20-F 1 d20f.htm FORM 20-F Form 20-F
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 20-F

 


 

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                     

Commission file number: 1-10110

 


BANCO BILBAO VIZCAYA ARGENTARIA, S.A.

(Exact name of Registrant as specified in its charter)

BANK BILBAO VIZCAYA ARGENTARIA, S.A.

(Translation of Registrant’s name into English)

 


Kingdom of Spain

(Jurisdiction of incorporation)

Plaza de San Nicolás 4

48005 Bilbao

Spain

(Address of principal executive offices)

 


Securities registered or to be registered pursuant to Section 12(b) of the Act.

 

Title of Each Class

  

Name of Each Exchange on which Registered

American Depositary Shares, each representing

the right to receive one ordinary share,

par value €0.49 per share

   New York Stock Exchange
Ordinary shares, par value €0.49 per share    New York Stock Exchange*

Non-Cumulative Guaranteed Preference Shares,

Series B, nominal value $25 each,

of BBVA Preferred Capital Ltd.

   New York Stock Exchange

Guarantee of Non-Cumulative Guaranteed

Preference Shares, Series B, nominal value $25 each,

of BBVA Preferred Capital Ltd.

   New York Stock Exchange**

 

* The ordinary shares are not listed for trading, but are listed only in connection with the registration of the American Depositary Shares, pursuant to requirements of the New York Stock Exchange.

 

** The guarantee is not listed for trading, but is listed only in connection with the registration of the corresponding Non-Cumulative Guaranteed Preference Shares of BBVA Preferred Capital Ltd. (a wholly-owned subsidiary of Banco Bilbao Vizcaya Argentaria, S.A.)

Securities registered or to be registered pursuant to Section 12(g) of the Act.

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

None

The number of outstanding shares of each class of stock of the Registrant at December 31, 2005 was:

Ordinary shares, par value €0.49 per share—3,390,852,043

Non-Cumulative Guaranteed Preference Shares, Series B, nominal value $25 each, of BBVA Preferred Capital Ltd.—9,600,000

 


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes x                 No ¨

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes ¨                 No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x                 No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer   x             Accelerated filer   ¨             Non-accelerated filer   ¨

Indicate by check mark which financial statement item the registrant has elected to follow.

Item 17 ¨                 Item 18 x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨                 No x

 



Table of Contents

BANCO BILBAO VIZCAYA ARGENTARIA, S.A.

TABLE OF CONTENTS

 

          Page

PRESENTATION OF FINANCIAL INFORMATION

   2

PART I

     

ITEM 1.

  

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

   3

A.

  

Directors and Senior Management

   3

B.

  

Advisers

   3

C.

  

Auditors

   3

ITEM 2.

  

OFFER STATISTICS AND EXPECTED TIMETABLE

   3

ITEM 3.

  

KEY INFORMATION

   3

A.

  

Selected Financial Data

   3

B.

  

Capitalization and Indebtedness

   6

C.

  

Reasons for the Offer and Use of Proceeds

   6

D.

  

Risk Factors

   7

ITEM 4.

  

INFORMATION ON THE COMPANY

   10

A.

  

History and Development of the Company

   10

B.

  

Business Overview

   14

C.

  

Organizational Structure

   29

D.

  

Property, Plants and Equipment

   30

E.

  

Selected Statistical Information

   30

F.

  

Competition

   54

ITEM 4A.

  

UNRESOLVED STAFF COMMENTS

   54

ITEM 5.

  

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

   54

A.

  

Operating Results

   57

B.

  

Liquidity and Capital Resources

   71

C.

  

Research and Development, Patents and Licenses, etc.

   72

D.

  

Trend Information

   73

E.

  

Off-Balance Sheet Arrangements

   73

F.

  

Tabular Disclosure of Contractual Obligations

   74

ITEM 6.

  

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

   75

A.

  

Directors and Senior Management

   75

B.

  

Compensation

   84

C.

  

Board Practices

   87

D.

  

Employees

   90

E.

  

Share Ownership

   91

 

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ITEM 7.

  

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

   92

A.

  

Major Shareholders

   92

B.

  

Related Party Transactions

   92

C.

  

Interests of Experts and Counsel

   93

ITEM 8.

  

FINANCIAL INFORMATION

   93

A.

  

Consolidated Statements and Other Financial Information

   93

B.

  

Significant Changes

   96

ITEM 9.

  

THE OFFER AND LISTING

   96

ITEM 10.

  

ADDITIONAL INFORMATION

   101

A.

  

Share Capital

   101

B.

  

Memorandum and Articles of Association

   101

C.

  

Material Contracts

   105

D.

  

Exchange Controls

   105

E.

  

Taxation

   106

F.

  

Dividends and Paying Agents

   110

G.

  

Statement by Experts

   110

H.

  

Documents on Display

   110

I.

  

Subsidiary Information

   111

ITEM 11.

  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   112

ITEM 12.

  

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

   138

PART II

     

ITEM 13.

  

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

   138

ITEM 14.

  

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

   139

ITEM 15.

  

CONTROLS AND PROCEDURES

   139

ITEM 16.

  

[RESERVED]

   139

ITEM 16A.

  

AUDIT COMMITTEE FINANCIAL EXPERT

   139

ITEM 16B.

  

CODE OF ETHICS

   139

ITEM 16C.

  

PRINCIPAL ACCOUNTANT FEES AND SERVICES

   139

ITEM 16D.

  

EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

   140

ITEM 16E.

  

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PERSONS

   141

PART III

     

ITEM 17.

  

FINANCIAL STATEMENTS

   141

ITEM 18.

  

FINANCIAL STATEMENTS

   141

ITEM 19.

  

EXHIBITS

   141

 

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GLOSSARY

The terms below are used as follows throughout this Annual Report:

 

    Argentaria” means Argentaria, Caja Postal y Banco Hipotecario, S.A. and its consolidated subsidiaries, unless otherwise indicated or the context otherwise requires.

 

    BBV” means Banco Bilbao Vizcaya, S.A. and its consolidated subsidiaries, unless otherwise indicated or the context otherwise requires.

 

    BBVA”, “Bank” or “Group” means Banco Bilbao Vizcaya Argentaria, S.A. and its consolidated subsidiaries unless otherwise indicated or the context otherwise requires. BBVA was formed by the merger of BBV and Argentaria, which was approved by the shareholders of each institution on December 18, 1999.

 

    Consolidated Financial Statements” means BBVA’s audited consolidated financial statements as of and for the years ended December 31, 2005 and 2004 prepared in accordance with the International Financial Reporting Standards previously adopted by the European Union (“EU-IFRS”).

FORWARD-LOOKING STATEMENTS

This Annual Report contains statements that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the U.S. Securities Exchange Act of 1934, as amended, and the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include words such as “believe”, “expect”, “estimate”, “project”, “anticipate”, “should”, “intend”, “probability”, “risk”, “VaR”, “target”, “goal”, “objective” and similar expressions or variations on such expressions. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those in the forward-looking statements as a result of various factors. The accompanying information in this Annual Report, including, without limitation, the information under

 

    “Item 3. Key Information—Risk Factors”;

 

    “Item 4. Information on the Company”;

 

    “Item 5. Operating and Financial Review and Prospects”; and

 

    “Item 11. Quantitative and Qualitative Disclosures About Market Risk”

identifies important factors that could cause such differences.

Other important factors that could cause actual results to differ materially from those in forward-looking statements include, among others:

 

    general political, economic and business conditions in Spain, the European Union, Latin America and other regions, countries or territories in which we operate;

 

    changes in applicable laws and regulations, including taxes;

 

    the monetary, interest rate and other policies of central banks in Spain, the European Union, the United States and elsewhere;

 

    changes or volatility in interest rates, foreign exchange rates (including the euro to U.S. dollar exchange rate), asset prices, equity markets, commodity prices, inflation or deflation;

 

    the effects of competition in the markets in which we operate, which may be influenced by regulation or deregulation;

 

    changes in consumer spending and savings habits, including changes in government policies which may influence investment decisions;

 

    our ability to hedge certain risks economically;

 

    our success in managing the risks involved in the foregoing, which depends, among other things, on our ability to anticipate events that cannot be captured by the statistical models we use; and

 

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    force majeure and other events beyond our control.

Readers are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date hereof. BBVA undertakes no obligation to release publicly the result of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof, including, without limitation, changes in its business or acquisition strategy or planned capital expenditures, or to reflect the occurrence of unanticipated events.

CERTAIN TERMS AND CONVENTIONS

First person personal pronouns used in this report, such as “we”, “us”, or “our”, mean BBVA.

In this report, “$”, “U.S. dollars”, and “dollars” refer to United States Dollars, “€” and “euro” refer to Euro.

PRESENTATION OF FINANCIAL INFORMATION

Accounting Principles Affecting 2003, 2002 and 2001

Unless otherwise indicated, the financial information included in this Annual Report with respect to 2003, 2002 and 2001 has been derived from financial statements that have been prepared in accordance with generally accepted accounting principles which were in effect during the above mentioned years for banks in Spain, which include the accounting requirements established by the Bank of Spain (“Spanish GAAP”).

Accounting Principles Affecting 2005 and 2004

Under Regulation (EC) no. 1606/2002 of the European Parliament and of the Council of 19 July 2002, all companies governed by the law of an EU Member State and whose securities are admitted to trading on a regulated market of any Member State must prepare their consolidated financial statements for the years beginning on or after January 1, 2005 in conformity with EU-IFRS. Therefore, the Group is required to prepare its consolidated financial statements for the year ended December 31, 2005 (together with comparative financial information for the year ended December 31, 2004) in conformity with the EU-IFRSs ratified by the European Union at that date. EU-IFRS, as adopted by the European Union and applied by us in our consolidated financial statements as of and for the year ended December 31, 2005, does not differ from IFRS, as published by the International Accounting Standards Board (IASB), effective as of December 31, 2005, and therefore, complies in full with IFRS, as published by the IASB.

EU-IFRS differs in certain significant respects from Spanish GAAP. As a result, our financial information presented under EU-IFRS is not directly comparable to our financial information presented with respect to previous years under Spanish GAAP, and readers should avoid such a comparison. For quantitative information regarding the adjustments required to reconcile our Spanish GAAP financial information to EU-IFRS, see Note 3 to the Consolidated Financial Statements.

See Note 59 to our Consolidated Financial Statements for a quantitative reconciliation of profit for the year and shareholders’ equity from IFRS to U.S. GAAP.

 

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The Consolidated Financial Statements have been presented in the same format as that used in the consolidated financial statements included in BBVA’s annual and interim reports to shareholders. This format differs from that required by the United States Securities and Exchange Commission (the “SEC” or “Commission”) for the consolidated financial statements of bank holding companies. Consolidated balance sheets and summary statements of income that reflect the reclassifications required by the Commission are included in Note 59 to the Consolidated Financial Statements.

We managed our business during 2005 along four segmental lines which are discussed in “Item 4. Information on the Company” and whose operating results are described in “Item 5. Operating and Financial Review and Prospects”. Certain numerical information in this Annual Report may not sum due to rounding.

Statistical and Financial Information

The following principles should be noted in reviewing the statistical and financial information contained herein:

 

    Average balances, when used, are based on the beginning and the month-end balances during each year. We do not believe that such monthly averages present trends that are materially different from those that would be presented by daily averages.

 

    The book value of BBVA’s ordinary shares held by its consolidated subsidiaries has been deducted from stockholders’ equity.

 

    Unless otherwise stated, any reference to loans refers to both loans and leases.

 

    Interest income figures include interest income on non-accruing loans to the extent that cash payments have been received in the period in which they are due.

 

    Financial information with respect to subsidiaries may not reflect consolidation adjustments.

PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

A. Directors and Senior Managers

Not Applicable.

 

B. Advisers

Not Applicable.

 

C. Auditors

Not Applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

 

ITEM 3. KEY INFORMATION

A. Selected Financial Data

The historical financial information set forth below has been selected from, and should be read together with, the Consolidated Financial Statements included herein. For information concerning the preparation and presentation of financial information contained herein, see “Presentation of Financial Information”. Also see Note 59 of the Consolidated Financial Statements for a presentation of our shareholders’ equity and net income reconciled to U.S. GAAP.

 

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EU-IFRS

 

     Year ended December 31,  
     2005     2004  
     (in millions of euro, except per share
/ ADS data (in euro) and
percentages)
 

Consolidated Statement of Income data

    

Interest and similar income

   15,848     12,352  

Interest expense and similar charges

   (8,932 )   (6,447 )

Income from equity instruments

   292     255  
            

Net interest income

   7,208     6,160  

Share of profit or loss of entities accounted for using the equity method

   121     97  

Fee and commission income

   4,669     4,057  

Fee and commission expenses

   (729 )   (644 )

Insurance activity income

   487     391  

Gains/losses on financial assets and liabilities (net)

   980     762  

Exchange differences (net)

   287     298  
            

Gross income

   13,023     11,121  

Sales and income from the provision of non-financial services

   576     468  

Cost of sales

   (451 )   (342 )

Other operating income

   134     22  

Personnel expenses

   (3,602 )   (3,247 )

Other administrative expenses

   (2,160 )   (1,851 )

Depreciation and amortization

   (449 )   (448 )

Other operating expenses

   (249 )   (132 )
            

Net operating income

   6,823     5,591  

Impairment losses (net)

   (854 )   (958 )

Provision expense (net)

   (454 )   (850 )

Finance income from non-financial activities

   2     9  

Finance expenses from non-financial activities

   (2 )   (5 )

Other gains

   285     622  

Other losses

   (208 )   (271 )
            

Income before tax

   5,592     4,138  

Income tax

   (1,521 )   (1,029 )
            

Income from ordinary activities

   4,071     3,109  

Income from discontinued operations (net)

   —       —    
            

Consolidated income for the year

   4,071     3,109  

Income attributed to minority interests

   (265 )   (186 )
            

Income attributed to the Group

   3,806     2,923  
            

Per Share/ADS(1) Data

    

Net operating income(2)

   2.02     1.66  

Numbers of shares

   3,390,852,043     3,390,852,043  

Income attributed to the Group(2)

   1.12     0.87  

Dividends(2) (3)

   0.53     0.44  

 

(1) Each American Depositary Share (“ADS”) represents the right to receive one ordinary share.

 

(2) Calculated on the basis of the weighted average number of BBVA’s ordinary shares outstanding during the relevant period (3,384 million and 3,369 million shares in 2005 and 2004, respectively).

 

(3) Calculated based on total dividends paid in respect of each period indicated.

 

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EU-IFRS

 

     At December 31,  
     2005     2004  
     (in millions of euro,
except per share /
ADS data (in euro)
and percentages)
 

Consolidated balance sheet data

    

Total assets

   392,389     329,441  

Loans and receivables (net)

   249,397     196,892  

Deposits from other creditors

   183,375     150,726  

Marketable debt securities and subordinated liabilities

   76,565     57,809  

Minority interests

   971     738  

Shareholders’ equity

   13,034     10,961  

Consolidated ratios

    

Profitability ratios:

    

Net interest margin(4)

   1.98 %   1.91 %

Return on average total assets(5)

   1.12 %   0.97 %

Return on average equity (6)

   37.0 %   33.2 %

Credit quality data

    

Loan loss reserve

   5,587     4,622  

Loan loss reserve as a percentage of total loans and receivables

   2.19 %   2.29 %

Substandard loans

   2,346     2,202  

Substandard loans as a percentage of total loans and receivables

   0.92 %   1.10 %

(1) Each American Depositary Share (“ADS”) represents the right to receive one ordinary share.

 

(2) Calculated on the basis of the weighted average number of BBVA’s ordinary shares outstanding during the relevant period (3,384 million and 3,369 million shares in 2005 and 2004, respectively).

 

(3) Calculated based on total dividends paid in respect of each period indicated.

 

(4) Represents net interest income as a percentage of average total assets.

 

(5) Represents income before minority interests as a percentage of average total assets.

 

(6) Represents net attributable profit as a percentage of average shareholders’ equity.

U.S. GAAP Information

 

     Year ended December 31,
     2005    2004    2003    2002    2001
     (in millions of euro, except per share/
ADS data (in euro) or as otherwise indicated)

Consolidated statement of income data

              

Net income(1)

   2,018    3,095    1,906    1,846    680

Basic earnings per share/ADS(2)(3)

   0.595    0.918    0.60    0.58    0.21

Diluted earnings per share/ADS(2)(3)

   0.595    0.918    0.60    0.58    0.21

Dividends per share/ADS (in dollars)(3)(4)

   0.658    0.552    0.34    0.33    0.34

Consolidated balance sheet data

              

Total assets(5)

   401,799    314,350    287,912    290,430    322,612

Stockholders’ equity(5)

   25,375    23,465    19,583    18,908    21,226

Basic stockholders’ equity per share/ADS(3)

   7.48    6.96    6.13    5.92    6.64

Diluted stockholders’ equity per share/ADS(3)

   7.48    6.96    6.13    5.91    6.63

(1)

We generally refer to our income after taxes and minority interests as “net attributable profit”. In the case of the U.S. GAAP information provided above, the term “net income” is used for consistency with Note 59

 

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to our Consolidated Financial Statements, which includes additional U.S. GAAP information and generally refers to “net income” in cases in which we would otherwise use the term “net attributable profit”.

 

(2) Calculated on the basis of the weighted average number of BBVA’s ordinary shares outstanding during the relevant period.

 

(3) Each ADS represents the right to receive one ordinary share.

 

(4) Dividends per share/ADS are translated into dollars for 2001 through 2005, at an average exchange rate for each year, calculated based on the average of the noon buying rates for euro from the Federal Reserve Bank of New York on the last date of each month during the relevant period.

 

(5) At the end of the reported period.

Exchange Rates

Spain’s currency is the euro. Unless otherwise indicated, the amounts that have been converted to euro in this Annual Report have been done so at the corresponding exchange rate published by the European Central Bank on December 31 of the relevant year.

For convenience in the analysis of the information, the following tables describe, for the periods and dates indicated, information concerning the noon buying rate for euro, expressed in dollars per €1.00. The term “noon buying rate” refers to the rate of exchange for euros, expressed in U.S. dollars per euro, in the City of New York for cable transfers payable in foreign currencies as certified by the Federal Reserve Bank of New York for customs purposes.

 

Year ended December 31

   Average (1)

2001

   0.8909

2002

   0.9495

2003

   1.1411

2004

   1.2478

2005

   1.2400

2006 (through June 30)

   1.2410

(1) The average of the noon buying rates for the euro on the last day of each month during the relevant period.

 

Month ended

   High    Low

December 31, 2005

   1.2041    1.1699

January 31, 2006

   1.2287    1.1980

February 28, 2006

   1.2100    1.1860

March 31, 2006

   1.2197    1.1886

April 30, 2006

   1.2624    1.2091

May 31, 2006

   1.2888    1.2607

June 30, 2006

   1.2522    1.2953

The noon buying rate for euro from the Federal Reserve Bank of New York, expressed in dollars per €1.00, on July 6, 2006, was $1.2757.

At December 31, 2005, approximately 29.9% of our assets and approximately 32.6% of our liabilities were denominated in currencies other than euro (principally dollars).

For a discussion of our foreign currency exposure, please see “Item 11. Quantitative and Qualitative Disclosures About Market Risk— Structural Risk —Structural Exchange Rate Risk”.

 

B. Capitalization and Indebtedness

Not applicable.

 

C. Reasons for the Offer and Use of Proceeds

Not applicable.

 

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D. Risk Factors

Risks Relating to us

Since our loan portfolio is highly concentrated in Spain, adverse changes affecting the Spanish economy could have a material adverse effect on our financial condition.

