10-K 1 santanderholdings10-k2012.htm 10-K Santander Holdings 10-K 2012 v2
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
þ
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     .
Commission File Number: 001-16581
SANTANDER HOLDINGS USA, INC.
 
(Exact name of registrant as specified in its charter)
  
Virginia
(State or other jurisdiction of
incorporation or organization)
 
23-2453088
(I.R.S. Employer
Identification No.)
 
 
 
75 State Street, Boston, Massachusetts
(Address of principal executive offices)
 
02109
(Zip Code)
(617) 346-7200
Registrant’s telephone number including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of Class
 
Name of Exchange on Which Registered
Depository Shares for Series C non-cumulative preferred stock
 
NYSE
Securities registered pursuant to Section 12(g) of the Act:
None 
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    
Yes o.   No þ.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    
Yes o.   No þ.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ. No o.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation ST (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ. No o.*
*Registrant is not subject to the requirements of Rule 405 of Regulation S-T at this time.



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer þ
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o. No þ.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at February 28, 2013
Common Stock (no par value)
 
520,307,043 shares



INDEX
 
Page
 
 
 2
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 200

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

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of Santander Holdings USA, Inc. (“SHUSA” or the “Company”). SHUSA may from time to time make forward-looking statements in its filings with the Securities and Exchange Commission (the “SEC” or the “Commission”) (including this Annual Report on Form 10-K and the exhibits hereto), and in other communications by SHUSA, which are made in good faith by SHUSA, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Some of the statements made by SHUSA, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “will,” “would,” “believe,” “expect,” “hope,” “anticipate,” “estimate,” “intend,” “plan,” “strive,” “hopefully,” “try,” “assume” or similar expressions constitute forward-looking statements.

These forward-looking statements include statements with respect to SHUSA's vision, mission, strategies, goals, beliefs, plans, objectives, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business and are not historical facts. Although SHUSA believes that the expectations reflected in these forward-looking statements are reasonable, these statements are not guarantees of future performance and involve risks and uncertainties which are subject to change based on various important factors, some of which are beyond SHUSA's control. Among the factors that could cause SHUSA's financial performance to differ materially from that suggested by the forward-looking statements are:

the strength of the United States economy in general and the strength of the regional and local economies in which SHUSA conducts operations, which may affect, among other things, the level of non-performing assets, charge-offs, and provision for credit losses;
the ability of certain European member countries to continue to service their debt and the risk that a weakened European economy could affect U.S.-based financial institutions, counterparties with which SHUSA does business. and the stability of the global financial markets negatively;
the effects of policies of the Federal Deposit Insurance Corporation and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;
inflation, interest rate, market and monetary fluctuations, which may, among other things, reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets;
adverse movements and volatility in debt and equity capital markets;
adverse changes in the securities markets, including those related to the financial condition of significant issuers in SHUSA's investment portfolio;
changes in asset quality;
revenue enhancement initiatives that may not be successful in the marketplace or may result in unintended costs;
changing market conditions that may force management to alter the implementation or continuation of cost savings or revenue enhancement strategies;
SHUSA's ability to timely develop competitive new products and services in a changing environment and the acceptance of such products and services by customers;
the willingness of customers to substitute competitors' products and services for ours;
the ability of SHUSA and its third-party vendors to convert and maintain SHUSA's data processing and related systems on a timely and acceptable basis and within projected cost estimates;
the impact of changes in financial services policies, laws and regulations, including laws, regulations and policies concerning taxes, banking, capital, liquidity, proper accounting treatment, securities and insurance, the applications and interpretations thereof by regulatory bodies and the impact of changes in and interpretation of generally accepted accounting principles in the United States;
the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in July 2010, which is a significant development for the industry. The full impact of this legislation to SHUSA and the industry will be unknown until the rule-making processes mandated by the legislation are complete, although the impact will involve higher compliance costs which have affected and will affect SHUSA's revenue and earnings negatively;
additional legislation and regulations or taxes, levies or other charges that may be enacted or promulgated in the future, the form of which legislation or regulation or the degree to which management would need to modify SHUSA's businesses or operations to comply with such legislation or regulation management is unable to predict;
the cost and other effects of the consent order issued by the Office of the Comptroller of the Currency ("the OCC") to Sovereign Bank ("Sovereign" or the "Bank") requiring the Bank to take certain steps to improve its mortgage servicing and foreclosures practices, as is further described in Part I;
technological changes;
competitors of SHUSA that may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than SHUSA;
changes in consumer spending and savings habits;
acts of terrorism or domestic or foreign military conflicts; and acts of God, including natural disasters;
regulatory or judicial proceedings;
the impact of Hurricane Sandy;
the outcome of ongoing tax audits by federal, state and local income tax authorities that may require additional taxes to be paid by SHUSA as compared to what has been accrued or paid as of period-end; and
SHUSA's success in managing the risks involved in the foregoing.

If one or more of the factors affecting SHUSA's forward-looking information and statements proves incorrect, its actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements. Therefore, SHUSA cautions not to place undue reliance on any forward-looking information or statements. The effect of these factors is difficult to predict. Factors other than these also could adversely affect SHUSA's results, and the reader should not consider these factors to be a complete set of all potential risks or uncertainties. New factors emerge from time to time, and management cannot assess the impact of any such factor on SHUSA's business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Any forward-looking statements only speak as of the date of this document, and SHUSA undertakes no obligation to update any forward-looking information or statements, whether written or oral, to reflect any change, except as required by law. All forward-looking statements attributable to SHUSA are expressly qualified by these cautionary statements.


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PART I


ITEM 1 - BUSINESS


General

Santander Holdings USA, Inc. (“SHUSA” or the “Company") is the parent company of Sovereign Bank, N.A. ("Sovereign" or the “Bank”), a national banking association. The Bank converted to a national banking association on January 26, 2012 from a federally-chartered savings bank. In connection with its charter conversion, the Bank changed its name to Sovereign Bank, National Association. Also effective on January 26, 2012, SHUSA became a bank holding company (a "BHC").

SHUSA is headquartered in Boston, Massachusetts, and its principal executive offices are located at 75 State Street, Boston, Massachusetts. The Bank’s home office is in Wilmington, Delaware.

The Bank had over 720 retail branches, over 2,200 ATMs and approximately 8,900 team members as of December 31, 2012, with principal markets in the Northeastern United States. The Bank’s primary business consists of attracting deposits from its network of retail branches, and originating small business loans, middle market, large and global commercial loans, large multi-family loans, residential mortgage loans, home equity loans and lines of credit, and auto and other consumer loans in the communities served by those offices. The Bank uses its deposits, as well as other financing sources, to fund its loan and investment portfolios. The Bank earns interest income on its loan and investment portfolios. In addition, the Bank generates non-interest income from a number of sources, including deposit and loan services, sales of loans and investment securities, capital markets products and bank-owned life insurance. The principal non-interest expenses include employee compensation and benefits, occupancy and facility-related costs, technology and other administrative expenses. The volumes, and accordingly the financial results, of the Bank are affected by the economic environment, including interest rates, consumer and business confidence and spending, as well as the competitive conditions within the Bank's geographic footprint.

SHUSA is a wholly-owned subsidiary of Banco Santander, S.A. (“Santander”). Santander is a retail and commercial bank headquartered in Spain, with a global presence in 10 core geographic markets. At the end of 2012, Santander was the largest bank in the euro zone and among the world's top 20 financial institutions by market capitalization. Founded in 1857, Santander had at December 31, 2012 €1,388 billion in managed funds, approximately 102 million customers, 14,392 branches - more than any other international bank - and approximately 187,000 employees. Furthermore, it has relevant positions in the United Kingdom, Portugal, Germany, Poland, Argentina, Brazil, Mexico, Chile, and the United States. Santander had €2.2 billion in net attributable profit in 2012 primarily generated in: Brazil, 26%; Spain, 15%; the United Kingdom, 13%; Mexico, 12%; and the U.S., 10%.

The Company has a significant equity-method investment in Santander Consumer USA, Inc. ("SCUSA"). SCUSA, headquartered in Dallas, Texas, is a specialized consumer finance company engaged in the purchase, securitization, and servicing of retail installment contracts. SCUSA acquires retail installment contracts principally from manufacturer‑franchised dealers in connection with their sale of used and new automobiles and light‑duty trucks primarily to non-prime customers with limited credit histories or past credit problems. SCUSA also originates receivables through a Web‑based direct lending program and purchases automobile retail installment contracts from other lenders.


Segments

The Company has five reportable segments including Retail Banking, Corporate Banking, Global Banking and Markets, Non-Strategic Assets (formerly known as Specialized Business), and SCUSA.

Except for the Company's equity investment in SCUSA, the Company’s segments are focused principally around the customers the Bank serves.

The Retail Banking segment is primarily comprised of its branch locations and the residential mortgage business. The branches offer a wide range of products and services to customers, and attracts deposits by offering a variety of deposit instruments including demand and interest-bearing demand deposit accounts, money market and savings accounts, certificates of deposit and retirement savings products. The branches also offer consumer loans such as home equity loans and line of credits. The Retail Banking segment also includes business banking loans and small business loans to individuals.

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The Corporate Banking segment provides the majority of the Company’s commercial lending platforms, such as commercial real estate loans, multi-family loans, commercial and industrial loans and the Company’s related commercial deposits.

The Global Banking and Markets segment includes businesses with large corporate domestic and foreign clients.

The Non-Strategic Assets segment is primarily comprised of non-strategic lending groups, which include indirect automobile, aviation and continuing care retirement communities financing.

SCUSA was managed as a separate reportable segment throughout 2012, and continues to be reported as a separate reportable segment as of December 31, 2012.

The financial results for each of these reportable segments are included in Note 24 of the Notes to Consolidated Financial Statements and are discussed in Item 7, "Line of Business Results" within Management's Discussion and Analysis of Financial Condition and Results of Operations. Results of the Company’s business segments are presented based on its management structure and management accounting practices.


Subsidiaries

SHUSA had one principal consolidated majority-owned subsidiary at December 31, 2012: the Bank.


Employees

At December 31, 2012, SHUSA had approximately 7,920 full-time and 1,000 part-time employees. This compares to approximately 7,540 full-time and 1,030 part-time employees as of December 31, 2011. None of the Company's employees are represented by a collective bargaining agreement.


Competition

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


Supervision and Regulation

The activities of the Company are subject to regulation under various U.S. Federal laws, including the Truth-in-Lending, Truth-in-Savings, Equal Credit Opportunity, Fair Credit Reporting, Fair Debt Collection Practices Service Members Civil Relief, Unfair and Deceptive Practices, Real Estate Settlement Procedures, and Electronic Funds Transfer Acts, as well as various state laws. Additional legal and regulatory matters affecting the Company's activities are further discussed in this Item 1 - Business section of the Company's annual report on Form 10-K.

Dodd-Frank Wall Street Reform and Consumer Protection Act

Congress often considers new financial industry legislation, and the federal banking agencies routinely propose new regulations. New legislation and regulation may include changes with respect to the federal deposit insurance system, consumer financial protection measures, compensation and systematic risk oversight authority. There can be no assurances that new legislation and regulations will not adversely affect us.

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On July 21, 2010, the "Dodd-Frank Wall Street Reform and Consumer Protection Act" (the “Act”), which instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of, and government intervention in, the financial services sector, was enacted. The Act includes a number of specific provisions designed to promote enhanced supervision and regulation of financial firms and financial markets. The Act introduces a substantial number of reforms that reshape the structure of the regulation of the financial services industry, requiring that more than 200 regulations be written. Although the full impact of this legislation on the Company and the industry will be unknown until these regulations are complete, the enhanced regulation will involve higher compliance costs and certain elements, such as the debit interchange legislation, have negatively affected the Company's revenue and earnings.

More specifically, the Act imposes heightened prudential requirements on bank holding companies with at least $50.0 billion in total consolidated assets, which includes the Company, and requires the FRB to establish prudential standards for such bank holding companies that are more stringent than those applicable to other bank holding companies, including standards for risk-based capital requirements and leverage limits; heightened capital standards, including eliminating trust preferred securities as Tier 1 regulatory capital, enhanced risk-management requirements, and credit exposure reporting and concentration limits. These changes are expected to impact the profitability and growth of the Company.

The Act mandates an enhanced supervision framework, which means that the Company will be subject to annual stress tests by the FRB, and the Company and the Bank will be required to conduct semi-annual and annual stress tests, respectively, reporting results to the FRB and the OCC. The FRB also has discretionary authority to establish additional prudential standards, on its own or at the Financial Stability Oversight Council's recommendation, regarding contingent capital, enhanced public disclosures, short-term debt limits, and otherwise as it deems appropriate.

Under the Durbin Amendment to the Act, on June 29, 2011, the FRB issued the final rule implementing debit card interchange fee and routing regulation. The final rule establishes standards for assessing whether debit card interchange fees received by debit card issuers are “reasonable and proportional” to the costs incurred by issuers for electronic debit transactions and prohibits network exclusivity arrangements on debit cards to ensure merchants have choices in how debit card transactions are routed.

The Act established the Consumer Financial Protection Bureau ("CFPB"), which has broad powers to set the requirements around the terms and conditions of financial products. This is expected to result in increased compliance costs and may result in reduced revenue.

The Bank routinely executes interest rate swaps for the management of its asset-liability mix, and also executes such swaps with its borrower clients. Under the Act, the Bank will be required to post an Independent Amount with certain of its counterparties and clearing exchanges. While clearing these financial instruments offers some benefits and additional transparency in valuation, the systems requirements for clearing execution add operational complexities to the business and accordingly increase operational risk exposure.

Provisions under the Act concerning the applicability of state consumer protection laws to national banks, including the Bank, became effective on July 21, 2011. Questions may arise as to whether certain state consumer financial laws that may have previously been preempted by federal law are no longer preempted as a result of the effectiveness of these new provisions. Depending on how such questions are resolved, the Bank may experience an increase in state-level regulation of its retail banking business and additional compliance obligations, revenue impacts and costs.
 
The Act and certain other legislation and regulations impose various restrictions on compensation of certain executive offers. Our ability to attract and/or retain talented personnel may be adversely affected by these developments.

Other requirements of the Act include increases to the amount of deposit insurance assessments the Bank must pay; changes to the nature and levels of fees charged to consumers which are negatively affecting the Bank's income; banning banking organizations from engaging in proprietary trading and restricting their sponsorship of, or investing in, hedge funds and private equity funds, subject to limited exceptions, and increasing regulation of the derivative markets through measures that broaden the derivative instruments subject to regulation and require clearing and exchange trading as well as imposing additional capital and margin requirements for derivative market participants which will increase the cost of conducting this business.

The Act also contains provisions that are in the process of being implemented which increase regulation of the derivative markets through measures that broaden the derivative instruments subject to regulation and requiring clearing and exchange trading as well as imposing additional capital and margin requirements for derivative market participants. These measures will increase the cost of conducting this business.

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The overall impact of the Act to the Company will be unknown until these reforms are complete. They have reduced and will reduce revenues and increase compliance costs.

Basel III

In December 2010, the Basel Committee on Banking Supervision issued “Basel III: A global regulatory framework for more resilient banks and banking systems” (“Basel III”). Basel III is a comprehensive set of reform measures designed to strengthen the regulation, supervision and risk management of the banking sector, and introduces for the first time an official definition and guideline for Tier 1 common equity and liquidity.

