UNITED STATES OF AMERICA SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period ended September 30, 2005
Commission File: 001-15849
SANTANDER BANCORP
(Exact name of Corporation as specified in its charter)
| | |
Commonwealth of Puerto Rico | | 66-0573723 |
| | |
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(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
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207 Ponce de Leon Avenue, Hato Rey, Puerto Rico | | 00917 |
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(Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code:
(787) 777-4100
Indicate by check mark whether the Corporation (1) has filed all reports required to be filed by Section 13 of the Securities Exchange act of 1934 during the preceding 12 months (or for such shorter period that the Corporation was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days.
Yesþ Noo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yesþ Noo
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).
Yeso Noo
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the last practicable date.
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
| | |
Title of each class | | Outstanding as of September 30, 2005 |
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Common Stock, $2.50 par value | | 46,639,104 |
SANTANDER BANCORP
CONTENTS
Forward-Looking Statements. When used in this Form 10-Q or future filings by Santander BanCorp (the “Corporation”) with the Securities and Exchange Commission, in the Corporation’s press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the word or phrases “would be”, “will allow”, “intends to”, “will likely result”, “are expected to”, “will continue”, “is anticipated”, “estimate”, “project”, “believe”, or similar expressions 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.
PART I — ITEM 1
FINANCIAL STATEMENTS
SANTANDER BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
AS OF SEPTEMBER 30, 2005 AND DECEMBER 31, 2004
(Dollars in thousands, except share data)
| | | | | | | | |
| | September 30, | | | December 31, | |
| | 2005 | | | 2004 | |
ASSETS | | | | | | | | |
CASH AND CASH EQUIVALENTS: | | | | | | | | |
Cash and due from banks | | $ | 130,584 | | | $ | 110,148 | |
Interest-bearing deposits | | | 9,839 | | | | 42,612 | |
Federal funds sold and securities purchased under agreements to resell | | | 248,585 | | | | 326,650 | |
| | | | | | |
Total cash and cash equivalents | | | 389,008 | | | | 479,410 | |
| | | | | | |
INTEREST BEARING DEPOSITS | | | 101,044 | | | | 50,000 | |
TRADING SECURITIES | | | 51,088 | | | | 34,184 | |
INVESTMENT SECURITIES AVAILABLE FOR SALE, at fair value: | | | | | | | | |
Securities pledged that can be repledged | | | 1,061,243 | | | | 1,454,858 | |
Other investment securities available for sale | | | 617,289 | | | | 523,274 | |
| | | | | | |
Total investment securities available for sale | | | 1,678,532 | | | | 1,978,132 | |
| | | | | | |
OTHER INVESTMENT SECURITIES, at amortized cost | | | 37,500 | | | | 37,500 | |
LOANS HELD FOR SALE, net | | | 220,591 | | | | 271,596 | |
LOANS, net | | | 5,922,929 | | | | 5,242,759 | |
PREMISES AND EQUIPMENT, net | | | 55,257 | | | | 52,854 | |
ACCRUED INTEREST RECEIVABLE | | | 64,116 | | | | 44,682 | |
GOODWILL | | | 34,791 | | | | 34,791 | |
INTANGIBLE ASSETS | | | 9,895 | | | | 8,003 | |
OTHER ASSETS | | | 134,346 | | | | 107,869 | |
| | | | | | |
| | $ | 8,699,097 | | | $ | 8,341,780 | |
| | | | | | |
| | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | |
DEPOSITS: | | | | | | | | |
Non-interest bearing | | $ | 651,853 | | | $ | 744,019 | |
Interest-bearing | | | 5,216,845 | | | | 4,004,120 | |
| | | | | | |
Total deposits | | | 5,868,698 | | | | 4,748,139 | |
| | | | | | |
FEDERAL FUNDS PURCHASED AND OTHER BORROWINGS | | | 650,000 | | | | 780,334 | |
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE | | | 1,018,187 | | | | 1,349,444 | |
COMMERCIAL PAPER ISSUED | | | 229,852 | | | | 629,544 | |
TERM NOTES | | | 39,902 | | | | 31,457 | |
SUBORDINATED CAPITAL NOTES | | | 72,985 | | | | 72,588 | |
ACCRUED INTEREST PAYABLE | | | 49,527 | | | | 22,666 | |
OTHER LIABILITIES | | | 202,820 | | | | 151,605 | |
| | | | | | |
Total liabilities | | | 8,131,971 | | | | 7,785,777 | |
| | | | | | |
STOCKHOLDERS’ EQUITY: | | | | | | | | |
Series A preferred stock, $25 par value; 10,000,000 shares authorized, none outstanding | | | — | | | | — | |
Common stock, $2.50 par value; 200,000,000 shares authorized; 50,650,364 shares issued; 46,639,104 shares outstanding in September 2005 and December 2004. | | | 126,626 | | | | 126,626 | |
Capital paid in excess of par value | | | 304,171 | | | | 304,171 | |
Treasury stock at cost, 4,011,260 shares in September 2005 and December 2004. | | | (67,552 | ) | | | (67,552 | ) |
Accumulated other comprehensive loss, net of taxes | | | (35,134 | ) | | | (6,818 | ) |
Retained earnings- | | | | | | | | |
Reserve fund | | | 127,086 | | | | 127,086 | |
Undivided profits | | | 111,929 | | | | 72,490 | |
| | | | | | |
Total stockholders’ equity | | | 567,126 | | | | 556,003 | |
| | | | | | |
| | $ | 8,699,097 | | | $ | 8,341,780 | |
| | | | | | |
The accompanying notes are an integral part of these financial statements
1
SANTANDER BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
FOR THE NINE MONTH PERIODS AND THE QUARTERS ENDED SEPTEMBER 30, 2005 AND 2004
(Dollars in thousands, except per share data)
| | | | | | | | | | | | | | | | |
| | For the nine month periods ended | | | For the quarters ended | |
| | September 30, | | | September 30, | | | September 30, | | | September 30, | |
| | 2005 | | | 2004 | | | 2005 | | | 2004 | |
INTEREST INCOME: | | | | | | | | | | | | | | | | |
Loans | | $ | 255,205 | | | $ | 184,995 | | | $ | 93,628 | | | $ | 66,242 | |
Investment securities | | | 54,723 | | | | 76,817 | | | | 16,309 | | | | 25,070 | |
Interest bearing deposits | | | 2,741 | | | | 573 | | | | 1,194 | | | | 338 | |
Federal funds sold and securities purchased under agreements to resell | | | 3,490 | | | | 2,018 | | | | 822 | | | | 799 | |
| | | | | | | | | | | | |
Total interest income | | | 316,159 | | | | 264,403 | | | | 111,953 | | | | 92,449 | |
| | | | | | | | | | | | |
INTEREST EXPENSE: | | | | | | | | | | | | | | | | |
Deposits | | | 88,386 | | | | 42,115 | | | | 35,172 | | | | 15,404 | |
Securities sold under agreements to repurchase and other borrowings | | | 61,481 | | | | 58,688 | | | | 20,926 | | | | 21,081 | |
Subordinated capital notes | | | 2,094 | | | | 54 | | | | 795 | | | | 25 | |
| | | | | | | | | | | | |
Total interest expense | | | 151,961 | | | | 100,857 | | | | 56,893 | | | | 36,510 | |
| | | | | | | | | | | | |
Net interest income | | | 164,198 | | | | 163,546 | | | | 55,060 | | | | 55,939 | |
PROVISION FOR LOAN LOSSES | | | 15,400 | | | | 21,770 | | | | 4,650 | | | | 7,020 | |
| | | | | | | | | | | | |
Net interest income after provision for loan losses | | | 148,798 | | | | 141,776 | | | | 50,410 | | | | 48,919 | |
| | | | | | | | | | | | |
OTHER INCOME (LOSS): | | | | | | | | | | | | | | | | |
Bank service charges, fees and other | | | 31,266 | | | | 28,949 | | | | 10,640 | | | | 9,725 | |
Broker-dealer, asset management and insurance fees | | | 40,558 | | | | 38,176 | | | | 14,219 | | | | 12,911 | |
Gain on sale of securities, net | | | 17,838 | | | | 11,465 | | | | 462 | | | | 2,462 | |
Gain (Loss) on extinguishment of debt | | | (5,959 | ) | | | — | | | | 784 | | | | — | |
Gain on sale of mortgage servicing rights | | | 69 | | | | 284 | | | | 14 | | | | 88 | |
Gain (loss) on sale of loans | | | 7,874 | | | | (84 | ) | | | 666 | | | | (240 | ) |
Gain on sale of building | | | — | | | | 2,754 | | | | — | | | | — | |
Other | | | 8,594 | | | | 6,463 | | | | 1,883 | | | | 3,452 | |
| | | | | | | | | | | | |
Total other income | | | 100,240 | | | | 88,007 | | | | 28,668 | | | | 28,398 | |
| | | | | | | | | | | | |
OPERATING EXPENSES: | | | | | | | | | | | | | | | | |
Salaries and employee benefits | | | 72,288 | | | | 69,037 | | | | 23,998 | | | | 22,808 | |
Occupancy costs | | | 12,581 | | | | 10,109 | | | | 4,193 | | | | 3,439 | |
Equipment expenses | | | 2,703 | | | | 2,848 | | | | 903 | | | | 963 | |
EDP servicing, amortization and technical expenses | | | 23,727 | | | | 25,688 | | | | 8,338 | | | | 7,873 | |
Communication expenses | | | 6,200 | | | | 6,792 | | | | 2,004 | | | | 2,202 | |
Business promotion | | | 8,239 | | | | 7,140 | | | | 3,198 | | | | 2,828 | |
Other taxes | | | 6,293 | | | | 6,574 | | | | 2,105 | | | | 2,049 | |
Other | | | 33,992 | | | | 34,390 | | | | 11,187 | | | | 11,689 | |
| | | | | | | | | | | | |
Total operating expenses | | | 166,023 | | | | 162,578 | | | | 55,926 | | | | 53,851 | |
| | | | | | | | | | | | |
Income before provision for income tax | | | 83,015 | | | | 67,205 | | | | 23,152 | | | | 23,466 | |
PROVISION FOR INCOME TAX | | | 21,186 | | | | 4,075 | | | | 6,087 | | | | 1,597 | |
| | | | | | | | | | | | |
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS | | $ | 61,829 | | | $ | 63,130 | | | $ | 17,065 | | | $ | 21,869 | |
| | | | | | | | | | | | |
BASIC AND DILUTED EARNINGS PER COMMON SHARE | | $ | 1.33 | | | $ | 1.35 | | | $ | 0.37 | | | $ | 0.47 | |
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The accompanying notes are an integral part of these financial statements
2
SANTANDER BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2005 AND THE YEAR ENDED DECEMBER 31, 2004
(Dollars in thousands)
| | | | | | | | |
| | Nine month period ended | | | Year ended | |
| | September 30, 2005 | | | December 31, 2004 | |
Common Stock: | | | | | | | | |
Balance at beginning of period | | $ | 126,626 | | | $ | 116,026 | |
Stock dividend distributed | | | — | | | | 10,600 | |
| | | | | | |
Balance at end of period | | | 126,626 | | | | 126,626 | |
| | | | | | |
Capital Paid in Excess of Par Value: | | | | | | | | |
Balance at beginning of period | | | 304,171 | | | | 211,742 | |
Stock dividend distributed | | | — | | | | 92,429 | |
| | | | | | |
Balance at end of period | | | 304,171 | | | | 304,171 | |
| | | | | | |
Treasury Stock at cost: | | | | | | | | |
Balance at beginning of period | | | (67,552 | ) | | | (67,552 | ) |
| | | | | | |
Balance at end of period | | | (67,552 | ) | | | (67,552 | ) |
| | | | | | |
Accumulated Other Comprehensive Loss, net of taxes: | | | | | | | | |
Balance at beginning of period | | | (6,818 | ) | | | (19,465 | ) |
Unrealized net (loss) gain on investment securities available for sale, net of tax | | | (30,081 | ) | | | 9,094 | |
Unrealized net gain on cash flow hedges, net of tax | | | 1,765 | | | | 3,463 | |
Minimum pension liability, net of tax | | | — | | | | 90 | |
| | | | | | |
Balance at end of period | | | (35,134 | ) | | | (6,818 | ) |
| | | | | | |
Reserve Fund: | | | | | | | | |
Balance at beginning of period | | | 127,086 | | | | 119,432 | |
Transfer from undivided profits | | | — | | | | 7,654 | |
| | | | | | |
Balance at end of period | | | 127,086 | | | | 127,086 | |
| | | | | | |
Undivided Profits: | | | | | | | | |
Balance at beginning of period | | | 72,490 | | | | 120,649 | |
Net income | | | 61,829 | | | | 84,459 | |
Transfer to reserve fund | | | — | | | | (7,654 | ) |
Deferred tax benefit amortization | | | (3 | ) | | | (13 | ) |
Common stock cash dividends | | | (22,387 | ) | | | (21,922 | ) |
Stock dividend distributed | | | — | | | | (103,029 | ) |
| | | | | | |
Balance at end of period | | | 111,929 | | | | 72,490 | |
| | | | | | |
Total stockholders’ equity | | $ | 567,126 | | | $ | 556,003 | |
| | | | | | |
The accompanying notes are an integral part of these financial statements
3
SANTANDER BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
FOR THE NINE MONTH PERIODS AND THE QUARTERS ENDED SEPTEMBER 30, 2005 AND 2004
(Dollars in thousands)
| | | | | | | | | | | | | | | | |
| | For the nine month periods ended | | | For the quarters ended | |
| | September 30, | | | September 30, | | | September 30, | | | September 30, | |
| | 2005 | | | 2004 | | | 2005 | | | 2004 | |
Net income | | $ | 61,829 | | | $ | 63,130 | | | $ | 17,065 | | | $ | 21,869 | |
| | | | | | | | | | | | |
Other comprehensive income (loss), net of tax: | | | | | | | | | | | | | | | | |
Unrealized gains (losses) on investments securities available for sale, net of tax | | | (15,731 | ) | | | 4,030 | | | | (15,931 | ) | | | (3,856 | ) |
Reclassification adjustment for (gains) losses included in net income, net of tax | | | (14,350 | ) | | | (9,864 | ) | | | 1,357 | | | | (8,424 | ) |
Unrealized losses on investments securities transferred to the held to maturity category, net of amortization | | | — | | | | (27 | ) | | | — | | | | (16 | ) |
| | | | | | | | | | | | |
Unrealized losses on investment securities available for sale, net of tax | | | (30,081 | ) | | | (5,861 | ) | | | (14,574 | ) | | | (12,296 | ) |
| | | | | | | | | | | | |
Unrealized gains on cash flow hedges, net of tax | | | 1,765 | | | | 2,609 | | | | 790 | | | | 2,099 | |
Reclassification adjustment for losses included in net income, net of tax | | | — | | | | (2 | ) | | | — | | | | (1 | ) |
| | | | | | | | | | | | |
Unrealized gains on cash flow hedges, net of tax | | | 1,765 | | | | 2,607 | | | | 790 | | | | 2,098 | |
| | | | | | | | | | | | |
Other comprehensive loss, net of tax | | | (28,316 | ) | | | (3,254 | ) | | | (13,784 | ) | | | (10,198 | ) |
| | | | | | | | | | | | |
Comprehensive income | | $ | 33,513 | | | $ | 59,876 | | | $ | 3,281 | | | $ | 11,671 | |
| | | | | | | | | | | | |
The accompanying notes are an integral part of these financial statements
4
SANTANDER BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(Dollars in thousands)
| | | | | | | | |
| | For the nine month periods ended | |
| | September 30, | | | September 30, | |
| | 2005 | | | 2004 | |
CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | | |
Net income | | $ | 61,829 | | | $ | 63,130 | |
| | | | | | |
Adjustments to reconcile net income to net cash used in operating activities: | | | | | | | | |
Depreciation and amortization | | | 9,597 | | | | 9,940 | |
Deferred tax provision | | | 3,004 | | | | 1,318 | |
Provision for loan losses | | | 15,400 | | | | 21,770 | |
Gain on sale of building | | | — | | | | (2,754 | ) |
Gain on sale of securities | | | (17,838 | ) | | | (11,465 | ) |
Loss (gain) on sale of loans | | | (7,874 | ) | | | 84 | |
Gain on sale of mortgage servicing rights | | | (69 | ) | | | (284 | ) |
Gain on derivatives | | | (1,884 | ) | | | (198 | ) |
Trading gains | | | (780 | ) | | | (908 | ) |
Net premium amortization on securities | | | 3,314 | | | | 2,825 | |
Net premium amortization on loans | | | 2,215 | | | | 3,623 | |
Purchases and originations of loans | | | (556,939 | ) | | | (534,850 | ) |
Proceeds from sales of loans | | | 245,947 | | | | 126,512 | |
Repayments of loans held for sale | | | 9,196 | | | | 36,438 | |
Proceeds from sales of trading securities | | | 1,200,411 | | | | 1,704,903 | |
Purchases of trading securities | | | (1,216,535 | ) | | | (1,674,871 | ) |
Increase in accrued interest receivable | | | (19,434 | ) | | | (8,956 | ) |
(Increase) decrease in other assets | | | (6,615 | ) | | | 3,888 | |
Increase in accrued interest payable | | | 26,861 | | | | 4,518 | |
Increase (decrease) in other liabilities | | | 25,021 | | | | (1,873 | ) |
| | | | | | |
Total adjustments | | | (287,002 | ) | | | (320,340 | ) |
| | | | | | |
Net cash used in operating activities | | | (225,173 | ) | | | (257,210 | ) |
| | | | | | |
| | | | | | | | |
CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | |
Increase in interest-bearing deposits | | | (51,044 | ) | | | (40,000 | ) |
Proceeds from sales of investment securities available for sale | | | 906,150 | | | | 1,450,058 | |
Proceeds from maturities of investment securities available for sale | | | 13,975,695 | | | | 1,584,455 | |
Purchases of investment securities available for sale | | | (14,740,643 | ) | | | (2,585,303 | ) |
Proceeds from maturities of investment securities held to maturity | | | — | | | | 35,825 | |
Purchases of investment securities held to maturity | | | — | | | | (52,566 | ) |
Repayment of securities and securities called | | | 126,676 | | | | 170,071 | |
Payments on derivative transactions | | | 2,303 | | | | — | |
Purchases of mortgage loans | | | (490,034 | ) | | | (756,682 | ) |
Net decrease in loans | | | 135,513 | | | | 47,100 | |
Proceeds from sales of mortgage servicing rights | | | 69 | | | | 284 | |
Proceeds from sale of building | | | — | | | | 14,000 | |
Capital expenditures | | | (6,828 | ) | | | (1,772 | ) |
| | | | | | |
Net cash used in investing activities | | | (142,143 | ) | | | (134,530 | ) |
| | | | | | |
(Continued)
The accompanying notes are an integral part of these financial statements
5
SANTANDER BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
(Dollars in thousands)
| | | | | | | | |
| | For the nine month periods ended | |
| | September 30, | | | September 30, | |
| | 2005 | | | 2004 | |
CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | |
Net increase in deposits | | $ | 1,144,667 | | | $ | 377,312 | |
Net (decrease) increase in federal funds purchased and other borrowings | | | (130,334 | ) | | | 372,000 | |
Net decrease in securities sold under agreements to repurchase | | | (331,257 | ) | | | (506,611 | ) |
Net (decrease) increase in commercial paper issued | | | (399,692 | ) | | | 344,472 | |
Net increase (decrease) in term notes | | | 8,445 | | | | (41,685 | ) |
Net increase in subordinated capital notes | | | 9 | | | | — | |
Dividends paid | | | (14,924 | ) | | | (9,330 | ) |
| | | | | | |
Net cash provided by financing activities | | | 276,914 | | | | 536,158 | |
| | | | | | |
| | | | | | | | |
NET CHANGE IN CASH AND CASH EQUIVALENTS | | | (90,402 | ) | | | 144,418 | |
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | | | 479,410 | | | | 393,233 | |
| | | | | | |
CASH AND CASH EQUIVALENTS, END OF PERIOD | | $ | 389,008 | | | $ | 537,651 | |
| | | | | | |
(Concluded)
The accompanying notes are an integral part of these financial statements
6
SANTANDER BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
QUARTERS AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2004
1. Summary of Significant Accounting Policies:
The accounting and reporting policies of Santander BanCorp (the “Corporation”), an 89% owned subsidiary of Banco Santander Central Hispano, S.A. (“Santander”) conform with accounting principles generally accepted in the United States of America (hereinafter referred to as “generally accepted accounting principles” or “GAAP”) and with general practices within the financial services industry. The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such SEC rules and regulations. The results of operations and cash flows for the quarters and nine month periods ended September 30, 2005 and 2004 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the Consolidated Financial Statements and footnotes thereto for the year ended December 31, 2004, included in the Corporation’s Annual Report on Form 10-K.
The interim consolidated financial statements included herein are unaudited, but reflect all adjustments, which, in the opinion of management, are necessary for a fair presentation of the consolidated financial position, results of operations and cash flows for the interim periods presented. Adjustments included herein are of a normal recurring nature and include appropriate estimated provisions. The interim consolidated financial statements as of and for the nine month period ended September 30, 2005 included herein have been prepared on a consistent basis with the audited consolidated financial statements as of and for the year ended December 31, 2004.
Following is a summary of the Corporation’s most significant accounting policies:
Nature of Operations and Use of Estimates
Santander BanCorp is a financial holding company offering a full range of financial services through its wholly owned banking subsidiary Banco Santander Puerto Rico and subsidiaries (the “Bank”). The Corporation also engages in broker-dealer, asset management, mortgage banking, international banking and insurance agency services through its subsidiaries, Santander Securities Corporation, Santander Asset Management Corporation, Santander Mortgage Corporation, Santander International Bank of Puerto Rico, Inc. and Santander Insurance Agency, Inc., respectively.
Santander BanCorp is subject to the Federal Bank Holding Company Act and to the regulations, supervision, and examination of the Federal Reserve Board.
In preparing the consolidated financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, income taxes, the valuation of foreclosed real estate, deferred tax assets and financial instruments.
Principles of Consolidation
The consolidated financial statements include the accounts of the Corporation, the Bank and the Bank’s wholly owned subsidiaries, Santander Mortgage Corporation and Santander International Bank of Puerto Rico, Inc.; Santander Securities Corporation and its wholly owned subsidiary, Santander Asset Management Corporation; and Santander Insurance Agency, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.
Securities Purchased/Sold under Agreements to
Resell/Repurchase
Repurchase and resell agreements are treated as collateralized financing transactions and are carried at the amounts at which the assets will be subsequently reacquired or resold.
