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| SBP > SEC Filings for SBP > Form 10-K on 13-Mar-2009 | All Recent SEC Filings |
13-Mar-2009
Annual Report
• Mortgage Banking - Banco Santander Puerto Rico (Santander Mortgage Corporation during 2007 and prior, which was merged into the Bank at January 1, 2008)
• Securities Brokerage and Investment Banking - Santander Securities Corporation
• Asset Management - Santander Asset Management Corporation
• Consumer Finance - Santander Financial Services, Inc.
• Insurance - Santander Insurance Agency, Inc. and Island Insurance Corporation
• International Banking - Santander International Bank of Puerto Rico, Inc.
Basis of Presentation
The Corporation's financial statements are prepared in conformity with
accounting principles generally accepted in the United States of America and
with general practices within the financial services industry, which are
described in the notes to the consolidated financial statements. In preparing
the consolidated financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Accounting
policies that are critical to the overall financial statements are fully
described in the "Critical Accounting Policies" section below.
Forward-Looking Statements
This discussion of financial results contains forward-looking statements about
the Corporation. Forward-looking statements can be identified by the fact that
they do not relate strictly to historical or current facts. They often include
words or phrases like "would be", "will allow", "intends to", "will likely
result", "are expected to", "will continue", "is anticipated", "estimate",
"project", "believe", or similar expressions and are intended to identify
"forward looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995.
The future results of the Corporation could be affected by subsequent events and
could differ materially from those expressed in forward-looking statements. If
future events and actual performance differ from the Corporation's assumptions,
the actual results could vary significantly from the performance projected in
the forward-looking statements. The Corporation wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors, including regional
and national conditions, substantial changes in levels of market interest rates,
credit and other risks of lending and investment activities, competitive and
regulatory factors and legislative changes, could affect the Corporation's
financial performance and could cause the Corporation's actual results for
future periods to differ materially from those anticipated or projected. The
Corporation does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
Overview of Management's Discussion and Analysis of Financial Condition and
Results of Operations
This overview of management's discussion and analysis highlights selected
information in this document and may not contain all of the information that is
important to the reader. For a more complete understanding of trends, events,
commitments, uncertainties, liquidity, capital resources and critical accounting
estimates, you should carefully read this entire document. All accompanying
tables, financial statements and notes included elsewhere in this report should
be considered an integral part of this analysis.
The Corporation, similarly to other financial institutions, is subject to
certain risks, many of which are beyond management's control, though efforts and
initiatives are undertaken to manage those risks in conjunction with return
optimization. Among the risks being managed are: (1) market risk, which is the
risk that changes in market rates and prices will adversely affect the
Corporation's financial condition or results of operations, (2) liquidity risk,
which is the risk that the Corporation will have insufficient cash or access to
cash to meet operating needs and financial obligations, (3) credit risk, which
is the risk that loan customers or other counterparties will be unable to
perform their contractual obligations, and (4) operational risk, which is the
risk of loss resulting from inadequate or failed internal processes, people and
systems, or from external events. In addition, the Corporation is subject to
legal, compliance and reputational risks, among others.
The Corporation had counterparty exposure to Lehman Brothers, Inc. ("LBI") in
connection with the sale of securities sold under agreements to repurchase
amounting to $200.2 million at September 19, 2008 under a Master Repurchase
Agreement. LBI was placed in a Securities Investor Protection Corporation
("SIPC") liquidation proceeding on September 19, 2008. The filing of the SIPC
liquidation proceeding was an event of default under the terms of the Master
Repurchase Agreement, which resulted in the acceleration of repurchase dates
under the Master Repurchase Agreement to September 19, 2008. This action
resulted in a reduction in the Corporation's total assets of $225.3 million and
a reduction in its total liabilities of $200.2 million. As soon as claims
procedures have been established in the LBI liquidation proceeding, the
Corporation intends to file a claim for the amount of $25.1 million, which is
the amount it is owed by LBI, as a result of the acceleration of the repurchase
date and the exercise by the Corporation of its rights under the Master
Repurchase Agreement, plus incidental expenses and damages. The Corporation has
recognized a claim receivable from LBI for $25.1 million and has established a
valuation allowance for the same amount since management, in consultation with
legal counsel, believes that based on current information and events, it is
probable that the Corporation will be unable to collect the full amount. The tax
effect related to the recognition of this valuation allowance was a deferred
benefit of $9.8 million.
