James H. Bathon, Managing Director - Legal and Compliance

Banco Santander, S.A.

New York Branch

45 E. 53rd Street

New York, New York 10022

(212) 350-3604

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

 

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

Title of each class		Name of each exchange on which registered
Units, each composed of 55 common shares, no par value, and 50 preferred shares, no par value		New York Stock Exchange*
Common Shares, no par value		New York Stock Exchange*
Preferred Shares, no par value		New York Stock Exchange*
American Depositary Shares, each representing the right to receive one unit which is composed of 55 common shares, no par value, and 50 preferred shares, no par value, of Banco Santander (Brasil) S.A.		New York Stock Exchange
7.375% Tier 1 Subordinated Perpetual Notes		N/A
6.000% Tier 2 Subordinated Notes due 2024		N/A

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US GAAP   ☐

International Financial Reporting Standards as issued by the International Accounting Standards Board   ☒

Other   ☐

PART I

 

ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

1A.	Directors and Senior Management

 

Not applicable.

 

1B.

Advisers

 

Not applicable.

 

1C.

Auditors

 

Not applicable.

 

ITEM 2.  OFFER STATISTICS AND EXPECTED TIMETABLE

 

2A.	Offer Statistics

 

Not applicable.

 

2B.	Method and Expected Timetable

 

Not applicable.

 

ITEM 3.  KEY INFORMATION

 

3A.	Selected Financial Data

 

Financial information for Santander Brasil at and for the years ended December 31, 2013, 2012, 2011, 2010 and 2009 has been derived from our audited consolidated financial statements prepared in accordance with IFRS. See “Item 18. Financial Statements.” This financial information should be read in conjunction with our audited consolidated financial statements and the related notes and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report.

 

The income statement data and balance sheet data for 2013, 2012, 2011, 2010 and 2009 was adjusted due to changes in accounting policies related to the adoption of International Accounting Standards IAS 19—Employee Benefits and IFRS 5—Discontinued Operations.

 

The adoption of IAS 19 applies to financial years beginning on or after January 1, 2013, with the effects accounted for retrospectively as a change in accounting policies. The adoption of this new accounting policy resulted in the full recognition of liabilities on account of actuarial losses (actuarial deficit) not yet recognized due to the corridor approach, in contrast to the stockholders’ equity (other comprehensive income). For further information, see note 3 of our audited consolidated financial statements.

 

On December 17, 2013, we sold our asset management business through the disposal of all of our shares in Santander Brasil Asset Management Distribuidora de Títulos e Valores Mobiliários S.A. (“DTVM”), The gains/losses with the sale of the asset management business, thus the gains/losses of DTVM are recorded in “Discontinued Operations,” in accordance with IFRS 5—Discontinued Operations. For further information, see notes 3.a and 42 of our audited consolidated financial statements.

 

 

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Income Statement Data

 

		For the year ended December 31,
		2013				2013				2012				2011				2010				2009
		(in millions of U.S.$)(1)				(in millions of R$)
Interest and similar income			21,863				51,217				52,644				51,716				40,887				39,324
Interest expense and similar charges			(9,706	)			(22,738	)			(21,057	)			(23,920	)			(16,823	)			(17,182	)
Net interest income			12,157				28,479				31,587				27,796				24,064				22,142
Income from equity instruments			35				81				94				94				52				30
Income from companies accounted for by the equity method			39				91				73				54				44				295
Fee and commission income			4,586				10,742				9,611				8,629				7,668				7,013
Fee and commission expense			(1,127	)			(2,641	)			(2,001	)			(1,429	)			(998	)			(910	)
Gains (losses) on financial assets and liabilities (net)			(489	)			(1,146	)			(548	)			(134	)			1,458				2,716
Exchange differences (net)			235				551				378				(121	)			417				(51	)
Other operating income (expenses)			(190	)			(445	)			(623	)			(378	)			(348	)			(115	)
Total income			15,246				35,712				38,571				34,511				32,357				31,120
Administrative expenses			(5,912	)			(13,850	)			(13,773	)			(12,783	)			(11,769	)			(11,483	)
Depreciation and amortization			(534	)			(1,252	)			(1,201	)			(1,000	)			(655	)			(680	)
Provisions (net)(2)			(1,149	)			(2,692	)			(2,057	)			(2,985	)			(1,922	)			(3,459	)
Impairment losses on financial assets (net)(3)			(6,027	)			(14,118	)			(16,476	)			(9,382	)			(8,234	)			(9,966	)
Impairment losses on other assets (net)			(147	)			(345	)			(38	)			(39	)			(21	)			(901	)
Gains (losses) on disposal of assets not classified as non-current assets held for sale			196				460				501				5				(59	)			3,369
Gains (losses) on non-current assets held for sale not classified as discontinued operations			44				103				(52	)			447				199				32
Operating profit before tax			1,717				4,018				5,475				8,774				9,896				8,032
Income taxes			(100	)			(233	)			(37	)			(1,101	)			(2,572	)			(2,583	)
Net Profit from Continuing Operations			1,617				3,785				5,438				7,673				7,323				5,450
Discontinued Operations			879				2,063				55				74				85				66
Consolidated Profit for the Year			2,496				5,848				5,493				7,747				7,408				5,516

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(1)	Translated for convenience only using the selling rate as reported by the Brazilian Central Bank at December 31, 2013, for reais into U.S. dollars of R$2.3426 to U.S.$1.00.

 

(2)	Mainly provisions for tax risks and legal obligations, and judicial and administrative proceedings of labor and civil lawsuits.

 

(3)	Net provisions to the credit loss allowance less recovery of loans previously written off.

 

 

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Earnings and Dividend per Share Information

 

		For the year ended December 31,
		2013				2012				2011				2010				2009
Basic Earnings per 1,000 shares
From continuing and discontinued operations
Basic Earnings per shares ( reais )			14.39				13.77				19.39				18.50				16.03
Diluted Earnings per shares ( reais )			14.38				13.77				19.39				18.50				16.03
Basic Earnings per shares (U.S. dollars)(1)			6.14				6.74				10.34				11.10				9.21
Diluted Earnings per shares (U.S. dollars)(1)			6.14				6.74				10.34				11.10				9.21
From continuing operations
Basic Earnings per shares ( reais )			9.20				13.63				19.21				18.29				15.84
Diluted Earnings per shares ( reais )			9.20				13.63				19.21				18.29				15.84
Basic Earnings per shares (U.S. dollars)(1)			3.93				6.67				10.24				10.97				9.10
Diluted Earnings per shares (U.S. dollars)(1)			3.93				6.67				10.24				10.97				9.10
From discontinued operations
Basic Earnings per shares ( reais )			5.19				0.14				0.18				0.21				0.19
Diluted Earnings per shares ( reais )			5.18				0.14				0.18				0.21				0.19
Basic Earnings per shares (U.S. dollars)(1)			2.21				0.07				0.10				0.13				0.11
Diluted Earnings per shares (U.S. dollars)(1)			2.21				0.07				0.10				0.13				0.11
Dividends and interest on capital per shares(2)
Dividends and interest on capital per shares - Units ( reais )			634,54				705,06				836,75				932,33				250,20
Dividends and interest on capital per shares - Units (U.S. dollars)(1)			270,87				344,98				446,12				559,28				143,72
Weighted average share outstanding (in thousands) – basic			397,875,180				398,046,965				399,044,117				399,044,117				343,506,993
Weighted average share outstanding (in thousands) – diluted			398,035,046				398,291,052				399,044,117				399,044,117				343,506,993

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(1)	Translated for convenience only using the selling rate as reported by the Brazilian Central Bank at December 31, 2013, for reais into U.S. dollars of R$2.3426 to U.S.$1.00.

 

(2)	Includes dividends based on net income and dividends based on reserves.

 

 

Balance Sheet Data

 

		At December 31,
		2013				2013				2012				2011				2010				2009
		(in millions of U.S.$)(1)				(in millions of R$)
Assets
Cash and balances with the Brazilian Central Bank			22,075				51,714				55,535				65,938				56,800				27,269
Financial assets held for trading			12,887				30,189				31,638				29,901				24,821				20,116
Other financial assets at fair value through profit or loss(2)			554				1,298				1,228				665				17,940				16,295
Available-for-sale financial assets			19,759				46,287				44,149				44,608				47,206				46,406
Loans and receivables			110,466				258,778				226,957				202,757				174,106				152,163
Hedging derivatives			151				353				156				81				116				163
Non-current assets held for sale			117				275				166				132				67				172
Investments in associates and joint ventures			454				1,064				472				422				371				419
Tax assets			9,417				22,060				21,497				17,017				15,117				15,960
Other assets			2,171				5,085				5,601				4,803				3,915				4,087
Tangible assets			2,939				6,886				5,938				5,008				4,518				3,702
Intangible assets			12,407				29,064				29,271				29,245				29,960				29,402
Total assets			193,398				453,053				422,608				400,579				374,937				316,154
Average assets			185,813				435,286				408,143				394,788				341,956				298,355

 

 

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		At December 31,
		2013				2013				2012				2011				2010				2009
		(in millions of U.S.$)(1)				(in millions of R$)
Liabilities
Financial liabilities held for trading			5,786				13,554				5,352				5,047				4,785				4,435
Other financial liabilities at fair value through profit or loss			—				—				—				—				—				2
Financial liabilities at amortized cost			140,741				329,701				306,976				291,452				253,341				203,568
Deposits from the Brazilian Central Bank and deposits from credit institutions			14,527				34,032				35,074				51,527				42,391				21,196
Customer deposits			85,442				200,156				188,595				174,474				167,949				149,440
Marketable debt securities			27,875				65,301				54,012				38,590				20,087				11,439
Subordinated debts			3,802				8,906				11,919				10,908				9,695				11,305
Other financial liabilities			9,095				21,306				17,376				15,952				13,218				10,188
Hedging derivatives			269				629				282				36				—				10
Liabilities for insurance contracts											—				—				19,643				15,527
Provisions(3)			4,650				10,892				12,775				11,358				10,082				9,933
Tax liabilities			4,991				11,693				13,784				11,876				10,530				9,457
Other liabilities			2,105				4,928				4,303				3,928				3,606				4,228
Total liabilities			158,542				371,397				343,472				323,696				301,986				247,160
Stockholders’ equity			35,575				83,340				79,921				77,117				72,653				68,762
Other Comprehensive Income			(842	)			(1,973	)			(1,022	)			(254	)			290				231
Non-controlling interests			123				289				237				19				8				1
Total Stockholders’ Equity			34,856				81,655				79,136				76,882				72,951				68,994
Total liabilities and stockholders’ equity			193,398				453,053				422,608				400,578				374,937				316,154
Average interest-bearing liabilities			122,676				287,382				265,328				244,453				198,453				184,332
Average stockholders’ equity			34,541				80,916				77,886				75,606				72,495				55,920

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(1)	Translated for convenience only using the selling rate as reported by the Brazilian Central Bank at December 31, 2013, for reais into U.S. dollars of R$2.3426 to U.S.$1.00.

 

(2)

In 2010 and 2009, this item includes investment fund units of guarantors of benefit plans – PGBL/VGBL, in the amount of R$17,426 million and R$14,184 million, respectively, related to the liabilities for insurance contracts held by Zurich Santander Brasil Seguros e Previdência S.A., formerly Santander Seguros S.A. (“Santander Seguros”), which were no longer included in the consolidation in 2011, following the sale of Santander Seguros. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Factors Affecting the Comparability of Our Results of Operation—Sale of Zurich Santander Brasil Seguros e Previdência S.A. (the new corporate name of Santander Seguros S.A.”).

 

(3)	Mainly provisions for tax risks and legal obligations, and judicial and administrative proceedings of labor and civil lawsuits.

 

 

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Selected Consolidated Ratios

 

		At and for the Year Ended December 31,
		2013				2012				2011				2010				2009
		in (%)
Profitability and performance
Net yield(1)			8.0				9.5				8.6				8.8				9.7
Return on average total assets			1.3				1.3				2.0				2.2				1.8
Return on average stockholders’ equity			7.3				7.1				10.3				10.2				9.9
Adjusted return on average stockholders’ equity(2)			10.9				10.8				16.3				16.7				19.6
Capital adequacy (3)
Average stockholders’ equity as a percentage of average total assets			18.5				19.1				19.2				21.2				18.7
Average stockholders’ equity excluding goodwill as a percentage of average total assets excluding goodwill(2)			13.1				13.3				13.0				14.1				10.4
Basel capital adequacy ratio(4)			19.2				20.8				24.8				28.4				33.4
Asset quality
Non-performing assets as a percentage of loans and advances to customers (gross)(5)			6.2				7.6				6.7				5.8				7.2
Non-performing assets as a percentage of total assets(5)			3.1				3.8				3.3				2.5				3.1
Non-performing assets as a percentage of computable credit risk(5)(6)			5.4				6.7				6.0				5.1				6.2
Impairment losses as a percentage of non-performing assets(5)			96.1				87.0				85.0				98.3				101.7
Impairment losses as a percentage of loans and advances to customers (gross)			6.0				6.6				5.7				5.7				7.2
Derecognized assets as a percentage of loans and advances to customers (gross)			6.5				7.2				4.7				6.2				6.2
Non-performing assets as a percentage of stockholders’ equity(5)			17.2				20.4				17.0				12.9				14.4
Non-performing assets as a percentage of stockholders’ equity excluding goodwill(2)(5)			25.9				31.1				26.3				21.1				24.5
Liquidity
Total loans, net as a percentage of total funding(7)			69.0				67.9				66.4				63.0				66.4
Other Information
Efficiency
Efficiency ratio(8)			38.8				35.7				37.0				36.3				36.8
Adjusted efficiency ratio			36.4				34.4				35.4				36.6				38.2

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(1)	Net yield is defined as net interest income (including dividends on equity securities) divided by average interest earning assets.

 

(2)

“Adjusted return on average stockholders’ equity,” “Average stockholders’ equity excluding goodwill as a percentage of average total assets excluding goodwill” and “Non-performing assets as a percentage of stockholders’ equity excluding goodwill” are non-GAAP financial measures which adjust “Return on average stockholders’ equity,” “Average stockholders’ equity as a percentage of average total assets” and “Non-performing assets as a percentage of stockholders’ equity,” to exclude the goodwill arising from the acquisition of Banco Real in 2008.

 

(3)	The average annual balance sheet data has been calculated based upon the average of the monthly of balances at 13 dates: at December 31 of the prior year and each of the month-end balances of the 12 subsequent months.

 

 

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(4)

Basel III capital adequacy ratio as measured pursuant to Brazilian Central Bank rules in effect as from December 31, 2013. In March 2013, the Brazilian Central Bank published a set of four resolutions and 15 circulars implementing Basel III. The regulations came into effect in October 2013, and apply to all banks operating in Brazil. This new set of regulations covers the revised definition of capital, capital requirements, capital buffers, credit valuation adjustments and exposures to central counterparties. Additional regulations and some important amendments were issued in late October 2013 to clarify and improve the risk-based capital framework. Some of the revisions came into effect in December 2013. The changes are especially relating to the definition of capital and other aspects of Pillar 1. The most important difference is the phase-in of the deduction of goodwill from regulatory capital. According to the new rules on regulatory capital in Brazil, the value of goodwill for the calculation of capital base will be deducted from the capital base according to the “phase-in” for implementation of Basel III in Brazil which will be completed by 2019. In December 2013, The Basel Committee on Banking Supervision issued a report presenting the findings of the Basel Committee’s RCAP Assessment Team on the domestic adoption of Basel III risk-based capital standards in Brazil and their consistency with Basel Committee requirements: Brazil’s capital regulations were found to be Compliant with the internationally agreed minimum Basel III standards. The set of regulations published in October 2013 has strengthened the Brazilian capital regulation. The final requirements of liquidity and leverage were not defined yet. The leverage ratio, the liquidity ratios and the framework for global systemically important banks (G-SIBs) will be assessed at a later date once those standards become effective as per the internationally agreed “phase-in” arrangements. For more information see “Item 4. Information on the Company—B. Business Overview—Regulatory Overview—Capital Adequacy and Leverage—Basel.”

 

(5)	Non-performing assets include all loans and advances past due by more than 90 days and other doubtful credits. For further information see “Item 4. Information on the Company—B. Business Overview—Selected Statistical Information—Impaired Assets”

 

(6)	Computable credit risk is the sum of the face amounts of loans and leases (including non-performing assets), guarantees and documentary credits.

 

(7)	Total funding is the sum of financial liabilities at amortized cost, excluding the other financial liabilities, for further information see “Item 5B.Liquidity and Capital Resources - Liquidity and Funding.”

 

(8)

Efficiency ratio is defined as administrative expenses divided by total income. The adjustment, which impacts the line items income tax, gains (losses) on financial assets and liabilities and exchange rate differences, does not affect net profit. Our management believes that the adjusted efficiency ratio provides a more consistent framework for evaluating and conducting business, as a result of excluding from our revenues the effect of the volatility caused by possible gains and losses on our hedging strategies for tax purposes. For example, in 2013, the effects of the devaluation of the real against foreign currency impacted our tax hedging of the investments denominated in dollars generating losses of R$2,367 million recorded under “gains/losses on financial assets and liabilities (net),” equivalent to 2.8 percentage points variance in the efficiency ratio. In 2012 the impact of tax hedging in dollars was a loss of R$1,437 million and a gain of R$1,646 million in 2011, which corresponded to a variation in the efficiency ratio of 1.3 percentage points in 2012.

 

 

The information below presents the calculation of these non-GAAP financial measures from each of their most directly comparable financial measures.

 

 

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		At and for the year ended December 31,
		2013				2012				2011				2010				2009
		(in millions of R$, except as otherwise indicated)
Return on average stockholders’ equity:
Consolidated profit for the year			5,848				5,493				7,747				7,408				5,516
Average stockholders’ equity			80,916				77,886				75,606				72,495				55,920
Return on average stockholders’ equity			7.3	%			7.1	%			10.3	%			10.2	%			9.9	%
Adjusted return on average stockholders’ equity:
Consolidated profit for the year			5,848				5,493				7,747				7,408				5,516
Average stockholders’ equity			80,916				77,886				75,606				72,495				55,920
Average goodwill			27,218				27,218				27,975				28,312				27,714
Average stockholders’ equity excluding goodwill			53,698				50,668				47,631				44,183				28,206
Adjusted return on average stockholders’ equity			10.9	%			10.8	%			16.3	%			16.7	%			19.6	%
Average stockholders’ equity as a percentage of average total assets:
Average stockholders’ equity			80,916				77,886				75,606				72,495				55,920
Average total assets			435,283				408,143				394,788				341,956				298,355
Average stockholders’ equity as a percentage of average total assets			18.5	%			19.1	%			19.2	%			21.2	%			18.7	%
Average stockholders’ equity excluding goodwill as a percentage of average total assets excluding goodwill:
Average stockholders’ equity			80,916				77,886				75,606				72,495				55,920
Average goodwill			27,218				27,218				27,975				28,312				27,714
Average stockholders’ equity excluding goodwill			53,698				50,668				47,631				44,183				28,206
Average total assets			435,283				408,143				394,788				341,956				298,355
Average goodwill			27,218				27,218				27,975				28,312				27,714
Average total assets excluding goodwill			408,065				380,925				366,813				313,644				270,641
Average stockholders’ equity excluding goodwill as a percentage of average total assets excluding goodwill			13.1	%			13.3	%			13.0	%			14.1	%			10.4	%
Non-performing assets as a percentage of stockholders’ equity:
Non-performing assets			14,022				16,057				13,073				9,349				9,900
Stockholders’ equity			81,366				78,899				76,863				72,653				68,762
Non-performing assets as a percentage of stockholders’ equity			17.2	%			20.4	%			17.0	%			12.9	%			14.4	%
Non-performing assets as a percentage of stockholders’ equity excluding goodwill:
Non-performing assets			14,022				16,057				13,073				9,349				9,900
Stockholders’ equity			81,366				78,899				76,863				72,653				68,762
Goodwill			27,218				27,218				27,218				28,312				28,312
Stockholders’ equity excluding goodwill			54,148				51,681				49,645				44,341				40,450
Non-performing assets as a percentage of stockholders’ equity excluding goodwill			25.9	%			31.1	%			26.3	%			21.1	%			24.5	%

Our calculation of these non-GAAP measures may differ from the calculation of similarly titled measures used by other companies. We believe that these non-GAAP financial measures supplement the GAAP information provided to investors regarding the substantial impact of the R$27 billion goodwill arising from the acquisition of Banco Real during the year ended December 31, 2008 and the significance of other factors affecting stockholders’ equity and the related ratios. Accordingly, we believe that the non-GAAP measures presented are useful to investors, because they reflect the economic substance of our capital. The limitation associated with the exclusion of goodwill from stockholders’ equity is that it has the effect of excluding a portion of the total investment in our assets. We compensate for this limitation by also considering stockholders´ equity including goodwill, as set forth in the above tables.

 

 

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The table below presents the reconciliation of our adjusted efficiency ratio to the most directly comparable GAAP financial measures for each of the periods presented.

 

		At and for the year ended December 31,
		2013				2012				2011				2010				2009
		(in millions of R$, except as otherwise indicated)
Efficiency ratio
Administrative expenses			13,850				13,773				12,783				11,813				11,516
Total income			35,712				38,570				34,510				32,544				31,274
of which:
Gains (losses) on financial assets and liabilities (net) and exchange differences (net)			(595	)			(170	)			(255	)			1,875				2,665
Efficiency ratio			38.8	%			35.7	%			37.0	%			36.3	%			36.8	%
Total Income			35,712				38,570				34,510				32,544				31,274
Effects of the tax hedge for investments held abroad			2,367				1,437				1,646				(272	)			(1,146	)
Total income excluding effects of the tax hedge for investments held abroad			38,079				40,007				36,156				32,272				30,128
Administrative expenses			13,850				13,773				12,783				11,813				11,516
Total income excluding effects of the tax hedge for investments held abroad			38,079				40,007				36,156				32,272				30,128
of which:
Gains (losses) on financial assets and liabilities (net) excluding effects of the tax hedge for investments held abroad			1,772				1,267				1,411				1,603				1,519
Efficiency ratio adjusted for effects of the tax hedge for investments held abroad			36.37	%			34.4	%			35.4	%			36.6	%			38.2	%

Exchange Rates

 

The Brazilian foreign exchange system allows the purchase and sale of foreign currency and the international transfer of reais by any person or legal entity, regardless of the amount, subject to certain regulatory procedures.

 

Since 1999, the Brazilian Central Bank has allowed the real /U.S. dollar exchange rate to float freely, which resulted in increased foreign exchange rate volatility. Until early 2003, the value of the real declined in relation to the U.S. dollar. Between 2006 and 2008, the real strengthened, except during the most severe period of the global economic crisis. Given the recent turmoil in international markets, the real has been depreciating since mid-2011. The Brazilian Central Bank has intervened in the foreign exchange market to control unstable movements of exchange rates. The real may fluctuate against the U.S. dollar substantially in the future. For further information on these risks, see “—D. Risk Factors—Risks Relating to Brazil and Macroeconomic Conditions in Brazil and Globally—Exchange rate volatility may have a material adverse effect on the Brazilian economy and on our business.”

 

 

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The following tables set forth the selling rate, expressed in reais per U.S. dollar (R$/U.S.$), for the periods indicated:

 

		Period-end				Average(1)				Low				High
		(per U.S. dollar)
Year:
2009			1.74				1.99				1.70				2.42
2010			1.67				1.76				1.65				1.88
2011			1.87				1.67				1.53				1.90
2012			2.04				1.96				1.70				2.11
2013			2.34				2.16				1.95				2.45

		Period-end				Average(1)				Low				High
		(per U.S. dollar)
Month Ended:
September 2013			2.23				2.27				2.20				2.39
October 2013			2.20				2.19				2.16				2.21
November 2013			2.32				2.30				2.24				2.34
December 2013			2.34				2.35				2.31				2.38
January 2014			2.43				2.38				2.33				2.44
February 2014			2.33				2.38				2.33				2.42
March 2014			2.26				2.33				2.26				2.36
April 2014 (through April 29)		2.22				2.23				2.20				2.28

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Source: Brazilian Central Bank

 

(1)	Represents the average of the exchange rates on the close of each business day during the period.

 

 

Our parent company, Santander Spain, reports its financial condition and results of operations in euros . As of December 31, 2013, the exchange rate for euro to real was R$3.2265 per €1.00.

 

3B.	Capitalization and Indebtedness

 

Not applicable.

 

3C.	Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

3D.	Risk Factors

 

Our business, financial condition and results of operations could be materially and adversely affected if any of the risks described below occur. As a result, the market price of our units and the American Depositary Shares (“ADSs”) could decline, and you could lose all or part of your investment.

 

Risks Relating to Brazil and Macroeconomic Conditions in Brazil and Globally

 

The Brazilian government has exercised significant influence over the Brazilian economy. The Brazilian government’s macro-economic management strategies, as well as Brazilian political and economic conditions, could adversely affect us and the trading price of our securities.

 

The Brazilian government has frequently intervened in the Brazilian economy and has on occasion made significant changes in policy and regulations. In the past, the Brazilian government has adopted measures, including, among others, changes in regulation, price controls, capital controls, change in the exchange rate regime and limitations on imports, which have affected Brazilian asset prices. Recently, the Brazilian government has adopted measures, including changes in tax policies and constraints that have affected Brazilian asset prices and the trading price of our securities. We and the trading price of our securities may be adversely affected by changes in policy or regulations at the federal, state and municipal levels involving or affecting factors such as:

 

 

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·

interest rates;

 

·

currency volatility;

 

·

inflation;

 

·

reserve requirements;

 

·

capital requirements;

 

·

liquidity of capital and lending markets

 

·

non-performing loans;

 

·

tax policies;

 

·

exchange rate controls and restrictions on remittances abroad, such as those that were briefly imposed in 1989 and early 1990;

 

·

outcome of the elections being held in October 2014; and

 

·

other political, social and economic developments in or affecting Brazil.

 

Uncertainty over whether the Brazilian government will implement changes in policy or regulation creates instability in the Brazilian economy, increasing the volatility of the Brazilian securities markets, which may have an adverse effect on us and our securities. Recent economic and political instability has led to a negative perception of the Brazilian economy and higher volatility in the Brazilian securities markets, which also may adversely affect us and our securities.

 

Between the end of 2010 and the beginning of 2011, the Brazilian Central Bank adopted certain measures in order to control outstanding credit growth, known as macro prudential measures. These measures focused on controlling the issuance of new loans, such as increasing the down payment required for new loans, increasing the minimum payment of credit card bills, as well as implementing a higher minimum capital requirement for certain types of loans, and increasing reserve requirements. Additionally, the government increased tax on foreign capital inflow in order to control the trend of exchange rate appreciation. These measures negatively impacted the results of all Brazilian banks. Since the beginning of 2012, the Brazilian Central Bank has loosened certain of these measures, including reducing the reserve requirements of demand and time deposits.

 

In 2012, the Brazilian government decided to promote credit growth at state-owned banks, increasing their market share mainly in the market for lending to individuals, which also adversely affected the results of operations for private-owned banks.

 

In addition, over the past twelve months, there has been an increase in volatility in all Brazilian markets due to, among other factors, uncertainties about how monetary policy adjustments in the United States will affect the international financial markets, the recent increasing risk aversion to emerging market countries, and the uncertainties regarding Brazilian macroeconomic conditions. These uncertainties adversely affect us and the market value of our securities.

 

Political demonstrations in Brazil also have affected the development of the Brazilian economy and investors’ perception about Brazil. For example, the street protests in mid-2013 in Brazil demonstrated the public’s dissatisfaction with corruption and certain political measures, and represent a potential risk to the Brazilian economic and social outlook.

 

We are not able to fully estimate the impact of economic shocks and economic regulatory policy changes on our business and lending activity, nor we are able to predict how current or future measures implemented by regulatory policy-makers may impact our business. Any changes in regulatory capital requirements for lending, reserve requirements, or product and service regulations, among others, may materially adversely affect our business.

 

 

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Government efforts to control inflation and changes in interest rates may hinder the growth of the Brazilian economy and could harm our business.

 

Brazil has experienced extremely high rates of inflation in the past and has therefore implemented monetary policies that have resulted in one of the highest interest rates in the world. The Brazilian government’s measures to fight inflation, principally through the Brazilian Central Bank, have had and may in the future have significant effects on the Brazilian economy and our business. Tight monetary policies with high interest rates and high compulsory reserve requirements may restrict Brazil’s growth and the availability of credit, reduce our loan volumes and increase our loan loss provisions. Conversely, less strict government and Brazilian Central Bank policies and interest rate decreases may trigger increases in inflation, and, consequently, growth volatility and the need for sudden and significant interest rate increases, which could negatively affect our credit spreads.

 

From January 2000 to August 2005, the average annual interest rate in Brazil was 18.9%, with the minimum rate of 15.25% and maximum of 26.50% during this period. With the favorable macroeconomic environment and inflation stability, the Brazilian Central Bank began a cycle of reducing the SELIC rate (the benchmark interest rate payable to holders of certain Brazilian government securities, based on bank’s overnight rate), starting at a rate of 19.5% in September 2005 and lowering it to 8.75% in March 2010, when the SELIC rate reached then a historical low. At the end of 2010, in order to balance domestic demand, the Brazilian Central Bank started to increase the SELIC rate again, reaching 12.5% in July 2011. However, the Brazilian Central Bank revised its monetary policy in August 2011, when it implemented a monetary easing policy to mitigate the spillover effects of the then ongoing international financial crisis (particularly in Europe). As a result of this change in policy, the SELIC rate was decreased a number of times during the second half of 2011 and throughout 2012, reaching 7.25% (the lowest rate on record) by the end of 2012. The Brazilian Central Bank tightened monetary policy once more in 2013, progressively increasing the SELIC rate starting in April 2013, and reaching 10.0% in November 2013. The SELIC rate continued to be increased, reaching 11.00% in April, 2014.

 

The majority of our income, expenses, assets and liabilities are directly tied to interest rates. Therefore, our results of operations and financial condition are significantly affected by inflation, interest rate fluctuations and related government monetary policies, all of which may materially and adversely affect the growth of the Brazilian economy, our loan portfolios, our cost of funding and our income from credit operations. We estimate that in 2013, a 1.0% increase or decrease in the base interest rate would have resulted in a decrease or increase, respectively, in our net interest income of R$383 million. Any changes in interest rates may negatively impact our business, financial condition and results of operations. In addition, increases in base interest rates may adversely affect us by reducing the demand for our credit and investment products, increasing funding costs and increasing in the short run the risk of default by our customers.

 

Inflation adversely affects our personnel and other administrative expenses that are directly or indirectly tied to inflation indexes, generally the consumer price index ( Índice de Preços ao Consumidor – Amplo) , or “IPCA,” and the general index of market prices ( Índice Geral de Preços-Mercado) , or IGP-M. For example, considering the amounts in 2013, each additional percentage point change in inflation, would impact our personnel and other administrative expenses by approximately R$70 million and R$63 million, respectively.

 

Exposure to Brazilian federal government debt could have a material adverse effect on us.

 

We invest in Brazilian government sovereign bonds. As of December 31, 2013, approximately 11% of our total assets, and 76% of our securities portfolio, was comprised of debt securities issued by the Brazilian government. Any failure by the Brazilian government to make timely payments under the terms of these securities, or a significant decrease in their market value, will have a material adverse effect on us.

 

Fluctuations in interest rates and other factors may affect our obligations under legacy employee pension funds.

 

We sponsor certain defined benefit pension plans and a health care plan that benefit certain of our former and current employees, most of which were inherited from Banespa (though we discontinued the use of defined benefit pension plans for our employees in 2005).

 

In order to determine the funded status of each legacy defined benefit pension plan and consequently the carried reserves necessary to pay future beneficiaries, we use certain actuarial techniques and assumptions which are inherently uncertain and involve the exercise of significant judgment, including with respect to interest rates, which

 

 

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are a key assumption in determining our current obligations under the legacy pension plans as interest rates are used to calculate the present value of such obligations.

 

Changes in the present value of our obligations under our legacy defined benefit pension plans, due to a reduction in the value of the pension fund assets (depending on the performance of financial markets) or an increase in the pension fund liabilities due to changes in mortality assumptions, the rate of increase of salaries, discount rate assumptions (primarily based on yield levels of high graded securities), inflation, the expected rate of return on plan assets, or other factors, could cause us to have to increase contributions to reduce or satisfy the deficits which would divert resources from use in other areas of our business and reduce our capital resources. While we can control a number of the above factors, there are some over which we have no or limited control. Increases in our pension liabilities and obligations could have a material adverse effect on our business, financial condition and results of operations.

 

For example, in an effort to stimulate economic growth, during 2012, the Brazilian Central Bank progressively decreased the SELIC rate to a historic low of 7.25% by the end of 2012. The real annual interest rate on government-linked bonds was also decreased from around 6% as of December 31, 2011 to approximately 4% by the end of 2012. In order to control inflation, in April 2013, the Brazilian Central Bank initiated an adjustment process of the SELIC rate, increasing the rate from 7.25% to 10.0% during 2013. The real annual interest rate (after inflation) on government-linked bonds was approximately 6.5% by the end of 2013.

 

Decreases in interest rates can increase the present value of obligations under our legacy defined benefit pension plans, such as occurred during 2012, and may materially and adversely affect the funded status of our legacy defined benefit plans and require us to make additional contributions to these plans to meet our pension funding obligations.

 

Exchange rate volatility may have a material adverse effect on the Brazilian economy and on our business.

 

The Brazilian currency has during the past decades experienced frequent and substantial variations in relation to the U.S. dollar and other foreign currencies. For example, as a result of the 2008 global financial markets crisis, the real depreciated 31.9% against the U.S. dollar, reaching R$2.34 per U.S.$1.00 on December 31, 2008. The real recovered in the second half of 2009 and continued to appreciate in 2010, reaching R$1.74 per U.S.$1.00 on December 31, 2009 and R$1.67 per U.S.$1.00 on December 31, 2010, mainly due to the recovery of consumer confidence and exports and foreign investments in the second half of 2009. These effects continued through 2010. In 2011, due to the ongoing international financial crisis (particularly in Europe) the exchange rate reached R$1.88 per U.S.$1.00 as of December 31, 2011. Since 2012, the real continued to depreciate, reaching R$2.04 per U.S.$1.00 on December 31, 2012 and R$2.34 per U.S.$1.00 on December 31, 2013.

 

Depreciation of the real against the U.S. dollar also could create inflationary pressures in Brazil and cause increases in interest rates, which could negatively affect the growth of the Brazilian economy as a whole and harm our financial condition and results of operations. Additionally, depreciation of the real could make our foreign currency-linked obligations and funding more expensive, negatively affect the market price of our securities portfolios and have similar consequences for our borrowers. Conversely, appreciation of the real relative to the U.S. dollar and other foreign currencies could lead to a deterioration of the Brazilian foreign exchange currency accounts, as well as dampen export-driven growth. Depending on the circumstances, either depreciation or appreciation of the real could materially and adversely affect the growth of the Brazilian economy and our business, financial condition and results of operations.

 

In the year ended December 31, 2013, a variation of 1 .0% in the exchange rate of reais to U.S. dollars would have resulted in a variation of expenses on our net foreign exchange position denominated in U.S. dollars of R$4.6 million.

 

Infrastructure and workforce deficiency in Brazil may impact economic growth and have a material adverse effect on our business.

 

Our performance depends on the overall health and growth of the Brazilian economy. GDP growth slowed since 2011, from 2.7% in 2011, to 1.0% in 2012 and 2.3% in 2013. Continued growth is limited by inadequate infrastructure, including potential energy shortages and deficient transportation, logistics and telecommunication sectors, the lack of a qualified labor force, and the lack of private and public investments in these areas, which limit productivity and efficiency. Any of these factors could lead to labor market volatility, and generally impact the

 

 

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availability of income, purchasing power and consumption levels, which could limit growth, increase delinquency rates and ultimately have a material adverse effect on our business.

