% Chile 59.6% Venezuela 12.6% Mexico 8.9% Argentina 7.7% Brazil 7.5% Puerto Rico 3.7%
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In Latin America, the larger volume of deposits than loans means that financing in the wholesale markets is in practice residual, and basically for reasons of presence and
diversification. For the rest of the Group (denominated as “area of convertible currencies”), the deposits added to the permanent funds in the balance sheet (capital and similar liabilities) cover around three-quarters of loans net of securitisations. In convertible currencies, only one-quarter of unsecuritised loans are financed via the wholesale markets with medium- and long-term debt with an adequate structure.
- Ample access to the wholesale liquidity markets on the basis of high short- and long-term ratings. In the last two years, all the rating agencies have upgraded Santander’s long-term rating, bringing it at the end of 2007 to AA or higher (Moody’s rating is Aa1, equivalent to AA+; the other three put it at AA), and all of them with stable outlook.
- Diversification of markets and instruments to obtain liquidity. The Group has an active presence in a broad and diversified series of financing markets, limiting dependence on specific markets and maintaining available a comfortable capacity of recourse to the markets.
This enables us to have an adequate structure of medium- and long-term issues, with reduced recourse to short-term wholesale financing (at the end of 2007, commercial paper and notes only accounted for 7% of total wholesale financing). This structure is based on securitisations (around one-third of the total) and a portfolio of medium- and long- term issues (around 60% of the total), well diversified by products and with an average maturity of 4.4 years. - High capacity to obtain liquidity in the balance sheet. The
Group maintains in its balance sheet a diversified portfolio of liquid assets or those that are so in the short time appropriate to its positions. In addition, the Group has a large amount of assets available in the European Central Bank that can be discounted (around EUR 30,000 million on average in the first quarter of 2008).
- Independence of the subsidiaries in financing within a centralised management. The most important subsidiaries, except for Santander Consumer Finance, must obtain its financing in wholesale markets in accordance with its needs, establishing its own liquidity plans and contingencies, without recourse to lines from the parent bank to finance its activity. The Group, as a holding, carries out the functions of control and management, which means planning the funding needs, structuring the financing sources, optimising their
diversification by maturities, instruments and markets, as well as defining the contingency plans.
In practice, the Group’s liquidity management consists of the following:
- A liquidity plan is drawn up every year, based on the financing needs resulting from the business budgets. On the basis of these needs, and bearing in mind the limits on recourse to short-term markets, the year’s issuance and securitisation plan is established.
- During the year the evolution of financing needs is regularly monitored, giving rise to changes to the plan.
- Control and analysis of liquidity risk is also very important. Its first objective is to ensure the Group maintains acceptable levels of liquidity to cover its financing needs in the short- and long-term under normal market situations. Various measures are used to control the balance sheet such as the liquidity gap and liquidity ratios.
Various scenarios are also analysed (stress scenarios) in which additional needs are considered that could arise because of different events of extreme but plausible features. By doing this, all eventualities are covered which, with a greater or lesser probability, could affect the Group and enable it to prepare the corresponding contingency plans.
The analysis conducted in the last four months of 2007 showed that the Group, even in a scenario of scant demand for medium- and long-term issues, maintained a comfortable liquidity situation.
The main aspects of structural liquidity management in 2007 were as follows.
The Group’s units in convertible currency areas captured during the whole of the year EUR 44,000 million in medium- and long- term issues in the wholesale markets and securitised assets for another EUR 44,500 million.
The Group was particularly active in the first half of 2007 in capturing medium- and long-term funds in the capital markets, at a time when these markets showed a very positive situation in terms of liquidity as well as costs. This enabled us to face the deterioration in the markets in the second half of the year in a very comfortable position.
As of the summer of 2007, the Group only made some one-off operations via transactions placed at a very reasonable cost bearing in mind the markets’ situation. Of note was the issue of EUR 7,000 million of bonds to finance the acquisition of ABN AMRO assets (to be converted into shares of the Bank), which were placed among Santander Branch Network customers in Spain (“Valores Santander”).
The Group also took advantage of the second half of the year to develop short-term financing markets (commercial paper, CDs). Thanks to our conservative liquidity management policies, the Group maintained a very small recourse to short-term institutional financing, enabling us to go to these sources when there are tensions in the longer maturity markets.
The Group’s structural liquidity situation (with 75% of its needs covered via deposits and permanent funds of the balance sheet in the area of convertible currencies and more than 100% in the Latin American banks) and the quantity and quality of our liquid assets have enabled and enable us to maintain normal lending activity.
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C. S
TRUCTURAL EXCHANGE-
RATE RISK/
HEDGING OF RESULTSStructural exchange rate risk arises from Group operations in currencies, mainly related to permanent financial investments, and the results and the dividends of these investments.
This management is dynamic and seeks to limit the impact on equity of currency devaluations and optimise the financial cost of hedging.
As regards the exchange-rate risk of permanent investments, the general policy is to finance them in the currency of the investment provided the depth of the market allows it and the cost is justified by the expected depreciation. One-off hedging is also done when a local currency could weaken against the euro significantly more quickly than the market is discounting.
At the end of 2007, the Group had hedged through options structures all its significant stakes in its foreign subsidiaries (including Banco Real). This protected the Group from the impact on its capital as of a certain level of currency devaluation.
