in excess of 25% (20% in the case of an affiliate) of the bank’s or group’s consolidated equity. Any exposure to a person or group exceeding 10% of a bank’s or group’s consolidated equity is deemed a concentration and the total amount of exposure represented by all of such concentrations must not exceed 800% of such equity.
Legal Reserve And Other Reserves
Spanish banks are subject to legal and other restricted reserves requirements. In addition, we must allocate profits to certain other reserves as described under Note 21 to our consolidated financial statements.
Allowances For Credit Losses And Country-Risk
For a discussion of Bank of Spain regulations relating to allowances for credit losses and country-risk, see “Item 4. Information on the Company—B.Business Overview—Selected Statistical Information—Classified Assets—Bank of Spain Classification Requirements—Non-Performing Assets” and “Country-risk Outstandings”.
Employee Pension Plans
The Bank of Spain requires Spanish banks’ pension funds to be fully funded. At December 31, 2003, our pension plans were all fully funded according to Bank of Spain requirements. See Note 2(j) to our consolidated financial statements.
Restrictions on Dividends
We may only pay dividends (including interim dividends) if such payment is in compliance with the Bank of Spain’s minimum capital requirement (described under “Item 4. Information on the Company—B. Business Overview —Capital Adequacy Requirements”) and other requirements or, as described below, under certain circumstances when we have capital that is 20% or less below the Bank of Spain’s minimum capital requirements.
If a banking group meets this capital requirement, it may dedicate all of its net profits to the payment of dividends, although in practice Spanish banks nomally consult with the Bank of Spain before declaring a dividend. Even if a banking group meets the capital requirement as a group, any consolidated Spanish credit entity that is a subsidiary that does not meet the capital requirement on its own will be subject to the limitations on dividends described below. If a banking group or any Spanish credit entity subsidiary of the group has capital that is 20% or less below the Bank of Spain’s minimum capital requirement, it must devote an amount of net profits (at least 50%) determined by the Bank of Spain to reserves, and dividends may be paid out of the remainder only with the prior approval of the Bank of Spain. If the capital is 20% or more below the minimum requirement, it may not pay any dividends and must allocate all profits to reserves. In the case of a banking group failing to meet the capital
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requirement, however, consolidated subsidiaries in the group may pay dividends without restriction, so long as they are at least 90% owned by group companies and, if they are credit entities, independently comply with the capital requirement.
If a bank has no net profits, its board of directors may propose at the general meeting of shareholders that a dividend be declared out of retained earnings. However, once the board of directors has proposed the dividend to be paid, it must submit the proposal to the Minister of Economy who, in consultation with the Bank of Spain, may in his discretion authorize or reject the proposal of the board.
Compliance with such requirements notwithstanding, the Bank of Spain is empowered to advise a bank against the payment of dividends on security and soundness grounds. If such advice is not followed, the Bank of Spain may require that notice of such advice be included in the bank’s annual report registered before the Mercantile Register. In no event may dividends be paid from certain legal reserves.
Interim dividends of any given year may not exceed the net profits for the period from the closing of the previous fiscal year to the date on which interim dividends are declared. In addition, the Bank of Spain recommends that interim dividends not exceed an amount equal to one-half of all net income from the beginning of the corresponding fiscal year. Although banks are not legally required to seek prior approval from the Bank of Spain before declaring interim dividends, the Bank of Spain has asked that banks consult with it on a voluntary basis before declaring interim dividends.
Limitations On Types Of Business
Spanish banks generally are not subject to any prohibitions on the types of businesses that they may conduct, although they are subject to certain limitations on the types of businesses they may conduct directly.
The activities that 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).
Deposit Guarantee Fund
The Deposit Guarantee Fund on Credit Institutions (“Fondo de Garantía de Depósitos”, or the “FGD”), which operates under the guidance of the Bank of Spain, guarantees: (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, 2003, we and our other domestic bank subsidiaries were members of the FGD and thus obligated to make annual contributions to it.
Recent Legislation
Law 44/2002 (November 22, 2002) on reform measures of the financial system, amended, among others, the Credit Entities Discipline and Intermediation Law, the Private Insurance law and the Securities Market Law. See “Item 9. The Offer and Listing – C. Markets – Spanish Securities Market – Securities Market Legislation”.
On July 4, 2003, Law 19/2003 was approved. This law is an update to Spanish exchange control and money laundering prevention provisions. See “Item 10. Additional Information – D. Exchange Controls – Restrictions on Foreign Investments”. This law also introduces an additional rule, Law 13/1985, which contains requirements for the issuance of preferred securities.
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On July 9, 2003, Law 22/2003 was approved, which implements certain reforms to the insolvency process, compiling all the material and formal aspects of the insolvency process into a single legal instrument.
Law 26/2003 (July 17, 2003) amended the Securities Market Law 24/1988 and the Corporations Law in order to reinforce the transparency of listed companies. See “Item 9. The Offer and Listing – C. Markets – Spanish Securities Market – Securities Market Legislation”.
Law 58/2003 (December 17, 2003), the General Tax Law, will become effective on July 1, 2004 and will supercede existing laws regulating this matter.
Royal Decree Law 3/2004, compiled all the existing legislation regarding personal income tax into a single law and abolished existing law on the subject, including Law 40/1998 which was the primary source of regulation.
Royal Decree Law 4/2004, compiled all the existing legislation regarding corporate income tax into a single law and abolished existing law on the subject, including Law 43/1995 which was the primary source of regulation.
Royal Decree Law 5/2004, compiled all the existing legislation regarding taxation of non-resident individuals and entities into a single law and abolished existing law on the subject, including Law 41/1998 which was the primary source of regulation.
Also, please see our discussion of the New Basel Capital Accord (which we anticipate will be implemented in 2006) above under “Capital Adequacy Requirements”.
United States Regulation
By virtue of the operation of our branches in New York City and our agency 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.
Monetary Policy and Exchange Controls
The decisions of the European System of Central Banks influence conditions in the money and credit markets, thereby affecting interest rates, the growth in lending, the distribution of lending among various industry sectors and the growth of deposits. Monetary policy has had a significant effect on the operations and profitability of Spanish banks in the past and this effect is expected to continue in the future. Similarly, the monetary policies of governments in other countries in which we have operations, particularly in Latin America, 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 Union’s monetary policy. On January 1, 2001, Greece also adopted the Euro as its national currency.
C. Organizational structure.
Banco Santander Central Hispano, S.A., the Bank, is the parent company of the Group which was comprised at December 31, 2003 of 335 companies that consolidate by the global integration method and 163 companies that are accounted for by the equity method.
See Exhibits I, II and III to our consolidated financial statements included in this Form 20-F, for details on our consolidated and non-consolidated companies.
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D. Property, plant and equipment.
During 2003 we and our bank subsidiaries either leased or owned premises in Spain and abroad, which at December 31, 2003 included 4,369 branch offices in Spain and 4,830 abroad. See Note 13 to our consolidated financial statements.
Item 5. Operating and Financial Review and Prospects
Critical Accounting Policies
Our primary financial statements are prepared following Spanish GAAP. Notes 1 and 2 to our Consolidated Financial Statements contain a summary of our significant accounting policies. Certain of these policies require management to make difficult, complex or subjective judgments. Following our accounting procedures, these judgments are submitted to our Audit and Compliance 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 readily available market for such instruments, while under Spanish GAAP such instruments are valued at cost which can be determined objectively.See Note 27.1 to our Consolidated Financial Statements for a summary of significant valuation and income recognition differences under Spanish and U.S. GAAP.
We believe that of our significant accounting policies, the following may involve a high degree of judgment:
Allowances for credit losses
Spanish GAAP requires the level of the allowance for credit losses to be determined in part on the basis of specific rules rather than the subjective judgment involved under the U.S. 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 with respect to specific exposures.
Amortization of goodwill
We amortize goodwill on a straight-line basis over the period in which we estimate the investment would be recovered (maximum 20 years). Nevertheless, if management estimates that the investment may not be recovered during the foreseen period, goodwill is amortized on an accelerated basis, recognizing an impairment loss in the year. In 2001, 2002 and 2003, goodwill from our investment in Banespa of €1,230.6 million, €400.6 million and €1,703.8 million, respectively, was amortized on an accelerated basis. Also, in 2002, goodwill from our investment in Banco Santander Colombia of €240.0 million was partially amortized on an accelerated basis and in 2003, goodwill of €775.7 million with respect to our operations in Argentina was fully written off with a charge to the allowances recorded in prior years. These decisions were coordinated with our regulatory authorities. (See Note 12 to our Consolidated Financial Statements).
Significant equity investments
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 and over which the Group exercises significant influence. 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”.
As of December 31, 2003, we have decided not to consider as “permanent” some of our equity holdings, among others, those of San Paolo-IMI and Commerzbank.
A. Operating results.
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
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reconciliations to U.S. GAAP of net income and stockholders’ equity as reported in the consolidated financial statements. Note 27.5 (J) to our consolidated financial statements includes financial information for our main business segments.
In a number of places in this report, in order to analyze changes in our business from period to period, we have isolated the effects of foreign exchange rates on our results of operations and financial condition. In particular, we have isolated the effects of depreciation of local currencies against the euro because we believe that doing so is useful to understand the evolution of our business. For these purposes, we calculate the effect of movements in the exchange rates by multiplying the previous period balances in local currencies by the difference between the exchange rate to the euro of the current and the previous period.
General
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, 2003.
First, the global economy experienced modest growth during 2003, primarily due to the recoveries in the economies of the U.S. and certain emerging Asian countries. This modest growth was not enhanced by Euro zone economies, which overall grew by only 0.5% in 2003, as a result of their rigid fiscal policies, the negative effect of a strong euro on exports and the slow adjustment in the fixed costs of non-financial companies. After a sluggish start to the year, the Latin American economy grew by 1.5% during 2003, due to greater budgetary discipline, lower interest rates and a higher volume of lending in the region. The Spanish economy, spurred by strong domestic demand, low interest rates and tax cuts experienced a 2.4% growth in GDP in 2003. Also noteworthy in Spain were the continued low levels of nonperforming loans and the strong pace of growth in lending.
Second, as in 2002, Argentina’s contribution to net income of the Group in the year 2003 was zero given that the positive or negative results of our Argentina subsidiaries are offset by an increase or decrease in the same amount of the specific allowance relating to the Bank’s investments in such subsidiaries. See Note 1 of the Consolidated Financial Statements.
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 of 2002 vs. 2001.
Third, the dollar’s fall against euro and the depreciation of certain Latin American currencies against the euro significantly impact comparisons between 2002 and 2003. Currency depreciation affected earnings (converted at average exchange rates) more than balances (converted at period-end rates). The impact of the depreciation of average exchange rates was -15 percentage points between 2002 and 2003, while the impact of the depreciation of year-end rates was -2.7 percentage points in lending and -4.5 in customer funds.
The largest depreciations of average exchange rates were those of the Brazilian real (from 2.64 to 3.46 per euro, a 31.1% change), the Mexican peso (from 9.06 to 12.18 per euro, a 41.3% change) and the Venezuelan bolivar (from 1,026 to 1,814 per euro, a 76.8% change). Venezuela, furthermore, imposed exchange controls in February 2003, establishing the exchange rate at 1,598 bolivars per US dollar where it remained throughout the year.
The pace of the depreciation of Latin American currencies as a whole slowed during 2003. There was an average weighted depreciation of the currencies of 11% against the euro between December 31, 2002 and December 31, 2003. This depreciation was significantly lower than that of average exchange rates.
Fourth, during 2002 and 2003, we made the following investments and divestments in an attempt to maximize our return of capital: we acquired an additional 34.5% interest in Banco Santiago on April 17, 2002; we sold our retail banking business in Peru in the fourth quarter of 2002 and sold 24.9% of Grupo Santander Serfin to Bank of America on February 28, 2003.
In this environment, our strategy has been to control costs and increase income by targeting customer business (particularaly retail banking). The result of this strategy was a notable improvement in income and gains in profitability, efficiency, credit quality ratios and solvency.
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Results of Operations
Summary
Net attributable income as reported in our consolidated financial statements for the year ended December 31, 2003 was €2,610.8 million, an increase of 16.2% from €2,247.2 million in 2002 which was a decrease of 9.6% from €2,486.3 million in 2001. The 2003 increase reflected mainly decreases in net interest income and net fees and commissions and increases in net gains on financial transactions, net income from companies accounted for by the equity method and net extraordinary results, all of which were partially offset by decreases in operating expenses and net provisions and increases in goodwill amortization.
Net Interest Income
Net interest income was €7,958.3 million in 2003, a 15.0% or €1,400.3 million decrease from €9,358.7 million in 2002, which was an 8.8% or €898.1 million decrease from €10,256.8 million in 2001. Excluding dividends from companies accounted for by the equity method, net interest income was €7,648.8 million in 2003, a 15.1% or €1,356.8 decrease from €9,005.6 million in 2002, which was an 8.4% or €827.5 million decrease from €9,833.1 million in 2001.
2003 Compared to 2002
Net interest income comparison with 2002 is still greatly affected by the performance of exchange rates. Eliminating the impact of exchange rates (€1,284.3 million), net interest income only declined 1.2%. Another negative factor was the decrease in interest rates in Europe and Latin America. These negative factors were partly offset by the greater volume of business in Spain and by the steps taken by the Group’s different units to defend customer spreads. The overall decline in net interest income in 2003 mainly reflected a decrease in the average balance of earning assets as well as a decline in overall yield spreads.
Average total earning assets were €298,840.8 million for the year ended December 31, 2003, an 0.7% or €1,976.1 million decrease from €300,816.9 million for the same period in 2002. This decrease was mainly due to a decrease of €23,321.9 million in the average balances of our international total earning assets (mainly because of the effect of the weakening of nearly all the Latin American currencies against the euro, and particularly the effect of this on our international loans and credits portfolio), partially offset by an increase of €21,345.9 million in the average balance of our domestic total earning assets (mainly due to an increase of €10,640.1 million and €6,663.3 million in the average balances of our domestic loans and credits portfolio and debt securities portfolio, respectively). Our loans and credits balance grew in Spain because of increased secured loans (mainly mortgage lending) resulting i n part from continuing low and declining domestic interest rates.
The decrease in net interest income also resulted from the decline in overall yield spread from 3.13% in 2002 to 2.63% in 2003 (which mainly reflected a decline in international yield spread). Domestic yield spread decreased from 2.67% in 2002 to 2.42% in 2003. This change reflected continued pressure on margins in Spain but was offset by adjustments to our domestic asset mix. The margin pressure in Spain was due to continued low and declining domestic interest rates as well as the continued effects of competition. Expanded volumes in our domestic loans and credits portfolio, which yielded relatively higher returns, improved our domestic asset mix given existing conditions. International yield spreads declined because of a decrease in interest rates in Portugal and in some Latin America countries (Mexico, Brazil and Chile).
2002 Compared to 2001
Net interest income 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 income in 2002 increased 6.8%. This growth was largely due to higher revenues from retail 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 income 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 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
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international loans and credits 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 loans and credits balance grew in Spain because of increased secured loans (mainly mortgage lending) resulting in part from continuing low and declining domestic interest rates.
The decrease in net interest income 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 loans and credits 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 businesses). This included expanding domestic deposit volumes, which pay significantly lower interest rates than international deposits, while contracting higher paying international deposit volumes.
Net Fees and Commissions
Net fees and commissions were €4,170.6 million in 2003, a 2.8% or €118.7 million decrease from €4,289.3 million in 2002, which was a 7.2% or €332.5 million decrease from €4,621.7 million in 2001.
Net fees and commissions for 2003 and 2002 were as follows:
Excluding the impact of exchange rates (€427.1 million), net fees and commissions in 2003 increased by 7.2%.
The €118.7 million decrease in 2003 primarily resulted from a €138.1 million or 24.7% decrease in fees from other operations and a €97.2 million or 19.3% decrease in fees from bill discounting, partially offset by a €93.6 million or 36.4% increase in fees from insurance (due to our marketing efforts, principally in Spain) and a €27.3 million or 4.9% increase in fees from securities services (due to commissions from underwriting and placement as those fees earned from the purchase and sale of securities continued to register moderate growth).
Fees from mutual and pension funds remained relatively flat, increasing €14.5 million or 1.1%.
Average mutual funds under management in Spain rose 11.6% from €50.7 billion in 2002 to €56.6 billion in 2003 due to our marketing efforts. Average mutual funds abroad decreased by 4.5% from €17.9 billion in 2002 to €17.1 billion in 2003 mainly due to the negative impact of exchange rates in our Latin American fund management companies, partially offset by an increase of average mutual funds in Portugal.
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Average pension funds in Spain increased by 10.9% from €5.5 billion in 2002 to €6.1 billion in 2003, mainly due to increased activity in individual pension funds. Average pension funds abroad increased slightly by 0.8% from €12.3 billion in 2002 to €12.4 billion in 2003 mainly due to the increase of average mutual funds in our Latin American pension fund companies due to our marketing efforts, partially offset by the negative impact of exchange rates.
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.
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 gains on financial transactions
Net gains on financial transactions were €998.8 million, a 180.4% or €642.6 million increase in 2003 from €356.3 million in 2002, which was a 48.0% or €328.9 million decrease in 2002 from €685.1 million in 2001. Net gains on financial transactions include gains and losses arising from the following: marking to market our trading portfolio and derivative instruments, including spot market foreign exchange transactions, and sales of investment securities and liquidation of our corresponding hedge or other derivative positions. See note 25(b) to our consolidated financial statements.
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The €642.6 million increase in 2003 was mainly due to positive trading results and ALCO positions (due to interest rates and exchange rates), in clear contrast with the losses arising from the portfolio sales in Brazil (in order to reduce risk positions) during the second and third quarters of 2002 which made last year’s figure much lower than the Group’s average.
Net gains on financial transactions in 2003 includes net gains of €392.1 million on fixed-income securities (net losses of €340.6 million in 2002); net gains of €432.0 million on equity securities (net losses of €150.9 million in 2002); net gains of €166.2 million on exchange differences (net gains of €417.0 million in 2002) and net gains of €8.5 million in derivatives (net gains of €430.8 million in 2002). In the case of hedging transactions entered into to reduce market risk exposure, any gains and losses on exchange differences and derivatives are generally symmetrical to the gains (losses) recorded on Spanish and foreign fixed-income securities and equity securities.
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 Other Operating Income
Other operating results generated a loss of €166.5 million in 2003, a 26.5% or €60.0 million decrease from €226.5 million in 2002, which was a 1.9% or €4.4 million decrease from a loss of €230.9 million in 2001. Net other operating income consists mainly of other operating income and other operating expenses generated by our consolidated financial and non-financial consolidated subsidiaries and contributions we make to the Spanish Deposit Guarantee Fund and similar deposit guarantee programs abroad.
The €60.0 million decrease in 2003 was mainly due to a decrease in the contributions to the deposit guarantee programs (mainly in Latin America) of €32.0 million and a decrease in net other operating losses generated by our consolidated subsidiaries of €27.9 million.
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.
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General administrative expenses
General administrative expenses were €6,477.7 million in 2003, a 11.5% or €844.4 million decrease from €7,322.1 million in 2002, which was a 12.8% or €1,078.9 million decrease from €8,401.0 million in 2001.
General administrative expenses for 2003 and 2002 were as follows:
The 11.5% decrease in general administrative expenses in 2003 reflected a 10.5% decline in personnel expenses and a 13.3% decline in other administrative expenses. These costs, like the rest of the income statement, were significantly impacted by changes in exchange rates. Eliminating the impact of exchange rates (€793.4 million), general administrative expenses declined 0.7%, with personnel expenses down 0.9% and other administrative expenses down 0.3%.
The reduction in personnel expenses reflects the effort made in 2002 to reduce the number of employees in Spain, Portugal and Latin America.
The Group’s purchasing and optimization of costs area continued to adopt measures to cut spending, while the organization and IT areas continued to improve processes in order to boost efficiency and productivity throughout the Group.
The performance of revenues and cost control improved the efficiency ratio, measured by dividing general administrative expenses by gross operating income, to 49.3%, 2.9 percentage points better than in 2002.
General administrative expenses for 2002 and 2001 were as follows:
The 12.8% decrease in general administrative expenses in 2002 reflected a 14.0% decline in personnel expenses and a 10.9% decline in other administrative expenses. There were reductions in expenses in almost all items, especially publicity, technical reports, building premises and printed and office material. Eliminating Argentina and
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the exchange rate effect, the reduction was 1.1%. General administrative 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, 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.
Depreciation and Amortization
Depreciation and amortization was €762.8 million in 2003, a 14.3% or €127.0 million decrease from €889.8 million in 2002, which was a 9.9% or €97.5 million decrease from €987.3 million in 2001.
The €127.0 million or 14.3% decrease in 2003 was largely due to the effect of exchange rate fluctuations.
The €97.5 million or 9.9% decrease in 2002 was largely due to the effect of exchange rate fluctuations.
Net Income from Companies Accounted for by the Equity Method
Excluding dividends from companies accounted for by the equity method which are reflected under net interest income, net income from companies accounted for by the equity method was €407.3 million in 2003, a 45.5% or €127.4 million increase from €279.9 million in 2002, which was a 46.4% or €242.0 million decrease from €521.9 million in 2001. Including dividends from companies accounted for by the equity method, net income from companies accounted for by the equity method was €716.8 million in 2003, a 13.2% or €83.9 million increase from €633.0 million in 2002, which was a 33.1% or €312.5 million decrease from €945.5 million in 2001.
The €127.4 million increase in 2003 excluding dividends from companies accounted for by the equity method and the €83.9 million including dividends, is mainly due to the higher contributions of Cepsa, Sanpaolo IMI, Unión Fenosa, Urbis and insurance companies that was offset by the lower contributions from Royal Bank of Scotland, Dragados and Vallehermoso we received as a result of our divestments in these holdings.
The entities providing a large portion of the contributions in 2003 include the following:
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The €242.0 million decrease in 2002 excluding dividends from companies accounted for by the equity method 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).
The entities providing a large portion of the contributions in 2002 include the following:
Amortization of Consolidation Goodwill
Amortization of consolidation goodwill was €2,241.7 million in 2003, a 65.0% or €883.1 million increase from €1,358.6 million in 2002, which was a 27.5% or €514.3 million decrease from €1,873.0 million in 2001.
The €883.1 million increase in 2003 is mainly due to the early amortization of €1,719.2 million (€1,016.3 million more than in 2002), relating mainly to Banespa (€1,703.8 million), whose goodwill was reduced to zero.
For further information on the variations in the balances of “Consolidation Goodwill” see Note 12 of the Consolidated Financial Statements.
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).
Gains (losses) on Group Transactions
Gains on Group transactions were €955.6 million in 2003, a 5.3% or €53.4 million decrease from €1,008.9 million in 2002, which was a 13.7% or €160.5 million decrease form €1,169.4 million in 2001.
The amount of €955.6 million relates primarily to the gains generated in the first quarter of 2003 (€680.6 million) from the sale of 24.9% of Santander Serfin to Bank of America, and €216.9 million in the fourth quarter of 2003 from the sale of shares in Royal Bank of Scotland.
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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).
Net Provisions for Credit Losses
Our net provisions for credit losses were €1,495.7 million in 2003, a 9.3% or €152.5 million decrease from €1,648.2 million in 2002, which was a 3.9% or €62.2 million increase from €1,586.0 million in 2001. Excluding the impact of exchange rates (€281.4 million), net provisions for credit losses increased by 7.8%.
The €152.5 million decrease in net provisions for credit losses reflected a €341.7 million decrease in gross provisions for credit losses (gross provisions for credit losses were €1,720.2 million in 2003 compared to €2,061.9 million in 2002), a €153.0 million increase in provisions for country-risk (provisions for country-risk were €133.0 million in 2003 compared to release of provisions for country-risk of €20.0 million in 2002), and a €36.2 million decrease in recoveries of loans previously charged-off (recoveries totaled €357.5 million in 2003 compared to €393.7 million in 2002).
The €341.7 million decrease in gross provisions for credit losses is mainly due to the positive effect of exchange rates, reduced provisions for loans to borrowers in Argentina, in accordance with Argentine local criteria, and lower needs for the rest of Latin America, offset by increased provisions for Spain, mainly because of increased statistical credit loss provisions (€328.8 million allocated in 2003 vs. a release €39.2 million in 2002) and generic provisions (from increased business). (See “Item 4. Information on the Company—B. Business Overview—Classified Assets—Bank of Spain Classification Requirements—Allowance for the Statistical Coverage of Credit Losses”).
The €153.0 million increase in provisions for country-risk is mainly due to the increase this year of the amount of coverage required by the Bank of Spain for country-risk in Argentina. Our total country-risk exposure with third parties, net of allowances, in accordance with Bank of Spain criteria increased by €19.0 million to €91.0 million at December 31, 2003, compared to €72.0 million at December 31, 2002. This increase was largely due to the application of stricter classification criteria in December 2003 to operations with political risk coverage by private agencies.
Our total allowances for credit losses increased by €250.1 million to €5,414.4 million at December 31, 2003, from €5,164.3 million at December 31, 2002.
Excluding country-risk, non-performing assets decreased by €454.0 million to €3,222.5 million at December 31, 2003, compared to €3,676.5 million at December 31, 2002. Domestic non-performing assets decreased by €72.3 million to €931.6 million at December 31, 2003 from €1,003.9 million at December 31, 2002, while international non-performing assets decreased by €381.7 million to €2,290.9 million at December 31, 2003 from €2,672.6 million at December 31, 2002, due to our strong efforts to reduce our non-performing assets in Latin America and our conservative lending policy. This trend may not continue and may even reverse in the future.