 

Developments and the perception of risk in other countries may adversely affect the Brazilian economy and market price of Brazilian issuers’ securities.

 

The market value of securities of Brazilian issuers is affected by economic and market conditions in other countries, including the United States, European countries (including Spain, where Santander Spain, our indirect controlling stockholder, is based), as well as in other Latin American and emerging market countries. Although economic conditions in Europe and the United States may differ significantly from economic conditions in Brazil, investors’ reactions to developments in these other countries may have an adverse effect on the market value of securities of Brazilian issuers. In particular, investor perceptions of the risks associated with our securities may be affected by perception of risk conditions in Spain. Additionally, crises in other emerging market countries may diminish investor interest in securities of Brazilian issuers, including our securities. This could adversely affect the market price of our securities, restrict our access to the capital markets and compromise our ability to finance our operations in the future on favorable terms, or at all.

 

In addition, we continue to be exposed to disruptions and volatility in the global financial markets because of their effects on the financial and economic environment in the countries in which we operate, particularly Brazil, such as a slowdown in the economy, an increase in the unemployment rate, a decrease in the purchasing power of consumers and the lack of credit availability. We lend primarily to Brazilian borrowers, and these effects could materially and adversely affect our customers and increase our non-performing loans, resulting in increased risk associated with our lending activity and requiring us to make corresponding revisions to our risk management and loan loss reserve models. For example, we experienced an increase in our non-performing loans overdue past 90 days, which reached 6.7% in December 2011 and 7.6% in December 2012, due in part to increasing economic uncertainty globally and a slowdown in the Brazilian economy. However, as of December 31, 2013, this indicator decreased to 6.2% representing improved performance compared to the prior two years.

 

Continued or worsening disruption or volatility in the global financial markets could further increase negative effects on the financial and economic environment in Brazil and the other countries in which we operate, which could have a material adverse effect on us.

 

Risks Relating to the Brazilian Financial Services Industry and our Business

 

The increasingly competitive environment and recent consolidations in the Brazilian financial services market may adversely affect our business prospects.

 

The Brazilian financial markets, including the banking, insurance and asset management sectors, are highly competitive. We face significant competition in all of our main areas of operation from other Brazilian and international banks, as well as state-owned institutions. In recent years, the competition has increased in the sectors of banking and insurance. Furthermore, the consolidation of the Brazilian financial sector, with the merger of large banks, especially in 2008 and 2009, and the privatization of state-owned banks have also increased competition in the Brazilian market for banking and financial services.

 

In 2012 and 2013, the Brazilian economy grew less than in prior years, while inflation and currency depreciation increased. The Brazilian government, in an attempt to foster economic growth, stimulated the availability of credit through large state-owned banks, sustaining the pace of the previous years’ growth. Such state-owned banks started to offer credit at significantly lower interest rates. The private-owned banks followed the lead by reducing interest rates for their customers, while tightening customer credit approval policies in an effort to control potential increases in delinquency rates. Due to these measures, margins and spread were reduced, and credit risk increased.

 

Increasing competition could require that we increase our rates offered on deposits or lower the rates we charge on loans, which could also have a material adverse effect on us.

 

In addition, if our customer service levels in our retail or wholesale businesses were perceived by the market to be materially below those of our competitor financial institutions, we could lose existing and prospective business opportunities. If we are not successful in retaining and strengthening customer relationships, we may lose market

 

 

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share, incur losses on some or all of our activities or fail to attract new or retain existing deposits, which would have a material adverse effect on us.

 

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

 

The Brazilian financial markets are subject to extensive and continuous regulatory control by the Brazilian government, principally by the Brazilian Central Bank, the CVM and CMN, which, in each case, materially affects our business. We have no control over the issuance of new regulations that may affects our operations, including in respect of:

 

·

minimum capital requirements;

 

·

reserve and compulsory deposit requirements;

 

·

limits on investments in fixed assets;

 

·

lending limits and other credit restrictions, including compulsory allocations;

 

·

limits and other restrictions on fees;

 

·

limits on the amount of interest banks can charge or the period for capitalizing interest;

 

·

accounting and statistical requirements; and

 

·

other requirements or limitations in the context of the global financial crisis.

 

The regulatory structure governing Brazilian financial institutions is continuously evolving, and the Brazilian Central Bank has been known to react actively and extensively to developments in our industry.

 

Changes in regulations in Brazil and international market may also expose us to increased compliance costs and limitations on our ability to pursue certain business opportunities and provide certain products and services. As some of the banking laws and regulations have been recently issued or become effective, the manner in which those laws and related regulations are applied to the operations of financial institutions is still evolving. Moreover, to the extent these recently adopted regulations are implemented inconsistently in the various jurisdictions in which we operate, we may face higher compliance costs. The measures of the Brazilian Central Bank and the amendment of existing laws and regulations, or the adoption of new laws or regulations could adversely affect our ability to provide loans, make investments or render certain financial services. No assurance can be given generally that laws or regulations will be adopted, enforced or interpreted in a manner that will not have a material adverse effect on our business and results of operations.

 

We may also be subject to potential impacts relating to regulatory changes affecting our controlling shareholder due to regulatory changes implemented as a result of the unification of the European banking system under a European Banking Union. We cannot predict the final outcome of any proposed regulations from the European Banking Union or their effects on our controlling shareholder and, consequently, their effects on us.

 

Increases in reserve, compulsory deposit and minimum capital requirements may have a material adverse effect on our business, financial condition and results of operations.

 

The Brazilian Central Bank has periodically changed the level of reserves and compulsory deposits that financial institutions in Brazil are required to maintain with the Brazilian Central Bank, as well as determine compulsory allocation requirements to finance government programs. The Brazilian Central Bank may increase the reserve and compulsory deposit or allocation requirements in the future or impose new requirements. Increases in reserve and compulsory deposit or allocation requirements reduce our liquidity to fund our loan portfolio and other investments and, as a result, may have a material adverse effect on our business, financial condition and results of operations.

 

Compulsory deposits and allocations generally do not yield the same return as other investments and deposits because a portion of compulsory deposits and allocations:

 

·

do not bear interest;

 

·

must be held in Brazilian federal government securities; and

 

 

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·

compulsory allocation which must be used to finance government programs, including a federal housing program and rural sector subsidies.

 

In 2013, the Brazilian Central Bank published several rules to implement Basel III in Brazil. This new set of regulations covers the revised definition of capital, capital requirements, capital buffers, credit valuation adjustments and exposures to central counterparties. For more information on the rules implementing Basel III, see “Item 4. Information on the Company—4B. Business Overview—Regulatory Overview—Capital Adequacy and Leverage—Basel” and “Item 5. Operating and Financial Review and Prospects—5B. Liquidity and Capital Resources—Capital Management.” No assurance can be given that the Basel III will be adopted, enforced or interpreted in a manner that will not have an adverse effect on us.

 

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

 

The Brazilian government regularly enacts reforms to the tax and other assessment regimes to which we and our customers are subject. Such reforms include changes in the rate of assessments and, occasionally, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. The effects of these changes and any other changes that result from enactment of additional tax reforms have not been, and cannot be, quantified and there can be no assurance that these reforms will not, once implemented, have an adverse effect upon our business. Furthermore, such changes may produce uncertainty in the financial system, increasing the cost of borrowing and contributing to the increase in our non-performing credit portfolio.

 

Future changes in tax policy that may affect financial operations include the creation of new taxes. For example, with the 2011 enactment of Provisional Measure 539, the Brazilian government established the Tax on Financial Transactions (“IOF Tax”) at a 1.0% rate per day on the notional value of the increased foreign exchange exposure, though with the publication of Decree 8,027 on June 12, 2013, the tax rate was reduced to zero. Also, in March 2012 the government changed the rules applicable to the tax assessed on the settlement of exchange transactions for the inflow of funds related to foreign loans, setting forth that loans with terms of less than 1,800 days would be subject to taxation at a rate of 6.0%. In June 2012, said rules were changed by the Brazilian government, so that the 1,800 days tenor was reduced to 720 days. In December 2012, the rule was changed again, stating that only foreign loans with tenors of less than 360 days would be subject to a 6.0% tax. Furthermore, the rules applicable to the tax assessed on local loans borrowed by individuals have also been changed in recent years: the tax rate (1.5%) was increased to 3.0% (April 2011) and subsequently decreased to 1.5% (0.5% in December 2011 and 1% in May 2012). While the IOF Tax is a tax on financial transactions used by the Brazilian government to control economic activity and does not directly impact our results of operations, changes in the IOF Tax can impact business volumes generally. It is not possible to quantify the impact of the Tax on business volumes because the influence of this one variable on our clients’ level of borrowing cannot be isolated.

 

Until 2007, certain financial transactions were subject to the provisional contribution on financial transactions ( Contribuição Provisória sobre a Movimentação ou Transmissão de Valores e de Créditos e Direitos de Natureza Financeira , or “CPMF”). However, uncertainty remains as to whether the CPMF or a similar tax will be re-introduced in the future. Also, the Brazilian Congress may discuss broad tax reforms in Brazil to improve the efficiency of allocation of the economic resources, as proposed by the executive branch of the Brazilian federal government. Major tax reforms in Brazil have been discussed over the last few years. We cannot predict if tax reforms will be implemented in the future. The effects of these changes, if enacted, and any other changes that could result from the enactment of additional tax reforms, cannot be quantified.

 

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

 

Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of our businesses. Non-performing or low credit quality loans have in the past and can continue to negatively impact our results of operations. We cannot assure you that we will be able to effectively control the level of the impaired loans in our total loan portfolio. In particular, the amount of our reported non-performing loans may increase in the future at a faster rate than the growth in our total loan portfolio. In 2013, our loan portfolio increased 7.3% as compared to 8.5% in 2012 and our non-performing credit portfolio decreased 12.7% compared to the increase of 22.8% in 2012, which increased in 2012 in large part due to the slowdown in economic activity in this period. The decrease in the non-performing credit portfolio was mainly

 

 

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due to the measures adopted by the Bank in 2012, such as revising the limits of new loans and requiring higher level of collateral on new loans and the review of collection practices. These and other actions done in the period brought quality improvement in the credit portfolio, though there can be no assurance that all of these measure will continue to be effective or that our non-performing credit portfolio will not increase again in the future due to factors outside of our control.

 

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

 

Our loan portfolio may not continue to grow at the same rate and economic uncertainty may lead to a contraction in our loan portfolio.

 

There can be no assurance that our loan portfolio will continue to grow at rates similar to the historical growth rate we have experienced. A reversal of the rate of growth of the Brazilian economy, a slowdown in the growth of customer demand, an increase in market competition or changes in governmental regulation and an increase of the SELIC rate, could adversely affect the rate of growth of our loan portfolio and our risk index and, accordingly, increase our required allowances for impairment losses. As a result of the slowdown in economic growth in Brazil in 2013, our loan portfolio increased 7.3% in 2013, as compared to 8.5% in 2012. Ongoing economic uncertainty could materially adversely affect the liquidity, businesses and financial condition of our customers as well as lead to a general decline in consumer spending and a rise in unemployment. All this could in turn lead to decreased demand for borrowings in general, which could have a material adverse effect on our business.

 

Our loan and investment portfolios are subject to risk of prepayment, which could have a material adverse effect on us.

 

Our fixed rate loan and investment portfolios are subject to prepayment risk, which results from the ability of a borrower or issuer to pay a debt obligation prior to maturity. Generally, in a declining interest rate environment, prepayment activity increases, this reduces the weighted average lives of our earning assets and could have a material adverse effect on us. We would also be required to amortize net premiums into income over a shorter period of time, thereby reducing the corresponding asset yield and net interest income. Prepayment risk also has a significant adverse impact on credit card and collateralized mortgage loans, since prepayments could shorten the weighted average life of these assets, which may result in a mismatch in our funding obligations and reinvestment at lower yields. Prepayment risk is inherent to our commercial activity and an increase in prepayments could have a material adverse effect on us.

 

Since our principal sources of funds are short-term deposits, a sudden shortage of funds could cause an increase in costs of funding and an adverse effect on our revenues and our liquidity levels.

 

Customer deposits are our primary source of funding. As of December 31, 2013, 62.5% of our customer deposits had remaining maturities of one year or less, or were payable on demand while 39.9% of our assets have longer maturities, resulting in a mismatch between the maturities of liabilities and the maturities of assets. The ongoing availability of this type of funding is sensitive to a variety of factors outside our control, such as general economic conditions and the confidence of commercial depositors in the economy, in general, and the financial services industry in particular, and the availability and extent of deposit guarantees, as well as competition between banks for deposits. If a substantial number of our depositors withdraw their demand deposits or do not roll over their time deposits upon maturity, our liquidity position, results of operations and financial condition may be materially and adversely affected. We cannot assure you that in the event of a sudden or unexpected shortage of funds in the banking system, any money markets in which we operate will be able to maintain levels of funding without

 

 

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incurring higher funding costs or the liquidation of certain assets. If this were to happen, our results of operations and financial condition may be materially adversely affected.

 

Credit, market and liquidity risks may have an adverse effect on our credit ratings and our cost of funds. Any downgrading in Brazil’s, our controlling stockholder’s, or our credit rating, would likely increase our cost of funding, require us to post additional collateral under some of our derivative contracts and adversely affect our interest margins and results of operations.

 

Credit ratings affect the cost and other terms upon which we are able to obtain funding. Rating agencies regularly evaluate us and their ratings of our long-term debt are based on a number of factors, including our financial strength, conditions that affect the financial services industry generally and the economic environment in which we operate.

 

Any downgrade in Brazil’s sovereign credit ratings, those of our controlling stockholder, or in our ratings, would likely increase our borrowing costs. For example, a ratings downgrade could adversely affect our ability to sell or market certain of our products, such as subordinated securities, engage in certain longer-term and derivatives transactions, and retain our customers, particularly customers who need a minimum rating threshold in order to invest. This, in turn, could reduce our liquidity and have an adverse effect on our operating results and financial condition

 

While certain potential impacts of any ratings downgrade may be quantifiable, the full consequences of a credit rating downgrade are inherently uncertain, as they depend upon numerous dynamic, complex and inter-related factors and assumptions, including market conditions at the time of any downgrade, whether any downgrade of a firm’s long-term credit rating precipitates downgrades to its short-term credit rating, and assumptions about the potential behaviors of various customers, investors and counterparties. Actual outflows could be higher or lower than any hypothetical example, depending upon certain factors including which credit rating agency downgrades our credit rating, any management or restructuring actions that could be taken to reduce cash outflows and the potential liquidity impact from loss of unsecured funding (such as from money market funds) or loss of secured funding capacity.

 

During 2012, the three major risk rating agencies, Standard & Poor’s Rating Services (“S&P”), Fitch Ratings Ltd. (“Fitch”) and Moody’s Investor Services, Inc. (“Moody’s”) downgraded the sovereign Spain rating due to the fiscal crises in Spain and in several other European countries. As a result, Santander Spain also had its credit rating downgraded by the three major rating agencies: Fitch (on June 11, 2012) from A to BBB+, Moody’s (on June 25, 2012) to Baa2 and S&P (on October 15, 2012) to BBB, which in each case was one notch above Spain’s sovereign rating. In the second half of 2013 and in early 2014, the Spanish economy demonstrated increased economic stability and improved growth prospects, which led to a revision in its credit rating outlook to stable from negative by the three major risk rating agencies mentioned above (S&P on November 29, Fitch on November 1 and Moody’s on December 4). Subsequently, Moody’s upgraded Spain’s sovereign rating to Baa2 from Baa3 with a positive outlook on February 21, 2014. Consequently, Santander Spain’s credit rating was upgraded and currently the credit ratings of Santander Spain are BBB+ by Fitch, BBB by S&P and Baa1 by Moody’s, with a stable outlook in each case.

 

In 2013, the Brazilian sovereign debt had its outlook revised downward by the three major risk rating agencies: Fitch and Moody’s from positive to stable and S&P from stable to negative. The main reasons for the downgrade were the extended period of decreased growth in the economy, an outlook for annual GDP growth of just over 2% in 2013 and 2014 and an expansionary fiscal policy that could lead to an increase in the Brazilian government’s debt levels. On March 24, 2014, S&P lowered the Brazilian sovereign foreign currency rating to BBB- from BBB, chiefly due to the performance of fiscal accounts. Currently the sovereign Brazilian rating is: BBB- by S&P and Fitch Ratings and Baa2 by Moody’s.

 

Our long-term debt in foreign currency is currently rated BBB- with a stable outlook by S&P, BBB with stable outlook by Fitch and Baa2 with a stable outlook by Moody’s. We estimate that any downgrade in our credit rating could increase our cost of international funding by around 200 basis points, in which case we expect we would concentrate our funding efforts in the domestic market.

 

We cannot assure you that the rating agencies will maintain their current ratings or outlooks, or with regard to those rating agencies that have a negative outlook with respect to us or our controlling stockholder, there can be no

 

 

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assurances that such agencies will revise such outlooks upward. Our failure to maintain favorable ratings and outlooks would likely increase our cost of funding and adversely affect our interest margins and results of operations.

 

The effectiveness of our credit risk management is affected by the quality and scope of information available in Brazil.

 

In assessing customers’ creditworthiness, we rely largely on the credit information available from our own internal databases, certain publicly available customer credit information and other sources. Due to limitations in the availability of information and the developing information infrastructure in Brazil, our assessment of credit risk associated with a particular customer may not be based on complete, accurate or reliable information. In addition, we cannot assure that our credit scoring systems collect complete or accurate information reflecting the actual behavior of customers or that their credit risk can be assessed correctly. Without complete, accurate and reliable information, we have to rely on other publicly available resources and our internal resources, which may not be effective. As a result, our ability to effectively manage our credit risk and subsequently our loan loss allowances may be materially adversely affected.

 

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

 

The management of risk is an integral part of our activities. We seek to monitor and manage our risk exposure through a variety of separate but complementary financial, credit, market, operational, compliance and legal reporting systems. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, such techniques and strategies may not be fully effective in mitigating our risk exposure in all economic market environments or against all types of risk, including risks that we fail to identify or anticipate. We use certain qualitative tools and metrics for managing market risk, including our use of value at risk, or “VaR,” and statistical modeling tools, which are based upon observed historical market behavior. We apply statistical and other tools to these observations to arrive at quantifications of our risk exposures. These qualitative tools and metrics may fail to predict future risk exposures. These risk exposures could, for example, arise from factors we did not anticipate or correctly evaluate in our statistical models. This would limit our ability to manage our risks. Our losses thus could be significantly greater than the historical measures indicate. In addition, our quantified modeling does not take all risks into account. Our more qualitative approach to managing those risks could prove insufficient, exposing us to material unanticipated losses. If existing or potential customers believe our risk management is inadequate, they could take their business elsewhere. This could harm our reputation as well as our revenues and profits. We also face risks from operational losses that may occur due to inadequate processes, people and systems failures or even from external events like natural disasters, terrorism, robbery and vandalism. Despite the operational risk management process supported by the Board and the internal audit tests, the internal controls and procedures effectiveness may not be fully adequate or sufficient to avoid all the known and unknown operational risks. We have suffered losses from operational risk in the past, including losses related to the migration of customer accounts in connection with acquisitions, phishing scams perpetuated by third parties, and information system platform upgrades. There can be no assurance that we will not suffer material losses from operational risk in the future, including losses related to cyber-attacks or other such security breaches. Further, as cyber-attacks continue to evolve, we may incur significant costs in the attempt to modify or enhance our protective measures or investigate or remediate any vulnerability.

 

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

 

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

 

 

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

 

The value of the collateral securing our loan portfolio may fluctuate or decline due to factors beyond our control, including macroeconomic factors globally and in Brazil. We may also not have sufficiently recent information on the value of collateral, which may result in an inaccurate assessment for impairment losses of our loans secured by such collateral. If this were to occur, we may need to make additional provisions to cover actual impairment losses of our loans, which may materially and adversely affect our results of operations and financial condition.

 

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

 

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

 

Financial instruments, including derivative instruments and securities represented 17.2% of our total assets as of December 31, 2013. Any realized or unrealized future gains or losses from these investments or hedging strategies could have a significant impact on our income. These gains and losses, which we account for when we sell or mark-to-market investments in financial instruments can vary considerably from one period to another. If, for example, we enter into derivatives transactions to protect ourselves against decreases in the value of the real or in interest rates and the real instead increases in value or interest rates increase, we may incur financial losses. We cannot forecast the amount of gains or losses in any future period, and the variations experienced from one period to another do not necessarily provide a meaningful forward-looking reference point. Gains or losses in our investment portfolio may create volatility in net revenue levels, and we may not earn a return on our consolidated investment portfolio, or on a part of the portfolio in the future. Any losses on our securities and derivative financial instruments could materially and adversely affect our operating income and financial condition. In addition, any decrease in the value of these securities and derivatives portfolios may result in a decrease in our capital ratios, which could impair our ability to engage in lending activity at the levels we currently anticipate.

 

We are subject to counterparty risk in our banking business.

 

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

 

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

 

If these risks give rise to losses, this could materially and adversely affect our results of operations and financial condition. We have a diversified loan portfolio, with no specific concentration exceeding 10 .0% of total loans, however we cannot assure this will continue to be the case. If counterparty risks give rise to losses, this could materially and adversely affect our results of operations and financial condition.

 

We engage in transactions with related parties that others may not consider to be on an arm’s-length basis.

 

We are likely to continue to engage in transactions with related parties (including our controlling stockholder) that others may not consider to be on an arm’s length basis. Conflicts of interest between us and related parties may

 

 

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arise. These conflicts are not required to be and may not be resolved in our favor. See “Item 7. Major Shareholders and Related Party Transactions.”

 

Our business is highly dependent on proper functioning of information technology systems

 

Our business is highly dependent on the ability of our information technology systems to accurately process a large number of transactions across numerous and diverse markets and products in a timely manner. The proper functioning of our financial control, risk management, accounting, customer service and other data processing systems is critical to our business and our ability to compete effectively. We have backup data for our key data processing systems that could be used in the event of a catastrophe or a failure of our primary systems, and have established alternative communication networks where available. However, we do not operate all of our redundant systems on a real-time basis and cannot assure you that our business activities would not be materially disrupted if there were a partial or complete failure of any of these primary information technology systems or communication networks. Such failures could be caused by, among other things, major natural catastrophes, software bugs, computer virus attacks or conversion errors due to system upgrading. In addition, any security breach caused by unauthorized access to information or systems, or intentional malfunctions or loss or corruption of data, software, hardware or other computer equipment, could have a material adverse effect on our business, results of operations and financial condition.

 

Our ability to remain competitive and achieve further growth will depend in part on our ability to upgrade our information technology systems and increase our capacity on a timely and cost effective basis. Any substantial failure to improve or upgrade information technology systems effectively or on a timely basis could materially and adversely affect our competitiveness, results of operations and financial condition.

 

Failure to protect personal information could adversely affect us.

 

We manage and hold confidential personal information of customers in the ordinary course of our banking operations. Although we have procedures and controls to safeguard personal information in our possession, unauthorized disclosures or security breaches could subject us to legal actions and administrative sanctions as well as damages that could materially and adversely affect our results of operations and financial condition.

 

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

 

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

 

Actions by the financial services industry generally or by certain members of, or individuals in, the industry may also affect our reputation. For example, the role played by financial services firms in the financial crisis and the seeming shift toward increasing regulatory supervision and enforcement has caused public perception of us and others in the financial services industry to decline. Any failure to establish or preserve a favorable reputation among our customers and in the market in general could have a material adverse effect on our business, financial condition and results of operations.

 

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

 

We are required to comply with applicable anti-money laundering, anti-terrorism and other laws and regulations in the jurisdictions in which we operate. These laws and regulations require us, among other things, to adopt and enforce “know-your-customer” policies and procedures and to report suspicious and large transactions to the applicable regulatory authorities. These laws and regulations have become increasingly complex and detailed, requiring improved systems, demanding sophisticated monitoring and compliance personnel and becoming the subject of enhanced regulatory supervision.  In addition, laws such as the U.S. Foreign Corrupt Practices Act and the recently enacted Brazilian Anti-Corruption Law require us, among other things, to institute policies and procedures aimed at preventing any unlawful offer or promise, or give anything of value, to government officials in order to secure a business advantage, and require us to maintain accurate books and records and a system of internal controls to ensure accuracy of our books and records and prevent illegal activity.

 

While we have adopted policies and procedures aimed at detecting and preventing the use of our banking network for money laundering and related activities, as well as policies and procedures aimed at preventing

   

 

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bribery and other corrupt practices by our employees and agents, such policies and procedures have in some cases only been recently adopted and may not completely eliminate instances where our banking network may be used by other parties to engage in money laundering and other illegal or improper activities, or may not prevent our employees and agents from engaging in corrupt dealings. To the extent we fail to fully comply with applicable laws and regulations, the relevant government agencies to which we report have the power and authority to impose fines and other penalties on us, including the revocation of licenses. In addition, our business and reputation could suffer if customers use our banking network for money laundering or illegal or improper purposes.

 

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

 

We plan to continue to expand our operations and we may not be able to manage such growth effectively, which could have an adverse impact on our profitability.

 

We allocate management and planning resources to develop strategic plans for organic growth and to identify possible acquisitions, disposals and areas for restructuring our businesses. We cannot provide assurance that we will, in all cases, be able to manage our growth effectively or achieve our strategic growth objectives. Challenges that may result from the strategic growth decisions include our ability to:

 

·

efficiently manage the operations and employees of expanding businesses;

 

·

maintain or grow our existing customer base;

 

·

assess the value, strengths and weaknesses of investment or acquisition candidates;

 

·

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

 

·

align our current information technology systems adequately with those of a larger group;

 

·

apply our risk management policy effectively to a larger group; and

 

·

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

 

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

 

Risks Relating to Our Controlling Shareholder, Our Units and American Depositary Shares (ADSs)

 

Our ultimate controlling shareholder has a great deal of influence over our business.

 

Santander Spain, our ultimate controlling shareholder, currently owns, directly and indirectly, approximately 74.9% of our total capital. Due to its share ownership, our controlling shareholder has the power to control us and our subsidiaries, including the power to:

 

·

elect a majority of our directors that appoint our executive officers, set our management policies and exercise overall control over our company and subsidiaries;

 

·

influence the appointment of our principal officers;

 

·

declare the payment of any dividends;

 

·

agree to sell or otherwise transfer its controlling stake in our company; and

 

·

determine the outcome of substantially all actions requiring shareholder approval, including transactions with related parties, corporate reorganizations, acquisitions and dispositions of assets, and dividends.

 

 

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In December 2012, primarily in response to the requirements of the European Banking Authority, Santander Spain adopted a corporate governance framework ( Marco de Gobierno Interno del Group Santander ). The purpose of the framework is to organize and standardize the corporate governance practices of certain companies of Santander Group (including us). We adopted this corporate governance framework in May 2013, subject to the precedence of applicable Brazilian laws and regulations and the limitations imposed thereby such as banking secrecy laws, as well as our corporate governance practices, including our policies for related-party transactions and for disclosure of material acts and fact s . See “Item 16G. Corporate Governance.” We operate as a stand-alone subsidiary within the Santander Group. Our controlling shareholder has no liability for our banking operations, except for the amount of its holdings of our capital stock and for other specific limited circumstances. The interests of Santander Spain may differ from the interests of our other shareholders, and the concentration of control in Santander Spain will limit other stockholders’ ability to influence corporate matters. As a result, we may take actions that our other shareholders do not view as beneficial.

 

Our status as a controlled company and a foreign private issuer exempts us from certain of the corporate governance standards of the New York Stock Exchange (“NYSE”), limiting the protections afforded to investors.

 

We are a “controlled company” and a “foreign private issuer” within the meaning of the NYSE corporate governance standards. Under the NYSE rules, a controlled company is exempt from certain NYSE corporate governance requirements. In addition, a foreign private issuer may elect to comply with the practice of its home country and not to comply with certain NYSE corporate governance requirements, including the requirements that (1) a majority of the board of directors consists of independent directors, (2) a nominating and corporate governance committee be established that is composed entirely of independent directors and has a written charter addressing the committee’s purpose and responsibilities, (3) a compensation committee be established that is composed entirely of independent directors and has a written charter addressing the committee’s purpose and responsibilities and (4) an annual performance evaluation of the nominating and corporate governance and compensation committees be undertaken. Although we have similar practices, they do not entirely conform to the NYSE requirements, therefore we currently use these exemptions and intend to continue using them. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all NYSE corporate governance requirements.

 

Cancellation of units may have a material and adverse effect on the market for the units and on the value of the units.

 

Holders of units may present these units or some of these units for cancellation in Brazil in exchange for the common shares and preferred shares underlying these units. If unit holders present a significant number of units for cancellation in exchange for the underlying common shares and preferred shares, the liquidity and price of the units may be materially and adversely affected.

 

The relative volatility and limited liquidity of the Brazilian securities markets may negatively affect the liquidity and market prices of the units and the ADSs.

 

The BM&FBOVESPA is significantly less liquid than the NYSE or other major exchanges in the world. As of December 31, 2013, the aggregate market capitalization of the BM&FBOVESPA was equivalent to approximately R$2.4 trillion (U.S.$1.0 trillion) and the top ten stocks in terms of trading volume accounted for approximately 51.2% of all shares traded on BM&FBOVESPA in the year ended December 31, 2013. In contrast, as of December 31, 2013, the aggregate market capitalization of the NYSE was approximately U.S.$25.0 trillion. Although any of the outstanding shares of a listed company may trade on the BM&FBOVESPA, in most cases fewer than half of the listed shares are actually available for trading by the public, the remainder being held by small groups of controlling persons, government entities or a principal shareholder. The relative volatility and limited liquidity of the Brazilian securities markets may substantially limit your ability to sell the units or ADSs at the time and price you desire and, as a result, could negatively impact the market price of these securities.

 

 

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The economic value of your investment may be diluted.

 

We may, from time to time, need additional funds and, in the event that public or private financing is unavailable or if our shareholders decide, we may issue additional units or shares. Any additional funds obtained by such a capital increase may dilute your interest in our company.

 

Actual or anticipated sales of a substantial number of units or our common shares or preferred shares in the future could decrease the market prices of the ADSs.

 

Sales of a substantial number of our units or our common shares or preferred shares in the future, or the anticipation of such sales, could negatively affect the market prices of our units and ADSs. If, in the future, substantial sales of units or common shares or preferred shares are made by existing or future holders, the market prices of the ADSs may decrease significantly. As a result, holders of ADSs may not be able to sell their ADSs at or above the price they paid for them.

 

Delisting of our shares from Level 2 of BM&FBOVESPA may negatively affect the price of our ADSs and units.

 

Companies listed on Level 2 of BM&FBOVESPA are required to have a public float of at least 25 .0% of their total capital. In connection with our listing on the BM&FBOVESPA, prior to October 7, 2012 (extendable under certain circumstances to October 7, 2014) we were required to have a public float representing at least 25 .0% of our total capital. On October 8, 2013, the BM&FBOVESPA granted the last extension period for our compliance with this requirement to October 7, 2014. As of December 31, 2013, our outstanding public float was 24.6% of our total capital. If we do not meet the minimum public float requirement, we may be subject to fines and eventually be delisted from Level 2 of BM&FBOVESPA and be traded at the regular level of BM&FBOVESPA. Level 2 regulations are also subject to change, and we may not be able to comply with such changes. Although such delisting could result in the obligation of the controlling shareholder to carry out a mandatory tender offer for the shares of the minority shareholders, such delisting may result in a decrease of the price of our shares, units and ADSs.

 

Holders of our units and our ADSs may not receive any dividends or interest on stockholders’ equity.

 

According to our by-laws, we must generally pay our shareholders at least 25 .0% of our annual net income as dividends or interest on stockholders’ equity, as calculated and adjusted under Brazilian Corporate Law (“adjusted net income”), which may differ significantly from our net income as determined under IFRS. This adjusted net income may be used to increase capital, used to absorb losses or otherwise retained as allowed under Brazilian Corporate Law and may not be available to be paid as dividends or interest on stockholders’ equity. Additionally, Brazilian Corporate Law allows a publicly traded company like ours, to suspend the mandatory distribution of dividends and interest on stockholders’ equity in any particular year if our board of directors informs our shareholders that such distributions would be inadvisable in view of our financial condition or cash availability. We paid R$3.2 billion, R$2.7 billion and R$2.4 billion (R$0.84, R$0.71 and R$0.63 per unit) as dividends and interest on stockholders’ equity (considering gross value) in 2011, 2012 and 2013, respectively, in accordance with our dividend policy. See “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Payment of Dividends and Interest Attributable to Stockholders’ Equity—Dividends.”

 

Holders of ADSs may find it difficult to exercise voting rights at our stockholders’ meetings.

 

Holders of ADSs will not be our direct shareholders and will be unable to enforce directly the rights of shareholders under our by-laws and Brazilian Corporate Law. Holders of ADSs may exercise voting rights with respect to the units represented by ADSs only in accordance with the deposit agreement governing the ADSs. Holders of ADSs will face practical limitations in exercising their voting rights because of the additional steps involved in our communications with ADS holders. For example, we are required to publish a notice of our stockholders’ meetings in specified newspapers in Brazil. Holders of our units will be able to exercise their voting rights by attending a stockholders’ meeting in person or voting by proxy. By contrast, holders of ADSs will receive notice of a stockholders’ meeting by mail from the American Depositary Receipts (“ADRs”) depositary following our notice to the depositary requesting the depository to do so. To exercise their voting rights, holders of ADSs must instruct the ADR depositary on a timely basis on how they wish to vote. This voting process necessarily will take longer for holders of ADSs than for holders of our units or shares. If the ADR depositary fails to receive timely voting instructions for all or part of the ADSs, the depositary will assume that the holders of those ADSs are

 

 

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instructing it to give a discretionary proxy to a person designated by us to vote their ADSs, except in limited circumstances.

 

Holders of ADSs also may not receive the voting materials in time to instruct the depositary to vote the units underlying their ADSs. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions of the holders of ADSs or for the manner of carrying out those voting instructions. Accordingly, holders of ADSs may not be able to exercise voting rights, and they will have little, if any, recourse if the units underlying their ADSs are not voted as requested.

 

Holders of ADSs could be subject to Brazilian income tax on capital gains from sales of ADSs.

 

Law 10,833 of December 29, 2003 provides that the disposal of assets located in Brazil by a non-resident to either a Brazilian resident or a non-resident is subject to taxation in Brazil, regardless of whether the disposal occurs outside or within Brazil. This provision results in the imposition of income tax on the gains arising from a disposal of our units by a non-resident of Brazil to another non-resident of Brazil. It is unclear whether ADSs representing our units, which are issued by the ADR depositary outside Brazil, will be deemed to be “property located in Brazil” for purposes of this law. We believe ADSs do not qualify as property located in Brazil and, thus, should not be subject to Brazilian income tax. Nevertheless, there is no judicial guidance as to the application of Law 10,833 of December 29, 2003 and, accordingly, we are unable to predict whether Brazilian courts may decide that it applies to dispositions of our ADSs between non-residents of Brazil. However, in the event that the disposition of assets is interpreted to include a disposition of our ADSs, this tax law would accordingly impose withholding taxes on the disposition of our ADSs by a non-resident of Brazil to another non-resident of Brazil. See “Item 10. Additional Information—E. Taxation—Brazilian Tax Considerations.”

 

Any gain or loss recognized by a U.S. taxpayer will generally be treated as U.S. source gain or loss. A U.S. taxpayer would not be able to credit any Brazilian tax imposed on the disposition of our units or ADSs against such person’s U.S. federal income tax liability, unless such credit can be applied (subject to applicable limitations) against tax due on other income of such person from foreign sources.

 

Judgments of Brazilian courts with respect to our units or ADSs will be payable only in reais.

