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As filed with the Securities and Exchange Commission on April 26, 2019

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2018

 

Commission file number 001-15266

 

 

BANCO DE CHILE

(Exact name of Registrant as specified in its charter)

 

BANK OF CHILE

(Translation of Registrant’s name into English)

 

REPUBLIC OF CHILE

(Jurisdiction of incorporation or organization)

 

Banco de Chile

Paseo Ahumada 251

Santiago, Chile

(562) 2637-1111

(Address of principal executive offices)

 

Rolando Arias Sánchez

 Banco de Chile

Paseo Ahumada 251

Santiago, Chile

Telephone:  (562) 2653-3535

E-mail: rarias@bancochile.cl

(Name, telephone, e-mail and/or facsimile number and address of company contact person)

 

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

 

Title of each class

 

Name of each exchange on which registered

American Depositary Shares, each representing 200 shares of common stock, without nominal (par) value (“ADSs”)

 

 

New York Stock Exchange

Shares of common stock, without nominal (par) value

 

New York Stock Exchange

(for listing purposes only)

 

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

 

None

(Title of Class)

 


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

 

None

(Title of Class)

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

 

 

Shares of common stock: 101,017,081,114

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes x No o

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes o No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer,” accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

Emerging growth company o

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, 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

 


† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP o

 

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

 

Other o

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

o Item 17    o Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

 


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TABLE OF CONTENTS

 

 

 

Page

 

 

 

PART I

 

1

 

 

 

Item 1

Identity of Directors, Senior Management and Advisors

1

 

 

 

Item 2

Offer Statistics and Expected Timetable

1

 

 

 

Item 3

Key Information

1

 

 

 

Item 4

Information on the Company

19

 

 

 

Item 4A

Unresolved Staff Comments

127

 

 

 

Item 5

Operating and Financial Review and Prospects

128

 

 

 

Item 6

Directors, Senior Management and Employees

173

 

 

 

Item 7

Major Shareholders and Related Party Transactions

191

 

 

 

Item 8

Financial Information

200

 

 

 

Item 9

The Offer and Listing

204

 

 

 

Item 10

Additional Information

207

 

 

 

Item 11

Quantitative and Qualitative Disclosures About Market Risk

229

 

 

 

Item 12

Description of Securities Other Than Equity Securities

229

 

 

 

Item 12A

Debt Securities

229

 

 

 

Item 12B

Warrants and Rights

229

 

 

 

Item 12C

Other Securities

229

 

 

 

Item 12D

American Depositary Shares

229

 

 

 

PART II

 

231

 

 

 

Item 13

Defaults, Dividend Arrearages and Delinquencies

231

 

 

 

Item 14

Material Modifications to the Rights of Security Holders and Use of Proceeds

231

 

 

 

Item 15

Controls and Procedures

231

 

 

 

Item 16A

Audit Committee Financial Expert

232

 

 

 

Item 16B

Code of Ethics

232

 

 

 

Item 16C

Principal Accountant Fees and Services

232

 

 

 

Item 16D

Exemptions from the Listing Standards for Audit Committees

233

 

 

 

Item 16E

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

233

 

 

 

Item 16F

Change in Registrant’s Certifying Accountant

233

 


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Item 16G

Corporate Governance

233

 

 

 

Item 16H

Mine Safety Disclosure

235

 

 

 

PART III

 

236

 

 

 

Item 17

Financial Statements

236

 

 

 

Item 18

Financial Statements

236

 

 

 

Item 19

Exhibits

237

 

 

 

LIST OF EXHIBITS

237

 

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FORWARD-LOOKING STATEMENTS

 

This annual report on Form 20-F contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Although we have based these forward-looking statements on our expectations and projections about future events, it is possible that actual results may differ materially from our expectations.  In many cases, we include a discussion of the factors that are most likely to cause forward-looking statements to differ from actual results together with the forward-looking statements themselves.  These statements appear throughout this annual report, including, without limitation, under “Item 4.  Information on the Company” and “Item 5.  Operating and Financial Review and Prospects.”  Examples of such forward-looking statements include:

 

·                  projections of operating revenues, net income (loss), net income (loss) per share, capital expenditures, dividends, capital structure or other financial items or ratios;

 

·                  statements of our plans, objectives or goals, including those related to anticipated trends, competition and regulation;

 

·                  statements about market risks, including interest rate risk and foreign exchange risk;

 

·                  statements about our future economic performance or that of Chile or other countries in which we operate; and

 

·                  statements of assumptions underlying such statements.

 

Words such as “believe,” “anticipate,” “plan,” “aims,” “seeks,” “expect,” “intend,” “target,” “objective,” “estimate,” “project,” “potential,” “predict,” “forecast,” “guideline,” “could,” “may,” “will,” “should” and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.  These statements may relate to (i) our asset growth and financing plans, (ii) trends affecting our financial condition or results of operations and (iii) the impact of competition and regulations, but are not limited to such topics.  Forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those described in such forward-looking statements included in this annual report as a result of various factors (including, without limitation, the actions of competitors, future global economic conditions, market conditions, foreign exchange rates and operating and financial risks), many of which are beyond our control.  The occurrence of any such factors not currently expected by us could significantly alter the results set forth in these statements.

 

Factors that could cause actual results to differ materially and adversely include, but are not limited to:

 

·                  changes in general economic, business, political or other conditions in Chile, or changes in general economic or business conditions in Latin America, the United States, Europe or Asia;

 

·                  changes in capital markets in general that may affect policies or attitudes towards lending to Chile or Chilean companies;

 

·                  increased costs;

 

·                  increased competition and changes in competition or pricing environments, including the effect of new technological developments;

 

·                  unanticipated increases in financing and other costs or the inability to obtain additional debt or equity financing on attractive terms;

 

·                  natural disasters;

 

·                  the effect of tax laws on our business; and

 

·                  the factors discussed under “Item 3. Key Information—Risk Factors.”

 

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You should not place undue reliance on forward-looking statements, which speak only as of the date that they were made.  This cautionary statement should be considered in connection with any written or oral forward-looking statements that we may issue in the future.  We do not undertake any obligation to publicly release any revisions to such forward-looking statements after the filing of this annual report to reflect later events or circumstances or to reflect the occurrence of unanticipated events.

 

PRESENTATION OF FINANCIAL INFORMATION

 

We prepare our audited consolidated financial statements in Chilean pesos and in accordance with International Financial Reporting Standards (“IFRS”) in effect from time to time as issued by the International Accounting Standards Board (“IASB”).

 

Unless otherwise indicated, the financial information included in this annual report with respect to 2014, 2015, 2016, 2017 and 2018 has been derived from financial statements that have been prepared in accordance with IFRS.  See Note 2(a) to our audited consolidated financial statements as of and for the year ended December 31, 2018 appearing elsewhere in this annual report.  IFRS differs in certain significant respects from Chilean Generally Accepted Accounting Principles (the “Chilean GAAP”) as issued by the Superintendencia de Bancos e Instituciones Financieras de Chile (the “Superintendency of Banks and Financial Institutions” or “SBIF”).  As a result, our financial information presented under IFRS is not directly comparable to any of our financial information presented under Chilean GAAP.  Accordingly, readers should avoid such comparison.

 

In this annual report, references to “$,” “U.S.$,” “U.S. dollars” and “dollars” are to United States dollars, references to “pesos” or “Ch$” are to Chilean pesos (see Note 2(r)) to our audited consolidated financial statements as of and for the year ended December 31, 2018 appearing elsewhere in this annual report), and references to “UF” are to “Unidades de Fomento.”  The UF is an inflation indexed Chilean monetary unit of account with a value in Chilean pesos that is linked to and adjusted daily to reflect changes in the Consumer Price Index (“CPI”) of the Instituto Nacional de Estadísticas (the “Chilean National Statistics Institute”). As of December 31, 2018 and April 18, 2019, one UF equaled Ch$27,565.79 and Ch$27,607.04, respectively.

 

This annual report contains translations of certain Chilean peso amounts into U.S. dollars at specified rates solely for your convenience.  These translations should not be construed as representations that the Chilean peso amounts actually represent such U.S. dollar amounts, were converted from U.S. dollars at the rate indicated in our audited consolidated financial statements as of and for the year ended December 31, 2018 or could be converted into U.S. dollars at the rate indicated.  Until November 30, 2011, Banco de Chile applied the observed exchange rate reported by the Banco Central de Chile (the “Central Bank”) in order to translate its financial statements from Chilean pesos to U.S. dollars.  However, beginning December 1, 2011, Banco de Chile adopted the exchange rate of accounting representation, or spot exchange rate, for such matters. This is also described in “Item 3.  Key Information—Selected Financial Data—Exchange Rates.”  Thus, unless otherwise indicated, the U.S. dollar amounts have been translated from Chilean pesos based on the exchange rate of accounting representation as of December 28, 2018 as determined by our Treasury on a daily basis, based on the average of the daily closing bid and offer rates reported by Bloomberg for the Santiago Stock Exchange.  As of December 28, 2018 (the latest practicable date, as December 31, 2018 was a banking holiday in Chile) and April 18, 2019, the exchange rates of accounting representation were Ch$693.60 = U.S. $1.00 and Ch$662.40 = U.S.$1.00, respectively.  As of the same dates, the observed exchange rates, as published by the Central Bank, were Ch$695.69 = U.S.$1.00 and Ch$660.48 = U.S.$1.00, respectively.

 

The Federal Reserve Bank of New York does not report a noon buying rate for Chilean pesos.

 

Unless otherwise specified, all references in this annual report to total loans are to loans to customers before deducting allowances for loan losses, and they do not include loans to banks or contingent loans.  In addition, all market share data and financial indicators for the Chilean banking system as compared to Banco de Chile’s financial information presented in this annual report are based on information published periodically by the SBIF which is published under Chilean GAAP and prepared on a consolidated basis, unless otherwise indicated.  For more information see “Item 4.  Information on the Company—Business Overview—Competition.”

 

In this annual report, “past due loans” are any loans for which the counterparty has failed to make a payment when contractually due, including installments that are overdue, plus the remaining balance of principal and interest on such loans.  In order to distinguish between different overdue time periods, the corresponding time period is included after the term “Past due Loans” (for example, “Past due Loans—90 days or more”).  For more information, please see “Item 4.  Information on the Company—Selected Statistical Information—Classification of Loan Portfolio Based on the Borrower’s Payment Performance.”

 

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According to Chilean regulations, as of the filing date and for the purposes of this annual report, regulatory capital (“Regulatory Capital”) consists of:

 

·                  basic capital, which is composed of our paid-in capital, reserves and retained earnings, excluding capital attributable to subsidiaries and foreign branches (“Basic Capital”); and

 

·                  supplementary capital, which is composed of the following:  (i) our subordinated bonds, considered at issue price (reduced by 20% for each year during the period commencing six years prior to maturity), but not exceeding 50% of our Basic Capital; plus (ii) our voluntary allowances for loan losses (up to 1.25% of risk-weighted assets to the extent voluntary allowances exceed those that banks are required to maintain by law or regulation); minus (iii) our goodwill and unconsolidated investments in companies (“Supplementary Capital”).

 

Certain figures included in this annual report and in our audited consolidated financial statements as of and for the year ended December 31, 2018 have been rounded for ease of presentation.  Percentage figures included in this annual report have not in all cases been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding.  For this reason, percentage amounts in this annual report may vary slightly from those obtained by performing the same calculations using the figures in our audited consolidated financial statements as of and for the year ended December 31, 2018.  Certain other amounts that appear in this annual report may similarly not sum due to rounding.

 

Inflation figures are those reported by the Chilean National Statistics Institute, unless otherwise stated herein or required by the context.

 

MACRO-ECONOMIC AND MARKET DATA

 

In this annual report, all macro-economic data relating to the Chilean economy is based on information published by the Central Bank.  All market share data, financial indicators and other data relating to the Chilean financial system are based on information published periodically by the SBIF, which is published under Chilean GAAP and prepared on a consolidated basis.

 

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PART I

 

Item 1                                    Identity of Directors, Senior Management and Advisors

 

Not Applicable.

 

Item 2                                    Offer Statistics and Expected Timetable

 

Not Applicable.

 

Item 3                                    Key Information

 

SELECTED FINANCIAL DATA

 

The following tables present historical financial information about us as of the dates and for each of the periods indicated.  The following tables should be read in conjunction with, and are qualified in their entirety by reference to, our audited consolidated financial statements as of and for the year ended December 31, 2018 appearing elsewhere in this annual report.  The financial information for the years ended December 31, 2014, 2015, 2016, 2017 and 2018 is presented under IFRS.

 

Our audited consolidated financial statements have been prepared in accordance with IFRS for the years ended December 31, 2014, 2015, 2016, 2017 and 2018.

 

 

 

For the Year Ended December 31,

 

 

 

2014

 

2015

 

2016

 

2017

 

2018(1)

 

2018

 

 

 

(in millions of Ch$, except share and per share data)

 

(in thousands
of U.S.$)(1)

 

IFRS:

 

 

 

 

 

 

 

 

 

 

 

 

 

CONSOLIDATED STATEMENT OF INCOME DATA

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest revenue

 

Ch$

2,045,604

 

Ch$

1,908,457

 

Ch$

1,916,992

 

Ch$

1,886,700

 

Ch$

2,000,617

 

US$

2,884,396

 

Interest expense

 

(788,788

)

(680,169

)

(690,259

)

(652,005

)

(679,640

)

(979,873

)

Net interest income

 

1,256,816

 

1,228,288

 

1,226,733

 

1,234,695

 

1,320,977

 

1,904,523

 

Net fees and commissions income

 

272,188

 

305,979

 

321,271

 

347,674

 

359,955

 

518,966

 

Net financial operating income

 

35,204

 

44,412

 

128,575

 

(29,661

)

117,142

 

168,890

 

Foreign exchange transactions, net

 

70,225

 

57,318

 

12,405

 

104,875

 

2,701

 

3,894

 

Other operating income

 

27,211

 

25,486

 

28,575

 

29,959

 

45,295

 

65,304

 

Provisions for loan losses

 

(261,566

)

(246,222

)

(259,263

)

(221,255

)

(251,323

)

(362,346

)

Total operating expenses

 

(727,360

)

(726,278

)

(787,047

)

(784,356

)

(838,156

)

(1,208,414

)

Income attributable to associates

 

2,486

 

3,243

 

4,014

 

5,511

 

6,811

 

9,820

 

Income before income taxes

 

675,204

 

692,226

 

675,263

 

687,442

 

763,402

 

1,100,637

 

Income taxes

 

(79,685

)

(83,321

)

(100,212

)

(115,361

)

(159,768

)

(230,346

)

Net income from continued operations, net of taxes

 

Ch$

595,519

 

Ch$

609,905

 

Ch$

575,051

 

Ch$

572,081

 

Ch$

603,634

 

US$

870,291

 

Net income from discontinued operations, net of taxes

 

 

 

 

 

 

 

Net income for the year

 

Ch$

595,519

 

Ch$

609,905

 

Ch$

575,051

 

Ch$

572,081

 

Ch$

603,634

 

US$

870,291

 

Attributable to:

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity holders of the parent

 

595,518

 

609,903

 

575,051

 

572,080

 

603,633

 

870,290

 

Non-controlling interest

 

1

 

2

 

 

1

 

1

 

1

 

Earnings per share(2)

 

5.90

 

6.04

 

5.69

 

5.66

 

5.98

 

0.01

 

Earnings per ADS

 

1,258.29

 

1,268.93

 

1,178.09

 

1,150.56

 

1,195.11

 

1,723.05

 

Dividends per share(3)

 

3.98

 

3.88

 

3.81

 

3.50

 

3.76

 

0.01

 

Weighted average number of shares (in millions)

 

101,017.08

 

101,017.08

 

101,017.08

 

101,017.08

 

101,017.08

 

 

 

 


(1)             IFRS 9 replaced IAS 39 for financial statements from January 1, 2018 onwards and includes new classification and measurement requirements for financial assets and liabilities, impairment requirements for financial assets and hedge accounting policy. The application of this standard as of January 1, 2018 has had an impact on our consolidated financial statements at that date. The effect of the first application of IFRS 9 is detailed in Note 5 “Transition Disclosures” to our audited consolidated financial statements.