We historically have developed our lending business in Spain, which continues to be our main place of business. As of December 31, 2005, business activity in Spain accounted for 70.3% of our loan portfolio. See “Item 4. Information on the Company—Selected Statistical Information—Loans by Geographic Area”. Any adverse changes affecting the Spanish economy are likely to have a significant adverse impact on our loan portfolio and, as a result, on our financial condition and results of operations.

A substantial percentage of our customer base is particularly sensitive to adverse developments in the economy, which renders our lending activities relatively riskier than if we lent primarily to higher-income customer segments.

Medium- and small-size companies and middle and lower middle income individuals typically have less financial strength than large companies and high-income individuals and accordingly can be expected to be more negatively affected by adverse developments in the economy. As a result, it is generally accepted that lending to these segments of our existing and targeted customer base represents a relatively higher degree of risk than lending to other groups.

A substantial portion of our loan portfolio consists of residential mortgages and consumer loans to middle and lower middle income customers and commercial loans to medium- and small -size companies. Consequently, during periods of slowdown in economic activity we may experience higher levels of past due amounts which could result in higher levels of allowance for loan losses. We cannot assure you that we will not suffer substantial adverse effects on our base loan portfolio to these customer segments in the event of adverse developments in the economy.

Increased exposure to real estate in Spain makes us more vulnerable to developments in this market.

The sound economic growth, the strength of the labor market and a decrease in interest rates in Spain have caused an increase in the demand for mortgage loans in the last few years. This has had repercussions in housing prices, which have also risen significantly. As residential mortgages are one of our main assets, comprising 44% and 46% of our loan portfolio at December 31, 2004 and 2005, respectively, we are currently highly exposed to developments in real estate markets. A strong increase in interest rates or unemployment in Spain might have a significant negative impact in mortgage payment delinquency rates. An increase in such delinquency rates could have an adverse effect on our business, financial condition and results of operations.

Highly-indebted households and corporations could endanger our asset quality and future revenues.

Spanish households and firms have reached, in recent years, a high level of indebtedness, which represents increased risk for the Spanish banking system. The increase of loans referenced to variable interest rates makes debt service on such loans more vulnerable to changes in interest rates than in the past. The increase in households’ and firms’ indebtedness also limits their ability to incur additional debt, decreasing the number of new products we may otherwise be able to sell them.

A sudden shortage of funds could cause an increase in our costs of funding and an adverse effect on our operating revenues.

Historically, one of our principal sources of funds has been savings and demand deposits. Time deposits represented 29.8% and 29.1% of our total funding at December 31, 2004 and 2005, respectively. Large-denomination time deposits may, under some circumstances, such as during periods of significant changes in market interest rates for these types of deposit products and resulting increased competition for such funds, be a less stable source of deposits than savings and demand deposits. In addition, since we rely heavily on short-term deposits for our funding, we cannot assure you that, in the event of a sudden or unexpected shortage of funds in

 

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the banking systems or money markets in which we operate, we will be able to maintain our current levels of funding without incurring higher funding costs or having to liquidate certain of our assets.

We face increasing competition in our business lines.

The markets in which we operate are highly competitive. Financial sector reforms in the markets in which we operate have increased competition among both local and foreign financial institutions, and we believe that this trend will continue. For example, the adoption of the euro as the common currency throughout the European Union (“EU”) is making it easier for European banks to compete against us in Spain. In addition, the trend towards consolidation in the banking industry has created larger and stronger banks with which we must now compete.

We also face competition from non-bank competitors, such as:

 

    department stores (for some credit products);

 

    leasing companies;

 

    factoring companies;

 

    mutual funds;

 

    pension funds; and

 

    insurance companies.

We cannot assure you that this competition will not adversely affect our business, financial condition and results of operations.

Our business is particularly vulnerable to volatility in interest rates.

Our results of operations are substantially dependent upon the level of our net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. Interest rates are highly sensitive to many factors beyond our control, including deregulation of the financial sectors in the markets in which we operate, monetary policies pursued by the European Union and national governments, domestic and international economic and political conditions and other factors.

Changes in market interest rates could affect the spread between interest rates charged on interest-earning assets and interest rates paid on interest-bearing liabilities and thereby negatively affect our results of operations. For example, an increase in interest rates could cause our interest expense on deposits to increase more significantly and quickly than our interest income from loans, resulting in a reduction in our net interest income.

In addition, income from treasury operations is particularly vulnerable to interest rate volatility. Since approximately 64% of our loan portfolio consists of variable interest rate loans maturing in more than one year, rising interest rates may also bring about an increase in the non-performing loan portfolio.

Our financial statements and periodic disclosure under securities laws may not give you the same information as financial statements prepared under U.S. accounting rules and periodic disclosures provided by domestic U.S. issuers.

Publicly available information about public companies in Spain is generally less detailed and not as frequently updated as the information that is regularly published by or about listed companies in the United States. In addition, although we are subject to the periodic reporting requirements of the United States Securities Exchange Act of 1934 (the “Exchange Act”), the periodic disclosure required of foreign issuers under the Exchange Act is more limited than the periodic disclosure required of U.S. issuers. Finally, we maintain our financial accounts and records and prepare our financial statements in conformity EU-IFRS, which differs in certain respects from U.S. GAAP, the financial reporting standard to which many investors in the United States may be more accustomed.

 

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Risks Relating to Latin America

Political events in Mexico could adversely affect our operations.

The Mexican government has exercised, and continues to exercise, significant influence over the Mexican economy. Mexican governmental actions concerning the economy and state-owned enterprises could have a significant effect on Mexican private sector entities in general, and on our Mexican subsidiaries in particular.

Mexico’s presidential elections were held on July 2, 2006. As of the date of this annual report, the outcome of the election is unknown. A vote recount is currently underway, and the results of the election could be contested. The uncertainty over the results of the election could result in political and economic instability and social unrest, which could adversely affect the business, financial condition and results of operations of our Mexican subsidiaries. Moreover, any new administration could implement significant changes in laws, public policies and government programs, which could have a material adverse effect on the business, financial condition and results of operations of our Mexican subsidiaries.

The devaluation of the Argentine peso, high inflation and other adverse macroeconomic conditions in Argentina and related emergency measures adopted by the Argentine Government in 2001 and 2002 have had, and may continue to have, a material adverse effect on our business, financial condition and results of operations.

The Argentine economy experienced a severe crisis in 2001 and 2002, marked by the continued movement of capital out of Argentina, the end of convertibility of the Argentine peso, devaluation, and the return of inflation. The crisis had a strong impact on the financial system and jeopardized the solvency and liquidity of banks. In 2004 and 2005, the Argentine economy stabilized and experienced significant growth, but uncertainty regarding the scope, sustainability and pace of the recovery remained. The Argentine economic and social situation has quickly deteriorated in the past and may quickly deteriorate in the future and we cannot assure you that the Argentine economy will continue to experience sustained growth.

The emergency measures adopted by the Argentine government in response to the economic crisis at the end of 2001 and during 2002 that affected our results of operations included: freezing public debt payments, ending convertibility between the Argentinean peso and the dollar, imposing cash withdrawal limits on savings accounts, re-scheduling of term deposit maturities and converting dollar assets and liabilities to Argentine pesos at different exchange rates.

As a result of the emergency measures described above, we have written off our entire investment in Argentina to date. However, despite our provisions and write-downs, a deterioration in the Argentine economy or further emergency measures adopted by the government in Argentina could have a material adverse effect on our business, financial condition and results of operations.

We cannot assure you that the laws and regulations currently governing the Argentinean economy will not change in the future, or that any changes which may occur will not adversely affect our business, financial condition or results of our operations in the country, or the business which we transact with counterparties located in the country.

Our Latin American subsidiaries’ growth, asset quality and profitability may be affected by volatile macroeconomic conditions, including government default on public debt, in the Latin American countries where they operate.

The Latin American countries in which we operate have experienced significant economic volatility in recent decades, characterized by slow growth, declining investment and significant inflation. This volatility has resulted in fluctuations in the levels of deposits and in the relative economic strength of various segments of the

 

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economies to which we lend. Negative and fluctuating economic conditions, such as a changing interest rate environment, also affect our profitability by causing lending margins to decrease and leading to decreased demand for higher-margin products and services.

Negative and fluctuating economic conditions in some Latin American countries could result in government defaults on public debt. This could affect us in two ways: directly, through portfolio losses, and indirectly, through instabilities that a default in public debt could cause to the banking system as a whole, particularly since commercial banks’ exposure to government debt is generally high in several Latin American countries in which we operate.

While we seek to mitigate these risks through what we believe to be conservative risk policies, no assurance can be given that our Latin American subsidiaries’ growth, asset quality and profitability will not be affected by volatile macroeconomic conditions in the Latin American countries in which we operate.

Latin American economies can be directly and negatively affected by adverse developments in other countries.

Financial and securities markets in Latin American countries in which we operate, are to varying degrees, influenced by economic and market conditions in other countries in Latin America and beyond. Negative developments in the economy or securities markets in one country, particularly in an emerging market, may have a negative impact on other emerging market economies. These developments may adversely affect the business, financial condition and operating results of our subsidiaries in Latin America.

We are exposed to foreign exchange and, in some instances, political risks as well as other risks in the Latin American countries in which we operate, which could cause an adverse impact on our business, financial condition and results of operations.

We operate commercial banks in 10 Latin American countries and our overall success as a global business depends, in part, upon our ability to succeed in differing economic, social and political conditions. We are confronted with different legal and regulatory requirements in many of the jurisdictions in which we operate. These include, but are not limited to, different tax regimes and laws relating to the repatriation of funds or nationalization of assets. Our international operations may also expose us to risks and challenges which our local competitors may not be required to face, such as exchange rate risk, difficulty in managing a local entity from abroad, and political risk which may be particular to foreign investors. Our expansion in these markets requires us to respond to rapid changes in market conditions in these countries. We cannot assure you that we will continue to succeed in developing and implementing policies and strategies that are effective in each country in which we operate or that any of the foregoing factors will not have a material adverse effect on our business, financial condition and results of operations.

Regulatory changes in Latin America that are beyond our control may have a material effect on our business, financial condition and results of operations.

A number of banking regulations designed to maintain the safety and soundness of banks and limit their exposure to risk are applicable in certain Latin American countries in which we operate. Local regulations differ in a number of material respects from equivalent regulations in Spain and the United States.

Changes in regulations that are beyond our control may have a material effect on our business and operations. In addition, since some of the banking laws and regulations have been recently adopted, the manner in which those laws and related regulations are applied to the operations of financial institutions is still evolving. No assurance can be given that laws or regulations will be enforced or interpreted in a manner that will not have a material adverse effect on our business, financial condition and results of operations.

 

ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

BBVA’s predecessor bank, BBV, was incorporated as a limited liability company (a sociedad anónima or “S.A.”) under the Spanish Corporations Law on October 1, 1988. BBVA was formed as the result of a merger by absorption of Argentaria into BBV that was approved by the shareholders of each institution on December 18, 1999 and registered on January 28, 2000. It conducts its business under the commercial name “BBVA”. BBVA is

 

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registered with the Commercial Registry of Vizcaya (Spain). It has its registered office at Plaza de San Nicolás 4, Bilbao, Spain, 48005, telephone number 34-94-420-3001. BBVA’s agent in the U.S. for U.S. federal securities law purposes is Raúl Santoro de Mattos Almeida (BBVA New York, 1345 Avenue of the Americas, 45th floor, New York, 10105). BBVA is incorporated for an unlimited term.

Capital Expenditures

Our principal investments are financial, in subsidiaries and in affiliates. The main capital expenditures from 2003 to the date of this Annual Report were the following:

2006

On June 12, 2006, BBVA reached agreements to acquire State National Bancshares Inc. and Texas Regional Bancshares Inc., each of which are U.S. banking groups domiciled in Texas. The acquisition price agreed for State National Bancshares Inc. is approximately $480 million while the acquisition price agreed for Texas Regional Bancshares Inc. is approximately $2,164 million. In both cases, the acquisitions are subject to both shareholder and regulatory approvals.

On March 3, 2006, BBVA purchased 0.43% of BBVA Chile’s share capital for 2,318 million Chilean pesos (€3.7 million), increasing BBVA’s share capital in BBVA Chile to 67.05%. As the share capital of BBVA in BBVA Chile is higher than two thirds of BBVA Chile’s total share capital, BBVA in compliance with Chilean legislation launched a public tender offer for all of BBVA Chile’s share capital. The public tender offer was effective from April 3, 2006 to May 2, 2006. After the acceptance of the public tender offer by 1.13% of BBVA Chile’s outstanding shares, BBVA’s share capital in BBVA Chile increased to 68.18%.

2005

On January 6, 2005, pursuant to the agreement entered into in September 2004 and after obtaining the mandatory authorizations, the Group, through BBVA Bancomer, acquired all the shares of Hipotecaria Nacional, S.A. de C.V., a Mexican company specializing in the mortgage business. The price paid was 4,121 million Mexican pesos (approximately € 276,048 thousand) and the goodwill recognized amounted to € 259,111 thousand at December 31, 2005.

On April 28, 2005, pursuant to the agreement entered into on September 20, 2004 and after obtaining the mandatory authorizations, BBVA, acquired all the shares of Laredo National Bancshares, Inc., a bank holding company located in Texas (United States) which operates in the banking business through two independent banks: Laredo National Bank and South Texas National Bank. The price paid was US$ 859.6 million (approximately € 666,110 thousand) and the goodwill recognized amounted to € 473,941 thousand at December 31, 2005.

On October 31, 2005, the Guarantee Fund for Colombian Financial Institutions, FOGAFIN, sold by public auction 98.78% of the share capital of Banco Granahorrar, S.A. (a Colombian financial institution) to the BBVA Group’s subsidiary in Colombia, BBVA Colombia, S.A. The offer made by BBVA Colombia, S.A. for the acquisition of Banco Granahorrar, S.A. totalled US$ 423.66 million. This transaction was consummated in December 2005 after the required authorizations had been obtained from the supervisory and control bodies. The price paid was 981,572.2 million Colombian pesos, approximately € 364,163 thousand, and the goodwill recognized amounted to € 266,862 thousand at December 31, 2005.

2004

On January 30, 2004, our Board of Directors adopted a resolution to launch a tender offer for the approximately 40.6% of the shares of Bancomer, our Mexican affiliate, which were not already owned by BBVA. The tender offer was launched on February 19, 2004 and expired on March 19, 2004. As a result of the successful completion of the tender offer and subsequent purchases during 2004 of Bancomer’s capital stock, at December 31, 2004, we owned 99.70% of Bancomer’s outstanding shares.

 

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On March 18, 2004, the Board of Directors of BBVA Banco Francés, S.A. (“Banco Francés”), our Argentine affiliate, resolved to implement a plan intended to improve Banco Francés’s adjusted stockholders’ equity and enable Banco Francés to comply with new minimum capital requirements established by the Argentine Central Bank. Under this plan, we:

 

    acquired from Banco Francés its entire interest in Banco Francés (Cayman) Limited for $238.5 million; and

 

    subscribed to a capital increase by capitalizing a loan we granted to Banco Francés in an amount of $78 million.

The transactions involving Banco Francés described above did not affect BBVA’s consolidated operating results because (i) in the case of the loan capitalization, BBVA had previously fully provisioned the loan, and (ii) in the case of the purchase of Banco Francés (Cayman) Limited, this entity was already fully consolidated by BBVA.

On October 8, 2004, we acquired all the shares of Valley Bank, a bank licensed in the state of California, for U.S.$16.7 million, which was BBVA’s first commercial banking acquisition in the United States.

2003

During 2003, BBVA acquired 0.176% of the capital stock of Gas Natural S.D.G, S.A. (“Gas Natural”) for €12.7 million, raising its interest in Gas Natural to 3.241% as of December 31, 2003.

During 2003, BBVA purchased 4.76% of the capital stock of Bancomer for a total of €304 million, raising its interest to 59.43% as of December 31, 2003.

Capital Divestitures

Our principal divestitures are financial, in subsidiaries and in affiliates. The main capital divestitures from 2003 to the date of this Annual Report were the following:

2006

On June 14, 2006, BBVA sold its 5.04% capital share in Repsol YPF S.A. The selling procedure was executed through the closing and settlement of hedging equity swaps previously contracted. This sale gave rise to a gain of €523 million.

On May 19, 2006, BBVA sold its stake in the share capital of Banca Nazionale del Lavoro (BNL) to BNP Paribas, for a price of €1,299 million following it’s adhesion on May 12, 2006, as shareholder of BNL, to the public tender offer launched by BNP Paribas to acquire 100% of BNL’s capital. The sale gave rise to a gain of €568.3 million.

On April 5, 2006, BBVA sold its stake of 51% in the share capital of Banc Internacional d´Andorra, S.A. to the rest of the shareholders of said entity, the Andorran founding partners of the bank, for a price of €395.15 million.

2005

There were no significant capital divestures during 2005.

2004

In January 2004, BBVA sold 2.2% of the capital stock of Gas Natural S.D.G., S.A. At the time the transaction closed, BBVA had not completed preparation of its 2003 Consolidated Financial Statements and therefore, in accordance with Spanish GAAP, reflected the amortization of €70 million of consolidation goodwill which resulted from the transaction in such financial statements rather than in its 2004 Consolidated Financial Statements.

 

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In March 2004, the Group sold its 24.4% holding in Banco Atlántico, S.A. at the price established by Banco Sabadell, S.A. in its tender offer for all the shares of Banco Atlántico, S.A. This sale gave rise to a gain of €217.7 million for the BBVA Group.

In March 2004, the Group sold its 50% holding in Hilo Direct Seguros y Reaseguros, S.A, which represented all of the Group’s interests. This sale gave rise to a gain of €26 million for the BBVA Group.

In June 2004, the Group sold its 5.0% holding in Acerinox, S.A., which represented all of the Group’s interests. This sale gave rise to a gain of €34.6 million for the BBVA Group.

On September 6, 2004, the Group sold its 17.2% holding in Vidrala, S.A., giving rise to a gain of €19.3 million.

On October 12, 2004, the Group sold the El Salvador welfare business composed of BBVA Crecer AFP and BBVA Seguros, S.A. – Seguros de Personas – in which BBVA had ownership interests of 62% and 51%, respectively, for $42.8 million (€34.76 million), giving rise to a gain of €12.3 million.

In December 2004, the Group sold its 3% holding in Gamesa, S.A., which represented all of the Group’s interests. This sale gave rise to a gain of €53.1 million for the BBVA Group.

In the second quarter of 2004, the Group exercised a sale option it had on its 33.3% holding in Grubarges Inversión Hotelera, S.L., and recognized a gain of €26.3 million on such sale.

During the first six months of 2004, the Group sold its 0.6% holding in Repsol YPF, S.A. These sales gave rise to a loss of €6.5 million for the BBVA Group.

During 2004, the Group purchased and sold shares of Telefónica, S.A. without any material variation in its aggregate holding in such company as of December 31, 2003. These sales gave rise to a gain of €141.7 million.

2003

On January 13, 2003, BBVA announced its intention to sell its Brazilian affiliate, Banco Bilbao Vizcaya Argentaria Brasil, S.A. (“BBV Brasil”) to Banco Bradesco, S.A. (“Bradesco”). On June 9, 2003, upon completion of due diligence, receipt of authorizations from regulatory authorities and approval by the corresponding corporate bodies, BBVA transferred 100% of BBV Brasil to Bradesco, in consideration for which Bradesco paid 35,481,460,311 of its newly-issued ordinary shares and 34,948,501,563 of its newly-issued preferred shares, totaling 4.44% of Bradesco’s share capital, as well as 1,864 million Brazilian Reais in cash, for a total consideration of approximately 2,626 million Brazilian Reais (approximately $900 million). We were required, under Spanish GAAP, to take an extraordinary charge in 2002 relating to exchange rate differences relating to our investment in BBV Brasil accumulated up to December 31, 2002. Under the transaction agreements with Bradesco, in addition to the cash consideration and equity participation described above, we have been granted the right to nominate one member of Bradesco’s board of directors so long as we maintain, subject to exceptions relating to capital increases where shareholders are not offered preemptive rights, at least a 4.0% interest in Bradesco’s share capital. We have agreed for a period of two years from the closing date or so long as we have a right to nominate one member of Bradesco’s board of directors, whichever is longer, that we will not control and/or manage a financial institution in Brazil.

