20-F 1 d135658d20f.htm FORM 20-F Form 20-F
Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

¨ 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, 2015

OR

 

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

for the transition period from                      to                     

 

¨ 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 001-12518

BANCO SANTANDER, S.A.

(Exact name of Registrant as specified in its charter)

Kingdom of Spain

(Jurisdiction of incorporation)

Ciudad Grupo Santander

28660 Boadilla del Monte (Madrid), Spain

(address of principal executive offices)

José G. Cantera

Banco Santander, S.A.

Ciudad Grupo Santander

28660 Boadilla del Monte

Madrid, Spain

Tel: +34 91 289 32 80

Fax: +34 91 257 12 82

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

 

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

 

Title of each class

 

Name of each exchange on which registered

American Depositary Shares, each representing the right to receive one Share of Capital Stock of Banco Santander, S.A., par value euro 0.50 each   New York Stock Exchange
Shares of Capital Stock of Banco Santander, S.A., par value euro 0.50 each   New York Stock Exchange *
Guarantee of Non-cumulative Guaranteed Preferred Stock of Santander Finance Preferred, S.A. Unipersonal, Series 1, 4, 5 and 6   New York Stock Exchange **

 

* Banco Santander Shares are not listed for trading, but are only listed 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 Preferred Stock of Santander Finance Preferred, S.A. Unipersonal (100% owned subsidiary of Banco Santander, S.A.)

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

None.

(Title of Class)

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

None.

(Title of Class)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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

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

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  ¨   

International Financial Reporting Standards as issued

by the International Accounting Standards Board  x

   Other  ¨

If “Other” has been checked in response to the previous question indicate by check mark which financial statement item the registrant has elected to follow.    Item 17  ¨    Item 18  ¨

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of outstanding shares of each of the issuer’s classes of capital stock or common stock as of the close of business covered by the annual report. 14,434,492,579 shares

 

 

 


Table of Contents

BANCO SANTANDER, S.A.

 

 

TABLE OF CONTENTS

 

         Page  

Presentation of Financial and Other Information

     5   

Cautionary Statement Regarding Forward-Looking Statements

     6   
PART I     
ITEM 1.  

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     8   
ITEM 2.  

OFFER STATISTICS AND EXPECTED TIMETABLE

     8   
ITEM 3.  

KEY INFORMATION

     8   
 

A. Selected financial data

     8   
 

B. Capitalization and indebtedness

     13   
 

C. Reasons for the offer and use of proceeds

     13   
 

D. Risk factors

     13   
ITEM 4.  

INFORMATION ON THE COMPANY

     36   
 

A. History and development of the company

     36   
 

B. Business overview

     43   
 

C. Organizational structure

     115   
 

D. Property, plant and equipment

     115   
ITEM 4A.  

UNRESOLVED STAFF COMMENTS

     115   
ITEM 5.  

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     115   
 

A. Operating results

     123   
 

B. Liquidity and capital resources

     153   
 

C. Research and development, patents and licenses, etc.

     154   
 

D. Trend information

     155   
 

E. Off-balance sheet arrangements

     158   
 

F. Tabular disclosure of contractual obligations

     158   
 

G. Other disclosures

     158   
ITEM 6.  

DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

     160   
 

A. Directors and senior management

     160   
 

B. Compensation

     167   
 

C. Board practices

     181   
 

D. Employees

     193   
 

E. Share ownership

     195   
ITEM 7.  

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

     196   
 

A. Major shareholders

     196   
 

B. Related party transactions

     198   
 

C. Interests of experts and counsel

     198   
ITEM 8.  

FINANCIAL INFORMATION

     199   
 

A. Consolidated statements and other financial information

     199   
 

B. Significant Changes

     208   


Table of Contents
ITEM 9.  

THE OFFER AND LISTING

     208   
 

A. Offer and listing details

     208   
 

B. Plan of distribution

     210   
 

C. Markets

     210   
 

D. Selling shareholders

     216   
 

E. Dilution

     216   
 

F. Expense of the issue

     216   
ITEM 10.  

ADDITIONAL INFORMATION

     216   
 

A. Share capital

     216   
 

B. Memorandum and articles of association

     216   
 

C. Material contracts

     228   
 

D. Exchange controls

     228   
 

E. Taxation

     228   
 

F. Dividends and paying agents

     234   
 

G. Statement by experts

     234   
 

H. Documents on display

     234   
 

I. Subsidiary information

     234   
ITEM 11.  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     235   
 

Introduction.

     235   
 

Part 1. Cornerstones of the risk function

     235   
 

Part 2. Risk management and control model - Advanced Risk Management (ARM)

     235   
 

Part 3. Credit risk

     244   
 

Part 4. Trading market and structural risk

     265   
 

Part 5. Liquidity and funding risk

     293   
 

Part 6. Operational risk

     299   
 

Part 7. Compliance and conduct risk

     304   
 

Part 8. Model risk

     310   
 

Part 9. Strategic risk

     312   
 

Part 10. Capital risk

     313   
ITEM 12.  

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     318   
 

A. Debt Securities

     318   
 

B. Warrants and Rights

     318   
 

C. Other Securities

     318   
 

D. American Depositary Shares

     318   
PART II     
ITEM 13.  

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     320   
ITEM 14.  

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

     320   
ITEM 15.  

CONTROLS AND PROCEDURES

     320   
ITEM 16  

[Reserved].

  
 

A. Audit committee financial expert

     323   
 

B. Code of Ethics

     323   
 

C. Principal Accountant Fees and Services

     324   
 

D. Exemptions from the Listing Standards for Audit Committees

     324   
 

E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers

     325   
 

F. Changes in Registrant’s Certifying Accountant

     325   
 

G. Corporate Governance

     326   
 

H. Mine Safety Disclosure

     328   


Table of Contents
PART III     
ITEM 17.  

FINANCIAL STATEMENTS

     329   
ITEM 18.  

FINANCIAL STATEMENTS

     329   
ITEM 19.  

EXHIBITS

     329   


Table of Contents

PRESENTATION OF FINANCIAL AND OTHER INFORMATION

Accounting Principles

Under Regulation (EC) No. 1606/2002 of the European Parliament and of the Council of July 19, 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 in conformity with the International Financial Reporting Standards previously adopted by the European Union (“EU-IFRS”). The Bank of Spain Circular 4/2004 of December 22, 2004 on Public and Confidential Financial Reporting Rules and Formats (“Circular 4/2004”) requires Spanish credit institutions to adapt their accounting systems to the principles derived from the adoption by the European Union of International Financial Reporting Standards. Therefore, Grupo Santander (“the Group” or “Santander”) is required to prepare its consolidated financial statements for the year ended December 31, 2015 in conformity with the EU-IFRS and Bank of Spain’s Circular 4/2004. Differences between EU-IFRS, Bank of Spain’s Circular 4/2004 and International Financial Reporting Standards as issued by the International Accounting Standard Board (IFRS-IASB) are not material. Therefore, we assert that the financial information contained in this annual report on Form 20-F complies with IFRS-IASB.

We have presented our financial information according to the classification format for banks used in Spain. We have not reclassified the line items to comply with Article 9 of Regulation S-X. Article 9 is a regulation of the US Securities and Exchange Commission that contains presentation requirements for bank holding company financial statements.

Our auditors, Deloitte, S.L., an independent registered public accounting firm, have audited our consolidated financial statements in respect of the three years ended December 31, 2015, 2014 and 2013 in accordance with IFRS-IASB. See page F-1 to our consolidated financial statements for the 2015, 2014 and 2013 report prepared by Deloitte, S.L.

General Information

Our consolidated financial statements are in Euros, which are denoted “euro”, “euros”, “EUR” or “€” throughout this annual report. Also, throughout this annual report, when we refer to:

 

  “we”, “us”, “our”, the “Group”, “Grupo Santander” or “Santander”, we mean Banco Santander, S.A. and its subsidiaries, unless the context otherwise requires;

 

  “dollars”, “US$” or “$”, we mean United States dollars; and

 

  “pounds” or “£”, we mean United Kingdom pounds.

When we refer to “average balances” for a particular period, we mean the average of the month-end balances for that period, unless otherwise noted. We do not believe that monthly averages present trends that are materially different from trends that daily averages would show. In calculating our interest income, we include any interest payments we received on non-accruing loans if they were received in the period when due. We have not reflected consolidation adjustments in any financial information about our subsidiaries or other business units.

When we refer to “loans”, we mean loans, leases, discounted bills and accounts receivable, unless otherwise noted. The loan to value “LTV” ratios disclosed in this report refer to LTV ratios calculated as the ratio of the outstanding amount of the loan to the most recent available appraisal value of the mortgaged asset. Additionally, if a loan is approaching a doubtful status, we update the appraisals which are then used to estimate allowances for loan losses.

When we refer to “non-performing balances”, we mean non-performing loans and contingent liabilities (“NPL”), securities and other assets to collect.

When we refer to “allowances for credit losses”, we mean the specific allowances for impaired assets, and unless otherwise noted, the allowance for inherent losses and any allowances for country-risk. See “Item 4. Information on the Company—B. Business Overview—Classified Assets—Allowances for Credit Losses and Country-Risk Requirements”.

When we refer to “perimeter effect”, we mean growth or reduction derived from changes in the companies that we consolidate resulting from acquisitions, dispositions or other reasons.

 

5


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Where a translation of foreign exchange is given for any financial data, we use the exchange rates of the relevant period (as of the end of such period for balance sheet data and the average exchange rate of such period for income statement data) as published by the European Central Bank, unless otherwise noted.

Management makes use of certain financial measures in local currency to help in the assessment of on-going operating performance. These non-GAAP financial measures include the results of operations of our subsidiary banks located outside the eurozone, excluding the impact of foreign exchange. We analyze these banks’ performance on a local currency basis to better measure the comparability of results between periods. Because changes in foreign currency exchange rates have a non-operating impact on the results of operations, we believe that evaluating their performance on a local currency basis provides an additional and meaningful assessment of performance to both management and the company’s investors. For a discussion of the accounting principles used in translation of foreign currency-denominated assets and liabilities to euros, see note 2(a) to our consolidated financial statements.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This annual report contains statements that constitute “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, information regarding:

 

    exposure to various types of market risks;

 

    management strategy;

 

    capital expenditures;

 

    earnings and other targets; and

 

    asset portfolios.

Forward-looking statements may be identified by words such as “expect,” “project,” “anticipate,” “should,” “intend,” “probability,” “risk,” “VaR,” “RORAC,” “target,” “goal,” “objective,” “estimate,” “future” and similar expressions. We include forward-looking statements in the “Operating and Financial Review and Prospects,” “Information on the Company,” and “Quantitative and Qualitative Disclosures About Risks” sections. 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.

 

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You should understand that the following important factors, in addition to those discussed in “Key Information—Risk Factors”, “Operating and Financial Review and Prospects,” “Information on the Company” and elsewhere in this annual report, could affect our future results and could cause those results or other outcomes to differ materially from those anticipated in any forward-looking statement:

 

Economic and Industry Conditions

 

  general economic or industry conditions in Spain, the U.K., the U.S., other European countries, Brazil, other Latin American countries and the other areas in which we have significant business activities or investments;

 

  exposure to various types of market risks, principally including interest rate risk, foreign exchange rate risk and equity price risk;

 

  a worsening of the economic environment in Spain, the U.K., other European countries, Brazil, other Latin American countries, and the U.S., and an increase of the volatility in the capital markets;

 

  the effects of a continued decline in real estate prices, particularly in Spain and the U.K.;

 

  monetary and interest rate policies of the European Central Bank and various central banks;

 

  inflation or deflation;

 

  the effects of non-linear market behavior that cannot be captured by linear statistical models, such as the VaR model we use;

 

  changes in competition and pricing environments;

 

  the inability to hedge some risks economically;

 

  the adequacy of loss reserves;

 

  acquisitions or restructurings of businesses that may not perform in accordance with our expectations;

 

  changes in demographics, consumer spending, investment or saving habits;

 

  potential losses associated with prepayment of our loan and investment portfolio, declines in the value of collateral securing our loan portfolio, and counterparty risk; and

 

  changes in competition and pricing environments as a result of the progressive adoption of the internet for conducting financial services and/or other factors.

Political and Governmental Factors

 

  political stability in Spain, the U.K., other European countries, Latin America and the U.S.;

 

  changes in Spanish, U.K., E.U., Latin American, U.S. or other jurisdictions’ laws, regulations or taxes, including changes in regulatory capital and liquidity requirements; and

 

  increased regulation in light of the global financial crisis.

Transaction and Commercial Factors

 

  damage to our reputation;

 

  our ability to integrate successfully our acquisitions and the challenges inherent in diverting management’s focus and resources from other strategic opportunities and from operational matters while we integrate these acquisitions; and

 

  the outcome of our negotiations with business partners and governments.

Operating Factors

 

  potential losses associated with an increase in the level of non-performance by counterparties to other types of financial instruments;

 

  technical difficulties and/or failure to improve or upgrade our information technology;

 

  changes in our ability to access liquidity and funding on acceptable terms, including as a result of changes in our credit spreads or a downgrade in our credit ratings or those of our more significant subsidiaries;

 

  our exposure to operational losses (e.g., failed internal or external processes, people and systems);

 

  changes in our ability to recruit, retain and develop appropriate senior management and skilled personnel;

 

  the occurrence of force majeure, such as natural disasters, that impact our operations or impair the asset quality of our loan portfolio; and

 

  the impact of changes in the composition of our balance sheet on future net interest income.
 

 

The forward-looking statements contained in this report speak only as of the date of this report. We do not undertake to update any forward-looking statement to reflect events or circumstances after that date or to reflect the occurrence of unanticipated events.

 

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Table of Contents

PART I

Item 1. Identity of Directors, Senior Management and Advisers

A. Directors and Senior Management

Not applicable.

B. Advisers

Not applicable.

C. Auditors

Not applicable.

Item 2. Offer Statistics and Expected Timetable

A. Offer Statistics

Not applicable.

B. Method and Expected Timetable

Not applicable.

Item 3. Key Information

A. Selected financial data

Selected Consolidated Financial Information

We have selected the following financial information from our consolidated financial statements. You should read this information in connection with, and it is qualified in its entirety by reference to, our consolidated financial statements.

In the F-pages of this annual report on Form 20-F, our audited financial statements for the years 2015, 2014 and 2013 are presented. The audited financial statements for 2012 and 2011 are not included in this document, but they can be found in our previous annual reports on Form 20-F. These previous annual reports do not include the effect of the change in our reported segments described in Item 4. Information on the Company—B. Business Overview for the year 2011. The audited financial statements for the years 2014, 2013 and 2012 were recast in our Report on Form 6-K filed with the SEC on November 5, 2015.

The income statement for the year ended December 31, 2014 reflects the impact of the reconsolidation of Santander Consumer USA Inc. (“SCUSA”) after we gained control of this company in January 2014. Prior to the aforementioned change of control, we accounted for our ownership interest in SCUSA using the equity method (see “Item 4. Information on the Company—A. History and development of the company—Principal Capital Expenditures and Divestitures—Acquisitions, Dispositions, Reorganizations—Santander Consumer USA”). In addition, the income statement for the year ended December 31, 2013 includes the results from Kredyt Bank S.A. after the merger in early 2013 of the subsidiaries in Poland of Banco Santander, S.A. and KBC Bank NV (Bank Zachodni WBK, S.A. and Kredyt Bank S.A.). Finally, the income statement for the year ended December, 31, 2011 reflects the impact of the consolidation of Bank Zachodni WBK, S.A.

 

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Table of Contents
    Year ended December 31,  
    2015     2014     2013     2012     2011  
    (in millions of euros, except percentages and per share data)  

Interest and similar income

    57,198        54,656        51,447        58,791        60,618   

Interest expense and similar charges

    (24,386     (25,109     (25,512     (28,868     (30,024

Interest income / (charges)

    32,812        29,547        25,935        29,923        30,594   

Income from equity instruments

    455        435        378        423        394   

Income from companies accounted for using the equity
method

    375        243        500        427        57   

Fee and commission income

    13,042        12,515        12,473        12,732        12,640   

Fee and commission expense

    (3,009     (2,819     (2,712     (2,471     (2,232

Gains/losses on financial assets and liabilities (net)

    (770     3,974        3,234        3,329        2,838   

Exchange differences (net)

    3,156        (1,124     160        (189     (522

Other operating income

    3,067        5,214        5,903        6,693        8,050   

Other operating expenses

    (3,233     (5,373     (6,205     (6,607     (8,180

Total income

    45,895        42,612        39,666        44,260        43,639   

Administrative expenses

    (19,302     (17,899     (17,452     (17,801     (17,644

Personnel expenses

    (11,107     (10,242     (10,069     (10,306     (10,305

Other general administrative expenses

    (8,195     (7,657     (7,383     (7,495     (7,339

Depreciation and amortization

    (2,418     (2,287     (2,391     (2,183     (2,098

Provisions (net)

    (3,106     (3,009     (2,445     (1,472     (2,534

Impairment losses on financial assets (net)

    (10,652     (10,710     (11,227     (18,880     (11,794

Impairment losses on other assets (net)

    (1,092     (938     (503     (508     (1,517

Gains/(losses) on disposal of assets not classified as
non-current assets held for sale

    112        3,136        2,152        906        1,846   

Negative difference of consolidation

    283        17        —          —          —     

Gains/(losses) on non-current assets held for sale not
classified as discontinued operations

    (173     (243     (422     (757     (2,109

Operating profit/(loss) before tax

    9,547        10,679        7,378        3,565        7,789   

Income tax

    (2,213     (3,718     (2,034     (584     (1,727

Profit from continuing operations

    7,334        6,961        5,344        2,981        6,062   

Profit/(loss) from discontinued operations (net)

    —          (26     (15     70        15   

Consolidated profit for the year

    7,334        6,935        5,329        3,051        6,077   

Profit attributable to the Parent

    5,966        5,816        4,175        2,283        5,289   

Profit attributable to non-controlling interest

    1,368        1,119        1,154        768        788   

Per share information:

         

Average number of shares (thousands) (1)

    14,113,617        11,858,690        10,836,111        9,766,689        8,892,033   

Basic earnings per share (euros)

    0.40        0.48        0.39        0.23        0.59   

Basic earnings per share continuing operation (euros)

    0.40        0.48        0.39        0.22        0.59   

Diluted earnings per share (euros)

    0.40        0.48        0.38        0.23        0.59   

Diluted earnings per share continuing operation (euros)

    0.40        0.48        0.38        0.22        0.59   

Remuneration paid (euros) (2)

    0.20        0.60        0.60        0.60        0.60   

Remuneration paid (US$) (2)

    0.22        0.73        0.83        0.79        0.78   

 

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    Year ended December 31,  
    2015     2014     2013     2012     2011  
    (in millions of euros, except percentages and per share data)  

Total assets

    1,340,260        1,266,296        1,115,763        1,269,645        1,251,048   

Loans and advances to credit institutions (net) (3)

    78,952        81,713        74,964        73,900        51,726   

Loans and advances to customers (net) (3)

    790,848        734,711        668,856        719,112        748,541   

Investment securities (net) (4)

    203,834        195,164        142,234        152,066        154,015   

Investments: Associates and joint venture

    3,251        3,471        5,536        4,454        4,155   

Contingent liabilities

    40,115        44,078        41,049        45,033        48,042   

Liabilities

         

Deposits from central banks and credit institutions (5)

    175,371        155,369        109,397        152,966        143,138   

Customer deposits (5)

    683,122        647,627        607,837        626,639        632,533   

Debt securities (5)

    205,029        196,889        175,477        205,969        197,372   

Capitalization

         

Guaranteed subordinated debt excluding preferred securities and preferred shares (6)

    6,091        3,276        4,603        5,207        6,619   

Other subordinated debt

    7,864        6,878        7,483        8,291        10,477   

Preferred securities (6)

    6,749        6,239        3,652        4,319        5,447   

Preferred shares (6)

    449        739        401        421        449   

Non-controlling interest (including net income of the period)

    10,713        8,909        9,314        9,415        6,354   

Stockholders’ equity (7)

    88,040        80,805        70,328        71,797        74,408   

Total capitalization

    119,906        106,846        95,781        99,450        103,754   

Stockholders’ equity per average share (7)

    6.24        6.81        6.49        7.35        8.37   

Stockholders’ equity per share at the year-end (7)

    6.12        6.42        6.21        6.99        8.71   

Other managed funds

         

Mutual funds

    109,028        109,519        93,304        89,176        102,611   

Pension funds

    11,376        11,481        10,879        10,076        9,645   

Managed portfolio

    20,337        20,369        20,987        18,889        19,200   

Total other managed funds (8)

    140,741        141,369        125,170        118,141        131,456   

Consolidated ratios

         

Profitability ratios:

         

Net yield (9)

    2.90     2.89     2.55     2.81     2.96

Return on average total assets (ROA)

    0.55     0.58     0.44     0.24     0.49

Return on average stockholders’ equity (ROE) (10)

    6.61     7.75     5.84     3.14     7.33

Capital ratio:

         

Average stockholders’ equity to average total assets

    6.70     6.24     5.89     5.65     5.88

Ratio of earnings to fixed charges (11)

         

Excluding interest on deposits

    1.77     1.90     1.69     1.27     1.62

Including interest on deposits

    1.39     1.43     1.29     1.11     1.26

Credit quality data

         

Loans and advances to customers

         

Allowances for non-performing balances including country risk and excluding contingent liabilities as a percentage of total gross loans

    3.24     3.57     3.59     3.41     2.45

Non-performing balances as a percentage of total gross loans (12)

    4.42     5.30     5.81     4.74     4.07

Allowances for non-performing balances as a percentage of non-performing balances (12)

    73.39     67.42     61.76     72.01     60.17

Net loan charge-offs as a percentage of total gross loans

    1.34     1.38     1.38     1.36     1.39

Ratios adding contingent liabilities to loans and advances to customers and excluding country risk (*)

         

Allowances for non-performing balances (**) as a percentage of total loans and contingent liabilities

    3.19     3.49     3.48     3.29     2.38

Non-performing balances as a percentage of total loans and contingent liabilities (**) (12)

    4.36     5.19     5.64     4.54     3.90

Allowances for non-performing balances as a percentage of non-performing balances (**)(12)

    73.11     67.24     61.65     72.41     61.02

Net loan and contingent liabilities charge-offs as a percentage of total loans and contingent liabilities

    1.29     1.30     1.29     1.28     1.29

 

(*) We disclose these ratios because our credit risk exposure comprises loans and advances to customers as well as contingent liabilities, all of which are subject to impairment and, therefore, allowances are taken in respect thereof.

 

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(**) Non-performing loans and contingent liabilities, securities and other assets to collect.

 

(1) Average number of shares has been calculated on the basis of the weighted average number of shares outstanding in the relevant year, net of treasury stock.
(2) The shareholders at the annual shareholders’ meeting held on June 19, 2009 approved a remuneration scheme (scrip dividend), whereby the Bank offered the shareholders the possibility to opt to receive an amount equivalent to the dividends in cash or new shares. The remuneration per share for 2011, 2012, 2013 and 2014 disclosed above, €0.60, is calculated assuming that the four dividends for these years were paid in cash.

On January 8, 2015, an extraordinary meeting of the board of directors took place to reformulate the dividend policy of the Bank to take effect with the first dividend to be paid with respect to our 2015 results, in order to distribute three cash dividends and a scrip dividend relating to such 2015 results. Each of these dividends will have an estimated amount of €0.05 per share. The Bank has paid the first 3 dividends on account of the earnings for the 2015 financial year in August 2015, November 2015 and February 2016 for a gross amount per share of €0.05 and will pay the fourth dividend in May 2016.

 

(3) Equals the sum of the amounts included under the headings “Financial assets held for trading”, “Other financial assets at fair value through profit or loss” and “Loans and receivables” as stated in our consolidated financial statements.
(4) Equals the amounts included as “Debt instruments” and “Equity instruments” under the headings “Financial assets held for trading”, “Other financial assets at fair value through profit or loss”, “Available-for-sale financial assets”, “Loans and receivables” and “Held-to-maturity investments” as stated in our consolidated financial statements.
(5) Equals the sum of the amounts included under the headings “Financial liabilities held for trading”, “Other financial liabilities at fair value through profit or loss” and “Financial liabilities at amortized cost” included in notes 20, 21 and 22 to our consolidated financial statements.
(6) In our consolidated financial statements, preferred securities and preferred shares are included under “Subordinated liabilities”.
(7) Equals the sum of the amounts included at the end of each year as “Equity” and “Valuation adjustments” as stated in our consolidated financial statements. We have deducted the book value of treasury stock from stockholders’ equity.
(8) At December 31, 2015 2014, and 2013 we held a 50% ownership interest in Santander Asset Management (“SAM”) and controlled this company jointly with Warburg Pincus and General Atlantic. Funds under “Other managed funds” are mostly managed by SAM.
(9) Net yield is the total of net interest income (including dividends on equity securities) divided by average earning assets. See “Item 4. Information on the Company—B. Business Overview—Selected Statistical Information—Assets—Earning Assets—Yield Spread”.
(10) The Return on average stockholders’ equity ratio is calculated as profit attributable to the Parent divided by average stockholders’ equity.
(11) For the purpose of calculating the ratio of earnings to fixed charges, earnings consist of pre-tax income from continuing operations before adjustment for income or loss from equity investees plus fixed charges. Fixed charges consist of total interest expense (including or excluding interest on deposits as appropriate) and the interest expense portion of rental expense.
(12) Non-performing loans reflect Bank of Spain classifications. These classifications differ from the classifications applied by U.S. banks in reporting loans as non-accrual, past due, restructured and potential problem loans. See “Item 4. Information on the Company—B. Business Overview—Classified Assets—Bank of Spain’s Classification Requirements”.

 

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Set forth below is a table showing our allowances for non-performing balances broken down by various categories as disclosed and discussed throughout this annual report on Form 20-F:

 

     IFRS-IASB  
     Year Ended December 31,  
     2015      2014      2013      2012      2011  
     (in millions of euros)  

Allowances refers to:

  

Allowances for non-performing balances (*) (excluding country risk)

     27,121         28,046         25,681         26,112         19,531   

Less: Allowances for contingent liabilities and commitments (excluding country risk)

     616         652         688         614         648   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Allowances for balances of loans (excluding country risk):

     26,505         27,394         24,993         25,497         18,883   

Allowances relating to country risk and other

     322         46         154         98         210   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Allowances for non-performing balances (excluding contingent liabilities)

     26,827         27,440         25,147         25,595         19,093   

Of which:

              

Allowances for loans and receivables:

     26,631         27,321         24,959         25,467         18,858   

Allowances for customers

     26,517         27,217         24,903         25,422         18,806   

Allowances for credit institutions and other financial assets

     19         79         37         30         36   

Allowances for debt instruments

     95         25         19         15         16   

Allowances for debt instruments available for sale

     196         119         188         129         235   

 

(*) Non-performing loans and contingent liabilities and other assets to collect.

Exchange Rates

The exchange rates shown below are those published by the European Central Bank (“ECB”), and are based on the daily consultation procedures between central banks within and outside the European System of Central Banks, which normally takes place at 14:15 p.m. CET.

 

     Rate During Period  
Calendar Period    Period End
($)
     Average Rate
($)
 

2011

     1.29         1.39   

2012

     1.32         1.28   

2013

     1.38         1.33   

2014

     1.21         1.33   

2015

     1.09         1.11   

 

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     Rate During Period  
Last six months    High $      Low $  

2015

     

October

     1.14         1.09   

November

     1.10         1.06   

December

     1.10         1.06   

2016

     

January

     1.09         1.07   

February

     1.13         1.09   

March

     1.14         1.09   

April (through April 8)

     1.14         1.13   

On April 8, 2016, the exchange rate for euros and dollars (expressed in dollars per euro), as published by the ECB, was $1.14.

For a discussion of the accounting principles used in translation of foreign currency-denominated assets and liabilities to euros, see note 2 (a) to our consolidated financial statements.

