UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 

FORM 20-F
 
(Mark One)    
o
  REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 
     
   
OR
     
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 for the fiscal year ended December 31, 2006
     
   
OR
     
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number: 1-14554

BANCO SANTANDER-CHILE
(d/b/a Banco Santander Santiago and Santander Santiago)
(Exact name of Registrant as specified in its charter)

SANTANDER-CHILE BANK
(d/b/a Santander Santiago Bank and Santander Santiago)
(Translation of Registrant’s name into English)

Chile
(Jurisdiction of incorporation)
Bandera 140
Santiago, Chile
Telephone: 011-562 320-2000
(Address of principal executive offices)

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

Title of each class
 
Name of each exchange on which registered
American Depositary Shares, each representing the right to receive 1,039 Shares of Common Stock without par value
 
New York Stock Exchange
Shares of Common Stock, without par value*
 
New York Stock Exchange

*  
Santander-Chile’s shares of common stock are not listed for trading, but only in connection with the registration of the American Depositary Shares pursuant to the requirements of the New York Stock Exchange.

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

None
(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

7.375% Subordinated Notes due 2012
 
Indicate the number of outstanding shares of each class of common stock of Banco Santander-Chile at December 31, 2006 was:

188,446,126,794 Shares of Common Stock, without par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes x   No o

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
Yes o    No x
 
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
 Large accelerated filer
 
 Accelerated filer
 
 Non-accelerated filer
x
 
o
 
o
 
Indicate by check mark which financial statement item the registrant has elected to follow.
 
Item 17 o Item 18 x
 
 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o   No x
 


 
TABLE OF CONTENTS

    Page 
     
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
1
CERTAIN TERMS AND CONVENTIONS
2
PRESENTATION OF FINANCIAL INFORMATION
4
ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
5
ITEM 2.
OFFER STATISTICS AND EXPECTED TIMETABLE
5
ITEM 3.
KEY INFORMATION
5
ITEM 4.
INFORMATION ON THE COMPANY
22
ITEM 4A.
UNRESOLVED STAFF COMMENTS
38
ITEM 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
38
ITEM 6.
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
99
ITEM 7.
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
108
ITEM 8.
FINANCIAL INFORMATION
111
ITEM 9.
THE OFFER AND LISTING
112
ITEM 10.
ADDITIONAL INFORMATION
114
ITEM 11.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
136
ITEM 12.
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
158
PART II
 
158
ITEM 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
158
ITEM 14.
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
 
ITEM 15.
CONTROLS AND PROCEDURES
158
ITEM 16A.
AUDIT COMMITTEE FINANCIAL EXPERT
160
ITEM 16B.
CODE OF ETHICS
160
ITEM 16C.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
160
ITEM 16D.
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
161
ITEM 16E.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
161
PART III
 
161
ITEM 17.
FINANCIAL STATEMENTS
161
ITEM 18.
FINANCIAL STATEMENTS
161
ITEM 19.
EXHIBITS
161

 
iii

 
CAUTIONARY STATEMENT CONCERNING
FORWARD-LOOKING STATEMENTS
 
We have made statements in this Annual Report on Form 20-F 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:
 
 
·
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 Annual Report which contain forward-looking statements include, without limitation, “Item 3: Key Information—Risk Factors,” “Item 4: Information on the Company,” “Item 5: Operating and Financial Review and Prospects,” “Item 8: Financial Information—Legal Proceedings,” and “Item 11: Quantitative and Qualitative Disclosures About Market Risk.” 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 annual report and in the documents which are incorporated by reference, 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 Central Bank
 
 
·
inflation or deflation
 
 
1

 
 
·
unemployment
 
 
·
unanticipated turbulence in interest rates
 
 
·
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
 
 
·
implementation of new technologies
 
 
·
an inaccurate or ineffective client segmentation model
 
You should not place undue reliance on such statements, which speak only as of the date that they were made.  The forward-looking statements contained in this document speak only as of the date of this Annual 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.
 
CERTAIN TERMS AND CONVENTIONS
 
As used in this Annual Report, “Santander-Chile”, “Banco Santander Chile”, “the Bank”, “we,” “our” and “us” mean Banco Santander-Chile and its consolidated subsidiaries, the bank resulting from the merger of Santiago and Old Santander-Chile.
 
When we refer to “Santiago” in this Annual Report, we refer to Banco Santiago and its consolidated subsidiaries prior to its merger with Old Santander-Chile. When we refer to “Old Santander-Chile” in this Annual Report, we refer to the former Banco Santander-Chile and its consolidated subsidiaries, which ceased to exist upon its merger into Santiago, effected on August 1, 2002.
 
As used in this Annual Report, the term “billion” means one thousand million (1,000,000,000).
 
 
2

 
In this Annual Report, references to “$”, “US$”, “U.S.$”, “U.S. dollars” and “dollars” are to United States dollars, references to “Chilean pesos,” “pesos” or “Ch$” are to Chilean pesos and 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) for the previous month. See “Item 5: Operating and Financial Review and Prospects” and Note 1(c) to the Audited Consolidated Financial Statements.
 
In this Annual Report, references to the Audit Committee are to the Bank’s Comité de Directores  y Auditoría. This committee is the successor of the Directors Committee created under Law 19,705 in 2000 and the Audit Committee created by the Board of Directors of Banco Santiago in 1995. On September 22, 2004, the Superintendency of Banks authorized that the functions of the Audit Committee be performed by the Directors Committee. On October 19, 2004, the Board of Directors of Banco Santander Chile, by resolution No. 357, approved the merger of both committees and the transfer of all functions of both committees to the Comité de Directores y Auditoría, which was created on the same date.
 
In this Annual Report, references to “BIS” are to the Bank for International Settlement, and references to “BIS ratio” are to the capital adequacy ratio as calculated in accordance with the Basel Capital Accord.
 
3

 
PRESENTATION OF FINANCIAL INFORMATION
 
Currency and Accounting Principles
 
Santander-Chile is a Chilean bank, which maintains its financial books and records in Chilean pesos and prepares its Audited Consolidated Financial Statements in conformity with generally accepted accounting principles in Chile and the rules of the Superintendencia de Bancos e Instituciones Financieras (the Superintendency of Banks and Financial Institutions, which is referred to herein as the “Superintendency of Banks”), which together differ in certain significant respects from generally accepted accounting principles in the United States (“U.S. GAAP”). References to “Chilean GAAP” in this Annual Report are to accounting principles generally accepted in Chile, as supplemented by the applicable rules of the Superintendency of Banks. See Note 26 to the Audited Consolidated Financial Statements of Santander-Chile as of December 31, 2005 and 2006 and for the years ended December 31, 2004, 2005 and 2006 contained elsewhere in this Annual Report (together with the notes thereto, the “Audited Consolidated Financial Statements”) for a description of the principal differences between Chilean GAAP and U.S. GAAP, as they relate to Santander-Chile, and a reconciliation to U.S. GAAP of net income and shareholders’ equity.
 
Pursuant to Chilean GAAP, amounts expressed in the Audited Consolidated Financial Statements and all other amounts included elsewhere throughout this Annual Report for all periods expressed in Chilean pesos are expressed in constant Chilean pesos as of December 31, 2006. See Note 1(c) to the Audited Consolidated Financial Statements.
 
Loans
 
Unless otherwise specified, all references herein (except in the 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 Superintendency of Banks. Non-performing loans include loans for which either principal or interest is overdue, and which 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. This practice differs from that normally followed in the United States, where the amount classified as past due would include the entire amount of principal and interest on any and all loans which have any portion overdue. See “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical Information,” “—Loan Portfolio,” “—Loans by Economic Activity—Classification of Loan Portfolio,” and “—Classification of Loan Portfolio Based on the Borrower’s Payment Performance.”
 
According to the regulations established by the Superintendency of Banks, Santander-Chile is required to charge off commercial loans no later than 24 months after being classified as past due, if unsecured, and if secured, no later than 36 months after being classified as past due. When an installment of a past due corporate loan (whether secured or unsecured) is charged off, we must charge off all installments which are overdue, notwithstanding our right to charge off the entire amount of the loan. Once any amount of a loan is charged off, each subsequent installment must be charged off as it becomes overdue, notwithstanding our right to charge off the entire amount of the loan. In the case of past due consumer loans, a similar practice applies, except that after the first installment becomes past due for 90 days or more, Santander-Chile must charge off the entire remaining part of the loan. We may charge off any loan (whether commercial or consumer) before the first installment becomes overdue, but only in accordance with special procedures established by the Superintendency of Banks. Loans are charged off against the loan loss allowance to the extent of any required allowances for such loans; the remainder of such loans is charged off against income.  See “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical Information—Analysis of Loan Loss Allowance.”
 
Outstanding loans and the related percentages of Santander-Chile’s loan portfolio consisting of corporate and consumer loans in “Item 4: Information on the Company—C. Business Overview” are categorized based on the nature of the borrower. Outstanding loans and related percentages of the loan portfolio of Santander-Chile consisting of corporate and consumer loans in the section entitled “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical
 
4

 
Information” are categorized in accordance with the reporting requirements of the Superintendency of Banks, which are based on the type and term of loans.
 
Effect of Rounding
 
Certain figures included in this Annual Report and in the Audited Consolidated Financial Statements have been rounded for ease of presentation. Percentage figures included in this Annual 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 Annual 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 Annual Report may not sum due to rounding.
 
Economic and Market Data
 
In this Annual Report, unless otherwise indicated, all macro economic data related to the Chilean economy is based on information published by the Banco Central de Chile (the “Central Bank”), and all market share and other data related to the Chilean financial system is based on information published by the Superintendency of Banks and our analysis of such information. Information regarding the consolidated risk index of the Chilean financial system as a whole is not available.
 
Exchange Rates
 
This Annual 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 rate indicated or were converted at all.
 
Unless otherwise indicated, all the U.S. dollar amounts at any year end or for any full year have been translated from Chilean pesos based on the observed exchange rate reported by the Central Bank on December 31, 2006, which was Ch$534.43 per US$1.00. The observed exchange rate reported by the Central Bank on December 31, 2006 is based upon the actual exchange rate as of December 31, 2006, and is the exchange rate specified by the Superintendency of Banks for use by Chilean banks in the preparation of their financial statements for the periods ended December 31, 2006. The observed exchange rate on June 14, 2007  was Ch$529.32 per US$1.00, reflecting an accumulated appreciation of 1.0% from December 31, 2006. 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 “Item 3: Key Information—Exchange Rates.”
 
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
 
 Not Applicable.
 
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
 
Not Applicable.
 
ITEM 3. KEY INFORMATION
 
A. Selected Financial Data
 
The following table presents historical financial information about us as of the dates and for each of the periods indicated. The following table should be read in conjunction with, and is qualified in its entirety by reference to, our Audited Consolidated Financial Statements appearing elsewhere in this Annual Report. Our Audited Consolidated Financial Statements are prepared in accordance with Chilean GAAP, which differs in certain significant respects from U.S. GAAP. Note 26 to our Audited Consolidated Financial Statements provides a description of the material
 
5

 
differences between Chilean GAAP and U.S. GAAP and a reconciliation to U.S. GAAP of net income for the years ended December 31, 2004, 2005 and 2006 and shareholders’ equity at December 31, 2005 and 2006.
 
Under Chilean GAAP, the merger between Santiago and Old Santander-Chile was accounted for as a “pooling of interest” on a prospective basis. As such, the historical financial statements for periods prior to the merger were not restated under Chilean GAAP. Under U.S. GAAP, the merger between the two banks, which have been under the common control of Banco Santander Central Hispano since May 3, 1999, is accounted for in a manner similar to a pooling of interest under U.S. GAAP. As a consequence of the merger, we were required to restate our previously issued U.S. GAAP historical financial information to retroactively present the financial results for the merged bank as if Santiago and Old Santander-Chile had been combined throughout the periods during which common control existed. See Note 26(a) to our Audited Consolidated Financial Statements.
 
   
At and for the years ended December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006)(1)
   
(in thousands of
U.S.$)(1)(2)
 
             
CONSOLIDATED INCOME STATEMENT DATA
                                   
Chilean GAAP:
                                   
Net interest revenue (3)
   
568,659
     
328,235
     
502,509
     
558,266
     
612,254
     
1,145,620
 
Provisions for loan losses
    (72,333 )     (73,110 )     (85,451 )     (64,879 )     (123,022 )     (230,193 )
Total fees and income from services, net
   
111,818
     
121,280
     
128,004
     
141,300
     
162,550
     
304,156
 
Other operating income, net (3)
    (15,129 )    
172,964
     
14,741
      (13,595 )    
18,643
     
34,884
 
Other income and expenses, net
    (34,985 )    
2,177
      (4,295 )     (21,923 )     (3,579 )     (6,697 )
Operating expenses
    (314,006 )     (271,383 )     (283,883 )     (284,968 )     (309,283 )     (578,716 )
Loss from price-level restatement
    (14,258 )     (8,352 )     (12,680 )     (18,524 )     (13,782 )     (25,788 )
Income before income taxes
   
202,253
     
271,812
     
258,945
     
295,677
     
343,781
     
643,266
 
Income (taxes) benefits
    (30,032 )     (47,365 )     (48,587 )     (50,885 )     (58,199 )     (108,899 )
Net income
   
172,220
     
224,445
     
210,358
     
244,792
     
285,582
     
534,367
 
Net income per share (7)
   
0.91
     
1.19
     
1.12
     
1.30
     
1.52
     
0.00284
 
Net income per ADS (4)(7)
   
949.54
     
1,237.48
     
1,159.81
     
1,349.66
     
1,574.56
     
2.95
 
Dividends per share (5)
   
1.36
     
0.91
     
1.19
     
1.12
     
0.84
     
0.00158
 
Dividends per ADS (5)
   
1,405.82
     
945.54
     
1,237.48
     
1,159.81
     
877.28
     
1.64
 
Weighted-average shares outstanding (in millions)
   
188,446.1
     
188,446.1
     
188,446.1
     
188,446.1
     
188,446.1
     
 
                                                 
U.S. GAAP:
                                               
Net interest income (6)
   
564,551
     
306,152
     
474,686
     
564,849
     
631,582
     
1,181,786
 
Provision for loan losses
    (72,415 )     (93,024 )     (68,924 )     (65,930 )     (123,022 )     (230,193 )
Amortization of goodwill
   
     
     
     
     
     
 
Net income
   
151,210
     
193,801
     
210,499
     
230,834
     
235,917
     
441,437
 
Net income per Share (7)
   
0.80
     
1.03
     
1.12
     
1.22
     
1.25
     
0.00234
 
Net income per ADS (4)(7)
   
833.70
     
1,068.52
     
1,160.59
     
1,272.70
     
1,300.73
     
2.43
 
Weighted-average shares outstanding (in millions)
   
188,446.1
     
188,446.1
     
188,446.1
     
188,446.1
     
188,446.1
     
 
Weighted-average ADSs outstanding (in millions)
   
181.373
     
181.373
     
181.373
     
181.373
     
181.373
     
 
                                                 
CONSOLIDATED BALANCE SHEET DATA
                                               
Chilean GAAP:
                                               
Cash and due from banks
   
1,070,912
     
1,067,134
     
1,003,407
     
1,250,931
     
1,092,407
     
2,044,060
 
Investments (8)
   
2,736,173
     
2,075,146
     
2,105,209
     
1,274,599
     
1,015,376
     
1,899,924
 
Loans, net of allowances
   
8,428,519
     
8,079,294
     
8,937,656
     
10,208,334
     
11,614,895
     
21,733,240
 
Loan loss allowances
    (183,537 )     (182,426 )     (183,366 )     (151,000 )     (174,064 )     (325,700 )
Derivatives (9)
   
     
     
     
418,795
     
372,688
     
697,356
 
Other assets (3)
   
223,233
     
310,315
     
442,565
     
613,780
     
748,073
     
1,399,759
 
Total assets  (6)
   
12,765,194
     
11,842,219
     
12,772,640
     
13,766,439
     
14,843,439
     
27,774,339
 
Deposits
   
6,660,305
     
5,993,196
     
7,139,737
     
8,246,723
     
9,392,332
     
17,574,485
 
Other interest-bearing liabilities
   
4,292,706
     
3,676,944
     
3,348,763
     
2,902,720
     
2,622,161
     
4,906,465
 
Derivatives (9)
   
     
     
     
391,823
     
355,922
     
665,984
 
Shareholders' equity
   
1,054,460
     
1,103,270
     
1,091,768
     
1,104,767
     
1,245,339
     
2,330,219
 
                                                 
U.S. GAAP:
                                               
Total assets
   
12,410,311
     
11,457,897
     
12,516,607
     
13,716,618
     
14,683,666
     
27,475,378
 

6

 
   
At and for the years ended December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006)(1)
   
(in thousands of
U.S.$)(1)(2)
 
             
CONSOLIDATED BALANCE SHEET DATA
                                   
U.S. GAAP:
                                               
Long-term borrowings
   
3,385,126
     
2,599,879
     
1,910,026
     
1,457,944
     
1,585,608
     
2,966,914
 
Shareholders' equity
   
1,958,157
     
1,961,493
     
1,952,196
     
1,938,505
     
2,019,658
     
3,779,088
 
Goodwill
   
806,521
     
806,521
     
806,521
     
806,521
     
806,521
     
1,509,124
 

   
At and for the year ended December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
 
                               
CONSOLIDATED RATIOS
 
 
   
 
   
 
   
 
   
 
 
Chilean GAAP:
 
 
   
 
   
 
   
 
   
 
 
Profitability and performance:
                             
Net interest margin(10)
    4.8 %     3.0 %     4.5 %     4.7 %     4.7 %
Return on average total assets(11)
    1.3 %     1.8 %     1.7 %     1.8 %     1.9 %
Return on average shareholders’ equity(12)
    16.2 %     22.1 %     20.2 %     24.1 %     24.8 %
Capital:
                                       
Average shareholders’ equity as a percentage of average total assets
    8.3 %     8.1 %     8.2 %     7.4 %     7.8 %
Total liabilities as a multiple of shareholders’ equity
   
11.1
     
9.7
     
11.7
     
12.1
     
11.9
 
Credit Quality:
                                       
Substandard loans as a percentage of total loans(13)
    3.2 %     3.6 %     3.7 %     2.6 %     2.9 %
Allowance for loan losses as percentage of total loans
    2.1 %     2.2 %     2.0 %     1.5 %     1.5 %
Past due loans as a percentage of total loans(14)
    2.1 %     2.2 %     1.5 %     1.1 %     0.8 %
Operating Ratios:
                                       
Operating expenses/operating revenue(15)
    47.2 %     43.6 %     44.0 %     41.5 %     39.0 %
Operating expenses/average total assets
    2.3 %     2.2 %     2.2 %     2.1 %     2.1 %
Ratio of earnings to fixed charges(16):
                                       
Including interest on deposits
   
1.3
6    
1.8
1    
1.7
7    
1.6
5    
1.6
1
Excluding interest on deposits
   
1.6
5    
2.3
4    
2.2
6    
2.4
6    
2.5
6
                                         
U.S. GAAP(17):
                                       
Profitability and performance:
                                       
Net interest margin (18)
    4.7 %     2.8 %     4.3 %     4.8 %     4.8 %
Return on average total assets (19)
    1.2 %     1.6 %     1.8 %     1.7 %     1.6 %
Return on average shareholders’ equity (20)
    8.6 %     9.9 %     10.8 %     11.9 %     11.7 %
Ratio of earnings to fixed charges(16):
                                       
Including interest on deposits
   
1.3
7    
1.8
3    
1.8
7    
1.7
1    
1.6
0
Excluding interest on deposits
   
1.6
7    
2.3
5    
2.4
3    
2.5
1    
2.5
2
                                         
OTHER DATA
                                       
Inflation rate(21)
    2.8 %     1.1 %     2.4 %     3.7 %     2.6 %
Revaluation (devaluation) rate (Ch$/U.S.$) at period end(21)
    8.6 %     (15.9 %)     (6.6 %)     (8.1 %)     3.9 %
Number of employees at period end
   
8,314   
     
7,535   
     
7,380   
     
7,482   
     
8,184   
 
Number of branches and offices at period end
   
347  
     
345   
     
315   
     
352  
     
397   
 

 


(1)
Except per share data, percentages and ratios, share numbers, employee numbers and branch numbers.
 
(2)
Amounts stated in U.S. dollars at and for the year ended December 31, 2006 have been translated from Chilean pesos at the observed exchange rate of Ch$534.43 = U.S.$1.00 as of December 31, 2006. See “Item 3: Key Information —Exchange Rates” for more information on the observed exchange rate.
 
(3)
In accordance with Circular N°3345 issued by the Superintendency of Banks, which became effective on June 30, 2006, the accounting standards for valuing financial instruments acquired for trading or investment purposes, including derivative instruments on the balance sheets, were amended. The new accounting standards require that these instruments be carried at their market or fair value, and the historical differences in valuation of such instruments recognized with respect to any dates prior to 2006 be adjusted directly against the Bank’s equity.  Banks were required to adopt the new accounting standards set forth in Circular No. 3345 in preparing their financial statements at and for the six-months ended June 30, 2006 and going forward.
 
7

 
 
In order to implement these new accounting standards, we have created a new line item “derivatives” under both “assets” and “liabilities” in our consolidated balance sheet, and reclassified certain other items within other assets, other liabilities, financial instruments, interest income, interest expenses and other operating income, net, in our consolidated balance sheet and income statement at and for the year ended December 31, 2006.  For comparison purposes, we have also retrospectively reclassified these items at December 31, 2005 and for the years ended December 31, 2004 and 2005, but did not retrospectively apply the new accounting standards to these items.  We did not reclassify any of these items at any date  prior to 2005 or for any period prior to the year ended December 31, 2004.  See “Item 5: Operating and Financial Review and Prospects—A. New Accounting Standards for Financial Investments and Derivatives.”
 
(4)
1 American depositary share (“ADS”) = 1,039 shares of common stock.
 
(5)
The dividends per share of common stock and per ADS are determined based on the previous year’s net income. The dividend per ADS is calculated on the basis of 1,039 shares per ADS.
 
(6)
Net interest income and total assets on a U.S. GAAP basis have been determined by applying the relevant U.S. GAAP adjustments to net interest income and total assets presented in accordance with Article 9 of Regulation S-X. See Note 27 to our Consolidated Financial Statements at and for the years ended December 31, 2002, 2003 and 2004 and Note 26 of our Consolidated Financial Statements for the year ended December 31, 2005 and 2006 included in our Annual Reports on Form 20-F.
 
(7)
Net income per share and per ADS in accordance with U.S. GAAP has been calculated on the basis of the weighted-average number of shares or ADSs, as applicable, outstanding during the period.
 
(8)
Includes principally Chilean government securities, corporate securities, other financial investments and investment collateral under agreements to repurchase (reverse repo).
 
(9)
For figures at December 31, 2006, derivatives were valued at market price and classified as a separate line item on the balance sheet. Our derivatives holdings at December 31, 2005 have been reclassified from “other assets” and “other liabilities” to “derivatives”, but have not been marked to market as would be required under currently applicable accounting principles. At prior dates, derivatives were classified under “other assets” or “other liabilities”, and generally recorded at net notional amount.  See “Item 5: Operating and Financial Review and Prospects—A. New Accounting Standards for Financial Investments and Derivatives” and Note 1 to our Audited Consolidated Financial Statements.
 
(10)
Net interest revenue divided by average-interest earning assets (as presented in “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical Information”).
 
(11)
Net income divided by average total assets (as presented in “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical Information”).
 
(12)
Net income divided by average shareholders’ equity (as presented in “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical Information”).
 
(13)
Substandard loans in the rating system prior to 2004 included all loans rated B- or worse. In the loan risk classification system which took effect in 2004, substandard loans include all consumer and mortgage loans rated B- or worse and all commercial loans rated C2 or worse. See “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical Information—Analysis of Substandard Loans and Amounts Past Due loans”. Therefore, the historical figures in 2002 and 2003 are not strictly comparable to figures in 2004, 2005 or 2006.
 
(14)
Past due loans are loans on which principal or interest is overdue for 90 or more days, and do not include the installments of such loans that are not overdue or that are less than 90 days overdue, unless legal proceedings have been commenced for the entire outstanding balance according to the terms of the loan.
 
(15)
Operating revenue includes “Net interest revenue,” “Total fees and income from services, net” and “Other operating income, net.”
 
(16)
For the purpose of computing the ratios of earnings to fixed charges, earnings consist of earnings before income tax and fixed charges. Fixed charges consist of gross interest expense and the proportion deemed representative of the interest factor of rental expense.
 
(17)
The following ratios have been calculated using U.S. GAAP figures except for net interest margin.  See footnote 18 regarding calculation of net interest margin.
 
(18)
Net interest margin has been determined by applying the relevant U.S. GAAP adjustments to net interest income for the years ended December 31, 2002, 2003, 2004, 2005 and 2006 presented in accordance with Article 9 of Regulation S-X divided by average interest-earning assets calculated on a Chilean GAAP basis.  See Note 27(y) to our Consolidated Financial Statements at and for the years ended December 31, 2002, 2003 and 2004 and Note 26(v) of our Consolidated Financial Statements for the years ended December 31, 2005 and 2006.
 
(19)
Net income divided by average total assets. Average total assets were calculated as an average of the beginning and ending balances for each year, and total assets on a U.S. GAAP basis have been determined by applying the relevant U.S. GAAP adjustments to total assets presented in accordance with Article 9 of Regulation S-X. See Note 26 to our Audited Consolidated Financial Statements.
 
8

 
(20)
Average shareholders’ equity was calculated as an average of the beginning and ending balances for each year. Shareholders’ equity on a U.S. GAAP basis has been determined by applying the relevant U.S. GAAP adjustments to shareholders’ equity presented in accordance with Article 9 of Regulation S-X. See Note 26(y) to our Audited Consolidated Financial Statements.
 
(21)
Based on information published by the Central Bank.
 

Exchange Rates
 
Chile has two currency markets, the Mercado Cambiario Formal, or the “Formal Exchange Market” and the Mercado Cambiario Informal, or the “Informal Exchange Market.” Under Law 18,840, the organizational law of the Central Bank, or the Central Bank Act (Ley Orgánica Constitucional del Banco Central de Chile), the Central Bank determines which purchases and sales of foreign currencies must be carried out in the Formal Exchange Market. Pursuant to Central Bank regulations which are currently in effect, all payments, remittances or transfers of foreign currency abroad which are required to be effected through the Formal Exchange Market may be effected with foreign currency procured outside the Formal Exchange Market. The Formal Exchange Market is comprised of the banks and other entities so authorized by the Central Bank. The conversion from pesos to U.S. dollars of all payments and distributions with respect to the ADSs described in this Annual Report must be transacted at the spot market rate in the Formal Exchange Market. Current regulations require that the Central Bank be informed of certain transactions and that they be effected through the Formal Exchange Market.
 
Purchases and sales of foreign currencies may be legally carried out in the Informal Exchange Market. The Informal Exchange Market reflects transactions carried out at informal exchange rates by entities not expressly authorized to operate in the Formal Exchange Market. 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. On December 31, 2006 and March 31, 2007, the exchange rate in the Informal Exchange Market was Ch$533.38 and Ch$539.27, or 0.2% and 0.02%, respectively, lower than the published observed exchange rates for such dates of Ch$534.43 and Ch$539.37, respectively, per U.S.$1.00.
 
The following table sets forth the annual low, high, average and period end observed exchange rates 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.
 
   
Daily Observed Exchange Rate Ch$ Per U.S.$(1)
 
Year
 
Low(2)
   
High(2)
   
Average(3)
   
Period End(4)
 
2002
   
641.75
     
756.56
     
689.24
     
712.38
 
2003
   
593.10
     
758.21
     
691.54
     
599.42
 
2004
   
559.21
     
649.45
     
609.55
     
559.83
 
2005
   
509.70
     
592.75
     
559.86
     
514.21
 
2006
   
511.44
     
549.63
     
530.26
     
534.43
 
                                 
Month
                               
September 2006
   
536.63
     
540.80
     
538.65
     
538.22
 
October 2006
   
524.12
     
537.63
     
530.95
     
525.99
 
November 2006
   
523.34
     
530.61
     
527.44
     
529.29
 
December 2006
   
524.78
     
534.43
     
527.58
     
534.43
 
January 2007
   
532.39
     
545.18
     
540.51
     
545.18
 
February 2007
   
535.29
     
548.67
     
542.27
     
538.42
 
March 2007
   
535.36
     
541.95
     
538.49
     
539.37
 
April 2007
   
527.08
     
539.69
     
532.30
     
527.08
 
May 2007
   
517.64
     
527.52
     
522.02
     
527.52
 
June 2007 (through June 14)
 
524.30
   
529.32
   
526.88
   
529.32
 
 

Source: Central Bank.
(1)
Nominal figures.
 
9

(2)
Exchange rates are the actual low and high, on a day-by-day basis for each period.
   
(3)
The average of monthly average rates during the year.
   
(4) As reported by the Central Bank on the first business day of the following period.
 
Dividends
 
Under the current General Banking Law, a Chilean bank may only pay a single dividend per year (i.e., interim dividends are not permitted). Santander-Chile’s annual dividend is proposed by its Board of Directors and is approved by the shareholders at the annual ordinary shareholders’ meeting held the year following that in which the dividend is generated. For example, the 2005 dividend must be proposed and approved during the first four months of 2006. Following shareholder approval, the proposed dividend is declared and paid. Historically, the dividend for a particular year has been declared and paid no later than one month following the shareholders meeting. Dividends are paid to shareholders of record on the fifth day preceding the date set for payment of the dividend. The applicable record dated for the payment of dividends to holders of ADSs will, to the extent practicable, be the same.
 
Under the General Banking Law, Ley General de Bancos, Decreto con Fuerza de Ley No.3 de 1997, a bank must distribute cash dividends in respect of any fiscal year in an amount equal to at least 30% of its net income for that year, as long as the dividend does not result in a violation of minimal capital requirements.  The balances of our distributable net income are generally retained for use in our business (including for the maintenance of any required legal reserves). Although our Board of Directors currently intends to pay regular annual dividends, the amount of dividend payments will depend upon, among other factors, our then current level of earnings, capital and legal reserve requirements, as well as market conditions, and there can be no assurance as to the amount or timing of future dividends.
 
Dividends payable to holders of ADSs are net of foreign currency conversion expenses of the depositary and will be subject to the Chilean withholding tax currently at the rate of 35% (subject to credits in certain cases as described in “Item 10: Additional Information—E. Taxation—Material Tax Consequences of Owning Shares of Our Common Stock or ADSs—Chilean Taxation”). See “Item 10: Additional Information—E. Taxation”.  Owners of the ADSs will not be charged any dividend remittance fees by the depositary with respect to cash or stock dividends.
 
Under the Foreign Investment Contract (as defined herein), the Depositary, on behalf of ADS holders, is granted access to the Formal Exchange Market to convert cash dividends from Chilean pesos to U.S. dollars and to pay such U.S. dollars to ADS holders outside Chile, net of taxes, and no separate registration by ADS holders is required. In the past, Chilean law required that holders of shares of Chilean companies who were not residents of Chile to register as foreign investors under one of the foreign investment regimes contemplated by Chilean law in order to have dividends, sale proceeds or other amounts with respect to their shares remitted outside Chile through the Formal Exchange Market. On April 19, 2001, the Central Bank deregulated the Exchange Market eliminating the need to obtain approval from the Central Bank in order to remit dividends, but at the same time this eliminated the possibility of accessing the Formal Exchange Market. These changes do not affect the current Foreign Investment Contract, which was signed prior to April 19, 2001, which grants access to the Formal Exchange Market with prior approval of the Central Bank. See “Item 10: Additional Information—D. Exchange Controls”.
 
The following table presents dividends paid by us in nominal terms in the following years:
 
 
Year
 
Dividend
Ch$ mn (1)
   
Per share
Ch$/share (2)
   
Per ADR
Ch$/ADR (3)
   
% of
earnings (4)
 
2003
   
157,315
     
0.83
     
  867.36
     
100%
 
2004
   
206,975
     
1.10
     
1,141.16
     
100%
 
2005
   
198,795
     
1.05
     
1,096.06
     
100%
 
2006
   
155,811
     
0.83
     
  859.06
     
  65%
 
2007
   
185,628
     
0.99
     
1,023.46
     
  65%
 

 
(1)
Million of nominal pesos.
 
(2)
Calculated on the basis of 188,446 million shares.
 
10

 
(3)
Calculated on the basis of 1,039 shares per ADS.
 
(4)
Calculated by dividing dividend paid in the year by net income for the previous year.
 

B. Capitalization and Indebtedness
 
Not applicable.
 
C. Reasons for the Offer and Use of Proceeds
 
Not applicable.
 
D. Risk Factors
 
You should carefully consider the following risk factors, as well as all the other information presented in this Annual Report before investing in securities issued by us. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties that we do not know about or that we currently think are immaterial may also impair our business operations. Any of the following risks, if they actually occur, could materially and adversely affect our business, results of operations, prospects and financial condition.
 
We are subject to market risks that are presented both in this subsection and in “Item 5: Operating and Financial Review and Prospects” and “Item 11: Quantitative and Qualitative Disclosures about Market Risk.”
 
Risks Associated with Our Business
 
Increased competition and industry consolidation may adversely affect results of our operations.
 
The Chilean market for financial services is highly competitive. We compete with other Chilean private sector domestic and foreign banks, with Banco del Estado, a public sector bank, with department stores and the 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 medium 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 medium 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) 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. Currently, banks continue to be the main suppliers of leasing, factoring and mutual funds, and the insurance sales business has seen rapid growth.
 
The increase in competition within the Chilean banking industry in recent years has led to, among other things, consolidation in the industry. We expect the trends of increased competition and consolidation to continue and result in the formation of new large financial groups. Consolidation, 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, Law No. 19,769 allows insurance companies to participate and compete with us in the residential mortgage and credit card businesses.
 
Our allowances for impairment losses may not be adequate to cover our future actual losses to our loan portfolio.
 
At December 31, 2006, our allowance for impairment losses on loans was Ch$174,064 million, and the ratio of our allowance for impairment losses to total loans was 1.48%. The amount of allowances is based on our current
 
11

 
assessment of and expectations concerning various factors affecting the quality of our loan portfolio. These factors include, among other things, our borrower’s financial condition, repayment ability and repayment intention, the realizable value of any collateral, the prospects for support from any guarantor, Chile’s economy, government macroeconomic policies, interest rates and legal and regulatory environment. Many of these factors are beyond our control. 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 consists of individuals (approximately 43.2% of the value of the total loan portfolio at December 31, 2006) and, to a lesser extent, small and medium sized companies (those with annual sales of less than US$2.2 million) which comprised approximately 16.0% of the value of the total loan portfolio at December 31, 2006. As part of our business strategy, we seek to increase lending and other services to small companies and individuals. Small companies and individuals are, however, more likely to be adversely affected by downturns in the Chilean economy than large corporations and high income individuals.  In addition, at December 31, 2006, our residential mortgage loans represented 23.7% of our total loans. If the economic conditions and real estate market in Chile experience a significant downturn, our asset quality, results of operations and financial condition may be materially and adversely affected. As a result of these factors, in the future we may experience higher levels of past due loans, which could result in higher provisions for loan losses. There can be no assurance that the levels of past due loans and subsequent write offs will not be materially higher in the future.
 
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.
 
At December 31, 2006, our past due loans were Ch$92,559 million, and the ratio of our past due loans to total loans was 0.79%. For additional information on our asset quality, see “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical Information—Analysis of Substandard Loans and Amounts Past Due”. 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 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. If such deterioration were to occur, it would materially and 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. However, we may not have current information on the value of collateral, which may result in an inaccurate assessment for impairment losses of our loans secured by such collateral. If this were to occur, we may need to make additional provisions to cover actual impairment losses of our loans, which may materially and adversely affect our results of operations and financial condition.
 
Additionally, there are certain provisions under Chilean law that may affect our ability to foreclose or liquidate residential mortgages granted to us by our customers if the affected real estate has been declared as “family property” by a court. Furthermore, foreclosure will be extremely limited if any party using the real estate has filed with a court a petition requesting that such real estate be declared as family property.
 
12

 
The growth of our loan portfolio may expose us to increased loan losses.
 
From December 31, 2001 to December 31, 2006, our aggregate loan portfolio (on an unconsolidated combined basis) grew by 40.7% in nominal terms to Ch$11,784,906 million (US$22 billion), while our consumer loan portfolio grew by 146.7% in nominal terms to Ch$1,580,038 million (US$2,956 million), excluding lines of credit and calculated in accordance with the loan classification system of the Superintendency of Banks. Because the method of classification of loans used by the Superintendency of Banks for its public information differs in minor respects from that used by us for internal accounting purposes, the foregoing figures may differ from the figures included in our financial statements. 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.
 
There can be no assurance that in the future our loan portfolio will continue to grow at the same or similar rates as the historical growth rate previously experienced by Santiago or Old Santander-Chile. Average loan growth has remained significant in the last five years. According to the Superintendency of Banks, from December 31, 2001 to December 31, 2006, the aggregate amount of loans outstanding in the Chilean banking system (on an unconsolidated basis) grew by 74.4% in nominal terms to Ch$52,782,245 million (US$98,764 million) at December 31, 2006. 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.
 
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 Superintendency of Banks, Dicom (a nationwide credit bureau) and other sources.  Due to limitations on 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 and adversely affected.
 
Fluctuations in the rate of inflation may affect our results of operations.
 
Although Chilean inflation has been moderate in recent years, Chile has experienced high levels of inflation in the past. 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. In 2006, inflation rate was 2.6% compared to 3.7% in 2005.
 
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 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 proportional amount of the change in the Chilean Consumer Price Index during the prior calendar month. One UF equaled to Ch$17,317.05 at December 31, 2004, Ch$17,974.81 at December 31, 2005 and Ch$18,336.38 at December 31, 2006.  The effect of any changes in the nominal peso value of our UF denominated assets and liabilities is reflected in our results of operations as an increase (or decrease, in the event of deflation) in interest revenue and expense, respectively. Our net interest revenue will be positively affected by an inflationary environment to the extent that our average UF denominated assets exceed our average UF denominated liabilities. Our net interest revenue will be negatively affected by inflation in any period in which our average UF denominated liabilities exceed our average UF denominated assets. Our average UF denominated assets exceeded our average UF
 
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denominated liabilities by Ch$1,285,290 million, Ch$1,446,290 and Ch$2,567,226 at December 31, 2004, 2005 and 2006, respectively. See “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical Information—Average Balance Sheets, Income Earned from Interest-Earning Assets and Interest Paid on Interest-Bearing Liabilities .”  We generally have more UF denominated financial assets than UF denominated financial liabilities and, therefore, benefit from positive monthly inflation figures and we actively manage the size of this gap in accordance with our views of futures inflation expectations.  Although we currently benefit from moderate levels of 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, especially in a period 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 revenue. In 2006, net interest revenue represented 77.2% of our operating revenue. 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 revenue or result in a decrease in customer’s 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. Any volatility 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 for the last five years.
 
 
 
Year
 
Period-end yield on
90-day notes (%)
 
 
2002
   
2.88
 
 
2003
   
2.58
 
 
2004
   
2.32
 
 
2005
   
4.75
 
 
2006
   
5.10
 
 

 
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 of funding. At December 31, 2006, 84.8% 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 portion 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 our 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 and adversely affected.
 
We may be unable to meet requirements relating to capital adequacy.
 
We are required by the General Banking Law to maintain regulatory capital of at least 8% of our 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 a result of the merger between Old Santander-Chile and Santiago, we were required to maintain a minimum regulatory capital to risk weighted assets ratio of 12%, which was reduced to 11% as of January 1, 2005. At December 31, 2006, the ratio of our basic capital to total assets, net of loan loss
 
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allowance, was 6.2%, and the ratio of our regulatory capital to risk-weighted assets, net of loan loss allowance and deductions, was 12.6%. Certain developments could affect our ability to continue to satisfy the current capital adequacy requirements applicable to us, including:
 
 
·
the increase in risk-weighted assets as a result of the expansion of our business;
 
 
·
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; and
 
 
·
changes in accounting rules or in the guidelines regarding the calculation of the capital adequacy ratios of banks in Chile.
 
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 Superintendency of Banks 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 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.
 
The restrictions on the exposure of Chilean pension funds may affect our access to funding
 
Chilean regulations impose restrictions on the share of assets that a Chilean pension fund management company (Administrador de Fondos de Pension, an “AFP”) 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, it is required to reduce its exposure below the limit within three years. At December 31, 2006, the aggregate exposure of AFPs to us was approximately Ch$2,519,789 million (US$4,715 million) or 5.4% of their total assets, and the largest exposure of a single AFP to us was 6.6% of its 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.
 
Pension funds must also comply with other investment limits.  Proposed legislation in Chile may relax the limits on making investments abroad in order to permit pension funds to further diversify their investment portfolios.  As a result, pension funds may change the composition of their portfolios, including reducing their deposits with local banks.  At December 31, 2006, 28.2% of the Bank’s time deposits were from AFPs. Although the proposed 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 material adverse impact on our business, financial condition and results of operations.
 
Our business is highly dependant on proper functioning and improvement of information technology systems.
 
Our business is highly dependant 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
 
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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, 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 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.
 
Santander-Chile, like all large financial institutions, is 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 Santander-Chile maintains 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 material 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 Superintendency of Banks. In addition, we are subject to regulation by the Central Bank with regard to certain matters, including reserve requirements and interest rates and foreign exchange mismatches and market risks . During the Chilean financial crisis of 1982 and 1983, the Central Bank and the Superintendency of Banks strictly controlled the funding, lending and general business matters of the banking industry in Chile.
 
Pursuant to the General Banking Law, all Chilean banks may, subject to the approval of the Superintendency of Banks, engage in certain businesses other than commercial banking depending on the risk associated with such business and the financial strength of the bank. 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 provides the Chilean banking system with a modified version of the capital adequacy guidelines issued by the Basle Committee on Banking Regulation and Supervisory Practices and limits the discretion of the Superintendency of Banks 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, than those currently in effect. 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 allows 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 accounts on which we pay interest, any such change could have a material adverse effect on our financial condition or results of operations.
 
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We must maintain higher regulatory capital to risk-weighted assets than other banks in Chile. The merger of Old Santander-Chile and Santiago required a special regulatory preapproval of the Superintendency of Banks, which was granted on May 16, 2002. The resolution granting this preapproval imposed a mandatory minimum regulatory capital to risk weighted assets ratio of 12% for the merged bank compared to the 8% minimum for other banks in Chile. Effective January 1, 2005, the Superintendency of Banks lowered our minimum regulatory capital to risk- weighted assets ratio to 11%.  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.
 
We are subject to regulatory inspections and examinations.
 
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 the applicable regulatory requirements and guidelines, or that we will not be subject to sanctions, fines and other penalties in the future as a result of non-compliance. If sanctions, fines and 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.
 
Risks Relating to Chile
 
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, 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 a substantial influence over many aspects of the private sector, or other political or economic developments in Chile. We cannot assure you that the Chilean economy will continue to grow in the future or that those future developments in or affecting Chile’s exports will not materially and adversely affect our business, financial condition or results of operations.
 
Economic 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 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 Latin America, especially in Argentina and Brazil. Although the government have stimulated economic growth in Argentina, if Argentina’s economic environment significantly deteriorates or does not further improve, the economy in Chile, as a neighboring country and  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 loan allowances, thus affecting our financial results, our results of operations and the price of our securities.  At December 31, 2006, approximately 3.3% of our loans were held abroad and 0.60% of our loans were comprised of loans to companies in Latin American countries. 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.
 
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 could affect the dollar value of our securities. The peso has been subject to large devaluations and appreciations in the past and could be subject to
 
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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 year end for the last five years.
 
 
 
Year
 
Exchange rate (Ch$)
Year-end
   
Devaluation
(appreciation) (%)
 
 
2002
   
712.38
     
 8.6%
 
 
2003
   
599.42
     
(15.9%)
 
 
2004
   
559.83
     
(6.6%)
 
 
2005
   
514.21
     
(8.1%)
 
 
2006
   
534.43
     
3.9%
 
 

 
Source: Central Bank.
 
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.
 
Furthermore, Chilean tradings in the shares underlying our ADSs will be conducted in pesos. Cash distributions with respect to our shares of common stock are received in Chilean pesos by the depositary which then will convert such amounts to U.S. dollars at the then prevailing exchange rate for the purpose of making payments in respect of our ADSs. If the value of the Chilean peso falls relative to the U.S. dollar, the dollar value of our ADSs and any distributions to be received from the depositary will be reduced. In addition, the depositary will incur customary current conversion costs (to be borne by the holders of our ADSs) in connection with the conversion and subsequent distribution of dividends or other payments.
 
Chile’s banking regulatory and capital markets environment is continually evolving and may change.
 
Chilean laws, regulations, policies and interpretations of laws relating to the banking sector and financial institutions are continually evolving and changing. For example, legislation is being discussed regarding the elimination of reserve requirements, permissions to enter the pension fund business and modifications to maximum lending rates.  Changes in banking regulations may materially and adversely affect our business, financial condition and results of operations.
 
In addition, certain aspects of Chilean legislation governing the capital markets is currently being reviewed by the Constitutional Court, after being approved by the Chilean Congress and a new law known as Mercado de Capitales II (“MK2”) is expected to be passed soon.  MK2 is expected to, among other things, modify certain provisions set forth in the General Banking Law that limit the lending activity of banks.  Under current legislation, banks are not allowed to grant unsecured loans to one individual or entity in an aggregate amount in excess of 5% of the regulatory capital of the bank.  This limit is increased to 25% if the amount that exceeds said 5% corresponds to loans secured by collateral with an aggregate value equal to or higher than such excess.  MK2 is expected to increase these limits to 10% and 30% of the regulatory capital of the bank, respectively, unless the loans are granted to individuals or entities directly or indirectly related to the property or management of the bank, in which case the limits are expected to be maintained in 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.  See “Item 3: Key Information—D. Risk Factors—Risks Associated with Our Business—The growth of our loan portfolio may expose us to increased loan losses.”
 
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Any downgrading of Chile debt credit rating for domestic and international debt by international credit rating agencies may adversely affect our business, our future financial performance, stockholder’s equity and the price of our shares and ADSs.
 
Our ratings are equivalent to the Chilean sovereign ratings. In 2006, Moody’s improved its rating for the Republic of Chile and also for us. Any adverse revisions to Chile’s credit ratings for domestic and international debt by international rating agencies may adversely affect our ratings, and our business, future financial performance, stockholder’s equity and the price of our equity shares and ADSs.
 
Chile has different corporate disclosure and accounting standards than those you may be familiar with in the United States.
 
We prepare our financial statements in accordance with Chilean GAAP, which requires management to make estimates and assumptions with respect to certain matters that are inherently uncertain. The consolidated financial statements include various estimates and assumptions, including but not limited to the adequacy of the allowance for loan losses, estimates of the fair value of certain financial instruments, the selection of useful lives of certain assets and the valuation and recoverability of goodwill and deferred taxes. We evaluate these estimates and judgments on an ongoing basis. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results in future periods could differ from those produced by such estimates and assumptions, and if these differences were significant enough, our reported results of operations would be affected materially.
 
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 Chilean and U.S. accounting and financial reporting standards. As a result, Chilean financial statements and reported earnings generally differ from those reported based on U.S. accounting and reporting standards.
 
As a regulated financial institution, we are required to submit to the Superintendency of Banks unaudited unconsolidated balance sheets and income statements, excluding any note disclosure, prepared in accordance with Chilean GAAP and the rules of the Superintendency of Banks on a monthly basis. 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, have  a principal objective of promoting 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, limiting the protections afforded to investors.
 
We are a “controlled company” and a “foreign private issuer” within the meaning of the New York Stock Exchange corporate governance standards. Under the New York Stock Exchange rules, a controlled company is exempt from certain New York Stock Exchange 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 New York Stock Exchange 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
 
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protections afforded to shareholders of companies that are subject to all New York Stock Exchange corporate governance requirements.
 
Chile imposes controls on foreign investment and repatriation of investments that may affect your investment in, and earnings from, our ADSs.
 
Equity investments in Chile by persons who are not Chilean residents have generally been subject to various exchange control regulations which restrict the repatriation of the investments and earnings therefrom. In April 2001, the Central Bank eliminated the regulations that affected foreign investors except that investors are still required to provide the Central Bank with information related to equity investments and conduct such operations within Chile’s Formal Exchange Market. The ADSs are subject to a contract, dated May 17, 1994, among the depositary, us and the Central Bank (the “Foreign Investment Contract”) that remains in full force and effect.  The ADSs continue to be governed by the provisions of the Foreign Investment Contract subject to the regulations in existence prior to April 2001.  The Foreign Investment Contract grants the depositary and the holders of the ADSs access to the Formal Exchange Market, which permits the depositary to remit dividends it receives from us to the holders of the ADSs.  The Foreign Investment Contract also permits ADS holders to repatriate the proceeds from the sale of shares of our common stock withdrawn from the ADR facility, or that have been received free of payment as a consequence of spin offs, mergers, capital increases, wind-ups, share dividends or preemptive rights transfers, enabling them to acquire the foreign currency necessary to repatriate earnings from such investments. Pursuant to Chilean law, the Foreign Investment Contract cannot be amended unilaterally by the Central Bank, and there are judicial precedents (although not binding with respect to future judicial decisions) indicating that contracts of this type may not be abrogated by future legislative changes or resolutions of the Advisory Council of the Central Bank. Holders of shares of our common stock, except for shares of our common stock withdrawn from the ADS facility or received in the manner described above, are not entitled to the benefits of the Foreign Investment Contract, may not have access to the Formal Exchange Market, and may have restrictions on their ability to repatriate investments in shares of our common stock and earnings therefrom.
 
Holders of ADSs are entitled to receive dividends on the underlying shares to the same extent as the holders of shares. Dividends received by holders of ADSs will be paid net of foreign currency exchange fees and expenses of the depositary and will be subject to Chilean withholding tax, currently imposed at a rate of 35.0% (subject to credits in certain cases). If for any reason, including changes in Chilean law, the depositary were unable to convert Chilean pesos to U.S. dollars, investors would receive dividends and other distributions, if any, in Chilean pesos.
 
We cannot assure you that additional Chilean restrictions applicable to holders of our ADSs, the disposition of the shares underlying them or the repatriation of the proceeds from such disposition or the payment of dividends will not be imposed in the future, nor can we advise you as to the duration or impact of such restrictions if imposed.
 
ADS holders may not be able to effect service of process on, or enforce judgments or bring original actions against, us, our directors or our executive officers, which may limit the ability of holders of ADSs to seek relief against us.
 
We are a Chilean corporation. None of our directors are residents of the United States and most of our executive officers reside outside the United States. In addition, a substantial portion of our assets and the assets of our directors and executive officers are located outside the United States. As a result, it may be difficult for ADS holders to effect service of process outside Chile upon us or our directors and executive officers or to bring an action against us or such persons in the United States or Chile to enforce liabilities based on U.S. federal securities laws. It may also be difficult for ADS holders to enforce in the United States or in Chilean courts money judgments obtained in United States courts against us or our directors and executive officers based on civil liability provisions of the U.S. federal securities laws. If a U.S. court grants a final money judgment in an action based on the civil liability provisions of the federal securities laws of the United States, enforceability of this money judgment in Chile will be subject to the obtaining of the relevant "exequatur" (i.e., recognition and enforcement of the foreign judgment) according to Chilean civil procedure law currently in force, and consequently, subject to the satisfaction of certain factors. The most important of these factors are the existence of reciprocity, the absence of a conflicting judgment by a Chilean court relating to the same parties and arising from the same facts and circumstances and the Chilean courts’ determination that the U.S. courts had jurisdiction, that process was appropriately served on the defendant and that
 
20

 
enforcement would not violate Chilean public policy. Failure to satisfy any of such requirements may result in non-enforcement of your rights.
 
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 global banking industries.
 
Facts, forecasts and statistics in this document relating to Chile, Chile’s economy and Chilean global banking industries, including market share information, are derived form various official and other publicly available sources generally believed to be reliable. However, we cannot guarantee the quality and reliability of such official and 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 possible 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.
 
Risks Relating to our ADSs
 
There may be a lack of liquidity and market for our shares and ADSs.
 
The ADSs are listed and traded on the NYSE. The common stock is listed and traded on the Santiago Stock Exchange, the Chile Electronic Stock Exchange and the Valparaiso Stock Exchange, which we refer to collectively as the Chilean Stock Exchanges, although the trading market for the common stock is small by international standards. At December 31, 2006, we had 188,446,126,794 shares of common stock outstanding. The Chilean securities markets are substantially smaller, less liquid and more volatile than major securities markets in the United States. According to Article 14 of the Ley de Mercado de Valores, Ley No. 18,045, or the Chilean Securities Market Law, the Superintendencia de Valores y Seguros, or the Superintendency of Securities and Insurance, may suspend the offer, quotation or trading of shares of any company listed on one or more Chilean Stock Exchanges for up to 30 days if, in its opinion, such suspension is necessary to protect investors or is justified for reasons of public interest. Such suspension may be extended for up to 120 days. If, at the expiration of the extension, the circumstances giving rise to the original suspension have not changed, the Superintendency of Securities and Insurance will then cancel the relevant listing in the registry of securities. In addition, the Santiago Stock Exchange may inquire as to any movement in the price of any securities in excess of 10% and suspend trading in such securities for a day if it deems necessary.
 
Although the common stock is traded on the Chilean Stock Exchanges, there can be no assurance that a liquid trading market for the common stock will continue. Approximately 23.09% of our outstanding common stock is held by the public (i.e., shareholders other than Banco Santander Central Hispano S.A., to which we refer as Banco Santander Central Hispano, and its affiliates), including our shares that are represented by ADSs trading on the NYSE.  A limited trading market in general and our concentrated ownership in particular may impair the ability of an ADS holder to sell in the Chilean market shares of common stock obtained upon withdrawal of such shares from the ADR facility in the amount and at the price and time such holder desires, and could increase the volatility of the price of the ADSs.
 
You may be unable to exercise preemptive rights.
 
The Ley Sobre Sociedades Anónimas, Ley No. 18,046 and the Reglamento de Sociedades Anónimas, which we refer to collectively as the Chilean Companies Law, and applicable regulations require that whenever we issue new common stock for cash, we grant preemptive rights to all of our shareholders (including holders of ADSs), giving them the right to purchase a sufficient number of shares to maintain their existing ownership percentage. Such an offering would not be possible unless a registration statement under the U.S. Securities Act of 1933, as amended, were effective with respect to such rights and common stock or an exemption from the registration requirements thereunder were available.
 
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Since we are not obligated to elect to make a registration statement available with respect to such rights and the common stock, you may not be able to exercise your preemptive rights. If a registration statement is not filed or an applicable exemption is not available, the depositary will sell such holders’ preemptive rights and distribute the proceeds thereof if a premium can be recognized over the cost of any such sale.
 
You may have fewer and less well defined shareholders’ rights than with shares of a company in the United States.
 
Our corporate affairs are governed by our estatutos, or bylaws, and the laws of Chile. Under such laws, our shareholders may have fewer or less well defined rights than they might have as shareholders of a corporation incorporated in a U.S. jurisdiction. For example, under legislation applicable to Chilean banks, our shareholders would not be entitled to appraisal rights in the event of a merger or other business combination undertaken by us.
 
ITEM 4. INFORMATION ON THE COMPANY
 
A. History and Development of the Company
 
Overview
 
We were formed on August 1, 2002 through the merger of Santiago and Old Santander-Chile, both of which were subsidiaries of our controlling shareholder, Banco Santander Central Hispano. We are the largest bank in Chile in terms of total assets, total deposits, loans and shareholders’ equity. At December 31, 2006, we had total assets of Ch$14,843,439 million (US$27,774 million), loans net of allowances outstanding of Ch$11,614,895 million (US$21,733 million), deposits of Ch$9,392,332 million (US$17,574 million) and shareholders’ equity of Ch$1,245,339 million (US$2,330 million). As of December 31, 2006, we employed 8,184 people (on a consolidated basis) and had the largest private branch network in Chile with 397 branches (includes payment centers Santander SuperCaja). Our headquarters are located in Santiago and we operate in every major region of Chile.
 
We provide a broad range of commercial and retail banking services to our customers, including Chilean peso and foreign currency denominated loans to finance a variety of commercial transactions, trade financing, foreign currency forward contracts, credit lines and a variety of retail banking services, including mortgage financing. We seek to offer our customers a wide range of products while providing high levels of service. In addition to our traditional banking operations, we offer a variety of financial services including financial leasing, financial advisory services, mutual fund management, securities brokerage, insurance brokerage and investment management.
 
The legal predecessor of Santander-Chile was Banco Santiago (Santiago). Santiago was incorporated by public deed dated September 7, 1977 granted at the Notary Office of Alfredo Astaburuaga Gálvez. Santiago received its permission to incorporate and function as a bank by Resolution No. 118 of the Superintendency of Banks on October 27, 1977. The Bank’s bylaws were approved by Resolution No. 103 of the Superintendency of Banks on September 22, 1977. In January 1997, Santiago merged with Banco O’Higgins with Santiago being the surviving entity.  In 1999, Santiago became a controlled subsidiary of Banco Santander Central Hispano.  As of June 30, 2002, Santiago was the second largest private sector bank in Chile in terms of total assets, deposits, loans and shareholders’ equity.
 
Old Santander-Chile was established as a subsidiary of Banco Santander Central Hispano in 1978. In 1982, Old Santander-Chile acquired a significant portion of the assets and liabilities of Banco Español-Chile, a domestic bank that had become insolvent. In July 1996, Old Santander-Chile was merged into Banco Osorno y la Unión ("Banco Osorno") becoming “Banco Santander-Chile”, the third largest private bank in terms of outstanding loans at that date.
 
Our principal executive offices are located at Bandera 140, Santiago, Chile. Our telephone number is 562-320-2000 and our website is www.santandersantiago.cl. None of the information contained on our website is incorporated by reference into, or forms part of, this Annual Report.  Our agent for service of process in the United States is Puglisi & Associates.
 
22

 
Relationship with Banco Santander Central Hispano
 
We believe that our relationship with our controlling shareholder, Banco Santander Central Hispano, offers us a significant competitive advantage over our peer Chilean banks. Banco Santander Central Hispano is one of the largest financial groups in Latin America, in terms of total assets measured on a region-wide basis. It is the largest financial group in Spain and is a major player elsewhere in Europe, including the United Kingdom through its Abbey subsidiary and Portugal, where it is the third-largest banking group.  Through Santander Consumer it also operates a leading consumer finance franchise in Germany, Italy, Spain and several other European countries.
 
Our relationship with Banco Santander Central Hispano provides us with access to the group’s client base, while its multinational focus allows us to offer international solutions to our clients’ financial needs. We also have the benefit of selectively borrowing from Banco Santander Central Hispano’s product offerings in other countries as well as benefiting from their know-how in systems management. We believe that our relationship with Banco Santander Central Hispano will also enhance our ability to manage credit and market risks by adopting policies and know-how developed by Banco Santander Central Hispano. Our internal auditing function has been strengthened and is more independent from management as a result of the addition of an internal auditing department that concurrently reports directly to our Audit Committee and the audit committee of Banco Santander Central Hispano. We believe that this structure leads to improved monitoring and control of our exposure to operational risks.
 
Banco Santander Central Hispano’s support includes the assignment of managerial personnel to key supervisory areas of Santander-Chile, like Risks, Auditing, Accounting and Financial Control. Santander-Chile does not pay any management fees to Banco Santander Central Hispano in connection with these support services.
 
B. Organizational Structure
 
Banco Santander Central Hispano controls Santander-Chile through its holdings in Teatinos Siglo XXI S.A., which we refer to as "Teatinos Siglo XXI", and Santander-Chile Holding, both controlled subsidiaries. This gives Santander Central Hispano control over 76.91% of the shares of the Bank. Economic participation when excluding minority shareholders that participate in Santander Chile Holding is 76.73%.
 
Shareholder
 
Number of Shares
   
Percentage
 
Teatinos Siglo XXI S.A.
   
78,108,391,607
      41.45%  
Santander Chile Holding
   
66,822,519,695
      35.46%  

Management Team
 
The chart below sets forth the names and areas of responsibility of our senior commercial managers.
 
The chart below sets forth the names and areas of responsibilities of our operating managers.
 
 
23


 

C. Business Overview
 
We have 375 branches in total, 103 of which operated under the Santander Banefe brand name. The remaining 272 branches are operated under the Santander Santiago brand name. In addition, we have 22 payment centers with a brand name of Santander SuperCaja. We provide a full range of financial services to corporate and individual customers. We divide our clients into the following segments:
 
The retail segment primarily serves the following types of customers:
 
 
·
Lower-middle to middle-income (Santander Banefe), consisting of individuals with monthly income between Ch$120,000 (US$225) and Ch$400,000 (US$749), which are served through our Banefe branch network. This segment accounts for 5.1% of our loans at December 31, 2006. This segment offers customers a range of products, including consumer loans, credit cards, auto loans, residential mortgage loans, debit card accounts, savings products, mutual funds and insurance brokerage.
 
 
·
Middle- and upper-income, consisting of individuals with a monthly income greater than Ch$400,000 (US$749). Clients in this segment account for 38.1% of our loans at December 31, 2006 and are offered a range of products, including consumer loans, credit cards, auto loans, commercial loans, foreign trade financing, residential mortgage loans, checking accounts, savings products, mutual funds and insurance brokerage.
 
 
·
Small businesses, consisting of small companies with annual sales less than Ch$1,200 million (US$2.2 million). At December 31, 2006, small companies, or SMEs, represented approximately 16.0% of our total loans outstanding. Customers in this segment are offered a range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, savings products, mutual funds and insurance brokerage.
 
The Middle-market segment consists primarily of mid-sized companies, companies in the real estate sector and large companies.
 
 
·
Mid-sized companies, consisting of companies with annual sales over Ch$1,200 million (US$2.2 million) and up to Ch$3,500 million (US$6.5 million). Customers in this segment are offered a wide range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, cash management, treasury services, financial advisory, savings products, mutual funds and insurance brokerage. At December 31, 2006, these clients represented 8.2% of our total loans outstanding.
 
 
·
Real estate. This segment includes all companies in the real estate sector. At December 31, 2006, these clients represented 4.7% of our total loans outstanding. Apart
 
24

 
 
 
from traditional banking services, we also offer clients in the real estate sector specialized services for financing primarily residential projects in order to increase the sale of residential mortgage loans.
 
 
·
Large companies, consisting of companies with annual sales over Ch$3,500 million (US$6.5 million). Customers in this segment are offered a wide range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, cash management, treasury services, financial advisory, savings products, mutual funds and insurance brokerage. At December 31, 2006, these clients represented 9.6% of our total loans outstanding.
 
The Wholesale segment is comprised of:
 
 
·
Companies that are foreign multinationals or part of a large Chilean economic group with sales over Ch$3,500 million (US$6.5 million). At December 31, 2006, these clients represented 15.1% of our total loans outstanding. Customers in this segment are offered a wide range of products, including commercial loans, leasing, factoring, foreign trade, mortgage loans, checking accounts, cash management, treasury services, financial advisory, savings products, mutual funds and insurance brokerage.
 
The Institutional segment is comprised of:
 
 
·
Institutional corporations such as universities, government agencies, municipalities and regional governments. At December 31, 2006, these clients represented 1.9% of our total loans outstanding. We offer these customers a range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, cash management, savings products, mutual funds and insurance brokerage.
 
The Treasury Division provides sophisticated financial products mainly to companies in the wholesale banking and the middle market segments, including such products as short-term financing and funding, securities brokerage, interest rate and foreign currency derivatives, securitization services and other tailored financial products. The Treasury division also manages the Bank’s trading positions as well as the non-trading investment portfolio.
 
Our leasing subsidiary (Santiago Leasing S.A.) has been segmented into the above categories. The subsidiary Santander S.A. Agente de Valores is included in the Treasury Division and the mutual fund and insurance brokerage subsidiaries are included in the various sub-segments (other than in the Treasury Division).
 
The table below sets forth our lines of business and certain statistical information relating to each of them at and for the year ended December 31, 2006. Please see Note 26(y) to our Audited Consolidated Financial Statements for details of revenue by business segment in the last three years.
 
   
At and for the year ended December 31, 2006
 
Segment
 
Loans
   
Net interest
revenue
   
Fees, net
   
Net loan loss
provisions (1)
   
Financial
transactions,
net (2)
   
Net segment
contribution (3)
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Individuals                                
   
5,097,010
     
332,444
     
103,476
      (101,753 )    
-
     
334,167
 
Santander Banefe                                
   
602,960
     
104,505
     
22,059
      (51,893 )    
-
     
74,671
 
Middle-upper income
   
4,487,044
     
227,590
     
81,374
      (49,957 )    
-
     
259,007
 
Santiago Leasing S.A.
   
7,006
     
349
     
43
     
97
     
-
     
489
 
Small companies                           
   
1,890,736
     
129,854
     
28,671
      (20,840 )    
-
     
137,685
 
Total Retail                                
   
6,987,746
     
462,298
     
132,147
      (122,593 )    
-
     
471,852
 
Middle-market                                
   
2,679,108
     
73,820
     
13,981
      (720 )    
-
     
87,081
 
Mid-sized companies
   
962,649
     
33,341
     
6,846
      (3,501 )    
-
     
36,686
 
Real estate                                
   
554,294
     
10,350
     
1,422
     
1,634
     
-
     
13,406
 
Large companies                                
   
1,128,536
     
28,456
     
5,508
     
680
     
-
     
34,644
 
Santiago Leasing S.A.
   
33,629
     
1,673
     
205
     
467
     
-
     
2,345
 
Wholesale                                
   
1,782,052
     
30,469
     
7,536
     
703
     
-
     
38,708
 
 
25

 
   
At and for the year ended December 31, 2006
 
Segment
 
Loans
   
Net interest
revenue
   
Fees, net
   
Net loan loss
provisions (1)
   
Financial
transactions,
net (2)
   
Net segment
contribution (3)
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Institutional                                
   
229,242
     
9,510
     
1,201
     
481
     
-
     
11,192
 
Treasury (4)                                
   
-
     
32,479
     
1,303
     
-
     
51,604
     
85,386
 
Others (5)                                
   
110,811
     
3,678
     
6,382
      (893 )    
-
     
9,167
 
Total    
11,788,959
     
612,254
     
162,550
      (123,022 )     51,604       703,386  
 

 
(1) Includes gross provisions for loan losses, net of releases on recoveries.
 
 
(2) Includes the net gains from trading, net mark-to-market gains and net foreign exchange transactions.
 
 
(3) Equal to the sum of net interest revenue, net fee income and net financial transactions, minus net provision for loan losses.
 
 
(4) Includes Santander S.A. Agente de Valores.
 
 
(5) Includes contribution of other Bank subsidiaries and other non-segmented items.
 

Operations through Subsidiaries
 
The General Banking Law was amended on November 4, 1997, to extend the scope of a bank’s permissible activities, which permitted us to directly provide leasing and financial advisory services we could formerly offer only through our subsidiaries, to offer investment advisory services outside of Chile and to undertake activities we could not formerly offer directly or through subsidiaries, such as factoring, securitization, foreign investment funds, custody and transport of securities and insurance brokerage services.
 
For the year ended December 31, 2006, our subsidiaries collectively accounted for approximately 13% of our consolidated net income. The assets and operating income of these subsidiaries as of and for the year ended December 31, 2006 represented 5.6% and 7.6% of our total assets and operating income, respectively.
 
   
Percentage Owned
 
   
At December 31, 2005
   
At December 31, 2006
 
   
Direct
   
Indirect
   
Total
   
Direct
   
Indirect
   
Total
 
   
%
   
%
   
%
   
%
   
%
   
%
 
Subsidiary
                                   
Santiago Leasing S.A.
   
99.50
     
     
99.50
     
99.50
     
     
99.50
 
Santiago Corredores de Bolsa Ltda.
   
99.19
     
0.81
     
100.00
     
99.19
     
0.81
     
100.00
 
Santander Santiago S.A. Administradora General de Fondos
   
99.96
     
0.02
     
99.98
     
99.96
     
0.02
     
99.98
 
Santander S.A. Agente de Valores
   
99.03
     
     
99.03
     
99.03
     
     
99.03
 
Santander Santiago S.A. Sociedad Securitizadora
   
99.64
     
     
99.64
     
99.64
     
     
99.64
 
Santander Santiago Corredora de Seguros Ltda.
   
99.99
     
     
99.99
     
99.99
     
     
99.99
 
Santander Servicios de Recaudación y Pagos Ltda.
   
     
     
     
99.90
     
0.10
     
100.00
 

The Board of Directors has approved the merger between Santiago Corredores de Bolsa Ltda, a subsidiary of the Bank, and Santander Investment S.A. Corredores de Bolsa, an indirect subsidiary of Banco Santander Central Hispano.  As a result of the proposed merger, the Bank will own 50.6% of the merged entity.
 
Competition
 
Overview
 
The Chilean financial services market consists of a variety of largely distinct sectors. The most important sector, commercial banking, includes a number of privately-owned banks and one public-sector bank, Banco del Estado (which operates within the same legal and regulatory framework as the private-sector banks). The private-sector banks include local banks and a number of foreign-owned banks which are operating in Chile. The Chilean banking system is comprised of 25 private-sector banks and one public-sector bank. Five private-sector banks along with the state-owned bank together accounted for 80.4% of all outstanding loans by Chilean financial institutions at December 31, 2006.
 
26

 
 
The Chilean banking system has experienced increased competition in recent years largely due to consolidation in the industry and new legislation. For example, the merger of Banco de Chile with Banco de A. Edwards, effective January 2, 2002, resulted in the creation at that moment of the largest bank in Chile. Shortly after that merger was consummated, Banco Santander Central Hispano announced the merger of the two banks it owned in Chile, Banco Santander-Chile and Banco Santiago, creating the largest bank in Chile. We also face competition from non-bank and non-finance competitors (principally department stores) 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 mutual funds, pension funds and insurance companies, with respect to savings products.  In May 2007, Falabella, Chile’s largest retailer, and DKS, Chile’s largest food retailer, announced plans to merge.  According to our internal estimates, this would create the largest non-bank consumer finance company in Chile.  Currently, banks continue to be the main suppliers of leasing, factoring and mutual funds, and the insurance sales business has grown rapidly.
 
As shown in the following table, we are the market leader in substantially all types of banking services in Chile:
 
 
 
Market Share
at December 31,
2005
   
Market Share
at December 31,
2006
   
Rank as of
at December 31,
2006
 
Commercial loans
    19.8 %     18.7 %    
2
 
Consumer loans
   
25.6
     
26.7
     
1
 
Mortgage loans (residential and general purpose)
   
23.5
     
24.2
     
1
 
Residential mortgage loans
   
24.9
     
25.9
     
1
 
Foreign trade loans (loans for export, import and contingent)
   
22.0
     
21.5
     
1
 
Total loans
   
22.6
     
22.3
     
1
 
Deposits
   
21.5
     
22.0
     
1
 
Mutual funds (assets managed)
   
21.6
     
22.1
     
2
 
Credit card accounts
   
37.3
     
35.8
     
1
 
Checking Accounts (1)
   
25.7
     
27.1
     
1
 
Branches (2)
   
20.3
     
20.3
     
1
 
ATM locations (3)
   
28.1
     
28.6
     
1
 

Source: Superintendency of Banks
 
(1)
According to latest data available as of November 2006.
 
(2)
According to latest data available as of March 2007.  Excluding special-service payment centers.
 
(3)
According to latest data available as of September 2006.
 
Our market share in Chile’s commercial loan market decreased from December 31, 2005 to December 31, 2006, and we ranked the second in this market at December 31, 2006, compared to the first at December 31, 2005.  This is primarily due to our reduction of the relatively low yielding large corporate portfolio.
 
The following tables set out certain statistics comparing our market position to that of our peer group, defined as the five largest banks in Chile in terms of shareholders’ equity as of December 31, 2006.
 
Loans
 
As of December 31, 2006, our loan portfolio was the largest among Chilean banks. Our loan portfolio on a stand-alone basis represented 22.3% of the market for loans in the Chilean financial system at such date. The following table sets forth our and our peer group’s market shares in terms of loans at the dates indicated.
 
          
At December 31, 2006
    
 
 
 
 
At December 31,
2005
 
                         
Loans
 
Ch$ million
   
US$ million
   
Market
Share
   
Market
Share 
 
Santander-Chile
   
11,759,586
     
22,004
      22.3 %     22.6 %
Banco de Chile
   
9,503,886
     
17,783
     
18.0
     
18.1
 
Banco del Estado
   
6,999,019
     
13,096
     
13.3
     
13.3
 
 
27

 
          
At December 31, 2006
    
 
 
 
 
At December 31,
2005
 
                         
Loans
 
Ch$ million
   
US$ million
   
Market
Share
   
Market
Share 
 
Banco de Crédito e Inversiones
   
6,544,576
     
12,246
     
12.4
     
12.3
 
BBVA, Chile
   
4,281,059
     
8,011
     
8.1
     
8.0
 
Corpbanca
   
3,331,824
     
6,234
     
6.3
     
6.4
 
Others
   
10,362,296
     
19,389
     
19.6
     
19.3
 
Chilean financial system
   
52,782,246
     
98,763
      100.0 %     100.0 %

Source: Superintendency of Banks
 
Deposits
 
On a stand alone basis, we had a 22.0% market share in deposits, ranking the first place among banks in Chile at December 31, 2006. Deposit market share is based on total time deposits at the respective dates and the average monthly checking and demand deposit accounts for the corresponding months net of clearance. The following table sets forth our and our peer group’s market shares in terms of deposits at the dates indicated.
 
   
At December 31, 2006
    
 
 At December 31,
2005
 
                         
Deposits
 
Ch$ million
   
US$ million
   
Market
Share(1)
   
Market
Share 
 
Santander-Chile
   
9,208,199
     
17,230
      22.0 %     21.5 %
Banco de Chile
   
7,399,525
     
13,846
     
17.7
     
16.4
 
Banco del Estado
   
6,401,831
     
11,979
     
15.3
     
17.2
 
Banco de Crédito e Inversiones
   
5,206,214
     
9,742
     
12.4
     
12.0
 
BBVA, Chile
   
3,394,178
     
6,351
     
8.1
     
8.0
 
Corpbanca
   
1,930,245
     
3,612
     
4.6
     
5.2
 
Others
   
8,331,739
     
15,590
     
19.9
     
19.7
 
Chilean financial system
   
41,871,931
     
78,350
      100.0 %     100.0 %

(1)
The balances of checking and demand deposit accounts are the average monthly balances instead of year-end balances, as we believe that period-end balances are not always reflective of a bank’s position in checking and demand deposit accounts. The source for the average balances is the Superintendency of Banks.
 

Shareholders’ equity
 
With Ch$1,245,339 million (US$2,330 million) in shareholders’ equity, at December 31, 2006, we were the largest commercial bank in Chile in terms of shareholders’ equity. The following table sets forth our and our peer group’s shareholders’ equity at December 31, 2005 and 2006.
 
   
At December 31, 2006
   
At December 31, 2005
 
Equity(1)
 
Ch$ million
   
US$ million
   
Market
Share
   
Market
Share
 
Santander-Chile
   
1,245,339
     
2,330
      21.9 %     21.1 %
Banco de Chile
   
834,631
     
1,562
     
14.7
     
15.1
 
Banco del Estado
   
502,232
     
940
     
8.8
     
8.7
 
Banco de Crédito e Inversiones
   
587,599
     
1,099
     
10.3
     
9.8
 
BBVA, Chile
   
295,786
     
553
     
5.2
     
5.6
 
Corpbanca
   
433,249
     
811
     
7.6
     
7.9
 
Others
   
1,798,086
     
3,365
     
31.5
     
31.8
 
Chilean financial system
   
5,696,922
     
10,660
      100.0 %     100.0 %

Source: Superintendency of Banks.
 
(1)
Percentage of total shareholders’ equity of all Chilean banks.
 
28


Efficiency
 
For the year ended December 31, 2006, we were the most efficient bank in our peer group. The following table sets forth our and our peer group’s efficiency ratio (defined as operating expenses as a percentage of operating revenue, which is aggregate of net interest revenue, fees and income from services (net ) and other operating income (net)) for the year indicated.
 
Efficiency ratio
 
As of December 31, 2006
   
As of December 31, 2005
 
   
%
   
%
 
Santander-Chile
    40.6 %     44.0 %
Banco de Chile
   
53.0
     
50.4
 
Banco del Estado
   
58.9
     
60.7
 
Banco de Crédito e Inversiones
   
57.3
     
52.7
 
BBVA, Chile
   
66.6
     
68.6
 
Corpbanca
   
56.6
     
40.7
 
Chilean financial system
    52.5 %     54.1 %

Source: Superintendency of Banks, stand alone basis
 
Return on average equity
 
As of December 31, 2006, we were the second most profitable bank in our peer group (as measured by return on average equity) and the second most capitalized bank as measured by the BIS ratio. The following table sets forth our and our peer group’s return on average equity for the year ended December 31, 2005 and 2006 and BIS ratio at the dates indicated:
 
   
Return on average equity
for the year ended December 31,
   
BIS Ratio
at December 31,
 
   
2006
   
2005
   
2006
   
2005
 
   
%
   
%
   
%
   
%
 
Santander-Chile
    24.8 %     24.1 %     12.6 %     12.9 %
Banco de Chile
   
25.5
     
26.7
     
10.7
     
11.2
 
Banco del Estado
   
9.9
     
9.2
     
11.1
     
10.7
 
Banco de Crédito e Inversiones
   
22.6
     
23.4
     
10.3
     
10.3
 
BBVA, Chile
   
10.0
     
10.7
     
10.3
     
10.8
 
Corpbanca
   
9.5
     
13.8
     
13.6
     
13.5
 
Chilean Financial System
    16.7 %     16.3 %     12.5 %     13.0 %

Source: Superintendency of Banks, except Santander-Chile. Calculated by dividing annual net income by monthly average equity. For Santander-Chile, the average equity is calculated on a daily basis by the Bank (See Item 5: Operating and Financial Review and Prospects — D. Selected Statistical Information— Average Balance Sheets, Income Earned from Interest-Earning Assets and Interest paid on Interest-Bearing Liabilities.

Asset Quality
 
At December 31, 2006, on a stand alone basis, we had the fourth lowest loan loss allowance to total loans ratio in our peer group. The following table sets forth our and our peer group’s loan loss allowance to total loans ratios as defined by the Superintendency of Banks at the dates indicated.
 
 
 
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Loan Loss allowances/total loans
at December 31,
 
   
2006
   
2005
 
Santander-Chile
    1.46 %     1.42 %
Banco de Chile
   
1.48
     
1.70
 
Banco del Estado
   
1.67
     
1.64
 
Banco de Crédito e Inversiones
   
1.27
     
1.54
 
BBVA, Chile
   
1.14
     
1.35
 
Corpbanca
   
1.40
     
1.56
 
Chilean financial system
    1.48 %     1.61 %

Source: Superintendency of Banks
 
D. Regulation and Supervision
 
General
 
In Chile, only banks may maintain checking accounts for their customers, conduct foreign trade operations, and together with non-banking financial institutions, accept time deposits. The principal authorities that regulate financial institutions in Chile are the Superintendency of Banks and the Central Bank. Chilean banks are primarily subject to the General Banking Law and secondarily, to the extent not inconsistent with this statute, the provisions of the Chilean Companies Law governing public corporations, except for certain provisions which are expressly excluded.
 
The modern Chilean banking system dates from 1925 and has been characterized by periods of substantial regulation and state intervention, as well as periods of deregulation. The most recent period of deregulation commenced in 1975 and culminated in the adoption of a series of amendments to General Banking Law. That law, amended most recently in 2001, granted additional powers to banks, including general underwriting powers for new issues of certain debt and equity securities and the power to create subsidiaries to engage in activities related to banking, such as brokerage, investment advisory and mutual fund services, administration of investment funds, factoring, securitization products and financial leasing services.
 
The Central Bank
 
The Central Bank is an autonomous legal entity created by the Chilean Constitution. It is subject to the Chilean Constitution and its own ley orgánica constitucional, or organic constitutional law. To the extent not inconsistent with the Chilean Constitution or the Central Bank’s organic constitutional law, the Central Bank is also subject to private sector laws (but in no event is it subject to the laws applicable to the public sector). It is directed and administered by a board of directors composed of five members designated by the President of Chile, subject to the approval of the Senate.
 
The legal purpose of the Central Bank is to maintain the stability of the Chilean peso and the orderly functioning of Chile’s internal and external payment system. The Central Bank’s powers include setting reserve requirements, regulating the amount of money and credit in circulation, establishing regulations and guidelines regarding finance companies, foreign exchange (including the Formal Exchange Market) and banks’ deposit-taking activities.
 
The Superintendency of Banks
 
Banks are supervised and controlled by the Superintendency of Banks, an independent Chilean governmental agency. The Superintendency of Banks authorizes the creation of new banks and has broad powers to interpret and enforce legal and regulatory requirements applicable to banks and financial companies. Furthermore, in case of noncompliance with such legal and regulatory requirements, the Superintendency of Banks has the ability to impose sanctions. In extreme cases, it can appoint, with the prior approval of the board of directors of the Central Bank, a provisional administrator to manage a bank. It must also approve any amendment to a bank’s bylaws or any increase in its capital.
 
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The Superintendency of Banks examines all banks from time to time, generally at least once a year. Banks are also required to submit their financial statements monthly to the Superintendency of Banks, and a bank’s financial statements are published at least four times a year in a newspaper with countrywide coverage. In addition, banks are required to provide extensive information regarding their operations at various periodic intervals to the Superintendency of Banks. A bank’s annual financial statements and the opinion of its independent auditors must also be submitted to the Superintendency of Banks.
 
Any person wishing to acquire, directly or indirectly, 10.0% or more of the share capital of a bank must obtain the prior approval of the Superintendency of Banks. Absent such approval, the acquiror of shares so acquired will not have the right to vote them. The Superintendency of Banks may refuse to grant its approval only based on specific grounds set forth in the General Banking Law.
 
According to Article 35 bis of the General Banking Law, the prior authorization of the Superintendency of Banks is required for:
 
 
·
the merger of two or more banks;
 
 
·
the acquisition of all or a substantial portion of a banks’ assets and liabilities by another bank;
 
 
·
the control by the same person, or controlling group, of two or more banks; or
 
 
·
a substantial increase in the existing control of a bank by a controlling shareholder of that bank.
 
Such prior authorization is required solely when the acquiring bank or the resulting group of banks would own a significant market share in loans, defined by the Superintendency of Banks to be more than 15.0% of all loans in the Chilean banking system. The intended purchase, merger or expansion may be denied by the Superintendency of Banks; or, if the acquiring bank or resulting group would own a market share in loans determined to be more than 20.0% of all loans in the Chilean banking system, the purchase, merger, or expansion may be conditioned on one or more of the following:
 
 
·
that the bank or banks maintain regulatory capital higher than 8.0% and up to 14.0% of their risk-weighted assets;
 
 
·
that the technical reserve established in article 65 of the General Banking Law be applicable when deposits exceed one and a half times the resulting bank’s paid-in capital and reserves; or
 
 
·
that the margin for interbank loans be reduced to 20.0% of the resulting bank’s regulatory capital.
 
If the acquiring bank or resulting group would own a market share in loans determined by the Superintendency of Banks to be more than 15% but less than 20%, the authorization will be conditioned on the bank or banks maintaining a regulatory capital not lower than 10% of their risks-weighted assets for the period specified by the Superintendency of Banks, which may not be less than one year. The calculation of the risk-weighted assets is based on a five-category risk classification system applied to a bank’s assets that is based on the Basel Committee recommendations.
 
Pursuant to the regulations of the Superintendency of Banks, the following ownership disclosures are required:
 
 
·
a bank is required to inform the Superintendency of Banks of the identity of any person owning, directly or indirectly, 5.0% or more of such banks’ shares;
 
 
·
holders of ADSs must disclose to the depositary the identity of beneficial owners of ADSs registered under such holders’ names;
 
 
·
the depositary is required to notify the bank as to the identity of beneficial owners of ADSs which such depositary has registered and the bank, in turn, is required to notify the Superintendency of Banks as to the identity of the beneficial owners of the ADSs representing 5.0% or more of such banks’ shares; and
 
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·
bank shareholders who individually hold 10.0% or more of a bank’s capital stock and who are controlling shareholders must periodically inform the Superintendency of Banks of their financial condition.
 
Limitations on Types of Activities
 
Chilean banks can only conduct those activities allowed by the General Banking Law: making loans, accepting deposits and, subject to limitations, making investments and performing financial services. Investments are restricted to real estates for the bank’s own use, gold, foreign currencies and debt securities. Through subsidiaries, banks may also engage in other specific financial service activities such as securities brokerage services, equity investments, securities, mutual fund management, investment fund management, financial advisory and leasing activities. Subject to specific limitations and the prior approval of the Superintendency of Banks and the Central Bank, Chilean banks may own majority or minority interests in foreign banks.
 
On March 2, 2002, the Central Bank of Chile authorized banks to pay interest on checking accounts. On March 20, 2002, the Superintendency of Banks published guidelines establishing that beginning on June 1, 2002, banks could offer a new checking account product that pays interest. The Superintendency of Banks also stated that these accounts may be subject to minimum balance limits and different interest rates depending on average balances held in the account and that banks may also charge fees for the use of this new product. For banks with a solvency score of less than A, the Central Bank has also imposed additional caps to the interest rate that can be paid.
 
Deposit Insurance
 
The Chilean government guarantees up to 90.0% of the principal amount of certain time and demand deposits and savings accounts held by natural persons with a maximum value of UF120 per person (Ch$2,200,366 or U.S.$4,117 at December 31, 2006) per calendar year in the entire financial system.
 
Reserve Requirements
 
Deposits are subject to a reserve requirement of 9.0% for peso and foreign currency-denominated demand deposits and 3.6% for UF, peso and foreign currency-denominated time deposits (with terms of less than one year). For purposes of calculating the reserve obligation, banks are authorized to deduct daily from their foreign currency denominated liabilities, the balance in foreign currencies of certain loans and financial investments held outside of Chile, the most relevant of which include:
 
 
·
cash clearance account, which should be deducted from demand deposits for calculating reserve requirement;
 
 
·
certain payment orders issued by pension providers;
 
 
·
the amount set aside for “technical reserve” (as described below), which can be deducted from reserve requirement.
 
The Central Bank has statutory authority to require banks to maintain reserves of up to an average of 40.0% for demand deposits and up to 20.0% for time deposits (irrespective, in each case, of the currency in which they are denominated) to implement monetary policy. In addition, to the extent that the aggregate amount of the following types of liabilities exceeds 2.5 times the amount of a bank’s paid-in capital and reserves, a bank must maintain a 100% “technical reserve” against them:  demand deposits, deposits in checking accounts, or obligations payable on sight incurred in the ordinary course of business, other deposits unconditionally payable immediately or within a term of less than 30 days and time deposits payable within 10 days prior to maturity.
 
The Chilean Congress is currently reviewing legislation that will reform various laws regulating the Chilean capital markets (Reforma al Mercado de Capitales II). Among other things, the regulations with respect to “technical reserve” will be modified to permit banks to use regulatory capital to determine the amount of the reserve.
 
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Minimum Capital
 
Under the General Banking Law, a bank is required to have a minimum of UF800,000 (approximately Ch$14,669 million and US$27.4 million as of December 31, 2006) of paid-in capital and reserves, a regulatory capital of at least 8% of its risk-weighted assets, net of required allowances, and paid-in capital and reserves of at least 3% of its total assets, net of required allowances.
 
However, a bank may begin its operations with 50.0% of such amount, provided that it has a regulatory capital of not less than 12.0% of its risk-weighted assets. Regulatory capital is defined as the aggregate of:
 
 
·
a bank’s paid-in capital and reserves, excluding capital attributable to subsidiaries and foreign branches or capital básico;
 
 
·
its subordinated bonds, valued at their placement price (but decreasing by 20.0% for each year during the period commencing six years prior to maturity), for an amount up to 50.0% of its basic capital; and
 
 
·
its voluntary allowances for loan losses for an amount of up to 1.25% of risk weighted-assets.
 
In 2002, the General Banking Law was modified, allowing banks to begin operations with a minimum capital of UF 400,000 (approximately US$13.7 million as of December 31, 2006) of paid-in capital and reserves with the obligation to increase it to UF 800,000 (approximately US$27.4 million as of December 31, 2006) in an undetermined period of time. If a bank maintains a minimum capital of UF 400,000 (approximately US$13.7 million as of December 31, 2006), it is required to maintain a minimum BIS ratio of 12%.  When such a bank’s paid-in capital reaches UF600,000 (approximately Ch$11,001 million and US$20.6 million as of December 31, 2006), the total capital ratio required is reduced to 10.0%.
 
Capital Adequacy Requirements
 
According to the General Banking Law, each bank should have a regulatory capital of at least 8.0% of its risk-weighted assets, net of required allowances.  The calculation of risk-weighted assets is based on a five-category risk classification system for bank assets that is based on the Basle Committee recommendations. In 2007, the third pillar of Basel II in Chile will include the implementation of capital limits with market risk- and operational risk-weighted assets.
 
Banks should also have capital básico, or basic capital, of at least 3.0% of their total assets, net of allowances. Basic capital is defined as a bank’s paid-in capital and reserves and is similar to Tier 1 capital except that it does not include net income for the period.
 
Lending Limits
 
Under the General Banking Law, Chilean banks are subject to certain lending limits, including the following material limits:
 
 
·
A bank may not extend to any entity or individual (or any one group of related entities), except for another financial institution, directly or indirectly, unsecured credit in an amount that exceeds 5.0% of the bank’s regulatory capital, or in an amount that exceeds 25.0% of its regulatory capital if the excess over 5.0% is secured by certain assets with a value equal to or higher than such excess. In the case of foreign export trade financing, the 5.0% ceiling for unsecured credits is raised to 10.0% and the 25.0% ceiling for secured credits to 30.0%. In the case of financing infrastructure projects built by government concession, the 5.0% ceiling for unsecured credits is raised to 15.0% if secured by a pledge over the concession, or if granted by two or more banks or finance companies which have executed a credit agreement with the builder or holder of the concession;
 
 
·
a bank may not extend loans to another financial institution subject to the General Banking Law in an aggregate amount exceeding 30.0% of its regulatory capital;
 
33

 
 
·
a bank may not directly or indirectly grant a loan whose purpose is to allow an individual or entity to acquire shares of the lender bank;
 
 
·
a bank may not lend, directly or indirectly, to a director or any other person who has the power to act on behalf of the bank; and
 
 
·
a bank may not grant loans to related parties (including holders of more than 1.0% of its shares) on more favorable terms than those generally offered to non-related parties. Loans granted to related parties are subject to the limitations described in the first bullet point above. In addition, the aggregate amount of loans to related parties may not exceed a bank’s regulatory capital.
 