 

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For the Year Ended December 31,

 

 

 

2014

 

2015

 

2016

 

2017

 

2018(1)

 

2018

 

 

 

(in millions of Ch$, except share and per share data)

 

(in thousands of
U.S.$)

 

IFRS:

 

 

 

 

 

 

 

 

 

 

 

 

 

CONSOLIDATED STATEMENT OF FINANCIAL POSITION DATA (1) (2) (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

Ch$

915,133

 

Ch$

1,361,222

 

Ch$

1,408,167

 

Ch$

1,057,393

 

Ch$

880,081

 

US$

1,268,860

 

Transactions in the course of collection

 

356,185

 

319,679

 

206,972

 

255,968

 

289,194

 

416,946

 

Financial assets held for trading

 

293,458

 

843,574

 

1,379,958

 

1,538,578

 

1,745,366

 

2,516,387

 

Cash collateral on securities borrowed and reverse repurchase agreements

 

27,661

 

46,164

 

55,703

 

91,641

 

97,289

 

140,267

 

Derivative instruments

 

832,267

 

1,127,122

 

939,649

 

1,247,941

 

1,513,947

 

2,182,738

 

Loans and advances to banks

 

1,155,365

 

1,395,544

 

1,173,187

 

760,021

 

1,494,384

 

2,154,533

 

Loans to customers, net

 

21,400,775

 

24,022,983

 

24,843,655

 

24,955,692

 

27,341,254

 

39,419,340

 

Financial assets available-for-sale and financial assets at fair value through other comprehensive income

 

1,608,796

 

1,007,263

 

374,470

 

1,526,315

 

1,053,191

 

1,518,441

 

Investments in other companies

 

23,043

 

25,849

 

30,314

 

35,771

 

42,252

 

60,917

 

Intangible assets

 

66,859

 

64,700

 

65,036

 

72,455

 

85,471

 

123,228

 

Property and equipment

 

205,403

 

215,671

 

219,082

 

216,259

 

215,872

 

311,234

 

Investment properties

 

15,936

 

15,042

 

14,674

 

14,306

 

13,938

 

20,095

 

Current tax assets

 

 

 

6,657

 

23,032

 

677

 

976

 

Deferred tax assets, net

 

94,240

 

129,192

 

176,923

 

161,265

 

192,840

 

278,028

 

Other assets

 

586,555

 

483,591

 

462,857

 

604,800

 

651,691

 

939,578

 

Total assets

 

Ch$

27,581,676

 

Ch$

31,057,596

 

Ch$

31,357,304

 

Ch$

32,561,437

 

Ch$

35,617,447

 

U.S.$

51,351,567

 

Current accounts and other demand deposits

 

6,934,373

 

8,327,048

 

8,321,148

 

8,915,706

 

9,584,488

 

13,818,466

 

Transactions in the course of payment

 

53,049

 

35,475

 

25,702

 

29,871

 

44,436

 

64,066

 

Cash collateral on securities lent and repurchase agreements

 

249,482

 

184,131

 

216,817

 

195,392

 

303,820

 

438,034

 

Saving accounts and time deposits

 

9,721,246

 

9,907,692

 

10,552,901

 

10,067,778

 

10,656,174

 

15,363,573

 

Derivative instruments

 

827,123

 

1,079,342

 

966,509

 

1,392,995

 

1,528,234

 

2,203,336

 

Borrowings from financial institutions

 

1,098,716

 

1,529,627

 

1,040,026

 

1,195,028

 

1,516,759

 

2,186,792

 

Debt issued

 

5,057,956

 

6,102,208

 

6,177,927

 

6,488,975

 

7,475,552

 

10,777,901

 

Other financial obligations

 

186,573

 

173,081

 

186,199

 

137,163

 

118,014

 

170,147

 

Currents tax liabilities

 

19,030

 

24,714

 

 

3,453

 

20,924

 

30,167

 

Deferred tax liabilities, net

 

 

 

 

 

 

 

Provisions

 

185,643

 

182,832

 

187,568

 

194,537

 

203,946

 

294,040

 

Employee benefits

 

81,515

 

74,791

 

83,345

 

86,628

 

92,579

 

133,476

 

Other liabilities

 

255,995

 

261,330

 

291,488

 

308,563

 

398,805

 

574,978

 

Total liabilities

 

Ch$

24,670,701

 

Ch$

27,882,271

 

Ch$

28,049,630

 

Ch$

29,016,089

 

Ch$

31,943,731

 

U.S.$

46,054,976

 

Total equity

 

2,910,975

 

3,175,325

 

3,307,674

 

3,545,348

 

3,673,716

 

5,296,591

 

Total liabilities and equity

 

Ch$

27,581,676

 

Ch$

31,057,596

 

Ch$

31,357,304

 

Ch$

32,561,437

 

Ch$

35,617,447

 

US$

51,351,567

 

 


(1)             IFRS 9 replaced IAS 39 for financial statements from January 1, 2018 onwards and includes new classification and measurement requirements for financial assets and liabilities, impairment requirements for financial assets and hedge accounting policy. The application of this standard as of January 1, 2018 has had an impact on our consolidated financial statements at that date. The effect of the first application of IFRS 9 is detailed in Note 5 “Transition Disclosures” to our audited consolidated financial statements.

 

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Table of Contents

 

 

 

As of December 31,

 

 

 

2014

 

2015

 

2016

 

2017

 

2018(4)

 

IFRS:

 

 

 

 

 

 

 

 

 

 

 

CONSOLIDATED RATIOS

 

 

 

 

 

 

 

 

 

 

 

Profitability and Performance

 

 

 

 

 

 

 

 

 

 

 

Net interest margin(5)

 

5.12

%

4.68

%

4.41

%

4.30

%

4.35

%

Return on average total assets(6)

 

2.24

 

2.08

 

1.86

 

1.79

 

1.76

 

Return on average equity(7)

 

20.98

 

19.60

 

18.00

 

16.09

 

16.78

 

Capital

 

 

 

 

 

 

 

 

 

 

 

Average equity as a percentage of average total assets

 

10.67

 

10.63

 

10.33

 

11.11

 

10.51

 

Bank regulatory capital as a percentage of minimum regulatory capital

 

279.83

 

275.34

 

290.48

 

304.38

 

287.32

 

Ratio of liabilities to regulatory capital(8)

 

10.65

 

10.87

 

10.26

 

9.76

 

10.40

 

Credit Quality

 

 

 

 

 

 

 

 

 

 

 

Substandard loans as a percentage of total loans(9)

 

3.79

 

3.83

 

3.42

 

3.07

 

2.96

 

Allowances for loan losses as a percentage of substandard loans(9)

 

59.17

 

58.51

 

63.91

 

63.50

 

70.87

 

Provision for loan losses as a percentage of average loans

 

1.21

 

1.07

 

1.05

 

0.87

 

0.95

 

Allowances for loan losses as a percentage of total loans

 

2.24

 

2.24

 

2.18

 

1.95

 

2.10

 

Operating Ratios

 

 

 

 

 

 

 

 

 

 

 

Operating expenses/operating revenue

 

43.77

 

43.71

 

45.82

 

46.48

 

45.40

 

Operating expenses/average total assets

 

2.73

%

2.48

%

2.55

%

2.45

%

2.45

 

 


(1)         Translations of Chilean peso amounts into U.S. dollars are based on the exchange rate of accounting representation, or the spot exchange rate, which is determined on a daily basis by our Treasury, based on the average of the daily closing bid and offer rates reported by Bloomberg for the Santiago Stock Exchange.  Thus, amounts stated in U.S. dollars as of and for the fiscal year ended December 31, 2018 have been translated from Chilean pesos based on the spot exchange rate of Ch$693.60 to U.S. $1.00 as of December 31, 2018.

(2)         Earnings per share data have been calculated by dividing net income by the weighted average number of shares outstanding during the year.

(3)         Dividends per share data are calculated by dividing the amount of the dividend paid during each year by the previous year’s number of shares outstanding.

(4)         IFRS 9 replaced IAS 39 for financial statements from January 1, 2018 onwards and includes new classification and measurement requirements for financial assets and liabilities, impairment requirements for financial assets and hedge accounting policy. The application of this standard as of January 1, 2018 has had an impact on our consolidated financial statements at that date. The effect of the first application of IFRS 9 is detailed in Note 5 “Transition Disclosures” to our audited consolidated financial statements.

(5)         Annualized net interest income divided by average interest earning assets.  The average balances for interest earning assets, including interest and readjustments, have been calculated on the basis of our daily balances and on the basis of monthly balances for our subsidiaries.  Net interest margin does not include the interest earned on trading securities, which is accounted for under Other Income (Loss), Net.

(6)         Annualized net income (loss) divided by average total assets.  The average balances for total assets have been calculated on the basis of our daily balances and on the basis of monthly balances for our subsidiaries.

(7)         Annualized net income (loss) divided by average equity.  The average balances for equity have been calculated on the basis of our daily balances.

(8)         Total liabilities divided by bank regulatory capital.

(9)         See “Item 4.  Information on the Company—Selected Statistical Information—Analysis of Substandard and Past Due Loans.”

 

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Exchange Rates

 

As a general matter, prior to 1989, Chilean law permitted the purchase and sale of foreign currency only in those cases explicitly authorized by the Central Bank.  The Ley Orgánica Constitucional del Banco Central de Chile 18,840 (the “Central Bank Act”) liberalized the rules governing the purchase and sale of foreign currency.  The Central Bank Act empowers the Central Bank to determine that certain purchases and sales of foreign currency specified by law must be carried out in the Mercado Cambiario Formal (the “Formal Exchange Market”).  The Formal Exchange Market is composed of banks and other entities so authorized by the Central Bank.  The observed exchange rate for any given day equals the average exchange rate of the transactions conducted in the Formal Exchange Market on the immediately preceding banking day, as certified by the Central Bank.  Even though the Central Bank is authorized to carry out its transactions at the rates it sets, it generally uses the spot rate for its transactions.  Authorized transactions by other banks are generally carried out at the spot rate.

 

Purchases and sales of foreign exchange are not required to be conducted in the Formal Exchange Market and therefore may be carried out in the Mercado Cambiario Informal (the “Informal Exchange Market”).  There are no price limits imposed on transactions carried out in the Informal Exchange Market.  On April 18, 2019, the average exchange rate in the Informal Exchange Market was Ch$669.0 per U.S. $1.00, or 1.29% higher than the observed exchange rate of Ch$660.48 per U.S.$1.00 as reported by the Central Bank on the same date.

 

Until November 30, 2011, Banco de Chile applied the observed exchange rate as reported by the Central Bank in order to translate its financial statements from Chilean pesos to U.S. dollars.  However, beginning December 1, 2011, Banco de Chile adopted the exchange rate of accounting representation, or spot exchange rate, for such matters.  The exchange rate of accounting representation is determined on a daily basis by our Treasury based on the average of the daily closing bid and offer rates reported by Bloomberg, for the Santiago Stock Exchange.

 

The observed exchange rate on April 18, 2019 was Ch$660.48 = U.S.$1.00. As of the same date, the exchange rate of accounting representation, or spot exchange rate, was Ch$662.40 = U.S.$1.00.

 

The Federal Reserve Bank of New York does not report a noon buying rate for Chilean pesos.

 

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Table of Contents

 

RISK FACTORS

 

The risks and uncertainties described below are not the only ones that we face.  Additional risks and uncertainties that we do not know about or that we currently think are immaterial may also impair our business operations in the future.  Any of the following risks, if they actually occur, could materially and adversely affect our business, results of operations, prospects and financial condition.

 

We are also subject to market risks that are presented both in this subsection and in Note 43 to our audited consolidated financial statements as of and for the year ended December 31, 2018 appearing elsewhere in this annual report.

 

Risks Relating to our Operations and the Chilean Banking Industry

 

The growth of our loan portfolio may expose us to increased loan losses.

 

During the last five years, our total loan portfolio has grown at a compounded average growth rate (“CAGR”) of 6.0% per year. This expansion has been primarily fostered by growth in both residential mortgage (11.2% per year on average) and consumer loans (7.6% per year on average), and, to a lesser extent, by an expansion in commercial loans (3.4% per year on average). The growth in our loan book has been aligned with our mid-term strategic goals, which aim to diversify our business model by optimizing our risk-return relationship in order to maintain profitable growth. In this regard, we recognize that the expansion experienced by our retail banking segment over the last years may expose us to higher levels of charge-offs and may require us to establish higher levels of allowances for loan losses in the future. For this reason, we are constantly striving to develop and utilize improved scoring and approval models while strengthening our collection procedures in order to mitigate the risks associated with this business growth. For the year ended December 31, 2018, our loan portfolio was Ch$27,926,632 million, which represented a 9.7% annual increase as compared to the Ch$25,451,513 million we recorded as of December 31, 2017.  Our allowances for loans losses increased 18.4% from Ch$495,821 million in 2017 to Ch$585,378 million in 2018, mainly attributable to the adoption of IFRS 9 in our consolidated financial statements. As a result, our risk-index ratio (allowances for loan losses to total loans) increased from 1.95% in 2017 to 2.10% in 2018.

 

Our loan portfolio may not continue to grow at the same or similar rates as it has in the past.

 

After a decade of double-digit loan growth, particularly fostered by increased banking penetration of lower and middle income segments, as well as small and medium-sized companies, resulting in a marked expansion in consumer, mortgage and commercial loans, the deceleration of the local economy from 2013 to 2017, and the introduction of diverse reforms on general matters, including both banking and non-banking rules, have threatened both the pace of growth of the industry and banking penetration rate. In fact, in the five years ended 2017, the loan portfolio of the Chilean banking industry grew at a CAGR of 8.3%, reflecting the decline in investment and lower consumer confidence, as evidenced by indices (Indice de Percepción Económica de los Consumidores (“IPEC”) and Indice Mensual de Confianza Empresarial (“IMCE”) used by the Central Bank. This trend appears to have shifted in 2018, particularly toward the end of the year, when a rebound in investment spending prompted a recovery of commercial loans, all of which resulted in an 11.9% annual growth of loan balances managed by the local banking industry in Chile as a whole. Despite this recovery, given the cyclical nature of the banking business, a slowdown or negative GDP growth, changes in household or investment spending, as well as a change in the behavior of banking customers, could adversely affect the growth rate of the industry and, therefore, the expansion of our loan portfolio. Similarly, this could affect our credit quality indicators and, accordingly, lead us to establish higher allowances for loan losses. For more information, see “Item 4.  Information on the Company—Regulation and Supervision” and “Item 4.  Information on the Company—Selected Statistical Information.”

 

Restrictions imposed by regulations may constrain our operations and thereby adversely affect our financial condition and results.

 

We are subject to regulation by the SBIF.  In addition, we are subject to regulation by the Central Bank with respect to certain matters, including liquidity management, among others.  See “Item 4.  Information on the Company—Regulation and Supervision.”

 

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Table of Contents

 

Pursuant to the Ley General de Bancos (the “General Banking Act”) all Chilean banks may, subject to the approval of the SBIF, engage in certain non-banking businesses approved by the law.  The SBIF’s approval will depend on the risk of the activity and the strength of the bank.  Furthermore, the General Banking Act imposes on the Chilean banking system a modified version of the capital adequacy guidelines issued by the Basel Committee on Banking Regulation and Supervisory Practices (the “Basel Committee”) and limits the discretion of the SBIF to deny new banking licenses.