B. Capitalization and indebtedness.

Not Applicable.

C. Reasons for the offer and use of proceeds.

Not Applicable.

D. Risk factors.

1. Macro-Economic and Political Risks

1.1 Because our loan portfolio is concentrated in Continental Europe, the United Kingdom, Latin America and the United States, adverse changes affecting the economies of Continental Europe, the United Kingdom, certain Latin American countries or the United States could adversely affect our financial condition.

Our loan portfolio is concentrated in Continental Europe (in particular, Spain), the United Kingdom, Latin America and the United States. At December 31, 2015, Continental Europe accounted for 36% of our total loan portfolio (Spain accounted for 20% of our total loan portfolio), the United Kingdom (where the loan portfolio consists primarily of residential mortgages) accounted for 36%, Latin America accounted for 17% (of which Brazil represents 8% of our total loan portfolio) and the United States accounted for 11%. Accordingly, the recoverability of these loan portfolios in particular, and our ability to increase the amount of loans outstanding and our results of operations and financial condition in general, are dependent to a significant extent on the level of economic activity in Continental Europe (in particular, Spain), the United Kingdom, Latin America and the United States. A return to recessionary conditions in the economies of Continental Europe (in particular, Spain), the United Kingdom, some of the Latin American countries in which we operate or the United States, or continued recessionary conditions in Brazil, would likely have a significant adverse impact on our loan portfolio and, as a result, on our financial condition, cash flows and results of operations. See “Item 4. Information on the Company—B. Business Overview”.

1.2 We are vulnerable to disruptions and volatility in the global financial markets.

In the past eight years, financial systems worldwide have experienced difficult credit and liquidity conditions and disruptions leading to less liquidity and greater volatility (such as volatility in spreads). Global economic conditions deteriorated significantly between 2007 and 2009, and many of the countries in which we operate fell into recession. Although most countries have begun to recover, this recovery may not be sustainable. Many major financial institutions, including some of the world’s largest global commercial banks, investment banks, mortgage lenders, mortgage guarantors and insurance companies experienced, and some continue to experience, significant difficulties. Around the world, there have also been runs on deposits at several financial institutions, numerous institutions have sought additional capital or have been assisted by governments, and many lenders and institutional investors have reduced or ceased providing funding to borrowers (including to other financial institutions).

 

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In particular, we face, among others, the following risks related to the economic downturn:

 

  Reduced demand for our products and services.

 

  Increased regulation of our industry. Compliance with such regulation will continue to increase our costs and may affect the pricing for our products and services and limit our ability to pursue business opportunities.

 

  Inability of our borrowers to timely or fully comply with their existing obligations. Macroeconomic shocks may negatively impact the household income of our retail customers and may adversely affect the recoverability of our retail loans, resulting in increased loan losses.

 

  The process we use to estimate losses inherent in our credit exposure requires complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The degree of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates, which may, in turn, impact the reliability of the process and the sufficiency of our loan loss allowances.

 

  The value and liquidity of the portfolio of investment securities that we hold may be adversely affected.

 

  Any worsening of global economic conditions may delay the recovery of the international financial industry and impact our financial condition and results of operations.

Despite recent improvements in certain segments of the global economy, uncertainty remains concerning the future economic environment. There can be no assurance that economic conditions in these segments will continue to improve or that the global economic condition as a whole will improve significantly. Such economic uncertainty could have a negative impact on our business and results of operations. Investors remain cautious. A slowing or failing of the economic recovery would likely aggravate the adverse effects of these difficult economic and market conditions on us and on others in the financial services industry.

Increased disruption and volatility in the global financial markets could have a material adverse effect on us, including our ability to access capital and liquidity on financial terms acceptable to us, if at all. If capital markets financing ceases to become available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits to attract more customers and become unable to maintain certain liability maturities. Any such increase in capital markets funding availability or costs or in deposit rates could have a material adverse effect on our interest margins and liquidity.

If all or some of the foregoing risks were to materialize, this could have a material adverse effect on us.

1.3 We may suffer adverse effects as a result of economic and sovereign debt tensions in the eurozone.

Our results of operations are materially affected by conditions in the capital markets and the economy generally in the eurozone, which, although improving recently, continue to show signs of fragility and volatility. Interest rate differentials among eurozone countries are affecting government finance and borrowing rates in those economies.

The European Central Bank (the “ECB”) and European Council have taken actions with the aim of reducing the risk of contagion in the eurozone and beyond. These included the creation of the Open Market Transaction facility of the ECB and the decision by eurozone governments to progress towards the creation of a banking union. In January 2015, the ECB announced an extensive quantitative easing scheme. The scheme comprises a €60 billion-a-month bond-buying program across the eurozone, which was raised to €80 billion in March 2016, such program to last until at least September 2016, with a potential for extension if inflation in the eurozone does not meet the ECB target of 2%. Notwithstanding these measures, a significant number of financial institutions throughout Europe have substantial exposures to sovereign debt issued by eurozone nations, which are under financial stress. Should any of those nations default on their debt, or experience a significant widening of credit spreads, major financial institutions and banking systems throughout Europe could be destabilized, resulting in the further spread of the recent economic crisis.

We have direct and indirect exposure to financial and economic conditions throughout the eurozone economies. While concerns relating to sovereign defaults or a partial or complete break-up of the European Monetary Union, including potential accompanying redenomination risks and uncertainties, seemed to have abated, such concerns could resurface (as it was demonstrated in the earlier part of 2015 with the doubts regarding Greece’s membership of the eurozone). A deterioration of the economic and financial environment could have a material adverse impact on the whole financial sector, creating new challenges in sovereign and corporate lending and resulting in significant disruptions in financial activities at both the market and retail levels. This could materially and adversely affect our operating results, financial position and prospects.

 

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1.4 Exposure to sovereign debt could have a material adverse effect on us.

Like many other banks, we invest in debt securities of governments in the geographies in which we operate. A failure by any such government to make timely payments under the terms of these securities, or a significant decrease in their market value, could have a material adverse effect on us.

1.5 Our growth, asset quality and profitability may be adversely affected by volatile macroeconomic and political conditions.

The economies of some of the countries where we operate, particularly in Latin America, have experienced significant volatility in recent decades. This volatility resulted in fluctuations in the levels of deposits and in the relative economic strength of various segments of the economies to which we lend. In addition, some of the countries where we operate are particularly affected by commodities price fluctuations, which in turn may affect financial market conditions through exchange rate fluctuations, interest rate volatility and deposits volatility. Negative and fluctuating economic conditions, such as slowing or negative growth and a changing interest rate environment, impact our profitability by causing lending margins to decrease and credit quality to decline and leading to decreased demand for higher margin products and services. For instance, Brazil’s present high rate of inflation, compounded by high and increasing interest rates, declining consumer spending and increasing unemployment, have had and may continue to have a material adverse impact on the Brazilian economy as a whole as well as on our financial condition and earnings in Brazil, which represented 20% of profit attributable to the Parent bank’s total operating areas in 2015 and 8% of our total loans as of December 31, 2015. In addition, our business in Brazil will continue to be adversely affected by recessionary conditions and political instability in that country.

There is uncertainty over the long-term effects of the monetary and fiscal policies that have been adopted by the central banks and financial authorities of some of the world’s leading economies, including China. China’s economy is entering a period of slower growth. Any continuing or worsening slowdown in China could further reduce domestic demand in China which in turn could have ripple effects on the global economy. Furthermore, financial turmoil in emerging markets tends to adversely affect stock prices and debt securities prices of other emerging markets as investors move their money to more stable and developed markets. Continued or increased perceived risks associated with investing in emerging economies in general, or the emerging market economies where the Group operates in particular, could further dampen capital flows to such economies and adversely affect such economies, and as a result, could have an adverse impact on the Group’s business and results of operations.

Negative and fluctuating economic conditions in the countries in which we operate, such as those that certain Latin American and European countries have experienced recently, could also 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 high in these regions or countries.

In addition, our revenues are subject to risk of loss from unfavorable political and diplomatic developments, social instability, and changes in governmental policies, including expropriation, nationalization, international ownership legislation, interest-rate caps and tax policies. In particular, the UK government has committed to hold a referendum on the UK’s membership of the European Union in June 2016. Future UK political developments, including but not limited to any changes in government structure and policies, could affect the fiscal, monetary and regulatory landscape to which we are subject and also therefore our financing availability and terms.

Our growth, asset quality and profitability may be adversely affected by volatile macroeconomic and political conditions.

2. Risks Relating to Our Business

2.1 Legal, Regulatory and Compliance Risks

2.1.1 We are exposed to risk of loss from legal and regulatory proceedings.

We face risk of loss from legal and regulatory proceedings, including tax proceedings, that could subject us to monetary judgments, regulatory enforcement actions, fines and penalties. The current regulatory environment in the jurisdictions in which we operate reflects an increased supervisory focus on enforcement, combined with uncertainty about the evolution of the regulatory regime, and may lead to material operational and compliance costs.

We are from time to time subject to certain claims and party to certain legal proceedings incidental to the normal course of our business, including in connection with conflicts of interest, lending activities, relationships with our employees and other

 

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commercial or tax matters. In view of the inherent difficulty of predicting the outcome of legal matters, particularly where the claimants seek very large or indeterminate damages, or where the cases present novel legal theories, involve a large number of parties or are in the early stages of discovery, we cannot state with confidence what the eventual outcome of these pending matters will be or what the eventual loss, fines or penalties related to each pending matter may be. We believe that we have made adequate reserves related to the costs anticipated to be incurred in connection with these various claims and legal proceedings (see note 25 to our consolidated financial statements). However, the amount of these provisions is substantially less than the total amount of the claims asserted against us and in light of the uncertainties involved in such claims and proceedings, there is no assurance that the ultimate resolution of these matters will not significantly exceed the reserves currently accrued by us. As a result, the outcome of a particular matter may be material to our operating results for a particular period, depending upon, among other factors, the size of the loss or liability imposed and our level of income for that period.

2.1.2 We are subject to substantial regulation which could adversely affect our business and operations.

As a financial institution, we are subject to extensive regulation, which materially affects our businesses. The statutes, regulations and policies to which we are subject may be changed at any time. In addition, the interpretation and the application by regulators of the laws and regulations to which we are subject may also change from time to time. Extensive legislation affecting the financial services industry has recently been adopted in regions that directly or indirectly affect our business, including Spain, the United States, the European Union, Latin America and other jurisdictions, and regulations are in the process of being implemented. The manner in which those laws and related regulations are applied to the operations of financial institutions is still evolving. Moreover, to the extent these recently adopted regulations are implemented inconsistently in the various jurisdictions in which we operate, we may face higher compliance costs. Any legislative or regulatory actions and any required changes to our business operations resulting from such legislation and regulations could result in significant loss of revenue, limit our ability to pursue business opportunities in which we might otherwise consider engaging and provide certain products and services, affect the value of assets that we hold, require us to increase our prices and therefore reduce demand for our products, impose additional compliance and other costs on us or otherwise adversely affect our businesses. Accordingly, there can be no assurance that future changes in regulations or in their interpretation or application will not adversely affect us.

The regulations which most significantly affect the Bank, or which could most significantly affect the Bank in the future, relate to capital requirements, liquidity and funding, development of a fiscal and banking union in the European Union and regulatory reforms in the United States, and are discussed in further detail below. Other regulatory reforms adopted or proposed in the wake of the financial crisis have increased and may continue to materially increase our operating costs and negatively impact our business model. In addition, the volume, granularity, frequency and scale of regulatory and other reporting requirements necessitate a clear data strategy to enable consistent data aggregation, reporting and management. Inadequate management information systems or processes, including those relating to risk data aggregation and risk reporting, could lead to a failure to meet regulatory reporting requirements or other internal or external information demands and we may face supervisory measures as a result.

Capital requirements, liquidity, funding and structural reform

Increasingly onerous capital requirements constitute one of the Bank’s main regulatory challenges. Increasing capital requirements may adversely affect the Bank’s profitability and create regulatory risk associated with the possibility of failure to maintain required capital levels. As a Spanish financial institution, the Bank is subject to the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (“CRD IV”), through which the European Union began implementing the Basel III capital reforms from January 1, 2014, with certain requirements in the process of being phased in until January 1, 2019. While the CRD IV requires national transposition, the CRR is directly applicable in all the EU member states. This regulation is complemented by several binding technical standards and guidelines issued by the EBA , directly applicable in all EU member states, without the need for national implementation measures. The implementation of the CRD IV Directive into Spanish law has largely taken place through Royal Decree Law 14/2013 and Law 10/2014, Bank of Spain Circular 2/2014 and Bank of Spain Circular 2/2016. Credit institutions, such as the Bank, are required, on a standalone and consolidated basis, to hold a minimum amount of regulatory capital of 8% of risk weighted assets (of which at least 4.5% must be Common Equity Tier 1 (“CET1”) capital and at least 6% must be Tier 1 capital). In addition to the minimum regulatory capital requirements, CRD IV also introduces capital buffer requirements that must be met with CET1 capital. CRD IV introduces five new capital buffers: (1) the capital conservation buffer for unexpected losses, requiring additional CET1 of up to 2.5% of total weighted exposures; (2) the institution-specific counter-cyclical capital buffer, requiring additional CET1 of up to 2.5% of total weighted exposures; (3) the global systemically important institutions buffer of between 1% and 3.5% of CET1; (4) the other systemically important institutions buffer, which may be as much as 2% of CET1; and (5) the Common Equity Tier 1 systemic risk buffer. Beginning in 2016, and subject to the applicable phase-in period, entities will be required to comply with the “combined buffer requirement” (broadly, the combination of the capital conservation buffer, the institution-specific counter-cyclical buffer and the higher of (depending on the institution) the systemic risk buffer, the global systemically important institutions buffer and the other systemically important financial institutions buffer, in each case as applicable to the institution).The Bank will be required

 

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to maintain a conservation buffer of 2.5% and a systemically important institutions buffer of 1%, in each case considered on a fully loaded basis. However, as of the date of this Report, due to the application of the phase-in period, the Bank is required to maintain a conservation buffer of 2.5% and a systemically important institutions buffer of 0.25%.

Article 104 of the CRD IV Directive, as implemented by Article 68 of Law 10/2014, and similarly Article 16 of Council Regulation (EU) No 1024/2013 of October 15, 2013 conferring specific tasks on the European Central Bank (the “ECB”) concerning policies relating to the prudential supervision of credit institutions (the “SSM Regulation”), also contemplate that in addition to the minimum “Pillar 1” capital requirements (including, if applicable, any buffer capital as discussed above), supervisory authorities may impose further “Pillar 2” capital requirements to cover other risks, including those not considered to be fully captured by the minimum capital requirements under CRD IV or to address macro-prudential considerations. This may result in the imposition of additional capital requirements on the Bank and/or the Group pursuant to this “Pillar 2” framework. Any failure by the Bank and/or the Group to maintain its “Pillar 1” minimum regulatory capital ratios, any “Pillar 2” additional capital requirements could result in administrative actions or sanctions, which, in turn, may have a material adverse impact on the Group’s results of operations.

The ECB is required to carry out, at least on an annual basis, assessments under CRD IV of the additional “Pillar 2” capital requirements that may be imposed for each of the European banking institutions subject to the Single Supervisory Mechanism (the “SSM”). Any additional capital requirement that may be imposed on the Bank and/or the Group by the ECB pursuant to these assessments may require the Bank and/or the Group to hold capital levels similar to, or higher than, those required under the full application of CRD IV. There can be no assurance that the Group will be able to continue to maintain such capital ratios.

In addition to the above, the EBA published on December 19, 2014 its final guidelines for common procedures and methodologies in respect of its supervisory review and evaluation process (SREP). Included in this were the EBA’s proposed guidelines for a common approach to determining the amount and composition of additional capital requirements to be implemented by January 1, 2016. Under these guidelines, national supervisors must set a composition requirement for the additional capital requirements to cover certain specified risks of at least 56% CET1 capital and at least 75% Tier 1 capital. The guidelines also contemplate that national supervisors should not set additional capital requirements in respect of risks which are already covered by capital buffer requirements and/or additional macro-prudential requirements; and, accordingly, the above “combined buffer requirement” is in addition to the minimum capital requirement and to the additional capital requirement. In this regard, under article 141 of the CRD IV Directive, Member States of the European Union must require that institutions that fail to meet the “combined buffer requirement” or the “Pillar 2” capital requirements described above, will be prohibited from paying any “discretionary payments” (which are defined broadly by the CRD IV Directive as payments relating to Common Equity Tier 1, variable remuneration and payments on Additional Tier 1 capital instruments), until it calculates its applicable restrictions and communicates them to the Regulator and, once completed, such institution will be subject to restricted “discretionary payments”. The restrictions will be scaled according to the extent of the breach of the “combined buffer requirement” and calculated as a percentage of the profits of the institution since the last distribution of profits or “discretionary payment”. Such calculation will result in a “Maximum Distributable Amount” in each relevant period. As an example, the scaling is such that in the bottom quartile of the “combined buffer requirement”, no “discretionary distributions” will be permitted to be paid. Articles 43 to 49 of Law 10/2014 and Chapter II of Title II of Royal Decree 84/2015 implement the above provisions in Spain. In particular article 48 of Law 10/2014 and articles 73 and 74 of Royal Decree 84/2014 deal with restrictions on distributions. In connection with this, Banco Santander announced on December 23, 2015 that it had received from the ECB its decision regarding prudential minimum capital phase-in requirements for 2016, following the results of SREP. The ECB decision requires that the Group maintains a Common Equity Tier 1 capital ratio of 9.75% on a consolidated basis. This 9.75% capital requirement includes: the minimum Pillar 1 requirement (4.5%); the Pillar 2 requirement including the capital conservation buffer (5.0%); and the requirement from its consideration as a global systemic financial institution (0.25%). The ECB decision also requires that Banco Santander, S.A. maintains a Common Equity Tier 1 capital ratio of 9.50% on an individual basis. This 9.50% capital requirement includes: the minimum Pillar 1 requirement (4.5%), and the Pillar 2 requirement including the capital conservation buffer (5.0%). These capital requirements do not imply any limitations referred to in CRR to distributions in the form of dividends, variable remuneration and coupon payments to holders of AT1 instruments.

In addition to the above, the CRR also includes a requirement for institutions to calculate a leverage ratio, report it to their supervisors and to disclose it publicly from January 1, 2015 onwards. More precisely, Article 429 of the CRR requires institutions to calculate their leverage ratio (LR) in accordance with the methodology laid down in that article. In January 2014, the Basel Committee finalized a definition of how the LR should be prepared and set an indicative benchmark (namely 3% of Tier 1 capital). Such 3% Tier 1 LR will be tested during the monitoring period until 2017 when the Basel Committee will decide on the final calibration. Thus, the CRR does not contain a requirement for institutions to have a capital requirement

 

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based on the LR and the decision on whether such a requirement will be introduced has been left for a later date. In accordance with Article 511 of the CRR, the European Commission is required to submit, by the end of 2016, a report on the LR to the Council and the Parliament. The report will be based on an EBA report and will be accompanied, where appropriate, by a legislative proposal to introduce a binding LR or different LRs for different business models, applicable from January 1, 2018 onwards. At December 31, 2015 the Group’s fully loaded LR was 4.73% and the phase-in LR was 5.38%.

On November 9, 2015, the Financial Stability Board (the “FSB”) published its final principles and term sheet containing an international standard to enhance the loss absorbing capacity of global systemically important banks (“G-SIBs”), such as the Bank. The final standard consists of an elaboration of the principles on loss absorbing and recapitalization capacity of G-SIBs in resolution and a term sheet setting out a proposal for the implementation of these proposals in the form of an internationally agreed standard on total loss absorbing capacity (“TLAC”) for G-SIBs. Once implemented in the relevant jurisdictions, these principles and terms will form a new minimum TLAC standard for G-SIBs, and in the case of G-SIBs with more than one resolution group, each resolution group within the G-SIB. If implemented as contemplated, the TLAC requirement is expected to create material additional quantitative requirements for the Bank and each of its resolution sub-groups, including new minimum risk-based and leverage TLAC ratios of (i) the Bank’s and each of its resolution sub-groups’ regulatory capital plus certain types of long-term unsecured debt instruments and other eligible liabilities that can be written down or converted into equity during resolution to (ii) the Bank’s or the resolution sub-group’s risk-weighted assets and the Basel III leverage ratio denominator.

The FSB term sheet reflects a minimum Pillar 1 risk-based TLAC requirement of 16% of the Bank’s and each of its resolution sub-groups’ risk weighted assets as from January 1, 2019 and 18% as from January 1, 2022. Minimum TLAC under the term sheet must be also at least 6% of the Basel III leverage ratio denominator as from January 1, 2019, and at least 6.75% as from January 1, 2022.

While definitive TLAC requirements remain subject to significant uncertainty, based on our interpretation of the FSB’s final principles and term sheet from November 2015 and assuming TLAC requirements at 18% (the fully phased-in requirement at 2022), a Basel III capital conservation buffer of 2.5% and a G-SIB surcharge of 1.0%, the estimated shortfall between our current capital levels and the requirements expected to be in force by 2019 would be such that, given historical annual debt issuance volumes by the Group, we believe the Group has flexibility to comply with expected TLAC requirements through recurring issuances of qualifying debt.

Furthermore, the European Bank Recovery and Resolution Directive (“BRRD”) requires all European banks to maintain a minimum requirement for own funds and eligible liabilities (“MREL”). The purpose of MREL, which is calculated as a percentage of the total liabilities and own funds of an institution, is to ensure that institutions maintain enough capital capable of being written down and/or bailed-in, so as to facilitate resolution. Therefore, the objective of the MREL is broadly the same as TLAC.

The obligation to set an MREL for the Group and individual Group entities applied under the BRRD from January 1, 2016. The European Union Single Resolution Board (SRB) intends to determine MREL for all major banking groups established in the Banking Union over the course of 2016 although during this year the SRB will focus on determining MREL at the consolidated level of each group only. The MREL determinations allow for a case-by-case analysis. In the case of G-SIBs and the other major banking groups for which it is the resolution authority, the SRB will make its decisions taking into account the main features of TLAC so that these entities would be subject to a single requirement for loss absorbing capacity.

TLAC requirements contain a common minimum requirement but allow resolution authorities to specify additional TLAC requirements on an individual institution basis. TLAC requirements may further be imposed in addition to the minimum “own funds” requirements under CRD IV. Any failure by an institution to meet the applicable minimum TLAC requirements are supposed to be treated in the same manner as a failure to meet minimum regulatory capital requirements, where resolution authorities must ensure that they intervene and place an institution into resolution sufficiently early if it is deemed to be failing or likely to fail and there is no reasonable prospect of recovery.

The conditions required of TLAC eligible instruments (other than own funds) and those required of eligible liabilities for MREL purposes under the BRRD are different. Furthermore, the implementation of TLAC at the European level is currently being discussed. Only some jurisdictions have designed a framework for such eligible instruments (other than own funds instruments) but there is not yet a European solution that gives certainty in relation to the eligibility of instruments and enforcement action for breach of the requirement to hold MREL. There can be no assurance that the Bank and each of its European resolution sub-groups, will be able to issue sufficient TLAC and MREL eligible liabilities to meet their requirements. That may limit the quantity of the Bank’s CET1 capital which is available to meet its “combined buffer requirement”, and may, therefore, limit the Bank’s ability to make “discretionary payments” in the form of dividends, variable remuneration and coupon payments to holders of AT1 instruments.

 

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EU fiscal and banking union

The project of achieving a European banking union was launched in the summer of 2012. Its main goal is to resume progress towards the European single market for financial services by restoring confidence in the European banking sector and ensuring the proper functioning of monetary policy in the eurozone.

The Banking union is expected to be achieved through new harmonized banking rules (the single rulebook) and a new institutional framework with stronger systems for both banking supervision and resolution that will be managed at the European level. Its two main pillars are the Single Supervisory Mechanism (“SSM”) and the Single Resolution Mechanism (“SRM”).

The SSM (comprised by both the ECB and the national competent authorities) is designed to assist in making the banking sector more transparent, unified and safer. In accordance with the SSM Regulation, the ECB fully assumed its new supervisory responsibilities within the SSM, in particular direct supervision of the 123 largest European banks (including the Bank), on November 4, 2014. In preparation for this step, between November 2013 and October 2014, the ECB conducted, together with national supervisors, a comprehensive assessment of 130 banks, which together hold more than 80% of eurozone banking assets. The exercise consisted of three elements: (i) a supervisory risk assessment, which assessed the main balance sheet risks including liquidity, funding and leverage; (ii) an asset quality review, which focused on credit and market risks; and (iii) a stress test to examine the need to strengthen capital or take other corrective measures.

The SSM represents a significant change in the approach to bank supervision at a European and global level. The SSM results in the direct supervision of 123 financial institutions (as of September 30, 2015), including the Bank, and indirect supervision of around 3,500 financial institutions and is now one of the largest in the world in terms of assets under supervision. In the coming years, the SSM is expected to work to establish a new supervisory culture importing best practices from the 19 national competent authorities that are part of the SSM. Several steps have already been taken in this regard such as the recent publication of the Supervisory Guidelines and the approval of the Regulation (EU) No 468/2014 of the European Central Bank of April 16, 2014, establishing the framework for cooperation within the Single Supervisory Mechanism between the European Central Bank and national competent authorities and with national designated authorities (SSM Framework Regulation). In addition, this new body represents an extra cost for the financial institutions that funds it through payment of supervisory fees.

The other main pillar of the EU banking union is the SRM, the main purpose of which is to ensure a prompt and coherent resolution of failing banks in Europe at minimum cost for the taxpayers and the real economy. Regulation (EU) No. 806/2014 of the European Parliament and the Council of the European Union (the “SRM Regulation”), which was passed on July 15, 2014, and became effective from January 1, 2015, establishes uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of the SRM and a Single Resolution Fund (“SRF”). Under the intergovernmental agreement (“IGA”) signed by 26 EU member states on May 21, 2014, contributions by banks raised at national level were transferred to the SRF. The new Single Resolution Board (“SRB”), which is the central decision-making body of the SRM, started operating on January 1, 2015 and has fully assumed its resolution powers on January 1, 2016. The SRB is responsible for managing the SRF and its mission is to ensure that credit institutions and other entities under its remit, which face serious difficulties, are resolved effectively with minimal costs to taxpayers and the real economy. From that date onwards the Single Resolution Fund is also in place, funded by contributions from European banks in accordance with the methodology approved by the Council of the European Union. The Single Resolution Fund is intended to reach a total amount of €55 billion by 2024 and to be used as a separate backstop only after an 8% bail-in of a bank’s liabilities has been applied to cover capital shortfalls (in line with the BRRD).

By allowing for the consistent application of EU banking rules through the SSM and the SRM, the banking union is expected to help resume momentum towards economic and monetary union. In order to complete such union, a single deposit guarantee scheme is still needed which may require a change to the existing European treaties. This is the subject of continued negotiation by European leaders to ensure further progress is made in European fiscal, economic and political integration.

Regulations adopted towards achieving a banking and/or fiscal union in the EU and decisions adopted by the ECB in its capacity as the Bank’s main supervisory authority may have a material impact on the Bank’s business, financial condition and results of operations. In particular, the BRRD and Directive 2014/49/EU on deposit guarantee schemes were published in the Official Journal of the EU on June 12, 2014. The BRRD was required to be implemented on or before January 1, 2015, although the bail-in tool only applies since January 1, 2016. The BRRD was partially implemented in Spain in June 2015 through Law 11/2015 and Royal Decree 1012/2015.

In addition, on January 29, 2014, the European Commission released its proposal on the structural reforms of the European banking sector that will impose new constraints on the structure of European banks. The proposal aims at ensuring the harmonization between the divergent national initiatives in Europe. It includes a prohibition on proprietary trading similar to that contained in Section 619 of the Dodd-Frank Act (also known as the Volcker Rule) and a mechanism to potentially require the separation of trading activities (including market making), such as in the Financial Services (Banking Reform) Act 2013, complex securitizations and risky derivatives.