In addition, the General Banking Law limits the aggregate amount of loans that a bank may grant to its employees to 1.5% of its regulatory capital, and provides that no individual employee may receive loans in excess of 10.0% of this 1.5% limit. Notwithstanding these limitations, a bank may grant to each of its employees a single residential mortgage loan for personal use once during such employee’s term of employment.
 
Certain aspects of Chilean legislation governing capital markets is currently being reviewed by the Chilean Congress. MK2 is expected to, among other things, modify some of the provisions concerning lending limits. The 5% limit affecting unsecured credit referred above is expected to be raised to 10% and the ceiling for secured credits is expected to be raised to 30%. Such limits are expected to be maintained in 5% and 25% for unsecured and secured credits, respectively, granted to individuals or entities directly or indirectly related to the property or management of the bank. See “Item 3: Key Information—D. Risk Factors—Risks Relating to Chile—Chile’s banking regulatory and capital markets environment is continually evolving and may change.”
 
Allowance for Loan Losses
 
Chilean banks are required to provide to the Superintendency of Banks detailed information regarding their loan portfolio on a monthly basis. The Superintendency of Banks examines and evaluates each financial institution’s credit management process, including its compliance with the loan classification guidelines. Banks are classified into four categories: 1, 2, 3 and 4. Each bank’s category depends on the models and methods used by the bank to classify its loan portfolio, as determined by the Superintendency of Banks. Category 1 banks are those banks whose methods and models are satisfactory to the Superintendency of Banks. Category 1 banks will be entitled to continue using the same methods and models they currently have in place. A bank classified as a category 2 bank will have to maintain the minimum levels of reserves established by the Superintendency of Banks while its board of directors will be made aware of the problems detected by the Superintendency of Banks and required to take steps to correct them. Banks classified as categories 3 and 4 will have to maintain the minimum levels of reserves established by the Superintendency of Banks until they are authorized by the Superintendency of Banks to do otherwise. We are classified in category 1.
 
Under the classifications effective January 1, 2004, loans are divided into: (i) consumer loans (including loans granted to individuals for the purpose of financing the acquisition of consumer goods or payment of services); (ii) residential mortgage loans (including loans granted to individuals for the acquisition, construction or repair of residential real estate, in which the value of the property covers at least 100% of the amount of the loan); and (iii) commercial loans (includes all loans other than consumer loans and residential mortgage loans).
 
In accordance with the regulations, which became effective as of January 1, 2004, the models and methods used to classify our loan portfolio must follow the following guiding principles, which have been established by the Superintendency of Banks and approved by our Board of Directors. In 2006, these models have been improved and various changes were and are being introduced. Group rating are being phased out and replaced by statistical scoring systems. A detailed description of this accounting policy is discussed below under “Item 5: Operating and Financial Review and Prospects—D. Selected Statistical Information—Loan Portfolio,” and “—Loans by Economic Activity—Classification of Loan Portfolio” and in Note 1 of our Audited Consolidated Financial Statements.
 
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Capital Markets
 
Under the General Banking Law, banks in Chile may purchase, sell, place, underwrite and act as paying agents with respect to certain debt securities. Likewise, banks in Chile may place and underwrite certain equity securities. Bank subsidiaries may also engage in debt placement and dealing, equity issuance advice and securities brokerage, as well as in financial leasing, mutual fund and investment fund administration, investment advisory services and merger and acquisition services. These subsidiaries are regulated by the Superintendency of Banks and, in some cases, also by the Superintendency of Securities and Insurance, the regulator of the Chilean securities market, open-stock corporations and insurance companies.
 
Legal Provisions Regarding Banking Institutions with Economic Difficulties
 
The General Banking Law provides that if specified adverse circumstances exist at any bank, its board of directors must correct the situation within 30 days from the date of receipt of the relevant financial statements. If the board of directors is unable to do so, it must call a special shareholders’ meeting to increase the capital of the bank by the amount necessary to return the bank to financial stability. If the shareholders reject the capital increase, or if it is not effected within the term and in the manner agreed to at the meeting, or if the Superintendency of Banks does not approve the board of directors’ proposal, the bank will be barred from increasing its loan portfolio beyond that stated in the financial statements presented to the board of directors and from making any further investments in any instrument other than in instruments issued by the Central Bank. In such a case, or in the event that a bank is unable to make timely payment in respect of its obligations, or if a bank is under provisional administration of the Superintendency of Banks, the General Banking Law provides that the bank may receive a two-year term loan from another bank. The terms and conditions of such a loan must be approved by the directors of both banks, as well as by the Superintendency of Banks, but need not be submitted to the borrowing bank’s shareholders for their approval. In any event, a creditor bank cannot grant interbank loans to an insolvent bank in an amount exceeding 25.0% of the creditor bank’s regulatory capital. The board of directors of a bank that is unable to make timely payment of its obligations must present a reorganization plan to its creditors in order to capitalize the credits, extend their respective terms, condone debts or take other measures for the payment of the debts. If the board of directors of a bank submits a reorganization plan to its creditors and such arrangement is approved, all subordinated debt issued by the bank, whether or not matured, will be converted by operation of law into common stock in the amount required for the ratio of regulatory capital to risk-weighted assets not to be lower than 12.0% . If a bank fails to pay an obligation, it must notify the Superintendency of Banks, which shall determine if the bank is solvent.
 
 Dissolution and Liquidation of Banks
 
The Superintendency of Banks may establish that a bank should be liquidated for the benefit of its depositors or other creditors when such bank does not have the necessary solvency to continue its operations. In such case, the Superintendency of Banks must revoke a bank’s authorization to exist and order its mandatory liquidation, subject to agreement by the Central Bank. The Superintendency of Banks must also revoke a bank’s authorization if the reorganization plan of such bank has been rejected twice. The resolution by the Superintendency of Banks must state the reason for ordering the liquidation and must name a liquidator, unless the Chilean Superintendency of Banks assumes this responsibility. When a liquidation is declared, all checking accounts, other demand deposits received in the ordinary course of business, other deposits unconditionally payable immediately or that have a maturity of no more than 30 days, and any other deposits and receipts payable within 10 days, are required to be paid by using existing funds of the bank, its deposits with the Central Bank or its investments in instruments that represent its reserves. If these funds are insufficient to pay these obligations, the liquidator may seize the rest of the bank’s assets, as needed. If necessary and in specified circumstances, the Central Bank will lend the bank the funds necessary to pay these obligations. Any such loans are preferential to any claims of other creditors of the liquidated bank.
 
Obligations Denominated in Foreign Currencies
 
Foreign currency denominated obligations of Chilean banks are subject to various limits and obligations. The regulations of the Central Bank do not permit the difference, whether positive or negative, between a bank’s assets and liabilities denominated in any foreign currency (including assets and liabilities denominated in U.S. dollars but payable in pesos, as well as those denominated in pesos and indexed to the U.S. dollar exchange rate) to exceed 20%
 
35

 
of the bank’s paid-in capital and reserves; except in the case where the balance of such assets exceeds the balance of such liabilities and the excess difference does not exceed the bank’s allowances and reserves denominated in such foreign currency (excluding profits to be remitted abroad). Santander-Chile must also comply with various regulatory and internal limits regarding exposure to movements in foreign exchange rates (See “Item 11: Quantitative and Qualitative Disclosures About Market Risk”).
 
Investments in Foreign Securities
 
Under current Chilean banking regulations, banks in Chile may grant loans to foreign individuals and entities and invest in certain securities of foreign issuers. Chilean banks may only invest in equity securities of foreign banks and certain other foreign companies which may be affiliates of the bank or which would be complementary to the bank’s business if such companies were incorporated in Chile. Banks in Chile may also invest in debt securities traded in formal secondary markets. Such debt securities must be (1) securities issued or guaranteed by foreign sovereign states or their central banks or other foreign or international financial entities, and (2) bonds issued by foreign companies. A Bank may invest up to 5% of its regulatory capital in securities of foreign issuers. Such securities must have a minimum rating as follows:
 
Table 1
       
         
Rating Agency
 
Short Term
 
Long Term
Moody’s
 
P2
 
Baa3
Standard and Poor’s
 
A3
 
BBB-
Fitch IBCA
 
F2
 
BBB-
Duff & Phelps
 
D2
 
BBB-
Thomson Bank Watch
 
TBW2
 
BBB

In the event that the sum of the investments in foreign securities which have a: (i) rating below that indicated in Table 1 above, and equal or exceeds the ratings mentioned in the Table 2 below; and (ii) loans granted to other entities resident abroad exceed 20% (and 30% for banks with a BIS ratio equal or exceeding 10%), of the regulatory capital of such bank, the excess is subject to a mandatory reserve of 100%.
 
Table 2        
         
Rating Agency
 
Short Term
 
Long Term
Moody’s
 
P2
 
Ba3
Standard and Poor’s
 
A3
 
BB-
Fitch IBCA
 
F2
 
BB-
Duff & Phelps
 
D2
 
BB-
Thomson Bank Watch
 
TBW2
 
B

In addition, banks may invest in foreign securities for an additional amount equal to a 70% of their regulatory capital which ratings are equal or exceeds those mentioned in the following Table 3. This limit constitutes an additional margin and it is not subject to the 100% mandatory reserve.
 
Additionally, a Chilean Bank may invest in foreign securities whose rating is equal or exceeds those mentioned in the following Table 3 in: (i) term deposits with foreign banks; and (ii) securities issued or guaranteed by sovereign states or their central banks or those securities issued or guaranteed by foreign entities within the Chilean State; such investment will be subject to the limits by issuer up to 30% and 50%, respectively, of the regulatory capital of the Chilean bank that makes the investment.
 
 
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Table 3        
         
Rating Agency
 
Short Term
 
Long Term
Moody’s
 
P1
 
Aa3
Standard and Poor’s
 
A1+
 
AA-
Fitch IBCA
 
F1+
 
AA-
Duff & Phelps
 
D1+
 
AA-
Thomson Bank Watch
 
TBW1
 
BB

Chilean banks may invest in securities without ratings issued or guaranteed by sovereign states or their central banks and structured notes issued by investment banks with a rating equal or above that in the immediately preceding Table 3, which return is linked with a corporate or sovereign note with a rating equal or above that in Table 2.
 
Subject to specific conditions, a bank may grant loans in U.S. dollars to subsidiaries or branches of Chilean companies located abroad, to companies listed on foreign stock exchanges authorized by the Central Bank and, in general, to individuals and entities domiciled abroad, as long as the Central Bank is kept informed of such activities.
 
New Regulations Regarding Market Risk
 
In 2005, the Superintendency of Banks introduced new market risk limits and measures for Chilean banks. On an unconsolidated basis, the Bank must separate its balance sheet into two separate categories: trading portfolio (Libro de Negociación) and non-trading, or permanent, portfolio (Libro de Banca). The trading portfolio as defined by the Superintendency of Banks includes all instruments that are valued for accounting purposes at market prices, free of any restrictions on immediate sale and frequently bought and sold by the Bank or maintained with the intention of selling them in the short-term in order to profit from short-term price variations. The non-trading portfolio is defined as all instruments in the balance sheet not considered in the trading portfolio (See Item 11: Quantitative and Qualitative Disclosures about Market Risk ).
 
D. Property, Plants and Equipment
 
 We are domiciled in Chile and own our principal executive offices located at Bandera 140, Santiago, Chile. We also own fifteen other buildings in the vicinity of our headquarters and we rent four other buildings. At December 31, 2006, we owned the premises at which 53% of our branches were located. The remaining branches operate at rented locations.  We believe that our existing physical facilities are adequate for our needs.
 
 
Main properties as of December 31, 2006
 
Number
 
Central Offices
 
 
 
Owned
   
13
 
Rented
   
8
 
Total
   
21
 
         
Branches (1)
       
Owned
   
165
 
Rented
   
163
 
Total
   
328
 
         
Other property (2)
       
Owned
   
43
 
Rented
   
19
 
Total
   
62
 
 
(1)
Some branches are located inside central office buildings and other properties. Including these branches, the total number of branches is 375.
 
(2)
Consists mainly of parking lots, mini-branches and property owned by our subsidiaries.
 
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The following table sets forth a summary of the main computer hardware and other systems-equipment that we own.
 
Category
 
Brand
 
Application
Mainframe
 
IBM
 
Back-end, Core-System Altair, Payment means and foreign trade.
Midrange
 
IBM
 
Interconnections between Mainframe and mid-range
Midrange
 
Stratus
SUN/Unix
SUN/UNIX
 
Tellers
Interconnections applications Credit & debit cards
Treasury, MIS, Work Flow, Accounting
Midrange
 
IBM
 
WEB
Desktop
 
IBM
 
Platform applications
Call Center
 
Avaya
Genesys
Nice
Periphonics
 
Telephone system
Integration Voice/data
Voice recorder
IVR

The main software systems that we use are:
 
Category
 
Product
 
Origin
Core-System
 
ALTAMIRA
 
Accenture
Data base
 
DB2
 
IBM
Data base
 
Oracle
 
Oracle
Data base
 
SQL Server
 
Microsoft
WEB Service
 
Internet Information Server
 
Microsoft
Message Service
 
MQSeries
 
IBM
Transformation
 
MQIntegrator
 
IBM

ITEM 4A. UNRESOLVED STAFF COMMENTS
 
As of the date of the filing of this Annual Report on 20-F, we do not have any unresolved comments from the Securities and Exchange Commission staff regarding our periodical reports under the Exchange Act.
 
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
 
A. New Accounting Standards for Financial investments and Derivatives
 
In accordance with Circular N°3345 issued by the Superintendency of Banks, which became effective on June 30, 2006, the accounting standards for valuing financial instruments acquired for trading or investment purposes, including derivative instruments on the balance sheets, were amended. The new accounting standards require that these instruments be carried at their market or fair value, and the historical differences in valuation of such instruments recognized with respect to any dates prior to 2006 be adjusted directly against the Bank’s equity.  Banks are required to adopt the new accounting standards set forth in Circular N° 3345 in preparing their financial statements at and for the six-months ended June 30, 2006 and going forward.
 
The following table summarizes the primary changes to the accounting standards as a result of our implementation of Circular N° 3345.
 
 
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Before changes to accounting principles
After changes to accounting principles
Derivatives
·  foreign exchange forward contracts
·  valued at closing spot exchange rate, initial discount/premium amortized over the life of contract
recognized at fair value;
 
trading contracts:
·  recorded at market/fair value on the balance sheet
 
 
·  forward contracts between U.S. dollars and Ch$/UF
·  valued at closing spot exchange rate, initial discount/premium amortized over the life of contract
·      revaluation gains or losses recorded as gains or losses 
from trading activities
 
hedge contracts:
·      fair value hedges:  hedged assets and liabilities are also recognized at fair value; revaluation gains or losses on both derivatives and hedged items are recognized as “gains/losses from trading activities” on the income statement
 
·      cash flow hedges:  effective portion of revaluation gains or losses on hedged risk recognized in shareholders’ equity (such amount is recognized in income statement when the offsetting changes hedged affect income statement); ineffective portion of revaluation gains or losses recognized in income statement
·  interest rate swaps
·  difference between interest income/expense recorded in net income in the period when agreement is settled in cash;
 
·  fair value and revaluation gains or losses are not recognized
 
·  net nominal amounts are recorded under “other assets” or “other liabilities”
Other financial investments
·  non- permanent investments (Trading instruments)
·  recognized at fair value on balance sheet; revaluation gains or losses and realized gains or losses are recognized in income statements under “gains/losses from trading activities”; interest income and indexation adjustments are reported as “interest revenue”
·      No changes
·  permanent investments (Available-for-Sale investment instruments)
·  recognized at fair value on balance sheet; revaluation gains or losses are reported under shareholders’ equity, and recognized in income statement under “gains/losses from trading activities” when sold or impaired
·     line item “available-for-sale” portfolio changed from “permanent”
   
 
·  Held-to-maturity investment instruments
·  N/A
·     New category; recorded at cost plus accrued interest and adjustments, less allowance for impairment
 
 
39

 
In order to implement these new accounting standards, we have created a new line item “derivatives” under both “assets” and “liabilities” on our consolidated balance sheet, and reclassified certain other items within other assets, other liabilities, financial instruments, interest income, interest expenses and other operating income, net, on our consolidated balance sheet and income statement at and for the year ended December 31, 2006.
 
The net effect of the accounting changes on our net income for the year ended December 31, 2006  was a gain of Ch$12,580 million.  For comparison purposes, we have also retrospectively reclassified these items at December 31, 2005 and for the years ended December 31, 2004 and 2005, but did not retrospectively apply the new accounting standards to these items. As a result, our results of operations and financial condition at and for the year ended December 31, 2006 are not entirely comparable to those at any dates or for any periods prior to January 1, 2006 previously reported by us. If we had applied the valuation of derivatives to market prices in the year ended December 31, 2005, the net effect on our net income would have been a gain of Ch$7,008 million.
 
In connection with our implementation of the new accounting standards, for the year ended December 31, 2006, interest revenue and interest expense no longer include the translation gain or loss of financial assets and liabilities indexed to foreign currencies. Such gain or loss is now reclassified as results of foreign exchange transactions. Amounts reported for the years ended December 31, 2004 and 2005 have been reclassified on a comparable basis.  Gains or losses on investments in mutual funds have also been reclassified from net interest income to other operating income for the years ended December 31, 2004, 2005 and 2006.
 
For the year ended December 31, 2006, gains and losses on forward transactions have been reclassified to net gains (losses) on trading activities. In prior periods, such transactions were not marked to market and the difference between the interest paid and received on a specified notional amount was recorded under “foreign exchange transactions, net”. Such amounts for the years ended December 31, 2004 and 2005 have been reclassified to net gains (losses) on trading activities in order to be more comparable to the results for the year ended December 31, 2006, but have not been retroactively adjusted to reflect the fair value of these instruments.
 
B. Critical Accounting Policies
 
We prepare our financial statements in accordance with Chilean GAAP, which requires management to make estimates and assumptions with respect to certain matters that are inherently uncertain. We also reconcile our financial statements to U.S. GAAP (See Note 26 to our Audited Consolidated Financial Statements) and are required to make estimates and assumptions in this reconciliation process. Certain critical accounting policies, in particular those relating to goodwill and intangible assets, are only applicable for U.S. GAAP purposes. Our consolidated financial statements include various estimates and assumptions, including but not limited to the adequacy of the allowance for loan losses, estimates of the fair value of certain financial instruments, the selection of useful lives of certain assets and the valuation and recoverability of goodwill. We evaluate these estimates and assumptions on an ongoing basis. Management bases its estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results in future periods could differ from those estimates and assumptions, and if these differences were significant enough, our reported results of operations would be affected materially.
 
We believe that the following are the more critical judgment areas or involve a higher degree of complexity in the application of the accounting policies that currently affect our financial condition and results of operations:
 
Derivative activities
 
 At December 31, 2006, derivatives are valued at market price on the balance sheet and the net unrealized gain (loss) on derivatives is classified as a separate line item on the income statement. In prior periods, the notional amounts were carried off the balance sheet. Our derivative holdings at December 31, 2005 have been reclassified
 
40

from “other assets” and “other liabilities” to “derivatives”, but have not been marked to market as would be required under currently applicable accounting principles.
 
Pursuant to the new accounting standards, banks must mark to market derivatives. A derivative financial instrument held for trading purposes must be marked to market and the unrealized gain or loss recognized in income statement.  New accounting standards have also been adopted for derivatives held for hedging purposes with effect for the six months ended June 30, 2006 and thereafter, changes in book value of hedged items are included in the mark to market and trading line items, except to the extent set forth below.
 
The Superintendency of Banks recognizes three kinds of hedge accounting: (i) cash flow hedges, (ii) fair value hedges and (iii) hedging of foreign investments.
 
  ·
When a cash flow hedge exists, the fair value movements on the part of the hedging instrument that is effective are recognized in equity. Any ineffective portion of the fair value movement on the hedging instrument is recognized in the income statement.
 
  ·
When a fair value hedge exists, the fair value movements on the hedging instrument and the corresponding fair value movements on the hedged item are recognized in the income statement. Hedged items in the balance sheet are presented at their market value in 2006.
 
  ·
When a hedge of foreign investment exposure exists (i.e. investment in a foreign branch), the fair value movements on the part of the hedging instrument that is effective are recognized in equity. Any ineffective portion of the fair value movement on the hedging instrument is recognized in the income statement.
 
We enter into forward contracts for our own account and for the accounts of our customers. The values of the forward contracts are marked to market on a monthly basis and the revaluation gain or loss is recognized in the line item mark to market and trading activities. Previously, they were classified as foreign exchange transactions, except gains or losses on UF – Ch$ forwards, which used to be classified as net interest income.
 
Allowance for loan losses
 
Chilean banks are required to maintain loan loss allowances in amounts determined in accordance with the regulations issued by the Superintendency of Banks. Under these regulations, we must classify our portfolio into various categories of payment capability. The minimum amount of required loan loss allowances is determined based on fixed percentages of estimated loan losses assigned to each category. Since January 1, 2006, we have improved our credit scoring systems for consumer and mortgage loans. The new credit scoring system considers both the length of time by which the loan is overdue and the borrower’s risk profile, which includes the borrower’s overall indebtedness and credit behavior under the obligations to third parties. See Item 5: Operating and Financial Review and Prospects – D. Selected Statistical Information – Loan Portfolio – Classification of Loan Portfolio – Allowances for consumer and mortgage loans.
 
In 2006, we improved our internal provisioning models by not only focusing on non-performance, but introducing statistical models that take into account a borrower’s credit history and indebtedness levels. Group ratings that determine loan loss allowances based only on non-performance are being phased out and replaced by statistical scoring systems. Commencing in December 2006, we no longer analyze large commercial loans on a group basis. All large commercial loans have since been rated on an individual basis. For large commercial loans, leasing and factoring, we assign a risk category level to each borrower and his respective loans. We consider the following risk factors in classifying a borrower’s risk category: the borrower’s industry or sector, owners or managers, financial condition, payment ability and payment behavior. For a detailed description of the models we use to determine loan loss allowances for commercial loans, see Item 5: Operating and Financial Review and Prospects D. Selected Statistical Information – Loan Portfolio – Classification of Loan Portfolio – Allowances for large commercial loans. Group assessment for loan loss allowances is permitted for a large number of borrowers whose individual loan amounts are relatively insignificant.  Currently, we use group analysis to determine loan loss allowances for certain types of loans, such as loans to small- and mid-sized companies and commercial loans to individuals. See Item 5: Operating and Financial Review and Prospects – D. Selected Statistical Information – Loan Portfolio – Classification of Loan Portfolio – Allowances for group evaluations on small- and mid-sized commercial loans.
 
41

 
Goodwill and Intangible Assets with Indefinite Useful Lives
 
Under U.S. GAAP, we have significant intangible assets consisting of goodwill and trademarks. We record all assets and liabilities acquired in purchase acquisitions, including goodwill and other acquired intangibles, at their fair value. These include amounts pushed down from Santander Chile Holding, S.A. and Teatinos Siglo XXI, S.A., each a direct or indirect subsidiary of Banco Santander Central Hispano, and, together, our majority shareholders.  In 2006, we decided to change our branding strategy to increasing the use of the brand “Santander” and phasing out the brand “Santiago”.  As a result, we have decided to amortize the brand “Santiago” in five years using a straight-line amortization method.
 
Goodwill and indefinite lived assets are no longer amortized over their estimated useful lives using straight line and accelerated methods, and are subject to at least an annual impairment review. The initial goodwill and intangibles recorded and subsequent impairment analysis requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future using a discounted cash flow analysis. Additionally, estimated cash flows may extend beyond ten years and, by their nature, are difficult to determine. Events and factors that may significantly affect the estimates include, among others, competitive forces, customer behavior and attrition, changes in revenue growth trends, cost structures and technology and changes in interest rates and specific industry or market sector conditions. For a further discussion of accounting practices for goodwill and intangible assets with indefinite useful lives under U.S. GAAP, see Note 26 to our Audited Consolidated Financial Statements.
 
Differences between Chilean and United States Generally Accepted Accounting Principles
 
Accounting principles generally accepted in Chile vary in certain important respects from the accounting principles generally accepted in the United States. Such differences involve certain methods for measuring the amounts shown in the consolidated financial statements, as well as additional disclosures required by accounting principles generally accepted in the United States and the accounting treatment of the merger.
 
Note 26 to our Audited Consolidated Financial Statements presents a description of the significant differences between Chilean GAAP and U.S. GAAP.  Note 26(ac) sets forth recent accounting pronouncements under U.S. GAAP.
 
C. 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 Chile. In 2006, Chile’s GDP grew by 4.0%. The Chile GDP grew by 6.4% in 2005 following growth of 6.1% in 2004 and 3.7% in 2003. The strength of the global economy has continued to benefit Chile’s economy despite the rise in international oil prices. These positive external economic conditions have also led to strong growth of internal consumption and investment demand that grew 6.0% in 2006. The average unemployment rate decreased to 8.0% in 2006 from 9.3% in 2005.
 
The export sector in Chile increased by 4.2% in 2006. Despite higher commodity prices, lower production affected growth in this sector. The price of copper increased by 45.8% in 2006, 45.4% in 2005 and 42.7% in 2004. Exports of copper totaled US$33 billion, or 56%, of total Chilean exports in 2006.
 
CPI Inflation in 2006 was 2.6%, compared to 3.7% in 2005. The sharp decrease in international oil prices in the last quarter of 2006 was the main factor that explains this decline. As a result, the Central Bank slowed the pace of interest rate increases in the year.  The overnight interbank rate set by the Central Bank increased by 225 basis points in 2005 to 4.5% in December 2005. In 2006, the Central Bank has raised its reference rate three times to 5.25%, but this rate was lowered to 5.00% in January 2007.
 
42

 
After surging in the last quarter of 2005, long-term rates declined throughout 2006 as inflation descended. The yield on the Chilean Central Bank’s 10-year note in real terms was 3.29% at December 31, 2005. At December 31, 2006, the yield was 3.02%.
 
Despite these developments in 2006 at the macroeconomic level, economic activities in Chile may slow down given the volatility of international markets and the possible slow-down of the world economic growth.
 
Impact of Inflation
 
Inflation impacts our results of operations. Although Chile’s inflation rate has been moderate in recent years, Chile has experienced high levels of inflation in the past. 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. Negative inflation rates also negatively impact our results.  In 2006, the inflation rate in Chile was 2.6% compared to 3.7% in 2005 and 2.4% in 2004.  There can be no assurance that Chilean inflation will not change significantly from the current level. Although we currently benefit from moderate levels of 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. In summary:
 
  ·
UF denominated assets and liabilities. 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 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 proportional amount of the change in the Chilean Consumer Price Index during the prior calendar month. One UF equaled to Ch$17,317.05 at December 31, 2004, Ch$17,974.81 at December 31, 2005 and Ch$ 18,336.38 at December 31, 2006.  The effect of any changes in the nominal peso value of our UF denominated assets and liabilities is reflected in our results of operations as an increase (or decrease, in the event of deflation) in interest revenue and expense, respectively. Our net interest revenue will be positively affected by an inflationary environment to the extent that our average UF denominated assets exceed our average UF denominated liabilities. Our net interest revenue will be negatively affected by inflation in any period in which our average UF denominated liabilities exceed our average UF denominated assets. Our average UF denominated assets exceeded our average UF denominated liabilities by Ch$2,567,226 million in 2006 compared to Ch$1,446,290 million in 2005. See “—D. Selected Statistical Information—Average Balance Sheets, Income Earned from Interest-Earned Assets and Interest Paid on Onterest-Bearing Liabilities.” The Bank generally has more UF denominated financial assets than UF denominated financial liabilities. In the year ended December 31, 2006, the interest gained on interest earning assets denominated in UF decreased by 8.4% compared to 2005 as a result of the lower inflation rate in 2006 compared to 2005, partially offset by the effect of the larger amount of assets than liabilities denominated in UF. The interest paid on these liabilities decreased by 29.4% during this period.
 
  ·
Price level restatement. Chilean GAAP requires that financial statements be restated to reflect the full effects of loss in the purchasing power of the Chilean peso on the financial position and results of operations of reporting entities. The Bank must adjust its capital, fixed assets and other non financial assets for variations in price levels. Since the Bank’s capital is generally larger than the sum of fixed and other non financial assets, in an inflationary economy, the Bank would record a loss from price level restatement.  For the year ended December 31, 2006, the loss from price level restatement totaled Ch$13,782 million compared to Ch$18,524 million in 2005. The inflation rate used for calculating price level restatement was 2.12% in 2006 and 3.62% in 2005.
 
 
 
43

 
   
At December 31,
 
IIInflation sensitive income
 
2005
   
2006
   
% Change
 
   
(In million of constant Chilean pesos at
December 31, 2006)
 
Interest gained on UF assets    
475,760
     
435,593
      (8.4% )
Interest paid on UF liabilities
    (252,692
)
    (178,468 )     (29.4% )
Price level restatement
    (18,524 )     (13,782 )     (25.6% )
Net Gain
   
204,544
     
243,343
      19.0%  
 
  ·
Peso denominated assets and liabilities. Interest rates prevailing in Chile during any period primarily reflect the inflation rate during the period and the expectations of future inflation. The sensitivity of our peso denominated interest earning assets and interest bearing liabilities to changes to such prevailing rates varies. See “—Interest Rates” below. We maintain a substantial amount of non interest bearing peso denominated demand deposits. Because such deposits are not sensitive to inflation, any decline in the rate of inflation would adversely affect our net interest margin on inflation indexed assets funded with such deposits, and any increase in the rate of inflation would increase the net interest margin on such assets. The ratio of the average of such demand deposits to average interest-earning assets was 16.6%, 16.4% and 13.9% for the years ended December 31, 2004, 2005 and 2006, respectively.
 
Interest Rates
 
Interest rates earned and paid on our assets and liabilities reflect, to a certain degree, inflation, expectations regarding inflation, changes in short-term interest rates set by the Central Bank and movements in long-term real rates. The Central Bank manages short-term interest rates based on its objectives of balancing low inflation and economic growth. Because our liabilities generally reprice sooner than our assets, changes in the rate of inflation or short-term rates in the economy are reflected in the rates of interest paid by us on our liabilities before such changes are reflected in the rates of interest earned by us on our assets. Therefore, when short-term interest rates fall, our net interest margin is positively impacted, but when short-term rates increase, our interest margin is negatively affected. At the same time, our net interest margin tends to be adversely affected in the short-term by a decrease in inflation rates since generally our UF denominated assets exceed our UF denominated liabilities. See “—Impact of Inflation—Peso denominated assets and liabilities.” An increase in long-term rates has a positive effect on our net interest margin, because our interest earning assets generally have longer tenors than our interest bearing liabilities. In addition, because our peso denominated liabilities have relatively short repricing periods, they are generally more responsive to changes in inflation or short-term rates than our UF denominated liabilities. As a result, during periods when current inflation or expected inflation exceeds the previous period’s inflation, customers often switch funds from UF denominated deposits to peso denominated deposits, which generally bear higher interest rates, thereby adversely affecting our net interest margin.
 
Foreign Exchange Fluctuations
 
The Chilean government’s economic policies and any future changes in the value of the Chilean peso against the U.S. dollar could adversely affect our financial condition and results of operations. The Chilean peso has been subject to significant devaluation in the past and may be subject to significant fluctuations in the future. In 2004 and 2005, the Chilean peso appreciated by 6.6% and 8.1% against the dollar, respectively.  In 2006, the Chilean peso depreciated by 3.9% against the U.S. dollar. See “Item 3: Key Information—A. Selected Financial Data—Exchange Rates.” A significant portion of our assets and liabilities are denominated in foreign currencies, principally the U.S. dollar, and we historically have maintained and may continue to maintain material gaps between the balances of such assets and liabilities. Because such assets and liabilities, as well as interest earned or paid on such assets and liabilities, and gains and losses realized upon the sale of such assets, are translated to Chilean pesos in preparing our financial statements, our reported income is affected by changes in the value of the Chilean peso relative to foreign currencies (principally the U.S. dollar).
 
Foreign currencies denominated obligations of Chilean banks are subject to various limits and obligations.  The regulations of the Central Bank do not permit the difference, whether positive or negative, between a bank’s assets and liabilities denominated in any foreign currency (including assets and liabilities denominated in U.S. dollars but payable in pesos, as well as those denominated in pesos and indexed to the U.S. dollar exchange rate) to exceed 20% of the bank’s paid in capital and reserves; except in the case where the balance of such assets exceeds the balance of such liabilities and the excess difference does not exceed the bank’s allowances and reserves denominated in such foreign currency (excluding profits to be remitted abroad).  The Bank also uses a sensitivity analysis to analyze and limit the
 
44

 
potential loss in net interest income resulting from fluctuations of interest rates on U.S. dollar denominated assets and liabilities and a VaR model to measure and limit foreign currency trading risk (See “Item 11: Quantitative and Qualitative Disclosures About Market Risk”).
 
Results of Operations for the Years Ended December 31, 2004, 2005 and 2006
 
The following discussion is based upon and should be read in conjunction with the Audited Consolidated Financial Statements. The Audited Consolidated Financial Statements have been prepared in accordance with Chilean GAAP (including the rules of the Superintendency of Banks relating thereto), which differ in certain significant respects from U.S. GAAP. Note 26 to the Audited Consolidated Financial Statements describes the principal differences between Chilean GAAP and U.S. GAAP and includes a reconciliation to U.S. GAAP of our net income for the years ended December 31, 2004, 2005 and 2006 and of our shareholders’ equity at December 31, 2005 and 2006. The Audited Consolidated Financial Statements have been restated in constant Chilean pesos of December 31, 2006. See Note 1(c) to the Audited Consolidated Financial Statements.
 
Introduction
 
 The following table sets forth the principal components of our net income for the years ended December 31, 2004, 2005 and 2006. 

   
For the year ended December 31,
   
% Change
 
   
2004
   
2005
   
2006
   
2006
   
2004/2005
   
2005/2006
 
   
(in millions of constant Ch$ as of
December 31, 2006)
   
(in thousands
of US$)(1)
             
CONSOLIDATED INCOME STATEMENT DATA
                                 
Chilean GAAP:
                                   
Interest income and expense
                                   
Interest revenue
   
841,588
     
1,017,830
     
1,168,851
     
2,187,098
      20.9%       14.8%  
Interest expense
    (339,079 )     (459,564 )     (556,597 )     (1,041,478 )     35.5%       21.1%  
Net interest revenue
   
502,509
     
558,266
     
612,254
     
1,145,620
      11.1%       9.7%  
Provision for loan losses
    (85,451 )     (64,879 )     (123,022 )     (230,193 )     (24.1% )     89.6%  
Fees and income from services
                                               
Fees and other services income
   
156,298
     
173,386
     
198,326
     
371,098
      10.9%       14.4%  
Other services expense
    (28,294 )     (32,086 )     (35,776 )     (66,942 )     13.4%       11.5%  
Total fees and income from services, net
   
128,004
     
141,300
     
162,550
     
304,156
      10.4%       15.0%  
Other operating income, net
                                               
Net gain (loss) from trading and brokerage
    (7,410 )     (62,569 )    
100,312
     
187,699
      744.4%       —%  
Foreign exchange transactions, net
   
47,445
     
72,381
      (48,708 )     (91,140 )     52.6%       —%  
Others, net
    (25,294 )     (23,407 )     (32,961 )     (61,675 )     (7.4% )     40.8%  
Total other operating income, net
   
14,741
      (13,595 )    
18,643
     
34,884
      —%       —%  
Other income and expenses
                                               
Non-operating income, net
    (4,669 )     (22,480 )     (4,214 )     (7,885 )     381.5%       (81.3% )
Income attributable to investments in other companies
   
568
     
693
     
786
     
1,471
      22.0%       13.5%  
Losses attributable to minority interest
    (194 )     (136 )     (151 )     (283 )     (29.8% )     11.0%  
Total other income and expenses
    (4,295 )     (21,923 )     (3,579 )     (6,697 )     410.5%       (83.7% )
 
45


   
For the year ended December 31,
   
% Change
 
   
2004
   
2005
   
2006
   
2006
   
2004/2005
   
2005/2006
 
   
(in millions of constant Ch$ as of
December 31, 2006)
   
(in thousands
of US$)(1)
             
Operating expenses
                                               
Personnel salaries and expenses
    (140,746 )     (142,171 )     (159,722 )     (298,864 )     1.0%       12.3%  
Administrative and other expenses
    (102,159 )     (102,717 )     (110,948 )     (207,601 )     0.5%       8.0%  
Depreciation and amortization
    (40,978 )     (40,080 )     (38,613 )     (72,251 )     (2.2% )     (3.7% )
Total operating expenses
    (283,883 )     (284,968 )     (309,283 )     (578,716 )     0.4%       8.5%  
Loss from price-level restatement
    (12,680 )     (18,524 )     (13,782 )     (25,788 )     46.1%       (25.%6 )
Income before income taxes
   
258,945
     
295,677
     
343,781
     
643,266
      14.2%       16.3%  
Income taxes
    (48,587 )     (50,885 )     (58,199 )     (108,899 )     4.7%       14.4%  
Net income
   
210,358
     
244,792
     
285,582
     
534,367
      16.4%       16.7%  
 

(1)
Amounts stated in U.S. dollars at and for the year ended December 31, 2006 have been translated from Chilean pesos at the exchange rate of Ch$534.43 = US$1.00 as of December 31, 2006. See “Item 3: Key Information—A. Selected Financial Data—Exchange Rates” for more information on the observed exchange rate.

2006 and 2005.  Net income for the year ended December 31, 2006 increased by 16.7% to Ch$285,582 million compared to Ch$244,792 million for the year ended December 31, 2005, primarily reflecting the growth of the Chilean economy, which continued to fuel loan growth and banking activities, especially in the higher yielding retail banking segments, which in turn has led to the growth of our net interest revenue and fee income. Our net interest revenue increased by 9.7% to Ch$612,254 million for the year ended December 31, 2006 compared to 2005, and fee income grew by 15.0% to Ch$162,550 million in 2006 compared to 2005. Net interest revenue growth was led by an increase in net interest revenue from our retail banking and middle-market segments. Net interest revenue from the retail banking segment increased by 24.2% to Ch$462,297 million in 2006, with increases of 19.4% in the individuals segment and 38.6% in the SMEs segment.  Net interest revenue in the middle-market segment increased by 38.4% to Ch$73,820 million in 2006 compared to 2005. The average balance of our interest-earning assets increased by 10.6% to Ch$13,079 billion in 2006 compared to 2005. As a result, our net interest margin remained stable at 4.7% in 2006 compared to 2005.
 
Total net fee income increased by 15.0% to Ch$162,550 million for the year ended December 31, 2006 compared to 2005. Fees from the retail banking segment increased by 38.8% in 2006 compared to 2005, mainly due to increases in fees from checking accounts, lines of credit and insurance brokerage and credit card fees. Fees from the wholesale banking segment decreased by 1.3% in 2006, primarily reflecting the decline in fees from payment agency services, letters of credit, guarantees, pledges and other contingent loan fees, fees from the sale and purchase of foreign currencies and underwriting fees. This was partially offset by a higher contribution from the sale of derivatives and other treasury services and a higher return on cash management services provided to our wholesale customers.
 
The increases in net interest revenue and fee income were partially offset by an 89.6% increase in provisions for loan losses to Ch$123,022 million for the year ended December 31, 2006 compared to 2005, primarily due to an 80.3% increase in net provision expense in the retail banking segment. Provision expense rose from a reversal of Ch$27,674 million in 2005 to a charge of Ch$26,614 million in 2006, primarily as a result of the growth of the Bank’s retail loans portfolio as a proportion of its total portfolio. Retail loans are generally higher-yielding, however, they present relatively higher credit risks than the Bank’s corporate loans. Charge-offs increased by 2.8% in 2006 compared to 2005, primarily as a result of the growth of our consumer loan portfolio, for which credit risk is higher and provisions are required to be made within much shorter periods than the rest of the loan portfolio. Charge-offs of the consumer loan portfolio increased by 50.0% to Ch$102,246 million in 2006 compared to 2005. In addition, recoveries on loans previously charged off remained stable in 2006 compared to 2005.
 
Operating expenses in 2006 increased by 8.5% compared to 2005, which was primarily due to a 12.3% rise in personnel salaries and expenses as a result of our payment of an end-of-negotiation bonus in conjunction with the
 
46

 
signing of the new collective bargaining agreement in the fourth quarter of 2006. This new collective bargaining agreement enters into effect on March 1, 2007 and expires on March 1, 2011. As a part of this process, an end-of-negotiation bonus was paid, which resulted in a one-time cost of Ch$8,622 million in 2006. Administrative expenses increased by 8.0% for the same periods, reflecting an increase in expenses as a result of the expansion our distribution network. Our efficiency ratio, despite higher costs, continued to improve, reaching a record low of 39.0% for the year ended December 31, 2006 compared to 41.5% in 2005.
 
We recorded a net gain of Ch$18,643 million for the year ended December 31, 2006 under total other operating income, net, compared to a loss of  Ch$13,595 million for 2005. Results in 2006 included a gain from trading activities of Ch$12,580 million as a result of our adoption of the new accounting standards for valuing financial instruments. If we had applied the new accounting standards for the year ended December 31, 2005, the net effect on our results would have been a gain of Ch$7,008 million. See Item 5: Operating and Financial Review and Prospect — A. New Accounting Standards for Financial Investments and Derivatives.
 
The net loss recorded in other income and expenses decreased by 83.7% in 2006 compared to 2005, primarily due to a lower level of provisions for other contingencies.
 
2004 and 2005. Net income for the year ended December 31, 2005 increased by 16.4% compared to net income in 2004. This increase was mainly due to an 11.1% increase in net interest revenue, a 24.1% decline in provisions for loan losses and a 10.4% increase in fee income. In 2005, the positive economic environment led to higher loan growth and banking activities in general, which fueled the increases in net interest revenue and net fee income. At the same time, the quality of the Bank’s loan portfolio improved, resulting in the decrease in provision expenses.
 
Other operating income, net totaled a loss of Ch$13,595 million in 2005 compared to a gain of Ch$14,741 million in 2004. This was mainly due to a 79.5% decline in net gains from financial transactions, primarily reflecting the movement in long-term local interest rates in 2005 compared to 2004.
 
Net non-operating losses also increased by 410.5% in 2005 compared to 2004 because results in 2004 included a one-time gain of Ch$23,093 million from the sale of our Santiago Express division to Empresas París.
 
Operating expenses in 2005 increased slightly by 0.4% and the efficiency ratio, representing operating expenses divided by operating income, improved to 41.5% in 2005 compared to 44.0% in 2004.
 
Net interest revenue
 
   
Year Ended December 31,
   
% Change
 
   
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
   
(in millions of constant Ch$ as of December 31, 2006,
except percentages)
 
Total individuals
   
241,092
     
278,433
     
332,444
      15.5%       19.4%  
SMEs
   
73,587
     
93,657
     
129,854
      27.2%       38.6%  
Total retail
   
314,679
     
372,090
     
462,298
      18.2%       24.2%  
Total middle-market
   
51,911
     
53,332
     
73,820
      2.7%       38.4%  
Wholesale banking
   
25,904
     
27,083
     
30,469
      4.5%       12.5%  
Institutional lending
   
5,654
     
6,640
     
9,510
      17.4%       43.2%  
Treasury
   
72,802
     
77,238
     
32,479
      6.1%       (57.9% )
Other
   
31,559
     
21,883
     
3,678
      (48.2% )     (83.2% )
Net interest revenue
   
502,509
     
558,266
     
612,254
      11.1%       9.7%  
Average interest-earning assets
   
11,149,321
     
11,830,880
     
13,079,254
      6.1%       10.6%  
Average non-interest-bearing demand deposits
   
1,855,619
     
1,945,572
     
1,823,018
      4.8%       (6.3% )
Net interest margin(1)
    4.5 %     4.7 %     4.7 %                
Average shareholders’ equity and average non-interest-bearing
   demand deposits to total average interest-earning assets
    26.0 %     25.0 %     22.7 %                
 

(1)
Net interest margin is net interest revenue divided by average interest-earning assets.
 

47


2005 and 2006. Net interest revenue for the year ended December 31, 2006 increased by 9.7% compared to 2005, mainly reflecting a 10.6% increase in average interest-earning assets.
 
The increase in net interest revenue was primarily attributable to an increase in net interest revenue from our retail banking and middle-market segments. Net interest revenue from the retail banking segment increased by 24.2% to Ch$462,298 million in 2006, with increases of 19.4% in the individuals segment and 38.6% in the SMEs segment.  Loans to higher yielding retail banking segments increased by 20.7% in 2006 compared to 2005. Net interest revenue from the middle-market segment increased by 38.4%, primarily due to a 14% increase in the average balance of the loans and increased net interest spread in this segment. In the wholesale banking segment, net interest revenue increased by 12.5%, primarily due to the higher interest rate environment for short-term lines of credit and trade finance. Total loans in this segment decreased by 1.8% from December 31, 2005 to December 31, 2006.  The average balance of loans in this segment also decreased in 2006 compared to 2005.  Net interest revenue in the treasury segment decreased by 57.9%, primarily reflecting the Bank’s strategy of shifting the asset mix to higher yielding assets. Total financial investments decreased by 20.3% from December 31, 2005 to December 31, 2006.  The average balance of financial investments decreased by 31.0% from 2005 to 2006.
 
This change in asset mix was the principal factor positively affecting the net interest margin. The increase in average interest-earning assets was primarily attributable to a 15.0% increase in average balance of loans. This growth in lending was driven by the stable economic environment and an increase in our market share in retail lending. Our total loan market share decreased by 30 basis points from 22.6% as of December 31, 2005 to 22.3% as of December 31, 2006.  Market share in lending to individuals increased from 25.2% as of December 31, 2005 to 26.2% as of December 31, 2006 led by a 101 basis point increase in residential mortgage lending and a 111 basis point increase in consumer lending market share. The average balance of consumer loans, which are higher yielding compared to our other loan products, increased by 29.3% in 2006 compared to 2005. The nominal rate earned on consumer loans in 2006 reached 20.9%. The average nominal rate earned on loans was 9.4% compared to 8.9% earned on interest-earning assets in 2006.
 
At the same time, higher interest rates on short-term debt also helped to increase margins in 2006, notwithstanding the decline in long-term rates.
 
The principal factors negatively affecting the net interest margin were the decrease in inflation rates, the increase in short-term interest rates and a decrease in the ratio of the average balances of non interest bearing demand deposits and shareholders’ equity to interest earning assets.
 
Our average UF denominated assets exceeded our average UF denominated liabilities by Ch$2,567,226 million in 2006, compared to Ch$1,446,290 million in 2005.  Inflation in 2006, measured by the annual variation of the UF, was 2.01% in 2006 compared to 3.80% in 2005.  As a result, the nominal rate earned on UF-denominated interest-earning assets declined from 8.6% in 2005 to 7.0% in 2006. See “─Impact of Inflation” for a quantitative disclosure of the impact of inflation on our net interest income.
 
As interest-bearing liabilities generally have shorter terms than interest-earning assets, a rise in short-term rates has a negative effect on our funding costs. As of December 31, 2006, the amount of our interest-bearing liabilities with a maturity of 90 days or less exceeded our interest-earning assets with the same maturity by Ch$353,602 million. The Central Bank’s overnight reference rate reached 5.25% as of December 31, 2006 compared to 4.50% as of December 31, 2005.  The average 90 day Central Bank rate, a benchmark rate for deposits, increased in nominal terms from 3.53% in 2005 to 4.83% in 2006. The average nominal rate paid on interest-bearing liabilities increased from 5.3% in 2005 to 5.7% in 2006. The average nominal rate paid on time deposits, which represented 64.8% of our average interest-bearing liabilities in 2006, increased from 4.7% in 2005 to 5.6% in 2006.
 
As short-term interest rates increased, so did the attractiveness of time deposits, thereby increasing the costs of our funding mix. Average balance of time deposits increased by 23.2% in 2006 compared to 2005. Average balance of time deposits represented 64.8% of our average interest-bearing liabilities in 2006, compared to 60.2% in 2005. In
 
48

 
addition, we lengthened the maturities of time deposits with institutional investors in order to partially offset the negative effects caused by the rising short-term interest rate environment.
 
The ratio of the average balance of free funds (non-interest bearing demand deposits and shareholders’ equity) to the average balance of interest-earning assets also decreased from 25.0% in 2005 to 22.7% in 2006, primarily as a result of the increase in short-term rates. This was partially offset by the increase in the spread earned on the free funds as a result of the rising interest rate environment.
 
2004 and 2005. Net interest revenue for the year ended December 31, 2005 increased by 11.1% compared to 2004, mainly as a result of the 6.1% increase in the average balance of interest-earning assets and an increase in our net interest margin from 4.5% in 2004 to 4.7% in 2005.
 
The principal factors positively affecting our net interest margin were the change in our asset mix and the higher inflation rate. The average balance of total loans increased by 8.3% in 2005, compared to a 6.1% increase in the average balance of our interest-earning assets. The average balance of loans represented 79.4% of the average balance of our interest-earning assets in 2005, compared to 77.8% in 2004. The average nominal rate earned on loans was 9.5%, compared to 8.5% earned on interest-earning assets as a whole in 2005.
 
At the same time, the higher inflation rate in 2005 compared to 2004 also contributed to the increase in the net interest margin. In 2005, the inflation rate reached 3.7% compared to 2.4% in 2004. The 12.5% increase in the gap between the average balances of UF-denominated assets and UF-denominated liabilities, combined with a higher inflation rate, had a positive effect on the net interest margin.  See “─Impact of Inflation”.
 
The principal factors negatively affecting the net interest margin were the rise in short-term interest rates and a decrease in the ratio of the average balances of non-interest-bearing demand deposits and shareholders’ equity to interest-earning assets. As interest-bearing liabilities generally have shorter terms than interest-earning assets, a rise in short-term rates has a negative effect on the Bank’s net interest margin.
 
The average nominal rate paid on interest-bearing liabilities increased from 4.2% in 2004 to 5.3% in 2005. In 2005, the overnight reference rate set by the Chilean Central Bank increased by 225 basis points to 4.50% in December 2005. The average 90-day Central Bank rate, a benchmark rate for deposits, increased in nominal terms from 1.83% in 2004 to 3.53% in 2005. As of December 31, 2005, the amount of our interest-bearing liabilities with a maturity of 90 days or less exceeded our interest-earning assets with the same maturity by Ch$501,595 million. The main reason for this gap is that interest-bearing liabilities are mainly comprised of short-term time deposits and short-term repurchase agreements. The average balance of time deposits represented 60.2% of the average balance of our interest-bearing liabilities in 2005 compared to 54.4% in 2004.
 
The rise in short-term interest rates also negatively affected our funding mix. The average balance of time deposits increased by 22.0% in 2005, compared to a 4.8% increase in the average balance of our non-interest-bearing demand deposits. As short-term interest rates increased, so did the attractiveness of time deposits. In order to reduce the impact of rising interest rates on our net interest margin, the Bank lengthened the maturity of deposits. In 2005, 15.6% of time deposits had a maturity greater than 12 months, compared to 6.6% in 2004. The ratio of the average balance of free funds (non-interest-bearing liabilities and shareholders’ equity) to the average balance of our interest-earning assets also decreased as a result of the decrease in short-term interest rates from 26.0% in 2004 to 25.0% in 2005. This was partially offset by the rise in the interest spread earned on free funds as a result of the higher inflation rate in 2005 compared to 2004.
 
Provision for loan losses
 
In accordance with applicable Chilean regulations, which became effective as of January 1, 2004, the models and methods for classifying our loan portfolio must follow the following guiding principles established by the Superintendency of Banks and approved by our Board of Directors. Under our loan classification categories effective January 1, 2004, loans are divided into: (i) consumer loans (including loans granted to individuals for the purpose of financing the purchase of consumer goods or payment of services); (ii) residential mortgage loans
 
49

 
(including loans granted to individuals for the purchase, construction or improvements of residential real estate, in which the value of the property covers at least 100% of the amount of the loan); and (iii) commercial loans (includes all loans other than consumer loans and residential mortgage loans).
 
In 2006, we improved our internal provisioning models by not only focusing on non-performance, but introducing statistical models that take into account a borrower’s credit history and indebtedness levels. Group ratings that determine loan loss allowances based only on non-performance are being phased out and replaced by statistical scoring systems. Commencing in December 2006, we no longer analyze large commercial loans on a group basis. All large commercial loans have since been rated on an individual basis. For large commercial loans, leasing and factoring, we assign a risk category level to each borrower and his respective loans. We consider the following risk factors in classifying a borrower’s risk category: the borrower’s industry or sector, owners or managers, financial condition, payment ability and payment behavior.
 
Group assessment for loan loss allowances is permitted for a large number of borrowers whose individual loan amounts are relatively insignificant.  Currently, we use group analysis to determine loan loss allowances for certain types of loans, such as loans to small- and mid-sized companies and commercial loans to individuals.
 
Commencing in 2006, we improved and modified the methodology for analyzing consumer and mortgage loans. All consumer and mortgage loans are assigned a provisioning level on an individual borrower basis using a more automated and sophisticated statistical model which considers a borrower’s credit history, including any defaults on obligations to other creditors, as well as the overdue periods with respect to loans granted by us. Once the borrower’s rating is determined, the allowance for consumer or mortgage loans is calculated based on the risk category and the respective provisioning ratio which is directly related to the aging of the loan.
 
For a detailed description of the models we use to determine loan loss allowances, see Item 5: Operating and Financial Review and Prospects— D. Selected Statistical Information – Loan Portfolio – Classification of Loan Portfolio.
 
For statistical information with respect to our substandard loans and allowance for probable loan losses, see “—D. Selected Statistical Information—Analysis of Substandard Loans and Amounts Past Due” and “—D. Selected Statistical Information—Analysis of Loan Loss Allowances”, as well as Note 7 to the Audited Consolidated Financial Statements. The amount of provision charged to income statement in any period consists of net provisions established for possible loan losses, net of recoveries on loans previously charged off.
 
The following table sets forth, for the years indicated, certain information relating to our provision expenses.
 
   
Year Ended December 31,
   
% Change
 
   
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
   
(in millions of constant Ch$ as of December 31, 2006,
except percentages)
 
Provision expenses
    (9,829 )    
27,674
      (26,614 )            
Charge-offs
    (126,394 )     (139,632 )     (143,475 )     10.5%       2.8%  
Recoveries for loans previously charged off
   
50,772
     
47,079
     
47,067
      (7.3% )     (0.0% )
Provision expenses, net
    (85,451 )     (64,879 )     (123,022 )     (24.1% )     89.6%  
Year-end loans
   
9,121,022
     
10,359,334
     
11,788,959
      13.6%       13.8%  
Substandard loans (1)
   
338,547
     
271,541
     
345,481
      (19.8% )     27.2%  
Past-due loans
   
138,692
     
108,799
     
92,559
      (21.6% )     (14.9% )
Loan loss allowance
   
183,366
     
151,000
     
174,064
      (17.7% )     15.3%  
Substandard loans / Year-end loans
    3.71 %     2.62 %     2.93 %                
Past due loans / Year-end loans
    1.52 %     1.05 %     0.79 %                
Consolidated risk index (2)
    2.01 %     1.46 %     1.48 %                
Coverage ratio (3)
    132.21 %     138.79 %     188.06 %                
 

(1)
Substandard loans are all mortgage and consumer loans rated B  or worse and all commercial loans rated C2 or worse.
 
(2)
Loan loss allowance divided by year end loans.
 
(3)
Loan loss allowance divided by past due loans.
 
 
50


2005 and 2006. Net provision expenses for loan losses totaled Ch$123,022 million for the year ended December 31, 2006, an increase of 89.6% compared to 2005, primarily due to increase in provision expense and charge-offs.  Provision expense rose from a reversal of Ch$27,674 million in 2005 to a charge of Ch$26,614 million in 2006. The Bank’s risk index or expected loan loss ratio, which is calculated according to the guidelines set by the Superintendency of Banks and our Board, increased from 1.46% in 2005 to 1.48% in 2006. This index is the main determinant of loan loss allowances. Loan loss allowances must be equal to the risk index multiplied by total loans. As the loan portfolio increased by 13.8% in 2006 and the risk index rose 2 basis points, required loan loss allowances rose 15.3% to Ch$174,064 million, resulting in the Ch$26,614 million provision expense in 2006. See “—D. Selected Statistical Information—Loan by Economic Activity—Classification of Loan Portfolio”.
 
Charge-offs increased by 2.8% in 2006 compared to 2005, primarily as a result of the growth of our consumer loan portfolio, for which credit risk is higher and loans become loss within much shorter periods than the rest of the loan portfolio.  Charge-offs of the consumer loan portfolio increased by 50.0% to Ch$102,246 million. This was partially offset by the 44.8% decrease in charge-offs in the commercial loan portfolio. In 2005, the Bank charged off various commercial loans that had been previously restructured and that bear no interest. See “—D. Selected Statistical Information - Analysis of Loan Loss Allowances” and “—Classification of Loan Portfolio Based on the Borrower’s Payment Performance”. These loans were already classified as D2 and were 90% provisioned for. Therefore, this increase in charge-offs was offset by the subsequent release of provisions recorded in 2005.
 
The following table sets forth, for the years indicated, a breakdown of our charged off loans.
 
   
Year Ended December 31,
   
% Change
 
   
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
   
(in millions of constant Ch$ as of December 31, 2006,
except percentages)
 
Consumer loans
   
86,703
     
68,144
     
102,246
      (21.4% )     50.0%  
Mortgage loans
   
4,149
     
7,314
     
5,789
      76.3%       (20.9% )
Commercial loans
   
35,542
     
64,174
     
35,440
      80.6%       (44.8% )
Total charge-offs
   
126,394
     
139,632
     
143,475
      10.5%       2.8%  

In addition, recoveries on loans previously charged off remained effectively stable in 2006 compared to 2005. Our recovery department is currently being reorganized and expanded in order to keep up with the growth in our retail lending business.
 
Overall asset quality indicators remained healthy in 2006. Past due loans at December 31, 2006 decreased by 14.9% compared to December 31, 2005. Past due loans as a percentage of total loans decreased from 1.05% at December 31, 2005 to 0.79% at December 31, 2006. Substandard loans increased by 27.2%, primarily due to an increase in substandard consumer loans, which rose mainly as a result of loan growth in this product. Total substandard loans as a percentage of total loans increased from 2.62% at year-end 2005 to 2.93% at year-end 2006, mainly due to the change in loan mix towards higher yielding retail loans, which generally present relatively higher risk than other retail loans.
 
The following table sets forth, for the years indicated, the components of our net provision expenses.
 
 
 
Year Ended December 31,
   
% Change
 
 
 
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
 
 
(in millions of constant Ch$ as of December 31, 2006,
except percentages)
 
Total individuals
    (73,566 )     (52,255 )     (101,753 )     (29.0% )     94.7%  
SMEs
    (16,630 )     (15,737 )     (20,840 )     (5.4% )     32.4%  
Total retail
    (90,196 )     (67,992 )     (122,593 )     (24.6% )     80.3%  

51

 
 
 
 
Year Ended December 31,
   
% Change
 
 
 
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
 
 
(in millions of constant Ch$ as of December 31, 2006,
except percentages)
 
Total middle-market
   
8,156
     
1,113
      (720 )     (86.4 %)     %
Wholesale banking
   
3,286
     
1,960
     
703
      (40.4 %)     (64.1 %)
Institutional lending
    (562 )     (16 )    
481
      (97.2 %)     %
Treasury
   
     
     
     
     
 
Other (1)
    (6,135 )    
56
      (893 )     %     %
Provision expense, net
    (85,451 )     (64,879 )     (123,022 )     (24.1 %)     89.6 %
 

 
(1)  Consists primarily of additional allowances on loans which are not assigned to any of the above types or segments, if any, and provisions for repossessed assets.
 
Provision expense increased by 80.3% in the retail banking segment, mainly as a result of the growth of our retail loan portfolio, for which credit risk is higher and provisions are required to be made within much shorter periods than the rest of the loan portfolio.  Charge-off of the consumer loan portfolio increased by 50.0% in 2006 compared to 2005. Provision expense in the SMEs segment increased in line with loan growth in this segment. Net provision expense in the rest of the segments remained relatively stable, reflecting the generally healthy credit quality indicators in those segments.
 
We expect provisions for loan losses to increase in future periods in line with the overall growth of our loan portfolio and our increased lending to small companies and individuals which poses a higher risk of default than lending to traditional corporate and commercial customers.  See “Item 3: Key Information—D. Risk Factors—Risks Associated with Business—Our exposure to individuals and small businesses could lead to higher levels of past due loans, allowances for loan losses and charge-offs” and “Item 3: Key Information—D. Risk Factors—Risks Associated with our Business—The growth of our loan portfolio may expose us to increased loan losses.”
 
2004 and 2005.  Provisions for loan losses decreased by 24.1% in 2005 compared to 2004. The growth of the Chilean economy has led to an improvement in asset quality indicators, which in turn resulted in a lower provision expense in the year. Past due loans at year-end 2005 decreased by 21.6% from year-end 2004. Past due loans as a percentage of total loans decreased from 1.52% at year-end 2004 to 1.05% at year-end 2005.  Substandard loans at year-end 2005 decreased by 19.8% from year-end 2004. The coverage ratio (loan loss allowance as a percentage of past due loans) improved to 138.79% at year-end 2005 from 132.21% at year-end 2004.
 
Charge-offs in 2005 increased by 10.5% in 2005 compared to 2004, mainly as a result of an increase in charge-off of commercial loans that had been previously restructured and that bear no interest. See “—D. Selected Statistical Information—Analysis of Loan Loss Allowances” and “—Classification of Loan Portfolio Based on the Borrower’s Payment Performance”. These loans were already classified as D2 and were 90% provisioned for. Therefore, this increase in charge-offs was offset by the subsequent release of provisions previously set aside for these loans.
 
Fee 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 the years ended December 31, 2004, 2005 and 2006.
 
   
Year ended December 31,
   
% Change
 
   
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
   
(in million of constant Ch$ as of December 31, 2006,
except percentages)
 
Checking accounts & lines of credit
   
35,400
     
42,429
     
53,731
      19.9 %     26.6 %
Collection and administration of insurance policies
   
17,694
     
20,598
     
23,233
      16.4 %     12.8 %

52

 
   
Year ended December 31,
   
% Change
 
   
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
   
(in million of constant Ch$ as of December 31, 2006,
except percentages)
 
Mutual fund services
   
19,087
     
19,275
     
20,039
      1.0 %     4.0 %
Credit cards
   
13,466
     
14,117
     
18,650
      4.8 %     32.1 %
Automatic teller cards
   
13,022
     
13,859
     
14,272
      6.4 %     3.0 %
Insurance brokerage
   
6,788
     
8,406
     
11,397
      23.8 %     35.6 %
Sales and purchase of foreign currencies
   
5,271
     
6,619
     
5,957
      25.6 %     (10.0 %)
Payment agency services
   
4,187
     
2,881
     
2,671
      (31.2 %)     (7.3 %)
Office Banking
   
     
1,380
     
2,602
      %     88.6 %
Letters of credit, guarantees, pledges and other contingent loans
   
4,828
     
2,816
     
2,522
      (41.7 %)     (10.4 %)
Stock brokerage
   
1,416
     
1,654
     
1,393
      16.7 %     (15.7 %)
Underwriting
   
6,322
     
2,383
     
1,345
      (62.3 %)     (43.5 %)
Bank drafts and fund transfers
   
260
     
258
     
624
      (0.8 %)     141.9 %
Custody and trust services
   
590
     
651
     
365
      10.5 %     (43.9 %)
Savings accounts
   
262
     
244
     
253
      (6.9 %)     3.7 %
Other
    (589 )    
3,730
     
3,496
      %     (6.3 %)
Total
   
128,004
     
141,300
     
162,550
      10.4 %     15.0 %
 
 
2005 and 2006. Total net fee income increased by 15.0% to Ch$162,550 million for the year ended December 31, 2006 compared to 2005. The positive economic environment and the bank’s successful marketing efforts led to an overall increase in the usage and penetration of bank products in 2006. The Bank’s total retail banking client base increased by 11.8% in 2006, totaling 2.4 million clients. The number of retail clients with a checking account increased by 23.0% in 2006, reaching 496 thousand. Middle- and upper-income individual clients who are cross sold, defined as clients with a checking account who also uses at least four other banking products, increased by 30.8% at December 31, 2006 compared to December 31, 2005. In Santander Banefe, the number of cross sold clients (clients who also use at least two other products) rose by 18.1% at December 31, 2006 compared to December 31, 2005.
 
Fees from checking accounts and lines of credit increased by 26.6%, primarily as a result of the growth of our checking accounts and credit lines. These products are offered together and, therefore, are being analyzed as a single product.  Our market share in checking accounts at November 2006, the last figure available, was 27.1% compared to 25.5% at November 2005. In this same period, our checking account base increased by 17.1%, compared to the 10.3% increase in the market as a whole.
 
Fees from collection and administration of insurance policies increased by 12.8% for the year ended December 31, 2006 compared to 2005, primarily due to the growth of our mortgage loan book and lower than estimated claim rates, which results in higher administration fees paid by insurers to us.
 
Fees from our mutual fund asset management subsidiary increased by 4.0%. Total assets under management increased by 35.9% to Ch$2,092,192 million (US$3.9 billion) at December 31, 2006 compared to December 31, 2005.
 
Credit card fees increased by 32.1% in 2006 compared to 2005. We were the market leader in bank credit card accounts, with a 35.8% market share as of December 31, 2006. The transaction volumes of credit cards issued by us, measured in UFs, increased by 12.9% in 2006 compared to 2005. The number of our credit card customer accounts increased by 16.0% to 948,918 at December 31, 2006 compared to December 31, 2005. The rise in credit card fees is partially offset by the other credit card expenses reflected in “Other operating losses, net.”
 
The 3.0% rise in ATM fees was mainly driven by the increase in the number of ATMs installed by the Bank. As of December 31, 2006, the Bank had 1,588 ATMs compared to 1,422 as of December 31, 2005. The rise in ATMs was offset by increased competition in order to obtain ATM locations with large retailers.
 
53

 
Insurance brokerage fees increased by 35.6% for the year ended December 31, 2006 compared to 2005. This was mainly as a result of an industry-wide expansion of insurance brokerage business as banks have successfully introduced simple and low cost insurance products to the market.
 
The decrease in fees from payment agency services, letters of credit, guarantees, pledges and other contingent loan fees, fees form the sale and purchase of foreign currencies, underwriting fees and other fees was mainly due to increased competitive pressure in the Corporate and Middle-market segments. This was offset by an increase in the sales of derivatives and other treasury services, which were included in “Other operating income” and a higher return on cash management services provided to these customers, which was reflected in our net interest income.
 
Office banking fees increased by 88.6% in 2006 compared to 2005 as the Bank has also sought to increase the coverage and pricing of its on-line corporate banking services in order to offset the decrease in collection fees.
 
By segment, changes in our fee income also reflects the increase in retail banking products. Retail banking fees increased by 38.8% in 2006 compared to 2005, mainly due to the rise in fees from checking accounts, lines of credit, insurance brokerage and credit cards.
 
Fees from the middle market increased by 62.4% in 2006 compared to 2005, led by the increase in office banking services and the reclassification of the fees from the mutual fund asset management from “other” fee income to fees from the middle market in 2006.
 
Fees from wholesale banking decreased by 1.3%, reflecting the decline in fees from payment agency services, letters of credit, guarantees, pledges and other contingent loan fees, fees form the sale and purchase of foreign currencies and underwriting fees.  This was offset by an increase in sales of derivatives and other treasury services and a higher return on cash management services provided to these customers.
 
The following table set forth, for the years indicated, a breakdown of our fee income by segment.
 
   
Year ended December 31,
   
% Change
   
% Change
 
   
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
   
(in million of constant Ch$ as of December 31, 2006,
except percentages)
 
Total individuals
   
66,574
     
76,057
     
103,476
      14.2 %     36.0 %
SMEs
   
14,496
     
19,136
     
28,671
      32.0 %     49.8 %
Total retail
   
81,070
     
95,193
     
132,147
      17.4 %     38.8 %
Total middle-market
   
8,543
     
8,611
     
13,981
      0.8 %     62.4 %
Wholesale banking
   
6,875
     
7,636
     
7,536
      11.1 %     (1.3 %)
Institutional lending
   
1,570
     
1,668
     
1,201
      6.3 %     (28.0 %)
Treasury
   
3,666
     
     
1,303
      %     %
Other
   
26,280
     
28,192
     
6,382
      7.3 %     (77.4 %)
Total
   
128,004
     
141,300
     
162,550
      10.4 %     15.0 %

2004 and 2005. In 2005, total fee income increased by 10.4%. The positive economic environment led to an overall increase in the usage and penetration of bank products in 2005. Fees from checking accounts and lines of credit increased by 19.9%, mainly a result of the growth of our checking accounts and credit lines. These products are sold together and, therefore, are being analyzed as a single product.
 
Insurance brokerage fees increased by 23.8%, mainly as a result of an industry-wide expansion of the insurance brokerage business as banks have successfully introduced simple and low cost insurance products to the market. The 6.4% rise in ATM fees was mainly driven by the rise of ATMs installed by the Bank that increased by 19.5% in 2005 to 1,422 tellers. This was offset in part by the US$2 million one-time fee earned in 2004 as a result of the strategic alliance signed between the Bank and Empresas París in December 2004. Excluding this item, ATM fees increased by 17.1%, generally in line with the increase of ATMs in the period.
 
54

 
The increase in other fees was mainly due to Ch$2,147 million in fees paid to the Bank in connection with financial advisory services provided to a company.
 
Fees from our mutual fund asset management subsidiary increased by 1.0%. Total assets under management increased by 4.7% in 2005 compared to 2004. In 2005, the Bank launched 12 new funds. The inflow to these new funds offset a reduction in amount managed in fixed income funds as money flowed away from these funds toward bank deposits due to an increase in short-term interest rates.
 
The growth in fees was offset by a 41.7% decrease in fees from letters of credit, guarantees, pledges and other contingent operations, in line with the decline in low yielding contingent loans. Underwriting fees decreased by 62.3%, mainly due to lower corporate bond issuances in 2005 compared to 2004. Payment agency service fees declined by 31.2% in 2005 compared to 2004. These charges are mainly related to collection services the Bank performs on behalf of corporate customers. These services are increasingly being performed through our internet banking services. Fees charged for office banking, which is internet banking service for companies, totaled Ch$1,380 million in 2005 compared to no significant income in previous years.
 
Other operating income (expenses), net
 
The following table sets forth information regarding our other operating income (expenses), net in the years ended December 31, 2004, 2005 and 2006.
 
 
 
Year ended December 31,
   
% Change
   
% Change
 
 
 
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
 
 
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Net gains from trading and mark-to-market
    (7,410 )     (62,569 )    
100,312
      744.4%        
Foreign exchange transactions, net
   
47,444
     
72,381
      (48,708 )     52.6%        
Other operating losses, net
    (25,293 )     (23,407 )     (32,961 )     (7.4% )     40.8%  
Total other operating income
   
14,741
      (13,595 )    
18,643
             

2005 and 2006. Total other operating income, net, amounted to a gain of Ch$18,643 million for the year ended December 31, 2006 compared to a loss of Ch$13,595 million for 2005. Total other operating income, net, consists primarily of (i) the results of our Treasury Department’s trading and hedging activities and financial transactions with customers, and (ii) other operating income and expenses primarily relating to repossessed assets that have not been charged-off, sales force expenses and other expenses relating to the Bank’s marketing and promotional efforts.
 
Net gains from trading activities and mark-to-market adjustments totaled Ch$100,312 million in 2006. This line item in 2006 included: (i) unrealized gains of Ch$83,825 million from mark-to-market adjustments of our derivatives portfolio (including foreign exchange derivatives) and, (ii) gains of Ch$16,487 million from mark to market adjustments and realized gains made in the securities portfolio. The net result from foreign exchange transactions totaled a loss of Ch$48,708 million in 2006. These results mainly included the translation loss of assets and liabilities denominated in foreign currencies (excluding derivatives), which was largely offset by the hedged positions with derivatives. Our exposure to the foreign currency market is limited by guidelines of the Central Bank and our Market Risk Department (See Item 11: Quantitative and Qualitative Disclosures about Market Risk).
 
Net gains from trading activities and mark-to-market adjustments and foreign exchange transactions for the years ended December 31, 2006 and 2005 are not strictly comparable since 2006 figures include the mark-to-market adjustments of derivatives. In accordance with Circular No. 3345 issued by the Superintendency of Banks, effective January 1, 2006, the accounting standards for valuing financial instruments acquired for trading or investment purposes, including derivative instruments, were amended. In summary, we must record our derivatives portfolio at fair value, and hedge accounting was introduced. See Item 5: Operation and Financial Review and Prospects — A. New Accounting Standards for Financial Investments and Derivatives. Results in 2006 included a gain of Ch$12,580 million following the adoption of new accounting standards reflecting recognizing financial instruments at fair value, which resulted in a gain from trading activities. If we had applied the new accounting standards for the year ended
 
55

 
December 31, 2005, the net effect on our results would have been a gain of Ch$7,008 million (this figure has been calculated based on the adjustment under U.S. GAAP for hedge accounting. See Note 26(m) to our Audited Consolidated Financial Statements).
 
In 2006, other operating losses, net, increased by 40.8% to Ch$32,961 million compared to a loss of Ch$23,407 million in 2005. This was primarily due to our increased business activities, which resulted in increases in credit card related expenses and other customer related expenses. Expenses relating to our credit card business increased by 117.7% to Ch$5,013 million for the year ended December 31, 2006 compared to 2005, primarily as a result of relatively higher premium rates on fraud insurance covering some of our new cards and an increase in the membership fees paid to Transbank, the company collectively owned by major banks in Chile which runs credit card payment networks in Chile. These increased costs were offset by increased fees from our credit cards.
 
Customer service expenses, which consist primarily of expenses paid to third parties for transporting funds for corporate customers as part of cash management agreements, and the costs of our call center, increased by 105.0% to Ch$10,889 million in 2006 compared to 2005. This was offset by positive performance of our cash management business. We generate fees for collection and corporate e-banking services and generate interest income on the floating balances of these clients. The growth of these expenses also reflects the shift towards more efficient sales channels such as our call center compared to the outsourced sales force.
 
The results from the sales and expenses in maintaining repossessed assets decreased by 78.2% to Ch$842 million in 2006 compared to 2005. In 2005, we recognized a gain of Ch$1,123 million from the leasing of a large repossessed asset, which mainly explains the decline in income in this line item in 2006.
 
2004 and 2005. Other operating income, net totaled a loss of Ch$13,595 million in 2005 compared to a gain of Ch$14,741 million in 2004. This was mainly due to an increase in net loss from trading and mark-to-market adjustments primarily reflecting the movement of long-term local interest rates in 2005 compared to 2004. In the first nine months of 2005, strong liquidity in the Chilean financial systems dampened long-term yields, resulting in mark-to-market gains. As the economy improved and inflation continued to rise, this trend reversed sharply in the last quarter of the year, reversing a substantial portion of the gains recorded to that point in the year. As of December 31, 2004, the market rate on the 10-year Central Bank bond in real terms was 3.29%. As of September 30, 2005, the yield on this same instrument had declined to 2.43%, but by December 31, 2005, it recovered to 3.29%. In 2004, the 10-year Chilean Central Bank bond was yielding 3.23%, down 104 basis points from year-end 2003. This was partially offset by a 52.6% increase in foreign exchange transactions. This line item in 2004 and 2005 includes net gain or loss in book value of assets or liabilities indexed to a foreign currency. The increase in gains from foreign exchange transactions was primarily attributable to a 8.1% appreciation of the peso during 2005, which partially offset the financial results on forward contracts included in net gains from trading and mark-to-market. Our exposure to the foreign currency market is limited by guidelines of the Central Bank and our Market Risk Department (See Item 11: Quantitative and Qualitative Disclosures about Market Risk).
 
Other operating losses, net decreased by 7.4% in 2005 compared to 2004, totaling a loss of Ch$23,407 million. This decrease was mainly due to a 20.9% decrease in commissions paid to our external sales force, which totaled Ch$17,227 million in 2005, primarily attributable to the fact that in 2004 sales force expenses included the recognition of Ch$4,174 million in one-time sales force expenses as a result of the sale of the Santiago Express Division to Empresas París.  Expenses on assets received in lieu of payment also decreased by 84.4% in 2005 compared to 2004. This was offset by a 16.6% decline in income from the sale of repossessed assets and a rise in other expenses related to our credit card business.
 
Other income and expenses, net
 
The following table sets forth information regarding our other income and expenses in the years ended December 31, 2004, 2005 and 2006.
 
 
 
Year ended December 31,
   
% Change
   
% Change
 
 
 
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
 
 
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Non-operating income (loss), net
    (4,669 )     (22,480 )     (4,214 )     381.5 %     (81.3 %)
Income attributable to investments in other companies
   
568
     
693
     
786
      21.9 %     13.4 %
Losses attributable to minority interest
    (194 )     (136 )     (151 )     (30.0 %)     11.0 %
Total
    (4,295 )     (21,923 )     (3,579 )     410.4 %     (83.7 %)

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2005 and 2006. The net loss recorded in other income and expenses, net, decreased by 83.7% in 2006 compared to 2005, primarily due to a lower level of provisions for other contingencies. These contingencies are mainly related to non credit risks, including non specific contingencies, tax contingencies and other non credit contingencies or impairments. In 2006, these provisions totaled Ch$6,515 million, a decrease of 67.8% compared to 2005. The lower non-operating loss was also due to a lower level of charge-offs of repossessed assets, which totaled Ch$13,616 million in 2006, a decrease of 36.2% compared to 2005. This was partially offset by a 52.6% decrease in gains from the sales of repossessed assets previously charged off, which totaled Ch$8,050 million in 2006. (See Note 17 to our Audited Consolidated Financial Statements).
 
2004 and 2005. The net loss recorded in other income and expenses, net, increased by 410.4% in 2005 compared to 2004. In 2004, the Bank recognized a one-time gain of Ch$23,093 million from the sale of our former Santiago Express Division to Empresas París. Excluding the sale, the net loss recorded in other income and expenses, net would decrease by 20.0% in 2005 compared to 2004, mainly as a result of a 141.1% increase in income from the sale of repossessed assets previously charged off. This was partially offset by a 73.2% increase in provisions for other contingencies.
 
Operating expenses
 
The following table sets forth information regarding our operating expenses in the years ended December 31, 2004, 2005 and 2006.
 
 
 
Year ended December 31,
   
% Change
 
 
 
2004
   
2005
   
2006
     
2004/2005
     
2005/2006
 
 
 
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Personnel salaries and expenses
   
140,746
     
142,171
     
159,722
      1.0%       12.3%  
Administrative expenses
   
102,159
     
102,717
     
110,948
      0.6%       8.0%  
Depreciation and amortization
   
40,978
     
40,080
     
38,613
      (2.2% )     (3.7% )
Total
   
283,883
     
284,968
     
309,283
      0.4%       8.5%  
Efficiency ratio(1)
    44.0 %     41.5 %     39.0 %                
 

(1)
The efficiency ratio is the ratio of total operating expenses to total operating revenue. Total operating revenue consists of net interest revenue, fee income from services, net, and other operating income, net.
 
2005 and 2006. Operating expenses in 2006 increased by 8.5% compared to 2005. The 12.3% rise in personnel salaries and expenses was mainly due to the end-of-negotiation bonus paid in conjunction with the signing of the new collective bargaining agreement in the fourth quarter of 2006. This new collective bargaining agreement enters into effect on March 1, 2007 and expires on March 1, 2011. As a part of this process, an end-of-negotiation bonus was to be paid, which resulted in a one-time cost of Ch$8,622 million in 2006. Personnel costs also grew as a result of the 5.4% rise in average headcount in 2006 compared to 2005 and an increase in bonuses paid to business teams for reaching business targets. Our efficiency ratio, despite higher costs, continued to improve, reaching a record low of 39.0% for the year ended December 31, 2006 compared to 41.5% in 2005.
 
Administrative expenses increased by 8.0% for the same periods, reflecting an increase in expenses as a result of the expansion of our distribution network. The branch network totaled 397 branches as of December 31, 2006, an increase of 12.8% since
 
57

 
December 2005. Our ATM network totaled 1,588 machines, an increase of 11.7% since December 2005. We expect personnel and administrative expenses to grow at a higher pace in future periods as a result of our strategy to expand our retail banking business.
 
Depreciation and amortization expenses decreased by 3.7% in 2006 compared to 2005. In the fourth quarter of 2005, the Bank accelerated the depreciation of obsolete IT projects, which resulted in the decline in depreciation expense in 2006.  Going forward we expect depreciation expenses to rise as the Bank continues to invest in branches and other fixed assets.
 
The expansion of our branch and ATM network helped us increase our retail business. The relatively larger expenses incurred as a result of the expansion of the branch and ATM network has been partially offset by increases in productivity as gross operating income increased by 15.7%. As a result, our efficiency ratio, representing operating expenses divided by operating income, improved from 41.5% in 2005 to a record low of 39.0% in 2006. The pace of expansion of our branch and ATM network in the medium-term may vary with fluctuations in the outlook of the Chilean economy.
 
2004 and 2005. Operating expenses in 2005 increased by 0.4% compared to 2004. The 1.0% rise in personnel expenses reflects an increase in variable compensation paid to commercial teams for reaching commercial targets. This was partially offset by a 1.7% decrease in average headcount in 2005 compared to 2004 as a result of the sale of Santiago Express. The 0.6% increase in administrative expenses reflect an increase in expenditures for branches and ATMs, which was partially offset by savings produced by the outsourcing of certain back office functions, such as systems management and mortgage processing, which we believe has improved productivity. We expect personnel and administrative expenses to grow at a higher pace in future periods as a result of our strategy to expand our retail banking business. This trend was already observable in the second half of 2005.
 
Depreciation and amortization expenses decreased by 2.2% in 2005 compared to 2004, which were positively affected by the completion of the depreciation schedule of our core IT systems.
 
Loss from price level restatement
 
2005 and 2006. The loss from price level restatement totaled Ch$13,782 million in 2006, a decrease of 25.6% compared to 2005. We must adjust our capital, fixed assets and other assets for the variations in price levels. Because our capital is larger than the sum of our fixed and other assets, price level restatement usually results in a loss and fluctuates with the inflation rate. The inflation rate used for calculating price level restatement decreased in 2006 compared to 2005 (2.01% in 2006 and 3.80% in 2005), resulting in a lower loss from price level restatement. This was partially offset by an increase in the gap between equity and other assets as we decreased our dividend payment in 2006. The lower loss from price level restatement is also partially offset by the negative impact on net interest income due to lower inflation rates.
 
2004 and 2005. Losses from price level restatement increased by 46.1% compared to 2004. The higher loss from price level restatement reflected the higher inflation rate used for calculating price level restatement in 2005 compared to 2004 (3.62% in 2005 compared to 2.35% in 2004).
 
Income tax
 
2005 and 2006. Our income tax expense increased by 14.4% to Ch$58,199 million for the year ended December 31, 2006 compared to 2005, primarily due to a 16.3% growth of income before taxes. The effective tax rate for 2006 was 16.9%, compared to 17.2% for 2005. The statutory corporate tax rate was 17% (See Note 20 to our Audited Consolidated Financial Statements).
 
2004 and 2005. Our income tax expense increased 4.7% for the year ended December 31, 2005 compared to 2004. This rise was mainly due to a net charge to deferred taxes of Ch$4,857 million compared to a net benefit of Ch$12,985 million in 2004.  This was partially offset by a 23.7% decrease in income tax provisions in 2005 compared to 2004. (See Note 20 to our Audited Consolidated Financial Statements). As a result, the total income tax expenses in 2005 increased at a lower rate than the growth of pre-tax income, leading to a lower effective tax rate. The Bank’s effective tax rate was 17.2% for the year ended December 31, 2005, compared to 18.8% in 2004.
 
58

 
C.  Liquidity and Capital Resources
 
Sources of Liquidity
 
Santander-Chile’s liquidity depends upon its (i) capital, (ii) reserves and (iii) financial investments, including investments in government securities. To cover any liquidity shortfalls and to augment its liquidity position, Santander-Chile has established lines of credit with foreign and domestic banks and also has access to Central Bank borrowings.
 
The following table sets forth our contractual obligations and commercial commitments by time remaining to maturity. At December 31, 2006, the scheduled maturities of our contractual obligations and of other commercial commitments, including accrued interest, were as follows:
 
 
 Contractual Obligations
 
Due within 1
year
   
Due after 1
year but
within 3 years
   
Due after 3
years but
within 6 years
   
Due after 6
years
   
Total 2006
 
 
 
(in millions of constant Ch$ as of December 31, 2006)
 
Deposit and other obligations(1)
   
5,483,618
     
1,196,139
     
219,126
     
10,452
     
6,909,335
 
Mortgage finance bonds
   
65,493
     
105,746
     
133,680
     
225,287
     
530,206
 
Subordinated bonds
   
40,294
     
     
133,427
     
316,695
     
490,416
 
Bonds
   
1,140
     
213,700
     
172,048
     
178,765
     
565,653
 
Chilean Central Bank borrowings:
                                       
Credit lines for renegotiations of Loans
   
5,080
     
     
     
     
5,080
 
Other Central Bank borrowings
   
134,417
     
     
     
     
134,417
 
Borrowings from domestic financial institutions
                                       
Investments sold under agreements to repurchase
   
19,929
     
     
     
     
19,929
 
Foreign borrowings
   
717,979
     
91,021
     
3,267
     
     
812,267
 
Derivatives
   
266,651
     
27,629
     
49,680
     
11,962
     
355,922
 
Other obligations
   
52,221
     
5,607
     
4,802
     
1,563
     
64,193
 
Total cash obligations
   
6,786,822
     
1,639,842
     
716,030
     
744,724
     
9,887,418
 
 

(1)  Excludes demand deposit accounts and saving accounts.
 
The Bank as of the date of the filing of this 20-F has no significant purchase obligations.
 
Operational leases
 
Certain bank premises and equipment are leased under various operating leases. Future minimum rental commitments as of December 31, 2006 under non-cancelable leases are as follows:
 
 
 
As of December 31, 2006
 
 
 
(in millions of constant Ch$ as of
December 31, 2006)
 
Due within 1 year
   
8,383
 
Due after 1 year but within 2 years
   
7,363
 
Due after 2 years but within 3 years
   
5,394
 
Due after 3 years but within 4 years
   
3,006
 
Due after 4 years but within 5 years
   
1,539
 
Due after 5 years
   
  254
 
Total
   
25,939  
 

59

 
Other Commercial Commitments
 
At December 31, 2006, the scheduled maturities of other commercial commitments, including accrued interest, were as follows:
 
 
Other Commercial Commitments
 
Due within 1
year
   
Due after 1
year but
within 3 years
   
Due after 3
years but
within 6 years
   
Due after 6
years
   
Total
 
 
 
(in millions of constant Ch$ as of December 2006)
 
Letters of credit
   
102,707
     
50,448
     
13,093
     
     
166,248
 
Guarantees
   
553,833
     
22,132
     
642
     
     
576,607
 
Other commercial commitments
   
275,723
     
5,403
     
67
     
     
281,193
 
Total other commercial commitments
   
932,263
     
77,983
     
13,802
     
     
1,024,048
 

Capital and Reserves
 
We currently have regulatory capital in excess of the minimum requirement under the current Chilean regulations. According to the General Banking Law, a bank should have regulatory capital of at least 8% of its risk weighted assets, net of required loan loss allowances, and paid-in capital and reserves (“basic capital”) 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 shall decrease 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. The merger of Old Santander-Chile and Santiago required a special regulatory preapproval of the Superintendency of Banks, which was granted on May 16, 2002. The resolution granting this preapproval imposed a regulatory capital to risk weighted assets ratio of 12% for the merged bank. This indicator was reduced to 11% by the Superintendency of Banks 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, the nature of the assets and the existence of collateral securing such assets.
 
The following table sets forth our regulatory capital at the dates indicated. See Note 13 to our Audited Consolidated Financial Statements for a description of the minimum capital requirements.
 
  
 
As of December 31,
 
 
 
2005
   
2006
 
 
 
(in millions of constant Ch$ as of 
December 31,
2006, except percentages)
 
Base net capital
   
859,975
     
959,757
 
3% of total assets net of provisions
    (402,432 )     (461,315 )
Excess over minimum required capital
   
457,543
     
498,442
 
Base net capital as a percentage of the total assets, net of provisions
    6.4 %     6.2 %
Regulatory capital
   
1,231,997
     
1,418,752
 
11% of risk-weighted assets
    (1,051,696 )     (1,234,458 )
Excess over minimum required capital
   
180,301
     
184,294
 
Regulatory capital as a percentage of risk-weighted assets
    12.9 %     12.6 %

Financial Investments
 
The following table sets forth our investment in Chilean government and corporate securities and certain other financial investments at the dates indicated. Financial investments that have a secondary market are carried at market value. All other financial investments are carried at acquisition cost, plus accrued interest and indexation readjustments, as applicable.
 
60

 
a) Trading
 
   
As of December 31,
 
   
2005
   
2006
 
   
(in millions of constant Ch$ as of
December 31, 2006)
 
Central Bank and Government Securities
           
Central Bank securities
   
390,002
     
381,260
 
Chilean Treasury Bonds
   
     
40,521
 
Other securities
   
17,101
     
357
 
Subtotal
   
407,103
     
422,138
 
Others Financial Securities
               
Time deposits in Chilean financial institutions
   
89,151
     
3,554
 
Mortgage finance bonds
   
59,555
     
23,189
 
Chilean financial institutions bonds
   
     
44
 
Chilean corporate bonds
   
2,002
     
22,561
 
Other Chilean securities
   
58,902
     
7,264
 
Other foreign securities
   
59,248
     
160,711
 
Subtotal
   
268,858
     
217,323
 
Total
   
675,961
     
639,461
 

b) Available for sale
 
   
As of December 31,
 
   
2005
   
2006
 
   
(in millions of constant Ch$ as of
December 31, 2006)
 
Central Bank and Government Securities
           
Central Bank securities
   
86,114
     
77,738
 
Chilean Treasury Bonds
   
1,226
     
623
 
Other securities
   
34,494
     
18,531
 
Subtotal
   
121,834
     
96,892
 
Others Financial Securities
               
Mortgage finance bonds
   
423,970
     
222,672
 
Other Foreign securities
   
29,224
     
25,544
 
Subtotal
   
453,194
     
248,216
 
Total
   
575,028
     
345,108
 

c) Held- to-maturity
 
No financial investments were classified as held-to-maturity as of December 31, 2005 and 2006.
 