New and evolving capital standards, both as a result of the Act and the implementation in the U.S. of Basel III, could have a significant effect on banks and bank holding companies ("BHCs"), including SHUSA and its bank subsidiaries. On August 30, 2012, the U.S. banking agencies published in the Federal Register three Notices of Proposed Rulemaking (the “NPRs”) that, among other things, implement Basel III in the U.S. The comment period for the NPRs expired on October 22, 2012. Among other things, the NPRs, as proposed, would narrow the definition of regulatory capital and establish higher minimum risk-based capital ratios that, when fully phased in, would require banking organizations, including SHUSA and its banking subsidiaries, to maintain a minimum “common equity Tier 1” (or “CET1”) ratio of 4.5%, a Tier 1 capital ratio of 6.0%, and a total capital ratio of 8.0%. A capital conservation buffer of 2.5% above each of these levels (to be phased in over three years beginning in 2016) would also be required for banking institutions to avoid restrictions on their ability to make capital distributions, including the payment of dividends. The implementation of certain regulations and standards with regard to regulatory capital could disproportionately affect our regulatory capital position relative to that of our competitors, including those that may not be subject to the same regulatory requirements.

The NPRs are highly complex, and are subject to revisions based on the public comment process. Therefore, many aspects of their application will remain uncertain and the full impact on the Company will not be known until the rules are finalized and the Company can analyze the impact of those final rules.

Historically, regulation and monitoring of bank and BHC liquidity has been addressed as a supervisory matter, both in the U.S. and internationally, without required formulaic measures. The Basel III liquidity framework requires banks and BHCs to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, will be required by regulation going forward. One test, referred to as the liquidity coverage ratio (“LCR”), is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to its expected net cash outflow for a 30-day time horizon. The other, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. These requirements would incentivize banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source. On January 6th, 2013, the Basel Committee published revised guidance for the LCR.  The Committee made several changes to the both the definition of liquid assets (the numerator) and the assumptions regarding liability cash outflows (the denominator) which made the LCR measurement less restrictive.  In addition, the Committee pushed back the requirement to achieve a 100% LCR ratio from 2015 to 2019.  The U.S. banking agencies have not yet proposed rules implementing the Basel III liquidity framework for U.S. banking organizations.

Similarly, Basel III contemplates that the NSFR will be subject to an observation period through mid-2016 and, subject to any revisions resulting from the analyses conducted and data collected during the observation period, implemented as a minimum standard by January 1, 2018. The Basel Committee reportedly is considering revisions to the Basel III liquidity framework as presented in December 2010. The U.S. banking agencies have not yet proposed rules implementing the Basel III liquidity framework for U.S. banking organizations.


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On December 14, 2012, the FRB proposed rules to strengthen regulatory oversight of foreign banking organizations.  These rules would require foreign banking organizations - such as the Company's parent, Santander, with over $50 billion in global consolidated assets and over $10 billion in total assets held by its U.S. subsidiaries - to create a U.S. intermediate holding company (“IHC”) over all of its U.S. bank and U.S. non-bank subsidiaries. U.S. branches and agencies of foreign banks would not be included in the IHC. The formation of these IHCs would allow U.S. regulators to supervise these institutions similarly to U.S. systemically important bank holding companies, meaning that they would be subject to similar capital rules and enhanced prudential standards, including capital stress tests, single-counterparty credit limits, overall risk management, and early remediation requirements, as systemically important bank holding companies. If implemented as proposed, Santander would be required to transfer its U.S. nonbank subsidiaries currently outside of the Company into the Company, which would become an IHC, and/or Santander would establish a top-tier IHC structure that would include all of its US bank and nonbank subsidiaries within the same chain of ownership. Institutions would be required to comply with these new standards on July 1, 2015. Public comments on this proposal will be accepted through April 30, 2013.


Enhanced Prudential Standards for Capital Adequacy

On January 24, 2012, the federal banking regulators published proposed rules on annual stress tests to be performed by banks having total consolidated assets of more than $10 billion. The Company is subject to these annual tests, which are already required by the Act. In addition to the annual stress testing requirement, under the proposal, the Company would also be subject to certain additional reporting and disclosure requirements. The Company was required to conduct its stress test and report results to the FRB in January 2013.

National Charter Change and Conversion to a BHC

Effective January 26, 2012, the Bank converted from a federal savings bank to a national banking association. In connection with the charter conversion, the Bank changed its name to Sovereign Bank, National Association. Also, effective on January 26, 2012, the Company became a BHC.

As a national bank, the Bank is no longer subject to federal thrift regulations and instead is subject to the OCC's regulations under the National Bank Act. The various laws and regulations administered by the OCC for national banks affect corporate practices and impose certain restrictions on activities and investments, but the Company does not believe that the Bank's current or currently proposed businesses are limited materially, if at all, by these restrictions. In addition, as a national bank, the Bank is no longer subject to the qualified thrift lender requirement, which requires thrifts to maintain a certain percentage of their “portfolio assets” in certain "qualified thrift investments,” such as residential housing related loans, certain consumer and small business loans and residential mortgage-backed securities. The Bank also is no longer subject to the restrictions in the Home Owners' Loan Act ("HOLA") limiting the amount of commercial loans that it may make.

As a bank holding company, the Company is subject to the comprehensive, consolidated supervision and regulation of the FRB. The Company is subject to risk-based and leverage capital requirements and information reporting requirements. As a bank holding company with more than $50.0 billion in total consolidated assets, it is subject to the heightened prudential and other requirements for large bank holding companies, including capital plan and capital stress testing requirements as defined under the FRB's capital plan rule.  The Company completed the required capital stress testing for the 2013 Capital Plan Review ("CapPR") program even though it was not included in the 2013 CapPR group of BHCs by the FRB.  The Company expects to be included in the 2014 Comprehensive Capital Analysis and Review program by the FRB.

Federal laws restrict the types of activities in which BHCs may engage, and subject them to a range of supervisory requirements, including regulatory enforcement actions for violations of laws and policies. BHCs may engage in the business of banking and managing and controlling banks, as well as closely related activities. The Company does not expect that the limitations described above will adversely affect its current operations or materially prohibit the Company from engaging in activities that are currently contemplated by its business strategies.


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On December 17, 2012, the FRB announced a new framework for the consolidated supervision of large financial institutions, including BHCs with consolidated assets of $50 billion or more. The updated guidance outlined in Supervision and Regulation Letter No. SR 12-17 has two primary objectives - enhancing the resiliency of institutions to lower the probability of failure or inability to serve as a financial intermediary, and reducing the impact on the financial system and economy in the event of a large institution's failure or material weakness. With regard to enhancing institutional resiliency, the guidance indicates that institutions should focus on capital and liquidity planning and positions, corporate governance, recovery planning and management of core business lines in order to survive significant stress. In terms of reducing the impact of an institution's failure, the guidance indicates that institutions should focus on management of critical operations, support for banking offices, resolution planning and additional macro-prudential supervisory approaches to address risks to financial stability. This framework would be implemented in multiple stages, with additional supervisory and operational guidance to follow.   

Incentive Compensation

On July 21, 2010, the banking regulatory agencies jointly published final guidance for structuring incentive compensation arrangements at financial institutions. While the guidance does not set forth any specific formula or pay cap, it contains principles financial institutions are required to follow with respect to compensation to employees who can expose the institution to material amounts of risk. The guidance’s primary principles include: (i) providing incentives that balance risk and rewards, (ii) having effective controls and risk management, and (iii) instituting strong corporate governance.


Holding Company Regulation

As the Company is a subsidiary of Santander, Santander may be required to obtain approval from the FRB if the Company were to acquire shares of any depository institution (bank or savings institution) or any holding company of a depository institution. In addition, Santander may have to provide notice to the FRB if the Company acquires any financial entity that is not a depository institution, such as a lending company.


Control of the Bank

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


Regulatory Capital Requirements

Federal regulations require federal savings associations and national banks to maintain minimum capital ratios. Under the Federal Deposit Insurance Act (“FDIA”), insured depository institutions must be classified in one of five defined categories (well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized). Under OCC regulations, an institution is considered “well-capitalized” if it (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 6% or greater, (iii) has a Tier 1 leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level. An institution’s capital category is determined by reference with respect to its most recent financial report filed with the OCC. In the event an institution’s capital deteriorates to the undercapitalized category or below, the FDIA and OCC regulations prescribe an increasing amount of regulatory intervention, including the adoption by the institution of a capital restoration plan, a guarantee of the plan by its parent holding company and restricting increases in assets, numbers of branches and lines of business.


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

At December 31, 2012, the Bank met the criteria to be classified as “well-capitalized.”


Standards for Safety and Soundness

The federal banking agencies adopted certain operational and managerial standards for depository institutions, including internal audit system components, loan documentation requirements, asset growth parameters, information technology and data security practices, and compensation standards for officers, directors and employees. The implementation or enforcement of these guidelines has not had a material adverse effect on the Company’s results of operations.


Insurance of Accounts and Regulation by the Federal Deposit Insurance Corporation

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

The FDIC charges financial institutions deposit premium assessments to ensure it has reserves to cover deposits that are under FDIC insured limits, which in early October 2008 the U.S. government increased to $250,000 per depositor per ownership category. In October 2008, the FDIC announced a program that provided unlimited insurance on non-interest bearing accounts for covered institutions through December 31, 2009, which was subsequently extended through December 31, 2012. The Bank participated in the unlimited coverage program through December 31, 2009, but did not participate in the extension.

During the fourth quarter of 2009, the FDIC announced that all depository institutions would be required to prepay three years of assessments in order to quickly raise funds and replenish the reserve ratio. The Bank paid $347.9 million on December 31, 2009 to the FDIC based on an estimate of what the deposit assessments would be over the next three years. This amount was accounted for as a prepaid asset and will be expensed based on the actual deposit assessments in future years until it is depleted. The remaining prepaid asset at December 31, 2012 was $97.3 million. No additional prepayment was ordered by the FDIC during 2012.

In February 2011, the FDIC amended 12 CFR 327 to implement revisions to the Federal Deposit Insurance Act (the "FDIA") made by the Act by modifying the definition of an institution’s deposit insurance assessment base; changing the assessment rate adjustments; revising the deposit insurance assessment rate schedules in light of the new assessment base and altered adjustments; implementing the Act's dividend provisions; revising the large insured depository institution assessment system to better differentiate for risk and better take into account losses from large institution failures that the FDIC may incur; and making technical and other changes to the FDIC’s assessment rules. The revisions also established a minimum ratio of deposit insurance reserves to estimated insured deposits of 1.15% prior to September 2020 and 1.35% thereafter. This amendment was effective on April 1, 2011. Please refer to the section Supervision and Regulation for further discussion on the Act.

In addition to deposit insurance premiums, all insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. In 2012, the Bank paid Finance Corporation assessments of $4.6 million, compared to $4.4 million in 2011. The annual rate for all insured institutions remained the same over the year, at $0.066 for every $1,000 in domestic deposits in 2012. The assessments are revised quarterly and will continue until the bonds mature in the year 2017.


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Federal Restrictions on Transactions with Affiliates and Insiders

All national banks are subject to affiliate and insider transaction rules applicable to member banks of the Federal Reserve System under the Federal Reserve Act and as well as additional limitations as the institutions’ primary federal regulator may adopt. These provisions prohibit or limit a banking institution from extending credit to, or entering into certain transactions with, affiliates, principal shareholders, directors and executive officers of the banking institution and its affiliates. For these purposes, the term “affiliate” generally includes a holding company such as SHUSA and any company under common control with the bank.


Restrictions on Subsidiary Banking Institution Capital Distributions

The Company has the following major sources of funding to meet its liquidity requirements: dividends and returns of investment from its subsidiaries, short-term investments held by non-bank affiliates and access to the capital markets.
Federal banking laws, regulations and policies limit the Bank’s ability to pay dividends and make other distributions to the Company. The Bank must obtain prior OCC approval to declare a dividend or make any other capital distribution for which it evaluates, among other considerations, if, after such dividend or distribution: (1) the Bank’s total distributions to the holding company within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years; (2) the Bank would not meet capital levels imposed by the OCC in connection with any order, or (3) the Bank is not adequately capitalized at the time. In addition, the OCC's prior approval would be required if the Bank’s examination or Community Reinvestment Act ("CRA") ratings fall below certain levels or the Bank is notified by the OCC that it is a problem institution or an institution in troubled condition. During the three years following September 30, 2010, the Bank must obtain the written non-objection of the OCC to declare a dividend or make any other capital distribution.

Any dividends declared and paid have the effect of reducing the Bank’s Tier 1 leverage capital to tangible assets and Tier 1 risk-based capital ratios. The Bank declared and paid $184 million and $150 million in dividends to SHUSA in 2012 and 2011, respectively.


Federal Reserve Regulation

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

The amounts of those reserve balances at December 31, 2012 and 2011 were $273.8 million and $214.8 million, respectively.

Numerous other regulations promulgated by the FRB affect the operations of the Bank. These include regulations relating to equal credit opportunity, electronic fund transfers, collection of checks, truth in lending, truth in savings, availability of funds, home mortgage disclosures and margin credit.


Federal Home Loan Bank System

The Federal Home Loan Bank ("FHLB") was created in 1932 and consists of twelve regional FHLBs. The FHLBs are federally chartered, but privately owned institutions created by Congress. The Federal Housing Finance Board is an agency of the federal government and is generally responsible for regulating the FHLB system. Each FHLB is owned by its member institutions. The primary purpose of the FHLBs is to provide funding to their members for making housing loans as well as for affordable housing and community development lending. FHLBs are generally able to make advances to their member institutions at interest rates that are lower than could otherwise be obtained by such institutions. As a member, the Bank is required to make minimum investments in FHLB stock based on its level of borrowings from the FHLB. The Bank is a member of the FHLB of Pittsburgh and had investments in it of $652.0 million as of December 31, 2012. The Bank utilizes advances from the FHLB to fund balance sheet growth and provide liquidity. The Bank had access to advances with the FHLB of up to $19.6 billion at December 31, 2012 and had outstanding advances of $13.2 billion at that date. The level of borrowing capacity the Bank has with the FHLB is contingent upon the level of qualified collateral the Bank holds at a given time.

In December 2008, the FHLB of Pittsburgh announced it was suspending dividends on its stock and that it would not repurchase any excess capital stock in order to maintain its liquidity and capital position. Management considered this and concluded that the investment in FHLB of Pittsburgh was not impaired at December 31, 2012, 2011, or 2010. Starting October 29, 2010 and continuing on a quarterly basis, the FHLB of Pittsburgh repurchased excess shares of its capital stock. In 2012, the FHLB of Pittsburgh re-instated paying quarterly dividends on its stock.  The Bank received $1.1 million in dividends in 2012. Management will continue to closely monitor this investment in future periods.


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Community Reinvestment Act

The CRA requires financial institutions regulated by the federal financial supervisory agencies to ascertain and help meet the credit needs of their communities, including low- to moderate-income neighborhoods within those communities, while maintaining safe and sound banking practices. The regulatory agencies periodically assess the Bank’s record in meeting the credit needs of the communities it serves. A bank’s performance under the CRA is important in determining whether the bank may obtain approval for, or utilize streamlined procedures in, certain applications for acquisitions or engage in new activities.

The Bank’s lending activities are in compliance with applicable CRA requirements, and the Bank’s current CRA rating is “outstanding,” the highest category. Federal regulators examined the Bank's mortgage, small business and community development lending practices, its community development investments, and its retail banking and community development services, and concluded that the Bank's record of lending to low and moderate income borrowers and the geographic distribution of loans in various census tracts were excellent.

