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SANTANDER HOLDINGS USA, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) EXECUTIVE SUMMARY
Santander Holdings USA, Inc ("SHUSA" or the "Company") is the parent company of
Sovereign Bank, N.A. ("Sovereign" or the "Bank"), a federally chartered savings
bank as of December 31, 2011, which converted to a national banking association
on January 26, 2012. In connection with the charter conversion, the Bank changed
its name to Sovereign Bank, N.A. Also effective on January 26, 2012, SHUSA
became a bank holding company.
SHUSA is headquartered in Boston, Massachusetts, and its principal executive
offices are at 75 State Street, Boston, Massachusetts. The Bank's home office is
in Wilmington, Delaware.
The Bank has $82.5 billion in assets as of September 30, 2012 with retail
branches, operations and team members located principally in Pennsylvania,
Massachusetts, New Jersey, Connecticut, New Hampshire, New York, Rhode Island,
Maryland, and Delaware. The Bank gathers substantially all of its deposits in
these market areas. The Bank uses the deposits, as well as other financing
sources, to fund the loan and investment portfolios. The Bank earns interest
income on the loans and investments. In addition, the Bank generates other
income from a number of sources including deposit and loan services, sales of
loans and investment securities, capital markets products and bank-owned life
insurance. The Bank's principal expenses include interest expense on deposits,
borrowings and other debt obligations, employee compensation and benefits,
occupancy and facility-related costs, technology and other administrative
expenses. The Bank's volumes and, accordingly, the financial results, are
affected by the economic environment, including interest rates, consumer and
business confidence and spending, as well as the competitive conditions within
the Bank's geographic footprint.
On January 30, 2009, SHUSA became a wholly owned subsidiary of Banco Santander,
S.A. ("Santander"). Santander is a retail and commercial bank, headquartered in
Spain, with a global presence in 10 core geographic markets. At the end of the
third quarter of 2012, Santander was the largest bank in the euro zone and among
the world's top 20 financial institutions by market capitalization. Founded in
1857, Santander had at September 30, 2012 €1,422 billion in managed funds, more
than 100 million customers, 14,496 branches - more than any other international
bank - and approximately 188,000 employees. Furthermore, it has relevant
positions in the United Kingdom, Portugal, Germany, Poland, Argentina, Brazil,
Mexico, Chile, and the United States. Santander had €1.8 billion in net
attributable profit in the first nine months of 2012 primarily generated in
Brazil 26%, Spain 16%, United Kingdom 13%, Mexico 13% and U.S. 9%.
Following the acquisition by Santander, the Company began to change its strategy
substantially. The Company has successfully completed the first phase which
included stabilization and turning around the operating results of the Company.
Successful stabilization efforts have included improving risk management and
collections and improving the Company's margins and efficiency. The second
phase, transformation, which began in 2010 and is expected to continue through
2014, focuses on strengthening the soundness, sustainability, and
competitiveness of the retail and commercial bank.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Noteworthy accomplishments related to the Company's transformation include the
execution of the national bank charter change, the successful launch of a new
proprietary technology platform and servicing portal, which migrated a majority
of the Company's customer accounts to allow the Company to better compete and
actively bring to market its capabilities, the
improvement of the Company's competitive position during the current challenging
economic times, the growth in its deposit base, the increase in the Company's
loan production to small businesses by more than 30% since 2010, continued
improvements in the asset quality of the Bank's loan portfolio, which included
reducing non-performing loans to total loans to below 3% and a reduction in the
run-off portfolio, increases in capital, and the improvement in its
cost-to-asset ratio. In addition, the Company increased its year-over-year net
revenues in its Global Banking and Market (GBM) business, and also expanded into
energy and technology sectors in its Corporate banking business, which has and
will continue to make it possible to attract new clients to the Bank.
Moving forward, the Company's priorities to transform the franchise include the
following key initiatives:
• Retail Banking efforts are focused on increasing market share in the
existing primary service area, cross-selling to existing and new
customers, and reducing dependence on third-party service providers. Significant initiatives in Retail Banking include transforming the retail
banking platform and subsequent implementation of more robust product
applications and MIS, enhancing the online, ATM, and call center
platforms, introducing mobile banking and enhanced functionality in the
existing electronic banking platform, and developing the capability to
issue and service credit cards directly.
• Growing Corporate Banking is a key priority for the Bank. Management plans
to take a measured and gradual approach to building a strong franchise.
Significant Corporate Banking initiatives include strengthening the Large
Corporate unit as a competitive provider for large corporate customers,
balancing penetration of different Corporate Banking units within the
Bank's footprint in New England, Metropolitan New York, and the
Mid-Atlantic region and upgrading the technology platform and operational
capabilities.
• Management's priority in GBM is to grow the business by developing relationships in the U.S. with global companies through a sector specific
approach with a differentiated product offering. This will include
different types of financing, hedging and transactional services with the
objective of improving the existing cross-selling and increasing revenue
per client. GBM also expects to grow as a product provider to the Large
Corporate and Middle Market client segments served by the Bank.
• Integrating information technology and operations systems by building a
reliable and sales-oriented technology infrastructure to drive efficiency
across all areas of the Bank. This allows leverage of the Company's access
to Santander's factories, technology expertise and cost management
approach as appropriate to minimize costs while maintaining quality of
service.