Remaining Maturities and Weighted Average Rates
 
The following table sets forth an analysis of our investments at December 31, 2006, by remaining maturity and the weighted average nominal rates of our investments:
 
61

 
   
Within one year
   
Weighted average Nominal Rate
   
After one year but within five years
   
Weighted average Nominal Rate
   
After five years but within ten years
   
Weighted average Nominal Rate
   
After ten years
   
Weighted average Nominal Rate
   
Total
   
Weighted average Nominal Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Held for Trading
                                                           
Central Bank and Government Securities
                                                           
Central Bank securities
          4.0 %           3.7 %           2.8 %           2.7 %    
381,260
      4.0 %
Chilean Treasury Bonds
                                          4.7 %                    
40,521
      4.7 %
Others securities
   
      2.7 %    
      3.1 %    
      3.0 %    
      3.2 %    
357
      3.0 %
Subtotal
   
68,005
             
252,528
             
83,118
             
18,487
             
422,138
         
Others Financial Securities
                                                                               
Time deposits in Chilean financial institutions
          6.2 %           6.0 %                                    
3,554
      6.0 %
Mortgage finance bonds
          5.0 %           4.4 %           5.6 %           4.0 %    
23,189
      4.0 %
Chilean financial institutions bonds
          6.1 %           3.4 %                                    
44
      5.4 %
Chilean corporate bonds
          6.9 %           5.0 %           4.1 %           4.0 %    
22,561
      4.0 %
Other Chilean securities
                                                                 
7,264
         
Others foreign securities
                                                                 
160,711
         
Subtotal
   
170,002
             
3,489
             
19,968
             
23,864
      0.0 %    
217,323
         
Total
   
238,007
             
256,017
             
103,086
             
42,351
      0.0 %    
639,461
         
Available-for-sale Investments
                                                                               
Central Bank and Government Securities
                                                                               
Central Bank securities
   
21,187
      4.3 %    
55,849
      3.5 %    
702
      4.7 %                    
77,738
      3.8 %
Chilean Treasury Bonds
   
623
      5.7 %                                                    
623
      5.7 %
Others securities
   
8,538
      3.3 %    
8,056
      3.0 %    
1,197
      3.0 %    
740
      3.2 %    
18,531
      3.2 %
Subtotal
   
30,348
             
63,905
             
1,899
             
740
             
96,892
         
Others Financial Securities
                                                                               
Mortgage finance bonds
   
173
      5.2 %    
2,030
      4.6 %    
16,860
      4.0 %    
203,609
      4.2 %    
222,672
      4.2 %
Others foreign securities
   
14,557
      5.2 %                    
10,987
      5.7 %                    
25,544
      5.5 %
Subtotal
   
14,730
             
2,030
             
27,847
             
203,609
             
248,216
         
Total
   
45,078
             
65,935
             
29,746
             
204,349
             
345,108
         

Unused sources of liquidity
 
The Bank also has credit ratings from three international agencies. We believe our credit ratings are a positive factor when obtaining financing.
 
Moody’s
 
Rating
Long-term bank deposits
 
A2
Senior bonds
 
Aa3
Subordinated debt
 
Aa3
Bank deposits in local currency
 
Aa2
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
 
62

 
Fitch
 
Rating
Foreign Currency Long-term Debt
 
A+
Local Currency Long-term Debt
 
A+
Foreign Currency Short-term Debt
 
F1
Local Currency Short-term Debt
 
F1
Outlook
 
Stable

Working capital
 
As a bank, we satisfy our working capital needs through general funding, the majority of which derives from deposits and other borrowings from the public. See “Item 5: Operating and Financial Review and Prospects—C. Liquidity and Capital Resources—Deposits and Other Borrowings.” In our opinion, our working capital is sufficient for our present needs.
 
Liquidity Management
 
Liquidity management seeks to ensure that, even under adverse conditions, we have access to the funds necessary to cover client needs, maturing liabilities and capital requirements. Liquidity risk arises in the general funding for our financing, trading and investment activities. It includes the risk of unexpected increases in the cost of funding the portfolio of assets at appropriate maturities and rates, the risk of being unable to liquidate a position in a timely manner at a reasonable price and the risk that we will be required to repay liabilities earlier than anticipated.
 
Our general policy is to maintain liquidity adequate to ensure our ability to honor withdrawals of deposits, make repayments of other liabilities at maturity, extend loans and meet our own working capital needs. Our minimum amount of liquidity is determined by the statutory reserve requirements of the Central Bank. Deposits are subject to a statutory reserve requirement of 9% for demand deposits and 3.6% for peso, UF denominated and foreign currency denominated time deposits with a term of less than a year. See “Item 4: Information on the Company—D. Regulation and Supervision.” The Central Bank has statutory authority to increase these percentages to up to 40% for demand deposits and up to 20% for time deposits. In addition, a 100% special reserve (reserva técnica) applies to demand deposits, deposits in checking accounts, other demand deposits received or obligations payable on sight and incurred in the ordinary course of business, other than deposits unconditionally payable immediately or within a term of less than 30 days and other time deposits payable within 10 days. This special reserve requirement applies to the amount by which the total of such deposits exceeds 2.5 times the amount of a bank’s paid-in capital and reserves. Interbank loans are deemed to have a maturity of more than 30 days, even if payable within the following 10 days.
 
The Central Bank also requires us to comply with the following liquidity limits:
 
Our total liabilities with maturities of less than 30 days cannot exceed our total assets with maturities of less than 30 days by an amount greater than our capital. This limit must be calculated in local currency and foreign currencies together as one gap.
     
Our total liabilities with maturities of less than 90 days cannot exceed our total assets with maturities of less than 90 days by more than twice of our capital. This limit must be calculated in local currency and foreign currencies together as one gap.
 
We have set other liquidity limits and ratios that minimize liquidity risk. See “Item 11: Quantitative and Qualitative Disclosure About Market Risk.”
 
Cash Flow
 
The tables below set forth our main sources of cash. The subsidiaries are not an important source of cash flow for us and therefore have no impact on our ability to meet our cash obligations. No legal or economic restrictions exist on the ability of subsidiaries to transfer funds to us in the form of loans or cash dividends as long as these subsidiaries abide by the regulations of the Ley de Sociedad Anónimas regarding loans to related parties and minimum dividend payments.
 
63

 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of
December 31, 2006)
 
Net cash provided by operating activities
   
420,710
     
333,611
     
453,379
 

The Ch$119,768 million increase in cash provided by operating activities in 2006 compared to 2005 was mainly due to (i) a Ch$66,187 million variation in the net change in interest accruals and (ii) higher level of commercial activities reflected in an increase in net interest revenue and net fee income.
 
The Ch$87,099 million reduction in cash provided by operating activities in 2005 compared to 2004 was mainly due to a Ch$143,619 million decrease in the net change in interest accruals in the same period.
 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of
December 31, 2006)
 
Net cash provided by (used in) investing activities
    (1,076,366 )     (682,519 )     (1,195,508 )

Net cash used in investing activities in 2006 totaled Ch$1,195,508 million, mainly as a result of the growth of the Bank’s loan and financial investment portfolios. In 2005, the increase in loans was partially offset by the decrease in financial investments. In 2004, the increase in loans also resulted in a reduction in cash flow for the Bank.
 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of
December 31, 2006)
 
Net cash provided by (used in) financing activities
   
590,145
     
593,002
     
608,364
 

In 2006, the Bank financed its lending activities with increases in current accounts, time deposits, short term funds borrowed and senior bonds. The rise in cash from financing activities compared to 2005 was mainly due to greater amounts of bonds issued and short term funds borrowed. In 2005, the Bank financed its activities with an increase in time deposits and senior bonds, which explains the slight rise in cash from financing activities in 2005 compared to 2004.
 
Deposits and Other Borrowings
 
The following table sets forth our average daily balance of liabilities for the years ended December 31, 2004, 2005 and 2006, in each case together with the related average nominal interest rates paid thereon.
 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
Average
Balance
   
% of Total
Average
Liabilities
   
Average
Nominal
Rate
   
Average
Balance
   
% of Total
Average
Liabilities
   
Average
Nominal
Rate
   
Average
Balance
   
% of Total
Average
Liabilities
   
Average
Nominal
Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Savings accounts
   
140,589
      1.1 %     2.0 %    
118,109
      0.9 %     4.3 %    
105,849
      0.7 %     1.3 %
Time deposits
   
4,254,985
      33.4 %     3.0 %    
5,192,563
      37.7 %     4.7 %    
6,401,824
      43.5 %     5.6 %
Central Bank borrowings
   
38,690
      0.3 %     4.5 %    
129,145
      0.9 %     3.7 %    
84,102
      0.6 %     5.1 %
Repurchase agreements
   
659,423
      5.2 %     1.9 %    
527,861
      3.8 %     5.0 %    
546,042
      3.7 %     4.9 %
Mortgage finance bonds
   
1,334,363
      10.5 %     8.2 %    
820,807
      6.0 %     9.4 %    
578,410
      3.9 %     7.5 %
Other interest-bearing liabilities
   
1,395,910
      11.0 %     5.2 %    
1,830,061
      13.2 %     5.6 %    
2,157,951
      14.6 %     6.2 %
Subtotal interest-bearing liabilities
   
7,823,960
      61.5 %     4.2 %    
8,618,546
      62.5 %     5.3 %    
9,874,178
      67.0 %     5.7 %
 
64

 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
Average
Balance
   
% of Total
Average
Liabilities
   
Average
Nominal
Rate
   
Average
Balance
   
% of Total
Average
Liabilities
   
Average
Nominal
Rate
   
Average
Balance
   
% of Total
Average
Liabilities
   
Average
Nominal
Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Non-interest bearing liabilities
                                                                       
Non-interest bearing deposits
   
1,855,619
      14.6 %            
1,945,572
      14.1 %            
1,823,018
      12.4 %        
Contingent liabilities
   
1,031,017
      8.1 %            
894,393
      6.5 %            
949,725
      6.5 %        
Other non-interest bearing liabilities
   
976,710
      7.7 %            
1,310,156
      9.5 %            
920,752
      6.3 %        
Shareholders’ equity
   
1,038,970
      8.7 %            
1,015,385
      7.4 %            
1,150,156
      7.8 %        
Subtotal non-interest bearing liabilities
   
4,902,316
      38.5 %            
5,165,506
      37.5 %            
4,843,651
      33.0 %        
Total liabilities
   
12,726,276
      100.0 %            
13,784,052
      100.0 %            
14,717,829
      100.0 %        
 
Our most important source of funding is our time deposits. Average time deposits represented 43.5% of our average total liabilities and shareholders’ equity in 2006. Our current funding strategy is to continue to utilize all sources of funding in accordance with their costs, their availability and our general asset and liability management strategy. Special emphasis is being placed on lengthening the maturities of time deposits with institutional clients and increasing in general our deposits from retail customers. We also intend to continue to broaden our customer deposit base and to emphasize core deposit funding. We believe that broadening our deposit base by increasing the number of account holders has created a more stable funding source.
 
Composition of Deposits and Other Commitments
 
The following table sets forth the composition of our deposits and similar commitments at December 31, 2004, 2005 and 2006.
 
   
At December 31,
 
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Checking accounts
   
1,363,417
     
1,486,790
     
1,663,414
 
Other demand liabilities
   
1,008,270
     
682,494
     
763,242
 
Savings accounts
   
129,945
     
111,742
     
100,848
 
Time deposits
   
4,597,510
     
5,920,191
     
6,808,487
 
Other commitments (1)
   
40,595
     
45,506
     
56,341
 
Total
   
7,139,737
     
8,246,723
     
9,392,332
 

(1)
Includes primarily leasing accounts payable relating to purchases of equipment.

Maturity of Deposits
 
The following table sets forth information regarding the currency and maturity of our deposits at December 31, 2006, expressed in percentages of our total deposits in each currency category. UF-denominated deposits are similar to peso-denominated deposits in all respects, except that the principal is readjusted periodically based on variations in the Chilean consumer price index.
 
   
Ch$
   
UF
   
Foreign
Currencies
   
Total
 
   
(in percentages)
 
Demand deposits
   
1.5
     
     
     
0.8
 
Savings accounts
   
     
4.2
     
     
1.4
 
Time deposits:
                               
Maturing within 3 months
   
54.6
     
15.5
     
76.3
     
46.1
 
 
65

 
   
Ch$
   
UF
   
Foreign
Currencies
   
Total
 
   
(in percentages)
 
Maturing after 3 but within 6 months
   
14.6
     
16.4
     
20.6
     
15.3
 
Maturing after 6 but within 12 months
   
17.4
     
22.8
     
3.0
     
16.8
 
Maturing after 12 months
   
11.9
     
41.1
     
0.1
     
19.6
 
Total time deposits
   
98.5
     
95.8
     
100.0
     
97.8
 
Total deposits
    100.0 %     100.0 %     100.0 %     100.0 %
 
The following table sets forth information regarding the maturity of our outstanding time deposits in excess of U.S.$100,000 at December 31, 2006.
 
   
Ch$
   
UF
   
Foreign
Currencies
   
Total
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Time deposits:
                       
Maturing within 3 months
   
1,817,277
     
347,504
     
484,861
     
2,649,642
 
Maturing after 3 but within 6 months
   
560,218
     
377,321
     
169,663
     
1,107,202
 
Maturing after 6 but within 12 months
   
276,600
     
474,018
     
19,916
     
770,534
 
Maturing after 12 months
   
749,149
     
1,039,752
     
4,140
     
1,793,041
 
Total time deposits
   
3,403,244
     
2,238,595
     
678,580
     
6,320,419
 

Short-term Borrowings
 
The principal categories of our short-term borrowings are amounts borrowed under foreign trade lines of credit, domestic interbank loans, Central Bank borrowings and repurchase agreements. The table below presents the amounts outstanding at each year-end indicated and the weighted-average nominal interest rate for each such year by type of short-term borrowings.
 
   
As of and for the year ended December 31,
 
   
2004
   
2005
   
2006
 
   
Balance
   
Weighted-
Average
Nominal
Interest
Rate
   
Balance
   
Weighted-
Average
Nominal
Interest
Rate
   
Balance
   
Weighted-
Average
Nominal
Interest
Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except for rate data)
 
Balances under repurchase agreements
   
457,971
      1.3 %    
50,834
      1.8 %    
19,929
      4.9 %
Central Bank borrowings
   
348,187
      0.3 %    
176,878
      2.1 %    
134,417
      5.1 %
Domestic interbank borrowings
   
30,409
      3.4 %    
2,582
      1.6 %    
     
 
Borrowings under foreign trade credit lines
   
256,836
      4.4 %    
1,055,924
      4.0 %    
717,979
      7.7 %
Total short-term borrowings
   
1,093,403
      1.8 %    
1,286,218
      2.4 %    
872,325
      6.6 %

The following table shows the average balance and the average nominal rate for each short-term borrowing category for the years indicated:
 
66

 
   
For the year Ended December 31,
 
   
2004
   
2005
   
2006
 
   
Average Balance
   
Average Nominal Interest Rate
   
Average Balance
   
Average Nominal Interest Rate
   
Average Balance
   
Average Nominal Interest Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except for rate data)
 
Balances under repurchase agreements
   
659,423
      1.9 %    
527,861
      5.0 %    
546,042
      4.9 %
Central Bank borrowings
   
38,690
      4.5 %    
129,145
      3.7 %    
84,102
      5.1 %
Domestic interbank borrowings
   
53,784
      0.8 %    
42,560
      3.6 %    
49,294
      5.1 %
Borrowings under foreign trade credit lines
   
258,561
      2.3 %    
318,809
      9.6 %    
1,145,538
      5.4 %
Total short-term borrowings
   
1,010,460
      2.6 %    
1,018,375
      5.0 %    
1,517,469
      6.9 %

The following table presents the maximum month-end balances of our principal sources of short-term borrowings during the years indicated:
 
   
Maximum
2004
Month-End
Balance
   
Maximum
2005
Month-End
Balance
   
Maximum
2006
Month-End
Balance
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Balances under repurchase agreements
   
361,856
     
592,809
     
437,131
 
Central Bank borrowings
   
340,213
     
378,684
     
304,563
 
Domestic interbank borrowings
   
140,797
     
43,904
     
3,777
 
Borrowings under foreign trade credit lines
   
460,152
     
503,147
     
1,756,659
 
Total short-term borrowings
   
1,303,018
     
1,518,544
     
2,502,130
 

Total Borrowings
 
Our long-term and short-term borrowings are summarized below. Borrowings are generally classified as short-term when they have original maturities of less than one year or are due on demand. All other borrowings are classified as long-term, including the amounts due within one year on such borrowings. The following table sets forth, at the dates indicated, the components of our borrowings.
 
   
December 31, 2006
 
   
Long-term
   
Short-term
   
Total
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Central Bank borrowings
   
     
134,417
     
134,417
 
Credit lines for renegotiations of loans (a)
   
     
5,080
     
5,080
 
Balances under repurchase agreements
   
     
19,929
     
19,929
 
Mortgage finance bonds (b)
   
464,713
     
65,493
     
530,206
 
Other borrowings: bonds (c)
   
564,513
     
1,140
     
565,653
 
Subordinated bonds (d)
   
450,122
     
40,294
     
490,416
 
Borrowings from domestic financial institutions
   
             
 
Foreign borrowings (e)
   
94,288
     
717,979
     
812,267
 
Other obligations (f)
   
11,972
     
52,221
     
64,193
 
Total borrowings
   
1,585,608
     
1,036,553
     
2,622,161
 
 
67

 
   
December 31, 2005
 
   
Long-term
   
Short-term
   
Total
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Central Bank borrowings
   
     
176,878
     
176,878
 
Credit lines for renegotiations of loans (a)
   
6,796
     
     
6,796
 
Balances under repurchase agreements
   
     
50,834
     
50,834
 
Mortgage finance bonds (b)
   
563,470
     
119,673
     
683,143
 
Other borrowings: bonds (c)
   
422,292
     
1,754
     
424,046
 
Subordinated bonds (d)
   
393,929
     
     
393,929
 
Borrowings from domestic financial institutions
   
     
2,582
     
2,582
 
Foreign borrowings (e)
   
65,605
     
1,055,923
     
1,121,528
 
Other obligations (f)
   
12,000
     
30,984
     
42,984
 
Total borrowings
   
1,464,092
     
1,438,628
     
2,902,720
 

a) Credit lines for renegotiations of loans
 
Central Bank borrowings include credit lines for the renegotiations of loans and other Central Bank borrowings. These credit lines were provided by the Central Bank for the renegotiations of loans due to the need to refinance debts as a result of the economic recession and crisis of the banking system in the early 1980’s. The lines for the renegotiations, which are considered long-term, are related with mortgage loans linked to the UF index and bore a real annual interest rate of 3.6% and 3.0% as of December 31, 2005 and 2006, respectively. The following table sets forth, at the dates indicated, our credit lines for renegotiations of loans.
 
   
At December 31,
 
   
2005
   
2006
 
   
(in millions of constant Ch$
as of
December 31, 2006)
 
Total credit lines for renegotiations of loans
   
6,796
     
5,080
 

The maturities of the outstanding amounts due under these credit lines, which are considered long-term, are as follows:
 
   
At December 31, 2006
 
   
(in millions of constant Ch$
as of
December 31, 2006)
 
Due within 1 year
   
5,080
 

(b) Mortgage finance bonds
 
These bonds are used to finance the granting of mortgage loans. The outstanding principal amounts of the bonds are amortized on a quarterly basis. The range of maturities of these bonds is between five and twenty years. The bonds are linked to the UF index and bear a real weighted-average annual interest rate of 5.2%. The following table sets forth the remaining maturities of our mortgage finance bonds at December 31, 2006.
 
   
At December 31, 2006
 
   
(in millions of constant Ch$
as of
December 31, 2006)
 
Due within 1 year
   
65,493
 
Due after 1 year but within 2 years
   
54,556
 
Due after 2 years but within 3 years
   
51,190
 
Due after 3 years but within 4 years
   
48,896
 
Due after 4 years but within 5 years
   
44,711
 
Due after 5 years
   
265,360
 
Total mortgage finance bonds
   
530,206
 
 
68

 
(c) Bonds
 
The following table sets forth, at the dates indicated, our issued bonds.
 
   
At December 31,
 
   
2005
   
2006
 
   
(in millions of constant Ch$
as of
December 31, 2006)
 
Santiago bonds, Series A,B,C,D and F
   
11,350
     
9,179
 
Santander Bonds denominated in UF
   
165,122
     
342,774
 
Santander Bonds denominated in US$
   
247,574
     
213,700
 
Total
   
424,046
     
565,653
 

Santiago bonds include series A, B, C and F issued by the former Santiago S.A. and series B and D issued by the former Banco O’Higgins prior to its merger with the Bank in 1997. These bonds are intended to finance loans that have a maturity of greater than one year, are linked to the UF index and bear a weighted-average annual interest rate of 7.0% with interest and principal payments due semi-annually.
 
On December 17, 2004, Santiago Leasing S.A., ceded through public deed a total of UF 3,041,102 (Ch$52,663 million at December 31, 2004) in bonds to Banco Santander Chile. These bonds are linked to the UF index and bear an annual interest rate of 5.6%. At December 31, 2005 and 2006, the balance was included in Santander bonds linked to the UF.
 
Santander bonds include bonds issued by the former Banco Santander-Chile and bonds issued by the Bank since August 2002. These bonds are intended to finance loans that have a maturity of greater than one year, are linked to the UF index and bear a weighted average annual interest rate of 6.5%.
 
On October 5, 2005, the Bank issued bonds denominated in UF in an aggregate principal amount of UF8,000,000, which bear an average annual interest rate of 3.0%.
 
On May 25, 2006, the Bank issued bonds denominated in UF in an aggregate principal amount of UF6,000,000, which bear an average annual interest rate of 4.6%.
 
On August 17, 2006, the Bank issued senior bonds denominated in UF in an aggregate principal amount of UF895,000, which bear an average annual interest rate of 3.7%.
 
On December 9, 2004, the Bank issued senior bonds denominated in U.S. dollars in an aggregate principal amount of US$400 million. These bonds carry a nominal interest rate of LIBOR plus 0.35% per annum (4.81% and 5.35% at December 31, 2005 and 2006). The interest is payable quarterly and the principal is to be paid after a term of 5 years.
 
The maturities of these bonds are as follows:
   
As of December 31, 2006
 
   
(in millions of constant Ch$ as of
December 31, 2006)
 
Due within 1 year
   
1,140
 
Due after 1 year but within 2 years
   
 
Due after 2 years but within 3 years
   
213,700
 
Due after 3 years but within 4 years
   
146,290
 
Due after 4 years but within 5 years
   
15,414
 
Due after 5 years
   
189,109
 
Total bonds
   
565,653
 
 
 
69

 
d) Subordinated bonds
 
The following table sets forth, at the dates indicated, the balances of our subordinated bonds.
 
   
As of December 31,
 
   
2005
   
2006
 
   
(in millions of constant Ch$
as of
December 31, 2006)
 
Santiago bonds denominated in US$ (1)
   
44,045
     
42,703
 
Santander bonds denominated in US$ (2) (6)
   
265,381
     
272,183
 
Santiago Bonds linked to the UF (3)
   
54,485
     
49,017
 
Santander Bonds linked to the UF (4) (5)
   
30,018
     
126,513
 
Total subordinated bonds
   
393,929
     
490,416
 

(1)
On July 17, 1997, the former Banco Santiago issued subordinated bonds denominated in U.S. dollars in an aggregate principal amount of US$300 million. The bonds carry a nominal interest rate of 7.0% per annum, with semi-annual interest payments and one repayment of principal after a term of 10 years.
(2)
On January 16, 2003, the Bank completed the voluntary exchange for its new subordinated bonds, which will mature in 2012. A total of US$221,961,000 in principal of the Santiago bonds was offered and redeemed by the Bank. The bonds carry a nominal interest rate of 7.375% per annum, with semi-annual interest payments and one repayment of principal after a term of 10 years.
(3)
The Series C and E Bonds outstanding as of December 31, 2005 and 2006 are intended for the financing of loans with a maturity of greater than one year. They are linked to the UF index and carry an annual interest rate of 7.5% and 6.0% respectively, with interest and principal payments due semi-annually.
(4)
The Series C, D and E Bonds outstanding as of December 31, 2005 and 2006 are intended for the financing of loans with a maturity of greater than one year. They are linked to the UF index and carry an annual interest rate of 7.0%, with interest and principal payments due semi-annually.
(5)
During 2006, the Bank issued subordinated bonds denominated in UF in an aggregate principal amount of UF5,000,000, which bear an average annual rate of 4.4%.
(6)
On December 9, 2004, the Bank issued subordinated bonds denominated in U.S. dollars in an aggregate principal amount of US$300 million. These bonds carry a nominal interest rate of 5.375% per annum, with semi-annual interest payments and one repayment of principal after a term of 10 years.

The maturities of these bonds, which are considered long-term, are as follows:
 
   
As of December 31, 2006
 
   
(in millions of constant Ch$
as of
December 31, 2006)
 
Due within 1 Year
   
40,294
 
Due after 1 year but within 2 years
   
 
Due after 2 years but within 3 years
   
 
Due after 3 years but within 4 years
   
 
Due after 4 years but within 5 years
   
17,378
 
Due after 5 years
   
432,744
 
Total subordinated bonds
   
490,416
 

e) Foreign borrowings
 
These are short-term and long-term borrowings from foreign banks. The maturities of these borrowings are as follows:
 
70

 
   
As of December 31, 2006
 
   
(in millions of constant Ch$
as of December 31, 2006)
 
Due within 1 Year
   
717,979
 
Due after 1 year but within 2 years
   
91,021
 
Due after 2 years but within 3 years
   
 
Due after 3 years but within 4 years
   
3,267
 
Due after 4 years but within 5 years
   
 
Due after 5 years
   
 
Total foreign borrowings
   
812,267
 

The foreign borrowings are denominated principally in U.S. dollars, and are principally used to fund the Bank’s foreign trade loans, and bear an annual average interest rate of 3.7% and 5.3% at December 31, 2005 and 2006, respectively.
 
f) Other obligations
 
Other obligations are summarized as follows:
 
   
As of December 31, 2006
 
   
(in millions of constant Ch$
as of December 31, 2006)
 
Due within 1 Year
   
3,369
 
Due after 1 year but within 2 years
   
3,454
 
Due after 2 years but within 3 years
   
2,153
 
Due after 3 years but within 4 years
   
2,143
 
Due after 4 years but within 5 years
   
1,623
 
Due after 5 years
   
2,599
 
Total long-term obligations
   
15,341
 
Amounts due to credit card operators
   
21,877
 
Acceptance of letters of credit
   
26,975
 
Total short-term obligations
   
48,852
 
Total other obligations
   
64,193
 

Other Off-Balance Sheet Arrangements and Commitments
 
We are party to transactions with off-balance sheet risk in the normal course of our business. These transactions expose us to credit risk in addition to amounts recognized in the consolidated financial statements.
 
These transactions include commitments to extend credit not otherwise accounted for as contingent loans, such as overdraft protection and credit card lines of credit. Such commitments are agreements to lend to a customer at a future date, subject to the customer compliance with the contractual terms. The aggregate amount of these commitments was Ch$2,957,980 million at December 31, 2006, which will be financed with our deposit base. Since a substantial portion of these commitments is expected to expire without being drawn upon, the total amount of commitments does not necessarily represent our actual future cash requirements. We use the same credit policies in making commitments to extend credit as we do for granting loans. In the opinion of our management, our outstanding commitments do not represent an unusual credit risk.
 
From time to time, the Bank enters into agreements to securitize certain assets by selling those assets to unconsolidated and unaffiliated entities, which then sell debt securities secured by those assets. These sales are non recourse to the Bank. However, in the past, the Bank has occasionally purchased a subordinated bond issued by the unconsolidated entity. At December 31, 2006, we did not hold any of these subordinated bonds in our investment portfolio.
 
71

 
Asset and Liability Management
 
Please refer to "Item 11: Quantitative and Qualitative Disclosures about Market Risk  Asset and Liability Management" regarding our policies with respect to asset and liability management.
 
Capital Expenditures
 
The following table reflects capital expenditures in each of the three years ended December 31, 2004, 2005 and 2006:
 
   
For the Year Ended December 31,
 
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Land and Buildings
   
3,713
     
5,682
     
10,138
 
Machinery and Equipment
   
9,635
     
10,609
     
7,774
 
Furniture and Fixtures
   
2,764
     
3,813
     
4,105
 
Vehicles
   
445
     
865
     
836
 
Other
   
3,456
     
963
     
2,267
 
Total
   
20,013
     
21,932
     
25,120
 

The increase in capital expenditures in 2006 compared to 2005 was mainly due to the investment in branches and automatic teller machines (ATMs). In 2007, we expect a similar level of investment in expanding our distribution network.
 
D.  Selected Statistical Information
 
The following information is included for analytical purposes and should be read in conjunction with our financial statements as well as the discussion in “Item 5: Operating and Financial Review and Prospects.” Pursuant to Chilean GAAP, the financial data in the following tables for all periods through December 31, 2005 have been restated in constant Chilean pesos as of December 31, 2006. The UF is linked to, and is adjusted daily to, reflect changes in the previous month’s Chilean consumer price index. See Note 1(c) to our Audited Financial Consolidated Statements.
 
Average Balance Sheets, Income Earned from Interest-Earning Assets and Interest Paid on Interest-Bearing Liabilities
 
The average balances for interest-earning assets and interest-bearing liabilities, including interest and readjustments received and paid, have been calculated on the basis of daily balances for us on an unconsolidated basis. Such average balances are presented in Chilean pesos (Ch$), in Unidades de Fomento (UF) and in foreign currencies (principally U.S.$). Figures from our subsidiaries have been calculated on the basis of monthly balances. The average balances of our subsidiaries, except Santander S.A. Agente de Valores , have not been categorized by currency. As such it is not possible to calculate average balances by currency for such subsidiaries on the basis of daily, weekly or monthly balances.
 
The nominal interest rate has been calculated by dividing the amount of interest and principal readjustment due to changes in the UF index (gain or loss) during the period by the related average balance, both amounts expressed in constant pesos. The nominal rates calculated for each period have been converted into real rates using the following formulas:
 
 
Where:
Rp = real average rate for peso-denominated assets and liabilities (in Ch$ and UF) for the period;
 
72

 
Rd = real average rate for foreign currency-denominated assets and liabilities for the period;
 
Np = nominal average rate for peso-denominated assets and liabilities for the period;
 
Nd = nominal average rate for foreign currency-denominated assets and liabilities for the period;
 
D = devaluation rate of the Chilean peso to the U.S. dollar for the period; and
 
I = inflation rate in Chile for the period (based on the variation of the Chilean Consumer Price Index).
 
The real interest rate can be negative for a portfolio of peso-denominated loans when the inflation rate for the period is higher than the average nominal rate of the loan portfolio for the same period. A similar effect could occur for a portfolio of foreign currency denominated loans when the inflation rate for the period is higher than the sum of the devaluation rate for the period and the corresponding average nominal rate of the portfolio.
 
The formula for the average real rate for foreign currency denominated assets and liabilities (Rd) reflects a gain or loss in purchasing power caused by the difference between the devaluation rate of the Chilean peso and the inflation rate in Chile during the period.
 
The following example illustrates the calculation of the real interest rate for a dollar-denominated asset bearing a nominal annual interest rate of 10.0% (Nd = 0.10), assuming a 5.0% annual devaluation rate (D = 0.05) and a 12.0% annual inflation rate (I = 0.12):
 
 
In the example, since the inflation rate was higher than the devaluation rate, the real rate is lower than the nominal rate in dollars. If, for example, the annual devaluation rate were 15.0%, using the same numbers, the real rate in Chilean pesos would be 12.9%, which is higher than the nominal rate in U.S. dollars. Using the same numbers, if the annual inflation rate were greater than 15.5%, the real rate would be negative.
 
Contingent loans (consisting of guarantees and open and unused letters of credit) have been treated as interest-earning assets. Although the nature of the income derived from such assets is similar to a fee, Chilean banking regulations require that such income be accounted for as interest revenue. As a result of this treatment, the comparatively low rates of interest earned on these assets have a distorting effect on the average interest rate earned on total interest-earning assets.
 
The real rate for contingent loans has been stated as the nominal rate, since we do not have an effective funding obligation for these loans. The foreign exchange gains or losses on foreign currency-denominated assets and liabilities have not been included in interest revenue or expense. Similarly, interest on financial investments does not include trading gains or losses on these investments. Interest is not recognized during periods in which loans are past due. However, interest received on past due loans includes interest on such loans from the original maturity date.
 
Non-performing loans that are overdue for 90 days or less have been included in each of the various categories of loans, and therefore affect the various averages. Non-performing loans consist of loans as to which either principal or interest is overdue (i.e., non accrual loans) and restructured loans earning no interest. Non-performing loans that are overdue for 90 days or more are shown as a separate category of loans (Past due loans). Interest and/or indexation readjustments received on all non-performing U.S. dollar-denominated loans during the periods are included as interest revenue. However, all peso-denominated loans that are classified as non-performing do not accrue interest or indexation adjustments as interest revenue.
 
Included in interbank deposits are checking accounts maintained in the Central Bank and foreign banks. Such assets have a distorting effect on the average interest rate earned on total interest-earning assets because currently balances maintained in Chilean peso amounts do not earn interest, and the only balances held in a foreign currency that earn interest are those maintained in U.S. dollars, but those only earn interest on the amounts that are 
 
73

 
legally required to be held for liquidity purposes. Additionally, this account includes interest earned by overnight investments. Consequently, the average interest earned on such assets is comparatively low. We maintain these deposits in these accounts to comply with statutory requirements and to facilitate international business, rather than to earn income.
 
The monetary gain or loss on interest-earning assets and interest-bearing liabilities is not included as a component of interest revenue or interest expense because inflation effects are taken into account in the calculation of real interest rates.
 
The average balances for 2004 and 2005 have been reclassified for comparative purposes in line with the changes made to the financial statements for those years under the new accounting standards. See Note 2 to the Audited Consolidated Financial Statements and Item 5: Operating and Financial Review and Prospects A. New Accounting Standards for Financial Investments and Derivatives.
 
74

 
The following tables show, by currency of denomination, average balances and, where applicable, interest amounts and real rates for our assets and liabilities for the years ended December 31, 2004, 2005 and 2006.
 
(in millions of constant Ch$ as of December 31, 2006, except for rate data)
 
 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
Average
Balance
   
Interest
Earned
   
Average
Real Rate
   
Average
Nominal Rate
   
Average
Balance
   
Interest
Earned
   
Average
Real Rate
   
Average
Nominal Rate
   
Average
Balance
   
Interest
Earned
   
Average
Real Rate
   
Average
Nominal Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except for rate data)
 
ASSETS
                                                                       
Interest-earning assets
 
 
 
Interbank deposits
                                                                       
Ch$
   
9,303
     
342
      1.2 %     3.7 %    
38,646
     
1,676
      0.7 %     4.3 %    
22,629
     
1,245
      3.3 %     5.5 %
UF
   
2,504
     
113
      2.0 %     4.5 %    
10,358
     
746
      3.5 %     7.2 %    
6,574
     
437
      4.4 %     6.6 %
Foreign currencies
   
     
      0.0 %     0.0 %    
     
      0.0 %     0.0 %    
     
      0.0 %     0.0 %
Subtotal
   
11,807
     
455
      1.3 %     3.9 %    
49,004
     
2,422
      1.3 %     4.9 %    
29,203
     
1,682
      3.6 %     5.8 %
Financial investments
                                                                                               
Ch$
   
509,609
     
13,905
      0.2 %     2.7 %    
512,289
     
30,076
      2.2 %     5.9 %    
668,134
     
44,327
      4.4 %     6.6 %
UF
   
744,471
     
51,536
      4.3 %     6.9 %    
616,717
     
54,221
      5.0 %     8.8 %    
559,115
     
45,977
      6.0 %     8.2 %
Foreign currencies
   
1,214,052
     
38,520
      (6.0 %)     3.2 %    
1,264,023
     
42,141
      (8.4 %)     3.3 %    
1,028,177
     
60,043
      7.7 %     5.8 %
Subtotal
   
2,468,132
     
103,961
      (1.6 %)     4.2 %    
2,393,029
     
126,438
      (2.6 %)     5.3 %    
2,255,426
     
150,347
      6.3 %     6.7 %
Commercial Loans
                                                                                               
Ch$
   
2,752,643
     
355,302
      10.2 %     12.9 %    
3,096,302
     
431,868
      10.0 %     13.9 %    
3,706,920
     
573,887
      13.1 %     15.5 %
UF
   
2,801,996
     
218,037
      5.2 %     7.8 %    
3,880,241
     
336,468
      4.9 %     8.7 %    
4,811,905
     
337,336
      4.8 %     7.0 %
Foreign currencies
   
605,992
     
17,353
      (6.3 %)     2.9 %    
640,455
     
25,568
      (7.8 %)     4.0 %    
683,405
     
40,696
      7.8 %     6.0 %
Subtotal
   
6,160,631
     
590,692
      6.3 %     9.6 %    
7,616,998
     
793,904
      5.9 %     10.4 %    
9,202,230
     
951,919
      8.4 %     10.3 %
Mortgage loans
                                                                                               
Ch$
   
578
     
36
      3.7 %     6.2 %    
529
     
34
      2.7 %     6.4 %    
462
     
37
      5.8 %     8.0 %
UF
   
1,321,903
     
131,871
      7.3 %     10.0 %    
757,220
     
82,136
      7.0 %     10.8 %    
549,144
     
48,985
      6.7 %     8.9 %
Foreign currencies
   
     
      0.0 %     0.0 %    
     
      0.0 %     0.0 %    
     
      0.0 %     0.0 %
Subtotal
   
1,322,481
     
131,907
      7.3 %     10.0 %    
757,749
     
82,170
      7.0 %     10.8 %    
549,606
     
49,022
      6.7 %     8.9 %
Contingent loans
                                                                                               
Ch$
   
78,359
     
1,516
      (0.5 %)     1.9 %    
152,147
     
1,935
      (2.3 %)     1.3 %    
203,043
     
2,770
      (0.7 %)     1.4 %
UF
   
194,459
     
1,848
      (1.5 %)     1.0 %    
225,195
     
2,189
      (2.6 %)     1.0 %    
266,867
     
2,858
      (1.0 %)     1.1 %
Foreign currencies
   
757,019
     
959
      (8.8 %)     0.1 %    
514,741
     
981
      (11.1 %)     0.2 %    
477,629
     
891
      2.0 %     0.2 %
Subtotal
   
1,029,837
     
4,323
      (6.8 %)     0.4 %    
892,083
     
5,105
      (7.4 %)     0.6 %    
947,539
     
6,519
      0.5 %     0.7 %
Past due loans
                                                                                               
Ch$
   
64,883
     
10,250
      13.0 %     15.8 %    
50,953
     
7,791
      11.3 %     15.3 %    
47,164
     
9,362
      17.4 %     19.8 %
UF
   
88,979
     
      (2.4 %)     0.0 %    
69,709
     
      (3.5 %)     0.0 %    
46,515
     
      (2.1 %)     0.0 %
Foreign currencies
   
2,571
     
      (8.9 %)     0.0 %    
1,355
     
      (11.3 %)     0.0 %    
1,571
     
      1.8 %     0.0 %
Subtotal
   
156,433
     
10,250
      3.9 %     6.6 %    
122,017
     
7,791
      2.6 %     6.4 %    
95,250
     
9,362
      7.6 %     9.8 %
Total interest-earning assets
                                                                                               
Ch$
   
3,415,375
     
381,351
      8.5 %     11.2 %    
3,850,866
     
473,380
      8.4 %     12.3 %    
4,648,352
     
631,628
      11.2 %     13.6 %
UF
   
5,154,312
     
403,405
      5.2 %     7.8 %    
5,559,440
     
475,760
      4.8 %     8.6 %    
6,240,120
     
435,593
      4.8 %     7.0 %
 
75

 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
Average
Balance
   
Interest
Earned
   
Average
Real Rate
   
Average
Nominal Rate
   
Average
Balance
   
Interest
Earned
   
Average
Real Rate
   
Average
Nominal Rate
   
Average
Balance
   
Interest
Earned
   
Average
Real Rate
   
Average
Nominal Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except for rate data)
 
ASSETS
                                                                       
Interest-earning assets
 
 
 
Foreign currencies
   
2,579,634
     
56,832
      (6.9 %)     2.2 %    
2,420,574
     
68,690
      (8.8 %)     2.8 %    
2,190,782
     
101,630
      6.5 %     4.6 %
Subtotal
   
11,149,321
     
841,588
      3.4 %     7.5 %    
11,830,880
     
1,017,830
      3.2 %     8.6 %          
1,168,851
      7.3 %     8.9 %

76


 

   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
Average
Balance
 
 
Interest
Earned
   
Average
Real Rate
   
Average
Nominal
Rate
   
Average
Balance
   
Interest
Earned
   
Average
Real Rate
   
Average
Nominal
Rate
   
Average
Balance
   
Interest
Earned
   
Average
Real Rate
   
Average
Nominal
Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except for rate data)
 
NON-INTEREST-EARNING ASSETS
                                                                       
Cash
                                                                       
Ch$
   
639,826
     
     
     
     
595,819
     
     
     
     
344,228
     
     
     
 
UF
   
     
     
     
     
     
     
     
     
     
     
     
 
Foreign currencies
   
16,294
     
     
     
     
14,579
     
     
     
     
14,203
     
     
     
 
Subtotal
   
656,120
     
     
     
     
610,398
     
     
     
     
358,431
     
     
     
 
Allowances for loan losses
                                   
     
     
     
                                 
Ch$
    (176,906 )    
     
     
      (171,323 )    
     
     
      (154,874 )    
     
     
 
UF
   
     
     
     
     
     
     
     
     
     
     
     
 
Foreign currencies
   
     
     
     
     
     
     
     
     
     
     
     
 
Subtotal
    (176,906 )    
     
     
      (171,323 )    
     
     
      (154,874 )    
     
     
 
Fixed assets
                                   
     
     
     
                                 
Ch$
   
221,410
     
     
     
     
200,636
     
     
     
     
227,523
     
     
     
 
UF
   
     
     
     
     
     
     
     
     
     
     
     
 
Foreign currencies
   
     
     
     
     
     
     
     
     
     
     
     
 
Subtotal
   
221,410
     
     
     
     
200,636
     
     
     
     
227,523
     
     
     
 
Other assets
                                   
     
     
     
                                 
Ch$
   
386,278
     
     
     
     
229,825
     
     
     
     
682,144
     
     
     
 
UF
   
21,711
     
     
     
     
22,111
     
     
     
     
28,638
     
     
     
 
Foreign currencies
   
468,342
     
     
     
     
1,061,525
     
     
     
     
496,713
     
     
     
 
Subtotal
   
876,331
     
     
     
     
1,313,461
     
     
     
     
1,207,495
     
     
     
 
Total non-interest earning assets
   
     
     
     
     
     
     
     
                                 
Ch$
   
1,070,608
     
     
     
     
854,957
     
     
     
     
1,099,021
     
     
     
 
UF
   
21,711
     
     
     
     
22,111
     
     
     
     
28,638
     
     
     
 
Foreign currencies
   
484,636
     
     
     
     
1,076,104
     
     
     
     
510,916
     
     
     
 
Total
   
1,576,955
     
     
     
     
1,953,172
     
     
     
     
1,638,575
     
     
     
 
TOTAL ASSETS
                                                                                               
Ch$
   
4,485,983
     
381,351
     
     
     
4,705,823
     
473,380
     
     
     
5,747,373
     
631,628
     
     
 
UF
   
5,176,024
     
403,405
     
     
     
5,581,551
     
475,760
     
     
     
6,268,758
     
435,593
     
     
 
Foreign currencies
   
3,064,270
     
56,832
     
     
     
3,496,678
     
68,690
     
     
     
2,701,698
     
101,630
     
     
 
Total
   
12,726,276
     
841,588
     
     
     
13,784,052
     
1,017,830
     
     
     
14,717,829
     
1,168,851
     
     
 
 
77


   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
Average Balance
   
Interest Paid
   
Average Real Rate
   
Average Nominal Rate
   
Average Balance
   
Interest Paid
   
Average Real Rate
   
Average Nominal Rate
   
Average Balance
   
Interest Paid
   
Average Real Rate
   
Average Nominal Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except for rate data)
 
LIABILITIES AND SHAREHOLDERS' EQUITY
                                                                       
Interest-bearing liabilities
                                                                       
Savings accounts
                                                                       
Ch$
   
162
     
3
      (0.5 %)     2.0 %    
430
     
3
      (2.9 %)     0.6 %    
595
     
9
      (0.6 %)     1.5 %
UF
   
140,427
     
2,739
      (0.5 %)     2.0 %    
117,679
     
5,026
      0.6 %     4.3 %    
105,254
     
1,356
      (0.8 %)     1.3 %
Foreign currencies
   
-
     
-
      0.0 %     0.0 %    
-
     
-
      0.0 %     0.0 %    
-
     
-
      0.0 %     0.0 %
Subtotal
   
140,589
     
2,742
      (0.5 %)     2.0 %    
118,109
     
5,029
      0.6 %     4.3 %    
105,849
     
1,365
      (0.8 %)     1.3 %
Time deposits
                                                                                               
Ch$
   
1,904,088
     
52,066
      0.2 %     2.7 %    
2,183,034
     
95,941
      0.7 %     4.4 %    
3,367,242
     
207,098
      3.9 %     6.2 %
UF
   
1,510,734
     
65,874
      1.8 %     4.4 %    
2,134,671
     
126,739
      2.2 %     5.9 %    
2,098,190
     
98,155
      2.5 %     4.7 %
Foreign currencies
   
840,163
     
11,025
      (7.7 %)     1.3 %    
874,858
     
21,569
      (9.1 %)     2.5 %    
936,392
     
44,162
      6.6 %     4.7 %
Subtotal
   
4,254,985
     
128,965
      (0.8 %)     3.0 %    
5,192,563
     
244,249
      (0.3 %)     4.7 %    
6,401,824
     
349,415
      3.9 %     5.6 %
Central Bank borrowings
                                                                                               
Ch$
   
18,103
     
393
      (0.3 %)     2.2 %    
115,670
     
3,748
      (0.4 %)     3.2 %    
32,879
     
1,737
      3.1 %     5.3 %
UF
   
20,587
     
1,342
      3.9 %     6.5 %    
13,475
     
995
      3.6 %     7.4 %    
51,223
     
2,546
      2.8 %     5.0 %
Foreign currencies
   
-
     
-
      0.0 %     0.0 %    
-
     
-
      0.0 %     0.0 %    
-
     
-
      0.0 %     0.0 %
Subtotal
   
38,690
     
1,735
      2.0 %     4.5 %    
129,145
     
4,743
      0.1 %     3.7 %    
84,102
     
4,283
      2.9 %     5.1 %
Repurchase agreements
                                                                                               
Ch$
   
292,516
     
17,396
      3.4 %     5.9 %    
241,947
     
7,314
      (0.6 %)     3.0 %    
383,511
     
18,411
      2.6 %     4.8 %
UF
   
9,864
      (805 )     (10.4 %)     (8.2 %)    
193,967
     
10,658
      1.8 %     5.5 %    
11,364
     
569
      2.8 %     5.0 %
Foreign currencies
   
357,043
     
7,023
      (9.8 %)     (1.0 %)    
91,947
     
8,695
      (2.9 %)     9.5 %    
151,167
     
7,675
      6.9 %     5.1 %
Subtotal
   
659,423
     
23,614
      4.0 %     1.9 %    
527,861
     
26,667
      (0.1 %)     5.0 %    
546,042
     
26,655
      3.8 %     4.9 %
Mortgage finance bonds
                                                                                               
Ch$
   
-
     
-
      0.0 %     0.0 %    
-
     
-
      0.0 %     0.0 %    
-
     
-
      0.0 %     0.0 %
UF
   
1,334,363
     
109,676
      5.6 %     8.2 %    
820,807
     
76,891
      5.5 %     9.4 %    
578,410
     
43,132
      5.2 %     7.5 %
Foreign currencies
   
-
     
-
      0.0 %     0.0 %    
-
     
-
      0.0 %     0.0 %    
-
     
-
      0.0 %     0.0 %
Subtotal
   
1,334,363
     
109,676
      5.6 %     8.2 %    
820,807
     
76,891
      5.5 %     9.4 %    
578,410
     
43,132
      5.2 %     7.5 %
Other interest-bearing liabilities
                                                                                               
Ch$
   
61,563
     
1,308
      (0.3 %)     2.1 %    
39,213
     
1,498
      0.2 %     3.8 %    
48,688
     
2,582
      3.1 %     5.3 %
UF
   
288,527
     
33,359
      8.9 %     11.6 %    
206,803
     
32,383
      11.6 %     15.7 %    
426,469
     
32,710
      5.4 %     7.7 %
Foreign currencies
   
1,045,820
     
37,680
      (5.6 %)     3.6 %    
1,584,045
     
68,104
      (7.5 %)     4.3 %    
1,682,794
     
96,455
      7.6 %     5.7 %
Subtotal
   
1,395,910
     
72,347
      (2.4 %)     5.2 %    
1,830,061
     
101,985
      (5.1 %)     5.6 %    
2,157,951
     
131,747
      7.1 %     6.2 %
Total interest-bearing liabilities
                                                                                               
Ch$
   
2,276,432
     
71,166
      0.6 %     3.1 %    
2,580,294
     
108,504
      0.6 %     4.2 %    
3,832,915
     
229,837
      3.8 %     6.0 %
UF
   
3,304,502
     
212,185
      3.8 %     6.4 %    
3,487,402
     
252,692
      3.5 %     7.2 %    
3,270,910
     
178,468
      3.3 %     5.5 %
Foreign currencies
   
2,243,026
     
55,728
      (7.0 %)     2.0 %    
2,550,850
     
98,368
      (7.8 %)     3.9 %    
2,770,353
     
148,292
      7.2 %     5.4 %
Total
   
7,823,960
     
339,079
      (0.2 %)     4.2 %    
8,618,546
     
459,564
      (0.7 %)     5.3 %    
9,874,178
     
556,597
      4.6 %     5.7 %

78

 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
Average Balance
   
Interest Paid
   
Average Real Rate
   
Average Nominal Rate
   
Average Balance
   
Interest Paid
   
Average Real Rate
   
Average Nominal Rate
   
Average Balance
   
Interest Paid
   
Average Real Rate
   
Average Nominal Rate
 
   
(in millions of constant Ch$ as of December 31, 2006, except for rate data)
 
NON-INTEREST-BEARING LIABILITIES
                                                                       
Non-interest-bearing demand deposits
                                                                       
Ch$
   
1,855,619
     
-
     
-
     
-
     
1,945,572
     
-
     
-
     
-
     
1,822,980
     
-
     
-
     
-
 
UF
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
34
     
-
     
-
     
-
 
Foreign currencies
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
4
     
-
     
-
     
-
 
Subtotal
   
1,855,619
     
-
     
-
     
-
     
1,945,572
     
-
     
-
     
-
     
1,823,018
     
-
     
-
     
-
 
Contingent obligations
                                                                                               
Ch$
   
78,359
     
-
     
-
     
-
     
152,146
     
-
     
-
     
-
     
203,043
     
-
     
-
     
-
 
UF
   
194,460
     
-
     
-
     
-
     
225,195
     
-
     
-
     
-
     
266,867
     
-
     
-
     
-
 
Foreign currencies
   
758,198
     
-
     
-
     
-
     
517,052
     
-
     
-
     
-
     
479,815
     
-
     
-
     
-
 
Subtotal
   
1,031,017
     
-
     
-
     
-
     
894,393
     
-
     
-
     
-
     
949,725
     
-
     
-
     
-
 
Other non-interest-bearing liabilities
                                                                                               
Ch$
   
948,627
     
-
     
-
     
-
     
687,565
     
-
     
-
     
-
     
605,472
     
-
     
-
     
-
 
UF
   
391,772
     
-
     
-
     
-
     
422,664
     
-
     
-
     
-
     
163,721
     
-
     
-
     
-
 
Foreign currencies
    (363,689 )    
-
     
-
     
-
     
199,926
     
-
     
-
     
-
     
151,559
     
-
     
-
     
-
 
Subtotal
   
976,710
     
-
     
-
     
-
     
1,310,156
     
-
     
-
     
-
     
920,752
     
-
     
-
     
-
 
Shareholders’ equity
                                                                                               
Ch$
   
1,038,970
     
-
     
-
     
-
     
1,015,385
     
-
     
-
     
-
     
1,150,156
     
-
     
-
     
-
 
UF
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Foreign currencies
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Subtotal
   
1,038,970
     
-
     
-
     
-
     
1,015,385
     
-
     
-
     
-
     
1,150,156
     
-
     
-
     
-
 
Total non-interest-bearing liabilities and shareholders’ equity
                                                                                               
Ch$
   
3,921,575
     
-
     
-
     
-
     
3,800,668
     
-
     
-
     
-
     
3,781,651
     
-
     
-
     
-
 
UF
   
586,232
     
-
     
-
     
-
     
647,860
     
-
     
-
     
-
     
430,622
     
-
     
-
     
-
 
Foreign currencies
   
394,509
     
-
     
-
     
-
     
716,978
     
-
     
-
     
-
     
631,378
     
-
     
-
     
-
 
Total
   
4,902,316
     
-
     
-
     
-
     
5,165,506
     
-
     
-
     
-
     
4,843,651
     
-
     
-
     
-
 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
                                                                                               
Ch$
   
6,198,007
     
71,166
                     
6,380,962
     
108,504
                     
7,614,566
     
229,837
                 
UF
   
3,890,734
     
212,185
                     
4,135,262
     
252,692
                     
3,701,532
     
178,468
                 
Foreign currencies
   
2,637,535
     
55,728
                     
3,267,828
     
98,368
                     
3,401,731
     
148,292
                 
Total
   
12,726,276
     
339,079
                     
13,784,052
     
459,564
                     
14,717,829
     
556,597
                 
 
79

 
Changes in Net Interest Revenue and Interest Expense: Volume and Rate Analysis
 
The following table allocates, by currency of denomination, changes in our interest revenue and interest expense between changes in the average volume of interest-earning assets and interest-bearing liabilities and changes in their respective nominal interest rates for 2006 compared to 2005 and 2005 compared to 2004. Volume and rate variances have been calculated based on movements in average balances over the period and changes in nominal interest rates on average interest-earning assets and average interest-bearing liabilities.
 
   
Increase (Decrease) from 2004 to 2005
Due to Changes in
         
Increase (Decrease) from 2005 to 2006
Due to Changes in
       
   
Volume
   
Rate
   
Rate and Volume
   
Net Change from 2004 to 2005
   
Volume
   
Rate
   
Rate and Volume
   
Net Change from 2005 to 2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Interest-earning assets
                                               
Interbank deposits
 
 
 
Ch$
   
1,078
     
61
     
193
     
1,334
      (689 )    
464
      (192 )     (431 )
UF
   
356
     
67
     
210
     
633
      (272 )     (62 )    
23
      (309 )
Foreign currencies
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Subtotal
   
1,434
     
128
     
403
     
1,967
      (961 )    
402
      (169 )     (740 )
Financial investments
                                                               
Ch$
   
75
     
16,002
     
84
     
16,171
     
9,195
     
3,586
     
1,091
     
14,251
 
UF
    (8,844 )    
13,922
      (2,389 )    
2,685
      (5,069 )     (3,700 )    
346
      (8,244 )
Foreign currencies
   
1,174
     
1,942
     
80
     
3,621
      (7,783 )    
31,601
      (5,896 )    
17,901
 
Subtotal
    (7,595 )    
31,866
      (2,225 )    
22,477
      (3,657 )    
31,487
      (4,459 )    
23,908
 
Commercial Loans
                                                               
Ch$
   
44,358
     
28,627
     
3,574
     
76,566
     
84,876
     
49,541
     
9,770
     
142,019
 
UF
   
83,904
     
24,938
     
9,596
     
118,431
     
81,055
      (65,964 )     (15,838 )    
868
 
Foreign currencies
   
834
     
6,848
     
389
     
8,215
     
1,718
     
12,809
     
859
     
15,128
 
Subtotal
   
129,096
     
60,413
     
13,559
     
203,212
     
167,649
      (3,614 )     (5,209 )    
158,015
 
Mortgage loans
                                                               
Ch$
    (3 )    
1
      (0 )     (2 )     (4 )    
8
      (1 )    
3
 
UF
    (56,355 )    
11,501
      (4,913 )     (49,735 )     (22,472 )     (14,387 )    
3,953
      (33,151 )
Foreign currencies
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Subtotal
    (56,358 )    
11,502
      (4,913 )     (49,737 )     (22,476 )     (14,379 )    
3,952
      (33,148 )
Contingent loans
                                                               
Ch$
   
1,427
      (519 )     (489 )    
419
     
662
     
152
     
51
     
835
 
UF
   
292
     
42
     
7
     
341
     
417
     
225
     
42
     
670
 
Foreign currencies
    (307 )    
485
      (155 )    
22
      (74 )    
-
     
-
      (90 )
Subtotal
   
1,412
     
8
      (637 )    
782
     
1,005
     
377
     
93
     
1,415
 
Past due loans
                                                               
Ch$
    (2,200 )     (328 )    
71
      (2,459 )     (580 )    
2,344
      (174 )    
1,571
 
UF
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Foreign currencies
    (0 )    
-
     
-
      (0 )    
-
     
-
     
-
     
-
 
Total
    (2,200 )     (328 )    
71
      (2,459 )     (580 )    
2,344
      (174 )    
1,571
 
Total interest-earning assets
                                                               
Ch$
   
44,735
     
43,844
     
3,433
     
92,029
     
93,460
     
56,095
     
10,545
     
158,248
 
UF
   
19,353
     
50,470
     
2,511
     
72,355
     
53,659
      (83,888 )     (11,474 )     (40,166 )
Foreign currencies
   
1,701
     
9,275
     
314
     
11,858
      (6,139 )    
44,410
      (5,037 )    
32,939
 
Total
   
65,789
     
103,589
     
6,258
     
176,242
     
140,980
     
16,617
      (5,966 )    
151,021
 

80


 
   
Increase (Decrease) from 2004 to 2005
Due to Changes in
   
Net Change
   
Increase (Decrease) from 2005 to 2006
Due to Changes in
   
Net Change
 
   
Volume
   
Rate
   
Rate and
V
olume
   
 from
2004 to 2005
   
Volume
   
Rate
   
Rate and
Volume
   
from
2005 to 2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Interest-bearing liabilities
   
Savings accounts
                                               
  Ch$
   
5
      (2 )     (3 )    
-
     
1
     
4
     
1
     
6
 
  UF
    (444 )    
3,259
      (528 )    
2,287
      (534 )     (3,530 )    
373
      (3,670 )
  Foreign currencies
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Subtotal
    (439 )    
3,257
      (531 )    
2,287
      (533 )     (3,526 )    
374
      (3,664 )
Time deposits
                                                               
  Ch$
   
7,628
     
31,615
     
4,631
     
43,875
     
52,105
     
34,929
     
18,947
     
111,158
 
  UF
   
27,206
     
23,821
     
9,838
     
60,865
      (2,152 )     (27,751 )    
474
      (28,584 )
  Foreign currencies
   
455
     
9,690
     
400
     
10,544
     
1,538
     
19,247
     
1,354
     
22,593
 
Subtotal
   
35,289
     
65,126
     
14,869
     
115,284
     
51,491
     
26,425
     
20,775
     
105,167
 
Central Bank borrowings
                                           
-
     
-
         
  Ch$
   
2,117
     
194
     
1,045
     
3,355
      (2,649 )    
2,429
      (1,739 )     (2,011 )
  UF
    (464 )    
179
      (62 )     (347 )    
2,793
      (323 )     (906 )    
1,551
 
  Foreign currencies
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Subtotal
   
1,653
     
373
     
983
     
3,008
     
144
     
2,106
      (2,645 )     (460 )
Repurchase agreements
                                                               
  Ch$
    (3,007 )     (8,571 )    
1,482
      (10,082 )     (6,237 )    
193,075
      (165,908 )    
11,097
 
  UF
    (15,030 )    
1,346
     
25,130
     
11,463
      (10,043 )    
9,310
      (8,765 )     (10,089 )
  Foreign currencies
    (1,225 )    
37,490
      (27,835 )    
1,672
     
5,626
      (4,046 )     (2,606 )     (1,019 )
Subtotal
    (19,262 )    
30,265
      (1,223 )    
3,053
      (10,654 )    
198,339
      (177,279 )     (11 )
Mortgage finance bonds
                                                               
  Ch$
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
  UF
    (42,211 )    
15,322
      (5,897 )     (32,785 )     (22,785 )     (15,595 )    
4,606
      (33,759 )
  Foreign currencies
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Subtotal
    (42,211 )    
15,322
      (5,897 )     (32,785 )     (22,785 )     (15,595 )    
4,606
      (33,759 )
Other interest-bearing liabilities
                                                               
  Ch$
    (475 )    
1,043
      (379 )    
190
     
360
     
588
     
142
     
1,084
 
  UF
    (9,449 )    
11,822
      (3,348 )     (976 )    
34,488
      (16,544 )     (17,573 )    
327
 
  Foreign currencies
   
19,373
     
7,321
     
3,768
     
30,424
     
4,246
     
22,177
     
1,382
     
28,351
 
Subtotal
   
9,449
     
20,186
     
41
     
29,638
     
39,094
     
6,221
      (16,049 )    
29,762
 
Total interest-bearing liabilities
                                                               
  Ch$
   
6,268
     
24,279
     
6,776
     
37,338
     
43,580
     
231,025
      (148,557 )    
121,334
 
  UF
    (40,392 )    
55,749
     
25,133
     
40,507
     
1,767
      (54,433 )     (21,791 )     (74,224 )
  Foreign currencies
   
18,603
     
54,501
      (23,667 )    
42,640
     
11,410
     
37,378
     
130
     
49,925
 
Total
    (15,521 )    
134,529
     
8,242
     
120,485
     
56,757
     
213,970
      (170,218 )    
97,035
 
 
81

 
Interest-Earning Assets: Net Interest Margin
 
The following table analyzes, by currency of denomination, the levels of average interest-earning assets and net interest earned by Santander-Chile, and illustrates the comparative margins obtained, for each of the years indicated in the table.
 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
( in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Total average interest-earning assets
                 
Ch$
   
3,415,375
     
3,850,866
     
4,648,352
 
UF
   
5,154,312
     
5,559,440
     
6,240,120
 
Foreign currencies
   
2,579,634
     
2,420,574
     
2,190,782
 
Total
   
11,149,321
     
11,830,880
     
13,079,254
 
Net interest earned (1)
                       
Ch$
   
310,185
     
364,876
     
401,791
 
UF
   
191,220
     
223,068
     
257,125
 
Foreign currencies
   
1,104
      (29,678 )     (46,662 )
Total
   
502,509
     
558,266
     
612,254
 
Net interest margin (2)
                       
Ch$
    9.1 %     9.5 %     8.6 %
UF
    3.7 %     4.0 %     4.1 %
Foreign currencies
    0.0 %     -1.2 %     -2.1 %
Total
    4.5 %     4.7 %     4.7 %
Net interest margin, excluding contingent loans (2) (3)
                       
Ch$
    9.3 %     9.9 %     9.0 %
UF
    3.9 %     4.2 %     4.3 %
Foreign currencies
    0.1 %     -1.6 %     -2.7 %
Total
    5.0 %     5.1 %     5.0 %
 

(1)
Net interest earned is defined as interest revenue earned less interest expense incurred.
 
(2)
Net interest margin is defined as net interest earned divided by average interest-earning assets.
 
(3)
Pursuant to Chilean GAAP, Santander-Chile also includes contingent loans as interest-earning assets. See “—Loan Portfolio—Contingent loans.”
 
Return on Equity and Assets; Dividend Payout
 
The following table presents certain information and selected financial ratios for Santander-Chile for the years indicated:
 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006, except for percentages)
 
Net income
   
210,358
     
244,792
     
285,582
 
Average total assets
   
12,726,276
     
13,784,052
     
14,717,829
 
Average shareholders’ equity
   
1,038,970
     
1,015,385
     
1,150,156
 
Net income as a percentage of:
                       
  Average total assets
    1.65 %     1.78 %     1.94 %
  Average shareholders’ equity
    20.25 %     24.11 %     24.83 %

 
 
82

 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006, except for percentages)
 
Average shareholders’ equity as a percentage of:
                       
  Average total assets
    8.16 %     7.37 %     8.98 %
Declared cash dividend
   
210,358
     
159,114
     
185,628
 
Dividend payout ratio, based on net income
    100.00 %     65.00 %     65.00 %
 
Loan Portfolio
 
The following table analyzes our loans by product type. Except where otherwise specified, all loan amounts stated below are before deduction for loan loss allowances. Total loans reflect our loan portfolio, including principal amounts of past due loans.
 
   
As of December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Commercial loans:
                             
General commercial loans
   
3,175,410
     
2,724,428
     
3,335,267
     
3,732,589
     
4,048,221
 
Foreign trade loans
   
583,648
     
469,114
     
523,292
     
522,605
     
741,776
 
Interbank loans
   
4,517
     
155,099
     
138,602
     
198,779
     
151,491
 
Leasing contracts
   
462,654
     
468,402
     
531,434
     
677,936
     
764,408
 
Other outstanding loans
   
1,011,731
     
898,520
     
1,414,957
     
2,099,746
     
2,681,461
 
Subtotal commercial loans
   
5,237,960
     
4,715,563
     
5,943,552
     
7,231,655
     
8,387,357
 
Mortgage loans backed by mortgage bonds
                                       
Residential
   
980,207
     
973,911
     
613,041
     
422,848
     
329,178
 
Commercial
   
754,854
     
646,002
     
361,562
     
225,332
     
156,671
 
Subtotal mortgage loans
   
1,735,061
     
1,619,913
     
974,603
     
648,180
     
485,849
 
Consumer loans
   
776,743
     
842,793
     
1,142,729
     
1,421,523
     
1,800,507
 
Past due loans
   
182,658
     
184,452
     
138,692
     
108,799
     
92,559
 
Subtotal
   
7,932,422
     
7,362,721
     
8,199,576
     
9,410,157
     
10,766,272
 
Contingent loans (1)
   
679,634
     
898,999
     
921,446
     
949,177
     
1,022,687
 
Total loans (2)
   
8,612,056
     
8,261,720
     
9,121,022
     
10,359,334
     
11,788,959
 
 

(1)
For purposes of loan classification, contingent loans are considered as commercial loans.
 
(2)
All of the above categories except mortgage loans, past due loans and contingent loans are combined into “Loans” as reported in the tables set forth under “—Average Balance Sheets, Income Earned from Interest-Earning Assets and Interest Paid on Interest-Bearing Liabilities.”
 
The loan categories are as follows:
 
Commercial loans are long-term and short-term loans granted in Chilean pesos, on an adjustable or fixed rate basis, primarily to finance working capital or investments. Starting January 1, 2004, checking overdraft lines for companies are classified as commercial loans.
 
Foreign trade loans are fixed rate, short-term loans made in foreign currencies (principally U.S.$) to finance imports and exports.
 
Interbank loans are fixed rate, short-term loans to financial institutions that operate in Chile.
 
Leasing contracts are agreements for the financial leasing of capital equipment and other property.
 
Other outstanding loans mainly include mortgage loans (fixed and variable rate) that are inflation-indexed long-term loans with monthly payments of principal and interest secured by a real property mortgage. These are financed by our general borrowings. Other outstanding loans also include factoring operations. Previous to 2004, this line item
 
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also included checking account overdrafts, which since January 1, 2004 have been classified as commercial or consumer loans depending on their origin.
 
Mortgage loans backed by mortgage bonds are inflation-indexed, fixed rate, long-term loans with monthly payments of principal and interest secured by a real property mortgage that are financed with mortgage finance bonds. At the time of approval, these types of mortgage loans cannot be more than 75.0% of the lower of the purchase price or the appraised value of the mortgaged property or such loan will be classified as a commercial loan.
 
Consumer loans are loans to individuals, granted in Chilean pesos, generally on a fixed rate basis, to finance the purchase of consumer goods or to pay for services. They also include credit card balances subject to interest charges. Starting January 1, 2004, checking overdraft lines for individuals have been classified as commercial loans.
 
Past due loans include, with respect to any loan, the amount of principal or interest that is overdue for 90 days or more, and does 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.
 
Contingent loans consist of guarantees granted by us in Ch$, UF and foreign currencies (principally U.S.$), as well as open and unused letters of credit. (Unlike U.S. GAAP, Chilean GAAP requires such loans to be included on a bank’s balance sheet.)
 
Collateral provided generally consists of mortgages on real estate, pledges of marketable securities, letters of credit or cash. The existence and amount of collateral generally vary from loan to loan.
 
Maturity and Interest Rate Sensitivity of Loans
 
The following table sets forth an analysis by type and time remaining to maturity of our loans at December 31, 2006:
 
   
Due 1 year or less
   
Due after 1 year
but up to 5 years
   
Due after 5 years
   
Total balance at
December 31, 2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Commercial loans
   
1,922,965
     
1,292,174
     
833,082
     
4,048,221
 
Consumer loans
   
1,067,706
     
721,834
     
10,967
     
1,800,507
 
Mortgage loans
   
57,317
     
186,524
     
242,008
     
485,849
 
Leasing contacts
   
205,712
     
387,303
     
171,393
     
764,408
 
Foreign trade loans
   
612,101
     
94,991
     
34,684
     
741,776
 
Interbank loans
   
151,491
     
-
     
-
     
151,491
 
Other outstanding loans
   
296,779
     
521,425
     
1,863,257
     
2,681,461
 
Past due loans
   
92,559
     
-
     
-
     
92,559
 
Subtotal
   
4,406,630
     
3,204,251
     
3,155,391
     
10,766,272
 
Contingent loans
   
744,194
     
269,154
     
9,339
     
1,022,687
 
Total loans
   
5,150,824
     
3,473,405
     
3,164,730
     
11,788,959
 

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The following tables present the interest rate sensitivity of outstanding loans due after one year at December 31, 2006 (not including contingent loans). See also “Item 11: Quantitative and Qualitative Disclosures About Market Risk—Interest Rate Sensitivity.”
 
   
At
December 31, 2006
 
   
(in millions of
constant Ch$
as of
December 31, 2006)
 
Variable Rate
     
Ch$
   
115
 
UF
   
1,062,737
 
Foreign currencies
   
1,772
 
Subtotal
   
1,064,624
 
Fixed Rate
       
Ch$
   
1,441,165
 
UF
   
3,766,811
 
Foreign currencies
   
87,042
 
Subtotal
   
5,295,018
 
Total
   
6,359,642
 
 
Loans by Economic Activity
 
The following table sets forth, at the dates indicated, an analysis of our loan portfolio based on the borrower’s principal economic activity. Loans to individuals for business purposes are allocated to their economic activity. The table does not reflect outstanding contingent loans.
 
   
As of December 31,
 
   
2005
   
2006
 
   
Loan Portfolio
   
% of Total
   
Loan Portfolio
   
% of Total
 
   
(in millions of constant Ch$ as of December 31, 2006, except for percentages)
 
Agriculture, Livestock, Agribusiness, Fishing
                       
Agriculture and livestock
   
250,397
     
2.7
     
304,163
     
2.8
 
Fruit
   
81,264
     
0.9
     
103,080
     
0.9
 
Forestry and wood extraction
   
49,608
     
0.5
     
105,804
     
1.0
 
Fishing
   
69,962
     
0.7
     
95,145
     
0.9
 
Subtotal
   
451,231
     
4.8
     
608,192
     
5.6
 
Mining and Petroleum
                               
Mining and quarries
   
35,195
     
0.4
     
43,168
     
0.4
 
Natural gas and crude oil extraction
   
29,308
     
0.3
     
33,152
     
0.3
 
Subtotal
   
64,503
     
0.7
     
76,320
     
0.7
 
Manufacturing
                               
Tobacco, food and beverages
   
119,358
     
1.3
     
141,069
     
1.3
 
Textiles, clothing and leather goods
   
59,002
     
0.6
     
53,834
     
0.5
 
Wood and wood products
   
54,274
     
0.6
     
66,589
     
0.7
 
Paper, printing and publishing
   
68,436
     
0.7
     
64,607
     
0.6
 
Oil refining, carbon and rubber
   
102,880
     
1.1
     
111,304
     
1.0
 
Production of basic metal, non minerals, machine and equipment
   
123,328
     
1.3
     
130,205
     
1.2
 
Other manufacturing industries
   
26,104
     
0.3
     
34,892
     
0.3
 
Subtotal
   
553,382
     
5.9
     
602,500
     
5.6
 
Electricity, Gas and Water
                               
Electricity, gas and water
   
78,220
     
0.8
     
92,360
     
0.9
 
Subtotal
   
78,220
     
0.8
     
92,360
     
0.9
 
 
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As of December 31,
 
   
2005
   
2006
 
   
Loan Portfolio
   
% of Total
   
Loan Portfolio
   
% of Total
 
   
(in millions of constant Ch$ as of December 31, 2006, except for percentages)
 
Construction
                               
Residential buildings
   
306,903
     
3.3
     
371,625
     
3.4
 
Other constructions
   
305,181
     
3.2
     
362,096
     
3.4
 
Subtotal
   
612,084
     
6.5
     
733,721
     
6.8
 
Commerce
                               
Wholesale
   
308,518
     
3.3
     
378,380
     
3.5
 
Retail, restaurants and hotels
   
479,816
     
5.1
     
514,744
     
4.8
 
Subtotal
   
788,334
     
8.4
     
893,124
     
8.3
 
Transport, Storage and Communications
                               
Transport and storage
   
212,928
     
2.3
     
276,227
     
2.6
 
Communications
   
105,001
     
1.1
     
129,789
     
1.2
 
Subtotal
   
317,929
     
3.4
     
406,016
     
3.8
 
Financial Services, Insurance and Real Estate
                               
Financial insurance and companies
   
609,723
     
6.5
     
612,610
     
5.7
 
Real estate and other services provided to companies
   
369,972
     
3.9
     
328,941
     
3.0
 
Subtotal
   
979,695
     
10.4
     
941,551
     
8.7
 
Community, Social and Personal Services
                               
Community, social and personal services
   
1,778,464
     
18.9
     
1,794,013
     
16.7
 
Subtotal
   
1,778,464
     
18.9
     
1,794,013
     
16.7
 
Consumer Credit
   
1,434,796
     
15.2
     
1,819,268
     
16.9
 
Residential mortgage loans
   
2,351,519
     
25.0
     
2,799,207
     
26.0
 
Total
   
9,410,157
     
100.0
     
10,766,272
     
100.0
 
 
At December 31, 2006, foreign country loans totaled Ch$390,010 million, representing 2.56% of our total assets.  No foreign country represents more than 1% of our assets.
 
Credit Review Process
 
The Risk Division, our credit analysis and risk management group, is largely independent of our Commercial Division. Risk evaluation teams interact regularly with our clients. For larger transactions, risk teams in our headquarters work directly with clients when evaluating credit risks and preparing credit applications. Various credit approval committees, all of which include Risk Division and Commercial Division personnel, must verify that the appropriate qualitative and quantitative parameters are met by each applicant. Each committee’s powers are defined by our Board of Directors.
 
In addition, Banco Santander Central Hispano is involved in the credit approval process of our largest loans and borrowers. If a single borrower or an economic group owes us an aggregate amount in excess of US$40 million, any additional loan to such borrower or member of such group must be reviewed by Banco Santander Central Hispano. Once a year, the Executive Committee of Banco Santander Central Hispano reviews those loans booked by us in excess of US$40 million.
 
Credit Approval: Corporate
 
In preparing a credit proposal for a corporate client, Santander-Chile’s personnel verify such parameters as debt servicing capacity (including, usually, projected cash flows), the company’s financial history and projections for the economic sector in which it operates. The Risk Division is closely involved in this process, and prepares the credit
 
86

 
application for the client. All proposals contain an analysis of the client’s strengths and weaknesses, a rating and a recommendation. Credit limits are determined not on the basis of outstanding balances of individual clients, but on the direct and indirect credit risk of entire financial groups. For example, a corporation will be evaluated together with its subsidiaries and affiliates.
 
Credit Approval: Retail Banking
 
Santander-Chile’s Risk Division for Individuals reports to the Risk Division for Individuals and small businesses, and is responsible for the risk policies for this segment. The credit evaluation process is based on an evaluation system known as Garra which is decentralized, automated and is based on a scoring system which incorporates our Credit Risk policies. The credit evaluation process is based on the gathering of information to determine a client’s financial stability, payment capacity and commercial nature. The following parameters are used to evaluate an applicant’s credit risk: (i) income, (ii) length of current employment, (iii) indebtedness, (iv) credit reports and (v) background information, which is accessed by means of internal and external databases. Operations which cannot be approved by Garra are sent to the Approval Center, a centralized area that carries out yearly analyses and renewals of credit lines and credit cards and evaluates higher risk credits.
 
Credit Approval: Banefe
 
Banefe’s Risk division is fully integrated into Santander-Chile’s Risk Department for Individuals and Micro businesses. In managing its credit risks, Banefe applies a specific set of general policies and rules which differs from the rest of Santander-Chile, due to its own market orientation. These policies and rules, as well as product specific guidelines, are developed by the Risk Division, which also defines the responsibilities of the various units and personnel participating in the credit approval process and the operating procedures for the granting of credit. Additionally, there exists a Risk Committee in which persons from the commercial area participate and where modifications to the risk policies are discussed.
 
The credit evaluation process is based on Santander-Chile’s general credit policies, which define, among other things, Banefe’s target markets, as well as the parameters used to evaluate an applicant’s credit risk. The most relevant parameters used to evaluate an applicant’s credit risk are (i) income, (ii) length of current employment, (iii) indebtedness, (iv) credit reports and (v) background information, which is accessed by means of internal and external databases. Additionally this area utilizes credit scoring models for evaluating the credit risk of some products.
 
The credit evaluation process is, for the most part, decentralized and is carried out by credit analysts at branch offices who use the Syseva system (Sistema de Evaluación de Riesgos) for approving an operation, which includes the credit risk parameters and credit scoring mechanisms mentioned above. Additionally, a central unit exists, which reports to Banefe’s Risk Division, that carries out yearly analyses and renewals of credit lines and credit cards and evaluates higher risk credit or operations that cannot be approved or rejected automatically through Syseva.
 
The following table lists our committees from which credit approval is required depending on total risk exposure:
 
Approved By
 
Maximum approval in
Thousands of US$
 
Executive Credit Committee
 
>20,000
 
Senior Credit Committee
   
20,000
 
Business Segment Committee
   
8,000-10,000
 
Large Companies
   
10,000
 
Real estate sector
   
10,000
 
Medium-sized companies
   
8,000
 
Regional Committee
   
5,000
 
Branch committee
   
300
 
Companies
   
300
 
Mortgage
   
120
 
Persons
   
30
 

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The Executive Credit Committee is comprised of the Chairman of the Board, three additional Board members, the Corporate Legal Counsel, the CEO, the Manager of Global Banking, the Corporate Director of Risk and two senior members of the Credit Risk department that present the loans being reviewed. This committee reviews the loan positions reviewed by the Senior Credit Committee above US$10 million and approves those loan positions greater than US$20 million. In addition, any loan position above US$40 million must also be reviewed by Banco Santander Central Hispano’s credit committee.
 
The Senior Credit Committee is comprised of the CEO, the Manager of the Wholesale segment, the Manager of the Medium sized companies segment, General Counsel, the Corporate Director of Credit Risk and the Manager of Credit Admissions. The Senior Credit Committee reviews and will either approve or deny transactions in the range of US$8 million to US$20 million that have been previously approved by one of the Business Segment Committees: (i) Large Companies, (ii) Medium sized Companies and (iii) Real Estate. The Regional Committees have a maximum approval of up to US$5 million. The Regional Committees oversee the branch networks outside of Santiago. At the branch level, the maximum approval is US$300,000 for companies, US$30,000 for individuals and US$120,000 for mortgages. For the lower level committees, credit granting authority varies according to the seniority and experience of the committee members, and the values indicated represent upper limits. All committees include at least two bank officers from the commercial and credit areas.
 
We also have a department designated to monitor the quality of the loan portfolio on a continuous basis. The purpose of this special supervision is to maintain constant scrutiny of the portions of the portfolio that represent the greatest risk and to anticipate any deterioration. Based on this ongoing review of the loan portfolio, we believe we are able to detect problem loans and make a decision on a client’s status. This includes measures such as reducing or extinguishing a loan, or requiring better collateral from the client. The control systems require that loans be reviewed at least three times per year for those clients in the lowest category of credit watch.
 
The following table lists Banefe’s personnel from whom credit approval is required, depending upon total risk exposure. These attributions are granted based on specific training processes given by the Risk Division and according to the experience and professional background of the employee.
 
   
Range in US$
(Excludes mortgage
loans)
 
Risk Division Manager
 
> 12,500
 
Assistant Risk Division Managers
   
6,250-12,500
 
Zone Manager
   
3,125-6,250
 
Branch Assistant Manager
   
1,550-3,125
 
Credit Analyst
   
1,170-1,550
 
Commercial Executive
   
0-1,170
 
 
Classification of Loan Portfolio
 
Chilean banks are required to provide to the Superintendency of Banks detailed information regarding their loan portfolio on a monthly basis. The Superintendency of Banks examines and evaluates each financial institution’s credit management process, including its compliance with the loan classification guidelines. Banks are classified into four categories: 1, 2, 3 and 4. Each bank’s category depends on the models and methods used by the bank to classify its loan portfolio, as determined by the Superintendency of Banks. Category 1 banks are those banks whose methods and models are satisfactory to the Superintendency of Banks. Category 1 banks will be entitled to continue using the same methods and models they currently have in place. A bank classified as a category 2 bank will have to maintain the minimum levels of reserves established by the Superintendency of Banks while its board of directors will be made aware of the problems detected by the Superintendency of Banks and required to take steps to correct
 
88

 
them. Banks classified as categories 3 and 4 will have to maintain the minimum levels of reserves established by the Superintendency of Banks until they are authorized by the Superintendency of Banks to do otherwise. We are classified in category 1.
 
Under the classifications effective January 1, 2004, loans are divided into: (i) consumer loans (including loans granted to individuals for the purpose of financing the purchase of consumer goods or payment of services); (ii) residential mortgage loans (including loans granted to individuals for the purchase, construction or improvement of residential real estate, in which the value of the property covers at least 100% of the amount of the loan); and (iii) commercial loans (includes all loans other than consumer loans and residential mortgage loans).
 
In accordance with the regulations, which became effective as of January 1, 2004, the models and methods used to classify our loan portfolio must follow the following guiding principles, which have been established by the Superintendency of Banks and approved by our Board of Directors. In 2006, these models have been improved and various changes have been introduced.  Since then, our internal provisioning models have focused on not only non-performance, we have also introduced statistical models that take into account a borrower’s credit history and indebtedness levels.  Group ratings that determine loan loss allowances based only on non-performance are being phased out and replaced by statistical scoring systems.
 
Allowances for large commercial loans
 
For large commercial loans, leasing and factoring, the Bank assigns a risk category level to each borrower and his respective loans. The Bank considers the following risk factors within the analysis: industry or sector of the borrower, owners or managers of the borrower, their financial situation, their payment capacity and payment behavior. The Bank assigns one of the following risk categories to each loan and borrower:
 
 
iv.
Classifications A1, A2 and A3, assigned to borrowers with no apparent credit risk.
 
 
v.
Classifications B, assigned to borrowers with some credit risk but no apparent deterioration of payment capacity.
 
 
vi.
Classifications C1, C2, C3, C4, D1 and D2, assigned to borrowers whose loans have deteriorated.
 
Before December 1, 2006, for loans classified as A1, A2, A3 and B, the Board of Directors was authorized to determine the levels of required reserves.  Effective December 1, 2006, for loans classified as A1, A2, A3 and B, the Bank assigns a specific level of risk to each borrower and, therefore, amount of loan loss allowance is determined on a case by case basis.  All commercial loans for Companies, including leasing and factoring, have since been rated using a model for evaluating and calculating provisions on an individual basis.  Since a debtor’s behavior varies over time, in order to determine the provisions, it is necessary to make a distinction between normal debtors and deteriorated debtors.
 
Debtor Classes
 
Two debtor classes have been determined based on debtors’ credit behavior in order to calculate loan loss allowance:
 
·  
Normal Debtors: Debtors that are current on their payment obligations and show no sign of deterioration in their credit quality.
 
·  
Deteriorated Debtors:  Debtors that present some degree of non-payment on the obligations to the Bank, including debtors 5% or more of whose loan balances with us have been non-performing for more than three months, whose loans with us have been charged off or administered by our Recovery Unit, or classified as Precontenciosos (PRECO or Deteriorated)
 
Definition of Expected Loan Loss = Loan Loss Allowance
 
 
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The expected loss is obtained by multiplying all risk factors defined in the following equation:
 
EL  
=           PNP x EXP x SEV
   
EL 
=           Expected Loss
PNP
=           Probability of Non-Performing
EXP  
=           Exposure
SEV 
=           Severity

EL = Expected Loss. The expected loss is how much could be lost in the event a debtor does not perform the obligations under the loan.
 
PNP = Probability of Non-performing.  This variable, expressed as a percentage, indicates the probability that a debtor will default next year. This percentage is  associated with the internal rating we give to each debtor, which is determined statistically according to the historical credit quality evolution of debtors with similar ratings.
 
EXP  = Exposure. This corresponds to the value of commercial loans without discounting the value of guarantees or collateral.
 
SEV = Severity. This is the effective loss rate for debtors in the same segment, which is determined statistically based on the historical effective losses for the Bank for each segment.
 
Determination of loan loss allowance  according to Borrower Class
 
Normal Debtors
 
  ·
The loan loss allowance for each debtor is calculated based on the Expected Loss equation (EL = PNP x EXP x SEV).
 
  ·
A risk category is assigned to each debtor based on the PNP summarized in the following table:
 
PNP result
 
Classification
 
Loan Loss
Allowance
(Pre-Dec. 2006)
 
Loan loss allowance
as of and after
Dec. 2006
             
External Classification> AA
 
A1
    0%  
Determined by a
PNP ≤  0.01%
 
A2
    0%  
model on an
0.01% < PNP ≤  0.04%
 
A3
    0.5%  
individual basis
PNP> 0.04%
 
B
    1.0%  
 
 
Deteriorated Debtors
 
For loans classified in Categories C1, C2, C3, C4, D1 and D2, the Bank must have the following levels of allowance:
 
 
Classification
 
 
Estimated range of loss
 
Allowance(1)
 
C1
 
Up to 3%
   
 2%
 
C2
 
More than 3% up to 19%
   
10%
 
C3
 
More than 19% up to 29%
   
25%
 
C4
 
More than 29% up to 49%
   
40%
 
D1
 
More than 49% up to 79%
   
65%
 
D2
 
More than 79%
   
90%
 
 

(1)
Represents percentages of the required allowance to the aggregate amount of principal and accrued but unpaid interest of the loan.
 
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Allowances for consumer and mortgage loans
 
The classification of consumer and mortgage loans is directly related to the aging of the installment. The following table sets forth our methodology for analyzing consumer and mortgage loans prior to 2006.
 
   
Consumer loans overdue status
   
Residential mortgage loans
overdue status
     
Allowances as a
percentage of
aggregate
exposure (1)
 
Category
 
From
   
To
   
From
   
To
     
   
(Days)
   
(Days)
       
A
   
     
     
     
      %
B
   
1
     
30
     
1
     
180
     
1
 
B-
   
31
     
60
     
181
   
>181
     
20
 
C
   
61
     
120
     
     
     
60
 
D
   
121
   
>121
     
     
     
90
 


(1)
In effect until December 31, 2005.  Represents the percentages of the required allowance to the aggregate amount of the principal and accrued but unpaid interest of loans.  As of January 1, 2006, the risk category was determined by days of non-payment.  However, the classification did not determine loan loss allowance levels.
 
Commencing in 2006, the Bank improved and modified the methodology for analyzing consumer and mortgage loans.  All consumer and mortgage loans are now assigned an allowance level on an individual borrower basis utilizing a more automated and sophisticated statistical model and considering borrower’s credit history, including any defaults on obligations to other creditors, as well as the overdue periods on the loans borrowed from the Bank.  Once the rating of the client is determined, the allowance for consumer and mortgage loans is calculated using a risk category and related allowance to loan ratio which is directly related to the overdue periods.  The following table sets forth the allowance to loan ratios on loans based on overdue time.
 
 
Loan type
 
Allowance %(1)
 
Overdue days
 
       
1-30
     
31-60
     
61-120
     
121-180
     
181-360
     
361- 720
   
>720
 
Consumer
Profile 1
    5.2 %     16.5 %     29.7 %     90.5 %  
Charged-off
     
     
 
 
Profile 2
    8.8 %     20.0 %     48.4 %     90.5 %  
Charged-off
     
     
 
 
Profile 3
    13.5 %     24.7 %     48.4 %     90.5 %  
Charged-off
     
     
 
                                                           
Mortgage
Profile 1
    0.3 %     0.5 %     1.2 %     2.4 %     6.8 %     14.1 %     28.3 %
 
Profile 2
    1.5 %     1.6 %     2.5 %     4.4 %     6.8 %     14.1 %     28.3 %


(1)
Represents the percentage of required allowance amount to the aggregate amount of the principal and accrued but unpaid interest on the loan.  These percentages may vary as the model is being improved.
 