 

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Moreover, regulations adopted on structural measures to improve the resilience of EU credit institutions may have a material impact on the Bank’s business, financial condition and results of operations. These regulations, if adopted, may also cause the Group to invest significant management attention and resources to make any necessary changes.

Other regulatory reforms adopted or proposed in the wake of the financial crisis

On August 16, 2012, the EU Regulation on over-the-counter (“OTC”) derivatives, central counterparties and trade repositories, referred to as EMIR, entered into force. While a number of the compliance requirements introduced by EMIR already apply, the European Securities and Markets Authority is still in the process of finalizing some of the implementing rules mandated by EMIR. EMIR introduced a number of requirements, including clearing obligations for certain classes of OTC derivatives, exchange of initial and variation margin and various reporting and disclosure obligations. Although some of the particular effects brought about by EMIR are not yet fully foreseeable, many of its elements have led and may lead to changes which may negatively impact our profit margins, require us to adjust our business practices or increase our costs (including compliance costs). The Markets in Financial Instruments legislation (which comprises a regulation (“MiFIR”) and a directive (“MiFID”)), introduces a trading obligation for those OTC derivatives which are subject to mandatory clearing and which are sufficiently standardized. Additionally, it includes other requirements such as enhancing the investor protection’s regime and governance and reporting obligations. It also extends transparency requirements to OTC operations in non-equity instruments. MiFID was initially intended to enter into effect on January 3, 2017. Notwithstanding this, in order to ensure legal certainty and avoid potential market disruption, the European Commission has proposed delaying the effective date of MiFID 12 months, until January 3, 2018.

Separately, on September 28, 2011, the European Commission tabled a proposal for an European Council Directive on a common system of financial transaction tax (FTT) and amending Directive 2008/7/EC. The objective of the proposal was to ensure a fair contribution of the financial sector to the costs of the financial crisis, avoid fragmentation of the single market and create appropriate disincentives for transactions that do not enhance the efficiency of financial markets. At the European Council meetings of June 22 and July 10, 2012 and at the European Council meeting on June 28/29, 2012, it was ascertained that essential differences in opinion remained as regards the need to establish a common system of FTT at EU level and that the proposal would have not received unanimous support within the Council in the foreseeable future. On the basis of the request of eleven Member States (Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain (the “Participating Member States”)), and in accordance with the authorization of the European Council of January 22, 2013, which was adopted following the European Parliament’s consent given on December 12, 2012, the European Commission on March 14, 2013 submitted a proposal for a Council Directive implementing enhanced cooperation in the area of financial transaction tax (the “Commission Proposal”). The Commission Proposal, essentially, mirrored the scope and objectives of the original FTT proposal put forward by the European Commission in 2011. Though further progress during 2015 was expected, work will have to continue in 2016 on a number of other open questions that constitute the “building blocks” of the design of the future FTT. This work will have to cover all remaining aspects of the Commission Proposal on FTT, and in particular whether the final compromise should include specific provisions or exemptions to address concerns relating to the potential impact of the future FTT on the real economy and retirement schemes (pension plans, funds, and other products serving similar objective). The ECOFIN meeting held on December 8, 2015 was intended to be a make or break meeting for the prospects of an enhanced co-operation FTT. A statement following the meeting released by the 10 remaining Participating Member states (Estonia has now dropped out) represents progress of sorts but significant differences still remain. A further deadline of June 2016 has been set to reach consensus, though there is still real uncertainty over the prospects of the EU FTT. Depending on the final details, the proposed financial transaction tax could have a materially negative effect on the Bank’s profits and business. Different forms of national financial transaction taxes have already been implemented in a number of European jurisdictions, including France and Italy, and these taxes may result in compliance costs as well as market consequences which may affect the Bank’s revenues.

United States significant regulation

In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was adopted in 2010, will continue to result in significant structural reforms affecting the financial services industry. This legislation provided for, among other things, the establishment of a Consumer Financial Protection Bureau with broad authority to regulate the credit, savings, payment and other consumer financial products and services that we offer, the creation of a structure to regulate systemically important financial companies, more comprehensive regulation of the over-the-counter derivatives market, prohibitions on engagement in certain proprietary trading activities and restrictions on ownership or sponsorship of, or entering into certain credit-related transactions with related, covered funds, restrictions on the interchange fees earned through debit card transactions, and a requirement that bank regulators phase out the treatment of trust preferred capital instruments as Tier 1 capital for regulatory capital purposes.

 

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With respect to OTC derivatives, the Dodd-Frank Act provides for an extensive framework for the regulation of OTC derivatives, including mandatory clearing, trading through electronic platforms and transaction reporting of certain OTC derivatives. Entities that are swap dealers, security-based swap dealers, major swap participants or major security-based swap participants are required to register with the CFTC or the SEC, or both, and are or will be subject to new capital, margin, business conduct, recordkeeping, clearing, execution, reporting and other requirements. Banco Santander, S.A. and Abbey National Treasury Services plc became provisionally registered as a swap dealer with the CFTC on July 8, 2013 and November 4, 2013, respectively. In addition, we may register one more subsidiary as swap dealer with the CFTC. Although many significant regulations applicable to swap dealers are already in effect, some of the most important rules, such as margin requirements for uncleared swaps and capital rules for swap dealers, are not yet effective and we continue to assess how compliance with these new rules will affect our business.

In July 2013, the U.S. bank regulators issued the U.S. Basel III final rules implementing the Basel III capital framework for U.S. banks and bank holding companies. Certain aspects of the U.S. Basel III final rules, such as new minimum capital ratios and a revised methodology for calculating risk-weighted assets, became effective for part of the Bank’s U.S. operations on January 1, 2015. Other aspects of the U.S. Basel III final rules, such as the capital conservation buffer and the new regulatory deductions from and adjustments to capital, will be phased in over several years beginning on January 1, 2015.

In addition, in September 2014 the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and other U.S. regulators issued a final rule introducing a quantitative liquidity coverage ratio requirement on certain large banks and bank holding companies. The liquidity coverage ratio is part of the Basel Committee’s international standards on quantitative liquidity metrics, which are in turn part of the international Basel III framework. The U.S. implementation of the liquidity coverage ratio is broadly consistent with the Basel Committee’s liquidity standards, but is more stringent in several important respects. Although this final rule does not apply to foreign banking organizations (“FBOs”), the Federal Reserve Board has stated that it intends, through future rulemakings, to apply the liquidity coverage ratio and another Basel III liquidity metric to the U.S. operations of some or all large FBOs.

On February 18, 2014, the Federal Reserve Board issued a final rule to enhance its supervision and regulation of certain FBOs. Among other things, this rule requires FBOs with over $50 billion of U.S. non-branch assets to establish or designate a U.S. intermediate holding company (an “IHC”) and to transfer its entire ownership interest in substantially all of its U.S. subsidiaries to such IHC by July 1, 2016. U.S. branches and agencies are not required to be transferred to the IHC. The IHC will be subject to an enhanced supervision framework, including enhanced risk-based and leverage capital requirements, liquidity requirements, risk management and governance requirements, and stress-testing requirements. A phased-in approach is being used for the standards and requirements. Certain enhanced standards are effective in 2015, with other standards and requirements becoming effective between July 1, 2016 and January 1, 2018. Pursuant to the final rule, as an FBO with over $50 billion of U.S. non-branch assets as of June 30, 2014, we submitted an IHC implementation plan to the Federal Reserve Board by January 1, 2015. As of the date of this annual report, we are continuing to refine this plan. Implementation and compliance with this plan have caused and will continue to cause the Group to invest significant management attention and resources.

The Volcker Rule, a statutory provision of the Dodd-Frank Act, prohibits “banking entities” from engaging in certain forms of proprietary trading or from sponsoring, investing in, or entering into certain credit-related transactions with related, covered funds, in each case subject to certain exceptions. The term “covered fund” is defined very broadly to include traditional hedge funds, private equity funds, certain securitization vehicles and other entities that rely on Sections 3(c)(1) or 3(c)(7) of the U.S. Investment Company Act of 1940 for an exemption under that Act, as well as certain similar foreign funds. The Volcker Rule became effective in July 2012 and in December 2013 U.S. regulators issued final rules implementing the Volcker Rule. The statute and final rules also contain exclusions and certain exemptions for market-making, hedging, underwriting, trading in U.S. government and agency obligations as well as certain foreign government obligations, and trading solely outside the United States, and also permit certain ownership interests in certain types of funds to be retained. Banking entities such as the Bank must bring their activities and investments into compliance with the requirements of the Volcker Rule by the end of the conformance period applicable to each requirement. In general, all banking entities were required to conform to the requirements of the Volcker Rule, except for provisions related to certain funds, and to implement a compliance program by July 21, 2015. In December 2014, the Federal Reserve Board issued an order extending the Volcker Rule’s general conformance period until July 21, 2016 for investments in and relationships with covered funds and certain foreign funds that were in place on or prior to December 31, 2013 (“legacy covered funds”), and stated its intention to grant a final one-year extension of the general conformance period, to July 21, 2017, for banking entities to conform ownership interests in and relationships with legacy covered funds. This extension of the conformance period does not apply to the Volcker Rule’s prohibitions on proprietary trading and does not appear to apply to any investments in and relationships with covered funds put in place after December 31, 2013. We have assessed how the final rules implementing the Volcker Rule affect our businesses and have adopted the necessary measures to bring our activities into compliance with the rules.

 

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Furthermore, Title I of the Dodd-Frank Act and the implementing regulations issued by the Federal Reserve Board and the Federal Deposit Insurance Corporation (“FDIC”) require each bank holding company with assets of $50 billion or more, including us, to prepare and submit annually to the Federal Reserve Board and the FDIC a plan for the orderly resolution of our subsidiaries and operations that are domiciled in the United States in the event of future material financial distress or failure. In addition, each insured depository institution (“IDI”) with assets of $50 billion or more, such as Santander Bank, N.A., our U.S. national bank subsidiary, must submit a separate IDI resolution plan annually to the FDIC. The Title I and IDI plans each must include information on resolution strategy, major counterparties and interdependencies, among other things, and require substantial effort, time and cost to prepare. We submitted our most recent annual U.S. resolution plans in December 2015. The Title I plan resolution plan is subject to review by the Federal Reserve Board and the FDIC. The IDI plan is subject to review solely by the FDIC.

On October 30, 2015, the Federal Reserve Board proposed a rule that would establish certain TLAC and long-term debt requirements in the United States generally consistent with the FSB’s international TLAC standard. The proposed U.S. TLAC rule would require, among other things, the U.S. IHCs of non-U.S. G-SIBs, including the Group’s future U.S. IHC, to maintain a minimum amount of internal TLAC and would separately require them to maintain a minimum amount of internal long-term debt. The terms “internal TLAC” and “internal long-term debt” refer to instruments that would be required to be issued internally within the banking group, from the IHC to a foreign parent entity. The proposed minimum amounts of internal TLAC and internal long-term debt vary depending on the home country resolution authority’s preferred resolution strategy. Under the proposed rule, the Group’s U.S. IHC, if it is treated as a resolution entity IHC under the proposed rule, would be required to maintain, on a fully phased-in basis by 2022, internal TLAC of at least 18% of risk-weighted assets (plus an internal TLAC buffer of an additional 2.5%), at least 6.75% of the Basel III leverage ratio denominator and at least 9% of average total consolidated assets, as well as internal long-term debt of at least 7% of risk-weighted assets, at least 3% of the Basel III leverage ratio denominator and at least 4% of average total consolidated assets. Internal long-term debt instruments would be subject to certain eligibility criteria, including issuance to a foreign parent entity (a non-U.S. entity that controls the IHC) and the inclusion of a contractual trigger allowing for, in limited circumstances, the cancellation of, or immediate conversion or exchange of the instrument into, common equity tier 1 capital upon an order by the Federal Reserve Board. As proposed, the internal TLAC requirements may be satisfied with a combination of eligible long-term debt instruments and tier 1 capital, whereas the internal long-term debt requirements would be required to be satisfied only with eligible long-term debt instruments. The proposed rule would also require internal TLAC to be contractually subordinated to ineligible debt instruments and prohibit the U.S. IHC from issuing any external short-term debt, issuing parent guarantees with certain impermissible cross defaults, entering into any qualified financial contract with a third party, benefitting from upstream guarantees or issuing any instruments with certain setoff rights.

Each of these aspects of the Dodd-Frank Act, as well as other changes in U.S. banking regulations, may directly and indirectly impact various aspects of our business. The full spectrum of risks that the Dodd-Frank Act poses to us is not yet known; however, such risks could be material and we could be materially and adversely affected by them.

United States stress testing, capital planning, and related supervisory actions

Certain of our U.S. subsidiaries, including Santander Holdings USA, our U.S. bank holding company subsidiary, are subject to stress testing and capital planning requirements under regulations implementing the Dodd-Frank Act or other banking laws or policies. In March 2014 and March 2015, the Federal Reserve Board, as part of its Comprehensive Capital Analysis and Review (“CCAR”) process, objected on qualitative grounds to the capital plans submitted by Santander Holdings USA. In its 2015 public report on CCAR, the Federal Reserve Board cited widespread and critical deficiencies in Santander Holdings USA’s capital planning processes, including specific deficiencies in governance, internal controls, risk identification and risk management, management information systems, and supporting assumptions and analysis. As a result of the 2014 and 2015 CCAR objections, Santander Holdings USA is not permitted to make any capital distributions without the Federal Reserve Board’s approval, other than the continued payment of dividends on Santander Holdings USA’s outstanding class of preferred stock, until a new capital plan is approved by the Federal Reserve Board. The deadline for Santander Holdings USA’s next capital plan submission is in April 2016, and there is the risk that the Federal Reserve Board will object to Santander Holdings USA’s next capital plan.

In addition, Santander Holdings USA is subject to supervisory actions in the United States related to the CCAR stress testing and capital planning processes. Specifically, on September 15, 2014, Santander Holdings USA and the Federal Reserve Bank of Boston (“FRB Boston”) executed a written agreement relating to a subsidiary’s declaration and payment of dividends in the second quarter of 2014 without the Federal Reserve Board’s approval. Under the written agreement, Santander Holdings USA agreed to submit to the FRB Boston written procedures to strengthen board oversight of management regarding planned capital distributions by Santander Holdings USA and its subsidiaries. In addition, Santander Holdings USA agreed to subject future distributions to the prior written approval of Federal Reserve System and to take necessary actions to ensure that no such distributions are made.

 

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Other supervisory actions and restrictions on U.S. activities

In addition to the foregoing, U.S. bank regulatory agencies from time to time take supervisory actions under certain circumstances that restrict or limit a financial institution’s activities. In some instances, we are subject to significant legal restrictions on our ability to publicly disclose these actions or the full details of these actions. Furthermore, as part of the regular examination process, our U.S. banking subsidiaries’ regulators may advise our U.S. banking subsidiaries to operate under various restrictions as a prudential matter. The U.S. supervisory environment has become significantly more demanding and restrictive since the financial crisis of 2008. Under the U.S. Bank Holding Company Act, the Federal Reserve Board has the authority to disallow us and our U.S. banking subsidiaries from engaging in certain categories of new activities in the United States or acquiring shares or control of other companies in the United States. Such actions and restrictions currently applicable to us or our U.S. banking subsidiaries could adversely affect our costs and revenues. Moreover, efforts to comply with nonpublic supervisory actions or restrictions could require material investments in additional resources and systems, as well as a significant commitment of managerial time and attention. As a result, such supervisory actions or restrictions could have a material adverse effect on our business and results of operations; and we may be subject to significant legal restrictions on our ability to publicly disclose these matters or the full details of these actions. In addition to such confidential actions and restrictions, in July 2015, Santander Holdings USA became subject to a public enforcement action with the FRB Boston under which Santander Holdings USA entered into a written agreement to make enhancements with respect to, among other matters, board oversight of the consolidated organization, risk management, capital planning and liquidity risk management.

2.1.3 We are subject to potential intervention by any of our regulators or supervisors, particularly in response to customer complaints.

As noted above, our business and operations are subject to increasingly significant rules and regulations that are required to conduct banking and financial services business. These apply to business operations, affect financial returns, include reserve and reporting requirements, and prudential and conduct of business regulations. These requirements are set by the relevant central banks and regulatory authorities that authorize, regulate and supervise us in the jurisdictions in which we operate.

In their supervisory roles, the regulators seek to maintain the safety and soundness of financial institutions with the aim of strengthening the protection of customers and the financial system. The supervisors’ continuing supervision of financial institutions is conducted through a variety of regulatory tools, including the collection of information by way of prudential returns, reports obtained from skilled persons, visits to firms and regular meetings with management to discuss issues such as performance, risk management and strategy. In general, these regulators have a more outcome-focused regulatory approach that involves more proactive enforcement and more punitive penalties for infringement. As a result, we face increased supervisory scrutiny (resulting in increasing internal compliance costs and supervision fees), and in the event of a breach of our regulatory obligations we are likely to face more stringent regulatory fines. Some of the regulators are focusing intently on consumer protection and on conduct risk and will continue to do so. This has included a focus on the design and operation of products, the behavior of customers and the operation of markets. Some of the laws in the relevant jurisdictions on which we operate, give the regulators the power to make temporary product intervention rules either to improve a firm’s systems and controls in relation to product design, product management and implementation, or to address problems identified with financial products. These problems may potentially cause significant detriment to consumers because of certain product features or governance flaws or distribution strategies. Such rules may prevent institutions from entering into product agreements with customers until such problems have been solved. Some of the regulatory regimes on the relevant jurisdictions on which we operate, require us to be in compliance across all aspects of our business, including the training, authorization and supervision of personnel, systems, processes and documentation. If we fail to comply with the relevant regulations, there would be a risk of an adverse impact on our business from sanctions, fines or other actions imposed by the regulatory authorities. Customers of financial services institutions, including our customers, may seek redress if they consider that they have suffered loss as a result of the mis-selling of a particular product, or through incorrect application of the terms and conditions of a particular product. Given the inherent unpredictability of litigation and the evolution of judgments by the relevant authorities, it is possible that an adverse outcome in some matters could harm our reputation or have a material adverse effect on our operating results, financial condition and prospects arising from any penalties imposed or compensation awarded, together with the costs of defending such an action, thereby reducing our profitability.

2.1.4 We are subject to review by taxing authorities, and an incorrect interpretation by us of tax laws and regulations may have a material adverse effect on us.

The preparation of our tax returns requires the use of estimates and interpretations of complex tax laws and regulations and is subject to review by taxing authorities. We are subject to the income tax laws of Spain and certain foreign countries. These tax laws are complex and subject to different interpretations by the taxpayer and relevant governmental taxing authorities, which are sometimes subject to prolonged evaluation periods until a final resolution is reached. In establishing a provision for income tax expense and filing returns, we must make judgments and interpretations about the application of these inherently complex tax laws. If the judgment, estimates and assumptions we use in preparing our tax returns are subsequently found to be incorrect, there could be a material adverse effect on our results of operations.

 

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2.1.5 Changes in taxes and other assessments may adversely affect us.

The legislatures and tax authorities in the tax jurisdictions in which we operate regularly enact reforms to the tax and other assessment regimes to which we and our customers are subject. Such reforms include changes in the rate of assessments and, occasionally, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. The effects of these changes and any other changes that result from enactment of additional tax reforms cannot be quantified and there can be no assurance that any such reforms would not have an adverse effect upon our business.

2.1.6 We may not be able to detect or prevent money laundering and other financial crime activities fully or on a timely basis, which could expose us to additional liability and could have a material adverse effect on us.

We are required to comply with applicable anti-money laundering (“AML”), anti-terrorism, sanctions and other laws and regulations in the jurisdictions in which we operate. These laws and regulations require us, among other things, to conduct full customer due diligence regarding sanctions and politically-exposed person screening, keep our customer, account and transaction information up to date and have implemented effective financial crime policies and procedures detailing what is required from those responsible. Our requirements also include AML training for our employees, reporting suspicious transactions and activity to appropriate law enforcement following full investigation by our local AML team.

Financial crime has become the subject of enhanced regulatory scrutiny and supervision by regulators globally. AML sanctions, laws and regulations are increasingly complex and detailed and have become the subject of enhanced regulatory supervision, requiring improved systems, sophisticated monitoring and skilled compliance personnel.

We have developed policies and procedures aimed at detecting and preventing the use of our banking network for money laundering and other financial crime related activities. These require implementation and embedding within our business effective controls and monitoring, which in turn requires on-going changes to systems and operational activities. Financial crime is continually evolving and subject to increasingly stringent regulatory oversight and focus. This requires proactive and adaptable responses from us so that we are able to deter threats and criminality effectively. Even known threats can never be fully eliminated, and there will be instances where we may be used by other parties to engage in money laundering and other illegal or improper activities. In addition, we rely heavily on our employees to assist us by spotting such activities and reporting them, and our employees have varying degrees of experience in recognizing criminal tactics and understanding the level of sophistication of criminal organizations. Where we outsource any of our customer due diligence, customer screening or anti financial crime operations, we remain responsible and accountable for full compliance and any breaches. If we are unable to apply the necessary scrutiny and oversight, there remains a risk of regulatory breach.

If we are unable to fully comply with applicable laws, regulations and expectations, our regulators and relevant law enforcement agencies have the ability and authority to impose significant fines and other penalties on us, including requiring a complete review of our business systems, day-to-day supervision by external consultants and ultimately the revocation of our banking license.

The reputational damage to our business and global brand would be severe if we were found to have breached AML or sanctions requirements. Our reputation could also suffer if we are unable to protect our customers or our business from being used by criminals for illegal or improper purposes.

In addition, while we review our relevant counterparties’ internal policies and procedures with respect to such matters, we, to a large degree, rely upon our relevant counterparties to maintain and properly apply their own appropriate anti-money laundering procedures. Such measures, procedures and compliance may not be completely effective in preventing third parties from using our (and our relevant counterparties’) services as a conduit for money laundering (including illegal cash operations) without our (and our relevant counterparties’) knowledge. If we are associated with, or even accused of being associated with, or become a party to, money laundering, then our reputation could suffer and/or we could become subject to fines, sanctions and/or legal enforcement (including being added to any “black lists” that would prohibit certain parties from engaging in transactions with us), any one of which could have a material adverse effect on our operating results, financial condition and prospects.

Any such risks could have a material adverse effect on our operating results, financial condition and prospects.

 

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2.2 Liquidity and Financing Risks

2.2.1 Liquidity and funding risks are inherent in our business and could have a material adverse effect on us.

Liquidity risk is the risk that we either do not have available sufficient financial resources to meet our obligations as they fall due or can secure them only at excessive cost. This risk is inherent in any retail and commercial banking business and can be heightened by a number of enterprise-specific factors, including over-reliance on a particular source of funding, changes in credit ratings or market-wide phenomena such as market dislocation. While we implement liquidity management processes to seek to mitigate and control these risks, unforeseen systemic market factors in particular make it difficult to eliminate completely these risks. Adverse and continued constraints in the supply of liquidity, including inter-bank lending, has affected and may materially and adversely affect the cost of funding our business, and extreme liquidity constraints may affect our current operations and our ability to fulfill regulatory liquidity requirements, as well as limit growth possibilities.

Disruption and volatility in the global financial markets could have a material adverse effect on our ability to access capital and liquidity on financial terms acceptable to us.

Our cost of obtaining funding is directly related to prevailing market interest rates and to our credit spreads. Increases in interest rates and our credit spreads can significantly increase the cost of our funding. Changes in our credit spreads are market-driven, and may be influenced by market perceptions of our creditworthiness. Changes to interest rates and our credit spreads occur continuously and may be unpredictable and highly volatile.

If wholesale markets financing ceases to become available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits, with a view to attracting more customers, and/or to sell assets, potentially at depressed prices. The persistence or worsening of these adverse market conditions or an increase in base interest rates could have a material adverse effect on our ability to access liquidity and cost of funding.

We rely, and will continue to rely, primarily on commercial deposits to fund lending activities. The ongoing availability of this type of funding is sensitive to a variety of factors outside our control, such as general economic conditions and the confidence of commercial depositors in the economy, in general, and the financial services industry in particular, and the availability and extent of deposit guarantees, as well as competition between banks for deposits or competition with other products, such as mutual funds. Any of these factors could significantly increase the amount of commercial deposit withdrawals in a short period of time, thereby reducing our ability to access commercial deposit funding on appropriate terms, or at all, in the future. If these circumstances were to arise, this could have a material adverse effect on our operating results, financial condition and prospects.

We anticipate that our customers will continue, in the near future, to make deposits (particularly demand deposits and short-term time deposits), and we intend to maintain our emphasis on the use of banking deposits as a source of funds. The short-term nature of some deposits could cause liquidity problems for us in the future if deposits are not made in the volumes we expect or are not renewed. If a substantial number of our depositors withdraw their demand deposits or do not roll over their time deposits upon maturity, we may be materially and adversely affected.

Central banks have taken extraordinary measures to increase liquidity in the financial markets as a response to the financial crisis. If current facilities were rapidly removed or significantly reduced, this could have an adverse effect on our ability to access liquidity and on our funding costs.

We cannot assure that in the event of a sudden or unexpected shortage of funds in the banking system, we will be able to maintain levels of funding without incurring high funding costs, a reduction in the term of funding instruments or the liquidation of certain assets. If this were to happen, we could be materially adversely affected.

2.2.2 Credit, market and liquidity risk may have an adverse effect on our credit ratings and our cost of funds. Any downgrading in our credit rating would likely increase our cost of funding, require us to post additional collateral or take other actions under some of our derivative contracts and adversely affect our interest margins and results of operations.

Credit ratings affect the cost and other terms upon which we are able to obtain funding. Rating agencies regularly evaluate us, and their ratings of our debt are based on a number of factors, including our financial strength and conditions affecting the financial services industry generally. In addition, due to the methodology of the main rating agencies, our credit rating is affected by the rating of Spanish sovereign debt. If Spain’s sovereign debt is downgraded, our credit rating would also likely be downgraded by an equivalent amount.

 

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Any downgrade in our debt credit ratings would likely increase our borrowing costs and require us to post additional collateral or take other actions under some of our derivative contracts, and could limit our access to capital markets and adversely affect our commercial business. For example, a ratings downgrade could adversely affect our ability to sell or market certain of our products, engage in certain longer-term and derivatives transactions and retain our customers, particularly customers who need a minimum rating threshold in order to invest. In addition, under the terms of certain of our derivative contracts, we may be required to maintain a minimum credit rating or terminate such contracts. Any of these results of a ratings downgrade, in turn, could reduce our liquidity and have an adverse effect on us, including our operating results and financial condition.

Banco Santander, S.A.’s long-term debt is currently rated investment grade by the major rating agencies—A3 stable outlook by Moody’s Investors Service España, S.A., A- stable outlook by Standard & Poor’s Ratings Services and A- stable outlook by Fitch Ratings Ltd. In June 2015, Moody’s upgraded Banco Santander, S.A.’s rating from Baa1 to A3 in light of their new banking methodology and in October 2015 Standard & Poor’s upgraded Banco Santander, S.A.’s rating from BBB+ to A- following the upgrade of the sovereign credit rating of Spain.

Santander UK’s long-term debt is currently rated investment grade by the major rating agencies: A1 with stable outlook by Moody’s Investors Service, A with stable outlook by Standard & Poor’s Ratings Services and A with positive outlook by Fitch Ratings.

Banco Santander (Brasil)’s long-term debt in foreign currency is currently rated BB with a negative outlook by Standard & Poor’s Ratings Services, BBB- with negative outlook by Fitch Ratings Ltd. and Ba3 with a negative outlook by Moody’s Investors Service. During the course of 2015 and the first quarter of 2016 the three major agencies lowered the rating as a result of the lowering of Brazil’s sovereign credit rating.

