FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Report of Foreign Issuer

Pursuant to Rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934

For the month of June 2011

Commission File Number: 001-14554

Banco Santander Chile
Santander Chile Bank
(Translation of Registrant's Name into English)

Bandera 140
Santiago, Chile
(Address of principal executive office)

Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F:
 
Form 20-F
X
 
Form 40-F
 
 
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1):
 
Yes
   
No
X
 
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7):
 
Yes
   
No
X

 




 
 

 


Banco Santander Chile


TABLE OF CONTENTS


Item
 
   
1.
2010 Disclosure Update



 
2

 
 
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
 
We have made statements in this report on Form 6-K that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear throughout this report and include statements regarding our intent, belief or current expectations regarding:
 
·
asset growth and alternative sources of funding
 
·
growth of our fee based business
 
·
financing plans
 
·
impact of competition
 
·
impact of regulation
 
·
exposure to market risks including:
 
 
·
interest rate risk
 
 
·
foreign exchange risk
 
 
·
equity price risk
 
·
projected capital expenditures
 
·
liquidity
 
·
trends affecting:
 
 
·
our financial condition
 
 
·
our results of operation
 
The sections of this report which contain forward-looking statements include, without limitation, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.  Our forward-looking statements also may be identified by words such as “believes”, “expects”, “anticipates”, “projects”, “intends”, “should”, “could”, “may”, “seeks”, “aim”, “combined”, “estimates”, “probability”, “risk”, “VaR”, “target”, “goal”, “objective”, “future” or similar expressions.
 
You should understand that the following important factors, in addition to those discussed elsewhere in this report, could affect our future results and could cause those results or other outcomes to differ materially from those expressed in our forward-looking statements:
 
·
changes in capital markets in general that may affect policies or attitudes towards lending to Chile or Chilean companies
 
·
changes in economic conditions
 
·
the monetary and interest rate policies of the Banco Central de Chile (the “Central Bank”)
 
·
inflation
 
·
deflation
 
·
unemployment
 
·
unanticipated turbulence in interest rates
 
 
 
3

 
 
·
movements in foreign exchange rates
 
·
movements in equity prices or other rates or prices
 
·
changes in Chilean and foreign laws and regulations
 
·
changes in taxes
 
·
competition, changes in competition and pricing environments
 
·
our inability to hedge certain risks economically
 
·
the adequacy of loss allowances
 
·
technological changes
 
·
changes in consumer spending and saving habits
 
·
increased costs
 
·
unanticipated increases in financing and other costs or the inability to obtain additional debt or equity financing on attractive terms
 
·
changes in, or failure to comply with, banking regulations
 
·
our ability to successfully market and sell additional services to our existing customers
 
·
disruptions in client service
 
·
natural disasters
 
·
an inaccurate or ineffective client segmentation model
 
 
You should not place undue reliance on such statements, which speak only as of the date at which they were made. The forward-looking statements contained in this report speak only as of the date of this report, and we do not undertake to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
 
 
 
4

 
 
CERTAIN TERMS AND CONVENTIONS
 
Unless otherwise indicated or the context otherwise requires, all references in this report on Form 6-K to “Santander Chile”, the “Bank”, “we”, “our”, “ours”, “us” or similar terms refer to Banco Santander Chile together with its consolidated subsidiaries.
 
References in this report to certain financial terms have the following meanings:
 
 
·
References to “Chilean GAAP” are to the generally accepted accounting principles in Chile, as supplemented by the applicable rules of the Superintendency of Banks and Financial Institutions (the “SBIF”).
 
 
·
References to “IFRS” are to the International Financial Reporting Standards issued by the International Accounting Standards Board.
 
 
·
References to our “Audited Consolidated Financial Statements” are to the audited consolidated financial statements of Santander Chile as of December 31, 2010 and 2009, together with the notes thereto. The Audited Consolidated Financial Statements were prepared in accordance with Chilean GAAP and are contained in our report on Form 6-K dated March 16, 2010 filed with the Securities and Exchange Commission (“SEC”).
 
As used in this report, the term “billion” means one thousand million (1,000,000,000).
 
In this report, references to “$”, “US$”, “U.S.$”, “U.S. dollars” and “dollars” are to United States dollars and references to “Chilean pesos”, “pesos” or “Ch$” are to Chilean pesos.
 
References to “UF” are to Unidades de Fomento. The UF is an inflation-indexed Chilean monetary unit with a value in Chilean pesos that changes daily to reflect changes in the official Consumer Price Index (“CPI”) of the Instituto Nacional de Estadísticas (the “Chilean National Institute of Statistics”). The UF is revalued in monthly cycles. Each day in the period beginning on the tenth day of the current month through the ninth day of the succeeding month, the nominal peso value of the UF is indexed up (or down in the event of deflation) in order to reflect a proportionate amount of the change in the Chilean Consumer Price Index during the prior calendar month.
 
 
 
5

 
 
PRESENTATION OF FINANCIAL INFORMATION
 
General
 
Santander Chile is a Chilean bank and maintains its financial books and records in Chilean pesos. As required by local regulations, our consolidated financial statements filed with Chilean regulators have been prepared in accordance with accounting principles issued by the SBIF. The accounting principles issued by the SBIF are substantially similar to International Financial Reporting Standards (“IFRS”) but there are some exceptions.  Our Audited Consolidated Financial Statements for the years ended December 31, 2010 and 2009 have been prepared in accordance with the Compendium of Accounting Standards (the Compendium of Accounting Standards or “Compendium”) issued by the SBIF, and are available in our Current Report on Form 6-K filed with the SEC on March 16, 2011.  The SBIF is the banking industry regulator that according to Article 15 of the General Banking Law, establishes the accounting principles to be used by the banking industry. For those principles not covered by the Compendium of Accounting Standards, banks can use generally accepted accounting principles issued by the Chilean Accountant’s Association AG (as approved by the National Council in its December 21, 2009, session which amended Technical Bulletins No. 79 and No. 80) and which coincides with IFRS issued by the International Accounting Standards Board (“IASB”). The term “Chilean Bank GAAP refers to the Compendium as so supplemented by such accounting principles. In the event that discrepancies exist between the accounting principles issued by the SBIF (Compendium of Accounting Standards) and IFRS, the Compendium of Accounting Standards will take precedence. The Notes to the Audited Consolidated Financial Statements contain additional information to that submitted in the Consolidated Statement of Financial Position, Consolidated Statement of Income, Consolidated Statement of Comprehensive Income, Consolidated Statement of Changes in Equity and Consolidated Statement of Cash Flows. These notes provide a narrative description of such statements in a clear, reliable and comparable manner.
 
Differences between IFRS and Chilean Bank GAAP
 
Chilean Bank GAAP, as prescribed by the Compendium of Accounting Standards, differs in certain important respects with IFRS.  The principal differences that should be considered by an investor are the following:
 
Suspension of Income Recognition on Accrual Basis
 
In accordance with the Compendium, financial institutions must suspend recognition of income on an accrual basis in their statements of income for certain loans included in the impaired portfolio.  IFRS does not allow the suspension of accrual of interest on financial assets for which an impairment loss has been determined. We do not believe that this difference materially impacts our financial statements.
 
Charge-offs and Accounts Receivable
 
The Compendium requires companies to establish deadlines for the charge-off of loans and accounts receivables.  IFRS does not require any such deadline for charge-offs.  A charge-off due to impairment would be incurred if, and only if, there is objective evidence of impairment as a result of one or more events occurring after the initial recognition.  This is measured on an ‘incurred’ basis. We do not believe that this difference materially impacts our financial statements.
 
Assets Received in Lieu of Payment
 
The Compendium requires that the initial value of assets received in lieu of payment be the value agreed with a debtor as a result of the loan settlement or the value awarded in an auction, as applicable.  These assets are required to be written off one year after their acquisition, if the assets have not been previously disposed of.
 
IFRS requires that assets received in lieu of payment be initially accounted for at fair value.  Subsequently, asset valuation depends on the classification provided by the entity for that type of asset.  No deadline is established for charging-off an asset. The restatement of gains and losses from repossessed assets would have an impact on the restatement of financial statements under full IFRS guidelines although we would not expect it to be material.
 
Goodwill and Intangible Assets
 
With respect to goodwill and intangible assets, the Compendium provides that:
 
 
6

 
 
 
·
The value of “goodwill” and other depreciable intangible assets will be supported by two reports issued by specialists independent from the (i) bank, (ii) the bank’s external auditors, and (iii) each other.
 
 
·
For assets acquired before December 31, 2008, “goodwill” will be determined according to the Compendium, and will be amortized according to the original amortization schedule for such assets.
 
 
·
Goodwill arising from acquisitions before the date of transition to new Chilean Bank GAAP in January 2009 will be determined based on the previously used accounting criteria.
 
With respect goodwill and intangible assets, IFRS provides that:
 
 
·
The use of independent experts’ valuations is not mandatory.
 
 
·
Beginning with the first full year in which IFRS applies, an entity must discontinue goodwill depreciation and is required to evaluate goodwill for impairment, in compliance with IAS 36.
 
 
·
It is possible to (i) choose a retroactive application of IFRS to goodwill generated before the date of the transition to IFRS, or (ii) adopt an optional exemption to record the balance of goodwill at December 31, 2008 as an attributed cost.
 
Since we have no goodwill, we do not believe that this difference impacts our financial statements.
 
Price Level Restatement of Paid-in Capital and Reserves
 
Due to the need to maintain paid-in capital and reserves in accordance with the regulations in force in prior years, the Compendium provides that the price level restatement applied to paid-in-capital and reserves up to December 31, 2008 will not be reversed.
 
IFRS allows price-level restatement in countries considered hyper-inflationary (more than a 100% accumulated inflation rate during the last three years, among other factors).  Chile is not a hyper-inflationary country and thus price-level restatement of paid-in-capital and reserves will not be allowed under IFRS. The reversal of the price level restatement of paid-in-capital and reserves would have a material adverse impact on equity if the financial statements were restated under full IFRS guidelines.
 
Fair Value Option with Respect to Financial Assets and Liabilities
 
According to the Compendium, banks are not allowed to value assets or liabilities at their fair value in place of the depreciated cost method.
 
IFRS allows an entity to value a financial asset or liability (or a group of financial assets or liabilities, or both), on the official recognition date, at fair value with changes in fair value to be recognized in its financial statements.  Once this option has been made, it is irrevocable.  The fair value option is not applicable to investments in capital instruments without a market price available in an active market, and thus whose fair value cannot be estimated in a reliable way.
 
We does not believe that this difference impacts our financial statements because this accounting treatment is optional.
 
Loan loss allowances
 
On December 29, 2009 the SBIF issued Circular No. 3,489 which incorporates changes to several provisions of the SBIF Compendium of Accounting Standards. Among other changes it states that effective January 2010, companies must complement the basis on which insolvency provisions related to contingent operations are determined, including unrestricted lines of credit, other contingent loans, and other loan commitments. In addition, companies should also apply the changes in risk exposure applicable to contingent loans, found in Chapter B-3 of the SBIF Compendium of Accounting Standards. The accumulated effect of this change in 2010 for us was approximately Ch$63,448 million (Ch$52,662 million net of deferred taxes), which was recorded as equity in our
 
 
7

 
 
Consolidated Statement of Financial Position. According to specific instructions from the SBIF in Letter to Management No. 10 dated December 21, 2010, the SBIF stated that it will not be necessary to calculate the adjustment retrospectively for 2009.

On June 10, 2010 the SBIF issued Circular No. 3,502 which among other things requires that Banks maintain a 0.5% minimum provision for the non-impaired part of the loan portfolio analyzed on an individual basis. In addition, on December 21, 2010 in the Letter to Management No. 9, the SBIF specified that the accounting treatment for the effects originating from the application of this minimum provision is to record it in the income for the period. This change in accounting policy results in a charge to income of Ch$16,845 million (Ch$ 13,767 million net of deferred taxes) in 2010.

On August 12, 2010 Circular No. 3,503 was issued which modified how we must classify loans included in Chapters B-1, B-2, B-3 and C1 of the Compendium of Accounting Standards, which are loans analyzed on an individual basis. Such modifications took effect from January 1, 2011, except for those modifications relating to additional provisions included in the Letter to Management No. 9 relating to Chapter B-1 which took effect in 2010. As a supplement to the Circular, the Letter to Management No. 9 was issued on December 21, 2010 which specifies that adjustments resulting from the adoption of these modifications starting on January 1, 2011 could be recorded during the first quarter of 2011; however, entities may anticipate recognition of the impact of these adjustments, in whole or in part, in 2010. As of December 31, 2010 we have chosen to book the entire provision adjustments aforementioned, which created a Ch$39,800 million (Ch$32,597 million net of deferred taxes) impact in the Consolidated Statements of Income, under the other operating expenses line.
 
Currency of Presentation
 
Currency amounts in our Audited Consolidated Financial Statements, unless otherwise indicated, are expressed in Chilean pesos.  See Note 1(e) to the Audited Consolidated Financial Statements.
 
Loans
 
Unless otherwise specified, all references herein (except in our Audited Consolidated Financial Statements) to loans are to loans and financial leases before deduction for loan loss allowance, and, except as otherwise specified, all market share data presented herein are based on information published periodically by the SBIF. Non-performing loans include the principal and interest of any loan with one installment that is 90 days overdue, and do not accrue interest. Restructured loans for which no payments are overdue are not ordinarily classified as non-performing loans. Past due loans include, with respect to any loan, only the portion of principal and interest that is overdue for 90 or more days, and do not include the installments of such loan that are not overdue or that are overdue for less than 90 days, unless legal proceedings have been commenced for the entire outstanding balance according to the terms of the loan, in which case the entire loan is considered past due within 90 days after initiation of such proceedings. See “Selected Statistical Information at and for the Years Ended December 31, 2010 and 2009–Classification of Loan Portfolio Based on the Borrower’s Payment Performance.”
 
According to the regulations established by IFRS, a loan is evaluated on each financial statement filing date to determine whether objective evidence of impairment exists.  A loan will be impaired if, and only if, objective evidence of impairment exists as a result of one or more events that occurred after the initial recognition of the loan, and such event or events have an impact on the estimated future cash flows of such loan that can be reliably estimated. It may not be possible to identify a single event that was the individual cause of the impairment.
 
An impairment loss relating to a loan is calculated as the difference between the recorded amount of the asset and the present value of estimated future cash flows, discounted at the effective interest rate.
 
Individually significant loans are individually tested to determine if impairment exists. The remaining financial assets are evaluated collectively in groups with similar credit risk characteristics.
 
The reversal of an impairment loss occurs only if it can be objectively related to an event occurring after the initial impairment loss was recorded. In the case of loans recorded at amortized cost, the reversal is recorded in
 
 
8

 
 
income.  See “Selected Statistical Information At And For The Years Ended December 31, 2010 And 2009–Analysis of Loan Loss Allowance”.
 