 

In 2014, the Chilean Ministry of Finance announced an overall review and various modifications to the Chilean Banking Act.  After convening a working-group of experts to address diverse topics related to the banking business and international evidence on capital adequacy matters, the Ministry of Finance submitted a bill to the Chilean congress on June 12, 2017, modifying the current General Banking Act. The bill was passed by the Chilean congress on October 3, 2018 and, following that, Law No. 21,130 (the Modernization of Banking Legislation) was enacted on December 27, 2018 and published on January 12, 2019. The new law addresses four main topics aimed at modernizing the Chilean banking framework by adopting the Basel III Guidelines (considering a phased-in transition from Basel I to be completed four years after the new specific banking framework is issued by the regulator), introducing changes to the corporate governance of the local regulator such that all the powers currently vested in the SBIF will be transferred in the future to Chile’s Financial Market Commission (“CMF”), establishing a resolution regime for Chilean banks in the case of insolvency, and introducing changes in relation to confidential information of banks’ customers, among others topics. According to the phase in period set by the law, the current SBIF has a maximum period of 12 months to merge into the CMF and within the 18 months following that integration, the specific regulation for the implementation of Basel III must be issued by the new regulator. Prior to that date, no additional capital requirements to those currently in force, will be imposed on local banks. In addition, there is no certainty yet regarding the methodologies that will be used by the regulator in order to set potential buffers to local banks (countercyclical, D-SIB or pillar II), which will be defined once the specific regulation is released (no later than 18 months after the integration of the SBIF into the CMF). The CMF was established in January 2018, pursuant to Law No. 21,000 and replaced the Superintendency of Securities and Insurance (SVS). It currently oversees the Chilean Financial Market (comprised of publicly traded companies, insurance companies, insurance brokers, mutual funds and investment funds). Since we have no certainty regarding the limits that will be finally imposed by the CMF to the banking industry and us in particular, either in terms of potential capital buffers and the precise timing for fulfilling them, we cannot assure you that our profitability will not be impacted by actions we may take in order to fulfil new regulatory thresholds. For more information see “Item 4.  Information on the Company—Regulation and Supervision—New General Banking Act”

 

During 2015, the Central Bank published a final version of new liquidity standards for local banks, based on Basel III guidelines. The SBIF is the institution empowered to put these guidelines into practice and monitor them on an ongoing basis.  The SBIF released a set of new liquidity requirements for banks (Circular No. 3,585) on July 31, 2015, which established reporting requirements for local banks with respect to management and measurement of banks’ liquidity position. Accordingly, since 2016, banks are required to report and monitor liquidity ratios such as Liquidity Coverage Ratio (“LCR”) and Net Stable Funding Ratio (“NSFR”). Aligned with this requirement, on May 4, 2018 the Chilean Central Bank published for comment an amendment to Chapter III.B.2.1 of Compendio de Normas Financieras (the Compendium of Financial Norms), which is primarily focused on proposing a minimum requirement for the LCR, considering a phase-in period of five years, starting at 60% in 2019 and reaching the final limit of 100% in 2023 (with annual increments of 10% between 2019 and 2023). Aligned with this new framework, on October 2, 2018 the SBIF published for comment new amendments to Chapter 12-20 of Recopilación Actualizada de Normas (which addresses the management and measurement of banks’ liquidity position) while establishing a new report on liquidity matters (C49) intended to refine the measurement of the LCR and the NFSR. Given the phase-in period established for the LCR limit, we do not see any significant impact on our financial condition, results of operation or profitability in the medium term. Nevertheless, we cannot comment as to whether any other new liquidity requirements, if any, would have a material adverse effect on us. For more information on liquidity matters see “Item 4.  Information on the Company—Regulation and Supervision.”

 

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As for credit risk allowances, on December 30, 2014, the SBIF published a set of amendments to the regulations on allowances for potential loan losses establishing a standardized method for calculating loan loss provisions for residential mortgage loans, based on past due behavior and loan-to-value ratios, while providing new and more precise definitions for impaired loans and new requirements to remove loans from such portfolio.  This set of rules also addressed the possibility of putting into practice standardized credit risk provisioning models for consumer and commercial loan portfolios, evaluated on a grouped basis, in the future. The new guidelines also introduced changes to the treatment of provisions related to factoring loans and guarantors. This new set of rules went into effect on January 1, 2016 and had no material impact on our results prepared under both IFRS and Chilean GAAP for the years ended December 31, 2017 and 2018. Notwithstanding the above, it is important to note that in January 2018, the SBIF published for comment a set of amendments to provisioning rules for commercial loans evaluated on a grouped basis. Following this announcement, on July 6, 2018 the SBIF published the final amendments to the provisioning rules for commercial loans evaluated on a group basis by establishing standardized models for leasing loans, student loans and other commercial loans (not included in the former categories). In addition, the new set of rules also addressed other topics related to loan provisioning. The new provisioning criteria will go into effect in July 2019. Based on our assessment the change is not expected to have a material impact on our results of operations under both Chilean GAAP and IFRS. Nevertheless we cannot rule out that future changes in provisioning rules for other types of loans or related definitions, if introduced, will not affect our results under IFRS or Chilean GAAP, as applicable.

 

Additionally, in recent years the Chilean government has focused on matters related to consumer protection. Since 2010 several legal and administrative regulations have been amended and revoked in order to strengthen consumer protection and the relationship between financial institutions and their customers.  On March 14, 2019, Law 21,081 became effective, amending the Consumer Protection Law (Law No. 19,496). This amendment aims to strengthen consumer protection by granting new powers to the Consumer Protection Agency (“SERNAC”) in matters of oversight, such as the authority to initiate collective voluntary proceedings. In addition, this law increases fines up to the maximum amount of UTA 45,000 (Unidades Tributarias Anuales) that represented approximately Ch$26,110.6 million (or U.S$38.4 million) as of March 31, 2019. For further information, see “Item 4.  Information on the Company—Regulation and Supervision— Consumer Oriented Regulation”. We cannot assure you whether this new law will or will not significantly affect the local banking industry.

 

Since January 2017, a bill has been under consideration in the Chilean congress with the aim of regulating the possible liability for payment service providers (such as banks) and for customers of such services, in case of fraudulent transactions carried out with credit or debit cards, including electronic transactions. The bill establishes that funds charged to credit or debit cards associated with transactions that are not recognized by the customer must be returned to the holder of the card or account. It will be up to the service provider to prove either that the customer took part in the fraudulent payment, that the customer obtained an unlawful profit, or that the customer acted fraudulently or with gross negligence facilitating its completion, in which case the bank may request the return of the funds. The bill also contemplates not allowing for fraud insurance to be offered. The bill also establishes obligations for the payment provider to have adequate measures to protect the payment services in case of unlawful acts, holding them liable for damages caused by security and protection deficiencies in their technological systems through which such services are provided. We cannot assure the impact that this law may have in the banking industry or in Banco de Chile, particularly in cases of electronic fraud and, therefore, the consequences of a possible legal obligation to pay compensation for damages to customers.

 

On August 23, 2018 the Chilean government presented a bill intended to modernize the Chilean tax system. The proposed bill considers a return to the integrated system by permitting that 100% of the income tax borne by corporations be used as a tax credit by the final taxpayer (individuals). In addition, the proposal incorporates a series of modifications to the tax system, including a new taxation regime levied on digital services, the introduction of some tax benefits for SMEs, the simplification of requisites to recognize expenses that may be deducted from taxable income, an update to the Chilean Internal Revenue Service procedures and the creation of a Taxpayer Protection & Advisory agency, among other matters. For more information see “Item 5. Operating and Financial Review and Prospects—Operating Results—Results of Operations for the Years Ended December 31, 2016, 2017 and 2018—Income Tax”.

 

Lastly, we cannot assure you that regulators will not impose more restrictive limitations in the future on the activities of banks, including us, than those that are currently in effect.  Any such change in terms of capital adequacy, liquidity, credit risk provisioning, consumer protection, bankruptcy, taxation, among other matters, could have a material adverse effect on our results of operations or financial condition in a fashion that we cannot determine in advance.  For more information, see “Item 4.  Information on the Company—Regulation and Supervision.”

 

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Table of Contents

 

Changes in accounting standards could impact our results.

 

The IASB, or other regulatory bodies, periodically introduce modifications to financial accounting and reporting standards under which we prepare our consolidated financial statements.  These changes can materially impact the means by which we report financial information, affecting our results of operations.  Also, we could be required to apply new or revised standards retroactively.

 

In this regard, various amendments to IFRS were adopted in 2018 and others are expected during the coming years. First, IFRS 9 “Financial Instruments” became effective on January 1, 2018. Under this standard, new models of expected loss must be developed by companies in order to determine the impairment of loans and instruments available for sale. Additionally, IFRS 9 provides new guidelines for the valuation and classification of financial instruments. Second, IFRS 15 “Revenues from Contracts with Customers” became effective on January 1, 2018. This standard establishes a new model for the recognition of recurrent income, which could differ to some extent from the current criteria. Lastly, IFRS16 “Leases” became effective on January 1, 2019. This standard modifies accounting models associated with an entity’s role as lessee or tenant in terms of the recognition of assets and liabilities for all leases existing on January 1, 2019. All of these standards require issuers to include new disclosures in the notes to their financial statements. Since becoming effective, IFRS 15 had no material impact on our results of operations and financial condition for the year ended December 31, 2018. Additionally, the first time application of IFRS 9, including the valuation of loans and financial assets, had a total negative effect of Ch$62,726 million (after taxes) that was recognized in equity accounts. For more information, see Note 5(c) to our audited consolidated financial statements as of and for the year ended December 31, 2018 appearing elsewhere in this annual report. Finally, IFRS 16 is not expected to have a material impact on our results of operations or financial condition.

 

Currently, we cannot assure you that future changes in financial accounting and reporting standards will not substantially affect our results of operations or performance indicators, as we do not know the extent of future standards.

 

Increased competition and industry consolidation may adversely affect our operations.

 

The Chilean market for financial services is highly competitive.  We compete with Chilean and foreign banks, with Banco del Estado de Chile, which is state-owned, and with others providers of financial services that are not part of the banking industry. In addition, the retail segment (which encompasses individuals and small and medium-sized companies) has become the target market of several banks, since banking penetration is still in progress in Chile, particularly in this segment. Accordingly, competition within this market is increasing as banks are continuously incorporating new and tailored products and services, while striving to improve service quality.  As a result, net interest margins (once deducted provisions for loan losses) in these sub-segments are likely to decline over time.

 

We also face competition from non-banking competitors in some of our credit products, especially credit cards and installment loans.  In these markets, competition from non-banking companies like large department stores, private compensation funds and saving and credit cooperatives has become increasingly significant.  In addition, we face competition from other types of lenders, such as non-banking leasing, crowdfunding, factoring and automobile financing companies (especially in credit products), as well as mutual funds, pension funds and insurance companies within the market for savings products and mortgage loans. It is important to note that some of these non-banking competitors are not regulated by the SBIF and, therefore, they are not subject to the same specific solvency or liquidity requirements, among other requisites, as banks. Nevertheless, banks continue to be the main suppliers of leasing, factoring and mutual fund management, while growing quickly in insurance brokerage services.  However, we cannot assure you that this trend will continue in the future.

 

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Table of Contents

 

Lastly, in the past, increasing competition within the Chilean banking industry has been accompanied by a consolidation wave and the entry of international players to the system through multiple mergers and acquisitions. We expect these trends will continue and result in the creation of larger and stronger banking conglomerates offering a wide range of products and services while targeting most of the segments in the Chilean banking market. These trends may adversely impact our results of operations as they may translate into higher interest rates paid on deposits and lower interest rates earned on loans, resulting in decreased net interest margins. For more detail regarding past and recent changes in the Chilean banking industry see “Item 4.  Information on the Company—Business Overview—Competition.”

 

Our exposure to certain segments of the retail market could lead to higher levels of total past due loans and subsequent charge-offs.

 

Although we have historically been focused on wholesale banking, over the last years we have continued to reorient our commercial strategy to increase penetration of the retail banking segment while maintaining our market-leading position in wholesale banking.  In fact, according to our management information systems, the share of the retail banking segment in our total loan book has increased from 46.6% in 2013 to 59.4% in 2018. Although this trend has been associated with expansion in middle and higher income personal banking, our retail banking segment is also composed of small and medium-sized companies (approximately 13.7% of our total loan book as of December 31, 2018, which consists of companies with annual sales of up to Ch$1,600 million) and, to a lesser extent, of lower-income individuals (approximately 2.4% of our total loan book as of December 31, 2018, which consists of individuals with monthly incomes ranging from Ch$180,000 to Ch$500,000). Since these customers are likely to be more severely affected by adverse developments in the Chilean economy than large corporations and higher-income individuals, we may be exposed to higher levels of past due loans and subsequent write-offs, in the future, which could result in materially higher allowances for loan losses that could adversely affect our results of operations.

 

As of December 31, 2018, our past due loans (loans 90 days or more past due) reached Ch$305,530 million, which represented a 1.0% annual increase when compared to the Ch$302,595 million recorded in 2017.  These figures translated into past due ratios (loans 90 days or more past due over total loans) of 1.19% in 2017 and 1.09% in 2018. According to our management information systems, as of December 31, 2018 our past due loans (loans 90 days or more past due) were composed of 94.8% retail banking 90 days or more past due loans (consumer and residential mortgage loans to individuals, as well as commercial loans to small and medium sized companies) and 5.2% wholesale banking 90 days or more past due loans (commercial loans to large companies and corporations). During the prior fiscal year, our past due loans (90 days or more) portfolio was composed of 91.7% retail banking past due loans (90 days or more) and 8.3% wholesale banking past due loans (90 days or more).

 

A combination of various market dynamics affecting our segments may affect our past due loans (loans 90 days or more past due) ratio year over year.  In fact, given specific market trends, for the year ended December 30, 2018, we experienced a moderate annual increase of approximately Ch$10,276 million in past due loans in the retail segment, whereas past due loans (loans 90 days or more past due) in the wholesale banking segment decreased by Ch$9,215 million, in each case as compared to 2017. The trend for the retail banking past due loans (90 days or more) was primarily explained by an annual increase of Ch$11,942 million in the amount of past due loans (loans 90 days or more past due) related to the commercial loans granted to small and medium enterprises in the retail segment (SMEs) primarily, mainly due to the high growth rates shown by these types of credits over the last years. On the other hand, the past-due loan book of the wholesale banking segment benefited from improvements in the financial condition of specific wholesale customers and moderate loan growth. Given the unpredictability of how certain market fluctuations and related changes to macroeconomic indicators may affect our diverse customer segments, we cannot assure you that we will be able to maintain a balanced risk-return equation if global or local economic conditions deteriorate in the future. In this regard, economic recessions or market volatility could adversely affect the financial condition of our borrowers, which could translate into an increase in our non-performing loans, impair our loan portfolio and result in lower demand for our loans. Any of these trends could have a material adverse effect on our business, financial condition and results of operations.

 

For more information on past due loans, see “Item 4.  Information on the Company—Selected Statistical Information—Analysis of Substandard and Past due Loans.”

 

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Our results of our operations are affected by interest rate volatility and inflation.

 

Our results of our operations depend to a great extent on our net interest income, which represented 71.6% of our total operating revenues in 2018. Changes in nominal interest rates and inflation could affect the interest rates earned on our interest-earning assets differently from the interest rates paid on our interest-bearing liabilities, resulting in net income reduction.  Inflation and interest rates are sensitive to several factors beyond our control, including the Central Bank’s monetary policy, deregulation of the Chilean financial sector, local and international economic developments and political conditions, among other factors. In addition, changes in interest rates affect securities and other investments or assets that are recorded at fair value and are therefore exposed to potential negative fair value adjustments. Any volatility in interest rates could have a material adverse effect on our financial condition and results of operations.

 

The average annual short-term nominal interest rate in Chile for 90 to 360 day deposits received by Chilean financial institutions was 4.04% in 2016, 3.03% in 2017 and 2.97% in 2018.  The average long-term nominal interest rate based on the interest rate of the Central Bank’s five-year bonds traded in the secondary market was 4.09% in 2016, 3.73% in 2017 and 4.07% in 2018.

 

Inflation in Chile has been moderate in recent years, especially in comparison with periods of high inflation experienced in the 1980s and 1990s.  High levels of inflation in Chile could adversely affect the Chilean economy, consumer purchasing power, household consumption and investment in machinery and equipment and, therefore, the demand for financing and our business.  The annual inflation rate (as measured by annual changes in the CPI and as reported by the Chilean National Institute of Statistics) during the last five years and the first three months of 2019 was:

 

Year

 

Inflation
(CPI Variation)

 

2014

 

4.6

 

2015

 

4.4

 

2016

 

2.7

 

2017

 

2.3

 

2018

 

2.6

 

2019 (through March 31)

 

0.6

%

 


Source:  Chilean National Institute of Statistics

 

Although we benefit from a higher than expected inflation rate in Chile due to the structure of our assets and liabilities (we have a significant net asset position indexed to the inflation rate), significant changes in inflation with respect to current levels could adversely affect our results of operations and, therefore, the value of both our shares and ADSs.

 

For more information, see “Item 5.  Operating and Financial Review and Prospects—Operating Results—Overview—Inflation” and “Item 5.  Operating and Financial Review and Prospects—Operating Results—Overview—Interest Rates.”

 

Part of the information included in our financial statements considers assumptions, estimates and modeling which, if inaccurate, could have a material impact on our results of operations and financial position.

 

The preparation of our financial statements requires management to make judgments and estimates that affect the amounts of assets, liabilities, income and expenses reported in our financial statements. Estimates and assumptions are based on historical experience, expert judgment and other factors, including expectations of future developments under certain alternative scenarios. Although assumptions and estimates are evaluated and revised on a continuous basis, we cannot rule out that projected scenarios could dramatically change in the short term, causing a severe impact on fundamentals and estimates.

