Santander Holdings USA, Inc. - Annual Report: 2018 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, 2018
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to .
Commission File Number: 001-16581
SANTANDER HOLDINGS USA, INC.
(Exact name of registrant as specified in its charter)
Virginia (State or other jurisdiction of incorporation or organization) | 23-2453088 (I.R.S. Employer Identification No.) | |
75 State Street, Boston, Massachusetts (Address of principal executive offices) | 02109 (Zip Code) | |
(617) 346-7200
Registrant’s telephone number including area code
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes þ. No o.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes o. No þ.
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 þ. No o.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation ST (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit). Yes þ. No o.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer þ | (Do not check if smaller reporting company) | |
Smaller reporting company o | ||
Emerging growth company o | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o. No þ.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding at February 28, 2019 | |
Common Stock (no par value) | 530,391,043 shares | |
INDEX
Page | |
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FORWARD-LOOKING STATEMENTS
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES
This Annual Report on Form 10-K of Santander Holdings USA, Inc. (“SHUSA” or the “Company”) contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 regarding the financial condition, results of operations, business plans and future performance of the Company. Words such as “may,” “could,” “should,” “looking forward,” “will,” “would,” “believe,” “expect,” “hope,” “anticipate,” “estimate,” “intend,” “plan,” “assume," "goal," "seek" or similar expressions are intended to indicate forward-looking statements.
Although SHUSA believes that the expectations reflected in these forward-looking statements are reasonable as of the date on which the statements are made, these statements are not guarantees of future performance and involve risks and uncertainties based on various factors and assumptions, many of which are beyond the Company's control. Among the factors that could cause SHUSA’s financial performance to differ materially from that suggested by forward-looking statements are:
• | the effects of regulation and/or policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the "FDIC"), the Office of the Comptroller of the Currency (the “OCC”) and the Consumer Financial Protection Bureau (the “CFPB”), and other changes in monetary and fiscal policies and regulations, including policies that affect market interest rates and money supply, as well as in the impact of changes in and interpretations of generally accepted accounting principles in the United States of America ("GAAP"), the failure to adhere to which could subject SHUSA to formal or informal regulatory compliance and enforcement actions and result in fines, penalties, restitution and other costs and expenses, changes in our business practice, and reputational harm; |
• | SHUSA’s ability to manage credit risk that may increase to the extent our loans are concentrated by loan type, industry segment, borrower type or location of the borrower or collateral; |
• | the slowing or reversal of the current U.S. economic expansion and the strength of the U.S. economy in general and regional and local economies in which SHUSA conducts operations in particular, which may affect, among other things, the level of non-performing assets, charge-offs, and provisions for credit losses; |
• | inflation, interest rate, market and monetary fluctuations, which may, among other things, reduce net interest margins and impact funding sources and the ability to originate and distribute financial products in the primary and secondary markets; |
• | Santander Consumer USA Inc.'s ("SC's") agreement with Fiat Chrysler Automobiles US LLC ("FCA") may not result in currently anticipated levels of growth, is subject to performance conditions that could result in termination of the agreement, and is also subject to an option giving FCA the right to acquire an equity participation in the Chrysler Capital portion of SC's business; |
• | the pursuit of protectionist trade or other related policies, including tariffs by the U.S., its global trading partners, and/or other countries; |
• | adverse movements and volatility in debt and equity capital markets and adverse changes in the securities markets, including those related to the financial condition of significant issuers in SHUSA’s investment portfolio; |
• | SHUSA's ability to grow revenue, manage expenses, attract and retain highly-skilled people and raise capital necessary to achieve its business goals and comply with regulatory requirements; |
• | SHUSA’s ability to effectively manage its capital and liquidity, including approval of its capital plans by its regulators and its ability to continue to receive dividends from its subsidiaries or other investments; |
• | changes in credit ratings assigned to SHUSA or its subsidiaries; |
• | the ability to manage risks inherent in our businesses, including through effective use of systems and controls, insurance, derivatives and capital management; |
• | SHUSA’s ability to timely develop competitive new products and services in a changing environment that are responsive to the needs of SHUSA's customers and are profitable to SHUSA, the success of our marketing efforts to customers, and the potential for new products and services to impose additional unexpected costs, losses, or other liabilities not anticipated at their initiation, and expose SHUSA to increased operational risk; |
• | competitors of SHUSA may have greater financial resources or lower costs, or be subject to different regulatory requirements than SHUSA, may innovate more effectively, or may develop products and technology that enable those competitors to compete more successfully than SHUSA and cause SHUSA to lose business or market share; |
• | consumers and small businesses may decide not to use banks for their financial transactions, which could impact our net income; |
• | changes in customer spending, investment or savings behavior; |
• | loss of customer deposits that could increase our funding costs; |
• | the ability of SHUSA and its third-party vendors to convert, maintain and upgrade, as necessary, SHUSA’s data processing and other information technology ("IT") infrastructure on a timely and acceptable basis, within projected cost estimates and without significant disruption to our business; |
• | SHUSA's ability to control operational risks, data security breach risks and outsourcing risks, and the possibility of errors in quantitative models SHUSA uses to manage its business, including as a result of cyberattacks, technological failure, human error, fraud or malice, and the possibility that SHUSA's controls will prove insufficient, fail or be circumvented; |
• | the ability of certain European member countries to continue to service their debt and the risk that a weakened European economy could negatively affect U.S.-based financial institutions, counterparties with which SHUSA does business, as well as the stability of global financial markets, including economic instability and recessionary conditions in Europe and the eventual exit of the United Kingdom from the European Union; |
• | changes to income tax laws and regulations and the outcome of ongoing tax audits by federal, state and local income tax authorities that may require SHUSA to pay additional taxes or recover fewer overpayments compared to what has been accrued or paid as of period-end; |
• | the costs and effects of regulatory or judicial proceedings, including possible business restrictions resulting from such proceedings; |
• | adverse publicity, and negative public opinion, whether specific to SHUSA or regarding other industry participants or industry-wide factors, or other reputational harm; and |
• | acts of terrorism or domestic or foreign military conflicts; and acts of God, including natural disasters. |
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GLOSSARY OF ABBREVIATIONS AND ACRONYMS
SHUSA provides the following list of abbreviations and acronyms as a tool for the readers that are used in Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Consolidated Financial Statements and the Notes to Consolidated Financial Statements.
ABS: Asset-backed securities | FASB: Financial Accounting Standards Board | |
ACL: Allowance for credit losses | FBO: Foreign banking organization | |
AFS: Available-for-sale | FCA: Fiat Chrysler Automobiles US LLC | |
ALLL: Allowance for loan and lease losses | FDIC: Federal Deposit Insurance Corporation | |
Alt-A: Loans originated through brokers outside the Bank's geographic footprint, often lacking full documentation | Federal Reserve: Board of Governors of the Federal Reserve System | |
ASC: Accounting Standards Codification | FHLB: Federal Home Loan Bank | |
ASU: Accounting Standards Update | FHLMC: Federal Home Loan Mortgage Corporation | |
Bank: Santander Bank, National Association | FICO®: Fair Isaac Corporation credit scoring model | |
BHC: Bank holding company | Final Rule: Rule implementing certain of the EPS mandated by Section 165 of the DFA | |
BOLI: Bank-owned life insurance | FINRA: Financial Industrial Regulatory Authority | |
BSI: Banco Santander International | FNMA: Federal National Mortgage Association | |
BSPR: Banco Santander Puerto Rico | FRB: Federal Reserve Bank | |
CBP: Citizens Bank of Pennsylvania | FVO: Fair value option | |
CCAR: Comprehensive Capital Analysis and Review | GAAP: Accounting principles generally accepted in the United States of America | |
CD: Certificate of deposit | GAP: Guaranteed auto protection | |
CEF: Closed-end fund | HFI: Held for investment | |
CET1: Common equity Tier 1 | HTM: Held to maturity | |
CFPA: Consumer Financial Protection Act | IHC: U.S. intermediate holding company | |
CFPB: Consumer Financial Protection Bureau | IPO: Initial public offering | |
Change in Control: First quarter 2014 change in control and consolidation of SC | IRS: Internal Revenue Service | |
Chrysler Agreement: Ten-year private label financing agreement with Fiat Chrysler Automobiles US LLC, formerly Chrysler Group LLC, signed by SC | ISDA: International Swaps and Derivatives Association, Inc. | |
Chrysler Capital: Trade name used in providing services under the Chrysler Agreement | LCR: Liquidity coverage ratio | |
CIB: Corporate and Investment Banking | LHFI: Loans HFI | |
CLTV: Combined loan-to-value | LHFS: Loans held-for-sale | |
CMO: Collateralized mortgage obligation | LIBOR: London Interbank Offered Rate | |
CODM: Chief Operating Decision Maker | LTD: Long-term debt | |
Company: Santander Holdings USA, Inc. | LTV: Loan-to-value | |
Covered Fund: hedge fund or a private equity fund under the Volcker Rule | MBS: Mortgage-backed securities | |
CRA: Community Reinvestment Act | MD&A: Management's Discussion and Analysis of Financial Condition and Results of Operations | |
CRE: Commercial Real Estate | MSR: Mortgage servicing right | |
DCF: Discounted cash flow | MVE: Market value of equity | |
DFA: Dodd-Frank Wall Street Reform and Consumer Protection Act | NCI: Non-controlling interest | |
DOJ: Department of Justice | NPL: Non-performing loan | |
DRIVE: Drive Auto Receivables Trust | NYSE: New York Stock Exchange | |
DTI: Debt-to-income | OCC: Office of the Comptroller of the Currency | |
ECOA: Equal Credit Opportunity Act | OEM: Original equipment manufacturer | |
EPS: Enhanced Prudential Standards | OREO: Other real estate owned | |
ETR: Effective tax rate | OTTI: Other-than-temporary impairment | |
Exchange Act: Securities Exchange Act of 1934, as amended | ||
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Parent Company: the parent holding company of SBNA and other consolidated subsidiaries | SEC: Securities and Exchange Commission | |
REIT: Real estate investment trust | Securities Act: Securities Act of 1933, as amended | |
RIC: Retail installment contract | SFS: Santander Financial Services, Inc. | |
RV: Recreational vehicle | SHUSA: Santander Holdings USA, Inc. | |
RWA: Risk-weighted asset | SIS: Santander Investment Securities Inc. | |
S&P: Standard & Poor's | SSLLC: Santander Securities LLC | |
SAM: Santander Asset Management, LLC | TCJA: Tax Cut and Jobs Act of 2017 | |
Santander: Banco Santander, S.A. | TDR: Troubled debt restructuring | |
Santander BanCorp: Santander BanCorp and its subsidiaries | TLAC: Total loss-absorbing capacity | |
Santander UK: Santander UK plc | Trusts: Securitization trusts | |
SBNA: Santander Bank, National Association | UPB: Unpaid principal balance | |
SC: Santander Consumer USA Holdings Inc. and its subsidiaries | VIE: Variable interest entity | |
SC Common Stock: Common shares of SC | VOE: Voting rights entity | |
SCF: Statement of cash flows | ||
SCRA: Servicemembers' Civil Relief Act | ||
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PART I
ITEM 1 - BUSINESS
General
Santander Holdings USA, Inc. ("SHUSA" or the "Company") is the parent company of Santander Bank, National Association, (the "Bank" or "SBNA"), a national banking association, and owns a majority interest (approximately 69.9% as of February 21, 2019) of Santander Consumer USA Holdings Inc. (together with its subsidiaries, "SC"), a specialized consumer finance company focused on vehicle finance and third-party servicing. SHUSA is headquartered in Boston, Massachusetts and the Bank's main office is in Wilmington, Delaware. SC is headquartered in Dallas, Texas. SHUSA is a wholly-owned subsidiary of Banco Santander, S.A. ("Santander"). SHUSA is also the parent company of Santander BanCorp (together with its subsidiaries, “Santander BanCorp”), a holding company headquartered in Puerto Rico which offers a full range of financial services through its wholly-owned banking subsidiary, Banco Santander Puerto Rico; Santander Securities, LLC (“SSLLC”), a broker-dealer headquartered in Boston; Banco Santander International (“BSI”), an Edge Act corporation located in Miami which offers a full range of banking services to foreign individuals and corporations based primarily in Latin America; Santander Investment Securities Inc. (“SIS”), a registered broker-dealer located in New York providing services in investment banking, institutional sales, trading and offering research reports of Latin American and European equity and fixed-income securities; and several other subsidiaries.
The Bank's principal markets are in the Mid-Atlantic and Northeastern United States. At December 31, 2018, the Bank had 627 branches and 2,274 automated teller machines ("ATMs") across its footprint. The Bank uses its deposits, as well as other financing sources, to fund its loan and investment portfolios. The Bank earns interest income on its loan and investment portfolios. In addition, the Bank generates non-interest income from a number of sources, including deposit and loan services, sales of loans and investment securities, capital markets products and bank-owned life insurance ("BOLI"). The Bank's principal non-interest expenses include employee compensation and benefits, occupancy and facility-related costs, technology and other administrative expenses. The financial results of the Bank are affected by the economic environment, including interest rates and consumer and business confidence and spending, as well as the competitive conditions within the Bank's geographic footprint.
SC's primary business is the indirect origination of retail installment contracts ("RICs"), principally through manufacturer-franchised dealers in connection with their sale of new and used vehicles to retail consumers. SC also offers a full spectrum of auto financing products and services to Chrysler customers and dealers under the Chrysler Capital brand, the trade name used in providing services ("Chrysler Capital") under the ten-year private label financing agreement with Fiat Chrysler Automobiles US LLC ("FCA"), formerly Chrysler Group LLC, signed by SC in 2013 (the "Chrysler Agreement"). These products and services include consumer RICs and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile and recreational and marine vehicle portfolios for other lenders. Additionally, SC has several relationships through which it provides other consumer finance products.
Since its initial public offering (the “IPO”), SC has been consolidated with the Company and Santander for financial reporting and accounting purposes. If the Company directly, and Santander indirectly, owned 80% or more of SC’s common shares (“SC Common Stock”), SC could be consolidated with the Company and Santander for tax filing and capital planning purposes as well. Among other things, tax consolidation would (1) facilitate certain offsets of SC’s taxable income, (2) eliminate the double taxation of dividends from SC, and (3) trigger a release into SHUSA’s income the non-goodwill portion of the deferred tax liability established with respect to its ownership of SC. In addition, SHUSA and Santander would recognize a larger percentage of SC's net income. SC Common Stock is listed for trading on the New York Stock Exchange (the "NYSE") under the trading symbol "SC".
SC's Relationship with FCA
Since May 2013, SC entered into the Chrysler Agreement, pursuant to which SC became the preferred provider for FCA’s consumer loans and leases and dealer loans. Business generated under terms of the Chrysler Agreement is branded as Chrysler Capital. During 2018, SC originated more than $7.9 billion of Chrysler Capital retail installment contracts ("RICs") and more than $9.7 billion of Chrysler Capital vehicle leases.
The Chrysler Agreement requires, among other things, that SC bears the risk of loss on loans originated pursuant to the agreement, but also that FCA shares in any residual gains and losses from consumer leases. The agreement also requires that SC maintains at least $5.0 billion in funding available for dealer inventory financing and $4.5 billion of financing dedicated to FCA retail financing. In turn, FCA must provide designated minimum threshold percentages of its subvention business to SC.
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The Chrysler Agreement has a ten-year term, subject to early termination in certain circumstances, including the failure by either party to comply with certain of their ongoing obligations. These obligations include, for SC, meeting specified escalating penetration rates for the first five years and, for FCA, treating SC in a manner consistent with comparable original equipment manufacturers' ("OEMs`") treatment of their captive providers, primarily regarding sales support. In addition, FCA may also terminate the agreement if, among other circumstances, (i) a person other than Santander or its affiliates or its other stockholders owns 20% or more of its common stock and Santander and its affiliates own fewer shares of common stock than such person, (ii) SC becomes, controls, or becomes controlled by, an OEM that competes with Chrysler, or (iii) certain of SC's credit facilities become impaired.
In connection with entering into the Chrysler Agreement, SC paid FCA a $150 million upfront, nonrefundable fee on May 1, 2013. This fee is considered payment for future profits generated from the Chrysler Agreement. Accordingly, the Company amortizes the Chrysler Agreement over the expected ten-year term as a component of net finance and other interest income. SC has also executed an equity option agreement with FCA, whereby FCA may elect to purchase, at any time during the term of the Chrysler Agreement, at fair market value, an equity participation of any percentage in the Chrysler Capital portion of SC's business.
For a period of 20 business days after FCA's delivery to SC of a notice of intent to exercise its option, SC is to discuss with FCA, in good faith, the structure and valuation of the proposed equity participation. If the parties are unable to agree on a structure and FCA still intends to exercise its option, SC will be required to create a new company into which the Chrysler Capital assets will be transferred and which will own and operate the Chrysler Capital business. If FCA and SC cannot agree on a fair market value during the 20-day negotiation period, each party will engage an investment bank and the appointed banks will mutually appoint a third independent investment bank to determine the value, with the cost of the valuation divided evenly between FCA and SC. Each party has the right to a one-time deferral of the independent valuation process for up to nine months. FCA will have a period of 90 days after a valuation has been determined, either by negotiation between the parties or by an investment bank, to deliver a binding notice of exercise. Following this notice, FCA's purchase is to be paid and settled within 10 business days, subject to a delay of up to 180 days if necessary to obtain any required consents from governmental authorities.
Any new company formed to effect FCA's exercise of its equity option will be a Delaware limited liability company unless otherwise agreed to by the parties. As long as each party owns at least 20% of the business, FCA and SC will have equal voting and governance rights without regard to ownership percentage. If either party has an ownership interest in the business of less than 20%, the party with less than 20% ownership will have the right to designate a number of directors proportionate to its ownership and will have other customary minority voting rights.
Because the equity option is exercisable at fair market value, SC could recognize a gain or loss upon exercise if the fair market value is determined to be different from book value. The Company believes that the fair market value of its Chrysler Capital financing business currently exceeds book value and therefore has not recorded a contingent liability for potential loss upon FCA's exercise.
Subsequent to the exercise of the equity option, SC's rights under the Chrysler Agreement would be assigned to the jointly-owned business. Exercise of the equity option would be considered a triggering event requiring re-evaluation of whether or not the remaining unamortized balance of the upfront fee SC paid to FCA on May 1, 2013 should be impaired.
In June 2018, SC announced that it was in exploratory discussions with FCA regarding the future of FCA's U.S. finance operations. FCA has announced its intention to establish a captive U.S. auto finance unit and indicated that acquiring Chrysler Capital is one option it would consider. In July 2018, FCA and the Company entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party in accordance with the Chrysler Agreement until December 31, 2018.
FCA has not delivered a notice to exercise its equity option, and the Company remains committed to the success of the Chrysler Capital business. Although the likelihood, timing and structure of any such transaction, and the likelihood that the Chrysler Agreement will terminate, cannot be reasonably determined, termination of the Chrysler Agreement, or a significant change in the business relationship between SC and FCA, could materially adversely affect SC's and SHUSA's operations, including the origination of receivables through the Chrysler Capital portion of SC's business and the servicing of Chrysler Capital receivables. Moreover, there can be no assurance that SC could successfully or timely implement any such transaction without significant disruption of its operations or restructuring, or without incurring additional liabilities, which could involve significant expense to the Company and have an adverse effect on its business, financial condition and results of operations.
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Intermediate Holding Company ("IHC")
On July 1, 2016, due to both its global and U.S. non-branch total consolidated asset size, Santander became subject to both of the provisions of the FBO Final Rule discussed below under the "Regulatory Matters" section of Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations (the "MD&A"), of this Form 10-K. As a result of this rule, ownership of several Santander subsidiaries, including Santander BanCorp, BSI, SIS and SSLLC, were transferred to the Company, which became a U.S. intermediate holding company (an "IHC"). On July 1, 2017, an additional Santander subsidiary, Santander Financial Services, Inc. (“SFS”), a finance company located in Puerto Rico, was transferred to SHUSA, and on July 2, 2018, another Santander subsidiary, Santander Asset Management, LLC ("SAM"), an investment adviser located in Puerto Rico, was transferred to SHUSA. Refer to Note 1 to the Consolidated Financial Statements for additional details.
Segments
The Company's reportable segments are focused principally around the customers the Company serves. In 2018, the Company has identified the following reportable segments:
Consumer and Business Banking
The Consumer and Business Banking segment includes the products and services provided to Bank customers, including consumer deposits, business banking, residential mortgage, unsecured lending and investment services. This segment offers a wide range of products and services to consumers and business banking customers, including demand and interest-bearing demand deposit accounts, money market and savings accounts, certificates of deposit ("CDs") and retirement savings products. It also offers lending products such as credit cards, home equity loans and lines of credit, and business loans such as business lines of credit and commercial cards. In addition, the Bank provides investment services to its retail customers, including annuities, mutual funds, and insurance products. Santander Universities, which provides grants and scholarships to universities and colleges as a way to foster education through research, innovation and entrepreneurship, is the last component of this segment.
Commercial Banking
The Commercial Banking segment provides commercial lines, loans, letters of credit, receivables financing and deposits to medium and large commercial customers as well as financing and deposits for government entities, commercial loans to dealers and financing for equipment and commercial vehicles. This segment also provides financing and deposits for government entities and niche product financing for specific industries, including oil and gas, among others. Commercial Banking also includes Commercial Real Estate, which offers commercial real estate loans and multifamily loans to customers.
Corporate and Investment Banking ("CIB")
The CIB segment serves the needs of global commercial and institutional customers by leveraging the international footprint of Santander to provide financing and banking services to corporations with over $500 million in annual revenues. CIB's offerings and strategy are based on Santander's local and global capabilities in wholesale banking.
SC
SC is a specialized consumer finance company focused on vehicle finance and third-party servicing. SC’s primary business is the indirect origination of RICs, principally through manufacturer-franchised dealers in connection with their sale of new and used vehicles to retail consumers. In conjunction with a ten-year private label financing agreement with FCA that became effective May 1, 2013, SC offers a full spectrum of auto financing products and services to FCA customers and dealers under the Chrysler Capital brand. These products and services include consumer RICs and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile, recreational and marine vehicle portfolios for other lenders. In the third quarter of 2015, SC announced that it would exit personal lending, and such assets were accordingly classified as held-for-sale.
SC continues to hold the Bluestem portfolio, which had a carrying balance of approximately $1.1 billion as of December 31, 2018, and remains a party to agreements with Bluestem that includes obligations, among other things, to purchase new advances originated by Bluestem and existing balances on accounts with new advances, for an initial term ending in April 2020 and renewable through April 2022 at Bluestem’s option. Although a third party is being sought to assume this obligation, SC may not be successful in finding such a party, and Bluestem may not agree to the substitution. The Bluestem portfolio continues to be classified as held-for-sale. Significant lower-of-cost-or-market adjustments have been recorded on this portfolio and may continue as long as SC holds the portfolio, particularly due to the purchase commitments.
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SC has entered into a number of intercompany agreements with the Bank. All intercompany revenue and fees between the Bank and SC are eliminated in the consolidated results of the Company.
The financial results for each of these reportable segments are included in Note 23 of the Notes to Consolidated Financial Statements and are discussed in Item 7, "Line of Business Results" within the MD&A section of this Form 10-K. These results have been presented based on the Company's management structure and management accounting practices. The structure and accounting practices are specific to the Company and, as a result, the financial results of the Company's reportable segments are not necessarily comparable with similar information for other financial institutions.
Other
The Other category includes certain immaterial subsidiaries such as BSI, Banco Santander Puerto Rico, SIS, SSLLC, and SFS, the unallocated interest expense on the Company's borrowings and other debt obligations and certain unallocated corporate income and indirect expenses.
Subsidiaries
SHUSA has two principal consolidated majority-owned subsidiaries at December 31, 2018, the Bank and SC.
Employees
At December 31, 2018, the Company had approximately 16,700 employees among its subsidiaries. No Company employees are represented by a collective bargaining agreement.
Competition
The Bank is subject to substantial competition in attracting and retaining deposits and in lending funds. The primary factors in competing for deposits include the ability to offer attractive rates, the convenience of office locations, the availability of alternate channels of distribution, and servicing capabilities. Direct competition for deposits comes primarily from other national, regional, and state banks, thrift institutions, and broker-dealers. Competition for deposits also comes from money market mutual funds, corporate and government securities, and credit unions. The primary factors driving competition for commercial and consumer loans are interest rates, loan origination fees, service levels and the range of products and services offered. Competition for originating loans normally comes from thrift institutions, national and state banks, mortgage bankers, mortgage brokers, finance companies, and insurance companies.
The Company also provides investment management, broker-dealer and private banking services for its clients. We face competition in providing these services from trust companies, full-service banks, asset managers, investment advisors, securities dealers, mutual fund companies, and other financial institutions.
SC is also subject to substantial competition, particularly in the automobile finance industry. SC competes on the pricing it offers on its loans and leases as well as the customer service SC provides automobile dealer customers. SC, along with its competitors, provides pricing and other terms and conditions for loans and leases through web-based credit application aggregation platforms. When dealers submit applications for consumers acquiring vehicles, they can compare SC's terms and conditions against its competitors’ pricing. Dealer relationships are important in the automotive finance industry. Vehicle finance providers tailor product offerings to meet dealers' needs. SC's primary competitors in the vehicle finance space are national and regional banks, credit unions, independent financial institutions, and the affiliated finance companies of automotive manufacturers.
Supervision and Regulation
SHUSA is a bank holding company (“BHC”) pursuant to the Bank Holding Company Act of 1956 (the “BHC Act”). As a BHC, the Company is subject to consolidated supervision by the Federal Reserve. SBNA is a Federal Deposit Insurance Corporation (“FDIC”) insured national bank chartered under the National Bank Act and subject to supervision by the Office of the Comptroller of the Currency (the "OCC"). In addition, the Consumer Financial Protection Bureau (the "CFPB") has oversight over SHUSA, SBNA, and SHUSA’s other non-bank affiliates, including SC, for compliance with federal consumer protection laws.
Refer to the "Regulatory Matters" section within Item 7- MD&A for discussion of current regulatory matters impacting the Company.
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BHC Activity and Acquisition Restrictions
Federal laws restrict the types of activities in which BHCs may engage, and subject them to a range of supervisory requirements, including regulatory enforcement actions for violations of laws and policies. BHCs may engage in the business of banking and managing and controlling banks, as well as closely-related activities.
The Company would be required to obtain approval from the Board of Governors of the Federal Reserve System (the "Federal Reserve") if the Company were to acquire shares of any depository institution or any holding company of a depository institution, or any financial entity that is not a depository institution, such as a lending company.
Control of the Company or the Bank
Under the Change in Bank Control Act, individuals, corporations or other entities acquiring SHUSA's common stock may, alone or together with other investors, be deemed to control the Company and thereby the Bank. Ownership of more than 10% of SHUSA’s capital stock may be deemed to constitute “control” if certain other control factors are present. If deemed to control the Company, those persons or groups would be required to obtain the Federal Reserve's approval to acquire the Company’s common stock and could be subject to certain ongoing reporting procedures and restrictions under federal law and regulations.
Standards for Safety and Soundness
The federal banking agencies adopted certain operational and managerial standards for depository institutions, including internal audit system components, loan documentation requirements, asset growth parameters, information technology and data security practices, and compensation standards for officers, directors and employees.
Insurance of Accounts and Regulation by the FDIC
The Bank is a member of the Deposit Insurance Fund, which is administered by the FDIC. Deposits are insured up to the applicable limits by the FDIC, and such insurance is backed by the full faith and credit of the U.S. government. The FDIC imposes deposit insurance premiums and is authorized to conduct examinations of, and require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the Deposit Insurance Fund. The FDIC also has the authority to initiate enforcement actions against banking institutions and may terminate an institution’s deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
The FDIC charges financial institutions deposit premium assessments to ensure it has reserves to cover deposits that are under FDIC-insured limits, which is currently $250,000 per depositor per ownership category for each ownership deposit account category.
FDIC insurance premium expenses were $53.3 million for the year ended December 31, 2018.
In addition to deposit insurance premiums, all insured institutions are required to pay a Financing Corporation assessment to fund the interest on bonds issued to resolve thrift failures in the 1980s. In 2018, the Bank paid Financing Corporation assessments of $2.5 million, compared to $4.0 million in 2017. The annual rate for all insured institutions dropped to $0.014 for every $1,000 in domestic deposits in 2018, compared to $0.046 in 2017. The assessments are revised quarterly and continue until the bonds mature between 2017 and 2019.
In March 2016, the FDIC finalized the rule to implement Section 334 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “DFA") to provide for a surcharge assessment at an annual rate of 4.5 basis points on banks with over $10 billion in assets to increase the FDIC insurance fund. The FDIC commenced this surcharge in the third quarter of 2016, which the FDIC estimated would take approximately two years. Under the rule, if the reserve ratio did not reach 1.35% by December 31, 2018, the FDIC would impose a shortfall assessment on larger depository institutions, including SBNA. The FDIC announced on November 28, 2018 that the reserve ratio had reached 1.35%, which ended the surcharge period.
Restrictions on Subsidiary Banking Institution Capital Distributions
Under the Federal Deposit Insurance Corporation Improvement Act (the “FDIA"), insured depository institutions must be classified in one of five defined tiers (well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized). Under OCC regulations, an institution is considered “well-capitalized” if it (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 8% or greater, (iii) has a common equity Tier 1 ("CET1") capital ratio of 6.5% or greater, (iv) has a Tier 1 leverage ratio of 5% or greater and (v) is not subject to any order or written directive to meet and maintain a specific capital level. As of December 31, 2018, the Bank met the criteria to be classified as “well capitalized.”
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If capital levels fall to significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and, in critically undercapitalized situations, appointment of a receiver or conservator. Critically undercapitalized institutions generally may not, beginning 60 days after becoming critically undercapitalized, make any payment of principal or interest on their subordinated debt. All but well-capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Pursuant to the FDIA and OCC regulations, institutions which are not categorized as well-capitalized or adequately-capitalized are restricted from making capital distributions, which include cash dividends, stock redemptions and repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the institution’s capital account.
Federal banking laws, regulations and policies limit the Bank’s ability to pay dividends and make other distributions to the Company. The Bank must obtain prior OCC approval to declare a dividend or make any other capital distribution if, after such dividend or distribution: (1) the Bank’s total distributions to the Company within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years; (2) the Bank would not meet capital levels imposed by the OCC in connection with any order, or (3) the Bank is not adequately capitalized at the time. In addition, the OCC's prior approval is required if the OCC deems it to be in troubled condition or a problem institution.
Any dividends declared and paid have the effect of reducing the Bank’s Tier 1 capital to average consolidated assets and risk-based capital ratios. The Company paid cash dividends on common stock of $410.0 million in 2018 while $10.0 million in dividends were declared or paid in 2017. The Company returned capital of $12.6 million in 2017, while no capital was returned in 2018.
Federal Reserve Regulation
Under Federal Reserve regulations, the Bank is required to maintain a reserve against its transaction accounts (primarily interest-bearing and non-interest-bearing checking accounts). Because reserves must generally be maintained in cash or in low-interest-bearing accounts, the effect of the reserve requirements is to reduce an institution’s asset yields.
The amount of total reserve requirements at December 31, 2018 and 2017 were $429.0 million and $294.2 million, respectively. At December 31, 2018 and 2017, the Company complied with these reserve requirements.
Federal Home Loan Bank ("FHLB") System
The FHLB system was created in 1932 and consists of 11 regional FHLBs. FHLBs are federally-chartered but privately owned institutions created by Congress. The Federal Housing Finance Agency is an agency of the federal government that is charged with overseeing the FHLBs. Each FHLB is owned by its member institutions. The primary purpose of the FHLBs is to provide funding to their members for making housing loans as well as for affordable housing and community development lending. FHLBs are generally able to make advances to their member institutions at interest rates that are lower than could otherwise be obtained by such institutions. As a member, the Bank is required to make minimum investments in FHLB stock based on its level of borrowings from the FHLB. The Bank is a member of and held investments in the FHLB of Pittsburgh which totaled $230.1 million as of December 31, 2018, compared to $116.1 million at December 31, 2017. The Bank utilizes advances from the FHLB to fund balance sheet growth, provide liquidity and for asset and liability management purposes. The Bank had access to advances with the FHLB of up to $17.7 billion at December 31, 2018, and had outstanding advances of $4.85 billion or 27% of total availability at that date. The level of borrowing capacity the Bank has with the FHLB of Pittsburgh is contingent upon the level of qualified collateral the Bank holds at a given time.
The Bank received $6.6 million and $12.9 million in dividends on its stock in the FHLB of Pittsburgh in 2018 and 2017, respectively.
Anti-Money Laundering and the USA Patriot Act
Several federal laws, including the Bank Secrecy Act, the Money Laundering Control Act, and the USA Patriot Act require all financial institutions to, among other things, implement policies and procedures relating to anti-money laundering, compliance, suspicious activities, currency transaction reporting and due diligence on customers. The USA Patriot Act substantially broadened existing anti-money laundering legislation and the extraterritorial jurisdiction of the U.S., imposed compliance and due diligence obligations, created criminal penalties, compelled the production of documents located both inside and outside the U.S., including those of non-U.S. institutions that have a correspondent relationship in the U.S., and clarified the safe harbor from civil liability to clients. The U.S. Treasury has issued a number of regulations that further clarify the USA Patriot Act’s requirements and provide more specific guidance on their application.
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Financial Privacy
Under the Gramm-Leach-Bliley Act (the "GLBA"), financial institutions are required to disclose to their retail customers their policies and practices with respect to sharing nonpublic customer information with their affiliates and non-affiliates, how they maintain customer confidentiality, and how they secure customer information. Customers are required under the GLBA to be provided with the opportunity to “opt out” of information sharing with non-affiliates, subject to certain exceptions.
Environmental Laws
Environmentally-related hazards are a source of high risk and potentially significant liability for financial institutions related to their loans. Environmentally contaminated properties owned by an institution’s borrowers may result in a drastic reduction in the value of the collateral securing the institution’s loans to such borrowers, high environmental cleanup costs to the borrower affecting its ability to repay its loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean-up costs, and liability to the institution for cleanup costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. To minimize this risk, the Bank may require an environmental examination of, and reports with respect to, the property of any borrower or prospective borrower if circumstances affecting the property indicate a potential for contamination, taking into consideration the potential loss to the institution in relation to the burdens to the borrower. Such examination must be performed by an engineering firm experienced in environmental risk studies and acceptable to the institution, and the costs of such examinations and reports are the responsibility of the borrower. These costs may be substantial and may deter a prospective borrower from entering into a loan transaction with the Bank. The Company is not aware of any borrower which is currently subject to any environmental investigation or clean-up proceeding or any other environmental matter that is likely to have a material adverse effect on the financial condition or results of operations of SHUSA or its subsidiaries.
Securities Regulation
The Company conducts its securities activities through its subsidiaries SIS and SSLLC. SIS and SSLLC are registered broker-dealers with the Securities and Exchange Commission (the “SEC”) and members of the Financial Industry Regulatory Authority, Inc. (“FINRA”). SIS’s activities include investment banking, institutional sales, trading and offering research reports of Latin American and European equity and fixed income securities. SIS, SSLLC and SAM are also registered investment advisers with the SEC, and BSI conducts certain securities transactions exempt from SEC registration on behalf of its clients.
Written Agreements and Regulatory Actions
See the “Regulatory Matters” section of the MD&A and Note 19 of the Consolidated Financial Statements in this Form 10-K for a description of current regulatory actions.
Corporate Information
All reports filed electronically by the Company with the SEC, including the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, as well as any amendments to those reports, are accessible on the SEC’s website at www.sec.gov. Our filings are also accessible through our website at https://www.santanderus.com/us/investorshareholderrelations. The information contained on our website is not being incorporated herein and is provided for the information of the reader and are not intended to be active links.
ITEM 1A - RISK FACTORS
The Company is subject to a number of risks that if realized could materially affect its business, financial condition, results of operations, cash flows and access to liquidity. As a financial services organization, certain elements of risk are inherent in our transactions and are present in the business decisions made by the Company. Accordingly, the Company encounters risk as part of the normal course of its business, and risk management processes are designed to help manage these risks.
Risk management and mitigation are important parts of the Company's business model and integrated into the Company's day-to-day operations. The success of the Company's business is dependent on management's ability to identify, understand, manage and mitigate the risks presented by business activities in light of the Company's strategic and financial objectives. These risks include credit risk, market risk, capital risk, liquidity risk, operational risk, model risk, investment risk, compliance and legal risk, and strategic and reputational risk. We discuss our principal risk management processes in the Risk Management section included in Item 7 of this Report.
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The following are the most significant risk factors that affect the Company. Any one or more of these could have a material adverse impact on the Company's business, financial condition, results of operations, or cash flows, in addition to presenting other possible adverse consequences, many of which are described below. These risk factors and other risks we may face are also discussed further in other sections of this Report.
Macro-Economic and Political Risks
Given that our loan portfolios are concentrated in the United States, adverse changes affecting the economy of the United States could adversely affect our financial condition.
Our loan portfolios are concentrated in the United States. Accordingly, the recoverability of our loan portfolios and our ability to increase the amount of loans outstanding and our results of operations and financial condition in general are dependent to a significant extent on the level of economic activity in the United States. A return to recessionary conditions in the United States economy would likely have a significant adverse impact on our loan portfolios and, as a result, on our financial condition, results of operations, and cash flows.
We are vulnerable to disruptions and volatility in the global financial markets.
Global economic conditions deteriorated significantly between 2007 and 2009, and the United States fell into recession. Many major financial institutions, including some of the country's largest commercial banks, investment banks, mortgage lenders, mortgage guarantors and insurance companies, including us, experienced significant difficulties.
We face, among others, the following risks in the event of an economic downturn or another recession:
• | Increased regulation of our industry. Compliance with such regulation has increased our costs and may affect the pricing of our products and services and limit our ability to pursue business opportunities. |
• | Reduced demand for our products and services. |
• | Inability of our borrowers to timely or fully comply with their existing obligations. |
• | The process we use to estimate losses inherent in our credit exposure requires complex judgments, including forecasts of economic conditions and how those economic conditions might impair the ability of our borrowers to repay their loans. |
• | The degree of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates, which may, in turn, impact the reliability of the process and the sufficiency of our loan and lease loss allowances. |
• | The value and liquidity of the portfolio of investment securities that we hold may be adversely affected. |
• | Any worsening of economic conditions may delay the recovery of the financial industry and impact our financial condition and results of operations. |
• | Macroeconomic shocks may impact the household income of our retail customers negatively and adversely affect the recoverability of our retail loans, resulting in increased loan and lease losses. |
Despite the long-term expansion of the U.S. economy, some uncertainty remains regarding U.S. monetary policy and the future economic environment. There can be no assurance that economic conditions will continue to improve. Such economic uncertainty could have an adverse effect on our business and results of operations. A downturn of the economic expansion or failure to sustain the economic recovery would likely aggravate the adverse effects of these difficult economic and market conditions on us and on others in the financial services industry.
In addition, the global recession and disruption of the financial markets led to concerns over the solvency of certain European countries, affecting those countries’ capital markets access and in some cases sovereign credit ratings, as well as market perception of financial institutions that have significant direct or indirect exposure to these countries. These concerns continue even as the global economy is recovering, and some previously stressed European economies have experienced at least partial recoveries from their low points during the recession. If measures to address sovereign debt and financial sector problems in Europe are inadequate, they may delay or weaken economic recovery, or result in the further exit of member states from the Eurozone or more severe economic and financial conditions. If realized, these risk scenarios could contribute to severe financial market stress or a global recession, likely affecting the economy and capital markets in the United States as well.
Increased disruption and volatility in the financial markets could have a material adverse effect on us, including our ability to access capital and liquidity on financial terms acceptable to us, if at all. If capital markets financing ceases to become available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits to attract more customers and become unable to maintain certain liability maturities. Any such decrease in capital markets funding availability or increased costs or in deposit rates could have a material adverse effect on our net interest margins and liquidity.
If some or all of the foregoing risks were to materialize, they could have a material adverse effect on us.
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Our growth, asset quality and profitability may be adversely affected by volatile macroeconomic and political conditions.
While the United States economy has performed well overall, it has experienced volatility in recent periods, characterized by slow or regressive growth. This volatility has resulted in fluctuations in the levels of deposits at depository institutions and in the relative economic strength of various segments of the economy to which we lend.
Negative and fluctuating economic conditions, such as a changing interest rate environment, impact our profitability by causing lending margins to decrease and leading to decreased demand for higher margin products and services. Negative and fluctuating economic conditions could also result in government defaults on public debt. This could affect us in two ways: directly, through portfolio losses, and indirectly, through instabilities that a default on public debt could cause to the banking system as a whole, particularly since commercial banks' exposure to government debt is high in certain Latin American and European regions or countries.
In addition, our revenues are subject to risk of loss from unfavorable political and diplomatic developments, social instability, and changes in governmental policies, international ownership legislation, interest rate caps and tax policies. Growth, asset quality and profitability may be affected by volatile macroeconomic and political conditions.
The actions of the U.S. administration could have a material adverse effect on us.
There is uncertainty about how proposals and initiatives of the current U.S. presidential administration or the broader government could directly or indirectly impact the Company. Although certain proposals and initiatives, such as income tax reform or increased spending on infrastructure projects, could result in greater economic activity and more expansive U.S. domestic economic growth,
other initiatives, such as protectionist trade policies or isolationist foreign policies, could constrict economic growth. The continued uncertainty around these proposals and initiatives, could increase market volatility and affect the Company’s businesses directly or indirectly, including through the effects of such proposals and initiatives on the Company’s customers and/or counterparties.
Developments stemming from the U.K.’s referendum on membership in the EU could have a material adverse effect on us.
Implementing the results of the United Kingdom’s (“UK’s”) referendum on whether to remain part of the European Union (“EU”) has had and may continue to have negative effects on global economic conditions and global financial markets. The UK's decision to withdraw from the EU, and the UK's implementation of that referendum, means that the UK's EU membership will cease. The long-term nature of the UK’s relationship with the EU is unclear (including with respect to the laws and regulations that will apply as the UK determines which EU laws to replicate or replace) and, as negotiations continue, there is considerable uncertainty as to when the framework for any such relationship governing both the access of the UK to European markets and the access of EU member states to the UK’s markets will be determined and implemented. The result of the referendum has created an uncertain political and economic environment in the UK, and may create such environments in other EU member states. While the Company does not maintain a presence in the UK, political and economic uncertainty in countries with significant economies and relationships to the global financial industry have in the past led to declines in market liquidity and activity levels, volatile market conditions, a contraction of available credit, lower or negative interest rates, weaker economic growth and reduced business confidence on an international level, each of which could adversely affect our business. In addition, the Company has been working with its UK affiliates to expand their business; if the UK were to leave the EU, the results of those efforts could be impacted adversely.
Uncertainty regarding the London interbank offered rate (“LIBOR”) may adversely affect our business
The UK Financial Conduct Authority, which regulates LIBOR, announced in July 2017 that it will no longer persuade or require banks to submit rates for the calculation of LIBOR after 2021. This announcement has resulted in uncertainty about the future of LIBOR and other rates used as interest rate “benchmarks,” and suggests that the continuation of LIBOR on the current basis will not be guaranteed after 2021, and that LIBOR could be discontinued or modified by 2021.
If LIBOR ceases to exist, or if new methods of calculating LIBOR are established, interest rates on our loans, deposits, derivatives and other financial instruments tied to LIBOR, as well as revenue and expenses associated with those financial instruments, may be adversely affected, and financial markets relevant to us could be disrupted. We could also incur further legal risks in the event of such changes, as changes to documentation for new and existing transactions may be required, as well as further operations risks due to the potential need to adapt information technology systems, trade reporting infrastructure, and operational processes and controls.
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Risks Relating to Our Business
Legal, Regulatory and Compliance Risks
We are subject to substantial regulation which could adversely affect our business and operations.
As a financial institution, the Company is subject to extensive regulation, which materially affects our businesses. The statutes, regulations, and policies to which the Company is subject may change at any time. In addition, regulators' interpretation and application of the laws and regulations to which the Company is subject may change from time to time. Extensive legislation affecting the financial services industry has been adopted in the United States, and regulations have been and are in the process of being implemented. The manner in which those laws and related regulations are applied to the operations of financial institutions is still evolving. Any legislative or regulatory actions and any required changes to our business operations resulting from such legislation and regulations could result in significant loss of revenue, limit our ability to pursue business opportunities in which we might otherwise consider engaging and provide certain products and services, affect the value of assets we hold, require us to increase our prices and therefore reduce demand for our products, impose additional compliance and other costs on us or otherwise adversely affect our businesses. Accordingly, there can be no assurance that future changes in regulations or in their interpretation or application will not affect us adversely.
Regulation of the Company as a BHC includes limitations on permissible activities. Moreover, the Company and the Bank are required to perform stress tests and submit capital plans to the Federal Reserve and the OCC on an annual basis, and receive a notice of non-objection to the plans from the Federal Reserve and the OCC before taking capital actions such as paying dividends, implementing common equity repurchase programs, or redeeming or repurchasing capital instruments. The Federal Reserve may also impose substantial fines and other penalties and enforcement actions for violations we may commit, and has the authority to disallow acquisitions we or our subsidiaries may contemplate, which may limit our future growth plans. Such constraints currently applicable to the Company and its subsidiaries and/or regulatory actions could have an adverse effect on our financial position and results of operations.
Other regulations which significantly affect the Company, or which could significantly affect the Company in the future, relate to capital requirements, liquidity and funding, taxation of the financial sector, and development of regulatory reforms in the United States.
In addition, the volume, granularity, frequency and scale of regulatory and other reporting requirements necessitate a clear data strategy to enable consistent data aggregation, reporting and management. Inadequate management information systems or processes, including those relating to risk data aggregation and risk reporting, could lead to a failure to meet regulatory reporting requirements or other internal or external information demands that may result in supervisory measures.
Significant United States Regulation
From time to time, we are or may become involved in formal and informal reviews, investigations, examinations, proceedings, and information gathering requests by federal and state government agencies, including, among others, the FRB, the OCC, the CFPB, the FDIC, the Department of Justice (the "DOJ"), the SEC, FINRA the Federal Trade Commission and various state regulatory and enforcement agencies.
The DFA will continue to result in significant structural reforms affecting the financial services industry. This legislation provided for, among other things, the establishment of the CFPB with broad authority to regulate the credit, savings, payment and other consumer financial products and services we offer, the creation of a structure to regulate systemically important financial companies, more comprehensive regulation of the over-the-counter derivatives market, prohibitions on engaging in certain proprietary trading activities, restrictions on ownership of, investment in or sponsorship of hedge funds and private equity funds and restrictions on interchange fees earned through debit card transactions.
The DFA provides for an extensive framework for the regulation of over-the-counter ("OTC") derivatives, including mandatory clearing, exchange trading and transaction reporting of certain OTC derivatives. Entities that are swap dealers, security-based swap dealers, major swap participants or major security-based swap participants are required to register with the SEC, the U.S. Commodity Futures Trading Commission (the "CFTC") or both, and are or will be subject to new capital, margin, business conduct, record-keeping, clearing, execution, reporting and other requirements. We may register as a swap dealer with the CFTC.
In February 2014, the Federal Reserve issued the Final Rule to enhance its supervision and regulation of certain FBOs. Among other things, this rule required FBOs, such as the Company, with over $50 billion of United States non-branch assets to establish or designate a United States IHC and to transfer its entire ownership interest in substantially all of its United States subsidiaries to that IHC by July 1, 2016. United States branches and agencies were not required to be transferred to the IHC. As a result of this rule, Santander
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transferred substantially all of its equity interests in its U.S. bank and non-bank subsidiaries previously outside the Company to the Company, which became an IHC effective July 1, 2016. These subsidiaries included Santander BanCorp, BSI, SIS and SSLLC, as well as several other subsidiaries. On July 1, 2017, an additional Santander subsidiary, Santander Financial Services, Inc. (“SFS”), a finance company located in Puerto Rico, was transferred to SHUSA. The IHC is subject to an enhanced supervision framework, including enhanced risk-based and leverage capital requirements, liquidity requirements, risk/management requirements, and stress-testing requirements. A phased-in approach is being used for those standards and requirements. SHUSA's status as an IHC requires it to invest significant management attention and resources.
Within the DFA, the Volcker Rule prohibits “banking entities” from engaging in certain forms of proprietary trading or from sponsoring or investing in covered funds, in each case subject to certain exceptions. The Volcker Rule also limits the ability of banking entities and their affiliates to enter into certain transactions with such funds with which they or their affiliates have certain relationships. The final regulations implementing the Volcker Rule contain exclusions and certain exemptions for market-making, hedging, underwriting, and trading in United States government and agency obligations as well as certain foreign government obligations, and trading solely outside the United States, and also permit certain ownership interests in certain types of funds to be retained.
Our resolution in a bankruptcy proceeding could result in losses for holders of our debt and equity securities.
Under regulations issued by the Federal Reserve and the FDIC, and as required by Section 165(d) of the DFA, we must provide to the Federal Reserve and the FDIC a plan (a “Section 165(d) Resolution Plan”) for our rapid and orderly resolution in the event of material financial distress affecting the Company or the failure of the Company. The purpose of this provision of the DFA is to provide regulators with plans that would enable them to resolve failing financial companies that pose a significant risk to the financial stability of the United States in a manner that mitigates such risk. The most recently filed Section 165(d) Resolution Plan by Santander, dated as of December 31, 2018 (the “2018 Resolution Plan”), provides a roadmap for the orderly resolution of the material U.S. operations of Santander under hypothetical stress scenarios and the failure of one or more of its U.S. material entities (“U.S. MEs”). Material entities are defined as subsidiaries or foreign offices of Santander that are significant to the activities of a critical operation or core business line. The U.S. MEs identified in the 2018 Resolution Plan include, among other entities, the Company, the Bank and SC.
The 2018 Resolution Plan describes a strategy for resolving Santander’s U.S. operations, including its U.S. MEs and the core business lines that operate within those U.S. MEs, in a manner that would substantially mitigate the risk that the resolutions would have serious adverse effects on U.S. or global financial stability. Under the 2018 Resolution Plan’s hypothetical resolutions of the U.S. MEs, the Bank would be placed into FDIC receivership and the Company and SC would be placed into bankruptcy under Chapter 7 and Chapter 11 of the U.S. Bankruptcy Code, respectively.
The strategy described in the 2018 Resolution Plan contemplates a “multiple point of entry” strategy, in which Santander and the Company would each undergo separate resolution proceedings under European regulations and the U.S. Bankruptcy Code, respectively. In a scenario in which the Bank and SC were in resolution, the Company would file a voluntary petition under Chapter 7 of the Bankruptcy Code, and holders of our LTD and other debt securities would be junior to the claims of priority (as determined by statute) and secured creditors of the Company.
The Company, the Federal Reserve and the FDIC are not obligated to follow the Company’s preferred resolution strategy for resolving its U.S. operations under its resolution plan. In addition, Santander could in the future change its resolution strategy for resolving its U.S. operations. In an alternative scenario, the Company alone could enter bankruptcy under the U.S. Bankruptcy Code, and the Company’s subsidiaries would be recapitalized as needed, using assets of the Company, so that they could continue normal operations as going concerns or subsequently be wound down in an orderly manner. As a result, the losses incurred by the Company and its subsidiaries would be imposed first on the holders of the Company’s equity securities and thereafter on unsecured creditors, including holders of our LTD and other debt securities. Holders of our LTD and other debt securities would be junior to the claims of creditors of the Company’s subsidiaries and to the claims of priority (as determined by statute) and secured creditors of the Company. Under either of these scenarios, in a resolution of the Company under Chapter 11 of the U.S. Bankruptcy Code, holders of our LTD and other debt securities would realize value only to the extent available to the Company as a shareholder of the Bank, SC and its other subsidiaries, and only after any claims of priority and secured creditors of the Company have been fully repaid.
The resolution of the Company under the orderly liquidation authority could result in greater losses for holders of our equity and debt securities.
The ability of holders of our LTD and other debt securities to recover the full amount that would otherwise be payable on those securities in a resolution proceeding under Chapter 11 of the U.S. Bankruptcy Code may be impaired by the exercise of the FDIC’s powers under the “orderly liquidation authority” under Title II of the DFA.
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Title II of the DFA created a new resolution regime known as the “orderly liquidation authority” to which financial companies, including U.S. IHC of FBOs with assets of $50 billion or more, such as the Company, can be subjected. Under the orderly liquidation authority, the FDIC may be appointed as receiver to liquidate a financial company if, upon the recommendation of applicable regulators, the United States Secretary of the Treasury determines that the entity is in severe financial distress, the entity’s failure would have serious adverse effects on the U.S. financial system, and resolution under the orderly liquidation authority would avoid or mitigate those effects, among other things. Absent such determinations, the Company would remain subject to the U.S. Bankruptcy Code.
If the FDIC is appointed as receiver under the orderly liquidation authority, then the orderly liquidation authority, rather than the U.S. Bankruptcy Code, would determine the powers of the receiver and the rights and obligations of creditors and other parties who have transacted with the Company. There are substantial differences between the rights available to creditors under the orderly liquidation authority and under the U.S. Bankruptcy Code. For example, under the orderly liquidation authority, the FDIC may disregard the strict priority of creditor claims in some circumstances (which would otherwise be respected under the U.S. Bankruptcy Code), and an administrative claims procedures is used to determine creditors’ claims (as opposed to the judicial procedure utilized in bankruptcy proceedings). Under the orderly liquidation authority, in certain circumstances, the FDIC could elevate the priority of claims if it determines that doing so is necessary to facilitate a smooth and orderly liquidation without the need to obtain the consent of other creditors or prior court review. Furthermore, the FDIC has the right to transfer assets or liabilities of the failed company to a third party or “bridge” entity under the orderly liquidation authority.
Regardless of what resolution strategy Santander might prefer for resolving its U.S. operations, the FDIC could determine that it is a desirable strategy to resolve the Company in a manner that would, among other things, impose losses on the Company’s shareholder, unsecured debtholders (including holders of LTD) and other creditors, while permitting the Company’s subsidiaries to continue to operate. It is likely that the application of such an entry strategy in which the Company would be the only legal entity in the U.S. to enter resolution proceedings would result in greater losses to holders of our LTD and other debt securities than the losses that would result from the application of a bankruptcy proceeding or a different resolution strategy for the Company. Assuming the Company entered resolution proceedings and support from the Company to its subsidiaries was sufficient to enable the subsidiaries to remain solvent, losses at the subsidiary level could be transferred to the Company and ultimately borne by the Company’s securityholders (including holders of our LTD and other debt securities), with the result that third-party creditors of the Company’s subsidiaries would receive full recoveries on their claims, while the Company’s securityholders (including holders of our LTD) and other unsecured creditors could face significant losses. In addition, in a resolution under the orderly liquidation authority, holders of our LTD and other debt securities of the Company could face losses ahead of our other similarly situated creditors if the FDIC exercised its right, to disregard the strict priority of creditor claims described above.
The orderly liquidation authority also requires that creditors and shareholders of the financial company in receivership must bear all losses before taxpayers are exposed to any losses, and amounts owed by the financial company or the receivership to the U.S. government would generally receive a statutory payment priority over the claims of private creditors, including holders of our LTD and other debt securities. In addition, under the orderly liquidation authority, claims of creditors (including holders of our LTD and other debt securities) could be satisfied through the issuance of equity or other securities in a bridge entity to which the Company’s assets are transferred, as described above. If securities were to be delivered in satisfaction of claims, there can be no assurance that the value of the securities of the bridge entity would be sufficient to repay all or any part of the creditor claims for which the securities were exchanged.
Although the FDIC has issued regulations to implement the orderly liquidation authority, not all aspects of how the FDIC might exercise this authority are known, and additional rulemaking is possible.
United States stress testing, capital planning, and related supervisory actions
The Company is subject to stress testing and capital planning requirements under regulations implementing the DFA and other banking laws and policies. Effective January 2017, the Federal Reserve finalized a rule adjusting its capital plan and stress testing rules, exempting from the qualitative portion of the Comprehensive Capital Analysis and Review (“CCAR") certain BHCs and U.S.
IHCs of FBOs with total consolidated assets between $50 billion and $250 billion and total nonbank assets of less than $75 billion, and that are not identified as global systemically important banks. Such firms, including the Company, are still required to meet CCAR’s quantitative requirements and are subject to regular supervisory assessments that examine their capital planning processes. In 2017 and 2018, the Federal Reserve provided its non-objection to SHUSA’s capital plan; however, in 2015 and 2016, the Federal Reserve, as part of its CCAR process, objected on qualitative grounds to the capital plans the Company submitted. There is risk that the Federal Reserve could object to the Company’s future capital plans, which would limit the Company's ability to make capital distributions or take certain capital actions.
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Other supervisory actions and restrictions on U.S. activities
In addition to the foregoing, U.S. bank regulatory agencies from time to time take supervisory actions under certain circumstances that restrict or limit a financial institution’s activities. In many instances, we are subject to significant legal restrictions on our ability to publicly disclose these actions or the full details of these actions. In addition, as part of the regular examination process, certain U.S. subsidiaries’ regulators may advise certain U.S. subsidiaries to operate under various restrictions as a prudential matter. The U.S. supervisory environment has become significantly more demanding and restrictive since the financial crisis of 2008. Under the BHC Act, the Federal Reserve has the authority to disallow us and certain of our U.S. subsidiaries from engaging in certain categories of new activities in the United States or acquiring shares or control of other companies in the United States. Such actions and restrictions currently applicable to us or certain of our U.S. subsidiaries could adversely affect our costs and revenues. Moreover, efforts to comply with nonpublic supervisory actions or restrictions could require material investments in additional resources and systems, as well as a significant commitment of managerial time and attention. As a result, such supervisory actions or restrictions could have a material adverse effect on our business and results of operations, and we may be subject to significant legal restrictions on our ability to publicly disclose these matters or the full details of these actions.
We are subject to potential intervention by any of our regulators or supervisors, particularly in response to customer complaints.
As noted above, our business and operations are subject to increasingly significant rules and regulations relating to the banking and financial services business. These apply to business operations, affect financial returns, include reserve and reporting requirements, and conduct of business regulations. These requirements are set by the relevant central banks and regulatory authorities that authorize, regulate and supervise us in the jurisdictions in which we operate. The relationship between the Company and its customers is also regulated extensively under federal and state consumer protection laws. Among other things, these prohibit unfair, deceptive and abusive trading practices, require disclosures of the cost of credit, provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide financial privacy protections, and restrict our ability to raise interest rates.
In their supervisory roles, regulators seek to maintain the safety and soundness of financial institutions with the aim of strengthening, but not guaranteeing, the protection of customers and the financial system. Supervisors' continuing supervision of financial institutions is conducted through a variety of regulatory tools, including the collection of information by way of reports obtained from skilled persons, visits to firms and regular meetings with management to discuss issues such as performance, risk management and strategy. In general, regulators have an outcome-focused regulatory approach that involves proactive enforcement and penalties for infringement. As a result, we face increased supervisory intrusion and scrutiny (resulting in increasing internal compliance costs and supervision fees), and in the event of a breach of our regulatory obligations we are likely to face more stringent regulatory fines.
Some of the regulators focus strongly on consumer protection and on conduct risk and will continue to do so. This has included a focus on the design and operation of products, the behavior of customers and the operation of markets. Some of the laws in the relevant jurisdictions in which we operate give regulators the power to make temporary product intervention rules either to improve a company's systems and controls in relation to product design, product management and implementation, or address problems identified with financial products. These problems may potentially cause significant detriment to consumers because of certain product features, governance flaws or distribution strategies. Such rules may prevent institutions from entering into product agreements with customers until such problems have been solved. Some regulators in the jurisdictions in which we operate also require us to be in compliance with training, authorization and supervision of personnel, systems, processes and documentation requirements. Sales practices with retail customers, including incentive compensation structures related to such practices, have recently been a focus of various regulatory and governmental agencies. If we fail to be compliant with such regulations, there would be a risk of an adverse impact on our business from sanctions, fines or other actions imposed by regulatory authorities. Customers of financial services institutions, including our customers, may seek redress if they consider that they have suffered loss as a result of the mis-selling of a particular product, or through incorrect application of the terms and conditions of a particular product.
Given the inherent unpredictability of litigation and the evolution of judgments by the relevant authorities, it is possible that an adverse outcome in some matters could harm our reputation or have a material adverse effect on our operating results, financial condition and prospects arising from any penalties imposed or compensation awarded, together with the costs of defending such actions, thereby reducing our profitability.
We are exposed to risk of loss from legal and regulatory proceedings.
As noted above, we face risk of loss from legal and regulatory proceedings, including tax proceedings that could subject us to monetary judgments, regulatory enforcement actions, fines and penalties. The current regulatory environment reflects an increased supervisory focus on enforcement, combined with uncertainty about the evolution of the regulatory regime, and may lead to material
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operational and compliance costs. In general, amounts financial institutions pay in settlements of regulatory proceedings or investigations and the severity of terms of regulatory settlements have been increasing. In certain cases, regulatory authorities have required criminal pleas, admissions of wrongdoing, limitations on asset growth, managerial changes, and other extraordinary terms as part of such settlements, all of which could have significant economic consequences for a financial institution.
We are subject to civil and tax claims and party to certain legal proceedings incidental to the normal course of our business from time to time, including in connection with lending activities, relationships with our employees and other commercial or tax matters. In view of the inherent difficulty of predicting the outcome of legal matters, particularly when the claimants seek very large or indeterminate damages, or when the cases present novel legal theories, involve a large number of parties or are in the early stages of investigation or discovery, we cannot state with confidence what the eventual outcome of these pending matters will be or what the eventual loss, fines or penalties related to each pending matter may be. We believe that we have established adequate reserves related to the costs anticipated to be incurred in connection with these various claims and legal proceedings. However, the amount of these provisions is substantially less than the total amount of the claims asserted against us and, in light of the uncertainties involved in such claims and proceedings, there is no assurance that the ultimate resolution of these matters will not significantly exceed the reserves we have currently accrued. As a result, the outcome of a particular matter may materially and adversely affect our financial condition and results of operations for a particular period, depending upon, among other factors, the size of the loss or liability imposed and our level of income for that period.
In addition, from time to time, the Company is, or may become, the subject of governmental and self-regulatory agency information-gathering requests, reviews, investigations and proceedings and other forms of regulatory inquiry, including by the SEC and law enforcement authorities.
Often, the announcement or other publication of claims or actions that may arise from such litigation and proceedings or of any related settlement may spur the initiation of similar claims by other clients or governmental entities. In any such claim or action, demands for substantial monetary damages may be asserted against us and may result in financial liability, changes in our business practices or an adverse effect on our reputation or client demand for our products and services. In regulatory settlements since the financial crisis, fines imposed by regulators have increased substantially and may in some cases exceed the profit earned or harm caused by the breach.
Our operations are subject to regular and ongoing inspection by our banking and other regulators, which may result in the need to enhance our regulatory compliance or risk management practices. Such remedial actions may entail significant costs, management attention, and systems development, and such efforts may affect our ability to expand our business until those remedial actions are completed. In some instances, we are subjected to significant legal restrictions on our ability to disclose these types of actions or the full detail of these actions publicly. Our failure to implement enhanced compliance and risk management procedures in a manner and timeframe deemed to be responsive by the applicable regulatory authority could adversely impact our relationship with that regulatory authority and lead to restrictions on our activities or other sanctions.
The magnitude and complexity of projects required to address the expectations of the Company’s regulators’ and legal proceedings, in addition to the challenging macroeconomic environment and pace of regulatory change, may result in execution risk and adversely affect the successful execution of such regulatory or legal priorities.
In many cases, we are required to self-report inappropriate or non-compliant conduct to regulatory authorities, and our failure to do so may represent an independent regulatory violation. Even when we promptly bring matters to the attention of appropriate authorities, we may nonetheless experience regulatory fines, liabilities to clients, harm to our reputation or other adverse effects in connection with self-reported matters.
We may not be able to detect money laundering and other illegal or improper activities fully or on a timely basis, which could expose us to additional liability and could have a material adverse effect on us.
We are required to comply with anti-money laundering, anti-terrorism and other laws and regulations in the jurisdictions in which we operate. These laws and regulations require us, among other things, to adopt and enforce “know-your-customer” policies and procedures and to report suspicious and large transactions to applicable regulatory authorities. These laws and regulations have become increasingly complex and detailed, require improved systems and sophisticated monitoring and compliance personnel, and have become the subject of enhanced government supervision.
While we have adopted policies and procedures aimed at detecting and preventing the use of our banking network for money laundering and related activities, those policies and procedures may not completely eliminate instances in which we may be used by other parties to engage in money laundering and other illegal or improper activities. Emerging technologies, such as cryptocurrencies and blockchain, could limit our ability to track the movement of funds. Our ability to comply with legal requirements depends on our ability to improve detection and reporting capabilities and reduce variation in control processes and oversight accountability.
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These require implementing and embedding effective controls and monitoring within our business and on-going changes to systems and operations. Financial crime is continually evolving and subject to increasingly stringent regulatory oversight and focus. Even known threats can never be fully eliminated, and there will be instances in which we may be used by other parties to engage in money laundering or other illegal or improper activities. To the extent we fail to fully comply with applicable laws and regulations, the relevant government agencies to which we report have the authority to impose fines and other penalties on us. In addition, our business and reputation could suffer if customers use our banking network for money laundering or other illegal or improper purposes.
While we review our relevant counterparties’ internal policies and procedures with respect to such matters, to a large degree we rely on our counterparties to maintain and properly apply their own appropriate anti-money laundering procedures. Such measures, procedures and compliance may not be completely effective in preventing third parties from using our and our counterparties’ services as conduits for money laundering (including illegal cash operations) or other illegal activities without our and our counterparties’ knowledge. If we are associated with, or even accused of being associated with, or become a party to, money laundering or other illegal activities, our reputation could suffer and/or we could become subject to fines, sanctions and/or legal enforcement (including being added to any “blacklists” that would prohibit certain parties from engaging in transactions with us), any one of which could have a material adverse effect on our operating results, financial condition and prospects.
An incorrect interpretation of tax laws and regulations may adversely affect us.
The preparation of our tax returns requires the use of estimates and interpretations of complex tax laws and regulations, and is subject to review by taxing authorities. We are subject to the income tax laws of the United States and certain foreign countries. These tax laws are complex and subject to different interpretations by the taxpayer and relevant governmental taxing authorities, which are sometimes subject to prolonged evaluation periods until a final resolution is reached. In establishing a provision for income tax expense and filing returns, we must make judgments and interpretations about the application of these inherently complex tax laws. If the judgments, estimates, and assumptions we use in preparing our tax returns are subsequently found to be incorrect, there could be a material effect on our results of operations.
In addition, if the Company does not obtain ownership of 80% or more of SC Common Stock, the tax and other potential benefits described in Item 1 “Business - General” above may not be realized.
Changes in taxes and other assessments may adversely affect us.
The legislatures and tax authorities in the jurisdictions in which we operate regularly enact reforms to the tax and other assessment regimes to which we and our customers are subject. Such reforms include changes in the rate of assessments and, occasionally, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. The effects of these changes and any other changes that result from enactment of additional tax reforms cannot be quantified and there can be no assurance that any such reforms would not have an adverse effect upon our business. Aspects of recent U.S. federal income tax reform such as the Tax Cuts and Jobs Act of 2017 limit or eliminate certain income tax deductions, including the home mortgage interest deduction and the deduction of interest on home equity loans. These limitations and eliminations could adversely affect demand for some of our retail banking products and the valuation of assets securing certain of our loans.
Credit Risks
If the level of our non-performing loans ("NPLs") increases or our credit quality deteriorates in the future, or if our loan and lease loss reserves are insufficient to cover loan and lease losses, this could have a material adverse effect on us.
Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of our businesses. Non-performing or low credit quality loans have in the past negatively impacted and can continue to
negatively impact our results of operations. In particular, the amount of our reported NPLs may increase in the future as a result of growth in our total loan portfolio, including as a result of loan portfolios we may acquire in the future, or factors beyond our control, such as adverse changes in the credit quality of our borrowers and counterparties or a general deterioration in economic conditions in the United States, the impact of political events, events affecting certain industries or events affecting financial markets. There can be no assurance that we will be able to effectively control the level of the NPLs in our loan portfolio.
Our loan and lease loss reserves are based on our current assessment of and expectations concerning various factors affecting the quality of our loan portfolio. These factors include, among other things, our borrowers’ financial condition, repayment abilities and repayment intentions, the realizable value of any collateral, the prospects for support from any guarantor, government macroeconomic policies, interest rates and the legal and regulatory environment. As the last global financial crisis demonstrated, many of these factors are beyond our control. As a result, there is no precise method for predicting loan and credit losses, and there can be no assurance
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that our current or future loan and lease loss reserves will be sufficient to cover actual losses. If our assessment of and expectations concerning the above-mentioned factors differ from actual developments, if the quality of our total loan portfolio deteriorates for any reason, including an increase in lending to individuals and small and medium enterprises, a volume increase in our credit card portfolio or the introduction of new products, or if future actual losses exceed our estimates of incurred losses, we may be required to increase our loan and lease loss reserves, which may adversely affect us. If we were unable to control or reduce the level of our non-performing or poor credit quality loans, this also could have a material adverse effect on us.
Our loan and investment portfolios are subject to risk of prepayment, which could have a material adverse effect on us.
Our fixed rate loan and investment portfolios are subject to prepayment risk, which results from the ability of a borrower or issuer to pay a debt obligation prior to maturity. Generally, in a low interest rate environment, prepayment activity increases, and this reduces the weighted average life of our earning assets and could have a material adverse effect on us. We would also be required to amortize net premiums into income over a shorter period of time, thereby reducing the corresponding asset yield and net interest income. Prepayment risk also has a significant adverse impact on credit card and collateralized mortgage loans, since prepayments could shorten the weighted average life of these assets, which may result in a mismatch in our funding obligations and reinvestment at lower yields. Prepayment risk is inherent in our commercial activity, and an increase in prepayments could have a material adverse effect on us.
The value of the collateral securing our loans may not be sufficient, and we may be unable to realize the full value of the collateral securing our loan portfolio.
The value of the collateral securing our loan portfolio may fluctuate or decline due to factors beyond our control, including macroeconomic factors affecting the United States. The value of the collateral securing our loan portfolio may be adversely affected by force majeure events such as natural disasters, particularly in locations in which a significant portion of our loan portfolio is composed of real estate loans. Natural disasters such as earthquakes and floods may cause widespread damage, which could impair the asset quality of our loan portfolio and have an adverse impact on the economy of the affected region. We also may not have sufficiently recent information on the value of collateral, which may result in an inaccurate assessment of impairment losses of our loans secured by such collateral. If any of the above were to occur, we may need to make additional provisions to cover actual impairment losses on our loans, which may materially and adversely affect our results of operations and financial condition.
We are subject to counterparty risk in our banking business.
We are exposed to counterparty risk in addition to credit risks associated with lending activities. Counterparty risk may arise from, for example, investing in securities of third parties, entering into derivatives contracts under which counterparties have obligations to make payments to us or executing securities, futures, currency or commodity trades that fail to settle at the required time due to non-delivery by the counterparty or systems failure by clearing agents, clearinghouses or other financial intermediaries.
We routinely transact with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual funds, hedge funds and other institutional clients. We rely on information provided by or on behalf of counterparties, such as financial statements, and we may rely on representations of our counterparties as to the accuracy and completeness of that information. Defaults by, and even rumors or questions about the solvency of, certain financial institutions and the financial services industry generally have led to market-wide liquidity problems and could lead to losses or defaults by other institutions. Many routine transactions we enter into expose us to significant credit risk in the event of default by one of our significant counterparties.
Liquidity and Financing Risks
Liquidity and funding risks are inherent in our business and could have a material adverse effect on us.
Liquidity risk is the risk that we either do not have available sufficient financial resources to meet our obligations as they become due or can secure them only at excessive cost. This risk is inherent in any retail and commercial banking business and can be heightened by a number of enterprise-specific factors, including over-reliance on a particular source of funding, changes in credit ratings or market-wide phenomena such as market dislocation. While we implement liquidity management processes to seek to mitigate and control these risks, unforeseen systemic market factors in particular make it difficult to eliminate these risks completely. Adverse and continued constraints in the supply of liquidity, including inter-bank lending, may materially and adversely affect the cost of funding our business, and extreme liquidity constraints may affect our current operations and our ability to fulfill regulatory liquidity requirements as well as limit growth possibilities.
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Our cost of obtaining funding is directly related to prevailing market interest rates and our credit spreads. Increases in interest rates and our credit spreads can significantly increase the cost of our funding. Changes in our credit spreads are market-driven, and may be influenced by market perceptions of our creditworthiness. Changes to interest rates and our credit spreads occur continuously and may be unpredictable and highly volatile.
If wholesale markets financing ceases to be available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits, with a view to attracting more customers, and/or to sell assets, potentially at depressed prices. The persistence or worsening of these adverse market conditions or an increase in base interest rates could have a material adverse effect on our ability to access liquidity and cost of funding.
We rely, and will continue to rely, primarily on deposits to fund lending activities. The ongoing availability of this type of funding is sensitive to a variety of factors outside our control, such as general economic conditions and the confidence of depositors in the economy in general, and the financial services industry in particular, as well as competition among banks for deposits. Any of these factors could significantly increase the amount of deposit withdrawals in a short period of time, thereby reducing our ability to access deposit funding in the future on appropriate terms, or at all. If these circumstances were to arise, they could have a material adverse effect on our operating results, financial condition and prospects.
We anticipate that our customers will continue to make deposits (particularly demand deposits and short-term time deposits) in the near future, and we intend to maintain our emphasis on the use of banking deposits as a source of funds. The short-term nature of some deposits could cause liquidity problems for us in the future if deposits are not made in the volumes we expect or are not renewed. If a substantial number of our depositors withdraw their demand deposits, or do not roll over their time deposits upon maturity, we may be materially and adversely affected.
There can be no assurance that, in the event of a sudden or unexpected shortage of funds in the banking system, we will be able to maintain levels of funding without incurring high funding costs, a reduction in the term of funding instruments, or the liquidation of certain assets. If this were to happen, we could be materially adversely affected.
Credit, market and liquidity risk may have an adverse effect on our credit ratings and our cost of funds. Any downgrading in our credit rating would likely increase our cost of funding, require us to post additional collateral or take other actions under some of our derivative contracts and adversely affect our interest margins and results of operations.
Credit ratings affect the cost and other terms upon which we are able to obtain funding. Rating agencies regularly evaluate us, and their ratings of our debt are based on a number of factors, including our financial strength and conditions affecting the financial services industry generally.
Any downgrade in our or Santander's debt credit ratings would likely increase our borrowing costs and require us to post additional collateral or take other actions under some of our derivatives contracts, and could limit our access to capital markets and adversely affect our commercial business. For example, a ratings downgrade could adversely affect our ability to sell or market certain of our products, engage in certain longer-term and derivatives transactions and retain customers, particularly customers who need a minimum rating threshold in order to invest. In addition, under the terms of certain of our derivatives contracts, we may be required to maintain a minimum credit rating or terminate the contracts. Any of these results of a ratings downgrade, in turn, could reduce our liquidity and have an adverse effect on us, including our operating results and financial condition.
We conduct a significant number of our material derivatives activities through Santander and Santander UK. We estimate that, as of December 31, 2018, if all of the rating agencies were to downgrade Santander’s or Santander UK’s long-term senior debt ratings, we would be required to post additional collateral pursuant to derivatives and other financial contracts. Refer to further discussion in Note 14 of the Notes to the Consolidated Financial Statements.
While certain potential impacts of these downgrades are contractual and quantifiable, the full consequences of a credit rating downgrade are inherently uncertain, as they depend on numerous dynamic, complex and inter-related factors and assumptions, including market conditions at the time of any downgrade, whether any downgrade of a company's long-term credit rating precipitates downgrades to its short-term credit rating, and assumptions about the potential behaviors of various customers, investors and counterparties. Actual outflows could be higher or lower than this hypothetical example depending on certain factors, including which credit rating agency downgrades our credit rating, any management or restructuring actions that could be taken to reduce cash outflows and the potential liquidity impact from loss of unsecured funding (such as from money market funds) or loss of secured funding capacity. Although unsecured and secured funding stresses are included in our stress testing scenarios and a portion of our total liquid assets is held against these risks, it is still the case that a credit rating downgrade could have a material adverse effect on the Company, the Bank, and SC.
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In addition, if we were required to cancel our derivatives contracts with certain counterparties and were unable to replace those contracts, our market risk profile could be altered.
There can be no assurance that the rating agencies will maintain their current ratings or outlooks. Failure to maintain favorable ratings and outlooks could increase the cost of funding and adversely affect interest margins, which could have a material adverse effect on us.
Market Risks
We are subject to fluctuations in interest rates and other market risks, which may materially and adversely affect us.
Market risk refers to the probability of variations in our net interest income or in the market value of our assets and liabilities due to volatility of interest rates, exchange rates or equity prices. Changes in interest rates affect the following areas, of our business, among others:
• | net interest income; |
• | the volume of loans originated; |
• | the market value of our securities holdings; |
• | the value of our loans and deposits; |
• | gains from sales of loans and securities; and |
• | gains and losses from derivatives. |
Interest rates are highly sensitive to many factors beyond our control, including increased regulation of the financial sector, monetary policies, domestic and international economic and political conditions, and other factors. Variations in interest rates could affect our net interest income, which comprises the majority of our revenue, reducing our growth rate and potentially resulting in losses. This is a result of the different effect a change in interest rates may have on the interest earned on our assets and the interest paid on our borrowings. In addition, we may incur costs (which, in turn, will impact our results) as we implement strategies to reduce future interest rate exposure.
Increases in interest rates may reduce the volume of loans we originate. Sustained high interest rates have historically discouraged customers from borrowing and have resulted in increased delinquencies in outstanding loans and deterioration in the quality of assets. Increases in interest rates may also reduce the propensity of our customers to prepay or refinance fixed-rate loans. Increases in interest rates may reduce the value of our financial assets and may reduce gains or require us to record losses on sales of our loans or securities.
In addition, we may experience increased delinquencies in a low interest rate environment when such an environment is accompanied by high unemployment and recessionary conditions.
We are exposed to foreign exchange rate risk as a result of mismatches between assets and liabilities denominated in different currencies. Fluctuations in the exchange rate between currencies may negatively affect our earnings and value of our assets and securities.
Some of our investment management services fees are based on financial market valuations of assets certain of our subsidiaries manage or hold in custody for clients. Changes in these valuations can affect noninterest income positively or negatively, and ultimately affect our financial results. Significant changes in the volume of activity in the capital markets, and in the number of assignments we are awarded, could also affect our financial results.
We are also exposed to equity price risk in our investments in equity securities. The performance of financial markets may cause changes in the value of our investment and trading portfolios. The volatility of world equity markets due to economic uncertainty and sovereign debt concerns has had a particularly strong impact on the financial sector. Continued volatility may affect the value of our investments in equity securities and, depending on their fair value and future recovery expectations, could become a permanent impairment which would be subject to write-offs against our results. To the extent any of these risks materialize, our net interest income and the market value of our assets and liabilities could be materially adversely affected.
Market conditions have resulted, and could result, in material changes to the estimated fair values of our financial assets. Negative fair value adjustments could have a material adverse effect on our operating results, financial condition and prospects.
In recent years, financial markets have been subject to volatility and the resulting widening of credit spreads. We have material exposures to securities and other investments that are recorded at fair value and are therefore exposed to potential negative fair value
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adjustments. Asset valuations in future periods, reflecting then-prevailing market conditions, may result in negative changes in the fair values of our financial assets, and also may translate into increased impairments. In addition, the value we ultimately realize on
disposal of the asset may be lower than its current fair value. Any of these factors could require us to record negative fair value adjustments, which may have a material adverse effect on our operating results, financial condition and prospects.
In addition, to the extent fair values are determined using financial valuation models, such values may be inaccurate or subject to change, as the data used by such models may not be available or may become unavailable due to changes in market conditions, particularly for illiquid assets and in times of economic instability. In such circumstances, our valuation methodologies require us to make assumptions, judgments and estimates in order to establish fair value, and reliable assumptions are difficult to make and are inherently uncertain. In addition, valuation models are complex, making them inherently imperfect predictors of actual results. Any resulting impairments or write-downs could have a material adverse effect on our operating results, financial condition and prospects.
We are subject to market, operational and other related risks associated with our derivatives transactions that could have a material adverse effect on us.
We enter into derivatives transactions for trading purposes as well as for hedging purposes. We are subject to market, credit and operational risks associated with these transactions, including basis risk (the risk of loss associated with variations in the spread between the asset yield and the funding and/or hedge cost) and credit or default risk (the risk of insolvency or other inability of the counterparty to a particular transaction to perform its obligations thereunder, including providing sufficient collateral).
The execution and performance of derivatives transactions depend on our ability to maintain adequate control and administration systems and to hire and retain qualified personnel. Moreover, our ability to adequately monitor, analyze and report derivatives transactions continues to depend, to a great extent, on our information technology ("IT") systems. These factors further increase the risks associated with these transactions and could have a material adverse effect on us.
In addition, disputes with counterparties may arise regarding the terms or the settlement procedures of derivatives contracts, including with respect to the value of underlying collateral, which could cause us to incur unexpected costs, including transaction, operational, legal and litigation costs, or result in credit losses, all of which may impair our ability to manage our risk exposure from these products.
Risk Management
Failure to successfully implement and continue to improve our risk management policies, procedures and methods, including our credit risk management system, could materially and adversely affect us, and we may be exposed to unidentified or unanticipated risks.
The management of risk is an integral part of our activities. We seek to monitor and manage our risk exposure through a variety of separate but complementary financial, credit, market, operational, compliance and legal reporting systems. Although we employ a broad and diversified set of risk monitoring and risk mitigation techniques, such techniques and strategies may not be fully effective in mitigating our risk exposure in all economic market environments or against all types of risk, including risks that we fail to identify or anticipate.
We rely on quantitative models to measure risks and estimate certain financial values. Models may be used in such processes as determining the pricing of various products, grading loans and extending credit, measuring interest rate and other market risks, predicting losses, assessing capital adequacy, and calculating economic and regulatory capital levels, as well as estimating the value of financial instruments and balance sheet items. Poorly designed or implemented models present the risk that our business decisions based on information incorporating models will be adversely affected due to the inadequacy of that information. Also, information we provide to the public or our regulators based on poorly designed or implemented models could be inaccurate or misleading.
Some of our qualitative tools and metrics for managing risk are based on our use of observed historical market behavior. We apply statistical and other tools to these observations to arrive at quantifications of our risk exposures. These qualitative tools and metrics may fail to predict future risk exposures. These risk exposures could, for example, arise from factors we did not anticipate or correctly evaluate in our statistical models. This would limit our ability to manage our risks. Our losses therefore could be significantly greater than the historical measures indicate. In addition, our quantified modeling does not take all risks into account. Our more qualitative approach to managing those risks could prove insufficient, exposing us to material unanticipated losses. We could face adverse consequences as a result of decisions based on models that are poorly developed, implemented, or used, or as a result of a modeled outcome being misunderstood or used of for purposes for which it was not designed. In addition, if existing or potential customers believe our risk management is inadequate, they could take their business elsewhere or seek to limit transactions with us. This could have a material adverse effect on our reputation, operating results, financial condition, and prospects.
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As a commercial bank, one of the main types of risks inherent in our business is credit risk. For example, an important feature of our credit risk management is to employ an internal credit rating system to assess the particular risk profile of a customer. Since this process involves detailed analyses of the customer, taking into account both quantitative and qualitative factors, it is subject to human and IT systems errors. In exercising their judgment on the current and future credit risk of our customers, our employees may not always assign an accurate credit rating, which may result in our exposure to higher credit risks than indicated by our risk rating system.
We have been refining our credit policies and guidelines to address potential risks associated with particular industries or types of customers. However, we may not be able to timely detect all possible risks before they occur or, due to limited tools available to us, our employees may not be able to implement them effectively, which may increase our credit risk. Failure to effectively implement,
consistently follow or continuously refine our credit risk management system may result in an increase in the level of NPLs and a higher risk exposure for us, which could have a material adverse effect on us.
General Business and Industry Risks
The financial problems our customers face could adversely affect us.
Market turmoil and economic recession could materially and adversely affect the liquidity, businesses and/or financial condition of our borrowers, which could in turn increase our NPL ratios, impair our loan and other financial assets and result in decreased demand for borrowings in general. In addition, our customers may further decrease their risk tolerance to non-deposit investments such as stocks, bonds and mutual funds significantly, which would adversely affect our fee and commission income. Any of the conditions described above could have a material adverse effect on our business, financial condition and results of operations.
We depend in part upon dividends and other funds from subsidiaries.
Some of our operations are conducted through our subsidiaries. As a result, our ability to pay dividends, to the extent we decide to do so, depends in part on the ability of our subsidiaries to generate earnings and pay dividends to us. Payment of dividends, distributions and advances by our subsidiaries will be contingent on our subsidiaries’ earnings and business considerations, and are limited by legal and regulatory restrictions. Additionally, our right to receive any assets of any of our subsidiaries as an equity holder of such subsidiaries upon their liquidation or reorganization will be effectively subordinated to the claims of our subsidiaries’ creditors, including trade creditors.
Increased competition and industry consolidation may adversely affect our results of operations.
We face substantial competition in all parts of our business from numerous banks and non-bank providers of financial services, including in originating loans and attracting deposits, and we expect competitive conditions to continue to intensify. Our competition in originating loans comes principally from other domestic and foreign banks, mortgage banking companies, consumer finance companies, insurance companies and other lenders and purchasers of loans.
There has been a trend towards consolidation in the banking industry, which has created larger and stronger banks with which we must now compete. Some of our competitors are substantially larger than we are, which may give those competitors advantages such as a more diversified product and customer base, the ability to reach more customers and potential customers, operational efficiencies, lower-cost funding and larger branch networks. Many competitors are also focused on cross-selling their products, which could affect our ability to maintain or grow existing customer relationships or require us to offer lower interest rates or fees on our lending products or higher interest rates on deposits. There can be no assurance that increased competition will not adversely affect our growth prospects and therefore our operations. We also face competition from non-bank competitors such as brokerage companies, department stores (for some credit products), leasing and factoring companies, mutual fund and pension fund management companies and insurance companies.
Non-traditional providers of banking services, such as internet based e-commerce providers, mobile telephone companies and internet search engines, may offer and/or increase their offerings of financial products and services directly to customers. These non-traditional providers of banking services currently have an advantage over traditional providers because they are not subject to the same regulatory or legislative requirements to which we are subject. Several of these competitors may have long operating histories, large customer bases, strong brand recognition and significant financial, marketing and other resources. They may adopt more aggressive pricing and rates and devote more resources to technology, infrastructure and marketing.
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New competitors may enter the market or existing competitors may adjust their services with unique product or service offerings or approaches to providing banking services. If we are unable to successfully compete with current and new competitors, or if we are unable to anticipate and adapt our offerings to changing banking industry trends, including technological changes, our business may be adversely affected. In addition, our failure to effectively anticipate or adapt to emerging technologies or changes in customer behavior, including among younger customers, could delay or prevent our access to new digital-based markets, which would in turn have an adverse effect on our competitive position and business. Furthermore, the widespread adoption of new technologies, including cryptocurrencies and payment systems, could require substantial expenditures to modify or adapt our existing products and services as we continue to grow our internet and mobile banking capabilities. Our customers may choose to conduct business or offer products in areas that may be considered speculative or risky. Such new technologies and the rise in customer use of internet and mobile banking platforms in recent years could negatively impact our investments in bank premises, equipment and personnel for our branch network. The persistence or acceleration of this shift in demand towards internet and mobile banking may necessitate changes to our retail distribution strategy, which may include closing and/or selling certain branches and restructuring our remaining branches and workforce. These actions could lead to losses on these assets and increased expenditures to renovate, reconfigure or close a number
of our remaining branches or otherwise reform our retail distribution channel. Furthermore, our failure to keep pace with innovation or to swiftly and effectively implement such changes to our distribution strategy could have an adverse effect on our competitive position.
If our customer service levels were perceived by the market to be materially below those of our competitors, we could lose existing and potential business. If we are not successful in retaining and strengthening customer relationships, we may lose market share, incur losses on some or all of our activities or fail to attract new deposits or retain existing deposits, which could have a material adverse effect on our operating results, financial condition and prospects.
Our ability to maintain our competitive position depends, in part, on the success of new products and services we offer our clients and our ability to continue offering products and services from third parties, and we may not be able to manage various risks we face as we expand our range of products and services that could have a material adverse effect on us.
The success of our operations and our profitability depend, in part, on the success of new products and services we offer our clients and our ability to continue offering products and services from third parties. However, we cannot guarantee that our new products and services will be responsive to client demands or successful once they are offered to our clients, or that they will be successful in the future. In addition, our clients’ needs or desires may change over time, and such changes may render our products and services obsolete, outdated or unattractive, and we may not be able to develop new products that meet our clients’ changing needs. Our success is also dependent on our ability to anticipate and leverage new and existing technologies that may have an impact on products and services in the banking industry. Technological changes may further intensify and complicate the competitive landscape and influence client behavior. If we cannot respond in a timely fashion to the changing needs of our clients, we may lose clients, which could in turn materially and adversely affect us.
The introduction of new products and services can entail significant time and resources, including regulatory approvals. Substantial risks and uncertainties are associated with the introduction of new products and services, including technical and control requirements that may need to be developed and implemented, rapid technological change in the industry, our ability to access technical and other information from our clients and the significant and ongoing investments required to bring new products and services to market in
a timely manner at competitive prices. Our failure to manage these risks and uncertainties also exposes us to the enhanced risk of operational lapses, which may result in the recognition of financial statement liabilities. Regulatory and internal control requirements, capital requirements, competitive alternatives, vendor relationships and shifting market preferences may also determine whether initiatives can be brought to market in a manner that is timely and attractive to our clients. Failure to manage these risks in the development and implementation of new products or services successfully could have a material adverse effect on our business and reputation, as well as on our consolidated results of operations and financial condition.
As we expand the range of our products and services, some of which may be at an early stage of development in the markets of certain regions in which we operate, we will be exposed to new and potentially increasingly complex risks and development expenses. Our employees and risk management systems as well as our experience and that of our partners may not be adequate to enable us to handle or manage such risks properly. In addition, the cost of developing products that are not launched is likely to affect our results of operations. Any or all of these factors, individually or collectively, could have a material adverse effect on us.
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If we are unable to manage the growth of our operations, this could have an adverse impact on our profitability.
We cannot ensure that we will, in all cases, be able to manage our growth effectively or deliver our strategic growth objectives. Challenges that may result from our strategic growth decisions include our ability to:
• | manage efficiently the operations and employees of expanding businesses; |
• | maintain or grow our existing customer base; |
• | align our current IT systems adequately with those of an enlarged group; |
• | apply our risk management policies effectively to an enlarged group; and |
• | manage a growing number of entities without over-committing management or losing key personnel. |
Any failure to manage growth effectively, including any or all of the above challenges associated with our growth plans, could have a material adverse effect on our operating results, financial condition and prospects.
Goodwill impairments may be required in relation to acquired businesses.
We have made business acquisitions for which it is possible that the goodwill which has been attributed to those businesses may have to be written down if our valuation assumptions are required to be reassessed as a result of any deterioration in the business’ underlying profitability, asset quality or other relevant matters. Impairment testing with respect to goodwill is performed annually, more frequently if impairment indicators are present, and includes a comparison of the carrying amount of the reporting unit with its fair value. If the carrying value of the reporting unit is higher than the fair value, the impairment is measured as this excess of carrying value over fair value. We recognized a $10.5 million impairment of goodwill in 2017 primarily due to the unfavorable economic environment in Puerto Rico and the additional adverse effect of Hurricane Maria. We did not recognize any impairments of goodwill in 2016. It is reasonably possible we may be required to record impairment of $4.5 billion of goodwill attributable to SC and SBNA in the future. There can be no assurance that we will not have to write down the value attributed to goodwill further in the future, which would not impact risk-based capital ratios adversely, but would adversely affect our results of operations and stockholder's equity.
We rely on recruiting, retaining and developing appropriate senior management and skilled personnel.
Our continued success depends in part on the continued service of key members of our management team. The ability to continue to attract, train, motivate and retain highly qualified professionals is a key element of our strategy. The successful implementation of our growth strategy depends on the availability of skilled management, both at our head office and at each of our business units. If we or one of our business units or other functions fails to staff its operations appropriately or loses one or more of its key senior executives and fails to replace them in a satisfactory and timely manner, our business, financial condition and results of operations, including control and operational risks, may be adversely affected.
The financial industry in the United States has experienced and may continue to experience more stringent regulation of employee compensation, which could have an adverse effect on our ability to hire or retain the most qualified employees. In addition, due to our relationship with Santander, we are subject to indirect regulation by the European Central Bank, which has recently imposed compensation restrictions that may apply to certain of our executive officers and other employees under the Capital Requirements Directive IV prudential rules. These restrictions may impact our ability to retain our experienced management team and key employees and our ability to attract appropriately qualified personnel, which could have a material adverse impact on our business, financial condition, and results of operations.
We rely on third parties for important products and services.
Third-party vendors provide key components of our business infrastructure such as loan and deposit servicing systems, internet connections and network access. Third parties can be sources of operational risk to us, including with respect to security breaches affecting those parties. We may be required to take steps to protect the integrity of our operational systems, thereby increasing our operational costs and potentially decreasing customer satisfaction. In addition, any problems caused by these third parties, including as a result of their not providing us their services for any reason, their performing their services poorly, or employee misconduct could adversely affect our ability to deliver products and services to customers and otherwise to conduct business, which could lead to reputational damage and regulatory investigations and intervention. Replacing these third-party vendors could also entail significant delays and expense. Further, the operational and regulatory risk we face as a result of these arrangements may be increased to the extent that we restructure them. Any restructuring could involve significant expense to us and entail significant delivery and execution risk, which could have a material adverse effect on our business, financial condition and operations.
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If a third party obtains access to our customer information and that third party experiences a cyberattack or breach of its systems, this could result in several negative outcomes for us, including losses from fraudulent transactions, potential legal and regulatory liability and associated damages, penalties and restitution, increased operational costs to remediate the consequences of the third party’s security breach, and harm to our reputation from the perception that our systems or third-party systems or services that we rely on may not be secure.
Damage to our reputation could cause harm to our business prospects.
Maintaining a positive reputation is critical to our attracting and maintaining customers, investors and employees and conducting business transactions with our counterparties. Damage to our reputation can therefore cause significant harm to our business and prospects. Harm to our reputation can arise from numerous sources including, among others, employee misconduct, litigation or regulatory outcomes, failure to deliver minimum standards of service and quality, dealing with sectors that are not well perceived by the public (e.g., weapons industries), dealing with customers on sanctions lists, ratings downgrades, compliance failures, unethical
behavior, and the activities of customers and counterparties. Further, adverse publicity, regulatory actions or fines, litigation, operational failures or the failure to meet client expectations or other obligations could materially and adversely affect our reputation, our ability to attract and retain clients or our sources of funding for the same or other businesses.
Actions by the financial services industry generally or by certain members of, or individuals in, the industry can also affect our reputation. For example, the role played by financial services firms in the financial crisis and the seeming shift toward increasing regulatory supervision and enforcement have caused public perception of us and others in the financial services industry to decline.
Preserving and enhancing our reputation also depends on maintaining systems, procedures and controls that address known risks and regulatory requirements, as well as our ability to timely identify, understand and mitigate additional risks that arise due to changes in our businesses and the markets in which we operate, the regulatory environment and customer expectations.
We could suffer significant reputational harm if we fail to identify and manage potential conflicts of interest properly. The failure to adequately address, or the perceived failure to adequately address, conflicts of interest could affect the willingness of clients to deal with us, or give rise to litigation or enforcement actions against us. Therefore, there can be no assurance that conflicts of interest will not arise in the future that could cause material harm to us.
Fraudulent activity associated with our products or networks could cause us to suffer reputational damage, the use of our products to decrease and our fraud losses to be materially adversely affected. We are subject to the risk of fraudulent activity associated with merchants, customers and other third parties handling customer information. The risk of fraud continues to increase for the financial services industry in general. Credit and debit card fraud, identity theft and related crimes are prevalent, and perpetrators are growing more sophisticated. Our resources, customer authentication methods and fraud prevention tools may not be sufficient to accurately predict or prevent fraud. Additionally, our fraud risk continues to increase as third parties that handle confidential consumer information suffer security breaches and we expand our direct banking business and introduce new products and features. Our financial condition, the level of our fraud charge-offs and other results of operations could be materially adversely affected if fraudulent activity were to increase significantly. High-profile fraudulent activity could negatively impact our brand and reputation. In addition, significant increases in fraudulent activity could lead to regulatory intervention and reputational and financial damage to our brands, which could negatively impact the use of our products and services and have a material adverse effect on our business.
The Bank engages in transactions with its subsidiaries or affiliates that others may not consider to be on an arm’s-length basis.
The Bank and its subsidiaries have entered into a number of services agreements pursuant to which we render services, such as administrative, accounting, finance, treasury, legal services and others.
United States law applicable to certain financial institutions, including the Bank and other Santander entities and offices in the U.S., establish several procedures designed to ensure that the transactions entered into with or among our subsidiaries and/or affiliates do not deviate from prevailing market conditions for those types of transactions.
The Bank and its affiliates are likely to continue to engage in transactions with their respective affiliates. Future conflicts of interests among our affiliates may arise, which conflicts are not required to be and may not be resolved in SHUSA's favor.
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Our business and financial performance could be adversely affected, directly or indirectly, by disasters, natural or otherwise, terrorist activities or international hostilities.
Neither the occurrence nor potential impact of disasters (such as earthquakes, hurricanes, tornadoes, floods and other severe weather conditions, pandemics, dislocations, fires, explosions, or other catastrophic accidents or events), terrorist activities or international hostilities can be predicted. However, these occurrences could impact us directly (for example, by causing significant damage to our facilities or preventing us from conducting our business in the ordinary course), or indirectly as a result of their impact on our borrowers, depositors, other customers, suppliers or other counterparties. We could also suffer adverse consequences to the extent that disasters, terrorist activities or international hostilities affect the financial markets or the economy in general or in any particular region. These types of impacts could lead, for example, to an increase in delinquencies, bankruptcies and defaults that could result in our experiencing higher levels of nonperforming assets, net charge-offs and provisions for credit losses.
Our ability to mitigate the adverse consequences of such occurrences is in part dependent on the quality of our resiliency planning and our ability to anticipate the nature of any such event that may occur. The adverse impact of disasters, terrorist activities or international hostilities also could be increased to the extent that there is a lack of preparedness on the part of national or regional emergency responders or on the part of other organizations and businesses with which we deal.
Technology and Cybersecurity Risks
Any failure to effectively improve or upgrade our IT infrastructure and management information systems in a timely manner could have a material adverse effect on us.
Our ability to remain competitive depends in part on our ability to upgrade our IT on a timely and cost-effective basis. We must continually make significant investments and improvements in our IT infrastructure in order to remain competitive. There can be no assurance that we will be able to maintain the level of capital expenditures necessary to support the improvement or upgrading of our IT infrastructure in the future. Any failure to improve or upgrade our IT infrastructure and management information systems effectively and in a timely manner could have a material adverse effect on us.
Risks relating to data collection, processing, storage systems and security are inherent in our business.
Like other financial institutions with a large customer base, we have been subject to and are likely to continue to be the subject of attempted cyberattacks in light of the fact that we manage and hold confidential personal information of customers in the conduct of our banking operations, as well as a large number of assets. Our business depends on the ability to process a large number of transactions efficiently and accurately, and on our ability to rely on our digital technologies, computer and e-mail services, spreadsheets, software and networks, as well as on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. The proper functioning of financial controls, accounting and other data collection and processing systems is critical to our businesses and our ability to compete effectively. Losses can result from inadequate personnel, inadequate or failed internal control processes and systems, or external events that interrupt normal business operations. We also face the risk that the design of our controls and procedures proves to be inadequate or is circumvented. Although we work with our clients, vendors, service providers, counterparties and other third parties to develop secure transmission capabilities and prevent information security risk, we routinely exchange personal, confidential and proprietary information by electronic means, which may be a target for attempted cyberattacks.
Many companies across the country and in the financial services industry have reported significant breaches in the security of their websites or other systems. Cybersecurity risks have increased significantly in recent years due to the development and proliferation of new technologies, increased use of the internet and telecommunications technology to conduct financial transactions, and increased sophistication and activities of organized crime groups, state-sponsored and individual hackers, terrorist organizations, disgruntled employees and vendors, activists and other third parties. Financial institutions, the government and retailers have in recent years reported cyber incidents that compromised data, resulted in the theft of funds or the theft or destruction of corporate information and other assets.
We take protective measures and continuously monitor and develop our systems to protect our technology infrastructure and data from misappropriation or corruption. We have policies, practices and controls designed to prevent or limit disruptions to our systems and enhance the security of our infrastructure. These include performing risk management for information systems that store, transmit or process information assets identifying and managing risks to information assets managed by third-party service providers through
on-going oversight and auditing of the service providers’ operations and controls. We develop controls regarding user access to software on the principle that access is forbidden to a system unless expressly permitted, limited to the minimum amount necessary for business purposes, and terminated promptly when access is no longer required. We seek to educate and make our employees aware of information security and privacy controls and their specific responsibilities on an ongoing basis.
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Nevertheless, while we have not experienced any material losses or other material consequences relating to cyberattacks or other information or security breaches, whether directed at us or third parties, our systems, software and networks, as well as those of our clients, vendors, service providers, counterparties and other third parties, may be vulnerable to unauthorized access, misuse, computer viruses or other malicious code, cyberattacks such as denial of service, malware, ransomware, phishing, and other events that could result in security breaches or give rise to the manipulation or loss of significant amounts of customer data and other sensitive information, disrupt, sabotage or degrade service on our systems, or result in the theft or loss of significant levels of liquid assets, including cash. As cybersecurity threats continue to evolve and increase in sophistication, we cannot guarantee the effectiveness of our policies, practices and controls to protect against all such circumstances that could result in disruptions to our systems. This is because, among other reasons, the techniques used in cyberattacks change frequently, cyberattacks can originate from a wide variety of sources, and third parties may seek to gain access to our systems either directly or by using equipment or passwords belonging to employees, customers, third-party service providers or other authorized users of our systems. In the event of a cyberattack or security breach affecting a vendor or other third party entity on whom we rely, our ability to conduct business, and the security of our customer information, could be impaired in a manner to that of a cyberattack or security breach affecting us directly. We also may not receive information or notice of the breach in a timely manner, or we may have limited options to influence how and when the cyberattack or security breach is addressed.
As financial institutions are becoming increasingly interconnected with central agents, exchanges and clearinghouses, they may be increasingly susceptible to negative consequences of cyberattacks and security breaches affecting the systems of such third parties. It could take a significant amount of time for a cyberattack to be investigated, during which time we may not be in a position to fully understand and remediate the attack, and certain errors or actions could be repeated or compounded before they are discovered and remediated, any or all of which could further increase the costs and consequences associated with a particular cyberattack. The perception of a security breach affecting us or any part of the financial services industry, whether correct or not, could result in a loss of confidence in our cybersecurity measures or otherwise damage our reputation with customers and third parties with whom we do business. Should such adverse events occur, we may not have indemnification or other protection from the third party sufficient to compensate or protect us from the consequences.
As attempted cyberattacks continue to evolve in scope and sophistication, we may incur significant costs in our attempts to modify or enhance our protective measures against such attacks to investigate or remediate any vulnerability or resulting breach, or in communicating cyberattacks to our customers. An interception, misuse or mishandling of personal, confidential or proprietary information sent to or received from a client, vendor, service provider, counterparty or third party or a cyberattack could result in our inability to recover or restore data that has been stolen, manipulated or destroyed, damage to our systems and those of our clients, customers and counterparties, violations of applicable privacy and other laws, or other significant disruption of operations, including disruptions in our ability to use our accounting, deposit, loan and other systems and our ability to communicate with and perform transactions with customers, vendors and other parties. These effects could be exacerbated if we would need to shut down portions of our technology infrastructure temporarily to address a cyberattack, if our technology infrastructure is not sufficiently redundant to meet our business needs while an aspect of our technology is compromised, or if a technological or other solution to a cyberattack is slow to be developed. Even if we timely resolve the technological issues in a cyberattack, a temporary disruption in our operations could adversely affect customer satisfaction and behavior, expose us to reputational damage, contractual claims, supervisory actions, or litigation.
U.S. banking agencies and other federal and state government agencies have increased their attention on cybersecurity and data privacy risks, and have proposed enhanced risk management standards that would apply to us. Such legislation and regulations relating to cybersecurity and data privacy may require that we modify systems, change service providers, or alter business practices or policies regarding information security, handling of data and privacy. Changes such as these could subject us to heightened operational costs. To the extent we do not successfully meet supervisory standards pertaining to cybersecurity, we could be subject to supervisory actions, litigation and reputational damage.
Financial Reporting and Control Risks
Changes in accounting standards could impact reported earnings.
The accounting standard setters and other regulatory bodies periodically change the financial accounting and reporting standards that govern the preparation of our Consolidated Financial Statements. These changes can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.
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For example, as noted in Note 2 to the Consolidated Financial Statements in this Form 10-K, in June 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. Effective January 1, 2020, this will substantially change accounting for credit losses on loans and other financial assets banks, financial institutions and other organizations hold. This standard will replace existing incurred loss impairment guidance and establish a single allowance framework for financial assets carried at amortized cost. Upon adoption of ASU 2016-13, companies must recognize credit losses on these assets equal to management’s estimate of credit losses over the assets’ full remaining expected lives. Companies must consider all relevant information when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts. In December 2018, the Federal Reserve, the OCC and the FDIC revised their regulatory capital rules to address this upcoming change to the treatment of credit expense and allowances. The final rule provides an optional three-year phase-in period for the Day One adverse regulatory capital effects upon adopting this standard. The impact of the final rule on the Company and the Bank will depend in part on whether we elect to phase in the impact of the standard over a three-year period. The standard is likely to have a negative impact, potentially materially, to the allowance and capital upon adoption in 2020; however, we are still evaluating its anticipated impact. It is also possible that our ongoing reported earnings and lending activity will be negatively impacted in periods following adoption of this ASU.
Our financial statements are based in part on assumptions and estimates which, if inaccurate, could cause material misstatement of the results of our operations and financial position.
The preparation of consolidated financial statements in conformity with GAAP requires management to make judgments, estimates and assumptions that affect our Consolidated Financial Statements and accompanying notes. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgments and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognized in the period in which the estimate is revised and in any future periods affected. The accounting policies deemed critical to our results and financial position, based upon materiality and significant judgments and estimates, include impairment of loans and advances, goodwill impairment, valuation of financial instruments, impairment of available-for-sale financial assets, deferred tax assets and provisions for liabilities.
The allowance for credit losses ("ACL") is a significant critical estimate. Due to the inherent nature of this estimate, we cannot provide assurance that the Company will not significantly increase the ACL or sustain credit losses that are significantly higher than the provided allowance.
The valuation of financial instruments measured at fair value can be subjective, in particular when models are used which include unobservable inputs. Given the uncertainty and subjectivity associated with valuing such instruments it is possible that the results of our operations and financial position could be materially misstated if the estimates and assumptions used prove inaccurate.
If the judgments, estimates and assumptions we use in preparing our Consolidated Financial Statements are subsequently found to be incorrect, there could be a material effect on our results of operations and a corresponding effect on our funding requirements and capital ratios.
Disclosure controls and procedures over financial reporting and internal controls over financial reporting may not prevent or detect all errors or acts of fraud, and lapses in these controls could materially and adversely affect our operations, liquidity and/or reputation.
Disclosure controls and procedures over financial reporting are designed to provide reasonable assurance that information required to be disclosed by the Company in reports filed or submitted under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We also maintain a system of internal controls over financial reporting. However, these controls may not achieve, and in some cases have not achieved, their intended objectives. Control processes that involve human diligence and compliance, such as our disclosure controls and procedures and internal controls over financial reporting, are subject to lapses in judgement and breakdowns resulting from human failures. Controls can be circumvented by collusion or improper management override. Because of these limitations, there are risks that material misstatements due to error or fraud may not be prevented or detected, and that information may not be reported on a timely basis.
We have identified control deficiencies in our financial reporting process and for which remediation was still in process as of December 31, 2018. These control deficiencies contributed to the restatement of the audited Consolidated Financial Statements in our Form 10-K for the year ended December 31, 2015 and the unaudited financial statements included in certain of our previously
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filed Quarterly Reports on Form 10-Q. See Part II, Item 9A in this Form 10-K. We have initiated certain measures, including increasing the number of employees on, and the expertise of, our financial reporting team, and the enhancement of our model risk management framework and documentation process to remediate these weaknesses, and plan to implement additional appropriate measures as part of this effort. There can be no assurance that we will be able to fully remediate our existing material weaknesses. Further, there can be no assurance that we will not suffer from other material weaknesses in the future. If we fail to remediate these material weaknesses or fail to otherwise maintain effective internal controls over financial reporting in the future, such failure could result in a material misstatement of our annual or quarterly financial statements that would not be prevented or detected on a timely basis and which could cause investors and other users to lose confidence in our financial statements and limit our ability to raise capital. Additionally, failure to remediate the material weaknesses or otherwise failing to maintain effective internal controls over financial reporting may negatively impact our operating results and financial condition, impair our ability to timely file our periodic reports with the SEC, subject us to additional litigation and regulatory actions and cause us to incur substantial additional costs in future periods relating to the implementation of remedial measures.
Failure to satisfy obligations associated with public securities filings may have adverse regulatory, economic, and reputational consequences.