Outstanding loans and the related percentages of our loan portfolio consisting of corporate and consumer loans in the section entitled “Business Overview” are categorized based on the nature of the borrower. Outstanding loans and related percentages of our loan portfolio consisting of corporate and consumer loans in the section entitled “Selected Statistical Information” are categorized in accordance with the reporting requirements of the SBIF, which are based on the type and term of loans. This disclosure is consistent with IFRS.
 
Effect of Rounding
 
Certain figures in this report and in the Audited Consolidated Financial Statements have been rounded for ease of presentation. Percentage figures included in this report have not in all cases been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding. For this reason, certain percentage amounts in this report may vary from those obtained by performing the same calculations using the figures in the Audited Consolidated Financial Statements. Certain other amounts that appear in this report may not sum due to rounding.
 
Economic and Market Data
 
Unless otherwise indicated, all macroeconomic data related to the Chilean economy is based on information published by the Central Bank, and all market share and other data related to the Chilean financial system is based on information published by the SBIF and our analysis of such information. Information regarding the consolidated risk index of the Chilean financial system as a whole is not available. The non-performing loan ratio in the Chilean banking industry decreased from 3.0% as of December 2009 to 2.7% as of December 2010.
 
Exchange Rates
 
This report contains translations of certain Chilean peso amounts into U.S. dollars at specified rates solely for the convenience of the reader. These translations should not be construed as representations that the Chilean peso amounts actually represent such U.S. dollar amounts, were converted from U.S. dollars at the rate indicated in preparing the Audited Consolidated Financial Statements, could be converted into U.S. dollars at the rates indicated, were converted or will be converted at all.
 
Unless otherwise indicated, all the U.S. dollar amounts at any period end, for any period have been translated from Chilean pesos based on the interbank market rate published by Reuters at 1:30 pm on the last business day of the period. On March 31, 2011, December 31, 2010 and December 31, 2009, the exchange rate in the Informal Exchange Market as published by Reuters at 1:30 pm on these days was Ch$477.45, Ch$467.95 and Ch$507.25, or 0.96% less, 0.09% less and 0.16% more, respectively, than the published observed exchange rate for such date of Ch$482.08, Ch$468.37 and Ch$506.43, respectively, per US$1.00. The Federal Reserve Bank of New York does not report a noon buying rate for the Chilean peso. For more information on the observed exchange rate, see “Exchange Rates”.
 
On January 3, 2011, Chile’s Central Bank announced plans to increase its total international reserves by US$12 billion in 2011. In the first phase, the Central Bank will buy US$50 million a day from January 5 to February 9. The Central Bank will announce the rest of the phases at a later date and, depending on market conditions, could revise the currency intervention program, which is expected to last throughout 2011. We expect the effect of these purchases will be to devalue the peso against the dollar, although actual outcomes could differ due to macroeconomic and other factors. As of March 31, 2011, there had been no further announcements from the Central Bank regarding this program.
 
As of March 31, 2011, one UF was equivalent to Ch$21,578.26 and one UF was equivalent to Ch$21,455.55 as of December 31, 2010. The U.S. dollar equivalent of one UF was U.S.$44.76 as of March 31, 2011, using the observed exchange rate reported by the Central Bank as of December 31, 2010, of Ch$482.08 per U.S.$1.00.

 
 
9

 
 
Risks Associated with Our Business
 
We are vulnerable to the current disruptions and volatility in the global financial markets.
 
In the past two years, the global financial system has experienced difficult credit and liquidity conditions and disruptions leading to less liquidity, greater volatility, general widening of spreads and, in some cases, lack of price transparency on interbank lending rates. Global economic conditions deteriorated significantly in the second half of 2008, and many countries, including the United States, fell into recession. Many major financial institutions, including some of the world’s largest global commercial banks, investment banks, mortgage lenders, mortgage guarantors and insurance companies, have been experiencing significant difficulties. Around the world, there have also been runs on deposits at several financial institutions, numerous institutions have sought additional capital and many lenders and institutional investors have reduced or ceased providing funding to borrowers (including to other financial institutions).
 
Continued or worsening disruption and volatility in the global financial markets could have a material adverse effect on our ability to access capital and liquidity on financial terms acceptable to us, if at all. If capital markets financing ceases to become available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits to attract more customers. Any such increase in capital markets funding costs or deposit rates could have a material adverse effect on our interest margins.
 
In Chile, the continued economic recession has also caused a rise in unemployment, a fall in consumer spending, a fall in real estate prices and a general decline in economic activity. All of these may lead to a decrease in demand for individual and corporate borrowing, a decrease in demand for financial services and a decrease in credit card spending, which may in turn materially adversely affect our financial condition and results of operation.
 
Increased competition and industry consolidation may adversely affect our results of operations.
 
The Chilean market for financial services is highly competitive. We compete with other private sector Chilean and non-Chilean banks, with Banco del Estado, the principal public sector bank, with department stores and larger supermarket chains that make consumer loans and sell other financial products to a large portion of the Chilean population. The lower middle- to middle-income segments of the Chilean population and the small- and mid- sized corporate segments have become the target markets of several banks and competition in these segments is likely to increase. As a result, net interest margins in these segments are likely to decline. Although we believe that demand for financial products and services from individuals and for small- and mid-sized companies will continue to grow during the remainder of the decade, we cannot assure you that net interest margins will be maintained at their current levels.
 
We also face competition from non-bank and non-finance competitors (principally department stores and larger supermarket chains) with respect to some of our credit products, such as credit cards, consumer loans and insurance brokerage. In addition, we face competition from non-bank finance competitors, such as leasing, factoring and automobile finance companies, with respect to credit products, and from mutual funds, pension funds and insurance companies with respect to savings products.
 
The increase in competition within the Chilean banking industry in recent years has led to consolidation in the industry. We expect the trends of increased competition and consolidation to continue and result in the formation of large new financial groups. Consolidation in the industry, which can result in the creation of larger and stronger competitors, may adversely affect our financial condition and results of operations by decreasing the net interest margins we are able to generate. In addition, since November 7, 2001, insurance companies have been allowed to participate and compete with banks in the residential mortgage and credit card businesses.
 
Our allowances for impairment losses may not be adequate to cover future actual losses to our loan portfolio.
 
As of December 31, 2010, our allowance for loan losses and other assets was Ch$442,292 million, and the ratio of our allowance for loan losses to total loans was 2.81%. The amount of allowances is based on our current assessment of and expectations concerning various factors affecting the quality of our loan portfolio. These factors
 
 
10

 
 
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, Chile’s economy, government macroeconomic policies, interest rates and the legal and regulatory environment. As the recent global financial crisis has demonstrated, many of these factors are beyond our control. In addition, as these factors evolve, the models we use to determine the appropriate level of allowance for impairment losses on loans and other assets require recalibration, which can lead to increased provision expense. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations–Operating Results–Results of Operations for the year-ended December 31, 2010 and 2009–Provision for loan losses”. We believe our allowance is adequate as of the date hereof for all known losses. If our assessment of and expectations concerning the above mentioned factors differ from actual developments, or if the quality of our loan portfolio deteriorates or the future actual losses exceed our estimates, our allowance for impairment losses may not be adequate to cover actual losses and we may need to make additional provisions for impairment losses, which may materially and adversely affect our results of operations and financial condition.
 
Our exposure to individuals and small businesses could lead to higher levels of past due loans, allowances for loan losses and charge-offs.
 
A substantial number of our customers consist of individuals (approximately 53.5% of the value of the total loan portfolio as of December 31, 2010, if interbank loans are included) and, to a lesser extent, small- and mid-sized companies (those with annual revenues of less than US$2.6 million), which comprised approximately 15.1% of the value of the total loan portfolio as of December 31, 2010. As part of our business strategy, we seek to increase lending and other services to small companies and individuals. Small companies and lower- to middle-income individuals are, however, more likely to be adversely affected by downturns in the Chilean economy than large corporations and individuals with high incomes. In addition, as of December 31, 2010, our residential mortgage loan book totaled Ch$4,651,137 million, representing 29.6% of our total loans. (See Note 9: “Interbank Loans” and “Note 10: Loans and Accounts Receivables from Customers” in our Audited Consolidated Financial Statements for a description and presentation of residential mortgages in the balance sheet). If the economy and real estate market in Chile experience a significant downturn, as they may due to the global financial and economic crisis, this could materially adversely affect the liquidity, businesses and financial conditions of our customers, which may in turn cause us to experience higher levels of past due loans, thereby resulting in higher provisions for loan losses and subsequent write-offs. This may materially and adversely affect our asset quality, results of operations and financial condition.
 
If we are unable to maintain the quality of our loan portfolio, our financial condition and results of operations may be materially and adversely affected.
 
As of December 31, 2010, our non-performing loans were Ch$416,739 million, and the ratio of our non-performing loans to total loans was 2.65%. For additional information on our asset quality, see “Selected Statistical Information at and for the Year Ended December 31, 2010 and 2009–Classification of Loan Portfolio Based on the Borrower’s Payment Performance”. We seek to continue to improve our credit risk management policies and procedures. However, we cannot assure you that our credit risk management policies, procedures and systems are free from any deficiency. Failure of credit risk management policies may result in an increase in the level of non-performing loans and adversely affect the quality of our loan portfolio. In addition, the quality of our loan portfolio may also deteriorate due to various other reasons, including factors beyond our control, such as the macroeconomic factors affecting Chile’s economy. If such deterioration were to occur, it could materially adversely affect our financial conditions and results of operations.
 
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 significantly fluctuate or decline due to factors beyond our control, including macroeconomic factors affecting Chile’s economy. The real estate market is particularly vulnerable in the current economic climate and this may affect us as real estate represents a significant portion of the collateral securing our residential mortgage loan portfolio. 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
 
 
11

 
 
impairment losses of our loans, which may materially and adversely affect our results of operations and financial condition.
 
Additionally, there are certain provisions under Chilean law that may affect our ability to foreclose or liquidate residential mortgages if the real estate in question has been declared as “family property” by a court. If any party occupying the real estate files a petition with the court requesting that such real estate be declared as family property, our ability to foreclose may be very limited.
 
The growth of our loan portfolio may expose us to increased loan losses.
 
From December 31, 2005 to December 31, 2010, our aggregate loan portfolio, excluding interbank loans, grew by 73.7% in nominal terms to Ch$15,657,556 million (US$33.5 billion), while our consumer loan portfolio grew by 92.2% in nominal terms to Ch$2,700,790 million (US$5.8 billion). From December 31, 2010 to December 31, 2009, our aggregate loan portfolio grew by 14.4% in nominal terms to Ch$15,727,282 million (US$33.6 billion), while our consumer loan portfolio grew by 20.4%. The further expansion of our loan portfolio (particularly in the consumer, small- and mid-sized companies and real estate segments) can be expected to expose us to a higher level of loan losses and require us to establish higher levels of provisions for loan losses.
 
Our loan portfolio may not continue to grow at the same rate. An economic turmoil may lead to a contraction in our loan portfolio.
 
There can be no assurance that our loan portfolio will continue to grow at similar rates to the historical growth rate. A reversal of the rate of growth of the Chilean economy, a slowdown in the growth of customer demand, an increase in market competition or changes in governmental regulations, could adversely affect the rate of growth of our loan portfolio and our risk index and, accordingly, increase our required allowances for loan losses. An economic turmoil 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.
 
The effectiveness of our credit risk management is affected by the quality and scope of information available in Chile.
 
In assessing customers’ creditworthiness, we rely largely on the credit information available from our own internal databases, the SBIF, DICOM en Capital (a Chilean nationwide credit bureau) and other sources. Due to limitations in the availability of information and the developing information infrastructure in Chile, our assessment of the credit risks associated with a particular customer may not be based on complete, accurate or reliable information. In addition, although we have been improving our credit scoring systems to better assess borrowers’ credit risk profiles, we cannot assure you 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 may be materially adversely affected.
 
Fluctuations in the rate of inflation may affect our results of operations.
 
Inflation in Chile gained momentum in 2007 and 2008. According to the Chilean National Statistics Institute, in 2007 and 2008, inflation reached 7.1% and 7.8%, respectively, due to, among other factors, the sharp rise in the international price of oil. High levels of inflation in Chile could adversely affect the Chilean economy and have an adverse effect on our business, financial condition and results of operations. Extended periods of deflation could also have an adverse effect on our business, financial condition and results of operations. In 2009, Chile experienced deflation of 1.4%. In 2010, CPI inflation was 3.0% .
 
Our assets and liabilities are denominated in Chilean pesos, UF and foreign currencies. The UF is revalued in monthly cycles. On each day in the period beginning on the tenth day of any given month through the ninth day of the succeeding month, the nominal peso value of the UF is indexed up (or down in the event of deflation) in order to reflect a proportionate amount of the change in the Chilean Consumer Price Index during the prior calendar month. For more information regarding the UF, see “Asset and Liability Management and Market Risk—Management of
 
 
12

 
 
Inflation Risk” Although we benefit from inflation in Chile, due to the current structure of our assets and liabilities (i.e., a significant portion of our loans are indexed to the inflation rate, but there are no corresponding features in deposits, or other funding sources that would increase the size of our funding base), there can be no assurance that our business, financial condition and result of operations in the future will not be adversely affected by changing levels of inflation, including from extended periods of inflation that adversely affect economic growth or periods of deflation.
 
Our results of operations are affected by interest rate volatility.
 
Our results of operations depend to a great extent on our net interest income. Net interest income represented 68.0% of our operating income in 2010 compared to 65.3% in 2009. Changes in market interest rates could affect the interest rates earned on our interest-earning assets differently from the interest rates paid on our interest-bearing liabilities, leading to a reduction in our net interest income or a decrease in customer demand for our loan or deposit products. Interest rates are highly sensitive to many factors beyond our control, including the reserve policies of the Central Bank, deregulation of the financial sector in Chile, domestic and international economic and political conditions and other factors. In the current economic climate, there is a greater degree of uncertainty and unpredictability in the policy decisions and the setting of interest rates by the Central Bank. Any changes in interest rates could adversely affect our business, our future financial performance and the price of our securities. The following table shows the yields on the Chilean government’s 90-day notes as reported by the Central Bank of Chile at year-end 2006 to 2010.
 
 
Year
 
90-day note at Period end (%)
 
2006
    5.11  
2007
    6.15  
2008
    7.86  
2009
    0.48  
2010
    3.40  


Source: Central Bank.
 
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.
 