In addition, the expected exchange rate risk of the Group’s results and dividends in those units whose base currency is not the euro is managed. In Latin America, local units manage the exchange rate risk between the local currency and the dollar, the currency used to manage the region. Financial Management at the consolidated level is responsible for its part of the risk
management between the euro and the rest of convertible currencies.
D. E
XPOSURES RELATED TO ASSETS OR SPECIAL BUSINESSESGrupo Santander’s exposure to instruments and complex structured vehicles is very limited:
•No exposure to subprime mortgages;
•No material exposure subject to Mark-to-Model;
•Limited exposure to hedge funds, asset-backed securities, monoliners, conduits, etc;
This policy meant that this type of activity had no negative impact on the Group’s results.
Santander’s policy regarding the approval of new operations has traditionally been very prudent and conservative, as it is subject to strict supervision by the Group’s senior management. Before giving the green light to a new operation, product or underlying asset, the Risks Division verifies:
•The existence of an appropriate valuation model to monitor the value of each exposure: Mark-to-Market, Mark-to-Model or Mark-to-Liquidity.
•The availability in the market of the necessary inputs to be able to apply this valuation model.
The two previous points must always be met,
•The availability of appropriate systems and duly adapted to calculate and monitor every day the results, positions and risks of new operations.
•The degree of liquidity of the product or underlying asset, in order to make possible their coverage when deemed opportune.
Without detriment to the Group’s limited exposure to businesses or special vehicles, this is currently specified in:
•CDOs and other complex credit instruments: the Group’s total exposure to these instruments is small (less than EUR 25 million).
•Hedge funds: the main exposure is via the financing to these funds (counterparty risk). This exposure, however, is not significant (EUR 1,906 million at the end of the year, of which EUR 101 million was in trading portfolios and the rest in investment portfolios) and with low levels of Loan- to-Value of around 45% (collateral of EUR 4,227 million at the end of the year).The risk with this type of counterparty is analysed case by case, establishing the percentages of collateral on the basis of the features and assets of each fund.
•Investments in structured investment vehicles (SIV), SIV-Lites and other investment vehicles with high leverage: no exposure.
•Conduits: at the end of 2007, the Group had two conduits promoted in the past, which have always been in the Group’s perimeter of consolidation:
•Altamira: at the end of 2007 it had total assets of EUR 276 million, none of them related to mortgage operations. At that date, it was in the process of being wound down and integrated into the Group’s standard structure.
•Cantabric: at the end of 2007 total assets amounted to EUR 183 million. The underlying asset is short-term commercial paper generated by retail banking activity in Spain, with a high degree of diversification and small nominal amounts.
•Monolines: Santander’s exposure to these bond insurance companies at the end of 2007 was less than EUR 350 million, mainly concentrated in the indirect exposure (EUR 342 million), by virtue of the guarantee provided for this type of entity to various financing operations or traditional
securitisation. The exposure in this case is double default; the primary underlying assets are of high credit quality (mostly AA). The small remainder is direct exposure (for example, via purchase of protection against the risk of non-payment by some of these insurers through a credit default swap).
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E. S
TRUCTUREDF
INANCINGO
PERATIONSGrupo Santander, in this sphere, has a low exposure and activity diversified by products, sector and number of operations. The exposure at the end of 2007 for 351 transactions was EUR 16,926 million, as follows: EUR 10,060 million (103 transactions) in acquisition finance; EUR 5,524 million (213 transactions) in project finance; and the rest in leveraged buy-outs (LBOs) and other modalities. Writedowns were not necessary in the
investment portfolio. There has been no significant LBO since July 2007.
4. OPERATIONAL RISK
DEFINITION AND OBJECTIVESGrupo Santander defines operational risk (OR) as “the risk of losses from defects or failures in its internal processes, employees or systems, or those arising from unforeseen circumstances”. They are purely operational events, which makes them different from market or credit risks.
The objective is to identify, valuate, mitigate and monitor this risk.
The Group’s greatest need, therefore, is to identify and eliminate risk focuses, regardless of whether they produce losses or not. Measurement also helps management as it enables priorities to be established and the creation of a decision-making hierarchy.
Grupo Santander opted, in principle, to use the standard method for calculating regulatory capital by operational risk, envisaged in the BIS II rules. The Group is weighing up the best moment to adopt the focus of Advanced Models (AM), bearing in mind that a) the short-term priority centres on its mitigation; and b) most of the regulatory requirements established for being able to adopt the AM must already be incorporated into the Standard Model and this has already been done in the case of Grupo Santander’s operational risk management model.
MANAGEMENT MODEL
The Central Unit, which supervises operational risks and is responsible for the Group’s global corporate programme, assesses and controls this type of risk.
The management structure of operational risk is based on the knowledge and experience of executives and experts in the different areas and units. Particular importance is attached to the role of operational risk coordinators, who are the key figures in the organisational framework.
Grupo Santander has adopted the following framework for the phases of the process for managing operational risk:
The main advantages of the Group’s management structure are: • Integral and effective management of operational risk
(identification, evaluation, monitoring, control/mitigation and report).
• Provides better knowledge of existing and potential
operational risks and the responsibility for them by managers of the business and support lines.
• Drawing up of data on losses, enabling operational risk to be quantified for calculating both the economic and the regulatory capital.
• Operational risk information helps to improve the processes and controls, reduce losses and the volatility of revenues.
Dissemination of results Best practices Training
Reports to regulators
and the Group’s management