We filed our Annual Report on Form 10-K for 2015 and certain Quarterly Reports on Form 10-Q in 2016 after the time periods prescribed by the SEC’s regulations. Those failures to file our periodic reports within the time periods prescribed by the SEC, among other consequences, resulted in the suspension of our eligibility to use Form S-3 registration statements until we timely filed our SEC periodic reports for a period of 12 months. We timely filed our SEC periodic reports for 12 consecutive months as of November 13, 2017. If in the future we are not able to file our periodic reports within the time periods prescribed by the SEC, among other consequences, we would be unable to use Form S-3 registration statements until we have timely filed our SEC periodic reports for a period of 12 consecutive months. Our inability to use Form S-3 registration statements would increase the time and resources we need to spend if we choose to access the public capital markets.
Risks Associated with our Majority-Owned Consolidated Subsidiary
The financial results of SC could have a negative impact on the Company's operating results and financial condition.
SC historically has provided a significant source of funding to the Company through earnings. Our investment in SC involves risk, including the possibility that poor operating results of SC could negatively affect the operating results of SHUSA.
Factors that affect the financial results of SC in addition to those which have been previously addressed include, but are not limited to:
• | Periods of economic slowdown may result in decreased demand for automobiles as well as declining values of automobiles and other consumer products used as collateral to secure outstanding loans. Higher gasoline prices, the general availability of consumer credit, and other factors which impact consumer confidence could increase loss frequency and decrease consumer demand for automobiles. In addition, during an economic slowdown, servicing costs may increase without a corresponding increase in finance charge income. Changes in the economy may impact the collateral value of repossessed automobiles and repossession, and foreclosure sales may not yield sufficient proceeds to repay the receivables in full and result in losses. |
• | SC’s growth strategy is subject to significant risks, some of which are outside its control, including general economic conditions, the ability to obtain adequate financing for growth, laws and regulatory environments in the states in which the business seeks to operate, competition in new markets, the ability to attract new customers, the ability to recruit qualified personnel, and the ability to obtain and maintain all required approvals, permits, and licenses on a timely basis |
• | SC’s business may be negatively impacted if it is unsuccessful in developing and maintaining relationships with automobile dealerships that correlate to SC’s ability to acquire loans and automotive leases. In addition, economic downturns may result in the closure of dealerships and corresponding decreases in sales and loan volumes. |
• | SC's business could be negatively impacted if it is unsuccessful in developing and maintaining its serviced for others portfolio. As this is a significant and growing portion of SC's business strategy, if an institution for which SC currently services assets chooses to terminate SC's rights as a servicer or if SC fails to add additional institutions or portfolios to its servicing platform, SC may not achieve the desired revenue or income from this platform. |
• | SC has repurchase obligations in its capacity as a servicer in securitizations and whole loan sales. If significant repurchases of assets or other payments are required under its responsibility as a servicer, this could have a material adverse effect on SC’s financial condition, results of operations, and liquidity. |
• | The obligations associated with being a public company require significant resources and management attention, which increases the costs of SC's operations and may divert focus from business operations. As a result of its initial public offering ("IPO"), SC is now required to remain in compliance with the reporting requirements of the SEC and the NYSE, maintain corporate infrastructure required of a public company, and incur significant legal and financial compliance costs, which may divert SC management’s attention and resources from implementing its growth strategy. |
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• | The market price of SC Common Stock may be volatile, which could cause the value of an investment in SC Common Stock to decline. Conditions affecting the market price of SC Common Stock may be beyond SC’s control and include general market conditions, economic factors, actual or anticipated fluctuations in quarterly operating results, changes in or failure to meet publicly disclosed expectations related to future financial performance, analysts’ estimates of SC’s financial performance or lack of research or reports by industry analysts, changes in market valuations of similar companies, future sales of SC Common Stock, or additions or departures of its key personnel. |
• | SC's business and results of operations could be negatively impacted if it fails to manage and complete divestitures. SC regularly evaluates its portfolio in order to determine whether an asset or business may no longer be aligned with its strategic objectives. For example, in October 2015, SC disclosed a decision to exit the personal lending business and to explore strategic alternatives for its existing personal lending assets. Of its two primary lending relationships, SC completed the sale of substantially all of its loans associated with the LendingClub relationship in February 2016. SC continues to classify loans from its other primary lending relationship, Bluestem, as held-for-sale. SC remains a party to agreements with Bluestem that obligate it to purchase new advances originated by Bluestem, along with existing balances on accounts with new advances, for an initial term ending in April 2020 and which is renewable through April 2022 at Bluestem's option. Although SC is seeking a third party willing and able to take on this obligation, it may not be successful in finding such a party, and Bluestem may not agree to the substitution. SC has recorded significant lower-of-cost-or-market adjustments on this portfolio and may continue to do so as long as the portfolio is held, particularly due to the new volume it is committed to purchase. |
• | SC's business could be negatively impacted if access to funding is reduced. Adverse changes in SC's ABS program or in the ABS market generally could materially adversely affect its ability to securitize loans on a timely basis or upon terms acceptable to SC. This could increase its cost of funding, reduce its margins, or cause it to hold assets until investor demand improves. |
• | As with SHUSA, adverse outcomes to current and future litigation against SC may negatively impact its financial position, results of operations, and liquidity. SC is party to various litigation claims and legal proceedings. In particular, as a consumer finance company, it is subject to various consumer claims and litigation seeking damages and statutory penalties. Some litigation against it could take the form of class action complaints by consumers. As the assignee of loans originated by automotive dealers, it also may be named as a co-defendant in lawsuits filed by consumers principally against automotive dealers. |
The Chrysler Agreement may not result in currently anticipated levels of growth and is subject to certain performance conditions that could result in termination of the agreement. If SC fails to meet certain of these performance conditions, FCA may seek to terminate the agreement. In addition, FCA has the option to acquire an equity participation in the Chrysler Capital portion of SC's business.
In February 2013, SC entered into the Chrysler Agreement with FCA through which SC launched the Chrysler Capital brand on May 1, 2013. Under the Chrysler Agreement, SC provides private-label loans and leases to facilitate the purchase of FCA vehicles by consumers and FCA-franchised automotive dealers. The financing services SC provides under the Chrysler Agreement include providing (1) credit lines to finance FCA-franchised dealers’ acquisitions of vehicles and other products FCA sells or distributes, (2) automotive loans and leases to finance consumer acquisitions of new and used vehicles at FCA-franchised dealerships, (3) financing for commercial and fleet customers, and (4) ancillary services. In addition, SC may facilitate, for an affiliate, offerings to dealers for dealer loan financing, construction loans, real estate loans, working capital loans, and revolving lines of credit. In May 2013, in accordance with the terms of the Chrysler Agreement, SC paid FCA a $150 million upfront, nonrefundable payment, to be amortized over ten years. The unamortized portion would be recognized as expense immediately if the Chrysler Agreement were terminated in accordance with its term.
Under and subject to the terms of the Chrysler Agreement, SC received limited exclusivity rights to participate in specified minimum percentages of certain of FCA's financing incentive programs, which include loan rate subvention and automotive lease residual support subvention. Among other covenants, SC has committed to certain revenue sharing arrangements. SC bears the risk of loss on loans originated pursuant to the Chrysler Agreement, while FCA shares in any residual gains and losses in respect of automotive leases, subject to specific provisions in the Chrysler Agreement, including limitations on SC’s participation in such gains and losses.
In connection with the Chrysler Agreement, SC and FCA entered into an option agreement pursuant to which FCA has the option to acquire, for fair market value, an equity participation in the business offering and providing the financial services contemplated by the Chrysler Agreement. FCA has announced its intention to establish a captive U.S. auto finance unit and indicated that acquiring Chrysler Capital is one option it will consider.
The equity option agreement does not specify the percentage of equity interests to be represented by the equity participation, but indicates that it can be greater than 80% and provides that FCA would specify the percentage to be purchased at the time of exercise of the option. The equity option agreement contains provisions that are designed to address a situation in which the parties disagree
31
on the fair market value of an equity participation interest. There is a risk that SC may ultimately receive less than what SC believes to be the fair market value for that interest, and the loss of SC's associated revenue and profits may not be offset fully by the proceeds for such interest. There can be no assurance that SC would be able to redeploy the immediate proceeds for such interest in other businesses or investments that would provide comparable returns, thereby reducing SC's profitability. Further, the likelihood, timing and structure of any such transaction cannot reasonably be determined at this time. There can be no assurance that SHUSA or SC could successfully or timely implement any such transaction without significant disruption of its operations or restructuring, or without incurring additional liabilities, which could involve significant expense to SHUSA and SC and have a material adverse effect on SHUSA's or SC's business, financial condition and results of operations.
The Chrysler Agreement is subject to early termination in certain circumstances, including the failure by either party to comply with certain of their ongoing obligations under the Chrysler Agreement. SC's obligations include SC meeting specified obligations in relation to escalating penetration rates for the first five years of the agreement, subject to FCA treating SC in a manner consistent with other comparable OEMs' treatment of their captive finance providers. Additional termination rights in favor of FCA include, among other circumstances, (i) a person other than Santander and its affiliates owns 20% or more of SC’s common stock and Santander and its affiliates own fewer shares of common stock than such person, (ii) SC becomes, controls, or becomes controlled by, an OEM that competes with FCA or (iii) certain of SC’s credit facilities become impaired.
SC’s ability to realize the full strategic and financial benefits of its relationship with FCA depends in part on the successful continued development of its Chrysler Capital business, which requires a significant amount of management's time and effort as well as continued cooperation from FCA. If FCA exercises its equity option, if the Chrysler Agreement (or FCA's limited exclusivity obligations thereunder) were to terminate, if FCA seeks to significantly change its business relationship with SC, or if SC otherwise is unable to realize the expected benefits of its relationship with FCA, there could be a materially adverse impact to SHUSA's and SC’s business, financial condition, results of operations, profitability, loan and lease volume, the credit quality of SHUSA's and SC’s portfolio, liquidity, funding and growth, and SHUSA's and SC's ability to implement its business strategy could be materially adversely affected. The Company has $1.0 billion of goodwill assigned to the SC reporting unit from the 2014 Change in Control of SC. It is possible that changes to the Chrysler Agreement may trigger a goodwill impairment evaluation, which could require the goodwill to be written down if SC's financial condition is materially adversely affected. In addition, the Company has a $65.0 million Chrysler relationship intangible, which may require an impairment evaluation if there are adverse changes to the Chrysler Agreement.
On July 11, 2018 FCA and SC entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party under the Chrysler Agreement until December 31, 2018. FCA has not delivered a notice to exercise its equity option, and the Company remains committed to the success of the Chrysler Capital business.
ITEM 1B - UNRESOLVED STAFF COMMENTS
None.
ITEM 2 - PROPERTIES
As of December 31, 2018, the Company utilized 787 buildings that occupy a total of 6.3 million square feet, including 196 owned properties with 1.5 million square feet, 469 leased properties with 3.4 million square feet, and 122 sale-and-leaseback properties with 1.5 million square feet. The executive and primary administrative offices for SHUSA and the Bank are located at 75 State Street, Boston, Massachusetts. This location is leased by the Company. SC's corporate headquarters are located at 1601 Elm Street, Dallas, Texas. This location is leased by SC.
Eleven major buildings serve as the headquarters or house significant operational and administrative functions, and are : Operations Center - 2 Morrissey Boulevard, Dorchester, Massachusetts-Leased; Call Center and Operations and Loan Processing Center-Santander Way; 95 Amaral Street, Riverside, Rhode Island-Leased; SHUSA/SBNA Administrative Offices-75 State Street, Boston, Massachusetts-Leased; Call Center and Operations and Loan Processing Center-450 Penn Street, Reading; Pennsylvania-Leased; Loan Processing Center-601 Penn Street; Reading, Pennsylvania-Owned; Operations and Administrative Offices-1130 Berkshire Boulevard, Wyomissing, Pennsylvania-Owned; Operations and Administrative Offices-1401 Brickell Avenue, Miami, Florida-Owned; Operations and Administrative Offices - San Juan, Puerto Rico-Leased; Computer Data Center - Hato Rey, Puerto Rico-Leased; SAM Administrative Offices-Guaynabo Puerto Rico-leased; and SC Administrative Offices-1601 Elm Street, Dallas, Texas-Leased.
32
The majority of these eleven properties of the Company identified above are utilized for general corporate purposes. The remaining 776 properties consist primarily of bank branches and lending offices. Of the total number of buildings, the Bank has 627 retail branches, and BSPR has 27 retail branches.
For additional information regarding the Company's properties refer to Note 6 - "Premises and Equipment" and Note 20 - "Commitments, Contingencies and Guarantees" in the Notes to Consolidated Financial Statements in Item 8 of this Report.
ITEM 3 - LEGAL PROCEEDINGS
Refer to Note 15 to the Consolidated Financial Statements for disclosure regarding the lawsuit filed by SHUSA against the Internal Revenue Service (“IRS”) and Note 20 to the Consolidated Financial Statements for SHUSA’s litigation disclosures, which are incorporated herein by reference.
ITEM 4 - MINE SAFETY DISCLOSURES
None.
PART II
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company has one class of common stock. The Company’s common stock was traded on the NYSE under the symbol “SOV” through January 29, 2009. On January 30, 2009, all shares of the Company's common stock were acquired by Santander and de-listed from the NYSE. Following this de-listing, there has not been, nor is there currently, an established public trading market in shares of the Company’s common stock. As of the date of this filing, Santander was the sole holder of the Company’s common stock.
At February 28, 2019, 530,391,043 shares of common stock were outstanding. There were no issuances of common stock during 2018, 2017, or 2016.
During the year ended, December 31, 2018 and 2017, the Company declared and paid cash dividends of $410.0 million and $10.0 million, respectively, to its shareholder. The Company did not pay any cash dividends on its common stock in 2016.
Refer to the "Liquidity and Capital Resources" section in Item 7 of the MD&A for the two most recent fiscal years' activity on the Company's common stock.
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ITEM 6 - SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA FOR THE YEAR ENDED DECEMBER 31, | ||||||||||||||||||||
(Dollars in thousands) | 2018 (1) | 2017 (1) | 2016 (1) | 2015 | 2014 | |||||||||||||||
Balance Sheet Data | ||||||||||||||||||||
Total assets | $ | 135,634,285 | $ | 128,274,525 | $ | 138,360,290 | $ | 141,106,832 | $ | 132,839,460 | ||||||||||
Loans HFI, net of allowance | 83,148,738 | 76,795,794 | 82,005,321 | 83,779,641 | 81,961,652 | |||||||||||||||
Loans held-for-sale | 1,283,278 | 2,522,486 | 2,586,308 | 3,190,067 | 294,261 | |||||||||||||||
Total investments (2) | 15,189,024 | 16,871,855 | 19,415,330 | 22,768,783 | 18,083,235 | |||||||||||||||
Total deposits and other customer accounts | 61,511,380 | 60,831,103 | 67,240,690 | 65,583,428 | 62,148,002 | |||||||||||||||
Borrowings and other debt obligations (2)(3) | 44,953,784 | 39,003,313 | 43,524,445 | 49,828,582 | 40,381,582 | |||||||||||||||
Total liabilities | 111,787,053 | 104,583,693 | 115,981,532 | 119,259,732 | 107,919,751 | |||||||||||||||
Total stockholder's equity (4) | 23,847,232 | 23,690,832 | 22,378,758 | 21,847,100 | 24,919,709 | |||||||||||||||
Summary Statement of Operations | ||||||||||||||||||||
Total interest income | $ | 8,069,053 | $ | 7,876,079 | $ | 7,989,751 | $ | 8,137,616 | $ | 7,330,742 | ||||||||||
Total interest expense | 1,724,203 | 1,452,129 | 1,425,059 | 1,236,210 | 1,087,642 | |||||||||||||||
Net interest income | 6,344,850 | 6,423,950 | 6,564,692 | 6,901,406 | 6,243,100 | |||||||||||||||
Provision for credit losses (5) | 2,339,898 | 2,759,944 | 2,979,725 | 4,079,743 | 2,459,998 | |||||||||||||||
Net interest income after provision for credit losses | 4,004,952 | 3,664,006 | 3,584,967 | 2,821,663 | 3,783,102 | |||||||||||||||
Total non-interest income (6) | 3,244,308 | 2,901,253 | 2,755,705 | 2,905,035 | 5,059,462 | |||||||||||||||
Total general, administrative and other expenses (7) | 5,832,325 | 5,764,324 | 5,386,194 | 9,381,892 | 4,135,346 | |||||||||||||||
Income/(loss) before income taxes | 1,416,935 | 800,935 | 954,478 | (3,655,194 | ) | 4,707,218 | ||||||||||||||
Income tax provision/(benefit) (8) | 425,900 | (157,040 | ) | 313,715 | (599,758 | ) | 1,673,123 | |||||||||||||
Net income / (loss) (10) | $ | 991,035 | $ | 957,975 | $ | 640,763 | $ | (3,055,436 | ) | $ | 3,034,095 | |||||||||
Selected Financial Ratios (9) | ||||||||||||||||||||
Return on average assets | 0.76 | % | 0.71 | % | 0.45 | % | (2.18 | )% | 2.46 | % | ||||||||||
Return on average equity | 4.11 | % | 4.10 | % | 2.88 | % | (11.98 | )% | 12.95 | % | ||||||||||
Average equity to average assets | 18.37 | % | 17.39 | % | 15.67 | % | 18.15 | % | 18.99 | % | ||||||||||
Efficiency ratio | 60.82 | % | 61.81 | % | 57.79 | % | 95.67 | % | 36.59 | % | ||||||||||
(1) | On July 1, 2016, ownership of several Santander subsidiaries, including Santander BanCorp, BSI, SIS and SSLLC, were transferred to the Company. As these entities were and are solely owned and controlled by Santander prior to and after July 1, 2016, in accordance with Accounting Standards Codification ("ASC") 805, the transaction has been accounted for under the common control guidance, which requires the Company to recognize the assets and liabilities transferred at their historical cost of the transferring entity at the date of the transfer. Additionally, as this transaction represents a change in reporting entity, the guidance requires retrospective combination of the entities for all periods presented in these financial statements as if the combination had been in effect since inception of common control. On July 1, 2017, an additional Santander subsidiary, Santander Financial Services, Inc. (“SFS”), a finance company located in Puerto Rico, was transferred to the Company. On July 2, 2018, an additional Santander subsidiary, Santander Asset Management LLC ("SAM"), an investment adviser located in Puerto Rico, was transferred to the Company. SFS and SAM are entities under common control of Santander; however, their results of operations, financial condition, and cash flows are immaterial to the historical financial results of the Company on both an individual and aggregate basis. As a result, the Company has reported the results of SFS on a prospective basis beginning July 1, 2017 and the results of SAM on a prospective basis beginning July 1, 2018. Refer to Note 1 for additional information. |
(2) | The decreases in Total investments and corresponding decreases in Borrowings and other debt obligations from 2016 to 2017 and 2015 to 2016 were primarily driven by the use of proceeds from the sales of investment securities to repurchase and pay off its outstanding borrowings. |
(3) | The increase in Borrowings and other debt obligations from 2014 to 2015 was primarily a result of the Company funding the growth of the loan portfolio and operating lease portfolio. |
(4) | The decrease in Stockholder's Equity from 2014 to 2015 reflects the goodwill impairment recorded of $4.5 billion in 2015. |
(5) | The decrease in the Provision for credit losses from 2017 to 2018 was primarily due to lower net charge-offs on the RIC portfolio, accompanied by a recovery on the purchased RIC portfolio and lower provision on the originated RIC portfolio and a lower provision on the commercial loan portfolio. The decrease from 2015 to 2016 was primarily due to significantly lower provision on the purchased RIC portfolio, accompanied by slightly lower net charge-offs across the total loan portfolio. The increase from 2014 to 2015, was primarily due to the build up of the reserve on the growing originated RIC portfolio and increased net charge-offs. |
(6) | The increase in Non-interest income from 2017 to 2018 is primarily attributed to an increase in lease income corresponding to the growth of the operating lease portfolio. Non-interest income in 2014 includes a one-time $2.4 billion gain on acquisition, which was related to the Change in Control. |
(7) | General, administrative, and other expenses increased annually between 2016 and 2018, primarily due to growth in compensation and benefits and lease expense, driven by corresponding growth of the operating lease portfolio. In 2015, this line included a $4.5 billion goodwill impairment charge on SC. |
(8) | Refer to Note 15 of the Notes to Consolidated Financial Statements for additional information on the Company's income taxes. The income tax benefit in 2017 was due to the impact of the TCJA, resulting in a tax benefit to the Company. The income tax benefit in 2015 was primarily the result of the release of the deferred tax liability in conjunction with the goodwill impairment charge. The higher income tax provision in 2014 was primarily attributable to the deferred tax expense recorded on the gain from the Change in Control. |
(9) | For the calculation components of these ratios, see the Non-GAAP Financial Measures section of the MD&A. |
(10) | Includes net income/(loss) attributable to non-controlling interest ("NCI") of $283.6 million, $405.6 million, $277.9 million, $(1.7) billion, and $464.6 million for the years ended December 31, 2018, 2017, 2016, 2015 and 2014, respectively. |
34
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ("MD&A")
EXECUTIVE SUMMARY
Santander Holdings USA, Inc. ("SHUSA" or the "Company") is the parent holding company of Santander Bank, National Association, (the "Bank" or "SBNA"), a national banking association, and owns approximately 69.9% (as of February 21, 2019) of Santander Consumer USA Holdings Inc. (together with its subsidiaries, "SC"), a specialized consumer finance company. SHUSA is headquartered in Boston, Massachusetts and the Bank's main office is in Wilmington, Delaware. SC is headquartered in Dallas, Texas. SHUSA is a wholly-owned subsidiary of Banco Santander, S.A. ("Santander"). SHUSA is also the parent company of Santander BanCorp (together with its subsidiaries, “Santander BanCorp”), a holding company headquartered in Puerto Rico which offers a full range of financial services through its wholly-owned banking subsidiary, Banco Santander Puerto Rico ("BSPR"); Santander Securities LLC (“SSLLC”), a broker-dealer headquartered in Boston; Banco Santander International (“BSI”), a financial services company located in Miami that offers a full range of banking services to foreign individuals and corporations based primarily in Latin America; Santander Investment Securities Inc. (“SIS”), a registered broker-dealer located in New York providing services in investment banking, institutional sales, trading and offering research reports of Latin American and European equity and fixed-income securities; and several other subsidiaries. SSLLC, SIS and another SHUSA subsidiary, SAM, are registered investment advisers with the Securities and Exchange Commission (the “SEC”).
The Bank's principal markets are in the Mid-Atlantic and Northeastern United States. The Bank uses its deposits, as well as other financing sources, to fund its loan and investment portfolios. The Bank earns interest income on its loan and investment portfolios. In addition, the Bank generates non-interest income from a number of sources, including deposit and loan services, sales of loans and investment securities, capital markets products and bank-owned life insurance ("BOLI"). The principal non-interest expenses include employee compensation and benefits, occupancy and facility-related costs, technology and other administrative expenses. The financial results of the Bank are affected by the economic environment, including interest rates and consumer and business confidence and spending, as well as the competitive conditions within the Bank's geographic footprint.
SC is a full-service, technology driven consumer finance company focused on vehicle finance and third-party servicing. SC's primary business is the indirect origination and securitization of retail installment contracts ("RICs"), principally through manufacturer-franchised dealers in connection with their sale of new and used vehicles to subprime retail consumers. Further information about SC’s business is provided below in the “Chrysler Capital” section.
SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile and recreational and marine vehicle portfolios for other lenders. Additionally, SC has several relationships through which it provides other consumer finance products.
SC has dedicated financing facilities in place for its Chrysler Capital business. SC periodically sells consumer RICs through these flow agreements and, when market conditions are favorable, it accesses the asset-backed securities ("ABS") market through securitizations of consumer RICs. SC also periodically enters into bulk sales of consumer vehicle leases with a third party. SC typically retains servicing of loans and leases sold or securitized, and may also retain some residual risk in sales of leases. SC has also entered into an agreement with a third party whereby SC will periodically sell charged-off loans.
Chrysler Capital
In conjunction with a ten-year private label financing agreement with Fiat Chrysler Automobiles US LLC ("FCA") that became effective May 1, 2013 (the "Chrysler Agreement"), SC offers a full spectrum of auto financing products and services to FCA customers and dealers under the Chrysler Capital brand ("Chrysler Capital"), These products and services include consumer RICs and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. RICs and vehicle leases entered into with FCA customers under the Chrysler Agreement represent a significant concentration of those portfolios and there is a risk that the Chrysler Agreement could be terminated prior to its expiration date. Termination of the Chrysler Agreement could result in a decrease in the amount of new RICs and vehicle leases entered into with FCA customers as well as dealer loans. Refer to Note 20 for additional details.
Under the terms of the Chrysler Agreement, certain standards were agreed to, including SC meeting specified escalating penetration rates for the first five years, subject to FCA treating SC in a manner consistent with comparable original equipment manufacturers ("OEMs'") treatment of their captive providers, primarily in regard to sales support. The failure of either party to meet its respective obligations under the Chrysler agreement, including SC's failure to meet target penetration rates, could result in the agreement being terminated. SC did not meet these penetration rates. Chrysler Capital continues to be a focal point of the Company's and SC's strategy,
35
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
and SC continues to work with FCA to improve penetration rates. SC's average penetration rate for the year ended December 31, 2018 was 30%, an increase from 18% in 2017.
In June 2018, SC announced that it was in exploratory discussions with FCA regarding the future of FCA's U.S. finance operations. FCA has announced its intention to establish a captive U.S. auto finance unit and indicated that acquiring Chrysler Capital is one option it would consider. Under the Chrysler Agreement, FCA has the option to acquire, for fair market value, an equity participation in the business offering and providing financial services contemplated by the Chrysler Agreement. In addition, in July 2018 FCA and the Company entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party under the Chrysler Agreement until December 31, 2018.
FCA has not delivered a notice to exercise its equity option, and the Company remains committed to the success of the Chrysler Capital business. Although the likelihood, timing and structure of any such transaction, and the likelihood that the Chrysler Agreement will terminate, cannot be reasonably determined, termination of the Chrysler Agreement, or a significant change in the business relationship between SC and FCA, could materially adversely affect SC's and SHUSA's operations, including the origination of receivables through the Chrysler Capital portion of SC's business and the servicing of Chrysler Capital receivables. Moreover, there can be no assurance that SC could successfully or timely implement any such transaction without significant disruption of its operations or restructuring, or without incurring additional liabilities, which could involve significant expense to the Company and have a adverse effect on its business, financial condition and results of operations.
As of December 31, 2018, the Company had a $65.0 million Chrysler relationship intangible. The intangible is related to the upfront fee paid to Chrysler in May 2013. A significant change to the Chrysler Agreement could potentially be considered a triggering event requiring re-evaluation of whether or not the remaining unamortized balance of the upfront fee should be deemed impaired.
In addition, the Company has $1.0 billion of goodwill allocated to the SC reporting unit. A significant change to the Chrysler Agreement could potentially be considered a triggering event requiring an interim goodwill impairment analysis. The Company will continue monitoring changes to the Chrysler Agreement that could lead to a potential impairment indicator in 2018. It is reasonably possible that impairment of the entire goodwill associated with the SC reporting unit could be recognized based on future changes to the Chrysler Agreement.
SC has dedicated financing facilities in place for its Chrysler Capital business. During the year ended December 31, 2018, SC originated more than $7.9 billion in Chrysler Capital loans, which represented 46% of its total RIC originations (unpaid principal balance ("UPB")), with an approximately even share between prime and non-prime, as well as more than $9.7 billion in Chrysler Capital leases. Since its May 2013 launch, Chrysler Capital has originated more than $53.1 billion in retail loans and $33.3 billion in leases, and facilitated the origination of $3.0 billion (excluding the SBNA RIC origination program) in leases and dealer loans for the Bank. As of December 31, 2018, SC's carrying value of its auto RIC portfolio consisted of $9.0 billion of Chrysler Capital loans, which represents 36% of SC's carrying value of its auto RIC portfolio.
SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile and recreational and marine vehicle portfolios for other lenders. Additionally, SC has several relationships through which it has provided other consumer finance products.
SC periodically sells consumer RICs through these flow agreements and, when market conditions are favorable, accesses the asset-backed securities ("ABS") market through securitizations of consumer RICs. SC typically retains servicing of loans and leases sold or securitized, and may also retain some residual risk in sales of leases. SC has also entered into an agreement with a third party whereby SC will periodically sell charged-off loans.
ECONOMIC AND BUSINESS ENVIRONMENT
Overview
During the fourth quarter of 2018, unemployment continued to decrease and the preliminary gross domestic product ("GDP") growth rate slowed slightly from the prior quarter. Year to date market results ended down overall, primarily driven by third quarter volatility which continued into the fourth quarter.
The unemployment rate at December 31, 2018 was down to 3.9% compared to 4.0% at September 30, 2018, and was lower compared to 4.1% one year ago. According to the U.S. Bureau of Labor Statistics, employment rose in professional and business services, healthcare, transportation, and warehousing.
36
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The Bureau of Economic Analysis ("BEA") initial estimate indicates that real GDP grew at an annualized rate of 2.6% for the fourth quarter of 2018, compared to 3.4% for the third quarter of 2018. Growth continued to be driven by increases in personal consumption expenditures, nonresidential fixed investment, exports, and federal government spending. This was offset by decreases to spending in residential fixed investment and state and local government, as well as increased imports.
Market year-to-date returns for the following indices based on closing prices at December 31, 2018 were:
December 31, 2018 | ||
Dow Jones Industrial Average | (5.6)% | |
Standard & Poor's ("S&P") 500 | (6.2)% | |
NASDAQ Composite | (3.9)% | |
At its December 2018 meeting, the Federal Open Market Committee decided to raise the federal funds rate target to 2.25%-2.50%, reflecting that the labor market has continued to strengthen and that economic activity has continued to expand at a solid pace. Overall inflation remains below the targeted rate of 2.0%.
The ten-year Treasury bond rate at December 31, 2018 was 2.69%, up from 2.40% at December 31, 2017. Within the industry, changes within this metric are often considered to correspond to changes in 15-year and 30-year mortgage rates.
For the third quarter of 2018, mortgage originations increased approximately 1.1% over the prior quarter and 6.7% year-over-year. Mortgage originations for home purchases increased 3.6% quarter-over-quarter while they increased 3.4% from the third quarter last year. Mortgage originations from refinancing activity decreased 5.9% from the second quarter of 2018 and 28.5% from the third quarter of last year. These rates are representative of U.S. national average mortgage origination activity.
The ratio of nonperforming loans ("NPLs") to total gross loans for U.S. banks declined for six consecutive years, to just under 1.5% in 2015. NPL trends have remained relatively flat since that time. NPLs for U.S. commercial banks were approximately 0.98% of loans using the latest available data, which was as of the third quarter of 2018, compared to 1.17% for the prior quarter.
Changing market conditions are considered a significant risk factor to the Company. The interest rate environment can present challenges in the growth of net interest income for the banking industry, which continues to rely on non-interest activities to support revenue growth. Changing market conditions and political uncertainty could have an overall impact on the Company's results of operations and financial condition. Such conditions could also impact the Company's credit risk and the associated provision for credit losses and legal expense.
Credit Rating Actions
The following table presents Moody's Investors Service, Inc. (“Moody’s”), S&P and Fitch credit ratings for the Bank, and BSPR, SHUSA, Santander, and the Kingdom of Spain, as of December 31, 2018:
BANK | BSPR(1) | SHUSA | ||||||||||
Moody's | S&P | Fitch (2) | Moody's | S&P | Fitch (2) | Moody's | S&P | Fitch | ||||
Long-Term | Baa1 | A- | BBB+ | Baa1 | N/A | BBB+ | Baa3 | BBB+ | BBB+ | |||
Short-Term | P-1 | A-2 | F-2 | P-1/P-2 | N/A | F-2 | n/a | A-2 | F-2 | |||
Outlook | Stable | Stable | Stable | Stable | N/A | Stable | Stable | Stable | Stable | |||
SANTANDER | SPAIN | ||||||||
Moody's | S&P | Fitch | Moody's | S&P | Fitch | ||||
Long-Term | A2 | A | A | Baa1 | A- | A- | |||
Short-Term | P-1 | A-1 | F-1 | P-2 | A-2 | F-1 | |||
Outlook | Stable | Stable | Stable | Stable | Positive | Stable | |||
(1) P-1 Short Term Deposit Rating; P-2 Short Term Debt Rating.
(2) Short Term Debt and Short Term Deposit Ratings are both F-2.
SHUSA funds its operations independently of the other entities owned by Santander, and believes its business is not necessarily closely related to the business or outlook of other entities owned by Santander. Future changes in the credit ratings of its parent, Santander, or the Kingdom of Spain could impact SHUSA's or its subsidiaries' credit ratings, and any other change in the condition of Santander could affect SHUSA.
37
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
At this time, SC is not rated by the major credit rating agencies.
Puerto Rico Economy
On May 3, 2017, the Financial Oversight and Management Board of Puerto Rico (“FOB”) submitted a request to the Federal District Court of Puerto Rico to apply Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”) to the Commonwealth of Puerto Rico. Title III of PROMESA allows the Commonwealth of Puerto Rico to enter into a debt restructuring process notwithstanding that Puerto Rico is barred from traditional bankruptcy protection under Chapter 9 of the U.S. Bankruptcy Code. On July 2, 2017, the Puerto Rican Electric Power Authority ("PREPA") submitted a request to the Federal District Court of Puerto Rico to apply Title III of PROMESA to PREPA.
During the fourth quarter of 2018, Puerto Rico’s economic conditions continued to improve, assisted by several proceedings under the PROMESA to restructure its outstanding obligations and those of certain of its instrumentalities. As part of the reconstruction process post-Hurricane Irma and Hurricane Maria, Puerto Rico is expected to receive $82 billion in federal relief fund and insurance payouts during the next 10-15 years. Access to this funding is instrumental to restore economic growth in the short term while the government works toward the implementation of structural reform to foster sustainable economic growth in the long term. So far, the partial disbursement of the federal relief funding and insurance is having a positive effect on the economy. The Economic Development Bank Economic Activity Index shows that the island’s economic activity increased 1.5% during 2018 when compared to 2017. The unemployment rate of 8.3% in December 2018 was one of the lowest in decades, while 6,700 jobs were created year-over-year. Other indicators are improving as well: the sale of housing units rose 23% in 2018 versus 2017, the sale of new automobiles continued increasing and tax revenue collections rose by $611.7 million to $3.5 billion from the second half of 2018 versus the same period in 2017.
On November 29, 2018, the Puerto Rico Fiscal Agency and Financial Advisory Authority and the Government Development Bank (“GDB”) announced the closing of the GDB restructuring process under Title VI of PROMESA, resulting in the first closure of a public debt restructuring process. During 2018, the U.S. District Court approved the adjustment plan for the Puerto Rico Urgent Interest Fund Corporation's debt restructuring process under Title III of PROMESA. The plan, already approved by the FOB and Puerto Rico’s legislature, contemplates the payment of $400 million annually in debt service in 2019 and up to $1,000 million annually in 2041.
On December 10, 2018, the Governor of Puerto Rico signed Act 257-2018 PR Tax Reform which includes, among the most significant changes to the Puerto Rico Internal Revenue Code, (i) a decrease in the corporate tax rate from 39% to 37.5, effective for taxable years beginning after December 31, 2018, (ii) a decrease from $500 to $25 on the amount paid or credited as interest subject to withholding, (iii) an increase to 90% of the limit on the deduction of net operating losses, (iv) an increase in the withholding rate on payments on account of services rendered from 7% to 10%, and (v) exemption of business-to-business retention to entities with business volume over $200,000.
Although as of the date hereof the FOB has sought to use the restructuring authority provided by PROMESA, limited to certain Commonwealth instrumentalities, the FOB may use the restructuring authority of Title III or Title VI of PROMESA for others, including its municipalities, in the future. Deterioration of the Commonwealth’s fiscal and economic situation, including any negative ratings implications, could further adversely affect the value of our Puerto Rico public sector exposure.
Although BSPR has a diversified loan portfolio, it continues with efforts to de-risk the portfolio, with credit risk indicators improving significantly year-over-year and surpassing budgeted targets. The lending strategy with respect to the public sector has been to enter into commitments with a short-term maturity, payment priority, and/or strong guarantees as well as with adequate profitability. Such commitments to the public sector amounted approximately to $265 million ($57 million of agencies and public corporations and $208 million of municipalities) and $293 million ($74 million of agencies and public corporations and $219 million of municipalities) as of December 31, 2018 and 2017, respectively, which represent 16% of BSPR's commercial loan portfolio for both periods. A substantial portion of BSPR’s credit exposure to the Government of Puerto Rico is either collateralized loans or obligations that have a specific source of income or revenues identified for their repayment, fixed income investment or real estate. For agencies and public corporations, guarantees are mainly mortgages, securities and standby letter of credits from low-risk multinational entities. In the case of municipalities, the main sources of income are from the Municipal Revenue Collection Center for property taxes and from the Secretary of the Treasury for sales and use taxes. In most cases, these are “general obligations” of a municipality, to which the municipality has pledged its good faith, credit and unlimited taxing power, or “special obligations” of a municipality, to which the applicable municipality has pledged other revenues. As of December 31, 2018 and 2017, $25 million, or 9%, and $40 million, or 13%, respectively, of commercial loans granted to the public sector mature in one year or less.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Impact from Hurricanes
Our footprint was impacted by three significant hurricanes during 2017, Hurricane Harvey, which struck the State of Texas and the surrounding region, Hurricane Irma, which primarily struck the State of Florida, and Hurricane Maria, which struck the island of Puerto Rico. Each of these hurricanes resulted in widespread flooding, power outages and associated damage to real and personal property in the affected areas. SC, headquartered in Dallas, Texas, BSI, headquartered in Miami, Florida, and Santander BanCorp, BSPR and SSLLC subsidiaries in Puerto Rico were most directly affected by these hurricanes. In Puerto Rico, there was significant damage to the infrastructure and the power grid on the entire island, which resulted in extended delays in BSPR returning to normal operations.
The Company assessed the potential additional credit losses related to its consumer and commercial lending exposures in the greater Texas, Florida and Puerto Rico regions. As a result, the Company's allowance for loan and lease losses (“ALLL") had approximately $25.0 million of reserves specifically related to the hurricanes at December 31, 2018 compared to $110 million at December 31, 2017. Approximately $50.0 million of the decrease in the qualitative allowance related to the hurricanes has been offset by an increase in model and specific reserves to other portfolios requiring additional allowance, including the municipality, commercial, and residential loan portfolios in Puerto Rico. The remaining hurricane reserve at December 31, 2018 is a specific reserve recorded for a commercial loan located in Puerto Rico.
See Note 20 to the Consolidated Financial Statement for a discussion of FINRA arbitration claims and class action litigation to which the Company and its affiliates are subject as a result of the sale of Puerto Rico bonds and closed-end funds.
REGULATORY MATTERS
The activities of the Company and its subsidiaries, including the Bank and SC, are subject to regulation under various U.S. federal laws and regulatory agencies which impose regulations, supervise and conduct examinations, and may affect the operations and management of the Company and its ability to take certain actions, including making distributions to our parent and shareholders. The Company is regulated on a consolidated basis by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), including the Federal Reserve Bank (the "FRB") of Boston, and the Consumer Financial Protection Bureau (the "CFPB"). The Company's banking and bank holding company subsidiaries are further supervised by the Federal Deposit Insurance Corporation (the "FDIC") and the Office of the Comptroller of the Currency (the “OCC”). As a subsidiary of the Company, SC is also subject to regulatory oversight by the Federal Reserve as well as the CFPB. Santander BanCorp and BSPR also are supervised by the Puerto Rico Office of the Commissioner of Financial Institutions.
Payment of Dividends
SHUSA is the parent holding company of SBNA and other consolidated subsidiaries, and is a legal entity separate and distinct from its subsidiaries. In addition to those arising as a result of the Comprehensive Capital Analysis and Review (“CCAR”) process described under the caption “Stress Tests and Capital Adequacy” below, SHUSA and SBNA are subject to various regulatory restrictions relating to the payment of dividends, including regulatory capital minimums and the requirement to remain "well-capitalized" under prompt corrective action regulations. As a consolidated subsidiary of the Company, SC is included in various regulatory restrictions relating to payment of dividends as described in the “Stress Tests and Capital Adequacy” discussion in this section. Refer to the Liquidity and Capital Resources section of this MD&A for detail of the capital actions of the Company and its subsidiaries during the period.
In addition, the following regulatory matters are in the process of being phased in or evaluated by the Company.
Foreign Banking Organizations ("FBOs")
In February 2014, the Federal Reserve issued the final rule implementing certain enhanced prudential standards (“EPS”) mandated by Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “DFA") (the “FBO Final Rule”). Under the Final Rule, FBOs with over $50 billion of U.S. non-branch assets, including Santander, were required to consolidate U.S. subsidiary activities under an intermediate holding company (an “IHC"). In addition, the FBO Final Rule required U.S. bank holding companies ("BHCs") and FBOs with at least $50 billion in total U.S. consolidated non-branch assets to be subject to EPS and heightened capital, liquidity, risk management, and stress testing requirements. Due to both its global and U.S. non-branch total consolidated asset size, Santander was subject to both of the above provisions of the FBO Final Rule. As a result of this rule, Santander has transferred substantially all of its U.S. bank and non-bank subsidiaries previously outside the Company to the Company, which became an IHC effective July 1, 2016. A phased-in approach is being used for the standards and requirements at both the FBO and the IHC. As a result of the phased-in approach, on July 1, 2017, Santander transferred ownership of Santander Financial Services, Inc. ("SFS") and on July 2, 2018, Santander transferred ownership of an additional entity, Santander Asset Management, LLC ("SAM") to the IHC. As a U.S. BHC with more than $50 billion in total consolidated assets, the Company became subject to the EPS on January 1, 2015.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Economic Growth Act
In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the "Economic Growth Act") was signed into law. The Economic Growth Act scales back certain requirements of the DFA, primarily benefiting banks with $10 billion or less in assets, but also reducing regulatory requirements and modifying the enhanced supervision and EPS that may benefit certain mid-sized and larger BHCs and financial institutions. The Company applied the change during the fourth quarter of 2018, which impacted highly volatile acquisition, development and construction ("HVADC") loans and resulted in an insignificant impact to RWA and the risk-based ratios.
Regulatory Capital Requirements
In July 2013, the Federal Reserve, the FDIC and the OCC released final U.S. Basel III regulatory capital rules implementing the global regulatory capital reforms of Basel III that are applicable to both SHUSA and the Bank. The final rules established a comprehensive capital framework that includes both the advanced approaches for the largest internationally active U.S. banks, formerly known as Basel II, and a standardized approach that applies to all banking organizations with over $500 million in assets. Subject to various transition periods, this rule became effective for SHUSA on January 1, 2015.
The rules narrow the definition of regulatory capital and establish higher minimum risk-based capital ratios and prompt corrective action thresholds that, when fully phased in, require banking organizations, including the Company and the Bank, to maintain a minimum common equity Tier 1 ("CET1") capital ratio of 4.5%, a Tier 1 capital ratio of 6.0%, a total capital ratio of 8.0% and a minimum leverage ratio, calculated as the ratio of Tier 1 capital to average consolidated assets for the quarter, of 4.0%.
A capital conservation buffer of 2.5% above these minimum ratios was being phased in over three years starting in 2016, beginning at 0.625% and increasing by that amount on each subsequent January 1, until the buffer reached 2.5% on January 1, 2019. This buffer is required for banking institutions and BHCs to avoid restrictions on their ability to make capital distributions, including paying dividends.
The U.S. Basel III regulatory capital rules include deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights ("MSRs"), deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities are deducted from CET1 to the extent any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 for the Company and the Bank began on January 1, 2015 and was initially planned over three years, with a fully phased-in requirement of January 1, 2018. However, during 2017, the regulatory agencies finalized changes to the capital rules that became effective on January 1, 2018. These changes extended the current treatment and will defer the final transition provision phase-in at non-advanced approach institutions for certain capital elements, and suspend the risk-weighting to 100 percent for deferred taxes and mortgage servicing assets not disallowed from capital, in lieu of advancing to 250 percent. In addition, the regulatory agencies issued a secondary proposal in 2017 to further revise the capital rule by introducing new treatment of high volatility acquisition, development and construction loans, and by modifying the calculation for minority interest includible within capital, for which the regulators have not released a final decision. In 2018, the regulatory agencies issued an additional proposal that would revise the definition of high volatility commercial real estate exposures.
See the Bank Regulatory Capital section of this MD&A for the Company's capital ratios under Basel III standards. The implementation of certain regulations and standards relating to regulatory capital could disproportionately affect the Company's regulatory capital position relative to that of its competitors, including those that may not be subject to the same regulatory requirements as the Company.
If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and, in critically undercapitalized situations, appointment of a receiver or conservator. Critically undercapitalized institutions generally may not, beginning 60 days after becoming critically undercapitalized, make any payment of principal or interest on their subordinated debt. All but well-capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Pursuant to the FDIA and OCC regulations, institutions which are not categorized as well-capitalized or adequately-capitalized are restricted from making capital distributions, which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of the institution. At December 31, 2018, the Bank met the criteria to be classified as “well-capitalized.”
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
On April 10, 2018, the Federal Reserve issued a notice of proposed rulemaking ("NPR") seeking comment on a proposal to simplify capital rules for large banks. If finalized as proposed, the NPR would eliminate the quantitative objection in CCAR and replace the capital conservation buffer. The capital conservation buffer would be replaced with a new stress capital buffer ("SCB"). The SCB is calculated as the maximum decline in CET1 in the severely adverse scenario (subject to a 2.5% floor) plus four quarters of dividends. The proposal would result in new regulatory capital minimums which are equal to 4.5% CET1 plus the SCB, any globally systemically important bank ("GSIB") surcharge, and any countercyclical capital buffer. The GSIB buffer is applicable only to the largest and most complex firms and does not apply to SHUSA. These new minimums would be firm-specific and would trigger restrictions on capital distributions and discretionary bonuses in the event a firm falls below their new minimums. Firms would still submit a capital plan annually and, absent prior Federal Reserve approval, would continue to be limited to the capital distributions included in their capital plan. Supervisory expectations for capital planning processes would not change under the proposal. The Company is still evaluating the impact this proposed rule would have on its financial position, results of operations and disclosures.
Stress Testing and Capital Planning
The DFA also requires certain banks and BHCs, including the Company, to perform a stress test and submit a capital plan to the Federal Reserve and receive a notice of non-objection before taking capital actions, such as paying dividends, implementing common equity repurchase programs, or redeeming or repurchasing capital instruments. In June 2018, the Company announced that the Federal Reserve did not object to the planned capital actions described in the Company’s capital plan through June 30, 2019. In February 2019, the Federal Reserve announced that SHUSA, as well as other less complex firms, would receive a one-year extension of the requirement to submit its capital plan until April 5, 2020. The Federal Reserve also announced that, for the period beginning July 1, 2019 through June 30, 2020, the Company would be allowed to make capital distributions up to the amount that would have allowed it to remain above all minimum capital requirements in CCAR 2018, adjusted for any changes in the Company’s regulatory capital ratios since the Federal Reserve acted on the 2018 Capital Plan. The Company continues to evaluate its planned capital actions.
Liquidity Rules
In September 2014, the Federal Reserve, the FDIC, and the OCC finalized a rule to implement the Basel III liquidity coverage ratio (the “LCR”) for certain internationally active banks and nonbank financial companies, and a modified version of the LCR for certain depository institution holding companies that are not internationally active. The LCR is designed to ensure that a banking entity maintains an adequate level of unencumbered high-quality liquid assets ("HQLA") equal to its expected net cash outflow for a 30-day time horizon. This rule implements a phased implementation approach under which the most globally important covered companies (more than $700 billion in assets) and large regional financial institutions ($250 billion to $700 billion in assets) were required to begin phasing-in the LCR requirements in January 2015. Smaller covered companies (more than $50 billion in assets), such as the Company, were required to calculate the LCR monthly beginning January 2016. In November 2015, the Federal Reserve published a revised final LCR rule. Under this revision, the Company was required to calculate the modified US LCR (the "US LCR") on a monthly basis beginning with data as of January 31, 2016 and is required to satisfy a minimum US LCR requirement of 100%. We are required to disclose elements under this final rule for quarterly periods ending after October 1, 2018, which can be found on our website at https://www.santanderus.com/us/investorshareholderrelations. At December 31, 2018, SHUSA's US LCR was above 100%.
In October 2014, the Basel Committee on Banking Supervision issued the final standard for the net stable funding ratio (the “NSFR”). The NSFR is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon The NSFR requires banks to maintain a stable funding profile in relation to their on- and off-balance sheet activities, thereby reducing the likelihood that disruptions to a bank's regular sources of funding will erode its liquidity in a way that could increase the risk of its failure and potentially lead to broader systemic stress. In May 2016, the Federal Reserve issued a proposed rule for NSFR applicable to U.S. financial institutions. The proposed rule has not been finalized, and the Company is currently evaluating the impact the proposed rule would have on its financial position, results of operations and disclosures.
Resolution Planning
The DFA requires all BHCs and FBOs with assets of $50 billion or more to prepare and regularly update resolution plans ("165(d) Resolution Plan"). The resolution plan must assume that the covered company is resolved under the U.S. Bankruptcy Code and that no “extraordinary support” is received from the U.S. or any other government. The most recent 165(d) Resolution Plan was submitted to the Federal Reserve and FDIC in December 2018. In addition, under amended Federal Deposit Insurance Act (“FDI Act”) rules, the Insured Depository Institution ("IDI") Resolution Plan rule requires that a bank with assets of $50 billion or more develop a plan for its resolution that supports depositors’ rapid access to their insured deposits, maximizes the net present value return from the sale
or disposition of its assets, and minimizes the amount of any loss realized by creditors in resolution. The most recent IDI Resolution Plan was submitted to the FDIC in June 2018. SHUSA and SBNA are currently awaiting feedback.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Total Loss-Absorbing Capacity (“TLAC")
The Federal Reserve adopted a final rule in December 2016 that requires certain U.S. organizations to maintain a minimum amount of loss-absorbing instruments, including a minimum amount of unsecured long-term debt ("LTD") (the “TLAC Rule”). The TLAC Rule applies to U.S. GSIBs and to IHCs with $50 billion or more in U.S. non-branch assets that are controlled by a global systemically important FBO. The Company is such an IHC.
Under the TLAC Rule, companies are required to maintain a minimum amount of TLAC, which consists of a minimum amount of LTD and Tier 1 capital. As a result, SHUSA will need to hold the higher of 18% of its risk-weighted assets ("RWAs") or 9% of its total consolidated assets in the form of TLAC, of which 6% of its RWAs or 3.5% of total consolidated assets must consist of LTD. In addition, SHUSA must maintain a TLAC buffer composed solely of CET1 capital and will be subject to restrictions on capital distributions and discretionary bonus payments based on the size of the TLAC buffer it maintains. The TLAC Rule became effective on January 1, 2019.
Volcker Rule
The DFA added new Section 13 to the BHC Act, which is commonly referred to as the “Volcker Rule.” The Volcker Rule prohibits a “banking entity” from engaging in “proprietary trading” or engaging in any of the following activities with respect to a hedge fund or a private equity fund (together, a “Covered Fund”): (i) acquiring or retaining any equity, partnership or other ownership interest in the Covered Fund; (ii) controlling the Covered Fund; or (iii) engaging in certain transactions with the fund if the banking entity or any affiliate is an investment adviser or sponsor to the Covered Fund. These prohibitions are subject to certain exemptions for permitted activities.
Because the term “banking entity” includes an IDI, a depository institution holding company and any of their affiliates, the Volcker Rule has sweeping worldwide application and covers entities such as Santander, the Company, and certain of the Company’s subsidiaries (including the Bank and SC), as well as other Santander subsidiaries in the United States and abroad.
The Company implemented certain policies and procedures, training programs, recordkeeping, internal controls and other compliance requirements that were necessary to comply with the Volcker Rule. As required by the Volcker Rule, the compliance infrastructure has been tailored to each banking entity based on its size and its level of trading and Covered Fund activities. SHUSA's compliance program includes, among other things, processes for prior approval of new activities and investments permitted under the Volcker Rule, testing and auditing for compliance and a process for attesting annually that the compliance program is reasonably designed to achieve compliance with the rule.
In May 2018, the joint agencies responsible for administering the Volcker Rule released an NPR to revise the Volcker Rule. The NPR would tailor the Volcker Rule’s compliance requirements to the amount of a firm’s trading activity, revise the definition of a trading account, clarify certain key provisions in the Volcker Rule, and simplify the information companies are required to provide the banking agencies. The NPR would also replace the short-term intent test in the Volcker Rule with an accounting test. The Company is still evaluating the impact this proposed rule would have on its financial position, results of operations and disclosures.
Risk Retention Rule
In December 2014, the Federal Reserve issued its final credit risk retention rule, which generally requires sponsors of asset-backed securities ("ABS") to retain at least five percent of the credit risk of the assets collateralizing ABS. Compliance with the rule with respect to ABS collateralized by residential mortgages was required beginning in December 2015. Compliance with the rule with regard to all other classes of ABS was required beginning in December 2016. SHUSA, primarily through SC, is an active participant in the structured finance markets and began to comply with the retention requirements effective in December 2016.
Heightened Standards
In September 2014, the OCC finalized guidelines to strengthen the governance and risk management practices of large financial institutions commonly known as “heightened standards.” The heightened standards apply to insured national banks with $50 billion or more in consolidated assets. The heightened standards require covered institutions to establish and adhere to a written risk governance framework to manage and control their risk-taking activities. The heightened standards also provide minimum standards for the institutions’ boards of directors to oversee the risk governance framework.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Transactions with Affiliates
Depository institutions must remain in compliance with Sections 23A and 23B of the Federal Reserve Act and the Federal Reserve's Regulation W, which governs the activities of the Company and its banking subsidiaries with affiliated companies and individuals. Section 23A imposes limits on certain specified “covered transactions,” which include loans, lines, and letters of credit to affiliated companies or individuals, and investments in affiliated companies, as well as certain other transactions with affiliated companies and individuals. The aggregate of all covered transactions is limited to 10% of a bank’s capital and surplus for any one affiliate and 20% for all affiliates. Certain covered transactions also must meet collateral requirements that range from 100% to 130% depending on the type of transaction.
Section 23B of the Federal Reserve Act prohibits a depository institution from engaging in certain transactions with affiliates unless the transactions are considered arms'-length. To meet the definition of arm's-length, the terms of the transaction must be the same,
or at least as favorable, as those for similar transactions with non-affiliated companies. As a U.S. domiciled subsidiary of a global parent with significant non-bank affiliates, the Company faces elevated compliance risk in this area.
Regulation AB II
In August 2014, the SEC adopted final rules known as Regulation AB II that, among other things, expanded disclosure requirements and modified the offering and shelf registration process for asset-backed securities (“ABS”). All offerings of publicly registered ABS and all reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for outstanding publicly-registered ABS were required to comply with the new rules and disclosures on and after November 23, 2015, except for asset-level disclosures. Compliance with the new rules regarding asset-level disclosures was required for all offerings of publicly registered ABS on and after November 23, 2016. SC must comply with these rules, which affects SC's public securitization platform.
Community Reinvestment Act ("CRA")
SBNA and BSPR are subject to the requirements of the CRA, which requires the appropriate federal financial supervisory agency to assess an institution's record of helping to meet the credit needs of the local communities in which it is located. BSPR’s current CRA rating is “Outstanding” and SBNA’s current CRA rating is "Satisfactory." The OCC takes into account the Bank’s CRA rating in considering certain regulatory applications the Bank makes, including applications related to establishing and relocating branches, and the Federal Reserve does the same with respect to certain regulatory applications the Company makes.
Other Regulatory Matters
On February 25, 2015, SC entered into a consent order with the Department of Justice (the "DOJ"), approved by the United States District Court for the Northern District of Texas, which resolves the DOJ’s claims against SC that certain of its repossession and collection activities during the period of time between January 2008 and February 2013 violated the Servicemembers’ Civil Relief Act (the “SCRA”). The consent order requires SC to pay a civil fine in the amount of $55,000, as well as at least $9.4 million to affected servicemembers, consisting of $10,000 per servicemember plus compensation for any lost equity (with interest) for each repossession by SC and $5,000 per servicemember for each instance where SC sought to collect repossession-related fees on accounts where a repossession was conducted by a prior account-holder. The consent order requires us to undertake additional remedial measures. The consent order also subjects SC to monitoring by the DOJ for compliance with the SCRA for a period of five years.
In February 2016, the CFPB issued a supervisory letter relating to its investigation of SC’s compliance systems, Board and senior management oversight, consumer complaint handling, marketing of guaranteed auto protection ("GAP") coverage and loan deferral disclosure practices. SC subsequently received a series of CIDs from the CFPB requesting information and testimony regarding SC’s marketing of GAP coverage and loan deferral disclosure practices. In November 2018, SC entered into a voluntary settlement with the CFPB under which the CFPB entered a consent order against SC in an administrative proceeding captioned In the Matter of Santander Consumer USA Holdings Inc., File No. 2018-BCFP-0008. In the consent order the CFPB found, among other things, that SC violated the Consumer Financial Protection Act of 2010 (the "CFPA") in its marketing of GAP coverage and in certain of its loan deferral disclosure practices. Without admitting or denying the findings, SC agreed to pay a civil penalty of $2.5 million to the CFPB and to provide remediation to certain impacted customers. The consent order also requires SC to submit a comprehensive plan to the CFPB demonstrating how it will comply with the CFPA and the terms of the consent order.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In October 2014, SC received a subpoena from the SEC commencing an investigation into the SC’s securitization practices. In June 2016, the SEC served an additional subpoena on SC requesting documents related to SC’s securitization practices as well as SC’s financial restatements. SC has produced documents responsive to these subpoenas, and the SEC has taken testimony from certain of SC’s employees. In December 2018, the SEC and SC reached a voluntary agreement to settle the SEC's investigation under which the SEC entered a cease-and-desist order against SC in an administrative matter captioned In the Matter of Santander Consumer USA Holdings Inc., File No. 3-18932. According to the SEC’s order, among other things, SC failed to calculate and report its credit loss allowance for certain impaired loans in accordance with GAAP. The SEC’s order also found that SC failed to maintain effective internal control over financial reporting, leading to SC’s financial restatements. Without admitting or denying the findings, SC paid a civil penalty of $1.5 million in January 2019 and agreed to cease and desist from any future violations of the Exchange Act and the rules thereunder.
On March 21, 2017, SC and the Company entered into a written agreement with the FRB of Boston. Under the terms of that agreement, SC is required to enhance its compliance risk management program, board oversight of risk management and senior management oversight of risk management, and the Company is required to enhance its oversight of SC's management and operations.
In July 2015, the CFPB notified SC that it had referred to the DOJ certain alleged violations by SC of the Equal Credit Opportunity Act (the “ECOA”) regarding (i) statistical disparities in mark-ups charged by automobile dealers to protected groups on loans originated by those dealers and purchased by SC and (ii) the treatment of certain types of income in SC's underwriting process. In September 2015, the DOJ notified SC that it had initiated an investigation under the ECOA of SC's pricing of automobile loans based on the referral from the CFPB. SC resolved the DOJ investigation pursuant to a confidential agreement with the CFPB.
As of December 31, 2018, SSLLC had received 589 FINRA arbitration cases related to Puerto Rico bonds and Puerto Rico closed-end funds ("CEFs"). Most of these cases are based upon concerns regarding the local Puerto Rico securities market. The statements of claims allege, among other things, fraud, negligence, breach of fiduciary duty, breach of contract, unsuitability, over-concentration and failure to supervise. There were 420 arbitration cases that remained pending as of December 31, 2018.
As a result of Hurricane Maria impacting the Puerto Rico market including declines in Puerto Rico bond and CEF prices, it is possible that additional arbitration claims and/or increased claim amounts may be asserted in future periods.
In addition, SSLLC, Santander BanCorp, BSPR, the Company and Santander are defendants in a putative class action alleging federal securities and common law claims relating to the solicitation and purchase of more than $180 million of Puerto Rico bonds and $101 million of CEFs during the period from December 2012 to October 2013. The case is pending in the United States District Court for the District of Puerto Rico and is captioned Jorge Ponsa-Rabell, et. al. v. SSLLC, Civ. No. 3:17-cv-02243. The amended complaint alleges that defendants acted in concert to defraud purchasers in connection with the underwriting and sale of Puerto Rico municipal bonds, CEFs and open-end funds.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Disclosure Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act
Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13(r) to the Exchange Act, an issuer is required to disclose in its annual or quarterly reports, as applicable, whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with individuals or entities designated pursuant to certain Executive Orders. Disclosure is generally required even where the activities, transactions or dealings were conducted in compliance with applicable law.
The following activities are disclosed in response to Section 13(r) with respect to affiliates of SHUSA within the Santander Group. During the period covered by this annual report:
• | Santander UK plc (“Santander UK”) holds two savings accounts and one current account for two customers. Both of the customers, who are resident in the UK, are currently designated by the U.S. under the Specially Designated Global Terrorist ("SDGT") sanctions program. Revenues and profits generated by Santander UK on these accounts in the year ended December 31, 2018 were negligible relative to the overall profits of Santander. |
• | Santander UK holds one savings account with a balance of £1.24 as of December 31, 2018 and one current account with a balance of £1,884.53 as of December 31, 2018, for another customer resident in the UK who is currently designated by the U.S. under the SDGT sanctions program. The United Nations and European Union removed this customer from their equivalent sanctions lists in 2008. The customer relationship predates the designations of the customer under these sanctions. After identifying the U.S. sanctions issue, Santander UK confirmed the absence of any U.S. dollar payments to or from the customer's accounts, determined to put a block on the accounts and the accounts were closed on January 14, 2019. Revenues generated by Santander UK on these accounts in the year ended December 31, 2018 were negligible relative to the overall profits of Santander. |
• | Santander UK holds two frozen current accounts for two UK nationals who are designated by the U.S. under the SDGT sanctions program. The accounts held by each customer have been frozen since their designation and remained frozen through 2018. The accounts are in arrears (£1,844.73 in debit combined) and are currently being managed by Santander UK's Collections and Recoveries Department. No revenues or profits were generated by Santander UK on these accounts through year ended December 31, 2018. |
• | The Santander Group also has certain legacy performance guarantees for the benefit of Bank Sepah and Bank Mellat (stand-by letters of credit to guarantee the obligations - either under tender documents or under contracting agreements - of contractors who participated in public bids in Iran) that were in place prior to April 27, 2007. |
In the aggregate, all of the transactions described above resulted in gross revenues and net profits in the year ended December 31, 2018, which were negligible relative to the overall revenues and profits of Santander. Santander has undertaken significant steps to withdraw from the Iranian market, such as closing its representative office in Iran and ceasing all banking activities therein, including correspondent relationships, deposit- taking from Iranian entities and issuing export letters of credit, except for the legacy transactions described above. Santander is not contractually permitted to cancel these arrangements without either (i) paying the guaranteed amount (in the case of the performance guarantees), or (ii) forfeiting the outstanding amounts due to it (in the case of the export credits). As such, Santander intends to continue to provide the guarantees and hold these assets in accordance with company policy and applicable laws.
45
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CRITICAL ACCOUNTING ESTIMATES
This MD&A is based on the Consolidated Financial Statements and accompanying notes that have been prepared in accordance with GAAP. The significant accounting policies of the Company are described in Note 1 to the Consolidated Financial Statements. The preparation of financial statements in accordance with GAAP requires management to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, accordingly, have a greater possibility of producing results that could be materially different than originally reported. However, the Company is not currently aware of any likely events or circumstances that would result in materially different results. Management identified accounting for ALLL and the reserve for unfunded lending commitments, accretion of discounts and subvention on RICs, estimates of expected residual values of leased vehicles subject to operating leases, goodwill, fair value measurements and income taxes as the Company's most critical accounting estimates, in that they are important to the portrayal of the Company's financial condition and results and require management’s most difficult, subjective and complex judgments as a result of the need to make estimates about the effects of matters that are inherently uncertain.
ALLL for Loan Losses and Reserve for Unfunded Lending Commitments
The ALLL and reserve for unfunded lending commitments represent management's best estimate of probable losses inherent in the loan portfolio. The adequacy of SHUSA's ALLL and reserve for unfunded lending commitments is regularly evaluated. This evaluation process is subject to several estimates and applications of judgment. Management's evaluation of the adequacy of the allowance to absorb loan and lease losses takes into consideration the risks in the loan portfolio, past loan and lease loss experience, specific loans that have loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. Management also considers loan quality, changes in the size and character of the loan portfolio, the amount of NPLs, and industry trends. Changes in these estimates could have a direct material impact on the provision for credit losses recorded in the Consolidated Statements of Operations and/or could result in a change in the recorded allowance and reserve for unfunded lending commitments. The loan portfolio represents the largest asset on the Consolidated Balance Sheets. Note 1 to the Consolidated Financial Statements describes the methodology used to determine the ALLL and reserve for unfunded lending commitments in the Consolidated Balance Sheets. A discussion of the factors driving changes in the amount of the ALLL and reserve for unfunded lending commitments for the periods presented is included in the Credit Risk Management section of this MD&A.
The ALLL includes: (i) an allocated allowance, which is comprised of allowances established on loans specifically evaluated for impairment and loans collectively evaluated for impairment, based on historical loan and lease loss experience adjusted for current trends general economic conditions and other risk factors, and (ii) an unallocated allowance to account for a level of imprecision in management's estimation process. Generally, the Company’s loans held for investment are carried at amortized cost, net of the ALLL. The ALLL includes the estimate of credit losses to be realized during the loss emergence period based on the recorded investment in the loan, including net discounts that are expected at the time of charge-off. In the case of loans purchased in a bulk purchase or business combination, the entire discount on the loan portfolio is considered as available to absorb the credit losses when determining the ALLL. For these loans, the Company records provisions for credit losses when incurred losses exceed the unaccreted purchase discount. Reserve levels are collectively reviewed for adequacy and approved quarterly.
The Company's allocated reserves are principally based on various models subject to the Company's Model Risk Management Framework. New models are approved by the Company's Model Risk Management Committee. Models, inputs and documentation are further reviewed and validated at least annually, and the Company completes a detailed variance analysis of historical model projections against actual observed results on a quarterly basis. Required actions resulting from the Company's analysis, if necessary, are governed by its Allowance for Loan and Lease Losses Committee.
The Company's unallocated allowance is no more than 5% of the overall allowance. This is considered to be reasonably sufficient to absorb imprecisions of models to otherwise provide for coverage of inherent losses in the Company's entire loan and lease portfolio. Imprecisions include loss factors in the loan portfolio that may not have been discreetly contemplated in the general and specific components of the allowance, as well as potential variability in estimates. Period-to-period changes in the Company's historical unallocated ALLL positions are considered in light of these factors.
46
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Valuation of Automotive Lease Assets and Residuals
The Company has significant investments in vehicles in SC's operating lease portfolio. In accounting for operating leases, management must make a determination at the beginning of the lease contract of the estimated realizable value (i.e., residual value) of the vehicle at the end of the lease. Residual value represents an estimate of the market value of the vehicle at the end of the lease term, which typically ranges from two to four years. At contract inception, the Company determines the projected residual value based on an internal evaluation of the expected future value. This evaluation is based on a proprietary model using internally-generated data that is compared against third-party, independent data for reasonableness. The customer is obligated to make payments during the term of the lease for the difference between the purchase price and the contract residual value plus a finance charge. However, since the customer is not obligated to purchase the vehicle at the end of the contract, the Company is exposed to a risk of loss to the extent the value of the vehicle is below the residual value estimated at contract inception. Management periodically performs a detailed review of the estimated realizable value of leased vehicles to assess the appropriateness of the carrying value of leased assets.
To account for residual risk, the Company depreciates automobile operating lease assets to estimated realizable value on a straight-line basis over the lease term. The estimated realizable value is initially based on the residual value established at contract inception. Periodically, the Company revises the projected value of the leased vehicle at termination based on current market conditions and other relevant data points, and adjusts depreciation expense appropriately over the remaining term of the lease.
The Company periodically evaluates its investment in operating leases for impairment if circumstances, such as a systemic and material decline in used vehicle values occurs. These circumstances could include, for example, a decline in the residual value of our lease portfolio due to an event caused by shocks to oil and gas prices (which may have a pronounced impact on certain models of vehicles) or pervasive manufacturer defects (which may systemically affect the value of a particular brand or model). Impairment is determined to exist if the fair value of the leased asset is less than its carrying value and it is determined that the net carrying value is not recoverable. The net carrying value of a leased asset is not recoverable if it exceeds the sum of the undiscounted expected future cash flows expected to result from the lease payments and the estimated residual value upon eventual disposition. If our operating lease assets are considered to be impaired, the impairment is measured as the amount by which the carrying amount of the assets exceeds the fair value as estimated by discounted cash flows ("DCF"). No such impairment was recognized in 2018, 2017, or 2016.
The Company's depreciation methodology for operating lease assets considers management's expectation of the value of the vehicles upon lease termination, which is based on numerous assumptions and factors influencing used vehicle values. The critical assumptions underlying the estimated carrying value of automobile lease assets include: (1) estimated market value information obtained and used by management in estimating residual values, (2) proper identification and estimation of business conditions, (3) our remarketing abilities, and (4) automobile manufacturer vehicle and marketing programs. Changes in these assumptions could have a significant impact on the value of the lease residuals. Expected residual values include estimates of payments from automobile manufacturers
related to residual support and risk-sharing agreements, if any. To the extent an automotive manufacturer is not able to fully honor its obligation relative to these agreements, the Company's depreciation expense would be negatively impacted.
Accretion of Discounts and Subvention on RICs
Loans held for investment ("LHFI") include the RIC portfolio which consists largely of nonprime automobile loans, and which are primarily acquired individually from dealers at a nonrefundable discount from the contractual principal amount. The Company also pays dealer participation on certain receivables. The amortization of discounts, subvention payments from manufacturers, and other origination costs are recognized as adjustments to the yield of the related contracts. The Company applies significant assumptions, including prepayment speeds in estimating the accretion rates used to approximate effective yield.
The Company estimates future principal prepayments specific to pools of homogeneous loans which are based on the vintage, credit quality at origination and term of the loan. Prepayments in our portfolio are sensitive to credit quality, with higher credit quality loans experiencing higher voluntary prepayment rates than lower credit quality loans. The impact of defaults is not considered in the prepayment rate; the prepayment rate only considers voluntary prepayments. The resulting prepayment rate specific to each pool is based on historical experience and is used as an input in the calculation of the constant effective yield.
47
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Goodwill
The acquisition method of accounting for business combinations requires the Company to make use of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value of the assets acquired and liabilities assumed. The excess of the purchase price of an acquired business over the fair value of the identifiable assets and liabilities represents goodwill. Goodwill and other indefinite-lived intangible assets are not amortized on a recurring basis, but rather are subject to periodic impairment testing.
As more fully described in Note 23 to the Consolidated Financial Statements, a reporting unit is an operating segment or one level below. The Company conducts its evaluation of goodwill impairment at the reporting unit level on an annual basis on October 1, and more frequently if events or circumstances indicate that the carrying value of a reporting unit exceeds its fair value. As of December 31, 2018, the reporting units with assigned goodwill were Consumer and Business Banking, Commercial Banking, CIB, and SC.
An entity's quantitative goodwill impairment analysis must be completed unless the entity determines, based on certain qualitative factors, that it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is greater than its carrying amount, including goodwill, and that no impairment exists. An entity has an unconditional option to bypass the preceding qualitative assessment for any reporting unit in any period and proceed directly to the quantitative analysis of the goodwill impairment test.
The quantitative analysis requires a comparison of the fair value of each reporting unit to its carrying amount, including its allocated goodwill. If the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and no further analysis is necessary. If the carrying value of the reporting unit is higher than the fair value, impairment is measured as the excess of the carrying amount over the fair value. A recognized impairment charge cannot exceed the amount of goodwill allocated to a reporting unit, and cannot subsequently be reversed even if the fair value of the reporting unit recovers. The Company utilizes the market capitalization approach to determine the fair value of its SC reporting unit, as it is a publicly traded company that has a single reporting unit. Determining the fair value of the remaining reporting units requires significant valuation inputs, assumptions, and estimates.
The Company determines the carrying value of each reporting unit using a risk-based capital approach. Certain of the Company's assets are assigned to a Corporate/Other category. These assets are related to the Company's corporate-only programs, such as BOLI, and are not employed in or related to the operations of a reporting unit or considered in determining the fair value of a reporting unit.
Goodwill impairment testing involves management's judgment, requiring an assessment of whether the carrying value of the reporting unit can be supported by its fair value. This is performed using widely-accepted valuation techniques, such as the guideline public company market approach (earnings and price-to-tangible book value multiples of comparable public companies), the market capitalization approach (share price of the reporting unit and control premium of comparable public companies), and the income approach (the DCF method). The Company uses a combination of these accepted methodologies to determine the fair valuation of reporting units. Several factors are taken into account, including actual operating results, future business plans, economic projections, and market data.
The guideline public company market approach ("market approach") includes earnings and price-to-tangible book value multiples of comparable public companies which were applied to the earnings and equity for all of the Company's reporting units. The market capitalization plus control premium approach was applied to the Company's SC reporting unit, as the SC reporting unit is a publicly traded subsidiary whose securities are traded in an active market.
In connection with the market capitalization plus control premium approach applied to the Company's SC reporting unit, the Company used SC's stock price as of the date of the annual impairment analysis. The Company also considered historical auto loan industry transactions and control premiums over the last three years in determining the control premium.
The DCF method of the income approach incorporates the reporting units' forecasted cash flows, including a terminal value to estimate the fair value of cash flows beyond the final year of the forecasts. The discount rates utilized to obtain the net present value of the reporting units' cash flows were estimated using a capital asset pricing model. Significant inputs to this model include a risk-free rate of return, beta (which is a measure of the level of non-diversifiable risk associated with comparable companies for each specific reporting unit), market equity risk premium, and, in certain cases, additional premium for size and/or unsystematic company-specific risk factors. The Company utilized discount rates that it believes adequately reflect the risk and uncertainty in the financial markets. The Company estimated expected rates of equity returns based on historical market returns and risk/return rates for similar industries of the reporting unit. The Company uses its internal forecasts to estimate future cash flows, so actual results may differ from forecasted results.
48
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
All of the preceding fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill impairment test will prove to be accurate predictions in the future. Examples of events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impacts the estimated fair value of the aforementioned reporting units include such items as:
• | a prolonged downturn in the business environment in which the reporting units operate; |
• | an economic recovery that significantly differs from our assumptions in timing or degree; |
• | volatility in equity and debt markets resulting in higher discount rates; and unexpected regulatory changes. |
• | Specific to the SC reporting unit, a decrease in SC's share price would impact the fair value of the reporting segment. |
Refer to the Financial Condition, Goodwill section of this MD&A for further details on the Company's goodwill, including the results of management's goodwill impairment analyses.
Fair Value Measurements
The Company uses fair value measurements to estimate the fair value of certain assets and liabilities for both measurement and disclosure purposes. Refer to Note 16 to the Consolidated Financial Statements for a description of valuation methodologies used to measure material assets and liabilities at fair value and details of the valuation models, key inputs to those models, and significant assumptions utilized. The Company follows the fair value hierarchy set forth in Note 16 to the Consolidated Financial Statements to prioritize the inputs utilized to measure fair value. The Company reviews and modifies, as necessary, the fair value hierarchy classifications on a quarterly basis. Accordingly, there may be reclassifications between hierarchy levels due to changes in inputs to the valuation techniques used to measure fair value.
The Company has numerous internal controls in place to ensure the appropriateness of fair value measurements, including controls over the inputs into and the outputs from the fair value measurements. Certain valuations are benchmarked to market indices when appropriate and available.
Considerable judgment is used in forming conclusions from observable market data used to estimate the Company's Level 2 fair value measurements and in estimating inputs to the Company's internal valuation models used to estimate Level 3 fair value measurements. Level 3 inputs such as interest rate movements, prepayment speeds, credit losses, recovery rates and discount rates are inherently difficult to estimate. Changes to these inputs can have a significant effect on fair value measurements. Accordingly, the Company's estimates of fair value are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange.
Income Taxes
The Company accounts for income taxes under the asset and liability method. Deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates that apply or will apply to taxable income in the years in which those temporary differences are expected to reverse or be realized. The effect of a change in tax rates on deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date. A valuation allowance will be established if the Company determines that it is more likely than not that a deferred tax asset will not be realized. This requires periodic analysis of the carrying amount of deferred tax assets and when the deferred tax assets will be realized in future periods. Consideration is given to all positive and negative evidence related to the realization of deferred tax assets. The critical assumptions used in the Company's deferred tax asset valuation allowance analysis are as follows: (a) the expectation of future earnings; (b) estimates of the Company's long-term annual growth rate, based on the Company's long-term economic outlook in the U.S.; (c) estimates of the dividend income payout ratio from the Company's consolidated subsidiary, SC, based on current policies and practices of SC; (d) estimates of book income to tax income differences, based on the analysis of historical differences and the historical timing of the reversal of temporary differences; (e) the ability to carry back losses to recoup taxes previously paid; (f) estimates of tax credits to be earned on current investments, based on the Company's evaluation of the credits applicable to each investment; (g) experience with operating loss and tax credit carryforwards not expiring unused; (h) estimates of applicable state tax rates based on current/most recent enacted tax rates and state apportionment calculations; (i) tax planning strategies; and (j) current tax laws. Significant judgment is required to assess future earnings trends and the timing of reversals of temporary differences.
49
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The Company bases its expectations of future earnings, which are used to assess the realizability of its deferred tax assets, on financial performance forecasts of its operating subsidiaries and unconsolidated investees. The budgets and estimates used in these forecasts are approved by the Company's management, and the assumptions underlying the forecasts are reviewed at least annually and adjusted as necessary based on current developments or when new information becomes available. The updates made and the variances between the Company's forecasts and its actual performance have not been significant enough to alter the Company's conclusions with regard to the realizability of its deferred tax asset, including the effect of the SC transaction that occurred in 2011 and the Change in Control that occurred in the first quarter of 2014. The Company continues to forecast sufficient taxable income to fully realize its current deferred tax assets. Forecasted taxable income is subject to changes in overall market and global economic conditions.
In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of inherently complex tax laws in the U.S., its states and municipalities, and abroad. Actual income taxes paid may vary from estimates depending on changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. The Company reviews its tax balances quarterly and as new information becomes available. Interest and penalties on income tax payments are included within income tax expense in the Consolidated Statements of Operations.
The Company recognizes tax benefits in its financial statements when it is more likely than not the related tax position will be sustained upon examination by tax authorities. Such tax positions are initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the taxing authority assuming full knowledge of the position and all relevant facts. See Note 15 of the Consolidated Financial Statements for details on the Company's income taxes.
50
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECMEMBER 31, 2018 AND 2017
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 6,344,850 | $ | 6,423,950 | $ | (79,100 | ) | (1.2 | )% | ||||||
Provision for credit losses | (2,339,898 | ) | (2,759,944 | ) | (420,046 | ) | (15.2 | )% | |||||||
Total non-interest income | 3,244,308 | 2,901,253 | 343,055 | 11.8 | % | ||||||||||
General, administrative and other expenses | (5,832,325 | ) | (5,764,324 | ) | 68,001 | 1.2 | % | ||||||||
Income before income taxes | 1,416,935 | 800,935 | 616,000 | 76.9 | % | ||||||||||
Income tax provision/ (benefit) | 425,900 | (157,040 | ) | 582,940 | 371.2 | % | |||||||||
Net income | 991,035 | 957,975 | 33,060 | 3.5 | % | ||||||||||
Net income attributable to non-controlling interest | 283,631 | 405,625 | (121,994 | ) | (30.1 | )% | |||||||||
Net income attributable to SHUSA | $ | 707,404 | $ | 552,350 | $ | 155,054 | 28.1 | % | |||||||
The Company reported pre-tax income of $1.4 billion for the year ended December 31, 2018, compared to pre-tax income of $800.9 million for the year ended December 31, 2017. Factors contributing to this change were as follows:
• | Net interest income decreased $79.1 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily due to an increase in interest expense on deposits and customer accounts as a result of higher interest rates overall and promotional rates offered during the year, and an increase in interest expense on borrowings due to higher borrowing rates, offset by an increase in interest income on loans driven by higher interest rates. |
• | The provision for credit losses decreased $420.0 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily due to decline in the Company's net charge-offs, improved credit performance and stable recovery rates of the loan portfolio. |
• | Total non-interest income increased $343.1 million for the year ended December 31, 2018 compared to 2017. This increase was primarily due to lease income associated with the continued growth of the lease portfolio and an increase in gain on sale of assets coming off lease. |
• | Total general, administrative and other expenses increased $68.0 million for the year ended December 31, 2018 compared to 2017. This increase was primarily due to an increase in lease depreciation expense as a result of growth of the Company's leased vehicle portfolio, offset by lower compensation and benefits expenses and lower loss on debt repurchases for the year ended December 31, 2018. |
• | Income tax provisions increased $582.9 million for the year ended December 31, 2018 compared to 2017. The income tax provision increased in 2018 primarily due to the enactment of the Tax Cuts and Jobs Act (“TCJA”) in 2017, which resulted in a significant benefit in 2017 to re-measure the net deferred tax liabilities due to the federal rate reduction. |
51
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CONSOLIDATED AVERAGE BALANCE SHEET / NET INTEREST MARGIN ANALYSIS | |||||||||||||||||||||||||||||||
YEAR ENDED December 31, 2018 AND 2017 | |||||||||||||||||||||||||||||||
2018 (1) | 2017 (1) | Change due to | |||||||||||||||||||||||||||||
(dollars in thousands) | Average Balance | Interest | Yield/ Rate(2) | Average Balance | Interest | Yield/ Rate(2) | Increase/(Decrease) | Volume | Rate | ||||||||||||||||||||||
EARNING ASSETS | |||||||||||||||||||||||||||||||
INVESTMENTS AND INTEREST EARNING DEPOSITS | $ | 21,342,992 | $ | 522,677 | 2.45 | % | $ | 26,251,822 | $ | 498,734 | 1.90 | % | $ | 23,943 | $ | (43,686 | ) | $ | 67,629 | ||||||||||||
LOANS(3): | |||||||||||||||||||||||||||||||
Commercial loans | 31,416,207 | 1,325,001 | 4.22 | % | 32,897,457 | 1,216,958 | 3.70 | % | 108,043 | (50,931 | ) | 158,974 | |||||||||||||||||||
Multifamily | 8,191,487 | 328,147 | 4.01 | % | 8,334,329 | 311,068 | 3.73 | % | 17,079 | (5,054 | ) | 22,133 | |||||||||||||||||||
Total commercial loans | 39,607,694 | 1,653,148 | 4.17 | % | 41,231,786 | 1,528,026 | 3.71 | % | 125,122 | (55,985 | ) | 181,107 | |||||||||||||||||||
Consumer loans: | |||||||||||||||||||||||||||||||
Residential mortgages | 9,716,021 | 392,660 | 4.04 | % | 8,471,891 | 334,463 | 3.95 | % | 58,197 | 50,381 | 7,816 | ||||||||||||||||||||
Home equity loans and lines of credit | 5,602,240 | 261,745 | 4.67 | % | 5,902,819 | 233,477 | 3.96 | % | 28,268 | (11,214 | ) | 39,482 | |||||||||||||||||||
Total consumer loans secured by real estate | 15,318,261 | 654,405 | 4.27 | % | 14,374,710 | 567,940 | 3.95 | % | 86,465 | 39,167 | 47,298 | ||||||||||||||||||||
RICs and auto loans | 27,559,139 | 4,570,641 | 16.58 | % | 26,881,782 | 4,603,561 | 17.13 | % | (32,920 | ) | 120,049 | (152,969 | ) | ||||||||||||||||||
Personal unsecured | 2,362,910 | 630,394 | 26.68 | % | 2,500,670 | 619,053 | 24.76 | % | 11,341 | (27,823 | ) | 39,164 | |||||||||||||||||||
Other consumer(4) | 526,170 | 37,788 | 7.18 | % | 698,654 | 58,765 | 8.41 | % | (20,977 | ) | (13,174 | ) | (7,803 | ) | |||||||||||||||||
Total consumer | 45,766,480 | 5,893,228 | 12.88 | % | 44,455,816 | 5,849,319 | 13.16 | % | 43,909 | 118,219 | (74,310 | ) | |||||||||||||||||||
Total loans | 85,374,174 | 7,546,376 | 8.84 | % | 85,687,602 | 7,377,345 | 8.61 | % | 169,031 | 62,234 | 106,797 | ||||||||||||||||||||
Intercompany investments | 3,572 | 142 | 3.98 | % | 10,832 | 626 | 5.78 | % | (484 | ) | (330 | ) | (154 | ) | |||||||||||||||||
TOTAL EARNING ASSETS | 106,720,738 | 8,069,195 | 7.56 | % | 111,950,256 | 7,876,705 | 7.04 | % | 192,490 | 18,218 | 174,272 | ||||||||||||||||||||
Allowance for loan losses(5) | (3,835,182 | ) | (3,954,133 | ) | |||||||||||||||||||||||||||
Other assets(6) | 28,346,465 | 26,526,834 | |||||||||||||||||||||||||||||
TOTAL ASSETS | $ | 131,232,021 | $ | 134,522,957 | |||||||||||||||||||||||||||
INTEREST-BEARING FUNDING LIABILITIES | |||||||||||||||||||||||||||||||
Deposits and other customer related accounts: | |||||||||||||||||||||||||||||||
Interest-bearing demand deposits | $ | 9,116,631 | $ | 40,355 | 0.44 | % | $ | 10,138,818 | $ | 23,560 | 0.23 | % | $ | 16,795 | $ | (2,084 | ) | $ | 18,879 | ||||||||||||
Savings | 5,887,341 | 12,325 | 0.21 | % | 5,888,011 | 11,004 | 0.19 | % | 1,321 | (1 | ) | 1,322 | |||||||||||||||||||
Money market | 25,308,245 | 248,683 | 0.98 | % | 25,403,882 | 132,993 | 0.52 | % | 115,690 | (497 | ) | 116,187 | |||||||||||||||||||
CDs | 5,989,993 | 87,765 | 1.47 | % | 6,592,535 | 73,487 | 1.11 | % | 14,278 | (5,603 | ) | 19,881 | |||||||||||||||||||
TOTAL INTEREST-BEARING DEPOSITS | 46,302,210 | 389,128 | 0.84 | % | 48,023,246 | 241,044 | 0.50 | % | 148,084 | (8,185 | ) | 156,269 | |||||||||||||||||||
BORROWED FUNDS: | |||||||||||||||||||||||||||||||
Federal Home Loan Bank ("FHLB") advances, federal funds, and repurchase agreements | 2,066,575 | 53,674 | 2.60 | % | 4,258,450 | 65,294 | 1.53 | % | (11,620 | ) | (18,987 | ) | 7,367 | ||||||||||||||||||
Other borrowings | 38,152,038 | 1,281,401 | 3.36 | % | 37,983,865 | 1,145,791 | 3.02 | % | 135,610 | 5,126 | 130,484 | ||||||||||||||||||||
TOTAL BORROWED FUNDS (7) | 40,218,613 | 1,335,075 | 3.32 | % | 42,242,315 | 1,211,085 | 2.87 | % | 123,990 | (13,861 | ) | 137,851 | |||||||||||||||||||
TOTAL INTEREST-BEARING FUNDING LIABILITIES | 86,520,823 | 1,724,203 | 1.99 | % | 90,265,561 | 1,452,129 | 1.61 | % | 272,074 | (22,046 | ) | 294,120 | |||||||||||||||||||
Noninterest bearing demand deposits | 15,117,229 | 15,629,718 | |||||||||||||||||||||||||||||
Other liabilities(8) | 5,490,385 | 5,239,268 | |||||||||||||||||||||||||||||
TOTAL LIABILITIES | 107,128,437 | 111,134,547 | |||||||||||||||||||||||||||||
STOCKHOLDER’S EQUITY | 24,103,584 | 23,388,410 | |||||||||||||||||||||||||||||
TOTAL LIABILITIES AND STOCKHOLDER’S EQUITY | $ | 131,232,021 | $ | 134,522,957 | |||||||||||||||||||||||||||
NET INTEREST SPREAD (9) | 5.57 | % | 5.43 | % | |||||||||||||||||||||||||||
NET INTEREST MARGIN (10) | 5.95 | % | 5.74 | % | |||||||||||||||||||||||||||
NET INTEREST INCOME (11) | $ | 6,344,850 | $ | 6,423,950 | |||||||||||||||||||||||||||
1.23x | 1.24x | ||||||||||||||||||||||||||||||
(1) | Average balances are based on daily averages when available. When daily averages are unavailable, mid-month averages are substituted. |
(2) | Yields calculated using taxable equivalent net interest income. |
(3) | Interest on loans includes amortization of premiums and discounts on purchased loan portfolios and amortization of deferred loan fees, net of origination costs. Average loan balances includes non-accrual loans and loans held-for-sale ("LHFS"). |
(4) | Other consumer primarily includes recreational vehicle ("RV") and marine loans. |
(5) | Refer to Note 4 to the Consolidated Financial Statements for further discussion. |
(6) | Other assets primarily includes goodwill and intangibles, premise and equipment, net deferred tax assets, equity method investments, BOLI, accrued interest receivable, derivative assets, miscellaneous receivables, prepaid expenses and MSRs. Refer to Note 9 to the Consolidated Financial Statements for further discussion. |
(7) | Refer to Note 11 to the Consolidated Financial Statements for further discussion. |
(8) | Other liabilities primarily includes accounts payable and accrued expenses, derivative liabilities, net deferred tax liabilities and the unfunded lending commitments liability. |
(9) | Represents the difference between the yield on total earning assets and the cost of total funding liabilities. |
(10) | Represents annualized, taxable equivalent net interest income divided by average interest-earning assets. |
(11) | Intercompany investment income is eliminated from this line item. |
52
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
NET INTEREST INCOME
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar increase/(decrease) | Percentage | |||||||||||
INTEREST INCOME: | |||||||||||||||
Interest-earning deposits | $ | 137,753 | $ | 86,205 | $ | 51,548 | 59.8 | % | |||||||
Investments available-for-sale ("AFS") | 297,557 | 352,601 | (55,044 | ) | (15.6 | )% | |||||||||
Investments held-to-maturity ("HTM") | 68,525 | 38,609 | 29,916 | 77.5 | % | ||||||||||
Other investments | 18,842 | 21,319 | (2,477 | ) | (11.6 | )% | |||||||||
Total interest income on investment securities and interest-earning deposits | 522,677 | 498,734 | 23,943 | 4.8 | % | ||||||||||
Interest on loans | 7,546,376 | 7,377,345 | 169,031 | 2.3 | % | ||||||||||
Total interest income | 8,069,053 | 7,876,079 | 192,974 | 2.5 | % | ||||||||||
INTEREST EXPENSE: | |||||||||||||||
Deposits and customer accounts | 389,128 | 241,044 | 148,084 | 61.4 | % | ||||||||||
Borrowings and other debt obligations | 1,335,075 | 1,211,085 | 123,990 | 10.2 | % | ||||||||||
Total interest expense | 1,724,203 | 1,452,129 | 272,074 | 18.7 | % | ||||||||||
NET INTEREST INCOME | $ | 6,344,850 | $ | 6,423,950 | $ | (79,100 | ) | (1.2 | )% | ||||||
Net interest income decreased $79.1 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily due to an increase in interest expense on deposits and customer accounts due to higher interest rates overall and rate promotions offered during the period, and an increase in interest expense on borrowings due to higher borrowing rates, offset by an increase in interest income on loans driven by higher interest rates.
Interest Income on Investment Securities and Interest-Earning Deposits
Interest income on investment securities and interest-earning deposits increased $23.9 million for the year ended December 31, 2018 compared to 2017. The average balances of investment securities and interest-earning deposits for the year ended December 31, 2018 were $21.3 billion with an average yield of 2.45% compared to an average balance of $26.3 billion and an average yield of 1.90% for the year ended December 31, 2017. The increase in interest income on investment securities and interest-earning deposits for the year ended December 31, 2018 was primarily due to an increase in the average yield on interest-earning deposits resulting from continued increases in the federal funds rate and increases in the average yield on investments HTM, offset by a decrease in the average balance and average yield on AFS investments.
Interest Income on Loans
Interest income on loans increased $169.0 million for the year ended December 31, 2018, compared to 2017. This increase was primarily due to an increase in the residential mortgage and RIC and auto loan portfolios. The average balance of total loans was $85.4 billion with an average yield of 8.84% for the year ended December 31, 2018 compared to $85.7 billion with an average yield of 8.61% for the year ended December 31, 2017. The decrease in the average balance of total loans of $313.4 million for 2018 was primarily due to a decline in the average balance of the commercial loan portfolio of $1.6 billion, offset by an increase in average consumer loans of $1.3 billion. The decrease in the average balance of the commercial loan portfolio was due to the Company's exit from the Commercial Mortgage Warehouse portfolio during 2018 and efforts to reduce risk exposure in the loan portfolio.
Interest Expense on Deposits and Related Customer Accounts
Interest expense on deposits and related customer accounts increased $148.1 million for the year ended December 31, 2018 compared to 2017. The increase was primarily due to overall higher interest rates and higher promotional rates offered to customers during the year. Higher rates were offered to customers on various deposit products in order to attract and grow the customer base. The average balances of total interest-bearing deposits was $46.3 billion with an average cost of 0.84% for the year ended December 31, 2018, compared to an average balance of $48.0 billion with an average cost of 0.50% for the year ended December 31, 2017.
Interest Expense on Borrowed Funds
Interest expense on borrowed funds increased $124.0 million for the year ended December 31, 2018, compared to 2017. The increase in interest expense on borrowed funds was due to higher interest rates being paid during 2018. The average balances of total borrowings
was $40.2 billion with an average cost of 3.32% for the year ended December 31, 2018, compared to an average balance of $42.2 billion with an average cost of 2.87% for the year ended December 31, 2017. The average balance of borrowed funds decreased in December 31, 2018 compared to December 31, 2017, primarily due to a decrease in FHLB advances as a result of maturities and terminations and repurchases of outstanding notes.
53
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
PROVISION FOR CREDIT LOSSES
The provision for credit losses is based on credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the portfolio. The provision for credit losses for the year ended December 31, 2018 was $2.3 billion compared to $2.8 billion for 2017. The decrease for the year ended December 31, 2018 was primarily due to stabilizing credit performance for non-TDR loans and recovery rates for the RIC and auto loan portfolio.
Year Ended December 31, | Year To Date Change | |||||||||||||
(in thousands) | 2018 | 2017 | Dollar | Percentage | ||||||||||
ALLL, beginning of period | $ | 3,994,887 | $ | 3,814,464 | $ | 180,423 | 4.7 | % | ||||||
Charge-offs: | ||||||||||||||
Commercial | (108,750 | ) | (144,002 | ) | 35,252 | (24.5 | )% | |||||||
Consumer | (4,974,547 | ) | (4,891,383 | ) | (83,164 | ) | 1.7 | % | ||||||
Total charge-offs | (5,083,297 | ) | (5,035,385 | ) | (47,912 | ) | 1.0 | % | ||||||
Recoveries: | ||||||||||||||
Commercial | 60,140 | 37,999 | 22,141 | 58.3 | % | |||||||||
Consumer | 2,572,607 | 2,401,614 | 170,993 | 7.1 | % | |||||||||
Total recoveries | 2,632,747 | 2,439,613 | 193,134 | 7.9 | % | |||||||||
Charge-offs, net of recoveries | (2,450,550 | ) | (2,595,772 | ) | 145,222 | (5.6 | )% | |||||||
Provision for loan and lease losses (1) | 2,352,793 | 2,770,556 | (417,763 | ) | (15.1 | )% | ||||||||
Other(2): | ||||||||||||||
Commercial | — | 356 | (356 | ) | (100.0 | )% | ||||||||
Consumer | — | 5,283 | (5,283 | ) | (100.0 | )% | ||||||||
ALLL, end of period | $ | 3,897,130 | $ | 3,994,887 | $ | (97,757 | ) | (2.4 | )% | |||||
Reserve for unfunded lending commitments, beginning of period | $ | 109,111 | $ | 122,418 | $ | (13,307 | ) | (10.9 | )% | |||||
Release of reserves for unfunded lending commitments (1) | (12,895 | ) | (10,612 | ) | (2,283 | ) | 21.5 | % | ||||||
Loss on unfunded lending commitments | (716 | ) | (2,695 | ) | 1,979 | (73.4 | )% | |||||||
Reserve for unfunded lending commitments, end of period | 95,500 | 109,111 | (13,611 | ) | (12.5 | )% | ||||||||
Total ACL, end of period | $ | 3,992,630 | $ | 4,103,998 | $ | (111,368 | ) | (2.7 | )% | |||||
(1) | The provision for credit losses in the Consolidated Statement of Operations is the sum of the total provision for loan and lease losses and the provision for unfunded lending commitments. |
(2) | Includes transfers in for the period ending December 31, 2017 related to the contribution of SFS to SHUSA. |
The Company's net charge-offs decreased $145.2 million for the year ended December 31, 2018 compared to 2017.
Consumer charge-offs increased $83.2 million for the year ended December 31, 2018, compared to 2017. This increase was primarily comprised of a $86.4 million increase in RIC and consumer auto loan charge-offs, offset by a $2.7M decrease in charge-offs for consumer loans in Puerto Rico.
Consumer recoveries increased $171.0 million for the year ended December 31, 2018, compared to 2017. This increase was comprised of a $172.0 million increase in RIC and consumer auto loan recoveries and a $1.0 million increase in consumer recoveries in Puerto Rico, offset by $2.3 million decrease in home mortgage recoveries.
Consumer net charge-offs as a percentage of average consumer loans were 5.2% for the year ended December 31, 2018, compared 5.6% in 2017.
Commercial charge-offs decreased $35.3 million for the year ended December 31, 2018, compared to 2017. This decrease was comprised of a $22.8 million decrease in Commercial Banking charge-offs, a $6.5 million decrease in Middle Market CRE charge-offs, a $6.8 million decrease in commercial fleet charge-offs, and a $10.6 million decrease in charge-offs for commercial loans in Puerto Rico, offset by a $11.9M increase in Continuing Care Retirement Community charge-offs.
Commercial recoveries increased $22.1 million for the year ended December 31, 2018 compared to 2017. This increase was comprised of an $18.9 million increase in Corporate Banking recoveries, and a $6.0 million increase in Continuing Care Retirement Communities recoveries, partially offset by a $2.1 million decrease in commercial fleet recoveries, and a $1.8 million decrease in Middle Market CRE recoveries.
Commercial loan net charge-offs as a percentage of average commercial loans, including multifamily loans, was less than 0.12% for the year ended December 31, 2018, compared to 0.26% for the year ended December 31, 2017.
54
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
NON-INTEREST INCOME
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar increase/(decrease) | Percentage | |||||||||||
Consumer fees | $ | 413,934 | $ | 442,483 | $ | (28,549 | ) | (6.5 | )% | ||||||
Commercial fees | 154,213 | 173,955 | (19,742 | ) | (11.3 | )% | |||||||||
Lease income | 2,375,596 | 2,017,775 | 357,821 | 17.7 | % | ||||||||||
Miscellaneous income, net | 307,282 | 269,484 | 37,798 | 14.0 | % | ||||||||||
Net losses recognized in earnings | (6,717 | ) | (2,444 | ) | (4,273 | ) | (174.8 | )% | |||||||
Total non-interest income | $ | 3,244,308 | $ | 2,901,253 | $ | 343,055 | 11.8 | % | |||||||
Total non-interest income increased $343.1 million for the year ended December 31, 2018 compared to 2017. The increase for the year ended December 31, 2018 was primarily due to an increase in lease income. This increase was partially offset by decreases in consumer and commercial loan fees due to the reduction of loans serviced by the Company.
Consumer fees
Consumer fees decreased $28.5 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily due to a decrease in loan fee income, which was attributable to a reduction in loans serviced by the Company as a result of loan sales and payoffs in 2018. This decrease was partially offset by an increase in consumer insurance-related fees.
Commercial fees
Commercial fees consists of deposit overdraft fees, deposit automated teller machine fees, cash management fees, letter of credit fees, and loan syndication fees for commercial accounts. Commercial fees decreased $19.7 million for the year ended December 31, 2018 compared to in 2017. This decrease was primarily due to lower commercial deposit fee income.
Lease income
Lease income increased $357.8 million for the year ended December 31, 2018 compared to 2017. This increase was the result of the growth in the Company's lease portfolio, with an average balance of $12.3 billion for the year ended December 31, 2018, compared to $10.1 billion during 2017.
Miscellaneous income/(loss)
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar increase/(decrease) | Percentage | |||||||||||
Mortgage banking income, net | $ | 34,612 | $ | 56,659 | $ | (22,047 | ) | (38.9 | )% | ||||||
BOLI | 58,939 | 66,784 | (7,845 | ) | (11.7 | )% | |||||||||
Capital market revenue | 165,392 | 195,906 | (30,514 | ) | (15.6 | )% | |||||||||
Net gain on sale of operating leases | 202,793 | 127,156 | 75,637 | 59.5 | % | ||||||||||
Asset and wealth management fees | 165,765 | 147,749 | 18,016 | 12.2 | % | ||||||||||
Loss on sale of non-mortgage loans | (351,751 | ) | (370,289 | ) | 18,538 | 5.0 | % | ||||||||
Other miscellaneous income, net | 31,532 | 45,519 | (13,987 | ) | (30.7 | )% | |||||||||
Total miscellaneous income/(loss) | $ | 307,282 | $ | 269,484 | $ | 37,798 | 14.0 | % | |||||||
Miscellaneous income increased $37.8 million for the year ended December 31, 2018 compared to 2017. This increase was primarily due to the Company's growing lease portfolio. As the lease portfolio continues to grow, the number of leases that ultimately are liquidated will correspondingly increase, which may result in an increase in the amount of net gain recognized on the sale of operating leases. This increase was partially offset by a decrease in capital markets revenue, due to lower underwriting service fees in 2018 compared to 2017.
55
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
GENERAL, ADMINISTRATIVE AND OTHER EXPENSES
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar | Percentage | |||||||||||
Compensation and benefits | $ | 1,799,369 | $ | 1,895,326 | $ | (95,957 | ) | (5.1 | )% | ||||||
Occupancy and equipment expenses | 659,789 | 669,113 | (9,324 | ) | (1.4 | )% | |||||||||
Technology, outside services, and marketing expense | 590,249 | 581,164 | 9,085 | 1.6 | % | ||||||||||
Loan expense | 384,899 | 386,468 | (1,569 | ) | (0.4 | )% | |||||||||
Lease expense | 1,789,030 | 1,553,096 | 235,934 | 15.2 | % | ||||||||||
Other expenses | 608,989 | 679,157 | (70,168 | ) | (10.3 | )% | |||||||||
Total general and administrative expenses | $ | 5,832,325 | $ | 5,764,324 | $ | 68,001 | 1.2 | % | |||||||
Total general, administrative and other expenses increased $68.0 million for the year ended December 31, 2018 compared to 2017. Factors contributing to this increase were as follows:
• | Compensation and benefits expense decreased $96.0 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily the result of other compensation and benefits decreasing $149.0 million. This decrease was related to a reduction in severance and employee settlement payments in 2018 compared to 2017, and was offset by increase in salary expense of $57.4 million for 2018 compared to 2017. The increase in salary expense primarily related to merit increases and an increase in employees. |
• | Technology, outside services, and marketing expenses increased $9.1 million for the year ended December 31, 2018 compared to 2017. Technology service expenses increased $25.4 million for the year ended December 31, 2018 compared to 2017, offset by a decrease of $19.5 million in marketing expenses for the year ended December 31, 2018 compared to 2017. |
• | Lease expense increased $235.9 million for the year ended December 31, 2018 compared to 2017. This increase was primarily due to the continued growth of the Company's leased vehicle portfolio and depreciation associated with that portfolio. |
• | Other expenses decreased $70.2 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily attributable to a $26.9 million decrease in loss on debt extinguishment, a $10.5 million decrease in impairment of goodwill, and a $113.9 million decrease in legal expenses, offset by increases in operational risk expenses of $77.8 million and trust and wealth management expenses of $18.5 million for the year ended December 31, 2018, compared to 2017. |
INCOME TAX PROVISION
An income tax provision of $425.9 million was recorded for the year ended December 31, 2018, compared to an income tax benefit of $157.0 million for 2017. This resulted in an effective tax rate ("ETR") of 30.1% for the year ended December 31, 2018, compared to (19.6)% for 2017. The income tax provision increased in 2018 primarily due to the enactment of the TCJA in 2017, which resulted in a $427.3 million one-time benefit recognized in 2017 to re-measure the net deferred tax liabilities due to the federal statutory rate reduction from 35% to 21%. The reduction in the federal statutory tax rate reduced the federal tax benefit recognized for state income tax expense in 2018 compared to 2017, therefore increasing the state income tax expense, net of the federal benefit, in 2018 and the overall ETR. The 2018 ETR also increased due to increased losses of subsidiaries in Puerto Rico that have not been tax-benefited due to the history of losses at those entities.
The Company's ETR in future periods will be affected by the results of operations allocated to the various tax jurisdictions in which the Company operates, any change in income tax laws or regulations within those jurisdictions, and interpretations of income tax regulations that differ from the Company's interpretations by tax authorities that examine tax returns filed by the Company or any of its subsidiaries.
LINE OF BUSINESS RESULTS
General
The Company's segments at December 31, 2018 consisted of Consumer and Business Banking, Commercial Banking, CIB which was formerly known as Global Corporate Banking, and SC. For additional information with respect to the Company's reporting segments and changes to the segments beginning in the first quarter of 2018, see Note 23 to the Consolidated Financial Statements.
56
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results Summary
Consumer and Business Banking
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 1,301,671 | $ | 1,115,169 | $ | 186,502 | 16.7 | % | |||||||
Total non-interest income | 308,614 | 356,936 | (48,322 | ) | (13.5 | )% | |||||||||
Provision for credit losses | 100,523 | 85,115 | 15,408 | 18.1 | % | ||||||||||
Total expenses | 1,487,835 | 1,500,815 | (12,980 | ) | (0.9 | )% | |||||||||
Income/(loss) before income taxes | 21,927 | (113,825 | ) | 135,752 | 119.3 | % | |||||||||
Intersegment revenue | 2,507 | 2,330 | 177 | 7.6 | % | ||||||||||
Total assets | 21,024,741 | 18,714,285 | 2,310,456 | 12.3 | % | ||||||||||
Consumer and Business Banking reported income before income taxes of $21.9 million for the year ended December 31, 2018, compared to a loss before income taxes of $113.8 million for the year ended December 31, 2017. Factors contributing to this change were:
• | Net interest income increased $186.5 million for the year ended December 31, 2018 compared to 2017. This increase was primarily driven by deposit product margin due to interest rate increases combined with disciplined pricing. The average balance of this segment's gross loans was $18.6 billion for the year ended December 31, 2018, compared to $17.2 billion for 2017. This increase was primarily driven by an increase in residential mortgages and auto loans of $1.3 billion and $383.0 million, respectively, partially offset by a decrease in home equity loans of $278.0 million. |
• | Total non-interest income decreased $48.3 million for the year ended December 31, 2018 compared to 2017, primarily driven by non-recurring gains on the sale of the Bank's branches in Brooklyn, New York in 2017. |
Commercial Banking
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 639,558 | $ | 630,078 | $ | 9,480 | 1.5 | % | |||||||
Total non-interest income | 87,803 | 70,219 | 17,584 | 25.0 | % | ||||||||||
(Release of) /provision for credit losses | (19,405 | ) | 29,586 | (48,991 | ) | (165.6 | )% | ||||||||
Total expenses | 327,291 | 324,385 | 2,906 | 0.9 | % | ||||||||||
Income before income taxes | 419,475 | 346,326 | 73,149 | 21.1 | % | ||||||||||
Intersegment revenue | 9,420 | 6,137 | 3,283 | 53.5 | % | ||||||||||
Total assets | 25,712,309 | 25,318,068 | 394,241 | 1.6 | % | ||||||||||
Commercial Banking reported income before income taxes of $419.5 million for the year ended December 31, 2018 compared to income before income taxes of $346.3 million for the year ended December 31, 2017. Contributing to this change were:
• | The provision for credit losses decreased $49.0 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily due to releases totaling $7.0 million for the Mortgage Warehouse portfolio, $15.6 million for the energy lending portfolio and a $23.5 million release for an asset-based lending customer paying their loan in full. |
CIB
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 136,402 | $ | 153,622 | $ | (17,220 | ) | (11.2 | )% | ||||||
Total non-interest income | 195,210 | 186,749 | 8,461 | 4.5 | % | ||||||||||
Provision for credit losses | 9,335 | 33,275 | (23,940 | ) | (71.9 | )% | |||||||||
Total expenses | 235,979 | 218,696 | 17,283 | 7.9 | % | ||||||||||
Income before income taxes | 86,298 | 88,400 | (2,102 | ) | (2.4 | )% | |||||||||
Intersegment expense | (12,362 | ) | (8,086 | ) | (4,276 | ) | (52.9 | )% | |||||||
Total assets | 8,521,004 | 6,949,373 | 1,571,631 | 22.6 | % | ||||||||||
57
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CIB reported income before income taxes of $86.3 million for the year ended December 31, 2018 compared to income before income taxes of $88.4 million for 2017.