In March 2003, BBVA sold its 25% interest in Metrovacesa Residencial, S.A., resulting in a capital gain of €2.1 million.

On June 5, 2003, BBVA agreed to sell its holding in Crédit Lyonnais, S.A., to Crédit Agricole, S.A. in exchange for €482 million in cash, representing 67% of the total consideration, and 16.3 million shares of Crédit Agricole, S.A., representing the remaining 33% of the total consideration. BBVA immediately sold the Crédit Agricole shares to institutional investors at a price of €16.64 per share, for a total consideration of €271 million. As a result of this transaction, BBVA liquidated its participation in Crédit Lyonnais and recorded a capital gain of €342 million.

In July 2003, BBVA sold 3% of the capital stock of Gamesa,S.A., giving rise to a capital gain of €29.9 million.

 

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In the last quarter of 2003, BBVA sold 2.465% of the capital stock of Repsol-YPF, S.A. giving rise to a loss of €73.3 million.

In 2003, a series of purchases and sales of shares of Telefónica, S.A., resulting in a 0.57% net reduction of our holding, gave rise to a capital gain of €220 million.

In 2003, a series of purchases and sales of shares of Iberdrola, S.A., resulting in a 1.02% net reduction of our holding, gave rise to a capital gain of €45.3 million.

In December 2003, BBVA sold its entire 9.9% interest in the Moroccan bank Wafabank, S.A. to Omnium Nord Africain, S.A. The total sale price was 529,505,625 dirhams (approximately €48 million) and gave rise to a capital gain of €3.5 million.

Public Takeover Offers

On June 20, 2005, we launched an exchange offer for the approximately 85.3% of the shares of Banco Nacionale del Lavoro, S.p.A. (“BNL”) which we did not already own (the “BNL Exchange Offer”). Under the terms of the BNL Exchange Offer, BBVA offered one of its ordinary shares for every five ordinary shares of BNL. The final day on which acceptances would be accepted, pursuant to the BNL Exchange Offer’s terms, was July 22, 2005. Prior to the expiration of the acceptance period, the Italian insurance group Unipol Assicurazioni S.p.A. (“Unipol”) announced that it had entered into side agreements with certain entities, as a result of which they controlled 46.95% of BNL’s capital. In light of this and the fact that we did not expect to obtain more than 50% of BNL’s capital pursuant to the BNL Exchange Offer we withdrew our tender offer.

On April 26, 2006, we announced our decision to abandon without effect the shareholders’ agreement executed on April 28, 2004, in relation to BNL.

On May 12, 2006, we reported, as shareholder of BNL, that we adhered to the tender offer launched by BNP Paribas to acquire 100% of BNL´s capital. With the price offered by BNP, the value of BBVA´s stake in the capital of BNL was approximately €1,299 million. The acceptance of the offer gave rise to a capital gain to BBVA of €567 million.

On May 19, 2006, BBVA sold its stake in the share capital of Banca Nazionale del Lavoro (BNL) to BNP Paribas, for a price of €1,299 million.

B. Business Overview

BBVA is a highly diversified international financial group, with strengths in the traditional banking businesses of retail banking, asset management, private banking and wholesale banking. We also have a portfolio of investments in some of Spain’s leading companies.

Business Areas

During 2005, our organizational structure was divided into the following business areas:

 

    Retail Banking in Spain and Portugal;

 

    Wholesale and Investment Banking;

 

    The Americas; and

 

    Corporate Activities.

In December 2005, our Board of Directors approved a new organizational structure for the BBVA Group, which has been implemented since the beginning of 2006:

 

    Retail Banking in Spain and Portugal;

 

    Wholesale Business;

 

    Mexico;

 

    South America;

 

    United States; and

 

    Corporate Activities.

 

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For purposes of the discussion below, we present our business along the historical business lines existing in 2004 and 2005. The financial information for our business areas for 2005 and 2004 presented below have been prepared on a uniform basis, consistent with our organization structure in 2005. Unless otherwise indicated, the financial information provided below for each business area does not reflect the elimination of transactions between companies within one business area or between different business areas, since we consider these transactions to be an integral part of each business area’s activities. For the presentation and discussion of our consolidated operating results in “Item 5. Operating and Financial Review and Prospects”, however, such intra- and inter-business area transactions are eliminated and the eliminations are generally reflected in the operating results of the Corporate Activities business area.

The following table sets forth information relating to income attributed to the group for each of our business areas for the years ended December 31, 2005 and 2004.

 

     Year ended December 31,  
     Income/(Loss)
Attributed to the Group (*)
    % of Subtotal     % of Income/Loss
Attributed to the Group (*)
 
     2005     2004     2005     2004     2005     2004  
     (in millions of euro)  

Retail Banking in Spain and Portugal

   1,613     1,426     40 %   47 %   42 %   49 %

Wholesale and Investment Banking

   592     404     15 %   13 %   16 %   14 %

The Americas

   1,819     1,194     45 %   40 %   48 %   40 %
                                    

Subtotal

   4,024     3,024     100 %   100 %   106 %   103 %
                                    

Corporate Activities

   (218 )   (102 )       (6 )%   (3 )%

Income attributed to the Group (*)

   3,806     2,922         100 %   100 %
                            

 

(*) Net income after minority interest.

Retail Banking in Spain and Portugal

The Retail Banking in Spain and Portugal area’s main lines of activity focused on providing banking services to private individuals, retailers and small and medium-sized entities. As of December 31, 2005, this business area conducted its activities through 3,558 branch offices.

The business units included in the Retail Banking in Spain and Portugal business area are:

 

    Financial Services, which include:

 

    Personal Financial Services;

 

    Commercial Financial Services; and

 

    Special Financial Services.

 

    Asset Management and Private Banking;

 

    BBVA Portugal; and

 

    Insurance Business in Europe.

 

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Total net lending in this business area as of December 31, 2005, was approximately €127,959 million, an increase of 20.1% from €106,510 million as of December 31, 2004, due to growth in mortgage lending and personal loans.

The non-performing loan (“NPL”) ratio decreased to 0.62% as of December 31, 2005 from 0.82% as of December 31, 2004.

Total customer funds (deposits, mutual and pension funds and other brokered products) were €126,947 million as of December 31, 2005, an increase of 10.0% from €115,391 million as of December 31, 2004 as a result of an increase in deposits collected during the year. Mutual funds under management were €46,232 million as of December 31, 2005, an increase of 10.1% from €41,988 million as of December 31, 2004. Pension fund assets under management were €15,405 million as of December 31, 2005, an increase of 12.2% from €13,731 million as of December 31, 2004.

Financial services

This business unit’s principal activities were focused on the development of the Financial Services Plan (our business model for this business unit), including:

 

    Personal Financial Services: focused on retail customers and aimed at providing customers with more value from their relationship with us by offering a wide range of products and services at attractive prices, which are made available through different channels, along with solutions tailored to their specific needs.

 

    Commercial Financial Services: focused on professionals, businesses and small- and medium-sized enterprises (“SMEs”) by providing them with customized services, a comprehensive range of products and continuous, quality financial advice.

 

    Special Financial Services: focused on the following lines of business (through Finanzia Bank and our online bank, Uno-e Bank, S.A.): financing of cars, consumer items and equipment; e-banking; bill payment; and car and equipment rental.

Lending by the Financial Services unit increased 20.0% to €123,210 million as of December 31, 2005 from €102,672 million as of December 31, 2004, principally due to strong growth in mortgage loans, which increased 22.9% from December 31, 2004.

Customer funds under management by the Financial Services unit increased 10.6% to €54,957 million as of December 31, 2005 from €49,671 million as of December 31, 2004, principally due to an increase in time deposits. Mutual and pension fund assets managed by the Financial Services unit increased by 9.2% and 14.9%, respectively, as of December 31, 2005 as compared to December 31, 2004.

In 2005, we launched the “Cuentas Claras” campaign, featuring a reduction in the price of various types of services, including financial services, legal assistance and household services. In 2005, we also introduced a rapid cash delivery service, “Dinero Express”, geared towards foreign residents in Spain, along with the “Crédito Fácil” service. In 2005, this “Dinero Express” service conducted approximately 200,000 remittances, totaling approximately €80 million.

In 2005, our Internet banking service, BBVAnet, recorded a 54.8% increase in the number of transactions (totaling approximately €134 million). In addition, we introduced a special platform to improve the security of our Internet services.

Asset Management and Private Banking

This business unit is responsible for the design and management of products to be distributed through the Retail Banking in Spain and Portugal business area’s different networks, as well as for the direct management of our private banking services (through the Personal Banking sub-unit and BBVA Patrimonios). As of December 31,

 

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2005, BBVA’s private banking business managed assets totaling approximately €73.1 billion, an increase of 12.3% from December 31, 2004.

BBVA Portugal

As of December 31, 2005, BBVA Portugal’s customer loans amounted to €3,695 million, an increase of 17.3% from 2004. In 2005, mortgage lending was the most dynamic sector, with a 40.2% increase over 2004.

As of December 31, 2005, customer funds managed by BBVA Portugal totaled €3,375 million, representing a 21.9% increase over 2004, principally due to the increase in mutual and pension fund assets under management by BBVA Portugal.

European Insurance

Our European insurance activities are conducted through various insurance companies that provide direct insurance, reinsurance and insurance brokering services in Spain and Portugal and market products for different types of customers (private individuals, SMEs, retailers, professional service firms and providers and self-employed individuals) through this unit’s branch offices.

Wholesale and Investment Banking

The Wholesale and Investment Banking business area focuses on large corporations, governmental and non-governmental organizations, finance companies and institutional investor clients.

The business units included in this business area are:

 

    Wholesale Banking, including:

 

    Global Corporate Banking; and

 

    Institutional banking

 

    Global Markets and Distribution;

 

    Business and Real Estate Projects; and

 

    Global Transactional Services.

As of December 31, 2005, lending by the Wholesale and Investment Banking business area totaled €46,896 million, an increase of 14.0% from €41,124 million as of December 31, 2004. Non-performing loans of this business area decreased 27.6% to an NPL ratio of 0.18% as of December 31, 2005, compared to 0.30% as of December 31, 2004, principally due to an improvement in risk quality. Deposits and mutual funds increased 13.4% and 7.1%, respectively, as of December 31, 2005 from December 31, 2004.

Global Corporate Banking

The Global Corporate Banking business unit provides services to large Spanish and foreign corporations. The Global Corporate Banking business unit is present in 15 countries on four continents with its customer and product units: Global and Investment Banking, catering to over 250 large corporate clients in 2005 and grouping together syndicated loan, fixed-income origination, project finance and corporate finance product units; Corporate Banking Iberica, with branches in Madrid, Bilbao, Barcelona, Palma de Mallorca, Lisbon and Porto; Corporate Banking Europe, catering to the European markets from its offices in Milan, Paris, London and Frankfurt; Corporate Banking Asia, with branches in Hong Kong and Tokyo and representation offices in Beijing and Shanghai; and Corporate Banking in the Americas, which, from its New York branch, manages the wholesale banking business in the United States and that of the BBVA Group’s banks in Latin America.

Institutional Banking

The Institutional Banking business unit provides services to public and private sector institutions in Spain, Portugal and Belgium. The BBVA Group operates in these markets under the BBVA brand name and through

 

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Banco de Crédito Local (BCL), an institution specializing in the long-term financing of regional public administrations through capital markets transactions.

Global Markets and Distribution

The Global Markets and Distribution business unit has trading floors located in Europe and New York and is responsible for the distribution of fixed-income and equity securities and our custodial services business.

Business and Real Estate Projects

As of December 31, 2005, the Business and Real Estate Projects business unit managed a portfolio of investments in 89 companies, highly diversified across different sectors (industrial, services, utilities and real estate), with an aggregate book value as of December 31, 2005 of €1,188 million and unrealized capital gains as of December 31, 2005 of €1,027 million, an increase of €168 million in unrealized capital gains compared to December 31, 2004. As of December 31, 2005, this business unit’s main investments were in Cementos Lemona, Corporación IBV, Duch, Grupo Anida, Iberia, Técnicas Reunidas and Tubos Reunidos.

Global Transactional Services

The Global Transactional Services business unit supports the other business areas and units of the BBVA Group by providing specialized corporate and institutional business transactional services for corporate and institutional customers, including services such as on-line banking, payment intermediation, factoring and confirming and trade finance.

The Americas

The Americas business area conducts all the activities of the BBVA Group’s banks in North and South America, as well as the BBVA Group’s International Private Banking Services in the region. As of December 31, 2005, this business area conducted its activities through 3,658 branch offices and had an aggregate of 61,604 employees.

The business units included in this business area are:

 

    Banks in the Americas, including banks in Mexico and other countries (including Argentina, Chile, Colombia, the United States, Panama, Paraguay, Peru, Uruguay and Venezuela);

 

    Pension Funds and Insurance in the Americas; and

 

    International Private Banking.

Unless otherwise specified, information included below relating to macroeconomic data in the Latin American countries in which we operate, such as GDP or inflation, has been derived from our internal statistical studies based on information published by local governmental or regulatory authorities.

Economic conditions in the region were favorable in 2005, with an economic upturn in the largest countries in Latin America, reflected in an average growth in GDP of approximately 4%. This positive economic climate is a result of a check on inflation — which decreased to record lows in some countries — and interest rates similar to 2004, though with some relatively important fluctuations over the year, especially in Mexico.

Unlike recent years, local currencies in the Americas appreciated against the euro in 2005, with a resulting positive impact on our consolidated financial statements as of and for the year ended December 31, 2005. See “Item 5. Operating and Financial Review and Prospects — Operating Results — Factors Affecting the Comparability of our Results of Operations and Financial Condition”. Nonetheless, in most cases, variations in average exchange rates were more moderate than in 2004, and, as a result, the overall effect on our results of operations for the year ended December 31, 2005 was not significant.

The following is a brief description of our operations and the economic and political factors that most significantly affect such operations, on a country-by-country basis, in the Americas business area. The operating

 

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results described below refer to each individual unit’s contribution to the Americas business area’s operating results, unless otherwise stated.

Banks in the Americas

Mexico

Mexican GDP increased approximately 3% in 2005, mainly due to favorable trends in domestic demand and moderate price increases. Inflation stood at just over 3%, substantially in line with the Bank of Mexico’s long-term goals. The Mexican peso remained strong against the dollar throughout 2005, which limited Mexican exports to the United States.

BBVA Bancomer’s income attributed to the Group for 2005 increased 63.1% to €1,191 million from €730 million in 2004, resulting in a Return on Equity (defined as income attributed to the group divided by average shareholders’ equity) of 39.4% compared to 30.8% in 2004. BBVA Bancomer’s income attributed to the Group in 2005 included €77 million from Hipotecaria Nacional, S.A. de C.V., which we acquired in January 2005.

As of December 31, 2005, lending by BBVA Bancomer totaled €20,378 million, an increase of 80.5% from €11,292 million as of December 31, 2004, while customer funds (deposits, securities sold under agreements to repurchase and mutual funds) increased 32.1% to €43,024 million as of December 31, 2005 from €32,576 million as of December 31, 2004.

Argentina

In 2005, the Argentinean economy benefited from the government’s successful debt exchange, with a GDP growth rate of 9%. This resulted in some pressure on prices, and at year-end 2005 inflation stood at 12.3% for the year.

Banco Francés’s income attributed to the Group for 2005 increased to €90 million from €14 million in 2004.

Chile

The year 2005 was marked by successive increases in interest rates by the Chilean Central Bank (increasing 2.25 percentage points to 4.5% as of December 31, 2005). Chilean GDP increased 6% in 2005, while inflation was 3.7% for the year.

BBVA Chile’s income attributed to the Group for 2005 increased 13.3% to €27 million from €24 million in 2004.

Colombia

Colombia’s GDP increased approximately 5% in 2005, coupled with a low inflation rate, interest rates at record lows, high levels of disposable cash, upwards trends in Colombia’s capital markets and a gradual decline in unemployment.

In December 2005, BBVA Colombia acquired Banco Granahorrar for €364 million pursuant to an auction process. BBVA Colombia’s income attributed to the Group for 2005 increased 181.3% to €47 million from €17 million in 2004.

Panama

Panama’s GDP increased 6% in 2005. BBVA Panama’s income attributed to the Group for 2005 increased 6.8% to €19 million from €18 million in 2004.

Paraguay

Paraguay’s GDP increased 2.7% in 2005, supported by growth in the agricultural industry. BBVA Paraguay’s income attributed to the Group for 2005 increased 21.5% to €10 million from €9 million in 2004.

 

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Peru

Peru’s GDP increased 6% in 2005. BBVA Banco Continental’s income attributed to the Group for 2005 increased 114.4% to €47 million from €22 million in 2004.

United States of America

BBVA’s U.S. business unit, which was created in 2005, includes BBVA Puerto Rico, Laredo National Bancshares, BBVA Bancomer USA (former Valley Bank) and Bancomer Transfer Services (BTS). BBVA’s U.S. business unit’s income attributed to the Group was €26 million in 2005.

Uruguay

Uruguay’s GDP increased 6% in 2005. BBVA Uruguay’s loss attributed to the Group for 2005 decreased 33.0% to €2 million from €3 million in 2004.

Venezuela

Venezuela’s GDP increased 9.4% in 2005. BBVA Banco Provincial’s income attributed to the Group for 2005 decreased 34.5% to €55 million from €84 million in 2004.

Pension Funds and Insurance in the Americas

The BBVA Group’s pension fund and insurance companies in the Americas’ income attributed to the Group for 2005 increased 29.6% to €260 million.

As of December 31, 2005, the BBVA Group’s pension fund and insurance companies in the Americas managed €38,541 million in pension fund assets, an increase of 14.7% over December 31, 2004.

The BBVA Group’s insurance companies in the Americas’ income attributed to the Group for 2005 increased 31.8% to €115 million.

International Private Banking

The International Private Banking business unit provides investment advice and manages the assets of high-income international customers. In 2005, this business unit completed the process of concentrating its operations in three centers: Andorra; Switzerland; and Miami (Florida, United States).

Customer funds managed by this business unit increased 3.4% to €14,921 million as of December 31, 2005. The International Private Banking business unit’s income attributed to the Group for 2005 increased 4.8% to €73 million.

Corporate Activities and Other

The Corporate Activities business area includes BBVA’s portfolio of strategic and financial investments and the activities of the Assets and Liabilities Management Committee.

The business units included in this business area are:

 

    Holdings in Industrial and Financial Companies; and

 

    The Assets and Liabilities Management Committee.

Holdings in Industrial and Financial Companies

The Holdings in Industrial and Financial Companies business unit manages the Group’s holdings in listed industrial companies, principally Telefónica, S.A., Iberdrola, S.A. and until June 2006, Repsol YPF, S.A., as well as its financial holdings, which are currently limited to Banco Bradesco S.A. All of these shareholdings are recorded on our consolidated balance sheet prepared in accordance with EU-IFRS as “available-for-sale”. As of

 

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December 31, 2005, the portfolio of shareholdings of this business unit had a market value (including equity swaps) of €8,811 million. In 2005, the BBVA Group’s holdings in industrial and financial companies generated €183 million in dividends (an increase of 12.4% over 2004) and net trading income of €298 million, a 22.3% increase over 2004.

Assets and Liabilities Management Committee

The Assets and Liabilities Management Committee (“ALCO”) manages the BBVA Group’s overall financing needs and interest and exchange rate risks. ALCO also manages the BBVA Group’s investments and capital resources in an effort to improve the return on capital for our shareholders.