In order to improve operating returns, management has continued to focus on
acquiring and retaining customers by demonstrating convenience through the
Bank's locations, technology and business approach while offering innovative and
easy-to-use products and services.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
CURRENT REGULATORY ENVIRONMENT
National Charter Change and Conversion to a Bank Holding Company
Effective on January 26, 2012, the Bank converted from a federal savings bank to
a national banking association. In connection with the charter conversion, the
Bank changed its name to Sovereign Bank, N.A. Also, effective on January 26,
2012, the Company became a bank holding company.
As a national bank, the Bank is no longer subject to federal thrift regulations
and instead is subject to the OCC's regulations under the National Bank Act. The
various laws and regulations administered by the OCC for national banks affect
corporate practices and impose certain restrictions on activities and
investments, but the Company does not believe that the Bank's current or
currently proposed business will be limited materially, if at all, by these
restrictions. In addition, as a national bank, the Bank is no longer subject to
the qualified thrift lender requirement, which requires thrifts to maintain a
certain percentage of their "portfolio assets" in certain "qualified thrift
investments," such as residential housing related loans, certain consumer and
small business loans and residential mortgage-backed securities. The Bank also
is no longer subject to the restrictions in the Home Owners' Loan Act limiting
the amount of commercial loans that it may make.
As a bank holding company, the Company is subject to the comprehensive,
consolidated supervision and regulation of the Federal Reserve Bank (the "FRB").
The Company is subject to risk-based and leverage capital requirements and
information reporting requirements. The Company is "well capitalized" as of
September 30, 2012 under the FRB's capital standards.
Federal laws restrict the types of activities in which bank holding companies
may engage, and subject them to a range of supervisory requirements, including
regulatory enforcement actions for violations of laws and policies. Bank holding
companies may engage in the business of banking and managing and controlling
banks, as well as closely related activities. The Company does not expect the
limitations described above will adversely affect the current operations or
materially prohibit the Company from engaging in activities that are currently
contemplated by its business strategies.
Additionally, because the Company has more than $50.0 billion in total
consolidated assets, as a bank holding company, it is subject to the heightened
prudential and other requirements for large bank holding companies.
Dodd-Frank Wall Street Reform and Consumer Protection Act
Congress often considers new financial industry legislation, and the federal
banking agencies routinely propose new regulations. New legislation and
regulation may include changes with respect to the federal deposit insurance
system, consumer financial protection measures, compensation and systematic risk
oversight authority. There can be no assurances that new legislation and
regulations will not adversely affect us.
On July 21, 2010, the "Dodd-Frank Wall Street Reform and Consumer Protection
Act" (the "Act"), which instituted major changes to the banking and financial
institutions regulatory regimes in light of the recent performance of, and
government intervention in, the financial services sector. The Act includes a
number of specific provisions designated to promote enhanced supervision and
regulation of financial firms and financial markets. The Act introduces a
substantial number of reforms that reshape the structure of the regulation of
the financial services industry, requiring that more than 200 regulations be
written over the next two years. Although the full impact of this legislation on
the Company and the industry will be unknown until these regulations are
complete, the enhanced regulation will involve higher compliance costs and
certain elements, such as the debit interchange legislation, will negatively
affect the Company's revenue and earnings.
More specifically, the Act imposes heightened prudential requirements on bank
holding companies with at least $50.0 billion in total consolidated assets,
which includes the Company, and requires the Federal Reserve Board ("FRB") to
establish prudential standards for such bank holding companies that are more
stringent than those applicable to other bank holding companies, including
standards for risk-based capital requirements and leverage limits; heightened
capital standards, including eliminating trust preferred securities as tier 1
regulatory capital, enhanced risk-management requirements, and credit exposure
reporting and concentration limits. These changes are expected to impact the
profitability and growth of the Company.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The Act mandates an enhanced supervision framework, which means that the Company
will be subject to annual stress tests by the FRB, and the Company and the Bank
will be required to conduct semi-annual and annual stress tests, respectively,
reporting results to the FRB and the OCC. The FRB also has discretionary
authority to establish additional prudential standards, on its own or at the
Financial Stability Oversight Council's recommendation, regarding contingent
capital, enhanced public disclosures, short-term debt limits, and otherwise as
it deems appropriate.
The Act established the Consumer Financial Protection Bureau ("CFPB") which has
broad powers to set the requirements around the terms and conditions of
financial products. This is expected to result in increased compliance costs and
may result in reduced revenue.
The Bank routinely executes interest rate swaps for the management of its
asset-liability mix, and also executes such swaps with its borrower clients.
Under the Act, the Bank will be required to post an Independent Amount ("IA")
with its counterparties and clearing exchanges. While clearing these financial
instruments offers some benefits and additional transparency in valuation, the
dynamic nature of the IA calculation will add to the funding volatility of the
Bank and potentially require higher capital levels in future periods. The
systems requirements for clearing execution add operational complexities to the
business and accordingly increase operational risk exposure.