Customer deposits are our primary source (56.9%) of funding. As of December 31, 2010, 92.0% of our customer deposits had remaining maturities of one year or less, or were payable on demand. A significant portion of our assets have longer maturities, resulting in a mismatch between the maturities of liabilities and the maturities of assets. 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 incurring high 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.
 
The legal restrictions on the exposure of Chilean pension funds may affect our access to funding.
 
Chilean regulations impose restrictions on the share of assets that Chilean pension fund management companies (Administradora de Fondos de Pension, or “AFPs”) may allocate to a single issuer, which is currently 7% per fund managed by an AFP (including any securities issued by the issuer and any bank deposits with the issuer). If the exposure of an AFP to a single issuer exceeds the 7% limit, the AFP is required to reduce its exposure below the limit within three years. As of December 31, 2010, the aggregate exposure of AFPs to us was approximately US$4.29 billion or 2.89% of their total assets. If the exposure of any AFP to us exceeds the regulatory limit, we would need to seek alternative sources of funding, which could be more expensive and, as a consequence, may have a material adverse effect on our financial condition and results of operations.
 
 
13

 
 
Pension funds must also comply with other investment limits. On June 5, 2007, approved legislation in Chile (Reformas al Mercado de Capitales II, also known as “MK2”) relaxed the limits on making investments abroad in order to permit pension funds to further diversify their investment portfolios. As of December 31, 2010, the limit on making investments abroad was 60% and in 2011 it increased up to 100%, depending on the fund. As a result, pension funds may change the composition of their portfolios, including reducing their deposits with local banks. As of December 31, 2010, 8.6% of our time deposits were from AFPs. Although the legislation referred to above is intended to promote a gradual relaxation of the investment limits, and we may be able to substitute the reduced institutional funds with retail deposits, there can be no assurance that this occurrence will not have a materially adverse impact on our business, financial condition and results of operations.
 
We may be unable to meet requirements relating to capital adequacy.
 
Chilean banks are required by the General Banking Law to maintain regulatory capital of at least 8% of risk-weighted assets, net of required loan loss allowance and deductions, and paid-in capital and reserves (“basic capital”) of at least 3% of our total assets, net of required loan loss allowances. As we are the result of the merger between two predecessors, we are currently required to maintain a minimum regulatory capital to risk-weighted assets ratio of 11%. As of December 31, 2010, the ratio of our regulatory capital to risk-weighted assets, net of loan loss allowance and deductions, was 14.52%. Certain developments could affect our ability to continue to satisfy the current capital adequacy requirements applicable to us, including:
 
·      the increase of risk-weighted assets as a result of the expansion of our business or regulatory changes;
 
·      the failure to increase our capital correspondingly;
 
·      losses resulting from a deterioration in our asset quality;
 
·      declines in the value of our investment instrument portfolio;
 
·      changes in accounting rules;
 
·      changes in provisioning guidelines that are charged directly against our equity or net income; and
 
·      changes in the guidelines regarding the calculation of the capital adequacy ratios of banks in Chile.
 
Starting in 2012, Chilean banks will most likely be required to adopt the guidelines set forth under the Basel II Capital Accord (“Basel II”) with adjustments incorporated by the SBIF once these changes are approved by Congress. This should result in a different level of minimum capital required to be maintained by us. According to initial estimates of the impact of market risk on regulatory capital, published by the SBIF for informational purposes only, our ratio of regulatory capital to risk-weighted assets, net of loan loss allowance and deductions, including an initial estimate of the adjustments for market risk set forth under Basel II, was 13.26% as of December 31, 2010. No assurance can be given that the adoption of the Basel II capital requirements will not have a material impact on our capitalization ratio.
 
We may also be required to raise additional capital in the future in order to maintain our capital adequacy ratios above the minimum required levels. Our ability to raise additional capital may be limited by numerous factors, including: our future financial condition, results of operations and cash flows; any necessary government regulatory approvals; our credit ratings; general market conditions for capital raising activities by commercial banks and other financial institutions; and domestic and international economic, political and other conditions.
 
If we require additional capital in the future, we cannot assure you that we will be able to obtain such capital on favorable terms, in a timely manner or at all. Furthermore, the SBIF may increase the minimum capital adequacy requirements applicable to us. Accordingly, although we currently meet the applicable capital adequacy requirements, we may face difficulties in meeting these requirements in the future. If we fail to meet the capital adequacy requirements, we may be required to take corrective actions. These measures could materially and adversely affect our business reputation, financial condition and results of operations. In addition, if we are unable to raise sufficient capital in a timely manner, the growth of our loan portfolio and other risk-weighted assets may be
 
 
14

 
 
restricted, and we may face significant challenges in implementing our business strategy. As a result, our prospects, results of operations and financial condition could be materially and adversely affected.
 
Our business is highly dependent on proper functioning and improvement 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 (such as earthquakes), 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.
 
Operational problems or errors can have a material adverse impact on our business, financial condition and results of operations.
 
Like all large financial institutions, we are exposed to many types of operational risks, including the risk of fraud by employees and outsiders, failure to obtain proper internal authorizations, failure to properly document transactions, equipment failures and errors by employees. Fraud or other misconduct by employees or third parties may be difficult to detect and prevent and could subject us to financial losses and sanctions imposed by governmental authorities as well as seriously harm our reputation. Although we maintain a system of operational controls, there can be no assurance that operational problems or errors will not occur and that their occurrence will not have a materially adverse impact on our business, financial condition and results of operations.
 
Banking regulations may restrict our operations and thereby adversely affect our financial condition and results of operations.
 
We are subject to regulation by the SBIF. In addition, we are subject to regulation by the Central Bank with regard to certain matters, including reserve requirements, interest rates, foreign exchange mismatches and market risks.
 
Pursuant to the General Banking Law, all Chilean banks may, subject to the approval of the SBIF, engage in certain businesses other than commercial banking depending on the risk associated with such business and their financial strength. Such additional businesses include securities brokerage, mutual fund management, securitization, insurance brokerage, leasing, factoring, financial advisory, custody and transportation of securities, loan collection and financial services. The General Banking Law also applies to the Chilean banking system a modified version of the capital adequacy guidelines issued by the Basel Committee on Banking Regulation and Supervisory Practices and limits the discretion of the SBIF to deny new banking licenses. There can be no assurance that regulators will not in the future impose more restrictive limitations on the activities of banks, including us. Any such change could have a material adverse effect on our financial condition or results of operations.
 
Historically, Chilean banks have not paid interest on amounts deposited in checking accounts. However, since June 1, 2002, the Central Bank has allowed banks to pay interest on checking accounts. Currently, there are no applicable restrictions on the interest that may be paid on checking accounts. We have begun to pay interest on some checking accounts under certain conditions. If competition or other factors lead us to pay higher interest rates on checking accounts, to relax the conditions under which we pay interest or to increase the number of checking
 
 
15

 
 
accounts on which we pay interest, any such change could have a material adverse effect on our financial condition or results of operations.
 
We must maintain higher regulatory capital to risk-weighted assets than other banks in Chile. Our current required minimum regulatory capital to risk-weighted assets ratio is 11% and as of December 31, 2010, we were at 14.52%. Although we have not failed in the past to comply with our capital maintenance obligations, there can be no assurance that we will be able to do so in the future.
 
Currently, there are discussions among the SBIF, SERNAC (Chile’s Consumer Protection Agency) and the Minister of Finance regarding a proposal to place limitations on banks' ability to sell products in packages combining multiple products. There are also discussions that may force banks to auction off subsidiaries that provide credit insurance.  Any such limitation could have a material adverse effect on our financial condition or results of operations.
 
We are subject to regulatory risk, or the risk of not being able to meet all of the applicable regulatory requirements and guidelines.
 
We are also subject to various inspections, examinations, inquiries, audits and other regulatory requirements by Chilean regulatory authorities. We cannot assure you that we will be able to meet all of the applicable regulatory requirements and guidelines, or that we will not be subject to sanctions, fines, restrictions on our business or other penalties in the future as a result of noncompliance. If sanctions, fines, restrictions on our business or other penalties are imposed on us for failure to comply with applicable requirements, guidelines or regulations, our business, financial condition, results of operations and our reputation and ability to engage in business may be materially and adversely affected.
 
We are subject to market and operational risks associated with derivative transactions.
 
We enter into derivative transactions primarily for hedging purposes and, on a limited basis, on behalf of customers. These transactions are subject to market and operational risks, 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 a counterparty to perform its obligations to us).
 
Market practices and documentation for derivative transactions in Chile may differ from those in other countries. For example, documentation may not incorporate terms and conditions of derivatives transactions as commonly understood in other countries. In addition, the execution and performance of these transactions depends on our ability to develop adequate control and administration systems and to hire and retain qualified personnel. Moreover, our ability to monitor and analyze these transactions depends on our information technology systems. These factors may further increase risks associated with derivative transactions and, if they are not adequately controlled, this could materially and adversely affect our results of operations and financial condition.
 
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. If these risks give rise to losses, this could materially and adversely affect our 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 conduct of our banking operations. Although we have procedures and controls to safeguard personal information in our possession, unauthorized disclosures 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.
 
 
16

 
 
Our loan portfolios are subject to risk of prepayment, which may result in reinvestment of assets on less profitable terms.
 
Our loan portfolios are subject to prepayment risk, which results from the ability of a borrower to pay a loan prior to maturity and which comes at a time that is inconsistent with the financing of such loan by us. Generally, in a declining interest rate environment, prepayment activity increases with the effect of reducing weighted average lives of interest earning assets and adversely affecting results. Prepayment risk also has an adverse impact on our credit card and residential mortgage portfolios, since prepayments could shorten the weighted average life of these portfolios, which may result in a mismatch in funding or in reinvestment at lower yields.
 
Risks Relating to Chile
 
The February 2010 earthquake and tsunami in Chile is likely to adversely affect the quality of our loan portfolio in segments of the Chilean economy that have been negatively affected and, as a result, is likely to negatively affect our results of operations.
 
Chile lies on the Nazca tectonic plate, making it one of the world’s most seismically active regions. Chile has been adversely affected by powerful earthquakes in the past, including an 8.0 magnitude earthquake that struck Santiago in 1985 and a 9.5 magnitude earthquake in 1960 which was the largest earthquake ever recorded. On February 27, 2010, an 8.8 magnitude earthquake struck central Chile. The quake epicenter was located 200 miles southwest of Santiago and 70 miles north of Concepción, Chile’s second largest city.
 
Our branches, systems and employees were all impacted by the February 2010 earthquake and tsunami. By March 1, 2010, the systems were functioning normally, all open branches were online and all remote channels were operating normally. As of December 31, 2010, all of our branches were functioning normally.
 
We estimate that the costs incurred and revenue foregone by us as a result of the February 2010 earthquake and tsunami was Ch$4,738 million in 2010, net of insurance proceeds, with no further costs expected in 2011.
 
Temporary increases in the corporate tax rate in Chile to finance part of the reconstruction effort may have an adverse effect on us and our corporate clients.
 
In the government and congress approved legislation that increased the corporate income tax rate in order to pay for part of the reconstruction following the earthquake and tsunami in February 2010. The new legislation has increased the corporate tax rate from its current rate of 17% to 20% in 2011. The rate will decrease to 18.5% in 2012 and further decrease back to 17% in 2013. This legislation may have an adverse effect on us and our corporate clients.
 
Our growth and profitability depend on the level of economic activity in Chile.
 
A substantial amount of our loans are to borrowers doing business in Chile. Accordingly, the recoverability of these loans in particular, and our ability to increase the amount of loans outstanding and our results of operations and financial condition in general, are dependent to a significant extent on the level of economic activity in Chile. Our results of operations and financial condition could be affected by changes in economic or other policies of the Chilean government, which has exercised and continues to exercise substantial influence over many aspects of the private sector, or other political or economic developments in Chile. In line with the global economic climate, Chile’s economy contracted in 2009 for the first time since 1999. However, despite the earthquake, the Chilean economy recovered significantly and GDP increased by 5.2% in 2010.  However, there can be no assurance that the Chilean economy will continue to grow in the future or that future developments will not negatively affect Chile’s overall levels of economic activity.
 
Economic and political problems encountered by other countries may adversely affect the Chilean economy, our results of operations and the market value of our securities.
 
The prices of securities issued by Chilean companies, including banks, are to varying degrees influenced by economic and market considerations in other countries. We cannot assure you that future developments in or
 
 
17

 
 
affecting the Chilean economy, including consequences of economic difficulties in other markets, will not materially and adversely affect our business, financial condition or results of operations.
 
We are directly exposed to risks related to the weakness and volatility of the economic and political situation in Asia, the United States, Europe, Brazil, Argentina and other nations, including the recent global financial and economic crisis. If these nations’ economic conditions deteriorate, the economy in Chile could also be affected and could experience slower growth than in recent years with possible adverse impact on our borrowers and counterparties. Thus, we may need to increase our allowances for loan losses, thus affecting our financial results, our results of operations and the price of our securities. As of December 31, 2010, approximately 0.36% of our assets were held abroad. The global financial and sub-prime crisis had a significant impact on the growth rate of the Chilean economy in 2009. Although the Chilean economy grew 5.2% in 2010, there can be no assurance that the ongoing effects of the global financial crisis will not negatively impact growth, consumption, unemployment, investment and the price of exports in Chile.
 
Chile is also involved in an international litigation with Peru regarding maritime borders and has had other conflicts with neighboring countries in the past. We cannot assure you that crisis and political uncertainty in other Latin American countries will not have an adverse effect on Chile, the price of our securities or our business.
 
Current economic conditions may make it more difficult for us to continue funding our business on favorable terms.
 
Historically, one of our principal sources of funds has been time deposits. Time deposits represented 35.9% and 37.6% of our total funding as of December 31, 2010 and 2009, respectively. Large-denominations in time deposits from institutional investors may, under some circumstances, be a less stable source of funding than savings and bonds, such as during periods of significant changes in market interest rates for these types of deposit products and any resulting increased competition for such funds. The liquidity crisis triggered by the U.S. subprime market impacted global markets and affected sources of funding, including time deposits. As of December 31, 2010, our investment portfolio did not contain instruments (i) backed by, or otherwise related to, U.S. subprime mortgages or (ii) with exposure to monoline financial guarantors. Although our results of operations and financial position have not suffered a significant impact as a consequence of the recent credit market instability in the U.S. and the liquidity available in the Chilean market has permitted us to fund out operations and maintain our regular business activities, we cannot assure you that we will be able to continue funding our business or, if so, maintain our current levels of funding without incurring higher funding costs or having to liquidate certain assets.
 
Economic problems in Argentina and Brazil may have an adverse effect on the Chilean economy and on our results of operations.