7
The counterparties to securities purchased under resell agreements maintain effective control over such securities and accordingly those are not reflected in the Corporation’s consolidated balance sheets. The Corporation monitors the market value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral where deemed appropriate.
The Corporation maintains effective control over assets sold under agreements to repurchase; accordingly, such securities continue to be carried on the consolidated balance sheets.
Investment Securities
Investment securities may be classified in four categories and accounted for as follows:
| • | | Debt securities that the Corporation has the intent and ability to hold to maturity are classified as securities held to maturity and reported at cost adjusted for premium amortization and discount accretion. The Corporation may not sell or transfer held-to-maturity securities without calling into question its intent to hold other securities to maturity, unless a nonrecurring or unusual event that could not have been reasonably anticipated has occurred. |
|
| • | | Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. Financial instruments including, to a limited extent, derivatives, such as option contracts, are used by the Corporation in dealing and other trading activities and are carried at fair value. Interest revenue and expense arising from trading instruments are included in the statement of income as part of net interest income. |
|
| • | | Debt and equity securities not classified as either securities held to maturity or trading securities, and which have a readily available fair value, are classified as securities available for sale and reported at fair value, with unrealized gains and losses reported, net of taxes, in accumulated other comprehensive income. The specific identification method is used to determine realized gains and losses on securities available for sale, which are included in gain (loss) on sale of investment securities in the consolidated statements of income. |
|
| • | | Investments in debt, equity or other securities that do not have readily determinable fair value, are classified as other investment securities in the consolidated balance sheets. These securities are stated at cost. Stock that is owned by the Corporation to comply with regulatory requirements, such as Federal Home Loan Bank (“FHLB”) stock, is included in this category. |
The amortization of premiums is deducted from and the accretion of discounts is added to net interest income based on a method which approximates the interest method over the outstanding period of the related securities. The cost of securities sold is determined by specific identification. For securities available for sale, held to maturity and other investment securities, the Corporation reports separately in the consolidated statements of income, net realized gains or losses on sales of investment securities and unrealized loss valuation adjustments considered other than temporary, if any.
Derivative Financial Instruments
The Corporation uses derivative financial instruments mostly as hedges of interest rate risk, changes in fair value of assets and liabilities and to secure future cash flows.
All of the Corporation’s derivative instruments are recognized as assets and liabilities at fair value. If certain conditions are met, the derivative may qualify for hedge accounting treatment and be designated as one of the following types of hedges: (a) hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment (“fair value hedge”); (b) a hedge of the exposure to variability of cash flows of a recognized asset, liability or forecasted transaction (“cash flow hedge”) or (c) a hedge of a foreign currency exposure (“foreign currency hedge”).
In the case of a qualifying fair value hedge, changes in the value of the derivative instruments that have been highly effective are recognized in current period earnings along with the change in value of the designated hedged item. If the hedge relationship is terminated, hedge accounting is discontinued and any balance related to the derivative is
8
recognized in current operations, and the fair value adjustment to the hedged item continues to be reported as part of the basis of the item and is amortized to earnings as a yield adjustment. In the case of a qualifying cash flow hedge, changes in the value of the derivative instruments that have been highly effective are recognized in other comprehensive income, until such time as those earnings are affected by the variability of the cash flows of the underlying hedged item. If the hedge relationship is terminated, the net derivative gain or loss related to the discontinued cash flow hedge should continue to be reported in accumulated other comprehensive income and shall be reclassified into earnings when the cash flows that were hedged occur, or when the forecasted transaction affects earnings or is no longer expected to occur. In either a fair value hedge or a cash flow hedge, net earnings may be impacted to the extent the changes in the value of the derivative instruments do not perfectly offset changes in the value of the hedged items. If the derivative is not designated as a hedging instrument, the changes in fair value of the derivative are recorded in earnings.
Certain contracts contain embedded derivatives. When the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristic of the host contract, it should be bifurcated, carried at fair value, and designated as a trading or non-hedging derivative instrument.
Loans Held for Sale
Loans held for sale are recorded at the lower of cost or market computed on the aggregated portfolio basis. The amount by which cost exceeds market value, if any, is accounted for as a valuation allowance with changes included in the determination of net income for the period in which the change occurs.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses, unearned finance charges and any deferred fees or costs on originated loans. Certain mortgage loans are hedged to generate a floating rate source of funds and are carried at fair value.
Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and amortized using methods that approximate the interest method over the term of the loans as an adjustment to interest yield. Discounts and premiums on purchased loans are amortized to income over the expected lives of the loans using methods that approximate the interest method.
The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due, but in no event is it recognized after 90 days in arrears on payments of principal or interest, except for credit cards and mortgage loans for which interest is not recognized after four months. When interest accrual is discontinued, all unpaid interest is reversed. Interest income is subsequently recognized only to the extent that it is received.
The Corporation leases vehicles and equipment to individual and corporate customers. The finance method of accounting is used to recognize revenue on lease contracts that meet the criteria specified in Statement of Financial Accounting Standards (“SFAS’) No. 13, “Accounting for Leases”, as amended. Aggregate rentals due over the term of the leases less unearned income are included in lease receivable. Unearned income is amortized to income over the lease term so as to yield a constant rate of return on the principal amounts outstanding. Lease origination fees and costs are deferred and amortized over the average life of the portfolio as an adjustment to yield.
Off-Balance Sheet Instruments
In the ordinary course of business, the Corporation enters into off-balance sheet instruments consisting of commitments to extend credit, stand by letters of credit and financial guarantees. Such financial instruments are recorded in the financial statements when they are funded or when related fees are incurred or received. The Corporation periodically evaluates the credit risks inherent in these commitments, and establishes loss allowances for such risks if and when these are deemed necessary.
Fees received for providing loan commitments and letters of credit that result in loans are typically deferred and amortized to interest income over the life of the related loan, beginning with the initial borrowing. Fees on commitments
9
and letters of credit are amortized to non-interest income as banking fees and commissions over the commitment period when funding is not expected.
Allowance for Loan Losses
The allowance for loan losses is a current estimate of the losses inherent in the present portfolio based on management’s ongoing quarterly evaluations of the loan portfolio. Estimates of losses inherent in the loan portfolio involve the exercise of judgment and the use of assumptions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, management’s estimate of credit losses in the loan portfolio and the related allowance may change in the near term.
The Corporation follows a systematic methodology to establish and evaluate the adequacy of the allowance for loan losses. This methodology consists of several key elements.
Larger commercial and construction loans that exhibit potential or observed credit weaknesses are subject to individual review. Where appropriate, allowances are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Corporation.
Included in the review of individual loans are those that are impaired as defined by GAAP. Any allowances for loans deemed impaired are measured based on the present value of expected future cash flows discounted at the loans’ effective interest rate or on the fair value of the underlying collateral if the loan is collateral dependent. Commercial business, commercial real estate and construction loans exceeding a predetermined monetary threshold are individually evaluated for impairment. Other loans are evaluated in homogeneous groups and collectively evaluated for impairment. Loans that are recorded at fair value or at the lower of cost or fair value are not evaluated for impairment. Impaired loans for which the discounted cash flows, collateral value or market price exceeds its carrying value do not require an allowance. The Corporation evaluates the collectibility of both principal and interest when assessing the need for loss accrual.
Historical loss rates are applied to other commercial loans not subject to individual review. The loss rates are derived from historical loss trends, market loss trends and other relevant economic factors.
Homogeneous loans, such as consumer installment, credit cards and residential mortgage loans are not individually risk graded. Allowances are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category, market loss trends and other relevant economic factors.
An unallocated allowance is maintained to recognize the imprecision in estimating and measuring loss when evaluating allowances for individual loans or pools of loans.
Historical loss rates for commercial and consumer loans may also be adjusted for significant factors that, in management’s judgment, reflect the impact of any current condition on loss recognition. Factors which management considers in the analysis include the effect of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs, non-accrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and the Corporation’s internal credit examiners.
Allowances on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.
Goodwill and Intangible Assets
Goodwill and other intangible assets that have indefinite useful lives are not amortized but rather are tested at least annually for impairment. Intangible assets with finite useful lives continue to be amortized over the period the Corporation expects to benefit from such assets. These intangible assets are periodically reviewed for other than temporary impairment
10
by determining whether the unamortized balances can be recovered through undiscounted future net cash flows of the related assets.
Based on management’s last annual impairment assessment of the value of the Corporation’s goodwill, which included an independent valuation, among others, management determined that the Corporation’s goodwill was not impaired.
Mortgage Servicing Rights
The Corporation’s mortgage-servicing rights (“MSRs”) are stated at the lower of carrying value or market at each balance sheet date. On a quarterly basis the Corporation evaluates its MSRs for impairment and charges any such impairment to current period earnings. In order to evaluate its MSRs the Corporation stratifies the related mortgage loans on the basis of their risk characteristics which have been determined to be: type of loan (government-guaranteed, conventional, conforming and non-conforming), interest rates and maturities. Impairment of MSRs is determined by estimating the fair value of each stratum and comparing it to its carrying value. No impairment has been identified as of September 30, 2005 or December 31, 2004.
MSRs are also subject to periodic amortization. The amortization of MSRs is based on the amount and timing of estimated cash flows to be recovered with respect to the MSRs over their expected lives. Amortization may be accelerated or decelerated to the extent that changes in interest rates or prepayment rates warrant.
Mortgage Banking
Mortgage loan servicing includes collecting monthly mortgagor payments, forwarding payments and related accounting reports to investors, collecting escrow deposits for the payment of mortgagor property taxes and insurance, and paying taxes and insurance from escrow funds when due. No asset or liability is recorded by the Corporation for mortgages serviced, except for mortgage-servicing rights arising from the sale of mortgages, advances to investors and escrow balances.
The Corporation recognizes as a separate asset the right to service mortgage loans for others whenever those servicing rights are acquired. The Corporation acquires mortgage-servicing rights by purchasing or originating loans and selling or securitizing those loans (with the servicing rights retained) and allocates the total cost of the mortgage loans sold to the mortgage-servicing rights (included in intangible assets in the accompanying consolidated balance sheets) and the loans based on their relative fair values. Mortgage loan-servicing fees, which are based on a percentage of the principal balances of the mortgages serviced, are credited to income as mortgage payments are collected.
Wealth Management Commissions
Commissions of the Corporation’s broker-dealer operations are composed of brokerage commission income and expenses and proprietary securities transactions recorded on a trade date basis. Investment banking revenues include gains, losses and fees net of syndicate expenses, arising from securities offerings in which the Corporation acts as an underwriter or agent. Investment banking management fees are recorded on offering date, sales concessions on trade date, and underwriting fees at the time the underwriting is completed and the income is reasonably determinable. Revenues from portfolio and other management and advisory fees include fees and advisory charges resulting from the asset management of certain funds and are recognized over the period when services are rendered.
Insurance Commissions
The Corporation’s insurance agency operation earns commissions on the sale of insurance policies issued by unaffiliated insurance companies. Commission revenue is reported net of the provision for commission returns on insurance policy cancellations, which are based on management’s estimate of future insurance policy cancellations as a result of historical turnover rates by types of credit facilities subject to insurance.
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Income Taxes
The Corporation uses the asset and liability method for the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Corporation’s financial statements or tax returns. Deferred income tax assets and liabilities are determined for differences between financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. The computation is based on enacted tax laws and rates applicable to periods in which the temporary differences are expected to be recovered or settled. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized. The Corporation also accounts for probable income tax contingencies, if any.
Earnings Per Common Share
Basic and diluted earnings per common share are computed by dividing net income available to common shareholders, by the weighted average number of common shares outstanding during the period. The Corporation’s average number of common shares outstanding used in the computation of earnings per common share was 46,639,104 for each of the quarters and nine month periods ended September 30, 2005 and 2004, respectively. Basic and diluted earnings per common share are the same since no stock options or other stock equivalents were outstanding during the periods ended September 30, 2005 and 2004.
Recent Accounting Pronouncements which Affect the Corporation
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123R (Revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), which requires the cost resulting from stock options be measured at fair value and recognized in earnings. This Statement replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB No. 25”) which permitted the recognition of compensation expense using the intrinsic value method. SFAS No. 123(R) was effective July 1, 2005. However, on April 15, 2005, the Securities Exchange Commission (“SEC”) issued a press release announcing the amendment of the compliance date for SFAS No. 123(R) to be no later than the beginning of the first fiscal year beginning after June 15, 2005. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), Share-Based Payment, providing guidance on option valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123(R), and the disclosures in MD&A subsequent to the adoption. The implementation of SFAS No. 123(R) and SAB No. 107 is not expected to have a material impact on the Corporation’s consolidated results of operations, financial position and disclosures.
On March 3, 2005, the FASB Staff issued FSP FIN 46(R)-5, “Implicit Variable Interests under FASB Interpretation No. 46 (FIN 46R — Revised December 2003), Consolidation of Variable Interest Entities (“VIE”)”. This FSP requires a reporting enterprise to consider the impact of implicit variable interests in determining whether the reporting enterprise may absorb variability of the VIE or potential VIE. This staff position was effective in the third quarter of 2005 and did not have a material impact on the Corporation’s consolidated results of operations and financial position.
The American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-3”), which addresses the accounting for differences between contractual cash flows and expected cash flows related to purchased debt securities and loans held for investment, if those differences are attributable, at least in part, to credit quality. The Corporation adopted SOP 03-3 on January 1, 2005 and there was no cumulative adjustment required.
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2. Investment Securities Available for Sale:
The amortized cost, gross unrealized gains and losses, fair value and weighted average yield of investment securities available for sale by contractual maturity are as follows:
| | | | | | | | | | | | | | | | | | | | |
| | September 30, 2005 |
| | | | | | Gross | | | Gross | | | | | | | Weighted | |
| | Amortized | | | Unrealized | | | Unrealized | | | Fair | | | Average | |
| | Cost | | | Gains | | | Losses | | | Value | | | Yield | |
| | (Dollars in thousands) |
Treasury and agencies of the United States Government: | | | | | | | | | | | | | | | | | | | | |
Within one year | | $ | 353,827 | | | $ | 1 | | | $ | 952 | | | $ | 352,876 | | | | 2.90 | % |
After one year but within five years | | | 231,444 | | | | — | | | | 6,825 | | | | 224,619 | | | | 3.63 | % |
After five years but within ten years | | | 257,764 | | | | — | | | | 6,299 | | | | 251,465 | | | | 4.12 | % |
| | | | | | | | | | | | | | | | |
| | | 843,035 | | | | 1 | | | | 14,076 | | | | 828,960 | | | | 3.47 | % |
| | | | | | | | | | | | | | | | |
Commonwealth of Puerto Rico and its subdivisions: | | | | | | | | | | | | | | | | | | | | |
Within one year | | | 12,550 | | | | 90 | | | | 2 | | | | 12,638 | | | | 4.91 | % |
After one year but within five years | | | 11,170 | | | | 10 | | | | 50 | | | | 11,130 | | | | 4.02 | % |
After five years but within ten years | | | 12,885 | | | | — | | | | 258 | | | | 12,627 | | | | 4.26 | % |
Over ten years | | | 8,013 | | | | 19 | | | | 64 | | | | 7,968 | | | | 6.25 | % |
| | | | | | | | | | | | | | | | |
| | | 44,618 | | | | 119 | | | | 374 | | | | 44,363 | | | | 4.74 | % |
| | | | | | | | | | | | | | | | |
Mortgage-backed securities: | | | | | | | | | | | | | | | | | | | | |
Over ten years | | | 823,085 | | | | — | | | | 17,951 | | | | 805,134 | | | | 5.01 | % |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Foreign securities: | | | | | | | | | | | | | | | | | | | | |
After one year but within five years | | | 75 | | | | — | | | | — | | | | 75 | | | | 5.60 | % |
| | | | | | | | | | | | | | | | |
| | $ | 1,710,813 | | | $ | 120 | | | $ | 32,401 | | | $ | 1,678,532 | | | | 4.33 | % |
| | | | | | | | | | | | | | | | |
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| | | | | | | | | | | | | | | | | | | | |
| | December 31, 2004 |
| | | | | | Gross | | | Gross | | | | | | | Weighted | |
| | Amortized | | | Unrealized | | | Unrealized | | | Fair | | | Average | |
| | Cost | | | Gains | | | Losses | | | Value | | | Yield | |
| | (Dollars in thousands) |
Treasury and agencies of the United States Government: | | | | | | | | | | | | | | | | | | | | |
Within one year | | $ | 10,632 | | | $ | 3 | | | $ | — | | | $ | 10,635 | | | | 2.18 | % |
After one year but within five years | | | 1,039,811 | | | | 25,690 | | | | 2,874 | | | | 1,062,627 | | | | 4.56 | % |
After five years but within ten years | | | 363,855 | | | | — | | | | 1,608 | | | | 362,247 | | | | 4.13 | % |
| | | | | | | | | | | | | | | | |
| | | 1,414,298 | | | | 25,693 | | | | 4,482 | | | | 1,435,509 | | | | 4.43 | % |
| | | | | | | | | | | | | | | | |
Commonwealth of Puerto Rico and its subdivisions: | | | | | | | | | | | | | | | | | | | | |
Within one year | | | 8,412 | | | | 58 | | | | — | | | | 8,470 | | | | 4.42 | % |
After one year but within five years | | | 21,777 | | | | 412 | | | | — | | | | 22,189 | | | | 4.51 | % |
After five years but within ten years | | | 13,800 | | | | — | | | | — | | | | 13,800 | | | | 4.24 | % |
Over ten years | | | 8,118 | | | | 111 | | | | — | | | | 8,229 | | | | 6.42 | % |
| | | | | | | | | | | | | | | | |
| | | 52,107 | | | | 581 | | | | — | | | | 52,688 | | | | 4.73 | % |
| | | | | | | | | | | | | | | | |
Mortgage-backed securities: | | | | | | | | | | | | | | | | | | | | |
After one year but within five years | | | 839 | | | | 51 | | | | — | | | | 890 | | | | 8.36 | % |
After five years but within 10 years | | | 70 | | | | 4 | | | | — | | | | 74 | | | | 9.50 | % |
Over ten years | | | 496,718 | | | | 129 | | | | 8,026 | | | | 488,821 | | | | 4.30 | % |
| | | | | | | | | | | | | | | | |
| | | 497,627 | | | | 184 | | | | 8,026 | | | | 489,785 | | | | 4.31 | % |
| | | | | | | | | | | | | | | | |
Foreign Securities: | | | | | | | | | | | | | | | | | | | | |
Within one year | | | 75 | | | | — | | | | — | | | | 75 | | | | 6.98 | % |
After one year but within five years | | | 75 | | | | — | | | | — | | | | 75 | | | | 5.60 | % |
| | | | | | | | | | | | | | | | |
| | | 150 | | | | — | | | | — | | | | 150 | | | | 6.29 | % |
| | | | | | | | | | | | | | | | |
| | $ | 1,964,182 | | | $ | 26,458 | | | $ | 12,508 | | | $ | 1,978,132 | | | | 4.41 | % |
| | | | | | | | | | | | | | | | |
Contractual maturities on certain securities, including mortgage-backed securities, could differ from actual maturities since certain issuers have the right to call or prepay these securities.
The weighted average yield on investment securities available for sale is based on amortized cost, therefore it does not give effect to changes in fair value.
The number of positions, fair value and unrealized losses at September 30, 2005, of investment securities available for sale that have been in a continuous unrealized loss position for less than twelve months and for twelve months or more, are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less than 12 months | | | 12 months or more | | | Total | |
| | Number | | | | | | | | | | | Number | | | | | | | | | | | Number | | | | | | | |
| | of | | | Fair | | | Unrealized | | | of | | | Fair | | | Unrealized | | | of | | | Fair | | | Unrealized | |
| | Positions | | | Value | | | Losses | | | Positions | | | Value | | | Losses | | | Positions | | | Value | | | Losses | |
| | (Dollars in thousands) |
Treasury and agencies of the United States Government | | | 5 | | | $ | 514,992 | | | $ | 6,177 | | | | 6 | | | $ | 307,257 | | | $ | 7,899 | | | | 11 | | | $ | 822,249 | | | $ | 14,076 | |
Commonwealth of Puerto Rico and its subdivisions | | | 16 | | | | 23,612 | | | | 374 | | | | — | | | | — | | | | — | | | | 16 | | | | 23,612 | | | | 374 | |
Mortgage-backed securities | | | 23 | | | | 518,568 | | | | 6,509 | | | | 8 | | | | 286,566 | | | | 11,442 | | | | 31 | | | | 805,134 | | | | 17,951 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | 44 | | | $ | 1,057,172 | | | $ | 13,060 | | | | 14 | | | $ | 593,823 | | | $ | 19,341 | | | | 58 | | | $ | 1,650,995 | | | $ | 32,401 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
The Corporation evaluates its investment securities for other than temporary impairment on a quarterly basis or earlier if other factors indicative of potential impairment exist. An impairment charge in the consolidated statements of income is recognized when the decline in the fair value of the securities below their cost basis is judged to be other-than-temporary. The Corporation considers various factors in determining whether it should recognize an impairment charge including, but not limited to the length of time and extent to which the fair value has been less than its cost basis,
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expectation of recoverability of its original investment in the securities and the Corporation’s intent and ability to hold the securities for a period of time sufficient to allow for any anticipated recovery in fair value.
As of September 30, 2005, management concluded that there was no other-than-temporary impairment in its investment securities portfolio. The unrealized losses in the Corporation’s investments in U.S. Government agencies were caused by interest rate increases. Since the Corporation has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Corporation does not consider these investments to be other-than-temporarily impaired at September 30, 2005. The unrealized losses in the Corporation’s investment in federal agency mortgage backed securities were caused by interest rate increases. The contractual cash flows of these investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities will not be settled at a price less than the amortized cost of the Corporation’s investment. The decline in fair value is attributable to changes in interest rates and not credit quality, and since the Corporation has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Corporation does not consider these investments to be other-than-temporarily impaired at September 30, 2005.