As of December 31, 2005, ALCO’s portfolio of fixed-income assets, which is held in an effort to reduce the negative effect on BBVA’s net interest income of a fall in interest rates, amounted to €31,249 million. ALCO’s income attributed to the Group for 2005 increased to €63 million.

Supervision and Regulation

The Spanish government traditionally has been closely involved with the Spanish banking system, both as a direct participant through its ownership of the Instituto de Crédito Oficial (“ICO”) and as a regulator retaining an important role in the regulation and supervision of financial institutions.

The Bank of Spain

The Bank of Spain was established in 1962 as a public law entity (entidad de derecho público) that operates as Spain’s autonomous central bank. In addition, it has the ability to function as a private bank. Except in its public functions, the Bank of Spain’s relations with third parties are governed by private law and its actions are subject to the civil and business law codes and regulations.

Until January 1, 1999, the Bank of Spain was also the sole entity responsible for implementing Spanish monetary policy. For a description of monetary policy since the introduction of the euro, see “—Monetary Policy—General”.

Since January 1, 1999, the Bank of Spain has performed the following basic functions attributed to the European System of Central Banks (“ESCB”):

 

    defining and implementing the ESCB’s monetary policy, with the principal aim of maintaining price stability across the euro area;

 

    conducting currency exchange operations consistent with the provisions of Article 109 of the Treaty on European Union (“EU Treaty”), and holding and managing the States’ official currency reserves;

 

    promoting the sound working of payment systems in the euro area and

 

    issuing legal tender banknotes.

Recognizing the foregoing functions as a fully-fledged member of the Eurosystem, the Ley de Autonomía del Banco de España (the Bank of Spain Law of Autonomy) stipulates the performance of the following functions by the Bank of Spain:

 

    holding and managing currency and precious metal reserves not transferred to the European Central Bank (“ECB”);

 

    supervising the solvency and behavior of credit institutions, other entities and financial markets, for which it has been assigned supervisory responsibility, in accordance with the provisions in force;

 

    promoting the sound working and stability of the financial system and, without prejudice to the functions of the ECB, of national payment systems;

 

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    placing coins in circulation and the performance, on behalf of the State, of all such other functions entrusted to it in this connection;

 

    preparing and publishing statistics relating to its functions, and assisting the ECB in the compilation of the necessary statistical information;

 

    providing treasury services and acting as financial agent for government debt;

 

    advising the government, preparing the appropriate reports and studies; and

 

    exercising all other powers attributed to it by legislation.

Subject to the rules and regulations issued by the Ministry of Economy, the Bank of Spain has the following supervisory powers over Spanish banks:

 

    conducting periodic inspections of Spanish banks to evaluate a bank’s compliance with current regulations including the preparation of financial statements, account structure and credit policies;

 

    advising a bank’s board of directors and management on its dividend policy;

 

    undertaking extraordinary inspections of banks; and

 

    collaborating with other regulatory entities to impose penalties for infringement or violation of applicable regulations.

Fondo de Garantía de Depósitos

The Fondo de Garantía de Depósitos en Establecimientos Bancarios (“FGD”), which operates under the guidance of the Bank of Spain, guarantees both bank and securities deposits up to €20,000 per customer for each type of deposit, which is the minimum insured amount for all EU member banks. Pursuant to Bank of Spain regulations, the FGD may purchase doubtful loans or may acquire, recapitalize and sell banks that are experiencing difficulties.

The FGD is funded by annual contributions from member banks. The rate of such contributions in 2005 was 0.06% of the year-end amount of deposits to which the guarantee extended, in accordance with legislation in effect. Nevertheless, once the capital of the FGD exceeds its requirements, the Minister of Economy may reduce the member banks’ contributions and, when the FGD’s funds exceed the capital requirements by one percent or more of the member banks’ deposits, such contributions may be suspended.

In order to safeguard the stability of its members, the FGD may also receive contributions from the Bank of Spain. At December 31, 2005, all of the Spanish banks belonging to the BBVA Group were members of the FGD and thus obligated to make annual contributions to it.

Fondo Garantía Inversores

Royal Decree 948 of August 3, 2001 regulates investor guarantee schemes related to both investment firms and to credit institutions. These schemes are set up through an investment guarantee fund for securities broker and broker-dealer firms and the deposit guarantee funds already in place for credit institutions. A series of specific regulations have also been enacted, defining the system for contributing to the funds.

The General Investment Guarantee Fund Management Company was created in a relatively short period of time and is a business corporation with capital in which all the fund members hold an interest. Member firms must make a joint annual contribution to the fund equal to 0.06% over the 5% of the securities that they hold on their client’s behalf. However, it is foreseen that these contributions may be reduced if the fund reaches a level considered to be sufficient.

Liquidity Ratio

In an effort to implement European monetary policy, effective January 1, 1999, the ECB and the national central banks of the member states of the European Monetary Union (“EMU”) adopted a regulation that requires

 

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banks to deposit an amount equal to two percent of their qualifying liabilities, as defined by the regulation, with the central bank of their home country. These deposits will earn an interest rate equal to the average interest rate of the ESCB. Qualifying liabilities for this purpose include:

 

    deposits;

 

    debt securities issued; and

 

    monetary market instruments.

Furthermore, the liquidity ratio is set at 0% instead of 2% for those qualifying liabilities that have a maturity over two years and are sold under repurchase agreements.

Investment Ratio

In the past, the government used the investment ratio to allocate funds among specific sectors or investments. As part of the liberalization of the Spanish economy, it was gradually reduced to a rate of zero percent as of December 31, 1992. However, the law that established the ratio has not been abolished and the government could re-impose the ratio, subject to applicable EU requirements.

Capital Adequacy Requirements

As part of a program to modernize Spain’s banking regulations, capital adequacy requirements were revised in 1985 and, pursuant to EU directives, amended as of January 1, 1993. The capital adequacy requirements are applicable to BBVA on both a consolidated and individual basis.

The principal characteristics of the capital adequacy requirements pursuant to EU directives are a distinction between “core” and “complementary” capital and the adoption of a ratio of stockholders’ equity to risk-weighted assets. Core capital generally includes:

 

    voting equity;

 

    certain nonvoting equity, including certain nonvoting guaranteed preference shares of subsidiaries;

 

    most reserves and generic allowances;

 

    less participation in other financial institutions; and

 

    treasury stock and financing for the acquisition, by persons other than the issuer’s employees, of the issuer’s shares.

Complementary capital generally includes certain nonvoting equity, revaluation and similar reserves, and subordinated and perpetual debt. The computation of both core and complementary capital is subject to provisions limiting the type of stockholding and the level of control which these stockholdings may give a banking group. The level of non-perpetual subordinated debt taken into account for the calculation of complementary capital may not exceed 50% of core capital. The total amount of complementary capital admissible for computing total capital may not exceed the total amount of core capital.

The consolidated total of core and complementary capital of a banking group calculated in the manner described above may not be less than eight percent of the group’s risk-weighted assets net of specified provisions and amortizations. The calculation of total risk-weighted assets applies minimum multipliers of 0%, 20%, 50% and 100% to the group’s assets. Countries with special loan arrangements with the International Monetary Fund, which have not renegotiated their foreign debt in the five preceding years, receive a 0% risk weight. Pursuant to Bank of Spain regulations, the following loans also receive a 0% risk weighting:

 

    credits to Spanish governmental autonomous bodies, credits to Social Security, and credits to certain Spanish governmental public entities;

 

    certain debt securities related to the securitization of the Spanish Nuclear Moratorium; and

 

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    credits guaranteed by:

 

  (a) the EU and the OECD countries’ governments or central banks,

 

  (b) governments or central banks of countries with special loan agreements with the International Monetary Fund (provided such countries have not renegotiated their external debt in the five preceding years), or

 

  (c) Spanish governmental public entities. Loans to autonomous communities, the EU and the OECD regional and local governments, banks, savings banks, brokerage firms and multilateral development banks receive at least a 20% weighting. Residential mortgage loans receive at least a 50% weighting.

All other loans are weighted at 100%; however, such weighting may be lower if the loan is guaranteed or secured. Off-balance sheet assets are also included in the calculation of risk-weighted assets.

The computation of core capital is subject to reductions of capital in amounts equivalent to unrealized losses on investment securities that are not charged to income and are accounted for as assets under the caption “Asset Accrual Accounts”.

The Basel Committee on Banking Supervision (the “Basel Committee”), which includes the supervisory authorities of thirteen major industrial countries, has adopted an international framework (the “Basel Accord”) for capital measurement and capital standards of banking institutions. The framework provides:

 

    definitions for “Tier 1” (core) capital and “Tier 2” (supplemental) capital;

 

    a system for weighting assets and off balance sheet items according to credit risk; and

 

    a requirement that banks engaged in international operations maintain Tier 1 capital of at least 4% of risk-weighted assets and “total” capital, Tier 1 capital plus up to an equal amount of Tier 2 capital, of at least 8% of risk-weighted assets.

The Basel Committee on Banking Supervision published a new Basel capital accord (also known as Basel II) which, when finalized, will replace the Basel Accord, and will come into effect in December, 2006. EU countries intend to implement the new regulatory framework in January 2007 or January 2008 if advanced risk models are adopted.

As described above, the capital adequacy of Spanish banks is regulated by EU directives applicable to the Spanish banking system as well as to the banking systems of other EU member states. Certain EU member states are parties to the Basel Accord. Spain joined the Basel Accord on February 1, 2001. Each national authority that is a party to the Basel Accord has implemented it in a significantly different fashion. The capital requirements imposed by the Basel Accord are in many respects similar to those imposed by EU directives, Spanish law and the Bank of Spain.

Banks in EU countries are permitted to net the credit exposure arising from certain interest rate and foreign exchange-related derivative contracts (rather than include the entire notional amount of such contracts) in calculating their total risk-adjusted assets for purposes of calculating their capital adequacy ratios, provided that such derivative contracts are subject to regulatory limitations on total credit exposure and the relevant regulatory authorities approve the inclusion in risk-adjusted assets of such credit risks on a net basis.

Spanish banks are permitted to include the net credit exposure arising from interest rate and foreign exchange transactions related to derivative products provided the following conditions are met:

 

    all derivative related transactions between the parties form a single agreement;

 

    the incumbent bank has submitted to the Bank of Spain two legal opinions with regard to the validity of the netting provisions; and

 

    the incumbent bank has implemented the appropriate procedures to revise the treatment of netting if there is an amendment of the regulations in force.

 

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In addition, the Bank of Spain may not accept the accounting treatment of netting if the conditions set forth above are not met or if the Bank of Spain does not concur with the legality or validity of the netting provisions.

Concentration of Risk

The Bank of Spain regulates the concentration of risk. Since January 1, 1999, any exposure to a person or group exceeding 10% of a group’s or bank’s regulatory capital has been deemed a concentration. The total amount of exposure represented by all of such concentrations may not exceed 800% of regulatory capital. Exposure to a single person or group may not exceed 25% (20% in the case of an affiliate) of a bank’s or group’s regulatory capital.

Legal and Other Restricted Reserves

We are subject to the legal and other restricted reserves requirements applicable to Spanish companies. Please see “—Capital Adequacy Requirements”. See Note 33 to the Consolidated Financial Statements.

Allowance for Loan Losses

For a discussion of the Bank of Spain regulations relating to allowances for loan losses and country risk, see “—Selected Statistical Information—Assets—Loan Loss Reserve”.

Regulation of the Disclosure of Fees and Interest Rates

Interest rates on most kinds of loans and deposits are not subject to a maximum limit. Banks must publish their preferential rates, rates applied on overdrafts, and fees and commissions charged in connection with banking transactions. Banking clients must be provided with written disclosure adequate to permit customers to ascertain transaction costs. The foregoing regulations are enforced by the Bank of Spain in response to bank client complaints.

Law 44/2002 concerning measures to reform the Spanish financial system contained a rule concerning the calculation of variable interest applicable to loans and credit secured by mortgages, bails, pledges or any other equivalent guarantee.

Employee Pension Plans

Under the relevant collective labor agreements, BBVA and some of its subsidiaries provide supplemental pension payments to certain active and retired employees and their beneficiaries. These payments supplement social security benefits from the Spanish state. See Note 2.2.f to the Consolidated Financial Statements.

Dividends

If a bank meets the Bank of Spain’s minimum capital requirements described above under “—Capital Adequacy Requirements”, it may dedicate all of its net profits to the payment of dividends, although, in practice, banks consult with the Bank of Spain before declaring a dividend. We calculate that as of December 31, 2005, we had approximately €2.07 billion of unrestricted reserves in excess of applicable capital and reserve requirements available for the payment of dividends. Compliance with such requirements notwithstanding, the Bank of Spain may advise a bank against the payment of dividends on grounds of prudence. In no event may dividends be paid from non-distributable reserves. Banks which fail to comply with the capital adequacy ratio by more than 20% are required to devote all of their net profits to increasing their capital ratios. Banks which fail to meet the required ratio by 20% or less must obtain prior approval of the Bank of Spain to distribute any dividends and must devote at least 50% of net profits to increasing their capital ratios. In addition, banks, and their directors and executive officers, that do not comply with the liquidity and investment ratios and capital adequacy requirements may be subject to fines or other sanctions. Compliance with the Bank of Spain’s capital requirements is determined on both a consolidated and individual basis. BBVA’s Spanish subsidiaries are in compliance with these capital adequacy requirements on both a consolidated and individual basis. If a bank has no net profits, the board of directors may propose at the general meeting of the stockholders that a dividend be declared out of retained earnings.

 

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The Bank of Spain recommends that interim dividends not exceed an amount equal to one-half of net attributable profit from the beginning of the corresponding fiscal year. No interim dividend may be declared when a bank does not meet the minimum capital requirements and, according to the recommendations of the Bank of Spain, interim dividends may not be declared until the Bank of Spain has sufficient knowledge with respect to the year’s profits. Although banks are not legally required to seek prior approval from the Bank of Spain before declaring interim dividends, the Bank of Spain has asked that banks consult with it on a voluntary basis before declaring interim dividends.

Limitations on Types of Business

Spanish banks are subject to certain limitations on the types of businesses in which they may engage directly, but they are subject to few limitations on the types of businesses in which they may engage indirectly.

Mortgage Legislation

Spanish law limits the prepayment penalties on floating rate mortgage loans and limits the notarial costs and registration fees charged to borrowers in connection with renegotiation of mortgage terms on fixed and floating rate mortgages.

Mutual Fund Regulation

Mutual funds in Spain are regulated by the Dirección General del Tesoro y Política Financiera del Ministerio de Economía (the Ministry of the Economy) and by the Comisión Nacional del Mercado de Valores (“CNMV”). All mutual funds and mutual fund management companies are required to be registered with the CNMV. Spanish mutual funds are subject to investment limits with respect to single sectors or companies and overall portfolio diversification minimums. In addition, periodic reports including a review of the fund’s performance and any material events affecting the fund are required to be distributed to the fund’s investors and filed with the CNMV.

U.S. Regulation

Banking Regulation

By virtue of our branch in New York, our agency in Miami and our ownership of commercial banks in Texas, California and Puerto Rico, we are subject to the U.S. Bank Holding Company Act of 1956, as amended, which imposes certain restrictions on the activities in which BBVA and its subsidiaries may engage in the United States and subjects us to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). In addition, certain of our banking activities in the United States are subject to supervision by state banking authorities. We have two securities subsidiaries operating in New York and Puerto Rico, which are regulated by the SEC and the National Association of Securities Dealers.

On June 12, 2000, BBVA and its Miami and New York offices entered into an agreement (the “Written Agreement”) with the Federal Reserve Board. The Written Agreement required BBVA, on behalf of its U.S. offices, to establish programs designed to identify and report known or suspected criminal activity with respect to money laundering and to comply with rules and regulations related to anti-money laundering compliance. BBVA responded to the Written Agreement by enhancing its U.S. internal controls through its Office of the Country Manager, implementing improved compliance policies and procedures, transferring its U.S. private banking activities from its New York branch to its Miami agency, and adopting an enhanced customer due diligence program. These remedial actions were subject to examination by the Federal Reserve Bank of New York and the New York State Banking Department. On February 21, 2003, the Written Agreement was terminated.

U.S. Foreign Corrupt Practices Act

BBVA, as well as all other foreign private issuers with a class of securities registered pursuant to Section 12 of the U.S. Securities Exchange Act of 1934, is subject to the U.S. Foreign Corrupt Practices Act. This Act generally prohibits such issuers and their directors, officers, employees and agents from using any means or instrumentality of U.S. interstate commerce in furtherance of any offer or payment of money to any foreign official or political party for the purpose of influencing a decision of such person in order to obtain or retain business. It also requires that the issuer maintain books and records and a system of internal accounting controls

 

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sufficient to provide reasonable assurance that accountability of assets is maintained and accurate financial statements can be prepared. Penalties, fines and imprisonment can be imposed for violations of such Act.

Monetary Policy

General

On May 2, 1998, the EU established the bilateral conversion rates among the member countries that make up the EMU, and on December 31, 1998 the EU established the irrevocable conversion rates between the euro and each of the member countries of the EMU. The exchange rate in Spain was fixed at 166.386 pesetas per euro.

Monetary policy within the 12 members of the euro zone is set by the ECB. The ECB has itself set the objective of containing inflation and will adjust interest rates in line with this policy. It has further declared that it will not set an exchange rate target for the euro.

As of January 1, 1999, the euro became the national currency of the Spanish monetary system, replacing the peseta. However, the peseta was used as a unit of account in any judicial/legal instrument as a fraction of the euro and according to the exchange rate during the transitory period (from January 1, 1999 through December 31, 2001).

On January 1, 1999, the monetary system adopted the euro exclusively as a unit of account. From this date through February 28, 2002, the Bank of Spain, commercial banks, savings banks and credit co-operatives exchanged pesetas into euro free of charge but did not exchange euro into pesetas. Beginning July 1, 2002, only the Bank of Spain was able to perform this exchange, as determined by the Ministry of the Economy.

As of January 1, 2002, all legal instruments that were not denominated in euro during the transitory period were understood to be expressed in the euro unit of account, subject to the established conversion and rounding procedure.

Monetary Policy in the EMU

The integration of Spain into the EMU on January 1, 1999 implied the yielding of monetary policy sovereignty to the ESCB. The ESCB is composed of the ECB and the national central banks of the 12 member countries that form the EMU.

The ESCB determines and executes the single monetary policy of the 12 member countries of the EMU. The ESCB collaborates with the central banks of member countries to take advantage of the experience of the central banks in each of its national markets. The basic tasks to be carried out by the ESCB include:

 

    defining and implementing the single monetary policy of the EU;

 

    conducting foreign exchange operations in accordance with the set exchange policy;

 

    holding and managing the official foreign reserves of the member states; and

 

    promoting the smooth operation of the payment systems.

In addition, the EU Treaty establishes a series of rules designed to safeguard the independence of the system, in its institutional as well as in its administrative functions.

Law Reforming the Spanish Financial System

On November 22, 2002, the Spanish government approved the Ley de Medidas de Reforma del Sistema Financiero (“Law 44/2002”), which amended, among others, the Spanish Securities Markets Act of 1988 (the “Securities Markets Act”), the Credit Entities Discipline and Intervention Law and Private Insurance law. Law 44/2002 affects the following matters: market transparency (concept of privileged information); accounting practices of companies (in particular, independence and reliability of external audits and creation of audit committees for every listed company); systems and risk coverage (promotion of the integration of various existing entry settlement systems into one); securitization (assignment of credit rights against public administration within a period before the bankruptcy of the companies, mortgage transfer certificates, territorial

 

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bonds, etc.); electronic money (definition and issuance); pre-emptive rights; collective investment schemes (merger of collective investments schemes and guarantees and security interest); venture capital (investments in its group companies, etc.); ring-fencing transactions (extending protection against bankruptcy to some special financial master transactions and OTC transactions); savings banks (legal regime of cuotas participativas, or participating shares) and other rules concerning the disciplinary regime for listed companies.