We are directly exposed to risks related to the weakness and volatility of the economic and political situation in Latin America, especially in Argentina and Brazil. If Argentina’s economic environment significantly deteriorates or does not improve, the economy in Chile, as both a neighboring country and a trading partner, could also be affected and could experience slower growth than in recent years. The recent cuts in gas exports from Argentina to Chile could also adversely affect economic growth in Chile. Our business could be affected by an economic downturn in Brazil. This could result in the need for us to increase our allowances for loan losses, thus affecting our financial results, our results of operations and the price of our securities. The crises and political uncertainties in other Latin American countries could also have an adverse effect on Chile, the price of our securities or our business.

Deceleration of economic growth in Asia, the United States and other developed nations may have an adverse effect on the Chilean economy and on our results of operations.

We are directly exposed to risks related to the weakness and volatility of the economic and political situation in Asia, the United States and other developed nations, including the recent global credit crunch and economic world crisis. If these nations’ economic environments deteriorate, the economy in Chile could also be affected and could experience slower growth than in recent years. Thus, we may need to increase our allowances for loan losses, thus affecting our financial results, our results of operations and the price of our securities. The crises and political uncertainties in Asian nations, the United States or other developed countries could also have an adverse effect on Chile, the price of our securities or our business.

 
18

 
 
Currency fluctuations could adversely affect our financial condition and results of operations and the value of our securities.
 
Any future changes in the value of the Chilean peso against the U.S. dollar will affect the U.S. dollar value of our securities. The Chilean peso has been subject to large devaluations and appreciations in the past and could be subject to significant fluctuations in the future. Our results of operations may be affected by fluctuations in the exchange rates between the peso and the dollar despite our policy and Chilean regulations relating to the general avoidance of material exchange rate exposure. In order to avoid material exchange rate exposure, we enter into forward exchange transactions. The following table shows the value of the Chilean peso relative to the U.S. dollar as reported by the Central Bank at period end for the last five years and the devaluation or revaluation of the peso relative to the U.S. dollar in each of those periods.
 
 
Year
 
Exchange rate (Ch$) Period end
   
Revaluation (Devaluation) (%)
 
2006
    534.43       3.9  
2007
    495.82       (7.2 )
2008
    629.11       26.9  
2009
    506.43       (19.5 )
2010
    468.37       (7.5 )
March 31, 2011
    482.08       2.9  


Source: Central Bank.
 
On January 3, 2011, Chile’s Central Bank announced plans to increase its total international reserves by US$12 billion in 2011. In the first phase, the Central Bank will buy US$50 million a day from January 5 to February 9. The Central Bank will announce the rest of the phases at a later date and, depending on market conditions, could revise the currency intervention program, which is expected to last throughout 2011. We expect the effect of these purchases will be to devalue the peso against the dollar, although actual outcomes could differ due to macroeconomic and other factors. As of April 30, 2011, there had been no further announcements from the Central Bank regarding this program.
 
We may decide to change our policy regarding exchange rate exposure. Regulations that limit such exposures may also be amended or eliminated. Greater exchange rate risk will increase our exposure to the devaluation of the peso, and any such devaluation may impair our capacity to service foreign currency obligations and may, therefore, materially and adversely affect our financial condition and results of operations. Notwithstanding the existence of general policies and regulations that limit material exchange rate exposures, the economic policies of the Chilean government and any future fluctuations of the peso against the dollar could affect our financial condition and results of operations.
 
Chile’s banking regulatory and capital markets environment is continually evolving and may change.
 
Changes in banking regulations may materially and adversely affect our business, financial condition and results of operations. Chilean laws, regulations, policies and interpretations of laws relating to the banking sector and financial institutions are continually evolving and changing. In 2007, new regulations governing the Chilean capital markets were approved (Reformas al Mercado de Capitales II, also known as MK2). These regulations, among other things, modified certain provisions set forth in the General Banking Law. Under new legislation, the limit on the amount that a bank is allowed to grant as an unsecured loan to a single individual or entity was increased to 10% of our regulatory capital (and up to 30% of our regulatory capital if any loans granted in excess of the 10% is secured by collateral). Previously, these limits were set at 5% and 25%, respectively. Although any such increase may increase our lending activity, it may also increase the risks associated with the growth of our loan portfolio and increase competition as the number of banks that can compete in the corporate segment increases.
 
Chile’s Congress passed a new law in August 2010 intended to increase trading in Chile, Latin America’s third-largest securities market, by allowing trading of new instruments such as exchange-traded funds and covered bonds.  The law also sought to ease credit access for consumers and small companies. For example, the law made it easier
 
 
19

 
 
for foreign banks to offer loans in Chile, cut securitization costs, allowed banks to sell bonds backed by mortgages, offers tax breaks to foreign investors in Chilean mutual funds, and repealed a law that prevented foreign banks from advertising loans. The law also intended to reduce the cost of setting up mutual funds, in part by removing limits on employing non-Chileans, and created an exchange-traded funds industry by modifying mutual fund rules to allow secondary trading and enable pension funds to invest in such mutual funds. The new class of bonds authorized by the law, known as “mortgage bonds,” are a debt obligation secured by a pool of mortgages, as is the case with European covered bonds. Unlike covered bonds, they may be issued by banks and non-banks.
 
The current Finance Minister, Felipe Larrain, plans another package of reforms, the Reformas al Mercado Financiero Bicentenario. These reforms are comprised of a series of administrative changes and new regulations over the next four years, including the creation of a financial consumer protection agency, the transformation of the local securities exchange regulator (SVS) into a securities commission and increasing the autonomy of the SBIF. These proposed regulations intend to expand the use of the Chilean peso, simplify taxes on fixed-income securities, increase bank penetration and household savings, reduce the pro-cyclicality of loan loss provisions and enhance solvency and liquidity (the latter must be done through a change in the General Banking Law). The reforms also intend to create new instruments that give more efficient financing alternatives to small and mid-sized companies and individuals, together with creating specific statutes for niche banks and micro-credit financing.
 
These new reforms could result in increased competition in the industry and thus may have a material adverse effect on our financial condition and results of operations.
 
Increased regulation of the financial services industry in Chile could increase our costs and result in lower profits.
 
As a result of the recent global financial crisis, there has been an increase in government regulation of the financial services industry in many countries. Such regulation may also be increased in Chile, including the imposition of higher capital requirements, heightened disclosure standards and restrictions on certain types of transaction structures.  In addition, novel regulatory proposals abound in the current environment. If enacted, new regulations could require us to inject further capital into our business as well as in businesses we acquire, restrict the type or volume of transactions we enter into, or set limits on or require the modification of rates or fees that we charge on certain loans or other products, any of which could lower the return on our investments, assets and equity.  We may also face increased compliance costs and limitations on our ability to pursue certain business opportunities.
 
In line with the future adoption of Basel II regulations in Chile, the SBIF has recently proposed to increase the minimum regulatory capital ratio from 8% to 10%, which would require an amendment to the General Banking Law. Although we currently have a regulatory capital ratio of 14.52%, this change could require us to inject additional capital to our business in the future. According to initial estimates of the impact of market risk on regulatory capital, published for informational purposes only by the SBIF, our ratio of regulatory capital to risk-weighted assets, net of loan loss allowance and deductions, including an initial estimate of the adjustments for market risk set forth under Basel  II was 13.26% as of December 31, 2010. No assurance can be given that these changes will not have a material impact on our capitalization ratio.
 
A worsening of labor relations in Chile could impact our business.
 
As of December 31, 2010, on a consolidated basis we had 11,001 employees, of which 66.0% were unionized. In May 2010, a new collective bargaining agreement was signed, which will become effective on January 1, 2011 and that will expire on December 31, 2014, but this may become effective ahead of schedule with the consent of management and the union. We generally apply the terms of our collective bargaining agreement to unionized and non-unionized employees. We have traditionally enjoyed good relations with our employees and their unions, but we cannot assure you that in the future a strengthening of cross-industry labor movements will not materially and adversely affect our business, financial condition or results of operations.
 
 
20

 
 
Any downgrading of Chile’s debt credit rating for domestic and international debt and/or our parent company’s ratings by international credit rating agencies may also affect our ratings, our business, our future financial performance and the value of our securities.
 
Our foreign currency deposit ratings are equivalent to the Chilean sovereign ratings. On February 23, 2010, Moody’s downgraded the subordinated debt ratings and preferred share ratings of our parent company, Banco Santander Spain. Additionally, on January 6, 2011, Standard & Poors announced that it is considering a proposal to revise its criteria for rating banks which could cause a downgrade of the ratings of banks, including our ratings or those of our parent company.  As of April 30, 2011 Moody’s and Standard and Poor’s both have a negative outlook for our parent company’s ratings. Any adverse revisions to our parent company’s ratings and/or Chile’s credit ratings for domestic and international debt by international rating agencies may adversely affect our ratings, our business, future financial performance, stockholder’s equity and the price of our securities.
 
Chile has different corporate disclosure and accounting standards than those you may be familiar with in the United States.
 
Accounting, financial reporting and securities disclosure requirements in Chile differ from those in the United States. Accordingly, the information about us available to you will not be the same as the information available to shareholders of a U.S. financial institution. There are also material differences between IFRS and  U.S. accounting and financial reporting standards.
 
As a regulated financial institution, we are required to submit to the Superintendency of Banks on a monthly basis unaudited consolidated balance sheets and income statements, excluding any note disclosure, prepared in accordance with generally accepted accounting principles in Chile and the rules of the Superintendency of Banks. Such disclosure differs in a number of significant respects from information generally available in the United States with respect to U.S. financial institutions.
 
 The securities laws of Chile, which govern open or publicly listed companies such as us, aim to promote disclosure of all material corporate information to the public. Chilean disclosure requirements, however, differ from those in the United States in some material respects. In addition, although Chilean law imposes restrictions on insider trading and price manipulation, applicable Chilean laws are different from those in the United States and in certain respects the Chilean securities markets are not as highly regulated and supervised as the U.S. securities markets.
 
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 consist 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. We currently use these exemptions and intend to continue using these exemptions. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all NYSE corporate governance requirements.
 
We cannot assure you of the accuracy or comparability of facts, forecasts and statistics contained in this report with respect to Chile, its economy and the global banking industry.
 
Facts, forecasts and statistics in this document relating to Chile, Chile’s economy and the Chilean banking industry, including market share information, are derived from various official and other publicly available sources that we generally believe to be reliable. However, we cannot guarantee the quality and reliability of such official and
 
 
21

 
 
other sources of materials. In addition, these facts, forecasts and statistics have not been independently verified by us and, therefore, we make no representation as to the accuracy of such facts, forecasts and statistics, which may not be consistent with other information compiled within or outside of Chile and may not be complete or up to date. We have taken reasonable care in reproducing or extracting the information from such sources. However, because of possibly flawed or ineffective methodologies underlying the published information or discrepancies between the published information and market practice and other problems, these facts, forecasts or statistics may be inaccurate and may not be comparable from period to period or to facts, forecasts or statistics produced for other economies, and you should not unduly rely upon them.
 
 
 
22

 
 
EXCHANGE RATES
 
Chile has two currency markets, the Formal Exchange Market (Mercado Cambiario Formal) and the Informal Exchange Market (Mercado Cambiario Informal). The Formal Exchange Market is comprised of banks and other entities authorized by the Central Bank. The Informal Exchange Market is comprised of entities that are not expressly authorized to operate in the Formal Exchange Market, such as certain foreign exchange houses and travel agencies, among others. The Central Bank is empowered to require that certain purchases and sales of foreign currencies be carried out on the Formal Exchange Market.
 
Both the Formal and Informal Exchange Markets are driven by free market forces. Current regulations require that the Central Bank be informed of certain transactions and that they be effected through the Formal Exchange Market. In order to keep the average exchange rate within certain limits, the Central Bank may intervene by buying or selling foreign currency on the Formal Exchange Market.
 
The U.S.$ Observed Exchange Rate (dólar observado), which is reported by the Central Bank and published daily in the Chilean newspapers, is the weighted average exchange rate of the previous business day’s transactions in the Formal Exchange Market. On September 2, 1999, the Central Bank eliminated the band within which the Observed Exchange Rate could fluctuate, in order to provide greater flexibility in the exchange market. Nevertheless, the Central Bank has the power to intervene by buying or selling foreign currency on the Formal Exchange Market to attempt to maintain the Observed Exchange Rate within a desired range.  Even though the Central Bank is authorized to carry out its transactions at the Observed Exchange Rate, it generally uses spot rates for its transactions.  Other banks generally carry out authorized transactions at spot rates as well.
 
The Informal Exchange Market reflects transactions carried out at an informal exchange rate (the “Informal Exchange Rate”). There are no limits imposed on the extent to which the rate of exchange in the Informal Exchange Market can fluctuate above or below the Observed Exchange Rate. In recent years, the variation between the Observed Exchange Rate and the Informal Exchange Rate has not been significant. On March 31, 2011, December 31, 2010 and December 31, 2009, the exchange rate in the Informal Exchange Market as published by Reuters at 1:30 pm on these days was Ch$477.45, Ch$467.95 and Ch$507.25, or 0.96% less, 0.09% less and 0.16% more, respectively, than the published observed exchange rate for such date of Ch$482.08, Ch$468.37 and Ch$506.43, respectively, per US$1.00.
 
 
 
23

 
 
The following table sets forth the annual low, high, average and period-end Observed Exchange Rate for U.S. dollars for each of the following periods, as reported by the Central Bank. We make no representation that the Chilean peso or the U.S. dollar amounts referred to herein actually represent, could have been or could be converted into U.S. dollars or Chilean pesos, as the case may be, at the rates indicated, at any particular rate or at all. The Federal Reserve Bank of New York does not report a noon buying rate for pesos.
 
   
Daily Observed Exchange Rate Ch$ Per US$(1)
 
 
Year
 
Low(2)
   
High(2)
   
Average(3)
   
Period End(4)
 
2004
    559.21       649.45       609.52       559.83  
2005
    509.70       592.75       559.77       514.21  
2006
    511.44       549.63       530.28       534.43  
2007
    493.14       548.67       522.47       495.82  
2008
    431.22       676.75       522.46       629.11  
2009
    491.09       643.87       559.61       506.43  
2010
    468.37       549.17       510.38       468.37  
 
Month 
                               
October 2010
    475.93       494.44       484.04       491.76  
November 2010
    477.05       488.72       482.32       486.39  
December 2010
    468.37       487.87       474.78       468.37  
January 2011
    466.05       499.03       489.44       483.32  
February 2011
    468.94       484.14       475.69       475.63  
March 2011
    472.74       485.37       479.65       482.08  
April 2011
    460.04       479.46       471.32       460.04  


Source: Central Bank.
 
(1)
Nominal figures.
 
(2)
Exchange rates are the actual low and high, on a day-by-day basis for each period.
 
(3)
The yearly or monthly average rate is calculated as the average of the exchange rates on the last day of each month during the period.
 