Our coverage ratio (excluding country risk) was 165.2% at December 31, 2003, and 139.9% at December 31, 2002. See “Selected Statistical Information—Non-Performing Asset Ratios”.
Our net provisions for credit losses were €1,648.2 million in 2002, a 3.9% or €62.2 million increase from €1,586.0 million in 2001. Excluding Argentina, net provisions for credit 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 credit losses, excluding Argentina, reflected a €68.3 million decrease in provisions for credit losses (provisions for credit losses were €1,761.5 million in 2002 compared to €1,829.7 million in 2001), 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 loans previously charged-off (recoveries totaled €364.9 million in 2002 compared to €444.4 million in 2001).
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Net provisions for credit 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 credit losses (excluding Argentina) reflects a €352.1 million decrease in provisions for statistical credit losses partially offset by a €283.8 million increase in specific and general provisions for credit losses. (See “Item 4. Information on the Company—B. Business Overview—Classified Assets—Bank of Spain Classification Requirements—Allowance for the Statistical Coverage of Credit Losses”). The overall decrease in provisions for credit losses relates to decreased non-performing assets in Spain and abroad despite a relatively difficult economic environment.
We continue our policy of managing our country-risk exposure on a rigorous basis. Our total country-risk exposure with third parties, net of allowances, 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 loans previously charged-off 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 credit 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.
Our coverage ratio (excluding country risk) was 139.9% at December 31, 2002, and 143.3% at December 31, 2001. See “Selected Statistical Information—Non-Performing Asset Ratios”.
Extraordinary Results
We had extraordinary net income of €668.7 million in 2003, compared to an extraordinary net loss of €338.8 million in 2002 and extraordinary net income of €61.2 million in 2001.
The net credit balance of €668.7 million in 2003 includes the gains or losses on disposal of property and equipment and long-term investments (gains of €696 million and losses of €93 million); the collection of interest on doubtful and nonperforming loans earned in prior years (€92 million); monetary adjustment (€9.1 million) (see note 2-b to our consolidated financial statements); provisions to pension allowances (€120.1 million) (see note 2-j to our consolidated financial statements); and other net income of €103 million.
The net debit balance of €338.8 million in 2002 includes the gains or losses on disposal of property and equipment and long-term financial investments (gains of €443 million and losses of €122 million); the collection of interest on doubtful and nonperforming loans earned in prior years (€76 million); losses from monetary adjustments (€69.5 million) (see note 2-b to our consolidated financial statements); provisions to pension allowances of €350.8 million (see note 2-j to our consolidated financial statements) and other net losses of €315 million, resulting mainly from the impact of writedowns of technological companies and other companies and businesses located outside Spain (including, those relating to the specific allowance recorded for Argentina 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.
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Provision for Income Taxes
The provision for corporate income and other taxes was €869.4 million in 2003, a 20.2% or €146.3 million increase from €723.1 million in 2002, which was a 20.6% or €187.3 million decrease from €910.4 million in 2001. The effective tax rate was 21.2% in 2003, 20.6% in 2002 and 21.5% in 2001. For information about factors affecting effective tax rates, see note 22 to our consolidated financial statements.
Minority Interests
Minority interests were €621.2 million in 2003, a 15.4% or €82.7 million increase from €538.5 million in 2002, which was a 35.9% or €302.1 million decrease from €840.6 million in 2001.
The €82.7 million increase in 2003 reflected mainly a €168.9 million increase in net income attributable to minority shareholders, principally related to increased minority interests in Banesto and Santander Serfín, and a €86.2 million decrease in dividends on preference shares of subsidiaries principally as a result of the early amortizations made during 2003 and the dollar’s slide against the euro.
The €302.1 million decrease in 2002 reflected mainly a €202.5 million decrease in net 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).
Net Income Information on U.S. GAAP Basis
Our consolidated financial statements have been prepared in accordance with Spanish GAAP. Spanish GAAP differs in certain significant respects from U.S. GAAP. For a summary of the most significant adjustments required to arrive at net income on U.S. GAAP basis, see note 27 to our consolidated financial statements.
Financial Condition
Assets and Liabilities
Our total assets were €351,790.5 million at December 31, 2003, a 8.5% or €27,582.4 million increase from total assets of €324,208.1 million at December 31, 2002, which was a 9.5% or €33.9 million decrease from total assets of €358,137.5 million at December 31, 2001. Our gross loans and credits to corporate clients, individual clients and government and public entities which include securities purchased from such clients under agreements to resell, increased by 5.8% to €177,620.7 million at December 31, 2003 from €167,911.2 million at December 31, 2002, mainly due to increased business in Spain, Germany and Portugal while in Latin America our gross loans and credits decreased due to the depreciation of some 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 clients under agreements to repurchase, decreased by 5.1% from €167,815.8 million at December 31, 2002, to €159.335.6 million at December 31, 2003, mainly due to the depreciation of some of the Latin American currencies. Other managed funds, including mutual funds, pension funds and other managed portfolios, increased by 16.7% from €93,337.9 million at
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December 31, 2002, to €108,903.0 million at December 31, 2003, mainly due to increased mutual funds in Spain and abroad.
Capital
Stockholders’ equity, net of treasury stock, at December 31, 2003, was €19,069.0 million, an increase of €826.9 million or 4.5% from €18,242.1 million at December 31, 2002, mainly due to increased reserves and net income. See Note 2 of our Consolidated Financial Statements.
At December 31, 2003, our ratio of total capital to risk-weighted assets under Bank of Spain regulations was 10.63%, which reflected a 32.8% or €5.7 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, 2003 and 2002 were as set forth below.
B. Liquidity and capital resources
As a financial group, our main source of liquidity is our customer deposits which consist primarily of demand, savings and time deposits. In addition, we complement our customer deposits through the access to the interbank market (overnight and time deposits) and to the domestic and international capital markets. For this purpose, we have in place a series of domestic and international programs for the issuance of commercial paper and medium and long term debt. We also maintain a diversified portfolio of liquid assets and securitized assets throughout the year. In addition, another source of liquidity is the generation of cash flow.
We have raised significant funds in the domestic and international capital markets in order to finance our activities. Under the 2003 Issues and Securitization Plan, we obtained €26.0 billion from the capital markets, 54% of which was obtained through medium and long-term issues, including preference shares and subordinated debt. Securitization of medium and long-term assets amounted to €8.0 billion in 2003.
At December 31, 2003, we had outstanding €28.8 billion of senior debt, of which €12.2 billion were mortgage bonds and €15.6 billion promissory notes, as well as €11.2 billion in subordinated debt and €4.5 billion in preferred stock.
The following table shows the average balances during the years 2003 and 2002 of our principal sources of funds:
The average maturity of the outstanding debt as of December 31, 2003 is the following:
Exhibits V and VI to our consolidated financial statements included herein show a detail of our senior and subordinated long-term debt, including their maturities.
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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. Our credit ratings are as follows:
Our total customer funds (customer deposits, excluding assets sold under repurchase agreements, marketable debt securities and subordinated debt) totaled €188.4 billion at December 31, 2003. Including assets sold under repurchase agreements, customer funds totaled €215.0 billion at December 31, 2003. Our loans and credits (gross) totaled €177.6 billion at the same date.
We, the Santander Group, are a European and Latin American financial group. Although, at this moment, except for Argentina and Venezuela, we are not aware of any legal or economic restrictions on the ability of our subsidiaries to transfer funds to the Bank (the parent company) in the form of cash dividends, loans or advances, capital repatriation and other forms, there is no assurance that in the future such restrictions will not be adopted or how they would affect our business. Nevertheless, the geographic diversification of our businesses 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, 2003 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”.
Other contingent liabilities and commitments
As of December 31, 2003 and 2002, we had outstanding the following contingent liabilities and commitments:
Relationship with unconsolidated companies
We have significant holdings in companies whose business activity is not directly related to that of the Bank. According to Spanish GAAP, these holdings are not consolidated. (See a detail of these companies in Exhibit II to our Consolidated Financial Statements).
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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 (“fondos de titulización”) in our securitization activity. We are not required to repurchase assets or contribute additional assets to any of these special purpose vehicles. We do, however, provide in the ordinary course of business certain loans to some of these special purpose vehicles, which loans are provisioned in accordance with the risks involved. In 2003, the Group securitized €8 billion of medium and long-term assets.
We do not have transactions with un-consolidated entities other than the aforementioned ones.
C. Research and development, patents and licenses, etc.
We do not currently conduct any significant research and development activities.
D. Trend information
The European financial services sector is likely to remain competitive with an increasing number of financial service providers and alternative distribution channels. Further, consolidation in the sector (through mergers, acquisitions or alliances) is likely to occur as the other major banks look to increase their market share or combine with complementary businesses. It is foreseeable that regulatory changes will take place in the future that will diminish barriers in the markets.
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:
International Financial Reporting Standards (“IFRS”) and International Accounting Standards (“IAS”)
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 in 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.
The rule that regulates the first application of the IAS was published in 2003. This new rule provides that the reformulation of the 2004 financial statements, which will have to be done so that the 2005 financial statements can be compared with those of 2004, will not be proforma but definitive. When the IAS goes into effect, the assets and liabilities of the initial balance sheet will be those of January 1, 2004 and thus it is likely that the goodwill maintained in the future on the Group’s balance sheet will be that at the end of 2003.
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E. Off-balance sheet arrangements
We have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
F. Tabular disclosure of contractual obligations
The following table summarizes our contractual obligations by remaining maturity at December 31, 2003.
The maturity of deposits from credit institutions and from customer deposits is given in Notes 14 and 15 of the consolidated financial statements, respectively.
Other than what is disclosed under “Purchase Obligations” in the table above, we do not have any capital or operating leases outstanding.
For a description of the Bank’s futures transactions, see Note 23 to our consolidated financial statements.
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Item 6. Directors, Senior Management and Employees
A. Directors and senior management.
We are managed by our board of directors which currently consists of 20 members. In accordance with our Bylaws (Estatutos), the board shall consist of at least 14 and not more than 30 members. Each member of the board is elected to a three-year term by our stockholders at a general meeting, with approximately one-third of the members being elected each year, but they can be reelected.
Our board of directors meets approximately eight or nine times per year. In 2003, it met 10 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, which generally meets twice a week. Executive officers are appointed and removed by the board.
The current members of our board of directors are (1):
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Our current Executive Officers are:
Following is a summary description of the relevant business experience and principal business activities of our current directors and executive officers performed both within and outside Banco Santander Central Hispano, S.A.:
Emilio Botín (Chairman of the Board of Directors and of the Executive Committee)
Born in 1934. He joined Banco Santander in 1958 and in 1986 he was appointed Chairman of the Board. He is also Director of The Royal Bank of Scotland Group, plc.
Jaime Botín (First Vice Chairman)
Born in 1936. Former Chairman of Bankinter, S.A. He is Chairman of Línea Directa Aseguradora, S.A.
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 and Director of Cepsa.
Matías R. Inciarte (Third Vice Chairman and Chairman of the Risk Committee)
Born in 1948. He joined Banco Santander in 1984 and was appointed Executive Vice President and Chief Financial Officer in 1986. In 1988 he was appointed Director and in 1994 Second Vice Chairman. He is also Chairman of Unión de Crédito Inmobiliario, S.A., and Director of Banesto, S.A., Financiera Ponferrada, S.A., Grupo Corporativo Ono, S.A. and Cía. 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 Vice Chairman and Director of Indra Sistemas, S.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., Inversiones Naira SIMCAVF, S.A. and Torreal SCR, S.A. and a representative of the director Nueva Compañía de Inversiones, S.A. and of the director Austral, BV on the boards of Sacyr-Vallehermoso, S.A. and Compañía Vinícola del Norte de España, S.A., respectively.
Assicurazioni Generali, S.p.A. (“Assicurazioni”)
An Italian insurance company represented by its Chairman, Mr. Antoine Bernhein who was born in 1924. Assicurazioni is a former Director of Banco Central Hispanoamericano from 1994 to 1999. Assicurazioni was appointed Director in April 1999.
Fernando de Asúa (Chairman of the Appointments and Remuneration Committee)
Born in 1932. Former Vice Chairman of Banco Central Hispanoamericano from 1991 to 1999. He was appointed Director in April 1999. He is a Honorary Chairman of IBM España, S.A. and a Director of Cepsa, Técnicas Reunidas, S.A., Air Liquide España, S.A. and Constructora Inmobiliaria Urbanizadora Vasco-Aragonesa, S.A., and a representative of the director FAA Inversiones, S.A. on the board of 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 Faes Farma, S.A. and a Director of Pescanova, S.A., Cepsa and Sacyr-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 and Secretary General of Commerce of the Spanish Government and Chief Executive Officer of Banco Pastor. He was appointed Director in June 2002. He is Chairman of AVIVA Vida y Pensiones, S.A. and a Director of Campofrío Alimentación, S.A., Unión Fenosa, S.A., Telepizza, S.A., Goldman Sachs Europe Ltd. and AVIVA plc.
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. and Inversiones Inmobiliarias Lar, S.A.
Antonio Escámez
Born in 1951. Former Director and Executive Vice President of Banco Central Hispanoamericano from 1988 to 1999. He was appointed Director in April 1999. He is also Chairman of Arena Communications España, S.A. and Vice Chairman of Banque Commerciale du Maroc.
Francisco Luzón
Born in 1948. He joined Banco Santander in 1996 as Executive Vice President, Adjoint to the Chairman. Former Chairman of Banco Exterior de España (from 1988 to 1996), Caja Postal (from 1991 to 1996), Corporación Bancaria de España (from 1991 to 1996) and of Argentaria (1996). He is also a Director of Industria de Diseño Textil, S.A. and Chairman of the Social Council of the Autonomous Region of Castilla – La Mancha.
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Elías Masaveu
Born in 1930. He is Chairman of Grupo Masaveu, Tudela Veguín, S.A. and Propiedades Urbanas, S.A. and Director of Bankinter, S.A.
George Mathewson
Born in 1940. Former Chief Executive Officer and Executive Vice Chairman of The Royal Bank of Scotland Group, 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 of the Spanish Government and EU Commissioner (from 1989 to 1993). He is also 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 Telecomunicaciones, S.A., Auna Operadores de Telecomunicaciones, S.A., Endesa Diversificación, S.A., Retevisión Móvil, S.A. and Constructora Inmobiliaria Urbanizadora Vasco-Aragonesa, S.A., Director of Saint Gobain Cristalería, S.A. and a representative of the director Constructora Inmobiliaria Urbanizadora Vasco Aragonesa, S.A. on the board of Centro Asegurador, S.A.
Mutua Madrileña Automovilista
Spanish car insurance company represented on our board by Mr. Luis Rodríguez who was born in 1941, Director of Mutua Madrileña Automovilista and Chairman of Mutuactivos.
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.
Ignacio Benjumea
Born in 1952. He joined Banco Santander in 1987 as General Secretary of Banco Santander de Negocios. In 1994 he was appointed General Secretary and Secretary of the Board of Banco Santander. In 1999, he was appointed Executive Vice President, Secretary General and of the Board of Banco Santander Central Hispano. He is also a Director of Sociedad Holding de Mercados y Sistemas Financieros, S.A., Sociedad Rectora de la Bolsa de Madrid, S.A., Bolsas y Mercados Españoles and La Unión Resinera, S.A.
Teodoro Bragado
Born in 1944. He joined the Bank in 1985. He was appointed Executive Vice President, Risks in March 2003. He is also a Director of Compañía Española de Seguros de Crédito a la Exportación (“CESCE”) and COFIDES.
Fernando Cañas
Born in 1950. Former Manager of Banco Santander Chile. He was appointed Executive Vice President in 2003, responsible for the Means of Payment Project of the Latin America Division.
Juan Manuel Cendoya
Born in 1967. Former Manager of the Legal and Tax Departament of Bankinter, S.A. from 1999 to 2001. He joined the Bank on July 23, 2001 as Executive Vice President, Communications and Economic Studies.
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, Risks. He is also Chairman of Unión de Crédito Inmobiliario, S.A., E.F.C. and Director of Unión de Crédito Inmobiliario, S.A.
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Enrique G. Candelas
Born in 1953. He joined Banco Santander in 1975 and was appointed Senior Vice President in 1993. He was appointed Executive Vice President, Retail Banking in January 1999. He is also a Director of Mobipay España, S.A.
Francisco G. Roldán
Born in 1953. Former Chief Executive Officer of Grupo Argentaria, Caja Postal and Banco Hipotecario from 1996 to June 2000, and of Banesto from June 2000 until March 2002. In March 2002, he was appointed Executive Vice President, Finance of Banco Santander Central Hispano, S.A. 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 Portfolio in June 2001. He is also Vice Chairman and Chief Executive Officer of AUNA, Operadores de Telecomunicaciones, S.A, and a Director of Antena 3 Televisión, Teka Industrial, and ACS Actividades de Construcción y Servicios, S.A.
Juan Guitard
Born in 1960. Former General Secretary of the Board of Banco Santander de Negocios (from 1994 to 1999) and Manager of the Investment Banking Department of the Bank (from 1999 to 2000). He rejoined the Bank in 2002, being appointed Executive Vice President, Vice-Secretary General and of the Board.
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 in 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 Group.
Francisco Martín
Born in 1955. He joined the Bank in 1985 and in 1992 was appointed Executive Vice President, Head of the International Division. In 2002, he became Executive Vice President, Head of Global Corporate Banking.
Pedro Mateache
Born in 1959. Former partner-manager of McKinsey & Co. He was appointed Executive Vice President, Resources and Costs in 2003.
Serafín Méndez
Born in 1947. He joined the Bank in 1964. He is the Manager of the Premises and Security Area and was appointed Executive Vice President, Resources and Costs in 2004.
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, Risks.
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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 America. He is also Vice Chairman of Comunitel Global, S.A. and Director of Best Global, S.A. and Unión Fenosa, S.A.
Juan R. Inciarte
Born in 1952. He joined Banco Santander in 1985 as Director and Executive Vice President of Banco Santander de Negocios. In 1989 he was appointed Executive Vice President and in 1991 Director of Banco Santander. He is also a Director of Cepsa, S.A., Finanzauto, S.A., and The Royal Bank of Scotland Group, plc.
José Tejón
Born in 1951. He joined the Bank in 1989. In 2002 he was appointed Executive Vice President, Finance.
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.
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 three 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 Mathewson (Chairman of the Royal Bank of Scotland Group), Assicurazioni Generali S.p.A., (represented by Mr. Antoine Bernhein) and Mutua Madrileña Automovilista (represented by Mr. Luis Rodriguez).
B. Compensation.
Directors’ compensation
Article 37 of the Bank’s bylaws provides that the members of our board of directors shall receive an amount up to 5% of the Bank’s net income for any fiscal year, for performing their duties as directors.
The Board of Directors, making use of the powers conferred on it, allocated 0.196% of the Bank’s income for 2003 (as compared to 0.191% for 2002 and 0.254% for 2001), as compensation (in the aggregate) for itself.
Consequently, the gross amount to be received by each director as compensation in 2003 and 2002 (€65,000 in each year) is 10% lower than that set for 2001 (€72,000). Additionally, the Executive Committee members receive additional compensation, the gross amount of which was €141,000 in 2003 and 2002 (also 10% below the €157,000 received in 2001).
Finally, from 2002 onwards, the members of the Audit and Compliance Committee receive additional compensation in the amount of €32,000 per year.
Salary compensation
The detail of the salary compensation received by the Bank’s executive directors, who as of December 31, 2003 and 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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The detail by director of the compensation earned by the Bank’s directors in 2003 as discussed above is as follows:
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Compensation to the Board members as representatives of the Bank and to senior management
Representation on other boards
By resolution of the Executive Committee, all the compensation received by the Bank’s directors who represent the Bank on the Boards of Directors of listed companies in which the Bank has a stake (at the expense of those companies) relating to appointments made after March 18, 2002, will accrue to the Group. The compensation received in 2003 in connection with representation duties of this kind, relating to appointments made after March 18, 2002, was as follows:
Senior management
Additionally, following is a detail of the aggregate compensation paid to the Bank’s Executive Officers (*) in 2003 and 2002:
Pension commitments, other insurance and other items
The total balance of supplementary pension obligations assumed by the Group over the years for its current and retired employees, which amounted to €13,305 million (covered mostly by in-house allowances) as of December 31, 2003, includes the obligations to those who have been directors of the Bank during the year and who discharge (or have discharged) executive functions during the year. The total pension commitments for these directors, together with the total sum insured under life insurance policies at that date and other items, amounted to €162 million as of December 31, 2003 (€256 million as of December 31, 2002, of which €108 million related to the settlement of the pension rights referred to below, and €209 million as of December 31, 2001, which did not include the extraordinary nonrecurring payment of €43.75 million paid in 2001 as a result of the retirement of the former co-chairman of the Bank, Mr. José María Amusátegui).
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The following table provides information on the obligations undertaken and covered by the Group relating to pension commitments to and other insurance for the Bank’s Executive Directors:
Additionally, other directors benefit from life insurance policies at the Group’s expense, the related insured sum being €3 million as of December 31, 2003, 2002 and 2001.
Pension settlement
Following the decision of Mr. Ángel Corcóstegui to resign, for personal reasons, in February 2002 from his position as First Vice Chairman of the Bank and board member (which entailed his corresponding resignation as Chief Executive Officer of the Bank and as member of the various Board Committees on which he sat), and in settlement for the pension commitments to him, the Bank paid on his resignation a gross amount of €108 million for his pension rights. This amount had been fully provided for as of that date. Upon payment, a withholding of 48% was made, and the amount withheld was paid into the Spanish Treasury. Accordingly, the net amount paid to Mr. Corcóstegui in this connection was €56 million.
Stock option plan
The detail of the Bank’s stock options granted to the Board members as of December 31, 2003, is as follows:
Description of Stock Option and Compensation Plans
In recent years, the Bank has put in place compensation systems for its managers and employees linked to the market performance of the Bank’s shares based on the achievement of certain objectives. Below is a summary of the different stock option and compensation plans in effect as from January 1, 2003:
Plan Four
Six 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
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date of exercise of the options. During 2003, no options were exercised and as of December 31, 2003, the balance of outstanding options under this plan was 264,000.
Managers Plan 1999
243 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 2003, 678,325 options were exercised and as of December 31, 2003, the balance of outstanding options under this plan was 1,313,999.
Additional Managers Plan 1999
14 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, 24,512 options were exercised and as of December 31, 2003, the balance of outstanding options under this plan was 59,967.
Investment Banking Plan
56 of our officers from the Global Wholesale Banking Division participate in an equity incentive plan known as the “Investment Banking Plan”. The number of options received by plan participants under this plan is based on the extent to which certain business objectives are achieved, each option received under this plan grants its holder the right to receive one share of Banco Santander Central Hispano ordinary common stock, par value €0.50. The exercise price of the shares subject to this plan is €10.25, and plan participants may exercise the first 50% of the options granted from June 16, 2003, and the remaining 50% from June 16, 2004. The exercise period ends in both cases on June 15, 2005. As of December 31, 2003, the balance of outstanding options under this plan was 4,503,750.
Young Executives Plan
319 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 the first 50% of the options granted from July 1, 2003 until June 30, 2005 and the remaining 50% from July 1, 2004 until June 30, 2005. Plan participants must hold the shares acquired through this plan for a period of twelve months following the date of exercise of the options. As of December 31, 2003, the balance of outstanding options under this plan was 926,250.
Managers Plan 2000
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, 2003, the balance of outstanding options under this plan was 14,367,000.
European Branches Plan
29 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 1,615,000 of the options granted from July 1, 2004 until July 15, 2004, and may exercise the remaining options granted from July 1, 2005 until July 15, 2005. As of December 31, 2003, the balance of outstanding shares to be delivered under this plan was 4,305,000.
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Stock Option and Compensation Plans
C. Board practices.
Date of expiration of the current term of office of the directors and the period during which the directors have served in that office:
The period during which the directors have served in their office is shown in the table under Section A of this Item 6.
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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, 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. Additionally, 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 entitling them to receive (i) an indemnity payment in an amount ranging from two times their fixed annual compensation to three times their total annual compensation (including fixed and variable compensation) (or in the case of certain members of management, up to 5 times their total fixed compensation) and forcing them to forfeit any pension or other retirement benefits to which they would have otherwise been entitled, or (ii) in some cases, to receive only their pension or other retirement benefits (without any indemnity payment).
On November 4, 2003, the SEC approved new rules proposed by the New York Stock Exchange (NYSE) intended to strengthen corporate governance standards for listed companies. In compliance therewith, the following is a summary of the significant differences between our corporate governance practices and those applicable to domestic issuers under the NYSE listing standards.
Independence of the Directors on the Board of Directors
Under the NYSE corporate governance rules, a majority of the Board of Directors must be composed of independent directors, the independence of whom is determined in accordance with highly detailed rules promulgated by the NYSE. Spanish law does not contain any such requirements. The Board of Directors of Banco Santander Central Hispano has seven independent directors (out of twenty directors total), as defined in Article 5 of the Regulations of the Board of Directors. We have not determined whether or not the directors on the Banco Santander Central Hispano Board would be considered independent under the NYSE rules. Article 5 of the Regulations of the Board of Directors defines the concept of an independent director as follows:
“Independent directors shall be deemed to be those external or non-executive Directors who: (i) are not, and do not represent, shareholders who have the power to influence the control of the Company; (ii) have not held executive positions therein in the last three years; (iii) are not connected to executive Directors by a family or professional bond; or (iv) do not maintain and have not maintained any relations with the Company or the Group which may impair their independence.”