3. Loans
The Corporation’s loan portfolio at September 30, 2005 and December 31, 2004 consists of the following:
| | | | | | | | |
| | September 30, 2005 | | | December 31, 2004 | |
| | (in thousands) | |
Commercial and industrial | | $ | 2,299,589 | | | $ | 2,236,253 | |
Consumer | | | 537,296 | | | | 448,385 | |
Leasing | | | 136,233 | | | | 126,148 | |
Construction | | | 216,400 | | | | 201,041 | |
Mortgage | | | 2,806,885 | | | | 2,306,473 | |
| | | | | | |
| | | 5,996,403 | | | | 5,318,300 | |
Unearned income and deferred fees/costs | | | (7,423 | ) | | | (6,364 | ) |
Allowance for loan losses | | | (66,051 | ) | | | (69,177 | ) |
| | | | | | |
| | $ | 5,922,929 | | | $ | 5,242,759 | |
| | | | | | |
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4. Allowance for Loan Losses:
Changes in the allowance for loan losses are summarized as follows:
| | | | | | | | | | | | | | | | |
| | For the nine month periods ended | | | For the quarters ended | |
| | Sept. 30 2005 | | | Sept. 30,2004 | | | Sept. 30,2005 | | | Sept. 30,2004 | |
| | | | | | (in thousands) | | | | | |
Balance at beginning of period | | $ | 69,177 | | | $ | 69,693 | | | $ | 65,623 | | | $ | 66,665 | |
Provision for loan losses | | | 15,400 | | | | 21,770 | | | | 4,650 | | | | 7,020 | |
Retroactive reclassification of provision for commitments, unused lines and standby letter of credit | | | — | | | | — | | | | — | | | | 392 | |
| | | | | | | | | | | | |
| | | 84,577 | | | | 91,463 | | | | 70,273 | | | | 74,077 | |
| | | | | | | | | | | | |
Losses charged to the allowance: | | | | | | | | | | | | | | | | |
Commercial | | | 6,777 | | | | 14,848 | | | | 1,383 | | | | 1,806 | |
Construction | | | 1,438 | | | | — | | | | — | | | | — | |
Consumer | | | 13,661 | | | | 14,821 | | | | 3,589 | | | | 4,488 | |
Leasing | | | 706 | | | | 1,212 | | | | 140 | | | | 375 | |
| | | | | | | | | | | | |
| | | 22,582 | | | | 30,881 | | | | 5,112 | | | | 6,669 | |
| | | | | | | | | | | | |
Recoveries: | | | | | | | | | | | | | | | | |
Commercial | | | 1,315 | | | | 4,013 | | | | 366 | | | | 1,467 | |
Consumer | | | 2,290 | | | | 5,767 | | | | 270 | | | | 1,716 | |
Leasing | | | 451 | | | | 369 | | | | 254 | | | | 140 | |
| | | | | | | | | | | | |
| | | 4,056 | | | | 10,149 | | | | 890 | | | | 3,323 | |
| | | | | | | | | | | | |
Net loans charged off | | | 18,526 | | | | 20,732 | | | | 4,222 | | | | 3,346 | |
| | | | | | | | | | | | |
Balance at end of period | | $ | 66,051 | | | $ | 70,731 | | | $ | 66,051 | | | $ | 70,731 | |
| | | | | | | | | | | | |
5. Goodwill and Intangible Assets:
Goodwill and intangible assets with an indefinite life are tested for impairment at least annually using a two-step process at each reporting unit.
The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, the goodwill of the reporting unit is not considered impaired and the second step of the impairment test is not performed. If the carrying value of the reporting unit exceeds its fair value, the second step in the impairment test consists of comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The Corporation uses the market multiple, the discounted cash flows and comparable transaction approaches to determine the fair value of each reporting unit.
The Corporation has assigned goodwill to reporting units at the time of acquisition. Goodwill is allocated to the Retail Banking segment and the Wealth Management segment as follows:
| | | | | | | | |
| | September 30, | | | December 31, | |
| | 2005 | | | 2004 | |
| | (In thousands) | |
Retail Banking | | $ | 10,537 | | | $ | 10,537 | |
Wealth Management | | | 24,254 | | | | 24,254 | |
| | | | | | |
| | $ | 34,791 | | | $ | 34,791 | |
| | | | | | |
16
Goodwill assigned to the Retail Banking segment is related to the acquisition of Banco Central Hispano Puerto Rico (“BCHPR”) in 1996, and the goodwill assigned to the Wealth Management segment is related to the acquisition of Merril Lynch’s retail brokerage business in Puerto Rico by Santander Securities Corporation in 2000. There has been no impairment of goodwill for any of the periods reported.
Other Intangible Assets
Other intangible assets subject to amortization at September 30, 2005 and December 31, 2004 were as follows:
| | | | | | | | |
| | September 30, | | | December 31, | |
| | 2005 | | | 2004 | |
| | (In thousands) | |
Mortgage-servicing rights | | $ | 8,545 | | | $ | 6,503 | |
Advisory servicing rights | | | 1,350 | | | | 1,500 | |
| | | | | | |
| | $ | 9,895 | | | $ | 8,003 | |
| | | | | | |
Mortgage-servicing rights have an estimated useful life of eight years. The advisory-servicing rights are related to the Corporation’s subsidiary acquisition of the right to serve as the investment advisor for the First Puerto Rico Tax-Exempt Fund, Inc. This intangible asset is being amortized over a 10-year estimated useful life.
6. Other Assets
Other assets at September 30, 2005 and December 31, 2004 consist of the following:
| | | | | | | | |
| | September 30, 2005 | | | December 31, 2004 | |
| | (In thousands) | |
Deferred tax assets, net | | $ | 15,334 | | | $ | 2,344 | |
Accounts receivable | | | 58,728 | | | | 61,311 | |
Securities sold not delivered, net | | | — | | | | 669 | |
Other real estate | | | 6,090 | | | | 3,034 | |
Software | | | 9,542 | | | | 12,263 | |
Prepaid expenses | | | 10,282 | | | | 9,447 | |
Customers’ liabilities on acceptances | | | 1,688 | | | | 2,166 | |
Other | | | 32,682 | | | | 16,635 | |
| | | | | | |
| | $ | 134,346 | | | $ | 107,869 | |
| | | | | | |
17
7. Borrowings:
Following are summaries of borrowings as of and for the periods indicated:
| | | | | | | | | | | | |
| | September 30, 2005 | |
| | Federal Funds | | | Securities Sold | | | Commercial | |
| | Purchased and | | | Under Agreements | | | Paper | |
| | Other Borrowings | | | to Repurchase | | | Issued | |
| | (Dollars in thousands) | |
Amount outstanding at period end | | $ | 650,000 | | | $ | 1,018,187 | | | $ | 229,852 | |
| | | | | | | | | |
Average indebtedness outstanding during the period | | $ | 745,690 | | | $ | 1,077,610 | | | $ | 454,738 | |
| | | | | | | | | |
Maximum amount outstanding during the period | | $ | 895,569 | | | $ | 1,565,269 | | | $ | 830,000 | |
| | | | | | | | | |
Average interest rate for the period | | | 3.06 | % | | | 4.13 | % | | | 2.98 | % |
| | | | | | | | | |
Average interest rate at period end | | | 3.64 | % | | | 4.29 | % | | | 3.72 | % |
| | | | | | | | | |
| | | | | | | | | | | | |
| | December 31, 2004 | |
| | Federal Funds | | | Securities Sold | | | Commercial | |
| | Purchased and | | | Under Agreements | | | Paper | |
| | Other Borrowings | | | to Repurchase | | | Issued | |
| | (Dollars in thousands) | |
Amount outstanding at year end | | $ | 780,334 | | | $ | 1,349,444 | | | $ | 629,544 | |
| | | | | | | | | |
Average indebtedness outstanding during the year | | $ | 571,251 | | | $ | 1,625,700 | | | $ | 454,186 | |
| | | | | | | | | |
Maximum amount outstanding during the year | | $ | 1,033,051 | | | $ | 2,052,790 | | | $ | 675,000 | |
| | | | | | | | | |
Average interest rate for the year | | | 1.75 | % | | | 3.48 | % | | | 1.53 | % |
| | | | | | | | | |
Average interest rate at year end | | | 2.09 | % | | | 4.11 | % | | | 2.38 | % |
| | | | | | | | | |
Federal funds purchased and other borrowings, securities sold under agreements to repurchase and commercial paper issued mature as follows:
| | | | | | | | |
| | September 30, | | | December 31, | |
| | 2005 | | | 2004 | |
| | (In thousands) | |
Federal funds purchased and other borrowings: | | | | | | | | |
Within thirty days | | $ | — | | | $ | 205,334 | |
Over ninety days | | | 650,000 | | | | 575,000 | |
| | | | | | |
Total | | $ | 650,000 | | | $ | 780,334 | |
| | | | | | |
Securities sold under agreements to repurchase: | | | | | | | | |
Within thirty days | | $ | 668,181 | | | $ | 374,438 | |
Over ninety days | | | 350,006 | | | | 975,006 | |
| | | | | | |
Total | | $ | 1,018,187 | | | $ | 1,349,444 | |
| | | | | | |
Commercial paper issued: | | | | | | | | |
Within thirty days | | $ | 229,852 | | | $ | 629,544 | |
| | | | | | |
As of September 30, 2005 and December 31, 2004, the weighted average maturity of Federal funds purchased and other borrowings over ninety days was 25.41 months and 21.18 months, respectively.
18
As of September 30, 2005, securities sold under agreements to repurchase (classified by counterparty) were as follows:
| | | | | | | | | | | | |
| | Balance of | | | Underlying | | | Average maturity | |
| | Borrowings | | | Securities | | | in Months | |
| | (Dollars in thousands) | |
Credit Suisse First Boston LLC | | $ | 92,313 | | | $ | 94,823 | | | | 0.23 | |
Federal Home Loan Bank New York | | | 100,000 | | | | 98,459 | | | | 30.54 | |
Barclays Capital | | | 204,967 | | | | 209,171 | | | | 0.24 | |
JP Morgan Chase Securities, Inc. | | | 187,610 | | | | 193,616 | | | | 0.35 | |
Lehman Brothers RS | | | 250,006 | | | | 277,230 | | | | 77.21 | |
UBS Financial Services, Inc. | | | 183,291 | | | | 187,944 | | | | 0.32 | |
| | | | | | | | | | |
| | $ | 1,018,187 | | | $ | 1,061,243 | | | | 22.15 | |
| | | | | | | | | | |
There may be a penalty on early termination of these securities sold under agreements to repurchase.
19
The following investment securities were sold under agreements to repurchase:
| | | | | | | | | | | | | | | | |
| | September 30, 2005 |
| | Carrying | | | | | | | Fair | | | Weighted | |
| | Value of | | | | | | | Value of | | | Average | |
| | Underlying | | | Balance of | | | Underlying | | | Interest | |
Underlying Securities | | Securities | | | Borrowings | | | Securities | | | Rate | |
| | | | | | | | | | | | | | | | |
| | |
| | (Dollars in thousands)
|
Obligations of the Treasury and agencies of the U.S. Government | | $ | 295,158 | | | $ | 262,860 | | | $ | 295,158 | | | | 5.43 | % |
Mortgage-backed securities | | | 766,085 | | | | 755,327 | | | | 766,085 | | | | 3.87 | % |
| | | | | | | | | | | | | |
Total | | $ | 1,061,243 | | | $ | 1,018,187 | | | $ | 1,061,243 | | | | 4.30 | % |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | December 31, 2004 |
| | Carrying | | | | | | | Fair | | | Weighted | |
| | Value of | | | | | | | Value of | | | Average | |
| | Underlying | | | Balance of | | | Underlying | | | Interest | |
Underlying Securities | | Securities | | | Borrowings | | | Securities | | | Rate | |
| | | | | | | | | | | | | | | | |
| | |
| | (Dollars in thousands)
|
Obligations of the Treasury and agencies of the U.S. Government | | $ | 1,085,183 | | | $ | 994,072 | | | $ | 1,085,183 | | | | 4.54 | % |
Mortgage-backed securities | | | 369,675 | | | | 355,372 | | | | 369,675 | | | | 4.36 | % |
| | | | | | | | | | | | | |
Total | | $ | 1,454,858 | | | $ | 1,349,444 | | | $ | 1,454,858 | | | | 4.49 | % |
| | | | | | | | | | | | | |
8. Derivative Financial Instruments:
As of September 30, 2005, the Corporation had the following derivative financial instruments outstanding:
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Other | |
| | | | | | | | | | Gain (Loss) for | | | Comprehensive Income* | |
| | | | | | | | | | the nine month | | | for the nine month | |
| | Notional | | | | | | | period ended | | | period ended | |
| | Value | | | Fair Value | | | September 30, 2005 | | | September 30, 2005 | |
| | |
| | (In thousands)
|
CASH FLOW HEDGES | | | | | | | | | | | | | | | | |
Foreign currency forward | | $ | 183,878 | | | $ | (10,999 | ) | | $ | — | | | $ | 396 | |
Interest rate swaps | | | — | | | | — | | | | — | | | | 1,369 | |
FAIR VALUE HEDGES | | | | | | | | | | | | | | | | |
Interest rate swaps | | | 2,347,856 | | | | (24,957 | ) | | | (214 | ) | | | — | |
OTHER DERIVATIVES | | | | | | | | | | | | | | | | |
Options | | | 121,606 | | | | 16,741 | | | | 6,381 | | | | — | |
Embedded options on stock-indexed deposits and notes | | | 121,606 | | | | (16,741 | ) | | | (4,078 | ) | | | — | |
Interest rate caps | | | 39,084 | | | | 63 | | | | 117 | | | | — | |
Customer interest rate caps | | | 37,287 | | | | (61 | ) | | | (104 | ) | | | — | |
Customer interest rate swaps | | | 707,604 | | | | 1,609 | | | | 2,547 | | | | — | |
Interest rate swaps | | | 686,604 | | | | (1,297 | ) | | | (2,750 | ) | | | — | |
Loan commitments | | | 12,266 | | | | (12 | ) | | | (15 | ) | | | — | |
| | | | | | | | | | | | | | |
| | | | | | | | | | $ | 1,884 | | | $ | 1,765 | |
| | | | | | | | | | | | | | |
20
As of December 31, 2004, the Corporation had the following derivative financial instruments outstanding:
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | Other | |
| | | | | | | | | | Gain (Loss) for | | | Comprehensive | |
| | | | | | | | | | the year | | | Income* for the | |
| | | | | | | | | | ended | | | year ended | |
| | Notional | | | Fair | | | December 31, | | | December 31, | |
| | Value | | | Value | | | 2004 | | | 2004 | |
| | |
| | (In thousands)
|
CASH FLOW HEDGES | | | | | | | | | | | | | | | | |
Interest rate swaps | | $ | 100,000 | | | $ | (2,244 | ) | | $ | — | | | $ | 3,463 | |
FAIR VALUE HEDGES | | | | | | | | | | | | | | | | |
Interest rate swaps | | | 1,545,634 | | | | (29,643 | ) | | | 579 | | | | — | |
OTHER DERIVATIVES | | �� | | | | | | | | | | | | | | |
Options | | | 69,770 | | | | 6,880 | | | | 5,325 | | | | — | |
Embedded options on stock-indexed deposits and notes | | | 69,125 | | | | (6,881 | ) | | | (2,401 | ) | | | — | |
Interest rate caps | | | 34,996 | | | | (54 | ) | | | 239 | | | | — | |
Customer interest rate caps | | | 32,975 | | | | 38 | | | | (217 | ) | | | — | |
Customer interest rate swaps | | | 167,713 | | | | (937 | ) | | | (1,491 | ) | | | — | |
Interest rate swaps | | | 167,713 | | | | 1,505 | | | | 1,422 | | | | — | |
Loan commitments | | | 2,415 | | | | 3 | | | | 3 | | | | — | |
| | | | | | | | | | | | | | |
| | | | | | | | | | $ | 3,459 | | | $ | 3,463 | |
| | | | | | | | | | | | | | |
The Corporation’s principal objective in entering into foreign currency derivative agreements is for the management of currency risk and changes in the fair value of assets and liabilities arising from fluctuations in foreign currencies. The Corporation’s policy is that each foreign currency contract be specifically tied to assets or liabilities with the objective of transforming the currency exposure of the hedged instrument to U.S. Dollars (“USD”). On May 31, 2005, the Corporation entered into a loan agreement with Banco Santander Central Hispano in which the Corporation borrowed 19,500,000,000 Japanese Yen (“JPY”) for a six month term at a per annum rate of 0.1866%. The purpose of this loan was to fund activity at the holding company level. Given that the Corporation’s business activity is primarily in U.S. Dollars (“USD”), management decided to hedge the foreign currency exposure arising from this transaction. The Corporation entered into a foreign currency swap (“FX Swap”), of approximately $180 million, with an unrelated third party in which the Corporation sold JPY spot to buy USD and bought JPY forward and sold USD, in this manner eliminating exposure to changes USD/JPY. The implicit economic cost of this transaction is 3.63%, this rate is equivalent to the six-month LIBOR (as of the date of the transaction) plus 9 basis points. Management classified this transaction as a foreign currency cash flow hedge because the FX swap is hedging the principal and interest to be paid at the maturity of the loan contract. The notional value of the FX swap is $183.9 million and matures in late 2005.
The Corporation’s principal objective in holding interest rate swap agreements is the management of interest rate risk and changes in the fair value of assets and liabilities. The Corporation’s policy is that each swap contract be specifically tied to assets or liabilities with the objective of transforming the interest rate characteristic of the hedged instrument. During July 2000, the Corporation swapped $100 million of term funds at a fixed spread over U.S. Treasury securities. These swaps were designated as cash flow hedges and matured in July 2005. As of December 31, 2004, the total amount, net of tax, included in accumulated other comprehensive income pertaining to the $100 million interest rate swap was an unrealized loss of $1.4 million.
As of September 30, 2005, the Corporation also had outstanding interest rate swap agreements, with a notional amount of approximately $2.3 billion, maturing through the year 2032. The weighted average rate paid and received on these contracts is 4.70% and 4.78%, respectively. As of September 30, 2005, the Corporation had retail fixed rate certificates of deposit amounting to approximately $1.3 billion and a subordinated note amounting to approximately $75 million swapped to create a floating rate source of funds, and $974 million of fixed rate mortgage loans swapped to create floating rate assets. These swaps were designated as a fair value hedges. For the nine months ended September 30, 2005, the Corporation recognized a loss of approximately $0.2 million on fair value hedges due to hedge ineffectiveness, which is included in other income in the consolidated statements of income.
21
As of December 31, 2004, the Corporation had outstanding interest rate swap agreements, with a notional amount of approximately $1.5 billion, maturing through the year 2032. The weighted average rate paid and received on these contracts was 4.64% and 4.07%, respectively. As of December 31, 2004, the Corporation had retail fixed rate certificates of deposit amounting to approximately $511.6 million, a subordinated note amounting to approximately $75 million swapped to create a floating rate source of funds, and $930.1 million of fixed rate mortgage loans swapped to create floating rate assets. These swaps were designated as fair value hedges. For the year ended December 31, 2004, the Corporation recognized a gain of approximately $0.6 million on fair value hedges due to hedge ineffectiveness, which is included in other income in the consolidated statements of income.
The $974 million and $930.1 million designated as fair value hedges as of September 30, 2005 and December 31, 2004, respectively, were associated with fixed rate residential mortgage loans that were swapped to create synthetic floating rate assets. In addition to originating residential mortgage loans for its portfolio, the Corporation also purchases fixed rate residential mortgage loans from third parties. Fixed rate mortgage loans expose the Corporation to variability in their fair market value due to changes in interest rates. Management believes it is prudent to limit the variability in the fair market value of a portion of its fixed rate mortgage loan portfolio. To meet this objective, the Corporation has purchased fixed rate 1-4 family residential mortgage loans from local financial institutions (the “Selling Counterparty”), and simultaneously entered into agreements with the Selling Counterparty to convert the fixed rate interest payments on the loans to uncapped floating rate interest payments on the same notional amount. The net effect of these transactions is the creation of a synthetic floating rate mortgage loan (the “Floating Rate Mortgage Loans”) in which the Corporation receives three-month LIBOR plus 150 basis points spread (the “Variable Rate”). At September 30, 2005 and December 31, 2004, the weighted average Variable Rate at period end was 5.40% and 3.82%, respectively; and the weighted average pay fixed rate at each period end was 6.14%.
As of September 30, 2005 and December 31, 2004, $653.2 million and $577.6 million of these Floating Rate Mortgage Loans were subject to a conditional call provision at the option of the Selling Counterparty, in the event the Variable Rate equals or exceeds an agreed upon fixed rate, which approximates the weighted average fixed rate in the underlying mortgage loans (the “Call Rate”). The Selling Counterparty owns the right, and not the obligation, to collapse these transactions at the fair market value of the combined package (Loan and Derivative) as long as this price is not less than the par value. The Corporation entered into all of these transactions at par value, therefore this call option should have no effect on the statement of income since there is no unamortized premium to write-down. The average Call Rate was equal to 6.03% and 6.04% at September 30, 2005 and December 31, 2004, respectively.
The Corporation issues certificates of deposit, individual retirement accounts and notes with returns linked to the different indexes, which constitute embedded derivative instruments that are bifurcated from the host deposit and recognized on the balance sheet. The Corporation enters into option agreements in order to manage the interest rate risk on these deposits and notes; however, these options have not been designated for hedge accounting, therefore gains and losses on the market value of both the embedded derivative instruments and the option contracts are marked to market through earnings and recorded in other gains and losses in the consolidated statements of income. For the nine month period ended September 30, 2005, a loss of approximately $4.1 million was recorded on embedded options on stock-indexed deposits and notes and a gain of approximately $6.4 million was recorded on the option contracts. Included in the option gain is the maturity of $1.0 billion in swaptions that resulted in a gain of approximately $2.3 million. For the year ended December 31, 2004, a loss of approximately $2.4 million was recorded on embedded options on stock-indexed deposits and notes and a gain of approximately $5.3 million was recorded on the option contracts. Included in the option gain is the maturity of $2.0 billion in swaptions that resulted in a gain of approximately $2.9 million.
The Corporation enters into certain derivative transactions with customers, which includes interest rate caps, collars and swaps, and simultaneously hedges the Corporation’s position with related and unrelated third parties under substantially the same terms and conditions. For the nine months ended September 30, 2005 and the year ended December 31, 2004, the Corporation recognized a net loss of $190,000 and $47,000, respectively, on these transactions.
The Corporation enters into loan commitments with customers to extend mortgage loans at a specified rate. These loan commitments are written options and are measured at fair value pursuant to SFAS 133. As of September 30, 2005 the Corporation had loan commitments outstanding for approximately $12.3 million and recognized a loss of $15,000 on these commitments. At December 31, 2004, the Corporation had loan commitments outstanding for approximately $2.4 million and recognized a gain of $3,000 on these commitments.
9. Contingencies and Commitments:
The Corporation is involved as plaintiff or defendant in a variety of routine litigation incidental to the normal course of business. Management believes, based on the opinion of legal counsel, that it has adequate defense with respect of such litigation and that any losses therefrom would not have a material adverse effect on the consolidated results of operations or consolidated financial position of the Corporation.
22
10. Pension Plans:
The Corporation maintains a qualified noncontributory defined benefit pension plan (the “Plan”), which covers substantially all active employees of the Corporation, and a frozen qualified noncontributory defined benefit plan assumed in connection with the 1996 acquisition of Banco Central Hispano de Puerto Rico (the “Central Hispano Plan”).