(4)
Each year period ends on December 31, and the respective period-end exchange rate is published by the Central Bank on the first business day of the following year. Each month period ends on the last calendar day of such month, and the respective period end exchange rate is published by the Central Bank on the first business day of the following month.
 
 
 
24

 
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
 
The tables below present selected financial and operating data from our Audited Consolidated Financial Statements and should be read in conjunction with, and are qualified in their entirety by, reference to our Audited Consolidated Financial Statements. The Audited Consolidated Financial Statements have been prepared in accordance with Chilean Bank GAAP.
 
   
As of December 31,
 
   
2010
   
2010
   
2009
 
   
(in thousands of US$)(1)
   
(in millions of Ch$)(2)
 
CONSOLIDATED STATEMENT OF INCOME DATA (Chilean Bank GAAP)
                 
Net interest revenue
    2,008,161       939,719       856,516  
Provision for loan losses
    (580,539 )     (271,663 )     (333,847 )
Fee income
    563,269       263,582       254,130  
Operating expenses(3) 
    (1,183,895 )     (554,004 )     (452,299 )
Other income, net(4) 
    385,852       180,559       200,668  
Income before taxes
    1,192,848       558,193       525,168  
Income tax
    (168,734 )     (78,959 )     (88,862 )
Net income
    1,024,114       479,234       436,306  

 
   
As of December 31,
 
   
2010
   
2010
   
2009
 
   
(in thousands of US$)(1)
   
(in millions of Ch$)(2)
 
CONSOLIDATED STATEMENT OF FINANCIAL POSITION DATA (Chilean Bank GAAP)
                 
Cash and deposits in banks
    3,765,783       1,762,198       2,043,458  
Financial investments(5) 
    4,326,605       2,024,635       2,642,649  
Loans
    33,608,894       15,727,282       13,751,276  
Loan loss allowance
    (945,169 )     (442,292 )     (349,527 )
Financial derivative contracts (assets)
    3,471,264       1,624,378       1,393,878  
Other assets(6) 
    2,961,893       1,386,018       1,289,262  
Total assets
    47,189,270       22,082,219       20,770,996  
Deposits
    24,564,998       11,495,191       10,708,791  
Other liabilities(7) 
    15,128,629       7,079,442       7,025,184  
Financial derivative contracts (liabilities)
    3,513,151       1,643,979       1,348,906  
Total equity(8) 
    3,982,492       1,863,607       1,688,115  

   
As of December 31,
 
   
2010
   
2009
 
CONSOLIDATED RATIOS (Chilean Bank GAAP)
           
Profitability and performance:
           
Net interest margin(9) 
    5.38 %     5.27 %
Return on average total assets(10) 
    2.30 %     2.18 %
Return on average equity(11) 
    27.35 %     27.27 %
Capital:
               
Average equity as a percentage of average total assets(12) 
    8.40 %     8.00 %
Total liabilities as a multiple of equity (13) 
    10.8       11.3  
Credit Quality:
               
Non-performing loans as a percentage of total loans(14) 
    2.65 %     2.97 %
Allowance for loan losses as percentage of total loans
    2.81 %     2.54 %
Operating Ratios:
               
Operating expenses /operating revenue(15) 
    40.07 %     39.50 %
Operating expenses /average total assets
    2.66 %     2.26 %
 

 
25

 
 


   
As of December 31,
 
   
2010
   
2009
 
OTHER DATA
               
Inflation Rate(16) 
    2.97 %     (1.38 %)
Revaluation (devaluation) rate (Ch$/US$) at period end(17) 
    (7.52 %)     (19.50 %)
Number of employees at period end
    11,001       11,118  
Number of branches and offices at period end
    504       498  


(1)
Amounts stated in U.S. dollars at and for the year ended December 31, 2010, have been translated from Chilean pesos at the exchange rate of Ch$467.95 = US$1.00 as of December 31, 2010. See “Presentation of Financial Information—Exchange Rates” for more information on the observed exchange rate.
 
(2)
Except per share data, percentages and ratios, share numbers, employee numbers and branch numbers.
 
(3)
Operating costs is equal to the sum of personnel expenses, administrative expenses, depreciation and amortization, impairment and other operating expenses.
 
(4)
Other income, net is the sum of other operating income, net gains (losses) from mark-to-market and trading and foreign exchange transactions, and income from investments in other companies.
 
(5)
Includes financial investments held for trading, repos, financial investments available for sale and financial investments held to maturity.
 
(6)
Includes unsettled transactions, investments in other companies, intangible assets, property, plant and equipment, current taxes, deferred taxes and other assets.
 
(7)
Includes unsettled transactions, investments under repurchase agreements, interbank borrowings, issued debt instruments, other financial liabilities, current taxes, deferred taxes, provisions, and other liabilities.
 
(8)
Total equity includes shareholders’ equity plus minority interest. Equity includes minority interest and a minimum provision for mandatory dividends. In accordance with our internal policy, this provision is made pursuant to Article 79 of the Corporations Act, under which at least 30% of net income for the period is distributed, except in the case of a contrary resolution adopted at the respective shareholders’ meeting by the unanimous vote of the outstanding shares.
 
(9)
Net interest revenue divided by average interest earning assets.
 
(10)
Net income divided by average total assets.
 
(11)
Net income divided by average equity.
 
(12)
This ratio is calculated using total equity including minority interest.
 
(13)
Total liabilities divided by equity.
 
(14)
Non-performing loans include the aggregate unpaid principal and accrued but unpaid interest on all loans with at least one installment over 90 days overdue.  
 
(15)
The efficiency ratio is equal to operating expenses over operating revenue. Operating expenses includes personnel expenses, administrative expenses, depreciation and amortizations, impairment and other operating expenses. Operating revenue includes net interest revenue, fee income, net gain (loss) from mark-to-market and trading, foreign exchange transactions and other operating income.
 
(16)
Based on information published by the Central Bank.
 

 
 
26

 

 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Accounting Standards applied in 2010
 
Santander-Chile is a Chilean bank and maintains its financial books and records in Chilean pesos and as required by local regulations, our consolidated financial statements filed with Chilean regulators have been prepared in accordance with generally accepted accounting principles in Chile, as supplemented by the rules issued by the SBIF (“Chilean GAAP”).
 
The SBIF, by means of Circular No. 3,410 (2007) and Circular No. 3,443 (2008) announced the “Compendium of Accounting Standards”, which contained new accounting standards and reporting formats for the financial industry that have applied to banking institutions effective January 1, 2009. Banks were required to apply the new accounting and reporting to the current period financial statements for 2009 and to retrospectively apply the new standard to January 1, 2008 and include an opening balance sheet for the reporting period ended December 31, 2008.
 
Although banks have been required by the Chilean securities regulators to apply IFRS as of January 1, 2009, certain exceptions introduced by the SBIF prevent the banks from achieving full convergence with IFRS.  In those situations which are not addressed by the guidance issued by the SBIF, banking institutions follow the generally accepted accounting principles issued by the Association of Chilean Accountants which coincide with IFRS as issued by the IASB (“IFRS-IASB”).
 
Differences between IFRS and Chilean Bank GAAP
 
Chilean Bank GAAP differs in certain important respects with IFRS.  The principal differences that should be considered by an investor are the following:
 
Suspension of Income Recognition on Accrual Basis
 
In accordance with the Compendium, financial institutions must suspend recognition of income on an accrual basis in their statements of income for certain loans included in the impaired portfolio.  IFRS does not allow the suspension of accrual of interest on financial assets for which an impairment loss has been determined. We do not believe that this difference materially impacts its financial statements.
 
Charge-offs and Accounts Receivable
 
The Compendium requires companies to establish deadlines for the charge-off of loans and accounts receivables.  IFRS does not require any such deadline for charge-offs.  A charge-off due to impairment would be incurred if, and only if, there is objective evidence of impairment as a result of one or more events occurring after the initial recognition.  This is measured on an ‘incurred’ base. We do not believe that this difference materially impacts its financial statements.
 
Assets Received in Lieu of Payment
 
The Compendium requires that the initial value of assets received in lieu of payment be the value agreed with a debtor as a result of the loan settlement or the value awarded in an auction, as applicable.  These assets are required to be written off one year after their acquisition, if the assets have not been previously disposed of.
 
IFRS requires that assets received in lieu of payment be initially accounted for at fair value.  Subsequently, asset valuation depends on the classification provided by the entity for that type of asset.  No deadline is established for charging-off an asset. The restatement of gains and losses from repossessed assets would have an impact on the restatement of financial statements under full IFRS guidelines although we would not expect it to be material.
 
Goodwill and Intangible Assets
 
With respect to goodwill and intangible assets, the Compendium provides that:
 
 
27

 
 
 
·
The value of “goodwill” and other depreciable intangible assets will be supported by two reports issued by specialists independent from the (i) bank, (ii) the bank’s external auditors, and (iii) each other.
 
 
·
For assets acquired before December 31, 2008, “goodwill” will be determined according to the Compendium, and will be amortized according to the original amortization schedule for such assets.
 
 
·
Goodwill arising from acquisitions before the date of transition to Chilean GAAP in January 2009 will be determined based on the previously used accounting criteria.
 
With respect goodwill and intangible assets, IFRS provides that:
 
 
·
The use of independent experts’ valuations is not mandatory.
 
 
·
Beginning with the first full year in which IFRS applies, an entity must discontinue goodwill depreciation and is required to evaluate goodwill for impairment, in compliance with IAS 36.
 
 
·
It is possible to (i) choose a retroactive application of IFRS to goodwill generated before the date of the transition to IFRS, or (ii) adopt an optional exemption to record the balance of goodwill at December 31, 2008 as an attributed cost.
 
Since we have no goodwill, we do not believe that this difference impacts our financial statements.
 
Price Level Restatement of Paid-in Capital and Reserves
 
Due to the need to maintain paid-in capital and reserves in accordance with the regulations in force in prior years, the Compendium provides that the price level restatement applied to paid-in-capital and reserves up to December 31, 2008 will not be reversed.
 
IFRS allows price-level restatement in countries considered hyper-inflationary (more than a 100% accumulated inflation rate during the last three years, among other factors).  Chile is not a hyper-inflationary country and thus price-level restatement of paid-in-capital and reserves will not be allowed under IFRS. The reversal of the price level restatement of paid-in-capital and reserves would have a material adverse impact on equity if the financial statements were restated under full IFRS guidelines.
 
Fair Value Option with Respect to Financial Assets and Liabilities
 
According to the Compendium, banks are not allowed to value assets or liabilities at their fair value in place of the depreciated cost method.
 
IFRS allows an entity to value a financial asset or liability (or a group of financial assets or liabilities, or both), on the official recognition date, at fair value with changes in fair value to be recognized in its financial statements.  Once this option has been made, it is irrevocable.  The fair value option is not applicable to investments in capital instruments without a market price available in an active market, and thus whose fair value cannot be estimated in a reliable way.
 
We does not believe that this difference impacts our financial statements because this accounting treatment is optional.
 
Loan loss allowances
 
On December 29, 2009 the SBIF issued Circular No. 3,489 which incorporates changes to several provisions of the SBIF Compendium of Accounting Standards. Among other changes it states that effective January 2010, companies must complement the basis on which insolvency provisions related to contingent operations are determined, including unrestricted lines of credit, other contingent loans, and other loan commitments provision. In addition, companies should also apply the changes in risk exposure applicable to contingent loans, found in Chapter B-3 of the SBIF Compendium of Accounting Standards. The accumulated effect of this change in 2010 for us was approximately Ch$63,448 million (Ch$52,662 million net of deferred taxes), which was recorded as equity in our Consolidated Statement of Financial Position. According to specific instructions from the SBIF in Letter to
 
 
28

 
 
Management No. 10 dated December 21, 2010, the SBIF stated that it will not be necessary to calculate the adjustment retrospectively for 2009.

On June 10, 2010 the SBIF issued Circular No. 3,502 which among other things requires that Banks maintain a 0.5% minimum provision for the non-impaired part of the loan portfolio analyzed on an individual basis. In addition, on December 21, 2010 in the Letter to Management No. 9, the SBIF specified that the accounting treatment for the effects originating from the application of this minimum provision is to record it in the income for the period. This change in accounting policy results in a charge to income of Ch$16,845 million (Ch$ 13,767 million net of deferred taxes) in 2010.

On August 12, 2010 Circular No. 3,503 was issued which modified how we must classify loans included in Chapters B-1, B-2, B-3 and C1 of the Compendium of Accounting Standards, which are loans analyzed on an individual basis. Such modifications took effect from January 1, 2011, except for those modifications relating to additional provisions included in the Letter to Management No. 9 relating to Chapter B-1 which took effect in 2010. As a supplement to the Circular, the Letter to Management No. 9 was issued on December 21, 2010 which specifies that adjustments resulting from the adoption of these modifications starting on January 1, 2011 could be recorded during the first quarter of 2011; however, entities may anticipate recognition of the impact of these adjustments, in whole or in part, in 2010. As of December 31, 2010 we have chosen to book the entire provision adjustments aforementioned, which created a Ch$39,800 million (Ch$32,597 million net of deferred taxes) impact in the Consolidated Statements of Income, under the other operating expenses line.
 
 
29

 
Operating Results
 
Chilean Economy
 
All of our operations and substantially all of our customers are located in Chile. Accordingly, our financial condition and results of operations are substantially dependent upon economic conditions prevailing in this country. In 2010, the Chilean economy grew 5.2%.
 
Quarterly and Yearly Evolution of GDP, %
 
 
Source: Banco Central de Chile and Santander Chile estimates
 
On February 27, 2010, Chile was struck by an 8.8 magnitude earthquake and a tsunami, which mainly affected the mid-southern regions of Chile. Growth of private and public sector investments and the rebound of consumption has offset the negative impacts caused by the February 2010 earthquake and tsunami. In 2010, internal demand increased 16.4%, private investment increased 18.8% and private consumption increased 10.4%.  Unemployment has also been decreasing. As of December 2010, the unemployment rate was 7.1% compared to 10.0% as of December 2009.
 
The recovery of the Chilean economy in 2010 was also being led in part by a recovery of the prices of Chile’s main exports, greater levels of investment, both private and public, and higher consumption levels. The average price of copper in 2010 increased 46.41% compared to the same period in 2009. In this same period, fish meal prices increased 58.2% and paper pulp prices increased 56.6%.
 
As a result of the economic recovery, the consumer price index (“CPI”) and interest rates have been increasing.  CPI inflation in 2010 increased 2.97% compared to a 1.38% decrease in 2009. As a result of rising price levels and higher economic activity, interest rates also increased in 2010 and are continuing their upward trend in 2011. The overnight interbank rate set by the Central Bank increased 275 basis points in 2010, 75 basis points year-to-date in 2011 and currently stands at 4.0%.
 