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Independence of the Directors on the Audit and Compliance Committee
Under the NYSE corporate governance rules, a majority of the audit committee must be composed of independent directors and by July 31, 2005, all members of the audit committee must be independent. Independence is determined in accordance with highly detailed rules promulgated by the NYSE.
The Audit and Compliance Committee of the Board of Directors of Banco Santander Central Hispano is composed of six directors, five of whom are independent in accordance with the standards set forth in the previously mentioned Article 5 of the Board’s Regulations. These independence standards may not necessarily be consistent with, or as stringent as, the director independence standards established by the NYSE. Under Spanish law, a majority of the members and the chairman of the audit committee must be non-executive. All members of our Audit and Compliance Committee are non-executive directors and its chairman is independent in accordance with the standards set forth by the Board’s Regulations. The composition of the Audit and Compliance Committee is described under “Item 6. Directors, Senior Management and Employees—C. Board Practices—Audit and Compliance Committee and Appointments and Remuneration Committee”.
Independence of the Directors on the Appointments and Remuneration Committee
In accordance with the NYSE corporate governance rules, all U.S. companies listed on the NYSE must have a compensation committee and a nominations committee and all members of such committees must be independent in accordance with highly detailed rules promulgated by the NYSE. Under Spanish law, these committees are not required, though there is a non-binding recommendation for listed companies in Spain to have these committees and for them to be composed of non-executive directors. Banco Santander Central Hispano satisfies this non-binding recommendation. The composition of the Appointments and Remuneration Committee is described under “Item 6. Directors, Senior Management and Employees—C. Board Practices—Audit and Compliance Committee and Appointments and Remuneration Committee”.
Separate Meetings for Independent Directors
In accordance with the NYSE corporate governance rules, independent directors must meet periodically outside of the presence of the executive directors. Under Spanish law, this practice is not contemplated and as such, the independent directors on the Board of Directors of Banco Santander Central Hispano do not meet outside of the presence of the other directors.
Code of Ethics
Under the NYSE corporate governance rules, all U.S. companies listed on the NYSE must adopt a Code of Business Conduct and Ethics which contains certain required topics. Banco Santander Central Hispano adopted a “General Code of Conduct”, which applies to all members of the boards of the companies of the Group, to all employees subject to the Code of Conduct in the Securities Market, including the Bank’s chief executive officer, chief financial officer and chief accounting officer, and to all those employees designated by the Human Resources Division that have been specifically informed of their subjection to this General Code of Conduct. This Code establishes the principles that guide the actions of officers and directors: ethical conduct, professional standards and confidentiality. It also establishes the limitations and defines the conflicts of interests arising from their status as senior executives or directors.
Banco Santander Central Hispano’s Code is available to the public on its website, which does not form part of this annual report on Form 20-F, at www.gruposantander.com under the heading “Corporate Governance – Internal Code of Conduct”. As of December 31, 2003, no waivers with respect to the General Code of Conduct had been applied for or granted.
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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. These independence standards may not necessarily be consistent with, or as stringent as, the director independence standards established by the NYSE).
The Audit and Compliance Committee:
The Audit and Compliance Committee was created to provide support and specialization in the tasks of controlling and reviewing the accounts and compliance. Its mission, which has been defined and approved by the Board, is established in the by-laws and in the Regulations of the Board. Only non-executive directors can be members of this Committee with independent directors (as defined in the Board’s Regulations) having a majority representation. Its chairman must always be an independent director (as defined in the Board’s Regulations) and someone who has the necessary knowledge and experience of accounting techniques and principles. Currently, the Chairman of the Audit and Compliance Committee is Mr. Manuel Soto, the Fourth Vice-Chairman of the Board of Directors.
Functions of the Audit and Compliance Committee:
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The Audit and Compliance Committee made a specific valuation of its functioning throughout the year 2003. A report on the activity of the Audit and Compliance Committee in 2003 was distributed jointly with the annual report of the Group sent to the shareholders.
The following are the current members of the Audit and Compliance Committee:
The Appointments and Remuneration Committee:
The Regulations of the Board state that the members of this Committee must all be non-executive directors with independent directors (as defined in the Board’s Regulations) having a majority representation and being its chairman an independent director (as defined in the Board’s Regulations).
Functions of the Appointments and Remuneration Committee
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The following are the members of the Appointments and Remuneration Committee:
D. Employees.
At December 31, 2003, we had 103,038 employees (104,178 in 2002 and 114,927 in 2001) of which 34,956 were employed in Spain (35,887 in 2002 and 40,741 in 2001) and 68,082 were employed outside Spain (68,291 in 2002 and 74,186 in 2001). 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 was executed in February 2004 and expires in December 2004.
The table below shows our employees by geographic area:
As of December 31, 2003, we had 2,172 temporary employees (1,622 at December 31, 2002).
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E. Share ownership.
As of June 28, 2004, 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.
Banco Santander Central Hispano’s capital is comprised of only one class of shares, all of which are ordinary and have the same rights.
As of June 28, 2004, our current executive officers (not directors) referred to above under Section A of this Item 6 as a group beneficially owned, directly or indirectly, 2,356,309 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 beneficially owns, directly or indirectly, one percent or more of the outstanding share capital as of that date.
Item 7. Major Shareholders and Related Party Transactions
A. Major shareholders.
As of December 31, 2003, 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.
At December 31, 2003 a total of 344,517,260 shares, or 7.23% of our share capital, were held by 836 registered holders with registered addresses in the United States and Puerto Rico, including JPMorgan Chase, as depositary of our American Depositary Share Program. These shares were held by 101 record holders. Since certain of such shares and
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ADRs are held by nominees, the foregoing figures are not representative of the number of beneficial holders. Our directors and executive officers did not own any ADRs as of December 31, 2003.
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.
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, 2003, amounted to €10.1 million (€14.4 million and €7.8 million as of December 31, 2002 and 2001, respectively) of loans and credits to such directors and €0.4 million (€1.2 million and €0.8 million as of December 31, 2002 and 2001, respectively) of guarantees provided to them. These loans and credits and guarantees were granted at market rates in all cases.
The detail by director as of December 31, 2003, is as follows:
Additionally, the total amount of loans and credits and guarantees made by us to our executive officers who are not directors, as of December 31, 2003, amounted to €8.4 million.
Loans extended to related parties were made in the ordinary course of business, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectibility or present other unfavorable features.
Loans made to other Related Parties
The companies of the Group engage, on a regular and routine basis, in a number of customary transactions among Group members, including:
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and others within the scope of the ordinary course of the banking business, such as loans and other banking services to our shareholders, to employees of all levels, and the associates and the members of the families of all the above-mentioned, as well as those other businesses conducted by the companies of the Group. All these transactions are made:
As of December 31, 2003, an aggregate of €1,445.5 million in loans and credits to non-consolidable and associated companies was outstanding (€1,364.5 million as of December 31, 2002). These loans and credits represented 0.8% of our total net loans and credits and 7.6% of our total stockholders' equity at December 31, 2003 (0.8% and 7.5%, respectively, at December 31, 2002).
For more information, see Notes 3 and 24 to our Consolidated Financial Statements.
Not Applicable
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Item 8. Financial Information
Financial Statements
See Item 18 for our Consolidated Financial Statements.
(a) Index to Consolidated Financial Statements of Banco Santander Central Hispano, S.A.
Legal Proceedings
Banco Santander Central Hispano
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 h is claim. The plaintiff's appeal was then rejected by the court on December 2, 2002. The plaintiff has appealed for redress and the Bank has asked the court not to admit such appeal. The second claim was rejected by the courts of the city of Santander on November 29, 2002 and the plaintiffs appealed. Such appeal was subsequently rejected by the court on July 5, 2004. 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 asked 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 appealed such rejection and, although the court allowed the admission of new evidence, the claim was again rejected on April 13, 2004. One of the plaintiffs has appealed for redress.
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 participation during the meeting and of receipt of 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 appealed the rejection but the court rejected the appeal on January 14, 2004. The plaintiff has appealed for redress and the Bank has asked the court not to admit such appeal.
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The resolutions adopted at 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 dismissal of one of the Directors. The Bank responded to the claim on October 5, 2002. During the term to respond to this claim, the Bank was required to respond to another claim, filed by a different shareholder, c hallenging some of the resolutions adopted at the same meeting. The claim was admitted by the same court of the city of Santander 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 and the Bank has already answered the appeal.
Since 1992, the Madrid Central Court number 3 has had preliminary investigative court proceedings in progress against the Bank and three of its officers 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 specific reserve is required. On July 16, 1996, the Madrid Central Court number 3 entered a partial dismissal order with respect to certain of the matters in dispute. This dismissal order was not appealed. However, the proceedings with respect to the other matters remained open. On June 27, 2002, the lower court changed the cited proceedings to an Abbreviated Procedure, thereby terminating the investigative phase of the proceedings. The Office of the Public Prosecutor and the Bank appealed this decision. On June 23, 2003, the appeals court partially reversed the lower court’s decision, substantially reducing the scope of the proceedings. Nevertheless, such proceedings against the Bank and three of its officers, although limited in scope, remain open. The indictment proceedings concluded on July 1, 2004 and during these proceedings both the Office of the Public Prosecutor (public criminal complainant) and the Attorney General (sole private criminal complainant) have reiterated their request for dismissal of the case. As a result, the legal action is supported only by a citizen complainant.
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 certain credit assignment transactions held by such clients. Although a similar case in an amount of €3.8 million was successfully appealed by the Bank in June 2003 (and then appealed in turn by the Regional tax authorities), our appeal against this writ was rejected. We filed a second appeal which was partially admitted by the court on October 30, 2003. Both the Bank and the State’s attorney have appealed such decision before the Supreme Court.
The resolutions adopted at our shareholders’ meeting held on June 21, 2003 have been challenged under Spanish law by three shareholders who filed their claims before the courts of the city of Santander. The three plaintiff shareholders challenged the resolution approving the annual accounts and the management of the Bank and of the Group for 2002. In addition, two out of the three plaintiff shareholders challenged the resolutions approving the profit allocation for 2002 and the regulation of shareholders’ meetings. On October 10, 2003, the Bank answered the claims. The preliminary hearing took place on January 21, 2004. On February 11, 2004 the Court decided to suspend the proceedings until the preliminary proceedings 352/2002 being carried out by the Madrid Central Court number 3 (referred to hereinbelow) are finalized.
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. The court rejected the claim on December 16, 2003, but the plaintiff has appealed.
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 9, 2003, and the plaintiff appealed the court’s decision. The appeal was opposed by the defendants. This claim is described for informational purposes only and does not constitute an implied representation that we have described all clai ms of equal or greater magnitude than this claim.
For the same informational purposes, it is also mentioned that several persons, who allegedly have funds deposited in Banco Río de la Plata, S.A., filed an application for conciliation before the courts of the city of Madrid against the Bank, the persons who were members of the Board 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. In January 2004, there was a preliminary hearing in connection with a similar
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case, in which a person who allegedly deposited funds in Banco Río de la Plata, S.A. is claiming USD 8,365.71. The Court has not determined the date for the next hearing yet.
For the same informational purposes, it is mentioned that the Madrid Central Court number 3 is carrying forward preliminary proceedings 352/2002 in connection with complaints filed by two shareholders against the chairman of the Bank, regarding the economic terms of the retirement in August 2001 of the former co-chairman, Mr. José María Amusátegui and the economic terms of the resignation in February 2002 of the former first vice-chairman and chief executive officer, Mr. Angel Corcóstegui. The prosecutor and the defendants requested the dismissal of the case, which was opposed by the plaintiff shareholders. On October 16, 2003 the Court decided to change the cited proceedings to an abbreviated procedure. The public prosecutor and the Chairman of the Bank appealed the decision. The hearing of the appeals took place on February 9, 2004, and on February 18, 2004 the Court decided not to admit such appeals without entering into the merits of the matter. The Chairman of the Bank then appealed to the Constitutional Court. The prosecutor again requested the dismissal of the case. On April 26, 2004, the Madrid Central Court number 3 decided to commence oral evidentiary proceedings. On May 10, 2004, with two dissenting votes, and in spite of the favorable report of the prosecutor, the Constitutional Court decided not to admit the appeal.
On September 25, 2003, the Bank announced that it would launch a public offering in Spain for the acquisition of up to 16% of the share capital of Compañía Española de Petróleos, S.A. (“Cepsa”), a Spanish oil and petrochemical company. On October 21, 2003, the Spanish National Securities Commission authorized the Bank to launch the offering. The acceptance term of the offering expired on November 24, 2003. The bid was accepted by shares representing 12.13% of Cepsa’s share capital.
The Bank decided to launch the bid for Cepsa once the agreements with the French group Total (“Total”), an oil and petrochemical group and major shareholder of Cepsa, to act in concert with respect to the parties’ investments in Cepsa had become ineffective after the enactment of Law 26/2003 of July 17, 2003 (“Ley de Transparencia”). These agreements included those related to the company Somaen Dos, S.L. (“Somaen Dos”), a holding company in which the Bank, Total and Unión Fenosa, S.A. (“Unión Fenosa”) have participations of approximately 60%, 25% and 15%, respectively. Somaen Dos owns shares representing 33.23% of Cepsa’s share capital, of which 19.92% belong to the Bank, 8.31% to Total and 5.00% to Unión Fenosa.
After our announcement to launch the public offering, Total filed on October 13, 2003 a request for a summary arbitral proceeding with the Netherlands Arbitration Institute seeking the adoption of certain injunctive measures. On November 25, 2003, that arbitration institute made public a ruling that, among other measures, imposed a temporary prohibition of the sale or encumbrance of the Cepsa shares owned by Somaen Dos as well as the Cepsa shares that the Bank had acquired in the bid. Furthermore, the ruling instructed both the Bank and Total to presently respect the supermajority rules contained in the agreements to act in concert in Cepsa and the rules, also established in those agreements, governing the right to appoint Directors of the boards of Cepsa and Somaen Dos.
Additionally, on October 20, 2003, the Total group filed a request for an arbitral proceeding with the Netherlands Arbitration Institute seeking a determination on the merits of its claim that, among others, the “Ley de Transparencia” did not render their agreements with the Bank ineffective. The Bank responded that it was opposed to such request. Currently, that arbitral proceeding remains open. The decision to be adopted in the proceeding on the merits of the claim will not be conditioned by the above-mentioned ruling which is temporary and which does not constitute a pre-judgment on the merits.
In May 2004, Chadia Limited, S.A. filed a suit against Banco Santander Central Hispano S.A., carried out before the Court of 1st Instance number 48 of Madrid, proceeding number 420/2004, alleging that the Bank breached an alleged agreement for the sale to the plaintiff of certain buildings and seeking damages in the amount of €133 million. The Bank has submitted its response to this claim.
In 1995 and 1996, the former directors of Banesto, who had been replaced by decision of the Bank of Spain’s Executive Council on December 28, 1993, filed claims challenging certain corporate resolutions adopted by the shareholders’ meetings held on March 26, and August 22, 1994 and February 15, 1995 approving, among other things, Banesto’s financial reorganization plan and the 1993 and 1994 financial statements of Banesto and the Banesto Group. In 2000, Madrid Appellate Court decisions rejected all the appeals filed by the plaintiffs in connection with the claim filed challenging the legality of the corporate resolutions approving the financial restructuring plan; the plaintiffs subsequently filed a cassation appeal against these decisions and the Bank has answered such cassation appeal. On March 5, 2002 the courts decided not to admit the cassation appeal against the Madrid Appellate Court’s decision rejecting the claims of some of the plaintiffs regarding the invalidity of the constitution of the shareholders’ meeting held on March 26, 1994. On July 22, 2003, the court admitted the cassation appeal filed by the remaining plaintiffs. The Bank filed its answer on September 20, 2003. 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
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appeal before the Madrid Appellate Court. The appeal was rejected in 2001 and the plaintiff has appealed in cassation. The claim filed against the approval by the shareholders’ meeting held on February 15, 1995 of the 1994 financial statements of Banesto was also rejected in 2000 by the Court of First Instance and was subsequently appealed by the plaintiffs. The appeal was dismissed by judgment of the Court of Appeals of Madrid, rendered on May 20, 2003. In September 2003, the plaintiffs’ appeal of this judgment was also dismissed. The plaintiffs have since appealed to the Supreme Court.
Banesto’s directors and legal advisers do not believe that these claims will have any effect on the financial statements of Banesto or its Group. The plaintiffs seek that the resolutions be declared null and void, not damages. It is very difficult to assess what the practical consequences of an adverse judgment would be.
Banco do Estado de Sao Paulo (Banespa)
Pursuant to the Brazilian labor regulations applicable to Banespa, this bank had recorded as of December 31, 2000, the pension allowances arising from the commitments to certain employees, which amounted to approximately 4,000 million Brazilian reais. Since 1987, the Directors of Banespa, as advised by their tax advisers, treated these expenses as deductible expenses in calculating the Brazilian corporate income tax. However, in September 1999, the ‘‘Secretaria de Receita Federal’’ issued a decision according to which these expenses, in an amount of approximately Brazilian reais 2,867 million would not be tax deductible. In October 1999, the Board of Directors of Banespa filed an appeal challenging this decision together with an ‘‘acción cautelar’’ regarding fiscal years 1999 and 2000, posted a deposit of Brazilian reais 1,297 million and recorded a provision of 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.
Santander Brasil DTVM, Ltda. and Banco Santander Brasil, S.A.
On May 19, 2003, the Secretaria de Receita Federal issued an “Auto de Infração” requiring from our Brazilian affiliate Santander Brasil DTVM, Ltda. the payment of Brazilian reais 290 million in taxes allegedly incurred in connection with certain cash management services rendered by such company to its clients which the company had treated during 2000, 2001 and the two first months of 2002 as exempt from the Tax on Financial Transactions, following the advice of its tax advisers. The Board of Directors of Santander Brasil DTVM, Ltda. appealed this decision in June 2003. The Tax Authorities confirmed the “Auto de Infração” and the Board of Directors appealed to “Conselho de Contribuintes” (final administrative court). The Court decision is pending. On December 31, 2003, the amount involved in the action was equivalent to reais 306 million.
Also on May 29, 2003, the Secretaria de Receita Federal issued another “Auto de Infração” requiring from our Brazilian affiliate Banco Santander Brasil, S.A. the payment of Brazilian reais 290 million in taxes allegedly incurred in connection with certain clearing services rendered by such company to Santander Brasil DTVM, Ltda. pursuant to an agreement between these two companies. Following the advice of its tax advisers, Banco Santander Brasil, S.A. had treated during 2000, 2001 and the two first months of 2002 such services as exempt from the Tax on Financial Transactions. The Board of Directors of Banco Santander Brasil, S.A. appealed this decision in June 2003. The Tax Authorities confirmed the “Auto de Infrançao” and the Board of Directors appealed to “Conselho de Contribuintes” (final administrative court). The Court decision is pending. On December 31, 2003, the amount involved in the action was equivalent to reais 306 million.
Other Litigation
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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Dividend Policy
We have normally paid an annual dividend in quarterly installments. The table below sets forth the historical per share and per ADS (each of which represents the right to receive one of our shares) amounts of interim and total dividends in respect of each fiscal year indicated. The amounts below reflect the stock split made in June 1999. Amounts for 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 the parent Bank’s non-consolidated audited profit and loss account prepared in accordance with Bank of Spain requirements and guidelines in effect at the time of such preparation. Such requirements and guidelines may be expected to reflect the bank 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). We generally control a sufficient proportion of our consolidated subsidiaries’ voting capital to enable us to require such subsidiaries to pay dividends to the extent permitted under the applicable law. As a result of our growth we, as the holding entity of the shares of our various companies, have added investm ents in our subsidiaries, the financial costs of which are borne by us.
B. Significant Changes.
For significant changes that have occurred since December 31, 2003, see our Form 6-K relating to our first quarter 2004 results filed with the Securities and Exchange Commission on April 30, 2004.
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Item 9. The Offer and Listing.
A. Offer and listing details.
Market Price and Volume Information
Banco Santander Central Hispano’s Shares
During the last year, our shares were the shares with the second highest trading volume on the Spanish stock exchanges. At December 31, 2003, our shares represented 16.24% of the IBEX 35 Stock Exchange Index, the highest percentage among Spanish banks and the second of all Spanish issuers represented in this index. Our market capitalization of €44,775.3 million at 2003 year-end was the largest of any Spanish financial entity and the second largest of any Spanish company, according to information published by the Sociedad de Bolsas.
At December 31, 2003, we had 1,075,733 registered holders of our shares and, as of such date, a total of 344,517,260 of our shares or 7.23% were held by 836 registered holders with registered addresses in the United States and Puerto Rico, including JP Morgan Chase, as depositary of our American Depositary Share program.
Our shares are traded on Spain’s automated “continuous market”, the national, centralized market which integrates by computer quotations originating in the four Spanish stock exchanges (Madrid, Barcelona, Valencia and Bilbao) (the “Automated Quotation Systems”). Our shares also are listed on the New York (in the form of American Depositary Shares), Milan, Lisbon and Buenos Aires Stock Exchanges. In 2001, we delisted our shares from the Tokyo Stock Exchange and in 2003, we delisted our shares from the London, Paris, Frankfurt and Swiss Exchanges. At December 31, 2003, 55.0% 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 July 12, 2004, the reported last sale price of our shares on the continous market was €8.52.
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American Depository Shares (ADSs)
Our ADSs have been listed and traded on the New York Stock Exchange since July 30, 1987. Each ADS represents one of our shares and is evidenced by an American Depositary Receipt, or ADR. The deposit agreement, pursuant to which ADRs have been issued, is among us, JP Morgan Chase, as depositary, and the holders from time to time of ADRs. At December 31, 2003, a total of 67,745,975 of our ADSs were held by 101 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.
B. Plan of distribution.
C. Markets.
Spanish Securities Market
The Spanish securities market for equity securities (the “Spanish Stock Exchanges”) consists of the four stock exchanges located in Madrid, Barcelona, Bilbao and Valencia (the “local exchanges”). The majority of the transactions conducted on them are done through the Automated Quotation System (Sistema Interbancario Bursátil Español or “S.I.B.E.”). During the year ended December 31, 2003, 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 under “Securities Market Legislation”), the shares of Spanish banks are among the most heavily-traded securities on the Spanish Stock Exchanges.
Automated Quotation System
The Automated Quotation System was introduced in 1989 and links the four local exchanges, providing those securities listed on it with a uniform continuous market that eliminates most of the differences among the local exchanges. The principal feature of the system is the computerized matching of buy and sell orders at the time of entry of the order. Each order is executed as soon as a matching order is entered, but can be modified or canceled until executed. The activity
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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 p.m., with a random closedown of 30 seconds. The price resulting from each auction will be the closing price of the session.
From May 14, 2001, new rules came into effect regarding the maximum price fluctuations in the price of stocks. Under the new rules, each stock in the continuous market is assigned a static and a dynamic range within which the price of stocks can fluctuate. The price of a stock may rise or fall by its static range (which is published once a month and is calculated according to the stock’s average historic price volatility) above or below its opening price (which shall be the closing price of the previous session). When the stock trades outside of this range, the trading of the stock is suspended for 5 minutes, during which an auction takes place. After this auction, the price of the stock can once again rise or fall by its static range above or below its last auction price (which will be considered as the new static price before triggering another auction). Furthermore, the price of a stock cannot rise or fall by more than its dynamic price r ange (which is fixed and published once a month and is calculated according to the stock's average intra-day volatility), from the last price at which it has traded. If the price variation exceeds the stock’s dynamic range a five minutes auction is triggered.
Between 5:30 p.m. and 8:00 p.m., trades may occur outside the computerized matching system without prior authorization of the Sociedad de Bolsas, at a price within the range of 5% above the higher of the average price and closing price for the day and 5% below the lower of the average price and closing price for the day, if there are no outstanding bids or offers, as the case may be, on the system matching or bettering the terms of the proposed off-system transaction, and if the trade involves more than €300,000 and more than 20% of the average daily trading volume of the stock during the preceding quarter. At any time before 8:00 p.m., trades may take place (with the prior authorization of the Sociedad de Bolsas) at any price if:
Information with respect to computerized trades between 9:00 a.m. and 5:30 p.m. is made public immediately, and information with respect to trades outside the computerized matching system is reported to the Sociedad de Bolsas and published in the Boletín de Cotización and in the computer system by the next trading day.
During 1998, the Block Market (el mercado de bloques) was implemented, allowing for block trades between buyers and sellers. Under certain conditions, this market allows cross-transactions of trades at prices different than at normal market sessions. Trading in the Block Market is subject to certain limits with regard to stocks and volumes.
Clearance and Settlement System
Until April 1, 2003, transactions carried out on the regional Spanish stock exchanges and the continuous market were cleared and settled through the Servicio de Compensación y Liquidación de Valores, S.A. (the “SCL”). Since April 1, 2003, the settlement and clearance of all trades on the Spanish stock exchanges, the Public Debt Market (Mercado de Deuda Pública), the AIAF Fixed Income Market (Mercado AIAF de Renta Fija) and Latibex - the Latin American stock -exchange denominated in euros, are made through the Sociedad de Gestión de los Sistemas de Registro, Compensación y Liquidación de Valores (“Iberclear”), which was formed as a result of a merger between SCL and Central de Anotaciones del Mercado de Deuda Pública (CADE), which was managed by the Bank of Spain.
Book-Entry System
Ownership of shares listed on any Spanish stock exchange is required to be represented by entries in a register maintained by Iberclear, and transfers or changes in ownership are effected by entries in such register. Iberclear is
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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.