 

Our by-laws provide that we, our shareholders, our directors and officers and the members of our fiscal council shall submit to arbitration any and all disputes or controversies that may arise amongst ourselves relating to, or originating from, the application, validity, effectiveness, interpretation, violations and effects of violations of the provisions of Brazilian Corporate Law, our by-laws, the rules and regulations of the CMN, the Brazilian Central Bank and the CVM, as well as other rules and regulations applicable to the Brazilian capital markets in addition to the listing regulations of the Level 2 segment of the BM&FBOVESPA, our listing agreement for adhesion to the Level 2 segment of the BM&FBOVESPA, and the rules and regulations of the Arbitration Regulation of the Market Arbitration Chamber. However, in specific situations, including whenever precautionary motions are needed for protection of rights, the dispute or controversy may have to be brought to a Brazilian court. If proceedings are brought in the courts of Brazil seeking to enforce our obligations in respect of the units or ADSs, we will not be required to discharge our obligations in a currency other than reais . Under Brazilian exchange control limitations and according to Brazilian laws, an obligation in Brazil to pay amounts denominated in a currency other than reais may be satisfied in Brazilian currency only at the exchange rate, as determined by the Brazilian Central Bank or competent court, in effect on the date the judgment is obtained, and such amounts are then adjusted to reflect exchange rate variations through the effective payment date. The then prevailing exchange rate may not afford non-Brazilian investors with full compensation for any claim arising out of or related to our obligations under the units or ADSs.

 

Holders of ADSs may be unable to exercise preemptive rights with respect to our units underlying the ADSs.

 

Holders of ADSs will be unable to exercise the preemptive rights relating to our units underlying ADSs unless a registration statement under the Securities Act is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file a registration statement with respect to the shares relating to these preemptive rights or to take any other action to make preemptive rights available to holders of units or ADSs. We may decide, at our discretion, not to file any such registration statement. If we do not file a registration statement or if we and the ADR depository decide not to make preemptive rights

 

 

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available to holders of units or ADSs, those holders may receive only the net proceeds from the sale of their preemptive rights by the depositary, or if they are not sold, their preemptive rights will be allowed to lapse.

 

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

 

Our corporate affairs are governed by our by-laws and Brazilian Corporate Law, which may differ from the legal principles that would apply if we were incorporated in a jurisdiction in the United States or in certain other jurisdictions outside Brazil.

 

Holders of our common shares are allowed to vote in our stockholders’ meetings, and each common share shall entitle its owner to one vote. Our preferred shares only allow voting rights in respect of a few matters. See “Item 10. Additional Information—B. Bylaws.”

 

Holders of ADSs are not our direct shareholders and will be unable to enforce directly the rights of shareholders under our bylaws and Brazilian Corporate Law. Holders of ADSs may exercise voting rights with respect to the units represented by ADSs only in accordance with the deposit agreement governing the ADSs. See “Holders of ADSs may find it difficult to exercise voting rights at our stockholders’ meetings.”

 

Thus, under Brazilian Corporate Law, holders of the ADSs and the holders of just the preferred shares may have fewer and less well-defined rights to protect their interests relative to actions taken by our board of directors or the holders of our common shares than under the laws of other jurisdictions outside Brazil.

 

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

 

ITEM 4 . INFORMATION ON THE COMPANY

 

4A.	History and Development of the Company

 

General

 

We are a publicly held company of indefinite term, incorporated under Brazilian law on August 9, 1985. Our corporate name is Banco Santander (Brasil) S.A. and our commercial name is Banco Santander. Our headquarters are located in Brazil, in the city of São Paulo, state of São Paulo, at Avenida Presidente Juscelino Kubitschek, 2,041 and 2,235, Bloco A, Vila Olímpia, 04543-011. Our telephone number is 55-11-3553-3300. Documentation of our incorporation is duly registered with the Junta Comercial do Estado de São Paulo (Commercial Registry of the State of São Paulo), or JUCESP, under NIRE (Registry Number) 35300332067.

 

Our agent for service is James H. Bathon, Managing Director - Legal and Compliance, Banco Santander, S.A., New York Branch, 45 E. 53rd Street New York, New York 10022.

 

History

 

The Santander Group has expanded globally through a number of acquisitions and the integration of the acquired businesses to achieve synergies.

 

In 1957, the Santander Group first entered the Brazilian market through an operating agreement with Banco Intercontinental do Brasil S.A. Since the 1990s, the Santander Group has sought to establish its presence in Latin America, particularly in Brazil. The Santander Group pursued this strategy through organic growth as well as acquisitions. In 1997, the Santander Group acquired Banco Geral do Comércio S.A., which subsequently changed its name to Banco Santander Brasil S.A. In the following year, the Santander Group acquired Banco Noroeste S.A. In 1999, Banco Noroeste was merged into Banco Santander Brasil. In January 2000, the Santander Group acquired Banco Meridional S.A. (including its subsidiary Banco Bozano, Simonsen S.A.).

 

In November 2000, the Santander Group acquired Banespa, a bank owned by the State of São Paulo, and became one of Brazil’s largest financial groups. In 2006, Santander Brasil consolidated its investments into one

 

 

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entity, Banco Santander Banespa S.A., which was later renamed Banco Santander (Brasil) S.A. In 2007, the Santander Group implemented a brand unification program to consolidate our operations in Brazil at such time under the Santander brand.

 

On November 1, 2007, RFS Holdings B.V., a consortium comprising Santander Spain, The Royal Bank of Scotland Group PLC, Fortis SA/NV and Fortis N.V. (“Fortis”), acquired 96.95% of the shares of ABN AMRO Holding N.V. (and together with ABN AMRO Bank N.V. “ABN AMRO”), the controlling shareholder of Banco Real. In the first quarter of 2008, Fortis and Santander Spain reached an agreement whereby Santander Spain acquired the right to the Brazilian asset management activities of ABN AMRO, which Fortis had acquired as part of the consortium’s purchase of ABN AMRO. On July 24, 2008, Santander Spain took indirect share control of Banco Real, which it then absorbed into the Santander Group to consolidate its investments in Brazil. On August 29, 2008, the acquisition by Santander Brasil of Banco Real’s share capital was approved through a share exchange transaction ( incorporação de ações ), and Banco Real became a wholly-owned subsidiary of Santander Brasil. On April 30, 2009, Banco Real was merged into Santander Brasil and Banco Real ceased to exist as a separate legal entity.

 

Important Events

 

Offer by Santander Spain to Acquire Our Shares not held by the Santander Group

 

On April 29, 2014, Santander Spain, our indirect controlling shareholder, announced its intention to launch a voluntary offer in Brazil and the United States for acquisition of up to the totality of our shares that are not held by the Santander Group, which represent approximately 25% of our share capital, with payment in shares of Santander Spain.

 

Our shareholders that accept the offer will receive in payment Brazilian or American Depositary Receipts (BDRs or ADRs) representing shares issued by Santander Spain, thus becoming shareholders of Santander Spain, at the rate of  0.70 newly-issued shares of Santander Spain for each of our units or ADRs.  As a result of this transaction, we will continue to be a listed company, although we will move from the Level 2 ( Nível 2 ) of Corporate Governance of the BM&FBOVESPA to the traditional segment of the BM&FBOVESPA.

 

This offer is subject to customary conditions for this type of transaction, including the granting of the relevant regulatory authorizations and approval at our  general shareholders’ meeting.

 

Sale of the Investment Fund Management and Managed Portfolio Operations

 

On December 17, 2013, we concluded the sale of our asset management business, by way of disposal of all shares of Santander Brasil Asset Management Distribuidora de Títulos e Valores Mobiliários S.A. (“DTVM”), a company controlled by us. The asset management activities then performed by DTVM were segregated into a new asset manager created for that purpose. The sales price was R$2,243 million, generating a post-tax capital gain of R$1,205 million.

 

We will remain as the administrator of the funds and in charge of distribution activities, receiving remuneration in line with market practices. As the administrator of the funds, we will continue to take care of the administration of the fund, performing the services related directly or indirectly to the functioning and maintenance of the fund. Additionally, we will also continue to engage in sales and distribution activities. We will not manage the funds invested or make investment decisions with respect thereto, which will be performed by the new asset manager.

 

 The transaction is part of a worldwide partnership between Santander Spain and two of the world’s leading private equity companies, Warburg Pincus and General Atlantic.

 

Net profit derived from our asset management business amounted to R$74 million in 2011, R$55 million in 2012, and approximately R$55 million in 2013 through the date of sale.

 

Agreement for sale of 30% of the capital stock of Webmotors S.A. to Carsales

 

On June 21, 2013, we entered into an agreement to issue shares representing 30% of the capital stock of our indirect subsidiary, Webmotors S.A. (an online car trading portal), to Carsales.com Limited (“Carsales”) for R$180 million.

 

Carsales is a leading Australian company in the online vehicle classifieds market, with more than 60% of the market share in Australia, and with operations throughout Asia and Oceania, including in China, New Zealand, Thailand, Malaysia, Singapore, Indonesia and Dubai. The partnership with Carsales is intended to accelerate the growth of Webmotors and consolidate its leadership position in Brazil’s online vehicle classifieds market, through transfers of technology and know-how, together with greater independence and operational focus.

 

Agreement for the Acquisition of GetNet Tecnologia em Captura e Processamento de Transações Eletrônicas Hua S.A. (GetNet) Operations by Santander Brasil

 

On April 7, 2014, we announced to the market, by means of a material fact, that we and our controlled company Santander Getnet Serviços para Meios de Pagamento Sociedade Anônima (“SGS”) have executed, on April 4, 2014, a Share Purchase Agreement, which purpose was the acquisition, by SGS, of 100% of the voting and total corporate capital of GetNet Tecnologia em Captura e Processamento de Transações Eletrônicas H.U.A.H. S.A. (“GetNet”).

 

 

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The purchase price of 100% of the shares issued by Getnet is R$1,104,000,000.00, of which: (i) R$1,020,000,000.00 will be paid to the sellers on the closing date, adjusted by the SELIC rate from 01/31/2014 until the date of the payment and (ii) R$84,000,000.00 will be paid in 5 equal annual installments as of the closing date.

 

The closing date and the implementation of the acquisition is subject to verification of certain precedent conditions usual for similar transactions, including the prior approval of the Brazilian Central Bank and the Administrative Economic Defense Council, and will be completed at the date of the closing date of the transaction, through the corporate rearrangement referred to in the material fact of April 7, 2014. Upon closing of the transaction, Santander Brasil will hold 88.5% of the total corporate capital of SGS and our partners will be entitled to 11.5% of such company.

 

The transaction will reinforce the strategy and the potential growth of our acquiring business, enabling (a) greater flexibility in managing the business, especially in terms of the necessary investments and the definitions regarding the commercial strategy to be adopted, (b) gains related to scale´s improvement, reduction of costs per transaction and additional synergies expected from the integration of operational and commercial structures.

 

Additionally, with the consolidation of the vertical business derived from GetNet, it will be possible for us to have a new, more complete commercial approach towards the business and enhance the differentiation of our services, assisting our customer loyalty and customer retention.

 

Plan to Optimize Our Capital Structure

 

To achieve a more efficient capital structure consistent with the new Basel III capital rules and our business strategy and asset growth plan, we developed in 2013 an equity optimization plan. In accordance with this plan, our shareholders approved on November 1, 2013, a capital decrease of Santander Brasil of R$6.0 billion, from R$62,828 million to R$56,828 million, without diluting the percentage of ownership held by our shareholders. Our shareholders also approved the amendment of our bylaws to confer upon our Board of Directors the authority to issue securities within the limits of the authorized capital. On January 7, 2014, all conditions for the equity distribution were concluded, including the expiration of the 60-day period for objections of any unsecured creditors, which expired on January 3, 2014. Payment of the distribution occurred on January 29, 2014. On January 29, 2014, we issued U.S. dollar denominated notes in an amount equivalent to R$6 billion. Santander Spain agreed to use its entire cash distribution to subscribe to the notes and agreed to subscribe to any notes from the total issuance that were not subscribed by our other shareholders.

 

The notes will be part of our Tier 1 and Tier 2 regulatory capital as approved by the Brazilian Central Bank on April 15, 2014. The Tier 1 notes were issued for an amount equivalent to R$3,000 million, bearing interest at 7.375% per annum and are perpetual. The Tier 2 notes were issued for an amount equivalent to R$3,000 million, bearing interest at 6.0% per annum and will mature on January 29, 2024. The notes shall be converted into our common shares and preferred shares upon the occurrence of certain conversion events. The notes constitute an unsecured and subordinated obligation. In accordance with applicable law, the rights and claims of holders of the (a) Tier 1 notes will rank prior to all holders of common equity Tier 1 capital and (b) Tier 2 notes will rank prior to all holders of common equity Tier 1 capital and additional Tier 1 capital.

 

Also in the context of the equity optimization plan, and with the purposes of eliminating the trades in centavos of our common and preferred shares, increasing liquidity and reducing costs of transaction thereof, on March 18, 2014, our shareholders approved (i) a stock dividend of 19,002,100,957 preferred shares to our shareholders, at the ratio of 0.047619048 preferred shares for each common share or preferred share, which results in five preferred shares for each Unit, through the capitalization of reserves in the amount of R$171,798,385.79; and (ii) a reverse share split of the totality of our common shares and preferred shares in a ratio of 1:55, so that each fifty-five (55) common shares and fifty-five preferred shares will correspond to one common share and one preferred share, and as a result, each Unit will be comprised of one common share and one preferred share. After such stock dividend and reverse share split, our corporate capital, in the total amount of R$57 million, will be divided into 7,600,840,325 shares, of which 3,869,849,668 will be common shares and 3,730,990,657 will be preferred shares, all of them with no par value. The stock dividend and reverse share split was approved by the Brazilian Central Bank on April 22, 2014 and its effective implementation will occur on June 2, 2014.

 

Extension of Period for Us to Reach the Minimum Percentage of Outstanding Shares (Free Float) of 25%

 

On October 8, 2013, BM&FBOVESPA granted our and our majority stockholders’ request to (i) extend the period for reaching the minimum free float until October 7, 2014; and (ii) reduce the current free float of 24.6% to 22.5%, exclusively in the context of: (a) the Buyback Program of depositary share certificates ( our units) or ADRs; and (b) the acquisition abroad, by Santander Spain, or any other member of Santander Group, of our ADRs. This authorization does not affect our obligation to achieve a free float of 25% by October 7, 2014, as set forth in the Agreement for the Adoption of Corporate Governance Level 2 Practices.

 

 

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Implementation of the Program for Reinvestment of Dividends (“PRD”)

 

On November 1, 2013 we informed our shareholders about the implementation of the PRD. The PRD is intended to offer our shareholders an alternative for systematic and organized reinvestment of their dividends and/or interest on capital in our shares. The PRD focuses on individuals that are shareholders holding book entry-shares and our account holders.

 

Exercise of the Exchange Rights by Qatar Holding Luxembourg II S.À R.L.

 

On October 29, 2013, our shareholder Qatar Holding Luxembourg II S.À R.L. (“QHL”), exercised its exchange rights related to mandatorily exchangeable bonds in the total amount of U.S.$2,719 million, acquired pursuant to a purchase agreement, dated October 28, 2010, entered into between Santander Spain, as issuer, and QHL, as purchaser.

 

On November 7, 2013, Qatar Holding received from Santander Spain 190,030,195 ADSs issued by us, therefore increasing its interest in us to 196,461,770 of our ADS, which represents 5.08% of our common shares and 5.28% of our preferred shares at that time. For further information, see note 24 of our audited consolidated financial statements.

 

Capital Expenditures and Divestitures

 

Our principal capital expenditures are comprised of investments in information technology. Our information technology (“IT”) platform focuses on our customers and supports our business model. In 2013, 2012 and 2011, total investments in information technology were R$1.014 million, R$958 million and R$848 million, respectively.

 

In 2012 and 2013, we continually improved our technology platform by means of investments in systems and hardware renewal. During these years, our main project was the construction of a new data center with the most advanced requirements in terms of data centers.

 

Technology management by specialized companies within the Santander Group enables us to achieve a global scale and other benefits similar to outsourcing, without the loss-of-control that is often seen when outsourcing core activities. For further discussion regarding our technology infrastructure see “—B. Business Overview—Technology and Infrastructure” below.

 

Our major divestitures in the past three fiscal years and until the date of this information were the sale, in December 2013, of our asset management business to a holding company owned by Santander Spain and the private equity funds Warburg Pincus and General Atlantic for R$2,243 million See “—4A. Important Events - Sale of the Investment Fund Management and Managed Portfolio Operations” and the sale, in 2012 and 2013, of real estate assets, mainly branches, to Santander Real Estate Mutual Fund (Santander Agências Fundo de Investimento Imobiliário), that generated gains of R$335 million and R$88 million, respectively.

 

4B .	Business Overview

 

Our Competitive Strengths

 

We believe that our main competitive advantages are: (i) being part of the Santander Group; (ii) maintaining a conservative risk profile; (iii) maintaining a strong capital base (iv) maintaining a modern technology platform; and (v) focusing on sustainable growth with a strong presence in attractive demographic and geographic areas.

 

Relationship with the Santander Group

 

We believe that being part of the Santander Group offers us a significant competitive advantage over our competitors. Under the Santander Group business model, each unit has to be self-sufficient in terms of capital and liquidity. However, our relationship allows us to:

 

·

access the Santander Group’s global information systems platform, which reduces our technology development costs, provides operational synergies with the Santander Group and enhances our ability to provide international products and services to our customers;

 

 

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·

access the Santander Group’s multinational client base;

 

·

take advantage of the Santander Group’s global presence, in particular in other countries in Latin America, to offer international solutions for our Brazilian corporate customers’ financial needs as they expand their operations globally;

 

·

selectively replicate or adapt the Santander Group’s successful product offerings from other countries in Brazil;

 

·

benefit from the Santander Group’s operational expertise in areas such as internal controls and risk management, which has been developed in response to a wide range of market conditions across the world and which we believe will enhance our ability to expand our business within desired risk limits;

 

·

leverage the Santander Group’s experience with integrations to maximize and accelerate the generation of synergies from any future acquisitions; and

 

·

benefit from the Santander Group’s management training and development which is composed of a combination of in-house training and development with access to managerial expertise in other Santander Group units outside Brazil.

 

Conservative Risk Profile

 

High quality risk management is one of the Santander Group hallmarks and thus one of our priorities. Throughout its 150 years, the Santander Group has combined prudence in risk management with use of advanced techniques, always aiming to generate recurrent and balanced earnings and to create shareholder value. Our risk management model is a key factor for achieving our strategic objectives.

 

Our risk management principles are: (i) independence and risk assessment; (ii) business support to maintain risk quality; (iii) decision-making based on committee involvement; and (iv) use of modern tools and systems to analyze risk. Our risk management policy seeks to maintain a medium-low and predictable profile for all our risks.

 

To manage our risks, we have incorporated the Santander Group’s global program of risk management in various levels of our organization. The whole Bank is involved in risk management, from our branch employees to our Risk Management Committee members.

 

Strong Capital Base

 

Due to our strong capital base, among other factors, we were considered in May 2013 to be the most solid bank both in Latin America and Brazil by Bloomberg Markets Magazine. As of December 31, 2013, our Basel capital adequacy ratio was 19.2%. To achieve a more efficient capital structure consistent with the new Basel III capital rules and our business strategy and asset growth plan, we developed an equity optimization plan in 2013. In accordance with this plan, our shareholders approved, on November 1, 2013, a capital decrease of Santander Brasil of R$6 billion, without diluting the percentage of ownership held by our shareholders of record on January 14, 2014. Payment of the distribution occurred on January 29, 2014.

 

On January 29, 2014, we issued U.S. dollar denominated notes in an amount equivalent to R$6 billion. Santander Spain agreed to use its entire cash distribution to subscribe to the notes and agreed to subscribe to any notes from the total issuance that were not subscribed by our other shareholders.

 

The notes will be part of our Tier 1 and Tier 2 regulatory capital, as approved by the Brazilian Central Bank on April 15, 2014. The Tier 1 notes were issued for an amount equivalent to R$3 billion, bearing interest at 7.375% per annum and are perpetual. The Tier 2 notes were issued for an amount equivalent to R$3 billion, bearing interest at 6.0% per annum and will mature on January 29, 2024. For further information on our equity optimization plan, see “Item 4.—Information on the Company—A. History and Development of the Company—Important Events—Plan to Optimize Our Capital Structure.”

 

For further information on our capital adequacy requirements, see “Item 4.—Information on the Company—Regulation and Supervision—Capital Adequacy and Leverage—Basel.”

 

 

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Modern Technology Platform

 

We operate a modern global technology platform that is interconnected with the platform of the Santander Group, which allows us to serve our customers on a global scale, under a platform that is uniquely customer-centered. Our technological platform is structured to allow us to provide core banking services and our standardized systems allow us to serve our customers quickly and efficiently.

 

Also, in 2013, we concluded the construction of our new data center, located in Campinas, which we believe to be the largest technology center in Latin America (with 800,000 square-meters). This data center has the maximum classification level in capacity and availability (Tier IV, with 99.99% availability) according to the UpTime Institute, a consortium of companies that engage in consulting for the enterprise data center industry. Our objectives in terms of technology are to: (i) maintain our systems with a high security level, (ii) optimize our systems technology activities and (iii) operate efficiently through improved use of energy and natural resources.

 

In 2013, we also initiated a partnership with iZettle, a Swedish mobile payments company, to offer credit and debit card readers that allow individuals and small businesses to accept card payments on their smartphones or tablets.

 

Sustainable growth with strong presence in attractive demographic and geographic areas

 

We continuously focus on sustainable growth, both organically and through select acquisitions and partnerships. We believe we are well positioned to benefit from the growth in our customer base and the relatively low penetration of financial products and services in Brazil. We have a strong presence in attractive demographic and geographic areas and we have strengthened our competitive position in all Brazilian regions, mainly in the South and Southeast, which are areas that account for approximately 72% of Brazil’s GDP.

 

Our strong presence in the South and Southeast regions also allows us to reach mid- and high-income customers that provide access to a stable and low-cost funding base through a wide variety of funding instruments. Furthermore, our focus on these customers has increased our profitability, as they have traditionally produced higher volumes and margins. Our presence in these attractive geographic areas allows us to effectively cover a significant portion of Brazil’s economic base.

 

We believe there is further potential for growth through the use of our existing, redesigned information technology platform, by increasing the penetration of financial products and services within our client base, which, as of December 31, 2013, comprised 29.5 million customers and 21.8 million checking accounts, according to the Brazilian Central Bank.

 

We rank third among private banks in Brazil in terms of assets, with a market share of 7.5%, as of December 31, 2013, according to the Brazilian Central Bank. Among these banks, we believe we hold a top three market position in most of our key product lines as evidenced by our market share in the following selected products and regions.

 

		At December 31, 2013 Market share (%)
Payroll/individual loans			7.7
Individual loans			11.7
Payroll loans			5.9
Auto leasing/CDC (Auto loans)			16.8
Credit cards			11.9
Branches(1)			11.3
Southeast(1)			15.2
South(1)			8.4

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Source: Brazilian Central Bank.

 

We believe that our size and market leadership position provide us with exceptional competitive opportunities including (i) the ability to gather market intelligence to support decision-making in determining business opportunities and (ii) the ability to meet our customers’ needs by operating as a full-service bank. In addition, we are

 

 

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a leading wholesale bank in Brazil. Through our unique access to the Santander Group’s global network, we are able to support our large Brazilian corporate customers in the globalization of their businesses.

 

Our Strategy

 

Our mission is to be our customer’s bank of choice as a simple, secure, efficient and profitable bank which constantly seeks to improve its service quality, with a team that enjoys working together to gain the recognition and trust of our clients. As a result, our strategy is focused on the following objectives:

 

·

To be the bank of choice for our customers, intensifying our relationship with them and providing the best value to all customer classes with a modern, simple and efficient commercial model;

 

·

To expand our main businesses, increasing revenues in a sustainable way and taking into account the balance between loans, funding and services;

 

·

To maintain sustainable and efficient risk and cost management;

 

·

To promote an intense agenda of productive transformation following the transformation of the financial industry focused on simplicity, productivity and efficiency; and

 

·

To maintain discipline in capital management and financial soundness in each of our business segments.

 

Our Business

 

Overview

 

Until the sale of our Asset Management business, we operated along three segments: Commercial Banking, Global Wholesale Banking and Asset Management and Insurance. As a result of the sale, we simplified our segmentation and merged our Asset Management and Insurance segment into our Commercial Banking Segment. For further information regarding the sale of our Asset Management business, see “—4A. Important Events - Sale of the Investment Fund Management and Managed Portfolio Operations”.

 

The following chart sets forth our operating segments and their main focus.

 

Commercial Banking		Global Wholesale Banking
·      Retail banking		·      Global Banking & Markets, or GB&M
·      Individuals		·      Proprietary Trading
·      Small and Medium enterprises (“SMEs”) (annual gross revenues up to R$80 million)
·      Corporate (annual gross revenues in excess of R$80 million, other than global corporate clients)
·      Consumer finance
·      Asset Management
·      Insurance
·      Capitalization Products

 

 

 

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The following table presents the breakdown of our net interest income and profit before tax by operating segment.

 

		For the year ended December 31,
		2013				2012				2011				2013				2012				2011
		Net interest income												Profit before tax
		(in millions of R$)
Commercial Banking			26,328				29,470				25,207				1,510				3,103				5,827
Global Wholesale Banking			2,151				2,117				2,589				2,508				2,372				2,947
Total			28,479				31,587				27,796				4,018				5,475				8,774

In our Commercial Banking business segment, we focus on long-term relationships with our individual and corporate customers (other than global enterprise customers that are serviced by our Global Wholesale Banking segment), seeking to support all of their financial needs through our credit, banking services, financial products, asset management and insurance products. We also offer special financing and credit opportunities for corporate customers pursuing social and environmental improvement programs. Our business model and segmentation allows us to provide a tailored approach to each client in order to address their specific needs.

 

Through our Global Wholesale Banking segment we offer financial services and sophisticated and structured solutions to our customers, in parallel with our proprietary trading activities. Our wholesale banking business focuses on servicing local and multinational conglomerates, which we refer to as Global Banking & Markets, or “GB&M” customers. Our wholesale business provides our customers with a wide range of domestic and international services that are specifically tailored to the needs of each client. Our customers benefit from the global services provided by the Santander Group’s integrated wholesale banking network and local market expertise. Our proprietary trading desk is under strict risk control oversight and has consistently shown positive results, even under volatile scenarios.

 

Our business is strongly committed to sustainability. Our sustainable strategy is based on three pillars: (i) social and financial inclusion, (ii) education and (iii) socio environmental business. In 2013, both the Financial Times, and the International Finance Corporation or IFC, recognized Santander Brasil as the most sustainable bank of the year in the Americas category.

 

As of December 31, 2013 our credit portfolio grew 7.3% and reached R$226,206 million compared to R$210,741 million in December 31, 2012.

 

The following table shows a managerial breakdown of our credit portfolio by client category at the dates indicated.

 

		For the year ended December 31,												Change, at December 31, 2013 vs. December 31, 2012
		2013				2012				2011				R$ million				%
		(in millions of R$)
Individuals			74,441				70,277				63,413				4,164				5.9
Consumer finance			28,692				29,566				30,459				(874	)			(3.0	)
Small and Medium Enterprises(1)			38,930				40,118				33,538				(1,188	)			(3.0	)
Large Corporations(2)			84,143				70,780				66,774				13,363				18.9
Total			226,206				210,741				194,184				15,465				7.3

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(1)	Companies with annual gross revenues of up to R$80 million.

 

(2)	Companies with annual gross revenues exceeding R$80 million, including our global corporate clients.

 

Commercial Banking

 

Our Commercial Banking business includes products and services for retail customers, enterprises and corporations (other than global corporate clients who are served by our Global Wholesale Banking segment), our consumer finance business and our asset management and insurance services.

 

 

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We serve clients throughout Brazil, primarily through our branch network, which as of December 31, 2013, consisted of 2,313 branches, 1,253 mini branches ( postos de atendimento bancário or “PABs” located at our corporate customers’ premises), and 16,958 ATMs.

 

In 2013, we revised both our Individuals and corporate client classification models to better reflect the macroeconomic changes of the Brazilian market and changes in customer preferences. We created a new high-income service sector, Santander Select, and we adjusted our corporate sector to better fulfill our corporate clients’ financial needs.

 

Retail Banking

 

Individuals

 

In 2013, we revised our Individuals classification model and created a new high-income service sector, Santander Select, designed to provide our high-income customers with a new category of specialized financial services that allows them to better manage their assets. We had opened 61 exclusive Santander Select branches with 400 relationship managers.

 

After our revision, our current Individuals classification model is as follows:

 

·

Private Banking Business: serves a select group of clients with a minimum of R$3.0 million in assets available for investment. Our objective is to offer our clients a comprehensive range of financial products, banking services, tax planning and advisory services that provide recommendations on investments and asset allocation.

 

·

Santander Select: customers who earn more than R$10,000 per month or have investments above R$200,000. Our objective is to offer wealth management advisory services to these customers.

 

·

Santander Van Gogh: customers who earn over R$4,000 per month or have investments above R$40,000. Our objective is to offer differentiated financial services to these customers.

 

·

Santander Individual: customers who earn less than R$4,000 per month. Our model offers simple and efficient solutions with options to improve cost-benefit of our banking services for these customers, primarily through electronic channels.

 

In order to better meet customer needs, in 2013 we launched the Santander Conta Combinada , which allows our clients to choose among four types of accounts, according to their profile. An example is the Santander Conta Combinada Universitária Fit (for university students), which has no monthly charge for the service package as long as basic account requirements are met. The Santander Conta Combinada is offered only to customers in our Individuals classification.

 

We offer our retail lending products to customers through our extensive branch network and on-site service units. See “—Distribution Network.” The following table sets forth our individual customer loan portfolio at the dates indicated, as per our management records:

 

		For the year ended December 31,												Change, at December 31, 2013 vs. December 31, 2012
		2013				2012				2011				R$ million				%
		(in millions of R$)
Leasing/Auto Loans(1)			3,185				2,740				2,277				445				16.3
Credit cards			17,070				16,138				14,144				932				5.8
Payroll loans(2)			12,994				13,529				12,248				(535	)			(4.0	)
Mortgages			16,058				12,321				10,018				3,737				30.3
Agricultural Loans			2,725				2,147				2,492				578				26.9
Personal loans/Other			22,409				23,402				22,234				(993	)			(4.2	)
Total			74,441				70,277				63,413				4,164				5.93

 

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(1)	Including the loans to individuals in the consumer finance segment, the auto loan portfolio totaled R$27.6 billion in the fourth quarter of 2013, R$27.9 billion in the fourth quarter of 2012, and R$27.5 billion in the fourth quarter of 2011.

 

(2)	Including the payroll loan acquired portfolio, payroll loans totaled R$13.7 billion at December 31, 2013, R$14.8 billion at December 31, 2012 and R$15.1 billion at December 31, 2011.

 

 

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Payroll Loans

 

Payroll loans are typical retail products with differentiated methods of payment. Monthly installments are deducted directly from the customer’s payroll by their employer and then credited to us, significantly reducing our credit risk. Our customers are typically employees from the public sector, private sector and state pension holders. We had 5.9% of market share in payroll loans at December 31, 2013, according to the Brazilian Central Bank.

 

Credit Cards

 

We participate in the credit card market, issuing cards from the Visa and MasterCard brands to our customers (including both account and non-account holders). Our revenues from credit cards include administration fees, interest on unpaid balances, annuities and rates charged on cash advances.

 

The total credit card portfolio in 2013 presented an increase of 5.6% compared to the same period in 2012, reaching R$17.4 billion. In 2013, our credit card customer base increased 7.6% from 2012, reaching 15.7 million credit cards, and our debit card customer base increased 11.1% from 2012, reaching 37.5 million debit cards.

 

In 2013, we maintained our partnerships with Vivo, a leading mobile phone operator in Brazil and the Raízen group (a Brazilian energy company operating more than 4,700 service stations under the Shell brand). These partnerships were designed to increase our customer base by combining our products with Raizen’s points of sales and Vivo’s customer base.

 

Merchant Acquiring Market

 

On April 4, 2014, we and our controlled company, Santander Getnet Serviços para Meios de Pagamento Sociedade Anônima, or SGS, executed a share purchase agreement for the acquisition, by SGS, of Getnet Tecnologia em Captura e Processamento de Transações H.U.A.H. S.A., our current partner in developing acquiring services and card processing activities. For further information on this transaction, see “Item 4.—Information on the Company—A. History and Development of the Company—Important Events—Agreement for the Acquisition of GetNet Tecnologia em Captura e Processamento de Transações Eletrônicas Hua S.A. (GetNet) Operations by Santander Brasil”. Our goal is to consolidate and strengthen a partnership initiated in 2010 by the two companies and to seek greater synergy.

 

During the third quarter of 2013 we initiated a partnership with iZettle, a Swedish mobile payments company, to offer credit and debit card-readers that allow individuals and small businesses to accept card payments on their smartphones or tablets.

 

In 2013 we had a 5.8% market share in Brazil in terms of revenues in the merchant acquiring market, covering more than 75% of the Brazilian territory, according to the Brazilian Central Bank.

 

Mortgages

 

We offer long-term loans to our customers for the purchase of real estate, secured by deeds of trust, which we consider a strategic product due to its lower risk and ability to increase customer loyalty. Mortgages were the credit product with the highest growth in our portfolio in 2013. In addition to financing for individuals, we also offer credit lines to corporate customers in the real estate construction industry for the financing of up to 80% of the project cost.

 

As of December 31, 2013, we had a 6.4% market share in Brazil in terms of amounts outstanding under mortgage products, according to the Brazilian Central Bank. As of December 31, 2013, our mortgage loans portfolio, including construction loans, was R$25.6 billion. Within the individual sector, mortgage loans increased 30.3%, reaching R$16.1 billion.

 

 

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On average, the loan-to-value ratio of our housing loans is 58.0%. We do not offer mortgage loans that do not meet prime lending standards. That is (i) we do not make any loans for more than 80% of the value of the property to be purchased, (ii) and borrowers must meet certain minimum monthly income levels evidenced by recent payroll information and tax returns to confirm their employment or other types of revenue which allows us to evaluate their credit risk profile and (iii) payments may not exceed 35% of borrowers’ monthly income.

 

Small and Medium Enterprises

 

Our current SMEs classification model is as follows:

 

·

Enterprise 3: companies with annual revenue over R$10 million and up to R$80 million. Our focus is to strengthen relationships through dedicated and differentiated account managers.

 

·

Enterprise 2: companies with annual revenue over R$1 million and up to R$10 million. Our focus is to strengthen relationships through the centralization of cash flow management and adequate credit offering.

 

·

Enterprise 1: companies with annual revenue up to R$1 million. Our focus is to increase penetration in this segment, primarily through merchant acquiring services, and by offering differentiated services, such as the integration of financial solutions for both the enterprise and its partners, bringing simplicity and economy to the enterprise’s day-to-day operations.

 

During 2013, we focused on offering our integrated service to our Enterprises 1 and 2 customers. The integrated service streamlines all stages of an enterprise, integrating services provided to both accounts, individual and business, bringing simplicity to our customers’ day-to-day operations. With respect to our Enterprise 2 customers, we also focused on improving our internet banking services and with respect to our Enterprise 3 customers, we focused on remodeling our product offering to better meet their needs.

 

The table below sets forth our SME loan portfolio at the dates indicated, as per our management records.