The components of net periodic benefit cost for the Plan for the nine-month periods and the quarters ended September 30, 2005 and 2004 were as follows:
| | | | | | | | | | | | | | | | |
| | For the nine month periods ended | | | For the quarters ended | |
| | September 30, | | | September 30, | |
| | 2005 | | | 2004 | | | 2005 | | | 2004 | |
| | | | | | (In thousands) | | | | | |
Service cost | | $ | 1,041 | | | $ | 999 | | | $ | 347 | | | $ | 333 | |
Interest cost | | | 1,524 | | | | 1,372 | | | | 508 | | | | 457 | |
Expected return on plan assets | | | (1,602 | ) | | | (1,227 | ) | | | (534 | ) | | | (409 | ) |
Net amortization | | | 342 | | | | (57 | ) | | | 114 | | | | (19 | ) |
| | | | | | | | | | | | |
Periodic benefit cost | | $ | 1,305 | | | $ | 1,087 | | | $ | 435 | | | $ | 362 | |
| | | | | | | | | | | | |
The Plan’s required minimum contribution to be paid during 2005 for the 2005 plan year is zero. The Plan is exempt from this year’s contribution since as of January 1, 2004 the ratio of the plan’s assets to current liabilities was over 100%. However, there was a pending amount payable corresponding to the 2004 plan year. This amount was $1,110,000, and was paid on September 14, 2005.
The components of net periodic benefit cost for the Central Hispano Plan for the nine-month periods and quarters ended September 30, 2005 and 2004 were as follows:
| | | | | | | | | | | | | | | | |
| | For the nine month periods ended | | | For the quarters ended | |
| | September 30, | | | September 30, | |
| | 2005 | | | 2004 | | | 2005 | | | 2004 | |
| | | | | | (In thousands) | | | | | |
Interest cost | | $ | 1,428 | | | $ | 1,484 | | | $ | 476 | | | $ | 495 | |
Expected return on plan assets | | | (1,500 | ) | | | (921 | ) | | | (500 | ) | | | (307 | ) |
Net amortization | | | 315 | | | | — | | | | 105 | | | | — | |
| | | | | | | | | | | | |
Periodic benefit cost | | $ | 243 | | | $ | 563 | | | $ | 81 | | | $ | 188 | |
| | | | | | | | | | | | |
For the Central Hispano Plan the required minimum contribution to be paid during 2005 for the 2005 plan year is $2,054,000.
11. Guarantees:
The Corporation issues financial standby letters of credit to guarantee the performance of its customers to third parties. If the customer fails to meet its financial performance obligation to the third party, then the Corporation would be obligated to make the payment to the guaranteed party. In accordance with the provisions of FIN 45, the Corporation recorded a liability of approximately $1,600,000 and $2,289,000 at September 30, 2005 and December 31, 2004, respectively, which represents the fair value of the obligations undertaken in issuing the guarantees under the standby letters of credit issued or modified after December 31, 2002, net of the related amortization at inception. The fair value approximates the unamortized portion of the fees received from the customers for issuing the standby letters of credit. The fees are deferred and recognized on a straight-line basis over the commitment period. Standby letters of credit outstanding at September 30, 2005 had terms ranging from six months to three years. The contract amounts of the standby letters of credit of approximately $254,210,000 and $244,107,000 at September 30, 2005 and December 31, 2004, respectively, represent the maximum potential amount of future payments the Corporation could be required to make under the guarantees in the event of non-performance by its customers. These standby letters of credit typically expire without being drawn upon. Management does not anticipate any material losses related to these guarantees.
23
12. Segment Information:
Types of Products and Services
The Corporation has four reportable segments: Commercial Banking, Mortgage Banking, Treasury and Investments and Wealth Management. Insurance operations and International Banking are other lines of business in which the Corporation commenced its involvement during 2000 and 2001, respectively. However, no separate disclosures are being provided for these operations, since they do not meet the quantitative thresholds for disclosure of segment information.
Measurement of Segment Profit or Loss and Segment Assets
The Corporation’s reportable business segments are strategic business units that offer distinctive products and services that are marketed through different channels. These are managed separately because of their unique technology, marketing and distribution requirements.
The following presents financial information of reportable segments as of and for the nine-month periods ended September 30, 2005 and 2004. General corporate expenses and income taxes have not been deducted in the determination of operating segment profits. The “Other” column includes the items necessary to reconcile the identified segments to the reported consolidated amounts. Included in the “Other” column are expenses of the internal audit, investors’ relations, strategic planning, administrative services, mail, marketing, public relations, electronic data processing departments and comptroller’s departments, among others. The “Eliminations” column includes all intercompany eliminations for consolidation.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | September 30, 2005 | |
| | Commercial | | | Mortgage | | | Treasury and | | | Wealth | | | | | | | | | | | Consolidated | |
| | Banking | | | Banking | | | Investments | | | Management | | | Other | | | Eliminations | | | Total | |
| | |
| | (In thousands)
|
Total external revenue | | $ | 177,515 | | | $ | 119,639 | | | $ | 72,105 | | | $ | 38,134 | | | $ | 20,231 | | | $ | (11,225 | ) | | $ | 416,399 | |
Intersegment revenue | | | 8,320 | | | | — | | | | — | | | | — | | | | 2,905 | | | | (11,225 | ) | | | — | |
Interest income | | | 149,104 | | | | 113,999 | | | | 58,745 | | | | 1,193 | | | | 1,803 | | | | (8,685 | ) | | | 316,159 | |
Interest expense | | | 39,925 | | | | 42,649 | | | | 71,460 | | | | 1,409 | | | | 5,343 | | | | (8,825 | ) | | | 151,961 | |
Depreciation and amortization | | | 4,374 | | | | 1,127 | | | | 475 | | | | 481 | | | | 3,140 | | | | — | | | | 9,597 | |
Segment income before income tax | | | 55,096 | | | | 68,285 | | | | (2,864 | ) | | | 10,796 | | | | (47,718 | ) | | | (580 | ) | | | 83,015 | |
Segment assets | | $ | 3,393,764 | | | $ | 3,060,283 | | | $ | 2,137,553 | | | $ | 100,928 | | | $ | 293,019 | | | $ | (286,450 | ) | | $ | 8,699,097 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | September 30, 2004 | |
| | Commercial | | | Mortgage | | | Treasury and | | | Wealth | | | | | | | | | | | Consolidated | |
| | Banking | | | Banking | | | Investments | | | Management | | | Other | | | Eliminations | | | Total | |
| | |
| | (In thousands)
|
Total external revenue | | $ | 141,889 | | | $ | 77,217 | | | $ | 88,397 | | | $ | 36,828 | | | $ | 14,133 | | | $ | (6,054 | ) | | $ | 352,410 | |
Intersegment revenue | | | 3,554 | | | | — | | | | 4 | | | | 6 | | | | 2,490 | | | | (6,054 | ) | | | — | |
Interest income | | | 115,730 | | | | 72,824 | | | | 77,581 | | | | 1,094 | | | | 794 | | | | (3,620 | ) | | | 264,403 | |
Interest expense | | | 24,740 | | | | 14,891 | | | | 62,938 | | | | 773 | | | | 1,209 | | | | (3,694 | ) | | | 100,857 | |
Depreciation and amortization | | | 4,692 | | | | 864 | | | | 177 | | | | 242 | | | | 3,965 | | | | — | | | | 9,940 | |
Segment income before income tax | | | 26,486 | | | | 54,564 | | | | 21,529 | | | | 11,301 | | | | (46,024 | ) | | | (651 | ) | | | 67,205 | |
Segment assets | | $ | 3,185,613 | | | $ | 2,434,435 | | | $ | 2,349,530 | | | $ | 91,645 | | | $ | 241,170 | | | $ | (341,358 | ) | | $ | 7,961,035 | |
24
Reconciliation of Segment Information to Consolidated Amounts
Information for the Corporation’s reportable segments in relation to the consolidated totals follows:
| | | | | | | | |
| | September 30, 2005 | | | September 30, 2004 | |
Revenues: | | | | | | | | |
Total revenues for reportable segments | | $ | 407,393 | | | $ | 344,331 | |
Other revenues | | | 20,231 | | | | 14,133 | |
Elimination of intersegment revenues | | | (11,225 | ) | | | (6,054 | ) |
| | | | | | |
Total consolidated revenues | | $ | 416,399 | | | $ | 352,410 | |
| | | | | | |
Total income before tax of reportable segments | | $ | 131,313 | | | $ | 113,880 | |
Income before tax of other segments | | | (47,718 | ) | | | (46,024 | ) |
Elimination of intersegment income before tax | | | (580 | ) | | | (651 | ) |
| | | | | | |
Consolidated income before tax | | $ | 83,015 | | | $ | 67,205 | |
| | | | | | |
| | | | | | | | |
Assets: | | | | | | | | |
Total assets for reportable segments | | $ | 8,692,528 | | | $ | 8,061,223 | |
Assets not attributed to segments | | | 293,019 | | | | 241,170 | |
Elimination of intersegment assets | | | (286,450 | ) | | | (341,358 | ) |
| | | | | | |
Total consolidated assets | | $ | 8,699,097 | | | $ | 7,961,035 | |
| | | | | | |
25
PART I — ITEM 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
26
Santander BanCorp
Selected Financial Data
(Dollars in thousands, except share and per share data)
| | | | | | | | | | | | | | | | |
| | Nine month periods ended | | | Quarters ended | |
| | September 30, | | | September 30, | |
| | 2005 | | | 2004 | | | 2005 | | | 2004 | |
CONDENSED INCOME STATEMENTS | | | | | | | | | | | | | | | | |
Interest income | | $ | 316,159 | | | $ | 264,403 | | | $ | 111,953 | | | $ | 92,449 | |
Interest expense | | | 151,961 | | | | 100,857 | | | | 56,893 | | | | 36,510 | |
| | | | | | | | | | | | |
Net interest income | | | 164,198 | | | | 163,546 | | | | 55,060 | | | | 55,939 | |
Gain on sale of securities | | | 17,838 | | | | 11,465 | | | | 462 | | | | 2,462 | |
Gain (loss) on extinguishment of debt | | | (5,959 | ) | | | — | | | | 784 | | | | — | |
Other income | | | 88,361 | | | | 76,542 | | | | 27,422 | | | | 25,936 | |
Operating expenses | | | (166,023 | ) | | | (162,578 | ) | | | (55,926 | ) | | | (53,851 | ) |
Provision for loan losses | | | (15,400 | ) | | | (21,770 | ) | | | (4,650 | ) | | | (7,020 | ) |
Income tax | | | (21,186 | ) | | | (4,075 | ) | | | (6,087 | ) | | | (1,597 | ) |
| | | | | | | | | | | | |
Net income | | $ | 61,829 | | | $ | 63,130 | | | $ | 17,065 | | | $ | 21,869 | |
| | | | | | | | | | | | |
PER COMMON SHARE DATA | | | | | | | | | | | | | | | | |
Net income | | $ | 1.33 | | | $ | 1.35 | | | $ | 0.37 | | | $ | 0.47 | |
Book value | | $ | 12.16 | | | $ | 11.28 | | | $ | 12.16 | | | $ | 11.28 | |
Outstanding shares: | | | | | | | | | | | | | | | | |
Average | | | 46,639,104 | | | | 46,639,104 | | | | 46,639,104 | | | | 46,639,104 | |
End of period | | | 46,639,104 | | | | 46,639,104 | | | | 46,639,104 | | | | 46,639,104 | |
Cash Dividend per Share | | $ | 0.48 | | | $ | 0.33 | | | $ | 0.16 | | | $ | 0.11 | |
AVERAGE BALANCES | | | | | | | | | | | | | | | | |
Loans held for sale and loans, net of allowance for loans losses | | $ | 5,829,538 | | | $ | 4,564,864 | | | $ | 6,137,775 | | | $ | 4,941,830 | |
Allowance for loan losses | | | 68,424 | | | | 73,576 | | | | 65,809 | | | | 73,200 | |
Earning assets | | | 7,896,436 | | | | 7,235,495 | | | | 8,061,275 | | | | 7,594,167 | |
Total assets | | | 8,284,626 | | | | 7,547,614 | | | | 8,448,636 | | | | 7,907,551 | |
Deposits | | | 5,113,112 | | | | 4,094,189 | | | | 5,394,153 | | | | 4,185,367 | |
Borrowings | | | 2,387,325 | | | | 2,797,027 | | | | 2,228,605 | | | | 3,047,510 | |
Common equity | | | 582,077 | | | | 489,888 | | | | 572,011 | | | | 507,619 | |
PERIOD END BALANCES | |
Loans held for sale and loans, net of allowance for loans losses | | $ | 6,143,520 | | | $ | 5,201,079 | | | $ | 6,143,520 | | | $ | 5,201,079 | |
Allowance for loan losses | | | 66,051 | | | | 70,731 | | | | 66,051 | | | | 70,731 | |
Earning assets | | | 8,400,692 | | | | 7,700,373 | | | | 8,400,692 | | | | 7,700,373 | |
Total assets | | | 8,699,097 | | | | 7,961,035 | | | | 8,699,097 | | | | 7,961,035 | |
Deposits | | | 5,868,698 | | | | 4,516,193 | | | | 5,868,698 | | | | 4,516,193 | |
Borrowings | | | 2,010,926 | | | | 2,763,209 | | | | 2,010,926 | | | | 2,763,209 | |
Common equity | | | 567,126 | | | | 526,237 | | | | 567,126 | | | | 526,237 | |
Continued
27
| | | | | | | | | | | | | | | | |
| | Nine month periods ended | | Quarters ended |
| | September 30, | | September 30, |
| | 2005 | | 2004 | | 2005 | | 2004 |
SELECTED RATIOS | | | | | | | | | | | | | | | | |
Performance: | | | | | | | | | | | | | | | | |
Net interest margin on a tax-equivalent basis (on an annualized basis) | | | 2.94 | % | | | 3.28 | % | | | 2.80 | % | | | 3.19 | % |
Efficiency ratio (1) | | | 63.41 | % | | | 64.65 | % | | | 66.25 | % | | | 61.97 | % |
Return on average total assets (on an annualized basis) | | | 1.00 | % | | | 1.12 | % | | | 0.80 | % | | | 1.10 | % |
Return on average common equity (on an annualized basis) | | | 14.20 | % | | | 17.21 | % | | | 11.84 | % | | | 17.14 | % |
Dividend payout | | | 36.09 | % | | | 24.44 | % | | | 43.24 | % | | | 23.40 | % |
Average net loans/average total deposits | | | 114.01 | % | | | 111.50 | % | | | 113.79 | % | | | 118.07 | % |
Average earning assets/average total assets | | | 95.31 | % | | | 95.86 | % | | | 95.42 | % | | | 96.04 | % |
Average stockholders’ equity/average assets | | | 7.03 | % | | | 6.49 | % | | | 6.77 | % | | | 6.42 | % |
Fee income to average assets (annualized) | | | 1.16 | % | | | 1.19 | % | | | 1.17 | % | | | 1.14 | % |
Capital: | | | | | | | | | | | | | | | | |
Tier I capital to risk-adjusted assets | | | 9.41 | % | | | 9.32 | % | | | 9.41 | % | | | 9.32 | % |
Total capital to risk-adjusted assets | | | 11.88 | % | | | 10.87 | % | | | 11.88 | % | | | 10.87 | % |
Leverage Ratio | | | 6.38 | % | | | 6.13 | % | | | 6.38 | % | | | 6.13 | % |
Asset quality: | | | | | | | | | | | | | | | | |
Non-performing loans to total loans | | | 1.15 | % | | | 1.84 | % | | | 1.15 | % | | | 1.84 | % |
Annualized net charge-offs to average loans | | | 0.42 | % | | | 0.60 | % | | | 0.27 | % | | | 0.27 | % |
Allowance for loan losses to period-end loans | | | 1.06 | % | | | 1.34 | % | | | 1.06 | % | | | 1.34 | % |
Allowance for loan losses to non-performing loans | | | 92.82 | % | | | 73.05 | % | | | 92.82 | % | | | 73.05 | % |
Allowance for loan losses to non-performing loans plus accruing loans past-due 90 days or more | | | 85.29 | % | | | 70.87 | % | | | 85.29 | % | | | 70.87 | % |
Non-performing assets to total assets | | | 0.90 | % | | | 1.26 | % | | | 0.90 | % | | | 1.26 | % |
Recoveries to charge-offs | | | 17.96 | % | | | 32.86 | % | | | 17.41 | % | | | 49.83 | % |
OTHER DATA AT END OF PERIOD | | | | | | | | | | | | | | | | |
Customer financial assets under management | | $ | 13,584,100 | | | $ | 12,065,000 | | | $ | 13,584,100 | | | $ | 12,065,000 | |
Total branches | | | 65 | | | | 65 | | | | 65 | | | | 65 | |
ATMs | | | 150 | | | | 149 | | | | 150 | | | | 149 | |
(Concluded)
| | |
(1) | | Operating expenses divided by net interest income on a tax equivalent basis, plus other income excluding securities gains and losses, loss on extinguishment of debt, and gain on sale of building in 2004. |
28
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This financial discussion contains an analysis of the consolidated financial position and consolidated results of operations of the Corporation and should be read in conjunction with the consolidated financial statements, notes and tables included elsewhere in this report.
Critical Accounting Policies
The consolidated financial statements of the Corporation are prepared in accordance with accounting principles generally accepted in the United States of America (hereinafter referred to as “generally accepted accounting principles” or “GAAP”) and with general practices within the financial services industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The Corporation’s critical accounting policies are detailed in the Financial Review and Supplementary Information section of the Corporation’s Form 10-K for the year ended December 31, 2004.
Overview of Results of Operations for the Nine-Month Period and the Quarter Ended September 30, 2005
Santander BanCorp is the financial holding company for Banco Santander Puerto Rico and subsidiaries (the “Bank”), Santander Securities Corporation and subsidiary, and Santander Insurance Agency, Inc.
Santander BanCorp (the “Corporation”) reported net income of $61.8 million for the nine-month period ended September 30, 2005, compared with $63.1 million for the same period in 2004, a decrease of 2.1%. EPS for the nine-month periods ended September 30, 2005 and 2004 were $1.33 and $1.35, respectively, based on 46,639,104 average common shares for each period. Return on average total assets (ROA) on an annualized basis and return on average common equity (ROE) on an annualized basis for the nine-month period ended September 30, 2005 were 1.00% and 14.20%, respectively, compared with 1.12% and 17.21% reported during the same nine-month period of 2004. The Efficiency Ratio1 for the nine months ended September 30, 2005 reflected an improvement of 124 basis point reaching 63.41% compared to 64.65% for the nine months ended September 30, 2004.
For the third quarter of 2005, the Corporation reported net income of $17.1 million, compared with $21.9 million for the same period in 2004, a decrease of $4.8 million. Earnings per common share (EPS) for the quarters ended September 30, 2005 and 2004 were $0.37 and $0.47, respectively, based on 46,639,104 average shares for each period. ROA and ROE, on an annualized basis, for the quarter ended September 30, 2005 were 0.80% and 11.84%, respectively, compared with 1.10% and 17.14% reported during the same quarter of 2004. The Efficiency Ratio1 for the quarter ended September 30, 2005 was 66.25% compared to 61.97% for the quarter ended September 30, 2004.
The decrease of $1.3 million or 2.1% in net income for the nine-month period ended September 30, 2005 compared to the same period in 2004 was principally due to an increase of $17.1 million in income tax expense and operating expenses of $3.4 million. These changes were reduced by a decrease of $6.4 million or 29.3% in the provision for loan losses and increases in other income of $12.2 million or 13.9% and $0.7 million in net interest income.
The decrease of $4.8 million or 22.0% in net income for the quarter ended September 30, 2005 compared to the same period in 2004 was principally due to an increase of $4.5 million in the provision for income taxes and $2.1 million in operating expenses. These changes were reduced by a decrease in the provision for loan losses of $2.4 million.
| | |
1 | | On a tax equivalent basis. |
29
Net Interest Income
To permit the comparison of returns on assets with different tax attributes, the interest income on tax-exempt assets has been adjusted by an amount equal to the income taxes which would have been paid had the income been fully taxable. This tax equivalent adjustment is derived using the applicable statutory tax rate and resulted in adjustments of $9.3 million and $14.1 million for the nine month periods ended September 30, 2005 and 2004, respectively. For the quarters ended September 30, 2005 and 2004 the tax equivalent adjustments were $1.9 million and $5.0 million, respectively.
The tables on page 33 and 34, Quarter to Date Average Balance Sheet and Summary of Net Interest Income – Tax Equivalent Basis and Year to Date Average Balance Sheet and Summary of Net Interest Income – Tax Equivalent Basis, respectively, present average balance sheets, net interest income on a tax equivalent basis and average interest rates for the third quarter of 2005 and 2004 and the nine month periods then ended. The table on Interest Variance Analysis — Tax Equivalent Basis on page 30, allocates changes in the Corporation’s interest income (on a tax-equivalent basis) and interest expense between changes in the average volume of interest earning assets and interest bearing liabilities and changes in their respective interest rates for the nine month period and third quarter of 2005 compared with the same periods of 2004.
The following table sets forth the principal components of the Corporation’s net interest income (on a tax-equivalent basis) for the nine month periods and the quarters ended September 30, 2005 and 2004.
| | | | | | | | | | | | | | | | |
| | Nine Month Periods Ended | | | Quarters Ended | |
| | Sept. 30, 2005 | | | Sept. 30, 2004 | | | Sept. 30, 2005 | | | Sept. 30, 2004 | |
| | | | | | (Dollars in thousands) | | | | | |
Interest income — tax equivalent basis | | $ | 325,410 | | | $ | 278,544 | | | $ | 113,883 | | | $ | 97,474 | |
Interest expense | | | 151,961 | | | | 100,857 | | | | 56,893 | | | | 36,510 | |
| | | | | | | | | | | | |
Net interest income — tax equivalent basis | | $ | 173,449 | | | $ | 177,687 | | | $ | 56,990 | | | $ | 60,964 | |
| | | | | | | | | | | | |
Net interest margin — tax equivalent basis (1) | | | 2.94 | % | | | 3.28 | % | | | 2.80 | % | | | 3.19 | % |
| | |
(1) | | Net interest margin (on an annualized basis) for any period equals tax-equivalent net interest income divided by average interest-earning assets for the period . |
The higher short-term interest rate scenario has impacted our net margin during 2005. The increase in short-term interest rates was mainly due to the increase by the Federal Reserve of the discount rate by 275 basis points during the period from June 2004 to September 2005. The increase in short-term rates with only a minor repricing of long-term rates has resulted in a flattening of the yield curve.