We conduct substantially all of our material derivative activities through Banco Santander, S.A. and Santander UK. We estimate that as of December 31, 2015, if all the rating agencies were to downgrade Banco Santander, S.A.’s long-term senior debt ratings by one notch we would be required to post up to €200 million in additional collateral pursuant to derivative and other financial contracts. A hypothetical two notch downgrade would result in a requirement to post up to €6 million in additional collateral. We estimate that as of December 31, 2015, if all the rating agencies were to downgrade Santander UK’s long-term credit ratings by one notch, and thereby trigger a short-term credit rating downgrade, this could result in contractual outflows from Santander UK’s total liquid assets of £4.6 billion of cash and additional collateral that Santander UK would be required to post under the terms of secured funding and derivatives contracts. A hypothetical two notch downgrade would result in an additional contractual outflow of £0.3 billion of cash and collateral under secured funding and derivatives contracts.

While certain potential impacts of these downgrades are contractual and quantifiable, the full consequences of a credit rating downgrade are inherently uncertain, as they depend upon numerous dynamic, complex and inter-related factors and assumptions, including market conditions at the time of any downgrade, whether any downgrade of a firm’s long-term credit rating precipitates downgrades to its short-term credit rating, and assumptions about the potential behaviors of various customers, investors and counterparties. Actual outflows could be higher or lower than this hypothetical example, depending upon certain factors including which credit rating agency downgrades our credit rating, any management or restructuring actions that could be taken to reduce cash outflows and the potential liquidity impact from loss of unsecured funding (such as from money market funds) or loss of secured funding capacity. Although, unsecured and secured funding stresses are included in our stress testing scenarios and a portion of our total liquid assets is held against these risks, it is still the case that a credit rating downgrade could have a material adverse effect on Banco Santander, S.A., and/or its subsidiaries.

In addition, if we were required to cancel our derivatives contracts with certain counterparties and were unable to replace such contracts, our market risk profile could be altered.

There can be no assurance that the rating agencies will maintain the current ratings or outlooks. Failure to maintain favorable ratings and outlooks could increase our cost of funding and adversely affect interest margins, which could have a material adverse effect on us.

2.3 Credit Risks

2.3.1 If the level of non-performing loans increases or the credit quality deteriorates in the future, or if our loan loss reserves are insufficient to cover loan losses, this could have a material adverse effect on us.

Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of our business. Non-performing or low credit quality loans have in the past and can continue to negatively impact our results of operations. In particular, the amount of our reported non-performing loans may increase in the future as a result of growth in our total loan portfolio, including as a result of loan portfolios that we may acquire in the future,

 

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or factors beyond our control, such as adverse changes in the credit quality of our borrowers and counterparties or a general deterioration in economic conditions in Continental Europe, the United Kingdom, Latin America, particularly Brazil, the United States or global economic conditions, impact of political events, events affecting certain industries or events affecting financial markets and global economies. We cannot assure that we will be able to effectively control the level of the non-performing loans in our total loan portfolio.

Our loan loss reserves are based on our current assessment of and expectations concerning various factors affecting the quality of our loan portfolio. These factors include, among other things, our borrowers’ financial condition, repayment abilities and repayment intentions, the realizable value of any collateral, the prospects for support from any guarantor, government macroeconomic policies, interest rates and the legal and regulatory environment. As the recent global financial crisis demonstrated, many of these factors are beyond our control. As a result, there is no precise method for predicting loan and credit losses, and we cannot assure that our current or future loan loss reserves will be sufficient to cover actual losses. If our assessment of and expectations concerning the above mentioned factors differ from actual developments, if the quality of our total loan portfolio deteriorates, for any reason, including the increase in lending to individuals and small and medium enterprises, the volume increase in the credit card portfolio and the introduction of new products, or if the future actual losses exceed our estimates of incurred losses, we may be required to increase our loan loss reserves, which may adversely affect us. If we were unable to control or reduce the level of our non-performing or poor credit quality loans, this could have a material adverse effect on us.

Mortgage loans are one of our principal assets, comprising 49% of our loan portfolio as of December 31, 2015. We are exposed to developments in housing markets, especially in Spain and the United Kingdom, and to a number of large real estate developers in Spain. From 2002 to 2007, demand for housing and mortgage financing in Spain increased significantly driven by, among other things, economic growth, declining unemployment rates, demographic and social trends, the desirability of Spain as a vacation destination and historically low interest rates in the eurozone. The United Kingdom also experienced an increase in housing and mortgage demand driven by, among other things, economic growth, declining unemployment rates, demographic trends and the increasing prominence of London as an international financial center. During late 2007, the housing market began to adjust in Spain and the United Kingdom as a result of excess supply (particularly in Spain) and higher interest rates. Since 2008, as economic growth stalled in Spain and the United Kingdom, persistent housing oversupply, decreased housing demand, rising unemployment, subdued earnings growth, greater pressure on disposable income, a decline in the availability of mortgage finance and the continued effect of global market volatility have caused home prices to decline, while mortgage delinquencies and forbearances have increased.

As a result of these and other factors, our NPL ratio increased from 0.94% at December 31, 2007, to 2.02% at December 31, 2008, to 3.24% at December 31, 2009, to 3.54% at December 31, 2010, to 3.90% at December 31, 2011, to 4.54% at December 31, 2012 and to 5.64% at December 31, 2013. Although the trend changed during the last two years as our NPL ratio decreased to 5.19% at December 31, 2014 and to 4.36% at December 31, 2015, we can provide no assurance that our NPL ratio will not increase again as a result of the aforementioned and other factors. High unemployment rates coupled with declining real estate prices, could have a material adverse impact on our mortgage payment delinquency rates, which in turn could have a material adverse effect on our business, financial condition and results of operations.

2.3.2 The value of the collateral securing our loans may not be sufficient, and we may be unable to realize the full value of the collateral securing our loan portfolio.

The value of the collateral securing our loan portfolio may fluctuate or decline due to factors beyond our control, including macroeconomic factors affecting Europe, the United States and Latin American countries. The value of the collateral securing our loan portfolio may be adversely affected by force majeure events, such as natural disasters, particularly in locations where a significant portion of our loan portfolio is composed of real estate loans. Natural disasters such as earthquakes and floods may cause widespread damage which could impair the asset quality of our loan portfolio and could have an adverse impact on the economy of the affected region. We may also not have sufficiently recent information on the value of collateral, which may result in an inaccurate assessment for impairment losses of our loans secured by such collateral. If any of the above were to occur, we may need to make additional provisions to cover actual impairment losses of our loans, which may materially and adversely affect our results of operations and financial condition.

2.3.3 We are subject to counterparty risk in our banking business.

We are exposed to counterparty risk in addition to credit risks associated with lending activities. Counterparty risk may arise from, for example, investing in securities of third parties, entering into derivative contracts under which counterparties have obligations to make payments to us or executing securities, futures, currency or commodity trades from proprietary trading activities that fail to settle at the required time due to non-delivery by the counterparty or systems failure by clearing agents, clearing houses or other financial intermediaries.

 

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We routinely transact with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual funds, hedge funds and other institutional clients. Defaults by, and even rumors or questions about the solvency of, certain financial institutions and the financial services industry generally have led to market-wide liquidity problems and could lead to losses or defaults by other institutions. Many of the routine transactions we enter into expose us to significant credit risk in the event of default by one of our significant counterparties.

2.4 Market Risks

2.4.1 Our financial results are constantly exposed to market risk. We are subject to fluctuations in interest rates and other market risks, which may materially and adversely affect us.

Market risk refers to the probability of variations in our net interest income or in the market value of our assets and liabilities due to volatility of interest rate, inflation, exchange rate or equity price. Changes in interest rates affect the following areas, among others, of our business:

 

    net interest income;

 

    the volume of loans originated;

 

    volatility of credit spreads;

 

    the market value of our securities holdings;

 

    gains from sales of loans and securities; and

 

    gains and losses from derivatives.

Interest rates are sensitive to many factors beyond our control, including increased regulation of the financial sector, monetary policies, domestic and international economic and political conditions and other factors. Variations in interest rates could affect our net interest income, which comprises the majority of our revenue, reducing our growth rate and potentially resulting in losses. This results from the varying effect that a change in interest rates may have on the interest earned on our assets and the interest paid on our borrowings. In addition, we may incur costs (which, in turn, will impact our results) as we implement strategies to reduce future interest rate exposure.

Increases in interest rates may reduce the volume of loans we originate. Sustained high interest rates have historically discouraged customers from borrowing and have resulted in increased delinquencies in outstanding loans and deterioration in the quality of assets. Increases in interest rates may also reduce the propensity of our customers to prepay or refinance fixed-rate loans. Increases in interest rates may reduce the value of our financial assets and may reduce gains or require us to record losses on sales of our loans or securities.

In addition, we may experience increased delinquencies in a low interest rate environment when such an environment is accompanied by high unemployment and recessionary conditions.

We are also exposed to foreign exchange rate risk as a result of mismatches between assets and liabilities denominated in different currencies. Fluctuations in the exchange rate between currencies may negatively affect our earnings and value of our assets and securities. The continued depreciation of the Latin American currencies against the U.S. dollar could make our Latin American subsidiaries’ foreign currency-linked obligations and funding more expensive and have similar consequences for our borrowers in Latin America.

We are also exposed to equity price risk in our investments in equity securities in the banking book and in the trading portfolio. The performance of financial markets may cause changes in the value of our investment and trading portfolios. The volatility of world equity markets due to the continued economic uncertainty and sovereign debt crisis has had a particularly strong impact on the financial sector. Continued volatility may affect the value of our investments in equity securities and, depending on their fair value and future recovery expectations, could become a permanent impairment which would be subject to write-offs against our results. To the extent any of these risks materialize, our net interest income or the market value of our assets and liabilities could be materially adversely affected.

 

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2.4.2 Market conditions have resulted and could result in material changes to the estimated fair values of our financial assets. Negative fair value adjustments could have a material adverse effect on our operating results, financial condition and prospects.

In the past eight years, financial markets have been subject to significant stress resulting in steep falls in perceived or actual financial asset values, particularly due to volatility in global financial markets and the resulting widening of credit spreads. We have material exposures to securities, loans and other investments that are recorded at fair value and are therefore exposed to potential negative fair value adjustments. Asset valuations in future periods, reflecting then-prevailing market conditions, may result in negative changes in the fair values of our financial assets and these may also translate into increased impairments. In addition, the value ultimately realized by us on disposal may be lower than the current fair value. Any of these factors could require us to record negative fair value adjustments, which may have a material adverse effect on our operating results, financial condition or prospects.

In addition, to the extent that fair values are determined using financial valuation models, such values may be inaccurate or subject to change, as the data used by such models may not be available or may become unavailable due to changes in market conditions, particularly for illiquid assets, and particularly in times of economic instability. In such circumstances, our valuation methodologies require us to make assumptions, judgments and estimates in order to establish fair value, and reliable assumptions are difficult to make and are inherently uncertain and valuation models are complex, making them inherently imperfect predictors of actual results. Any consequential impairments or write-downs could have a material adverse effect on our operating results, financial condition and prospects.

2.4.3 We are subject to market, operational and other related risks associated with our derivative transactions that could have a material adverse effect on us.

We enter into derivative transactions for trading purposes as well as for hedging purposes. We are subject to market, credit and operational risks associated with these transactions, including basis risk (the risk of loss associated with variations in the spread between the asset yield and the funding and/or hedge cost) and credit or default risk (the risk of insolvency or other inability of the counterparty to a particular transaction to perform its obligations thereunder, including providing sufficient collateral).

Market practices and documentation for derivative transactions in the countries where we operate differ from each other. In addition, the execution and performance of these transactions depend on our ability to maintain adequate control and administration systems and to hire and retain qualified personnel. Moreover, our ability to adequately monitor, analyze and report derivative transactions continues to depend, to a great extent, on our information technology systems. This factor further increases the risks associated with these transactions and could have a material adverse effect on us.

2.5 Risk Management

2.5.1 Failure to successfully implement and continue to improve our risk management policies, procedures and methods, including our credit risk management system, could materially and adversely affect us, and we may be exposed to unidentified or unanticipated risks.

The management of risk is an integral part of our activities. We seek to monitor and manage our risk exposure through a variety of separate but complementary financial, credit, market, operational, compliance and legal reporting systems. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, such techniques and strategies may not be fully effective in mitigating our risk exposure in all economic market environments or against all types of risk, including risks that we fail to identify or anticipate.

Some of our qualitative tools and metrics for managing risk are based upon our use of observed historical market behavior. We apply statistical and other tools to these observations to arrive at quantifications of our risk exposures. These qualitative tools and metrics may fail to predict future risk exposures. These risk exposures could, for example, arise from factors we did not anticipate or correctly evaluate in our statistical models. This would limit our ability to manage our risks. Our losses thus could be significantly greater than the historical measures indicate. In addition, our quantified modeling does not take all risks into account. Our more qualitative approach to managing those risks could prove insufficient, exposing us to material unanticipated losses. We could face adverse consequences as a result of decisions, which may lead to actions by management, based on models that are poorly developed, implemented or used, or as a result of the modelled outcome being misunderstood or the use of such information for purposes for which it was not designed. In addition, if existing or potential customers or counterparties believe our risk management is inadequate, they could take their business elsewhere or seek to limit their transactions with us. This could have a material adverse effect on our reputation, operating results, financial condition and prospects.

 

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As a commercial bank, one of the main types of risks inherent in our business is credit risk. For example, an important feature of our credit risk management system is to employ an internal credit rating system to assess the particular risk profile of a customer. As this process involves detailed analyses of the customer, taking into account both quantitative and qualitative factors, it is subject to human or IT systems errors. In exercising their judgment on current or future credit risk behavior of our customers, our employees may not always be able to assign an accurate credit rating, which may result in our exposure to higher credit risks than indicated by our risk rating system.

In addition, we have refined our credit policies and guidelines to address potential risks associated with particular industries or types of customers. However, we may not be able to timely detect all possible risks before they occur, or due to limited tools available to us, our employees may not be able to effectively implement them, which may increase our credit risk. Failure to effectively implement, consistently follow or continuously refine our credit risk management system may result in an increase in the level of non-performing loans and a higher risk exposure for us, which could have a material adverse effect on us.

2.6 General Business and Industry Risks

2.6.1 The financial problems faced by our customers could adversely affect us.

Market turmoil and economic recession could materially and adversely affect the liquidity, credit ratings, businesses and/or financial conditions of our borrowers, which could in turn increase our non-performing loan ratios, impair our loan and other financial assets and result in decreased demand for borrowings in general. In addition, our customers may further significantly decrease their risk tolerance to non-deposit investments such as stocks, bonds and mutual funds, which would adversely affect our fee and commission income. We may also be adversely affected by the negative effects of the heightened regulatory environment on our customers due to the high costs associated with regulatory compliance and proceedings. Any of the conditions described above could have a material adverse effect on our business, financial condition and results of operations.

2.6.2 Changes in our pension liabilities and obligations could have a material adverse effect on us.

We provide retirement benefits for many of our former and current employees through a number of defined benefit pension plans. We calculate the amount of our defined benefit obligations using actuarial techniques and assumptions, including mortality rates, the rate of increase of salaries, discount rates, inflation, the expected rate of return on plan assets, or others. The accounting and disclosures are based on IFRS and on those other requirements defined by the local supervisors. Given the nature of these obligations, changes in the assumptions that support valuations, including market conditions, can result in actuarial losses which would in turn impact the financial condition of our pension funds. Because pension obligations are generally long term obligations, fluctuations in interest rates have a material impact on the projected costs of our defined benefit obligations and therefore on the amount of pension expense that we accrue.

Any increase in the current size of the deficit in our defined benefit pension plans, due to reduction in the value of the pension fund assets (depending on the performance of financial markets) or an increase in the pension fund liabilities due to changes in mortality assumptions, the rate of increase of salaries, discount rate assumptions, inflation, the expected rate of return on plan assets, or other factors, could result in our having to make increased contributions to reduce or satisfy the deficits which would divert resources from use in other areas of our business and reduce our capital resources. While we can control a number of the above factors, there are some over which we have no or limited control. Increases in our pension liabilities and obligations could have a material adverse effect on our business, financial condition and results of operations.

2.6.3 We depend in part upon dividends and other funds from subsidiaries.

Some of our operations are conducted through our financial services subsidiaries. As a result, our ability to pay dividends, to the extent we decide to do so, depends in part on the ability of our subsidiaries to generate earnings and to pay dividends to us. Payment of dividends, distributions and advances by our subsidiaries will be contingent upon our subsidiaries’ earnings and business considerations and is or may be limited by legal, regulatory and contractual restrictions. Additionally, our right to receive any assets of any of our subsidiaries as an equity holder of such subsidiaries, upon their liquidation or reorganization, will be effectively subordinated to the claims of our subsidiaries’ creditors, including trade creditors.

2.6.4 Increased competition and industry consolidation may adversely affect our results of operations.

We face substantial competition in all parts of our business, including in originating loans and in attracting deposits. The competition in originating loans comes principally from other domestic and foreign banks, mortgage banking companies, consumer finance companies, insurance companies and other lenders and purchasers of loans.

 

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In addition, there has been a trend towards consolidation in the banking industry, which has created larger and stronger banks with which we must now compete. There can be no assurance that this increased competition will not adversely affect our growth prospects, and therefore our operations. We also face competition from non-bank competitors, such as brokerage companies, department stores (for some credit products), leasing and factoring companies, mutual fund and pension fund management companies and insurance companies.

Non-traditional providers of banking services, such as Internet based e-commerce providers, mobile telephone companies and internet search engines may offer and/or increase their offerings of financial products and services directly to customers. These non-traditional providers of banking services currently have an advantage over traditional providers because they are not subject to banking regulation. Several of these competitors may have long operating histories, large customer bases, strong brand recognition and significant financial, marketing and other resources. They may adopt more aggressive pricing and rates and devote more resources to technology, infrastructure and marketing. New competitors may enter the market or existing competitors may adjust their services with unique product or service offerings or approaches to providing banking services. If we are unable to successfully compete with current and new competitors, or if we are unable to anticipate and adapt our offerings to changing banking industry trends, including technological changes, our business may be adversely affected. In addition, our failure to effectively anticipate or adapt to emerging technologies or changes in customer behavior, including among younger customers, could delay or prevent our access to new digital-based markets which would in turn have an adverse effect on our competitive position and business.

Increasing competition could also require that we increase our rates offered on deposits or lower the rates we charge on loans, which could also have a material adverse effect on us, including our profitability. It may also negatively affect our business results and prospects by, among other things, limiting our ability to increase our customer base and expand our operations and increasing competition for investment opportunities.

If our customer service levels were perceived by the market to be materially below those of our competitor financial institutions, we could lose existing and potential business. If we are not successful in retaining and strengthening customer relationships, we may lose market share, incur losses on some or all of our activities or fail to attract new deposits or retain existing deposits, which could have a material adverse effect on our operating results, financial condition and prospects.

2.6.5 Our ability to maintain our competitive position depends, in part, on the success of new products and services we offer our clients and our ability to continue offering products and services from third parties, and we may not be able to manage various risks we face as we expand our range of products and services that could have a material adverse effect on us.

The success of our operations and our profitability depends, in part, on the success of new products and services we offer our clients and our ability to continue offering products and services from third parties. However, we cannot guarantee that our new products and services will be responsive to client demands or successful once they are offered to our clients, or that they will be successful in the future. In addition, our clients’ needs or desires may change over time, and such changes may render our products and services obsolete, outdated or unattractive and we may not be able to develop new products that meet our clients’ changing needs. Our success is also dependent on our ability to anticipate and leverage new and existing technologies that may have an impact on products and services in the banking industry. Technological changes may further intensify and complicate the competitive landscape and influence client behavior. If our products and services employ technology that is not as attractive to our clients as that employed by our competitors, if we fail to employ technologies desired by our clients before our competitors do so, or if we fail to execute effectively on targeted strategic technology initiatives, our business and results could be adversely affected. In addition, we cannot respond in a timely fashion to the changing needs of our clients, we may lose clients, which could in turn materially and adversely affect us.

As we expand the range of our products and services, some of which may be at an early stage of development in the markets of certain regions where we operate, we will be exposed to new and potentially increasingly complex risks and development expenses. Our employees and risk management systems, as well as our experience and that of our partners may not be sufficient or adequate to enable us to properly handle or manage such risks. In addition, the cost of developing products that are not launched is likely to affect our results of operations. Any or all of these factors, individually or collectively, could have a material adverse effect on us.

Further, our customers may issue complaints and seek redress if they consider that they have suffered loss from our products and services, for example, as a result of any alleged mis-selling or incorrect application of the terms and conditions of a particular product. This could in turn subject us to risks of potential legal action by our customers and intervention by our regulators. We have in the past experienced losses due to claims of mis-selling in the U.K., Spain and other jurisdictions and may do so again in the future. For further detail on our legal and regulatory risk exposures, please see the risk factor entitled “We are exposed to risk of loss from legal and regulatory proceedings.”

 

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2.6.6 If we are unable to manage the growth of our operations this could have an adverse impact on our profitability.

We allocate management and planning resources to develop strategic plans for organic growth, and to identify possible acquisitions and disposals and areas for restructuring our businesses. From time to time, we evaluate acquisition and partnership opportunities that we believe offer additional value to our shareholders and are consistent with our business strategy. However, we may not be able to identify suitable acquisition or partnership candidates, and our ability to benefit from any such acquisitions and partnerships will depend in part on our successful integration of those businesses. Any such integration entails significant risks such as unforeseen difficulties in integrating operations and systems and unexpected liabilities or contingencies relating to the acquired businesses, including legal claims. We can give no assurances that our expectations with regards to integration and synergies will materialize. We also cannot provide assurance that we will, in all cases, be able to manage our growth effectively or deliver our strategic growth objectives. Challenges that may result from our strategic growth decisions include our ability to:

 

    manage efficiently the operations and employees of expanding businesses;

 

    maintain or grow our existing customer base;

 

    assess the value, strengths and weaknesses of investment or acquisition candidates, including local regulation that can reduce or eliminate expected synergies;

 

    finance strategic investments or acquisitions;

 

    fully integrate strategic investments, or newly-established entities or acquisitions in line with its strategy;

 

    align our current information technology systems adequately with those of an enlarged group;

 

    apply our risk management policy effectively to an enlarged group; and

 

    manage a growing number of entities without over-committing management or losing key personnel.

Any failure to manage growth effectively, including any or all of the above challenges associated with our growth plans, could have a material adverse effect on our operating results, financial condition and prospects.

In addition, any acquisition or venture could result in the loss of key employees and inconsistencies in standards, controls, procedures and policies.

Moreover, the success of the acquisition or venture will at least in part be subject to a number of political, economic and other factors that are beyond our control. Any of these factors, individually or collectively, could have a material adverse effect on us.

2.6.7 Goodwill impairments may be required in relation to acquired businesses.

We have made business acquisitions in recent years and may make further acquisitions in the future. It is possible that the goodwill which has been attributed, or may be attributed, to these businesses may have to be written-down if our valuation assumptions are required to be reassessed as a result of any deterioration in their underlying profitability, asset quality and other relevant matters. Impairment testing in respect of goodwill is performed annually, more frequently if there are impairment indicators present, and comprises a comparison of the carrying amount of the cash-generating unit with its recoverable amount. Goodwill impairment does not, however, affect our regulatory capital. While no material impairment of goodwill was recognized at Group level in 2013, 2014 or 2015, there can be no assurances that we will not have to write down the value attributed to goodwill in the future, which would adversely affect our results and net assets.

2.6.8 We rely on recruiting, retaining and developing appropriate senior management and skilled personnel.

Our continued success depends in part on the continued service of key members of our management team. The ability to continue to attract, train, motivate and retain highly qualified professionals is a key element of our strategy. The successful implementation of our growth strategy depends on the availability of skilled management, both at our head office and at each of our business units. If we or one of our business units or other functions fails to staff its operations appropriately or loses one or more of its key senior executives and fails to replace them in a satisfactory and timely manner, our business, financial condition and results of operations, including control and operational risks, may be adversely affected.

 

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In addition, the financial industry has and may continue to experience more stringent regulation of employee compensation, which could have an adverse effect on our ability to hire or retain the most qualified employees. If we fail or are unable to attract and appropriately train, motivate and retain qualified professionals, our business may also be adversely affected.

2.6.9 We rely on third parties for important products and services.

Third party vendors provide key components of our business infrastructure such as loan and deposit servicing systems, internet connections and network access. Third parties can be sources of operational risk to us, including with respect to security breaches affecting such parties. We are also subject to risk with respect to security breaches affecting the vendors and other parties that interact with our third party vendors. As our interconnectivity with these third parties increases, we increasingly face the risk of operational failure with respect to their systems. We may be required to take steps to protect the integrity of our operational systems, thereby increasing our operational costs and potentially decreasing customer satisfaction. In addition, any problems caused by these third parties, including as a result of their not providing us their services for any reason, their performing their services poorly, or employee misconduct, could adversely affect our ability to deliver products and services to customers and otherwise to conduct business. Replacing these third party vendors could also entail significant delays and expense.

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

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

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

We could suffer significant reputational harm if we fail to identify and manage potential conflicts of interest properly. The failure to adequately address, or the perceived failure to adequately address, conflicts of interest could affect the willingness of clients to deal with us, or give rise to litigation or enforcement actions against us. Therefore, there can be no assurance that conflicts of interest will not arise in the future that could cause material harm to us.

2.6.11 We engage in transactions with our subsidiaries or affiliates that others may not consider to be on an arm’s-length basis.

We and our affiliates have entered into a number of services agreements pursuant to which we render services, such as administrative, accounting, finance, treasury, legal services and others.

Spanish law provides for several procedures designed to ensure that the transactions entered into with or among our financial subsidiaries and/or affiliates do not deviate from prevailing market conditions for those types of transactions.

We are likely to continue to engage in transactions with our affiliates. Future conflicts of interests between us and any of affiliates, or among our affiliates, may arise, which conflicts are not required to be and may not be resolved in our favor.

2.7 Technology Risks

2.7.1 Any failure to effectively improve or upgrade our information technology infrastructure and management information systems in a timely manner could have a material adverse effect on us.

Our ability to remain competitive depends in part on our ability to upgrade our information technology on a timely and cost-effective basis. We must continually make significant investments and improvements in our information technology infrastructure in order to remain competitive. We cannot assure that in the future we will be able to maintain the level of capital expenditures necessary to support the improvement or upgrading of our information technology infrastructure. Any failure to effectively improve or upgrade our information technology infrastructure and management information systems in a timely manner could have a material adverse effect on us.

 

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2.7.2 Risks relating to data collection, processing and storage systems and security are inherent in our business.

Like other financial institutions with a large customer base, we manage and hold confidential personal information of customers in the conduct of our banking operations, as well as a large number of assets. Accordingly, our business depends on the ability to process a large number of transactions efficiently and accurately, and on our ability to rely on our digital technologies, computer and email services, software and networks, as well as on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. The proper functioning of financial control, accounting or other data collection and processing systems is critical to our businesses and to our ability to compete effectively. Losses can result from inadequate personnel, inadequate or failed internal control processes and systems, or from external events that interrupt normal business operations. We also face the risk that the design of our controls and procedures prove to be inadequate or are circumvented. Although we work with our clients, vendors, service providers, counterparties and other third parties to develop secure transmission capabilities and prevent against information security risk, we routinely exchange personal, confidential and proprietary information by electronic means, and we may be the target of attempted cyber-attacks. If we cannot maintain an effective data collection, management and processing system, we may be materially and adversely affected.

We take protective measures and continuously monitor and develop our systems to protect our technology infrastructure and data from misappropriation or corruption, but our systems, software and networks nevertheless may be vulnerable to unauthorized access, misuse, computer viruses or other malicious code and other events that could have a security impact. An interception, misuse or mishandling of personal, confidential or proprietary information sent to or received from a client, vendor, service provider, counterparty or third party could result in legal liability, regulatory action and reputational harm. There can be no assurance that we will not suffer material losses from operational risk in the future, including those relating to any security breaches.