Provisions under the Act concerning the applicability of state consumer
protection laws to national banks, including the Bank, became effective on July
21, 2011. Questions may arise as to whether certain state consumer financial
laws that may have previously been preempted by federal law are no longer
preempted as a result of the effectiveness of these new provisions. Depending on
how such questions are resolved, the Bank may experience an increase in
state-level regulation of its retail banking business and additional compliance
obligations, revenue impacts and costs.
The Act and certain other legislation and regulations impose various
restrictions on compensation of certain executive offers. Our ability to attract
and/or retain talented personnel may be adversely affected by these
developments.
Other requirements of the Act include increases to the amount of deposit
insurance assessments the Bank must pay; changes to the nature and levels of
fees charged to consumers which are negatively affecting the Bank's income;
banning banking organizations from engaging in proprietary trading and
restricting their sponsorship of, or investing in, hedge funds and private
equity funds, subject to limited exceptions, and increasing regulation of the
derivative markets through measures that broaden the derivative instruments
subject to regulation and require clearing and exchange trading as well as
imposing additional capital and margin requirements for derivative market
participants which will increase the cost of conducting this business.
The overall impact of the Act to the Company will be unknown until these reforms
are complete. They have and will reduce revenues and increase compliance costs.
Basel III
In December 2010, the Basel Committee on Banking Supervision issued "Basel III:
A global regulatory framework for more resilient banks and banking systems"
("Basel III"). Basel III is a comprehensive set of reform measures designed to
strengthen the regulation, supervision and risk management of the banking
sector, and introduces for the first time an official definition and guideline
for Tier 1 common equity and liquidity.
New and evolving capital standards, both as a result of the Act and the
implementation in the U.S. of Basel III, could have a significant effect on
banks and bank holding companies ("BHCs"), including SHUSA and its bank
subsidiaries. On August 30, 2012, the U.S. banking agencies published in the
Federal Register three Notices of Proposed Rulemaking (the "NPRs") that, among
other things, implement Basel III in the U.S. The comment period for the NPRs
expired on October 22, 2012. Among other things, the NPRs, as proposed, would
narrow the definition of regulatory capital and establish higher minimum
risk-based capital ratios that, when fully phased in, would require banking
organizations, including SHUSA and its banking subsidiaries, to maintain a
minimum "common equity Tier 1" (or "CET1") ratio of 4.5%, a Tier 1 capital ratio
of 6.0%, and a total capital ratio of 8.0%. A capital conservation buffer of
2.5% above each of these levels (to be phased in over three years beginning in
2016) would also be required for banking institutions to avoid restrictions on
their ability to make capital distributions, including the payment of dividends.
The implementation of certain regulations and standards with regard to
regulatory capital could disproportionately affect our regulatory capital
position relative to that of our competitors, including those that may not be
subject to the same regulatory requirements, which could put further pressure on
the price of our securities.
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SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIESItem 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The NPRs are highly complex, and are subject to revisions based on the public
comment process. Therefore, many aspects of their application will remain
uncertain and the full impact on the Company will not be known until the rules
are finalized and the Company can analyze the impact under those final rules.
Historically, regulation and monitoring of bank and BHC liquidity has been
addressed as a supervisory matter, both in the U.S. and internationally, without
required formulaic measures. The Basel III liquidity framework requires banks
and BHCs to measure their liquidity against specific liquidity tests that,
although similar in some respects to liquidity measures historically applied by
banks and regulators for management and supervisory purposes, will be required
by regulation going forward. One test, referred to as the liquidity coverage
ratio ("LCR"), is designed to ensure that the banking entity maintains an
adequate level of unencumbered high-quality liquid assets equal to its expected
net cash outflow for a 30-day time horizon. The other, referred to as the net
stable funding ratio ("NSFR"), is designed to promote more medium- and long-term
funding of the assets and activities of banking entities over a one-year time
horizon. These requirements would incentivize banking entities to increase their
holdings of U.S. Treasury securities and other sovereign debt as a component of
assets and increase the use of long-term debt as a funding source. The Basel III
liquidity framework contemplates that the LCR will be subject to an observation
period continuing through mid-2013 and, subject to any revisions resulting from
the analyses conducted and data collected during that period, implemented as a
minimum standard on January 1, 2015. Similarly, it contemplates that the NSFR
will be subject to an observation period through mid-2016 and, subject to any
revisions resulting from the analyses conducted and data collected during that
period, implemented as a minimum standard by January 1, 2018. The Basel
Committee reportedly is considering revisions to the Basel III liquidity
framework as presented in December 2010. The U.S. banking agencies have not yet
proposed rules implementing the Basel III liquidity framework for U.S. banking
organizations.
Durbin Amendment
On June 29, 2011, the FRB issued the final rule implementing the debit card
interchange fee and routing regulation rules pursuant to the "Durbin amendment".
The final rule establishes standards for assessing whether debit card
interchange fees received by debit card issuers are "reasonable and
proportional" to the costs incurred by issuers for electronic debit
transactions. In addition, the final rule prohibits network exclusivity
arrangements on debit cards to ensure merchants have choices in how debit card
transactions are routed. The effective date for the provision regarding debit
card interchange fees and the network exclusivity prohibition was October 1,
2011 and April 1, 2012, respectively. The negative impact of the Durbin
amendment has been approximately $50-60 million on an annual basis.