On June 18, 2003, the Spanish Government approved the Ley de Transparencia (“Law 26/2003”), modifying both the Spanish Securities Markets Act and Law 22/2003, to reinforce the transparency of information regarding listed Spanish companies. This law adds a new chapter, Title X, to the Securities Markets Act, which (i) requires disclosure of shareholder agreements relating to listed companies, (ii) regulates the operation of the general shareholders’ meetings and of the boards of directors of listed companies, (iii) requires the publication of an annual report of corporate governance and (iv) establishes measures designed to increase the availability of information to shareholders.

In addition, this law amends the Ley de Sociedades Anonimas (the “Corporate Law”), and requires: (i) offering to shareholders the possibility of exercising voting rights directly or remotely by delegation, so long as the identity of the person who exercises the vote can be properly guaranteed, (ii) an increase in the information that shareholders have the right to obtain from the company and (iii) that existing regulation of the duties and responsibilities of directors be expanded.

Order on Securities Information

On September 27, 2004, the Order on Securities Information (EHA/3050/2004) was published in the Official Gazette.

The order is part of an effort to increase the transparency of companies with securities listed on a public stock exchange, which has been implemented by legislation that includes the Law on Reform of the Financial System (44/2002) and Law 26/2003, which amended the Securities Market Law and the Corporations Law in order to increase the transparency of listed corporations.

The transparency laws imposed new obligations with regard to corporate information (e.g., to publish an annual corporate governance report which, among other matters, must include information on related-party transactions between the company and its shareholders, directors and executives).

The order imposes an obligation on companies issuing securities which are admitted to listing on any official Spanish secondary market (e.g., the stock exchanges, the Association of Financial Asset Brokers (AIAF) fixed income market and the financial futures exchange) to include in their biannual information quantified data on all their transactions with related parties.

This obligation is in addition to the obligation to include information on related-party transactions in the annual corporate governance report, as provided by the Corporate Governance Report Order (ECO/3722/2003).

Royal Decree-Law on Measures to Promote Productivity (5/2005)

The Spanish government has published the Royal Decree-Law on Measures to Promote Productivity (5/2005). Among other things, the measures include:

 

    implementation of the EU Prospectus Directive (2003/71/EC) into Spanish law;

 

    reform of the system for securities represented by book entry; and

 

    reform of the system for bonds and other debt securities.

Implementation of the EU Prospectus Directive

The first measure seeks partly to implement the EU Prospectus Directive into Spanish law. The EU Prospectus Directive governs the content of prospectuses that must be delivered when securities are offered to the public or admitted to listing on a regulated market in the EU. The EU Prospectus Directive was required to be implemented by member states by July 1, 2005.

The measure amends Part III of the Securities Market Act, including Articles 25 to 30(2) concerning primary markets.

 

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Securities represented by book entry

The new measures also eliminate the requirement that certain securities represented by book entry must be executed in a public instrument. Under Royal Decree-Law 5/2005, a document delivered by the issuer with the key terms of such securities is sufficient.

Debt securities

Royal Decree 5/2005 adds a new Chapter II to Part III (on primary markets) of the Securities Market Act concerning issues of bonds and other debt securities.

The new Chapter II removes certain requirements imposed by Spanish legislation on certain issues of bonds and other debt securities. The following requirements have been removed:

 

    to execute a public instrument;

 

    to record the issuance in the Commercial Registry; and

 

    to publish an announcement in the Official Gazette of the Commercial Registry.

Royal Decree on Market Abuse (1333/2005)

This Royal Decree develops the Securities Market Act and completes the implementation into the Spanish legal regime of the European Directive regarding insider trading and market manipulation. This Royal Decree establishes the definitions of insider trading and listing manipulation, regulates activities that could affect market prices and imposes certain disclosure obligations on participants in the market in order to avoid market manipulation.

Law Establishing a European Company with a Corporate Domicile in Spain (19/2005)

This law has amended several provisions of Spanish Company Law with general applicability not only to European companies with a corporate domicile in Spain (sociedades anónimas europeas) but also to all Spanish companies, irrespective of whether such companies are listed on a stock exchange. For instance, one of the most notable amendments to Spanish Company Law is that all Spanish companies are now required to give shareholders at least 30 days’ notice, as opposed to 15 days’ notice previously required, of General Shareholders’ Meetings by publishing a notice in the Official Gazette of the Company Registry and in one daily newspaper.

C. Organizational Structure

Below is a simplified organizational chart of BBVA’s significant subsidiaries as of March 31, 2006. An additional 282 companies are domiciled in the following countries: Andorra, Argentina, Belgium, Bolivia, Brazil, Chile, Colombia, Ecuador, France, Gibraltar, Ireland ,Cayman Islands, Italy, Jersey, Luxembourg, Morocco, Mexico, Netherlands, Panama, Peru, Portugal, Puerto Rico, Spain, United Kingdom, United States of America, Dominican Republic, Uruguay and Venezuela.

 

Subsidiary

   Country of
Incorporation
   Activity    BBVA
Voting
Power
   BBVA
Ownership
   Total
Assets
               (percent)    (in millions
of euro)

Administradora de Fondos Para el Retiro-Bancomer, S.A. de C.V.

   Mexico    Financial services    100.00    97.29    114

Administradora de Fondos de Pensiones Provida

   Chile    Financial services    64.32    64.32    318

Banco Bilbao Vizcaya Argentaria (Portugal), S.A.

   Portugal    Bank    100.00    100.00    4,379

Banco Bilbao Vizcaya Argentaria Puerto Rico, S.A.

   Puerto Rico    Bank    100.00    100.00    5,541

Banco Continental, S.A.

   Peru    Bank    92.08    46.04    4,806

Banco de Crédito Local, S.A.

   Spain    Bank    100.00    100.00    11,759

Banco Provincial S.A.—Banco Universal

   Venezuela    Bank    55.60    55.60    4,937

BBVA Chile, S.A.

   Chile    Bank    67.05    67.05    6,189

 

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Table of Contents

BBVA Banco Francés, S.A.

   Argentina    Bank    76.10    76.08    3,609

BBVA Colombia, S.A.

   Colombia    Bank    95.37    95.37    3,081

Banco Granahorrar, S.A.

   Colombia    Bank    98.78    94.21    1,447

BBVA Factoring E.F.C., S.A.

   Spain    Financial services    100.00    100.00    4,417

BBVA Renting, S.A.

   Spain    Financial services    100.00    99.95    462

BBVA Ireland Public Limited Company

   Ireland    Financial services    100.00    100.00    2,662

BBVA Paraguay, S.A.

   Paraguay    Bank    99.99    99.99    266

BBVA Bancomer, S.A. de C.V.

   Mexico    Bank    100.00    99.96    49,583

Hipotecaria Nacional, S.A. de C.V.

   Mexico    Financial services    100.00    99.96    931

Pensiones Bancomer, S.A. de C.V.

   Mexico    Insurance    100.00    99.95    1,491

Seguros Bancomer

   Mexico    Insurance    100.00    99.97    675

BBVA Switzerland

   Switzerland    Bank    100.00    100.00    525

BBVA Privanza Bank (Jersey) Ltd.

   Jersey    Bank    100.00    100.00    399

BBVA Seguros, S.A.

   Spain    Insurance    99.94    99.94    12,562

Finanzia, Banco de Credito, S.A.

   Spain    Bank    100.00    100.00    2,081

Uno-e Bank, S.A.

   Spain    Bank    67.00    67.00    1,320

Laredo National Bancshares Inc.

   U.S.A    Bank    100.00    100.00    45

D. Property, Plants and Equipment

We own and rent a substantial network of properties in Spain and abroad, including 3,578 branch offices in Spain and, principally through our various affiliates, 3,832 branch offices abroad at December 31, 2005. Approximately 47.9% of these properties are rented in Spain from third parties pursuant to short-term leases that may be renewed by mutual agreement. The remaining properties, including most of our major branches and our headquarters, are owned by us.

E. Selected Statistical Information

The following is a presentation of selected statistical information for the periods indicated. Where required under Industry Guide 3, we have provided such selected statistical information separately for our domestic and foreign activities, pursuant to our calculation that our foreign operations are significant according to Rule 9-05 of Regulation S-X.

Average Balances and Rates

The tables below set forth selected statistical information on our average balance sheets, which are based on the beginning and month-end balances in each year. We do not believe that monthly averages present trends materially different from those that would be presented by daily averages. Interest income figures, when used, include interest income on non-accruing loans to the extent that cash payments have been received. Loan fees are included in the computation of interest revenue.

EU-IFRS

 

     Average Balance Sheet—Assets and Interest from Earning Assets  
     2005     2004  
     Average
Balance
   Interest    Average
Yield(1)
    Average
Balance
   Interest    Average
Yield(1)
 
     (in millions of euro, except percentages)  

Assets

                

Cash and Balances with central banks

   10,494    458    4.37 %   9,089    275    3.03 %

Debt securities, equity instruments and derivatives

   116,373    4,328    3.72 %   100,174    3,604    3.60 %

Loans and receivables

   213,520    11,170    5.23 %   181,899    8,626    4.74 %

In euro (2)

   161,011    5,974    3.71 %   139,220    5,297    3.80 %

Loans and advances to credit institutions

   10,653    276    2.59 %   10,144    192    1.89 %

 

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EU-IFRS

 

     Average Balance Sheet—Assets and Interest from Earning Assets  
     2005     2004  
     Average
Balance
   Interest    Average
Yield(1)
    Average
Balance
   Interest    Average
Yield(1)
 
     (in millions of euro, except percentages)  

Loans and advances to customers

   150,358    5,698    3.79 %   129,076    5,105    3.96 %

In other currencies (3)

   52,509    5,196    9.89 %   42,679    3,329    7.80 %

Loans and advances to credit institutions

   9,947    491    3.79 %   13,000    570    4.38 %

Loans and advances to customers

   42,562    4,705    11.06 %   29,679    2,759    9.30 %

Other financial income

   —      186    —       —      103    —    

Non-earning assets

   23,668    —      —       30,664    —      —    
                                

Total average assets

   364,055    16,142    4.43 %   321,826    12,608    3.92 %
                                

(1) Rates have been presented on a non-taxable equivalent basis.

 

(2) Amounts reflected in euro correspond to predominantly domestic activities.

 

(3) Amounts reflected in other currencies correspond to predominantly foreign activities.

Spanish GAAP

 

     Average Balance Sheet—Assets
and Interest from Earning Assets
 
     2003  
     Average
Balance
    Interest     Average
Yield (1)
 
     (in millions of euro, except percentages)  

Assets

      

Credit entities

   28,777     1,156     4.0 %

In euro

   10,479     222     2.1 %

In other currencies

   18,298     934     5.1 %

Lending

   147,915     8,015     5.4 %

In euro (5)

   114,121     5,185     4.5 %

Government and other agencies

   12,470     396     3.2 %

Commercial loans (2)

   7,363     336     4.6 %

Secured loans (3)

   48,654     2,111     4.3 %

Others (4)

   45,634     2,341     5.1 %

In other currencies (6)

   33,794     2,831     8.4 %

Secured loans

   9,547     599     6.3 %

Others

   24,247     2,231     9.2 %

Securities portfolio

   77,852     3,788     4.9 %

Fixed income securities

   68,172     3,324     4.9 %

In euro

   40,220     1,321     3.3 %

In other currencies

   27,952     2,002     7.2 %

Equity securities

   9,680     464     4.8 %

Holdings of companies carried by the equity method

   6,814     319     4.7 %

Other holdings

   2,866     145     5.1 %

Other financial income

   —       43     —    

Non-earning assets

   24,701     —       —    
                  

Total average assets

   279,245     13,002     4.7 %
                  

Total euro assets/total assets

   71.34 %   55.65 %   —    

(1) Rates have been presented on a non-taxable equivalent basis.

 

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(2) Principally short-term lending to companies and businesses.

 

(3) Principally mortgages loans.

 

(4) Principally other loans to individuals and companies and consumer loans.

 

(5) Amounts reflected in euro correspond to predominantly domestic activities.

 

(6) Amounts reflected in other currencies correspond to predominantly foreign activities.

EU-IFRS

 

     Average Balance Sheet—Liabilities and Interest from Interest-
bearing Liabilities
 
      2005     2004  
     Average
Balance
   Interest    Average
Rate(1)
    Average
Balance
   Interest    Average
Rate(1)
 
     (in millions of euro, except percentages)  

Liabilities

                

Deposits from central banks and credit institutions

   64,804    2,176    3.36 %   67,187    1,814    2.70 %

In euro

   36,453    797    2.19 %   41,327    824    1.99 %

In other currencies

   28,352    1,379    4.86 %   25,860    989    3.83 %

Customer deposits

   159,103    4,433    2.79 %   147,695    2,838    1.92 %

In euro (2)

   87,418    1,078    1.23 %   87,207    1,089    1.25 %

In other currencies(3)

   71,685    3,355    4.68 %   60,488    1,750    2.89 %

Debt certificates and subordinated liabilities

   68,924    1,886    2.74 %   51,518    1,466    2.85 %

In euro

   64,188    1,573    2.45 %   47,455    1,254    2.64 %

In other currencies

   4,736    313    6.61 %   4,063    211    5.20 %

Other financial costs

   0    439    —       —      331    —    

Non-interest-bearing liabilities

   55,544    —      —       42,688    —      —    

Shareholder’s equity

   15,680    —      —       12,739    —      —    
                                

Total average liabilities

   364,055    8,934    2.45 %   321,827    6,448    2.00 %
                                

(1) Rates have been presented on a non-taxable equivalent basis.

 

(2) Amounts reflected in euro correspond to predominantly domestic activities.

 

(3) Amounts reflected in other currencies correspond to predominantly foreign activities.

 

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Table of Contents

Spanish GAAP

 

     Average Balance Sheet—Liabilities and
Interest paid on Interest Bearing
Liabilities
 
     2003  
     Average
Balance
    Interest     Average
Rate(1)
 
     (in millions of euro, except percentages)  

Liabilities

      

Credit entities

   55,061     1,809     3.3 %

In euro

   33,407     818     2.4 %

In other currencies

   21,654     992     4.6 %

Customer funds

   181,977     4,282     2.4 %

Customer deposits

   142,279     3,068     2.2 %

In euro (2)

   84,868     1,316     1.6 %

Government and other agencies

   3,459     57     1.6 %

Current accounts

   23,079     219     0.9 %

Savings accounts

   16,117     90     0.6 %

Time accounts

   26,757     681     2.5 %

Others

   15,456     270     1.7 %

In other currencies (3)

   57,411     1,752     3.1 %

Current accounts

   13,147     120     0.9 %

Savings accounts

   6,263     96     1.5 %

Time accounts

   32,061     1,272     4.0 %

Others

   5,939     263     4.4 %

Debt securities and other marketable securities

   39,698     1,214     3.1 %

In euro

   33,864     974     2.9 %

In other currencies

   5,834     241     4.1 %

Other financial costs

   —       168     —    

Non-interest-bearing liabilities

   42,207     —       —    

Shareholders’ funds

   12,069     —       —    

Other funds without cost

   30,138     —       —    
              

Total average liabilities

   279,245     6,260     2.2 %
              

Total euro liabilities/total liabilities

   69.60 %   52.33 %   —    

(1) Rates have been presented on a non-taxable equivalent basis.

 

(2) Amounts reflected in euro correspond to predominantly domestic activities.

 

(3) Amounts reflected in other currencies correspond to predominantly foreign activities.

Changes in Net Interest Income-Volume and Rate Analysis

The following table allocates changes in our net interest income between changes in volume and changes in rate for 2005 compared to 2004. Volume and rate variance have been calculated based on movements in average balances over the period and changes in interest rates on average interest-earning assets and average interest-bearing liabilities. The only out-of-period items and adjustments excluded from the following table are interest payments on loans which are made in a period other than the period during which they are due. Loan fees were included in the computation of interest income.

 

     2005/2004  
     Increase (Decrease) Due to
changes in
 
     Volume(1)     Rate(1)(2)     Net
Change
 
     (in millions of euro)  

Interest income

      

Cash and balances with central banks

   42     141     183  

Debt securities, equity instruments and derivatives

   583     141     724  

Loans and advances to credit institutions

   (84 )   90     6  

In euro (2)

   10     75     85  

In other currencies

   (134 )   55     (79 )

Loans and advances to customers

   1,692     847     2,539  

In euro (2)

   842     (249 )   593  

In other currencies

   1,198     749     1,946  

Other financial income

   —       82     82  
                  

Total income

   1,654     1,880     3,534  

 

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Table of Contents
     2005/2004  
     Increase (Decrease) Due to
changes in
 
     Volume(1)     Rate(1)(2)     Net
Change
 
     (in millions of euro)  

Interest expense

      

Deposits from central banks and credit institutions

   (64 )   427     362  

In euro

   (97 )   70     (28 )

In other currencies

   95     294     390  

Customer deposits

   219     1,375     1,595  

In euro

   3     (14 )   (11 )

In other currencies

   324     1,282     1,606  

Debt certificates and subordinated liabilities

   495     (75 )   421  

In euro

   442     (123 )   319  

In other currencies

   35     67     102  

Other financial costs

   —       109     109  
                  

Total expense

   846     1,640     2,486  
                  

Net interest income

   808     240     1,048  
                  

(1) Variances caused by changes in both volume and rate have been allocated proportionally to volume and rate.

 

(2) Rates have been presented on a non-taxable equivalent basis.

The following table allocates changes in our net interest income between changes in volume and changes in rate for 2004 compared to 2003 in accordance with generally accepted accounting principles which were in effect during the mentioned years for banks in Spain:

 

     2004/2003  
     Increase (Decrease) Due to
changes in
 
     Volume(2)     Rate(1)(2)     Net Change  
     (in millions of euro)  

Interest income

      

Credit entities

   (23 )   (34 )   (58 )

In euro

   24     (11 )   13  

In other currencies

   (87 )   17     (71 )

Lending

   880     (937 )   (57 )

In euro

   787     (751 )   37  

Government and other Agencies

   53     (55 )   (2 )

Commercial Loans

   31     (43 )   (12 )

Secured loans

   447     (420 )   27  

Others

   241     (217 )   24  

In other currencies

   (92 )   (2 )   (94 )

Secured Loans

   23     (26 )   (3 )

Other

   (135 )   44     (91 )

Securities portfolio

   305     (76 )   229  

Fixed income securities

   263     (273 )   (10 )

 

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Table of Contents

In euro

   207     (133 )   73  

In other currencies

   (65 )   (19 )   (84 )

Equity securities

   42     198     240  

Holdings in companies carried by the equity method

   (37 )   155     118  

Other holdings

   84     38     122  

Other assets

   4     51     54  
                  

Total assets

   1,118     (949 )   168  
                  

Interest expense

      

Credit entities

   366     (360 )   6  

In euro

   168     (161 )   7  

In other currencies

   197     (197 )   (1 )

Customer funds

   244     (445 )   (201 )

Customer deposits

   90     (343 )   (253 )

In euro

   23     (249 )   (226 )

Government and other agencies

   7     1     7  

Current accounts

   8     (53 )   (45 )

Savings accounts

   10     (19 )   (9 )

Time accounts

   (102 )   (40 )   (142 )

Others

   43     (80 )   (37 )

In other currencies

   82     (109 )   (27 )

Current accounts

   10     (3 )   7  

Savings accounts

   8     (9 )   (1 )

Time accounts

   80     (151 )   (71 )

Others

   (39 )   77     39  

Debt securities and other marketable securities

   190     (138 )   52  

In euro

   229     (131 )   99  

In other currencies

   (73 )   27     (47 )

Other liabilities

   10     26     36  
                  

Total liabilities

   538     (697 )   (159 )
                  

Net interest income

   580     (252 )   327  
                  

 

(1) Rates have been presented on a non-taxable equivalent basis.