For the nine-month period ended September 30, 2005, net interest income on a tax equivalent basis amounted to $173.5 million, a decrease of 2.4% compared to $177.7 million reported for the same period in 2004. The decrease is mainly attributed to an increment of 82 basis points in the cost of funds while the yield in interest earning assets increased 37 basis points. Average net loans increased $1.3 billion or 27.7% for the nine-month period ended September 30, 2005, compared to the same period in 2004. Additional, there was an increase in average interest bearing deposits of $22.5 million. These increases were partially offset by a reduction in average investment securities of $626.2 million, or 26.1% and an increment in average interest bearing liabilities of $577.5 or 9.3% as compared to September 30, 2004.
For the quarter ended September 30, 2005, net interest income on a tax equivalent basis amounted to $57.0 million, a decrease of 6.5% compared to $61 million for the third quarter in 2004. This decrease was principally due to an increase in the cost of funds of 103 basis points that was partially offset by an increase in the yield on interest earning assets of 49 basis points.
For the third quarter of 2005 average interest earning assets increased by $467.1 million while average interest bearing liabilities increased $392.9 million. The increase in average interest earning assets compared to the third quarter of 2004 was driven by an increase in average net loans of $1.2 billion which was partially offset by a decrease in average investment securities of $698.1 million. The decrease in investment securities is mainly attributed to the sale of $785 million of securities during the first quarter of 2005 resulting in a reduction in the yield on investment securities of 78 basis points from 4.94% for the quarter ended September 30, 2004 to 4.16% for the quarter ended September 30, 2005, which further explains the reduction in net interest income for the quarter. The above mentioned sale generated a gain of $16.9 million that
30
was partially offset by a loss of $6 million on the extinguishment of certain term repo transactions that were funding part of the securities sold. The increase in average interest bearing liabilities of $392.9 million was driven by an increase in average time deposits and brokered deposits of $439.4 million and $737.1 million, respectively, being partially offset by a decrease in average borrowings of $775.1 million as compared to the quarter ended September 30, 2004.
The following table allocates changes in the Corporation’s interest income, on a tax-equivalent basis, and interest expense for the nine month period and the quarter ended September 30, 2005 compared to the nine month period and the quarter ended September 30, 2004, between changes related to the volume of average interest earning assets and average interest bearing liabilities, and changes related to interest rates. Volume and rate variances have been calculated based on the activity in average balances over the period and changes in interest rates on average interest earning assets and average interest bearing liabilities. The changes that are not due solely to volume or rate are allocated to volume and rate based on the proportion of change in each category.
INTEREST VARIANCE ANALYSIS
on a Tax Equivalent Basis
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Month Period Ended September 30, 2005 | | | Quarter ended September 30, 2005 | |
| | Compared to the Nine Month Period | | | Compared to the Quarter Ended | |
| | Ended September 30, 2004 | | | September 30, 2004 | |
| | Increase (Decrease) Due to Change in: | | | Increase (Decrease) Due to Change in: | |
| | Volume | | | Rate | | | Total | | | Volume | | | Rate | | | Total | |
| | | | | |
| | (In thousands) | |
Interest income, on a tax equivalent basis: | | | | | | | | | | | | | | | | | | | | | | | | |
Federal funds sold and securities purchased under agreements to resell | | $ | (586 | ) | | $ | 2,058 | | | $ | 1,472 | | | $ | (606 | ) | | $ | 629 | | | $ | 23 | |
Time deposits with other banks | | | 1,094 | | | | 1,074 | | | | 2,168 | | | | 503 | | | | 353 | | | | 856 | |
Investment securities | | | (22,218 | ) | | | (4,762 | ) | | | (26,980 | ) | | | (7,790 | ) | | | (4,093 | ) | | | (11,883 | ) |
Loans | | | 54,858 | | | | 15,348 | | | | 70,206 | | | | 17,596 | | | | 9,817 | | | | 27,413 | |
| | | | | | | | | | | | | | | | | | |
Total interest income, on a tax equivalent basis | | | 33,148 | | | | 13,718 | | | | 46,866 | | | | 9,703 | | | | 6,706 | | | | 16,409 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest expense: | | | | | | | | | | | | | | | | | | | | | | | | |
Savings and NOW accounts | | | 644 | | | | 9,610 | | | | 10,254 | | | | 120 | | | | 3,891 | | | | 4,011 | |
Other time deposits | | | 18,470 | | | | 17,547 | | | | 36,017 | | | | 8,703 | | | | 7,054 | | | | 15,757 | |
Borrowings | | | (7,501 | ) | | | 15,013 | | | | 7,512 | | | | (6,161 | ) | | | 6,803 | | | | 642 | |
Long-term borrowings | | | (2,013 | ) | | | (666 | ) | | | (2,679 | ) | | | (429 | ) | | | 402 | | | | (27 | ) |
| | | | | | | | | | | | | | | | | | |
Total interest expense | | | 9,600 | | | | 41,504 | | | | 51,104 | | | | 2,233 | | | | 18,150 | | | | 20,383 | |
| | | | | | | | | | | | | | | | | | |
|
Net interest income, on a tax equivalent basis | | $ | 23,548 | | | $ | (27,786 | ) | | $ | (4,238 | ) | | $ | 7,470 | | | $ | (11,444 | ) | | $ | (3,974 | ) |
| | | | | | | | | | | | | | | | | | |
For the nine months ended September 30, 2005, the Corporation’s interest income on a tax equivalent basis increased $46.9 million to $325.4 million from $278.5 million for the same period in 2004. The $46.9 million increase in tax equivalent interest income is attributable to a $33.2 million increase related to the volume of average interest earning assets and a $13.7 million increase related to the yield on such assets.
Average interest earning assets increased 9.1% for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004. This increase was due mainly to an increase in average net loans of $1.3 billion or 27.7% which was partially offset by a decrease in average investment securities of $626.2 million or 26.1%. The increase in average net loans was due to an increase in the average mortgage loan portfolio of 52.5% or $976.8 million during the nine month period of 2005 compared to the same period in 2004. Average commercial loans also increased 9.9% or $203.1 million and consumer loans reflected an increase of 21.1% or $86.3 million during the same periods. The decrease in investment securities was mainly attributed to the sale of $785 million of securities during the first quarter of 2005.
The Corporation’s interest expense for the nine months ended September 30, 2005 increased $51.1 million or 50.7% compared to the nine months ended September 30, 2004. This increase was attributable to a $9.6 million increase related to the volume of interest bearing liabilities and a $41.5 million increase related to the cost of interest bearing liabilities. The increase in interest expense was due, in part, to a growth in average interest bearing liabilities of $577.5 million or 9.3% for the nine month periods of 2005 compared to the same period in 2004, comprised of increase in average interest bearing deposits of $987.3 million and offset by a decrease in average total borrowings of $409.7 million.
The Corporation’s interest income on a tax equivalent basis increased $16.4 million, or 16.8% to $113.9 million for the quarter ended September 30, 2005 from $97.5 million for the quarter ended September 30, 2004. The increase of $16.4
31
million in tax equivalent interest income is attributable to a $9.7 million increase related to the volume of average interest earning assets and a $6.7 million increase related to the yield on such assets.
Average interest earning assets increased 6.2% for the quarter ended September 30, 2005 compared to the third quarter of 2004. This change was primarily driven by an increase in average net loans, which rose 24.2% or $1.2 billion for the third quarter of 2005 compared to the same period in 2004. Due to the continued low interest rate scenario in the mortgage lending market, the average mortgage loan portfolio reflected a growth of 39.5% or $867.3 million. Management continued to place a high emphasis on the mortgage loan portfolio due to the low interest rate scenario and the active market for residential real estate in Puerto Rico. The consumer loan portfolio also reflected an increase of 21.3% or $93.4 million as a result of the Corporation’s marketing strategies to increase its participation in this sector by offering innovative and attractive loan products and credit cards. Average commercial loans reflected an increase of 10.74% or $221.7 million. Average investment securities reflected a decrease of 29.5% or $698.1 million for the third quarter of 2005 compared to the third quarter of 2004 due to the sale of $785 million of investment securities during the first quarter of 2005. Average interest bearing deposits also decreased $30.8 million during the third quarter of 2005, when compared to the same quarter of 2004.
The average yield on interest earning assets for the nine months and the quarter ended September 30, 2005 increased 37 and 49 basis points, respectively compared to the same periods in 2004. These increases were a result of the higher interest rate scenario, specifically, the commercial loan portfolio has a high proportion of loans with floating rates which resulted in an increase in the average yield of this portfolio of 112 basis points for the nine month period and 140 basis points for the quarter ended September 30, 2005 compared to the same periods in 2004. This was partially offset by lower rates on consumer loans during 2005.
The Corporation’s interest expense for the quarter ended September 30, 2005 increased by 55.8% to $56.9 million from $36.5 million for the quarter ended September 30, 2004. The $20.4 million increase in interest expense is attributable to a $2.2 million increase related to the volume of interest bearing liabilities and an $18.2 million increase related to the cost of interest bearing liabilities. This increase in interest expense was attributed to a growth of 6% or $392.9 million in average interest bearing liabilities, as well as an increase of 103 basis points in the average cost of interest bearing liabilities due to short term interest rate increases. There was an increase of 34.3% or $1.2 billion in the average balance of interest bearing deposits during the third quarter of 2005 compared to the same period in 2004. There was also a decrease of $818.9 million or 26.9% in average borrowings (including term and subordinated notes).
The following tables show average balances and, where applicable, interest amounts earned on a tax-equivalent basis and average rates for the Corporation’s assets and liabilities and stockholders’ equity for the quarters and nine months ended September 30, 2005 and 2004.
32
SANTANDER BANCORP
QUARTER TO DATE AVERAGE BALANCE SHEET AND SUMMARY OF NET INTEREST INCOME
Tax Equivalent Basis
| | | | | | | | | | | | | | | | | | | | | | | | |
| | September 30, 2005 | | | September 30, 2004 | |
| | | | | | | | | | Annualized | | | | | | | | | | | Annualized | |
| | Average | | | | | | | Average | | | Average | | | | | | | Average | |
| | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | |
| | | | | | |
| | | | | | | | | | (Dollars in thousands) | | | | | | | | | |
Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest bearing deposits | | $ | 159,874 | | | $ | 1,194 | | | | 2.96 | % | | $ | 78,344 | | | $ | 338 | | | | 1.72 | % |
Federal funds sold and securities purchased under agreements to resell | | | 92,455 | | | | 822 | | | | 3.53 | % | | | 204,764 | | | | 799 | | | | 1.55 | % |
| | | | | | | | | | | | | | | | |
Total interest bearing deposits | | | 252,329 | | | | 2,016 | | | | 3.17 | % | | | 283,108 | | | | 1,137 | | | | 1.60 | % |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
U.S.Treasury securities | | | 3,359 | | | | 26 | | | | 3.07 | % | | | 8,076 | | | | 27 | | | | 1.33 | % |
Obligations of other U.S. government agencies and corporations | | | 719,915 | | | | 7,647 | | | | 4.21 | % | | | 1,177,629 | | | | 16,490 | | | | 5.57 | % |
Obligations of the government of Puerto Rico and political subdivisions | | | 71,934 | | | | 960 | | | | 5.29 | % | | | 48,167 | | | | 921 | | | | 7.61 | % |
Collateralized mortgage obligations and mortgage backed securities | | | 824,214 | | | | 8,431 | | | | 4.06 | % | | | 1,100,014 | | | | 11,531 | | | | 4.17 | % |
Other | | | 51,749 | | | | 480 | | | | 3.68 | % | | | 35,343 | | | | 458 | | | | 5.16 | % |
| | | | | | | | | | | | | | | | |
Total investment securities | | | 1,671,171 | | | | 17,544 | | | | 4.16 | % | | | 2,369,229 | | | | 29,427 | | | | 4.94 | % |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Loans: | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 2,286,166 | | | | 33,725 | | | | 5.85 | % | | | 2,064,476 | | | | 23,127 | | | | 4.46 | % |
Construction | | | 201,278 | | | | 4,198 | | | | 8.27 | % | | | 203,473 | | | | 2,767 | | | | 5.41 | % |
Consumer | | | 531,205 | | | | 12,488 | | | | 9.33 | % | | | 437,766 | | | | 11,337 | | | | 10.30 | % |
Mortgage | | | 3,063,807 | | | | 42,012 | | | | 5.44 | % | | | 2,196,500 | | | | 27,702 | | | | 5.02 | % |
Lease financing | | | 121,128 | | | | 1,900 | | | | 6.22 | % | | | 112,815 | | | | 1,977 | | | | 6.97 | % |
| | | | | | | | | | | | | | | | |
Gross loans | | | 6,203,584 | | | | 94,323 | | | | 6.03 | % | | | 5,015,030 | | | | 66,910 | | | | 5.31 | % |
Allowance for loan losses | | | (65,809 | ) | | | | | | | | | | | (73,200 | ) | | | | | | | | |
| | | | | | | | | | | | | | | | |
Loans, net | | | 6,137,775 | | | | 94,323 | | | | 6.10 | % | | | 4,941,830 | | | | 66,910 | | | | 5.39 | % |
Total interest earning assets/ interest income (on a tax equivalent basis) | | | 8,061,275 | | | | 113,883 | | | | 5.60 | % | | | 7,594,167 | | | | 97,474 | | | | 5.11 | % |
| | | | | | | | | | | | | | | | |
Total non-interest earning assests | | | 387,361 | | | | | | | | | | | | 313,384 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 8,448,636 | | | | | | | | | | | $ | 7,907,551 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Liabilities and stockholders’ equity: | | | | | | | | | | | | | | | | | | | | | | | | |
Savings and NOW accounts | | $ | 1,960,629 | | | $ | 10,458 | | | | 2.12 | % | | $ | 1,925,289 | | | $ | 6,447 | | | | 1.33 | % |
Other time deposits | | | 1,651,407 | | | | 14,432 | | | | 3.47 | % | | | 1,211,994 | | | | 6,131 | | | | 2.01 | % |
Brokered deposits | | | 1,132,741 | | | | 10,282 | | | | 3.60 | % | | | 395,643 | | | | 2,826 | | | | 2.84 | % |
| | | | | | | | | | | | | | | | |
Total interest bearing deposits | | | 4,744,777 | | | | 35,172 | | | | 2.94 | % | | | 3,532,926 | | | | 15,404 | | | | 1.73 | % |
Borrowings | | | 2,111,803 | | | | 20,382 | | | | 3.83 | % | | | 2,886,927 | | | | 19,740 | | | | 2.72 | % |
Term Notes | | | 42,243 | | | | 544 | | | | 5.11 | % | | | 144,658 | | | | 1,341 | | | | 3.69 | % |
Subordinated Notes | | | 74,559 | | | | 795 | | | | 4.23 | % | | | 15,925 | | | | 25 | | | | 0.62 | % |
| | | | | | | | | | | | | | | | |
Total interest bearing liabilities/interest expense | | | 6,973,382 | | | | 56,893 | | | | 3.24 | % | | | 6,580,436 | | | | 36,510 | | | | 2.21 | % |
| | | | | | | | | | | | | | | | |
Total non-interest bearing liabilities | | | 903,243 | | | | | | | | | | | | 819,496 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | | 7,876,625 | | | | | | | | | | | | 7,399,932 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Stockholders’ Equity | | | 572,011 | | | | | | | | | | | | 507,619 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 8,448,636 | | | | | | | | | | | $ | 7,907,551 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Net interest income, on a tax equivalent basis | | | | | | $ | 56,990 | | | | | | | | | | | $ | 60,964 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Net interest spread | | | | | | | | | | | 2.36 | % | | | | | | | | | | | 2.90 | % |
Cost of funding earning assets | | | | | | | | | | | 2.80 | % | | | | | | | | | | | 1.91 | % |
Net interest margin, on a tax equivalent basis | | | | | | | | | | | 2.80 | % | | | | | | | | | | | 3.19 | % |
33
SANTANDER BANCORP
YEAR TO DATE AVERAGE BALANCE SHEET AND SUMMARY OF NET INTEREST INCOME
Tax Equivalent Basis
| | | | | | | | | | | | | | | | | | | | | | | | |
| | September 30, 2005 | | | September 30, 2004 | |
| | | | | | | | | | Annualized | | | | | | | | | | | Annualized | |
| | Average | | | | | | | Average | | | Average | | | | | | | Average | |
| | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | |
| | | | | | |
| | (Dollars in thousands) | |
Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest bearing deposits | | $ | 134,244 | | | $ | 2,741 | | | | 2.73 | % | | $ | 61,059 | | | $ | 573 | | | | 1.25 | % |
Federal funds sold and securities purchased under agreements to resell | | | 159,163 | | | | 3,490 | | | | 2.93 | % | | | 209,838 | | | | 2,018 | | | | 1.28 | % |
| | | | | | | | | | | | | | | | |
Total interest bearing deposits | | | 293,407 | | | | 6,231 | | | | 2.84 | % | | | 270,897 | | | | 2,591 | | | | 1.28 | % |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
U.S.Treasury securities | | | 4,775 | | | | 84 | | | | 2.35 | % | | | 5,000 | | | | 42 | | | | 1.12 | % |
Obligations of other U.S.government agencies and corporations | | | 904,694 | | | | 34,397 | | | | 5.08 | % | | | 1,087,760 | | | | 45,630 | | | | 5.60 | % |
Obligations of the government of Puerto Rico and political subdivisions | | | 78,795 | | | | 3,187 | | | | 5.41 | % | | | 45,106 | | | | 2,794 | | | | 8.27 | % |
Collateralized mortgage obligations and mortgage backed securities | | | 737,664 | | | | 23,463 | | | | 4.25 | % | | | 1,224,876 | | | | 38,616 | | | | 4.21 | % |
Other | | | 47,563 | | | | 1,139 | | | | 3.20 | % | | | 36,992 | | | | 2,168 | | | | 7.83 | % |
| | | | | | | | | | | | | | | | |
Total investment securities | | | 1,773,491 | | | | 62,270 | | | | 4.69 | % | | | 2,399,734 | | | | 89,250 | | | | 4.97 | % |
| | | | | | | | | | | | | | | | |
Loans: | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 2,250,759 | | | | 90,899 | | | | 5.40 | % | | | 2,047,663 | | | | 65,850 | | | | 4.30 | % |
Construction | | | 196,355 | | | | 10,652 | | | | 7.25 | % | | | 208,979 | | | | 7,930 | | | | 5.07 | % |
Consumer | | | 495,973 | | | | 35,711 | | | | 9.63 | % | | | 409,701 | | | | 34,614 | | | | 11.29 | % |
Mortgage | | | 2,838,481 | | | | 113,977 | | | | 5.37 | % | | | 1,861,659 | | | | 72,292 | | | | 5.19 | % |
Lease financing | | | 116,394 | | | | 5,670 | | | | 6.51 | % | | | 110,438 | | | | 6,017 | | | | 7.28 | % |
| | | | | | | | | | | | | | | | |
Gross loans | | | 5,897,962 | | | | 256,909 | | | | 5.82 | % | | | 4,638,440 | | | | 186,703 | | | | 5.38 | % |
Allowance for loan losses | | | (68,424 | ) | | | | | | | | | | | (73,576 | ) | | | | | | | | |
| | | | | | | | | | | | | | | | |
Loans, net | | | 5,829,538 | | | | 256,909 | | | | 5.89 | % | | | 4,564,864 | | | | 186,703 | | | | 5.46 | % |
Total interest earning assets/ interest income (on a tax equivalent basis) | | | 7,896,436 | | | | 325,410 | | | | 5.51 | % | | | 7,235,495 | | | | 278,544 | | | | 5.14 | % |
| | | | | | | | | | | | | | | | |
Total non-interest earning assests | | | 388,190 | | | | | | | | | | | | 312,119 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 8,284,626 | | | | | | | | | | | $ | 7,547,614 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Liabilities and stockholders’ equity: | | | | | | | | | | | | | | | | | | | | | | | | |
Savings and NOW accounts | | $ | 1,963,244 | | | $ | 28,348 | | | | 1.93 | % | | $ | 1,897,769 | | | $ | 18,094 | | | | 1.27 | % |
Other time deposits | | | 1,572,065 | | | | 36,650 | | | | 3.12 | % | | | 1,170,315 | | | | 16,296 | | | | 1.86 | % |
Brokered deposits | | | 896,512 | | | | 23,388 | | | | 3.49 | % | | | 376,487 | | | | 7,725 | | | | 2.74 | % |
| | | | | | | | | | | | | | | | |
Total interest bearing deposits | | | 4,431,821 | | | | 88,386 | | | | 2.67 | % | | | 3,444,571 | | | | 42,115 | | | | 1.63 | % |
Borrowings | | | 2,278,038 | | | | 60,579 | | | | 3.56 | % | | | 2,616,945 | | | | 53,067 | | | | 2.71 | % |
Term Notes | | | 36,178 | | | | 902 | | | | 3.33 | % | | | 165,446 | | | | 5,621 | | | | 4.54 | % |
Subordinated Notes | | | 73,109 | | | | 2,094 | | | | 3.83 | % | | | 14,636 | | | | 54 | | | | 0.49 | % |
| | | | | | | | | | | | | | | | |
Total interest bearing liabilities/interest expense | | | 6,819,146 | | | | 151,961 | | | | 2.98 | % | | | 6,241,598 | | | | 100,857 | | | | 2.16 | % |
| | | | | | | | | | | | | | | | |
Total non-interest bearing liabilities | | | 883,403 | | | | | | | | | | | | 816,128 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | | 7,702,549 | | | | | | | | | | | | 7,057,726 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Stockholders’ Equity | | | 582,077 | | | | | | | | | | | | 489,888 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 8,284,626 | | | | | | | | | | | $ | 7,547,614 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Net interest income, on a tax equivalent basis | | | | | | $ | 173,449 | | | | | | | | | | | $ | 177,687 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Net interest spread | | | | | | | | | | | 2.53 | % | | | | | | | | | | | 2.98 | % |
Cost of funding earning assets | | | | | | | | | | | 2.57 | % | | | | | | | | | | | 1.86 | % |
Net interest margin, on a tax equivalent basis | | | | | | | | | | | 2.94 | % | | | | | | | | | | | 3.28 | % |
34
Provision for Loan Losses
The Corporation’s provision for loan losses for the nine months ended September 30, 2005 decreased $6.4 million or 29.3% compared to the same period in 2004. For the quarter ended September 30, 2005, the reduction in the provision for loan losses was $2.4 million or 33.8% from $7.0 million for the quarter ended September 30, 2004. The reduction in the provision for loan losses was due to a 26.5% decrease in non-performing loans which are down to $71.2 million as of September 30, 2005, from $96.8 million as of September 30, 2004, and $87.5 million as of December 31, 2004.