The Corporation had a $100 million floating-for-fixed interest rate swap
designated as a cash flow hedge with LBI affiliate Lehman Brothers Special
Financing Inc. ("LBSF"). The derivative liability of this swap was $371,736 as
of September 19, 2008 and was paid on December 5, 2008. As a result of the
bankruptcy filing of Lehman Brothers Holding, Inc. ("LBHI") and default on its
contractual payments as of September 19, 2008, the Corporation terminated the
swap and the cash flow hedge designation on this swap. The net loss of $371,000
was reclassified into earnings in the last quarter of 2008. In addition, the
Corporation terminated $23.8 million of fixed for floating interest rate swaps.
The derivative liability of the swap with LBSF was $681,535 as of September 19,
2008 and was paid on December 5, 2008. The Corporation also terminated
$13.8 million of interest rate swaps with LBSF. The derivative liability of this
swap was $166,333 as of September 19, 2008 and was paid on December 5, 2008.
As a provider of financial services, the Corporation's earnings are
significantly affected by general economic and business conditions. Credit,
funding, including deposit origination and fee income generation activities are
influenced by the level of business spending and investment, consumer income,
spending and savings, capital market activities, competition, customer
preferences, interest rate conditions and prevailing market rates on competing
products. The Corporation constantly monitors general business and economic
conditions, industry-related trends and indicators, competition from traditional
and non-traditional financial services providers, interest rate volatility,
indicators of credit quality, demand for loans and deposits, operational
efficiencies, including systems, revenue and profitability improvement and
regulatory changes in the financial services industry, among others. The
Corporation operates in a highly regulated environment and may be adversely
affected by changes in federal and local laws and regulations. Also, competition
with other financial services providers could adversely affect the Corporation's
profitability.
The Corporation reported a net income of $10.5 million for the year ended
December 31, 2008, or $0.23 per common share, a significant increase of
$46.8 million or 129.1% over the net loss of $36.2 million or $0.78 per share
reported for the year ended December 31, 2007. The increase in net income was
principally due to increases in net interest income of $44.6 million, a decrease
in operating expenses of $19.4 million and a decrease in provision for income
tax of $10.7 million, partially offset by an increase of $27.7 million in the
provision for loan losses.
Return on average assets (ROA) reflected an improvement of 51 basis points to
0.12% for the year ended December 31, 2008 compared (0.39)% reported for the
year ended December 31, 2007. Return on average common equity (ROE) was 1.87%
and (6.32)%, respectively, for the years ended December 31, 2008 and 2007,
reflecting an improvement 819 basis points. The efficiency ratio (on a
tax-equivalent basis) also reflected an improvement of 593 basis points to reach
60.39% for the year ended December 31, 2008 from 66.32% for 2007.
The Corporation's financial results for the year ended December 31, 2008 were
impacted by the following:
• The Corporation recognized a provision for claim receivable of $25.1 million
which represents the excess of the value of the securities held by LBI above
the amounts owed by the Corporation under the securities sold under
agreements to repurchase. The related tax benefit of this valuation
allowance amounts to $9.8 million.