 

We are also subject to model risk since the valuation of financial instruments relies on models and inputs, which —in some cases— are not observable. Accordingly, computed values for securities and financial instruments may be inaccurate or subject to change, since the inputs used for specific models may not be available, particularly for illiquid assets or under scenarios of financial turmoil. In these cases, we will make assumptions and judgments in order to establish the fair value of certain instruments, which involves uncertainty and may translate into inaccurate estimates of actual results.

 

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In this regard, the replacement of certain market indices or benchmarks extensively used in by financial markets for valuation purposes, such as for interest rates or foreign exchange rates indices could also impact the accuracy of the estimates we include in our financial statements. In fact, after 2021 banks will not be required to submit rates for the calculation of the London interbank offered rate (“LIBOR”) benchmark, which could produce changes in the LIBOR rate as we currently know it, affecting its precision or comprehensiveness when representing the worldwide fixed-income market. This reform and other changes in the same way may result in diverse risks for the financial and banking business, including but not limited to: (i) changes in the valuation of financial instruments; (ii) changes in pricing procedures for some instruments; (iii) misunderstandings with customers or counterparties; (iv) necessity of adapting current IT systems, trading platforms, financial reporting infrastructure and clearing processes; among others. The implementation of alternative benchmark rates may have an adverse effect on our business, results of operations or financial condition that we are not able to determine in advance. Although we expect to adapt our valuation processes, IT infrastructure and pricing systems as new information arises, we can neither assure you nor calculate the impact this could have in our business and results of operations, if any.

 

The main accounting items subject to risk of incorrect valuation include impairment of loans and advances, valuation of financial instruments, impairment of available-for-sale securities, deferred tax assets and provisions for liabilities. If our judgment, assumptions or models used in valuing these items are inaccurate, there could be a material effect on our results, funding requirements and capital ratios.

 

Market turmoil could result in material negative adjustments to the fair value of our financial assets, which could translate into a material effect on our results or financial condition.

 

Over the last decade worldwide financial markets have been subject to stress that has resulted in sharp temporary changes in interest rates and credit spreads. We have material exposures to debt securities issued by the local government and the Central Bank and other fixed-income investments in securities issued by local and foreign issuers, all of which are booked at fair value with direct impact on our profit and loss statement or in equity through other comprehensive income. These positions, therefore, expose us to potential negative fair value adjustments in the short or medium term and to impairments in the long-run, due to dramatic and unexpected changes in short- or long-term local and foreign interest rates and credit spreads. Any of these factors could have a material adverse effect on our results of operations and financial condition.

 

Operational problems, errors, criminal events or terrorism may have a material adverse impact on our business, financial condition and results of operations.

 

As all large financial institutions, we are exposed to many operational risks, including the risk of fraud by employees and outsiders, failure to obtain suitable internal authorizations, failure to properly document in-person and online transactions, equipment failures, mistakes made by employees and natural disasters, such as earthquakes, tsunamis, wildfires and floods.  Furthermore, we are exposed to criminal events or terrorist attacks resulting in physical damage to our buildings (including our headquarters, offices, branches and ATMs) and/or injury to customers, employees and others.  Although we maintain a system of operational controls composed of both trained staff and world-class technological resources, as well as comprehensive contingency plans and security procedures, there can be no assurances that operational problems, errors, criminal events or terrorist attacks will not occur and that their occurrence will not have a material adverse impact on our results of operations, financial condition and the value of our shares and ADSs.

 

Cybersecurity events could negatively affect our reputation or results of operations and may result in litigation.

 

We have access to large amounts of confidential financial information and hold substantial financial assets belonging to our customers as well as to us.  In addition, we provide our customers with continuous online access to their accounts and the possibility of transferring substantial financial assets by electronic means while purchasing goods or withdrawing funds, in Chile and abroad with credit and debit cards issued by us. Among the most significant cyber-attack risks that we are constantly facing are internet fraud and loss of sensitive information, both from our customers and ourselves. In particular, loss from internet fraud occurs when cyber criminals extract funds directly from clients’ or our accounts using fraudulent schemes that may include internet-based fund transfers. We are also exposed to cyber-attacks, hacking and other cybersecurity incidents in the normal course of business. Thus, as a financial institution, we are under a constant threat of suffering losses due to such reasons. In addition, our risk and exposure to these matters remains heightened because of the evolving nature and complexity of these threats from cybercriminals and hackers, our plans to continue to provide and to enhance internet banking and mobile banking channels, and our plans to develop additional remote connectivity solutions to serve our customers.  Accordingly, cybersecurity is a material risk for us.

 

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There has recently been an increased level of attention focused on cyber-attacks against large corporations that include, but are not limited to, obtaining unauthorized access to digital systems for purposes of misappropriating cash, other assets or sensitive information, corrupting data or causing operational disruption.  Cybersecurity incidents such as computer break-ins, phishing, identity theft and other disruptions could negatively affect the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us in excess of insurance coverage, which may carry low coverage limits, and may cause that existing and potential customers to refrain from doing business with us.  Additionally, cyber-attacks on our network or other systems could have a material adverse effect on our business and results of operations, due to, among other things, financial losses, losses of sensitive information,  interruption or delays in our business and operations, regulatory fines, reimbursement or other compensation costs, compliance costs and reputational damage.

 

On May 24, 2018, we suffered a cybersecurity incident by international cyber-criminals involving the theft of funds that subsequently resulted in an operational write-off of approximately Ch$6,900 million (or U.S.$ 9.9 million). The incident also caused temporary interruptions to some of our operations, which during a short period of time affected the quality of certain services provided to our customers. In summary, our systems, some of our servers and part of the workstations deployed in our headquarters and a network were infected by zero-day malware that was introduced in our systems and scheduled to activate at a certain point of time. The damage caused by this malware on computers and servers was intended to distract us from the real objective of this attack, which was to obtain access to our swift system. When accessing this key platform, various international fund transfers were executed with charges to our accounts. Following the incident, we took immediate action to effectively contain and eradicate any disruption in our operations. At the same time, we took appropriate measures to recover the stolen funds, including but not limited to, (i) contacting our international network of correspondent banks to which some of the funds had been transferred without our approval, which enabled us to successfully recover significant part of the funds just hours after the incident , (ii) applying for the redemption of an insurance policy we hold for these issues, and (iii) requesting advice and technical support to restore our operating capacity while rebooting computers and servers, see “Item 5.  Operating Results—Results of Operations for the Years Ended December 31, 2016, 2017 and 2018—Other Income (Loss), Net” and “Item 5.  Operating Results—Results of Operations for the Years Ended December 31, 2016, 2017 and 2018—Operating Expenses”. In spite of this incident and the temporary damage to our IT infrastructure, we were able to deploy a contingency plan, which allowed us: (i) to maintain the continuity of our operations and customer assistance in branches and through remote channels, (ii) to take immediate measures in order to assure that the funds of our customers were absolutely secured, and (iii) to comply with our short-term financial commitments with third parties and customers based on liquidity management. Furthermore, in line with enhancements in our cybersecurity standards that were performed during the last years, and to further improve our protections against events such as the one that occurred in May 2018, during 2018 we put significant efforts and took steps in order to enhance our data security and IT infrastructure, including, among others, the purchase of protection systems and world-class infrastructure. In addition, we reinforced our organizational structure by creating the Cybersecurity Division in June 2018, which replaced our former Technological Security Area, whose main role is to be the first line of defense and be in charge of mitigating and managing cybersecurity threats, while at the same time improving cybersecurity policies, spreading related knowledge among our bank, customers and developing competences that all our employees must possess on this regard, see “Item 4. Information about the Company—Our Business Strategy—Operating Efficiency and Productivity”. However, notwithstanding every measure taken to address cybersecurity matters and although we have not experienced any material losses relating to this incident and are currently performing our best efforts to prevent them, we cannot assure you that we will not suffer additional losses in the future related to these kind of events.

 

The occurrence of any cyber-attack or information security breach could result in material adverse consequences to us including damage to our reputation and the loss of customers. We could also face litigation or additional regulatory scrutiny. Litigation or regulatory actions in turn could lead to significant liability or other sanctions, including fines and penalties or reimbursement of customers adversely affected by this security breach. As mentioned above, although we did not suffer any material adverse effects as a result of the cyber-attack, successful attacks or systems failures at our bank or at other financial institutions could lead to a general loss of customer confidence in financial institutions, including us.

 

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In addition, we depend on a variety of internet-based data processing, communication, and information exchange platforms and networks.  We cannot assure you that all of our systems are entirely free from vulnerability.  Additionally, we enter into contracts with several third parties to provide our customers with data processing and communication services.  Therefore, if information security is breached, or if one of our employees or external service providers breaches compliance procedures, information could be lost or misappropriated, which may affect our results of operations, damage others or result in potential litigation.

 

Although we have substantially increased measures to address cybersecurity during the last year and, with the help of service providers, intend to continuously implement security technology devices and establish operational procedures to prevent such damage, we cannot assure you that these security measures will be successful.

 

Any downgrade in Chile’s or our credit rating could increase our cost of funding, affecting our interest margins, results of operations and profitability.

 

Our current credit ratings determine the cost and the terms upon which we are able to obtain funding in the ordinary course of business. Rating agencies regularly evaluate us by taking into account diverse factors, including our financial strength, the business environment and the economic backdrop in which we operate. Thus, methodologies used by rating agencies evaluate Chile’s sovereign debt ratings when determining our ratings. During 2018, both Standard & Poor’s Ratings Service (“S&P”) and Fitch Ratings Service (“Fitch”) did not change Chile’s sovereign credit rating, while Moody’s Investors Service (“Moody’s”) downgraded Chiles’s credit rating from Aa3 to A1 and updated the outlook from negative to stable. Following these rating actions, Moody’s also modified our credit rating from Aa3 to A1 and changed our outlook from negative to stable, in a similar fashion that the rating action for Chile’s sovereign debt. On the other hand, S&P and Fitch maintained our credit rating at A+ and A, respectively. While Chile’s current long-term debt credit ratings remain investment grade, these credit ratings may deteriorate further and adversely affect our credit rating.

 

Any downgrade in our debt credit ratings could result in higher borrowing costs for us while requiring us to post additional collateral or limiting our access to capital markets.  All of these factors could adversely impact our commercial business by affecting our ability to:  (i) sell or market our products, (ii) obtain long-term debt and engage in derivatives transactions, (iii) retain customers who need minimum ratings thresholds to operate with us, (iv) maintain derivative contracts that require us to have a minimum credit rating and (v) enter into new derivative contracts, which could impact our market risk profile, among other effects.  Any of these factors could have an adverse effect on our liquidity, results of operations and financial condition.

 

Due to the recent volatility in the financial markets and concerns about the soundness of developed and emerging economies, we cannot assure you that rating agencies will maintain our and Chile’s sovereign debt current ratings and outlooks.

 

As a financial institution, we are subject to reputational risk that could materially affect our results of operations or financial condition

 

Corporate reputation is a crucial competitive advantage for us, as it allows us to attract and retain customers, appeal to investors and avoid employee attrition. Also, reputation is a key element in banking since access to funding is driven by the confidence of depositors and the opinion of ratings agencies on the value of our franchise. Therefore, any disreputable event, including employee misconduct, legal proceedings, regulatory sanctions, failure to deliver minimum standards of service quality, failure to comply with regulatory requirements, unethical behavior by our staff or involvement in political issues or public scandals (or gossip related thereto) could damage our reputation and produce significant harm to our results of operations or financial condition. Furthermore, our reputation is highly aligned with the reputation of the banking industry in which we participate and, therefore, actions by other providers of financial services or the banking industry as a whole could also harm our own reputation.

 

Similarly, the ability to manage potential conflicts of interest has become increasingly important factor for our business given our widespread operations in many economic sectors with diverse third parties. Accordingly, the failure to address —or even the perceived failure to address— conflicts of interest could affect the willingness of customers and investors to work with us, or could lead to legal actions against us. In order to address and avoid these potential events we are continuously improving our corporate governance standards by detecting potential failures and adopting world-class principles and procedures.  Nevertheless, we cannot assure you that we will not face reputational events in the future that could harm our prospects or the value of our franchise. For more information on corporate governance, see “Item 6.  Directors, Senior Management and Employees—Board Practices”.

 

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Risks Relating to our ADSs

 

Our principal shareholders may have interests that differ from those of our other shareholders and their significant share ownership may have an adverse effect on the future market price of our ADSs and shares.

 

As of April 18, 2019, LQ Inversiones Financieras S.A. (“LQIF”), a holding company beneficially owned by Quiñenco S.A. and Citigroup Chile S.A., holds directly and indirectly approximately 51.15% of the voting rights of our shares.  Subject to our bylaws and applicable law, these principal shareholders are in a position to elect a majority of the members of our board of directors and control all matters decided by a shareholder vote, including the approval of fundamental corporate transactions.

 

Actions by our principal shareholders with respect to the disposition of the shares or ADSs they beneficially own, or the perception that such actions may occur, may adversely affect the trading price of our shares on the various stock exchanges on which they are listed and, consequently, the market price of the ADSs.

 

There may be a lack of liquidity and a limited market for our shares and ADSs.

 

While our ADSs have been listed on the New York Stock Exchange (the “NYSE”) since the first quarter of 2002, there can be no assurance that an active trading market for our ADSs will be sustained.  During 2018, a daily average volume of approximately 37,973 of our American Depositary Receipts (“ADRs”) were traded on the NYSE, according to data provided by Bloomberg. Although our shares are traded on the Santiago Stock Exchange and the Chilean Electronic Stock Exchange, the Chilean market for our shares in Chile is small and somewhat illiquid. As of April 18, 2019, approximately 32.2% of our outstanding shares were held by shareholders other than our principal shareholders, including LQIF (and the participation of LQ-SM), SM-Chile and SAOS, considering direct ownership and voting rights.

 

If an ADS holder withdraws the underlying shares from the ADR facility, the small size of the market, its limited liquidity, as well as our concentrated ownership, may impair the ability of the ADS holder to sell the shares in the Chilean market in the amount and at the price and time such holder desires, and could increase the volatility of the price of our ADSs.

 

ADS holders may be unable to exercise voting rights at shareholders’ meetings and preemptive rights.

 

ADS holders may exercise voting rights associated with common stock only in accordance with the deposit agreement governing our ADSs.  Accordingly, ADS holders will face practical limitations when exercising their voting rights because ADS holders must first receive a notice of a shareholders’ meeting from the Depositary and may then exercise their voting rights by instructing the Depositary, on a timely basis, on how they wish to vote.  This voting process necessarily will take longer for ADS holders than for direct common stock holders, who are able to exercise their vote by attending our shareholders’ meetings.  Therefore, if the Depositary fails to receive timely voting instructions from some or all ADS holders, the Depositary will assume that ADS holders agree to give a discretionary proxy to a person designated by us to vote their ADSs on their behalf.  Furthermore, ADS holders may not receive voting materials in time to instruct the Depositary to vote.  Accordingly, ADS holders may not be able to properly exercise their voting rights.

 

Furthermore, the Ley Sobre Sociedades Anónimas No. 18,046 (the “Chilean Corporations Law”) and the Reglamento de Sociedades Anónimas (the “Chilean Corporations Regulations”) require that whenever we issue new common stock for cash, we grant preemptive rights to all of our shareholders (including holders of ADSs) to purchase a sufficient number of shares to maintain their existing ownership percentage.  Such an offering would not be possible unless a registration statement under the Securities Act were effective with respect to such rights and common stock or an exemption from the registration requirements thereunder were available.

 

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We may elect not to make a registration statement available with respect to the preemptive rights and the common stock, in which case you may not be able to exercise your preemptive rights.  If a registration statement is not filed, the depositary will sell such holders’ preemptive rights and distribute the proceeds thereof if a premium can be recognized over the cost of any such sale.

 

Developments in international financial markets may adversely affect the market price of the ADSs and shares

 

The market price of our ADSs and shares may be adversely affected by volatility in international financial markets and adverse global economic conditions.  The market for Chilean securities and the Chilean economy as a whole are influenced by economic and market conditions in the United States, Europe and certain emerging market economies, especially Asian countries, and also economic as well as political developments in Latin American countries.  Although economic conditions are different in each country, investors’ reactions to specific issues in one country may affect the financial markets in others, including Chile.  Therefore, unfavorable developments in other countries—especially in developed economies and Chile’s main commercial partners—may adversely affect the market price of our ADSs and shares.