Chilean Banking Sector
 
The Chilean banking sector evolved in line with the economic developments during 2010 with an increase in the volume of loans.  Total loans as of December 31, 2010 in the Chilean financial system were Ch$74,953,981 million (US$160.0 billion), an increase of 8.7% since year-end 2009.  Total customer deposits (defined as time deposits plus checking accounts) totaled Ch$64,966,884 million (US$148.7 billion) as of December 31, 2010, an increase of 10.9% compared to year-end 2009.  The non-performing loan ratio in the Chilean banking industry decreased from 3.0% at year-end 2009 to 2.7% as of December 2010.
 
 
30

 
 
Results of Operations for the Years Ended December 31, 2010 and 2009
 
The following discussion is based upon and should be read in conjunction with the Audited Consolidated Financial Statements included in our Current Report on Form 6-K filed with the SEC on March 16, 2011.  The Audited Consolidated Financial Statements have been prepared in accordance with Chilean Bank GAAP. The following table sets forth the principal components of our net income for the years ended December 31, 2010 and 2009.
 
   
For the Year ended December 31,
       
   
2010
   
2010
   
2009
       
CONSOLIDATED INCOME STATEMENT DATA
 
US$ ths.(1)
   
Ch$ million of constant pesos
   
% Change
2010 /2009
 
Chilean GAAP:
                       
Interest income and expense
                       
Interest income
    3,019,517       1,412,983       1,207,778       17.0 %
Interest expense
    (1,011,356 )     (473,264 )     (351,262 )     34.7 %
Net interest income
    2,008,161       939,719       856,516       9.7 %
Fees and income from services
                               
Fees and commission income
    722,690       338,183       315,925       7.0 %
Fees and commission expense
    (159,421 )     (74,601 )     (61,795 )     20.7 %
Net fees and commission income
    563,269       263,582       254,130       3.7 %
Operating profit before loan losses
                               
Net income from financial operations
    82,819       38,755       3,887       897.0 %
Foreign exchange gains (losses), net
    122,306       57,233       163,241       (64.9 %)
Financial transactions, net
    205,125       95,988       167,128       (42.6 %)
Other operating income
    178,225       83,400       33,243       150.9 %
Net operating profit before loan losses
    2,954,780       1,382,689       1,311,017       5.5 %
Provision for loan losses
    (580,539 )     (271,663 )     (333,847 )     (18.6 %)
Total operating income, net of loan losses, interest, fees and commission
    2,374,241       1,111,026       977,170       13.7 %
Operating expenses
                               
Personnel salaries and expenses 
    (534,811 )     (250,265 )     (224,484 )     11.5 %
Administrative expenses
    (314,869 )     (147,343 )     (136,712 )     7.8 %
 

 
31

 
 
 
   
For the Year ended December 31,
       
   
2010
   
2010
   
2009
       
CONSOLIDATED INCOME STATEMENT DATA
 
US$ ths.(1)
   
Ch$ million of constant pesos
   
% Change
2010 /2009
 
Depreciation and amortization
    (105,573 )     (49,403 )     (46,623 )     6.0 %
Impairment
    (10,525 )     (4,925 )     (75 )     6,466.7 %
Other operating expenses
    (218,117 )     (102,068 )     (44,405 )     129.9 %
Total operating expenses
    (1,183,895 )     (554,004 )     (452,299 )     22.5 %
Total net Operating income
    1,190,346       557,022       524,871       6.1 %
Other non-operating results
                               
Income from investments in other companies
    2,502       1,171       297       294.3 %
Total other non-operating results
                               
Income before income taxes
    1,192,848       558,193       525,168       6.3 %
Income taxes
    (168,734 )     (78,959 )     (88,862 )     (11.1 %)
Consolidated income for the period
    1,024,114       479,234       436,306       9.8 %
Net income attributable to:
                               
Equity holders of the Bank
    1,019,671       477,155       431,253       10.6 %
Non-controlling interest
    4,443       2,079       5,053       (58.9 %)


(1)
Amounts stated in U.S. dollars at and for the year ended December 31, 2010, have been translated from Chilean pesos at the exchange rate of Ch$467.95 = US$1.00 as of December 31, 2010. See “Selected Financial Data–Exchange Rates” for more information on exchange rate.
 

 
32

 
Net interest income
 
(in millions of Ch$, except percentages)
 
Year-ended December 31,
   
% Change
 
   
2010
   
2009
      2010/2009  
Individuals
    524,920       532,060       (1.3 %)
Small and mid sized companies
    175,538       228,928       (23.3 %)
Institutional
    28,609       18,789       52.3 %
Middle-market
    114,460       114,432       0.0 %
Global banking & markets
    81,203       33,738       140.7 %
Other(1) 
    14,989       (71,431 )     -- %
Net interest income(2) 
    939,719       856,516       9.7 %
Average interest-earning assets
    17,479,485       16,265,592       7.5 %
Average non-interest-bearing demand deposits
    3,152,513       2,475,050       27.4 %
Net interest margin(3) 
    5.38 %     5.27 %        
Average shareholders’ equity and average non-interest-bearing demand deposits to total average interest-earning assets
    28.06 %     25.05 %        
 

(1)
Consists mainly of net interest income from the Financial Management Division and the cost of funding our fixed income trading portfolio.
 
(2)
Each segment obtains funding from its clients. Any surplus deposits are transferred to the Financial Management Division, which in turn makes such excess available to other areas that need funding. The Financial Management Division also sells the funds it obtains in the institutional funding market at a transfer price equal to the market price of the funds.
 
(3)
Net interest margin is net interest income divided by average interest-earning assets.
 
Our net interest income increased 9.7% to Ch$939,719 million in the year ended December 31, 2010 from net interest income of Ch$856,516 million in the corresponding period in 2009. Average interest earning assets increased 7.5% in 2010 compared to 2009. Net interest margin in 2010 was 5.38% compared to 5.27% in the same period in 2009, reflecting the higher inflationary environment. In 2010, the value of the UF increased by 2.5% compared to a decline of 2.4% in 2009. As we have more interest-earning assets than liabilities linked to the UF, our net interest income was positively affected by this change in inflationary trends. In 2010, the average gap between UF-denominated interest-earning assets and UF-denominated average interest bearing liabilities was approximately Ch$3,171,140 million compared to Ch$2,689,614 million in 2009. This moderate inflationary trend increased our average nominal rate earned over interest earning assets to 8.1% in 2010 from 7.4% in 2009.
 
Our funding mix also improved. The ratio of non-interest bearing demand deposits and shareholders’ equity to interest earning assets was 28.1% in 2010 compared to 25.1% in 2009. Average non-interest bearing demand deposits increased 27.4% in 2010 compared to 2009, mainly as a result of growth in our cash management business with corporate clients.
 
These factors were partly offset by the lower interest income earned on consumer loans. The average nominal rate earned on consumer loans in 2010 was 20.4% compared to 23.8% and interest income from consumer loans decreased 4.5%, in 2010 compared to 2009. In 2009, we increased our consumer loan yields in order to compensate for the expected rise in non-performing levels and charge-offs. As the economy has rebounded and provision expense has decreased (See –Provision Expense, below) yields on these products have normalized. This normalization of yields also explains, in part, the 23.3% decrease in net interest income from small and mid-sized companies (“SMEs”).
 
Net interest income and margins were also positively affected by the lower average short-term interest rates. As a result, the average nominal rate we paid on our peso denominated interest-bearing liabilities was 2.7% in 2010 compared to 3.9% in 2009. These factors were offset by the higher nominal rate paid on our interest bearing liabilities linked to inflation. In 2010, the average nominal rate paid on interest-bearing liabilities denominated in UFs was 6.4% compared to 1.4% in 2009. Going forward, if the Central Bank increases interest rates, this will negatively impact our funding costs in pesos and our margins.
 
 
33

 
The changes in net interest income by segment in 2010 compared to 2009 were as follows:
 
 
·
Net interest income from individuals in our retail segment decreased 1.3%, mainly as a result of the normalization of loan spreads mentioned above. This was partially offset by a 15.4% increase in loan volumes to individuals in the period being analyzed due to the more favorable economic environment and improvements in asset quality after the 2009 recession. Interest income from residential mortgage loans also increased 197.2% as a result of the rise in inflation rate as the majority of these loans are linked to inflation.
 
 
·
Net interest income from small and mid-sized companies in our retail segment decreased 23.3%. This segment was affected by rising funding costs while interest rate yields declined. This decline was mainly due to the normalization of loan spreads mentioned above.
 
 
·
Net interest income from the middle-market segment was flat year-over-year, mainly as a result of the 33.1% increase in loans to this segment, which was offset by rising funding costs while interest rate yields declined. This decline was mainly due to the normalization of loan spreads mentioned above.
 
 
·
Net interest income from the global banking and markets segment increased 140.7% in 2010 compared to 2009 mainly due to the rising interest rate environment that increased spreads in this segment, especially in the second half of the year, and the higher inflation rate, which had a positive effect on interest gained from our commercial loan book denominated in UFs. Loan volumes in this segment increased 8.3%. This segment also improved due to an improvement in our funding mix through demand deposits and cash management, as well as the movement of some of our former mid-sized clients to the global banking segment as a result of their growth.
 
 
·
Net interest income from non-segmented portions of interest earning assets, which consists mainly of net interest income from the Financial Management Division’s available for sale investment portfolio improved from a loss of Ch$71,431 million in 2009 to a gain of Ch$14,989 million in 2010. This was mainly as a result of higher net interest revenue from financial investments that are mainly denominated in UFs and, therefore, were positively affected by the rise in inflation. This portfolio manages the largest portion of our inflation gap and generally shows greater changes than the changes in interest rates.  See “Quantitative and Qualitative Disclosure about Market Risk–Impact of Inflation”.
 
The following table shows our balances of loans and accounts receivables from customers and interbank loans by segment at the dates indicated.
 
   
Year-ended December 31,
   
% Change
 
Loans by segment (Ch$ million)
 
2010
   
2009
   
2010
 
Individuals
    8,407,416       7,287,925       15.4 %
Small and mid sized companies
    2,375,192       2,485,505       (4.4 %)
Institutional 
    331,153       282,933       17.0 %
Middle-market
    3,288,107       2,471,162       33.1 %
Global banking & markets(1) 
    1,293,305       1,194,706       8.3 %
Other(1) 
    32,109       29,045       10.5 %
Total loans(1) 
    15,727,282       13,751,276       14.4 %
 

(1)
Includes interbank loans.

 
 
34

 
Fee and commission income
 
The following table sets forth certain components of our income from services (net of fees paid to third parties directly connected to providing those services, principally fees relating to credit card processing and ATM network administration) in 2010 and 2009.
 
(in millions of Ch$, except percentages)
 
Year-ended December 31,
   
% Change
 
   
2010
   
2009
   
2010
 
Collections    
    60,136       65,782       (8.6 %)
Credit, debit and ATM cards      
    55,899       51,670       8.2 %
Checking accounts and lines of credit 
    42,614       53,388       (20.2 %)
Asset management  
    39,952       30,766       29.9 %
Insurance brokerage  
    32,783       16,307       101.0 %
Letters of credit  
    22,852       24,558       (6.9 %)
Custody and brokerage services
    9,101       6,532       39.3 %
Office banking  
    1,832       2,552       (28.2 %)
Other fees   
    (1,587 )     2,575       (-- %)
Total fees and commission income, net
    263,582       254,130       3.7 %
 
Net fees and commission income grew by 3.7% to Ch$263,582 million in 2010 compared to the same period in 2009.
 
Fees from collections decreased by 8.6% in 2010 compared to 2009. This was mainly due to the impact of the February 2010 earthquake and tsunami as some collection fees were temporarily waived in the more affected zones and the collection process was disrupted due to an inability to contact appropriate parties.
 
Fees from credit, debit and ATM cards increased by 8.2%, reflecting increased usage of our credit cards. Usage measured in terms of monetary purchases was up 22.1% in 2010 compared to 2009.  As of December 31, 2010, the Bank, which has a 28.2% market share of all bank credit card accounts, had generated 32.9% of all purchases year-to-date.
 
Fees from checking accounts and lines of credit, which includes the maintenance fee for checking accounts and lines of credit and fees charged for the unauthorized overdraft of lines of credit, decreased 20.2% in 2010 compared to 2009.  This decrease was in part a result of the decline in fees from unauthorized overdrafts of credit lines which were prohibited by the SBIF beginning in May 2009.  In 2010, these fees totaled Ch$0 compared to Ch$7,992 million in the same period in 2009. Additionally, this decrease was also due in part to the February 2010 earthquake and tsunamis as some of these fees were temporarily waived in the more affected zones.
 
Fees from our asset management business increased 29.9% in 2010 compared to the same period in 2009. Total funds under management decreased 7.0% in the period being analyzed and totaled Ch$3,186,784 million (US$6.8 billion). The recovery of the local and global equity markets in 2010 has resulted in an increase in equity funds which earn higher management fees than non-equity funds, as well as an increase in the performance of our funds under management. This has been partially offset by the reduction in lower yielding fixed income funds due to mark-to-market as rates have increased, and by the translation loss on foreign currency denominated funds due to the appreciation of the Chilean peso against the dollar.
 
Fees from letters of credit and other contingent operations decreased 6.9%. This was mainly due to a 17.0% decrease in stand-by letters of credit in our foreign trade business, which in turn resulted from lower average fees as the Chilean peso has appreciated against the dollar in 2010.
 
Insurance brokerage fees increased by 101.0%. This was mainly due to an increase in prices on behalf of insurance underwriters following the February 2010 earthquake and tsunami, greater business volumes in our insurance brokerage subsidiary and higher sales of insurance products through our website.
 
Custody and brokerage fees increased 39.3% in 2010 as compared to the corresponding period in 2009. This was primarily due to higher stock brokerage fees, which increased 47.4% to Ch$5,264 million as equity markets had strong activity levels, and also higher brokerage volumes as more clients have used our online brokerage services.
 
Fees from office banking decreased 28.2%. The 9.9% increase in income from office banking resulting from more clients using this product was more than offset by the 26.0% increase in costs associated with this program as we increased incentives for clients to switch to online banking services.
 
 
35

 
Other fee income totaled a net expense of Ch$1,587 million compared to a net gain of Ch$2,575 million in 2009. This was mainly due to higher fee expenses paid to correspondent banks and other expenses related to marketing efforts of various products and services.
 
The following table sets forth, for the periods indicated our fee income broken down by segment.
 