Enhanced Prudential Standards for Capital Adequacy
On January 24, 2012, the federal banking regulators published proposed rules on
annual stress tests to be performed by banks having total consolidated assets of
more than $10 billion. The Company is subject to these annual tests ,which are
already required by the Act. In addition to the annual stress testing
requirement, under the proposal, the Company would also be subject to certain
additional reporting and disclosure requirements. The Company will be required
to conduct its stress test and report results to the FRB in January 2013.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Foreclosure Matters
As further described in Note 12 to the Consolidated Financial Statements, the
Bank agreed to the issuance of a consent order as part of an interagency
horizontal review of foreclosure practices at 14 mortgage servicers. The consent
order requires the Bank to take a number of actions, including designating a
Board committee to monitor and coordinate the Bank's compliance with the
provisions of the consent order, develop and implement plans to improve the
Bank's mortgage servicing and foreclosure practices, designate a single point of
contact for borrowers throughout the loss and mitigation foreclosure processes
and take certain other remedial actions. The Bank has made significant progress
in complying with these requirements. Specifically, the Bank has:
• retained an independent consultant to conduct a review of certain
foreclosure actions or proceedings for loans serviced by the Bank;• strengthened coordination with its borrowers by providing them with a
single point of contact to avoid borrower confusion and ensure effective
communication in connection with any foreclosure, loss mitigation or loan
modification activities;
• improved processes and controls to ensure that foreclosures are not
pursued once a mortgage has been approved for modification, unless
repayments under the modified loan are not made;
• enhanced controls and oversight over the activities of third-party
vendors, including external legal counsel and Mortgage Electronic
Registration Systems, Inc. ("MERS");
• strengthened its compliance programs to ensure mortgage-servicing and
foreclosure operations comply with all applicable legal requirements and
supervisory guidance, and assure appropriate policies and procedures staffing, training oversight, and quality control of those processes;
• improved its management information systems for foreclosure, loss
mitigation and loan modification activities that ensure timely delivery of
complete and accurate information to facilitate effective decision-making;
• centralized governance and management for the originations, servicing and
collections in the mortgage business.
Risk Management Framework
In 2012, the Company initiated an enhancement of its risk management process and
put in place an enterprise-wide Risk Management department, headed by the Chief
Risk Officer (the "CRO") to provide risk oversight to senior management and the
Board of Directors. The Board approves the Risk Tolerance Statement, which
details the types of risk and size of the risk-taking activities permissible for
the Chief Executive Officer to take in the execution of business strategy. The
Risk Tolerance Statement is the Board's explicit statement of the boundaries
within which executive management is expected to operate.
The Risk Tolerance Statement is the basis for the Risk Framework, which ties the
strategic plan and the budget together, to ensure that the Bank is taking risks
appropriate to its strategy and risk appetite, the risks are adequately and
independently controlled, and the controls are effective.
The Risk Framework sets out the high level principles for risk management at the
Bank. The CEO is ultimately responsible for risk management. The Board
authorizes the amount and type of risks that can be taken. A Board Committee,
the Board Enterprise Risk Committee (the "BERC"), advises the Board on the
decisions. The role of the CRO is one of independent oversight, ensuring the
adequacy, appropriateness, and effectiveness of the Risk Framework. To perform
this task, the CRO sets the agenda for the BERC and advises the BERC on the
decision of whether or not to recommend approval of the Risk Framework to the
Board.
The Risk Framework aids the CEO in ensuring that risk-taking mandates are
appropriately and transparently delegated; that risk-takers are accountable; and
that risk-taking mandates are executed within prudent controls and under
appropriate governance. When combined with pricing discipline and prudent,
effective controls, this process serves to optimize risk-taking within the
constraints of capital adequacy, liquidity, and asset quality to the benefit of
the Bank's stakeholders.
The risk management governance is designed to provide a structured approach to
allocating responsibilities for identification, measurement and assessment,
monitoring, controlling and communicating financial and non-financial risk
within the Bank.
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SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIESItem 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The Risk Framework is being established through the Company, with risk
definitions, governance processes and risk controls being harmonized. A Risk
Tolerance Statement for the Company is being developed.
Risk is multi-faceted and variable. The Risk Framework provides flexibility to
encompass new risks as they emerge, or current risks as they change. Change can
come either idiosyncratically, through changes to the risk profile of the Bank
or due to an external or systematic change in the types of risk to which we are
vulnerable. As risks change, the allocation of capital can change, and/or the
expected return appropriate for taking on risk can change. Therefore, the risk
tolerance must be designed so that changes in strategy and risk-taking amount
can be modified with the appropriate authority.
The Company and the Bank have established a governance structure based on three
lines of defense against loss. The first line of defense (business line
management and staff) reports into the CEO and is responsible for risk
management. The second line of defense reports into the CRO and is responsible
for risk oversight. The third line of defense reports into the Chief Auditor and
is responsible for review and assessment of the control infrastructure. Both the
second and third lines of defense report into Board committees.
CREDIT RISK ENVIRONMENT
Economic and Business Environment
Three years after the official end of the longest and deepest recession since
World War II, the United States is continuing to undergo a slower-than-average
recovery, similar to the experience of other countries facing financial crises.