 

The global economy appears to have overcome a long period of turbulence and volatility, which began in 2007 with the subprime mortgage crisis, when many U.S. banks and financial institutions disclosed significant write-downs related to their exposure to mortgage-backed securities and other similar financial instruments. This situation led to significant government intervention for important banks worldwide, bankruptcy for others and active M&A activity intended to rescue failing banks and maintain the confidence of investors and customers while avoiding bank runs.  Today, these government actions are less frequent and the U.S. economy has shown signs of recovery such that in December 2015, the U.S. Federal Reserve began to taper its quantitative easing programs undertaken after the subprime crisis. Since then, the U.S. Federal Reserve has gradually increased the marginal standing facility rate from 0.50% in December 2015 to 2.5% in December of 2018. Investor sentiment around the marginal increases has fluctuated and we cannot assure you that past developments will not occur again in the future or that recent volatility in the international markets will not affect us, including our results of operations and, consequently, the market price of our ADSs and shares.

 

Additionally, during 2015, new doubts about the financial condition of European banks arose.  Similarly, the fiscal condition of many countries remained weak. We cannot assure you that volatility in global financial markets due to the uncertainty regarding the fiscal condition of some European countries will not continue and affect the Chilean economy and consequently the financial condition and results of operations of the entire Chilean banking system, including us. Accordingly, the price of our ADS could be adversely affected by a new financial turmoil in the Eurozone, political issues, armed conflicts, uncertainty due to terrorism, a slower than expected recovery, or a deterioration in healthier economies.

 

Lastly, uncertainty regarding the future of emerging and developed economies remains and continues to be a source of instability worldwide. For example, the recent “trade war” between the United States and China, by which the U.S. administration seeks to revise tariffs on Chinese imported goods and China seeks to impose revised tariffs on imported U.S. goods, political and social instability in Latin America (particularly focused on Venezuela),  the materialization of the exit of Great Britain from the Eurozone, armed conflicts in the Middle East and Asia, ongoing negotiations between the U.S. and North Korea, terrorism, the global migration crisis and waves of populism looming in different countries, illustrate volatile social and political environments that could harm foreign trade and economic growth for both developed and developing countries and also generate significant volatility in international markets and commodity prices.  In this regard, deceleration in developed countries and Chile’s commercial partners and global volatility could adversely impact the local economy, the local banking industry and, ultimately, our results of operations, financial condition and the price of our ADS. Additionally, the slowdown of the Chinese economy have led to increasing volatility in the financial markets in the past, affecting international commodity prices, including copper which is Chile’s main export. Due to the importance of copper exports and overall mining activity to Chilean economic growth, a prolonged slowdown in the Chinese economy, a Chinese-U.S. trade war or other developments may drive copper prices down and adversely affect the Chilean economy.  Although copper prices have not been affected by the effect of economic slowdown in China or the Chinese-U.S. trade war (given optimism regarding negotiations between the Chinese and U.S. governments), our exposure to the Chilean mining sector does not exceed 1.6% in terms of total loans, we cannot assure you that new developments affecting the Chinese economy will not have a material impact on overall Chilean economic activity and, therefore, in the local banking industry which could lead to lower loan growth for us and the Chilean financial industry as a whole, affecting the price of our shares and ADS.

 

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While we are not experiencing any immediate adverse impact on our financial condition as a direct result of Brexit, adverse consequences such as deterioration in economic conditions, volatility in currency exchange rates or other adverse changes such as reduced growth and higher volatility in global capital markets—all of which could adversely affect the price of our ADSs.

 

In the past, Chile has imposed controls on foreign investment and repatriation of investments that affected investments in, and earnings from, our ADSs.

 

Equity investments held in Chile by non-Chilean residents have historically been subject to various exchange control regulations that restrict the repatriation of investments and earnings from Chile.  In April 2001, the Central Bank eliminated most of the regulations affecting foreign investors, although they still have to provide the Central Bank with information related to equity investments and must conduct such operations within the Formal Exchange Market.  Additional Chilean restrictions applicable to holders of our ADSs, the disposition of the shares underlying them, the repatriation of the proceeds from such disposition or the payment of dividends may be imposed in the future, and we can neither determine in advance nor advise you as to when or how those restrictions could impact you, if imposed.

 

If for any reason, including changes in Chilean law, the depositary for our ADSs were unable to convert Chilean pesos to U.S. dollars, investors would receive dividends and other distributions, if any, in Chilean pesos.

 

Risks Relating to Chile

 

Our growth and profitability depend on the level of economic activity in Chile.

 

Our core business and transactions are with customers doing business in Chile.  Accordingly, our ability to grow our business volumes and results of operations, as well as enhance our financial condition, in general, depends on the dynamism of the Chilean economy and specific macroeconomic variables such as inflation, unemployment, interest rates, consumption and investment.  The global financial crisis of 2008 that dramatically affected the economic growth in developed countries also affected the Chilean economy by the end of 2008 and during the first three quarters of 2009.  This translated into a subsequent slowdown in the local banking industry due to lower levels of consumption and deteriorated credit quality in loan portfolios prompted by unemployment and financial stress experienced by certain economic sectors.  Conversely, between 2010 and 2012 the local economy and the banking industry evidenced a significant upturn, fostered by real GDP growth that averaged 5.7% per year, mainly as a result of the recovery in consumption and investment, as well as higher fiscal spending associated with the reconstruction process after a significant earthquake in 2010.

 

During 2013, the Chilean economy entered into a moderate slowdown, recording only a 4.0% GDP growth, which deepened throughout the following years with GDP annual expansions of just 1.9%, 2.3%, 1.3% and 1.5% in 2014, 2015, 2016 and 2017, respectively. This trend in GDP deceleration was the result of low levels of both corporate and individual confidence, as evidenced by indexes (IPEC and IMCE) used by the Central Bank, due to factors such as slower growth of Chile’s main commercial partners, especially China, and uncertainty associated with diverse reforms presented by the administration appointed in 2014. During 2018, however, the Chilean economy showed positive signs of recovery, when compared to the last four years, by recording a 4.0% annual expansion of GDP, mainly supported by a similar increase of 4.0% in private consumption, better performance of some key trade partners and a strong recovery in investment spending (understood as fixed capital formation), which experienced a 4.7% annual increase, which in turn was primarily the result of the recovery of copper prices that translated into new investment projects undertaken in the mining sector. Although the Chilean economy has growth potential of at least 3.2% per year and GDP behaved in line with that potential in 2018, we cannot assure you that the local economy will continue growing in the future or that developments affecting the Chilean economy and the local banking industry will not materially affect our business, financial condition or results of operations.  For more information, see “Item 5.  Operating and Financial Review and Prospects—Operating Results—Overview”.

 

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Currency fluctuations could adversely affect the value of our ADSs and any distributions on the ADSs.

 

The Chilean government’s economic policies and any future changes in the value of the Chilean peso with respect to the U.S. dollar could affect the dollar value of our common stock and our ADSs.  Given the floating exchange rate regime that exists in Chile, the Chilean peso has been subject to large fluctuations in the past and this trend could occur again in the future.  According to information published by the Central Bank, between December 31, 2017 and December 31, 2018, the value of the U.S. dollar relative to the Chilean peso increased by approximately 13.1%, as compared to the decrease of 7.8% recorded in the period from December 31, 2016 to December 31, 2017.  Chilean trading in the shares underlying our ADSs is conducted in Chilean pesos.  Cash dividends associated with our shares of common stock are received in Chilean pesos by the depositary, which then converts such amounts to U.S. dollars at the then-prevailing exchange rate for making payments in respect of our ADSs.  If the value of the U.S. dollar increases relative to the Chilean peso, the dollar value of our ADSs and any distributions to be received from the depositary will decrease.  In addition, the depositary will incur customary currency conversion costs (to be borne by the holders of our ADSs) in connection with the conversion and subsequent distribution of dividends or other payments.  For more information, see “Item 10.  Additional Information—Exchange Controls.”

 

Our results of operations may be affected by fluctuations in the exchange rates between the Chilean peso and the U.S. dollar despite our policy and Chilean regulations related to the general avoidance of material exchange rate mismatches.  In order to reduce the effect of exchange rate mismatches we enter into foreign exchange derivative transactions that hedge our exposure.  As of December 31, 2018, our foreign currency-denominated assets and Chilean peso-denominated assets, which contain repayment terms linked to changes in foreign currency exchange rates, exceeded our foreign currency-denominated liabilities and Chilean peso-denominated liabilities, which contain repayment terms linked to changes in foreign currency exchange rates, by an amount of Ch$1,851  million, or 0.06% of our paid-in capital and reserves.

 

We may decide to change our policy regarding exchange rate mismatches.  Regulations that limit such mismatches may also be amended or eliminated by regulatory institutions.  Higher exchange rate mismatches will increase our exposure to the devaluation of the Chilean peso, and any such devaluation may impair our capacity to service foreign-currency obligations and may, therefore, materially and adversely affect us, our financial condition and results of operations.  Additionally, the economic policies of the Chilean government and any future fluctuations of the Chilean peso with respect to the U.S. dollar could adversely affect our financial condition and results of operations.

 

Chile has corporate disclosure standards different from those you may be familiar with in the United States.

 

Chilean disclosure requirements for publicly listed companies differ from those in the United States in some significant aspects.  In addition, although Chilean law imposes restrictions on insider trading and price manipulation, the Chilean securities markets are not as highly regulated and closely supervised as the U.S. securities markets.  Accordingly, the information about us available to you will not be the same as the information available to shareholders of a U.S. company.  For more information, see “Item 16G.  Corporate Governance.”

 

Chilean law may provide shareholders with fewer and less well-defined rights.

 

Our corporate affairs are governed by our estatutos (bylaws) and the laws of Chile.  Under such laws, our shareholders may have fewer or less well-defined rights than they might have as shareholders of a corporation incorporated in a U.S. jurisdiction.  For example, our shareholders would not be entitled to appraisal rights in the event of a merger or other business combination undertaken by us.

 

Our business growth, asset quality and profitability may be affected by political and social developments in Chile in the long run.

 

Our operations are highly dependent on the Chilean political and social environment, as most of our customers and borrowers do business in Chile. Thus our results of operations could be negatively impacted by unfavorable political and diplomatic developments, social instability or unrest, as well as dramatic changes in public policies, including expropriation, nationalization, international ownership legislation, interest rate caps and tax policy. Although Chile has a tradition of compliance with the rule of law, we cannot assure you that this trend will continue in the future.

 

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Reforms to labor and pension laws as well as labor strikes or slowdowns could adversely affect our results of operations.

 

We are a party to collective bargaining agreements with various labor unions to which most of our employees belong. Therefore, disputes with regard to the terms of these agreements or our potential inability to negotiate acceptable contracts with these unions could result in, among other things, strikes, work stoppages, or other slowdowns by the affected workers.  If unionized workers were to engage in a strike, work stoppage, or other slowdown, or other employees were to become unionized, we could experience disruption of our operations or higher ongoing labor costs, either of which could have a material adverse effect on our results of operations.  See “Item 6.  Directors, Senior Management and Employees—Employees.”

 

On September 8, 2016 the Chilean government passed a law reforming the Chilean labor framework, which went into effect on April 1, 2017. This law enhances and empowers labor unions’ negotiation position through amendments to the collective bargaining process, such as (i) a prohibition against replacing employees during a strike, (ii) the authorization for inter-company unions to collectively bargain in specific cases, (iii) the extension of a union’s access to information, such as the employer’s financial information and labor conditions, among others, (iv) the establishment of minimum threshold requirements for the terms and conditions of the collective bargaining process, which cannot be more restrictive than the previous collective agreement, and (v) the definition of a company’s minimum services and emergency teams by the applicable labor regulator after negotiations between a company and each labor union prior to the commencement of a collective bargaining process. With respect to clause (v), minimum services refer to those functions of a company which must continue to be provided during a strike because they have been determined to be essential to protect assets and facilities, to prevent accidents, guarantee public utility services, meet the basic needs of the population and prevent environmental damage or harm to health.  A company’s emergency teams are made up of workers assigned by each union to fulfill such minimum services. As further explained in “Item 8 — Financial Information — Legal Proceedings — Setting of Minimum Services and Emergency Teams in Case of a Strike”, we are currently in the process of challenging the minimum services and emergency teams that have been assigned to us.  As of the date of this annual report, we cannot offer any assurance as to the final outcome of these legal proceedings. To the extent we are not able to prevail, in the event of futures strikes, we could face operational disruption due to an inadequate number of minimum services and insufficient staff for the emergency teams.

 

In August 2017, a reform to the local pension system was presented by the former Chilean government to the Chilean congress for discussion. The main change to the current system would consist of an increase in the compulsory rate of savings, from the current 10% contribution rate to a 15% rate. The 5% net increase would be paid exclusively by employers.  However, in October 2018 the current government announced several changes to said reform, which were presented to the Chilean congress by the beginning of November, 2018. The main changes proposed in the current bill are the increase in the compulsory rate of savings, from the current contribution rate of 10% to 14%, of which 4% of the net increase would also be paid by the employer but gradually applied over a period of eight years upon the passage of the bill and the increase of the state contribution for low income pensioners by means of enhancing public expenditure for these purposes. The bill also includes the opening of the pension fund management industry to new actors, lowering entrance barriers to this market, enhancing the powers of the Superintendency of Pensions and introduces the CMF as a supervisory entity, among other reforms. Because there is no certainty as to when and how this reform would go into effect, if approved, we cannot yet assess whether this reform would substantially affect our results of operations.

 

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Item 4                                    Information on the Company

 

History and Development of the Bank

 

Overview

 

We were founded in 1893, and we have been, for much of our history, among the largest and most profitable Chilean banks in terms of return on average assets and average equity in Chile.  Our core business is commercial banking in Chile, providing traditional banking products and specialized financial services to our large and diversified customer base of individuals and companies.

 

Our legal name is Banco de Chile and we are organized as a banking corporation under the laws of Chile and were licensed by the SBIF to operate as a commercial bank on September 17, 1996. Our main executive offices are located at Paseo Ahumada 251, Santiago, Chile, our telephone number is +56 (2) 2637-1111 and our website is www.bancochile.cl.  Our representative in the United States is Puglisi & Associates, with offices at 850 Library Avenue, Suite 204, Newark, Delaware 19711.

 

We are a full service financial institution that provides, directly and indirectly through our subsidiaries, a wide variety of lending and non-lending products and services to all segments of the Chilean financial market, providing our customers with powerful, differentiated and comprehensive value offerings. In addition to our traditional banking operations, our subsidiaries and affiliates permit us to offer a variety of non-banking but specialized financial services including securities brokerage, mutual funds management, investment banking, insurance brokerage, securitization and collection services.

 

Our business is not materially affected by seasonality.

 

We organize our operations and deliver our services to our customers through the following four principal business segments:

 

(i)             retail banking;

 

(ii)          wholesale banking;

 

(iii)       treasury and money markets; and

 

(iv)      subsidiaries.

 

Through our retail banking segment, we provide our individual customers with credit cards, installment loans and residential mortgage loans, as well as traditional deposit services, such as current accounts, demand deposits, demand accounts, savings accounts and time deposits. We and our subsidiaries also offer financial solutions such as insurance brokerage, securities brokerage, mutual funds management, among others.  In addition to personal banking, our retail segment comprises micro, small and medium sized companies that we serve by providing them with short and long term financing, deposit and cash management solutions, in addition to an array of financial services, such as insurance brokerage. In addition, our banking services for wholesale customers include commercial loans (including factoring and leasing), trade finance, capital markets services, cash management and non-lending services, such as payroll, payment and collection services, as well as a wide range of treasury, financial advisory and risk management products.

 

In 2008, we enhanced our value offerings by entering into a strategic partnership with Citigroup Inc., as a result of our merger with Citibank Chile. We also offer international banking services through our representative office in Beijing and a worldwide network of correspondent banks.

 

According to the SBIF, under Chilean GAAP, as of December 31, 2018, we ranked first in the Chilean banking industry in terms of net income attributable to equity holders with a market share of 25.3%. As of the same date and excluding operations of subsidiaries abroad, we were the second largest bank in Chile in terms of total loans with a market share of 16.9%, the largest provider of commercial loans with a market share of 16.7%, the second largest provider of consumer loans with a market share of 17.9% and the third largest private sector bank in terms of residential mortgage loans with a market share of 16.8%.  As for liabilities, excluding operations of subsidiaries abroad, we were the largest bank in Chile in terms of current accounts and demand deposit balances with a market share of 22.2% and, more importantly, we ranked first in current account balances held by individuals with a market share of 27.2%, both as reported by the SBIF and as of December 31, 2018.  Lastly, according to the Chilean Association of Mutual Funds, as of December 31, 2018, we were the largest provider of mutual funds management services in Chile with a market share of 21.1%.