Securities Market Legislation
The Spanish Securities Markets Act, which came into effect in 1989, among other things:
The Securities Markets Act was amended by Law 37/1998, which implemented two European Union directives into Spanish law. The first is Directive 93/22/CE, relating to investment services within securities, later amended by Directive 95/26/CE of European Parliament and Council. The second is Directive 97/9/CE of European Parliament and Council, relating to indemnity systems.
Law 37/1998 introduced some innovations to the Securities Markets Act. The first was the recognition that both Spanish and other European Union Member State companies authorized to provide investment services have full access to the official secondary markets, with full capacity to operate, thereby enabling the direct admission of banking entities into the stock exchange area. The second innovation was that the scope of the Securities Markets Act was enlarged to include a list of financial instruments, such as financial exchange contracts, or installment financial contracts, which expanded the category of securities.
Other modifications under Law 37/1998 include:
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The Securities Markets Act has been further amended by Law 44/2002 (November 22, 2002) on reform measures of the financial system, which introduced certain modifications to the laws governing financial markets and corporations, generally, including:
Finally, on July 17, 2003, the Securities Market law was amended by Law 26/2003 in order to reinforce the transparency of listed companies. It introduces:
Trading by Banco Santander Central Hispano’s Subsidiaries in the Shares
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 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. 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 acquisitions of treasury stock made since the last notification reaches 1% of the outstanding capital stock, regardless of any other preceding sales. Prior to adoption of the 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.
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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 2003, 15.0% of the volume traded of the shares was effected not as a principal by Santander Central Hispano-SVB and 5.4% 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 20.3% in the same period. The monthly average percentage of outstanding shares held by our consolidated subsidiaries ranged from 0.411% to 1.005% in 2003. Our consolidated subsidiaries held 2,538,237 of our shares (0.05% of our total capital stock) at December 31, 2003.
D. Selling shareholders.
E. Dilution.
F. Expense of the issue.
Item 10. Additional Information.
A. Share capital.
B. Memorandum and articles of association.
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, 2003, the Bank’s share capital was €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.
Register
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.
Corporate Object and Purpose
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.
Certain Provisions Regarding Shareholder Rights
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.”
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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 at least 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 19, 2004 and our last extraordinary general meeting of shareholders was held on February 9, 2002.
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. The ordinary general shareholders’ meeting held on June 19, 2004, approved modifications of our by-laws, which are pending registration on the Mercantile Register, to eliminate the restriction mentioned before so that holders of any number of shares will be entitled to attend shareholders’ meetings. Our by-laws do not contain provisions regarding cumulative voting.
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.
In accordance with the Regulations of the General Shareholders’ Meeting, the Group’s website includes as of the date the General Shareholders’ Meeting is called, the details regarding the manner and procedures for shareholders to follow to confer representation on any other shareholder who is eligible to attend the General Shareholders’ Meeting in his own right and to vote by proxy. The manner and procedures for electronic delegation and voting via the Internet are also indicated.
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.
Resolutions at general meetings are passed by a simple majority of the voting capital present or represented at the meeting.
In accordance with Spanish law, a quorum on first call for a duly constituted ordinary or extraordinary general meeting of shareholders requires the presence in person or by proxy of shareholders representing 25% of our subscribed voting capital. On second call there is no quorum requirement. Notwithstanding the above, a quorum of 50% of our subscribed voting capital is required on the first call to approve any of the following actions:
A quorum of 25% of the subscribed voting capital is required to vote on such actions on the second call. A two-third majority of our present or represented voting capital is required to approve all of the above listed actions when the shareholders’ meeting is held on second call and less than 50% of our subscribed voting capital is present.
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Changes in Capital
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.”
Dividends
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. 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 ”fondos de previsión” (general allowances). After separating the amount which should be carried forward, if the board deems it advisable, the remaining amount will be divided equally amongst our shareholders under the limitations imposed by Spanish law.
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).
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.
Redemption
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.
Registration and Transfers
The Banco Santander Central Hispano shares are in book-entry form. We maintain a registry of shareholders. 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.
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Liquidation Rights
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.
Change of Control
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.
Legal Restrictions on Acquisitions of Shares in Spanish Banks
Certain provisions of Spanish law require notice to the Bank of Spain prior to the acquisition by any individual or corporation of a substantial number 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 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 that 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.
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Tender Offers
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.
Finally, RD 432/2003 modifies the exceptions to the mandatory launching of a tender offer; it allows for conditional tender offers upon certain requirements being met and it substantially modifies the regime of competing tender offers.
Reporting Requirements
The acquisitions or transfers of shares of any company listed on a Spanish Stock Exchange where, following the transaction, the acquiror’s ownership participation reaches 5% or any multiple of 5% of the capital stock of such company, or the seller’s participation is reduced from one of the above mentioned levels of ownership, must be reported, within 7 business days after such acquisition or transfer. The reporting must be made to the company that issued the traded shares, to the Governing Companies (Sociedades Rectoras) of the Spanish stock exchanges on which such company is listed, and to the 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 a resident of a tax haven as defined in accordance with Royal Decree 1080/1991, or of a country or territory where there is no authority entrusted with the supervision of the securities markets, or when the designated authority declines to exchange information with the Comisión 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 acq uisition or transfer of option rights over the company’s shares.
In addition, managers of any listed company must report to the Comisión 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.
Board of Directors
Our Board of Directors may be made up of a minimum of 14 and a maximum of 30 members, appointed by the general meeting of shareholders. Members of the Board of Directors are elected for an initial term of three years but can be re-elected. One third of the members of the Board are elected each year. 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, as defined by the Board’s Regulations, be part of the external ones. These independence standards
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may not necessarily be consistent with, or as stringent as, the director independence standards established by the NYSE. See “Item 6. Directors, Senior Management and Employees—C. Board Practices—Independence of the Directors on the Board of Directors.”
Certain Powers of the Board of Directors
The actions of the members of the board are limited by Spanish law and certain general provisions contained in our by-laws. For instance, Article 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 ordinary general shareholders’ meeting held on June 19, 2004 approved a modification of Article 31 of our bylaws. Such modification is pending registration on the Mercantile Register. Once registered, Article 31 will add omissions contrary to law or to the by-laws to the causes for which directors will be liable and will specify that directors will also be liable for any acts or omissions contrary to the duties inherent in the exercise of their office rather than, as currently stated, being liable for any acts that are carried out without observing the formalities 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 when the payment is due and without the need for any judicial or extra-judicial summons. We will also be able to take any action authorized by law to collect such sums.
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”.
Board of Director Qualification
There are no mandatory retirement provisions due to age for board members in our by-laws or in the regulations of our board of directors. These regulations contain provisions relating to the cessation of directorship for other reasons.
Subject to legal limitations, any person will be eligible to serve as a Director of Banco Santander Central Hispano, S.A. without having to be a shareholder of the Bank.
C. Material contracts.
During the past two years, the Bank was not a party to any contract outside its ordinary course of business that was material to the Group as a whole.
D. Exchange controls.
Restrictions on Foreign Investments
Under present regulations, foreign investors may transfer invested capital, capital gains and dividends out of Spain without limitation on the amount other than applicable taxes. See “Taxation”. On July 4, 2003, Law 19/2003 was approved which updates Spanish exchange control and money laundering prevention provisions, by recognizing the principle of freedom of the movement of capital between Spanish residents and non residents. The law establishes procedures for the declaration of capital movements for purposes of administrative or statistical information and authorizes the Spanish Government to take measures which are justified on grounds of public policy or public security. It also provides the mechanism to take exceptional measures with regard to third countries if such measures have been approved by the European Union or by an international organization to which Spain is a party. The Spanish stock exchanges and securities markets are open to foreign investors. Royal Decree 664/1999, on Foreign Investments (April 23, 1999), established a new framework for the regulation of foreign investments in Spain which, on a general basis, will no longer require any prior consents or authorizations from authorities in Spain (without prejudice to specific regulations for several specific sectors, such as television, radio, mining, telecommunications, etc.). Royal Decree 664/1999 requires notification of all foreign investments in Spain and liquidations of such investments upon completion of such investments to the Investments Registry of the Ministry of Economy, strictly for administrative statistical and economical purposes. Only investments from “tax haven” countries (as they are defined in Royal Decree 1080/1991), shall require notice before and after performance of the investment, except that no prior notice shall be required for: (1) investments in securities or participations in funds of the investment that are registered with the CNMV, and (2) investments that do not increase
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the foreign ownership of the capital stock of a Spanish company to over 50%. In specific instances, the Counsel of Ministers may agree to suspend, all or part of, Royal Decree 664/1999 following a proposal of the Minister of Economy, or, in some cases, a proposal by the head of the government department with authority for such matters and a report of the Foreign Investment Body. These specific instances include a determination that the investments, due to their nature, form or condition, affect activities, or may potentially affect activities relating to the exercise of public powers, national security or public health. Royal Decree 664/1999 is currently suspended for investments relating to national defense. Whenever Royal Decree 664/1999 is suspended, the affected investor must obtain prior administrative authorization in order to carry out the investment.
E. Taxation.
The following is a discussion of the material Spanish and U.S. federal income tax consequences to you of the acquisition, ownership and disposition of the ADSs or shares.
This discussion only applies to you if you are a beneficial owner of shares or ADSs and are:
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.
Spanish tax considerations
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.
Taxation of dividends
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.
Taxation of capital gains
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 nonresident 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
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authorities an IRS certificate of residence in the United States, together with the appropriate Spanish tax form, not later than 30 days after the capital gain was realized.
Spanish wealth tax
Individuals not residing in Spain who hold shares or ADSs located in Spain are subject to the Spanish wealth tax (Spanish Law 19/1991), which imposes a tax on property located in Spain on the last day of any year. The Spanish tax authorities may take the view that all shares of Spanish corporations and all ADSs representing such shares are located in Spain for Spanish tax purposes. If such a view were to prevail, non-residents of Spain who held shares or ADSs on the last day of any year would be subject to the Spanish wealth tax for such year at marginal rates varying between 0.2% and 2.5% of the average market value of such shares or ADSs during the last quarter of such year.
Spanish inheritance and gift taxes
Transfers of shares or ADSs upon death or by gift are subject to Spanish inheritance and gift taxes (Spanish Law 29/1987) if the transferee is a resident in Spain for tax purposes, or if the shares or ADSs are located in Spain at the time of gift or death, regardless of the residence of the beneficiary. In this regard, the Spanish tax authorities may determine that all shares of Spanish corporations and all ADSs representing such shares are located in Spain for Spanish tax purposes. The applicable tax rate, after applying all relevant factors, ranges between 0 and 81.6% for individuals.
Gifts granted to corporations non-resident in Spain are subject to Spanish Non-Resident Income Tax at a 35% tax rate on the fair market value of the shares as a capital gain. If the donee is a United States corporation, the exclusions available under the Treaty described in the section “Taxation of capital gains” above will be applicable.
Expenses of transfer
Transfers of ADSs or shares will be exempt from any transfer tax or value-added tax. Additionally, no stamp tax will be levied on such transfers.
U.S. Tax Considerations
The following summary describes the material United States federal income tax consequences of the acquisition, ownership and disposition of ADSs or shares, but it does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a particular person’s decision to acquire such securities. The summary applies only to U.S. Holders (as 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 States, Spanish or
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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:
In general, for United States federal income tax purposes, U.S. Holders of ADSs will be treated as the holders of the underlying shares represented by those 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. Such actions would also be inconsistent with the claiming of the reduced rate of tax, described below, applicable to dividends received by certain non-corporate holders. Accordingly, the creditability of Spanish taxes and the availability of the reduced tax rate for dividends received by certain non-corporate holders, each described below, could be affected by actions taken by parties to whom the ADSs are pre-released.
Taxation of Distributions
Subject to the discussion of the passive foreign investment company rules below, 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 receiving dividends from domestic 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 rate 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.
Subject to meeting certain conditions, dividends paid to a non-corporate U.S. holder paid before January 1, 2009 will be taxed at a maximum rate of 15%. Non-corporate holders should consult their own tax advisers to determine the implications of the rules regarding this favorable rate in their particular circumstances.
A U.S. Holder must satisfy minimum holding period requirements in order to be eligible to claim a foreign tax credit for foreign taxes withheld on dividends. 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.
Sale and Other Disposition of ADSs or Shares
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.
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Passive Foreign Investment Company Rules
We believe that we are not a “passive foreign investment company”, or “PFIC”, for United States federal income tax purposes for the taxable year 2003. 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 materially adverse tax consequences could apply to you.
Information Reporting and Backup Withholding
Information returns may 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 may 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.
F. Dividends and paying agents.
G. Statement by experts.
H. Documents on display.
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 website that contains information filed electron ically with the SEC, which can be accessed over the internet at http://www.sec.gov.
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Item 11. Quantitative and Qualitative Disclosures About Market Risks
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 seven parts:
Part 1. Organization of Risk Management
We regard risk management as one of our key priorities in generating value on a sustained basis. This model of management is in line with the principles of the New Basle Capital Accord.
The Risks Division reports to the third Vice-Chairman and Chairman of the Risk Committee of the Board of Directors. The Committee deals with all types of risk including credit, market, liquidity, operational and counterparty risk. This Committee:
The Board’s subsidiary bodies have the necessary skills and independence to supervise development of the general strategy, as well as the decisions taken by senior management which, in turn, sets the business plans, supervises the daily decisions and ensures they are in line with the objectives and policies set by the Board.
We use a series of techniques and tools, which are mentioned in detail in different parts of this Item. Of note are:
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In 2003, we changed our organizational structure in order to group together the executive functions and adapt the organizational structure of the risk units to the business areas and segments more precisely. With these objectives in mind, the credit and market risk functions are integrated into a single unit and organized by large segments of clients, covering admission, tracking, and recovery in all countries where we operate and under the following organizational framework:
In accordance with the requirements of independence established in the New Basle Capital Accord (BIS II), we established another autonomous management unit for integrated management and internal control of risks. This unit’s functions are to contribute a global view of the Bank’s risk policies, to measure risk, to provide analysis and methodologies for different risk exposures, as well as to exercise the control needed to guarantee the consistency and homogeneity of processes and tools.
Both management units report to the third Vice-Chairman who is responsible for the Risks Division.
Part 2. Global Analysis of Risk. Integral Risk Framework.
In 2003, we developed a tool to assign and aggregate the economic capital of the Group and of its main business units. Known as the Integral Risk Framework (IRF), the tool addresses the main risks to which the Group is exposed: credit, market, structural, operational and business, as well as the degree of correlation (diversification) between these risks and the different business units.
The model provides a reasonably precise measurement of the economic capital needed to support the risk assumed by the Group with the level of confidence associated with a rating target of AA. It also produces measurements of return adjusted to the risk of the main business units and of the Group as a whole.
A comparison of the results of the economic capital needed with the capital funds available shows that the Group is sufficiently well capitalized to support the risk of its business with a level of confidence equivalent to a rating target of AA.
The global risk map of the Group at the end of 2003, according to the IRF, and the distribution of the economic capital among the different types of risk and among the main business units is shown below.
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Credit risk is the Group’s main risk and accounts for 42% of the total risk in terms of economic capital. Market risk, which includes trading and the structural exchange rate position (as highlighted under “Rest of Market” in the table above) as well as the industrial portfolio and the Group’s alliances (as highlighted under “Equity Stakes” in the table above), accounts for just over one-third of total risk. The other risks represent 21%. The aggregate capital is 15% lower than the sum of the capital of the independent units because of the Group’s diversification. A multi-factor model and simulation techniques are used to estimate the aggregated economic capital and assign it by units. This enables the effect of the diversification to be quantified.
According to the results of the IRF, the Group’s risk-adjusted return is 16.6% compared to an estimated cost of capital of 10.75%, which means that there is a high capacity to generate value.
The methodology used for operational risk is that proposed by the Basle Committee (standardized model), while international benchmarks are used for the business risk model.
Part 3. Credit risk
Our management of credit risk is concerned with the identification, measurement, integration, control and evaluation of our different credit exposures, as well as the risk-adjusted return from a global perspective and 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, without detriment to the need to adapt to the particular features of local markets.
At the end of 2003, 65.4% of the Group’s credit risk was in Spain, 15.9% in Latin America, 14.5% in the rest of Europe (mainly Portugal and Germany) and 4.3% in the rest of the world.
The following tables show the Group’s gross exposure (before conversion factors) to credit risk, distinguishing between credit risk with clients, fixed income and credit entities, as of December 31, 2003:
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Data at 31/12/03. Amounts in millions of euros.
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The following charts show the distribution of the exposure (EaD or exposure at default), according to the equivalent external rating of the main groupings of credit risk and the expected loss for each tranche (the line):
The rating distribution in the portfolio of clients is typical of retail banking. Most of the ratings below BBB are the portfolios of small and medium sized companies (“SMEs”), consumer loans and part of the Group’s mortgage portfolios. They have a high degree of fragmentation, lower proportional consumption of capital and levels of expected loss comfortably covered by the spread on the operations.
Customer segmentation for credit risk management
Credit risk management is conducted according to customer segments and the features of products.
The treatment of global clients (governments, large corporate groups and multinational financial groups) is done on a centralized basis for the whole Group, with set global exposure limits. There are specific departments for analyzing country and sovereign risk, counterparty risk, etc.
In 2003, we set internal limits for large corporate groups based on the economic capital consumed by those groups.
Global clients, large companies and local institutions receive personal treatment by risk analysts, specialized by sectors or countries, who are assigned a portfolio of clients for analysis and continuous tracking. This structure of risk management is similar to the structure of business management.
We manage risk with retail clients (small firms, businesses and individuals) on a decentralized basis, following policies and guidelines that are designed centrally, with the support of automatic systems for valuation and decision-making.
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Internal rating tools
The Bank has been using internal ratings in order to assess and track risk for more than 10 years. The aim is to measure the degree of risk of a client or transaction. Each rating corresponds to a certain probability of non-fulfilment or non-payment, as a result of past experience.
The process for assigning the rating of companies depends on the segment. The weight of the view of the analyst is greater in the case of large clients, which involve more complex analysis, while the rating of clients and operations in retail segments is based more on pre-established rules of valuation where a more computerized treatment can be used. The process of assessment can differ depending on the business sector (financial entities, public institutions, industrial companies, real estate development, etc).
The graph on the left shows the distribution of the companies that comprise Santander Central Hispano Spain’s credit risk portfolio. The graph on the right shows the outstanding balances of loans by rating of those companies.
The curves shown in the following tables reflect non-performing loans relating to individual customers, granted in Spain, each year up until their maturity (vintages). The historical data provided permits a simulation of future performance.
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Master scale of ratings
The Group has a Master Scale (see table below), which compares, at the same rate of anticipated non-performing loans, the different ratings which are used in the various homogeneous segments of risk.
Concept of expected loss
As well as evaluating the client, the assessment of expected loss considers aspects such as the maturity, the type of product and the guarantees that exist, adjusting the initial rating based on that assesment. As a result, not only is the probability of default (PD) taken into account, but also the estimated exposure at the time of default (EaD) and the loss given default (LGD).
The correct calculation of expected loss is important to ensure that the price adequately reflects the resulting risk premium, and that the expected loss is reflected as one of the costs of the activity.
The following tables, reflecting data on non-performing loans in Spain, include the distribution of delinquent consumer and mortgage loans since 1995, according to the percentage of recoveries, after deducting all costs (financial and opportunity) incurred in recovery.
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The concept of expected loss, moreover, is the basic element of the new Spanish and international credit risk regulations. Circular 9/99 of the Bank of Spain established a quarterly obligation to allocate a statistical provision based on the intrinsic risk of each operation or expected loss. The provision can be calculated either by applying the standard coefficients set by the regulator for each homogeneous risk group or by using internal estimates that have been previously validated by the supervisor.
In the international sphere, the Basel Committee’s proposal to reform the 1988 Capital Accord is also based on the concept of expected loss, using internal ratings in order to determine the minimum levels of regulatory capital in the most advanced frameworks.
Measurements of expected loss
Our expected credit risk loss, at the end of 2003, was €1,973 million, 0.65% of the exposure, (equivalent to 0.56% of the gross exposure and 0.98% of the risk balance of clients). The distribution of the expected loss by areas is detailed in the following chart:
Test of reasonableness in expected loss of the parent bank
In order to test the calculation model for expected loss, the following table compares the specific provisions, net of recoveries, that were actually allocated for the portfolio of Banco Santander Central Hispano’s business in Spain over the last few years with the estimated expected loss.
The allocations fell substantially during 1995-99, grew again during the last period as a result of the slowdown in the economy, thereby reflecting their cyclical nature, and declined again in 2003. The average losses must be adjusted to the effect of the economic cycle (the series contains more “good” than “bad” years). The adjusted average of 0.39% compares reasonably with the expected loss of 0.44% envisaged in the model.
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The following table provides a detail of the expected loss of the Santander Central Hispano Bank’s business in Spain credit portfolios:
Measurements of cost of credit (observed loss)
The following charts show the cost of credit risk at the Santander Group and its main business areas during 2003 and its comparison with previous years, measured through different frameworks:
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Risk premium quantification
Our policy is to maintain a medium to low risk profile, both in credit and market risk.
With regard to credit risk, this qualitative objective can be expressed in terms of expected loss. Currently, our expected loss target for business in Spain must not exceed 0.40% of the outstanding balance of risk (lending plus guarantees), while for the Group as a whole it must not be more than 1%.
Concept of economic capital. RORAC methodology
Credit losses can surpass the level of expected loss for various reasons (economic cycle, concentration of exposure, and errors in the model). The volatility of losses or unexpected loss is the real credit risk. While provisions are in response to the expected losses as well as the spread, to the extent that the risk premium affects prices, entities endow themselves with capital to cover the contingency of higher than expected credit losses.
Conceptually, economic capital is the capital necessary to bear the credit losses with a level of confidence that depends on the institution’s target rating. In the case of the Santander Group, the level of confidence with which the economic capital is measured is 99.97% (losses could exceed capital three times in 10,000 years) which is equivalent to an AA target rating.
Traditionally, the concept of economic capital has been contrasted with that of regulatory capital which is the capital required by the regulation of solvency which currently is not sufficiently sensitive to risk. However, the reform of the 1988 Capital Accord is going to bring both concepts closer together.
Once the expected loss is calculated on the basis of the rating of the client and other aspects of the operation, a determination can be made on the economic capital required to respond to this risk. By aggregation, we can calculate the economic capital of the rest of the operations of the client and, bearing in mind the appropriate factors of diversification/correlation, of a portfolio of clients, a business unit or a whole bank.
Determining the economic capital enables the risk adjusted return of credit operations to be measured (RORAC methodology), setting the return – with the expected loss considered as one of the costs of the activity – against the economic capital consumed.
RORAC methodology enables the return on operations, clients, portfolios and businesses to be compared on a homogeneous basis, identifying those that obtain a risk adjusted return higher than the cost of our capital, and thus aligning risk and business management with the overall objective of creating value.
We have been using RORAC methodology in our credit risk management since 1993, with the following purposes:
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 operating costs incurred.
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Internal risk models for calculating statistical or anti cyclical provisions (Circular 9/99 of the Bank of Spain)
On June 23, 2000, shortly before the reference regulations came into effect, we sought recognition from the Bank of Spain of our internal model for calculating provisions, based on internal ratings, for our whole lending portfolio in Spain.
We were the first Spanish large bank to fully make use of Circular 9/99 of the Bank of Spain which also anticipated the rules and disciplines of the BIS II.
Our internal model for corporate risks has been approved by the Bank of Spain, and our model for consumer lending and mortgages is currently under review (as more than a year has passed since its initial validation).
New Basel Capital Accord (BIS II)
In accordance with BIS II, we have placed greater emphasis on risk management and fostered continuous improvements for purposes of evaluation.
We have also been participating very actively in different forums on risk management, both Spanish and international, as well as maintaining contacts with the regulatory authorities of different countries and working on quantitative impact studies, contributing constructively to improve the technical aspects of the Accord.
We will apply for formal recognition of our internal risk models in accordance with the BIS II requirements, as soon as the new regulation allows us to do so.
We developed the Leadership Project which led to the approval of our internal models in Spain, as well as the Master Plan which was approved in 2002 in order to establish the internal Basle II models in the various units and geographic areas.
The development of the Master Plan gave rise to a series of actions, including:
An independent unit within the Risks Division is responsible for developing the tasks necessary to satisfy the requirements of the New Accord. These tasks include:
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Control and tracking systems
Control is crucial in assuring adequate management of credit risk and maintaining a risk profile within the parameters set by the Board and senior management.
This function is carried out by various mechanisms inside and outside the Risks Division.
Within the Division, and with the independence of the business areas that characterize the Division, decision-making in the admission phase is subject to a system of controls established by the Risk Committee of the Board of Directors. The decisions in the admission phase are predominantly collective. One of the functions of the Division is to track the risks assumed, as a differentiated phase of the credit cycle, for which resources and specific people are identified.
The following occurs during the tracking phase:
The following table sets forth the Bank’s business in Spain outstanding loan balances by category of special watch classification.
Santander Central Hispano Bank – Business in Spain Companies. Special Watch Classification
The Global Risk Management Area carries out specific functions of control and tracking of internal credit risk models such as:
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Performance of the main magnitudes in 2003
Our non-performing loan (NPL) ratio dropped from 1.89% in 2002 to 1.55% in 2003 and provision coverage increased from 139.9% to 165.2%.
Our NPL ratio in Spain decreased to 0.87% from 0.92% in 2002. Retail banking performed well as its net NPL entries, especially in the segments of companies, were well below the levels budgeted for 2003. Coverage was 33 points higher at 223.8%.
Credit risk management in Latin America
The region’s share of the Group’s credit risk declined to 15.9% in 2003.