Growth is not accelerating as swiftly as it normally does in a recovery, which
is rendering the economy particularly vulnerable to possible shocks such as war,
terrorism and severe natural disasters. U.S. real gross domestic product
increased at an annual rate of 2.0% during the third quarter of 2012. In the
second and first quarters of 2012, real GDP increased 1.5% and 2.0%,
respectively. On an annual basis, the economy is expected to grow at a rate of
1.9% to 2.4% in 2012. The international economy is expected to grow even more
slowly than previously expected as flagging momentum in the U.S., a fiscal
crisis in Europe and falling demand in China and India restrict recovery,
according to the International Monetary Fund (the "IMF"). The IMF lowered its
outlook for expansion to 3.3% this year, and anticipates the global economy will
grow at a rate of only 3.6% next year.
Unemployment in the United States continues to remain near historically high
levels, and conditions are expected to remain challenging for financial
institutions into 2013. The unemployment rate fell from a peak of 10.0% in late
2009 to 7.8% by September 2012.
Conditions in the housing market have been difficult over the past several years
and declining real estate values and financial stress on borrowers have resulted
in elevated levels of delinquencies and charge-offs. Accordingly, consumers and
financial institutions remain cautious as weak housing markets, high
unemployment and volatile global credit and market environments remain a
concern.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Conditions in the housing market have significantly impacted areas of the
Company's business. Certain segments of the Bank's consumer and commercial loan
portfolios have exposure to the housing market. Total residential real estate
loans including held for sale grew were $11.6 billion at September 30, 2012 and
December 31, 2011, and Alt-A(also known as limited documentation) residential
real estate loans reduced moderately to $1.4 billion at September 30, 2012 and
$1.5 billion at December 31, 2011. Charge-offs on the Alt-A residential real
estate loans were $7.5 million and $22.2 million during the three-month and
nine-month periods ended September 30, 2012, compared to $70.3 million and
$87.3 million for the corresponding periods in the prior year. Future
performance of the residential loan portfolio will continue to be significantly
influenced by home prices in the residential real estate market, unemployment
and general economic conditions.
The homebuilder industry also has been impacted by difficult new home sales
volumes and values of residential real estate, which has impacted the
profitability and liquidity of these companies. Declines in real estate prices
have been the most pronounced in certain states where previous increases were
the largest, such as California, Florida and Nevada. Additionally, heightened
foreclosure volumes have continued in other areas due to the generally
challenging economic environment and levels of unemployment. The Company
provided financing to various homebuilder companies, which is included in the
commercial loan portfolio.
European Exposure
Recent economic market developments have raised doubt about the credit quality
of certain European jurisdictions. Other than transactions with its parent
company, Santander, as further described in Note 13 to the Consolidated
Financial Statements, the Company's exposure to European countries includes the
following :
Financial Non-Financial Government
Country Covered Bonds Institution Bonds Institutions Bonds Institution Bonds Total
(in thousands)
Germany $ - $ - $ 37,000 $ - $ 37,000
Spain 92,395 - 121,160 74,750 288,305
Switzerland 102,000 94,010 - - 196,010
Great Britain 53,548 142,235 95,065 - 290,848
Netherlands 99,350 71,700 5,000 - 176,050
Sweden 78,372 - - - 78,372
France - 98,400 30,000 - 128,400
Greece - - - - -
Ireland - - - - -
Italy - - 69,768 - 69,768
Portugal - - 74,300 - 74,300
$ 425,665 $ 406,345 $ 432,293 $ 74,750 $ 1,339,053
Overall, gross exposure to the foregoing countries is less than 2.0% of the
Company's total assets as of September 30, 2012. The Company currently does not
have credit protection on any of these exposures. The Company enters into cross
currency swaps in order to hedge the foreign exchange risk on certain Euro
denominated investments.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Credit Rating Actions
The following table presents Moody's and S&P credit ratings for Sovereign Bank,
SHUSA, Banco Santander and Spain as of September 30, 2012:
SOVEREIGN SHUSA SANTANDER SPAIN
Moody's S&P Moody's S&P Moody's S&P Moody's S&P
LT Senior Debt Baa1 BBB+ Baa2 BBB+ Baa2 A- Baa3 BBB+
ST Deposits P-2 A-2 P-2 A-2 P-2 A-2 P-3 A-2
Outlook Stable Negative Negative Negative Negative Negative Negative Negative
SHUSA funds its operations independently of the other entities owned by the
Santander Group, and believes its business is not necessarily closely related to
the business or outlook of the rest of the Santander Group. However, in June
2012, Moody's Investors Service downgraded the ratings of SHUSA and the Bank,
citing challenges faced by the Santander Group. Future adverse changes in the
credit ratings of the Santander Group or the Kingdom of Spain could also further
adversely impact SHUSA's or its subsidiaries' credit ratings, and any other
adverse change in the condition of the Santander Group could adversely affect
SHUSA.
As of June 30, 2012, due to a decrease in its Moody's ratings, the Bank was
required to post an additional $23.0 million of collateral to comply with the
terms of existing derivative agreements. On October 17, 2012, due to a decrease
in S&P ratings, the Bank was required to post an additional $6.0 million, in
order to comply with existing derivative agreements.