• | Total assets increased $1.6 billion for the year ended December 31, 2018 compared to 2017, primarily driven by an increase in loan balances in the global transaction banking portfolio as a result of generating business with new customers. |
Other
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 239,664 | $ | 255,096 | $ | (15,432 | ) | (6.0 | )% | ||||||
Total non-interest income | 405,319 | 548,806 | (143,487 | ) | (26.1 | )% | |||||||||
Provision for credit losses | 24,254 | 93,165 | (68,911 | ) | (74.0 | )% | |||||||||
Total expenses | 887,681 | 955,292 | (67,611 | ) | (7.1 | )% | |||||||||
Loss before income taxes | (266,952 | ) | (244,555 | ) | (22,397 | ) | (9.2 | )% | |||||||
Intersegment revenue/(expense) | 435 | (381 | ) | 816 | 214.2 | % | |||||||||
Total assets | 36,416,376 | 37,890,000 | (1,473,624 | ) | (3.9 | )% | |||||||||
The Other category reported a loss before income taxes of $267.0 million for the year ended December 31, 2018 compared to a loss before income taxes of $244.6 million for 2017. Factors contributing to this change were:
• | Total non-interest income decreased $143.5 million for the year ended December 31, 2018 compared to 2017, primarily related to SBNA's auto lease portfolio runoff. |
• | The provision for credit losses decreased $68.9 million for the year ended December 31, 2018 compared to 2017. This decrease was primarily related to the impact of Hurricane Maria in 2017 requiring additional reserves that were not required in 2018. |
• | Total expenses decreased $67.6 million for the year ended December 31, 2018 compared to 2017. |
SC
The Chief Operating Decision Maker ("CODM") manages SC on a historical basis by reviewing the results of SC on a pre-Change in Control basis. The line of business results table discloses SC's operating information on the same basis that it is reviewed by the CODM.
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2018 | 2017 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 3,958,280 | $ | 4,114,600 | $ | (156,320 | ) | (3.8 | )% | ||||||
Total non-interest income | 2,297,517 | 1,793,408 | 504,109 | 28.1 | % | ||||||||||
Provision for credit losses | 2,205,585 | 2,363,812 | (158,227 | ) | (6.7 | )% | |||||||||
Total expenses | 2,857,944 | 2,740,190 | 117,754 | 4.3 | % | ||||||||||
Income before income taxes | 1,192,268 | 804,006 | 388,262 | 48.3 | % | ||||||||||
Total assets | 43,959,855 | 39,402,799 | 4,557,056 | 11.6 | % | ||||||||||
SC reported income before income taxes of $1.2 billion for the year ended December 31, 2018 compared to income before income taxes of $804.0 million for 2017. Contributing to this change was:
• | Total non-interest income increased $504.1 million for the year ended December 31, 2018 compared to 2017, due to the continued growth in the operating lease vehicle portfolio since SC launched Chrysler Capital in 2013. |
58
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2017 AND 2016
On July 1, 2016, ownership of several Santander subsidiaries, including Santander BanCorp, BSI, SIS and SSLLC, were transferred to the Company. As these entities were and are solely owned and controlled by Santander prior to and after July 1, 2016, in accordance with ASC 805, the transaction has been accounted for under the common control guidance, which requires the Company to recognize the assets and liabilities transferred at their historical cost of the transferring entity at the date of the transfer. Additionally, as this transaction represented a change in reporting entity, the guidance requires retrospective combination of the entities for all periods presented in these financial statements as if the combination had been in effect since inception of common control. On July 1, 2017, an additional Santander subsidiary, SFS, a finance company located in Puerto Rico, was transferred to the Company and accounted for prospectively. Refer to Note 1 for additional information.
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar | Percentage | |||||||||||
Net interest income | $ | 6,423,950 | $ | 6,564,692 | $ | (140,742 | ) | (2.1 | )% | ||||||
Provision for credit losses | (2,759,944 | ) | (2,979,725 | ) | 219,781 | 7.4 | % | ||||||||
Total non-interest income | 2,901,253 | 2,755,705 | 145,548 | 5.3 | % | ||||||||||
General, administrative and other expenses | (5,764,324 | ) | (5,386,194 | ) | (378,130 | ) | (7.0 | )% | |||||||
Income before income taxes | 800,935 | 954,478 | (153,543 | ) | (16.1 | )% | |||||||||
Income tax provision/(benefit) | (157,040 | ) | 313,715 | (470,755 | ) | (150.1 | )% | ||||||||
Net income (1) | $ | 957,975 | $ | 640,763 | $ | 317,212 | 49.5 | % | |||||||
(1) | Includes NCI. |
The Company reported a pre-tax income of $800.9 million for the year ended December 31, 2017, compared to pre-tax income of $954.5 million for the year ended December 31, 2016. Factors contributing to this decline were as follows:
• | Net interest income decreased $140.7 million for the year ended December 31, 2017 compared to 2016. This decrease was primarily due to a decrease in interest income earned on loans due to declining yields on consumer loans and an increase in interest expense on Other borrowings due to the rates paid on new debt issuances. |
• | Provisions for credit losses decreased $219.8 million for the year ended December 31, 2017, compared to 2016. This decrease was primarily due to a decline in loan balances, improved credit performance and stable recovery rates for the auto loan portfolio and a decrease in the Corporate Banking and Middle Market CRE portfolio provisions. |
• | Total non-interest income increased $145.5 million for the year ended December 31, 2017 compared to 2016. This increase was primarily due to lease income associated with the continued growth of the lease portfolio, an increase in gain on sale of assets coming off lease, and an increase on the gain on sale of Bank branches. These were offset by a decrease in consumer and commercial loan fees due to a reduction in loans serviced by the Company for the year ended December 31, 2017. |
• | Total general, administrative, and other expenses increased $378.1 million for the year ended December 31, 2017 compared to 2016. This increase was primarily due to an increase in lease depreciation expense as a result of the growth of the Company's leased vehicle portfolio and an increase in compensation expense. These increases were offset by a decrease in outside service costs for consulting and processing services and a decrease in loan servicing expense. |
• | The income tax provision decreased $470.8 million for the year ended December 31, 2017 compared to 2016. This decrease was primarily due to the enactment of the TCJA. Effective January 1, 2018, the TCJA, among other things, reduced the federal corporate income tax rate from 35% to 21%. As a result of the TCJA's enactment, GAAP required that companies re-measure their deferred tax balances as of the enactment of the legislation. During the fourth quarter of 2017, we reduced our income tax provision by $427.3 million as a result of re-measuring our net deferred tax liabilities due to the federal rate reduction. |
59
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CONSOLIDATED AVERAGE BALANCE SHEET / NET INTEREST MARGIN ANALYSIS | |||||||||||||||||||||||||||||||
YEARS ENDED DECEMBER 31, 2017 AND 2016 | |||||||||||||||||||||||||||||||
2017 (1) | 2016 (1) | Interest | Change due to | ||||||||||||||||||||||||||||
(dollars in thousands) | Average Balance | Interest | Yield/ Rate(2) | Average Balance | Interest | Yield/ Rate(2) | Increase/ Decrease | Volume | Rate | ||||||||||||||||||||||
EARNING ASSETS | |||||||||||||||||||||||||||||||
INVESTMENTS AND INTEREST EARNING DEPOSITS | $ | 26,251,822 | $ | 498,734 | 1.90 | % | $ | 29,287,122 | $ | 378,404 | 1.29 | % | $ | 120,330 | $ | (33,777 | ) | $ | 154,107 | ||||||||||||
LOANS(3): | |||||||||||||||||||||||||||||||
Commercial loans | 32,897,457 | 1,216,958 | 3.70 | % | 37,313,431 | 1,219,667 | 3.27 | % | (2,709 | ) | (20,182 | ) | 17,473 | ||||||||||||||||||
Multifamily | 8,334,329 | 311,068 | 3.73 | % | 9,126,075 | 331,344 | 3.63 | % | (20,276 | ) | (29,710 | ) | 9,434 | ||||||||||||||||||
Total commercial loans | 41,231,786 | 1,528,026 | 3.71 | % | 46,439,506 | 1,551,011 | 3.34 | % | (22,985 | ) | (49,892 | ) | 26,907 | ||||||||||||||||||
Consumer loans: | |||||||||||||||||||||||||||||||
Residential mortgages | 8,471,891 | 334,463 | 3.95 | % | 7,887,893 | 316,015 | 4.01 | % | 18,448 | 23,121 | (4,673 | ) | |||||||||||||||||||
Home equity loans and lines of credit | 5,902,819 | 233,477 | 3.96 | % | 6,076,177 | 219,691 | 3.62 | % | 13,786 | (6,015 | ) | 19,801 | |||||||||||||||||||
Total consumer loans secured by real estate | 14,374,710 | 567,940 | 3.95 | % | 13,964,070 | 535,706 | 3.84 | % | 32,234 | 17,106 | 15,128 | ||||||||||||||||||||
RICs and auto loans | 26,881,782 | 4,603,561 | 17.13 | % | 26,636,271 | 4,831,270 | 18.14 | % | (227,709 | ) | 45,177 | (272,886 | ) | ||||||||||||||||||
Personal unsecured | 2,500,670 | 619,053 | 24.76 | % | 2,310,996 | 610,998 | 26.44 | % | 8,055 | 35,669 | (27,614 | ) | |||||||||||||||||||
Other consumer(4) | 698,654 | 58,765 | 8.41 | % | 910,686 | 82,362 | 9.04 | % | (23,597 | ) | (18,160 | ) | (5,437 | ) | |||||||||||||||||
Total consumer | 44,455,816 | 5,849,319 | 13.16 | % | 43,822,023 | 6,060,336 | 13.83 | % | (211,017 | ) | 79,792 | (290,809 | ) | ||||||||||||||||||
Total loans | 85,687,602 | 7,377,345 | 8.61 | % | 90,261,529 | 7,611,347 | 8.43 | % | (234,002 | ) | 29,900 | (263,902 | ) | ||||||||||||||||||
Intercompany investments | 10,832 | 626 | 5.78 | % | 14,640 | 904 | 6.17 | % | (278 | ) | (224 | ) | (54 | ) | |||||||||||||||||
TOTAL EARNING ASSETS | 111,950,256 | 7,876,705 | 7.04 | % | 119,563,291 | 7,990,655 | 6.68 | % | (113,950 | ) | (4,101 | ) | (109,849 | ) | |||||||||||||||||
Allowance for loan losses(5) | (3,954,133 | ) | (3,664,095 | ) | |||||||||||||||||||||||||||
Other assets(6) | 26,526,834 | 26,022,585 | |||||||||||||||||||||||||||||
TOTAL ASSETS | $ | 134,522,957 | $ | 141,921,781 | |||||||||||||||||||||||||||
INTEREST-BEARING FUNDING LIABILITIES | |||||||||||||||||||||||||||||||
Deposits and other customer related accounts: | |||||||||||||||||||||||||||||||
Interest-bearing demand deposits | $ | 10,138,818 | $ | 23,560 | 0.23 | % | $ | 11,682,723 | $ | 42,013 | 0.36 | % | $ | (18,453 | ) | $ | (4,944 | ) | $ | (13,509 | ) | ||||||||||
Savings | 5,888,011 | 11,004 | 0.19 | % | 5,956,770 | 12,723 | 0.21 | % | (1,719 | ) | (186 | ) | (1,533 | ) | |||||||||||||||||
Money market | 25,403,882 | 132,993 | 0.52 | % | 25,029,571 | 126,417 | 0.51 | % | 6,576 | 2,845 | 3,731 | ||||||||||||||||||||
CDs | 6,592,535 | 73,487 | 1.11 | % | 9,738,344 | 95,869 | 0.98 | % | (22,382 | ) | (37,978 | ) | 15,596 | ||||||||||||||||||
TOTAL INTEREST-BEARING DEPOSITS | 48,023,246 | 241,044 | 0.50 | % | 52,407,408 | 277,022 | 0.53 | % | (35,978 | ) | (40,263 | ) | 4,285 | ||||||||||||||||||
BORROWED FUNDS: | |||||||||||||||||||||||||||||||
FHLB advances, federal funds, and repurchase agreements | 4,258,450 | 65,294 | 1.53 | % | 9,466,243 | 126,799 | 1.34 | % | (61,505 | ) | (82,860 | ) | 21,355 | ||||||||||||||||||
Other borrowings | 37,983,865 | 1,145,791 | 3.02 | % | 38,042,187 | 1,021,238 | 2.68 | % | 124,553 | (1,520 | ) | 126,073 | |||||||||||||||||||
TOTAL BORROWED FUNDS (7) | 42,242,315 | 1,211,085 | 2.87 | % | 47,508,430 | 1,148,037 | 2.42 | % | 63,048 | (84,380 | ) | 147,428 | |||||||||||||||||||
TOTAL INTEREST-BEARING FUNDING LIABILITIES | 90,265,561 | 1,452,129 | 1.61 | % | 99,915,838 | 1,425,059 | 1.43 | % | 27,070 | (124,643 | ) | 151,713 | |||||||||||||||||||
Noninterest-bearing demand deposits | 15,629,718 | 14,410,397 | |||||||||||||||||||||||||||||
Other liabilities(8) | 5,239,268 | 5,362,817 | |||||||||||||||||||||||||||||
TOTAL LIABILITIES | 111,134,547 | 119,689,052 | |||||||||||||||||||||||||||||
STOCKHOLDER’S EQUITY | 23,388,410 | 22,232,729 | |||||||||||||||||||||||||||||
TOTAL LIABILITIES AND STOCKHOLDER’S EQUITY | $ | 134,522,957 | $ | 141,921,781 | |||||||||||||||||||||||||||
NET INTEREST SPREAD (9) | 5.43 | % | 5.25 | % | |||||||||||||||||||||||||||
NET INTEREST MARGIN (10) | 5.74 | % | 5.49 | % | |||||||||||||||||||||||||||
NET INTEREST INCOME | $ | 6,423,950 | $ | 6,564,692 | |||||||||||||||||||||||||||
Ratio of interest-earning assets to interest-bearing liabilities | 1.24x | 1.20x | |||||||||||||||||||||||||||||
(1) | Average balances are based on daily averages when available. When daily averages are unavailable, mid-month averages are substituted. |
(2) | Yields calculated using taxable equivalent net interest income. |
(3) | Interest on loans includes amortization of premiums and discounts on purchased loan portfolios and amortization of deferred loan fees, net of origination costs. Average loan balances includes non-accrual loans and LHFS. |
(4) | Other consumer primarily includes RV and marine loans. |
(5) | Refer to Note 4 to the Consolidated Financial Statements for further discussion. |
(6) | Other assets primarily includes goodwill and intangibles, premise and equipment, net deferred tax assets, equity method investments, BOLI, accrued interest receivable, derivative assets, miscellaneous receivables, prepaid expenses and MSRs. Refer to Note 9 to the Consolidated Financial Statements for further discussion. |
(7) | Refer to Note 11 to the Consolidated Financial Statements for further discussion. |
(8) | Other liabilities primarily includes accounts payable and accrued expenses, derivative liabilities, net deferred tax liabilities and the unfunded lending commitments liability. |
(9) | Represents the difference between the yield on total earning assets and the cost of total funding liabilities. |
(10) | Represents annualized, taxable equivalent net interest income divided by average interest-earning assets. |
60
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
NET INTEREST INCOME
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar | Percentage | |||||||||||
INTEREST INCOME: | |||||||||||||||
Interest-earning deposits | $ | 86,205 | $ | 57,361 | $ | 28,844 | 50.3 | % | |||||||
Investments AFS | 352,601 | 284,796 | 67,805 | 23.8 | % | ||||||||||
Investments HTM | 38,609 | 3,526 | 35,083 | 995.0 | % | ||||||||||
Other investments | 21,319 | 32,721 | (11,402 | ) | (34.8 | )% | |||||||||
Total interest income on investment securities and interest-earning deposits | 498,734 | 378,404 | 120,330 | 31.8 | % | ||||||||||
Interest on loans | 7,377,345 | 7,611,347 | (234,002 | ) | (3.1 | )% | |||||||||
Total interest income | 7,876,079 | 7,989,751 | (113,672 | ) | (1.4 | )% | |||||||||
INTEREST EXPENSE: | |||||||||||||||
Deposits and customer accounts | 241,044 | 277,022 | (35,978 | ) | (13.0 | )% | |||||||||
Borrowings and other debt obligations | 1,211,085 | 1,148,037 | 63,048 | 5.5 | % | ||||||||||
Total interest expense | 1,452,129 | 1,425,059 | 27,070 | 1.9 | % | ||||||||||
NET INTEREST INCOME: | $ | 6,423,950 | $ | 6,564,692 | $ | (140,742 | ) | (2.1 | )% | ||||||
Net interest income decreased $140.7 million for the year ended December 31, 2017 compared to 2016. This decrease was primarily due to a decrease in interest income earned on loans and an increase in interest expense on borrowings due to higher borrowing rate.
Interest Income on Investment Securities and Interest-Earning Deposits
Interest income on investment securities and interest-earning deposits increased $120.3 million for the year ended December 31, 2017 compared to 2016. The average balance of investment securities and interest-earning deposits for the year ended December 31, 2017 was $26.3 billion with an average yield of 1.90%, compared to an average balance of $29.3 billion with an average yield of 1.29% for 2016. The increase in interest income on investment securities and interest-earning deposits for the year ended December 31, 2017 was primarily attributable to an increase of $35.1 million in interest income on investments HTM due to increased volume, and an increase of $67.8 million in interest income on investments AFS.
Interest Income on Loans
Interest income on loans decreased $234.0 million for the year ended December 31, 2017 compared to 2016, primarily due to declines in RIC rates, which comprised $272.9 million of the decrease. The average balance of total loans was $85.7 billion with an average yield of 8.61% for the year ended December 31, 2017, compared to $90.3 billion with an average yield of 8.43% for the year ended December 31, 2016. The decrease in the average balance of total loans of $4.6 billion was primarily due to a decline in the balance of the commercial loan portfolio. The average balance of commercial loans was $41.2 billion with an average yield of 3.71% for the year ended December 31, 2017, compared to $46.4 billion with an average yield of 3.34% for 2016.
Interest Expense on Deposits and Related Customer Accounts
Interest expense on deposits and related customer accounts decreased $36.0 million for the year ended December 31, 2017 compared to 2016, primarily due to a decrease in average interest-bearing deposits and interest rates. The average balance of total interest-bearing deposits was $48.0 billion with an average cost of 0.50% for the year ended December 31, 2017, compared to an average balance of $52.4 billion with an average cost of 0.53% for 2016.
Interest Expense on Borrowed Funds
Interest expense on borrowed funds increased $63.0 million for the year ended December 31, 2017 compared to 2016. The increase in interest expense on borrowed funds was due to interest paid at a higher rate 2017. The average balance of total borrowings was $42.2 billion with an average cost of 2.87% for 2017, compared to an average balance of $47.5 billion with an average cost of 2.42% for 2016. The average balance of borrowed funds decreased from December 31, 2016, to December 31, 2017, primarily due to a decrease in FHLB advances as a result of maturities and terminations. The increase in interest expense on borrowed funds was due to the Company issuing $5.5 billion of long-term debt at higher fixed rates in 2017 to increase liquidity and meet the Federal Reserve's TLAC requirement.
61
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
PROVISION FOR CREDIT LOSSES
The provision for credit losses is based on credit loss experience, growth or contraction of specific segments of the loan portfolio, and an estimate of losses inherent in the loan portfolio. The provision for credit losses for the year ended December 31, 2017 was $2.8 billion compared to $3.0 billion for the year ended December 31, 2016. This decrease was primarily due to decreases in the overall loan portfolio resulting in a decreased ALLL and a decline in originations, stabilizing credit performance for non-TDR loans, and recovery rates for the RIC and auto loan portfolio.
Year Ended December 31, | Year To Date Change | |||||||||||||
(in thousands) | 2017 | 2016 | Dollar | Percentage | ||||||||||
ALLL, beginning of period | $ | 3,814,464 | $ | 3,246,145 | $ | 568,319 | 17.5 | % | ||||||
Charge-offs: | ||||||||||||||
Commercial | (144,002 | ) | (245,399 | ) | 101,397 | (41.3 | )% | |||||||
Consumer | (4,891,383 | ) | (4,720,135 | ) | (171,248 | ) | 3.6 | % | ||||||
Total charge-offs | (5,035,385 | ) | (4,965,534 | ) | (69,851 | ) | 1.4 | % | ||||||
Recoveries: | ||||||||||||||
Commercial | 37,999 | 86,312 | (48,313 | ) | (56.0 | )% | ||||||||
Consumer | 2,401,614 | 2,442,921 | (41,307 | ) | (1.7 | )% | ||||||||
Total recoveries | 2,439,613 | 2,529,233 | (89,620 | ) | (3.5 | )% | ||||||||
Charge-offs, net of recoveries | (2,595,772 | ) | (2,436,301 | ) | (159,471 | ) | 6.5 | % | ||||||
Provision for loan and lease losses (1) | 2,770,556 | 3,004,620 | (234,064 | ) | (7.8 | )% | ||||||||
Other(2): | ||||||||||||||
Commercial | 356 | — | 356 | 100.0% | ||||||||||
Consumer | 5,283 | — | 5,283 | 100.0% | ||||||||||
ALLL, end of period | $ | 3,994,887 | $ | 3,814,464 | $ | 180,423 | 4.7 | % | ||||||
Reserve for unfunded lending commitments, beginning of period | $ | 122,418 | $ | 149,021 | $ | (26,603 | ) | (17.9 | )% | |||||
(Release)/provision for unfunded lending commitments (1) | (10,612 | ) | (24,895 | ) | 14,283 | (57.4 | )% | |||||||
(Gain)/loss on unfunded lending commitments | (2,695 | ) | (1,708 | ) | (987 | ) | 57.8 | % | ||||||
Reserve for unfunded lending commitments, end of period | 109,111 | 122,418 | (13,307 | ) | (10.9 | )% | ||||||||
Total ACL, end of period | $ | 4,103,998 | $ | 3,936,882 | $ | 167,116 | 4.2 | % | ||||||
(1) | The provision for credit losses in the Consolidated Statements of Operations is the sum of the total provision for loan and lease losses and provision for unfunded lending commitments. |
(2) | Includes transfers in for the period ending December 31, 2017 related to the contribution of SFS to SHUSA. |
The Company's net charge-offs increased $159.5 million for the year ended December 31, 2017 compared to 2016.
Consumer charge-offs increased $171.2 million for the year ended December 31, 2017 compared to 2016. This increase was due to a $153.7 million increase in consumer auto loan charge-offs, offset by an $8.5 million decrease in home mortgage charge-offs. Consumer recoveries decreased $41.3 million for the year ended December 31, 2017 compared to 2016. This decrease was comprised of a $38.4 million decrease in consumer auto loan recoveries and a $1.6 million decrease in other consumer loan recoveries. Consumer loan net charge-offs as a percentage of average consumer loans were 5.6% for the year ended December 31, 2017, compared to 5.2% for the year ended December 31, 2016.
Commercial charge-offs decreased $101.4 million for the year ended December 31, 2017 compared to 2016. This decrease was comprised of a $77.2 million decrease in Commercial Banking charge-offs, a $28.5 million decrease in commercial fleet charge-offs, and a $6.7 million decrease in Middle Market CRE charge-offs, offset by a $8.3 million increase in charge-offs for commercial loans in Puerto Rico. Commercial recoveries decreased $48.3 million for the year ended December 31, 2017 compared to 2016. This decrease was primarily due to a $12.7 million decrease in recoveries for Continuing Care Retirement Communities, a $10.9 million decrease in Corporate Banking recoveries, an $18.8 million decrease in commercial fleet recoveries, and a $4.6 million decrease in Middle Market CRE recoveries. Commercial loan net charge-offs as a percentage of average commercial loans, including multifamily loans, were 0.26% for the year ended December 31, 2017 compared to 0.34% for the year ended December 31, 2016.
62
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
NON-INTEREST INCOME
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar | Percentage | |||||||||||
Consumer fees | $ | 442,483 | $ | 499,591 | $ | (57,108 | ) | (11.4 | )% | ||||||
Commercial fees | 173,955 | 190,248 | (16,293 | ) | (8.6 | )% | |||||||||
Lease income | 2,017,775 | 1,839,307 | 178,468 | 9.7 | % | ||||||||||
Miscellaneous income, net | 269,484 | 169,056 | 100,428 | 59.4 | % | ||||||||||
Net (losses)/gain recognized in earnings | (2,444 | ) | 57,503 | (59,947 | ) | (104.3 | )% | ||||||||
Total non-interest income | $ | 2,901,253 | $ | 2,755,705 | $ | 145,548 | 5.3 | % | |||||||
Total non-interest income increased $145.5 million for the year ended December 31, 2017 compared to the 2016. The increase for the year ended December 31, 2017 was primarily due to the increase in lease income associated with the continued growth of the lease portfolio and increases in miscellaneous income. The increase was offset by decreases in consumer loan fees due to the reduction in loans serviced by the Company, as well as a decrease in net gains recognized in earnings.
Consumer Fees
Consumer fees decreased $57.1 million for the year ended December 31, 2017 compared to 2016. This decrease was primarily due to a decrease in loan fee income, which was attributable to a reduction in loans serviced by the Company due to loan sales and payoffs and lower reserve recourse releases in 2017. This was partially offset by an increase in consumer deposit fees for 2017.
Commercial Fees
Commercial fees consists of deposit overdraft fees, automated teller machine deposit fees, cash management fees, letter of credit fees, and loan syndication fees for commercial accounts. Commercial fees decreased primarily due to lower capital markets income.
Lease Income
Lease income increased $178.5 million for the year ended December 31, 2017, compared to 2016. This increase was the result of the growth in the Company's lease portfolio, with an average balance of $10.1 billion for 2017, compared to $9.1 billion for 2016.
Miscellaneous Income
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar increase/(decrease) | Percentage | |||||||||||
Mortgage banking income, net | $ | 56,659 | $ | 63,790 | $ | (7,131 | ) | (11.2 | )% | ||||||
BOLI | 66,784 | 57,796 | 8,988 | 15.6 | % | ||||||||||
Capital market revenue | 195,906 | 190,647 | 5,259 | 2.8 | % | ||||||||||
Net gain on sale of operating leases | 127,156 | 66,909 | 60,247 | 90.0 | % | ||||||||||
Asset and wealth management fees | 147,749 | 148,514 | (765 | ) | (0.5 | )% | |||||||||
Loss on sale of non-mortgage loans | (370,289 | ) | (399,312 | ) | 29,023 | 7.3 | % | ||||||||
Other miscellaneous income, net | 45,519 | 40,712 | 4,807 | 11.8 | % | ||||||||||
Total miscellaneous income/(loss) | $ | 269,484 | $ | 169,056 | $ | 100,428 | 59.4 | % | |||||||
Miscellaneous income decreased $100.4 million for the year ended December 31, 2017 compared to 2016. Factors contributing to this change were as follows:
• | An increase in the net gain on sale of operating leases of $60.2 million. |
• | A decrease in the loss on the sale of non-mortgage loans of $29.0 million. This was primarily driven by lower of cost or market adjustments on the Company's Bluestem personal loan portfolio, which was held for sale at December 31, 2017 and 2016. |
• | Net gain on sale of fixed assets increased by $30.2 million in 2017, primarily due to the Company selling and leasing back ten properties in 2017. |
63
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
GENERAL, ADMINISTRATIVE AND OTHER EXPENSES
Year Ended December 31, | YTD Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar | Percentage | |||||||||||
Compensation and benefits | $ | 1,895,326 | $ | 1,719,645 | $ | 175,681 | 10.2 | % | |||||||
Occupancy and equipment expenses | 669,113 | 618,597 | 50,516 | 8.2 | % | ||||||||||
Technology, outside services, and marketing expense | 581,164 | 644,079 | (62,915 | ) | (9.8 | )% | |||||||||
Loan expense | 386,468 | 415,267 | (28,799 | ) | (6.9 | )% | |||||||||
Lease expense | 1,553,096 | 1,305,712 | 247,384 | 18.9 | % | ||||||||||
Other expenses | 679,157 | 682,894 | (3,737 | ) | (0.5 | )% | |||||||||
Total general and administrative expenses | $ | 5,764,324 | $ | 5,386,194 | $ | 378,130 | 7.0 | % | |||||||
Total general, administrative and other expenses increased $378.1 million for the year ended December 31, 2017 compared to 2016. Factors contributing to this increase were as follows:
• | Compensation and benefits expense increased $175.7 million for the year ended December 31, 2017 compared to 2016. This increase was primarily the result of the Company's other compensation and benefits expense increase of $104.5 million, salary expense increase of $47.6 million and commission expense increase of 17.1 million for 2017 compared to 2016. |
• | Occupancy and equipment expenses increased $50.5 million for the year ended December 31, 2017 compared to 2016. This was primarily due to an increase in depreciation expense of $17.9 million for the 2017 compared to 2016. This increase was primarily a result of more assets being placed in service and an increase in depreciation for assets that were moved to held for sale and sold during the periods. Also, there were increases of $15.4 million in maintenance and repair expense and 6.8 million in impairment loss on building expense for the year ended 2017 compared to 2016. |
• | Technology services expense decreased $62.9 million for the year ended December 31, 2017 compared to 2016. This decrease was primarily due to a decrease in consulting services of $73.7 million related to regulatory initiatives, including preparation for meeting the requirements of the IHC during 2016. This was offset by an increase of $6.0 million for outside processing services and an increase of $6.8 million in marketing expenses related to direct mail, advertising and outside processing services. |
• | Loan expense decreased $28.8 million for the year ended December 31, 2017 compared to 2016. This decrease was primarily due to decreases of $21.6 million in loan collection expenses and $11.7 million in loan servicing expense. These decreases were offset by an increase in origination expense of $5.9 million for the year ended 2017 compared to 2016. |
• | Lease expense increased $247.4 million for the year ended December 31, 2017 compared to 2016. This increase was primarily due to the continued growth of the Company's leased vehicle portfolio and depreciation associated with that portfolio. |
• | Other expenses decreased $3.7 million for the year ended December 31, 2017 compared to 2016. This decrease was primarily attributable to a decrease of $83.9 million in losses on debt extinguishment for 2017 compared to 2016, offset by an increase in legal reserve expense of $79.7 million for 2017 compared to 2016. During 2017, the Company increased its legal reserves for certain matters discussed in Note 19 to the Consolidated Financial Statements. |
INCOME TAX PROVISION
An income tax benefit of $157.0 million was recorded for the year ended December 31, 2017, compared to an income tax provision of $313.7 million for 2016. This resulted in an ETR of (19.6)% for the year ended December 31, 2017, compared to 32.9% for 2016.
On December 22, 2017, the TCJA was enacted. Effective January 1, 2018, the TCJA, among other things, reduced the federal corporate income tax rate from 35% to 21%. As a result of the TCJA's enactment, GAAP required that companies re-measure their deferred tax balances as of the enactment of the legislation. During the fourth quarter of 2017, we reduced our income tax provision by $427.3 million as a result of re-measuring our deferred tax liabilities due to the federal rate reduction. The rate reduction is expected to have a positive impact to future earnings.
The Company's ETR in future periods will be affected by the results of operations allocated to the various tax jurisdictions in which the Company operates, any change in income tax laws or regulations within those jurisdictions, and interpretations of income tax regulations that differ from the Company's interpretations by tax authorities that examine tax returns filed by the Company or any of its subsidiaries.
64
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
LINE OF BUSINESS RESULTS
General
The Company's segments at December 31, 2017 consisted of Consumer and Business Banking, Commercial Banking, CRE, CIB, and SC. For additional information with respect to the Company's reporting segments, see Note 23 to the Consolidated Financial Statements.
Results Summary
Consumer and Business Banking
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 1,115,169 | $ | 981,951 | $ | 133,218 | 13.6 | % | |||||||
Total non-interest income | 356,936 | 384,210 | (27,274 | ) | (7.1 | )% | |||||||||
Provision for credit losses | 85,115 | 56,446 | 28,669 | 50.8 | % | ||||||||||
Total expenses | 1,500,815 | 1,511,427 | (10,612 | ) | (0.7 | )% | |||||||||
Loss before income taxes | (113,825 | ) | (201,712 | ) | 87,887 | 43.6 | % | ||||||||
Intersegment revenue | 2,330 | 42,168 | (39,838 | ) | (94.5 | )% | |||||||||
Total assets | 18,714,285 | 18,131,643 | 582,642 | 3.2 | % | ||||||||||
Consumer and Business Banking reported a loss before income taxes of $113.8 million for the year ended December 31, 2017 compared to a loss before income taxes of $201.7 million for 2016. Factors contributing to this change were:
• | Net interest income increased $133.2 million for the year ended December 31, 2017 compared to 2016. This increase was primarily driven by deposit product margin where, despite rising interest rates, costs have been managed down. |
• | The provision for credit losses increased by $28.7 million for the year ended December 31, 2017 compared to 2016, driven by the absence of reserve releases in 2017 for home equity loans and increased delinquency in the credit cards and personal loan portfolios. |
Commercial Banking
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 630,078 | $ | 638,001 | $ | (7,923 | ) | (1.2 | )% | ||||||
Total non-interest income | 70,219 | 87,144 | (16,925 | ) | (19.4 | )% | |||||||||
Provision for credit losses | 29,586 | 85,910 | (56,324 | ) | (65.6 | )% | |||||||||
Total expenses | 324,385 | 318,400 | 5,985 | 1.9 | % | ||||||||||
Income before income taxes | 346,326 | 320,835 | 25,491 | 7.9 | % | ||||||||||
Intersegment revenue | 6,137 | 28,464 | (22,327 | ) | (78.4 | )% | |||||||||
Total assets | 25,318,068 | 26,590,079 | (1,272,011 | ) | (4.8 | )% | |||||||||
Commercial Banking reported income before income taxes of $346.3 million for the year ended December 31, 2017, compared to income before income taxes of $320.8 million for 2016. Factors contributing to this change were:
• | The provision for credit losses decreased $56.3 million for the year ended December 31, 2017 compared to 2016, primarily driven by reserves for the energy finance business line. The decrease in provision for 2017 was due to increased provisions required for the energy finance portfolio in 2016 that did not recur in 2017 and one large, previously unreserved charge-off that occurred in 2016 in the Middle Market portfolio. |
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CIB
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 153,622 | $ | 239,074 | $ | (85,452 | ) | (35.7 | )% | ||||||
Total non-interest income | 186,749 | 241,992 | (55,243 | ) | (22.8 | )% | |||||||||
Provision for credit losses | 33,275 | 7,952 | 25,323 | 318.4 | % | ||||||||||
Total expenses | 218,696 | 228,999 | (10,303 | ) | (4.5 | )% | |||||||||
Income before income taxes | 88,400 | 244,115 | (155,715 | ) | (63.8 | )% | |||||||||
Intersegment expense | (8,086 | ) | (1,728 | ) | (6,358 | ) | (367.9 | )% | |||||||
Total assets | 6,949,373 | 10,600,872 | (3,651,499 | ) | (34.4 | )% | |||||||||
CIB reported income before income taxes of $88.4 million for the year ended December 31, 2017, compared to income before income taxes of $244.1 million for 2016. Factors contributing to this change were:
• | Net interest income decreased $85.5 million for 2017 compared to 2016. The average balance of this segment's gross loans were $6.0 billion for 2017 compared to $9.3 billion for 2016. The decrease in loan balances was attributable to the strategic goal of building a less capital-intensive U.S. franchise, which was attained by exiting less profitable relationships across all sectors, and by pro-actively reducing exposures related to the commodities and oil and gas sectors. |
• | Total non-interest income decreased $55.2 million for the 2017 compared to 2016. |
• | The provision for credit losses increased $25.3 million for 2017 compared to 2016. The increase was due to higher reserves required for oil and gas clients and higher reserves on a renewable energy investment that was substantially damaged by Hurricane Maria in 2017. |
Other
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 255,096 | $ | 51,736 | $ | 203,360 | 393.1 | % | |||||||
Total non-interest income | 548,806 | 622,145 | (73,339 | ) | (11.8 | )% | |||||||||
Provision for credit losses | 93,165 | 52,490 | 40,675 | 77.5 | % | ||||||||||
Total expenses | 955,292 | 1,065,027 | (109,735 | ) | (10.3 | )% | |||||||||
Loss before income taxes | (244,555 | ) | (443,636 | ) | 199,081 | 44.9 | % | ||||||||
Intersegment revenue | (381 | ) | (68,904 | ) | 68,523 | 99.4 | % | ||||||||
Total assets | 37,890,000 | 44,498,592 | (6,608,592 | ) | (14.9 | )% | |||||||||
The Other category reported a loss before income taxes of $244.6 million for the year ended December 31, 2017, compared to a loss before income taxes of $443.6 million for 2016. Factors contributing to this change were:
• | Net interest income increased $203.4 million for 2017 compared to 2016. |
• | Total non-interest income decreased $73.3 million for 2017 compared 2016. |
• | The provision for credit losses increased $40.7 million for 2017 compared to 2016. |
• | Total expenses decreased $109.7 million for 2017 compared to 2016. |
SC
Year Ended December 31, | Year To Date Change | ||||||||||||||
(dollars in thousands) | 2017 | 2016 | Dollar increase/(decrease) | Percentage | |||||||||||
Net interest income | $ | 4,114,600 | $ | 4,448,535 | $ | (333,935 | ) | (7.5 | )% | ||||||
Total non-interest income | 1,793,408 | 1,432,634 | 360,774 | 25.2 | % | ||||||||||
Provision for credit losses | 2,363,812 | 2,468,199 | (104,387 | ) | (4.2 | )% | |||||||||
Total expenses | 2,740,190 | 2,252,259 | 487,931 | 21.7 | % | ||||||||||
Income before income taxes | 804,006 | 1,160,711 | (356,705 | ) | (30.7 | )% | |||||||||
Total assets | 39,402,799 | 38,539,104 | 863,695 | 2.2 | % | ||||||||||
SC reported income before income taxes of $804.0 million for the year ended December 31, 2017 compared to income before income taxes of $1.2 billion for 2016. Factors contributing to this change were:
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
• | Total non-interest income increased $360.8 million for 2017 compared to 2016, due to the continued growth in the operating lease vehicle portfolio since SC launched Chrysler Capital in 2013. |
• | Total expenses increased $487.9 million for 2017 compared to 2016, primarily due to the continued growth in the operating lease vehicle portfolio since SC launched Chrysler Capital in 2013. |
FINANCIAL CONDITION
LOAN PORTFOLIO
The Company's loans held for investment ("LHFI") portfolio consisted of the following at the dates indicated:
December 31, 2018 | December 31, 2017 | December 31, 2016 | December 31, 2015 | December 31, 2014 | |||||||||||||||||||||||||||||||
(dollars in thousands) | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | Amount | Percent | |||||||||||||||||||||||||
Commercial LHFI: | |||||||||||||||||||||||||||||||||||
CRE | $ | 8,704,481 | 10.0 | % | $ | 9,279,225 | 11.5 | % | $ | 10,112,043 | 11.8 | % | $ | 9,846,236 | 11.3 | % | $ | 9,741,442 | 11.6 | % | |||||||||||||||
Commercial & Industrial ("C&I") | 15,738,158 | 18.1 | % | 14,438,311 | 17.9 | % | 18,812,002 | 21.9 | % | 20,908,107 | 24.0 | % | 18,453,165 | 22.1 | % | ||||||||||||||||||||
Multifamily | 8,309,115 | 9.5 | % | 8,274,435 | 10.1 | % | 8,683,680 | 10.1 | % | 9,438,463 | 10.8 | % | 8,705,890 | 10.4 | % | ||||||||||||||||||||
Other commercial | 7,630,004 | 8.8 | % | 7,174,739 | 8.9 | % | 6,832,403 | 8.0 | % | 6,257,072 | 7.2 | % | 5,539,848 | 6.6 | % | ||||||||||||||||||||
Total commercial loans (1) | 40,381,758 | 46.4 | % | 39,166,710 | 48.4 | % | 44,440,128 | 51.8 | % | 46,449,878 | 53.3 | % | 42,440,345 | 50.7 | % | ||||||||||||||||||||
Consumer loans secured by real estate: | |||||||||||||||||||||||||||||||||||
Residential mortgages | 9,884,462 | 11.4 | % | 8,846,765 | 11.0 | % | 7,775,272 | 9.1 | % | 7,566,301 | 8.7 | % | 8,190,461 | 9.8 | % | ||||||||||||||||||||
Home equity loans and lines of credit | 5,465,670 | 6.3 | % | 5,907,733 | 7.3 | % | 6,001,192 | 7.1 | % | 6,151,232 | 7.1 | % | 6,211,298 | 7.4 | % | ||||||||||||||||||||
Total consumer loans secured by real estate | 15,350,132 | 17.7 | % | 14,754,498 | 18.3 | % | 13,776,464 | 16.2 | % | 13,717,533 | 15.8 | % | 14,401,759 | 17.2 | % | ||||||||||||||||||||
Consumer loans not secured by real estate: | |||||||||||||||||||||||||||||||||||
RICs and auto loans - originated | 28,532,085 | 32.8 | % | 23,131,253 | 28.6 | % | 22,104,918 | 25.8 | % | 18,539,588 | 21.3 | % | 9,935,503 | 11.9 | % | ||||||||||||||||||||
RICs and auto loans - purchased | 803,135 | 0.9 | % | 1,834,868 | 2.3 | % | 3,468,803 | 4.0 | % | 6,108,210 | 7.0 | % | 12,449,526 | 14.8 | % | ||||||||||||||||||||
Total RICs and auto loans | 29,335,220 | 33.7 | % | 24,966,121 | 30.9 | % | 25,573,721 | 29.8 | % | 24,647,798 | 28.3 | % | 22,385,029 | 26.7 | % | ||||||||||||||||||||
Personal unsecured loans | 1,531,708 | 1.8 | % | 1,285,677 | 1.6 | % | 1,234,094 | 1.4 | % | 1,177,998 | 1.4 | % | 3,205,847 | 3.8 | % | ||||||||||||||||||||
Other consumer | 447,050 | 0.4 | % | 617,675 | 0.8 | % | 795,378 | 0.8 | % | 1,032,579 | 1.2 | % | 1,306,562 | 1.6 | % | ||||||||||||||||||||
Total consumer loans | 46,664,110 | 53.6 | % | 41,623,971 | 51.6 | % | 41,379,657 | 48.2 | % | 40,575,908 | 46.7 | % | 41,299,197 | 49.3 | % | ||||||||||||||||||||
Total LHFI | $ | 87,045,868 | 100.0 | % | $ | 80,790,681 | 100.0 | % | $ | 85,819,785 | 100.0 | % | $ | 87,025,786 | 100.0 | % | $ | 83,739,542 | 100.0 | % | |||||||||||||||
Total LHFI with: | |||||||||||||||||||||||||||||||||||
Fixed | $ | 56,696,491 | 65.1 | % | $ | 50,703,619 | 62.8 | % | $ | 51,752,761 | 60.3 | % | $ | 52,283,715 | 60.1 | % | $ | 50,237,181 | 60.0 | % | |||||||||||||||
Variable | 30,349,377 | 34.9 | % | 30,087,062 | 37.2 | % | 34,067,024 | 39.7 | % | 34,742,071 | 39.9 | % | 33,502,361 | 40.0 | % | ||||||||||||||||||||
Total LHFI | $ | 87,045,868 | 100.0 | % | $ | 80,790,681 | 100.0 | % | $ | 85,819,785 | 100.0 | % | $ | 87,025,786 | 100.0 | % | $ | 83,739,542 | 100.0 | % | |||||||||||||||
(1) As of December 31, 2018, the Company had $311.2 million of commercial loans that were denominated in a currency other than the U.S. dollar.
Commercial
Commercial loans increased approximately $1.2 billion, or 3.1%, from December 31, 2017 to December 31, 2018. This increase was comprised of an increase in C&I loans of $1.3 billion and an increase in other commercial loans of $455.3 million, partially offset by a decrease in CRE loans of $574.7 million, as the Company switches its focus from CRE loans to place emphasis on core commercial business.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
At December 31, 2018, Maturing | ||||||||||||||||
(in thousands) | In One Year Or Less | One to Five Years | After Five Years | Total | ||||||||||||
CRE loans | $ | 1,990,492 | $ | 5,138,756 | $ | 1,575,233 | $ | 8,704,481 | ||||||||
C&I and other commercial | 9,160,940 | 12,378,300 | 1,828,922 | 23,368,162 | ||||||||||||
Multifamily loans | 628,484 | 6,070,818 | 1,609,813 | 8,309,115 | ||||||||||||
Total | $ | 11,779,916 | $ | 23,587,874 | $ | 5,013,968 | $ | 40,381,758 | ||||||||
Loans with: | ||||||||||||||||
Fixed rates | $ | 3,345,400 | $ | 11,808,260 | $ | 2,538,189 | $ | 17,691,849 | ||||||||
Variable rates | 8,434,516 | 11,779,614 | 2,475,779 | 22,689,909 | ||||||||||||
Total | $ | 11,779,916 | $ | 23,587,874 | $ | 5,013,968 | $ | 40,381,758 | ||||||||
Consumer Loans Secured By Real Estate
Consumer loans secured by real estate increased $595.6 million, or 4.0%, from December 31, 2017 to December 31, 2018. This increase was comprised of an increase in the residential mortgage portfolio of $1.0 billion due to an increase in new loan originations, offset by a decrease in the home equity loans and lines of credit portfolio of $442.1 million.
Consumer Loans Not Secured By Real Estate
RICs and auto loans
RICs and auto loans increased $4.4 billion, or 17.5%, from December 31, 2017 to December 31, 2018. The increase in the RIC and auto loan portfolio was primarily due to an increase of $5.4 billion in originations, net of securitizations, which was partially offset by a $1.0 billion decrease in the RIC and auto loan portfolio-purchased. This decrease in the RIC and auto loan portfolio-purchased was due to run-off of the portfolio from normal paydown and chargeoff activity. RICs are collateralized by vehicle titles, and the lender has the right to repossess the vehicle in the event the consumer defaults on the payment terms of the contract. Most of the Company's RICs HFI are pledged against warehouse lines or securitization bonds. Refer to further discussion of those in Note 11.
As of December 31, 2018, 79.1% (excluding purchase accounting) of the Company's RIC and auto loan portfolio was comprised of nonprime loans (defined by the Company as customers with a Fair Isaac Corporation ("FICO®) score of below 640) with customers who did not qualify for conventional consumer finance products as a result of, among other things, a lack of or adverse credit history, low income levels and/or the inability to provide adequate downpayments. While underwriting guidelines were designed to establish that the customer would be a reasonable credit risk, nonprime loans will nonetheless experience higher default rates than a portfolio of obligations of prime customers. Additionally, higher unemployment rates, higher gasoline prices, unstable real estate values, re-sets of adjustable rate mortgages to higher interest rates, the general availability of consumer credit, and other factors that impact consumer confidence or disposable income could lead to an increase in delinquencies, defaults, and repossessions, as well as decrease consumer demand for used automobiles and other consumer products, weaken collateral values and increase losses in the event of default. Because SC's historical focus for such credit has been predominantly on nonprime consumers, the actual rates of delinquencies, defaults, repossessions, and losses on these loans could be more dramatically affected by a general economic downturn.
The Company's automated originations process for these credits reflects a disciplined approach to credit risk management to mitigate the risks of nonprime customers. The Company's robust historical data on both organically originated and acquired loans provides it with the ability to perform advanced loss forecasting. Each applicant is automatically assigned a proprietary custom score using information such as FICO scores, debt-to-income ("DTI") ratios, loan-to-value ("LTV") ratios, and over 30 other predictive factors, placing the applicant in one of 100 pricing tiers. The pricing in each tier is continuously monitored and adjusted to reflect market and risk trends. In addition to the Company's automated process, it maintains a team of underwriters for manual review, consideration of exceptions, and review of deal structures with dealers.
At December 31, 2018, a typical RIC was originated with an average annual percentage rate of 17.3% and was purchased from the dealer at a discount of 0.2%. All of the Company's RICs and auto loans are fixed-rate loans.
Nonprime loans have a higher inherent risk of loss than prime loans. The Company records an ALLL to cover its estimate of inherent losses on its RICs incurred as of the balance sheet date.
Personal unsecured and other consumer loans
Personal unsecured and other consumer loans decreased from December 31, 2017 to December 31, 2018, by $75.4 million.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
As a result of the strategic evaluation of SC's personal lending portfolio, in the third quarter of 2015, SC began reviewing strategic alternatives for exiting its personal loan portfolios. SC's other significant personal lending relationship is with Bluestem. SC continues to perform in accordance with the terms and operative provisions of the agreements under which it is obligated to purchase personal revolving loans originated by Bluestem for a term ending in 2020, or 2022 if extended at Bluestem's option. The Bluestem loan portfolio is carried as held for sale in our Consolidated Financial Statements. Accordingly, the Company has recorded lower-of-cost-or-market adjustments on this portfolio, and there may be further such adjustments required in future periods' financial statements. Management is currently evaluating alternatives for the Bluestem portfolio. As of December 31, 2018, SC's personal unsecured portfolio was held for sale and thus does not have a related allowance.
CREDIT RISK MANAGEMENT
Extending credit to customers exposes the Company to credit risk, which is the risk that contractual principal and interest due on loans will not be collected due to the inability or unwillingness of the borrower to repay the loan. The Company manages credit risk in its loan portfolio through adherence to consistent standards, guidelines, and limitations established by the Company’s Board of Directors as set forth in its Board-approved Risk Appetite Statement. Written loan policies establish further implement these underwriting standards, lending limits, and other standards or limits deemed necessary and prudent. Various approval levels based on the amount of the loan and other key credit attributes have also been created. To ensure credit quality, loans are originated in accordance with the Company’s credit and governance standards consistent with its Enterprise Risk Management Framework. Loans over certain dollar thresholds require approval by the Company's credit committees, with higher balance loans requiring approval by more senior level committees.
The Credit Risk Review group conducts ongoing independent reviews of the credit quality of the Company’s loan portfolios and credit management processes to ensure the accuracy of the risk ratings, adherence to established policies and procedures, verify compliance with applicable laws and regulations, provide objective measurement of the risk inherent in the loan portfolio, and ensure that proper documentation exists. The results of these periodic reviews are reported to business line management, Risk Management and the Audit Committee of both the Company and the Bank. The Company maintains a classification system for loans that identifies those requiring a higher level of monitoring by management because of one or more factors, including borrower performance, business conditions, industry trends, the liquidity and value of the collateral, economic conditions, or other factors. Loan credit quality is subject to scrutiny by business unit management, credit risk professionals, and Internal Audit.
The following discussion summarizes the underwriting policies and procedures for the major categories within the loan portfolio and addresses SHUSA’s strategies for managing the related credit risk. Additional credit risk management related considerations are discussed further in the "ALLL" section of this MD&A.
Commercial Loans
Commercial loans principally represent commercial real estate loans (including multifamily loans), loans to C&I customers, and automotive dealer floor plan loans. Credit risk associated with commercial loans is primarily influenced by prevailing and expected economic conditions and the level of underwriting risk SHUSA is willing to assume. To manage credit risk when extending commercial credit, the Company focuses on assessing the borrower’s capacity and willingness to repay and obtaining sufficient collateral. C&I loans are generally secured by the borrower’s assets and by personal guarantees. Commercial real estate loans are originated primarily within the Mid-Atlantic, New York, and New England market areas and are secured by real estate at specified LTV ratios and often by a guarantee of the borrower.
Consumer Loans Secured by Real Estate
Credit risk in the direct and indirect consumer loan portfolio is controlled by strict adherence to underwriting standards that consider DTI levels, the creditworthiness of the borrower, and collateral values. In the home equity loan portfolio, combined LTV ("CLTV") ratios are generally limited to 90% for both first and second liens. SHUSA originates and purchases fixed-rate and adjustable rate
residential mortgage loans that are secured by the underlying 1-4 family residential properties. Credit risk exposure in this area of lending is minimized by the evaluation of the creditworthiness of the borrower, including debt-to-equity ratios, credit scores, and adherence to underwriting policies that emphasize conservative LTV ratios of generally no more than 80%. Residential mortgage loans originated or purchased in excess of an 80% LTV ratio are generally insured by private mortgage insurance, unless otherwise guaranteed or insured by the Federal, state, or local government. SHUSA also utilizes underwriting standards which comply with those of the Federal Home Loan Mortgage Corporation (the “FHLMC") or the Federal National Mortgage Association (the “FNMA").
Credit risk is further reduced, since a portion of the Company’s mortgage loan production is sold to investors in the secondary market without recourse.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Consumer Loans Not Secured by Real Estate
The Company’s consumer loans not secured by real estate include RICs acquired from manufacturer-franchised dealers in connection with their sale of used and new automobiles and trucks, as well as acquired consumer marine, RV and credit card loans. Credit risk is mitigated to the extent possible through early and robust collection practices, which includes the repossession of vehicles.
Collections
The Company closely monitors delinquencies as another means of maintaining high asset quality. Collection efforts generally begin within 15 days after a loan payment is missed by attempting to contact all borrowers and offer a variety of loss mitigation alternatives. If these attempts fail, the Company will attempt to gain control of collateral in a timely manner in order to minimize losses. While liquidation and recovery efforts continue, officers continue to work with the borrowers, if appropriate, to recover all money owed to the Company. The Company monitors delinquency trends at 30, 60, and 90 days past due. These trends are discussed at monthly management Credit Risk Review Committee meetings and at the Company's and the Bank's Board of Directors' meetings.
NON-PERFORMING ASSETS
The following table presents the composition of non-performing assets at the dates indicated:
Period Ended | Change | ||||||||||||||
(dollars in thousands) | December 31, 2018 | December 31, 2017 | Dollar | Percentage | |||||||||||
Non-accrual loans: | |||||||||||||||
Commercial: | |||||||||||||||
CRE | $ | 88,500 | $ | 139,236 | $ | (50,736 | ) | (36.4 | )% | ||||||
C&I loans | 189,827 | 230,481 | (40,654 | ) | (17.6 | )% | |||||||||
Multifamily | 13,530 | 11,348 | 2,182 | 19.2 | % | ||||||||||
Other commercial | 72,841 | 83,468 | (10,627 | ) | (12.7 | )% | |||||||||
Total commercial loans | 364,698 | 464,533 | (99,835 | ) | (21.5 | )% | |||||||||
Consumer loans secured by real estate: | |||||||||||||||
Residential mortgages | 216,815 | 265,436 | (48,621 | ) | (18.3 | )% | |||||||||
Home equity loans and lines of credit | 115,813 | 134,162 | (18,349 | ) | (13.7 | )% | |||||||||
Consumer loans not secured by real estate: | |||||||||||||||
RICs and auto loans - originated | 1,455,406 | 1,257,122 | 198,284 | 15.8 | % | ||||||||||
RICs - purchased | 89,916 | 256,617 | (166,701 | ) | (65.0 | )% | |||||||||
Total RICs and Auto loans | 1,545,322 | 1,513,739 | 31,583 | 2.1 | % | ||||||||||
Personal unsecured loans | 3,602 | 2,366 | 1,236 | 52.2 | % | ||||||||||
Other consumer | 9,187 | 10,657 | (1,470 | ) | (13.8 | )% | |||||||||
Total consumer loans | 1,890,739 | 1,926,360 | (35,621 | ) | (1.8 | )% | |||||||||
Total non-accrual loans | 2,255,437 | 2,390,893 | (135,456 | ) | (5.7 | )% | |||||||||
Other real estate owned | 107,868 | 130,777 | (22,909 | ) | (17.5 | )% | |||||||||
Repossessed vehicles | 224,046 | 210,692 | 13,354 | 6.3 | % | ||||||||||
Other repossessed assets | 1,844 | 2,190 | (346 | ) | (15.8 | )% | |||||||||
Total other real estate owned ("OREO") and other repossessed assets | 333,758 | 343,659 | (9,901 | ) | (2.9 | )% | |||||||||
Total non-performing assets | $ | 2,589,195 | $ | 2,734,552 | $ | (145,357 | ) | (5.3 | )% | ||||||
Past due 90 days or more as to interest or principal and accruing interest | $ | 98,979 | $ | 96,461 | $ | 2,518 | 2.6% | ||||||||
Annualized net loan charge-offs to average loans (1) | 2.9 | % | 3.0 | % | n/a | n/a | |||||||||
Non-performing assets as a percentage of total assets | 1.9 | % | 2.1 | % | n/a | n/a | |||||||||
NPLs as a percentage of total loans | 2.6 | % | 2.9 | % | n/a | n/a | |||||||||
ALLL as a percentage of total NPLs | 172.8 | % | 167.1 | % | n/a | n/a | |||||||||
Potential problem loans are loans not currently classified as NPLs for which management has doubts about the borrowers’ ability to comply with the present repayment terms. These assets are principally loans delinquent more than 30 days but less than 90 days. Potential problem commercial loans totaled approximately $98.8 million and $112.3 million at December 31, 2018 and December 31, 2017, respectively. Potential problem consumer loans amounted to $4.7 billion and $4.4 billion at December 31, 2018 and December 31, 2017, respectively. Management has included these loans in its evaluation and reserved for them during the respective periods.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Non-performing assets decreased to $2.6 billion, or 1.9% of total assets, at December 31, 2018, compared to $2.7 billion, or 2.1% of total assets, at December 31, 2017, primarily attributable to a decrease in NPLs in the CRE, C&I and Mortgage portfolios.
General
Non-performing assets consist of NPLs, which represent loans and leases no longer accruing interest, OREO properties, and other repossessed assets. When interest accruals are suspended, accrued but uncollected interest income is reversed, with accruals charged against earnings. The Company generally places all commercial loans and consumer loans secured by real estate on non-performing status at 90 days past due for interest, principal or maturity, or earlier if it is determined that the collection of principal or interest on the loan is in doubt. RICs are classified as non-performing (or non-accrual) when they are greater than 60 days past due as to contractual principal or interest payments. Personal unsecured loans, including credit cards, generally continue to accrue interest until they are 180 days delinquent, at which point they are charged-off and all accrued but uncollected interest is removed from interest income.
In general, when the borrower's ability to make required interest and principal payments has resumed and collectability is no longer believed to be in doubt, the loan or lease is returned to accrual status. Generally, commercial loans categorized as non-performing remain in non-performing status until the payment status is current and an event occurs that fully remediates the impairment or the loan demonstrates a sustained period of performance without a past due event, and there is reasonable assurance as to the collectability of all amounts due. Within the residential mortgage and home equity portfolios, accrual status is generally systematically driven, so that if the customer makes a payment that brings the loan below 90 days past due, the loan automatically returns to accrual status.
Commercial
Commercial NPLs decreased $99.8 million from December 31, 2017 to December 31, 2018. Commercial NPLs accounted for 0.9% and 1.2% of commercial LHFI at December 31, 2018 and December 31, 2017, respectively. The decrease in commercial NPLs was comprised of a $40.7 million decrease in C&I NPLs, a $50.7 million decrease in the CRE portfolio, and a $10.6 million decrease in the Other commercial portfolio, partially offset by a $2.2 million increase in the Multifamily portfolio.
Consumer Loans Not Secured by Real Estate
RICs and amortizing personal loans are classified as non-performing when they are greater than 60 days past due (i.e., 61 or more days past due) with respect to principal or interest. Except for loans accounted for using the FVO, at the time a loan is placed on non-performing status, previously accrued and uncollected interest is reversed against interest income. When an account is 60 days or less past due, it is returned to performing status and the Company returns to accruing interest on the loan. The accrual of interest on revolving personal loans continues until the loan is charged off.
RIC TDRs are placed on non-accrual status when the account becomes past due more than 60 days. For loans on non-accrual status, interest income is recognized on a cash basis; however, the Company continues to assess the recognition of cash received on those loans in order to identify whether certain of the loans should also be placed on a cost recovery basis. For loans on non-accrual status, the accrual of interest is resumed if a delinquent account subsequently becomes 60 days or less past due. However, for TDR loans placed on cost recovery basis, the Company returns to accrual status when a sustained period of repayment performance has been achieved. NPLs in the RIC and auto loan portfolio increased $31.6 million from December 31, 2017 to December 31, 2018. At December 31, 2018, non-performing RICs and auto loans accounted for 5.3% of total RIC and auto LHFI, compared to 6.1% of total RICs and auto loans at December 31, 2017.
NPLs in the personal unsecured and other consumer loan portfolio decreased $0.2 million from December 31, 2017 to December 31, 2018. At December 31, 2018 and December 31, 2017, non-performing personal unsecured and other consumer loans accounted for 0.6% of total unsecured and other consumer loans, respectively.
Consumer Loans Secured by Real Estate
The following table shows NPLs compared to total loans outstanding for the residential mortgage and home equity portfolios as of December 31, 2018 and December 31, 2017, respectively:
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
December 31, 2018 | December 31, 2017 | |||||||||||||||
(dollars in thousands) | Residential mortgages | Home equity loans and lines of credit | Residential mortgages | Home equity loans and lines of credit | ||||||||||||
NPLs | $ | 216,815 | $ | 115,813 | $ | 265,436 | $ | 134,162 | ||||||||
Total LHFI | 9,884,462 | 5,465,670 | 8,846,765 | 5,907,733 | ||||||||||||
NPLs as a percentage of total LHFI | 2.2 | % | 2.1 | % | 3.0 | % | 2.3 | % | ||||||||
NPLs in foreclosure status | 43.3 | % | 56.7 | % | 48.8 | % | 52.2 | % | ||||||||
The NPL ratio is higher for the Company's residential mortgage loan portfolio compared to its consumer loans secured by real estate portfolio due to a number of factors, including the prolonged workout and foreclosure resolution processes for residential mortgage loans, differences in risk profiles, and mortgage loans located outside the Northeast and Mid-Atlantic United States.
Delinquencies
The Company generally considers an account delinquent when an obligor fails to pay substantially all (defined as 90%) of the scheduled payment by the due date.
At December 31, 2018 and December 31, 2017, the Company's delinquencies consisted of the following:
December 31, 2018 | December 31, 2017 | |||||||||||
(dollars in thousands) | Consumer Loans Secured by Real Estate | RICs and auto loans | Personal Unsecured and Other Consumer Loans | Commercial Loans | Total | Consumer Loans Secured by Real Estate | RICs and auto loans | Personal Unsecured and Other Consumer Loans | Commercial Loans | Total | ||
Total delinquencies | $495,854 | $4,760,361 | $226,181 | $232,264 | $5,714,660 | $571,229 | $4,452,075 | $229,547 | $295,138 | $5,547,989 | ||
Total loans(1) | $15,564,653 | $29,335,220 | $3,047,515 | $40,381,758 | $88,329,146 | $14,964,668 | $26,067,169 | $2,965,442 | $39,315,888 | $83,313,167 | ||
Delinquencies as a % of loans | 3.2% | 16.2% | 7.4% | 0.6% | 6.5% | 3.8% | 17.1% | 7.7% | 0.8% | 6.7% | ||
(1) | Includes LHFS. |
Overall, total delinquencies increased by $166.7 million, or 3.0%, from December 31, 2017 to December 31, 2018 primarily driven by RIC and auto loans, which increased $308.3 million. This was offset by a decrease in consumer loans secured by real estate, of $75.4 million, a decrease in commercial loans of $62.9 million and personal unsecured and other consumer loans, which decreased $3.4 million. Delinquencies may vary from period to period based upon the average age or seasoning of the portfolio, seasonality within the calendar year, and economic factors. Historically, RIC and auto loan delinquencies have been highest in the period from November through January due to consumers’ holiday spending.
TDRs
TDRs are loans that have been modified as the Company has agreed to make certain concessions to both meet the needs of the customers and maximize its ultimate recovery on the loans. TDRs occur when a borrower is experiencing, or is expected to experience, financial difficulties and the loan is modified with terms that would otherwise not be granted to the borrower. The types of concessions granted are generally interest rate reductions, limitations on accrued interest charged, term extensions, and deferments of principal.
TDRs are generally placed in nonaccrual status upon modification, unless the loan was performing immediately prior to modification. For most portfolios, TDRs may return to accrual status after demonstrating at least six consecutive months of sustained payments following modification, as long as the Company believes the principal and interest of the restructured loan will be paid in full. RIC TDRs are placed on nonaccrual status when the Company believes repayment under the revised terms is not reasonably assured, and considered for return to accrual when a sustained period of repayment performance has been achieved. To the extent the TDR is determined to be collateral-dependent and the source of repayment depends on the operation of the collateral, the loan may be returned to accrual status based on the foregoing parameters. To the extent the TDR is determined to be collateral-dependent and the source of repayment depends on disposal of the collateral, the loan may not be returned to accrual status.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following table summarizes TDRs at the dates indicated:
As of December 31, 2018 | ||||||||||||||||||||||||||||
(in thousands) | Commercial | % | Consumer Loans Secured by Real Estate | % | RICs and Auto Loans | % | Other Consumer | % | Total TDRs | |||||||||||||||||||
Performing | $ | 78,744 | 42.4 | % | $ | 262,449 | 72.3 | % | $ | 4,587,081 | 87.3 | % | $ | 85,950 | 70.6 | % | $ | 5,014,224 | ||||||||||
Non-performing | 107,024 | 57.6 | % | 100,543 | 27.7 | % | 664,688 | 12.7 | % | 35,873 | 29.4 | % | 908,128 | |||||||||||||||
Total | $ | 185,768 | 100.0 | % | $ | 362,992 | 100.0 | % | $ | 5,251,769 | 100.0 | % | $ | 121,823 | 100.0 | % | $ | 5,922,352 | ||||||||||
% of loan portfolio | 0.5 | % | n/a | 2.3 | % | n/a | 17.9 | % | n/a | 4.0 | % | n/a | 6.7 | % | ||||||||||||||
(1) Excludes LHFS | ||||||||||||||||||||||||||||
As of December 31, 2017 | ||||||||||||||||||||||||||||
(in thousands) | Commercial | % | Consumer Loans Secured by Real Estate | % | RICs and Auto Loans | % | Other Consumer | % | Total TDRs | |||||||||||||||||||
Performing | $ | 146,808 | 54.4 | % | $ | 292,634 | 70.8 | % | $ | 5,337,234 | 88.4 | % | $ | 83,443 | 68.3 | % | $ | 5,860,119 | ||||||||||
Non-performing | 123,266 | 45.6 | % | 120,458 | 29.2 | % | 700,461 | 11.6 | % | 38,683 | 31.7 | % | 982,868 | |||||||||||||||
Total | $ | 270,074 | 100.0 | % | $ | 413,092 | 100.0 | % | $ | 6,037,695 | 100.0 | % | $ | 122,126 | 100.0 | % | $ | 6,842,987 | ||||||||||
% of loan portfolio | 0.7 | % | n/a | 2.8 | % | n/a | 23.2 | % | n/a | 4.1 | % | n/a | 8.2 | % | ||||||||||||||
(1) Excludes LHFS
The following table provides a summary of TDR activity:
Year Ended December 31, 2018 | Year Ended December 31, 2017 | |||||||||||||||
(in thousands) | RICs and Auto Loans | All Other Loans | RICs and Auto Loans | All Other Loans(1) | ||||||||||||
TDRs, beginning of period | $ | 6,037,695 | $ | 805,292 | $ | 5,159,135 | $ | 914,369 | ||||||||
New TDRs(1) | 1,877,058 | 136,716 | 4,184,380 | 246,729 | ||||||||||||
Charged-Off TDRs | (1,706,788 | ) | (14,554 | ) | (2,211,027 | ) | (270,219 | ) | ||||||||
Sold TDRs | (2,884 | ) | (7,148 | ) | (3,141 | ) | (10,410 | ) | ||||||||
Payments on TDRs | (953,312 | ) | (249,723 | ) | (1,091,652 | ) | (75,177 | ) | ||||||||
TDRs, end of period | $ | 5,251,769 | $ | 670,583 | $ | 6,037,695 | $ | 805,292 | ||||||||
(1) | New TDRs includes drawdowns on lines of credit that have previously been classified as TDRs. |
In accordance with its policies and guidelines, the Company at times offers payment deferrals to borrowers on its RICs, under which the consumer is allowed to move up to three delinquent payments to the end of the loan. More than 90% of deferrals granted are for two months. The policies and guidelines limit the number and frequency of deferrals that may be granted to one deferral every six months and eight months over the life of a loan, while some marine and RV contracts have a maximum of twelve months in extensions to reflect their longer term. Additionally, the Company generally limits the granting of deferrals on new accounts until a requisite number of payments has been received. During the deferral period, the Company continues to accrue and collect interest on the loan in accordance with the terms of the deferral agreement.
At the time a deferral is granted, all delinquent amounts may be deferred or paid, which may result in the classification of the loan as current and therefore not considered delinquent. However, there are instances when a deferral is granted but the loan is not brought completely current such as when the account's days past due is greater than the deferment period granted. Such accounts are aged based on the timely payment of future installments in the same manner as any other account. Historically, the majority of deferrals are approved for borrowers who are either 31-60 or 61-90 days delinquent, and these borrowers are typically reported as current after deferral. A customer is limited to one deferral each six months, and if a customer receives two or more deferrals over the life of the loan, the loan will advance to a TDR designation.
The Company evaluates the results of its deferral strategies based upon the amount of cash installments that are collected on accounts after they have been deferred compared to the extent to which the collateral underlying the deferred accounts has depreciated over the same period of time. Based on this evaluation, the Company believes that payment deferrals granted according to its policies and guidelines are an effective portfolio management technique and result in higher ultimate cash collections from the portfolio.
Changes in deferral levels do not have a direct impact on the ultimate amount of consumer finance receivables charged off. However, the timing of a charge-off may be affected if the previously deferred account ultimately results in a charge-off. To the extent deferrals impact the ultimate timing of when an account is charged off, historical charge-off ratios, loss confirmation periods, and cash flow
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
forecasts used in the determination of the adequacy of the ALLL for loans classified as TDRs are also impacted. Increased use of deferrals may result in a lengthening of the loss confirmation period, which would increase expectations of credit losses inherent in the portfolio and therefore increase the ALLL and related provision for loan and lease losses. Changes in these ratios and periods are considered in determining the appropriate level of the ALLL and related provision for loan and lease losses. For loans that are classified as TDRs, the Company generally compares the present value of expected cash flows to the outstanding recorded investment of TDRs to determine the amount of allowance and related provision for credit losses that should be recorded. For loans that are considered collateral-dependent, such as certain bankruptcy modifications, impairment is measured based on the fair value of the collateral, less its estimated costs to sell.
ACL
The ACL is maintained at levels management considers adequate to provide for losses based upon an evaluation of known and inherent risks in the loan portfolio. Management's evaluation takes into consideration the risks inherent in the portfolio, past loan and lease loss experience, specific loans with loss potential, geographic and industry concentrations, delinquency trends, the level of originations, credit quality metrics such as FICO scores and CLTV, internal risk ratings, economic conditions and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the ACL may be necessary if conditions differ substantially from the assumptions used in making the evaluations.
The following table presents the allocation of the ALLL and the percentage of each loan type to total LHFI at the dates indicated:
December 31, 2018 | December 31, 2017 | |||||||||||||
(dollars in thousands) | Amount | % of Loans to Total LHFI | Amount | % of Loans to Total LHFI | ||||||||||
Allocated allowance: | ||||||||||||||
Commercial loans | $ | 441,083 | 46.4 | % | $ | 443,796 | 48.4 | % | ||||||
Consumer loans | 3,409,024 | 53.6 | % | 3,504,068 | 51.6 | % | ||||||||
Unallocated allowance | 47,023 | n/a | 47,023 | n/a | ||||||||||
Total ALLL | 3,897,130 | 100.0 | % | 3,994,887 | 100.0 | % | ||||||||
Reserve for unfunded lending commitments | 95,500 | 109,111 | ||||||||||||
Total ACL | $ | 3,992,630 | $ | 4,103,998 | ||||||||||
General
The ACL decreased $111.4 million from December 31, 2017 to December 31, 2018. This change in the overall ACL was primarily attributable to the decreased amount of TDRs within SC's RIC and auto loan portfolio.
Management regularly monitors the condition of the Company's portfolio, considering factors such as historical loss experience, trends in delinquencies and NPLs, changes in risk composition and underwriting standards, the experience and ability of staff, and regional and national economic conditions and trends.
Generally, the Company’s LHFI are carried at amortized cost, net of ALLL, which includes the estimate of any related net discounts that are expected at the time of charge-off. In the case of loans purchased in a bulk purchase or business combination, the entire discount on the loan portfolio is considered as available to absorb the credit losses when determining the ALLL. For these loans, the Company records provisions for credit losses when incurred losses exceed the unaccreted purchase discount.
The risk factors inherent in the ACL are continuously reviewed and revised by management when conditions indicate that the estimates initially applied are different from actual results. The Company also performs a comprehensive analysis of the ACL on a quarterly basis. In addition, the Company performs a review each quarter of allowance levels and trends by major portfolio against the levels of peer banking institutions to benchmark our allowance and industry norms.
Commercial
For the commercial loan portfolio excluding small business loans (businesses with annual sales of up to $3 million), the Company has specialized credit officers, a monitoring unit, and workout units that identify and manage potential problem loans. Changes in management factors, financial and operating performance, company behavior, industry factors and external events and circumstances are evaluated on an ongoing basis to determine whether potential impairment is evident and/or additional analysis is needed. For the commercial loan portfolios, risk ratings are assigned to each loan to differentiate risk within the portfolio, reviewed on an ongoing basis by credit risk management and revised, if needed, to reflect the borrower’s current risk profile and the related collateral position.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The risk ratings consider factors such as financial condition, debt capacity and coverage ratios, market presence and quality of management. Generally, credit officers reassess a borrower’s risk rating on at least an annual basis, and more frequently if warranted. This reassessment process is managed by credit officers and is overseen by the credit monitoring group to ensure consistency and accuracy in risk ratings, as well as the appropriate frequency of risk rating reviews by the Company’s credit officers. The Company’s Credit Risk Review Committee assesses whether the Company’s Credit Risk Review Framework and risk management guidelines established by the Company’s Board and applicable laws and regulations are being followed, and reports key findings and relevant information to the Board. The Company’s Credit Risk Review group regularly performs loan reviews and assesses the appropriateness of assigned risk ratings. When credits are downgraded below a certain level, the Company’s Workout Department becomes responsible for managing the credit risk. Risk rating actions are generally reviewed formally by one or more credit committees depending on the size of the loan and the type of risk rating action being taken. Detailed analyses are completed that support the risk rating and management’s strategies for the customer relationship going forward.
A loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan. An insignificant delay (e.g., less than 90 days) or insignificant shortfall in the amount of payments does not necessarily result in the loan being identified as impaired. Impaired commercial loans are comprised of all TDRs plus non-accrual loans in excess of $1 million that are not TDRs. In addition, the Company may perform a specific reserve analysis on loans that fail to meet this threshold if the nature of the collateral or business conditions warrant. The Company performs a specific reserve analysis on certain loans regardless of loan size. If a loan is identified as impaired and is collateral-dependent, an initial appraisal is obtained to provide a baseline to determine the property’s fair market value. The frequency of appraisals depends on the type of collateral being appraised. If the collateral value is subject to significant volatility (due to location of the asset, obsolescence, etc.), an appraisal is obtained more frequently. At a minimum, updated appraisals for impaired loans are obtained within a 12-month period if the loan remains outstanding for that period of time.
If a loan is identified as impaired and is not collateral-dependent, impairment is measured based on a DCF methodology.
When the Company determines that the value of an impaired loan is less than its carrying amount, the Company recognizes impairment through a provision estimate or a charge-off to the allowance. Management performs these assessments on at least a quarterly basis. For commercial loans, a charge-off is recorded when a loan, or a portion thereof, is considered uncollectible and of such little value that its continuance on the Company’s books as an asset is not warranted. Charge-offs are recorded on a monthly basis, and partially charged-off loans continue to be evaluated on at least a quarterly basis, with additional charge-offs or loan and lease loss provisions taken on the remaining loan balance, if warranted, utilizing the same criteria.
The portion of the ALLL related to the commercial portfolio was $441.1 million at December 31, 2018 (1.1% of commercial LHFI) and $443.8 million at December 31, 2017 (1.1% of commercial LHFI). The primary factor resulting in the decreased ACL allocated to the commercial portfolio was, in part, due to a decline in the overall balance of the CRE loan portfolio.
Consumer
The consumer loan and small business loan portfolios are monitored for credit risk and deterioration with statistical tools considering factors such as delinquency, LTV ratios, and internal and external credit scores. Management evaluates the consumer portfolios throughout their lifecycles on a portfolio basis. When problem loans are identified that are secured with collateral, management examines the loan files to evaluate the nature and type of collateral. Management documents the collateral type, the date of the most recent valuation, and whether any liens exist to determine the value to compare against the committed loan amount.
Residential mortgages not adequately secured by collateral are generally charged-off to fair value less cost to sell when deemed to be uncollectible or are delinquent 180 days or more, whichever comes first, unless it can be clearly demonstrated that repayment will occur regardless of the delinquency status. Examples that would demonstrate repayment likelihood include a loan that is secured
by collateral and is in the process of collection, a loan supported by a valid guarantee or insurance, or a loan supported by a valid claim against a solvent estate.
For residential mortgage loans, loss severity assumptions are incorporated into the loan and lease loss reserve models to estimate loan balances that will ultimately charge-off. These assumptions are based on recent loss experience within various CLTV bands in these portfolios. CLTVs are refreshed quarterly by applying Federal Housing Finance Agency Home Price Index changes at a state-by-state level to the last known appraised value of the property to estimate the current CLTV. The Company's ALLL incorporates the refreshed CLTV information to update the distribution of defaulted loans by CLTV as well as the associated loss given default for each CLTV band. Reappraisals at the individual property level are not considered cost-effective or necessary on a recurring basis;
however, reappraisals are performed on certain higher risk accounts to support line management activities and default servicing decisions, or when other situations arise for which the Company believes the additional expense is warranted.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
A home equity loan or line of credit not adequately secured by collateral is treated similarly to the way residential mortgages are treated. The Company incorporates home equity loan or line of credit loss severity assumptions into the loan and lease loss reserve model following the same methodology as for residential mortgage loans. To ensure the Company has captured losses inherent in its home equity portfolios, the Company estimates its ALLL for home equity loans and lines of credit by segmenting its portfolio into sub-segments based on the nature of the portfolio and certain risk characteristics such as product type, lien positions, and origination channels. Projected future defaulted loan balances are estimated within each portfolio sub-segment by incorporating risk parameters, including the current payment status as well as historical trends in delinquency rates. Other assumptions, including prepayment and attrition rates, are also calculated at the portfolio sub-segment level and incorporated into the estimation of the likely volume of defaulted loan balances. The projected default volume is stratified across CLTV ratio bands, and a loss severity rate for each CLTV band is applied based on the Company's historical net credit loss experience. This amount is then adjusted, as necessary, for qualitative considerations to reflect changes in underwriting, market, or industry conditions, or changes in trends in the composition of the portfolio, including risk composition, seasoning, and underlying collateral.
The Company considers the delinquency status of its senior liens in cases in which the Company services the lien. The Company currently services the senior lien on 23.0% of its junior lien home equity principal balances. Of the junior lien home equity loan and line of credit balances that are current, 1.1% have a senior lien that is one or more payments past due. When the senior lien is delinquent but the junior lien is current, allowance levels are adjusted to reflect loss estimates consistent with the delinquency status of the senior lien. The Company also extrapolates these impacts to the junior lien portfolio when the senior lien is serviced by another investor and the delinquency status of that senior lien is unknown.
Depository and lending institutions in the U.S. generally are expected to experience a significant volume of home equity lines of credit that will be approaching the end of their draw periods over the next several years, following the growth in home equity lending experienced during 2003 through 2007. As a result, many of these home equity lines of credit will either convert to amortizing loans or have principal due as balloon payments. The Company's home equity lines of credit generated after 2007 are generally open-ended, revolving loans with fixed-rate lock options and draw periods of up to 10 years, along with amortizing repayment periods of up to 20 years. The Company currently monitors delinquency rates for amortizing and non-amortizing lines, as well as other credit quality metrics, including FICO credit scoring model scores and LTV ratios. The Company's home equity lines of credit are generally underwritten considering fully drawn and fully amortizing levels. As a result, the Company currently does not anticipate a significant deterioration in credit quality when these home equity lines of credit begin to amortize.
For RICs, including RIC loans acquired from a third-party lender that are considered to have no credit deterioration at acquisition, and personal unsecured loans at SC, the Company maintains an ALLL for the Company's held-for-investment portfolio not classified as TDRs at a level estimated to be adequate to absorb credit losses of the recorded investment inherent in the portfolio, based on a holistic assessment, including both quantitative and qualitative considerations. For TDR loans, the allowance is comprised of impairment measured using a DCF model. RICs and personal unsecured loans are considered separately in assessing the required ALLL using product-specific allowance methodologies applied on a pooled basis.
The quantitative framework is supported by credit models that consider several credit quality indicators including, but not limited to, historical loss experience and current portfolio trends. The transition-based Markov model provides data on a granular and disaggregated/segment basis as it utilizes recently observed loan transition rates from various loan statuses to forecast future losses. Transition matrices in the Markov model are categorized based on account characteristics such as delinquency status, TDR type (e.g., deferment, modification, etc.), internal credit risk, origination channel, seasoning, thin/thick file and time since TDR event. The credit models utilized differ among the Company's RIC and personal loan portfolios. The credit models are adjusted by management through qualitative reserves to incorporate information reflective of the current business environment.
Auto loans are charged off when an account becomes 120 days delinquent if the Company has not repossessed the vehicle. The Company writes the vehicle down to the estimated recovery amount of the collateral when the automobile is repossessed and legally available for disposition.
The allowance for consumer loans was $3.4 billion and $3.5 billion at December 31, 2018 and December 31, 2017, respectively. The allowance as a percentage of held-for-investment consumer loans was 7.3% at December 31, 2018 and 8.4% at December 31, 2017. The decrease in the allowance for consumer loans was primarily attributable to increased recovery rates and lower TDR volume in SC's RIC and auto loan portfolio.
The Company's allowance models and reserve levels are back-tested on a quarterly basis to ensure that both remain within appropriate ranges. As a result, management believes that the current ALLL is maintained at a level sufficient to absorb inherent losses in the consumer portfolios.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Unallocated
The Company reserves for certain inherent but undetected losses that are probable within the loan and lease portfolios. This is considered to be reasonably sufficient to absorb imprecisions of models and to otherwise provide for coverage of inherent losses in the Company's entire loan and lease portfolios. These imprecisions may include loss factors inherent in the loan portfolio that may not have been discreetly contemplated in the general and specific components of the allowance, as well as potential variability in estimates. Period-to-period changes in the Company's historical unallocated ALLL positions are considered in light of these factors. The unallocated ALLL was $47.0 million at both December 31, 2018 and December 31, 2017.
Reserve for Unfunded Lending Commitments
In addition to the ALLL, the Company estimates probable losses related to unfunded lending commitments. The reserve for unfunded lending commitments consists of two elements: (i) an allocated reserve, which is determined by an analysis of historical loss experience and risk factors, current economic conditions, performance trends within specific portfolio segments, and any other pertinent information, and (ii) an unallocated reserve to account for a level of imprecision in management's estimation process. Additions to the reserve for unfunded lending commitments are made by charges to the provision for credit losses, and this reserve is classified within Other liabilities on the Company's Consolidated Balance Sheets. Once an unfunded lending commitment becomes funded and is carried as a loan, the corresponding reserves are transferred to the ALLL.
The reserve for unfunded lending commitments decreased from $109.1 million at December 31, 2017 to $95.5 million at December 31, 2018. During the year ended December 31, 2018, the reserve for unfunded commitments decreased $13.6 million, primarily due to the funding of a letter of credit. At the time of funding, the letter of credit had an associated reserve of $14.5 million which was transferred to the ALLL. The remaining decrease of the unfunded reserve is primarily related to the Company strategically reducing its exposure to certain business relationships and industries. The net impact of the change in the reserve for unfunded lending commitments to the overall ACL was immaterial.
INVESTMENT SECURITIES
Investment securities consist primarily of U.S. Treasuries, MBS, ABS and stock in the FHLB and FRB. MBS consist of pass-through, collateralized mortgage obligations (“CMOs"), and adjustable rate mortgages issued by federal agencies. The Company’s MBS are either guaranteed as to principal and interest by the issuer or have ratings of “AAA” by S&P and Moody’s Investor Service at the date of issuance. The Company’s AFS investment strategy is to purchase liquid fixed-rate and floating-rate investments to manage the Company's liquidity position and interest rate risk adequately.
Total investment securities AFS decreased $2.8 billion to $11.6 billion at December 31, 2018, compared to $14.4 billion at December 31, 2017. During the year ended December 31, 2018, the composition of the Company's investment portfolio changed due to a decrease in MBS, partially offset by an increase in U.S Treasury securities. MBS decreased by $3.7 billion primarily due to a transfer to HTM for $1.2 billion, $1.8 billion of principal paydowns and $1.2 billion of sales and maturities, partially offset by purchases of $575.1 million. U.S. Treasuries increased by $806.6 million, primarily due to investment purchases of $776.0 million. For additional information with respect to the Company’s investment securities, see Note 3 to the Consolidated Financial Statements.
Debt securities for which the Company has the positive intent and ability to hold the securities until maturity are classified as HTM securities. HTM securities are reported at cost and adjusted for amortization of premium and accretion of discount. Total investment
securities HTM were $2.8 billion at December 31, 2018. The Company had 71 investment securities classified as HTM as of December 31, 2018.
Total gross unrealized losses on investment securities AFS increased by $73.9 million during the year ended December 31, 2018. This increase was primarily related to an increase in unrealized losses of $70.0 million on MBS, primarily due to rising interest rates.
The average life of the AFS investment portfolio (excluding certain ABS) at December 31, 2018 was approximately 4.48 years. The average effective duration of the investment portfolio (excluding certain ABS) at December 31, 2018 was approximately 3.52 years. The actual maturities of MBS AFS will differ from contractual maturities because borrowers have the right to prepay obligations without prepayment penalties.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following table presents the fair value of investment securities by obligor at the dates indicated:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Investment securities AFS: | ||||||||
U.S. Treasury securities and government agencies | $ | 5,485,392 | $ | 7,042,828 | ||||
FNMA and FHLMC securities | 5,550,628 | 6,840,696 | ||||||
State and municipal securities | 16 | 23 | ||||||
Other securities (1) | 596,951 | 529,636 | ||||||
Total investment securities AFS | 11,632,987 | 14,413,183 | ||||||
Investment securities HTM: | ||||||||
U.S. government agencies | 2,750,680 | 1,799,808 | ||||||
Total investment securities HTM(2) | 2,750,680 | 1,799,808 | ||||||
Other investments | 805,357 | 658,864 | ||||||
Total investment portfolio | $ | 15,189,024 | $ | 16,871,855 | ||||
(1) | Other securities primarily include corporate debt securities and ABS. |
(2) | HTM securities are measured and presented at amortized cost. |
The following table presents the securities of single issuers (other than obligations of the United States and its political subdivisions, agencies, and corporations) having an aggregate book value in excess of 10% of the Company's stockholder's equity that were held by the Company at December 31, 2018:
December 31, 2018 | ||||||||
(in thousands) | Amortized Cost | Fair Value | ||||||
FNMA | $ | 3,102,447 | $ | 3,011,571 | ||||
FHLMC | 2,636,582 | 2,539,057 | ||||||
Government National Mortgage Association (1) | 6,534,406 | 6,356,696 | ||||||
Government - Treasuries | 1,815,914 | 1,804,745 | ||||||
Total | $ | 14,089,349 | $ | 13,712,069 | ||||
(1) | Includes U.S. government agency MBS. |
GOODWILL
The Company records the excess of the cost of acquired entities over the fair value of identifiable tangible and intangible assets acquired less the fair value of liabilities assumed as goodwill. Consistent with ASC 350, the Company does not amortize goodwill, and reviews the goodwill recorded for impairment on an annual basis or more frequently when events or changes in circumstances indicate the potential for goodwill impairment. At December 31, 2018, goodwill totaled $4.4 billion and represented 3.3% of total assets and 18.6% of total stockholder's equity. The following table shows goodwill by reporting units at December 31, 2018:
(in thousands) | Consumer and Business Banking | Commercial Banking | CIB | SC | Total | |||||||||||||||
Goodwill at December 31, 2018 | $ | 1,880,304 | $ | 1,412,995 | $ | 131,130 | $ | 1,019,960 | $ | 4,444,389 | ||||||||||
During 2018, the reportable segments (and reporting units) formerly known as Commercial Banking and CRE were combined and presented as Commercial Banking. Refer to Note 23 for further discussion on the change in reportable segments. There were no
additions or removals of underlying lines of business in connection with this reporting change. As a result, goodwill assigned to these former reporting units of $542.6 million and $870.4 million for Commercial Banking and CRE, respectively, have been combined. There were no additions or impairments of goodwill for the year ended December 31, 2018.
Also during 2018, Santander renamed its Global and Corporate Banking business to CIB to more accurately reflect its business strategy and business proposition to clients, and to align with the name used by a majority of its competitors in the industry. There were no changes to composition of the reportable segment or reporting unit as a result of this change.
The Company conducted its annual goodwill impairment tests as of October 1, 2018 using generally accepted valuation methods. The Company completes a quarterly review for impairment indicators over each of its reporting units, which includes consideration of economic and organizational factors that could impact the fair value of the Company's reporting units. At the completion of the 2018 fourth quarter review, the Company did not identify any indicators which resulted in the Company's conclusion that an interim impairment test would be required to be completed. As discussed further in the section of this MD&A above captioned “Executive Summary,” SC and FCA are in exploratory discussions regarding the Chrysler Agreement that could have a future impact on the Company's goodwill.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
For the Consumer and Business Banking reporting unit's fair valuation analysis, an equal weighting of the market approach ("market approach") and income approach was applied. For the market approach, the Company selected a 25.0% control premium based on the Company's review of transactions observable in the market place that were determined to be comparable. The projected tangible book value ("TBV") of 1.5x was selected based on publicly traded peers of the reporting unit. For the income approach, the Company selected a discount rate of 10.3%, which was most representative of the reporting unit's cost of equity at the time of the analysis. Long-term growth rates of 4.0% were applied in determining the terminal value. The results of the equally weighted fair value analyses exceeded the carrying value for the Consumer and Business Banking reporting unit by 15.8%, indicating the reporting unit was not considered to be impaired or at risk for impairment.
For the Commercial Banking reporting unit's fair valuation analysis, an equal weighting of the market and income approach was applied. For the market approach, the Company selected a 25.0% control premium based on the Company's review of transactions observable in the market place that were determined to be comparable. The projected TBV of 1.5x was selected based on the selected publicly traded peers of the reporting unit. For the income approach, the Company selected a discount rate 10.8%, which was most representative of the business' cost of equity at the time of the analysis. Long-term growth rates of 3.5% were applied in determining the terminal value. The results of the equally weighted fair value analyses exceeded the carrying value for the Commercial Banking reporting unit by 17.8%, indicating the Commercial Banking reporting unit was not considered to be impaired or at risk for impairment.
For the CIB reporting unit's fair valuation analysis, an equal weighting of the market and income approach was applied. For the market approach, the Company selected a 25.0% control premium based on the Company's review of transactions observable in the market place that were determined to be comparable. The projected TBV of 1.5x was selected based on the selected publicly traded peers of the reporting unit. For the income approach, the Company selected a discount rate of 11.6%, which is most representative of the reporting unit's cost of equity at the time of the analysis. Long-term growth rates of 3.0% were applied in determining the terminal value. The results of the equally weighted fair value analyses exceeded the carrying value for the CIB reporting unit by 46.2%, indicating that the CIB reporting unit was not considered to be impaired or at risk for impairment.
For the SC reporting unit's fair valuation analysis, the Company used only the market capitalization approach. For the market capitalization approach, SC's stock price from October 1, 2018 of $19.68 was used and a 25.0% control premium was used based on the Company's review of transactions observable in the market-place that were determined to be comparable. The results of the fair value analyses exceeded the carrying value of the SC reporting unit by 48%, indicating that the SC reporting unit was not considered to be impaired. Management continues to monitor SC's stock price, along with changes in the financial position and results of operations that would impact the reporting unit's carrying value on a regular basis. Through the date of this filing, there have been no indicators which would change management's assessment as of October 1, 2018.
DEFERRED TAXES AND OTHER TAX ACTIVITY
The Company had a net deferred tax liability balance of $587.5 million at December 31, 2018 (consisting of a deferred tax asset balance of $625.1 million and a deferred tax liability balance of $1,212.5 million), compared to a net deferred tax liability balance of $193.6 million at December 31, 2017 (consisting of a deferred tax asset balance of $771.7 million and a deferred tax liability balance of $965.3 million). The $393.8 million increase in net deferred liabilities for the year ended December 31, 2018 was due to an increase in deferred tax liabilities related to accelerated depreciation from leasing transactions.
OFF-BALANCE SHEET ARRANGEMENTS
See further discussion of the Company's off-balance sheet arrangements in Note 7 and Note 20 to the Consolidated Financial Statements, and the Liquidity and Capital Resources section of this MD&A.
For a discussion of the status of litigation with which the Company is involved with the Internal Revenue Service, please refer to Note 13 to the Condensed Consolidated Financial Statements.
BANK REGULATORY CAPITAL
The Company's capital priorities are to support client growth and business investment while maintaining appropriate capital in light of economic uncertainty and the Basel III framework.
The Company is subject to the regulations of certain federal, state, and foreign agencies and undergoes periodic examinations by those regulatory authorities. At December 31, 2018 and December 31, 2017, based on the Bank’s capital calculations, the Bank was considered well-capitalized under the applicable capital framework. In addition, the Company's capital levels as of December 31, 2018 and December 31, 2017, based on the Company’s capital calculations, exceeded the required capital ratios for BHCs.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
For a discussion of Basel III, which became effective for SHUSA and the Bank on January 1, 2015, including the standardized approach and related future changes to the minimum U.S. regulatory capital ratios, see the section captioned "Regulatory Matters" in this MD&A.
Federal banking laws, regulations and policies also limit the Bank's ability to pay dividends and make other distributions to the Company. The Bank must obtain prior OCC approval to declare a dividend or make any other capital distribution if, after such dividend or distribution: (1) the Bank's total distributions to SHUSA within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years, (2) the Bank would not meet capital levels imposed by the OCC in connection with any order, or (3) the Bank is not adequately capitalized at the time. The OCC's prior approval would also be required if the Bank were notified by the OCC that it is a problem institution or in troubled condition.
Any dividend declared and paid or return of capital has the effect of reducing capital ratios. During the years ended December 31, 2018 and 2017. The Company paid cash dividends of $410.0 million, and $10.0 million, respectively, to its common stock shareholder and cash dividends to preferred shareholders of $11.0 million and $14.6 million, respectively. On August 15, 2018, SHUSA redeemed all of its outstanding preferred stock.
The following schedule summarizes the actual capital balances of SHUSA and the Bank at December 31, 2018:
SHUSA | |||||||||
December 31, 2018 | Well-capitalized Requirement(1) | Minimum Requirement(1) | |||||||
CET1 capital ratio | 15.53 | % | 6.50 | % | 4.50 | % | |||
Tier 1 capital ratio | 16.86 | % | 8.00 | % | 6.00 | % | |||
Total capital ratio | 18.35 | % | 10.00 | % | 8.00 | % | |||
Leverage ratio | 14.03 | % | 5.00 | % | 4.00 | % | |||
(1) | As defined by Federal Reserve regulations. The Company's ratios are presented under a Basel III phasing-in basis. |
BANK | |||||||||
December 31, 2018 | Well-capitalized Requirement(2) | Minimum Requirement(2) | |||||||
CET1 capital ratio | 17.14 | % | 6.50 | % | 4.50 | % | |||
Tier 1 capital ratio | 17.14 | % | 8.00 | % | 6.00 | % | |||
Total capital ratio | 18.22 | % | 10.00 | % | 8.00 | % | |||
Leverage ratio | 14.08 | % | 5.00 | % | 4.00 | % | |||
(2) | As defined by OCC regulations. The Bank's ratios are presented on a Basel III phasing-in basis. |
In June 2018, the Company announced that the Federal Reserve did not object to the planned capital actions described in the Company’s capital plan submitted as part of the CCAR process. That capital plan included planned capital distributions across the following categories: (1) common stock dividends from SHUSA to Santander, (2) common stock dividends from SC, (3) a common stock buyback by SC, (4) redemption of SHUSA's Capital Trust IX preferred securities, (5) redemption of SHUSA’s preferred stock, and (6) dividends on the Company’s preferred stock and payments on its trust preferred securities until they were redeemed.
In February 2019, the Federal Reserve announced that the Company, as well as other less complex firms, would receive a one-year extension of the requirement to submit its 2019 capital plan until April 5, 2020. The Federal Reserve also announced that, for the period beginning on July 1, 2019 through June 30, 2020, the Company would be allowed to make capital distributions up to an amount that would have allowed the Company to remain well-capitalized under the minimum capital requirements for CCAR 2018. The Company is evaluating its planned capital actions for the period from July 1, 2019 through June 30, 2020, and will submit those planned capital actions to the Federal Reserve by April 5, 2019.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
LIQUIDITY AND CAPITAL RESOURCES
Overall
The Company continues to maintain strong liquidity positions. Liquidity represents the ability of the Company to obtain cost-effective funding to meet the needs of customers as well as the Company's financial obligations. Factors that impact the liquidity position of the Company include loan origination volumes, loan prepayment rates, the maturity structure of existing loans, core deposit growth levels, CD maturity structure and retention, the Company's credit ratings, investment portfolio cash flows, the maturity structure of the Company's wholesale funding, and other factors. These risks are monitored and managed centrally. The Company's Asset/Liability Committee reviews and approves the Company's liquidity policy and guidelines on a regular basis. This process includes reviewing all available wholesale liquidity sources. The Company also forecasts future liquidity needs and develops strategies to ensure adequate liquidity is available at all times. SHUSA conducts monthly liquidity stress test analyses to manage its liquidity under a variety of scenarios, all of which demonstrate that the Company has ample liquidity to meet its short-term and long-term cash requirements.
Further changes to the credit ratings of SHUSA, Santander and its affiliates or the Kingdom of Spain could have a material adverse effect on SHUSA's business, including its liquidity and capital resources. The credit ratings of SHUSA have changed in the past and may change in the future, which could impact its cost of and access to sources of financing and liquidity. Any reductions in the long-term or short-term credit ratings of SHUSA would increase its borrowing costs and require it to replace funding lost due to the downgrade, which may include the loss of customer deposits, limit its access to capital and money markets and trigger additional
collateral requirements in derivatives contracts and other secured funding arrangements. See further discussion on the impacts of credit ratings actions in the "Economic and Business Environment" section of this MD&A.
Sources of Liquidity
Company and Bank
The Company and the Bank have several sources of funding to meet liquidity requirements, including the Bank's core deposit base, liquid investment securities portfolio, ability to acquire large deposits, FHLB borrowings, wholesale deposit purchases, and federal funds purchased, as well as through securitizations in the ABS market and committed credit lines from third-party banks and Santander. The Company has the following major sources of funding to meet its liquidity requirements: dividends and returns of investments from its subsidiaries, short-term investments held by non-bank affiliates, and access to the capital markets.
SC
SC requires a significant amount of liquidity to originate and acquire loans and leases and to service debt. SC funds its operations through its lending relationships with 12 third-party banks, Santander and SHUSA, as well as through securitizations in the ABS market and large flow agreements. SC seeks to issue debt that appropriately matches the cash flows of the assets that it originates. SC has approximately $7.0 billion of stockholders’ equity that supports its access to the securitization markets, credit facilities, and flow agreements.
During the year ended December 31, 2018, SC completed on-balance sheet funding transactions totaling approximately $19.0 billion, including:
• | five securitizations on its Santander Drive Auto Receivables Trust ("SDART") platform for approximately $5.3 billion; |
• | five securitizations on its Drive Auto Receivables Trust (“DRIVE"), deeper subprime platform for approximately $5.7 billion; |
• | one private lease securitization for approximately $1.2 billion; |
• | one lease securitization on its Santander Retail Auto Lease Trust platform for approximately $1.0 billion; |
• | eight private amortizing lease facilities for approximately $5.2 billion; |
• | issuance of ten retained bonds on its SDART platform for approximately $708.0 million; and |
• | issuance of five retained bonds on its DRIVE platform for approximately $312.0 million. |
SC also completed approximately $2.9 billion in asset sales to Santander.
For information regarding SC's debt, see Note 11 to the Consolidated Financial Statements.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
IHC
On June 6, 2017, SIS entered into a revolving subordinated loan agreement with SHUSA not to exceed $290.0 million for a two-year term to mature in 2019. On September 13, 2017, the revolving subordinated loan agreement with SHUSA was increased to $350.0 million and, on October 6, 2017, it was increased to $495.0 million. On October 16, 2018, the revolving loan agreement was increased further to $895.0 million. In addition, SHUSA provided SIS with $200.0 million of additional capital in October 2018 prior to the increase of the revolving loan agreement.
As needed, SIS will draw down from another subordinated loan with Santander in order to enable SIS to underwrite certain large transactions in excess of the foregoing subordinated loan. At December 31, 2018, there was no outstanding balance on the subordinated loan.
BSI's primary sources of liquidity are from customer deposits and deposits from affiliated banks.
BSPR's primary sources of liquidity include core deposits, FHLB borrowings, wholesale and/or brokered deposits, and liquid investment securities.
Institutional borrowings
The Company regularly projects its funding needs under various stress scenarios, and maintains contingency plans consistent with the Company’s access to diversified sources of contingent funding. The Company maintains a substantial level of total available liquidity in the form of on-balance sheet and off-balance sheet funding sources. These include cash, unencumbered liquid assets, and capacity to borrow at the FHLB and the FRB’s discount window.
Available Liquidity
As of December 31, 2018, the Bank had approximately $20.7 billion in committed liquidity from the FHLB and the FRB. Of this amount, $15.2 billion was unused and therefore provides additional borrowing capacity and liquidity for the Company. At December 31, 2018 and December 31, 2017, liquid assets (cash and cash equivalents and LHFS), and securities AFS exclusive of securities pledged as collateral) totaled approximately $15.9 billion and $18.4 billion, respectively. These amounts represented 25.8% and 30.3% of total deposits at December 31, 2018 and December 31, 2017, respectively. As of December 31, 2018, the Bank, BSI and BSPR had $1.1 billion, $1.5 billion, and $1.1 billion, respectively, in cash held at the FRB. Management believes that the Company has ample liquidity to fund its operations.
BSPR has $677.6 million in committed liquidity from the FHLB, all of which was unused as of December 31, 2018, as well as $703.5 million in liquid assets aside from cash unused as of December 31, 2018.
Cash, cash equivalents, and restricted cash
As of January 1, 2018, the classification of restricted cash within the Company's Statement of Cash Flows (“SCF") has changed. Refer to Note 1 to the Consolidated Financial Statements for additional details.
Year Ended December 31, | ||||||||||||
(in thousands) | 2018 | 2017 | 2016 | |||||||||
Net cash flows from operating activities | $ | 7,015,061 | $ | 4,964,060 | $ | 5,271,542 | ||||||
Net cash flows from investing activities | (12,460,839 | ) | 3,281,179 | 577,786 | ||||||||
Net cash flows from financing activities | 5,829,308 | (10,959,272 | ) | (4,874,036 | ) | |||||||
Cash flows from operating activities
Net cash flow from operating activities was $7.0 billion for the year ended December 31, 2018, which was primarily comprised of net income of $991.0 million, $4.3 billion in proceeds from sales of LHFS, $1.9 billion in depreciation, amortization and accretion, and $2.3 billion of provision for credit losses, partially offset by $3.0 billion of originations of LHFS, net of repayments.
Net cash flow from operating activities was $5.0 billion for the year ended December 31, 2017, which was primarily comprised of net income of $958.0 million, $4.6 billion in proceeds from sales of LHFS, $1.6 billion in depreciation, amortization and accretion, and $2.8 billion of provision for credit losses, partially offset by $4.9 billion of originations of LHFS, net of repayments.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Net cash flow from operating activities was $5.3 billion for the year ended December 31, 2016, which was primarily comprised of net income of $640.8 million, $5.9 billion in proceeds from sales of LHFS, $1.3 billion in depreciation, amortization and accretion, and $3.0 billion of provisions for credit losses, partially offset by $6.2 billion of originations of LHFS, net or repayments.
Cash flows from investing activities
For the year ended December 31, 2018, net cash flow from investing activities was $(12.5) billion, primarily due to $8.5 billion in normal loan activity, $2.4 billion of purchases of investment securities AFS, and $9.9 billion in operating lease purchases and originations, partially offset by $3.9 billion of AFS investment securities sales, maturities and prepayments, $1.0 billion in proceeds from sales of LHFI, and $3.6 billion in proceeds from sales and terminations of operating leases.
For the year ended December 31, 2017, net cash flow from investing activities was $3.3 billion, primarily due to $8.4 billion of AFS investment securities sales, maturities and prepayments, $2.7 billion in normal loan activity, $3.1 billion in proceeds from sales and terminations of operating leases, and $1.2 billion in proceeds from sales of LHFI, partially offset by $6.2 billion of purchases of investment securities AFS and $6.0 billion in operating lease purchases and originations.
For the year ended December 31, 2016, net cash flow from investing activities was $577.8 million, primarily due to $17.0 billion of AFS investment securities sales, maturities and prepayments, $1.7 billion in proceeds from sales of LHFI, $2.2 billion in proceeds from sales and terminations of operating leases, and $1.2 billion of manufacturer incentives, partially offset by $12.2 billion of purchases of investment securities AFS, $5.6 billion in operating lease purchases and originations, $1.8 billion in normal loan activity, and $1.7 billion of purchases of investment securities HTM.
Cash flows from financing activities
For the year ended December 31, 2018, net cash flow from financing activities was $5.8 billion, which was primarily due to an increase in net borrowing activity of $5.9 billion, partially offset by $410.0 million in dividends paid on common stock and $200.0 million in redemption of preferred stock.
Net cash flow from financing activities for the year ended December 31, 2017 was $(11.0) billion, which was primarily due to a decrease in net borrowing activity of $4.7 billion and a $6.2 billion decrease in deposits.
Net cash flow from financing activities for the year ended December 31, 2016 was $(4.9) billion, which was primarily due to a decrease in net borrowing activity of $6.4 billion, partially offset by a $1.7 billion increase in deposits.
See the SCF for further details on the Company's sources and uses of cash.
Credit Facilities
Third-Party Revolving Credit Facilities
Warehouse Lines
SC uses warehouse facilities to fund its originations. Each facility specifies the required collateral characteristics, collateral concentrations, credit enhancement, and advance rates. SC's warehouse facilities generally are backed by auto RICs or auto leases. These facilities generally have one- or two-year commitments, staggered maturities and floating interest rates. SC maintains daily and long term funding forecasts for originations, acquisitions, and other large outflows such as tax payments to balance the desire to minimize funding costs with its liquidity needs.
SC's warehouse facilities generally have net spread, delinquency, and net loss ratio limits. Generally, these limits are calculated based on the portfolio collateralizing the respective line; however, for certain of SC's warehouse facilities, delinquency and net loss ratios are calculated with respect to its serviced portfolio as a whole. Failure to meet any of these covenants could trigger increased overcollateralization requirements or, in the case of limits calculated with respect to the specific portfolio underlying certain credit lines, result in an event of default under these agreements. If an event of default occurred under one of these agreements, the lenders could elect to declare all amounts outstanding under the impacted agreement to be immediately due and payable, enforce their interests against collateral pledged under the agreement, restrict SC's ability to obtain additional borrowings under the agreement, and/or remove SC as servicer. SC has never had a warehouse facility terminated due to failure to comply with any ratio or a failure to meet any covenant. A default under one of these agreements can be enforced only with respect to the impacted warehouse facility.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
SC has one credit facility with seven banks providing an aggregate commitment of approximately $4.4 billion for the exclusive use of providing short-term liquidity needs to support FCA retail financing. As of December 31, 2018 and December 31, 2017, there were outstanding balances of approximately $2.2 billion and $2.0 billion, respectively, on this facility in aggregate. The facility requires reduced advance rates in the event of delinquency, credit loss, or residual loss ratios, as well as other metrics exceeding specified thresholds.
SC has six credit facilities with nine banks providing an aggregate commitment of approximately $5.7 billion for the exclusive use of providing short-term liquidity to support Chrysler Capital loan financing and other financing needs. As of December 31, 2018 and December 31, 2017, there was an outstanding balance of approximately $2.0 billion on these facilities in aggregate. These facilities reduced advance rates in the event of delinquency, credit loss, as well as various other metrics exceeding specific thresholds.
Repurchase Agreements
SC also obtains financing through investment management or repurchase agreements under which it pledges retained bonds on its own securitizations as collateral for repurchase agreements with various borrowers and at renewable terms ranging up to 365 days. As of December 31, 2018 and December 31, 2017, there were outstanding balances of $298.9 million and $744.5 million, respectively, under these repurchase agreements.
Santander Credit Facilities
Santander serves as the counterparty for many of SC's derivative financial instruments (all of which have been amended to reflect clearing with central clearing parties), with outstanding notional amounts of zero and $3.7 billion at December 31, 2018 and December 31, 2017, respectively.
Under an agreement with Santander, SC pays Santander a fee of 12.5 basis points per annum on certain amortizing commitments. The guarantee fee is paid against each month's ending balance. SC recognized guarantee fee expense of $5.0 million and $6.0 million for the years ended December 31, 2018 and 2017, respectively.
SHUSA Lending to SC
The Company provides SC with $3.5 billion in committed revolving credit that can be drawn on an unsecured basis. The Company also provides SC with $3.5 billion in term promissory notes with maturities ranging from March 2019 to December 2023. These loans eliminate in the consolidation of SHUSA.
Secured Structured Financings
SC's secured structured financings primarily consist of both public, SEC-registered securitizations, as well as private securitizations under Rule 144A of the Securities Act of 1933, as amended (the “Securities Act”), and privately issues amortizing notes. SC has on-balance sheet securitizations outstanding in the market with a cumulative ABS balance of approximately $26.9 billion.
Flow Agreements
In addition to SC's credit facilities and secured structured financings, SC has a flow agreement in place with a third party for charged-off assets. Loans and leases sold under these flow agreements are not on SC's balance sheet, but provide a stable stream of servicing fee income and may also provide a gain or loss on sale. SC continues to actively seek additional such flow agreements.
Off-Balance Sheet Financing
Beginning in 2017, SC has had the option to sell a contractually determined amount of eligible prime loans to Santander through securitization platforms. As all of the notes and residual interests in the securitizations are acquired by Santander, SC recorded these transactions as true sales of the RICs securitized, and removed the sold assets from its Consolidated Balance Sheets. Beginning in 2018, this program was replaced with a new program with SBNA, whereby SC agreed to provide SBNA with origination support services in connection with the processing, underwriting, and purchase of retail loans, primarily from Chrysler dealers, all of which are serviced by SC.