The credit risk balance with clients (lending and guarantees) amounted to €32,604 million at the end of 2003, 11.1% lower than in 2002. The reduction was principally due to the currency depreciation, except for the Brazilian real and the Chilean peso, against the dollar and the euro, and a very selective admission policy.
Mexico, Chile and Puerto Rico accounted for 72.4% of the exposure. They have all been rated investment grade countries by international agencies.
Our risk performance in terms of NPLs, coverage and the cost of defaults was favorable, despite a still adverse economic environment.
NPLs declined 15% and represented 3.89% of credit risk at the end of 2003, down from 4.07% in 2002. Coverage of non-performing assets was strengthened by more than 11 points to 125.2%.
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Specific credit loss provisions, net of recoveries of loans previously charged-off, declined in 2003 74% to €258.3 million. This was largely due to the reduced needs in Argentina, Brazil and Uruguay. The cost against the average risk was 0.75% compared to 2.1% in 2002.
Of note was Mexico, a major country in the region for the Group where 29% of total credit risk is concentrated. Its NPLs declined 26% in 2003, as a result of significant recoveries.
Our risk management in each Latin American bank is the same as the risk management of our parent bank in Spain, with the necessary adjustments for the local markets.
In 2003, we made a strong effort to implement the homogeneous management model GARRA. This model consists of a series of applications which conduct the tasks of requesting, analyzing, resolving, formalizing, tracking and recovering risks, in a technological environment completely linked to the rest of the corporate systems of each bank (basically the ALTAIR platform). GARRA is a computerized management system based on applications developed in accordance with the Group’s risks culture. Our aim is to complete the installation of GARRA in Brazil in 2004 and begin the project in Venezuela.
Meanwhile, and in relation to the New Capital Accord, the objective in 2004, after the map of functional gaps that has been drawn up, is to incorporate the adjustments needed in the platforms for storing and processing data on the necessary risk factors.
Concentration Risk
The Group continuously tracks the degree of concentration of its credit risk portfolios under different categories: geographic areas and countries, economic sectors, products and groups of clients.
The Risk Committee of the Board of Directors establishes the policies and reviews the exposure limits for adequate management of the degree of concentration of credit risk portfolios.
At December 31, 2003, the 20 economic-financial groups with the largest loans accounted for 9.7% of credit risk, which means a low degree of concentration.
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The distribution by economic sector of credit risk (expresed in percentages) is shown in the table below:
Contribution by sector to total risk
Country-risk
Country-risk is a credit risk component in all cross-border credit operations. Its main elements are sovereign risk and transfer risk and, as a result of the recent exchange-rate crises, it may include the risk of a very strong fluctuation of local currencies which could produce a collective credit risk in economies with a high degree of foreign currency debt.
Management of country-risk, which is a part of the Risks Division, includes analysis and assignment of country ratings, control of risk positions and setting limits, in accordance with the risk policies established.
The assignment of a country rating is done through a process of qualitative and quantitative valuation, which determines a country’s capacity to meet its external obligations. The country-risk limits are established on the basis of the credit quality or rating of the country and on the business opportunities, differentiating between different products and maturities.
Despite the better economic climate in emerging markets during 2003, we maintained a low degree of exposure to cross border risk. At the end of 2003, our country-risk with third parties requiring provisions, in accordance with the Bank of Spain’s criteria, amounted to $627.9 million, 46.2% more than in 2002, of which 82% was covered by provisions. This growth was due to the application of stricter criteria in December on operations with political risk coverage by private agencies.
The principles of country-risk management continued to follow prudent criteria; country-risk is assumed very selectively in operations that are clearly profitable for the Bank and which enhance the global relationship with a customer.
Country-risk management
Mill. euro
Mill. US$
Amount
(%)
Counterparty risk
Counterparty risk includes the risk with credit entities, both on- and off-balance sheet, as well as the risk with financial and non-financial counterparties implemented through financial derivatives and other off-balance sheet treasury products.
We control counterparty risk through an integrated system which provides information on the available credit line of any counterparty, in any product and maturity and at any branch of the Group. In 2003, we replaced the system that the
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Group had been using since 1991 with a more technologically advanced one (including connections via Intranet) which, using the market’s best practices, continues to follow the same philosophy of control and management of credit risk.
Risk is still measured by both its current and its 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 (NRV) of the portfolios of over-the-counter (“OTC”) derivative products that the Group maintained with its counterparties at December 31, 2003 amounted to $3,279.6 million, 0.68% of the nominal value of these contracts compared with 0.65% in 2002.
The table below sets forth the notional value of derivatives by maturity in millions of dollars as of December 31, 2003.
Santander Group. Notional value of derivatives by maturity (at 31.12.2003)
The Equivalent Credit Risk (that is, the sum of the NRV and the maximum potential value of these contracts in the future) was 11.9% more than in 2002 at $23,819.7 million. This increase was mainly due to a higher potential risk both in interest rate derivatives (as the average life of operations increased) as well as in equity derivatives (as the volume was higher).
Santander GroupEquivalent risk and average life (at 31.12.2003)
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Derivatives transactions continue to be carried out with counterparties that enjoy excellent credit quality, such that 95.4% of counterparty risk is at a rating equal or superior to A-.
In terms of geographic distribution, the changes are marginal, apart from a small rise in Spanish risk and a reduction in North American and European Union risk. Latin American risk is mainly concentrated in the local operations of the Group’s subsidiaries in the region.
The distribution of risk in OTC derivatives by type of counterparty remained concentrated in banks in developed countries (93.3%). Only 1% relates to credit entities of emerging countries and 5.8% with corporate clients.
Part 4.– Operational risk
We define operational risk as the risk of losses from defects or failures in internal processes, employees or systems, or losses arising from unforeseen circumstances. In 2003, we continued to identify, mitigate, manage and quantify this risk by:
The main elements of our organizational structure for operational risk management include the Risks Division which is responsible for evaluating and controlling operational risks, and the Central Unit which supervises operational risk reports and is responsible for the global corporate program. This management structure is based on the knowledge and experience of executives and experts in the different areas and units, with particular emphasis placed on the role of coordinators who are key figures in line with the sound practices document of the Basel Committee.
This framework satisfies the qualitative criteria contained in the New Basle Capital Accord, both for standard methods and advanced measurement, as well as in “advance notice of proposed rulemaking” of the U.S. Federal Reserve, regarding the independence of the global management unit, responsibility for designing and implementing policies, procedures and strategies, information systems, etc. Internal Auditing also keeps its independence with regard to management of operational risk, without harming its ability to change the management structure in this area.
All of our units are part of the project, on the same footing and only varying in their historical depth of the respective data bases, on the basis of the date when information began to be stored.
The Group’s own data base has accumulated a total of 136,500 events since it was created, regardless of amount, or whether they have an accounting impact.
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The tables below set out all the factors behind operational risk by number and amount in the main units in Portugal, Brazil and retail banking in Spain.
Santander CentralHispano RetailBanking
HispamerGroup (Spain and Portugal)
Impact on operational risk: 1 - None, 2 - Low, 3 - Medium, 4 - High, 5 - MaximumCoverage of operational risk 1 - Maximum 2 - High, 3 - Medium, 4 - Low, 5 - None
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In Treasury, qualitative and quantitative tools are used as well as self-evaluation questionnaires, both in Spain and in the main units abroad.
In addition, the Central Unit carries out other activities related to the management of operational risk, including:
Part 5. Environmental risk
Analysis of the environmental risk of credit operations is part of the Strategic Plan of Corporate Social Responsibility.
In addition to the steps taken in 2003 (courses given by CESCE-Garrigues, inclusion of clauses in contractual documents, among others), we have continued addressing environmental risk by developing a specific training plan for all of the Group’s banks and geographic areas, aimed at corporate and retail managers, risk analysts and internal auditors.
The project was developed in accordance with the following features:
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Step 1: Analyze the portfolio of customers and assign an initial level of basic risk (high, low, etc).
The final result is a rating scale (for example 1-9), which is increasingly relevant in a more detailed evaluation process. This rating serves as an additional reference for making decisions and is being gradually incorporated into our rating system.
Part 6. Reputational risk
For the Santander Group managing reputational risk in all of its areas is key. The main aspects of managing this type of risk are:
Global Committee of New Products
All of our new products and services have to be approved by the Global Committee of New Products. The Committee held 13 meetings in 2003 to analyze 96 products or families of products.
Each country where a Group entity operates has a Local Committee of New Products. This committee, once it has authorized a new product or service, must request approval from the Global Committee. In Spain, the figure of the Local Committee is assumed by the Global Committee.
The areas that participate in the Global Committee are: Tax Advice, Legal Advice, Customer Attention, Internal Auditing, Retail Banking, Global Corporate Banking, International Private Banking, Operational Control of Treasury, General Accounting, Operations and Services, Country and Counterparty Risk, Credit Risk, Market Risks, Operational Risk, Technology, Global Treasury and, finally, the unit proposing the new product or the Local Committee of New Products.
Prior to the launch of a new product or service, these areas, as well as, where appropriate, other independent experts needed to correctly assess the risks incurred, analyze the aspects that could affect the process and give their opinion on the product or service.
The Global Committee, will approve, reject or establish the conditions for the new product or service based on the documentation received and the risk guidelines established by the Group’s Risk Committee.
The Global Committee pays particular attention to the suitability of the new product or service for the targeted areas. Emphasis is placed on ensuring that:
Santander Central Hispano was the first bank in Spain to obtain the approval from the National Securities Market Commission (CNMV) for its Manual on the retail selling of financial products.
This approval was the culmination of a process which began in June 2003 of adhering to the Procedures Guide drawn up by the CNMV. Teams from the General Secretary, Retail Banking, Asset Management, Operations and Services, Technology, Systems, Global Wholesale Banking, Financial Division, Training and Publicity took part in this project.
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The purpose of the Manual is to improve the quality of information provided to investors so that they understand the features, return and risk of products.
The Manual establishes customer segmentation by three categories – Private Banking, Personal Banking and Banking for Individuals – and products are also placed in three categories (green, red and yellow) on the basis of their complexity and the guarantees offered to recover capital and obtain a certain return.
The Manual deals with savings products that are sold to individual customers, such as, for example, investments in mutual funds and shares in public offerings. The Global Committee can also include others in its Manual.
Maintainance of the Manual requires: (i) rigorous information on products and in contracts and (ii) paying attention to the relevant customer segment of the product offered.
Risk Committee
The Risk Committee of the Board of Directors, the key body for global management of risk and of all kinds of banking operations, assesses reputational risk.
Part 7. Market risk
Generally
We are exposed to market risk mainly as a result of the following activities:
Primary Market Risks and How They Arise
The primary market risks to which we are exposed are interest rate risk, foreign exchange rate risk, equity price risk and liquidity risk. We are exposed to interest rate risk whenever there is a mismatch between interest rate sensitive assets and liabilities, subject to any hedging with interest rate swaps or other off-balance sheet derivative instruments. Interest rate risk arises in connection with both our trading and non-trading activities.
We are exposed to foreign exchange rate risk as a result of mismatches between assets and liabilities, and off-balance sheet items denominated in different currencies, either as a result of trading or in the normal course of business. We maintain non-trading open currency positions arising from our investments in overseas subsidiaries, affiliates and their currency funding. The principal non-trading currency exposures are the euro to the US dollar and the euro to the main Latin American currencies. Trading foreign exchange rate open risk is not material compared to non-trading foreign exchange risk.
We are exposed to equity price risk in connection with both our trading and non-trading investments in equity securities.
We are also exposed to liquidity risk. Market depth is the main liquidity driver in our trading portfolio, even though our policy is to trade the most liquid assets. Our liquidity risk also arises in non-trading activity due to the maturity gap between assets and liabilities in the retail banking business.
We use derivatives for both trading and non-trading activities. Trading derivatives are used to eliminate, to reduce or to modify risk in trading portfolios (interest rate, foreign exchange and equity), and to provide financial services to clients. Our principal counterparties for this activity are financial institutions. The principal types of derivatives used are: interest rate swaps, future rate agreements, interest rate options and futures, foreign exchange forwards, foreign exchange futures, foreign exchange options, foreign exchange swaps, cross currency swaps, equity index futures and equity options.
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Derivatives are also used in non-trading activity in order to manage the interest rate risk and foreign exchange risk arising from asset and liability management activity. Interest rate and foreign exchange non-optional derivatives are used in non-trading activity.
Procedures for Measuring and Managing Market Risk
Our board, through its Risk Committee, is responsible for establishing our policies, procedures and limits with respect to market risks, including which businesses to enter and maintain. The Committee also monitors our overall performance in light of the risks assumed. Together with the local and global Assets and Liabilities Committees (“ALCO”), each Market Risk Unit measures and monitors our market risks, and provides figures for ALCO to use in managing such risks, as well as liquidity risk.
Our market risk policy is to maintain a medium to low risk profile in business units. The risk activity is regulated and controlled through certain policies, documented in our Market Risk Management Policies Manual (as described below), and through a limit structure on our exposure to these market risks which includes global limits for the entire Group (total risk limit unit) to specific portfolio limits; in addition, authorized products are listed and reviewed periodically.
These policies, procedures and limits on market risk are applicable to all units, businesses or portfolios susceptible to market risk.
1. Market Risk Management Policies Manual
The Market Risk Management Policies Manual is a compilation of policies that describe the control framework used by our Group to identify, measure and manage market risk exposures inherent to our activities in the financial markets. The Manual is employed for market risk management purposes at all involved levels in the Group and subsidiaries, providing a general and global action framework and establishing risk rules for all levels.
The Manual’s main objective is to describe and report all risk policies and controls that our Board of Directors has established as well as its risk predisposition.
All Group managers must ensure that each business activity is performed in accordance with the policies established in the Manual. The Manual is applied to all business units and activities, directly or indirectly, related to market risk decision-making.
2. Market Risk Management Procedures
All the functions developed by a risk manager are documented and regulated by different procedures, including measurement, control and reporting responsibilities. Internal and external auditors audit the compliance with this internal regulation control in order to ensure that our market risk policies are being followed.
3. Market Risk Limit Structure
The market risk limit structure can be defined as the Board of Directors risk “appetite” and is managed by the Global Market Risk Function that accounts for all Group business units.
Its main functions are to:
The Global Market Risk Function defines the limit structure while the Risk Committee reviews and approves it. Business managers then administer their activities within these limits. The limit structure covers both our trading and non-
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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:
Statistical Tools for Measuring and Managing Market Risk
1. Trading activity
The Trading Portfolio is defined as proprietary positions in financial instruments held for resale and/or bought to take advantage of current and/or expected differences between purchase and sale prices. These portfolios also include positions in financial instruments deriving from market-making, sale and brokering activity.
As a result of trading fixed income securities, equity securities and foreign exchange, we are exposed to interest rate, equity price and foreign exchange rate risks. We are also exposed to volatility when derivatives (options) are used.
Market risk arising from proprietary trading and market-making activities is actively managed through the use of cash and derivative financial instruments traded in OTC and organized markets.
Interest rate risk derived from market-making is typically hedged by buying or selling very liquid cash securities such as government bonds, or futures contracts listed in 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, as well as through forward foreign exchange, cross currency swaps and foreign exchange options.
Equity price risk is hedged by buying or selling the underlying individual stocks in the organized equity markets in which they are traded, or futures contracts on individual stocks listed in organized markets like Meff and Liffe.
In the case of equity indexes such as S&P 500, Euro STOXX, or IBEX-35, the hedging is done through futures contracts listed in the aforementioned organized markets.
Volatility risk arising from market-making in options and option-related products is hedged by, either buying and selling option contracts listed in organized markets like Eurex, Meff, and CBOT, or entering risk reversal transactions in the interbank OTC market.
We use VaR to measure our market risk associated with all our trading activity.
1.1 VaR Model
We use a variety of mathematical and statistical models, including value at risk (“VaR”) models, historical simulations, stress testing and evaluations of Return on Risk Adjusted Capital (“RORAC”) to measure, monitor, report and manage market risk. We call our VaR figures daily or annual “capital at risk” figures (“DCaR” or “ACaR”), depending on their time horizon, since we use them to allocate economic capital to various activities in order to evaluate the RORAC of such activities.
As calculated by us, DCaR is an estimate of the expected maximum loss in the market value of a given portfolio over a one-day time horizon at a 99% confidence interval. It is the maximum one-day loss that we estimate we would suffer on a given portfolio 99% of the time, subject to certain assumptions and limitations discussed below. Conversely, it is the figure that we would expect to exceed only 1% of the time, or approximately three days per year. DCaR provides a single estimate of market risk that is comparable from one market risk to the other.
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The standard methodology used in the majority of the business units is based on historical simulation (520 days). In order to capture recent market volatility in the model, our DCaR figure is the maximum between the 1% percentile and the 1% weighted percentile of the simulated profit and loss distribution.
We use DCaR estimates to alert senior management whenever the statistically estimated losses in our portfolios exceed prudent levels. Limits on DCaR are used to control exposure on a portfolio by portfolio basis. DCaR is also used to calculate the RORAC for a particular activity in order to make risk-adjusted performance evaluations.
1.2 Assumptions and Limitations
Our DCaR and VaR methodology should be interpreted in light of the limitations of our model, which include:
1.3 Scenario Analysis and Calibration Measures
Because of these limitations in DCaR and VaR methodology, in addition to historical simulation, we use stress testing to analyze the impact of extreme market movements and to adopt policies and procedures in an effort to protect our capital and results of operation against such contingencies.
In order to calibrate our VaR model, we use 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 our backtesting comply, at a minimum, with the BIS recommendations regarding the verification of the internal systems used to measure and manage market risks.
2. Non Trading activity
2.1 Foreign Exchange Risk and Equity Price Risk
Due to its nature, changes in strategic positions have to be approved by local/global functions in ALCO committee. Position limits with respect to these investments are established, although they will be measured under VaR and other methods which attempt to implement immediate action plans if a particular loss level is reached.
Our foreign exchange rate risk with respect to our non-trading activity can be either permanent or temporary. The permanent risk reflects the book value of investments net of the initial goodwill, while the temporary risk basically stems from purchase/sale operations made to hedge the exchange rate risk derived from dividend flows and expected results. The exchange rate differences generated for each position are recorded in reserves and in profit and loss account respectively.
In order to manage the exchange rate risk of the book value of permanent investments, our general policy is to finance the investment in local currency, provided there is a deep market which allows it and that the cost of doing so is justified by the expected depreciation. This is the case of investments in sterling and in some Latin American countries. Also, during 2003 we covered, using foreign exchange non-optional derivatives (swaps and forwards), almost all of the book value of our investments in Mexico, Chile and partially Brazil, analyzing the specific forecasts 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. 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.
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2.2 Interest Rate Risk
We analyze the sensitivity of net interest revenue and net worth to changes in interest rates. This sensitivity arises from gaps in maturity dates and review of interest rates in the different asset and liability accounts. Certain repricing hypotheses are used for products without explicit contractual maturities based on the economic environment (financial and commercial).
We manage investments by determining a target range for each sensitivity and providing the appropriate hedge (mainly with government debt, interest rate swaps and interest rate options) in order to maintain these sensitivities within that range.
The measures used to control interest rate risk are the interest rate gap and the sensitivity of net interest revenue and net worth to changes in interest rates, VaR and analysis of scenarios.
a) Interest rate gap of assets and liabilities
The interest rate gap is based on the analysis of the gaps between the maturities of the asset, liability and off-balance sheet items. Gap analysis provides a basic representation of the balance sheet structure and enables concentrations of interest rate risk by maturity to be identified. It is also a useful tool for estimating the possible impact of eventual interest rate movements on net interest revenue and net worth.
b) Net interest revenue sensitivity (NIR)
The sensitivity of net interest revenue measures the change in the short/medium term in the accruals expected over a particular period (12 months), in response to a parallel shift in the yield curve.
c) Net worth sensitivity (MVE)
Net worth sensitivity measures in the long term (the whole life of the operation) the interest risk implicit in net worth (equity) on the basis of the effect that a change in interest rates has on the current values of financial assets and liabilities.
d) Value at Risk (VaR)
The Value at Risk for balance sheet activity is calculated with the same standard as for trading: historic simulation with a confidence level of 99% and a time frame of one day.
e) Analysis of scenarios
Two scenarios for the performance of interest rates are established: maximum volatility and sudden crisis. These scenarios are applied to the balance sheet, obtaining the impact on net worth as well as the projections of net interest revenue for the year.
2.3 Liquidity Risk
Liquidity risk is associated with our capacity to finance our commitments, at reasonable market prices, as well as to carry out our business plans with stable sources of funding. We permanently monitor maximum gap profiles.
We have a diversified portfolio of assets that are liquid or can be made so in the short term. We also have an active presence in a wide and diversified series of financing and securitization markets, limiting our dependence on specific markets and keeping open the capacity of recourse to alternative markets.
The measures used to control liquidity risk are the liquidity gap, liquidity ratio, stress scenarios and contingency plans.
a) Liquidity gap
The liquidity gap provides information on contractual and expected cash inflows and outflows for a certain period of time, for each of the currencies in which we operate. The gap measures the net need or excess of funds at a particular date, and reflects the level of liquidity maintained under normal market conditions.
b) Liquidity ratios
The liquidity coefficient compares liquid assets available for sale (after applying the relevant discounts and adjustments) with total liabilities to be settled, including contingencies. This coefficient shows, for currencies that cannot be consolidated, the level of immediate response of the entity to firm commitments.
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c) Analysis of scenarios/Contingency Plan
Our liquidity management focuses on preventing a crisis. Liquidity crises, and their immediate causes, cannot always be predicted. Consequently, our Contingency Plan concentrates on creating models of potential crises by analyzing different scenarios, identifying crisis types, internal and external communications and individual responsibilities.
The Contingency Plan covers the activity of a local unit and of central headquarters. Each local unit must prepare a Plan of Contingency Financing, indicating the amount it would potentially require as aid or financing from headquarters during a crisis. Each unit must inform headquarters (Madrid) of its plan at least every six months so that it can be reviewed and updated. These plans, however, must be updated more frequently if market circumstances make it advisable.
Control system
The process of setting limits is the instrument we use to establish the level of equity that each activity has available. Setting the limits is conceived as a dynamic process which responds to senior management’s risk acceptance level.
Quantitative analysis
Quantitative analysis of daily VaR in 2003
Our risk performance with regard to trading activity in financial markets during 2003, measured by daily VaR, is shown in the following graph.
As the above graph shows, we have a medium to low risk profile, which was actively managed throughout the year. This active level of management allows for changes of strategy to take advantage of opportunities in an environment of uncertainity and high volatility.
The maximum risk level was reached on March 17 ($22.59 million in VaR terms) and the minimum on June 24 ($10.51 million), due to the reduction of risk in Madrid and Mexico positions. The levels of volatility in markets moved depending on the geopolitical situation and the expectations of a slower than expected economic recovery. The average risk in 2003 was $15.8 million in terms of VaR.
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The risk histogram below shows the distribution of frequencies of average risk in terms of daily VaR during 2003. The maximum risk levels were reached at specific moments and never surpassed $23 million. The minimum risk levels were reached more frequently and were lower than $12 million on 36 occasions.
Risk by product
The minimum, maximum, average and year-end 2003 values in VaR terms were as follows:
The average risk in Latin America in terms of VaR was $12.5 million, ending the year with a VaR of $17.9 million. Our risks were concentrated in fixed income and currencies (average daily VaR of $12.7 million and $7.5 million, respectively, and located in both Latin America and Europe).
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Distribution of risks and results
During 2003, the main feature of the geographic distribution of results of the Group’s trading activities was a greater concentration in Latin America, particularly Brazil and Mexico and, to a lesser extent, in Europe. Latin America’s contribution to the Group’s total VaRD was 58% and Europe’s contribution was 33%.
The geographic contribution, in percentage terms, both in risks as well as in results over the Group’s total VaRD and annual gross operating income from trading activity, is shown in the graph below.
The minimum, average, maximum and year-end risk values in daily VaR terms, by geographic area, are shown in the table.
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The table below shows the performance of risk versus monthly results for our trading activity.
Histogram of the frequency of daily marked-to-market results
The histogram below details the distribution of the frequency of daily Marked-to-Market (“MtM”) results on the basis of size. The most common yield interval was $0-$3 million, which occurred on 84 days of the year (33% of the days of the year). During 77% of the days of the year, the interval was between -$3 and $6 million.
Risk management of structured derivatives
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, Portugal, Brazil, Chile and Mexico.
The average VaR was $2.7 million, the maximum $5.9 million and the minimum $0.9 million.
Stress Test
Different stress test scenarios were analyzed during 2003. A scenario of maximum volatility, applying six standard deviations to different market factors, which results as of December 31, 2003 are provided below.
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a) Maximum volatility scenario
The table below shows, at December 31, 2003, 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 we would suffer an economic loss of $ 29.2 million, if this scenario materialized in the market.
b) Stress test statistics
The following table of statistics is based on the aforementioned scenario. It shows the minimum, average, maximum and year-end loss of each scenario.
B. Asset and liability management in Latin America
Quantitative analysis of interest rate risk in 2003
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 2003, with a gradual increase compared to the end of 2002.
At the end of December of 2003, risk consumption by region, measured by the sensitivity of net worth to 100 basis points, was $266.4 million, and measured by the sensitivity of net interest revenue at one year to 100 basis points, was $49.6 million. This risk profile corresponds to a gradual taking of positions in order to guarantee margin in a scenario of constant interest rate cuts because of the weak global economy.
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Interest rate risk profile at December 31, 2003
The gap tables below show the distribution by maturity of the risk in Latin America at December 31, 2003.