In addition to the decrease in long-term ratings, the Bank's short-term ratings
have been reduced from A1/P1 to A2/P2. The Bank confirms for customers variable
rate demand notes ("VRDBs"). Due to this downgrade, the Company expects to
continue to incur additional costs to comply with these VRDB agreements.
The following actions were taken by S&P and Moody's following the end of the
third quarter:
On October 10, 2012 S&P lowered the ratings of Spain by 2 notches (from
BBB+/A-2 to BBB-/A-3).
On October 16, 2012 S&P lowered Santander's ratings by 2 notches (from
A-/A-2 to BBB/A-2).
On October 16, 2012 S&P lowered SHUSA and Sovereign Bank's ratings by 1
notch (from BBB+/A-2 to BBB/A-2). S&P did not change SHUSA or Sovereign's
Stand Alone Credit Profile (SACP) rating.
On October 17, 2012 Moody's completed its review of Spain and left Spain's
ratings affirmed at Baa3/P-3 with a negative outlook.
On October 26, 2012 Moody's affirmed its ratings on Santander.
On October 26, 2012, Moody's affirmed SHUSA and Sovereign's ratings. In
addition, Sovereign's Outlook was returned to Stable.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
CURRENT INTEREST RATE ENVIRONMENT
Net interest income represents a significant portion of the Company's revenues.
Accordingly, the interest rate environment has a substantial impact on the
Company's earnings. Currently, the Company is in an asset sensitive interest
rate risk position. During the three-months ended September 30, 2012, the net
interest margin decreased to 2.40% from 4.79% for the three-month period ended
September 30, 2011. This decrease is primarily attributable to the impact of the
SCUSA Transaction, which accounted for approximately 2.22% of the total 2.39%
decrease for the quarter. During the nine months ended September 30, 2012, the
net interest margin decreased to 2.48% from 4.85% for the nine-month period
ended September 30, 2011. This decrease is primarily attributable to the impact
of the SCUSA Transaction, which accounted for approximately 2.22% of the total
2.37% decrease for the year. Net interest margin in future periods will be
impacted by several factors such as, but not limited to, the Company's ability
to grow and retain core deposits, the future interest rate environment, loan and
investment prepayment rates, and changes in non-accrual loans. See the
discussion of "Asset and Liability Management" practices, including the
estimated impact of changes in interest rates on the Company's net interest
income.
RECENT INDUSTRY CONSOLIDATION
The Company believes its acquisition by Santander strengthened the Company's
financial position and enabled it to execute its strategy of focusing on its
core retail and commercial customers in the Company's geographic footprint. The
banking industry has experienced significant consolidation in recent years,
which is likely to continue in future periods. Consolidation may affect the
markets in which the Company operates, as new or restructured competitors
integrate acquired businesses, adopt new business practices or change product
pricing as they attempt to maintain or grow market share. Recent merger activity
involving national, regional and community banks and specialty finance companies
in the Northeastern United States has affected the competitive landscape in the
markets the Company serves. Management continually monitors the environment in
which it operates to assess the impact of industry consolidation on the Company,
as well as the practices and strategies of the Company's competitors, including
loan and deposit pricing, as well as customer expectations and the capital
markets.
82
-------------------------------------------------------------------------------- SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
THE SCUSA TRANSACTION
Santander Consumer USA, Inc. ("SCUSA"), a specialized consumer finance company
engaged in the purchase, securitization, and servicing of retail installment
contracts originated by automobile dealers, was a consolidated subsidiary prior
to December 31, 2011.
On December 31, 2011, SCUSA increased its share capital through the issuance of
shares to third party investors through a sponsor entity (the "Sponsors") and
certain members of its management for approximately $1.16 billion, resulting in
a dilution of the Company's ownership in SCUSA to approximately 65%.
Also on December 31, 2011, SCUSA's investors entered into an agreement (the
"Shareholders Agreement") providing each of its investors with several
substantive participating rights and certain protective rights known as "Board
Reserved Matters" and "Shareholder Reserved Matters", thereby requiring each of
its investors to jointly manage SCUSA and share control over it.
The Board Reserved Matters include significant strategic financial and operating
decisions including decisions related to the approval of certain significant
contracts; asset acquisitions, sales or dispositions; dividends or other capital
distributions; director compensation; budget approvals; equity compensation
plans; and the appointment, compensation and termination of certain executives
that represent substantive participating rights.
The Shareholder Reserved Matters further includes certain significant governance
decisions related to the dissolution or bankruptcy of the company, non pro-rata
reductions to share capital, change of company name or jurisdiction of
incorporation, changes in board structure, sale or merger of the company or a
significant subsidiary or similar transactions, sale or disposition of
substantially all assets of the company or a significant subsidiary and changes
in principal line of businesses that represent protective participating rights.
The Shareholder Reserved Matters require a 100% vote of all shares held by
SHUSA, Mr. Dundon and the Sponsors. The Board Reserved Matters requires the
affirmative vote of at least four of seven SHUSA directors; and the affirmative
vote of at least three of five directors from both Mr. Dundon and the Sponsor
directors, collectively, where Mr. Dundon is entitled to one vote and the
Sponsor directors are entitled to four votes.