(in millions of Ch$, except percentages)
 
Year-ended December 31,
   
% Change
 
   
2010
   
2009
   
2010
 
Individuals         
    191,841       171,433       11.9 %
Small and mid sized companies 
    34,460       41,917       (17.8 %)
Institutions  
    2,452       1,962       25.0 %
Middle-market  
    20,215       20,567       (1.7 %)
Global banking and markets 
    23,173       18,747       23.6 %
Other   
    (8,559 )     (496 )     1,625.6 %
Total fees and commission income, net
    263,582       254,130       3.7 %

Fees from individuals increased 11.9% in 2010 compared to the same period in 2009 mainly as a result of the increase in fees from credit and debit cards, asset management, stock brokerage and insurance brokerage.
 
Fees from small and mid-sized companies in our retail segment decreased 17.8% mainly as a result of the lower fees received from the unauthorized overdraft of checking accounts.
 
Fees from institutions increased 25.0% primarily as a result of our increased business activity with universities, mainly as a result of increased fees from debit cards and cash management services.
 
Fees in the middle-market decreased by 1.7%, mainly as a result of a decrease in stand-by letters of credit in our foreign trade business and lower fees from the unauthorized overdraft of checking accounts.
 
 Fees from the global banking and markets segments increased by 23.6%, mainly as a result of an increase in fees from mutual funds, brokerage services, custody services and investment banking activities.
 
Financial transactions, net
 
The following table sets forth information regarding our income (expenses) from financial transactions in 2010 and 2009.
 
(in millions of Ch$, except percentages)
 
Year-ended December 31,
   
% Change
 
   
2010
   
2009
   
2010
 
Derivatives classified as trading
    3,598       (102,825 )     (103.5 %)
Trading investments
    31,058       49,220       (36.9 %)
Sale of loans
    12,397       9,231       34.3 %
Available-for-sale instruments sales
    (8,319 )     47,335       (117.6 %)
Other results
    21       926       (97.7 %)
Net income from financial operations
    38,755       3,887       897.0 %
Foreign exchange transactions
    273,997       401,695       (31.8 %)
Hedge-accounting derivatives
    (215,721 )     (266,221 )     (19.0 %)
Translation gains and losses over  assets and liabilities indexed to foreign currencies
    (1,043 )     27,767       (103.8 %)
Net results from foreign exchange profit (loss)
    57,233       163,241       (64.9 %)
Total financial transactions, net
    95,988       167,128       (42.6 %)

 
The net gains from financial transactions, which is the sum of trading activities, mark-to-market adjustments in our securities portfolio and foreign exchange transactions totaled Ch$95,988 million in 2010, a decrease of 42.6% compared to the corresponding period in 2009. These results include the results of our Treasury’s trading business and financial transactions with customers as well the results of our Financial Management Division.
 
 
36

 
The net income from financial operations was Ch$38,755 million in 2010 compared to Ch$3,887 million in 2009. In 2010, the Chilean peso appreciated 7.5% compared to a 19.5% appreciation in 2009. This explains the difference in results from derivatives classified as trading which totaled Ch$3,598 million in 2010 compared to a loss of Ch$102,825 million in 2009. The majority of the derivatives are composed of forwards and swaps that hedge our spot position in foreign currency.  Our spot position includes all assets and liabilities in foreign currency and in Ch$ linked to US$ that are not derivatives.  For more details see “–Management of Foreign Exchange Fluctuations.” As the Chilean peso appreciates, we usually record a low or negative result from the mark-to-market of its derivatives held for trading. Going forward, if the Chilean peso’s appreciation continues to slow down the results from derivatives classified as trading should continue to improve, but will be partially offset by a continued decline in our foreign exchange transaction results, which includes the mark-to-market of the our spot foreign currency position.
 
In 2010, we also recorded a gain of Ch$12,397 million from the sale of loans, mainly loans that have been previously charged-off compared to Ch$9,231 million in 2009. These loans were sold to various collection companies and asset managers.
 
These positive factors have been partially offset by the higher interest rate environment which has negatively affected realized gains from the sale of available for sale fixed income instruments, which totaled a loss of Ch$8,319 million in 2010 compared to a gain of Ch$47,335 million in 2009 when interest rates declined significantly and we sold available-for-sale fixed income investments. This was partially offset by the increase in the inflation rates, which has increased the interest earned from our fixed income portfolio classified as trading included in this line item.
 
Foreign exchange profit (loss), net totaled a net gain of Ch$57,233 million in 2010 compared to a gain of Ch$163,241 million in 2009.  This decrease is the result of the lower rate of appreciation of the Chilean peso against the dollar in 2010 compared to 2009. The effects on net income from the change in value of our spot foreign currency position should continue to be positive if the peso continues to appreciate as our funding base in foreign currency is larger than our spot asset position in foreign currency.
 
Foreign exchange transactions totaled a net gain of Ch$273,997 million in 2010 compared to a gain of Ch$401,695 million in 2009.  This lower result was mainly due to the lower rate of appreciation of the peso in 2010 compared to 2009.  This is largely offset by the mark-to-market of foreign exchange derivatives in net gains from trading and mark-to-market as described above. The derivatives included in this line item are mainly cross-currency swaps that hedge the interest rate risk of bonds issued abroad. Excluding derivatives that qualify for hedge accounting, the conversion and mark-to-market of foreign currency derivatives are for the most part recognized as a gain or loss in the net results from mark-to-market and trading and not as foreign exchange transactions. This distorts the results from mark-to-market and trading and foreign exchange transactions. In order to more easily compare the results from financial transactions, net, we present the following table that separates the results by line of business.
 
   
Year-ended December 31,
   
% Change
 
   
2010
   
2009
   
2010
 
   
(in millions of Ch$, except percentages)
 
Santander Global Connect (1)
    54,472       58,123       (6.3 %)
Market-making with clients
    23,837       31,525       (24.4 %)
Sale of loans and charged-off loans
    12,397       9,231       34.3 %
Client treasury services
    90,706       98,879       (8.3 %)
Proprietary trading
    5,879       16,392       (64.1 %)
Financial Management (ALCO) and other results (2)
    (597 )     51,856       (101.2 %)
Non-client treasury income
    5,282       68,248       (92.3 %)
Total financial transactions, net
    95,988       167,127       (42.6 %)

(1)
Santander Global Connect is our platform to sell derivatives to our clients, mainly corporations and the middle-market.
(2)
The Financial Management Division manages the structural interest rate risk, the structural position in inflation-indexed assets and liabilities, shareholders’ equity and liquidity. The aim of the Financial Management Division is to inject stability and recurrence into the net interest income of commercial activities and to ensure that we comply with internal and regulatory limits regarding liquidity, regulatory capital, reserve requirements and market risk.

 
 
37

 
 
The results from Santander Global Connect and market-making mainly include the results from the sale of derivatives, foreign exchange and fixed income instruments to our client base. Santander Global Connect is a specialized platform designed to facilitate the sale of derivatives to a broad range of companies in all segments and through the branch network. In 2010, the results from Santander Global Connect decreased 6.3% mainly as a result of  lower demand on behalf of clients of derivative instruments due to more stable market conditions in 2010 compared to 2009. Results from market making decreased 24.4% in 2010 as a result of the rising interest rate environment.
 
The results from proprietary trading totaled a gain of Ch$5,879 million in 2010 and decreased 64.1% compared to 2009. This decrease was mainly due to the rise in interest rates, which had a negative effect on our proprietary trading positions compared to the inverse scenario in 2009.
 
The results from the Financial Management Division and other results totaled a loss of Ch$597 million in 2010 compared to a gain of Ch$51,856 million in 2009. The lower gain recognized by the Financial Management Division was mainly due to lower gains from the sale of available-for-sale fixed income instruments in a rising interest rate environment.
 
Other operating income
 
   
Year-ended December 31,
   
% Change
 
   
2010
   
2009
   
2010
 
   
(in millions of Ch$, except percentages)
 
Income from assets received in lieu of payment
    5,544       7,406       (25.1 %)
Net results from sale of investment in other companies
    -       1,859       (100.0 %)
Operational leases
    117       1,123       (89.6 %)
Gain on sale of Bank premises and equipment
    31,246       7,622       309.9 %
Recovery of provisions for non-specific contingencies
    7,040       14,793       (52.4 %)
Insurance coverage for earthquake
    3,175       -       -- %
Other
    36,278       440       8145.0 %
Total other operating income
    83,400       33,243       150.9 %

Total other operating income totaled a gain of Ch$83,400 million in 2010 a 150.9% increase compared to 2009.
 
In 2010, we sold 43 branches for a gain of Ch$30,934 million recognized as income from the sale of our property, plant and equipment. These branches are now rented to us. We did not finance this acquisition and the acquirers were non-related parties.
 
Gains from the recovery of provisions for non-specific contingencies decreased 52.4% in 2010. This income is offset in part by higher provisions contingencies in other operating expenses.
 
We also recognized Ch$3,175 million from insurance claims from earthquake damage to branches and other installations, which in turn partially offset the impairment recognized in operating expenses as a result of the loss in value of some fixed assets attributable to this same event.
 
Other income totaled a gain of Ch$36,278 million in 2010 and increased 8,145.0% compared to 2009. On December 29, 2009, the SBIF issued Circular No. 3,489 which incorporates changes in several chapters of the SBIF Compendium of Accounting Standards. Among other changes it states that starting on January 2010, an entity should complement the basis on which insolvency provisions related to contingent operations are determined, including unrestricted lines of credit, other contingent loans, and other loan commitments provisions. In addition, it should also apply the changes in risk exposure applicable to contingent loans, to be found in Chapter B-3 of the SBIF Compendium of Accounting Standards. Under our old consumer loan provisioning model, the accumulated effect of this was approximately Ch$63,448 million (Ch$52,662 million net of deferred taxes), which was recorded in equity at the beginning of 2010 in our Consolidated Statements of Financial Position. In September of 2010, however, we introduced certain improvements to our consumer loan provisioning model. Among other changes, which are detailed in “Selected Statistical Information At And For The Years Ended December 31, 2010 And 2009–Classification of Loan Portfolio”, we adjusted the minimum provision levels that are set aside for the unused portion
 
 
38

 
 
of credit card lines for clients that use their card for transactional and not credit purposes. Initially, these clients were assigned a provision level equal to the average for the whole credit card sample independent of whether they actually used their approved lines or not. The change in our model resulted in a reversal of Ch$35,804 million of the Ch$63,448 million we had previously charged against equity and which we recognized as other operating income. As these provisions are for unused credit lines, accounting rules requires us to record this reversal under other operating income in the income statement and the charges against equity as a non-credit provision in other liabilities.
 
Provision for loan losses
 
The following table sets forth, for the periods indicated, certain information relating to our provision expenses.
 
(in millions of Ch$, except percentages)
 
Year-ended December 31,
   
% Change
 
   
2010
   
2009
   
2010
 
Gross provision expenses(1) 
    (95,096 )     (77,290 )     23.0 %
Charge-offs
    (207,046 )     (295,831 )     (30.0 %)
Recoveries of loans previously charged-off
    30,479       39,274       (22.4 %)
Provision expenses, net
    (271,663 )     (333,847 )     (18.6 %)
Period-end loans(2) 
    15,727,282       13,751,276       14.4 %
Non-performing loans(3) 
    416,739       409,067       1.9 %
Impaired loans(4) 
    1,480,476       1,485,737       (0.4 %)
Loan loss allowance(5) 
    442,292       349,527       26.5 %
Non-performing loans / period-end loans(6) 
    2.65 %     2.97 %        
Risk Index(7) 
    2.81 %     2.54 %        
Coverage ratio non-performing loans(8) 
    106.13 %     85.44 %        
 

(1)
Net of the reversal of allowances on loans charged off during the period.
 
(2)
Includes Ch$69,726 million as of December 31, 2010 and Ch$23,412 million as of December 31, 2009 in interbank loans.
 
(3)
Non-performing loans include the principal and interest of any loan with one installment that is 90 days overdue, and do not accrue interest
 
(4)
Impaired loans include: (A) for loans whose allowance is determined on an individual basis, impaired loans include: (1) all loans to a debtor that are rated C1 through D2 and (2) total loans to single debtors with a loan that is non-performing, excluding residential mortgage loans if the non-performance of the mortgage loans is less than 90 days. (B) for loans whose loan loss allowance is determined on a group basis, impaired loans include: (1) total loans to a debtor, when a loan to that debtor is non-performing or has been renegotiated, excluding performing residential mortgage loans and (2) if the loan that is non-performing or renegotiated is a residential mortgage loan all loans to that debtor are considered impaired.
 
(5)
Includes Ch$54 million as of December 31, 2010 and Ch$42 million as of December 31, 2009 in loan loss allowances for interbank loans.
 
(6)
Non-performing loans divided by total loans.
 
(7)
Loan loss allowance divided by total loans.
 
(8)
Loan loss allowance divided by non-performing loans.
 
 
Net provision expense decreased by 18.6% to Ch$271,663 million in 2010 compared to 2009. Gross provision expense increased 23.0% to Ch$95,096 million. This increase was mainly due to higher gross provisions in consumer lending. We recognized Ch$30,466 million in provisions mainly for consumer loans as a result of improvements made to our credit scoring models. The minimum provision required for clients in most risk profiles was increased for performing consumer loans (See “Selected Statistical Information At And For The Years Ended December 31, 2010 And 2009–Classification of Loan Portfolio”) and this effect was recognized as a larger Provision Expenses and greater Loan Loss Allowances. This improvement also included the modification described in Other Operating Income.
 