Further improvements were implemented in the three month period ended March 31, 2007.  First, the Bank now differentiates between old and new clients when determining a client’s risk profile for consumer loans.  This modification did not result in any significant change in provision expense, but is expected to reduce monthly volatility of provisions and charge-offs.  Second, the Bank is in the process of implementing additional modifications, the most important of which is to lengthen the period for back-testing to determine a client’s risk profile from 12 to 24 months for consumer loans.  To determine loan loss allowance for residential mortgage loans, the Bank still uses the table shown above.
 
Allowances for group evaluations on small and mid-sized commercial loans
 
  ·  
Allowances for group evaluations are permitted for a large number of borrowers whose individual loan amounts are relatively insignificant.  These models are intended to be used primarily to analyze commercial loans to individuals and small companies.
 
  ·  
Levels of required allowance are determined by the Bank according to the estimated loss that may result from the loans, by classifying the loan portfolio using one or both of the following models:
 
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i.
A model based on the characteristics of the borrowers and their outstanding loans.  Borrowers and their loans with similar characteristics will be placed into groups and each group will be assigned a risk level.
 
 
ii.
A model based on the performance of a group of loans.  Loans with analogous past payment histories and similar characteristics will be placed into groups and each group will be assigned a risk level.  Currently, the Bank is utilizing group analysis for determining the loan loss for certain types of loans such as lending to small and mid-sized companies and commercial loans to individuals.
 
Additional reserves
 
Banks are permitted to establish allowances above the limits described above only to cover specific risks that have been authorized by their board of directors. Voluntary reserves that cover no specific risk are no longer permitted.
 
Analysis of Santander-Chile’s Loan Classification
 
The following tables provide statistical data regarding the classification of our loans at the end of each of the last five years.
 
   
At December 31, 2002
 
Category
 
Commercial Loans
   
Consumer Loans
   
Residential
Mortgage Loans
   
Total Loans
   
Percentage of
Evaluated Loans
 
     
(in millions of constant Ch$ as of December 31, 2006, except percentages)
A
   
2,929,507
     
637,719
     
1,399,766
     
4,966,992
      64.2 %
B
   
2,309,672
     
88,541
     
102,904
     
2,501,117
      32.3 %
B-
   
118,081
     
28,280
     
34,030
     
180,391
      2.3 %
C
   
30,979
     
20,448
     
2,925
     
54,352
      0.7 %
D
   
26,524
     
13,145
     
2
     
39,671
      0.5 %
Total of evaluated loans
   
5,414,763
     
788,133
     
1,539,627
     
7,742,523
      100.0 %
Total loans
   
6,284,296
     
788,133
     
1,539,627
     
8,612,056
         
Percentage evaluated
    86.2 %     100.0 %     100.0 %     89.90 %        
 
   
At December 31, 2003
 
Category
 
Commercial Loans
   
Consumer Loans
   
Residential
Mortgage Loans
   
Total Loans
   
Percentage of
Evaluated Loans
 
     
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
A
   
3,176,211
     
675,259
     
1,344,592
     
5,196,062
      69.7 %
B
   
1,727,932
     
103,337
     
127,301
     
1,958,570
      26.3 %
B-
   
109,200
     
33,611
     
41,740
     
184,551
      2.5 %
C
   
30,330
     
26,879
     
2,550
     
59,759
      0.8 %
D
   
34,457
     
16,795
     
2
     
51,254
      0.7 %
Total of evaluated loans
   
5,078,130
     
855,881
     
1,516,185
     
7,450,196
      100.0 %
Total loans
   
5,889,654
     
855,881
     
1,516,185
     
8,261,720
         
Percentage evaluated
    86.2 %     100.0 %     100.0 %     90.2 %        

92

 
   
At December 31, 2004
 
Category
 
Commercial Loans
   
Consumer Loans
   
Residential
Mortgage Loans
   
Total Loans
   
Percentage of
Evaluated Loans
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
A
         
965,821
     
1,777,768
     
2,743,589
      30.1 %
A1
   
442,636
                     
442,636
      4.9 %
A2
   
3,794,387
                     
3,794,387
      41.6 %
A3
   
677,021
                     
677,021
      7.4 %
B
   
665,011
     
99,236
     
91,615
     
855,862
      9.4 %
B-
           
35,022
     
39,319
     
74,341
      0.8 %
C
           
32,559
     
2,200
     
34,759
      0.4 %
C1
   
268,980
                     
268,980
      2.9 %
C2
   
58,584
                     
58,584
      0.6 %
C3
   
33,240
                     
33,240
      0.4 %
C4
   
25,197
                     
25,197
      0.3 %
D
           
20,849
     
1
     
20,850
      0.2 %
D1
   
26,724
                     
26,724
      0.3 %
D2
   
64,852
                     
64,852
      0.7 %
Total of evaluated loans
   
6,056,632
     
1,153,487
     
1,910,903
     
9,121,022
      100.0 %
Total loans
   
6,056,632
     
1,153,487
     
1,910,903
     
9,121,022
         
Percentage evaluated
    100.0 %     100.0 %     100.0 %     100.0 %        
 
   
At December 31, 2005
 
 
Category
 
Commercial Loans
   
Consumer Loans
   
Residential
Mortgage Loans
   
Total Loans
   
Percentage of
Evaluated Loans
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
A
         
1,176,550
     
2,198,450
     
3,375,000
      32.6 %
A1
   
437,692
                     
437,692
      4.2 %
A2
   
4,201,820
                     
4,201,820
      40.6 %
A3
   
946,197
                     
946,197
      9.1 %
B
   
664,408
     
149,579
     
123,588
     
937,575
      9.1 %
B-
           
46,630
     
27,405
     
74,035
      0.7 %
C
           
36,574
     
1,887
     
38,461
      0.4 %
C1
   
189,509
                     
189,509
      1.8 %
C2
   
40,684
                     
40,684
      0.4 %
C3
   
20,654
                     
20,654
      0.2 %
C4
   
14,014
                     
14,014
      0.1 %
D
           
25,415
             
25,415
      0.3 %
D1
   
24,199
                     
24,199
      0.2 %
D2
   
34,079
                     
34,079
      0.3 %
Total of evaluated loans
   
6,573,256
     
1,434,748
     
2,351,330
     
10,359,334
      100.0 %
Total loans
   
6,573,256
     
1,434,748
     
2,351,330
     
10,359,334
         
Percentage evaluated
    100.0 %     100.0 %     100.0 %     100.0 %        
 
   
As of December 31, 2006
 
Category
 
Commercial Loans
   
Consumer Loans
   
Residential
Mortgage Loans
   
Total Loans
   
Percentage of
Evaluated Loans
 
   
(in millions of constant Ch$ as of December 31, 2006, except for percentages)
 
A
         
1,487,466
     
2,634,335
     
4,121,801
      35.0 %
A1
                                     
A2
   
5,120,492
                     
5,120,492
      43.4 %
A3
   
1,629,798
                     
1,629,798
      13.8 %
B
   
152,256
     
169,411
     
122,194
     
443,861
      3.8 %
B-
           
62,506
     
19,778
     
82,284
      0.7 %
C
           
63,471
     
31,848
     
95,319
      0.8 %
C1
   
127,526
                     
127,526
      1.1 %
C2
   
22,094
                     
22,094
      0.2 %
C3
   
19,100
                     
19,100
      0.2 %
C4
   
22,601
                     
22,601
      0.2 %
D
           
36,344
     
14,396
     
50,740
      0.4 %
D1
   
26,430
                     
26,430
      0.2 %
D2
   
26,913
                     
26,913
      0.2 %
Total of evaluated loans
   
7,147,210
     
1,819,198
     
2,822,551
     
11,788,959
      100.0 %
Total loans
   
7,147,210
     
1,819,198
     
2,822,551
     
11,788,959
         
Percentage evaluated
    100.0 %     100.0 %     100.0 %     100.0 %        

93

 
 Classification of Loan Portfolio Based on the Borrower’s Payment Performance
 
Accrued interest and UF indexation adjustments from overdue loans are recognized only when, and to the extent, received. Non performing loans include loans as to which either principal or interest is overdue, and which do not accrue interest. Restructured loans as to which payments are not overdue are not ordinarily classified as non performing loans. Past due loans include, with respect to any loan, only the portion of principal or 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 of the beginning of such proceedings. This practice differs from that normally followed in the United States, where the amount classified as past due would include the entire amount of principal and interest on any and all loans which have any portion overdue.
 
According to the regulations established by the Superintendency of Banks, we are required to write off commercial loans not later than 24 months after being classified as past due, if unsecured, and if secured, not later than 36 months after being classified as past due. When an installment of a past due commercial loan (either secured or unsecured) is written off, we must write off all installments which are overdue, notwithstanding our right to write off the entire amount of the loan. Once any amount of a loan is written off, each subsequent installment must be written off as it becomes overdue, notwithstanding our right to write off the entire amount of the loan. In the case of past due consumer loans, a similar practice applies, except that after the first installment becomes past due for six-months, we must write off the entire remaining part of the loan. We may write off any loan (commercial or consumer) before the first installment becomes overdue only in accordance with special procedures established by the Superintendency of Banks. In certain circumstances we must write off an overdue loan (commercial or consumer) sooner than the terms set forth above. Loans are written off against the loan loss allowance to the extent of any required allowances for such loans; the remainder of such loans is written off against income.
 
In general, legal collection proceedings are commenced with respect to consumer loans once they are overdue for 90 days and, with respect to mortgage loans, once they are past due for 120 days. Legal collection proceedings are always commenced within one year of such loans becoming past due, unless the bank determines that the size of the past due amount does not warrant such proceedings. In addition, the majority of our commercial loans are short–term, with single payments at maturity. Past due loans are required to be covered by individual loan loss allowance equivalent to 100.0% of any unsecured portion thereof. See “—Loan Loss Allowances.”
 
The following table sets forth as of December 31 of each of the last five years the amounts that are current as to payments of principal and interest and the amounts overdue:
 
Total Loans
 
The following table sets forth a loan aging schedule at the end of each of the last five years.
 
   
At December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Current
   
8,340,170
     
8,014,989
     
8,935,845
     
10,191,728
     
11,637,090
 
Overdue for 1-29 days
   
46,706
     
40,419
     
31,077
     
38,353
     
39,150
 
Overdue for 30-89 days
   
42,522
     
21,860
     
15,408
     
20,454
     
20,160
 
Overdue for 90 days or more (“past due”)
   
182,658
     
184,452
     
138,692
     
108,799
     
92,559
 
Total loans
   
8,612,056
     
8,261,720
     
9,121,022
     
10,359,334
     
11,788,959
 
Overdue loans expressed as a percentage of total loans
    3.2 %     3.0 %     2.0 %     1.6 %     1.3 %
Past due loans as a percentage of total loans
    2.1 %     2.2 %     1.5 %     1.1 %     0.8 %
 
94

 
We suspend the accrual of interest and readjustments on all overdue loans. The amount of interest that would have been recorded on overdue loans if they had been accruing interest was Ch$5,163 million, Ch$6,012 million and Ch$5,087 million for the years ended December 31, 2004, 2005 and 2006, respectively. Accrued interest and UF indexation adjustments from overdue loans are recognized only when, and to the extent, received.
 
Loans included in the previous table which have been restructured and that bear no interest are as follows:
 
   
At December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Ch$
   
9,418
     
15,258
     
19,408
     
1,556
     
1,590
 
Foreign currency
   
783
     
4,914
     
9,990
     
1,624
     
27,471
 
UF
   
3,462
     
3,137
     
4,567
     
7,617
     
2,571
 
Total
   
13,663
     
23,309
     
33,965
     
10,797
     
31,632
 
 
The amount of interest that would have been recorded on these loans for the years ended December 31, 2004, 2005 and 2006 if these loans had been earning a market interest rate was Ch$3,102 million, Ch$410 million and Ch$2,075 million, respectively.
 
Loan Loss Allowances
 
The following table sets forth our balance of loan loss allowances, the minimum allowances to be established by us in accordance with the regulations of the Superintendency of Banks and our total loan loss allowances expressed as a percentage of total loans. Amounts at December 31, 2002 and 2003 were determined under the regulations then in effect, and amounts at December 31, 2004, 2005 and 2006 were determined under the current rules.
 
   
At December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Allowance based on the requirements of the Superintendency of Banks
   
144,683
     
155,320
     
183,366
     
151,000
     
174,064
 
Allowance based on 0.75%
   
64,591
     
61,963
     
-
     
-
     
-
 
Individual, global and additional loan loss allowances
   
169,674
     
182,039
     
183,366
     
151,000
     
174,064
 
Minimum allowance required
   
169,674
     
182,039
     
183,366
     
151,000
     
174,064
 
Voluntary allowance
   
13,863
     
387
     
-
     
-
     
-
 
Total loan loss allowances
   
183,537
     
182,426
     
183,366
     
151,000
     
174,064
 
Total loan allowances as a percentage of total loans
    2.1 %     2.2 %     2.0 %     1.5 %     1.5 %

95

 
Analysis of Substandard Loans and Amounts Past Due
 
The following table analyzes our substandard loans (i.e., all of the loans included in categories B-, C and D) and past due loans and the allowances for loan losses existing at the dates indicated. Substandard loans in the old rating system included all loans rated B- or worse. In the current loan rating system, substandard loans include all consumer loans and mortgage loans rated B- or worse and all commercial loans rated C2 or worse. Therefore, the figure for substandard loans in 2002 and 2003 are not comparable to the figures in the following years.
 
   
At December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Total loans
   
8,612,056
     
8,261,720
     
9,121,022
     
10,359,334
     
11,788,959
 
Substandard loans (1)
   
274,413
     
295,563
     
338,547
     
271,541
     
345,481
 
Substandard loans as a percentage of total loans
    3.19 %     3.58 %     3.71 %    
2.62
      2.93 %
                                         
Amounts past due(2)
   
182,658
     
184,452
     
138,692
     
108,799
     
92,559
 
To the extent secured(3)
   
68,820
     
63,082
     
45,254
     
44,664
     
43,694
 
To the extent unsecured
   
113,838
     
121,370
     
93,438
     
64,135
     
48,865
 
                                         
Amounts past due as a percentage of total loans
    2.12 %     2.23 %     1.52 %     1.05 %     0.79 %
To the extent secured(3)
    0.80 %     0.76 %     0.50 %     0.43 %     0.37 %
To the extent unsecured
    1.32 %     1.47 %     1.02 %     0.62 %     0.41 %
                                         
Loans loss allowances as a percentage of:
                                       
Total loans
    2.13 %     2.21 %     2.01 %     1.46 %     1.48 %
Total loans excluding contingent loans
    2.31 %     2.48 %     2.24 %     1.60 %     1.62 %
Total amounts past due
    100.48 %     98.90 %     132.21 %     138.79 %     188.06 %
Total amounts past due-unsecured
    161.23 %     150.31 %     196.24 %     235.44 %     356.21 %


(1)
Substandard loans in the old rating system included all loans rated B- or worse. In the new loan rating system, substandard loans include all consumer and mortgage loans rated B- or worse and all commercial loans rated C2 or worse. Therefore, the December 31, 2002 and 2003 numbers are not entirely comparable to the numbers at the year-end of 2004, 2005 and 2006.
 
(2)
Represents only the past due amounts.  In accordance with Chilean regulations, past due loans are those that are overdue for 90 days or more as to any payments of principal or interest.
 
(3)
Security generally consists of mortgages on real estate, pledges of marketable securities, letters of credit or cash.
 
Analysis of Loan Loss Allowances
 
The following table analyzes our loan loss allowances and changes in the allowances attributable to write-offs, provisions, allowances released, allowances on loans acquired and the effect of price-level restatement on loan loss allowances. Chilean GAAP requires that the loan loss allowance be debited the full amount of all charge-offs (irrespective of whether the charged-off loan was fully provisioned) and simultaneously credited the same amount through the taking of a new provision. The net effect of these two entries, which are included in the table below under “charge-offs” and “allowances established,” respectively, is to leave the loan loss allowance unchanged following the charge-off of a loan. Subsequently, at the end of each calendar month, loan loss allowances are released to the extent not needed. Such releases, which are included in the table below under “allowances released,” therefore include any amounts relating to provisions originally made in respect of loans that have been charged off.
 
96

 
   
For the Year Ended December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Loan loss allowances at beginning of the year
   
106,478
     
183,537
     
182,426
     
183,366
     
151,000
 
Increase in loan allowance due to the Merger
   
73,524
                                 
Release of allowances upon charge-offs (1)
    (88,170 )     (108,690 )     (126,394 )     (139,632 )     (143,475 )
Allowances established (2)
   
112,171
     
135,785
     
153,406
     
164,697
     
206,087
 
Allowances released(3)
    (15,291 )     (26,475 )     (21,280 )     (51,024 )     (36,414 )
Price-level restatement(4)
    (5,175 )     (1,731 )     (4,792 )     (6,407 )     (3,134 )
Loan loss allowances at end of year
   
183,537
     
182,426
     
183,366
     
151,000
     
174,064
 
Ratio of charge-offs to total loans
    1.0 %     1.3 %     1.4 %     1.3 %     1.2 %
Loan loss allowances at end of period as a percentage of total loans
    2.1 %     2.2 %     2.0 %     1.5 %     1.5 %


(1)
Reflects release of loan loss allowance equal to the entire amount of loans charged off, including any portion of such loans with respect to which no allowance had been established prior to the charge-off.
 
(2)
Includes, in addition to provisions made in respect of increased risk of loss during the period, provisions made to replace allowances released upon charge-off of loans. See Note (1) to this table.
 
(3)
Represents the amount of loan loss allowances released during the year as a consequence of reduction in the level of risk existing in the loan portfolio, including as a result of improvement in the credit risk classification of borrowers and the charge-off of loans.
 
(4)
Reflects the effect of inflation on the allowances for loan losses at the beginning of each period, adjusted to constant pesos of December 31, 2006.
 
The following table shows charge-offs by Santander-Chile by type of loans:
 
   
For the Year Ended December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Consumer loans
   
39,614
     
61,927
     
86,703
     
68,144
     
102,246
 
Residential Mortgage loans
   
2,541
     
4,869
     
4,149
     
7,314
     
5,789
 
Commercial loans
   
46,015
     
41,894
     
35,542
     
64,174
     
35,440
 
Total
   
88,170
     
108,690
     
126,394
     
139,632
     
143,475
 
 
The following table shows recoveries by Santander-Chile by type of loans:
 
   
For the Year Ended December 31,
 
   
2002
   
2003
   
2004
   
2005
   
2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Commercial loans
   
10,940
     
16,292
     
22,157
     
15,836
     
15,330
 
Consumer loans
   
15,087
     
18,972
     
26,321
     
28,865
     
29,000
 
Residential mortgage loans
   
1,416
     
1,503
     
2,294
     
2,378
     
2,737
 
Loans reacquired from the Central Bank
   
72
     
17
     
-
     
-
     
-
 
Total
   
27,515
     
36,784
     
50,772
     
47,079
     
47,067
 
 
Based on information available regarding our borrowers, we believe that our loan loss allowances are sufficient to cover known potential losses and losses inherent in a loan portfolio of the size and nature of our loan portfolio.
 
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Allocation of the Loan Loss Allowances
 
The following tables set forth, at December 31 of each of the last five years, the proportions of our required minimum loan loss allowances that were attributable to our commercial, consumer and residential mortgage loans, and the amount of voluntary allowances (which are not allocated to any particular category) at each such date.
 
   
At December 31, 2002
   
At December 31, 2003
 
   
Allowance
amount(1)
   
Allowance
amount as a
percentage of
loans in
category
   
Allowance
amount as a
percentage of
total loans
   
Allowance
amount as a
percentage
of total
allocated
allowances(2)
   
Allowance
amount(1)
   
Allowance
amount as a
percentage of
loans in
category
   
Allowance
amount as a
percentage of
total loans
   
Allowance
amount as a
percentage of
total
allocated
allowances(2)
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Commercial loans
   
115,230
      1.83%       1.34%       73.0%      
116,286
      1.97%       1.41%       66.42%  
Consumer loans
   
40,240
      5.11%       0.47%       9.2%      
47,621
      5.56%       0.57%       27.21%  
Residential mortgage loans
   
10,469
      0.68%       0.12%       17.8%      
11,159
      0.74%       0.14%       6.37%  
Total allocated allowances
   
165,966
      1.93%       1.93%       100.0%      
175,066
      2.12%       2.12%       100.0%  
Leasing
   
3,707
      0.05%       0.04%              
6,973
      0.08%       0.08%          
Voluntary allowances
   
13,864
      0.15%       0.16%              
387
      0.01%       0.01%          
Total allowances
   
183,537
      2.13%       2.13%              
182,426
      2.21%       2.21%          
 
   
At December 31, 2004
   
At December 31, 2005
 
   
Allowance
amount(1)
   
Allowance
amount as a
 percentage of
loans in
category
   
Allowance
amount as
a percentage of
total loans
   
Allowance
amount as a
percentage of
total allocated
allowances(2)
   
Allowance
amount(1)
   
Allowance
amount as
a percentage
 of loans
in category
   
Allowance
amount as a
 percentage of
total loans
   
Allowance
 amount as a
 percentage of
total
allocated
allowances(2)
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Commercial loans
   
109,167
      1.80%       1.20%       62.73%      
71,134
      1.08%       0.69%       49.73%  
Consumer loans
   
54,761
      4.75%       0.60%       31.47%      
64,060
      4.46%       0.62%       44.78%  
Residential mortgage loans
   
10,102
      0.53%       0.11%       5.80%      
7,847
      0.33%       0.07%       5.49%  
Total allocated allowances
   
174,030
      1.91%       1.91%       100.0%      
143,041
      1.38%       1.38%       100.0%  
Leasing
   
9,336
      0.10%       0.10%              
7,959
      0.08%       0.08%          
Voluntary allowances
                                                               
Total allowances
   
183,366
      2.01%       2.01%              
151,000
      1.46%       1.46%          

 
   
At December 31, 2006
 
   
Allowance
amount(1)
   
Allowance
amount as
a percentage
of loans
in category
   
Allowance
amount as a
percentage of
total loans
   
Allowance
amount as
a percentage
of total
allocated
allowances(2)
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Commercial loans
   
62,541
     
0.88
      0.53%       37.32%  
Consumer loans
   
98,253
     
5.40
      0.83%       58.63%  
Residential mortgage loans
   
6,789
      0.24%       0.06%       4.05%  
Total allocated allowances
   
167,583
      1.42%       1.42%       100.0%  
Leasing
   
6,481
      0.06%       0.06%          
Voluntary allowances
                               
Total allowances
   
174,064
      1.48%       1.48%          
 

(1)
In millions of constant Chilean pesos as of December 31, 2006.
 
(2)
Based on our loan classification, as required by the Superintendency of Banks for the purpose of determining the loan loss allowance.
 
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E. Research and Development, Patents and Licenses, etc.
 
We do not currently conduct any significant research and development activities.
 
F. Trend Information
 
As of the date of filing this Annual Report, we are unaware of any trend, uncertainty, demands, commitments or events that would have a material effect on the company’s net revenues, profitability, liquidity or capital resources that has not been discussed above or that would cause reported financial information to not necessarily be indicative of future operating results or financial conditions.  For the three month period ended March 31, 2007, our net income totaled Ch$72,189 million, an increase of 9.1% in real terms compared to the same period in 2006.  Net interest income increased by 20.6% and fee income increased by 14.6% compared to the same period in 2006.  Provision expense rose by 38.9% for the three month period ended March 31, 2007 compared to the same period in 2006.  Operating expenses increased by 7.5% compared to the same period in 2006.  The efficiency ratio reached 37.9% at March 31, 2007 compared to 38.3% at March 31, 2006.
 
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
 
A. Directors and Senior Management
 
Directors
 
We are managed by our Board of Directors, which, in accordance with our by-laws, consists of 11 directors and two alternates who are elected at annual ordinary shareholders’ meetings. The current members of the board of directors were elected by the shareholders in the ordinary shareholders’ meeting held on April 19, 2005. Members of the board of directors are elected for three-year terms. The term of each of the current board members expires on April of 2008. Cumulative voting is permitted for the election of directors. The board of directors may appoint replacements to fill any vacancies that occur during periods between elections. If any member of the board of directors resigns before his or her term has ended, and no other alternate director is available to take the position at the next annual ordinary shareholders’ meeting, a new replacing member will be elected. In January 2006, Juan Colombo resigned and on April 25, 2006 Claudia Bobadilla was elected by shareholders to the Board. On April 24, 2007, Juan Manuel Hoyos Martínez de Irujo was elected to the Board, replacing Juan Andrés Fontaine who resigned in March 2007. Our executive officers are appointed by the Board of Directors and hold office at its discretion. Scheduled meetings of the board of directors are held monthly. Extraordinary meetings can be held when called in one of three ways: by the Chairman of the board of directors, by three directors with the consent of the Chairman of the board of directors or by the majority of directors. None of the members of our Board of Directors has a service contract which entitles any Director to any benefits upon termination of employment with Santander-Chile.
 
Our current directors are as follows:
 
Directors
 
Position
 
Committees
 
Term Expires
Mauricio Larraín Garcés
 
Chairman and Director
 
Asset and Liability Committee
Executive Credit Committee
Marketing and Communications Committee
 
April 2008
Marcial Portela Alvarez
 
First Vice Chairman and Director
 
 
April 2008
Benigno Rodríguez Rodríguez
 
Second Vice Chairman and Director
 
Audit Committee
 
April 2008
Víctor Arbulú Crousillat
 
Director
 
Audit Committee
 
April 2008
Marco Colodro Hadjes
 
Director
 
Executive Credit Committee
 
April 2008
Lucía Santa Cruz Sutil
 
Director
 
 
April 2008
Juan Manuel Hoyos Martínez de Irujo
 
Director
 
 
April 2008

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Directors
 
Position
 
Committees
 
Term Expires
Juan Andrés Fontaine Talavera(1)
 
Director
 
Asset and Liability Committee
 
March 2007
Roberto Méndez Torres
 
Director
 
Executive Credit Committee
Marketing and Communications Committee
 
April 2008
Carlos Olivos Marchant
 
Director
 
Audit Committee
Executive Credit Committee
 
April 2008
Roberto Zahler Mayanz
 
Director
 
Asset and Liability Committee
 
April 2008
Claudia Bobadilla Ferrer
 
Director
 
 
April 2008
Raimundo Monge Zegers
 
Alternate Director
 
 
April 2008
Jesús Zabalza Lotina
 
Alternate Director
 
 
April 2008
 

 
(1) Resigned in March 2007.
 
Mauricio Larraín Garcés is our Chairman. He is a member of the Asset and Liability Committee, the Executive Credit Committee and the Marketing and Communication Committee. He is the former Executive Vice Chairman of the Board of Directors of Old Santander-Chile. He is also director of Santander Chile Holding S.A. and Universia Chile S.A. He is a director of the Asociación de Bancos e Instituciones Financieras de Chile.  Mr. Larraín began working at Santander-Chile in 1989. Previous to that he was Intendente of the Superintendency of Banks, Manager of External Debt at the Banco Central de Chile and a Senior Finance Specialist at the World Bank in Washington. He holds degrees in Economics (Candidate) and in Law from Universidad Católica de Chile and from Harvard University.
 
Marcial Portela Alvarez became a Director on May 6, 1999 and Vice Chairman of the Board on May 18, 1999. He currently oversees all of Banco Santander Central Hispano’s investments in Latin America and was the Director of Administration (Medios) at Banco Santander from November 1998 until the formation of Banco Santander Central Hispano. In the past, he was the CEO of Telefónica Internacional, Vice Chairman of Telefonica España and the Managing Director of Banco Argentaria and also worked at several other banks, including Banco Exterior, Caja Postal, Banco Hipotecario and BBV. Mr. Portela is also a member of the Advisory Council of the University of Chicago and a professor at Universidad Deusto. Mr. Portela holds a degree in Sociology from the University of Lovaina and a Political Science degree from the Universidad de Madrid.
 
Benigno Rodríguez Rodríguez became a Director on March 19, 1996. He is a member of the Audit Committee. He served as Vice Chairman of the Board of Santiago from April 17, 2002 through the date the merger was consummated. Before that he served as Santiago’s Director of Management Information Systems. He is a director of Santander Chile Holding S.A., Aurum S.A., Altec Chile, Teatinos Siglo XXI, Santander Holding Perú and Segovía XXI España. Mr. Rodriguez holds a degree in Economics from the Universidad Complutense of Madrid.
 
Víctor Arbulú Crousillat became a Director on May 6, 1999. He is a member of the Audit Committee. He is also director of Teatinos Siglo XXI and Aurum S.A. He was a Managing Director of JPMorgan, member of its European management committee and Chief Executive Officer for Spain and Portugal from 1988 until 1998. He has worked for JPMorgan for over 25 years in various positions in Europe, North America and South America. Mr. Arbulu also worked for the Inter-American Development Bank. Mr. Arbulu holds a degree in Engineering and a Masters of Business Administration.
 
Marco Colodro Hadjes became a Director on April 19, 2005. Mr. Colodro is a member of the Executive Credit Committee.  Mr. Colodro also serves as a Director of Telefónica Chile and a Director of Codelco. He is a former chairman of TVN (national television network) and vice chairman of Banco del Estado (state bank). He was also owner of Agencia de Valores Alfa S.A. Prior to that he was Foreign Trade Director at the Central Bank of Chile. Mr. Colodro holds a degree in Economics from Universidad de Chile, and a Ph.D. from University of Paris.
 
Lucía Santa Cruz Sutil became a Director on August 19, 2003. Ms. Santa Cruz holds a degree in History and a Masters Degree in Philosophy from Oxford University. She has been a Director of the Political Economy Institute of Universidad Adolfo Ibañez since 2001. Ms. Santa Cruz is also a director of Universia Chile S.A. She is also on the Board of Compañía de Seguros Generales y de Vida La Chilena Consolidada and Fundación Minera Escondida. She
 
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is also on the Advisory Board of Nestle Chile and the Fundación Educacional Santa Teresa de Avila. She is also a member of the Self-Regulation Committee for Insurance Companies in Chile.
 
Juan Manuel Hoyos Martínez de Irujo was the Managing Director of McKinsey & Company in Spain between 1997 and 2004. He was also President of the Client Committee of this company’s Board. Currently, he is in charge of partner development worldwide and is still part of the Board of the firm.  His consulting career has been focused in the areas of strategy and organization of corporations, especially in the telecommunications, banking and metallurgy sectors. He has worked with companies in Spain, USA, Latin America, United Kingdom, Portugal and Africa. He is an Economist from the Universidad Complutense de Madrid and he has an MBA in Finance and Accounting from Columbia University. He began his career in 1978 at Mckinsey, he was named partner in 1984 and Director in 1991.
 
Juan Andrés Fontaine Talavera became a Director on February 26, 1998 and resigned as Director in March 2007. He was a member of the Asset and Liability Committee. He is a senior partner at Juan Andrés Fontaine y Asociados, an economic consulting firm in Chile, a board member of several companies and a professor at the Catholic University in Chile.
 
Roberto Méndez Torres is a former member of the Board of Old Santander-Chile, to which he was appointed in 1996. He is a member of the Executive Credit Committee and the Marketing and Communication Committee. He is also Director of AFP Bansander S.A. and Director of Universia S.A.  He is a professor of Economics at Universidad Católica de Chile. Mr. Mendez also sits on the Consejo Consultor del Rector de la Universidad Católica de Chile. He has been Advisor to Grupo Santander-Chile since 1989. Mr. Méndez is President and Director of Adimark Chile. He graduated with a degree in Business from Universidad Católica de Chile, and holds an MBA and a Ph.D. from the Graduate School of Business at Stanford University.
 
Carlos Olivos Marchant became a Director on April 15, 1987. He is Chairman of the Audit Committee and a member of the Executive Credit Committee. He was Chairman of the Board of Santiago from May, 1999 until the date of the merger. He is also a director of Compañia Cervecerías Unidas S.A., Inversiones Rentas S.A. and Inversiones Tajamar Ltda. Prior to that, he was Vice Chairman of the board since March 31, 1998. He is a partner in the law firm Guerrero, Olivos, Novoa y Errazuriz. From 1981 to 1983, Mr. Olivos served as General Counsel of the Central Bank of Chile, and from 1984 to 1986 he served as Chairman of the board of directors of Banco Osorno. Mr. Olivos holds a law degree from the Universidad de Chile and a Masters of Jurisprudence from New York University School of Law.
 
Roberto Zahler Mayanz became a Director on August 31, 1999. He is a member of the Asset and Liability Committee. Currently, he is President of Zahler & Co, a consulting firm. He is also director of Air Liquide-Chile and member of the CLAAF or the Latin American Committee for Financial Affairs. He was also President of the Board of Siemens Chile and the Advisory Board of Deutsche Bank Americas Bond Fund. He was also a visiting professor at the IMF’s Research Department and a member of the Quota Formula Review Committee of the International Monetary Fund. Between 1991 and 1996 he was President of the Central Bank of Chile and Vice-President from 1989-1991. He also serves as a consultant for the World Bank, the IDB, the IMF and the International Bank of Settlements. Mr. Zahler has also provided technical assistance to various Central Banks and Finance Ministries in most countries of Latin America, Indonesia, Kosovo and Thailand. Mr. Zahler holds a degree in Business Administration from the Universidad de Chile and a Masters in Economics from the University of Chicago.
 
Claudia Bobadilla Ferrer was elected to the Board in April 2006. She is CEO of Fundación País Digital, a member of the Executive Committee of Innovation and Technology of ICARE, council member of Endeavor Chile and Executive Director of the Chile-Japón Siglo XXI Committee. She was also founder and President of Comunidad Mujer, an organization dedicated to increasing women’s participation in the workforce. She was previously Director of Legal Affairs at Terra Networks Chile S.A. Between 2003 and 2005 she was an external consultant to companies in matters regarding work and family and was a manager of an alliance between the private sector and the Ministry of Education regarding quality certification of nursery schools and day care centers. She is a lawyer from the Universidad Diego Portales.
 
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Raimundo Monge Zegers became an Alternate Director on April 29, 2003. He is Corporate Director of Strategic Planning for Grupo Santander-Chile and is CEO of Santander-Chile Holding S.A. and Santander Inversiones Ltda. He is also President of Santander S.A. Sociedad Securitizadora and Santander Factoring S.A. He is a director of Santander Multimedios S.A., Soince S.A., AFP Bansander S.A., Santiago Leasing S.A., Teatinos Siglo XXI S.A. and Bansa Santander S.A.. Mr. Monge has a degree in business from the Universidad Católica de Chile and a MBA from the University of California, Los Angeles.
 
Jesús Zabalza Lotina became a Director on April 19, 2005. He has worked for 22 years in the Spanish financial systems, and served as CEO in Banco Viscaya, Banco Hipotecario, Caja Postal and La Caixa. He as also served as director in several affiliate companies on La Caixa and Telefónica in Spain. He is Managing Director of America’s División of Santander Group for retail banking, and vice president of the Spanish Association of Finance Executives (AEEF). He also serves as Director of Banco Santander Bancorp in Puerto Rico. Mr. Zabalza holds a degree in Industrial Engineering from the University of Bilbao.
 
Senior Management
 
Our senior managers are as follows:
 
Senior Manager
 
Position
 
Date Appointed
Oscar von Chrismar
 
Chief Executive Officer
 
August 1, 2003
José Alberto García Matanza
 
Corporate Director of Credit Risk
 
January 1, 2005
Guillermo Sabater
 
Corporate Financial Controller
 
July 1, 2006
Ramón Sanchez
 
Corporate Director of Internal Audit
 
January 1, 2004
José Manuel Manzano
 
Corporate Director of Human Resources
 
October 31, 2002
Andres Roccatagliata
 
Manager, Retail Banking
 
October 31, 2002
Fernando Massú
 
Manager, Global Banking
 
October 6, 2005
Alejandro Cuevas
 
Manager, Banefe Consumer Division
 
July 18, 2002
Andrés Heusser
 
Manager, Middle-market Banking
 
October 1, 2004
Roberto Jara
 
Chief Accounting Officer
 
July 18, 2002
Juan Fernández
 
Manager, Administration and Operations
 
July 18, 2002
Gonzalo Romero
 
General Counsel
 
July 18, 2002
 
Oscar von Chrismar C. became the CEO of Santander-Chile in August 2003 after being Manager of Global Banking following the merger. Prior to that he was the former CEO of Old-Santander Chile since September 1997, after being General Manager of Banco Santander-Peru since September 1995. Mr. von Chrismar is also President of Santander S.A. Agente de Valores and a director of Santiago Leasing S.A. Prior to that, Mr. von Chrismar was the manager of the Finance Division of Santander-Chile, a position he had held since joining Santander-Chile in 1990. Mr. von Chrismar holds an Engineering degree from the Universidad de Santiago de Chile.
 
José Alberto García Matanza became Director of the Risk Division in January 2005. Mr. García has served in various senior positions Banco Santander Central Hispano since 1990 in Spain, Colombia and Argentina. Mr. García holds a degree in Economics from the University of Cantabria, Spain.
 
Guillermo Sabater is the Corporate Financial Controller of Santander-Chile, and is in charge of the Accounting and Financial Control Departments. He has held this position since July 2006. Previously, Mr. Sabater was responsible for Risk and Management Control at Santander Consumer (the European Consumer Finance Division of Santander Group) at the Madrid headquarters and Internal Audit Manager of the Group. Mr. Sabater has an Economics and Business Administration degree from C.U.N.E.F. (Universidad Complutense of Madrid).
 
Ramón Sánchez is the Corporate Director of Internal Auditing, a position he has held since January 2004. Previously, Mr. Sánchez was Director of Internal Auditing in Banco Santander in Puerto Rico. Mr. Sánchez has served in various positions in Banco Santander Central Hispano since 1995, including Senior Vice President of auditing in Madrid. Mr. Sánchez holds a law degree from the Universidad of Salamanca.
 
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José Manuel Manzano was appointed Corporate Director of Human Resources for Santander-Chile on October 31, 2002. Previously he served as Manager of Human Resources for Old Santander-Chile since 1999. Prior to that he was General Manager of Santander Fund Management and Managing Director of Bancassurance. He is also a Director of Santander Chile Holding. Mr. Manzano holds an MBA and a degree in Business from Universidad Católica de Chile.
 
Andrés Roccatagliata is our Retail Banking Manager. He is the former manager of Old Santander-Chile’s Retail Division, a position he held from 1999 until August 2002, when the merger with Santiago was consummated. Mr. Roccatagliata is also a director of Santander Santiago S.A. Administradora de Fondos Mutuos, Altavida Santander Seguros de Vida S.A. and Redbank S.A. Prior to that he served as Manager of Distribution of Old Santander-Chile in June 1997 and was responsible for the branch network of Old Santander-Chile. From 1993 to 1997, Mr. Roccatagliata was the Commercial Manager of Banefe. Before that, he was a Regional and Branch Manager from 1987 to 1990. Mr. Roccatagliata holds a degree in business from the Universidad de Santiago and an MBA from the Universidad Adolfo Ibáñez.
 
Fernando Massú Taré is the Manager of Global Banking that includes wholesale banking and treasury services. He is the former manager of the Treasury and Finance Division of Old-Santander Chile, a position he held since May 1995. Mr. Massú is also a director of Santander Santiago S.A. Administradora de Fondos Mutuos and Sociedad Interbancaria de Depósito de Valores S.A. From September 1992 until May 1995 he was Treasurer at Banco de Comercio e Industria, a Portuguese affiliate of Banco Santander Central Hispano, S.A., and prior to that he was a Vice-President at Citibank, Chile. Mr. Massú, a graduate of Universidad Técnica Federico Santa María, holds a degree in Business Administration.
 
Alejandro Cuevas became Manager of the Banefe Division of Santander-Chile in January 2000. Mr. Cuevas is also a director of Altavida Santander Seguros de Vida S.A. and Transbank S.A. Prior to that he was the Commercial Manager of Banefe between May 1997 and December 1999 and Marketing Manager of Banefe from March 1995 to May 1997. Mr. Cuevas has a business degree from Universidad de Chile.
 
Andrés Heusser is our Middle Banking Manager. He has held the same position in the Old Santander-Chile since 1990, when he joined the Santander Group. Mr. Heusser is also a director of Santiago Leasing S.A. and Santander Factoring S.A. Mr. Heusser holds a degree in business from the Universidad de Santiago and an MBA from the Universidad Adolfo Ibáñez.
 
Roberto Jara is our Chief Accounting Officer. He is the former Chief Accounting Officer at Old Santander-Chile, a position he held from March 1998 until August 2002, when the merger with Santiago was consummated. He joined Old Santander-Chile in 1978 and held several positions there, such as Sub-Manager of Budget and Costs and Chief of IT Projects. Mr. Jara is a CPA and holds a degree in Tax Management from Universidad Adolfo Ibañez.
 
Juan Fernández is our manager of Administration and Operations. He is the former Manager of Administration and Cost Control of Old Santander-Chile, a position he held from April 1999 until August 2002, when the merger with Santiago was consummated. Mr. Fernández is also Director of Santander Chile Holding S.A., Santander S.A. Sociedad Securitizadora, Santander Factoring S.A., Altec S.A., Bansa Santander S.A., Multinegocios S.A. and Procura Digital Chile S.A. Previously Mr. Fernández served as Manager for Accounting and Administration of Old Santander-Chile since January 1993.  Prior to that, Mr. Fernández  held positions at Banchile Agencia de Valores y Subsidiarias, and at JPMorgan in Santiago and Madrid.
 
Gonzalo Romero is our General Counsel, a position he has held since July 18, 2002. He is also a director of Santander Santiago S.A. Sociedad Securitizadora. Mr. Romero, a lawyer, joined Old Santander-Chile in February 1997 as General Counsel.  He was the General Manager of Banco Concepción from 1991 to 1996 and the General Counsel of Banco Concepción from 1986 to 1990. He has a Degree in Law from the Universidad de Chile.
 
B.   Compensation
 
For the year ended December 31, 2006, the aggregate amount of compensation paid by us to all of our directors was Ch$489,3 million, including attendance fees and monthly stipends. For the year ended December 31, 2006, the
 
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aggregate amount of compensation paid by us to all of our executive officers and our management members was Ch$28,307 million (US$52.9 million). At our annual shareholder meeting held on April 25, 2007, shareholders approved a monthly stipend per director of UF 209 (US$7,171). This amount will be increased by UF 25 per month (US$858) if a Board member is named to one or more committees of the Board.  In addition, we pay certain directors professional service fees for the consulting services they rendered to us in their fields of expertise. For the year ended December 31, 2006, payments to our directors for consulting fees totaled Ch$410 million (US$767,000).
 
We do not pay any contingent or deferred compensation and there is no stock option or profit-sharing plan for our administrative, supervisory or management personal. Furthermore, nothing was set aside or accrued by us to provide pension, retirement or similar benefits for our directors and executive officers.
 
We pay bonuses to our administrative, supervisory and management personnel based on pre-defined goals (mainly commercial but also including items such as customer satisfaction) and our overall performance in the year. These bonuses are provisioned for monthly, according to the degree of accomplishment of our budget. We also give bonuses throughout the year to commercial teams for performance in other commercial contests. None of the members of our Board of Directors has a service contract which would entitle any director to any benefits upon termination of employment with Santander-Chile. Santander-Chile currently does not have any profit-sharing arrangements with its employees. There is no system for the granting of options or securities of Santander - Chile to employees. In January 2007, the management of Banco Santander Central Hispano announced an intention to grant each active employee working for Banco Santander Central Hispano or an entity controlled by Banco Santander Central Hispano as of June 2007 a one-time gift of 100 shares in Banco Santander Central Hispano to celebrate its 150th anniversary.
 
C.   Board Practices
 
Summary Comparison of Corporate Governance Standards and New York Stock Exchange Listed Company Standards
 
As a “Foreign Private Issuer” under the United States Securities Exchange Act of 1934 that is listed on the New York Stock Exchange (“NYSE”), we are required to provide a brief general summary of the significant ways in which our corporate governance standards, which are dictated by Chilean corporate law, differ from those followed by U.S. companies under NYSE listing standards.
 
Please note that because more than 50% of our voting power is held by another company, Banco Santander Central Hispano, S.A., we would be permitted to elect certain exemptions under NYSE corporate governance standards. Specifically, as a U.S. company, we could elect to be exempted from the requirements (i) that we have a majority of independent directors (as defined by the NYSE), (ii) that we have a nominating/ corporate governance committee meeting certain conditions, and (iii) that we have a compensation committee meeting certain requirements. Because we would not be required to follow these standards if we were a U.S. company, we do not discuss the differences, if any, between these provisions and our own corporate governance procedures in the table below.
 
The table below summarizes the significant differences between our corporate governance standards and those required by the NYSE for listed U.S. companies.
 
NYSE Listed Company Requirement
 
Santander-Chile Corporate Governance Standard
Non-management directors must meet at regularly scheduled executive sessions without management.
 
Under Chilean law, a company’s executive officers may not serve as such company’s directors. As a result, our board consists entirely of “non-management” directors, making separate meetings unnecessary.
     
Shareholders must be given the opportunity to vote on all equity-compensation plans and material revisions thereto.
 
Shareholders’ vote is not required for any equity-compensation plans other than those for the directors. Our compensation policies currently do not provide for equity compensation, therefore do not trigger shareholders’ vote.
 
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Listed companies must adopt and disclose corporate governance guidelines.
 
We follow the corporate governance guidelines established under Chilean laws, a summary of which is included in this 20-F.
     
Listed companies must adopt and disclose a code of business conduct and ethics for directors and employees, and promptly disclose any waivers of the code for directors or executive officers.
 
We have a code of business ethics and conduct which must be signed by all employees and are included as exhibits to this 20-F.
 
Summary of Corporate Governance Standards
 
Santander-Chile has adopted diverse measures to promote good corporate governance. Among the measures adopted are:
 
 
·
Board of Directors mainly composed of professionals not related to Banco Santander Central Hispano, our parent company.
 
 
·
Active participation of directors in main committees of the Bank.
 
 
·
All personnel must subscribe to a code of ethics and good conduct. Those who interact directly with the capital markets must also subscribe to an additional code of conduct.
 
 
·
Segregation of functions in order to assure adequate management of risks. Commercial functions separated from back office functions. Risk management functions independent of commercial functions. Main credit decisions taken in committees.
 
 
·
Internal Auditing functions clearly independent from the administrative functions.
 
 
·
The Bank also has an Internal Compliance Division that oversees the fulfillment of the Bank’s codes of conduct.
 
Santander-Chile has a commitment to transparency. This includes:
 
 
·
Equal treatment for all shareholders. One share = one vote.
 
 
·
Monthly publication of the Bank’s results by the Superintendency of Banks.
 
 
·
Quarterly report of a detailed analysis of Bank results published by us about 30 days after the close of each interim quarter and 40 days after close of the full year.
 
 
·
Quarterly conference call open to the public.
 
 
·
All information relevant to the public available immediately on the web page www.santandersantiago.cl.
 
 
·
Ample and periodic coverage of Bank by international and local stock analysts.
 
 
·
The Bank has five credit risk ratings by five independent rating agencies, local and international.
 
Audit Committee
 
Board member
 
Position in Committee
Carlos Olivos
 
Chairman
Benigno Rodríquez. R.
 
Vice Chairman
Víctor Arbulú. C.
 
Member
 
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The Audit Committee (Comité de Directores y Auditoría) is comprised of three members of the board of directors.  The General Secretary is the Committee Secretary.  The Chief Executive Officer, General Auditor and other persons from the Bank can be invited to the meetings if necessary and presents on specific matters. This Committee’s primary responsibility is to support the board of directors in the continuous improvement of our system of internal controls, which includes reviewing the work of both the external auditors and the Internal Audit Department. The committee is also responsible for analyzing observations made by regulatory entities of the Chilean financial system about us and for recommending measures to be taken by our management in response. This committee also performs functions of a remuneration committee as established in Chilean Law, and reviews annually the salary and bonus programs for the executive officers of the Bank.  The external auditors are recommended by this committee to our board of directors and appointed by our shareholders at the annual shareholders’ meeting.
 
Additionally, this committee is responsible for:
 
 
·
Presenting to the board of directors a list of candidates for the selection of an external auditor.
 
 
·
Presenting to the board or directors a list of candidates for the selection of rating agencies.
 
 
·
Overseeing and analyzing the results of the external audit and the internal reviews.
 
 
·
Coordinating the activities of internal auditing with the external auditors’ review.
 
 
·
Analyzing the interim and year-end financial statements and reporting the results to the board of directors.
 
 
·
Analyzing the external auditors’ reports and their content, procedures and scope.
 
 
·
Analyzing the rating agencies’ reports and their content, procedures and scope.
 
 
·
Obtaining information regard the effectiveness and reliability of the internal control systems and procedures.
 
 
·
Analyzing the information systems performance, its sufficiency, reliability and use in connection with decision-making processes.
 
 
·
Obtaining information regarding compliance with the company’s policies regarding the due observance of laws, regulations and internal rules to which the company is subject.
 
 
·
Obtaining information and resolve conflict of interest matters and investigating suspicious and fraudulent activities.
 
 
·
Analyzing the reports of the inspection visits, instructions and presentations of the Superintendency of Banks.
 
 
·
Obtaining information, analyzing and verifying the company’s compliance with the annual audit program prepared by the Internal Audit Department.
 
 
·
Informing the board of directors of accounting changes and their effects.
 
 
·
Examining on an annual basis the compensation plans of high level executives and managers.
 
Asset and Liability Committee
 
Board member
 
Position in Committee
Mauricio Larraín
 
Chairman
Roberto Zahler
 
Member
Juan Andrés Fontaine
 
Member
 
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The Comité de Activos y Pasivos or the Asset and Liability Committee (the “ALCO”), following guidelines set by the Board of Directors, Santander Central Hispano’s Global Risk Department, is responsible for establishing Santander-Chile’s policies, procedures and limits with respect to market risks and monitoring the overall performance in light of the risks assumed. The ALCO constantly monitors whether these policies are fulfilled. Santander-Chile’s Market Risk and Control Department and the Finance Division carry out the day-to-day risk management of the trading and non-trading activities of Santander-Chile.
 
The composition of the Asset and Liabilities Committee includes the Chairman of the Board, two additional members of the Board, the Chief Executive Officer, the Manager of the Finance Division, the Manager of Market Risk, the Financial Controller and other senior members of management. Senior members of Santander-Chile’s Finance Division meet monthly on a formal basis with the Asset and Liabilities Management Committee and outside consultants.
 
Executive Credit Committee
 
Board member
 
Position in Committee
Mauricio Larraín
 
Chairman
Carlos Olivos
 
Member
Roberto Méndez
 
Member
Marco Colodro
 
Member
 
The Executive Credit Committee is comprised of the Chairman of the Board, three additional Board members, the Corporate Legal Counsel, the CEO, the Manager of Global Banking, the Corporate Director of Risk, the Manager of Corporate Banking, the Manager of Middle Market and two senior members of the Credit Risk department that present the loans being reviewed for approval. This committee confirms the loan positions reviewed by the Senior Credit Committee, with approval rights up to the maximum exposure permitted by the General Banking Law.
 
Marketing and Communications Committee
 
Board member
 
Position in Committee
Mauricio Larraín
 
Chairman
Roberto Méndez
 
Member
 
The Marketing and Communications Committee is comprised of the Chairman of the Board and an additional Board member, the CEO, the Manager of Retail Banking, the Manager of Banefe, the Manager of Human Resources, the Manager of Corporate Communications, the Manager of Marketing and other senior managers of the Bank. This committee reviews and confirms all matters related to products, corporate image and communications.
 
D.    Employees
 
As of December 31, 2006, on a consolidated basis, we had 8,184 employees, 7,839 of whom were bank employees and 345 of whom were employees of our subsidiaries. With respect to the average number of employees for the Bank only, during the year ended December 31, 2005 and 2006 we had an average of 7,192 and 7,607 employees, respectively. We have traditionally enjoyed good relations with our employees and their unions. Of the total headcount, 3,510 or 42,9% were unionized. In 2003, we signed a collective bargaining agreement with the Bank’s main unions. In November 2006, we concluded advance negotiations of a new collective bargaining agreement to replace the 2003 agreement. The new collective bargaining agreement became effective on March 1,2007 and will expire on March 1, 2011. The primary terms of the new collective bargaining agreement include improved employee benefits relating to scholarships, sick days and insurance coverage for employees and a 5% increase in salaries as of May 2007 for employees with gross monthly incomes below Ch$800,000 (US$1,500). Furthermore, we agreed to award an end-of-negotiation bonus based on the level of salaries, and non-executive employees will receive an additional special bonus based on each employee’s years of service at the Bank. The payment of these bonuses represents a total cost of US$20 million. We generally apply the terms of our collective
 
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bargaining agreement to unionized and nonunionized employees. The following chart summarizes the number of employees employed by the bank.
 
Employees
 
2006
Executives                                
 
     365
Professionals                                
 
  3,970
Administrative
 
  3,849
Total                                
 
  8,184
 
E.    Share Ownership
 
As of December 31, 2006, the following directors and executives held shares in Santander-Chile:
 
Director
 
Number of Shares
Mauricio Larraín G
 
     568
Juan Andrés Fontaine T
 
    561,954 (1)
Juan Fernández F
 
35,536

(1)
Resigned as Director in March 2007.
 
No director or executive officer owns more than 1% of the shares of Santander-Chile.
 
Santander-Chile currently does not have any arrangements for involving employees in its capital and there is no systematic arrangement for grant of options or shares or securities to them.  However, our parent company, Banco Santander Central Hispano,  has announced that it will be granting to each employee working for an entity within the Banco Santander Central Hispano group 100 shares in Banco Santander Central Hispano in 2007. See "B. Compensation" above.
 
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
 
A.   Major Shareholders
 
As of December 31, 2006, Santander-Chile’s largest shareholders were the following:
 
 
Shareholder
 
Number of Shares
   
Percentage
 
Teatinos Siglo XXI S.A.
   
78,108,391,607
      41.45 %
Santander Chile Holding
   
66,822,519,695
      35.46 %
 
Banco Santander Central Hispano controls Santander-Chile through its holdings in Teatinos Siglo XXI and Santander-Chile Holding, which are controlled subsidiaries of Banco Santander Central Hispano. As of December 31, 2006, Banco Santander Central Hispano directly or indirectly owned or controlled 99.5% of Santander-Chile Holding and directly or indirectly owned or controlled 100% of Teatinos Siglo XXI S.A. This gives Banco Santander Central Hispano control over 76.91% of the shares of the Bank, and an economic participation, when excluding minority shareholders, of 76.73% at December 31, 2006.
 
Prior to December 11, 2006, Grupo Empresarial Santander, a subsidiary of Banco Santander Central Hispano, held 7.23% of Santander-Chile’s outstanding capital stock in the form or ADSs.  On December 11, 2006, Grupo Empresarial Santander sold its entire holding of our shares through a registered public offering.  As a result of this offering, Banco Santander Central Hispano currently owns, directly or indirectly, 76.91% of our outstanding capital stock.
 
Banco Santander Central Hispano is in a position to cause the election of a majority of the members of Santander-Chile’s Board of Directors, to determine its dividend and other policies and to determine substantially all matters to be decided by a vote of shareholders.  Banco Santander Central Hispano holds ordinary shares to which no
 
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special voting rights are attached. Each share represents one vote and there are no shareholders with different voting rights.
 
The number of outstanding shares of Santander-Chile (of which there is only one class, being ordinary shares) at December 31, 2006 was 188,446,126,794 shares, without par value. Santander-Chile’s shares are listed for trading on the Chilean Stock Exchanges and on the New York Stock Exchange in the form of ADRs. The market capitalization of Santander-Chile at the same date was Ch$4,673,463 million (US$8,745 million), representing 188,446,126,794 shares of common stock. At December 31, 2006, Santander-Chile had 13,909 holders registered in Chile, including the Bank of New York, as depositary (the “Depositary”) of Santander-Chile’s American Depositary Share Program. As of December 31, 2006, there were a total of 8 ADR holders on record. Since some of these ADRs are held by nominees, the number of record holders may not be representative of the number of beneficial holders.
 
Other than the information disclosed in this section, there are no arrangements, in the knowledge of Santander-Chile, which can result in a change of control of Santander-Chile.
 
B.   Related Party Transactions
 
The Chilean Companies Law requires that our transactions with related parties be on a market basis, that is, on similar terms to those customarily prevailing in the market.  We are required to compare the terms of any such transaction to those prevailing in the market at the date the transaction is to be entered into.  Directors of companies that violate this provision are liable for losses resulting from such violations.
 
In addition, under the Chilean Companies Law, a company may not enter into a transaction in which one or more of its directors has a direct or indirect interest unless (i) such transaction has received the prior approval of the company’s board of directors and (ii) the terms of such transaction are consistent with the terms of transactions of a similar type prevailing in the market.  If  it is not possible to make this determination, the board may appoint two independent evaluators.  The evaluators’ final conclusions must be made available to shareholders and directors for a period of 20 business days, during which shareholders representing 5% or more of the issued voting shares may request the board to call a shareholders’ meeting to resolve the matter, with the agreement of two thirds of the issued voting shares required for approval.  For purposes of this regulation, the law considers the amount of a proposed transaction to be material if (1) it exceeds 1% of the company’s net worth (provided that it also exceeds 2,000UF) or (2) it exceeds 20,000 UF.
 
All resolutions approving such transactions must be reported to the company’s shareholders at the next annual shareholders’ meeting.  Violations of this provision may result in administrative, criminal or civil liability to the corporation, the shareholders and/or third parties who suffer losses as a result of such violation.
 
Loans granted to related parties
 
Related party loans, all of which are current, are as follows:
 
   
As of December 31, 2006
 
   
Loans
   
Collateral Pledged
 
   
(in millions of constant Ch$ as of December 31, 2006)   
Operating companies
   
150,070
     
112,986
 
Investment companies (1)
   
203,261
     
3,948
 
Individuals (2)
   
24,450
     
22,343
 
Total
   
377,781
     
139,277
 

(1)
Includes companies whose purpose is to hold shares in other companies.
 
(2)
Includes debt obligations that are equal to or greater than UF3,000, the aggregate principal amount of which amounted to an equivalent of US$102,930 at December 31, 2006. Includes loans to certain executive officers. All of the loans to the executive officers were made in our
 
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ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectibility or present other unfavorable features.
 
Under the Chilean General Banking Law, Chilean banks are subject to certain lending limits, including the following:
 
 
·
a bank may not extend to any person or legal entity (or group of related entities), directly or indirectly, unsecured loans in an amount that exceeds 5.0% of the bank’s regulatory capital, or secured loans in an amount that exceeds 25.0% of its regulatory capital. In the case of foreign export trade finance, this 5.0% ceiling is raised to: 10.0% for unsecured financing, 30.0% for secured financing. This ceiling is raised to 15.0% for loans granted to finance public works under the concessions system contemplated in the Decree with Force of Law 164 of 1991, of the Ministry of Public Works, provided that either the loan is secured on the concession, or the loan is granted as part of a loan syndication;
 
 
·
a bank may not grant loans bearing more favorable terms than those generally offered by banks in the same community to any entity (or group of related entities) that is directly or indirectly related to its owners or management;
 
 
·
a bank may not extend loans to another bank in an aggregate amount exceeding 30.0% of its regulatory capital;
 
 
·
a bank may not directly or indirectly grant a loan the purpose of which is to allow the borrower to acquire shares in the lending bank;
 
 
·
a bank may not lend, directly or indirectly, to a director or any other person who has the power to act on behalf of the bank, or to certain related parties;
 
 
·
a bank may not grant loans to individuals or legal entities involved in the ownership or management of the bank, whether directly or indirectly (including holders of 1.0% or more of its shares), on more favorable terms than those generally offered to non-related parties. Loans may not be extended to senior executives and to companies in which such individuals have a participation of 5.0% or more of the equity or net earnings in such companies. The aggregate amount of loans to related parties may not exceed a bank’s regulatory capital; and
 
 
·
the maximum aggregate amount of loans that a bank may grant to its employees is 1.5% of its regulatory capital, and no individual employee may receive loans in excess of 10.0% of such 1.5% limit. These limitations do not apply to a single home mortgage loan for personal use per term of employment of each employee.
 
 
 
We are not aware of any loans to any related parties exceeding the above lending limits.
 
Other transactions with related parties:
 
During the years ended December 31, 2006, the Bank had the following significant income (expenses) from services provided to (by) related parties:
 
   
Year ended December 31, 2006
 
Company
 
Income/(Expenses)
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Redbanc S.A. (payment for administering ATM network)
    (4,056 )
Transbank S.A. (payments for administering credit card network)
    (8,168 )
Sixtra Chile S.A. (Computer services)
   
-
 
Santander G.R.C. Ltda. (collection services)
    (1,563 )
Santander Chile Holding S.A. (rent)
   
32
 
 
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Year ended December 31, 2006
 
Company
 
Income/(Expenses)
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Santander Factoring S.A. (rent)
   
52
 
Bansa Santander S.A. (rent and sale of repossessed assets)
    (2,426 )
AFP Bansander S.A (rent)
   
179
 
Altec S.A. (technology services)
    (5,627 )
Santander Investment Chile S.A. (rent)
   
91
 
Altavida Cia. De Seguro De Vida S.A. (rent and payment of life insurance policies relating to certain loans)
    (1,005 )
Plaza El Trebol S A (rent)
    (195 )
Other(1)
    (479 )
Total
    (23,165 )

(1)   Consists primarily of payment of stipend to Board members.
 
 
C.   Interests of Experts and Counsel
 
Not applicable.
 
ITEM 8. FINANCIAL INFORMATION
 
A.   Consolidated Statements and Other Financial Information
 
Financial Information
 
See “Item 18: Financial Statements”
 
Legal Proceedings
 
On August 28, 1996, Banco Español de Crédito (later acquired by Banco BBVA BHIF) filed a complaint against Auca Forestal S.A. and O’Higgins Corredores de Bolsa Ltda. (currently Santander Investment S.A. Corredores de Bolsa, a subsidiary of the Bank ). This suit was resolved in favor of the plaintiff in July, 2006.  As of December 31, 2006, the subsidiary maintained a provision of Ch$271 million, which covers this contingency in its entirety and is in process of being liquidated once the interest payment is determined.
 
On August 26, 1992, a suit was filed by the Chilean Internal Revenue Service against the Bank and is still pending.  The Appeals Court partially resolved in favor of the Bank and substantially reduced the amount of tax contested.  In the opinion of our legal advisors, these claims are not likely to have, individually or in the aggregate, a material adverse effect on our consolidated financial condition or results of operations, and as of December 31, 2006, the Bank maintained a provision of Ch$530 million, which covers the entire claim.
 
Banco Santander-Chile and Santander S.A. Agente de Valores (“Agencia”) were subject to a lawsuit brought by Orsini con Orsini y Otros, which was seeking damages in an amount of approximately US$500,000, claiming the Bank and the Agencia incorrectly issued and cashed funds from a deceased client’s account. In 2006, the Supreme Court ruled in our favor, bringing an end to this legal proceeding.
 
As a result of a fraud committed by Grupo Inverlink against the Corporación de Fomento de la Producción (CORFO) and others, various legal actions were brought against certain instruments that are managed by the funds administered by Santander S.A. Administradora General de Fondos, a subsidiary of the Bank. Grupo Inverlink fraudulently obtained financial instruments from CORFO, mainly time deposits, and sold them in the market. Unaware of the illegal actions of Grupo Inverlink, the funds managed by a subsidiary of us acquired and administered these instruments. On March 13, 2003, our subsidiary signed a letter stating that it will return to CORFO the value of these instruments if ordered by a court to do so, which freed up the financial instruments from
 
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legal action. As no legal proceedings have been instituted against us in connection with this matter, we have not made any provisions in respect of it.
 
Our General Counsel was indicted by the national treasury in a lawsuit regarding the repayment by Inverlink Corredores de Bolsa of a Ch$980 million (equivalent to US$1.8 million) loan made to it by Banco Santander Chile. Repayment was made by tendering to Banco Santander Chile a cashier’s check issued by another bank in favor of Banco Santander Chile.  The Bank was not legally required to verify the legitimacy of the funds used to obtain the cashier’s check and, authenticity of the cashier’s check and, accordingly, cashed it in satisfaction of its loan to Inverlink.  Subsequently, the Bank learned that the cashier’s check had been obtained from the issuing bank by Inverlink Corredores de Bolsa with funds fraudulently obtained from CORFO. The Bank has actively cooperated with the investigation and agreed to pay Ch$980 million to CORFO. In Janaury 2007, the Courts approved the motion to end this trial against our General Counsel. The national treasury appealed this ruling and the motion of the Court has since been stayed. We believe that our actions and those of our General Counsel, who continues in his position, were lawful.
 
In addition, we are subject to certain claims and are party to certain legal and arbitration proceedings incidental to the normal course of our business including claims for alleged operational errors.  We do not believe that the liabilities related to such claims and proceedings are likely to have, individually or in the aggregate, a material adverse effect on our consolidated financial condition or results of operations. Nevertheless, based on management’s individual analysis of each proceeding, we have made provisions in the amount reported as “Provisions for lawsuit and other” in Note 10(b) to our Audited Consolidated Financial Statements. Other than the proceedings described above, there are no material proceedings in which any of our directors, any members of our senior management or any of our affiliates is either a party adverse to us or to our subsidiaries or has a material interest adverse to us or our subsidiaries.
 
Dividends and dividend policy
 
See “Item 3: Key Information—A. Selected Financial Data—Dividends”.
 
ITEM 9. THE OFFER AND LISTING
 
A.   Historical Trading Information
 
As the former Santiago was the legal surviving entity of the merger with Old Santander-Chile and the corporate name was changed to “Banco Santander-Chile” upon the merger, shareholders of Old Santander Chile received 3.55366329 shares of Banco Santiago for every one share of Old Santander Chile that they owned on the record date for the merger.  Therefore, trading information for 2002 prior to the merger corresponds to former Santiago shares and ADRs.  The table below shows, for the periods indicated, the annual, quarterly and monthly high and low closing prices (in nominal Chilean pesos) of the shares of our common stock on the Santiago Stock Exchange and the annual, quarterly and monthly high and low closing prices (in U.S. dollars) as reported by the NYSE.
 
   
Santiago Stock Exchanges
   
NYSE
 
   
Common Stock
   
ADS(2)
 
   
High
   
Low
   
High
   
Low
 
   
(Ch$ per share(1))
   
(U.S.$ per ADS)
 
Annual Price History
                       
2002
   
14.70
     
10.80
     
22.90
     
15.99
 
2003
   
15.30
     
12.65
     
24.65
     
17.05
 
2004
   
18.20
     
13.30
     
33.90
     
23.55
 
2005
   
22.75
     
17.11
     
45.86
     
30.40
 
2006
   
26.20
     
19.60
     
51.46
     
37.40
 
 
                               
 
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Santiago Stock Exchanges
   
NYSE
 
   
Common Stock
   
ADS(2)
 
   
High
   
Low
   
High
   
Low
 
   
(Ch$ per share(1))
   
(U.S.$ per ADS)
 
 
                               
Quarterly Price History
                               
2005
                               
1st Quarter
   
19.60
     
17.55
     
35.25
     
30.71
 
2nd Quarter
   
19.20
     
17.11
     
34.50
     
30.40
 
3rd Quarter
   
22.30
     
17.79
     
43.87
     
32.10
 
4th Quarter
   
22.75
     
20.00
     
45.86
     
38.00
 
2006
                               
1st Quarter
   
25.09
     
21.60
     
49.85
     
43.10
 
2nd Quarter
   
23.20
     
19.60
     
46.80
     
37.40
 
3rd Quarter
   
24.00
     
19.75
     
46.50
     
37.66
 
4th Quarter
   
26.20
     
22.90
     
51.46
     
44.69
 
2007
                               
1st Quarter
   
26.75
     
24.35
     
51.14
     
46.75
 
Monthly Price History
                               
December 2006
   
24.92
     
23.38
     
49.18
     
46.08
 
January 2007
   
25.85
     
24.60
     
49.49
     
47.11
 
February 2007
   
26.75
     
24.35
     
51.14
     
46.90
 
March 2007
   
26.44
     
24.45
     
51.14
     
46.75
 
April 2007
   
27.10
     
25.20
     
53.13
     
49.40
 
May 2007
   
26.20
     
24.49
     
52.15
     
48.39
 
June 2007 (through June 14)
 
25.41
   
24.90
 
 
50.16
   
49.06
 
 
Sources: Santiago Stock Exchange Official Quotation Bulletin; NYSE.

(1) Pesos per share reflect nominal price at trade date.
(2) One ADS represents 1,039 shares of common stock.
 
B.    Plan of Distribution
 
Not applicable
 
C.   Nature of Trading Market
 
Nature of Trading Market
 
Shares of our common stock are traded on the Chilean Stock Exchanges. Each ADS represents 1,039 shares of common stock. ADRs have been issued pursuant to the Deposit Agreement, dated as of August 1, 2002, among Santander-Chile, the Depositary and all holders from time to time of ADRs. As of December 31, 2006, 25,957,667 ADSs were outstanding (equivalent to 26,970,016,013 shares of common stock or 14.3% of the total number of issued shares of common stock).
 
D.   Selling Shareholders
 
Not Applicable.
 
E.   Dilution
 
Not Applicable.
 
F.    Expenses of the Issue
 
Not Applicable.
 
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ITEM 10. ADDITIONAL INFORMATION
 
A.    Share Capital
 
Not applicable.
 
B.    Memorandum and Articles of Association
 
The legal predecessor of Santander-Chile was Banco Santiago (Santiago). Santiago was incorporated by public deed dated September 7, 1977 granted at the Notary Office of Alfredo Astaburuaga Gálvez. Santiago received its permission to incorporate and function as a bank by Resolution No. 118 of the Superintendency of Banks on October 27, 1977. The Bank’s bylaws were approved by Resolution No. 103 of the Superintendency of Banks on September 22, 1977. In January 1997, Santiago merged with Banco O’Higgins’ with Santiago as the surviving entity. In 1999, Santiago became a controlled subsidiary of Banco Santander Central Hispano.
 
Shareholder rights in a Chilean bank that is also an open stock (public) corporation are governed by (1) the corporation’s estatutos, which effectively serve the purpose of both the articles or certificate of incorporation and the by-laws of a company incorporated in the United States, (2) the General Banking Law and (3) to the extent not inconsistent with the General Banking Law, by the provisions of Chilean Companies Law applicable to open stock corporations, except for certain provisions that are expressly excluded. Article 137 of the Chilean Companies Law provides that all provisions of the Chilean Companies Law take precedence over any contrary provision in a corporation’s estatutos. Both the Chilean Companies Law and our estatutos provide that legal actions by shareholders against us (or our officers or directors) to enforce their rights as shareholders or by one shareholder against another in their capacity as such are to be brought in Chile in arbitration proceedings, notwithstanding the plaintiff’s right to submit the action to the ordinary courts of Chile.
 
The Chilean securities markets are principally regulated by the Superintendency of Securities and Insurance under the Chilean Securities Market Law and the Chilean Companies Law. In the case of banks, compliance with these laws is supervised by the Superintendency of Banks. These two laws provide for disclosure requirements, restrictions on insider trading and price manipulation and protection of minority investors. The Chilean Securities Market Law sets forth requirements relating to public offerings, stock exchanges and brokers, and outlines disclosure requirements for companies that issue publicly offered securities. The Chilean Companies Law sets forth the rules and requirements for establishing open stock corporations while eliminating government supervision of closed (closely-held) corporations. Open stock (public) corporations are those with 500 or more shareholders, or companies in which 100 or more shareholders own at least 10.0% of the subscribed capital (excluding those whose individual holdings exceed 10.0%), and all other companies that are registered in the Securities Registry of the Superintendency of Securities and Insurance.
 
Board of Directors
 
The Board of Directors has 11 regular members and 2 alternate members, elected by shareholder vote at General Shareholders’ Meetings. The directors may be either shareholders or non-shareholders of the Company.
 
A director remains in office for three years and may be reelected indefinitely.  If for any reason, the General Shareholders’ Meeting where the newly appointments of directors are to be made is not held, the duties of those serving as such shall be extended until their replacements are designated, in which case, the Board of Director shall convene a Meeting at the earliest possible time in order to effect the appointments.
 
The directors are entitled to compensation for the performance of their duties. The amount of their compensation is determined annually by the General Shareholders’ Meeting. In addition, payments in the form of wages, fees, travel accounts, expense accounts, dues as representatives of the Board of Directors and other cash payments, payments in kind or royalties of any sort whatsoever, may be paid to certain directors for the performance of specific duties or tasks in addition to their functions as directors imposed upon them specifically by the General Shareholders’ Meeting. Any special compensation is authorized or approved at the General Shareholders’ Meeting,
 
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and for that purpose, a detailed and separate entry shall be made in the Annual Report, which shall expressly indicate the complete name of each of the directors receiving special compensation.
 
Without prejudice to any other incapacity or incompatibility established by law, the following may not be directors: (a) those persons who have been sentenced or are being tried, either as principals or accessories, for crimes punishable with a penalty of temporary or permanent suspension from or incapacity to hold public office; (b) those persons who have been declared bankrupt and have not been rehabilitated; (c) members of the House of Representatives and the Senate; (d) directors or employees of any other financial institution; employees appointed by the President of the Republic and employees or officers of (i) the State, (ii) any public service, public institution, semi-public institution, autonomous entity or state-controlled company (any such entity a “Public Entity”) (iii) any enterprise, corporation or public or private entity in which the State or a Public Entity has a majority interest, has made capital contributions, or is represented or participating, provided that persons holding positions in teaching activities in any of the above entities may be directors; and (e) The Bank’s employees, which shall not prevent a director from holding on a temporary basis and for a term not to exceed ninety days the position of General Manager. Chief Executive Officers may not be elected as directors.
 
For purposes of the appointment of directors, each shareholder shall have the right to one vote per share for purposes of appointing a single person, or to distribute his votes in between candidates as he may deem convenient, and the persons obtaining the largest number of votes in the same and single process shall be awarded positions, until all positions have been filled. The election of the regular and alternate board members shall be carried out separately. For purposes of the casting of the vote, the Chairman and the Secretary, together with any other persons that may have been previously designated by the Meeting to sign the minutes thereof, shall issue a certificate giving evidence of the oral votes of shareholders attending, following the order of the list of attendance being taken.
 
Each shareholder shall be entitled, however, to cast his vote by means of a ballot signed by him, stating whether he signs for his own account or as a representative. This entitlement notwithstanding, in order to expedite the voting process, the Chairman of the Bank or the Superintendency, as the case may be, is entitled to order that the vote be taken alternatively or by oral vote or by means of ballots. At the time of polling, the Chairman may instruct that the votes be read aloud, in order for those in attendance to count for themselves the number of votes issued and verify the outcome of the voting process.
 
The Secretary tabulates the votes and the Chairman announces those who have obtained the largest majorities until all the director positions have been filled. The Secretary places the documents evidencing the outcome of the count, duly signed by the persons charged with the duty of verifying the number of votes issued, together with the ballots delivered by the shareholders who did not vote orally, in an envelope which shall be closed and sealed with the corporate seal and shall remain deposited with the Bank for a least two years.
 
Every appointment of directors, or any changes in the appointment of directors, shall be transcribed into a public deed before a notary public, published in a newspaper of Santiago and notified to the Superintendency of Banks and Financial Institutions, by means of the filing of a copy of the respective public deed. Likewise, the appointments of General Manager, Manager and Deputy Managers shall be communicated and transcribed into a public deed.
 
If a director ceases to be able to perform his or her duties, whether by reason of conflict of interest, limitation, legal incapacity or bankruptcy, impossibility, resignation or any other legal cause, the vacancy shall be filled as follows: (a) the positions of regular directors shall be filled by an alternate director; and (b) the positions of alternate directors vacated upon the application of (a) above, and the positions of regular directors if a regular director’s position can not be filled pursuant to clause (a) because both alternate members have already become regular members, shall be filled by the Board of Directors on its first meeting after the vacancy occurs. Board members appointed pursuant to clause (b) will remain in the position until the next General Shareholders’ Meeting, where the appointment may be ratified, in which case, the replacment director will remain in his or her position until the expiration of the term of the director he or she replaced.
 
The alternate directors may temporarily replace regular directors in case of their absence or temporary inability to attend a board meeting, or in a definitive manner in case of vacancy. The alternate board members are always
 
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entitled to attend and speak at board meetings. They will be entitled to vote at such meetings only when a regular member is absent and such alternate member acts as the absent member’s replacement.
 
During the first meeting following the General Shareholders’ Meeting, the Board of Directors shall elect in separate votes from among its members, a Chairman, a First Vice Chairman and a Second Vice Chairman. In the event of a tie, the appointment shall be decided by lottery.
 
The Board of Directors meet in ordinary sessions at least once a month, held on pre-set dates and times determined by the Board. Extraordinary meetings are held whenever called by the Chairman, whether at his own will or upon the request of three or more directors, so long as the Chairman determines in advance that the meeting is justified, except if the request is made by the absolute majority of the directors in office, in which case the meeting shall be held without such prior determination. The extraordinary meetings may only address those matters specifically included in the agenda for the extraordinary meeting, except that, if the meeting is attended by all the directors in office, they may agree otherwise by a unanimous vote. Extraordinary meetings shall be called by means of a written instrument signed by the Chairman or the Secretary or his alternate and delivered to each of the directors at least three days prior to the date set for the meeting.
 
The quorum for the Board of Directors’ Meeting is six of its members. Resolutions shall be adopted by the affirmative vote of the absolute majority of the attending directors. In the event of a tie, the person acting as the Chairman of the meeting shall cast a deciding vote.
 
Directors having a vested interest in a negotiation, act, contract or transaction that is not related to the bank business, either as principal or as representative of another person, shall communicate such fact to the other directors. If the respective resolutions are approved by the Board, it shall be in accordance to the prevailing fair market conditions and director’s interest must be disclosed at the next General Shareholders’ Meeting.
 
The discussions and resolutions of the Board of Directors shall be recorded in a special book of minutes maintained by the Secretary. The relevant minutes shall be signed by the directors attending the meeting and by the Secretary, or his alternate. If a director determines that the minutes for a meeting are inaccurate or incomplete, he is entitled to record an objection before actually signing the minutes. The resolutions adopted may be carried out prior to the approval of the minutes at a subsequent meeting. In the event of death, refusal or incapacity for any reason of any of the directors attending to sign the minutes, such circumstance shall be recorded at the end of the minutes stating the reason for the impediment.
 
The directors are personally liable for all of the acts they effect in the performance of their duties. Any director who wishes to disclaim responsibility for any act or resolution of the Board of Directors must to record his opposition in the minutes, and the Chairman must report the opposition at the following General Shareholders’ Meeting.
 
The Board will represent the Bank in and out of court and, for the performance of the Bank’s business, a circumstance that will not be necessary to prove before third parties, it will be empowered with all the authorities and powers of administration that the law or the By-laws do not set as exclusive to the General Shareholders’ Meeting, without being necessary to grant any special power of attorney, even for those acts that the law requires to do so. This provision is notwithstanding the judicial representation of the Bank that is part of the General Manager’s authorities. The Board may delegate part of its authority to the General Manager, to the Managers, Deputy Managers or Attorneys of the Bank, a Director, a Commission of Directors, and for specifically determined purposes, in other persons.
 
Meetings and Voting Rights
 
An ordinary annual meeting of shareholders is held within the first four months of each year. The ordinary annual meeting of shareholders is the corporate body that approves the annual financial statements, approves all dividends in accordance with the dividend policy determined by our Board of Directors, elects the Board of Directors and approves any other matter that does not require an extraordinary shareholders’ meeting. The last ordinary annual meeting of our shareholders was held on April 24, 2007.  Extraordinary meetings may be called by
 
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our Board of Directors when deemed appropriate, and ordinary or extraordinary meetings must be called by our Board of Directors when requested by shareholders representing at least 10.0% of the issued voting shares or by the Superintendency of Banks. Notice to convene the ordinary annual meeting or an extraordinary meeting is given by means of three notices which must be published in a newspaper of our corporate domicile (currently Santiago) or in the Official Gazette in a prescribed manner, and the first notice must be published not less than 15 days nor more than 20 days in advance of the scheduled meeting. Notice must also be mailed 15 days in advance to each shareholder and given to the Superintendency of Banks and the Chilean Stock Exchanges. Currently, we publish our official notices in the El Mercurio newspaper of Santiago.
 
The quorum for a shareholders’ meeting is established by the presence, in person or by proxy, of shareholders representing at least an absolute majority of the issued shares. If a quorum is not present at the first meeting, the meeting can be reconvened (in accordance with the procedures described in the previous paragraph) and, upon the meeting being reconvened, shareholders present at the reconvened meeting are deemed to constitute a quorum regardless of the percentage of the shares represented. The shareholders’ meetings pass resolutions by the affirmative vote of an absolute majority of those voting shares present or represented at the meeting. The vote required at any shareholders’ meeting to approve any of the following actions, however, is a two-thirds majority of the issued shares:
 
 
·
a change in corporate form, spin-off or merger;
 
 
·
an amendment of the term of existence, if any, and the early dissolution of the bank;
 
 
·
a change in corporate domicile;
 
 
·
a decrease of corporate capital previously approved by the Superintendency of Banks, provided it is not reduced below the legal minimum capital;
 
 
·
a decrease in the number of directors previously approved by the Superintendency of Banks;
 
 
·
the approval of contributions and appraisal of properties other than cash, in those cases where it is permitted by the General Banking Act;
 
 
·
the amendment of authority of the general shareholders meeting or the restriction of the authority of the board of directors;
 
 
·
the transfer of 50.0% or more of the corporate assets, regardless of whether it includes liabilities, or the implementation or amendment of any business plan that contemplates the transfer of 50.0% or more of the corporate assets;
 
 
·
a change in the manner of distribution of profits established in the by-laws;
 
 
·
any non-cash distribution in respect of the shares;
 
 
·
the repurchase of shares of stock in the Bank; or
 
 
·
the approval of material related-party transactions when requested by shareholders representing at least 5.0% of the issued and outstanding shares with right to vote if they determine that the terms and conditions of those transactions are not favorable to the interests of the bank or if two independent assessments of those transactions requested by the Board materially differ from each other.
 
Shareholders may accumulate their votes for the election of directors and cast all of their votes in favor of one person.
 
In general, Chilean law does not require a Chilean open stock corporation to provide the level and type of information that U.S. securities laws require a reporting company to provide to its shareholders in connection with a solicitation of proxies. However, shareholders are entitled to examine the books of the bank within the 15-day period
 
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before the ordinary annual meeting. Under Chilean law, a notice of a shareholders’ meeting listing matters to be addressed at the meeting must be mailed not fewer than 15 days prior to the date of such meeting, and, in cases of an ordinary annual meeting, shareholders holding a prescribed minimum investment must be sent an Annual Report of the bank’s activities which includes audited financial statements. Shareholders who do not fall into this category but who request it must also be sent a copy of the bank’s Annual Report. In addition to these requirements, we regularly provide, and management currently intends to continue to provide, together with the notice of shareholders’ meeting, a proposal for the final annual dividend.
 
The Chilean Corporations Law provides that whenever shareholders representing 10.0% or more of the issued voting shares so request, a Chilean company’s Annual Report must include, in addition to the materials provided by the board of directors to shareholders, such shareholders’ comments and proposals in relation to the company’s affairs. Similarly, the Chilean Corporations Law provides that whenever the board of directors of an open stock corporation convenes an ordinary shareholders’ meeting and solicits proxies for that meeting, or distributes information supporting its decisions, or other similar material, it is obligated to include as an annex to its Annual Report any pertinent comments and proposals that may have been made by shareholders owning 10.0% or more of the company’s voting shares who have requested that such comments and proposals be so included.
 
Only shareholders registered as such with us on the fifth business day prior to the date of a meeting are entitled to attend and vote their shares. A shareholder may appoint another individual (who need not be a shareholder) as his proxy to attend and vote on his behalf. Every shareholder entitled to attend and vote at a shareholders’ meeting has one vote for every share subscribed. Each share represents one vote and there are no special classes of shares with different rights. Our bylaws do not include any condition that is more significant than required by law to change the right of shareholders.
 
Capitalization
 
Under Chilean law, the shareholders of a company, acting at an extraordinary shareholders’ meeting, have the power to authorize an increase in such company’s capital. When an investor subscribes for issued shares, the shares are registered in such investor’s name, even if not paid for, and the investor is treated as a shareholder for all purposes except with regard to receipt of dividends and the return of capital, provided that the shareholders may, by amending the by-laws, also grant the right to receive dividends or distributions of capital. The investor becomes eligible to receive dividends and returns of capital once it has paid for the shares (if it has paid for only a portion of such shares, it is entitled to reserve a corresponding pro-rata portion of the dividends declared and/or returns of capital with respect to such shares unless the company’s by-laws provide otherwise). If an investor does not pay for shares for which it has subscribed on or prior to the date agreed upon for payment, the company is entitled under Chilean law to auction the shares on the stock exchange and collect the difference, if any, between the subscription price and the auction proceeds. However, until such shares are sold at auction, the subscriber continues to exercise all the rights of a shareholder (except the right to receive dividends and return of capital).
 
Article 22 of Chilean Corporations Law states that the purchaser of shares of a company implicitly accepts its by-laws and any agreements adopted at shareholders’ meetings.
 
Approval of Financial Statements
 
Our Board of Directors is required to submit our audited financial statements to the shareholders annually for their approval. The approval or rejection of such financial statements is entirely within our shareholders’ discretion. If our shareholders reject our financial statements, our board of directors must submit new financial statements not later than 60 days from the date of such rejection. If our shareholders reject our new financial statements, our entire Board of Directors is deemed removed from office and a new board of directors is elected at the same meeting. Directors who individually approved such rejected financial statements are disqualified for re-election for the ensuing period.
 
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Registrations and Transfers
 
We act as our own registrar and transfer agent, as is customary among Chilean companies. In the case of jointly owned shares, an attorney-in-fact must be appointed to represent the joint owners in dealings with us.
 
Dividend, Liquidation and Appraisal Rights
 
Under the Chilean Corporations Law, Chilean companies are generally required to distribute at least 30.0% of their earnings as dividends.
 
In the event of any loss of capital, no dividends can be distributed so long as such loss is not recovered. Also, no dividends of a bank above the legal minimum can be distributed if doing so would result in the bank exceeding its ratio of risk-weighted assets to regulatory capital or total assets.
 
Dividends that are declared but not paid by the date set for payment at the time of declaration are adjusted from the date set for payment to the date such dividends are actually paid, and they accrue interest.
 
We may declare a dividend in cash or in shares. When a share dividend is declared above the legal minimum (which minimum must be paid in cash), our shareholders must be given the option to elect to receive cash. Our ADS holders may, in the absence of an effective registration statement under the Securities Act or an available exemption from the registration requirement thereunder, effectively be required to receive a dividend in cash. See “—Ownership Restrictions—Preemptive Rights and Increases of Share Capital.”
 
In the event of our liquidation, the holders of fully paid shares would participate equally and ratably, in proportion to the number of paid-in shares held by them, in the assets available after payment of all creditors.
 
In accordance with the General Banking Law, our shareholders do not have appraisal rights.
 
Ownership Restrictions
 
Under Article 12 of the Chilean Securities Market Law and the regulations of the Superintendency of Banks, shareholders of open stock corporations are required to report the following to the Superintendency of Securities and Insurance and the Chilean Stock Exchanges:
 
 
·
any direct or indirect acquisition or sale of shares that results in the holder’s acquiring or disposing, directly or indirectly, 10.0% or more of an open stock corporation’s share capital; and
 
 
·
any direct or indirect acquisition or sale of shares or options to buy or sell shares, in any amount, if made by a holder of 10.0% or more of an open stock corporation’s capital or if made by a director, liquidator, main officer, general manager or manager of such corporation.
 
In addition, majority shareholders must include in their report whether their purpose is to acquire control of the company or if they are making a financial investment. A beneficial owner of ADSs representing 10.0% or more of our share capital will be subject to these reporting requirements under Chilean law.
 
Under Article 54 of the Chilean Securities Market Law and the regulations of the Superintendency of Securities and Insurance, persons or entities intending to acquire control, directly or indirectly, of an open stock corporation, regardless of the acquisition vehicle or procedure, and including acquisitions made through direct subscriptions or private transactions, are also required to inform the public of such acquisition at least 10 business days before the date on which the transaction is to be completed, but in any case, as soon as negotiations regarding the change of control begin (i.e., when information and documents concerning the target are delivered to the potential acquiror) through a filing with the Superintendency of Securities and Insurance, the stock exchanges and the companies controlled by and that control the target and through a notice published in two Chilean newspapers, which notice must disclose, among other information, the person or entity purchasing or selling and the price and conditions of any negotiations.
 
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Prior to such publication, a written communication to such effect must be sent to the target corporation, to the controlling corporation, to the corporations controlled by the target corporation, to the Superintendency of Securities and Insurance, and to the Chilean stock exchanges on which the securities are listed.
 
In addition to the foregoing, Article 54A of the Chilean Securities Market Law requires that within two business days of the completion of the transactions pursuant to which a person has acquired control of a publicly traded company, a notice shall be published in the same newspapers in which the notice referred to above was published and notices shall be sent to the same persons mentioned in the preceding paragraphs.
 
The provisions of the aforementioned articles do not apply whenever the acquisition is being made through a tender or exchange offer.
 
Title XXV of the Chilean Securities Market Law on tender offers and the regulations of the Superintendency of Securities and Insurance provide that the following transactions must be carried out through a tender offer:
 
 
·
an offer which allows a person to take control of a publicly traded company, unless (i) the shares are being sold by a controlling shareholder of such company at a price in cash which is not substantially higher than the market price and the shares of such company are actively traded on a stock exchange and (ii) those shares are acquired (a) through a capital increase, (b) as a consequence of a merger, (c) by inheritance or (d) through a forced sale; and
 
 
·
an offer for a controlling percentage of the shares of a listed company if such person intends to take control of the parent company (whether listed or not) of such listed company, to the extent that the listed company represents 75.0% or more of the consolidated net worth of the parent company.
 
In addition, Article 69 ter of the Companies Law requires that whenever a controlling shareholder acquires two thirds of the voting shares of a listed company, such controlling shareholder must offer to purchase the remaining shares from the minority shareholders in a tender offer.
 
Article 200 of the Chilean Securities Market Law prohibits any shareholder that has taken control of a publicly traded company to acquire, for a period of 12 months from the date of the transaction in which it gained control of the publicly traded company, a number of shares equal to or greater than 3.0% of the outstanding issued shares of the target without making a tender offer at a price per share not lower than the price paid at the time of taking control. Should the acquisition from the other shareholders of the company be made on a stock exchange and on a pro rata basis, the controlling shareholder may purchase a higher percentage of shares, if so permitted by the regulations of the stock exchange.
 