These substantive participating shareholder rights preclude the Company from
controlling SCUSA. As a result, SCUSA was deconsolidated on December 31, 2011,
and is accounted for as an equity method investment (the "SCUSA Transaction").
The following tables show the Company's results of operations on a pro-forma
basis (assuming the SCUSA Transaction occurred on January 1, 2009) for the
three-month and nine-month periods ended September 30, 2011 as well as actual
results for the three-month and nine-month periods ended September 30, 2012. See
further discussion on the SCUSA Transaction in Note 1 to the Consolidated
Financial Statements.
83
--------------------------------------------------------------------------------
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Three-Month Period Ended
September 30, 2011 September 30, 2012
SHUSA as Proforma Unaudited Pro-forma
reported(1) adjustments(2) Balance(3) SHUSA as reported(4)
(in thousands)
Net interest income $ 954,568 $ (541,175 ) $ 413,393 $ 418,318
Provision for credit
losses (368,713 ) 238,513 (130,200 ) (71,000 )
Total non-interest income 235,041 33,393 268,434 249,483
General and administrative
expenses (454,594 ) 121,358 (333,236 ) (355,486 )
Other expenses (55,259 ) 1,035 (54,224 ) (290,405 )
Income before income taxes 311,043 (146,876 ) 164,167 (49,090 )
Income tax provision (104,707 ) 66,871 (37,836 ) 77,730
Net income $ 206,336 $ (80,005 ) $ 126,331 $ 28,640
Nine-Month Period Ended
September 30,
September 30, 2011 2012
SHUSA as Proforma Unaudited Pro-forma SHUSA as
reported(1) adjustments(2) Balance(3) reported(4)
(in thousands)
Net interest income $ 2,886,722 $ (1,623,286 ) $ 1,263,436 $ 1,272,835
Provision for credit
losses (949,629 ) 508,516 (441,113 ) (281,800 )
Total non-interest income 791,261 150,843 942,104 894,874
General and administrative
expenses (1,360,032 ) 393,480 (966,552 ) (1,089,424 )
Other expenses (139,032 ) 3,244 (135,788 ) (361,081 )
Income before income taxes 1,229,290 (567,203 ) 662,087 435,404
Income tax provision (426,840 ) 303,361 (123,479 ) 5,950
Net income $ 802,450 $ (263,842 ) $ 538,608 $ 441,354
(1) Amounts represent historical financial information from our Quarterly
Report on Form 10-Q for the three-month and nine-month periods ended
September 30, 2011.
(2) Reflects the deconsolidation of SCUSA and adjustments relating to
normal recurring intercompany transactions between SHUSA and SCUSA, which as a result of the deconsolidation would no longer be eliminated.
(3) Amounts represent a non-GAAP financial measure and is presented to
assist in the evaluation of SHUSA's results.
(4) Amounts represent financial information from the Consolidated Statement
of Comprehensive Income as reported in this Quarterly Report on Form
10-Q
The Company reported pre-tax loss of $49.1 million and pre-tax income of $435.4
million for the three-month and nine-month periods ended September 30, 2012,
compared to pre-tax income of $311.0 million and $1.2 billion for the
three-month and nine-month periods ended September 30, 2011. Results for the
three-month and nine-month periods ended September 30, 2012 compared to the
three-month and nine-month periods ended September 30, 2011 were primarily
impacted by the SCUSA Transaction.
84
--------------------------------------------------------------------------------
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIESItem 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
CONSOLIDATED AVERAGE BALANCE SHEET / TAX EQUIVALENT NET INTEREST MARGIN ANALYSIS
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2012 AND 2011
2012 2011
Tax Tax
Average Equivalent Yield/ Average Equivalent Yield/
Balance Interest Rate Balance Interest Rate
(in thousands)
EARNING ASSETS
INVESTMENTS AND INTEREST
EARNING DEPOSITS $ 19,897,868 $ 107,971 2.17 % $ 16,788,635 $ 112,481 2.68 %
LOANS(1):
Commercial loans 24,496,395 225,125 3.66 % 21,988,017 214,849 3.88 %
Multi-family 7,227,934 86,571 4.77 % 6,987,085 89,075 5.07 %
Consumer loans:
Residential mortgages 11,559,676 119,087 4.12 % 11,524,543 128,533 4.46 %
Home equity loans and
lines of credit 6,774,919 64,094 3.76 % 6,910,035 67,081 3.85 %
Total consumer loans
secured by real estate 18,334,595 183,181 3.99 % 18,434,578 195,614 4.23 %