 

		For the year ended December 31,												Change, December 31, 2013 vs. December 31, 2012
		2013				2012				2011				R$ million				%
		(in millions of R$)
Agricultural lending			167				155				110				12				7.3
Working capital loans			18,502				19,811				16,486				(1,309	)			(6.6	)
Buyer financing			19				30				16				(11	)			(36.5	)
Vendor financing			6				5				7				1				15.2
Discounted receivables			772				1,174				736				(402	)			(34.2	)
Comex			471				322				354				149				46.2
Overdraft facility			3,168				3,922				3,961				(754	)			(19.2	)
Refinancing			2,803				3,598				3,195				(795	)			(22.1	)
Resolution 2,770			13				10				38				3				31.4
Account overdraft loans			2,640				2,737				2,627				(97	)			(3.5	)
CDC/leasing(1)			1,988				2,276				2,257				(288	)			(12.6	)
Other(2)			8,381				6,078				3,751				2,303				38.0
Total(3)			38,930				40,118				33,538				(1,188	)			3.0

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(1)	Does not include consumer finance products.

 

(2)	Includes credit cards, mortgage finance products and other products.

 

(3)	Includes small and medium companies with annual gross revenues up to R$80 million.

 

Corporate

 

Our corporate segment is comprised of large companies that have annual gross revenues greater than R$80 million (other than global corporate clients). We focus on fostering a close relationship with our corporate customers by providing them with customer-tailored services. To that end, we offer a wide range of specialized products and

 

 

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services that are compatible with the products and services we offer to our GB&M customers. In 2013, we had more than 200 bankers and 110 product specialists dedicated exclusively to our corporate sector.

 

Consumer Finance

 

Aymoré Crédito, Financiamento e Investimento S.A. (“Santander Financiamentos”) is our main channel for consumer finance with expertise in providing consumer credit directly to borrowers or through intermediate agencies. Our consumer finance operations are based on four pillars: (1) vehicle financing, (2) commercial partnerships (particularly with automakers such as Nissan, Renault and Hyundai); (3) Webmotors (our online vehicle trading platform); and (4) consumer credit, which includes opportunities in sectors such as furniture, tourism, nautical, health and technology, accessibility equipment, renewable energies and cleaner processes, among others.

 

In December 2013, we had over 14,500 business partners, a sales team composed of 1,644 employees (operators and businesses managers) and 141 branches of Santander Financiamentos throughout Brazil dedicated to consumer finance. As of December 31, 2013, our core business, vehicle financing, represents approximately 89% of our consumer credit portfolio.

 

Asset Management

 

On December 17, 2013, we concluded the sale of our asset management business by way of a disposal of all shares of DTVM. For further information on the sale of our asset management business, see “Item 4.—Information on the Company—A. History and Development of the Company—Important Events—Sale of the Investment Fund Management and Managed Portfolio Operations”.

 

Following the sale of our asset management business, we continue to act as administrator, meaning we will continue to represent the fund, carry out certain activities before the client and engage in sales and distribution activities. We will not manage the funds invested or make investment decisions with respect thereto, which will be performed by the new asset manager.

 

Our main strategy in this segment continues to be offering innovative products to our customers. In 2013, we focused on launching products that provide Brazilian investors with access to external markets. Drawing on our global expertise, we began to offer our Brazilian customers a group of funds that invest in global equity. We believe that the sale of our asset management business will allow us to better cater to our customers’ growing need for global diversification.

 

Insurance Brokerage Services

 

We aim to provide our customers with streamlined and customized products focused on the retail segment. As a result of the sale of Santander Seguros in 2011, we operate exclusively with insurance products offered by the joint venture that was formed in connection with the sale of Santander Seguros, particularly in our insurance and private pension plan portfolio. We also sell automobile insurance policies from the major providers in Brazil.

 

For further information on the sale of Santander Seguros, see “Item 5—Operating and Financial Review and Prospects—A. Operating Results—Factors Affecting the Comparability of Our Results of Operations—- Sale of Zurich Santander Brasil Seguros e Previdência S.A. (the new corporate name of Santander Seguros S.A.).”

 

Capitalization Products

 

Capitalization Products are savings account products that generally require customers to deposit a fixed amount with us to be returned at the end of an agreed upon term, with accrued interest. In addition, the customer is automatically entered into periodic drawings for the opportunity to win significant cash prizes. Thus, capitalization products are similar to certificates of deposits, except that, along with purchasing a product that receives a return on principal, the customer has a chance of receiving cash prizes during the term of the product based on random drawings.

 

Our Capitalization Products transactions are carried out through our subsidiary Santander Capitalização S.A. and are focused on bank assurance products.

 

 

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Global Wholesale Banking

 

Global Banking & Markets

 

GB&M is a global business unit that covers those clients that, due to their size, complexity or sophistication, require tailored services or high value added wholesale products. In this segment, we provide a wide range of domestic and international financial services to large Brazilian and multinational conglomerates in parallel to our proprietary trading activities. Our customers in the GB&M segment benefit from the global structure of services provided by the Santander Group with its worldwide integrated wholesale banking network and global services solutions, combined with its local market expertise. This structure allows services to be provided in an integrated fashion.

 

In 2013, we focused on developing our customer relationships by implementing a new client coverage model and strengthening partnerships with other sectors of the Bank through product cross-selling. The Global Wholesale Banking segment’s products and services are available not only to our GB&M clients, but also to Corporate, SME customers, private banking and retail clients.

 

We offer a range of services from core products to highly complex customized solutions in the following key areas:

 

·

Global transaction banking, which includes cash management, local loans and bank guarantees, trade finance, global custody, securities services, guarantees (both trade and non-trade) and trade services;

 

·

Credit markets, which is responsible for project financing and advising, debt capital markets, acquisition financing and loan syndication, credit sales, trading and asset and capital structuring;

 

·

Corporate finance, which includes mergers and acquisitions and equity capital markets operations;

 

·

Equities, which includes cash equities services for individuals and institutional clients, exchange traded derivatives and equity research;

 

·

Rates, which is responsible for offering treasury products such as foreign exchange transactions, derivatives (including equity derivatives), deposits and other financial and structured products;

 

·

Market making, which is responsible for the pricing of client deals originated by the sales force from our corporate, institutional, private banking and retail operations;

 

Our GB&M team is dedicated to client coverage comprising a range of industries, including telecommunications, retail, aviation, real estate and logistics, power, construction and infrastructure, natural resources, food, agribusiness and financial institutions.

 

We are one of the leading banks in capital markets and financial advisory services in the Brazilian and international markets, as evidenced by the leading league tables for the industry.

 

Our mergers and acquisitions team in Latin America ranked third in 2013 compared to ninth in 2012. We ranked fifth in Brazil in terms of announced transactions in 2013, compared to seventh in 2012, according to Bloomberg, with a total of twelve transactions, which amounted to U.S.$20 billion.

 

Our Brazilian equity capital markets division participated as bookrunner in numerous offerings in recent years. In 2013, we ranked fifth in equity issuances according to Bloomberg, with a total of fourteen transactions, which amounted to U.S.$2 billion.

 

In 2013, we also played an important role in both local and international debt capital markets for Brazilian issuers. In the local debt capital markets, we participated in 23 transactions, compared to fifteen transactions in 2012, arranging R$2.6 billion in funding for companies. We expanded our market share to 7.6% in 2013, rising two positions in the ANBIMA rankings to fifth place. In the international debt market, we increased our revenue by 38% by using a diversification strategy. In 2013, we participated in the coordination of fifteen transactions of financial and corporate bonds, which totaled U.S.$1.7 billion, according to the Bond Radar ranking.

 

 

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Our project finance team has advised and structured the most important projects in recent years in several sectors of the economy. The Santander Group is one of the main project lenders in the world and is one of the leaders in the Brazilian market, as evidenced by ANBIMA’s ranking in recent years.

 

In 2013, we participated in almost all the infrastructure auctions held by the government, acting as advisors to the majority of the auction winners, including in the urban mobility, airports, toll roads, power generation, transmission lines, and water and waste sectors, among others. We expect project finance to continue being a key element of our business as infrastructure improvements remain one of the Brazilian government’s main priorities.

 

Our main activities in asset and capital structuring include proprietary investments in infrastructure projects and renewable energy. In 2013, we became a major shareholder in an important wind farm complex in the northeast of Brazil, consolidating our leadership in the wind farm industry.

 

Through our equities department, we provide advisory and trading execution for individuals and institutional investors, and manage hedge funds throughout Latin America, the United States, Europe and Asia. Our equity sales team and traders follow the equity strategy recommendations and the reports developed by our equity research team. Currently, our equity research team is regarded as one of the best in Latin America according to a poll by Institutional Investor magazine.

 

Our brokerage operations, which are focused on individuals offer premium advisory services to our clients, based on our proprietary equity research. During 2013, our equity brokerage operations delivered outstanding performance. While the Bovespa Index dropped 15.50% in 2013, our recommended portfolio (called “Carteira Dinâmica”) obtained returns of 11.5%. Our recommended portfolio is more flexible than traditional portfolios as it allows investors to allocate their positions according to market conditions, through more aggressive strategies. In 2013, short-term recommended strategies demonstrated an even greater performance of 47.0% returns.

 

We also offer, through our treasury sales team, foreign exchange products, derivatives and deposits to all of our clients, including corporate clients in large, middle and small enterprises, institutional investors and individuals. We have an effective coverage, based on teams which are specialized in each of these segments as well as structuring and products teams that work to create and maintain a portfolio that allows us to offer our customers the most innovative solutions available in the market.

 

We have a structure dedicated to international correspondent banking operations, which include trade financing and funding from correspondent banks. Our trade financing activities consist of import and export financing. Both import and export financings are extended in U.S. dollars or the relevant foreign currency of the commercial transaction.

 

We offer a comprehensive range of cash management solutions, both locally and globally. We offer clients the opportunity to significantly improve the management of domestic flows so as to gain access to local clearing services and process transactions quickly and effectively. This enhances our customer loyalty through integrated and personalized solutions, together with our global service model.

 

Our GB&M operations helped us achieve the following awards in 2013:

 

·

“Deal of the Year” awards were granted to two of our transactions: (I) CNO Bond: “Bond of the Year” by Latin Finance; and (II) Project Bond OOG: “LatAm Oil & Gas Deal of the Year” by Project Finance International and “TBC Award” by Euromoney.

 

·

“Deal of the Quarter Century” awards were granted to two of our transactions: (i) Odebrecht Drilling Norbe VIII / IX in 2010: “Best Project / Infrastructure Finance Deal” by Latin Finance; (ii) Purchase by Vale Inco Ltd. in 2006: “Best M&A Deal” by Latin Finance.

 

Proprietary Trading

 

Our Proprietary Trading is responsible for the management of our proprietary books and the establishment of a relevant presence as a leading liquidity provider across local and foreign markets.

 

 

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Distribution Network

 

Our distribution network provides integrated financial services and products to our customers through a variety of channels, including branches and mini-branches (or PABs), as well as complementary distribution channels such as ATMs, call centers and Internet banking. These distribution channels are concentrated in the Southeast and South, Brazil’s wealthiest regions measured in terms of GDP per capita (representing approximately 72% of Brazil’s GDP in 2011).

 

The following table presents our principal distribution outlets at December 31, 2013:

 

		At December 31, 2013
Branches			2,313
PABs			1,253
ATMs			16,958

Branch Network

 

Our branch network offers all of our products and services to our customers. As of December 31, 2013, we had a network of 2,313 full service branches throughout Brazil, 85% of which were concentrated in the Southeast and South regions.

 

The table below shows the geographic distribution of our distribution network throughout Brazil, as of December 31, 2013.

 

		Branches				PABs				ATMs
Central West			99				84				727
Northeast			198				117				1,602
North			38				47				387
Southeast			1,669				865				12,198
South			309				140				2,044
Total(1)			2,313				1,253				16,958

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(1)	Physical location.

 

The following map shows the geographic distribution of our branch network, each region’s share of 2011 GDP and our market share as of December 31, 2013, according to the Brazilian Central Bank. Market share is calculated by dividing the number of our branches in the region by the number of branches for all principal banks in such region:

 

 

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Source for GDP: IBGE 2011

 

 

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PABs

 

We offer daily banking services to our SME and other corporate customers and their employees through our PABs located on their premises as well as in hospitals and universities. Our PABs are generally the exclusive point of sale at the premises. We believe that our PABs strengthen our relationships with our clients and builds customer loyalty with those individuals who benefit from the convenience of conducting their banking transactions at their workplace.

 

ATMs

 

We operate an extensive network of 16,958 ATMs, including those located in our branches and on-site service units. In addition, our customers have access to the “ Banco 24 Horas ” network which has more than 14,000 ATMs and the “ Rede Compartilhada Banco 24 Horas ” network which operates approximately 15,000 ATMs for over 40 participating banks located throughout Brazil. Through these networks our customers may access their accounts and conduct banking transactions (typically paying a per-transaction fee).

 

Complementary Distribution Channels

 

We also distribute our products and services through complementary distribution channels, which we believe contribute significantly to increased product sales and banking transactions. These channels consist of internet banking, mobile banking services and call centers. These distribution channels provide a significant amount of information to our customers and also improve direct sales. Because of their lower cost and large attendance capacity, we believe that complementary distribution channels are an important way to have more effective relationships with our customer base.

 

Call Centers

 

Our call centers provide our customers with the opportunity to make inquiries, execute payment transactions and apply for products and services, such as personal loans. Our call centers also serve as a distribution channel to offer our clients additional products and services.

 

The following table presents summarized operating statistics for our call centers.

 

		At December 31,												Change, December 31, 2013 vs. December 31, 2012
		2013				2012				2011				Change				%
Number of individual customers (in thousands)			2,333				2,452				2,525				(119	)			(4.9	)
PAS(1)			3,567				3,563				3,631				4				0.1
Headcount			5,831				5,705				6,588				126				2.2
Percentage of using customers per month			25	%			28	%			27	%			—				—

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(1)	Work stations set up for call center activities.

 

Internet Banking

 

We view Internet banking as a key instrument for offering additional products to our customers. Individuals and SMEs can also access their accounts through the Internet to conduct banking transactions at their convenience, such as obtaining account information, financial transfers, contracting loans and making payments. The following table presents summarized operating statistics for our Internet banking.

 

		At December 31,												Change, December 31, 2013 vs. December 31, 2012
		2013				2012				2011				Change				%
Number of individual customers (in thousands)			2,743				2,588				2,448				155				6.0
Percentage of using customers			33	%			29	%			28	%			—				—

 

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Customer Funding

 

Since we are primarily a commercial bank, customer deposits are our main source of funding. These deposits, combined with capital and other instruments, enable us to cover our liquidity needs and legal reserve requirements. As of December 31, 2013, customer deposits amounted to R$200.2 billion, representing 64.9% of total funding, which amounted to R$308.4 billion.

 

The following table presents a managerial break-down of our customer funding for each period presented:

 

		At December 31, 2013
		2013				2012				2011
		(in millions of R$)
Customer deposits			200,156				188,595				174,474
Current accounts			15,585				13,585				13,561
Savings accounts			33,589				26,857				23,293
Time deposits			81,351				84,586				83,942
Repurchase agreements			69,631				63,566				53,678
Backed operations with Private Securities(1)			41,852				35,737				30,247
Backed operations with Public Securities(1)			27,779				27,831				23,431
Deposits from the Brazilian Central Bank and credit institutions			34,032				35,074				51,527
Time deposits			30,510				26,077				27,023
Demand deposits			251				48				134
Repurchase agreements			3,271				8,949				24,371
Backed operations with Private Securities(1)			373				559				223
Backed operations with Public Securities(1)			2,898				8,389				24,147
Total deposits			234,188				223,669				226,001
Marketable debt securities			65,301				54,013				38,590
Agribusiness Credit Notes			1,682				2,009				1,341
Treasury Bills			28,222				25,320				19,926
Real Estate Credit Notes			17,077				11,237				8,550
Securities issued abroad			18,319				15,447				8,773
Subordinated debt			8,906				11,919				10,908
Total Funding			308,395				289,601				275,499

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(1)	Refers primarily to repurchase agreements backed by debentures of own issue.

 

For further discussion of our funding, see “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Liquidity and Funding.”

 

Technology and Infrastructure

 

In order to serve our customers effectively, improve our profitability and grow our business, we continuously invest in new technology and renewal of equipment and infrastructure. We believe that proper management of technology is key to the efficient management of our business. Our technology platform focuses on our customers and supports our business model. We operate a modern global technology platform that is interconnected with the platform of the Santander Group, which allows us to serve our customers on a global scale, under a platform that is uniquely customer-centered. See “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions—Information Technology Platform.”

 

In 2013, we concluded the construction of our new data center located in Campinas, which we believe to be the largest technology center in Latin America, with 800,000 square-meters. Our objectives are: (i) maintain our

 

 

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systems with a high security level, (ii) optimize our technology activities and (iii) operate efficiently through the best use of energy and natural resources. The data center was planned in order to be an example of sustainable construction and consumes 20% less water and 30% less energy than our other data centers. Our new data center is the only data center in Latin America to have received the maximum classification level in capacity and availability (Tier IV, with 99.99% availability), within the design and implementation phases, according to the UpTime Institute.

 

In 2013, we also initiated a partnership with iZettle, a Swedish mobile payments company, to offer credit and debit card readers that allow individuals and small businesses to accept card payments on their smartphones or tablets.

 

Communications and Marketing

 

Our strategy, which is focused on close and transparent customer relations, requires that communication and marketing play a vital role in our business. Tools such as advertising, social networks, sponsorships, events and institutional publications provide us with opportunities to promote different forms of interaction with our audiences, each of which involves a different function. These objectives include the presentation of our activities, products and services, in addition to our strategy in relation to the promotion of sustainable business.

 

Marketing

 

In addition to supporting our business strategy, marketing expresses our corporate position. Our marketing activities throughout 2013 were based on the slogan “Your turn. Your voice. Your bank.” This slogan, linked to the global catch phrase “A bank for your ideas,” reflects the idea of acknowledging the empowerment and leading role of our customers with regard to brand relations. As a means of optimizing investments, our strategy is to concentrate efforts on the areas which set the Santander brand apart from others. This, for example, led to the launch of the high-income sector service Santander Select, the aim of which is to help high-income customers manage their assets. Through our communication platforms, we targeted customers in need of specialist financial guidance to enable them to actively participate in investment decisions, instead of relying on the manager to deal with such decisions.

 

Sponsorships and Culture

 

We maintained our considerable presence in sports marketing in 2013, by sponsoring three major Latin American football tournaments (Copa Libertadores, Copa Sulamericana and Recopa), in addition to the Ferrari Formula 1 team. In relation to cultural investment, we ought to benefit projects which promote creativity and innovation, the transfer of knowledge, conscientious consumption and entrepreneurship. Highlights for cultural programs in 2013 include the expositions “Poetic Narratives – Santander Collection” (an itinerant exposition from the Bank´s collection), the “9th MERCOSUL Biennial” and the “Santander Art Circuit,” a project which involved artists decorating the facades of ten bank branches in Porto Alegre, in the state of Rio Grande do Sul.

 

Communication and Events

 

The topics and forms of communication vary in accordance with the tools used and the audiences addressed. We relate with stakeholders including customers, journalists, shareholders and university students via the different platforms available. We believe social networks provide an excellent opportunity for stakeholder interaction because they provide the widest range of audiences and because everyone is able to participate in any given conversation. We utilize social networks to constantly establish dialog in connection with issues of common interest, as a means of increasing the engagement and involvement of the followers of our brand. As a result, we have over 2.1 million Facebook fans and 113,000 followers on Twitter. We also interact with interested parties through events, which bring us closer to our customers and potential customers. Our Annual Report is also an important means of communication with our various stakeholders and for 2012 was prepared in line with the standards of the Global Reporting Initiative (GRI).

 

Sustainability

 

Our strategy regarding sustainability is based on three pillars, which are essential for the development of Brazil: (i) social and financial inclusion; (ii) education; and (iii) socio-environmental businesses.

 

 

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In 2013, the Financial Times, along with the IFC recognized Santander as the most sustainable bank of the year in the Americas category. The award was granted based on the evaluation of our commitment to sustainability and related practices. Other recognitions in 2013 included: (i) Época Negócios 360° , where we were ranked first in the social and environmental responsibility category; (ii) Prêmio Eco , one of Brazil’s main sustainability awards, promoted by the American Chamber of Commerce; (iii) Guia Exame de Sustentabilidade , which covers the best practices of corporate responsibility in the country; and (iv) the Fundo Ethical rating as “excellent” by the Investidor Institucional magazine ranking.

 

For the fourth consecutive year, our shares were included in the portfolio of the Business Sustainability Index ( Índice de Sustentabilidade Empresarial ) or “ISE”) from BM&FBOVESPA. We also maintained our presence at the Efficient Carbon Index ( Índice Carbono Eficiente ) or “ICO2,” composed by the shares of companies that take part in the IBrX-50 index, and which adopt transparency practices regarding their greenhouse gases emission (GEE – gases de efeito estufa ). In addition to that, we have been elected to be part of the “Global Compact 100,” a stock index comprised by shares of companies committed to the ten principles of the United Nations Global Compact.

 

We strive to be the bank in Brazil which provides the best financial mechanisms to enable our clients and society to be more sustainable. For example, in 2013, our climate governance model focused on structuring new low carbon business models. A result from this strategy, we created the Reduce and Compensate CO2 Program ( Programa Reduza e Compense CO2 ).

 

Social and Financial Inclusion

 

We are the largest microcredit private-owned bank in Brazil, based on market participation and portfolio value, with a total of R$2.0 billion microcredit provided and more than 285,000 entrepreneurs served since 2002.

 

We also promote social and financial inclusion by opening branches in low income communities and offering job opportunities for members of these communities. In 2013, we opened a new service station inside Paraisópolis, a low-income community in São Paulo. Another example of initiative is the Programa Amigo de Valor , which allows Santander’s employees and customers to transfer part of their income tax to the Child and Adolescent’s Rights Funds. In 2013, this program achieved a new record: R$8.4 million collected (71.4% more than 2012), which has been directed to 56 cities.

 

Education

 

Santander Universidades is a global program that supports and encourages higher education. We are the most active private institution in the country to partner with the higher education value chain (students, young professionals, teachers and administrative employees). As of December 31, 2013, we had partnerships with 450 universities and had nearly 2 million clients in this program.

 

Since its creation, in 1996, Santander Universidades has already granted over 100 thousand scholarships. Between 2011 and 2015, the estimated investments at a global level will reach R$1.4 billion, from which R$259 million will be directed to higher education support in Brazil. In 2013, one of the highlights of our Santander Universidades program was the Prêmios Santander Universidades , which received 16,838 projects, and granted more than R$2.0 million in awards, international scholarships and on-line entrepreneurship courses to all projects submitted. We also offer the Programa Escola Brasil , a corporate volunteer program that contributes to the improvement of public schools education. The Programa Escola Brasil is present in 56 cities and 297 partner schools, and with the participation of 4,248 employees, relatives, customers and suppliers.

 

Socio-environmental Businesses

 

We finance projects for our corporate customers that improve their social and environmental impacts by (i) reducing water and/or energy consumption; (ii) optimizing waste management and operational efficiency; (iii) using sustainable constructions and/or renovations techniques and (iv) improving accessibility and corporate governance. In 2013, our socio-environmental business financing provided to our corporate and retail clients amounted to more than R$2.0 billion.

 

For our consumer finance customers, we offer products related to accessibility, renewable energies and cleaner processes.

 

 

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The Mantiq, created in 2012 to manage Santander Brasil’s private equity business, ended 2013 with R$2,376 million in funds under. The Mantiq is one of the country’s largest private equity managers. It focuses on the infrastructure and oil and gas sectors, and its investment strategy takes into account socio-environmental criteria besides economics.

 

In 2013, we also reinforced our shareholder participation in companies which develop sustainable businesses, such as Ambievo, a company whose businesses include the development of sustainable solutions for soil cleaning and industrial degreasing.

 

Insurance Coverage

 

We maintain insurance policies that we renew annually in order to protect our assets. All of our branches and administrative buildings are insured against loss caused by fire, lightning, explosions and other “all risks” policy coverage. Such coverage establishes reimbursement for the asset replacement value.

 

We also maintain an insurance policy against third party damages to our properties.

 

Additionally, we maintain a directors and officers, or “D&O” insurance policy for our management against third parties complaints regarding management acts. There are insurance policies against crimes, employee dishonesty and damages arising out of public offerings.

 

Dependency on Patents, Licenses, Contracts and Processes

 

In Brazil, ownership of trademarks can be acquired only through a validly approved registration with the National Institute of Intellectual Property ( Instituto Nacional de Propriedade Industrial , or “INPI”), the agency responsible for registering trademarks, patents and designs in Brazil. After registration, the owner has exclusive use of the trademark throughout Brazil for a ten-year period that can be successively renewed for equal periods.

 

The major trademarks we use, including, among others, the “Santander” and “Banco Santander” brands, are owned by the Santander Group. One of the Santander Group’s affiliates granted us a license to use such brands. All material trademarks for our business are registered or have been submitted to INPI by us or by the Santander Group. We own the principal domain names used in our business which include:

 

(1)      www.santanderbrasil.com.br;

 

(2)      www.bancosantander.com.br;

 

(3)      www.bsantander.com.br;

 

(4)      www.bancosantanderlight.com.br;

 

(5)      www.corretorasantander.com.br;

 

(6)      www.realsantander.com.br;

 

(7)      www.santander.com.br.

 

Competition

 

In the last few decades, the Brazilian financial system has experienced significant structural changes, following the evolution on the country’s economic environment and developing a solid framework, for both legal and financial supervision.

 

In recent years, the consolidation of the Brazilian financial sector, with the merger of large banks and the privatization of state-owned banks, has increased competition in the Brazilian market for banking and financial services. According to the Brazilian Central Bank, in November 2013 there were 133 universal banks, 22 commercial banks and 14 investment banks, along with several brokers, leasing companies and other financial institutions operating in Brazil. In 2012 and 2013, the Brazilian economy grew less than in prior years, while delinquency rates, inflation and currency depreciation increased. The Brazilian government, in an attempt to foster economic growth, stimulated the availability of credit through large state-owned banks, sustaining the pace of the

 

 

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previous years’ credit growth. Such state-owned banks started to offer credit at significantly lower interest rates. The privately-owned banks followed their lead by reducing the interest rates for their customers, while tightening customer credit approval policies in an effort to control potential increases in delinquency rates. Due to these measures, margins and spread were reduced, and credit risk increased.

 

Currently, there are six financial institutions at the forefront of the Brazilian financial industry in terms of assets: Santander Brasil, Bradesco, Itaú Unibanco, Banco do Brasil, Caixa Econômica Federal and BNDES. Together, these financial institutions accounted for 79% of the credit and 81% of the funding available in the country in December 2013.

 

Industry Transformation

 

Recently, the Brazilian banking industry has tried to adapt itself to the economic environment of the post-global crisis world, in a transformation process that has brought important changes to the country’s banking model.

 

One of these changes is the shift to a more conservative product mix. Due to the increase in default rates and the regulatory changes that increased banks’ capital requirements, the leading banks started to move their credit portfolio from products with larger spreads (and therefore, increased credit risk) to products with lower risks (and therefore, lower spreads). The leading banks also attempted to change the composition of their revenue, reducing revenue derived from financial margins (which are subject to default risks) and increasing revenue derived from fees (which are not subject to default risks).

 

Another relevant change is the decrease in banking spreads. The Brazilian government, through the state-owned banks, induced a reduction in interest rates available on certain products to foster credit demand, which led the private-owned banks to compress their spreads to remain competitive.

 

As a result of the above mentioned changes, there was a significant increase of interest of the banks in efficiency improvement, aiming to offset, at least partially, losses resulting from the change in product mix and the decrease in credit spreads.

 

Public Sector

 

Despite the privatizations and consolidations in the banking industry, the Brazilian government still controls commercial banks at state and federal levels. In addition to its significant role as a credit supplier (with a 51% market share) and a deposit taker (with a 48% market share), the state-owned banks also act as regional development agencies, with a strong position in markets like housing and rural credit.

 

The three main financial institutions controlled by the federal government are:

 

·

Banco do Brasil, a full service bank that offers a wide range of products to the public and private sectors. It is the main financial agent of the Brazilian government;

 

·

Caixa Econômica Federal, a full service bank, mainly involved in deposit taking, housing credit and urban infrastructure development; and

 

·

Banco Nacional do Desenvolvimento (BNDES), an investment bank that offers credit lines of medium and long-term financing at competitive interest rates to the private sector, especially the industrial sector. It operates with direct or indirect financing, through the transfer of resources to other state or private-owned financial institutions.

 

Private Sector

 

Following the movements involving the country’s largest private banks, we consider two financial institutions to be our main competitors: Bradesco and Itaú Unibanco. Both have established brands and distribution capacity throughout the country, competing in every category of banking activity. Furthermore, we also face competition from local and regional banks that operate with commercial banking products in specific niches. In the GB&M segment, our competitors are global financial institutions focused on investment bank services, which fill this role as a result of their experience in complex and structured operations, as well as their distribution network throughout Europe, North America and Asia.

 

 

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Market Share

 

The following table shows the market share of the four leading financial institutions in Brazil in 2013.

 

		Santander Brasil				Bradesco				Itaú Unibanco				Banco do Brasil
		(In percentage)
Total Assets(1)			8.2				11.2				16.1				17.8
Total Lending(2)			8.4				11.9				15.2				23.0
Total Deposits(2)			8.0				13.3				16.3				28.4
Demand Deposits(2)			7.1				18.5				19.6				34.6
Savings Accounts(2)			5.9				14.2				17.7				24.8
Time Deposits(2)			9.6				11.3				13.8				29.2
Mutual Funds(3)			6.1				18.1				16.6				20.9
Retail(3)			11.7				10.0				20.4				23.7

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(1)	According to the Brazilian Central Bank’s report of the 50 largest banks in Brazil in accordance with Brazilian GAAP (December 2013).

 

(2)	According to the Brazilian Central Bank, reported and presented in accordance with Brazilian GAAP (December 2013).

 

(3)	According to ANBIMA (December 2013).

 

Credit Market in Brazil

 

There has been a steady increase in credit penetration in Brazil since 2002, but it is still at a level below that of other developed and emerging markets. However, after a decade where the credit penetration more than doubled compared to the GDP, the pace of growth slowed in 2013.

 

Total Credit as a percentage of GDP*

 

 

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* Data from 2010 for all countries, except Brazil (2013).

 

Source: Brazilian Central Bank and IBGE

 

The Brazilian credit market is based on two types of loans:

 

·

mandatory or earmarked credit, which is subject to government controlled interest rates and follows rules for funding and destination defined by law.

 

·

market-based credit, which is not subject to any constraints regarding interest rates, funding or resource allocation.

 

By the end of December 2013, 55.5% of the R$2,715 billion of total credit outstanding in Brazil was market-based credit, of which 49.4% was loans to individuals and 50.6%, corporate loans.

 

 

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		2013				2012				2011
		(in billions of Reais)
Total Credit Outstanding			2,715				2,368				2,034
Earmarked Credit			1,207				969				802
Market-Based Credit			1,508				1,399				1,232
Corporate			763				707				604
Individuals			745				692				628

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Source: Brazilian Central Bank

 

 

Retail Credit

 

According to the Brazilian Central Bank, the total outstanding market-based credit for individuals increased at an average annual compounded rate (CAGR) of 12.4% between April 2011 and December 2013, reaching R$1,508.1 billion or 55.5% of all the loans in Brazil.

 

The following table shows the evolution of the main retail credit products offered to individuals:

 

		2013				2012				2011				Change between December 31, 2013 vs. December 31, 2012
		(in billions of R$, except percentages)
Overdraft Accounts			20.2				18.3				17.6				10.2	%
Payroll Loans			221.8				188.9				159.3				17.5	%
Personal Credit			97.6				90.2				79.5				8.2	%
Credit Card			36.1				34.2				33.0				5.6	%
Consumer Goods (except Auto)			11.6				10.5				9.4				9.1	%
Autos			192.8				193.2				177.7				(0.2	%)
Leasing			7.9				17.9				35.0				(55.9	%)
Mortgage Financing (only individuals)			341.5				255.4				189.4				33.7	%
Others			322.0				267.2				220.2				20.5	%
Total			1,251.3				1,075.8				921.1				16.3	%

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Source: Brazilian Central Bank

 

Historically, the costs of market-based loans in Brazil have always been high, due to the lack of competition and high default rates. A safer and more attractive market-based loan for individuals is the payroll loan. As its payments are deducted directly from the borrower’s paycheck, it is considerably less risky and, therefore, has lower interest rates than unsecured consumer credit, and grew 18.1% in 2013. As of December 31, 2013, payroll loans represent approximately 30% of the retail credit market in Brazil. Except with respect to the Brazilian Social Security Institute, which holds 11.5% of the payroll loans business, no single entity holds more than 10% of the revenues from this product. As of December 31, 2013, we had 5.9% of the market share in payroll loans, according to the Brazilian Central Bank.

 

The auto financing market has very competitive interest rates and the access to a low-cost source of funding is an important advantage. Thus, this market has been dominated by the large retail banks, which gradually assumed the business from the automakers’ lending arms. As this product is secured by the asset being financed, it tends to have lower default rates than other market-based products. However, in 2012, the default rate of auto financing increased considerably because of an easing of credit standards—basically long term loans and low down payments—leading the main competitors into tighten the conditions for granting new credit, such that this market shrank (4.9%) in 2013. As of December 31, 2013, we had 17% of the market share in vehicle financings, according to the Brazilian Central Bank.

 

 

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The credit card market has relatively high default rates and, as a result, higher interest rates than other market-based products. This market is dominated by the large retail banks, operating their own labels associated with international labels (such as Visa and MasterCard). In May, 2013, the Brazilian Central Bank began to regulate electronic payment services. It is expected that this supervision will help decrease the risk of electronic transactions and reduce related costs. As of December 31, 2013, we had 12% of the market share in credit cards, according to the Brazilian Central Bank.

 

The housing and real estate financing market is still developing in Brazil, after a few decades of stagnation. According to the Brazilian Central Bank, the ratio of mortgage loans and GDP went from 5.3% in December 2011 to 8.2% in December 2013. The country’s housing deficit (8.53% in 2012, according to IPEA) is gradually decreasing due to the structural changes in the economy and the government incentives, including:

 

·

incentives and tax exemptions for civil construction;

 

·

reduction of default risks for contractors through real estate collateralization;

 

·

improved safety for home buyers through a special tax regime, which separates the contractors assets from the construction project’s assets; and

 

·

simplification and increased enforcement of the foreclosure laws.

 

Housing and real estate financing represent approximately 15% of the retail credit market in Brazil according to the Brazilian Central Bank. As of December 31, 2013, our market share was 6%.

 

Corporate Credit

 

According to the Brazilian Central Bank, the amount of loans granted to companies has increased at a CAGR of 15.6% between April 2011 and December 2013, reaching R$1,395.1 billion, or 53.5% of the country’s total lending. The main corporate products are the BNDES loans, which represents 17.5% of the country’s total lending, and working capital loans, that represents 14.4%.

 

In the period of high inflation, the supply of long-term credit lines to Brazilian companies were limited, leading to a low level of corporate leverage in the country. However, according to the Brazilian Central Bank, the amount of corporate credit increased significantly, from R$186.7 million in December 2000 to R$1.4 billion in December 2013, a CAGR of 16.8%.

 

Asset Management

 

According to ANBIMA, the asset management industry in Brazil increased at a CAGR of 12.2% between January 2008 and September 2013, reaching R$2,344.6 billion of total assets. Retail funds represent 14.5% of this total, or R$340.1 billion. The largest players of the market are the large financial conglomerates and their main clients are institutional investors, including pension funds, insurance companies and private banking clients.

 

The constant evolution of the investment fund industry has encouraged market participants to adopt better corporate governance practices and increase transparency in the management of investment funds. Besides, the industry also benefited from macro-economic factors such as:

 

·

economic stability in Brazil and increased disposable income and savings;

 

·

expansion of the insurance and private pension markets influenced, in part, by the growth of products such as private pension plans, whose assets increased the volume of assets under management of the Brazilian mutual fund industry;

 

·

improved credit ratings of Brazilian issuers; and

 

·

increased access to financial products offered over the internet.