The Bank developed a new Community Reinvestment Plan for 2011-2013, equaling more than $5.3 billion in lending and investment to low- and moderate-income individuals and communities in its principal banking markets. This commitment also continues the Bank's financial support and volunteer services to the many non-profit organizations within its market.


Anti-Money Laundering and the USA Patriot Act

Several federal laws, including the Bank Secrecy Act, the Money Laundering Control Act, and the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”) require all financial institutions to, among other things, implement policies and procedures relating to anti-money laundering, compliance, suspicious activities, and currency transaction reporting and due diligence on customers. The USA Patriot Act substantially broadened existing anti-money laundering legislation and the extraterritorial jurisdiction of the U.S.; imposed compliance and due diligence obligations; created crimes and penalties; compelled the production of documents located both inside and outside the U.S., including those of non-U.S. institutions that have a correspondent relationship in the U.S.; and clarified the safe harbor from civil liability to clients. The U.S. Treasury has issued a number of regulations that further clarify the USA Patriot Act’s requirements and provide more specific guidance on their application. The Company has complied with these regulations.


Financial Privacy

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


Environmental Laws

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


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

Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13(r) to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), an issuer is required to disclose in its annual or quarterly reports, as applicable, whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with individuals or entities designated pursuant to certain Executive Orders. Disclosure is generally required even where the activities, transactions or dealings were conducted in compliance with applicable law.

The Company does not have any activities, transactions or dealings with Iran requiring disclosure.

Santander has certain legacy export credits and performance guarantees with Bank Sepah and Bank Mellat, which are included in the U.S. Department of the Treasury's Office of Foreign Assets Control's Specially Designated Nationals and Blocked Persons List.

With respect to Bank Sepah, Santander entered into bilateral credit facilities in May 1996 and in February 2004 of $95.7 million and $4.2 million, respectively. The former matured on May 29, 2012 and the latter matures on September 11, 2013. As of December 31, 2012, €0.5 million remained outstanding under the 2004 bilateral credit facility.

With respect to Bank Mellat, Santander entered into two bilateral credit facilities in February 2000 in an aggregate principal amount of €25.9 million. Both credit facilities matured in 2012. In addition, in 2005 Santander participated in a syndicated credit facility for Bank Mellat of €15.5 million, which matures on July 6, 2015. As of December 31, 2012, Santander was owed €6.5 million under this credit facility.

Both Bank Sepah and Bank Mellat have been in default under all of these agreements for the last years and Santander has been and expects to continue to be repaid any amounts due by official export credit agencies, which insure between 95% and 99% of the outstanding amounts under these credit facilities.  No funds have been extended by Santander under these facilities since they were granted.

Santander also has certain legacy performance guarantees for the benefit of Bank Sepah and Bank Mellat (stand-by letters of credit to guarantee the obligations - either under tender documents or under contracting agreements - of contractors who participated in public bids in Iran) that were in place prior to April 27, 2007. However, should any of the contractors default in their obligations under the public bids, Santander would not be able to pay any amounts due to Bank Sepah or Bank Mellat because any such payments would be frozen pursuant to Council Regulation (EU) No. 961/2010.

In the aggregate, all of the transactions described above resulted in approximately €100,000 gross revenues and approximately €(15,000) net loss to Santander in 2012, all of which resulted from the performance of export credit agencies rather than any Iranian entity. Santander has undertaken significant steps to withdraw from the Iranian market such as closing its representative office in Iran and ceasing all banking activities therein, including correspondent relationships, deposit taking from Iranian entities and issuing export letters of credit, except for the legacy transactions described above. Santander is not contractually permitted to cancel these arrangements without either (i) paying the guaranteed amount - which payment would be frozen as explained above (in the case of the performance guarantees), or (ii) forfeiting the outstanding amounts due to it (in the case of the export credits). As such, Santander intends to continue to provide the guarantees and hold these assets in accordance with company policy and applicable laws.


Corporate Information

All reports filed electronically by the Company with the SEC, including the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, as well as any amendments to those reports, are accessible on the SEC’s Web site at www.sec.gov. These forms are also accessible at no cost on the Company's website at www.sovereignbank.com.


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ITEM 1A - RISK FACTORS

The Company is subject to a number of risks potentially impacting its business, financial condition, results of operations and cash flows. As a financial services organization, certain elements of risk are inherent in transactions and are present in the business decisions made by the Company. Thus, the Company encounters risk as part of the normal course of the business, and risk management processes are designed to help manage these risks.

Risk management is an important part of the Company's business model. The success of the business is dependent on management's ability to identify, understand and manage the risks presented by business activities so that management can appropriately balance revenue generation and profitability. These risks include credit risk, market risk, liquidity risk, operational risk, model risk, compliance and legal risk, and strategic and reputation risk. We discuss our principal risk management processes in the Risk Management section included in Item 7 of this Report.

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


Market and credit risks

The Current Economic Environment May Deteriorate Adversely Affecting Asset Quality, Earnings and Cash Flow.

The Company faces various material risks, including credit risk and the risk that the demand for products will decrease. In a recession or other economic downturn, these risks would become more acute. In an economic downturn, the Company's credit risk and associated provision for credit losses and legal expense will increase. Also, decreases in consumer confidence, real estate values, and interest rates, usually associated with a downturn, could combine to make the types of loans the Bank originates less profitable and could cause elevated levels of losses on the Company's commercial and consumer loans. While economic conditions in the United States and worldwide have begun to improve, there can be no assurance that this improvement will continue. Such conditions could adversely affect the credit quality of the Company's loans, results of operations and financial condition.

Adverse Economic Conditions in Europe and Latin America May Negatively Impact the Company.

As a wholly-owned subsidiary of Santander, significant aspects of the Company's strategy, infrastructure and capital funding are dependent on its parent, Santander. Although Santander has a significant presence in various markets around the world, Santander's results of operations are materially affected by conditions in the capital markets and the economy generally in Europe and Latin America. Accordingly, a significant decline in general economic conditions in Europe or Latin America, whether caused by recession, inflation, unemployment, changes in securities markets, acts of terrorism, or other occurrences could impact Santander, and, in turn, have a material adverse effect on the Company's financial condition and results of operations.

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Disruptions in the Global Financial Markets have Affected, and May Continue to Adversely Affect, SHUSA's Business and Results of Operations.

Although market conditions have improved, unemployment in the United States continues to remain near historically high levels, and conditions are expected to remain challenging for financial institutions in 2013. Dramatic declines in the housing market during the most recent recession, with falling home prices and increasing foreclosures and unemployment, resulted in significant write−downs of asset values by financial institutions, including government−sponsored entities and major commercial and investment banks. These write−downs, initially of mortgage−backed securities but spreading to credit default swaps and other derivatives, have caused many financial institutions to seek additional capital and to merge with other financial institutions. Furthermore, certain European member countries have fiscal obligations that exceed their revenue, which has raised concerns about such countries' abilities to continue to service their debt and foster economic growth. A weakened European economy may spread beyond Europe and could cause investors to lose confidence in the safety and soundness of European financial institutions and the stability of European member economies. Such events could, likewise, negatively affect U.S.-based financial institutions, counterparties with which SHUSA does business and the stability of the global financial markets. Disruptions in the global financial markets also adversely affected the corporate bond markets, debt and equity underwriting and other elements of the financial markets. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, some lenders and institutional investors reduced and, in some cases, ceased to provide funding to certain borrowers, including other financial institutions. The impact on available credit, increased volatility in the financial markets and reduced business activity has adversely affected, and may continue to adversely affect, SHUSA's businesses, capital, liquidity, financial condition, results of operations, and access to credit.

SHUSA May Experience Further Write-downs of its Financial Instruments and Other Losses Related to Volatile and Illiquid Market Conditions.

Market volatility, illiquid market conditions and disruptions in the credit markets continue to present difficulties in valuing certain of SHUSA's assets. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values of these assets in future periods. In addition, at the time of any sale of these assets, the price SHUSA ultimately realizes will depend on the demand and liquidity in the market at that time and may be materially lower than their current fair value. Any of these factors could require the Company to take further write−downs in respect of these assets, which may have an adverse effect on the Company's results of operations and financial condition in future periods.

A Change in the United States Sovereign Debt Credit Rating Could Have a Significant Impact on the Value of the Bank's Assets.

On August 5, 2011, Standard & Poor's (“S&P”), one of three major credit rating agencies which also include Moody's Investors Service and Fitch, lowered its long-term credit rating on the United States sovereign debt from AAA to AA+. Moody's and Fitch each maintained the highest rating on U.S. sovereign debt, but have assigned a negative outlook to their ratings. The implications of these actions by the rating agencies could include negative effects on U.S. Treasury securities as well as instruments issued, guaranteed or insured by government agencies or government-sponsored institutions. These types of instruments are significant assets for the Company. In addition, the potential impact could exacerbate the other risks to which the Company is subject to including, but not limited to, the risk factors described therein.

Changing Interest Rates may Adversely Affect the Bank's Profits.

To be profitable, the Bank must earn more money from interest on loans and investments and fee-based services than the interest the Bank pays to the depositors and creditors and the amount necessary to cover the cost of the operations of the Bank. Rising interest rates may hurt income because they may reduce the demand for loans and the value of investment securities and loans, and increase the amount that is paid to attract deposits and borrow funds. If interest rates decrease, net interest income could be negatively affected if interest earned on interest-earning assets, such as loans, mortgage-related securities, and other investment securities, decreases more quickly than interest paid on interest-bearing liabilities, such as deposits and borrowings. This would cause net interest income to decrease. In addition, if interest rates decline, loans and investments may prepay earlier than expected, which may also lower income. Interest rates do and will continue to fluctuate, and management cannot predict future FRB actions or other factors that may cause rates to change. If the yield curve steepens or flattens, it could impact net interest income in ways management may not accurately predict.

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The Bank Experiences Intense Competition for Loans and Deposits

Competition among financial institutions in attracting and retaining deposits and making loans is intense. The Bank's most direct competition for deposits has come from commercial banks, savings and loan associations and credit unions doing business in the Bank's areas of operation, as well as from nonbanking sources, such as money market mutual funds and corporate and government debt securities. Competition for loans comes primarily from commercial banks, savings and loan associations, consumer finance companies, insurance companies and other institutional lenders. The Bank competes primarily on the basis of products offered, customer service and price. A number of institutions with which the Bank competes have greater assets and capital than the Bank does and, thus, may have a competitive advantage.

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

SCUSA represents a significant equity method investment of the Company. SCUSA provides a significant source of funding to the Company through the payment of dividends. The investment in SCUSA involves risk, including the possibility that the value of the investment could fall substantially and that dividends or other distributions on the investment could be reduced or eliminated. Poor operating results of SCUSA and the failure to pay dividends to the Company could negatively affect the operating results of SHUSA.  


Liquidity and Financing Risks

Liquidity is Essential to the Company's Businesses, and the Company Relies on External Sources, Including Government Agencies to Finance a Significant Portion of its Operations

Adequate liquidity is essential to SHUSA's businesses. The Company primarily relies on the FHLB, deposits and other third party sources of funding for its liquidity needs. Further changes to the credit ratings of SHUSA, Santander and its affiliates ("The Santander Group") or the Kingdom of Spain could have a material adverse effect on SHUSA's business, financial condition and results of operations. The credit ratings of SHUSA have changed in the past and may change in the future, which could impact its cost of and access to sources of financing and liquidity. Any reductions in the long-term or short-term credit ratings of SHUSA would increase its borrowing costs, require SHUSA to replace funding lost due to the downgrade, which may include the loss of customer deposits, and may also limit SHUSA's access to capital and money markets and trigger additional collateral requirements in derivatives contracts and other secured funding arrangements. Credit ratings are also important to SHUSA when competing in certain markets, such as the market for standby letters of credit. As a result, any reductions in SHUSA's long-term or short-term credit ratings could have a material adverse impact on SHUSA's business, financial condition and results of operations.


Regulatory Reporting Risks

Impact of Future Regulation Changes may have an Adverse Impact on the Company's Profitability.

The Company's operations are subject to extensive laws and regulation by federal and state governmental authorities. Congress often considers new financial industry legislation, and the federal banking agencies routinely propose new regulations. New legislation and regulation may include changes with respect to the federal deposit insurance system, consumer financial protection measures, compensation and systematic risk oversight authority. There can be no assurances that new legislation and regulations will not adversely affect us.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act"), which instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of, and government intervention in, the financial services sector, was enacted. The Act includes a number of specific provisions designed to promote enhanced supervision and regulation of financial firms and financial markets. The Act introduced a substantial number of reforms that reshape the structure of the regulation of the financial services industry, requiring that more than 200 regulations be written. Although the full impact of this legislation on the Company and the industry will be unknown until these regulations are complete, the enhanced regulation will involve higher compliance costs and certain elements, such as the debit interchange legislation, has negatively affected the Company's revenue and earnings.

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More specifically, the Act imposes heightened prudential requirements on bank holding companies with at least $50.0 billion in total consolidated assets, which includes the Company, and requires the Federal Reserve Board (FRB) to establish prudential standards for such bank holding companies that are more stringent than those applicable to other bank holding companies, including standards for risk-based capital requirements and leverage limits; heightened capital standards, including eliminating trust preferred securities as Tier 1 regulatory capital; enhanced risk-management requirements; and credit exposure reporting and concentration limits. These changes are expected to impact the profitability and growth of the Company.

The Act mandates an enhanced supervision framework, which means that the Company will be subject to annual stress tests by the FRB, and the Company and the Bank will be required to conduct semi-annual and annual stress tests, respectively, reporting results to the FRB and the OCC. The FRB also has discretionary authority to establish additional prudential standards, on its own or at the Financial Stability Oversight Council's recommendation, regarding contingent capital, enhanced public disclosures, short-term debt limits, and otherwise as it deems appropriate.

Under the Durbin Amendment to the Act, on June 29, 2011 the FRB issued the final rule implementing debit card interchange fee and routing regulation rules. The final rule establishes standards for assessing whether debit card interchange fees received by debit card issuers are “reasonable and proportional” to the costs incurred by issuers for electronic debit transactions and prohibits network exclusivity arrangements on debit cards to ensure merchants have choices in how debit card transactions are routed.

The Act established the CFPB, which has broad powers to set the requirements around the terms and conditions of financial products. This is expected to result in increased compliance costs and may result in reduced revenue.

The Bank routinely executes interest rate swaps for the management of its asset-liability mix, and also executes such swaps with its borrower clients. Under the Act, the Bank will be required to post an Independent Amount with certain of its counterparties and clearing exchanges. While clearing these financial instruments offers some benefits and additional transparency in valuation, the systems requirements for clearing execution add operational complexities to the business and accordingly increase operational risk exposure.

Provisions under the Act concerning the applicability of state consumer protection laws to national banks, including the Bank, became effective on July 21, 2011. Questions may arise as to whether certain state consumer financial laws that may have previously been preempted by federal law are no longer preempted as a result of the effectiveness of these new provisions. Depending on how such questions are resolved, the Bank may experience an increase in state-level regulation of its retail banking business and additional compliance obligations, revenue impacts and costs.
 
The Act and certain other legislation and regulations impose various restrictions on compensation of certain executive offers. Our ability to attract and/or retain talented personnel may be adversely affected by these developments.