Uses of Liquidity
The Company uses liquidity for debt service and repayment of borrowings, as well as for funding loan commitments and satisfying deposit withdrawal requests.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
SIS uses liquidity primarily to support underwriting transactions.
The primary use of liquidity for BSI is to meet customer liquidity requirements, such as maturing deposits, investment activities, funds transfers, and payment of its operating expenses.
BSPR uses liquidity for funding loan commitments and satisfying deposit withdrawal requests.
Dividends, Contributions and Stock Issuances
At December 31, 2018, the Company's liquidity to meet debt payments, debt service and debt maturities was in excess of 12 months.
As of December 31, 2018, the Company had 530,391,043 shares of common stock outstanding. During the year ended December 31, 2018, the Company paid dividends of $410.0 million to its sole shareholder, Santander, and in January 2019 declared a cash dividend of $75.0 million on its common stock, which was payable on February 15, 2019.
During the year ended December 31, 2018, Santander made cash contributions of $85.0 million to the Company. In March 2019, Santander made an additional cash contribution of $34.3 million to the Company.
During the year ended December 31, 2018, the Company paid dividends of $11.0 million on its preferred stock. SHUSA redeemed all of its outstanding preferred stock on August 15, 2018.
SC paid dividends of $0.05 per share in the first and second quarters of 2018 and dividends of $0.20 per share in the third and fourth quarters of 2018. During January 2019, SC declared a cash dividend of $0.20 per share, which was paid on February 21, 2019 to shareholders of record as of the close of business on February 11, 2019. SC has paid a total of $180.3 million in dividends through
December 31, 2018, of which $57.5 million has been paid to NCI and $122.8 million to the Company, which eliminates in the consolidated results of the Company.
On July 20, 2018, the SC Board of Directors approved purchases of up to $200.0 million of its outstanding common stock through June 30, 2019. Approved amounts exclude commissions. The following table presents the number of its shares SC purchased during the year ended December 31, 2018, the average price paid per share, and the dollar value of shares that still could have been purchased pursuant to its repurchase authorization.
Period | Total Number of Shares Purchased | Average Price paid per Share | Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs | ||||||||
July 1 - July 31 | — | $ | — | $ | 200,000 | ||||||
August 1 - August 31 | 1,359,893 | 20.63 | 171,945 | ||||||||
September 1 - September 30 | 1,027,798 | 21.35 | 150,000 | ||||||||
October 1 - October 31 | — | — | 150,000 | ||||||||
November 1 - November 30 | 3,571,100 | 19.07 | 81,890 | ||||||||
December 1 - December 31 | 3,515,164 | 18.24 | 17,761 | ||||||||
Total | 9,473,955 | $ | 19.24 | ||||||||
During the year ended December 31, 2018, SC purchased 9.5 million shares of its common stock under its share repurchase program at a cost of approximately $182.0 million, excluding commissions. As of December 31, 2018, SC had a remaining purchase authorization of approximately $18.0 million, all of which was purchased in January 2019, at a weighted average price of $18.40 per share.
During 2018, SHUSA's subsidiaries had the following capital activity which eliminated in consolidation:
• | The Bank declared and paid $450.0 million in dividends to SHUSA; |
• | BSI declared and paid $20.0 million in dividends to SHUSA; |
• | SFS returned $130.0 million of capital to SHUSA; |
• | SHUSA contributed $130.0 million to SSLLC; and |
• | SHUSA contributed $200.0 million of capital to SIS. |
During the first quarter of 2019, the Bank declared a cash dividend on its common stock of $50.0 million, which was paid on February 15, 2019 to SHUSA.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
The Company enters into contractual obligations in the normal course of business as a source of funds for its asset growth and asset/liability management and to meet required capital needs. These obligations require the Company to make cash payments over time as detailed in the table below.
Payments Due by Period | ||||||||||||||||||||
(in thousands) | Total | Less than 1 year | Over 1 year to 3 years | Over 3 years to 5 years | Over 5 years | |||||||||||||||
Payments due for contractual obligations: | ||||||||||||||||||||
FHLB advances (1) | $ | 4,997,149 | $ | 2,247,786 | $ | 2,749,363 | $ | — | $ | — | ||||||||||
Notes payable - revolving facilities | 4,478,214 | 489,085 | 3,989,129 | — | — | |||||||||||||||
Notes payable - secured structured financings | 26,959,621 | 1,135,311 | 7,335,443 | 12,077,823 | 6,411,044 | |||||||||||||||
Other debt obligations (1) (2) | 12,676,568 | 2,472,419 | 4,096,546 | 3,416,606 | 2,690,997 | |||||||||||||||
CDs (1) | 7,613,961 | 5,187,322 | 2,106,243 | 313,942 | 6,454 | |||||||||||||||
Non-qualified pension and post-retirement benefits | 129,464 | 13,032 | 26,089 | 26,768 | 63,575 | |||||||||||||||
Operating leases(3) | 672,486 | 141,448 | 210,453 | 152,074 | 168,511 | |||||||||||||||
Total contractual cash obligations | $ | 57,527,463 | $ | 11,686,403 | $ | 20,513,266 | $ | 15,987,213 | $ | 9,340,581 | ||||||||||
Other Commitments: | ||||||||||||||||||||
Commitments to extend credit | $ | 30,269,311 | $ | 4,938,924 | $ | 5,151,866 | $ | 6,899,990 | $ | 13,278,531 | ||||||||||
Letters of credit | 1,488,714 | 703,745 | 438,919 | 317,232 | 28,818 | |||||||||||||||
Total Contractual Obligations and Other Commitments | $ | 89,285,488 | $ | 17,329,072 | $ | 26,104,051 | $ | 23,204,435 | $ | 22,647,930 | ||||||||||
(1) | Includes interest on both fixed and variable rate obligations. The interest associated with variable rate obligations is based on interest rates in effect at December 31, 2018. The contractual amounts to be paid on variable rate obligations are affected by changes in market interest rates. Future changes in market interest rates could materially affect the contractual amounts to be paid. |
(2) | Includes all carrying value adjustments, such as unamortized premiums and discounts and hedge basis adjustments. |
(3) | Does not include future expected sublease income. |
Excluded from the above table are deposits of $54.0 billion that are due on demand by customers.
The Company is a party to financial instruments and other arrangements with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and manage its exposure to fluctuations in interest rates. See further discussion on these risks in Note 14 and Note 20 to the Consolidated Financial Statements.
Lending Arrangements
SC's personal lending relationship is with Bluestem. SC continues to perform in accordance with the terms and operative provisions of agreements under which it is obligated to purchase personal revolving loans originated by Bluestem for a term ending in 2020, or 2022 if extended at Bluestem's option. The Bluestem portfolio is carried as held for sale in the Company's Consolidated Financial Statements, similar to SC. Accordingly, the Company recorded $367.0 million during 2018 in lower of cost or market adjustments on this portfolio, and there may be further such adjustments required in future periods' financial statements. SC is currently evaluating alternatives for sale of the Bluestem portfolio, which had a carrying value of $1.1 billion at December 31, 2018.
ASSET AND LIABILITY MANAGEMENT
Interest Rate Risk
Interest rate risk arises primarily through the Company’s traditional business activities of extending loans and accepting deposits. Many factors, including economic and financial conditions, movements in market interest rates, and consumer preferences, affect the spread between interest earned on assets and interest paid on liabilities. Interest rate risk is managed by the Company's Treasury group and measured by its Market Risk Department, with oversight by the Asset/Liability Committee. In managing interest rate risk, the Company seeks to minimize the variability of net interest income across various likely scenarios, while at the same time maximizing net interest income and the net interest margin. To achieve these objectives, the Treasury group works closely with each business line in the Company. The Treasury group also uses various other tools to manage interest rate risk, including wholesale funding maturity targeting, investment portfolio purchase strategies, asset securitizations/sales, and financial derivatives.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Interest rate risk focuses on managing four elements of risk associated with interest rates: basis risk, repricing risk, yield curve risk and option risk. Basis risk stems from rate index timing differences with rate changes, such as differences in the extent of changes in Federal funds rates compared with the three-month London Interbank Offered Rate ("LIBOR"). Repricing risk stems from the different timing of contractual repricing, such as one-month versus three-month reset dates, as well as the related maturities. Yield curve risk stems from the impact on earnings and market value resulting from different shapes and levels of yield curves. Option risk stems from prepayment or early withdrawal risk embedded in various products. These four elements of risk are analyzed through a combination of net interest income and balance sheet valuation simulations, shocks to those simulations, and scenario and market value analyses, and the subsequent results are reviewed by management. Numerous assumptions are made to produce these analyses, including assumptions about new business volumes, loan and investment prepayment rates, deposit flows, interest rate curves, economic conditions and competitor pricing.
Net Interest Income Simulation Analysis
The Company utilizes a variety of measurement techniques to evaluate the impact of interest rate risk, including simulating the impact of changing interest rates on expected future interest income and interest expense, to estimate the Company's net interest income sensitivity. This simulation is run monthly and includes various scenarios that help management understand the potential risks in the Company's net interest income sensitivity. These scenarios include both parallel and non-parallel rate shocks as well as other scenarios that are consistent with quantifying the four elements of risk described above. This information is used to develop proactive strategies to ensure that the Company’s risk position remains within SHUSA Board of Directors-approved limits so that future earnings are not significantly adversely affected by future interest rates.
The table below reflects the estimated sensitivity to the Company’s net interest income based on interest rate changes at December 31, 2018 and December 31, 2017:
The following estimated percentage increase/(decrease) to net interest income would result | ||||||
If interest rates changed in parallel by the amounts below | December 31, 2018 | December 31, 2017 | ||||
Down 100 basis points | (3.07 | )% | (3.33 | )% | ||
Up 100 basis points | 2.87 | % | 2.88 | % | ||
Up 200 basis points | 5.58 | % | 5.48 | % | ||
Market Value of Equity ("MVE") Analysis
The Company also evaluates the impact of interest rate risk by utilizing MVE modeling. This analysis measures the present value of all estimated future cash flows of the Company over the estimated remaining life of the balance sheet. MVE is calculated as the difference between the market value of assets and liabilities. The MVE calculation utilizes only the current balance sheet, and therefore does not factor in any future changes in balance sheet size, balance sheet mix, yield curve relationships or product spreads, which may mitigate the impact of any interest rate changes.
Management examines the effect of interest rate changes on MVE. The sensitivity of MVE to changes in interest rates is a measure of longer-term interest rate risk, and highlights the potential capital at risk due to adverse changes in market interest rates. The following table discloses the estimated sensitivity to the Company’s MVE at December 31, 2018 and December 31, 2017.
The following estimated percentage increase/(decrease) to MVE would result | ||||||
If interest rates changed in parallel by the amounts below | December 31, 2018 | December 31, 2017 | ||||
Down 100 basis points | (1.55 | )% | (2.55 | )% | ||
Up 100 basis points | (1.25 | )% | (0.04 | )% | ||
Up 200 basis points | (3.49 | )% | (1.62 | )% | ||
As of December 31, 2018, the Company’s profile reflected a decrease of MVE of 1.55% for downward parallel interest rate shocks of 100 basis points and a decrease of 1.25% for upward parallel interest rate shocks of 100 basis points. The asymmetrical sensitivity between up 100 and down 100 shock is due to the negative convexity as a result of the prepayment option embedded in mortgage-related products, the impact of which is not fully offset by the behavior of the funding base (largely non-maturity deposits ("NMDs")).
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In downward parallel interest rate shocks, mortgage-related products’ prepayments increase, their duration decreases and their market value appreciation is therefore limited. At the same time, with deposit rates remaining at comparatively low levels, the Company cannot effectively transfer interest rate declines to its NMD customers. For upward parallel interest rate shocks, extension risk weighs on a sizable portion of the Company’s mortgage-related products, which are predominantly long-term and fixed-rate; and for larger shocks, the loss in market value is not offset by the change in NMD.
Limitations of Interest Rate Risk Analyses
Since the assumptions used are inherently uncertain, the Company cannot predict precisely the effect of higher or lower interest rates on net interest income or MVE. Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes, the difference between actual experience and the assumed volume, characteristics of new business, behavior of existing positions, and changes in market conditions and management strategies, among other factors.
Uses of Derivatives to Manage Interest Rate and Other Risks
To mitigate interest rate risk and, to a lesser extent, foreign exchange, equity and credit risks, the Company uses derivative financial instruments to reduce the effects that changes in interest rates may have on net income, the fair value of assets and liabilities, and cash flows.
Through the Company’s capital markets and mortgage banking activities, it is subject to price risk. The Company employs various tools to measure and manage price risk in its portfolios. In addition, SHUSA's Board of Directors has established certain limits relative to positions and activities. The level of price risk exposure at any point in time depends on the market environment and expectations of future price and market movements, and will vary from period to period.
Management uses derivative instruments to mitigate the impact of interest rate movements on the fair value of certain liabilities, assets and highly probable forecasted cash flows. These instruments primarily include interest rate swaps that have underlying interest rates based on key benchmark indices and forward sale or purchase commitments. The nature and volume of the derivative instruments used to manage interest rate risk depend on the level and type of assets and liabilities on the balance sheet and the risk management strategies for the current and anticipated interest rate environments.
The Company's derivatives portfolio includes mortgage banking interest rate lock commitments, forward sale commitments and interest rate swaps. As part of its overall business strategy, the Bank originates residential mortgages. It sells a portion of this production to the FHLMC, the FNMA, and private investors. The Company uses forward sales as a means of hedging against the economic impact of changes in interest rates on the mortgages that are originated for sale and on interest rate lock commitments.
The Company typically retains the servicing rights related to residential mortgage loans that are sold. The majority of the Company's residential MSRs are accounted for at fair value. As deemed appropriate, the Company economically hedges MSRs, using interest rate swaps and forward contracts to purchase MBS. For additional information on MSRs, see Note 16 to the Consolidated Financial Statements.
The Company uses foreign exchange contracts to manage the foreign exchange risk associated with certain foreign currency-denominated assets and liabilities. Foreign exchange contracts, which include spot and forward contracts, represent agreements to exchange the currency of one country for the currency of another country at an agreed-upon price on an agreed-upon settlement date. Exposure to gains and losses on these contracts increase or decrease over their respective lives as currency exchange and interest rates fluctuate.
The Company also utilizes forward contracts to manage market risk associated with certain expected investment securities sales and equity options, which manage its market risk associated with certain customer deposit products.
For additional information on foreign exchange contracts, derivatives and hedging activities, see Note 14 to the Consolidated Financial Statements.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
BORROWINGS AND OTHER DEBT OBLIGATIONS
The Company has term loans and lines of credit with Santander and other lenders. The Bank utilizes borrowings and other debt obligations as a source of funds for its asset growth and asset/liability management. The Bank also utilizes repurchase agreements, which are short-term obligations collateralized by securities. In addition, SC has warehouse lines of credit and securitizes some of its RICs and operating leases, which are structured secured financings. Total borrowings and other debt obligations at December 31, 2018 were $45.0 billion, compared to $39.0 billion at December 31, 2017. Total borrowings increased $6.0 billion, primarily due to an increase of $2.9 billion in FHLB advances at the Bank and an overall increase of $3.2 billion in SC debt. See further detail on borrowings activity in Note 11 to the Consolidated Financial Statements.
Year Ended December 31, | ||||||
(Dollars in thousands) | 2018 | 2017 | ||||
Parent Company & other subsidiary borrowings and other debt obligations | ||||||
Parent Company senior notes: | ||||||
Balance | $8,351,685 | $7,995,462 | ||||
Weighted average interest rate at year-end | 3.79 | % | 3.67 | % | ||
Maximum amount outstanding at any month-end during the year | $8,351,685 | $7,995,462 | ||||
Average amount outstanding during the year | $7,626,199 | $5,965,006 | ||||
Weighted average interest rate during the year | 3.66 | % | 3.40 | % | ||
Junior subordinated debentures to capital trusts:(1) | ||||||
Balance | $0 | $154,102 | ||||
Weighted average interest rate at year-end | — | % | 3.14 | % | ||
Maximum amount outstanding at any month-end during the year | $154,640 | $233,902 | ||||
Average amount outstanding during the year | $118,650 | $203,502 | ||||
Weighted average interest rate during the year | 3.92 | % | 4.27 | % | ||
Subsidiary subordinated notes: | ||||||
Balance | $40,703 | $40,842 | ||||
Weighted average interest rate at year-end | 2.00 | % | 2.02 | % | ||
Maximum amount outstanding at any month-end during the year | $40,934 | $40,842 | ||||
Average amount outstanding during the year | $40,784 | $40,650 | ||||
Weighted average interest rate during the year | 2.03 | % | 2.02 | % | ||
Subsidiary short-term and overnight borrowings: | ||||||
Balance | $59,900 | $78,669 | ||||
Weighted average interest rate at year-end | 1.86 | % | 1.97 | % | ||
Maximum amount outstanding at any month-end during the year | $132,827 | $78,669 | ||||
Average amount outstanding during the year | $71,432 | $178,836 | ||||
Weighted average interest rate during the year | 2.19 | % | 1.97 | % | ||
(1) Includes related common securities.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Year Ended December 31, | ||||||
(Dollars in thousands) | 2018 | 2017 | ||||
Bank borrowings and other debt obligations | ||||||
Real estate investment trust ("REIT") preferred: | ||||||
Balance | $145,590 | $144,167 | ||||
Weighted average interest rate at year-end | 13.22 | % | 13.35 | % | ||
Maximum amount outstanding at any month-end during the year | $145,590 | $156,970 | ||||
Average amount outstanding during the year | $144,827 | $148,808 | ||||
Weighted average interest rate during the year | 13.22 | % | 13.35 | % | ||
Bank senior notes: | ||||||
Balance | $0 | $0 | ||||
Weighted average interest rate at year-end | — | % | — | % | ||
Maximum amount outstanding at any month-end during the year | $0 | $998,192 | ||||
Average amount outstanding during the year | $0 | $321,905 | ||||
Weighted average interest rate during the year | — | % | 2.25 | % | ||
Bank subordinated notes: | ||||||
Balance | $0 | $192,018 | ||||
Weighted average interest rate at year-end | — | % | 8.92 | % | ||
Maximum amount outstanding at any month-end during the year | $192,125 | $499,456 | ||||
Average amount outstanding during the year | $78,408 | $436,043 | ||||
Weighted average interest rate during the year | 9.04 | % | 8.94 | % | ||
Term loans: | ||||||
Balance | $126,172 | $139,794 | ||||
Weighted average interest rate at year-end | 8.57 | % | 7.47 | % | ||
Maximum amount outstanding at any month-end during the year | $139,888 | $151,616 | ||||
Average amount outstanding during the year | $130,722 | $143,838 | ||||
Weighted average interest rate during the year | 5.70 | % | 6.03 | % | ||
Securities sold under repurchase agreements: | ||||||
Balance | $0 | $150,000 | ||||
Weighted average interest rate at year-end | — | % | 1.56 | % | ||
Maximum amount outstanding at any month-end during the year | $150,000 | $150,000 | ||||
Average amount outstanding during the year | $41,096 | $35,847 | ||||
Weighted average interest rate during the year | 1.90 | % | 1.56 | % | ||
Federal funds purchased: | ||||||
Balance | $0 | $0 | ||||
Weighted average interest rate at year-end | — | % | — | % | ||
Maximum amount outstanding at any month-end during the year | $0 | $0 | ||||
Average amount outstanding during the year | $0 | $0 | ||||
Weighted average interest rate during the year | — | % | — | % | ||
FHLB advances: | ||||||
Balance | $4,850,000 | $1,950,000 | ||||
Weighted average interest rate at year-end | 2.74 | % | 1.53 | % | ||
Maximum amount outstanding at any month-end during the year | $4,850,000 | $5,550,000 | ||||
Average amount outstanding during the year | $2,025,479 | $4,222,603 | ||||
Weighted average interest rate during the year | 2.61 | % | 1.53 | % | ||
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Year Ended December 31, | ||||||
(Dollars in thousands) | 2018 | 2017 | ||||
SC borrowings and other debt obligations | ||||||
Revolving credit facilities: | ||||||
Balance | $4,478,214 | $5,598,316 | ||||
Weighted average interest rate at year-end | 3.92 | % | 2.73 | % | ||
Maximum amount outstanding at any month-end during the year | $5,632,053 | $6,449,441 | ||||
Average amount outstanding during the year | $5,043,462 | $5,932,121 | ||||
Weighted average interest rate during the year | 5.60 | % | 4.28 | % | ||
Public securitizations: | ||||||
Balance | $19,225,169 | $14,995,304 | ||||
Weighted average interest rate range at year-end | 1.16% - 3.53% | 0.89% - 2.80% | ||||
Maximum amount outstanding at any month-end during the year | $19,647,748 | $15,222,575 | ||||
Average amount outstanding during the year | $18,353,127 | $15,091,799 | ||||
Weighted average interest rate during the year | 2.52 | % | 2.64 | % | ||
Privately issued amortizing notes: | ||||||
Balance | $7,676,351 | $7,564,637 | ||||
Weighted average interest rate range at year-end | 0.88% - 3.17% | 0.88% - 4.09% | ||||
Maximum amount outstanding at any month-end during the year | $7,676,351 | $8,529,281 | ||||
Average amount outstanding during the year | $6,379,987 | $8,238,435 | ||||
Weighted average interest rate during the year | 3.54 | % | 2.39 | % | ||
NON-GAAP FINANCIAL MEASURES
The Company's non-GAAP information has limitations as an analytical tool and, therefore, should not be considered in isolation or as a substitute for analysis of our results or any performance measures under GAAP as set forth in the Company's financial statements. These limitations should be compensated for by relying primarily on the Company's GAAP results and using this non-GAAP information only as a supplement to evaluate the Company's performance.
The Company considers various measures when evaluating capital utilization and adequacy. These calculations are intended to complement the capital ratios defined by banking regulators for both absolute and comparative purposes. Because GAAP does not include capital ratio measures, the Company believes that there are no comparable GAAP financial measures to these ratios. These ratios are not formally defined by GAAP and are considered to be non-GAAP financial measures. Since analysts and banking regulators may assess the Company's capital adequacy using these ratios, the Company believes they are useful to provide investors the ability to assess its capital adequacy on the same basis. The Company believes these non-GAAP measures are important because they reflect the level of capital available to withstand unexpected market conditions. Additionally, presentation of these measures may allow readers to compare certain aspects of the Company's capitalization to other organizations. However, because there are no standardized definitions for these ratios, the Company's calculations may not be directly comparable with those of other organizations, and the usefulness of these measures to investors may be limited. As a result, the Company encourages readers to consider its Consolidated Financial Statements in their entirety and not to rely on any single financial measure.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following table includes the related GAAP measures included in our non-GAAP financial measures.
Year Ended December 31, | |||||||||||||||||||||||
(Dollars in thousands) | 2018 | 2017 | 2016 | 2015 (1) | 2014 | ||||||||||||||||||
Return on Average Assets: | |||||||||||||||||||||||
Net income/(loss) | $ | 991,035 | $ | 957,975 | $ | 640,763 | $ | (3,055,436 | ) | $ | 3,034,095 | ||||||||||||
Average assets | 131,232,021 | 134,522,957 | 141,921,781 | 140,461,913 | 123,410,743 | ||||||||||||||||||
Return on average assets | 0.76% | 0.71% | 0.45% | (2.18)% | 2.46% | ||||||||||||||||||
Return on Average Equity: | |||||||||||||||||||||||
Net income/(loss) | $ | 991,035 | $ | 957,975 | $ | 640,763 | $ | (3,055,436 | ) | $ | 3,034,095 | ||||||||||||
Average equity | 24,103,584 | 23,388,410 | 22,232,729 | 25,495,652 | 23,434,691 | ||||||||||||||||||
Return on average equity | 4.11% | 4.10% | 2.88% | (11.98)% | 12.95% | ||||||||||||||||||
Average Equity to Average Assets: | |||||||||||||||||||||||
Average equity | $ | 24,103,584 | $ | 23,388,410 | $ | 22,232,729 | $ | 25,495,652 | $ | 23,434,691 | |||||||||||||
Average assets | 131,232,021 | 134,522,957 | 141,921,781 | 140,461,913 | 123,410,743 | ||||||||||||||||||
Average equity to average assets | 18.37% | 17.39% | 15.67% | 18.15% | 18.99% | ||||||||||||||||||
Efficiency Ratio: | |||||||||||||||||||||||
General, administrative, and other expenses (numerator) | $ | 5,832,325 | $ | 5,764,324 | $ | 5,386,194 | $ | 9,381,892 | $ | 4,135,346 | |||||||||||||
Net interest income | $ | 6,344,850 | $ | 6,423,950 | $ | 6,564,692 | $ | 6,901,406 | $ | 6,243,100 | |||||||||||||
Non-interest income | 3,244,308 | 2,901,253 | 2,755,705 | 2,905,035 | 5,059,462 | ||||||||||||||||||
Total net interest income and non-interest income (denominator) | 9,589,158 | 9,325,203 | 9,320,397 | 9,806,441 | 11,302,562 | ||||||||||||||||||
Efficiency ratio | 60.82% | 61.81% | 57.79% | 95.67% | 36.59% | ||||||||||||||||||
(1) General, administrative, and other expenses includes $4.5 billion goodwill impairment charge on SC. | |||||||||||||||||||||||
Transitional | Fully Phased In(4) | ||||||||||||||||||||||
SBNA | SHUSA | SBNA | SHUSA | ||||||||||||||||||||
December 31, 2018 | December 31, 2017 | December 31, 2018 | December 31, 2017 | December 31, 2018 | December 31, 2018 | ||||||||||||||||||
Common Equity Tier 1(1) | Common Equity Tier 1(1) | Common Equity Tier 1(1) | Common Equity Tier 1(1) | Common Equity Tier 1(1) | Common Equity Tier 1(1) | ||||||||||||||||||
Total stockholder's equity (GAAP) | $ | 13,407,676 | $ | 13,522,396 | $ | 21,321,057 | $ | 21,173,981 | $ | 13,407,676 | $ | 21,321,057 | |||||||||||
Less: Preferred stock | — | — | — | (195,445 | ) | — | — | ||||||||||||||||
Goodwill | (3,402,637 | ) | (3,402,637 | ) | (4,444,389 | ) | (4,444,389 | ) | (3,402,637 | ) | (4,444,389 | ) | |||||||||||
Intangible assets | (2,176 | ) | (2,751 | ) | (475,193 | ) | (535,753 | ) | (2,176 | ) | (475,193 | ) | |||||||||||
Deferred taxes on goodwill and intangible assets | 238,747 | 220,218 | 392,563 | 372,036 | 238,747 | 392,563 | |||||||||||||||||
Other adjustments to CET1(3) | (230,942 | ) | (157,707 | ) | (39,275 | ) | 196,989 | (230,942 | ) | (39,275 | ) | ||||||||||||
Disallowed deferred tax assets | (167,701 | ) | (391,449 | ) | (317,667 | ) | (423,554 | ) | (167,701 | ) | (317,667 | ) | |||||||||||
Accumulated other comprehensive loss | 336,332 | 226,704 | 321,652 | 198,431 | 336,332 | 321,652 | |||||||||||||||||
CET1 capital (numerator) | $ | 10,179,299 | $ | 10,014,774 | $ | 16,758,748 | $ | 16,342,296 | $ | 10,179,299 | $ | 16,758,748 | |||||||||||
RWAs (denominator)(2) | 59,394,280 | 55,110,740 | 107,915,606 | 99,756,459 | 60,406,730 | 108,937,614 | |||||||||||||||||
Ratio | 17.14 | % | 18.17 | % | 15.53 | % | 16.38 | % | 16.85 | % | 15.38 | % | |||||||||||
(1) | CET1 is calculated under Basel III regulations required as of January 1, 2015. |
(2) | Under the banking agencies' risk-based capital guidelines, assets and credit equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. The resulting weighted values are added together with the measure for market risk, resulting in the Company's and the Bank's total RWAs. |
(3) | Represents the impact of NCI, transitional and other intangible adjustments for regulatory capital. |
(4) | Represents non-GAAP measures |
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
SELECTED QUARTERLY CONSOLIDATED FINANCIAL DATA
The following table presented selected quarterly consolidated financial data (unaudited):
THREE MONTHS ENDED | ||||||||||||||||||||||||||||||||
(in thousands) | December 31, 2018 | September 30, 2018 | June 30, 2018 | March 31, 2018 | December 31, 2017 | September 30, 2017 | June 30, 2017 | March 31, 2017 | ||||||||||||||||||||||||
Total interest income | $ | 2,094,575 | $ | 2,042,938 | $ | 2,001,073 | $ | 1,930,467 | $ | 1,913,105 | $ | 1,987,140 | $ | 1,991,278 | $ | 1,984,556 | ||||||||||||||||
Total interest expense | 490,925 | 444,177 | 408,987 | 380,114 | 361,564 | 379,840 | 357,696 | 353,029 | ||||||||||||||||||||||||
Net interest income | 1,603,650 | 1,598,761 | 1,592,086 | 1,550,353 | 1,551,541 | 1,607,300 | 1,633,582 | 1,631,527 | ||||||||||||||||||||||||
Provision for credit losses | 731,202 | 621,014 | 433,802 | 553,880 | 694,108 | 686,685 | 607,493 | 771,658 | ||||||||||||||||||||||||
Net interest income after provision for credit loss | 872,448 | 977,747 | 1,158,284 | 996,473 | 857,433 | 920,615 | 1,026,089 | 859,869 | ||||||||||||||||||||||||
Gain/(loss) on investment securities, net | (4,785 | ) | (1,688 | ) | 419 | (663 | ) | (18,719 | ) | 6,707 | 9,049 | 519 | ||||||||||||||||||||
Total fees and other income | 806,664 | 823,744 | 818,754 | 801,863 | 668,610 | 788,772 | 720,761 | 725,554 | ||||||||||||||||||||||||
General, administrative and other expenses | 1,490,829 | 1,450,387 | 1,449,749 | 1,441,360 | 1,639,788 | 1,386,945 | 1,387,044 | 1,350,547 | ||||||||||||||||||||||||
Income/(loss) before income taxes | 183,498 | 349,416 | 527,708 | 356,313 | (132,464 | ) | 329,149 | 368,855 | 235,395 | |||||||||||||||||||||||
Income tax provision/(benefit) | 51,738 | 109,949 | 168,151 | 96,062 | (414,073 | ) | 92,942 | 87,868 | 76,223 | |||||||||||||||||||||||
Net income before NCI | 131,760 | 239,467 | 359,557 | 260,251 | 281,609 | 236,207 | 280,987 | 159,172 | ||||||||||||||||||||||||
Less: Net income attributable to NCI | 31,861 | 72,491 | 104,141 | 75,138 | 180,174 | 74,851 | 101,877 | 48,723 | ||||||||||||||||||||||||
Net income attributable to SHUSA | $ | 99,899 | $ | 166,976 | $ | 255,416 | $ | 185,113 | $ | 101,435 | $ | 161,356 | $ | 179,110 | $ | 110,449 | ||||||||||||||||
2018 FOURTH QUARTER RESULTS
SHUSA reported net income for the fourth quarter of 2018 of $131.8 million, compared to a net income of $239.5 million for the third quarter of 2018 and net income of $281.6 million for the fourth quarter of 2017.
During the fourth quarter of 2018, the Company had a net loss on investment securities of $4.8 million, compared to a net loss of $1.7 million during the third quarter of 2018 and a net loss of $18.7 million during the fourth quarter of 2017. The net loss on investment securities for the fourth quarter of 2018 was primarily due to losses incurred on the sale of CMOs.
The provision for credit losses was $731.2 million for the fourth quarter of 2018, compared to $621.0 million for the third quarter of 2018 and $694.1 million for the fourth quarter of 2017. The increase in the provision for credit losses from the third quarter of 2018 to the fourth quarter of 2018 was primarily to replenish the allowance for charge-offs incurred during the fourth quarter, as the ALLL remained consistent quarter over quarter. The increase in the provision from the fourth quarter of 2017 to the fourth quarter of 2018 was primarily due to higher net charge-off activity in the fourth quarter of 2018 for both the commercial and consumer portfolios, which was partially offset by lower provisions for unfunded commitments, compared to the fourth quarter of 2017.
Total fees and other income for the fourth quarter of 2018 were $806.7 million, compared to $823.7 million for the third quarter of 2018 and $668.6 million for the fourth quarter of 2017. The quarter over quarter decrease was driven by the mark to fair value on the unsecured loan portfolio held for sale, offset by higher lease income. The increase from the fourth quarter of 2018 compared to the fourth quarter of 2017 was primarily due to higher lease income from the continued growth in the Company's lease portfolio over the year.
General, administrative and other expenses for the fourth quarter of 2018 were $1.5 billion, compared to $1.5 billion for the third quarter of 2018 and $1.6 billion for the fourth quarter of 2017. The decrease in the fourth quarter of 2018 compared to the fourth quarter of 2017, was primarily due to a decrease in legal expenses, loss on debt extinguishment, and compensation and benefits expenses. In addition there were impairments to goodwill and long-lived assets recorded in fourth quarter of 2017. These decreases were offset by an increase in lease expenses from the continued growth in the Company's lease portfolio over the year.
Income tax provision for the fourth quarter of 2018 was $51.7 million, compared to an income tax provision of $109.9 million in the third quarter of 2018 and an income tax benefit of $414.1 million in the fourth quarter of 2017. The lower provision between the third quarter of 2018 and the fourth quarter of 2018 was a result of lower profits. The benefit in the fourth quarter of 2017 was primarily due to re-measuring our net deferred tax liabilities due to the federal rate reduction that occurred during the fourth quarter of 2017 in connection with the TCJA.
93
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Incorporated by reference from Part II, Item 7, MD&A — "Asset and Liability Management" above.
ITEM 8 - CONSOLIDATED FINANCIAL STATEMENTS
Index to Consolidated Financial Statements and Supplementary Data | Page |
94
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholder of
Santander Holdings USA, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Santander Holdings USA, Inc. and its subsidiaries (the "Company") as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income/(loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company did not maintain, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO because material weaknesses in internal control over financial reporting existed as of that date related to (i) the Company’s ineffective control environment, (ii) the ineffective control environment, risk assessment, control activities and monitoring at the Company’s consolidated subsidiary Santander Consumer USA Holdings Inc., and (iii) the Company’s ineffective review of the statement of cash flows and the notes to the consolidated financial statements.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses referred to above are described in Management's Annual Report on Internal Control over Financial Reporting appearing under Item 9A. We considered these material weaknesses in determining the nature, timing, and extent of audit tests applied in our audit of the 2018 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in management's report referred to above. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
95
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed 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 company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’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. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
March 15, 2019
We have served as the Company’s auditor since 2016.
96
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2018 | December 31, 2017 | ||||||
(in thousands) | |||||||
ASSETS | |||||||
Cash and cash equivalents | $ | 7,790,593 | $ | 6,519,967 | |||
Investment securities: | |||||||
Available-for-sale ("AFS") at fair value | 11,632,987 | 14,413,183 | |||||
Held-to-maturity ("HTM") (fair value of $2,676,049 and $1,773,938 as of December 31, 2018 and December 31, 2017, respectively) | 2,750,680 | 1,799,808 | |||||
Other investments (includes Trading securities of $10 and $1 as of December 31, 2018 and December 31, 2017, respectively) | 805,357 | 658,864 | |||||
Loans held-for-investment ("LHFI")(1) (5) | 87,045,868 | 80,790,681 | |||||
Allowance for loan and lease losses ("ALLL") (5) | (3,897,130 | ) | (3,994,887 | ) | |||
Net LHFI | 83,148,738 | 76,795,794 | |||||
Loans held-for-sale ("LHFS") (2) | 1,283,278 | 2,522,486 | |||||
Premises and equipment, net (3) | 805,940 | 849,061 | |||||
Operating lease assets, net (5)(6) | 14,078,793 | 10,474,308 | |||||
Goodwill | 4,444,389 | 4,444,389 | |||||
Intangible assets, net | 475,193 | 535,753 | |||||
Bank-owned life insurance ("BOLI") | 1,833,290 | 1,795,700 | |||||
Restricted cash (5) | 2,931,711 | 3,818,807 | |||||
Other assets (4) (5) | 3,653,336 | 3,646,405 | |||||
TOTAL ASSETS | $ | 135,634,285 | $ | 128,274,525 | |||
LIABILITIES | |||||||
Accrued expenses and payables | $ | 3,035,848 | $ | 2,825,263 | |||
Deposits and other customer accounts | 61,511,380 | 60,831,103 | |||||
Borrowings and other debt obligations (5) | 44,953,784 | 39,003,313 | |||||
Advance payments by borrowers for taxes and insurance | 160,728 | 159,321 | |||||
Deferred tax liabilities, net | 1,212,538 | 965,290 | |||||
Other liabilities (5) | 912,775 | 799,403 | |||||
TOTAL LIABILITIES | 111,787,053 | 104,583,693 | |||||
Commitments and Contingencies (Note 16) | |||||||
STOCKHOLDER'S EQUITY | |||||||
Preferred stock (no par value; $25,000 liquidation preference; 7,500,000 shares authorized; zero and 8,000 shares outstanding at December 31, 2018 and December 31, 2017, respectively) | — | 195,445 | |||||
Common stock and paid-in capital (no par value; 800,000,000 shares authorized; 530,391,043 shares outstanding at both December 31, 2018 and December 31, 2017) | 17,859,304 | 17,723,010 | |||||
Accumulated other comprehensive loss | (321,652 | ) | (198,431 | ) | |||
Retained earnings | 3,783,405 | 3,453,957 | |||||
TOTAL SANTANDER HOLDINGS USA, INC. ("SHUSA") STOCKHOLDER'S EQUITY | 21,321,057 | 21,173,981 | |||||
Noncontrolling interest ("NCI") | 2,526,175 | 2,516,851 | |||||
TOTAL STOCKHOLDER'S EQUITY | 23,847,232 | 23,690,832 | |||||
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY | $ | 135,634,285 | $ | 128,274,525 | |||
(1) LHFI includes $126.3 million and $186.5 million of loans recorded at fair value at December 31, 2018 and December 31, 2017, respectively.
(2) Includes $209.5 million and $197.7 million of loans recorded at the fair value option ("FVO") at December 31, 2018 and December 31, 2017, respectively.
(3) Net of accumulated depreciation of $1.4 billion and $1.4 billion at December 31, 2018 and December 31, 2017, respectively.
(4) Includes mortgage servicing rights ("MSRs") of $149.7 million and $146.0 million at December 31, 2018 and December 31, 2017, respectively, for which the Company has elected the FVO. See Note 16 to these Consolidated Financial Statements for additional information.
(5) The Company has interests in certain securitization trusts ("Trusts") that are considered variable interest entities ("VIEs") for accounting purposes. At December 31, 2018 and December 31, 2017, LHFI included $24.1 billion and $22.7 billion, Operating leases assets, net included $14.0 billion and $10.2 billion, restricted cash included $1.6 billion and $2.0 billion, other assets included $685.4 million and $747.1 million, Borrowings and other debt obligations included $31.9 billion and $28.5 billion, and Other Liabilities included $122.0 million and $198.0 million of assets or liabilities that were included within VIEs, respectively. See Note 7 to these Consolidated Financial Statements for additional information.
(6) Net of accumulated depreciation of $3.5 billion and $3.4 billion at December 31, 2018 and December 31, 2017, respectively.
See accompanying notes to Consolidated Financial Statements.
97
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
(in thousands) | ||||||||||||
INTEREST INCOME: | ||||||||||||
Loans | $ | 7,546,376 | $ | 7,377,345 | $ | 7,611,347 | ||||||
Interest-earning deposits | 137,753 | 86,205 | 57,361 | |||||||||
Investment securities: | ||||||||||||
AFS | 297,557 | 352,601 | 284,796 | |||||||||
HTM | 68,525 | 38,609 | 3,526 | |||||||||
Other investments | 18,842 | 21,319 | 32,721 | |||||||||
TOTAL INTEREST INCOME | 8,069,053 | 7,876,079 | 7,989,751 | |||||||||
INTEREST EXPENSE: | ||||||||||||
Deposits and other customer accounts | 389,128 | 241,044 | 277,022 | |||||||||
Borrowings and other debt obligations | 1,335,075 | 1,211,085 | 1,148,037 | |||||||||
TOTAL INTEREST EXPENSE | 1,724,203 | 1,452,129 | 1,425,059 | |||||||||
NET INTEREST INCOME | 6,344,850 | 6,423,950 | 6,564,692 | |||||||||
Provision for credit losses | 2,339,898 | 2,759,944 | 2,979,725 | |||||||||
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES | 4,004,952 | 3,664,006 | 3,584,967 | |||||||||
NON-INTEREST INCOME: | ||||||||||||
Consumer and commercial fees | 568,147 | 616,438 | 689,839 | |||||||||
Lease income | 2,375,596 | 2,017,775 | 1,839,307 | |||||||||
Miscellaneous income, net(1) (2) | 307,282 | 269,484 | 169,056 | |||||||||
TOTAL FEES AND OTHER INCOME | 3,251,025 | 2,903,697 | 2,698,202 | |||||||||
Other-than-temporary impairment ("OTTI") recognized in earnings | — | — | (44 | ) | ||||||||
Net (losses)/gains on sale of investment securities | (6,717 | ) | (2,444 | ) | 57,547 | |||||||
Net (losses)/gains recognized in earnings | (6,717 | ) | (2,444 | ) | 57,503 | |||||||
TOTAL NON-INTEREST INCOME | 3,244,308 | 2,901,253 | 2,755,705 | |||||||||
GENERAL, ADMINISTRATIVE AND OTHER EXPENSES: | ||||||||||||
Compensation and benefits | 1,799,369 | 1,895,326 | 1,719,645 | |||||||||
Occupancy and equipment expenses | 659,789 | 669,113 | 618,597 | |||||||||
Technology, outside service, and marketing expense | 590,249 | 581,164 | 644,079 | |||||||||
Loan expense | 384,899 | 386,468 | 415,267 | |||||||||
Lease expense | 1,789,030 | 1,553,096 | 1,305,712 | |||||||||
Other expenses | 608,989 | 679,157 | 682,894 | |||||||||
TOTAL GENERAL, ADMINISTRATIVE AND OTHER EXPENSES | 5,832,325 | 5,764,324 | 5,386,194 | |||||||||
INCOME BEFORE INCOME TAX PROVISION | 1,416,935 | 800,935 | 954,478 | |||||||||
Income tax provision/(benefit) | 425,900 | (157,040 | ) | 313,715 | ||||||||
NET INCOME INCLUDING NCI | 991,035 | 957,975 | 640,763 | |||||||||
LESS: NET INCOME ATTRIBUTABLE TO NCI | 283,631 | 405,625 | 277,879 | |||||||||
NET INCOME ATTRIBUTABLE TO SHUSA | $ | 707,404 | $ | 552,350 | $ | 362,884 | ||||||
(1) Includes impact of $382.3 million, $386.4 million, and $424.1 million in 2018, 2017, and 2016 of lower of cost or market adjustments on a portion of the Company's LHFS portfolio.
(2) Includes equity investment (income)/expense, net.
See accompanying notes to Consolidated Financial Statements.
98
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
Year Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
(in thousands) | |||||||||||
NET INCOME INCLUDING NCI | $ | 991,035 | $ | 957,975 | $ | 640,763 | |||||
OTHER COMPREHENSIVE INCOME, NET OF TAX | |||||||||||
Net unrealized (losses) / gains on cash flow hedge derivative financial instruments, net of tax (1),(2) | (3,796 | ) | 337 | 9,856 | |||||||
Net unrealized (losses) / gains on AFS and HTM investment securities, net of tax (2) | (80,891 | ) | (9,744 | ) | (34,812 | ) | |||||
Pension and post-retirement actuarial gains / (losses), net of tax(2) | 560 | 4,184 | 2,278 | ||||||||
TOTAL OTHER COMPREHENSIVE (LOSS) / GAIN, NET OF TAX | (84,127 | ) | (5,223 | ) | (22,678 | ) | |||||
COMPREHENSIVE INCOME | 906,908 | 952,752 | 618,085 | ||||||||
NET INCOME ATTRIBUTABLE TO NCI | 283,631 | 405,625 | 277,879 | ||||||||
COMPREHENSIVE INCOME ATTRIBUTABLE TO SHUSA | $ | 623,277 | $ | 547,127 | $ | 340,206 | |||||
(1) Excludes $3.1 million, $6.0 million, $10.8 million of other comprehensive income attributable to NCI for the years ended December 31, 2018, 2017, 2016, respectively.
(2) Excludes $39.1 million impact of other comprehensive income reclassified to Retained earnings as a result of the adoption of Accounting Standards Update ("ASU") 2018-02.
See accompanying notes to Consolidated Financial Statements.
99
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER’S EQUITY
Common Shares Outstanding | Preferred Stock | Common Stock and Paid-in Capital | Accumulated Other Comprehensive (Loss)/Income | Retained Earnings | Noncontrolling Interest | Total Stockholder's Equity | ||||||||||||||||||||
Balance, January 1, 2016 | 530,391 | $ | 270,445 | $ | 16,629,822 | $ | (170,530 | ) | $ | 2,672,393 | $ | 2,444,970 | $ | 21,847,100 | ||||||||||||
Comprehensive income attributable to SHUSA | — | — | — | (22,678 | ) | 362,884 | — | 340,206 | ||||||||||||||||||
Other comprehensive income attributable to NCI | — | — | — | — | — | 10,807 | 10,807 | |||||||||||||||||||
Net Income attributable to NCI | — | — | — | — | — | 277,879 | 277,879 | |||||||||||||||||||
Impact of SC stock option activity | — | — | 69 | — | — | 23,219 | 23,288 | |||||||||||||||||||
Redemption of preferred stock | (75,000 | ) | — | — | — | — | (75,000 | ) | ||||||||||||||||||
Capital distribution of shareholder | — | — | (30,789 | ) | — | — | — | (30,789 | ) | |||||||||||||||||
Stock issued in connection with employee benefit and incentive compensation plans | — | — | 395 | — | — | — | 395 | |||||||||||||||||||
Dividends paid on preferred stock | — | — | — | — | (15,128 | ) | — | (15,128 | ) | |||||||||||||||||
Balance, December 31, 2016 | 530,391 | $ | 195,445 | $ | 16,599,497 | $ | (193,208 | ) | $ | 3,020,149 | $ | 2,756,875 | $ | 22,378,758 | ||||||||||||
Cumulative effect adjustment upon adoption of ASU 2016-09 | — | — | (26,457 | ) | — | 14,763 | 37,401 | 25,707 | ||||||||||||||||||
Comprehensive (loss)/income attributable to SHUSA | — | — | — | (5,223 | ) | 552,350 | — | 547,127 | ||||||||||||||||||
Other comprehensive income attributable to NCI | — | — | — | — | — | 6,048 | 6,048 | |||||||||||||||||||
Net income attributable to NCI | — | — | — | — | — | 405,625 | 405,625 | |||||||||||||||||||
Impact of SC stock option activity | — | — | — | — | — | 22,116 | 22,116 | |||||||||||||||||||
Contribution of Santander Financial Services ("SFS") from shareholder (Note 1) | — | — | 430,783 | — | (108,705 | ) | — | 322,078 | ||||||||||||||||||
Capital contribution from shareholder (Note 13) | — | — | 11,747 | — | — | — | 11,747 | |||||||||||||||||||
Contribution of incremental SC shares from shareholder | — | — | 707,589 | — | — | (707,589 | ) | — | ||||||||||||||||||
Dividends paid to NCI | — | — | — | — | — | (4,475 | ) | (4,475 | ) | |||||||||||||||||
Stock issued in connection with employee benefit and incentive compensation plans | — | — | (149 | ) | — | — | 850 | 701 | ||||||||||||||||||
Dividends declared and paid on common stock | — | — | — | — | (10,000 | ) | — | (10,000 | ) | |||||||||||||||||
Dividends declared and paid on preferred stock | — | — | — | — | (14,600 | ) | — | (14,600 | ) | |||||||||||||||||
Balance, December 31, 2017 | 530,391 | $ | 195,445 | $ | 17,723,010 | $ | (198,431 | ) | $ | 3,453,957 | $ | 2,516,851 | $ | 23,690,832 | ||||||||||||
Cumulative-effect adjustment upon adoption of new ASUs and other (Note 1) | — | — | — | (39,094 | ) | 47,549 | — | 8,455 | ||||||||||||||||||
Comprehensive (loss)/income attributable to SHUSA | — | — | — | (84,127 | ) | 707,404 | — | 623,277 | ||||||||||||||||||
Other comprehensive income attributable to NCI | — | — | — | — | — | (3,130 | ) | (3,130 | ) | |||||||||||||||||
Net income attributable to NCI | — | — | — | — | — | 283,631 | 283,631 | |||||||||||||||||||
Impact of SC stock option activity | — | — | — | — | — | 12,411 | 12,411 | |||||||||||||||||||
Contribution from shareholder and related tax impact (Note 13) | — | — | 88,468 | — | — | — | 88,468 | |||||||||||||||||||
Contribution of Santander Asset Management, LLC ("SAM") from shareholder (Note 1) | — | — | 4,396 | — | — | — | 4,396 | |||||||||||||||||||
Redemption of preferred stock | — | (195,445 | ) | — | — | (4,555 | ) | — | (200,000 | ) | ||||||||||||||||
Dividends declared and paid on common stock | — | — | — | — | (410,000 | ) | — | (410,000 | ) | |||||||||||||||||
Dividends declared and paid to NCI | — | — | — | — | — | (57,511 | ) | (57,511 | ) | |||||||||||||||||
Stock repurchase attributable to NCI | — | — | 43,430 | — | — | (226,077 | ) | (182,647 | ) | |||||||||||||||||
Dividends declared and paid on preferred stock | — | — | — | — | (10,950 | ) | — | (10,950 | ) | |||||||||||||||||
Balance, December 31, 2018 | 530,391 | $ | — | $ | 17,859,304 | $ | (321,652 | ) | $ | 3,783,405 | $ | 2,526,175 | $ | 23,847,232 | ||||||||||||
See accompanying notes to Consolidated Financial Statements.
100
SANTANDER HOLDINGS USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, | |||||||||||
2018 | 2017 | 2016 | |||||||||
(in thousands) | |||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||||||
Net income including NCI | $ | 991,035 | $ | 957,975 | $ | 640,763 | |||||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
Impairment of goodwill | — | 10,536 | — | ||||||||
Provision for credit losses | 2,339,898 | 2,759,944 | 2,979,725 | ||||||||
Deferred tax expense/(benefit) | 416,875 | (196,614 | ) | 213,949 | |||||||
Depreciation, amortization and accretion | 1,913,225 | 1,606,862 | 1,272,415 | ||||||||
Net loss on sale of loans | 379,181 | 373,532 | 455,330 | ||||||||
Net loss/(gain) on sale of investment securities | 6,717 | 2,444 | (57,547 | ) | |||||||
OTTI recognized in earnings | — | — | 44 | ||||||||
Loss on debt extinguishment | 3,470 | 30,349 | 114,232 | ||||||||
Net loss/(gain) on real estate owned and premises and equipment | 10,610 | (9,567 | ) | 10,644 | |||||||
Stock-based compensation | 913 | 4,674 | 17,677 | ||||||||
Equity (income)/loss on equity method investments | (4,324 | ) | 28,323 | 11,054 | |||||||
Originations of LHFS, net of repayments | (2,982,366 | ) | (4,920,570 | ) | (6,215,770 | ) | |||||
Purchases of LHFS | (1,381 | ) | (4,280 | ) | (4,730 | ) | |||||
Proceeds from sales of LHFS | 4,264,959 | 4,601,777 | 5,883,608 | ||||||||
Purchases of trading securities | (1,749 | ) | (3,015 | ) | (629,947 | ) | |||||
Proceeds from sales of trading securities | 3,875 | 18,347 | 657,494 | ||||||||
Net change in: | |||||||||||
Revolving personal loans | (371,716 | ) | (329,168 | ) | (317,506 | ) | |||||
Other assets and BOLI | (202,506 | ) | (114,638 | ) | 98,331 | ||||||
Other liabilities | 248,345 | 147,149 | 141,776 | ||||||||
NET CASH PROVIDED BY OPERATING ACTIVITIES | 7,015,061 | 4,964,060 | 5,271,542 | ||||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||||||
Proceeds from sales of AFS investment securities | 1,262,409 | 3,216,595 | 6,755,299 | ||||||||
Proceeds from prepayments and maturities of AFS investment securities | 2,616,417 | 5,231,910 | 10,209,477 | ||||||||
Purchases of AFS investment securities | (2,421,286 | ) | (6,248,059 | ) | (12,205,062 | ) | |||||
Proceeds from prepayments and maturities of HTM investment securities | 338,932 | 200,085 | 11,784 | ||||||||
Purchases of HTM investment securities | (135,898 | ) | (352,786 | ) | (1,671,285 | ) | |||||
Proceeds from sales of other investments | 153,294 | 327,029 | 492,761 | ||||||||
Proceeds from maturities of other investments | 45 | 560 | 45 | ||||||||
Purchases of other investments | (214,427 | ) | (217,007 | ) | (172,292 | ) | |||||
Proceeds from sales of LHFI | 1,016,652 | 1,227,052 | 1,737,780 | ||||||||
Proceeds from the sales of equity method investments | — | 25,145 | — | ||||||||
Distributions from equity method investments | 9,889 | 10,522 | 4,819 | ||||||||
Contributions to equity method and other investments | (122,816 | ) | (87,267 | ) | (42,798 | ) | |||||
Proceeds from settlements of BOLI policies | 20,931 | 37,028 | 18,452 | ||||||||
Purchases of LHFI | (1,243,574 | ) | (723,793 | ) | (278,810 | ) | |||||
Net change in loans other than purchases and sales | (8,462,103 | ) | 2,724,489 | (1,843,299 | ) | ||||||
Purchases and originations of operating leases | (9,859,861 | ) | (6,036,193 | ) | (5,642,120 | ) | |||||
Proceeds from the sale and termination of operating leases | 3,588,820 | 3,119,264 | 2,163,497 | ||||||||
Manufacturer incentives | 1,098,055 | 878,219 | 1,205,911 | ||||||||
Proceeds from sales of real estate owned and premises and equipment | 53,569 | 112,497 | 67,702 | ||||||||
Purchases of premises and equipment | (159,887 | ) | (164,111 | ) | (234,075 | ) | |||||
NET CASH (USED IN)/PROVIDED BY INVESTING ACTIVITIES | (12,460,839 | ) | 3,281,179 | 577,786 | |||||||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||||||
Net change in deposits and other customer accounts | 680,277 | (6,218,010 | ) | 1,657,262 | |||||||
Net change in short-term borrowings | (168,769 | ) | (50,331 | ) | (522,927 | ) | |||||
Net proceeds from long-term borrowings | 46,461,404 | 43,325,311 | 46,598,213 | ||||||||
Repayments of long-term borrowings | (43,277,142 | ) | (44,005,642 | ) | (44,567,564 | ) | |||||
Proceeds from Federal Home Loan Bank ("FHLB") advances (with terms greater than 3 months) | 4,900,000 | 1,000,000 | 5,850,000 | ||||||||
Repayments of FHLB advances (with terms greater than 3 months) | (2,000,000 | ) | (5,000,000 | ) | (13,799,232 | ) | |||||
Net change in advance payments by borrowers for taxes and insurance | 1,407 | (4,177 | ) | (7,639 | ) | ||||||
Cash dividends paid to preferred stockholders | (10,950 | ) | (14,600 | ) | (15,128 | ) | |||||
Dividends paid on common stock | (410,000 | ) | (10,000 | ) | — | ||||||
Dividends paid to NCI | (57,511 | ) | (4,475 | ) | — | ||||||
Stock repurchase attributable to NCI | (182,647 | ) | — | — | |||||||
Proceeds from the issuance of common stock | 8,204 | 13,652 | 7,979 | ||||||||
Capital contribution from shareholder | 85,035 | 9,000 | — | ||||||||
Redemption of preferred stock | (200,000 | ) | — | (75,000 | ) | ||||||
NET CASH PROVIDED BY/(USED IN) FINANCING ACTIVITIES | 5,829,308 | (10,959,272 | ) | (4,874,036 | ) | ||||||
NET INCREASE/(DECREASE) IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH (1) | 383,530 | (2,714,033 | ) | 975,292 | |||||||
CASH, CASH EQUIVALENTS AND RESTRICTED CASH, BEGINNING OF PERIOD (1) | 10,338,774 | 13,052,807 | 12,077,515 | ||||||||
CASH, CASH EQUIVALENTS AND RESTRICTED CASH, END OF PERIOD (1) | $ | 10,722,304 | $ | 10,338,774 | $ | 13,052,807 | |||||
SUPPLEMENTAL DISCLOSURES | |||||||||||
Income taxes paid/(received), net | $ | 26,261 | $ | 3,954 | $ | (146,132 | ) | ||||
Interest paid | 1,694,850 | 1,442,484 | 1,439,126 | ||||||||
NON-CASH TRANSACTIONS | |||||||||||
Loans transferred to/(from) other real estate owned | 86,467 | 44,650 | 83,364 | ||||||||
Loans transferred from/(to) held-for-investment ("HFI") (from)/to held-for-sale, net ("HFS") | 731,944 | 202,760 | 143,825 | ||||||||
Unsettled purchases of investment securities | 2,298 | — | 230,052 | ||||||||
Unsettled sales of investment securities | — | 39,783 | — | ||||||||
Residential loan securitizations | 3,844 | 18,214 | 26,736 | ||||||||
Contribution of SFS from shareholder (2) | — | 322,078 | — | ||||||||
Capital distribution to shareholder | — | — | 30,789 | ||||||||
Contribution of incremental SC shares from shareholder | — | 707,589 | — | ||||||||
Contribution of SAM from shareholder (2) | 4,396 | — | — | ||||||||
AFS investment securities transferred to HTM investment securities | 1,167,189 | — | — | ||||||||
(1) The beginning, ending and net change balances for the periods ended December 31, 2018, December 31, 2017, and December 31, 2016 include restricted cash balances of $3.8 billion, $2.9 billion, and $(887.1) million; $3.0 billion, $3.8 billion, and $801.9 million; and $2.6 billion, $3.0 billion, and $386.4 million, respectively.
(2) The contributions of SFS and SAM were accounted for as non-cash transactions. Refer to Note 1 - Basis of Presentation and Accounting Policies for additional information.
See accompanying notes to Consolidated Financial Statements.
101
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
Introduction
Santander Holdings USA, Inc. ("SHUSA" or "the Company") is the parent company (the "Parent Company") of Santander Bank, National Association, (the "Bank" or "SBNA"), a national banking association; Santander Consumer USA Holdings Inc. (together with its subsidiaries, "SC"), a consumer finance company; Santander BanCorp (together with its subsidiaries, "Santander BanCorp"), a financial holding company headquartered in Puerto Rico that offers a full range of financial services through its wholly-owned banking subsidiary, Banco Santander Puerto Rico ("BSPR"); Santander Securities LLC ("SSLLC"), a broker-dealer headquartered in Boston, Massachusetts; Banco Santander International ("BSI"), an Edge corporation located in Miami, Florida, that offers a full range of banking services to foreign individuals and corporations based primarily in Latin America; and Santander Investment Securities Inc. ("SIS"), a registered broker-dealer located in New York providing services in investment banking, institutional sales, and trading and offering research reports of Latin American and European equity and fixed income securities; as well as several other subsidiaries. SSLLC, SIS, and another SHUSA subsidiary, Santander Asset Management, LLC (“SAM”), are registered investment advisers with the Securities and Exchange Commission (the “SEC”). SHUSA is headquartered in Boston and the Bank's home office is in Wilmington, Delaware. SHUSA is a wholly-owned subsidiary of Banco Santander, S.A. ("Santander"). The Parent Company's two largest subsidiaries by asset size and revenue are the Bank and SC.
The Bank’s primary business consists of attracting deposits and providing other retail banking services through its network of retail branches, and originating small business loans, middle market, large and global commercial loans, multifamily loans, residential mortgage loans, home equity lines of credit, and auto and other consumer loans throughout the Mid-Atlantic and Northeastern areas of the United States, focused throughout Pennsylvania, New Jersey, New York, New Hampshire, Massachusetts, Connecticut, Rhode Island, and Delaware. The Bank uses its deposits, as well as other financing sources, to fund its loan and investment portfolios.
SC is a specialized consumer finance company focused on vehicle finance and third-party servicing. SC's primary business is the indirect origination and securitization of retail installment contracts ("RICs") principally through manufacturer-franchised dealers in connection with their sale of new and used vehicles to subprime retail consumers.
In conjunction with a ten-year private label financing agreement with Fiat Chrysler Automobiles US LLC ("FCA") that became effective May 1, 2013 (the "Chrysler Agreement"), SC offers a full spectrum of auto financing products and services to FCA customers and dealers under the Chrysler Capital brand. These products and services include consumer RICs and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. RICs and vehicle leases entered into with FCA customers, as part of the Chrysler Agreement represent a significant concentration of those portfolios and there is a risk that the Chrysler Agreement could be terminated prior to its expiration date. Termination of the Chrysler Agreement could result in a decrease in the amount of new RICs and vehicle leases entered into with FCA customers as well as dealer loans. Refer to Note 20 for additional details.
In June 2018, SC announced that it was in exploratory discussions with FCA regarding the future of FCA's U.S. finance operations. FCA has announced its intention to establish a captive U.S. auto finance unit and indicated that acquiring Chrysler Capital is one option it will consider. Under the Chrysler Agreement, FCA has the option to acquire, for fair market value, an equity participation in the business offering and providing financial services contemplated by the Chrysler Agreement. The likelihood, timing and structure of any such transaction, and the likelihood that the Chrysler Agreement will terminate, cannot be reasonably determined. In July 2018, FCA and the Company entered into a tolling agreement pursuant to which the parties agreed to preserve their respective rights, claims and defenses under the Chrysler Agreement as they existed on April 30, 2018 and to refrain from delivering a written notice to the other party under the Chrysler Agreement until December 31, 2018. FCA has not delivered a notice to exercise its equity option.
SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile and recreational and marine vehicle portfolios for other lenders. Additionally, SC has other relationships through which it provides personal loans, private-label revolving lines of credit and other consumer finance products.
As of December 31, 2018, SC was owned approximately 69.7% by SHUSA and 30.3% by other shareholders. SC Common Stock is listed on the New York Stock Exchange (the "NYSE") under the trading symbol "SC."
102
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Intermediate Holding Company ("IHC")
The enhanced prudential standards mandated by Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "DFA")(the “Final Rule") were enacted by the Federal Reserve System (the "Federal Reserve") to strengthen regulatory oversight of foreign banking organizations ("FBOs"). Under the Final Rule, FBOs with over $50 billion of U.S. non-branch assets, including Santander, are required to consolidate U.S. subsidiary activities under an IHC. Due to its U.S. non-branch total consolidated asset size, Santander is subject to the Final Rule. As a result of this rule, Santander transferred substantially all of its equity interests in U.S. bank and non-bank subsidiaries previously outside the Company to the Company, which became an IHC effective July 1, 2016. These subsidiaries included Santander BanCorp, BSI, SIS and SSLLC, as well as several other subsidiaries. On July 1, 2017, an additional Santander subsidiary, SFS, a finance company located in Puerto Rico, was transferred to the Company. Additionally, effective July 2, 2018, Santander transferred SAM to the IHC. The contribution of SAM to the Company transferred approximately $5.4 million of assets, $1.0 million of liabilities, and $4.4 million of equity to the Company.
Although SAM is an entity under common control, its results of operations, financial condition, and cash flows are immaterial to the historical financial results of the Company. As a result, the Company elected to report the results of SAM on a prospective basis beginning July 2, 2018. SFS’ results of operations, financial condition, and cash flows are immaterial to the historical financial results of the Company and the Company also elected to report its results prospectively. As a result of the 2017 contribution of SFS in 2017 and SAM in 2018, SHUSA's net income is understated by $1.0 million and $6.0 million for the years ended December 31, 2018 and 2017, respectively, and overstated for the year ended December 31, 2016 by $9.3 million. In addition, a contribution to stockholder's equity of $4.4 million and $322.1 million was recorded on July 2, 2018, and July 1, 2017, respectively. These amounts are immaterial to the overall presentation of the Company's financial statements for each of the periods presented.
Basis of Presentation
These Condensed Consolidated Financial Statements include accounts of the Company and its consolidated subsidiaries, and certain special purpose financing trusts that are considered VIEs. The Company generally consolidates VIEs for which it is deemed to be the primary beneficiary and voting interest entities ("VOEs") in which the Company has a controlling financial interest. All significant intercompany balances and transactions have been eliminated in consolidation. These Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") and pursuant to SEC regulations. Additionally, where applicable, the Company's accounting policies conform to the accounting and reporting guidelines prescribed by bank regulatory authorities. In the opinion of management, the accompanying Consolidated Financial Statements reflect all adjustments of a normal and recurring nature necessary for a fair statement of the Consolidated Balance Sheets, Statements of Operations, Statements of Comprehensive Income, Statements of Stockholder's Equity and Statements of Cash Flows ("SCF") for the periods indicated, and contain adequate disclosure to make the information presented not misleading.
Corrections to Previously Reported Amounts
Certain accounting for RICs and auto loans
In connection with preparing its financial statements for the quarter ended September 30, 2018, the Company identified and corrected two immaterial errors. To correct the errors, the Company has prepared its Consolidated Financial Statement as of and for the period ended December 31, 2018 on a corrected basis and revised its comparative Consolidated Financial Statements included in this Form 10-K. The matters giving rise to the corrections are summarized below:
• | For core retail auto loans originated at SC after January 1, 2017, as previously disclosed, the Company had determined past due status using a 90% required minimum payment threshold, while continuing to use a 50% threshold to report past due status on core retail auto loans originated prior to that date. SC had accounted for this change as a change in accounting estimate. In the third quarter of 2018, the Company and SC determined that a borrower’s payment of 50% of the contractual amount was not sufficient to qualify as substantially all of the contractual payments due, and historically a 90% required minimum payment threshold should be used for all loans and prior reporting was in error. Therefore, the consolidated financial statements and related delinquency disclosures have been corrected to be on that basis. |
103
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
• | On January 1, 2017, as previously disclosed, SC prospectively began classifying as non-accrual loans (1) any loans designated as troubled debt restructurings (“TDRs") and 60 days past due at the time of TDR and (2) any loans less than 60 days past due at the time of TDR that had a third instance of deferral. These TDR loans were also placed on a cost recovery basis from that time forward and not returned to accrual status until there was sustained evidence of collectability. The Company treated the changes as changes in an accounting estimate. In the third quarter of 2018, the Company determined that the changes in both nonaccrual designation and cost recovery basis were in error and, in turn, has corrected the error by reverting to its accounting policy at December 31, 2016 whereby loans are placed on non-accrual when they are more than 60 days past due, and reversing the impacts of the change going back to January 1, 2017. |
The following tables summarize the impacts of the corrections on the Company's Consolidated Balance Sheet and Consolidated Statement of Operations for the periods indicated:
As of | For the year ended | |||||||||||||||||||||||
December 31, 2017 | December 31, 2017 | |||||||||||||||||||||||
As Reported | Corrections | As Revised | As Reported | Corrections | As Revised | |||||||||||||||||||
ASSETS | INTEREST INCOME | |||||||||||||||||||||||
LHFI | $ | 80,740,852 | $ | 49,829 | $ | 80,790,681 | Loans | $ | 7,287,400 | $ | 89,945 | $ | 7,377,345 | |||||||||||
ALLL | (3,911,575 | ) | (83,312 | ) | (3,994,887 | ) | TOTAL INTEREST INCOME | 7,786,134 | 89,945 | 7,876,079 | ||||||||||||||
Other assets | 3,632,427 | 13,978 | 3,646,405 | NET INTEREST INCOME | 6,334,005 | 89,945 | 6,423,950 | |||||||||||||||||
TOTAL ASSETS | 128,294,030 | (19,505 | ) | 128,274,525 | Provision for credit losses | 2,650,494 | 109,450 | 2,759,944 | ||||||||||||||||
LIABILITIES | NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES | 3,683,511 | (19,505 | ) | 3,664,006 | |||||||||||||||||||
Deferred tax liabilities, net | 969,996 | (4,706 | ) | 965,290 | Income tax provision / (benefit) | (152,334 | ) | (4,706 | ) | (157,040 | ) | |||||||||||||
TOTAL LIABILITIES | 104,588,399 | (4,706 | ) | 104,583,693 | NET INCOME including NCI | 972,774 | (14,799 | ) | 957,975 | |||||||||||||||
STOCKHOLDER'S EQUITY | Less: Net income attributable to NCI | 411,707 | (6,082 | ) | 405,625 | |||||||||||||||||||
Retained earnings | 3,462,674 | (8,717 | ) | 3,453,957 | NET INCOME ATTRIBUTABLE TO SHUSA | $ | 561,067 | $ | (8,717 | ) | $ | 552,350 | ||||||||||||
TOTAL SHUSA STOCKHOLDER'S EQUITY | 21,182,698 | (8,717 | ) | 21,173,981 | ||||||||||||||||||||
NCI | 2,522,933 | (6,082 | ) | 2,516,851 | ||||||||||||||||||||
TOTAL STOCKHOLDER'S EQUITY | 23,705,631 | (14,799 | ) | 23,690,832 | ||||||||||||||||||||
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY | $ | 128,294,030 | $ | (19,505 | ) | $ | 128,274,525 | |||||||||||||||||
The following table summarizes the impacts of the corrections on the Company's Condensed Consolidated SCF for the period indicated:
For the year ended | |||||||||||
December 31, 2017 | |||||||||||
As Reported (1) | Corrections | As Revised | |||||||||
Net cash provided by operating activities | $ | 4,888,092 | $ | 75,968 | $ | 4,964,060 | |||||
Net cash provided by (used in) investing activities | $ | 3,357,147 | $ | (75,968 | ) | $ | 3,281,179 | ||||
(1) Amounts have been adjusted for the adoption of ASU 2016-15 and ASU 2016-18.
In addition to the revision of the Company's Consolidated Financial Statements, information within the Notes to the Consolidated Financial Statements has been revised to reflect the correction of errors discussed above. The following tables summarize the impacts of the correction of those items:
December 31, 2017 | |||||||||||
As Reported | Corrections | As Revised | |||||||||
Non-performing - RICs and auto loans - originated | $ | 1,816,226 | $ | (559,104 | ) | $ | 1,257,122 | ||||
Total non-performing loans | 2,949,997 | (559,104 | ) | 2,390,893 | |||||||
Total non-performing assets | 3,293,656 | (559,104 | ) | 2,734,552 | |||||||
104
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
December 31, 2017 | |||||||||||||||||||||||||||||||||||
As Reported | Corrections | As Revised | |||||||||||||||||||||||||||||||||
30-89 DPD(1) | 90+ DPD | Current | 30-89 DPD | 90+ DPD | Current | 30-89 DPD | 90+ DPD | Current | |||||||||||||||||||||||||||
RICs and auto loans - originated | $ | 3,405,721 | $ | 327,045 | $ | 20,449,706 | $ | 196,587 | $ | 29,971 | $ | (176,729 | ) | $ | 3,602,308 | $ | 357,016 | $ | 20,272,977 | ||||||||||||||||
Total loans | $ | 4,349,047 | $ | 972,384 | $ | 77,941,907 | $ | 196,587 | $ | 29,971 | $ | (176,729 | ) | $ | 4,545,634 | $ | 1,002,355 | $ | 77,765,178 | ||||||||||||||||
(1) Days past due ("DPD").
Recently Adopted Accounting Standards
Since January 1, 2018, the Company adopted the following Financial Accounting Standards Board ("FASB") Accounting Standards Updates (“ASUs"):
• | ASU 2014-09, Revenue from Contracts with Customers (Topic 606), as amended. This ASU requires an entity to recognize revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. It includes a five-step process to assist an entity in achieving the main principles of revenue recognition under ASC 606. Because the ASU does not apply to revenue associated with leases and financial instruments (including loans, securities, and derivatives), it did not have a material impact on the elements of the Company's Consolidated Statements of Operations most closely associated with leases and financial instruments (such as interest income, interest expense and securities gains and losses). |
The Company adopted this ASU as of January 1, 2018 using the modified retrospective method of transition, resulting in an immaterial cumulative-effect adjustment recorded to opening retained earnings for the current period. The adoption of this ASU did not result in material changes in the timing of the Company's revenue recognition, but requires gross presentation of certain costs previously offset against revenue. This change in presentation is reflected in the current period and will increase both noninterest revenue and noninterest expense for the Company. The increase is predominantly associated with certain distribution costs on wealth management products (historically offset against Miscellaneous income), with the remainder of the increase associated with certain underwriting service costs (historically offset against Miscellaneous income). Refer to Note 17 for additional details. Results for reporting periods beginning after January 1, 2018 are presented under the new revenue recognition standard, while prior period amounts have not been adjusted and continue to be reported in accordance with our historic accounting.
The cumulative-effect of the changes made to our January 1, 2018 Consolidated Balance Sheet for the adoption of the new revenue recognition standard were as follows:
(in thousands) | Balance at December 31, 2017 | Adjustments | Balance at January 1, 2018 | |||||||||
Assets - LHFI | $ | 80,790,681 | $ | 5,514 | $ | 80,796,195 | ||||||
Other assets | 3,646,405 | (3,592 | ) | 3,642,813 | ||||||||
Total assets | 128,274,525 | 1,922 | 128,276,447 | |||||||||
Liabilities - other liabilities | 799,403 | (1,378 | ) | 798,025 | ||||||||
Total liabilities | 104,583,693 | (1,378 | ) | 104,582,315 | ||||||||
Stockholders' equity - retained earnings | 3,453,957 | 3,300 | 3,457,257 | |||||||||
Total stockholders' equity | 23,690,832 | 3,300 | 23,694,132 | |||||||||
The following discloses the impact on the Company's Consolidated Balance Sheet at December 31, 2018 and the Consolidated Statement of Operations for the year ended December 31, 2018 of the adoption of this new accounting standard:
December 31, 2018 | ||||||||
(in thousands) | As Reported | Balance Without Adoption | ||||||
Assets - LHFI | $ | 87,045,868 | $ | 87,041,454 | ||||
Other assets | 3,653,336 | 3,656,543 | ||||||
Total assets | 135,634,285 | 135,633,078 | ||||||
Liabilities - other liabilities | 912,775 | 914,153 | ||||||
Total liabilities | 111,787,053 | 111,788,431 | ||||||
Stockholders' equity - retained earnings | 3,783,405 | 3,780,820 | ||||||
Total stockholders' equity | 23,847,232 | 23,844,647 | ||||||
105
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Year Ended December 31, 2018 | ||||||||
(in thousands) | As Reported | Balance Without Adoption | ||||||
Non-interest income | ||||||||
Consumer and commercial fees | $ | 568,147 | $ | 565,137 | ||||
Miscellaneous income/(loss) | 307,282 | 293,973 | ||||||
Total non-interest income | 3,244,308 | 3,227,989 | ||||||
General, administrative and other expenses | ||||||||
Technology, outside service, and marketing expense | 590,249 | 582,614 | ||||||
Loan expense | 384,899 | 395,331 | ||||||
Other administrative expenses | 608,989 | 588,773 | ||||||
Total general, administrative, and other expenses | 5,832,325 | 5,814,906 | ||||||
Income before income tax provision | 1,416,935 | 1,418,035 | ||||||
Income tax provision | 425,900 | 426,285 | ||||||
Net income including NCI | $ | 991,035 | $ | 991,750 | ||||
• | ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, as amended. This new guidance amends the presentation and accounting for certain financial instruments, including liabilities measured at fair value under the FVO and equity investments. The guidance also updates fair value presentation and disclosure requirements for financial instruments measured at amortized cost. The Company adopted this standard on January 1, 2018, and it did not have a material impact on the Company's financial position or results of operations. As a result of the adoption of this standard, the Company reclassified approximately $10.0 million of equity securities from Investments AFS to Other investments on January 1, 2018. Future changes in the fair value of the Company's equity securities will be recognized in the Condensed Consolidated Statements of Operations rather than Other comprehensive Income. |
• | ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This new guidance amends the hedge accounting model to enable entities to better portray their risk management activities in their financial statements. The amendments expand an entity’s ability to hedge nonfinancial and financial risk components and reduce complexity in hedges of interest rate risk. The guidance eliminates the requirement to separately measure and report hedge ineffectiveness, and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line in which the earnings effect of the hedged item is reported. The new guidance is effective for public companies for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. The Company adopted this standard in the first quarter of 2018. It did not have a material impact on the opening balance of retained earnings for the cumulative-effect adjustment related to eliminating the separate measurement of ineffectiveness. Refer to Note 12 for further discussion of the Company's derivatives. |
• | ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this ASU allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cut and Jobs Act of 2017 (the “TCJA"). As a result of adoption of this ASU in the first quarter of 2018, the Company reclassified $39.1 million from accumulated other comprehensive income with an offsetting credit to retained earnings. |
Cumulative net impact to opening retained earnings
As a result of the adoption of the new accounting standards outlined above, the Company recorded a cumulative net increase to opening retained earnings of $42.0 million. Those impacts were attributed to the following ASUs adopted during the period:
Impact to Retained earnings | ||||
(in thousands) | ||||
Adoption of ASU 2014-09, Revenue Recognition | $ | 3,300 | ||
Adoption of ASU 2016-1, Financial Instruments | (418 | ) | ||
Adoption of ASU 2018-02, Statement of Comprehensive Income | 39,094 | |||
Cumulative-effect adjustment upon adoption of new accounting standards | 41,976 | |||
Other adjustments at subsidiary | 5,573 | |||
Net impact to opening retained earnings | $ | 47,549 | ||
106
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
The adoption of the following ASUs did not have an impact on the Company's financial position or results of operations:
• | ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments |
• | ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory |
• | ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (A consensus of the FASB Emerging Issues Task Force) |
• | ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business |
• | ASU 2017-05, Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets |
• | ASU 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost |
• | ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting |
• | ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 |
• | ASU 2018-06, Codification Improvements to Topic 942, Financial Services—Depository and Lending |
Significant Accounting Policies
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosures of contingent assets and liabilities, as of the date of the financial statements, and the amount of revenue and expenses during the reporting periods. Actual results could differ from those estimates, and those differences may be material.
Management has identified (i) the allowance for loan losses and the reserve for unfunded lending commitments, (ii) estimates of expected residual values of leases vehicles subject to operating leases, (iii) accretion of discounts and subvention on RICs, (iv) goodwill, (v) fair value of financial instruments, and (vi) income taxes as the Company's significant accounting policies and estimates, in that they are important to the portrayal of the Company's financial condition, results of operations and cash flows and the accounting estimates related thereto require management's most difficult, subjective and complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Consolidation
In accordance with the applicable accounting guidance for consolidations, the Consolidated Financial Statements include any VOEs in which the Company has a controlling financial interest and any VIEs for which the Company is deemed to be the primary beneficiary. The Company consolidates its VIEs if the Company has (i) a variable interest in the entity; (ii) the power to direct activities of the VIE that most significantly impact the entity's economic performance; and (iii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE (i.e., the Company is considered to be the primary beneficiary). The Company generally consolidates its VOEs if the Company, directly or indirectly, owns more than 50% of the outstanding voting shares of the entity and the noncontrolling shareholders do not hold any substantive participating or controlling rights. Interests in VIEs and VOEs can include equity interests in corporations, partnerships and similar legal entities, subordinated debt, securitizations, derivatives contracts, leases, service agreements, guarantees, standby letters of credit, loan commitments, and other contracts, agreements and financial instruments.
Upon the occurrence of certain significant events, as required by the VIE model, the Company reassesses whether a legal entity in which the Company is involved is a VIE. The reassessment process considers whether the Company has acquired or divested the power to direct the activities of the VIE through changes in governing documents or other circumstances. The reassessment also considers whether the Company has acquired or disposed of a financial interest that could be significant to the VIE, or whether an interest in the VIE has become significant or is no longer significant. The consolidation status of the entities with which the Company is involved may change as a result of such reassessments. Changes in consolidation status are applied prospectively, with assets and liabilities of a newly consolidated VIE initially recorded at fair value. A gain or loss may be recognized upon deconsolidation of a VIE, depending on the carrying amounts of deconsolidated assets and liabilities compared to the fair value of retained interests and ongoing contractual arrangements.
The Company uses the equity method to account for unconsolidated investments in VOEs if the Company has significant influence over the entity's operating and financing decisions but does not maintain a controlling financial interest. Unconsolidated investments in VOEs or VIEs in which the Company has a voting or economic interest of less than 20% generally are carried at cost less any impairment. These investments are included in Other assets on the Consolidated Balance Sheets, and the Company's proportionate share of income or loss is included in Miscellaneous income, net within the Consolidated Statements of Operations.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Business Combinations
The Company accounts for business combinations using the acquisition method of accounting, and records the identifiable assets, liabilities and any NCI of the acquired business at their acquisition date fair values. The excess of the purchase price over the estimated fair value of the net assets acquired is recorded as goodwill. Any changes in the estimated acquisition date fair values of the net assets recorded prior to the finalization of a more detailed analysis, but not to exceed one year from the date of acquisition, will change the amount of the purchase price allocable to goodwill. Any subsequent changes to any purchase price allocations that are material to the Company’s Consolidated Financial Statements will be adjusted retrospectively. All acquisition related costs are expensed as incurred.
The results of operations of the acquired companies are recorded in the Consolidated Statements of Operations from the date of acquisition. The application of business combination principles including the determination of the fair value of the net assets acquired, requires the use of significant estimates and assumptions. Please see the related discussion under the caption "Goodwill and Intangible Assets" below.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The most significant estimates pertain to fair value measurements, the ALLL and reserve for unfunded lending commitments, accretion of discounts and subvention on RICs, estimates of expected residual values of leased vehicles subject to operating leases, goodwill, and income taxes. Actual results may differ from the estimates, and the differences may be material to the Consolidated Financial Statements.
Revenue Recognition
The Company primarily earns interest and non-interest income from various sources, including:
• | Lending (interest income and loan fees). |
• | Investment securities. |
• | Loan sales and servicing. |
• | Finance leases. |
• | BOLI. |
• | Depository services |
• | Commissions and trailer fees |
• | Interchange income, net. |
• | Asset and wealth management fees. |
Lending and Investment Securities
The principal source of revenue is interest income from loans and investment securities. Interest income is recognized on an accrual basis primarily according to non-discretionary formulas in written contracts, such as loan agreements or securities contracts. Revenue earned on interest-earning assets, including unearned income and the accretion of discounts recognized on acquired or purchased loans, is recognized based on the constant effective yield of such interest-earning assets. Unearned income pertains to the net of fees collected and certain costs incurred from loan originations.
Gains or losses on sales of investment securities are recognized on the trade date.
Loan Sales and Servicing
The Company recognizes revenue from servicing commercial mortgages and consumer loans as earned. Mortgage banking income, net includes fees associated with servicing loans for third parties based on the specific contractual terms and changes in the fair value of MSRs. Gains or losses on sales of residential mortgage, multifamily and home equity loans are included within mortgage banking revenues and are recognized when the sale is complete.
Finance Leases
Income from finance leases is recognized as part of interest income over the term of the lease using the constant effective yield method, while income arising from operating leases is recognized as part of other non-interest income over the term of the lease on a straight-line basis.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
BOLI
Income from BOLI represents increases in the cash surrender value of the policies, as well as insurance proceeds and interest.
Depository services
Depository services are performed under an agreement with a customer, and those services include personal deposit account opening and maintenance, checking services, online banking services, debit card services, etc. Depository service fees related to customer deposits can generally be distinguished between monthly service fees and transactional fees within the single performance obligation of providing depository account services. Monthly account service and maintenance fees are provided over a period of time (usually a month), and revenue is recognized as the Company performs the service (usually at the end of the month). The services for transactional fees are performed at a point in time and revenue is recognized when the transaction occurs.
Commissions and trailer fees
Commission fees are earned from the selling of annuity contracts to customers on behalf of insurance companies, acting as the broker for certain equity trading, and sales of interests in mutual funds. The Company elected the expected value method for estimating commission fees due to the large number of customer contracts with similar characteristics. However, commissions and trailer fees are fully constrained as the Company cannot sufficiently estimate the consideration to which it could be entitled to earn. Commissions are generally associated with point-in-time transactions or agreements that are one year or less. The performance obligation is satisfied immediately and revenue is recognized as the Company performs the service.
Interchange income, net
The Company has entered into agreements with payment networks under which the Company will issue the payment network's credit card as part of the Company's credit card portfolio. Each time a cardholder makes a purchase at a merchant and the transaction is processed, the Company receives an interchange fee in exchange for the authorization and settlement services provided to the payment networks.
The performance obligation for the Company is to provide authorization and settlement services to the payment network when the payment network submits a transaction for authorization. The Company considers the payment network to be the customer, and the Company is acting as a principal when performing the transaction authorization and settlement services. The performance obligation for authorization and settlement services is satisfied at a point in time, and revenue is recognized on the date when the Company authorizes and routes the payment to the merchant. The expenses paid to payment networks are accounted for as consideration payable to the customer and therefore reduce the transaction price. Therefore, interchange income is recorded net against the expenses paid to the payment network and the cost of rewards programs.
The agreements also contain immaterial fixed consideration related to upfront sign-on bonuses and program development bonuses, which are amortized over the remainder of the agreement's life on a straight-line basis.
Underwriting service fees
SIS, as a registered broker-dealer, performs underwriting services by raising investment capital from investors on behalf of corporations that are issuing securities. Underwriting services have one performance obligation, which is satisfied on the day SIS purchases the securities.
Underwriting services include multiple parties in delivering the performance obligation. The Company has evaluated whether it is the principal or agent when we provide underwriting services. The Company acts as the principal when performing underwriting services, and recognizes fees on a gross basis. Revenue is recorded as the difference between the price the Company pays the issuer of the securities and the public offering price, and expenses are recorded as the proportionate share of the underwriting costs incurred by SIS. The Company is the principal because we obtain control of the services provided by third-party vendors and combine them with other services as part of delivering on the underwriting service.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Asset and wealth management fees
Asset and wealth management fees includes fee income generated from discretionary investment management and non-discretionary investment advisory contracts with customers. Discretionary investment management fees are earned for the management of the assets in the customer's account and are recognized as earned and charged to the customer on a quarterly basis. Non-discretionary investment advisory fees are earned for providing investment advisory services to customers, such as recommending the re-balancing or restructuring of the assets in the customer’s account. The investment advisory fee is recognized as earned and charged to the customer on a quarterly basis. The fee for the discretionary and nondiscretionary contracts is based on a percentage of the average assets included in the customer’s account.
Fair Value Measurements
The Company values assets and liabilities based on the principal market in which each would be sold (in the case of assets) or transferred (in the case of liabilities). The principal market is the forum with the greatest volume and level of activity. In the absence of a principal market, valuation is based on the most advantageous market. In the absence of observable market transactions, the Company considers liquidity valuation adjustments to reflect the uncertainty in pricing the instruments. The fair value of a financial asset is measured on a stand-alone basis and cannot be measured as a group, with the exception of certain financial instruments held and managed on a net portfolio basis. In measuring the fair value of a nonfinancial asset, the Company assumes the highest and best use of the asset by a market participant, not just the intended use, to maximize the value of the asset. The Company also considers whether any credit valuation adjustments are necessary based on the counterparty's credit quality.
When measuring the fair value of a liability, the Company assumes that the transfer will not affect the nonperformance risk associated with the liability. The Company considers the effect of the credit risk on the fair value for any period in which fair value is measured. There are three valuation approaches for measuring fair value: the market approach, the income approach and the cost approach. Selecting the appropriate technique for valuing a particular asset or liability should consider the exit market for the asset or liability, the nature of the asset or liability being measured, and how a market participant would value the same asset or liability. Ultimately, selecting the appropriate valuation method requires significant judgment.
Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability. Inputs can be observable or unobservable. Observable inputs are assumptions based on market data obtained from an independent source. Unobservable inputs are assumptions based on the Company's own information or assessment of assumptions used by other market participants in pricing the asset or liability. The unobservable inputs are based on the best and most current information available on the measurement date.
Cash, Cash Equivalents, and Restricted Cash
Cash and cash equivalents include cash and amounts due from depository institutions, interest-bearing deposits in other banks, federal funds sold, and securities purchased under agreements to resell. Cash and cash equivalents have original maturities of three months or less and, accordingly, the carrying amount of these instruments is deemed to be a reasonable estimate of fair value. The Company has maintained balances in various operating and money market accounts in excess of federally insured limits.
Cash deposited to support securitization transactions, lockbox collections, and the related required reserve accounts is recorded in the Company's Consolidated Balance Sheet as restricted cash. Excess cash flows generated by Trusts are added to the restricted cash reserve account, creating additional over-collateralization until the contractual securitization requirement has been reached. Once the targeted reserve requirement is satisfied, additional excess cash flows generated by the Trusts are released to the Company as distributions from the Trusts. Lockbox collections are added to restricted cash and released when transferred to the appropriate warehouse facility or Trust. The Company also maintains restricted cash primarily related to cash posted as collateral related to derivative agreements and cash restricted for investment purposes.
Investment Securities and Other Investments
Investment in debt securities are classified as either AFS, HTM, trading, or other investments. Investments in equity securities are generally recorded at fair value with changes recorded in earnings. Management determines the appropriate classification at the time of purchase.
Debt securities expected to be held for an indefinite period of time are classified as AFS and are carried at fair value, with temporary unrealized gains and losses reported as a component of accumulated other comprehensive income within stockholder's equity, net of estimated income taxes.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Debt securities purchased which the Company has the positive intent and ability to hold until maturity are classified as HTM securities. HTM securities are reported at cost and adjusted for payments, amortization of premium and accretion of discount. Transfers of debt securities into the HTM category from the AFS category are made at fair value at the date of transfer. The unrealized holding gain or loss at the date of transfer is retained in other comprehensive income (“OCI”) and in the carrying value of the HTM securities. Such amounts are amortized over the remaining lives of the securities. In 2018, the Company transferred securities with a $1.2 billion carrying value and $1.2 billion fair value from AFS to HTM. Unrealized holding losses of $29.1 million were retained in OCI at the date of transfer and will be amortized over the remaining lives of the securities. There were no transfers from AFS to HTM during the year ended December 31, 2017.
The Company conducts a comprehensive security-level impairment assessment quarterly on all securities with a fair value that is less than their amortized cost basis to determine whether the loss represents OTTI. The quarterly OTTI assessment takes into consideration whether (i) the Company has the intent to sell or, (ii) it is more likely than not that it will be required to sell the security before the expected recovery of its amortized cost. The Company also considers whether or not it would expect to receive all of the contractual cash flows from the investment based on its assessment of the security structure, recent security collateral performance metrics, external credit ratings, failure of the issuer to make scheduled interest or principal payments, judgment and expectations of future performance, and relevant independent industry research, analysis and forecasts. The Company also considers the severity of the impairment in its assessment. In the event of a credit loss, the credit component of the impairment is recognized within non-interest income as a separate line item, and the non-credit component is recorded within accumulated OCI.
Realized gains and losses on sales of investment securities are recognized on the trade date and included in earnings within Net(losses)/gains on sale of investment securities, which is a component of non-interest income. Unamortized premiums and discounts are recognized in interest income over the estimated life of the security using the interest method.
Debt securities held for trading purposes and equity securities are carried at fair value, with changes in fair value recorded in non-interest income. Investments that are purchased principally for the purpose of economically hedging the MSR in the near term are classified as trading securities and carried at fair value, with changes in fair value recorded as a component of the Miscellaneous income, net line of the Consolidated Statements of Operations.
Other investments primarily include the Company's investment in the stock of the FHLB of Pittsburgh and the Federal Reserve Bank ("FRB"). Although FHLB and FRB stock are equity interests in the FHLB and FRB, respectively, neither has a readily determinable fair value, because ownership is restricted and they are not readily marketable. FHLB stock can be sold back only at its par value of $100 per share and only to FHLBs or to another member institution. Accordingly, FHLB stock and FRB stock are carried at cost. The Company evaluates this investment for impairment on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.
See Note 3 to the Consolidated Financial Statements for details on the Company's investments.
LHFI
LHFI include commercial and consumer loans (including RICs) originated by the Company as well as loans acquired by the Company, which the Company intends to hold for the foreseeable future or until maturity. RICs consist largely of nonprime automobile finance receivables that are acquired individually from dealers at a nonrefundable discount from the contractual principal amount. RICs also include receivables originated through a direct lending program and loan portfolios purchased from other lenders.
Originated LHFI
Originated LHFI are reported net of cumulative charge offs, unamortized loan origination fees and costs, and unamortized discounts and premiums. Interest on loans is credited to income as it is earned. For most of the Company's originated LHFI, loan origination fees and certain direct loan origination costs and premiums and discounts are deferred and recognized as adjustments to interest income in the Consolidated Statements of Operations over the contractual life of the loan utilizing the effective interest method. For RICs, loan origination fees and costs, premiums and discounts are deferred and amortized over their estimated lives as adjustments to interest income utilizing the effective interest method using estimated prepayment speeds, which are updated on a monthly basis. The Company estimates future principal prepayments specific to pools of homogeneous loans, which are based on the vintage, credit quality at origination and term of the loan. Prepayments in our portfolio are sensitive to credit quality, with higher credit quality loans experiencing higher voluntary prepayment rates than lower credit quality loans. The resulting prepayment rate specific to each pool is based on historical experience and is used as an input in the calculation of the constant effective yield. The impact of defaults is not considered in the prepayment rate; the prepayment rate only considers voluntary prepayments. Our estimated weighted average prepayment rates ranged from 5.7% to 10.8% at December 31, 2018 and 6.1% to 10.4% at December 31, 2017.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
The Company’s LHFI, including RICs and personal unsecured loans originated by SC since the change in control of SC in the first quarter of 2014 (the "Change in Control"), are carried at amortized cost, net of the ALLL. When a RIC is originated, certain cost basis adjustments (the net discounts) to the principal balance of the loan are recognized in accordance with the accounting guidance for loan origination fees and costs in ASC 310-20. These cost basis adjustments generally include the following:
• | Origination costs. |
• | Dealer discounts - dealer discounts to the principal balance of the loan generally occur in circumstances in which the contractual interest rate on the loan is not sufficient to compensate for the credit risk of the borrower. |
• | Participation - participation fees, or premiums, paid to the dealer as a form of profit-sharing, rewarding the dealer for originating loans that perform. |
• | Subvention - payments received from the vehicle manufacturer as compensation (yield enhancement) for the cost of below-market interest rates offered to consumers. |
Originated loans are initially recorded at the proceeds paid to fund the loan. Any discount at origination for loans is considered by the Company to reflect yield enhancements and is accreted to income using the effective interest method.
See LHFS subsection below for accounting treatment when an HFI loan is re-designated an LHFS.
Purchased LHFI
Purchased loans are loans acquired in a bulk purchase or business combination. RICs acquired directly from a dealer are considered to be originated loans, not purchased loans. The Company has accounted for its January 2014 consolidation of SC as a business combination. The RIC and personal unsecured loans purchased in the Change in Control were initially recognized at fair value, and no ALLL was recognized at the Change in Control date pursuant to business combination accounting. The purchased portfolio acquired included performing loans as well as those loans acquired with evidence of credit deterioration (defined as those on non-accrual status at the time of the acquisition). All of SC’s performing RICs and personal unsecured loans that were HFI were recorded by the Company at a discount.
Subsequent to the Change in Control, the purchase discounts on the retail installment loans are accreted over the remaining expected lives of the loans to their par values using the retrospective effective interest method, which considers the impact of estimated prepayments that is updated on a quarterly basis. The purchase discount on personal unsecured loans (given their revolving nature) are amortized on a straight-line basis in accordance with ASC 310-20.
The Company irrevocably elected to account for RICs acquired with evidence of credit deterioration at the Change in Control date at fair value in accordance with ASC 825. Accordingly, the Company does not recognize interest income for these RICs and recognizes the fair value adjustments on these loans as part of other non-interest income in the Company’s Consolidated Statements of Operations. For certain of the RICs which the Company has elected to account for at fair value but are not considered non-accrual, the Company separately recognizes interest income from the total fair value adjustment. No ALLL is recognized for loans that the Company has elected to account for at fair value.
ALLL for Loan Losses and Reserve for Unfunded Lending Commitments
The ALLL and reserve for unfunded lending commitments (together, the ACL) are maintained at levels that management considers adequate to provide for losses on the recorded investment of the loan portfolio, based upon an evaluation of known and inherent risks in the loan portfolio. Management's evaluation takes into consideration the risks in the loan portfolio, past loan and lease loss experience, specific loans with loss potential, geographic and industry concentrations, delinquency trends, economic conditions and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the ACL may be necessary if conditions differ substantially from the assumptions used in making the evaluations.
The ALLL consists of two elements: (i) an allocated allowance, which is comprised of allowances established on loans specifically evaluated for impairment, and loans collectively evaluated for impairment, based on historical loan and lease loss experience adjusted for current trends and both general economic conditions and other risk factors in the Company's loan portfolios, and (ii) an unallocated allowance to account for a level of imprecision in management's estimation process. Reserve levels are collectively reviewed for adequacy and approved quarterly by Board-level committees.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
The ALLL includes the estimate of credit losses that management expects will be realized during the loss emergence period, including the amount of net discounts that is included in the loans' recorded investment at the time of charge-off. In the case of loans purchased in a bulk purchase or business combination, the entire discount on the loan portfolio is considered as available to absorb the credit losses when determining the ALLL. For these loans, the Company records provisions for credit losses when incurred losses exceed the unaccreted purchase discount.
Management regularly monitors the condition of borrowers and assesses both internal and external factors in determining whether any relationships have deteriorated considering factors such as historical loss experience, trends in delinquency and non-performing loans ("NPLs"), changes in risk composition and underwriting standards, experience and ability of staff and regional and national economic conditions and trends.
The Company's allocated reserves are principally based on its various models subject to the Company's model risk management framework. New models are approved by the Company's Model Risk Management Committee, and inputs are reviewed periodically by the Company's internal audit function. Models, inputs and documentation are further reviewed and validated at least annually, and the Company completes a detailed variance analysis of historical model projections against actual observed results on a quarterly basis. Required actions resulting from the Company's analysis, if necessary, are governed by its Allowance for Loan and Lease Losses Committee.
The Company's unallocated allowance is no more than 5% of the overall allowance. This is considered to be reasonably sufficient to absorb imprecisions of models to otherwise provide for coverage of inherent losses in the Company's entire loan and lease portfolio. Imprecisions include loss factors inherent in the loan portfolio that may not have been discreetly contemplated in the general and specific components of the allowance, as well as potential variability in estimates.
The unallocated allowance is also established in consideration of several factors such as inherent delays in obtaining information regarding a customer's financial condition or changes in its unique business conditions and the interpretation of economic trends. While this analysis is conducted at least quarterly, the Company has the ability to revise the allowance factors whenever necessary in order to address improving or deteriorating credit quality trends or specific risks associated with a loan pool classification.
Regardless of the extent of the Company's analysis of customer performance, portfolio evaluations, trends or risk management processes established, a level of imprecision will always exist due to the judgmental nature of loan portfolio and/or individual loan evaluations. The Company maintains an unallocated allowance to recognize the existence of these exposures.
For the commercial loan portfolio segment, the Company has specialized credit officers and workout units that identify and manage potential problem loans. Changes in management factors, financial and operating performance, company behavior, industry factors and external events and circumstances are evaluated on an ongoing basis to determine whether potential impairment is evident and additional analysis is needed. For the commercial loan portfolio segment, risk ratings are assigned to each loan to differentiate risk within the portfolio, and are reviewed on an ongoing basis by Credit Risk Management and revised, if needed, to reflect the borrower's current risk profile and the related collateral positions. The risk ratings consider factors such as financial condition, debt capacity and coverage ratios, market presence and quality of management. Generally, credit officers reassess a borrower's risk rating on no less than an annual basis, and more frequently if warranted. This reassessment process is managed on a continual basis by the Credit Risk Review group to ensure consistency and accuracy in risk ratings as well as appropriate frequency of risk rating review by the Company's credit officers. The Company's Credit Risk Review group regularly performs loan reviews and assesses the appropriateness of assigned risk ratings.
When a loan's risk rating is downgraded beyond a certain level, the Company's Workout Department becomes responsible for managing the credit risk. Risk rating actions are generally reviewed formally by one or more credit committees, depending on the size of the loan and the type of risk rating action being taken. Detailed analyses are completed that support the risk rating and management's strategies for the customer relationship going forward.
The consumer loan portfolio segment and small business loans are monitored for credit risk and deterioration with statistical tools considering factors such as delinquency, loan-to-value ("LTV") ratio, and credit scores. The Bank evaluates the consumer portfolios throughout their life cycles on a portfolio basis. When problem loans are identified that are secured with collateral, management examines the loan files to evaluate the nature and type of collateral supporting the loans. Management documents the collateral type, the date of the most recent valuation, and whether any liens exist, to determine the value to compare against the committed loan amount.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Within the consumer loan portfolio segment, for both residential and home equity loans, loss severity assumptions are incorporated into the loan and lease loss reserve models to estimate loan balances that will ultimately charge off. These assumptions are based on recent loss experience for six LTV bands within the portfolios. LTV ratios are updated based on movements in the state-level Federal Housing Finance Agency house pricing indices.
For non-TDR RICs and personal unsecured loans, the Company estimates the ALLL at a level considered adequate to cover probable credit losses in the recorded investment of the portfolio. Probable losses are estimated based on contractual delinquency status and historical loss experience, in addition to the Company’s judgment of estimates of the value of the underlying collateral, bankruptcy trends, economic conditions such as unemployment rates, changes in the used vehicle value index, delinquency status, historical collection rates and other information in order to make the necessary judgments as to probable loan and lease losses.
In addition to the ALLL, management estimates probable losses related to unfunded lending commitments. Unfunded lending commitments for commercial customers are analyzed and segregated by risk according to the Company's internal risk rating scale. These risk classifications, in conjunction with an analysis of historical loss experience, current economic conditions, performance trends within specific portfolio segments, and any other pertinent information result in the estimation of the reserve for unfunded lending commitments. Additions to the reserve for unfunded lending commitments are made by charges to the provision for credit losses, and this reserve is classified within Other liabilities on the Company's Consolidated Balance Sheets.
Risk factors are continuously reviewed and revised by management when conditions warrant. A comprehensive analysis of the ACL is performed by the Company on a quarterly basis. In addition, a review of allowance levels based on nationally published statistics is conducted on at least an annual basis.
The factors supporting the ACL do not diminish the fact that the entire ACL is available to absorb losses in the loan and lease portfolio and related commitment portfolio, respectively. The Company's principal focus, therefore, is on the adequacy of the total ACL.
The ACL is subject to review by banking regulators. The Company's primary bank regulators conduct examinations of the ACL and make assessments regarding its adequacy and the methodology employed in its determination.
Provisions for credit losses are charged to provision expense in amounts sufficient to maintain the ACL at levels considered adequate to cover probable credit losses incurred in the Company’s HFI loan portfolios. The Company uses the incurred loss approach in providing an ACL on the recorded investment of its existing loans. This approach requires that loan loss provisions are recognized and the corresponding allowance recorded when, based on all available information, it is probable that a credit loss has been incurred. The estimate for credit losses for loans that are individually evaluated for impairment is generally determined through an analysis of the present value of the loan’s expected future cash flows, except for those that are deemed to be collateral dependent. For those loans that are collectively assessed for impairment, the Company utilizes historical loan loss experience information as part of its evaluation. In addition, when establishing the collective ACL for originated loans, the Company’s estimate of losses on recorded investment includes the estimate of the related net discount balance that is expected at the time of charge-off. Although the ACL is established on a collective basis, actual charge-offs are recorded on a loan-by-loan basis when losses are confirmed or when established delinquency thresholds have been met. Additional discussions related to the Company’s charge-off and credit loss provision policies are provided in the “Charge-offs of Uncollectible Loans” section below.
When a loan in any portfolio or class has been determined to be impaired (e.g., TDRs and non-accrual commercial loans in excess of $1 million) as of the balance sheet date, the Company measures impairment based on the present value of expected future cash flows discounted at the loan's original effective interest rate. However, as a practical expedient, the Company may measure impairment based on a loan's observable market price, or the fair value of the collateral less costs to sell if the loan is a collateral-dependent loan. A specific reserve is established as a component of ACL for these impaired loans. Subsequent to the initial measurement of impairment, if there is a significant change to the impaired loan’s expected future cash flows, the Company recalculates the impairment and appropriately adjusts the specific reserve. This is also the case if there was a significant change in the initial estimate for impaired loans that are measured based on a loan's observable market price or the fair value of the collateral less costs to sell if the loan is a collateral-dependent loan. Some impaired loans have risk characteristics similar to other impaired loans and may be aggregated for the measurement of impairment. For those impaired loans that are collectively assessed for impairment, the Company utilizes historical loan loss experience information as part of its evaluation. When the Company determines that the present value of the estimated cash flows of an impaired loan is less than its carrying amount, the Company recognizes impairment through a provision estimate or a charge-off to the allowance. Management performs these assessments on at least a quarterly basis.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Interest Recognition and Non-accrual loans
Interest from loans is accrued when earned in accordance with the terms of the loan agreement. The accrual of interest is discontinued and uncollected interest is reversed once a loan is placed in non-accrual status. A loan is determined to be non-accrual when it is probable that scheduled payments of principal and interest will not be received when due according to the contractual terms of the loan agreement. The Company generally places commercial loans and consumer loans on non-accrual status when they become 90 days or more past due. When the collectability of the recorded loan balance of a nonaccrual loan is in doubt, any cash payments received from the borrower are applied first to reduce the carrying value of the loan. Otherwise, interest income may be recognized to the extent cash is received. Generally, a nonaccrual loan is returned to accrual status when, based on the Company’s judgment, the borrower’s ability to make the required principal and interest payments has resumed and collectability of remaining principal and interest is no longer doubtful. Interest income recognition resumes for nonaccrual loans that were accounted for on a cash basis method when they return to accrual status, while interest income that was previously recorded as a reduction in the carrying value of the loan would be recognized as interest income based on the effective yield to maturity on the loan. Please refer to the TDRs section below for discussion related to TDR loans placed on non-accrual status. Credit cards continue to accrue interest until they become 180 days past due, at which point they are charged-off.
For RICs, the accrual of interest is discontinued and accrued but uncollected interest is reversed once a RIC becomes more than 60 days past due, and is resumed if a delinquent account subsequently becomes 60 days or less past due. The Company considers an account delinquent when an obligor fails to pay substantially all (defined as 90%) of the scheduled payment by the due date. The payment following the partial payment must be a full payment, or the account will move into delinquency status at that time.
Charge-off of Uncollectible Loans
Any loan may be charged-off if a loss confirming event has occurred. Loss confirming events usually involve the receipt of specific adverse information about the borrower and may include bankruptcy (unsecured), foreclosure, or receipt of an asset valuation indicating a shortfall between the value of the collateral and the book value of the loan when that collateral asset is the sole source of repayment. The Company generally charges off commercial loans when it is determined that the specific loan or a portion thereof is uncollectible. This determination is based on facts and circumstances of the individual loans and normally includes considering the viability of the related business, the value of any collateral, the ability and willingness of any guarantors to perform and the overall financial condition of the borrower. Partially charged-off loans continue to be evaluated on not less than a quarterly basis, with additional charge-offs or loan and lease loss provisions taken on the remaining loan balance, if warranted, utilizing the same criteria.
The Company generally charges off consumer loans, or a portion thereof, as follows: residential mortgage loans and home equity loans are charged-off to the estimated fair value of their collateral (net of selling costs) when they become 180 days past due, and other loans (closed-end) are charged-off when they become 120 days past due. Auto loans are charged-off to the estimated net recovery value in the month an account becomes greater than 120 days delinquent if the Company has not repossessed the related vehicle. The Company charges off accounts in repossession to estimated net recovery value when the automobile is repossessed and legally available for disposition. Loans receiving a bankruptcy notice or for which fraud is discovered are written down to the collateral value less costs to sell within 60 days of such notice or discovery. Revolving personal unsecured loans are charged off when they become 180 days past due. Credit cards are charged off when they are 180 days delinquent or within 60 days after the receipt of notification of the cardholder’s death or bankruptcy. Charge-offs are not required when it can be clearly demonstrated that repayment will occur regardless of delinquency status. Factors that would demonstrate repayment include a loan that is secured by collateral and is in the process of collection, a loan supported by a valid guarantee or insurance, or a loan supported by a valid claim against a solvent estate.
RICs are charged off against the allowance in the month in which the account becomes 120 days contractually delinquent if the Company has not repossessed the related vehicle. The Company charges off accounts in repossession when the automobile is repossessed and legally available for disposition. A net charge off represents the difference between the estimated net sales proceeds and the Company's recorded investment in the related contract. Accounts in repossession that have been charged off and are pending liquidation are removed from RIC status and the related repossessed automobiles are included in Other assets in the Company's Consolidated Balance Sheets.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
TDRs
TDRs are loans that have been modified for which the Company has agreed to make certain concessions to customers to both meet the needs of the customers and maximize the ultimate recovery of the loan. TDRs occur when a borrower is experiencing financial difficulties and the loan is modified involving a concession that would otherwise not be granted to the borrower. TDRs are generally placed on non-accrual status until the Company believes repayment under the revised terms is reasonably assured and a sustained period of repayment performance has been achieved (typically defined as six months for a monthly amortizing loan). All costs incurred by the Company in connection with a TDR are expensed as incurred. The TDR classification remains on the loan until it is paid in full or liquidated.