 

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As of December 31, 2018, we had:

 

·                  total assets of Ch$35,617,447 million (approximately U.S.$ 51,351.6 million);

 

·                  total loans of Ch$27,926,632 million (approximately U.S.$ 40,263.3 million), before deducting allowances for loan losses;

 

·                  total deposits of Ch$20,240,662 million (approximately U.S.$ 29,182.0 million), of which Ch$9,584,488 million (approximately U.S.$ 13,818.5 million) correspond to current account and demand deposits;

 

·                  equity (including net income, non-controlling interest and provisions for minimum dividends) of Ch$3,673,716 million (approximately U.S.$ 5,296.6 million);

 

·                  net income attributable to equity holders of Ch$603,633 million (approximately U.S.$ 870.3 million); and

 

·                  market capitalization of approximately Ch$10,017,864 million (approximately U.S.$14,443.2 million).

 

As of December 31, 2018, we had 11,381 employees and delivered financial products and services through a nationwide distribution network of 390 branches and 1,485 automatic teller machines (“ATMs”). Our ATMs are part of a larger network of 7,254 ATMs operating in Chile, of which 4,385 ATMs operate under a network managed by Redbanc S.A., a company we partly own along with nine other private sector banks.

 

History

 

We were founded in 1893 as a result of the merger of Banco Nacional de Chile, Banco Agrícola and Banco de Valparaíso, which created the largest private sector bank in Chile.  We have played an important role in the economic history of Chile.  Before the creation of the Central Bank in 1926 and prior to the enactment of the General Banking Act, we were the main stabilization agent of the Chilean banking system, a role that is now performed by the Central Bank.  Beginning in the early 1970s, the Chilean government assumed control of a majority of Chilean banks, and all but one of the foreign banks that were operating at that time closed their branches and offices within the country.  Throughout this era, we remained as a private sector bank, with the exception of a portion of our shares owned by the Chilean government that were sold to private investors in 1975.  Throughout our history we have developed a well-recognized brand name in Chile and expanded our operations in foreign markets, where we developed an extensive network of correspondent banks.  In the early twentieth century, we established a representative office in London, which we maintained until 1985, when our operations in Europe were moved to Frankfurt.  The office in Frankfurt was closed in 2000, when our foreign operations were centralized at the New York branch.  In 1987 and 1988, we established four subsidiaries to provide a full range of specialized financial products and services as permitted by the General Banking Act.  In 1999, we widened our scope of specialized financial services by creating our insurance brokerage and factoring subsidiaries.  According to our estimates, we remained the largest private bank in Chile until 1996.  During the early 2000s, the Chilean banking industry witnessed intense merger and acquisition activity.  In 2002, we merged with Banco de A. Edwards, which allowed us to expand our business to new customer segments.  In 2008, we sold our U.S. branch to Citigroup in connection with our merger with Citibank Chile that was carried out during the same year.  As a result of these consolidations, we currently operate a distribution network that is composed of three brand names, namely, “Banco de Chile” (which operates throughout Chile), “Banco Edwards-Citi” (which is primarily oriented to higher income segments) and “Banco CrediChile” (which is focused on consumer loans and demand accounts for lower and middle income segments).

 

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During 2014, the Chilean economy entered into a slowdown cycle, which affected investment and the growth of commercial loans.  Amid this slowdown, we took advantage of our competitive strengths and continued to optimize our risk-return relationship by keeping our credit risk under control and developing innovative commercial strategies.  As a result, we remained at the top of the industry in terms of net income generation and return on average equity, according to information published by the SBIF as of December 31, 2014.  In order to achieve these goals, we improved customer experience by launching cutting-edge mobile banking solutions and applying world-class business intelligence methodologies.  Furthermore, we continued to diversify our funding structure by issuing long term bonds in Switzerland, Japan and Hong Kong, while taking advantage of our U.S.$1,000 million commercial paper program, which was established in 2010 (‘the Commercial Paper Program”) to raise short-term funds.  Lastly, we recorded a 15.9% annual expansion in current accounts and demand deposit (year-end balances) that enabled us to rank first in these liabilities within the local banking industry, according to information released by the SBIF as of December 31, 2014.  These figures were reflected by the interest of investors in Banco de Chile’s stock, which recorded an 86.5% annual increase in trading volumes (excluding the effect of the LQIF secondary offering), the highest increase among all publicly listed Chilean banks.

 

During 2015, the economic backdrop remained a leading challenge for the banking industry.  However, we remained the most profitable bank in Chile (in terms of return of return on average capital and reserves and return of average assets for banks with market share in loans above 3.0%) and the first bank in net income attributable to equity holders.  These accomplishments were due to diverse initiatives implemented during the year, including innovation in IT solutions for our customers, which has become one of our main goals.  Due to these initiatives, we were recognized as the Best Consumer Digital Bank in Chile by GlobalFinance and as the Best Internet and Mobile Bank in Chile by Global Banking & Finance Review in 2015.  In addition, we entered into two strategic partnerships with both a local and an international airline, which will benefit our 1.5 million credit card holders. We also acquired a commercial loan portfolio from a local bank amounting to approximately Ch$564 billion. Moreover, 2015 was a record year for Banco de Chile in terms of bond placements amounting to approximately Ch$1,342 billion, of which Ch$156 billion were placed abroad under the U.S.$3 billion MTN Program we maintain in Luxembourg.

 

Throughout 2016 we continued to face economic headwinds as the local economy’s growth continued to slowdown. Amid this environment, we focused on growing profitably by concentrating on those segments with a more balanced risk-return relationship. Thus, in spite of recording a moderate annual expansion of 3.4% in total loans, we managed to remain first in terms of net income attributable to equity holders and profitability (for banks with market share above 3.0% in total loans) within the local banking industry, with a market share of 28.4% and a ROAE of 19.6%, both under our internal reporting policies. Our customer-centric approach has been crucial to these achievements and we believe our service quality makes a difference when compared to our competition. During 2016 we accomplished significant advances on this matter such as attaining the highest net promotion score among the main Chilean banks for first time in our recent history while also reducing our attrition rate. We believe these achievements were the result of diverse projects and strategies intended to enhance customer proximity. Thus, during 2016 we launched a new personal banking website, with improved functionalities and enhanced our mobile banking solutions by adding new applications for smartphones. In terms of service quality, we revised and updated our portfolio of high income customers, opened new specifically-oriented branches for preferential customers and set up a new service model for premium customers called “Private Wealth Management.” Lastly, we continued to strengthen the benefits associated with our loyalty program for credit card users by adding new alliances, such as Iberia Airlines, to the package of already existing services and providers. Based on all of these initiatives, during 2016 we were recognized by various specialized publications covering multiple areas of banking activity including “Most Valuable Banking Brand” in Chile by The Banker, “Most Innovative Banking Solutions” in Chile by Global Business Outlook, “Best Consumer Digital Bank” in Chile by Global Finance and “Best Bank” in Chile by World Finance.

 

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During 2017, we were first in terms of net income and profitability within the local banking industry, with a market share of 26.1% and a ROAE of 19.3%, both under our internal reporting policies. These achievements were attained during a difficult economic landscape, which resulted in a significant slowdown of the corporate lending business that impacted certain macroeconomic indicators such as unemployment, which adversely affected the credit quality of our personal banking business. Amid this environment, we maintained our customer-centric approach and focused on developing new ways to enhance the customer experience by expanding our service offerings, business platforms and benefits to our loyalty program. For example, we launched a new website for companies, aimed at serving corporates, other large companies and SME customers. Similarly, we created a new mobile application and upgraded existing ones. We released “MiInversion” which serves as a portfolio management platform for retail customers and developed an “On/Off” functionality for the MiBanco application that enables customers to block/unblock their credit cards in case of theft or misplacement. We believe remote channels are the future of banking and are continuously promoting their use among customers while seeking new solutions to offer banking products through mobile or internet technologies. This strategy boosted demand for mobile and internet services that during 2017 reflected increases of 78% and 11% in monetary transactions using these means, respectively. In addition, our enhanced loyalty program added new alliances with GOL Airlines and British Airways and negotiated access to a VIP lounge for customers at the Santiago airport. These initiatives continue to demonstrate our commitment to superior customer service and have allowed us to obtain a 73.3 % average net promoter score in 2017, as measured by a syndicated study conducted by Consultores Asociados de Marketing Cadem S.A., or CADEM, the highest among our relevant peers. We also undertook transformational changes by assessing relevant processes in terms of efficiency, cost control and operational risk. We believe these actions are necessary to maintain our market leading position in an increasingly competitive banking industry. Lastly, we received recognition for our business performance and digital strategy including being recognized as the Best Bank in Chile, Best Digital Bank for Companies in Chile and Best Sub-Custodian Bank in Chile by Global Finance and being named the Best Mobile and Digital Bank in Chile and the Best Investment Bank in Chile by Global Banking & Finance Review.

 

Throughout 2018, we continued to show outstanding performance when compared to our main competitors. We led the market in terms of net income attributable to equity holders with a 25.3% market share, which translated into an above-average ROAE of 19% (both figures under Chilean GAAP). Thanks to this performance, we were able to earn sufficient income to fully repay the subordinated debt held by SAOS with the Central Bank in April 2019. This is a significant milestone in our history, since we were able to pay off this debt 17 years before the original maturity date. In 2018, the Chilean economy maintained the trend shown by the end of 2017. Thus, GDP grew solidly at 4.0%, primarily due to the rebound of private investment. Amid this scenario, our loan book increased 9.7%, thanks to record sales in installment and mortgage loans while also adding a record amount of new current account holders. Moreover, the wholesale segment achieved a significant recovery by the end of the year, after two consecutive years of contraction.

 

During 2018, we continued to focus on superior customer service, attaining first place in service quality among our peers by posting an average net promoter score of 71.2%, as measured by a syndicated study conducted by CADEM, and an attrition rate of only 6.2%, according to our management information system. Based on these attributes we received the “National Customer Satisfaction Award” and the “Consumer Loyalty Award” in 2018. Aligned with this view, we continued to develop our digital strategy in order to assure stability and efficiency on our diverse platforms while innovating in new products and services provided online. Thus, we added new functionalities to some of our applications (MiBanco, MiPago and MiInversion), which allow our customers to perform new transactions through their smartphones including time deposits, money exchange and the RedGiro service. Due to these improvements the amount of mobile transactions in our mobile platforms increased to 35.1 million in 2018, which represents an annual increase of 60.8%. Also, thanks to our digital banking strategy we were once again recognized as the “Best Digital and Mobile Bank in Chile” by Global Banking & Finance Review and “Innovative Digital Bank of the year in Chile” by The European Magazine. Cybersecurity was also a central point of attention for us in 2018. After the cyber-attack occurred in May 2018, on which we timely reacted based on solid security protocols, we decided to enhance our organizational structure and IT infrastructure by creating the new Cybersecurity Division. This new division took various actions in order to promote a cybersecurity culture across the company, while spreading the knowledge that all of our employees should have in respect to this important topic.

 

Merger with Banco de A. Edwards

 

On December 6, 2001, our shareholders approved our merger with Banco de A. Edwards, which became effective on January 1, 2002.  Banco de A. Edwards had been listed on the NYSE since 1995, and since January 2002, we have been listed on the NYSE under the symbol BCH.  We concluded the merger process with the consolidation of a new corporate structure and the integration of our technological platforms.

 

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Merger with Citibank Chile

 

On December 27, 2007, our shareholders approved our merger with Citibank Chile, which became effective on January 1, 2008.  During 2008, we integrated Citibank Chile’s technological platforms with ours and established a new organizational structure in order to satisfy the needs of our customers and to achieve important synergies.  We concluded the merger process with the integration of Corporación Financiera Atlas S.A. (Citibank Chile’s consumer area) into our consumer finance area (CrediChile), which allowed us to nearly double our customer base and market share in consumer finance.  As result of this merger and integration process, we entered into the following agreements with Citigroup Inc. to provide a framework for our relationship with Citigroup Inc., its services and trademarks in Chile: (i) the Global Connectivity Agreement, (ii) the Cooperation Agreement, (iii) the Trademark License Agreement and, (iv) the Master Services Agreement.  On October 22, 2015, we entered into a new Global Connectivity Agreement, a new Cooperation Agreement and a new Trademark License Agreement with Citigroup Inc.  All of these new agreements replaced the original agreements we entered into on December 27, 2008.  In addition, on January 26, 2017, we entered into a new Master Services Agreement with Citigroup Inc. On August 24, 2017, we agreed to extend the Cooperation Agreement dated October 22, 2015 for a period of two years beginning on January 1, 2018, pursuant to which the parties may agree, to extend for another two-year term to commence on January 1, 2020. As a result of the extension of the Cooperation Agreement, the new Global Connectivity Agreement, Trademark License Agreement and Master Services Agreement were extended under the same terms as the Cooperation Agreement. For more information, see “Item 7. Major Shareholders and Related Party Transactions—Related Party Transactions.

 

Technological Projects

 

In 2016 we undertook diverse technological initiatives intended to adequately support our core business and improve our operating efficiency. Our main initiative to support to our core business was the implementation of a new internet-based platform for personal banking with a friendlier design and more efficient architecture that boosted online transactions, increased customer satisfaction and decreased web surfing time. Furthermore, we implemented the first stage of a new commercial platform, called “Business Center,” which includes a new system aimed at integrating the sale and post-sale process. Business Center will also become our CRM system in the future. We also put into practice a modern platform for our leasing business. In addition, we continued to enhance the capabilities of our Treasury by upgrading the Murex system, completing a new phase of the platform that allows us to clear derivatives with other Chilean banks while setting up diverse IT solutions to clear derivatives contracts with European counterparties (EMIR). We also continued to reinforce our mobile offerings by improving the mass-market appeal of MiPass, originally introduced in 2015. In addition, we implemented online notifications of payments, money transfers and credit card charges, which are received by customers on their smartphones at the moment of transaction. In regard to efficiency, during 2016 we completed several projects intended to digitalize documents, reports and forms in order to avoid printing and implemented a new image-based model for controlling operations carried out by tellers and representative officers. Similarly, we automated diverse form filling procedures for operations related to personal banking and SMEs and set up platforms and procedures for pre-approval operations. Finally, we continued to develop the last stages of our ATM replacement schedule by renewing 96% of our total network, in accordance with the requirements imposed by the Chilean regulator.

 

During 2017 we continued to develop the “Business Center” project, which is our new Sales & Customer Relationship Management tool. This system is expected to support significant improvements in the quality and responsiveness of our back-office and front-office operating processes to enhance our customer centric vision. In response to a 360-degree survey of our customer base, we launched, developed and completed various modules of our CRM platform which positioned us for the successful implementation of a new pricing model that enabled us to provide tailored lending solutions to our diversified customer base. We also upgraded the “Time Deposits and Savings” module, which permits account officers to tailor offerings to personal banking customers. Moreover, we completed the renewal of our ATM network to meet the new security and quality standards required by the SBIF. Additionally, we launched two new platforms for companies. We renewed the website business platform for these customers by adding new functionalities, security standards and the ability to conduct paperless transactions. We implemented a new electronic platform for factoring, which is aimed at improving the interaction with customers by making transactions easier while also upgrading the middle and back-office systems for this business. In personal banking, we maintained our focus on innovation and digital banking by adding new functionalities to existing mobile applications including the authorization of web transactions through MiPass application, access to MiBanco by means of fingerprint scanner, e-commerce payments through MiPago and an On/Off functionality for credit cards in MiBanco.

 

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During 2018, we continued to enhance our diverse IT infrastructure and digital platforms in order to assure stability and efficiency to our processes, attract new potential clients while continuously improving the service provided to our current customers. To this extent, we focused on continued developing new stages of our new CRM system and sales platform by introducing a new pricing tool for individuals (Pricing 360°) that allow our account officers to easily use and access to our customers’ information. The CRM system is a key project for us and we expect to keep on developing new functionalities over the next years. Moreover, we intensified our efforts to expand and improve our remote channels given the massive use of internet and fast adoption of smart phones. In that direction, we added new functionalities to some of our applications, and expanded our RedGiro service to the mobile banking, only available on our website until 2017.