Other requirements of the Act include increases to the amount of deposit insurance assessments the Bank must pay; changes to the nature and levels of fees charged to consumers which are negatively affecting the Bank's income; banning banking organizations from engaging in proprietary trading and restricting their sponsorship of, or investing in, hedge funds and private equity funds, subject to limited exceptions, and increasing regulation of the derivative markets through measures that broaden the derivative instruments subject to regulation and require clearing and exchange trading as well as imposing additional capital and margin requirements for derivative market participants which will increase the cost of conducting this business.

The Act also contains provisions that are in the process of being implemented which increase regulation of the derivative markets through measures that broaden the derivative instruments subject to regulation and requiring clearing and exchange trading as well as imposing additional capital and margin requirements for derivative market participants. These measures will increase the cost of conducting this business.

The overall impact of the Act to the Company will be unknown until these reforms are complete. They have reduced and will reduce revenues and increase compliance costs.

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The Company is Subject to Substantial Regulation which Could Adversely Affect its Business and Operations

As financial institutions, the Company and the Bank are subject to extensive regulation, which materially affects their businesses. Statutes, regulations and policies to which the Company and the Bank are subject may be changed at any time, and the interpretation and application of those laws and regulations by regulators is also subject to change. There can be no assurance that future changes in regulations or in their interpretation or application will not adversely affect either the Company or the Bank.

New and evolving capital standards, both as a result of the Act and the implementation in the U.S. of Basel III, could have a significant effect on banks and bank holding companies (BHCs), including SHUSA and its bank subsidiaries. On August 30, 2012, the U.S. banking agencies published in the Federal Register three Notices of Proposed Rulemaking (the “NPRs”) that, among other things, implement Basel III in the U.S. The comment period for the NPRs expired on October 22, 2012. Among other things, the NPRs, as proposed, would narrow the definition of regulatory capital and establish higher minimum risk-based capital ratios that, when fully phased in, would require banking organizations, including SHUSA and its banking subsidiaries, to maintain a minimum “common equity Tier 1” (or “CET1”) ratio of 4.5%, a Tier 1 capital ratio of 6.0%, and a total capital ratio of 8.0%. A capital conservation buffer of 2.5% above each of these levels (to be phased in over three years beginning in 2016) would also be required for banking institutions to avoid restrictions on their ability to make capital distributions, including the payment of dividends. The implementation of certain regulations and standards with regard to regulatory capital could disproportionately affect our regulatory capital position relative to that of our competitors, including those that may not be subject to the same regulatory requirements.

The NPRs are highly complex, and are subject to revisions based on the public comment process. Therefore, many aspects of their application will remain uncertain and their full impact on the Company will not be known until the rules are finalized and the Company can analyze the impact under those final rules.

Historically, regulation and monitoring of bank and BHC liquidity has been addressed as a supervisory matter, both in the U.S. and internationally, without required formulaic measures. The Basel III liquidity framework requires banks and BHCs to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, will be required by regulation going forward. One test, referred to as the liquidity coverage ratio (“LCR”), is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to its expected net cash outflow for a 30-day time horizon. The other, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. These requirements would incentivize banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source. On January 6th, 2013, the Basel Committee published revised guidance for the LCR.  The Committee made several changes to the both the definition of liquid assets (the numerator) and the assumptions regarding liability cash outflows (the denominator) which made the LCR measurement less restrictive.  In addition, the Committee pushed back the requirement to achieve a 100% LCR ratio from 2015 to 2019.  The U.S. banking agencies have not yet proposed rules implementing the Basel III liquidity framework for U.S. banking organizations.

Similarly, Basel III contemplates that the NSFR will be subject to an observation period through mid-2016 and, subject to any revisions resulting from the analyses conducted and data collected during the observation period, implemented as a minimum standard by January 1, 2018. The Basel Committee reportedly is considering revisions to the Basel III liquidity framework as presented in December 2010. The U.S. banking agencies have not yet proposed rules implementing the Basel III liquidity framework for U.S. banking organizations.


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On December 14, 2012, the FRB proposed rules to strengthen regulatory oversight of foreign banking organizations.  These rules would require foreign banking organizations - such as the Company's parent, Santander, with over $50 billion in global consolidated assets and over $10 billion in total assets held by its U.S. subsidiaries - to create a U.S. intermediate holding company (“IHC”) over all of its U.S. bank and U.S. non-bank subsidiaries. U.S. branches and agencies of foreign banks would not be included in the IHC. The formation of these IHCs would allow U.S. regulators to supervise these institutions similarly to U.S. systemically important bank holding companies, meaning that they would be subject to similar capital rules and enhanced prudential standards, including capital stress tests, single-counterparty credit limits, overall risk management, and early remediation requirements, as systemically important bank holding companies. If implemented as proposed, Santander would be required to transfer its U.S. nonbank subsidiaries currently outside of the Company into the Company, which would become an IHC and/or Santander would establish a top-tier IHC structure that would include all of its US bank and nonbank subsidiaries within the same chain of ownership. Institutions would be required to comply with these new standards on July 1, 2015. Public comments on this proposal will be accepted through April 30, 2013.


Compliance risks

Changes in Accounting Standards Could Impact Reported Earnings

The accounting standard setters, including the Financial Accounting Standards Board (the "FASB"), SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation of SHUSA's consolidated financial statements. These changes can be hard to predict and can materially impact how SHUSA records and reports its financial condition and results of operations. In some cases, SHUSA could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.

The Company Relies on Third Parties for Important Products and Services

Third party vendors provide key components of the Company's business infrastructure, such as loan and deposit servicing systems, internet connections and network access. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or performing their services poorly, could adversely affect the Company's ability to deliver products and services to customers and otherwise to conduct business.
Replacing these third party vendors could also entail significant delays and expense.

The Preparation of SHUSA's Financial Statements Requires the Use of Estimates that May Vary from Actual Results.

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make significant estimates that affect the financial statements. One example of a significant critical estimate is the level of the allowance for credit losses. Due to the inherent nature of this estimate, SHUSA cannot provide assurance that it will not significantly increase the allowance for credit losses and/or sustain credit losses that are significantly higher than the provided allowance.

The Preparation of SHUSA's Tax Returns Requires the Use of Estimates and Interpretations of Complex Tax Laws and Regulations and Is Subject to Review by Taxing Authorities.

SHUSA is subject to the income tax laws of the U.S., its states and municipalities and certain foreign countries. These tax laws are complex and subject to different interpretations by the taxpayer and relevant Governmental taxing authorities, which are sometimes subject to prolonged evaluation periods until a final resolution is reached. In establishing a provision for income tax expense and filing returns, the Company must make judgments and interpretations about the application of these inherently complex tax laws.

17




Disclosure Controls and Procedures over Financial Reporting may not Prevent or Detect all Errors or Acts of Fraud

Disclosure controls and procedures over financial reporting are designed to reasonably assure that information required to be disclosed by the Company in reports filed or submitted under the Securities Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Any disclosure controls and procedures over financial reporting or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by any unauthorized override of the controls. Accordingly, because of the inherent limitations in the control system, misstatements due to error or fraud may occur and not be detected.


Strategic Risks

Framework for Managing Risks may not be Effective in Mitigating Risk and Loss to the Company.

Risk management framework is made up of various processes and strategies to manage the Company's risk exposure. Types of risks to which the Company is subject include liquidity risk, credit risk, market risk, interest rate risk, operational risk, legal risk, compliance risk and reputation risk, among others. The framework to manage risk, including the framework's underlying assumptions, may not be effective under all conditions and circumstances. If the risk management framework proves ineffective, the Company could suffer unexpected losses and could be materially adversely affected.


Operational and Technology Risks

System Integration Risks Exist Related to the Acquisition of the Company by Santander

Systems integration risks are typically broad-reaching, and impact multiple processes. As such, they are difficult to mitigate. In 2012, the Company continued to make a significant investment in technology with its IT Core project, which changed its production system and infrastructures by incorporating all the retail branch systems onto a common platform. While the overall conversion was successful, the resolution of issues identified in the transition process will impact technology resources for some time. As well, there will likely be additional downstream projects identified as the impact of process change is felt. As such, the risk still exists, and is part of the non-prudential operational risk category in the Company's Risk Tolerance Statement. However, the Company believes these risks are manageable and within the permitted Risk Tolerance.

18




Compromises of the Company's Data Security Could Materially Harm the Company's Reputation and Business

The Company is subject to the risk of data security breaches. In the ordinary course of business, the Company's activities include the collection, storage and transmission of certain personal and financial information from individuals, such as customers and employees. Security breaches could expose the Company to a risk of loss of this information, litigation, and potential liability. The Company's cyber security measures may be breached due to the actions of outside parties, employee error, or otherwise, and, as a result, an unauthorized party may obtain access to the Company's or customers' information. Additionally, outside parties may attempt to fraudulently induce employees, users, or customers to disclose sensitive information in order to gain access to the Company's or customers' information. Any such breach or unauthorized access could result in significant legal and financial exposure, damage to the Company's reputation, and a loss of confidence that could potentially have an adverse effect on future business with current and potential customers. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and often are not recognized until launched against a target, the Company may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of the Company's security occurs, the market perception of the effectiveness of the Company's cyber security measures could be harmed and the Company could lose potential future business.


Reputational Risks

Damage to our reputation could cause harm to our business prospects.

Maintaining a positive reputation is critical to our attracting and maintaining customers, investors and employees. Damage to our reputation can therefore cause significant harm to its business and prospects.  Harm to our reputation can arise from numerous sources, including, among others, employee misconduct, litigation or regulatory outcomes, failure to deliver minimum standards of service and quality, compliance failures, unethical behavior, and the activities of customers and counterparties.  Further, negative publicity regarding us, whether or not true, may result in harm to our prospects.

Actions by the financial services industry generally or by certain members of, or individuals in, the industry can also affect our reputation.  For example, the role played by financial services firms in the financial crisis and the seeming shift toward increasing regulatory supervision and enforcement has caused public perception in the financial services industry to decline.



19




Litigation Risks

The Company is or may become involved from time to time in suits, legal proceedings, information-gathering requests, investigations and proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.

Many aspects of the Company's business involve substantial risk of legal liability. The Company and/or its subsidiaries have been named or threatened to be named as defendants in various lawsuits arising from its or its subsidiaries' business activities (and in some cases from the activities of companies SHUSA has acquired). In addition, from time to time, SHUSA is, or may become, the subject of governmental and self-regulatory agency information-gathering requests, reviews, investigations and proceedings and other forms of regulatory inquiry, including by the SEC and law enforcement authorities. SHUSA is also at risk when it has agreed to indemnify others for losses related to legal proceedings, including litigation and governmental investigations and inquiries, they face, such as in connection with the purchase or sale of a business or assets. The results of such proceedings could lead to significant monetary damages or penalties, adverse judgments, settlements, fines, injunctions, restrictions on the way in which the Company conducts its business, or reputational harm.
Although the Company establishes accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated, the Company does not have accruals for all legal proceedings where it faces a risk of loss. In addition, due to the inherent subjectivity of the assessments and unpredictability of the outcome of legal proceedings, amounts accrued may not represent the ultimate loss to the Company from the legal proceedings in question. Thus, the Company's ultimate losses may be higher, and possibly significantly so, than the amounts accrued for legal loss contingencies, which could adversely affect the Company's financial condition and results of operations.


20




ITEM 1B - UNRESOLVED STAFF COMMENTS

None.



ITEM 2 - PROPERTIES

SHUSA utilizes 770 buildings that occupy a total of 5.8 million square feet, including 223 owned properties with 1.7 million square feet, 423 leased properties with 2.4 million square feet and 124 sale and leaseback properties with 1.7 million square feet. The executive and primary administrative offices for SHUSA and the Bank are located at 75 State Street, Boston, Massachusetts. This location is leased by the Company.

Seven major buildings, which serve as the headquarters or house significant operational and administrative functions:

Columbia Park Operations Center - Dorchester, Massachusetts - Leased

195 Montague Street Regional Headquarters for Independence Community Bank Corp. - Brooklyn, New York - Owned

East Providence Call Center and Operations and Loan Processing Center - East Providence, Rhode Island - Leased

75 State Street Bank - Boston, Massachusetts - Leased

405 Penn Street Sovereign Bank Plaza Call Center and Operations and Loan Processing Center - Reading, Pennsylvania - Leased

601 Penn Street Loan Processing Center - Reading, Pennsylvania - Owned

1130 Berkshire Boulevard Administrative Offices - Wyomissing, Pennsylvania - Owned

The majority of the seven properties of the Company outlined above are utilized for general corporate purposes by the Other function. The remaining 763 properties consist primarily of bank branches and lending offices used by the Retail banking segment.

The other premises are for use in conducting business activities, including operations centers, offices, and branch and other facilities. We consider the facilities owned or occupied under lease by our subsidiaries to be adequate. For additional information regarding the Company's properties refer to Note 6 - "Premises and Equipment" and Note 20 - "Commitments, Contingencies and Guarantees" in the Notes to Consolidated Financial Statements in Item 8 of this Report.



ITEM 3 - LEGAL PROCEEDINGS

Reference should be made to Note 16 to the Consolidated Financial Statements for disclosure regarding the lawsuit filed by SHUSA against the Internal Revenue Service and Note 20 to the Consolidated Financial Statements for SHUSA’s litigation disclosure, which is incorporated herein by reference.



ITEM 4 - MINE SAFETY DISCLOSURES

Not applicable.



21




PART II


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

(a) The Company’s common stock was traded on the New York Stock Exchange (“NYSE”) under the symbol “SOV” through January 29, 2009. On January 30, 2009, all shares of the Company's common stock were acquired by Santander and delisted from the NYSE. Following such delisting, there has not been, nor is there currently, an established public trading market in shares of the Company’s common stock. As of the date of this filing, Santander was the sole holder of the Company’s common stock.

Refer to the Liquidity and Capital Resources section in Item 7, MD&A for further discussion on dividends.

(b) Not applicable

(c) Refer to Note 17 to the Consolidated Financial Statements for further discussion on equity compensation plans.