Title XV of the Chilean Securities Market Law sets forth the basis to determine what constitutes a controlling power, a direct holding and a related party. The Chilean Securities Market Law defines control as the power of a person or group of persons acting (either directly or through other entities or persons) pursuant to a joint action agreement, to direct the majority of the votes at the shareholders’ meetings of the corporation, to elect the majority of members of its board of directors, or to influence the management of the corporation significantly. Significant influence is deemed to exist in respect of the person or group of persons with an agreement to act jointly that holds, directly or indirectly, at least 25.0% of the voting share capital, unless:
 
 
·
another person or group of persons acting pursuant to joint action agreement, directly or indirectly, controls a stake equal to or greater than the percentage controlled by such person or group of persons;
 
 
·
the person or group does not control, directly or indirectly, more than 40.0% of the voting share capital and the percentage controlled is lower than the sum of the shares held by other shareholders holding more than 5.0% of the share capital (either directly or pursuant to a joint action agreement); or
 
 
·
in cases where the Superintendency of Securities and Insurance has ruled otherwise, based on the distribution or atomization of the overall shareholding.
 
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According to the Chilean Securities Market Law, a joint action agreement is an agreement among two or more parties which, directly or indirectly, own shares in a corporation at the same time and whereby they agree to participate with the same interest in the management of the corporation or in taking control of the same. The law presumes that such an agreement exist between:
 
 
·
a principal and its agents;
 
 
·
spouses and relatives within certain degrees of kinship;
 
 
·
entities within the same business group; and
 
 
·
an entity and its controller or any of the members of the controller.
 
Likewise, the Superintendency of Securities and Insurance may determine that a joint action agreement exists between two or more entities considering, among other things, the number of companies in which they participate and the frequency with which they vote identically in the election of directors, appointment of managers and other resolutions passed at extraordinary shareholders’ meetings.
 
According to Article 96 of the Chilean Securities Market Law, a business group is a group of entities with such ties in their ownership, management or credit liabilities that it may be assumed that the economic and financial action of such members is directed by, or subordinated to, the joint interests of the group, or that there are common credit risks in the credits granted to, or in the acquisition of securities issued by, them. According to the Chilean Securities Market Law, the following entities are part of the same business group:
 
 
·
a company and its controller;
 
 
·
all the companies with a common controller together with that controller;
 
 
·
all the entities that the Superintendency of Securities and Insurance declares to be part of the business group due to one or more of the following reasons:
 
 
·
a substantial part of the assets of the company is involved in the business group, whether as investments in securities, equity rights, loans or guaranties;
 
 
·
the company has a significant level of indebtedness and the business group has a material participation as a lender or guarantor;
 
 
·
any member of a group of controlling entities of a company mentioned in the first two bullets above and there are grounds to include it in the business group; or
 
 
·
the company is controlled by a member of a group of controlling entities and there are grounds to include it in the business group.
 
Article 36 of the General Banking Law states that as a matter of public policy, no person or company may acquire, directly or indirectly, more than 10.0% of the shares of a bank without the prior authorization of the Superintendency of Banks, which may not be unreasonably withheld. The prohibition would also apply to beneficial owners of ADSs. In the absence of such authorization, any person or group of persons acting in concert would not be permitted to exercise voting rights with respect to the shares or ADSs acquired. In determining whether or not to issue such an authorization, the Superintendency of Banks considers a number of factors enumerated in the General Banking Law, including the financial stability of the purchasing party.
 
According to Article 35 bis of the General Banking Law, the prior authorization of the Superintendency of Banks is required for:
 
 
·
the merger of two or more banks;
 
 
·
the acquisition of all or a substantial portion of a banks’ assets and liabilities by another bank;
 
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·
the control by the same person, or controlling group, of two or more banks; or
 
 
·
a substantial increase in the existing control of a bank by a controlling shareholder of that bank.
 
This prior authorization is only required when the acquiring bank or the resulting group of banks would own a significant market share in loans, defined by the Superintendency of Banks to be more than 15.0% of all loans in the Chilean banking system. The intended purchase, merger or expansion may be denied by the Superintendency of Banks; or, if the acquiring bank or resulting group would own a market share in loans determined to be more than 20.0% of all loans in the Chilean banking system, the purchase, merger, or expansion may be conditioned on one or more of the following:
 
 
·
the bank or banks maintaining regulatory capital higher than 8.0% and up to 14.0% of risk-weighted assets;
 
 
·
the technical reserve established in Article 65 of the General Banking Law being applicable when deposits exceed one and a half times the resulting bank’s paid-in capital and reserves; or
 
 
·
the margin for interbank loans be reduced to 20.0% of the resulting bank’s regulatory capital.
 
If the acquiring bank or resulting group would own a market share in loans determined by the Superintendency of Banks to be more than 15% but less than 20%, the authorization will be conditioned on the bank or banks maintaining a regulatory capital not lower than 10% of their risks weighted assets for the period specified by the Superintendency of Banks, which may not be less than one year. The calculation of the risk weighted assets is based on a five category risk classification system applied to a bank’s assets that is based on the Basel Committee recommendations.
 
According to the General Banking Law, a bank may not grant loans to related parties on terms more favorable than those generally offered to non-related parties. Article 84 No. 2 of the General Banking Law and the regulations issued by the Superintendency of Banks creates the presumption that natural persons who are holders of shares and who beneficially own more than 1.0% of the shares are related to the bank and imposes certain restrictions on the amounts and terms of loans made by banks to related parties. This presumption would also apply to beneficial owners of ADSs representing more than 1.0% of the shares. Finally, according to the regulations of the Superintendency of Banks, Chilean banks that issue ADSs are required to inform the Superintendency of Banks if any person, directly or indirectly, acquires ADSs representing 5.0% or more of the total amount of shares of capital stock issued by such bank.
 
Article 16 bis of the General Banking Law provides that the individuals or legal entities that, individually or with other people, directly control a bank and who individually own more than 10.0% of its shares must send to the Superintendency of Banks reliable information on their financial situation in the form and in the opportunity set forth in Resolution No 3,156 of the Superintendency of Banks.
 
Preemptive Rights and Increases of Share Capital
 
The Chilean Corporations Law provides that whenever a Chilean company issues new shares for cash, it must offer its existing shareholders the right to purchase a number of shares sufficient to maintain their existing ownership percentages in the company. Pursuant to this requirement, preemptive rights in connection with any future issue of shares will be offered by us to the depositary as the registered owner of the shares underlying the ADSs. However, the depositary will not be able to make such preemptive rights available to holders of ADSs unless a registration statement under the Securities Act is effective with respect to the underlying shares or an exemption from the registration requirements thereunder is available.
 
We intend to evaluate, at the time of any preemptive rights offering, the practicality under Chilean law and Central Bank regulations in effect at the time of making such rights available to our ADS holders, as well as the costs and potential liabilities associated with registration of such rights and the related shares of common stock under the Securities Act, and the indirect benefits to us of thereby enabling the exercise by all or certain holders of ADSs of their preemptive rights and any other factors we consider appropriate at the time, and then to make a decision as to whether to file such registration statement. We cannot assure you that any registration statement
 
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would be filed. If we do not file a registration statement and no exemption from the registration requirements under the Securities Act is available, the depositary will sell such holders’ preemptive rights and distribute the proceeds thereof if a premium can be recognized over the cost of such sale. In the event that the depositary is not able, or determines that it is not feasible, to sell such rights at a premium over the cost of any such sale, all or certain holders of ADSs may receive no value for such rights. Non-U.S. holders of ADSs may be able to exercise their preemptive rights regardless of whether a registration statement is filed. The inability of all or certain holders of ADSs to exercise preemptive rights in respect of shares of common stock underlying such ADSs could result in such holders not maintaining their percentage ownership of the common stock following such preemptive rights offering unless such holder made additional market purchases of ADSs or shares of common stock.
 
Under Chilean law, preemptive rights are exercisable or freely transferable by shareholders during a period that cannot be less than 30 days following the grant of such rights. During such period, and for an additional 30-day period thereafter, a Chilean corporation is not permitted to offer any unsubscribed shares for sale to third parties on terms which are more favorable than those offered to its shareholders. At the end of such additional 30-day period, a Chilean open stock corporation is authorized to sell unsubscribed shares to third parties on any terms, provided they are sold on a Chilean stock exchange. Unsubscribed shares that are not sold on a Chilean stock exchange can be sold to third parties only on terms no more favorable for the purchaser than those offered to shareholders.
 
Description of American Depositary Shares
 
This section summarizes all of the material provisions of the Amended and Restated Deposit Agreement, dated as of August 1, 2002, among Banco Santander-Chile (formerly known as Banco Santiago), The Bank of New York, as depositary, and the holders of ADRs from time to time pursuant to which the American Depositary Receipts (which we refer to as ADRs) were issued. We refer to this agreement as the “deposit agreement.” We do not, however, describe every aspect of the deposit agreement. You should read the deposit agreement for a more detailed description of the terms of the ADRs. Additional copies of the deposit agreement are available for inspection at the Corporate Trust Office of the depositary, which is presently located at 101 Barclay Street, New York, New York 10286.
 
American Depositary Receipts
 
The depositary will issue ADRs evidencing American depositary shares (which we refer to as ADSs) pursuant to the deposit agreement. Each ADS will represent 1,039 shares of our common stock deposited with us, as custodian. An ADR may represent any number of ADSs. Only persons in whose names ADRs are registered on the books of the depositary will be treated by the depositary and us as holders of ADRs.
 
Pursuant to the terms of the deposit agreement, holders, owners and beneficial owners of ADRs will be subject to any applicable disclosure requirements regarding acquisition and ownership of shares of common stock or ADSs representing shares of our common stock as are applicable pursuant to the terms of our estatutos or Chilean laws, as each may be amended from time to time. See “—Ownership Restrictions” for a description of the disclosure requirements applicable to shares of common stock and the consequences of noncompliance. The depositary has agreed, subject to the terms and conditions of the deposit agreement, to comply with our instructions as to such requirements.
 
Deposit and Withdrawal of Common Stock
 
Upon written order of the depositor, the depositary will execute and deliver to the persons specified in the written order, an ADR or ADRs registered in the name of such person or persons for the number of ADSs issuable in respect of such deposit, subject to the terms of the deposit agreement and upon the:
 
 
·
deposit with the custodian of the required number of shares of common stock accompanied by any appropriate instrument of transfer or endorsement in the form satisfactory to the custodian;
 
 
·
delivery of such certifications and payments as may be required by the custodian or the depositary;
 
 
·
payment of the required fees, charges and taxes; and
 
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·
if required by the depositary and as applicable, the delivery to the depositary of an agreement or instrument providing full transfer to the custodian or its nominee of any dividend or right to subscribe shares or to receive other property or the proxy or proxies entitling the custodian to vote on the shares.
 
The execution and delivery of the ADRs will take place at any of the depositary’s designated transfer offices.
 
The depositary will not accept for deposit any shares of common stock unless it receives evidence of necessary regulatory approvals, if any.
 
The depositary may issue ADRs against rights to receive shares from us, any of our agents or a central clearing agency approved in writing by us. The depositary may issue ADRs against other rights to receive shares only if:
 
 
·
such other rights are fully collateralized (marked-to-market daily) with cash or U.S. government securities until such shares of common stock are deposited;
 
 
·
each applicant for such ADRs represents in writing that it owns such shares, has assigned all beneficial right, title and interest in such shares to the depositary and will hold such shares for the account of the depositary until delivery of the shares following the depositary’s request;
 
 
·
such transaction may be terminated by the depositary on no more than five business days’ notice; and
 
 
·
all ADRs issued against rights to receive shares represent no more than 20.0% of the shares actually deposited. The depositary may retain any compensation received by it in connection with these transactions, including without limitation, earnings on such collateral.
 
Notwithstanding any other provisions of the deposit agreement or the ADR to the contrary, holders of ADRs are entitled to withdraw the deposited shares at any time, subject only to:
 
 
·
temporary delays caused by closing the transfer books of the depositary or us;
 
 
·
temporary delays caused by the deposit of shares of common stock in connection with voting at a shareholders’ meeting or the payment of dividends;
 
 
·
the payment of fees, taxes and similar charges; and
 
 
·
compliance with any U.S. or foreign laws or governmental regulations relating to the ADRs or to the withdrawal of the deposited shares.
 
ADR holders are entitled to receive from the custodian’s office in Chile, after they surrender ADRs at the depositary’s office and pay any fees, governmental charges and taxes provided in the deposit agreement:
 
 
·
the deposited shares;
 
 
·
any other property that the surrendered ADRs evidence the right to receive; and
 
 
·
a certificate from the custodian stating that the applicable deposited shares are being transferred to the person or persons specified by the surrendering holder and that the depositary waives in favor of such person the right of access to the formal exchange market relating to such withdrawn shares.
 
At its discretion, the depositary may deliver the property that the ADR holders surrendering ADRs have the right to receive (other than the certificates representing the shares) at its office. At the request, risk and expense of the ADR holder surrendering ADRs, deposited shares and other proper documents of title may be forwarded from our office in Chile to the depositary’s office for delivery to the surrendering holders. In the event the depositary determines that there is a reasonable possibility that a tax would be imposed upon the withdrawal of shares in exchange for surrendered ADRs, it may require that the withdrawing investor provide satisfactory security to it in an amount sufficient to cover the estimated amount of the tax.
 
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Dividends, Other Distributions and Rights
 
The depositary is required to convert promptly into dollars and transfer to the United States all cash dividends and other cash distributions denominated in Chilean pesos (or any other currency other than dollars) that it receives in respect of the deposited shares, to the extent that it can do so on a reasonable basis and subject to Chilean law and the Foreign Investment Contract. The depositary is also required to distribute the amount received in dollars to the holders of ADRs upon an averaged or other practicable basis without regard to any distinctions among holders on account of exchange restrictions or the date of delivery of any ADR or ADRs or otherwise. The amount distributed by the depositary will be reduced by any amounts to be withheld by us, the depositary or by us acting as custodian, including amounts on account of any applicable taxes and certain other expenses. For further information regarding applicable taxes, see “—Taxation.”
 
If the depositary determines that in its judgment any currency other than dollars received by it cannot be converted on a reasonable basis and transferred, or if the Foreign Investment Contract shall cease to be in effect or the rights of the depositary thereunder shall be restricted or suspended, the depositary, may after consultation with us, distribute such foreign currency received by it or hold such foreign currency (without liability for interest) for the respective accounts of the ADR holders entitled to receive the same.
 
If we declare a dividend in or free distribution of additional shares, the depositary may (with our approval) and shall (if we so request), distribute to the ADR holders (in proportion to the number of ADSs evidenced by their respective ADRs) additional ADRs evidencing an aggregate number of ADSs that represents the number of shares of common stock received in such dividend or free distribution. Instead of delivering ADRs of fractional ADSs, the depositary will sell the amount of shares represented by the aggregate of such fractions and will distribute the net proceeds to holders of ADRs in accordance with the deposit agreement. If additional ADRs (other than ADRs for fractional ADSs) are not so distributed, each ADS shall thereafter also represent the additional shares distributed.
 
If we offer (or cause to be offered) to the holders of shares any rights to subscribe for additional shares of common stock or any rights of any other nature, the depositary shall, after consultation with us, have discretion:
 
 
·
as to the procedure followed to make such rights available to ADR holders;
 
 
·
in disposing of such rights for the benefit of such owners and making the net proceeds available in dollars to holders; or
 
 
·
if the depositary may not make such rights available or dispose of such rights and make the proceeds available, allowing the rights to lapse unexercised (without incurring liability to any person as a consequence thereof);
 
provided that the depositary will, at our request, either:
 
 
·
if it determines that it is lawful and feasible to do so, make such rights available to ADR holders by means of warrants or employ such other method as it may deem feasible in order to facilitate the exercise, sale or transfer of rights by such holder; or
 
 
·
sell such rights or warrants or other instruments at public or private sale, at such place or places and upon such terms as it may deem proper, and allocate the net proceeds of such sales for the account of the owners of ADRs otherwise entitled upon an averaged or other practicable basis without regard to any distinctions among holders on account of exchange restrictions or the date of delivery of an ADR or ADRs or otherwise.
 
Conversion of such net proceeds from pesos to dollars is subject to the terms and conditions of the Foreign Investment Contract, including presentation to the Central Bank of a request for access to the Formal Exchange Market.
 
In this regard, we may, in our sole discretion, decide not to register the securities to which such rights relate under the Securities Act where such registration may be required in connection with the offer or sale of such
 
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securities. In this case, ADR holders would not be permitted to purchase such securities or otherwise exercise such rights and the depositary would, to the extent possible, dispose of such rights for the account of such holders as provided above. Such a disposal or rights may reduce the equity interest that ADR holders have in us.
 
If the depositary determines that any distribution of property other than cash (including shares of common stock or rights to subscribe therefor) is subject to any tax or governmental charge that it is obligated to withhold, the depositary may dispose of all or a portion of such property in such amounts and in such manner as it deems necessary and practicable to pay such taxes or governmental charges. The depositary will distribute the net proceeds of any such sale or the balance of any such property after deduction of such taxes or governmental charges to the ADR holders.
 
Upon any split, consolidation, cancellation or any other reclassification of shares of common stock, or upon any recapitalization, reorganization, merger or consolidation or sale of assets affecting us, or to which we are a party, any securities that shall be received by the depositary or the custodian in respect of shares shall be treated as newly deposited shares under the deposit agreement, and ADSs shall from then on represent the right to receive the securities so received, except when (1) additional ADRs (as in the case of a stock dividend), or (2) the depositary calls for the surrender of outstanding ADRs to be exchanged for new ADRs.
 
Record Dates
 
Whenever any distribution is being made upon deposited shares of common stock, or whenever the depositary shall receive notice of any meeting of holders of shares or whenever the depositary shall find it necessary or convenient in connection with the giving of any notice, solicitation or any consent or any other matter, the depositary will fix, by notice to ADR holders and to us, a record date (which, to the extent practicable, shall be the same as the corresponding record date set by us or otherwise shall be the earliest practicable day thereafter) for the determination of the ADR holders who are entitled to receive such dividend, distribution or rights, or net proceeds of the sale thereof, to exercise the rights of ADR holders with respect to such changed number of shares, or to give instructions for the exercise of voting rights, if any, at any such meeting, subject to the provisions of the deposit agreement.
 
Voting of the Underlying Deposited Securities
 
When the depositary receives any notice of a meeting of holders of common stock, it will mail to all ADR holders a notice containing:
 
  ·
the information included in such notice received by it;
 
  ·
a statement that each holder as of a specified record date will be entitled, subject to Chilean law and the provisions of or governing the deposited shares, to instruct the depositary as to the exercise of the voting rights, if any, pertaining to the deposited shares represented by ADSs evidenced by such holder’s ADRs; and
 
  ·
a statement as to the manner in which each such holder of ADRs may instruct the depositary to exercise any right to vote held by such holder.
 
See “—Meetings and Voting Rights.” The holders of ADRs at the close of business on the date specified by the depositary are entitled, subject to any applicable provisions of Chilean law, our bylaws or the shares, to instruct the depositary how to exercise the voting rights, if any, pertaining to the shares represented by their ADSs. The depositary will endeavor, insofar as practicable and permitted under Chilean law and the shares, to vote the shares so represented in accordance with any such written instructions of holders of ADRs. The depositary may not itself exercise any voting discretion over any shares. If the depositary does not receive instructions from a holder of ADRs, the depositary shall deem such holder to have instructed it to give discretionary proxy to a person designated by us to vote the underlying shares.
 
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Reports and Notices
 
The depositary will mail ADR holders any reports and communications received from us that are made generally available to holders of shares of common stock. The depositary will also send to ADR holders copies or summaries of such reports when furnished by us.
 
On or before the first date notice is given by us, by publication or otherwise, of any meeting or adjournment of a meeting of shareholders or of the taking of any action by shareholders other than at a meeting, or the making of any distribution on or offering of rights in respect of the deposited shares, we will send the depositary a copy of the notice in the form given or to be given to holders of shares. The depositary will arrange for the mailing to all ADR holders of a notice containing the information (or a summary of the information) contained in any notice of a meeting of holders of shares it receives.
 
Amendment and Termination of the Deposit Agreement
 
The form of the ADRs and the deposit agreement may at any time be amended by an agreement between us and the depositary. Any amendment that imposes or increases any fees or charges (other than the fees of the depositary for the execution and delivery or the cancellation of ADRs and taxes and other governmental charges), or that otherwise prejudices any substantial existing right of ADR holders, will not take effect as to outstanding ADRs until the expiration of 30 days after notice of such amendment has been given to the holders of outstanding ADRs. Every holder of an ADR at the time such amendment becomes effective will be deemed, by continuing to hold such ADR, to consent and agree to such amendment and to be bound by the deposit agreement as amended. Except in order to comply with mandatory provisions of applicable law, in no event may any amendment impair the right of any ADR holder to surrender his ADR and receive therefor the shares and other property represented by it.
 
Whenever so directed by us, the depositary will terminate the deposit agreement by mailing notice of such termination to the holders of all ADRs at least 30 days prior to the date fixed in such notice for termination. The depositary may likewise terminate the deposit agreement at any time 90 days after it has delivered to us a notice of its election to resign, provided that a successor depositary shall not have been appointed and accepted its appointment as provided in the deposit agreement.
 
If any ADRs remain outstanding after the date of termination, the depositary will:
 
  ·
discontinue the registration of transfer of ADRs;
 
  ·
suspend the distribution of dividends to the holders thereof; and
 
  ·
not give any further notices or perform any further acts under the deposit agreement, except
 
  ·
the collection of dividends and other distributions pertaining to the shares of common stock and any other property represented by such ADRs;
 
  ·
the sale of rights as provided in the deposit agreement; and
 
  ·
the delivery of shares, together with any dividends or other distributions received with respect thereto and the net proceeds of the sale of any rights or other property, in exchange for surrendered ADRs.
 
As soon as practicable after the one year anniversary of any date of termination, the depositary shall sell the shares and any other property represented by any ADRs that have not been surrendered and hold the net proceeds in a segregated account, together with any other cash then held, without liability for interest, in trust for the pro rata benefit of ADR holders that have not surrendered their ADRs. After making such sale, the depositary shall be discharged from all obligations to us, except for certain indemnification and accounting obligations. Upon termination of the deposit agreement, we will also be discharged from all obligations thereunder, except for certain obligations to the depositary.
 
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Charges of Depositary
 
The depositary will charge anyone to whom ADRs are delivered and anyone who surrenders ADRs $5.00 per 100 ADSs (or portion thereof) so issued or surrendered.
 
We will pay certain other charges of the depositary under the deposit agreement, except for:
 
  ·
taxes and other governmental charges (which are payable by ADR holders and persons depositing shares);
 
  ·
any applicable share transfer or registration fees on deposit or withdrawal of shares (which are also payable by such holders and persons);
 
  ·
any applicable fees in connection with the execution, delivery, transfer or surrender of, or distributions on, ADRs (which are also payable by such holders and persons);
 
  ·
such cable, telex, facsimile transmission and delivery charges and such expenses as are expressly provided to be at the expense of such holders and persons; and
 
  ·
expenses that are paid or incurred by the depositary in connection with the conversion into dollars, pursuant to the deposit agreement, or any other currency received by the depositary in respect of the shares held on deposit (which are reimbursable to the depositary out of such dollars).
 
Liability of Holders for Taxes or Other Charges
 
Any tax or other governmental charge or expense (including, without limitation, any Chilean tax on a gain realized or deemed to be realized, upon the withdrawal or sale of shares of common stock or other property held by the custodian or depository in respect of such shares) payable by the custodian, the depositary or its nominee as the registered holder of any deposited shares represented by ADSs evidenced by any ADR shall be payable by the holder of such ADR to the depositary. The depositary may refuse to effect registration of transfer and withdrawal of shares underlying such ADR until such payment is made, and may withhold any dividends or other distributions or may sell for the account of the holder thereof any part or all of the deposited shares underlying such ADR and may apply such dividends or distributions or the proceeds of any such sale in payment of any such tax or other governmental charge or expense, the holder of such ADR remaining liable for any deficiency.
 
Transfer of American Depositary Receipts
 
The ADRs are transferable on the books of the depositary, provided that the depositary may close the transfer books, at any time and from time to time, when deemed expedient by it in connection with the performance of its duties or at our request. The depositary or the custodian may require payment from the person presenting an ADR or the depositor of the shares of a sum sufficient to reimburse it for any tax or other governmental charge, and any stock transfer or registration fee with respect thereto and payment of any applicable fees payable by the holders of ADRs as a condition to the execution and delivery, registration of transfer, split-up, combination or surrender of any ADR or transfer and withdrawal of shares of common stock.
 
The depositary may refuse to deliver ADRs, register the transfer of any ADR or make any distribution of, or related to, shares until it has received such proof of citizenship, residence, exchange control approval, payment of all applicable Chilean taxes or other governmental charges, legal or beneficial ownership or other information as it may deem necessary or proper or as we may require by written request to the depositary. The execution and delivery or transfer of ADRs generally may be suspended during any period when our transfer books or the transfer books of the depositary are closed or if deemed necessary or advisable by us or the depositary. ADR holders may inspect the transfer books of the depositary at any reasonable time, provided that such inspection shall not be for the purpose of communicating with other holders of the ADRs in the interest of a business or object other than our business or a matter related to the deposit agreement or the ADRs.
 
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General
 
Neither we nor the depositary will be liable to the holders of ADRs if prevented or delayed in performing their obligations under the deposit agreement by any present or future law, regulation, decree, order or other action of the United States, Chile or any other country, or of any other governmental authority (including any action that may constitute a breach by the Central Bank of its obligation under the Foreign Investment Contract), or by reason of any provision, present or future, of the Foreign Investment Contract, or by reason of any act of God, war or circumstances beyond their control or in the case of the depositary, any provision of our bylaws or of the securities deposited. Our obligations and those of the depositary are expressly limited to performing their respective duties specified therein without negligence or bad faith.
 
So long as any ADRs or ADSs are listed on one or more stock exchanges, the depositary will act as registrar or, with our approval, appoint a registrar or one or more co-registrars, for registration of such ADRs in accordance with any requirements of such exchanges. Such registrars or co-registrars shall, upon our request, and may, with our approval, be removed and a substitute or substitutes appointed by the depositary. The depositary will periodically furnish the Chilean Superintendency of Banks with the list of the registered holders of ADRs and a list of all beneficial owners who do not object to the disclosure of this information.
 
ADS holders are subject to certain provisions of the rules and regulations promulgated under the U.S. Securities Exchange Act of 1934, as amended, or the Exchange Act, and to the regulations of the Chilean Superintendency of Banks relating to the disclosure of interests in the shares of common stock. Any ADS holder who has or comes to have a directly or indirectly, an interest of 5.0% (or such other percentage as may be prescribed by law or regulation) or more of our outstanding shares must:
 
  ·
under the Exchange Act, within 10 days after acquiring such interest and thereafter upon certain changes in such interests, notify us as required by such rules and regulations; and
 
  ·
under regulations of the Chilean Superintendency of Banks, within 15 days after acquiring such interest, send to us a notarized declaration as to the number of shares and ADSs beneficially owned by it and commit to report to us any subsequent acquisitions of shares or ADSs.
 
In addition, ADR holders are subject to the reporting requirements contained in Articles 12 and 54 and Titles XV and XXV of the Chilean Securities Market Law and Article 16 bis of the General Banking Law and the ownership limitations of Articles 35 bis and 36 of the General Banking Law (which provisions may apply when a holder beneficially owns or intends to purchase 10.0% or more of our shares or has the intention of taking control of us).
 
ADS holders who beneficially own more than 1.0% of the shares of common stock are also subject to the presumption created by Article 84 No. 2 of the General Banking Law that such owners are related parties to the Bank, and are thus subject to certain restrictions on the amounts and terms of loans made by banks to related parties.
 
Valuation of Underlying Shares for Chilean Law Purposes
 
For all purposes of valuation under Chilean law, the acquisition value of the shares of common stock delivered to any holder upon surrender of ADRs shall be the highest reported sale price of the shares on the Santiago Stock Exchange on the day during which the transfer of the shares is recorded under the name of such holder. In the event that no such sale price is reported by such Exchange during that day, the value shall be deemed to be the highest trade price on the day during which the last trade took place. However, if 30 or more days have elapsed since the last trade, such value shall be adjusted in accordance with the variation of the Chilean consumer price index during the period since such last trade date.
 
C.     Material Contracts
 
On June 30, 2000, we entered into a long-term contract with IBM for the operation of certain of our systems. On October 15, 2002, this contract was amended as a result of the merger. IBM provides us with information technology services and hardware infrastructure to run our core transactional systems. We signed a contract with
 
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IBM for such activities which expires in 2012, pursuant to which we agreed to pay IBM approximately US$10 million per year for five years.  At December 31, 2006, aggregate remaining payments were expected to total US$44.4 million over the life of the contract, including taxes.
 
In the fourth quarter of 2003, the Bank and Almacenes París, the third largest retailer in Chile, announced a strategic alliance to strengthen commercial synergies between both entities and offer exclusive benefits to their clients. This alliance was consummated in December 2004 when Santander-Chile transferred to Empresas París part of the financial assets and branch network of Santander-Chile’s Santiago Express division, along with this division’s personnel, which became Banco París. In addition, the Bank transferred Ch$120,808 million (US$226 million) in assets to Empresas París, generating a profit of Ch$23,093 million (US$43.2 million) recorded in non-operating income in 2004.
 
In December 2003, we signed an agreement with Altec, Banco Santander Central Hispano’s systems management company for Latin America, in order to outsource certain system management functions. This contract has a term of three years commencing on January 1, 2004. The main services Altec provides to us are development and maintenance of applications and systems technology and engineering.  Pursuant to this contract, We pay Altec certain service fees comprising of fixed charges and variable charges.  The current service rates effective 2007 include annual fixed charges in a total amount of UF24,186 (Ch$443.3 million or US$829,856) and variable rates ranging from UF0.90 to UF0.95 per hour.
 
In August 2005, the Bank entered into a contract with the Sociedad Operadora de la Cámara de Compensación de Pagos de alto Valor S.A. (ComBanc) in order to participate in the “Servicio Cámara de Compensación de Pagos de Alto Valor”, which is an electronic clearing system for transactions for large movements between demand deposit accounts. The Bank must pay fixed and variable fees for participating in this system. The fixed fee was UF243 (Ch$4.5 million or US$8,337). The variable fee depends on the Bank’s market share in demand deposits and was UF1,339 (Ch$24.6 million or US$45,941) at December 31, 2006.
 
In February 2007, the Bank agreed to pledge its shares in Administrador Financiero de Transantiago ("AFT") in favor of the service providers of Santiago’s new public transportation system, TransSantiago. AFT is the company in charge of administering the finances of the new transportation system, TransSantiago, and all shareholders in AFT had to pledge their shares to the service providers.  This pledge was approved by our shareholders at a special Shareholders’ Meeting held on April 24, 2007.  The book value of the Bank’s investment in AFT was US$2.2 million at December 31, 2006.
 
D.     Exchange Controls
 
The Central Bank is responsible for, among other things, monetary policies and exchange controls in Chile. Appropriate registration of a foreign investment in Chile grants the investor access to the Formal Exchange Market. See“Item 3: Key Information—A. Selected Financial Data—Exchange Rates.” Foreign investments can be registered with the Foreign Investment Committee under Decree Law No. 600 or can be registered with the Central Bank under the Central Bank Act. The Central Bank Act is an organic constitutional law requiring a “special majority” vote of the Chilean Congress to be amended.  Since April 18, 2001, all exchange controls in Chile have been eliminated.
 
Previously, Chilean law mandated that holders of shares of Chilean companies that were not residents of Chile register as foreign investors under one of the foreign investment regimes contemplated by Chilean law in order to receive dividends, sale proceeds or other amounts with respect to their shares remitted outside Chile through the Formal Exchange Market. Under the Foreign Investment Contract (as defined herein), the Depositary, on behalf of ADS holders, is granted access to the Formal Exchange Market to convert cash dividends from Chilean pesos to U.S. dollars and to pay such U.S. dollars to ADS holders outside Chile, net of taxes, and no separate registration by ADR holders is required. As of April 19, 2001, the Central Bank deregulated the Exchange Market, eliminating the need to obtain approval from the Central Bank in order to remit dividends, but at the same time eliminating the possibility of guaranteeing access to the Formal Exchange Market. It is important to point out that this does not affect the current Foreign Investment Contract, which was signed prior to April 19, 2001 and still permits access to the Formal Exchange Market based on the prior approval of the Central Bank. Therefore the holders of ADRs of
 
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Santander-Chile are still subject to the Foreign Investment Contract, including its clauses referring to the prior exchange rules including the now extinct Chapter XXVI of the Compedium.
 
E.     Taxation
 
The following discussion summarizes certain material Chilean tax and United States federal income tax consequences to beneficial owners arising from the purchase, ownership and disposition of the ADSs. The summary does not purport to be a comprehensive description of all potential Chilean tax and United States federal income tax considerations that may be relevant to a decision to purchase, own or dispose of the ADSs and is not intended as tax advice to any particular investor. This summary does not describe any tax consequences arising under the laws of any state, locality or other taxing jurisdiction other than Chile and the United States. There is currently no income tax treaty between the United States and Chile.
 
Material Tax Consequences of Owning Shares of Our Common Stock or ADSs
 
Chilean Taxation
 
The following is a summary of certain Chilean tax consequences of the ownership of shares of Santander-Chile’s common stock or of ADSs evidenced by ADRs by Foreign Holders (as defined herein). The summary does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a decision to purchase, own or dispose of shares or ADSs and does not purport to deal with the tax consequences applicable to all categories of investors, some of whom may be subject to special rules. Holders of shares or ADSs are advised to consult their own tax advisors concerning the Chilean and other tax consequences of the ownership of shares or of ADSs evidenced by ADRs.
 
The description of Chilean tax laws set forth below is based on Chilean laws in force as of the date of this Annual Report and is subject to any changes in such laws occurring after the date of this Annual Report. These changes can be made on a retroactive basis.
 
For purposes of this summary, the term “Foreign Holder” means either (1) in the case of an individual, a person who is not resident or domiciled in Chile (for purposes of Chilean taxation, (a) an individual holder is resident in Chile if he or she has resided in Chile for more than six months in one calendar year, or a total of more than six months in two consecutive fiscal years and (b) an individual is domiciled in Chile if he or she resides in Chile with the actual or presumptive intent of staying in Chile); or (2) in the case of a legal entity, a legal entity that is not domiciled in Chile, unless the shares of Santander-Chile’s common stock or ADSs are assigned to a branch or a permanent establishment of such entity in Chile.
 
Taxation of Dividends
 
Cash dividends paid by Santander-Chile with respect to shares of its common stock held by a Foreign Holder, including shares represented by ADSs, will be subject to a 35% Chilean withholding tax, which is withheld and paid over by Santander-Chile (the “Withholding Tax”). If Santander-Chile has paid corporate income tax (the “First Category Tax”) on the income from which the dividend is paid, a credit for the First Category Tax effectively reduces the rate of Withholding Tax. When a credit is available, the Withholding Tax is computed by applying the 35% rate to the pre-tax amount needed to fund the dividend and then subtracting from the tentative withholding tax so determined the amount of First Category Tax actually paid on the pre-tax income. For purposes of determining the rate at which First Category Tax was paid, dividends are treated as paid from Santander-Chile’s oldest retained earnings.
 
The effective rate of Withholding Tax to be imposed on dividends paid by Santander-Chile will vary depending upon the amount of First Category Tax paid by Santander-Chile on the earnings underlying the dividends. The effective rate for the First Category Tax attributed to earnings generated during the fiscal year 2004 and onwards is 17.0%. Full applicability of the First Category Tax credit at the 17.0% rate results in an effective Withholding Tax rate of 2l.7 %. Consequently, the Withholding Tax rate with respect to dividends fluctuates between 21.7% and 35.0%, depending on whether or not we are subject to the First Category Tax.
 
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The example below illustrates the effective Chilean Withholding Tax burden on a cash dividend received by a Foreign Holder, assuming a Withholding Tax rate of 35%, an effective First Category Tax rate of 17% and a distribution of all of the net proceeds available after payment of the First Category Tax.
 
Taxable income
 
US$ 100
 
First Category Tax (17% of US$100)
    (17 )
Net proceeds available
   
83
 
Dividend payment
   
83
 
Withholding Tax (35% of the sum of the dividend (US$83) and the available First Category Tax credit (US$17)
    (35 )
First Category Tax credit
   
17
 
Payable Withholding Tax
    (18 )
Net dividend received
   
65(83-18
)
Effective dividend withholding tax rate
   
21.7
%
     
(18/83
)
 
Dividend distributions made in kind would be subject to the same Chilean tax rules as cash dividends. Stock dividends are not subject to Chilean taxation. The distributions of preemptive rights relating to shares of common stock will not be subject to Chilean taxation.
 
Taxation of Capital Gains
 
Gain realized on the sale, exchange or other disposition by a Foreign Holder of ADSs (or ADRs evidencing ADSs) will not be subject to Chilean taxation, provided that such disposition occurs outside Chile or that it is performed under the rules of Title XXIV of the Chilean Securities Market Law, as amended by Law No. 19,601, dated January 18, 1999. The deposit and withdrawal of shares of common stock in exchange for ADRs will not be subject to any Chilean taxes.
 
Gain recognized on a sale or exchange of shares of common stock (as distinguished from sales or exchanges of ADSs representing such shares of common stock) by a Foreign Holder will be subject to both the First Category Tax and the Chilean withholding tax (the former being creditable against the latter) if (1) the Foreign Holder has held such shares of common stock for less than one year since exchanging ADSs for the shares of common stock, (2) the Foreign Holder acquired and disposed of the shares of common stock in the ordinary course of its business or as a regular trader of stock or (3) the sale is made to a company in which the Foreign Holder holds an interest. In all other cases, gain on the disposition of shares of common stock will be subject only to the First Category Tax levied as sole tax. The sale of shares of common stock by a Foreign Holder to an individual or entity resident or domiciled in Chile is subject to a provisional withholding.  Such a provisional withholding will be equal to (i) 5% of the amount, without any deduction, paid to, credited to, account for, put at the disposal of, or corresponding to, the Foreign Holder if the transaction is subject to the First Category Tax as sole tax, unless the gain subject to taxation can be determined, case in which the withholding is equal to 17% on the gain, or (ii) 20% of the amount, without any deduction, paid to, credited to, account for, put at the disposal of, or corresponding to, the Foreign Holder if the transaction is subject to the First Category Tax, and the Chilean withholding tax, with a credit of the First Category Tax already paid. For income tax purposes, the capital gain shall be the difference between the sales price and the acquisition cost of the stock.  The tax basis of shares of common stock received in exchange for ADSs will be the acquisition value of such shares. The valuation procedure set forth in the deposit agreement, which values shares of common stock that are being exchanged at the highest price at which they trade on the Santiago Stock Exchange on the date of the exchange, generally will determine the acquisition value for this purpose. Consequently, the conversion of ADSs into shares of common stock and sale of such shares of common stock for the value established under the deposit agreement will not generate a capital gain subject to taxation in Chile.
 
In the case where the sale of the shares is made on a day that is different than the date on which the exchange is recorded, capital gains subject to taxation in Chile may be generated. On October 1, 1999, the Chilean Internal Revenue Service issued Ruling No. 3708 whereby it allowed Chilean issuers of ADSs to amend the deposit
 
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agreements to which they are parties in order to include a clause that states that, in the case that the exchanged shares are sold by the ADSs’ holders in a Chilean Stock Exchange, either on the same day in which the exchange is recorded in the shareholders’ registry of the issuer or the two prior business days to such date, the acquisition price of such exchanged shares shall be the price registered in the invoice issued by the stock broker that participated in the sale transaction. Consequently, because we have included this clause in the form of ADR attached to the deposit agreement, the capital gain that may be generated if the shares received in exchange for ADSs were sold within two days prior to the date on which the exchange is recorded, will not be subject to taxation.
 
The distribution and exercise of preemptive rights relating to the shares of common stock will not be subject to Chilean taxation. Cash amounts received in exchange for the shares or assignment of preemptive rights relating to the shares will be subject to both the First Category Tax and the Chilean withholding tax (the former being creditable against the latter to the extent described above).
 
In certain cases and provided certain requirements are met, capital gains realized on the sale of actively traded stock of Chilean public companies may be exempt from Chilean income taxes. Our stock is currently considered an actively traded stock in the Santiago Stock Exchange, and Foreign Holders of the stock may qualify for an income tax exemption. Foreign Holders are urged to consult with their own tax advisors to determine whether an exemption applies to them.
 
Other Chilean Taxes
 
No Chilean inheritance, gift or succession taxes apply to the transfer or disposition of the ADSs by a Foreign Holder, but such taxes generally will apply to the transfer at death or by gift of shares of Santander-Chile’s common stock by a Foreign Holder. No Chilean stamp, issue, registration or similar taxes or duties apply to Foreign Holders of shares or ADSs.
 
Withholding Tax Certificates
 
Upon request, Santander-Chile will provide to foreign holders appropriate documentation evidencing the payment of Chilean withholding taxes. For further information, the investor should contact:  Robert Moreno, rmorenoh@santander.cl.
 
Dividends payable to holders of ADSs are net of foreign currency conversion expenses of the Depositary and will be subject to the Chilean withholding tax currently at the rate of 35% (subject to credits in certain cases as described above). Owners of the ADSs will not be charged any dividend remittance fees by the Depositary with respect to cash or stock dividends.
 
U.S. Federal Income Tax Considerations
 
The following is a discussion of material U.S. federal income tax consequences of purchasing, owning and disposing of shares or ADSs, but it does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a particular person’s decision to acquire such securities. The discussion applies only if you hold shares or ADSs as capital assets for tax purposes and it does not address special classes of holders, such as:
 
  ·
certain financial institutions;
 
  ·
insurance companies;
 
  ·
dealers and traders in securities or foreign currencies;
 
  ·
persons holding shares or ADSs as part of a hedge, straddle or conversion transaction;
 
  ·
persons whose functional currency for U.S. federal income tax purposes is not the U.S. dollar;
 
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  ·
partnerships or other entities classified as partnerships for U.S. federal income tax purposes;
 
  ·
persons liable for the alternative minimum tax;
 
  ·
tax-exempt organizations; or
 
  ·
persons holding shares or ADSs that own or are deemed to own ten percent or more of our voting stock.
 
This discussion is based on the Internal Revenue Code of 1986, as amended (the “Code”), administrative pronouncements, judicial decision and final, temporary and proposed Treasury regulations, all as currently in effect. These laws are subject to change, possibly on a retroactive basis. It is also based in part on representations by the depositary and assumes that each obligation under the Deposit Agreement and any related agreement will be performed in accordance with its terms. Please consult your own tax advisers concerning the U.S. federal, state, local and foreign tax consequences of purchasing, owning and disposing of shares or ADSs in your particular circumstances.
 
The discussion below applies to you only if you are a beneficial owner of shares or ADSs and are for U.S. federal tax purposes:
 
  ·
a citizen or resident of the United States;
 
  ·
a corporation, or other entity taxable as a corporation, created or organized in or under the laws of the United States or any political subdivision thereof; or
 
  ·
an estate or trust the income of which is subject to U.S. federal income taxation regardless of its source.
 
In general, if you hold ADSs, you will be treated as the holder of the underlying shares represented by those ADSs for U.S. federal income tax purposes. Accordingly, no gain or loss will be recognized if you exchange ADSs for the underlying shares represented by those ADSs.
 
The U.S. Treasury has expressed concerns that parties to whom ADSs are pre-released may be taking actions that are inconsistent with the claiming of foreign tax credits for holders of ADSs. Such actions would also be inconsistent with the claiming of the reduced rate of tax, described below, applicable to dividends received by certain non-corporate holders. Accordingly, the analysis of the creditability of Chilean taxes and the availability of the reduced rate for dividends received by certain non-corporate holders, each described below, could be affected by future actions that may be taken by the parties to whom the ADSs are pre-released.
 
Taxation of Distributions
 
Distributions paid on ADSs or shares, other than certain pro rata distributions of common shares or rights, will be treated as dividends to the extent paid out of current or accumulated earnings and profits (as determined under U.S. federal income tax principles). Since we do not maintain calculations of our earnings and profits under U.S. federal income tax principles, U.S. holders will generally be required to treat such distributions as taxable dividends. Subject to applicable limitations and the discussion above regarding concerns expressed by the U.S. Treasury, under current law, certain dividends paid by qualified foreign corporations to certain non-corporate U.S. Holders in taxable years beginning before January 1, 2011, are taxable at a maximum rate of 15%. A foreign corporation is treated as a qualified foreign corporation with respect to dividends paid on stock which is readily tradable on a securities market in the United States, such as the New York Stock Exchange where our ADSs are traded. You should consult your own tax advisers to determine whether the favorable rates may apply to dividends you receive and whether you are subject to any special rules that limit your ability to be taxed at this favorable rate.   The amount of the dividend will include any amounts withheld by us or our paying agent in respect of Chilean taxes at the effective rate as described above under “—Chilean Taxation.” The amount of the dividend will be treated as foreign source dividend income to you and will not be eligible for the dividends received deduction generally allowed to U.S. corporations under the Code.
 
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Dividends paid in Chilean pesos will be included in your income in a U.S. dollar amount calculated by reference to the exchange rate in effect on the date of your (or in the case of ADSs, the depositary’s) receipt of the dividend, regardless of whether the payment is in fact converted into U.S. dollars. If the dividend is converted into U.S. dollars on the date of receipt, you generally should not be required to recognize foreign currency gain or loss in respect of the dividend income. You may have foreign currency gain or loss if you do not convert the amount of such dividend into U.S. dollars on the date of its receipt.
 
Subject to applicable limitations that may vary depending upon your circumstances and the discussion above regarding concerns expressed by the U.S. Treasury, Chilean taxes withheld from cash dividends on shares or ADSs at the withholding tax rate, reduced in respect of any First Category Tax, as described above under “ —Chilean Taxation,” generally will be creditable against your U.S. federal income tax liability. The limitation on foreign taxes eligible for credit is determined separately with respect to specific classes of income. Instead of claiming a credit, you may, at your election, deduct such Chilean taxes in computing your taxable income, subject to generally applicable limitations under U.S. law. You should consult your own tax advisers to determine whether you are subject to any special rules that limit your ability to make effective use of foreign tax credits.
 
Sale and Other Disposition of Shares or ADSs
 
For U.S. federal income tax purposes, gain or loss you realize on the sale or other disposition of shares or ADSs generally will be capital gain or loss, and will be long-term capital gain or loss if you held the shares or ADSs for more than one year. The amount of your gain or loss will be equal to the difference between your tax basis in the shares or ADSs disposed of and the amount realized on the disposition. Such gain or loss will generally be U.S. source gain or loss for foreign tax credit purposes. Consequently, you may not be able to utilize a credit for Chilean withholding taxes imposed on gain from shares or ADSs.  You should consult your own tax advisers regarding the availability of foreign tax credits upon the sale or other disposition of your shares or ADSs.
 
Passive Foreign Investment Company Rules
 
Based on proposed Treasury regulations (“Proposed Regulations”), we believe that we were not a “Passive Foreign Investment Company” (“PFIC”) for U.S. federal income tax purposes for the year ended December 31, 2006, and we do not anticipate becoming a PFIC thereafter.  However, since the Proposed Regulations may not be finalized in their current form and since PFIC status depends upon the composition of a company’s income and assets and the market value of its assets (including, among others, less than 25 percent owned equity investments) from time to time, there can be no assurance that we will not be considered a PFIC for any taxable year. If we were treated as a PFIC for any taxable year during which you held an ADS or a share, certain adverse tax consequences could apply to you.
 
If we are treated as a PFIC for any taxable year, gain recognized by you on a sale or other disposition of an ADS or share would generally be allocated ratably over your holding period for the ADS or share. The amounts allocated to the taxable year of the sale or other exchange and to any year before we became a PFIC would be taxed as ordinary income. The amount allocated to each other taxable year would be subject to tax at the highest rate in effect for individuals or corporations, as appropriate, and an interest charge would be imposed on the amount allocated to such taxable year. Further, any distribution in respect of ADSs or shares in excess of 125 percent of the average of the annual distributions on ADSs or shares received by you during the preceding three years or your holding period, whichever if shorter, would be subject to taxation as described above. Certain elections may be available (including a mark to market election) to you that may help mitigate the adverse tax consequences. In addition, if we were to be treated as a PFIC in a taxable year in which we pay a dividend or the prior taxable year, the 15% dividend rate discussed above with respect to dividends paid to non-corporate shareholders would not apply.
 
Information Reporting and Backup Withholding
 
Payment of dividends and sales proceeds that are made within the United States or through certain U.S.-related financial intermediaries generally are subject to information reporting and to backup withholding unless (i) you are a
 
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corporation or other exempt recipient or (ii), in the case of backup withholding, you provide a correct taxpayer identification number and certify that you are not subject to backup withholding.
 
The amount of any backup withholding from a payment to you will be allowed as a credit against your U.S. federal income tax liability and may entitle you to a refund, provided that the required information is timely furnished to the Internal Revenue Service.
 
F.     Dividends and Paying Agents
 
Not applicable.
 
G.     Statement by Experts
 
Not applicable.
 
H.    Documents on Display
 
The documents concerning Santander-Chile which are referred to in this Annual Report may be inspected at our offices at Bandera 140 Santiago, Chile. We are, and Santiago and Old Santander-Chile were, subject to the information reporting requirements of the Exchange Act, except that, as a foreign issuer, we are not subject to the proxy rules or the short-swing profit and disclosure rules of the Exchange Act. In accordance with these statutory requirements, we file or furnish reports and other information with the SEC. Reports and other information filed or furnished by us with the SEC may be inspected and copied at the public reference room maintained by the SEC at 100 F street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Section by calling the SEC at 1-800-732-0330. Our filings with the SEC are also available through the SEC'S Internet site at http://www.sec.gov and can also be inspected and copied at the offices of the New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005.
 
I.     Subsidiary Information
 
Not applicable.
 
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Introduction
 
This section describes the market risks that we are exposed to, the tools and methodology used to control these risks, the portfolios over which these market risk methods were applied and quantitative disclosure that demonstrate the level of exposure to market risk that we are assuming. This section also discloses the derivative instruments that we use to hedge exposures and offer to our clients.
 
The principal types of risk inherent in Santander-Chile’s business are market, liquidity, operational and credit risks. The effectiveness with which we are able to manage the balance between risk and reward is a significant factor in our ability to generate long term, stable earnings growth. Toward that end, our senior management places great emphasis on risk management.
 
Market Risk
 
Market risk is the risk of losses due to unexpected changes in interest rates, foreign exchange rates, inflation rates and other rates or prices. We are exposed to market risk mainly as a result of the following activities:
 
·
trading in financial instruments, which exposes us to interest rate and foreign exchange rate risk;
 
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  ·
engaging in banking activities, which subjects us to interest rate risk, since a change in interest rates affected gross interest income, gross interest expense and customer behavior;
 
  ·
engaging in banking activities, which exposes us to inflation rate risk, since a change in expected inflation affects gross interest income, gross interest expense and customer behavior;
 
  · 
trading in the local equity market, which subjects us to potential losses caused by fluctuations of the stock market; and
 
  ·
investing in assets whose returns or accounts are denominated in currencies other than the Chilean peso, which subjects us to foreign exchange risk between the Chilean peso and such other currencies.
 
Market Risk Exposure Categories
 
Inflation
 
Although Chilean inflation has been moderate in recent years, Chile has experienced high levels of inflation in the past. 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. In 2006, inflation rate was 2.6%, compared to 3.7% in 2005 and 2.4% in 2004.
 
UF denominated assets and liabilities. The “Unidad de Fomento” (UF) is revalued in monthly cycles. On every day in the period beginning 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 each day a proportional amount of the prior calendar month’s change in the CPI. One UF equaled to Ch$17,317.05 at December 31, 2004, Ch$17,974.81 at December 31, 2005 and Ch$18,336.38 at December 31, 2006.  The effect of any changes in the nominal peso value of our UF denominated assets and liabilities is reflected in our results of operations as an increase (or decrease, in the event of deflation) in interest revenue and expense, respectively. The majority of long-term bonds with a maturity greater than 5 years are denominated in UFs.
 
Peso Denominated Assets and Liabilities. Rates of interest prevailing in Chile during any period reflect in significant part the rate of inflation during the period and expectations of future inflation. All bonds with a maturity of up to 5 years are denominated in pesos.
 
Interest Rates
 
Interest rates earned and paid on Santander-Chile’s assets and liabilities reflect to a certain degree inflation and expectations regarding inflation as well as shifts in short term rates related to the Central Bank’s monetary policies. The Central Bank manages short term interest rates based on its objectives of balancing low inflation and economic growth. In 2006, the Central Bank last increased the reference rate on July 14, 2006 to 5.25%, but reduced it by 25 basis points to 5.0% in January 2007.
 
Foreign Exchange Fluctuations
 
Changes in the value of the Chilean peso against the U.S. dollar could adversely affect the financial condition and results of operations of Santander-Chile. Santander-Chile had a policy of minimizing the effect of the fluctuation of the exchange rate on its results and balance sheet. In 2004 and 2005, the Chilean peso appreciated 6.6% and 8.1% against the dollar, respectively.  In the year ended December 31, 2006, the Chilean peso depreciated 3.9% against the U.S. dollar.
 
Asset and Liability Management
 
Our policy with respect to asset and liability management is to capitalize on our competitive advantages in treasury operations, maximizing our net interest revenue and return on assets and equity with a view to limiting interest rate, liquidity and foreign exchange risks within the limits provided by Chilean banking regulations. Subject to these constraints, we constantly have mismatched positions with respect to interest rates and foreign
 
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currencies. Our asset and liability management policies are developed by ALCO following guidelines and limits established by our Board of Directors, Banco Santander Central Hispano’s Global Risk Department and our Market Risk and Control Department. The ALCO is composed of the Chairman of the Board, two additional members of the Board, the Chief Executive Officer, the Manager of the Finance Division, the Manager of Market Risk, the Financial Controller and other senior members of management. Senior members of Santander-Chile’s Finance Division meet daily and, on a formal basis, weekly with the Asset and Liabilities Management Committee and outside consultants. In addition, our Controller reports weekly on all of our positions to the ALCO. Our limits and positions are reported on a daily basis to Banco Santander Central Hispano’s Global Risk Department. The ALCO reports as often as deemed necessary to our Board of Directors. The risk limits set by the ALCO are implemented by our Finance Division and are controlled by the Market Risk and Control Department, which establishes guidelines and policies for risk management on a day-to-day basis. The composition of our assets, liabilities and shareholders’ equity at December 31, 2006 by currency and term is as follows:
 
   
December 31, 2006
 
   
Ch$
   
UF
   
Foreign
Currencies
   
Total
   
Percentage
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Assets
                             
Cash and due from banks
   
337,675
     
-
     
754,732
     
1,092,407
      7.4 %
Other assets:(1)
                                       
Less than one year
   
3,359,913
     
1,131,543
     
1,318,070
     
5,809,526
      39.2 %
From one to three years
   
604,810
     
836,978
     
75,903
     
1,517,691
      10.2 %
More than three years
   
929,043
     
4,736,150
     
184,613
     
5,849,806
      39.4 %
Bank premises and equipment and others
   
579,432
     
3,499
     
165,142
     
748,073
      5.0 %
Allowance for loan losses
    (174,064 )                     (174,064 )     (1.2 %)
                                         
Total
   
5,636,809
     
6,708,170
     
2,498,460
     
14,843,439
      100.0 %
                                         
Percentage of total assets
    38.0 %     45.2 %     16.8 %     100.0 %        
                                         
Liabilities and Shareholders’ Equity
                                       
Non-interest-bearing deposits
   
2,155,828
     
169,961
     
157,208
     
2,482,997
      16.7 %
Other liabilities:(1)
                                       
Less than one year
   
3,790,326
     
1,944,785
     
2,186,874
     
7,921,985
      53.4 %
From one to three years
   
241,062
     
631,721
     
149,956
     
1,022,739
      6.9 %
More than three years
   
289,969
     
1,356,228
     
524,182
     
2,170,379
      14.6 %
Shareholders’ equity
   
959,757
     
-
     
-
     
959,757
      6.5 %
2006 net income
   
285,582
     
-
     
-
     
285,582
      1.9 %
                                         
Total
   
7,722,524
     
4,102,695
     
3,018,220
     
14,843,439
      100.0 %
                                         
Percentage of total liabilities and shareholders’ equity
    52.0 %     27.6 %     20.4 %     100.0 %        
 

(1)
Other assets include our rights under foreign exchange contracts, and other liabilities include our obligations under foreign exchange contracts. Mortgage finance bonds issued by us are included as other liabilities, and mortgage finance bonds held in our financial investment portfolio (issued by third parties) are included as other assets.
 
We have generally maintained more peso denominated liabilities than peso denominated assets and more UF-denominated assets than UF-denominated liabilities. In the context of a rising CPI, this has in the past had a positive impact on our net income by generating net income from adjustments of the UF that exceeds losses arising from price level restatements. This effect is expected to decrease significantly if rates of inflation decrease.
 
Interest Rate Sensitivity
 
A key component of our asset and liability policy is the management of interest rate sensitivity. Interest rate sensitivity is the relationship between market interest rates and net interest revenue due to the maturity or repricing characteristics of interest-earning assets and interest-bearing liabilities. For any given period, the pricing structure is matched when an equal amount of such assets and liabilities mature or reprice in that period. Any mismatch of
 
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interest-earning assets and interest-bearing liabilities is known as a gap position. A positive gap denotes asset sensitivity and means that an increase in interest rates would have a positive effect on net interest revenue while a decrease in interest rates would have a negative effect on net interest revenue.
 
Our interest rate sensitivity strategy takes into account not only the rates of return and the underlying degree of risk, but also liquidity requirements, including minimum regulatory cash reserves, mandatory liquidity ratios, withdrawal and maturity of deposits, capital costs and additional demand for funds. We monitor our maturity mismatches and manage them within established limits.
 
The following table sets forth the repricing of our interest-earning assets and interest-bearing liabilities at December 31, 2006 and may not reflect interest rate gap positions at other times. In addition, variations in interest rate sensitivity may exist within the repricing periods presented due to the differing repricing dates within the period. Variations may also arise among the different currencies in which interest rate positions are held.
 
As the following table reflects, we have a negative gap for most periods of one year or less as our main source of funding are short term time deposits. The majority of assets and liabilities with a maturity of 90 days or less are denominated in nominal pesos. Ninety days or more is also the most common repricing period for UF-denominated time deposits. In the case of interest-earning assets and interest-bearing liabilities denominated in UF, our exposure to changes in interest rates is reduced by the fact that a significant portion of the interest rate earned or paid on such assets or liabilities is indexed to reflect the effect of inflation, and as a result our gap position is limited to variations in the real interest rate among such assets and liabilities. Moreover, mortgage loans which have 8- to 20-year terms were generally financed through bonds issued for the same terms and in the same currency.
 
   
As of December 31, 2006
 
   
Up to 30
 days
   
31-60
days
   
61-90
days
   
91-180
days
   
181-365
days
   
1-3
years
   
Over 3
years
   
Total
 
   
(in millions of constant Ch$ as of December 31, 2006, except percentages)
 
Interest-earning assets:
                                               
Interbank deposits
   
144,666
     
-
     
-
     
-
     
-
     
-
     
-
     
144,666
 
Financial investments
   
236,145
     
125
     
11,149
     
7,267
     
59,206
     
309,949
     
391,535
     
1,015,376
 
Loans
   
1,881,622
     
423,772
     
371,530
     
796,436
     
783,394
     
1,846,630
     
4,084,480
     
10,187,864
 
Mortgage loans
   
5,865
     
4,676
     
4,658
     
14,219
     
27,899
     
101,096
     
327,436
     
485,849
 
Contingent loans
   
143,318
     
128,559
     
103,868
     
190,827
     
177,622
     
240,145
     
38,348
     
1,022,687
 
Past due loans
   
92,559
     
-
     
-
     
-
     
-
     
-
     
-
     
92,559
 
                                                                 
Total interest-earning assets
   
2,504,175
     
557,132
     
491,205
     
1,008,749
     
1,048,121
     
2,497,820
     
4,841,799
     
12,949,001
 
 
                                                               
Interest-bearing liabilities:
                                                               
Deposits
   
1,964,107
     
940,303
     
547,954
     
1,111,341
     
919,913
     
1,195,779
     
229,938
     
6,909,335
 
Central Bank borrowings
   
135,266
     
598
     
-
     
-
     
3,633
     
-
     
-
     
139,497
 
Balances under agreements to repurchase
   
19,820
     
109
     
-
     
-
     
-
     
-
     
-
     
19,929
 
Mortgage finance bonds
   
30,407
     
2,361
     
2,182
     
14,473
     
16,070
     
105,746
     
358,967
     
530,206
 
Other liabilities
   
164,789
     
50,803
     
47,415
     
225,078
     
323,549
     
310,328
     
810,567
     
1,932,529
 
                                                                 
Total interest-bearing liabilities
   
2,314,389
     
994,174
     
597,551
     
1,350,892
     
1,263,165
     
1,611,853
     
1,399,472
     
9,531,496
 
 
                                                               
Asset/liability gap
   
189,786
      (437,042 )     (106,346 )     (342,143 )     (215,044 )    
885,967
     
3,442,327
     
3,417,505
 
Cumulative gap
   
189,786
      (247,256 )     (353,602 )     (695,745 )     (910,789 )     (24,822 )    
3,417,505
         
 
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Exchange Rate Sensitivity
 
The regulations of the Central Bank do not permit the difference, whether positive or negative, between a bank’s assets and liabilities denominated in any foreign currency (including assets and liabilities denominated in U.S. dollars but payable in pesos, as well as those denominated in pesos and indexed to the U.S. dollar exchange rate) to exceed 20% of the bank’s paid in capital and reserves; except in case where the balance of such assets exceeds the balance of such liabilities and the excess difference does not exceed the bank’s allowances and reserves denominated in such foreign currency (excluding profits to be remitted abroad). Santander-Chile has set an absolute limit on the size of its net foreign currency trading position.  At December 31, 2006, this was equal to US$200 million. The Bank also uses a sensitivity analysis to limit the potential loss in fluctuations of U.S. interest rates on interest income and a VaR model to limit foreign currency risk.
 
In recent years, our results of operations have benefited from fluctuations in the exchange rate between the Chilean peso and the U.S. dollar in part due to our policy and Central Bank regulations relating to the control of material exchange rate mismatches. However, the rate of devaluation or appreciation of the peso against the U.S. dollar could also be expected to have the following principal effects:
 
(i)     If we maintain a net asset position in U.S. dollars and a devaluation of the peso against the U.S. dollar occurs, we would record a related gain, and if an appreciation of the peso occurs, we would record a related loss;
 
(ii)     If we maintain a net liability position in U.S. dollars and a devaluation of the peso against the dollar occurs, we would record a related loss, and if an appreciation of the peso occurs, we would record a related gain;
 
(iii)     If the inflation rate for a period exceeded the devaluation of the peso against the U.S. dollar during the same period, this would mean that in real terms the peso appreciated against the U.S. dollar. Therefore, we would record a related gain if we had a net asset position in UFs that exceeded a net liability position in U.S. dollars, and we would record a related loss if we had a net liability position in U.S. dollars that exceeded a net asset position in UFs; and
 
(iv)     If the inflation rate for a period were lower than the rate of devaluation of the peso against the U.S. dollar during the same period, this would mean that in real terms the peso depreciated against the U.S. dollar. Therefore, we would record a related gain if we maintained a net asset position in U.S. dollars and a net liability position in UFs and would record a related loss if it had a net liability position in U.S. dollars and a net asset position in UFs.
 
We enter into foreign exchange forward contracts and interest rate swap contracts as part of our asset and liability management. We enter into two fundamental types of foreign forward exchange contracts: (i) transactions covering two foreign currencies and (ii) transactions covering only Chilean pesos and UFs against U.S. dollars. We use the first type for hedging purposes, such as when we take a liability position in foreign currency other than the U.S. dollar, and use the second type, which is carried out only in the Chilean local market, to take foreign currency positions, subject to the regulatory requirement that the forward foreign currency exposure must be included in the maximum net foreign currency position permitted by applicable regulations. See “Item 4: Information on the Company—D. Regulation and Supervision” and “Item 5:Operating and Financial Review and Prospects—D. Asset and Liability Managemen—Average Balance Sheets, Income Earned from Interest-Earned Assets and Interest Paid on Interest-Bearing Liabilities.”
 
The Central Bank requires that foreign exchange forward contracts be made only in U.S. dollars and other major foreign currencies. As noted above, substantially all of our forward contracts are made in U.S. dollars against the Chilean peso or the UF. We may enter into foreign currency forward contracts with companies organized and located outside of Chile, including foreign subsidiaries of Chilean companies. We believe that as the market for forward contracts deepens, our client base in Chile as well as our relationship with Banco Santander Central Hispano will give us an advantage in positioning ourselves within this new market.
 
 
140

 
Statistical Tools for Measuring and Managing Risk: Regulatory Method
 
On an unconsolidated basis, the Bank must separate its balance sheet in two separate categories: trading portfolio (Libro de Negociación) and non-trading, or permanent, portfolio (Libro de Banca). The trading portfolio as defined by the Superintendency of Banks includes all instruments valued at market prices, free of any restrictions on their immediate sale and that are frequently bought and sold by the bank or are maintained with the intention of selling them in the short term in order to profit from short term price variations. The non-trading portfolio is defined as all instruments in the balance sheet not considered in the trading portfolio.
 
We must also report the following absolute risk levels:
 
Trading portfolio:
 
 
·
Exposure to interest rate risk: Interest rate risk of the trading portfolio is basically a sensitivity analysis, which is the calculated potential losses assuming an increase in nominal rate yield curves, real rates and foreign currency rates by 75 to 350 basis points.
 
 
·
Exposure to foreign currency risk: The foreign currency risk is calculated using sensitivity factors linked to the credit risk rating of the issuing country.
 
 
·
Market risk exposure of options: Options risk is calculated using sensitivity factors called delta, gamma and vega that basically measure the sensitivity of the value of the options to changes in the price of the underlying security and its volatility.
 
Non-trading portfolio:
 
 
·
Exposure to short-term interest rate risk: Sensitivity analysis that is calculated for assets and liabilities with maturities of less than 1 year, assuming a 200 basis point parallel shift of the nominal yield curve, 400 for real rates and 200 for foreign interest rates.
 
 
·
Exposure to inflation risk: Sensitivity analysis that is calculated for assets and liabilities with maturities of less than 1 year, assuming a 200 basis point parallel shift of the nominal yield curve, 400 for real rates and 200 for foreign interest rates.
 
 
·
Exposure to long-term interest rate risk: Sensitivity analysis that is calculated for assets and liabilities with maturities from 1 to over 20 years, assuming a 200 basis point parallel shift of the nominal yield curve, 400 for real rates and 200 for foreign interest rates.
 
The Superintendency of Banks has defined various limits for these risks.
 
1)
EMR limit. A bank’s regulatory capital must be greater or equal to the sum of the exposure to market risk multiplied by the minimum capital adequacy ratio defined in the General Banking Law. In other words:
 
RC – ((k * RWA) + EMR) > 0
 
Where:
 
RC: 
Regulatory capital as defined by the General Banking Law.
K:
Minimum capital adequacy ratio. The Bank is required to use a 10% minimum capital adequacy ratio for the purpose of calculating the EMR limit.
RWA:
Consolidated risk-weighted assets as defined by the General Banking Law.
EMR: 
Exposure to market risk. Santander-Chile’s EMR is equal to the total market risk of its unconsolidated trading portfolio. This includes interest rate risk, foreign currency risk and risks derived from options.
 
                      
 
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2)                 Limit on exposure to short-term interest rate and inflation risk of the Bank’s non-trading portfolio. Santander-Chile’s exposure to short-term interest rate and inflation risk of the non-trading portfolio cannot exceed 20% of its unconsolidated net interest income plus fees sensitive to interest rate volatility.
 
3)                 Limit on exposure to long-term interest rate risk of a bank’s non-trading portfolio. Santander-Chile’s exposure to long-term interest rate risk of the unconsolidated non-trading portfolio cannot exceed 35% of its regulatory capital.
 
The following is a description of the models adopted by local regulators for measuring market risks.
 
Interest rate risk of trading portfolio: Regulatory method
 
The interest rate risk of the trading portfolio as defined by the Central Bank of Chile is equal to the sum of:
 
1)                The sensitivity analysis of the trading portfolio
2)                Vertical adjustment factor
3)                Horizontal adjustment factor

The sensitivity factor of the trading portfolio is calculated using the following formula:
 
 
 M
14
 
                                                    Sensitivity =
 S
S
(amt * Amt - amt * Lmt )
 
 M
t=1
 

Where:
 
Amt  
= Trading Assets (pesos, inflation linked and foreign currency)
Lmt
= Liabilities funding trading positions (pesos, inflation linked and foreign currency)
amt
= Sensitivity factor to rise in interest rates
t
= Time period
M
= Currency (pesos, inflation linked and foreign currency)
S
= Summation
   
= Absolute value
 
The vertical adjustment factor is calculated in the following manner
 
 
 M
14
 
                                                    Vertical adjustment =
 S
S
b * Compensated net position
 
 M
T=1
 

 
 M
14
 
Compensated net position =
 S
S
Min(amt * Amt ; amt * Lmt )
 
 M
T=1
 
 
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Where:
 
Amt  
= Trading Assets (pesos, inflation linked and foreign currency)
Lmt
= Liabilities funding trading positions (pesos, inflation linked and foreign currency)
amt
= Sensitivity factor to rise in interest rates
t
= Time period
M
= Currency (pesos, inflation linked and foreign currency)
b
= Vertical adjustment factor = 10%
 
A horizontal adjustment must be made following the vertical adjustment. To determine the horizontal adjustment, one must multiply the horizontal adjustment factor by the compensated net position for Zones 1, Zone 2, Zone 3, Zones 1 and 2, Zones 2 and 3 and Zones 1 through 3.
 

Horizontal adjustment =
λ * Adjusted net position
Compensated net position Zone 1, 2 or 3
Min(Σ Adjusted net asset position; Σabsolute value of adjusted net liability position in Zone 1, 2 or 3 )
Compensated net position Zones 1 and 2
Min(Σ Adjusted net asset position in Zones 1 and 2, Σabsolute value of adjusted net liability position in Zones 1 and 2)
Compensated net position Zones  2 and 3
Min(Σ Adjusted net asset position in Zone 3 and Zone 2 (deducting adjusted net asset position that have been compensated for with net liability positions in Zone 1), Σabsolute value of adjusted net liability position in Zone 3 and Zone 2 (deducting adjusted net liability positions that have been compensated for with net liability positions in Zone 1))
Compensated net position Zones 1 – 3
Min(Σ Adjusted net asset position in Zone 3 and Zone 1 (deducting adjusted net asset position that have been compensated for with net liability positions in Zone 2), Σabsolute value of adjusted net liability position in Zone 3 and Zone 1 (deducting adjusted net liability positions that have been compensated for with net liability positions in Zone 2))
 
143

 
The following table illustrates the value of the different factors used for calculating the interest rate risk of the trading portfolio.
 
Table 1 Sensitivity Factors - Trading Portfolio
Zone
T
Period
Change in
Interest rate (bp)
Sensitivity factor( amt )
Vertical adjustment
factor
Horizontal  adjustment
factor
     
peso
UF
FX
Peso
UF
FX
(β)
(λ)
Zone 1
1
Up to 30 days
125
350
125
0.0005
0.0014
0.0005
10%
40%
40%
 
100%
2
31 days to 3 mths
125
300
125
0.0019
0.0047
0.0020
3
3 – 6 mths
125
250
125
0.0042
0.0088
0.0044
4
6 – 9 mths
125
200
125
0.0069
0.0116
0.0072
5
9 mths – 1 year
125
175
125
0.0095
0.0140
0.0100
Zone 2
6
1-2 years
100
125
100
0.0124
0.0166
0.0133
30%
40%
7
2-3 years
100
100
100
0.0191
0.0211
0.0211
8
3-4 years
100
100
100
0.0248
0.0281
0.0281
Zone 3
9
4-5 years
75
75
75
0.0221
0.0258
0.0258
30%
 
10
5-7 years
75
75
75
0.0263
0.0320
0.0320
11
7-10 years
75
75
75
0.0307
0.0401
0.0401
12
10-15 years
75
75
75
0.0332
0.0486
0.0486
13
15-20 years
75
75
75
0.0317
0.0534
0.0534
14
> 20 years
75
75
75
0.0278
0.0539
0.0539

 
Below is an example of how the interest risk of the trading portfolio is calculated. This calculation must be done for each type of currency (peso, inflation indexed and foreign currency).
 

144

 
Interest rate and inflation risk of non-trading portfolio: Regulatory method
 
The short-term interest rate risk and inflation risk of the non-trading portfolio as defined by the Central Bank is equal to:
 
   
M
5
               
 
 Sensitivity =   
S
S
 (Amt - Lmt ) * mt
 
+
 
NPur * t
+
Df
 
 
 
M
t=1
 
 
 
 
       
 
The long-term interest rate risk of the non-trading portfolio is calculated according to the following formula:
 
   
M
14
   
 
Sensitivity =   
S
S
(Amt - Lmt ) * rt
 
 
 
M
t=1
   
 
Where:
 
Amt  
= Non-trading Assets (pesos, inflation linked and foreign currency)
Lmt
= Non-trading Liabilities (pesos, inflation linked and foreign currency)
mt
= Sensitivity factor associated with interest rate movement scenario
NPur
= Net position in inflation linked instruments, including those subject to price level restatement
t
= Factor that measures the sensitivity of/to movements in the inflation index. This factor is equal to 2%
Df
= Effect on fees from shifts in interest rate. Each bank must determine which fees are sensitive to shifts in interest rates and assume a 200 basis point movement.
rt
= Sensitivity factor to increase in interest rates
t
= Time period
M
= Currency (pesos, inflation linked and foreign currency)
S
= Summation
   
= Absolute value
 
The following table illustrates the value of the different factors used for calculating the interest and inflation rate risks of the non-trading portfolio.
 
Table 2 Sensitivity Factors Non-trading Portfolio
t
Period
Change in
interest rate (bp)
Sensitivity factor long-term
(rt)
Sensitivity factor short-term
   
peso
UF
FX
peso
UF
FX
(mt)
1
Up to 30 days
200
400
200
0.0008
0.0016
0.0008
0.0192
2
31 days to 3 mths
200
400
200
0.0030
0.0063
0.0031
0.0167
3
3 – 6 mths
200
400
200
0.0067
0.0140
0.0070
0.0125
4
6 – 9 mths
200
400
200
0.0110
0.0231
0.0116
0.0075
5
9 mths – 1 year
200
400
200
0.0152
0.0320
0.0160
0.0025
6
1-2 years
200
400
200
0.0248
0.0399
0.0266
 
7
2-3 years
200
400
200
0.0382
0.0422
0.0422
 
8
3-4 years
200
400
200
0.0496
0.0563
0.0563
 
9
4-5 years
200
400
200
0.0591
0.0690
0.0690
 
10
5-7 years
200
400
200
0.0702
0.0856
0.0856
 
11
7-10 years
200
400
200
0.0823
0.1076
0.1076
 
12
10-15 years
200
400
200
0.0894
0.1309
0.1309
 
13
15-20 years
200
400
200
0.0860
0.1450
0.1450
 
14
> 20 years
200
400
200
0.0762
0.1480
0.1480
 
 
 
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Foreign currency risk: local method
 
The foreign currency risk as defined by the Central Bank is equal to:
 

 
Where:
 
 
NAP
=Net asset position
 
NLP
=Net liability position
 
NPgold
=Net position in gold
 
si
=Sensitivity factor
 
Maximum
=Maximum value
 
S
=Summation
     
=Absolute value
 
The following table illustrates the value of the different factors used for calculating foreign currency risk.
 
Table 3 Sensitivity Factors Foreign Currency Risk
 
Currency Group
 
 
Description
 
 
Sensitivity factor (si  )
I
 
All currencies of countries with a AAA sovereign rating
 
  8%
J
 
All other currencies
 
35%

 
Options risk: Regulatory method
 
The exposure to market risk of options is calculated using sensitivity factors delta, gamma and vega.
 
Delta
 
Delta of a derivative security is the rate of change of its price relative to the price of the underlying asset. It is the first derivative of the curve that relates the price of the derivative to the price of the underlying security. When delta is large, the price of the derivative is sensitive to small changes in the price of the underlying security.
 
Gamma
 
Gamma of a derivative security is the rate of change of delta relative to the price of the underlying asset; i.e., the second derivative of the option price relative to the security price. When gamma is small, the change in delta is small. The Gamma impact is calculated using the following formula.
 
Gamma impact = Gamma * (Variation of underlying security)^2 / 2
 
When the underlying security for an interest rate options is a debt instrument, then the variation of the value of the underlying security will be calculated using the sensitivity factors established in Tables 1 and 2 above. When the underlying security is an interest rate, then the change in interest rates assumed will be those used in Table 1 and 2 above. Finally, for foreign exchange options, the variation of the underlying security will be calculated using the factors used in Table 3 above.
 
Vega
 
Vega is one of the sensitivity factors used to measure sensitivity to the implied volatilities of the underlying security. Vega is the rate of change in the price of a derivative security relative to the volatility of the underlying security. When vega is large, the security is sensitive to small changes in volatility. In general, a long option position will benefit from rising implied volatilities and suffer from declining implied volatilities. Short option positions display opposite behavior. As defined by the Central Bank, the Vega Risk is the sum in absolute value of the vega
 
146

 
impacts for each option a bank holds. These impacts will be calculated assuming a change of 25% in the volatility rate.
 
Assumptions and Limitations of Scenario Simulations/Sensitivity Analysis (Regulatory method)
 
Our scenario simulation methodology should be interpreted in light of the limitations of our models, which include:
 
 
·
The scenario simulation assumes that the volumes remain on balance sheet and that they are always renewed at maturity, omitting the fact that credit risk considerations and pre-payments may affect the maturity of certain positions.
 
 
·
This model assumes set shifts in interest rates and sensitivity factors for different time periods and does not take into consideration any other scenario for each time period or other sensitivity factors.
 
 
·
The model does not take into consideration the sensitivity of volumes to these shifts in interest rates.
 
 
·
The model does not take into consideration our subsidiaries which are subject to market risks.
 
Quantitative Disclosures about Market Risk: Regulatory Method
 
The following table illustrates at December 31, 2005 and 2006, our market risk exposure according to the Chilean regulatory method.  This report is sent to the Superintendency of Banks and is published on our website on a quarterly basis. In 2006, the Bank increased its maximum exposure to long term interest rate fluctuations from 25% to 35% of regulatory capital. This modification was approved by the Board of Directors and was performed in order to conform internal interest rate risk limits with regulatory limits.
 
 
Regulatory Market Risk
 
At December 31, 2005
   
At December 31, 2006
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Market risk of Trading portfolio (EMR)
           
Interest rate risk of trading portfolio
   
80,423
     
22,489
 
Foreign currency risk of trading portfolio
   
2,984
     
24,841
 
Risk from interest rate options
   
23,753
     
31,111
 
Risk from foreign currency options
   
9,182
     
1
 
Total market risk of trading portfolio
   
116,342
     
78,442
 
10% x Risk-weighted assets
   
946,201
     
1,126,349
 
Subtotal
   
1,062,543
     
1,204,791
 
Limit = Regulatory Capital
   
1,209,635
     
1,418,303
 
Available margin
   
147,092
     
213,512
 
                 
Non-trading portfolio market risk
               
Short-term interest rate risk
   
24,281
     
27,344
 
Inflation risk
   
22,172
     
37,050
 
Long term interest rate risk
   
289,675
     
305,834
 
Total market risk of non-trading portfolio
   
336,128
     
370,228
 
                 
Regulatory limit of exposure to short-term interest rate and inflation risk
               
Short-term exposure to interest rate risk
   
24,281
     
27,344
 
Exposure to inflation risk
   
22,172
     
37,050
 
Limit: 20% of (net interest income + net fee income sensitive to interest rates)
   
89,929
     
119,339
 
Available margin
   
43,476
     
54,945
 
 
147

 
 
Regulatory Market Risk
 
At December 31, 2005
   
At December 31, 2006
 
   
(in millions of constant Ch$
as of December 31, 2006)
 
Regulatory limit of exposure to long term interest rate risk
               
Long-term exposure to interest rate risk
   
289,675
     
305,834
 
Limit: 25% of regulatory capital in 2005, 35% of regulatory capital in 2006
   
302,409
     
496,406
 
Available margin
   
12,734
     
190,572
 

 
Internal Regulations Regarding Market Risk
 
Our relationship with Banco Santander Central Hispano has allowed us to take advantage of Banco Santander Central Hispano’s banking policies, procedures and standards, especially with respect to credit approval and risk management. Banco Santander Central Hispano has successfully used these policies and expertise in the Spanish and other banking markets, and our management believes that such policies and expertise have a beneficial effect upon our operations. Below is a qualitative and quantitative description of our market risks according to our internal guidelines. These guidelines were established prior to the adoption of the applicable regulations required by local authorities and are still being used.
 
The main difference between the regulatory and internal methods is that the internal measures divide the Bank’s balance sheet into three categories and impose limits based on these categories. Our internal methods also takes into account Santander S.A. Agente de Valores. As a result, the sensitivity analysis performed incorporates a broader range of instruments and portfolios. The internal method also incorporates a value at risk (“VaR”) methodology for measuring the market risk of our consolidated trading positions.
 
Value at Risk: Consolidated Trading Portfolio
 
The VaR model is mainly used to measure the market risk of our trading portfolio. The Finance Division manages trading activities following the guidelines set by the ALCO and Banco Santander Central Hispano’s Global Risk Department. The Market Risk and Control Department’s activities consist of (i) applying VaR techniques (as discussed above) to measure interest rate risk; (ii) marking to market our trading portfolios and measuring daily profit and loss from trading activities; (iii) comparing actual trading VaR and other limits against the established limits; (iv) establishing control procedures for losses in excess of such limits; and (v) providing information about trading activities to the ALCO, other members of senior management, the Finance Division and Banco Santander Central Hispano’s Global Risk Department.
 
The Bank has a consolidated trading position comprised of fixed income trading, foreign currency trading and a minor equity trading position. The market risk of this trading portfolio is measured by using a VaR technique. The composition of this portfolio mainly consisted of Central Bank bonds, mortgage bonds and low risk Chilean corporate bonds issued locally. There is also an equity portfolio that represents less than 5% of the total trading portfolio. Under Chilean GAAP, a bank must separate its unconsolidated financial investment portfolio between “trading” and “available for sale” investment portfolios. Under Chilean GAAP, the unrealized holding gains (losses) related to investments classified as available for sale have been included in equity. The size of the available for sale portfolio is limited to an amount equal to such bank’s capital. Any amount above this must be considered as “trading”; the unrealized gains (losses) related to investments classified as “trading” are included in operating results. The ALCO has taken a conservative approach and has set even more restrictive limits on the Finance Division’s actual trading portfolio. This portfolio is denominated “Cartera de Negociación”. The market risk of the portfolio defined as “trading” for accounting purposes is measured by using the regulatory method.
 
VaR Model
 
All VaR measurements are intended to determine the distribution function for the change in value of a given portfolio, and once this distribution is known, to calculate a percentile linked to the confidence level required which will be equal to the VaR under those parameters. Therefore, if the distribution function of the change in value of a portfolio is known and given by f(x), where x is the random variable of the change in value of the portfolio, then the VaR for a determined level of confidence of k% is given by the number such that:
 
148

 
 
or:
 
 
As calculated by Santander-Chile, VaR is an estimate of the expected maximum loss in the market value of a given portfolio over a one day horizon at a one tailed 99.00% confidence interval. It is the maximum one day loss that Santander-Chile would expect to suffer on a given portfolio 99.00% of the time, subject to certain assumptions and limitations discussed below. Conversely, it is the figure that Santander-Chile would expect to exceed only 1.0% of the time. VaR provides a single estimate of market risk that is comparable from one market risk to the other. Volatility is calculated utilizing 520 historical observations. A one day holding period is utilized.
 
Santander-Chile uses VaR estimates to alert senior management whenever the statistically expected losses in its trading portfolio exceed prudent levels. Limits on VaR are used to control exposure on the fixed income trading portfolio, the net foreign currency trading position and the equity trading portfolio. Santander-Chile’s trading portfolio is mainly comprised of government bonds, mortgage finance bonds, the foreign currency trading position and a minor position in equities through Santander S.A. Agente de Valores.  A daily VaR is calculated for the trading portfolio.
 
Assumptions and Limitations of VaR Model
 
Our VaR model assumes that changes in the market risk factors have a normal distribution and that the parameters of this joint distribution (in particular, the standard deviation of risk factor changes and the correlation between them) have been estimated accurately. The model assumes that the correlation and changes in market rates/prices included in our historical databases are independent and identically distributed random variables, and provide a good estimate of correlation and rate/price changes in the future.
 
Our VaR methodology should be interpreted in light of the limitations of our models, which include:
 
 
·
Changes in market rates and prices may not be independent and identically distributed random variables or have a normal distribution. In particular, the normal distribution assumption may underestimate the probability of extreme market moves;
 
 
·
The historical data we use in our VaR model may not provide the best estimate of the joint distribution of risk factor changes in the future, and any modifications in the data may be inadequate. In particular, the use of historical data may fail to capture the risk of possible extreme adverse market movements independent of the time range utilized. For example, the use of extended periods of historical data might erroneously lead to an important decrease in volatility especially after the Asian crisis. We typically use 520 historical observations of market data depending on circumstances, but also monitor other ranges of market data in order to be more conservative. However, reliable historical risk factor data may not be readily available for certain instruments in our portfolio;
 
 
·
A one day time horizon may not fully capture the market risk positions that cannot be liquidated or hedged within one day. It would not be possible to liquidate or hedge all positions in one day;
 
 
·
At present, we compute VaR at the close of business and trading positions may change substantially during the course of the trading day;
 
 
·
The use of 99% confidence level does not take account of, nor makes any statement about, any losses that might occur beyond this level of confidence; and
 
 
·
Value at risk does not capture all of the complex effects of the risk factors on the value of positions and portfolios and could, therefore, underestimate potential losses.
 
149

 
There are also a number of approximations in the VaR calculation. For example, benchmark indexes are used instead of certain risk factors, and in the case of some activities, not all the relevant risk factors are taken into account which can be due to difficulties obtaining daily data.
 
Quantitative Disclosures: Market Risk Consolidated Trading Portfolio (VaR)
 
 
We did not exceed our daily VaR in 2005 and 2006 in the fixed income, equity or foreign currency trading portfolios. For Santander-Chile’s various trading portfolios, the average, high and low amounts of the daily VaR in the years ended December 31, 2005 and 2006 were the following:
 
   
For the year ended December 31,
 
 
Consolidated Trading Portfolio
 
2005
   
2006
 
     
(in millions of U.S.$)
 
High
   
9.2
     
12.3
 
Low
   
4.6
     
3.9
 
Average
   
6.6
     
6.2
 

 
   
For the year ended December 31,
 
 
Fixed income Trading Portfolio
 
2005
   
2006
 
     
(in millions of U.S.$)
 
High
   
9.3
     
8.6
 
Low
   
3.7
     
3.9
 
Average
   
6.3
     
6.3
 

   
For the year ended December 31,
 
 
Equity Trading Portfolio
 
2005
   
2006
 
     
(in millions of U.S.$)
 
High
   
0.9
     
0.67
 
Low
   
0.0
     
0.0
 
Average
   
0.4
     
0.27
 

   
For the year ended December 31,
 
 
Foreign currency Trading Portfolio
 
2005
   
2006
 
     
(in millions of U.S.$)
 
High
   
4.0
     
3.3
 
Low
   
0.0
     
0.02
 
 
150


   
For the year ended December 31,
 
Foreign currency Trading Portfolio
 
2005
   
2006
 
     
(in millions of US.$)
 
Average
   
1.4
     
0.93
 
 
Quantitative Disclosure: Derivatives
 
Derivatives
 
The Bank enters into transactions involving derivative instruments, particularly foreign exchange contracts, as part of its asset and liability management, and in acting as a dealer in order to satisfy its clients’ needs. The notional amounts of these contracts are carried off-balance sheet.
 
Foreign exchange forward contracts involve an agreement to exchange the currency of one country for the currency of another country at an agreed-upon price and settlement date. These contracts are generally standardized contracts, normally for periods between 1 and 180 days and are not traded in a secondary market; however, in the normal course of business and with the agreement of the original counterparty, they may be terminated or assigned to another counterparty.
 
When the Bank enters into a forward exchange contract, it analyses and approves the credit risk (the risk that the counterparty might default on its obligations). Subsequently, on an ongoing basis, it monitors the possible losses involved in each contract. To manage the level of credit risk, the Bank generally deals with counterparties of good credit standing, enters into master netting agreements whenever possible and when appropriate, and obtains collateral.
 
The Chilean Central Bank requires that foreign exchange forward contracts be made only in U.S. dollars and other major foreign currencies. In the case of the Bank, most forward contracts are made in U.S. dollars against the Chilean peso or the UF. Occasionally, forward contracts are also made in other currencies, but only when the Bank acts as an intermediary.
 
During the year ended December 31, 2005 and 2006, the Bank entered into interest rate and cross currency swap agreements to manage exposure to fluctuation in currencies and interest rates.  The differential between the interest paid or received on a specified notional amount is recognized under the caption “Amounts payable from forward contracts, net”. The fair value of the swap agreement and changes in the fair value as a result of changes in market interest rates are recognized in the consolidated financial statements.
 