Net interest revenue sensitivity
For the whole of Latin America, the consumption at December 2003 was $49.59 million (sensitivity to 100 basis points). The geographic distribution is shown below.
Brazil, Mexico and Puerto Rico account for 80% of the net interest revenue risk. 2003 was characterized by an increase in the net interest revenue risk, mainly due to the portfolio purchases in Mexico, Puerto Rico and to a lesser extent Brazil.
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.
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Business units shown on the right side of the graph are exposed to losses in NIR in scenarios of local and U.S. interest rate reductions. Business units shown on the left side of the graph are exposed to losses in NIR in scenarios of local and U.S. interest rate increases. The size of the circles represents the total sensitivity of the unit.
Net worth sensitivity
Consumption for all Latin America in 2003 amounted to $266.4 million (sensitivity to 100 basis points). The geographic distribution is shown below.
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. Business units shown on the right side of the graph are exposed to losses in MVE in scenarios of local and U.S. interest rate reductions. Business units shown on the left side of the graph are exposed to losses in MVE in scenarios of local and U.S. interest rate increases. The size of the circles represents the total sensitivity of the unit.
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Investment portfolios in Latin America
As the graph below shows, the risk of investment portfolios at December 2003, in terms of 1 year equivalent volume for Latin America countries and 10 years equivalent volume for Puerto Rico (core market), is concentrated in Mexico, Brazil and Chile. The investment portfolio mainly consists of local public debt and hedging instruments (swaps, repos, etc.).
C. Financial management
We actively manage the market risks inherent in retail banking, which is the core of our business. Management covers the structural risks of interest rates, liquidity, exchange rates and capital.
The purpose of financial management is to make net interest revenue from our commercial activities more stable and recurrent, maintaining adequate levels of liquidity and solvency.
The Financial Management Area manages structural risk on a centralized basis. This allows the use of homogenous methodologies, adapted to each local market where we operate.
In the euro-dollar area, the Financial Management Area directly manages the risks of the parent bank and coordinates management of the rest of the units that operate in convertible currencies. There are local teams in the banks in Latin America that manage balance sheet risks under the same frameworks, in coordination with the global area of Financial Management of the parent bank.
The Asset and Liability Committees (ALCOs) of each country and, where necessary, the Markets Committee of the parent bank are responsible for these risk management decisions.
Interest rate risk
The Financial Management Area analyzes structural interest rate risk derived from mismatches in maturity and revision dates for assets and liabilities in each of the currencies in which we operate. For each currency, the risk measured is the interest gap, the sensitivity of net interest revenue, the economic value and the duration of equity.
Depending on the position of the interest rates of the balance sheet and taking into account the market’s prospects, the necessary financial measures are adopted to adjust the position to that desired by the Bank. These measures include the taking of positions in markets to defining the interest rate features of products.
There are two spheres of management: convertible currencies (mainly the euro and the US dollar) and non-convertible currencies (largely Latin American). The Markets Committee, through the Financial Management Area, directly manages convertible currencies and coordinates management of the local ALCOs of the banks in Latin America.
This activity is particularly important when interest rates are historically low as have been the case with the euro and dollar, or in environments with sharp falls in interest rates such as in the main markets where the Group operates in Latin America.
In these scenarios, adequate management of structural interest rate risk protects revenues via net interest revenue without exposing assets and liabilities to purely speculative positions.
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In 2003, management of the ALCO portfolio of the parent bank contributed €317 million to the Group’s earnings. The sensitivity of the economic value of the parent bank to a shift of 100 basis points in the market yield curve was €129 million at the end of the year.
Exchange rate risk
Structural exchange rate risk is largely derived from our currency operations, including permanent financial investments, collection of earnings and dividends from subsidiaries and purchase/sale of assets.
In order to manage the exchange rate risk of the book value of permanent investments, our general policy is to finance it in local currency provided there is a profound market which allows it and that the cost of doing so is justified by the expected depreciation.
Throughout the year, our structural foreign exchange rate risk remained almost constant, with some fluctuations associated with changes in the volatilities of the main Latin American currencies. At the end of 2003, there was a full coverage of the book value of our investment in Chile, Mexico and Venezuela and partial coverage of the book value of our investment in Brazil.
Portfolio of industrial and strategic shareholdings
In the first six months of the year, the risk level of our industrial and strategic equity portfolio increased, despite volatility levels in the Equity Markets declining after the war in Iraq. This increase can be attributed to the upward trend in the equity markets and accordingly, the increase in the share values of certain large holdings (such as Royal Bank of Scotland and San Paolo IMI). These increases were partially offset by reductions in shares of Vodafone.
In the second six months of the year, the risk level of this portfolio decreased primarily because volatility levels in the Equity Markets dropped slightly and the historical simulation window used for VaR calculation did not include the high volatility levels of September 2001.
During the second six months of the year, there were also some significant changes in positions, with reductions in large holdings such as Vodafone and Royal Bank of Scotland, and increases in others such as Cepsa and San Paolo IMI.
Fluctuations in the market value of the shares in such portfolios do not affect our operational results since 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 2003, was $604.6 million, with a low of $510.1 million and a high of $726.8 million.
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Management of structural liquidity
Management of structural liquidity enables assets to be financed in optimun 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 assets, limiting its dependence on specific markets and keeping open the capacity of recourse to markets.
Management of structural liquidity involves planning the funding needs, structuring the sources of financing (optimizing diversification by maturities, instruments and markets) and drawing up contingency plans.
In the euro-dollar area, an annual liquidity plan is drawn up based on the financing needs arising from the business budgets. On the basis of these needs and taking into account the limits of recourse to the short-term markets, an issuance and securitization plan is drawn up for the year. Financing needs are closely tracked during the year, resulting in changes to the plan when necessary.
The volume of convertible currencies captured under the Issues and Securitization Plan amounted to €26.0 billion, 54% of which were medium- and long-term issues, including preference shares and subordinated debt which are included in our eligible capital. Securitization of medium- and long-term assets amounted to €8.0 billion.
Of note was the significant reduction in our lending spreads and, consequently, of financing costs in 2003, due to our better risk perception in the financial markets. This was also backed by ratings upgrades by the three main agencies (Fitch and Moody’s in November 2003 and Standard & Poor’s in January 2004).
The banks in Latin America are autonomous in terms of liquidity, and do not resort to the lines of the parent bank for financing their activities. Each bank has its own liquidity and contingency plans without calling on the Group’s financing. The cross-border and reputational risks arising from external financing are limited and authorized by the parent bank.
Unlike what generally happens in the euro-dollar area, the business activity of the Latin American banks has a surplus of funds and does not require structural financing from the markets.
Capital management
Capital management aims to optimize its structure and cost from the regulatory and economic standpoints. In order to ensure our solvency, we use different instruments and policies: capital increases and issues eligible for equity (preferred shares and subordinated debt), retained earnings, dividend policy and securitizations.
From a regulatory standpoint (BIS criteria), we increased our eligible equity and improved its composition in 2003: €3,200 million of core capital (defined as Tier I capital excluding preference shares and hybrid capital investments) was generated and our ratio rose from 5.07% to 6.14%, while the percentage of preference shares in Tier I capital dropped from 37% to 26%.
In addition to managing the regulatory capital, we are undertaking various projects to optimize the return on the economic capital. We assign economic capital to the business units in order to measure, on a homogeneous basis, the return of each unit and thus its contribution to the Group’s value.
The return on economic capital is a basic yardstick for assessing the management of each unit, enabling the interests of the managers to be aligned to those of shareholders.
Financial Management assesses the different businesses on the basis of their creation of value and the growth rates expected, and analyzes management alternatives for the Group’s portfolio of businesses.
The main risk and thus the chief consumer of our economic capital comes from credit risk. The Financial Management Area is developing a project for active management of loan portfolios that increases the diversification, reduces the economic capital consumed and improved the return.
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D. Market Risk: VaR Consolidated Analysis
Our total daily VaR at December 31, 2002 and December 31, 2003, broken down by trading and structural (non-trading) portfolios, were as follows (excluding our Argentine portfolios) at the dates below:
Our daily VaR estimates of interest rate risk, foreign exchange rate risk and equity price risk, broken down by trading and structural (non-trading) portfolios, were as follows at and for the periods ended on the dates set forth below:
Interest Rate Risk
Foreign Exchange Rate Risk
Equity Price Risk
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Item 12. Description of Securities Other than Equity Securities.
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PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies.
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds.
E. Use of proceeds.
Item 15. Controls and Procedures
(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-15(e) and 15d-15(e)), have concluded that as of December 31, 2003, our disclosure controls and procedures were adequate and effective and designed to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities.
(b) Changes in internal controls over financial reporting. There was no change in our internal control over financial reporting that occurred during the period covered by this annual report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 16. [Reserved]
Item 16A. Audit committee financial expert
The Audit and Compliance Committee has six members, all of whom are non-executive directors and five of whom are independent (as defined by Article 5 of the Board’s Regulations). Our Regulations of the Board provide that the chairman of the Audit and Compliance Committee must be an independent director (as defined by Article 5 of the Board’s Regulations) and someone who has the necessary knowledge and experience of accounting techniques and principles. Currently, the chairman of the Audit and Compliance Committee is Mr. Manuel Soto, the Fourth Vice-Chairman of the Board of Directors. Our standards for director independence may not necessarily be consistent with, or as stringent as, the standards for director independence established by the NYSE.
Our Board of Directors has determined that Mr. Manuel Soto, the Chairman of the Audit and Compliance Committee, is an “Audit Committee Financial Expert” in accordance with SEC rules and regulations.
Item 16B. Code of Ethics
We have adopted a code of ethics (the “General Code of Conduct”) that is applicable to all members of the boards of the companies of the Group, to all employees subject to the Code of Conduct of the Securities Market, including the Bank’s chief executive officer, chief financial officer and chief accounting officer, and to all those employees designated by the Human Resources Division that have been specifically informed of their subjection to this General Code of Conduct. This Code establishes the principles that guide these officers’ and directors’ respective actions: ethical conduct, professional standards and confidentiality. It also establishes the limitations and defines the conflicts of interest arising from their status as senior executives or directors.
This Code is available on our website, which does not form part of this Annual Report on Form 20-F, at www.gruposantander.com under the heading “Corporate Governance – Internal Code of Conduct”.
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Item 16C. Principal Accountant Fees and Services
Amounts paid to the firms belonging to the Deloitte worldwide organization, the Group’s principal auditor, for statutory audit and other services were as follows:
The Audit and Compliance Committee proposes to the Board the fees to be paid to the external auditor and the scope of its professional mandate.
The Audit and Compliance Committee is required to pre-approve the main audit contract of the Bank or of any other company of the Group with its principal auditing firm. This main contract sets forth the scope of the audit services and audit-related services to be provided by the auditing firm, the term (typically, three years), the fees to be paid and the Group companies to which it will be applied. Once the term of the first contract expires, it can be rolled over by subsequent periods of one year upon approval by the Audit and Compliance Committee.
If a new Group company is required to engage an auditing firm for audit and audit-related services, those services have to be pre-approved by the Audit and Compliance Committee.
All non-audit services to be provided by the Group’s principal auditing firm (i.e.: tax services and all other services) have to be approved by the Audit and Compliance Committee on a case by case basis.
The Audit and Compliance Committee is regularly informed of all fees paid to the auditing firm by the Group companies.
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PART III
Item 17. Financial Statements.
We have responded to Item 18 in lieu of this item.
Item 18. Financial Statements.
Reference is made to Item 19 for a list of all financial statements filed as part of this Form 20-F.
Item 19. Exhibits.
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.
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INDEX TO FINANCIAL STATEMENTS
(a) Index to Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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 Group (the “Group” - Notes 1 and 3), as of December 31, 2003, 2002 and 2001, and the related consolidated statements of income for the years then ended. These consolidated financial statements are the responsibility of the controlling Company’s directors. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States of America). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 statements 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, the Bank and other Group entities recorded in 2003, 2002 and 2001 - with a charge to unrestricted reserves (€336 million, €856 million and €452 million, respectively) and to the related deferred tax asset accounts (€181 million, €461 million and €244 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).
The consolidated financial statements referred to above are based on the Spanish financial statements of the Santander Group, prepared in accordance with accounting principles generally accepted in Spain (“Spanish GAAP”) by the controlling Company’s Directors.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Banco Santander Central Hispano, S.A., and Companies composing the Santander Group as of December 31, 2003, 2002 and 2001, and of the results of its operations and of the funds obtained and applied by them for the years then ended in conformity with accounting principles generally accepted in Spain.
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 periods ended December 31, 2003, 2002 and 2001, and the determination of stockholders’ equity and financial position as of December 31, 2003 and 2002, to the extent summarized in Note 27.
/s/ DELOITTE & TOUCHE ESPAÑA, S.L.
Deloitte & Touche España, S.L.Madrid—Spain, March 29, 2004, except for Note 27 as to which the date is June 30, 2004
F-1
Banco Santander Central Hispano, SA and Companies Composing the Santander GroupConsolidated Balance Sheets as of December 31, 2003, 2002 and 2001 (Notes 1,2,3 and 4)
F-2
F-3
(Debit) Credit
F-4
Notes to Consolidated Financial Statements for the year ended December 31, 2003
1. Description of the Bank, basis of presentation of the consolidated financial statements and other information
Description of the Bank
Banco Santander Central Hispano, S.A. (“the Bank” or “the Parent Bank”) is a private-law entity subject to the rules and regulations applicable to banks operating in Spain. The bylaws and other public information of the Bank can be consulted on the web page of the Group (www.gruposantander.com) and in its registered office at Paseo de Pereda 9-12, Santander.
Basis of presentation of the consolidated financial statements
The consolidated financial statements of the Bank and of the companies which, together with it, compose the Santander 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).
In view of the business activities carried on by the Group Companies, the Group does not have any environmental liability, expenses, assets, provisions or contingencies that might be material with respect to its consolidated net worth, financial position or results. Therefore, no specific disclosures relating to environmental issues are included in these notes to consolidated financial statements.
The 2002 and 2001 consolidated financial statements were approved by the Shareholders’ Meetings of the Bank on June 21, 2003 and June 24, 2002, respectively.
The 2003 consolidated financial statements of the Group and the financial statements of 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 changes.
Objections to corporate resolutions
The directors of the Bank and their legal advisers consider that the objection to certain resolutions adopted by the Bank’s Shareholders’ Meetings on June 21, 2003, 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 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 cessation 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 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 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 resolutions adopted at the Shareholders’ Meeting on February 9, 2002. On January 14, 2004, the Cantabria Provincial Appellate Court dismissed the appeal. An extraordinary appeal has been prepared and filed against the judgment on the ground of a procedural infringement, as well as an appeal in cessation.
On May 29, 2003, the Santander Court of First Instance number 6 rejected in full the claims contesting the resolutions adopted at the Shareholders’ Meeting on June 24, 2002. An appeal has been filed against the judgment.
Accounting policies
The consolidated financial statements of the Group were prepared in accordance with the accounting principles and valuation methods described in Note 2, which coincide with those established by Bank of Spain Circular 4/1991 and subsequent amendments thereto. All obligatory accounting principles and valuation methods with a material effect on the consolidated financial statements were applied in preparing them.
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Consolidation principles
The companies whose business activity is directly related to that of the Bank and which are directly or indirectly 50% or more owned by the Bank or, if less than 50% owned, are effectively controlled by the Bank and constitute, together with the Bank, a single decision-making unit, were fully consolidated.
All significant accounts and transactions between consolidated companies were eliminated in consolidation. The equity of third parties in the Group is presented under the "Minority Interests" caption and in the "Consolidated Net Income for the Year – Minority Interests" account in the consolidated balance sheets (Note 19).
The investments in companies controlled by the Bank and not consolidated because their business activity is not directly related to that of the Bank (Note 11) and the investments in companies which have a lasting relationship with the Group, which are intended to contribute to the Group’s business activities, in which the Group’s ownership interests are generally equal to or exceed 20% – 3% if listed –, and over which the Group exercises significant influence – as evidenced by its representation in the associated company’s governing body, significant transactions between the other Group companies and the investee, or the exchange of management personnel, among others (“associated companies” – Note 10) –, are carried at the fraction of the investees' net worth corresponding to such investments, net of the dividends collected from them and other net worth eliminations (equity method).
The income or loss generated by companies acquired in each year is consolidated by taking into account only the income or loss relating to the period between the acquisition date and the related year-end.
Determination of net worth
In evaluating the Group's net worth, the balances of the following captions in the accompanying consolidated balance sheets should be taken into consideration:
Thousands of Euros
The entry into force of Law 13/1992 and Bank of Spain Circular 5/1993 and subsequent amendments introduced new regulations governing minimum capital requirements for credit institutions at both individual and consolidated group levels.
As of December 31, 2003, 2002 and 2001, the Group’s eligible capital exceeded the minimum requirements stipulated by the aforementioned regulations by approximately €5,700 million, €5,500 million and €6,300 million, respectively.
Detail of risk provisions and coverage
In accordance with the Bank of Spain regulations, the risk provisions and coverage are presented as assigned to the related assets and/or in specific accounts. The detail of the aggregate risk provisions, coverage and guarantees, disregarding their accounting classification, are 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 in 2001 (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 2003, 2002 and 2001 consolidated financial statements were prepared as described below, in accordance with the Group’s traditional policy of prudence in valuation:
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In 2003 and 2002 no cash contributions were made from other Group entities to the subsidiaries located in Argentina.
The accounting principles and valuation methods applied in preparing the consolidated financial statements were as follows:
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Banco Santander Central Hispano, S.A.The growth of the Group in the last decade has led the Bank to also act, in practice, as a holding entity of shares of the various companies in its Group, and its results are becoming progressively less representative of the performance and earnings of the Group. Therefore, each year the Bank determines the amount of dividends to be distributed to its shareholders on the basis of the consolidated net income, while maintaining the Group’s traditionally high level of capitalization and taking into account that the transactions of the Bank and of the rest of the Group are managed on a consolidated basis (notwithstanding the allocation to each company of the related net worth effect).
International Group StructureAt the international level, the various banks and other subsidiary and associated companies belonging to the Group are integrated in a corporate structure comprising various holding companies which are the ultimate shareholders of the banks and subsidiaries abroad.
The purpose of this structure, all of which is controlled by the Bank, is to optimize the international organization from the strategic, economic, financial and tax standpoints, 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.
The Exhibits provide relevant data on the consolidable Group companies (Exhibits I and III) and on those accounted for by the equity method which are included, inter alia, in Exhibit II.
The principal equity investments acquired and sold by the Group in 2001, 2002 and 2003 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, after this transaction our ownership interest in Banesto was reduced to 88.57% at the end of 2002 (Note 21).
Orígenes AFJP, S.A. (Orígenes AFJP)In accordance with the agreements reached with Bank of Boston in 2000, in 2003 the Group acquired an additional 20% holding in the capital stock of Orígenes AFJP for €141 million. The goodwill which arose from this acquisition (Note 12) was amortized using the provisions recorded under the “Provisions for Contingencies and Expenses – Other Provisions” caption as of December 31, 2002 (Note 17).
Banco Santander Portugal, S.A. (Banco Santander Portugal)In 2003, we acquired a 12.74% ownership interest in the capital stock of Banco Santander Portugal for €106 million, thus increasing our holding to 97.95%.
Shinsei BankIn 2003, we increased our holding in the capital stock of the Japanese bank Shinsei Bank from 6.5% as of December 31, 2002, to 11.4% as of December 31, 2003. The total cost of the investment at that date was approximately €144 million.
Finconsumo Banca SpA (Finconsumo)In 2003, we resolved to acquire the remaining 50% of the capital stock of Finconsumo that we did not own and acquired 20% for €60 million in 2003 (Note 12) and the remaining 30% (paid in 2004) for €80 million.
AKB Holding (AKB)In 2001, we reached an agreement with the Werhahn Group for the acquisition of AKB (a German group specializing in consumer finance). In 2002 we issued 109,040,444 new shares of €0.5 par value each and a 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 Extraordinary Shareholders’ Meeting on February 9, 2002. In 2002 AKB merged with CC-Bank Ag.
Banco SantiagoUnder 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. On August 1, 2002, Banco Santiago merged into Banco Santander Chile, with retroactive effect as of January 1, 2002, after the required resolutions of their respective Shareholders’ Meetings and approval by the Chilean regulatory authorities. The name of the post-merger entity is Banco Santander Chile.
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Banco Río de la Plata, S.A. (Banco Río)
As of December 31, 2003, we had a 99.1% interest in Banco Río (98.9% and 80.3% as of December 31, 2002 and 2001, respectively) following 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, 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) and the conversion into equity in 2003 of the subordinated debt owned by the Group as of December 31, 2002.
Banco Santander Colombia, S.A. (Banco Santander Colombia)
As a result of a capital increase and of certain agreements reached in prior years, in 2002 we increased our holding in the capital stock of Banco Santander Colombia by 34.32% and paid €303 million. As of December 31,2003, we held a 97.64% of the capital of Banco Santander Colombia.
Banco do Estado de Sao Paulo, S.A. (Banespa)
In November 2000, we acquired a 33% holding (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. We paid 2,275 million Brazilian reais for this additional interest.
Grupo Financiero Santander Serfin, S.A. de C.V. (Grupo Financiero Santander Serfin)
In December 2002, we reached an agreement with Bank of America Corporation whereby the latter acquired 24.9% of Grupo Financiero Santander Serfin for $1,600 million (equivalent to €1,457 million), for which we recognised capital gains of €681 million. These gains were recorded under the “Gains on Disposal of Investments in Fully Consolidated Companies” caption in the consolidated statement of income for the year ended December 31, 2003. Under this agreement, Bank of America Corporation will maintain its 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 Serfin 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.
After this sale, our holding in the capital stock of Grupo Financiero Santander Serfin was 73.98%.
Patagon Group
In 2002, we restructured our Internet banking business, sold our holding in Patagon America, the Latin America financial portal, to the other shareholders for $9.84 million (approximately €10.7 million) and released the provisions recorded for the full amount of the investment.
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 $258 million, for which we recognized capital gains of approximately $160 million.
Santander Central Hispano Previsión, S.A., de Seguros y Reaseguros
In 2003, we reached an agreement for the sale of our entire investment in the capital stock of this company for €160 million.
Other investments
Compañía Española de Petróleos, S.A. (Cepsa)
In 2003, we launched a tender offer for up to 42,811,991 Cepsa shares. The offer was accepted by 32,461,948 shares, representing an investment of €909 million (Note 12).
Total, S.A. considered that the tender offer constituted a breach of historical agreements between it and the Bank relating to (i) the exercise of voting rights in General Meetings of Cepsa and (ii) certain transfer restrictions on the Cepsa shares held by Total and the Bank (agreements which had, however, been rendered ineffective automatically by Law 26/2003) and, accordingly, filed a request for arbitration seeking injunctive measures at the Netherlands Court of Arbitration. The award rendered in this injunctive arbitration proceeding, which does not constitute a preliminary ruling on, or considers the merits of, the matters raised since they must be resolved in an arbitration on the merits already in progress, established injunctive measures that can be summarized as follows:
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Royal Bank of Scotland Group, plc. (RBOS)
In 2001, we sold 1.53% of the capital stock of RBOS, at a gain of approximately €400 million, thus reducing our investment to 8.03% as of December 31, 2001.
In 2002, we made a net divestment of 3% of our holding in RBOS, giving rise to gains of approximately €806 million. As of December 31, 2002, our ownership interest was 5.04%.
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, 2003 and 2002, we had a 23.02% and a 23.35% holding, respectively, in the capital stock of Unión Fenosa.
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 Societé Générale as of December 31, 2001. This holding was divested in 2002 at a gain of €94 million.
Grupo Financiero Bital
In 2002, we subscribed to 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 of Grupo Financiero Bital. 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.
Grupo Sacyr-Vallehermoso, S.A. (Sacyr-Vallehermoso)
In 2002, we divested 24.5% of our holding in Sacyr-Vallehermoso (as of December 31, 2001, the holding was 25.14% of capital stock) at a capital gain of approximately €301 million.
Metropolitan Life Insurance Company (Metlife)
In 2001, we reduced our stake in Metlife from 4.00% to 0.67% at a capital gain of approximately €300 million. Subsequently, in January 2002 we sold our remaining 0.67%.
San Paolo IMI, S.p.A. (San Paolo IMI)
In 2003, we increased our holding in San Paolo IMI, from 5.2% as of December 31, 2002, to 8.6% as of December 31, 2003, with a net investment of €525 million in 2003. As of December 31, 2003, this holding was recorded under the “Common Stocks and Other Equity Securities” caption (Note 9).
* * * * *
The cost, total assets and gross revenues of the other consolidated companies acquired and sold in 2003, 2002 and 2001 were not material with respect to the related consolidated totals.
Distribution of the Bank’s income
The Board of Directors submited for approval the Shareholders' Meeting the following proposal for distribution of the Parent Bank’s 2003 net income:
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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 2003 interim dividends, were as follows:
Compensation and other benefits of the Bank’s directors and senior management
Emoluments per the bylaws
Article 37 of the Bank’s bylaws provides that the Bank’s Executive Directors shall receive an amount up to 5% of the Bank net income for any fiscal year, for performing their duties as directors.
The Board of Directors, making use of the powers conferred on it, allocated 0.196% of the Bank’s income for 2003 (as compared to 0.191% for 2002 and 0.254% for 2001) as compensation (in the aggregate) for itself.
Finally, from 2002 onwards, the members of the Audit and Compliance Committee receive additional compensation in the amount of of €32,000 per year.