22




ITEM 6 - SELECTED FINANCIAL DATA

 
 
SELECTED FINANCIAL DATA
FOR THE YEAR ENDED DECEMBER 31,
(Dollars in thousands)
 
2012 (1)
 
2011 (1)
 
2010 (1)
 
2009 (1)
 
2008
Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
85,790,202

 
$
80,565,199

 
$
89,651,815

 
$
82,953,215

 
$
77,093,668

Loans held for investment, net of allowance
 
51,375,442

 
50,223,888

 
62,820,434

 
55,733,953

 
54,439,146

Loans held for sale at fair value
 
843,442

 
352,471

 
150,063

 
118,994

 
327,332

Investment securities
 
19,737,743

 
16,133,946

 
15,691,984

 
14,301,638

 
10,020,110

Total deposits and other customer accounts
 
50,790,038

 
47,797,515

 
42,673,293

 
44,428,065

 
48,438,573

Borrowings and other debt obligations
 
19,264,206

 
18,278,433

 
33,630,117

 
27,235,151

 
20,964,185

Total liabilities
 
72,548,200

 
67,969,036

 
78,391,145

 
73,565,680

 
71,496,954

Total stockholders’ equity
 
13,242,002

 
12,596,163

 
11,260,670

 
9,387,535

 
5,596,714

Summary Statement of Operations
 
 
 
 
 
 
 
 
 
 
Total interest income
 
$
2,547,881

 
$
5,253,013

 
$
4,784,489

 
$
4,423,586

 
$
3,923,164

Total interest expense
 
873,758

 
1,388,199

 
1,385,850

 
1,780,082

 
2,040,722

Net interest income
 
1,674,123

 
3,864,814

 
3,398,639

 
2,643,504

 
1,882,442

Provision for credit losses (2)
 
392,800

 
1,319,951

 
1,627,026

 
1,984,537

 
911,000

Net interest income after provision for credit losses
 
1,281,323

 
2,544,863

 
1,771,613

 
658,967

 
971,442

Total non-interest income / (expense) (3)
 
1,139,596

 
1,981,823

 
1,002,856

 
320,885

 
(947,273
)
Total general and administrative expenses(4)
 
1,481,248

 
1,842,224

 
1,573,100

 
1,520,460

 
1,484,306

Total other expenses (5)
 
484,884

 
517,937

 
182,384

 
582,291

 
173,497

Income/(loss) before income taxes
 
454,787

 
2,166,525

 
1,018,985

 
(1,122,899
)
 
(1,633,634
)
Income tax provision/(benefit) (6)
 
(106,448
)
 
908,279

 
(40,390
)
 
(1,284,464
)
 
723,576

Net income/(loss)
 
$
561,235

 
$
1,258,246

 
$
1,059,375

 
$
161,565

 
$
(2,357,210
)
Selected Financial Ratios
 
 
 
 
 
 
 
 
 
 
Return on average assets (7)
 
0.68
%
 
1.37
%
 
1.25
%
 
0.20
%
 
(2.99
)%
Return on average equity (7)
 
4.29
%
 
10.53
%
 
10.12
%
 
1.98
%
 
(31.36
)%
Average equity to average assets (7)
 
15.75
%
 
12.97
%
 
12.34
%
 
9.89
%
 
9.55
 %
Efficiency ratio (7)
 
69.88
%
 
40.37
%
 
39.88
%
 
70.93
%
 
177.27
 %
 
Certain prior period amounts have been reclassified to conform with the current period presentation, which we believe is more meaningful to readers of our consolidated financial statements.

(1)
In July 2009, Santander contributed SCUSA, a majority owned subsidiary, to the Company.  The July 2009 contribution of SCUSA resulted in increases to total assets, borrowings and debt obligations, and stockholder’s equity at December 31, 2009 of $9.1 billion, $7.5 billion and $1.3 billion, respectively. The 2009 statement of operations was also impacted with increases to net interest income, provision for credit losses and general and administrative expense of $1.3 billion, $720.9 million and $253.0 million, respectively.

SCUSA’s results of operations were consolidated from January 2009 until December 31, 2011. Beginning on December 31, 2011, as a result of the SCUSA Transaction, SCUSA was accounted for as an equity method investment. Refer to Note 3 of the Notes to Consolidated Financial Statements for additional information on the SCUSA Transaction. At December 31, 2011, the SCUSA Transaction resulted in decreases to total assets, net loans, investments, and borrowings of $17.6 billion, $16.7 billion, $188.3 million, and $16.8 billion, respectively.

(2)
The U.S. recession during 2008 and 2009 and resulting continued levels of high unemployment have negatively impacted provisions for credit losses. Beginning in 2010 and continuing through 2012, the Company began to experience favorable credit quality trends and declining provisions due, in large part, to the modest economic recovery in the U.S. and the Company’s footprint. The decrease in provision for credit losses of $927.2 million from 2011 to 2012 was primarily due to the SCUSA Transaction and lower loan loss reserves.

23





(3)
Non-interest income in 2012 includes equity investment income related to SCUSA in the amount of $447.6 million. Non-interest income in 2011 includes the pre-tax gain related to the SCUSA Transaction of $987.7 million. Non-interest income in 2010 includes $205.3 million of gains on the sale of investment securities as well as higher servicing fees due to portfolio acquisition volume at SCUSA. Non-interest income in 2009 includes other-than-temporary impairment (“OTTI”) charges of $180.2 million and increases to multi-family recourse reserves of $188.9 million. Non-interest income for 2008 includes a $602.3 million loss on the sale of the collateralized debt obligation portfolio and a $575.3 million pre-tax OTTI charge on Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation ("FHLMC") preferred stock and a pre-tax OTTI charge of $307.9 million on certain non-agency mortgage backed securities.

(4)
Increases in general and administrative expenses from 2008 through 2011 were primarily due to increased compensation and benefit expenses. Compensation and benefit expense increased due to additional employee count and the reinstatement of personnel retirement benefits. Increases from 2010 to 2011 were also due to increased loan servicing expenses related to SCUSA. The decrease from 2011 to 2012 is due to the SCUSA Transaction. Excluding SCUSA, general and administrative expenses in 2011 were $1.3 billion. The increase from 2011 to 2012 was due to increased compensation and benefit costs of $71.8 million related to increased headcount, and foreclosure review costs of $16.1 million. For further information, see the Non-GAAP Financial Measures section of the MD&A.

(5)
Other expenses includes PIERS litigation accrual expenses of $258.5 million and $344.2 million in 2012 and 2011, respectively. See further discussion in Note 20 to the Consolidated Financial Statements. Other expenses also includes debt extinguishment charges of $100.1 million, $38.7 million and $25.8 million in 2012, 2011, and 2010, respectively. The increase in debt extinguishment charges in 2012 was related to the Trust PIERS litigation. 2009 results include $299.1 million of merger-related and restructuring charges and costs primarily associated with the acquisition by Santander. Additionally, during the first quarter of 2009, the Bank redeemed $1.4 billion of high cost FHLB advances incurring a debt extinguishment charge of $68.7 million. 2008 results include an impairment charge of $95.0 million on an equity method investment.

(6)
The tax benefit in 2012 is mainly due to new investments in 2012 that qualify for federal tax credits. Refer to Note 16 of the Notes to Consolidated Financial Statements for additional information. The income tax provision in 2011 includes the tax effect of the gain related to the SCUSA Transaction of $381.6 million, the tax effect related to the accrual for the PIERS litigation, and an increase to the deferred tax valuation allowance. Due to the profitability of SHUSA in 2010 and expected future growth in profits of SHUSA by the end of 2010, SHUSA began to consider the projected taxable income of the total company, and not just that of SCUSA, in its realizability analysis. As a result, the Company was able to reduce its deferred tax valuation allowance by $309.0 million for the year ended December 31, 2010. During 2009, Santander contributed SCUSA to SHUSA. As a result of incorporating the future taxable income projections of SCUSA, the Company was able to reduce its deferred tax valuation allowance by $1.3 billion for the year ended December 31, 2009. SHUSA recorded a $1.4 billion valuation allowance against its deferred tax assets for the year ended December 31, 2008.

(7)
For further information on these ratios, see the Non-GAAP Financial Measures section of the MD&A.





24


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


EXECUTIVE SUMMARY

Santander Holdings USA, Inc. (“SHUSA” or the “Company") is the parent company of Sovereign Bank, N.A. ("Sovereign" or the “Bank”), a national banking association. The Bank converted to a national banking association on January 26, 2012 from a federally chartered savings bank. In connection with its charter conversion, the Bank changed its name to Sovereign Bank, National Association. Also effective on January 26, 2012, SHUSA became a bank holding company.

SHUSA is headquartered in Boston, Massachusetts, and its principal executive offices are at 75 State Street, Boston, Massachusetts. The Bank's home office is in Wilmington, Delaware.

The Bank has retail branches, operations and team members located principally in Pennsylvania, Massachusetts, New Jersey, Connecticut, New Hampshire, New York, Rhode Island, Maryland, and Delaware. The Bank gathers substantially all of its deposits in these market areas. The Bank uses the deposits, as well as other financing sources, to fund its loan and investment portfolios. The Bank earns interest income on its loans and investments. In addition, the Bank generates other income from a number of sources, including deposit and loan services, sales of loans and investment securities, capital markets products and bank-owned life insurance. The Bank’s principal expenses include interest expense on deposits, borrowings and other debt obligations, employee compensation and benefits, occupancy and facility-related costs, technology and other administrative expenses. The Bank’s volumes and, accordingly, the Company's financial results, are affected by the economic environment, including interest rates, consumer and business confidence and spending, as well as the competitive conditions within the Bank’s geographic footprint.

SHUSA is a wholly owned subsidiary of Banco Santander, S.A. (“Santander”). Santander is a retail and commercial bank headquartered in Spain, with a global presence in 10 core geographic markets. At the end of 2012, Santander was the largest bank in the euro zone and among the world's top 20 financial institutions by market capitalization. Founded in 1857, Santander had at December 31, 2012 €1,388 billion in managed funds, approximately 102 million customers, 14,392 branches - more than any other international bank - and approximately 187,000 employees. Furthermore, it has relevant positions in the United Kingdom, Portugal, Germany, Poland, Argentina, Brazil, Mexico, Chile, and the United States. Santander had €2.2 billion in net attributable profit in 2012 primarily generated: in Brazil, 26%; Spain, 15%; United Kingdom, 13%; Mexico, 12%; and U.S., 10%.

Following its acquisition by Santander, the Company began to change its strategy substantially. The Company has successfully completed the first phase of its transformation, which included stabilization, turning around its operating results, improving risk management and collections, and improving margins and asset quality. The second phase of its transformation began in 2012 and will continue through 2014, with a focus on further strengthening the soundness, sustainability, and competitiveness of the Bank's core businesses while diversifying its product and service offerings.

Noteworthy accomplishments related to the Company's transformation include:

execution of the national bank charter change, which has been instrumental in the growth of the commercial banking business,
successful launch of a new proprietary technology platform and servicing portal which connects all branches on one network to improve customer capabilities,
improvement of the Company's competitive position during challenging economic times,
significant growth in its deposit base, with over $2 billion of new deposits in 2012,
increase in Global Banking and Market ("GBM") and Commercial and Industrial loan production,
continued improvements in the asset quality of the Bank's loan portfolio, and
significant improvement in the Company's capital and liquidity levels.

25


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



Moving forward, the Company's priorities to transform the franchise include the following key initiatives:

Rebranding the Bank from Sovereign to Santander in 2013. Santander is one of the world's most recognized financial brands. Rebranding will mark an important transition in the Company's turnaround strategy, and the Company will align the new branding with its business strategies to strengthen its position and improve its customer relations.

Expand our capabilities through alternative sales methods, including mobile banking, new ATMs and upgrade existing ATMs, improve online banking capabilities and leverage our call centers to improve sales and service to our customers. Also, develop our service and corporate sales platform in order to align our product offerings to match the specific needs of our customers.

Retail Banking efforts are focused on increasing market share in the existing primary service area, cross-selling to existing and new customers, and reducing dependence on third-party service providers. Significant initiatives in Retail Banking include developing the capability to issue and service credit cards directly.

Management plans to take a measured and gradual approach to building a stronger Corporate Banking franchise. Significant Corporate Banking initiatives include strengthening the position as a competitive provider for large corporate customers, growing primarily among our local customer base, while also expanding services to existing Santander global clients, and leveraging Santander’s international capabilities.

Management's priority in GBM is to grow the business by developing relationships in the U.S. with global companies through a sector specific approach with a differentiated product offering. This will include different types of financing, hedging and transactional services, with the objective of improving the existing cross-selling and increasing revenue per client. GBM also expects to grow as a product provider to the large corporate and middle market clients served by the Bank.


ECONOMIC AND BUSINESS ENVIRONMENT

Overview

The United States continues to undergo a slower-than-average recovery following the severe recession experienced from 2007 to 2009.  While economic conditions are expected to remain challenging, the United States has experienced three years of moderate economic growth and falling unemployment since the end of the recession. U.S. real gross domestic product increased at an annual rate of 2.2% during 2012, and the unemployment rate fell from a peak of 10.0% in late 2009 to 7.8% by December 2012. As a result, consumer confidence improved moderately during 2012 as consumer spending increased driven by the improved labor conditions. Conditions in the housing market have continued to improve during 2012 as home prices nationally rose 7.3%, housing starts increased 28%, and homebuilder confidence improved 124% to its highest levels since 2006.

Generally, financial markets and corporate balance sheets have continued to improve during the year as corporations have accumulated significant amounts of cash to reinvest and fund future growth opportunities. The S&P 500 equity index has increased over 13% during 2012, as investors remain more optimistic about the overall strength of the business environment.

While we continue to see signs of economic stabilization, our total credit portfolio will likely continue to be affected by sustained levels of high unemployment and uncertainty in the financial and housing markets. During the year ended December 31, 2012, the credit performance of our portfolios remained strong overall as our asset quality trends continued to improve. Non-accrual loans decreased from $1.36 billion at December 31, 2011, to $1.17 billion (2.20% of total loans) at December 31, 2012, which was primarily due to the continued improvement in the overall quality of the loan portfolio. Offsetting the decrease was an increase of $113.9 million of loans (0.21% of total loans), which began being reported as non-accrual in the third quarter of 2012 in accordance with OCC guidance requiring loans discharged under Chapter 7 bankruptcy and not reaffirmed by the borrower to be reported as non-accrual, regardless of their delinquency status.

26


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



Long- and short-term interest rates continued to remain at historically low levels, presenting a significant challenge to growing net interest income for most deposit and lending institutions, including the Bank. The FRB anticipates maintaining short-term interest rates at low levels as long as the unemployment rate remains above 6.5% and its long-term inflation goals are not met. Moreover, the FRB continues to maintain large portfolios of U.S. Treasury notes and bonds and agency MBS with plans to continue adding Treasuries and agency MBS to the portfolio in 2013.

In early 2013, the U.S. Congress reached an agreement to resolve the “fiscal cliff” by passing the American Taxpayer Relief Act of 2012, which made permanent most of the tax cuts initiated in 2001 and 2003 while increasing the marginal tax rate on certain high income taxpayers. Spending and debt ceiling issues were postponed further into 2013.

Going forward into 2013, the U.S. economy will likely be affected by the continuing uncertainty in connection with European debt levels, discussed further below, China's slowing growth rate and expanding housing bubble, the FRB's monetary policy, and the ongoing fiscal debate over the U.S. debt limit, government spending and taxes.

European Exposure

Concerns about the European Union’s sovereign debt and the future of the euro have caused uncertainty for financial markets globally. Other than borrowing agreements and related party transactions with its parent company, Santander, as further described in Note 12 and Note 22 to the Consolidated Financial Statements, the Company's exposure to European countries includes the following:

Country
 
 Covered Bonds
 
Financial Institution Bonds
 
Non-Financial Institutions Bonds
 
Government Institution Bonds
 
Total
 
 
(in thousands)
Germany
 
 
 
 
 
$
87,000

 
 
 
$
87,000

Spain
 
92,395

 
 
 
121,160

 
74,750

 
288,305

Switzerland
 
102,000

 
94,010

 
 
 
 
 
196,010

Great Britain
 
53,548

 
147,235

 
149,265

 
 
 
350,048

Netherlands
 
99,350

 
71,700

 
5,000

 
 
 
176,050

Sweden
 
78,372

 
 
 
 
 
 
 
78,372

France
 
 
 
166,755

 
30,000

 
 
 
196,755

Norway
 
 
 
 
 
8,000

 
 
 
8,000

Greece
 
 
 
 
 
 
 
 
 

Ireland
 
 
 
 
 
 
 
 
 

Italy
 
 
 
 
 
69,768

 
 
 
69,768

Portugal
 
 
 
 
 
40,000

 
 
 
40,000

 
 
$
425,665

 
$
479,700

 
$
510,193

 
$
74,750

 
$
1,490,308


These preceding investments are included within "Corporate Debt Securities" in the Note 4 to the Consolidated Financial Statements.

As of December 31, 2012 the Company had approximately $129.8 million of loans that were denominated in a currency other than the USD.