 

In May 2018 we suffered a cyber-attack involving the theft of funds that subsequently resulted in an operational write-off of approximately Ch$6,900 million or U.S.$ 9.9 million (mostly recovered from the redemption of an insurance policy). Even though this incident temporarily affected certain services provided to our customers, we were able to maintain the continuity of our operations. In addition, as of this date, based on our internal analysis we have found no evidence whatsoever that our customers were affected by this incident in terms of misappropriation of funds. See “Item 3. Key Information—Risk Factors—Risks Relating to our Operations and the Chilean Banking Industry—Cybersecurity events could negatively affect our reputation or results of operations and may result in litigation.” This cybersecurity incident, although successfully overcome, posed new challenges for us in terms of cybersecurity infrastructure, controls and procedures. Thus, as part of the efforts to improve our cybersecurity risk management, we created the Cybersecurity Division in June 2018, which replaced our former Technological Security Area. The new division is the first line of defense for us on these matters and is in charge of mitigating and managing cybersecurity threats. The division is composed of two areas, the Cybersecurity Engineering Area and the Cyberdefense Area, in addition to diverse units that are focused on managing projects aimed at improving our cybersecurity protocols and procedures. During 2018, the Cybersecurity Division undertook diverse IT projects in order to reinforce our infrastructure and cybersecurity capabilities, acquiring world-class protection software and firewalls while investing in specialized platforms to address this significant topic. During 2018, we invested approximately Ch$9,915 million in cybersecurity equipment and software and incurred approximately Ch$9,847 million in operating expenses related to cybersecurity matters. These disbursements almost doubled the total amount incurred in 2017.

 

Through these efforts we have maintained our commitment to anticipating changes and minimizing risks related to technological advances, including cybersecurity risks, as mentioned in “Item 3.  Key Information—Risk Factors—Risks Relating to our Operations and the Chilean Banking Industry” and “Item 3.  Key Information—Risk Factors—Risks Relating to our Operations and the Chilean Banking Industry—Cybersecurity events could negatively affect our reputation or results of operations and may result in litigation.”

 

The 1982-1983 Economic Crisis and the Central Bank Subordinated Debt

 

During the 1982-1983 economic crisis, the Chilean banking system experienced significant instability that required the Central Bank and the Chilean government to provide assistance to most Chilean private sector banks, including us.  During this period, we experienced significant financial difficulties.  In 1985 and 1986, we increased our capital and sold shares representing 88% of our capital to more than 30,000 new shareholders.  As a result, no single shareholder held a controlling stake in the Bank.  In 1987, the SBIF returned complete control and administration of the Bank to our shareholders and our board of directors by ending our provisional administration based on our successful capital increases as required by Law No. 18,401.

 

Subsequent to the crisis, like most major Chilean banks, we sold certain of our non-performing loans to the Central Bank at face value on terms that included a repurchase obligation.  The repurchase obligation was later exchanged for subordinated debt of each participating bank issued in favor of the Central Bank.  In 1989, pursuant to Law No. 18,818, banks were permitted to repurchase the portfolio of non-performing loans for a price equal to the economic value of such loans, provided that the banks assume a subordinated obligation equal to the difference between the face and economic value of such loans.  In November 1989, we repurchased our portfolio of non-performing loans from the Central Bank and assumed the Central Bank’s subordinated debt related to our non-performing loans.

 

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The original repayment terms of our Central Bank subordinated debt, which at December 31, 1989 equaled approximately Ch$1,716,705 million or U.S.$2,475 million, in real terms, as of December 31, 2018, required that a certain percentage of our income before provisions for the subordinated debt be applied to repay this obligation.  The Central Bank subordinated debt did not have a fixed maturity, and payments were made only to the extent that we earned income before provisions for the subordinated debt.  In 1993 we applied 72.9% of our income before provisions to repay the Central Bank subordinated debt.  In 1994 we applied 67.6%, and in 1995 we applied 65.8% of our income before provisions to repay the Central Bank subordinated debt.

 

In November 1996, pursuant to Law No. 19,396, our shareholders approved a reorganization by which we were converted into a holding company named SM-Chile.  In turn, SM-Chile organized a new wholly-owned banking subsidiary named Banco de Chile, to which the former contributed all of its assets and liabilities, other than the Central Bank subordinated debt, to the latter.  In addition, SM-Chile created SAOS, a second wholly-owned subsidiary that, pursuant to a prior agreement with the Central Bank, assumed a new repayment obligation in favor of the Central Bank that replaced the Central Bank subordinated debt in its entirety.

 

This Central Bank debt, for which SAOS is solely responsible and for which there is no recourse to us or SM-Chile, was equal to the unpaid principal of the Central Bank subordinated debt that it replaced but had terms that differed in some aspects, such as the rescheduling of the debt for a term of 40 years providing for equal annual installments and a pledge of our shares as collateral for such debt.  The Central Bank debt bears interest at a rate of 5.0% per year and is UF-denominated.

 

In exchange for assuming the Central Bank debt, SAOS received from SM-Chile 63.6% of our shares as collateral.  Although shares held by SAOS as collateral have economic rights that belong to the Central Bank, their voting rights are exercised by SM-Chile’s shareholders.

 

Pursuant to SM-Chile’s bylaws, that company will exist until the Central Bank subordinated debt has been completely paid off by SAOS. Once SM-Chile is liquidated, shares of Banco de Chile owned by SM-Chile and held by SAOS, and the proceeds obtained from the liquidation of any other assets owned by SAOS, shall be distributed among SM-Chile’s shareholders as described in “Item 7. Major Shareholders and Related Party Transactions—Ownership Structure.” At that time, the former SM-Chile shareholders will become direct shareholders of Banco de Chile. As noted below, while we cannot offer any assurances, that fact pattern is expected to occur in 2019.

 

As a result of our merger with Banco de A. Edwards, the percentage of our shares held by SAOS decreased to 42.0%.  Subsequently, as of December 31, 2018 the percentage of our shares held by SAOS declined to 28.3%, as a result of:  (i) capital increases agreed to at the Extraordinary Shareholders’ Meetings held in May 2007, January 2011 and October 2012, (ii) stock dividends paid in May 2006, May 2007, June 2009, April 2011, June 2012, May 2013, July 2014, July 2015, June 2016, July 2017 and July 2018 and (iii) our merger with Citibank Chile in January 2008.

 

Dividends received from us are the sole source of SAOS’s revenues, to be applied by legal mandate to repay its debt to the Central Bank.  SAOS does not have any other material debt, as it is a special purpose legal entity created by Law No. 19,396 whose only business is to own Banco de Chile shares and repay the obligation to the Central Bank.  To the extent distributed dividends are not sufficient to pay the amount due on its debt, SAOS is permitted to maintain a cumulative deficit balance with the Central Bank that SAOS commits to pay with future dividends.  If the cumulative deficit balance exceeds an amount equal to 20% of our paid in capital and reserves, the Central Bank may require SAOS to sell a sufficient number of shares of our stock to pay the entire accumulated deficit amount.  As of March 31, 2019, SAOS maintained a surplus with the Central Bank of Ch$955,913 million, equivalent to 30.6% of our paid in capital and reserves as of the same date.

 

If from time to time in the future, our shareholders decide to retain and capitalize all or part of our annual net income in order to finance our future growth and distribute stock dividends instead of cash dividends, the Central Bank may require us to pay the portion of the net income corresponding to shares owned by SAOS in cash to SAOS.  If we distribute stock dividends and the Central Bank does not require us to pay that portion in cash, the shares received by SAOS in such dividend distribution must be sold by SAOS within the following 12 months.  The shareholders of SM-Chile will have a right of first refusal with respect to that sale.

 

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As of March 31, 2019, the outstanding subordinated debt balance held by SAOS was Ch$ 89,640.2 million (including accrued interest). SAOS paid to the Central Bank a total of Ch$140,614 million in 2016, Ch$142,003 million in 2017 and Ch$152,930 million in 2018, exceeding in each of those years the required minimum annual payment. SAOS will fully repay the Central Bank subordinated debt in April 30, 2019 based on the dividend it received from us from our net distributable earnings for the year ended December 31, 2018. As a consequence of such full payment, SM-Chile and SAOS will be liquidated and its shareholders, LQ Inversiones Financieras S.A. and Inversiones LQ SM Ltda, will increase their direct ownership in Banco de Chile, from current shareholdings of 27.18% and 0.29%, respectively, to 46.34% and 4.81% in each case. Similarly, other shareholders of SM-Chile will become our shareholders, which will significantly increase the public float of stock. For more information, see “Item 7. Major Shareholders and Related Party Transactions—Ownership Structure.”

 

As of December 31, 2018, the major shareholder of SM-Chile was LQ Inversiones, which owned, directly and indirectly, 58.24% of SM-Chile’s total shares. As of the same date, our major shareholders were SAOS, LQ Inversiones Financieras S.A. and SM-Chile, each having a direct participation of 28.31%, 27.18% and 12.02% in our total common stock, respectively. Following the liquidation of SM-Chile and the dissolution of SAOS, LQ Inversiones Financieras will be the major direct shareholder of Banco de Chile with a shareholding of 46.3%. See Item 7. Major Shareholders and Related Party Transactions—Ownership Structure and Item 7. Major Shareholders and Related Party Transactions— Major Shareholders.

 

Capital Expenditures

 

The following table sets forth our capital expenditures in each of the three years ended December 31, 2016, 2017 and 2018:

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

(in millions of Ch$)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

Computer equipment

 

Ch$

14,105

 

Ch$

8,898

 

Ch$

12,702

 

Furniture, machinery and installations

 

2,645

 

2,963

 

2,409

 

Real estate

 

10,174

 

10,606

 

12,589

 

Vehicles

 

895

 

757

 

365

 

Subtotal

 

27,819

 

23,224

 

28,065

 

Software

 

11,248

 

18,779

 

23,512

 

Total

 

Ch$

39,067

 

Ch$

42,003

 

Ch$

51,577

 

 

Our budget for capital expenditures for 2019 amounts to approximately Ch$72,421 million, of which expenditures in information technology investments represent 72%, while infrastructure projects represent the remaining 28%.  The budget for capital expenditures is in line with our mid-term strategic priorities of improving our efficiency and enhancing our customer service capabilities with a firm focus on digitalization. These capital expenditures will be principally financed by cash on hand and long-term debt financing.

 

Among the budgeted expenditures for information technology, 51% corresponds to new and ongoing IT projects undertaken by Banco de Chile, which are intended to provide us with business solutions for customers, technological stability and improvements in productivity. Of the remaining 49% budgeted for IT expenditures, 19% is expected to be deployed to further optimize our nationwide ATM network through a long-term joint venture with a local retailer, another 19% consists of investments in technological equipment and system improvements to be carried out by certain subsidiaries and the remaining 11% is intended to reinforce our cybersecurity infrastructure and systems.

 

Our 2019 budget for infrastructure expenditures includes disbursements associated with renovation and restoration of our corporate buildings (45%), renovation of some of our branches particularly as a result of a new customer service model we are deploying in some of our locations (34%), general maintenance investments (15%), security-related expenditures (5%) and other initiatives related to our social commitment (1%).

 

All of the aforementioned investments have been or will be made in Chile.

 

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BUSINESS OVERVIEW

 

Our Competitive Strengths

 

Building on our knowledge of the Chilean financial market, we have historically been able to develop significant competitive advantages based on our strong brand recognition, our widespread branch network, the diversity and relative size of our customer base, our highly competitive funding structure, the superior asset quality of our loan portfolio as compared to our peers in Chile, an attractive risk-return relationship and our market leadership in a diverse range of financial products and services.

 

Our main competitive strengths are:

 

Brand Recognition and Strong Corporate Image

 

We have operated in the Chilean financial industry for over 125 years under the “Banco de Chile” brand name.  In order to provide our customers with specialized value offerings and a wider range of financial products and services, we have also developed the “Banco Edwards-Citi”, “Banco CrediChile” and “Banchile” brand names.  We believe our long standing history in the Chilean market is recognized by our customers and the general public, who associate our brands with value, quality, reliability and social responsibility within the Chilean financial industry, as demonstrated in various polls conducted by well-known market research companies. We believe that our long history in the Chilean banking industry is a key element that differentiates us from our competitors.

 

Additionally, we believe that our merger with Citibank Chile reinforced our corporate image as a leading financial institution within Chile and allowed us to gain recognition among customers and investors all over the world.

 

We also believe that our strong corporate image is further strengthened by our commitment to social responsibility, which includes supporting the Teleton Foundation (a non-governmental organization dedicated to assisting and treating disabled Chilean children), our partnership with institutions dedicated to improving the quality of Chilean education, our participation in campaigns intended to improve the quality of life of needy people, our commitment to supporting and sponsoring diverse monetary and non-monetary campaigns for recovery efforts from natural disasters in Chile, including wildfires, earthquakes, floods and tsunamis, and the development of other initiatives intended to strengthen our role in, and contribution to, Chilean society.

 

Business Scale and Leading Market Position

 

We are one of the largest financial institutions in Chile and a market leader in a broad range of financial products and services within the Chilean financial system, as listed in the following table:

 

 

 

As of December 31, 2018

 

 

 

Market Share

 

Market Position

 

Net Income Attributable to Equity Holders

 

25.3

%

1st

 

Total Balances of Demand Deposits and Current Account (1)

 

22.2

%

1st

 

Current Accounts Balances held by Individuals

 

27.2

%

1st

 

Mutual Funds (Assets Under Management)

 

21.1

%

1st

 

Net Fees and Commissions Income

 

19.4

%

1st

 

Net Income of Securities Brokerage Subsidiary (2)

 

31.4

%

1st

 

 


Source:  SBIF, Chilean Association of Mutual Funds and the Financial Market Commission (“CMF”).

(1)         Excluding operations of subsidiaries abroad and net of clearings.

(2)         Including the whole market and not only subsidiaries of local banks.

 

We have traditionally had a strong presence in the wholesale segment by maintaining long-term relationships with major local and multinational companies that operate in Chile.  We have been able to maintain this leading position by continuously improving our products and services and supplementing them with comprehensive and tailored service models that allow us to successfully serve our customers’ needs.  We have also added value to our service offerings by including treasury products for hedging purposes, together with investment banking, insurance brokerage and other specialized financial services provided by our subsidiaries.

 

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In addition, in recent years we have focused on further penetrating the retail banking market through diverse value offerings intended to cover our target demographics and enterprises. Therefore, in recent years we have prioritized the expansion of our residential mortgage portfolio and our presence in transactional services such as credit cards, current accounts and demand accounts, as we believe they are effective means to build long-term relationships and customer loyalty, while increasing cross-selling opportunities. For this reason, through our Individual and SME Banking Area, we aim to lead the market in services offered to high income individuals for whom we have developed an attractive and complete portfolio of financial services, including a full range of wealth management services through one of our subsidiaries.  Also, our Consumer Finance Area (Banco CrediChile) is one of the largest banking providers of consumer loans among the Chilean banks’ consumer areas, based on comprehensive service offerings for low income individuals.  This has been recently supplemented by the implementation of value offerings satisfying small scale entrepreneurs’ financial needs and individual customers in outlying districts seeking deposit and transactional solutions.  This broad variety of services has also enabled us to lead the Chilean market in terms of income from fees and commissions.

 

We believe our financial strength, prestige and brand recognition among Chilean customers have allowed us to become the market leader in terms of current account balances within the Chilean financial system, especially among individuals, who have demonstrated their preference for our services.  Our position was further consolidated in the financial downturn that started in 2008, when we benefited from a “flight-to-quality” effect as investors were seeking a reliable institution to keep their funds.

 

Broad and Diversified Customer Base

 

We believe that we have one of the largest customer bases among financial institutions in Chile. In recent years, we have been able to expand our customer base by providing attractive and tailored value offerings based on continuously improving segmentation and by applying sophisticated business intelligence tools.  As of December 31, 2018, we had approximately 1,393,000 core clients, which had at least a current account or a loan outstanding with us. However, in regards to main banking products, we serve a broader customer base composed of 1,215,000 borrowers, approximately 915,000 current accounts holders, approximately 140,000 time deposit holders, approximately 125,000 saving account holders and approximately 1,100,000 credit card account holders.

 

We believe that our broad customer base is both an essential driver of our business and a valuable asset that enables us to cross-sell our traditional lending products and services along with non-lending services provided primarily through our subsidiaries, including our securities brokerage, mutual funds management, securitization, financial advisory, insurance brokerage and collection services.

 

Multichannel Distribution Approach

 

In order to better serve our customers, we offer a distribution approach composed of both physical and non-physical channels.