Commercial Loan TDRs
All of the Company’s commercial loan modifications are based on the circumstances of the individual customer, including specific customers' complete relationship with the Company. Loan terms are modified to meet each borrower’s specific circumstances at a point in time and may allow for modifications such as term extensions and interest rate reductions. Modifications for commercial loan TDRs generally, although not always, result in bifurcation of the original loan into A and B notes. The A note is restructured to allow for an upgraded risk rating and return to accrual status after a sustained period of payment performance has been achieved (typically six months for monthly payment schedules). The B note, if any, is structured as a deficiency note and the balance is charged off but the debt is usually not forgiven. As TDRs, they will be subject to analysis for specific reserves by either calculating the present value of expected future cash flows or, if collateral-dependent, calculating the fair value of the collateral less its estimated cost to sell. The TDR classification will remain on the loan until it is paid in full or liquidated.
Consumer Loan TDRs
The majority of the Company's TDR balance is comprised of RICs and auto loans. The terms of the modifications for the RIC and auto loan portfolio generally include one or a combination of: a reduction of the stated interest rate of the loan at a rate of interest lower than the current market rate for new debt with similar risk or an extension of the maturity date.
In accordance with our policies and guidelines, the Company at times offers extensions (deferrals) to consumers on our RICs under which the consumer is allowed to defer a maximum of three payments per event to the end of the loan. More than 90% of deferrals granted are for two payments. Our policies and guidelines limit the frequency of each new deferral that may be granted to one deferral every six months, regardless of the length of any prior deferral. The maximum number of months extended for the life of the loan for all automobile RICs is eight, while some marine and recreational vehicle ("RV") contracts have a maximum of twelve months extended to reflect their longer term. Additionally, we generally limit the granting of deferrals on new accounts until a requisite number of payments has been received. During the deferral period, we continue to accrue and collect interest on the loan in accordance with the terms of the deferral agreement. The Company considers all individually acquired RICs that have been modified at least once, deferred for a period of 90 days or more, or deferred at least twice, as TDRs. Additionally, restructurings through bankruptcy proceedings are deemed to be TDRs.
RIC TDRs are placed on non-accrual status when the Company believes repayment under the revised terms is not reasonably assured and, at the latest, when the account becomes past due more than 60 days. For loans on nonaccrual status, interest income is recognized on a cash basis; however, the Company continues to assess the recognition of cash received on those loans in order to identify whether certain of those loans should also be placed on a cost recovery basis. For TDR loans on nonaccrual status, the accrual of interest is resumed if a delinquent account subsequently becomes 60 days or less past due.
At the time a deferral is granted on a RIC, all delinquent amounts may be deferred or paid, resulting in the classification of the loan as current and therefore not considered a delinquent account. Thereafter, the account is aged based on the timely payment of future installments in the same manner as any other account.
Changes in deferral levels do not have a direct impact on the ultimate amount of consumer finance receivables charged off. However, the timing of a charge-off may be affected if the previously deferred account ultimately results in a charge-off. To the extent that deferrals impact the ultimate timing of when an account is charged off, historical charge-off ratios, loss confirmation periods, and cash flow forecasts for loans classified as TDRs used in the determination of the adequacy of the ALLL are also impacted. Increased use of deferrals may result in a lengthening of the loss confirmation period, which would increase expectations of credit losses inherent in the portfolio and therefore increase the ALLL and related provision for loan and lease losses. Changes in these ratios and periods are considered in determining the appropriate level of ALLL and related provision for loan and lease losses.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
The primary modification program for the Company’s residential mortgage and home equity portfolios is a proprietary program designed to keep customers in their homes and, when appropriate, prevent them from entering into foreclosure. The program is available to all customers facing a financial hardship regardless of their delinquency status. The main goal of the modification program is to review the customer’s entire financial condition to ensure that the proposed modified payment solution is affordable according to a specific debt-to-income ("DTI") ratio range. The main modification benefits of the program allow for term extensions, interest rate reductions, and/or deferment of principal. The Company reviews each customer on a case-by-case basis to determine which benefit or combination of benefits will be offered to achieve the target DTI range.
Consumer TDRs in the residential mortgage and home equity portfolios are generally placed on non-accrual status until the Company believes repayment under the revised terms is reasonably assured and a sustained period of repayment performance has been achieved (typically six months for a monthly amortizing loan). Any loan that has remained current for the six months immediately prior to modification will remain on accrual status after the modification is implemented. The TDR classification will remain on the loan until it is paid in full or liquidated. In addition to those identified as TDRs above, accounting guidance also requires loans discharged under Chapter 7 bankruptcy to be considered TDRs and collateral-dependent, regardless of delinquency status. These loans are written down to fair market value and classified as non-accrual/non-performing for the remaining life of the loan.
TDR Impact to ALLL
The ALLL is established to recognize losses in funded loans intended to be HFI that are probable and can be reasonably estimated. Prior to loans being placed in TDR status, the Company generally measures its allowance under a loss contingency methodology in which consumer loans with similar risk characteristics are pooled and loss experience information is monitored for credit risk and deterioration with statistical tools considering factors such as delinquency, LTV and credit scores.
Upon TDR modification, the Company generally measures impairment based on a present value of expected future cash flows methodology considering all available evidence using the effective interest rate or fair value of collateral. The amount of the required valuation allowance is equal to the difference between the loan’s impaired value and the recorded investment.
RIC TDRs that subsequently default continue to have impairment measured based on the difference between the recorded investment of the RIC and the present value of expected cash flows. For the Company's other consumer TDR portfolios, impairment on subsequently defaulted loans is generally measured based on the fair value of the collateral, if applicable, less its estimated cost to sell.
Typically, commercial loans whose terms are modified in a TDR will have been identified as impaired prior to modification and accounted for generally using a present value of expected future cash flows methodology, unless the loan is considered collateral-dependent. Loans considered collateral-dependent are measured for impairment based on the fair values of their collateral less its estimated cost to sell. Accordingly, upon TDR modification or if a TDR modification subsequently defaults, the allowance methodology remains unchanged.
Impaired loans
A loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan. An insignificant delay (e.g., less than 61 days for RICs or less than 90 days for all of the Company's other loans) or insignificant shortfall in amount of payments does not necessarily result in the loan being identified as impaired.
The Company considers all of its TDRs and all of its non-accrual commercial loans in excess of $1 million to be impaired as of the balance sheet date. The Company may perform an impairment analysis on loans that fail to meet this threshold if the nature of the collateral or business conditions warrant. The Company considers all individually acquired RICs that have been modified at least once, deferred for a period of 90 days or more, or deferred at least twice, as TDRs.
The Company measures impairment on impaired loans based on the present value of expected future cash flows discounted at the loan's original effective interest rate, except that, as a practical expedient, the Company may measure impairment based on a loan's observable market price, or the fair value of the collateral, less the costs to sell, if the loan is a collateral-dependent loan. Some impaired loans share common risk characteristics. Such loans are collectively assessed for impairment and the Company utilizes historical loan loss experience information as part of its evaluation. When the Company determines that the present value of the estimated cash flows of an impaired loan is less than its carrying amount, the Company recognizes impairment through a provision estimate or a charge-off to the allowance. Management performs these assessments on at least a quarterly basis.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Additional discussions related to the Company’s loan and lease loss provisions is included in the “ALLL for Loan Losses and Reserve for Unfunded Lending Commitments” section above.
LHFS
LHFS are recorded at either estimated fair value (if the FVO is elected) or the lower of cost or fair value. The Company has elected to account for most of its residential real estate mortgages originated with the intent to sell at fair value. Generally, residential loans are valued on an aggregate portfolio basis, and commercial loans are valued on an individual loan basis. Gains and losses on LHFS which are accounted for at fair value are recorded in Miscellaneous income, net. For residential mortgages for which the FVO is selected, direct loan origination costs and fees are recorded in Miscellaneous income, net
at origination.
All other LHFS which the Company does not have the intent and ability to hold for the foreseeable future or until maturity or payoff are carried at the lower of cost or fair value. When loans are transferred from HFI, if the recorded investment of the loan exceeds its market value at the time of initial designation as held for sale, the Company will recognize a direct write-down of the excess of the recorded investment over market value through a charge-off to the ALLL. Subsequent to the initial measurement of LHFS, market declines in the recorded investment, whether due to credit or market risk, are recorded through miscellaneous income, net as lower of cost or market adjustments.
Leases
The Company provides financing for various types of equipment, aircraft, energy and power systems, and automobiles through a variety of lease arrangements.
The Company’s investments in leases that are accounted for as direct financing leases are carried at the aggregate of lease payments plus estimated residual value of the leased property less unearned income, and are reported as part of LHFI in the Company’s Consolidated Balance Sheets. Leveraged leases, a form of financing lease, are carried net of non-recourse debt. The Company recognizes income over the term of the lease using the effective interest method, which provides a constant periodic rate of return on the outstanding investment on the lease.
Leased vehicles under operating leases are carried at amortized cost net of accumulated depreciation and any impairment charges and presented as Operating lease assets, net in the Company’s Consolidated Balance Sheets. Leased assets acquired in a business combination such as the Change in Control are initially recorded at their estimated fair value. Leased vehicles purchased in connection with newly originated operating leases are recorded at amortized cost. The depreciation expense of the vehicles is recognized on a straight-line basis over the contractual term of the leases to the expected residual value. The expected residual value and, accordingly, the monthly depreciation expense may change throughout the term of the lease. The Company estimates expected residual values using independent data sources and internal statistical models that take into consideration economic conditions, current auction results, the Company’s remarketing abilities, and manufacturer vehicle and marketing programs.
Lease payments due from customers are recorded as income within Lease income in the Company’s Consolidated Statements of Operations, unless and until a customer becomes more than 60 days delinquent, at which time the accrual of revenue is discontinued. The accrual is resumed if a delinquent account subsequently becomes 60 days or less past due. Payments from the vehicle’s manufacturer under its subvention programs are recorded as reductions to the cost of the vehicle and are recognized as an adjustment to depreciation expense on a straight-line basis over the contractual term of the lease.
The Company periodically evaluates its investment in operating leases for impairment if circumstances such as a systemic and material decline in used vehicle values occurs. This would include, for example, a decline in the residual value of our lease portfolio due to an event caused by shocks to oil and gas prices that have a pronounced impact on certain models of vehicles, pervasive manufacturer defects, or other events that could systemically affect the value of a particular brand or model of leased asset, which indicates that impairment may exist.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Under the accounting for impairment or disposal of long-lived assets, residual values of leased assets under operating leases are evaluated individually for impairment. When aggregate future cash flows from the operating lease, including the expected realizable fair value of the leased asset at the end of the lease, are less than the book value of the lease, an immediate impairment write-down is recognized if the difference is deemed not recoverable. Otherwise, reductions in the expected residual value result in additional depreciation of the leased asset over the remaining term of the lease. Upon disposition, a gain or loss is recorded for any difference between the net book value of the leased asset and the proceeds from the disposition of the asset, including any insurance proceeds. Gains or losses on the sale of leased assets are included in Miscellaneous income, net, while valuation adjustments on operating lease residuals are included in Other administrative expense in the Consolidated Statements of Operations. No impairment for leased assets was recognized during the years ended December 31, 2018, 2017, or 2016.
Premises and Equipment
Premises and equipment are carried at cost, less accumulated depreciation. Depreciation is calculated utilizing the straight-line method. Estimated useful lives are as follows:
Office buildings | 10 to 50 years | |
Leasehold improvements(1) | 10 to 30 years | |
Software(2) | 3 to 7 years | |
Furniture, fixtures and equipment | 3 to 10 years | |
Automobiles | 5 years | |
(1) Leasehold improvements are depreciated over the shorter of the useful lives of the assets or the remaining term of the leases.
(2) The standard depreciable period for software is three years. However, for certain software implementation projects, a seven-year period is utilized.
Expenditures for maintenance and repairs are charged to Occupancy and equipment expense in the Consolidated Statements of Operations as incurred.
Equity Method Investments
The Company uses the equity method for general and limited partnership interests, limited liability companies and other unconsolidated equity investments in which the Company is considered to have significant influence over the operations of the investee. Under the equity method, the Company records its equity ownership share of net income or loss of the investee in "Other miscellaneous expenses." Investments accounted for under the equity method of accounting above are included in the caption "Other Assets" on the Consolidated Balance Sheets.
Goodwill and Intangible Assets
Goodwill is the excess of the purchase price over the fair value of the tangible and identifiable intangible assets and liabilities of companies acquired through business combinations accounted for under the acquisition method. Goodwill and other indefinite-lived intangible assets are not amortized on a recurring basis, but rather are subject to periodic impairment testing. The Company conducts its evaluation of goodwill impairment at the reporting unit level on an annual basis at October 1, and more frequently if events or circumstances indicate that the carrying value of a reporting unit exceeds its fair value. A reporting unit is an operating segment or one level below.
An entity's goodwill impairment quantitative analysis is required to be completed unless the entity determines, based on certain qualitative factors, that it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is greater than its carrying amount, including goodwill, in which case no further analysis is required. An entity has an unconditional option to bypass the preceding qualitative assessment (often referred to as step 0) for any reporting unit in any period and proceed directly to the quantitative goodwill impairment test.
The quantitative test includes a comparison of the fair value of each reporting unit to its respective carrying amount, including its allocated goodwill. If the fair value of the reporting unit is in excess of the carrying value, the related goodwill is considered not to be impaired and no further analysis is necessary. If the carrying value of the reporting unit is higher than the fair value, the impairment is measured as the excess of carrying value over fair value. A recognized impairment charge cannot exceed the amount of goodwill allocated to a reporting unit and cannot subsequently be reversed even if the fair value of the reporting unit recovers.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
The Company's intangible assets consist of assets purchased or acquired through business combinations, including tradenames and dealer networks. Certain intangible assets are amortized over their useful lives. The Company evaluates identifiable intangibles for impairment when an indicator of impairment exists, but not less than annually. Separable intangible assets that are not deemed to have an indefinite life continue to be amortized over their useful lives.
MSRs
The Company has elected to measure most of its residential MSRs at fair value to be consistent with the risk management strategy to hedge changes in the fair value of these assets. The fair value of residential MSRs is estimated by using a cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors which are determined based on current market conditions. Assumptions incorporated into the residential MSRs valuation model reflect management's best estimate of factors that a market participant would use in valuing the residential MSRs. Although sales of residential MSRs do occur, residential MSRs do not trade in an active market with readily observable prices. Those MSRs not accounted for at fair value are accounted for at amortized cost, less impairment.
As a benchmark for the reasonableness of the residential MSRs' fair value, opinions of value from independent third parties ("Brokers") are obtained. Brokers provide a range of values based upon their own discounted cash flow (“DCF") calculations of our portfolio that reflect conditions in the secondary market and any recently executed servicing transactions. Management compares the internally-developed residential MSR values to the ranges of values received from Brokers. If the residential MSRs fair value falls outside the Brokers' ranges, management will assess whether a valuation adjustment is warranted. Residential MSRs value is considered to represent a reasonable estimate of fair value.
See Note 16 to the Consolidated Financial Statements for detail on MSRs.
BOLI
BOLI represents the cash surrender value of life insurance policies for certain current and former employees who have provided positive consent to allow the Bank to be the beneficiary of such policies. Increases in the net cash surrender value of the policies, as well as insurance proceeds received, are recorded in non-interest income, and are not subject to income taxes.
Other Real Estate Owned (“OREO") and Other Repossessed Assets
OREO and other repossessed assets consist of properties, vehicles, and other assets acquired by, or in lieu of, foreclosure or repossession in partial or total satisfaction of NPLs, including RICs and leases. Assets obtained in satisfaction of a loan are recorded at the estimated fair value minus estimated costs to sell based upon the asset's appraisal value at the date of transfer. The excess of the carrying value of the loan over the fair value of the asset minus estimated costs to sell are charged to the ALLL at the initial measurement date. Subsequent to the acquisition date, OREO and repossessed assets are carried at the lower of cost or estimated fair value, net of estimated cost to sell. Any declines in the fair value of OREO and repossessed assets below the initial cost basis are recorded through a valuation allowance with a charge to non-interest income. Increases in the fair value of OREO and repossessed assets net of estimated selling costs will reverse the valuation allowance, but only up to the cost basis which was established at the initial measurement date. Costs of holding the assets are recorded as operating expenses, except for significant property improvements, which are capitalized to the extent that the carrying value does not exceed the estimated fair value. The Company generally begins vehicle repossession activity once a customer's account becomes 60 days past due. The customer has an opportunity to redeem the repossessed vehicle by paying all outstanding balances, including finance changes and fees. Any vehicles not redeemed are sold at auction. OREO and other repossessed assets are recorded within Other assets on the Consolidated Balance Sheets.
Derivative Instruments and Hedging Activities
The Company uses derivative financial instruments primarily to help manage exposure to interest rate, foreign exchange, equity, and credit risk. Derivative financial instruments are also used to reduce the effects that changes in interest rates may have on net income, the fair value of assets and liabilities, and cash flows. The Company also enters into derivatives with customers to facilitate their risk management activities, and often sells commercial loan customers derivative products to hedge interest rate risk associated with loans made the Company. The Company uses derivative financial instruments as risk management tools and not for speculative trading purposes for its own account. Derivative financial instruments are recognized as either assets or liabilities in the consolidated balance sheets at fair value. The accounting for changes in the fair value of each derivative financial instrument depends on whether it has been designated and qualifies as a hedge for accounting purposes, as well as the type of hedging relationship identified.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability or firm commitment attributable to a particular risk such as interest rate risk are considered fair value hedges. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows or other types of forecasted transactions are considered cash flow hedges. The Company formally documents the relationships of qualifying hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking each hedge transaction.
Fair value hedges that are highly effective are accounted for by recording the change in the fair value of the derivative instrument and the related hedged asset, liability or firm commitment on the Consolidated Balance Sheets, with the corresponding income or expense recorded in the Consolidated Statements of Operations. The adjustment to the hedged asset or liability is included in the basis of the hedged item, while the fair value of the derivative is recorded as an other asset or other liability. Actual cash receipts or payments and related amounts accrued during the period on derivatives included in a fair value hedge relationship are recorded as adjustments to the income or expense associated with the hedged asset or liability.
Cash flow hedges that are highly effective are accounted for by recording the fair value of the derivative instrument on the Consolidated Balance Sheets as an asset or liability, with a corresponding charge or credit for the change in the fair value of the derivative, net of tax, recorded in accumulated OCI within stockholder's equity in the accompanying Consolidated Balance Sheets. Amounts are reclassified from accumulated OCI to the Consolidated Statements of Operations in the period or periods the hedged transaction affects earnings. In the case in which certain cash flow hedging relationships have been terminated, the Company continues to defer the net gain or loss in accumulated OCI and reclassifies it into interest expense as the future cash flows occur, unless it becomes probable that the future cash flows will not occur.
We discontinue hedge accounting when it is determined that the derivative no longer qualifies as an effective hedge; the derivative expires or is sold, terminated or exercised; the derivative is de-designated as a fair value or cash flow hedge; or, for a cash flow hedge, it is no longer probable that the forecasted transaction will occur by the end of the originally specified time period. If we determine that the derivative no longer qualifies as a fair value or cash flow hedge and hedge accounting is discontinued, the derivative will continue to be recorded on the balance sheet at its fair value, with changes in fair value included in current earnings. For a discontinued fair value hedge, the previously hedged item is no longer adjusted for changes in fair value.
Changes in the fair value of derivatives not designated in hedging relationships are recognized immediately in the Consolidated Statements of Operations. Derivatives are classified in the Consolidated Balance Sheets as "Other assets" or "Other liabilities," as applicable. See Note 14 to the Consolidated Financial Statements for further discussion.
Income Taxes
The Company accounts for income taxes under the asset and liability method. Deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. On December 22, 2017, the TCJA was enacted. Effective January 1, 2018, the TCJA, among other things, reduced the federal corporate income tax rate from 35% to 21%. Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to reverse or be realized. The effect of a change in tax rates on deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date. As a result of the TCJA's enactment, the effect of a change in tax rates on deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.
A valuation allowance will be established if the Company determines that it is more likely than not that a deferred tax asset will not be realized. This requires periodic analysis of the carrying amount of deferred tax assets and when the deferred tax assets will be realized in future periods. Consideration is given to all positive and negative evidence related to the realization of deferred tax assets.
In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of inherently complex tax laws of the U.S., its states and municipalities, and abroad. Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. The Company reviews its tax balances quarterly and as new information becomes available. Interest and penalties on income tax payments are included within Income tax provision on the Consolidated Statements of Operations.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
The Company recognizes tax benefits in its financial statements when it is more likely than not the related tax position will be sustained upon examination by tax authorities. Such tax positions are initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the taxing authority, assuming full knowledge of the position and all relevant facts. See Note 15 to the Consolidated Financial Statements for details on the Company's income taxes.
Sales of RICs and Leases
The Company, through SC, transfers RICs into newly formed Trusts which then issue one or more classes of notes payable backed by the RICs. The Company’s continuing involvement with the credit facilities and Trusts are in the form of servicing loans held by the special purpose entities ("SPEs") and, generally, through holding a residual interest in the SPE. These transactions are structured without recourse. The Trusts are considered VIEs under GAAP and are consolidated when the Company has: (a) power over the significant activities of the entity and (b) an obligation to absorb losses or the right to receive benefits from the VIE which are potentially significant to the VIE. The Company has power over the significant activities of those Trusts as servicer of the financial assets held in the Trust. Servicing fees are not considered significant variable interests in the Trusts; however, when the Company also retains a residual interest in the Trust, either in the form of a debt security or equity interest, the Company has an obligation to absorb losses or the right to receive benefits that are potentially significant to the SPE. Accordingly, these Trusts are consolidated within the Consolidated Financial Statements, and the associated RICs, borrowings under credit facilities and securitization notes payable remain on the Consolidated Balance Sheets. Securitizations involving Trusts in which the Company does not retain a residual interest or any other debt or equity interest are treated as sales of the associated RICs. While these Trusts are included in our Consolidated Financial Statements, they are separate legal entities; thus, the finance receivables and other assets sold to these Trusts are legally owned by the Trusts, are available only to satisfy the notes payable related to the securitized RICs, and are not available to the Company's creditors or other subsidiaries.
The Company also sells RICs and leases to VIEs or directly to third parties, which the Company may determine meet sale accounting treatment in accordance with applicable guidance. Due to the nature, purpose, and activity of these transactions, the Company either does not hold potentially significant variable interests or is not the primary beneficiary as a result of the Company's limited further involvement with the financial assets. The transferred financial assets are removed from the Company's Consolidated Balance Sheets at the time the sale is completed. The Company generally remains the servicer of the financial assets and receives servicing fees. The Company also recognizes a gain or loss for the difference between the fair value, as measured based on sales proceeds plus (or minus) the value of any servicing asset (or liability) retained and the carrying value of the assets sold.
See further discussion on the Company's securitizations in Note 7 to these Consolidated Financial Statements.
Stock-Based Compensation
The Company, through Santander, sponsors stock plans under which incentive and non-qualified stock options and non-vested stock may be granted periodically to certain employees. The Company recognizes compensation expense related to stock options and non-vested stock awards based upon the fair value of the awards on the date of the grant, which is charged to earnings over the requisite service period (i.e., the vesting period). The impact of the forfeiture of awards is recognized as forfeitures occur. Amounts in the Consolidated Statements of Operations associated with the Company's stock compensation plan were negligible in all years presented.
The Company assumed stock-based arrangements in connection with the Change in Control. The Company was required to recognize stock option awards that were outstanding as of the Change in Control date at fair value. The portion of the fair value measurement of the share-based payments that is attributable to pre-business combination service is recognized as NCI and the portion relating to any remaining post-business combination service is recognized as stock compensation expense over the remaining vesting period of the awards in the Company’s post-business combination financial statements.
Guarantees
Certain off-balance sheet financial instruments of the Company meet the definition of a guarantee that require the Company to perform and make future payments in the event specified triggering events or conditions were to occur over the term of the guarantee. In accordance with the applicable accounting rules, it is the Company’s accounting policy to recognize a liability at inception associated with such a guarantee at the greater of the fair value of the guarantee or the Company's estimate of the contingent liability arising from the guarantee. Subsequent to initial recognition, the liability is adjusted based on the passage of time to perform under the guarantee and the changes to the probabilities of occurrence related to the specified triggering events or conditions that would require the Company to perform on the guarantee.
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NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (continued)
Subsequent Events
The Company evaluated events from the date of the Consolidated Financial Statements on December 31, 2018 through the issuance of these Consolidated Financial Statements, and has determined that there have been no material events that would require recognition in its Consolidated Financial Statements or disclosure in the Notes to the Consolidated Financial Statements for the year ended December 31, 2018 other than the transactions disclosed in Note 11 and Note 23 of these Consolidated Financial Statements.
NOTE 2. RECENT ACCOUNTING DEVELOPMENTS
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The primary effect of this ASU is the requirement of lessees to recognize a right of-use-asset and lease liability for all operating leases with a term greater than 12 months. The right-of-use-asset and lease liability are then derecognized in a manner that effectively yields a straight-line lease expense over the lease term. Lessee accounting requirements for finance leases (previously described as capital leases) and lessor accounting requirements for operating, sales-type, and direct financing leases (sales-type and direct financing leases were both previously referred to as capital leases) are largely unchanged. This ASU is effective on January 1, 2019, with early adoption permitted.
We adopted the standard as of January 1, 2019, resulting in the recognition of right of use assets of approximately $664.1 million and liabilities of approximately $705.6 million for our operating leases where the Company is the lessee. In addition, and as a result of the standard, the Company recorded a cumulative net increase to opening Retained earnings of $18.7 million. We do not believe the standard will materially affect our Consolidated Statements of Operations or SCF.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. This guidance significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace today’s “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost. For AFS debt securities, entities will be required to record allowances rather than reduce the carrying amount, as they do today under the OTTI model. The standard also simplifies the accounting model for purchased credit-impaired debt securities and loans. The guidance will be effective for the Company for the first reporting period beginning after December 15, 2019, including interim periods within that year. The Company does not intend to adopt the this ASU early and is currently evaluating the impact the new guidance will have on its financial position, results of operations and cash flows; however, it is expected that the new current expected credit loss model will alter the assumptions used in calculating the Company's ACL, given the change to estimated losses for the estimated life of the financial asset, and will likely result in material changes to the Company's ACL and related decrease to capital ratios.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, which modifies the disclosure requirements for fair value measurements. This ASU removes the requirement to disclose: the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels; and the valuation processes for Level 3 fair value measurements. This ASU requires disclosure of changes in unrealized gains and losses for the period included in OCI (loss) for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. This new guidance will be effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effect the new guidance will have on its Consolidated Financial Statements and related disclosures.
In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This new guidance will be effective for public companies for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effect the new guidance will have on its Consolidated Financial Statements and related disclosures.
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NOTE 2. RECENT ACCOUNTING DEVELOPMENTS (continued)
In October 2018, the FASB issued ASU 2018-16, Derivatives and Hedging (Topic 815), Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. This ASU permits use of the Overnight Indexed Swap (“OIS”) rate based on the Secured Overnight Financing Rate as an eligible benchmark interest rate for purposes of applying hedge accounting under Topic 815. This update was adopted January 1, 2019, and the Company does not expect the new guidance to have a material on its Consolidated Financial Statements or related disclosures.
In addition to those described in detail above, the Company is in the process of evaluating the following ASUs, but does not expect them to have a material impact on the Company's financial position, results of operations, or disclosures:
ASU's Effective in 2019:
• | ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities |
• | ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception |
• | ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting |
• | ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities |
NOTE 3. INVESTMENT SECURITIES
Summary of Investment in Debt Securities - AFS and HTM
The following tables present the amortized cost, gross unrealized gains and losses and approximate fair values of debt securities AFS at the dates indicated:
December 31, 2018 | December 31, 2017 | |||||||||||||||||||||||||||||||
(in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Loss | Fair Value | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Loss | Fair Value | ||||||||||||||||||||||||
U.S. Treasury securities | $ | 1,815,914 | $ | 560 | $ | (11,729 | ) | $ | 1,804,745 | $ | 1,006,219 | $ | — | $ | (8,107 | ) | $ | 998,112 | ||||||||||||||
Corporate debt securities | 160,164 | 12 | (62 | ) | 160,114 | 11,639 | 21 | — | 11,660 | |||||||||||||||||||||||
Asset-backed securities (“ABS”) | 435,464 | 3,517 | (2,144 | ) | 436,837 | 501,575 | 6,901 | (1,314 | ) | 507,162 | ||||||||||||||||||||||
Equity securities (1) | — | — | — | — | 11,428 | — | (614 | ) | 10,814 | |||||||||||||||||||||||
State and municipal securities | 16 | — | — | 16 | 23 | — | — | 23 | ||||||||||||||||||||||||
Mortgage-backed securities (“MBS”): | ||||||||||||||||||||||||||||||||
Government National Mortgage Association ("GNMA") - Residential | 2,829,075 | 861 | (85,675 | ) | 2,744,261 | 4,745,998 | 3,531 | (62,524 | ) | 4,687,005 | ||||||||||||||||||||||
GNMA - Commercial | 954,651 | 1,250 | (19,515 | ) | 936,386 | 1,377,449 | 179 | (19,917 | ) | 1,357,711 | ||||||||||||||||||||||
Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA") - Residential | 5,687,221 | 267 | (188,515 | ) | 5,498,973 | 6,958,433 | 1,093 | (141,393 | ) | 6,818,133 | ||||||||||||||||||||||
FHLMC and FNMA - Commercial | 51,808 | 384 | (537 | ) | 51,655 | 23,003 | — | (440 | ) | 22,563 | ||||||||||||||||||||||
Total investments in debt securities AFS | $ | 11,934,313 | $ | 6,851 | $ | (308,177 | ) | $ | 11,632,987 | $ | 14,635,767 | $ | 11,725 | $ | (234,309 | ) | $ | 14,413,183 | ||||||||||||||
(1) Reflects the reclassification of the Company's investments in equity securities to Other investments as a result of the adoption of ASU 2016-01 as of January 1, 2018.
124
NOTE 3. INVESTMENT SECURITIES (continued)
The following tables present the amortized cost, gross unrealized gains and losses and approximate fair values of debt securities HTM at the dates indicated:
December 31, 2018 | December 31, 2017 | |||||||||||||||||||||||||||||||
(in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Loss | Fair Value | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Loss | Fair Value | ||||||||||||||||||||||||
GNMA - Residential | $ | 1,718,687 | $ | 1,806 | $ | (54,184 | ) | $ | 1,666,309 | $ | 1,447,669 | $ | 722 | $ | (26,150 | ) | $ | 1,422,241 | ||||||||||||||
GNMA - Commercial | 1,031,993 | 1,426 | (23,679 | ) | 1,009,740 | 352,139 | 325 | (767 | ) | 351,697 | ||||||||||||||||||||||
Total investments in debt securities HTM | $ | 2,750,680 | $ | 3,232 | $ | (77,863 | ) | $ | 2,676,049 | $ | 1,799,808 | $ | 1,047 | $ | (26,917 | ) | $ | 1,773,938 | ||||||||||||||
The Company continuously evaluates its investment strategies in light of changes in the regulatory and market environments that could have an impact on capital and liquidity. Based on this evaluation, it is reasonably possible that the Company may elect to pursue other strategies relative to its investment securities portfolio. During the year ended December 31, 2018, the Company transferred approximately $1.2 billion of MBS from AFS to HTM in conjunction with its capital management strategy.
As of December 31, 2018 and 2017, the Company had investment securities with an estimated carrying value of $6.6 billion and $5.9 billion, respectively, pledged as collateral, which was comprised of the following: $3.0 billion and $3.0 billion, respectively, were pledged as collateral for the Company's borrowing capacity with the FRB; $2.7 billion and $2.3 billion, respectively, were pledged to secure public fund deposits; $78.0 million and $243.8 million, respectively, were pledged to various independent parties to secure repurchase agreements, support hedging relationships, and for recourse on loan sales; $423.3 million and zero, respectively, were pledged to deposits with clearing organizations; and $415.1 million and $387.9 million, respectively, were pledged to secure the Company's customer overnight sweep product.
At December 31, 2018 and December 31, 2017, the Company had $40.2 million and $47.0 million, respectively, of accrued interest related to investment securities which is included in the Other assets line of the Company's Consolidated Balance Sheets.
Contractual Maturity of Debt Securities
Contractual maturities of the Company’s AFS debt securities at December 31, 2018 were as follows:
(in thousands) | Due Within One Year | Due After 1 Within 5 Years | Due After 5 Within 10 Years | Due After 10 Years/No Maturity | Total(1) | Weighted Average Yield(2) | |||||||||||||||||
U.S Treasury and government agency | $ | 735,379 | $ | 1,069,366 | $ | — | $ | — | $ | 1,804,745 | 1.78 | % | |||||||||||
Corporate debt securities | 160,101 | — | 13 | — | 160,114 | 3.33 | % | ||||||||||||||||
ABS | 251,958 | 75,225 | 17,681 | 91,973 | 436,837 | 3.70 | % | ||||||||||||||||
State and municipal securities | — | 16 | — | — | 16 | 7.49 | % | ||||||||||||||||
MBS: | |||||||||||||||||||||||
GNMA - Residential | — | 2,625 | 69,463 | 2,672,173 | 2,744,261 | 2.63 | % | ||||||||||||||||
GNMA - Commercial | — | — | — | 936,386 | 936,386 | 2.74 | % | ||||||||||||||||
FHLMC and FNMA - Residential | — | 6,089 | 191,423 | 5,301,461 | 5,498,973 | 2.51 | % | ||||||||||||||||
FHLMC and FNMA - Commercial | — | 7,364 | 24,169 | 20,122 | 51,655 | 2.98 | % | ||||||||||||||||
Total fair value | $ | 1,147,438 | $ | 1,160,685 | $ | 302,749 | $ | 9,022,115 | $ | 11,632,987 | 2.50 | % | |||||||||||
Weighted Average Yield | 2.52 | % | 1.90 | % | 2.24 | % | 2.59 | % | 2.50 | % | |||||||||||||
Total amortized cost | $ | 1,145,692 | $ | 1,170,312 | $ | 309,158 | $ | 9,309,151 | $ | 11,934,313 | |||||||||||||
(1) | The maturities above do not represent the effective duration of the Company's portfolio, since the amounts above are based on contractual maturities and do not contemplate anticipated prepayments. |
(2) | Yields on tax-exempt securities are calculated on a tax equivalent basis and are based on the statutory federal tax rate. |
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NOTE 3. INVESTMENT SECURITIES (continued)
Contractual maturities of the Company’s HTM debt securities at December 31, 2018 were as follows:
(in thousands) | Due Within One Year | Due After 1 Within 5 Years | Due After 5 Within 10 Years | Due After 10 Years/No Maturity | Total(1) | Weighted Average Yield | |||||||||||||||||
MBS: | |||||||||||||||||||||||
GNMA - Residential | $ | — | $ | — | $ | — | $ | 1,666,309 | $ | 1,666,309 | 2.56 | % | |||||||||||
GNMA - Commercial | — | — | — | 1,009,740 | 1,009,740 | 2.61 | % | ||||||||||||||||
Total fair value | $ | — | $ | — | $ | — | $ | 2,676,049 | $ | 2,676,049 | 2.58 | % | |||||||||||
Weighted average yield | — | % | — | % | — | % | 2.58 | % | 2.58 | % | |||||||||||||
Total amortized cost | $ | — | $ | — | $ | — | $ | 2,750,680 | $ | 2,750,680 | |||||||||||||
(1) | The maturities above do not represent the effective duration of the Company's portfolio, since the amounts above are based on contractual maturities and do not contemplate anticipated prepayments. |
Actual maturities may differ from contractual maturities when there is a right to call or prepay obligations with or without call or prepayment penalties.
Gross Unrealized Loss and Fair Value of Debt Securities AFS and HTM
The following tables present the aggregate amount of unrealized losses as of December 31, 2018 and December 31, 2017 on securities in the Company’s AFS investment portfolios classified according to the amount of time those securities have been in a continuous loss position:
December 31, 2018 | December 31, 2017 | |||||||||||||||||||||||||||||||
Less than 12 months | 12 months or longer | Less than 12 months | 12 months or longer | |||||||||||||||||||||||||||||
(in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||||||||||
U.S. Treasury securities | $ | 288,660 | $ | (315 | ) | $ | 914,212 | $ | (11,414 | ) | $ | 998,112 | $ | (8,107 | ) | $ | — | $ | — | |||||||||||||
Corporate debt securities | 152,247 | (62 | ) | 13 | — | — | — | — | — | |||||||||||||||||||||||
ABS | 31,888 | (249 | ) | 77,766 | (1,895 | ) | 8,013 | (125 | ) | 103,559 | (1,189 | ) | ||||||||||||||||||||
Equity securities (1) | — | — | — | — | 335 | (2 | ) | 10,398 | (612 | ) | ||||||||||||||||||||||
MBS: | ||||||||||||||||||||||||||||||||
GNMA - Residential | 102,418 | (2,014 | ) | 2,521,278 | (83,661 | ) | 1,236,716 | (8,600 | ) | 2,583,955 | (53,924 | ) | ||||||||||||||||||||
GNMA - Commercial | 199,495 | (2,982 | ) | 622,989 | (16,533 | ) | 1,022,452 | (11,492 | ) | 251,209 | (8,425 | ) | ||||||||||||||||||||
FHLMC and FNMA - Residential | 237,050 | (5,728 | ) | 5,236,028 | (182,787 | ) | 3,429,678 | (32,899 | ) | 3,017,533 | (108,494 | ) | ||||||||||||||||||||
FHLMC and FNMA - Commercial | — | — | 21,819 | (537 | ) | 6,948 | (103 | ) | 15,614 | (337 | ) | |||||||||||||||||||||
Total investments in debt securities AFS | $ | 1,011,758 | $ | (11,350 | ) | $ | 9,394,105 | $ | (296,827 | ) | $ | 6,702,254 | $ | (61,328 | ) | $ | 5,982,268 | $ | (172,981 | ) | ||||||||||||
(1) Reflects the reclassification of the Company's investments in equity securities to Other investments as a result of the adoption of ASU 2016-01 as of January 1, 2018.
The following tables present the aggregate amount of unrealized losses as of December 31, 2018 and December 31, 2017 on debt securities in the Company’s HTM investment portfolios classified according to the amount of time those securities have been in a continuous loss position:
December 31, 2018 | December 31, 2017 | |||||||||||||||||||||||||||||||
Less than 12 months | 12 months or longer | Less than 12 months | 12 months or longer | |||||||||||||||||||||||||||||
(in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||||||||||
MBS: | ||||||||||||||||||||||||||||||||
GNMA - Residential | $ | 205,573 | $ | (4,810 | ) | $ | 1,295,554 | $ | (49,374 | ) | $ | 434,322 | $ | (6,419 | ) | $ | 739,612 | $ | (19,731 | ) | ||||||||||||
GNMA - Commercial | 221,250 | (5,572 | ) | 629,847 | (18,107 | ) | 118,951 | (767 | ) | — | — | |||||||||||||||||||||
Total investments in debt securities HTM | $ | 426,823 | $ | (10,382 | ) | $ | 1,925,401 | $ | (67,481 | ) | $ | 553,273 | $ | (7,186 | ) | $ | 739,612 | $ | (19,731 | ) | ||||||||||||
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NOTE 3. INVESTMENT SECURITIES (continued)
OTTI
Management evaluates all investment securities in an unrealized loss position for OTTI on a quarterly basis. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. The OTTI assessment is a subjective process requiring the use of judgments and assumptions. During the securities-level assessments, consideration is given to (1) the intent not to sell and probability that the Company will not be required to sell the security before recovery of its cost basis to allow for any anticipated recovery in fair value, (2) the financial condition and near-term prospects of the issuer, as well as company news and current events, and (3) the ability to collect the future expected cash flows. Key assumptions utilized to forecast expected cash flows may include loss severity, expected cumulative loss percentage, cumulative loss percentage to date, weighted average Fair Isaac Corporation ("FICO") scores and weighted average LTV ratio, rating or scoring, credit ratings and market spreads, as applicable.
The Company assesses and recognizes OTTI in accordance with applicable accounting standards. Under these standards, if the Company determines that impairment on its debt securities exists and it has made the decision to sell the security or it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis, it recognizes the entire portion of the unrealized loss in earnings. If the Company has not made a decision to sell the security and it does not expect that it will be required to sell the security prior to the recovery of the amortized cost basis but the Company has determined that OTTI exists, it recognizes the credit-related portion of the decline in value of the security in earnings.
The Company did not record any material OTTI related to its investment securities for the years ended December 31, 2018, 2017 or 2016.
Management has concluded that the unrealized losses on its debt securities for which it has not recognized OTTI (which were comprised of 975 individual securities at December 31, 2018) are temporary in nature since (1) they reflect the increase in interest rates, which lowers the current fair value of the securities, (2) they are not related to the underlying credit quality of the issuers, (3) the entire contractual principal and interest due on these securities is currently expected to be recoverable, (4) the Company does not intend to sell these investments at a loss and (5) it is more likely than not that the Company will not be required to sell the investments before recovery of the amortized cost basis, which for the Company's debt securities may be at maturity. Accordingly, the Company has concluded that the impairment on these securities is not other than temporary.
Gains (Losses) and Proceeds on Sales of Investment Securities
Proceeds from sales of investments in debt securities and the realized gross gains and losses from those sales were as follows:
Year Ended December 31, | ||||||||||||
(in thousands) | 2018 | 2017 | 2016 | |||||||||
Proceeds from the sales of AFS securities | $ | 1,262,409 | $ | 3,256,378 | $ | 6,755,299 | ||||||
Gross realized gains | $ | 5,517 | $ | 22,224 | $ | 61,344 | ||||||
Gross realized losses | (12,234 | ) | (24,668 | ) | (3,797 | ) | ||||||
OTTI | — | — | (44 | ) | ||||||||
Net realized gains/(losses) (1) | $ | (6,717 | ) | $ | (2,444 | ) | $ | 57,503 | ||||
(1) | Includes net realized gain/(losses) on trading securities of $(1.4) million, $(4.2) million and $(0.3) million for the years ended December 31, 2018, 2017 and 2016, respectively. |
The Company uses the specific identification method to determine the cost of the securities sold and the gain or loss recognized.
Other Investments
Other Investments consisted of the following as of:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
FHLB of Pittsburgh and FRB stock | $ | 631,239 | $ | 516,693 | ||||
Low Income Housing Tax Credit investments ("LIHTC") | 163,113 | 88,170 | ||||||
Equity securities not held for trading (1) | 10,995 | — | ||||||
CDs with a maturity greater than 90 days | — | 54,000 | ||||||
Trading securities | 10 | 1 | ||||||
Total | $ | 805,357 | $ | 658,864 | ||||
(1) Reflects the reclassification of the Company's investments in equity securities to Other investments as a result of the adoption of ASU 2016-01 as of January 1, 2018.
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NOTE 3. INVESTMENT SECURITIES (continued)
Other investments primarily include the Company's investment in the stock of the FHLB of Pittsburgh and the FRB. These stocks do not have readily determinable fair values because their ownership is restricted and they lack a market. The stocks can be sold back only at their par value of $100 per share, and FHLB stock can be sold back only to the FHLB or to another member institution. Accordingly, these stocks are carried at cost. During the years ended December 31, 2018, the Company purchased $267.5 million of FHLB stock at par and redeemed $153.3 million of FHLB stock at par. There was no gain or loss associated with these redemptions. During the years ended December 31, 2018, the Company purchased $0.2 million of FRB stock at par.
Other investments also includes LIHTC investments, time deposits with a maturity of greater than 90 days held at non-affiliated financial institutions, trading securities, and $11.0 million of equity securities. Equity securities are measured at fair value as of December 31, 2018, with changes in fair value recognized in net income, and consist primarily of Community Reinvestment Act (“CRA") mutual fund investments reclassified as a result of the 2018 adoption of ASU 2016-01, discussed further in Note 1. They were included in Investments AFS at December 31, 2017. The Company's LIHTC investments are accounted for using the proportional amortization method.
With the exception of equity and trading securities which are measured at fair value, the Company evaluates these other investments for impairment based on the ultimate recoverability of the carrying value, rather than by recognizing temporary declines in value. The Company held an immaterial amount of equity securities without readily determinable fair values at the reporting date.
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES
Overall
The Company's loans are reported at their outstanding principal balances net of any cumulative charge-offs, unamortized deferred fees and costs and unamortized premiums or discounts. The Company maintains an ACL to provide for losses inherent in its portfolios. Certain loans are pledged as collateral for borrowings, securitizations, or SPEs. These loans totaled $49.5 billion at December 31, 2018 and $50.9 billion at December 31, 2017.
Loans that the Company intends to sell are classified as LHFS. The LHFS portfolio balance at December 31, 2018 was $1.3 billion, compared to $2.5 billion at December 31, 2017. LHFS in the residential mortgage portfolio are reported at either estimated fair value (if the FVO is elected) or the lower of cost or fair value. For a discussion on the valuation of LHFS at fair value, see Note 16 to the Consolidated Financial Statements. Loans under SC’s personal lending platform have been classified as HFS and adjustments to lower of cost or market are recorded through Miscellaneous income, net on the Consolidated Statements of Operations. As of December 31, 2018 and 2017, the carrying value of the personal unsecured HFS portfolio was $1.1 billion.
Interest on loans is credited to income as it is earned. Loan origination fees and certain direct loan origination costs are deferred and recognized as adjustments to interest income in the Consolidated Statements of Operations over the contractual life of the loan utilizing the interest method. Loan origination costs and fees and premiums and discounts on RICs are deferred and recognized in interest income over their estimated lives using estimated prepayment speeds, which are updated on a monthly basis. At December 31, 2018 and December 31, 2017, accrued interest receivable on the Company's loans was $524.0 million and $529.9 million, respectively.
During the year ended December 31, 2018, the Company sold substantially all of its mortgage warehouse facilities, which had a book value of $499.2 million for net proceeds of $515.8 million. The $16.7 million gain on sale was recognized within Miscellaneous income, net on the Condensed Consolidated Statements of Operations.
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NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
Loan and Lease Portfolio Composition
The following presents the composition of the gross loans and leases HFI by portfolio and by rate type:
December 31, 2018 | December 31, 2017 | |||||||||||||
(dollars in thousands) | Amount | Percent | Amount | Percent | ||||||||||
Commercial LHFI: | ||||||||||||||
Commercial real estate ("CRE") loans | $ | 8,704,481 | 10.0 | % | $ | 9,279,225 | 11.5 | % | ||||||
Commercial and industrial ("C&I") loans | 15,738,158 | 18.1 | % | 14,438,311 | 17.9 | % | ||||||||
Multifamily loans | 8,309,115 | 9.5 | % | 8,274,435 | 10.1 | % | ||||||||
Other commercial(2) | 7,630,004 | 8.8 | % | 7,174,739 | 8.9 | % | ||||||||
Total commercial LHFI | 40,381,758 | 46.4 | % | 39,166,710 | 48.4 | % | ||||||||
Consumer loans secured by real estate: | ||||||||||||||
Residential mortgages | 9,884,462 | 11.4 | % | 8,846,765 | 11.0 | % | ||||||||
Home equity loans and lines of credit | 5,465,670 | 6.3 | % | 5,907,733 | 7.3 | % | ||||||||
Total consumer loans secured by real estate | 15,350,132 | 17.7 | % | 14,754,498 | 18.3 | % | ||||||||
Consumer loans not secured by real estate: | ||||||||||||||
RICs and auto loans - originated (4) | 28,532,085 | 32.8 | % | 23,131,253 | 28.6 | % | ||||||||
RICs and auto loans - purchased | 803,135 | 0.9 | % | 1,834,868 | 2.3 | % | ||||||||
Personal unsecured loans | 1,531,708 | 1.8 | % | 1,285,677 | 1.6 | % | ||||||||
Other consumer(3) | 447,050 | 0.4 | % | 617,675 | 0.8 | % | ||||||||
Total consumer loans | 46,664,110 | 53.6 | % | 41,623,971 | 51.6 | % | ||||||||
Total LHFI(1) | $ | 87,045,868 | 100.0 | % | $ | 80,790,681 | 100.0 | % | ||||||
Total LHFI: | ||||||||||||||
Fixed rate | $ | 56,696,491 | 65.1 | % | $ | 50,703,619 | 62.8 | % | ||||||
Variable rate | 30,349,377 | 34.9 | % | 30,087,062 | 37.2 | % | ||||||||
Total LHFI(1) | $ | 87,045,868 | 100.0 | % | $ | 80,790,681 | 100.0 | % | ||||||
(1)Total LHFI includes deferred loan fees, net of deferred origination costs and unamortized purchase premiums, net of discounts as well as purchase accounting adjustments. These items resulted in a net increase in the loan balances of $1.4 billion and $1.3 billion as of December 31, 2018 and December 31, 2017, respectively.
(2)Other commercial includes commercial equipment vehicle financing ("CEVF") leveraged leases and loans.
(3)Other consumer primarily includes RV and marine loans.
(4)Beginning in 2018, the Bank has an agreement with SC by which SC provides the Bank with origination support services in connection with the processing, underwriting and purchase of RICs, primarily from Chrysler dealers.
Portfolio segments and classes
GAAP requires that entities disclose information about the credit quality of their financing receivables at disaggregated levels, specifically defined as “portfolio segments” and “classes,” based on management’s systematic methodology for determining the ACL. The Company utilizes similar categorization compared to the financial statement categorization of loans to model and calculate the ACL and track the credit quality, delinquency and impairment status of the underlying loan populations. In disaggregating its financing receivables portfolio, the Company’s methodology begins with the commercial and consumer segments.
The commercial segmentation reflects line of business distinctions. The CRE line of business includes commercial and industrial owner-occupied real estate and specialized lending for investment real estate. The Company's allowance methodology further classifies loans in this line of business into construction and non-construction loans; however, the methodology for development and determination of the allowance is generally consistent between the two portfolios. "C&I" includes non-real estate-related C&I loans. "Multifamily" represents loans for multifamily residential housing units. “Other commercial” includes loans to global customer relationships in Latin America which are not defined as commercial or consumer for regulatory purposes. The remainder of the portfolio primarily represents the CEVF business.
The Company's portfolio classes are substantially the same as its financial statement categorization of loans for consumer loan populations. “Residential mortgages” includes mortgages on residential property, including single family and 1-4 family units. "Home equity loans and lines of credit" include all organic home equity contracts and purchased home equity portfolios. "RICs and auto loans" includes the Company's direct automobile loan portfolios, but excludes RV and marine RICs. "Personal unsecured loans" includes personal revolving loans and credit cards. “Other consumer” includes an acquired portfolio of marine RICs and RV contracts as well as indirect auto loans.
In accordance with the Company's accounting policy when establishing the collective ACL for originated loans, the Company's estimate of losses on recorded investment includes the estimate of the related net unaccreted discount balance that is expected at the time of charge-off, while it considers the entire unaccreted discount for loan portfolios purchased at a discount as available to absorb the credit losses when determining the ACL specific to these portfolios. This accounting policy is not applicable to the purchased loan portfolios acquired with evidence of credit deterioration, on which we elected to apply the FVO.
129
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
The RIC and auto loan portfolio is comprised of: (1) RICs originated by SC prior to the first quarter 2014 consolidation and change in control of SC (the “Change in Control"), (2) RICs originated by SC after the Change in Control, and (3) auto loans originated by SBNA. The composition of the portfolio segment is as follows:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
RICs - Purchased HFI: | ||||||||
Unpaid principal balance ("UPB") (1) | $ | 844,582 | $ | 1,929,548 | ||||
UPB - FVO (2) | 9,678 | 24,926 | ||||||
Total UPB | 854,260 | 1,954,474 | ||||||
Purchase marks (3) | (51,125 | ) | (119,606 | ) | ||||
Total RICs - Purchased HFI | 803,135 | 1,834,868 | ||||||
RICs - Originated HFI: | ||||||||
UPB (1) | 27,049,875 | 23,423,031 | ||||||
Net discount | (135,489 | ) | (309,920 | ) | ||||
Total RICs - Originated | 26,914,386 | 23,113,111 | ||||||
SBNA auto loans | 1,617,699 | 18,142 | ||||||
Total RICs - originated post-Change in Control | 28,532,085 | 23,131,253 | ||||||
Total RICs and auto loans HFI | $ | 29,335,220 | $ | 24,966,121 | ||||
(1) | UPB does not include amounts related to the loan receivables - unsecured and loan receivables from dealers due to the short-term and revolving nature of these receivables. |
(2) | The Company elected to account for these loans, which were acquired with evidence of credit deterioration, under the FVO. |
(3) | Includes purchase marks of $2.1 million and $5.5 million related to purchase loan portfolios on which we elected to apply the FVO at December 31, 2018 and December 31, 2017, respectively. |
During the years ended December 31, 2018 and 2017, SC originated $7.9 billion and $6.7 billion, respectively, in Chrysler Capital loans (which excludes the SBNA originations program), which represented 46% and 47%, respectively, of the Company's total RIC originations (UPB). As of December 31, 2018 and December 31, 2017, the Company's carrying value of its auto RIC portfolio consisted of $9.0 billion and $8.2 billion, respectively, of Chrysler Capital loans (excluding the SBNA originations program), which represented 36% and 37%, respectively, of the Company's auto RIC portfolio.
ACL Rollforward by Portfolio Segment
The activity in the ACL by portfolio segment for the years ended December 31, 2018, 2017, and 2016 was as follows:
Year Ended December 31, 2018 | ||||||||||||||||
(in thousands) | Commercial | Consumer | Unallocated | Total | ||||||||||||
ALLL, beginning of period | $ | 443,796 | $ | 3,504,068 | $ | 47,023 | $ | 3,994,887 | ||||||||
Provision for loan and lease losses | 45,897 | 2,306,896 | — | 2,352,793 | ||||||||||||
Charge-offs | (108,750 | ) | (4,974,547 | ) | — | (5,083,297 | ) | |||||||||
Recoveries | 60,140 | 2,572,607 | — | 2,632,747 | ||||||||||||
Charge-offs, net of recoveries | (48,610 | ) | (2,401,940 | ) | — | (2,450,550 | ) | |||||||||
ALLL, end of period | $ | 441,083 | $ | 3,409,024 | $ | 47,023 | $ | 3,897,130 | ||||||||
Reserve for unfunded lending commitments, beginning of period (2) | $ | 103,835 | $ | 5,276 | $ | — | $ | 109,111 | ||||||||
(Release of) / Provision for reserve for unfunded lending commitments | (13,647 | ) | 752 | — | (12,895 | ) | ||||||||||
Loss on unfunded lending commitments | (716 | ) | — | — | (716 | ) | ||||||||||
Reserve for unfunded lending commitments, end of period | 89,472 | 6,028 | — | 95,500 | ||||||||||||
Total ACL, end of period | $ | 530,555 | $ | 3,415,052 | $ | 47,023 | $ | 3,992,630 | ||||||||
Ending balance, individually evaluated for impairment(1) | $ | 94,120 | $ | 1,457,174 | $ | — | $ | 1,551,294 | ||||||||
Ending balance, collectively evaluated for impairment | 346,963 | 1,951,850 | 47,023 | 2,345,836 | ||||||||||||
Financing receivables: | ||||||||||||||||
Ending balance | $ | 40,381,758 | $ | 47,947,388 | $ | — | $ | 88,329,146 | ||||||||
Ending balance, evaluated under the FVO or lower of cost or fair value | — | 1,393,476 | — | 1,393,476 | ||||||||||||
Ending balance, individually evaluated for impairment(1) | 444,031 | 5,779,998 | — | 6,224,029 | ||||||||||||
Ending balance, collectively evaluated for impairment | 39,937,727 | 40,773,914 | — | 80,711,641 | ||||||||||||
(1) | Consists of loans in TDR status. |
(2) Includes an immaterial reallocation between Commercial and Consumer for the period ending December 31, 2018.
130
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
Year Ended December 31, 2017 | ||||||||||||||||
(in thousands) | Commercial | Consumer | Unallocated | Total | ||||||||||||
ALLL, beginning of period | $ | 449,837 | $ | 3,317,604 | $ | 47,023 | $ | 3,814,464 | ||||||||
Provision for loan and lease losses | 99,606 | 2,670,950 | — | 2,770,556 | ||||||||||||
Other(1) | 356 | 5,283 | — | 5,639 | ||||||||||||
Charge-offs | (144,002 | ) | (4,891,383 | ) | — | (5,035,385 | ) | |||||||||
Recoveries | 37,999 | 2,401,614 | — | 2,439,613 | ||||||||||||
Charge-offs, net of recoveries | (106,003 | ) | (2,489,769 | ) | — | (2,595,772 | ) | |||||||||
ALLL, end of period | $ | 443,796 | $ | 3,504,068 | $ | 47,023 | $ | 3,994,887 | ||||||||
Reserve for unfunded lending commitments, beginning of period | $ | 116,866 | $ | 5,552 | $ | — | $ | 122,418 | ||||||||
Release of unfunded lending commitments | (10,336 | ) | (276 | ) | — | (10,612 | ) | |||||||||
Loss on unfunded lending commitments | (2,695 | ) | — | — | (2,695 | ) | ||||||||||
Reserve for unfunded lending commitments, end of period | 103,835 | 5,276 | — | 109,111 | ||||||||||||
Total ACL, end of period | $ | 547,631 | $ | 3,509,344 | $ | 47,023 | $ | 4,103,998 | ||||||||
Ending balance, individually evaluated for impairment(2) | $ | 102,326 | $ | 1,824,640 | $ | — | $ | 1,926,966 | ||||||||
Ending balance, collectively evaluated for impairment | 341,470 | 1,679,428 | 47,023 | 2,067,921 | ||||||||||||
Financing receivables: | ||||||||||||||||
Ending balance | $ | 39,315,888 | $ | 43,997,279 | $ | — | $ | 83,313,167 | ||||||||
Ending balance, evaluated under the FVO or lower of cost or fair value | 149,177 | 2,420,155 | — | 2,569,332 | ||||||||||||
Ending balance, individually evaluated for impairment(2) | 593,585 | 6,652,949 | — | 7,246,534 | ||||||||||||
Ending balance, collectively evaluated for impairment | 38,573,126 | 34,924,175 | — | 73,497,301 | ||||||||||||
(1) | Includes transfers in for the period ending September 30, 2017. |
(2) | Consists of loans in TDR status. |
Year Ended December 31, 2016 | ||||||||||||||||
(in thousands) | Commercial | Consumer | Unallocated | Total | ||||||||||||
ALLL, beginning of period | $ | 456,812 | $ | 2,742,088 | $ | 47,245 | $ | 3,246,145 | ||||||||
Provision for loan losses | 152,112 | 2,852,730 | (222 | ) | 3,004,620 | |||||||||||
Charge-offs | (245,399 | ) | (4,720,135 | ) | — | (4,965,534 | ) | |||||||||
Recoveries | 86,312 | 2,442,921 | — | 2,529,233 | ||||||||||||
Charge-offs, net of recoveries | (159,087 | ) | (2,277,214 | ) | — | (2,436,301 | ) | |||||||||
ALLL, end of period | $ | 449,837 | $ | 3,317,604 | $ | 47,023 | $ | 3,814,464 | ||||||||
Reserve for unfunded lending commitments, beginning of period | $ | 143,461 | $ | 5,560 | $ | — | $ | 149,021 | ||||||||
Provision for unfunded lending commitments | (24,887 | ) | (8 | ) | — | (24,895 | ) | |||||||||
Loss on unfunded lending commitments | (1,708 | ) | — | — | (1,708 | ) | ||||||||||
Reserve for unfunded lending commitments, end of period | 116,866 | 5,552 | — | 122,418 | ||||||||||||
Total ACL end of period | $ | 566,703 | $ | 3,323,156 | $ | 47,023 | $ | 3,936,882 | ||||||||
Ending balance, individually evaluated for impairment(2) | $ | 98,596 | $ | 1,520,375 | $ | — | $ | 1,618,971 | ||||||||
Ending balance, collectively evaluated for impairment | 351,241 | 1,797,229 | 47,023 | 2,195,493 | ||||||||||||
Financing receivables: | ||||||||||||||||
Ending balance | $ | 44,561,193 | $ | 43,844,900 | $ | — | $ | 88,406,093 | ||||||||
Ending balance, evaluated under the FVO or lower of cost or fair value(1) | 121,065 | 2,482,595 | — | 2,603,660 | ||||||||||||
Ending balance, individually evaluated for impairment(2) | 666,386 | 5,795,366 | — | 6,461,752 | ||||||||||||
Ending balance, collectively evaluated for impairment | 43,773,742 | 35,566,939 | — | 79,340,681 | ||||||||||||
The following table presents the activity in the allowance for loan losses for the RICs acquired in the Change in Control and those originated by SC subsequent to the Change in Control.
131
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
Year Ended | |||||||||||
December 31, 2018 | |||||||||||
(in thousands) | Purchased | Originated | Total | ||||||||
ALLL, beginning of period | $ | 384,167 | $ | 2,862,355 | $ | 3,246,522 | |||||
(Release of) / Provision for loan and lease losses | (53,551 | ) | 2,278,155 | 2,224,604 | |||||||
Charge-offs | (319,069 | ) | (4,508,583 | ) | (4,827,652 | ) | |||||
Recoveries | 182,195 | 2,360,649 | 2,542,844 | ||||||||
Charge-offs, net of recoveries | (136,874 | ) | (2,147,934 | ) | (2,284,808 | ) | |||||
ALLL, end of period | $ | 193,742 | $ | 2,992,576 | $ | 3,186,318 | |||||
Year Ended | |||||||||||
December 31, 2017 | |||||||||||
(in thousands) | Purchased | Originated | Total | ||||||||
ALLL, beginning of period | $ | 559,092 | $ | 2,538,127 | $ | 3,097,219 | |||||
Provision for loan and lease losses | 181,698 | 2,332,160 | 2,513,858 | ||||||||
Charge-offs | (606,898 | ) | (4,128,249 | ) | (4,735,147 | ) | |||||
Recoveries | 250,275 | 2,120,317 | 2,370,592 | ||||||||
Charge-offs, net of recoveries | (356,623 | ) | (2,007,932 | ) | (2,364,555 | ) | |||||
ALLL, end of period | $ | 384,167 | $ | 2,862,355 | $ | 3,246,522 | |||||
Year ended | |||||||||||
December 31, 2016 | |||||||||||
(in thousands) | Purchased | Originated | Total | ||||||||
ALLL, beginning of period | $ | 590,807 | $ | 1,891,989 | $ | 2,482,796 | |||||
Provision for loan and lease losses | 309,664 | 2,459,588 | 2,769,252 | ||||||||
Charge-offs | (1,024,882 | ) | (3,539,153 | ) | (4,564,035 | ) | |||||
Recoveries | 683,503 | 1,725,703 | 2,409,206 | ||||||||
Charge-offs, net of recoveries | (341,379 | ) | (1,813,450 | ) | (2,154,829 | ) | |||||
ALLL, end of period | $ | 559,092 | $ | 2,538,127 | $ | 3,097,219 | |||||
Refer to Note 20 for discussion of contingencies and possible losses related to the impact of hurricane activity in regions where the Company has lending activities.
Non-accrual loans by Class of Financing Receivable
The recorded investment in non-accrual loans disaggregated by class of financing receivables and other non-performing assets is summarized as follows:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Non-accrual loans: | ||||||||
Commercial: | ||||||||
CRE | $ | 88,500 | $ | 139,236 | ||||
C&I | 189,827 | 230,481 | ||||||
Multifamily | 13,530 | 11,348 | ||||||
Other commercial | 72,841 | 83,468 | ||||||
Total commercial loans | 364,698 | 464,533 | ||||||
Consumer: | ||||||||
Residential mortgages | 216,815 | 265,436 | ||||||
Home equity loans and lines of credit | 115,813 | 134,162 | ||||||
RICs and auto loans - originated | 1,455,406 | 1,257,122 | ||||||
RICs - purchased | 89,916 | 256,617 | ||||||
Personal unsecured loans | 3,602 | 2,366 | ||||||
Other consumer | 9,187 | 10,657 | ||||||
Total consumer loans | 1,890,739 | 1,926,360 | ||||||
Total non-accrual loans | 2,255,437 | 2,390,893 | ||||||
OREO | 107,868 | 130,777 | ||||||
Repossessed vehicles | 224,046 | 210,692 | ||||||
Foreclosed and other repossessed assets | 1,844 | 2,190 | ||||||
Total OREO and other repossessed assets | 333,758 | 343,659 | ||||||
Total non-performing assets | $ | 2,589,195 | $ | 2,734,552 | ||||
132
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
Age Analysis of Past Due Loans
The Company generally considers an account delinquent when an obligor fails to pay substantially all (defined as 90%) of the scheduled payment by the due date.
The age of recorded investments in past due loans and accruing loans 90 days or greater past due disaggregated by class of financing receivables is summarized as follows:
As of: | ||||||||||||||||||||||||
December 31, 2018 | ||||||||||||||||||||||||
(in thousands) | 30-89 Days Past Due | 90 Days or Greater | Total Past Due | Current | Total Financing Receivables(1) | Recorded Investment > 90 Days and Accruing | ||||||||||||||||||
Commercial: | ||||||||||||||||||||||||
CRE | $ | 20,179 | $ | 49,317 | $ | 69,496 | $ | 8,634,985 | $ | 8,704,481 | $ | — | ||||||||||||
C&I (1) | 61,495 | 74,210 | 135,705 | 15,602,453 | 15,738,158 | — | ||||||||||||||||||
Multifamily | 1,078 | 4,574 | 5,652 | 8,303,463 | 8,309,115 | — | ||||||||||||||||||
Other commercial | 16,081 | 5,330 | 21,411 | 7,608,593 | 7,630,004 | 6 | ||||||||||||||||||
Consumer: | ||||||||||||||||||||||||
Residential mortgages | 186,222 | 171,265 | 357,487 | 9,741,496 | 10,098,983 | — | ||||||||||||||||||
Home equity loans and lines of credit | 58,507 | 79,860 | 138,367 | 5,327,303 | 5,465,670 | — | ||||||||||||||||||
RICs and auto loans - originated | 4,076,015 | 419,819 | 4,495,834 | 24,036,251 | 28,532,085 | — | ||||||||||||||||||
RICs and auto loans - purchased | 242,604 | 21,923 | 264,527 | 538,608 | 803,135 | — | ||||||||||||||||||
Personal unsecured loans | 93,675 | 102,463 | 196,138 | 2,404,327 | 2,600,465 | 98,973 | ||||||||||||||||||
Other consumer | 16,261 | 13,782 | 30,043 | 417,007 | 447,050 | — | ||||||||||||||||||
Total | $ | 4,772,117 | $ | 942,543 | $ | 5,714,660 | $ | 82,614,486 | $ | 88,329,146 | $ | 98,979 | ||||||||||||
(1) Residential mortgages includes $214.5 million of LHFS at December 31, 2018.
(2) Personal unsecured loans includes $1.1 billion of LHFS at December 31, 2018.
As of | ||||||||||||||||||||||||
December 31, 2017 | ||||||||||||||||||||||||
(in thousands) | 30-89 Days Past Due | 90 Days or Greater | Total Past Due | Current | Total Financing Receivable(1) | Recorded Investment > 90 Days and Accruing | ||||||||||||||||||
Commercial: | ||||||||||||||||||||||||
CRE | $ | 25,174 | $ | 100,524 | $ | 125,698 | $ | 9,153,527 | $ | 9,279,225 | $ | — | ||||||||||||
C&I | 49,584 | 75,924 | 125,508 | 14,461,981 | 14,587,489 | — | ||||||||||||||||||
Multifamily | 3,562 | 2,990 | 6,552 | 8,267,883 | 8,274,435 | — | ||||||||||||||||||
Other commercial | 34,021 | 3,359 | 37,380 | 7,137,359 | 7,174,739 | — | ||||||||||||||||||
Consumer: | ||||||||||||||||||||||||
Residential mortgages | 217,558 | 210,777 | 428,335 | 8,628,600 | 9,056,935 | — | ||||||||||||||||||
Home equity loans and lines of credit | 50,919 | 91,975 | 142,894 | 5,764,839 | 5,907,733 | — | ||||||||||||||||||
RICs and auto loans - originated | 3,602,308 | 357,016 | 3,959,324 | 20,272,977 | 24,232,301 | — | ||||||||||||||||||
RICs and auto loans - purchased | 452,235 | 40,516 | 492,751 | 1,342,117 | 1,834,868 | — | ||||||||||||||||||
Personal unsecured loans | 85,394 | 105,054 | 190,448 | 2,157,319 | 2,347,767 | 96,461 | ||||||||||||||||||
Other consumer | 24,879 | 14,220 | 39,099 | 578,576 | 617,675 | — | ||||||||||||||||||
Total | $ | 4,545,634 | $ | 1,002,355 | $ | 5,547,989 | $ | 77,765,178 | $ | 83,313,167 | $ | 96,461 | ||||||||||||
(1) | C&I loans included $149.2 million of LHFS at December 31, 2017. |
(2) | Residential mortgages included $210.2 million of LHFS at December 31, 2017. |
(3) | RICs and auto loans included $1.1 billion of LHFS at December 31, 2017. |
(4) | Personal unsecured loans included $1.1 billion of LHFS at December 31, 2017. |
133
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
Impaired Loans by Class of Financing Receivable
Impaired loans are generally defined as all TDRs plus commercial non-accrual loans in excess of $1.0 million.
Impaired loans disaggregated by class of financing receivables are summarized as follows:
December 31, 2018 | ||||||||||||||||
(in thousands) | Recorded Investment(1) | UPB | Related Specific Reserves | Average Recorded Investment | ||||||||||||
With no related allowance recorded: | ||||||||||||||||
Commercial: | ||||||||||||||||
CRE | $ | 79,056 | $ | 88,960 | $ | — | $ | 102,731 | ||||||||
C&I | 25,859 | 36,067 | — | 54,200 | ||||||||||||
Multifamily | 18,260 | 19,175 | — | 14,074 | ||||||||||||
Other commercial | 7,348 | 7,380 | — | 4,058 | ||||||||||||
Consumer: | ||||||||||||||||
Residential mortgages | 144,899 | 201,905 | — | 126,110 | ||||||||||||
Home equity loans and lines of credit | 46,069 | 48,021 | — | 49,233 | ||||||||||||
RICs and auto loans - originated | 1 | 1 | — | 1 | ||||||||||||
RICs and auto loans - purchased | 7,061 | 9,071 | — | 11,627 | ||||||||||||
Personal unsecured loans | 4 | 4 | — | 42 | ||||||||||||
Other consumer | 3,591 | 3,591 | — | 6,574 | ||||||||||||
With an allowance recorded: | ||||||||||||||||
Commercial: | ||||||||||||||||
CRE | 58,861 | 66,645 | 6,449 | 78,271 | ||||||||||||
C&I | 180,178 | 197,937 | 66,329 | 178,474 | ||||||||||||
Multifamily | — | — | — | 3,101 | ||||||||||||
Other commercial | 59,914 | 59,914 | 21,342 | 68,813 | ||||||||||||
Consumer: | ||||||||||||||||
Residential mortgages | 253,965 | 289,447 | 29,156 | 288,029 | ||||||||||||
Home equity loans and lines of credit | 60,540 | 71,475 | 4,272 | 62,684 | ||||||||||||
RICs and auto loans - originated | 4,630,614 | 4,652,013 | 1,231,164 | 4,742,820 | ||||||||||||
RICs and auto loans - purchased | 614,071 | 694,000 | 184,545 | 890,274 | ||||||||||||
Personal unsecured loans | 16,182 | 16,446 | 6,875 | 16,330 | ||||||||||||
Other consumer | 10,060 | 13,275 | 1,162 | 10,826 | ||||||||||||
Total: | ||||||||||||||||
Commercial | $ | 429,476 | $ | 476,078 | $ | 94,120 | $ | 503,722 | ||||||||
Consumer | 5,787,057 | 5,999,249 | 1,457,174 | 6,204,550 | ||||||||||||
Total | $ | 6,216,533 | $ | 6,475,327 | $ | 1,551,294 | $ | 6,708,272 | ||||||||
(1) | Recorded investment includes deferred loan fees, net of deferred origination costs and unamortized purchase premiums, net of discounts, as well as purchase accounting adjustments. |
134
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
The Company recognized interest income, not including the impact of purchase accounting adjustments, of $761.0 million for the year ended December 31, 2018 on approximately $5.0 billion of TDRs that were in performing status as of December 31, 2018.
December 31, 2017 | ||||||||||||||||
(in thousands) | Recorded Investment(1) | UPB | Related Specific Reserves | Average Recorded Investment | ||||||||||||
With no related allowance recorded: | ||||||||||||||||
Commercial: | ||||||||||||||||
CRE | $ | 126,406 | $ | 174,842 | $ | — | $ | 139,063 | ||||||||
C&I | 82,541 | 96,324 | — | 75,338 | ||||||||||||
Multifamily | 9,887 | 10,838 | — | 10,129 | ||||||||||||
Other commercial | 767 | 911 | — | 903 | ||||||||||||
Consumer: | ||||||||||||||||
Residential mortgages | 107,320 | 128,458 | — | 141,195 | ||||||||||||
Home equity loans and lines of credit | 52,397 | 54,421 | — | 50,635 | ||||||||||||
RICs and auto loans - purchased | 16,192 | 20,783 | — | 25,283 | ||||||||||||
Personal unsecured loans | 80 | 80 | — | 345 | ||||||||||||
Other consumer | 9,557 | 13,055 | — | 14,446 | ||||||||||||
With an allowance recorded: | ||||||||||||||||
Commercial: | ||||||||||||||||
CRE | 97,680 | 117,730 | 18,523 | 118,492 | ||||||||||||
C&I | 176,769 | 200,382 | 59,696 | 196,674 | ||||||||||||
Multifamily | 6,201 | 6,201 | 313 | 4,566 | ||||||||||||
Other commercial | 77,712 | 77,772 | 23,794 | 42,465 | ||||||||||||
Consumer: | ||||||||||||||||
Residential mortgages | 322,092 | 392,833 | 40,963 | 303,361 | ||||||||||||
Home equity loans and lines of credit | 64,827 | 77,435 | 4,770 | 57,345 | ||||||||||||
RICs and auto loans - originated | 4,855,026 | 4,914,656 | 1,422,834 | 4,063,171 | ||||||||||||
RICs and auto loans - purchased | 1,166,476 | 1,318,306 | 347,663 | 1,511,212 | ||||||||||||
Personal unsecured loans | 16,477 | 16,661 | 6,259 | 16,668 | ||||||||||||
Other consumer | 11,592 | 15,290 | 2,151 | 12,343 | ||||||||||||
Total: | ||||||||||||||||
Commercial | $ | 577,963 | $ | 685,000 | $ | 102,326 | $ | 587,630 | ||||||||
Consumer | 6,622,036 | 6,951,978 | 1,824,640 | 6,196,004 | ||||||||||||
Total | $ | 7,199,999 | $ | 7,636,978 | $ | 1,926,966 | $ | 6,783,634 | ||||||||
(1) | Recorded investment includes deferred loan fees, net of deferred origination costs and unamortized purchase premiums, net of discounts, as well as purchase accounting adjustments. |
The Company recognized interest income, not including the impact of purchase accounting adjustments, of $795.4 million for the year ended December 31, 2017 on approximately $5.9 billion of TDRs that were in performing status as of December 31, 2017.
Commercial Lending Asset Quality Indicators
The Company's Risk Department performs a credit analysis and classifies certain loans over an internal threshold based on the commercial lending classifications described below:
PASS. Asset is well-protected by the current net worth and paying capacity of the obligor or guarantors, if any, or by the fair value less costs to acquire and sell any underlying collateral in a timely manner.
SPECIAL MENTION. Asset has potential weaknesses that deserve management’s close attention, which, if left uncorrected, may result in deterioration of the repayment prospects for an asset at some future date. Special mention assets are not adversely classified.
SUBSTANDARD. Asset is inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. A well-defined weakness or weaknesses exist that jeopardize the liquidation of the debt. The loans are characterized by the distinct possibility that the Company will sustain some loss if deficiencies are not corrected.
135
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
DOUBTFUL. Exhibits the inherent weaknesses of a substandard credit. Additional characteristics exist that make collection or liquidation in full highly questionable and improbable, on the basis of currently known facts, conditions and values. Possibility of loss is extremely high, but because of certain important and reasonable specific pending factors which may work to the advantage and strengthening of the credit, an estimated loss cannot yet be determined.
LOSS. Credit is considered uncollectible and of such little value that it does not warrant consideration as an active asset. There may be some recovery or salvage value, but there is doubt as to whether, how much or when the recovery would occur.
Commercial loan credit quality indicators by class of financing receivables are summarized as follows:
December 31, 2018 | CRE | C&I | Multifamily | Remaining commercial | Total(1) | |||||||||||||||
(in thousands) | ||||||||||||||||||||
Rating: | ||||||||||||||||||||
Pass | $ | 7,698,373 | $ | 14,518,566 | $ | 8,072,407 | $ | 7,466,419 | $ | 37,755,765 | ||||||||||
Special mention | 628,097 | 772,704 | 204,262 | 67,313 | 1,672,376 | |||||||||||||||
Substandard | 373,356 | 408,515 | 32,446 | 36,255 | 850,572 | |||||||||||||||
Doubtful | 4,655 | 38,373 | — | 60,017 | 103,045 | |||||||||||||||
Total commercial loans | $ | 8,704,481 | $ | 15,738,158 | $ | 8,309,115 | $ | 7,630,004 | $ | 40,381,758 | ||||||||||
(1) | Financing receivables include LHFS. |
December 31, 2017 | CRE | C&I | Multifamily | Remaining commercial | Total(1) | |||||||||||||||
(in thousands) | ||||||||||||||||||||
Rating: | ||||||||||||||||||||
Pass | $ | 8,281,626 | $ | 13,176,248 | $ | 8,123,727 | $ | 7,059,627 | $ | 36,641,228 | ||||||||||
Special mention | 645,835 | 941,683 | 105,225 | 29,657 | 1,722,400 | |||||||||||||||
Substandard | 317,510 | 398,325 | 45,483 | 21,747 | 783,065 | |||||||||||||||
Doubtful | 34,254 | 71,233 | — | 63,708 | 169,195 | |||||||||||||||
Total commercial loans | $ | 9,279,225 | $ | 14,587,489 | $ | 8,274,435 | $ | 7,174,739 | $ | 39,315,888 | ||||||||||
(1) | Financing receivables include LHFS. |
Consumer Lending Asset Quality Indicators-Credit Score
Consumer financing receivables for which either an internal or external credit score is a core component of the allowance model are summarized by credit score as follows:
Credit Score Range(2) | December 31, 2018 | December 31, 2017 | ||||||||||||
(dollars in thousands) | RICs and auto loans (3) | Percent | RICs and auto loans | Percent | ||||||||||
No FICO®(1) | $ | 3,136,449 | 10.7 | % | $ | 3,429,190 | 13.6 | % | ||||||
<600 | 14,884,385 | 50.7 | % | 13,445,032 | 53.9 | % | ||||||||
600-639 | 5,185,412 | 17.7 | % | 4,332,278 | 17.4 | % | ||||||||
640-679 | 4,758,394 | 16.2 | % | 3,759,621 | 15.1 | % | ||||||||
680-719 | 289,270 | 1.0 | % | — | — | % | ||||||||
720-759 | 283,052 | 1.0 | % | — | — | % | ||||||||
>=760 | 798,258 | 2.7 | % | — | — | % | ||||||||
Total | $ | 29,335,220 | 100.0 | % | $ | 24,966,121 | 100.0 | % | ||||||
(1) | Consists primarily of loans for which credit scores are not considered in the ALLL model. |
(2) | Credit scores updated quarterly. |
(3) Reflects Chrysler portfolio originated for SBNA beginning in July 2018.
Consumer Lending Asset Quality Indicators-FICO and LTV Ratio
136
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
For both residential and home equity loans, loss severity assumptions are incorporated in the loan and lease loss reserve models to estimate loan balances that will ultimately charge off. These assumptions are based on recent loss experience within various current LTV bands within these portfolios. LTVs are refreshed quarterly by applying Federal Housing Finance Agency Home price index changes at a state-by-state level to the last known appraised value of the property to estimate the current LTV. The Company's ALLL incorporates the refreshed LTV information to update the distribution of defaulted loans by LTV as well as the associated loss given default for each LTV band. Reappraisals on a recurring basis at the individual property level are not considered cost-effective or necessary; however, reappraisals are performed on certain higher risk accounts to support line management activities, default servicing decisions, or when other situations arise for which the Company believes the additional expense is warranted.
Residential mortgage and home equity financing receivables by LTV and FICO range are summarized as follows:
Residential Mortgages(1)(3) | ||||||||||||||||||||||||||||||||
December 31, 2018 | N/A(2) | LTV<=70% | 70.01-80% | 80.01-90% | 90.01-100% | 100.01-110% | LTV>110% | Grand Total | ||||||||||||||||||||||||
FICO Score | (dollars in thousands) | |||||||||||||||||||||||||||||||
N/A(2) | $ | 87,808 | $ | 4,465 | $ | — | $ | — | $ | 423 | $ | — | $ | — | $ | 92,696 | ||||||||||||||||
<600 | 69 | 225,647 | 54,101 | 35,625 | 26,863 | 2,450 | 4,604 | 349,359 | ||||||||||||||||||||||||
600-639 | 35 | 157,281 | 47,712 | 34,124 | 37,901 | 943 | 1,544 | 279,540 | ||||||||||||||||||||||||
640-679 | — | 308,780 | 112,811 | 76,512 | 101,057 | 1,934 | 1,767 | 602,861 | ||||||||||||||||||||||||
680-719 | — | 560,920 | 266,877 | 148,283 | 175,889 | 3,630 | 3,593 | 1,159,192 | ||||||||||||||||||||||||
720-759 | 50 | 1,061,969 | 535,840 | 210,046 | 218,177 | 4,263 | 6,704 | 2,037,049 | ||||||||||||||||||||||||
>=760 | 213 | 3,518,916 | 1,253,733 | 354,629 | 220,695 | 6,477 | 9,102 | 5,363,765 | ||||||||||||||||||||||||
Grand Total | $ | 88,175 | $ | 5,837,978 | $ | 2,271,074 | $ | 859,219 | $ | 781,005 | $ | 19,697 | $ | 27,314 | $ | 9,884,462 | ||||||||||||||||
(1) Excludes LHFS.
(2) Residential mortgages and home equity loans and lines of credit in the "N/A" range for LTV or FICO score primarily represent the balance on loans serviced by others, in run-off portfolios or for which a current LTV or FICO score is unavailable.
(3) Allowance model considers LTV for financing receivables in first lien position for the Company and combined LTV ("CLTV") for financing receivables in second lien position for the Company.
Home Equity Loans and Lines of Credit(2) | ||||||||||||||||||||||||
December 31, 2018 | N/A(1) | LTV<=70% | 70.01-90% | 90.01-110% | LTV>110% | Grand Total | ||||||||||||||||||
FICO Score | (dollars in thousands) | |||||||||||||||||||||||
N/A(1) | $ | 133,436 | $ | 841 | $ | 197 | $ | — | $ | 5 | $ | 134,479 | ||||||||||||
<600 | 1,130 | 209,536 | 64,202 | 14,948 | 5,988 | 295,804 | ||||||||||||||||||
600-639 | 398 | 166,384 | 48,543 | 7,932 | 2,780 | 226,037 | ||||||||||||||||||
640-679 | 919 | 305,642 | 112,937 | 10,311 | 6,887 | 436,696 | ||||||||||||||||||
680-719 | 869 | 527,374 | 215,824 | 17,231 | 13,482 | 774,780 | ||||||||||||||||||
720-759 | 1,139 | 732,467 | 292,516 | 20,812 | 14,677 | 1,061,611 | ||||||||||||||||||
>=760 | 2,280 | 1,844,830 | 614,221 | 46,993 | 27,939 | 2,536,263 | ||||||||||||||||||
Grand Total | $ | 140,171 | $ | 3,787,074 | $ | 1,348,440 | $ | 118,227 | $ | 71,758 | $ | 5,465,670 | ||||||||||||
(1) | Residential mortgages and home equity loans and lines of credit in the "N/A" range for LTV or FICO score primarily represent the balance on loans serviced by others, in run-off portfolios or for which a current LTV or FICO score is unavailable. |
(2) | Allowance model considers LTV for financing receivables in first lien position for the Company and CLTV for financing receivables in second lien position for the Company. |
Residential Mortgages(1)(3) | ||||||||||||||||||||||||||||||||
December 31, 2017 | N/A (2) | LTV<=70% | 70.01-80% | 80.01-90% | 90.01-100% | 100.01-110% | LTV>110% | Grand Total | ||||||||||||||||||||||||
FICO Score | (dollars in thousands) | |||||||||||||||||||||||||||||||
N/A(2) | $ | 174,426 | $ | 6,759 | $ | 1,214 | $ | — | $ | — | $ | — | $ | — | $ | 182,399 | ||||||||||||||||
<600 | 21 | 220,738 | 55,108 | 35,617 | 23,834 | 2,505 | 6,020 | 343,843 | ||||||||||||||||||||||||
600-639 | 45 | 155,920 | 42,420 | 35,009 | 34,331 | 2,696 | 6,259 | 276,680 | ||||||||||||||||||||||||
640-679 | 37 | 320,248 | 94,601 | 90,582 | 86,004 | 3,011 | 2,641 | 597,124 | ||||||||||||||||||||||||
680-719 | 98 | 554,058 | 236,408 | 136,916 | 145,545 | 3,955 | 10,317 | 1,087,297 | ||||||||||||||||||||||||
720-759 | 92 | 952,532 | 480,900 | 177,700 | 179,648 | 4,760 | 8,600 | 1,804,232 | ||||||||||||||||||||||||
>=760 | 588 | 3,019,418 | 1,066,103 | 262,490 | 185,579 | 8,418 | 12,594 | 4,555,190 | ||||||||||||||||||||||||
Grand Total | $ | 175,307 | $ | 5,229,673 | $ | 1,976,754 | $ | 738,314 | $ | 654,941 | $ | 25,345 | $ | 46,431 | $ | 8,846,765 | ||||||||||||||||
(1) | Excludes LHFS. |
(2) | Residential mortgages and home equity loans and lines of credit in the "N/A" range for LTV or FICO score primarily represent the balance on loans serviced by others, in run-off portfolios or for which a current LTV or FICO score is unavailable. |
(3) | Allowance model considers LTV for financing receivables in first lien position for the Company and CLTV for financing receivables in second lien position for the Company. |
137
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
Home Equity Loans and Lines of Credit(2) | ||||||||||||||||||||||||
December 31, 2017 | N/A(1) | LTV<=70% | 70.01-90% | 90.01-110% | LTV>110% | Grand Total | ||||||||||||||||||
FICO Score | (dollars in thousands) | |||||||||||||||||||||||
N/A(1) | $ | 154,690 | $ | 536 | $ | 238 | $ | — | $ | — | $ | 155,464 | ||||||||||||
<600 | 8,064 | 190,657 | 64,554 | 16,634 | 22,954 | 302,863 | ||||||||||||||||||
600-639 | 6,276 | 158,461 | 61,250 | 9,236 | 9,102 | 244,325 | ||||||||||||||||||
640-679 | 6,745 | 297,003 | 127,347 | 19,465 | 14,058 | 464,618 | ||||||||||||||||||
680-719 | 8,875 | 500,234 | 258,284 | 24,675 | 20,261 | 812,329 | ||||||||||||||||||
720-759 | 8,587 | 724,831 | 332,508 | 30,526 | 19,119 | 1,115,571 | ||||||||||||||||||
>=760 | 17,499 | 1,917,373 | 768,905 | 73,573 | 35,213 | 2,812,563 | ||||||||||||||||||
Grand Total | $ | 210,736 | $ | 3,789,095 | $ | 1,613,086 | $ | 174,109 | $ | 120,707 | $ | 5,907,733 | ||||||||||||
(1) | Residential mortgages and home equity loans and lines of credit in the "N/A" range for LTV or FICO score primarily represent the balance on loans serviced by others, in run-off portfolios or for which a current LTV or FICO score is unavailable. |
(2) | Allowance model considers LTV for financing receivables in first lien position for the Company and CLTV for financing receivables in second lien position for the Company. |
TDR Loans
The following table summarizes the Company’s performing and non-performing TDRs at the dates indicated:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Performing | $ | 5,014,224 | $ | 5,860,119 | ||||
Non-performing | 908,128 | 982,868 | ||||||
Total (1) | $ | 5,922,352 | $ | 6,842,987 | ||||
(1) Excludes LHFS.
Commercial Loan TDRs
All of the Company’s commercial loan modifications are based on the circumstances of the individual customer, including specific customers' complete relationships with the Company. Loan terms are modified to meet each borrower’s specific circumstances at a point in time and may allow for modifications such as term extensions and interest rate reductions. Modifications for commercial loan TDRs generally, although not always, result in bifurcation of the original loan into A and B notes. The A note is restructured to allow for upgraded risk rating and return to accrual status after a sustained period of payment performance has been achieved (typically six months for monthly payment schedules). The B note, if any, is structured as a deficiency note; the balance is charged off but the debt is usually not forgiven. Commercial TDRs are generally placed on non-accrual status until the Company believes repayment under the revised terms is reasonably assured and a sustained period of repayment performance has been achieved (typically six months for a monthly amortizing loan). TDRs are subject to analysis for specific reserves by either calculating the present value of expected future cash flows or, if collateral-dependent, calculating the fair value of the collateral less its estimated cost to sell. The TDR classification will remain on the loan until it is paid in full or liquidated.
Consumer Loan TDRs
The primary modification program for the Company’s residential mortgage and home equity portfolios is a proprietary program designed to keep customers in their homes and, when appropriate, prevent them from entering into foreclosure. The program is available to all customers facing a financial hardship regardless of their delinquency status. The main goal of the modification program is to review the customer’s entire financial condition to ensure that the proposed modified payment solution is affordable according to a specific DTI ratio range. The main modification benefits of the program allow for term extensions, interest rate reductions, and/or deferment of principal. The Company reviews each customer on a case-by-case basis to determine which benefit or combination of benefits will be offered to achieve the target DTI range.
For the Company’s other consumer portfolios, including RICs and auto loans, the terms of the modifications generally include one or a combination of: a reduction of the stated interest rate of the loan to a rate of interest lower than the current market rate for new debt with similar risk, an extension of the maturity date or principal forgiveness.
138
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
Consumer TDRs excluding RICs are generally placed on non-accrual status until the Company believes repayment under the revised terms is reasonably assured and a sustained period of repayment performance has been achieved (typically six months for a monthly amortizing loan). Any loan that has remained current for the six months immediately prior to modification will remain on accrual status after the modification is implemented. RIC TDRs are placed on nonaccrual status when the Company believes repayment under the revised terms is not reasonably assured, and considered for return to accrual when a sustained period of repayment performance has been achieved. The TDR classification will remain on the loan until it is paid in full or liquidated.
In addition to loans identified as TDRs above, the guidance also requires loans discharged under Chapter 7 bankruptcy proceedings to be considered TDRs and collateral-dependent, regardless of delinquency status. TDRs that are collateral-dependent loans must be written down to the fair market value of the collateral, less costs to sell and classified as non-accrual/NPLs for the remaining life of the loan.
TDR Impact to ALLL
The ALLL is established to recognize losses inherent in funded loans intended to be HFI that are probable and can be reasonably estimated. Prior to loans being placed in TDR status, the Company generally measures its allowance under a loss contingency methodology in which consumer loans with similar risk characteristics are pooled and loss experience information is monitored for credit risk and deterioration with statistical tools considering factors such as delinquency, LTV and credit scores.
Upon TDR modification, the Company generally measures impairment based on a present value of expected future cash flows methodology considering all available evidence, by discounting expected future cash flows using the original effective interest rate or fair value of collateral less costs to sell. The amount of the required ALLL is equal to the difference between the loan’s impaired value and the recorded investment.
RIC TDRs that subsequently default continue to have impairment measured based on the difference between the recorded investment of the RIC and the present value of expected cash flows. For the Company's other consumer TDR portfolios, impairment on subsequent defaults is generally measured based on the fair value of the collateral, if applicable, less its estimated cost to sell.
Typically, commercial loans whose terms are modified in a TDR will have been identified as impaired prior to modification and accounted for generally using a present value of expected future cash flows methodology, unless the loan is considered collateral-dependent. Loans considered collateral-dependent are measured for impairment based on their fair values of collateral less estimated cost to sell. Accordingly, upon TDR modification or if a TDR modification subsequently defaults, the allowance methodology remains unchanged.
Financial Impact and TDRs by Concession Type
The following tables detail the activity of TDRs for the years ended December 31, 2018, 2017, and 2016 respectively:
Year Ended December 31, 2018 | ||||||||||||||||||||
Number of Contracts | Pre-TDR Recorded Investment(1) | Term Extension | Rate Reduction | Other(4) | Post-TDR Recorded Investment(2) | |||||||||||||||
(dollars in thousands) | ||||||||||||||||||||
Commercial: | ||||||||||||||||||||
CRE | 99 | $ | 145,214 | $ | (2,867 | ) | $ | 1,749 | $ | (3,943 | ) | $ | 140,153 | |||||||
C&I | 247 | 9,932 | (33 | ) | — | (384 | ) | 9,515 | ||||||||||||
Consumer: | ||||||||||||||||||||
Residential mortgages(3) | 189 | 32,606 | — | — | (836 | ) | 31,770 | |||||||||||||
Home equity loans and lines of credit | 159 | 10,629 | 18 | 36 | (138 | ) | 10,545 | |||||||||||||
RICs and auto loans - originated | 128,103 | 2,176,299 | 10,907 | — | 399 | 2,187,605 | ||||||||||||||
RICs - purchased | 4,305 | 28,596 | (27 | ) | — | (17 | ) | 28,552 | ||||||||||||
Personal unsecured loans | 363 | 4,650 | — | — | (61 | ) | 4,589 | |||||||||||||
Other consumer | 11 | 308 | — | — | (80 | ) | 228 | |||||||||||||
Total | 133,476 | $ | 2,408,234 | $ | 7,998 | $ | 1,785 | $ | (5,060 | ) | $ | 2,412,957 | ||||||||
(1) Pre-TDR modification outstanding recorded investment amount is the month-end balance prior to the month in which the modification occurred.
(2) Post-TDR modification outstanding recorded investment amount is the month-end balance for the month in which the modification occurred.
(3) The post-TDR modification outstanding recorded investment amounts for residential mortgages exclude interest reserves.
(4) Other modifications may include modifications such as interest rate reductions, fee waivers, or capitalization of fees.
139
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
Year Ended December 31, 2017 | ||||||||||||||||||||
Number of Contracts | Pre-TDR Recorded Investment(1) | Term Extension | Rate Reduction | Other(4) | Post-TDR Recorded Investment(2) | |||||||||||||||
(dollars in thousands) | ||||||||||||||||||||
Commercial: | ||||||||||||||||||||
CRE | 75 | $ | 152,550 | $ | (13,944 | ) | $ | — | $ | (13,896 | ) | $ | 124,710 | |||||||
C&I | 790 | 24,915 | (11 | ) | — | (42 | ) | 24,862 | ||||||||||||
Consumer: | ||||||||||||||||||||
Residential mortgages(3) | 212 | 40,578 | 5 | 133 | 118 | 40,834 | ||||||||||||||
Home equity loans and lines of credit | 70 | 5,554 | — | — | 1,014 | 6,568 | ||||||||||||||
RICs and auto loans - originated | 189,246 | 3,339,056 | (2,699 | ) | — | (290 | ) | 3,336,067 | ||||||||||||
RICs - purchased | 17,717 | 159,462 | (1,679 | ) | — | (44 | ) | 157,739 | ||||||||||||
Personal unsecured loans | 391 | 4,678 | — | — | (130 | ) | 4,548 | |||||||||||||
Other consumer | 109 | 3,055 | — | — | 24 | 3,079 | ||||||||||||||
Total | 208,610 | $ | 3,729,848 | $ | (18,328 | ) | $ | 133 | $ | (13,246 | ) | $ | 3,698,407 | |||||||
(1) Pre-TDR modification outstanding recorded investment amount is the month-end balance prior to the month in which the modification occurred.
(2) | Post-TDR modification outstanding recorded investment amount is the month-end balance for the month in which the modification occurred. |
(3) | The post-TDR modification outstanding recorded investment amounts for residential mortgages exclude interest reserves. |
(4) | Other modifications may include modifications such as interest rate reductions, fee waivers, or capitalization of fees. |
Year Ended December 31, 2016 | ||||||||||||||||
Number of Contracts | Pre-TDR Recorded Investment(1) | Term Extension | Other(4) | Post-TDR Recorded Investment(2) | ||||||||||||
(dollars in thousands) | ||||||||||||||||
Commercial: | ||||||||||||||||
CRE | 92 | $ | 207,004 | $ | 567 | $ | (23,957 | ) | $ | 183,614 | ||||||
C&I | 1,416 | 47,003 | (7 | ) | (149 | ) | 46,847 | |||||||||
Consumer: | ||||||||||||||||
Residential mortgages(3) | 277 | 36,203 | (53 | ) | 9,982 | 46,132 | ||||||||||
Home equity loans and lines of credit | 161 | 10,360 | — | 416 | 10,776 | |||||||||||
RICs and auto loans - originated | 155,114 | 2,878,648 | (438 | ) | (292 | ) | 2,877,918 | |||||||||
RICs - purchased | 42,774 | 496,224 | (2,353 | ) | (115 | ) | 493,756 | |||||||||
Personal unsecured loans | 390 | 5,070 | — | (201 | ) | 4,869 | ||||||||||
Other consumer | 691 | 18,246 | (38 | ) | (1,133 | ) | 17,075 | |||||||||
Total | 200,915 | $ | 3,698,758 | $ | (2,322 | ) | $ | (15,449 | ) | $ | 3,680,987 | |||||
TDRs Which Have Subsequently Defaulted
A TDR is generally considered to have subsequently defaulted if, after modification, the loan becomes 90 days past due. For RICs, a TDR is considered to have subsequently defaulted after modification at the earlier of the date of repossession or 120 days past due. The following table details period-end recorded investment balances of TDRs that became TDRs during the past twelve-month period and have subsequently defaulted during the years ended December 31, 2018, 2017, and 2016 respectively.
140
NOTE 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES (continued)
Year Ended December 31, | |||||||||||||||||||||
2018 | 2017 | 2016 | |||||||||||||||||||
Number of Contracts | Recorded Investment(1) | Number of Contracts | Recorded Investment(1) | Number of Contracts | Recorded Investment(1) | ||||||||||||||||
(dollars in thousands) | |||||||||||||||||||||
Commercial | |||||||||||||||||||||
CRE | 7 | $ | 21,654 | 18 | $ | 27,286 | — | $ | — | ||||||||||||
C&I | 155 | 20,920 | 205 | 7,741 | 264 | 16,996 | |||||||||||||||
Other commercial | — | — | 2 | 22 | — | — | |||||||||||||||
Consumer: | |||||||||||||||||||||
Residential mortgages | 165 | 20,783 | 302 | 36,112 | 63 | 9,120 | |||||||||||||||
Home equity loans and lines of credit | 43 | 2,609 | 6 | 257 | 15 | 890 | |||||||||||||||
RICs and auto loans | 40,007 | 673,875 | 47,789 | 831,102 | 48,686 | 814,454 | |||||||||||||||
Personal Unsecured loans | 194 | 1,743 | 320 | 3,250 | — | — | |||||||||||||||
Other consumer | — | — | 35 | 394 | 215 | 3,117 | |||||||||||||||
Total | 40,571 | $ | 741,584 | 48,677 | $ | 906,164 | 49,243 | $ | 844,577 | ||||||||||||
(1) | The recorded investment represents the period-end balance. Does not include Chapter 7 bankruptcy TDRs. |
NOTE 5. OPERATING LEASE ASSETS, NET
The Company has operating leases, including leased vehicles and commercial equipment vehicles and aircraft, which are included in the Company's Consolidated Balance Sheets as Operating lease assets, net. The leased vehicle portfolio consists primarily of leases originated under the Chrysler Agreement.
Operating lease assets, net consisted of the following as of December 31, 2018 and December 31, 2017:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Leased vehicles | $ | 18,737,338 | $ | 14,751,568 | ||||
Less: accumulated depreciation | (3,518,025 | ) | (3,333,125 | ) | ||||
Depreciated net capitalized cost | 15,219,313 | 11,418,443 | ||||||
Origination fees and other costs | 66,967 | 27,246 | ||||||
Manufacturer subvention payments | (1,307,424 | ) | (1,047,113 | ) | ||||
Leased vehicles, net | 13,978,856 | 10,398,576 | ||||||
Commercial equipment vehicles and aircraft, gross | 130,274 | 93,981 | ||||||
Less: accumulated depreciation | (30,337 | ) | (18,249 | ) | ||||
Commercial equipment vehicles and aircraft, net | 99,937 | 75,732 | ||||||
Total operating lease assets, net | $ | 14,078,793 | $ | 10,474,308 | ||||
The following summarizes the future minimum rental payments due to the Company as lessor under operating leases as of December 31, 2018 (in thousands):
2019 | $ | 2,316,799 | ||
2020 | 1,652,894 | |||
2021 | 599,278 | |||
2022 | 34,250 | |||
2023 | 6,003 | |||
Thereafter | 11,739 | |||
Total | $ | 4,620,963 | ||
Lease income was $2.4 billion, $2.0 billion, and $1.8 billion for the years ended December 31, 2018, 2017, and 2016, respectively.
During the years ended December 31, 2018, 2017, and 2016 the Company recognized $202.8 million, $127.2 million, and $66.9 million respectively, of net gains on the sale of operating lease assets that had been returned to the Company at the end of the lease term. These amounts are recorded within Miscellaneous income, net in the Company's Consolidated Statements of Operations.
Lease expense was $1.8 billion, $1.6 billion, $1.3 billion for the years ended December 31, 2018, 2017, and 2016, respectively.
141
NOTE 6. PREMISES AND EQUIPMENT
A summary of premises and equipment, less accumulated depreciation, follows:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Land | $ | 87,531 | $ | 89,350 | ||||
Office buildings | 185,218 | 201,927 | ||||||
Furniture, fixtures, and equipment | 427,245 | 434,591 | ||||||
Leasehold improvement | 509,314 | 551,442 | ||||||
Computer software | 990,429 | 1,002,260 | ||||||
Automobiles and other | 1,475 | 1,146 | ||||||
Total premise and equipment | 2,201,212 | 2,280,716 | ||||||
Less accumulated depreciation | (1,395,272 | ) | (1,431,655 | ) | ||||
Total premises and equipment, net | $ | 805,940 | $ | 849,061 | ||||
Depreciation expense for premises and equipment, included in Occupancy and equipment expenses in the Consolidated Statements of Operations, was $268.0 million, $300.0 million, and $282.2 million for the years ended December 31, 2018, 2017 and 2016, respectively.
During the year ended December 31, 2018 the Company sold 13 properties. The Company received net proceeds of $5.8 million from the sales, with a net gain of $2.1 million. The carrying value of these properties was $3.6 million. Of the 13 properties sold, the Company leased back one property and accounted for the transaction as a sale-leaseback resulting in recognition of a $154.0 thousand gain on the date of the transaction, and deferral of the remaining $1.3 million gain. Gain on sale of premises and equipment are included within Miscellaneous income in the Consolidated Statements of Operations.
In 2017, the Company sold and leased back ten properties. The Company received net proceeds of $58.0 million in connection with the sales. The carrying value of the properties sold was $15.3 million. The Company accounted for the transaction as a sale-leaseback resulting in recognition of a $31.2 million gain on the date of the transactions, and deferral of the remaining $11.5 million. The Company sold eight properties for a $2.4 million gain in 2016.
NOTE 7. VIEs
The Company transfers RICs and vehicle leases into newly formed Trusts that then issue one or more classes of notes payable backed by the collateral. The Company’s continuing involvement with these Trusts is in the form of servicing the assets and, generally, through holding residual interests in the Trusts. The Trusts are considered VIEs under GAAP and the Company may or may not consolidate these VIEs on its Consolidated Balance Sheets.
The collateral borrowings under credit facilities and securitization notes payable of the Company’s consolidated VIEs remain on the Consolidated Financial Statements. The Company recognizes finance charges, fee income, and provision for credit losses on the RICs, and leased vehicles and interest expense on the debt. Revolving credit facilities generally also utilize entities that are considered VIEs, which are included on the Consolidated Balance Sheets.
The Company also uses a titling trust to originate and hold its leased vehicles and the associated leases in order to facilitate the pledging of leases to financing facilities or the sale of leases to other parties without incurring the costs and administrative burden of retitling the leased vehicles. This titling trust is considered a VIE.
On-balance sheet VIEs
The assets of consolidated VIEs, that are included in the Company's Consolidated Financial Statements, presented based upon the legal transfer of the underlying assets in order to reflect legal ownership, and that can be used only to settle obligations of the consolidated VIEs and the liabilities of those entities for which creditors (or beneficial interest holders) do not have recourse to the Company's general credit were as follows(1):
142
NOTE 7. VIEs (continued)
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Assets | ||||||||
Restricted cash | $ | 1,582,158 | $ | 1,995,557 | ||||
Loans(2)(3) | 24,098,638 | 22,679,381 | ||||||
Operating lease assets, net | 13,978,855 | 10,160,327 | ||||||
Various other assets | 685,383 | 747,101 | ||||||
Total Assets | $ | 40,345,034 | $ | 35,582,366 | ||||
Liabilities | ||||||||
Notes payable(3) | $ | 31,949,839 | $ | 28,469,999 | ||||
Various other liabilities | 122,010 | 197,969 | ||||||
Total Liabilities | $ | 32,071,849 | $ | 28,667,968 | ||||
(1) Certain amounts shown above are greater than the amounts shown in the corresponding line items in the accompanying Consolidated Balance Sheets due to intercompany eliminations between the VIEs and other entities consolidated by the Company. For example, for most of its securitizations, the Company retains one or more of the lowest tranches of bonds. Rather than showing investment in bonds as an asset and the associated debt as a liability, these amounts are eliminated in consolidation as required by GAAP.
(2) Includes zero and $1.1 billion of RICs HFS at December 31, 2018 and December 31, 2017, respectively.
(3) Reflects the impacts of purchase accounting.
The Company retains servicing rights for receivables transferred to the Trusts and receives a monthly servicing fee on the outstanding principal balance. Supplemental fees, such as late charges, for servicing the receivables are reflected in Miscellaneous income, net. As of December 31, 2018 and December 31, 2017, the Company was servicing $27.1 billion and $26.2 billion, respectively, of gross RICs that have been transferred to consolidated Trusts. The remainder of the Company’s RICs remains unpledged.
A summary of the cash flows received from the consolidated securitization Trusts for the years ended December 31, 2018, 2017 and 2016 is as follows:
Year Ended December 31, | ||||||||||||
(in thousands) | 2018 | 2017 | 2016 | |||||||||
Assets securitized | $ | 26,650,284 | $ | 18,442,793 | $ | 15,828,921 | ||||||
Net proceeds from new securitizations (1) | $ | 17,338,880 | $ | 14,126,211 | $ | 13,319,530 | ||||||
Net proceeds from sale of retained bonds | 1,059,694 | 499,354 | 436,812 | |||||||||
Cash received for servicing fees (2) | 887,988 | 866,210 | 787,778 | |||||||||
Net distributions from Trusts (2) | 2,767,509 | 2,613,032 | 1,748,013 | |||||||||
Total cash received from Trusts | $ | 22,054,071 | $ | 18,104,807 | $ | 16,292,133 | ||||||
(1) Includes additional advances on existing securitizations.
(2) These amounts are not reflected in the accompanying Consolidated SCF because the cash flows are between the VIEs and other entities included in the consolidation.
Off-balance sheet VIEs
During the years ended December 31, 2018, 2017 and 2016, the Company sold $2.9 billion, $2.6 billion and $886.3 million, respectively, of gross RICs to VIEs in off-balance sheet securitizations for a loss (excluding lower of cost or market adjustments, if any) of $20.7 million, $13.0 million and $10.5 million, respectively, recorded in Miscellaneous income, net in the Consolidated Financial Statements. Beginning in 2017, the transactions were executed under the Company's securitization platforms with Santander. Santander, as a majority owned affiliate, holds eligible vertical interests in notes and certificates of not less than 5% to comply with the DFA's risk retention rules.
As of December 31, 2018 and December 31, 2017, the Company was servicing $4.1 billion and $3.4 billion, respectively, of gross RICs that have been sold in off-balance sheet securitizations and were subject to an optional clean-up call. The portfolio was comprised as follows:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Santander Private Auto Issuing Note ("SPAIN") trust | $ | 3,461,793 | $ | 2,024,016 | ||||
Total serviced for related parties | 3,461,793 | 2,024,016 | ||||||
Chrysler Capital securitizations | 611,050 | 1,404,232 | ||||||
Total serviced for third parties | 611,050 | 1,404,232 | ||||||
Total serviced for other portfolio | $ | 4,072,843 | $ | 3,428,248 | ||||
143
NOTE 7. VIEs (continued)
Other than repurchases of sold assets due to standard representations and warranties, the Company has no exposure to loss as a result of its involvement with these VIEs.
A summary of the cash flows received from the Trusts for the years ended December 31, 2018, 2017 and 2016 is as follows:
Year Ended December 31, | ||||||||||||
(in thousands) | 2018 | 2017 | 2016 | |||||||||
Receivables securitized (1) | $ | 2,905,922 | $ | 2,583,341 | $ | 904,108 | ||||||
Net proceeds from new securitizations | $ | 2,909,794 | $ | 2,588,227 | $ | 876,592 | ||||||
Cash received for servicing fees | 43,859 | 35,682 | 47,804 | |||||||||
Total cash received from Trusts | $ | 2,953,653 | $ | 2,623,909 | $ | 924,396 | ||||||
(1) Represents the UPB at the time of original securitization.
NOTE 8. GOODWILL AND OTHER INTANGIBLES
Goodwill
Goodwill is assigned to reporting units, which are operating segments or one level below an operating segment, as of the acquisition date. The following table presents the Company's goodwill by its reporting units at December 31, 2018:
(in thousands) | Consumer and Business Banking | Commercial Banking | CIB | SC | Total | |||||||||||||||
Goodwill at December 31, 2018 | $ | 1,880,304 | $ | 1,412,995 | $ | 131,130 | $ | 1,019,960 | $ | 4,444,389 | ||||||||||
During 2018, the reportable segments (and reporting units) formerly known as Commercial Banking and CRE were combined and presented as Commercial Banking. Refer to Note 23 for further discussion on this change in reportable segments. There were no additions or removals of underlying lines of business in connection with this reporting change. As a result, goodwill assigned to these former reporting units of $542.6 million and $870.4 million, for Commercial Banking and CRE, respectively, have been combined.