27


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



Overall, gross exposure to the foregoing countries was less than 2.0% of the Company's total assets as of December 31, 2012 and no more than 1% to any given country or third party. The Company currently does not have credit protection on any of these exposures, nor does it provide lending services in Europe. The Company transacts with various European banks as counterparties to interest rate swaps and foreign currency transactions for its hedging and customer-related activities; however, these derivative transactions are subject to master netting and collateral support agreements, which significantly limit the Company’s exposure to loss. At December 31, 2012, the Company was in a net receivable position to each of these European banks.

Management conducts periodic stress tests of our significant country risk exposures, analyzing the direct and indirect impacts on the risk of loss from various macroeconomic and capital markets scenarios. We do not have significant exposure to foreign country risks because our foreign portfolio is relatively small. However, we have identified exposure to increased loss from U.S. borrowers associated with the potential indirect impact of a European downturn on the U.S. economy. We mitigate these potential impacts through our normal risk management processes, which include active monitoring and, if necessary, the application of loss mitigation strategies.

Credit Rating Actions

The following table presents Moody's and S&P credit ratings for the Bank, SHUSA, Banco Santander and the Kingdom of Spain as of December 31, 2012:

 
BANK
 
SHUSA
 
SANTANDER
 
SPAIN
 
Moody's
S&P
 
Moody's
S&P
 
Moody's
S&P
 
Moody's
S&P
LT Senior Debt
Baa1
BBB
 
Baa2
BBB
 
Baa2
BBB
 
Baa3
BBB-
ST Deposits
P-2
A-2
 
P-2
A-2
 
P-2
A-2
 
P-3
A-3
Outlook
Stable
Negative
 
Negative
Negative
 
Negative
Negative
 
Negative
Negative

SHUSA funds its operations independently of the other entities owned by Santander, and believes its business is not necessarily closely related to the business or outlook of other entities owned by Santander. However, in June 2012, Moody's Investors Service downgraded the ratings of SHUSA and the Bank, citing challenges faced by Santander and its subsidiaries. Future adverse changes in the credit ratings of Santander or the Kingdom of Spain could also further adversely impact SHUSA's or its subsidiaries' credit ratings, and any other adverse change in the condition of Santander could adversely affect SHUSA.
As of June 30, 2012, due to a decrease in its Moody's ratings, the Bank was required to post an additional $23.0 million of collateral to comply with the terms of existing derivative agreements. On October 17, 2012, due to a decrease in S&P ratings, the Bank was required to post an additional $6.0 million, in order to comply with existing derivative agreements. The Bank estimates a further 1 or 2 notch downgrade by either S&P or Moody's would require the Bank to post up to an additional $4.3 million or $4.5 million, respectively, to comply with existing derivative agreements.
In addition to the decrease in long-term ratings, the Bank's short-term ratings have been reduced from A1/P1 to A2/P2. The Bank confirms for customers variable rate demand notes ("VRDBs"). Due to this downgrade, the Company expects to continue to incur additional costs to comply with these VRDB agreements. The Company notes that its exposure to its equity investment in SCUSA has also been cited as a contributing factor to certain of the Company's recent downgrades.

28


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



The following actions were taken by S&P and Moody's following the end of the third quarter of 2012:

S&P
On October 10, 2012, S&P lowered the ratings of Spain by 2 notches (from BBB+/A-2 to BBB-/A-3).
On October 16, 2012, S&P lowered Santander's ratings by 2 notches (from A-/A-2 to BBB/A-2).
On October 16, 2012, S&P lowered SHUSA's and the Bank's ratings by 1 notch (from BBB+/A-2 to BBB/A-2). S&P did not change SHUSA's or Sovereign's Stand Alone Credit Profile (SACP) rating.

Moody's            
On October 17, 2012, Moody's completed its review of Spain and left Spain's ratings affirmed at Baa3/P-3 with a negative outlook.
On October 26, 2012, Moody's affirmed its ratings on Santander.
On October 26, 2012, Moody's affirmed SHUSA and the Bank's ratings. In addition, the Bank's outlook was returned to stable.

There have been no further actions taken.

Hurricane Sandy

In late October 2012, Hurricane Sandy caused widespread damage across the Company's geographic footprint in the Mid-Atlantic and Northeastern United States.  Despite the detrimental impact caused by the hurricane, the Company demonstrated its commitment to its communities and clients during this crisis by providing charitable contributions to non-profit organizations, and offering financial assistance to its customers.
The Company incurred approximately $33.0 million in costs resulting from Hurricane Sandy, which primarily related to an increase in the provision for credit losses and fixed asset impairments. Financial assistance provided to the Company's customers in connection with Hurricane Sandy including fee reversals did not have a significant impact to the Company's financial statements.


REGULATORY MATTERS

The Company's operations are subject to extensive laws and regulation by federal and state governmental authorities. Congress often considers new financial industry legislation, and the federal banking agencies routinely propose new regulations. New legislation and regulation may include changes with respect to the federal deposit insurance system, consumer financial protection measures, compensation and systematic risk oversight authority. There can be no assurances that new legislation and regulations will not adversely affect us.

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, the Act, which instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of, and government intervention in, the financial services sector, was enacted. The Act includes a number of specific provisions designed to promote enhanced supervision and regulation of financial firms and financial markets. The Act introduced a substantial number of reforms that reshape the structure of the regulation of the financial services industry, requiring that more than 200 regulations be written. Although the full impact of this legislation on the Company and the industry will be unknown until these regulations are complete, the enhanced regulation will involve higher compliance costs and certain elements, such as the debit interchange legislation, has negatively affected the Company's revenue and earnings.

More specifically, the Act imposes heightened prudential requirements on bank holding companies with at least $50.0 billion in total consolidated assets, which includes the Company, and requires the FRB to establish prudential standards for such bank holding companies that are more stringent than those applicable to other bank holding companies, including standards for risk-based capital requirements and leverage limits; heightened capital standards, including eliminating trust preferred securities as Tier 1 regulatory capital; enhanced risk-management requirements; and credit exposure reporting and concentration limits. These changes are expected to impact the profitability and growth of the Company.


29


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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


The Act mandates an enhanced supervision framework, which means that the Company will be subject to annual stress tests by the FRB, and the Company and the Bank will be required to conduct semi-annual and annual stress tests, respectively, reporting results to the FRB and the OCC. The FRB also has discretionary authority to establish additional prudential standards, on its own or at the Financial Stability Oversight Council's recommendation, regarding contingent capital, enhanced public disclosures, short-term debt limits, and otherwise as it deems appropriate.

Under the Durbin Amendment to the Act, on June 29, 2011 the FRB issued the final rule implementing debit card interchange fee and routing regulation. The final rule establishes standards for assessing whether debit card interchange fees received by debit card issuers are “reasonable and proportional” to the costs incurred by issuers for electronic debit transactions and prohibits network exclusivity arrangements on debit cards to ensure merchants have choices in how debit card transactions are routed.

The Act established the CFPB, which has broad powers to set the requirements around the terms and conditions of financial products. This is expected to result in increased compliance costs and may result in reduced revenue.

The Bank routinely executes interest rate swaps for the management of its asset-liability mix, and also executes such swaps with its borrower clients. Under the Act, the Bank will be required to post an Independent Amount with certain of its counterparties and clearing exchanges. While clearing these financial instruments offers some benefits and additional transparency in valuation, the systems requirements for clearing execution add operational complexities to the business and accordingly increase operational risk exposure.

Provisions under the Act concerning the applicability of state consumer protection laws to national banks, including the Bank, became effective on July 21, 2011. Questions may arise as to whether certain state consumer financial laws that may have previously been preempted by federal law are no longer preempted as a result of the effectiveness of these new provisions. Depending on how such questions are resolved, the Bank may experience an increase in state-level regulation of its retail banking business and additional compliance obligations, revenue impacts and costs.
 
The Act and certain other legislation and regulations impose various restrictions on compensation of certain executive offers. Our ability to attract and/or retain talented personnel may be adversely affected by these developments.

Other requirements of the Act include increases to the amount of deposit insurance assessments the Bank must pay; changes to the nature and levels of fees charged to consumers which are negatively affecting the Bank's income; banning banking organizations from engaging in proprietary trading and restricting their sponsorship of, or investing in, hedge funds and private equity funds, subject to limited exceptions, and increasing regulation of the derivative markets through measures that broaden the derivative instruments subject to regulation and require clearing and exchange trading as well as imposing additional capital and margin requirements for derivative market participants which will increase the cost of conducting this business.

The Act also contains provisions that are in the process of being implemented which increase regulation of the derivative markets through measures that broaden the derivative instruments subject to regulation and requiring clearing and exchange trading as well as imposing additional capital and margin requirements for derivative market participants. These measures will increase the cost of conducting this business.

The overall impact of the Act to the Company will be unknown until these reforms are complete. They have reduced and will continue to reduce revenues and increase compliance costs.

30


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



Basel III

In December 2010, the Basel Committee on Banking Supervision issued “Basel III: A global regulatory framework for more resilient banks and banking systems” (“Basel III”). Basel III is a comprehensive set of reform measures designed to strengthen the regulation, supervision and risk management of the banking sector, and introduces for the first time an official definition and guideline for Tier 1 common equity and liquidity.

New and evolving capital standards, both as a result of the Act and the implementation in the U.S. of Basel III, could have a significant effect on banks and BHCs, including SHUSA and its bank subsidiaries. On August 30, 2012, the U.S. banking agencies published in the Federal Register three Notices of Proposed Rulemaking (the “NPRs”) that, among other things, implement Basel III in the U.S. The comment period for the NPRs expired on October 22, 2012. Among other things, the NPRs, as proposed, would narrow the definition of regulatory capital and establish higher minimum risk-based capital ratios that, when fully phased in, would require banking organizations, including SHUSA and its banking subsidiaries, to maintain a minimum “common equity Tier 1” (or “CET1”) ratio of 4.5%, a Tier 1 capital ratio of 6.0%, and a total capital ratio of 8.0%. A capital conservation buffer of 2.5% above each of these levels (to be phased in over three years beginning in 2016) would also be required for banking institutions to avoid restrictions on their ability to make capital distributions, including the payment of dividends. The implementation of certain regulations and standards with regard to regulatory capital could disproportionately affect our regulatory capital position relative to that of our competitors, including those that may not be subject to the same regulatory requirements.

The NPRs are highly complex, and are subject to revisions based on the public comment process. Therefore, many aspects of their application will remain uncertain and their full impact on the Company will not be known until the rules are finalized and the Company can analyze the impact under those final rules.

Historically, regulation and monitoring of bank and BHC liquidity has been addressed as a supervisory matter, both in the U.S. and internationally, without required formulaic measures. The Basel III liquidity framework requires banks and BHCs to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, will be required by regulation going forward. One test, referred to as the liquidity coverage ratio (“LCR”), is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to its expected net cash outflow for a 30-day time horizon. The other, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. These requirements would incentivize banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source. On January 6, 2013, the Basel Committee published revised guidance for the LCR.  The Committee made several changes to the both the definition of liquid assets (the numerator) and the assumptions regarding liability cash outflows (the denominator), which made the LCR measurement less restrictive.  In addition, the Committee pushed back the requirement to achieve a 100% LCR ratio from 2015 to 2019.  The U.S. banking agencies have not yet proposed rules implementing the Basel III liquidity framework for U.S. banking organizations.

Similarly, Basel III contemplates that the NSFR will be subject to an observation period through mid-2016 and, subject to any revisions resulting from the analyses conducted and data collected during the observation period, implemented as a minimum standard by January 1, 2018. The Basel Committee reportedly is considering revisions to the Basel III liquidity framework as presented in December 2010. The U.S. banking agencies have not yet proposed rules implementing the Basel III liquidity framework for U.S. banking organizations.


31


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



On December 14, 2012, the FRB proposed rules to strengthen regulatory oversight of foreign banking organizations.  These rules would require foreign banking organizations - such as the Company's parent, Santander, with over $50 billion in global consolidated assets and over $10 billion in total assets held by its U.S. subsidiaries - to create a U.S. intermediate holding company (“IHC”) over all of its U.S. bank and U.S. non-bank subsidiaries. U.S. branches and agencies of foreign banks would not be included in the IHC. The formation of these IHCs would allow U.S. regulators to supervise these institutions similarly to U.S. systemically important bank holding companies, meaning that they would be subject to similar capital rules and enhanced prudential standards, including capital stress tests, single-counterparty credit limits, overall risk management, and early remediation requirements, as systemically important bank holding companies. If implemented as proposed, Santander would be required to transfer its U.S. nonbank subsidiaries currently outside of the Company into the Company, which would become an IHC and/or Santander would establish a top-tier IHC structure that would include all of its US bank and nonbank subsidiaries within the same chain of ownership. Institutions would be required to comply with these new standards on July 1, 2015. Public comments on this proposal will be accepted through April 30, 2013.

Enhanced Prudential Standards for Capital Adequacy

On January 24, 2012, the federal banking regulators published proposed rules on annual stress tests to be performed by banks having total consolidated assets of more than $10 billion. The Company is subject to these annual tests ,which are already required by the Act. In addition to the annual stress testing requirement, under the proposal, the Company would also be subject to certain additional reporting and disclosure requirements. The Company was required to conduct its stress test and report results to the FRB in January 2013.

National Charter Change and Conversion to a Bank Holding Company

Effective on January 26, 2012, the Bank converted from a federal savings bank to a national banking association. In connection with the charter conversion, the Bank changed its name to Sovereign Bank, National Association. Also, effective on January 26, 2012, the Company became a bank holding company.

As a national bank, the Bank is no longer subject to federal thrift regulations and instead is subject to the OCC's regulations under the National Bank Act. The various laws and regulations administered by the OCC for national banks affect corporate practices and impose certain restrictions on activities and investments, but the Company does not believe that the Bank's current or currently proposed business will be limited materially, if at all, by these restrictions. In addition, as a national bank, the Bank is no longer subject to the qualified thrift lender requirement, which requires thrifts to maintain a certain percentage of their “portfolio assets” in certain "qualified thrift investments,” such as residential housing related loans, certain consumer and small business loans and residential mortgage-backed securities. The Bank also is no longer subject to the restrictions in the HOLA limiting the amount of commercial loans that it may make.

As a BHC, the Company is subject to the comprehensive, consolidated supervision and regulation of the FRB. The Company is subject to risk-based and leverage capital requirements and information reporting requirements. As a BHC with more than $50.0 billion in total consolidated assets, it is subject to the heightened prudential and other requirements for large BHCs, including capital plan and capital stress testing requirements as defined under the FRB's capital plan rule.  The Company completed the required capital stress testing for the 2013 Capital Plan Review ("CapPR") program even though it was not included in the 2013 CapPR group of BHCs by the FRB.  The Company expects to be included in the 2014 Comprehensive Capital Analysis and Review program by the FRB.
 
Federal laws restrict the types of activities in which bank holding companies may engage, and subject them to a range of supervisory requirements, including regulatory enforcement actions for violations of laws and policies. Bank holding companies may engage in the business of banking and managing and controlling banks, as well as closely related activities. The Company does not expect that the limitations described above will adversely affect the current operations or materially prohibit the Company from engaging in activities that are currently contemplated by its business strategies.