• The Corporation experienced an improvement of 76 basis points in net interest margin, on a tax equivalent basis, to 4.50% for the year ended December 31, 2008 versus 3.74% for 2007;
• The provision for loan losses increased $27.7 million or 18.7% for the year ended December 31, 2008 compared to 2007. The increase in the provision for loan losses reflects the current recessionary cycle in Puerto Rico affecting the loan portfolio, including commercial and construction loans. The provision for loan losses represented 116.56% of the net charge-offs for the year ended December 31, 2008;
• The allowance for loan losses of $191.9 million as of December 31, 2008 represented 3.12% of total loans, 90.21% of non-performing loans and 225.06% of non-performing loans excluding loans secured by real estate. As of December 31, 2007, the allowance for loan losses was $167.0 million, represented 2.36% of total loans, 56.70% of non-performing loans and 82.32% of non-performing loans excluding loans secured by real estate;
• Non-interest income remained basically flat when comparing the years ended December 31, 2008 and 2007. Non-interest income was impacted during 2008 principally by: (i) an increase in broker-dealer, asset management and insurance fees of $6.5 million; (ii) a gain of $8.6 million on the sale of a portion of the Corporation's investment in Visa, Inc. in connection with its initial public offering during the first quarter of 2008; (iii) an increase in gain on derivatives of $3.0 million; (iv) an increase in gain on sale of securities of $3.9 million; (v) an unfavorable valuation adjustment of $7.4 million on loans held for sale; (vi) a decrease in other gain of $12.8 million due mainly due to a $12.3 million in gain of sale of merchant business to an unrelated party during 2007; (vii) a $3.4 million decrease in gain on sale of loans; (viii) a $1.2 million increase in technical assistance collected from affiliates;
• Operating expenses reflected a decrease of $19.4 million or 5.6% when compared to 2007. This decrease was affected principally by: (i) $43.3 million related to goodwill and other intangible assets impairment charges recognized during 2007; (ii) $16.0 million decrease in stock incentive compensation expense sponsored by Santander Group; (iii) a provision for claim receivable of $25.1 million recognized during 2008; (iv) $7.8 million increase in professional fees; (v) $6.9 million increase in salaries and other personnel expenses; (vi) $3.9 million increase in occupancy cost (vii) $3.8 million increase in FDIC assessment; (viii) offset by a decrease of $9.0 million in business promotion and a decrease of $1.8 million in repossessed asset provision and expenses.
• During the year ended December 31, 2008, the Corporation sold loans, including some classified as impaired, to an affiliate for $300.1 million in cash. These loans had a net book value of $300.1 million comprised of an outstanding principal balance of $334.6 million and a specific valuation allowance of $34.5 million. The type of loans by net book value was $212.3 million in construction loans and $87.8 million in commercial loans. No gain or loss was recognized on these transactions.
• The common stock dividend for the year ended December 31, 2008 was $0.20 per share resulting in a current annualized dividend yield of 1.60%. On August 2008, the Board of Directors of the Corporation determined to discontinue the payment of the quarterly cash dividend on the Corporation's common stock to strengthen the institution's core capital position. The Corporation may use a portion of the funds previously used to pay as dividends to reduce its outstanding debt.
The Corporation's principal source of revenues is net interest income, which is
the difference between the interest earned on loans and investments and the
interest paid on customer deposits and other interest-bearing liabilities. Net
interest income represents approximately 70.7% and 67.8% of the Corporation's
total net revenues (defined as net interest income plus other income) for 2008
and 2007, respectively. Net interest income is affected by the relative amounts
of interest-earning assets and interest-bearing liabilities, and the interest
rates earned or paid on these balances.
Lending activities are one of the most important aspects of the Corporation's
operations. The economic environment and uncertainties in Puerto Rico caused
reduced lending activity and impacted the quality of the Corporation's loan
portfolio increasing the delinquency rates and charge offs. The net loan
portfolio, including loans held for sale, decreased $0.9 billion, or 13.7%
reaching $6.0 billion at December 31, 2008, compared to the figures reported at
December 31, 2007. As of December 31, 2008, the allowance for loan losses
reached $191.9 million, reflecting an increase of $24.9 million or 14.9%, which
includes $122.8 million related to the Bank portfolio and $69.1 million related
to the Island Finance portfolio. The ratio of allowance for loan losses to total
loans increased to 3.12% at December 31, 2008 from 2.36% at December 31, 2007.
Although the Corporation has diversified its sources of revenue, interest income
from the loan portfolio continues to account for the majority of total revenues,
representing 73.2% and 72.9% of total gross revenues for 2008 and 2007,
respectively. As a result, the primary influence on the Corporation's operating
results is the demand for loans in Puerto Rico, which is significantly affected
by economic conditions, competition, the demand and supply of housing, the
fiscal policies of the federal and Puerto Rico governments and interest rate
levels. Changes in interest rates, the Corporation's principal market risk, can
significantly impact its results of operations by affecting net interest income
and the gains or losses realized on the sale of loans and securities. As
described under "Risk Management", the Corporation uses derivative instruments
to hedge, to a limited extent, its interest rate risk in order to protect its
net interest income under different interest rate scenarios.