 

 

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REGULATION AND SUPERVISION

 

The basic institutional framework of the Brazilian financial system was established by Law 4,595, of December 31, 1964, as amended (the “Banking Reform Law”). The Banking Reform Law created the CMN, responsible for establishing the general guidelines of the monetary, foreign currency and credit policies as well as regulating the institutions of the financial system.

 

Principal Regulatory Agencies

 

CMN

 

The CMN oversees the Brazilian monetary, credit, budgetary, fiscal and public debt policies. The CMN is formed by the president of the Brazilian Central Bank, the Minister of Planning and the Minister of Finance and is chaired by the Minister of Finance. Pursuant to the Banking Reform Law, the CMN is authorized to regulate the credit operations of the Brazilian financial institutions, to regulate the Brazilian currency, to supervise Brazil’s reserves of gold and foreign exchange, to determine Brazilian savings and investment policies and to regulate the Brazilian capital markets with the purpose of promoting the economic and social development of Brazil. In this regard, the CMN also oversees the activities of the Brazilian Central Bank and the CVM.

 

Brazilian Central Bank

 

The Brazilian Central Bank is responsible for implementation of the CMN policies related to foreign currency and credit control, regulation of the Brazilian financial institutions, including as regards the minimum capital and compulsory deposit requirements, disclosure of the transactions carried out by financial institutions, as well as their financial information and monitoring and regulation of foreign investments in Brazil. The Brazilian Central Bank has committees to address specific issues, among which one highlights the Monetary Policy Committee (Copom) having the purpose of adopting measures to fulfill the inflation targets defined by the CMN and establish the monetary policy guidelines. The activity of the Copom in the control of inflation targets includes the definition of the target for the Selic Rate (the average rate for daily financing, backed by federal instruments, as assessed under the Special Settlement and Custody System) and publication of reports on the Brazilian economic and financial environment and projections for the inflation rate.

 

CVM

 

The CVM is responsible for implementation of the policies established by the CMN related to securities, with the purpose of regulating, developing, controlling and inspecting the securities market and its participants (companies with securities traded in the market, investment funds, investors, financial agents, such as custodians of instruments and securities, asset managers, independent auditors, consultants and instruments and securities analysts).

 

Self-regulating entities

 

The Brazilian financial and capital markets are also subject to the regulation of self-regulating entities that are divided by field of activity. The self-regulating entities include, among others, the National Association of Investment Banks – ANBIMA, the Brazilian Association of Credit Card and Services Companies – ABECS, the Brazilian Banks Federation – Febraban, the Brazilian Association of Publicly-Held Companies – ABRASCA and the BM&FBOVESPA.

 

Principal Limitations and Obligations of the Financial Institutions

 

In line with leading international standards of regulation, Brazilian financial institutions are subject to a series of limitations and obligations. In general such limitations and obligations concern the offering of credit, the concentration of risk, investments, operating procedures, loans and other transactions in foreign currency, the administration of third party funds and micro-credit. The restrictions and requirements for the banking activities established by applicable legislation and regulations include the following:

 

·

No financial institution may operate in Brazil without the prior approval of the Brazilian Central Bank. In addition, foreign banks must be expressly authorized by a presidential decree to operate in Brazil.

 

 

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·

A financial institution may not hold direct or indirect equity interest in any company located in Brazil or abroad without prior approval of the Brazilian Central Bank. In addition, the corporate purpose of the company in which the financial institutions invest shall be complementary or subsidiary to the activities carried out by the financial institution. The following do not depend on such prior approval: (i) equity interests typically held in the investment portfolios of investment banks, development banks, development agencies ( agências de fomento ) and full-service banks with investment or development portfolios and (ii) temporary equity interests not registered as permanent assets of the financial institution.

 

·

Financial institutions must submit for prior approval by the Brazilian Central Bank the corporate documents that govern their organization and operation, including but not limited to those relative to capital increases, transfer of headquarters, opening, transfer or closing of branches (whether in Brazil or abroad), election of the members of the statutory bodies, as well as any corporate restructuring or alteration in the composition of their equity control.

 

·

Financial institutions must fulfill minimum capital and compulsory deposit requirements, as well as observe certain operational limits.

 

·

A financial institution may not own real estate, except for properties it occupies and subject to certain limitations imposed by the CMN. If a financial institution receives real estate, for example, in satisfaction of a debt, such property must be sold within one year, unless if otherwise authorized by the Brazilian Central Bank.

 

·

Financial institutions must comply with the principles of selectivity, guarantee, liquidity and risk diversification.

 

·

A financial institution cannot lend more than 25% of its shareholder’s equity to a single person or group.

 

·

A financial institution cannot grant loans or advances to companies in which it participates with more than 10% of latter’s capital, to companies that it controls directly or indirectly, that are subject to common control of the financial institution in question or to individuals or companies which participate with more than 10% of the financial institution’s capital. Also, loans or advances may not be granted to the executive officers, members of the board of directors and of the fiscal council and to certain members of the families of such individuals, as well as to companies in which said individuals hold an interest of more than 10%.

 

·

The activities of management of third party assets must be segregated from other activities and must observe the regulations issued by the CVM.

 

·

The total amount of the funds applied in permanent assets of the financial institutions cannot exceed 50% of their adjusted stockholders’ equity.

 

·

Financial institutions must comply with anti-money laundering and anti-corruption regulation.

 

·

Financial institutions must implement policies and internal procedures to control their systems of financial, operating and management information, as well as their conformity to all of the applicable regulations.

 

·

Financial institutions must implement a policy for remuneration of board members and executive officers that is compatible with their risk management policies. At least 50% of the variable remuneration must be paid in stock or instruments based on stock, and at least 40% of the variable remuneration must be deferred for payment at least 3 years in the future.

 

·

The Law of Banking Reform and specific regulations enacted by the CMN provides on imposition of penalties to financial institutions in certain situations where there has not been observance of the applicable requirements, controls and requisites. In addition, the Brazilian Central Bank may cancel the financial institution’s authorization to operate if the Brazilian Central Bank identifies at any time, in relation to a given financial institution: (1) habitual non-performance of the transactions considered to be essential for financial institutions, (2) operational inactivity, (3) non-establishment at the address informed to the Brazilian Central Bank, (4) non-remittance to the Brazilian Central Bank for a period of more than four months, without acceptable justification, of the consolidated financial statements required by the applicable

 

 

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regulations, and (5) non-accomplishment of the business plan. The cancellation of an authorization for operation of a financial institution may only occur upon the establishment and processing of the appropriate administrative proceeding by the Brazilian Central Bank.

 

Additionally, being part of Santander Group and due to the global nature of our organization, we are subject to related international rules.

 

Capital Adequacy and Leverage – Basel

 

Current Requirements

 

The Brazilian Central Bank supervises the Brazilian banking system in accordance with the Basel Committee on Banking Supervision (“Basel Committee”) guidelines and other applicable regulations, including the Basel II Accord (“Basel II”), which was implemented in Brazil in the last years, and the Basel III Accord (“Basel III”), which supplements and amends Basel II and is in the process of being implemented. For this purpose, banks provide the Brazilian Central Bank with the information necessary for it to perform its supervisory functions, which include supervising the movements in the solvency and the capital adequacy of banks.

 

The main principle that guides the directives set forth in the Basel II and Basel III is that a bank’s own resources must cover its principal risks, including credit risk, market risk and operational risk.

 

Brazilian financial institutions are subject to capital measurement and standards based on a weighted risk-asset ratio. The parameters of this methodology resemble the international framework for minimum capital measurements adopted by Basel II, except for certain differences (for instance, Basel II requires banks to have a capital to risk-weighted assets ratio of at least 8.0%, while Brazilian current rules require minimum capital of 11.0% of risk weighted assets). Brazilian financial institutions’ regulatory capital is composed of two tiers. Tier I capital is represented by stockholders’ equity plus certain reserves, earned income and hybrid debt and capital instruments authorized by the Brazilian Central Bank. Tier II capital is represented by revaluation reserves, contingency reserves, special profit reserves related to mandatory dividends not yet distributed, preferred cumulative stock, certain subordinated debt and hybrid instruments and non-realized earnings related to available-for-sale securities market value adjustments.

 

Basel III

 

On December 16, 2010, the Basel Committee issued the Basel III framework which supplements and amends Basel II. Basel III includes higher minimum capital requirements and new conservation and countercyclical buffers capital requirements, revised risk-based capital measures, and the introduction of a new leverage ratio and two liquidity standards. As it occurred with other Basel directives, the Basel III will not be self-effectuating, but will be implemented gradually by each country through legislation or regulation to be imposed upon that country’s home banks. Basel III is currently being implemented in Brazil and its implementation is expected to conclude on January 1, 2022, according to the agreed international timeframe.

 

The Tier I capital will have to reach a minimum index of 6.0% floor, (according to the schedule established by the Brazilian Central Bank), divided into two portions: (1) Principal Capital consisting mainly of corporate capital and profit reserves (shares, units of ownership, reserves and earned income) of at least 4.5%, and (2) Supplementary Capital (certain reserves, revenue earned and hybrid securities and instruments capital authorized by the Brazilian Central Bank). To improve the quality of the capital of financial institutions, Basel III restricts the acceptance of financial instruments that fail to demonstrate effective capability of absorbing losses and requires the reduction of assets that in certain situations could jeopardize the financial institution’s capital value due to their low liquidity, dependence on future profits for realization or difficulty of value measurement.

 

Current hybrid instruments and subordinated debt approved by the Brazilian Central Bank as additional capital or Tier II are expected to be maintained if they also comply with requirements introduced by the Basel III, including the mandatory conversion clauses into equity or write-off upon the occurrence of triggering events provided for in the regulations. The instruments that do not comply with Basel III rules shall be gradually reduced until January 2022.

 

In accordance with the Basel III standards, the Brazilian Central Bank created the Premium Principal Capital, which corresponds to the following additional capitals (buffers): (1) conservative (fixed) capital to assist in the

 

 

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absorption of losses; and (2) countercyclical (variable) capital, to deal with the risks of the macro-economic environment. The conservative and countercyclical capital creates additional capital reserves to be used in periods of stress. After a period of transition, the Brazilian Central Bank will determine the exact percentage of the Premium Principal Capital required, which may vary from 2.5% to 5% of the weighted risk-asset ratio. The Basel minimum capital index will increase from the current 11% to a maximum of 13%. The total index will be calculated by the sum of two parts: the Regulatory Capital and the Premium Principal Capital (consisting of the conservative capital and the countercyclical capital).

 

The Basel III rules also provide for the implementation of a leverage ratio calculated by the division of the Tier I capital by a bank’s total exposure. In addition, the new rules establish liquidity ratios of short and long term which shall control the cash position of banks (for example, obligation to maintain liquid assets for stress scenarios of the financial system for 30 days and funding with solid and stable capital).The following table presents an estimate of the implementation schedule of the main changes related to capital adequacy and leverage expected as a result of Basel III, as established by the Brazilian Central Bank:

 

Parameters		2013				2014				2015				2016				2017				2018				As from 2019
Common Equity			4.5	%			4.5	%			4.5	%			4.5	%			4.5	%			4.5	%			4.5	%
Tier I			5.5	%			5.5	%			6.0	%			6.0	%			6.0	%			6.0	%			6.0	%
Regulatory Capital			11.0	%			11.0	%			11.0	%			9.9	%			9.3	%			8.6	%			8.0	%
Conservative Capital			—				—				—				0.6	%			1.3	%			1.9	%			2.5	%
Countercyclical Capital			—			up to 0.6		%		up to 1.3		%		up to 1.9		%		up to 2.5		%		up to 2.5		%		up to 2.5		%

In addition, in order to enable the implementation of the Basel III framework in Brazil certain legislative changes were made. Among others, Law No 12,838 enacted on July 9, 2013 granted powers to the Brazilian Central Bank to limit the payment of dividends by financial institutions in case of non-compliance with the prudential capital requirements defined by the National Monetary Council.

 

Consolidated Enterprise Level (conglomerado prudencial)

 

As from January 2014, financial institutions must submit to the Brazilian Central Bank, with monthly and semi-annual periodicity, consolidated financial statements based on the “consolidated enterprise level” ( conglomerado prudencial ) of which the financial institution is a member, which serve as the base for calculation of the requisites of regulating capital of the Brazilian institutions. The concept of “consolidated enterprise level” ( conglomerado prudencial ) includes the data relative to the financial institutions and other institutions authorized to operate by the Brazilian Central Bank, administrators of consortia, payment institutions and credit factoring companies, including real estate credit, or of credit rights, as for example mercantile foment companies, securitization companies and specific purpose companies, located in Brazil or abroad, as well as other legal entities headquartered in Brazil that have as their exclusive business purpose the equity participation in the mentioned entities.

 

Compulsory Reserve Requirements

 

Currently, the Brazilian Central Bank imposes a series of compulsory reserves requirements. Financial institutions must deposit these reserves with the Brazilian Central Bank. BACEN uses such reserve requirements as a mechanism to control the liquidity of the Brazilian financial system. Reserves imposed on time deposits, demand deposits and saving accounts represent almost the entirety of the amount that must be deposited at the Brazilian Central Bank.

 

Time Deposits (CDBs). The Brazilian Central Bank imposes a reserve requirement of 20.0% in relation to time deposits. Financial institutions must deposit an amount equivalent to the surplus of (1) R$3 billion for financial institutions with consolidated Tier 1 capital under R$2 billion; (2) R$2 billion for financial institutions with consolidated Tier 1 capital between R$2 billion and R$5 billion; (3) R$1 billion for financial institutions with consolidated Tier 1 capital between R$5 billion and R$15 billion; and (4) zero for financial institutions with Regulatory Capital higher than R$15 billion.

 

Demand Deposits. As a general rule the Brazilian Central Bank imposes a reserve requirement of 45% in relation to demand deposits.

 

 

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Savings Deposits. The Brazilian Central Bank imposes reserve requirement of 15% in relation to savings deposits. In addition, a minimum of 65.0% of the total amount of deposits in savings accounts must be used to finance the housing sector.

 

Additional Deposit Requirements. The Brazilian Central Bank also stipulates an additional reserve requirement on deposits raised by full service banks, investment banks, commercial banks, development banks, finance, credit and investment companies, real estate credit companies and savings and loan associations. These institutions are required to deposit on a weekly basis the total sum of the following amounts: (1) 11% of the mathematical average of funds from time deposits and other specific amount subject to the reserve requirement; and (2) 10% of the mathematical average of funds from savings accounts subject to the reserve requirement. These amounts must be discounted by: (1) R$3 billion for financial institutions with consolidated Tier 1 capital under R$2 billion; (2) R$2 billion for financial institutions with consolidated Tier 1 capital between R$2 billion and R$5 billion; (3) R$1 billion for financial institutions with consolidated Tier 1 capital between R$5 billion and R$15 billion, and (4) zero for financial institutions with Regulatory Capital higher than R$15 billion. At the close of each day, the balance of such account should be equivalent to 100% of the additional reserve requirement.

 

Asset Composition Requirements

 

Permanent assets (defined as property and equipment other than commercial leasing operations, unconsolidated investments and deferred charges) of Brazilian financial institutions may not exceed 50% of their adjusted net equity, calculated in accordance with the criteria established by the Brazilian Central Bank.

 

The Brazilian financial institutions may not have more than 25.0% of their Regulatory Capital allocated to credit and leasing transactions and guarantees extended to the same customer or group of customers acting jointly or representing the same economic interest. In addition, the Brazilian financial institutions must comply with an exposure limit of 25.0% of their Regulatory Capital in connection with underwriting for or investments in securities of the same entity, its affiliates, controlled or controlling companies.  Repurchase transactions executed in Brazil are subject to operational capital limits based on the financial institution’s Regulatory Capital, as adjusted in accordance with Brazilian Central Bank regulations. A financial institution may carry out repurchase transactions in an amount of up to thirty times its Regulatory Capital. Within that limit, repurchase transactions involving private securities may not exceed five times the Regulatory Capital. Limits on repurchase transactions involving securities backed by Brazilian governmental authorities vary in accordance with the type of security involved in the transaction and the perceived risk of the issuer as established by the Brazilian Central Bank.

 

The regulation issued by the Brazilian Central Bank as regards the classification and valuation of securities and derivative financial instruments—including government securities—owned by financial institutions, based on the investment strategy of the financial institution, determined that securities and derivatives are to be classified into three categories: (1) trading; (2) available for sale; and (3) held to maturity.

 

“Trading” and “available for sale” securities are to be marked-to-market with effects in income and stockholders’ equity, respectively. Securities classified as “held to maturity” are recorded at amortized cost. Derivatives are marked-to-market and recorded as assets and liabilities in the balance sheet. Changes in the market value of the derivatives are generally recognized in income with certain modifications, if these are designated as hedges and qualify for hedge accounting under the regulations issued by the Brazilian Central Bank. Securities and derivatives in the “held to maturity” portfolio may be hedged for accounting purposes, but their increase or decrease in value derived from the marked-to-market accounting method should not be taken into account.

 

Brazilian Payment and Settlement System

 

The rules for the settlement of payments in Brazil are based on the guidelines adopted by the Bank of International Settlements, or “BIS,” and the current Brazilian Payment and Settlement System ( Sistema Brasileiro de Pagamentos e Compensação , the “SPB”) that began operating in April 2002. The Brazilian Central Bank and CVM (in respect of transactions with securities) have the power to regulate and supervise this system. Pursuant to these rules, all clearinghouses are required to adopt procedures designed to reduce the possibility of systemic crises and to reduce the risks previously borne by the Brazilian Central Bank. The most important principles of SPB are:

 

·

the existence of two main payment and settlement systems: real time gross settlements, using the reserves deposited with the Brazilian Central Bank; and deferred net settlements, through the clearinghouses;

 

 

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·

the clearinghouses, with some exceptions, will be liable for the payment orders they accept; and

 

·

bankruptcy laws do not affect the payment orders made through the credits of clearinghouses nor the collateral granted to secure those orders. However, clearinghouses have ordinary credits against any participant under bankruptcy laws.

 

Treatment of Overdue Debts

 

The Brazilian Central Bank requires financial institutions to classify credit transactions in accordance with their level of credit risk and make provisions according to the level attributed to each transaction. Such credit classifications shall be determined in accordance with criteria set forth from time to time by the Brazilian Central Bank, relating to the condition of the debtor and the guarantor and the transaction terms. Where there are several credit transactions involving the same customer, economic group or group of companies, the credit risk must be determined by analyzing the particular credit transaction of such customer or group which represents the greatest credit risk to the financial institution.

 

Credit transactions of up to R$50 thousand may be classified either by the financial institution’s own evaluation method or according to the number of days such transaction is past due, whichever is the more stringent. Credit classifications are required to be reviewed (i) monthly, in the event of a delay in the payment of any installment of principal or interest, in accordance with the maximum risk classifications; (ii) every six months, in the case of transactions involving the same customer, economic group or group of companies, the amount of which exceeds 5% of the adjusted net worth of the financial institution in question; and (iii) once every twelve months, in all circumstances, except in the case of credit transactions with a customer whose total liability is lower than R$50 thousand, the classification of which may be reviewed as provided above. Such R$50 thousand limit may be amended by the Brazilian Central Bank from time to time.

 

The provisions set forth above are not applicable to our IFRS consolidated financial statements, which are based on the criteria described under “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Critical Accounting Policies—Impairment Losses on Financial Assets.”

 

Credit Performance Information – Positive Registration

 

Brazilian law regulates databases containing credit performance information of individuals and legal entities. Dissemination of information from these databases is subject to the express request or authorization of the institution’s clients.

 

Stockholders’ Rules about the Collection of Bank Fees

 

The collection of bank fees and commissions is extensively regulated by the rules that seek standardization of the collection of bank fees and the cost of credit transactions for individuals. According to these rules, bank services to individuals are divided into the following four groups: (1) essential services; (2) priority services; (3) special services; and (4) specific or differentiated services. Banks are not able to collect fees in exchange for supplying essential services to individuals with regard to checking accounts, such as (1) supplying a debit card; (2) supplying ten checks per month to accountholders who meet the requirements to use checks, as per the applicable rules; (3) supplying a second debit card (except in cases of loss, theft, damage and other reasons not caused by the bank); (4) up to four withdrawals per month, which can be made at a branch of the bank, using checks or in ATM terminals; (5) supplying up to two statements describing the transactions during the month, to be obtained through ATM terminals; (6) inquiries over the internet; (7) up to two transfers of funds between accounts held by the same bank, per month, at a branch, through ATM terminals or over the internet; (8) clearing checks and (9) supplying a consolidated statement describing, on a month-by-month basis, the fees charged over the preceding year with regard to checking accounts and savings accounts.

 

Certain services rendered to individuals with regard to savings accounts also fall under the category of essential services and, therefore, are exempt from the payment of fees. CMN prohibits banks from charging fees for supplying essential services in connection with deposit and savings accounts where clients agree to access and use their accounts by electronic means only. In the case of these exclusively electronic deposit and savings accounts, banks are only authorized to charge fees for supplying essential services when the client voluntarily elects to obtain personal service at the banks’ branches or client service locations.

 

 

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Priority services are the ones rendered to individuals with regard to checking accounts, transfers of funds, credit transactions, leasing, standard credit cards, over-the-counter exchange transactions for the purchase or sale of foreign currency in respect of international travel and records and are subject to the collection of fees by the financial institutions only if the service and its nomenclature are listed in its regulations. Commercial banks must also offer to their individual clients a “standardized package” of priority services, whose content is defined, as well as the clients’ option to acquire individual services, instead of adhering to the package.

 

The collection of fees in exchange for the supply of special services (including, among others, services relating to rural credit, currency exchange market and on-lending of funds from the real estate financial system, for example) are still governed by the specific provisions found in the laws and regulations relating to such services. The regulation authorizes financial institutions to charge fees for the performance of specific services, provided that the account holder or user is informed of the conditions for use and payment or the fee and charging method are defined in the contract. Some of the specific services are (1) approval of signatures; (2) management of investment funds; (3) rental of safe deposit boxes; (4) courier services; (5) custody and brokerage services, (6) endorsement of clients debts ( aval , or guarantee); and (7) foreign currency exchange, among others.

 

It is worth pointing out: (1) prohibition of charging fees for amending adhesion contracts, except in the cases of asset replacement in leasing transactions and early liquidation or amortization, cancelation or termination; (2) prohibition of including services related to credit cards and other services not subject to fees in service packages that include priority, special and/or differentiated services; (3) subscription to service packages must be through a separate contract; (4) information given to the customer with respect to a service package must include the value of each service included in the package, the number of times that each service may be utilized per month, and the total price of the package; (5) a customer’s annual banking statement must separately identify default interest, penalties and other costs charged on loans and leasing transactions; (6) registration fees cannot be cumulatively charged; (7) overdraft fees can be charged, at most, once over the course of 30 days.

 

In addition, CMN regulations establish that all debits related to the collection of fees must be charged to a bank account only if there are sufficient funds to cover such debits in such account thus forbidding overdrafts caused by the collection of banking fees. Furthermore, a minimum of 30 days’ notice must precede any increase or creation of fees (except if related to credit card services, when a minimum of 45 days’ notice is required), while fees related to priority services and the “standardized package” can be increased only after 180 days from the date of the last increase (except if related to credit card services, when a minimum of 365 days’ notice is required) (whereas reductions can take place at any time).

 

Credit Cards

 

The banking regulations also have specific rules relative to the charges of credit card fees, as well as publication of information in the card invoices and the obligation of a package of basic services upon offering credit cards to clients. The credit card holders must pay monthly at least 15% of the outstanding credit card balances. This minimum payment does not apply to credit cards with payment by means of direct payroll deductions.

 

Payment Agents and Payment Arrangements

 

In 2013 it was established in Brazil a legal and regulatory framework for the payment industry, pursuant to which the CMN and the Brazilian Central Bank now have powers to regulate payment mechanisms, players and transactions.

 

The regulation issued by the Brazilian Central Bank, which will become effective in May 2014, determines, among other aspects: (1) consumer protection and anti-money laundering compliance and risk prevention systems that should be observed by all supervised entities when dealing with payment agents and payment arrangers; (2) the procedures for incorporation, organization, authorization and operation of payment agents, as well transfer of shareholding control, subject to the Brazilian Central Bank’s prior approval; (3) capital requirements; (4) definition of arrangements excluded from the SPB; and (5) payment accounts, which are divided into prepaid and post-paid accounts and require the allocation of the totality of their balance to a special account at the Brazilian Central Bank or investment in government bonds.

 

 

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Portability of Credit Transactions

 

In 2013, the Brazilian Central Bank regulated the possibility of financial institutions’ customers transferring their credit transactions from an institution to another. The regulation that becomes effective in May 2014 establishes specific rules for such transfer, including, among others, the prohibition of the amount and term of the transaction in the financial institution receiving the transaction being higher than the amount due and term of the original transaction. It is authorized, however, the amendment of the interest fee on the transaction.

 

Anti-Money Laundering Regulations

 

Brazilian Anti-Money Laundering Law establishes that it is a crime to conceal or dissimulate the nature, origin, location, disposal, movement or ownership of assets, rights or valuables deriving directly or indirectly from a criminal violation, as well as their use in economic or financial activity and the participation in a group, association or office while being aware that its principal or secondary activities is directed towards the practice of such acts.

 

Brazilian Anti-Money Laundering Law also created the Conselho de Controle de Atividades Financeiras (the Council of Control of Financial Activities, or “COAF”), which operates under the Ministry of Finance. The purpose of the COAF is to investigate, examine, identify and impose administrative penalties in respect of, any suspicious or unlawful activities related to money laundering in Brazil. The COAF is composed of a president nominated by the Ministry of Finance and appointed by the President and eight members of the council, one of whom is appointed by each of the following entities: (1) the Brazilian Central Bank; (2) the CVM; (3) the Ministry of Foreign Affairs; (4) the SUSEP; (5) the Brazilian Federal Revenue Service; (6) the Office of the Attorney-General of the National Treasury; (7) the Federal Police Department; and (8) the Federal Intelligence Agency. The term of office of each of the president and the other members of the council is three years.

 

Brazilian anti-money laundering legislation establishes that financial institutions must, among others:

 

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keep up-to-date records regarding their permanent customers (including registration data, statements of purpose and nature of transactions, their financial capacity, as well as the verification of characterization of customers as politically-exposed individuals).

 

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adopt preventive and internal policies, processes and controls;

 

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record transactions involving Brazilian and foreign currency, securities, metals or any other asset which may be converted into money, including specific registries of issuances or recharging of prepaid cards;

 

·

keep records of transactions or groups of turnover of funds carried out by individuals or entities belonging to the same group or financial conglomerate in a total amount that exceeds R$10 thousand in a calendar month or which reveal a pattern of activity that suggests a scheme to avoid identification, control and registration;

 

·

review transactions or proposals the features of which may indicate criminal intentions;

 

·

keep records of every transfer of funds related to, among others (a) deposits, wire transfers and checks, and (b) the issuance of checks and payment orders, in amounts that exceed R$1 thousand; and

 

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notify the pertinent authority within time frames ranging for one business day from a proposed transaction to five business days from the end of the calendar month of any transaction that is considered suspect by the financial institution.

 

The financial institutions must inform COAF in the manner established by the Brazilian Central Bank, by the day following the date on which any of the following transactions, proposed or carried out, were verified:

 

·

transactions carried out or services provided, which amount equals or is greater than R$10 thousand and that, considering the parties involved, the amounts, the forms of execution, the instrument used or the lack of economic or legal bases, could characterize the existence of evidence of the crimes provided for in the Brazilian Anti-Money Laundering Law;

 

 

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·

the transactions carried out or the services rendered that, based on their frequency, amount or form, could be aimed at deceiving the identification, control and record mechanisms;

 

·

the transactions carried out by or the services rendered to, regardless of their amount, the persons that recognizably have perpetrated or attempted to perpetrate terrorist acts or participated in them or facilitated their practice, as well as the existence of funds that belong to or are directly or indirectly controlled by them or by entities that belong or are directly or indirectly controlled by such persons, as well as by persons and entities acting on their behalf or under their orders; and

 

·

any acts that are believed to be financing terrorism.

 

These communications must be made without providing knowledge thereof to the parties involved.

 

The records referred to above must be kept for five to ten years, depending on the nature of the information, from the end of the relationship with the customer.

 

Failure to comply with any of the obligations indicated above may subject the financial institution and its officers and directors to penalties that range from fines (not above 200% of the transaction amount or the real profit obtained or that would be obtained by carrying out the transaction or the amount of R$20 million) to the declaration of its officers and directors as ineligible to exercise any position at a financial institution and/or the cancellation of the financial institution’s operating license.

 

Government and auditors from the Brazilian Federal Revenue Service may also inspect an institution’s documents, books and financial registry in certain circumstances.

 

The financial institutions must also maintain specific records of the transactions in cash (deposit, withdrawal, withdrawal by means of a prepaid card or request of provision for withdrawal) so as to enable the identification of a deposit in cash, withdrawal in cash, withdrawal in cash by means of a prepaid card, or request of provision for withdrawal, of an amount equal to or greater than R$100 thousand or that presents evidence of concealment or dissimulation of the nature, of the origin, of the location, of the disposal, of the movement or of the ownership of assets, rights and valuables, as well as issuance of banker’s checks, TED (Readily Available Electronic Transfer) or of any other instrument of transfer of funds upon payment in cash, for an amount equal to or greater than R$100 thousand.

 

Politically Exposed Individuals

 

Financial institutions and other institutions authorized to operate by the Brazilian Central Bank must take certain actions and have certain controls to establish business relationships with and to follow up financial transaction of customers who are deemed to be politically exposed individuals. The internal procedures developed and implemented by such financial institutions must be structured in such a way as to enable the identification of politically exposed individuals, as well as the origin of the funds involved in the transactions of such customers. One option is to verify the compatibility between the customer’s transactions and the net worth stated in such customer’s file.

 

Politically exposed individuals are public agents and their immediate family members, spouses, life partners and stepchildren who occupy or have occupied a relevant public office or position over the past five years in Brazil or other countries, territories and foreign jurisdictions.

 

Bank Secrecy

 

Brazilian financial institutions shall also maintain the secrecy of their banking operations and services provided to their customers. The only circumstances in which information about customers, services or transactions of Brazilian financial institutions or credit card companies may be disclosed to third parties are the following:

 

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the disclosure of information with the express consent of the interested parties;

 

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the exchange of information between financial institutions for record purposes;

 

 

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·

the supply to credit reference agencies of information based on data from the records of issuers of bank checks drawn on accounts without sufficient funds and defaulting debtors; and

 

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as to the occurrence or suspicion that criminal or administrative illegal acts have been performed, in which case the financial institutions and the credit card companies may provide the pertinent authorities with information relating to such criminal acts when necessary for the investigation of such acts.

 

Complementary Law 105/01 also allows the Brazilian Central Bank or the CVM to exchange information with foreign governmental authorities, provided that a specific treaty has previously been executed.

 

Auditing Requirements

 

The legislation and regulations issued by the CMN, CVM and BM&FBOVESPA determine that the periodic financial statements of financial institutions be audited by independent auditors (individuals or legal entities) registered with CVM and who meet the minimum requirements set forth by the Brazilian Central Bank, as well as that they must be presented together with an independent auditor’s report.

 

As result of the auditing work, the independent auditor must prepare the following reports: (1) audit report, issuing an opinion regarding the accounting statements and the respective explanatory notes, including regarding the compliance with financial regulations issued by the CMN and the Brazilian Central Bank; (2) internal control system quality and adequacy evaluation report, including regarding electronic data processing and risk management systems, evidencing any identified deficiencies; (3) legal and regulatory provisions noncompliance report, regarding those which have, or may have, material impacts on the financial statements or on the audited financial institution’s operations; (4) limited assurance report, analyzing Santander Brasil’s Annual and Sustainability Report pursuant to the guidelines and requirements of Global Reporting Initiative (GRI); and (5) any other reports required by the Brazilian Central Bank, CVM and BM&FBovespa. The reports issued by independent auditors must be available for consultation upon request by the overseeing authorities.

 

Independent auditors and the fiscal council when established, individually or jointly, must formally notify the Brazilian Central Bank of the existence or evidence of error or fraud, within three business days of the identification of the respective occurrence, including:

 

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non-compliance with legal rules and regulations that place the continuity of the audited entity at risk;

 

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frauds of any amount perpetrated by the management of the institution;

 

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material frauds perpetrated by the institution’s employees or third parties; and

 

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errors that result in major incorrectness in the financial statements of the audited entity.

 

The executive office of the financial institution must inform the independent auditor and the fiscal council, when established, if any of the above situations occur.

 

CMN Regulation also requires financial institutions and certain other entities holding regulatory capital equal to or greater than R$1 billion to create a corporate body designated as “audit committee.”

 

To obtain more information concerning the audit committee, see “Item 6. Directors, Senior Management Board Members, Executive Board and Employees—C. Board Practices—of the Board Advisory of Directors—Committees—Audit for Advisory to the Board of Directors of the Company—Audit Committee.”

 

Consumer Protection

 

Relationships between consumers and financial institutions are governed by Law 8078, dated September 11, 1990 (the “Brazilian Consumer Protection Code”), which grants consumers certain rights and sets forth measures to be observed by suppliers, which must by complied with by financial institutions. The Consumer Protection Code sets forth as consumer rights, among others, the assistance/facilitation in the defense of consumer’s rights, including through reverse burden of proof in their favor, and possibility of judicial review of contractual provisions deemed abusive.

 

 

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Furthermore, banking regulation establishes procedures that financial institutions must observe when contracting any transactions, as well as when rendering services. We may highlight the following as examples of said procedures:

 

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to timely provide the necessary information to allow client’s and user’s free choice and decision making process, including rights, duties, responsibilities, costs or advantages, penalties and possible risks when carrying out a transaction or rendering a service;

 

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to timely provide, to the client or user, agreements, receipts, statements, advices and other documents related to the transactions and services, as well as the possibility of timely cancellation of the agreements;

 

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formalization of an adequate instrument setting forth the rights and obligations for opening, using and maintaining a post-paid payment account;

 

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to forward a payment instrument to the client’s or user’s residence or to enable the respective instrument only upon express request or authorization; and

 

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identification of final users beneficiaries of payments or transfer in statements and bills of the payer, including in situations in which the payment service involves institutions participating in different payment arrangements.

 

Ombudsman

 

Financial institutions and other entities which are authorized to operate by the Brazilian Central Bank must have an ombudsman office to facilitate communication between the institutions and their customers, and in order to observe consumer defense legislation as well as the improvement of products and customer service. Institutions that are part of a financial group are allowed to establish one ombudsman department to service the whole group. The officer in charge of the ombudsman office must prepare a report every six months and whenever a material event is identified pursuant to the instructions of the Brazilian Central Bank.

 

Investment Funds Industry Regulation

 

Investment funds are subject to the regulation and supervision of the CMN and the CVM and, in certain specific matters, the Brazilian Central Bank. Investment funds may be managed by full-service banks, commercial banks, savings banks, investment banks, credit, financing and investment companies and brokerage and dealer companies within certain operational limits.

 

Investment funds may invest in any type of financial instrument available in the financial and capital markets, including for example, fixed income instruments, stocks, debentures and derivative products, provided that, in addition to the denomination of the fund, a reference to the relevant type of fund is included.

 

Investment funds may not:

 

·

have more than 10% of their net worth invested in securities of a single publicly-held issuer that is not a financial institution, its controlling shareholders, subsidiaries and affiliates or of another investment fund; and

 

·

have more than 20% of their net worth invested in securities issued by a financial institution (including the fund manager), its controlling shareholders, subsidiaries and affiliates.