The Bank’s foreign currency futures and forward operations and other derivative products outstanding at December 31, 2005 and 2006 are summarized below:
 
         
As of December 31, 2006
 
         
Notional Amounts
   
Fair Value
 
 
Derivative  instruments in designated hedge accounting relationships
 
Cash Flow hedge (CF) or fair value hedge (FV)
   
Within 3 months
   
After 3 months but within one year
   
After one year
   
Assets
   
Liabilities
 
         
(in millions of constant Ch$ as of December 31, 2006)
 
Currency Forwards
   
( )
     
-
     
-
     
-
     
-
     
-
 
Interest rate swaps
 
  (FV)
     
-
     
-
     
210,298
     
1,173
     
2,354
 
Currency swaps
   
( )
     
-
     
-
     
-
     
-
     
-
 
Cross currency swaps
 
  (FV)
     
843,969
     
-
     
-
     
-
     
37,871
 
Call currency options
   
( )
     
-
     
-
     
-
     
-
     
-
 
Call interest rate options
   
( )
     
-
     
-
     
-
     
-
     
-
 
Put currency options
   
( )
     
-
     
-
     
-
     
-
     
-
 
Put interest rate options
   
( )
     
-
     
-
     
-
     
-
     
-
 
Interest rate future
   
( )
     
-
     
-
     
-
     
-
     
-
 
Other derivatives
   
( )
     
-
     
-
     
-
     
-
     
-
 
Subtotal
           
843,969
     
-
     
210,298
     
1,173
     
40,225
 
 
151

 
         
As of December 31, 2006
 
         
Notional Amounts
   
Fair Value
 
 
Derivative  instruments in designated hedge accounting relationships
 
Cash Flow hedge (CF) or fair value hedge (FV)
   
Within 3 months
   
After 3 months but within one year
   
After one year
   
Assets
   
Liabilities
 
         
(in millions of constant Ch$ as of December 31, 2006)
 
Derivative instruments for trading
                                               
                                                 
Currency forwards
           
6,017,519
     
3,435,681
     
378,885
     
82,608
     
99,422
 
Interest rate swaps
           
457,994
     
1,178,930
     
3,923,328
     
34,958
     
68,165
 
Currency swaps
           
-
     
-
     
-
     
-
     
-
 
Cross currency swaps
           
2,744,066
     
1,348,617
     
129,703
     
247,486
     
142,058
 
Call currency options
           
47,608
     
372,092
     
-
     
4,384
     
4,372
 
Call interest rate options
           
-
     
100
     
-
     
-
     
-
 
Put currency options
           
-
     
-
     
-
     
-
     
-
 
Put interest rate options
           
29,706
     
346,691
     
-
     
1,448
     
1,032
 
Interest rate future
           
-
     
-
     
-
     
-
     
-
 
Other derivatives
           
313,055
     
106,886
     
101,542
     
631
     
648
 
Subtotal
           
9,609,948
     
6,788,997
     
4,533,458
     
371,515
     
315,697
 
Total
           
10,453,917
     
6,788,997
     
4,743,756
     
372,688
     
355,922
 
 
The notional amounts refer to the U.S. dollar bought or sold or to the U.S. dollar equivalent of foreign currency bought or sold for future settlement.  The contract terms correspond to the maturity of the contracts as from the date of the transaction to the date of the settlement.
 
         
As of December 31, 2005
 
         
Notional Amounts
   
BookValue(*)
 
 
Derivative instruments in designated hedge accounting relationships
 
Cash Flow hedge (CF) or fair value hedge (FV)
   
Within 3 months
   
After 3 months but within
one year
   
After one year
   
Assets
   
Liabilities
 
         
(in millions of constant Ch$ as of December 31, 2006)
 
                                     
                                     
Currency Forwards
   
( )
     
-
     
-
     
-
     
-
     
-
 
Interest rate swaps
 
  (FV)
     
-
     
-
     
401
     
131
     
212
 
Currency swaps
   
( )
     
-
     
-
     
-
     
-
     
-
 
Cross currency swaps
 
  (FV)
     
77
     
129
     
-
     
-
     
10,276
 
Call currency options
   
( )
     
-
     
-
     
-
     
-
     
-
 
Call interest rate options
   
( )
     
-
     
-
     
-
     
-
     
-
 
Put currency options
   
( )
     
-
     
-
     
-
     
-
     
-
 
Put interest rate options
   
( )
     
-
     
-
     
-
     
-
     
-
 
Interest rate future
   
( )
     
-
     
-
     
-
     
-
     
-
 
Other derivatives
   
( )
     
-
     
-
     
-
     
-
     
-
 
Subtotal
           
77
     
129
     
401
     
131
     
10,488
 
                                                 
Derivative instruments for trading
                                               
                                                 
Currency forwards
           
4,862,614
     
3,690,484
     
359,919
     
249,275
     
283,218
 
Interest rate swaps
           
362,666
     
2,244,684
     
2,651,871
     
3,593
     
9,799
 
Currency swaps
           
-
     
-
     
-
     
-
     
-
 
Cross currency swaps
           
907
     
559
     
37
     
165,209
     
88,131
 
Call currency options
           
-
     
26,255
     
-
     
413
     
-
 
 
152

 
         
As of December 31, 2006
 
         
Notional Amounts
   
BookValue(*)
 
 
Derivative instruments in designated hedge accounting relationships
 
Cash Flow hedge (CF) or fair value hedge (FV)
   
Within 3 months
   
After 3 months but within
one year
   
After one year
   
Assets
   
Liabilities
 
         
(in millions of constant Ch$ as of December 31, 2006)
 
                                     
                                     
Call interest rate options
           
-
     
-
     
-
     
-
     
-
 
Put currency options
           
-
     
10,502
     
-
     
174
     
174
 
Put interest rate options
           
-
     
-
     
-
     
-
     
-
 
Interest rate future
           
-
     
-
     
-
     
-
     
-
 
Other derivatives
           
651,257
     
-
     
-
     
-
     
13
 
Subtotal
           
5,877,444
     
5,972,484
     
3,011,827
     
418,664
     
381,335
 
                                                 
Total
           
5,877,521
     
5,972,613
     
3,012,228
     
418,795
     
391,823
 

(*)
For the operations prior to January 1, 2006, the Bank has applied the criteria described in Note 1g to our Audited Consolidated Financial Statement.
 
The notional amounts refer to the U.S. dollar bought or sold or to the U.S. dollar equivalent of foreign currency bought or sold for future settlement. The contract terms correspond to the maturity of the contracts as from the date of the transaction to the date of the settlement.
 
Sensitivity Analysis: Consolidated Non-trading Portfolios
 
The Bank’s non-trading portfolio or Financial Management (Gestión Financiera) portfolio includes the majority of the Bank’s assets and liabilities that are not trading, including the loan portfolio. Investment and funding decisions are heavily influenced by commercial strategies.
 
We use a sensitivity analysis to measure the market risk of the local and foreign currency-denominated non-trading portfolio.  We perform a scenario simulation by calculating the potential loss over the entire balance from an increase (or decrease) of 100 basis points in the entire yield curve in terms of local rates. All local currency positions indexed to inflation are adjusted for a sensitivity factor of 0.57, which represents a shift of yield curve by 57 basis points in real rates and 100 basis point in nominal rates. The same scenario is performed for the net foreign currency position and U.S. dollar interest rates. We set limits as to the maximum loss these types of movements in interest rates can lead to over our capital and net financial income budgeted for the year.  These limits are calculated according to the formulas discussed below.
 
Scenario Simulation (Net Financial Income)
 
To determine the percentage of our budgeted net financial income for the year that is at risk of loss upon a sudden 100 basis point movement in the entire yield curve, we utilize the following equation:
 
 
n:                 Number of intervals in which sensitivity is measured.
ti:                 Average maturity (or duration) for each interval being measured.
Δr:               Change in interest rate. A 100 basis point increase (decrease) in the yield curve is used.
GAP:           Difference between assets and liabilities that are sensitive to interest rates for each period.
 
Scenario Simulation (Capital and Reserves)
 
153

 
To determine the percentage of our capital and reserves that is at risk of loss upon a sudden 100 basis point movement in the entire yield curve, we utilize the following equation:
 
 
N:                 Number of intervals in which sensitivity is measured.
 
Dmj:             Modified duration for interval i.
 
Δr:                Change in interest rate. A 100 basis point increase (decrease) in the yield curve is used.
 
GAP:            Difference between assets and liabilities that are sensitive to interest rates for each period.
 
Consolidated limits:
 
To determine the consolidated limit, the foreign currency limit is added to the local currency limit for both the net financial income loss limit and the loss limit over capital and reserves using the following formula:
 
Consolidated limit = Square root of a2 + b2 + 2ab
 
a: limit in local currency.
 
b: limit in foreign currency.
 
Since correlation is assumed to be 0, 2ab = 0.
 
Assumptions and Limitations of Scenario Simulations/Sensitivity Analysis
 
The most important assumption is the usage of a 100 basis point shift in the yield curve (57 basis points for real rates). We use a 100 basis point shift since a sudden shift of this magnitude is considered realistic, but not an everyday occurrence given historical movements in the yield curve, and significant in terms of the possible effects a shift of this size could have on our performance. The Global Risk Department at Banco Santander Central Hispano has also set comparable limits by country in order to be able to compare, monitor and consolidate market risk by country in a realistic and orderly manner.
 
Our scenario simulation methodology should be interpreted in light of the limitations of our models, which include:
 
 
·
The scenario simulation assumes that the volumes remain on the balance sheet and that they are always renewed at maturity, omitting the fact that credit risk considerations and pre-payments may affect the maturity of certain positions.
 
 
·
This model assumes an equal shift throughout the entire yield curve and does not take into consideration different movements for different maturities.
 
 
·
The model does not take into consideration the sensitivity of volumes to these shifts in interest rates.
 
 
·
The limits to the loss of the budgeted financial income are calculated over an expected financial income for the year which may not be obtained, signifying that the actual percentage of financial income at risk could be higher than expected.
 
Quantitative Disclosure of Market Risk: Non-trading Portfolio (Sensitivity Analysis/Scenario Simulations)
 
The Finance Division manages the risk arising out of the consolidated non-trading portfolios under guidelines approved by the ALCO and Banco Santander Central Hispano’s Global Risk Department. In carrying out its market risk management functions, the Finance Division manages interest rate risk that arises from any mismatches with
 
154

 
respect to rates, maturities, repricing periods, notional amounts or other mismatches between our interest earning assets and our interest bearing liabilities.
 
The Market Risk and Control Department: (i) applies scenario simulations (as discussed below) to measure the interest rate risk of the local currency activities and the potential loss as forecast by these simulations; and (ii) provides the ALCO, the Finance Division and Banco Santander Central Hispano’s Global Risk Department with risk/return reports.
 
Non-trading local currency portfolio
 
The potential loss in the market value of our local currency-denominated non-trading portfolio resulting from a 100 basis point shift in the yield curve was set at approximately Ch$60,000 million of equity in 2006. The Bank has remained within the consolidated limit for this portfolio that is set by the ALCO in 2006, with only a minor breach of US$284,415 above the limit. At the same time, the variation in net interest income caused by a 100 basis point shift of the local yield curve may not exceed Ch$20,000 million and Santander-Chile was within the limits established in 2006. This limit is internally set by the ALCO.  The ALCO has authority to lower this limit.  However, approval from the Banco Santander Central Hispano's Global Risk Department is required to lift this limit.  The following table sets forth the loss limit and the high, low and average potential loss in 2005 and 2006 resulting from a 100 basis point shift in the relevant interest rate.
 
   
Local Currency-denominated Financial Management Portfolio
 
   
Financial Income
   
Capital and Reserves
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Loss limit at December 31, 2006
   
20,000
     
60,000
 
High
   
18,281
     
60,152
 
Low
   
2,564
     
43,561
 
Average in 2006
   
9,397
     
53,844
 

 
   
Local Currency-denominated Financial Management Portfolio
 
   
Financial Income
   
Capital and Reserves
 
   
(in millions of constant Ch$ as of December 31, 2006)
 
Loss limit at December 31, 2006
   
20,000
     
60,000
 
High
   
10,537
     
61,958
 
Low
   
115
     
36,592
 
Average in 2005
   
2,642
     
51,389
 

 
Non-trading foreign currency portfolio
 
For our net non-trading foreign currency position, any loss caused by a 100 basis point shift in U.S. dollar interest rates may not exceed US$45 million of equity and US$30 million of budgeted net interest income. These limits are internally imposed limits set by the ALCO.  The ALCO has the authority to lower this limit.  However, approval from Banco Santander Central Hispano's Global Risk Department is required to lift this limit.  The following table sets forth the loss limit and the high, low and average potential loss in 2005 and 2006 resulting from a 100 basis point shift in the interest rates on U.S. dollar-denominated assets and liabilities.
 
   
Foreign Currency-denominated Financial Management Portfolio
 
   
Financial Income
   
Capital and Reserves
 
   
(in millions of U.S.$)
 
Loss limit at December 31, 2006
   
30.0
     
45.0
 
High
   
28.0
     
10.6
 
Low
   
2.5
     
1.0
 
Average in 2006
   
12.0
     
6.0
 

155

 
   
Foreign Currency-denominated Financial Management Portfolio
 
   
Financial Income
   
Capital and Reserves
 
   
(in millions of U.S.$)
 
Loss limit at December 31, 2005
   
30.0
     
45.0
 
High
   
14.1
     
30.0
 
Low
   
0.0
     
1.4
 
Average in 2005
   
3.7
     
20.2
 

 
Combined non-trading local and foreign currency
 
We track a consolidated indicator to track the total interest risk of the local and foreign currency-denominated non-trading portfolios. The consolidated loss limit for equity at risk was set at Ch$60,000 million for 2006. In 2006, we remained within the limits established except for a minor breach of US$352,777 above the limit. In 2005, it was temporarily raised to Ch$66,000 million, but was again lowered to its historical level in 2006.  At the same time, the variation in net interest income caused by a 100 basis point shift of the local yield curve may not exceed Ch$30,000 million. The following table, which contemplates a 100 basis point shift in the relevant interest rate, indicates that Santander-Chile was within the limits established in 2006.  These limits are an internally imposed limit set by the ALCO and Banco Santander Central Hispano’s Global Risk Department.  The ALCO has authority to lower these limits.  However, approval from Banco Santander Central Hispano's Global Risk Department is required to lift these limits.
 
   
Combined Financial Management Portfolio
 
   
Financial Income
   
Capital and Reserves
 
   
(in millions of U.S.$)
 
Loss limit at December 31, 2006
   
30,000
     
60,000
 
High
   
23,719
     
60,188
 
Low
   
4,458
     
43,758
 
Average in 2006 (through June 30, 2006)
   
11,604
     
53,961
 

 
   
Combined Financial Management Portfolio
 
   
Financial Income
   
Capital and Reserves
 
   
(in millions of U.S.$)
 
Loss limit at December 31, 2005
   
30,000
     
66,000
 
High
   
12,059
     
62,624
 
Low
   
599
     
39,866
 
Average in 2005
   
3,764
     
52,969
 

 
Volume Limits
 
We have also developed volume limits, which place a cap on the actual size of the different portfolios being monitored.
 
Fixed Income: Volume Equivalent. This system is considered to be an additional limit to the size of our consolidated fixed income trading portfolio. This measure seeks to conform the different instruments in our fixed income trading portfolio and convert the portfolio into a single instrument with a duration of one year. Santander-Chile limits the size of this volume equivalent portfolio.  The equivalent volume is calculated by the Market Risk and Control Department and limits are set by the ALCO with respect to the size of the volume equivalent portfolio.
 
Net Foreign Currency Trading Position: Maximum Net Position. We also set an absolute limit on the size of Santander-Chile’s consolidated net foreign currency trading position. At December 31, 2006, this was equal to US$200 million. The limit on the size of the net foreign currency position is determined by the ALCO and is calculated and monitored by the Market Risk and Control Department.
 
156

 
Liquidity Management
 
The Central Bank also requires us to comply with the following liquidity limits:
 
 
·
The sum of the liabilities with a maturity of less than 30 days may not exceed the sum of the assets with a maturity of less than 30 days by more than an amount greater than our capital. This limit must be calculated in local currency and foreign currencies together as one gap.  At December 31, 2006, the percentage of (x) our liabilities with a maturity of less than 30 days in excess of our assets with a maturity of less than 30 days to (y) our capital and reserves was 43%.
 
 
·
The sum of the liabilities with a maturity of less than 90 days may not exceed the sum of the assets with a maturity of less than 90 days by more than 2 times our capital. This limit must be calculated in local currency and foreign currencies together as one gap.  At December 31, 2006, the percentage of (x) our liabilities with a maturity of less than 90 days in excess of our assets with a maturity of less than 90 days to (y) 2 times our capital and reserves was 58%.
 
We have also set internal liquidity limits. The Market Risk Control Department measures two other liquidity indicators:
 
1. Net accumulated liquidity gap:
 
 
·
Net accumulated liquidity gap, which represents the amount of the assets with a maturity of up to 30 days in excess of the liabilities with a maturity of up to 30 days, is required to be no less than US$0, i.e.,
 
The following table sets forth our net accumulated liquidity gap at December 31, 2006 and our average net accumulated liquidity gap for the year of 2006.
 
 
Net accumulated liquidity gap
 
in millions of US$
 
At December 31, 2006
   
275
 
Average in 2006
   
455
 

2. Liquidity coefficient (LC):
 
Liquidity coefficient, calculated by dividing (x) liquid assets (at liquidation value) by (y) the sum of total liabilities, capital and contingent liabilities, is required to be no less than 2%, i.e., Liquid assets (at liquidation value) / (Total liabilities   capital + contingent)>= 2%
 
The following table sets forth our liquidity coefficients at December 31, 2006 and for the year of 2006.
 
 
LC
 
Local currency
   
Foreign currency
 
At December 31, 2006
    19.2 %     39.0 %
Average in 2006
    23.5 %     42.3 %

Other Subsidiaries
 
For VaR measurements and scenario simulations, our consolidated trading and consolidated non-trading portfolios do not consolidate the asset liability structure of the following subsidiaries:
 
 
·
Santiago Leasing S.A.
 
 
·
Santiago Corredores de Bolsa Ltda.
 
 
·
Santander Santiago S.A. Administradora General de Fondos
 
 
·
Santander Santiago S.A. Sociedad Securitizadora
 
 
·
Santander Santiago Corredora de Seguros Santander Ltda.
 
157

 
 
·
Santander Servicios de Recaudación y Pagos Ltda.
 
The balance sheets of these subsidiaries are mainly comprised of assets and liabilities that are not sensitive to market risk, fixed assets and capital, and in total only represent 1.0% of our total consolidated assets.
 
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
 
Not applicable.
 
PART II
 
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
 
Not applicable.
 
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
 
Not applicable.
 
ITEM 15. CONTROLS AND PROCEDURES
 
Management’s Annual Report on Internal Control Over Financial Reporting (English translation)
 
The Bank’s President, Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining adequate internal control over financial reporting.
 
For this purpose, we confirm that we have designed the controls and procedures, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements as well as of other financial data for external purposes in accordance with generally accepted accounting principles.
 
The Bank’s internal control over financial reporting is a process designed and effected under the supervision of management to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements and other financial data for external purposes in accordance with generally accepted accounting principles applicable to the Bank, and includes those policies and procedures that:
 
 
·
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transaction and dispositions of assets of the Bank;
 
 
·
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements and other financial data in accordance with generally accepted accounting principles applicable to the Bank, and that receipts and expenditures of the Bank are being made only in accordance with authorizations of the Bank’s management and directors; and
 
 
·
provide reasonable assurance regarding prevention or timely detection of an unauthorized acquisition, use or disposition of the Bank’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions that affect the Bank, such as rules and regulations, business conditions, etc., or that the degree of compliance with the policies or procedures may deteriorate.
 
The Bank’s President, Chief Executive Officer and Chief Financial Officer, have assessed the effectiveness of the Bank’s internal control over financial reporting as of December 31, 2006 in accordance with the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in the “Enterprise Risk Management – Integrated Framework”.
 
158

 
Based on our assessment, our management believes that, as of December 31, 2006, our internal control over financial reporting is effective based on those criteria.
 
Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by Deloitte S.L., an independent registered public accounting firm, as stated in their audit report, which follows below.
 
Report of Independent Registered Public Accounting Firm (English translation)
 
To the Board of Directors and Shareholders of Banco Santander Chile
 
We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting, that Banco Santander Chile and its subsidiaries (collectively referred to as “Banco Santander Chile” or the “Bank”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  The Bank’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.  Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Bank’s internal control over financial reporting based on our audit.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.  Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances.  We believe that our audit provides a reasonable basis for our opinions.
 
A bank’s internal control over financial reporting is a process designed by, or under the supervision of, the bank’s principal executive and principal financial officers, or persons performing similar functions, and effected by the bank’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  A bank’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the bank; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the bank are being made only in accordance with authorizations of management and directors of the bank; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the bank’s assets that could have a material effect on the financial statements.
 
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis.  Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, management’s assessment that the Bank maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Also, in our opinion, the Bank maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2006 and 2005 of the Bank and the related
 
159

 
consolidated statements of income, cash flows and changes in shareholders’ equity for each of the two years ended December 31, 2006, and our report dated May 10, 2007, expressed an unqualified opinion on those consolidated financial statements and included three explanatory paragraphs stating that (1) during 2006 the Bank modified its basis for recording and valuation of financial investments acquired for trading, available-for-sale or held-to-maturity investments and derivative instruments.  The nature and effect of such modification is explained in Note 2 to the consolidated financial statements of the Bank, (2) the accounting principles generally accepted in Chile vary in certain significant respects from accounting principles generally accepted in the United States of America (“U.S. GAAP”), and that the information relating to the nature and effect of such differences is presented in Note 26 to the consolidated financial statements of the Bank and (3) that a convenience translation of Chilean peso amounts to U.S. dollars was presented.
 
/s/ Deloitte & Touche
 
Santiago - Chile
May 10, 2007
 
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
 
Our board of directors has determined that two of the members of our Audit Committee, Benigno Rodríguez Rodríguez and Víctor Arbulú Crousillat, meet the requirements of an “audit committee financial expert” in accordance with SEC rules and regulations, in that they have an understanding of Chilean GAAP and financial statements, the ability to assess the general application of Chilean GAAP in connection with the accounting for estimates, accruals and reserves, experience analyzing and evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by our consolidated financial statements, an understanding of internal controls over financial reporting, and an understanding of audit committee functions. All three members of our Audit Committee have experience overseeing and assessing the performance of Santander-Chile and its consolidated subsidiaries and our external auditors with respect to the preparation, auditing and evaluation of our consolidated financial statements.
 
All three members of our Audit Committee are considered to be independent according to applicable NYSE criteria. Benigno Rodríguez R. and Víctor Arbulú C. are relying on the exemption provided by Rule 10A-3(b)(1)(iv)(B), which allows an otherwise independent director to serve on both the audit committee of the issuer and the board of directors of an affiliate.
 
ITEM 16B. CODE OF ETHICS
 
The Bank has adopted a code of ethics that is applicable to all of the Bank’s employees and a copy is included as an exhibit hereto. We will provide to any person without charge, upon request, a copy of our code of ethics. Please email rmorenoh@santander.cl to request a copy.
 
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
Amounts paid to the auditors for statutory audit and other services were as follows:
 
   
For the year ended December 31,
 
   
2005
   
2006
 
Audit Services
 
(in millions of constant Ch$
as of December 31, 2006)
 
- Statutory audit
   
805
     
677
 
- Audit-related regulatory reporting
   
     
645
 
Tax Fees
               
- Compliance
   
     
 
- Advisory Services
   
     
 
All Other Services
   
     
 
Total
   
805
     
1,322
 
 
 
160

 
Statutory audit: Consists of fees billed for professional services rendered in connection with the audit of our consolidated financial statements that are provided by Deloitte in 2005 and 2006 in connection with statutory and regulatory filings or engagements, and attest services.
 
Audit-related regulatory reporting: Consists of fees billed for assurance and related services that were specifically related to the performance of the audit and review of our filings under the 1933 Act.
 
Auditors are pre-approved by the Audit Committee. The selection of external auditors is subject to approval by shareholders at the Annual Shareholders’ Meeting. All proposed payments have been presented to our Audit Committee, which has determined that they are reasonable and consistent with internal policies.
 
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.
 
Not applicable.
 
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.
 
In 2006, neither Santander-Chile nor any of its affiliates purchased any of Santander-Chile’s equity securities.
 
PART III
 
ITEM 17. FINANCIAL STATEMENTS.
 
We have responded to Item 18 in lieu of this item.
 
ITEM 18. FINANCIAL STATEMENTS.
 
Reference is made to Item 19 for a list of all financial statements filed as a part of this Annual Report.
 
ITEM 19. EXHIBITS.
 
(a) Index to Financial Statements
 
 
Page
Reports of Independent Registered Public Accounting Firms
F-2
Consolidated Balance Sheets at December 31, 2005 and 2006
F-4
Consolidated Statements of Income for each of the three years ended December 31, 2006
F-6
Consolidated Statements of Cash Flows for each of the three years ended December 31, 2006
F-7
Consolidated Statements of Shareholders’ Equity for each of the three years ended December 31, 2006
F-8
Notes to the Consolidated Financial Statements
F-9

 
(b) Index to Exhibits:
 
Exhibit
 
Number
Description
   
1A.1
Restated Articles of Incorporation of Santander-Chile (Spanish Version) (incorporated by reference to our Registration Statement on Form F-4 (Registration No. 333-100975) filed with the Commission on December 12, 2002).
   
1A.2
Restated Articles of Incorporation of Santander-Chile (English translation) (incorporated by reference to our Registration Statement on Form F-4 (Registration No. 333-100975) filed with the Commission on December 12, 2002).
 

 
1B.1
Amended and Restated By-Laws (estatutos) of Santander-Chile (Spanish Version) (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2004 (File No. 1-14554) filed with the Commission on June 30, 2005).
   
1B.2
Amended and Restated By-Laws (estatutos) of Santander-Chile (English translation) (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2004 (File No. 1-14554) filed with the Commission on June 30, 2005).
   
2A.1
Form of Amended and Restated Deposit Agreement, dated August 1, 2002, among Banco Santander-Chile (formerly known as Banco Santiago), the Bank of New York (as depositary) and Holders of American Depositary Receipts (incorporated by reference to our Registration Statement on Form F-6 (Registration No. 333-97303) filed with the Commission on July 26, 2002).
   
2A.2
Form of Foreign Investment Contract among Banco Santiago, JPMorgan Chase Bank and the Central Bank of Chile relating to the foreign exchange treatment of an investment in ADSs (accompanied by an English translation) (Incorporated by reference to our Registration Statement on Form F-1 (Registration No. 333-7676) filed with the Commission on October 23, 1997).
   
2A.3
Copy of the Central Bank Chapter XXVI Regulations Related to the Acquisition of Shares in Chilean Corporations and the Issuance of Instrument on Foreign Stock Exchanges or under Other Terms and Conditions of Issue (accompanied by an English translation) (incorporated by reference to Old Santander-Chile’s Annual Report for the fiscal year ended December 31, 1996 (File No. 1-13448) filed with the Commission on June 30, 1997).
   
2B.1
Agreement for the Issuance of Bonds dated November 26, 1996 between Old Santander-Chile and Banco Security (accompanied by an English translation) (incorporated by reference to Old Santander-Chile’s Annual Report for the fiscal year ended December 31, 1996 (File No. 1-13448) filed with the Commission on June 30, 1997).
   
2B.2
Indenture dated December 9, 2004 between Santander-Chile and Deutsche Bank Trust Company Americas, as trustee, providing for issuance of securities in series (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2006 (File No. 1-14554) filed with the Commission on April 12, 2006).
   
2B.3
Indenture dated March 16, 2001, as amended on May 30, 2003, October 22, 2004, May 3, 2005, and September 20, 2005 between Santander-Chile and Banco de Chile, as trustee, relating to issuance of UF14 million senior notes (copy to be furnished upon request).
   
4A.1
Automatic Teller Machines Participation Agreement dated October 1, 1988 between Banco Espanol-Chile (predecessor to Old Santander-Chile) and REDBANC (accompanied by an English translation) (incorporated by reference to Old Santander-Chile’s Annual Report for the fiscal year ended December 31, 1996 (File No. 1-13448) filed with the Commission on June 30, 1997).
   
4A.2
Outsourcing agreement between Banco Santiago and IBM de Chile S.A.C. dated June 30, 2000 (including English summary) (incorporated by reference to Banco Santiago’s Annual Report on Form 20-F for the fiscal year ended December 31, 2000 (File No. 1-14554) filed with the Commission on December 31, 2000).
   
4A.3
Systems and Technology Service and Consulting Agreement between Santander-Chile and Altec dated December 30, 2003 (English translation) (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2003 (File No. 1-14554) filed with the Commission on December 31, 2004).
   
4A.4
Purchase-Sale Contract between Santander-Chile and Empresas Almacenes París dated December 6, 2004 (English translation) (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2006 (File No. 1-14554) filed with the Commission on April 12, 2006).
 

 
4A.5
Service Participant operationg contract dated August 9, 2005 between Banco Santander-Chile and Socieded Operadora de la Cámera de Compensación de Pagos de Alto Valor (English translation) (filed herewith).
   
4A.6
Commercial Pledge Agreement dated February 5, 2007 by Santander-Chile of shares in Administrador Financiero de Transantiago (English Translation) (filed herewith).
   
7.1
Statement explaining Calculation of Ratios (incorporated by reference to Old Santander-Chile’s Annual Report on Form 20-F for the fiscal year ended December 31, 2000 (File No. 1-13448) filed with the Commission on June 28, 2001).
   
8.1
List of Subsidiaries (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2004 (File No. 1-14554) filed with the Commission on June 30, 2005).
   
11.1
Code of Conduct for Executive Personnel of Banco Santander-Chile and Subsidiaries (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2004 (File No. 1-14554) filed with the Commission on June 30, 2005).
   
11.2
Code of Conduct for all Grupo Santander Personnel (incorporated by reference to our Annual Report on Form 20-F for the fiscal year ended December 31, 2004 (File No. 1-14554) filed with the Commission on June 30, 2005).
   
12.1
Section 302 Certification by the Chief Executive Officer.
   
12.2
Section 302 Certification by the Chief Financial Officer.
   
13.1
Section 906 Certification.
   
23.1
Consent of Deloitte & Touche Sociedad de Auditores y Consultores, Ltda.
   
23.2
Consent of PricewaterhouseCoopers
 
We will furnish to the Securities and Exchange Commission, upon request, copies of any unfiled instruments that define the rights of holders of long-term debt of Banco Santander-Chile.
 




 
SIGNATURES
 
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this Annual Report on its behalf.
 
 
BANCO SANTANDER-CHILE
     
 
By:
/s/ Gonzalo Romero A.
 
Name:
Gonzalo Romero A.
 
Title:
General Counsel
Date:        June 18, 2007.
 


BANCO SANTANDER CHILE

CONSOLIDATED FINANCIAL STATEMENTS

CONTENTS

 
 
Page
   
Reports of independent registered public accounting firms
F-2
Audited consolidated financial statements:
 
Consolidated balance sheets at December 31, 2005 and 2006
F-4
Consolidated statements of income for each of the three years in the period ended December 31, 2006.
F-6
Consolidated statements of cash flows for each of the three years in the period ended December 31, 2006
F-7
Consolidated statements of shareholders’ equity for each of the three years in the period ended December 31, 2006
F-8
Notes to consolidated financial statements
F-9



Ch$
-
Chilean pesos
MCh$
-
Millions of Chilean pesos
US$
-
United States dollars
ThUS$
-
Thousands of United States dollars
UF
-
A UF is a daily-indexed, peso-denominated monetary unit.  The UF rate is set daily in advance based on the previous month’s inflation rate.


F-1

 
    Deloitte & Touche
Sociedad de Auditores y Consultores Ltda.
RUT: 80.276.200-3
Av. Providencia 1760
Floors 6, 7, 8 y 9
Providencia, Santiago
Chile
Phone: (56-2) 270 3000
Fax: (56-2) 374 9177
e-mail: deloittechile@deloitte.com
www.deloitte.cl
     
     
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of
   Banco Santander Chile:

We have audited the accompanying consolidated balance sheets of Banco Santander Chile and its subsidiaries (collectively referred to as “Banco Santander Chile” or the “Bank”) as of December 31, 2006 and 2005, and the related consolidated statements of income, cash flows and changes in shareholders’ equity for each of the two years ended December 31, 2006, all expressed in millions of constant Chilean pesos.  These consolidated financial statements (including the related Notes) are the responsibility of the Bank’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.  The consolidated financial statements of Banco Santander Chile for the year ended December 31, 2004 were audited by other auditors whose report, dated June 28, 2005 (except for the restatement to constant Chilean pesos of December 31, 2006, for which the date is April 13, 2007) expressed an unqualified opinion on those statements.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States of America).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Banco Santander Chile and its subsidiaries as of December 31, 2006 and 2005, the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in Chile and the rules of the Superintendencia de Bancos e Instituciones Financieras.
 
As explained further indicated in Note 2 to the consolidated financial statements, during 2006 the Bank modified its basis for recording and valuation of financial investments acquired for trading, available-for-sale or held-to-maturity investments and derivative instruments.

Accounting principles generally accepted in Chile vary in certain significant respects from accounting principles generally accepted in the United States of America (U.S. GAAP).  Information relating to the nature and effect of such differences is presented in Note 26 to the consolidated financial statements.

Our audit also comprehended the translation of Chilean peso amounts into U.S. dollar amounts and, we are not aware of any modifications that should be made for such translation to be in conformity with the basis stated in Note 1.r. Such U.S. dollar amounts are presented solely for the convenience of readers in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Bank’s internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 10, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Bank’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Bank’s internal control over financial reporting.

/s/ Deloitte & Touche
 
Santiago – Chile
May 10, 2007
    Member of
Deloitte Touche Tohmatsu

F-2

 
 
   PricewaterhouseCoopers
 Santiago de Chile
 Av. Andrés Bello 2711
 Torre Costanera -Pisos 3, 4 y 5
 Las Condes
 Teléfono [56](2) 9400000

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders of
   Banco Santander Chile

We have audited the accompanying consolidated statements of income, of cash flows and of shareholders’ equity of Banco Santander Chile (formerly Banco Santiago) and its subsidiaries (the “Bank”) for the year ended December 31, 2004, all expressed in millions of constant Chilean pesos.  These financial statements are the responsibility of the Bank’s management.  Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with auditing standards generally accepted in Chile and the Standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Banco Santander Chile (formerly Banco Santiago) and its subsidiaries for the year ended December 31, 2004, in conformity with accounting principles generally accepted in Chile and the rules of the regulatory agencies referred to in Note 1.

Accounting principles generally accepted in Chile vary in certain important respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 26 to the consolidated financial statements.


/s/ PricewaterhouseCoopers


Santiago, Chile
June 28, 2005, except for the restatement to
constant Chilean pesos of December 31, 2006,
for which the date is April 13, 2007.


F-3


BANCO SANTANDER CHILE

CONSOLIDATED BALANCE SHEETS
 
Adjusted for general price-level changes and expressed
in millions of constant Chilean pesos (MCh$) as of
December 31, 2006 and thousands of US dollars (ThUS$)
     
As of  December 31,  
   
   
2005
   
2006
   
2006
 
   
MCh$
   
MCh$
   
ThUS$
(Note 1 r)
 
ASSETS
                 
                   
CASH AND DUE FROM BANKS (Note 3)
                 
Non - interest bearing
   
1,035,350
     
947,741
     
1,773,368
 
Interbank deposits-interest bearing
   
215,581
     
144,666
     
270,692
 
                         
Total cash and due from banks
   
1,250,931
     
1,092,407
     
2,044,060
 
                         
INVESTMENTS (Note 4)
                       
Trading
   
675,961
     
639,461
     
1,196,529
 
Available for sale
   
575,028
     
345,108
     
645,750
 
Investment  under agreements to resell
   
23,610
     
30,807
     
57,645
 
                         
Total investments
   
1,274,599
     
1,015,376
     
1,899,924
 
                         
LOANS, NET (Note 5)
                       
Commercial loans
   
3,732,589
     
4,048,221
     
7,574,839
 
Consumer loans
   
1,421,523
     
1,800,507
     
3,369,023
 
Mortgage loans
   
648,180
     
485,849
     
909,098
 
Foreign trade loans
   
522,605
     
741,776
     
1,387,976
 
Interbank loans
   
198,779
     
151,491
     
283,463
 
Leasing contracts (Note 6)
   
677,936
     
764,408
     
1,430,324
 
Other outstanding loans
   
2,099,746
     
2,681,461
     
5,017,422
 
Past due loans
   
108,799
     
92,559
     
173,192
 
Contingent loans
   
949,177
     
1,022,687
     
1,913,603
 
Reserve  for loan losses (Note 7)
    (151,000 )     (174,064 )     (325,700 )
                         
Total loans, net
   
10,208,334
     
11,614,895
     
21,733,240
 
                         
    DERIVATIVES (Note 12)
   
418,795
     
372,688
     
697,356
 
                         
OTHER ASSETS
                       
Bank premises and equipment, net (Note 8)
   
226,068
     
231,360
     
432,910
 
Assets received in lieu of payment
   
18,328
     
15,775
     
29,517
 
Assets to be leased
   
32,694
     
30,293
     
56,683
 
Investments in other companies (Note 9)
   
6,838
     
6,654
     
12,451
 
Other (Note 10)
   
329,852
     
463,991
     
868,198
 
                         
 Total other assets
   
613,780
     
748,073
     
1,399,759
 
                         
TOTAL ASSETS
   
13,766,439
     
14,843,439
     
27,774,339
 
                         
 
The accompanying Notes are an integral part of these consolidated financial statements.

F-4

 
BANCO SANTANDER CHILE

CONSOLIDATED BALANCE SHEETS

Adjusted for general price-level changes and expressed
in millions of constant Chilean pesos (MCh$) as of
December 31, 2006 and thousands of US dollars (ThUS$)
 
 

   
As of December 31,
 
   
2005
   
2006
   
2006
 
   
MCh$
   
MCh$
   
ThUS$
 
LIABILITIES AND SHAREHOLDERS' EQUITY
             
(Note 1 r)
 
                   
DEPOSITS
                 
Non-interest bearing
                 
Current accounts
   
1,486,790
     
1,663,414
     
3,112,501
 
Bankers' drafts and other deposits
   
728,000
     
819,583
     
1,533,565
 
                         
   Total non-interest bearing
   
2,214,790
     
2,482,997
     
4,646,066
 
                         
Interest bearing
                       
Savings accounts and other deposits
   
6,031,933
     
6,909,335
     
12,928,419
 
                         
   Total deposits
   
8,246,723
     
9,392,332
     
17,574,485
 
                         
OTHER INTEREST BEARING LIABILITIES (Note 11)
                 
Chilean Central Bank borrowings
                       
Credit lines for renegotiations of loans
   
6,796
     
5,080
     
9,505
 
 Other Central Bank borrowings
   
176,878
     
134,417
     
251,515
 
   Total Chilean Central Bank borrowings
   
183,674
     
139,497
     
261,020
 
                         
Investments under agreements to repurchase
   
50,834
     
19,929
     
37,291
 
Mortgage finance bonds
   
683,143
     
530,206
     
992,097
 
Other borrowings
                       
Bonds
   
424,046
     
565,653
     
1,058,423
 
Subordinated bonds
   
393,929
     
490,416
     
917,643
 
Borrowings from domestic financial institutions
   
2,582
     
-
     
-
 
Foreign borrowings
   
1,121,528
     
812,267
     
1,519,876
 
Other obligations
   
42,984
     
64,193
     
120,115
 
                         
   Total other borrowings
   
1,985,069
     
1,932,529
     
3,616,057
 
                         
   Total other interest bearing liabilities
   
2,902,720
     
2,622,161
     
4,906,465
 
                         
DERIVATIVES  (Note 12)
   
391,823
     
355,922
     
665,984
 
                         
OTHER LIABILITIES
                       
Contingent liabilities (Note 10)
   
951,062
     
1,024,048
     
1,916,150
 
Other (Note 10)
   
167,849
     
202,115
     
378,188
 
                         
   Total other liabilities
   
1,118,911
     
1,226,163
     
2,294,338
 
                         
CONTINGENCIES AND COMMITMENTS (Note 21)
                 
                         
MINORITY INTEREST
   
1,495
     
1,522
     
2,848
 
                         
       Total liabilities
   
12,661,672
     
13,598,100
     
25,444,120
 
                         
SHAREHOLDERS' EQUITY (Note 14)
                       
Capital and reserves
   
859,975
     
959,757
     
1,795,852
 
Income for the year
   
244,792
     
285,582
     
534,367
 
                         
 Total shareholders' equity
   
1,104,767
     
1,245,339
     
2,330,219
 
                         
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
   
13,766,439
     
14,843,439
     
27,774,339
 
 

The accompanying Notes are an integral part of these consolidated financial statements.

F-5


BANCO SANTANDER CHILE
 
CONSOLIDATED STATEMENTS OF INCOME
 
Expressed in millions of constant Chilean pesos (MCh$) as of
December 31, 2006 and thousands of US dollars (ThUS$)
 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
   
2006
 
   
MCh$
   
MCh$
   
MCh$
   
ThUS$
 
                     
(Note 1 r)
 
                         
INTEREST REVENUE AND EXPENSE
                       
Interest revenue
   
841,588
     
1,017,830
     
1,168,851
     
2,187,098
 
Interest expense
    (339,079 )     (459,564 )     (556,597 )     (1,041,478 )
Net interest revenue
   
502,509
     
558,266
     
612,254
     
1,145,620
 
                                 
PROVISIONS FOR LOAN LOSSES (Note 7)
    (85,451 )     (64,879 )     (123,022 )     (230,193 )
                                 
FEES AND INCOME FROM SERVICES (Note 16)
                         
Fees and other services income
   
156,298
     
173,386
     
198,326
     
371,098
 
Other services expenses
    (28,294 )     (32,086 )     (35,776 )     (66,942 )
           Total fees income and expenses from services, net
   
128,004
     
141,300
     
162,550
     
304,156
 
                                 
OTHER OPERATING INCOME
                               
Gains from trading activities
   
117,514
     
68,009
     
141,869
     
265,458
 
Losses from trading activities
    (124,924 )     (130,578 )     (41,557 )     (77,759 )
Foreign exchange transactions, net
   
47,445
     
72,381
      (48,708 )     (91,140 )
Other operating income
   
12,060
     
5,549
     
5,619
     
10,514
 
Other operating expenses
    (37,354 )     (28,956 )     (38,580 )     (72,189 )
Total other operating income (loss), net
   
14,741
      (13,595 )    
18,643
     
34,884
 
                                 
OTHER INCOME AND EXPENSES
                               
Non-operating income (Note 17)
   
35,574
     
21,311
     
16,592
     
31,046
 
Non-operating expenses (Note 17)
    (40,243 )     (43,791 )     (20,806 )     (38,931 )
Income attributable to investments in other companies (Note 9)
   
568
     
693
     
786
     
1,471
 
Minority interest
    (194 )     (136 )     (151 )     (283 )
Total other income and (expenses), net
    (4,295 )     (21,923 )     (3,579 )     (6,697 )
                                 
OPERATING EXPENSES
                               
Personnel salaries and expenses
    (140,746 )     (142,171 )     (159,722 )     (298,864 )
Administrative and other expenses
    (102,159 )     (102,717 )     (110,948 )     (207,601 )
Depreciation and amortization
    (40,978 )     (40,080 )     (38,613 )     (72,251 )
Total operating expenses
    (283,883 )     (284,968 )     (309,283 )     (578,716 )
                                 
NET LOSS FROM PRICE-LEVEL RESTATEMENT (Note 23)
    (12,680 )     (18,524 )     (13,782 )     (25,788 )
                                 
INCOME BEFORE INCOME TAXES
   
258,945
     
295,677
     
343,781
     
643,266
 
Income taxes (Note 20)
    (48,587 )     (50,885 )     (58,199 )     (108,899 )
                                 
NET INCOME FOR THE YEAR
   
210,358
     
244,792
     
285,582
     
534,367
 
 
The accompanying Notes are an integral part of these consolidated financial statements.

F-6


BANCO SANTANDER CHILE
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Expressed in millions of constant Chilean pesos (MCh$) as of
December 31, 2006 and thousands of US dollars (ThUS$)
 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
   
2006
 
   
MCh$
   
MCh$
   
MCh$
   
ThUS$
 
                     
(Note 1r)
 
CASH FLOWS FROM OPERATING ACTIVITIES
                       
   
 
         
 
   
 
 
Net income for the year
   
210,358
     
244,792
     
285,582
     
534,367
 
Charge (credit) to income not representing cash flows:
       
 
                 
Provision for loan losses
   
136,222
     
111,958
     
170,088
     
318,261
 
Depreciation and amortization
   
40,978
     
40,080
     
38,613
     
72,251
 
Net decrease in financial investments (trading account)
    (671 )    
4,357
      (3,090 )     (5,783 )
(Gain) loss on sales of bank premises and equipment
    (205 )     (207 )     (563 )     (1,054 )
(Gain) loss on sales of goods received in lieu of payment
    (4,528 )     (4,621 )     (1,963 )     (3,673 )
Net changes in other assets and liabilities
    (71,539 )     (24,505 )     (111,093 )     (207,872 )
Share of profit in equity method investments
    (568 )     (693 )     (786 )     (1,471 )
Minority interest
   
194
     
136
     
151
     
283
 
Write-offs of assets received in lieu of payment
   
22,150
     
21,435
     
13,616
     
25,477
 
Net change in interest accruals
   
59,187
      (84,432 )     (18,245 )     (34,139 )
Price-level restatement
   
12,680
     
18,524
     
13,782
     
25,789
 
Other
   
16,452
     
6,787
     
49,287
     
92,224
 
NET CASH PROVIDED BY  OPERATING ACTIVITIES
   
420,710
     
333,611
     
435,379
     
814,660
 
 
       
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES
       
 
                 
Net increase in loans
    (1,086,477 )     (1,103,351 )     (1,516,675 )     (2,837,930 )
Net change in proceeds from sale of goods received in lieu of payment
   
44,177
     
48,610
     
27,040
     
50,596
 
Purchases of bank premises and equipment
    (20,013 )     (21,932 )     (25,120 )     (47,004 )
Investments in other companies
    (309 )     (1,365 )    
-
     
-
 
Net (increase) decrease in securities purchased under agreements to resell
   
-
      (99,988 )    
69,644
     
130,314
 
Net change in other financial investments
    (15,461 )    
491,038
     
246,274
     
460,817
 
Proceeds from sales of bank premises and equipment
   
770
     
3,685
     
2,718
     
5,087
 
Dividends received from equity investments
   
947
     
784
     
611
     
1,143
 
NET CASH USED IN INVESTING ACTIVITIES
    (1,076,366 )     (682,519 )     (1,195,508 )     (2,236,977 )
 
       
 
                 
CASH FLOWS FROM FINANCING ACTIVITIES
       
 
                 
Net increase in current accounts
   
140,177
     
117,869
     
173,996
     
325,573
 
Net increase (decrease) in savings accounts and time deposits
   
728,752
     
1,397,198
     
836,693
     
1,565,580
 
Net increase (decrease) in bankers drafts and other deposits
   
71,824
      (370,603 )    
118,438
     
221,616
 
Net increase (decrease) in investments sold under agreements to repurchase
   
38,363
      (177,511 )     (32,220 )     (60,288 )
Increase in mortgage finance bonds
   
72,188
     
18,254
     
217
     
405
 
Repayments of mortgage finance bonds
    (410,799 )     (490,809 )     (204,392 )     (382,448 )
Proceeds from bond issues
   
414,511
     
113,677
     
201,700
     
377,412
 
Repayments of bond issues
    (155,594 )     (244,881 )     (66,902 )     (125,182 )
Short-term funds borrowed
   
101,880
     
225,825
     
405,565
     
758,873
 
Short-term borrowings repaid
    (440,251 )    
613,450
      (309,261 )     (578,675 )
Proceeds from issuance of long-term borrowings
    (92,222 )     (42,132 )     (9,091 )     (17,011 )
Central Bank borrowings
   
345,941
      (356,651 )     (350,568 )     (655,966 )
Dividends paid
    (224,625 )     (210,684 )     (155,811 )     (291,547 )
NET CASH PROVIDED BY  FINANCING ACTIVITIES
   
590,145
     
593,002
     
608,364
     
1,138,342
 
                             
EFFECT OF PRICE-LEVEL RETATEMENT ON CASH AND DUE FROM BANKS
   
1,784
     
3,430
      (6,759 )     (12,648 )
NET DECREASE IN CASH AND DUE  FROM BANKS
    (63,727 )    
247,524
      (158,524 )     (296,623 )
CASH AND DUE FROM BANKS, BEGINNING OF THE YEAR
   
1,067,134
     
1,003,407
     
1,250,931
     
2,340,683
 
CASH AND DUE FROM BANKS, END OF THE YEAR
   
1,003,407
     
1,250,931
     
1,092,407
     
2,044,060
 
 
SUPPLEMENTAL CASH FLOW INFORMATION:
                       
Non cash movements (assets received in lieu of payment)
   
40,991
     
29,378
     
19,614
     
36,701
 
                                 
Cash paid during the year for:
                               
   Interest
   
446,151
     
479,029
     
591,401
     
1,106,601
 
   Taxes
   
2,820
     
1,617
     
1,988
     
3,720
 
 
The accompanying Notes are an integral part of these consolidated financial statements.

F-7


BANCO SANTANDER CHILE
 
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
Expressed in millions of constant Chilean pesos (MCh$) as of December 31, 2006
(except for number of shares)
 
   
Number
   
Paid-in
         
Financial
   
Net Income
       
   
of
   
Share
   
Legal
   
Investment
   
for the
       
   
Shares
   
capital
   
Reserve
   
Reserve
   
Year
   
Total
 
   
Millions
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
                                     
Balances at January 1, 2004, (historical)
   
188,446
     
702,551
     
105,363
     
2,503
     
212,108
     
1,022,525
 
Retained earnings
   
-
     
-
     
212,108
     
-
      (212,108 )    
-
 
Dividend paid
   
-
     
-
      (212,108 )    
-
     
-
      (212,108 )
Price-level restatement
   
-
     
17,423
     
2,448
     
-
     
-
     
19,871
 
Unrealized losses in financial investment
 classified as permanent
   
-
     
-
     
-
     
2,671
     
-
     
2,671
 
Net Income for the year
   
-
     
-
     
-
     
-
     
198,795
     
198,795
 
Balances as of December 31, 2004
   
188,446
     
719,974
     
107,811
     
5,174
     
198,795
     
1,031,754
 
Balances at December 31, 2004  restated in  constant Chilean pesos  of  December 31, 2006
   
188,446
     
761,853
     
114,082
     
5,475
     
210,358
     
1,091,768
 
                                                 
                                                 
Balances as of January 1, 2005, (historical)
   
188,446
     
719,974
     
107,811
     
5,174
     
198,795
     
1,031,754
 
Retained earnings
   
-
     
-
     
198,795
     
-
      (198,795 )    
-
 
Dividends paid
   
-
     
-
      (198,795 )    
-
     
-
      (198,795 )
Price-level restatement
   
-
     
26,063
     
3,585
     
-
     
-
     
29,648
 
Unrealized losses in financial investment
 classified as permanent
   
-
     
-
     
-
      (20,485 )    
-
      (20,485 )
Net Income for the year
   
-
     
-
     
-
     
-
     
239,710
     
239,710
 
Balances as of  December 31, 2005
   
188,446
     
746,037
     
111,396
      (15,311 )    
239,710
     
1,081,832
 
Balance at December 31, 2005, restated in  constant Chilean pesos of December 31, 2006
   
188,446
     
761,853
     
113,759
      (15,635 )    
244,792
     
1,104,767
 
                                                 
                                                 
Balances as of January 1, 2006, (historical)
   
188,446
     
746,037
     
111,396
      (15,311 )    
239,710
     
1,081,832
 
Retained earnings
   
-
     
-
     
239,710
     
-
      (239,710 )    
-
 
Dividends paid
   
-
     
-
      (155,811 )    
-
     
-
      (155,811 )
Price-level restatement
   
-
     
15,816
     
4,513
     
-
     
-
     
20,329
 
Change in accounting principles (See note 2)
   
-
     
-
     
-
      (936 )    
-
      (936 )
Unrealized losses in financial investment classified as available for sale
   
-
     
-
     
-
     
14,343
     
-
     
14,343
 
Net Income for the year
   
-
     
-
     
-
     
-
     
285,582
     
285,582
 
Balance as of December 31, 2006
   
188,446
     
761,853
     
199,808
      (1,904 )    
285,582
     
1,245,339
 

 
The accompanying Notes are an integral part of these consolidated financial statements.

F-8


Expressed in millions of constant Chilean pesos (MCh$)
of December 31, 2006 (except as indicated)

NOTE 1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a. Basis of presentation - Banco Santander Santiago (formerly Banco Santiago) is a corporation (sociedad anónima bancaria) organized under the laws of the Republic of Chile that provides a broad range of general banking services to customers, from individuals to major corporations.  Banco Santander Santiago and its subsidiaries (collectively referred to herein as the “Bank” “Banco Santander Chile”) offer general commercial and consumer banking services and provide other services, including factoring, collection, leasing, securities and insurance brokerage, mutual and investment funds management and investment banking.

Through resolution No.79 dated July 26, 2002 the Chilean Superintendencia de Bancos e Instituciones Financieras (the “Superintendency of Banks”) approved the merger agreed upon by the Extraordinary Shareholders’ Meetings of the former Banco Santander-Chile and Banco Santiago, both held on July 18, 2002.

On August 1, 2002, the legal merger agreed upon by Banco Santiago with former Banco Santander-Chile took place, through the contribution of the assets of the latter to Banco Santiago, which assumed the total liabilities. The merger was accounted for under Chilean GAAP in a manner commonly referred to as a “pooling of interests” on a prospective basis from January 1, 2002. As such, the financial statements of the former Banco Santander-Chile were retroactively combined with those of Banco Santiago at book values at January 1, 2002.

By virtue of the merger, Banco Santiago later changed its name to Banco Santander Chile.  The shareholders of the former Banco Santander-Chile became shareholders of the merged bank, receiving 3.55366329 shares of the merged Bank in exchange for each share of the former Banco Santander-Chile.

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in Chile and regulations of the Superintendency of Banks, collectively referred to as “Chilean GAAP.”  For the convenience of the reader, the consolidated financial statements have been translated into English.

The consolidated financial statements include Banco Santander Chile and its majority owned subsidiaries.  All significant intercompany transactions and balances have been eliminated in consolidation.  The majority interests of Banco Santander Chile as of December 31, 2005 and 2006 were as follows:
   
Percentage Owned
 
   
December 2005
   
December 2006
 
   
Direct
   
Indirect
   
Total
   
Direct
   
Indirect
   
Total
 
   
%
   
%
   
%
   
%
   
%
   
%
 
Subsidiary
                                   
Santiago Leasing S.A.
   
99.50
     
-
     
99.50
     
99.50
     
-
     
99.50
 
Santiago Corredores de Bolsa Ltda. (2)
   
99.19
     
0.81
     
100.00 
     
99.19
     
0.81
     
100.00 
 
Santander Santiago S.A. Administradora General de Fondos
   
99.96
     
0.02
     
99.98
     
99.96
     
0.02
     
99.98
 
Santander S.A. Agente de Valores
   
99.03
     
-
     
99.03
     
99.03
     
-
     
99.03
 
Santander Santiago S.A. Sociedad Securitizadora
   
99.64
     
-
     
99.64
     
96.64
     
-
     
99.64
 
Santander Santiago Corredora de Seguros Ltda.
   
99.99
     
-
     
99.99
     
99.99
     
-
     
99.99
 
Santander Servicios de Recaudación y Pagos Ltda. (1)
   
-
     
-
     
-
     
99.90
     
0.10
     
100.00 
 

F-9


(1)
On September 27, 2006 the Bank formed a new subsidiary, “Santander Servicios de Recaudación y Pagos Ltda.” in which they became a 99.9% owner for Mch$739 millions dedicated to collection and payment services.  The new subsidiary is organized under the laws of Republic of  Chile and started its operations in October 2006.

(2)
On December 28, 2006 the partners of the company accorded to increase capital by Ch$7,768 million. Additionally, and as indicated in Note 25 to the financial statements, in 2007 this company plans to merged with the related company Santander Investment S.A. Corredores de Bolsa, which will be the legal surviving entity and subsidiary of de Bank.

b. Use of estimates in the preparation of financial statements - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates. In certain cases generally accepted accounting principles require that assets or liabilities be recorded or disclosed at their fair values.  The fair value is the amount at which an asset could be bought or sold, or in the case of a liability could be incurred or settled in a current transaction between willing parties, other than in a forced or liquidation sale. Where available, quoted market prices in active markets have been used as the basis for the measurement.  Where quoted market prices in active markets are not available, the Bank has estimated such values based on the best information available, including using modeling and other valuation techniques.

We have established allowances to cover probable loan losses in accordance with regulations issued by the Chilean Superintendency of Banks.  These regulations require us to estimate allowances based on an individual and group classification system as explained in Note 1 (m).

As described above, the allowance for loan losses requires us to make estimates and, consequently, we regularly evaluate our allowance for loan losses by taking into consideration factors such as changes in the nature and volume of our loan portfolio, trends in forecasted portfolio credit quality and economic conditions that may affect our borrowers’ ability to pay.  Increases in our allowance for loan losses are reflected as provisions for loan losses in our income statement.  Loans are charged off when management determines that the loan or a portion thereof is uncollectible.  Charge-offs are recorded as a reduction of the allowance for loan losses.

c. Price-level restatement - The consolidated financial statements are prepared on the basis of general price-level accounting in order to reflect the effect of changes in the purchasing power of the Chilean peso during each period.  At the end of each reporting period, the consolidated financial statements are restated in terms of the general purchasing power of the Chilean peso (“constant pesos”) using changes in the Chilean Consumer Price Index (“CPI”) as follows:

-
Non-monetary assets, liabilities and shareholders’ equity accounts are restated in terms of period-end purchasing power.

-
Consistent with general banking practices in Chile, no specific purchasing power adjustments of income statement amounts are made.

-
Monetary items are not restated as such items are, by their nature, stated in terms of current purchasing power in the financial statements.

F-10


-
The price-level restatement credit or charge in the income statement represents the monetary gain or loss in purchasing power from holding monetary assets and liabilities exposed to the effects of inflation.

-
All the amounts contained in the accompanying consolidated financial statements have been restated in Chilean pesos of general purchasing power of December 31, 2006 (“constant pesos”) applied under the “prior month rule”, as described below, to reflect changes in the CPI from the financial statement dates to December 31, 2006.  This updating does not change the prior periods’ statements or information in any way except to update the amounts to constant pesos of similar purchasing power.

The general price-level restatements are calculated using the official CPI of the Chilean National Institute of Statistics and are based on the “prior month rule”, in which the inflation adjustments at any balance sheet date are based on the consumer price index at the close of the preceding month.  The CPI is considered by the business community, the accounting profession and the Chilean government to be the index which most closely complies with the technical requirement to reflect the variation in the general level of prices in the country and, consequently, is widely used for financial reporting purposes in Chile.

The values of the CPI used for price-level restatement purposes are as follows:

       
Change
 
Period
 
Index*
 
in index
 
2004
   
117.28
   
2.5%
 
2005
   
121.53
   
3.6%
 
2006
   
124.11
   
2.1%
 

*
Index as of November 30 of each period compared with the index as of November 30 of the prior year, under the prior month rule described above.

The price-level adjusted consolidated financial statements do not purport to represent appraised values, replacement cost, or any other current value of assets at which transactions would take place currently and are only intended to restate all non-monetary financial statement components in terms of local currency of a single purchasing power and to include in the net result for each year the gain or loss in purchasing power arising from the holding of monetary assets and liabilities exposed to the effects of inflation.

F-11


d. Index-linked assets and liabilities - Certain of the Bank’s interest-earning assets and interest-bearing liabilities are expressed in index-linked units of account.  The principal index-linked unit used in Chile is the Unidad de Fomento (UF), a unit of account which changes daily from the tenth day of the current month to the ninth day of the next month, to reflect the changes in the Chilean CPI over the previous month.  The carrying amounts of such assets and liabilities change with the changes in the UF and serve to offset the price-level restatement gains or losses from holding such assets and liabilities.  As the Bank’s UF assets exceed its UF liabilities, any increase in the index results in a net gain on indexation.  Values for the UF as of  December 31 of each period are as follows in historical Chilean pesos:

Period
 
Ch$
 
2004
   
17,317.05
 
2005
   
17,974.81
 
2006
   
18,336.38
 

e. Interest revenue and expense recognition - Interest revenue and expense are recognized on an accrual basis using the effective interest method. The carrying amounts of loans, investments and liabilities are stated at their cost, adjusted for accrued interest and the indexation adjustment applicable to such balances that are index-linked.  The effect of index linkage charges on interest-earning assets end interest earning liabilities is reflected in the income statement as an increase or decrease in interest revenue or expense.

The Bank suspends the accrual of interest and indexation adjustments of principal on loan installment payments due beginning on the first day that such loan installment payments are overdue.  The Bank continues to accrue interest and indexation on the principal payments not yet overdue for those loans that have installments overdue unless the Bank believes those amounts are uncollectible.  Interest accrued prior to the loan becoming overdue remains on the Bank’s books and is considered to be a part of the loan balance when determining the allowance for loan losses.  Payments received on overdue loans are first applied to reduce the recorded balance of accrued interest receivable, if any, and thereafter are recognized as income to the extent of interest earned but not recorded; any excess payments are then applied to principal.  Accrued interest and indexation adjustments are included in the Bank’s recorded investment in the loan for the purpose of determining the required allowance for loan losses.

f. Foreign currency - The Bank makes loans and accepts deposits in amounts denominated in foreign currencies, principally the US dollar.  Such assets and liabilities are translated at the observed rate reported by the Central Bank of Chile at the balance sheet date.

The amount of net gains and losses on foreign exchange includes the recognition of the effects that variations in the exchange rates have on assets and liabilities denominated in foreign currencies and the gains or losses on foreign exchange spot and forward transactions undertaken by the Bank.

g. Derivative activities – Prior to January 1, 2006, under Chilean GAAP, the Bank accounted for forward contracts between foreign currencies and U.S. dollars at fair value with realized and unrealized gains and losses on these instruments recognized in net income. Forward contracts between the U.S. dollar and the Chilean peso or the UF are valued at the closing spot exchange rate of each balance sheet date, with the initial discount or premium being amortized over the life of the contract in accordance with Chilean hedge accounting criteria.

F-12


Under Chilean GAAP the Bank records differences between interest income and interest expense on interest rate swap transactions and interest on debt instruments, in net income in the period when cash settlements under the agreements are made.  The fair value of the swap agreement and changes in the fair value as a result of changes in market interest rates were not recognized at each period-close in the Chilean GAAP consolidated financial statements.

Effective January 1, 2006, under the requirements of Circular No. 3,345 of the Superintendency of Banks, the accounting treatment of certain derivative instruments and hedges of financial assets changed.  Traditional financial instruments which meet the definition of a “derivative” such as forwards in foreign currency and unidades de fomento (inflation index-linked units of account), interest rate futures, currency and interest rate swaps, currency and interest rate options, and others are recognized initially in the balance sheet at cost (including transaction fees) and, at subsequent period ends, at their fair value.  The fair value is obtained from market quotes, discounted cash flow models and option valuation models, as applicable.

Certain terms may be incorporated into non-derivative financial instruments whose risk and economic characteristics are not clearly and closely related to those of the host contract which may require their bifurcation from the host contract and treatment as a separate derivative subject to that dictated by Circular No.3,345.

When a derivative contract is signed, it must be designated by the Bank as a speculative contract or a hedge. Any changes in the fair value of speculative financial derivative contracts  are  recorded in  Income under “Gains from trading activities” or “Losses from trading activities”, as applicable.  If the derivative is classified as a hedge , it may be: (1) a fair value hedge, or (2) a cash flow hedge . To qualify as a hedge for accounting purposes, the instruments must comply with all the following conditions: (a) hedging must be formally documented at initiation; (b) hedging must be expected to be highly effective; (c) the efficiency of the hedge can be measured reasonably; and (d) the hedge is highly effective with regard to the risk hedged, continuously throughout its lifetime, to qualify as highly effective, the hedge relationship should meet, both at the inception and in any moment, the following requirements:

a)
Prospectively: It should be expected that the changes in the fair value or in the cash flows of the hedged financial instruments will almost be offset by the changes in the fair value or in the cash flows of the hedging instruments.
   
b)
Retrospectively: The offsetting effects should be  within 80% and 125% of the changes in the hedged item.
   
c)
All the values should be reliably calculated.
   
d)
Effectiveness should be tested at least each time that the financial statements are prepared
 
Certain derivative transactions that do not classify to be accounted for as hedges  are treated and reported as trading, even though they may provide an effective economic hedge for managing risk positions.

F-13


When a derivative hedges exposure to changes in the fair value of an existing asset or liability, the latter is recorded at its fair value. Earnings or losses from measuring the fair value of both the item hedged and the hedging derivative are recognized in income. If the item hedged in a fair value hedge is a firm commitment, the changes in the fair value of the commitment with regard to the risk hedged are recorded as assets or liabilities with the offsetting effect recorded in income. When an asset or liability is acquired as a result of the commitment, the initial recognition of the acquired asset or liability is adjusted to fair value.

When a derivative hedges exposure to changes in the cash flows of existing assets or liabilities, or expected transactions, the effective portion of the changes in fair value with regard to the risk hedged is recorded in shareholders’ equity.  Any ineffective portion is recognized directly in the period’s income. The amounts recorded directly in shareholders’ equity are transferred to in income in the same periods in which the offsetting changes in  assets or liabilities hedged affect the income statement.

When fair value hedge accounting is used for a portfolio hedge of interest rate risk and the hedge item is designated as an amount of currency, the earnings or losses from measuring the fair value of both the portfolio hedged and the hedge are recognized in income.

h. Financial investments - Before January 1, 2006, the Bank’s financial investments were classified as trading or permanent in accordance with the regulations of the Superintendency of Banks with unrealized gains and losses on trading investments included in Other operating income (expenses), and unrealized gains and losses on permanent investments included in a separate component of Shareholders’ equity.  Investment securities maintained by the Bank’s subsidiaries were carried on a stand-alone basis on the subsidiary’s financial statements at the lower of price-level restated cost or market value.

The Bank’s previously identified “trading” investments, although not classified as such in prior years, for accounting purposes, were treated the same as those classified as “trading” since January 1, 2006. Additionally, over all periods presented, classification for accounting purposes has been conformed.

Effective January 1, 2006 the accounting for financial instruments acquired for trading or investments purposes (available-for-sale or held-to- maturity) are classified as follows:

i.
Trading Instruments - Instruments for trading are securities acquired for which the Bank has the intent to generate earnings from short-term price fluctuations or through brokerage margins, or that are included in a portfolio created for such purposes.
   
  Instruments for trading are valued at their fair value according to market prices on the closing date of the balance sheet.  Mark to market adjustments, as well as realized gains/losses from trading , are included in the Income Statement under “Earnings (losses) from trading activities”. Interest income  and indexation adjustments are reported as “Interest revenue”.
 
ii.
Investment Instruments - Investment instruments are classified into two categories: Held to maturity investments and Instruments available for sale. Held to maturity investments only include those instruments for which the Bank has the intent and ability to hold to maturity. Investment instruments not classified as held to maturity or trading are considered to be available for sale.  Investment instruments are recognized initially at cost, which includes transaction costs.

F-14

 
 
Investment instruments are recorded initially at cost. Instruments available for sale are valued at each subsequent period-end at their fair value according to market prices or valuations obtained by using models. Mark to market adjustments are reported in a separate component of Shareholders’ equity.  When these investments are sold or become impaired, the amount of the adjustments to fair value accumulated in Shareholders’ equity is reclassified to the income statement and reported under “Gain from trading activities” or “Losses from trading activities”, as applicable.

Held to maturity investments are recorded at their cost value plus accrued interest and adjustments, less provisions for impairment recorded when the book value is higher than its estimated return.

Interest and indexation adjustments of held to maturity investments and available for sale investments are included under “Interest revenue and expenses”. Investment instruments designated as hedges are accounted for under the appropriate derivative accounting literature.

All purchases and sales of investment instruments, to be  delivered within the deadline stipulated by market regulations and conventions, are recognized on the commitment date , which is the date on which the commitment is made to purchase or sell the asset. Other purchases or sales are treated as forwards until they are liquidated.

The Bank enters into security repurchase agreements as a form of borrowing.  In this regard, the Bank’s investments that are sold subject to a repurchase obligation and that serve as collateral for the borrowing are reclassified as “investment collateral under agreements to repurchase” and carried at market value. The liability for the repurchase of the investment is classified as “investments under agreements to repurchase” and is carried at cost plus accrued interest.

The Bank also enters into resale agreements as a form of investment. Under these agreements the Bank purchases securities, which are included as assets under the caption “investments under agreements to resell” and are carried at cost plus accrued interest.

All other financial investments are carried at acquisition cost plus accrued interest and UF-indexation adjustments, as applicable.
 
i. Leasing contracts - The Bank leases certain property that meets the criteria for direct financing leases.  At the time of entering into a direct financing lease transaction, the Bank records the gross financing receivable, unearned income and estimated residual value of leased equipment.  There are no significant residual values assumed by the Bank.  Unearned income represents the excess of the gross financing receivable plus the estimated residual value over the cost of the property acquired.  Unearned income is recognized in such a manner as to produce a constant periodic rate of return on the net investment in the direct financing lease.  The net investment in financing leases is included in the account “Lease Contracts” in the loan section of the consolidated balance sheet.

j. Factored receivables - Factoring receivable loans are valued at the amount disbursed to the borrower.  The price difference between the amounts disbursed and the actual face value of the receivables is earned and recorded as interest income over the financing period.  The borrowers are responsible for the payments of the loans if the receivables are not collected.

k. Premises and equipment - Premises and equipment are stated at acquisition cost net of accumulated depreciation and have been restated for price-level changes.  Depreciation is calculated on a straight-line method over the estimated useful lives of the underlying assets.

F-15


The costs of maintenance and repairs are charged to expense.  The costs of significant refurbishment and improvements are capitalized and are then amortized over the period of the benefit or the remaining life of the premises and equipment, whichever is less, on a straight-line basis.

l. Investments in other companies - Shares or rights in companies that are integral to the operations of the Bank, where the Bank holds less than majority interest, are accounted for under the equity method. Other minority investments are carried at cost restated for price-level changes.

m. Allowance for loan losses - The Bank has set up allowances for probable loan losses in accordance with the instructions issued by the Superintendency of Banks and the models for rating and evaluating credit risk approved by the Bank’s Board of Directors.

The following describes the calculation of the allowance for loan losses.

Allowances for individual evaluations on commercial loans

The Bank assigns a risk category level to each borrower and his respective loans.

The Bank considers the following risk factors within the analysis: industry or sector of the borrower, owners or managers of the borrower, their financial situation, their payment capacity and payment behavior.

The Bank assigns one of the following risk categories to each loan and borrower:

i.
Classifications A1, A2 and A3, correspond to borrowers with no apparent credit risk.
ii.
Classifications B, correspond to borrowers with some credit risk but no apparent deterioration of payment capacity.
iii.
Classifications C1, C2, C3, C4, D1 and D2 correspond to borrowers whose loans have deteriorated.

For loans classified as A1, A2, A3 and B, the board of directors of the Bank is authorized to determine the levels of required reserves.  For loans classified in Categories C1, C2, C3, C4, D1 and D2, the bank must have the following levels of reserves:

Classification
Estimated range of loss
Reserve
C1
Up to 3%
2%
C2
More than 3% up to 19%
10%
C3
More than 19% up to 29%
25%
C4
More than 29% up to 49%
40%
D1
More than 49% up to 79%
65%
D2
More than 79%
90%

Commencing in 2006, the Bank improved the methodology for loans classified as categories A1, A2, A3 and B. All commercial loans were assigned with a specific level of risk.


F-16

 
Loan classification model for commercial, consumer and mortgage loans on an group basis
Allowances for group evaluations

·
Suitable for the evaluation of a large number of borrowers whose individual loan amounts are relatively small.  These models are intended to be used primarily to analyze loans to individuals and small companies.

·
Levels of required reserves are to be determined by the Bank,  according to the estimated loss that may result from the loans, by classifying the loan portfolio using one or both of the following models:

 
i.
A model based on the characteristics of the borrowers and their outstanding loans.  Borrowers and their loans with similar characteristics will be placed into groups and each group will be assigned a risk level.
  ii.
A model based on the behavior of a group of loans.  Loans with analogous past payment histories and similar characteristics will be placed into groups and each group will be assigned a risk level.
 
Provisioning for consumer and mortgage loan

The provisioning for consumer and mortgage loan is directly related to the aging of the installment.

Commencing in 2006, the Bank improved and modified the methodology for analyzing consumer and mortgage loans. All consumer and mortgage loans will be assigned a rating on an individual basis utilizing a more automated and sophisticated statistical model and considering also borrower’s credit behavior.  Once the rating of the client is determined the provisioning of consumer and mortgage loans is calculated using a risk category and related % which is directly related to the aging.

Additional reserves

Under the regulations, banks are permitted to establish reserves above the limits described above only to cover specific risks that have been authorized by their board of directors.

Charge-offs

In accordance with the regulations of the Superintendency of Banks the Bank charges off loans or portions thereof when collection efforts have been exhausted.  Under the rules and regulations established by the Superintency of Banks, charge-offs must be made within the following maximum prescribed limits:

·
24 months after a loan is past due (3 months for consumer loans) for loans without collateral; and
·
36 months after a loan is past due for loans with collateral.

The Bank will also charge-off commercial loans prior to the meeting of this criteria when the Bank no longer considers such loans or portions thereof to be collectible.

Loan loss recoveries

Recoveries on charged-off loans as well as recoveries on loans which were reacquired from the Chilean Central Bank (the “Central Bank”), are recorded directly to income and presented as a reduction of the provision for loans losses.
F-17


n. Fees and expenses related to loans and services - Fees and expenses related to loans, as well as fees for services rendered, are deferred and recognized in income over the term of the loans to which they relate equivalent to the period during which the services are performed.

The fees correspond to remunerations charged to the mutual funds and investment funds administered are registered on base yielded.  These fees are established in the Internal Regulations of each one the funds administered

o. Income taxes - Income taxes payable are recognized in an amount that approximates the amount due on the respective income tax return pursuant to Chilean tax legislation.

Deferred taxes are recorded in accordance with Technical Bulletin No. 60 and the complementary technical bulletins thereto issued by the Chilean Association of Accountants.

p. Assets received in lieu of payment - Assets received in lieu of payment are carried at the lower of price-level restated cost and the market value of such assets, considered as a whole. Assets that have not been sold within one year are written-off, as instructed by the Superintendency of Banks.

q. Statement of cash flows - For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks. (For the year ended December 31, 2004, 2005 and 2006), the consolidated statements of cash flows have been prepared in accordance with Technical Bulletin No. 65 of the Chilean Association of Accountants.

r. Convenience translation to U.S. dollars - The Bank maintains its accounting records and prepares its consolidated financial statements in Chilean pesos.  The US dollar amounts disclosed in the accompanying financial statements are presented solely for the convenience of the reader at the December 31, 2006 observed exchange rate of Ch$534.43 per US$1.00.  This translation should not be construed as representing that the Chilean peso amounts actually represent or have been, or could be, converted into U.S. dollars at such a rate or at any other rate.

NOTE 2.
ACCOUNTING CHANGES

On December 20, 2005, the Superintendency of Banks and Financial Institutions issued Circular No. 3,345 and related amendments through Circular No.3,349 dated February 7, 2006, Circular No. 3,355 dated May 25, 2006 and Circular No. 3,358 dated May 31, 2006, governing the application of new accounting principles and the valuation and classification of financial instruments acquired, derivative instruments, accounting hedges and write-offs of financial assets on the balance sheet.  The aforementioned changes in  accounting principles and valuation at January 1, 2006, called for adjustments, if applicable, to fair value, on said instruments to be made directly against shareholders’ equity; the amount was MCh$(936).

For comparative purposes, the balances at December 31, 2005 have been regrouped and reclassified, but not adjusted to fair value, based on the transition provisions established in Circular No.3,345 and its subsequent amendments as mentioned above.
 
F-18


NOTE 3.
CASH AND DUE FROM BANKS
 
In accordance with the rules of the Superintendency of Banks, the Bank must maintain certain non interest-bearing balances in its account with the Central Bank. The required balances are based upon specified financial criteria, including the level of the Bank’s assets, the amount of its foreign borrowings and its average liabilities.  Restricted amounts totaled MCh$238,410 and MCh$290,958 as of December 31, 2005 and 2006, respectively.

NOTE 4.
INVESTMENTS

Financial investments are classified at the time of the purchase, based on management’s intentions, as either trading instruments or investment instruments the latter of which are categorized as Available for sale and Held to maturity.

A summary of financial investments is as follows:

a) Trading Investments
 
 
   
As of December 31,   
 
Central Bank and Government Securities  
2005
   
2006
 
   
MCh$
   
MCh$
 
Central Bank Securities
   
390,002
     
381,260
 
Chilean Treasury Bonds
   
-
     
40,521
 
Other Securities
   
17,101
     
357
 
 Subtotal
   
407,103
     
422,138
 
                 
Others Financial Securities
               
Time deposits in Chilean Financial Institutions
   
89,151
     
3,554
 
Mortgage Finance Bonds
   
59,555
     
23,189
 
Chilean financial Institutions Bonds
   
-
     
44
 
Chilean Corporate Bonds
   
2,002
     
22,561
 
Chilean Others Securities
   
58,902
     
7,264
 
Central Bank and Government Foreign Securities
   
-
     
-
 
Other Foreign Securities
   
59,248
     
160,711
 
  Subtotal
   
268,858
     
217,323
 
Total
   
675,961
     
639,461
 
 
Central Bank and government securities include repurchase agreements sold to clients and financial institutions for an amount of MCh$50,250 and MCh$20,061 as of December 31, 2005 and 2006 respectively. Other Financial Investments does not include any repurchase agreements sold to clients and financial institutions.

F-19


b) Available for sale Investments
 
   
As of December 31,   
 
   
2005
   
2006
 
Central Bank and Government Securities  
MCh$
   
MCh$
 
Central Bank Securities
   
86,114
     
77,738
 
Chilean Treasury Bonds
   
1,226
     
623
 
Other Securities
   
34,494
     
18,531
 
Subtotal
   
121,834
     
96,892
 
                 
Others Financial Securities
               
Time deposits in Chilean Financial Institutions
   
-
     
-
 
Mortgage Finance Bonds
   
423,970
     
222,672
 
Chilean financial Institutions Bonds
   
-
     
-
 
Chilean Corporate Bonds
   
-
     
-
 
Chilean Others Securities
   
-
     
-
 
Central Bank and Government Foreign Securities
   
-
     
-
 
Other Foreign Securities
   
29,224
     
25,544
 
Subtotal
   
453,194
     
248,216
 
Total
   
575,028
     
345,108
 
 
Central Bank and government securities include repurchase agreements sold to clients and financial institutions for an amount of MCh$1,756 and MCh$2,067 as of December 31, 2005 and 2006 respectively. Other Financial Investments does not include any repurchase agreements sold to clients and financial institutions.

c) Held to maturity Investments

As of December 31, 2005 and 2006 no financial investments were classified as held to maturity.

NOTE 5.
LOANS
 
The loans on the accompanying consolidated balance sheets consist of the subcategories as described below.

Commercial loans are long-term and short-term loans made to companies and businesses.  These loans are granted in Chilean pesos on an adjustable or fixed rate basis to finance working capital or investments.

Consumer loans are loans to individuals granted in Chilean pesos, generally on a fixed rate basis, to finance the purchase of consumer goods or to pay for services.  Credit card balances subject to interest charges are also included in this category.

Mortgage loans are inflation-indexed, fixed rate, long-term loans with monthly payments of principal and interest collateralized by a real property mortgage.  These loans are specifically funded through the issuance of mortgage finance bonds, which are bonds generally issued to third party investors in order that the Bank finance its loans to property owners.  At the time of issuance, the amount of a mortgage loan cannot exceed 75% of the value of the property.

Foreign trade loans are fixed rate, short-term loans granted in foreign currencies (principally U.S. dollars) to finance imports and exports.

F-20


Interbank loans are fixed rate, short-term loans to financial institutions that operate in Chile.

Lease contracts are agreements to finance the acquisition of capital equipment and other property.

Other outstanding loans principally include current account overdrafts, bills of exchange and mortgage loans that are financed by the Bank’s general borrowings.

Past due loans include, with respect to any loan, the amount of principal or interest that is 90 days or more overdue, and do not include the installments of such loan that are not overdue or that are less than 90 days overdue, unless legal proceedings have been commenced for the entire outstanding balance according to the terms of the loan.

Contingent loans mainly consist of open and unused letters of credit together with guarantees granted by the Bank in Ch$, UF and foreign currencies (principally U.S. dollars).

The following table summarizes the most significant loan concentrations, expressed as a percentage of total loans, excluding contingent loans and on a gross basis.

   
As of December 31,
 
   
2005
   
2006
 
             
Community, social and personal services
    18.9%       16.7%  
Residential mortgage loans
    25.0%       26.0%  
Consumer credit
    15.2%       16.9%  
Financial services
    10.4%       8.8%  
Commerce
    8.4%       8.3%  
Manufacturing
    6.0%       5.6%  
Construction
    6.5%       6.8%  
Agriculture, livestock, agribusiness, fishing
    4.7%       5.7%  
Electricity, gas and water
    0.8%       0.9%  
Transport, storage and communications
    3.4%       3.6%  
Mining and petroleum
    0.7%       0.7%  
                 
    Total
    100.0%       100.0%  

A substantial amount of the Bank’s loans are to borrowers doing business in Chile.

F-21


 
 

NOTE 6.
LEASE CONTRACTS

The amounts shown as leasing contracts are amounts receivable under lease agreements and have the following maturities as of December 31, 2005 and 2006.  Unearned income presented in the table corresponds to the interest to be earned in the future as of each year-end.

   
As of December 31, 2005
   
As of December 31, 2006
 
   
Total
   
Unearned
   
Net lease
   
Total
   
Unearned
   
Net lease
 
   
receivable
   
income
   
receivable
   
receivable
   
income
   
receivable
 
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Years
                                   
Due within one year
   
203,726
      (30,424 )    
173,302
     
266,485
      (29,544 )    
236,941
 
Due after 1 year but within 2 years
   
161,425
      (24,428 )    
136,997
     
189,480
      (25,425 )    
164,055
 
Due after 2 year but within 3 years
   
116,673
      (17,969 )    
98,704
     
132,837
      (21,842 )    
110,995
 
Due after 3 year but within 4 years
   
79,750
      (13,530 )    
66,220
     
89,100
      (17,050 )    
72,050
 
Due after 4 year but within 5 years
   
59,239
      (10,317 )    
48,922
     
55,476
      (10,665 )    
44,811
 
Due after 5 years
   
190,778
      (36,987 )    
153,791
     
180,935
      (45,379 )    
135,556
 
                                                 
    Total
   
811,591
      (133,655 )    
677,936
     
914,313
      (149,905 )    
764,408
 

Leased assets consist principally of real estate, industrial machinery, vehicles and computer equipment.

NOTE 7.
ALLOWANCE FOR LOAN LOSSES

The changes in the allowance for loan losses are as follows:

   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
                   
Balance as of January 1,
   
182,426
     
183,366
     
151,000
 
Price-level restatement (1)
    (4,792 )     (6,407 )     (3,134 )
Charge offs
    (126,394 )     (139,632 )     (143,475 )
Allowances established
   
153,406
     
164,697
     
206,087
 
Allowances released
    (21,280 )     (51,024 )     (36,414 )
                         
Balance as December 31,
   
183,366
     
151,000
     
174,064
 

(1)
Reflects the effect of inflation on the allowance for loan losses at the beginning of each period, adjusted to constant pesos of December 31, 2006.


F-22


The provision for loan losses included in the results of operations for the periods indicated is as follows:

   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
                   
Provision established
   
153,406
     
164,697
     
206,087
 
Net provision established (released)
                       
   for assets received in lieu of payment
   
1,027
      (724 )    
1,268
 
Direct charge-offs
   
3,070
      (991 )     (852 )
Provision released
    (21,280 )     (51,024 )     (36,414 )
Recovery of loans previously charged off
    (50,772 )     (47,079 )     (47,067 )
                         
Net charge to income
   
85,451
     
64,879
     
123,022
 

NOTE 8.
BANK PREMISES AND EQUIPMENT, NET

The major categories of Bank premises and equipment, net of accumulated depreciation are as follows:

   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
             
Land and buildings
   
197,016
     
198,980
 
Furniture and fixtures
   
7,618
     
10,035
 
Machinery and equipment
   
14,485
     
15,451
 
Vehicles
   
1,075
     
1,246
 
Other
   
5,874
     
5,648
 
                 
Total bank premises and equipment, net
   
226,068
     
231,360
 

Related depreciation expense was MCh$17,320 and MCh$19,291 as of December 31, 2005 and 2006 respectively.
 
F-23

 
NOTE 9.
INVESTMENTS IN OTHER COMPANIES

Investments in other companies consist of the following:
 
     
As of December 31,
 
   
Ownership interest
   
Participation in net income
   
Book Value
 
   
2005
   
2006
   
2004
   
2005
   
2006
   
2005
   
2006
 
   
%
   
%
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
                                           
Redbank S.A.
   
33.42
     
33.42
     
192
     
187
     
201
     
1,225
     
1,239
 
Transbank S.A.
   
32.71
     
32.71
     
262
     
263
     
264
     
1,716
     
1,717
 
Tarjetas Inteligentes S.A.  (1)
   
-
     
-
      (141 )     (43 )    
-
     
-
     
-
 
Centro de Compensación Automática
   
33.33
     
33.33
     
32
     
35
     
40
     
218
     
240
 
Sociedad Interbancaria de Depósito de Valores S.A.
   
29.28
     
29.28
     
59
     
58
     
68
     
310
     
313
 
Camara de Compensacion Alto Valor S.A. (4)
   
11.66
     
11.52
      (18 )     (23 )    
58
     
287
     
346
 
Adm Financ. Transantiago  (2)
   
20.00
     
20.00
     
-
      (126 )     (95 )    
1,292
     
1,197
 
Nexus S.A. (4)
   
12.90
     
12.90
     
91
     
93
     
119
     
584
     
610
 
Bolsa de Comercio de Santiago (Stock Exchange) (4)
   
4.17
     
4.17
     
93
     
233
      (128 )    
590
     
616
 
Bolsa Electrónica de Chile. (4)
   
2.50
     
2.50
     
-
     
29
      (3 )    
71
     
75
 
Bolsa de Comercio de Valparaíso (3) (4)
   
2.22
     
1.67
     
-
      (2 )    
-
     
10
     
10
 
Cámara de Compensación (4)
   
0.15
     
0.15
     
-
      (1 )    
-
     
3
     
4
 
                                                         
Total investments in other companies accounted
    for under the equity method
                   
570
     
703
     
524
     
6,306
     
6,367
 
Other investments carried at cost
                    (2 )     (10 )    
262
     
532
     
287
 
Total investments in other companies
     
568
     
693
     
786
     
6,838
     
6,654
 

(1)
On December 19, 2005, in compliance with the agreement adopted by the Shareholders Extraordinary meeting, the company “Empresas Tarjetas Inteligentes S.A.”, was liquidated.
(2)
On July 7, 2005, the Bank acquired 20% of “Administrador Financiero Transantiago S.A. in the amount of MCh$1,353 (historical).
(3)
On August 19, 2005, the company “Bolsa de Comercio de Valparaiso” make a capital increase which was not subscribed to by the Bank.
(4)
Acquired prior to January 1, 2004.
 
NOTE 10.
OTHER ASSETS AND OTHER LIABILITIES

a)    Other assets
 
   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
             
Amounts receivable under spot foreign exchange transactions
   
49,339
     
91,302
 
Real time gross settlement (RTGS) receivable
   
21,499
     
31,377
 
Credit card charges in process
   
30,472
     
27,318
 
Deferred income taxes (Note 20)
   
46,090
     
45,453
 
Prepaid and deferred expenses
   
55,615
     
62,710
 
Transactions in process
   
7,421
     
13,409
 
Recoverable taxes
   
7,850
     
14,816
 
Stamp taxes recoverable
   
517
     
4,821
 
Receivable on sales of assets received in lieu of payment
   
1,885
     
1,783
 
Guarantees issued
   
35,234
     
79,079
 
Pending consignment
   
-
     
291
 
Account receivable
   
56,392
     
38,990
 
Mutual Funds
   
1,385
     
30,565
 
Other
   
16,153
     
22,077
 
                 
         Total Other Assets
   
329,852
     
463,991
 


F-24


b)    Other liabilities

   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
             
Amounts payable under spot foreign exchange transactions
   
76,216
     
99,082
 
Deferred income taxes (Note 20)
   
5,409
     
8,437
 
Transactions in process
   
3,604
     
5,157
 
Provision for staff benefits
   
11,930
     
14,115
 
Income taxes
   
8,540
     
15,116
 
Provisions for lawsuits and others
   
32,937
     
29,571
 
Value added tax payable
   
4,619
     
5,143
 
Deferred fees
   
8,083
     
7,597
 
Real time gross settlement (RTGS) payable
   
5,319
     
14,483
 
Other
   
11,192
     
3,221
 
                 
           Total Other Liabilities
   
167,849
     
202,115
 

c)    Contingent liabilities

Contingent liabilities consist of open and unused letters of credit, together with guarantees by the Bank in Chilean pesos, UF's and foreign currencies (principally US dollars).  The liability represents the Bank’s obligations under such agreements.  The Bank’s rights under these agreements are recognized as assets under the caption “Contingent loans” (Note 5).  Since many of these commitments to extend credit may expire without being drawn upon, the total contingent liabilities do not necessarily represent future cash obligations.

NOTE 11.
OTHER INTEREST BEARING LIABILITIES

The Bank’s long-term and short-term borrowings are summarized below.  Borrowings are generally classified as short-term when they have original maturities of less than one year or are due on demand.  All other borrowings are classified as long-term, including the amounts due within one year on such borrowings.