Broker-dealer, asset management and insurance fees accounted for 50.6% and 46.1%
of the Corporation's other income and 10.0% and 8.3% of its total revenues for
2008 and 2007, respectively. The Corporation also earns revenues from other
sources that are not as dependent on interest levels, such as bank service fees
on deposit accounts and credit card fees. Other income, including broker-dealer,
asset management and insurance fees, accounted for 19.8% and 18.0% of total
revenues for 2008 and 2007, respectively.
Deposits at December 31, 2008 were $5.0 billion, reflecting a decrease of
$145.8 million or 2.8% compared to deposits of $5.2 billion as of December 31,
2007.
Total borrowings at December 31, 2008 (comprised of federal funds purchased and
other borrowings, securities sold under agreements to repurchase, commercial
paper issued, term and capital notes) reflected a decrease of $1.2 billion or
38.3% to $1.9 billion at December 31, 2008 compared with $3.1 billion at
December 31, 2007.
As of December 31, 2008, the Corporation had $13.4 billion in customer financial
assets under management, reflecting an increase of 1.1% compared with the prior
year. This is a significant part of the financial assets of Puerto Rico
households and reflects the Corporation's strong positioning in its primary
market. Customer financial assets under management include bank deposits
(excluding brokered deposits), broker-dealer customer accounts, mutual fund
assets managed, and trust, institutional and private accounts under management.
SBP common stock price per share was $12.49 as of December 31, 2008 resulting in
a market capitalization of $0.6 billion (including affiliated holdings).
During 2008, Santander BanCorp declared and paid a cash dividend of 20 cents per
common share to its shareholders of record, resulting in a current annual
dividend yield of 1.6%.
Critical Accounting Policies
The consolidated financial statements of Santander BanCorp are prepared in
accordance with accounting principles generally accepted in the United States of
America and with general practices within the financial services industry. In
preparing the consolidated financial statements, management is required to make
judgments, involving significant estimates and assumptions, in the application
of its accounting policies about matters that are inherently uncertain.
Management arrives at these estimates and assumptions, which may materially
affect the reported amounts of certain assets, liabilities, revenues and
expenses, considering the facts and circumstances at a specific point in time.
Changes in those facts and circumstances could produce actual results that
differ from those estimates. Detailed below is a discussion of the Corporation's
critical accounting
policies. These policies are critical because they are highly dependent upon
subjective or complex judgments, assumptions and estimates. For a complete
discussion of the Corporation's significant and critical accounting policies
refer to the notes to the consolidated financial statements and the discussion
throughout this document which should be read in conjunction with this section.
Current Accounting Developments
Effective January 1, 2008, the Corporation adopted Financial Accounting
Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) 157,
Fair Value Measurements, for all financial instruments accounted for at fair
value on a recurring basis. In February 2008, the FASB issued a final staff
position (FSP FAS 157-2) that partially delayed the effective date of SFAS 157
for one year for certain nonfinancial assets and nonfinancial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis. As such, the Corporation did not adopt SFAS 157
for those nonfinancial assets and liabilities eligible for deferral under FSP
FAS 157-2 and is evaluating the impact that this adoption may have on its
consolidated financial statements and disclosures. Adoption of SFAS 157 did not
have a material effect on the Corporation's financial position and results of
operations. Illiquidity in the credit markets contributed to the amount of our
reported Level 3 instruments, primarily in our trading and loan portfolios. At
December 31, 2008, the aggregate amount of instruments requiring fair value
measurement on a recurring basis included in Level 3 represented approximately
2.8% and 0.16% of the aggregate amount of consolidated assets and liabilities
recorded at fair value, respectively. The amount we report in Level 3 in future
periods will be affected by market conditions. See Notes 1 and 24 to the
accompanying consolidated financial statements for further information related
to the adoption of SFAS 157.
In conjunction with the adoption of SFAS 157, effective January 1, 2008, the
Corporation adopted Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standards (SFAS) 159, The Fair Value Option for Financial
Assets and Financial Liabilities. SFAS 159 provides an option for most financial
assets and liabilities to be reported at fair value on an
instrument-by-instrument basis with changes in fair value reported in earnings.