 

Broker-Dealer Regulation

 

Broker and dealer firms are part of the national financial system and are subject to CMN, Brazilian Central Bank and CVM regulation and supervision. Brokerage firms must be chartered by the Brazilian Central Bank and are the only institutions in Brazil authorized to trade on stock exchanges. Both brokers and dealers may act as underwriters in the public placement of securities and engage in the brokerage of foreign currency in any exchange market.

 

 

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Broker and dealer firms may not execute operations that may be qualified as the granting of loans to their customers, including the assignment of rights with limited exceptions; collect commissions from their customers related to transactions of securities during the primary distribution; acquire real estate which is not for their own use; or obtain loans from financial institutions, except for (1) loans for the acquisition of goods for use in connection with the firm’s corporate purpose or (2) loans the amount of which does not exceed two times the relevant firm’s net worth.

 

Foreign Exchange Market

 

Transactions involving the sale and purchase of foreign currency in Brazil may be conducted only by institutions duly authorized by the Brazilian Central Bank to operate in the foreign exchange market. There is no current limit to long or short positions in foreign currency for banks authorized to carry out transactions on the foreign exchange market. Other institutions within the national financial system are not allowed to have short positions in foreign currency, although there are no limits with respect to foreign exchange long positions.

 

The Brazilian Central Bank imposes a limit on the net exposure of Brazilian financial institutions and their affiliates for assets and debt subject to foreign currency and gold fluctuation. The limit is currently equivalent to 30.0% of the institution’s adjusted stockholders’ equity.

 

Penalties for non-compliance with foreign currency position limits range from compulsory sale of foreign currency to revocation of authorization to operate in the foreign exchange market.

 

On December 16, 2013, the Brazilian Central Bank issued a series of rules that will replace the Regulation of Foreign Exchange and International Capital Market ( Regulamento do Mercado de Câmbio e Capitais Internacionais , or the “RMCCI”) of the Brazilian Central Bank as of February 3, 2014. These rules are intended to optimize and simplify regulation involving the foreign exchange market, Brazilian capital abroad and foreign capital in Brazil previously contemplated by the RMCCI. The new foreign exchange rules also aim to cover situations that were not contemplated in the prior regulations.

 

Foreign Investment in Brazilian Financial Institutions

 

The Brazilian constitution permits foreign individuals or companies to invest in the voting shares of Brazilian financial institutions only if they have specific authorization by the President of Brazil based on national interest or reciprocity. A decree on November 13, 1997, issued in respect of Banco Meridional do Brasil S.A. (our legal predecessor) allows 100% foreign participation in our capital stock. Foreign investors may acquire the shares issued by the Bank as a result of this decree. In addition, foreign investors may acquire publicly traded non-voting shares of Brazilian financial institutions traded on a stock exchange or securities depositary receipts offered abroad representing shares without specific authorization.

 

In addition, the Brazilian constitution prohibits foreign financial institutions from establishing new branches or subsidiaries in Brazil except when duly authorized by the President of Brazil and by the Brazilian Central Bank. A foreign financial institution duly authorized to operate in Brazil through a branch or a subsidiary is subject to the same rules, regulations and requirements that are applicable to any Brazilian financial institution.

 

Banking Correspondents

 

Financial institutions are allowed to provide specific services to clients, including customer services, through other entities. These entities are called “bank correspondents” and the relationship between the financial institution and the bank correspondent is ruled by a specific regulation published by CMN and is subject to the supervision of the Brazilian Central Bank.

 

Regulation of Branches

 

Authorization by the Brazilian Central Bank is required for operations of branches or subsidiaries of Brazilian financial institutions, upon the compliance with certain term, capital and equity requirements as well as the submission of an economic and financial feasibility analysis.

 

The Brazilian Central Bank’s prior authorization is also required in order to: (1) allocate new funds to branches or subsidiaries abroad; (2) subscribe capital increases, directly or indirectly, in subsidiaries abroad; (3) increase

 

 

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equity participation, directly or indirectly, in subsidiaries abroad; and/or (4) merge or spin off, directly or indirectly, subsidiaries abroad.

 

The Brazilian Central Bank determines that the financial institutions can install the following establishment in Brazil: (1) branches, (2) teller booths, (3) automatic teller machines, and (4) segregated administrative units, provided that, for items (1) to (3) conformity with requirements of minimum capital and operating limits are necessary.

 

Cayman Islands Banking Regulation

 

Banks and trust companies wishing to conduct business from within the Cayman Islands must be licensed by the Cayman Islands Monetary Authority under the Banks and Trust Companies Law (2009 Revision) (the “Banks and Trust Companies Law”), independent if the business is to be actually conducted in the Cayman Islands.

 

Under the Banks and Trust Companies Law, there are two main categories of banking license: a category “A” license, which permits unrestricted domestic and off-shore banking business, and a category “B” license, which permits principally off-shore banking business. As of December 31, 2011, there were 15 banks holding category “A” licenses and 219 banks holding category “B” licenses. The holder of a category “B” license may have an office in the Cayman Islands and conduct business with other licensees and offshore companies but, except in limited circumstances, may not do banking business locally with the public or residents in the Cayman Islands. We have an unrestricted category “B” license.

 

There are no specific ratio or liquidity requirements under the Banks and Trust Companies Law, but the Cayman Islands Monetary Authority will expect observance of prudent banking practices, and the Banks and Trust Companies Law imposes a minimum net worth requirement of an amount equal to CI$400 thousand (or, in the case of licensees holding a restricted category “B” or a restricted trust license, CI$20 thousand).

 

U.S. Banking Regulation - Volcker Rule

 

On July 21, 2010, the United States enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which provides a broad framework for significant regulatory changes that extend to almost every area of U.S. financial regulation. Within the Dodd-Frank Act, the Volcker Rule prohibits “banking entities” from engaging in certain forms of proprietary trading or from sponsoring or investing in certain covered funds, in each case subject to certain limited exceptions. The Volcker Rule became effective on July 21, 2012 and on December 10, 2013, U.S. regulators issued final rules implementing the Volcker Rule. The final rules also limit the ability of banking entities and their affiliates to enter into certain transactions with such funds with which they or their affiliates have certain relationships. The final rules contain exclusions and certain exemptions for market-making, hedging, underwriting, trading in U.S. government and agency obligations as well as certain foreign government obligations, trading solely outside the United States, and also permits certain ownership interests in certain types of funds to be retained. The final rules implementing the Volcker Rule extended the period for all banking entities to conform with the Volcker Rule and implement a compliance program until July 21, 2015, and additional extensions are possible. Banking entities such as Banco Santander must bring their activities and investments worldwide into compliance with the requirements of the Volcker Rule by the end of the conformance period. Banco Santander is assessing how the final rules implementing the Volcker Rule will affect its businesses, including Santander Brasil, and is developing and implementing plans to bring affected businesses into compliance.

 

Antitrust Regulation

 

According to the Brazilian antitrust law, actions which concentrate market share must be previously submitted to CADE for approval if the following criteria are met: (1) at least one of the groups involved in the deal has posted annual gross revenues or volume of business equal to or over R$750 million, in Brazil, in the year prior to the transaction; and (2) at least another group has posted annual gross revenues or volume of business equal to or over R$75 million, in Brazil, in the year prior to the transaction. Closing of a transaction without CADE’s approval will subject the parties to fines ranging from R$60 thousand to R$60 million.

 

The Brazilian Central Bank will also examine certain corporate reorganizations and other acts involving two or more financial institutions not only considering their potential effects on the financial system and its stability but also any potential impacts regarding market concentration and competition. Upon approval of the transaction, the Brazilian Central Bank may establish certain restrictions and require that the financial institutions execute an

 

 

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agreement of market concentration control, pursuant to which the terms and conditions of the sharing of the efficiency gain resulting from the act shall be set forth.

 

Insolvency Laws Concerning Financial Institutions

 

Financial institutions are subject to the proceedings established by Law 6,024 of March 13, 1974 (“Law 6024”), which establishes the applicable provisions in the event of intervention or extra-judicial liquidation by the Brazilian Central Bank as well as to bankruptcy proceedings.

 

Intervention and extra-judicial liquidation occur when the Brazilian Central Bank has determined that the financial institution is in bad financial condition or upon the occurrence of events that may impact the creditors’ situation. Such measures are imposed by the Brazilian Central Bank in order to avoid the bankruptcy of the entity.

 

Intervention

 

An intervention can be carried out at the discretion of the Brazilian Central Bank in the following cases:

 

·

risk to the creditors due to mismanagement;

 

·

consistent violation of Brazilian banking laws or regulations; or

 

·

if the intervention is a feasible alternative to the liquidation of the financial institution.

 

As of the date on which it is ordered, the intervention will automatically suspend the enforceability of the payable obligations; prevent early termination or maturity of any previously contracted obligations; and freeze deposits existing on the date on which the intervention is decreed.

 

The intervention will cease if interested parties undertake to continue the economic activities of the financial institution, by presenting the necessary guarantees, as determined by the Brazilian Central Bank, when the situation of the entity is regularized as determined by the Brazilian Central Bank; or when extra-judicial liquidation or bankruptcy of the entity is ordered.

 

Intervention may also be ordered upon the request of a financial institution’s management.

 

Extra-judicial Liquidation

 

Extra-judicial liquidation is an administrative proceeding decreed by the Brazilian Central Bank (except that it is not applicable to financial institutions controlled by the Brazilian federal government) and conducted by a liquidator appointed by the Brazilian Central Bank. This extraordinary measure aims at terminating the activities of the affected financial institution, liquidating its assets and paying its liabilities, as in a judicially decreed bankruptcy. The Brazilian Central Bank will extra-judicially liquidate a financial institution if:

 

·

the institution’s economic or financial situation is at risk, particularly when the institution ceases to meet its obligations as they become due, or upon the occurrence of an event that could indicate a state of insolvency under the rules of the Bankruptcy Law;

 

·

management seriously violates Brazilian banking laws, regulations or rulings;

 

·

the institution suffers a loss which subjects its unprivileged and unsecured creditors to severe risk; and/or

 

·

upon revocation of the authorization to operate, the institution does not initiate ordinary liquidation proceedings within ninety days or, if initiated, the Brazilian Central Bank determines that the pace of the liquidation may harm the institution’s creditors.

 

A request for liquidation procedures can also be filed on reasonable grounds by the officers of the respective financial institution or by the receiver appointed by the Brazilian Central Bank in the receivership procedure.

 

The decree of extra-judicial liquidation will: (1) suspend the actions or foreclose on rights and interests relating to the estate of the entity being liquidated, while no other actions or executions may be brought during the

 

 

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liquidation; (2) accelerate the obligations of the entity; and (3) interrupt the statute of limitations with regard to the obligations assumed by the institution.

 

Extra-judicial liquidation procedures may be terminated:

 

·

by discretionary decision of the Brazilian Central Bank if the parties involved undertake the administration of the financial institution after having provided the necessary guarantees; or

 

·

when the final accounts of the receiver are delivered and approved and subsequently registered in the relevant public records; or

 

·

when converted into ordinary liquidation; or

 

·

when a financial institution is declared bankrupt.

 

Temporary Special Administration Regime (Regime de Administração Especial Temporária or “RAET”)

 

In addition to the intervention procedures described above, the Brazilian Central Bank may also establish RAET, under Law 9447, dated March 14, 1997 combined with Law 6024/74, which is a less severe form of the Brazilian Central Bank intervention in private and non-federal public financial institutions that allows institutions to continue to operate normally. The RAET may be ordered in the case of an institution which:

 

·

continually enters into recurrent operations which are against economic or financial policies set forth in federal law;

 

·

faces a shortage of assets;

 

·

fails to comply with the compulsory reserves rules;

 

·

reveals the existence of hidden liabilities;

 

·

experiences the occurrence of situations that cause receivership pursuant to current legislation;

 

·

has reckless or fraudulent management; or

 

·

carries out activities which call for an intervention.

 

The main objective of a RAET is to assist the recovery of the financial condition of the institution under special administration and thereby avoid intervention and/or liquidation. Therefore, a RAET does not affect the day-to-day business, operations, liabilities or rights of the financial institution, which continues to operate in the ordinary course of business.

 

There is no minimum term for a RAET, which ceases upon the occurrence of any of the following events: (1) acquisition by the Brazilian federal government of control of the financial institution, (2) corporate restructuring, merger, spin-off, amalgamation or transfer of the controlling interest of the financial institution, (3) decision by the Brazilian Central Bank, or (4) declaration of extra-judicial liquidation of the financial institution.

 

Bankruptcy Law

 

The Law No. 11,101 (“Bankruptcy Law”) regulates judicial reorganizations, out-of-court reorganizations and bankruptcy of individuals and corporations since 2005 and applies to financial institutions only with respect to the matters not specifically regulated by the intervention and extra-judicial liquidation regimes described above.

 

Repayment of Creditors in a Liquidation or Bankruptcy

 

In the event of extra-judicial liquidation or bankruptcy of a financial institution, creditors are paid pursuant to their priorities and privileges. Pre-petition claims are paid on a ratable basis in the following order: labor credits; secured credits; tax credits; credits with special privileges; credits with general privileges; unsecured credits;

 

 

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contractual fines and pecuniary penalties for breach of administrative or criminal laws, including those of a tax nature; and subordinated credits.

 

The current law confers immunity from attachment of compulsory deposits maintained by financial institutions with the Brazilian Central Bank. Such deposits may not be attached in actions by a bank’s general creditors for the repayment of debts as well as requires that the assets of any insolvent bank funded by loans made by foreign banks under trade finance lines be used to repay amounts owing under such lines in preference to those amounts owing to the general creditors of such insolvent bank.

 

Deposit Insurance - FGC

 

The purpose of the FGC is to guarantee the payment of funds deposited with financial institutions in case of intervention, liquidation, bankruptcy or insolvency. The FGC is funded by ordinary contributions made by the financial institutions in the amount of up to 0.0125% of the total amount of outstanding balances of the accounts corresponding to guaranteed obligations, and certain special contributions as determined. Delay in performing such contributions is subject to a penalty of 2% over the amount of the contribution.

 

The total amount of credit in the form of demand deposits, savings deposits, time deposits, deposits maintained in accounts blocked for transactions with checks (for the registration and control of funds relating to the rendering of services of payment of salaries, earnings, pensions), bills of exchange, real estate bills, mortgage bills, real estate credit bills and repurchase and resale agreements which object are instruments issued after March 8, 2012 by a company of the same group due to each customer by a financial institution (or by financial institutions of the same financial group) will be guaranteed by the FGC for up to a maximum of R$70 thousand per customer. When the assets of the FGC reach 2% of the total amounts they guarantee, the CMN may temporarily suspend or reduce the contribution of financial institutions to the FGC. The volume of deposits that financial institutions can accept with the guarantee granted by FGC will be reduced by 20% every year from January 2012 to January 2016, thereby ending such insurance by 2016.

 

Taxation

 

Corporate Income Tax (IRPJ) and Social Contribution Tax (CSLL)

 

The IRPJ is calculated at a rate of 15.0%, plus a surtax of 10.0% and the CSLL is calculated at a rate of 15.0% for financial institutions and 9.0% for companies, after adjustments determined by the tax legislation.

 

Deferred tax assets and liabilities are computed based on temporary differences between the book basis and tax basis of assets and liabilities, tax losses, and adjustments to fair value of securities and derivatives.

 

According to the requirements in the current regulations, the expected realization of deferred tax assets is based on projections of future results and a technical study approved by the Directors of Banco Santander.

 

The changes introduced by Law 11,638/2007 and by Law 11,941/2009 (articles 37 and 38), which modified the criterion for recognizing revenues, costs and expenses computed in the determination of net income, have no effect for purposes of determining the taxable profit for a legal entity which opted for the Transitional Tax Regime (RTT), being used for tax purposes the regulations in effect on December 31, 2007. The tax effects on the adoption of such rules are recorded, for accounting purposes, in the corresponding deferred assets and liabilities.

 

There is a Provisory Measure enacted in November 2013, pending on approval, which establishes that the Transitional Tax Regime (RTT) is going to finish in 2014 or 2015, depending on the option on each tax payer.

 

Tax on Services (ISS)

 

Each of the Municipalities and the Federal District are responsible to define the applicable ISS current rate, which is charged on the service value where the Group has branches or administrative centers. The rates vary from 2.0% to 5.0% and depend on the nature of the service.

 

 

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PIS and COFINS Tax Rates

 

PIS and COFINS payable by financial institutions and similar entities, as defined by law, are due at the rate of 0.65% and 4% respectively. They are levied cumulatively on gross revenue billed, understood as the total revenues earned by the legal entity, net of certain expenses, such as funding costs.

 

The non-financial entities are taxed at the rates of 1.65% and 7.6% of PIS and COFINS respectively, and are subject to non-cumulative incidence, that consists of deduction of certain expenses from the tax base as allowed by law.

 

Tax on Financial Transactions (IOF)

 

IOF is a tax levied on credit, currency exchange, insurance and securities transactions and it is imposed on the following transactions and at the following rates:

Transaction(1)		Maximum Legal Rate		Present Rate
Credit extended by financial institutions and non-financial entities		1.5%		Up to 0.0041% per day for loans contracted by legal entities and 0.0041% per day for individuals. An additional 0.38% rate is applicable.
Transactions relating to securities(2)		1.5% per day		0.5% per day for certain investment funds
				0% on transactions with equity securities and certain debt securities, such as debentures and real estate receivables notes (CRIs)
				1% per day on transactions with fixed income derived from federal, state, or municipal bonds, and fixed income investment funds limited to certain percentages of the income raised from investment
				0% on the assignment of securities to permit the issuance of Depositary Receipts abroad
Transactions relating to derivatives		25.0%		0% on the notional value of the adjusted purchase sale or maturity of financial derivative contract in the country that individually result in an increased foreign exchange exposure on a short position
				0% on derivative contracts to hedge risks inherent to the price fluctuation of foreign exchange resulting from export contracts signed by an individual or legal entity resident or domiciled in the country
				0% other transactions with derivative contracts not expressly mentioned by the tax law

 

 

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Transaction(1)		Maximum Legal Rate		Present Rate
Insurance transactions entered into by insurance companies		25%		2.38% for health insurance
				0.38% for life insurance
				7.38% for other types of insurance
Foreign exchange transactions(2)		25%		0.38% (general rule)
				6.38% on credit card transactions as from April 27, 2011
				6.38% on withdrawals abroad using credit or debit cards as from December 28, 2013
				6.38% on purchase of travelers cheque or loading of international prepaid card as from December 28, 2013
				0% for outflow of funds related to loans obtained from abroad (irrespective of the term) and for inflow of funds related to loans obtained from abroad for a period greater than 360 days.
				6% for remittances from abroad related to loans that will remain in Brazil for a period lower than or equal to 360 days.
				0% for interbank transactions
				0% for exchange transactions in connection with the outflow of proceeds from Brazil for the remittance of interest on net equity and dividends to be received by foreign investors
				0% for exchange transactions, including by means of simultaneous foreign exchange transactions, for the inflow of funds by foreign investors in the Brazilian financial and capital markets, except that variable income investments in stock exchanges and share acquisitions as part of an initial public offering, as well as investments in certain private equity funds, are not subject to an IOF rate
				0% for exchange transactions, including by means of simultaneous foreign exchange transactions, for the inflow of funds by foreign investors for purposes of initial or additional margin requirements in connection with transactions in stock exchanges
				0% for exchange transactions for the

 

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Transaction(1)		Maximum Legal Rate		Present Rate
				outflow of funds invested by foreign investors in the Brazilian financial and capital markets
				0% for exchange transactions for the inflow and outflow of funds invested by foreign investors, including by means of simultaneous foreign exchange transactions, in certificates of deposit of securities, known as Brazilian Depositary Receipts, or “BDRs.”
				0% for simultaneous exchange transactions effected on or after December 1, 2011, for the inflow of funds by foreign investors derived from the conversion of direct investments in Brazil made pursuant to Law 4,131/62 into investments in stock tradable in stock exchanges
				0% for revenues related to the export of goods and services transactions

---

(1)	The transactions mentioned in the table are for illustration purposes and do not reflect an exhaustive list of transactions subject to the IOF.

 

(2)	There are some exemptions or specific cases in which the applicable rate is zero.

 

Disclosure pursuant to Section 219 of the Iran threat reduction and Syria human rights act

 

Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13(r) to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), an issuer is required to disclose in its annual or quarterly reports, as applicable, whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with individuals or entities designated pursuant to certain Executive Orders. Disclosure is generally required even where the activities, transactions or dealings were conducted in compliance with applicable law.

 

During the period covered by this annual report, neither Santander Brasil nor any of its subsidiaries engaged in any activities or transactions requiring disclosure pursuant to Section 13(r).

 

The following activities are disclosed in response to Section 13(r) with respect to affiliates of Santander Brasil within the Santander Group. During the period covered by this annual report:

 

(a)      A Santander UK plc (“Santander UK”) customer, an Iranian national resident in the United Kingdom, was designated in September 2013 as acting for or on behalf of the Government of Iran. This accountholder’s current account and credit card with Santander UK were closed in December 2013. No revenue was generated by Santander UK on these products.

 

(b)      In early October 2013, Santander UK opened an account for a Tunisian national, resident in the United Kingdom, who is currently designated by the United States for terrorism. After becoming aware of this customer’s designation, Santander UK exited the relationship later in October 2013. No revenue was generated by Santander UK on these accounts.

 

(c)      Santander UK holds frozen savings and current accounts for three customers resident in the United Kingdom who are currently designated by the United States for terrorism. The accounts held by each customer were

 

 

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blocked after the customer’s designation and have remained blocked and dormant throughout 2013. No revenue was generated by Santander UK on these accounts.

 

(d)      A UK company maintained two commercial accounts at Santander UK that were used to provide payroll processing services for a United Kingdom entity that is currently designated by the United States under the Iran sanctions regime. The accounts may have been used to provide payroll services to other Iranian clients. Santander UK became aware of this account activity in September 2013 and exited the relationship in January 2014. No revenue was generated by Santander UK on these accounts.

 

(e) An Iranian national, resident in the United Kingdom, who is currently designated by the United States and the United Kingdom under the Iran sanctions regime held a mortgage with Santander UK that was issued prior to any such designation. No further drawdown has been made (or would be allowed) under this mortgage although we continue to receive repayment installments. In 2013, total revenue in connection with the mortgage was £10,421 while net profits were negligible relative to the overall profits of Santander UK. Santander UK does not intend to enter into any new relationships with this customer, and any disbursements will only be made in accordance with applicable sanctions. The same Iranian national also holds two investment accounts with Santander Asset Management UK Limited, part of the Santander Group. The accounts have remained frozen throughout 2013. The investment returns are being automatically reinvested, and no disbursements have been made to the customer. Total revenue for the Santander Group in connection with the investment accounts was £247 while net profits in 2013 were negligible relative to the overall profits of Santander Spain on a consolidated basis.

 

In addition, the Santander Group has certain legacy export credits and performance guarantees with Bank Mellat, which are included in the U.S. Department of the Treasury’s Office of Foreign Assets Control’s Specially Designated Nationals and Blocked Persons List. Santander Spain entered into two bilateral credit facilities in February 2000 in an aggregate principal amount of €25.9 million. Both credit facilities matured in 2012. In addition, in 2005 Santander Spain participated in a syndicated credit facility for Bank Mellat of €15.5 million, which matures on July 6, 2015. As of December 31, 2013, the Santander Group was owed €4.3 million under this credit facility.

 

Bank Mellat has been in default under all of these agreements in recent years and Santander Spain has been and expects to continue to be repaid any amounts due by official export credit agencies, which insure between 95% and 99% of the outstanding amounts under these credit facilities. No additional funds have been extended by Santander Spain under these facilities since they were initially granted.

 

The Santander Group also has certain legacy performance guarantees for the benefit of Bank Sepah and Bank Mellat (stand-by letters of credit to guarantee the obligations—either under tender documents or under contracting agreements—of contractors who participated in public bids in Iran) that were in place prior to April 27, 2007. However, should any of the contractors default in their obligations under the public bids, the Santander Group would not be able to pay any amounts due to Bank Sepah or Bank Mellat because any such payments would be frozen pursuant to Council Regulation (EU) No. 961/2010.

 

In the aggregate, all of the transactions described above resulted in approximately €72,000 gross revenues and approximately €123,000 net loss to the Santander Group in 2013, all of which resulted from the performance of export credit agencies rather than any Iranian entity. The Santander Group has undertaken significant steps to withdraw from the Iranian market such as closing its representative office in Iran and ceasing all banking activities therein, including correspondent relationships, deposit taking from Iranian entities and issuing export letters of credit, except for the legacy transactions described above. The Santander Group is not contractually permitted to cancel these arrangements without either (i) paying the guaranteed amount—which payment would be frozen as explained above (in the case of the performance guarantees), or (ii) forfeiting the outstanding amounts due to it (in the case of the export credits). As such, the Santander Group intends to continue to provide the guarantees and hold these assets in accordance with company policy and applicable laws.

 

SELECTED STATISTICAL INFORMATION

 

The following information for Santander Brasil is included for analytical purposes and is derived from and should be read in conjunction with the consolidated financial statements contained elsewhere herein as well as “Item 5. Operating and Financial Review and Prospects.”

 

Average annual balance sheet data has been calculated based upon the average of the monthly balances at 13 dates: at December 31 of the prior year and each of the month-end balances of the 12 subsequent months. Average

 

 

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income statement and balance sheet data and other related statistical information have been prepared on a consolidated annual basis. We believe that the average data set forth herein accurately reflect in all material respects our financial condition and results of operations at the dates and for the periods specified.

 

The selected statistical information set forth below includes information at and for the years ended December 31, 2013, 2012, 2011, 2010 and 2009 extracted from the audited financial statements prepared in conformity with IFRS as issued by the IASB. See “Presentation of Financial and Other Information” and “Item 3. Key Information—3A. Selected Financial Data—Average Balance Sheet and Interest Rates.”

 

The following tables show our average balances and interest rates for each of the periods presented. With respect to the tables below and the tables under “—Changes in Net Interest Income—Volume and Rate Analysis” and “—Assets—Earning Assets—Yield Spread,” (1) we have stated average balances on a gross basis, before netting impairment losses, except for the total average asset figures, which include such netting, and (2) all average data have been calculated using month-end balances, which is not significantly different from having used daily averages. We stop accruing interest on loans once they are more than 60 days past due. All our non-accrual loans are included in the table below under “Other assets.”

 

		For the year ended December 31,
		2013												2012												2011
		Average Balance				Interest				Average Rate				Average Balance				Interest				Average Rate				Average Balance				Interest				Average Rate
		(in millions of R$, except percentages)
Assets and Interest Income
Cash and balances with the Brazilian Central Bank			54,966				6,797				12.4	%			57,249				5,731				10.0	%			55,100				6,297				11.4	%
Loans and amounts due from credit institutions			34,605				751				2.2	%			25,177				1,042				4.1	%			19,017				1,219				6.4	%
Loans and advances to customers			200,060				35,737				17.9	%			187,060				38,735				20.7	%			163,046				35,398				21.7	%
Debt instruments			65,699				6,529				9.9	%			61,012				6,082				10.0	%			68,770				8,084				11.8	%
Other interest – earning assets			—				1,403				0.0				—				1,070				—				—				738				—
Total interest – earning assets			355,329				51,217				14.4	%			330,498				52,661				15.9	%			305,934				51,736				16.9	%
Equity instruments			2,753				81				3.0	%			2,224				94				4.2	%			17,324				94				0.5	%
Investments in associates			799				—				—				444				—				—				402				—				—
Total earning assets			358,881				51,298				14.3	%			333,166				52,754				15.8	%			323,660				51,830				16.0	%
Cash and balances with the Brazilian Central Bank			3,326				—				—				4,793				—				—				6,830				—				—
Loans and amounts due from credit institutions			2,777				—				—				2,792				—				—				3,082				—				—
Impairment losses			(14,198	)			—				—				(12,647	)			—				—				(10,359	)			—				—
Other assets			48,316				—				—				43,383				—				—				35,478				—				—
Tangible assets			6,227				—				—				5,316				—				—				4,647				—				—
Intangible assets			29,955				—				—				31,340				—				—				31,450				—				—
Total average assets			435,286				51,298				11.8	%			408,143				52,754				12.9	%			394,788				51,830				13.1	%
Liabilities and Interest Expense
Deposits from the Brazilian Central Bank and Deposits from credit institutions			34,673				1,774				5.1	%			38,421				1,585				4.1	%			41,670				2,006				4.8	%
Customer deposits			183,234				13,517				7.4	%			167,863				13,494				8.0	%			161,159				16,494				10.2	%
Marketable debt securities			59,711				4,355				7.3	%			47,604				3,662				7.7	%			31,336				3,227				10.3	%
Subordinated debts			9,764				810				8.3	%			11,440				1,011				8.8	%			10,288				1,213				11.8	%
Other interest-bearing liabilities			—				2,281				—				—				1,217				—				—				893				—
Total interest-bearing liabilities			287,382				22,738				7.9	%			265,322				20,970				7.9	%			244,446				23,834				9.8	%
Deposits from credit institutions			176				—				—				197				—				—				321				—				—
Customer deposits – demand deposits			12,907				—				—				11,797				—				—				13,648				—				—
Other liabilities			53,906				—				—				52,906				—				—				60,749				—				—
Non-controlling interests			266				—				—				29				—				—				11				—				—
Stockholders’ Equity			80,650				—				—				77,886				—				—				75,606				—				—
Total average liabilities and equity			435,286				22,738				5.2	%			408,143				20,969				5.1	%			394,788				23,834				6.0	%

 

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Changes in Net Interest Income—Volume and Rate Analysis

 

The following tables present the changes in our net interest income allocated between changes in average volume and changes in average rate for the year ended December 31, 2013, compared to the year ended December 31, 2012, and for the year ended December 31, 2012 compared to the year ended December 31, 2011. We have calculated volume variances based on movements in average balances over the period and rate variance based on changes in interest rates on average interest-earning assets and average interest-bearing liabilities. We have allocated variances caused by changes in both volume and rate to volume. You should read the following tables and the footnotes thereto in light of our observations noted in “—Average Balance Sheet and Interest Rates.”

 

		For the years ended 2013/2012												For the years ended 2012/2011
		Increase (decrease) due to changes in
		Volume				Rate				Net change				Volume				Rate				Net change
		(in millions of R$)
Interest and Similar Income
Interest-earning assets
Cash and balances with the Brazilian Central Bank			(236	)			1,302				1,065				238				(804	)			(566	)
Loans and amounts due from credit institutions			308				(599	)			(291	)			328				(505	)			(177	)
Loans and advances to customers			2,568				(5,566	)			(2,998	)			5,030				(1,692	)			3,338
Debt instruments			(466	)			(18	)			447				(853	)			(1,149	)			(2,002	)
Other interest-earning assets			333				—				333				332				—				332
Total interest-earning assets			3,438				(4,882	)			(1,443	)			5,076				(4,151	)			925
Equity Instruments			19				(32	)			(12	)			(145	)			145				—
Total earning assets			3,458				(4,913	)			(1,456	)			(4,93	)			(4,006	)			925
Interest Expense and Similar Charges
Interest-bearing liabilities
Deposits from the Brazilian Central Bank and Deposits from credit institutions			(165	)			354				189				(149	)			(272	)			(421	)
Customer deposits			1,182				(1,159	)			23				662				(3,663	)			(3,000	)
Marketable debt securities			892				(199	)			693				1,391				(955	)			435
Subordinated liabilities			(142	)			(59	)			(200	)			125				(328	)			(202	)
Other interest-bearing liabilities			1,064				—				1,064				323				—				324
Total interest-bearing liabilities			2,831				(1,062	)			1,768				2,353				(5,218	)			(2,864	)

 

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Assets

 

Earning Assets – Yield Spread

 

The following table analyzes our average earning assets, interest income and dividends on equity securities and net interest income and shows gross yields, net yields and yield spread for each of the periods indicated. You should read this table and the footnotes thereto in light of our observations noted in “—Average Balance Sheet and Interest Rates.”

 

		For the year ended December 31,
		2013				2012				2011
		(in millions of R$, except percentages)
Average earning assets			358,881				333,166				323,660
Interest and dividends on equity securities(1)			51,298				52,754				51,830
Net interest income			28,479				31,691				27,902
Gross yield(2)			14.3	%			15.8	%			16.0	%
Net yield(3)			8.0	%			9.5	%			8.6	%
Yield spread(4)			6.4	%			7.9	%			6.3	%

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(1)	Dividends on equity securities include dividends from companies accounted for by the equity method.

 

(2)	Gross yield is the quotient of interest and dividends on equity securities divided by average earning assets.

 

(3)	Net yield is the quotient of net interest income divided by average earning assets.

 

(4)	Yield spread is the difference between gross yield on earning assets and the average cost of interest-bearing liabilities.

 

Return on Equity and Assets

 

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

 

		For the year ended December 31,
		2013				2012				2011
ROA: Return on average total assets			1.3	%			1.3	%			2.0	%
ROE: Return on average stockholders’ equity			7.3	%			7.1	%			10.3	%
ROE (adjusted): Average stockholders’ equity excluding goodwill as a percentage of average total assets excluding goodwill(1)			13.1	%			13.3	%			13.0	%
Average stockholders’ equity as a percentage of average total assets			18.5	%			19.1	%			19.2	%
Payout(2)			44.1	%			49.0	%			41.0	%

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(1)

“Average stockholders’ equity excluding goodwill as a percentage of average total assets excluding goodwill” is a non-GAAP financial measure which adjusts “Return on average stockholders’ equity” to exclude the goodwill arising from the acquisition of Banco Real in 2008.  See “Item 3. Key Information—3A. Selected Financial Data—Selected Consolidated Ratios” for a reconciliation of “Average stockholders’ equity excluding goodwill as a percentage of average total assets excluding goodwill” to “Return on average stockholders’ equity.”

 

(2)	Divided payout ratio (dividends declared per share divided by net income per share).

 

Interest-Earning Assets

 

The following table shows the percentage mix of our average interest-earning assets for the years indicated. You should read this table in light of our observations noted in “—Average Balance Sheet and Interest Rates.”

 

		For the year ended December 31,
		2013				2012				2011
Cash and balances with the Brazilian Central Bank			15.5	%			17.3	%			18.0	%
Loans and amounts due from credit institutions			9.7	%			7.6	%			6.2	%
Loans and advances to customers			56.3	%			56.6	%			53.3	%
Debt instruments			18.5	%			18.5	%			22.5	%
Total interest-earning assets			100.0	%			100.0	%			100.0	%

 

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Loans and amounts due from credit institutions

 

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

 

		For the year ended December 31,
		2013				2012				2011
		(in millions of R$)
Time deposits			4,443				8,720				7,136
Reverse repurchase agreements			19,602				3,616				1,040
Escrow deposits			7,422				7,574				6,869
Cash and Foreign currency investments			14,609				9,921				4,247
Other accounts			135				163				459
Total			46,212				29,993				19,751

Investment Securities

 

At December 31, 2013, the book value of investment securities was R$71 billion (representing 15.0% of our total assets in the period). Brazilian government securities totaled R$51.6 billion, or 72.8%, of our investment securities at December 31, 2013. For a discussion of how our investment securities are valuated, see notes 6 and 7 to the consolidated financial statements.

 

The following table shows the carrying amounts of our investment securities by type and residence of the counterparty at each of the indicated dates:

 

		At December 31,
		2013				2012				2011
		(in millions of R$)
Debt securities
Government securities—Brazil			51,619				57,189				56,833
Government securities—other countries			—				—				—
Other debt securities			16,285				12,896				12,058
Total domestic/debt securities			67,904				70,085				68,891
Equity securities Shares of Brazilian companies			1,124				914				1,002
Shares of foreign companies			149				0				1
Investment fund units and shares			1,726				1,718				1,128
Total equity securities			2,999				2,632				2,131
Total investment securities			70,903				72,717				71,022

As of December 31, 2013, we held no securities of single issuers or related groups of companies whose aggregate book or market value exceed 10.0% of our stockholders’ equity, other than the Brazilian government securities, which represented 63.2% of our stockholders’ equity. The total value of our debt securities was approximately 83.2% of stockholders’ equity.