Also during 2018, Santander renamed its Global and Corporate Banking ("GCB") business to CIB to more accurately reflect its business strategy and business proposition to clients, and to align with the name used by a majority of its competitors in the industry. There were no changes to the composition of the reportable segment or reporting unit as a result of this change.
There were no disposals, additions or impairments of goodwill for the year ended December 31, 2018. There were no disposals, additions or re-allocations of goodwill for the years ended December 31, 2017 or December 31, 2016. After conducting an analysis of the fair value of each reporting unit as of October 1, 2017, the Company determined that the full amount of goodwill attributed to Santander BanCorp of $10.5 million was impaired and, as a result, it was written off, primarily due to the unfavorable economic environment in Puerto Rico and the additional adverse effects of Hurricane Maria. No impairments of goodwill attributed to other reporting units were identified. There were no impairments of goodwill for the year ended December 31, 2016.
The Company evaluates goodwill for impairment at the reporting unit level. The Company completes its annual goodwill impairment test as of October 1 each year. The Company conducted its last annual goodwill impairment tests as of October 1, 2018 using generally accepted valuation methods.
144
NOTE 8. GOODWILL AND OTHER INTANGIBLES (continued)
Other Intangible Assets
The following table details amounts related to the Company's intangible assets subject to amortization for the dates indicated.
December 31, 2018 | December 31, 2017 | |||||||||||||||
(in thousands) | Net Carrying Amount | Accumulated Amortization | Net Carrying Amount | Accumulated Amortization | ||||||||||||
Intangibles subject to amortization: | ||||||||||||||||
Dealer networks | $ | 387,196 | $ | (192,804 | ) | $ | 426,411 | $ | (153,589 | ) | ||||||
Chrysler relationship | 65,000 | (73,750 | ) | 80,000 | (58,750 | ) | ||||||||||
Trade name | 14,700 | (3,300 | ) | 15,900 | (2,100 | ) | ||||||||||
Other intangibles | 8,297 | (46,894 | ) | 13,442 | (56,021 | ) | ||||||||||
Total intangibles subject to amortization | $ | 475,193 | $ | (316,748 | ) | $ | 535,753 | $ | (270,460 | ) | ||||||
At December 31, 2018 and December 31, 2017, the Company did not have any intangibles, other than goodwill, that were not subject to amortization.
Amortization expense on intangible assets was $60.7 million, $61.5 million, and $70.0 million the years ended December 31, 2018, 2017, and 2016, respectively.
The estimated aggregate amortization expense related to intangibles, excluding any impairment charges, for each of the five succeeding calendar years ending December 31 is:
Year | Calendar Year Amount | |||
(in thousands) | ||||
2019 | $ | 55,717 | ||
2020 | 58,929 | |||
2021 | 42,903 | |||
2022 | 39,901 | |||
2023 | 28,649 | |||
Thereafter | 249,094 | |||
NOTE 9. OTHER ASSETS
The following is a detail of items that comprised other assets at December 31, 2018 and 2017:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Deferred tax assets | $ | 625,087 | $ | 771,652 | ||||
Accrued interest receivable | 566,602 | 577,585 | ||||||
Derivative assets at fair value | 511,916 | 448,977 | ||||||
Other repossessed assets | 225,890 | 212,882 | ||||||
Equity method investments | 204,687 | 194,434 | ||||||
MSRs | 152,121 | 149,197 | ||||||
OREO | 107,868 | 130,777 | ||||||
Miscellaneous assets, receivables and prepaid expenses | 1,259,165 | 1,160,901 | ||||||
Total other assets | $ | 3,653,336 | $ | 3,646,405 | ||||
Other assets is comprised of:
• | Deferred tax asset, net - Refer to Note 15 of these Consolidated Financial Statements for more information on tax-related activities. |
• | Derivative assets at fair value - Refer to the offsetting of financial assets table in Note 14 to these Consolidated Financial Statements for the detail of these amounts. |
145
NOTE 9. OTHER ASSETS (continued)
• | Equity method investments - The Company makes certain equity investments in various limited partnerships, some of which are considered VIEs, that invest in and lend to qualified community development entities, such as renewable energy investments, through the New Market Tax Credits ("NMTC") and CRA programs. The Company acts only in a limited partner capacity in connection with these partnerships, so the Company has determined that it is not the primary beneficiary of the partnerships because it does not have the power to direct the activities of the partnerships that most significantly impact the partnerships' economic performance. |
• | MSRs - See further discussion on the valuation of the MSRs in Note 16. |
• | Miscellaneous assets and receivables includes $373.2 million and $292.2 million of Income tax receivables and $199.0 million and $172.5 million of prepaid expenses at December 31, 2018 and 2017, respectively. In addition subvention receivables in connection with the Chrysler Agreement, investment and capital market receivables, derivatives trading receivables, and unapplied payments are also included in miscellaneous assets. The 2018 increase was due to increases in subvention receivables, income tax receivables, and due from others related to broker dealer activities offset by decreases in wire transfer clearing, and investment proceeds receivable. |
NOTE 10. DEPOSITS AND OTHER CUSTOMER ACCOUNTS
Deposits and other customer accounts are summarized as follows:
December 31, 2018 | December 31, 2017 | |||||||||||||
(dollars in thousands) | Balance | Percent of total deposits | Balance | Percent of total deposits | ||||||||||
Interest-bearing demand deposits | $ | 8,827,704 | 14.4 | % | $ | 8,784,597 | 14.4 | % | ||||||
Non-interest-bearing demand deposits | 14,420,450 | 23.4 | % | 15,402,235 | 25.3 | % | ||||||||
Savings | 5,875,787 | 9.6 | % | 5,903,897 | 9.7 | % | ||||||||
Customer repurchase accounts | 654,843 | 1.1 | % | 802,119 | 1.4 | % | ||||||||
Money market | 24,263,929 | 39.4 | % | 24,530,661 | 40.3 | % | ||||||||
CDs | 7,468,667 | 12.1 | % | 5,407,594 | 8.9 | % | ||||||||
Total Deposits (1) | $ | 61,511,380 | 100.0 | % | $ | 60,831,103 | 100.0 | % | ||||||
(1) | Includes foreign deposits, as defined by the FRB, of $8.4 billion and $9.1 billion at December 31, 2018 and December 31, 2017, respectively. |
Deposits collateralized by investment securities, loans, and other financial instruments totaled $2.7 billion and $2.3 billion at December 31, 2018 and December 31, 2017, respectively.
Demand deposit overdrafts that have been reclassified as loan balances were $50.0 million and $38.9 million at December 31, 2018 and December 31, 2017, respectively.
Interest expense on deposits and other customer accounts is summarized as follows:
YEAR ENDED DECEMBER 31, | ||||||||||||
(in thousands) | 2018 | 2017 | 2016 | |||||||||
Interest-bearing demand deposits | $ | 41,481 | $ | 21,628 | $ | 40,262 | ||||||
Savings | 12,325 | 11,004 | 12,723 | |||||||||
Customer repurchase accounts | 1,761 | 1,932 | 1,750 | |||||||||
Money market | 245,794 | 132,993 | 126,418 | |||||||||
CDs | 87,767 | 73,487 | 95,869 | |||||||||
Total Deposits | $ | 389,128 | $ | 241,044 | $ | 277,022 | ||||||
The following table sets forth the maturity of the Company's CDs of $100,000 or more at December 31, 2018 as scheduled to mature contractually:
(in thousands) | ||||
Three months or less | $ | 731,665 | ||
Over three through six months | 513,196 | |||
Over six through twelve months | 1,349,221 | |||
Over twelve months | 1,191,485 | |||
Total | $ | 3,785,568 | ||
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NOTE 10. DEPOSITS AND OTHER CUSTOMER ACCOUNTS (continued)
The following table sets forth the maturity of all the Company's CDs at December 31, 2018 as scheduled to mature contractually:
(in thousands) | ||||
2019 | $ | 5,265,491 | ||
2020 | 956,587 | |||
2021 | 932,662 | |||
2022 | 247,684 | |||
2023 | 60,209 | |||
Thereafter | 6,034 | |||
Total | $ | 7,468,667 | ||
At December 31, 2018 and December 31, 2017, the Company had $1.9 billion and $1.3 billion of CDs greater than $250 thousand.
NOTE 11. BORROWINGS
Total borrowings and other debt obligations at December 31, 2018 were $45.0 billion, compared to $39.0 billion at December 31, 2017. The Company's debt agreements impose certain limitations on dividends other payments and transactions. The Company is currently in compliance with these limitations.
Periodically, as part of the Company's wholesale funding management, it opportunistically repurchases outstanding borrowings in the open market and subsequently retires the obligations.
Bank
The Bank had no new securities issuances and did not repurchase any outstanding borrowings in the open market during the year ended December 31, 2018.
During 2017, the Bank had the following borrowings and other debt obligations activity:
• | repurchased $1.0 billion of its 2.00% senior notes due 2018 and senior floating rate notes due 2018. |
• | repurchased $14.2 million of its real estate investment trust (“REIT") preferred debt. |
• | repurchased $307.9 million of its 8.75% subordinated notes due 2018. The Company recorded a loss on debt extinguishment related to this repurchase of $14.0 million. |
• | On February 4th, 2019 the Bank paid off its subordinated term loan due February 2019. |
SHUSA
During 2018, the Company issued $1.4 billion in debt consisting of:
• | $427.9 million of its senior floating rate notes |
• | $1.0 billion of its 4.45% senior notes due 2021 |
During 2018, the Company repurchased the following borrowings and other debt obligations:
• | $244.6 million of its 3.45% senior notes |
• | $821.3 million of its 2.7% senior notes |
• | $154.6 million of its Sovereign Cap Trust IX subordinated debentures and common securities. |
During 2017, the Company issued $4.7 billion in debt consisting of:
• | $1.4 billion of its 3.70% senior notes due 2022 |
• | $759.7 million of its senior floating rate notes due 2019 |
• | $1.1 billion of its 4.40% senior notes due 2027 |
• | $418.5 million of its senior floating rate notes due 2020 |
• | $1.0 billion of its 3.40% senior notes due 2023 |
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NOTE 11. BORROWINGS (continued)
During 2017, the Company repurchased the following borrowings and other debt obligations:
• | $255.4 million of its 3.45% senior notes |
• | $80.3 million of its Capital Trust VI junior subordinated debentures due June 2036 |
The Company recorded loss on debt extinguishment related to debt repurchases and early repayments at SHUSA of $3.5 million and $30.3 million for the years ended December 31, 2018, and 2017, respectively.
Parent Company and other Subsidiary Borrowings and Debt Obligations
The following table presents information regarding the Parent Company and its subsidiaries' borrowings and other debt obligations at the dates indicated:
December 31, 2018 | December 31, 2017 | |||||||||||||
(dollars in thousands) | Balance | Effective Rate | Balance | Effective Rate | ||||||||||
Parent Company | ||||||||||||||
3.45% senior notes, due August 2018 | $ | — | — | % | $ | 244,317 | 3.62 | % | ||||||
2.70% senior notes, due May 2019 | 178,628 | 2.82 | % | 998,349 | 2.82 | % | ||||||||
2.65% senior notes, due April 2020 | 997,848 | 2.82 | % | 996,238 | 2.82 | % | ||||||||
4.45% senior notes, due December 2021 | 995,540 | 4.61 | % | — | — | % | ||||||||
3.70% senior notes, due March 2022 | 1,440,063 | 3.74 | % | 1,440,044 | 3.74 | % | ||||||||
3.40% senior notes, due January 2023 | 994,831 | 3.54 | % | 993,662 | 3.54 | % | ||||||||
4.50% senior notes, due July 2025 | 1,095,966 | 4.56 | % | 1,095,449 | 4.56 | % | ||||||||
4.40% senior notes, due July 2027 | 1,049,799 | 4.40 | % | 1,049,787 | 4.40 | % | ||||||||
Junior subordinated debentures - Sovereign Capital Trust IX, due July 2036 | — | — | % | 149,462 | 3.14 | % | ||||||||
Common securities - Sovereign Capital Trust IX | — | — | % | 4,640 | 3.14 | % | ||||||||
Senior notes, due July 2019 (1) | 388,717 | 3.22 | % | 388,565 | 2.31 | % | ||||||||
Senior notes, due September 2019 (1) | 370,936 | 3.18 | % | 370,754 | 2.34 | % | ||||||||
Senior notes, due January 2020 (1) | 302,619 | 3.22 | % | 302,494 | 2.40 | % | ||||||||
Senior notes, due September 2020 (2) | 108,888 | 3.17 | % | 115,804 | 3.32 | % | ||||||||
Senior notes, due June 2022(1) | 427,850 | 3.38 | % | — | — | % | ||||||||
Subsidiaries | ||||||||||||||
2.00% subordinated debt, maturing through 2042 | 40,703 | 2.00 | % | 40,842 | 2.00 | % | ||||||||
Short-term borrowing, due within one year, maturing January 2019 | 44,000 | 2.40 | % | 24,000 | 1.38 | % | ||||||||
Total due to others overnight, due within one year, due July 2018 | — | — | % | 10,000 | 1.38 | % | ||||||||
Short-term borrowing, due within one year, maturing January 2019 | 15,900 | 0.38 | % | 37,546 | 0.25 | % | ||||||||
Short-term borrowings, due within one year, maturing through 2018 | — | — | % | 7,123 | 0.83 | % | ||||||||
Total Parent Company and subsidiaries' borrowings and other debt obligations | $ | 8,452,288 | 3.76 | % | $ | 8,269,076 | 3.45 | % | ||||||
(1) These notes bear interest at a rate equal to the three-month London Interbank Offered Rate (“LIBOR") plus 100 basis points per annum.
(2) This note will bear interest at a rate equal to the three-month LIBOR plus 105 basis points per annum.
Bank Borrowings and Debt Obligations
The following table presents information regarding the Bank's borrowings and other debt obligations at the dates indicated:
December 31, 2018 | December 31, 2017 | |||||||||||||
(dollars in thousands) | Balance | Effective Rate | Balance | Effective Rate | ||||||||||
8.750% subordinated debentures, due May 2018 | $ | — | — | % | $ | 192,019 | 8.92 | % | ||||||
Subordinated term loan, due February 2019 | 99,402 | 8.20 | % | 111,883 | 7.12 | % | ||||||||
FHLB advances, maturing through September 2021 | 4,850,000 | 2.74 | % | 1,950,000 | 1.53 | % | ||||||||
Securities sold under repurchase agreements | — | — | % | 150,000 | 1.56 | % | ||||||||
REIT preferred, callable May 2020 | 145,590 | 13.22 | % | 144,167 | 13.35 | % | ||||||||
Subordinated term loan, due August 2022 | 26,770 | 9.95 | % | 27,911 | 8.89 | % | ||||||||
Total Bank borrowings and other debt obligations | $ | 5,121,762 | 3.18 | % | $ | 2,575,980 | 3.07 | % | ||||||
The Bank had outstanding irrevocable letters of credit totaling $688.8 million from the FHLB of Pittsburgh at December 31, 2018, used to secure uninsured deposits placed with the Bank by state and local governments and their political subdivisions.
148
NOTE 11. BORROWINGS (continued)
Revolving Credit Facilities
The following tables present information regarding SC's credit facilities as of December 31, 2018 and December 31, 2017, respectively:
December 31, 2018 | |||||||||||||||||||
(dollars in thousands) | Balance | Committed Amount | Effective Rate | Assets Pledged | Restricted Cash Pledged | ||||||||||||||
Warehouse line, maturing on various dates(1) | $ | 314,845 | $ | 1,250,000 | 4.83 | % | $ | 458,390 | $ | — | |||||||||
Warehouse line, due November 2020 | 317,020 | 500,000 | 3.53 | % | 359,214 | 525 | |||||||||||||
Warehouse line, due August 2020(2) | 2,154,243 | 4,400,000 | 3.79 | % | 2,859,113 | 4,831 | |||||||||||||
Warehouse line, due October 2020 | 242,377 | 2,050,000 | 5.94 | % | 345,599 | 120 | |||||||||||||
Warehouse line, due August 2019 | 53,584 | 500,000 | 8.34 | % | 78,790 | — | |||||||||||||
Warehouse line, due November 2020 | 1,000,000 | 1,000,000 | 3.32 | % | 1,430,524 | 6 | |||||||||||||
Warehouse line, due October 2019 | 97,200 | 350,000 | 4.35 | % | 108,418 | 328 | |||||||||||||
Repurchase facility, due April 2019(3) | 167,118 | 167,118 | 3.84 | % | 235,540 | — | |||||||||||||
Repurchase facility, due March 2019(3) | 131,827 | 131,827 | 3.54 | % | 166,308 | — | |||||||||||||
Total SC revolving credit facilities | $ | 4,478,214 | $ | 10,348,945 | 3.92 | % | $ | 6,041,896 | $ | 5,810 | |||||||||
(1) | As of December 31, 2018, one-half of the outstanding balance on this facility matures in March 2019 and the remaining balance matures in March 2020. |
(2) | This line is held exclusively for financing of Chrysler Capital leases. |
(3) | These repurchase facilities are collateralized by securitization notes payable retained by SC. These facilities have rolling maturities of up to one year. As the borrower, SC is exposed to liquidity risk due to changes in the market value of retrained securities pledged. In some instances, SC places or receives cash collateral with counterparties under collateral arrangements associated with SC's repurchase agreements. |
December 31, 2017 | |||||||||||||||||||
(dollars in thousands) | Balance | Committed Amount | Effective Rate | Assets Pledged | Restricted Cash Pledged | ||||||||||||||
Warehouse line, maturing on various dates | $ | 339,145 | $ | 1,250,000 | 2.53 | % | $ | 461,353 | $ | 12,645 | |||||||||
Warehouse line, due November 2019 | 435,220 | 500,000 | 1.92 | % | 521,365 | 16,866 | |||||||||||||
Warehouse line, due August 2019 | 2,044,843 | 3,900,000 | 2.96 | % | 2,929,890 | 53,639 | |||||||||||||
Warehouse line, due October 2019 | 226,577 | 1,800,000 | 4.95 | % | 311,336 | 6,772 | |||||||||||||
Warehouse line, due October 2019 | 81,865 | 400,000 | 4.09 | % | 114,021 | 3,057 | |||||||||||||
Warehouse line, due January 2018 | 336,484 | 500,000 | 2.87 | % | 473,208 | — | |||||||||||||
Warehouse line, due November 2019 | 403,999 | 1,000,000 | 2.66 | % | 546,782 | 14,729 | |||||||||||||
Warehouse line, due October 2018 | 235,700 | 300,000 | 2.84 | % | 289,634 | 10,474 | |||||||||||||
Warehouse line, due December 2018 | — | 300,000 | 1.49 | % | — | — | |||||||||||||
Repurchase facility, maturing on various dates | 325,775 | 325,775 | 3.24 | % | 474,188 | 13,842 | |||||||||||||
Repurchase facility, due April 2018 | 202,311 | 202,311 | 2.67 | % | 264,120 | — | |||||||||||||
Repurchase facility, due March 2018 | 147,500 | 147,500 | 3.91 | % | 222,108 | — | |||||||||||||
Repurchase facility, due March 2018 | 68,897 | 68,897 | 3.04 | % | 95,762 | — | |||||||||||||
Line of credit with related party, due December 2018 | — | 1,000,000 | 3.09 | % | — | — | |||||||||||||
Line of credit with related party, due December 2018 | 750,000 | 750,000 | 1.33 | % | — | — | |||||||||||||
Total SC revolving credit facilities | $ | 5,598,316 | $ | 12,444,483 | 2.73 | % | $ | 6,703,767 | $ | 132,024 | |||||||||
149
NOTE 11. BORROWINGS (continued)
Secured Structured Financings
The following tables present information regarding SC's secured structured financings as of December 31, 2018 and December 31, 2017, respectively:
December 31, 2018 | ||||||||||||||||||
(dollars in thousands) | Balance | Initial Note Amounts Issued(3) | Initial Weighted Average Interest Rate Range | Collateral(2) | Restricted Cash | |||||||||||||
SC public securitizations, maturing on various dates between April 2021 and April 2026(1) | $ | 19,225,169 | $ | 41,380,952 | 1.16% - 3.53% | $ | 24,912,904 | $ | 1,541,714 | |||||||||
SC privately issued amortizing notes, maturing on various dates between June 2019 and September 2024 | 7,676,351 | 11,305,368 | 0.88% - 3.17% | 10,383,266 | 35,201 | |||||||||||||
Total SC secured structured financings | $ | 26,901,520 | $ | 52,686,320 | .88% - 3.53% | $ | 35,296,170 | $ | 1,576,915 | |||||||||
(1) Securitizations executed under Rule 144A of the Securities Act of 1933, as amended (the "Securities Act"), are included within this balance.
(2) Secured structured financings may be collateralized by SC's collateral overages of other issuances.
(3) Excludes initial note amounts issued balance for any securitizations deals that were paid off during the year or any new top ups for the year
December 31, 2017 | ||||||||||||||||||
(dollars in thousands) | Balance | Initial Note Amounts Issued | Initial Weighted Average Interest Rate Range | Collateral | Restricted Cash | |||||||||||||
SC public securitizations, maturing on various dates between January 2019 and September 2024(1)(2) | $ | 14,995,304 | $ | 36,800,642 | 0.89% - 2.80% | $ | 19,873,621 | $ | 1,470,459 | |||||||||
SC privately issued amortizing notes, maturing on various dates between March 2018 and September 2028(1) | 7,564,637 | 12,278,282 | 0.88% - 4.09% | 9,232,658 | 377,300 | |||||||||||||
Total SC secured structured financings | $ | 22,559,941 | $ | 49,078,924 | 0.88% - 4.09% | $ | 29,106,279 | $ | 1,847,759 | |||||||||
(1) SC has entered into various securitization transactions involving its retail automobile installment loans and leases. These transactions are accounted for as secured financings and therefore both the securitized RICs and the related securitization debt issued by SPEs remain on the Consolidated Balance Sheets. The maturity of this debt is based on the timing of repayments from the securitized assets.
(2) Securitizations executed under Rule 144A of the Securities Act are included within this balance.
Most of SC's secured structured financings are in the form of public, SEC-registered securitizations. SC also executes private securitizations under Rule 144A of the Securities Act, and periodically issues private term amortizing notes, which are structured similarly to securitizations but are acquired by banks and conduits. SC's securitizations and private issuances are collateralized by RICs or vehicle leases. As of December 31, 2018 and December 31, 2017, SC had private issuances of notes backed by vehicle leases outstanding totaling $7.8 billion and $3.7 billion, respectively.
The following table sets forth the maturities of the Company's consolidated borrowings and debt obligations at December 31, 2018:
(in thousands) | |||
2019 | $ | 4,988,996 | |
2020 | 9,427,828 | ||
2021 | 7,009,986 | ||
2022 | 9,282,303 | ||
2023 | 5,661,986 | ||
Thereafter | 8,582,685 | ||
Total | $ | 44,953,784 | |
150
NOTE 12. ACCUMULATED OTHER COMPREHENSIVE INCOME / (LOSS)
The following table presents the components of accumulated other comprehensive income/(loss), net of related tax, for the years ended December 31, 2018, 2017, and 2016 respectively.
Total Other Comprehensive Income/(Loss) | Total Accumulated Other Comprehensive (Loss)/Income | |||||||||||||||||||||||
Year Ended December 31, 2018 | December 31, 2017 | December 31, 2018 | ||||||||||||||||||||||
(in thousands) | Pretax Activity | Tax Effect | Net Activity | Beginning Balance | Net Activity | Ending Balance | ||||||||||||||||||
Change in accumulated OCI on cash flow hedge derivative financial instruments | $ | (6,225 | ) | $ | (848 | ) | $ | (7,073 | ) | |||||||||||||||
Reclassification adjustment for net losses on cash flow hedge derivative financial instruments(1) | 4,781 | (1,504 | ) | 3,277 | ||||||||||||||||||||
Net unrealized (losses) on cash flow hedge derivative financial instruments | (1,444 | ) | (2,352 | ) | (3,796 | ) | $ | (6,388 | ) | $ | (3,796 | ) | $ | — | ||||||||||
Cumulative impact of adoption of new ASU(4) | (9,629 | ) | ||||||||||||||||||||||
Net unrealized (losses) on cash flow hedge derivative financial instruments upon adoption | (13,425 | ) | (19,813 | ) | ||||||||||||||||||||
Change in unrealized (losses) on investments in debt securities AFS and HTM | (84,316 | ) | (3,577 | ) | (87,893 | ) | ||||||||||||||||||
Reclassification adjustment for net losses included in net income/(expense) on non-OTTI securities (2) | 6,717 | 285 | 7,002 | |||||||||||||||||||||
Net unrealized (losses) on investments in debt securities AFS and HTM | (77,599 | ) | (3,292 | ) | (80,891 | ) | (140,498 | ) | (80,891 | ) | ||||||||||||||
Cumulative impact of adoption of new ASU(4) | (24,378 | ) | ||||||||||||||||||||||
Net unrealized (losses) on investments in debt securities AFS and HTM - upon adoption | (105,269 | ) | (245,767 | ) | ||||||||||||||||||||
Pension and post-retirement actuarial (loss)(3) | 7,527 | (6,967 | ) | 560 | (51,545 | ) | 560 | |||||||||||||||||
Cumulative impact of adoption of new ASU(4) | (5,087 | ) | ||||||||||||||||||||||
Pension and post-retirement actuarial gain upon adoption | (4,527 | ) | (56,072 | ) | ||||||||||||||||||||
As of December 31, 2018 | $ | (71,516 | ) | $ | (12,611 | ) | $ | (84,127 | ) | $ | (198,431 | ) | $ | (123,221 | ) | $ | (321,652 | ) | ||||||
(1) | Net gains/(losses) reclassified into Interest on borrowings and other debt obligations in the Consolidated Statements of Operations for settlements of interest rate swap contracts designated as cash flow hedges. |
(2) | Net (gains)/losses reclassified into Net gain on sale of investment securities sales in the Consolidated Statements of Operations for the sale of AFS securities. |
(3) | Included in the computation of net periodic pension costs. |
(4) Includes impact of other comprehensive income reclassified to Retained earnings as a result of the adoption of ASU 2018-02. Refer to Note 1 for further discussion.
151
NOTE 12. ACCUMULATED OTHER COMPREHENSIVE INCOME / (LOSS) (continued)
Total Other Comprehensive Income/(Loss) | Total Accumulated Other Comprehensive (Loss)/Income | |||||||||||||||||||||||
Year Ended December 31, 2017 | December 31, 2016 | December 31, 2017 | ||||||||||||||||||||||
(in thousands) | Pretax Activity | Tax Effect | Net Activity | Beginning Balance | Net Activity | Ending Balance | ||||||||||||||||||
Change in accumulated OCI on cash flow hedge derivative financial instruments | $ | 10,620 | $ | 7,508 | $ | 18,128 | ||||||||||||||||||
Reclassification adjustment for net (gains) on cash flow hedge derivative financial instruments(1) | (15,005 | ) | (2,786 | ) | (17,791 | ) | ||||||||||||||||||
Net unrealized (losses) on cash flow hedge derivative financial instruments | (4,385 | ) | 4,722 | 337 | $ | (6,725 | ) | $ | 337 | $ | (6,388 | ) | ||||||||||||
Change in unrealized (losses) on investment securities AFS | (17,972 | ) | 6,694 | (11,278 | ) | |||||||||||||||||||
Reclassification adjustment for net losses included in net income/(expense) on non-OTTI securities (2) | 2,444 | (910 | ) | 1,534 | ||||||||||||||||||||
Net unrealized (losses) on investment securities AFS | (15,528 | ) | 5,784 | (9,744 | ) | (130,754 | ) | (9,744 | ) | (140,498 | ) | |||||||||||||
Pension and post-retirement actuarial gain(3) | 4,954 | (770 | ) | 4,184 | (55,729 | ) | 4,184 | (51,545 | ) | |||||||||||||||
As of December 31, 2017 | $ | (14,959 | ) | $ | 9,736 | $ | (5,223 | ) | $ | (193,208 | ) | $ | (5,223 | ) | $ | (198,431 | ) | |||||||
(1) | Net gains/(losses) reclassified into Interest on borrowings and other debt obligations in the Consolidated Statements of Operations for settlements of interest rate swap contracts designated as cash flow hedges. |
(2) | Net (gains)/losses reclassified into Net gain on sale of investment securities sales in the Consolidated Statements of Operations for the sale of AFS securities. |
(3) | Included in the computation of net periodic pension costs. |
Total Other Comprehensive Income/(Loss) | Total Accumulated Other Comprehensive (Loss)/Income | |||||||||||||||||||||||
For the Year Ended December 31, 2016 | December 31, 2015 | December 31, 2016 | ||||||||||||||||||||||
(in thousands) | Pretax Activity | Tax Effect | Net Activity | Beginning Balance | Net Activity | Ending Balance | ||||||||||||||||||
Change in accumulated OCI on cash flow hedge derivative financial instruments | $ | 1,203 | $ | (130 | ) | $ | 1,073 | |||||||||||||||||
Reclassification adjustment for net losses on cash flow hedge derivative financial instruments(1) | 9,848 | (1,065 | ) | 8,783 | ||||||||||||||||||||
Net unrealized gains on cash flow hedge derivative financial instruments | 11,051 | (1,195 | ) | 9,856 | $ | (16,581 | ) | $ | 9,856 | $ | (6,725 | ) | ||||||||||||
Change in unrealized gains on investment securities AFS | 4,040 | (1,459 | ) | 2,581 | ||||||||||||||||||||
Reclassification adjustment for net (gains) included in net income/(expense) on non-OTTI securities (2) | (57,771 | ) | 20,350 | (37,421 | ) | |||||||||||||||||||
Reclassification adjustment for net losses included in net income/(expense) on OTTI securities (3) | 44 | (16 | ) | 28 | ||||||||||||||||||||
Reclassification adjustment for net (gains) included in net income | (57,727 | ) | 20,334 | (37,393 | ) | |||||||||||||||||||
Net unrealized (losses) on investment securities AFS | (53,687 | ) | 18,875 | (34,812 | ) | (95,942 | ) | (34,812 | ) | (130,754 | ) | |||||||||||||
Pension and post-retirement actuarial gain(4) | 3,768 | (1,490 | ) | 2,278 | (58,007 | ) | 2,278 | (55,729 | ) | |||||||||||||||
As of December 31, 2016 | $ | (38,868 | ) | $ | 16,190 | $ | (22,678 | ) | $ | (170,530 | ) | $ | (22,678 | ) | $ | (193,208 | ) | |||||||
(1) | Net gains/(losses) reclassified into Interest on borrowings and other debt obligations in the Consolidated Statements of Operations for settlements of interest rate swap contracts designated as cash flow hedges. |
(2) | Net (gains)/losses reclassified into Net gain on sale of investment securities sales in the Consolidated Statements of Operations for the sale of AFS securities. |
(3) | Unrealized losses/(gains) previously recognized in accumulated OCI on securities for which OTTI was recognized during the period. See further discussion in Note 3 to the Consolidated Financial Statements. |
(4) | Included in the computation of net periodic pension costs. |
152
NOTE 13. STOCKHOLDER'S EQUITY
At December 31, 2018, the Company had 530,391,043 shares of common stock outstanding. Additional transactions with Santander that are disclosed within the Consolidated Statements of Stockholder's Equity that are shown net are disclosed within the table below:
Impact to common stock and paid in capital | ||||
(in thousands) | ||||
Deferred tax asset on purchased assets | $ | 3,156 | ||
Adjustment to book value of assets purchased on January 1 | 277 | |||
February 2018 contribution | 5,741 | |||
October 2018 contribution | 45,846 | |||
December 2018 contribution | 33,448 | |||
2018 Net contribution from shareholder | $ | 88,468 | ||
March 2017 cash contribution | $ | 9,000 | ||
December 2017 contribution(1) | 15,317 | |||
December 2017 return of capital(1) | (12,570 | ) | ||
2017 net contribution from shareholder | $ | 11,747 | ||
(1) - The December contribution was utilized to purchase certain assets and liabilities from other Santander subsidiaries. The fair value of the net assets acquired exceeded their carrying value by $12.6 million, which is recorded as a return of capital. Refer to Note 21 for additional details.
On November 15, 2017, Santander contributed 34,598,506 shares of SC Common Stock purchased from DDFS LLC (“DDFS”), which reduced NCI and increased additional paid-in capital by $707.6 million.
During the year ended December 31, 2018, SC repurchased $182.6 million of SC Common Stock.
In April 2006, the Company’s Board of Directors authorized 8,000 shares of Series C Preferred Stock, and granted the Company authority to issue fractional shares of the Series C Preferred Stock. Dividends on each share of Series C Preferred Stock were payable quarterly, on a non-cumulative basis, at an annual rate of 7.30%, when and if declared by the Company's Board of Directors. In May 2006, the Company issued 8,000,000 depository shares of Series C Preferred Stock for net proceeds of $195.4 million. Each depository share represented 1/1000th ownership interest in a share of Series C Preferred Stock. As a holder of depository shares, the depository shareholder were entitled to all proportional rights and preferences of the Series C Preferred Stock. The Company’s Board of Directors declared cash dividends to preferred stockholders of $11.0 million, $14.6 million and $15.1 million for the years ended December 31, 2018, 2017 and 2016, respectively.
The shares of Series C Preferred Stock were redeemable in whole or in part for cash, at the Company’s option, at a redemption price of $25,000 per share (equivalent to $25 per depository share), subject to the prior approval of the OCC. On August 15th, 2018 the Company redeemed all outstanding shares of its Series C preferred stock.
NOTE 14. DERIVATIVES
General
Derivatives represent contracts between parties that usually require little or no initial net investment and result in one or both parties delivering cash or another type of asset to the other party based on a notional amount and an underlying asset, index, interest rate or future purchase commitment or option as specified in the contract. Derivative transactions are often measured in terms of notional amount, but this amount is generally not exchanged, is not recorded on the balance sheet, and does not represent the Company`s exposure to credit loss. The notional amount is the basis on which the financial obligation of each party to the derivative contract is calculated to determine required payments under the contract. The Company controls the credit risk of its derivative contracts through credit approvals, limits and monitoring procedures. The underlying asset is typically a referenced interest rate (commonly the OIS rate or LIBOR), security, credit spread or index.
The Company’s capital markets and mortgage banking activities are subject to price risk. The Company employs various tools to measure and manage price risk in its portfolios. In addition, the Board of Directors has established certain limits relative to positions and activities. The level of price risk exposure at any given time depends on the market environment and expectations of future price and market movements and will vary from period to period.
153
NOTE 14. DERIVATIVES (continued)
See Note 16 for discussion of the valuation methodology for derivative instruments.
Credit Risk Contingent Features
The Company has entered into certain derivative contracts that require the posting of collateral to counterparties when those contracts are in a net liability position. The amount of collateral to be posted is based on the amount of the net liability and thresholds generally related to the Company's long-term senior unsecured credit ratings. In a limited number of instances, counterparties also have the right to terminate their International Swaps and Derivatives Association, Inc. ("ISDA") Master Agreements if the Company's ratings fall below a specified level, typically investment grade. As of December 31, 2018, derivatives in this category had a fair value of $1.2 million. The credit ratings of the Company and the Bank are currently considered investment grade. During the fourth quarter of 2018, no additional collateral would be required if there were a further 1- or 2- notch downgrade by either Standard & Poor's ("S&P") or Moody's Investor Services ("Moody's").
As of December 31, 2018 and December 31, 2017, the aggregate fair value of all derivative contracts with credit risk contingent features (i.e., those containing collateral posting or termination provisions based on the Company's ratings) that were in a net liability position totaled $9.5 million and $10.4 million, respectively. The Company had $11.5 million and $15.7 million in cash and securities collateral posted to cover those positions as of December 31, 2018 and December 31, 2017, respectively.
Hedge Accounting
Management uses derivative instruments designated as hedges to mitigate the impact of interest rate and foreign exchange rate movements on the fair value of certain assets and liabilities and on highly probable forecasted cash flows. These instruments primarily include interest rate swaps that have underlying interest rates based on key benchmark indices. The nature and volume of the derivative instruments used to manage interest rate risk depend on the level and type of assets and liabilities on the balance sheet and the risk management strategies for the current and anticipated interest rate environment.
Interest rate swaps are generally used to convert fixed-rate assets and liabilities to variable rate assets and liabilities and vice versa. The Company utilizes interest rate swaps that have a high degree of correlation to the related financial instrument.
Cash Flow Hedges
The Company has outstanding interest rate swap agreements designed to hedge a portion of the Company’s floating rate assets and liabilities (including its borrowed funds). All of these swaps have been deemed highly effective cash flow hedges. The gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings and is presented in the same Consolidated Statements of Operations line item as the earnings effect of the hedged item.
The last of the hedges is scheduled to expire in December 2030. The Company includes all components of each derivative's gain or loss in the assessment of hedge effectiveness. As of December 31, 2018, the Company expected $26.8 million of gains/losses recorded in accumulated other comprehensive loss to be reclassified to earnings during the subsequent twelve months as the future cash flows occur.
154
NOTE 14. DERIVATIVES (continued)
Derivatives Designated in Hedge Relationships – Notional and Fair Values
Derivatives designated as accounting hedges at December 31, 2018 and December 31, 2017 included:
(dollars in thousands) | Notional Amount | Asset | Liability | Weighted Average Receive Rate | Weighted Average Pay Rate | Weighted Average Life (Years) | ||||||||||||||
December 31, 2018 | ||||||||||||||||||||
Cash flow hedges: | ||||||||||||||||||||
Pay fixed — receive variable interest rate swaps | $ | 4,176,105 | $ | 44,054 | $ | 10,503 | 2.67 | % | 1.74 | % | 2.07 | |||||||||
Pay variable - receive fixed interest rate swaps | 4,000,000 | — | 89,769 | 1.41 | % | 2.40 | % | 2.02 | ||||||||||||
Interest rate floor | 2,000,000 | 10,932 | — | 0.04 | % | — | % | 1.91 | ||||||||||||
Total | $ | 10,176,105 | $ | 54,986 | $ | 100,272 | 1.66 | % | 1.66 | % | 2.02 | |||||||||
December 31, 2017 | ||||||||||||||||||||
Cash flow hedges: | ||||||||||||||||||||
Pay fixed — receive variable interest rate swaps | $ | 5,183,511 | $ | 46,422 | $ | 4,458 | 0.05 | % | 0.14 | % | 2.12 | |||||||||
Pay variable - receive fixed interest rate swaps | 4,000,000 | — | 80,453 | 1.41 | % | 1.42 | % | 3.02 | ||||||||||||
Interest rate floor | 1,000,000 | 3,020 | — | — | % | — | % | 2.64 | ||||||||||||
Total | $ | 10,183,511 | $ | 49,442 | $ | 84,911 | 0.58 | % | 0.63 | % | 2.53 | |||||||||
Other Derivative Activities
The Company also enters into derivatives that are not designated as accounting hedges under GAAP. The majority of these derivatives are customer-related derivatives relating to foreign exchange and lending arrangements, as well as derivatives to hedge interest rate risk on SC's secured structured financings and the borrowings under its revolving credit facilities. SC uses both interest rate swaps and interest rate caps to satisfy these requirements and to hedge the variability of cash flows on securities issued by Trusts and borrowings under its warehouse facilities. In addition, derivatives are used to manage risks related to residential and commercial mortgage banking and investing activities. Although these derivatives are used to hedge risk and are considered economic hedges, they are not designated as accounting hedges because the contracts they are hedging are carried at fair value on the balance sheet, resulting in generally symmetrical accounting treatment for the hedging instrument and the hedged item.
Mortgage Banking Derivatives
The Company's derivatives portfolio includes mortgage banking interest rate lock commitments, forward sale commitments and interest rate swaps. As part of its overall business strategy, the Company originates fixed-rate and adjustable rate residential mortgages. It sells a portion of this production to the FHLMC, the FNMA, and private investors. The Company uses forward sales as a means of hedging against the economic impact of changes in interest rates on the mortgages that are originated for sale and on interest rate lock commitments.
The Company typically retains the servicing rights related to residential mortgage loans that are sold. Most of the Company`s residential MSRs are accounted for at fair value. As deemed appropriate, the Company economically hedges MSRs using interest rate swaps and forward contracts to purchase MBS.
Customer-related derivatives
The Company offers derivatives to its customers in connection with their risk management needs and requirements. These financial derivative transactions primarily consist of interest rate swaps, caps, floors and foreign exchange contracts. Risk exposure from customer positions is managed through transactions with other dealers, including Santander.
155
NOTE 14. DERIVATIVES (continued)
Other derivative activities
The Company uses foreign exchange contracts to manage the foreign exchange risk associated with certain foreign currency-denominated assets and liabilities. Foreign exchange contracts, which include spot and forward contracts as well as cross-currency swaps, represent agreements to exchange the currency of one country for the currency of another country at an agreed-upon price on an agreed-upon settlement date and may or may not be physically settled depending on the Company’s needs. Exposure to gains and losses on these contracts will increase or decrease over their respective lives as currency exchange and interest rates fluctuate.
Other derivative instruments primarily include forward contracts related to certain investment securities sales, an OIS, a total return swap on Visa, Inc. Class B common shares, and equity options, which manage the Company's market risk associated with certain investments and customer deposit products.
Derivatives Not Designated in Hedge Relationships – Notional and Fair Values
Other derivative activities at December 31, 2018 and December 31, 2017 included:
Notional | Asset derivatives Fair value | Liability derivatives Fair value | ||||||||||||||||||||||
(in thousands) | December 31, 2018 | December 31, 2017 | December 31, 2018 | December 31, 2017 | December 31, 2018 | December 31, 2017 | ||||||||||||||||||
Mortgage banking derivatives: | ||||||||||||||||||||||||
Forward commitments to sell loans | $ | 329,189 | $ | 311,852 | $ | 4 | $ | 3 | $ | 4,821 | $ | 459 | ||||||||||||
Interest rate lock commitments | 133,680 | 126,194 | 2,677 | 2,105 | — | — | ||||||||||||||||||
Mortgage servicing | 455,000 | 330,000 | 1,575 | 193 | 8,953 | 2,092 | ||||||||||||||||||
Total mortgage banking risk management | 917,869 | 768,046 | 4,256 | 2,301 | 13,774 | 2,551 | ||||||||||||||||||
Customer-related derivatives: | ||||||||||||||||||||||||
Swaps receive fixed | 11,335,998 | 9,328,079 | 92,542 | 72,912 | 120,185 | 70,348 | ||||||||||||||||||
Swaps pay fixed | 11,825,804 | 9,576,893 | 163,673 | 110,109 | 72,662 | 51,380 | ||||||||||||||||||
Other | 2,162,302 | 1,834,962 | 11,151 | 19,971 | 14,294 | 18,308 | ||||||||||||||||||
Total customer-related derivatives | 25,324,104 | 20,739,934 | 267,366 | 202,992 | 207,141 | 140,036 | ||||||||||||||||||
Other derivative activities: | ||||||||||||||||||||||||
Foreign exchange contracts | 3,635,119 | 2,764,999 | 47,330 | 24,932 | 37,466 | 25,521 | ||||||||||||||||||
Interest rate swap agreements | 2,281,379 | 1,749,349 | 11,553 | 9,596 | 3,264 | 1,631 | ||||||||||||||||||
Interest rate cap agreements | 7,758,710 | 10,932,707 | 128,467 | 135,942 | — | 32,109 | ||||||||||||||||||
Options for interest rate cap agreements | 7,741,765 | 10,906,081 | — | 32,165 | 128,377 | 135,824 | ||||||||||||||||||
Other | 1,038,558 | 824,786 | 4,527 | 5,874 | 7,137 | 5,228 | ||||||||||||||||||
Total | $ | 48,697,504 | $ | 48,685,902 | $ | 463,499 | $ | 413,802 | $ | 397,159 | $ | 342,900 | ||||||||||||
156
NOTE 14. DERIVATIVES (continued)
Gains (Losses) on All Derivatives
The following Consolidated Statement of Operations line items were impacted by the Company’s derivative activities for the years ended December 31, 2018, 2017 and 2016:
(in thousands) | Year Ended December 31, | |||||||||||||
Derivative Activity(1) | Line Item | 2018 | 2017 | 2016 | ||||||||||
Fair value hedges: | ||||||||||||||
Cross-currency swaps | Net Interest Income | $ | — | $ | — | $ | 174 | |||||||
Interest rate swaps | Net Interest Income | — | 2,397 | (4,891 | ) | |||||||||
Cash flow hedges: | ||||||||||||||
Pay fixed-receive variable interest rate swaps | Interest expense on borrowings | 33,881 | (10,152 | ) | (6,397 | ) | ||||||||
Pay variable receive-fixed interest rate swap | Interest income on loans | (24,346 | ) | 9,104 | 2,353 | |||||||||
Other derivative activities: | ||||||||||||||
Forward commitments to sell loans | Miscellaneous income, net | (4,362 | ) | (9,033 | ) | 8,034 | ||||||||
Interest rate lock commitments | Miscellaneous income, net | 572 | (211 | ) | (224 | ) | ||||||||
Mortgage servicing | Miscellaneous income, net | (7,560 | ) | 2,075 | 1,552 | |||||||||
Customer-related derivatives | Miscellaneous income, net | 34,987 | 16,703 | 14,861 | ||||||||||
Foreign exchange | Miscellaneous income, net | 2,259 | 6,520 | 5,189 | ||||||||||
Interest rate swaps, caps, and options | Miscellaneous income, net | 11,901 | 10,897 | 4,450 | ||||||||||
Interest expense | — | 6,060 | 51,862 | |||||||||||
Total return settlement | Other administrative expenses | — | — | (4,365 | ) | |||||||||
Other | Miscellaneous income, net | (4,030 | ) | 1,747 | 3,495 | |||||||||
(1) | Gains are disclosed as positive numbers while losses are shown as a negative number regardless of the line item being affected. |
The net amount of change recognized in OCI for cash flow hedge derivatives was a loss of $7.1 million, net of tax, for the year ended December 31, 2018 and gains of $18.1 million and $1.1 million for the years ended December 31, 2017 and 2016, respectively.
The net amount of change reclassified from OCI into earnings for cash flow hedge derivatives was a loss of $3.3 million, net of tax, for the year ended December 31, 2018, and the net amount of change reclassified from OCI into earnings for cash flow hedge derivatives was a gain of $17.8 million and a loss of $8.8 million, net of tax, for the years ended December 31, 2017 and 2016, respectively.
Disclosures about Offsetting Assets and Liabilities
The Company enters into legally enforceable master netting agreements, which reduce risk by permitting netting of transactions with the same counterparty on the occurrence of certain events. A master netting agreement allows two counterparties the ability to net-settle amounts under all contracts, including any related collateral posted, through a single payment and in a single currency. The right to offset and certain terms regarding the collateral process, such as valuation, credit events and settlement, are contained in the ISDA Master Agreement. The Company's financial instruments, including resell and repurchase agreements, securities lending arrangements, derivatives and cash collateral, may be eligible for offset on its Consolidated Balance Sheets.
The Company has elected to present derivative balances on a gross basis even if the derivative is subject to a legally enforceable nettable ISDA Master Agreement for all trades executed after April 1, 2013. Collateral that is received or pledged for these transactions is disclosed within the “Gross amounts not offset in the Consolidated Balance Sheets” section of the tables below. Prior to April 1, 2013, the Company had elected to net all caps, floors, and interest rate swaps when it had an ISDA Master Agreement with the counterparty. The collateral received or pledged in connection with these transactions is disclosed within the “Gross amounts offset in the Consolidated Balance Sheets" section of the tables below.
157
NOTE 14. DERIVATIVES (continued)
Information about financial assets and liabilities that are eligible for offset on the Consolidated Balance Sheets as of December 31, 2018 and December 31, 2017, respectively, is presented in the following tables:
Offsetting of Financial Assets | ||||||||||||||||||||||||
Gross Amounts Not Offset in the Consolidated Balance Sheet | ||||||||||||||||||||||||
(in thousands) | Gross Amounts of Recognized Assets | Gross Amounts Offset in the Condensed Consolidated Balance Sheet | Net Amounts of Assets Presented in the Condensed Consolidated Balance Sheet | Financial Instruments | Cash Collateral Received | Net Amount | ||||||||||||||||||
December 31, 2018 | ||||||||||||||||||||||||
Cash flow hedges | $ | 54,986 | $ | — | $ | 54,986 | $ | — | $ | 22,451 | $ | 32,535 | ||||||||||||
Other derivative activities(1) | 460,822 | 6,570 | 454,252 | 1,066 | 116,516 | 336,670 | ||||||||||||||||||
Total derivatives subject to a master netting arrangement or similar arrangement | 515,808 | 6,570 | 509,238 | 1,066 | 138,967 | 369,205 | ||||||||||||||||||
Total derivatives not subject to a master netting arrangement or similar arrangement(2) | 2,677 | — | 2,677 | — | — | 2,677 | ||||||||||||||||||
Total Derivative Assets | $ | 518,485 | $ | 6,570 | $ | 511,915 | $ | 1,066 | $ | 138,967 | $ | 371,882 | ||||||||||||
December 31, 2017 | ||||||||||||||||||||||||
Cash flow hedges | $ | 49,442 | $ | — | $ | 49,442 | $ | — | $ | 3,076 | $ | 46,366 | ||||||||||||
Other derivative activities(1) | 411,697 | 6,731 | 404,966 | 2,021 | 77,975 | 324,970 | ||||||||||||||||||
Total derivatives subject to a master netting arrangement or similar arrangement | 461,139 | 6,731 | 454,408 | 2,021 | 81,051 | 371,336 | ||||||||||||||||||
Total derivatives not subject to a master netting arrangement or similar arrangement(2) | 2,105 | — | 2,105 | — | — | 2,105 | ||||||||||||||||||
Total Derivative Assets | $ | 463,244 | $ | 6,731 | $ | 456,513 | $ | 2,021 | $ | 81,051 | $ | 373,441 | ||||||||||||
(1) | Includes customer-related and other derivatives. |
(2) | Includes mortgage banking derivatives. |
158
NOTE 14. DERIVATIVES (continued)
Offsetting of Financial Liabilities | ||||||||||||||||||||||||
Gross Amounts Not Offset in the Consolidated Balance Sheet | ||||||||||||||||||||||||
(in thousands) | Gross Amounts of Recognized Liabilities | Gross Amounts Offset in the Condensed Consolidated Balance Sheet | Net Amounts of Liabilities Presented in the Condensed Consolidated Balance Sheet | Financial Instruments | Cash Collateral Pledged | Net Amount | ||||||||||||||||||
December 31, 2018 | ||||||||||||||||||||||||
Cash flow hedges | $ | 100,272 | $ | — | $ | 100,272 | $ | — | $ | 5,612 | $ | 94,660 | ||||||||||||
Other derivative activities(1) | 392,338 | 13,422 | 378,916 | — | 316,285 | 62,631 | ||||||||||||||||||
Total derivatives subject to a master netting arrangement or similar arrangement | 492,610 | 13,422 | 479,188 | — | 321,897 | 157,291 | ||||||||||||||||||
Total derivatives not subject to a master netting arrangement or similar arrangement(2) | 4,821 | — | 4,821 | — | 3,827 | 994 | ||||||||||||||||||
Total Derivative Liabilities | $ | 497,431 | $ | 13,422 | $ | 484,009 | $ | — | $ | 325,724 | $ | 158,285 | ||||||||||||
December 31, 2017 | ||||||||||||||||||||||||
Cash flow hedges | $ | 84,911 | $ | — | $ | 84,911 | $ | — | $ | 622 | $ | 84,289 | ||||||||||||
Other derivative activities(1) | 342,752 | 16,236 | 326,516 | — | 165,716 | 160,800 | ||||||||||||||||||
Total derivatives subject to a master netting arrangement or similar arrangement | 427,663 | 16,236 | 411,427 | — | 166,338 | 245,089 | ||||||||||||||||||
Total derivatives not subject to a master netting arrangement or similar arrangement(2) | 148 | — | 148 | — | — | 148 | ||||||||||||||||||
Total Derivative Liabilities | $ | 427,811 | $ | 16,236 | $ | 411,575 | $ | — | $ | 166,338 | $ | 245,237 | ||||||||||||
(1) | Includes customer-related and other derivatives. |
(2) | Includes mortgage banking derivatives. |
NOTE 15. INCOME TAXES
The Company is subject to the income tax laws of the U.S., its states and municipalities and certain foreign countries. These tax laws are complex and are potentially subject to different interpretations by the taxpayer and the relevant governmental taxing authorities. In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of these inherently complex tax laws.
Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. The Company reviews its tax balances quarterly and, as new information becomes available, the balances are adjusted as appropriate. The Company is subject to ongoing tax examinations and assessments in various jurisdictions.
On December 22, 2017, the TCJA was enacted. Effective January 1, 2018, the TCJA, among other things, reduced the federal corporate income tax rate from 35% to 21%.
Due to the complexities involved in accounting for the enactment of the TCJA, SEC Staff Accounting Bulletin (“SAB”) 118 specifies, among other things, that reasonable estimates of the income tax effects of the TCJA should be used, if determinable. Further, SAB 118 clarifies accounting for income taxes under ASC Topic 740, Income Taxes (ASC 740), if information is not yet available or complete and provides for up to a one-year period in which to complete the required analyses and accounting (the measurement period). The Company has obtained and analyzed all currently available information to record the effect of the change in tax law. At December 31, 2017, the Company recorded a one-time tax benefit of $427.3 million, primarily due to the re-valuation of its net deferred tax liability at the lower 21% rate. At December 31, 2018, we have completed our accounting for all of the enactment date income tax effects of the TCJA.
159
NOTE 15. INCOME TAXES (continued)
Income Taxes from Continuing Operations
The provision for income taxes in the Consolidated Statement of Operations is comprised of the following components:
Year Ended December 31, | ||||||||||||
(in thousands) | 2018 | 2017 | 2016 | |||||||||
Current: | ||||||||||||
Foreign | $ | 13,183 | $ | 7,288 | $ | 30,983 | ||||||
Federal | (68,160 | ) | 24,335 | 71,429 | ||||||||
State | 64,002 | 7,951 | (2,646 | ) | ||||||||
Total current | 9,025 | 39,574 | 99,766 | |||||||||
Deferred: | ||||||||||||
Foreign | 16,882 | (15,065 | ) | (36,039 | ) | |||||||
Federal | 360,780 | (193,837 | ) | 143,494 | ||||||||
State | 39,213 | 12,288 | 106,494 | |||||||||
Total deferred | 416,875 | (196,614 | ) | 213,949 | ||||||||
Total income tax provision/(benefit) | $ | 425,900 | $ | (157,040 | ) | $ | 313,715 | |||||
Reconciliation of Statutory and Effective Tax Rate
The following is a reconciliation of the U.S. federal statutory rate of 21.0% for the year ended December 31, 2018 and 35% for the years ended December 31, 2017 and 2016 to the Company's effective tax rate for each of the years indicated:
Year Ended December 31, | |||||||||
2018 | 2017 | 2016 | |||||||
Federal income tax at statutory rate | 21.0 | % | 35.0 | % | 35.0 | % | |||
Increase/(decrease) in taxes resulting from: | |||||||||
Valuation allowance | 4.6 | % | 0.9 | % | (5.0 | )% | |||
Tax-exempt income | (0.8 | )% | (1.9 | )% | (1.6 | )% | |||
Section 162(m) limitation | 0.2 | % | — | % | — | % | |||
Non-deductible FDIC insurance premiums | 0.8 | % | — | % | — | % | |||
BOLI | (0.9 | )% | (2.8 | )% | (2.1 | )% | |||
State income taxes, net of federal tax benefit | 5.9 | % | 2.6 | % | 5.7 | % | |||
General business tax credits | (1.7 | )% | (2.1 | )% | (2.1 | )% | |||
Electric vehicle credits | (0.7 | )% | (3.0 | )% | (2.7 | )% | |||
Basis in SC | 3.0 | % | 3.4 | % | 3.1 | % | |||
Uncertain tax position reserve | (0.3 | )% | (0.4 | )% | 3.3 | % | |||
Tax reform | — | % | (53.3 | )% | — | % | |||
Other | (1.0 | )% | 2.0 | % | (0.7 | )% | |||
Effective tax rate | 30.1 | % | (19.6 | )% | 32.9 | % | |||
160
NOTE 15. INCOME TAXES (continued)
Deferred Tax Assets and Liabilities
The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are presented below:
At December 31, | ||||||||
(in thousands) | 2018 | 2017 | ||||||
Deferred tax assets: | ||||||||
ALLL | $ | 208,507 | $ | 214,873 | ||||
Internal Revenue Code ("IRC") Section 475 mark to market adjustment | 296,145 | 520,256 | ||||||
Unrealized loss on available-for-sale securities | 76,915 | 57,325 | ||||||
Unrealized loss on derivatives | 11,340 | 13,217 | ||||||
Held to maturity | 5,901 | — | ||||||
Capital loss carryforwards | 22,661 | 28,873 | ||||||
Net operating loss carryforwards | 1,836,767 | 921,498 | ||||||
Non-solicitation payments | 87 | 237 | ||||||
Employee benefits | 98,735 | 112,206 | ||||||
General business credit & other tax credit carryforwards | 670,502 | 627,969 | ||||||
Broker commissions paid on originated mortgage loans | 11,073 | 11,179 | ||||||
Minimum tax credit carryforwards | 87,822 | 164,661 | ||||||
Recourse reserves | 5,346 | 5,143 | ||||||
Deferred interest expense | 66,146 | 55,552 | ||||||
Depreciation and amortization | 111,438 | — | ||||||
Other | 153,370 | 120,450 | ||||||
Total gross deferred tax assets | 3,662,755 | 2,853,439 | ||||||
Valuation allowance | (300,584 | ) | (235,920 | ) | ||||
Total deferred tax assets | 3,362,171 | 2,617,519 | ||||||
Deferred tax liabilities: | ||||||||
Purchase accounting adjustments | 81,151 | 82,217 | ||||||
Deferred income | 38,448 | 20,562 | ||||||
Originated MSR | 42,625 | 38,775 | ||||||
Change in Control deferred gain | 375,573 | 345,014 | ||||||
Leasing transactions | 3,270,042 | 2,076,602 | ||||||
Depreciation and amortization | — | 122,417 | ||||||
Other | 141,782 | 125,570 | ||||||
Total gross deferred tax liabilities | 3,949,621 | 2,811,157 | ||||||
Net deferred tax (liability) | $ | (587,450 | ) | $ | (193,638 | ) | ||
The IRC Section 475 mark-to-market adjustment deferred tax asset is related to SC's business as a dealer, which is required to be recognized under IRC Section 475 for net gains that have been recognized for tax purposes on loans that are required to be marked to market for tax purposes but not book purposes. The leasing transactions deferred tax liability is primarily related to accelerated tax depreciation on leasing transactions. The Change in Control deferred gain is the book over tax basis difference in the Company's investment in SC. The deferred tax liability would be realized upon the Company's disposition of its interest in SC or through dividends received from SC.
Periodic reviews of the carrying amount of deferred tax assets are made to determine if the establishment of a valuation allowance is necessary. If, based on the available evidence in future periods, it is more likely than not that all or a portion of the Company’s deferred tax assets will not be realized, a deferred tax valuation allowance would be established. Consideration is given to all positive and negative evidence related to the realization of the deferred tax assets.
161
NOTE 15. INCOME TAXES (continued)
Items considered in this evaluation include historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, the length of statutory carryforward periods, experience with operating loss and tax credit carryforwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. The Company's evaluation is based on current tax laws, as well as its expectations of future performance. As of December 31, 2018, the Company maintained a valuation allowance of $300.6 million, compared to$235.9 million as of December 31, 2017, related to deferred tax assets subject to carryforward periods for which the Company has determined it is more likely than not that these deferred tax assets will remain unused after the carryforward periods have expired. The $64.7 million increase year-over-year was primarily driven by increased losses of subsidiaries in Puerto Rico for which the related deferred tax assets are not expected to be realized in future periods.
The deferred tax asset realization analysis is updated at each year-end using the most recent forecasts. An assessment is made quarterly as to whether the forecasts and assumptions used in the deferred tax asset realization analysis should be revised in light of any changes that have occurred or are expected to occur that would significantly impact the forecasts or modeling assumptions. At December 31, 2018, the Company has recorded the following:
(in thousands) | Gross Deferred Tax Balance | Valuation Allowance | Final Expiration Year (1) | |||||||
Net operating loss carryforwards | $ | 1,712,321 | $ | 131,332 | 2037 | |||||
State net operating loss carryforwards | 124,446 | 5,841 | 2038 | |||||||
General business credit carryforward | 670,502 | 78,427 | 2038 | |||||||
Minimum tax credit carryforward | 87,822 | 4,723 | N/A | |||||||
Capital loss carryforward | 22,661 | 22,661 | 2023 | |||||||
Deferred tax timing differences | — | 57,600 | N/A | |||||||
Total | $ | 2,617,752 | $ | 300,584 | ||||||
(1) These will expire in varying amounts through the final expiration year.
As of December 31, 2018, the Company’s intention to permanently reinvest unremitted earnings of certain foreign subsidiaries (with the exception of one subsidiary) in accordance with ASC 740-30 (formerly Accounting Principles Board Opinion No. 23) remains unchanged. This will continue to be evaluated as the Company’s business needs and requirements evolve. While the TCJA includes a transition tax which amounts to a deemed repatriation of foreign earnings and a one-time inclusion of these earnings in U.S. taxable income, there could be additional costs of actual repatriation of the foreign earnings, such as state taxes and foreign withholding taxes, which are inherently difficult to quantify. With respect to the subsidiary for which the Company did make a decision to no longer permanently reinvest its unremitted earnings, a $25.1 million liability was recorded for the year ended December 31, 2017 to reflect the applicable transition tax. This liability remained unchanged at December 31, 2018.
The TCJA also requires a U.S. shareholder of a controlled foreign corporation ("CFC") to include in income, as a deemed dividend, the global intangible low-taxed income ("GILTI") of the CFC. This provision is effective for taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of United States shareholders in which or with which such taxable years of foreign corporations end. The Company has elected to treat taxes due on future U.S. inclusions in taxable income under the GILTI provision as a current period expense when incurred. An immaterial GILTI liability was incurred for 2018.
The Company has not provided deferred income taxes of $28.7 million on approximately $112.1 million of the Bank's existing pre-1988 tax bad debt reserve at December 31, 2018, due to the indefinite nature of the recapture provisions. Certain rules under section 593 of the IRC govern when the Company may be subject to tax on the recapture of the existing base year tax bad debt reserve, such as distributions by the Bank in excess of certain earnings and profits, the redemption of the Bank’s stock, or a liquidation. The Company does not expect any of those events to occur.
162
NOTE 15. INCOME TAXES (continued)
Changes in Liability Related to Uncertain Tax Positions
At December 31, 2018, the Company had reserves related to tax benefits from uncertain tax positions of $81.6 million. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
(in thousands) | Unrecognized Tax Benefits | Accrued Interest and Penalties | Total | |||||||||
Gross unrecognized tax benefits at January 1, 2016 | $ | 259,863 | $ | 26,259 | $ | 286,122 | ||||||
Additions based on tax positions related to 2016 | 17,323 | 1,505 | 18,828 | |||||||||
Additions for tax positions of prior years | 4,644 | 37,508 | 42,152 | |||||||||
Reductions for tax positions of prior years | (218,994 | ) | (18,828 | ) | (237,822 | ) | ||||||
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations | (4,194 | ) | (43 | ) | (4,237 | ) | ||||||
Settlements | (2,886 | ) | (3,028 | ) | (5,914 | ) | ||||||
Gross unrecognized tax benefits at December 31, 2016 | 55,756 | 43,373 | 99,129 | |||||||||
Additions based on tax positions related to 2017 | 987 | — | 987 | |||||||||
Additions for tax positions of prior years | 2,728 | 1,877 | 4,605 | |||||||||
Reductions for tax positions of prior years | (784 | ) | (1,926 | ) | (2,710 | ) | ||||||
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations | (9,999 | ) | (1,526 | ) | (11,525 | ) | ||||||
Gross unrecognized tax benefits at December 31, 2017 | 48,688 | 41,798 | 90,486 | |||||||||
Additions based on tax positions related to the current year | 1,005 | — | 1,005 | |||||||||
Additions for tax positions of prior years | 2,030 | 1,527 | 3,557 | |||||||||
Reductions for tax positions of prior years | (1,545 | ) | (65 | ) | (1,610 | ) | ||||||
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations | (4,813 | ) | (764 | ) | (5,577 | ) | ||||||
Settlements | (62 | ) | (29 | ) | (91 | ) | ||||||
Gross unrecognized tax benefits at December 31, 2018 | $ | 45,303 | $ | 42,467 | $ | 87,770 | ||||||
Gross net unrecognized tax benefits that if recognized would impact the effective tax rate at December 31, 2018 | $ | 45,303 | $ | 42,467 | ||||||||
Less: Federal, state and local income tax benefits | (6,171 | ) | ||||||||||
Net unrecognized tax benefit reserves | $ | 81,599 | ||||||||||
Tax positions will initially be recognized in the financial statements when it is more likely than not that the position will be sustained upon examination by the tax authorities. Such tax positions are initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts. The Company is subject to the income tax laws of the U.S., its states and municipalities and certain foreign countries. These tax laws are complex and are potentially subject to different interpretations by the taxpayer and relevant governmental taxing authorities. In establishing an income tax provision, the Company must make judgments and interpretations about the application of these inherently complex tax laws. The Company recognizes penalties and interest accrued related to unrecognized tax benefits within Income tax provision on the Consolidated Statements of Operations.
The Company filed a lawsuit against the United States in 2009 in Federal District Court in Massachusetts relating to the proper tax consequences of two financing transactions with an international bank through which the Company borrowed $1.2 billion. As a result of these financing transactions, the Company paid foreign taxes of $264.0 million during the years 2003 through 2007 and claimed a corresponding foreign tax credit for foreign taxes paid during those years, which the Internal Revenue Service ("IRS") disallowed. The IRS also disallowed the Company's deductions for interest expense and transaction costs, totaling $74.6 million in tax liability, and assessed penalties and interest totaling approximately $92.5 million. The Company has paid the taxes, penalties and interest associated with the IRS adjustments for all tax years, and the lawsuit will determine whether the Company is entitled to a refund of the amounts paid.
163
NOTE 15. INCOME TAXES (continued)
In November 2015, the Federal District Court granted the Company’s motions for summary judgment and later ordered amounts assessed by the IRS for the years 2003 through 2005 to be refunded to the Company. The IRS appealed that judgment and the U.S. Court of Appeals for the First Circuit partially reversed the judgment of the Federal District Court, finding that the Company is not entitled to claim the foreign tax credits it claimed but will be allowed to exclude from income $132.0 million (representing half of the U.K. taxes the Company paid) and will be allowed to claim the interest expense deductions. The case has been remanded to the Federal District Court for further proceedings to determine, among other issues, whether penalties should be sustained. On remand, the Company moved for summary judgment on two issues. On July 17, 2018, those motions were denied by the Court.
In response to the First Circuit's decision, the Company, at December 31, 2016, used its previously established $230.1 million tax reserve to write off deferred tax assets and a portion of the receivable that would not be realized under the Court's decision. Additionally, the Company established a $36.8 million tax reserve in relation to items that have not yet been determined by the courts, including potential penalties. The Company anticipates the matter will be finally resolved with no effect on net income.
With few exceptions, the Company is no longer subject to federal, state and non-U.S. income tax examinations by tax authorities for years prior to 2006.
The Company applies an aggregate portfolio approach whereby income tax effects from accumulated OCI are released only when an entire portfolio (i.e. all related units of account) of a particular type is liquidated, sold or extinguished.
NOTE 16. FAIR VALUE
General
A portion of the Company’s assets and liabilities are carried at fair value, including AFS investment securities and derivative instruments. In addition, the Company elects to account for its residential mortgages HFS and a portion of its MSRs at fair value. Fair value is also used on a nonrecurring basis to evaluate certain assets for impairment or for disclosure purposes. Examples of nonrecurring uses of fair value include impairments for certain loans and foreclosed assets.
Fair value measurement requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs and also establishes a fair value hierarchy that categorizes the inputs to valuation techniques used to measure fair value into three levels as follows:
•Level 1 inputs are quoted prices in active markets for identical assets or liabilities that can be accessed as of the measurement date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
•Level 2 inputs are those other than quoted prices included in Level 1 that are observable for the assets or liabilities, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
•Level 3 inputs are those that are unobservable or not readily observable for the asset or liability and are used to measure fair value to the extent relevant observable inputs are not available.
Assets and liabilities measured at fair value, by their nature, result in a higher degree of financial statement volatility. When available, the Company uses quoted market prices or matrix pricing in active markets to determine fair value and classifies such items as Level 1 or Level 2 assets or liabilities. If quoted market prices in active markets are not available, fair value is determined using third-party broker quotes and/or DCF models incorporating various assumptions including interest rates, prepayment speeds and credit losses. Assets and liabilities valued using broker quotes and/or DCF models are classified as either Level 2 or Level 3, depending on the lowest level classification of an input that is considered significant to the overall valuation.
The Company values assets and liabilities based on the principal market in which each would be sold (in the case of assets) or transferred (in the case of liabilities). The principal market is the forum with the greatest volume and level of activity. In the absence of a principal market, the valuation is based on the most advantageous market. In the absence of observable market transactions, the Company considers liquidity valuation adjustments to reflect the uncertainty in pricing the instruments. The fair value of a financial asset is measured on a stand-alone basis and cannot be measured as a group, with the exception of certain financial instruments held and managed on a net portfolio basis. In measuring the fair value of a nonfinancial asset, the Company assumes the highest and best use of the asset by a market participant, not just the intended use, to maximize the value of the asset. The Company also considers whether any credit valuation adjustments are necessary based on the counterparty's credit quality.
164
NOTE 16. FAIR VALUE (continued)
Any models used to determine fair values or validate dealer quotes based on the descriptions below are subject to review and testing as part of the Company's model validation and internal control testing processes.
The Bank's Market Risk Department is responsible for determining and approving the fair values of all assets and liabilities valued at fair value, including the Company's Level 3 assets and liabilities. Price validation procedures are performed and the results are reviewed for Level 3 assets and liabilities by the Market Risk Department. Price validation procedures performed for these assets and liabilities can include comparing current prices to historical pricing trends by collateral type and vintage, comparing prices by product type to indicative pricing grids published by market makers, and obtaining corroborating dealer prices for significant securities.
The Company reviews the assumptions utilized to determine fair value on a quarterly basis. Any changes in methodologies or significant inputs used in determining fair values are further reviewed to determine if a change in fair value level hierarchy has occurred. Transfers in and out of Levels 1, 2 and 3 are considered to be effective as of the end of the quarter in which they occur.
There were no material transfers between Levels 1, 2 or 3 during the years ended December 31, 2018 or 2017 for any assets or liabilities valued at fair value on a recurring basis.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables present the assets and liabilities that are measured at fair value on a recurring basis by major product category and fair value hierarchy as of December 31, 2018 and December 31, 2017.
(in thousands) | Level 1 | Level 2 | Level 3 | Balance at December 31, 2018 | Level 1 | Level 2 | Level 3 | Balance at December 31, 2017 | ||||||||||||||||||||||||
Financial assets: | ||||||||||||||||||||||||||||||||
U.S. Treasury securities | $ | 526,364 | $ | 1,278,381 | $ | — | $ | 1,804,745 | $ | 139,615 | $ | 858,497 | $ | — | $ | 998,112 | ||||||||||||||||
Corporate debt | — | 160,114 | — | 160,114 | — | 11,660 | — | 11,660 | ||||||||||||||||||||||||
ABS | — | 109,638 | 327,199 | 436,837 | — | 156,910 | 350,252 | 507,162 | ||||||||||||||||||||||||
State and municipal securities | — | 16 | — | 16 | — | 23 | — | 23 | ||||||||||||||||||||||||
MBS | — | 9,231,275 | — | 9,231,275 | — | 12,885,412 | — | 12,885,412 | ||||||||||||||||||||||||
Investment in debt securities AFS(3)(6) | 526,364 | 10,779,424 | 327,199 | 11,632,987 | 139,615 | 13,912,502 | 350,252 | 14,402,369 | ||||||||||||||||||||||||
Other investments - trading securities | 4 | 6 | — | 10 | 1 | — | — | 1 | ||||||||||||||||||||||||
RICs HFI(4) | — | — | 126,312 | 126,312 | — | — | 186,471 | 186,471 | ||||||||||||||||||||||||
LHFS (1)(5) | — | 209,506 | — | 209,506 | — | 197,691 | — | 197,691 | ||||||||||||||||||||||||
MSRs (2) | — | — | 149,660 | 149,660 | — | — | 145,993 | 145,993 | ||||||||||||||||||||||||
Other assets - derivatives (3) | — | 515,781 | 2,704 | 518,485 | — | 461,139 | 2,105 | 463,244 | ||||||||||||||||||||||||
Total financial assets (7) | $ | 526,368 | $ | 11,504,717 | $ | 605,875 | $ | 12,636,960 | $ | 139,616 | $ | 14,571,332 | $ | 684,821 | $ | 15,395,769 | ||||||||||||||||
Financial liabilities: | ||||||||||||||||||||||||||||||||
Other liabilities - derivatives (3) | — | 496,593 | 838 | 497,431 | — | 427,217 | 594 | 427,811 | ||||||||||||||||||||||||
Total financial liabilities | $ | — | $ | 496,593 | $ | 838 | $ | 497,431 | $ | — | $ | 427,217 | $ | 594 | $ | 427,811 | ||||||||||||||||
(1) | LHFS disclosed on the Consolidated Balance Sheets also includes LHFS that are held at the lower of cost or fair value and are not presented within this table. |
(2) | The Company has total MSRs of $152.1 million and $149.2 million as of December 31, 2018.and December 31, 2017, respectively. The Company has elected to account for the majority of its MSR balance using the FVO, while the remainder of the MSRs are accounted for using the lower of cost or fair value and are not presented within this table. |
(3) | Refer to Note 3 for the fair value of investment securities and to Note 14 for the fair values of derivative assets and liabilities, on a further disaggregated basis. |
(4) RICs collateralized by vehicle titles at SC and RV/marine loans at SBNA.
(5) Residential mortgage loans.
(6) Investment in debt securities AFS disclosed on the Consolidated Balance Sheets at December 31, 2017 included $10.8 million of equity securities valued using the net asset value as a practical expedient that are not presented within this table.
(7) Approximately $605.9 million of these financial assets were measured using model-based techniques, or Level 3 inputs, and represented approximately 4.8% of total assets measured at fair value on a recurring basis and approximately 0.4% of total consolidated assets.
165
NOTE 16. FAIR VALUE (continued)
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The Company may be required to measure certain assets and liabilities at fair value on a nonrecurring basis in accordance with GAAP from time to time. These adjustments to fair value usually result from application of lower-of-cost-or-fair value accounting or certain impairment measures. Assets measured at fair value on a nonrecurring basis that were still held on the balance sheet were as follows:
(in thousands) | Level 1 | Level 2 | Level 3 | Balance at December 31, 2018 | Level 1 | Level 2 | Level 3 | Balance at December 31, 2017 | ||||||||||||||||||||||||
Impaired commercial LHFI | $ | 5,182 | $ | 150,208 | $ | 219,258 | $ | 374,648 | $ | — | $ | 226,832 | $ | 356,343 | $ | 583,175 | ||||||||||||||||
Foreclosed assets | — | 16,678 | 81,208 | 97,886 | — | 20,011 | 106,581 | 126,592 | ||||||||||||||||||||||||
Vehicle inventory | — | 342,617 | — | 342,617 | — | 325,203 | — | 325,203 | ||||||||||||||||||||||||
LHFS(1) | — | — | 1,073,795 | 1,073,795 | — | — | 2,324,830 | 2,324,830 | ||||||||||||||||||||||||
Auto loans impaired due to bankruptcy | — | 189,114 | — | 189,114 | — | 121,578 | — | 121,578 | ||||||||||||||||||||||||
MSRs | — | — | 9,386 | 9,386 | — | — | 9,273 | 9,273 | ||||||||||||||||||||||||
(1) | These amounts include $1.1 billion and $1.1 billion of personal LHFS that were impaired as of December 31, 2018 and December 31, 2017, respectively. |
Valuation Processes and Techniques
Impaired commercial LHFI in the table above represents the recorded investment of impaired commercial loans for which the Company measures impairment during the period based on the fair value of the underlying collateral supporting the loan. Written offers to purchase a specific impaired loan are considered observable market inputs, which are considered Level 1 inputs. Appraisals are obtained to support the fair value of the collateral and incorporate measures such as recent sales prices for comparable properties and are considered Level 2 inputs. Loans for which the value of the underlying collateral is determined using a combination of real estate appraisals, field examinations and internal calculations are classified as Level 3. The inputs in the internal calculations may include the loan balance, estimation of the collectability of the underlying receivables held by the customer used as collateral, sale and liquidation value of the inventory held by the customer used as collateral and historical loss-given-default parameters. In cases in which the carrying value exceeds the fair value of the collateral less cost to sell, an impairment charge is recognized. The net carrying value of these loans was $479.4 million and $491.5 million at December 31, 2018 and December 31, 2017, respectively. Loans previously impaired which were not marked to fair value during the periods presented are excluded from this table.
Foreclosed assets represent the recorded investment in assets taken during the period presented in foreclosure of defaulted loans, and are primarily comprised of commercial and residential real properties and generally measured at fair value less costs to sell. The fair value of the real property is generally determined using appraisals or other indications of market value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace.
The Company estimates the fair value of its vehicles, which are obtained either through repossession or lease termination, using historical auction rates and current market values of used cars.
The Company's LHFS portfolios that are measured at fair value on a nonrecurring basis primarily consist of personal, commercial, and RICs LHFS. The estimated fair value of these LHFS is calculated based on a combination of estimated market rates for similar loans with similar credit risks and a DCF analysis in which the Company uses significant unobservable inputs on key assumptions, including historical default rates and adjustments to reflect voluntary prepayments, prepayment rates, discount rates reflective of the cost of funding, and credit loss expectations. The lower of cost or fair value adjustment for personal LHFS includes customer default activity and adjustments related to the net change in the portfolio balance during the reporting period.
For loans that are considered collateral-dependent, such as certain bankruptcy loans, impairment is measured based on the fair value of the collateral less its estimated cost to sell. For the underlying collateral, the estimated fair value is obtained using historical auction rates and current market levels of used car prices.
166
NOTE 16. FAIR VALUE (continued)
Fair Value Adjustments
The following table presents the increases and decreases in value of certain assets that are measured at fair value on a nonrecurring basis for which a fair value adjustment has been included in the Consolidated Statements of Operations relating to assets held at period-end:
Year Ended December 31, | |||||||||||||
(in thousands) | Statement of Operations Location | 2018 | 2017 | 2016 | |||||||||
Impaired LHFI | Provision for credit losses | $ | (58,818 | ) | $ | (73,925 | ) | $ | (99,082 | ) | |||
Foreclosed assets | Miscellaneous income, net (1) | (12,137 | ) | (13,505 | ) | (8,339 | ) | ||||||
LHFS | Provision for credit losses | (387 | ) | (3,700 | ) | — | |||||||
LHFS | Miscellaneous income, net (1) | (382,298 | ) | (386,422 | ) | (424,121 | ) | ||||||
Auto loans impaired due to bankruptcy | Provision for credit losses | (93,277 | ) | (75,194 | ) | — | |||||||
Goodwill impairment | Impairment of goodwill | — | (10,536 | ) | — | ||||||||
MSRs | Miscellaneous income, net (1) | (743 | ) | (549 | ) | 503 | |||||||
(1) | Gains are disclosed as positive numbers while losses are shown as a negative number regardless of the line item being affected. |
Level 3 Rollforward for Assets and Liabilities Measured at Fair Value on a Recurring Basis
The tables below present the changes in Level 3 balances for the years ended December 31, 2018 and 2017, respectively, for those assets and liabilities measured at fair value on a recurring basis.
Year Ended December 31, 2018 | Year Ended December 31, 2017 | |||||||||||||||||||||||||||||||||||||||
(in thousands) | Investments AFS | RICs HFI | MSRs | Derivatives, net | Total | Investments AFS | RICs HFI | MSRs | Derivatives, net | Total | ||||||||||||||||||||||||||||||
Balances, beginning of period | $ | 350,252 | $ | 186,471 | $ | 145,993 | $ | 1,514 | $ | 684,230 | $ | 814,567 | $ | 217,170 | $ | 146,589 | $ | (29,000 | ) | $ | 1,149,326 | |||||||||||||||||||
Losses in OCI | (3,323 | ) | — | — | — | (3,323 | ) | (9,570 | ) | — | — | — | (9,570 | ) | ||||||||||||||||||||||||||
Gains/(losses) in earnings | — | 17,018 | 7,906 | (1,324 | ) | 23,600 | — | 54,363 | 1,967 | (1,002 | ) | 55,328 | ||||||||||||||||||||||||||||
Additions/Issuances | — | 6,631 | 12,778 | — | 19,409 | — | 21,671 | 15,788 | — | 37,459 | ||||||||||||||||||||||||||||||
Settlements(1) | (19,730 | ) | (83,808 | ) | (17,017 | ) | 1,676 | (118,879 | ) | (454,745 | ) | (106,733 | ) | (18,351 | ) | 31,516 | (548,313 | ) | ||||||||||||||||||||||
Balances, end of period | $ | 327,199 | $ | 126,312 | $ | 149,660 | $ | 1,866 | $ | 605,037 | $ | 350,252 | $ | 186,471 | $ | 145,993 | $ | 1,514 | $ | 684,230 | ||||||||||||||||||||
Changes in unrealized gains (losses) included in earnings related to balances still held at end of period | $ | — | $ | 17,018 | $ | 7,906 | $ | (1,896 | ) | $ | 23,028 | $ | — | $ | 54,363 | $ | 1,967 | $ | (791 | ) | $ | 55,539 | ||||||||||||||||||
(1) | Settlements include charge-offs, prepayments, paydowns and maturities. |
The gains in earnings reported in the table above related to the RICs HFI for which the Company elected the FVO are driven by three primary factors: 1) the recognition of interest income, 2) recoveries of previously charged-off RICs, and 3) actual performance of the portfolio since the Change in Control. Recoveries from RICs that were charged off at the Change in Control date are a direct increase to the gain recognized within the portfolio. In accordance with ASC 805, Business Combinations, the Company did not ascribe a fair value to the portfolio of sub-prime charged-off RICs at the Change in Control date. Recoveries of previously charged off loans are usually recorded as a reduction to charge-offs in the period in which the recovery is made; however, in instances where the FVO is elected, it will flow through the fair value mark. At the Change in Control date, the UPB of the previously charged-off RIC portfolio was approximately $3.0 billion.
Valuation Processes and Techniques - Recurring Fair Value Assets and Liabilities
The following is a description of the valuation techniques used for instruments measured at fair value on a recurring basis:
Debt Securities Classified as AFS and Trading Securities
Debt securities accounted for at fair value include both the AFS and trading securities portfolios. The Company utilizes a third-party pricing service to value its investment securities portfolios on a global basis. Its primary pricing service has consistently proved to be a high quality third-party pricing provider. For those investments not valued by pricing vendors, other trusted market sources are utilized. The Company monitors and validates the reliability of vendor pricing on an ongoing basis, which can include pricing methodology reviews, performing detailed reviews of the assumptions and inputs used by the vendor to price individual securities, and price validation testing. Price validation testing is performed independently of the risk-taking function and can include corroborating the prices received from third-party vendors with prices from another third-party source, reviewing valuations of comparable instruments, comparison to internal valuations, or by reference to recent sales of similar securities.
167
NOTE 16. FAIR VALUE (continued)
The classification of securities within the fair value hierarchy is based upon the activity level in the market for the security type and the observability of the inputs used to determine their fair values. Trading securities and certain of the Company's U.S. Treasury securities are valued utilizing observable market quotes. The Company obtains vendor trading platform data (actual prices) from a number of live data sources, including active market makers and interdealer brokers. These certain investment securities are, therefore, classified as Level 1.
Actively traded quoted market prices for the majority of the debt securities AFS, such as U.S. Treasury and government agency securities, corporate debt, state and municipal securities, and MBS, are not readily available. The Company's principal markets for its investment securities are the secondary institutional markets with an exit price that is predominantly reflective of bid-level pricing in these markets. These investment securities are priced by third-party pricing vendors. The third-party vendors use a variety of methods when pricing these securities that incorporate relevant observable market data to arrive at an estimate of what a buyer in the marketplace would pay for a security under current market conditions. These investment securities are, therefore, considered Level 2.
Certain ABS are valued using DCF models. The DCF models are obtained from a third-party pricing vendor who uses observable market data and therefore are classified as Level 2. Other ABS that could not be valued using a third-party pricing service are valued using an internally-developed DCF model. When estimating the fair value using this model, the Company uses its best estimate of the key assumptions, which include the discount rates and forward yield curves. The Company uses comparable bond indices based on industry, term, and rating to discount the expected future cash flows. Determining the comparability of assets involves significant subjectivity related to asset type differences, cash flows, performance and other inputs. The inability of the Company to corroborate the fair value of the ABS due to the limited available observable data on these ABS resulted in a fair value classification of Level 3.
Realized gains and losses on investments in debt securities are recognized in the Consolidated Statements of Operations through Net (losses)/gains on sale of investment securities.
RICs HFI
For certain RICs HFI, the Company has elected the FVO. The fair values of RICs are estimated using the DCF model. In estimating the fair value using this model, the Company uses significant unobservable inputs on key assumptions, which includes historical default rates and adjustments to reflect voluntary prepayments, prepayment rates based on available data from a comparable market securitization of similar assets, discount rates reflective of the cost of funding debt issuances and recent historical equity yields, recovery rates based on the average severity utilizing reported severity rates and loss severity utilizing available market data from a comparable securitized pool. Accordingly, RICs HFI for which the Company has elected the FVO are classified as Level 3.
LHFS
The Company's LHFS portfolios that are measured at fair value on a recurring basis consist primarily of residential mortgage LHFS. The fair values of LHFS are estimated using published forward agency prices to agency buyers such as FNMA and FHLMC. The majority of the residential mortgage LHFS portfolio is sold to these two agencies. The fair value is determined using current secondary market prices for portfolios with similar characteristics, adjusted for servicing values and market conditions.
These loans are regularly traded in active markets, and observable pricing information is available from market participants. The prices are adjusted as necessary to include the embedded servicing value in the loans as well as the specific characteristics of certain loans that are priced based on the pricing of similar loans. These adjustments represent unobservable inputs to the valuation, and are not significant given the relative insensitivity of the value to changes in these inputs to the fair value of the loans. Accordingly, residential mortgage LHFS are classified as Level 2. Gains and losses on residential mortgage LHFS are recognized in the Consolidated Statements of Operations through Miscellaneous income, net. See further discussion below in the section captioned "FVO for Financial Assets and Financial Liabilities."
168
NOTE 16. FAIR VALUE (continued)
MSRs
The model to value MSRs estimates the present value of the future net cash flows from mortgage servicing activities based on various assumptions. These cash flows include servicing and ancillary revenue, offset by the estimated costs of performing servicing activities. Significant assumptions used in the valuation of residential MSRs include changes in anticipated loan prepayment rates ("CPRs") and the discount rate, reflective of a market participant's required return on an investment for similar assets. Other important valuation assumptions include market-based servicing costs and the anticipated earnings on escrow and similar balances held by the Company in the normal course of mortgage servicing activities. All of these assumptions are considered to be unobservable inputs. Historically, servicing costs and discount rates have been less volatile than CPR and earnings rates, both of which are directly correlated with changes in market interest rates. Increases in prepayment speeds, discount rates and servicing costs result in lower valuations of MSRs. Decreases in the anticipated earnings rate on escrow and similar balances result in lower valuations of MSRs. For each of these items, the Company makes assumptions based on current market information and future expectations. All of the assumptions are based on standards that the Company believes would be utilized by market participants in valuing MSRs and are derived and/or benchmarked against independent public sources. Accordingly, MSRs are classified as Level 3. Gains and losses on MSRs are recognized on the Consolidated Statements of Operations through Miscellaneous income, net.
Listed below are the most significant inputs that are utilized by the Company in the evaluation of residential MSRs:
• | A 10% and 20% increase in the CPR speed would decrease the fair value of the residential servicing asset by $5.1 million and $9.9 million, respectively, at December 31, 2018. |
• | A 10% and 20% increase in the discount rate would decrease the fair value of the residential servicing asset by $5.4 million and $10.5 million, respectively, at December 31, 2018. |
Significant increases/(decreases) in any of those inputs in isolation would result in significantly (lower)/higher fair value measurements, respectively. These sensitivity calculations are hypothetical and should not be considered to be predictive of future performance. Changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of an adverse variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumption, while in reality changes in one factor may result in changes in another, which may either magnify or counteract the effect of the change. Prepayment estimates generally increase when market interest rates decline and decrease when market interest rates rise. Discount rates typically increase when market interest rates increase and/or credit and liquidity risks increase, and decrease when market interest rates decline and/or credit and liquidity conditions improve.
Derivatives
The valuation of these instruments is determined using commonly accepted valuation techniques, including DCF analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable and unobservable market-based inputs. The fair value represents the estimated amount the Company would receive or pay to terminate the contract or agreement, taking into account current interest rates, foreign exchange rates, equity prices and, when appropriate, the current creditworthiness of the counterparties.
The Company incorporates credit valuation adjustments in the fair value measurement of its derivatives to reflect the counterparty's nonperformance risk in the fair value measurement of its derivatives, except for those derivative contracts with associated credit support annexes which provide credit enhancements, such as collateral postings and guarantees.
The Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy. Certain of the Company's derivatives utilize Level 3 inputs, which are primarily related to mortgage banking derivatives-interest rate lock commitments and total return settlement derivative contracts.
The DCF model is utilized to determine the fair value of the mortgage banking derivatives-interest rate lock commitments and the total return settlement derivative contracts. The significant unobservable inputs for mortgage banking derivatives used in the fair value measurement of the Company's loan commitments are "pull through" percentage and the MSR value that is inherent in the underlying loan value. The pull through percentage is an estimate of loan commitments that will result in closed loans. The significant unobservable inputs for total return settlement derivative contracts used in the fair value measurement of the Company's liabilities are discount percentages, which are based on comparable financial instruments. Significant increases (decreases) in any of these inputs in isolation would result in significantly higher (lower) fair value measurements. Significant increases (decreases) in the fair value of a mortgage banking derivative asset (liability) results when the probability of funding increases (decreases). Significant increases (decreases) in the fair value of a mortgage loan commitment result when the embedded servicing value increases (decreases).
169
NOTE 16. FAIR VALUE (continued)
Gains and losses related to derivatives affect various line items in the Consolidated Statements of Operations. See Note 14 for a discussion of derivatives activity.
Level 3 Inputs - Significant Recurring and Nonrecurring Fair Value Assets and Liabilities
The following table presents quantitative information about the significant unobservable inputs within significant Level 3 recurring and nonrecurring assets and liabilities at December 31, 2018 and December 31, 2017, respectively:
(dollars in thousands) | Fair Value at December 31, 2018 | Valuation Technique | Unobservable Inputs | Range (Weighted Average) | |||||||
Financial Assets: | |||||||||||
ABS | |||||||||||
Financing bonds | $ | 303,224 | DCF | Discount Rate (1) | 2.68% - 2.73% (2.69%) | ||||||
Sale-leaseback securities | 23,975 | Consensus Pricing (2) | Offered quotes (3) | 110.28 | % | ||||||
RICs HFI | 126,312 | DCF | CPR (4) | 6.66 | % | ||||||
Discount Rate (5) | 9.50% - 14.50% (12.55%) | ||||||||||
Recovery Rate (6) | 25.00% - 43.00% (41.6%) | ||||||||||
Personal LHFS (10) | 1,068,757 | Lower of Market or Income Approach | Market Participant View | 70.00% - 80.00% | |||||||
Discount Rate | 15.00% - 25.00% | ||||||||||
Default Rate | 30.00% - 40.00% | ||||||||||
Net Principal & Interest Payment Rate | 70.00% - 85.00% | ||||||||||
Loss Severity Rate | 90.00% - 95.00% | ||||||||||
MSRs (9) | 149,660 | DCF | CPR (7) | 7.06% - 100.00% (9.22%) | |||||||
Discount Rate (8) | 9.71 | % | |||||||||
(1) | Based on the applicable term and discount index. |
(2) | Consensus pricing refers to fair value estimates that are generally developed using information such as dealer quotes or other third-party valuations or comparable asset prices. |
(3) | Based on the nature of the input, a range or weighted average does not exist. For sale-leaseback securities, the Company owns one security. |
(4) | Based on the analysis of available data from a comparable market securitization of similar assets. |
(5) | Based on the cost of funding of debt issuance and recent historical equity yields. |
(6) | Based on the average severity utilizing reported severity rates and loss severity utilizing available market data from a comparable securitized pool. |
(7) | Average CPR projected from collateral stratified by loan type and note rate. |
(8) | Average discount rate from collateral stratified by loan type and note rate. |
(9) | Excludes MSR valued on a non-recurring basis for which we do not consider there to be significant unobservable assumptions. |
(10) | Excludes non-significant level 3 LHFS portfolios. |
(dollars in thousands) | Fair Value at December 31, 2017 | Valuation Technique | Unobservable Inputs | Range (Weighted Average) | ||||||
Financial Assets: | ||||||||||
ABS | ||||||||||
Financing bonds | $ | 304,727 | DCF | Discount Rate (1) | 2.16% - 2.90% (2.28%) | |||||
Sale-leaseback securities | $ | 45,525 | Consensus Pricing (2) | Offered Quotes (3) | 120.19 | % | ||||
RICs HFI | $ | 186,471 | DCF | CPR (4) | 6.66 | % | ||||
Discount Rate (5) | 9.50% - 14.50% (12.37%) | |||||||||
Recovery Rate (6) | 25.00% - 43.00% (41.51%) | |||||||||
Personal LHFS (10) | $ | 1,062,090 | Lower of Market or Income Approach | Market Participant View | 70.00% - 80.00% | |||||
Discount Rate | 15.00% - 20.00% | |||||||||
Default Rate | 30.00% - 40.00% | |||||||||
Net Principal & Interest Payment Rate | 70.00% - 85.00% | |||||||||
Loss Severity Rate | 90.00% - 95.00% | |||||||||
RICs HFS (10) | $ | 1,101,049 | DCF | Discount Rate | 3.00% - 6.00% | |||||
Default Rate | 3.00% - 4.00% | |||||||||
Prepayment Rate | 15.00% - 20.00% | |||||||||
Loss Severity Rate | 50.00% - 60.00% | |||||||||
MSRs (9) | $ | 145,993 | DCF | CPR (7) | 0.06% - 46.95% (9.80%) | |||||
Discount Rate (8) | 9.90 | % | ||||||||
(1), (2), (3), (4), (5), (6), (7), (8), (9), (10) - See corresponding footnotes to the December 31, 2018 Level 3 Significant Inputs table above.
170
NOTE 16. FAIR VALUE (continued)
Fair Value of Financial Instruments
The carrying amounts and estimated fair values, as well as the level within the fair value hierarchy, of the Company's financial instruments are as follows:
December 31, 2018 | December 31, 2017 | |||||||||||||||||||||||||||||||||||||||
(in thousands) | Carrying Value | Fair Value | Level 1 | Level 2 | Level 3 | Carrying Value | Fair Value | Level 1 | Level 2 | Level 3 | ||||||||||||||||||||||||||||||
Financial assets: | ||||||||||||||||||||||||||||||||||||||||
Cash and cash equivalents | $ | 7,790,593 | $ | 7,790,593 | $ | 7,790,593 | $ | — | $ | — | $ | 6,519,967 | $ | 6,519,967 | $ | 6,519,967 | $ | — | $ | — | ||||||||||||||||||||
Investment in debt securities AFS (2) | 11,632,987 | 11,632,987 | 526,364 | 10,779,424 | 327,199 | 14,402,369 | 14,402,369 | 139,615 | 13,912,502 | 350,252 | ||||||||||||||||||||||||||||||
Investment in debt securities HTM | 2,750,680 | 2,676,049 | — | 2,676,049 | — | 1,799,808 | 1,773,938 | — | 1,773,938 | — | ||||||||||||||||||||||||||||||
Other investments - trading securities | 10 | 10 | 4 | 6 | — | 1 | 1 | 1 | — | — | ||||||||||||||||||||||||||||||
LHFI, net | 83,148,738 | 83,415,697 | 5,182 | 150,208 | 83,260,307 | 76,795,794 | 78,579,144 | — | 136,832 | 78,442,312 | ||||||||||||||||||||||||||||||
LHFS | 1,283,278 | 1,283,301 | — | 209,506 | 1,073,795 | 2,522,486 | 2,522,521 | — | 197,691 | 2,324,830 | ||||||||||||||||||||||||||||||
Restricted cash | 2,931,711 | 2,931,711 | 2,931,711 | — | — | 3,818,807 | 3,818,807 | 3,818,807 | — | — | ||||||||||||||||||||||||||||||
MSRs(1) | 152,121 | 159,046 | — | — | 159,046 | 149,197 | 155,266 | — | — | 155,266 | ||||||||||||||||||||||||||||||
Derivatives | 518,485 | 518,485 | — | 515,781 | 2,704 | 463,244 | 463,244 | — | 461,139 | 2,105 | ||||||||||||||||||||||||||||||
Financial liabilities: | ||||||||||||||||||||||||||||||||||||||||
Deposits | 61,511,380 | 61,456,268 | 54,039,848 | 7,416,420 | — | 60,831,103 | 60,864,110 | 55,456,511 | 5,407,599 | — | ||||||||||||||||||||||||||||||
Borrowings and other debt obligations | 44,953,784 | 45,083,518 | — | 31,494,126 | 13,589,392 | 39,003,313 | 39,335,087 | — | 23,281,166 | 16,053,921 | ||||||||||||||||||||||||||||||
Derivatives | 497,431 | 497,431 | — | 496,593 | 838 | 427,811 | 427,811 | — | 427,217 | 594 | ||||||||||||||||||||||||||||||
(1) | The Company has elected to account for the majority of its MSR balance using the FVO, while the remainder of the MSRs are accounted for using the lower of cost or fair value. |
(2) Investment in debt securities AFS disclosed on the Consolidated Balance Sheets at December 31, 2017 included $10.8 million of equity securities valued using net asset value as a practical expedient that are not presented within this table. The balance of these equity securities at December 31, 2018 was $11.0 million and was included in the Other investments line item on the Consolidated Balance Sheets.
Valuation Processes and Techniques - Financial Instruments
The preceding tables present disclosures about the fair value of the Company's financial instruments. Those fair values for certain instruments are presented based upon subjective estimates of relevant market conditions at a specific point in time and information about each financial instrument. In cases in which quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. These techniques involve uncertainties resulting in variability in estimates affected by changes in assumptions and risks of the financial instruments at a certain point in time. Therefore, the derived fair value estimates presented above for certain instruments cannot be substantiated by comparison to independent markets. In addition, the fair values do not reflect any premium or discount that could result from offering for sale at one time an entity’s entire holding of a particular financial instrument, nor do they reflect potential taxes and the expenses that would be incurred in an actual sale or settlement. Accordingly, the aggregate fair value amounts presented above do not represent the underlying value of the Company.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments not measured at fair value on the Consolidated Balance Sheets:
Cash, cash equivalents and restricted cash
Cash and cash equivalents include cash and due from depository institutions, interest-bearing deposits in other banks, federal funds sold, and securities purchased under agreements to resell. The related fair value measurements have been classified as Level 1, since their carrying value approximates fair value due to the short-term nature of the asset.
Restricted cash is related to cash restricted for investment purposes, cash posted for collateral purposes, cash advanced for loan purchases, and lockbox collections. Cash and cash equivalents, including restricted cash, have maturities of three months or less and, accordingly, the carrying amount of these instruments is deemed to be a reasonable estimate of fair value.
171
NOTE 16. FAIR VALUE (continued)
Held-to-maturity investment securities
Investment securities held to maturity are recorded at amortized cost and are priced by third-party pricing vendors. The third-party vendors use a variety of methods when pricing these securities that incorporate relevant observable market data to arrive at an estimate of what a buyer in the marketplace would pay for a security under current market conditions. These investment securities are, therefore, considered Level 2.
LHFI, net
The fair values of loans are estimated based on groupings of similar loans, including but not limited to stratifications by type, interest rate, maturity, and borrower creditworthiness. Discounted future cash flow analyses are performed for these loans incorporating assumptions of current and projected voluntary prepayment speeds. Discount rates are determined using the Company's current origination rates on similar loans, adjusted for changes in current liquidity and credit spreads (if necessary). Because the current liquidity spreads are generally not observable in the market and the expected loss assumptions are based on the Company's experience, these are Level 3 valuations. Impaired loans are valued at fair value on a nonrecurring basis. See further discussion under the section captioned "Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis" above.
LHFS
The Company's LHFS portfolios that are accounted for at the lower of cost or market primarily consists of RICs HFS. The estimated fair value of the RICs HFS is based on prices obtained in recent market transactions or expected to be obtained in the subsequent sales for similar assets.
Deposits
The fair value of deposits with no stated maturity, such as non-interest-bearing demand deposits, interest-bearing demand deposit accounts, savings accounts and certain money market accounts, is equal to the amount payable on demand and does not take into account the significant value of the cost advantage and stability of the Company’s long-term relationships with depositors. The fair value of fixed-maturity CDs is estimated by discounting cash flows using currently offered rates for deposits of similar remaining maturities. The related fair value measurements have generally been classified as Level 1 for core deposits, since the carrying value approximates fair value due to the short-term nature of the liabilities. All other deposits are considered to be Level 2.
Borrowings and other debt obligations
Fair value is estimated by discounting cash flows using rates currently available to the Company for other borrowings with similar terms and remaining maturities. Certain other debt obligation instruments are valued using available market quotes for similar instruments, which contemplates issuer default risk. The related fair value measurements have generally been classified as Level 2. A certain portion of debt relating to revolving credit facilities is classified as Level 3. Management believes that the terms of these credit agreements approximate market terms for similar credit agreements and, therefore, they are considered to be Level 3.
FVO for Financial Assets and Financial Liabilities
LHFS
The Company's LHFS portfolios that are measured using the FVO consist of residential mortgage LHFS. The adoption of the FVO for residential mortgage loans classified as HFS allows the Company to record the mortgage LHFS portfolio at fair market value compared to the lower of cost, net of deferred fees, deferred origination costs, or market. The Company economically hedges its residential LHFS portfolio, which is reported at fair value. A lower of cost or market accounting treatment would not allow the Company to record the excess of the fair market value over book value, but would require the Company to record the corresponding reduction in value on the hedges. Both the loans and related hedges are carried at fair value, which reduces earnings volatility, as the amounts more closely offset.
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NOTE 16. FAIR VALUE (continued)
RICs HFI
To reduce accounting and operational complexity, the Company elected the FVO for certain of its RICs HFI. These loans consisted primarily of SC’s RICs accounted for by SC under ASC 310-30, as well as all of SC’s RICs that were more than 60 days past due at the date of the Change in Control, which collectively had an aggregate outstanding UPB of $2.6 billion with a fair value of $1.9 billion at that date. The balance also includes non-performing loans acquired by SC under optional clean up calls from its non-consolidated Trusts.
The following table summarizes the differences between the fair value and the principal balance of LHFS and RICs measured at fair value on a recurring basis as of December 31, 2018 and December 31, 2017:
December 31, 2018 | December 31, 2017 | |||||||||||||||||||||||
(in thousands) | Fair Value | Aggregate UPB | Difference | Fair Value | Aggregate UPB | Difference | ||||||||||||||||||
LHFS(1) | $ | 209,506 | $ | 204,061 | $ | 5,445 | $ | 197,691 | $ | 194,928 | $ | 2,763 | ||||||||||||
RICs HFI | 126,312 | 142,882 | (16,570 | ) | 186,471 | 211,580 | (25,109 | ) | ||||||||||||||||
Nonaccrual loans | 7,630 | 10,427 | (2,797 | ) | 15,023 | 19,836 | (4,813 | ) | ||||||||||||||||
(1) | LHFS disclosed on the Consolidated Balance Sheets also includes LHFS that are held at the lower of cost or fair value that are not presented within this table. There were no nonaccrual loans related to the LHFS measured using the FVO. |
Interest income on the Company’s LHFS and RICs HFI is recognized when earned based on their respective contractual rates in Interest income on loans in the Consolidated Statements of Operations. The accrual of interest is discontinued and reversed once the loans become more than 90 days past due for LHFS and more than 60 days past due for RICs HFI.
Residential MSRs
The Company maintains an MSR asset for sold residential real estate loans serviced for others. The Company elected to account for the majority of its existing portfolio of MSRs at fair value. This election created greater flexibility with regard to risk management of the asset by aligning the accounting for the MSRs with the accounting for risk management instruments, which are also generally carried at fair value. At December 31, 2018 and December 31, 2017, the balance of these loans serviced for others accounted for at fair value was $14.4 billion and $14.9 billion, respectively. Changes in fair value are recorded through Miscellaneous income, net on the Consolidated Statements of Operations. As deemed appropriate, the Company economically hedges MSRs using interest rate swaps and forward contracts to purchase MBS. See further discussion on these derivative activities in Note 14 to these Consolidated Financial Statements. The remainder of the MSRs are accounted for using the lower of cost or fair value and are presented above in the section captioned "Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis."
NOTE 17. NON-INTEREST INCOME AND OTHER EXPENSES
The following table presents the details of the Company's Non-interest income for the following periods:
Year Ended December 31, | ||||||||||||
(in thousands) | 2018 | 2017 (1) | 2016 (1) | |||||||||
Non-interest income: | ||||||||||||
Consumer and commercial fees | $ | 568,147 | $ | 616,438 | $ | 689,839 | ||||||
Lease income | 2,375,596 | 2,017,775 | 1,839,307 | |||||||||
Miscellaneous income, net | ||||||||||||
Mortgage banking income, net | 34,612 | 56,659 | 63,790 | |||||||||
BOLI | 58,939 | 66,784 | 57,796 | |||||||||
Capital market revenue | 165,392 | 195,906 | 190,647 | |||||||||
Net gain on sale of operating leases | 202,793 | 127,156 | 66,909 | |||||||||
Asset and wealth management fees | 165,765 | 147,749 | 148,514 | |||||||||
Loss on sale of non-mortgage loans | (351,751 | ) | (370,289 | ) | (399,312 | ) | ||||||
Other miscellaneous income, net | 31,532 | 45,519 | 40,712 | |||||||||
Net (losses)/gains on sale of investment securities | (6,717 | ) | (2,444 | ) | 57,503 | |||||||
Total Non-interest income | $ | 3,244,308 | $ | 2,901,253 | $ | 2,755,705 | ||||||
(1) - Prior period amounts have not been adjusted under the modified retrospective method. For further information on the adoption of this standard, see Note 1.
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NOTE 17. NON-INTEREST INCOME AND OTHER EXPENSES (continued)
Disaggregation of Revenue from Contracts with Customers
Beginning January 1, 2018, the Company adopted the new accounting standard, "Revenue from Contracts with Customers", which requires the Company to disclose a disaggregation of revenue from contracts with customers that falls within the scope of this new accounting standard. The scope of the guidance explicitly excludes net interest income as well as many other revenues for financial assets and liabilities including loans, leases, securities, and derivatives. Therefore, the Company has evaluated the revenue streams within our Non-interest income line items to determine whether they are in-scope or out-of-scope. The following table presents the Company's Non-interest income disaggregated by revenue source:
Year Ended December 31, | ||||||||||||
(in thousands) | 2018 | 2017 (1) | 2016 (1) | |||||||||
Non-interest income: | ||||||||||||
In-scope of revenue from contracts with customers: | ||||||||||||
Depository services(2) | $ | 236,381 | $ | 242,995 | $ | 232,993 | ||||||
Commission and trailer fees(3) | 143,733 | 136,497 | 159,275 | |||||||||
Interchange income, net(3) | 60,258 | 58,525 | 53,294 | |||||||||
Underwriting service fees(3) | 71,536 | 97,143 | 99,366 | |||||||||
Asset and wealth management fees(3) | 138,108 | 112,533 | 113,850 | |||||||||
Other revenue from contracts with customers(3) | 36,692 | 40,722 | 33,607 | |||||||||
Total In-scope of revenue from contracts with customers | 686,708 | 688,415 | 692,385 | |||||||||
Out-of-scope of revenue from contracts with customers: | ||||||||||||
Consumer and commercial fees(4) | 294,371 | 347,216 | 341,426 | |||||||||
Lease income | 2,375,596 | 2,017,775 | 1,839,307 | |||||||||
Miscellaneous income/(loss)(4) | (105,650 | ) | (149,709 | ) | (174,916 | ) | ||||||
Net (losses)/gains on sale of investment securities | (6,717 | ) | (2,444 | ) | 57,503 | |||||||
Total Out-of-scope of revenue from contracts with customers | 2,557,600 | 2,212,838 | 2,063,320 | |||||||||
Total Non-interest income | $ | 3,244,308 | $ | 2,901,253 | $ | 2,755,705 | ||||||
(1) - Prior period amounts have not been adjusted under the modified retrospective method. For further information on the adoption of this standard, see Note 1.
(2) - Primarily recorded in the Company's Condensed Consolidated Statements of Operations within Consumer and commercial fees.
(3) - Primarily recorded in the Company's Condensed Consolidated Statements of Operations within Miscellaneous income, net.
(4) - The balance presented excludes certain revenue streams that are considered in-scope and presented above.