Refer to the discussions under “Allowance for Loan Losses” and “Risk Management” for further analysis of the allowance for loan losses and non-performing assets and related ratios.
Other Income
Other income consists of service charges on the Corporation’s deposit accounts, other service fees, including mortgage servicing fees and fees on credit cards, broker-dealer, asset management and insurance fees, gains and losses on sales of securities, gain on sale of mortgage servicing rights, certain other gains and losses and certain other income.
The following table sets forth the components of the Corporation’s other income for the periods indicated:
OTHER INCOME
| | | | | | | | | | | | | | | | |
| | For the nine month periods ended | | | For the quarters ended | |
| | September 30, | | | September 30, | | | September 30, | | | September 30, | |
| | 2005 | | | 2004 | | | 2005 | | | 2004 | |
| | (In thousands) | |
Bank service fees on deposit accounts | | $ | 9,488 | | | $ | 9,611 | | | $ | 3,334 | | | $ | 3,170 | |
Other service fees: | | | | | | | | | | | | | | | | |
Credit card fees | | | 11,091 | | | | 9,358 | | | | 3,880 | | | | 3,122 | |
Mortgage servicing fees | | | 1,590 | | | | 1,339 | | | | 587 | | | | 521 | |
Trust fees | | | 2,318 | | | | 2,228 | | | | 583 | | | | 746 | |
Other fees | | | 6,779 | | | | 6,413 | | | | 2,256 | | | | 2,166 | |
Broker/dealer, asset management, and insurance fees | | | 40,558 | | | | 38,176 | | | | 14,219 | | | | 12,911 | |
Gain on sale of securities, net | | | 17,838 | | | | 11,465 | | | | 462 | | | | 2,462 | |
Gain (loss) on extinguishment of debt | | | (5,959 | ) | | | — | | | | 784 | | | | — | |
Gain (loss) on sale of loans | | | 7,874 | | | | (84 | ) | | | 666 | | | | (240 | ) |
Gain of sale of mortgage servicing rights | | | 69 | | | | 284 | | | | 14 | | | | 88 | |
Trading (losses) gains | | | 211 | | | | 16 | | | | 815 | | | | (185 | ) |
Gain (loss) on derivatives | | | 1,884 | | | | 198 | | | | (840 | ) | | | 426 | |
Other gains, net | | | 4,135 | | | | 6,335 | | | | 1,146 | | | | 2,366 | |
Other | | | 2,364 | | | | 2,668 | | | | 762 | | | | 845 | |
| | | | | | | | | | | | |
| | $ | 100,240 | | | $ | 88,007 | | | $ | 28,668 | | | $ | 28,398 | |
| | | | | | | | | | | | |
35
The table below details the breakdown of commissions from broker-dealer, asset management and insurance operations:
| | | | | | | | | | | | | | | | |
| | For the nine month periods ended | | | For the quarters ended | |
| | September 30, 2005 | | | September 30, 2004 | | | September 30, 2005 | | | September 30, 2004 | |
| | | | | | |
| | | | | | (In thousands) | | | | | |
Broker-dealer | | $ | 20,231 | | | $ | 22,794 | | | $ | 7,343 | | | $ | 7,503 | |
Asset management | | | 15,209 | | | | 11,307 | | | | 4,898 | | | | 4,057 | |
| | | | | | | | | | | | |
Total Santander Securities | | | 35,440 | | | | 34,101 | | | | 12,241 | | | | 11,560 | |
Insurance | | | 5,118 | | | | 4,075 | | | | 1,978 | | | | 1,351 | |
| | | | | | | | | | | | |
Total | | $ | 40,558 | | | $ | 38,176 | | | $ | 14,219 | | | $ | 12,911 | |
| | | | | | | | | | | | |
The Corporation’s other income for the nine months ended September 30, 2005 increased $12.2 million or 13.9% to $100.2 million from $88.0 million for the same period in 2004. This increase was the result of higher gain on sale of securities of $6.4 million. During March 2005, the Company sold $785 million of investment securities and realized a gain of $16.9 million. This gain was partially offset by a loss of $6.7 million on the extinguishment of certain repo transactions that were funding part of the securities sold. During the nine-month period ended September 30,2005, there was a higher gain on sale of loans of $8.0 million as a result of the sale of mortgage loans and the sale of certain previously charged off consumer loans to an unrelated third party. Further explaining the increment in the other income for the nine-month period ended September 30, 2005, there was an increase in gain on derivatives of $1.7 million and higher broker-dealer, asset management and insurance fees of $2.4 million. These gains were also partially offset by non recurring gains on the sale of building (in 2004) of $2.8 million.
The Corporation’s other income reached $28.7 million for the quarter ended September 30, 2005 compared to $28.4 million for the quarter ended September 30, 2004 reflecting an increase of $0.3 million or .95%. This increase was the result of higher broker-dealer, asset management and insurance fees of $1.3 million, or 10.1%, an increase of $1.0 million in trading gains and $0.9 million in Bank services fees and gain on sale of loans. These increases were partially offset by a decrease in gain on sale of securities of $2.0 million, lower gains on derivatives of $1.2 million and lower gains on mortgage servicing rights (“MSR”) recognized on loans sold with servicing retained.
Broker-dealer, asset management and insurance fees reflected increases of $2.4 million and $1.3 million for the nine months and the quarter ended September 30, 2005 compared to the same periods in 2004. Santander Securities business includes securities underwriting and distribution, sales, trading, financial planning, investment advisory services and securities brokerage services. In addition, Santander Securities provides portfolio management services through its wholly owned subsidiary, Santander Asset Management Corporation. The broker-dealer, asset management and insurance operations contributed 40.5% to the Corporation’s other income for the nine months ended September 30, 2005 and 43.4% for the same period in 2004. For the quarter ended September 30, 2005 and 2004, the broker-dealer, asset management and insurance operations contributed 49.6% and 45.5%, respectively to the Corporation’s other income.
The increase in broker-dealer commissions is due to an increase in underwriting activity and an increase in fixed income activity during the nine month period and quarter ended September 30, 2005 compared to the same periods in 2004. The increase in asset management commissions is due to the growth in assets under management resulting from the issuance of new closed end mutual funds.
The Corporation’s gain on sale of loans was primarily due to the sale of certain previously charged off consumer loans to an unrelated third party. There are also sales of loans in the portfolio of mortgage loans held for sale. Mortgage loan sales are executed from time to time when interest rate movements permit the Corporation to maximize its returns.
In February 2004, the Corporation sold the building known as Torre Santander, a seventeen story building located at 221 Ponce de León Avenue, Hato Rey, Puerto Rico, to an unrelated third party in a sales-leaseback transaction and recognized a gain of $2.8 million, recorded under other gains. A deferred gain of $4.0 million was recorded and is being amortized as a reduction of rent expense over the term of the related leases through January 2009. The unamortized deferred gain in books as of September 2005 is $2.2 million.
Operating Expenses
36
The following table presents the detail of other operating expenses for the periods indicated:
OPERATING EXPENSES
| | | | | | | | | | | | | | | | |
| | Nine month periods ended | | | Quarters ended | |
| | September 30, | | | September 30, | | | September 30, | | | September 30, | |
| | 2005 | | | 2004 | | | 2005 | | | 2004 | |
| | (In thousands) | |
Salaries | | $ | 43,978 | | | $ | 43,045 | | | $ | 13,189 | | | $ | 12,945 | |
Pension and other benefits | | | 37,731 | | | | 37,773 | | | | 13,922 | | | | 13,538 | |
Expenses deferred as loan origination costs | | | (9,421 | ) | | | (11,781 | ) | | | (3,113 | ) | | | (3,675 | ) |
| | | | | | | | | | | | |
Total personnel costs | | | 72,288 | | | | 69,037 | | | | 23,998 | | | | 22,808 | |
| | | | | | | | | | | | | | | | |
Occupancy costs | | | 12,581 | | | | 10,109 | | | | 4,193 | | | | 3,439 | |
| | | | | | | | | | | | |
Equipment expenses | | | 2,703 | | | | 2,848 | | | | 903 | | | | 963 | |
| | | | | | | | | | | | |
EDP servicing expense, amortization and technical services | | | 23,727 | | | | 25,688 | | | | 8,338 | | | | 7,873 | |
| | | | | | | | | | | | |
Communications | | | 6,200 | | | | 6,792 | | | | 2,004 | | | | 2,202 | |
| | | | | | | | | | | | |
Business promotion | | | 8,239 | | | | 7,140 | | | | 3,198 | | | | 2,828 | |
| | | | | | | | | | | | |
Other taxes | | | 6,293 | | | | 6,574 | | | | 2,105 | | | | 2,049 | |
| | | | | | | | | | | | |
Other operating expenses: | | | | | | | | | | | | | | | | |
Professional fees | | | 7,754 | | | | 8,722 | | | | 2,554 | | | | 3,526 | |
Amortization of intangibles | | | 1,066 | | | | 685 | | | | 386 | | | | 274 | |
Printing and supplies | | | 1,380 | | | | 1,292 | | | | 526 | | | | 421 | |
Credit card expenses | | | 6,393 | | | | 5,622 | | | | 2,235 | | | | 1,973 | |
Insurance | | | 1,812 | | | | 1,552 | | | | 649 | | | | 687 | |
Examinations & FDIC assessment | | | 1,344 | | | | 708 | | | | 456 | | | | 325 | |
Transportation and travel | | | 1,637 | | | | 1,611 | | | | 601 | | | | 514 | |
Repossessed assets provision and expenses | | | 1,465 | | | | 2,002 | | | | 346 | | | | 404 | |
Collections and related legal costs | | | 1,202 | | | | 2,234 | | | | 235 | | | | 765 | |
All other | | | 9,939 | | | | 9,962 | | | | 3,199 | | | | 2,800 | |
| | | | | | | | | | | | |
Other operating expenses | | | 33,992 | | | | 34,390 | | | | 11,187 | | | | 11,689 | |
| | | | | | | | | | | | |
Non personnel expenses | | | 93,735 | | | | 93,541 | | | | 31,928 | | | | 31,043 | |
| | | | | | | | | | | | |
Total Operating expenses | | $ | 166,023 | | | $ | 162,578 | | | $ | 55,926 | | | $ | 53,851 | |
| | | | | | | | | | | | |
For the nine months ended September 30, 2005, the Corporation’s efficiency ratio on a tax equivalent basis improved 124 basis points to 63.41% from 64.65% for the same period in 2004. These improvements were the result of higher revenues (excluding gains on sales of securities, loss on extinguishment of debt in 2005 and a gain on the sale of a building during the first quarter of 2004) partially offset by an increase of $3.4 million in operating expenses.
Operating expenses increased $3.4 million or 2.1% for the nine-month period ended September 30, 2005 compared to the same period in 2004. There was an increase of $3.2 million in salaries and employee benefits and an increase of $0.2 million in non personnel expenses. The increase in salaries and employee benefits was due to a decrease of $2.4 million in expenses deferred as loan origination cost (as a result of the periodic revision of the standard cost of originating consumer loans which incorporated technological efficiencies in the origination process) and an increase in salaries of $0.9 million. Non-personnel expenses increased $0.2 million or .2% to $93.7 million for the nine months ended September 30, 2005 from $93.5 million for the same period in 2004. There were decreases of $2.0 million in EDP servicing expense, amortization and technical services due to lower servicing costs and lower amortization of EDP due in part to fully amortized equipment, $1.0 million in professional services, $1.0 million in collections and related legal costs, $0.6 in communications expenses. These decreases were partially offset by increases in occupancy costs of $2.5 million due primarily to the high lease rates of rent at a new facility and additional payments of rent because of construction delays. Further, there was an increase in business
37
promotion of $1.1 million consistent with our strategy to increase market share and grow the volume of our business and $0.6 million in examinations & FDIC assessment.
During the third quarter of 2005 compared to the same period in 2004, operating expenses increased $2.1 million, or 3.9% to $55.9 million for the quarter ended in September 2005 from $53.9 million for the same period in 2004. This increase was due to an increase in salaries and employee benefits of $1.2 million and non personnel expenses operating expenses of $0.9 million. The increase in salaries and employee benefits was due to an increase of $0.4 million in commissions and bonuses of $0.2 million in salaries and a decrease of $0.6 million in expenses deferred as loan origination costs (as a result of the periodic revision of the standard cost of originating consumer loans which incorporated technological efficiencies in the origination process). Non-personnel expenses increased $0.9 million or 2.9% from $31.0 million for the quarter ended September 30, 2004 to $31.9 million for the quarter ended September 30, 2005. This increase was due primarily to increases in occupancy cost of $0.8 million due to higher lease rates of new facilities because of construction delays and additional payments of rents, $0.5 million in EDP servicing expenses, amortization and technical services, $0.4 million in business promotion consistent with our strategy to increase market share and grow the volume of our business and $0.3 million credit card expenses. These increases were partially offset by a decrease in professional fees of $1.0 million.
Provision for Income Tax
The Corporation and each of its subsidiaries are treated as separate taxable entities and are not allowed to file consolidated tax returns in Puerto Rico. The maximum statutory marginal corporate income tax rate is 39%. However, there is an alternative minimum tax of 22%. The difference between the statutory marginal tax rate and the effective tax rate is primarily due to the interest income earned on certain investments and loans, which is exempt from income tax (net of the disallowance of expenses attributable to the exempt income) and to the disallowance of certain expenses and other items.
Puerto Rico international banking entities, or IBE’s, such as Santander International Bank, are currently exempt from taxation under Puerto Rico law. During 2004, the Legislature of Puerto Rico and the Governor of Puerto Rico approved a law amending the IBE Act. This law imposes income taxes at normal statutory rates on each IBE that operates as a unit of a bank, if the IBE’s net income generated after December 31, 2003 exceeds 40% of the bank’s net income in the taxable year commenced on July 1, 2003, 30% of the bank’s net income in the taxable year commencing on July 1, 2004, and 20% of the bank’s net income in the taxable year commencing on July 1, 2005, and thereafter. It does not impose income taxation on an IBE that operates as a subsidiary of a bank as is the case for the Corporation.
On August 1, 2005, a temporary, two-year surtax of 2.5% applicable to corporations was enacted. This surtax is applicable to taxable years beginning after December 31, 2004 and increases the maximum marginal corporate income tax rate from 39% to 41.5%. The incremental effect of this surtax corresponding to the nine months ended September 30, 2005 was $1.3 million which was recorded during the third quarter of 2005.
During October 2005, the Puerto Rico Legislature approved a bill to impose an additional temporary two-year surtax of 1% of taxable income, applicable to Puerto Rico banking institutions. This additional surtax, if signed into law by the governor of Puerto Rico, is applicable for taxable years 2005 and 2006 and would increase the maximum marginal corporate income tax rate for Puerto Rico financial institution to 42.5%. This bill is in substitution of the previously proposed 4% transitory tax on taxable interest income. There is no assurance that this proposal will not be approved or significant changes made before it is signed into law. The final impact of this proposal will depend on the final bill, if approved, and the actual distribution of taxable and exempt income each applicable year.
The provision for income tax amounted to $21.2 million, or 25.5% of pretax earnings, for the nine month period ended September 30, 2005, compared to $4.1 million, or 6.1% of pretax earnings, for the same period in 2004. For the quarter ended September 30, 2005, the provision for income tax was $6.1 million or 26.3% of pretax earnings compared to $1.6 million or 6.8% of pretax earnings for the quarter ended September 30, 2004. The increase in the provision for income tax during 2005 was due to a change in the composition of the Corporation’s taxable and exempt assets over those periods. Additionally, the provision for income taxes for the quarter and nine-month period ended September 30,2005 includes the retroactive effect of 2.5% surtax (explained above) in the amount of $1.3 million.
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Financial Position — September 30, 2005
Assets
The Corporation’s assets reached $8.7 billion as of September 30, 2005, a 4.3% or $0.4 billion increase when compared to total assets of $8.3 billion at December 31, 2004 and a 9.3% or $0.7 billion increase when compared to total assets of $8.0 billion at September 30, 2004. As of September 30, 2005 there was an increase of $629.2 million and $942.4 million in net loans, including loans held for sale, compared to December 31 and September 30, 2004 balances, respectively. The investment securities portfolio decreased by $300.0 million or 14.9% compared to December 31, 2004. During the first quarter of 2005, the Corporation modified its asset/liability mix to adjust for expectations of further rises in short term rates. The Corporation sold $785 million of its investment securities and realized a gain of $16.9 million. This gain was partially offset by a loss of $6.0 million on the extinguishment of certain term repo transactions that were funding part of the securities sold.
The composition of the loan portfolio, including loans held for sale, was as follows:
| | | | | | | | | | | | |
| | September 30, | | | December 31, | | | Increase | |
| | 2005 | | | 2004 | | | (Decrease) | |
| | (In thousands) | |
Commercial and industrial | | $ | 2,299,510 | | | $ | 2,236,020 | | | $ | 63,490 | |
Construction | | | 214,123 | | | | 199,799 | | | | 14,324 | |
Mortgage | | | 3,031,774 | | | | 2,581,301 | | | | 450,473 | |
Consumer | | | 541,119 | | | | 454,260 | | | | 86,859 | |
Leasing | | | 123,045 | | | | 112,152 | | | | 10,893 | |
| | | | | | | | | |
Gross Loans | | | 6,209,571 | | | | 5,583,532 | | | | 626,039 | |
Allowance for loan losses | | | (66,051 | ) | | | (69,177 | ) | | | 3,126 | |
| | | | | | | | | |
Net Loans | | $ | 6,143,520 | | | $ | 5,514,355 | | | $ | 629,165 | |
| | | | | | | | | |
Net loans, including loans held for sale, at September 30, 2005 were $6.1 billion, reflecting an increase in the loan portfolio of $629.2 million or 11.4% when compared to $5.5 billion at December 31, 2004. The mortgage banking business represented the primary source of growth of the loan portfolio due to aggregate housing demand and prevailing market rates for residential mortgages. Mortgage loans purchased and originated continued to grow during first nine-month period of 2005 resulting in an increase of $450.5 million or 17.5%, in the mortgage loan portfolio. Mortgage loans originated for the third quarter of 2005 reached $179.5 million and purchases and sales for the same period were $200.1 million and $87.0 million, respectively. The mortgage loans purchased and sold during the third quarter of 2005 were negotiated at their fixed rates. Mortgage loan production for the nine month periods ended September 2005 reached $556.9 million. The total mortgage loan purchases and sales of loans for the same period were $490.0 million and $232.4 million, respectively. Of the $490.9 million of loans purchased during nine month period ended September 2005, $200.2 million were fixed rate loans that were swapped to create floating rate assets and the mortgage loans were sold at their fixed rates.
Commercial banking provides financial services and products primarily to middle-market companies. These products and services are sold through a group of relationship managers and officers distributed among six regions throughout the island. Business has grown during 2004 and into 2005 due in part to the success of campaigns designed to improve penetration of the middle-market customer base. The Corporation has also established the so called “Business Orientation Meetings” between credit and relationship officers at the middle-market and corporate segments in order to facilitate and expedite business transactions. The Corporate/Institutional segment coordinates all banking and credit related services to customers through a group of corporate relationship officers. The corporate group provides financial services and products basically to corporations with annual revenues over $75 million. The commercial and industrial loan portfolio also reflected an increase of $63.5 million or 2.8% over the nine months ended September 30, 2005 while consumer loans grew 19.1% to $541.1 million. The Consumer Lending division provides financing solutions to individuals in the form of unsecured personal loans, credit cards, overdraft lines and auto leasing. These products are offered through our retail branch network, sales representatives, telephone banking, and the internet. Growth in the consumer loan portfolio came as a result of
39
a shift in the acquisition strategy, with emphasis on pre-approved/pre-qualified solicitations in the personal loans and bankcards portfolios. Management continues to focus on regaining market share with a strong emphasis on the mortgage and consumer loan portfolios. Due to more effective marketing strategies, streamlining of the loan application and approval process with continued stringent credit policies, and innovative products and massive consumer and credit card campaigns, the Corporation has been able to continue growing its loan portfolio.
Allowance for Loan Losses
The Corporation systematically assesses the overall risks in its loan portfolio and establishes and maintains an allowance for possible 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 loan portfolio. Management evaluates the adequacy of the allowance for loan losses on a monthly basis. This evaluation involves the exercise of judgement and the use of assumptions and estimates that are subject to revision, as more information becomes available. In determining the allowance, management considers the portfolio risk characteristics, prior loss experience and collection practices, prevailing and projected economic conditions, loan impairment measurements and results of internal and regulatory agencies’ loan reviews. Based on current and expected economic conditions, the expected level of net loan losses and the methodology established to evaluate the adequacy of the allowance for loan losses, management considers that the allowance for loan losses is adequate to absorb probable losses in the Corporation’s loan portfolio.
Commercial and construction loans over a predetermined amount are individually evaluated on a quarterly basis for impairment following the provisions of SFAS No. 114, “Accounting by Creditors of a Loan”. A loan is impaired when based on current information and events; it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. The impairment loss, if any, on each individual loan identified as impaired is measured based on the present value of expected cash flows discounted at the loan’s effective interest rate, except as a practical expedient, we may measure impairment based on the loan’s observable market price, or the fair value of the collateral, if the loan is collateral dependent. Substantially all of the Corporation’s impaired loans are measured on the basis of the fair value of the collateral, net of estimated disposition costs. The Corporation maintains a detailed analysis of all loans identified as impaired with their corresponding allowances and the specific component of the allowance is computed on a quarterly basis. Additions, deletions or adjustments to the analysis are tracked and formal justification is documented detailing the rationale for such adjustments.
For small-homogeneous type loans, a general allowance is computed based on average historical loss experience or ratios for each corresponding type of loans (consumer, credit cards, residential mortgages, auto, etc.) The methodology of accounting for all probable losses is made in accordance with the guidance provided by Statement of Accounting Standards (SFAS) No. 5, “Accounting for Contingencies”. In determining the general allowance, the Corporation applies a loss factor for each type of loan based on the average historical net charge off for the previous two or three years for each portfolio adjusted for other statistical loss estimates, as deemed appropriate. Historical loss rates are reviewed at least quarterly and adjusted based on changes in actual collections and charge off experience as well as significant factors that in management’s judgement reflect the impact of any current conditions on loss recognition. Factors that management considers in the analysis of the general reserve include the effect of the trends in the nature and volume of loans (delinquency, charge-offs and non-accrual loans), changes in the mix or type of collateral, asset quality trends, changes in the internal lending policies and credit standards, collection practices and examination results from bank regulatory agencies.
The determination of the allowance for loan losses under SFAS No. 5 for the Corporation is based on historical loss experience by loan type, management judgment of the quantitative factors (historical net charge-offs, statistical loss estimates, etc.), as well as qualitative factors (current economic conditions, portfolio composition, delinquency trends, industry concentrations, etc.) which result in the final determination of the provision for loan losses to maintain a level of allowance for loan losses deemed to be adequate.