 

 

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The following table analyzes the maturities and weighted average yields of our debt investment securities (before impairment allowance) at December 31, 2013. Yields on tax-exempt obligations have not been calculated on a tax equivalent basis because the effect on such calculation is not significant.

 

		Maturing within 1 year				Maturing between 1 and 5 years				Maturing between 5 and 10 years				Maturing after 10 years				Total
Debt securities
Government securities—Brazil			5,495				36,492				4,861				4,770				51,619
Other debt securities			3,568				7,667				3,411				1,638				16,285
Total debt investment securities			9,064				44,160				8,272				6,408				67,904

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(1)	The average rate for debt investment securities is 9%.

 

Loan Portfolio

 

At December 31, 2013, our total loans and advances to customers were R$226.2 billion (49.9% of our total assets). Net of allowances for impairment losses, loans and advances to customers were R$212.7 billion at December 31, 2013 (46.9% of our total assets). In addition to loans, we had outstanding at December 31, 2013, 2012, 2011, 2010 and 2009, R$102.7 billion, R$106.8 billion, R$98.6 billion, R$93.5 billion and R$77.8 billion respectively, of loan commitments drawable by third parties.

 

Types of Loans by Type of Customer

 

Substantially all of our loans are to borrowers domiciled in Brazil and are denominated in reais . The following tables analyze our loans and advances to customers (including securities purchased under agreements to resell), by type of customer loan, at each of the dates indicated. For each category of loan, we maintain specific risk management policies in line with the standards of the Santander Group and as managed and monitored by our board of directors through the credit committee. Our credit approval processes for each category of loan are structured primarily around our business segments. See “Item 11. Quantitative and Qualitative Disclosures about Risk—Credit Risk” for details on our credit approval policies for retail and wholesale lending.

 

We have a diversified loan portfolio with no specific concentration exceeding 9.4% of total loans.

 

		At December 31,
		2013				2012				2011				2010				2009
		(in millions of R$)
Commercial, financial and industrial(1)			113,571				103,209				94,921				78,101				66,601
Real estate (2)			25,555				20,107				16,298				12,090				9,054
Installment loans to individuals(3)			84,312				83,243				76,459				60,251				49,103
Lease financing(4)			2,768				4,182				6,506				10,116				13,636
Loans and advances to customers, gross(5)			226,206				210,741				194,184				160,558				138,394
Impairment losses			(13,473	)			(13,967	)			(11,118	)			(9,192	)			(10,070	)
Loans and advances to customers, net			212,733				196,775				183,066				151,366				128,324

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(1)      Includes primarily loans to small and medium-size businesses, or SMEs in our Commercial Banking segment, and to GB&M, corporate and business enterprise customers in our Wholesale Global Banking segment. The principal products offered to SMEs in this category include revolving loans, overdraft facilities, installment loans, working capital and equipment finance loans. Credit approval for SMEs is based on customer income, business activity, collateral coverage and internal and external credit scoring tools. Collateral on commercial, financial and industrial lending to SMEs generally includes receivables, liens, pledges, guarantees and mortgages, with coverage generally ranging from 100.0% to 150.0% of the loan value depending on the risk profile of the loan. Our Wholesale Global Banking customers are offered a range of loan products ranging from typical corporate banking products (installment loans, working capital and equipment finance loans) to more sophisticated products (derivative and capital markets transactions). As Wholesale Global Banking customers tend to be larger businesses, credit approval is based on customer credit quality as evaluated by a specialized teams of risk analysts taking

 

 

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account of, among other things, business revenues and credit history of each customer. Underwriting policies for this category of loans to our Wholesale Global Banking customers are focused on the type of guarantee or collateral provided. Certain loans (BNDES products) are generally secured by liens on financed machinery and equipment, though guarantees may be provided as additional security.

 

(2)      Includes loans on residential real estate to individuals. Credit approval policies in this category are determined by reference to the type of lending product being offered, the type and location of the real estate, the revenue or income of the business or customer, respectively, requesting the loan and internal and external credit scoring information. All loans granted under this category are secured by the financed real estate. Loan-to-value ratios for loans in this category are generally limited to 80.0% and the average loan to value ratio for new loans is approximately between 54.0% and 60.0%. Moreover, real estate also includes construction loans made principally to real estate developers that are SMEs and corporate customers in our Wholesale Global Banking Segment. Loans in this category are generally secured by mortgages and receivables, though guarantees may be provided as additional security.

 

(3)      Consists primarily of unsecured personal installment loans (including loans the payments for which are automatically deducted from a customer’s payroll), revolving loans, overdraft facilities, consumer finance facilities and credit cards. Credit approval in this category is based on individual income, debt-to-income ratio and internal and external credit scoring models. Credit approval for many of these types of loans is based on automatic scoring models, with pre-set lending limits based on credit scores. For example, the maximum lending amount on revolving loans and overdraft facilities may vary from between 60.0% to 240.0% of an individual’s monthly income, depending on the specific product and credit score of the individual.

 

(4)      Includes primarily automobile leases and loans to individuals. Credit approval is based both on an automatic scoring model using external credit scores and on evaluation by our branch personnel following our risk management policies. The vehicle financed acts as collateral for the particular loan granted.

 

(5)      Includes the debit balances (financial assets) of all the credit and loans granted by us, including money market operations through central counterparties, except for credit of any nature in the name of credit institutions or those represented by securities.

 

Maturity

 

The following table sets forth an analysis by maturity of our loans and advances to customers by type of loans at December 31, 2013.

 

		Maturity
		Less than one year								One to five years								Over five years								Total
		Balance				% of Total Loans				Balance				% of Total Loans				Balance				% of Total Loans				Balance				% of Total Loans
		(in millions of R$, except percentages)
Commercial, financial and industrial			78,548				58.1				31,675				41.4				3,348				23.1				113,571				50.2
Real estate			5,787				4.3				9,632				12.6				10,136				70.0				25,555				11.3
Installment loans to individuals			49,356				36.5				33,958				44.4				998				6.9				84,312				37.3
Lease financing			1,569				1.2				1,192				1.6				7				0.0				2,768				1.2
Loans and advances to customers, gross			135,260				100.0				76,457				100.0				14,489				100.0				226,206				100.0

Fixed and Variable Rate Loans

 

The following table sets forth a breakdown of our fixed and variable rate loans by maturity at December 31, 2013.

 

		Fixed and variable rate loans with maturity
		Less than one year								One to five years								Over five years								Total
		Balance				% of Total				Balance				% of Total				Balance				% of Total				Balance				% of Total
		(in millions of R$, except percentages)
Fixed rate			103,976				76.9				60,522				79.2				3,806				26.3				168,304				74.4
Variable rate			31,284				23.1				15,935				20.8				10,683				73.7				57,902				25.6
Total			135,260				100.0				76,457				100.0				14,489				100.0				226,206				100.0

 

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Cross-Border Outstandings

 

The following table presents, at each balance sheet date indicated, the aggregate amount of our cross-border outstandings (which consist of loans, interest-bearing deposits with other banks, acceptances and other monetary assets denominated in a currency other than the home-country currency of the office where the item is booked). Cross-border outstandings do not include local currency loans made by subsidiary banks in other countries to the extent that such loans are funded in the local currency or hedged. As a result, they do not include the majority of the loans made by our Cayman Islands branch, which are fully hedged.

 

		At December 31,
		2013								2012								2011
		Balance				% of Total Assets				Balance				% of Total Assets				Balance				% of Total Assets
		(in millions of R$, except percentages)
OECD countries(1)
Austria			481				0.1				664				0.2				366				0.1
Spain			629				0.1				—				0.0				256				0.1
United States			3,383				0.7				3,606				0.9				8,305				2.1
Netherlands			8,990				2.0				6,439				1.5				5,675				1.4
Other OECD countries(2)			1,940				0.4				229				0.1				583				0.1
Total OECD			15,423				3.4				10,938				2.6				15,186				3.8
Non-OECD countries
Latin American countries(2)			667				0.1				29				0.0				60				0.0
Cayman Islands			1,093				0.2				3,320				0.8				4,081				1.0
Other(2)			730				0.2				298				0.1				354				0.1
Total non-OECD			2,490				0.5				3,647				0.9				4,495				1.1
Total			17,913				4.0				14,585				3.5				19,681				4.9

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(1)      The Organization for Economic Cooperation and Development.

 

(2)      Aggregate outstandings in any single country in this category do not exceed 0.75% of our total assets.

 

The following table presents the amounts of our cross-border outstandings at December 31, 2013, 2012 and 2011 by type of borrower where outstandings in the borrower’s country exceeded 0.75% of total assets.

 

		Government				Banks and Other Financial Institutions				Commercial and Industrial				Other Loans				Total
		(in millions of R$)
2011
United States			185				7,863				257				—				8,305
Netherlands			—				—				5,675				—				5,675
Cayman Islands			—				—				4,081				—				4,081
Total			185				7,863				10,013				—				18,061
2012
United States			203				3,336				67				—				3,606
Netherlands			—				10				6,429				—				6,439
Cayman Islands			—				—				3,100				220				3,320
Total			203				3,346				9,596				220				13,365
2013
United States			—				2,350				647				—				2,997
Netherlands			—				33				8,956				—				8,989
Cayman Islands			—				—				304				503				807
Total			—				2,383				9,907				503				12,793

 

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Movements in Allowances for Impairment Losses

 

The following tables analyze movements in our allowances for impairment losses for the periods indicated. For further discussion of movements in the allowances for impairment losses, see “Item 5.A. Operating Results—Results of Operations for the Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012—Impairment Losses on Financial Assets” and “—Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011—Impairment Losses on Financial Assets.”

 

		At December 31,
		2013				2012				2011				2010				2009
		(in millions of R$)
Balance at beginning of year			14,042				11,180				9,192				10,070				8,181
Impairment losses charged to income for the year			14,356				18,004				11,191				9,051				10,520
Write-off of impaired balances against recorded impairment allowance			(14,757	)			(15,142	)			(9,203	)			(9,929	)			(8,631	)
Balance at end of year			13,641				14,042				11,180				9,192				10,070
Of which:
Loans and advances to customers			13,473				13,967				11,118				9,192				10,070
Loans and amounts due from credit institutions			168				75				62				—				—
Recoveries of loans previously written off(1)			456				1,528				1,809				818				537

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(1)	Impairment losses on financial assets, net, as reported in our consolidated financial statements, reflect net provisions for credit losses less recoveries of loans previously written off.

 

The table below shows a breakdown of recoveries, net provisions and write-offs against credit loss allowance by type and domicile of the borrower for the periods indicated.

 

		At December 31,
		2013				2012				2011				2010				2009
		(in millions of R$)
Recoveries of loans previously written off(1)			456				1,528				1,809				818				537
Commercial, financial and industrial			122				456				353				88				42
Real estate			78				64				65				69				58
Installment loans to individuals			215				960				1,331				635				420
Lease finance			41				48				60				26				17
I mpairment losses charged to income for the year(1)			14,356				18,004				11,191				9,051				10,520
Commercial, financial and industrial			5,186				5,776				2,943				3,098				3,071
Real estate – mortgage			126				149				98				71				28
Installment loans to individuals			8,803				11,795				7,972				5,780				7,198
Lease finance			241				284				178				102				223
Write-off of impaired balances against recorded impairment allowance			(14,757	)			(15,142	)			(9,203	)			(9,929	)			(8,631	)
Commercial, financial and industrial			(3,195	)			(4,992	)			(2,470	)			(3,209	)			(3,073	)
Real estate			(177	)			(48	)			(37	)			(42	)			(31	)
Installment loans to individuals			(11,093	)			(9,855	)			(6,484	)			(6,509	)			(5,377	)
Lease finance			(292	)			(247	)			(212	)			(169	)			(150	)

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(1)	Impairment losses on financial assets, net, as reported in our consolidated financial statements, reflect net provisions for credit losses less recoveries of loans previously written off.

 

 

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The table below shows a breakdown of allowances for credit losses by type of borrowers and the percentage of loans in each category as a share of total loans at the date indicated.

 

		At December 31,
		2013				% of Total Loans				2012				% of Total Loans				2011				% of Total Loans
		(in millions of R$, except percentages)
Borrowers
Commercial, financial and industrial			6,524				50.2				4,532				49.0				3,747				48.9
Real estate			229				11.3				281				9.5				180				8.4
Installment loans to individuals			6,745				37.3				9,035				39.5				7,096				39.4
Lease financing			143				1.2				194				1.9				157				3.4
Total			13,641				100.0				14,042				100.0				11,180				100.0

Renegotiation Portfolio

 

The renegotiation portfolio for the year ended December 31, 2013 amounted to R$14.0 billion compared to R$10.9 billion for the same period in 2012, an increase of R$3.1 billion or 27.5%, mainly due to one of the measures adopted by the Bank in late 2012 focused on recovery campaigns to offer to delinquent customers loan terms adjustments to help them meet their payment obligations. This portfolio includes credit contracts that were extended and/or modified to facilitate repayment under conditions agreed upon with customers, including renegotiated operations previously classified as write-offs.

 

The renegotiation portfolio was covered by allowances for impairment losses of 50.3% in December 2013 and 51.2% in December 2012. These levels are considered appropriate for the characteristics of these operations.

 

The following table presents a breakdown of our managerial renegotiation portfolio by type of customer, allowances for impairment losses and our coverage ratio at the dates indicated:

 

		2013				2012
		(in millions of R$, except percentages)
Renegotiation Portfolio by type of customer
Commercial, financial and industrial			6,497				5,190
Real Estate			1				1
Installment loans to individuals			7,042				5,391
Financial Leasing			470				408
Total			14,010				10,990
Allowances for impairment losses			7,049				5,632
Coverage ratio			50.3	%			51.2	%

 

 

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Balances are deemed to be impaired when there are reasonable doubts as to their full recovery and/or the collection of the related interest for the amounts on the dates indicated in the loan agreement, after taking into account the collateral guarantees received to secure (fully or partially) collection of the related balances.

 

Impaired Assets

 

The following table shows our impaired assets, excluding country risk.

 

		At December 31,
		2013				2012				2011				2010				2009
		(in millions of R$, except percentages)
Non-performing assets
Past-due and other non-performing assets(1)			14,022				16,057				13,073				9,348				9,899
Non-performing assets as a percentage of total loans			6.2	%			7.6	%			6.7	%			5.8	%			7.2	%
Net loan charge-offs as a percentage of total loans			6.5	%			7.2	%			4.7	%			6.2	%			6.2	%
Net loan charge-offs as a percentage of average total loans			6.8	%			7.5	%			5.2	%			6.7	%			6.3	%

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(1)

Includes at December 31, 2013, R$1,744 million of doubtful loans (2012 – R$1,087 million, 2011 – R$689 million and 2010 – R$927 million) that were not past-due and therefore were accounted for on an accrual basis. In the period ended December 31, 2013, the amount of interest owed on non-accruing assets that would have been recorded had such assets accrued interest from January 1, 2013 would have been R$2,790 million, in the period from January 1, 2012 to December 31, 2012, would have been R$3,306 million, in the period from January 1, 2011 to December 31, 2011, would have been R$2,769 million, in the period from January 1, 2010 to December 31, 2010, would have been R$2,049 million and in the period from January 1, 2009 to December 31, 2009, would have been R$2,005 million. No loan that was more than 60 days past due was accounted for on an accrual basis.

 

Evolution of Impaired Assets

 

Our impaired assets decreased 12.67%, or R$2 billion, to R$14 billion at December 31, 2013 compared to R$16.1 billion at December 31, 2012. Provisions for impairment losses, including total revenue recovery, decreased 2.85%, or R$401 million, to R$13.6 billion at December 31, 2013 compared to R$14 billion at December 31, 2012. Offsetting these effects were recoveries of R$456 million on loans previously written off at December 31, 2013 and R$1.5 billion at December 31, 2012.

 

The following table shows the changes in our impaired assets at the dates indicated:

 

		At December 31,
		2013				2012				2011				2010				2009
		(in millions of R$)
Balance at beginning of year			16,057				13,073				9,348				9,899				7,730
Net additions			12,722				18,126				12,928				9,378				10,800
Write-offs			(14,757	)			(15,142	)			(9,203	)			(9,929	)			(8,631	)
Balance at end of year			14,022				16,057				13,073				9,348				9,899

 

 

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Impaired Assets by Type of Customer

 

The following table shows the changes in our impaired assets by type of customers at the dates indicated:

 

		At December 31,
		2013				2012
		(in millions of R$)
Commercial, financial and industrial			6,410				6,157
Real estate			316				283
Installment loans to individuals			7,167				9,368
Lease financing			129				249
Total			14,022				16,057

 

Commercial, Financial and Industrial

 

Non-performing assets in the portfolio of commercial, financial and industrial loans amounted to R$6,410 million at December 31, 2013, an increase of R$253 million, or 4.1%, compared to 2012.

 

The increase in non-performing assets in this portfolio was mainly caused by the slowdown in the Brazilian economy, for which the GDP of 2.3% in 2013 was below initial expectations.

 

In 2013, the Brazilian economy was negatively impacted by the measures adopted by the Brazilian government. In 2013, the Brazilian Central Bank increased the SELIC rate from 7.25% at December 31, 2012 to 10.0% at December 31, 2013 in response to inflation in the first half of the year and also to mitigate the devaluation of the Brazilian currency as a consequence of the uncertainties in international financial markets caused by policy measures in the European and North American economy.

 

Trends observed in 2013 were consistent with the trend observed in 2012 and 2011, when government measures aimed to control inflation also led to increases in production costs and adversely affected the ability of our industrial customers to honor their debts.

 

Despite the increase in non-performing assets, there has been a reduction in default rates since the second quarter of 2013. This behavior was mainly due to the measures adopted by the Bank in late 2012, primarily related to the reassessment of limits for loans with higher level of collateral requirements and to the review of collection practices with respect to our borrowers whereby we offered certain customers the chance to negotiate a restructuring of their debts. These and other actions in 2013 helped improve the quality of this credit portfolio.

 

Real Estate

 

Non-performing assets in the real estate lending portfolio totaled R$316 million at December 31, 2013, an increase of R$33 million, or 11.6%, compared to 2012.

 

The increase in non-performing assets was primarily due to the growth of this credit portfolio, which grew by 27.1% in 2013. Notwithstanding the increase in non-performing assets, the default rate in the real estate lending portfolio reached 1.24% at December 31, 2013, a decrease of 17 basis points compared to December 31, 2012.

 

In general, the decrease in the default rate was mainly due to the improvement in the quality of this loan portfolio, as a consequence of the change in our portfolio mix in late 2012, with an increased share of secured mortgage loans, which we consider a strategic product due to the lower risk of default.

 

Installment loans to individuals

 

Non-performing assets in the installment loans to individuals lending portfolio totaled R$7,167 at December 31, 2013, with a reduction of 23.5%, or R$2,201 million compared to 2012.

 

The decrease in non-performing assets reflects the measures adopted by the Bank in late 2012 to manage default rates in this portfolio, which included the adaptation of credit limits for new customers, the development of new loan models with “predictive scoring” enhancements and recovery campaigns to offer to delinquent customers loan terms adjustments to help them meet their payment obligations.

 

 

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Although the Brazilian economy continues presenting an unfavorable outlook for growth, low unemployment levels and a continued rise in real income have contributed positively to the reduction in default rates in this portfolio.

 

Financial Leasing

 

Non-performing assets in the financial leasing lending portfolio totaled R$129 million at December 31, 2013, with a reduction of 48.2%, or R$120 million compared to the same period last year, primarily due to the reduction in lending in this portfolio, in line with the market trend of decreased automobile financing to individuals. This trend was also observed in 2012, when non-performing assets in the financial leasing lending portfolio decreased 38.7%, or R$157 million compared to the same period in 2011.

 

Methodology for Impairment Losses

 

Our methodology for impairment losses efficiently captured the acceleration in delinquencies due to internal rating models based on client behavior data and available external credit bureau rating information, which updates the probability of default, or “PD” (the probability of a borrower failing to meet its principal and/or interest payment obligations), used by us to estimate our provisions for loan losses.

 

PD is measured using a time horizon of one year; that is, it quantifies the probability of a borrower defaulting in the coming year. A loan is in default if either the principal or interest is past due by ninety days or more or the loan is current but there are doubts as to the solvency of the borrower (which is recorded as subjective doubtful assets).

 

In addition to PD, we manage our loan portfolio by granting loans to borrowers who have higher volumes of guarantees relating to the loans and also maximizes the bank’s loan recovery. These and other actions combined are responsible for ensuring the adequacy of the LGD parameters (loss resulting from the event of default by the borrower to honor the principal and/or interest payments).

 

LGD calculation is based on the net charge offs on defaulted loans, taking into account the guarantees/collateral associated with the loans, the income and expenses associated with the recovery process and the timing of delinquency.

 

The methodology for impairment losses also considers the loss identification period, that is, the time period between the occurrence of a loss event and the identification of an objective evidence of this loss by the Bank. In other words, it represents the time horizon from the credit loss occurrence until the effective confirmation of this loss.

 

Prior to writing off past due loans (which is only done after we have completed all recovery efforts), we record provisions for the remaining balance of the loan so our allowance for impairment losses fully cover, our losses. Thus, we understand that our allowance for impairment loss methodology has been developed to fit its risk metrics and capture loans that could potentially become impaired.

 

Finally, loans originated in 2013 and 2012 have a higher proportion of loans with higher level of collateral or other credit enhancements as required pursuant to our updated underwriting standards, which therefore requires a lower level of provisioning.

 

Loans past due for less than 90 days but not classified as impaired

 

The following table shows the loans past due for less than 90 days but not classified as impaired at the dates indicated:

 

		At December 31,
		2013				% of total				2012				% of total
		(in millions of R$, except percentages)
Commercial, financial and industrial			5,208				23.7				7,071				36.4
Mortgage loans			6,841				31.2				1,305				6.7
Installment loans to individuals			9,652				44.0				10,346				53.3
Lease financing			231				1.1				703				3.6
Total (*)			21,932				100.0				19,425				100.0

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(*)	Refers only to loans past due between 1 and 90 days.

 

 

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Impaired Asset Ratios

 

The following table shows the ratio of our impaired assets to total computable credit risk and our coverage ratio at the dates indicated.

 

		At December 31,
		2013				2012				2011				2010				2009
		(in millions of R$ except percentages)
Computable credit risk(1)			257,420				238,807				216,756				183,121				159,362
Non-performing assets			14,022				16,057				13,073				9,348				9,899
Allowances for impairment losses			13,641				14,042				11,180				9,192				10,070
Ratios
Non-performing assets to computable credit risk			5.4	%			6.7	%			6.0	%			5.1	%			6.2	%
Coverage ratio(2)			97.3	%			87.3	%			85.5	%			98.3	%			101.7	%
Net Expenses			(13,900	)			(16,476	)			(9,382	)			(8,233	)			(9,983	)
Other financial instruments not measured at fair value			(218	)			—				—				(0.9	)			17
Total net expenses			(14,118	)			(16,476	)			(9,382	)			(8,234	)			(9,966	)

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(1)	Computable credit risk is the sum of the face amounts of loans and leases (including non-performing assets but excluding country risk loans), guarantees and documentary credits.

 

(2)	Allowances for impairment losses as a percentage of non-performing assets.

 

 

Non-current assets held for sale

 

The following table shows the movement in non-current assets held for sale at the dates indicated.

 

		At December 31,
		2013				2012				2011
		(in millions of R$, except percentages)
Balance at beginning of year			315				223				168
Foreclosures loans and other assets transferred(1)			51				113				24,875
Disposals(1)			(42	)			(30	)			(24,820	)
Others			—				9				—
Final balance, gross			324				315				223
Impairment losses			(50	)			(149	)			(91	)
Impairment as a percentage of foreclosed assets			15.3	%			47.5	%			40.8	%
Balance at end of year			275				166				132

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(1)	In 2011, includes R$24.7 billion of assets of Santander Seguros. Additionally, in 2011 we sold R$22.3 billion of liabilities that were associated with non-current assets held for sale of Santander Seguros. For further details see Note 3.b to our audited consolidated financial statements.

 

Liabilities

 

Deposits

 

The principal components of our deposits are customer demand, time and notice deposits, and international and domestic interbank deposits. Our retail customers are the principal source of our demand, time and notice deposits.

 

 

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The following tables analyze our deposits at the dates indicated.

 

		At December 31,
		2013				2012				2011
		(in millions of R$)
Deposits from central banks and credit institutions
Time deposits			30,510				26,077				27,023
Demand deposits			251				48				133
Repurchase agreements			3,271				8,949				24,371
of which:
Backed operations with Private Securities (1)			373				559				223
Backed operations with Public Securities			2,898				8,390				24,148
Total deposits of the Brazilian Central Bank and Credit Institutions			34,032				35,074				51,527
Customer deposits
Current accounts			15,585				13,585				13,561
Savings accounts			33,589				26,857				23,293
Time deposits			81,350				84,586				83,942
Repurchase agreements			69,632				63,567				53,678
of which:
Backed operations with Private Securities (1)			41,853				35,736				30,247
Backed operations with Public Securities (1)			27,779				27,831				23,431
Total Customer deposits			200,156				188,595				174,474
Total deposits			234,188				223,669				226,001

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(1)	Refers primarily to repurchase agreements backed by debentures of own issue.

 

 

The following table shows the maturity of time deposits (excluding inter-bank deposits) in denominations of U$100,000 or more at the dates indicated. Large denomination customer deposits may be a less stable source of funds than demand and savings deposits.

 

		At December 31, 2013
		Domestic				International
		(in millions of R$)
Under 3 months			5,705				1,002
3 to 6 months			24,847				4
6 to 12 months			3,531				—
Over 12 months			5,203				511
Total			39,286				1,517

Short-Term Borrowings

 

The following table shows our short-term borrowings consisting of government securities that we sold under agreements to repurchase for purpose of funding our operations.

 

		For the year ended December 31,
		2013								2012								2011
		Amount				Average Rate				Amount				Average Rate				Amount				Average Rate
		(in millions of R$, except percentages)
Securities sold under agreements to repurchase
At December 31			72,879				10.8	%			72,516				10.6	%			78,048				10.9	%
Average during the period			77,241				10.7	%			70,723				11.1	%			64,510				11.9	%
Maximum month-end balance			84,004								75,759								76,693
Total short-term borrowings at year end			72,879								72,516								78,048

 

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4C .   Organizational Structure

 

Santander Group controls Santander Brasil directly and indirectly through Sterrebeeck B.V. (“Sterrebeeck”), Grupo Empresarial Santander, S.L. (“GES”) and Santander Insurance Holding, S.L., which are controlled subsidiaries. As of December 31, 2013, Santander Spain held, directly and indirectly, 75.68% of our voting stock.

 

Santander Spain ended December 2013 as the largest bank in the euro zone, with market capitalization, of €73,732 million. As of December 31, 2013, Santander Spain’s attributable profit totaled €4,370 million, 90.5% higher than the previous year, and shareholder dividends were €0.60 per share. The Santander Group operates principally in Spain, the United Kingdom, other European countries, Brazil and other Latin American countries and the United States, offering a wide range of financial products. In Latin America, the Santander Group has majority shareholdings in financial institutions in Argentina, Brazil, Chile, Mexico, Peru, Puerto Rico and Uruguay. As of December 31, 2013, Santander Brasil contributed 23.0% of the profit attributable to the Santander Group.

 

The following table presents the name, country of incorporation or residence and proportion of ownership interest of our main subsidiaries in accordance with the criteria for consolidation pursuant to IFRS:

 

			Country of Incorporation		Ownership Interest
	Activity				Direct				Indirect
Direct and Indirect subsidiaries of Banco Santander (Brasil) S.A.
Banco Bandepe S.A.	Bank		Brazil			100.00	%			100.00	%
Santander Leasing S.A. Arrendamento Mercantil	Leasing		Brazil			78.57	%			99.99	%
Aymoré Crédito, Financiamento e Investimento S.A.	Financial		Brazil			100.00	%			100.00	%
Santander Brasil Administradora de Consórcio Ltda.(2)	Buying club		Brazil			100.00	%			100.00	%
Santander Microcrédito Assessoria Financeira S.A.	Microcredit		Brazil			100.00	%			100.00	%
Santander Brasil Advisory Services S.A.	Other Activities		Brazil			96.52	%			96.52	%
CRV Distribuidora de Títulos e Valores Mobiliários S.A.	Dealer		Brazil			100.00	%			100.00	%
Santander Corretora de Câmbio e Valores Mobiliários S.A	Broker		Brazil			99.99	%			100.00	%
Santander Participações S.A	Holding		Brazil			100.00	%			100.00	%
Santander Getnet Serviços para Meios de Pagamento S.A.(1)	Other Activities		Brazil			50.00	%			50.00	%
Sancap Investimentos e Participações S.A	Holding		Brazil			100.00	%			100.00	%
Mantiq Investimentos Ltda.	Other Activities		Brazil			100.00	%			100.00	%
Santos Energia Participações S.A.	Holding		Brazil			100.00	%			100.00	%
Santander Brasil, EFC	Financial		Spain			100.00	%			100.00	%
Santander S.A. Serviços Técnicos, Administrativos e de Corretagem de Seguros	Insurance Broker		Brazil			60.65	%			60.65	%
Controlled by Sancap
Santander Capitalização S.A.	Savings and annuities		Brazil			—				100.00	%
Ablasa Participações S.A.	Holding		Brazil			—				100.00	%
Controlled by Santander Serviços S.A.
Webcasas S.A.	Other Activities		Brazil			—				100.00	%
Controlled by Santos Energia Participações S.A.
Central Eólica Santo Antônio de Pádua S.A.	Wind Energy		Brazil			—				100.00	%
Central Eólica São Cristovão S.A.	Wind Energy		Brazil			—				100.00	%
Central Eólica São Jorge S.A.	Wind Energy		Brazil			—				100.00	%
Brazil Foreign Diversified Payment Rights Finance Company(a)	Securitization		Cayman Islands			—					(a)
Santander FIC FI Contract I Referenciado DI(a)	Investment Fund		Brazil			—					(a)
Santander Fundo de Investimento Unix Multimercado Crédito Privado(a)	Investment Fund		Brazil			—					(a)
Santander Fundo de Investimento Diamantina Multimercado Crédito Privado de Investimento no Exterior(a)	Investment Fund		Brazil			—					(a)
Santander Fundo de Investimento Amazonas Multimercado Crédito Privado de Investimento no Exterior(a)	Investment Fund		Brazil			—					(a)
Santander Fundo de Investimento SBAC Referenciado DI Crédito Privado(a)	Investment Fund		Brazil			—					(a)
Santander Fundo de Investimento Guarujá Multimercado Crédito Privado de Investimento no Exterior(a)	Investment Fund		Brazil			—					(a)
Santander Fundo de Investimento Financial Curto Prazo(a)	Investment Fund		Brazil			—					(a)
Santander Fundo de Investimento Capitalization Renda Fixa(a)	Investment Fund		Brazil			—					(a)
Santander Paraty QIF PLC(a)	Investment Fund		Brazil			—					(a)

 

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(a)	Company over which effective control is exercised, according to IFRS 10 - Consolidated Financial Statements, and there is no ownership interest.

 

(1)	We have authority to make decisions related to business strategy. Additionally, we allow Santander GetNet the use of our branch network and brand for the sale of products, which among other factors determines our control of Santander GetNet.

 

(2)

At meetings held on July 25, 2012, the Board of Directors of Santander Consórcios and Santander Brasil Consórcios agreed and decided to submit for approval from their respective partners, the proposed incorporation of Santander Consórcios (Incorporated) by Santander Brasil Consórcio (Incorporator) (Incorporation) which was approved at meeting of the Partners Incorporated and Incorporator on July 31, 2012. The merger will give through the transfer of the net book value of incorporated for the stockholders’ equity of the incorporator, based on the audited balance sheet at June 30, 2012. The equity variations occurred between the base date of that balance sheet and the effectiveness of the incorporation (the date of the Contract Amendment) were recognized and recorded directly on the incorporator. On November 30, 2012 this process of incorporation was approved by the BACEN.

 

 

4D .	Property, Plant and Equipment

 

We operate five major administrative operational centers, of which four were owned properties and one was rented. Additionally, we own 458 properties for the activities of our banking network and rent 1,852 properties for the same purpose. Furthermore, in 2013, we have concluded the construction of our new data center in Campinas, which also is an owned property. For further information about the location of our branches, see—”Item 4. Information on the Company — B. Business Overview — Distribution Network.” Our headquarters are located at Av. Presidente Juscelino Kubitschek, 2,041 and 2,235 (Torre São Paulo)–Bloco A, Vila Olímpia, São Paulo, State of São Paulo, Brazil.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

5A.	Operating Results

 

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements for the years ended December 31, 2013, 2012 and 2011 and the related notes thereto, and with the financial information presented under the section entitled “Item 3. Key Information—A. Selected Financial Data” included elsewhere in this annual report. The preparation of the consolidated financial statements referred to in this section required the adoption of assumptions and estimates that affect the amounts recorded as assets, liabilities, revenue and expenses in the years and periods presented and are subject to certain risks and uncertainties. Our future results may vary substantially from those indicated as a result of various factors that affect our business, including, among others, those mentioned in the sections “Forward-Looking Statements” and “Item 3. Key Information—D. Risk Factors,” and other factors discussed elsewhere in this annual report. Our consolidated financial statements for the years ended December 31, 2013, 2012 and 2011, prepared in accordance

 

 

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with IFRS and the report of our independent registered public accounting firm are included in “Item 18. Financial Statements.”

 

Effects of the Global Financial Markets Crisis on our Financial Condition and Results of Operations

 

The global financial markets crisis has significantly affected the world economy since the second half of 2008. It has led to recessions and increasing unemployment in the world’s leading economies, a reduction in investments on a global scale, a decrease in raw material prices and a sharp decline in credit availability and liquidity, as well as a general closure of the capital markets worldwide.

 

In Brazil, however, the effects of the global financial markets crisis were initially relatively moderate compared to those in the United States and Europe, and the Brazilian economy experienced a rapid and strong recovery shortly following the global crisis. After contracting 0.3% in 2009, GDP increased 7.5% in 2010 as compared to the previous year. In 2011, the economy slowed down to a growth of an estimated 2.7%, reflecting the lagged effects of a more restrictive monetary policy of the Brazilian Central Bank and the spillover of the international financial crisis (primarily in Europe). In 2012 and 2013, the latent effects of the international crisis persisted in Brazil and the domestic economy continued to slow down despite monetary and fiscal easing. Relatively strong domestic demand has sustained economic growth in Brazil, particularly due to high consumer confidence, strong labor markets and readjustments to the minimum wage. Also, the Brazilian Central Bank lowered reserve requirements and, in response, public banks increased their supply of credit. As a result, the global liquidity crisis had relatively little impact in Brazil.

 

The global financial crisis did not have a material impact on our liquidity and capital resources due to the relatively stable economic environment in Brazil, our relatively low dependence on funding from the international markets, a proactive approach from the Brazilian Central Bank and the liquidity cushion we built up in response to the global financial markets crisis. We gauge liquidity needs on a recurring basis based on our business plans and we pursue funding actions based on anticipated funding needs.

 

Brazilian Macroeconomic Environment

 

In the first half of 2011, the Brazilian Central Bank began focusing on measures to control economic growth and inflation in Brazil. By mid-year, when the global economy began showing signs of uncertainty, the government and the Brazilian Central Bank reversed this course and started implementing measures to stimulate the economy, including reducing interest rates. In December 2011, in further efforts to increase liquidity in the banking system, the Brazilian Central Bank announced changes to decrease the return on a portion of required reserves when these resources are not used by banks to either buy loan portfolios from smaller banks, or Financial Bills ( Letras Financeiras ), or used as interbank loans.