The detail of the salary compensation received by the Bank’s Board members with executive duties, who as of December 31, 2003 and 2002, were Mr. Emilio Botín-Sanz de Sautuola y García de los Ríos, Mr. Alfredo Sáenz Abad, Mr. Matías Rodríguez Inciarte, Ms. Ana Patricia Botín-Sanz de Sautuola y O’Shea, and Mr. Francisco Luzón López, is as follows:
Detail by director
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By resolution of the Executive Committee, all the compensation received by the Bank’s directors who represent the Bank on the Boards of Directors of listed companies in which the Bank has a stake (at the expense of those companies) and relating to appointments made after March 18, 2002, will accrue to the Group. The compensation received in 2003 in connection with representation duties of this kind, relating to appointments made after March 18, 2002, was as follows:
Additionally following is a detail of the aggregate compensation paid to the Bank’s Executive Officers (*) in 2003 and 2002:
The total balance of supplementary pension obligations assumed by the Group over the years for its current and retired employees, which amounted to €13,305 million (covered mostly by in-house allowances) as of December 31, 2003, 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 commitments for these directors, together with the total sum insured under life insurance policies at that date and other items, amounted to €162 million as of December 31, 2003 (€256 million as of December 31, 2002, of which €108 million related to the settlement of the pension rights referred to bellow, and €209 million as of December 31, 2001, which did not include the extraordinary nonrecurring payment of €43.75 million paid in 2001 as a result of the retirement of the former co-chairman of the Bank Mr. José María Almusátegui).
Following the decision of Mr. Ángel Corcóstegui Guraya to resign, for personal reasons, in February 2002 from his position as First Vice-Chairman of the Bank and board member (which entailed his corresponding resignation as Chief Executive Officer of the Bank and as member of the various Board Committees on which he sat), and in settlement for the pension commitments to him, the Bank paid on his resignation a gross amount of €108 million for his pension rights. This amount had been fully provided for as of that date. Upon payment, a withholding of 48% was made, and the amount withheld was paid into the Spanish Treasury. Accordingly, the net amount paid to Mr. Corcóstegui in this connection was €56 million.
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Loans made to member of our Board of Directors and our Executive Officers
Our direct or indirect risk exposure to the Bank’s directors as of December 31, 2003, amounted to €10.1 million (€14.4 million and €7.8 million as of December 31, 2002 and 2001, respectively) of loans and credits to such directors and €0.4 million (€1.2 million and €0.8 million as of December 31, 2002 and 2001, respectively) of guarantees provided to them. These loans, credits and guarantees were granted at market rates in all cases.
Detail of directors’ investments in companies with similar business activities and performance by directors, for their own account or for the account of others, of similar activities
In accordance with the requirements of Article 127 ter.4 of the Spanish Corporations Law, in order to enhance the transparency of listed corporations, following is a detail of the directors’ investments in the capital stock of non-Group companies engaging in: (i) banking, financing or lending; (ii) insurance; (iii) management of Collective Investment Institutions; or (iv) securities brokerage, and of the management or governing functions, if any, that the directors discharge therein:
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The Annual Corporate Governance Report contains information regarding the Bank’s directors’ holdings in Group companies and the governing bodies thereof to which they belong.
None of the Board members perform, for their own account or for the account of others, any activities similar to those included in the foregoing table. Additionally, as required by Article 114.2 of the Securities Market Law, it is hereby stated that in 2003 the Bank’s directors did not perform, either directly or indirectly, any transaction with the Bank or with other Group companies other than in the ordinary course of operations or on an arm’s-length basis.
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Breakdown
The detail of the balances of this caption in the consolidated balance sheets is as follows:
Term to maturity
The breakdown of the balances of this caption, by term to maturity, disregarding the security price fluctuation allowance, is as follows:
Other information
Of the assets included in the “Government Debt Securities – Fixed-Income Securities” and “Debentures and Other Fixed-Income Securities” captions (Note 8) and of the assets acquired under resale agreement, recorded under the “Due from Credit Institutions” (Note 6) and “Loans and Credits” (Note 7) captions, as of December 31, 2003, the Group had sold under repurchase agreement €69,992 million to the Bank of Spain and to other financial intermediaries and customers (public authorities, other resident sectors and nonresidents), and these amounts are recorded under the “Due to Credit Institutions – Time or Notification Deposits” (Note 14) and “Customer Deposits” (Note 15) captions in the consolidated balance sheets (€55,466 million and €57,852 million as of December 31, 2002 and 2001, respectively).
The average annual interest rate on Treasury bills in 2003 was 2.14% (3.67% in 2002 and 4.58% in 2001).
The "Other Listed Debt Securities Traded by the Book-Entry System" account includes debentures, bonds and government debt securities with an average annual interest rate of 4.10% in 2003 (5.05% in 2002 and 5.43% in 2001).
As of December 31, 2003, the nominal amount of government debt securities pledged to certain commitments of Group companies and third parties amounted to €267 million (€600 million and €604 million as of December 31, 2002 and 2001, respectively).
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Security price fluctuation allowance
The variations in the balances of the "Security Price Fluctuation Allowance" account were as follows:
6. Due from credit institutions
The breakdown of the balances of this caption in the consolidated balance sheets, by type and term to maturity, is as follows:
7. Loans and credits
The detail, by borrower sector, of the balances of this caption is as follows:
As of December 31, 2003 and 2002, €11,667 and €4,444 millions of mortgage loans were assigned as garantee of Mortgage backed securities issued pursuant to the Mortgage Market law (see note 16).
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Term to maturity, loan type and status
The detail, by term to maturity and loan type and status, of the balances of this caption, disregarding the "Credit Loss Allowance" account balance, is as follows:
Credit loss allowance
The variations in the balances of the “Credit Loss Allowance” account which, as indicated in Note 2-c, covers nonperforming and doubtful loans and country-risk of the “Due from Credit Institutions” (Note 6), “Loans and Credits” and “Debentures and Other Fixed-Income Securities” captions (Note 8), were as follows:
The €357 million of written-off assets recovered in 2003 are presented as a reduction of the balance of the "Writeoffs and Credit Loss Provisions" caption in the consolidated statement of income. This caption also includes the direct writeoffs of loans classified as bad debts, which amounted to €104 million in 2003. Written-off assets recovered in 2002 and 2001 amounted to €394 million and €494 million, respectively, and direct writeoffs of loans classified as bad debts were €132 million and €53 million, respectively.
The allowance for possible losses that might arise in the realization of loans and credits, deposits placed with financial institutions (Note 6), fixed-income securities (Note 8) and guarantees provided, relating to public- and private-sector entities in problem debtor countries experiencing differing degrees of debt-servicing difficulty exceeded the minimum provision requirements under Bank of Spain regulations (Note 2-c).
As of December 31, 2003, the Group’s positions exposed to country-risk (disregarding intercompany balances) amounted to approximately €500 million (€400 million and €1,200 million as of December 31, 2002 and 2001, respectively).
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The breakdown, by listing status and classification, of the balances of this caption is as follows:
As of December 31, 2003, 2002 and 2001, 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, 2003, was 6.2% (10.2% and 9.1% as of December 31, 2002 and 2001, 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, 2003, of the "Public-Sector Issuers" account in the consolidated balance sheet includes €27,065 million relating to securities issued by nonresident public-sector entities (€22,639 million and €31,991 million as of December 31, 2002 and 2001, respectively).
The variation in the balance of this caption as of December 31, 2003, with respect to December 31, 2002, was due basically to the acquisition of securities of European public-sector issuers, financed with short-term repurchase agreements (Note 5).
€18,646 million of the Group's total fixed-income securities portfolio as of December 31, 2003, mature in 2004.
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 over which no significant influence is exercised (Note 2-e), and investments in mutual funds.
The detail, by classification and listing status, of the balances of this caption is as follows:
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Variations
The variations in the balances of this caption, disregarding the security price fluctuation allowance, were as follows:
Following the issuance of the First-Time Application Standard of International Accounting Standards in 2003, as of December 31, 2003, after recording the annual goodwill amortization charge, the Group transferred the holdings (Note 10) of less than 20% which are not intended to be held at long term. The transfer was made at the cost previously recorded in the “Investments in Non-Group Companies” caption plus the related goodwill. The required security price fluctuation allowance is recorded if the market value after the transfer is lower than net cost.
The variations in the balances of the “Security Price Fluctuation Allowance” account were as follows:
Vodafone Airtouch, plc. (Vodafone)
In 2001 the Group sold 44% of its investment in the capital stock of Vodafone, generating a gross gain of €1,713 million. In 2003, the Group sold 0.67% of its holding in Vodafone, at a gain of €369 million.
Auna Operadores de Telecomunicaciones, S.A. (Auna)
Following the various corporate transactions that took place in 2001 and 2002, as of December 31, 2003 and 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, 2003, the Group had entered into certain agreements which will enable it, if they were exercised, to increase its holding by a further 2.5%. These agreements were exercised in 2004.
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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 IV.
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, and over which significant influence is exercised (Exhibit II).
The breakdown, by company, of the balances of this caption (Note 3) in the consolidated balance sheets is as follows:
(*) Transferred to “Common Stocks and Other Equity Securities”, as indicated in Note 9.
The variations in the balances of this caption were as follows:
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This caption 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, 2003, there were no significant capital increases in progress at any nonconsolidable subsidiary.
The breakdown, by company, of the balances of the “Consolidation Goodwill” caption (Note 3) is as follows:
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. The goodwill of the Group units located in Argentina was written off in 2003 with a charge to the provisions previously recorded.
Based on the estimates, projections and assessments available to the Bank’s directors, the forecasted revenues attributable to the Group from these companies are at least equal to the amounts of the respective goodwill balances yet to be amortized in the related periods.
The variations in the balances of the “Consolidation Goodwill” caption were as follows:
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The variations in the "Property and Equipment" accounts and in the related accumulated depreciation were as follows:
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Other property
The “Other Property” and “Furniture, Fixtures and Other” accounts include, among other items, the assets acquired through foreclosure on nonrecovered 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 €316 million as of December 31, 2003, and represented 57% of the recorded value (€395 million and €563 million and 58% and 56% as of December 31, 2002 and 2001, respectively).
The breakdown, by type and term to maturity, of the balances under this caption is as follows:
As of December 31, 2003, the limit set by the Bank of Spain for the Bank and for the Banesto Group in the system of loans guaranteed by public-sector debt securities amounted to €1,988 million and €1,017 million, respectively (€1,209 million and €1,214 million for the Bank and for the Banesto Group, respectively, as of December 31, 2002, and €1,683 million and €1,570 million for the Bank and for the Banesto Group, respectively, as of December 31 2001).
The breakdown, by geographical area and depositor sector, of the balances of this caption is as follows:
The detail, by term to maturity, of the balances of the “Savings Deposits – Time” and “Other Deposits – Time” captions in the consolidated balance sheets is as follows:
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16. Marketable debt securities
Bonds and debentures
The breakdown, by currency and interest rate, of the balances of this caption is as follows:
None of the securities outstanding at December 31, 2003, 2002 and 2001, are convertible into Bank’s shares or grant any privileges or rights that could make them contingently convertible into Bank’s shares. As of December 31, 2003 and 2002, €11,667 and €4,444 millions of mortgage loans were assigned as guarantee of Mortgage backed securities issued pursuant to the Mortgage Market law (see note 19).
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The variations in “Bonds and Debentures” accounts were as follows:
The detail, by maturity, of the balance of this caption as of December 31, 2003, is as follows:
Promissory notes and other securities
The detail, by term to maturity, of the balances of the “Promissory Notes and Other Securities” caption, relating to instruments 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, S.A., is as follows:
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The breakdown of the balances of this caption in the consolidated balance sheets is as follows:
The detail of the variations in the balances of the "Provisions for Contingencies and Expenses" caption is as follows:
Other provisions
The balances of the "Provisions for Contingencies and Expenses – Other Provisions" caption included the following items:
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Banespa
In accordance with the applicable Brazilian labor regulations, Banespa had recorded as of December 31, 2000, the pension allowances required for 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, 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 proceeding. The company dissented from 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.
The detail, by currency and interest rate, of the balances of this caption is as follows:
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These issues are subordinated debt and, therefore, for credit 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. None of the securities outstanding at December 31, 2003, are convertible into Bank’s shares or grant any privileges or rights that could make them contingently convertible into Bank’s shares.
As of December 31, 2002 and 2001, 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 interest on subordinated debt amounted to €679 million in 2003 (€736 million in 2002 and €751 million in 2001).
The detail, by Group entity, of the balances of the "Minority Interests" caption is as follows:
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Preferred shares
These are perpetual noncumulative nonvoting shares. They were subscribed by third parties outside the Group and are fully or partially redeemable after five years, at the issuer’s discretion. There is no obligation that requires the Group to redeem them. Prior to any redemption, the Group should receive the approval of the Bank of Spain and communicate such redemption to the local financial supervisor.
Aditional information is disclosed in Note 27.5.k and Exhibit III.
In the years 2002 and 2003 the Group redeemed 10 issuances and issued 2 new series of preference shares. The objective was to reduce the total outstanding and to change the euro / dollar balance.
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.
Young Executives incentives plan
On February 28, 2001, 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 (Note 21) were issued within the framework of an incentive plan targeted at young executives.
To finance early redemption of preferred stock
On December 19, 2001, 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 (see Note 21). 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.
For acquisition of AKB shares
On May 14, 2002, the Group made one capital increase, issuing 109,040,444 new ordinary shares (2.3% of the Bank’s capital) of €0.50 nominal value each and an issue premium of €9.588 per share, which were fully subscribed and disbursed through shares representing all the capital of AKB, in accordance with the resolutions adopted by the Bank’s Extraordinary Shareholders’ Meeting on February 9, 2002. (Notes 3 and 21)
After this operation and as of December 31, 2001 and 2002, the Bank’s capital stock consisted of 4,768,402,943 fully subscribed and paid shares of €0.50 par value each.
The variations in the Bank’s capital stock were 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, Lisbon and Buenos Aires stock exchanges, and all of them have the same features and rights. As of December 31, 2003, the only shareholders with an ownership interest in the Bank’s capital stock of over 3% were Chase Nominees Limited (with a 5.25% holding).
Other considerations
As of December 31, 2003, the additional capital stock authorized by the Shareholders’ Meeting of the Bank amounted to €1,492 million. The time periods that the Bank’s directors have to carry out capital increases up to this limit expire in June 2008.
On June 21, 2003, the Shareholders’ Meeting set the maximum number of Bank shares that the Bank and/or any Group subsidiary may acquire at 5% of the capital stock outstanding at any time.
Also, the aforementioned Shareholders’ Meeting authorized the Bank’s Board of Directors to issue fixed-income securities not convertible into equity up to a maximum amount of €18,000 million over a period of five years and fixed-income securities convertible into new shares and/or exchangeable for outstanding shares for up to €4,000 million over a five-year period, and empowered the Board of Directors to increase capital by the required amount to cater for the requests for conversion.
As of December 31, 2003, the shares of the following companies were listed on official stock markets: Banco Río de la Plata, S.A.; Banco de Venezuela, S.A.; Banco Santander Colombia, S.A.; Santander BankCorp (Puerto Rico); Grupo Financiero Santander Serfin, S.A. de C.V.; Banco Santander Chile; Cartera Mobiliaria, S.A., S.I.M.; Santander Chile Holding, S.A.; Inmuebles B de V 1985 C.A.; Banco do Estado de Sao Paulo, S.A.; Banesto; Portada S.A. and Banco Totta & Açores, S.A.
As of December 31, 2003, the capital increases in progress at Group companies and the additional capital authorized by their Shareholders’ Meetings were not material at Group level.
The variations in the overall balances of reserves at the Group (see composition in Note 1) were as follows:
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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.
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 as 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, 2003, includes “Voluntary Reserves Recorded Early”, of which approximately €2,314 million (€3,277 million and €3,397 million as of December 31, 2002 and 2001, 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 reduction in the goodwill arising in the acquisitions. This amount increased initially the acquisition cost of the investments acquired.
Reserves and accumulated losses at consolidated companies
The breakdown, by company, of the balances of these captions, based on each company’s contribution to the Group (after considering the effect of consolidation adjustments), is as follows:
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Consolidated Tax Group
In accordance with current regulations, the Consolidated Tax Group includes Banco Santander Central Hispano, S.A. (as the parent company) and the Spanish subsidiaries that meet the requirements stipulated in the regulations on taxation of the consolidated net income of corporate groups (as the controlled companies).
The other Group banks and companies file individual tax returns in accordance with the tax regulations applicable in the respective countries.
Years open for tax audit
The years open for tax audit in the Consolidated Tax Group as of December 31, 2003, were 1999, 2000, 2001, 2002 and 2003 for the main taxes applicable to it. Also, the Consolidated Tax Group whose parent bank was the former Banco Central Hispanoamericano, S.A. has 1999 open for inspection.
The other Spanish consolidated entities generally have the last four years open for review by the tax inspection authorities with respect to the main taxes applicable to them, except in the case of those companies for which the statute of limitations has been interrupted due to tax audits.
In 2003 there were no significant developments in the matters being contested at the different instances of the tax disputes pending resolution as of December 31, 2002.
In 2001 tax assessments were received relating to the Consolidated Tax Group headed by the former Banco Central Hispanoamericano for corporate income tax from 1993 to 1995, VAT from 1992 to 1997 and withholdings for 1996 and 1997; the amounts that were contested totaled €59,572 thousand. This amount relates mainly to corporate income tax timing differences. Also, it should be noted that in practically all cases the field tax inspector considered that the taxpayer’s behavior was not a tax infringement, and, accordingly, no penalty was imposed. In 2002 tax assessments were received relating to 1996, 1997 and 1998 for a total amount of €48 million, of which €39 million were contested. In 2003 tax assessments were received relating to 1998, 1999 and 2000 for a total amount of €3.4 million, of which €3.2 million were contested.
The Bank’s directors consider that the liabilities, if any, which might arise as a result of these claims would not have a material effect on the 2003 consolidated statement of income.
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Because of the possible different interpretations which can be made of the tax regulations, the outcome of future reviews of the open years by the tax authorities might give rise to contingent tax liabilities which cannot be objectively quantified. However, the Bank’s tax advisers consider it unlikely that such contingent liabilities or the contingent liabilities relating to the inspectors' assessments referred to above will become actual liabilities, and that in any event the tax charge which might arise therefrom would not materially affect the consolidated financial statements of the Group.
Since 1992 the Madrid Central Court number 3 has kept open preliminary proceedings to determine the liabilities which might arise in connection with certain credit assignment transactions carried out by Banco Santander, S.A. from 1987 through 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. The dismissal order by the aforementioned Court on July 16, 1996, represented a very considerable step towards achieving this aim, and the attorney general (representing the tax authorities) and the Public Prosecutor’s Office have also applied repeatedly to have the case against the Bank and its management dismissed and removed from the docket. On June 27, 2002 a decision was rendered turning the aforementioned preliminary proceedings into an abbreviated procedure. The decision was appealed against by the Public Prosecutor’s Office and by the Bank and its management.
On June 23, 2003, Panel Two of the Criminal Chamber of the National Appellate Court partially upheld these appeals, expressly recognizing that the marketing of the certain credit assignment transactions (“cesiones de crédito”) had been entirely lawful, and reducing the number of transactions under scrutiny in the proceeding and with respect to which the Bank’s possible involvement is still being alleged from 138 to 38 (in general, the attorney general and the Public Prosecutor’s Office also applied to have the case dismissed and removed from the docket on the ground that no offense had been committed). Based on this decision of the Criminal Chamber, and together with the prosecutions brought by citizens, the attorney general and the Public Prosecutor’s Office will have to again make a decision assessing the investigated facts and on any application for dismissal of the case. On January 16, 2004, the Public Prosecutor’s Office reiterated its application to have the case dismissed. However, the proceeding remains open.
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 2003 corporate income tax return has not yet been filed, the provision for 2003 corporate income tax shown in the consolidated balance sheet as of December 31, 2003, 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 debit balances with the tax authorities relating to deferred tax assets. The balance of the “Other Liabilities” caption includes the liability for the various deferred taxes of the Group and the tax collection accounts.
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The detail of the two balances is as follows:
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Memorandum accounts, futures transactions and off-balance-sheet funds under management
Memorandum accounts
The “Memorandum Accounts” caption includes the following commitments and contingent liabilities of the Group that arose in the normal course of its operations:
Derivative transactions
The detail, by term to maturity, of the notional and/or contractual amounts of each type of derivative transactions arranged by the Group as of December 31, 2003, is as follows:
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The notional and/or contractual amounts of the aforementioned transactions do not 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 foreign exchange risk, the resulting gains or losses on which are included under the “Net Gains 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:
The detail of the Group’s main balances with nonconsolidable companies controlled by it and with associated companies as of December 31 of each year, and of the impact of the transactions with them on the statements of income, is as follows:
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Following is certain relevant information in connection with the consolidated statements of income:
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The average number of employees at the Group, by professional category, was as follows:
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Also, in 2003 the various Group companies engaged other services, the detail being as follows:
d) Extraordinary Results
F-53
The consolidated statements of changes in financial position are as follows:
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27. Significant differences between Spanish and U.S. generally accepted accounting principles
As described in Note 1, the Consolidated Financial Statements of the Santander 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:
27.1. Significant valuation and income recognition principles under Spanish and U.S. GAAP-
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 Group:
Spanish GAAP allows two different methods of consolidation: Global Integration method and Proportional Integration Method.
The Global Integration method fully consolidates the financial statements of companies controlled by the parent company after eliminating all intercompany transactions and recognizing minority interest.
The Proportional consolidation method is used when a company is managed jointly by two or more different business groups (joint ventures). In this method of consolidation the financial statements of a subsidiary are added to those of the rest of the Group in proportion to the participation on its capital.
Our Group does not use the Proportional Integration Method.
The Proportional consolidation method is not allowed under U.S. GAAP
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For purpose of consolidation net translation gains and losses resulting from translation of the financial statements of operating units with functional currencies different from that of the parent, are recorded as a component of accumulated other comprehensive income.
The financial statements of operating units in a highly inflationary economy are remeasured as if the functional currency of the operating unit were the same as that of the parent reporting currency. For the purposes of this requirement, a highly inflationary economy is one that has cumulative inflation of approximately 100 percent or more over a 3-year period.
There are two alternatives to evaluate this expense:
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There are no specific guidelines in accounting for business combinations.
It should be accounted as pooling of interest when a deep managerial and economical reorganization is implied, and when the difference in net value of both entities is not significant. Otherwise, it should be recorded as an acquisition.
Generally, valuation of acquisitions is based on the book value of the net assets acquired. The difference between net assets and consideration paid is assigned, where appropriate, to those assets and liabilities whose fair value differs from their book value. Any difference remaining after this imputation is classified as goodwill. Income of the acquired company is reflected only from the acquisition date onwards.
Positive goodwill is amortized over the period estimated to be benefited not exceeding 20 years (reasons for periods in excess of five years should be explained in Notes to the financial statements).
Under special circumstances, and with the authorization of the Bank of Spain, goodwill may be charged-off against reserves.
Positive goodwill arising in business combinations was amortized to income over the period in which they were estimated to be benefited.
From July 1, 2001, as stated in SFAS 141 all business combinations must be accounted for using the purchase method. Intangible Assets must be identified and recognized as assets apart from goodwill.
According to SFAS 142 Goodwill and Intangible Assets with indefinite useful lives will no longer be amortized, instead they will be subject to an impairment test at least annually.
From July 1, 2001 to December 31, 2001, goodwill of past purchases was subject to amortization.
Capital increase expenses are classified as a reduction of Stockholders’ Equity when incurred.Start-up activity expenses are accounted for as non-interest expenses as incurred.
Refurbishment of rented office premises needed to start operations is classified under intangible assets and amortized with a charge to net income during the shorter of the useful life of the assets (maximum of five years) or the remaining life of the lease contract.
Expenditures for the acquisition and preparation of computer systems and programs that will be useful over several years do not include expenses incurred in changing, adapting or modifying the existing systems and programs. The capitalized expenses are amortized with a charge to net income over a period of time not exceeding 3 years.
It is forbidden to maintain other intangible assets on the balance sheet.
Refurbishment of rented office premises is considered leasehold improvement and classified in the premises and equipment caption on the balance sheet and are amortized over the shorter of the life of the improvement of the lease.
Intangible assets should be recorded at its fair value. A recognized intangible asset shall be amortized over its useful life to the reporting entity unless that life is determined to be indefinite.Intangible asset shall be reviewed for impairment; an impairment loss shall be recognized if the carrying amount of an intangible asset is not recoverable and it exceeds its fair value. Subsequent reversal of a previously recognized impairment loss is prohibited. If it has an indefinite life the impairment test should be carried annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired.
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Pension costs are accounted for using actuarial computations of current salaries, taking into account the return achieved by the pension fund in excess of the actuarial interest rate. Actuarial gains or losses are reflected in full in the income statement for the year in which they occur.
Commitments covered by insurance policies or separate funds are accounted for in the Group’s financial statements as an asset (the amount covered) and as a liability (included in the pension allowance). The remaining commitments are recorded as a liability (pension allowance) in the Group’s financial statement.
U.S. Financial Accounting Standard No. 87 provides detailed guidance regarding the accounting for pension liability and cost. This guidance requires the recording of the excess of a defined actuarial valuation of the present value of post retirement benefits over the adjusted fair value of plan assets maintained in an external fund.Actual changes in pension liability or asset values different from actuarial estimates are treated as actuarial gains and losses. Such gains and losses may be amortized, by the straight-line method over a period not exceeding the average remaining service period of active employees, or by charges to income in the period incurred. Amounts recognized as expense may differ from amounts funded in the same year. The accrual of pension expense is intended to effectively match the full cost of the expected pension benefits to the period of employee service.