The Corporation’s methodology for allocating the allowance among the different parts of the portfolio or different elements of the allowance is based on the historical loss percentages for each type or pool of loan (consumer, commercial, construction, mortgage and other), after assigning the specific allowances for impaired loans on an individual review process. The sum of specific allowances for impaired loans plus the general allowances for each type of loan not specifically examined and the unallocated allowance constitutes our total allowance for loan losses at the end of any reporting period.
An unallocated allowance is maintained to absorb changes and unexpected losses that may result from certain significant external factors, such as (a) the Corporation’s moderate concentration in certain industries, specially health care, and agriculture businesses; (b) the slow growth of the Puerto Rico economy as evidenced by high unemployment figures; (c) the broad negative effect on the Puerto Rico economy of the increased price of oil and oil-related products; (d) interest rates
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forecasts; and (e) the negative collateral economic effect of the war in Iraq or additional terrorist attacks, both which add material risk to the economy and curtail economic recovery. This allowance is based primarily on historical experience, current trends in factors such as bankruptcies and loss trends among others.
On a quarterly basis, management reviews its determination of the allowance for loan losses which includes the specific allowance computed according to the provisions of SFAS No.114 and the general allowance for small-homogenous type loans, which is based on historical loss percentages for each type or pool of loan. This analysis also considers loans classified by the internal loan review department, the internal auditors, the in-house Watch System Unit, and banking regulators.
The Corporation has not changed any aspects of its overall approach in the determination of the allowance for loan losses, and there have been no material changes in assumptions or estimation techniques, as compared to prior periods.
ALLOWANCE FOR LOAN LOSSES
| | | | | | | | | | | | | | | | |
| | For the nine month periods ended | | | For the quarters ended | |
| | September 30, | | | September 30, | |
| | 2005 | | | 2004 | | | 2005 | | | 2004 | |
| | (In thousands) | |
Balance at beginning of period | | $ | 69,177 | | | $ | 69,693 | | | $ | 65,623 | | | $ | 66,665 | |
Provision for loan losses | | | 15,400 | | | | 21,770 | | | | 4,650 | | | | 7,020 | |
Retroactive reclassification of provision for commitments, unused lines and stanby letter of credit | | | — | | | | — | | | | — | | | | 392 | |
| | | | | | | | | | | | |
| | | 84,577 | | | | 91,463 | | | | 70,273 | | | | 74,077 | |
| | | | | | | | | | | | |
Losses charged to the allowance: | | | | | | | | | | | | | | | | |
Commercial and industrial | | | 6,777 | | | | 14,848 | | | | 1,383 | | | | 1,806 | |
Construction | | | 1,438 | | | | — | | | | — | | | | — | |
Consumer | | | 13,661 | | | | 14,821 | | | | 3,589 | | | | 4,488 | |
Leasing | | | 706 | | | | 1,212 | | | | 140 | | | | 375 | |
| | | | | | | | | | | | |
| | | 22,582 | | | | 30,881 | | | | 5,112 | | | | 6,669 | |
| | | | | | | | | | | | |
Recoveries: | | | | | | | | | | | | | | | | |
Commercial and industrial | | | 1,315 | | | | 4,013 | | | | 366 | | | | 1,467 | |
Consumer | | | 2,290 | | | | 5,767 | | | | 270 | | | | 1,716 | |
Leasing | | | 451 | | | | 369 | | | | 254 | | | | 140 | |
| | | | | | | | | | | | |
| | | 4,056 | | | | 10,149 | | | | 890 | | | | 3,323 | |
| | | | | | | | | | | | |
Net loans charged-off | | | 18,526 | | | | 20,732 | | | | 4,222 | | | | 3,346 | |
| | | | | | | | | | | | |
Balance at end of period | | $ | 66,051 | | | $ | 70,731 | | | $ | 66,051 | | | $ | 70,731 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Ratios: | | | | | | | | | | | | | | | | |
Allowance for loan losses to period-end loans | | | 1.06 | % | | | 1.34 | % | | | 1.06 | % | | | 1.34 | % |
Recoveries to charge-offs | | | 17.96 | % | | | 32.86 | % | | | 17.41 | % | | | 49.83 | % |
Annualized net charge-offs to average loans | | | 0.42 | % | | | 0.60 | % | | | 0.27 | % | | | 0.27 | % |
The Corporation’s allowance for loan losses was $66.1 million or 1.06% of period-end loans at September 30, 2005 a 28 basis point reduction compared to $70.7 million, or 1.34% of period-end loans at September 30, 2004. The decrease in this ratio was due to lower non-performing loans during the period. The reduction in the provision for loan losses was $6.4 million or 29.3% due to a 26.5% decrease in non-performing loans, which are down to $71.2 million as of September 30, 2005, from $96.8 million as of September 30, 2004, and $87.5 million as of December 31, 2004. The coverage ratio (allowance for loan losses to non-performing loans) increased to 92.8% at September 30, 2005, from 73.1% at September 30, 2004. At December 31, 2004, the coverage ratio was 79.05%. Excluding non-performing mortgage loans (which have immaterial historical losses) this ratio is 243.9% at September 30, 2005 compared to 123.4% as of September 30, 2004 and 135.0% as of December 31, 2004.
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For the nine months and the quarter ended September 30, 2005 compared to the same periods in 2004 the ration of recoveries to charge-offs reflected a decrease of 1,490 basis points and 3,242 basis points, respectively. This reduction was due to the sale of certain previously charged off consumer loans to an unrelated third party during the second quarter of 2005 that resulted in a reduction of charge-offs subject to recovery. A gain on sale of loans of $6.1 million was recorded pursuant to this transaction.
The annualized ratio of net charge-offs to average loans for the nine months ended September 30, 2005 improved 18 basis points to 0.42% from 0.60% reported for the nine months ended September 30, 2004. For the quarters ended September 30, 2005 and 2004, the annualized ratio of net charge-offs to average loans remained at .27%.
At September 30, 2005, the allowance for loan losses was $66.1 million, a decrease of $3.1 million or 4.5% over the allowance at December 31, 2004 and a decrease of $4.7 million, from $70.7 million at September 30, 2004. At September 30, 2005, impaired loans (loans evaluated individually for impairment) with related allowance amounted to approximately $57.8 million and $2.5 million, respectively. At December 31, 2004 impaired loans with related allowance amounted to $80.1 million and $4.9 million.
Although the Corporation’s provision and allowance for loan losses will fluctuate from time to time based on economic conditions, net charge-off levels and changes in the level and mix of the loan portfolio, management considers that the allowance for loan losses is adequate to absorb probable losses in its loan portfolio.
Non-performing Assets and Past Due Loans
As of September 30, 2005, the Corporation’s total non-performing loans (excluding other real estate owned) decreased to $71.2 million or 1.15% of total loans from $87.5 million or 1.57% of total loans as of December 31, 2004. Non-performing mortgage loans increased $7.8 million, compared to December 2004, however the Corporation has historically experienced a low loss rate on this portfolio. The non-performing commercial loan portfolio (without real estate collateral) reflected a decrease of $13.4 million or 48.0% compared to December 31, 2004. The decrease in this higher risk portfolio had a positive impact on the determination of the allowance for loan losses. Construction and consumer loans also reflected decreases during the nine months periods ended September 2005 of $9.7 million or 87.0% and $2.0 million or 29.4%, respectively. Non-performing lease financing loans increased to $3.7 million at September 30, 2005, from $2.7 million at December 31, 2004. As of September 30, 2005, the coverage ratio (allowance for loan losses to total non-performing loans) improved to 92.82% from 79.05% as of December 31, 2004 and 73.05% as of September 30, 2004.
The Corporation continuously monitors non-performing assets and has deployed additional resources to manage the non-performing loan portfolio.
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Non-performing Assets and Past Due Loans
| | | | | | | | |
| | September 30, | | | December 31, | |
| | 2005 | 2004 |
| | (Dollars in thousands) | |
Commercial and Industrial | | $ | 14,550 | | | $ | 27,975 | |
Construction | | | 1,455 | | | | 11,200 | |
Mortgage | | | 44,076 | | | | 36,252 | |
Consumer | | | 4,805 | | | | 6,808 | |
Leasing | | | 3,714 | | | | 2,715 | |
Restructured Loans | | | 2,560 | | | | 2,560 | |
| | | | | | |
Total non-performing loans | | | 71,160 | | | | 87,510 | |
Repossessed Assets | | | 6,721 | | | | 3,937 | |
| | | | | | |
Total non-performing assets | | $ | 77,881 | | | $ | 91,447 | |
| | | | | | |
| | | | | | | | |
Accruing loans past-due 90 days or more | | $ | 6,282 | | | $ | 3,377 | |
| | | | | | | | |
Non-Performing loans to total loans | | | 1.15 | % | | | 1.57 | % |
Non-Performing loans plus accruing loans past due 90 days or more to total loans | | | 1.25 | % | | | 1.63 | % |
Non-Performing assets to total assets | | | 0.90 | % | | | 1.10 | % |
Liabilities
As of September 30, 2005, total liabilities reached $8.1 billion, an increase of $346.2 million compared to the December 31, 2004 balance. This increase in total liabilities was principally due to increases in deposits of $1.1 billion or 19.1%, in accrued interest payable of $26.9 million or 54.2% and in other liabilities of $51.2 million or 25.3%. These increases were partially offset by a decrease in borrowings (comprised of federal funds purchased and other borrowings, securities sold under agreements to repurchase, commercial paper issued, term and capital notes) of $852.4 million or 29.8%. Federal funds purchased and other borrowings decreased $130.3 million, repurchase agreements decreased $331.3 million and commercial paper decreased $399.7 million.
At September 30, 2005, total deposits were $5.9 billion, reflecting an increase of $1.1 billion, or 23.6% over deposits of $4.7 billion as of December 31, 2004. This change was composed of an increase of $793.1 million in brokered deposits and $326.6 million in customer deposits. Non-interest bearing deposits reflected a decrease of $92.2 million or 12.4% compared to December 31, 2004. The Corporation continues its efforts to increase its core deposit base by maintaining competitive interest rates, maximizing the cross selling of products and services by the segmentation of its client base, introducing innovative products and the extensive use of alternative marketing tools such as telephone and internet banking.
Total borrowings at September 30, 2005 (comprised of federal funds purchased and other borrowings, securities sold under agreements to repurchase, commercial paper issued, and term and capital notes) decreased $752.3 million or 27.2% and $852.4 million or 29.8%, compared to borrowings at September 30, 2004 and December 31, 2004, respectively. The reduction in higher cost borrowings was the result of the extinguishment of certain repurchase agreements that were funding part of the position of investment securities sold.
Capital and Dividends
The Corporation expects no favorable or unfavorable trends that could materially affect its capital resources.
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As an investment-grade rated entity by several nationally recognized rating agencies, the Corporation has access to a variety of capital issuance alternatives in the United States and Puerto Rico capital markets. The Corporation continuously monitors its capital issuance alternatives. It may issue capital in the future, as needed, to maintain its “well-capitalized” status.
Stockholders’ equity was $567.1 million, or 6.5% of total assets at September 30, 2005, compared to $556.0 million or 6.7% of total assets at December 31, 2004. The increase in stockholders’ equity was mainly due to net income for the period and was partially offset by unrealized losses on investment securities available for sale and dividends declared.
During the nine month period ended September 2005, the Corporation declared a cash dividend of 48 cents per common share, and expects to continue to pay quarterly dividends. This has resulted in an annualized dividend yield of 2.60%.
There were no stock repurchases during 2005 and 2004 under the Stock Repurchase Program. As of September 30, 2005, the Corporation had repurchased 4,011,260 shares of its common stock under these programs at a cost of $67.6 million. The Corporation’s management believes that the repurchase program will not have a significant effect on the Corporation’s liquidity and capital positions.
The Corporation adopted and implemented various Stock Repurchase Programs in May 2000, December 2000 and June 2001. Under these programs the Corporation acquired 3% of its then outstanding common shares. During November 2002, the Corporation started a fourth Stock Repurchase program under which it plans to acquire 3% of its outstanding common shares. In November 2002, the Corporation’s Board of Directors authorized the Corporation to repurchase up to 928,204 shares, or approximately 3%, of its shares of outstanding common stock, of which 325,100 shares have been purchased. The Board felt that the Corporation’s shares of common stock represented an attractive investment at prevailing market prices at the time of the adoption of the common stock repurchase program and that, given the relatively small amount of the program, the stock repurchases would not have any significant impact on the Corporation’s liquidity and capital positions. The program has no time limitation and management is authorized to effect repurchases at its discretion. The authorization permits the Corporation to repurchase shares from time to time in the open market or in privately negotiated transactions. The timing and amount of any repurchases will depend on many factors, including the Corporation’s capital structure, the market price of the common stock and overall market conditions. All of the repurchased shares will be held by the Corporation as treasury stock and reserved for future issuance for general corporate purposes.
The Corporation has a Dividend Reinvestment Plan and a Cash Purchase Plan wherein holders of common stock have the opportunity to automatically invest cash dividends to purchase more shares of the Corporation. Shareholders may also make, as frequently as once a month, optional cash payments for investment in additional shares of the Corporation’s common stock.
As of September 30, 2005, the Corporation’s common stock price per share was $24.63, a market capitalization of $1.1 billion (including affiliated holdings).
The Corporation is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s consolidated financial statements. The regulations require the Corporation to meet specific capital guidelines that involve quantitative measures of the Corporation’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
As of September 30, 2005, the Corporation was well capitalized under the regulatory framework for prompt corrective action. At September 30, 2005 the Corporation continued to exceed the regulatory risk-based capital requirements for well-capitalized institutions. Tier I capital to risk-adjusted assets and total capital ratios at September 30, 2005 were 9.41% and 11.88%, respectively, and the leverage ratio was 6.38%.
Liquidity
The Corporation’s general policy is to maintain liquidity adequate to ensure its ability to honor withdrawals of deposits, make repayments at maturity of other liabilities, extend loans and meet its own working capital needs. Liquidity is derived from the Corporation’s capital, reserves, and securities portfolio. The Corporation has established lines of credit with
44
foreign and domestic banks, has access to U.S. markets through its commercial paper program, and also has broadened its relations in the federal funds and repurchase agreement markets to increase the availability of other sources of funds and to augment liquidity as necessary.
Management monitors liquidity levels each month. The focus is on the liquidity ratio, which presents total liquid assets over net volatile liabilities and core deposits. The Corporation believes it has sufficient liquidity to meet current obligations.
Derivative Financial Instruments:
The Corporation uses derivative financial instruments mostly as hedges of interest rate risk, changes in fair value of assets and liabilities and to secure future cash flows. Refer to Notes 1 and 8 to the accompanying consolidated financial statements for additional details of the Corporation’s derivative transactions as of September 30, 2005 and December 31, 2004.
In the normal course of business, the Corporation utilizes derivative instruments to manage exposure to fluctuations in interest rates, currencies and other markets, to meet the needs of customers and for proprietary trading activities. The Corporation uses the same credit risk management procedures to assess and approve potential credit exposures when entering into derivative transactions as those used for traditional lending.
Hedging Activities:
The following table summarizes the derivative contracts designated as hedges as of September 30, 2005 and December 31, 2004, respectively:
| | | | | | | | | | | | | | | | |
| | September 30, 2005 | |
| | | | | | | | | | | | | | Other | |
| | | | | | | | | | | | | | Comprehensive | |
| | Notional | | | | | | | Gain | | | Income | |
(In thousands) | | Amounts * | | | Fair Value | | | (Loss) | | | (Loss)** | |
Cash Flow Hedges | | | | | | | | | | | | | | | | |
Foreign Currency Forward | | $ | 183,878 | | | $ | (10,999 | ) | | $ | — | | | $ | 396 | |
Interest Rate Swaps | | | — | | | | — | | | | — | | | | 1,369 | |
Fair Value Hedges | | | | | | | | | | | | | | | | |
Interest Rate Swaps | | | 2,347,856 | | | | (24,957 | ) | | | (214 | ) | | | — | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | |
Totals | | $ | 2,531,734 | | | $ | (35,956 | ) | | $ | (214 | ) | | $ | 1,765 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | December 31, 2004 | |
| | | | | | | | | | | | | | Other | |
| | | | | | | | | | | | | | Comprehensive | |
| | Notional | | | | | | | Gain | | | Income | |
(In thousands) | | Amounts * | | | Fair Value | | | (Loss) | | | (Loss)** | |
Cash Flow Hedges | | | | | | | | | | | | | | | | |
Interest Rate Swaps | | $ | 100,000 | | | $ | (2,244 | ) | | $ | — | | | $ | 3,463 | |
Fair Value Hedges | | | | | | | | | | | | | | | | |
Interest Rate Swaps | | | 1,545,634 | | | | (29,643 | ) | | | 579 | | | | — | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | |
Totals | | $ | 1,645,634 | | | $ | (31,887 | ) | | $ | 579 | | | $ | 3,463 | |
| | | | | | | | | | | | |
| | |
* | | The notional amount represents the gross sum of long and short. |
|
** | | Net of tax. |
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Cash Flow Hedges:
The Corporation designates hedges as Cash Flow Hedges when its main purpose is to reduce the exposure associated with the variability of future cash flows related to fluctuations in short term financing rates (such as LIBOR). At the inception of each hedge, management documents the hedging relationship, including its objective and probable effectiveness. To assess ongoing effectiveness of the hedges, the Corporation compares the hedged item’s periodic variable rate with the hedging item’s benchmark rate (such as LIBOR) at every reporting period to determine the effectiveness of the hedge. Any hedge ineffectiveness is recorded currently as a derivative gain or loss in the consolidated statement of income.
As of September 30, 2005, the Corporation had a FX swap with a notional value of $183.9 million classified as cash flow hedges, which matures in November 2005. As of September 30, 2005, the total amount, net of tax, included in accumulated other comprehensive income pertaining to the cash flow hedges was an unrealized loss of $1.4 million.
Fair Value Hedges:
The Corporation designates hedges as Fair Value Hedges when its main purpose is to hedge the changes in market value of an associated asset or liability. The Corporation only designates these types of hedges if at inception it is believed that the relationship in the changes in the market value of the hedged item and hedging item will offset each other in a highly effective manner. At the inception of each hedge, management documents the hedging relationship, including its objective and probable effectiveness. To assess ongoing effectiveness of the hedges, the Corporation marks to market both the hedging item and the hedged item at every reporting period to determine the effectiveness of the hedge. Any hedge ineffectiveness is recorded currently as a derivative gain or loss in the income statement.
The fair value hedges have maturities through the year 2032 as of September 30, 2005 and December 31, 2004. The weighted-average rate paid and received on these contracts is 4.70% and 4.78%, and 4.64% and 4.07%, as of September 30, 2005 and December 31, 2004, respectively.
As of September 30, 2005 and December 31, 2004, respectively, $2.3 billion and $1.5 billion were designated as fair value hedges, of which $1.3 billion and $586.6 million were associated to the swapping of fixed rate certificate of deposits and other obligations. The Corporation regularly issues fixed term certificates of deposit and other obligations, which it in turn swaps to create synthetic floating rate obligations via interest rate swaps. In these cases, the Corporation matches all of the relevant economic variables (notional amount, interest rate, payment date, and other terms) of the fixed rate obligations it issues to the fixed rate portion of the interest rate swap (which it receives from the counterparty) and pays the floating rate portion of the interest rate swap.
The remaining $974 million and $930.1 million designated as fair value hedges as of September 30, 2005 and December 31, 2004, respectively, were associated with fixed rate residential mortgage loans that were swapped to create synthetic floating rate assets. In addition to originating residential mortgage loans for its portfolio, the Corporation also purchases fixed rate residential mortgage loans from third parties. Fixed rate mortgage loans expose the Corporation to variability in their fair market value due to changes in interest rates. Management believes it is prudent to limit the variability in the fair market value of a portion of its fixed rate mortgage loan portfolio. To meet this objective, the Corporation has purchased fixed rate 1-4 family residential mortgage loans from local financial institutions (the “Selling Counterparty”), and simultaneously entered into agreements with the Selling Counterparty to convert the fixed rate interest payments on the loans to uncapped floating rate interest payments on the same notional amount. The net effect of these transactions is the creation of a synthetic floating rate mortgage loan (the “Floating Rate Mortgage Loans”) in which the Corporation receives three-month LIBOR plus 150 basis points spread (the “Variable Rate”). At September 30, 2005 and December 31, 2004, the weighted average Variable Rate at period end was 5.40% and 3.82%, respectively; and the weighted average pay fixed rate at each period end was 6.14%.
As of September 30, 2005 and December 31, 2004, $653.2 million and $577.6 million of these Floating Rate Mortgage Loans were subject to a conditional call provision at the option of the Selling Counterparty, in the event the Variable Rate equals or exceeds an agreed upon fixed rate, which approximates the weighted average fixed rate in the underlying mortgage loans (the “Call Rate”). The Selling Counterparty owns the right, and not the obligation, to collapse these transactions at the fair market value of the combined package (Loan and Derivative) as long as this price is not less than the par value. The Corporation entered into all of these transactions at par value, therefore this call option should have no
46
effect on the statement of income since there is no unamortized premium to write-down. The average Call Rate was equal to 6.03% and 6.04% at September 30, 2005 and December 31, 2004, respectively .