32


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



On December 17, 2012, the FRB announced a new framework for the consolidated supervision of large financial institutions, including BHCs with consolidated assets of $50 billion or more. The updated guidance outlined in Supervision and Regulation Letter No. SR 12-17, has two primary objectives - enhancing the resiliency of institutions to lower the probability of failure or inability to serve as a financial intermediary, and reducing the impact on the financial system and economy in the event of a large institution's failure or material weakness. With regard to enhancing institutional resiliency, the guidance indicates that institutions should focus on capital and liquidity planning and positions, corporate governance, recovery planning and management of core business lines in order to survive significant stress. In terms of reducing the impact of an institution's failure, the guidance indicates that institutions should focus on management of critical operations, support for banking offices, resolution planning and additional macro-prudential supervisory approaches to address risks to financial stability. This framework would be implemented in multiple stages, with additional supervisory and operational guidance to follow.   

Foreclosure Matters

On April 13, 2011, the Bank consented to the issuance of a consent order by the Bank's previous primary federal banking regulator, the OTS, as part of an interagency horizontal review of foreclosure practices at 14 mortgage servicers. The Bank, upon its conversion to a national bank on January 26, 2012, entered into a stipulation consenting to the issuance of a consent order (the "Order") by the OCC, which contains the same terms as the OTS consent order.

The Order requires the Bank to take a number of actions, including designating a Board committee to monitor and coordinate the Bank's compliance with the provisions of the Order, develop and implement plans to improve the Bank's mortgage servicing and foreclosure practices, designate a single point of contact for borrowers throughout the loss and mitigation foreclosure processes and take certain other remedial actions. The Bank has made significant progress in complying with these requirements.  Specifically, the Bank has:

retained an independent consultant to conduct a review of certain foreclosure actions or proceedings for loans serviced by the Bank;
strengthened coordination with its borrowers by providing them with a single point of contact to avoid borrower confusion and ensure effective communication in connection with any foreclosure, loss mitigation or loan modification activities;
improved processes and controls to ensure that foreclosures are not pursued once a mortgage has been approved for modification, unless repayments under the modified loan are not made;
enhanced controls and oversight over the activities of third-party vendors, including external legal counsel and Mortgage Electronic Registration Systems, Inc. ("MERS"); 
strengthened its compliance programs to ensure mortgage-servicing and foreclosure operations comply with all applicable legal requirements and supervisory guidance , and assure appropriate policies and procedures staffing, training oversight, and quality control of those processes;
improved its MIS for foreclosure, loss mitigation and loan modification activities that ensure timely delivery of complete and accurate information to facilitate effective decision-making.
centralized governance and management for the originations, servicing and collections in the mortgage business

Excluding the costs discussed below, the Company incurred $24.7 million and $25.5 million of costs in 2011 and 2012, respectively, relating to compliance with the Order.

In addition, the Company paid $0.2 million and $0.9 million of fees in 2011 and 2012, respectively, with an additional $0.5 million outstanding at December 31, 2012 related to compensatory fees related to foreclosure delays.

On January 7, 2013, the Bank and nine other mortgage servicing companies, subject to enforcement actions for deficient practices in mortgage loan servicing and foreclosure processing, reached an agreement in principle with the OCC and the FRB to make cash payments and provide other assistance to borrowers. On February 28, 2013, the agreements were finalized with all ten mortgage servicing companies, including the Bank. Other assistance includes reductions of principal on first and second liens, payments to assist with short sales, deficiency balance waivers on past foreclosures and short sales, and forbearance assistance for unemployed homeowners. As of January 24, 2013, twelve other mortgage servicing companies subject to enforcement action for deficient practices in mortgage loan servicing and foreclosure processes have also reached an agreement with the OCC or the FRB, as applicable.     

33


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



As a result of the agreement, the participating servicers, including the Bank, would cease the Independent Foreclosure Review, which involved case-by-case reviews, and replace it with a broader framework allowing eligible borrowers to receive compensation in a more timely manner. This arrangement has not eliminated all of the Company's risks associated with foreclosures, as it does not protect the Bank from potential individual borrower claims, class actions lawsuits, actions by state attorneys general, or actions by the Department of Justice.  In addition, all of the other terms of the Order are still in place.

Under the agreement, the Bank will pay $6.2 million into a remediation fund, which will be distributed to borrowers, and engage in mortgage modifications over the next two years in an aggregate principal amount of $9.9 million. In return, the OCC will waive any civil money penalties that may have been assessed against the Bank. The Bank is approximately 0.17% of the total $9.3 billion settlement among the ten banks and is the smallest participant in the agreement. The total $16.1 million related to the remediation fund and mortgage modifications was recognized in "other expense" in the Consolidated Statement of Comprehensive Income during the fourth quarter of 2012. While the Bank expects to incur additional operating expenses in implementing these standards, it does not currently expect that the impact of these expenses will be material.

Risk Management Framework

In 2012, the Company initiated an enhancement of its risk management process and put in place an enterprise-wide Risk Management Department, headed by the Chief Risk Officer (the "CRO") to provide risk oversight to senior management and the Board of Directors. The Board approves the Risk Tolerance Statement, which details the types of risk and size of the risk-taking activities permissible for the Chief Executive Officer to take in the execution of business strategy. The Risk Tolerance Statement is the Board's explicit statement of the boundaries within which executive management is expected to operate.

The Risk Tolerance Statement is the basis for the Risk Framework, which ties the strategic plan and the budget together, to ensure that the Bank is taking risks appropriate to its strategy and risk appetite, the risks are adequately and independently controlled, and the controls are effective.

The Chief Executive Officer (the "CEO") is ultimately responsible for risk management. The Board authorizes the amount and type of risks that can be taken. The Risk Framework aids the CEO in ensuring that risk-taking is appropriately and transparently delegated, that risk-takers are accountable and that risk-taking is executed within effective controls and under appropriate governance.

The risk management governance is designed to provide a structured approach to allocating responsibilities for identification, measurement and assessment, monitoring, controlling and communicating financial and non-financial risk within the Bank.

Risk is multi-faceted and variable. The Risk Framework provides flexibility to encompass new risks as they emerge, or current risks as they change. Change can come either idiosyncratically, through changes to the risk profile of the Bank, or due to an external or systematic change in the types of risk to which we are vulnerable. As risks change, the allocation of capital can change, and/or the expected return appropriate for taking on risk can change. Therefore, the risk tolerance must be designed so that changes in strategy and risk-taking can be modified with the appropriate authority.

The Company and the Bank have established a governance structure based on three lines of defense against loss. The first line of defense comprises business line management and centralized corporate functions that report to the CEO and are responsible for day-to-day risk management. The second line of defense is the enterprise risk management function, which is led by the Chief Risk Officer and is responsible for risk oversight. The third line of defense is the Company's internal audit function, which is led by the Chief Internal Auditor, and is responsible for providing an independent and objective review and assessment of the control infrastructure. The second line of defense reports to the Board Enterprise Risk Committee. The third line of defense reports to the Audit Committee. Both the Board Enterprise Risk Committee and the Audit Committee are committees of the Board of Directors.


34


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



RESULTS OF OPERATIONS


The following discussion provides a review of the Company's financial performance from a consolidated perspective over the past three years. This review is analyzed in the following two sections - "Results of Operations for the Years Ended December 31, 2012 and 2011" and "Results of Operations for the Years Ended December 31, 2011 and 2010". Each section includes a detailed income statement and segment results review. Key consolidated balance sheet trends are discussed in the "Financial Condition" section.


RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2012 AND 2011

 
YEAR ENDED DECEMBER 31,

 
(Dollars in thousands)
2012
 
2011
Net interest income
$
1,674,123

 
$
3,864,814

 
Provision for credit losses
(392,800
)
 
(1,319,951
)
 
Total non-interest income
1,139,596

 
1,981,823

 
General and administrative expenses
(1,481,248
)
 
(1,842,224
)
 
Other expenses
(484,884
)
 
(517,937
)
 
Income tax (provision)/benefit
106,448

 
(908,279
)
 
Net income
$
561,235

 
$
1,258,246

 

The Company reported pre-tax income of $454.8 million for the year-ended December 31, 2012, compared to pre-tax income of $2.2 billion for the year-ended December 31, 2011.

The major factors affecting the comparison of earnings between 2012 and 2011 results of operations were:

The major factor affecting the comparison of earnings between 2012 and 2011 was the SCUSA Transaction. SCUSA’s results of operations were consolidated from January 2009 until December 31, 2011. On December 31, 2011, the Company deconsolidated SCUSA as a result of certain agreements with investors entered into during the fourth quarter of 2011. Refer to Note 3 to the Consolidated Financial Statements for additional information on the SCUSA Transaction.

The provision for credit losses decreased due to an overall continued improvement in the credit quality of the loan portfolio.

General and administrative expenses increased, primarily due to increases in compensation and benefits due to increased headcount as well as foreclosure review costs.

Other expenses included $258.5 million and $344.2 million in 2012 and 2011 respectively related to Trust PIERS. Other expenses in 2012 also includes a $61.4 million increase in loss on debt extinguishment due to Trust PIERS. See further discussion in Note 20 to the Consolidated Financial Statements.

Income taxes resulted in a benefit in 2012 due to dividends from SCUSA and investment tax credits from direct financing lease transactions.


35


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



NON-GAAP FINANCIAL MEASURES

We believe that the most meaningful way to discuss our results of operations for the periods ended December 31, 2012 and 2011 is to compare (i) our results of operations for the year ended December 31, 2012 with (ii) our results of operations on a pro forma basis for the year ended December 31, 2011. We believe that presenting the discussion and analysis of the results of operations in this manner promotes the overall usefulness of the comparison given the complexities involved with comparing periods that includes a basis of presentation reflecting accounting for SCUSA's operations on a consolidated and deconsolidated basis within periods presented in the financial statements, respectively. In addition, we have provided a separate discussion of the results of operations for the years ended December 31, 2011 and 2010 on a historical basis within “Results of Operations for the Years Ended December 31, 2011 and 2010".

The following financial information presents the Company's results of operations on a pro-forma basis. The unaudited pro forma consolidated financial and other data for the year ended December 31, 2011 has been prepared to give effect to the SCUSA Transaction as discussed in Note 3 of these financial statements and the notes thereto as if they had occurred on January 1, 2011. The pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable. The unaudited pro forma condensed consolidated statement of operations has been derived by the mathematical subtraction of the results of SCUSA's operations for the year ended December 31, 2011, and then applying the pro forma adjustments to give effect to: recognize a full year of equity method investment income from SCUSA, eliminate the gain recognized as result of the SCUSA Transaction and incorporate any transactions between SHUSA and SCUSA that would have been eliminated as part of consolidation. A pro forma balance sheet has not been presented, as SCUSA was deconsolidated on December 31, 2011. The summary unaudited pro forma consolidated financial information is presented for informational purposes only and does not purport to represent what our results of operations actually would have been if the SCUSA Transaction had occurred at any date, and such data does not purport to project the results of operations for any future period.

Our non-GAAP information has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results or any performance measures under U.S. GAAP as set forth in our financial statements. You should compensate for these limitations by relying primarily on our U.S. GAAP results and using this non-GAAP information only as a supplement to evaluate our performance.

36


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



Unaudited Pro Forma Condensed Consolidated Financial Information

The following pro forma financial information contains our unaudited pro forma condensed consolidated statement of operations for the year-ended December 31, 2011.

 
 
Year-Ended
 
 
December 31, 2011
 
December 31, 2012
 
 
SHUSA as reported(1)
 
Proforma adjustments(2)
 
Unaudited Pro-forma(3)
 
SHUSA as reported(4)
 
 
 
 
 
 
 
(in thousands)
Net interest income
 
$
3,864,814

 
$
(2,185,314
)
 
$
1,679,500

 
$
1,674,123

Provision for credit losses
 
(1,319,951
)
 
819,221

 
(500,730
)
 
(392,800
)
Total non-interest income
 
1,981,823

 
(889,051
)
 
1,092,772

 
1,139,596

General and administrative expenses
 
(1,842,224
)
 
510,324

 
(1,331,900
)
 
(1,481,248
)
Other expenses
 
(517,937
)
 
4,279

 
(513,658
)
 
(484,884
)
Income before income taxes
 
2,166,525

 
(1,740,541
)
 
425,984

 
454,787

Income tax (provision)/benefit
 
(908,279
)
 
781,905

 
(126,374
)
 
106,448

Net income
 
$
1,258,246

 
$
(958,636
)
 
$
299,610

 
$
561,235


(1) 
Amounts represent historical financial information from our Annual Report on Form 10-K for the year-ended December 31, 2011.
(2) 
Reflects the deconsolidation of SCUSA, elimination of the gain recognized as a result of the SCUSA Transaction and adjustments relating to normal recurring intercompany transactions between SHUSA and SCUSA, which as a result of the deconsolidation would no longer be eliminated.
(3) 
Amounts represent the sum of the columns "SHUSA as reported" and "Proforma adjustments," which is a non-GAAP financial measure and is presented to assist in the evaluation of SHUSA's 2012 results.
(4) 
Amounts represent financial information from the Consolidated Statement of Comprehensive Income as reported in this Annual Report on Form 10-K.

The Company considers various measures when evaluating capital utilization and adequacy. These calculations are intended to complement the capital ratios defined by banking regulators for both absolute and comparative purposes. Because U.S. GAAP does not include capital ratio measures, the Company believes there are no comparable U.S. GAAP financial measures to these ratios. These ratios are not formally defined by U.S. GAAP or codified in the federal banking regulations and, therefore, are considered to be non-GAAP financial measures. Since analysts and banking regulators may assess the Company's capital adequacy using these ratios, the Company believes they are useful to provide investors the ability to assess its capital adequacy on the same basis. The Company believes these non-GAAP measures are important because they reflect the level of capital available to withstand unexpected market conditions. Additionally, presentation of these measures allows readers to compare certain aspects of the Company's capitalization to other organizations. However, because there are no standardized definitions for these ratios, the Company's calculations may not be comparable with other organizations, and the usefulness of these measures to investors may be limited. As a result, the Company encourages readers to consider its Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

The following table reconciles non-GAAP financial measures to U.S. GAAP.