We have seen in recent years computer systems of companies and organizations being targeted, not only by cyber criminals, but also by activists and rogue states. We have been and continue to be subject to a range of cyber-attacks, such as denial of service, malware and phishing. Cyber-attacks could give rise to the loss of significant amounts of customer data and other sensitive information, as well as significant levels of liquid assets (including cash). In addition, cyber-attacks could give rise to the disablement of our information technology systems used to service our customers. As attempted attacks continue to evolve in scope and sophistication, we may incur significant costs in our attempt to modify or enhance our protective measures against such attacks, or to investigate or remediate any vulnerability or resulting breach, or in communicating cyber-attacks to our customers. If we fail to effectively manage our cyber security risk, e.g. by failing to update our systems and processes in response to new threats, this could harm our reputation and adversely affect our operating results, financial condition and prospects through the payment of customer compensation, regulatory penalties and fines and/or through the loss of assets. In addition, we may also be subject to cyber-attacks against critical infrastructures of the countries where we operate. Our information technology systems are dependent on such national critical infrastructure and any cyber-attack against such critical infrastructure could negatively affect our ability to service our customers. As we do not operate such national critical infrastructure, we have limited ability to protect our information technology systems from the adverse effects of such a cyber-attack. For further information see Item 11. Quantitative and Qualitative Disclosures about Market Risk—Part 6. Operational risk—3 Mitigation measures—Cybersecurity and data security plans.

We manage and hold confidential personal information of customers in the conduct of our banking operations. Although we have procedures and controls to safeguard personal information in our possession, unauthorized disclosures could subject us to legal actions and administrative sanctions as well as damages that could materially and adversely affect our operating results, financial condition and prospects. Further, our business is exposed to risk from potential non-compliance with policies, employee misconduct or negligence and fraud, which could result in regulatory sanctions and serious reputational or financial harm. It is not always possible to deter or prevent employee misconduct, and the precautions we take to detect and prevent this activity may not always be effective. In addition, we may be required to report events related to information security issues (including any cyber security issues), events where customer information may be compromised, unauthorized access and other security breaches, to the relevant regulatory authorities. Any material disruption or slowdown of our systems could cause information, including data related to customer requests, to be lost or to be delivered to our clients with delays or errors, which could reduce demand for our services and products and could materially and adversely affect us.

 

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2.8 Financial Reporting and Control Risks

2.8.1 Changes in accounting standards could impact reported earnings.

The accounting standard setters and other regulatory bodies periodically change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. These changes can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.

2.8.2 Our financial statements are based in part on assumptions and estimates which, if inaccurate, could cause material misstatement of the results of our operations and financial position.

The preparation of financial statements requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgments and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognized in the period in which the estimate is revised and in any future periods affected. The accounting policies deemed critical to our results and financial position, based upon materiality and significant judgments and estimates, include impairment of loans and advances, goodwill impairment, valuation of financial instruments, impairment of available-for-sale financial assets, deferred tax assets provision and pension obligation for liabilities.

If the judgment, estimates and assumptions we use in preparing our consolidated financial statements are subsequently found to be incorrect, there could be a material effect on our results of operations and a corresponding effect on our funding requirements and capital ratios.

2.8.3 Disclosure controls and procedures over financial reporting may not prevent or detect all errors or acts of fraud.

Disclosure controls and procedures over financial reporting are designed to provide reasonable assurance that information required to be disclosed by the company in reports filed or submitted under the Securities Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

These disclosure controls and procedures have inherent limitations which include the possibility that judgments in decision-making can be faulty and that breakdowns occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by any unauthorized override of the controls. Consequently, our businesses are exposed to risk from potential non-compliance with policies, employee misconduct or negligence and fraud, which could result in regulatory sanctions and serious reputational or financial harm. In recent years, a number of multinational financial institutions have suffered material losses due to the actions of ‘rogue traders’ or other employees. It is not always possible to deter employee misconduct and the precautions we take to prevent and detect this activity may not always be effective. Accordingly, because of the inherent limitations in the control system, misstatements due to error or fraud may occur and not be detected.

2.9 Foreign Private Issuer and Other Risks

2.9.1 Our corporate disclosure may differ from disclosure regularly published by issuers of securities in other countries, including the United States.

Issuers of securities in Spain are required to make public disclosures that are different from, and that may be reported under presentations that are not consistent with, disclosures required in other countries, including the United States. In particular, for regulatory purposes, we currently prepare and will continue to prepare and make available to our shareholders statutory financial statements in accordance with IFRS, which differs from U.S. GAAP in a number of respects. In addition, as a foreign private issuer, we are not subject to the same disclosure requirements in the United States as a domestic U.S. registrant under the Exchange Act, including the requirements to prepare and issue quarterly reports, or the proxy rules applicable to domestic U.S. registrants under Section 14 of the Exchange Act or the insider reporting and short-swing profit rules under Section 16 of the Exchange Act. Accordingly, the information about us available to you will not be the same as the information available to shareholders of a U.S. company and may be reported in a manner that you are not familiar with.

 

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2.9.2 Investors may find it difficult to enforce civil liabilities against us or our directors and officers.

The majority of our directors and officers reside outside of the United States. In addition, all or a substantial portion of our assets and their assets are located outside of the United States. Although we have appointed an agent for service of process in any action against us in the United States with respect to our ADSs, none of our directors or officers has consented to service of process in the United States or to the jurisdiction of any United States court. As a result, it may be difficult for investors to effect service of process within the United States on such persons.

Additionally, investors may experience difficulty in Spain enforcing foreign judgments obtained against us and our executive officers and directors, including in any action based on civil liabilities under the U.S. federal securities laws. Based on the opinion of Spanish counsel, there is doubt as to the enforceability against such persons in Spain, whether in original actions or in actions to enforce judgments of U.S. courts, of liabilities based solely on the U.S. federal securities laws.

2.9.3 As a holder of ADSs you will have different shareholders’ rights than in the United States and certain other jurisdictions.

Our corporate affairs are governed by our Bylaws and Spanish corporate law, which may differ from the legal principles that would apply if we were incorporated in a jurisdiction in the United States or in certain other jurisdictions outside Spain. Under Spanish corporate law, you may have fewer and less well-defined rights to protect your interests than under the laws of other jurisdictions outside Spain.

Although Spanish corporate law imposes restrictions on insider trading and price manipulation, the form of these regulations and the manner of their enforcement may differ from that in the U.S. securities markets or markets in certain other jurisdictions. In addition, in Spain, self-dealing and the preservation of shareholder interests may be regulated differently, which could potentially disadvantage you as a holder of the shares underlying ADSs.

2.9.4 ADS holders may be subject to additional risks related to holding ADSs rather than shares.

Because ADS holders do not hold their shares directly, they are subject to the following additional risks, among others:

 

    as an ADS holder, you may not be able to exercise the same shareholder rights as a direct holder of ordinary shares;

 

    we and the depositary may amend or terminate the deposit agreement without the ADS holders’ consent in a manner that could prejudice ADS holders or that could affect the ability of ADS holders to transfer ADSs; and

 

    the depositary may take or be required to take actions under the Deposit Agreement that may have adverse consequences for some ADS holders in their particular circumstances.

Item 4. Information on the Company

A. History and development of the company

Introduction

Banco Santander, S.A. (“Santander”, the “Bank”, the “Parent” or the “Parent bank”) is the Parent bank of Grupo Santander. It was established on March 21, 1857 and incorporated in its present form by a public deed executed in Santander, Spain, on January 14, 1875.

On January 15, 1999, the boards of directors of Banco Santander, S.A. and Banco Central Hispanoamericano, S.A. agreed to merge Banco Central Hispanoamericano, S.A. into Banco Santander, S.A., and to change Banco Santander’s name to Banco Santander Central Hispano, S.A. The shareholders of Banco Santander, S.A. and Banco Central Hispanoamericano, S.A. approved the merger on March 6, 1999, at their respective general meetings. The merger and the name change were registered with the Mercantile Registry of Santander, Spain, by the filing of a merger deed. Effective April 17, 1999, Banco Central Hispanoamericano, S.A. shares were extinguished by operation of law and Banco Central Hispanoamericano, S.A. shareholders received new Banco Santander shares at a ratio of three shares of Banco Santander, S.A. for every five shares of Banco Central Hispanoamericano, S.A. formerly held. On the same day, Banco Santander, S.A. changed its legal name to Banco Santander Central Hispano, S.A.

The general shareholders’ meeting held on June 23, 2007 approved the proposal to change the name of the Bank to Banco Santander, S.A.

 

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The general shareholders’ meeting held on March 22, 2013 approved the merger by absorption of Banco Español de Crédito, S.A. (Banesto) and Banco Banif, S.A.

We are incorporated under, and governed by the laws of the Kingdom of Spain. We conduct business under the commercial name “Santander”. Our headquarters are located in Ciudad Grupo Santander, Avda. de Cantabria s/n, 28660 Boadilla del Monte (Madrid), Spain. Telephone: (011) 34-91-259-6520 and the corporate offices are located at Paseo de Pereda, numbers 9 to 12, Santander, Spain.

Principal Capital Expenditures and Divestitures

Acquisitions, Dispositions, Reorganizations

Our principal acquisitions and dispositions in 2015, 2014 and 2013 were as follows:

Merger of Bank Zachodni WBK S.A. and Kredyt Bank S.A.

On February 28, 2012, the Group announced that Banco Santander, S.A. and KBC Bank NV (KBC) had entered into an investment agreement to merge their two subsidiaries in Poland, Bank Zachodni WBK S.A. and Kredyt Bank S.A., respectively, following which the Group would control approximately 76.5% of the entity resulting from the merger and KBC 16.4%, with the remaining 7.1% being owned by non-controlling interests. Also, the Group undertook to place a portion of its ownership interest among investors and to acquire up to 5% of the entity resulting from the merger in order to help KBC to reduce its holding in the merged entity to below 10%. KBC’s objective is to dispose of its entire investment in order to maximize its value.

The transaction was carried out through a capital increase at Bank Zachodni WBK S.A., whose new shares would be offered to KBC and the other shareholders of Kredyt Bank S.A. in exchange for their shares in Kredyt Bank S.A. The related exchange ratio was established at 6.96 shares of Bank Zachodni S.A. for every 100 shares of Kredyt Bank S.A.

In early 2013, following the approval from the Polish financial regulator (KNF), the aforementioned transaction was consummated. As a result, the Group controlled approximately 75.2% of the post-merger entity and KBC controlled approximately 16.2%, with the remaining 8.6% being owned by non-controlling holders. This transaction gave rise to an increase of €1,037 million in non-controlling interests – €169 million as a result of the acquisition of control of Kredyt Bank S.A. and €868 million as a result of the reduction in the percentage of ownership of Bank Zachodni WBK S.A.

On March 22, 2013, Banco Santander, S.A. and KBC completed the placement of all the shares owned by KBC and 5.2% of the share capital of Bank Zachodni WBK S.A. held by the Group in the market for €285 million, which gave rise to an increase of €292 million in non-controlling interests.

Following these transactions, the Group held 70% of the share capital of Bank Zachodni WBK S.A. and the remaining 30% was held by non-controlling holders.

Mergers by absorption of Banesto and Banco Banif

On December 17, 2012, we announced that we had resolved to approve the plan for the merger by absorption of Banesto and Banco Banif, S.A. as part of the restructuring of the Spanish financial sector. These transactions are part of a commercial integration which brought Banesto and Banif under the Santander brand.

At their respective board of directors meetings held on January 9, 2013, the directors of the Bank and Banesto approved the common draft terms of the merger by absorption of Banesto into the Bank with the dissolution without liquidation of the former and the transfer en bloc of all its assets and liabilities to the Bank, which were acquired, by universal succession, the rights and obligations of the absorbed entity. As a result of the merger, the shareholders of Banesto, other than the Bank, received in exchange shares of the Bank.

January 1, 2013 was established as the date from which the transactions of Banesto shall be considered to have been performed for accounting purposes for the account of the Bank.

On March 22, 2013 and March 21, 2013, the general shareholders meetings of the Bank and Banesto, respectively, approved the terms of the merger.

 

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On April 29, 2013, pursuant to the provisions of the terms of the merger and to the resolutions of the general shareholders’ meetings of both companies, the regime and procedure for the exchange of Banesto shares for shares of Banco Santander was made public. Banco Santander covered the exchange of Banesto shares with shares held as treasury stock based on the exchange ratio of 0.633 shares of Banco Santander, each with a nominal value of €0.50, for each share of Banesto, each with a nominal value of €0.79, without provision for any supplemental cash remuneration.

On May 3, 2013, the merger was registered with the Commercial Registry of Cantabria and the dissolution of Banesto was completed.

The directors of Banco Banif, S.A., at its board of directors meeting held on January 28, 2013, and the directors of Banco Santander, S.A., at its board of directors meeting held on that same day, approved the common drafts terms of the merger by absorption of Banco Banif, S.A. into Banco Santander, S.A. with the dissolution without liquidation of the former and the transfer en bloc of all its assets and liabilities to Banco Santander, S.A., which acquired, by universal succession, the rights and obligations of the absorbed entity.

January 1, 2013 was established as the date from which the transactions of Banif were considered to have been performed for accounting purposes for the account of the Bank.

On May 7, 2013, the merger was registered with the Commercial Registry of Cantabria and the dissolution of Banco Banif, S.A. was completed.

Insurance business in Spain

On December 20, 2012, we announced that we had reached an agreement with Aegon. In this regard, we created two insurance companies, one for life insurance and the other for general insurance, in which Aegon would acquire ownership interests of 51%, and management responsibility would be shared by Aegon and the Group. We would hold 49% of the share capital of the companies and we would enter into a distribution agreement for the sale of insurance products in Spain through the commercial networks for a period of 25 years. The agreement would not affect savings, health and vehicle insurance, which would continue to be owned and managed by Santander.

In June 2013, after obtaining the relevant authorizations from the Directorate-General of Insurance and Pension Funds and from the European competition authorities, Aegon acquired a 51% ownership interest in the two insurance companies created by the Group for these purposes, one for life insurance and the other for general insurance (currently Aegon Santander Vida Seguros y Reaseguros, S.A. and Aegon Santander Generales Seguros y Reaseguros, S.A.), for which it paid €220 million, thereby gaining joint control together with the Group over the aforementioned companies. The agreement also includes payments to Aegon that are deferred over two years and amounts receivable for the Group that are deferred over five years, depending on the business plan.

The aforementioned agreement includes the execution of a distribution agreement for the sale of insurance products in Spain for 25 years through commercial networks, for which the Group will receive commissions at market rates.

This transaction gave rise to a gain of €385 million recognized under Gains (losses) on disposal of assets not classified as non-current assets held for sale (€270 million net of tax), of which €186 million related to the fair value recognition of the 49% ownership interest retained by the Group.

Agreement with Elavon Financial Services Limited

On October 19, 2012, we announced that we had entered into an agreement with Elavon Financial Services Limited to jointly develop the payment services business in Spain through point-of-sale credit and debit card terminals at merchants.

This transaction involved the creation of a joint venture, 51% owned by Elavon and 49% owned by us, to which we transferred our aforementioned payment services business in Spain (excluding the former Banesto).

The transaction was completed in the first half of 2013 and generated a gain of €122 million (€85 million net of tax).

 

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Agreement with Warburg Pincus and General Atlantic

On May 30, 2013, we announced that we had entered into an agreement with subsidiaries of Warburg Pincus and General Atlantic to foster the global development of our asset management unit, Santander Asset Management (SAM). Pursuant to the terms and conditions of the agreement, Warburg Pincus and General Atlantic together own 50% of the holding company which comprises the eleven management companies we have, mainly in Europe and Latin America, while the other 50% are held by us.

The purpose of the alliance is to enable SAM to improve its ability to compete with the large independent international asset management companies, since the businesses to be strengthened include asset management in the global institutional market, with the additional advantage of having knowledge and experience in the markets in which we are present. The agreement also contemplates the distribution of products managed by SAM in the countries in which we have a commercial network for a period of ten years, renewable for five additional two-year periods, for which we will receive commissions at market rates, thus benefiting from broadening the range of products and services we offer our customers. SAM also distributes its products and services internationally, outside our commercial network.

Since the aforementioned asset management companies belonged to different Group companies, a corporate restructuring took place prior to the completion of the transaction whereby each of the asset management companies was sold by its shareholders for its fair value to SAM Investment Holdings Limited (SAM), a holding company created by us. The aggregate value of the asset management companies was approximately €1.7 billion.

Subsequently, in December 2013, once the required authorizations were obtained from various regulators, the agreement was executed through the acquisition of a 50% ownership interest in SAM’s share capital by Sherbrooke Acquisition Corp SPC (an investee of Warburg Pincus and General Atlantic) for €449 million. At that date, SAM had financing from third parties for €845 million. The agreement includes deferred contingent amounts payable and receivable for the Group based on the achievement of the business plan targets over the coming five years.

Also, we entered into a shareholders’ agreement with Sherbrooke Acquisition Corp SPC shareholders regulating, inter alia, the taking of strategic, financial, operational and other significant decisions regarding the ordinary management of SAM on a joint basis. Certain restrictions on the transferability of the shares were also agreed, and a commitment was made by the two parties to retain the restrictions for at least 18 months. Lastly, Sherbrooke Acquisition Corp SPC will be entitled to sell to the Group its ownership interest in the share capital of SAM at market value on the fifth and seventh anniversaries of the transaction, unless a public offering of SAM shares has taken place prior to those dates.

Following these transactions, at year-end we held a 50% ownership interest in SAM and controlled this company jointly with the aforementioned shareholders.

As a result of the aforementioned transaction, we recognized a gain of €1,372 million in the consolidated income statement for 2013, of which €671 million related to the fair value of the 50% ownership interest retained by us.

Sale of Altamira Asset Management

On November 21, 2013, we announced that we had reached a preliminary agreement with Apollo European Principal Finance Fund II, a fund managed by subsidiaries of Apollo Global Management, LLC, for the sale of the platform for managing the recovery of Banco Santander, S.A.’s loans in Spain and for managing and marketing the properties obtained through this activity (“Altamira Asset Management, S.L.”).

On January 3, 2014, we announced that we had sold 85% of the share capital of Altamira Asset Management, S.L. to Altamira Asset Management Holdings, S.L., an investee of Apollo European Principal Finance Fund II, for €664 million, giving rise to a net gain of €385 million, which was recognized in our consolidated income statement for 2014.

Following this transaction, we retained the aforementioned property assets and loan portfolio on our balance sheet, while management of these assets is carried out from the platform owned by Apollo.

Santander Consumer USA

In January 2014, the public offering of shares of Santander Consumer USA Inc. (“SCUSA”) was completed and the company was admitted to trading on the New York Stock Exchange. The offering represented 21.6% of SCUSA’s share capital, of which 4.23% related to the ownership interest sold by the Group. Following this sale, we held 60.74% of the share capital

 

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of SCUSA (December 31, 2014: 60.46%). Both Sponsor Auto Finance Holdings Series LP (“Sponsor Holdings”) – an investee of funds controlled by Warburg Pincus LLC, Kohlberg Kravis Roberts & Co. L.P. and Centerbridge Partners L.P. – and DDFS LLC (“DDFS”) – a company controlled by Thomas G. Dundon, who holds the position of Chief Executive Officer of SCUSA – also reduced their ownership interest in SCUSA.

Since the ownership interests of the aforementioned shareholders were reduced below specified percentages following the offering, the shareholders’ agreement previously entered into by the shareholders was terminated in accordance with its terms; this entailed the termination of the agreement which, inter alia, had granted Sponsor Holdings and DDFS representation on the board of directors of SCUSA and had established a voting system under which the strategic, financial and operating decisions, and other significant decisions associated with the ordinary management of SCUSA, were subject to joint approval by the Group and the aforementioned shareholders. Therefore, SCUSA ceased to be controlled jointly by all the above and is now controlled by the Group on the basis of the percentage held in its share capital (“change of control”).

Prior to this change of control the Group accounted for its ownership interest in SCUSA using the equity method. Following the change of control, the Group fully consolidated its ownership interest in SCUSA and, on the date it obtained control, included all of SCUSA’s assets and liabilities in its consolidated balance sheet at their fair value.

As a result of the aforementioned transaction, we recognized a net gain of €730 million in the consolidated income statement for 2014.

On July 3, 2015, we announced that we had reached an agreement to acquire the stake held by DDFS LLC in SCUSA, representing 9.68% of the company, for U.S. $928 million. The transaction is subject to regulatory approval. If the transaction closes, our stake in SCUSA will be approximately 68.62%.

Agreement with El Corte Inglés

On October 7, 2013, we announced that we had entered into a strategic agreement through our subsidiary Santander Consumer Finance, S.A. with El Corte Inglés, S.A. in the area of consumer finance, which included the acquisition of 51% of the share capital of Financiera El Corte Inglés E.F.C., S.A., with El Corte Inglés, S.A. retaining the remaining 49%. On February 27, 2014, following the receipt of the relevant regulatory and competition authorizations, the acquisition was completed. Santander Consumer Finance, S.A. paid €140 million for 51% of the share capital of Financiera El Corte Inglés E.F.C., S.A.

GetNet Tecnologia Em Captura e Processamento de Transações H.U.A.H. S.A.

On April 7, 2014, Banco Santander (Brasil) S.A. announced that it had reached an agreement to purchase through an investee all the shares of GetNet Tecnologia Em Captura e Processamento de Transações H.U.A.H. S.A. (“GetNet”). The transaction was completed on July 31, 2014 for a purchase price of BRL1,156 million (approximately €383 million), giving rise to goodwill of €229 million.

Acquisition of non-controlling interests in Banco Santander (Brasil) S.A.

On April 28, 2014, the Bank’s board of directors approved a bid for the acquisition of all the shares of Banco Santander (Brasil) S.A. not then owned by the Group, which represented approximately 25% of the share capital of Banco Santander (Brasil) S.A., offering in consideration Bank shares in the form of Brazilian Depositary Receipts (BDRs) or American Depositary Receipts (ADRs). As part of the bid, the Bank requested that its shares be listed on the São Paulo Stock Exchange in the form of BDRs.

The offer was voluntary, in that the non-controlling shareholders of Banco Santander (Brasil) S.A. were not obliged to participate, and it was not conditional upon a minimum acceptance level. The consideration offered, following the adjustment made as a result of the application of the Santander Dividendo Elección scrip dividend scheme in October 2014, consisted of 0.7152 new Banco Santander shares for each unit or ADR of Banco Santander (Brasil) S.A. and 0.3576 new Banco Santander shares for each ordinary or preference share of Banco Santander (Brasil) S.A.

The bid was accepted by holders of 13.65% of the share capital of Banco Santander (Brasil) S.A. Accordingly, the Group’s ownership interest in Banco Santander (Brasil) S.A. rose to 88.30% of its share capital. To cater for the exchange, the Bank, executing the agreement adopted by the extraordinary general shareholders’ meeting held on September 15, 2014, issued 370,937,066 shares, representing approximately 3.09% of the Bank’s share capital at the issue date. The aforementioned transaction gave rise to an increase of €185 million in Share capital, €2,372 million in Share premium and €15 million in Reserves, and a reduction of €2,572 million in Non-controlling interests.

 

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The shares of Banco Santander (Brasil) S.A. continue to be listed on the São Paulo and New York stock exchanges.

Agreement with CNP

On July 10, 2014, we announced that we had reached an agreement with the French insurance company CNP to acquire a 51% stake in three insurance companies based in Ireland (Santander Insurance Life Limited, Santander Insurance Europe Limited and Santander Insurance Services Ireland Limited) that distribute life and non-life products through the Santander Consumer Finance network.

In December 2014, after the regulatory authorizations were obtained, CNP paid €297 million to acquire 51% , or a controlling interest in, the three aforementioned insurance companies. The agreement includes deferred payments to CNP in 2017 and 2020 and deferred amounts receivable by the Group in 2017, 2020 and 2023, based on the business plan.

The agreement included the execution of a 20-year retail agreement, renewable for five-year periods, for the sale of life and non-life insurance products through the Santander Consumer Finance network, for which we will receive commissions at market rates.

This transaction gave rise to the recognition of a gain of €413 million under Gains/(losses) on disposal of assets not classified as non-current assets held for sale, of which €207 million related to the fair value recognition of the 49% ownership interest retained by us.

Agreement with GE Capital

On June 23, 2014, we announced that Santander Consumer Finance, S.A., Banco Santander’s consumer finance unit had reached an agreement with GE Money Nordic Holding AB to acquire GE Capital’s business in Sweden, Denmark and Norway for approximately €693 million at the date of the announcement. The acquisition was completed on November 6, 2014, following the receipt of the relevant authorizations.

Agreement with Banque PSA Finance

We, through our subsidiary Santander Consumer Finance, S.A., and Banque PSA Finance, the vehicle financing unit of the PSA Peugeot Citroën Group, entered into an agreement in July 2014 for the joint operation of a vehicle financing business in twelve European countries. Pursuant to the terms of the agreement, we will finance this business under certain circumstances and conditions from the date on which the transaction is completed. In addition, in certain countries, we will purchase the current lending portfolio of Banque PSA Finance. We also entered into a cooperation agreement relating to the insurance business in all these countries.

In January 2015, the relevant regulatory authorizations were obtained for the commencement of activities in France and the United Kingdom. As a result, we acquired in February 2015 50% of Société Financière de Banque - SOFIB and PSA Finance UK Limited for €462 million and €148 million, respectively.

In addition, under the framework agreement, PSA Insurance Europe Limited and PSA Life Insurance Europe Limited (both insurance companies with registered office in Malta) were incorporated on May 1, 2015 in which we contributed 50% of the share capital, amounting to €23 million. On August 3, 2015 we acquired a full ownership interest in PSA Gestão - Comércio E Aluguer de Veiculos, S.A. (a company with registered office in Portugal) and the loan portfolio of the Portuguese branch of Banque PSA Finance for €10 million and €25 million, respectively. On October 1, 2015 PSA Financial Services Spain, E.F.C., S.A. (a company with registered office in Spain) was incorporated, in which we contributed €181 million (50% of the share capital).

Agreement to acquire Carfinco

On September 16, 2014, we announced that we had reached an agreement to acquire the listed Canadian company Carfinco Financial Group Inc. (“Carfinco”). The board of directors of Carfinco approved the transaction and recommended to its shareholders that they vote in favor of it at the general meeting called for such purpose, and the transaction was completed on March 6, 2015 for an amount of €209 million generating goodwill of €162 million.

 

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Metrovacesa, S.A.

On December 19, 2012, the creditor entities that participated in a debt restructuring agreement for the Sanahuja Group under which they received shares of Metrovacesa, S.A. as payment for that group’s debt, announced that they reached an agreement to promote the delisting of the shares of Metrovacesa, S.A. and they voted in favor of this at the general meeting held for this purpose on January 29, 2013. Following the approval of the delisting and the public takeover offer at the Metrovacesa, S.A. general meeting, the entities made a delisting public takeover offer of €2.28 per share to the Metrovacesa, S.A. shareholders that had not entered into the agreement. We participated in the delisting public takeover offer by acquiring an additional 1.953% of Metrovacesa, S.A. for €44 million.

Following this transaction, at December 31, 2013, we held an ownership interest of 36.82% in the share capital of Metrovacesa, S.A.

On December 23, 2014, we acquired 19.07% of Metrovacesa, S.A. from Bankia, S.A. for €98.9 million, as a result of which our stake increased to 55.89%, thus obtaining control over this company. After this transaction, Metrovacesa, S.A. is fully consolidated with the Group (until then it was accounted for by the equity method).

Lastly, on September 15, 2015, we acquired 13.8% of Metrovacesa, S.A. from Banco Sabadell, S.A. for €253 million, raising our ownership interest to 72.51%.

For further information see note 3.b. xv. Metrovacesa to our consolidated financial statements.