Derivative instruments not designated as hedging instruments:
Any derivative not associated to hedging activity is booked as a freestanding derivative. In the normal course of business the Corporation may enter into derivative contracts as both a market maker or proprietary position taker. The Corporation’s mission is to meet the clients’ needs by providing them with a wide array of financial products, which include derivative contracts. The Corporation’s major role in this aspect is to serve as a derivative counterparty to these clients. Positions taken with these clients are hedged (although not designated as hedges) in the OTC market with interbank participants or in the organized futures markets. The market and credit risk associated with this activity is measured, monitored and controlled by the Corporation’s Market Risk Group, an independent division from the treasury department. Among other things, this group is responsible for: policy, analysis, methodology and reporting of anything related to market risk and credit risk. The following table summarizes the aggregate notional amounts and the reported derivative assets or liabilities (i.e. the fair value of the derivative contracts) as of September 30, 2005 and December 31, 2004, respectively:
| | | | | | | | | | | | |
| | September 30, 2005 | |
| | Notional | | | | | | | Gain | |
(In thousands) | | Amounts * | | | Fair Value | | | (Loss) | |
Interest Rate Contracts | | | | | | | | | | | | |
Interest Rate Swaps | | $ | 1,394,208 | | | $ | 312 | | | $ | (203 | ) |
Interest Rate Caps | | | 76,371 | | | | 2 | | | | 13 | |
Other | | | 12,266 | | | | (12 | ) | | | (15 | ) |
Equity Derivatives | | | 243,212 | | | | — | | | | 2,303 | |
| | | | | | | | | |
Totals | | $ | 1,726,057 | | | $ | 302 | | | $ | 2,098 | |
| | | | | | | | | |
| | | | | | | | | | | | |
| | December 31, 2004 | |
| | Notional | | | | | | | Gain | |
(In thousands) | | Amounts * | | | Fair Value | | | (Loss) | |
Interest Rate Contracts | | | | | | | | | | | | |
Interest Rate Swaps | | $ | 335,426 | | | $ | 568 | | | $ | (69 | ) |
Interest Rate Caps | | | 67,971 | | | | (16 | ) | | | 22 | |
Other | | | 2,415 | | | | 3 | | | | 3 | |
Equity Derivatives | | | 138,895 | | | | — | | | | 2,924 | |
| | | | | | | | | |
Totals | | $ | 544,707 | | | $ | 555 | | | $ | 2,880 | |
| | | | | | | | | |
| | |
* | | The notional amount represents the gross sum of long and short. |
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PART I – ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Asset and Liability Management
The Corporation’s policy with respect to asset liability management is to maximize its net interest income, return on assets and return on equity while remaining within the established parameters of interest rate and liquidity risks provided by the Board of Directors and the relevant regulatory authorities. Subject to these constraints, the Corporation takes mismatched interest rate positions. The Corporation’s asset and liability management policies are developed and implemented by its Asset and Liability Committee (“ALCO”), which is composed of senior members of the Corporation including the President, Chief Operating Officer, Chief Accounting Officer, Treasurer and other executive officers of the Corporation. The ALCO reports on a monthly basis to the members of the Bank’s Board of Directors.
Market Risk and Interest Rate Sensitivity
A key component of the Corporation’s asset and liability policy is the management of interest rate sensitivity. Interest rate sensitivity is the relationship between market interest rates and net interest income due to the maturity or repricing characteristics of interest-earning assets and interest-bearing liabilities. For any given period, the pricing structure is matched when an equal amount of such assets and liabilities mature or reprice in that period. Any mismatch of interest-earning assets and interest-bearing liabilities is known as a gap position. A positive gap denotes asset sensitivity, which means that an increase in interest rates would have a positive effect on net interest income, while a decrease in interest rates would have a negative effect on net interest income. A negative gap denotes liability sensitivity, which means that a decrease in interest rates would have a positive effect on net interest income, while an increase in interest rates would have a negative effect on net interest income. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution were perfectly matched in each maturity category.
The Corporation’s one-year cumulative GAP position at September 30, 2005, was negative $1.6 billion or -18.53% of total assets. This is a one-day position that is continually changing and is not indicative of the Corporation’s position at any other time. This denotes liability sensitivity, which means that an increase in interest rates would have a negative effect on net interest income while a decrease in interest rates would have a positive effect on net interest income. While the GAP position is a useful tool in measuring interest rate risk and contributes toward effective asset and liability management, shortcomings are inherent in GAP analysis since certain assets and liabilities may not move proportionally as interest rates change.
The Corporation’s interest rate sensitivity strategy takes into account not only rates of return and the underlying degree of risk, but also liquidity requirements, capital costs and additional demand for funds. The Corporation’s maturity mismatches and positions are monitored by the ALCO and managed within limits established by the Board of Directors.
The following table sets forth the repricing of the Corporation’s interest earning assets and interest bearing liabilities at September 30, 2005 and may not be representative of interest rate gap positions at other times. In addition, variations in interest rate sensitivity may exist within the repricing period presented due to the differing repricing dates within the period. In preparing the interest rate gap report, the following assumptions are made, all assets and liabilities are reported according to their repricing characteristics. For example, a commercial loan maturing in five years with monthly variable interest rate payments is stated in the column of “up to 90 days”. The investment portfolio is reported considering the effective duration of the securities. Expected prepayments and remaining terms are considered for the residential mortgage portfolio. Core deposits are reported in accordance with their effective duration. Effective duration of core deposits is based on price and volume elasticity to market rates. The Corporation reviews on a monthly basis the effective duration of core deposits. Assets and liabilities with embedded options are stated based on full valuation of the asset/liability and the option to ascertain their effective duration.
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SANTANDER BANCORP
MATURING GAP ANALYSIS
As of September 30, 2005
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 0 to 3 | | 3 months | | 1 to 3 | | 3 to 5 | | 5 to 10 | | More than | | No Interest | | |
| | months | | to a Year | | Years | | Years | | Years | | 10 Years | | Rate Risk | | Total |
| | (dollars in thousands) |
ASSETS: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
Investment Portfolio | | $ | 333,202 | | | $ | 86,323 | | | $ | 267,628 | | | $ | 958,587 | | | $ | 77,415 | | | $ | — | | | $ | 43,965 | | | $ | 1,767,120 | |
Deposits in Other Banks | | | 329,498 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 160,554 | | | | 490,052 | |
Loan Portfolio, gross | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 1,314,272 | | | | 217,838 | | | | 240,785 | | | | 347,383 | | | | 166,900 | | | | 76,311 | | | | 59,066 | | | | 2,422,555 | |
Construction | | | 191,629 | | | | 2,512 | | | | 2,402 | | | | 9,450 | | | | 6,925 | | | | — | | | | 1,205 | | | | 214,123 | |
Consumer | | | 217,298 | | | | 75,279 | | | | 165,117 | | | | 67,877 | | | | 9,748 | | | | 7 | | | | 5,793 | | | | 541,119 | |
Mortgage | | | 143,561 | | | | 434,451 | | | | 933,772 | | | | 673,758 | | | | 788,704 | | | | 42,353 | | | | 15,175 | | | | 3,031,774 | |
Other Assets, net | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 232,354 | | | | 232,354 | |
| | |
Total Assets | | $ | 2,529,460 | | | $ | 816,403 | | | $ | 1,609,704 | | | $ | 2,057,055 | | | $ | 1,049,692 | | | $ | 118,671 | | | $ | 518,112 | | | $ | 8,699,097 | |
| | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
External Funds Purchased | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial Paper | | $ | 229,852 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 229,852 | |
Repurchase Agreements | | | 668,181 | | | | — | | | | 150,006 | | | | — | | | | 200,000 | | | | — | | | | — | | | | 1,018,187 | |
Federal Funds | | | 650,000 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 650,000 | |
Deposits | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Certificates of Deposit | | | 1,567,298 | | | | 715,257 | | | | 201,618 | | | | 248,390 | | | | 450,928 | | | | 129,333 | | | | (7,421 | ) | | | 3,305,403 | |
Non-interest bearing deposits | | | 129,605 | | | | 96,502 | | | | 28,960 | | | | 396,786 | | | | — | | | | — | | | | — | | | | 651,853 | |
NOW and Savings Accounts | | | 438,435 | | | | 251,404 | | | | 485,105 | | | | 736,498 | | | | — | | | | — | | | | — | | | | 1,911,442 | |
Term and Subordinated Debt | | | — | | | | — | | | | — | | | | 25,105 | | | | 87,166 | | | | — | | | | 616 | | | | 112,887 | |
Other Liabilities and Capital | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 819,473 | | | | 819,473 | |
| | |
Total Liabilities and Capital | | $ | 3,683,371 | | | $ | 1,063,163 | | | $ | 865,689 | | | $ | 1,406,779 | | | $ | 738,094 | | | $ | 129,333 | | | $ | 812,668 | | | $ | 8,699,097 | |
| | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Off-Balance Sheet Financial Information | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | �� | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest Rate Swaps (Assets) | | $ | 1,891,565 | | | $ | 733,446 | | | $ | 218,555 | | | $ | 241,969 | | | $ | 432,898 | | | $ | 223,632 | | | $ | — | | | $ | 3,742,065 | |
Interest Rate Swaps (Liabilities) | | | 2,305,911 | | | | 489,388 | | | | 402,612 | | | | 249,236 | | | | 184,257 | | | | 110,661 | | | | — | | | | 3,742,065 | |
Caps | | | 39,084 | | | | — | | | | — | | | | 37,287 | | | | — | | | | — | | | | — | | | | 76,371 | |
Caps Final Maturity | | | 37,287 | | | | — | | | | — | | | | 39,084 | | | | — | | | | — | | | | — | | | | 76,371 | |
| | |
GAP | | $ | (1,566,460 | ) | | $ | (2,702 | ) | | $ | 559,958 | | | $ | 641,212 | | | $ | 560,239 | | | $ | 102,309 | | | $ | (294,556 | ) | | $ | — | |
| | |
Cumulative GAP | | $ | (1,566,460 | ) | | $ | (1,569,162 | ) | | $ | (1,009,204 | ) | | $ | (367,992 | ) | | $ | 192,247 | | | $ | 294,556 | | | $ | — | | | $ | — | |
| | |
Cumulative interest rate gap to earning assets | | | -18.50 | % | | | -18.53 | % | | | -11.92 | % | | | -4.35 | % | | | 2.27 | % | | | 3.48 | % | | | | | | | | |
Interest rate risk is the primary market risk to which the Corporation is exposed. Nearly all of the Corporation’s interest rate risk arises from instruments, positions and transactions entered into for purposes other than trading. They include loans, investment securities, deposits, short-term borrowings, senior and subordinated debt and derivative financial instruments used for asset and liability management.
As part of its interest rate risk management process, the Corporation analyzes on an ongoing basis the profitability of the balance sheet structure, and how this structure will react under different market scenarios. In order to carry out this task, management prepares three standardized reports with detailed information on the sources of interest income and expense: the “Financial Profitability Report”, the “Net Interest Income Shock Report” and the “Market Value Shock Report”. The former deals with historical data while the latter two deal with expected future earnings.
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The Financial Profitability Report identifies individual components of the Corporation’s non-trading portfolio independently with their corresponding interest income or expense. It uses the historical information at the end of each month to track the yield of such components and to calculate net interest income for such time period.
The Net Interest Income Shock Report uses a simulation analysis to measure the amount of net interest income the Corporation would have from its operations throughout the next twelve months and the sensitivity of these earnings to assumed shifts in market interest rates throughout the same period. The important assumptions of this analysis are: ( i ) rate shifts are parallel and immediate throughout the yield curve; (ii) rate changes affect all assets and liabilities equally; (iii) interest-bearing demand accounts and savings passbooks will run off in a period of one year; and (iv) demand deposit accounts will run off in a period of one to three years. Cash flows from assets and liabilities are assumed to be reinvested at market rates in similar instruments. The object is to simulate a dynamic gap analysis enabling a more accurate interest rate risk assessment.
The ALCO has decided to run a negative interest rate gap to capitalize on current spreads between short and long term interest rates while preparing for higher short-term rates. To that effect, the investment portfolio was restructured, selling Agency bullet securities, and canceling certain associated repurchase agreements. This strategy slightly decreased the duration of the portfolio and shortened the repricing gap.
The ALCO monitors interest rate gaps in combination with net interest margin (NIM) sensitivity and duration of market value equity (MVE).
NIM sensitivity analysis captures the maximum acceptable net interest margin loss for a one percent parallel change of all interest rates across the curve. Duration of market value equity analysis entails a valuation of all interest bearing assets and liabilities under parallel movements in interest rates. The ALCO has established limits of $25 million of maximum NIM loss for a 1% parallel shock and $125 million maximum MVE loss for a 1% parallel shock.
As of September 30, 2005, it was determined for purposes of the Net Interest Income Shock Report that the Corporation had a potential loss in net interest income of approximately $19.6 million if market rates were to increase 100 basis points immediately parallel across the yield curve, less than the $25.0 million limit. For purposes of the Market Value Shock Report it was determined that the Corporation had a potential loss of approximately $84.8 million if market rates were to increase 100 basis points immediately parallel across the yield curve, less than the $125.0 million limit.
As of September 30, 2005 the Corporation had a liability sensitive profile as explained by the negative gap, the NIM shock report and the MVE shock report. Management feels comfortable with the current level of market risk on the balance sheet, and it will change the market risk profile of the Corporation as market conditions vary. Any decision to reposition the balance sheet is taken by the ALCO committee, and is subject to compliance with the established risk limits. Some factors that could lead to shifts in policy could be, but are not limited to, changes in views on interest rate markets, monetary policy, macroeconomic factors as well as legal, fiscal and other factors which could lead to shifts in the asset liability mix.
Liquidity Risk
Liquidity risk is the risk that not enough cash will be generated from either assets or liabilities to meet deposit withdrawals or contractual loan funding. The Corporation’s general policy is to maintain liquidity adequate to ensure its ability to honor withdrawals of deposits, make repayments at maturity of other liabilities, extend loans and meet its own working capital needs. The Corporation’s principal sources of liquidity are capital, core deposits from retail and commercial clients, and wholesale deposits raised in the inter-bank and commercial markets. The Corporation manages liquidity risk by maintaining diversified short-term and long-term sources through the federal funds market, FHLB advances, commercial paper program, repurchase agreements and retail and institutional certificate of deposit programs. As of September 30, 2005, the Corporation had $3.0 billion in unsecured lines of credit ($2.8 billion available) and $7.0 billion in collateralized lines of credit with banks and financial entities ($5.4 billion available). All securities in portfolio are highly rated and very liquid enabling the Corporation to treat them as a secondary source of liquidity.
The Corporation does not have significant usage or limitations on the ability to upstream or downstream funds as a method of liquidity. However, the Corporation faces certain tax constraints when borrowing funds (excluding the placement of deposits) from Santander or affiliates because Puerto Rico’s tax code requires local corporations to withhold 29% of the interest income paid to non-resident affiliates. The Corporation currently maintains two intra-group credit lines
50
provided by Santander and affiliates: an annual revolving credit line for a total of $150 million and JPY 20.8 billion (approximately $183.9 million), respectively both of which were fully utilized as of September 30, 2005.
Liquidity is derived from the Corporation’s capital, reserves and securities portfolio. The Corporation has established lines of credit with foreign and domestic banks, has access to U.S. markets through its commercial paper program and also has broadened its relations in the federal funds and repurchase agreement markets to increase the availability of other sources of funds and to augment liquidity as necessary.
On October 13, 2005, the Corporation issued its Pre-Effective Amendment No.2 to Form S-3. This Form S-3 was issued in order to offer and sell from time to time up to $1,000,000,000 of debt securities, preferred stock and common stock; and to offer and sell up to 6,000,000 shares of common stock owned by Administración de Bancos Latinoamericanos Santander, S.L. (ABLASA), the Corporation’s principal stockholder. The Corporation intends to use the net proceeds from the sale of securities for general corporate purposes which may include making investments in, or extensions of credit to its subsidiaries; financing acquisitions and/or business expansions and repaying or refinancing outstanding borrowings. ABLASA, the selling stockholder will receive all of the proceeds from sales of the shares of the Corporation’s common stock offered by it from time to time. The Corporation will not receive any of the proceeds from such sale of its common stock.
During 2004 the Corporation undertook several financing transactions to fund its operations, including cash flow requirements and future growth. On October 7, 2004, the Corporation issued $75 million of its 6.30% Subordinated Notes due June 2032 that are swapped to create a floating rate source of funds. In addition, during the first quarter of 2004, Banco Santander issued $30 million in S&P Linked Notes to obtain long term financing. These notes have an option agreement in order to manage the interest rate risk.
Management monitors liquidity levels each month. The focus is on the liquidity ratio, which compares net liquid assets (all liquid assets not subject to collateral or repurchase agreements) against total liabilities plus contingent liabilities. As of September 30, 2005, the Corporation had a liquidity ratio of 9.04%. At September 30, 2005, the Corporation had total available liquid assets of $879.8 million. The Corporation believes it has sufficient liquidity to meet current obligations.
The Corporation does not contemplate material uncertainties in the rolling over of deposits, both retail and wholesale, and is not engaged in capital expenditures that would materially affect the capital and liquidity positions. Should any deficiency arise for seasonal or more critical reasons, the Bank would make recourse to alternative sources of funding such as the commercial paper program, its lines of credit with domestic and national banks, unused collateralized lines with Federal Home Loan Banks and others.
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PART I. ITEM 4
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, the Corporation’s management, including the Chief Executive Officer, the Chief Operating Officer and the Chief Accounting Officer (as the Corporation’s principal financial officer), conducted an evaluation of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer, the Chief Operating Officer and the Chief Accounting Officer (as the Corporation’s principal financial officer) concluded that the design and operation of these disclosure controls and procedures were effective.
Changes in Internal Controls
There have been no changes in the Corporation’s internal controls over financial reporting during the fiscal quarter covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal controls over financial reporting.
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PART II — OTHER INFORMATION
ITEM I — LEGAL PROCEEDINGS
The Corporation is involved as plaintiff or defendant in a variety of routine litigation incidental to the normal course of business. Management believes, based on the opinion of legal counsel, that it has adequate defense with respect to such litigation and that any losses therefrom would not have a material adverse effect on the consolidated results of operations or consolidated financial condition of the Corporation.
ITEM 2 — UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3 — DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4 — SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5 — OTHER INFORMATION
None
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ITEM 6 – EXHIBITS
| | | | | | | | |
A. | | Exhibit No. | | Exhibit Description | | Reference |
| | | (2.0) | | | Agreement and Plan of Merger-Banco Santander Puerto Rico and Santander Bancorp | | Exhibit 3.3 8-A12B |
| | | | | | | | |
| | | (2.1) | | | Stock Purchase Agreement Santander BanCorp and Banco Santander Central Hispano, S.A. | | Exhibit 2.1 10K-12/31/00 |
| | | | | | | | |
| | | (2.2) | | | Stock Purchase Agreement dated as of November 28, 2003 by and among Santander BanCorp, Administración de Bancos Latinoamericanos Santander, S.L. and Santander Securities Corporation | | Exhibit 2.2 10Q-06/30/04 |
| | | | | | | | |
| | | (2.3) | | | Settlement Agreement between Santander BanCorp and Administración de Bancos Latinoamericanos Santander, S.L. | | Exhibit 2.3 10Q-06/30/04 |
| | | | | | | | |
| | | (3.1) | | | Articles of Incorporation | | Exhibit 3.1 8-A12B |
| | | | | | | | |
| | | (3.2) | | | Bylaws | | Exhibit 3.1 8-A12B |
| | | | | | | | |
| | | (4.1) | | | Authoring and Enabling Resolutions 7% Noncumulative Perpetual Monthly Income Preferred Stock, Series A | | Exhibit 4.1 10Q-06/30/04 |
| | | | | | | | |
| | | (4.2) | | | Offering Circular for $30,000,000 Banco Santander PR Stock Market Growth Notes Linked to the S&P 500 Index | | Exhibit 4.610Q-03/31/04 |
| | | | | | | | |
| | | (4.3) | | | Private Placement Memorandum Santander BanCorp $75,000,000 6.30% Subordinated Notes | | Exhibit 4.3 10K-12/31/04 |
| | | | | | | | |
| | | (10.1) | | | Contract for Systems Maintenance between ALTEC and Banco Santander Puerto Rico | | Exhibit 10A10K-12/31/02 |
| | | | | | | | |
| | | (10.2) | | | Deferred Compensation Contract – Benito Cantalapiedra | | Exhibit 10B10K-12/31/02 |
| | | | | | | | |
| | | (10.3) | | | Deferred Compensation Contract – María Calero | | Exhibit 10C10K-12/31/02 |
| | | | | | | | |
| | | (10.4) | | | Employment Contract – José Ramón González | | Exhibit 10.110Q-03/31/05 |
| | | | | | | | |
| | | (10.5) | | | Employment Contract – Carlos M. García | | Exhibit 10.210Q-03/31/05 |
| | | | | | | | |
| | | (10.6) | | | Information Processing Services Agreement between America Latina Tecnologia de Mexico SA and Banco Santander Puerto Rico, Santander International Bank of Puerto Rico, Inc. and Santander Investment International Bank, Inc. | | Exhibit 10A10Q-06/30/03 |
| | | | | | | | |
| | | (10.7) | | | Employment Contract – Roberto Córdova | | Exhibit 10.310Q-03/31/05 |
| | | | | | | | |
| | | (10.8) | | | Employment Contract – Bartolomé Vélez | | Exhibit 10.410Q-03/31/05 |
| | | | | | | | |
| | | (10.9) | | | Employment Contract – Lillian Díaz | | Exhibit 10.510Q-03/31/05 |
| | | | | | | | |
| | | (10.10) | | | Technology Assignment Agreement between CREFISA, Inc. and Banco Santander Puerto Rico | | Exhibit 10.1210KA-12/31/03 |
| | | | | | | | |
| | | (10.11) | | | Altair System License Agreement between CREFISA, Inc. and Banco Santander Puerto Rico | | Exhibit 10.1310KA-12/31/03 |
| | | | | | | | |
| | | (10.12) | | | Employment Contract-Anthony Boon | | Exhibit 10.1410Q-03/31/04 |
| | | | | | | | |
| | | (10.13) | | | Deferred Compensation Contract – Anthony Boon | | Exhibit 10.1510Q-03/31/04 |
| | | | | | | | |
| | | (10.14) | | | 2005 Employee Stock Option Plan | | Exhibit B Def14A-03/26/05 |
| | | | | | | | |
| | | (14) | | | Code of Ethics | | Exhibit 14 10K-12/31/04 |
| | | | | | | | |
| | | (22) | | | Registrant’s Proxy Statement for the April 28, 2005 Annual Meeting of Stockholders | | Def14A-03/26/05 |
| | | | | | | | |
| | | (31.1) | | | Certification from the Chief Executive Officer pursuant to Section 302 of The Sarbanes-Oxley Act of 2002 | | Exhibit 31.1 |
| | | | | | | | |
| | | (31.2) | | | Certification from the Chief Operating Officer pursuant to Section 302 of The Sarbanes-Oxley Act of 2002 | | Exhibit 31.2 |
| | | | | | | | |
| | | (31.3) | | | Certification from the Chief Accounting Officer pursuant to Section 302 of The Sarbanes-Oxley Act of 2002 | | Exhibit 31.3 |
| | | | | | | | |
| | | (32.1) | | | Certification from the Chief Executive Officer, Chief Operating Officer and Chief Accounting Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | | Exhibit 32.1 |
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SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SANTANDER BANCORP
Name of Registrant
| | | | |
Dated: November 7, 2005 | | | | By: /s/ José Ramón González |
| | | | President and Chief Executive Officer |
| | | | |
Dated: November 7, 2005 | | | | By: /s/ Carlos M. García |
| | | | Senior Executive Vice President and |
| | | | Chief Operating Officer |
| | | | |
Dated: November 7, 2005 | | | | By: /s/ María Calero |
| | | | Executive Vice President and |
| | | | Chief Accounting Officer |
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