Arrangements with Multiple Performance Obligations
Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenue to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin.
Practical Expedients
In instances where incremental costs, such as commission expenses, are incurred and the period of benefit is equal to or less than one year, the Company has elected to apply the practical expedient where the Company expenses such amounts as incurred. These costs are recorded within Compensation and benefits within the Condensed Consolidated Statements of Operations.
In instances where contracts with customers contain a financing component and the Company expects the customer to pay for the goods or services within one year or less, the Company has elected to apply the practical expedient where the Company does not adjust the contracted amount of consideration for the effects of financing components.
The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less or (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. As a result of the practical expedient and for the Company's material revenue streams, there are no unperformed performance obligations. As a result of the practical expedient and the Company's revenue recognition for contracts with customers, there are no material contract assets or liabilities.
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NOTE 17. NON-INTEREST INCOME AND OTHER EXPENSES (continued)
Other Expenses
The following table presents the Company's other expenses for the following periods:
Year Ended December 31, | ||||||||||||
(in thousands) | 2018 | 2017 | 2016 | |||||||||
Other expenses: | ||||||||||||
Amortization of intangibles | $ | 60,650 | $ | 61,491 | $ | 70,034 | ||||||
Deposit insurance premiums and other expenses | 61,983 | 70,661 | 77,976 | |||||||||
Loss on debt extinguishment | 3,470 | 30,349 | 114,232 | |||||||||
Impairment of goodwill | — | 10,536 | — | |||||||||
Other administrative expenses | 461,291 | 484,992 | 418,911 | |||||||||
Other miscellaneous expenses | 21,595 | 21,128 | 1,741 | |||||||||
Total Other expenses | $ | 608,989 | $ | 679,157 | $ | 682,894 | ||||||
NOTE 18. STOCK-BASED COMPENSATION
SC Stock Compensation Plans
SC granted stock options to certain executives, other employees, and independent directors under SC's 2011 Management Equity Plan (the "MEP"), which enabled SC to make stock awards up to a total of approximately 29.4 million common shares (net of shares canceled and forfeited). The MEP expired in January 2015 and SC will not grant any further awards under the MEP. The Company has granted stock options, restricted stock awards and restricted stock units ("RSUs") under the Omnibus Incentive Plan (the "Plan"), was established in 2013 and enables SC to grant awards of non-qualified and incentive stock options, stock appreciation rights, restricted stock awards, RSUs, and other awards that may be settled in or based upon the value of SC Common Stock, up to a total of 5,192,641 common shares. The Plan was amended and restated as of June 16, 2016.
Stock options granted under the MEP and the Plan have an exercise price based on the estimated fair market value of SC Common Stock on the grant date. The stock options expire ten years after grant date and include both time vesting options and performance vesting options. The fair value of the stock options is amortized into income over the vesting period as time and performance vesting conditions are met.
In 2013, the SC Board approved certain changes to the MEP and the Management Shareholders Agreement, including acceleration of vesting for certain employees, removal of transfer restrictions for shares underlying a portion of the options outstanding under the Plan, and addition of transfer restrictions for shares underlying another portion of the outstanding options. All of the changes were contingent on, and effective upon, SC's execution of an IPO and, as such, became effective upon pricing of the IPO on January 22, 2014.
Compensation expense related to 583,890 shares of restricted stock that the Company has issued to certain executives is recognized over a five-year vesting period, with zero, $5.5 million and $0.7 million recorded for the years ended December 31, 2018, 2017 and 2016, respectively. SC recognized $7.7 million, $13.0 million and $8.8 million related to stock options and RSUs within compensation expense for the years ended December 31, 2018, 2017 and 2016, respectively. In addition, SC recognizes forfeitures of awards as they occur.
Also in connection with the IPO, SC granted additional stock options under the MEP to certain executives, other employees, and an independent director with an estimated compensation cost of $10.2 million, which is being recognized over the awards' vesting period of five years for the employees and three years for the director. Additional stock option grants were made to employees under the Plan during the year ended December 31, 2016. The estimated compensation cost associated with these additional grants was $0.7 million and will be recognized over the vesting periods of the awards. The grant date fair values of these stock option awards were determined using the Black-Scholes option valuation model.
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NOTE 18. STOCK-BASED COMPENSATION (continued)
A summary of SC's stock options and related activity as of and for the year ended December 31, 2018, is as follows:
Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value | ||||||
(in whole dollars) | (in 000's) | ||||||||
Options outstanding at January 1, 2018 | 1,695,008 | $ | 12.39 | 4.7 | $ | 12,058 | |||
Exercised | (863,811 | ) | 9.50 | 7,918 | |||||
Expired | (92,885 | ) | 23.27 | ||||||
Forfeited | (92,936 | ) | 23.06 | ||||||
Options outstanding at December 31, 2018 | 645,376 | $ | 13.15 | 4.0 | $ | 3,682 | |||
Options exercisable at December 31, 2018 | 557,555 | $ | 12.07 | 3.7 | $ | 3,572 | |||
Options expected to vest after December 31, 2018 | 87,821 | $ | 20.03 | 5.6 | $ | 110 | |||
A summary of the status and changes of SC's nonvested stock options as of and for the year ended December 31, 2018, is presented below:
Shares | Weighted Average Grant Date Fair Value | ||||
Non-vested at January 1, 2018 | 239,838 | $ | 7.29 | ||
Granted | — | — | |||
Vested | (59,081 | ) | 7.33 | ||
Forfeited | (92,936 | ) | 7.96 | ||
Non-vested at December 31, 2018 | 87,821 | $ | 6.55 | ||
At December 31, 2018, total unrecognized compensation expense for nonvested stock options was $0.3 million, which is expected to be recognized over a weighted average period of 1.4 years.
No stock options were granted to employees in 2018 or 2017. The following summarizes the assumptions used for estimating the fair value of stock options granted to employees for the year ended December 31, 2016.
For the year ended December 31, 2016 | |||
Assumption: | |||
Risk-free interest rate | 1.79% | ||
Expected life (in years) | 6.5 | ||
Expected volatility | 33% | ||
Dividend yield | 3.69% | ||
Weighted average grant date fair value | $3.14 | ||
The Company has the same fair value basis with that of SC for any stock option awards after the IPO date.
In connection with compensation restrictions imposed on certain executive officers and other employees by the European Central Bank under the Capital Requirements Directive IV ("CRD IV") prudential rules, which require a portion of such officers' and employees' variable compensation to be paid in the form of equity and deferred, SC periodically grants RSUs. Under the Plan, a portion of these RSUs vested immediately upon grant, and a portion will vest annually over the following three or five years subject to the achievement of certain performance conditions as and where applicable. After the shares subject to the RSUs vest and are settled, they are subject to transfer and sale restrictions for one year. RSUs are valued based upon the fair market value on the date of the grant.
A summary of the Company’s RSUs and performance stock units and related activity as of and for the year ended December 31, 2018 is as follows:
Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value | ||||||
(in whole dollars) | (in 000's) | ||||||||
Outstanding at January 1, 2018 | 650,252 | $ | 12.68 | 1.0 | $ | 12,108 | |||
Granted | 617,279 | 16.11 | |||||||
Vested | (522,810 | ) | 14.18 | 8,616 | |||||
Forfeited/cancelled | (45,922 | ) | 11.64 | ||||||
Unvested at December 31, 2018 | 698,799 | $ | 14.53 | 1.1 | $ | 12,292 | |||
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NOTE 19.OTHER EMPLOYEE BENEFIT PLANS
Defined Contribution Plans
All employees of the Bank are eligible to participate in the 401(k) Plan, sponsored by the Company, following their completion of one month of service. There is no age requirement to join the 401(k) Plan. Beginning January 2018, the Bank matched 100% of employee contributions up to 4% of their compensation. Prior to 2018, the Bank matched 100% of employee contributions up to 3% of the employee's compensation and then 50% of employee contributions between 3% and 5% of their compensation. The Bank's match is immediately vested and is allocated to the employee’s various 401(k) Plan investment options in the same percentages as the employee’s own contributions. The Bank recognized expense for contributions to the 401(k) Plan of $26.8 million, $20.6 million and $21.1 million during 2018, 2017 and 2016, respectively, within the Compensation and benefits line on the Consolidated Statements of Operations. Beginning January 2019, the Bank will match 100% of employee contributions up to 5% of the employee's compensation.
SC sponsors a defined contribution plan offered to qualifying employees. Employees participating in the plan may contribute up to 75% of their eligible compensation, subject to federal limitations on absolute amounts contributed. SC will match up to 6% of their eligible compensation, with matching contributions of up to 100% of employee contributions. The total amount contributed by SC under this plan in 2018, 2017 and 2016 was $14.0 million, $12.4 million and $11.8 million, respectively.
Defined Benefit Plans and Other Post Retirement Benefit Plans
The Company sponsors several defined benefit plans and other post retirement benefit plans that cover certain employees. All of these plans are frozen and therefore closed to new entrants; all benefits are fully vested, and therefore the plans ceased accruing benefits. The Company complies with minimum funding requirements in all countries. The Company also sponsors several supplemental executive retirement plans and other unfunded post-retirement benefit plans that provide health care to certain retired employees.
The Company recognizes the funded status of its defined benefit pension plans and other post-retirement benefit plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, within Other liabilities on the Consolidated Balance Sheets. The Company has accrued liabilities of $29.0 million and $65.9 million related to its total defined benefit pension plans and other post-retirement benefit plans at December 31, 2018 and December 31, 2017, respectively. The net unfunded status related to actuarially-valued defined benefit pension plans and other post-retirement plans was $13.5 million and $50.5 million at December 31, 2018 and December 31, 2017, respectively.
NOTE 20. COMMITMENTS, CONTINGENCIES AND GUARANTEES
Off-Balance Sheet Risk - Financial Instruments
In the normal course of business, the Company utilizes a variety of financial instruments with off-balance sheet risk to meet the financing needs of its customers and manage its exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, letters of credit, loans sold with recourse, forward contracts, and interest rate and cross currency swaps, caps and floors. These financial instruments may involve, to varying degrees, elements of credit, liquidity, and interest rate risk in excess of the amount recognized on the Consolidated Balance Sheets. The contractual or notional amounts of these financial instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, letters of credit and loans sold with recourse is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. For forward contracts and interest rate swaps, caps and floors, the contract or notional amounts do not represent exposure to credit loss. The Company controls the credit risk of its forward contracts and interest rate swaps, caps and floors through credit approvals, limits and monitoring procedures. See Note 14 to these Consolidated Financial Statements for discussion of all derivative contract commitments.
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NOTE 20. COMMITMENTS, CONTINGENCIES AND GUARANTEES (continued)
The following table details the amount of commitments at the dates indicated:
Other Commitments | December 31, 2018 | December 31, 2017 | ||||||
(in thousands) | ||||||||
Commitments to extend credit | $ | 30,269,311 | $ | 29,475,864 | ||||
Letters of credit | 1,488,714 | 1,559,297 | ||||||
Unsecured revolving lines of credit | 28,145 | 27,938 | ||||||
Recourse exposure on sold loans | 49,733 | 46,572 | ||||||
Commitments to sell loans | 875 | 19,477 | ||||||
Total commitments | $ | 31,836,778 | $ | 31,129,148 | ||||
Commitments to Extend Credit
Commitments to extend credit generally have fixed expiration dates, are variable rate, and contain provisions that permit the Company to terminate or otherwise renegotiate the contracts in the event of a significant deterioration in the customer’s credit quality. These arrangements normally require payment of a fee by the customer, the pricing of which is based on prevailing market conditions, credit quality, probability of funding, and other relevant factors. Since many of these commitments are expected to expire without being drawn upon, the contract amounts are not necessarily indicative of future cash requirements.
Included within the reported balances for Commitments to extend credit at December 31, 2018 and December 31, 2017 are $5.7 billion and $6.4 billion, respectively, of commitments that can be canceled by the Company without notice.
Letters of Credit
The Company’s letters of credit meet the definition of a guarantee. Letters of credit commit the Company to make payments on behalf of its customers if specified future events occur. The guarantees are primarily issued to support public and private borrowing arrangements. The weighted average term of these commitments at December 31, 2018 was 16.4 months. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the event of a requested draw by the beneficiary that complies with the terms of the letter of credit, the Company would be required to honor the commitment. The Company has various forms of collateral for these letters of credit, including real estate assets and other customer business assets. The maximum undiscounted exposure related to these commitments at December 31, 2018 was $1.5 billion. The fees related to letters of credit are deferred and amortized over the life of the respective commitments, and were immaterial to the Company’s financial statements at December 31, 2018. Management believes that the utilization rate of these letters of credit will continue to be substantially less than the amount of the commitments, as has been the Company’s experience to date. As of December 31, 2018 and December 31, 2017, the liability related to these letters of credit was $4.6 million and $18.2 million, respectively, which is recorded within the reserve for unfunded lending commitments in Other liabilities on the Consolidated Balance Sheets. The credit risk associated with letters of credit is monitored using the same risk rating system utilized within the loan and financing lease portfolio. Also included within the reserve for unfunded lending commitments at December 31, 2018 and December 31, 2017 were lines of credit outstanding of $88.7 million and $90.9 million, respectively.
Unsecured Revolving Lines of Credit
Such commitments arise primarily from agreements with customers for unused lines of credit on unsecured revolving accounts and credit cards, provided there is no violation of conditions in the underlying agreement. These commitments, substantially all of which the Company can terminate at any time and which do not necessarily represent future cash requirements, are reviewed periodically based on account usage, customer creditworthiness and loan qualifications.
Loans Sold with Recourse
The Company has loans sold with recourse that meet the definition of a guarantee. For loans sold with recourse under the terms of its multifamily sales program with FNMA, the Company retained a portion of the associated credit risk.
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NOTE 20. COMMITMENTS, CONTINGENCIES AND GUARANTEES (continued)
Commitments to Sell Loans
The Company enters into forward contracts relating to its mortgage banking business to hedge the exposures from commitments to make new residential mortgage loans with existing customers and from mortgage loans classified as LHFS. These contracts mature in less than one year.
SC Commitments
The following table summarizes liabilities recorded for commitments and contingencies as of December 31, 2018 and 2017, all of which are included in accounts payable and accrued expenses in the accompanying consolidated balance sheets:
Agreement or Legal Matter | Commitment or Contingency | December 31, 2018 | December 31, 2017 | |||||||
(in thousands) | ||||||||||
Chrysler Agreement | Revenue-sharing and gain-sharing payments | $ | 7,001 | $ | 6,580 | |||||
Agreement with Bank of America | Servicer performance fee | 6,353 | 8,072 | |||||||
Agreement with Citizens Bank of Philadelphia (CBP") | Loss-sharing payments | 3,708 | 5,625 | |||||||
Other contingencies | Consumer arrangements | 2,138 | 6,326 | |||||||
Following is a description of the agreements pursuant to which the liabilities in the preceding table were recorded.
Chrysler Agreement
Under terms of the Chrysler Agreement, SC must make revenue sharing payments to FCA and also must make gain-sharing payments to FCA when residual gains on leased vehicles exceed a specified threshold. SC had accrued $7.0 million and $6.6 million at December 31, 2018 and December 31, 2017, respectively, related to these obligations.
The Chrysler Agreement requires, among other things, that SC bears the risk of loss on loans originated pursuant to the agreement, but also that FCA shares in any residual gains and losses from consumer leases. The Chrysler agreement also requires that SC maintains at least $5.0 billion in funding available for Floorplan Loans and $4.5 billion of financing dedicated to FCA retail financing. In turn, FCA must provide designated minimum threshold percentages of its subvention business to SC. The Chrysler Agreement is subject to early termination in certain circumstances, including the failure by either party to comply with certain of its ongoing obligations under the Chrysler agreement. These obligations include SC's meeting specified escalating penetration rates for the first five years of the agreement. SC did not meet these penetration rates. Also, FCA has the option to acquire, for fair market value, an equity participation in the business offering and providing the financial services contemplated by the Chrysler Agreement. If FCA exercises its equity option, the Chrysler Agreement were to terminate or SC otherwise is unable to realize the expected benefits of its relationship with FCA, there could be a materially adverse impact to the Company's and SC's business, financial condition, results of operations, profitability, loan and lease volume, the credit quality of its portfolio, liquidity, funding and growth, and the Company's or SC's ability to implement its business strategy could be materially adversely affected.
Agreement with Bank of America
Until January 31, 2017, SC had a flow agreement with Bank of America whereby SC was committed to sell up to $300.0 million of eligible loans to the bank each month. SC retains servicing on all sold loans and may receive or pay a servicer performance payment based on an agreed-upon formula if performance on the sold loans is better or worse, respectively, than expected performance at the time of sale. Servicer performance payments are due six years from the cut-off date of each loan sale. SC had accrued $6.4 million and $8.1 million at December 31, 2018 and December 31, 2017, respectively, related to this obligation.
Agreement with CBP
Until May 1, 2017, SC sold loans to CBP under terms of a flow agreement and predecessor sale agreements. SC retains servicing on the sold loans and will owe CBP a loss-sharing payment capped at 0.5% of the original pool balance if losses exceed a specified threshold, established on a pool-by-pool basis. Loss-sharing payments are due the month in which net losses exceed the established threshold of each loan sale. The Company had accrued $3.7 million and $5.6 million at December 31, 2018 and December 31, 2017, respectively, related to this obligation.
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NOTE 20. COMMITMENTS, CONTINGENCIES AND GUARANTEES (continued)
Other Contingencies
SC is or may be subject to potential liability under various other contingent exposures. SC had accrued $2.1 million and $6.3 million at December 31, 2018 and December 31, 2017, respectively, for other miscellaneous contingencies.
Bluestem
SC is party to agreements with Bluestem whereby SC is committed to purchase certain new advances on personal revolving financings receivables, along with existing balances on accounts with new advances, originated by Bluestem for an initial term ending in April 2020 and renewing through April 2022 at Bluestem's option. As of December 31, 2018 and 2017, the total unused credit available to customers was $3.1 billion and $3.9 billion, respectively. In 2018, SC purchased $1.2 billion of receivables, out of the $3.9 billion unused credit available to customers as of December 31, 2017. In 2017, SC purchased $1.2 billion of receivables out of the $4.0 billion unused credit available to customers as of December 31, 2016. In addition, SC purchased $0.3 billion and $0.3 billion of receivables related to newly-opened customer accounts in 2018 and 2017, respectively.
Each customer account generated under the agreements generally is approved with a credit limit higher than the amount of the initial purchase, with each subsequent purchase automatically approved as long as it does not cause the account to exceed its limit and the customer is in good standing. As of December 31, 2018 and December 31, 2017, SC was obligated to purchase $15.4 million and $11.5 million, respectively, in receivables that had been originated by the Bluestem but not yet purchased by SC. SC also is required to make a profit-sharing payment to Bluestem each month if performance exceeds a specified return threshold. During the year ended December 31, 2015, SC and the third-party retailer executed an amendment that, among other provisions, increases the profit-sharing percentage retained by SC, gives the retailer the right to repurchase up to 9.99% of the existing portfolio at any time during the term of the agreement, and, provided that the repurchase right is exercised, gives the retailer the right to retain up to 20% of new accounts subsequently originated.
Others
Under terms of an application transfer agreement with Nissan, SC has the first opportunity to review for its own portfolio any credit applications turned down by Nissan’s captive finance company. The agreement does not require SC to originate any loans, but for each loan originated SC will pay Nissan a referral fee.
In connection with the sale of RICs through securitizations and other sales, SC has made standard representations and warranties customary to the consumer finance industry. Violations of these representations and warranties may require SC to repurchase loans previously sold to on- or off-balance sheet Trusts or other third parties. As of December 31, 2018, there were no loans that were the subject of a demand to repurchase or replace for breach of representations and warranties for SC's ABS or other sales. In the opinion of management, the potential exposure of other recourse obligations related to SC’s RICs will not have a material adverse effect on SC’s consolidated financial position, results of operations, or cash flows.
Santander has provided guarantees on the covenants, agreements, and obligations of SC under the governing documents of its warehouse facilities and privately issued amortizing notes. These guarantees are limited to the obligations of SC as servicer.
In November 2015, SC executed a forward flow agreement with a third party under the terms of which SC is committed to sell charged-off loan receivables in bankruptcy status on a quarterly basis until sales total at least $350.0 million. However, any sale of more than $275.0 million is subject to a market price check. The remaining aggregate commitments as of December 31, 2018 and December 31, 2017, not subject to a market price check were $64.0 million and $98.9 million, respectively.
Impact from Hurricanes
Our footprint was impacted by three significant hurricanes during 2017, Hurricane Harvey, which struck the State of Texas and the surrounding region, Hurricane Irma, which primarily struck the State of Florida, and Hurricane Maria, which struck the island of Puerto Rico. Each of these hurricanes resulted in widespread flooding, power outages and associated damage to real and personal property in the affected areas. SC, headquartered in Dallas, Texas, BSI, headquartered in Miami, Florida, and Santander BanCorp, BSPR and SSLLC in Puerto Rico were most directly affected by these hurricanes. In Puerto Rico, there was significant damage to the infrastructure and the power grid on the entire island, which resulted in extended delays in BSPR returning to normal operations.
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NOTE 20. COMMITMENTS, CONTINGENCIES AND GUARANTEES (continued)
The Company assessed the potential additional credit losses related to its consumer and commercial lending exposures in the greater Texas, Florida and Puerto Rico regions. As a result, the Company's ALLL had approximately $25 million of reserves specifically related to the hurricanes at December 31, 2018 compared to $110 million at December 31, 2017. Approximately $50 million of the decrease in the qualitative allowance related to the hurricanes has been offset by an increase in model reserves to other portfolios requiring additional allowance, including the municipality, commercial, and residential loan portfolios in Puerto Rico. The remaining hurricane reserve at December 31, 2018 is a specific reserve recorded for a commercial loan located in Puerto Rico.
See discussion under the "Puerto Rico FINRA Arbitrations" section of Note 20 below for further discussion.
Other Off-Balance Sheet Risk
Other off-balance sheet risk stems from financial instruments that do not meet the definition of guarantees under applicable accounting guidance, and from other relationships that include items such as indemnifications provided in the ordinary course of business and intercompany guarantees.
Legal and Regulatory Proceedings
Periodically, the Company is party to, or otherwise involved in, various lawsuits, investigations, regulatory matters and other legal proceedings that arise in the ordinary course of business. In view of the inherent difficulty of predicting the outcome of any such lawsuit, investigation, regulatory matter and/or legal proceeding, particularly where the claimants seek very large or indeterminate damages or where the matters present novel legal theories or involve a large number of parties, the Company generally cannot predict the eventual outcome of the pending matters, the timing of the ultimate resolution of the matters, or the eventual loss, fines or penalties related to the matters. Accordingly, except as provided below, the Company is unable to reasonably estimate a range of its potential exposure, if any, to these lawsuits, investigations, regulatory matters and other legal proceedings at this time. However, it is reasonably possible that actual outcomes or losses may differ materially from the Company's current assessments and estimates, and any adverse resolution of any of these matters against it could have a material adverse effect on the Company's financial position, liquidity, and results of operations.
In accordance with applicable accounting guidance, the Company establishes an accrued liability for litigation, investigation, regulatory matters and other legal proceedings when those matters present material loss contingencies that are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. When a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. As a litigation, investigation or regulatory matter develops, the Company, in conjunction with any outside counsel handling the matter, evaluates on an ongoing basis whether the matter presents a material loss contingency that is probable and estimable. If a determination is made during a given quarter that a material loss contingency is probable and estimable, an accrued liability is established during such quarter with respect to such loss contingency, and the Company continues to monitor the matter for further developments that could affect the amount of the accrued liability previously established.
As of December 31, 2018 and December 31, 2017, the Company accrued aggregate legal and regulatory liabilities of $215.2 million and $161.8 million, respectively. Further, the Company estimates the aggregate range of reasonably possible losses for legal and regulatory proceedings in excess of reserves of up to $286 million and $255 million as of December 31, 2018 and December 31, 2017, respectively. Descriptions of the material lawsuits, regulatory matters and other legal proceedings to which the Company is subject are set forth below.
On March 21, 2017, SC and SHUSA entered into a written agreement with the FRB of Boston. Under the terms of that agreement, SC is required to enhance its compliance risk management program, board oversight of risk management and senior management oversight of risk management, and SHUSA is required to enhance its oversight of SC's management and operations.
SC Matters
Periodically, SC is party to, or otherwise involved in, various lawsuits and other legal proceedings that arise in the ordinary course of business.
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NOTE 20. COMMITMENTS, CONTINGENCIES AND GUARANTEES (continued)
Securities Class Action and Shareholder Derivative Lawsuits
Deka Lawsuit: SC is a defendant in a purported securities class action lawsuit (the "Deka Lawsuit") in the United States District Court, Northern District of Texas, captioned Deka Investment GmbH et al. v. Santander Consumer USA Holdings Inc. et al., No. 3:15-cv-2129-K. The Deka Lawsuit, which was filed in August 26, 2014, was brought against SC, certain of its current and former directors and executive officers and certain institutions that served as underwriters in the IPO, including SIS, on behalf of a class consisting of those who purchased or otherwise acquired SC securities between January 23, 2014 and June 12, 2014. The complaint alleges, among other things, that the IPO registration statement and prospectus and certain subsequent public disclosures violated federal securities laws by containing misleading statements concerning SC’s ability to pay dividends and the adequacy of SC’s compliance systems and oversight. The complaint seeks unspecified damages. In December 2015, SC and the individual defendants moved to dismiss the lawsuit, which was denied. In December 2016, the plaintiffs moved to certify the proposed classes. In July 2017, the court entered an order staying the Deka Lawsuit pending the resolution of the appeal of a class certification order in In re Cobalt Int’l Energy, Inc. Sec. Litig., No. H-14-3428, 2017 U.S. Dist. LEXIS 91938 (S.D. Tex. June 15, 2017). In October 2018, the court vacated the order staying the Deka Lawsuit but ordered that merits discovery be stayed until the court ruled on the issue of class certification.
Feldman Lawsuit: In October 2015, a shareholder derivative complaint was filed in the Court of Chancery of the State of Delaware, captioned Feldman v. Jason A. Kulas, et al., C.A. No. 11614 (the "Feldman Lawsuit"). The Feldman Lawsuit names as defendants certain current and former members of SC’s Board of Directors, and names SC as a nominal defendant. The complaint alleges, among other things, that the current and former director defendants breached their fiduciary duties in connection with overseeing SC’s nonprime auto lending practices, resulting in harm to SC. The complaint seeks unspecified damages and equitable relief. In December 2015, the Feldman Lawsuit was stayed pending the resolution of the Deka Lawsuit.
Jackie888 Lawsuit: In September 2016, a shareholder derivative complaint was filed in the Court of Chancery of the State of Delaware captioned Jackie888, Inc. v. Jason Kulas, et al., C.A. # 12775 (the "Jackie888 Lawsuit"). The Jackie888 Lawsuit names as defendants current and former members of SC’s Board of Directors, and names SC as a nominal defendant. The complaint alleges, among other things, that the defendants breached their fiduciary duties in connection with SC’s accounting practices and controls. The complaint seeks unspecified damages and equitable relief. In April 2017, the Jackie888 Lawsuit was stayed pending the resolution of the Deka Lawsuit.
Parmelee Lawsuits: SC is a defendant in two purported securities class action lawsuits filed in March and April 2016 in the United States District Court, Northern District of Texas. The lawsuits were consolidated and are now captioned Parmelee v. Santander Consumer USA Holdings Inc. et al., No. 3:16-cv-783. The lawsuits were filed against SC and certain of its current and former directors and executive officers on behalf of a class consisting of all those who purchased or otherwise acquired SC securities between February 3, 2015 and March 15, 2016. The complaint alleges that SC violated federal securities laws by making false or misleading statements, as well as failing to disclose material adverse facts, in its periodic reports filed under the Securities Exchange Act of 1934, as amended (the "Exchange Act") and certain other public disclosures, in connection with, among other things, SC’s change in its methodology for estimating its ACL and the correction of such ACL for prior periods. In January 2018, the court granted SC’s motion to dismiss the lawsuit as to defendant Ismail Dawood (SC’s former Chief Financial Officer) and denied the motion as to all other defendants. In July 2018, the lead plaintiffs filed an unopposed motion for preliminary approval of a class action settlement of the lawsuit for a cash payment of $9.5 million. In September 2018, the court entered an order granting the motion for preliminary approval of the settlement of the lawsuit.
Consumer Lending Cases
SC is also party to various lawsuits pending in federal and state courts alleging violations of state and federal consumer lending laws, including, without limitation, the Equal Credit Opportunity Act (the “ECOA”), the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, Section 5 of the Federal Trade Commission Act, the Telephone Consumer Protection Act, the Truth in Lending Act, wrongful repossession laws, usury laws and laws related to unfair and deceptive acts or practices. In general, these cases seek damages and equitable and/or other relief.
Regulatory Proceedings
SC is party to, or is periodically otherwise involved in, reviews, investigations, examinations and proceedings (both formal and informal), and information-gathering requests, by government and self-regulatory agencies, including the FRB of Boston, the CFPB, the Department of Justice (the “DOJ”), the SEC, the Federal Trade Commission and various state regulatory and enforcement agencies.
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NOTE 20. COMMITMENTS, CONTINGENCIES AND GUARANTEES (continued)
Currently, such matters include, but are not limited to, the following:
• | SC received a civil subpoena from the DOJ under Financial Institutions Reform, Recovery and Enforcement Act requesting the production of documents and communications that, among other things, relate to the underwriting and securitization of nonprime vehicle loans. SC has responded to these requests within the deadlines specified in the subpoenas and has otherwise cooperated with the DOJ with respect to this matters. |
• | In October 2014, SC received a subpoena from the SEC commencing an investigation into the SC’s securitization practices. In June 2016, the SEC served an additional subpoena on SC requesting documents related to SC’s securitization practices as well as SC’s financial restatements. SC has produced documents responsive to these subpoenas, and the SEC has taken testimony from certain of SC’s employees. In December 2018, the SEC and SC reached a voluntary agreement to settle the SEC's investigation under which the SEC entered a cease-and-desist order against SC in an administrative matter captioned In the Matter of Santander Consumer USA Holdings Inc., File No. 3-18932. SC paid a civil penalty of $1.5 million in January 2019 and agreed to cease and desist from any future violations of the Exchange Act and the rules thereunder. |
• | In October 2014, May 2015, July 2015 and February 2017, SC received subpoenas and/or civil investigative demands ("CIDs") from the Attorneys General of California, Illinois, Oregon, New Jersey, Maryland and Washington under the authority of each state's consumer protection statutes. SC has been informed that these states will serve as an executive committee on behalf of a group of 32 state Attorneys General (and the District of Columbia). The subpoenas and/or CIDs from the executive committee states contain broad requests for information and the production of documents related to SC’s underwriting, securitization, servicing and collection of nonprime vehicle loans. SC has responded to these requests within the deadlines specified in the subpoenas and/or CIDs, and has otherwise cooperated with the Attorneys General with respect to this matter. |
• | In February 2016, the CFPB issued a supervisory letter relating to its investigation of SC’s compliance systems, Board and senior management oversight, consumer complaint handling, marketing of guaranteed auto protection ("GAP") coverage and loan deferral disclosure practices. SC subsequently received a series of CIDs from the CFPB requesting information and testimony regarding SC’s marketing of GAP coverage and loan deferral disclosure practices. In November 2018, SC entered into a voluntary settlement with the CFPB under which the CFPB entered a consent order against SC in an administrative proceeding captioned In the Matter of Santander Consumer USA Holdings Inc., File No. 2018-BCFP-0008. In the consent order the CFPB found, among other things, that SC violated the Consumer Financial Protection Act of 2010 (the "CFPA") in its marketing of GAP coverage and in certain of its loan deferral disclosure practices. Without admitting or denying the findings, SC agreed to pay a |
civil penalty of $2.5 million to the CFPB and to provide remediation to certain impacted customers. The consent order also requires SC to submit a comprehensive plan to the CFPB demonstrating how it will comply with the CFPA and the terms of the consent order.
• | In August 2017, SC received a CID from the CFPB. The stated purpose of the CID was to determine whether SC has complied with the Fair Credit Reporting Act and related regulations. SC has responded to these requests within the deadlines specified in the CID and has otherwise cooperated with the CFPB with respect to this matter. |
Mississippi Attorney General Lawsuit
In January 2017, the Attorney General of the State of Mississippi (the "Mississippi AG") filed a lawsuit against SC in the Chancery Court of the First Judicial District of Hinds County, State of Mississippi, captioned State of Mississippi ex rel. Jim Hood, Attorney General of the State of Mississippi v. Santander Consumer USA Inc., C.A. # G-2017-28. The complaint alleges that SC engaged in unfair and deceptive business practices to induce Mississippi consumers to apply for loans that they could not afford. The complaint asserts claims under the Mississippi Consumer Protection Act (the "MCPA") and seeks unspecified civil penalties, equitable relief and other relief. In March 2017, SC filed motions to dismiss the Mississippi AG’s, lawsuit and the parties are proceeding with discovery.
Servicemembers’ Civil Relief Act (“SCRA”) Consent Order
In February 2015, SC entered into a consent order with the DOJ, approved by the United States District Court for the Northern District of Texas, which resolves the DOJ's claims against SC that certain of its repossession and collection activities during the period between January 2008 and February 2013 violated the SCRA. The consent order requires SC to pay a civil fine in the amount of $55,000, as well as at least $9.4 million to affected servicemembers consisting of $10,000 per servicemember plus compensation for any lost equity (with interest) for each repossession by SC, and $5,000 per servicemember for each instance where SC sought to collect repossession-related fees on accounts where a repossession was conducted by a prior account holder. The consent order also provides for monitoring by the DOJ of the SC’s SCRA compliance for a period of five years and requires SC to undertake certain additional remedial measures.
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NOTE 20. COMMITMENTS, CONTINGENCIES AND GUARANTEES (continued)
IHC Matters
Periodically, SSLLC is party to pending and threatened legal actions and proceedings, including Financial Industry Regulatory Authority (“FINRA”) arbitration actions and class action claims.
Puerto Rico FINRA Arbitrations
As of December 31, 2018, SSLLC had received 589 FINRA arbitration cases related to Puerto Rico bonds and Puerto Rico closed-end funds ("CEFs"). Most of these cases are based upon concerns regarding the local Puerto Rico securities market. The statements of claims allege, among other things, fraud, negligence, breach of fiduciary duty, breach of contract, unsuitability, over-concentration and failure to supervise. There were 420 arbitration cases that remained pending as of December 31, 2018.
As a result of Hurricane Maria impacting the Puerto Rico market including declines in Puerto Rico bond and CEF prices and attorney advertisements encouraging customers to file claims, it is possible that additional arbitration claims and/or increased claim amounts may be asserted in future periods.
Puerto Rico Class Actions
SSLLC, Santander BanCorp, BSPR, the Company and Santander are defendants in a putative class action alleging federal securities and common law claims relating to the solicitation and purchase of more than $180 million of Puerto Rico bonds and $101 million of CEFs during the period from December 2012 to October 2013. The case is pending in the United States District Court for the District of Puerto Rico and is captioned Jorge Ponsa-Rabell, et. al. v. SSLLC, Civ. No. 3:17-cv-02243. The amended complaint alleges that defendants acted in concert to defraud purchasers in connection with the underwriting and sale of Puerto Rico municipal bonds, CEFs and open-end funds.
Mexican Government Bonds Consolidated Purported Antitrust Class Action: A consolidated purported antitrust class action is pending in the United States District Court, Southern District of New York, captioned In re Mexican Government Bonds Antitrust Litigation, No. 1:18-cv-02830-JPO (the “MGB Lawsuit”). The MGB Lawsuit is against the Company, SIS, Santander, Banco Santander (Mexico), S.A. Institucion de Banca Multiple, Grupo Financiero Santander and Santander Investment Bolsa, Sociedad de Valores, S.A. on behalf of a class of persons who entered into Mexican government bond (“MGB”) transactions between January 1, 2006 and April 19, 2017, where such persons were either domiciled in the United States or, if domiciled outside the United States, transacted in the United States. The complaint alleges, among other things, that the Santander defendants and the other defendants violated U.S. antitrust laws by conspiring to rig auctions and/or fix prices of MGBs. On September 17, 2018, the defendants filed motions to dismiss the consolidated complaint.
These matters are ongoing and could in the future result in the imposition of damages, fines or other penalties. No assurance can be given that the ultimate outcome of these matters or any resulting proceedings would not materially and adversely affect the Company's business, financial condition and results of operations.
Leases
The Company is committed under various non-cancelable operating leases relating to branch facilities having initial or remaining terms in excess of one year. Renewal options exist for the majority of these lease agreements.
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NOTE 20. COMMITMENTS, CONTINGENCIES AND GUARANTEES (continued)
Future minimum annual rentals under non-cancelable operating leases and sale-leaseback leases, net of expected sublease income, at December 31, 2018, are summarized as follows:
AT DECEMBER 31, 2018 | ||||||||||||
(in thousands) | Lease Payments | Future Minimum Expected Sublease Income | Net Payments | |||||||||
2019 | $ | 146,108 | $ | (4,660 | ) | $ | 141,448 | |||||
2020 | 116,871 | (2,527 | ) | 114,344 | ||||||||
2021 | 96,784 | (675 | ) | 96,109 | ||||||||
2022 | 83,028 | (550 | ) | 82,478 | ||||||||
2023 | 70,158 | (562 | ) | 69,596 | ||||||||
Thereafter | 169,046 | (535 | ) | 168,511 | ||||||||
Total | $ | 681,995 | $ | (9,509 | ) | $ | 672,486 | |||||
The Company recorded rental expense of $149.6 million, $150.0 million and $143.9 million, net of $6.8 million, $8.9 million and $8.1 million of sublease income, in 2018, 2017 and 2016, respectively, in Occupancy and equipment expenses in the Consolidated Statements of Operations.
NOTE 21. RELATED PARTY TRANSACTIONS
The parties related to the Company are deemed to include, in addition to its subsidiaries, jointly controlled entities, the Company’s key management personnel (the members of its Board of Directors and certain officers at the level of senior executive vice president or above, together with their close family members) and the entities over which the key management personnel may exercise significant influence or control.
Stockholder's Equity
Contributions from Santander that impact common stock and paid in capital within the Consolidated Statements of Stockholder's Equity are disclosed within the table below:
For Year Ended December 31, | ||||||||
(in thousands) | 2018 | 2017 | ||||||
Cash contribution | $ | 85,035 | $ | 9,000 | ||||
Net assets acquired | — | 2,747 | ||||||
Adjustment to book value of assets purchased on January 1 | 277 | — | ||||||
Deferred tax asset on purchased assets | 3,156 | — | ||||||
Contribution from shareholder | $ | 88,468 | $ | 11,747 | ||||
On January 1, 2018, the Company purchased certain assets and assumed certain liabilities of Produban Servicios Informaticos Generales S.L. (“Produban”) and Ingenieria De Software Bancario S.L. ("Isban"), both affiliates of Santander. The book value and fair value of the net assets acquired were $2.8 million and $15.3 million, respectively. Related to this transaction, in 2017, the Company received a net capital contribution from Santander of $2.8 million, representing cash received of $15.3 million and a return of capital of $12.5 million for the difference between the fair value of the assets purchased and the book value on the balance sheets of the affiliates. The Company re-evaluated the assets received on January 1, 2018 and recorded an additional $0.3 million to additional paid-in capital. During the year ended December 31, 2018, the Company recorded a $3.2 million deferred tax asset on the assets purchased by the Company to establish the intangible under Section 197 of the IRC. The Company contributed these assets at book value of $6.2 million to SBNA, a subsidiary of the Company, on January 1, 2018.
Effective November 2, 2018, Produban was merged with and into Isban, which immediately following the merger changed its name to Santander Global Technology S.L. (“Santander Global Technology”).
The Company received additional cash contributions of $85.0 million in 2018 from Santander.
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NOTE 21. RELATED PARTY TRANSACTIONS (continued)
Loan Sales
During 2017, SBNA sold $372.1 million of commercial loans to Santander. The sale resulted in $2.4 million of net gain for the year ended December 31, 2017, which is included in Miscellaneous income, net in the Consolidated Statements of Operations.
Letters of credit
In the normal course of business, SBNA provides letters of credit and standby letters of credit to affiliates. During the years ended December 31, 2018 and December 31, 2017, the average unfunded balance outstanding under these commitments was $82.7 million and $82.9 million, respectively.
Debt and Other Securities
The Company has various debt agreements with Santander. For a listing of these debt agreements, see Note 11 to the Consolidated Financial Statements. The Company has $8.5 billion of public securities consisting of various senior note obligations and trust preferred security obligations. Santander owned approximately 0.4% of the outstanding principal of these securities as of December 31, 2018.
Derivatives
As of December 31, 2018, the Company has entered into derivative agreements with Santander, which consist primarily of swap agreements to hedge interest rate risk and foreign currency exposure with notional values of $2.7 billion. As of December 31, 2017, the Company had derivative agreements with Santander and Abbey National Treasury Services plc, a subsidiary of Santander, with notional values of $2.0 billion and $0.1 billion, respectively.
Service Agreements
The Company and its affiliates entered into or were subject to various service agreements with Santander and its affiliates. Each of the agreements was made in the ordinary course of business and on market terms. Those agreements include the following:
• | NW Services Co., a Santander affiliate doing business as Aquanima, is under contract with the Company to provide procurement services, with fees paid in 2018 in the amount of $5.4 million, $3.7 million in 2017 and $3.6 million in 2016. There were no payables in connection with this agreement for the years ended December 31, 2018 or 2017. The fees related to this agreement are recorded in Technology, outside service, and marketing expense in the Consolidated Statements of Operations. |
• | Geoban, S.A., a Santander affiliate, is under contract with the Company to provide administrative services, consulting and professional services, application support and back-office services, including debit card disputes and claims support, and consumer and mortgage loan set-up and review, with total fees paid in 2018 in the amount of $1.8 million, $3.3 million in 2017 and $15.1 million in 2016. In addition, as of December 31, 2018 and 2017, the Company had payables with Geoban, S.A. in the amounts of zero and $0.2 million, respectively. The fees related to this agreement are recorded in Technology, outside service, and marketing expense in the Consolidated Statements of Operations. |
• | Santander Back-Offices Globales Mayoristas S.A., a Santander affiliate, is under contract with the Company to provide administrative services and back-office support for the Bank’s derivative, foreign exchange and hedging transactions and programs. Fees in the amounts of $1.9 million were paid to Santander Back-Offices Globales Mayoristas S.A. with respect to this agreement in 2018, and $1.1 million and $1.8 million in 2017 and 2016, respectively. There were no payables in connection with this agreement in 2018 or 2017. The fees related to this agreement are recorded in Technology, outside service, and marketing expense in the Consolidated Statements of Operations. |
• | Santander Global Technology S.L. (“Santander Global Technology”), is under contract with the Company to provide information technology development, support and administration, with fees for these services paid in 2018 in the amount of $38.7 million, $77.9 million in 2017 and $91.7 million in 2016. In addition, as of December 31, 2018 and 2017, the Company had payables for these services in the amounts of $0.8 million and $26.3 million, respectively. The fees related to this agreement are capitalized in Premises and equipment, net on the Consolidated Balance Sheets. |
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NOTE 21. RELATED PARTY TRANSACTIONS (continued)
• | Santander Global Technology is also under contract with the Company to provide professional services, and administration and support of information technology production systems, telecommunications and internal/external applications, with fees for these services paid in 2018 in the amount of $74.9 million, $110.7 million in 2017 and $123.4 million in 2016. In addition, as of December 31, 2018 and 2017, the Company had payables for these services in the amounts of $18.1 million and $10.2 million, respectively. The fees related to this agreement are capitalized in Premises and equipment, net on the Consolidated Balance Sheets. |
• | In addition, Santander Global Technology, is under contract with the Company to provide information technology development, support and administration, with fees paid in the amount of $5.5 million in 2018. As of December 31, 2018, the Company had payables with Santander Global Technology in the amounts of $21.9 million for these services. The fees related to this agreement are capitalized in Premises and equipment, net on the Consolidated Balance Sheets. |
• | During the year ended December 31, 2018, the Company paid $17.1 million to Santander for the development and implementation of global projects as part of group expense allocation. |
• | During the year ended December 31, 2018, the Company paid $3.9 million in rental payments to Santander, compared to $11.2 million in 2017 and $6.1 million in 2016. |
SC has entered into or was subject to various agreements with Santander, its affiliates or the Company. Each of the agreements was done in the ordinary course of business and on market terms. Those agreements include the following:
Revolving Agreements
SC had a $1.75 billion committed revolving credit agreement with Santander that can be drawn on an unsecured basis. During the years ended December 31, 2018, December 31, 2017 and December 31, 2016, SC incurred interest expense, including unused fees of $11.6 million, $51.7 million and $69.9 million, respectively. As of December 31, 2018 and 2017, SC had accrued interest payable of zero and $1.4 million, respectively. This facility was terminated during 2018.
In August 2015, under a new agreement with Santander, SC agreed to begin incurring a fee of 12.5 basis points per annum on certain warehouse facilities, as they renew, for which Santander provides a guarantee of SC's servicing obligations. SC recognized guarantee fee expense of $5.0 million, $6.0 million and $6.4 million for the years ended December 31, 2018, 2017 and 2016, respectively. As of December 31, 2018 and 2017, SC had $1.9 million and $7.6 million of fees payable to Santander under this arrangement.
Lease Origination and Servicing Agreement
During 2014 and until May 9, 2015, SC was party to a flow agreement with SBNA under which SBNA has the first right to review and approve Chrysler Capital consumer vehicle lease applications. SC could review any applications declined by SBNA for SC’s own portfolio. SC provides servicing and received an origination fee on all leases originated under this agreement. Pursuant to the Chrysler Agreement, SC pays FCA on behalf of SBNA for residual gains and losses on the flowed leases. All fees and expenses associated with this agreement between SBNA and SC eliminate in consolidation. In April 2015, SBNA and SC determined not to renew this agreement, which expired by its terms on May 9, 2015.
Securitizations
Other information relating to SPAIN securitization platform for the years ended December 31, 2018 and 2017 is as follows:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Servicing fee income | $ | 35,058 | $ | 12,346 | ||||
Loss (Gain) on sale, excluding lower of cost of market adjustments (if any) | 20,736 | 13,026 | ||||||
Servicing fees receivable | 2,983 | 1,848 | ||||||
Collections due to Santander | 15,968 | 12,961 | ||||||
During the year ended December 31, 2018, SC re-acquired certain class of notes amounting to approximately $76 million from unrelated third parties that it previously sold to Santander under the SPAIN securitization platform. These notes were redeemed by Santander at par value.
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NOTE 21. RELATED PARTY TRANSACTIONS (continued)
Origination Support Services
Beginning in 2018, SC agreed to provide SBNA with origination support services in connection with the processing, underwriting and purchase of retail loans, primarily from Chrysler dealers. In addition, SC has agreed to perform the servicing for any loans originated on SBNA’s behalf.
Other related-party transactions
• | As of December 31, 2018, Jason A. Kulas and Thomas Dundon, both former members of SC's Board of Directors and Chief Executive Officers ("CEOs") of SC, each had a minority equity investment in a property in which SC leases approximately 373,000 square feet as its corporate headquarters. During the years ended December 31, 2018, 2017 and 2016 SC recorded $4.8 million, $5.0 million and $5.0 million, respectively, in lease payments on this property. Future minimum lease payments over the nine-year term of the lease, which extends through 2026, total $55.6 million. |
• | SC entered into a Master Securities Purchase Agreement (an "MSPA") with Santander, under which it had the option to sell a contractually determined amount of eligible prime loans to Santander under the SPAIN securitization platform, for a term ending in December 2018. SC provides servicing on all loans originated under this arrangement. For the year ended December 31, 2018 and December 31, 2017, SC sold $2.9 billion and $2.6 billion of prime loans at fair value under the MSPA. |
• | SC is party to a master service agreement ("MSA") with a company in which it has a cost method investment and holds a warrant to increase its ownership if certain vesting conditions are satisfied. The MSA enables SC to review point-of-sale credit applications of retail store customers. During the year ended December 31, 2016, SC fully impaired its cost method investment in this entity and recorded a loss of $6.0 million. Effective August 17, 2016, SC ceased funding new originations from all of the retailers for which it reviews credit applications under this MSA. |
• | SC's wholly-owned subsidiary, Santander Consumer International Puerto Rico, LLC (SCI), opened deposit accounts with BSPR, an affiliated entity. As of December 31, 2018 and 2017, SCI had cash of $8.9 million and $106.6 million, respectively, on deposit with BSPR. This transaction eliminates in the consolidation of SHUSA. |
• | SBNA also has agreements with SC by which SC will service auto RICs and RV and marine portfolios. In addition, during the year ended December 31, 2017, SBNA purchased an RV/marine loan portfolio from SC. All fees and expenses associated with this agreement eliminate in consolidation. |
Entities that transferred to the IHC have entered into or were subject to various agreements with Santander or its affiliates. Each of the agreements was made in the ordinary course of business and on market terms. Those agreements include the following:
• | BSI enters into transactions with affiliated entities in the ordinary course of business. As of December 31, 2018, BSI had short-term borrowings from unconsolidated affiliates of $59.9 million compared to $78.7 million as of December 31, 2017. BSI had cash and cash equivalents deposited with affiliates of $46.2 million and $152.7 million as of December 31, 2018 and December 31, 2017, respectively. BSI had foreign exchange rate forward contracts with affiliates as counterparties with notional amounts of approximately $1.5 billion and $1.6 billion as of December 31, 2018 and December 31, 2017, respectively. BSI held deposits from unconsolidated affiliates of $55.7 million as of December 31, 2018. |
• | SIS enters into transactions with affiliated entities in the ordinary course of business. SIS executes, clears and custodies certain of its securities transactions through various affiliates in Latin America and Europe. The balance of payables to customers due to Santander at December 31, 2018 was $1.0 billion, compared to $1.1 billion at December 31, 2017. |
NOTE 22. REGULATORY MATTERS
The Company is subject to the regulations of certain federal, state, and foreign agencies, and undergoes periodic examinations by such regulatory authorities.
The minimum U.S. regulatory capital ratios for banks under Basel III are 4.5% for the common equity Tier 1 ("CET1") capital ratio, 6.0% for the Tier 1 capital ratio, 8.0% for the total capital ratio, and 4.0% for the leverage ratio. To qualify as “well-capitalized,” regulators require banks to maintain capital ratios of at least 6.5% for the CET1 capital ratio, 8.0% for the Tier 1 capital ratio, 10.0% for the total capital ratio, and 5.0% for the leverage ratio. At December 31, 2018 and 2017, the Bank met the well-capitalized capital ratio requirements.
188
NOTE 22. REGULATORY MATTERS (continued)
As a BHC, SHUSA is required to maintain a CET1 capital ratio of at least 4.5%, Tier 1 capital ratio of at least 6.0%, total capital ratio of at least 8.0%, and Leverage ratio of at least 4.0%. The Company’s capital levels exceeded the ratios required for BHCs. The Company's ability to make capital distributions will depend on the Federal Reserve's accepting the Company's capital plan, the results of the stress tests described in this Form 10-K, and the Company's capital status, as well as other supervisory factors.
The DFA mandates an enhanced supervisory framework, which, among other things, means that the Company is subject to both internal and Federal Reserve run stress tests. The Federal Reserve also has discretionary authority to establish additional prudential standards, on its own or at the Financial Stability Oversight Council's recommendation, regarding contingent capital, enhanced public disclosures, short-term debt limits, and otherwise as it deems appropriate.
The Company is also required to receive a notice of non-objection to its capital plans from the Federal Reserve and the OCC before taking capital actions, such as paying dividends, implementing common equity repurchase programs, or redeeming or repurchasing capital instruments.
For a discussion of Basel III and the standardized approach and related future changes to the minimum U.S. regulatory capital ratios, see the section of the MD&A captioned "Regulatory Matters."
The Federal Deposit Insurance Corporation Improvement Act established five capital tiers: well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A depository institution’s capital tier depends on its capital levels in relation to various capital measures, which include leverage and risk-based capital measures and certain other factors. Depository institutions that are not classified as well-capitalized or adequately-capitalized are subject to various restrictions regarding capital distributions, payment of management fees, acceptance of brokered deposits and other operating activities.
Federal banking laws, regulations and policies also limit the Bank’s ability to pay dividends and make other distributions to the Company. The Bank must obtain prior OCC approval to declare a dividend or make any other capital distribution if, after such dividend or distribution: (1) the Bank’s total distributions to SHUSA within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years; (2) the Bank would not meet capital levels imposed by the OCC in connection with any order, or (3) the Bank is not adequately capitalized at the time. The OCC's prior approval would be required if the Bank is notified by the OCC that it is a problem institution or in troubled condition.
Any dividend declared and paid or return of capital has the effect of reducing capital ratios. During 2018, 2017, and 2016 the Company paid cash dividends of $410.0 million, $10.0 million and zero, respectively. During 2018, 2017 and 2016, the Company also paid cash dividends to preferred shareholders of $11.0 million, $14.6 million and $15.1 million, respectively. During the third quarter of 2018, SHUSA redeemed all of its outstanding preferred stock.
The following schedule summarizes the actual capital balances of the Bank and SHUSA at December 31, 2018 and 2017:
REGULATORY CAPITAL | ||||||||||||||||
(Dollars in thousands) | Common Equity Tier 1 Capital Ratio | Tier 1 Capital Ratio | Total Capital Ratio | Leverage Ratio | ||||||||||||
SBNA at December 31, 2018(1): | ||||||||||||||||
Regulatory capital | $ | 10,179,299 | $ | 10,179,299 | $ | 10,819,641 | $ | 10,179,299 | ||||||||
Capital ratio | 17.14 | % | 17.14 | % | 18.22 | % | 14.08 | % | ||||||||
SHUSA at December 31, 2018(1): | ||||||||||||||||
Regulatory capital | $ | 16,758,748 | $ | 18,193,361 | $ | 19,807,403 | $ | 18,193,361 | ||||||||
Capital ratio | 15.53 | % | 16.86 | % | 18.35 | % | 14.03 | % | ||||||||
Common Equity Tier 1 Capital Ratio | Tier 1 Capital Ratio | Total Capital Ratio | Leverage Ratio | |||||||||||||
SBNA at December 31, 2017(1): | ||||||||||||||||
Regulatory capital | $ | 10,014,774 | $ | 10,014,774 | $ | 10,668,635 | $ | 10,014,774 | ||||||||
Capital ratio | 18.17 | % | 18.17 | % | 19.36 | % | 13.86 | % | ||||||||
SHUSA at December 31, 2017(1): | ||||||||||||||||
Regulatory capital | $ | 16,342,296 | $ | 17,795,929 | $ | 19,450,655 | $ | 17,795,929 | ||||||||
Capital ratio | 16.38 | % | 17.84 | % | 19.50 | % | 14.17 | % | ||||||||
(1) | Represents transitional ratios under Basel III |
189
NOTE 23. BUSINESS SEGMENT INFORMATION
Business Segment Products and Services
The Company’s reportable segments are focused principally around the customers the Company serves. During the first quarter of 2018, the Chief Operating Decision Maker ("CODM") made certain changes in its business lines that drove a reorganization of its business leadership to provide enhanced customer service to its clients and to better align management teams and resources with the manner in which the CODM allocates resources and assesses business performance. Accordingly, the following changes were made within the Company's reportable segments:
• | The Commercial Banking and the CRE reportable segments were combined into the Commercial Banking reportable segment. |
• | SIS, a subsidiary of SHUSA, that was formerly located within the Other category was moved to the GCB reportable segment. |
• | The Company's internal funds transfer pricing ("FTP") methodologies and cost allocations were updated to align with Santander corporate criteria for internal management reporting. These FTP and cost allocation changes impact how certain costs are allocated for all reporting segments, excluding SC. |
During the second quarter of 2018, Santander renamed its GCB business to CIB to more accurately reflect its business strategy and business proposition to clients, and to align with the name used by a majority of its competitors in the industry. There were no changes to composition of the reportable segment or reporting unit as a result of this change.
All prior period results have been recast to conform to the new composition of reportable segments, and for the revised errors disclosed in Note 1.
The Company has identified the following reportable segments:
• | The Consumer and Business Banking segment includes the products and services provided to Bank consumer and business banking customers, including consumer deposit, business banking, residential mortgage, unsecured lending and investment services. This segment offers a wide range of products and services to consumers and business banking customers, including demand and interest-bearing demand deposit accounts, money market and savings accounts, CDs and retirement savings products. It also offers lending products such as credit cards, mortgages, home equity lines of credit, and business loans such as business lines of credit and commercial cards. In addition, the Bank provides investment services to its retail customers, including annuities, mutual funds, and insurance products. Santander Universities, which provides grants and scholarships to universities and colleges as a way to foster education through research, innovation and entrepreneurship, is the last component of this segment. |
• | The Commercial Banking segment currently provides commercial lines, loans, letters of credit, receivables financing and deposits to medium and commercial customers, as well as financing and deposits for government entities, commercial real estate loans and multifamily loans to customers, commercial loans to dealers and financing for equipment and commercial vehicles. This segment also provides financing and deposits for government entities and niche product financing for specific industries. |
• | The CIB segment serves the needs of global commercial and institutional customers by leveraging the international footprint of Santander to provide financing and banking services to corporations with over $500 million in annual revenues. CIB also includes SIS, a registered broker-dealer located in New York that provides services in investment banking, institutional sales, and trading and offering research reports of Latin American and European equity and fixed-income securities. CIB's offerings and strategy are based on Santander's local and global capabilities in wholesale banking. |
• | SC is a specialized consumer finance company focused on vehicle finance and third-party servicing. SC’s primary business is the indirect origination of RICs, principally through manufacturer-franchised dealers in connection with their sale of new and used vehicles to retail consumers. In conjunction with a ten-year private label financing agreement with FCA that became effective May 1, 2013, SC offers a full spectrum of auto financing products and services to FCA customers and dealers under the Chrysler Capital brand. These products and services include consumer RICs and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. SC also originates vehicle loans through a web-based direct lending program, purchases vehicle RICs from other lenders, and services automobile, recreational and marine vehicle portfolios for other lenders. During 2015, SC announced its intention to exit the personal lending business. |
SC has entered into a number of intercompany agreements with the Bank as described above as part of the Other segment. All intercompany revenue and fees between the Bank and SC are eliminated in the consolidated results of the Company.
190
NOTE 23. BUSINESS SEGMENT INFORMATION (continued)
The Other category includes certain immaterial subsidiaries such as BSI, BSPR, SSLLC, and SFS, the unallocated interest expense on the Company's borrowings and other debt obligations and certain unallocated corporate income and indirect expenses. This category also includes the Bank’s community development finance activities, including originating CRA-eligible loans and making CRA-eligible investments.
The Company’s segment results, excluding SC and the entities that have been transferred to the IHC, are derived from the Company’s business unit profitability reporting system by specifically attributing managed balance sheet assets, deposits and other liabilities and their related interest income or expense to each of the segments. FTP methodologies are utilized to allocate a cost for funds used or a credit for funds provided to business line deposits, loans and selected other assets using a matched funding concept. The methodology includes a liquidity premium adjustment, which considers an appropriate market participant spread for commercial loans and deposits by analyzing the mix of borrowings available to the Company with comparable maturity periods.
Other income and expenses are managed directly by each reportable segment, including fees, service charges, salaries and benefits, and other direct expenses, as well as certain allocated corporate expenses, and are accounted for within each segment’s financial results. Accounting policies for the lines of business are the same as those used in preparation of the Consolidated Financial Statements with respect to activities specifically attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and benefits, expenses and other financial elements to each line of business. Where practical, the results are adjusted to present consistent methodologies for the segments.
The application and development of management reporting methodologies is a dynamic process and is subject to periodic enhancements. The implementation of these enhancements to the internal management reporting methodology may materially affect the results disclosed for each segment with no impact on consolidated results. Whenever significant changes to management reporting methodologies take place, prior period information is reclassified wherever practicable.
The CODM manages SC on a historical basis by reviewing the results of SC on a pre-Change in Control basis. The Results of Segments table discloses SC's operating information on the same basis that it is reviewed by the CODM. The adjustments column includes adjustments to reconcile SC's GAAP results to SHUSA's consolidated results.
Results of Segments
The following tables present certain information regarding the Company’s segments.
For the Year Ended | SHUSA Reportable Segments | |||||||||||||||||||||||||
December 31, 2018 | Consumer & Business Banking | Commercial Banking | CIB | Other(2) | SC(3) | SC Purchase Price Adjustments(4) | Eliminations(4) | Total | ||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||
Net interest income | $ | 1,301,671 | $ | 639,558 | $ | 136,402 | $ | 239,664 | $ | 3,958,280 | $ | 31,083 | $ | 38,192 | $ | 6,344,850 | ||||||||||
Non-interest income | 308,614 | 87,803 | 195,210 | 405,319 | 2,297,517 | 9,678 | (59,833 | ) | 3,244,308 | |||||||||||||||||
Provision for / (release of) credit losses | 100,523 | (19,405 | ) | 9,335 | 24,254 | 2,205,585 | 19,606 | — | 2,339,898 | |||||||||||||||||
Total expenses | 1,487,835 | 327,291 | 235,979 | 887,681 | 2,857,944 | 47,173 | (11,578 | ) | 5,832,325 | |||||||||||||||||
Income/(loss) before income taxes | 21,927 | 419,475 | 86,298 | (266,952 | ) | 1,192,268 | (26,018 | ) | (10,063 | ) | 1,416,935 | |||||||||||||||
Intersegment revenue/(expense)(1) | 2,507 | 9,420 | (12,362 | ) | 435 | — | — | — | — | |||||||||||||||||
Total assets | 21,024,741 | 25,712,309 | 8,521,004 | 36,416,376 | 43,959,855 | — | — | 135,634,285 | ||||||||||||||||||
(1) | Intersegment revenue/(expense) represents charges or credits for funds used or provided by each of the segments and is included in net interest income. |
(2) | Other includes the results of the entities transferred to the IHC, earnings from non-strategic assets, the investment portfolio, interest expense on the Bank’s and the Company's borrowings and other debt obligations, amortization of intangible assets and certain unallocated corporate income and indirect expenses. |
(3) | Management of SHUSA manages SC by analyzing the pre-Change in Control results of SC as disclosed in this column. |
(4) | SC Purchase Price Adjustments represents the impact that SC purchase marks had on the results of SC included within the consolidated operations of SHUSA, while eliminations eliminate intercompany transactions. |
191
NOTE 23. BUSINESS SEGMENT INFORMATION (continued)
For the Year Ended | SHUSA Reportable Segments | |||||||||||||||||||||||||
December 31, 2017 | Consumer & Business Banking | Commercial Banking | CIB | Other(2) | SC(3) | SC Purchase Price Adjustments(4) | Eliminations(4) | Total | ||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||
Net interest income | $ | 1,115,169 | $ | 630,078 | $ | 153,622 | $ | 255,096 | $ | 4,114,600 | $ | 124,551 | $ | 30,834 | $ | 6,423,950 | ||||||||||
Non-interest income | 356,936 | 70,219 | 186,749 | 548,806 | 1,793,408 | (9,177 | ) | (45,688 | ) | 2,901,253 | ||||||||||||||||
Provision for / (release of) credit losses | 85,115 | 29,586 | 33,275 | 93,165 | 2,363,812 | 154,991 | — | 2,759,944 | ||||||||||||||||||
Total expenses | 1,500,815 | 324,385 | 218,696 | 955,292 | 2,740,190 | 44,066 | (19,120 | ) | 5,764,324 | |||||||||||||||||
Income/(loss) before income taxes | (113,825 | ) | 346,326 | 88,400 | (244,555 | ) | 804,006 | (83,683 | ) | 4,266 | 800,935 | |||||||||||||||
Intersegment revenue/(expense)(1) | 2,330 | 6,137 | (8,086 | ) | (381 | ) | — | — | — | — | ||||||||||||||||
Total assets | 18,714,285 | 25,318,068 | 6,949,373 | 37,890,000 | 39,402,799 | — | — | 128,274,525 | ||||||||||||||||||
(1) | Intersegment revenue/(expense) represents charges or credits for funds used or provided by each of the segments and is included in net interest income. |
(2) | Other includes the results of the entities transferred to the IHC, earnings from non-strategic assets, the investment portfolio, interest expense on the Bank’s and the Company's borrowings and other debt obligations, amortization of intangible assets and certain unallocated corporate income and indirect expenses. |
(3) | Management of SHUSA manages SC by analyzing the pre-Change in Control results of SC as disclosed in this column. |
(4) | SC Purchase Price Adjustments represents the impact that SC purchase marks had on the results of SC included within the consolidated operations of SHUSA, while eliminations eliminate intercompany transactions. |
For the Year Ended | SHUSA Reportable Segments | |||||||||||||||||||||||||
December 31, 2016 | Consumer & Business Banking | Commercial Banking | CIB | Other(2) | SC(3) | SC Purchase Price Adjustments(4) | Eliminations(4) | Total | ||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||
Net interest income | $ | 981,951 | $ | 638,001 | $ | 239,074 | $ | 51,736 | $ | 4,448,535 | $ | 187,296 | $ | 18,099 | $ | 6,564,692 | ||||||||||
Total non-interest income | 384,210 | 87,144 | 241,992 | 622,145 | 1,432,634 | 42,271 | (54,691 | ) | 2,755,705 | |||||||||||||||||
Provision for credit losses | 56,446 | 85,910 | 7,952 | 52,490 | 2,468,199 | 308,728 | — | 2,979,725 | ||||||||||||||||||
Total expenses | 1,511,427 | 318,400 | 228,999 | 1,065,027 | 2,252,259 | 56,557 | (46,475 | ) | 5,386,194 | |||||||||||||||||
Income/(loss) before income taxes | (201,712 | ) | 320,835 | 244,115 | (443,636 | ) | 1,160,711 | (135,718 | ) | 9,883 | 954,478 | |||||||||||||||
Intersegment revenue/(expense)(1) | 42,168 | 28,464 | (1,728 | ) | (68,904 | ) | — | — | — | — | ||||||||||||||||
(1) | Intersegment revenue/(expense) represents charges or credits for funds used or provided by each of the segments and is included in net interest income. |
(2) | Other includes the results of the entities transferred to the IHC, earnings from non-strategic assets, the investment portfolio, interest expense on the Bank’s and the Company's borrowings and other debt obligations, amortization of intangible assets and certain unallocated corporate income and indirect expenses. |
(3) | Management of SHUSA manages SC by analyzing the pre-Change in Control results of SC as disclosed in this column. |
(4) | SC Purchase Price Adjustments represents the impact that SC purchase marks had on the results of SC included within the consolidated operations of SHUSA, while eliminations eliminate intercompany transactions. |
During the fourth quarter of 2018, the CODM drove a reorganization of its business leadership to better align the teams with how the CODM allocates resources and assesses business performance. Changes were made to the internal management reporting in 2019 and, accordingly, beginning in the first quarter of 2019, the current Commercial Banking segment will be reported as two separate reportable segments: Commercial Banking and Commercial Real Estate.
192
NOTE 24. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of the parent company is as follows:
BALANCE SHEETS
AT DECEMBER 31, | ||||||||
2018 | 2017 | |||||||
(in thousands) | ||||||||
Assets | ||||||||
Cash and cash equivalents | $ | 3,562,789 | $ | 4,369,307 | ||||
AFS investment securities | 247,510 | 248,692 | ||||||
Loans to non-bank subsidiaries | 3,500,000 | 3,000,000 | ||||||
Investment in subsidiaries: | ||||||||
Bank subsidiary | 11,219,433 | 11,160,429 | ||||||
Non-bank subsidiaries | 10,915,872 | 10,375,573 | ||||||
Premises and equipment, net | 52,447 | 84,873 | ||||||
Equity method investments | 3,801 | 9,324 | ||||||
Restricted cash | 79,555 | 74,156 | ||||||
Deferred tax assets, net | 66 | 29,096 | ||||||
Other assets | 348,268 | 284,500 | ||||||
Total assets | $ | 29,929,741 | $ | 29,635,950 | ||||
Liabilities and stockholder's equity | ||||||||
Borrowings and other debt obligations | $ | 8,351,685 | $ | 8,149,565 | ||||
Borrowings from non-bank subsidiaries | 145,165 | 142,554 | ||||||
Deferred tax liabilities, net | 61,332 | 65,814 | ||||||
Other liabilities | 235,144 | 245,249 | ||||||
Total liabilities | 8,793,326 | 8,603,182 | ||||||
Stockholder's equity | 21,136,415 | 21,032,768 | ||||||
Total liabilities and stockholder's equity | $ | 29,929,741 | $ | 29,635,950 | ||||
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME/(LOSS)
YEAR ENDED DECEMBER 31, | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
(in thousands) | ||||||||||||
Interest income | $ | 123,389 | $ | 67,369 | $ | 12,350 | ||||||
Income from equity method investments | 78 | 2,737 | 185 | |||||||||
Other income | 67,100 | 52,584 | 34,213 | |||||||||
Net gains on sale of investment securities | — | 1,845 | — | |||||||||
Total income | 190,567 | 124,535 | 46,748 | |||||||||
Interest expense | 288,006 | 214,280 | 155,256 | |||||||||
Other expense | 301,418 | 349,882 | 361,229 | |||||||||
Total expense | 589,424 | 564,162 | 516,485 | |||||||||
Loss before income taxes and equity in earnings of subsidiaries | (398,857 | ) | (439,627 | ) | (469,737 | ) | ||||||
Income tax (benefit)/provision | (51,114 | ) | 18,165 | (121,840 | ) | |||||||
Loss before equity in earnings of subsidiaries | (347,743 | ) | (457,792 | ) | (347,897 | ) | ||||||
Equity in undistributed earnings of: | ||||||||||||
Bank subsidiary | 489,452 | 239,887 | 230,017 | |||||||||
Non-bank subsidiaries | 565,695 | 770,255 | 480,764 | |||||||||
Net income | 707,404 | 552,350 | 362,884 | |||||||||
Other comprehensive income, net of tax: | ||||||||||||
Net unrealized (losses)/gains on cash flow hedge derivative financial instruments | (3,796 | ) | 337 | 9,856 | ||||||||
Net unrealized losses recognized on investment securities | (80,891 | ) | (9,744 | ) | (34,812 | ) | ||||||
Amortization of defined benefit plans | 560 | 4,184 | 2,278 | |||||||||
Total other comprehensive loss | (84,127 | ) | (5,223 | ) | (22,678 | ) | ||||||
Comprehensive income | $ | 623,277 | $ | 547,127 | $ | 340,206 | ||||||
193
NOTE 24. PARENT COMPANY FINANCIAL INFORMATION (continued)
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31 | ||||||||||||
2018 | 2017 | 2016 | ||||||||||
(in thousands) | ||||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||
Net income | $ | 707,404 | $ | 552,350 | $ | 362,884 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Deferred tax expense/(benefit) | 24,277 | 75,053 | (94,551 | ) | ||||||||
Undistributed earnings of: | ||||||||||||
Bank subsidiary | (489,452 | ) | (239,887 | ) | (230,017 | ) | ||||||
Non-bank subsidiaries | (565,695 | ) | (770,255 | ) | (480,764 | ) | ||||||
Net gain on sale of investment securities | — | (1,845 | ) | — | ||||||||
Stock based compensation expense | — | (164 | ) | 395 | ||||||||
Equity earnings from equity method investments | (78 | ) | (2,737 | ) | (185 | ) | ||||||
Dividends from investment in subsidiaries | 592,797 | 150,330 | — | |||||||||
Depreciation, amortization and accretion | 44,388 | 45,475 | 24,201 | |||||||||
Loss on debt extinguishment | 3,955 | 5,582 | — | |||||||||
Net change in other assets and other liabilities | (60,256 | ) | 51,267 | 11,484 | ||||||||
Net cash provided by/(used in) operating activities | 257,340 | (134,831 | ) | (406,553 | ) | |||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||
Proceeds from sales of AFS investment securities | — | 741,250 | — | |||||||||
Proceeds from prepayments and maturities of AFS investment securities | — | — | 2,000,000 | |||||||||
Purchases of AFS investment securities | — | — | (2,990,800 | ) | ||||||||
Net capital (contributed to)/returned from subsidiaries | (208,622 | ) | (37,380 | ) | 45,616 | |||||||
Originations of loans to subsidiaries | (4,295,000 | ) | (5,105,000 | ) | — | |||||||
Repayments of loans by subsidiaries | 3,795,000 | 2,405,000 | — | |||||||||
Purchases of premises and equipment | (15,333 | ) | (22,493 | ) | (33,762 | ) | ||||||
Net cash used in investing activities | (723,955 | ) | (2,018,623 | ) | (978,946 | ) | ||||||
CASH FLOWS FROM FINANCIAL ACTIVITIES: | ||||||||||||
Repayment of parent company debt obligations | (1,224,474 | ) | (931,252 | ) | (1,976,037 | ) | ||||||
Net proceeds received from Parent Company senior notes and senior credit facility | 1,423,274 | 4,656,279 | 3,094,249 | |||||||||
Net change in borrowings from non-bank subsidiaries | 2,611 | 1,400 | 1,010 | |||||||||
Dividends to preferred stockholders | (10,950 | ) | (14,600 | ) | (15,128 | ) | ||||||
Dividends paid on common stock | (410,000 | ) | (10,000 | ) | — | |||||||
Capital contribution from shareholder | 85,035 | 9,000 | — | |||||||||
Impact of SC stock option activity | — | — | 69 | |||||||||
Redemption of preferred stock | (200,000 | ) | — | (75,000 | ) | |||||||
Net cash (used in)/provided by financing activities | (334,504 | ) | 3,710,827 | 1,029,163 | ||||||||
Net (decrease)/increase in cash, cash equivalents, and restricted cash (1) | (801,119 | ) | 1,557,373 | (356,336 | ) | |||||||
Cash, cash equivalents, and restricted cash at beginning of period (1) | 4,443,463 | 2,886,090 | 3,242,426 | |||||||||
Cash, cash equivalents, and restricted cash at end of period (1) | $ | 3,642,344 | $ | 4,443,463 | $ | 2,886,090 | ||||||
NON-CASH TRANSACTIONS | ||||||||||||
Capital expenditures in accounts payable | $ | 8,174 | $ | 10,729 | $ | 25,027 | ||||||
Capital distribution to shareholder | — | — | 30,789 | |||||||||
Contribution of SFS from shareholder (2) | — | 322,078 | — | |||||||||
Contribution of incremental SC shares from shareholder | — | 566,378 | — | |||||||||
Contribution of SAM from shareholder (2) | 4,396 | — | — | |||||||||
(1) The beginning, ending and net change balances for the periods ended December 31, 2018, December 31, 2017, and December 31, 2016 include restricted cash balances of $74.2 million, $79.6 million, and $5.4 million, respectively; $74.0 million, $74.2 million, and $133 thousand, respectively; and $73.1 million, $74.0 million, and $963 thousand, respectively.
(2) The contributions of SFS and SAM were accounted for as non-cash transactions. Refer to Note 1 - Basis of Presentation and Accounting Policies for additional information.
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ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Company has had no disagreements with its auditors on accounting principles, practices or financial statement disclosure during and through the date of the financial statements included in this report.
ITEM 9A - CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our CEO and Chief Financial Officer ("CFO"), has evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a- 15(e) and 15d- 15(e) under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that, as of December 31, 2018, we did not maintain effective disclosure controls and procedures because of the material weaknesses in internal control over financial reporting described below. In light of these material weaknesses, management completed additional procedures and analysis to validate the accuracy and completeness of the reported financial results. In addition, management engaged the Audit Committee directly, in detail, to discuss the procedures and analysis performed to ensure the reliability of the Company's financial reporting. Notwithstanding these material weaknesses, based on the additional analysis and other procedures performed, management concluded that the Consolidated Financial Statements included in this report fairly present in all material respects our financial position, results of operations, capital position, and cash flows for the periods presented, in conformity with GAAP.
Management's Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). The Company's internal control over financial reporting is a process designed under the supervision of the Company's CEO and CFO to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external purposes in accordance with GAAP.
Management's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
As of December 31, 2018, management assessed the effectiveness of the Company's internal control over financial reporting based on the criteria established in "Internal Control - Integrated Framework," issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission (the 2013 framework). A material weakness (as defined in Rule 12b-2 under the Exchange Act) is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement in our annual or interim financial statements will not be prevented or detected on a timely basis.
Based on the assessment, management determined that the Company did not maintain effective internal control over financial reporting as of December 31, 2018, because of the material weaknesses noted below. These deficiencies in the Company's controls could result in a misstatement of any account balance or disclosure that in turn, would result in a material misstatement of the annual or interim consolidated financial statements that would not be prevented or detected.
1. | Control Environment |
The Company's financial reporting involves complex accounting matters emanating from our majority-owned subsidiary SC. We determined there was a material weakness in the design and operating effectiveness of the controls pertaining to our oversight of SC's accounting for transactions that are significant to the Company’s internal control over financial reporting. These deficiencies included (a) ineffective oversight to ensure accountability at SC for the performance of internal controls over financial reporting and to ensure corrective actions, where necessary, were appropriately prioritized and implemented in a timely manner; and (b) inadequate resources and technical expertise at SHUSA to perform effective oversight of the application of accounting and financial reporting activities that are significant to the Company’s consolidated financial statements.
This material weakness did not result in a material misstatement to the annual or interim consolidated financial statements.
We have identified the following material weakness emanating from SC:
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2. | SC’s Control Environment, Risk Assessment, Control Activities and Monitoring |
We did not maintain effective internal control over financial reporting related to our control environment, risk assessment, control activities and monitoring:
• | Management did not effectively execute a strategy to hire and retain a sufficient complement of personnel with an appropriate level of knowledge, experience, and training in certain areas important to financial reporting. |
• | The tone at the top was insufficient to ensure there were adequate mechanisms and oversight to ensure accountability for the performance of internal control over financial reporting responsibilities and to ensure corrective actions were appropriately prioritized and implemented in a timely manner. |
• | There was not adequate management oversight of accounting and financial reporting activities in implementing certain accounting practices to conform to the Company’s policies and GAAP. |
• | There was not an adequate assessment of changes in risks by management that could significantly impact internal control over financial reporting or an adequate determination and prioritization of how those risks should be managed. |
• | There was not adequate management oversight and identification of models, spreadsheets and completeness and accuracy of data material to financial reporting. |
• | There were insufficiently documented Company accounting policies and insufficiently detailed Company procedures to put policies into effective action. |
• | There was a lack of appropriate tone at the top in establishing an effective control owner for the risk and controls self-assessment process, which contributed to a lack of clarity about ownership of risk assessments and control design and effectiveness. |
• | There was insufficient governance, oversight and monitoring of the credit loss allowance and accretion processes and a lack of defined roles and responsibilities in monitoring functions. |
This material weakness resulted in the revision of the Company’s consolidated financial statements for the year ended December 31, 2017, as well as the unaudited condensed consolidated financial statements for the quarters ended June 30, 2018, March 31, 2018, September 30, 2017, June 30, 2017 and March 31, 2017.
In addition to the above items emanating from SC, the following material weakness was identified at the SHUSA level:
3. Review of Statement of Cash Flows and Footnotes
Management identified a material weakness in internal control over the Company's process to prepare and review the Statement of Cash Flows (“SCF”) and Notes to the Consolidated Financial Statements. Specifically, the Company concluded that it did not have adequate controls designed and in place over the preparation and review of such information.
This material weakness did not result in a material misstatement to the annual or interim consolidated financial statements.
PricewaterhouseCoopers LLP, our independent registered public accounting firm, has audited the effectiveness of the Company's internal control over financial reporting as of December 31, 2018, as stated in their report which appears herein.
Remediation Status of Reported Material Weaknesses
The Company is currently working to remediate the material weaknesses described above, including assessing the need for additional remediation steps and implementing additional measures to remediate the underlying causes that gave rise to the material weaknesses. The Company is committed to maintaining a strong internal control environment and to ensure that a proper, consistent tone is communicated throughout the organization, including the expectation that previously existing deficiencies will be remediated through implementation of processes and controls to ensure strict compliance with GAAP.
To address the material weakness in the control environment (material weakness 1, noted above), the Company is in the process of strengthening its processes and controls as follows:
• | Established regular working group meetings, with appropriate oversight by management, to review and challenge complex accounting matters and strengthen accountability for performance of internal control over financial reporting responsibilities and prioritization of corrective actions. |
• | Appointed a Head of Internal Controls with significant public company financial reporting experience and the requisite skillsets in areas important to financial reporting. |
• | Developed a plan to enhance its risk assessment processes, control procedures and documentation, including the implementation of a Company-wide comprehensive risk assessment to identify the processes and financial statement areas with higher risks of misstatement. |
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• | Continued to establish policies and procedures for the oversight of subsidiaries that includes accountability for each subsidiary for maintenance of accounting policies, evaluation of significant and unusual transactions, material estimates, and regular reporting and review of changes in the control environment and related accounting processes. |
• | Reallocated additional Company resources to improve the oversight of subsidiary operations and to ensure sufficient staffing to conduct enhanced financial reporting reviews. |
• | Collaborated with other departments, such as Accounting Policy and Legal, to ensure entity information/data is shared and reviewed accordingly. |
To address the material weakness in SC’s control environment, risk assessment, control activities and monitoring (material weakness 2, noted above), the Company is in the process of strengthening its processes and controls as follows:
• | Appointed an additional independent director to the Audit Committee of the SC Board with extensive experience as a financial expert in SC's industry to provide further experience on the committee. |
• | Established regular working group meetings, with appropriate oversight by management of both the Company and SC, to strengthen accountability for performance of internal control over financial reporting responsibilities and prioritization of corrective actions. |
• | Hired a Chief Accounting Officer and other key personnel with significant public company financial reporting experience and the requisite skillsets in areas important to financial reporting. |
• | Developed and implemented a plan to enhance its risk assessment processes, control procedures and documentation. |
• | Reallocated additional Company resources to improve the oversight for certain financial models. |
• | Increased accounting resources with qualified permanent resources to ensure sufficient staffing to conduct enhanced financial reporting procedures and to continue the remediation efforts. |
• | Improved management documentation, review controls and oversight of accounting and financial reporting activities to ensure accounting practices conform to the Company’s policies and GAAP. |
• | Increased accounting participation in critical governance activities to ensure an adequate assessment of risk activities which may impact financial reporting or the related internal controls. |
• | Completed a comprehensive review and update of all accounting policies, process descriptions and control activities. |
• | Developed and implemented additional documentation, controls and governance for the credit loss allowance and accretion processes. |
• | Conducted internal training courses over Sarbanes-Oxley regulations and the Company’s internal control over financial reporting program for Company personnel that take part and assist in the execution of the program. |
To address the material weaknesses in the review of SCF and footnotes (material weakness 3, noted above), the Company is in the process of strengthening its controls as follows:
• | Improved the review controls over financial statements and the related disclosures to include a more comprehensive disclosure checklist and improved review procedures from certain members of the management. |
• | Designed and implemented additional controls over the preparation and the review of the SCF and Notes to the Consolidated Financial Statements. |
• | Strengthening the review controls, reconciliations and supporting documentation related to the classification of cash flows between operating activities and investing activities in the SCF. |
• | Enhanced the risk assessment process to identify higher risk data provisioning processes. |
• | Implementing additional completeness and accuracy reviews at a detailed level at the statement preparation and data provider levels. |
While progress has been made to remediate all of these material weaknesses, including the development and implementation of enhanced processes, procedures and controls, as of December 31, 2018, we are still in the process of testing the operating effectiveness of the new and enhanced controls. We believe our actions will be effective in remediating the material weaknesses, and we continue to devote significant time and attention to these efforts. However, the material weaknesses will not be considered remediated until the applicable remedial processes and procedures have been in place for a sufficient period of time and management has concluded, through testing, that these controls are effective. Accordingly, the material weaknesses are not remediated as of December 31, 2018.
Remediation Status of Previously Reported Material Weaknesses
Management completed the implementation of remediation efforts related to the following previously reported material weaknesses emanating from SC and considers the following remediated:
Development, Approval, and Monitoring of Models Used to Estimate the Credit Loss Allowance
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Various deficiencies were identified in the credit loss allowance process related to review, monitoring and approval processes over models and model changes that aggregated to a material weakness. The following controls did not operate effectively:
• | Review controls over completeness and accuracy of data, inputs and assumptions in models and spreadsheets used for estimating credit loss allowance and related model changes were not effective and management did not adequately challenge significant assumptions. |
• | Review and approval controls over the development of new models to estimate credit loss allowance and related model changes were ineffective. |
• | Adequate and comprehensive performance monitoring over related model output results was not performed and we did not maintain adequate model documentation. |
To address this material weakness, the Company completed the following measures:
• | Completed a comprehensive design effectiveness review and augmentation of the controls to ensure all critical risks are addressed. |
• | Implemented a more comprehensive monitoring plan for the credit loss allowance with a specific focus on model inputs, changes in model assumptions and model outputs to ensure an effective execution of the Company’s risk strategy. |
• | Implemented improved controls over the development of new models or changes to models used to estimate credit loss allowance. |
• | Implemented enhanced on-going performance monitoring procedures. |
• | Developed comprehensive model documentation. |
• | Enhanced the Company’s communication on related issues with its senior leadership team and the Board, including the Risk Committee and the Audit Committee. |
• | Increased resources dedicated to the analysis, review and documentation to ensure compliance with GAAP and the Company’s policies. |
Identification, Governance, and Monitoring of Models Used to Estimate Accretion
Various deficiencies were identified in the accretion process related to review, monitoring and governance processes over models that aggregated to a material weakness. The following controls did not operate effectively:
• | Review controls over completeness and accuracy of data, inputs, calculation and assumptions in models and spreadsheets used for estimating accretion were not effective and management did not adequately challenge significant assumptions. |
• | Review and approval controls over the development of new models to estimate accretion and related model changes were ineffective. |
• | Adequate and comprehensive performance monitoring over related model output results was not performed and we did not maintain adequate model documentation. |
To address this material weakness, the Company completed the following measures:
• | Developed a comprehensive accretion model documentation manual and implemented on-going performance monitoring to ensure compliance with required standards. |
• | Automated the process for the application of the effective interest rate method for accreting discounts, subvention payments from manufacturers and other origination costs on individually acquired RICs. |
• | Implemented comprehensive review controls over data, inputs and assumptions used in the models. |
• | Strengthened review controls and change management procedures over the models used to estimate accretion. |
• | Increased accounting resources with qualified, permanent resources to ensure an adequate level of review and execution of control activities. |
Changes in Internal Control over Financial Reporting
Except as described above under "Remediation Status of Reported Material Weaknesses," there were no changes in the Company's internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter-ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Effectiveness of Disclosure Controls and Procedures
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.
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ITEM 9B - OTHER INFORMATION
None.
PART III
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Our Board has established the following standing Board level committees of SHUSA: Audit Committee, Compensation and Talent Management Committee (“Compensation Committee”), Nominations and Executive Committee (“Nominations Committee”), and Joint SHUSA and Combined U.S. Operations of Santander Risk Committee (“SHUSA/US Risk Committee”). Certain information relating to the directors of SHUSA as of the filing date of this Form 10-K is set forth below.
Directors of SHUSA
Jose Doncel - Age 57. Mr. Doncel was appointed to SHUSA’s Board in July 2016, SBNA’s Board in June 2016, and SC’s Board in December 2015. He serves as the Chairman of Banco de Albacete, S.A., Administración de Bancos Latinoamericanos Santander, S.L., Grupo Empresarial Santander, S.L., Santander Investment I, S.A., Ablasa Participaciones, S.L. and Finsantusa, S.L., and a member of the Boards of Santander Holding Internacional, S.A., Santusa Holding, S.L., Ingenieria de Software Bancario, S.L., Geoban, S.A., Santander Global Technology and Banco Popular Espanol S.A. Mr. Doncel has served as a senior executive of Santander and certain predecessor companies since 1993, currently as Senior Executive Vice President and Director of the Accounting and Control division since October 2014. He has also served as the Director of the Corporate Division of Internal Audit from June 2013 to October 2014 and Director of the Retail Banking Management Control Area from April 2013 to June 2013. Prior to his time with Santander, Mr. Doncel worked for Arthur Andersen Auditores, S.A., Division of Financial Institutions. Mr. Doncel holds a degree in Economic and Business Studies from Universidad Complutense de Madrid. He brings extensive banking industry leadership experience to the Board as a result of his Board and professional experience.
Stephen A. Ferriss - Age 73. Mr. Ferriss was appointed to SHUSA’s Board in 2012 and is a member of its Audit and Compensation Committees. In 2018, he was appointed to BSI's Board and he is Chairman of its Risk Committee and a member of its Audit Committee. Since 2015, he has served as Chairman of the Board of Santander BanCorp, where he is a member of the Compensation and Nomination Committee, and as the Chairman of the Board of Santander BanCorp’s banking subsidiary, BSPR. He was appointed to SC’s Board in 2013 and has served as Vice Chairman of the Board since 2015. He is Chairman of its Risk Committee and a member of its Audit, Compensation and Executive Committees. From 2012 to 2015, Mr. Ferriss served on the Board of the Bank, where he was a member of the Audit, Enterprise Risk, and Bank Secrecy Act/Anti-Money Laundering Oversight Committees. From 2006 to June 2016, he was Chairman of the Nominations Committee and senior independent director of Management Consulting Group PLC, London, a publicly traded company on the London Stock Exchange, and served as Chairman of its Audit Committee from 2008 to 2011. From 2007 to 2013, he served on the Board of Iberchem in Madrid, Spain. From 1999 to 2002, Mr. Ferriss served as President and Chief Executive Officer of Santander Central Hispano Investment Securities, Inc. Prior to his service for Santander Central Hispano Investment Services, Inc., Mr. Ferriss held various roles at Bankers Trust Global Investment Bank in Madrid, London and New York. Prior to his time at Bankers Trust Global Investment Bank, Mr. Ferriss served in various leadership positions for 19 years at Bank of America. Mr. Ferriss received a B.A. from Columbia College and an M.I.A. from Columbia University’s School of International Affairs. He brings extensive global experience to the Board as a result of his Board and professional experience.
Alan Fishman - Age 72. Mr. Fishman was appointed to SHUSA’s and the Bank’s Boards in 2015. He is a member of SHUSA’s Audit and SHUSA/US Risk Committees and is the Bank's Lead Independent Director, and serves as the Chairman of the Bank's Audit Committee and a member of the Nominations and Risk Committees. Mr. Fishman was appointed to the SIS Board in 2017 where he serves as Chairman of the Board. Since 2008, Mr. Fishman has served as Chairman of the Board of Ladder Capital, a leading commercial real estate finance company, and, since 2005, has served on the Board of Continental Grain Company. Mr. Fishman has had an extensive career in the financial services industry. From 2008 to 2013, he served as Chairman of the Board of Beech Street Capital, and for a brief time in 2008, served as Chief Executive Officer of Washington Mutual, Inc. Prior to serving with Washington Mutual, he served as Chairman of Meridian Capital Group and as President of Sovereign Bancorp. From 2001 to 2006, Mr. Fishman served as President and Chief Executive Officer of Independence Community Bank until its sale to Sovereign Bank in 2006. Previously, Mr. Fishman served as President and Chief Executive Officer of Conti Financial Corp. He was also a private equity investor, focused on financial services, at Neuberger and Berman, Adler & Shaykin, and at his own firm, Columbia Financial Partners LP. He held a variety of senior executive positions at Chemical Bank and American International Group. He is active in the community, having served as Chairman of the Brooklyn Academy of Music from 2002 to 2016, Chairman of the Brooklyn Navy Yard from 2002 to 2014, and currently as Chairman of the Brooklyn Community Foundation. He received a B.A. from Brown University and an M.A. from Columbia University. Mr. Fishman brings extensive leadership experience and financial services industry expertise to the Board.
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Juan Guitard- Age 59. Mr. Guitard was appointed to SHUSA’s Board in 2014 and is a member of its Compensation and SHUSA/US Risk Committees. He has served as a member of the Bank's Board since March 2016 and BSI's Board since August 2016, where he is a member of the Risk and Compensation Committees. Mr. Guitard currently serves as Head of Internal Audit of Santander. He has worked within Santander since 1999, having also served as Head of its Corporate Risk Division, Head of its Recovery and Resolution Plans Corporate Project, Head of its Corporate Legal Department, and Head of its Corporate Investment Banking Division. He has served on the Boards of Santander, Banco Español de Crédito, S.A., and Banco Hipotecario de España. He holds a law degree from the Universidad Autónoma de Madrid. Mr. Guitard brings extensive risk and audit experience to the Board.
Thomas S. Johnson - Age 78. Mr. Johnson was appointed to SHUSA’s and the Bank’s Boards in 2015. He serves as SHUSA’s Lead Independent Director, Chairman of its Audit Committee, and a member of its Nominations and SHUSA/US Risk Committees. He serves as a member of the Bank’s Audit and Risk Committees. Mr. Johnson serves on the Boards of the Institute of International Education, the Inner-City Scholarship Fund, the National 9/11 Memorial, the Board of the Norton Museum of Art and Museum Foundation, and the Lower Manhattan Development Corporation. From 1993 to 2004, he served as Chairman and CEO of GreenPoint Financial Corp. and GreenPoint Bank. Prior to his tenure at GreenPoint, Mr. Johnson served as President and Director of Manufacturers Hanover Trust Company from 1989 to 1991. Mr. Johnson’s career in banking started in 1969 at Chemical Bank and Chemical Banking Corporation, where he became President and Director in 1983. In addition, Mr. Johnson is a former director of Alleghany Corporation, R.R. Donnelly & Sons Co. Inc., The Phoenix Companies, Inc., FHLMC, North Fork Bancorporation, Prudential Life Insurance Company of America, and Online Resources Corp. From 1966 to 1969, he served as a special assistant to the Comptroller of the U.S. Department of Defense in the Pentagon. He received a B.A. in Economics from Trinity College and an M.B.A., with distinction, from Harvard Business School. Mr. Johnson brings extensive leadership experience in the banking industry to the Board.
Javier Maldonado - Age 56. Mr. Maldonado has served as Vice Chairman of SHUSA’s Board since 2015, and he is a member of the Nominations and SHUSA/US Risk Committees. He was appointed to SC’s Board in 2015 and is a member of its Compensation, Nominations, and Regulatory and Compliance Oversight Committees. He was appointed to the Bank’s Board in 2015 and is a member of its Risk Committee. Mr. Maldonado was appointed to BSI's Board in August 2016 and is a member of its Executive Committee. Since 2015, he has served as a Director of Santander BanCorp, where he is a member of its Executive Committee and is Chairman of the Compensation Committee, and serves as a Director of BSPR and SIS. He served as Acting Chairman of SIS' Board from April 2016 to April 2017. Mr. Maldonado has served on the Board of Alawwal Bank (formerly known as theSaudi Hollandi Bank Riyadh) since 2008. He currently serves as Senior Executive Vice President, Global Head of Cost Control for Santander. Since 1995, he has held numerous management positions with Santander, including Senior Executive Vice President, Head of the General Directorate for Coordination and Control of Regulatory Projects in the Risks Division, and Executive Committee Director and Head of Internal Control and Corporate Development for Santander UK. Prior to his time with Santander, Mr. Maldonado was an attorney with Baker & McKenzie and Head of the Corporate and International Law Department at J.Y. Hernandez-Canut Law Firm. He received a law degree from UNED University and a law degree from Northwestern University. Mr. Maldonado brings to the Board extensive corporate and international legal experience, as well as leadership in the financial services sector.
Victor Matarranz - Age 42. Mr. Matarranz was appointed to SHUSA’s and the Bank’s Boards in 2015 and to BSI's Board in 2018. He is a member of SHUSA’s Compensation and Nominations Committees and a member of the Bank’s Compensation Committee. He is Chairman of Santander Asset Management Holdings Ltd. since 2017 and is a Board Member of Zurich Santander Insurance America S.L. since 2019. He has been a member of the Portal Universia SA Board from 2015 to 2018 and he served on the Santander Fintech Board from 2014 to 2017. Since September 2014, Mr. Matarranz has served as Group Senior Executive Vice President of Santander, and in September 2017 he was appointed as Head of Santander's Wealth Management division, including the Private Banking, Asset Management and Insurance businesses of Santander. From September 2014 to September 2017, he served as Head of Group Strategy and Chief of Staff to Santander's Executive Chairman. From 2012 to 2014, Mr. Matarranz served as the Director of Strategy and Chief of Staff to the Chief Executive Officer, and a member of the Executive Committee for Santander UK. From 2004 to 2012, he worked at McKinsey & Company in Madrid, where he served as a partner, working primarily in the financial services practice advising local and global banks on strategic and retail banking issues. He received a Master’s Degree in Telecommunications Engineering from the Politechnical University of Madrid and an M.B.A. with a specialization in Finance, from the London Business School, where he graduated with distinction. Mr. Matarranz brings expertise in financial services and retail banking strategy and significant international experience to the Board.
Juan Olaizola - Age 57. Mr. Olaizola was appointed to SHUSA’s and the Bank’s Boards in 2015. He serves as a member of the SHUSA/US Risk Committee of SHUSA's Board and the Risk Committee of the Bank's Board. From April 2018 to the present he has held a directorship at Sistema de Tarjetas y Medios de Pago, S.A. (Spanish Cards and Payments Board) and, additionally, of Santander Seguros and Reaseguros (Insurance Spain). He has served as a Director of Santander Insurance Services UK Ltd from 2014-2017 and as a member of the advisory board of Fintech Investments from 2012 to 2017. In addition, he is a former director of VISA Europe, where he served from 2010 to 2013 and from 2015 to 2016. Since January 2018, Mr. Olaizola has served as Chief Operating Officer of Santander Spain and is leading the Banco Popular integration. From 2005-2017, Mr. Olaizola served as Chief
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Operating Officer at Santander UK. From 1986 to 2003, Mr. Olaizola worked at IBM Global Services, having served as the Vice President of EMEA (IBM Financial Services Consulting) in London from 2000 to 2004 and as the Vice President of Professional Services in the U.S. from 1999 to 2000, among other roles. He graduated from Universidad Autonoma and received an M.B.A. from IESE Business School. Mr. Olaizola brings significant financial services and technology experience to the Board.
Scott Powell - Age 56. Mr. Powell has served as Santander's U.S. Country Head, President and CEO since February 2015. He was appointed to each of the Boards of SHUSA and the Bank in March 2015 and to SC's Board in September 2016. Additionally, since September 2017, Mr. Powell has served as Senior Executive Vice President of the Bank; he served as President and CEO of the Bank from March 2015 until his appointment as SC’s President and CEO in 2017. Mr. Powell is a member of SHUSA’s Nominations Committee, the Bank’s Nominations Committee, and SC's Executive Committee. Prior to joining the Company, Mr. Powell was Executive Chairman of National Flood Services Inc. From 2002 to 2012, he was employed at JPMorgan Chase & Co. and its predecessor Bank One Corporation. During that time, he served as Head of Home Lending Default from July 2011 to February 2012, Head of JPMorgan Chase’s Banking and Consumer Lending Operations from June 2010 to June 2011, CEO of Consumer Banking from January 2007 to May 2010, Head of the Consumer Lending businesses from March 2005 to December 2006, and Chief Risk Officer, Consumer from 2004 to February 2005. From May 2003 through June 2004, Mr. Powell was President of Retail Lending at Bank One, and from February 2002 to April 2003 he was its Chief Risk Officer, Consumer. He has held a variety of senior positions at JPMorgan Chase and spent 14 years at Citigroup/Citibank in a variety of risk management roles. Mr. Powell is Chairman of the Santander Consumer USA Foundation, and a director of the Financial Services Roundtable and the Boys and Girls Club of Boston as well as the Phipps Houses and The END Fund in New York City. He received a B.A. from the University of Minnesota and an M.B.A. from the University of Maryland. Mr. Powell brings extensive experience in retail banking, risk management and consumer and auto lending to the Board.
Henri-Paul Rousseau - Age 70. Mr. Rousseau was appointed to SHUSA’s Board in March 2017 and the Bank’s Board in 2015. He serves as a member of the SHUSA/US Risk and Compensation Committee and as Chairman of the Bank’s Risk Committee and as a member of its Audit, Compensation, and Nominations Committees. Mr. Rousseau served as Vice President of Power Corporation International from January 2018 through July 2018. He is a visiting professor at the Paris School of Economics for the academic year September 2018 through August 2019. In December 2018, he received the Order of Canada. From 2009 until his retirement effective as of January 2018, Mr. Rousseau served as Vice-Chairman of the Boards of Power Corporation of Canada and Power Financial Corporation, while also serving on the Boards of Great-West Lifeco Inc. and IGM Financial Inc. and those of their respective subsidiaries. Mr. Rousseau is a member of the Board of Noovelia, Inc. and has served as Chairman of the Board of the Tremplin Sante Foundation since 2015. From 2011 until July 2018, Mr. Rousseau served as the Chairman of the Board of Montreal Heart Institute Foundation, having served on its Board since 1995, and served the Orchestra Symphonique de Montreal Foundation as Co-Chair of its Finance Committee from 2010 through 2014. He received a B.A. in Economics from the University of Sherbrooke and an M.A. and Ph.D. in Economics from the University of Western Ontario. He was a Professor of Economics at both Université Laval and Université du Québec à Montréal, Mr. Rousseau brings extensive experience in financial services industry management to the Board.
T. Timothy Ryan, Jr. - Age 73. Mr. Ryan was appointed to SHUSA’s and the Bank's Boards in 2014 and serves as Chairman of each, as well as of their Nominations and Compensation Committees. He was appointed to BSI's Board in July 2016 and serves as Chairman of its Board's Compensation and Executive Committees and is a member of its Audit and Risk Committees. Mr. Ryan served as Global Head of Regulatory Strategy and Policy of JPMorgan Chase & Co. from February 2013 to January 2015. From December 2008 to February 2013, he was President and Chief Executive Officer of the Securities Industry and Financial Markets Association ("SIFMA") and CEO of the Global Financial Markets Association, SIFMA's global affiliate. Prior to 2008, Mr. Ryan was Vice Chairman, Financial Institutions and Governments, at JPMorgan Chase. Before joining JPMorgan Chase in 1993, Mr. Ryan served as the director of the Office of Thrift Supervision, a director of the Resolution Trust Corporation and a director of the FDIC. Since 2011, he has served on the Board of Power Corp. of Canada and Power Financial Company and as Chairman of its Audit Committee and as a member of its Executive, Compensation, Investment and Risk Committees. Since 2010, Mr. Ryan also has served on the Board of Great West LifeCo Inc. and is a member of its Compensation, Executive, and Risk Committees. He also served as a director of Markit Ltd. in 2014 and of Lloyds Banking Group from 2009 to 2013. He received a B.A. from Villanova University and a law degree from American University. Mr. Ryan brings to the Board extensive experience as a former regulator and banker and a deep understanding of the U.S. banking market, regulatory environment and financial services industry management.
Richard Spillenkothen - Age 69. Mr. Spillenkothen was appointed to SHUSA’s and the Bank’s Boards in 2015. He serves as Chairman of the SHUSA/US Risk Committee, and a member of its Nominations and Compensation Committees. Additionally, Mr. Spillenkothen serves as a member of the Bank’s Audit and Risk Committees. Mr. Spillenkothen served as the Chairman of the SBNA Risk Committee from 2015 to September 2016. From 2007 to 2011, he served as a consultant and advisor at Deloitte & Touche LLP.
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From 1976 to 2006, Mr. Spillenkothen worked for the Federal Reserve, where he served as Director of the Federal Reserve’s Division of Banking Supervision and Regulation. In this capacity, he was the senior Federal Reserve staff official with responsibility for banking supervision and regulation policy. He worked with the Federal Reserve Banks, which have day-to-day responsibility for supervising BHCs and financial holding companies, state member banks, and the U.S. activities of foreign banks. He also coordinated financial institution supervisory policy with other federal, state, and foreign banking authorities, and with the international supervisory coordinating bodies. He served on the Basel Committee on Banking Supervision from 1992 to 2006, and was Chairman of the Board of the Association of Supervisors of Banks of the Americas from 2003 to 2006. From 2013 to 2015, Mr. Spillenkothen served on the Board of Mitsubishi UFJ Securities (USA) as an independent non-executive director, serving on the Risk, Audit and Compensation Committees. In February 2017, he joined the Rappahannock County, Virginia Food Pantry Board. He received an A.B. from Harvard University and an M.B.A. from the University of Chicago. Mr. Spillenkothen brings extensive experience as a former regulator and a deep understanding of the U.S. banking market, regulatory environment, and financial services industry management to the Board.
Executive Officers of SHUSA
Certain information, including the principal occupation during the past five years, relating to the executive officers of SHUSA as of the filing date of this Form 10-K is set forth below:
Mahesh Aditya - Age 56. Mr. Aditya has served as Chief Risk Officer of SHUSA since May 2018 and Senior Executive Vice President since May 2017. Additionally, since April 2018, Mr. Aditya has served as the Bank's Chief Risk Officer, and is a member of each of SHUSA's and SBNA's CEO Executive Committees. From May 2017 to May 2018, Mr. Aditya served as SHUSA's Chief Operating Officer. Prior to joining SHUSA, Mr. Aditya served as Chief Risk Officer for Visa, Inc. from June 2014 to February 2017. Prior to that, he served as Retail Bank/Mortgage Chief Risk Officer for JPMorgan Chase from April 2011 to June 2014. Mr. Aditya received a Bachelor of Engineering from BMS College of Engineering and an M.B.A. from the Faculty of Management Studies.
Madhukar Dayal - Age 54. Mr. Dayal has served as Chief Financial Officer and Senior Executive Vice President of SHUSA since April 2016, and he is a member of SHUSA’s CEO Executive Committee. Mr. Dayal has served as the Bank's CEO since August 2017, President since September 2017, and as a member of its CEO Executive Committee. Additionally, in September 2017, Mr. Dayal was appointed to the Bank Board and also serves on the Bank Board's Nominations and Executive Committee. Prior to joining SHUSA and the Bank, Mr. Dayal served as Chief Financial Officer for BNP Paribas USA Holdings, BancWest and Bank of the West from 2015 to March 2016, BancWest Corporation and Bank of the West from 2012 to 2015 and Bank of the West from 2010 to 2012. Prior to Bank of the West, Mr. Dayal helped lead a private equity start-up for JP Morgan Chase & Co., Brysam Global Partners, focused on building an international consumer banking franchise. Prior to that, he spent eight years with Citi in a variety of operations and finance roles in New York, California, South Korea and Brussels. Mr. Dayal earned a B.A. with honors in Accounting and Finance from Nottingham Trent University and is a member of the Chartered Institute of Management Accountants in London. Mr. Dayal serves as a member of the Executive Committee of the Board of Trustees for the Institute of International Banking and in 2017 was elected a Board member of the FHLB of Pittsburgh.
Daniel Griffiths - Age 50. Mr. Griffiths has served as Chief Technology Officer and Senior Executive Vice President of SHUSA and the Bank since June 2016, and is a member of each of SHUSA's and the Bank's CEO Executive Committees. From 2011 to 2016, Mr. Griffiths was Chief Technology Officer at TD Bank and, from 2008 to 2011, he was Managing Director, Emerging Markets and Commodities, at Barclays Capital. Mr. Griffiths received a B.S. in Computer Studies from Polytechnic of Wales.
Michael Lipsitz - Age 54. Mr. Lipsitz has served as Chief Legal Officer and Senior Executive Vice President of SHUSA since August 2015 and of the Bank since April 2016, and is a member of each of SHUSA’s and the Bank’s CEO Executive Committees. Prior to joining SHUSA, Mr. Lipsitz served as Managing Director and General Counsel for Retail and Community Banking at JPMorgan Chase & Co. and, prior to that, held multiple senior and general counsel roles supporting consumer banking and lending, corporate and regulatory activities, and mergers and acquisitions at JPMorgan Chase & Co. and its predecessor companies. Mr. Lipsitz received a B.A. from Northwestern University and a J.D. from Loyola University Chicago School of Law.
Scott Powell - Age 56. For a description of Mr. Powell's business experience, please see "Directors of SHUSA" above.
Maria Veltre - Age 55. Maria Veltre has served as the Company’s Head of U.S. Digital and Innovation and Senior Executive Vice President since September 2018, and is a member of SHUSA’s CEO Executive Committee. Ms. Veltre has served as the Bank’s Chief Marketing and Digital Officer since September 2016. Prior to joining SHUSA and the Bank, Ms. Veltre’s experience was comprised of substantial banking industry experience, including most recently as Chief Marketing Officer at Fifth Third Bank from May 2013 to August 2016 as well as leadership positions at Citibank from 2006 to 2013, including Chief Marketing Officer and Managing Director of Small Business Banking. Ms. Veltre received a B.S. in Economics from the Wharton School at the University of Pennsylvania and an M.B.A. from the Stern School of Business at New York University.
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William Wolf - Age 53. Mr. Wolf has served as Chief Human Resources Officer and Senior Executive Vice President of SHUSA and the Bank since February 2016, and is a member of each of SHUSA’s and the Bank’s CEO Executive Committees. Prior to joining SHUSA and the Bank, he was Managing Director, Global Head of Talent Acquisition and Development, for Credit Suisse from 2011 to 2016. Mr. Wolf received a B.A. from Dartmouth College and an M.B.A. from the University of North Carolina.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires each person who is an officer or director of SHUSA, or who directly or indirectly is the beneficial owner of more than ten percent of any class of SHUSA's equity securities, to file in his or her personal capacity an initial statement of beneficial ownership, statements of changes in beneficial ownership and annual statements of beneficial ownership with the SEC. SEC regulations provide that any person required to file such beneficial ownership statements must send or deliver a copy to SHUSA and require that SHUSA disclose in this Form 10-K any known failure of those persons to timely file the required beneficial ownership statements with the SEC. Based solely on SHUSA's review of any copies of such beneficial ownership statements furnished to it and on written representations from SHUSA's directors and officers, SHUSA has not identified any failure to timely file such statements with the SEC. Following Santander's acquisition of SHUSA in January 2009, SHUSA’s common stock was removed from listing with the New York Stock Exchange (the “NYSE”), as Santander became the sole holder of 100% of SHUSA’s common stock and remains the sole holder as of the date of this filing. Since Santander’s acquisition, no person subject to the beneficial ownership reporting rules of Section 16(a) of the Exchange Act has owned any of SHUSA's equity securities.