 

(2) Variances caused by changes in both volume and rate have been allocated proportionally to volume and rate.

Interest Earning Assets—Margin and Spread

The following table analyzes the levels of our average earning assets and illustrates the comparative gross and net yields and spread obtained for each of the years indicated.

EU-IFRS

 

     Year ended December 31,  
     2005     2004  
     (in millions of euro, except percentages)  

Average interest earning assets

   340,387     291,163  

Gross yield(1)

   4.74 %   4.33 %

Net yield(2)

   4.43 %   3.92 %

Net interest margin(3)

   2.12 %   2.12 %

Average effective rate paid on all interest-bearing liabilities

   2.45 %   2.00 %

Spread(4)

   2.29 %   2.33 %

 

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Table of Contents

Spanish GAAP

 

     Year ended December 31,
2003
 
     (in millions of euro,
except percentages)
 

Average earning assets

   254,544  

Gross yield(1)

   5.10 %

Net yield(2)

   2.41 %

Net interest margin(3)

   2.65 %

Average effective rate paid on all interest-bearing liabilities

   2.20 %

Spread(4)

   2.90 %

(1) Gross yield represents total interest income divided by average interest earning assets.

 

(2) Net yield represents total interest income divided by total average assets.

 

(3) Net interest margin represents net interest income as percentage of average interest earning assets.

 

(4) Spread is the difference between gross yield and the average cost of interest-bearing liabilities.

ASSETS

Interest-Bearing Deposits in Other Banks

As of December 31, 2005, interbank deposits represented 6.77% of our assets. Of such interbank deposits, 47.43% were held outside of Spain and 52.57% in Spain. We believe that our deposits are generally placed with highly rated banks and have a lower risk than many loans we could make in Spain. Such deposits, however, are subject to the risk that the deposit banks may fail or the banking system of certain of the countries in which a portion of our deposits are made may face liquidity or other problems.

Securities Portfolio

As of December 31, 2005, our securities were carried on our Consolidated Balance Sheet at a book value of €94.74 billion, representing 24.14% of our assets. €17.23 billion or 18.19% of our securities consisted of Spanish Treasury bonds and Treasury bills. The average yield during 2005 on Treasury bonds and Treasury bills that BBVA held was 4.63%, compared to an average yield of approximately 5.23% earned on loans and leases during 2005. The market or appraised value of our total securities portfolio as of December 31, 2005 was €94.90 billion. See Notes 11, 12, 13 and 15 to the Consolidated Financial Statements. For a discussion of our investments in affiliates, see Note 18 to the Consolidated Financial Statements. For a discussion of the manner in which we value our securities, see Notes 2.1 and 2.2.c to the Consolidated Financial Statements.

The following table analyzes the book value and market value of our ownership of debt securities and equity securities at December 31, 2004 and December 31, 2005. Investments in affiliated companies consolidated under the equity method are not included in the table below.

EU-IFRS

 

     2005    2004
    

Book

Value

   Market or
appraised
  

Book

Value

   Market or
appraised
     Thousands of Euros

DEBT SECURITIES

           

TRADING PORTFOLIO

           

Domestic:

           

Spanish Government Securities

   2,344,643    2,344,643    6,776,570    6,776,570

Securities of, or guaranteed by, the Spanish government

   257,041    257,041    448,492    448,492

Other debt securities

   1,495,321    1,495,321    1,059,904    1,059,904

Total Domestic

   4,097,005    4,097,005    8,284,966    8,284,966

Total International

   20,406,502    20,406,502    22,111,613    22,111,613
                   

TOTAL TRADING PORTFOLIO

   24,503,507    24,503,507    30,396,579    30,396,579
                   

 

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Table of Contents

AVAILABLE FOR SALE PORTFOLIO

           

Domestic:

           

Spanish Government Securities

   13,006,983    13,006,983    14,776,179    14,776,179

Other Spanish Government securities

   1,173,493    1,173,493    1,561,653    1,561,653

Securities of, or guaranteed by, the Spanish government

   2,902    2,902    5,983    5,983

Other securities of the Spanish government

   90,104    90,104    93,416    93,416

Other debt securities

   2,431,401    2,431,401    2,621,807    2,621,807

Total Domestic

   16,704,883    16,704,883    19,059,038    19,059,038

International:

           

United States:

           

US Treasury

   252,011    252,011    14,486    14,486

Other US Government agencies

   2,705,939    2,705,939    1,031,575    1,031,575

States and political subdivisions

   51,672    51,672    56,254    56,254

Other government securities

   50    50    0    0

Other US securities

   979,906    979,906    647,877    647,877

Other countries:

           

Securities of other foreign Governments

   21,792,844    21,792,844    16,407,867    16,407,867

Other debt securities outside Spain

   8,484,673    8,484,673    7,820,130    7,820,130

Total International

   34,267,094    34,267,094    25,978,189    25,978,189
                   

TOTAL AVAILABLE FOR SALE

   50,971,977    50,971,977    45,037,227    45,037,227
                   

HELD TO MATURITY PORTFOLIO

           

Domestic:

           

Spanish Government

   363,022    374,594    337,434    346,357

Other debt securities

   842,116    862,679    265,420    273,162

Total Domestic

   1,205,138    1,237,273    602,854    619,519

Total International

   2,754,127    2,797,975    1,618,648    1,645,227
                   

TOTAL HELD TO MATURITY

   3,959,265    4,035,248    2,221,502    2,264,746
                   

TOTAL DEBT SECURITIES

   79,434,749    79,510,732    77,655,308    77,698,552
                   

EQUITY SECURITIES

           

TRADING PORTFOLIO

   6,245,534    6,245,534    5,690,885    5,690,885
                   

AVAILABLE FOR SALE PORTFOLIO

           

Domestic:

           

Equity listed

   6,190,118    6,190,118    6,683,561    6,683,561

Equity unlisted

   71,318    134,466    110,876    178,630

Other equities

   1,134,017    1,134,017    207,759    207,759

Total Domestic

   7,395,453    7,458,601    7,002,196    7,069,950

International:

           

United States:

           

Equity listed

   15,580    15,580    41    41

Equity unlisted

   10,149    10,149    3,769    3,769

Other equities

   24,025    25,959    6,477    6,477

Other countries:

           

Equity listed

   1,312,564    1,312,564    623,213    623,213

Equity unlisted

   45,451    45,451    270,135    270,135

Other equities

   258,788    273,099    60,486    60,486

Total International

   1,666,557    1,682,802    964,121    964,121
                   

TOTAL AVAILABLE FOR SALE

   9,062,010    9,141,403    7,966,317    8,034,071
                   

TOTAL EQUITY SECURITIES

   15,307,544    15,386,937    13,657,202    13,724,956
                   

TOTAL INVESTMENT SECURITIES

   94,742,293    94,897,662    91,312,510    91,423,508
                   

 

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The following table analyzes the book value and market value of our ownership of debt and equity securities at December 31, 2003. Investments in affiliated companies consolidated under the equity method are not included in the table below.

Spanish GAAP

 

     At December 31, 2003
     Book
Value
   Market or
Appraised*
     Million of Euros

Government debt securities

     

Trading portfolio:

     

Spanish government securities

   5,616    5,616

Securities of, or guaranteed by, the Spanish government

   —      —  

Available-for-sale portfolio:

     

Bank of Spain certificates of deposit

   —      —  

Spanish Treasury bills

   601    601

Other fixed interest securities:

     

Securities of, or guaranteed by, the Spanish government

   12,114    12,297

Held to maturity securities

   614    652
         

Total government securities

   18,945    19,166
         

Debentures and other debt securities

     

Trading portfolio:

     

Other fixed income securities

   20,015    20,015

Available-for-sale portfolio:

     

Other fixed income securities listed in Spain

   3,092    3,117

U.S. Treasury securities

   12    12

Securities of other U.S. government agencies and corporations

   1,515    1,510

Securities of other foreign governments

   23,645    23,792

Other fixed interest securities listed outside of Spain

   3,586    3,596

Other fixed interest securities not listed

   560    563

Held to maturity portfolio

   511    543
         

Total debentures and other debt securities

   52,936    53,148
         

Equity securities

     

Trading securities:

     

Equity securities

   2,029    2,029

Investment securities:

     

Equity listed

   501    523

Equity unlisted

   562    645
         

Total equity securities

   3,092    3,196
         

Total securities portfolio

   74,973    75,510
         

* Market values for listed securities are determined on the basis of their quoted values at the end of the year. Appraised values are used for unlisted securities based on our estimate or on unaudited financial statements, when available.

 

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The following table analyzes the maturities of our investment and fixed income securities excluding trading portfolio by type and geographical area as of December 31, 2005.

 

     Maturing at one year or
less
    Maturing after one year
to five years
    Maturing after five year
to ten years
    Maturing after ten
years
    Total
     Amount    Yield %     Amount    Yield %     Amount    Yield %     Amount    Yield %    
     (millions of euros, except percentages)

DEBT SECURITIES AVAILABLE FOR SALE PORTFOLIO

                      

Domestic:

                      

Spanish Government

   5,071,719    4.18 %   3,228,527    5.49 %   872,908    4.84 %   3,833,830    4.92 %   13,006,984

Other Spanish Government securities

   387,476    5.09 %   400,953    5.62 %   241,520    6.68 %   143,544    6.00 %   1,173,493

Securities of, or guaranteed by, the Spanish government

   2,902    0.10 %   —      —       —      —       —      —       2,902

Other securities of the Spanish government

   5,023    0.00 %   2,805    10.87 %   —      —       82,277    11.48 %   90,104

Other debt securities

   280,842    3.36 %   416,792    5.43 %   387,665    4.15 %   1,346,102    2.14 %   2,431,401
                                                

Total Domestic

   5,747,962    4.20 %   4,049,077    5.50 %   1,502,092    4.96 %   5,405,753    4.36 %   16,704,883
                                                

International:

                      

United States:

                      

US Treasury

   27,136    3.22 %   50    3.90 %   224,770    1.97 %   56    3.36 %   252,011

Other US Government agencies

   236,646    3.38 %   861,179    3.97 %   231,967    4.56 %   1,376,147    4.24 %   2,705,939

States and political subdivisions

   3,534    5.10 %   13,343    4.02 %   2,058    4.91 %   32,738    4.77 %   51,673

Other government securities

   —      —       50    —       —      —       —      —       50

Other US securities

   265,799    4.13 %   207,570    4.11 %   77,488    5.60 %   429,049    6.82 %   979,905

Other countries:

                      

Securities of other foreign Governments

   5,653,837    4.92 %   8,480,822    5.68 %   4,451,103    6.66 %   3,207,083    8.08 %   21,792,845

Other debt securities outside Spain

   1,244,452    4.18 %   1,999,918    4.17 %   2,407,707    4.34 %   2,832,595    4.70 %   8,484,672
                                                

Total International

   7,431,404    4.71 %   11,562,932    5.26 %   7,395,092    5.68 %   7,877,667    6.11 %   34,267,094
                                                

Total Available for sale

   13,179,366    4.49 %   15,612,009    5.32 %   8,897,184    5.56 %   13,283,419    5.39 %   50,971,977
                                                

HELD TO MATURITY PORTFOLIO

                      

Domestic:

                      

Spanish Government

   —      —       182,690    4.59 %   180,332    4.99 %   —      —       363,022

Other debt securities

   —      —       90,736    3.53 %   685,753    4.02 %   65,627    4.53 %   842,116

International:

   282,874    5.12 %   853,031    4.01 %   1,546,023    4.29 %   72,199    5.27 %   2,754,127
                                                

Total Held to maturity

   282,874    5.12 %   1,126,457    4.07 %   2,412,108    4.27 %   137,826    4.92 %   3,959,265
                                                

TOTAL DEBT SECURITIES

   13,462,240    4.50 %   16,738,466    5.24 %   11,309,291    5.28 %   13,473,945    5.39 %   54,931,242

 

(1) Rates have been presented on a non-taxable equivalent basis.

Loan Portfolio

As of December 31, 2005, our total loans and leases amounted to €222.0 billion, or 56.6% of total assets. During 2005, our loans in Spain increased by 18.0% compared to 2004. Our foreign loans increased by 60.4%, compared to 2004, as a result of the growth in lending in the Latin American countries where we operate. In local currency terms, the most significant growth in loans were of 18.2% in Chile, 34.3% in Peru, 21.0% in Colombia, 62.7% in Venezuela and 36.4% in Mexico. Net of our loan loss reserve, loans and leases amounted to €216.9 billion as of December 31, 2005. For a discussion of certain mandatory ratios relating to our loan portfolio, see “—Supervision and Regulation—Liquidity Ratio” and “—Investment Ratio”.

 

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Loans by Geographic Area

The following table analyzes, by domicile of the customer, our net loans and leases for each of the years indicated.

 

     At December 31,  
EU-IFRS    2005     2004  
     (in millions of euro)  

Domestic

   156,127     137,687  

Foreign:

    

Western Europe

   14,662     6,645  

Central and South America

   43,490     27,099  

United States

   6,196     3,044  

Other

   1,519     1,118  
            

Total foreign

   65,867     37,906  
            

Total lending

   221,994     175,593  

Valuation adjustments

   (5,144 )   (3,510 )

Total net lending

   216,850     172,083  
            

 

      At December 31,
Spanish GAAP    2003    2002    2001
     (in millions of euro)

Domestic

   113,485    101,013    97,910

Foreign:

        

Western Europe

   8,082    7,261    8,241

Central and South America

   23,016    28,321    36,202

United States

   3,118    757    4,157

Other

   1,126    3,963    3,710
              

Total foreign

   35,342    40,302    52,310
              

Total net lending

   148,827    141,315    150,220
              

Loans by Type of Customer

The following table analyzes by domicile and type of customer our net loans and leases for each of the years indicated. The analyses by type of customer are based principally on the requirements of the regulatory authorities in each country.

 

     At December 31,
EU-IFRS    2005    2004
     (in millions of euro)

Domestic:

     

Government

   16,089    16,039

Agriculture

   1,550    1,272

Industrial

   14,774    13,216

Real estate and construction

   24,937    19,952

Commercial and financial

   11,736    13,998

Loans to individuals

   67,964    54,725

Lease financing

   5,910    5,014

Other

   13,167    13,471
         

Total domestic

   156,127    137,687
         

 

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Foreign:

    

Government

   6,036     2,686  

Agriculture

   955     529  

Industrial

   3,155     9,360  

Real estate and construction

   11,624     4,457  

Commercial and financial

   24,459     8,083  

Loans to individuals

   14,619     9,262  

Lease financing

   816     352  

Other

   4,203     3,177  
            

Total foreign

   65,867     37,906  
            

Total loans and leases

   221,994     175,593  

Loan loss reserve

   (5,144 )   (3,510 )
            

Total net lending

   216,850     172,083  
            

 

     At December 31,  
Spanish GAAP    2003     2002     2001  
     (in millions of euro)  

Domestic:

      

Government

   13,403     12,562     12,196  

Agriculture

   1,057     698     533  

Industrial

   11,991     11,970     11,378  

Real estate and construction

   14,823     13,652     12,767  

Commercial and financial

   12,742     9,336     8,677  

Loans to individuals

   44,160     38,515     36,105  

Lease financing

   4,160     3,217     2,685  

Other

   13,333     12,923     10,900  
                  

Total domestic

   115,669     102,873     95,241  

Foreign

   37,602     43,540     60,907  
                  

Total loans and leases

   153,271     146,413     156,148  

Loan loss reserve

   (4,444 )   (5,098 )   (5,928 )
                  

Total net lending

   148,827     141,315     150,220  
                  

The following table sets forth a breakdown, by currency, of our net loan portfolio for 2004 and 2005.

 

     At December 31,
EU-IFRS    2005    2004
     (in millions of euro)

In euro

   164,309    140,398

In other currencies

   52,541    31,685
         

Total

   216,850    172,083
         

 

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     At December 31,
Spanish GAAP    2003    2002    2001
     (in millions of euro)

In euro

   120,152    106,590    98,982

In other currencies

   28,675    34,725    51,238
              

Total

   148,827    141,315    150,220

As of December 31, 2005, loans by BBVA and its subsidiaries to companies we are required to account for by the equity method amounted to €267.6 million, compared to €227.2 million as of December 31, 2004. Loans outstanding to the Spanish government and its agencies amounted to €22.13 billion, or 9.97% of our total loans and leases as of December 31, 2005, compared to €20.35 billion, or 11.59% of our total loans and leases as of December 31, 2004. None of our loans to companies controlled by the Spanish government are guaranteed by the government and, accordingly, we apply normal credit criteria in extending credit to such entities. Moreover, we carefully monitor such loans because governmental policies necessarily affect such borrowers.

Diversification in our loan portfolio is our principal means of reducing the risk of loan losses. We also carefully monitor our loans to borrowers in sectors or countries experiencing liquidity problems. Our exposure to our five largest borrowers as of December 31, 2005, excluding government-related loans, amounted to €8.48 billion, or approximately 3.82% of our total outstanding loans and leases.

Maturity and Interest Sensitivity

The following table sets forth an analysis by maturity of our total loans and leases by domicile of the office that issued the loan and type of customer as of December 31, 2005. The determination of maturities is based on contract terms.

 

EU-IFRS    Maturity     
     Due in One
Year or Less
   Due After One
Year Through
Five Years
   Due After
Five Years
   Total
     (in millions of euros)     

Domestic:

           

Government

   5,247    2,676    8,166    16,089

Agriculture

   953    444    153    1,550

Industrial

   6,124    3,445    5,205    14,774

Real estate and construction

   3,237    5,756    15,944    24,937

Commercial and financial

   10,340    1,001    395    11,736

Loans to individuals

   14,432    17,779    35,753    67,964

Lease financing

   176    3,098    2,636    5,910

Other

   8,557    2,686    1,924    13,167
                   

Total domestic

   49,066    36,885    70,176    156,127
                   

Foreign:

           

Government

   671    1,263    4,102    6,036

Agriculture

   513    311    131    955

Industrial

   1,708    731    716    3,155

Real estate and construction

   2,163    3,236    6,225    11,624

Commercial and financial

   11,408    10,059    2,992    24,459

Loans to individuals

   2,319    8,132    4,168    14,619

Lease financing

   480    200    136    816

Other

   1,897    1,251    1,055    4,203
                   

Total foreign

   21,159    25,183    19,525    65,867

Total loans and leases

   70,225    62,068    89,701    221,994
                   

 

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The following table sets forth a breakdown of our fixed and variable rate loans which had a maturity of one year or more as of December 31, 2005.

 

     Interest Sensitivity of
Outstanding Loans and Leases
Maturing in More Than One
Year
     Domestic    Foreign    Total
     (in millions of euro)

Fixed rate

   33,727    21,135    54,862

Variable rate

   73,332    23,575    96,907
              

Total

   107,059    44,710    151,769
              

Loan Loss Reserve

For a discussion of loan loss reserves, see “Item 5. Operating and Financial Review and Prospects—Critical accounting policies—Allowance for loan losses” and Note 2.2.c.4) to the Consolidated Financial Statements.

 

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The following table provides information, by domicile of customer, regarding our loan loss reserve and movements of loan charge-offs and recoveries for periods indicated.