Our risk index is defined as loan loss allowances over total loans and reflects how much loan loss allowances we must recognize according to our internal models and the guidelines of the SBIF (See “Selected
 
 
39

 
 
Statistical Information At And For The Years Ended December 31, 2010 And 2009–Classification of Loan Portfolio”). On June 2010, the SBIF issued Circular No. 3,502 which among other things requires that banks maintain a 0.5% minimum provision for the normal part of the loan portfolio analyzed on an individual basis. As of December 31, 2010, the adoption of these changes created a charge to income of Ch$16,845 million recognized as a gross provision expense. These factors explain the increase in our risk index from 2.54% as of December 31, 2009 to 2.81% as of December 31, 2010. The following table shows gross provision expense by type of loan:

Gross provision expense by loan product
 
Year-ended December 31,
   
% Change
 
(in millions of Ch$, except percentages)
 
2010
   
2009
   
2010
 
Consumer loans
    (58,984 )     (19,030 )     210.0 %
Residential mortgage loans
    (799 )     (3,903 )     (79.5 %)
Commercial loans
    (33,742 )     (53,042 )     (36.4 %)
Contingent loans (off-balance sheet)
    (1,559 )     (1,308 )     19.2 %
Interbank loans
    (12 )     (7 )     71.4 %
Total gross provisions
    (95,096 )     (77,290 )     23.0 %

Charge-offs decreased 30.0% in the periods being analyzed, totaling Ch$207,046 million. This was mainly due to an improvement in the asset quality of our consumer loans. Consumer loan charge-offs decreased 49.1% in 2010 compared to 2009. The ratio of non-performing consumer loans to total consumer loans improved from 3.73% as of December 31, 2009 to 3.00% as of December 31, 2010. Coverage of consumer non-performing loans has also increased from 198.7% as of December 31, 2009 to 278.6% as of December 31, 2010. The rise in charge-offs in residential mortgage and commercial loans were mainly due to impacts of the earthquake. The following table shows charge-offs by type of loan:
 
Charge-offs by loan product
 
Year-ended December 31,
   
% Change
 
(in millions of Ch$, except percentages)
 
2010
   
2009
   
2010
 
Consumer loans
    (121,621 )     (239,005 )     (49.1 %)
Residential mortgage loans
    (14,549 )     (8,708 )     67.1 %
Commercial loans
    (70,876 )     (48,118 )     47.3 %
Contingent loans (off-balance sheet)
    -       -       -- %
Interbank loans
    -       -       -- %
Total charge-offs
    (207,046 )     (295,831 )     (30.0 %)

Recoveries on loans previously charged-off decreased by 22.4% in 2010 compared to 2009. In 2010 and previous periods, we have sold charged-off loans to third parties, recognizing a net gain in financial transactions. We view this as a more efficient manner to recover value from the older stock of charged-off loans as this decreases our costs of collections; however, this leads to a decrease in recoveries recognized in this line item.  The following table shows recoveries by type of loan:
 
Recoveries
 
Year-ended December 31,
   
% Change
 
(in millions of Ch$, except percentages)
 
2010
   
2009
   
2010
 
Consumer loans
    22,096       28,268       (21.8 %)
Residential mortgage loans
    1,389       2,560       (45.7 %)
Commercial loans
    6,994       8,446       (17.2 %)
Contingent loans (off-balance sheet)
    -       -       -- %
Interbank loans
    -       -       -- %
Total gross recoveries
    30,479       39,274       (22.4 %)
 
We only recognize recoveries on loans previously charged off when interest and/or principal is paid in cash in connection with a loan that has already been charged-off in its entirety. Such recoveries do not have an impact on our allowance for loan losses because these recoveries are for loans that have been already charged-off and recognized as a loss in our income statement and are no longer on our balance sheet.
 
 
40

 
In some instances, we will sell a portfolio of charged-off loans to a third party. The income received from the sale of these charged-off loans is recognized as net income from financial transactions as disclosed in Note 24 of our Audited Consolidated Financial Statements.  The following table sets forth information about our sale of charged-off loans in 2010 and 2009.
 
   
Year-ended December 31,
   
% Change
 
   
2010
   
2009
   
2010
 
   
(in millions of Ch$, except percentages)
 
Sale of charged-off loans
    9,824       8,689       13.1 %

 
The following table shows provision expense by business segment type of loan:
 
Net provision expense by loan product
 
Year-ended December 31,
   
% Change
 
(in millions of Ch$, except percentages)
 
2010
   
2009
   
2010
 
Consumer loans
    (158,509 )     (229,767 )     (31.0 %)
Residential mortgage loans
    (13,959 )     (10,051 )     38.9 %
Commercial loans
    (97,624 )     (92,714 )     5.3 %
Contingent loans (off-balance sheet)
    (1,559 )     (1,308 )     19.2 %
Interbank loans
    (12 )     (7 )     71.4 %
Total gross provisions
    (271,663 )     (333,847 )     (18.6 %)

 
We believe that our loan loss allowances are currently adequate for all known and expected losses.
 
Operating expenses
 
The following table sets forth information regarding our operating expenses in 2010 and 2009.
 
   
Year-ended December 31,
   
% Change
 
(in millions of Ch$, except percentages)
 
2010
   
2009
   
2010
 
Personnel salaries and expenses
    250,265       224,484       11.5 %
Administrative expenses
    147,343       136,712       7.8 %
Depreciation and amortization
    49,403       46,623       6.0 %
Impairment
    4,925       75       6466.7 %
Other operating expenses
    102,068       44,405       129.9 %
Total operating expenses
    554,004       452,299       22.5 %
Efficiency ratio (1) 
    40.1 %     39.5 %        
 

(1)
The efficiency ratio is the ratio of total operating expenses to total operating income. Total operating income consists of net interest income, fee income, and other operating income.
 
Operating expenses in 2010 increased 22.5% compared to 2009. The efficiency ratio was 40.1% in 2010 compared to 39.5% in 2009, as the increase in operating income was offset by earthquake-related expenses, greater expenses incurred as a result of stronger business activity and one-time expenses related to the new provisioning guidelines for commercial loans.
 
The 11.5% increase in personnel salaries and expenses was mainly due to higher variable incentives and higher salaries as a result of greater commercial activity and productivity, as well as higher severance payments. Average headcount in the periods being analyzed decreased 2.9%
 
Administrative expenses increased 7.8%. This was mainly due to higher rent and maintenance expenses of branches, ATM locations and other equipment as a result of higher expenses incurred due to the February 2010 earthquake and tsunami. The rise in administrative expenses was also due to an increase in technology and communication services, an increase in costs of outsourced data processing and higher marketing expenses.
 
 
41

 
 
Depreciation and amortization expense increased 6.0%, mainly due to higher amortization expenses of intangible assets such as software and other computer systems.
 
Operating expenses were also negatively affected by the Ch$4,925 million impairment charged recognized in 2010. This was mainly due to impairment charges directly related to earthquake-related effects on our installations. This was partially offset by insurance claim revenue recognized in other operating income.
 
The following table sets forth information regarding other operating expenses in 2010 and 2009.
 
Other operating expenses
 
Year-ended December 31,
   
% Change
 
(in millions of Ch$, except percentages)
 
2010
   
2009
   
2010
 
Repossessed asset expenses
    16,854       13,871       21.5 %
Credit card expenses
    6,777       5,902       14.8 %
Customer service expenses
    7,756       8,807       (11.9 %)
Earthquake related expenses
    5,875       -       -- %
Provision for contingencies
    47,476       1,088       4263.6 %
Other expenses
    17,330       14,737       17.6 %
Total
    102,068       44,405       129.9 %

Other operating expenses were Ch$102,068 million in 2010, a 129.9% increase compared to 2009.
 
Other operating expenses also include provisions for contingencies that may be related to non-specific credits or other impairments such as tax, legal and labor contingencies. These expenses totaled Ch$47,476 million in 2010 compared to Ch$1,088 million in 2009. This increase was due to provisions related to the new guidelines for provision levels for commercial loans in 2011. On August 12, 2010, Circular No. 3,503 was issued which modified how we must classify loans included in Chapters B-1, B-2, B-3 and C1 of the Compendium of Accounting Standards, which are loans analyzed on an individual basis. Such modifications took effect from January 1, 2011, except for those modifications relating to additional provisions included in the Letter to Management No. 9 relating to Chapter B-1. As a supplement to the Circular, the Letter to Management No. 9 was issued on December 21, 2010 which specifies that adjustments resulting from the adoption of these modifications starting on January 1, 2011 could be recorded during the first quarter of 2011; however, entities may anticipate recognition of the impact of these adjustments, in whole or in part, in 2010. As of December 31, 2010, we have chosen to record the entire provision adjustments aforementioned, which created a Ch$39,800 million (Ch$32,597 million net of deferred taxes) impact in our Consolidated Statements of Income, under the other operating expenses line.
 
Excluding this effect, provisions for contingencies totaled Ch$7,676 million compared to Ch$1,088 million in 2009. This increase was offset by the Ch$7,040 million reversal of provisions for contingencies recognized in other operating income. The net effect on income for provisions for other contingencies, excluding the Ch$39,800 million one-time expense totaled Ch$636 million in 2010, as set forth in the following table.
 
   
Year-ended December 31,
   
% Change
 
Provisions for contingencies, net
 
2010
   
2009
   
2010
 
Gross provision for contingencies (other operating expenses) (1)
    (7,040 )     (14,793 )     (52.4 %)
Reversal of provisions for contingencies (other operating income)
    7,676       1,088       605.5 %
Total
    636       (13,705 )     (104.6 %)
 
(1)
Excludes Ch$39,800 million charge related to the change in provisioning levels for commercial loans analyzed on an individual basis.
 
 
 
42

 
 
The increase in other expenses was also due in part to: (i) higher expenses caused by the February 2010 earthquake, which totaled Ch$5,875 million in 2010, (ii) higher expenses from our repossessed assets. These increased 21.5% in 2010 mainly as a result of a 32.0% rise in charge-off of repossessed assets that were repossessed by us in 2009 and 2010 following the economic downturn, and (iii) the 14.8% increase in credit card related expenses in line with greater commercial activity and the increase in the number of alliances for co-branding credit cards.
 
Income tax
 
   
Year-ended December 31,
   
% Change
 
   
2010
   
2009
   
2010
 
Income before tax
    558,193       525,168       6.3 %
Income tax
    (78,959 )     (88,862 )     (11.1 %)
Effective tax rate(1) 
    14.1 %     16.9 %        


(1)
The effective tax is the income tax divided by net income before tax.
 
Our income tax expense decreased by 11.1% in 2010 compared to 2009. The effective tax rate paid was 14.1% in 2010 compared to 16.9% in 2009. The statutory tax rate in Chile has not changed in 2010 and was 17% on income before taxes.  The lower effective tax rate is mainly due to the fact that Chilean tax regulations still require corporations to recognize the effects of price level restatement on equity even though inflation accounting is no longer required by Chilean GAAP. In 2009, as inflation was negative, stated net income and taxable net income were similar. In 2010, the higher inflation rate has resulted in a loss for tax purposes from price level restatement and thus a lower effective tax rate.
 
The Chilean government and Congress have approved a temporary increase in the corporate tax rate to 20% in 2011, 18.5% in 2012 and back to 17% in 2013, as part of the plan to finance the reconstruction of public works in the zones most affected by the February 2010 earthquake and tsunami.  As a result of these changes, we had to apply these future tax rates to deferred taxes. The application of the new corporate tax rates over deferred taxes, resulted in a higher net asset position in deferred taxes, and the resulting changes to our assets and liabilities from this change in deferred taxes resulted in a lower effective tax rate in 2010.
 
 
 
43

 
 
Credit Risk Ratings
 
Our foreign currency deposit ratings are equivalent to the Chilean sovereign ratings. In June 2010, Moody’s upgraded our foreign deposits risk ratings. In October 2010, Fitch also increased our long-term foreign currency ratings. In December 2010, Standard and Poor’s placed our foreign currency long-term debt ratings on a positive outlook. Moody’s and Standard and Poor’s placed our parent company’s ratings on a negative outlook.  Any adverse revisions to our parent company’s ratings and/or Chile’s credit ratings for domestic and international debt by international rating agencies may adversely affect our ratings. Our ratings may also be negatively affected by a worsening of our financial condition, especially in terms of asset quality indicators.
 
Our current credit ratings from three international agencies are set forth below.
 
 
Moody’s
 
 
Rating
Long-term foreign currency bank deposits
 
Aa3
Senior bonds
 
Aa3
Subordinated debt
 
A1
Bank Deposits in Local Currency
 
Aa3
Bank financial strength
 
B-
Short-term deposits
 
P-1
Outlook
 
Stable

 
Standard & Poor’s
 
 
Rating
Long-term Foreign Issuer Credit
 
A+
Long-term Local Issuer Credit
 
A+
Short-term Foreign Issuer Credit
 
A-1
Short-term Local Issuer Credit
 
A-1
Outlook
 
Positive

 
Fitch
 
 
Rating
Foreign Currency Long-term Debt
 
AA-
Local Currency Long-term Debt
 
AA-
Foreign Currency Short-term Debt
 
F1+
Local Currency Short-term Debt
 
F1+
Individual rating
 
B
Outlook
 
Stable

Risk-Weighted Assets and Regulatory Capital
 
We currently have regulatory capital in excess of the minimum requirement under the current Chilean regulations. According to the General Banking Law, a bank is required to have regulatory capital of at least 8% of its risk weighted assets, net of required loan loss allowances, and paid in capital and reserves (i.e., the basic capital, as defined above) of at least 3% of its total assets, net of required loan loss allowances. For these purposes, the regulatory capital of a bank is the sum of (1) the bank’s basic capital, (2) subordinated bonds issued by the bank valued at their placement price for an amount up to 50% of its basic capital; provided that the value of the bonds is required to be decreased by 20% for each year that elapses during the period commencing six years prior to their maturity, and (3) its voluntary allowances for loan losses, for an amount of up to 1.25% of its risk weighted assets. Santander Chile does not have goodwill, but if it did, this value would be required to be deducted from regulatory capital. When calculating risk weighted assets, we also include off-balance sheet contingent loans. The merger of Old Santander Chile and Santiago on August 1, 2002 required a special regulatory pre-approval of the SBIF, which was granted on May 16, 2002. The resolution granting this pre-approval imposed a regulatory capital to risk weighted assets ratio of 12% for the merged bank. This requirement was reduced to 11% by the SBIF effective January 1, 2005. For purposes of weighing the risk of a bank’s assets, the General Banking Law considers five different categories of assets, based on the nature of the issuer, the availability of funds, and the nature of the assets and the existence of collateral securing such assets.
 
 
44

 
 
The following table sets forth our consolidated and risk-weighted assets and regulatory capital as of December 31, 2010 and 2009.
 
   
Consolidated assets as of
   
Risk-weighted assets
 
   
December 31, 2010
   
December 31, 2009
   
December 31, 2010
   
December 31, 2009
 
   
(Ch$ million)
 
Asset Balance (Net of allowances)(3)
     
Cash and deposits in bank
    1,762,198       2,043,458       -       -  
Unsettled transactions 
    374,368       468,134       126,083       191,287  
Trading investments
    379,670       798,539       57,588       41,918  
Investments under resale agreements
    170,985       14,020       98,323       14,020  
Financial derivative contracts 
    1,452,068       1,391,886       871,872       837,692  
Interbank loans
    69,672       23,370       13,934       4,674  
Loans and accounts receivables from customers
    15,215,318       13,378,379       13,350,182       11,717,337  
Available for sale investments 
    1,473,980       1,830,090       101,875       154,089  
Investments in other  companies
    7,275       7,417       7,275       7,417  
Intangibles assets
    77,990       77,260       77,990       77,260  
Property, plant and equipment 
    154,985       184,122       154,985       184,122  
Current taxes
    12,499       4,541       1,250       454  
Deferred taxes 
    117,964       95,229       11,796       9,523  
Other assets 
    640,937       452,559       474,135       269,313  
Off-balance sheet assets
                               
Contingent loans