 

In 2012, in a challenging market environment, the economy slowed down substantially (with GDP growth of 1.0%), which resulted in a direct impact on credit quality in Brazil. As a consequence, the financial system suffered an increase in overall delinquency ratios, driven mainly by lending to individuals. The efforts of the government and the Brazilian Central Bank to increase liquidity and boost the economy continued in 2012, with additional measures such as reducing reserve requirements on time deposits and demand deposits and channeling liquidity to smaller banks.

 

In 2013, the pace of economic growth has remained slow (with GDP growth of 2.3%), while the credit quality in Brazil had improved, especially in lending to individuals. The delinquency ratio decreased in a reversal from the trend of an increasing delinquency ratio in 2012 as compared to 2011, reaching 3.0% as of December 31, 2013 as compared to 3.7% in 2012 and unemployment reached historically low rates.

 

 

 

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Other Factors Affecting Our Financial Condition and Results of Operations

 

As a Brazilian bank, we are significantly affected by the general economic environment in Brazil. The following table presents key data of the Brazilian economy for the periods indicated:

 

		For the year ended December 31,
		2013				2012				2011
GDP growth(1)			2.3	%			1.0	%			2.7	%
CDI rate(2)			8.0	%			8.4	%			11.6	%
TJLP(3)			5.0	%			5.7	%			6.0	%
SELIC rate(4)			10.0	%			7.25	%			11.0	%
Increase (decrease) in Real value against the U.S. dollar			14.5	%			8.9	%			12.6	%
Selling exchange rate (at period end) R$ per U.S.$1.00			2.34				2.04				1.88
Average exchange rate R$ per U.S.$1.00(5)			2.17				1.95				1.67
Inflation (IGP-M)(6)			5.5	%			7.8	%			5.1	%
Inflation (IPCA)(7)			5.9	%			5.8	%			6.5	%

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Sources: BNDES, Brazilian Central Bank, FGV and IBGE.

 

(1)	Revised series. Source: IBGE.

 

(2)	The overnight interbank deposit rate ( Certificado de Depósito Interbancário ), or “CDI” is the average daily interbank deposit rate in Brazil (at the end of each month and annually).

 

(3)	Represents the interest rate applied by the BNDES for long-term financing (at the end of the period).

 

(4)	The benchmark interest rate payable to holders of some securities, such as treasury financial letters, issued by the Brazilian government and traded on the SELIC.

 

(5)	Average of the selling exchange rate for the last day of each month during the period.

 

(6)	The inflation rate is the general index of market prices ( Índice Geral de Preços-Mercado, or “IGP-M”), as calculated by FGV.

 

(7)	The inflation rate is the consumer price index ( Índice de Preços ao Consumidor – Amplo , or “IPCA”), as calculated by the IBGE.

 

 

Interest Rates

 

Since the implementation of an inflation target framework in 1999, local interest rates have been on a downward trend. The SELIC was lowered from 45.00% per annum in 1999 to 13.75% in 2008, shortly before the 2008/2009 global financial crisis began. The global financial crisis led to further reductions of the SELIC, which reached 8.75% in 2009 (its lowest historical level until then). The reduction in the SELIC contributed significantly to the economic recovery in Brazil. The normalization of local liquidity conditions and inflationary pressure in 2010 led the Brazilian Central Bank to raise rates by 375 basis points between April 2010 and July 2011, when the SELIC reached 12.50%. Nevertheless, the persistence of uncertainty in international markets and the first signs of slowdown in domestic activity led the Brazilian Central Bank to resume monetary easing in August 2011. Thus, the SELIC rate was cut by 525 basis points between August 2011 and December 2012. On October 10, 2012 the SELIC reached an annual rate of 7.25%, the lowest level in history. In 2013, the Brazilian Central Bank began a monetary tightening cycle due to rising inflation in the 6% range, the depreciation of the real , and a perception of the recovery of certain economic activity. The SELIC rate was increased by 275 basis points, reaching 10% on November 27, 2013 at the last monetary policy committee meeting of the year. As of April 29, 2014, the SELIC rate was 11.00%.

 

The following table presents the low, high, average and period-end SELIC rate since 2009, as reported by the Brazilian Central Bank:

 

		Low				High(1)				Average(2)				Period-End
Year
2009			8.75				12.75				9.92				8.75
2010			8.75				10.75				10.00				10.75
2011			11.00				12.50				11.71				11.00
2012			7.25				10.50				8.46				7.25
2013			7.25				10.00				8.44				10.00

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(1)	Highest month-end rate.

 

(2)	Average of month-end rates during the period

 

 

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Our assets are predominantly fixed rate and our liabilities predominantly floating. The resulting exposure to increases in market rates of interest is modified by our use of cash flow hedges to convert floating rates to fixed, but we maintain an exposure to interest rate movements. As of December 31, 2013, a 100 basis points increase in the yield curve would have resulted in R$383 million decline in the net interest income over a one-year period.

 

Credit Volume

 

Credit volume in Brazil has increased significantly since 2004, mainly driven by lower inflation, decreasing interest rates and consistent economic growth. The worldwide financial crisis temporarily affected the credit growth rates in late 2008 and early 2009. The monetary stimulus implemented by the Brazilian Central Bank as well as the intensive expansion of state-owned banks on credit supply have led to a recovery already in 2009, and intensified in 2010. Between 2010 and 2011, the outstanding credit increased 20% on average, the household debt burden (defined as the percentage of monthly available family income owed to service debt) was 20.2% in this same period, and in the end of 2011 the non-performing loans of individuals was 7.7%. In 2012, with the economic activity slowdown, the household debt burden climbed to 22.5%, and the non-performance loans of individuals rose to 8.0%, which resulted in deceleration of outstanding credit annual growth to 16.4%. The slowdown of credit growth continued through 2013, even with a remarkable expansion of credit supply by state-owned banks. The total outstanding credit increased 14.7% in 2013. Non-performance loans of individuals decreased to 6.7%, and the household debt burden decreased to 21.6% at the end of the year.

 

The total outstanding credit to GDP ratio has increased from 34.2% in December 2007 to 56.1% in December 2013. Although this is one of the highest levels ever achieved by Brazil, it is still low compared to other economies.

 

		2013				2012				2011
		(in billions of R$)
Total Credit Outstanding (*)			2,715				2, 368				2,034
Earmarked credit			1,207				969				802
Non-earmarked based credit			1,508				1,399				1,232
of which:
Corporate			763				706				604
Individuals (retail)			745				693				628

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(*) Some figures may be subject to revision by the Brazilian Central Bank

 

Source: Brazilian Central Bank

 

 

Foreign Exchange Rates

 

Our policy is to maintain limited foreign exchange rate exposure by seeking to match foreign currency denominated assets and liabilities as closely as possible, including through the use of derivative instruments. In 2013, we recorded foreign exchange gains of R$551 million. In 2012, we recorded foreign exchange gains of R$378 million, and in 2011, we recorded foreign exchange losses of R$121 million. These results are due to the variation of the U.S. dollar against the real on our assets and liabilities positions in U.S. dollar denominated instruments during these years. These foreign exchange gains and losses were offset in large part in each year by a corresponding loss or gain on derivatives entered into to hedge this exposure. Such losses and gains are recorded under “Exchange differences (net).”

 

The Brazilian currency has during the last decades experienced frequent and substantial variations in relation to the U.S. dollar and other foreign currencies. Most recently, the real was R$1.566 per U.S.$1.00 in August 2008. Primarily as a result of the crisis in the global financial markets, the real depreciated 31.9% against the U.S. dollar, and reached R$2.337 per U.S.$1.00 at year end 2008. In 2009 and 2010, the real appreciated against the U.S. dollar and reached R$1.666 per U.S.$1.00 at year end 2010. During 2011 the real depreciated and on December 31 st , 2011 the exchange rate was R$1.876 per U.S.$1.00. During 2012 and 2013, the real continued to depreciate and on December 31, 2013, the exchange rate was R$2.343 per U.S.$1.00.

 

 

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Inflation

 

The adoption of inflation targeting in 1999 resulted in a significant reduction in inflation rates in Brazil (measured by the IPCA, Consumer Price Index, the official inflation rate provided by the IBGE). In recent years, inflation has been oscillating around the target, which is set by the National Monetary Council. The target has been set at 4.5% since 2005 with a tolerance interval of 2 percentage points above and below this target.

 

The 2008 global financial crisis contributed to containing inflation in 2009, however domestic demand recovery and commodity price increases contributed to an inflation increase to 5.9% in 2010. In 2011, consumer price inflation climbed to 6.5%, driven by a 9% increase in service prices, and through 2012, consumer price inflation showed a mild reduction to 5.8%, mainly due to the impact of tax reduction on durable goods prices. The inflation rate was 5.91% in 2013, well above the inflation target of 4.5%, due to inflation for services around 9%, and food inflation, which was partially offset by the very low inflation of regulated prices, such as urban transport fares and electricity and telecommunication tariffs.

 

Reserve and Lending Requirements

 

The requirements set by the Brazilian Central Bank for reserves and credit has a significant impact on the operational results of the financial institutions in Brazil. Increases or decreases in such requirements may have an impact on our operational results by limiting or expanding the amounts available for commercial credit transactions.

 

During 2013, there were no changes in the percentage reserve requirements. However the Brazilian Central Bank introduced a timetable of the remuneration on time deposits reserve requirements, introduced by Circular 3,660, dated July 1, 2013. The initial rule stipulated that 36% of the time deposits reserve requirements would not receive remuneration from February 2014, changing this percentage to 27% in April 2014, 18% in June 2014 and 0% in August 2014. According to Circular 3,660, the deadline was brought forward to 36% in July 2013, 27% in November 2013, 18% in January 2014 and 0% in March 2014.

 

The Brazilian Central Bank issued the original rule to give incentive to the transfer of liquidity from large institutions to smaller ones. After verifying that it produced the intended goal, the Brazilian Central Bank decided to anticipate the timetable for completion of the implementation of the provisions of such regulation.

 

 

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The table below shows the requirements for reserves and credit to which we are subject for each financing category:

 

Product		At December 31, 2012				At December 31, 2013				Form of Required Reserve		Yield
Demand deposits
Rural credit loans(1)			34.0	%			34.0	%		Loans		Cap rate: 5.5% p.a.
Microcredit loans(2)			2.0	%			2.0	%		Loans		Cap rate: 2.0% p.m.
Reserve requirements			44.0	%			44.0	%		Cash		Zero
Additional reserve requirements			0.0	%			0.0	%		Cash		SELIC
Free funding(3)			20.0	%			20.0	%
Savings accounts
Mortgage loans			65.0	%			65.0	%		Loans		Cap of TR + 12.0% p.a.
												TR + 6.17% p.a., or
Reserve requirements(4)			20.0	%			20.0	%		Cash		TR + 70.0% of the target SELIC
Additional reserve requirements			10.0	%			10.0	%		Cash		SELIC
Free funding(3)			5.0	%			5.0	%
Time deposits
Reserve requirements			20.0	%			20.0	%
In cash or other instruments(5)			10.0	%			5.4	%		Cash or other instruments		Zero for Cash
In cash			10.0	%			14.6	%		Cash		SELIC
Additional reserve requirements			11.0	%			11.0	%		Cash		SELIC
Free funding(3)			69.0	%			69.0	%

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(1)	Rural credits are credits granted to farmers in the amount of R$4.4 billion and R$5.0 billion on December 31, 2012 and December 31, 2013, respectively.

 

(2)	Micro-credits are credits granted to very small businesses with open position of R$261.6 million and R$268.0 million on December 31, 2012 and December 31, 2013, respectively.

 

(3)	Interest-free financing is the amount to be used on a free of interest basis for other purposes in each financing category.

 

(4)

Upon publication of Circular No. 3,596/2012, the rule for calculation of the interest received on deposit reserves in savings accounts requirements was changed. As of May 31, 2012, whenever SELIC rate target was lower than or equal to 8.5% per year, Cap TR + 70.0% of SELIC target was used, otherwise the former rule was used, i.e. Cap TR + 6.17% per year.

 

(5)	Other instruments include motorcycle financing and certain assets (mainly loan portfolios and Treasury Bills) from eligible financial institutions in accordance with Circular 3,569 of December 2011.

 

 

Taxes

 

See “Item 4. Information on the Company—B. Business Overview— Regulation and Supervision—”Taxation.”

 

Hedging in Foreign Investments

 

We operate a branch in the Cayman Islands and a subsidiary named Santander Brasil Establecimiento Financiero de Credito, EFC, or “Santander EFC” (an independent wholly-owned subsidiary in Spain) which are used primarily for sourcing funds in the international banking and capital markets to provide credit lines for us that are extended to our customers for working capital and trade-related financings. Under Brazilian income tax rules, the gains or losses resulting from the impact of appreciation or devaluation of the real on foreign investments is non-taxable. This tax treatment results in volatility in the income tax line on our income statement. This asymmetry is offset through a derivative position in U.S. dollar futures, which generates gains or losses depending of any devaluation or appreciation of the real , which is our strategy to protect our after-tax results. The reconciliation of our effective tax rate to the statutory tax rate is set forth in note 23b to our consolidated financial statements.

 

Goodwill of Banco Real

 

We generated goodwill of R$27 billion as a result of our acquisition of Banco Real in 2008. Under IFRS, we are required to analyze goodwill for impairment at least annually or whenever there are indications of impairment. In 2013, 2012 and 2011, we assessed goodwill impairment based on net present value techniques. “Value in use” is used as the base to evaluate goodwill with the impairment test. For this purpose, we estimate cash flows for a period of 5 years considering several factors, including: (i) macro-economic projections, such as interest rates, inflation and

 

 

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exchange rates, among others, (ii) the performance and growth estimates of the Brazilian financial system, (iii) increased costs, returns, synergies and investment plans, (iv) the behavior of customers; and (v) the growth rate and long-term adjustments to cash flows. These estimates rely on assumptions regarding the likelihood of future events, and changing certain factors could result in different outcomes. The estimate of cash flows is based on valuations prepared by an independent research company, which is reviewed and approved by the board of executive officers. The goodwill realization in at our level is also considered remote because the possibility of loss from impairment or disposal only applies to the entity as a whole and, according to the characteristics of the business combination performed it is not possible to segregate and identify the business originally acquired. Therefore, amortization of goodwill related to tax generates a permanent difference and no record of the deferred tax liability.

 

		2013				2012				2011
		(Value in use: cash flows)
Main Assumptions
Basis of valuation
Period of the projections of cash flows(1)		5 years				10 years				10 years
Growth rate(2)			7.0	%			6.0	%			5.0	%
Discount rate(3)			14.8	%			15.0	%			15.2	%

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(1)	The projections of cash flow are prepared using internal budget and growth plans of management based on historical data, market expectations and conditions such as industry growth, interest rates and inflation.

 

(2)	The growth rate is calculated based on a real growth rate of 2% p.a. adding to this an annual long term inflation.

 

(3)	The discount rate is calculated based on the capital asset pricing model.

 

We performed a sensitivity test in the goodwill impairment analysis considering the main assumptions that could reasonably be expected to possibly change, as required by the IFRS. Accordingly, we applied such a test considering the discount rate as the main assumption subject to reasonably possible change and we did not identify any impairment to goodwill.

 

Factors Affecting the Comparability of Our Results of Operations

 

Sale of the Investment Fund Management and Managed Portfolio Operations

 

On December 17, 2013, we concluded the sale of our asset management business, by way of disposal of all shares of Santander Brasil Asset Management Distribuidora de Títulos e Valores Mobiliários S.A. (“DTVM”), a company controlled by us. Net income derived from our asset management business amounted to R$74 million in 2011, R$55 million in 2012, and approximately R$55 million in 2013 through the date of sale. For further information on the sale of our asset management business, see “Item 4.—Information on the Company—A. History and Development of the Company—Important Events—Sale of the Investment Fund Management and Managed Portfolio Operations.”

 

Sale of Zurich Santander Brasil Seguros e Previdência S.A. (the new corporate name of Santander Seguros S.A.)

 

On October 5, 2011, we concluded the sale of all shares issued by Zurich Santander Brasil Seguros e Previdência S.A. and indirectly by Zurich Santander Brasil Seguros S.A. (the new corporate name of Santander Brasil Seguros S.A.) to the following companies: (i) Zurich Santander Insurance America S.L. (Zurich Santander), a holding company based in Spain that was 51% held (fifty one percent) by Zurich Financial Services Ltd. and its affiliates (Zurich) and 49% held (forty nine percent) by Santander Spain, and (ii) Inversiones ZS America SPA, a company established in Chile and held by Zurich Santander (Inversiones ZS). On June 8, 2012 SUSEP approved the transfer of the direct control of Zurich Santander Brasil Seguros e Previdência S.A. to Zurich Santander Holding (Spain), S.L., a holding company based in Spain that is 100% held by Zurich Santander and currently the owner of the shares initially transferred to Zurich Santander.

 

This closing effected the transfer (i) by us to Zurich Santander of 11,251,174,948 common shares of Zurich Santander Brasil Seguros e Previdência S.A., and to Inversiones ZS of 3 common shares of Zurich Santander Brasil Seguros e Previdência S.A. and (ii) payment of the preliminary purchase sale price to us, amounting to a net of R$2,741,102 thousand (received on October 5, 2011). On May 10, 2013 the final purchase price was defined by the

 

 

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parties in the amount of R$2,744,990 thousand. On September 3, 2013, we concluded the offering of preemptive rights to shareholders, in accordance with Article 253 of Brazilian Corporate Law.

 

The assets of Zurich Santander Brasil Seguros e Previdência S.A. R$24,731,463 thousand, are primarily composed of R$21,551,422 thousand in debt instruments and equity (public securities, private securities and fund units specially constituted – guarantors of benefit plans – PGBL/VGBL). The liabilities of Zurich Santander Brasil Seguros e Previdência S.A. amount to R$22,349,428 thousand, main, represented by R$21,278,718 thousand in liabilities for securities agreements relating to technical provision for insurance operations and pension plans. The gain recognized in this operation was R$424,292 thousand, recorded as a result of our disposal of non-current assets held for sale that were not classified as discontinued operations.

 

This transaction fits into the strategic partnership between Santander Spain and Zurich, involving the acquisition by Zurich Santander of all property and casualty insurers and life and welfare of Santander Spain in Argentina, Brazil, Chile, Mexico and Uruguay.

 

As part of the arrangement of the transaction, we exclusively distribute these insurance products over the next 25 years through our branch network, with the exception of automobile insurance that is not included in the scope of the transaction. As a result of these contracts, we receive a relative payment equivalent to that received before the transaction. The operation aims to promote and strengthen our activities in the insurance market, providing a greater range of products, reaching classes of customers not currently being reached and leveraging our distribution capabilities.

 

Critical Accounting Policies

 

Our consolidated financial statements have been prepared in accordance with IFRS.

 

General

 

Our principal accounting policies are described in note 2 to our audited consolidated financial statements. The following discussion describes those areas that require the most judgment or involve a higher degree of complexity in the application of the accounting policies, and estimates that currently affect our financial condition and operational results. The accounting estimates made in these contexts require management to make assumptions about matters that are highly uncertain. In this regard, if management decides to change these estimates, or even if changes in these estimates occur from period to period, these accounting estimates could have a material impact on our financial condition and operational results.

 

Management bases its estimates and judgments on historical experience and on various other factors and circumstances, which are believed to be reasonable. Actual results may differ from these estimates if assumptions and conditions change. Judgments or changes in assumptions are submitted to the audit and compliance committee and to our regulatory authorities and are disclosed in the notes to our consolidated financial statements.

 

Fair Value of Financial Instruments

 

We record financial assets and liabilities as financial instruments that are classified at fair value through profit or loss, available for sale securities, and all derivatives at fair value on the balance sheet. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, regardless of whether that price is directly observable or estimated using another valuation technique.

 

In estimating the fair value of an asset or a liability, we take into account the characteristics of the asset or liability if market participants would take those characteristics into account when pricing the asset and liability at the measurement date. That assumed transaction establishes the price to sell the asset or to transfer the liability. In the absence thereof, the price is established on the basis of valuation techniques commonly used by the financial markets.

 

We use derivative financial instruments for both trading and non-trading activities. The principal types of derivatives used are interest rate swaps, future rate agreements, interest rate options and futures, foreign exchange forwards, foreign exchange futures, foreign exchange options, foreign exchange swaps, cross currency swaps, equity index futures, equity options and equity swaps. The fair value of standard derivatives is calculated based on

 

 

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published price quotations. The fair value of over-the-counter derivatives is calculated as the sum of the expected future cash flows arising from the instrument, discounted to present value at the date of measurement (“present value” or “theoretical close”) using valuation techniques commonly used by the financial markets as follows:

 

·

The present value method for valuing financial instruments permitting static hedging (principally, forwards and swaps) and loans and advances. Expected future cash flows are discounted using the interest rate curves of the applicable currencies. The interest rate curves are generally observable market data.

 

·

The Black-Scholes model for valuing financial instruments requiring dynamic hedging (principally structured options and other structured instruments). Certain observable market inputs are used in the Black-Scholes model to generate variables such as the bid-offer spread, exchange rates, volatility, correlation between indexes and market liquidity, as appropriate.

 

·

Each of the present value methods and the Black-Scholes models are used for valuing financial instruments exposed to interest rate risk, such as interest rate futures, caps and floors. The main inputs used in these models are principally observable market data, including appropriate interest rate curves, volatilities, correlations and exchange rates.

 

·

We use dynamic models similar to those used in the measurement of interest rate risk for measuring credit risk of linear instruments (such as bonds and fixed-income derivatives). In the case of non-linear instruments, if the portfolio is exposed to credit risk (such as credit derivatives), the joint probability of default is determined using the Standard Gaussian Copula model. The main inputs used to determine the underlying cost of credit for credit derivatives are quoted credit risk spreads, and the correlation between quoted credit derivatives of various issuers.

 

·

The determination of fair value requires us to make certain estimates and assumptions. If quoted market prices are not available, fair value is calculated using widely accepted pricing models that consider contractual prices of the underlying financial instruments, yield curves, contract terms, observable market data and other relevant factors. The use of different estimates or assumptions in these pricing models could lead to a different valuation being recorded in our consolidated financial statements.

 

See note 2d (iii) to our consolidated financial statements for additional information on valuation techniques used by us and details of the principal assumptions and estimates used in these models and the sensitivity of the valuation of financial instruments to changes in the principal assumptions used.

 

Impairment Losses on Financial Assets

 

Regarding the provision for impairment losses from credit risk, we evaluate all loans. Significant loans are individually evaluated for impairment and the loans that are not individually significant are collectively evaluated by grouping similar credit risk characteristics.

 

To measure the impairment loss on loans individually evaluated for impairment, we consider the conditions of the borrowers, such as their economic and financial situation, level of indebtedness, ability to generate income, cash flow, management, corporate governance and quality of internal controls, payment history, industry expertise, contingencies and credit limits, as well as characteristics of assets, such as their nature and purpose, type, sufficiency and liquidity level guarantees and total amount of credit, as well as based on historical experience of impairment and other circumstances known at the time of evaluation.

 

To measure the impairment loss on loans collectively evaluated for impairment, we segregate financial assets into groups considering the characteristics and similarity of credit risk, in other words, according to segment, the type of assets, guarantees and other factors associated such as the historical experience of impairment and other circumstances known at the time of assessment.

 

The impairment loss is calculated by the incurred loss method using statistical models that consider the following factors:

 

·

Exposure at default or “EAD” is the amount of risk exposure at the date of default by the borrower. In accordance with IFRS, the exposure at default used for this calculation is the current exposure, as reported in the balance sheet.

 

 

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·

PD is the probability of the borrower failing to meet its principal and/or interest payment obligations. PD is measured using a time horizon of one year; that is, it quantifies the probability of the borrower defaulting in the coming year. A loan is in default if either the principal or interest is past due by ninety days or more or the loan is current but there are doubts as to the solvency of the counterparty (subjective doubtful assets).

 

·

Loss given default, or “LGD,” is the loss arising in the event of default. In addition to the Probability of Default (PD), we manage our portfolio looking for loans where borrowers will provide higher volumes of guarantees relating to the operations and also acts constantly strengthening the area of loan recovery. These and other actions combined are responsible for ensuring the adequacy of the LGD parameters (loss resulting from the event of default by the borrower to honor the principal and / or interest payments).

 

LGD calculation is based on the net charge offs on defaulted loans, taking into account the guarantees/collateral associated with the loans, the income and expenses associated with the recovery process and the timing of delinquency.

 

·

Loss identification period, or “LIP,” is the time period between the occurrence of a loss event and the identification of an objective evidence of this loss by the Bank. In other words, it represents the time horizon from the credit loss occurrence until the effective confirmation of this loss.

 

Moreover, prior to charging off past due loans (which is only done after we have completed all recovery efforts), we record provisions to the remaining balance of the loan so our allowance for impairment losses fully covers our losses. Thus, we understand that our allowance for impairment losses methodology has been developed to fit its risk metrics and capture loans that could potentially become impaired.

 

Impairment

 

Certain assets, such as intangible assets, including goodwill, equity method investments, financial assets not carried at fair value through profit or loss and other assets are subject to impairment review. We record impairment charges when we believe there is objective evidence of impairment, or that the cost of the assets may not be recoverable.

 

The assessment of what constitutes impairment is defined based on the following models:

 

We test goodwill for impairment on an annual basis, or more frequently if events or changes in economics circumstances, such as an adverse change in the Bank’s business condition or observable market data, indicate that these assets may be impaired. The recoverable amount determination used in the impairment assessment requires prices of comparable businesses, present value or other valuation techniques, or a combination thereof, requiring management to make subjective judgments and assumptions. Events and factors that may significantly affect the estimates include, among other things, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, and changes in discount rates and specific industry or market sector conditions. If an impairment loss is recognized for goodwill, it may not be reversed in a subsequent period (as a result of the impairment test of goodwill for 2013 and 2012 the recoverable amount of the cash generating unit did not present deterioration). The recognition of impairment is applicable when significant changes occur in the main estimates used to evaluate the recoverable amounts of the cash-generating unit (recoverable amount below the carrying amount.

 

Given the level of uncertainty related to these assumptions, our directors carry out sensitivity analysis using reasonably possible changes in the key assumptions on which the recoverable amount of the cash-generating units are based in order to confirm that the recoverable amounts still exceed the carrying amounts.

 

All debt and equity securities (other than those carried at fair value through profit or loss) are subject to impairment testing every reporting period. The carrying value is reviewed in order to determine whether an impairment loss has been incurred.

 

Evaluation for impairment includes both quantitative and qualitative information. For debt securities, such information include actual and estimated incurred credit losses indicated by payment default, market data on (estimated) incurred losses and other current evidence that the issuer may not pay amounts when due. Equity securities are impaired when management believes that, based on a significant or prolonged decline of fair value

 

 

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below the acquisition price, there is sufficient reason to believe that the acquisition cost may not be recovered. “Significant” and “prolonged” are interpreted on a case-by-case basis for specific equity securities.

 

Upon impairment of either debt or equity instruments, the amount considered as effective loss is recognized in profit or loss. In addition, we did not identify any impairment of tangible assets in 2013 and 2012 (see notes 14, 13 and 12, respectively, to our audited consolidated financial statements).

 

Post-employment Benefit Plan

 

The Post-employment benefits plans include the following obligations undertaken by us: (i) to supplement the public social security system benefits, and (ii) medical assistance in the event of retirement, permanent disability or death for eligible employees and their direct beneficiaries.

 

Defined contribution plan

 

A defined contribution plan is the post-employment benefits plan for which we and our controlled entities as employer entities pay pre-determined contributions to a separate entity and will have no legal or constructive obligation to pay further contributions if the separate entity does not hold sufficient assets to honor all benefits relating to the service rendered in the current and prior periods.

 

These contributions are recognized as personnel expenses in the consolidated income statement.

 

Defined benefit plans

 

A defined benefit plan is the post-employment benefit plan which is not a defined contribution plan and is shown in note 21 to our audited consolidated financial statements. For this type of plan, the sponsoring entity’s obligation is to provide the agreed benefits to employees, assuming the potential actuarial risk that benefits will cost more than expected.

 

A defined benefit plan, the amendment of IAS 19 established fundamental changes in the accounting for and disclosure of employee post-employment benefits such as removing the mechanism of the corridor approach for recording of the obligation of the plans, as well as changes in the criteria for recognition of conventional interest of plan assets (valuation based on the discount rate actuarial liability).

 

The adoption of this new accounting policy involves, fundamentally, full recognition of liabilities on account of actuarial losses (actuarial deficit) not recognized previously, against to the stockholders’ equity (Statements of Comprehensive Income).

 

Main Definitions:

 

·

The present value of the defined benefit obligation is the present value of expected future payments required to settle the obligation resulting from employee service in the current and past periods, without deducting any plan assets.

 

·

Deficit or surplus is: (a) the present value of the defined benefit obligation, less (b) the fair value of plan assets.

 

·

The sponsoring entity may recognize the plan’s assets in the balance sheet when they meet the following characteristics: (i) the assets of the fund are sufficient to meet all employee benefit plan or a sponsor obligations; or (ii) the assets are returned to the sponsoring entity in order to reimburse it for employee benefits already paid.

 

·

Actuarial gains and losses are changes in present value of defined benefit obligation resulting from: (a) adjustments due to experience (the effects of differences between the actuarial assumptions adopted and what has actually occurred); and (b) effects of changes in actuarial assumptions.

 

·

Current service cost is the increase in the present value of the defined benefit obligation resulting from employee service in the current period.

 

 

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·

The past service cost is the change in present value of defined benefit obligation for employee service in prior periods resulting from a change in the plan or reductions in the number of employees covered.

 

Post-employment benefits are recognized in the income statement in the lines of “Interest expense and similar charges” and “Provisions (net).”

 

The defined benefit plans are recorded based on an actuarial study, conducted annually by an external consultant, at the end of each year to be effective for the subsequent period.

 

Results of Operations for the year ended December 31, 2013 Compared to the year ended December 31, 2012

 

On December 17, 2013, we gave notice to the market of the sale of our asset management business by way of disposal of all shares of DTVM, a company controlled by us. The asset management activities then performed by DTVM were segregated into a new asset manager created for that purpose. The sales price was R$2,243 million, generating a post-tax capital gain of R$1,205 million (after deducting costs).

 

We will remain as the administrator of the funds and in charge of distribution activities, receiving remuneration in line with market practices. The transaction is part of a worldwide partnership between Santander Spain and two of the world’s leading private equity companies, Warburg Pincus and General Atlantic.

 

Due to the sale of the Asset Management business, we reviewed our business segmentation and concluded that it would be more appropriate to merge both of our insurance and asset management segments with the Commercial Banking segment. This change was reflected retrospectively on the periods reported on this form.

 

Highlights

 

For the year ended December 31, 2013, we reported a consolidated net income of R$5.8 billion, a 6.5% increase as compared to 2012. Impairment losses on financial assets decreased 14.3%, or R$2.4 billion, to R$14.1 billion for the year ended December 31, 2013 as compared to R$16.5 billion for the year ended December 31 2012, as a consequence of decreases in delinquency rates during 2013.

 

Changes in our default rates were in line with the general trend of decreasing default rates in the financial system, particularly as observed among private banks, which started in 2012 and lasted throughout 2013, as observed by a decrease in our delinquency rate of loans past due over 90 days from 7.6% in December 2012 to 6.2% in December 2013 (a decrease of 1.4 percentage points).

 

The coverage ratio was 97.3% in December 2013, a 9.9 percentage point increase as compared to 87.4% in December 2012.

 

Our total loan portfolio increased by 7.3% from R$210.7 billion on December 31, 2012 to R$226.2 billion on December 31, 2013. Loans to individuals and corporate customers presented the strongest growth, with increases of R$4,163 million and R$13,363 million, respectively, during the year ended December 31, 2013 compared to 2012. Growth in lending to individuals was driven by an increase of 30.3% in mortgage loans and 5.8% in credit cards. The growth in lending to corporate customers of 18.9% was positively impacted by the exchange rate variation.

 

Deposits from Brazilian Central Bank and deposits from credit institutions plus customer deposits increased by 4.7% to R$234.2 billion on December 31, 2013 from R$223.7 billion on December 31, 2012.

 

Our efficiency ratio was 38.8% in December 2013, a 3.1 percentage point increase from 35.7% in December 2012.

 

Our Basel capital adequacy ratio, in accordance with the Brazilian Central Bank was 19.2% as of December 31, 2013. According to the new rules on regulatory capital in Brazil, the value of goodwill for the calculation of capital base will be deducted from the capital base according to the “phase-in” for implementation of Basel III in Brazil which will be completed by 2019. For further information, see “Item 4. B. Business Overview—Regulation and supervision— Capital Adequancy and Leverage—Basel .”

 

 

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Results of Operations

 

The following table shows the main components of our net income for 2013 and 2012.

 

		For the year ended December 31
		2013				2012				% Change				Change
		(in millions of R$, except percentages)
Net interest income			28,479				31,587				(9.8	)%			(3,108	)
Income from equity instruments			81				94				(13.3	)%			(12	)
Income from companies accounted for by the equity method			91				73				24.6	%			18
Net fees and commissions			8,100				7,610				6.4	%			491
Gains/losses on financial assets and liabilities (net) and exchange differences (net)			(595	)			(170	)		n.d.					(425	)
Other operating income (expenses)			(445	)			(623	)			(28.6	)%			179
Total income			35,713				38,570				(7.4	)%			(2,858	)
Administrative expenses			(13,850	)			(13,773	)			0.6	%			(78	)
Depreciation and amortization			(1,252	)			(1,201	)			4.3	%			(51	)
Provisions (net)			(2,693	)			(2,057	)			30.9	%			(636	)
Impairment losses on financial assets (net)			(14,118	)			(16,476	)			(14.3	)%			2,358
Impairment losses on other assets (net)			(345	)			(38	)		n.d.					(306	)
Other non-financial gains/losses			563				449				25.5	%			115
Operating profit before tax			4,018				5,475				(26.6	)%			(1,457	)
Income taxes			(234	)			(37	)		n.d.					(197	)
Net profit from continuing operations			3,785				5,438				(30.4	)%			(1,653	)
Discontinued operations			2,063				55			n.d.					2,008
Consolidated Profit for the Year			5,848				5,493				6.5	%			355

Our consolidated profit for the year ended December 31, 2013 was R$5.8 billion, a 6.5%, increase as compared to 2012.

 

This variation in our consolidated profit for the year was mainly due to:

 

·

A decrease of 14.3%, or R$2,358 million, in impairment losses on financial assets (net) for the year ended December 31, 2013 compared to the year ended December 31, 2012, mainly as a consequence of the improvement in the quality of our loan portfolio.

 

·

An increase of R$2,008 million, in discontinued operations for the year ended December 31, 2013 compared to the year ended December 31, 2012, principally due to gains of the sale of Santander Brasil Asset Management Distribuidora de Títulos e Valores Mobiliários. For further information, see “Item 4. Information on the Company—A History and Development of the Company—Important Events—Sale of the Investment Fund Management and Managed Portfolio Operations.”

 

These increases were offset by:

 

·

A 9.8% or R$3,108 million, decrease in net interest income for the year ended December 31, 2013 as compared to the year ended December 31, 2012 mainly due to lower average spreads, which are mainly explained by a greater share of products within our credit portfolio with lower spreads and lower risk.

 

·

A 30.9% or R$636 million, increase in net provisions for the year ended December 31, 2013 compared to the year ended December 31, 2012. This increase was mainly due to R$988 million in expenses to establish a fund to cover the impact of projects aimed at improving operational productivity and efficiency, partially offset by gains of R$568 million related to the installment program and cash payment of tax and social security debts.

 

 

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