   
As of December 31, 2005
 
Total Borrowings
 
Long-term
   
Short-term
   
Total
 
   
MCh$
   
MCh$
   
MCh$
 
                   
Central bank borrowings (a)
   
-
     
176,878
     
176,878
 
Credit lines for renegotiations of loans (a)
   
6,796
     
-
     
6,796
 
Investment under agreements to repurchase
   
-
     
50,834
     
50,834
 
Mortgage finance bonds (b)
   
563,470
     
119,673
     
683,143
 
Other borrowings bonds (c)
   
422,292
     
1,754
     
424,046
 
Subordinated bonds (d)
   
393,929
     
-
     
393,929
 
Borrowings from domestic financial institutions
   
-
     
2,582
     
2,582
 
Foreign borrowings (e)
   
65,605
     
1,055,923
     
1,121,528
 
Other obligations (f)
   
12,000
     
30,984
     
42,984
 
                         
         Total borrowings
   
1,464,092
     
1,438,628
     
2,902,720
 
 
F-25

 
   
As of December 31, 2006
 
   
Long-term
   
Short-term
   
Total
 
Total Borrowings
 
MCh$
   
MCh$
   
MCh$
 
                   
Central bank borrowings (a)
   
-
     
134,417
     
134,417
 
Credit lines for renegotiations of loans (a)
   
-
     
5,080
     
5,080
 
Investment under agreements to repurchase
   
-
     
19,929
     
19,929
 
Mortgage finance bonds (b)
   
464,713
     
65,493
     
530,206
 
Other borrowings bonds (c)
   
564,513
     
1,140
     
565,653
 
Subordinated bonds (d)
   
450,122
     
40,294
     
490,416
 
Borrowings from domestic financial institutions
   
-
     
-
     
-
 
Foreign borrowings (e)
   
94,288
     
717,979
     
812,267
 
Other obligations (f)
   
11,972
     
52,221
     
64,193
 
                         
          Total borrowings
   
1,585,608
     
1,036,553
     
2,622,161
 
 
a)    Central Bank borrowings
 
Central Bank borrowings include credit lines for the renegotiations of loans and other Central Bank borrowings. These credit lines were provided by the Central Bank for the renegotiations of loans due to the need to refinance debts as a result of the economic recession and crisis of the banking system in the early 1980's. The credit lines for the renegotiations, which are considered long-term, are related with mortgage loans linked to the UF index and bear an annual interest rate of 3.6% and 3.0% at December 31, 2005 and 2006 respectively. The maturities of the outstanding amounts due to the Central Bank are as follows:
 
   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
             
Total credit lines for renegotiation of loans
   
6,796
     
5,080
 

The maturities of MCh$5,080 due under these long-term credit lines, are due within one year.
 
b)    Mortgage finance bonds
 
These bonds are used to finance mortgage loans.  The outstanding principal amounts of the bonds are amortized on a quarterly basis.  The range of maturities of these bonds is between five and twenty years.  The bonds are linked to the UF index and bear a weighted-average annual interest rate of 5.2%.
 
   
As of December 31,
 
   
2006
 
   
MCh$
 
       
Due within 1 Year
   
65,493
 
Due after 1 year but within 2 years
   
54,556
 
Due after 2 years but within 3 years
   
51,190
 
Due after 3 years but within 4 years
   
48,896
 
Due after 4 years but within 5 years
   
44,711
 
Due after 5 years
   
265,360
 
 
   Total mortgage finance bonds
   
530,206
 
 
F-26

 
c)    Bonds
 
   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
             
Santiago bonds, Series A,B,C,D and F
   
11,350
     
9,179
 
Santander Bonds linked to the UF
   
165,122
     
342,774
 
Santander Bonds denominated in US$
   
247,574
     
213,700
 
     
424,046
     
565,653
 

Santiago bonds include series A, B, C and F issued by the former Santiago S.A. and series B and D issued by the former Banco O’Higgins, prior to its merger with the Bank in 1997. These bonds are intended to finance loans that have a maturity of greater than one year, are linked to the UF index and bear a weighted-average annual interest rate of 7.0% with interest and principal payments due semi-annually.

On December 17, 2004 Santiago Leasing S.A., ceded through public deed a total of UF 3,041,102 (MCh$53,779 at December 31, 2004) in bonds to Banco Santander Chile, this bonds are linked to the UF index and bear an annual interest rate of 5.6%.  As of December 31, 2005 and 2006, the balance is included in Santander bonds linked to the UF.

Santander bonds were issued by the former Banco Santander-Chile.  These bonds are intended to finance loans that have a maturity of greater than one year, are linked to the UF index and bear a weighted average annual interest rate of 6.5%.

On October 5, 2005 the Bank issued bonds, denominated in UF for a total of UF8.000.000 which  bear an average annual interest rate of 3.0%.

On May 25, 2006 the Bank issued bonds, denominated in UF for a total of UF6.000.000 which bear an average annual interest rate of 4.6%.

On August 17, 2006 the Bank issued bonds, denominated in UF for a total of UF895.000 which bear an average annual interest rate of 3.7%.

On December 9, 2004, the Bank issued senior bonds, denominated in U.S. dollars, for a total of US$400 million. These bonds carry a nominal interest rate of LIBOR plus 0.35% per annum (4.81% and 5.35% at December, 2005 and 2006), quarterly interest payments and one repayment of principal after a term of 5 years.

F-27


The maturities of these bonds are as follows:
 
   
As of
December 31,
 
   
2006
 
   
MCh$
 
       
Due within 1 Year
   
1,140
 
Due after 1 year but within 2 years
   
-
 
Due after 2 years but within 3 years
   
213,700
 
Due after 3 years but within 4 years
   
146,290
 
Due after 4 years but within 5 years
   
15,414
 
Due after 5 years
   
189,109
 
 
    Total bonds
   
565,653
 
 
d)    Subordinated bonds
 
   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
Santiago bonds denominated in US$(1)
   
44,045
     
42,703
 
Santander bonds denominated in US$(2) (6)
   
265,381
     
272,183
 
Santiago Bonds linked to the UF (3)
   
54,485
     
49,017
 
Santander Bonds linked to the UF (4) (5)
   
30,018
     
126,513
 
 
   Total subordinated bonds
   
393,929
     
490,416
 
 
(1)
On July 17, 1997, the former Banco Santiago issued subordinated bonds, denominated in U.S. dollars, for a total of US$300 million. The bonds carry a nominal interest rate of 7.0% per annum, semi-annual interest payments and one repayment of principal after a term of 10 years.

(2)
On January 16, 2003, the Bank completed the voluntary exchange of its new subordinated bonds, which will mature in 2012.  A total of US$221,961,000 in principal of the Santiago bonds was offered and redeemed by the Bank.  The bonds carry a nominal interest rate of 7.375% per annum, semi-annual interest payments and one repayment of principal after a term of 10 years.

(3)
The Series C and E Bonds outstanding as of December 31, 2005 and 2006 are intended for the financing of loans with a maturity of greater than one year.  They are linked to the UF index and carry an annual interest rate of 7.5% and 6.0% respectively, with interest and principal payments due semi-annually.

(4)
The Series C, D and E Bonds outstanding as of December 30, 2005 and 2006 are intended for the financing of loans with a maturity of greater than one year.  They are linked to the UF index and carry an annual interest rate of 7.0% with interest and principal payments due semi-annually.

(5)
During 2006 the Bank issued subordinated bonds, denominated in UF for a total of UF5.000.000 which bear an average annual interest rate of 4.4%.

(6)
On December 9, 2004, the Bank issued subordinated bonds, denominated in U.S. dollars, for a total of US$300 million. These bonds carry a nominal interest rate of 5.375% per annum, semi-annual interest payments and one repayment of principal after a term of 10 years.

F-28


The maturities of these bonds, which are considered long-term, are as follows:

   
As of
December 31,
 
   
2006
 
   
MCh$
 
         
Due within 1 Year
   
40,294
 
Due after 1 year but within 2 years
   
-
 
Due after 2 years but within 3 years
   
-
 
Due after 3 years but within 4 years
   
-
 
Due after 4 years but within 5 years
   
17,378
 
Due after 5 years
   
432,744
 
 
   Total subordinated bonds
   
490,416
 
 
e)    Foreign borrowings
 
These are short-term and long-term borrowings from foreign banks.  The maturities of these borrowings are as follows:
 
   
As of
December 31,
 
   
2006
 
   
MCh$
 
       
Due within 1 Year
   
717,979
 
Due after 1 year but within 2 years
   
91,021
 
Due after 2 years but within 3 years
   
-
 
Due after 3 years but within 4 years
   
3,267
 
Due after 4 years but within 5 years
   
-
 
Due after 5 years
   
-
 
 
Total foreign borrowings
   
812,267
 

The foreign borrowings are denominated principally in U.S. dollars, and are principally used to fund the Bank’s foreign trade loans and bear an annual average interest rate of 3.7% and 5.3% at  December 31, 2005 and 2006.


F-29


f)    Other obligations

Other obligations are summarized as follows:

   
As of
December 31,
 
   
2006
 
   
MCh$
 
       
Due within 1 Year
   
3,369
 
Due after 1 year but within 2 years
   
3,454
 
Due after 2 years but within 3 years
   
2,153
 
Due after 3 years but within 4 years
   
2,143
 
Due after 4 years but within 5 years
   
1,623
 
Due after 5 years
   
2,599
 
   Total long term obligations
   
15,341
 

Short-term obligations:

Amounts due to credit card operators
   
21,877
 
Acceptance of letters of credit
   
26,975
 
   Total short – term obligations
   
48,852
 
         
   Total other obligations
   
64,193
 

NOTE 12.
DISCLOSURES REGARDING DERIVATIVE FINANCIAL INSTRUMENTS

The Bank enters into transactions involving derivative instruments, particularly foreign exchange contracts, as part of its asset and liability management, and in acting as a dealer in order to satisfy its clients’ needs. The notional amounts of these contracts are carried off-balance sheet.

Foreign exchange forward contracts involve an agreement to exchange the currency of one country for the currency of another country at an agreed-upon price and settlement date. These contracts are generally standardized contracts, normally for periods between 1 and 180 days and are not traded in a secondary market; however, in the normal course of business and with the agreement of the original counterparty, they may be terminated or assigned to another counterparty.

When the Bank enters into a forward exchange contract, it analyses and approves the credit risk (the risk that the counterparty might default on its obligations). Subsequently, on an ongoing basis, it monitors the possible losses involved in each contract. To manage the level of credit risk, the Bank deals with counterparties of good credit standing, enters into master netting agreements whenever possible and when appropriate, obtains collateral.

The Chilean Central Bank requires that foreign exchange forward contracts be made only in US dollars and other major foreign currencies. In the case of the Bank, most forward contracts are made in US dollars against the Chilean peso or the UF. Occasionally, forward contracts are also made in other currencies, but only when the Bank acts as an intermediary.


F-30


During the period ended December 31, 2005 and 2006, the Bank entered into interest rate and cross currency swap agreements to manage exposure to fluctuation in currencies and interest rates.  The differential between the interest paid or received on a specified notional amount is recognized under the caption “Amounts payable from forward contracts, net”.  The fair value of the swap agreement and changes in the fair value as a result of changes in market interest rates are recognized in the consolidated financial statements.

The Bank’s foreign currency futures and forward operations and other derivative products outstanding at December 31, 2005 and 2006 are summarized below:
 
     
As of December 31, 2006
 
     
Notional amounts
   
Fair Value
 
 
Cash Flow
hedge (CF)
or fair
value hedge
(FV)
 
Within 3
months
   
After 3 months
but within one
year
   
After one year
   
Assets
   
Liabilities
 
     
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Derivative instruments in designated hedge accounting relationships
                             
                                 
Currency Forwards
( )
   
-
     
-
     
-
     
-
     
-
 
Interest rate Swaps
(FV)
   
-
     
-
     
210,298
     
1,173
     
2,354
 
Currency Swaps
( )
   
-
     
-
     
-
     
-
     
-
 
Cross currency Swaps
(FV)
   
843,969
     
-
     
-
     
-
     
37,871
 
Call currency options
( )
   
-
     
-
     
-
     
-
     
-
 
Call interest rate options
( )
   
-
     
-
     
-
     
-
     
-
 
Put currency options
( )
   
-
     
-
     
-
     
-
     
-
 
Put interest rate options
( )
   
-
     
-
     
-
     
-
     
-
 
Interest rate future
( )
   
-
     
-
     
-
     
-
     
-
 
Other derivatives
( )
   
-
     
-
     
-
     
-
     
-
 
Subtotal
     
843,969
     
-
     
210,298
     
1,173
     
40,225
 
                                           
Derivative instruments for trading
                                         
                                           
Currency forwards
     
6,017,519
     
3,435,681
     
378,885
     
82,608
     
99,422
 
Interest rate swaps
     
457,994
     
1,178,930
     
3,923,328
     
34,958
     
68,165
 
Currency swaps
     
-
     
-
     
-
     
-
     
-
 
Cross currency swaps
     
2,744,066
     
1,348,617
     
129,703
     
247,486
     
142,058
 
Call currency options
     
47,608
     
372,092
     
-
     
4,384
     
4,372
 
Call interest rate options
     
-
     
100
     
-
     
-
     
-
 
Put currency options
     
-
     
-
     
-
     
-
     
-
 
Put interest rate options
     
29,706
     
346,691
     
-
     
1,448
     
1,032
 
Interest rate future
     
-
     
-
     
-
     
-
     
-
 
Other derivatives
     
313,055
     
106,886
     
101,542
     
631
     
648
 
Subtotal
     
9,609,948
     
6,788,997
     
4,533,458
     
371,515
     
315,697
 
                                           
Total
     
10,453,917
     
6,788,997
     
4,743,756
     
372,688
     
355,922
 
 
The notional amounts refer to the US dollar bought or sold or to the US dollar equivalent of foreign currency bought or sold for future settlement.  The contract terms correspond to the duration of the contracts as from the date of the transaction to the date of the settlement.


F-31

 
     
As of December 31, 2005
 
     
Notional amounts
   
Book Value (*)
 
     
Within 3
months
   
After 3 months
but within one
year
   
After one
year
   
Assets
   
Liabilities
 
     
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Derivative instruments in designated hedge accounting relationships
Cash Flow
hedge (CF)
or fair
value hedge
(FV)
                             
                                 
Currency Forwards
( )
   
-
     
-
     
-
     
-
     
-
 
Interest rate Swaps
(FV)
   
-
     
-
     
401
     
131
     
212
 
Currency Swaps
( )
   
-
     
-
     
-
     
-
     
-
 
Cross currency Swaps
(FV)
   
77
     
129
     
-
     
-
     
10,276
 
Call currency options
( )
   
-
     
-
     
-
     
-
     
-
 
Call interest rate options
( )
   
-
     
-
     
-
     
-
     
-
 
Put currency options
( )
   
-
     
-
     
-
     
-
     
-
 
Put interest rate options
( )
   
-
     
-
     
-
     
-
     
-
 
Interest rate future
( )
   
-
     
-
     
-
     
-
     
-
 
Other derivatives
( )
   
-
     
-
     
-
     
-
     
-
 
Subtotal
     
77
     
129
     
401
     
131
     
10,488
 
                                           
Derivative instruments for trading
                                         
                                           
Currency forwards
     
4,862,614
     
3,690,484
     
359,919
     
249,275
     
283,218
 
Interest rate swaps
     
362,666
     
2,244,684
     
2,651,871
     
3,593
     
9,799
 
Currency swaps
     
-
     
-
     
-
     
-
     
-
 
Cross currency swaps
     
907
     
559
     
37
     
165,209
     
88,131
 
Call currency options
     
-
     
26,255
     
-
     
413
     
-
 
Call interest rate options
     
-
     
-
     
-
     
-
     
-
 
Put currency options
     
-
     
10,502
     
-
     
174
     
174
 
Put interest rate options
     
-
     
-
     
-
     
-
     
-
 
Interest rate future
     
-
     
-
     
-
     
-
     
-
 
Other derivatives
     
651,257
     
-
     
-
     
-
     
13
 
Subtotal
     
5,877,444
     
5,972,484
     
3,011,827
     
418,664
     
381,335
 
                                           
Total
     
5,877,521
     
5,972,613
     
3,012,228
     
418,795
     
391,823
 
 
(*) For the operations previous to January 1, 2006, the Bank has applied the criteria described in note 1g.

The notional amounts refer to the US dollar bought or sold or to the US dollar equivalent of foreign currency bought or sold for future settlement.  The contract terms correspond to the duration of the contracts as from the date of the transaction to the date of the settlement.
 
F-32

 
NOTE 13.
MINIMUM CAPITAL REQUIREMENTS

The Superintendency of Banks requires Chilean Banks to maintain a minimum capital of 800,000 UF, equivalent to MCh$14,669 as of December 31, 2006. In addition, Banks are required to maintain a minimum basic capital of at least 3% of total assets after deductions for mandatory provisions, while effective net equity may not be lower than 8% of its risk weighted assets.  However, as a result of the merger in 2002, the Chilean Superintendency of Banks and Financial Institutions determined that the actual equity of the merged bank could not be lower than 11% of its risk-weighted assets.  Effective net equity is defined as basic equity, plus voluntary loan loss allowances, up to a maximum of 1.25% of risk-weighted assets, and the qualifying proportion of subordinated bonds with scheduled maturities in excess of six years, for which early repayment is not permitted. Chilean Banks are permitted to include in effective net equity principal subordinated bond amounts up to a maximum of fifty percent of the basic capital.

The Bank’s actual qualifying “net capital base” and “effective equity” to support the Bank’s risk-weighted assets as of  December 31, 2005 and 2006, are shown in the following table:

   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
             
Net capital base
   
859,975
     
959,757
 
3% of total assets net of provisions
    (402,432 )     (461,315 )
Excess over minimum required equity
   
457,543
     
498,442
 
Net capital base as a percentage of the total assets, net of provisions
    6.4 %     6.2 %
                 
Effective equity
   
1,231,997
     
1,418,752
 
11% of the risk-weighted assets
    (1,051,696 )     (1,234,458 )
Excess over minimum required equity
   
180,301
     
184,294
 
Effective equity as a percentage of the risk-weighted assets
    12.9 %     12.6 %
                 

NOTE 14.
SHAREHOLDERS’ EQUITY

a)    Share capital

As of December 31, 2005 and 2006 the Bank's paid-in capital consisted of 188,446,126,794 authorized issued and outstanding shares with no fixed nominal value.

b)    Dividends

The distributions of dividends related to net income for the periods 2004 and 2005 as approved by the Annual Shareholders' Meeting of Banco Santander Chile, are as follows:

Shareholders
 
Dividend
   
Dividend
   
Dividend
   
Percentage
 
Meeting
 
(historical)
   
Paid
   
per share
   
Paid
 
   
MCh$
   
MCh$
   
Ch$
   
(2)
 
                           
Apr-05
 
198,795
   
210,358
   
1.12
   
100%
 
Apr-06
 
155,811
   
159,114
   
0.84
   
65%
 
 
F-33

 
(1)
Dividend paid has been restated in constant Chilean pesos of December 31, 2006
(2)
% of net income paid as dividend, agreed by the Ordinary Shareholders’ Meeting
 
NOTE 15.
TRANSACTIONS WITH RELATED PARTIES
 
In accordance with the Chilean General Banking Law and the rules of the Superintendency of Banks, related parties are defined as individuals and companies who are directors, officers or shareholders who own more than one percent of the Bank’s shares. Companies in which a director, officer or shareholder of the Bank holds more than a 5% interest and companies that have common directors with the Bank are also considered to be related parties. In the following table, trading or manufacturing companies are defined as operating companies, and companies whose purpose is to hold shares in other companies are defined as holding  companies.
 
a)    Loans granted to related parties

Related party loans, all of which are current, are as follows:

   
As of December 31,
 
   
2005
   
2006
 
   
Loans
   
Collateral Pledged
   
Loans
   
Collateral Pledged
 
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
                         
Operating companies
   
144,539
     
74,356
     
150,070
     
112,986
 
Investment companies
   
299,694
     
67,389
     
203,261
     
3,948
 
Individuals
   
20,665
     
19,286
     
24,450
     
22,343
 
Total
   
464,898
     
161,031
     
377,781
     
139,277
 

(1)
Includes companies whose purpose is to hold shares in other companies.
(2)
Includes debt obligations that are individually equal to or greater than UF 3,000, equivalent to MCh$55 as of December 31, 2006.

The activities in the balances of loans to related parties are as follows:

   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
             
Balance as of January 1,
   
237,148
     
464,898
 
New loans
   
683,231
     
398,477
 
Repayments
    (447,197 )     (492,248 )
Price- level restatements
    (8,284 )    
6,654
 
Balance as of December 31,
   
464,898
     
377,781
 
 
F-34


b)    Other transactions with related parties

During the years ended December 31, 2004, 2005 and 2006, the Bank had the following significant income (expenses) from services provided to (by) related parties:

   
Years ended December 31,
 
   
2004
   
2005
   
2006
 
   
Income/Expense
   
Income/Expense
   
Income/Expense
 
   
MCh$
   
MCh$
   
MCh$
 
                   
Redbanc S.A.
    (3,378 )     (3,615 )     (4,056 )
Transbank S.A.
    (4,770 )     (5,984 )     (8,168 )
Sixtra Chile S.A.
    (46 )     (34 )    
-
 
Santander G.R.C. Ltda.
   
565
      (1,146 )     (1,563 )
Santander Chile Holding S.A.
   
87
     
49
     
32
 
Santander Factoring S.A.
   
55
     
51
     
52
 
Bansa Santander S.A.
    (2,407 )    
1,144
      (2,426 )
A.F.P. Bansander S.A.
   
151
     
155
     
179
 
Altec S.A.
    (5,938 )     (6,644 )     (5,627 )
Santander Investment Chile S.A.
   
90
     
90
     
91
 
Altavida Cia. De Seguros De Vida S.A.
   
6,960
     
69
      (1,005 )
Plaza El Trébol S A
    (112 )     (201 )     (195 )
Other
    (437 )     (304 )     (479 )
                         
   Total
    (9,180 )     (16,370 )     (23,165 )

Article 89 of the Chilean Companies Law requires that the Bank’s transactions with related parties be on a market basis or on terms similar to those customarily prevailing in the market.

NOTE 16.
FEES AND INCOME FROM SERVICES

Fees and income from services and the related expenses are summarized as follows:

   
Year ended December 31,   
 
   
Income   
   
Expenses   
 
 
 
2004
   
2005
   
2006
   
2004
   
2005
   
2006
 
Fees and income from services:
 
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
 
       
 
   
 
         
 
   
 
 
Payment agency services
   
4,187
     
2,881
     
2,671
     
-
     
-
     
-
 
Checking accounts
   
37,201
     
38,939
     
45,734
      (3,973 )     (5,055 )     (4,138 )
Credit cards
   
25,157
     
28,198
     
36,858
      (11,691 )     (14,081 )     (18,208 )
Automatic teller cards
   
21,049
     
22,466
     
24,293
      (8,027 )     (8,607 )     (10,021 )
Letters of credit, guarantees, pledges and other  contingent loans
   
4,828
     
2,816
     
2,522
     
-
     
-
     
-
 
Lines of credit
   
2,172
     
8,826
     
12,422
     
-
      (281 )     (287 )
Underwriting
   
6,322
     
2,383
     
1,345
     
-
     
-
     
-
 
Bank drafts and fund transfers
   
260
     
258
     
624
     
-
     
-
     
-
 
Sales and purchases of foreign currencies
   
5,892
     
7,056
     
6,418
      (621 )     (437 )     (461 )
Insurance brokerage
   
8,994
     
10,787
     
11,833
      (2,206 )     (2,381 )     (436 )
Custody and trust services
   
590
     
704
     
714
     
-
      (53 )     (349 )
Mutual fund services
   
19,087
     
19,275
     
20,067
     
-
     
-
      (28 )
Saving accounts
   
262
     
244
     
253
     
-
     
-
     
-
 
Agreements of administration and collection
   
17,694
     
20,598
     
23,233
     
-
     
-
     
-
 
Stock brokerage
   
1,545
     
1,718
     
1,460
      (129 )     (64 )     (67 )
Other
   
1,058
     
6,237
     
7,879
      (1,647 )     (1,127 )     (1,781 )
                                                 
     Total income (expense)
   
156,298
     
173,386
     
198,326
      (28,294 )     (32,086 )     (35,776 )
 
F-35

 
NOTE 17.
NON-OPERATING INCOME AND EXPENSES

Non-operating income and expenses are set forth below:

   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
Non-operating income:
 
 
   
 
   
 
 
Gain on sale of Bank premises and equipment
   
315
     
321
     
568
 
Gain on sales of assets received in lieu of payment previously charged -off
   
7,039
     
16,970
     
8,050
 
Rental income
   
1,168
     
1,235
     
1,196
 
Recovery of expenses
   
202
     
116
     
27
 
Recovery of previously written-off loans
   
3,498
     
2,637
     
6,250
 
Gain on sale of credit division Santiago Express (1)
   
23,093
     
-
     
-
 
Other
   
259
     
32
     
501
 
          Total non-operating income
   
35,574
     
21,311
     
16,592
 

(1)
On December 6, 2004, the contract regarding the sale of the Bank’s Santiago Express Division to Empresas Almacenes París S.A. was signed. This contract included the sale and transfer of financial assets comprised of loans given by Santiago Express and intangible assets that permit for this Division to continue operating. The final sale price was MCh$ 120,807 that generated a gain of MCh$23,093.

   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
Non-operating expenses:
                 
                   
Charge-offs of assets received in lieu of payment
   
22,150
     
21,532
     
13,616
 
Loss on sales of bank premises and equipment
   
110
     
57
     
5
 
Other
   
17,983
     
22,202
     
7,185
 
    Total non-operating expenses
   
40,243
     
43,791
     
20,806
 

NOTE 18.
DIRECTORS' EXPENSES AND REMUNERATION

The following items were charged to expense for services provided by the members of the Board:
 
 
Years ended December 31,
 
 
2004
 
2005
 
2006
 
 
MCh$
 
MCh$
 
MCh$
 
             
Remuneration established by the General Shareholders’
           
    meeting, including attendance fees
351
 
416
 
489
 
 
F-36

 
NOTE 19.
FOREIGN CURRENCY POSITION

The consolidated balance sheets include assets and liabilities denominated in foreign currencies which have been translated into Chilean pesos at the applicable exchange rates as of December 31, 2005 and 2006, and assets and liabilities which are denominated in Chilean pesos subject to exchange rate fluctuations, as detailed below.

   
As of December 31, 2005
   
As of December 31, 2006
 
   
Denominated in
   
Denominated in
 
   
Foreign
   
Chilean
   
Total
   
Foreign
   
Chilean
   
Total
 
   
currency
   
pesos
   
 
   
currency
   
pesos
   
 
 
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Assets
 
 
   
 
   
 
   
 
   
 
   
 
 
Cash and due from banks
   
944,936
     
-
     
944,936
     
754,732
     
-
     
754,732
 
Financial investments
   
116,889
     
127,311
     
244,200
     
247,073
     
93,240
     
340,313
 
Loans ( including contingent loans )
   
1,073,236
     
22,945
     
1,096,181
     
1,238,139
     
135
     
1,238,274
 
Other assets (*)
   
6,021,790
     
3
     
6,021,793
     
165,133
     
8
     
165,141
 
 
                                               
Total assets
   
8,156,851
     
150,259
     
8,307,110
     
2,405,077
     
93,383
     
2,498,460
 
 
                                               
 
                                               
Liabilities
                                               
Deposits
   
1,208,306
     
465
     
1,208,771
     
1,201,469
     
141
     
1,201,610
 
Contingent liabilities
   
487,404
     
-
     
487,404
     
491,435
     
-
     
491,435
 
Due to domestic bank
   
9,645
     
932
     
10,577
     
27,199
     
761
     
27,960
 
Due to foreign bank
   
1,121,529
     
-
     
1,121,529
     
812,267
     
-
     
812,267
 
Other liabilities (*)
   
5,484,365
     
867
     
5,485,232
     
484,946
     
2
     
484,948
 
 
                                               
Total liabilities
   
8,311,249
     
2,264
     
8,313,513
     
3,017,316
     
904
     
3,018,220
 
Net assets (liabilities) in foreign currency
    (154,398 )    
147,995
      (6,403 )     (612,239 )    
92,479
      (519,760 )

(*)
Regarding with the changes described in Note 2 to the consolidated financial statements, starting on January 1, 2006, the derivative transactions are recorded at fair value which includes the effects of any foreign currency fluctuation as denominated in Chilean pesos, if applicable, therefore, for 2006, they are not included in this note.
 
F-37

 
NOTE 20.
INCOME TAXES

a) Deferred taxes

The Bank records the effects of deferred taxes on its consolidated financial statements in accordance with Technical Bulletin No. 60 and the complementary technical bulletins thereto issued by the Colegio de Contadores de Chile A.G.

As described in that accounting standard, beginning January 1, 1999, the Bank recognized the consolidated tax effects generated by the temporary differences between financial and tax values of assets and liabilities. At the same date, the net deferred tax asset/liability determined was completely offset against a net “complementary” account. Such complementary deferred tax balances are being amortized over the estimated reversal periods corresponding to the underlying temporary differences as of January 1, 1999. In accordance with Technical Bulletin No. 60, deferred tax asset and liability amounts are presented net of the related unamortized complementary account balances in the consolidated balance sheet. Deferred income tax balances were as follows:
 
   
Deferred taxes as of
 
   
December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
Assets
           
Interest and indexation for tax purposes
   
6,568
     
6,204
 
Assets received in lieu of payment
   
1,629
     
1,410
 
Foreign exchange
   
774
     
768
 
Allowance for loan losses
   
16,534
     
21,230
 
Other provisions
   
10,929
     
11,202
 
Forward contracts
   
1,010
      (497 )
Leasing assets
   
8,628
     
5,076
 
Other
   
18
     
60
 
Total
   
46,090
     
45,453
 
                 
Liabilities
               
Valuation of investments
   
22
      (2,129 )
Deferred expenses
    (1,536 )     (1,945 )
Other
    (3,895 )     (4,363 )
Total
    (5,409 )     (8,437 )
Net difference
   
40,681
     
37,016
 

b) Income tax expense for the year ended December 31, 2004, 2005 and 2006 was as follows:
 
   
Year ended December 31,
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
Amortization of deferred tax complementary account
   
80
      (27 )    
-
 
Deferred tax benefit (expense) for the year
   
12,905
      (4,830 )     (2,820 )
Net benefit (charge) to deferred taxes
   
12,985
      (4,857 )     (2,820 )
Income tax provision – current
    (59,932 )     (45,725 )     (55,278 )
Other taxes
    (1,640 )     (303 )     (101 )
Income tax expense
    (48,587 )     (50,885 )     (58,199 )
 
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NOTE 21.
CONTINGENCIES AND COMMITMENTS

a)    Committed resources:
 
At December 31, 2005, the Bank placed a lien on financial investments for approximately MCh$44,861 (UF 2,446,570), on guaranties associated with business operations, which at year-end have not been set up.

b)    Contingencies:

On August 28, 1996, Banco Español de Crédito filed a complaint against Auca Forestal S.A. and O’Higgins Corredores de Bolsa Ltda. (currently Santiago Corredores de Bolsa Ltda.). The Bank’s management and its legal counsel, believe that the resolution of this contingency is not likely to result in significant losses to the subsidiary.  As of December 31, 2006, the subsidiary maintained a provision of MCh$271 which covers this contingency.

As of December 31, 2005 and 2006, the subsidiary Santiago Leasing S.A. leased property with deferred customs duties. The subsidiary may eventually have to pay such duties, amounting to MUS$72 and MUS$10, respectively, on behalf of the leaseholder, if not paid by the latter. Leased assets subject to deferred custom duties amounts to MCh$55.5 as of December 31, 2006 (MCh$56.0. in 2005).

On August 26, 1992, a suit was filed by the Chilean Internal Revenue Service against the Bank and is still pending.  The Appeals Court partially resolved in favor of Banco Santander Chile and substantially reduced the amount of the tax difference.  In the opinion of our legal advisors, these claims are not likely to have, in the aggregate, a material adverse effect on our consolidated financial condition or results of operations and as of December 31, 2006 the Bank maintained a provision of Ch$530 million, which covers the totality of this claim.

In addition, we are subject to certain claims and are party to certain legal and arbitration proceedings incidental to the normal course of our business including claims for alleged operational errors.  We do not believe that the liabilities related to such claims and proceedings are likely to have, in the aggregate, a material adverse effect on our consolidated financial condition or results of operations, however, based on management individual analysis of each proceeding, we have provisioned the amount in “Provisions for lawsuit and other” in Note 10 (b).

The subsidiary Santander S.A. Agente de Valores (the “Agent”), maintains a claim for indemnity of losses named “Orsini con Orsini y Otros”, Rol N°1452-2000, before the 28° Civil Court of Santiago. The final sentence in first instance, dated December 18, 2001, was unfavorable for the Agent; therefore it filed an annulment action against the judicial decision, and an appeal. On November 4, 2005, the Court of Appeals rejected the annulment action against the judicial decision, however it accepted the appeal filed by the Agent, repealing the first instance sentence and rejecting the claim filed against Santander  S.A. Agente de Valores. The defendant filed, before the Supreme Court, an annulment action against the judicial decision, which is in process.  This legal contingency has not been provisioned as the amount of the claim cannot be estimated at this time.

There are no material proceedings in which any of our directors, any members of our senior management, or any of our affiliates is either a party adverse to us or our subsidiaries or has a material interest adverse to us or our subsidiaries.

F-39


As a result of the fraud committed by Grupo Inverlink against the Corporación de Fomento de la Producción (CORFO) and others, various legal measures were taken against certain instruments administered by Santander S.A. Administradora General de Fondos. On March 13, 2003 this Company assumed the obligation to return to CORFO the amount of these instruments if ordered by a court to do so. As of December 31, 2006 and in accordance with our legal advisors we do not believe any type of provisions is necessary given the current state of this legal proceeding.

c)    Guarantees from operations:

In order to ensure the correct and full compliance of all its obligations as Securities Agent, in conformity with article No 30, and subsequent articles of Law 18.045 on the Securities Market, the subsidiary Santander S.A. Agente de Valores established a guaranty for UF 4,000 for insurance policy N° 206112564, underwritten by Compañía de Seguros de Crédito Continental S.A. whose maturity is December 19, 2007.

In order to comply with Article 30 of Law No. 18,045, Santiago Corredores de Bolsa Ltda. maintains in custody with the Bolsa de Comercio de Santiago a guarantee of their performance worth Ch$440.2 million that expires on October 31, 2007.

Additionally, Santiago Corredores de Bolsa Ltda. has a  guarantee with the Bolsa de Comercio de Santiago in the amount of Ch$961.3 million in fixed income instruments in order to be able to participate in the Compensation and Liquidation system of this stock Exchange.

In conformity with the General Character Regulation N°125, the subsidiary Santander Santiago S.A. Administradora General de Fondos designated the Bank as the representative of the benefits of guarantees set up per each of its funds administered for UF 1,187,863.12. In addition to these bank guarantees, other guarantees were entered into for approximately Ch$ 117,525.9 millions for the Mutual Funds’ guaranteed profitability.

Integral Insurance:

In conformity with a resolution of the Board of Directors of the la Bolsa de Comercio de Santiago in a resolution dated November 1997, Santiago Corredores de Bolsa Ltda. has contracted an insurance policy with the Compañía de Seguros Generales la Interamericana, that covers matters such as: employee fraud, document loss, falsification or modification of documents and counterfeit documents for an amount of US$ 50 million. This policy expires on June 30, 2007.

In accordance with Circular No. 1,160 of the Superintendencia de Valores y Seguros, Santander Santiago Corredora de Seguros Ltda. maintains an insurance policy in order to fulfill all obligations in connection with its obligations as a broker of insurance polcies. This insurance policy was taken with Compañía de Seguros Chilena Consolidada S.A. in an amount equal to UF 60,000 and that covers the period between April 15, 2006 and April 14, 2007.
 
F-40

 
NOTE 22.
FIDUCIARY ACTIVITIES

The following items are recorded in memorandum accounts by the Bank and represent fiduciary safekeeping and custody services:

   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
             
Securities held in safe custody
   
9,407,155
     
11,196,514
 
Amount to be collected on behalf of local third parties
   
129,018
     
115,682
 
Amount to be collected on behalf of foreign third parties
   
205,746
     
201,873
 
Total
   
9,741,919
     
11,514,069
 
 
NOTE 23.
PRICE-LEVEL RESTATEMENT
 
The price-level restatement loss is determined by restating the following non-monetary assets, liabilities and equity:
 
   
Years ended December 31,       
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
Restatement of non monetary accounts based on Consumer Price Index:
                 
Bank premises and equipment, net
   
5,536
     
9,151
     
4,765
 
Investments in other companies
   
90
     
354
     
170
 
Other non-monetary assets and liabilities
   
2,721
     
2,248
     
1,612
 
Shareholders' equity
    (21,027 )     (30,277 )     (20,329 )
Loss from price-level restatement, net
    (12,680 )     (18,524 )     (13,782 )
 
NOTE 24.
SALES AND PURCHASE OF LOANS
 
From time to time, the bank sells and purchases loans based on specific requirements from customers.  During the years ended December 31, 2004, 2005 and 2006, the Bank sold loans in the amount of MCh$164,727, MCh$93,492 and MCh$185,690, respectively; however, the Bank does not enter into loans for future sale. During the years ended December 31, 2004, 2005 and 2006, the Bank purchased loans totaling MCh$28,536, MCh$22,744 and MCh$26,367 respectively. Any gains or losses on such transactions are recognized in results of operations at the time of the transactions.

The aggregate gains (losses) on sales of loans were MCh$23,093, MCh$631 and MCh$1,718 for the years ended December 31, 2004, 2005 and 2006, respectively.
 
F-41

NOTE 25.
SUBSEQUENT EVENTS

In conformity with the established in Articles 9 and 10 of Law No. 18,045 and Chapter 18-10 of the Recopilación Actualizada de Normas de la Superintendencia  de Bancos e Instituciones Financieras, in the Extraordinary Shareholders’ Meeting held on January 15, 2007 by Santander Investment S.A. Corredores de Bolsa, a related company to Banco Santander Chile, approved the merger between Santiago Corredores de Bolsa Ltda, a subsidiary of Banco Santander Chile, into  Santander Investment S.A. Corredores de Bolsa, effective January 1, 2007.  Santander Investment S.A. Corredores de Bolsa, as of January 15, 2007, became a subsidiary of Banco Santander Chile and the legal successor of Santiago Corredores de Bolsa Ltda.
 
In January 2007, it was announced that management plans that each active employee of Santander in June 2007 will be given 100 free shares in Banco Santander Central Hispano S.A. to mark the 150th anniversary of Santander.
 
Between December 31, 2006 and the date of these financial statements, no other significant subsequent event exists that could materially affect these financial statements.

NOTE 26.
DIFFERENCES BETWEEN CHILEAN AND UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

The following is a description of the significant differences between accounting principles generally accepted in Chile and accounting principles of the Superintendency of Banks (collectively, “Chilean GAAP”), and accounting principles generally accepted in the United States (“U.S. GAAP”).

References below to “SFAS” are to United States Statements of Financial Accounting Standards. Pursuant to Chilean GAAP, the Bank’s consolidated financial statements recognize certain effects of inflation.

The cumulative inflation rate in Chile as measured by the CPI for the three years period ended December, 2006 was approximately 8.45%. Chilean GAAP requires that financial statements of banks be restated to reflect the total effect of the loss in the purchasing power of the Chilean peso on the financial position and results of operations of reporting entity. The method, described in Note 1 (c), is based on a model which enables calculation of net inflation gains or losses caused by monetary assets and liabilities exposed to changes in the purchasing power of local currency, by restating all non-monetary accounts in the financial statements. The model prescribes that the historical cost of such accounts be restated for general price-level changes between the date of origin of each item and the end of the period.  As permitted under Item 18 of Form 20-F of SEC Regulation S-X no adjustments have been made to reflect the elimination of price-level adjustments.

(a)
Business Combinations

          (1)
Under Chile GAAP, business combinations accounted for under the purchase accounting method do not require the pushdown of the associated goodwill to the acquired entity. Furthermore, prior to January 1, 2004, assets acquired and liabilities assumed were recorded at their carrying value upon acquisition with the excess of the purchase price over the carrying value recorded as goodwil1.  Additionally, “pooling of interests” treatment may be more widely applied than under U.S. GAAP.
   
  Under U.S. GAAP, when following the purchase accounting method, pushdown accounting to the acquired entity is required when certain conditions are met. Also, under U.S. GAAP, purchase accounting requires that the fair value of the assets acquired and the liabilities assumed be recorded with the excess of the purchase price over such fair values recorded as goodwill.
 
F-42


 
The following business combinations of the holding companies of the Bank were accounted for as follows thereby generating the differences noted in the Chile GAAP to U.S. GAAP reconci1iations of net income and shareholders' equity:

On April 17, 1999, Banco Centra1 Hispanoamericano S.A. (“BCH”) merged into Banco Santander S.A. to create Banco Santander Central Hispano (“BSCH”).  For Chile GAAP purposes, the merger was accounted for as a “pooling of interests”.  For U.S. GAAP purposes, purchase accounting was applied.  Prior to Apri1 17, 1999, BCH indirectly held a 21.75% investment in Banco Santiago (a predecessor entity to the Bank) through a 50% participation in Teatinos Siglo XXI (“Teatinos”). At the time, the other 50% of Teatinos was owned by Quiñenco S.A. (“Quiñenco”). A minority interest of approximately 35.5% was held by the Central Bank of Chile.

On May 3, 1999, BSCH purchased the 50% of Teatinos that it did not already own from Quiñenco.  Purchase accounting was applied under both Chile GAAP and U.S. GAAP.

On May 17, 1999 the Central Bank and BSCH announced they had entered into an agreement regarding the disposition  of their respective shares of Santiago.  Under this agreement, the Central Bank has an irrevocable put option to sell to BSCH its Santitago shares in the two years, period beginning  May 15, 2000.

The total goodwi1l and other fair value accounting adjustments generated under U.S. GAAP were pushed down to the level of the predecessor entities to the Bank books. Fair value amounts recorded for assets acquired and liabi1ities assumed under U.S. GAAP were recorded at carrying value on the Chile GAAP books.
   
          (2)
Under Chi1ean GAAP, mergers of common control entities are recorded under the "pooling of interests" method. Should the minority interest be bought out, purchase accounting is not applied to that percentage. Additionally, historical financial statements for periods prior to the merger are not restated under the “as if” pooling of interests methodology.
   
 
Under U.S. GAAP, mergers of common control entities are also recorded under the "pooling of interests" method.  However, under U.S. GAAP, in certain circumstances, the step acquisition of a minority interest would be required to be accounted for under purchase accounting (which step acquisition goodwill would also require "pushdown" as mentioned in (1)).  Additionally, U.S. GAAP requires the restatement of prior period financial statements under the “as if” pooling of interests methodology.

The following transactions were structured such that they generated the above differences resulting in adjustments in the Bank's Chile GAAP to U.S. GAAP reconciliations of net income and shareholders' equity:

On Apri1 22, 2002, the Central Bank, under the agreement described above sold its remaining 35.44% participation in Banco Santiago to Teatinos, the primary shareholder of the former Banco Santander-Chile and a wholly owned subsidiary of BSCH.
 
F-43

 
On August 1, 2002, Banco Santiago and the former Banco Santander-Chile (predecessor entity to the Bank) merged.  To effect the merger, the minority interest of 11% of Banco Santander-Chile was bought out through the issuance of former Banco Santiago shares (as Banco Santiago was considered the acquirer).  As a resu1t of the merger between the former Banco Santiago and the former Banco Santander-Chi1e, the former Banco Santiago issued 89,511,910,227 shares in exchange for all the outstanding common shares of the former Banco Santander-Chi1e using an exchange ratio of 3.55366329 for each former Banco Santander-Chile share.

The Bank did not record deferred taxes under either Chile GAAP or U.S. GAAP on any goodwill or intangible asset acquired as the result of the acquisition as these items do not generate temporary differences as defined in either Chile GAAP nor U.S. GAAP accounting pronouncements.
 
(b)
Amortization of Goodwill and Intangible Asset

The Bank adopted Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets”, (“SFAS 142”) as of January 1, 2002. SFAS 142 applies to all goodwill and identified intangible assets acquired in a business combination. Under the new standard, beginning January 1, 2002, all goodwill, including that acquired before initial application of the standard, and indefinite-lived intangible assets are not amortized, but must be tested for impairment at least annually. The Bank has not amortized any U.S. GAAP goodwill since the provisions of SFAS N°142, became effective. As the Bank has performed the annual impairment tests of goodwill and intangible assets with indefinite lives as required by the standard, which did not result in any impairment.

Additionally, the Bank has evaluated the remaining useful life of their intangible assets, that are not being amortized in each reporting period in other to determine whether events and circumstances continue to support an indefinite useful life.
During 2006, the Bank decided to change the strategy related to the use of its brand name by encouraging the use of Banco Santander and phasing out the Banco Santander - Santiago. The Bank has started to amortize the Santiago brand name pushed down to it as part of Teatino’s acquisition of the former Banco Santiago over a period of 5 years using a straight line amortization method.

(c)
Income taxes

Under Chilean GAAP, prior to 1999, the Bank did not record the effects of deferred income taxes. Effective January 1, 1999, and in accordance with the new accounting standard under Chilean GAAP (Technical Bulletin No. 60), the Bank was required to record the effects of deferred tax assets and liabilities based on the liability method, with deferred tax assets and liabilities established for temporary differences between the financial reporting basis and the tax basis of the Bank’s assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized. As a transitional provision to reduce the impact of adoption of this standard, the Bank was permitted to record a contra ("complementary") asset or liability as of the date of implementation of the new accounting standard, i.e. January 1, 1999, related to the effects of deferred income taxes from prior years. These complementary assets and liabilities are to be amortized over the average estimated period of reversal of the temporary differences which generate the future income tax asset or liability.

At the end of 2005, these complementary accounts were fully amortized.

F-44


Under SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”), income taxes are recognized using the balance sheet method (since 1999) in a manner similar to Chilean GAAP, however U.S. GAAP did not adopt transitional provisions equivalent to the “complementary accounts” mentioned in the previous paragraph, but instead, flowed any adoption effects directly through the income statements in “Cumulative Effect of a Change in Accounting Principle”.

The effects of elimination of the complementary assets and liabilities and their respective amortization as well as effects of recording deferred income taxes on U.S. GAAP adjustments are included in the reconciliation of consolidated net income and shareholders’ equity in paragraph (t) below. Additional disclosures required under SFAS 109 are further described in paragraph (w) below.

(d)
Mandatory dividends

As required by Chilean General Banking Law, unless otherwise decided by a two-thirds vote of the issued and subscribed shares, the Bank must distribute a cash dividend in an amount equal to at least 30% of its net income for each year as determined in accordance with Chilean GAAP, and record that dividend against retained earnings or current year income in shareholders’ equity when it has been approved by the Annual Shareholders’ meeting subsequent to year-end unless a higher legally binding commitment to distribute dividends exists, or unless and except to the extent the Bank has unabsorbed prior year losses.  Under the provisions issued by the AICPA International Practice Task Force, such mandatory dividends, as of the year end reporting date, represent and are reported as “temporary equity”.  However, when, as allowed by regulation, actions of shareholders are taken prior to the date of financial statement issuance, evidencing that such minimum dividend will not be fully distributed, the reclassification of such dividend may be limited to such lesser amount authorized by shareholder ratification. The effect of recording mandatory dividends in accordance with U.S. GAAP is included in the reconciliation of net income and shareholders’ equity in paragraph (t) below.

(e)
Interest income recognition on non-accrual loans

Under Chilean GAAP the Bank suspends the accrual of interest on loans when it is determined to be a loss or when it becomes past due.  Previously accrued but uncollected interest on overdue loans is not reversed at the time the loan ceases to accrue interest.  Under U.S. GAAP, recognition of interest on loans is generally discontinued when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due. As a general practice, this occurs when loans are 90 days or more overdue.  Any accrued but uncollected interest is reversed against interest income at that time.

In addition, under Chilean GAAP, any payment received on overdue loans is treated as income to the extent of interest earned but not recorded, after reducing any recorded accrued interest receivable. Any remaining amount is then applied to reduce the outstanding principal balance. Under U.S. GAAP, any payment received on loans when the collectibility of the principal is in doubt is treated as a reduction of the outstanding principal balance of the loan until such doubt is removed. The effect of the difference in interest recognition on non accrual loans is considered not material to the Bank’s financial position and results of its operations.

F-45


(f)
Repurchase agreements

The Bank enters into repurchase agreements as a source of financing. In this regard, until 2005, the Bank’s investments which are sold subject to repurchase agreements were reclassified from their investment category to “investment collateral under agreements to repurchase”. Under U.S. GAAP, no such reclassification would be made, since, in substance, the investment securities serve only as collateral for the borrowing. For purposes of presentation of balance sheet in accordance with U.S. GAAP and in format required by the Securities and Exchange Commission under rules 210.9 to 210.9-07 of Regulation S-X (“Article 9”), which is included in paragraph (v) to this note, investments which collateralize such borrowings are shown in their investment category.

As is described in Note 2, under the new rules established by Circular Nº 3,345 and related amendments, starting January 1, 2006, the new accounting criteria do not differ significantly  from U.S. GAAP, SFAS No. 115.

(g)
Contingent assets and liabilities

In accordance with Chilean GAAP, the Bank recognizes rights and obligations with respect to contingent loans as contingent assets and liabilities.  Contingent liabilities consist of open, unused and standby letters of credit, together with guarantees by the Bank in Chilean peso, UF and foreign currencies (principally US dollars). The liabilities represent the Bank’s obligations under such agreements. Under U.S. GAAP, such contingent amounts are not recognized on the consolidated balance sheets, however, they are disclosed. The reclassification to eliminate the contingent assets against the contingent liabilities recorded under Chile GAAP has been included in the balance sheets Article 9 in paragraph (v) below.

Within contingent assets and liabilities the Bank includes financial guarantees. Disclosures required in accordance with FIN 45 “Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” are included in paragraph (ab) below. For neither contingencies nor guarantees is there recorded an adjustment to the U.S. GAAP reconciliation of net income or shareholders’ equity, as none met the requirements for recognition in the income statements.

(h)
Investment securities

Under U.S. GAAP, SFAS N°115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”) requires that debt and equity securities be classified in accordance with the Bank’s intent and ability to hold the security, as follows:

·
Debt securities for which the Bank has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and are reported at amortized cost.  As of December 31, 2005 and 2006 the Bank did not classify any security as held-to-maturity.

·
Debt and equity securities that are bought and held by the Bank, principally for the purpose of selling them in the near term, are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings.

·
Debt and equity securities not classified as either held–to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders’ equity.
 
F-46


SFAS N° 115 established that in the case of foreign-currency-denominated available-for-sale debt securities, the change in fair value expresses in an entity’s functional currency is the total of the changes in market price of the security as expressed in the local currency due to factors such as changes in interest rates and credit risk and the change in the exchange rate between the local currency and the instruments denominated currency.  EITF 96-15 established that the entire change in the fair value of   foreign-currency-denominated available-for-sale debt securities should be reported in stockholders’ equity.

Until 2005, under Chilean GAAP the Bank classifies its financial investments as “trading” or “permanent”(see Note 1). Financial investments held by the Bank with a secondary market are stated at fair market value with unrealized gains and losses included in a separate component of shareholders’ equity for those classified as permanent and with unrealized gains and losses included in other operating results for those classified as trading which all realized gains and losses flow through income. All other financial investments are carried at acquisition cost plus accrued interest and UF indexation adjustments. Investment securities maintained by the Bank’s subsidiaries were carried at the lower of price-level restated cost or market value. Additionally, during 2001 the former Banco Santander-Chile received permission from the Superintendency of Banks to record at amortized cost (i.e. not adjusted to market value) a portion of its portfolio of Chilean Government securities, which are hedged by specific interest rate swap agreements. During 2005, the aforementioned portfolio of Chilean government securities was completely amortized. Similarly, under Chilean GAAP, interest rate swap agreements were not recorded at fair value (see paragraph (m) below).

As of December 31, 2005, under Chilean GAAP, the unrealized holding gains (losses) related to investments classified as permanent have been included in equity, which does not differ from the treatment “available-for-sale” under U.S. GAAP. Similarly “trading” securities accounting treatment did not differ from “trading” securities treatment under U.S. GAAP.

As is described in Note 2, on December 20, 2005 the Superintendency of Banks issued Circular No. 3,345 and related amendments, requiring the application of new accounting principles and valuation criteria for financial instruments acquired for trading  or investment (available-for-sale or held to maturity), derivative instruments, accounting hedges and write-offs of  financial assets in the balance sheet. Starting January 1, 2006, the Bank classifies their financial investments in accordance with the Bank’s intent and ability to hold the security, as trading, available for sale or held to maturity. The new accounting principles and valuation criteria do not differ significantly from U.S. GAAP, SFAS No 115. The accounting criteria followed by the Bank’s subsidiaries on a standalone basis have not been changed, however, under the new rules established by Circular No. 3,345, for consolidated purposes, the Bank was required to perform all the necessary adjustments at the consolidation level to conform with the requirements of Circular No. 3,345.

Based upon the criteria described above and for presentation purposes, the Bank reclassified its portfolio of investments in debt and equity securities to “available-for-sale” or “trading”.

Prior to January 1, 2006, the adjustment to U.S. GAAP represents the foreign exchange difference on available-for-sale securities which, under EITF 96-15, is recorded in Shareholders equity. For the year ended December 31, 2006, the cumulative effect of prior year differences reversed.

F-47


The following are required disclosures for investments classified as available-for-sale in accordance with SFAS 115 and based on Article 9 balance sheet under U.S. GAAP. Realized gains and losses are determined using the proceeds from sales less the cost (specific identification method) of the investments identified to be sold.  Additionally, any unrealized gain/loss previously recorded in equity for these investments is reversed through the income statements.  Gross gains and losses realized on the sale of available-for-sale securities for the years ended as of December 31, 2004, 2005 and 2006 are as follows:

   
Years ended December 31,
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
Proceeds from sales of “available-for-sale” securities generating realized gains
   
996,264
     
679,622
     
590,057
 
Realized gains
   
23,556
     
7,611
     
9,085
 
Proceeds from sales of “available-for-sale” securities generating realized losses
   
269,511
     
315,509
     
216,802
 
Realized losses
   
1,752
     
2,553
     
3,877
 

(i)           Other than temporary impairment of available for sale securities

Until 2005 under Chilean GAAP the Bank was not required to evaluate if marketable securities were considered to be other than temporarily impaired.  As is described in Note 2, starting January 1, 2006, under Chilean GAAP, the evaluation of marketable securities considered to be other than temporarily impaired is required, if the decline in fair value is judged to be other than temporary. In such circumstances, the cost basis of the security is written down to fair value and the amount written down is charged against income.  The impairment is not considered as having established a new cost basis for the security and therefore, under certain conditions, recovery up to the extent of the initial cost basis may be recorded. Additionally, Chile GAAP does not require the inclusion of foreign exchange differences to be included in the unrealized gains/loss on available-for-sale securities in equity. The portion related to foreign exchange gain (loss) is recorded directly in income.

Under U.S. GAAP, SFAS 115 requires that the Bank determine whether  individual securities classified as available for sale have been impaired on an other than temporary basis.  If the decline in value is judged to be other than temporary, the cost basis of the individual security is written down to  a new cost basis and the amount by which it is   written down is included in earnings (that is, accounted for as a realized loss).  The new cost basis does not change when subsequent recoveries in fair value occur.  Subsequent increases in the fair value of available for sale securities are included in other comprehensive income and subsequent decreases in fair value, if not other than  temporary ,  are also included in the other comprehensive income.

The bank reviewed its portfolio as of December 31, 2005 and concluded that there was no other than temporary impairment as of this date. This review consisted of evaluating the economic reasons for any  declines, credit rating of the issuers of the securities and management’s intention and ability to hold the securities until the unrealized loss is recovered. At December 31, 2005, based on this analysis, the Bank believed that there were  no other than temporary impairments in its  investment portfolio because most of the decline in fair value of these securities were caused by the appreciation of the Chilean Peso in relation to the U.S. Dollar which the Bank considered to be temporary. Most of the securities that have unrealized losses as of December 31, 2005 had been in a continuous unrealized loss position for less than one year.

F-48


As of December 31, 2006 the Bank considered that the continued devaluation of the U.S. Dollar relative to the Chilean Peso was an indication of other-than temporary impairment. As a result, an impairment of MCh$4,954 as of June 30, 2006 an additional MCh$634 as of December 31, 2006 for U.S. GAAP purposes was recognized for unrealized losses related to U.S. Dollar denominated debt securities classified as available for sale. The effect of other than temporary impairment of available for sale securities is included in the reconciliation of consolidated net income paragraph (t) below.

The bank reviewed the remaining portfolio as of December 31, 2006 and concluded that there was no other than temporary impairment as of this date. This review consisted of evaluating the economic reasons for any  declines, credit rating of the issuers of the securities and management’s intention and ability to hold the securities until the unrealized loss is recovered. At December 31, 2006, based on this analysis, the Bank believed that there were  no other than temporary impairments in its  investment portfolio because most of the decline in fair value of these securities were caused by market condition which the Bank considered to be temporary. Most of the securities that have unrealized losses as of December 31, 2006 had been in a continuous unrealized loss position for less than one year.

The carrying value and market value of securities available-for-sale as of December 31, 2004, 2005 and 2006 are as follows:

Available-for-Sale Investments 2006
 
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses (1) (2)
   
Estimated
Fair Value
 
Central Bank and Government Securities
 
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Central Bank Securities
   
77,694
     
123
      (79 )    
77,738
 
Chilean Treasury bonds
   
625
     
-
      (2 )    
623
 
Others Securities
   
18,518
     
106
      (93 )    
18,531
 
Subtotal
   
96,837
     
229
      (174 )    
96,892
 
Others Financial Securities
                               
Mortgage finance Bonds
   
223,215
     
964
      (1,507 )    
222,672
 
Others Foreign Securities
   
26,222
     
-
      (678 )    
25,544
 
Subtotal
   
249,437
     
964
      (2,185 )    
248,216
 
Total
   
346,274
     
1,193
      (2,359 )    
345,108
 

Available-for-Sale Investments 2005
 
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses (1)
   
Estimated
Fair Value
 
Central Bank and Government Securities
 
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Central Bank Securities
   
86,720
     
370
      (977 )    
86,113
 
Chilean Treasury bonds
   
1,227
     
4
      (4 )    
1,227
 
Others Securities
   
33,994
     
701
      (201 )    
34,494
 
Subtotal
   
121,941
     
1,075
      (1,182 )    
121,834
 
Others Financial Securities
                               
Mortgage finance Bonds
   
442,250
     
334
      (18,613 )    
423,971
 
Others Foreign Securities
   
29,674
     
-
      (451 )    
29,223
 
Subtotal
   
471,924
     
334
      (19,064 )    
453,194
 
Total
   
593,865
     
1,409
      (20,246 )    
575,028
 

F-49


 
Available-for-Sale Investments 2004
 
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses (1)
   
Estimated
Fair Value
 
Central Bank and Government Securities
 
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Central Bank Securities
   
118,734
     
965
      (222 )    
119,477
 
Chilean Treasury bonds
   
164,044
     
6,309
      (34 )    
170,319
 
Others Securities
   
-
     
-
     
-
     
-
 
Subtotal
   
282,778
     
7,274
      (256 )    
289,796
 
Others Financial Securities
                               
Mortgage finance Bonds
   
51,958
     
314
      (257 )    
52,015
 
Chilean Financial Institutions Bonds
   
118,793
     
674
      (901 )    
118,566
 
Chilean Corporate Bonds
   
76,578
     
113
      (452 )    
76,239
 
Others Foreign Securities
   
50,390
     
456
      (477 )    
50,369
 
Subtotal
   
297,719
     
1,557
      (2,087 )    
297,189
 
Total
   
580,497
     
8,831
      (2,343 )    
586,985
 

(1)
Investments with unrealized losses are disclosed and segregated in accordance with paragraph 21 of EITF 03-01. Such unrealized losses were caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment.
(2)
During 2006, as was described in paragraph above the Bank determined that certain of its foreign-currency-denominated available-for-sale debt securities had declines in value that were considered other than temporary, recording a charge to net income of MCh$5,588 to record these securities at their market values at that date. Future unrealized gains or losses will be recorded in other comprehensive income consistent with the accounting treatment for available-for-sale securities.

The following table shows the unrealized loss position of the available-for-sale investments as of December 31, 2006 and 2005.

   
Less than 12 months
   
12 months or more
   
Total
Available for sale Investments
 
Amortized
cost
   
Fair value
   
Unrealized
losses
   
Amortized
cost
 
Fair value
   
Unrealized
losses
   
Amortized
cost
   
Fair value
   
Unrealized
losses
 
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Central Bank and Government Securities
                                                   
Central Bank Securities
   
20,505
     
20,427
      (78 )    
-
   
-
     
-
     
20,505
     
20,427
      (78 )
Chilean Treasury Bonds
   
625
     
623
      (2 )    
-
   
-
     
-
     
625
     
623
      (2 )
Other Securities
   
14,114
     
14,021
      (94 )    
-
   
-
     
-
     
14,114
     
14,021
      (94 )
Subtotal
   
35,244
     
35,070
      (174 )    
-
   
-
     
-
     
35,244
     
35,070
      (174 )
                                                                       
Others Financial Securities
                                                                     
Time deposits in Chilean Financial Institutions
   
-
     
-
     
-
     
-
   
-
     
-
     
-
     
-
     
-
 
Mortgage Finance  Bonds
   
130,308
     
128,801
      (1,507 )    
-
   
-
     
-
     
130,308
     
128,801
      (1,507 )
Chilean financial Institutions Bonds
   
-
     
-
     
-
     
-
   
-
     
-
     
-
     
-
     
-
 
Chilean Corporate Bonds
   
-
     
-
     
-
     
-
   
-
     
-
     
-
     
-
     
-
 
Chilean Others Securities
   
-
     
-
     
-
     
-
   
-
     
-
     
-
     
-
     
-
 
Central Bank and Government Foreign
   
-
     
-
     
-
     
-
   
-
     
-
     
-
     
-
     
-
 
Others Foreign Securities
   
26,222
     
25,544
      (678 )    
-
   
-
     
-
     
26,222
     
25,544
      (678 )
Subtotal
   
156,530
     
154,345
      (2,185 )    
-
   
-
     
-
     
156,530
     
154,345
      (2,185 )
Total
   
191,774
     
189,415
      (2,359 )    
-
   
-
     
-
     
191,774
     
189,415
      (2,359 )

F-50


   
Less than 12 months
   
12 months or more
   
Total
 
Available for sale Investments
 
Amortized
cost
   
Fair value
   
Unrealized
losses
   
Amortized
cost
   
Fair value
   
Unrealized
losses
   
Amortized
cost
   
Fair value
   
Unrealized
losses
 
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Central Bank and Government Securities
                                                     
Central Bank Securities
   
68,624
     
67,647
      (977 )    
18
     
18
     
-
     
68,642
     
67,665
      (977 )
Chilean Treasury Bonds
   
12,398
     
12,193
      (205 )    
110
     
110
     
-
     
12,508
     
12,303
      (205 )
Other Securities
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Subtotal
   
81,022
     
79,840
      (1,182 )    
128
     
128
     
-
     
81,150
     
79,968
      (1,182 )
                                                                         
Others Financial Securities
                                                                       
Time deposits in Chilean Financial Institutions
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Mortgage Finance  Bonds
   
411,610
     
393,022
      (18,588 )    
570
     
545
      (25 )    
412,180
     
393,567
      (18,613 )
Chilean financial Institutions Bonds
   
-
     
-
     
-
     
-
     
-
             
-
     
-
     
-
 
Chilean Corporate Bonds
   
-
     
-
     
-
     
-
     
-
             
-
     
-
     
-
 
Chilean Others Securities
   
-
     
-
     
-
     
-
     
-
             
-
     
-
     
-
 
Central Bank and Government Foreign
   
-
     
-
     
-
     
-
     
-
             
-
     
-
     
-
 
Others Foreign Securities
   
-
     
-
     
-
     
26,118
     
25,667
      (451 )    
26,118
     
25,667
      (451 )
Subtotal
   
411,610
     
393,022
      (18,588 )    
26,688
     
26,212
      (476 )    
438,298
     
419,234
      (19,064 )
Total
   
492,632
     
472,862
      (19,770 )    
26,816
     
26,340
      (476 )    
519,448
     
499,202
      (20,246 )

(j) Contractual maturities and other disclosures

The contractual maturities of securities classified by the Bank as available-for-sale are as follows:

   
As of December 31, 2006
 
Available-for-Sale Investments:
 
Within one
year
   
After one year
but within
five years
   
After five years
but within
ten years
   
After ten
years
   
Total
 
   
(in millions of constant Ch$ of December 31, 2006)
 
Central Bank and Government Securities
                             
Central Bank Securities
   
21,187
     
55,849
     
702
     
-
     
77,738
 
Chilean Treasury bonds
   
623
     
-
     
-
     
-
     
623
 
Others Securities
   
8,538
     
8,056
     
1,197
     
740
     
18,531
 
Total
   
30,348
     
63,905
     
1,899
     
740
     
96,892
 
Others Financial Securities
                                       
Mortgage Finance Bonds
   
173
     
2,030
     
16,860
     
203,609
     
222,672
 
Chilean Financial Institutions Bonds
   
-
     
-
     
-
     
-
     
-
 
Chilean Corporate Bonds
   
-
     
-
     
-
     
-
     
-
 
Chilean Others Securities
   
-
     
-
     
-
     
-
     
-
 
Central Bank and Government Foreign Securities
   
-
     
-
     
-
     
-
     
-
 
Others Foreign Securities
   
14,557
     
-
     
10,987
     
-
     
25,544
 
Subtotal
   
14,730
     
2,030
     
27,847
     
203,609
     
248,216
 
Total
   
45,078
     
65,935
     
29,746
     
204,349
     
345,108
 


F-51



   
As of December 31, 2005
 
Available-for-Sale Investments:
 
Within one
year
   
After one year
but within
five years
   
After five years
but within
ten years
   
After ten
years
   
Total
 
   
(in millions of constant Ch$ of December 31, 2005)
 
Central Bank and Government Securities
                             
Central Bank Securities
   
13,246
     
51,821
     
21,016
     
30
     
86,113
 
Chilean Treasury bonds
   
5,192
     
15,188
     
13,689
     
1,609
     
35,678
 
Others Securities
   
-
     
-
     
-
     
-
     
-
 
Total
   
18,438
     
67,009
     
34,705
     
1,639
     
121,791
 
Others Financial Securities
                                       
Mortgage Finance Bonds
   
-
     
-
     
-
     
-
     
-
 
Chilean Financial Institutions Bonds
   
-
     
-
     
-
     
-
     
-
 
Chilean Corporate Bonds
   
-
     
-
     
-
     
-
     
-
 
Chilean Others Securities
   
85
     
6,682
     
53,071
     
364,176
     
424,014
 
Central Bank and Government Foreign Securities
   
-
     
-
     
-
     
-
     
-
 
Others Foreign Securities
   
3,556
     
14,617
     
11,050
     
-
     
29,223
 
Subtotal
   
3,641
     
21,299
     
64,121
     
364,176
     
453,237
 
Total
   
22,079
     
88,308
     
98,826
     
365,815
     
575,028
 

Under U.S.GAAP, the Bank is required to disclose the amounts of unrealized holding gains and losses included in income on securities classified as trading.  For the years ended December 31, 2004, 2005 and 2006, the Bank recognized in income net unrealized holding gains (losses) of MCh$2,627, MCh$(1,614) and MCh$(163,7) respectively, on these securities.

(k) Allowance for loan losses

The determination of loan losses under U.S. GAAP differs from that under Chilean GAAP in the following respects:
 
1. Allowance for loan losses
 
Under Chilean GAAP, the allowance for loan losses is calculated according to specific guidelines set out by the rules of the Superintendency of Banks.

Under U.S. GAAP, allowances for loan losses should be adequate to cover inherent losses in the loan portfolio at the respective balance sheet dates. The Bank has estimated its required allowance under U.S. GAAP in the following manner:
 
  ·
All loans of the Bank were classified in accordance with the rules of the Superintendency of Banks.

 
·
Allowances for commercial loans classified in loan risk category A1, A2, A3, B or C1 which were not considered impaired under SFAS No. 114, “Accounting by Creditors for Impairment of a Loan” (“SFAS 114”) were analyzed by loan category and were adjusted where necessary to reflect the estimated inherent losses in the loan portfolio based upon the historical movements and trends in the Bank’s loan classifications (“migration analysis”).

F-52

 
 
·
In addition, specific additional allowances were determined for commercial loans, i.e. those loans which were not considered above, on the following basis:

 
i.
Commercial loans greater than MCh$100, which were considered impaired in accordance with the criteria established by SFAS 114 were valued at the present value of the expected future cash flows discounted at the loan’s effective contractual interest rate, or at the fair value of the collateral if the loans were collateral dependent.
     
  ii. Allowances for commercial loans which were under MCh$100 (i.e. those loans which were not considered in the above SFAS 114 analysis), were calculated using the weighted average loan provision, by loan classification, as determined in (i).  In addition, estimated incurred losses were adjusted based on results of a migration analysis referred to above.
     
 
iii.
Allowance for loan losses for mortgage and consumer loans were determined based on historical loan charge-offs, after considering the recoverability of the underlying collateral.
 
Based on the preceding calculations under provisions of SFAS No.114 the Bank reduced the total loan loss allowance by MCh$8,170 and MCh$8,170 for the years ended December 31, 2005 and 2006, respectively.

Based on the loan losses allowance estimation process described above, the Bank determined the allowance for loan losses under U.S. GAAP, and compared this estimate with the reported allowance determined in accordance with the guidelines established by the Superintendency of Banks.  The fluctuation of the recorded additional loan loss allowance required by the Superintendency of Banks, was then deducted from the additional allowance requirements under U.S. GAAP to arrive at a cumulative U.S. GAAP adjustment for the Bank, as follows:

     
As of December 31,
 
     
2005
   
2006
 
     
MCh$
   
MCh$
 
 
U.S. GAAP loan loss allowance
    (142,830 )     (165,894 )
 
Chilean GAAP loan allowance required by the Superintendency of Banks
   
151,000
     
174,064
 
 
U.S. GAAP adjustment
   
8,170
     
8,170
 
                   
 
Less: Chilean GAAP additional loan loss allowance
   
-
     
-
 
 
Cumulative U.S. GAAP adjustment
   
8,170
     
8,170
 

The effect of accounting for loan losses in accordance with U.S. GAAP is included in the reconciliation of the net income and shareholders' equity in paragraph (t) below.

2.
Recognition of Income

As of December 31, 2005 and 2006, the recorded investment in loans for which impairment has been recognized in accordance with SFAS 114 totaled MCh$257,736 and MCh$310,656, respectively, with a corresponding valuation allowance of MCh$117,692 and MCh$124,924, respectively.  For the years ended December 31, 2005 and 2006, the average recorded investment in impaired loans was MCh$290,882 and MCh$271,582, respectively.  For the three years ended December 31, 2004, 2005 and 2006, during the portion of the year that the loans were impaired, the Bank recognized MCh$2,019, MCh$559 and MCh$438 of interest on impaired loans. As of December 31, 2005 and 2006, the Bank had made provisions against all loans which it considered to be impaired.
 
F-53

 
3.
Loan loss recoveries

Under Chilean GAAP and U.S. GAAP recoveries of loans previously charged-off are presented as a reduction of the provision for loan losses.

The following presents an analysis under U.S. GAAP, for the years ended December 31, 2004, 2005 and 2006, of the changes in the reserve for loan losses during the years presented:

     
As of December 31, 
 
     
2004
 
 
2005
   
2006
 
     
MCh$
   
MCh$
   
MCh$
 
 
Allowances for loan losses in accordance with U.S. GAAP, as of January 1
   
188,827
     
174,145
     
142,830
 
 
Price-level restatement (1)
    (4,792 )     (6,407 )     (3,134 )
 
Loan loss recoveries
   
50,772
     
47,079
     
47,067
 
 
Charge-offs
    (126,394 )     (139,632 )     (143,475 )
 
Additions charged to operations
   
65,732
     
67,645
     
122,606
 
                           
 
Allowances for loan losses in accordance with U.S. GAAP, as of December 31,
   
174,145
     
142,830
     
165,894
 

 
(1)
Reflects the effect of inflation on the allowance of loan losses under Chilean GAAP at the beginning of each period, adjusted to constant Chilean pesos of December 31, 2006.

4.
Charge-offs

As discussed in Note 1 (m) of these financial statements, under Chilean GAAP the Bank charges off loans when collection efforts have been exhausted. Under the rules and regulations established by the Superintendency of Banks, charge-offs must be made within the following maximum prescribed limits:

 
-
24 months after a loan is past due (6 months for consumer loans) for loans without collateral;
 
-
36 months after a loan is past due for loans with collateral.

Under U.S. GAAP, loans should be written-off in the period that they are deemed uncollectible. The Bank believes that the charge-off policies it applies in accordance with Chilean GAAP are substantially the same as those required under U.S. GAAP, and therefore the potential difference is not significant to the presentation of its financial statements.

(l) Investments in other companies

Under Chilean GAAP, certain long-term investments of less than 20% (as the definition of “significant influence” included investments of between 10% and 20% prior to January 1, 2004) of the outstanding shares in other companies had been and continue to be recorded using the equity method of accounting (see Note 9 (4)) those acquired subsequent to that date use the cost method. Under U.S. GAAP those investments generally would have been recorded at cost.  The effect of accounting for investments in other companies in accordance with U.S. GAAP is included in the reconciliation of consolidated net income and shareholders’ equity in paragraph (t) below.

(m) Derivatives

Chilean banks are permitted to use foreign exchange forward contracts (covering either foreign currencies against the U.S. dollar, the UF against the Chilean peso or the UF and the Chilean peso against the U.S. dollar), forward rate agreements and interest rate swaps. Currently, the use of derivatives in Chile is regulated by the Chilean Central Bank, which requires that all foreign exchange forward contracts be made only in U.S. dollars and other major foreign currencies.

F-54


All derivative instruments are subject to market risk, which is defined as the risk that future changes in market conditions may make an investment more or less valuable. The Bank managed their individual exposure to market risk on a global basis in accordance with risk limits set by senior management by buying or selling instruments or entering into offsetting foreign exchange and interest rate positions.

The Bank enters into derivative transactions for its own behalf and to meet customers’ risk management needs.  Generally the Bank enters into forward contracts in U.S. dollars against the Chilean peso or the UF, however, occasionally, forward contracts are also made in other currencies, but only when the Bank acts as an intermediary. Other derivative transactions include primarily interest rate swaps (pay fixed-receive floating) and rate lock agreements.  These are used for hedging purposes in order to manage, among other risks, interest rate and fair value risk related to the Yankee bonds of Chilean companies, Chilean Government securities bought by the Bank and certain mortgage loans.

In order to manage any credit risk associated with its derivative products, the Bank grants lines of credit to its counterparties, in accordance with its credit policies, for each derivative transaction. The counterparty risk exposure is a function of the type of derivative, the term to maturity of the transaction and the volatility of the risk factors that affect the derivative’s market value.

Under Chilean GAAP, the Bank accounts for forward contracts between foreign currencies and U.S. dollars at fair value with realized and unrealized gains and losses on these instruments recognized in other income. Until 2005, forward contracts between the U.S. dollar and the Chilean peso or the UF were valued at the closing spot exchange rate of each balance sheet date, with the initial discount or premium being amortized over the life of the contract in accordance with Chilean hedge accounting criteria outstanding at this date. Also until 2005, under Chilean GAAP the Bank records differences between interest income and interest expense on interest rate swap transactions, in net income in the period when cash settlements under the agreements were made.  The fair value of the swap agreement and changes in the fair value as a result of changes in market interest rates were not recognized at each period-close in the Chilean GAAP consolidated financial statements.

As is described in Note 2, on December 20, 2005 the Superintendency of Banks and Financial Institutions (SBIF) issued Circular No.3,345 and related amendments, instructing the application of new accounting principles and valuation criteria for derivative instruments and hedges accounting in the balance sheet as is described in Note 1 g. The new accounting principles and valuation criteria do not differ significantly from U.S. GAAP, SFAS N° 133 and related amendments.

Effective January 1, 2006, under the requirements of Circular No. 3,345 of the Superintendency of Banks, the accounting treatment of certain derivative instruments and hedges of financial assets changed.  Traditional financial instruments which meet the definition of  a “derivative” such as forwards in foreign currency and unidades de fomento (inflation index-linked units of account), interest rate futures, currency and interest rate swaps, currency and interest rate options, and others are recognized initially in the balance sheet at cost (including transaction fees) and, at subsequent period ends, at their fair value.  The fair value is obtained from market quotes, discounted cash flow models and option valuation models, as applicable.

Beginning January 1, 2001, the Bank adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No.138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment of FASB Statement No. 133" (collectively “SFAS 133”), which establishes comprehensive accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and hedging activities. The standard requires that all derivative instruments be recorded in the balance sheet at fair value. However, the accounting for changes in fair value of the derivative instrument depends on the purpose for which the derivative instrument was entered into and whether the derivative instrument qualifies as a hedge. The standards also require formal documentation of hedging relationships and effectiveness testing when hedge accounting is to be applied. If the derivative
F-55

 
instrument does not qualify as a hedge, changes in fair value are reported in earnings when they occur. If the derivative instrument qualifies as a hedge, the accounting treatment varies based on the type of risk being hedged.

Even thought the methodology to asses Hedge Accounting under Chilean GAAP and U.S. GAAP are the same, there are certain criteria’s that are presented under Chilean GAAP and not under U.S. GAAP. As of December 31, 2006 hedged accounting applied under Chilean GAAP on the mortgage loans portfolio classified in “Other Outstanding Loans” does not meet the criteria described in SFAS No 133 paragraph 21 a), which paragraph establishes that the change in fair value attributable to the hedged risk for each individual item in a hedged portfolio must be expected to respond in a generally proportionate manner to the overall change in the fair value of the aggregate portfolio attributable to the hedged risk. Given the lack of compliance with this paragraph of the hedge undertaken and documented as such in Chilean GAAP, an adjustment has been included in the amount of MCh$31,833 and MCh$29,915 as of and for the year ended December 31, 2006, respectively, in our reconciliation of  shareholders’ equity and net income in paragraph (t) below. As there are differences in Hedge Accounting between Chilean GAAP and U.S. GAAP some transactions registered as Hedging derivatives under Chilean GAAP are reversed for U.S. GAAP purposes and registered as Trading derivatives as is described in the table below.

   
Assets
MCh$
   
Liabilities
MCh$
   
Chilean GAAP
Balance Sheet
 MCh$
   
U.S. GAAP
Adjustment
MCh$
   
U.S. GAAP
Balance Sheet
MCh$
 
Hedging Derivatives
                             
                               
Interest Risk Contracts:
                             
  Interest Rate Swap
   
1,173
      (2,354 )     (1,181 )    
-
      (1,181 )
  Currency Swap
   
-
      (37,871 )     (37,871 )    
31,833
      (6,038 )
                                         
Total Hedging Derivatives
   
1,173
      (40,225 )     (39,052 )    
31,833
      (7,219 )
                                         
Trading Derivatives
                                       
                                         
Interest Risk Contracts:
                                       
  Interest Rate Swap
   
34,958
      (68,165 )     (33,207 )    
-
      (33,207 )
  Options and Future
   
1,448
      (1,032 )    
416
     
-
     
416
 
  Currency Swap
   
-
     
-
     
-
      (31,833 )     (31,833 )
Foreign Exchange Contracts:
                                       
  Forward purchase/sale of foreign currency
   
82,608
      (99,422 )     (16,814 )    
-
      (16,814 )
  Currency Options
   
4,384
     
4,372
     
12
     
-
     
12
 
  Currency Swap
   
247,486
      (142,058 )    
105,428
     
-
     
105,428
 
  Other
   
631
      (648 )     (17 )    
-
      (17 )
                                         
Total Trading Derivatives
   
371,515
      (315,697 )    
55,818
      (31,833 )    
23,985
 
Total Net Derivatives
   
372,688
      (355,922 )    
16,766
     
-
     
16,766
 

Before January 1, 2006 Chilean accounting rules do not consider the existence of derivative instruments embedded in other contracts and therefore they were not reflected in the financial statements. For U.S. GAAP purposes, certain implicit or explicit terms included in host contracts that affect some or all of the cash flows or the value of other exchanges required by the contract in a manner similar to a derivative instrument, must be separated from the host contract and accounted for at fair value. The Bank separately measures embedded derivatives as freestanding derivative instruments at their estimated fair values recognizing changes in earnings when they occur. Currently the only host contracts that the Bank has, which have implicit or explicit terms that must be separately accounted for at fair value, are service type contracts related to computer service agreement and insurance agreements.

F-56


For December 31, 2005 the effects of the adjustments with respect to foreign exchange contracts, interest rate and foreign currency swaps agreements on the net income and shareholders’ equity of the Bank are included in paragraph (t) below.

For the years ended December 31, 2004, 2005 and 2006 the effects of embedded derivatives were not significant.

(n) Recoveries of loans previously charged-off

Under Chilean GAAP recoveries on charged-off loans as well as recoveries on loans which were reacquired from the Chilean Central Bank were recorded directly to income. Under U.S. GAAP, loans that have been previously written-off cannot be reinstated, and only actual cash recoveries from any previously charged-off loans would be recognized as income. Consequently, the effect of the recovery of these reinstated loans for Chilean GAAP purposes, net of cash recoveries, has been eliminated in the reconciliation to U.S. GAAP

(o) Capitalization of interest costs

For Chilean GAAP purposes, the Bank does not capitalize interest costs on the assets that are constructed for its own use.  Under SFAS No. 34, interest costs should be capitalized as they are considered part of the historical cost of acquiring these assets.  The effect of accounting for capitalization of interest costs in accordance with U.S. GAAP is included in the reconciliation of net income and shareholders’ equity in paragraph (t) below.

(p) Mortgage loans purchased

Banco Santander Chile acquired mortgage loans (so called ANAP portfolio) from former savings and loans institutions at a discount. In 1990, based on the then-existing regulations, the discount on a portion of the loans acquired was recognized as income. Under U.S. GAAP, such discount should be amortized over the life of the related loans. The effect of accounting for mortgage loans purchased in accordance with U.S. GAAP is included in the reconciliation of net income and shareholders’ equity in paragraph (t) below. As of December 31, 2005, the discount was completely amortized.

(q) Acquisition of Financial Assets

The following business combinations took place prior to the merger of Banco Santiago and Banco Santander-Chile which continue to require adjustments between Chilean GAAP and U.S. GAAP in the net income and shareholders’ equity reconciliations in (t):

(1)
Acquisition of Banco O’Higgins

For Chilean GAAP purposes, the merger between the former Banco Santiago and Banco O’Higgins that took place during 1997 was accounted for using “pooling of interests”.  The assets acquired and liabilities assumed were combined at their carrying values on the books of the successor entity and the operations were accounted for as combined from January 1, 1997.

For U.S. GAAP purposes, the former Banco Santiago accounted for the business combination as a purchase of Banco O’Higgins.  Consequently, goodwill was recorded as the difference between the purchase price and the fair value of the assets acquired and the liabilities assumed (which, in management’s opinion, approximated book value).

F-57


The unamortized goodwill associated with this merger on the books of Banco Santiago, for U.S. GAAP purposes, as of the date of the merger with the former Banco Santiago Santander-Chile is implicitly included in the goodwill of Teatinos which  had been acquired by BCSH as explained in (a).

(2)
Acquisition of Banco Osorno y la Unión

During 1996, the former Banco Santander-Chile merged with Banco Osorno y la Unión (“Banco Osorno”).  The treatment for both Chilean GAAP purposes and U.S. GAAP purposes was equivalent to the treatment in the Banco O’Higgins transaction in (1) with the exception that the acquisition of Banco Osorno was defined as a reverse acquisition.

(r) Assets received in lieu of payment

As instructed by the Superintendency of Banks, assets received in lieu of payment are carried at cost, less a global valuation allowance if the total of the fair value of those assets is lower than the carrying amount. If the asset is not sold within one year, then recorded asset amounts should be written-off on a straight-line basis over the following 12-month period.

Under U.S. GAAP, assets received in lieu of payment are initially recorded at fair value less any estimated costs to sell at the date of foreclosure, on an individual asset basis. Subsequent to foreclosure, valuations should be periodically performed to record any impairment. The effect of recording these assets in accordance with U.S. GAAP in the Bank is included in the reconciliation of net income and shareholders' equity in paragraph (t) below.

(s) Accrued interest and indexation adjustment

Under Chilean GAAP, accrued interest and indexation adjustment are presented with the principle amounts of the investments to which they accrete.  Under U.S. GAAP accrued interest and indexation adjustment would be presented as separate line items in the balance sheet. The amount of this reclassification is not readily determinable.


F-58


(t) Summary of net income and shareholders’ equity differences

The following is a reconciliation of net income under Chilean GAAP to the corresponding amounts under U.S. GAAP:

   
Year Ended December 31,
 
   
2004
   
2005
   
2006
   
2006
 
   
MCh$
   
MCh$
   
MCh$
   
ThUS$
 
                     
(Note 1(r))
 
                         
Net income in accordance with Chilean GAAP
   
210,358
     
244,792
     
285,582
     
534,367
 
                                 
Push-down accounting (Note 26 (a))
                               
Amortization and writte-off of trademarks and other
    (10,934 )     (13,261 )     (17,032 )     (31,869 )
Amortization of fair value increment of net assets
    (3,848 )     (3,850 )     (3,846 )     (7,197 )
Deferred income taxes (Note 26(c))
   
26
     
28
     
-
     
-
 
Investment securities (Note 26(h))
   
664
     
2,575
      (472 )     (883 )
Allowance for loan losses (Note 26(k))
   
15,622
      (1,050 )    
-
     
-
 
Other than temporary impairment (Note 26(i))
   
-
     
-
      (5,588 )     (10,456 )
Investments in other companies (Note 26(l))
    (8 )    
9
      (117 )     (219 )
Derivatives  (Note 26(m))
    (6,650 )    
7,008
      (29,915 )     (55,975 )
Recoveries of loans (Note 26(n))
   
10
     
-
     
-
     
-
 
Capitalization of interest costs (Note 26(o))
    (51 )     (51 )     (51 )     (95 )
Mortgage loans purchased (Note 26(p))
   
42
     
89
     
-
     
-
 
Assets received in lieu of payment (Note 26(r))
   
8,138
      (4,817 )    
1,484
     
2,777
 
Deferred tax effect of U.S. GAAP adjustments
    (2,870 )     (638 )    
5,872
     
10,987
 
Net income in accordance with U.S. GAAP
   
210,499
     
230,834
     
235,917
     
441,437
 
Other comprehensive income, net of tax:
                               
Unrealized gain (losses) on available-for-sale securities (26 (x))
   
664
      (23,319 )    
16,772
     
31,383
 
Comprehensive income in accordance with U.S. GAAP
   
211,163
     
207,515
     
252,689
     
472,820
 
 
F-59


The following is a reconciliation of shareholders’ equity under Chilean GAAP to the corresponding amounts under U.S. GAAP:

   
At December 31,
 
   
2005
   
2006
   
2006
 
   
MCh$
   
MCh$
   
ThUS$
 
               
(Note 1(r))
 
                   
Shareholders’ equity in accordance with Chilean GAAP
   
1,104,767
     
1,245,339
     
2,330,219
 
                         
Push Down Accounting (Note 26(a))
                       
Goodwill
   
501,242
     
501,242
     
937,900
 
Fair value of intangibles
   
78,096
     
61,064
     
114,259
 
Fair value increment of net assets
   
9,206
     
5,360
     
10,030
 
Mandatory dividends (Note 26(d))
    (73,439 )     (85,675 )     (160,311 )
Investment securities (Note 26(h))
   
3,070
     
-
     
-
 
Allowance for loan losses (Note 26(k))
   
8,170
     
8,170
     
15,287
 
Investments in other companies (Note 26(l))
   
411
     
294
     
550
 
Derivatives (Note 26(m))
    (1,918 )     (31,833 )     (59,564 )
Recoveries of loans (Note 26(n))
    (1,302 )     (1,302 )     (2,436 )
Capitalization of interest costs (Note 26(o))
   
3,875
     
3,824
     
7,155
 
Assets received in lieu of payment (Note 26(r))
   
3,699
     
5,183
     
9,698
 
Deferred tax effect of U.S. GAAP adjustments
    (2,651 )    
2,713
     
5,076
 
Acquisition of financial assets (Note 26(q))
   
305,279
     
305,279
     
571,225
 
Shareholders’ equity in accordance with U.S. GAAP
   
1,938,505
     
2,019,658
     
3,779,088
 

The following summarized the changes in the shareholders’ equity of the Bank under U.S. GAAP during the years ended December 31, 2004, 2005 and 2006:

   
As of December 31,
 
   
2004
   
2005
   
2006
   
2006
 
   
Total
   
Total
   
Total
   
Total
 
   
MCh$
   
MCh$
   
MCh$
   
ThUS$
 
                     
(Note (1r))
 
                         
Balance at January 1,
   
1,961,494
     
1,952,196
     
1,938,505
     
3,627,238
 
Monetary indexation of dividends paid
    (241 )     (517 )     (186 )     (348 )
Dividends paid
    (224,445 )     (210,358 )     (159,114 )     (297,726 )
Mandatory dividends, previous date
   
67,333
     
63,108
     
73,439
     
137,415
 
Mandatory dividends, closing date
    (63,108 )     (73,439 )     (85,675 )     (160,311 )
Unrealized gains on available-for-sale investments, net of tax
   
664
      (23,319 )    
16,772
     
31,383
 
Net income in accordance with U.S. GAAP
   
210,499
     
230,834
     
235,917
     
441,437
 
Balance at December 31,
   
1,952,196
     
1,938,505
     
2,019,658
     
3,779,088
 
 
F-60

(u) Earnings per share

The following disclosure of net income per share information is not generally required for presentation in the financial statements under Chilean GAAP but is required under U.S. GAAP. Earnings per share are determined by dividing net income by the weighted average number of total shares outstanding.

   
Years Ended December 31,
 
   
2004
   
2005
   
2006
 
Chilean GAAP (1)
 
Ch$
   
Ch$
   
Ch$
 
Earnings per share
   
1.12
     
1.30
     
1.52
 
Weighted average number of total shares outstanding (in millions)
   
188,446.1
     
188,446.1
     
188,446.1
 
                         
U.S. GAAP (1)
                       
Earnings per share from continuing operations
   
0.99
     
-
     
-
 
Earnings per share from discontinued operations
   
0.12
     
-
     
-
 
Net income per share
   
1.12
     
1.22
     
1.24
 
Weighted average number of total shares outstanding (in millions)
   
188,446.1
     
188,446.1
     
188,446.1
 

(1)
Basic earnings per share have been calculated by dividing net income by the weighted average number of common shares outstanding during the year. There are no potentially dilutive effects on the calculation of earnings per share.