Code of Ethics
SHUSA adopted a Code of Ethics that applies to the CEO and senior financial officers of the Company including the Chief Financial Officer, Treasurer, and Chief Accounting Officer and Controller. SHUSA undertakes to provide to any person without charge, upon request, a copy of such Code of Ethics by writing to: Chief Legal Officer, Santander Holdings USA, Inc., 75 State Street, Boston, Massachusetts 02109.
Procedures for Nominations to the SHUSA Board
On January 30, 2009, SHUSA became a wholly-owned subsidiary of Santander. Immediately following the effective time of the Santander transaction, because Santander is the sole shareholder of all of SHUSA’s outstanding voting securities, SHUSA's Board no longer has a formal procedure for shareholders to recommend nominees to SHUSA's Board.
Audit Committee of the Board
SHUSA has a separately-designated standing Audit Committee established by and among the Board. Mr. Johnson serves as Chairman of SHUSA's Audit Committee, and Messrs. Ferriss and Fishman serve as the other members. The Board has determined that Messrs. Ferriss, Fishman, and Johnson are independent and qualify as audit committee financial experts under SEC requirements applicable to audit committees.
ITEM 11 - EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
This Compensation Discussion and Analysis relates to our executive officers included in the Summary Compensation Table, who we refer to collectively as the "named executive officers." SHUSA (who we refer to in this Item as "we," "us," or "our") is a wholly owned subsidiary of Santander. We also refer in this Item to our wholly owned subsidiary, Santander Bank, N.A. as "SBNA" and our majority owned subsidiary Santander Consumer USA Holdings Inc. as "SC." This Compensation Discussion and Analysis explains our role and the role of Santander in setting the compensation of the named executive officers.
For 2018, our named executive officers were:
• | Scott Powell, our President and CEO; |
• | Madhukar Dayal, our Chief Financial Officer and Principal Financial Officer; |
• | Daniel Griffiths, our Chief Technology Officer; |
• | William Wolf, our Chief Human Resources Officer; |
• | Mahesh Aditya, our Chief Risk Officer; and |
• | Brian Gunn, Special Advisor and our former Chief Risk Officer. |
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This section of the Compensation Discussion and Analysis provides information with respect to our named executive officers:
• | the general philosophy and objectives underlying their compensation, |
• | our and Santander`s respective roles and involvement in the analysis and decisions regarding their compensation, |
• | the general process of determining their compensation, |
• | each component of their compensation, and |
• | the rationale behind the components of their compensation. |
Since we are a wholly owned subsidiary of Santander and do not hold public shareholder meetings, we do not conduct shareholder advisory votes.
General Philosophy and Objectives
The fundamental principles that Santander and we follow in designing and implementing compensation programs for the named executive officers are to:
• | attract, motivate, and retain highly skilled executives with the business experience and acumen necessary for achieving our short-term and long-term business objectives; |
• | link pay and performance, while appropriately balancing risk and financial results and complying with regulatory requirements; |
• | align, to an appropriate extent, the interests of management with those of Santander and its shareholders; and |
• | leverage our compensation practices to support our core values and strategic mission and vision. |
Santander aims to provide a total compensation package that is comparable to that of similar financial institutions in the country in which the executive officer is located, the United States in our case. Within this framework, Santander considers both total compensation and the individual components (i.e., salary and incentives) of each named executive officer’s compensation package independently. Any other perquisites are also considered independently of total compensation. When setting each named executive officer’s compensation for 2018, we took into account market competitive pay, historical pay within Santander, our budget, level of duties and responsibilities, experience and expertise, individual performance, and historical track record within the organization for each individual.
Responsibility for determining the compensation of our named executive officers resides both at our level as well as the Santander level. We set forth the various parties involved in determining executive compensation and their specific responsibilities below.
The Parties Involved in Determining Executive Compensation
Both we and Santander have responsibility for overseeing and determining the compensation of our named executive officers. We are involved in setting the compensation of all our employees. Santander is involved in overseeing its senior level employees globally, including the named executive officers. We set forth the various parties, including both Board committees and management committees, involved in contributing to and determining executive compensation and their specific responsibilities below.
The Role of Our and SC's Compensation and Talent Management Committees (which we refer to in this Item 11 as "BCTMC" and "SC BCTMC", respectively)
Our BCTMC has the responsibility of, among other things:
• | at least annually, reviewing and approving the terms of our compensation programs, including the Executive Bonus Program, in which our named executive officers participate, in accordance with all applicable guidelines that Santander establishes with respect to variable compensation; |
• | reviewing and approving the annual corporate goals and objectives of the President and CEO, evaluating the President and CEO’s performance in light of these corporate goals, and approving the base and variable compensation of our President and CEO, as proposed by the Santander Executive Chairman and CEO and validated by the Santander Remuneration Committee. The BCTMC provides valuable input based on the Board's evaluation of the CEO's performance and the Company's performance, in accordance with all applicable guidelines that Santander establishes with respect to variable compensation; |
• | monitoring the performance and regularly approving the design and function of the incentive compensation programs, including the Executive Bonus Program, to assess whether the overall design and performance of such programs are consistent with Santander guidelines, are safe and sound, and do not encourage employees, including our named executive officers, to take excessive risk; |
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• | reviewing and approving the overall goals and purpose of our incentive compensation programs and providing guidance to our Board and management so that the Board's policies and procedures are appropriately carried out in a manner that achieves appropriate balance between risk and reward and is consistent with ensuring safety and soundness; |
• | approving amounts paid under the Executive Bonus Program according to Santander guidelines and applicable regulations; |
• | overseeing the administration of our qualified retirement plan and other employee benefit plans in which all eligible employees can participate, including the named executive officers, as well as certain other deferred compensation plans in which our named executive officers are eligible to participate; |
• | evaluating the applicability of any malus and clawback provisions to our senior executive officers, including the named executive officers; |
• | at least annually, reviewing and recommending any changes to our director compensation program; |
• | reviewing and discussing with management the Compensation Discussion and Analysis required to be included in this Annual Report on Form 10-K; and |
• | approving the Board Compensation and Talent Management Committee Report for inclusion in this Annual Report on Form 10-K. |
Our BCTMC met nine times in 2018.
Because Mr. Powell provides services to both us and to SC, our BCTMC, and the SC BCTMC, agreed to allocate Mr. Powell's 2018 total compensation at 37% to us and 63% to SC. We jointly decided on these allocations to reflect the percentage of time that Mr. Powell spent working for and with respect to each organization based on time allocation tracking.
The Role of Santander’s Human Resources Committee
Santander’s Human Resources Committee's responsibilities include the design and the calculation of the applicable funding level of the Executive Bonus Program and oversight of performance management and compensation, including consideration of all present and future risks that may impact the bonus process as well as the application of malus and clawback related clauses, when applicable. Santander's Human Resources Committee also reviews and validates the compensation proposals for our named executive officers, except for our President and CEO.
The Role of Santander`s Board Remuneration Committee
Santander’s Board Remuneration Committee has the authority and responsibility to, among other things, review, revise, and then present to Santander’s Board of Directors the compensation of Santander’s senior executives, which include our President and CEO.
The Board Remuneration Committee also has the responsibility to review, revise and present to Santander's Board the key elements of the compensation of our named executive officers.
The Role of Santander’s Board of Directors
Santander’s Board of Directors validates and approves the compensation of certain of our management, including our President and CEO.
The Role of Our Management
Our Human Resources Committee oversees our incentive compensation programs (except for the Executive Bonus Program) and makes recommendations to our BCTMC with respect to these programs. A key responsibility of our Human Resources Committee is to review our incentive compensation programs to ensure the programs do not incentivize excessive risk-taking and make recommendations to our BCTMC regarding certain compensation matters. The members of the Human Resources Committee include the heads of our Risk, Legal, Finance, Change Management, Communications, Office of the CEO and Human Resources Departments. In addition, the head of our Internal Audit Department participates as a non-voting member.
Our management also played a role in other parts of the compensation process with respect to the named executive officers in 2018. Our President and CEO generally performed (or delegated to our Human Resources Department) management’s responsibilities (except with respect to his own compensation) in accordance with the requirements set forth by Santander, our applicable policies and procedures, and applicable law. The most significant aspects of management’s role in the compensation process were presenting, and recommending for approval, salary and bonuses for the named executive officers to our BCTMC and to the applicable committees at Santander.
None of the named executive officers determined or approved any portion of his own compensation for 2018.
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The Role of Outside Independent Compensation Advisors
Santander, SHUSA and its subsidiaries seek guidance and advice from a diversified mix of outside independent compensation advisors.
• | Santander’s Remuneration Committee engaged Willis Towers Watson to provide advice on the general policies and approaches with respect to the compensation of Santander’s worldwide employees. |
• | At the request of our BCTMC, we engaged McLagan Partners, Inc. to provide competitive market compensation ranges for our senior executive officers, including the named executive officers. |
• | The SC BCTMC has engaged Pay Governance to advise on compensation matters relevant to its business (e.g., peer benchmarking) and to the additional demands required of public companies. |
• | As discussed under "Benchmarking" below, we also engaged Pay Governance to assist the BCTMC in setting 2018 compensation targets for our President and CEO. |
Benchmarking
For 2018 target compensation review purposes, both Willis Towers Watson and McLagan Partners provided independently compiled benchmarking data for our President and CEO position, which Pay Governance summarized along with additional data extracted from publicly disclosed proxy statements. The peer group data set comprises 42 financial institutions as follows: Bank of the West, BBVA Compass, BMO Financial, BB&T Corporation, HSBC, MUFG Union Bank, RBC, TD Securities, BNP Paribas, Deutsche Bank, Barclays, RBS, Mizuho, UBS, Credit Suisse, The Toronto Dominion Bank, Ally Financial, Citizens Financial, Comerica, Credit Acceptance Corp., Encore Capital, Lending Club, Nationstar Mortgage, Navient, Nelnet, One Main Holdings, PRA Group, SLM Corp., Capital One Financial Group, Discover Financial Services Inc., Fifth Third Bancorp, Huntington Bancshares Incorporated, KeyCorp, M&T Bank Corporation, PNC Financial Services Group, Inc., Regions Financial Corporation, SunTrust Banks, Inc., U.S. Bancorp, Bank of America Corporation (Consumer), Citigroup Inc. (Global Consumer Bank), JPMorgan Chase & Co. (Community Banking), and Wells Fargo & Company (Community Banking).
For 2018 target compensation review purposes, McLagan Partners also provided benchmarking data for our named executive officers’ compensation and used the following peer group: Capital One, Ally Bank, Discover, CIT Bank, BB&T Corporation, BBVA Compass Bancshares, Inc., Citizens Financial Group, Inc., Comerica, Inc., Fifth Third Bank, Huntington Bancshares Incorporated, Keycorp, M&T Bank Corporation, MUFG Union Bank, Regions Financial Corporation, SunTrust Banks, Inc., The Toronto Dominion Bank, Bank of the West, and BMO Financial.
Lastly, we describe the peer group used in connection with specific measures leveraged within the Executive Bonus Program under the caption "Executive Bonus Program." We and Santander have also periodically used additional independent third-party compensation surveys to assist in assessing certain of our executive officers’ overall compensation.
We use this data to periodically evaluate market trends, pay levels, and relative performance in executive compensation, but without any formulaic benchmarking.
Components of Executive Compensation
For 2018, the compensation that we provided to our named executive officers consisted primarily of base salary and both short- and long-term incentive opportunities, as we describe more fully below. In addition, the named executive officers are eligible for participation in benefit plans that we generally offer to all our employees, and we also provide the named executive officers with certain benefits and perquisites not available to the general employee population.
Base Salary
Base salary represents the fixed portion of the named executive officers’ compensation, and we intend it to provide compensation for expected day-to-day performance. The base salaries of the named executive officers were generally set in accordance with each named executive officer’s employment agreement or letter considering market competitive pay, historical pay at Santander, our budget, level of duties and responsibilities, experience and expertise. While each named executive officer’s employment letter provides for the possibility of increases in base salary, annual increases are not guaranteed. We review our named executive officers’ salary levels as a part of our annual compensation review process.
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Our Chief Human Resources Officer (and in the case of Mr. Wolf, our CEO) consulted with Santander’s Human Resources Department to confirm named executive officers’ salaries are competitive and take into account market survey data of our peers, salary history at Santander, scope of duties and responsibilities, experience and expertise, individual performance, applicable regulatory requirements, and our budget. Santander’s Human Resources Department consulted with the Santander Board Remuneration Committee and Santander’s Board of Directors in setting the base salary of Mr. Powell. In 2018, we made the following changes to our named executive officer salaries:
• | In accordance with a letter agreement with Mr. Powell dated as of September 14, 2018, we increased Mr. Powell's annual base salary from $2.0 million to $3.0 million, effective January 1, 2018, to better align his total compensation relative to peers. |
• | We increased Mr. Aditya's annual base salary from $1.0 million to $1.475 million to recognize his new role as our Chief Risk Officer, to ensure total compensation alignment to market and compliance with Capital Requirements Directive (“CRD-IV”) pay ratio restrictions. |
• | We increased Mr. Griffith's annual base salary effective June 2, 2018 from $1.0 million to $1.1 million to compensate for the discontinuance of certain perquisites. |
We did not adjust any other named executive officer's base salary for 2018.
Incentive Compensation
We provide annual incentive opportunities for our executive officers, including the named executive officers, to reward achievement of both business and individual performance objectives and to link pay to both short-term and long-term performance. We intend our incentive programs to motivate participants to achieve and exceed these objectives at the Santander, U.S., and business/function levels, as well as to reward the progressive improvement of individual performance. All of our named executive officers are designated as Identified Staff and, therefore, are subject to the compensation guidelines of the European Banking Authority and limits of the CRD IV. These regulations and guidelines define the short-term/immediate and long-term/deferred percentages for incentives awards with respect to the total compensation package as well as mandate that such awards be delivered in at least 50% shares or other equity instruments, such as American Depositary Receipts (“ADRs”), with a mandatory one-year holding period upon delivery, and no more than 50% paid in cash.
For the 2018 performance year of the Executive Bonus Program (described below), the targeted incentive opportunity for each of the named executive officers was as follows:
Named Executive Officer | Target Bonus ($) |
Scott Powell (1) | $4,250,000 |
Madhukar Dayal | $1,885,500 |
Daniel Griffiths | $1,660,500 |
William Wolf | $1,180,000 |
Mahesh Aditya | $1,025,000 |
Brian Gunn (2) | $922,500 |
(1) Mr. Powell’s bonus target for 2018 was increased from $2.1M to $4.25M to better align his total compensation relative to peers.
(2) Mr. Gunn’s bonus target for 2018 was adjusted from $1.1M to $922,500 as part of his role change to Special Advisor.
Executive Bonus Program
Our incentive program, which we refer to as the "Executive Bonus Program," establishes both financial and non-financial measures to determine the bonus pool level from which we pay annual bonuses. We align the Executive Bonus Program each year with Santander’s corporate bonus program for executives of similar levels across Santander. Each of the named executive officers participated in the Executive Bonus Program for 2018. The general structure of the Executive Bonus Program:
• | defers a portion of a participant’s award over a three- or five-year period, depending on the participant’s position within our organization, subject to the non-occurrence of certain events; |
• | links a portion of such amount to Santander performance over a multi-year period; and |
• | pays a portion of such award in cash and a portion in equity, in accordance with the rules and standards referenced above and set forth in more detail below. |
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On February 13, 2018, Santander’s Board of Directors adopted the Second Cycle of the Deferred Multi-year Objectives Variable Plan for executives (which is generally aligned with our Executive Bonus Program), and Santander’s shareholders approved it at its annual meeting of shareholders on March 23, 2018. On March 6, 2018, we approved the preliminary design of the Executive Bonus Program scorecard. Santander’s Remuneration Committee and Board of Directors approved the final scorecard for the Executive Bonus Program, as recommended by our BCTMC, on April 16, 2018 and April 23, 2018, respectively.
The Executive Bonus Program provides for differences in the amount of final awards, higher or lower than their target bonus amounts (which we describe below), in order to reinforce our pay for performance philosophy.
Under the Executive Bonus Program, we determine an aggregate pool from which awards for all participants are determined and paid. The pool incorporates both quantitative (via a scorecard) and qualitative considerations as well as feedback from Santander to ensure that the Executive Bonus Program links our executives' pay to performance. Our BCTMC worked with Mr. Powell and Santander’s Human Resources Committee and the Board Remuneration Committee to validate that the proposed scorecard performance metrics aligned with overall business goals. Our BCTMC reviewed the appropriateness of the financial measures used in the Executive Bonus Program with respect to the named executive officers and the degree of difficulty in achieving specific performance targets and determined that there was a sufficient balance. All scorecard calculations for us under the Executive Bonus Program are determined in accordance with International Financial Reporting Standards because Santander uses similar terms and metrics in its incentive programs across the Group, making the use of country-specific accounting standards infeasible.
Our named executive officers all perform functions for both us and SBNA, and in the case of Mr. Powell, also for SC. Our BCTMC, and in the case of Mr. Powell, the SC BCTMC, agreed to consider individual allocation of the final bonus pool funding level for these executives based on both our and SBNA's performance, and in the case of Mr. Powell, SC's performance, to align pay decisions to all applicable businesses' performance as well as certain principles set forth by our regulators.
SHUSA Bonus Pool Scorecard Overview: The bonus pool funding is determined through a scorecard, which is primarily driven by a quantitative (mathematically informed) score, and is then adjusted by qualitative and discretionary measures. We develop the scorecard metrics to measure our, our subsidiaries’ and our business units’ performance on an aggregate basis over the full year.
Together these make up our overall bonus pool funding level. As we describe in more detail below, the bonus pool funding was approved by Santander at 100.0% of aggregate target amounts for 2018. We determine the aggregate total of the bonus amounts, in U.S. dollars, available for distribution to our participating employees, including the named executive officers, by multiplying this bonus pool funding level by the sum of target incentives.
Below is a summary of how we calculated the bonus pool for 2018.
Part 1: Quantitative Score | 95.3 | % |
1. Quantitative Score: The quantitative score is a mathematically derived score based on our achievement of pre-determined business goals (which we reflect in Table 1 below under the heading "Quantitative Metrics").
In collaboration with Santander, we pre-assign each metric with a weight and a goal. Then Santander calculates the percentage credit towards the quantitative score for each metric by multiplying its percentage weight by its percentage achievement. Finally, we add up all the percentages to derive the total quantitative score.
For 2018, our total quantitative score was 95.3%.
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Table 1: SHUSA Bonus Pool Funding Scorecard
Scorecard Component (Part) | Quantitative Metrics | Weight | 2018 Goal | Full Year Result (1) | % Achievement(2) | % Credit Towards Quantitative Score ("Weight" * "% Achievement") | Component (Part) Score (sum previous column) | |||||
Part 1: Quantitative Score | Customer Satisfaction (%) | 2.5 | % | 22 | % | 20 | % | 87.5 | % | 2.2 | % | 95.3% |
Loyal Customers (#) | 2.5 | % | 327,359 | 344,860 | 105.4 | % | 2.6 | % | ||||
Employee Engagement (%) | 5 | % | 69 | % | 67 | % | 87.5 | % | 4.4 | % | ||
Cost of Credit Ratio (Loan Loss Ratio) (%) | 5 | % | 3.35 | % | 3.09 | % | 107.7 | % | 5.4 | % | ||
Non-Performing Ratio (%) | 5 | % | 2.97 | % | 3.07 | % | 96.6 | % | 4.8 | % | ||
% Completion of Certain Regulatory Requirements | 10 | % | 95 | % | 97 | % | 102.1 | % | 10.2 | % | ||
Contribution to Santander's Capital ($ millions) | 20 | % | $556 | $425 | 76.3 | % | 15.3 | % | ||||
Net Profit ($ millions) | 27.5 | % | $899 | $908 | 101.0 | % | 27.8 | % | ||||
Return on Risk Weighted Assets (%) | 22.5 | % | 0.98 | % | 0.98 | % | 100.5 | % | 22.6 | % | ||
(1) | Figures shown in the "Full Year Result" column are forecasts as of November 2018. We used these forecasts in determining the 2018 bonus pool. The full-year results were not materially different from the forecasts. |
(2) | If percent achievement is less than 75% for any individual quantitative metric, then 0% credit is applied towards quantitative score applicable to that metric. Additionally, % achievement for each metric is capped at 150%, except for return on risk-weighted assets (“RoRWA”) and net profit, which have no cap on % achievement. |
Part 2: Qualitative Adjustment | -1.4 | % |
2. Qualitative Adjustment: Santander's Remuneration Committee, in consultation with Santander's control functions may in their discretion add or subtract up to 25% to or from the quantitative score based on qualitative factors, including:
•progress of our regulatory agenda
•advancement of our integration and governance model
•management of our Risk Appetite Statement
Santander's Remuneration Committee applied a -1.4% qualitative adjustment to our quantitative score based on its assessment of our progress against these qualitative factors.
Part 3: Santander Multiplier | +3.0 | % |
3. Adjustment due to Santander Multiplier: The Santander Multiplier is an incremental adjustment that provides for a link between our results and overall Santander results. The adjustment is the difference between Santander’s global bonus pool funding level (108.7%) and our score after the qualitative adjustment (93.9%), multiplied by 20%. The adjustment resulting from the application of the Santander multiplier was +3.0%.
The evaluation of Santander's categories of quantitative metrics and qualitative factors, which results in the Santander bonus pool funding level of 108.7%, is as follows:
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• | Customers: the goals set for customer satisfaction and loyalty were met with a result of 105.5%, which was qualitatively adjusted upwards to 107.9% for the Group's overall progress on the implementation of conduct risk controls with customers. |
• | Risks: the quantitative results obtained from the evaluated metrics, cost of credit and NPL ratio provided a result of 103.9%, which was qualitatively adjusted upwards to 105.1% for aspects related to the management of the risk appetite model. |
• | Capital: Santander exceeded the capital targets set for the year, providing a result of 101.9%, which was qualitatively adjusted upwards to 105.1% for aspects related to the sustainability of the capital creation. |
• | Profitability: Ordinary net profit result was 98.5%, and the RoRWA result was at 102.2%. Qualitative factors were evaluated, including comparison with comparable companies and the solidity and sustainability of results, and no material qualitative modification was applied (-0.02%), resulting in a category achievement of 100.1%. |
Part 4: Exceptional Adjustment by Santander's Remuneration Committee | +3.1 | % |
4. Exceptional Adjustment by Santander's Remuneration Committee: Santander’s Remuneration Committee may, in its discretion, make an exceptional adjustment to the pool funding level. Santander took into account various factors, including U.S contributions to Santander's capital goal and profitability growth and in its discretion assigned an exceptional adjustment of +3.1%.
Bonus Pool Calculation Result: Notwithstanding the analysis and calculation above, Santander ultimately determined that our Executive Bonus Pool would equal an amount that could support bonuses paid at an aggregate level up to 107.7% of targets. This level of bonus payout is aligned with the original recommendation of our BCTMC to Santander based on our assessment of scorecard results and our overall performance.
Setting Bonus Targets: We assigned each of the named executive officers a target bonus amount at the beginning of 2018, as disclosed in the Incentive Compensation section above. We determined the target bonus awards taking into account market competitive pay, historical pay at Santander, level of duties and responsibilities, individual performance, historical track record within the organization for each individual, impacts of regulatory changes, and our budget. We review these factors at least annually and the target bonus amounts for 2018 were subject to our BCTMC and Santander's Remuneration Committee review.
Discretionary Pay for Performance Decisions: During the decision-making process, we used target bonus amounts to establish an initial starting point for the executive. Each named executive officer’s target bonus was subject to a discretionary adjustment, either upwards or downwards, based on the SHUSA bonus pool funding results and the executive’s individual performance evaluation, to determine an initial proposed bonus amount.
We conducted a detailed assessment of each named executive officer’s accomplishments versus pre-established goals for the year with respect to the individual performance evaluation results. These goals included specific objectives directly related to the named executive officer’s job responsibilities. These goals are not all objective, formulaic, or quantifiable. Rather they include both quantitative and qualitative measures that cut across critical objectives related to business strategy and performance; regulatory, compliance and risk management; and our customers and clients; as well as our employees and culture. We describe certain of these measures for each of the named executive officers:
Mr. Powell
Mr. Powell’s 2018 functional objectives included, but were not limited to:
• | Deliver budget financials, with a focus on net income, RoRWA, and return on tangible equity, which are all common financial measures in the banking industry. |
• | Execute year one of Santander U.S. integration. |
• | Complete risk framework implementation. |
• | Continue to make progress on outstanding regulatory issues. |
• | Improve compliance, operational risk, including data quality, cyber security, information security, internal controls, and risk control self-assessments ("RCSAs") and SC specific regulatory issues. |
• | Continue to implement a culture of risk management and compliance, and ensure Santander values (including, Simple, Personal and Fair) are embedded. |
• | Improve engagement scores and senior management diversity. |
• | Ensure integration with Santander and Santander initiatives. |
Based on his performance results for 2018, we paid Mr. Powell 100% of his target bonus level.
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Mr. Dayal
Mr. Dayal’s 2018 functional objectives included, but were not limited to:
• | Deliver 2018 budget commitments by line of business. |
• | Optimize balance sheet to enhance capital, liquidity, and profitability. |
• | Ensure that we pass financial regulation tests such as the Comprehensive Capital Analysis and Review ("CCAR") and the DFA stress test. |
• | Implement year one of strategic transformation in Commercial. |
• | Grow Commercial deposits and loans. |
• | CRA upgrade to Satisfactory. |
• | Contribute to our culture of risk management and compliance and ensure that we maintain our values. |
• | Improve engagement scores and senior management diversity. |
• | Ensure integration with Santander and Santander initiatives. |
Based on his performance results for 2018, we paid Mr. Dayal approximately 114% of his target bonus level.
Mr. Griffiths
Mr. Griffiths’ 2018 functional objectives included, but were not limited to:
• | Deliver the 2018 financial plan and efficiency target within Information Technology. |
• | Continue information security remediation processes and materially reduce exposure in order to meet Sarbanes Oxley compliance requirements by Q1 2019. |
• | Improve data quality and governance by continuing to mature the Chief Data Officer organization and deploy a standard model across all IHC subsidiaries. |
• | Leverage IHC project governance and realize opportunities across core infrastructure, information security, and corporate functions while eliminating duplicate and redundant systems. |
• | Improve engagement scores and senior management diversity. |
• | Ensure integration with Santander and Santander initiatives. |
Based on his performance results for 2018, we paid Mr. Griffiths approximately 108% of his target bonus level.
Mr. Wolf
Mr. Wolf’s 2018 functional objectives included, but were not limited to:
• | Implement the Career Framework, a comprehensive re-set of titling, job families and roles. |
• | Evolve employee communications, including U.S. intranet landing page and a new Human Resources ("HR") portal. |
• | Develop and begin implementation of a new compensation and benefits strategy. |
• | Enhance governance over compliance training and increase quality and effectiveness. |
• | Improve engagement scores across Santander U.S. and improve senior management diversity. |
• | Execute on HR function expectations for Santander U.S. integration. |
Based on his performance results in 2018, we paid Mr. Wolf approximately 108% of his target bonus level.
Mr. Aditya
Mr. Aditya's 2018 functional objectives included, but were not limited to:
• | Deliver credit and fraud loss and expense budget for Risk. |
• | Accurate and timely production of month-end results and monthly review packages. |
• | Stabilize Risk leadership, develop bench strength. |
• | Addition of talent as needed. |
• | Significantly improve U.S. risk management framework. |
• | Improve collaboration with Santander and SHUSA's subsidiaries. |
• | Enhance and improve Board Risk Committee presentations with better coverage of risks and stronger oversight and accountability. |
• | Improve engagement scores and senior management diversity. |
• | Ensure integration with Santander and Santander initiatives. |
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Based on his performance results for 2018, we paid Mr. Aditya approximately 100% of his target bonus level.
Mr. Gunn
Based on his performance results for 2018, considering his accomplishments and time in role as the Chief Risk Officer and as a Special Advisor, we paid Mr. Gunn 100% of his target bonus level.
BCTMC Review and Approval
On December 12, 2018, the BCTMC determined preliminary bonus awards under the Executive Bonus Program for the named executive officers (other than Mr. Powell, who is discussed below) subject to validation by Santander’s CEO and Santander's Board of Directors. On January 23, 2019, the BCTMC approved the final bonus awards for the named executive officers other than Mr. Powell. On January 29, 2019, Santander's Board of Directors also approved the final bonus awards for all of the named executive officers.
On January 28, 2019, Santander’s Board Remuneration Committee recommended Mr. Powell’s award to Santander’s Board of Directors and, on January 29, 2019, Santander’s Board of Directors validated and approved Mr. Powell’s award. Our and SC's Board of Directors approved Mr. Powell’s final bonus on February 15, 2019 and February 20, 2019, respectively.
Bonus Delivery: We paid current awards to the named executive officers under the Executive Bonus Program for 2018 as short-term and long-term incentive awards payable in a combination of cash and Santander ADRs, and in the case of Mr. Powell, a combination of cash, Santander ADRs, and SC common stock and Restricted Stock Units ("RSUs"). These amounts include payments made with respect to each of the named executive officer’s individual performance and the performance of Santander, SC (in the case of Mr. Powell), and us, as applicable. Amounts that we pay in equity as short-term incentive awards are immediately vested and are in the form of Santander ADRs (and, in the case of Mr. Powell, SC Common Stock). Amounts that we pay in equity as long-term incentive awards are subject to vesting criteria, as we describe below, and are in the form of restricted Santander ADRs (and, in the case of Mr. Powell, SC RSUs). Any payment made in shares of Santander ADRs or SC Common Stock under the Executive Bonus Program is subject to a one-year holding requirement from the grant date (in the case of immediately vested ADRs/SC shares) or vesting date, if any, of the deferred ADRs/SC RSU shares.
Short-term/Immediate: Under the Executive Bonus Program, the named executive officers receive the short-term award 50% in cash and 50% in immediately vested Santander ADRs, or in the case of Mr. Powell, 50% in cash and 50% in a combination of immediately-vested Santander ADRs and SC shares (with the division between Santander ADRs and SC shares determined based on the allocation of Mr. Powell’s time in 2018 between us and SC).
Long-term/Deferred: Under the Executive Bonus Program, participants are required to defer a portion of their bonus depending on their position and/or targeted incentive levels within Santander. For 2018, Santander considers:
• | Mr. Powell to be a "Category 1" executive, and therefore 60% of his overall bonus award is deferred for five years. |
• | Mr. Dayal to be a "Category 2" executive, and therefore 50% of his overall bonus award is deferred for five years, and |
• | Messrs. Griffiths, Aditya, Wolf, and Gunn to be "Category 3" executives and therefore 40% of their respective overall bonus awards are deferred for three years. |
We deliver deferred amounts under the Executive Bonus Program 50% in cash and 50% in restricted Santander ADRs, and in the case of Mr. Powell, 50% in cash, 18% in restricted Santander ADRs, and approximately 32% in SC RSUs. The deferred amounts vest over three or five years, depending on the participant’s category (as described above) and the participant remaining employed through the applicable payment date (except in certain limited circumstances). The deferred amounts are subject to our Policy on Malus and Clawback Requirements, including the requirement that none of the following events have occurred due to the participant's actions during the period prior to each payment:
• | A significant failure with respect to our risk management or any control or support function; |
• | A material or negative (in each case as determined by our external auditors) restatement of our financial statements (other than any restatement undertaken as a result of a change in accounting standards); |
• | The participant’s material breach of any of our material internal rules or regulations, particularly if such rules or regulations relate to risk management; |
• | A material, negative change in our capitalization or our risk profile; |
• | A material, unforeseen increase in our economic or regulatory capital requirements; |
• | The participant or the participant’s business unit is subject to material regulatory sanctions; |
• | The participant is convicted of or indicted for a felony, or a lesser crime involving moral turpitude; |
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• | Any material misconduct by the participant, whether individually or as part of a group, particularly in connection with the marketing of unsuitable products; |
• | Our deficient financial performance; |
• | A material error by the participant, including such activities by the participant that result in material losses to us or an affiliate or material regulatory sanctions being imposed on us or on an affiliate; |
• | A material downturn in our, an affiliate’s or a business unit’s financial performance as a result of the participant’s inappropriate business management activities; or |
• | The participant’s detrimental conduct (as defined in the Executive Bonus Program). |
The accrual of a portion of such deferred amounts is subject to the compliance with certain multi-year objectives, which we describe below, during the 2018-2020 period. At the end of the 2020 fiscal year, Santander`s Board will set the maximum amount of each annual payment of the deferred portion for each participant.
Multi-year objectives, metrics and compliance scales for deferred cash and Santander ADRs applicable to the Executive Bonus Program are as follows:
a) | Compliance with consolidated earnings per share ("EPS") growth target of Santander for 2020 versus 2017. The coefficient corresponding to this target (the "EPS Coefficient") will be obtained from the following table: |
2020 EPS growth (% against 2017) | EPS Coefficient | |
≥ 25% | 1 | |
b) | Relative performance of total shareholder return ("TSR", as we define below) of Santander for the 2018-2020 period compared to the weighted TSRs of a peer group of 17 financial institutions, which we set forth below. |
We define "TSR" as the difference (expressed as a percentage) between the final value of an investment in Santander common stock and the initial value of the same investment. Dividends or other similar items received by a Santander shareholder during the corresponding period of time are treated as if they had been invested in more shares of the same class at the first date on which the dividend or similar item is owed to the shareholder and at the average weighted listing price on that date. To calculate TSR, we use the average weighted daily volume of the average weighted listing prices of Santander common stock corresponding to the 15 trading sessions prior to January 1, 2018 (for the calculation of the initial value), and of the 15 trading sessions prior to January 1, 2021 (for the calculation of the final value).
The peer group is the following 17 financial institutions:
Financial Institutions | |
Banco Bilbao Vizcaya Argentaria SA | Itaú Unibanco Holding SA |
JPMorgan Chase & Co. | Wells Fargo & Co |
Bank of America Corp | Unicredit SpA |
UBS Group AG | Standard Chartered PLC |
Intesa San Paolo SpA | Citigroup Inc |
HSBC Holdings PLC | ING Groep NV |
Barclays PLC | Lloyds Banking Group PLC |
BNP Paribas SA | Deutsche Bank AG |
Société Générale SA | |
In case of unexpected changes in the peer group and in light of objective circumstances, Santander's Board may adjust the rules of comparison among them or modify the peer group’s composition.
TSR compliance scale:
TSR position of Santander | "TSR Coefficient" | |
Exceeding the 66th percentile | 1 | |
From the 33rd to the 66th percentiles | 0-1 | |
Below the 33rd percentile | 0 | |
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c) | Compliance with the fully-loaded CET1 ratio target of Santander Group for the financial year 2020. The coefficient corresponding to this target (the "CET1 Coefficient") will be obtained from the following table: |
CET1 in 2019 | CET1 Coefficient | |
≥ 11.30% | 1 | |
≥ 11% but < 11.30% | 0.5‑1 | |
< 11% | 0 | |
In order to verify if this target has been met, in general, any potential increase in CET1 deriving from share capital increases will be disregarded. Moreover, Santander may adjust the CET1 ratio, in order to remove the effects of any regulatory change on the calculation rules that may occur through December 31, 2020.
To determine the maximum amount of the deferred portion subject to objectives that, if applicable, must be paid to each participant on the applicable payment date, the following formula will be applied to each one of the annual payments pending payment:
Final Annual Payment = Amount x ((1/3 x A) + (1/3 x B) + (1/3 x C))
where:
• | "Amount" corresponds to the amount of award equivalent to an annual payment. |
• | "A" is the EPS coefficient according to the scale in paragraph (a) above based on EPS growth in 2020 with respect to 2017. |
• | "B" is the TSR coefficient according to the scale in paragraph (b) above based on the relative performance of the TSR of Santander for the 2018-2020 period with respect to the peer group. |
• | "C" is the CET1 coefficient according to compliance with the CET1 target for 2020 described in paragraph (c) above. |
For SC RSUs awarded to Mr. Powell, the performance metrics are weighted 50% towards Santander performance and 50% towards SC performance and follow a balanced "scorecard" approach.
The Santander goals are described above.
The SC goals relate equally to (1) SC attaining a specified level of EPS by December 31, 2020; (2) SC attaining certain capital ratio goals by December 31, 2020; (3) SC attaining a specified level of return on assets by December 31, 2020; and (4) SC attaining a specified level of expense ratio by December 31, 2020. Performance below target goals for any component will result in below-target payout for the component and performance below certain threshold goals will result in no payout for the component. No amount greater than the target award can be earned.
Special Regulatory Incentive Program ("SRIP")
During 2016, we developed a special regulatory incentive program, which we refer to as the "SRIP," for performance periods 2017, 2018 and 2019. The SRIP was approved by Santander’s Remuneration Committee on June 27, 2016. The SRIP is part of the Executive Bonus Program. We designed the SRIP to support meeting our U.S. regulatory commitments, an important factor in helping to shape our strategy over the next several years. The SRIP reinforces our regulatory focus, and we intend it to reward those select leaders who drive our success. Each of our named executive officers participates in the SRIP.
Overall Program Objectives:
• | The purpose of the SRIP is to strengthen the alignment between pay and the annual achievement of critical U.S. regulatory priorities. |
• | We establish the SRIP measures for each period to ensure that payouts align to critical regulatory milestones, which differ for each period, and to ensure our adherence to CRD-IV pay ratio requirements. |
• | SRIP eligibility is directed to select leadership roles responsible for achieving these goals and will provide meaningful compensation over time in order to reinforce accountability and assist with retention. |
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2018 Program:
Total target opportunity over the life of the multi-year program was set at $2,000,000 for Mr. Powell and at $1,000,000 each for the other named executive officers.
For 2018, 35% of each participant’s total targeted opportunity was based on achieving certain regulatory and/or compliance criteria or goals.
We successfully achieved or met the criteria to satisfy achieving these goals for 2018, and therefore our BCTMC, the SC BCTMC in the case of Mr. Powell, and Santander's Remuneration Committee each approved the named executive officers' actual award amounts for 2018 at 35% of their respective total target opportunity.
Any payments made under the SRIP to our named executive officers are subject to the same payment, deferral, and performance requirements as those applicable to payments made under the Executive Bonus Program, which we describe above.
Total Results for 2018 Executive Bonus Program and SRIP
The following chart summarizes the 2018 Executive Bonus Program and SRIP awards for the named executive officers:
Name | Cash | Equity | |||||
Immediate ($) | Deferred ($) | Total ($) | Immediate ($) | Deferred ($) | Total ($) | ||
Mr. Powell | Bonus | $850,000 | $1,275,000 | $2,125,000 | $850,000 | $1,275,000 | $2,125,000 |
SRIP | $140,000 | $210,000 | $350,000 | $140,000 | $210,000 | $350,000 | |
Mr. Dayal | Bonus | $537,500 | $537,500 | $1,075,000 | $537,500 | $537,500 | $1,075,000 |
SRIP | $87,500 | $87,500 | $175,000 | $87,500 | $87,500 | $175,000 | |
Mr. Griffiths | Bonus | $537,000 | $358,000 | $895,000 | $537,000 | $358,000 | $895,000 |
SRIP | $105,000 | $70,000 | $175,000 | $105,000 | $70,000 | $175,000 | |
Mr. Wolf | Bonus | $382,500 | $255,000 | $637,500 | $382,500 | $255,000 | $637,500 |
SRIP | $105,000 | $70,000 | $175,000 | $105,000 | $70,000 | $175,000 | |
Mr. Aditya | Bonus | $322,800 | $215,200 | $538,000 | $322,800 | $215,200 | $538,000 |
SRIP | $105,000 | $70,000 | $175,000 | $105,000 | $70,000 | $175,000 | |
Mr. Gunn | Bonus | $276,750 | $184,500 | $461,250 | $276,750 | $184,500 | $461,250 |
SRIP | $105,000 | $70,000 | $175,000 | $105,000 | $70,000 | $175,000 | |
The total cash amount for each named executive officer, both immediate and deferred, is included in the 2018 "Bonus" column in the Summary Compensation Table.
As noted above, the equity awards are provided in immediate and deferred Santander ADRs and for Mr. Powell SC shares/RSUs. The number of ADRs is determined using the average weighted daily volume of the average weighted listing prices of shares of Santander on the Spanish Stock Exchange for the 15 trading sessions prior to the Friday (exclusive) of the previous week to January 29, 2019. Since the awards are established in a currency other than euro, the amount for immediate payment and deferral applicable is converted to euros using the average closing exchange rate over the 15 trading sessions prior to the Friday (exclusive) of the previous week to January 29, 2019. For the SC shares/RSUs, the number of shares/RSUs is determined by using the closing price of a SC share on the NYSE on the grant date.
These equity awards were granted in early 2019 after the 2018 performance assessments, and under SEC rules will be reported as 2019 compensation based on their accounting grant date fair values.
Additional Long-Term Incentive Compensation
Santander discontinued use of any additional long-term incentive plan beginning with the 2016 performance year. Santander merged the targeted awards made under the long-term incentive plan in previous years with the targeted incentive awards granted under the Executive Bonus Program.
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Annual Discretionary Bonuses
In certain cases, we award annual discretionary bonuses to the named executive officers to motivate and reward outstanding performance outside of our incentive compensation program, which we describe above. These awards permit us to apply discretion in determining awards rather than applying a formulaic approach that may inadvertently reward inappropriate risk-taking. None of the named executive officers received a discretionary bonus outside the Executive Bonus Program for 2018.
Employment and Other Agreements
We have entered into employment letters with each of our named executive officers to establish key elements of compensation that differ from our standard plans and programs. Santander and we both believe these agreements provide stability to the organization and further our overarching compensation objective of attracting and retaining the highest quality executives to manage and lead us. We discuss these agreements below under the caption "Description of Letter Agreements."
Sign-On, Buy-Out and Retention Bonuses
We paid sign-on and buy-out bonuses to certain of the named executive officers in connection with their commencing employment with us. Providing these sign-on and buy-out bonuses is an industry-standard practice that supports the attraction of executives and makes executives whole for forfeited compensation that they would otherwise receive if they had not left their prior employment. The letter agreements for Messrs. Dayal, Gunn, Griffiths, Wolf, and Aditya include buy-out or sign-on bonuses, and were necessary to recruit these individuals from their prior employers. The portion of these bonuses earned and paid in 2018 is included in the 2018 "Bonus" column in the Summary Compensation Table. In certain limited cases, we will grant retention awards, including bonuses, to certain of our executive officers as an inducement for them to stay in active service with us. No retention awards were provided to any of the named executive officers in or with respect to 2018.
Other Compensation
We provide limited perquisites and personal benefits to our named executive officers. The BCTMC has determined that each of these benefits has a valid business purpose. We describe these perquisites and benefits that we paid to the named executive officers below in the notes to the Summary Compensation Table.
Retirement Benefits
Each of the named executive officers is eligible to participate in our qualified retirement plan under the same terms as our other eligible employees. In addition, the named executive officers are eligible to defer receipt of all or part of their annual bonuses under a nonqualified deferred compensation arrangement. We describe this arrangement below under the caption "Deferred Compensation Plan."
Board Compensation and Talent Management Committee Report
For purposes of Item 407(e)(5) of Regulation S-K, the Board Compensation and Talent Management Committee furnishes the following information. The Committee has reviewed and discussed the Compensation Discussion and Analysis included in Part III - Item 11 of this Form 10-K with management. Based upon the Committee’s review and discussion with management, the Committee has recommended that the Compensation Discussion and Analysis be included in the Form 10-K for the fiscal year ended December 31, 2018.
Submitted by:
T. Timothy Ryan, Jr., Acting Chair
Stephen A. Ferriss
Juan Guitard
Henri-Paul Rousseau
Victor Matarranz
Richard Spillenkothen
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The foregoing "Board Compensation and Talent Management Committee Report" shall not be deemed to be "filed" with the SEC or subject to the liabilities of Section 18 of the Exchange Act, and notwithstanding anything to the contrary set forth in any of our previous filings under the Act, or the Exchange Act, that incorporate future filings, including this Form 10-K, in whole or in part, the foregoing "Board Compensation and Talent Management Committee Report" shall not be incorporated by reference into any such filings.
Board Compensation and Talent Management Committee Interlocks and Insider Participation
• | The following directors served as members of our BCTMC in 2018: Catherine Keating (resigned June 29, 2018), T. Timothy Ryan, Jr., Stephen A. Ferriss, Juan Guitard, Richard Spillenkothen, Henri-Paul Rousseau and Victor Matarranz. Mr. Guitard is the Head of Internal Audit at Santander and Mr. Matarranz is the Head of Santander’s Wealth Management Division. With these exceptions, no member of the BCTMC (i) was during the 2018 fiscal year, or had previously been, an officer or employee of SHUSA or its subsidiaries nor (ii) had any direct or indirect material interest in a transaction of SHUSA or a business relationship with SHUSA, in each case that would require disclosure under the applicable SEC rules. |
• | None of our executive officers is a member of the compensation committee or board of directors of another entity whose executive officers have served on our Board of Directors or the BCTMC, except that Mr. Powell serves as our and SC's director, President and CEO and Mr. Aditya serves as our Chief Risk Officer and a director of SC. Neither Mr. Powell nor Mr. Aditya serve on our or the SC BCTMC. |
CEO Pay Ratio Disclosure
As required by applicable SEC rules, we are providing the following information about the relationship of the annual total compensation of our employees and the annual total compensation of Mr. Powell, our President and CEO.
For 2018, our last completed fiscal year:
• | the median of the annual total compensation of all our employees (other than Mr. Powell) was $54,658; and |
• | the annual total compensation of Mr. Powell, as reported in the Summary Compensation Table included elsewhere in this Form 10-K, was $6,935,789. |
Based on this information, for 2018 the ratio of the annual total compensation of Mr. Powell, our President and CEO, was 126.9 times that of the median of the annual total compensation of all our other employees. |
As permitted by SEC rules, we used the same median employee as identified for 2017, because there have been no significant changes to our workforce or pay design for 2018 that we believe would significantly change our CEO pay ratio results.
The following briefly describes the process we used to identify our median employee for 2017, as well as to determine the annual total compensation of our median employee and Mr. Powell:
1. | We determined that, as of October 1, 2017, our employee population consisted of approximately 16,963 individuals. This population consisted of our full-time, part-time, and temporary employees employed with us as of the determination date. This number differs from the number of employees that we disclose elsewhere in this Form 10-K because, for purposes of the CEO pay ratio disclosure, we do not calculate the number of employees as of the end of our fiscal year. |
2. | To identify the "median employee" from our employee population, we used the amount of "gross wages" for the identified employees as reflected in our payroll records for the nine-month period beginning January 1, 2017 and ending October 1, 2017. For gross wages, we generally used the total amount of compensation the employees were paid before any taxes, deductions, insurance premiums, and other payroll withholding. We did not use any statistical sampling techniques. |
3. | For the annual total compensation of our median employee, we identified and calculated the elements of that employee’s compensation for 2018 in accordance with the requirements of Item 402(c)(2)(x) of SEC Regulation S-K, resulting in annual total compensation of $54,658. |
4. | For the annual total compensation of Mr. Powell, we used the amount reported in the "Total" column of our 2018 Summary Compensation Table included in this Form 10-K. |
The CEO pay ratio that we report above is a reasonable estimate calculated in a manner consistent with SEC rules based on the methodologies and assumptions described above. SEC rules for identifying the median employee and determining the CEO pay ratio permit companies to employ a wide range of methodologies, estimates, and assumptions. As a result, the CEO pay ratios reported by other companies, which may have employed other permitted methodologies or assumptions and which may have a significantly different workforce structure from ours, are likely not comparable to our CEO pay ratio.
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Summary Compensation Table - 2018
Name and Principal Position | Year | Salary(3) | Bonus(4) | Stock Awards(5) | All Other Compensation(6) | Total | ||||||||||||||||||
Scott Powell (1) | 2018 | $ | 2,980,769 | $ | 2,475,000 | $ | 1,417,683 | $ | 62,337 | $ | 6,935,789 | |||||||||||||
President and Chief Executive Officer | 2017 | $ | 2,000,000 | $ | 1,447,500 | $ | 1,296,202 | $ | 32,277 | $ | 4,775,979 | |||||||||||||
2016 | $ | 2,000,000 | $ | 1,250,000 | $ | 1,129,778 | $ | 108,529 | $ | 4,488,307 | ||||||||||||||
Madhukar Dayal | 2018 | $ | 1,200,000 | $ | 1,725,500 | $ | 1,102,652 | $ | 23,583 | $ | 4,051,735 | |||||||||||||
Chief Financial Officer | 2017 | $ | 1,200,000 | $ | 1,625,500 | $ | 918,820 | $ | 105,974 | $ | 3,850,294 | |||||||||||||
2016 | $ | 788,462 | $ | 2,151,000 | $ | — | $ | 213,111 | $ | 3,152,573 | ||||||||||||||
Daniel Griffiths | 2018 | $ | 1,055,769 | $ | 1,737,000 | $ | 978,001 | $ | 42,419 | $ | 3,813,189 | |||||||||||||
Chief Technology Officer | 2017 | $ | 1,000,000 | $ | 1,687,000 | $ | 826,939 | $ | 597,453 | $ | 4,111,392 | |||||||||||||
2016 | $ | 653,846 | $ | 1,310,000 | $ | — | $ | 88,412 | $ | 2,052,258 | ||||||||||||||
William Wolf (2) | 2018 | $ | 800,000 | $ | 1,532,500 | $ | 755,080 | $ | 23,583 | $ | 3,111,163 | |||||||||||||
Chief Human Resources Officer | 2017 | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||||||
2016 | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||||
Mahesh Aditya | 2018 | $ | 1,327,019 | $ | 1,113,000 | $ | 647,210 | $ | 11,000 | $ | 3,098,229 | |||||||||||||
Chief Operating Officer | 2017 | $ | 819,231 | $ | 2,125,000 | $ | — | $ | 404,718 | $ | 3,348,949 | |||||||||||||
Brian Gunn | 2018 | $ | 1,600,000 | $ | 1,167,120 | $ | 647,210 | $ | 17,300 | $ | 3,431,630 | |||||||||||||
Chief Risk Officer | 2017 | $ | 1,600,000 | $ | 1,205,870 | $ | 929,549 | $ | 28,239 | $ | 3,763,658 | |||||||||||||
2016 | $ 1,000,000 | $ 1,431,869 | $ | 945,001 | $ | 121,217 | $ | 3,498,087 | ||||||||||||||||
Footnotes:
(1) | Mr. Powell served as a director of us, SBNA, and SC. Mr. Powell received no compensation for that service as a director. Amounts for 2017 and 2018 include aggregate compensation that we and SC paid Mr. Powell for his services for our respective companies. For information about the allocation of these amounts, see "The Role of Our Board and SC's BCTMCs." |
(2) | Mr. Wolf commenced employment with us on March 28, 2016. Mr. Wolf is being reported in this disclosure for the first time and therefore no historical information is presented. |
(3) | Reflects actual base salary paid through the end of the applicable fiscal year. |
(4) | The amounts in this column for 2018 reflect the cash portion of the bonus awards for performance in 2018 under the Executive Bonus Program and SRIP, both immediate and deferred amounts that vest in future years based on fulfillment of time and performance conditions. See "Total Results for 2018 Executive Bonus Program and SRIP" in the Compensation Discussion and Analysis above for details on these amounts. The amounts in this column also include any sign-on or buy-out bonuses earned for the year. For 2018, the following named executive officers earned buy-out bonuses under their letter agreements as follows: Mr. Dayal: $475,500; Mr. Wolf, $420,000; Mr. Aditya: $400,000; and Mr. Gunn: $530,870. Additionally, the following executives earned sign-on bonuses under their letter agreements as follows: Mr. Griffiths: $667,000 and Mr. Wolf: $300,000. |
(5) | The amounts in this column for 2018 reflect the grant date fair value of equity-based awards granted in 2018 under the 2017 Executive Bonus Program determined in accordance with ASC Topic 718 as further detailed in the Grants of Plan-Based Awards Table below. The Company recognizes compensation expense related to stock awards based upon the fair value of the awards on the date of the grant. For Santander ADRs, (both vested and deferred), the grant date fair value is based on market purchase price as of the grant date converted to USD using the exchange rate on the day of the grant, ignoring any risk of forfeiture. For SC shares and RSUs, see Note 1 and ("Description of Business, Basis of Presentation, and Significant Accounting Policies and Practices-Stock Based Compensation") and Note 16 ("Employee Benefit Plans") of the SC consolidated financial statements filed with the SEC on Form 10-K for the fiscal year ended December 31, 2018. The related expense is charged to earnings over the requisite service period. |
SEC rules require the Summary Compensation Table to include in each year’s amount the aggregate grant date fair value of stock awards granted during the year. Typically, we grant equity awards early in the year as part of the Executive Bonus Program and SRIP award for prior year performance. As a result, the amounts for equity awards generally appear in the Summary Compensation Table for the year after the performance year upon which they were based and, therefore, the Summary Compensation Table does not fully reflect the BCTMC’s or SC BCTMC’s view of its pay-for-performance executive compensation program for a particular performance year. See the discussion under "Incentive Compensation" in the Compensation Discussion and Analysis regarding the 2018 awards of immediate and deferred cash and equity awards for 2018 performance under the 2018 Executive Bonus Program and SRIP.
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(6)Includes the following amounts that we paid to or on behalf of the named executive officers in the 2018 fiscal year with respect to service for us:
Year | Powell | Dayal | Griffiths | Wolf | Aditya | Gunn | ||||||||||||||||||||
Contribution to Defined Contribution Plan | 2018 | $ | 11,000 | $ | 11,000 | $ | — | $ | 11,000 | $ | 11,000 | $ | 11,000 | |||||||||||||
Relocation Expenses, Temporary Housing, and Spousal Allowance | 2018 | $ | — | $ | — | $ | 5,462 | $ | — | $ | — | $ | — | |||||||||||||
Housing Allowance, Utility Payments, and Per Diem | 2018 | $ | — | $ | — | $ | 20,000 | $ | — | $ | — | $ | — | |||||||||||||
Legal, Tax, and Financial Consulting Expenses | 2018 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||||||
Tax Reimbursements (*) | 2018 | $ | 44,347 | $ | 5,593 | $ | 16,957 | $ | 5,593 | $ | — | $ | — | |||||||||||||
Paid Parking | 2018 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 6,300 | |||||||||||||
Taxable Fringe Benefits | 2018 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||||||
Home and Family Travel | 2018 | $ | 6,990 | $ | 6,990 | $ | — | $ | 6,990 | $ | — | $ | — | |||||||||||||
Total | 2018 | $ | 62,337 | $ | 23,583 | $ | 42,419 | $ | 23,583 | $ | 11,000 | $ | 17,300 | |||||||||||||
(*) | Includes amounts paid to gross up for tax purposes certain perquisites and tax payments in accordance with an applicable employment or letter agreement or other arrangement. |
Grants of Plan-Based Awards-2018
Estimated Possible Payouts Under Equity Incentive Plan Awards | All Other Stock Awards: Number of Shares of Stock or Units (#) | Grant Date Fair Value of Stock and Option Awards ($) | ||||||||||
Name | Grant Date | Target (#) | ||||||||||
Scott Powell | 3/1/2018 | $ | 22,448 | (1) | $ | 361,862 | ||||||
3/1/2018 | $ | 22,448 | (2) | $ | 361,862 | |||||||
2/21/2018 | $ | 49,821 | (3) | $ | 346,980 | |||||||
2/21/2018 | $ | 49,821 | (4) | $ | 346,980 | |||||||
Madhukar Dayal | 2/21/2018 | $ | 79,162 | (3) | $ | 551,326 | ||||||
2/21/2018 | $ | 79,162 | (4) | $ | 551,326 | |||||||
Daniel Griffiths | 2/21/2018 | $ | 70,213 | (3) | $ | 489,000 | ||||||
2/21/2018 | $ | 70,213 | (4) | $ | 489,000 | |||||||
William Wolf | 2/21/2018 | $ | 65,051 | (3) | $ | 453,049 | ||||||
2/21/2018 | $ | 43,367 | (5) | $ | 302,031 | |||||||
Mahesh Aditya | 2/21/2018 | $ | 55,758 | (3) | $ | 388,326 | ||||||
2/21/2018 | $ | 37,172 | (5) | $ | 258,884 | |||||||
Brian Gunn | 2/21/2018 | $ | 55,758 | (3) | $ | 388,326 | ||||||
2/21/2018 | $ | 37,172 | (5) | $ | 258,884 | |||||||
Footnotes:
(1) | Reflects the number of immediately vested SC shares granted in 2018 to the applicable named executive officer under the 2017 Executive Bonus Program and SRIP subject to one-year retention. |
(2) Reflects the number of SC RSUs awarded on March 1, 2018 under the 2017 Executive Bonus Program and SRIP. These vest on March 1 of each year over a five-year period, in equal installments, with first vesting occurring in 2019 and the final vesting occurring in 2023. The shares vesting in the last three years are subject to performance conditions.
(3) Reflects the number of immediately vested Santander ADRs granted in 2018 to the applicable named executive officer under the 2017 Executive Bonus Program and SRIP subject to one-year retention.
(4) | Reflects the number of Santander deferred ADRs awarded on February 21, 2018 under the 2017 Executive Bonus Program and SRIP. These vest within 30 days of the initial grant date of each year over a five-year period in equal installments, with first vesting occurring in 2019 and the final vesting occurring in 2023. The shares vesting in the last three years are subject to performance conditions. |
(5) | Reflects the number of Santander deferred ADRs awarded on February 21, 2018 under the 2017 Executive Bonus Program and SRIP. These vest within 30 days of the initial grant date of each year over a three-year period in equal installments, with the first vesting occurring in 2019 and the final vesting occurring in 2021. The shares vesting in the last year are subject to performance conditions. |
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Outstanding Equity Awards at Fiscal 2018 Year End
Stock Awards | |||||||
Name | Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights that have not Vested (#) | Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights that have not Vested ($) | |||||
Scott Powell | 22,448 | (1) | $ | 394,860 | |||
49,821 | (2) | $ | 223,198 | ||||
3,246 | (4) | $ | 14,542 | ||||
92,671 | (5) | $ | 415,168 | ||||
55,746 | (7) | $ | 249,742 | ||||
69,579 | (8) | $ | 311,714 | ||||
Madhukar Dayal | 79,162 | (2) | $ | 354,646 | |||
661 | (4) | $ | 2,961 | ||||
44,483 | (6) | $ | 199,284 | ||||
Daniel Griffiths | 70,213 | (2) | $ | 314,554 | |||
596 | (4) | $ | 2,670 | ||||
40,034 | (6) | $ | 179,352 | ||||
William Wolf | 43,367 | (3) | $ | 194,285 | |||
442 | (4) | $ | 1,980 | ||||
29,654 | (6) | $ | 132,850 | ||||
Mahesh Aditya | 37,172 | (3) | $ | 166,530 | |||
Brian Gunn | 37,172 | (3) | $ | 166,530 | |||
1,497 | (4) | $ | 6,706 | ||||
44,532 | (6) | $ | 199,503 | ||||
31,357 | (7) | $ | 140,481 | ||||
24,740 | (9) | $ | 110,835 | ||||
Footnotes:
(1) | SC awarded these RSUs on March 1, 2018 under the 2017 Executive Bonus Program and SRIP. They vest on March 1 of each year over a five-year period, in equal installments, with the first vesting in 2019 and the last vesting in 2023. The shares vesting in the last three years are subject to performance conditions. |
(2) | Santander awarded these deferred Santander ADRs on February 21, 2018 under the 2017 Executive Bonus Program and SRIP. These vest within 30 days of the initial grant date of each year over a five-year period in equal installments, with the first vesting in 2019 and the last vesting in 2023. The shares vesting in the last three years are subject to performance conditions. |
(3) | Santander awarded these deferred Santander ADRs on February 21, 2018 under the 2017 Executive Bonus Program and SRIP. These vest within 30 days of the initial grant date of each year over a three-year period in equal installments, with the first vesting occurring in 2019 and the final vesting occurring in 2021. The shares vesting in the last year are subject to performance conditions. |
(4) | Santander awarded these deferred Santander ADRs on September 26, 2017 as additional shares for all outstanding deferred awards granted prior to December 31, 2017 that vest in 2018 and beyond to account for share dilution resulting from Santander's purchase of Banco Popular in June 2017. The share numbers reflect the 1.49% upward adjustment of all the outstanding deferred shares granted prior to December 31, 2017 that vest in 2018 and beyond, as shown in this table, and follow the vesting schedule applicable to each grant. |
(5) | Santander awarded these deferred Santander ADRs on February 21, 2017 under the 2016 Executive Bonus Program. One-fifth of these shares vested on February 21, 2018, and the remainder will vest within 30 days of the initial grant date, in equal installments, in each year from 2019 through 2022. The shares vesting in the last three years are subject to performance conditions. |
(6) | Santander awarded these deferred Santander ADRs on February 21, 2017 under the 2016 Executive Bonus Program. One-third of these shares vested on February 21, 2018, and the remainder will vest within 30 days of the initial grant date, in equal installments, in each year from 2019 through 2020. The shares vesting in the last year are subject to performance conditions. |
(7) | Santander awarded these deferred Santander ADRs on July 5, 2016 under the second cycle of the 2015 Performance Shares Plan. All shares cliff vest on the third anniversary of the award date, and the number of shares delivered depend on achievement of performance criteria set forth in the second cycle plan, which we have previously described in the Compensation Discussion and Analysis included in our Form 10-K filed in prior years. Performance period for this plan has been completed and the awards were adjusted to 60.1% of initial targeted value, vesting in March 2019. |
(8) | Santander awarded these deferred Santander ADRs on February 22, 2016 under the 2015 Executive Bonus Program. These vest in equal installments over a five-year period. One-fifth of these shares vested on February 22, 2017, one-fifth vested on February 21, 2018 and the remainder will vest within 30 days of the initial grant date, in equal installments, in each year from 2019 through 2021. The shares vesting in the last three years are subject to performance conditions. |
(9) | Santander awarded these deferred Santander ADRs on February 22, 2016 under the 2015 Executive Bonus Program. These vest in equal installments over a three-year period. One-third of these shares vested on February 22, 2017, one third vested on February 21, 2018 and one third will vest within 30 days of February 22, 2019. The shares vesting in the last year are subject to performance conditions. |
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Option Exercises and Stock Vested - 2018
ADR Awards | SC RSU Awards | |||||||||||||
Name | Number of Shares Acquired on Vesting (#) | Value Realized on Vesting ($) | Number of Shares Acquired on Vesting (#) | Value Realized on Vesting ($) | ||||||||||
Scott Powell | 96,872 | $ | 674,229 | 22,448 | $ | 361,862 | ||||||||
Madhukar Dayal | 101,734 | $ | 708,069 | — | $ | 0 | ||||||||
Daniel Griffiths | 90,528 | $ | 630,075 | — | $ | — | ||||||||
William Wolf | 80,099 | $ | 557,489 | — | $ | — | ||||||||
Mahesh Aditya | 55,758 | $ | 388,076 | — | $ | — | ||||||||
Brian Gunn | 103,463 | $ | 720,102 | — | $ | — | ||||||||
Deferred Compensation Plan
We maintain the Sovereign Bancorp, Inc. 2007 Nonqualified Deferred Compensation Plan, which we refer to as the "Deferred Compensation Plan." The Deferred Compensation Plan has the following features:
• | Participants may defer up to 100% of their cash bonus and choose among various investment options upon which we will base the rate of return on amounts deferred. We adjust participants’ accounts periodically to reflect the deemed gains and losses attributable to the deferred amounts. The specific investment options mirror the investment options in our qualified retirement plan, with some additional investment alternatives available. |
• | We distribute all account balances in cash. |
• | Participants are always 100% vested in all amounts deferred. |
• | Our and SBNA’s directors may defer receipt of cash fees for service as a director into the Deferred Compensation Plan. |
• | Distribution events will be only as permitted under Section 409A of the Internal Revenue Code. |
No named executive officer deferred any salary or bonus earned in 2018 into the Deferred Compensation Plan.
Description of Employment Letters
We and/or Santander have entered into employment letters with our named executive officers that were in effect in 2018. We describe below each of the letters providing for termination or change in control benefits or other one-time bonus payments that were due in the last fiscal year.
Scott Powell
We entered into an employment letter agreement with Mr. Powell dated September 14, 2018 relating to his employment responsibilities for us, Santander, and SC during the period from January 1, 2018 - December 31, 2019. The agreement sets Mr. Powell’s salary for 2018 at $3 million and his target bonus for 2018 at $4.25 million.
Under Mr. Powell’s employment letter agreement, if he is terminated by us or by SC without cause (as defined in the agreement) or if he terminates employment with us or with SC for good reason (as defined in the agreement), he will be entitled to the following:
• | A lump sum payment equal to 12 months of base salary; |
• | A pro-rata bonus for the time worked during the year subject to treatment as variable compensation under CRD-IV; and |
• | Provided he is willing to provide continued services on a consulting basis as necessary in order to assist future management with a smooth transition of his responsibilities, continued vesting (and payment) of all unvested deferred variable compensation on the same schedule as if he had remained employed for the remainder of the deferral period. |
Mr. Powell is subject to the following restrictive covenants under his employment letter agreement:
• | Perpetual nondisclosure of confidential information; |
• | Non-solicitation during employment and for one year after; |
• | Non-competition during employment and for one year after; and |
• | Perpetual non-disparagement of us. |
Madhukar Dayal
We entered into an employment letter with Mr. Dayal dated December 9, 2015 that was revised on May 2, 2017. Our employment letter with Mr. Dayal does not provide for severance benefits in the context of termination or a change in control or any specific commitments regarding 2018 compensation.
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Daniel Griffiths
We entered into an employment letter with Mr. Griffiths dated April 18, 2016 that was revised on April 10, 2018. Our employment letter with Mr. Griffiths does not provide for severance benefits in the context of termination or a change in control.
The employment letter provides that Mr. Griffiths will receive a sign-on bonus to compensate him for forfeited equity from his prior position, to be paid in four installments totaling $2,500,000, of which $1,167,000 had already been paid before 2018, $667,000 was paid in 2018, and $667,000 will be paid in 2019. No payment will be made if Mr. Griffiths voluntarily terminates employment or we terminate him for cause (as defined in the employment letter) through the date of payment. Mr. Griffiths must repay a payment if he voluntarily terminates employment or we terminate him for cause (as defined in the employment letter) within 12 months of such payment.
Mr. Griffiths was also eligible to receive a 24-month relocation benefit (ending in June 2018) in accordance with our policies.
William Wolf
We entered into an employment letter with Mr. Wolf dated as of January 7, 2016. Our employment letter with Mr. Wolf does not provide for severance benefits in the context of termination or a change in control.
The employment letter provides that Mr. Wolf will receive a sign-on bonus paid in three installments, of which $900,000 was paid before 2018 and the remaining $300,000 was paid in 2018.
The employment letter also provides that Mr. Wolf will receive compensation for his forfeited equity, of which $420,000 was paid in April 2017, the second installment of $420,000 was paid in April 2018, and the final installment of $420,000 is payable in April 2019. No additional payments will be made if Mr. Wolf voluntarily terminates employment or if we terminate him for cause (as defined in the employment letter) through the dates of payment, and Mr. Wolf must repay the second payment if we terminate him for cause (as defined in the employment letter) on or before one-year after the third payment (i.e. April 2020).
Mahesh Aditya
We entered into an employment letter with Mr. Aditya dated as of February 2, 2017 that was revised on April 28, 2017. Our employment letter with Mr. Aditya does not provide for severance benefits in the context of termination or a change in control.
The employment letter provides that Mr. Aditya will receive $2,175,000 as compensation for his forfeited equity in four installments, of which the first installment of $900,000 was paid in July 2017, the second installment of $550,000 was paid in November 2017, the third installment of $400,000 was paid in November 2018, and the final installment of $325,000 will be paid in November 2019. No additional payments will be made if Mr. Aditya voluntarily terminates employment or if we terminate him for cause (as defined in the employment letter) through the dates of payment and Mr. Aditya must repay such amounts if he voluntarily terminates employment or we terminate him for cause (as defined in the employment letter) within 12 months of each such payment.
Brian Gunn
Mr. Gunn, who stepped down as our Chief Risk Officer and assumed the position of Special Advisor in May 2018, entered into a separation agreement with us in May 2018, pursuant to which he continues in service with us until March 8, 2019, at which time his employment ends. In exchange for his services and a release of claims, the separation agreement provides that he remains eligible for his 2018 bonus and SRIP awards, and that his deferred awards will continue to vest in accordance with their schedules and subject to our Malus and Clawback Policy. No severance benefits are payable under the agreement.
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Potential Payments upon Termination or Change in Control
Executive Bonus Program, SRIP, and Performance Share Plan
Deferred cash and Santander ADRs granted under the Executive Bonus Plan, SRIP, and Performance Share Plan (as described in the footnotes under the section Outstanding Equity Awards at Fiscal 2018 Year End) generally require the participating named executive officer to remain employed until each scheduled vesting date to earn payment for the award. The arrangements, however, permit the award to continue to become earned and payable over the vesting schedule as if the named executive officer had remained employed in the event that the named executive officer terminates employment due to (i) the executive’s death or disability; (ii) an involuntary termination due to reduction in force, divestiture, or acquisition; or (iii) the executive’s retirement. "Retirement" means the executive’s termination of employment after attaining a combined age and years of service of at least 60, with at least five years of service and at least age 55. In case of retirement, the named executive officer must also certify the intent to retire from the for-profit financial services industry for a minimum of 12 months. As of the end of the last fiscal year, none of the named executive officers was eligible for Retirement. The vesting of the awards remains subject to any performance goals, as well as the Policy on Malus and Clawback Requirements, as described under "Long-Term/Deferred" in the Compensation Discussion and Analysis above. In addition, under Mr. Powell’s letter agreement as described above, he may be required to provide post-employment consulting services to us in order to continue to vest in his awards.
SC RSUs (only Mr. Powell)
SC RSUs generally require that Mr. Powell to remain employed until each scheduled vesting date to earn payment of the award. The award agreements, however, permit the award to continue to become earned and payable over the vesting schedule as if Mr. Powell had remained employed in the event that he terminates employment due to (i) his death or disability, (ii) an involuntary termination by SC without "cause" or by Mr. Powell for "good reason" (as those terms are defined in Mr. Powell’s letter agreement described above), or (iii) his retirement, subject to the achievement of certain performance goals set forth in the applicable award agreement.
In addition, under the SC equity compensation plan under which the RSUs are granted, in the event of a "change in control" of SC, treatment of the RSUs will depend on whether or not the RSUs are assumed, converted, or replaced by the buyer:
• | If the RSUs are not assumed, converted, or replaced, (i) the time-vesting portion will fully vest upon the change in control; and (ii) the performance-vesting portion will vest based on the achievement of all performance goals at the “target” level, and will be prorated based on the portion of the performance period that had been completed through the date of the change in control. |
• | If the RSUs are assumed, converted, or replaced, no automatic vesting will occur upon the change in control. Instead, the RSUs, as adjusted in connection with the transaction, will continue to vest in accordance with their terms. In addition, the time-vesting portion will fully vest if Mr. Powell has a termination of employment within two years after the change in control by the company other than for cause or by Mr. Powell for good reason (each as defined in the applicable award agreement). For the performance-vesting portion, the amount vesting upon involuntary termination within two years of a change in control will be based on the achievement of all performance goals at the “target” level. |
Severance Plan and Agreements
See above regarding the description of severance benefits payable to Mr. Powell in case of his termination of employment by us or SC without "cause" or by Mr. Powell for "good reason."
The other named executive officers are covered by our Enterprise Severance Policy. Under this policy, if a named executive officer’s employment is involuntarily terminated by us, other than for unsatisfactory performance or misconduct, the executive is eligible to receive a lump sum severance ranging from 26 to 52 weeks of base salary based on a formula in the policy that depends on the executive’s length of service. As of December 31, 2018, each of the other named executive officers would be eligible for a minimum of 26 weeks of salary under this formula. The named executive officer would also receive three months of premiums under the Consolidated Omnibus Budget Reconciliation Act (“COBRA”) and six months of outplacement services. The named executive officer must provide us with a release of claims and comply with certain post-employment covenants to be eligible to receive the severance benefits.
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Potential Payments Upon Termination or Change in Control
The table below sets forth the value of the benefits (other than payments that were generally available to salaried employees) that would have been due to the named executive officers if they had terminated employment with us on December 31, 2018 based on the arrangements described above.
Termination for Death | Termination for Disability | Involuntary Termination Other than for Cause | Voluntary Termination or Termination for Cause | Change in Control | ||||||||||||||||||
Scott Powell | Executive Bonus Program (1) | $ | 2,484,654 | $ | 2,484,654 | $ | 2,484,654 | $ | — | $ | — | |||||||||||
Performance Share Plan (2) | $ | 253,458 | $ | 253,458 | $ | 253,458 | $ | — | $ | — | ||||||||||||
Santander Consumer RSUs (3) | $ | 394,860 | $ | 394,860 | $ | 394,860 | $ | — | $ | 394,860 | ||||||||||||
Severance Benefits (4) | $ | — | $ | — | $ | 7,250,000 | $ | — | $ | — | ||||||||||||
Total | $ | 3,132,972 | $ | 3,132,972 | $ | 10,382,972 | $ | — | $ | 394,860 | ||||||||||||
Madhukar Dayal | Executive Bonus Program (1) | $ | 1,371,892 | $ | 1,371,892 | $ | 1,371,892 | $ | — | $ | — | |||||||||||
Performance Share Plan (2) | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Severance Benefits (4) | $ | — | $ | — | $ | 611,700 | $ | — | $ | — | ||||||||||||
Total | $ | 1,371,892 | $ | 1,371,892 | $ | 1,983,592 | $ | — | $ | — | ||||||||||||
Daniel Griffiths | Executive Bonus Program (1) | $ | 1,222,578 | $ | 1,222,578 | $ | 1,222,578 | $ | — | $ | — | |||||||||||
Performance Share Plan (2) | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Severance Benefits (4) | $ | — | $ | — | $ | 561,700 | $ | — | $ | — | ||||||||||||
Total | $ | 1,222,578 | $ | 1,222,578 | $ | 1,784,278 | $ | — | $ | — | ||||||||||||
William Wolf | Executive Bonus Program (1) | $ | 814,115 | $ | 814,115 | $ | 814,115 | $ | — | $ | — | |||||||||||
Performance Share Plan (2) | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Severance Benefits (4) | $ | — | $ | — | $ | 411,700 | $ | — | $ | — | ||||||||||||
Total | $ | 814,115 | $ | 814,115 | $ | 1,225,815 | $ | — | $ | — | ||||||||||||
Mahesh Aditya | Executive Bonus Program (1) | $ | 436,530 | $ | 436,530 | $ | 436,530 | $ | — | $ | — | |||||||||||
Performance Share Plan (2) | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Severance Benefits (4) | $ | — | $ | — | $ | 749,200 | $ | — | $ | — | ||||||||||||
Total | $ | 436,530 | $ | 436,530 | $ | 1,185,730 | $ | — | $ | — | ||||||||||||
Brian Gunn | Executive Bonus Program (1) | $ | 1,098,416 | $ | 1,098,416 | $ | 1,098,416 | $ | — | $ | — | |||||||||||
Performance Share Plan (2) | $ | 142,573 | $ | 142,573 | $ | 142,573 | $ | — | $ | — | ||||||||||||
Severance Benefits (4) | $ | — | $ | — | $ | 811,700 | $ | — | $ | — | ||||||||||||
Total | $ | 1,240,989 | $ | 1,240,989 | $ | 2,052,689 | $ | — | $ | — | ||||||||||||
(1) | Amounts shown for the Executive Bonus Program are the value of deferred cash and Santander ADRs under the Executive Bonus Program and SRIP as of December 31, 2018 (based on the closing price of the ADRs on that date). As noted above, payment of deferred amounts is made in accordance with the original vesting schedule and subject to all performance conditions, as if employment had not been terminated. |
(2) | Amounts shown for the Performance Share Plan are the value as of December 31, 2018 of the outstanding ADRs (based on the closing price of ADRs on that date), which cliff vest in March 2019. Payment is not accelerated due to termination of employment, but will vest in accordance with the original vesting schedule and subject to all performance conditions, as if employment had not been terminated. |
(3) | Amounts shown for the SC RSUs are the value of unvested SC RSUs as of December 31, 2018 (based on the closing price of the SC common stock on that date). As noted above, payment of the RSUs is made in accordance with the original vesting schedule and subject to all performance conditions, as if employment had not been terminated. For Mr. Powell, an "involuntary termination other than for cause" also includes his termination of employment for "good reason" (as defined in his letter agreement). The "Change in Control" column shows amounts payable in the event of a change in control of SC (if the RSUs are not assumed, converted or replaced in the transaction) or upon a termination of employment without cause or with good reason within two years after a change in control of SC (if the RSUs are assumed, converted or replaced in the transaction). |
(4) | Amounts shown are as follows: (i) for Mr. Powell, in accordance with his letter agreement described above, 12 months of base salary and the full amount of his 2018 bonus under the Executive Bonus Program (for the pro rata bonus requirement); and (ii) for each of the other named executive officers, in accordance with the Enterprise Severance Policy as described above, 26 weeks of salary plus the estimated value of three months of COBRA premiums and six months of outplacement services. As noted above, for Mr. Powell, an "involuntary termination other than for cause" also includes his termination of employment for "good reason" (as defined in his letter agreement). |
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Director Compensation in Fiscal Year 2018
We believe that the amount, form, and methods used to determine compensation of our non-executive directors are important factors in:
• | attracting and retaining directors who were independent, interested, diligent, and actively involved in overseeing our affairs and who satisfy the standards of Santander, the sole shareholder of our common stock; and |
• | providing a reasonable, competitive, and effective approach that compensates our directors for the responsibilities and demands of the role of director. |
Director Compensation Program
Our 2018 Director Compensation Program for service on our Board and the SBNA Board included payment of the following amounts, quarterly in arrears, to our non-executive directors:
• | a $150,000 cash retainer annually; plus |
• | a $20,000 supplement as an additional cash retainer annually, if the director also serves as a director of SBNA or of SC; plus |
• | $70,000 in cash annually, if the director serves as chair of the our Risk Committee, Audit Committee or BCTMC; plus |
• | $35,000 in cash annually if the director serves as chair of SBNA’s or SC’s Risk Committee, Audit Committee or BCTMC; plus |
• | $20,000 in cash annually if the director serves as a non-chair member of our Nominations Committee, Risk Committee, Audit Committee, or BCTMC; plus |
• | $5,000 in cash annually if the director also serves as a non-chair member of SBNA’s or SC’s Risk Committee, Audit Committee or BCTMC or SBNA’s Nominations and Executive Committee or SC’s Executive Committee. |
For 2019, we expect that the compensation program for non-executive directors will remain substantially the same.
The following table sets forth a summary of the compensation that we paid to each director for service as a director of SHUSA and its subsidiaries for 2018:
Name | Fees Earned or Paid in Cash (1) | Stock Awards(2) | Other Compensation | Total (1) | ||||||||||||
Stephen Ferriss (3) | $ | 410,417 | $ | 50,000 | $ | — | $ | 460,417 | ||||||||
Alan Fishman(4) | $ | 394,583 | $ | — | $ | — | $ | 394,583 | ||||||||
Thomas S. Johnson(5) | $ | 294,583 | $ | — | $ | — | $ | 294,583 | ||||||||
Catherine Keating(6) | $ | 170,000 | $ | — | $ | — | $ | 170,000 | ||||||||
Henri-Paul Rousseau(7) | $ | 314,583 | $ | — | $ | — | $ | 314,583 | ||||||||
T. Timothy Ryan, Jr.(8) | $ | 1,450,000 | $ | — | $ | — | $ | 1,450,000 | ||||||||
Richard Spillenkothen(9) | $ | 305,833 | $ | — | $ | — | $ | 305,833 | ||||||||
Footnotes:
(1) | Reflects amounts earned in 2018. |
(2) | Reflects awards of RSUs payable in shares of SC Common Stock. The RSUs will vest on the earlier of (i) the first anniversary of the grant date and (ii) SC’s first annual shareholders' meeting following the grant date. Reflects the aggregate grant date fair value computed in accordance with ASC Topic 718, based on the closing price of SC Common Stock on the applicable grant date. Refer to Note 18 of the Consolidated Financial Statements contained in this Form 10-K for a discussion of the relevant assumptions used to account for these awards. |
(3) | Mr. Ferriss received $100,000 for service as the Chair of Santander BanCorp, which amount is included in the above table. The table also includes cash compensation of $230,000 and $50,417 that Mr. Ferriss earned for service on the Boards of SC and BSI, respectively. As of December 31, 2018, Mr. Ferriss held 2,641 of outstanding, unvested SC RSUs and 5,207 of outstanding, vested options to purchase shares of SC Common Stock. |
(4) | Includes cash compensation of $180,000 and $100,000 that Mr. Fishman earned for service on the Boards of SBNA and SIS, Inc., respectively. |
(5) | Includes cash compensation of $95,000 that Mr. Johnson earned for service on the SBNA Board. |
(6) | Ms. Keating resigned from our Board and the SBNA Board on June 29, 2018. Includes cash compensation of $72,500 that Ms. Keating earned for service on the SBNA Board. |
(7) | Includes cash compensation of $200,000 that Mr. Rousseau earned for service on the SBNA Board. |
(8) | Includes cash compensation of $450,000 and $100,000 that Mr. Ryan earned for service on the Boards of SBNA and BSI, respectively. |
(9) | Includes cash compensation of $106,250 that Mr. Spillenkothen earned for service on SBNA’s Board. |
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Agreement with Mr. Ryan
Mr. Ryan serves as our non-executive chair. We and SBNA entered into an agreement with Mr. Ryan as of December 1, 2014 to serve as our and SBNA’s chair. Under this agreement, we pay Mr. Ryan an annual cash retainer of $900,000 for serving as our chair and a $450,000 cash retainer for serving as SBNA’s chair. The initial term of the agreement was for three years through November 30, 2017. Under the agreement, if Mr. Ryan forfeits any equity or equity-based awards in connection with his prior employment with JPMorgan Chase & Co., we will pay him an amount equal to the present value of such equity awards. Mr. Ryan is also eligible to receive equity compensation on the same basis as other non-executive members of our or SBNA’s Board (no such equity compensation has been granted to date).
On August 30, 2017, we, SBNA, and Mr. Ryan entered into an amendment to the original agreement to provide for an additional one-year term through November 30, 2018. The amendment also provided that we and SBNA could, at our option, propose to extend the term of Mr. Ryan’s service for additional terms. On November 14, 2018, we, SBNA, and Mr. Ryan entered in a second amendment to the original agreement to provide for a second additional one-year term through November 30, 2019.
Under the amended agreement, Mr. Ryan is subject to a non-solicitation obligation while serving on our and SBNA’s boards. The other terms of Mr. Ryan’s original agreement with respect to the compensation that we pay him for his services as board chair continue to apply without change.
Mr. Ryan also serves as a director on the BSI board, and receives compensation for such services as noted in the Directors Compensation Table footnotes above.
Directors Participation in Deferred Compensation Plan
The Deferred Compensation Plan provides for the participation of our and SBNA's non-executive directors. The relevant terms of the Deferred Compensation Plan, as we describe in the section entitled "Deferred Compensation Arrangements" above, apply in the same manner to participants who are directors as they do to participants who are executive officers.
No director deferred fees earned for 2018 into the Deferred Compensation Plan.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT RELATED STOCKHOLDER MATTERS
As noted elsewhere in this Form 10-K, on January 30, 2009, SHUSA became a wholly-owned subsidiary of Santander (the "Santander Transaction"). As a result, following January 30, 2009, all of SHUSA’s voting securities are owned by Santander.
As a result of the Santander Transaction, there are no longer any outstanding equity awards under SHUSA’s equity incentive compensation plans. Pursuant to the Santander Transaction, (i) all stock options outstanding immediately prior to the Santander Transaction were canceled and any positive difference between the exercise price of any given stock option and the closing price of SHUSA’s common stock on January 29, 2009 was paid in cash to the option holder, and (ii) all shares of restricted stock outstanding immediately prior to the Santander Transaction vested and were treated the same way as all other shares of SHUSA common stock in the transaction.
ITEM 13 - RELATED PARTY TRANSACTIONS
Certain Relationships and Related Transactions
During each of 2018, 2017 and 2016, SHUSA and/or the Bank were participants in the transactions described below in which a “related person” (as defined in Item 404(a) of Regulation S-K, which includes directors and executive officers who served during the applicable fiscal year) had a direct or indirect material interest and the amount involved in such transaction exceeded $120,000. Item 13 should be read in conjunction with Note 21 of the Company's Consolidated Financial Statements.
Santander Relationship: Santander owns 100% of SHUSA's common stock. As a result, Santander has the right to elect the members of SHUSA's Board of Directors. In addition, certain individuals who serve as officers of SHUSA are also employees or officers of, or may be deemed to be officers of, Santander and/or its affiliates. The following transactions occurred during the 2018, 2017 and 2016 fiscal years between SHUSA or the Bank and their respective affiliates, on the one hand, and Santander or its affiliates, on the other hand.
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Please refer to Note 21 of the Company's Consolidated Financial Statements for contributions from Santander during the year.
Loan Sales
During 2017, SBNA sold $372.1 million of commercial loans to Santander. The sale resulted in $2.4 million of net gain for the year ended December 31, 2017, which is included in Miscellaneous income, net in the Consolidated Statements of Operations.
Letters of credit
In the normal course of business, SBNA provides letters of credit and standby letters of credit to affiliates. During the years ended December 31, 2018 and December 31, 2017, the average unfunded balance outstanding under these commitments was $82.7 million and $82.9 million, respectively.
Debt and Other Securities
As of December 31, 2018, 2017 and 2016, SHUSA had $8.5 billion, $8.7 billion and $6.1 billion, respectively, of public securities consisting of various senior note obligations, trust preferred securities obligations and preferred stock. As of such dates, Santander owned approximately 0.4%, 1.6% and 2.0% of these securities, respectively.
Derivatives
The Bank has established a derivatives trading program with Santander pursuant to which Santander and its subsidiaries and affiliates provide advice with respect to derivative trades, coordinate trades with counterparties, and act as counterparty in certain transactions. The agreement and the trades are on market rate terms and conditions. In 2018, 2017 and 2016, the aggregate notional amounts of $2.7 billion, $2.1 billion and $4.6 billion, respectively, were completed in which Santander and its subsidiaries and affiliates participated.
Service Agreements
The Company and its affiliates entered into, or were subject to, various service agreements with Santander and its affiliates. Each of the agreements was made in the ordinary course of business and on market terms. The agreements are as follows:
• | NW Services Co. is under contract with the Company to provide procurement services, with total fees paid in 2018, 2017 and 2016 in the amount of $5.4 million, $3.7 million and $3.6 million, respectively. There were no payables in connection with this agreement for the years ended December 31, 2018 or 2017. The fees related to this agreement are recorded in Technology, outside service, and marketing expense in the Consolidated Statements of Operations. |
• | Geoban, S.A. is under contract with the Company to provide administrative services, consulting and professional services, application support and back-office services, including debit card disputes and claims support, and consumer and mortgage loan set-up and review; with total fees paid in 2018, 2017 and 2016 in the amounts of $1.8 million, $3.3 million and $15.1 million, respectively. In addition, as of December 31, 2018 and 2017, the Company had payables with Geoban, S.A. in the amounts of zero and $0.2 million, respectively. The fees related to this agreement are recorded in Technology, outside service, and marketing expense in the Consolidated Statements of Operations. |
• | Santander Back-Offices Globales Mayoristas S.A. is under contract with the Company to provide administrative services and back-office support for the Bank's derivative, foreign exchange and hedging transactions and programs, with total fees paid in each of 2018, 2017 and 2016 of $1.9 million, $1.1 million and $1.8 million, respectively. There were no payables in connection with this agreement in 2018 or 2017. The fees related to this agreement are recorded in Technology, outside service, and marketing expense in the Consolidated Statements of Operations. |
• | Santander Global Technology is under contract with the Company to provide information technology development, support and administration, with total fees paid for these services in 2018, 2017 and 2016 in the amount of $38.7 million, $77.9 million and $91.7 million, respectively. In addition, as of December 31, 2018 and 2017, the Company had payables for these services in the amounts of $0.8 million and $26.3 million, respectively. The fees related to this agreement are capitalized in Premises and equipment, net on the Consolidated Balance Sheets. |
• | Santander Global Technology is under contract with the Company to provide professional services and administration and support of IT production systems, telecommunications and internal/external applications, with total fees for these services paid in 2018, 2017 and 2016 in the amount of $74.9 million, $110.7 million and $123.4 million, respectively. In addition, as of December 31, 2018 and 2017, the Company had payables for these services in the amounts of $18.1 million and $10.2 million, respectively. The fees related to this agreement are capitalized in Premises and equipment, net on the Consolidated Balance Sheets. |
• | In addition, Santander Global Technology is under contract with the Company to provide information technology development, support and administration, with fees paid in the amount of $5.5 million in 2018. In addition, as of December 31, |
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2018, the Company had payables with Santander Global Technology in the amounts of $21.9 million. The fees related to this agreement are capitalized in Premises and equipment, net on the Consolidated Balance Sheets.
• | During the year ended December 31, 2018, the Company paid $17.1 million to Santander for the development and implementation of global projects as part of group expense allocation. |
• | During the year ended December 31, 2018, the Company paid $3.9 million in rental payments to Santander, compared to $11.2 million in 2017 and $6.1 million in 2016. |
SC Transactions: SC has entered into or was subject to various agreements with Santander or its affiliates. Each of the agreements was done in the ordinary course of business and on market terms. Those agreements include the following:
Revolving Agreements
SC had a $1.75 billion committed revolving credit agreement with Santander that could be drawn on an unsecured basis. During the years ended December 31, 2018 , 2017 and 2016, SC incurred interest expense, including unused fees of $11.6 million, $51.7 million and $69.9 million, respectively, which included zero and $1.4 million of accrued interest payable for the years ended December 31, 2018 and 2017, respectively. This facility was terminated during 2018.
In August 2015, under a new agreement with Santander, SC agreed to begin incurring a fee of 12.5 basis points per annum on certain warehouse facilities as they renew, for which Santander provides a guarantee of SC's servicing obligations. SC recognized guarantee fee expense of $5.0 million, $6.0 million and $6.4 million for the years ended December 31, 2018, 2017 and 2016, respectively. As of December 31, 2018 and 2017, SC had $1.9 million and $7.6 million of fees payable to Santander under this arrangement.
Lease Origination and Servicing Agreement
During 2014 and until May 9, 2015, SC was party to a flow agreement with SBNA under which SBNA has the first right to review and approve Chrysler Capital consumer vehicle lease applications. SC could review any applications declined by SBNA for SC’s own portfolio. SC provides servicing and received an origination fee on all leases originated under this agreement. Pursuant to the Chrysler Agreement, SC pays FCA on behalf of SBNA for residual gains and losses on the flowed leases. All fees and expenses associated with this agreement between SBNA and SC eliminate in consolidation. In April 2015, SBNA and SC determined not to renew this agreement, which expired by its terms on May 9, 2015.
Securitizations
Other information relating to SC's SPAIN securitization platform for the years ended December 31, 2018 and 2017 is as follows:
(in thousands) | December 31, 2018 | December 31, 2017 | ||||||
Servicing fee income | $ | 35,058 | $ | 12,346 | ||||
Loss (Gain) on sale, excluding lower of cost of market adjustments (if any) | 20,736 | 13,026 | ||||||
Servicing fees receivable | 2,983 | 1,848 | ||||||
Collections due to Santander | 15,968 | 12,961 | ||||||
During the year ended December 31, 2018, SC re-acquired certain class of notes amounting to approximately $76 million from unrelated third parties that it previously sold to Santander under the SPAIN securitization platform. These notes were redeemed by Santander at par value.
Origination Support Services
Beginning in 2018, SC agreed to provide SBNA with origination support services in connection with the processing, underwriting and purchase of retail loans, primarily from Chrysler dealers. In addition, SC has agreed to perform the servicing for any loans originated on SBNA’s behalf.
Other related-party transactions
• | As of December 31, 2018, Jason A. Kulas and Thomas Dundon, both former members of SC's Board of Directors and CEOs of SC, each had a minority equity investment in a property in which SC leases approximately 373,000 square feet as its corporate headquarters. During the years ended December 31, 2018, 2017 and 2016, SC recorded $4.8 million, $5.0 million and $5.0 million, respectively, in lease payments on this property. Future minimum lease payments over the nine-year term of the lease, which extends through 2026, total $55.6 million. |
• | SC entered into a Master Securities Purchase Agreement (an "MSPA") with Santander under which it had the option to sell a contractually determined amount of eligible prime loans to Santander under the SPAIN securitization platform, for a term ending in December 2018. SC provides servicing on all loans originated under this arrangement. For the years ended |
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December 31, 2018 and December 31, 2017, SC sold $2.9 billion and $2.6 billion of prime loans at fair value under the MSPA.
• | SC is party to a master service agreement ("MSA") with a company in which it has a cost method investment and holds a warrant to increase its ownership if certain vesting conditions are satisfied. The MSA enables SC to review point-of-sale credit applications of retail store customers. During the year ended December 31, 2016, SC fully impaired its cost method investment in this entity and recorded a loss of $6.0 million. Effective August 17, 2016, SC ceased funding new originations from all of the retailers for which it reviews credit applications under this MSA. |
• | SC's wholly-owned subsidiary, Santander Consumer International Puerto Rico, LLC ("SCI"), opened deposit accounts with BSPR, an affiliated entity. As of December 31, 2018 and 2017, SCI had cash of $8.9 million and $106.6 million, respectively, on deposit with BSPR. This transaction eliminates in the consolidation of SHUSA. |
• | SBNA also has agreements with SC under which SC will service auto RICs and RV and marine portfolios. In addition, during the year ended December 31, 2017, SBNA purchased an RV/marine loan portfolio from SC. All fees and expenses associated with this agreement eliminate in consolidation. |
Entities that transferred to the IHC have entered into or were subject to various agreements with Santander or its affiliates. Each of these agreements was made in the ordinary course of business and on market terms. Those agreements include the following:
• | BSI enters into transactions with affiliated entities in the ordinary course of business. As of December 31, 2018, BSI had short-term borrowings from unconsolidated affiliates of $59.9 million compared to $78.7 million as of December 31, 2017. BSI had cash and cash equivalents deposited with affiliates of $46.2 million and $152.7 million as of December 31, 2018 and December 31, 2017, respectively. BSI had foreign exchange rate forward contracts with affiliated companies as counterparties with notional amounts of approximately $1.5 billion and $1.6 billion as of December 31, 2018 and December 31, 2017, respectively. BSI held deposits from unconsolidated affiliates of $55.7 million as of December 31, 2018. |
• | SIS enters into transactions with affiliated entities in the ordinary course of business. SIS executes, clears and custodies certain of its securities transactions through various affiliates in Latin America and Europe. The balance of payables to customers due to Santander at December 31, 2018 was $1.0 billion, compared to $1.1 billion at December 31, 2017. |
Loans to Directors and Executive Officers
SHUSA, through the Bank, is in the business of gathering deposits and making loans. Like many financial institutions, SHUSA actively encourages its directors and the companies which they control and/or are otherwise affiliated with to maintain their banking business with the Bank, rather than with a competitor.
In addition, the Bank provides certain other banking services to its directors and entities with which they are affiliated. In each case, these services are provided in the ordinary course of the Bank's business and on substantially the same terms as those prevailing at the time for comparable transactions with others.
As part of its banking business, the Bank also extends loans to directors, executive officers and employees of SHUSA and the Bank and their respective subsidiaries. Such loans are provided in the ordinary course of the Bank’s business, are on substantially the same general terms (including interest rates, collateral and repayment terms) as, and follow credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with others not affiliated with the Bank and do not involve more than the normal risk of collectability. As permitted by Regulation O, certain loans to directors and employees of SHUSA and the Bank, including SHUSA’s executive officers, are priced at up to a 0.25% discount to market and require no application fee, but contain no other terms different than terms available in comparable transactions with non-employees. The 0.25% discount is discontinued when an employee terminates his or her employment with SHUSA or the Bank. No such loans have been non-accrual, past due, restructured, or potential problem loans. Loans to directors and executive officers required to be disclosed under Item 404(b) of Regulation S-K were as follows:
• | An adjustable rate first mortgage loan to Federico Papa, a former executive officer of the Bank, in the original principal amount $995,000. The current interest rate on this loan was 2.00%. For 2018, the highest outstanding balance was $488,014, and the balance outstanding at December 31, 2018 was $472,284. Mr. Papa paid $15,730 in principal and $9,617 in interest on this loan in 2018. For 2017, the highest outstanding balance was $503,432, and the balance outstanding at December 31, 2017 was $488,014. Mr. Papa paid $15,418 in principal and $9,928 in interest on this loan in 2017. For 2016, the highest outstanding balance was $902,888, and the balance outstanding at December 31, 2016 was $503,432. Mr. Papa paid $399,456 in principal and $12,153 in interest on this loan in 2016. |
• | A fixed-rate first mortgage loan to Kenneth Goldman, a former executive officer, in the original principal amount of $824,000. The interest rate on this loan was 2.875%. For 2018, the highest outstanding balance was $725,893, and the balance outstanding at December 31, 2018 was $703,742. Mr. Goldman paid $22,151 in principal and $22,292 in interest on this loan in 2018. For 2017, the highest outstanding balance was $745,738, and the balance outstanding at December 31, 2017 |
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was $725,893. Mr. Goldman paid $19,845 in principal and $21,180 in interest on this loan in 2018. For 2016, the highest outstanding balance was $765,021, and the balance outstanding at December 31, 2016 was $745,738. Mr. Goldman paid $19,283 in principal and $21,742 in interest on this loan in 2016.
• | A fixed-rate first mortgage loan to Lisa Vanroekel, a former executive officer of the Bank, in the original principal amount of $400,000. The most recent interest rate on this loan was 3.50%. For 2016, the highest outstanding balance was $338,730, and this loan was paid in full as of December 31, 2016. Ms. Vanroekel paid $338,730 in principal and $3,409 in interest on this loan in 2016. |
• | A fixed-rate first mortgage loan to Ms. Vanroekel in the original principal amount of $687,000. The interest rate on this loan was 3.25%. For 2018, the highest outstanding balance was $644,621, and the balance outstanding at December 31, 2018 was $616,712. Ms. Vanroekel paid $27,910 in principal and $20,537 in interest on this loan in 2018. For 2017, the highest outstanding balance was $671,640, and the balance outstanding at December 31, 2017 was $644,621. Ms. Vanroekel paid $27,018 in principal and $21,428 in interest on this loan in 2017. For 2016, the highest outstanding balance was $687,000, and the balance outstanding at December 31, 2016 was $671,640. Ms. Vanroekel paid $15,360 in principal and $13,086 in interest on this loan in 2016. |
• | An adjustable rate first mortgage loan to Cameron Letters, a former executive officer of the Bank, in the original principal amount of $950,000. The interest rate on this loan was 3.00%. For 2018, the highest outstanding balance was $814,262, and the balance outstanding at December 31, 2018 was zero. Mr. Letters paid $814,262 in principal and $18,256 in interest on this loan in 2018. For 2017, the highest outstanding balance was $839,768, and the balance outstanding at December 31, 2017 was $814,262. Mr. Letters paid $25,507 in principal and $16,189 in interest on this loan in 2017. For 2016, the highest outstanding balance was $865,553, and the balance outstanding at December 31, 2016 was $839,768. Mr. Letters paid $25,785 in principal and $14,941 in interest on this loan in 2016. |
• | A fixed-rate first mortgage loan to Marcelo Brutti, a former executive officer of the Bank, in the original principal amount of $631,200. The most recent interest rate on this loan was 3.875%. For 2016, the highest outstanding balance was $617,745, and this loan was paid in full as of December 31, 2016. Mr Brutti paid $617,745 in principal and $12,423 in interest on this loan in 2016. |
• | An adjustable rate first mortgage loan to Melissa Ballenger, a former executive officer of the Bank, in the original principal amount of $700,000. The interest rate on this loan was 1.625%. For 2018, the highest outstanding balance was $655,366, and the balance outstanding at December 31, 2018 was zero. Ms. Ballenger paid $655,366 in principal and $5,607 in interest on this loan in 2018. For 2017, the highest outstanding balance was $674,048, and the balance outstanding at December 31, 2017 was $655,366. Ms. Ballenger paid $18,682 in principal and $10,815 in interest on this loan in 2017. For 2016, the highest outstanding balance was $692,429, and the balance outstanding at December 31, 2016 was $674,048. Ms. Ballenger paid $18,381 in principal and $11,115 in interest on this loan in 2016. |
• | An adjustable rate first mortgage loan to Carol Hunley, a former executive officer of the Bank, in the original principal amount of $926,400. The most recent interest rate on this loan was 2.625%. For 2016, the highest outstanding balance was $833,733, and the loan was paid in full as of December 31, 2016. Ms. Hunley paid $833,733 in principal and $8,873 in interest on this loan in 2016. |
• | An adjustable rate first mortgage loan to John Murphy, a former executive officer of the Bank, in the original principal amount of $535,000. The interest rate on this loan is 3.0%. For 2018, the highest outstanding balance was $457,150, and the balance outstanding at December 31, 2018 was $443,612. Mr. Murphy paid $13,537 in principal and $13,529 in interest on this loan in 2018. For 2017, the highest outstanding balance was $470,288, and the balance outstanding at December 31, 2017 was $457,150. Mr. Murphy paid $13,138 in principal and $13,929 in interest on this loan in 2017. For 2016, the highest outstanding balance was $483,648, and the balance outstanding at December 31, 2016 was $470,288. Mr. Murphy paid $13,361 in principal and $12,316 in interest on this loan in 2016. |
Related Party Transactions
SHUSA's policies require that all related person transactions be reviewed for compliance and applicable banking and securities laws. Moreover, SHUSA's policies require that all material transactions be approved by SHUSA's Board or the Bank's Board.
Director Independence
As noted elsewhere in this Form 10-K, SHUSA is a wholly-owned subsidiary of Santander. As a result, all of SHUSA's voting common equity securities are owned by Santander. However, the depository shares of SHUSA's Series C non-cumulative preferred stock continue to be listed on the NYSE. In accordance with the NYSE rules, because SHUSA does not have common equity securities but rather only preferred and debt securities listed on the NYSE, the SHUSA Board is not required to have a majority of “independent” directors.
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ITEM 14 - PRINCIPAL ACCOUNTING FEES AND SERVICES
Fees of the Independent Auditor
The following table set forth the aggregate fees for services rendered to the Company, for the fiscal year ended December 31, 2018 by our principal accounting firm, PricewaterhouseCoopers LLP.
Fiscal Year Ended December 31, 2018(1) | Parent Company and SBNA | SC | All Other Entities | Total | |||||||||||
(in thousands) | |||||||||||||||
Audit Fees (2) | $ | 9,338 | $ | 7,450 | $ | 3,216 | $ | 20,004 | |||||||
Audit-Related Fees (3) | 392 | 975 | 142 | 1,509 | |||||||||||
Tax Fees (4) | 269 | 332 | — | 601 | |||||||||||
All Other Fees (5) | 438 | 7 | — | 445 | |||||||||||
Total Fees | $ | 10,437 | $ | 8,764 | $ | 3,358 | $ | 22,559 | |||||||
(1) Represents proposed fees approved by the Audit Committee.
(2) Audit fees include fees associated with the annual audit of the Company's financial statements and the audit of internal control over financial reporting of the Company, reviews of the interim financial statements included in the Company's quarterly reports and statutory/subsidiary audits.
(3) Audit-related fees principally include attestation and agreed-upon procedures which address accounting, reporting and control matters, consent to use the Company's report in connection with various documents filed with the SEC, and comfort letters issued to underwriters for securities offerings.
(4) Tax fees include tax compliance, tax advice and tax planning.
(5) All other fees are fees for any services not included in the first three categories.
The following table set forth the aggregate fees for services rendered to the Company for the fiscal year ended December 31, 2017.
Fiscal Year Ended December 31, 2017(1) | Parent Company and SBNA | SC | All Other Entities | Total | |||||||||||
(in thousands) | |||||||||||||||
Audit Fees (2) | $ | 9,331 | $ | 8,501 | $ | 3,125 | $ | 20,957 | |||||||
Audit-Related Fees (3) | 540 | 900 | 95 | 1,535 | |||||||||||
Tax Fees (4) | 226 | 485 | — | 711 | |||||||||||
All Other Fees(5) | — | — | — | — | |||||||||||
Total Fees | $ | 10,097 | $ | 9,886 | $ | 3,220 | $ | 23,203 | |||||||
(1) Audit fees for 2017 have been adjusted reflect amounts billed in 2018 related to 2017 audits.
(2) Audit fees include fees associated with the annual audit of the Company's financial statements and the audit of internal control over financial reporting of the Company, reviews of the interim financial statements included in the Company's quarterly reports and statutory/subsidiary audits.
(3) Audit-related fees principally include attestation and agreed-upon procedures which address accounting, reporting and control matters, consent to use the Company's report in connection with various documents filed with the SEC, and comfort letters issued to underwriters for securities offerings.
(4) Tax fees include tax compliance, tax advice and tax planning.
(5) All other fees are fees for any services not included in the first three categories.
Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services by Independent Auditor
During 2018 SHUSA’s Audit Committee pre-approved audit and non-prohibited, non-audit services provided by the independent auditor. These services may have included audit services, audit-related services, tax services and other services. Pre-approval was generally provided by the Audit Committee for up to one year and any pre-approval was detailed as to the particular service or category of services and was subject to a specific budget. In addition, the Audit Committee may also have pre-approved particular services on a case-by-case basis. For each proposed service, the Audit Committee received detailed information sufficient to enable it to pre-approve and evaluate such service. The Audit Committee may have delegated pre-approval authority to one or more of its members. Any pre-approval decision made under delegated authority was communicated to the Audit Committee at or before its next scheduled meeting. There were no waivers by the Audit Committee of the pre-approval requirement for permissible non-audit services in 2018.
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PART IV
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
1. Financial Statements.
The following financial statements are filed as part of this report:
Consolidated Balance Sheets | |||
Consolidated Statements of Operations | |||
Consolidated Statements of Comprehensive Income | |||
Consolidated Statements of Stockholder's Equity | |||
Consolidated Statements of Cash Flows | |||
Notes to Consolidated Financial Statements | |||
2. Financial Statement Schedules.
Financial statement schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statements or in the notes thereto.
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(b)
(3.1 | ) | |
(3.2 | ) | |
(3.3 | ) | |
(3.4 | ) | |
(3.5 | ) | |
(3.6 | ) | |
(4.1 | ) | Santander Holdings USA, Inc. has certain debt obligations outstanding. None of the instruments evidencing such debt authorizes an amount of securities in excess of 10% of the total assets of Santander Holdings USA, Inc. and its subsidiaries on a consolidated basis; therefore, copies of such instruments are not included as exhibits to this Annual Report on Form 10-K. Santander Holdings USA, Inc. agrees to furnish copies to the SEC on request. |
(10.1 | ) | |
(10.2 | ) | |
(21.1 | ) | |
(23.1 | ) | |
(31.1 | ) | |
(31.2 | ) | |
(32.1 | ) | |
(32.2 | ) | |
(101.INS) | XBRL Instance Document (Filed herewith) | |
(101.SCH) | XBRL Taxonomy Extension Schema (Filed herewith) | |
(101.CAL) | XBRL Taxonomy Extension Calculation Linkbase (Filed herewith) | |
(101.DEF) | XBRL Taxonomy Extension Definition Linkbase (Filed herewith) | |
(101.LAB) | XBRL Taxonomy Extension Label Linkbase (Filed herewith) | |
(101.PRE) | XBRL Taxonomy Extension Presentation Linkbase (Filed herewith) | |
ITEM 16 - FORM 10-K SUMMARY
None applicable
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SANTANDER HOLDINGS USA, INC. (Registrant) | |||
Date: | March 15, 2019 | /s/ Madhukar Dayal | |
Madhukar Dayal | |||
Chief Financial Officer and Senior Executive Vice President | |||
Date: | March 15, 2019 | /s/ David L. Cornish | |
David L. Cornish | |||
Chief Accounting Officer, Corporate Controller and Executive Vice President | |||
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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date |
/s/ Scott E. Powell Scott E. Powell | Director, President Chief Executive Officer (Principal Executive Officer) | March 15, 2019 |
/s/ Madhukar Dayal Madhukar Dayal | Senior Executive Vice President Chief Financial Officer (Principal Financial Officer) | March 15, 2019 |
/s/ David L. Cornish David L. Cornish | Executive Vice President Chief Accounting Officer and Corporate Controller (Principal Accounting Officer) | March 15, 2019 |
/s/ T. Timothy Ryan, Jr. T. Timothy Ryan Jr. | Director Chairman of the Board | March 15, 2019 |
/s/ Javier Maldonado Javier Maldonado | Director | March 15, 2019 |
/s/ Thomas S. Johnson Thomas S. Johnson | Director | March 15, 2019 |
/s/ Stephen A. Ferriss Stephen A. Ferriss | Director | March 15, 2019 |
/s/ Alan Fishman Alan Fishman | Director | March 15, 2019 |
/s/ Juan Guitard Juan Guitard | Director | March 15, 2019 |
/s/ Jose Doncel Jose Doncel | Director | March 15, 2019 |
/s/ Victor Matarranz Victor Matarranz | Director | March 15, 2019 |
/s/ Juan Olaizola Juan Olaizola | Director | March 15, 2019 |
/s/ Henri-Paul Rousseau Henri-Paul Rousseau | Director | March 15, 2019 |
/s/ Richard Spillenkothen Richard Spillenkothen | Director | March 15, 2019 |
235