Acquisition of Banco Internacional do Funchal (Banif)

On December 21, 2015, we announced that, with the aim of providing continuity to Banco Internacional do Funchal (Banif) and safeguarding the interest of its customers, the Bank of Portugal, the resolution authority, had decided to award Banco Banif’s business to Banco Santander Totta, a subsidiary of Banco Santander.

The transaction was carried out via the transfer of a large part (the commercial banking business) of Banif’s assets and liabilities to Santander Totta. Banco Santander Totta paid €150 million for Banco Banif’s assets and liabilities. Meanwhile, other assets and liabilities remained in Banco Banif, which is responsible for any possible litigation resulting from its past activity, for their orderly liquidation or sale.

The acquisition of Banco Banif’s businesses positioned Banco Santander Totta as Portugal’s second privately-held bank, after BCP-Milenium, with a 14.5% market share in loans and deposits. Banco Banif contributes 2.5 points in market share and has a network of 150 branches and 400,000 customers.

This transaction has no material impact on our capital.

Custody business

On June 19, 2014, we announced that we had reached a definitive agreement with FINESP Holdings II B.V., a subsidiary of Warburg Pincus, to sell a 50% stake in Santander’s current custody business in Spain, Mexico and Brazil, retaining the remaining 50%. The transaction values the business at €975 million at the date of the announcement. At December 31, 2015, the sale remained subject to the obtainment of the relevant regulatory authorizations.

On March 16, 2016, the parties agreed to leave aside the original investment structure and continue to work in good faith until June 30, 2016 on an alternative investment structure that would allow the sale by Santander of the 50% stake referred to above.

Merger of Santander Asset Management and Pioneer Investments

On April 23, 2015, we announced that we had reached a preliminary and exclusive agreement with our partners Warburg Pincus and General Atlantic, subject to the signing of final terms, to merge Santander Asset Management and Pioneer Investments to create a leading global asset manager in Europe and Latin America. The combined company, with approximately €353 billion in assets under management at the close of 2014, will be called Pioneer Investments.

The agreement contemplates the creation of a new company into which the local asset managers of Santander Asset Management and Pioneer Investments will be incorporated. Santander will have a direct 33.3% stake in the new company, UniCredit will have a 33.3% stake, and private equity fund managers Warburg Pincus and General Atlantic will share a 33.3% stake. Pioneer Investments’ operations in the United States will not be included in the new company but will be owned by UniCredit (50%) and Warburg Pincus and General Atlantic (50%).

 

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The transaction values Santander Asset Management at €2.6 billion and Pioneer Investments at €2.75 billion. Warburg Pincus and General Atlantic will make an additional equity investment into the company as part of the transaction. This transaction will not have any material impact on our capital.

On November 11, 2015, the final framework agreement was signed by UniCredit, Santander, Warburg Pincus and General Atlantic for the integration of these businesses in accordance with the aforementioned structure. The transaction is scheduled to be completed in 2016 once the preconditions established in the framework agreement have been met and the relevant regulatory authorizations have been obtained.

Capital Increases

As of December 31, 2013, our capital had increased by 1,012,240,738 shares, or 9.81% of our total capital as of December 31, 2012, to 11,333,420,488 shares as a result of the following transactions:

 

    Scrip Dividend: On January 30, 2013, April 30, 2013, July 31, 2013 and October 31, 2013, we issued 217,503,395 shares, 270,917,436 shares, 282,509,392 shares and 241,310,515 shares, giving rise to capital increases of €108,751,697.50, €135,458,718, €141,254,696 and €120,655,257.50, respectively.

As of December 31, 2014, our capital had increased by 1,250,994,171 shares, or 11.04% of our total capital as of December 31, 2013, to 12,584,414,659 shares as a result of the following transactions:

 

    Scrip Dividend: On January 30, 2014, April 29, 2014, July 30, 2014 and November 5, 2014, we issued 227,646,659 shares, 217,013,477 shares, 210,010,506 shares and 225,386,463 shares (2.01%, 1.88%, 1.78%, and 1.82% of the share capital, respectively), giving rise to capital increases of €113,823,329.50, €108,506,738.50, €105,005,253 and €112,693,231.50, respectively.

 

    Acquisition of non-controlling interests in Banco Santander (Brasil) S.A.: On November 4, 2014 we issued 370,937,066 shares (3.27% of the share capital) giving rise to a capital increase of €185,468,533.

As of December 31, 2015, our capital had increased by 1,850,077,920 shares, or 14.70% of our total capital as of December 31, 2014, to 14,434,492,579 shares as a result of the following transactions:

 

    Capital increase: On January 8, 2015 an extraordinary meeting of the board of directors took place to approve a capital increase with the exclusion of pre-emption rights for an amount of up to €7,500 million. The transaction was implemented through an accelerated book-building. The objective of this transaction was to accelerate our plans to grow organically allowing us to increase both customer credit and market share in our core geographies, and to take advantage of our business model. Our capital was increased for a nominal amount of €606,796,117 through the issuance of 1,213,592,234 ordinary shares of Banco Santander (9.64% of the share capital before the capital increase) with a nominal value of 0.50 each. The price for the new shares was fixed at €6.18 per share. Consequently, the total amount of the capital increase was of €7,500,000,006.12 (€606,796,117 nominal amount and €6,893,203,889.12 share premium). The new shares were admitted to trade in the Spanish markets on January 12, 2015.

 

    Scrip Dividend: On January 29, 2015, April 29, 2015 and November 4, 2015, we issued 262,578,993 shares, 256,046,919 shares and 117,859,774 shares (1.90%, 1.82% and 0.82% of the share capital, respectively), giving rise to capital increases of €131,289,496.50, €128,023,459.50 and €58,929,887, respectively.

B. Business overview

At December 31, 2015, we had a market capitalization of €65.8 billion, stockholders’ equity of €88.0 billion and total assets of €1,340.3 billion. We had €1,050.0 billion in customer funds under management3 at that date. As of December 31, 2015, we had 58,049 employees and 5,548 branch offices in Continental Europe, 25,866 employees and 858 branches in the United Kingdom, 89,819 employees and 5,841 branches in Latin America, 18,123 employees and 783 branches in the United States and 2,006 employees in Corporate Activities (for a full breakdown of employees by country, see “Item 6. Directors, Senior Management and Employees—D. Employees” herein).

We are a financial group operating principally in Spain, the United Kingdom, other European countries, Brazil and other Latin American countries and the United States, offering a wide range of financial products.

 

3  Including customer deposits, marketable debt securities, subordinated liabilities and other customer funds under management.

 

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In Latin America, we have majority shareholdings in banks in Argentina, Brazil, Chile, Colombia, Mexico, Peru and Uruguay.

Grupo Santander maintains the general criteria used in our 2014 Form 20-F, with the exceptions explained below, all of which are reflected in the recast financial information included in our Report on Form 6-K filed with the SEC on November 5, 2015.

In the third quarter 2015, we carried out a change in our reported segments resulting from the application of new financial criteria to reflect our current reporting structure.

This change in our reported segments aimed to (i) increase transparency in the Corporate Center segment; (ii) facilitate the analysis of all business units; and (iii) highlight the activity carried out by the Corporate Center segment. The consolidated figures for the Group are unaffected.

The main changes were the following:

 

  1. Change of criteria: the change in segments mainly affected the income statement line items of net interest income, gains on financial transactions and operating expenses, due to decrease in the Corporate Center segment and its allocation to the business units. The main changes were as follows:

 

Previous criteria

  

New criteria

The Spain business unit was treated as a retail network, thus individualized internal transfer rates (ITR)* by operation were applied to calculate the financial margin, and the balance sheet was matched in terms of interest rate risk. The counterparty of these results was the Corporate Center segment.    The Spain business unit is treated like the other units of the Group. All results from financial management of the balance sheet are recorded in Spain, including the results from interest rate risk management.
The cost of issuances eligible as additional Tier 1 capital (AT1) made by Brazil and Mexico to replace common equity tier 1 (CET1) was recorded in the Corporate Center segment, as the issuances were made for capital optimization in these units.    Each country recognizes the cost related to its AT1 issuances.
The Corporate Center segment costs were charged to the countries/units; this criterion has not changed in recent years.    The scope of costs allocated to the units from the Corporate Center segment is expanded.

 

* ITR is a mechanism designed to help manage interest rate and liquidity risks, by isolating them from the business areas and centralizing them into the Financial Management Area in the Corporate Center. The main function of a transfer rate system is to set the price of the fund exchanges between business areas and the Corporate Center. This price represents the true opportunity cost of the funds (raised or invested) and has to take into account the costs of all associated interest rate and liquidity risks. Whether it is a fund investment or a fund raising transaction, the different business areas obtain a spread over or under the current transfer rate, and that spread is used to analyze the results of these business areas.

 

  2. Creation of a new business segment Real Estate Operations in Spain, which combines the former “Spain’s Run-Off Real Estate” business segment and other real estate assets, such as our subsidiary Metrovacesa, the assets from our old real estate fund (Santander Banif Inmobiliario) and others, previously included in the Corporate Center segment.

 

  3. The United States geographic segment is modified such that it continues to include the businesses of Santander Holdings USA (“SHUSA”), Santander Bank and Santander Consumer USA Holding Inc. (“SCUSA”), and the commercial banking activity of Banco Santander Puerto Rico and in addition includes Banco Santander International, Santander Investment Securities Inc. and the Bank’s New York branch, units that were previously included in Latin America.

 

  4. The business of Private Banking, Asset Management and Insurance, which previously appeared as an independent global business, is now integrated into Retail Banking.

Other changes: Annual change in the scope of the customer global relationship model between commercial banking and global banking and markets. This change does not have any effect on the geographical segments.

 

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The financial statements of each business area have been drawn up by aggregating the Group’s basic operating units. The information relates to both the accounting data of the companies in each area as well as that provided by the management information systems. In all cases, the same general principles as those used in the Group are applied.

In accordance with the criteria established by IFRS-IASB, the structure of our operating business areas has been segmented into two levels:

First (or geographic) level. The activity of our operating units is segmented by geographical areas. This coincides with our first level of management and reflects our positioning in the world’s main currency areas.

The reported segments are:

 

    Continental Europe. This covers all retail banking business and corporate banking in this region. This segment includes the following units: Spain, Portugal, Poland, Santander Consumer Finance (which includes the consumer business in Europe, including that of Spain, Portugal and Poland) and Real Estate Operations in Spain.

 

    United Kingdom. This includes retail and corporate banking conducted by the various units and branches of the Group in the country.

 

    Latin America. This embraces all the Group’s financial activities conducted via its subsidiary banks and subsidiaries. It also includes the specialized units of Santander Private Banking, as an independent and globally managed unit.

 

    United States. This includes the holding entity (SHUSA), Santander Bank, National Association, Banco Santander Puerto Rico, Santander Consumer USA Inc., Banco Santander International (BSI), Santander Investment Securities Inc. and the Santander branch in New York.

Second (or business) level. This segments the activity of our operating units by type of business. The reported segments are:

 

    Retail Banking. This area covers all customer banking businesses (except those of Corporate Banking, managed through the Global Customer Relationship Model). Also included in this business area are the results of the hedging positions taken in each country within the scope of the relevant ALCO portfolio.

 

    Santander Global Corporate Banking. This business reflects the revenues from global corporate banking, investment banking and markets worldwide including all treasuries managed globally, both trading and distribution to customers (after the appropriate distribution with Retail Banking customers), as well as equities business.

 

    Real Estate Operations in Spain. This business includes loans to customers in Spain whose activity is mainly real estate development, equity stakes in real estate companies and foreclosed assets.

In addition to these operating units, which cover everything by geographic area and business, we continue to maintain a separate Corporate Center area. This area incorporates the centralized activities relating to equity stakes in financial companies, financial management of the structural exchange rate position, as well as management of liquidity and of stockholders’ equity through issuances. As the Group’s holding entity, the Corporate Center area manages all capital and reserves and allocations of capital and liquidity. It also incorporates the goodwill’s impairment but not the costs related to the Group’s central services except for corporate and institutional expenses related to the Group’s functioning. Finally, we also include in this area significant Group one-offs.

For purposes of our financial statements and this report on Form 20-F, we have calculated the results of operations of the various units of the Group listed below using these criteria. As a result, the data set forth herein may not coincide with the data published independently by each unit individually.

First level (or geographic):

Continental Europe

Continental Europe includes all activities carried out in this region: Retail Banking and Santander Global Corporate Banking. During 2015, there were four main units within this area: Spain, Portugal, Poland and Santander Consumer Finance. Additionally, this area includes the Real Estate Operations in Spain unit.

 

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Continental Europe is the largest business area of Grupo Santander by assets. At the end of 2015, it accounted for 38% of total managed customer funds, 36% of total loans to customers and 28% of profit attributed to the Parent bank’s total operating areas.

The area had 5,548 branches and 58,049 employees (direct and assigned) of which 3,196 were temporary employees, at the end of 2015.

The eurozone growth as a whole accelerated, but varied from country to country. Spain was one of the countries that expanded the most. Inflation was around 0% in the zone, resulting in the European Central Bank continuing its expansive monetary policy: interest rates at historic lows and quantitative easing.

In 2015, this segment obtained profit attributable to the Parent of €2,218 million, an increase of €571 million or 35% as compared to 2014, mainly due to improved interest income/(charges) (which increased by €489 million) and to the decrease of €892 million in impairment losses on financial assets. Return on equity (“ROE”) stood at 7.1%.

Spain

We have a solid retail presence in Spain (3,467 branches) which is reinforced with global businesses in key products and segments (corporate banking, private banking, asset management, insurance and cards). We had a total of 24,216 employees (direct and assigned), all of which were hired on a full time basis.

In order to consolidate the Group’s leadership in Spain and increase profitability and efficiency, Santander merged its two large retail networks (Santander and Banesto) and its private bank (Banif) in 2013. See “—A. History and development of the company—Principal Capital Expenditures and Divestitures—Acquisitions, Dispositions, Reorganizations”.

The integration was completed in July 2014, ahead of schedule. All private banking clients were incorporated to Banif’s specialized customer attention model. We took advantage of the integration to optimize segmentation and specialization of branches, with a particular emphasis on private banking, Select and company banking, and increasing coverage in specialized portfolios to almost 100%.

In 2015 Spain grew by around 3.2% with a well-diversified base that made it possible to bring the unemployment rate down to around 21% by the end of the year. In addition, progress was made in correcting the imbalance in the public accounts while at the same time maintaining the foreign trade surplus. Energy prices kept inflation rates negative for a large part of the year, although the underlying rate remained positive.

Against this background, activity in Spain is well placed to accelerate its growth and build long-term relationships with its customers, in addition to boosting its business with SMEs and businesses, and maintaining its lead in big companies.

In 2015, profit attributable to the Parent bank in Spain was €977 million, a €150 million or 18% increase as compared to 2014, while the ROE was 8.1%.

Total income decreased by €556 million or 8% in 2015 in an environment of interest rates at historic lows and strong competition in loans (interest income/(charges) fell 5% compared to 2014) and a regulatory environment that hits net fees and commissions income (-6% compared to 2014). Gains/losses on financial assets and liabilities decreased by €250 million or 24% due to lower results in financial activity. While Other operating income/(expenses) decreased by €53 million mainly due to the charges to the Deposit Guarantee Fund and Resolution fund.

There was a €63 million or 2% reduction in operating expenses as a result of the synergies achieved through the optimization plans introduced. Loan losses provisions were €754 million or 43% lower than 2014 with the continuing process of normalization in a more favorable economic cycle.

In 2015, Spain’s loans and advances to costumers decreased by 1%, customer deposits decreased by 2% and other customer funds under management increased by 4%.

The non-performing loans (“NPL”) ratio was 6.53%, an 86 basis point decrease as compared to 2014. The coverage ratio increased from 45% in 2104 to 48% in 2015.

 

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Portugal

Our main Portuguese retail and investment banking operations are conducted by Banco Santander Totta, S.A. (“Santander Totta”).

On December, 21, 2015, the Bank of Portugal selected Santander Totta to acquire most of the assets and liabilities of Banco Internacional do Funchal (Banif) for €150 million. With this transaction, which evidences the commitment to the economic development of Portugal, Santander became the second private bank in the country with a market share in loans and deposits of over 14%.

At the end of 2015, Portugal had 752 branches and 6,568 employees (direct and assigned), of which 62 employees were temporary.

The Portuguese economy continued to recover in 2015. The growth of GDP accelerated to a rate of 1.5% compared with 0.9% in 2014. The recovery benefited from the ECB’s expansive monetary policy and the positive effect it had on spreads and the euro exchange rate. The country’s economic fundamentals continued to improve, the rate of unemployment fell for the last three years and the current account balance remained positive.

In 2015, the strategy was very focused on managing interest rates for loans and deposits, gaining market share particularly in companies, controlling non-performing loans and improvement the efficiency

In 2015, profit attributable to the Parent bank was €300 million, a €116 million or 63% increase from 2014. There was a growth of €60 million or 6% in total income, with increase of €9 million in interest income/(charges) due to the improvement in the cost of funding, and in Gains/losses on financial assets and liabilities with an increase of €77 million mainly due to sales of government debt securities.

Operating expenses fell €3 million or 1% due to the optimization of the commercial network in line with the business environment.

Loan losses provisions were down by €52 million or 42% due to the decrease in net additions to delinquent balances.

In 2015, loans and advances to customers and customer deposits increased by 22% and 21% respectively, due to the acquisition of Banif. Excluding Banif, lending’s declining trend slowed in 2015 (-1% compared to -5% in 2014) and growth in loans to companies rose (+5%) compared to a fall in the market. Funds increased 5%, under the strategy of boosting demand deposits (+37%) and mutual funds (+18%), while time deposits fell 7%. The result was a further improvement in the cost of deposits.

2015 ended with an NPL ratio of 7.46%, as compared to 8.89% at the end of 2014. The coverage ratio stood at 99% compared to 52% in December 2014. The ROE stood at 12.4%.

Poland

At the end of 2015, Poland had 723 branches and 11,474 employees (direct and assigned), of which 1,269 employees were temporary.

The Polish economy grew strongly in 2015 (3.6%) with inflation at -1% well below the target of 2.5% set by the National Bank of Poland, which lowered the reference rates to 1.5% in March 2015. Noteworthy as the most positive factor was the significant improvement in the labor market, with steady creation of jobs and a substantial fall in unemployment to the lowest rate since 2008.

In 2015, profit attributable to the Parent bank was €300 million, €55 million or 15% lower than in 2014. Total income decreased by €99 million or 7% for the following reasons: (i) Interest income/ (charges) decreased by €52 million impacted by the fall in interest rates which particularly affected the consumer finance rates due to the ceiling set by the Lombard rate, (ii) Fees and commissions decreased by €13 million due to increased regulation mainly affecting the card business and (iii) Other operating income/(expenses) decreased by €80 million due to the one-time charge to the Deposit Guarantee Fund as a result of the failure of SK Wołomin Bank.

Furthermore, operating expenses increased by €9 million or 2% as compared to 2014 while Loan losses provisions were down by €18 million or 10% despite the increase in lending.

 

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Loans and advances to customers and customer deposits increased by 12% and 7% respectively as compared to 2014, however the other customer funds under management decrease 9% compared with 2014. The NPL ratio decreased 112 basis points to 6.30% and the coverage ratio increased 4 percentage points to 64%. The ROE stood at 12.5%.

Santander Consumer Finance

Our consumer financing activities are conducted through our subsidiary Santander Consumer Finance (SCF) and its group of companies. Most of the activity of SCF relates to auto financing, personal loans, credit cards, insurance and customer deposits. These consumer financing activities are mainly focused on Germany, Spain, Italy, Norway, Poland, Finland and Sweden. SCF also conducts business in the UK, France, Portugal, Austria and the Netherlands, among others.

The main European markets where business is conducted grew at between 1.7% and 3.5% in 2015.

In 2015 the management focuses were: (i) the integration of the GE Nordics businesses, (ii) the implementation of the agreements with PSA, and (iii) promoting new lending and cross-selling tailored to the situation in each market, supported by brand agreements.

The following agreements were entered into in 2014 and strengthen SCF’s position in its markets: (i) the agreement with Banque PSA Finance (PSA Peugeot Citroën Group), (ii) the acquisition in Spain of 51% of Financiera El Corte Inglés, and (iii) the acquisition of GE Nordics (GE Money’s business in Norway, Sweden and Denmark). See “—A. History and development of the company—Principal Capital Expenditures and Divestitures—Acquisitions, Dispositions, Reorganizations”.

At the end of 2015, this unit had 588 branches and 14,533 employees (direct and assigned), of which 1,189 employees were temporary.

The Santander Consumer Finance units in Continental Europe operated in an environment of incipient recovery of both consumer spending and vehicle registrations (+9% year on year in the countries in which they operate). In 2015, SCF continued to gain market share, supported by a business model that has been strengthened during the crisis thanks to a high level of geographical diversification with critical mass in key projects, high levels of efficiency, and a shared risk control and recovery system that makes it possible to maintain a high level of credit quality.

In 2015, this unit generated €938 million in Profit attributable to the Parent bank, a €143 million or 18% increase compared with 2014. This growth benefited from the impact of the previously mentioned agreements, with Total income growing faster than operating expenses and Impairment losses on financial assets. Total income rose €742 million or 23% (interest income/charges increased €728 million or 31%), while operating expenses grew €306 million or 21%. Loan losses provisions declined €7 million or 1%, due to improved credit quality. Minority interests increased by €99 million resulting from the PSA agreements.

Loans and advances to customers increased by 22% and customer deposits increased by 6%. The NPL ratio decreased 140 basis points to 3.42%, while the coverage increased to 109% from 100% in 2014. The ROE stood at 12.0%.

Real Estate Operations in Spain

The segment, which has a specialized management model, combines (i) the run-off real estate activity in Spain, which includes loans to customers mainly for real estate promotion, where our strategy focuses on a significant reduction of our exposure; (ii) quality real estate operating assets (mainly from our old real estate fund, Santander Banif Inmobiliario); (iii) our subsidiary Metrovacesa; and (iv) certain other assets such as our stake in Spanish Bank Restructuring Asset Management Company, or Sareb (see note 8.b.ii to our consolidated financial statements). As of the end of 2014, the stake in Metrovacesa was consolidated by global integration. See “—A. History and development of the company—Principal Capital Expenditures and Divestitures—Acquisitions, Dispositions, Reorganizations—Metrovacesa, S.A.”

The Group’s strategy in recent years has been directed at reducing these assets, mainly loans and foreclosed assets. Net loans totaled €2,794 million, which was 33% less than in 2014 and accounted for 0.4% of the Group’s loans and less than 2% of those of Santander Spain.

In 2015, this segment had €420 million of losses attributable to the Parent bank, a €232 million decrease in losses as compared to 2014, mainly due to the lower need for write-downs.

 

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United Kingdom

As of December 31, 2015, the United Kingdom accounted for 31% of the total managed customer funds of the Group’s operating areas. Furthermore, it accounted for 36% of total loans to customers and 24% of profit attributed to the Parent bank’s total operating areas.

At the end of 2015, we had 858 branches and a total of 25,866 employees (direct and assigned), of which 661 employees were temporary, in the United Kingdom.

The UK economy continued to grow at 2.2%, registering another year of steady growth. The main driver was domestic demand (particularly private consumption, robust labor market, improved consumer confidence and favorable financial conditions) and a recovery in investment. The unemployment rate fell in the year to 5.2%, in part due to a large increase in self-employment. This pushed the number of people in employment to a record high. Inflation was around 0%, mainly due to lower oil and commodity prices and the consolidation of sterling’s appreciation registered since mid-2013. Based on this, the Bank of England kept interest rates unchanged in 2015.

There have been significant changes recently, in terms of regulation, tax and public policy as well as a significant advance in the use of technology in banking, especially mobile. Additionally the impact of the new entrants and existing competitors who have renewed focus on the UK market opportunities. The strategic direction has been fine-tuned, to align with the economic, regulatory and market environment changes. Based on the new scenario we have focused on the customer loyalty, on increasing the flows in retail and corporate segments and ongoing investment in business growth and in digital channels.

In 2015, Santander UK contributed €1,971 million of profit attributable to the Parent bank, a €415 million or 27% (14% in local currency) increase from 2014. The main developments were: (i) a €708 million or 17% (5% in local currency) increase in interest income/(charges) mainly due to higher volumes, (ii) a €302 million or 10% (-1% in local currency) increase in operating expenses due to investment in business growth, higher regulatory costs and the continued enhancements to our digital channels and (iii) a €225 million or 68% (71% local currency) decrease in impairment losses on financial assets with improved credit quality across the loan portfolios, conservative loan-to-value criteria, and supported by a favorable economic environment.

As of December 31, 2015, loans and advances to customers increased by 13% (6% excluding the exchange rate impact), and customer deposits increased 15% (8% excluding the exchange rate impact). Other customer funds under management were flat as compared to 2014. The NPL ratio decreased 27 basis points to 1.52% and the coverage ratio decreased to 38% from 42% in 2014. The ROE was 11.5%

Latin America

At December 31, 2015, we had 5,841 branches and 89,819 employees (direct and assigned) in Latin America, of which 1,794 were temporary employees. At that date, Latin America accounted for 22% of the total managed customer funds, 17% of total loans to customers and 40% of profit attributed to the Parent bank’s total operating areas.

In a complex international environment, the Latin American economy was affected in 2015 by various external factors such as the outlook for US interest rate rises, the price of commodities and the slowing of the Chinese economy.

Our Latin American banking business is principally conducted by the following banking subsidiaries:

 

     Percentage held
at December 31, 2015
          Percentage held
at December 31, 2015
 

Banco Santander (Brasil), S.A.

     89.25      

Banco Santander, S.A. (Uruguay)

     100.00   

Banco Santander Chile

     67.12      

Banco Santander Perú, S.A.

     100.00   

Banco Santander (Mexico), S.A., Institución de Banca Múltiple, Grupo Financiero Santander

     75.07      

Banco Santander Río, S.A. (Argentina)

     99.30   

Banco Santander de Negocios Colombia S.A.

     99.99         

 

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We engage in a full range of retail banking activities in Latin America, although the range of our activities varies from country to country. We seek to take advantage of whatever particular business opportunities local conditions present.

Our significant position in Latin America is attributable to our financial strength, high degree of diversification (by countries, businesses, products, etc.), and the breadth and depth of our franchise. Grupo Santander has the region’s largest international franchise.

In Latin America the regional GDP shrank 0.4% in 2015 after the growth of 1.2% in 2014, in a complex international environment faced with the prospect of a rise in interest rates in the United States, the downturn of international trade and the lower growth in China. There was very different performance country by country, with some in recession and others showing a gradual recovery. There was a slight upturn in inflation, mainly as a result of the effects of the depreciation of the Latin American currencies.

The Group continued to focus as a priority on strengthening customer relations by improving their experience and increasing their satisfaction. For this purpose, 2015 saw the launch in the principal geographical areas of the “1|2|3 World” range of products that are designed to attract and engage private individual customers, and the Advance program, the aim of which is to strengthen the Bank’s positioning in business customers.

Profit attributable to the Parent bank from Latin America in 2015 was €3,193 million, a €291 million or 10% increased as compared to 2014 (excluding the exchange rate impact 17%). Total income increased €198 million or 1% (excluding the exchange rate impact 10%) driven by the growth of volumes and transactionality, which impacted both the interest income and the fees and commissions. Operating expenses increased €56 million or 1%, however excluding the exchange rate impact they grew 10% as a result of salary increase agreements in an environment of high inflation in countries such as Brazil, Argentina and Uruguay, dollar-indexed costs, and investments to develop the commercial and digital networks. The growth was moderate as compared to inflation rates. The change in lending mix towards products with a lower risk premium continued in 2015 and Impairment losses decreased 1% as compared to 2014.