Auto loans 452,038 8,164 7.19 % 15,541,333 622,373 15.89 %
Other 2,225,169 36,188 6.47 % 2,597,994 55,212 8.43 %
Total consumer 21,011,802 227,533 4.32 % 36,573,905 873,199 9.48 %
Total loans 52,736,131 539,229 4.08 % 65,549,007 1,177,123 7.13 %
Allowance for loan losses (1,044,043 ) - - (2,257,567 ) - -
NET LOANS 51,692,088 539,229 4.16 % 63,291,440 1,177,123 7.39 %
TOTAL EARNING ASSETS 71,589,956 647,200 3.60 % 80,080,075 1,289,604 6.40 %
Other assets 12,049,622 11,372,644
TOTAL ASSETS $ 83,639,578 $ 91,452,719
INTEREST BEARING FUNDING
LIABILITIES
Deposits and other
customer related accounts:
Interest bearing demand
deposits $ 8,781,998 $ 3,150 0.14 % $ 9,072,820 $ 4,796 0.21 %
Savings 3,830,519 1,354 0.14 % 3,505,864 1,141 0.13 %
Money market 15,944,508 20,585 0.51 % 16,725,966 25,868 0.61 %
Certificates of deposit 12,241,295 33,898 1.10 % 10,414,319 33,263 1.27 %
TOTAL INTEREST BEARING
DEPOSITS 40,798,320 58,987 0.58 % 39,718,969 65,068 0.65 %
BORROWED FUNDS:
FHLB advances 12,754,412 93,518 2.92 % 9,512,703 101,653 4.25 %
Federal funds and
repurchase agreements 3,067,762 3,167 0.41 % 1,257,397 551 0.17 %
Other borrowings 3,568,343 60,996 6.80 % 18,933,471 156,295 3.28 %
TOTAL BORROWED FUNDS 19,390,517 157,681 3.24 % 29,703,571 258,499 3.46 %
TOTAL INTEREST BEARING
FUNDING LIABILITIES 60,188,837 216,668 1.44 % 69,422,540 323,567 1.85 %
Noninterest bearing demand
deposits 8,300,228 7,743,408
Other liabilities 1,921,929 2,265,465
TOTAL LIABILITIES 70,410,994 79,431,413
STOCKHOLDER'S EQUITY 13,228,584 12,021,306
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 83,639,578 $ 91,452,719
TAXABLE EQUIVALENT NET
INTEREST INCOME $ 430,532 $ 966,037
NET INTEREST SPREAD (2) 2.17 % 4.55 %
NET INTEREST MARGIN (3) 2.40 % 4.79 %
85
--------------------------------------------------------------------------------
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIESItem 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
CONSOLIDATED AVERAGE BALANCE SHEET / TAX EQUIVALENT NET INTEREST MARGIN ANALYSIS
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2012 AND 2011
2012 2011
Tax Tax
Average Equivalent Yield/ Average Equivalent Yield/
Balance Interest Rate Balance Interest Rate
(in thousands)
EARNING ASSETS
INVESTMENTS AND
INTEREST-EARNING DEPOSITS $ 19,328,780 $ 328,362 2.27 % $ 16,621,823 $ 348,747 2.80 %
LOANS(1):
Commercial loans 23,847,913 664,219 3.72 % 22,134,069 671,249 4.05 %
Multi-family 7,166,710 266,063 4.96 % 6,916,730 264,644 5.11 %
Consumer loans:
Residential mortgages 11,600,432 365,166 4.20 % 11,524,692 391,959 4.53 %
Home equity loans and
lines of credit 6,808,715 191,221 3.75 % 6,939,197 201,374 3.88 %
Total consumer loans
secured by real estate 18,409,147 556,387 4.03 % 18,463,889 593,333 4.29 %
Auto loans 657,841 34,418 6.99 % 16,289,524 1,897,248 15.57 %
Other 2,239,097 113,508 6.77 % 2,310,747 157,988 9.14 %
Total consumer 21,306,085 704,313 4.41 % 37,064,160 2,648,569 9.55 %
Total loans 52,320,708 1,634,595 4.17 % 66,114,959 3,584,462 7.25 %
Allowance for loan losses (1,066,567 ) - - % (2,230,302 ) - - %
NET LOANS 51,254,141 1,634,595 4.26 % 63,884,657 3,584,462 7.50 %
TOTAL EARNING ASSETS 70,582,921 1,962,957 3.71 % 80,506,480 3,933,209 6.53 %
Other assets 12,152,103 11,418,898
TOTAL ASSETS 82,735,024 91,925,378
INTEREST BEARING FUNDING
LIABILITIES
Deposits and other
customer related accounts:
Interest bearing demand
deposits $ 9,103,372 $ 10,627 0.16 % $ 9,305,758 $ 14,820 0.21 %
Savings 3,744,590 4,296 0.15 % 3,508,192 3,333 0.13 %
Money market 16,552,774 62,738 0.51 % 15,614,015 74,984 0.64 %
CDs 11,719,351 97,820 1.11 % 10,556,842 94,700 1.20 %
TOTAL INTEREST BEARING
DEPOSITS 41,120,087 175,481 0.57 % 38,984,807 187,837 0.64 %
BORROWED FUNDS:
FHLB advances 11,475,290 281,085 3.27 % 9,973,027 322,621 4.32 %
Federal funds and
repurchase agreements 3,358,254 8,819 0.35 % 2,021,096 5,498 0.36 %
Other borrowings 3,750,590 187,759 6.69 % 19,045,975 495,445 3.48 %
TOTAL BORROWED FUNDS 18,584,134 477,663 3.43 % 31,040,098 823,564 3.54 %
TOTAL INTEREST BEARING
FUNDING LIABILITIES 59,704,221 653,144 1.46 % 70,024,905 1,011,401 1.93 %
86
--------------------------------------------------------------------------------
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