Exceptionally and, when the Bank of Spain deems it appropriate, pension and early retirement costs may be provided for with a charge to reserves.
A liability and a loss in net income are registered for early retirement plans when the employees accept the offer and the amount can be reasonably estimated.
Debt securities are classified as trading, available-for-sale investment or held-to-maturity securities, depending on the intent of the investment.
Equity investments in listed companies owned less than 3% and non-listed companies owned less than 20% are classified as trading, available-for-sale investment or permanent investment securities, depending on the intent of the investment.
Trading securities are stated at market value, and differences between market value and book value are reported in the statement of income.
Available-for-sale investment securities are measured either at lower of:
Held-to-maturity and permanent investment securities are stated at adjusted acquisition price.
Debt securities are classified as trading, available-for-sale or held-to-maturity securities, depending on the intent of the investment.
Equity investments in companies owned less than 20% with readily determinable fair values are classified as trading or available-for-sale, depending on the intent of the investment.
Available-for-sale securities are measured at fair value and unrealized gains and losses are reported as a net amount within Accumulated Other Comprehensive Income (Note 27.2.p).
A loss in value of an investment which is other than a temporary decline should be recognized. Evidence of a loss in value might include, but would not necessarily be limited to, absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. A current fair value of an investment that is less than its carrying amount may indicate a loss in value of the investment. However, a decline in the quoted market price below the carrying amount or the existence of operating losses is not necessarily indicative of a loss in value that is other than temporary. All are factors to be evaluated.
Held-to-maturity securities are stated at amortized cost.
Non-marketable equity investments of 20% or less are accounted for under the cost method. Carrying values of individual non-marketable equity securities are reduced through write-downs to reflect other-than-temporary impairments in value.
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Loans are identified as impaired and placed on a non-accrual basis when any interest or principal is past due for 90 days or more or when it is determined that the payment of interest or principal is doubtfully collectible. It is doubtfully collectible when the borrower is incurring continued losses, frequent delays in payments, cannot obtain new financing, is reducing its stockholders’ equity, or other reasons based on available information.
A loan could be on non-accrual status even if it is classified in part as a performing loan.
The same loan could be partially classified as non-performing and as performing.
Primarily only the amounts past due for 90 days or more are classified as non-performing. The entire loan is classified as non-performing if one of the following conditions is met:
Partial write-offs are not permitted. Credit losses are charged to earnings through provisions to credit allowances.
A loan is impaired when, based on available information and facts, it is probable that a creditor will be unable to collect all the amounts due according to the contractual terms of the loan agreement.
The total amount of loans identified as impaired is classified as non-performing and placed on a non-accrual basis.
Banks are required to record a specific allowance for credit losses, which is not less than the prescribed reserve ratios applied against defined stratification of the loan portfolio. Based on judgmental assessments of credit issues banks may record successive increases to this minimum allowance. Pursuant to Bank of Spain regulations, an allowance must be recorded based on the time elapsed since a loan is past due and for those loans for which collection is considered to be doubtful.
A generic allowance covering 1% of total loans, guarantees, private sector debt securities and contingent liabilities must also be made. This allowance is limited to 0.5% for fully secured mortgage loans.
Additionally, a Country-risk allowance must be recorded to cover the transfer risk arising from outstanding loans to borrowers in countries falling into certain risk categories established, including intercompany transactions.
Finally, the Bank of Spain requires an allowance for the statistical coverage of credit losses. The amount of this allowance depends on calculations made using different coefficients for each category of the loan portfolio and on the net charges to income statement related to other loan losses.
The allowance for loan losses represents a reserve that is adequate to cover reasonably estimated probable loan losses incurred as of a reporting date but which is not excessive.
The reserve estimation process is judgmental and includes consideration of identified losses as well as losses reasonably expected to exist based on judgmental assessment of historical trends, credit concentrations and other factors.
For loans identified as impaired and evaluated individually for impairment the allowance must at a minimum be such that the net carrying amount of the loan is one of the following:
The allowance for loan losses of loans collectively reviewed for impairment is based on representative historical losses updated to reflect current trends and conditions.
On the balance sheet, loans are always presented net of their credit loss allowances.
The entire loan balance and its credit allowance are maintained on the balance sheet until any portion of it has been classified as non-performing for 3 years, or up to 6 years for some secured mortgage loans. After that period the loan balance and its 100% specific allowance are removed from the balance sheet and recorded in off-balance sheet accounts, with no resulting impact on net income at that time.
Only under unusual circumstances (bankruptcy, insolvency proceedings, etc.) the credit loss could be directly recognized through write-offs.
More detailed information can be found in Item 4. Information on the Company- B. Business Overview- Classified Assets.
Actual credit losses, which may be for all or part of a particular loan, are deducted from the allowance and the related loan balance is charged off in the period in which the loan or a portion thereof is deemed uncollectible.
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These instruments are registered in off-balance sheet accounts. Their gains and losses are recognized in the income statement depending on their designation as speculative or as part of a hedging relationship.
Transactions aimed at eliminating or significantly reducing 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, are designated as hedging transactions. 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.
Non-hedging transactions arranged on organized markets are valued at market price, and market price fluctuations are 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 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.
All derivatives are recognized either as assets or liabilities on the balance sheet and measured at their fair value.
The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation.
For a derivative to be designed as a hedging instrument some explicit conditions must be met, among others the hedge should be documented, identifying the risk to hedge and how effectiveness is being assessed. Also there are some specific elements that could not be eligible to be part of an accounting hedging relationship.
For a derivative not designated as a hedging instrument, the gain or loss is recognized in earnings in the period of change.
A hedging derivative may be specifically designated as:
For balance sheet financial instruments that include stipulations that could change the value or cash flows in a similar way as a derivative, an “implicit derivative” is recorded in off-balance sheet accounts.
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Premises and equipment are stated at revalued cost, net of the related accumulated depreciation. Revaluation is permitted only pursuant to relevant legislation.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 life basis.
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In accordance with FIN 45, at the inception of a guarantee, the guarantor shall recognize in its statement of financial position a liability for the fair value of the guarantee.
When a guarantee is issued as part of a transaction with multiple elements with an unrelated party, the liability recognized at the inception of the guarantee should be an estimate of the guarantee’s fair value, amounting to the greater of:
Contingent liabilities:
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A transfer of financial assets (or all or a portion of a financial asset) in which the transferor surrenders control over those financial assets shall be accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange.
The transferor has surrendered control over transferred assets if and only if all of the following conditions are met:
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Otherwise, such transaction would be considered secured borrowing and the gain or loss obtained would be deferred and amortized to income
Securitizations that meet the criteria described above should be accounted for as a sale and therefore:
If a transfer of financial assets in exchange for cash or other consideration (other than beneficial interests in the transferred assets) does not meet the 3 criteria for a sale describe above, the transferor and transferee shall account for the transfer as a secured borrowing with pledge of collateral.
Securitizations that meet the three criteria described above are accounted for as a sale.
All financial assets obtained or retained and liabilities incurred by the transferor in a securitization that qualifies as a sale shall be recognized and measured as provided at fair value.
Qualifying Special Purpose Entities are not consolidated into the financial statements of the transferor or its affiliates.
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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 can be found in Note P.
Finally, in Note Q information about U.S. GAAP recent pronouncements is included.
The accompanying Notes are an integral part of the consolidated net income and stockholders’ equity reconciliation to U.S. GAAP as of December 31, 2003, 2002 and 2001.
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F-66
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:
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NOTES TO THE NET INCOME AND TO THE STOCKHOLDERS’ RECONCILIATION
Following are some explanations of the reconciliation items. Most of them come from recurrent differences.
a) Consolidation procedures
There is a number of companies which are more than 50% owned by the Bank, whose business activities differ from those of the Bank and, following Spanish GAAP (see “Consolidation Principles” in Note 1) are accounted for by the equity method (basically insurance and real estate companies, see a list of them in Exhibit II). Under U.S. GAAP, these companies should be consolidated using the global integration method. The effect of using one method instead of the other would have no impact on the consolidated Stockholders’ Equity or on the consolidated net income. Identified differences between Spanish GAAP and U.S. GAAP in these nonconsolidated entities are included in this reconciliation. The total consolidated assets and liabilities would be increased by, approximately, €12,085, €11,948 and €9,991 million in 2003, 2002 and 2001, respectively (3%, 4% and 3% of total assets respectively). Identified differences between Spanish GAAP and U.S. GAAP in these nonconsolidated entities are included in this reconciliation.
b) Foreign Currency Translation and Stock Option Plans
There is no adjustment related to the accounting treatment of highly inflationary environments since a Securities and 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).
c) Allowances for loan losses
Under Spanish GAAP, loan losses are generally recognized through provisions to allowances for loan losses, well before the removal from the balance sheet. Under certain unusual circumstances (for example bankruptcy, insolvency, etc), the loss could be directly recognized through write-offs.
Provisions to specific allowances come from the impairment process. Loans are identified as impaired and placed on a non-accrual basis when it is determined that collection of the payment of interest or principal is doubtful or when the interest or principal has been past due for 90 days or more, except when the loan is well secured and in the process of collection.
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 their impairment is established when interest or principal is past due for 90 days or more.
According to Bank of Spain requirements non-performing loans must be 100% provisioned when they are more than 21 months overdue (more than 6 years in secured mortgage loans).
An additional allowance for credit losses attributed to the remaining portfolio is established via a process that considers the potential loss inherent in the portfolio. Also, an allowance is recorded for those exposures where the transfer risk adds some doubts as to the collection of debts (the Country Risk Allowance). Finally, an additional Statistical Allowance is also created to recognize future losses in the current loan portfolio (the Statistical Coverage of Loan Losses).
The entire loan balance is kept on the balance sheet until any portion of it has been classified as non-performing for 3 years, or up to 6 years for some secured mortgage loans. After that period the loan balance and its 100% specific allowance are removed from the balance sheet and recorded in off-balance sheet accounts, with no resulting impact on net income at that time.
Under Spanish GAAP, partial write-offs of impaired loans are not permitted. The credit loss recognition process is independent of the process for the removal of impaired loans from the balance sheet.
When a loan is deemed partially uncollectible, the credit loss is charged against earnings through provisions to credit allowances instead of through partial write-offs of the loan. If a loan becomes entirely uncollectible, its allowance is increased until it reaches 100% of the loan balance. Generally, credit loss recognition under Spanish GAAP is similar in amounts and in time to credit loss recognition under U.S. GAAP.
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Under Spanish GAAP, an uncollectible loan always has a 100% allowance, but may be maintained on the balance sheet until it reaches the three or six year maximum period established in Bank of Spain regulations, depending on our management’s view as to the recoverability of the loan. Under U.S. GAAP, this loan would be removed from the balance sheet earlier.
Given that loans are presented on the balance sheet net of their credit allowances, there is no difference in the amounts disclosed on the balance sheet under Spanish or U.S. GAAP. However, our non-performing loans under Spanish GAAP include balances that would have been removed from the balance sheet under U.S. GAAP. This difference is precisely the specific allowance for credit losses, which does not exist under U.S. GAAP.
Loan loss recognition under Spanish GAAP does not differ from 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:
d) Investments in affiliated companies
Some investments in listed affiliated companies in which the Group holds an ownership interest of more than 3% and less than 20% 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 (available for sale securities under Spanish GAAP 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.
During 2003 the Group reclassified some significant investments that were previously accounted for by the equity method to available for sale equity portfolio, as it was changing its investment policy to adapt to the European upcoming accounting change. This reclassification has no effect on U.S. GAAP reconciliation as these investments already were accounted for under U.S. GAAP under FAS 115 (see Notes 9 and 10).
The adjustment to net income eliminates profits and losses recorded following the equity method (gains from affiliated companies of €323,859, €1,378,285, and €455,934 thousand, and goodwill amortization of €16,969, €36,059 and €64,140 thousand) and includes the results that would have been recorded if considered available for sale portfolio (gains from investment securities of €7,530, €1,343,122 and €215,421 thousand in 2003, 2002 and 2001 respectively).
In stockholder’s equity the adjustment also includes the negative net effect on reserves (equity) of €195,240, €133,901 and €326,211 thousand in 2003, 2002 and 2001 respectively.
e) Investment securities, available for sale portfolio
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:
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The net income reconciliation item reverses the net provisions made to the security 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 €35,847, €146,461 and €139,837 thousand in 2003, 2002 and 2001 respectively). Valuation differences considered to be other than-temporary impairmet losses are charged to net income. Net provisions of €1,976, €108,295 thousand were reported in 2003 and 2002, while net releases amounted €36,716 thousand in 2001.
The Stockholders’ Equity reconciliation item amounting to €3,682,335 and €2,307,361 thousand in 2003 and 2002, includes the reversion of the effect of the security 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) (other comprehensive income) for information about realized and unrealized gains on securities.
f) Deferred charges
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 in Stockholders’ Equity. This adjustment also includes as an expense the cost of start-up activities, which under Spanish GAAP are capitalized and depreciated on a straight-line basis.
g) Goodwill, Intangibles and business combinations
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 these 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.
In connection with business combinations accounted for as purchases after to June 30, 2003, the Bank has isolated and recognized intangible assets apart from goodwill, but these intangible assets were insignificant.
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 2003, 2002 and 2001 is disclosed in Note 3.
As the 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 (under Spanish and under U.S. GAAP) over different goodwill balances.
The 2003 and 2002 negative goodwill net income reconciliation item comes from the application of SFAS 141, which states that negative goodwill should be recognized as income in the year it is adopted (2002).
As described in Note 1 Banco Santander and Banco Central Hispano merged in 1999. The accounting of this business combination under Spanish GAAP was similar but not equal to pooling of interest accounting under U.S. GAAP. This merger was accounted under U.S. GAAP as a purchase. The adjustments made to change to purchase accounting in that year included:
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The net income 2003 reconciling adjustments of €34,759 thousands is detailed in the following table:
(1) As in previous years Spanish GAAP goodwill amortization includes additional charges due to impairment of goodwill from Banespa. U.S. GAAP impairment process is different and the charge to net income should be done in full only when the 2 step of FAS 142 impairment process requires it.
The components of intangible assets other than goodwill under Spanish GAAP were as follows:
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h) Revaluation of premises and equipment
Under special circumstances and pursuant to relevant legislation revaluation is permitted under Spanish GAAP. In addition, the premises and equipment of certain foreign companies have been restated pursuant to legislation enacted in their respective countries.
Following Spanish GAAP, the depreciation of these fixed assets is calculated on the restated value. This new valuation is also considered when calculating profits on sale of fixed assets.
The adjustment to net income reflects the reversal of the additional depreciation on the revalued premises and equipment and corrections to profits on sale. The related deferred tax asset is being recorded in income in the years in which the relevant deductions are allowed for income tax purposes. The adjustment to Stockholders’ Equity reflects the reversal of all unamortized revaluation surpluses.
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 under Spanish GAAP. Under U.S.GAAP the net loss arising from this 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.
Prior year’s adjustment to net income relate primarily to the amortization of such gains and losses and the recognition of prepaid income taxes derived from pension plan liabilities. This year’s charge finalizes the amortization as affected employees were retired early (see Note 27.2.l).
The Group (which opted to maintain its pension allowances in-house, in accordance with the applicable regulations) has no significant post-retirement benefit obligations to its employees other than the pension commitments. See Notes 2.j and 27.5.g.
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k) General risk allowance
In past years, 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 was reversed with an adjustment to Stockholders’ Equity.
In 2003, after Bank of Spain authorization, the allowance was released to net income. This year’s net income reconciliation adjustment reverses the release of the allowance.
l) Early retirements
In 2003, 2002 and 2001, 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.
The specific allowance for these special termination benefits could be created with charge to reserves, in accordance with Rule 13.13 of Bank of Spain’s Circular 4/1991 and with the authorization from the Bank of Spain. The specific allowance needed is usually registered in December, after having been approved by the Bank of Spain, with charge to reserves and deferred tax assets.
Under U.S. GAAP, the costs incurred for early retirements should be recognized in net income. Also U.S. GAAP requires that 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
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 hedging requirements. A full description of the principles applied by the Group in accounting for derivative financial instruments is disclosed in the Note 2.l. to the financial statements. Spanish GAAP and U.S. GAAP differ in the accounting treatment of these transactions. See Note 27.1 for a summary of the accounting criteria.
In the Group, the use of derivatives for trading purposes is subject to limits clearly defined (at all levels: 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. However risk reduction is not enough to qualify for hedge accounting.
We have procedures in place that ensure that the requirements with respect to the designation as hedge or speculative, transaction documentation, identification of hedged items and hedging instrument, and the assessment and testing of hedge effectiveness are met.
Accordingly, the Group’s policies require to perform an effectiveness test for each hedge position at inception and on a monthly basis. Only if the hedge effectiveness percentage is between 80% - 120% the hedge is considered effective. If the calculated percentage is outside this range the hedge is not considered to be effective and hedge accounting is discontinued (the hedging instrument is accounted for as a speculative derivative).
Additionally, there are differences in designation requirements and hedge accounting between Spanish and U.S. GAAP. Many hedge accounted transactions existing under Spanish GAAP are reversed for U.S. GAAP purposes and designated as speculative transactions, especially macro hedging transactions and hedging of equity instruments issued by the Bank. For purposes of the U.S. GAAP reconciliation, those transactions are accounted for as speculative transactions.
For all the transactions that are considered as hedging both under Spanish and U.S. GAAP, additional information is collected to adapt to the accounting treatment required. Accordingly, for U.S. GAAP reconciliation purposes, only those transactions which fully comply with SFAS 133 requirements are considered to be hedge transactions.
To calculate the reconciliation item to U.S. GAAP (of €165,130, €226,382 and €104,901 thousands for the period ended 2003, 2002 and 2001, respectively), the following adjustments were made:
For more information about derivatives, see Notes 23 and 27.5.H.
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 made a capital increase.
The Bank, with authorization of Bank of Spain, immediately netted the goodwill arising 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).
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In November 2002 Banesto made 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 restored reserves by €271,805 thousand that were not included in Net Income.
The 2002 reconciling 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 g) above for 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 which have a specific reversal period of less than 10 years have been recorded. All other timing differences are deemed to be permanent differences for all purposes.
As a result of application of SFAS No. 109, the Group has recorded deferred tax assets of €24,583, €34,619 and €47,480 thousand in 2003, 2002 and 2001, and deferred tax liabilities of €677,112, €488,360 and €1,322,040 thousand in 2003, 2002 and 2001 arising form valuation of investment securities adjustment in Spanish to U.S. GAAP reconciliation. Additionally, as under Spanish GAAP, 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.
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The accumulated balances of other comprehensive income for the years ended December 31, 2003, 2002 and 2001 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 and divestments.
Taxes allocated to each component of other comprehensive income in 2003, 2002 and 2001 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 reduced significantly its exposure to currency changes throught 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 was effective.
Unrealized gains on securities:
Under U.S. GAAP, the main reason of changes in 2003 was that the Group positioned its investments to benefit from the upturn of stock markets.
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 Société Générale. The reduction in unrealized gains also comes from the downturn of stock markets. The most important effect on the reduction of positive other comprehensive income comes form our holding in Vodafone which lost 41% of its market value (37% due to stock price and the rest due to the devaluation of the Pound Sterling 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:
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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Statement of Income-
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.
In addition to the presentation differences explained above, these financial statements do not consolidate two entities that could be designated variable interest entities under FIN 46-R. As a result, two issuances of preference shares were classified as long term debt (of €581,144 thousand), and its share of net income considered as interest expense (€3,144 thousand). See Notes 27.2.q.7 and 27.5.k.
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(1) As of December 31, 2003 and 2002, the investment securities pledged to retain commitments amounted to €267 million and €600 million, respectively.
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CONSOLIDATED STATEMENTS OF INCOME
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (NOTES 1, 20 AND 21)
CHANGES IN STOCKHOLDERS’ EQUITY
(*) Includes negative exchange differences in 2003, 2002 and 2001 of €8,584; €2,666,942, and €527,310 respectively. Exchange differences of year 2002 are related to the devaluation on Brazilian Real and those of 2001 to the devaluation on Argentinean Peso.(**) Under U.S. GAAP this figure is recorded as an additional income instead of additional reserves, the effect in Stockholders’ equity is nil (see reconciliation in Note 27.2).
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27.5. Additional disclosures required by U.S. GAAP
A) STATEMENT OF CASH FLOWS
The following consolidated statements of cash flows are presented in accordance with SFAS No. 95:
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This statement of Cash Flow was made taking into consideration the deconsolidation of two entities created after January 31, 2003, that could be designated variable interest entities as per FIN 46-R (see Note 27.2.q.7)
The most important non-cash transactions made by the Group during 2003 were the transfer of loans to assets acquired through foreclosure amounting €256,979 thousand.
In 2002 the Group made one important non-cash transaction: the acquisition of the AKB Group through the issuance of 109,040,444 shares. The transaction was valued €1,100,000 thousand and is fully described in Note 3.
The assets acquired through foreclosure during the 2002 amounted to €174,720 thousand.
The most important non-cash transactions made by the Group during 2001 were the transfer of loans to assets acquired through foreclosure amounting €338,370 thousand.
B) EARNINGS PER SHARE
Effective December 31, 1997, the Group adopted SFAS No. 128, Earnings per share, which specifies the computation, presentation and disclosure requirements for earnings per share (EPS).
Basic EPS is computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator), which may include contingently issuable shares where all necessary conditions for issuance have been satisfied.
Diluted EPS includes the determinants of basic EPS and, in addition, gives effect to the potential dilution that could occur if securities or other contract to issue common stock (including stock options) were exercised or converted into common stock and then shared in the earnings of the entity.
In August and September 1998, the Group issued 6.4 million convertible subordinated bonds (Note 18 and Exhibit VI) with a unitary face value of 50 Euro and which pay annual interest of 2.0%. These bonds were convertible into Banco Santander Central Hispano ordinary shares at a conversion rate of approximately 3.02 shares for every bond. These convertible subordinated bonds were redeemed in September 2003. The dilution effect of these bonds was considered in previous year’s EPS calculations.
At December 31, 2003, the stock options plans to employees could result in the issuance of 25,739,966 shares, as it is explained in Note 25 and 27.5.l. The effect of these stock options plans is included in EPS calculation.
This EPS calculation was made taking into consideration the deconsolidation of two entities that could be designated variable interest entities as per FIN 46-R (see Note 27.2.q.7)
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The computation of basic and diluted EPS for the years ended December 31 is presented in the following table.
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C) INVESTMENT SECURITIES
The following table reflects the book and fair value of the investment securities portfolio by accounting categories exclusive of the allocation of Security Price Fluctuation Allowance or the allowance for credit losses:
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. This is a valuation difference.
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The following table is a breakdown of the Group's Investment Securities caption of the U.S. formatted Balance Sheet presented in Note 27.4:
(1) At December 31, 2002, gross pretax unrealized gains and losses on fixed and equity securities totaled €1,069.8 billion and €569.7 billion, respectively. See below for the equivalent 2003 data.
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The following table shows a disclosure of the book value, gross unrealized gains and losses, and fair value of fixed maturity securities and equity securities for 2003:
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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 € 6,033,318, €6,152,621 and €6,856,821 thousand and gross losses of €4,835,414, €6,582,568 and €4,819,288 thousand have been realized during 2003, 2002 and 2001 on:
The following table includes the detail of the available for sale and held to maturity portfolios:
The details of the trading portfolio by type of security are set out below:
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The following table includes the detail of the trading portfolios:
D) Allowance for loan losses
The balances of the recorded investment in impaired loans and of the related valuation allowance as of December 31, 2003, 2002 and 2001 is as follows:
Spanish GAAP doesn’t require classifying the entire loan as 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.
Non-performing loans are carried out by the cash basis method. 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 accrued represents €43,909, €55,611 and €52,900 thousand from borrowers in Spain and €204,258, €288,332 and €436,320 thousand from borrowers outside Spain in 2003, 2002 and 2001, respectively.
For the twelve months ended December 31, 2003, 2002 and 2001, the average recorded investments in impaired loans were €965,031, €1,037,525 and €867,211 thousand from borrowers in Spain, and €2,553,229, €3,003,459 and €3,553,096 thousand from borrowers outside Spain, for a total recorded investment in impaired loans of €3,518,260, €4,040,984 and €3,639,807, respectively.
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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, 2003 and as of such date is presented below:
Following is an analysis of the components of the “Short-term borrowings” caption for 2003 and 2002:
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. This different balance sheet classification does not generate a net income or stockholders’ equity variation.
Spanish GAAP “Total Accrued Commitments” differ from its U.S. GAAP equivalent “Projected Benefit Obligation” (“PBO”) (as defined according to SFAS 87) because it includes other commitments such as those arising from employees early retired or annuity contracts. Spanish GAAP “Plan assets” also include annuity contracts which are not permitted to be included in SFAS 87 calculations. Total Accrued Commitments should be funded both under Spanish or U.S. GAAP, and the only difference is the classification as one liability under Spanish GAAP and various liabilities under U.S. GAAP.
The information herein included is presented to fulfill SFAS 132 disclosure requirements. See Note 2.j to find the total commitment obligations under Spanish GAAP classification and how they are funded.
The need for pension liabilities arises because certain personnel employed in Spain are entitled to pension benefits, in addition to the Social Security pension provided by the State. The benefits under the plans are based primarily on years of service and a final payment formula.
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Benefits for retired employees are subject to annual adjustments (see Note 2.j). Nonconsolidated 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 2003, 2002 and 2001 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, 2003, 2002 and 2001 as required by SFAS 132.
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