As of December 31, 2015, loans and advances to customers decreased by 5%, however excluding the exchange rate impact increased 14%. Customer deposits decreased 7% as compared to 2014, nevertheless excluding the exchange rate impact increased 12%. The NPL ratio stood at 4.96% and the coverage ratio at 79% at December 31, 2015.

Detailed below are the performance highlights of the main Latin American countries in which we operate:

Brazil. Santander Brazil is the country’s third largest private sector bank by assets and the largest foreign bank in the country. The institution operates in the main regions, with 3,443 branches and points of banking attention, 49,520 employees (direct and assigned), all of which were hired on a full time basis.

During the first quarter of 2015 Santander Brazil entered into an agreement to acquire Banco Bonsucesso to leverage activities in the payroll business, as well as increase the number of products offered and improve the distribution and marketing capacity.

Brazil went into recession in 2015, with contraction of consumer spending and private investment and rising unemployment. There was an upturn in inflation to over 10%. The central bank reinforced its commitment to control inflation by raising the Selic rate 250 basis points in the year, taking it to 14.25%.

In 2015, the Bank made progress in its process of transformation to simplify, modernize and improve the experience of customers, while agreements were also reached in order to increase the more transactional portion of the Bank’s income.

Profit attributable to the Parent bank from Brazil in 2015 was €1,631 million, a €194 million or 13% (33% excluding the exchange rate impact) increase as compared to 2014. Total income fell €739 million or 6% compared with 2014 (excluding the exchange rate impact increased 10%), mainly due to interest income/(charge).

Operating expenses decreased €491 million or 10% (excluding the exchange rate impact increased 5%). Excluding the inflation and exchange rate impact and on a like-for-like basis, they fell 6%, reflecting the efforts made in previous years to improve efficiency and productivity.

Loan losses provisions declined by €385 million or 10%, however excluding the exchange rate impact they raised by 5%.

During 2015, total loans and advances to customers decreased by 19%, in local currency increased 8%, mainly due to the forex impact on dollar portfolios and the entry of Bonsucesso. Customer deposits decrease 17% as compared to 2014, excluding the exchange rate impact increased 11%. The NPL ratio was 5.98% at December 31, 2015 compared with 5.05% at December 31, 2014. The coverage ratio stood at 84% at December 31, 2015. The ROE stood at 13.6%.

 

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Mexico. Banco Santander (Mexico), S.A., Institución de Banca Múltiple, Grupo Financiero Santander, is one of the leading financial services companies in Mexico. Santander is the third largest banking group in Mexico by business volume. As of December 31, 2015, it had 1,377 branches throughout the country, 17,847 employees (direct and assigned), of which 1,634 were temporary.

Mexico gave clear signs of improvement in the second half of the year driven by the recovery of both domestic demand and exports. Although the inflation rate remained low, the central bank decided to raise the official interest rate in response to the increase by the Federal Reserve, in order to prevent possible outbreaks of volatility given the country’s strong commercial and financial connection with the United States.

2015 saw the completion of the branch expansion plan, following the opening of 200 branch offices in the last three years. The increase in installed capacity was accompanied by improvements in customer segmentation and sales platforms.

Profit attributable to the Parent bank from Mexico in 2015 was €629 million, a €22 million or 4% (3% excluding the exchange rate impact) increase as compared to 2014. The growth of €298 million or 10% in total income, was mainly driven by an increase of €313 million in interest income/(charge) due to the higher loans volume.

Operating expenses increased €87 million or 7%, due to the greater installed capacity and new commercial projects to increase attraction and penetration in the customer base.

Loan losses provisions increased by €120 million or 16% due to greater lending volume.

As of December 31, 2015, loans and advances to customers increased by 17% (23% excluding the exchange rate impact), and customer deposits decreased 1% (5% increase excluding the exchange rate impact). Other customer funds under management were flat as compared to 2014.

At December 31, 2015, the NPL ratio decreased 46 basis points to 3.38% while the coverage ratio was 91%. The ROE was 12.9%.

Chile. Banco Santander Chile is the leading bank in Chile in terms of assets and customers, with a particular focus on retail activity (individuals and SMEs). As of December 31, 2015, Banco Santander Chile had 472 branches and 12,454 employees (direct and assigned), all of which were hired on a full time basis.

The Chilean economy recovered in 2015 as a result of the expansion of investment and private consumer spending, which led the central bank to begin to normalize its monetary policy by raising the official interest rate 50 basis points to 3.50%.

In 2015 more branches and exclusive Select spaces for high-income customers were opened, as well as the new model of branch offices in the traditional network. The Group continued to pursue its strategy of increasing long-term profitability in a climate of smaller margins and greater regulation.

Profit attributable to the Parent bank from Chile in 2015 was €455 million, a €43 million or 9% (13% excluding the exchange rate impact) decrease as compared to 2014, mainly due to lower inflation-indexed UF, some regulatory impact, higher technology costs and higher tax pressure.

In 2015, customer loans increased 6% (11% in local currency) and customer deposits increase 4% (9% in local currency) as compared to 2014. Other customer funds under management increased 2% as compared to 2014.

At December 31, 2015, the NPL ratio decreased 35 basis points to 5.62% while the coverage ratio was 54% and the ROE 15.32%.

Argentina. Santander Río is the country’s leading private sector bank in terms of assets, loans and customer funds. At December 31, 2015 we had 436 branches and 7,952 employees in Argentina.

Argentina ended the year with an economy that was still weak and inflation that was among the highest in the region. In mid-December the new government announced the liberalization of capital movements and the exchange rate of the Argentine peso began to float freely.

 

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The Group’s strategy in 2015 focused on increasing its penetration through its branch office expansion plan, the transformation towards a digital bank with the focus on efficiency and customer experience, and the engagement of the customer segments of high-income private individuals and SMEs.

Profit attributable to the Parent bank was €378 million, a 29% (22% in local currency) increase compared with 2014. The commercial strategy helped to push up total income by 34%, mainly due to the increase of interest income/ (charge) by 35% and fees and commissions by 46%. Operating expenses rose 51% (43% in local currency) because of the opening of new branches, the transformation and technology projects and the review of the salary increase agreement. Loan loss provisions increased 22% (16% in local currency), below the growth in lending.

During the year, lending and customer deposits increased 10% and 15%, respectively. Nevertheless, in local currency lending rose 52%, focused on lending to SMEs and companies and deposits increased 58%. Mutual funds grew 26% during 2015 (73% in local currency).

At the end of 2015, the ROE was 30.6%, while the NPL ratio decreased 46 basis points to 1.15% and the coverage ratio was 194%.

Uruguay. The Group maintained its leadership in Uruguay. We are the largest private sector bank in the country. Overall, the Group had 111 branches and 1,808 employees.

Inflation was 9.4%, well above the central bank’s target of (+3% to 7%). The key rate remained high in order to converge toward this goal. The Uruguayan peso depreciated 20% against the dollar and 10% against the euro.

The Group continued to be the country’s leading private sector bank, focusing on growing in retail banking and improving efficiency and the quality of service.

Profit attributable to the Parent bank from Uruguay in 2015 was €70 million, a €20 million or 41% (38% in local currency) increase as compared to 2014. Lending increased by 8%, with particular growth in individual customers and SMEs, and deposits rose by 19%, in each case compared with 2014.

Peru. As of December 31, 2015, Banco Santander Perú, S.A. had 1 branch and 156 employees. The unit’s activity is focused on companies and on the Group’s global customers. An auto finance company began to operate in 2013, together with a well-known international partner with considerable experience in Latin America. The company has a specialized business model, focused on service and with products that enable customers to acquire any brand of new car from any dealer in Peru.

Profit attributable to the Parent bank from Peru reached €32 million, a €10 million or 46% increase compared with 2014.

Colombia. Banco Santander de Negocios Colombia S.A. began operating in January 2014. The bank targets the corporate and business markets, with a special focus on global customers and local customers aiming to expand to gain international presence.

Colombia had a €1 million loss attributable to the Parent bank.

United States

At the end of 2015, we had 783 branches and a total of 18,123 employees (direct and assigned), none of them temporary.

The US economy grew a modest but solid pace (2.5%). Thanks to the improving economy, the unemployment rate fell on a sustained basis to 5% at the end of the year, a level regarded as full employment. Inflation, however, remained low (1.3%) and at some distance from the Federal Reserve’s target (set in terms of the underlying deflator of private consumption), which is 2%. In this context, the Fed raised its interest rates at the end of the year, accompanied by a message indicating the interest rate profile outlook would be moderate.

The U.S. segment includes the holding entity (SHUSA), Santander Bank, National Association, Banco Santander Puerto Rico, Santander Consumer USA Inc., Banco Santander International (BSI), Santander Investment Securities Inc. and the Santander branch in New York.

Santander US continues to focus on several strategic priorities directed at enhancing its position and diversification, including: the implementation of a multi-year project to comply with regulatory requirements globally, the improvement of the governance structure, the setting up of local managerial team with wide experience in the management of large financial companies, the improvement of profitability at Santander Bank, National Association, and the optimization of the vehicle finance business at SCUSA.

 

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The U.S. segment accounted for 9% of the total managed customer funds, 11% of total loans to customers and 8% of profit attributed to the Parent bank’s total operating areas.

Profit attributable to the Parent decreased €184 million or €352 without exchange rates. Despite the increase in total income of €1,821 million or 30% (9% in local currency), Profit attributable to the Parent was lower due to higher operating expenses by €786 million or 35% (13% excluding the exchange rate impact) and higher impairment losses of €858 million or 38% (16% in local currency) relating to greater lending in SCUSA, and income taxes.

For 2015, ROE was 6.0% and the NPL ratio was 2.13%. The coverage ratio stood at 225% at year end.

Second or business level:

Retail Banking

Retail Banking’s profit attributable to the Parent bank in 2015 increased 14% (10% excluding the exchange rate impact), to €6,854 million. This evolution was spurred by the good performance of total income which grew 7% (+6% excluding the exchange rate impact). Operating expenses were 7% higher (+1% excluding perimeter and in real terms) and loan loss provisions were 5% lower.

In 2015, Retail Banking generated 88% of the operating areas’ total income and 85% of profit attributable to the Parent bank. This segment had 183,182 employees as of December 31, 2015.

In 2015 Santander continued to make progress with its program for transforming commercial banking focusing on the following:

 

    In order to gain greater knowledge of customers, progress is being made in improving the analytical capabilities. A new commercial front has been developed for the branch offices in order to improve commercial productivity and customer satisfaction.

 

    In order to increase customer engagement and long-term relations, progress was made in 2015 in the launching and consolidation of differential value offerings. These included most notably (i) the “1|2|3 World” strategy (with the launch of proposals in other geographical regions such as Portugal, Spain and certain Latin America countries, after the success in the United Kingdom), (ii) integral offers launched in Chile with proposals which reward transactionality and increase customer benefits, (iii) the expansion of the Select value offering for high-income customers which is now available throughout the geographical regions, and (iv) the roll-out of the program for SMEs that combines a very attractive financial offering with non-financial solutions and that is now available in eight countries.

 

    The Bank made further progress with the development of its distribution models focused on digital channels, resulting in substantial improvements to the different channels, most notably with new apps, developments and functionalities for mobile phones in the various geographical areas and the new model of branch office in Spain and Brazil, which offers simpler procedures, more intuitive technology and differentiated areas within the branch.

 

    The Bank supports the internationalization of its business customers by harnessing the synergies and international capabilities of the Group, thereby ensuring consistent and uniform customer relations throughout all the local units and enabling our customers to connect with each other and capture international trade flows with the Santander Trade Portal and the Santander Trade Club.

Santander Global Corporate Banking

This area covers our corporate banking, treasury and investment banking activities throughout the world.

Global Corporate Banking generated 12% of total income and 20% of the profit attributable to the Parent bank in 2015. This segment had 8,037 employees at December 31, 2015.

Profit attributable to the Parent bank in 2015 was €1,626 million, an increase of €1 million as compared to 2014. This performance was impacted by an increase in interest income/(charges) (€349 million or 14%) offset by an increase in operating expenses (€218 million or 12%) and in impairment losses (€130 million or 22%).

Global Corporate Banking has 3 major areas: (i) Global Transaction Banking (which includes cash management, trade finance and basic financing and custody), (ii) Financing Solutions and Advisory (which includes the units that originate and

 

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distribute corporate loans or structured financing, the teams that originate bonds and securitization, the corporate finance units (mergers and acquisitions, primary equity markets, investment solutions for corporate clients via derivatives), as well as asset and capital structuring), and (iii) Global Markets (which include the sale and distribution of fixed income and equity derivatives, interest rates and inflation, the trading and hedging of exchange rates, short-term money markets for the Group’s corporate and retail clients, management of books associated with distribution, brokerage of equities, and derivatives for investment and hedging solutions).

Real Estate Operations in Spain

See above under “First level (or geographic)—Continental Europe—Real Estate Operations in Spain.”

Corporate Center

Loss attributable to the Parent increased by €943 million as the increase in Interest income / (charges) and the decrease in Provisions (net) was compensated by the decrease in gains from centralized management of risks and to a greater extent the drop in Gains/(losses) on other assets (net), as compared to 2014. At the end of 2015 this area had 2,006 employees.

The Corporate Center is responsible for, on the one hand, a series of centralized activities to manage the structural risks of the Group and of the Parent bank. It executes the necessary activities for managing interest rates, exposure to exchange-rate movements and the required levels of liquidity in the Group. On the other hand, it acts as the Group’s holding entity, managing the Group’s global capital as well as that of each of the business units.

Within corporate activities, the financial management area conducts the global functions of balance sheet management, both structural interest rate and liquidity risk management (the latter via issuances and securitizations), as well as the structural position of exchange rates:

 

    Interest rate risk is actively managed by taking market positions to soften the impact of interest rate changes on net interest income, and is done via bonds and derivatives of high credit quality and liquidity and low consumption of capital.

 

    The objective of structural liquidity management is to finance the Group’s recurring activity in optimum conditions of maturity and cost, maintaining an appropriate profile (in volumes and maturities) by diversifying the funding sources.

 

    Management of the exposure to exchange rate movements is also carried out on a centralized basis. This management (which is dynamic) is conducted through exchange-rate derivatives, seeking to optimize at all times the financial cost of hedging.

Hedging of net investments in the capital of businesses abroad aims to neutralize the impact on capital of converting into euros the balances of our material subsidiaries that are consolidated and whose currency is not the euro.

The Group’s policy seeks to mitigate the impact, which, in situations of high volatility in the markets, sudden changes in interest rates would have on these exposures of a permanent nature. At the end 2015, we had €20,349 million hedged relating to our investments in Brazil, the U.K., Mexico, Chile, the U.S., Poland and Norway and the instruments used were spot and foreign exchange forwards.

Exposures of a temporary nature—those regarding results that the Group’s units will contribute in the next 12 months in non-euro currencies—are also managed on a centralized basis in order to limit their volatility in euros.

Meanwhile, and separately from the financial management described here, the Corporate Center manages all capital and reserves and allocations of capital to each of the units, as well as providing the liquidity that some of the business units might need. The price at which these transactions are carried out is the market rate (Euribor or swap) plus a risk premium associated with the hold of the funds during the life of the transaction, which in terms of liquidity, the Group supports.

Lastly, and marginally, the equity stakes of a financial nature that the Group takes within its policy of optimizing investments are reflected in the Corporate Center.

Total Revenues by Activity and Geographic Location

For a breakdown of our total revenues by category of activity and geographic market, see note 52 to our consolidated financial statements.

 

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Selected Statistical Information

The following tables show our selected statistical information.

Average Balance Sheets and Interest Rates

The following tables show, by domicile of customer, our average balances and interest rates for each of the past three years.

You should read the following tables and the tables included under “—Changes in Net Interest Income—Volume and Rate Analysis” and “—Assets—Earning Assets—Yield Spread” in conjunction with the following:

 

    We have included interest received on non-accruing assets in interest income only if we received such interest during the period in which it was due;

 

    We have included loan arrangement fees in interest income;

 

    We have not recalculated tax-exempt income on a tax-equivalent basis because the effect of doing so would not be significant;

 

    We have included income and expenses from interest-rate hedging transactions as a separate line item under interest income and expenses if these transactions qualify for hedge accounting under IFRS-IASB. If these transactions did not qualify for such treatment, we have included income and expenses on these transactions elsewhere in our income statement. See note 2 to our consolidated financial statements for a discussion of our accounting policies for hedging activities;

 

    We have stated average balances on a gross basis, before netting our allowances for credit losses, except for the total average asset figures, which includes such netting; and

 

    All average data have been calculated using month-end balances, which is not significantly different from having used daily averages.

As stated above under “Presentation of Financial and Other Information”, we have prepared our financial statements for 2015, 2014, 2013, 2012 and 2011 under IFRS-IASB.

 

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Average Balance Sheet - Assets and Interest Income

 

     Year Ended December 31,  
ASSETS    2015     2014     2013  
     Average
Balance
     Interest     Average
Rate
    Average
Balance
     Interest      Average
Rate
    Average
Balance
     Interest      Average
Rate
 
     (in millions of euros, except percentages)                      

Cash and due from central banks

                       

Domestic

     2,511         7        0.28     1,737         13         0.75     6,590         54         0.83

International

     72,101         1,385        1.92     75,567         2,025         2.68     77,467         2,647         3.42
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
     74,612         1,392        1.87     77,304         2,038         2.64     84,057         2,701         3.21

Due from credit entities

                       

Domestic

     28,449         126        0.44     22,614         98         0.43     28,206         152         0.54

International

     60,238         1,719        2.85     59,090         1,684         2.85     56,983         614         1.08
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
     88,687         1,845        2.08     81,704         1,782         2.18     85,189         766         0.90

Loans and credits

                       

Domestic

     159,897         4,134        2.59     164,517         5,125         3.12     178,227         5,755         3.23

International

     625,763         41,311        6.60     541,635         37,050         6.84     519,037         34,450         6.64
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
     785,660         45,445        5.78     706,152         42,175         5.97     697,264         40,205         5.77

Debt securities

                       

Domestic

     51,467         859        1.67     44,797         1,582         3.53     55,497         2,113         3.81

International

     130,918         6,502        4.97     110,741         5,665         5.12     94,144         4,322         4.59
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
     182,385         7,361        4.04     155,538         7,247         4.66     149,641         6,435         4.30

Income from hedging operations

                       

Domestic

        83             95              85      

International

        (350          198              125      
     

 

 

        

 

 

         

 

 

    
        (267          293              210      

Other interest

                       

Domestic

        658             689              677      

International

        764             432              453      
     

 

 

        

 

 

         

 

 

    
        1,422             1,121              1,130      

Total interest-earning assets

                       

Domestic

     242,324         5,867        2.42     233,665         7,602         3.25     268,520         8,836         3.29

International

     889,020         51,331        5.77     787,033         47,054         5.98     747,631         42,611         5.70
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
     1,131,344         57,198        5.06     1,020,698         54,656         5.35     1,016,151         51,447         5.06

Other non-interest earning assets

     214,313             181,149              198,097         

Assets from discontinued operations

     —               —                —           
  

 

 

    

 

 

     

 

 

    

 

 

      

 

 

    

 

 

    

Total average assets

     1,345,657         57,198          1,201,847         54,656           1,214,248         51,447      

Notes: 1) Amounts previously reported in Other interest-earning assets have been reclassified to Other non interest-earning assets, consistent with their non interest-earning nature.

2) As of December 31, 2015, 2014 and 2013, Total average assets attributed to international activities accounted for 76%, 75% and 70%, respectively, of the Group’s Total average assets.

 

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Average Balance Sheet - Liabilities and Interest Expense

 

     Year Ended December 31,  

LIABILITIES AND

STOCKHOLDERS

EQUITY

   2015     2014     2013  
   Average
Balance
     Interest     Average
Rate
    Average
Balance
     Interest     Average
Rate
    Average
Balance
     Interest     Average
Rate
 

Due to credit entities

                     

Domestic

     31,931         180        0.56     16,006         225        1.41     21,654         335        1.55

International

     134,781         2,176        1.61     116,499         1,980        1.70     107,956         1,635        1.51
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
     166,712         2,356        1.41     132,505         2,205        1.66     129,610         1,970        1.52

Customers deposits

                     

Domestic

     173,793         1,102        0.63     170,327         1,629        0.96     173,833         3,053        1.76

International

     511,282         12,347        2.41     459,133         11,787        2.57     458,506         11,752        2.56
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
     685,075         13,449        1.96     629,460         13,416        2.13     632,339         14,805        2.34

Marketable debt securities

                     

Domestic

     62,510         1,628        2.60     68,571         2,242        3.27     83,445         2,993        3.59

International

     140,147         5,337        3.81     121,194         4,602        3.80     105,509         3,886        3.68
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
     202,657         6,965        3.44     189,765         6,844        3.61     188,954         6,879        3.64

Subordinated debt

                     

Domestic

     6,840         250        3.65     7,114         407        5.72     8,547         496        5.80

International

     8,296         684        8.24     7,762         677        8.72     8,098         764        9.43
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
     15,136         934        6.17     14,876         1,084        7.29     16,645         1,260        7.57

Other interest-bearing liabilities

                     

Domestic

     6,896         137        1.99     6,988         192        2.75     7,062         200        2.83

International

     2,160         133        6.16     2,158         152        7.04     2,654         164        6.18
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
     9,056         270        2.98     9,146         344        3.76     9,716         364        3.75

Expenses from hedging operations

                     

Domestic

        (307          (388          (1,138  

International

        (103          (158          (290  
     

 

 

        

 

 

        

 

 

   
        (410          (546          (1,428  

Other interest

                     

Domestic

        761             725             762     

International

        61             1,037             900     
     

 

 

        

 

 

        

 

 

   
        822             1,762             1,662     

Total interest-bearing liabilities

                     

Domestic

     281,970         3,751        1.33     269,006         5,032        1.87     294,541         6,701        2.28

International

     796,666         20,635        2.59     706,746         20,077        2.84     682,723         18,811        2.76
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
     1,078,636         24,386        2.26     975,752         25,109        2.57     977,264         25,512        2.61

Other non-interest bearing liabilities

     166,518             141,291             155,410        

Non-controlling interest

     10,283             9,757             10,066        

Stockholders’ Equity

     90,220             75,047             71,508        

Liabilities from discontinued operations

     —               —               —          
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

   

Total average Liabilities and Stockholders’ Equity

     1,345,657         24,386          1,201,847         25,109          1,214,248         25,512     

Notes: 1) Certain balances previously reported in Other interest-bearing liabilities and Subordinated debt have been reclassified to Other non interest-bearing liabilities, consistent with their non interest-bearing nature.

2) As of December 31, 2015, 2014 and 2013, Total average liabilities attributed to international activities accounted for 71%, 70% and 67%, respectively, of the Group’s Total average liabilities.

 

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Changes in Interest Income / (charges)—Volume and Rate Analysis

The following tables allocate, by domicile of customer, changes in our interest income / (charges) between changes in average volume and changes in average rate for 2015 compared to 2014 and 2014 compared to 2013. We have calculated volume variances based on movements in average balances over the period and rate variance based on changes in interest rates on average interest-earning assets and average interest-bearing liabilities. We have allocated variances caused by changes in both volume and rate to volume. You should read the following tables and the footnotes thereto in light of our observations noted in the preceding sub-section entitled “—Average Balance Sheets and Interest Rates”, and the footnotes thereto.

 

Volume and rate analysis    IFRS-IASB
2015/2014
 
     Increase (Decrease) due to changes in  
     Volume      Rate      Net change  
     (in millions of euros)  
Interest and similar income         

Cash and due from central banks

        

Domestic

     4         (10      (6

International

     (89      (551      (640
  

 

 

    

 

 

    

 

 

 
     (85      (561      (646

Due from credit entities

        

Domestic

     26         2         28   

International

     33         2         35   
  

 

 

    

 

 

    

 

 

 
     59         4         63   

Loans and credits

        

Domestic

     (140      (851      (991

International

     5,591         (1,330      4,261   
  

 

 

    

 

 

    

 

 

 
     5,451         (2,181      3,270   

Debt securities

        

Domestic

     209         (932      (723

International

     1,005         (168      837   
  

 

 

    

 

 

    

 

 

 
     1,214         (1,100      114   

Total interest-earning assets without hedging operations

        

Domestic

     99         (1,791      (1,692

International

     6,540         (2,047      4,493   
  

 

 

    

 

 

    

 

 

 
     6,639         (3,838      2,801   

Income from hedging operations

        

Domestic

     (12      —           (12

International

     (548      —           (548
  

 

 

    

 

 

    

 

 

 
     (560      —           (560

Other interests

        

Domestic

     (31      —           (31

International

     332         —           332   
  

 

 

    

 

 

    

 

 

 
     301         —           301   

Total interest-earning assets

        

Domestic

     56         (1,791      (1,735

International

     6,324         (2,047      4,277   
  

 

 

    

 

 

    

 

 

 
     6,380         (3,838      2,542   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents
Volume and rate analysis    IFRS-IASB
2014/2013
 
     Increase (Decrease) due to changes in  
     Volume      Rate      Net change  
     (in millions of euros)  
Interest and similar income         

Cash and due from central banks

        

Domestic

     (36      (5      (41

International

     (63      (559      (622
  

 

 

    

 

 

    

 

 

 
     (99      (564      (663

Due from credit entities

        

Domestic

     (27      (27      (54

International

     24         1,046         1,070   
  

 

 

    

 

 

    

 

 

 
     (3      1,019         1,016   

Loans and credits

        

Domestic

     (432      (198      (630

International

     1,527         1,073         2,600   
  

 

 

    

 

 

    

 

 

 
     1,095         875         1,970   

Debt securities

        

Domestic

     (386      (145      (531

International

     814         529         1,343   
  

 

 

    

 

 

    

 

 

 
     428         384         812   

Total interest-earning assets without hedging operations

        

Domestic

     (881      (375      (1,256

International

     2,302         2,089         4,391   
  

 

 

    

 

 

    

 

 

 
     1,421         1,714         3,135   

Income from hedging operations

        

Domestic

     10         —           10   

International

     73         —           73   
  

 

 

    

 

 

    

 

 

 
     83         —           83   

Other interests

        

Domestic

     12         —           12   

International

     (21      —           (21
  

 

 

    

 

 

    

 

 

 
     (9      —           (9

Total interest-earning assets

        

Domestic

     (859      (375      (1,234

International

     2,354         2,089         4,443   
  

 

 

    

 

 

    

 

 

 
     1,495         1,714         3,209   
  

 

 

    

 

 

    

 

 

 

 

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Volume and rate analysis    IFRS-IASB
Year Ended December 31, 2015/2014
 
     Increase (Decrease) due to changes in  
     Volume      Rate      Net change  
     (in millions of euros)  
Interest charges         

Due to credit entities

        

Domestic

     140         (185      (45

International

     299         (103      196   
  

 

 

    

 

 

    

 

 

 
     439         (288      151   

Customers’ deposits

        

Domestic

     33         (560      (527

International

     1,287         (727      560   
  

 

 

    

 

 

    

 

 

 
     1,320         (1,287      33   

Marketable debt securities

        

Domestic

     (186      (428      (614

International

     722         13         735   
  

 

 

    

 

 

    

 

 

 
     536         (415      121   

Subordinated debt

        

Domestic

     (15      (142      (157

International

     45         (38      7   
  

 

 

    

 

 

    

 

 

 
     30         (180      (150

Other interest-bearing liabilities

        

Domestic

     (2      (53      (55

International

     —           (19      (19
  

 

 

    

 

 

    

 

 

 
     (2      (72      (74

Total interest-bearing liabilities without hedging operations

        

Domestic

     (30      (1,368      (1,398

International

     2,353         (874      1,479   
  

 

 

    

 

 

    

 

 

 
     2,323         (2,242      81   

Expenses from hedging operations

        

Domestic

     81         —           81   

International

     55         —           55   
  

 

 

    

 

 

    

 

 

 
     136         —           136   

Other interests

        

Domestic

     36         —           36   

International

     (976      —           (976
  

 

 

    

 

 

    

 

 

 
     (940      —           (940

Total interest-bearing liabilities

        

Domestic

     87         (1,368      (1,281

International

     1,432         (874      558   
  

 

 

    

 

 

    

 

 

 
     1,519         (2,242      (723
  

 

 

    

 

 

    

 

 

 

 

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Volume and rate analysis    IFRS-IASB
2014/2013
 
     Increase (Decrease) due to changes in  
     Volume      Rate      Net change  
     (in millions of euros)  
Interest expense and similar charges         

Due to credit entities

        

Domestic

     (81      (29      (110

International

     136         209         345   
  

 

 

    

 

 

    

 

 

 
     55         180         235   

Customers’ deposits

        

Domestic

     (60      (1,364      (1,424

International

     16         19         35   
  

 

 

    

 

 

    

 

 

 
     (44      (1,345      (1,389

Marketable debt securities

        

Domestic

     (502      (249      (751

International

     593         123         716   
  

 

 

    

 

 

    

 

 

 
     91         (126      (35

Subordinated debt

        

Domestic

     (82      (7      (89

International

     (31      (56      (87
  

 

 

    

 

 

    

 

 

 
     (113      (63      (176

Other interest-bearing liabilities

        

Domestic

     (2      (6      (8

International

     (33      21         (12
  

 

 

    

 

 

    

 

 

 
     (35      15         (20

Total interest-bearing liabilities without hedging operations

        

Domestic

     (727      (1,655      (2,382

International

     681         316         997   
  

 

 

    

 

 

    

 

 

 
     (46      (1,339      (1,385

Expenses from hedging operations

        

Domestic

     750         —           750   

International

     132         —           132   
  

 

 

    

 

 

    

 

 

 
     882         —           882   

Other interests

        

Domestic

     (37      —           (37

International

     137         —           137   
  

 

 

    

 

 

    

 

 

 
     100         —           100   

Total interest-bearing liabilities

        

Domestic

     (14      (1,655      (1,669

International

     950         316         1,266   
  

 

 

    

 

 

    

 

 

 
     936         (1,339      (403
  

 

 

    

 

 

    

 

 

 

 

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Assets

Earning Assets—Yield Spread

The following table analyzes, by domicile of customer, our average earning assets, interest income and dividends on equity securities and interest income / (charges) and shows gross yields, net yields and yield spread for each of the years indicated. You should read this table and the footnotes thereto in light of our observations noted in the preceding sub-section entitled “—Average Balance Sheets and Interest Rates”, and the footnotes thereto.