37


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



Table 1: Non-GAAP Financial Measures
 
Year Ended December 31,
 
2012
 
2011
 
2010
 
2009
 
2008
 
(in thousands)
Return on average assets:
 
 
 
 
 
 
 
 
 
Net income
$
561,235

 
$
1,258,246

 
$
1,059,375

 
$
161,565

 
$
(2,357,210
)
Average assets
83,044,676

 
92,078,048

 
84,843,371

 
82,348,782

 
78,681,899

      Return on average assets
0.68
%
 
1.37
%
 
1.25
%
 
0.20
%
 
(2.99
)%
 
 
 
 
 
 
 
 
 
 
Return on average equity:
 
 
 
 
 
 
 
 
 
Net income
$
561,235

 
$
1,258,246

 
$
1,059,375

 
$
161,565

 
$
(2,357,210
)
Average equity
13,075,464

 
11,944,901

 
10,469,100

 
8,148,366

 
7,517,755

      Return on average equity
4.29
%
 
10.53
%
 
10.12
%
 
1.98
%
 
(31.36
)%
 
 
 
 
 
 
 
 
 
 
Average equity to average assets:
 
 
 
 
 
 
 
 
 
Average equity
$
13,075,464

 
$
11,944,901

 
$
10,469,100

 
$
8,148,366

 
$
7,517,755

Average assets
83,044,676

 
92,078,048

 
84,843,371

 
82,348,782

 
78,681,899

      Average equity to average assets
15.75
%
 
12.97
%
 
12.34
%
 
9.89
%
 
9.55
 %
 
 
 
 
 
 
 
 
 
 
Efficiency ratio:
 
 
 
 
 
 
 
 
 
General and administrative expenses
$
1,481,248

 
$
1,842,224

 
$
1,573,100

 
$
1,520,460

 
$
1,484,306

Other expenses
484,884

 
517,937

 
182,384

 
582,291

 
173,497

   Total expenses (numerator)
1,966,132

 
2,360,161

 
1,755,484

 
2,102,751

 
1,657,803

 
 
 
 
 
 
 
 
 
 
Net interest income
1,674,123

 
3,864,814

 
3,398,639

 
2,643,504

 
1,882,442

Non-interest income
1,139,596

 
1,981,823

 
1,002,856

 
320,885

 
(947,273
)
   Total net interest income and non-interest income (denominator)
2,813,719

 
5,846,637

 
4,401,495

 
2,964,389

 
935,169

 
 
 
 
 
 
 
 
 
 
      Efficiency ratio
69.88
%
 
40.37
%
 
39.88
%
 
70.93
%
 
177.27
 %
 
 
 
 
 
 
 
 
 
 
Tier 1 Common Capital Ratio:
 
 
 
 
 
 
 
 
 
Sovereign Bank
 
 
 
 
 
 
 
 
 
Total stockholders' equity (U.S. GAAP)
$
12,849,368

 
$
12,494,249

 
 
 
 
 
 
Less: Goodwill and other certain intangible assets
(3,565,639
)
 
(3,223,411
)
 
 
 
 
 
 
   Servicing assets
(9,961
)
 
(8,414
)
 
 
 
 
 
 
   Deferred tax assets
(1,192,261
)
 
(1,242,906
)
 
 
 
 
 
 
   Accumulated losses/(gains) on certain available-for-sale
   securities and cash flow hedges
(54,334
)
 
20,243

 
 
 
 
 
 
Add: Other

 
26,476

 
 
 
 
 
 
      Tier 1 common capital (numerator)
8,027,173

 
8,066,237

 
 
 
 
 
 
      Risk weighted assets (denominator)1
62,411,116

 
57,311,427

 
 
 
 
 
 
      Ratio
12.86
%
 
14.07
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SHUSA
 
 
 
 
 
 
 
 
 
Total stockholders' equity (U.S. GAAP)
$
13,242,002

 
$
12,596,163

 
 
 
 
 
 
Less: Goodwill and other certain intangible assets
(3,587,430
)
 
(3,559,005
)
 
 
 
 
 
 
   Servicing assets
(9,961
)
 
(8,414
)
 
 
 
 
 
 
   Deferred tax assets
(1,313,501
)
 
(1,382,998
)
 
 
 
 
 
 
   Accumulated losses/(gains) on certain available-for-sale
   securities and cash flow hedges
(54,334
)
 
46,718

 
 
 
 
 
 
   Preferred stock
(195,445
)
 
(195,445
)
 
 
 
 
 
 
   Other
(5,336
)
 
(328
)
 
 
 
 
 
 
      Tier 1 common capital (numerator)
8,075,995

 
7,496,691

 
 
 
 
 
 
      Risk weighted assets (denominator)1
64,959,248

 
59,455,051

 
 
 
 
 
 
      Ratio
12.43
%
 
12.61
%
 
 
 
 
 
 

1 Under the banking agencies' risk-based capital guidelines, assets and credit equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. The resulting weighted values are added together with the measure for market risk, resulting in the Company's and the Bank's total risk-weighted assets.

38


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



Net Interest Income

Net interest income for the year-ended December 31, 2012 was $1.7 billion compared to $3.9 billion for 2011, a decrease of $2.2 billion, or 56.7%. This decrease was primarily due to the impact of the SCUSA Transaction. Excluding SCUSA, net interest income was $1.7 billion for 2011. Additionally, the Bank continued to focus on net interest spreads, both in loans and deposits, as the interest rate environment remained low in 2012. For further information, see the Non-GAAP Financial Measures section of the MD&A.

Interest income on investment securities and interest-earning deposits was $398.8 million and $419.0 million for the years-ended December 31, 2012, and 2011, respectively. The average balance of investment securities and interest-earning deposits was $19.5 billion, with an average tax equivalent yield of 2.23% for the year-ended December 31, 2012, compared to an average balance of $16.6 billion with an average yield of 2.74% in 2011. Average investment securities increased to 23.5% of total average assets as of December 31, 2012, compared to 18.0% as of December 31, 2011. The average life of the investment portfolio decreased to 4.02 years at December 31, 2012 compared to 4.24 years at December 31, 2011.

Interest income on loans was $2.1 billion and $4.8 billion for the years ended December 31, 2012, and 2011, respectively. Excluding SCUSA's interest income on loans of $2.6 billion, interest income on loans in 2011 was $2.2 billion. The average balance of loans was $52.5 billion, with an average yield of 4.12% for 2012 compared to an average balance of $66.1 billion with an average yield of 7.32% for 2011. The decrease in average loans is due to the SCUSA Transaction. At December 31, 2012, approximately 39% of the Bank's total loan portfolio repriced monthly or more frequently.

Interest expense on deposits and related customer accounts was $238.0 million and $248.7 million for the years-ended December 31, 2012 and 2011, respectively. The average balance of deposits was $41.4 billion, with an average cost of 0.57% for 2012, compared to an average balance of $39.2 billion with an average cost of 0.64% for 2011. The decrease in interest expense is due to the continued lower interest rate environment in 2012. Additionally, the average balance of non-interest bearing deposits increased to $8.1 billion in 2012 from $7.6 billion in 2011.

Interest expense on borrowed funds and other debt obligations was $635.7 million and $1.1 billion for the years-ended December 31, 2012 and 2011, respectively. Excluding SCUSA's interest expense on borrowed funds of $417.8 million, interest expense on borrowed funds and other debt obligations was $721.7 million in 2011. The average balance of total borrowings was $18.4 billion, with an average cost of 3.45% for 2012 compared to an average balance of $30.9 billion with an average cost of 3.69% for 2011. Excluding SCUSA's borrowings of $14.1 billion with an average cost of 2.96%, the average balance of total borrowings was $16.8 billion with an average cost of 4.31% in 2011. The average balance of the Bank's borrowings was $15.7 billion with an average cost of 3.01% for 2012, compared to an average balance of $13.9 billion with an average cost of 4.12% for 2011. The average balance of SHUSA's borrowings was $2.7 billion with an average cost of 6.01% for 2012 compared to an average balance of $2.8 billion with an average cost of 5.23% for 2011.

Table 2 presents a summary on a tax equivalent basis of the Company’s average balances, the yields earned on average assets and the cost of average liabilities for the years indicated (in thousands):

39


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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


Table 2: Net Interest Margin
CONSOLIDATED AVERAGE BALANCE SHEET / TAX EQUIVALENT NET INTEREST MARGIN ANALYSIS
 
YEARS ENDED DECEMBER 31
 
2012
 
2011
 
2010
 
Average
Balance

Tax
Equivalent
Interest

Yield/
Rate

Average
Balance

Tax
Equivalent
Interest

Yield/
Rate
 
Average Balance
 
Tax Equivalent Interest
 
Yield/Rate
 
(in thousands)
EARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
INVESTMENTS AND INTEREST-EARNING DEPOSITS
$
19,493,062

 
$
434,878

 
2.23
%
 
$
16,609,467

 
$
455,069

 
2.74
%
 
$
15,248,423

 
$
512,963

 
3.36
%
LOANS(1):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial loans
24,117,972

 
882,697

 
3.66
%
 
22,180,497

 
891,797

 
4.02
%
 
23,255,452

 
1,024,413

 
4.41
%
Multi-family
7,237,060

 
356,950

 
4.93
%
 
6,954,761

 
352,159

 
5.06
%
 
5,502,976

 
292,098

 
5.31
%
Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgages
11,535,089

 
479,693

 
4.16
%
 
11,530,366

 
518,721

 
4.50
%
 
10,993,027

 
535,783

 
4.87
%
Home equity loans and lines of credit
6,775,922

 
251,500

 
3.71
%
 
6,924,307

 
267,493

 
3.86
%
 
7,031,078

 
282,760

 
4.02
%
Total consumer loans secured by real estate
18,311,011

 
731,193

 
3.99
%
 
18,454,673

 
786,214

 
4.26
%
 
18,024,105

 
818,543

 
4.54
%
Auto loans
578,211

 
40,839

 
7.06
%
 
16,110,669

 
2,599,689

 
16.14
%
 
13,325,555

 
2,173,337

 
16.31
%
Other (2)
2,215,684

 
150,889

 
6.81
%
 
2,435,783

 
215,503

 
8.85
%
 
257,055

 
17,891

 
6.96
%
Total consumer
21,104,906

 
922,921

 
4.37
%
 
37,001,125

 
3,601,406

 
9.73
%
 
31,606,715

 
3,009,771

 
9.52
%
Total loans
52,459,938

 
2,162,568

 
4.12
%
 
66,136,383

 
4,845,362

 
7.32
%
 
60,365,143

 
4,326,282

 
7.17
%
Allowance for loan losses
(1,039,611
)
 

 
%
 
(2,225,595
)
 

 
%
 
(2,035,040
)
 

 
%
NET LOANS
51,420,327

 
2,162,568

 
4.21
%
 
63,910,788

 
4,845,362

 
7.58
%
 
58,330,103

 
4,326,282

 
7.42
%
TOTAL EARNING ASSETS
70,913,389

 
2,597,446

 
3.66
%
 
80,520,255

 
5,300,431

 
6.58
%
 
73,578,526

 
4,839,245

 
6.58
%
Other assets
12,131,287

 
 
 
 
 
11,557,793

 
 
 
 
 
11,264,845

 
 
 
 
TOTAL ASSETS
$
83,044,676

 
 
 
 
 
$
92,078,048

 
 
 
 
 
$
84,843,371

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
INTEREST BEARING FUNDING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits and other customer related accounts:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
9,094,035

 
$
14,699

 
0.16
%
 
$
9,231,636

 
$
19,218

 
0.21
%
 
$
9,400,107

 
$
19,570

 
0.21
%
Savings
3,753,851

 
5,778

 
0.15
%
 
3,502,121

 
4,503

 
0.13
%
 
3,563,816

 
4,740

 
0.13
%
Money market
16,561,115

 
83,603

 
0.50
%
 
16,049,921

 
99,185

 
0.62
%
 
13,724,620

 
88,603

 
0.65
%
Certificate of Deposit ("CD")
12,010,765

 
133,939

 
1.12
%
 
10,378,880

 
125,805

 
1.21
%
 
8,303,582

 
115,720

 
1.39
%
TOTAL INTEREST BEARING DEPOSITS
41,419,766

 
238,019

 
0.57
%
 
39,162,558

 
248,711

 
0.64
%
 
34,992,125

 
228,633

 
0.65
%
BORROWED FUNDS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
FHLB advances
11,613,869

 
372,058

 
3.20
%
 
9,890,849

 
420,669

 
4.25
%
 
11,170,385

 
503,157

 
4.50
%
Federal funds and repurchase agreements
3,035,532

 
10,962

 
0.36
%
 
1,904,642

 
5,982

 
0.31
%
 
2,349,922

 
8,367

 
0.36
%
Other borrowings
3,783,835

 
252,718

 
6.68
%
 
19,056,403

 
712,837

 
3.74
%
 
16,644,450

 
645,693

 
3.88
%
TOTAL BORROWED FUNDS
18,433,236

 
635,738

 
3.45
%
 
30,851,894

 
1,139,488

 
3.69
%
 
30,164,757

 
1,157,217

 
3.84
%
TOTAL INTEREST BEARING FUNDING LIABILITIES
59,853,002

 
873,757

 
1.46
%
 
70,014,452

 
1,388,199

 
1.98
%
 
65,156,882

 
1,385,850

 
2.13
%
Noninterest bearing demand deposits
8,061,992

 
 
 
 
 
7,623,390

 
 
 
 
 
7,097,506

 
 
 
 
Other liabilities (3)
2,054,218

 
 
 
 
 
2,495,305

 
 
 
 
 
2,119,883

 
 
 
 
TOTAL LIABILITIES
69,969,212

 
 
 
 
 
80,133,147

 
 
 
 
 
74,374,271

 
 
 
 
STOCKHOLDER’S EQUITY
13,075,464

 
 
 
 
 
11,944,901

 
 
 
 
 
10,469,100

 
 
 
 
TOTAL LIABILITIES AND STOCKHOLDER’S EQUITY
$
83,044,676

 
 
 
 
 
$
92,078,048

 
 
 
 
 
$
84,843,371

 
 
 
 
TAX EQUIVALENT BASIS INTEREST INCOME
 
 
$
1,723,689

 
 
 
 
 
$
3,912,232

 
 
 
 
 
$
3,453,395

 
 
NET INTEREST SPREAD (4)
 
 
 
 
2.20
%
 
 
 
 
 
4.60
%
 
 
 
 
 
4.45
%
NET INTEREST MARGIN (5)
 
 
 
 
2.43
%
 
 
 
 
 
4.86
%
 
 
 
 
 
4.69
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
TAX EQUIVALENT BASIS ADJUSTMENT
 
 
(49,566
)
 
 
 
 
 
(47,418
)
 
 
 
 
 
(54,756
)
 
 
NET INTEREST INCOME
 
 
1,674,123

 
 
 
 
 
3,864,814

 
 
 
 
 
3,398,639

 
 
Ratio of interest-earning assets to interest-bearing liabilities

 
 
 
 
1.18
x
 
 
 
 
 
1.15
x
 
 
 
 
 
1.13
x
(1)
Interest on loans includes amortization of premiums and discounts on purchased loans and amortization of deferred loan fees, net of origination costs. Average loan balances include non-accrual loans and loans held for sale.
(2)
Primarily includes RV/marine and personal unsecured portfolios.
(3)
Primarily includes accrued payables, accrued expenses, unfunded liabilities and derivative liabilities.
(4) Represents the difference between the yield on total earning assets and the cost of total funding liabilities.
(5) Represents annualized, taxable equivalent net interest income divided by average interest-earning assets.

40


SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES

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



Table 3 presents, on a tax equivalent basis, the relative contribution of changes in volumes and in rates to changes in net interest income for the periods indicated. The change in interest income not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each (in thousands):

Table 3: Volume/Rate Analysis

 
 
YEAR ENDED DECEMBER 31,
 
 
2012 VS. 2011
INCREASE/(DECREASE)
 (2)
 
2011 VS. 2010
INCREASE/(DECREASE)
 
 
Volume
 
Rate
 
Total
 
Volume
 
Rate
 
Total
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-earning deposits
 
$
(1,483
)
 
$
936

 
$
(547
)
 
$
3,195

 
$
(471
)
 
$
2,724

Investment securities available-for-sale
 
90,079

 
(131,820
)
 
(41,741
)
 
4,197

 
(63,697
)
 
(59,500
)
Investment securities other
 
143

 
21,954

 
22,097

 
(174
)
 
(944
)
 
(1,118
)
Net loans(1)
 
(818,340
)
 
(1,864,454
)
 
(2,682,794
)
 
421,368

 
97,712

 
519,080

Total interest-earning assets
 
(729,601
)
 
(1,973,384
)
 
(2,702,985
)
 
428,586

 
32,600

 
461,186

Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
13,820

 
(24,512
)
 
(10,692
)
 
26,630

 
(6,552
)
 
20,078

Borrowings
 
(432,593
)
 
(71,157
)
 
(503,750
)
 
25,988

 
(43,717
)
 
(17,729
)
Total interest-bearing liabilities
 
(418,773
)