The election is made at the initial adoption, at the acquisition of a financial
asset, financial liability or a firm commitment and it may not be revoked. Under
the SFAS 159 transition provisions, the Corporation has elected to report
certain callable brokered certificates of deposits and subordinated notes at
fair value with future changes in value reported in earnings. SFAS 159 provides
an opportunity to mitigate volatility in reported earnings as well as reducing
the burden associated with complex hedge accounting requirements. As a result of
this adoption and the election under the fair value option, the Corporation
reported an after-tax increase in opening retained earnings of $3.2 million. See
Notes 1 and 24 to the accompanying consolidated financial statements for further
information related to the adoption of SFAS 159.
Fair Value Measurement. The Corporation's estimates of fair value for financial
instruments are based on the framework established in SFAS 157. The fair value
of a financial instrument is the estimated amount at which the instrument could
be exchanged in an orderly transaction between knowledgeable, unrelated willing
parties, i.e., not in a forced transaction. The disclosure of fair value
estimates in the SFAS 157 hierarchy is based on whether the significant inputs
into the valuation are observable. In determining such estimates and the level
of the hierarchy in which the estimate is disclosed, the highest priority is
given to unadjusted quoted prices in active markets, the lowest priority to
unobservable inputs that reflect the Corporation's market assumptions. SFAS 157
requires the use of observable inputs when available. Additionally, the level at
which a financial instrument is reported is based on the lowest level of any
significant input into the estimation of fair value. The three levels of the
hierarchy are as follows:
• Level 1 - Unadjusted quoted market prices for identical assets or
liabilities in active markets that the Corporation has the ability to
access.
• Level 2 - Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
• Level 3 - Valuations based on models where significant inputs are not observable. The unobservable inputs reflect the Corporation's own assumptions about the assumptions that market participants would use.
The Corporation uses quoted market prices, when available, to determine estimates of fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. When quoted market prices are unavailable, the Corporation obtains fair value estimates from a nationally recognized pricing service that determines fair value estimates based on objectively verifiable
information: relevant market information, relevant credit information, perceived
market movements and sector news. The market inputs utilized in the pricing
evaluation, listed in the approximate order of priority, include: benchmark
yields, reported trades, broker/dealer quotes, issuer spreads, two-sided
markets, benchmark securities, bids, offers, reference data, and industry and
economic events. Depending on the security, the priority of the use of inputs
may change or some market inputs may not be relevant. For some securities
additional inputs may be necessary. The Corporation reviews the estimates of
fair value provided by the pricing service and compares the estimates to the
Corporation's knowledge of the market to determine if the estimates obtained are
representative of the prices in the market. The Corporation will challenge any
prices deemed not to be representative of fair value. The fair value estimates
provided from this pricing service are included in the amount disclosed in Level
2 of the hierarchy.
If quoted market prices and an estimate from a pricing service are unavailable,
the Corporation produces an estimate of fair value based on internally developed
valuation techniques, which, depending on the level of observable market inputs,
will render the fair value estimate as Level 2 or Level 3. See Note 24 to the
accompanying consolidated financial statements for further information related
to valuation methods used by the Corporation for each type of financial
instruments that are carried at fair value.
The Corporation employs control processes to validate the fair value of its
financial instruments. These control processes are designed to assure that the
values used for financial reporting are based on observable inputs wherever
possible. In the event that observable inputs are not available, the control
processes are designed to assure that the valuation approach utilized is
appropriate and consistently applied, and the assumptions are reasonable. These
control processes include validation and corroboration procedures over the
quotes and prices obtained from brokers and counterparties, as well as reviews
of the pricing models' appropriateness by the personnel with relevant expertise,
which are independent from the trading desks on a quarterly basis. In addition,
the Corporation is considering recently executed comparable transaction and
other observable market data for purposes of validating assumptions used in the
models.
The Corporation understands that any increases and/or decreases in the aggregate
fair value of its assets and liabilities will not materially affect its
liquidity and capital resources.
Allowance for Loan Losses. The Corporation assesses the overall risks in its
loan portfolio and establishes and maintains a reserve for probable losses
thereon. The allowance for loan losses is maintained at a level sufficient to
provide for estimated loan losses based on the evaluation of known and inherent
risks in the Corporation's loan portfolio. The Corporation's management
evaluates the adequacy of the allowance for loan losses on a monthly basis.
. . .
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