 

Earning Assets—Yield Spread    IFRS-IASB  
     Year Ended December 31,  
     2015     2014     2013  
     (in millions of euros, except percentages)  

Average earning assets

      

Domestic

     242,324        233,665        268,520   

International

     889,020        787,033        747,631   
  

 

 

   

 

 

   

 

 

 
     1,131,344        1,020,698        1,016,151   

Interest and similar income

      

Domestic

     5,867        7,602        8,836   

International

     51,331        47,054        42,611   
  

 

 

   

 

 

   

 

 

 
     57,198        54,656        51,447   

Interest income / (charges) (1)

      

Domestic

     2,116        2,570        2,135   

International

     30,696        26,977        23,800   
  

 

 

   

 

 

   

 

 

 
     32,812        29,547        25,935   

Gross yield (2)

      

Domestic

     2.42     3.25     3.29

International

     5.77     5.98     5.70
  

 

 

   

 

 

   

 

 

 
     5.06     5.35     5.06

Net yield (3)

      

Domestic

     0.87     1.10     0.80

International

     3.45     3.43     3.18
  

 

 

   

 

 

   

 

 

 
     2.90     2.89     2.55

Yield spread (4)

      

Domestic

     1.09     1.38     1.02

International

     3.18     3.14     2.94
  

 

 

   

 

 

   

 

 

 
     2.79     2.78     2.45

 

(1) Interest income / (charges) is the net amount of interest and similar income and interest expense and similar charges. See “Income Statement” on page 9 of this annual report.
(2) Gross yield is the quotient of interest income divided by average earning assets.
(3) Net yield is the quotient of net interest income divided by average earning assets.
(4) Yield spread is the difference between gross yield on earning assets and the average cost of interest-bearing liabilities. For a discussion of the changes in yield spread over the periods presented, see “Item 5. Operating and Financial Review and Prospects—A. Operating results—Results of Operations for Santander—Interest Income / (Charges)” herein.

 

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Return on Equity and Assets

The following table presents our selected financial ratios for the years indicated.

 

     Year Ended December 31,  
     2015     2014     2013  

ROA: Return on average total assets

     0.55     0.58     0.44

ROE: Return on average stockholders’ equity

     6.61     7.75     5.84

PAY-OUT: Dividends per average share as a percentage of net attributable income per average share (*)

     38.02     19.65     20.22

Average stockholders’ equity as a percentage of average total assets

     6.70     6.24     5.89

 

  (*) The pay-out ratio does not include in the numerator the amounts paid under the Santander Dividendo Elección program (scrip dividends) which are not dividends paid on account of the net attributable income of the period. Such amounts equivalent to dividends are €607 million, €6,595 million, and €5,920 million, for 2015, 2014 and 2013, respectively. The pay-out ratio for 2015 is an estimate that includes the part of the final dividend expected to be paid in cash in May 2016.

Interest-Earning Assets

The following table shows, by domicile of customer, the percentage mix of our average interest-earning assets for the years indicated. You should read this table in light of our observations noted in the preceding sub-section entitled “—Average Balance Sheets and Interest Rates”, and the footnotes thereto.

Interest-earning assets

 

     IFRS-IASB  
     Year Ended December 31,  
     2015     2014     2013  

Cash and due from Central Banks

      

Domestic

     0.24     0.16     0.65

International

     6.37     7.40     7.62
  

 

 

   

 

 

   

 

 

 
     6.61     7.56     8.27

Due from credit entities

      

Domestic

     2.51     2.22     2.78

International

     5.32     5.79     5.61
  

 

 

   

 

 

   

 

 

 
     7.83     8.01     8.39

Loans and credits

      

Domestic

     14.13     16.12     17.54

International

     55.31     53.07     51.08
  

 

 

   

 

 

   

 

 

 
     69.44     69.19     68.62

Debt securities

      

Domestic

     4.55     4.39     5.46

International

     11.57     10.85     9.26
  

 

 

   

 

 

   

 

 

 
     16.12     15.24     14.72

Total interest-earning assets

      

Domestic

     21.43     22.89     26.43

International

     78.57     77.11     73.57
  

 

 

   

 

 

   

 

 

 
     100.00     100.00     100.00

 

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The following tables show our short-term funds deposited with other banks at each of the dates indicated.

 

     IFRS-IASB
Year Ended December 31,
 
     2015     2014     2013     2012     2011  
     (in millions of euros)  

Reciprocal accounts

     2,947        1,571        1,858        1,863        2,658   

Time deposits

     7,142        8,177        16,284        15,669        11,419   

Reverse repurchase agreements

     37,744        39,807        29,702        25,486        10,647   

Other accounts

     31,119        32,158        27,120        30,882        27,002   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     78,952        81,713        74,964        73,900        51,726   

Of which impairment allowances

     (19     (79     (37     (30     (36

Investment Securities

At December 31, 2015, the book value of our investment securities was €203.8 billion (representing 15% of our total assets). These investment securities had a yield of 3.81% in 2015 compared with a yield of 4.51% in 2014 and a yield of 4.23% in 2013. Approximately €45.8 billion, or 22.5%, of our investment securities at December 31, 2015 consisted of Spanish Government and government agency securities. For a discussion of how we value our investment securities, see note 2 to our consolidated financial statements.

The following tables show the book values of our investment securities by type and domicile of counterparty at each of the dates indicated.

 

     IFRS-IASB
Year Ended December 31,
 
     2015      2014      2013  
     (in millions of euros)  

Debt securities

        

Domestic-

        

Spanish Government

     44,583         37,324         31,160   

Other domestic issuer:

        

Public authorities

     1,204         1,858         1,720   

Other domestic issuer

     7,387         8,542         11,752   
  

 

 

    

 

 

    

 

 

 

Total domestic

     53,174         47,724         44,632   

International-

        

United States:

        

U.S. Treasury and other U.S. Government agencies

     9,040         4,289         2,620   

States and political subdivisions

     713         1,558         1,653   

Other securities

     11,919         8,793         5,945   
  

 

 

    

 

 

    

 

 

 

Total United States

     21,672         14,640         10,218   

Other:

        

Governments

     78,593         87,190         55,387   

Other securities

     26,982         26,954         22,416   
  

 

 

    

 

 

    

 

 

 

Total Other

     105,575         114,144         77,803   
  

 

 

    

 

 

    

 

 

 

Total International

     127,247         128,784         88,021   

Less- Allowance for credit losses

     (291 )      (144      (207

Total Debt Securities

     180,130         176,364         132,446   

Equity securities

        

Domestic

     3,470         4,197         3,449   

International-

        

United States

     1,340         1,106         951   

Other

     18,894         13,497         5,388   
  

 

 

    

 

 

    

 

 

 

Total international

     20,234         14,603         6,339   

Total Equity Securities

     23,704         18,800         9,788   

Total Investment Securities

     203,834         195,164         142,234   

 

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The following table sets out the aggregate book value and aggregate market value of the securities of single issuers, other than the Government of the United States, which exceeded 10% of our stockholders’ equity as of December 31, 2015 (and other debt securities with aggregate values near to 10% of our stockholders’ equity).

 

     Aggregate as of December 31, 2015  
     Book value      Market value  

Debt securities:

   (in millions of euros)  

Exceed 10% of stockholder’s equity:

     

Spanish Government

     45,787         45,755   

Brazilian Government

     25,588         25,549   

Mexican Government

     15,296         15,296   

Portuguese Government

     9,975         9,975   

US Government

     9,753         9,753   

Near 10% of stockholder’s equity:

     

UK Government

     6,456         6,456   

Polish Government

     5,470         5,470   

 

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The following table shows the maturities of our debt securities (before impairment allowances) as of December 31, 2015.

 

                          Year Ended December 31, 2015                
                   Maturing             Maturing                              
     Maturing
Within

1 Year
     Yield
Within
1 Year
     Between
1 and
5 Years
     Yield
1 and
5 Years
     Between
5 and

10 Years
     Yield
5 and
10 Years
     Maturing
After

10 Years
     Yield
After

10 Years
     Total  

DEBT SECURITIES

                        (in millions of euros)                

Domestic:

                          

Spanish Government

     10,989         0.43         8,142         1.61         17,947         2.26         7,505         4.61         44,583   

Other domestic issuer:

                          

Public authorities

     106         3.32         233         2.95         739         2.39         126         3.21         1,204   

Other domestic issuer

     2,764         1.72         3,109         3.43         640         3.73         874         2.31         7,387   
  

 

 

       

 

 

       

 

 

       

 

 

       

 

 

 

Total domestic

     13,859            11,484            19,326            8,505            53,174   

International:

                          

United States:

                          

U.S. Treasury and other U.S. Government agencies

     1,321         0.45         2,507         0.85         383         1.93         4,829         2.78         9,040   

States and political subdivisions

     —           —           —           4.00         178         4.68         535         4.27         713   

Other securities

     472         1.56         2,857         1.39         886         2.81         7,704         2.97         11,919   
  

 

 

       

 

 

       

 

 

       

 

 

       

 

 

 

Total United States

     1,793            5,364            1,447            13,068            21,672   

Other:

                          

Governments

     22,210         3.20         32,598         5.88         20,185         5.89         3,600         7.27         78,593   

Other securities

     8,634         4.29         9,922         4.37         5,815         4.05         2,611         2.82         26,982   
  

 

 

       

 

 

       

 

 

       

 

 

       

 

 

 

Total Other

     30,844            42,520            26,000            6,211            105,575   
  

 

 

       

 

 

       

 

 

       

 

 

       

 

 

 

Total International

     32,637            47,884            27,447            19,279            127,247   

Total debt investment securities

     46,496            59,368            46,773            27,784            180,421   

 

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Loan Portfolio

At December 31, 2015, our total loans and advances to customers equaled €817.4 billion (61.0% of our total assets). Net of allowances for credit losses, loans and advances to customers equaled €790.8 billion at December 31, 2015 (59.0% of our total assets). In addition to loans, we had outstanding as of December 31, 2015, 2014, 2013, 2012 and 2011 €195.6 billion, €183.0 billion, €154.3 billion, €187.7 billion and €181.6 billion, respectively, of undrawn balances available to third parties.

Loans by Geographic Area and Type of Customer

The following tables illustrate our loans and advances to customers (including securities purchased under agreement to resell), by domicile and type of customer at each of the dates indicated.

 

     IFRS-IASB  
   Year Ended December 31,  
     2015     2014     2013     2012     2011  
     (in millions of euros)  

Loans to borrowers in Spain: (**):

          

Spanish Government

     13,993        17,465        13,374        16,884        12,147   

Commercial, financial, agricultural and industrial

     32,426        46,355        47,583        61,527        65,935   

Real estate and construction (*)

     20,438        24,673        27,158        29,008        36,260   

Other mortgages

     69,234        60,583        62,180        63,886        69,297   

Installment loans to individuals

     14,654        11,644        8,668        12,775        12,964   

Lease financing

     3,472        3,267        3,372        3,857        5,043   

Other

     13,639        8,384        11,517        12,077        12,912   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     167,856        172,371        173,852        200,014        214,558   

Loans to borrowers outside Spain: (**):

          

Non-Spanish Governments

     7,772        7,053        4,402        4,983        4,394   

Mortgage loans

     322,816        296,236        275,739        290,825        296,330   

Commercial, industrial and installment loans to individuals

     276,895        253,843        209,820        217,358        225,961   

Other

     42,026        32,425        29,946        31,354        26,104   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     649,509        589,557        519,907        544,520        552,789   

Total loans and advances to customers, gross

     817,365        761,928        693,759        744,534        767,347   

Allowance for loan losses (***)

     (26,517     (27,217     (24,903     (25,422     (18,806

Total loans and advances to customers, net of allowances

     790,848        734,711        668,856        719,112        748,541   

 

(*) As of December 31, 2015, the portfolio of loans to real estate and construction companies included €7,388 million of loans, the proceeds of which were to be used for real estate purposes, defined in accordance with the Bank of Spain’s purpose-based classification guidelines, compared to €9,349 million, €12,105 million, €15,867 million and €23,442 million of such loans in 2014, 2013, 2012 and 2011, respectively.
(**) Credit of any nature granted to credit institutions is included in the “Loans and advances to credit institutions” caption of our balance sheet.
(***) Refers to loan losses of “Loans and Advances to customers”. See “Item 3. Key information - A. Selected financial data”.

 

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At December 31, 2015, our loans and advances to associated companies and jointly controlled entities amounted to €5,997 million (see “Item 7. Major Shareholders and Related Party Transactions—B. Related party transactions”). Excluding government-related loans and advances, the largest outstanding exposure to a single counterparty at December 31, 2015 was €2.2 billion (0.3% of total loans and advances, including government-related loans), and the five next largest exposures totaled €8.7 billion (1.1% of total loans, including government-related loans).

Maturity

The following table sets forth an analysis by maturity of our loans and advances to customers by domicile and type of customer as of December 31, 2015.

 

    Maturity  
    Less than     One to five     Over five               
    one year     years     years     Total  
    Balance     % of Total     Balance      % of Total     Balance      % of Total     Balance      % of Total  
    (in millions of euros, except percentages)  

Loans to borrowers in Spain: (*)

                  

Spanish Government

    1,859        0.93     3,593         1.76     8,541         2.06     13,993         1.71

Commercial, financial, agriculture and industrial

    10,429        5.24     12,864         6.29     9,133         2.21     32,426         3.97

Real estate and construction

    10,669        5.36     4,410         2.16     5,359         1.29     20,438         2.50

Other mortgages

    7,390        3.72     2,687         1.31     59,157         14.29     69,234         8.47

Installment loans to individuals

    6,146        3.09     5,276         2.58     3,232         0.78     14,654         1.79

Lease financing

    329        0.17     1,940         0.95     1,203         0.29     3,472         0.42

Other

    7,415        3.73     5,239         2.56     985         0.24     13,639         1.67
 

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total borrowers in Spain

    44,237        22.24     36,009         17.61     87,610         21.16     167,856         20.54

Loans to borrowers outside Spain: (*)

                  

Non-Spanish Governments

    3,128        1.57     1,946         0.95     2,698         0.65     7,772         0.95

Mortgage loans

    17,007        8.55     33,854         16.56     271,955         65.69     322,816         39.49

Commercial, industrial and installment loans to individuals

    103,689        52.12     126,606         61.92     46,600         11.26     276,895         33.88

Other

    30,887        15.53     6,036         2.95     5,103         1.23     42,026         5.14
 

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total loans to borrowers outside Spain

    154,711        77.76     168,442         82.39     326,356         78.84     649,509         79.46

Total loans and leases, gross

    198,948        100.00     204,451         100.00     413,966         100.00     817,365         100.00

 

(*) Credit of any nature granted to credit institutions is included in the “Loans and advances to credit institutions” caption of our balance sheet.

For roll-over not due to clients’ financial difficulties, the analysis is performed under standard acceptance terms and a comprehensive review of the client.

 

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Fixed and Variable Rate Loans

The following table sets forth a breakdown of our fixed and variable rate loans having a maturity of more than one year at December 31, 2015.

 

     Fixed and variable rate loans  
     having a maturity of more than one year  
     Domestic      International      Total  
     (in millions of euros)  

Fixed rate

     30,159         244,073         274,232   

Variable rate

     93,460         250,725         344,185   
  

 

 

    

 

 

    

 

 

 

Total

     123,619         494,798         618,417   

Cross-Border Outstandings

The following table sets forth, as of the end of the years indicated, the aggregate amount of our cross-border outstandings (which consist of loans, interest-bearing deposits with other banks, acceptances and other monetary assets denominated in a currency other than the home-country currency of the office where the item is booked) where outstandings in the borrower’s country exceeded 0.75% of our total assets. Cross-border outstandings do not include local currency loans made by subsidiary banks in other countries to the extent that such loans are funded in the local currency or hedged. As a result, they do not include the vast majority of the loans by Santander UK or our Latin American subsidiaries.

 

     IFRS-IASB  
     2015     2014     2013  
            % of            % of            % of  
            total            total            total  
            assets            assets            assets  
     (in millions of euros, except percentages)  

OECD (1) (2) Countries:

               

Total OECD Countries

     11,067         0.83     11,909         0.94     12,518         1.12

Non-OECD Countries:

               

Total Latin American Countries (2) (3)

     13,786         1.03     13,751         1.09     10,962         0.98

Other Non-OECD

     7,969         0.59     10,142         0.80     10,698         0.96
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Non-OECD

     21,755         1.62     23,893         1.89     21,660         1.94
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

     32,822         2.45     35,802         2.83     34,178         3.06

 

(1) The Organization for Economic Cooperation and Development.
(2) Aggregate outstandings in any single country in this category do not exceed 0.75% of our total assets.
(3) With regards to these cross-border outstandings, at December 31, 2015, 2014 and 2013, we had allowances for country-risk equal to €13,0 million, €12.4 million, and €14.7 respectively. Such allowances for country-risk exceeded the Bank of Spain’s minimum requirements at such dates.

As of December 31, 2015, 2014 and 2013, we did not have any cross-border outstanding to any single borrower that exceeded 0.75% of total assets.

Exposure to sovereign counterparties by credit rating

Our exposure to sovereign counterparties (the exposure is included in the financial statement line items “Financial assets held for trading—Debt instruments”, “Other financial assets at fair value through profit or loss—Debt instruments”, “Available for sale financial assets—Debt instruments”, “Loans and receivables—Debt instruments” and “Held-to-maturity investments”) organized by credit rating and our exposure to private and sovereign debt organized by origin of the issuer is included in note 7 to the Financial Statements.

Additionally, in note 10 to our consolidated financial statements we present the disclosure by credit rating of our exposure to sovereign counterparties recorded under the caption “loans and advances to customers”.

 

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The detail at December 31, 2015, 2014 and 2013, by type of financial instrument, of the Group’s sovereign risk exposure to Europe’s peripheral countries and of the short positions held with them, taking into consideration the criteria established by the European Banking Authority (EBA) is explained in note 51.d to our consolidated financial statements.

Classified Assets

In the following pages, we describe the Bank of Spain’s requirements for classification of non-performing assets. The Group has established a credit loss recognition process that is independent of the process for balance sheet classification and derecognition of non-performing loans from the balance sheet.

The description below sets forth the minimum requirements that are followed and applied by all of our subsidiaries. Nevertheless, if the regulatory authority of the country where a particular subsidiary is located imposes stricter or more conservative requirements for classification of the non-performing balances, the more strict or conservative requirements are followed for classification purposes.

The classification described below applies to all debt instruments not measured at fair value through profit or loss, and to contingent liabilities.

Bank of Spain’s Classification Requirements

a) Standard Assets

Standard assets include loans, fixed-income securities, guarantees and certain other extensions of credit that are not classified in any other category. Under this category, assets that require special attention must be identified, including restructured loans and standard assets with clients that have other outstanding risks classified as Non-Performing Past Due.

b) Sub-standard Assets

This category includes all types of credits and off-balance sheet risks that cannot be classified as non-performing or charged-off assets but that have certain weaknesses that may result in losses for the bank higher than those described in the previous category. Credits and off-balance sheet risks with insufficient documentation must also be classified under this category.

c) Assets classified as non-performing due to counterparty arrears

The Bank of Spain requires Spanish banks to classify as non-performing the entire outstanding principal amount and accrued interest on any loan, fixed-income security, guarantee and certain other extensions of credit on which any payment of principal or interest or agreed cost is 90 days or more past due (“non-performing past-due assets”).

In relation to the aggregate risk exposure (including off-balance sheet risks) to a single obligor, if the amount of non-performing balances exceeds 20% of the total outstanding risks (excluding non-accrued interest on loans to such borrower), then banks must classify all outstanding risks to such borrower as non-performing.

Once any portion of a loan is classified as non-performing, the entire loan is placed on a non-accrual status. Accordingly, even the portion of any such a loan which may still be identified as performing will be recorded on non-accrual status.

d) Assets classified as non-performing for reasons other than counterparty arrears

The Bank of Spain requires Spanish banks to classify any loan, fixed-income security, guarantee and certain other extensions of credit as non-performing if they have a reasonable doubt that these extensions of credit will be collected (“other non-performing assets”), even if any past due payments have been outstanding for less than 90 days or the asset is otherwise performing. When a bank classifies an asset as non-performing on this basis, it must classify the entire principal amount of the asset as non-performing.

Once any such asset is classified as non-performing, it is placed on a non-accrual status.

 

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e) Charged-off Assets

Credit losses are generally recognized through provisions for allowances for credit losses, well before they are removed from the balance sheet. Under certain unusual circumstances (such as bankruptcy, insolvency, etc.), the loss is directly recognized through write-offs.

The Bank of Spain requires Spanish banks to charge-off immediately those non-performing assets that management believes will never be repaid. Otherwise, the Bank of Spain requires Spanish banks to charge-off non-performing assets four years after they were classified as non-performing. Accordingly, even if allowances have been established equal to 100% of a non-performing asset, Spanish banks may maintain that non-performing asset, fully provisioned, on their balance sheet for the full four-year period if management believes based on objective factors that there is some possibility of recoverability of that asset.

Because the Bank of Spain does not permit partial write-offs of non-performing loans, when a loan is deemed partially uncollectible, the credit loss is charged against earnings through provisions to credit allowances instead of through partial write-offs of the loan. If a loan becomes entirely uncollectible, its allowance is increased until it reaches 100% of the loan balance. The credit loss recognition process is independent of the process for the derecognition of non-performing loans from the balance sheet. The entire loan balance is kept on the balance sheet until any portion of it has been classified as non-performing for 4 years. Loans can be charged-off earlier depending on our management’s view as to the recoverability of the loan. After that period, the loan balance and its 100% specific allowance are removed from the balance sheet and recorded in off-balance sheet accounts, with no resulting impact on net income at that time.

f) Country-Risk Outstandings

The Bank of Spain requires Spanish banks to classify as country-risk outstandings all loans, fixed-income securities and other outstandings to any countries, or residents of countries, that the Bank of Spain has identified as being subject to transfer risk or sovereign risk and the remaining risks derived from the international financial activity.

All outstandings must be assigned to the country of residence of the client except in the following cases:

 

  Outstandings guaranteed by residents in other countries in a better category or by the Spanish Government Export Credit Insurer (CESCE) or by residents in Spain, should be classified in the category of the guarantor.

 

  Fully secured loans, when the security covers sufficiently the outstanding risk and can be enforced in Spain or in any other “category 1” country, should be classified as category 1.

 

  Outstanding risks with foreign branches of a bank should be classified according to the residence of the headquarters of those branches.

The Bank of Spain has established six categories to classify such countries, as shown in the following table:

 

Country-Risk Categories

  

Description

1    European Union, Norway, Switzerland, Iceland, USA, Canada, Japan, Australia and New Zealand
2    Low risk countries not included in 1
3    Countries with transitory difficulties
4    Countries with serious difficulties
5    Doubtful countries
6    Bankrupt countries

The Bank of Spain allows each bank to decide how to classify the listed countries within this classification scheme, subject to the Bank of Spain’s oversight. The classification is made based on criteria such as the payment record (in particular, compliance with renegotiation agreements), the level of the outstanding debt and of the charges for debt services, the debt quotations in the international secondary markets and other indicators and factors of each country as well as all the criteria indicated by the Bank of Spain. All credit extensions and off-balance sheet risks included in country-risk categories 3 to 6, except the excluded cases described below, will be classified as follows:

 

  Sub-standard assets: All outstandings in categories 3 and 4 except when they should be classified as non-performing or charged-off assets due to credit risk attributable to the client.

 

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  Non-performing assets: All outstandings in category 5 and off-balance sheet risks classified in category 6, except when they should be classified as non-performing or charged-off assets due to credit risk attributable to the client.

 

  Charged-off assets: All other outstandings in category 6 except when they should be classified as charged-off assets due to credit risk attributable to the client.

Among others, the Bank of Spain excludes from country-risk outstandings:

 

  Regardless of the currency of denomination of the asset, risks with residents in a country registered in subsidiary companies in the country of residence of the holder.

 

  Any trade credits established by letter of credit or documentary credit with a due date of one year or less after the drawdown date.

 

  Any trade credits granted under specific export contracts with a due date of six months or less if the credits mature on the date of the export.

 

  Any interbank obligations of branches of foreign banks in the European Union and of the Spanish branches of foreign banks.

 

  Private sector risks in countries included in the monetary zone of a currency issued by a country classified in category 1; and

 

  Any negotiable financial assets purchased at market prices for placement with third parties within the framework of a portfolio separately managed for that purpose, held for less than six months by the company.

Non-Accrual of Interest Requirements

We stop accruing interest on the basis of contractual terms on the principal amount of any asset that is classified as an non-performing asset and on category 5 (doubtful) and category 6 (bankrupt) country-risk outstandings. Thereafter, we recognize the passage of time (financial effect) releasing provisions for loan losses by calculating the present value of the estimated future cash flows using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. On the other hand, any collected interest for any assets classified as non-performing are accounted for on a cash basis.

 

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The following table shows the amount of non-accrued interest owed on non-performing assets and the amount of such interest that was received:

 

     IFRS-IASB  
     At December 31,  
     2015      2014      2013  
     (in millions of euros)  

Non accrued interest on the basis of contractual terms owed on non-performing assets

        

Domestic

     472         658         606   

International

     1,351         1,342         1,294   
  

 

 

    

 

 

    

 

 

 

Total

     1,823         2,000         1,900   

Non accrued interest on the basis of contractual terms received on non-performing assets

        

Domestic

     188         202         190   

International

     255         256         265   
  

 

 

    

 

 

    

 

 

 

Total

     443