 

     At December 31,  
EU-IFRS    2005     2004  
     (in millions of euro,
except percentages)
 

Loan loss reserve at beginning of period:

    

Domestic

   2,374     1,771  

Foreign

   2,248     3,274  
            

Total loan loss reserve at beginning of period

   4,622     5,046  
            

Loans charged off:

    

Government and other Agencies

   0     0  

Real estate and loans to individuals

   (138 )   (103 )

Commercial and financial

   (76 )   (36 )

Other

   0     0  

Total Domestic

   (215 )   (134 )

Foreign

   (452 )   (579 )
            

Total loans charged off

   (667 )   (713 )
            

Provision for loan losses:

    

Domestic

   624     737  

Foreign

   196     408  
            

Total provision for loan losses

   820     1,145  

Acquisition and disposition of subsidiaries

   144     —    

Effect of foreign currency translation

   370     (146 )

Other

   297     (708 )
            

Loan loss reserve at end of period:

    

Domestic

   3,079     2,374  

Foreign

   2,507     2,248  

Total loan loss reserve at end of period

   5,587     4,622  

Loan loss reserve as a percentage of total loans and leases at end of period

   2.52 %   2.63 %

Net loan charge-offs as a percentage of total loans and leases at end of period

   0.30 %   0.41 %

 

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Our loan loss reserves as a percentage of total loans and leases declined from 2.63% as of December 31, 2004, to 2.52% as of December 31, 2005, principally due to the increase in the volume of loans granted in 2005.

We do not maintain records allocating the amount of charge-offs and the amount of recoveries by loan category. See “—Substandard Loans” for information as to the breakdown as of December 31, 2005 by loan category of substandard loans. Also, at the time that a loan is charged off in accordance with Bank of Spain guidelines, it will normally be substantially or fully reserved and, accordingly, such charge-off would have a very limited effect on our net attributable profit or shareholders’ equity. Accordingly, we believe that information relating to domestic reserves and charge-offs by loan category is of less relevance than would be the case for a U.S. bank.

 

     At December 31,  
Spanish GAAP    2003     2002     2001  
     (in millions of euro, except percentages)  

Loan loss reserve at beginning of period:

      

Domestic

   1,599     1,375     1,222  

Foreign

   3,747     4,945     6,933  

Acquisition and disposition of subsidiaries

   —       (2 )   12  

Total loan loss reserve at beginning of period

   5,346     6,318     8,167  
                  

Loans written off:

      

Domestic

   (292 )   (337 )   (409 )

Foreign

   (931 )   (1,205 )   (4,929 )

of which due to FOBAPROA(*)

       (3,259 )
                  

Total loans written off

   (1,223 )   (1,542 )   (5,338 )
                  

Recoveries of loans previously written off:

      

Domestic

   105     112     124  

Foreign

   122     96     164  
                  

Total recoveries of loans previously written off

   227     208     288  

Net loans written off

   (996 )   (1,334 )   (5,050 )
                  

Provision for possible loan losses:

      

Domestic

   468     504     464  

Foreign

   809     1,238     1,455  

Total

   1,277     1,742     1,919  

Effect of foreign currency translation

   (711 )   (1,441 )   715  

Other

   (179 )   61     569  
                  

Total provision for possible loan losses

   387     362     3,203  
                  

Loan loss reserve at end of period:

      

Domestic

   1,832     1,599     1,375  

Foreign

   2,905     3,747     4,945  
                  

Total loan loss reserve at end of period

   4,737     5,346     6,320  
                  

(*) Due to accounting adjustments relating to FOBAPROA promissory notes.

 

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FOBAPROA adjustments

The foregoing table indicates that a €3,259 million charge off of loans in 2002 related to FOBAPROA promissory notes. Of this balance, €2,690 million related to a reduction to the provision for possible loan losses and the remaining €569 million related to other items which increased the provision for possible loan losses. BBVA’s ownership of the FOBAPROA promissory notes, which were held by Bancomer, arose in connection with measures taken by the Mexican Government during the Mexican economic crisis in 1994 and 1995. Under these measures, Mexican banks, including Bancomer, were allowed to transfer to the Mexican government the right to collect on a portion of their loan portfolio that was experiencing payment difficulties. In exchange, the Mexican government issued to such banks FOBAPROA promissory notes, guaranteed in part by the Mexican government, in an amount equal to the book value (net of provisions) of the loans transferred. The banks, however, remained responsible for 25% of the losses arising from the difference between the amount of the FOBAPROA promissory notes at the time exchanged, plus the accumulated accrued interest on such promissory notes, and the amount the Mexican government was able to recover on the loans transferred to it.

Since the Mexican government only guaranteed up to 75% of the FOBAPROA promissory notes, in 2001 BBVA concluded that the amount not guaranteed by the Mexican government was not collectible. Under Spanish GAAP, this 25% was considered a loss and was written off, with a reduction of assets and of the Allowance for Loan Losses on BBVA’s Consolidated Balance Sheets.

Substandard Loans

We classify loans as substandard loans in accordance to the requirements under IFRS in respect of “impaired loans”. As we described in Note 2.2.c.4 to the Consolidated Financial Statements, loans are considered to be impaired loans, and accrual of the interest thereon is suspended, when there are reasonable doubts that the loans will be recovered in full and/or the related interest will be collected for the amounts and on the dates initially agreed upon, taking into account the guarantees received by the consolidated entities to assure (in part or in full) the performance of transactions. In addition, all loans that are 90 days past due, even if well-collateralized and in the process of being collected, are automatically considered non-accrual if they are classified as substandard loans.

When the recovery of any recognized amount is considered to be remote, this amount is removed from the consolidated balance sheet, without prejudice to any actions taken by the consolidated entities in order to collect the amount until their rights extinguish in full through expiry, forgiveness or for other reasons.

Interest on all of our substandard non-accrual loans is not credited to income until actually collected. The amount of gross interest income that would have been recorded in respect of our substandard loans as of December 31, 2004 and 2005 under EU-IFRS was €750 million and €1,052 million, respectively.

Amounts collected in relation to impaired loans and receivables are used to recognize the related accrued interest and any excess amount is used to reduce the principal not yet repaid. The approximate amount of interest income on our substandard loans which was included in net attributable profit under Spanish GAAP in 2003 was €357.4 million. The approximate amount of interest income on our substandard loans which was included in income attributed to the Group in 2004 and 2005 under EU-IFRS was €138.3 million and 148.1 million, respectively

 

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The following table provides information, by domicile of customer, regarding our substandard loans for periods indicated.

EU-IFRS

 

     At December 31,  
     2005     2004  
     (in millions of euro, except
percentages)
 

Substandard loans:

    

Domestic

   849     954  

Public sector

   33     33  

Other resident sectors

   721     832  

Non-resident sector

   96     89  

Country risk

   5     7  

Other

   90     82  

Foreign

   1,497     1,248  

Public sector

   89     74  

Other resident sectors

   73     48  

Non-resident sector

   1,335     1,126  

Country risk

   1     3  

Other

   1,334     1,123  
            

Total substandard loans

   2,346     2,202  
            

Total loan loss reserve

   5,587     4,622  
            

Substandard loans net of reserves

   (3,241 )   (2,420 )

Substandard loans as a percentage of loans and receivables

   0.92 %   1.10 %

Substandard loans (net of reserves) as a percentage of loans and receivables

   (1.27 %)   (1.21 )%

Spanish GAAP

 

     At December 31,  
     2003     2002     2001  
     (in millions of euro, except percentages)  

Substandard loans:

      

Non-performing loans

   2,672     3,474     2,737  

Public sector

   535     508     41  

Other resident sectors

   733     771     786  

Non-resident sector

      

Country risk

   12     196     27  

Other

   1,392     1,999     1,883  

Other non-performing loans

   454     57     6  

Resident sector

   —       —       —    

Non-resident sector

   454     57     6  
                  

Total substandard loans

   3,127     3,531     2,743  
                  

Loan loss reserve

      

Credit loan loss reserve

   4,444     5,098     5,928  

Other loan loss reserve—Fixed income portfolio

   121     125     253  

Credit entities

   171     123     139  
                  

Total loan loss reserve

   4,736     5,346     6,320  
                  

Substandard loans net of reserves

   (1,609 )   (1,815 )   (3,577 )

Non-performing loans as a percentage of total loans and leases

   1.74 %   2.37 %   1.75 %

Non performing loans (net of reserves) as a percentage of total loans

   (1.16 )%   (1.11 )%   (2.04 )%

 

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Our total substandard loans amounted to €2,346 million as of December 31, 2005, compared to €2,202 million as of December 31, 2004, principally due to the consolidation of the companies acquired during 2005, and the effect of the appreciation of Latin American currencies with respect to the euro. As a result of the increase in loan loss reserves described above under “—Loan Loss Reserve” and the small increase in total substandard loans described above, our substandard loans as a percentage of total loans and receivables decreased from 1.10% to 0.92% and our loan loss reserves as a percentage of substandard loans increased from 209.90% to 238.15%, in each case as of December 31, 2004 and December 31, 2005, respectively.

We experience higher substandard loans in our Latin American operations, as a percentage of total loans, than in our Spanish operations and actively monitor the higher risk profile of the loan portfolios of our Latin American operations.

As of December 31, 2005, we do not believe that there is a material amount of loans not included in the foregoing table where known information about possible credit problems of the borrowers gives rise to serious doubts as to the ability of the borrowers to comply with the currently applicable loan repayment terms.

The following table provides information, by domicile and type of customer, regarding our substandard loans and the loan loss reserves taken for each substandard loan category, as of December 31, 2005.

EU-IFRS

 

      Substandard
Loans
   Loan
Loss
Reserve
   Substandard
Loans as a
percentage
of Loans in
Category
 
     (in millions of euro)  

Domestic:

        

Government

   33    66    0.21 %

Agricultural

   10    7    0.65 %

Industrial

   84    53    0.57 %

Real estate and construction

   120    78    0.48 %

Commercial and financial

   119    85    1.01 %

Loans to individuals

   410    200    0.60 %

Other

   73    53    0.40 %
            

Total domestic

   849    542    0.55 %

Foreign:

        

Country risk

   20    88   

Other

   1,477    1,404   
            

Total foreign

   1,497    1,492    2.28 %

General reserve

      3,553   
            

Total substandard loans

   2,346    5,587    1.06 %
            

Foreign Country Outstandings

The following tables sets forth, as of the end of the years indicated, the aggregate amounts of our cross-border outstandings (which consist of loans, interest-bearing deposits with other banks, acceptances and other monetary assets denominated in a currency other than the home-country currency of the office where the item is booked) where outstandings in the borrower’s country exceeded 1% of our total assets at December 31, 2005,

 

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and at December 31, 2004. Cross-border outstandings do not include loans in local currency made by our subsidiary banks to customers in other countries to the extent that such loans are funded in the local currency or hedged. As a result, they do not include the vast majority of the loans made by our Latin American subsidiaries.

EU-IFRS

 

     At December 31,  
     2005     2004  
     Amount    % of
Total Assets
    Amount    % of
Total Assets
 
     (in millions of euro, except percentages)  

O.E.C.D.

          

United Kingdom

   5,497    1.40 %   2,326    0.71 %

Mexico

   5,961    1.52 %   5,892    1.79 %

Other O.E.C.D.

   5,239    1.34 %   4,313    1.31 %
                      

Total O.E.C.D.

   16,697    4.26 %   12,531    3.80 %
                      

Central and South America

   3,747    0.95 %   3,005    0.91 %

Other

   1,785    0.45 %   1,208    0.37 %
                      

Total

   22,229    5.67 %   16,744    5.08 %
                      

Spanish GAAP

 

     At December 31,  
     2003  
     Amount    % of
Total Assets
 
     (in millions of euro, except
percentages)
 

O.E.C.D.

     

United Kingdom

   3,532    1.23 %

Mexico

   6,682    2.33 %

Other O.E.C.D.

   4,335    1.51 %
           

Total O.E.C.D.

   14,549    5.07 %
           

Central and South America

   3,595    1.25 %

Other

   1,265    0.44 %
           

Total

   19,409    6.76 %
           

 

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The following tables sets forth the amounts of our cross-border outstandings as of December 31 of each year indicated by type of borrower where outstandings in the borrower’s country exceeded 1% of our total assets.

EU-IFRS

 

     Governments    Banks and
Other
Financial
Institutions
   Commercial,
Industrial
and Other
   Total
     (in millions of euro)

2005

           

Mexico

   2,650    739    2,572    5,961

United Kingdom

   —      3,701    1,796    5,497
                   

Total

   2,650    4,440    4,368    11,458
                   

2004

           

Mexico

   2,494    892    2,507    5,892

United Kingdom

   —      1,360    966    2,326
                   

Total

   2,494    2,252    3,473    8,218
                   

Spanish GAAP

 

     Governments    Banks and
Other
Financial
Institutions
   Commercial,
Industrial
and Other
   Total
     (in millions of euro)

2003

           

Mexico

   3,662    702    2,318    6,682

United Kingdom

   —      2,426    1,106    3,532
                   

Total

   3,662    3,128    3,424    10,214
                   

The Bank of Spain requires that minimum reserves be maintained for cross-border risk arising with respect to loans and other outstandings to countries, or residents of countries, falling into certain categories established by the Bank of Spain on the basis of the level of perceived transfer risk. The category that a country falls into is determined by us, subject to review by the Bank of Spain.

The following table shows the minimum required reserves with respect to each category of country. For BBVA’s level of coverage as of December 31, 2005.

 

Categories(1)

   Minimum Percentage of
Coverage (Outstandings
Within Category)

Countries belonging to the OECD whose currencies are quoted in the Spanish foreign exchange market

   0.0

Countries with transitory difficulties(2)

   10.1

Doubtful countries(2)

   22.8

Very doubtful countries(2)(3)

   83.5

Bankrupt countries(4)

   100.0

(1) Any outstanding which is guaranteed may be treated, for the purposes of the foregoing, as if it were an obligation of the guarantor.

 

(2) Coverage for the aggregate of these three categories must equal at least 35% of outstanding loans within the three categories. The Bank of Spain has recommended up to 50% aggregate coverage.

 

(3) Outstandings to very doubtful countries are treated as substandard under Bank of Spain regulations.

 

(4) Outstandings to bankrupt countries must be charged off immediately. As a result, no such outstandings are reflected on our consolidated balance sheet. Notwithstanding the foregoing minimum required reserves, certain interbank outstandings with an original maturity of three months or less have minimum required reserves of 50%. We met or exceeded the minimum percentage of required coverage with respect to each of the foregoing categories.

 

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Our exposure to borrowers in countries with difficulties (the last 4 categories in the foregoing table), excluding our exposure to subsidiaries or companies we manage and trade-related debt, amounted to €927 million €378 million and €690 million as of December 31, 2003, 2004 and 2005, respectively. These figures do not reflect loan loss reserves of 66.2%, 30.0% and 11.9%, respectively, against the relevant amounts outstanding at such dates. Deposits with or loans to borrowers in all such countries as of December 31, 2005 did not in the aggregate exceed 0.18% of our total assets.

The country-risk exposures described in the preceding paragraph as of December 31, 2005, 2004 and 2003 do not include exposures for which insurance policies have been taken out with third parties that include coverage of the risk of confiscation, expropriation, nationalization, nontransfer, nonconvertibility and, if appropriate, war and political violence. The sums insured as of December 31, 2005, 2004 and 2003, amounted to $108 million, $153 million and $466 million, respectively (approximately €91 million, €113 million and €369 million, respectively based on a euro/dollar exchange rate on December 31, 2005 of $1.00 = €0.85, on December 31, 2004 of $1.00=€0.73 and on December 31, 2003 of $1.00 = €0.79).

LIABILITIES

Deposits

The principal components of our customer deposits are domestic demand and savings deposits and foreign time deposits. The following tables provide information regarding our deposits by principal geographic area for the dates indicated.

EU-IFRS

 

      At December 31, 2005
     Customer
Deposits
  

Bank of Spain and
Other Central

Banks

  

Other

Credit
Institutions

   Total
     (in millions of euro)

Domestic

   62,471,990    19,652,319    8,487,493    90,611,802

Foreign:

           

Western Europe

   43,018,989    —      15,615,660    58,634,649

Latin America

   11,871,560    1,512,672    7,750,921    21,135,153

United States

   58,172,985    2,368    5,388,919    63,564,272

Other

   5,903,602    —      7,725,480    13,629,082
                   

Total foreign

   118,967,136    1,515,040    36,480,980    156,963,156
                   

Total

   181,439,126    21,167,359    44,968,473    247,574,958
                   
     At December 31, 2004
     Customer
Deposits
  

Bank of Spain and

Other Central
Banks

  

Other

Credit
Institutions

   Total
     (in millions of euro)

Domestic

   77,221,614    17,907,860    13,012,661    108,142,135

Foreign:

           

Western Europe

   11,937,071    —      16,882,647    28,819,718

Latin America

   46,054,545    2,228,168    7,135,061    55,417,774

United States

   7,852,097    —      775,779    8,627,876

Other

   5,175,346    —      5,853,690    11,029,036
                   

Total foreign

   71,019,059    2,228,168    30,647,177    103,894,404
                   

Total

   148,240,673    20,136,028    43,659,838    212,036,539
                   

 

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Spanish GAAP

 

     At December 31, 2003
     Customer
Deposits
   Bank of Spain and
Other Central
Banks
   Other
Credit
Institutions
   Total
     (in millions of euro)

Domestic

   74,032    18,374    14,863    107,269

Foreign:

           

Western Europe

   10,914    —      11,078    21,992

Latin America

   44,674    2,550    9,175    56,399

United States

   3,381    —      1,687    5,068

Other

   8,048    —      3,842    11,890
                   

Total foreign

   67,017    2,550    25,782    95,349
                   

Total

   141,049    20,924    40,645    202,618
                   

For an analysis of our deposits, including non-interest bearing demand deposits, interest-bearing demand deposits, saving deposits and time deposits, see Note 26 to the Consolidated Financial Statements.

As of December 31, 2005, the maturity of our time deposits (excluding interbank deposits) in denominations of $100,000 (approximately €80,645 considering the noon buying rate as of December 31, 2005) or greater was as follows:

 

     At December 31, 2005
     Domestic    Foreign    Total
     (in millions of euro)

3 months or Under

   7,038    36,779    43,817

Over 3 to 6 months

   1,221    4,507    5,728

Over 6 to 12 months

   592    2,458    3,050

Over 12 months

   4,271    291    4,562
              

Total

   13,122    44,035    57,157
              

Time deposits from Spanish and foreign financial institutions amounted to €28.8 billion as of December 31, 2005, substantially all of which were in excess of $100,000 (approximately €80,645 as of December 31, 2005).

Large denomination deposits may be a less stable source of funds than demand and savings deposits because they are more sensitive to variations in interest rates. For a breakdown by currency of deposits as of December 31, 2005 and 2004, see Note 26 to the Consolidated Financial Statements.

Short-term Borrowings

Securities sold under agreements to repurchase and promissory notes issued by us constituted the only categories of short-term borrowings that equaled or exceeded 30% of stockholders’ equity at December 31, 2004 and 2005.