(v) Article 9 Income Statements and Balance Sheets

The presentation of the consolidated financial statements differs significantly from the format required by the Securities and Exchange Commission under rules 210.9 to 210.9-07 of Regulation S-X (Article 9). The Chilean GAAP balance sheets and income statements have been restated in constant Chilean pesos of December 31, 2006 purchasing power using the adjustment factor arising from the CPI, and are presented in the format prescribed by Article 9 of Regulation S-X. Additionally all adjustments to U.S. GAAP included in paragraph (t) have been incorporated.

The principal reclassifications which were made to the primary Chilean GAAP consolidated financial statements in order to present them in the Article 9 format are as follows:

1.
Elimination of contingent assets and liabilities from the balance sheet.
2.
Reclassification of fees relating to contingent loans from interest income under Chilean GAAP to non interest income under Article 9.
3.
Presentation in the Income Statements of the results of discontinued operations arising from the sale of the Santiago Express Division in 2004 and in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of long-Lived Assets”.
4.
Reclassification of Mutual Funds registered in Other Assets under Chilean GAAP to trading securities under Article 9.

F-61


The following balance sheets as of December 31, 2005 and 2006 have been prepared in accordance with U.S. GAAP, except for the inclusion of price-level restatement permitted under item 18 of Regulation S-X , and are presented in accordance with the requirements of Article 9.

   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
ASSETS
           
Cash and due from banks
   
1,035,351
     
947,741
 
Interest bearing deposits
   
302,407
     
148,220
 
Investments under agreements to resell
   
23,610
     
30,807
 
Investments:
               
Trading Investments
   
593,591
     
666,472
 
Available-for-sale investments
   
575,028
     
345,108
 
Sub-total
   
2,529,987
     
2,138,348
 
                 
Loans
   
9,572,446
     
10,914,351
 
Unearned income
    (133,657 )     (149,905 )
Allowance for loan losses
    (142,830 )     (165,894 )
Loans, net
   
9,295,959
     
10,598,552
 
Premises and equipment, net
   
264,130
     
266,508
 
Goodwill, net
   
806,521
     
806,521
 
Intangibles, net
   
78,096
     
61,064
 
Derivatives
   
428,888
     
372,688
 
Other assets
   
313,037
     
439,985
 
Total Assets
   
13,716,618
     
14,683,666
 
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Deposits:
               
Non interest bearing
   
2,214,790
     
2,482,997
 
Interest bearing
   
6,033,248
     
6,909,335
 
Total deposits
   
8,248,038
     
9,392,332
 
Short-term borrowings
   
1,394,598
     
1,016,624
 
Investments sold under agreement to repurchase
   
50,834
     
19,929
 
Derivatives
   
391,965
     
355,922
 
Other liabilities
   
233,239
     
292,071
 
Long-term debt
   
1,457,944
     
1,585,608
 
Sub-total
   
3,528,580
     
3,270,154
 
Minority interest
   
1,495
     
1,522
 
Common stock
   
761,853
     
761,853
 
Other shareholders’ equity
   
1,176,652
     
1,257,805
 
Total Liabilities and Shareholders’ Equity
   
13,716,618
     
14,683,666
 


F-62


Total assets set forth in the basic Chilean GAAP balance sheets are reconciled to total assets in the Article 9 balance sheets above as follows:

   
As of December 31,
 
   
2005
   
2006
 
   
MCh$
   
MCh$
 
Total assets of the Bank under Chilean GAAP
   
13,766,439
     
14,843,439
 
Elimination of off-setting assets and liabilities:
               
Contingent loans
    (949,177 )     (1,022,687 )
U.S. GAAP adjustments (1)
   
899,356
     
862,914
 
Total assets under Article 9 presentation
   
13,716,618
     
14,683,666
 


(1)
These net assets represent those which differ in recorded cost from Chile GAAP or are non-existent in Chile GAAP.


F-63


The following income statements have been prepared in accordance with U.S. GAAP and are presented in accordance with requirements of Article 9, except for the inclusion of price-level restatement permitted under Item 18 of Regulation S-X:

   
Years ended December 31,
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
Interest income
                 
Interest and fees on loans
   
709,774
     
910,932
     
1,039,334
 
Interest on investments
   
94,310
     
117,104
     
118,620
 
Interest on deposits with banks
   
455
     
2,422
     
33,409
 
Interest on investments under agreement to resell
   
1,884
     
1,519
     
574
 
Total interest income
   
806,423
     
1,031,977
     
1,191,937
 
Interest expense
                       
Interest on deposits
    (131,394 )     (248,769 )     (340,409 )
Interest on investments under agreement to repurchase
    (18,242 )     (16,302 )     (36,518 )
Interest on short-term debt
    (27,910 )     (47,855 )     (63,562 )
Interest on long-term debt
    (133,732 )     (130,605 )     (103,537 )
Interest on other borrowed funds
    (7,749 )     (5,072 )     (2,547 )
Price level restatement (1)
    (12,710 )     (18,525 )     (13,782 )
Total interest expense
    (331,737 )     (467,128 )     (560,355 )
Net interest income
   
474,686
     
564,849
     
631,582
 
Provision for loan losses
    (68,924 )     (65,930 )     (123,022 )
Net interest income after provision for loan losses
   
405,762
     
489,919
     
508,560
 
Other income
                       
Fees and commissions, net
   
86,488
     
87,427
     
125,593
 
Gain on trading activities
   
32,791
     
18,166
     
64,338
 
Net gains (losses) on foreign exchange activities
   
8,050
     
2,741
      (48,708 )
Other
   
29,729
     
22,101
      (15,583 )
Total other income
   
157,058
     
130,435
     
125,640
 
Other expenses
                       
Salaries
    (137,981 )     (142,170 )     (159,723 )
Net premises and equipment expenses
    (50,386 )     (50,453 )     (49,936 )
Administration expenses
    (89,586 )     (92,395 )     (99,676 )
Other expenses
    (51,177 )     (61,868 )     (36,470 )
Minority interest
    (194 )     (136 )     (151 )
Total other expenses
    (329,324 )     (347,022 )     (345,956 )
Income from continuing operations before income taxes
   
233,496
     
282,329
     
288,244
 
Income taxes from continuing operations
    (46,597 )     (51,495 )     (52,327 )
Income from continuing operations
   
186,899
     
230,834
     
235,917
 
Discontinued operations:
                       
Gain from discontinued operations of Santiago Express Division
   
5,341
     
-
     
-
 
Gain on disposal of Santiago Express Division
   
23,093
     
-
     
-
 
Income tax expense
    (4,834 )    
-
     
-
 
Income from discontinued operations
   
23,600
     
-
     
-
 
Net income
   
210,499
     
230,834
     
235,917
 
Other comprehensive income
   
664
      (23,319 )    
16,772
 
Comprehensive income
   
211,163
     
207,515
     
251,689
 

(1)
The price-level adjustment includes the effect of inflation primarily resulting from interest-earning assets and interest-bearing liabilities. As the Bank does not record the price-level adjustment for separate categories of assets and liabilities, such adjustment is presented as a component of interest expense.


F-64


Consolidated statements of cash flows

Under U.S. GAAP, changes in other assets and liabilities such as other receivables, prepaid assets and accruals for salaries and vacations should be presented as cash flows from operating activities.  Under Chilean GAAP, these are presented as cash flows from investing activities.  Additionally, the non-cash movements related to assets received in lieu of payments are not reported as supplemental information under Chilean GAAP, as usually required under U.S. GAAP.

The consolidated statements of cash flows have been prepared in accordance with Chilean GAAP, and are presented in accordance with the requirements of Article 9, except for the inclusion of price-level restatement permitted under item 18 of Regulation S-X. Presentation of the cash flow statements under U.S. GAAP would require additional breakdown of certain line items presented “net” in the Chilean GAAP cash flow. Additionally, for Chilean GAAP purposes, certain items classified as “Other assets” are defined as cash equivalent for cash flow purposes which would also be defined as cash equivalents in the balance sheet in U.S. GAAP. And, lastly cash flow from purchases, sales and maturity of trading securities are presented as investing activities in Chilean GAAP while they would be presented as operating activity in U.S. GAAP.

The following condensed consolidated statements of cash flows have been prepared in accordance with U.S. GAAP, and are presented in accordance with the requirements of Article 9 as described above:

   
Years Ended December 31,
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
                   
Net cash provided by (used in) operating activities
   
1,018,046
      (498,836 )    
508,260
 
Net cash used in (provided by) investing activities
    (1,673,702 )    
149,928
      (1,268,389 )
Net cash provided by financing activities
   
590,145
     
593,002
     
608,364
 
                         
Net cash flow
    (65,511 )    
244,094
      (151,765 )
Inflation effect on cash and cash equivalents
   
1,784
     
3,430
      (6,759 )
                         
Net decrease in cash and due from banks
    (63,727 )    
247,524
      (158,524 )
Cash and due from Banks, beginning of the year
   
1,067,134
     
1,003,407
     
1,250,931
 
Cash and due from banks, end of the year
   
1,003,407
     
1,250,981
     
1,092,407
 

(w) Income taxes

The reconciliation of the provision for income taxes charged to income under Chilean GAAP to the corresponding amounts under U.S. GAAP is as follows:

   
Years Ended December 31,
 
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
Charge for the period under Chilean GAAP
   
48,587
     
50,885
     
58,199
 
U.S. GAAP Adjustments:
                       
Deferred tax effect of applying SFAS No. 109
    (26 )     (28 )    
-
 
Deferred tax effect  of U.S. GAAP adjustments
   
2,870
     
638
      (5,872 )
Charge for the period under U.S. GAAP
   
51,431
     
51,495
     
52,327
 


F-65


Deferred tax assets and liabilities for the Bank under U.S. GAAP are summarized as follows:

   
As of December 31,
 
Temporary differences
 
2005
   
2006
 
   
MCh$
   
MCh$
 
Assets
           
Assets received in lieu of payment
   
1,629
     
529
 
Foreign exchange
   
774
     
768
 
Accrued interest
   
3,032
     
2,808
 
Allowance for loan losses
   
10,361
     
19,841
 
Other provisions
   
14,465
     
14,598
 
Derivatives
   
1,336
     
4,915
 
Bank premises and equipment
   
8,628
     
4,426
 
Other
   
3,214
     
281
 
Total deferred tax assets
   
43,439
     
48,166
 
                 


   
As of December 31,
 
Temporary differences
 
2005
   
2006
 
   
MCh$
   
MCh$
 
Liabilities
           
Accelerated depreciation
   
2,629
     
3,522
 
Valuation of investments
    (21 )    
2,129
 
Prepaid expenses
   
1,536
     
1,945
 
Other
   
1,266
     
841
 
Total deferred tax liabilities
   
5,410
     
8,437
 
Net deferred tax assets
   
38,029
     
39,729
 

The Bank has not recorded a valuation allowance against any of its deferred tax assets as it believes that it is more likely than not that it will recover their value.

The U.S. GAAP provision for income taxes differs from the amount of income tax provision determined by applying the Chilean statutory income tax rate to U.S. GAAP pretax income as a result of the following differences:
                   
   
2004
   
2005
   
2006
 
   
MCh$
   
MCh$
   
MCh$
 
Chilean taxes due at the statutory rate
   
44,529
     
47,996
     
49,001
 
Increase (decrease) in rates resulting from:
                       
Non-taxable income
    (96 )     (6,009 )     (6,268 )
Non-deductible expenses
   
4,485
     
7,254
     
6,698
 
Amortization of intangibles
   
2,513
     
2,254
     
2,895
 
At effective tax rate
   
51,431
     
51,495
     
52,327
 

The Chilean statutory first category (corporate) income tax rate was 17% for the years ended December 31, 2004, 2005 and 2006.


F-66


(x) Accumulated other comprehensive income

The Bank presents accumulated other comprehensive income and its components with the objective of reporting a measure of all changes in shareholders’ equity that result from transactions and other economic events of the period other than transactions with owners (“comprehensive income”). Comprehensive income is the total net income and other non-owner equity transactions that result in changes in net equity. The following represents accumulated other comprehensive income of the Bank, net of deferred taxes as of  December 31, 2004, 2005 and 2006:

   
As of December 31, 2006
 
   
Before-tax amount
   
Tax (expense)
or benefit
   
Net-of-tax amount
 
   
MCh$
   
MCh$
   
MCh$
 
Beginning balance
    (21,826 )    
3,710
      (18,116 )
Price-level restatement (1)
   
453
      (77 )    
376
 
Unrealized gains on securities available for sale:
                       
Unrealized gains arising during the period
   
25,415
      (4,320 )    
21,095
 
Less: reclassification adjustment for gains included in net income
   
5,208
      (885 )    
4,323
 
Net unrealized gains
   
20,207
      (3,435 )    
16,772
 
 Ending balance
    (1,166 )    
198
      (968 )

   
As of December 31, 2005
 
   
Before-tax amount
   
Tax (expense)
or benefit
   
Net-of-tax amount
 
   
MCh$
   
Mch$
   
MCh$
 
Beginning balance
   
6,488
      (1,104 )    
5,384
 
Price-level restatement (1)
    (219 )    
38
      (181 )
Unrealized gains on securities available for sale:
                       
Unrealized gains arising during the period
    (33,153 )    
5,636
      (27,517 )
Less: reclassification adjustment for net gains/losses included in net income
   
5,058
      (860 )    
4,198
 
Net unrealized gains
    (28,095 )    
4,776
      (23,319 )
Ending balance
    (21,826 )    
3,710
      (18,116 )
       
   
As of December 31, 2004
 
   
Before-tax amount
   
Tax (expense)
or benefit
   
Net-of-tax amount
 
   
MCh$
   
MCh$
   
MCh$
 
Beginning balance
   
5,828
      (991 )    
4,837
 
Price-level restatement (1)
    (141 )    
23
      (117 )
Unrealized gains on securities available for sale:
                       
Unrealized gains arising during the period
    (21,003 )    
3,570
      (17,433 )
Less: reclassification adjustment for net gains/losses included in net income
   
21,804
      (3,707 )    
18,097
 
Net unrealized gains
   
801
      (137 )    
664
 
Ending balance
   
6,488
      (1,104 )    
5,384
 

(1)
Reflects the effect of inflation on the accumulated other comprehensive income at the beginning of each period, adjusted to constant pesos as of December 31, 2006.


F-67


(y) Segment Information

The following disclosure of segment information is not required for presentation in the financial statements under Chilean GAAP, however in accordance with SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information” the Bank discloses the following segment information based on the management approach. The Bank’s internal organization is structured on the basis of the client segments the Bank serves. We provide a full range of financial services to corporate and individual customers. We divide clients in this segment into the following segments:

·
Lower-middle to middle-income (Santander Banefe), consisting of individuals with monthly income between Ch$120,000 (US$225) and Ch$400,000 (US$ 749), which are served through our Banefe branch network. This segment accounts for 5.1% of our loans as of December 31, 2006. This segment offers customers a range of products, including consumer loans, credit cards, auto loans, residential mortgage loans, debit card accounts, savings products, mutual funds and insurance brokerage.

·
Middle- and upper-income, consisting of individuals with a monthly income greater than Ch$400,000 (US$749). Clients in this segment account for 38.1% of our loans as of December 31, 2006 and are offered a range of products, including consumer loans, credit cards, auto loans, commercial loans, foreign trade financing, residential mortgage loans, checking accounts, savings products, mutual funds and insurance brokerage.

·
Small businesses, consisting of small companies with annual sales less than Ch$1,200 million (US$2.2 million). As of December 31, 2006, small companies represented approximately 16.0% of our total loans outstanding. Customers in this segment are offered a range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, savings products, mutual funds and insurance brokerage.

The Middle-market comprised of mid-sized companies, companies in the real estate sector and large companies as follows:

·
Mid-sized companies, consisting of companies with annual sales over Ch$1,200 million (US$2.2 million) and up to Ch$3,500 million (US$6.5 million). Customers in this segment are offered a wide range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, cash management, treasury services, financial advisory, savings products, mutual funds and insurance brokerage. As of December 31, 2006, these clients represented 8.2% of our total loans outstanding.

·
Real estate. This segment also includes all companies in the real estate sector. As of December 31, 2006, these clients represented 4.7% of our total loans outstanding. To clients in the real estate sector we offer apart from traditional banking services, specialized services for financing primarily residential projects in order to increase the sale of residential mortgage loans.

·
Large companies, consisting of companies with annual sales over Ch$3,500 million (US$6.5 million). Customers in this segment are offered a wide range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, cash management, treasury services, financial advisory, savings products, mutual funds and insurance brokerage. As of December 31, 2006, these clients represented 9.6% of our total loans outstanding.


F-68


The Wholesale segment is comprised of:

·
Companies that are foreign multinationals or part of a large Chilean economic group with sales over Ch$3,500 million (US$6.5 million). As of December 31, 2006, these clients represented 15.1% of our total loans outstanding. Customers in this segment are offered a wide range of products, including commercial loans, leasing, factoring, foreign trade, mortgage loans, checking accounts, cash management, treasury services, financial advisory, savings products, mutual funds and insurance brokerage. 

The Institutional segment is comprised of:

·
Institutional corporations such as universities, government agencies, municipalities and regional governments. As of December 31, 2006, these clients represented 1.9% of our total loans outstanding and offer customers a range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, cash management, savings products, mutual funds and insurance brokerage.

·
The Treasury Division provides sophisticated financial products mainly to companies in the wholesale banking and the middle market segments. This includes products such as short-term financing and funding, securities brokerage, interest rate and foreign currency derivatives, securitization services and other tailor made financial products. The Treasury division also manages the Bank’s trading positions as well as the non-trading investment portfolio. 

·
Our leasing subsidiary (Santiago Leasing S.A.) has been segmented into the above categories. The subsidiary Santander S.A. Agente de Valores is included in the Treasury Division and the mutual fund and insurance brokerage subsidiaries are included in the various sub-segments (other than in the Treasury Division).

The accounting policies of the segments are the same as those described in the summary of significant accounting principles, and are customized to meet the needs of management of the Bank. The Bank derives a majority of its revenues from interest income and the chief operating decision maker relies primarily on net interest revenue to assess the performance of the segments and make decisions about resources to be allocated to the segments.

The table below sets forth our lines of business and certain statistical information relating to each of them as of December 31, 2004, 2005 and 2006.

F-69


For the twelve month period ended December 31, 2006
 
(millions of constant Ch$ as of December 31, 2006)
 
Segment
 
Loans
   
Net interest
revenue
   
Fees
   
Net loan loss
allowances (1)
   
Financial
transactions, net
(2)
   
Net segment
contribution (3)
 
Individuals
   
5,097,010
     
332,444
     
103,476
      (101,753)      
-
     
334,167
 
Santander Banefe
   
602,960
     
104,505
     
22,059
      (51,893)      
-
     
74,671
 
Middle-upper income
   
4,487,044
     
227,590
     
81,374
      (49,957)      
-
     
259,007
 
Santiago Leasing
   
7,006
     
349
     
43
     
97
     
-
     
489
 
SMEs
   
1,890,736
     
129,854
     
28,671
      (20,840)      
-
     
137,685
 
Total Retail
   
6,987,746
     
462,298
     
132,147
      (122,593)      
-
     
471,852
 
Middle-market
   
2,679,108
     
73,820
     
13,981
      (720)      
-
     
87,081
 
Mid-sized companies
   
962,649
     
33,341
     
6,846
      (3,501)      
-
     
36,686
 
Real estate
   
554,294
     
10,350
     
1,422
     
1,634
     
-
     
13,406
 
Large companies
   
1,128,536
     
28,456
     
5,508
     
680
     
-
     
34,644
 
Santiago Leasing
   
33,629
     
1,673
     
205
     
467
     
-
     
2,345
 
Wholesale
   
1,782,052
     
30,469
     
7,536
     
703
     
-
     
38,708
 
Institutional
   
229,242
     
9,510
     
1,201
     
481
     
-
     
11,192
 
Treasury (4)
   
-
     
32,479
     
1,303
     
-
     
51,604
     
85,386
 
Others (5)
   
110,811
     
3,678
     
6,382
      (893)      
-
     
9,167
 
Total
   
11,788,959
     
612,254
     
162,550
      (123,022)      
51,604
     
703,386
 
                                                 
Other operating income
                                            (32,961)  
Other income and expenses
                                            (3,579)  
Operating expenses
                                            (309,283)  
Price level restatement
                                            (13,782)  
Net income before taxes
                                           
343,781
 
(1)
Includes allowances for loan losses, charge-offs and loan loss recoveries.
(2)
Equal to the sum of net gains (loss) from trading and brokerage and foreign exchange transactions, net
(3)
Equal to net interest revenue plus fee income plus financial transactions, net minus allowances for loan losses.
(4)
Includes Santander S.A. Agente de Valores
(5)
Includes contribution of other Bank subsidiaries and other non-segmented items.
 

F-70

 
For the twelve month period ended December 31, 2005
 
(millions of constant Ch$ as of December 31, 2006)
 
Segment
 
Loans
   
Net interest
revenue
   
Fees
   
Net loan
loss allowances (1)
   
Financial
transactions, net
(2)
   
Net segment
contribution (3)
 
Individuals
   
4,296,691
     
278,433
     
76,057
      (52,255)      
-
     
302,235
 
Santander Banefe
   
501,842
     
84,064
     
16,240
      (26,828)      
-
     
73,476
 
Middle-upper income
   
3,794,345
     
194,207
     
59,817
      (25,457)      
-
     
228,567
 
Santiago Leasing
   
504
     
162
     
-
     
30
     
-
     
192
 
SMEs
   
1,493,527
     
93,657
     
19,136
      (15,737)      
-
     
97,056
 
Total Retail
   
5,790,218
     
372,090
     
95,193
      (67,992)      
-
     
399,291
 
Middle-market
   
2,350,111
     
53,332
     
8,611
     
1,113
     
-
     
63,056
 
Mid-sized companies
   
822,159
     
25,136
     
4,265
      (1,787)      
-
     
27,614
 
Real estate
   
510,010
     
8,546
     
1,091
      (712)      
-
     
8,925
 
Large companies
   
1,015,521
     
18,874
     
3,255
     
3,469
     
-
     
25,598
 
Santiago Leasing
   
2,421
     
776
     
-
     
143
     
-
     
919
 
Wholesale
   
1,815,041
     
27,083
     
7,636
     
1,960
     
-
     
36,679
 
Institutional
   
197,285
     
6,640
     
1,668
      (16)      
-
     
8,292
 
Treasury (4)
   
-
     
77,238
     
-
     
-
     
9,812
     
87,050
 
Others (5)
   
206,679
     
21,883
     
28,192
     
57
     
-
     
50,131
 
Total
   
10,359,334
     
558,266
     
141,300
      (64,879)      
9,812
     
644,499
 
                                                 
Other operating income
                                            (23,407)  
Other income and expenses
                                            (21,923)  
Operating expenses
                                            (284,968)  
Price level restatement
                                            (18,524)  
Net income before taxes
                                           
295,677
 
(1)
Includes allowances for loan losses, charge-offs and loan loss recoveries.
(2)
Equal to the sum of net gains (loss) from trading and brokerage and foreign exchange transactions, net
(3)
Equal to net interest revenue plus fee income plus financial transactions, net minus allowances for loan losses.
(4)
Includes Santander S.A. Agente de Valores
(5)
Includes contribution of other Bank subsidiaries and other non-segmented items.
 

F-71

 
For the twelve month period ended December 31, 2004
 
(millions of constant Ch$ as of December 31, 2006)
 
Segment
 
Loans
   
Net interest
revenue
   
Fees
   
Net loan
loss allowances (1)
   
Financial
transactions, net
(2)
   
Net segment
contribution (3)
 
Individuals
   
3,571,781
     
241,092
     
66,574
      (73,566)      
-
     
234,100
 
Santander Banefe
   
419,725
     
74,749
     
13,633
      (24,633)      
-
     
63,749
 
Middle-upper income
   
3,149,990
     
166,129
     
52,941
      (48,926)      
-
     
170,144
 
Santiago Leasing
   
2,066
     
214
     
-
      (7)      
-
     
207
 
SMEs
   
1,176,385
     
73,587
     
14,496
      (16,630)      
-
     
71,453
 
Total Retail
   
4,748,166
     
314,679
     
81,070
      (90,196)      
-
     
305,553
 
Middle-market
   
2,114,160
     
51,911
     
8,543
     
8,156
     
-
     
68,610
 
Mid-sized companies
   
711,571
     
22,621
     
3,469
      (4,015)      
-
     
22,075
 
Real estate
   
475,693
     
9,738
     
748
      (2,244)      
-
     
8,242
 
Large companies
   
916,977
     
18,526
     
4,326
     
14,447
     
-
     
37,299
 
Santiago Leasing
   
9,919
     
1,026
     
-
      (32)      
-
     
994
 
Wholesale
   
1,956,499
     
25,904
     
6,875
     
3,286
     
-
     
36,065
 
Institutional
   
163,785
     
5,654
     
1,570
      (562)      
-
     
6,662
 
Treasury (4)
   
-
     
72,802
     
3,666
     
-
     
40,035
     
116,503
 
Others (5)
   
138,412
     
31,559
     
26,280
      (6,135)      
-
     
51,704
 
Total
   
9,121,022
     
502,509
     
128,004
      (85,451)      
40,035
     
585,097
 
                                                 
Other operating income
                                            (25,294)  
Other income and expenses
                                            (4,295)  
Operating expenses
                                            (283,883)  
Price level restatement
                                            (12,680)  
Net income before taxes
                                           
258,945
 
(1)
Includes allowances for loan losses, charge-offs and loan loss recoveries.
(2)
Equal to the sum of net gains (loss) from trading and brokerage and foreign exchange transactions, net
(3)
Equal to net interest revenue plus fee income plus financial transactions, net minus allowances for loan losses.
(4)
Includes Santander S.A. Agente de Valores
(5)
Includes contribution of other Bank subsidiaries and other non-segmented items.

F-72

 
(z) Estimated Fair Value of Financial Instruments

The estimated fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. For those financial instruments with no quoted market prices available, fair values have been estimated using present values or other valuation techniques. These techniques are inherently subjective and are significantly affected by the assumptions used, including the discounts rate, estimates of future cash flows and prepayment assumptions. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments.

In addition, the estimated fair values presented below do not attempt to estimate the value of the Bank’s revenue generating businesses and anticipated future business activities, and therefore do not represent the Bank’s value as a going concern.

The following notes summarize the major methods and assumptions used in estimating the fair values of financial instruments:

·
Cash and due from banks

The book value of cash and due from banks approximates its estimated fair value due to the short-term nature of these instruments.

·
Spot foreign exchange transactions

The book value of spot foreign exchange transactions approximates its estimated fair value due to the short-term nature of these instruments.

·
Financial investments, investments under agreements to repurchase and investments under agreements to resell

The estimated fair value of these financial instruments was determined using either quoted market prices or dealer quotes where available, or quoted market prices of financial instruments with similar characteristics.  Investments maturing in less than one year are valued at book value because they are, due to their relatively short period to maturity, considered to have a fair value which is not materially different from their book value.

·
Loans

For variable-rate loans that reprice frequently and have no significant change in credit risk, estimated fair values are based on book values.  The estimated fair-values for certain mortgage loans, credit card loans, and other consumer loans are based on quoted market prices of similar loans, adjusted for differences in loan characteristics.  Fair values of commercial loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Fair values for non-accruing loans are estimated using discounted cash flow analyses arising from the liquidation of the underlying collateral values, where applicable (or other expected sources of payments), at an estimated discount rate.
 
F-73

 
·
Deposits

The fair value disclosed for non-interest bearing deposits and savings accounts is the amount payable at the reporting date and, as a result, is equal to the carrying amount.  Fair value for time deposits is estimated using a discounted cash flow calculation that applies interest rates currently offered to a schedule of aggregated expected monthly maturities on time deposits.  The value of long-term relationships with depositors is not taken into account in estimating the fair values disclosed.

·
Chilean Central Bank borrowings, Mortgage finance bonds and Other borrowings

The fair value of these financial instruments is estimated using discounted cash flow analyses based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements with similar remaining maturities.

·
Derivative instruments

The estimated fair value of foreign exchange forward contracts was determined using quoted market prices of financial instruments with similar characteristics.

The fair value of interest rate swaps represents the estimated amount the Bank would expect to receive or pay to terminate the contracts or agreements, taking into account current interest rates.

As no quoted market prices are available for the interest rate swap, cross currency swap and forward exchange rate instruments held by the Bank, such estimates have been estimated using modeling and other valuation techniques.

The estimated fair values of financial instruments are as follows:

   
As of December 31,
 
   
2005
   
2006
 
   
Carrying
amount (1)
   
Estimated
fair value
   
Carrying
amount (1)
   
Estimated
fair value
 
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
ASSETS
                       
Cash and due from banks
   
1,035,351
     
1,035,351
     
947,741
     
947,741
 
Interest bearing deposits
   
302,406
     
302,406
     
148,220
     
148,220
 
Investment under agreements to resell
   
23,610
     
23,610
     
30,807
     
30,807
 
Financial investments
   
1,168,619
     
1,168,619
     
981,015
     
981,015
 
Loans, net (2)
   
9,295,959
     
10,037,509
     
10,598,552
     
11,057,159
 
Derivatives instruments
   
418,795
     
428,888
     
372,688
     
372,688
 
                                 
LIABILITIES
                               
Deposits
   
8,100,586
     
8,379,744
     
9,392,332
     
9,405,393
 
Investments under agreements to repurchase
   
50,834
     
50,834
     
19,929
     
19,929
 
Short and long-term debt
   
2,852,542
     
2,508,375
     
2,602,232
     
2,877,179
 
Derivative financial instruments
   
391,823
     
391,965
     
355,922
     
355,922
 

(1)
Carrying amounts correspond to Chilean GAAP figures plus U.S. GAAP adjustments described in paragraph (t) which are shown in Article 9 balance sheet paragraph (v).

(2)
The amounts of loans in the above table excludes contingent loans since they represent undisbursed amounts under undrawn letters of credit and other credit guarantees granted by the Bank.


F-74


(aa) Obligations Arising From Lease Commitments

The bank leases certain premises, which are accounted for as operating leases. The amounts payable under the terms of the leases, which are not reflected on the consolidated balance sheets, are shown in the following table and reflect future rental expenses in constant Chilean pesos as of December 31, 2006:

   
As of December 31,
 
   
2006
 
   
MCh$
 
Due within 1 year
   
8,383
 
Due after 1 year but within 2 years
   
7,363
 
Due after 2 years but within 3 years
   
5,394
 
Due after 3 years but within 4 years
   
3,006
 
Due after 4 years but within 5 years
   
1,539
 
Due after 5 years
   
254
 
Total
   
25,939
 

The rental expense on premises for the Bank was MCh$10,127, MCh$10,206 and MCh$11,188 for the years ended December 31, 2004, 2005 and 2006, respectively.

(ab) Contingent liabilities
 
Contingent liabilities consist of open and unused letters of credit, together with guarantees granted by the Bank in Chilean pesos, UF and foreign currencies (principally U.S. dollars). The liability represents the Bank’s obligations under such agreements. The Bank’s rights under these agreements are recognized as assets on the Bank’s Chilean GAAP balance sheets under the caption “Contingent loans” (See note 5).
 
   
As of December 31, 2006    
 
   
Book value 
   
Contract amount 
 
 
 
MCh$
   
MCh$
 
Standby letters of credits
   
86
     
166,248
 
Foreign office guarantees
   
1,457
     
576,607
 
Performance bond
   
244
     
281,193
 
                 
Total
   
1,787
     
1,024,048
 
 
Guarantees in the form of performance bonds, standby letters of credit and foreign office guarantees are issued in connection with agreements made by customers to counterparties. If the customer fails to comply with the agreement, the counterparty may enforce the performance bond as a remedy. Credit risk arises from the possibility that the customer may not be able to repay the Bank for performance bonds. To mitigate credit risk, the Bank generally determines the need for specific covenant, guarantee and collateral requirements on a case-by-case basis, depending on the nature of the financial instrument and the customer’s creditworthiness.

 
F-75

 
The expiration of guarantees per period is as follows:
 
   
As of December 31, 2006
 
   
Due within
1 year
   
Due after 1
year but
within 3
years
   
Due after 3
years but
within 5
years
   
Due after
5 years
   
Total
 
 
 
MCh$
   
MCh$
   
MCh$
   
MCh$
   
MCh$
 
Standby letters of credits
   
102,707
     
50,448
     
13,093
     
-
     
166,248
 
Foreign office guarantees
   
553,833
     
22,132
     
642
     
-
     
576,607
 
Performance bonds
   
275,723
     
5,403
     
67
     
-
     
281,193
 
Total
   
932,263
     
77,983
     
13,802
     
-
     
1,024,048
 
 
(ac) Recent accounting pronouncements
 
·
On November 3, 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP, which is effective for reporting periods beginning after December 15, 2005, replaces the impairment evaluation guidance (paragraphs 10-18) of EITF issue No.03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, with references to existing other-than-temporary (OTT) impairment guidance.  The FSP also clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made.  The adoption of this FSP did not have a material effect on the Bank´s consolidated financial position, results of operations or cash flows.
 
·
In May, 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”.  This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Account Principles Board Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle.  This Statement requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.  When it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period rather than being reported in an income statement.  When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable.
 
F-76

 
·
On February, 2006, the FASB issued SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments” an amendment at FASB Statements No. 133 and 140. This Statement:
 
a.
Permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation

b.
Clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133

c.
Establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation

d.
Clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives

e.
Amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.

This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The fair value election provided for in paragraph 4(c) of this Statement may also be applied upon adoption of this Statement for hybrid financial instruments that had been bifurcated under paragraph 12 of Statement 133 prior to the adoption of this Statement. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including financial statements for any interim period for that fiscal year. Provisions of this Statement may be applied to instruments that an entity holds at the date of adoption on an instrument-by-instrument basis.

·
On March, 2006, the FASB issued SFAS No. 156 “Accounting for Servicing of Financial Assets” an amendment at FASB Statements No.140. This Statement requires:

1.
An entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in any of the following situations:

a.
A transfer of the servicer’s financial assets that meets the requirements for sale accounting

b.
A transfer of the servicer’s financial assets to a qualifying special-purpose entity in a guaranteed mortgage securitization in which the transferor retains all of the resulting securities and classifies them as either available-for-sale securities or trading securities in accordance with FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities”.

c.
An acquisition or assumption of an obligation to service a financial asset that does not relate to financial assets of the servicer or its consolidated affiliates
 
F-77


2.
Requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable.

3.
Permits an entity to choose either of the following subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities:

a.
Amortization method - Amortize servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and assess servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date.

b.
Fair value measurement method - Measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur.
 
4.
At its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value.
 
5.
Requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.
 
An entity should adopt this Statement as of the beginning of its first fiscal year that begins after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements, for any period of that fiscal year. The effective date of this Statement is the date an entity adopts the requirements of this Statement.
 
·
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes”—an interpretation of FASB Statement No. 109 (“FIN 48”).  FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance on accounting for derecognition, interest, penalties, accounting in interim periods, disclosure and classification of matters related to uncertainty in income taxes, and transitional requirements upon adoption of FIN 48.  The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006.  We are currently evaluating the impact of the adoption of FIN 48 on our consolidated financial position and results of operations.
 
F-78

 
·
On September, 2006, the FASB issued SFAS No. 157 “Fair Value Measurements”. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. Fair Value Measurements, is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year.

·
On September, 2006, the FASB issued SFAS No. 158 “Accounting for Defined Benefit Pension and Other Postretirement Plans” an amendment of FASB statements No. 87, 88, 106 and 132 (reviewed).

This Statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The required date of adoption of the recognition and disclosure provisions of this Statement differs for an employer that is an issuer of publicly traded equity securities (as defined) and an employer that is not. For purposes of this Statement, an employer is deemed to have publicly traded equity securities if any of the following conditions is met: The employer has issued equity securities that trade in a public market, which may be either a stock exchange (domestic or foreign) or an over-the-counter market, including securities quoted only locally or regionally.  The employer has made a filing with a regulatory agency in preparation for the sale of any class of equity securities in a public market.

·
On February, 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Liabilities” including an amendment of FASB Statement No. 115.

This statements permits entities to choose to measure at fair value many financial instruments and certain other items.  The objective it to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently  without having to apply complex hedge accounting provisions.  This Statements is expected to expand the use of fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments.
 
The Bank does not believe these pronouncements will have a material effect on its results of operations, cash flows, or financial position.


* * * * * *
 
F-80
 
 

 
Exhibit 4A.5

SERVICE PARTICIPANT OPERATING CONTRACT
FOR THE “CAMARA DE COMPENSACION DE PAGOS
DE ALTO VALOR” (HIGH VALUE PAYMENTS
CLEARING HOUSE)


This Service Participant Operating Contract of the High Value Payments Clearing House is signed in Santiago de Chile on August 9, 2005, by and between the Sociedad Operadora de la Cámara de Compensación de Pagos de Alto Valor, S.A., hereinafter “COMBANC”, represented herein by its President, Segismundo Schulin-Zeuthen Serrano and its General Manager, Felipe Ledermann Bernal, both domiciled at Calle Huérfanos No. 770, 16th floor, suite 1601, in the city of Santiago, party of the first part, and the Banco Santander-Chile, a banking institution, hereinafter the “Participant”, represented herein by its General Manager, Oscar von Chrismar Carvajal, both domiciled at Calle Bandera 140 in the city of Santiago, party of the second part.

Based on the above, the parties stipulate and agree as follows:

1. GENERAL BACKGROUND
   
1.1
ComBanc is a corporation organized and existing under the laws of the Republic of Chile as a banking support institution, whose line of business is providing payment clearance and remittance services and the undertaking of activities allied with or supplementary to the banking support business.

1.2
The company is governed by Chapter III.H.5 of the Compendium of Financial Rules & Regulations of the Banco Central de Chile, and by the corresponding regulations of the Office of the Superintendent of Banks and Financial Institutions.

1.3
On June 2, 2005, it was authorized to operate a Cámara de Compensación de Pagos de Alto Valor (High Value Payments Clearing House), and to provide the service which is the subject of this agreement.

1.4
ComBanc has developed, and is the holder of a usage license for, a high value payment clearance and remittance system, which among other functionalities provides the Participants with a safe, secure and expeditious electronic medium for making those payments, which on their own behalf or that of third parties, must be made to the other Participants, and to pay and otherwise settle the remittance in the Real Time Gross Payment System of the Banco Central de Chile (the “RTGP System”).

      
        Service Participant Operating Contract for the High Value Payments Clearing House
        Page  of 1 of 15
    


1.5
The Participant, for its part, declares that it has the technological capability, the infrastructure and the staff necessary for receiving the ComBanc services, in accordance with what is set forth in the present agreement.


2.
ADHERENCE TO THE OPERATING RULES OF THE HIGH VALUE PAYMENTS CLEARING HOUSE

2.1
The Participant hereby expressly declares that it shall abide by the “Operating Rules and Regulations of the Sociedad Operadora de la Cámara de Compensación de Pagos de Alto Valor, S.A.” (the “Regulations”), adhering to the laws governing it and any amendments that may be made to such laws. Consequently, the Participant declares that any and all operations conducted through the Clearing House operated by ComBanc shall be governed fully by said Regulations.

2.2
ComBanc herein delivers to the Participant one copy of the Regulations, and the latter declares that it has received these Regulations, that it is fully knowledgeable of the contents thereof, and that they are within the scope of its operations.


3.             DEFINITIONS

3.1
For purposes of this agreement, the parties agree to apply the definitions given in Appendix 9, Glossary, of the Regulations.


4.             PURPOSE OF THE CONTRACT

4.1
This instrument sets forth the terms, conditions, rights, obligations and responsibilities that will govern the reciprocal relations of the parties, so that ComBanc can provide the subject high value payment clearance and remittance service.


5.
GENERAL DESCRIPTION OF THE HIGH VALUE PAYMENT CLEARANCE AND REMITTANCE SERVICE

5.1
The detailed description of the high value payment clearance and remittance service is found in the Regulations. Without prejudice thereto, a summary of this operation is given below:

5.2
The high value payment clearance and remittance service is provided within a clearing house (the “Clearing House”), which allows for remittance in real time, bilaterally and multilaterally, of payment orders issued by the Participants.


      
        Service Participant Operating Contract for the High Value Payments Clearing House
        Page 2 of 15
    


5.3
The Clearing House has a risk management model that is composed of the following elements.

a.
Bilateral and multilateral limits that delimit the Participants’ risk exposure;

b.
The availability of DAES funds that back up the Participants’ obligations within the Clearing House; and

c.
A Mandatory Financing Agreement, hereinafter the “MFA”, which irrevocably obligates the Participants to have the necessary financing to cover at least 1.15 times the highest Multilateral Net Debtor Position.

5.4
The settlement of the results of the Clearing House remittance(s) is made at the end of the day in the RTGP system operated by the Banco Central de Chile.


6.
HIGH VALUE PAYMENTS CLEARING HOUSE DEPOSIT ACCOUNT FOR EXTRAORDINARY SETTLEMENT (“DAES”)

6.1
In order to participate in the Clearing House, the Participant agrees to apply to the Banco Central de Chile (BCCH) for the opening of a High Value Payments Clearing House Deposit Account for Extraordinary Settlement (“DAES”).

6.2
The funds established in the DAES may be used only for the Clearing House’s special Settlement Procedure, upon request of ComBanc, who will act on behalf and in representation of the Participant.

6.3
The procedure for the daily establishment of funds in this account, its method of utilization and restitution, is governed by Chapter 7, “Risk Management and Control in Payment and Settlement Processes”, and by Chapter 10, “Special or Extraordinary Settlement Procedure”, as well as by Appendix 7, “Mandatory Financing Agreement”, of the Regulations.


7.             IRREVOCABILITY

7.1
The parties expressly agree that once payment orders are accepted into the Clearing House, they shall be considered



      
        Service Participant Operating Contract for the High Value Payments Clearing House
Page 3 of 15
    

           

 
final and irrevocable, and may not under any pretext be modified or invalidated by the issuing Participant.
   
8. OBLIGATIONS
   
8.1
ComBanc must comply strictly with the obligations established in the Regulations, in the present agreement and its Appendices, and with any rules, regulations and the like issued by the Banco Central de Chile and the Office of the Superintendent of Banks and Financial Institutions.

8.2           More specifically, the obligations of ComBanc are as follows:

a.
To verify that the Participants have established the Bilateral Limits corresponding to a Business Cycle;

b.
To calculate the Multilateral Limit corresponding to each Participant in a Business Cycle;

c.
To verify that the Participants have established the corresponding Mandatory and Voluntary Deposits;

d.
To comply with the participation rules of a Business Cycle;

e.
To receive and validate the Payment Orders sent by the Participants for remittance;

f.
To pay bilaterally and multilaterally the Payment Orders issued by the Participants, in conformity with Articles 1.655 et seq. of the Civil Code, and further in accordance with the regulations established by the Banco Central de Chile, to the extent that these regulations are in accordance with the limits established in Chapter 7, “Risk Management and Control in Payment and Settlement Processes” of the Regulations.

g.
To keep the Participants informed with respect to all of their positions;

h.
To communicate to the Banco Central de Chile the results of the payment for purposes of settlement within the RTGP system;

i.
To apply the Mandatory Financing Agreement in the case set forth in Chapter 10, “Special or Extraordinary Settlement Procedure”, and Appendix 7, “Mandatory Financing Agreement”, of the Regulations.

j.
To assess the penalties provided for in the Regulations.
   
8.3  Other ComBanc obligations:


      
        Service Participant Operating Contract for the High Value Payments Clearing House
        Page 4 of 15
    


a.
To offer and maintain a proper and adequate infrastructure that will properly provide the high value payment clearance and remittance service;

b.
To have available at all times the necessary elements, equipment and staff for maintaining the continuity and effectiveness of the high value payment clearance and remittance services;

8.4
The Participant must comply strictly with the obligations established in the Regulations, in the present agreement and its Appendices, and in any rules, regulations and the like issued by the Banco Central de Chile and the Office of the Superintendent of Banks and Financial Institutions.
   
8.5  More specifically, the obligations of the Participant are as follows:
         
a.
To make available during all hours of operation its systems and a properly trained staff for correctly performing and completing the tasks associated with the high value payment clearance and remittance services;

b.
To formally appoint all Authorized Agents to act before ComBanc. In addition, the Participant must advise of any changes in such authorized agents in a timely fashion.

c.
To designate the security managers for those applications provided by ComBanc.

d.
To contract the communications networks and cover the cost of maintaining them.

e.
To pay the service fee in accordance with the provisions of Appendix No. 3, “Fee System”.
   
9. RESPONSIBILITIES
 
9.1
Without prejudice to the responsibilities set forth in the Regulations, in the present agreement and its Appendices that are incumbent upon each party, the parties expressly agree upon the following:
   
9.2 ComBanc shall be solely responsible for:
 
a.
Receiving, processing and reporting, as appropriate, each and every one of the payment orders that it receives from the Participants, and in each case guaranteeing their timely and safe processing.

b.
Ensuring the integrity and authenticity of every message that is sent.

      
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c.
Complying with both current and future rules issued by the Banco Central de Chile or the Office of the Superintendent of Banks and Financial Institutions governing the operation of clearing houses.
   
9.3 The Participant shall be solely responsible for:
        
a.
Ensuring the integrity and authenticity of every message that it sends;

b.
Complying with the provisions established in this agreement, in the Regulations, and with any current and future rules issued by the Banco Central de Chile and the Office of the Superintendent of Banks and Financial Institutions with respect to the high value payment clearance and remittance services.

9.4
Both ComBanc and the Participant shall be individually and independently liable for any damages and losses that either of them cause third-parties through the non-performance of any the obligations that are stipulated in this agreement and its Appendices or in the Regulations, which derive from its sole negligence or the actions or omissions of any of its employees, advisors or sub-contractors, or which are caused by objects or assets or property used by it or under its care and custody.

9.5
The Participant and ComBanc shall be individually liable for any damages and losses caused their respective employees, advisors or sub-contractors through negligence, fraud, or improper or erroneous use of the high value payment clearance and remittance service.

9.6
In no case may the parties claim from each other payment of indemnities for losses that they may experience because of the negligence or fraud of other Participants or of any third-party. Without prejudice to the foregoing, the parties shall cooperate and put forth their best efforts possible to have the party causing the damage or loss to be held accountable for it.
   
10. EXEMPTION FROM LIABILITY
   
10.1
ComBanc is released from any liability for any losses caused directly or indirectly, whether through erroneous, improper or fraudulent use of the Participant’s identifying codes and its respective access keys to the computer system through which the Participant accesses the ComBanc systems. This release includes any type of loss that might result, whether monetary or otherwise.
    
 
      
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10.2
In the same way, the hardware, programs and computer applications administered by ComBanc are tools for data processing that by their very nature are subject to failures, whether because of ordinary functioning, maintenance, or development. In view of the foregoing, the Participant must take the necessary preventive measures that are customary in computing activities in order to avoid any failures that might result in some type of damage or loss, whether to itself or others, and shall make available the necessary back-ups and will establish the appropriate methods and designs for verifying the results thereof; ComBanc shall assume no liability for any damages or losses stemming from the direct or indirect use or operation of the aforementioned hardware, programs and applications.

10.3
Both ComBanc and the Participant shall be exempt from all liability and released from the performance of their respective obligations if the contracted service cannot be maintained or operated because of reasons of force majeure or acts of God, such as earthquakes, electric and/or telephone and/or data transmission line outages, third-party acts intervening against public and/or private networks, acts of terrorism, strikes or other similar labor actions.

10.4
The Participant hereby waives any action, claim or legal proceeding against ComBanc for damages or losses, whether material and/or immaterial, expenses or costs, with respect to what is indicated in numeral 10.2 above.
 
11.   AUTHORIZED AGENT
   
11.1
Any instructions sent to ComBanc by the Participant’s Authorized Agent(s) shall be understood for all due and legal purposes as having been formulated and sent by the Participant. In view of the foregoing, the Participant agrees that it is its exclusive obligation to monitor the compliance of its authorized agent(s) with regard to the provisions of this agreement and the Regulations.
   
12. OPERATING RULES AND REQUIREMENTS.
   
 
Without prejudice to what is indicated in the Appendices to this agreement, the parties undertake to comply with the following rules and requirements necessary for the proper operation of the service:
   
12.1 SWIFT Messaging: Payment orders issued by the Participant and received by ComBanc, as well as messages between both parties
 
      
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deriving from the processing of the aforementioned payment orders, shall be transmitted via SWIFT messaging, of which the parties declare to be fully knowledgeable and declare this is within the scope of its operations. The technical specifications of this messaging system are given in Appendix No. 5, “Message Formats”.
   
12.2
Information for the Participant: ComBanc shall provide real time information on the Participant’s transactions, the characteristics and definitions of which are found in Appendix 4, “Participant’s Operating Instructions”.

12.3
Systems: The equipment of each party through which the subject services are this agreement are provided, must ensure the continuity of those services.

12.4 Schedules: Will be those established in the Regulations.
   
12.5
Security: The Participant will gain access to the Clearing House systems by using access keys and digital identification codes. Obtaining, handling, use and custody of these codes and logins fall under the exclusive responsibility of the Participant.
   
   
13.  APPENDICES
   
13.1    The following Appendices form part of this agreement:
 
·  
Appendix No. 1, “Operating Regulations of the Sociedad Operadora de la Cámara de Compensación de Pagos de Alto Valor S.A.”

·  
Appendix No. 2, “Operating Mandate, Deposit Account for Extraordinary or Special Settlement and Promissory Note Subscription”

·  
Appendix No. 3, “Fee System”

·  
Appendix No. 4, “Operating Instructions for Participants”

·  
Appendix No. 5, “Message Format”

13.2
The Appendices indicated above form an integral part of this agreement, and the parties hereto declare that they are fully knowledgeable of the contents of those Appendices and accept them, and moreover given that they fall within their operating domains, they undertake to comply in full with the contents thereof.

13.3
The parties expressly state that Appendices 3, 4 and 5 may be modified by ComBanc, who must advise
 

      
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the Participant of any such modification at least fifteen days in advance of such modification’s effectiveness.


14.         STAFF

14.1
The staff required for operating the high value payment clearance and remittance service shall fall under the exclusive responsibility of ComBanc insofar as concerns the providing of the services offered by it. On its part, the Participant shall be exclusively responsible for its staff that is assigned to do what is necessary for receiving and facilitating the services that will be rendered to it by ComBanc.

14.2
The staff for which the Participant will be responsible for and will require in order to comply with the functions that relate to the high value payment clearance and remittance services, shall be subject to any and all technical specifications and instructions that ComBanc may issue. If in ComBanc’s judgment, the staff must undergo training provided by ComBanc, such training shall not in any way limit the rights and authority of the Participant in its capacity as the employer of said staff, a status that it shall fully maintain.

14.3
ComBanc shall not be liable for the acts or actions of those associated with the Participant in connection with the performance by such employees in work or tasks related to the payment clearance and remittance service.

14.4
The Participant shall be liable for any damages or losses that may be caused by its employees because of misuse or improper use of the high value payment clearance and remittance service. Likewise, the Participant shall be liable for any damages that it or its employees might cause because of failure to follow the instructions and guidelines given by ComBanc with respect to the methods and procedures set forth for the proper and correct operation of the said high value payment and remittance service.

14.5
The Participant shall be subject to ComBanc’s instructions and guidelines regarding organization, methods and procedures pertaining to said proper and correct operation of the high value payment clearance and remittance service.

14.6
The Participant or ComBanc shall be liable for any damages or losses caused by their employees, advisors or
 

      
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sub-contractors through negligence, fraud, or improper or erroneous use of the high value payment clearance and remittance service.

15.         CONTINUITY OF THE SERVICES

15.1
ComBanc shall operate on all banking days at the times established in the Regulations.

15.2
Notwithstanding the foregoing, the services provided by ComBanc may be discontinued, suspended or interrupted in whole or in part, when:

a.
It is necessary to make repairs and/or do scheduled maintenance on all or part of the components and equipment that ComBanc uses for providing the high value payment clearance and remittance service; in such event, ComBanc must give notification within a period of not less than 24 hours in advance, or

b.
Under and because of circumstances of force majeure or an act of God. In that case, no prior communication will be necessary, but the services must be restored as soon as possible and with diligent promptness. Understood as force majeure or act of God for the purpose of this agreement, shall be what the law defines as such.

15.3
Under the circumstances or situations of force majeure or an act of God, ComBanc shall not be liable for any damages or losses that may be caused to the Participant. In any case, ComBanc undertakes to restore the services as soon as the causes that resulted in their interruption or suspension have ceased.
 
16.         ARCHIVING OF TRANSACTIONS

16.1
The Participant shall be obligated and responsible for maintaining the archives of all operations conducted through the high value payment and remittance service.

16.2
ComBanc shall maintain an active or on-line archive of only those transactions that have taken place in the last thirty (30) days, but shall subsequently maintain an archive of them on magnetic media. In the event that the Participant requests ComBanc to recover data, it must reimburse it for all costs incurred.

16.3
The ComBanc archives shall constitute sufficient proof in the event a dispute arises between the parties.
 
      
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17.         CONFIDENTIALITY AND SECRECY

17.1
ComBanc and the Participant and those associated with it, advisors and sub-contractors agree not to disclose in any way or by any means any of the data or information that they may receive from their respective counterpart, or any other information that might circumstantially fall into their hands, or to which they may have access in connection with the providing of the services subject to this instrument.

17.2
ComBanc and the Participant undertake to remain expressly vigilant regarding this obligation of confidentiality and secrecy in any contracts or agreements signed with those associated with it, advisors and sub-contractors, penalizing any infraction with immediate termination of the respective contract, without prejudice to any other penalties and fines that might be appropriate under the law.

17.3
Both ComBanc and the Participant undertake to reciprocally transmit only the information and data that are essential for the proper rendering of the services and in connection with the services subject to this contract.

17.4
The prohibitions referred to in the preceding paragraphs shall not apply if some legal provision or court ruling exists that obligates either of the parties to submit matters subject to the aforementioned confidentiality and secrecy to courts of justice or institutions or agencies empowered by law and acting within the scope of their authority.

17.5
In other cases, when the requested background information falls under ComBanc’s or the Participant’s confidentiality and secrecy obligation, the parties hereto may not deliver that information without the prior consent of the other.

17.6
The aforementioned confidentiality and secrecy obligations shall remain in full force even after the expiration of this agreement.
 
18.        FEES

18.1
The Participant undertakes to pay ComBanc the fees indicated in Appendix 3, “Fee System”.
 
19.         BANKING CONFIDENTIALITY AND SECRECY

19.1
Both the Participant and ComBanc with respect to the high value payment clearance and remittance service conducted through ComBanc, shall be subject to the
 

      
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banking secrecy and confidentiality referred to in Article 154 of the General Banking Law. In addition, they will be subject to all directives, rules and regulations that may in such respect be issued in the future by the Office of the Superintendent of Banks & Financial Institutions within the scope of the authority vested in that agency by law.
   
19.2
The obligations regarding banking confidentiality and secrecy shall continue indefinitely and beyond the life of this instrument.

20. MEANS OF EVIDENCE
   
20.1
The digital records of ComBanc are considered admissible as means of evidence, and shall be kept up-to-date with records showing the times of sending and receipt, content and sums indicated in messages interchanged and stored and/or debits and credits made; these records shall have probative value pursuant to the provisions of Articles 4 and 5 of Law 19,799.
 
21.  NEW SERVICES
   
21.1
ComBanc may offer new services to the Participant. If such new services are agreed to by the parties, these services shall be considered as having been agreed to by the mere approval of ComBanc’s proposal to the Authorized Agent, including operating conditions and fees, which shall form an integral part of the respective current Appendices to the present agreement, as applicable.
   
21.2 The Participant may opt not to accept the new services.
   
22. KNOWLEDGE OF THE SYSTEM

22.1
The parties undertake to make each of their customers, in an express and timely manner, familiar with the characteristics, potential outcomes and inherent risks of a high value payment clearance and remittance service, as established in this agreement, so that such customers will assume in an informed and responsible manner the risks and responsibilities of signing this contract.

22.2
Consequently, the Participant shall have the exclusive obligation of making its customers aware of the conditions governing the providing of the services subject to this agreement, as well as of informing those customers of the conditions governing the high value payment clearance and remittance service. Notwithstanding, in some cases, those agreements might run counter to the purpose and terms of the present service.
 

      
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23.        LIFE OF THE PRESENT AGREEMENT

23.1
The term of the present agreement shall be indefinite. Without prejudice to the foregoing, either party may terminate this agreement by giving notice to the other via certified mail sent to the address indicated herein at least one hundred twenty (120) days in advance. For the purpose of the present agreement, it shall be understood that the parties will maintain the addresses indicated in the introductory part of this agreement, except if notice is given by certified mail of a change in address, which must indicate the complete new address.

23.2
Notwithstanding the foregoing, providing of the services subject to this agreement shall terminate in advance in the following cases:

a.
Bankruptcy, insolvency, cessation of payments or proposals of payment agreements with its creditors on the part of ComBanc or the Participant;

b.
Mutual agreement by ComBanc and the Participant to terminate in advance;

c.
At the request of the properly performing party, in the case of gross non-performance of the contractual obligations, in part or in whole, by ComBanc or the Participant, such non-performance will be ruled upon by a subsequently appointed arbitrator.
 
24.        ASSIGNMENT OF THE AGREEMENT

24.1
It is expressly stipulated that neither party may assign or transfer for any reason whatsoever the rights under this agreement, except with the express written authorization given in advance by the other party.
 
25.         NON-EXCLUSIVITY

25.1
The present agreement does not grant exclusivity to either party, and both may request and provide similar services to other institutions or companies in general.
 
26.        PENALTY INTEREST

26.1
In the event that any sums of money owed by the Participant to ComBanc are not paid within
 

      
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the agreed-upon time, they shall be subject to the maximum rate of interest allowed under the law for credit and lending transactions; such interest shall be converted to local currency at the rate in effect on the day of default, and the interest shall run from that date until the actual date on which the payment obligation is met.
   
27.  ARBITRATION
   
27.1
Any disagreements, disputes or conflicts arising between the parties for any reason and under any circumstance that relate directly or indirectly to this agreement, or to any of its clauses, including but not limited to the agreement’s effects, term, application, interpretation, performance, non-performance, validity or invalidity, nullity or cancellation, existence or non-existence, shall be submitted to an arbitrator in accordance with the provisions of Chapter 15, “Resolution of Disputes” of the Regulations. The arbitrator shall be appointed by mutual agreement between the parties, and absent such an agreement, by the Chamber of Commerce of Santiago A.G. (the “Chamber of Commerce”), upon whom the parties confer a special irrevocable mandate for such purposes. The mere fact that either party appeals to the Chamber of Commerce for naming an arbitrator shall imply the existence of a disagreement between the parties respecting the amicable designation of an arbitrator.

27.2
Without prejudice to the foregoing, the parties may opt for technical mediation conducted by a mutually-agreed-upon expert. This mediation shall not pose an impediment to the aforementioned arbitration.
 
28.       GENERAL PROVISIONS

28.1
Separation of clauses: In the event that any provision embodied in this agreement or its Appendices is declared null, legally flawed or ineffective, it is hereby stipulated that such determination shall affect only the provision in question, and the remaining clauses of the agreement and/or its Appendices shall continue in full force and effect.

28.2
Conflicting rules or regulations: In the event of a conflict upon rules and/or regulations, the following order of precedence shall apply:

a.
Operating rules and regulations of the Sociedad Operadora de la Cámara de Compensación de Pagos de Alto Valor S.A.

      
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b.
Service Participant Operating Contract for the High Value Payment Clearance and Remittance Service

c.
Appendices to the present agreement

28.3
Domicile: The present parties elect their domiciles in the city of Santiago de Chile, and submit to the jurisdiction of the arbitration court indicated in Clause 24.

28.4
Execution of this agreement: This agreement is executed and signed in two (2) copies with the same content, with one (1) copy being given to each of the parties.

28.5     Legal Status:

 
The legal status of Felipe Ledermann Bernal to act on behalf of the Sociedad Operadora de la Cámara de Compensación de Pagos de Alto Valor S.A. is embodied in the public instrument dated October 13, 2004, made and executed before José Musalem Saffle, Notary in Santiago.

 
The legal status of Oscar von Chrismar Carvajal to act on behalf of the Banco Santander-Chile is embodied in the public instrument dated July 23, 2003, made and executed before Nancy de la Fuente Hernández, Notary in Santiago.




/s/ Segismundo Schulin-Zeuthen Serrano                                                    /s/ Oscar von Chrismar Carvajal
                    President                                                                                             Chief Executive Officer
Sociedad Operadora de la Cámara de                                                              Banco Santander-Chile
Compensación de Pagos de Alto Valor S.A.




/s/ Felipe Ledermann Bernal
            General Manager
Sociedad Operadora de la Cámara de
Compensación de Pagos de Alto Valor S.A.


      
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APPENDIX No. 3

Fee System


Introduction:

The fees that will apply to participants of the “Servicio Cámara de Compensación de Pago de Alto Valor” (High Value Clearing House Payment Service) are based on the following concepts:

a) Connection:

A one-time payment is made when signing the contract for services covering connection, testing, start-up, training and support provided by ComBanc.

As of August 1, 2005, there is no charge for connection.

b) Operation:

There is a monthly payment for operation of the High Value Clearing House Payment and Delivery-Against-Payment services.

In accordance with the “Regulations”, the billing allowed by ComBanc for operation, with respect to the number of participants, has a fixed component equivalent to 50.9% and a variable component equivalent to 49.1%.

The Fixed Component has an identical quota for all Participants.

The Variable Component is determined according to the percentage of participation in total net exchange sight balances in domestic currency of all the participants, determined as of the end of January 2003. A minimum percentage of 0.01% will be applied to those participants who in January 2003 had no share in the total net exchange sight balances in domestic currency.

For purposes of this agreement, 24.81% of the variable component of the projected billing will be applied to the Banco Santander-Chile.

Consequently, the operating fees are:

Fixed Component: UF 243 (Two hundred forty three UFs);
Variable component: UF 1,339 (One thousand three hundred thirty-nine UFs)


      
        Appendix 3
Page 1 of 3
    


c) SWIFT message reimbursement:

The Participant must reimburse ComBanc for expenses incurred by it on behalf of the Participant in regards to sending Transfer-of-Funds Instructions through Swift to a Payment System, or for messaging to the DCV and to the banks, that derive from payment operations undertaken by the Participant.

d) Authorization and power of attorney:

In accordance with letter c) above, the Participant grants and confers power of attorney to ComBanc to act on its behalf for receiving and paying invoices for messaging services charged by SWIFT and initiated by ComBanc for sending messages on behalf of the Participant through the Communications Network.

ComBanc, acting through its own authorized agents, accepts the power of attorney herein conferred, without prejudice to stipulating that this power of attorney will be exercised only pursuant to authorization given by the Participant.

For the proper implementation of this power of attorney, the parties stipulate the following:

a)
That the fees to be paid to SWIFT by ComBanc shall be disbursed by the latter, subject to reimbursement by the Participant;
b)
That the fees to be paid to SWIFT by ComBanc shall not be paid by ComBanc’s employees;
c)
That any sums paid to SWIFT in exercise of said power of attorney shall be recorded in special books, indicating the name of the beneficiary so as to facilitate reimbursement to ComBanc, and
d)
That in any exempt invoices that ComBanc issues to the banks, the different items in question will have to be clearly detailed and itemized so that the banks can proceed with reimbursement, with these supporting documents serving as sufficient verification of the reporting obligations of the holder of power of attorney.

e) New services:

New services are any services that the Board of Directors of ComBanc may establish, and which the Participant decides to use.


      
        Appendix 3
Page 2 of 3
    


Billing and payment

The billing and payment for the services subject to this Appendix shall be made in national currency, in accordance with the value given the UF on the last day of the month in which the service is provided.

The user must pay the amount of this invoice within ten (10) days following its receipt.

If said invoice is not paid when due, payment must be made of the value of the UF that is in effect on the actual payment date, for which a supplementary invoice will be issued covering the difference.

Any and all sums that the user owes ComBanc that are not settled on the corresponding due dates, shall be subject to the maximum interest rate allowed by law on loan and credit transactions, adjusted to local currency in accordance with the rate in effect on the day of default.

Commencement of Fees

The fees shall become effective from the first month of operation of the Clearing House.
 
 
 
Appendix 3
Page 3 of 3
 
 
 

 
 
 
Exhibit 4A.6

 
I.G./
Register No. 4,199


COMMERCIAL PLEDGE AGREEMENT ON SHARES

COMMERCIAL PLEDGE AGREEMENT ON SHARES OF

ADMINISTRADOR FINANCIERO DE TRANSANTIAGO, S.A.

PLEDGED TO

INVERSIONES ALSACIA S.A. ET AL


In Santiago de Chile, on this 5th day of February in the year 2007, before me, RAÚL IVÁN PERRY PEFAUR, a local Notary Public with offices located at Calle Ahumada 312, suite 36, incumbent Notary of the 21st Notarial Office of Santiago, appeared JOSÉ MANUEL MENA VALENCIA, a Chilean citizen, married, industrial civil engineer by profession, holder of national identification card No. 6,196,849-0, verifiably representing the BANCO DEL ESTADO DE CHILE, an autonomous entity of the Chilean government, tax identification No. 97,030,000-7, both domiciled in this city of Santiago at Avenida del Libertador Bernardo O’Higgins No. 1111; JULIO GUZMAN HERRERA, a Chilean citizen, married, commercial engineer by profession, holder of



national identification card No. 3,673,092-9, verifiably representing the BANCO DE CHILE, a corporation engaged in the banking business, tax identification No. 97,004,000-5, both domiciled in this city of Santiago at Calle Ahumada No. 251; OSCAR VON CHRISMAR CARVAJAL, a Chilean citizen, married, an engineer by profession, holder of national identification card No. 6,926,511-1, verifiably representing the BANCO SANTANDER-CHILE, a corporation engaged in the banking business, tax identification No. 97,036,000-K, both domiciled in this city of Santiago at Calle Bandera No. 140; MARIO GOMEZ DUBRAVCIC, a Chilean citizen, married, commercial engineer by profession, holder of national identification card No. 5,865,947-9, verifiably representing the BANCO DE CREDITO E INVERSIONES, a corporation engaged in the banking business, tax identification No. 97,006,000-6, both domiciled in this city of Santiago at Calle Huérfanos No. 1134; RAUL LUPERCIO VÉJAR OLEA, a Chilean citizen, married, civil engineer by profession, holder of national identification card No. 6,580,740-8, verifiably representing SONDA S.A., a corporation engaged in data processing services, tax identification No. 83,620,000-4, both domiciled in this city of Santiago at Calle Teatinos No. 500, and CLAUDIO CISTERNAS DUQUE, a Chilean citizen, married, commercial engineer by profession, holder of national identification card No. 10,174,449-3 and MARIA ANGELICA SILVA ARRUE, a Chilean citizen, married, accountant by profession, holder of national identification card No. 6,651,290-8,



both verifiably representing PROMOTORA CMR FALABELLA S.A., a corporation engaged in lending, tax identification No. 96,743,000-6, all domiciled in this city of Santiago at Calle Ahumada No. 236, 7th floor, all jointly for purposes of this agreement being called the “Shareholders” or the “Pledge Debtors”, parties of the first part, and as parties of the second part, RICARDO JOSE BARTEL JEFFERY, a Chilean citizen, holder of national identification card No. 8,741,336-5, verifiably representing INVERSIONES ALSACIA S.A., tax identification No. 99,577,400-3, a corporation legally organized and existing under Chilean law, both domiciled at Calle Marchant Pereira No. 10, 20th floor, suite 2001, Town of Providencia; ANDRES OCAMPO BORRERO, a Colombian citizen, holder of alien identification card No. 21,917,402-0, and HECTOR DEL TRANSITO MOYA MARTIN, a Chilean citizen, holder of national identification card No. 6,076,632, both verifiably representing SU BUS CHILE, S.A., taxpayer identification No. 21,918,402-0, a corporation organized and existing under the laws of Chile, all domiciled in the city of Santiago at Calle Santa Lucia No. 324, suites 41 and 42; MANUEL ULISES NAVARRETE MUÑOZ, a Chilean citizen, holder of national identification card No. 4,462,201-7, verifiably representing BUSES GRAN SANTIAGO, S.A., taxpayer identification No. 99,557,450-0,



a corporation organized and existing under the laws of Chile, both domiciled in the city of Santiago at Calle Catedral No. 1712, 3rd floor, suite 4; RICARDO JOSE BARTEL JEFFREY, a Chilean citizen, holder of national identification card No. 8,741,336-5, verifiably representing EXPRESS DE SANTIAGO, S.A., taxpayer identification No. 99,577,390-2, a corporation organized and existing under the laws of Chile, both domiciled in the Town of Providence at Calle Marchant Pereira No. 10, floor 20, suite 2001; MANUEL ULISES NAVARRETE MUÑOZ, a Chilean citizen, holder of national identification card No. 4,462,201-7, verifiably representing BUSES METROPOLITANA, S.A., taxpayer identification No. 99,557,440-3, a corporation organized and existing under the laws of Chile, both domiciled in the city of Santiago at Calle Catedral No. 1712, 3rd floor, suite 4; Mr. RAMON YAVAR BASCUÑAN, a Chilean citizen, married, civil engineer by profession, holder of national identification card No. 6,758,105-9 and Mr. MARCOS RETAMAL MUÑOZ, a Chilean citizen, married, commercial engineer by profession, holder of national identification card No. 14,268,425-K, both verifiably representing REDBUS URBANO S.A., tax identification number 99,578,170-0, a corporation organized and existing under the laws of Chile, all domiciled at Avenida Panamericana Norte No. 9800



in the Town of Quilicura; Mr. LUIS BARAHONA MORAGA, a Chilean citizen, holder of national identification card No. 8,711,413-9 and Mr. JORGE ROLANDO GÓMEZ PÉREZ, a Chilean citizen, holder of national identification card No. 6,051,829-7, both verifiably representing SERVICIOS DE TRANSPORTE DE PERSONAS SANTIAGO S.A., tax identification number 99,559,010-7, a corporation organized and existing under the laws of Chile, all domiciled at Calle Abdón Cifuentes No. 51 in the city of Santiago; ROBERTO HERNAN RODRIGUEZ SILVA, holder of national identification card No. 10,577,000-6, verifiably representing UNION DEL TRANSPORTE S.A., tax identification number 99,577,940-4, a corporation organized and existing under the laws of Chile, both domiciled at Calle Compañía No. 1390, suite 414, in the city of Santiago; SIMON ABELARDO DOSQUE SAN MARTIN, holder of national identification card No. 5,800,674-2, verifiably representing COMERCIAL NUEVO MILENIO S.A., tax identification number 99,546,310-5, a corporation organized and existing under the laws of Chile, both domiciled at Avenida Libertador Bernardo O’Higgins No. 1948, in the city of Santiago; and JOSE GABRIEL MARTINEZ MUÑOZ, a Chilean citizen, holder of national identification card No. 5,550,804-6 and ADRIANA DEL CARMEN TRONCOSCO LIZANA, a Chilean citizen, holder of national identification card No.



5,799,135-6, both verifiably representing TRANS ARAUCARISAS S.A., tax identification number 99,578,170-0, a corporation organized and existing under the laws of Chile, all domiciled at Los Nogales No. 2845 in the Town of La Pintana, also hereinafter referred to as the “Pledge Creditors”. The appearing parties named are all of legal age, have accredited their identities by exhibiting the aforementioned identification cards, and state that they have agreed to make, as they do in fact make the following commercial pledge agreement, in accordance with Articles 813 and following of the Commercial Code. Clause One. Background – 1) The Shareholders are currently shareholders of the closed corporation known as ADMINISTRADOR FINANCIERO DE TRANSANTIAGO S.A., subject to the laws of open or publicly-held corporations that support the banking industry, hereinafter referred to indistinctly as the “Corporation” or “AFT”, founded and established by a public instrument dated June 8, 2005, executed before Raúl Iván Perry Pefaur, Notary in Santiago, an extract of which is recorded on page 20,009, number 14,486 of the Registry of Trade of the Custodian of Real Estate of Santiago for the year 2005, and was also published in the Official Gazette of June 14th of that same year. 2) José Manuel Mena Valencia declares that the BANCO DEL ESTADO DE CHILE is currently sole owner, among others, of 210,000 shares issued by AFT, as officially shown in stock certificate number 001 of June 8, 2005; Ignacio Ruiz-Tagle Vergara declares that the BANCO SANTANDER-CHILE is currently sole owner, among others, of 200,000 shares issued by AFT, as officially shown in stock certificate number 002 of June 8, 2005; Julio Guzmán Herrera declares



that the BANCO DE CHILE is currently sole owner, among others, of 200,000 shares issued by AFT, as officially shown in stock certificate number 003 of June 8, 2005; Mario Gómez Dubravcic declares that the BANCO DE CREDITO E INVERSIONES is currently sole owner, among others, of 200,000 shares issued by AFT, as officially shown in stock certificate number 004 of June 8, 2005; Raúl Lupercio Véjar Olea declares that SONDA S.A. is currently sole owner, among others, of 95,000 shares issued by AFT, as officially shown in stock certificate number 005 of June 8, 2005, and Claudio Cisternas Duque and María Angélica Silva Arrúe declare that PROMOTORA CMR FALABELLA S.A. is currently sole owner, among others, of 95,000 shares issued by AFT, as officially shown in stock certificate number 006 of June 8, 2005. The shares of the Shareholders in the Corporation, hereinafter referred to all together as the “Shares”, are validly recorded in the names of each of the corporations in the pertinent Registry of Shareholders of the Corporation; said shares are registered, common, without nominal value, of equal value and all of one same and sole series. 3) Per resolution number 15 of 2004 issued by the Ministry of Transportation & Telecommunications, hereinafter referred to as the “Ministry”, the Basic Conditions and Specifications of the Public Bid respecting the Supplementary Financial Administration Services Contract for the funds of the public passenger transportation system of Santiago, hereinafter referred to as the “AFT Bid Specifications 2004”, were approved. 4) Per resolution number 897 of April 18, 2005, of the Ministry, the awarding of AFT Bid Specifications 2004 was approved, said award having been made to the Banco del Estado de Chile. 5) On July 28, 2005, the Corporation and the Ministry entered into the



Supplementary Financial Administration Services Contract for the funds of the public passenger transportation system of Santiago, hereinafter referred to as the “AFT Agreement”, which was approved by Special Resolution number 1853 of 2005 of the Ministry. Clause Two. PURPOSE OF THE AGREEMENT. By this agreement, the Shareholders, duly represented as described above, constitute a commercial pledge in favor of the Pledge Creditors, in accordance with Articles 813 et seq. of the Commercial Code, and pursuant to the terms and conditions set forth above, on the Shares owned by them, as itemized and described in Clause One of this instrument, for the purpose of guaranteeing the full, effective, faithful and timely performance of each and every one of the obligations contracted by the Corporation under the AFT Agreement and the mandates conferred by the Pledge Creditors in their capacities as providers of transportation services, conforming with what is stipulated in the aforementioned AFT Agreement, and likewise by virtue of any other document that may supplement the subject agreement in the future; the subject pledge also covers the reimbursement, if any, of all costs and expenses, legal and extra-legal, including attorneys’ fees, if any, that may be incurred in connection with any proceedings or transfer of this pledge. Clause Three. NON-EXISTENCE OF LIENS AND/OR ENCUMBRANCES ON THE PLEDGED SHARES. The Shareholders likewise undertake not to constitute or permit any lien or encumbrance on, or otherwise engage in any act or make any contract respect the Shares pledged by this instrument, whether such lien, encumbrance, act or contract pertains to all of the Shares or a part thereof, without the prior express and written approval of the Pledge Creditors, and pursuant to the terms of the within Agreement. The parties appearing declare that the term “lien” means any real guarantees or any obligation, encumbrance, prohibition, condition, rights granted to third-parties, attachments, impediments or
 

 
restrictions that may affect or impede or limit the free use, enjoyment and disposal of the Shares. Clause Four. DELIVERY OF SHARES AND ACCEPTANCE. The parties appearing declare in this agreement that the Pledge Debtors shall deliver to the full satisfaction of the Pledge Creditors through their representatives designated in the introduction of this instrument, certificates Nos. 001, 002, 003, 004, 005 and 006 to the Banco del Estado de Chile, the Banco Santander-Chile, the Banco de Chile, the Banco de Crédito e Inversiones, and the corporations known as Sonda S.A. and Promotora CMR Falabella S.A., respectively, issued by the Corporation to whom the shares pledged in the present instrument belong. Likewise, Ricardo José Bartel Jeffery, Andrés Ocampo Borrero, Héctor del Tránsito Moya Martín, Manuel Ulises Navarrete Muñoz, Ramón Yávar Bascuñan, Marcos Retamal Muñoz, Luis Barahona Moraga, Jorge Rolando Gómez Pérez, Roberto Hernán Rodríguez Silva, Simón Abelardo Dosque San Martín, José Gabriel Martínez Muñoz and Adriana del Carmen Troncoso Lizana, in the name and on behalf of the Pledge Creditors, accept the pledge of shares described herein and prohibition of establishing any liens and/or encumbrances thereon, and acquire for their respective principals the real right of pledge. Clause Five. EXTENT OF THE PLEDGE. The pledge and the restrictions and prohibitions made in this instrument include and extend ipso jure to any appreciation the shares might undergo, and include but are not limited to paid shares, preferential rights or options of any kind, whether of preferential subscription to shares, stock-convertible bonds or any other securities that confer future rights on the Corporation or on any successor or substitute corporation or entity. Likewise, in the case of issuance of new paid shares, any new securities that may be issued with respect to the pledge



presently made are understood to be affected. The Pledge Debtors irrevocably authorize the Pledge Creditors, on behalf of whom the named representatives accept, to request from the Corporation or its successor corporation or substitute entity, and for withdrawing and receiving from such corporation, any new stock certificates or other securities that may be issued as a consequence of an issuance of paid shares or exchange of shares for the issuance of new shares for any reason, without having to be delivered by the Corporation or any successor or substitute corporation or entity to the Pledge Debtors, with the Pledge Creditors being obligated to immediately request a Notary Public to give notice of the pledge agreement to record said encumbrance on these new shares in the Registry of Shareholders of the Corporation or any successor or substitute corporation. With respect to the ownership rights pertaining to the Shares, these rights will belong to the Pledge Debtors, who may collect any distributions on the pledged Shares that relate to dividends declared on the net earnings for the last business year. Without prejudice to what is stated above, in the event of any non-performance of any of the obligations guaranteed under Clause Two hereof, the Pledge Creditors may immediately demand the enforcement of the pledge made in this instrument. Any non-performance by the Corporation will not require verification to the corporation issuing the Shares or any successor or replacement corporation, rather, a written notice of non-performance issued by the Notary of the corporation issuing the Shares or any successor or replacement corporation, with a copy to the Pledge Debtors will therefore suffice. This latter circumstance will not require verification to the corporation issuing the Shares or any successor or replacement corporation. Commencing from the date of said notice and on the merits of it alone, the Pledge Creditors may



demand that the corporation, or any successor or replacement corporation, collect dividends and earnings that the holder or owner of the Shares is due, and for such purposes, the corporation or any successor or replacement corporation shall be empowered to pay said amounts to the Pledge Creditors, thereby releasing the Pledge Debtors from any liability to the Corporation, or its successor or replacement, as the entity issuing the shares that have been pledged in this instrument, with respect to those payments. Clause Six. PRESERVATION OF THE RIGHTS OF THE PLEDGE DEBTORS. The Pledge Debtors shall maintain full exercise of the right to participate in the General Meetings of Shareholders of the Corporation or any successor or replacement corporation, as a full member, and shall also maintain full exercise of any other rights corresponding to them that are different from those mentioned in Clause Five above. However, for approving any amendment to the by-laws of the Corporation the Pledge Debtors or any successor or replacement corporation that may affect the pledge and prohibitions constituted hereunder, in terms of reducing in a relevant manner the value of the guarantee, the prior written authorization of the Pledge Creditors shall be required, and the Pledge Creditors may not deny or delay such authorization without reasonable and due cause. Clause Seven. TRANSFORMATION OF THE CORPORATION. In the event of any break-up, merger or transformation of the corporation issuing the Shares previously authorized in writing by the Pledge Creditors in the manner stipulated in the preceding clause, the pledge and the restrictions and the prohibitions established hereunder shall extend to all of the shares of any new corporation or corporations that might be formed as a result of a break-up or merger, or of the surviving companies existing after the break-up or merger, pertinent to the rights or investment, as the case may be, in the transformed corporation. The Pledge Creditors are exclusively authorized to withdraw directly
 

 
through any of their authorized representatives or through a Notary Public who is petitioned in their name, the corresponding stock certificates in all of the preceding cases, and to request the recording of this pledge and prohibition(s) in the appropriate registries of shareholders, with the Pledge Debtors consequently waiving its right to request such delivery to itself or to another party. Clause Eight. COMMERCIAL PLEDGE. The commercial pledge made in this instrument is constituted in accordance with the provisions embodied in Articles 813 et seq. of the Commercial Code, and in accordance with Article Two hereof, and further in accordance with Articles 2384 et seq. of the Civil Code. Clause Nine. DECLARATION OF OWNERSHIP. Each of the Pledge Debtors declare that it is the sole and exclusive owner of the pledged shares; that these shares are duly recorded in its name in the Registry of Shareholders of the Corporation and that all of them are duly paid, and that the Pledge Debtors have the corresponding authorizations and approvals required by law. Likewise, the Pledge Debtors declare that the pledged shares are free and clear of any and all liens, encumbrances, obligations, judgments, restrictions, limitations, attachments, injunctions, resolutory actions or preferential third-party rights, save for the pledge that is made hereunder to the Pledge Creditors, and that the pledge shares are not affected by any options, promises of sale, conditional or term sales, or any other act or contract that has or might have as its purpose the transfer of ownership of said shares, and that no impediment exists that might affect their free disposal or the making of this pledge and prohibition on liens and sales. Legal Status. The legal status of Manuel Ulises Navarrete Muñoz to act in representation of Buses Gran Santiago S.A. is embodied in the public instrument of June 2, 2006,



executed before Osvaldo Pereira González, Notary in Santiago. The legal status of Simon Alberto Dosque San Martín to act in representation of Comercial Nuevo Milenio S.A. is embodied in the public instrument of May 4, 2006, executed before Alberto González Caamaño, Notary in Santiago. The legal status of Manuel Ulises Navarrete Muñoz to act in representation of Buses Metropolitana S.A. is embodied in public instrument of June 2, 2006, executed before Osvaldo Pereira González, Notary in Santiago. The legal status of Mr. Andrés Ocampo Borrero and Mr. Héctor del Tránsito Martín to act in representation of Su Bus Chile S.A. is embodied in the public instrument of September 26, 2005, executed before Notary Patricio Raby Benavente. The legal status of Ricardo José Bartel to act in representation of Express de Santiago Uno S.A. is embodied in the public instrument of June 2, 2006, executed before Osvaldo Pereira González, Notary in Santiago. The legal status of Manuel Ricardo José Bartel Jeffery to act in representation of Alsacia S.A. is contained in the public instrument of February 22, 2006, executed before Antonieta Mendoza Escalas, Notary in Santiago. The legal status of Mr. Luis Barahona Moraga and Mr. Jorge Rolando Gómez Pérez to act in representation of Servicio de Transporte de Personas Santiago S.A. is embodied in the public instrument of July 15, 2004, executed before Notary Pamela Hernández Machuca. The legal status of Roberto Hernán Rodríguez Silva to act in representation of Unión del Transporte S.A. is contained in the public instrument of February 22, 2005, executed before Notary Félix Jara Cadot. The legal status of José Gabriel Martínez Muñoz and Adriana del Carmen Troncoso Lizana to act in representation of



Trans Araucaia S.A. is embodied in the public instrument of January 27, 2006, executed before Juan Ricardo San Martín Urrejola, Notary in Santiago. The legal status of Ramón Yávar Bascuñan and Marcos Retamal Muñoz to act in representation of Redbus Urbano S.A. is embodied in the public instrument of December 1, 2005, executed before Patricio Zaldívar Mackenna, Notary in Santiago. The legal status of Raúl Lupercio Véjar Olea to act in representation of Sonda S.A. is contained in the public instrument of June 3, 2004, executed before Notary René Benavente Cash. The legal status of José Manuel Mena Valencia Muñoz to act in representation of the Banco del Estado de Chile is embodied in Treasury Department Supreme Decree No. 754 of 1995, published in the Official Gazette of August 4, 1995. The legal status of Julio Guzmán Herrera to act in representation of the Banco de Chile is embodied in the public instrument of March 4, 2002, executed before René Benavente Cash, Notary in Santiago. The legal status of Oscar Von Chrismar Carvajal to act in representation of the Banco Santander-Chile is embodied in the public instruments of July 25, 2002, and July 23, 2003, both executed before Nancy de la Fuente Hernández, Notary in Santiago. The legal status of Mario Gómez Dubravcic to act in representation of the Banco de Crédito e Inversiones is contained in the public instruments of May 30, 2005, and August 1, 2006, both executed before Alberto Mozó Aguilar, Notary in Santiago. The legal status of Claudio Cisternas Duque and María Angélica Silva Arrué to act in representation of Promotora CMR Falabella S.A. is embodied in the public instrument of October 8, 2004, executed before Notary Alberto Mozó Aguilar.




IN WITNESS WHEREOF, the instrument was signed after having been read. This instrument will be recorded in the Register of Public Instruments for the current month under the number indicated. A copy is being issued. I so attest.
 
 
 
By:
/s/ Oscar von Chrismar             
   
Name:
Oscar von Chrismar
     
Chief Executive Officer
 







Exhibit 12.1
 
 
CHIEF EXECUTIVE OFFICER CERTIFICATION
 
I, Oscar von Chrismar, certify that:
 
1.           I have reviewed this annual report on Form 20-F of Banco Santander-Chile;
 
2.           Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.           Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;
 
4.           The company’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the company and have:
 
(a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
(b)           Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
(c)           Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
(d)           Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; and
 
5.           The company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent functions):
 
(a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial information; and
 
(b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal control over financial reporting.
 
 
 
   
 
By:
/s/ Oscar von Chrismar
   

   
Name:
Oscar von Chrismar
   
Title:
Chief Executive Officer
Date:      June 18, 2007

 





Exhibit 12.2
 
 
CHIEF FINANCIAL OFFICER CERTIFICATION
 
I, Guillermo Sabater, certify that:
 
1.           I have reviewed this annual report on Form 20-F of Banco Santander-Chile;
 
2.           Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.           Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;
 
4.           The company’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the company and have:
 
(a)           Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
(b)           Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
(c)           Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
(d)           Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; and
 
5.           The company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent functions):
 
(a)           All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial information; and
 
(b)           Any fraud, whether or not material, that involves management or other employees who have a significant role in the company’s internal control over financial reporting.
 
 
By:
/s/ Guillermo Sabater
   
   
Name:
Guillermo Sabater
   
Title:
Chief Financial Officer
Date:      June 18, 2007


 



Exhibit 13.1
 
Section 906 Certification
 
The certification set forth below is being submitted in connection with the Annual Report on Form 20-F for the year ended December 31, 2005 (the “Report”) for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Section 1350 of Chapter 63 of Title 18 of the United States Code.
 
Oscar von Chrismar, the Chief Executive Officer and Guillermo Sabater, the Chief Financial Officer of Banco Santander-Chile, each certifies that, to the best of his knowledge:
 
 
1.
the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and
 
 
2.
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Banco Santander-Chile.
 
           June 18, 2007
 
 
By:
/s/ Oscar von Chrismar             
   
Name:
Oscar von Chrismar
     
Chief Executive Officer
 
 
 
By:
/s/ Guillermo Sabater             
   
Name:
Guillermo Sabater
     
Chief Financial Officer


 

 
 
EXHIBIT 23.1
   
 
Deloitte & Touche 
Sociedad de Auditores y Consultores Ltda.
RUT: 80.276.200-3 
Av. Providencia 1760Pisos 6,7,8 y 9 Providencia, Santiago                                    
Chile
Fono: (56-2)270 3000
Fax: (56-2) 374 9177
e-mail: deloittechile@deloitte.com
www.deloitte.cl
 
 
 
 
 
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
We consent to the incorporation by reference in the Registration Statement No. 333-138953 on Form F-3 of our reports dated May 10, 2007 relating to the consolidated financial statements of Banco Santander Chile and its subsidiaries (collectively referred to as “Banco Santander Chile”) (which report expresses an unqualified opinion and contains explanatory paragraphs (1) referring to the translation of Chilean peso amounts into U.S. dollar amounts, (2) the reconciliation of Chilean GAAP to U.S. GAAP for net income and shareholders’ equity and the application thereof and (3) the modified accounting basis under Chile GAAP for recording and valuation of financial investments acquired for trading, available-for-sale and held-to-maturity investments and derivative instruments), and management’s report on the effectiveness of internal control over financial reporting appearing in the Annual Report on Form 20-F of Banco Santander Chile for the year ended December 31, 2006.
 
 
/s/ Deloitte & Touche
Santiago, Chile
June 14, 2007
 
 
 
Una firma miembro de
Deloitte Touche Tohmatsu
 
 
EXHIBIT 23.2
 
 
   
 

PricewaterhouseCoopers
RUT. 81.513.400-1
Santiago de Chile
Av. Andrés Bello 2711
Torre La Costanera - Pisos 2, 3, 4, y 5
Las Condes
Teléfono [56](2) 940 0000
www.pwc.cl
 
 
 
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
We hereby consent to the incorporation by reference in the Registration Statement on Form F-3 (File No. 333-138953) of Banco Santander-Chile of our report dated June 28, 2005, except for the restatement to constant Chilean pesos of December 31, 2006, for which the date is April 13, 2007 relating to the financial statements which appears in this Form 20-F.
 
/s/ PricewaterhouseCoopers 

PricewaterhouseCoopers
Santiago, Chile
June 14, 2007