EU-IFRS

 

     At December 31,  
     2005     2004  
     Amount    Average Rate     Amount    Average Rate  
     (in millions of euro, except percentages)  

Securities sold under agreements to repurchase

          

At December 31

   48,254    3.54 %   38,529    3.36 %

Average during year

   38,467    3.52 %   43,488    3.44 %

Maximum quarter-end balance

   48,254    —       49,642    —    

Bonds, debentures outstanding and subordinated debt

          

At December 31

   14,273    3.54 %   7,082    2.81 %

Average during year

   10,324    3.61 %   7,628    2.39 %

Maximum quarter-end balance

   14,273    —       9,568    —    

Bank promissory notes:

          

At December 31

   7,569    2.58 %   6,255    2.20 %

Average during year

   6,894    2.34 %   5,675    2.08 %

Maximum quarter-end balance

   7,569    —       6,255    —    

Total short-term borrowings at December 31

   70,096    3.44 %   51,866    3.14 %

 

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Spanish GAAP

 

     At December 31,  
     2003  
     Amount    Average Rate  
     (in millions of euro, except
percentages)
 

Securities sold under agreements to repurchase (principally Spanish Treasury bills):

     

At December 31

   38,483    2.81 %

Average during year

   36,759    3.52 %

Maximum quarter-end balance

   38,483    —    

Bonds, debentures outstanding and subordinated debt

     

At December 31

   8,173    3.00 %

Average during year

   7,829    3.09 %

Maximum quarter-end balance

   10,764    —    

Bank promissory notes:

     

At December 31

   6,087    2.11 %

Average during year

   4,666    2.13 %

Maximum quarter-end balance

   6,219    —    

Total short-term borrowings at December 31

   52,743    2.76 %

Return on Equity

The following table sets out our return on equity ratios:

EU-IFRS

 

      As of or for the year ended
December 31,
     2005    2004

ROE (income attributed to the group/average equity)

   37.0    33.2

ROA (income before minority interests/average total assets)

   1.12    0.97

RORWA (income before minority interests/risk weighted assets)

   1.91    1.62

Dividend pay-out ratio

   47.3    53.4

Equity to assets ratio

   3.32    3.32

Spanish GAAP

 

      As of or for the year ended
December 31, 2003

ROE (income attributed to the group/average equity)

   18.4

ROA (income before minority interests/average total assets)

   1.04

RORWA (income before minority interests/risk weighted assets)

   1.74

Dividend pay-out ratio

   55.0

Equity to assets ratio

   4.32

 

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F. Competition

The commercial banking sector in Spain has undergone significant consolidation. In the majority of the markets where we provide financial services, Santander Central Hispano is our strongest competitor.

We face strong competition in all of our principal areas of operation. The deregulation of interest rates on deposits in the past decade has led to increased competition for large demand deposits in Spain and the widespread promotion of interest-bearing demand deposit accounts and mutual funds. The capturing of customer funds in Spain had been characterized for several years by a large shift of deposits into mutual funds. However, in recent years both types of assets have recorded substantial growth. In 2004, mutual fund assets under management grew by 12.0% and in 2005 by 12,9%. The trend in deposits has been favorable and deposits in the banking sector increased by 14.3% and 26.8% in 2004 and 2005, respectively.

Spanish savings banks and money market mutual funds provide strong competition for savings deposits, which form an important part of our deposit base, and, in the case of savings banks, for other retail banking services. Credit cooperatives, which are active principally in rural areas, where they provide savings bank and loan services and related services such as the financing of agricultural machinery and supplies, are also a source of competition.

The entry of on-line banks into the Spanish banking system has increased competition, mainly in customer funds businesses such as deposits and especially in saving and time deposits. Insurance companies and other financial services firms also compete for customer funds. Like the commercial banks, savings banks, insurance companies and other financial services firms are expanding the services offered to consumers in Spain. We face competition in mortgage loans from saving banks and, to a lesser extent, cooperatives.

The EU Directive on Investment Services took effect on December 31, 1995. The EU Directive permits all brokerage houses authorized to operate in other member states of the EU to carry out investment services in Spain. Although the EU Directive is not specifically addressed to banks, it affects the activities of banks operating in Spain.

Foreign banks also have a strong presence in Spain. As of December 31, 2005, approximately 85 foreign banks, of which 65 were branches, operated in Spain and several foreign banks have acquired small and medium-sized Spanish banks.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

Not applicable.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Overview

2005 witnessed the continued expansion of the world economy which, with growth of over 4% in terms of global GDP (according to our internal estimates), notably withstood the pressure exerted by rising oil prices. As economic growth gathered momentum and inflation risk rose, the U.S. Federal Reserve gradually increased its official interest rates from 1% in June 2004 to 4.25% at year-end 2005, in spite of which long-term interest rates remained very low (on average, in 2005, the 10 year rate was the same as in 2004), resulting in a flattening of the rate curve.

On December 1, 2005, the European Central Bank signaled an imminent rise in interest rates when it set its official rate at 2.25%, following two-and-a-half years in which it had stood at 2.00%. Although this triggered an upswing in Euribor in the fourth quarter of 2005, in 2005, 10-year interest rates were lower, on average, than in 2004. In 2005, the European economy grew at a slower rate than in 2004. However, according to the Spanish National Institute of Statistics (Instituto Nacional de Estadística) the Spanish economy reported 3.4% growth, up

 

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from 3.1% in 2004, fuelled by burgeoning domestic consumer demand and household and corporate investment; this growth figure also reflects the adverse contribution of the foreign sector and rising inflation.

Latin America, one of the regions benefiting from the international economic climate, achieved growth in 2005 of more than 4% in terms of GDP (according to our internal estimates). In what proved to be the third consecutive year of significant expansion, the economic performance of this region was characterized by the fact that most of the Latin American countries experienced economic growth in 2005. The increase in raw materials prices, the appreciation of the nominal exchange rate of the local currencies and the reduction in risk premiums all had a favorable impact on the region. Interest rates in Mexico, which peaked in May 2005, began to fall back at the end of August of that year; this, combined with the appreciation of the Mexican peso against the U.S. dollar, helped to keep inflation at an all-time low.

Critical Accounting Policies

The BBVA Group’s consolidated financial statements as of and for the years ended December 31, 2005 and December 31, 2004 were prepared by the Bank’s directors in accordance with EU-IFRS and by applying the basis of consolidation, accounting policies and measurement bases described in Note 2 to the Consolidated Financial Statements, so that they present fairly the Group’s equity and financial position at December 31, 2005 and December 31, 2004, and the results of its operations, the changes in consolidated equity and the consolidated cash flows in 2005 and 2004. These consolidated financial statements were prepared on the basis of the accounting records kept by the Bank and by each of the other Group companies and include the adjustments and reclassifications required to unify the accounting policies and measurement bases used by the Group (Note 2.2 to the Consolidated Financial Statements).

In preparing the consolidated financial statements estimates were occasionally made by the Group and the consolidated companies in order to quantify certain of the assets, liabilities, income, expenses and commitments reported herein. These estimates relate mainly to the following:

 

    The impairment losses on certain assets.

 

    The assumptions used in the actuarial calculation of the post-employment benefit liabilities and commitments.

 

    The useful life of tangible and intangible assets.

 

    The measurement of goodwill arising on consolidation.

 

    The fair value of certain unquoted assets.

Although these estimates were made on the basis of the best information available at December 31, 2005 on the events analyzed, events that take place in the future might make it necessary to change these estimates (upwards or downwards) in coming years.

The presentation format used and EU-IFRS applied vary in certain respects from the presentation format and accounting rules required to be applied under generally accepted accounting principles in the United States (“U.S. GAAP”) and other rules that are applicable to U.S. banks. The tables included in Note 59 to our Consolidated Financial Statements give the effect that application of U.S. GAAP would have on income for the year and shareholders’ equity as reported under EU-IFRS.

Note 2 to the Consolidated Financial Statements contains a summary of our significant accounting policies. We consider certain of these policies to be particularly important due to their effect on the financial reporting of our financial condition and because they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Our reported financial condition and results of operations are sensitive to accounting methods, assumptions and estimates that underlie the preparation of the Consolidated Financial Statements. The nature of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors to be considered when reviewing our Consolidated Financial Statements and the discussion below. We have identified the following accounting policies as critical to the understanding of our results of operations, since the application of these policies requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change.

Fair value of financial instruments

The fair value of an asset or a liability on a given date is taken to be the amount for which it could be bought or sold on that date by two knowledgeable, independent parties in an arm’s length transaction acting prudently. The most objective and common reference for the fair value of an asset or a liability is the price that would be paid for it on an organized, transparent and deep market (“quoted price” or “market price”).

If there is no market price for a given asset or liability, its fair value is estimated on the basis of the price established in recent transactions involving similar instruments and, in the absence thereof, by using mathematical measurement models sufficiently tried and trusted by the international financial community. Such estimates would take into consideration the specific features of the asset or liability to be measured and, in particular, the various types of risk associated with the asset or liability. However, the limitations inherent to the

 

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measurement models developed and the possible inaccuracies of the assumptions required by these models may signify that the fair value of an asset or liability thus estimated does not coincide exactly with the price for which the asset or liability could be purchased or sold on the date of its measurement.

Derivatives and other futures transactions

These instruments include unmatured foreign currency purchase and sale transactions, unmatured securities purchase and sale transactions, futures transactions relating to securities, exchange rates or interest rates, forward interest rate agreements, options relating to exchange rates, securities or interest rates and various types of financial swaps.

All derivatives are recognized in the balance sheet at fair value from the date of arrangement. If the fair value of a derivative is positive, it is recorded as an asset and if it is negative, it is recorded as a liability. Unless there is evidence to the contrary, it is understood that on the date of arrangement the fair value of the derivatives is equal to the transaction price. Changes in the fair value of derivatives after the date of arrangement are recognized with a balancing entry under the heading Gains or Losses on Financial Assets and Liabilities in the consolidated income statement. Specifically, the fair value of the standard financial derivatives included in the held for trading portfolios is equal to their daily quoted price, If, under exceptional circumstances, their quoted price cannot be established on a given date, these derivatives are measured using methods similar to those used to measure over-the-counter (“OTC”) derivatives.

The fair value of OTC derivatives is equal to the sum of the future cash flows arising from the instrument, discounted at the measurement date (“present value” or “theoretical close”); these derivatives are measured using methods recognized by the financial markets, including the net present value (NPV) method and option price calculation models.

Financial derivatives that have as their underlying equity instruments whose fair value cannot be determined in a sufficiently objective manner and are settled by delivery of those instruments, are measured at cost.

Goodwill in consolidation

The positive differences between the cost of business combinations and the acquired percentage of the net fair value of the assets, liabilities and contingent liabilities of the acquirees are recorded as goodwill on the asset side of the balance sheet. Goodwill represents the future economic benefits from assets that cannot be individually identified and separately recognized. Goodwill is not amortized but is submitted to impairment analysis. Any impaired goodwill is written off.

Goodwill is allocated to one or more cash-generating units expected to benefit from the synergies arising from business combinations. The cash-generating units represent the Group’s business and/or geographical segments as managed internally by its directors.

The cash-generating units to which goodwill has been allocated are tested for impairment based on the carrying amount of the unit including the allocated goodwill. Such testing is performed at least annually and whenever there is an indication of impairment.

For the purpose of determining the impairment of a cash-generating unit to which goodwill has been allocated, the carrying amount of that unit, adjusted by the theoretical amount of the goodwill attributable to the minority interest, shall be compared with its recoverable amount. The resulting loss shall be apportioned by reducing, firstly, the carrying amount of the goodwill allocated to that unit and, secondly, if there are still impairment losses remaining to be recognized, the carrying amount of the rest of the assets. This shall be done by allocating the remaining loss in proportion to the carrying amount of each of the assets in the unit. It will be taken into account that no impairment of goodwill attributable to the minority interest may be recognized, In any case, impairment losses on goodwill can never be reversed.

 

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Pension commitments and other commitments to employees

Pension and post-retirement benefit costs and credits are based on actuarial calculations. Inherent in these calculations are assumptions including discount rates, rate of salary increase and expected return on plan assets. Changes in pension and post-retirement costs may occur in the future as a consequence of changes in interest rates, expected return on assets or other assumptions. See Note 2.2.f) to the Consolidated Financial Statements contains a summary of our significant accounting policies and the actuarial Assumptions used.

Allowance for loan losses

Our loan loss reserve is intended to cover losses in connection with substandard loans (including risks and other losses relating to certain performing loans and operations). As we describe in Note 2.2.c.4) to the Consolidated Financial Statements, a loan is considered to be an impaired or substandard loan—and therefore its carrying amount is adjusted to reflect the effect of its impairment—when there is objective evidence that events have occurred which, in the case of loans, give rise to a negative impact on the future cash flows that were estimated at the time the transaction was arranged.

As a general rule, the carrying amount of an impaired loan is adjusted with a charge to the consolidated income statement for the year in which the impairment becomes known, and the recoveries of previously recognized impairment losses are recognized in the consolidated income statement for the year in which the impairment is reversed or reduced.

The amount of the impairment losses incurred on these instruments relates to the positive difference between their respective carrying amounts and the present values of their expected future cash flows. The following is to be taken into consideration when estimating the future cash flows:

 

    all the amounts that are expected to be obtained over the residual life of the instrument, including, where appropriate, those which may result from the guarantees provided for the instrument (after deducting the costs required for foreclosure and subsequent sale);

 

    the various types of risk to which each instrument is subject; and

 

    the circumstances in which collections will foreseeably be made.

These cash flows are subsequently discounted using the instrument’s effective interest rate (if its contractual rate is fixed) or the effective contractual interest rate at the discount date (if it is variable).

The possible impairment losses on these assets are determined:

 

    individually, for all significant loans and for those which, although not significant, cannot be classified in homogenous groups of instruments of similar characteristics, i.e., by instrument type, debtor’s industry and geographical location, type of guarantee, age of past-due amounts, etc.

 

    collectively, in all other cases.

Criteria for determining impairment losses resulting from materialization of the insolvency risk of the obligors have been established. Under these criteria, a loan is impaired due to insolvency:

 

    when there is evidence of a deterioration of the obligor’s ability to pay, either because it is in arrears or for other reasons, and/or

 

    when country risk materializes; country risk is considered to be the risk associated with debtors resident in a given country due to circumstances other than normal commercial risk.

Similarly, different classifications of transactions have been established on the basis of the nature of the obligors, the conditions of the countries in which they reside, transaction status, type of associated guarantees, and time in arrears. For each of these risk groups minimum impairment losses (“identified losses”) that must be recognized in the financial statements of consolidated entities are established by BBVA.

In addition to the recognition of identified losses, provisioning, for the losses inherent in loans not measured at fair value through profit or loss and in contingent risks classified as standard is recognized taking into account the historical experience of impairment and the other circumstances known at the time of the assessment. For these purposes, inherent losses are the losses incurred at the date of the financial statements, calculated using statistical procedures, that have not been allocated to specific transactions.

The Group has implemented a methodology which complies with IFRS and is consistent with by the Bank of Spain requirements related to the determination of the level of provisions required to cover inherent losses. The aforementioned methodology takes as the first step the classification of portfolios considered as normal risk (debt instruments not valued at their fair value with changes in the income statement, as with contingent risks and contingent commitments). Once the portfolios have been classified in the aforementioned groups, the Bank of Spain, based on its experience and the information available to it with respect to

the Spanish banking sector, has determined the method and amount of the parameters that entities should apply in the calculation of the provisions for inherent losses in debt instruments and contingent risks classified as normal risk.

The Group estimates the provisions to be made to create these allowances using models based on our own credit loss experience and management’s estimates of future credit losses. The Group has developed internal risk models, based on historical information available for each country and type of risk (homogenous portfolios). For a discussion of our credit risk management system, see “Item 11. Quantitative and Qualitative Disclosures about Market Risk”. These models produce a range of results that comprises the level of provisions that we arrive at using the model established by the Bank of Spain as explained above. These internal models may be applied in future periods but are subject to local regulatory review (the Bank of Spain). In order for each internal model to be considered valid by the local regulator, the calculation should be methodologically correct, and be supported by historical information which covers at least one complete economic cycle and stored in databases which are consistent with information that has been audited by both the Group’s internal audit function and external auditors.

The development of the internal model has led to the introduction of databases that can be used to accurately estimate the risk parameters required in the calculation of capital and expected loss, following best practices in the market and the guidelines of the New Capital Accord (Basel II).

Although there should be no substantial difference in the calculation of loan allowances between IFRS and U.S. GAAP, the Bank has included in the reconciliation of stockholders’ equity and net income a difference between IFRS and U.S. GAAP related to the determination of allowance losses not allocated to specific loans. According to U.S. GAAP, the loan loss allowance should represent the best estimate of probable losses in possible scenarios. Under IFRS, the Bank has additionally applied the statistical percentages obtained from historical trends as determined by the Bank of Spain’s guidance. As a result, the loan allowances not allocated to specific loans, as determined by using this method, are higher than those meeting the requirements of U.S. GAAP, being the amounts determined under both generally accepted accounting principles within the range of possible estimated losses calculated internally by the Group.

The estimates of the portfolio’s inherent risks and overall recovery vary with changes in the economy, individual industries, countries and individual borrowers’ or counterparties’ ability and willingness to repay their obligations. The degree to which any particular assumption affects the allowance for credit losses depends on the severity of the change and its relationship to the other assumptions.

Key judgments used in determining the allowance for loan losses include: (i) risk ratings for pools of commercial loans and leases; (ii) market and collateral values and discount rates for individually evaluated loans; (iii) product type classifications for consumer and commercial loans and leases; (iv) loss rates used for consumer and commercial loans and leases; (v) adjustments made to assess current events and conditions; (vi) considerations regarding domestic, global and individual countries economic uncertainty; and (vii) overall credit conditions.

A. Operating Results

Factors Affecting the Comparability of our Results of Operations and Financial Condition

We are exposed to foreign exchange rate risk in that our reporting currency is the euro, whereas certain of our subsidiaries keep their accounts in other currencies, principally Mexican pesos, Argentine pesos, Chilean pesos and Colombian pesos, Venezuelan bolivars, Peruvian nuevos soles and U.S. dollars. For example, if Latin American currencies and the U.S. dollar depreciate against the euro, when the results of operations of our Latin American subsidiaries are included in our Consolidated Financial Statements, the euro value of their results declines, even if, in local currency terms, their results of operations and financial condition have remained the same or improved relative to the prior year. Accordingly, declining exchange rates may limit the ability of our results of operations, stated in euro, to fully describe the performance in local currency terms of our Latin American subsidiaries. By contrast, the appreciation of Latin American currencies and the U.S. dollar against the euro would have a positive impact on the results of operations of our Latin American subsidiaries, when their results of operations are included in our Consolidated Financial Statements.

The assets and liabilities of our subsidiaries which keep their accounts in currencies other than the euro have been translated to euro at the period-end exchange rates for inclusion in our Consolidated Financial Statements. Income statement items have been translated at the average exchange rates for the period. The following table sets forth the exchange rates of several Latin American currencies against the euro, expressed in local currency per €1.00 at December 31, 2005 and 2004, respectively, according to the European Central Bank.

 

     As of December 31,    Change  
     2005    2004    2005/2004  

Mexican peso

   12.6357    15.1823    16.8 %

Venezuelan bolivar

   2,531.65    2,610.97    3.0 %

Colombian peso

   2,695.42    3,205.13    15.9 %

Chilean peso

   606.80    759.30    20.1 %

Peruvian new sol

   4.0434    4.4745    9.6 %

Argentinean peso

   3.5907    4.0488    11.3 %

U.S. dollar

   1.1797    1.3621    13.4 %

As shown in the table above, in 2005, the main Latin American currencies and the U.S. dollar appreciated against the euro, which had a positive impact on our results of operations for 2005 compared to 2004 and therefore affects the comparability of our historical results of operations for these two years.

 

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Table of Contents

BBVA Group Results of Operations

The changes in the Group’s consolidated income statements for 2005 and 2004 were as follows:

 

     Year ended
December 31,
    Change  
     2005     2004     2005/2004  
     (in millions of euro)     (in percentages)  

Consolidated Statement of Income

      

Interest and similar income

   15,848     12,352     28.3  

Interest expense and similar charges

   (8,932 )   (6,447 )   38.5  

Income from equity instruments

   292     255     14.6  
              

Net interest income

   7,208     6,160     17.0  

Share of profit or loss of entities accounted for using the equity method

   122     97     25.2  

Fee and commission income

   4,669     4,057     15.1  

Fee and commission expenses

   (729 )   (644 )   13.2  

Insurance activity income

   487     391     24.7  

Gains/(losses) on financial assets and liabilities (net)

   980     762     28.7  

Exchange differences (net)

   287     298     (3.7 )