 

We are present in all regions of Chile and strive to be accessible to every Chilean customer through our large branch network as well as non-physical contact channels.  As of December 31, 2018, we had a nationwide branch network of 390 branches, the largest in Chile among private sector banks, according to information published by the SBIF. This network is composed of 245 branches under our “Banco de Chile” brand name, 41 branches under our “Banco Edwards Citi” brand name and 104 branches under our “Banco CrediChile” brand name. We believe that our branch network enables us to develop close relationships with our customers and therefore we are constantly assessing new branch locations throughout Chile.

 

We have also complemented our branch network with non-physical remote channels, such as ATMs, internet-based online platforms and mobile banking applications. As of December 31, 2018, we had 1,485 ATMs throughout Chile and we provided our customers with specialized internet websites for each of the segments we target, coupled with diverse mobile banking applications, including MiBanco, MiBeneficio, MiCuenta, MiPago, MiPass, MiInversion and MiSeguro. During 2018, 70.0% of the total transactions carried out by customers and non-customers in our distribution channels were performed through non-physical remote channels.

 

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Competitive Funding Structure

 

We believe that we have a cost effective and highly competitive funding structure based on our leading market position in current accounts and demand deposits, especially among individuals. According to the SBIF, as of December 31, 2018, with a 27.2% market share, we ranked first within the Chilean banking industry in current account and demand deposits held by individuals. Similarly, as of that same date and excluding operations of subsidiaries abroad, we were the principal bank in Chile in terms of total balances of non-interest bearing current accounts and demand deposits representing 22.2% of the industry (net of clearing), as reported by the SBIF. Also, our total balances of current accounts and demand deposits represented 26.7% of our funding structure as of December 31, 2018 (under Chilean GAAP), as compared to the 19.8% reported by the Chilean financial industry as a whole, excluding Banco de Chile. In addition, we have a solid base of funding from retail customers, who held demand deposits and time deposits that jointly represented 41% of our total funding as of December 31, 2018. This characteristic provides us with a stable source of funding that is reflected by a 30-day moving average renewal rate of retail time deposits which reached around 70% as of December 31, 2018.

 

We are constantly striving to diversify our liability structure in terms of sources, types of instruments and markets with the aim of maintaining a competitive cost of funding and improving our liquidity. Thus, given the tempered growth recorded by our total loan book in 2018, we were more cautious and less active than previous years in terms of long-term debt placements, particularly in overseas markets due to the steady increase in foreign interest rates. Instead, we continued to strengthen our liability structure by taking advantage of specific windows of opportunity abroad while prioritizing issuances in the local debt market, against a low interest rate environment given the expansionary policy set by the Chilean Central Bank. As a result, in 2018 we carried out the following debt placements:

 

·             Approximately U.S.$1,580 million (mostly denominated in UF) within the local market. These debt placements had maturities ranging from four to 12 years (eight years on average) while bearing premium spreads over the relevant benchmark (Central Bank UF-denominated bonds or BCU rates).

 

·             A 10-year fixed rate U.S. dollar-denominated unsecured bond in Japan for approximately U.S.$50 million  and

 

·             A 5-year fixed rate CHF-denominated unsecured bond in Switzerland for approximately U.S.$115 million.

 

The debt placements carried out in foreign markets above were accompanied by cross currency swap hedge arrangements in order to neutralize any effects associated with changes in foreign exchange that could impact our cost of funding.

 

In addition, we continued to utilize short-term funding associated with our commercial paper program, which provides us with premium funding for Trade Finance transactions, and during 2018, we issued a total amount of approximately U.S.$1,450 million. As of December 31, 2018 we had an outstanding balance of approximately U.S.$367.1 million.

 

In summary, our funding structure provides us with a cost advantage over many of our competitors (which use a higher proportion of interest bearing liabilities), as current accounts and demand deposits are non-interest bearing in Chile.  Our solid market position in demand deposits, together with our high international credit ratings, translated into one of the lowest costs of funding from liabilities associated with interest bearing deposits and long-term debt, among the five largest banks in Chile.

 

Superior Asset Quality

 

We are one of the Chilean financial institutions with the highest credit quality and the healthiest loan portfolio in Chile. We believe this asset quality is the result of our well known prudent risk management approach and accurate credit risk models that are continuously being updated and have enabled us to maintain relatively low levels of past due loans (loans 90 days or more past due) and high coverage indicators over the last few years. According to the SBIF, and under our internal reporting policies, as of December 31, 2018, we had a delinquency ratio (loans 90 days or more past due as a percentage of total loans) of 1.1% which was well below the industry average delinquency ratio of 2.1% posted by the Chilean banking industry (excluding Banco de Chile) as of the same date. Additionally, according to data published by the SBIF, as of December 31, 2018, we had a coverage ratio (allowances for loan losses over loans 90 days or more past due) of 198.7%, which was well above the industry average coverage ratio of 121.4% as of the same date (excluding Banco de Chile).

 

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Over the last years, the utilization of business intelligence tools has also contributed to an improvement in our credit risk management. In this regard, during 2018 we successfully re-launched our pre-approved loan program through which we target a select group of retail customers to help them meet their borrowing needs depending on their life cycle stage and credit profile.

 

International Coverage

 

In 2008 we enhanced our value offerings by entering into a strategic partnership with Citigroup Inc., as a result of our merger with Citibank Chile, effective on January 1, 2008.  As result of the merger and integration process, we entered into various agreements with Citigroup Inc. to establish a framework for our relationship with Citigroup Inc., including the services to be rendered by each party and the use of trademarks in Chile. For more information, see “Item 7. Major Shareholders and Related Party Transactions—Related Party Transactions.

 

This strategic alliance, backed by a Global Connectivity Agreement with Citigroup Inc., has allowed us to broaden our service offerings by adding a comprehensive portfolio of international financial services that previously we could only partially provide. Based on this relationship, we are able to provide our local customers with world-class financial services and participate with them in their international ventures. Furthermore, we provide a reliable business platform for Citibank’s customers who aim to operate in Chile.

 

Our Business Strategy

 

Mission

 

‘We are a leading and globally-connected corporation with a prestigious business tradition.  We provide excellent financial services to all of our customer segments by offering creative and effective solutions while at the same time ensuring that we add value for our shareholders, employees and community as a whole.’

 

To accomplish this mission, we believe it is essential to attain industry leadership in all businesses and financial areas in which we operate, namely, profitability, efficiency, business scale, customer base, human resources development and corporate social responsibility.

 

Vision

 

‘We aspire to be, in all things we do, the best bank for our customers, the best place to work and the best investment for our shareholders.  In order to accomplish this vision, we are committed to the development of our employees and the community as a whole.’

 

Our mission and vision commits us to all of the diverse stakeholders related to our business, including customers, employees, investors and the community.  Thus, our vision is shared and internalized by all areas across the corporation, senior management and the board of directors while also constituting the basis for our strategic objectives. This vision requires initiatives to achieve comprehensive excellence in management, with customer satisfaction as our major goal.  For this reason, we apply high industry standards in information technology, business models and service quality, all of which are summarized by the value creation cycle below:

 

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Corporate Values

 

Our way of thinking is reflected by a set of values that are shared by our employees and shareholders, which are aimed at providing our customers with world-class financial solutions and quality standards.

 

·             Integrity

 

·             Commitment

 

·             Respect

 

·             Loyalty

 

·             Prudence

 

·             Responsibility

 

·             Justice

 

Purpose

 

‘We are a company that contributes to the economic development of the country by generating favorable conditions for the development of individuals and enterprises, providing them with financial solutions that fit their needs at every stage of their lifetime.’

 

In order to accomplish this, we have made commitments to all of our stakeholders, since we are convinced that we will achieve excellence in all of our businesses and projects as long as we are able to satisfy stakeholders in their interactions with us.

 

Commitments

 

We aim to satisfy the expectations of the following stakeholders by:

 

·                 Our Customers

 

·                  Offering innovative and top-quality banking products and financial services.

 

·                  Providing customers with excellent service based on customized relationships and a proactive attitude.

 

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·                  Ensuring the availability and stability of physical and non-physical service channels.

 

·                  Maintaining trusted relationships in order to be our customers’ main bank.

 

·                 Our Employees

 

·                  Providing employees with career opportunities based on merit.

 

·                  Promoting a respectful and friendly work environment.

 

·                  Offering competitive compensation and economic benefits.

 

·                  Supplying adequate technological tools and infrastructure.

 

·                 Our Community

 

·                  Improving quality of life and managing adversity.

 

·                  Strengthening the quality of education in Chile.

 

·                  Promoting entrepreneurship.

 

·                  Protecting the environment.

 

·                  Building strong relationships with suppliers.

 

·                 Our Shareholders

 

·                  Leading the industry in net income generation and profitability.

 

·                  Maintaining a strong market position in terms of business volume.

 

·                  Fostering operating efficiency and productivity.

 

·                  Developing a prudent approach to risk management.

 

Strategic Priorities

 

Our long-term strategy is intended to maintain profitable growth by placing the customer at the center of all of our decisions and continuously improving efficiency and productivity in all of our processes and procedures while maintaining a strong commitment to the country. These are our strategic priorities and we aspire to attain them through collaboration and teamwork.

 

 

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·                 Customer Centric Decision Making

 

We aim to support our customers and meet their needs throughout their lives. In order to achieve this goal we strive to promote customer proximity and reliability, while providing our customers with the best service quality within the local market.

 

In our retail banking segment, our aim is to lead the market by providing differentiated and comprehensive value offerings based on a deep and continuously improving segmentation that permits us to engage in profitable and high-growth potential business opportunities.  Thus, we expect to expand our business and customer base by developing tailored service models, optimizing our branch network, enhancing our presence in the small and medium-size company market and reinforcing certain lending products that should enable us to consolidate long-term relationships with the upper and middle-income individual customers, particularly through payment channel usage (such as credit cards), digital banking, installment loans and residential mortgage loans. Similarly, we aspire to target lower-income individuals and microbusinesses by promoting payroll-deduction lending and attracting customers previously unattached to any bank through a basic array of services.

 

We firmly believe that there is room to grow in retail banking. Although Chile’s per capita GDP has increased fourfold over the last 30 years, banking penetration is still below that in developed countries, particularly in relation to residential mortgage and consumer loans. In fact, as of December 31, 2018, the loan book of the Chilean banking industry (excluding operations of subsidiaries abroad) represented 86% of Chilean GDP. As of the same date, mortgage and consumer loans represented 25% and 13%, respectively. On the other hand, according to the SBIF, as of December 31, 2018, we had market shares of 16.8% and 17.9% in residential mortgage loans and consumer loans, respectively, both behind the market leader by 4.4% and 1.8% in each case. Given the fierce competition in the Chilean banking industry, in order to take advantage of these opportunities, we are continuously developing innovative products and services to diversify our revenue sources. Accordingly, we have strived to build comprehensive value offerings for our retail segment in order to continue enhancing our fee-based income by promoting digitalization of products and services provided to these customers while improving benefits related to our customer loyalty programs.

 

Similarly, in our wholesale banking segment (which targets companies with annual sales over Ch$1,600 million), we aim to maintain a market-leading position in loans while growing profitably in a market that is characterized by low margins and fierce competition. We intend to accomplish these goals by increasing our cross-selling of non-lending products and services. For this reason, we are focused on improving our cash management services, enhancing our internet-based services, increasing the penetration of products designed by our treasury and money market operations segment, strengthening our presence in certain lending products such as leasing and factoring and promoting international businesses by taking advantage of the Global Connectivity Agreement we maintain with Citigroup and the specialized array of financial services offered by our subsidiaries, such as securities brokerage, mutual funds management and financial advisory in order to meet the needs of certain niches within this business segment. The success of our wholesale banking segment is critical to our ability to maintain sustainable growth in revenues, particularly in fee-based income. Thus, cross-selling is one of our main priorities in this segment.

 

In our treasury and money market operations segment, we intend to take advantage of our specialized knowledge in order to increase the penetration of widely-used products in our current customer base while offering innovative products to potential clients. Also, we continuously seek newer and more convenient funding choices, locally and internationally, in order to support our long term business strategy by promoting an adequate diversification of our funding structure.

 

·                  Main Achievements in 2018

 

(1)         Record Sales of Retail Loans and Current Accounts

 

In 2018, we achieved record sales in many lending and saving products, particularly in the retail banking segment, based on our commitment to customer service, excellent brand recognition and solid reputation. We achieved the highest amount of sales of installments loans in our history by granting Ch$2,102,664 million in new credits, representing an annual increase of 25.2%. In terms of mortgage loans, we granted new loans amounting to Ch$1,244,742 million in 2018, a 10.8% annual increase as compared to 2017. As for savings accounts, we added approximately 118,000 new current account holders, which is the highest amount ever achieved and represented 25.9% increase when compared to 2017.

 

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(2)         Mobile and Digital Banking: New Applications and Functionalities

 

In 2018, we continued to enhance our digital banking offering by introducing new functionalities to our existing set of mobile applications: MiBanco, MiCuenta, MiPago, MiPass, MiSeguro, MiInversion and MiBeneficio. In particular, our upgraded MiBanco application now allows our retail customers to easily reset their internet password. We also expanded the RedGiro service (an electronic money transfer that allows the recipient to withdraw money from our ATM network), formerly available on our website only, to permit our clients to perform transactions through their smartphones. In addition, during 2018 we added new functionalities to MiInversion, launched in 2017, through which our customers are able to invest in time deposits while performing foreign currency exchanges.

 

Once again, we received diverse recognitions of our digital banking strategy including Best Digital and Mobile Bank in Chile by Global Banking & Finance Review and Innovative Digital Bank of the year in Chile by The European Magazine. Additionally, we continued to enhance our Innovation and Digital Banking Area, which was created at the end on 2017 and aims to further enhance our mobile offerings with a customer centric approach. During 2018, our customers conducted 35.1 million monetary transactions using our mobile banking applications, representing a 60.8% annual increase when compared to 2017.

 

(3)         Loyalty Program Enhancements

 

Transactional services, especially credit cards, constitute a crucial part of our value offering particularly for individual customers. We strongly believe that transactional services are an effective means to improve cross-selling and further penetrate current customers, two key elements to growing profitably in a highly competitive industry. During 2018, we focused on improving benefits to our 1,1 million credit card account holders by widening strategic partnerships and adding more alliances with local stores and several other products and service providers.

 

In 2018, we continued strengthening our loyalty program by entering into new partnerships in order to widen the array of benefits to our customers, including discounts and other benefits for music shows and festivals in Chile for the next three years.

 

Furthermore, we continually strive to improve benefits for our credit card account holders and other customers by widening strategic partnership and alliances with airlines or local stores in order to offer several product and service discounts related to airline tickets or miles, among other benefits. In 2018, 119,912 customers made use of their benefits by exchanging their Dolares-Premio (a credit card points system) for airline tickets, discounts or other benefits.

 

(4)         Improvements in Service Quality

 

We are convinced that in a highly competitive industry such as the Chilean banking system, a customer-centric focus is critical to generating loyalty and creating long-term profitable relationships. We believe that our high service quality is a competitive strength that differentiates us from competitors and supports our long term strategy by responding to the preferences of our current and potential customers.  Accordingly, we strive to continuously improve our relationships with customers by developing commercial strategies and value offerings aligned with their needs, as well as improving our response time and customer satisfaction indicators. Consistent with this view, during 2018 we continued to improve customer satisfaction by enhancing our commitment to service quality, improving existing and developing new online channels, such as our internet-based platforms and mobile applications, while promoting organizational changes intended to provide our customers with a more comprehensive approach.

 

These actions, coupled with an organizational culture oriented to customer satisfaction, allowed us to rank first in brand recognition, recommendations among customers in the banking industry and service quality among our main banking peers in 2018, by posting an average net promoter score of 71.2% according to a syndicated study performed by an independent provider at the request of the largest Chilean banks. Consistent with our net promoter score, our customer attrition rate was 6.2% in 2018. We believe our low attrition rate and superior customer service were reflected in the diverse distinctions we received during 2018, including the “National Customer Satisfaction Award” provided by ProCalidad and the Consumer Loyalty Award granted by ALCO (an independent customer experience management consulting company).

 

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·                 Operating Efficiency and Productivity

 

We believe that efficiency and productivity are key competitive strengths that we have to maintain in order to sustain profitable growth. Accordingly, we aim to become a productive and efficiency-oriented organization in all business aspects by developing simple, effective, secure and low-cost processes while maintaining the tightest cost control in the industry.  We believe these elements will be increasingly important in our efforts to maintain high profitability ratios in a changing business environment that is under increasing regulatory focus. To accomplish these goals, we have invested in information technology and the development of simpler, more manageable, secure and modern business processes and platforms to attain faster response times and higher productivity.  We also continue to enhance our strategic development capabilities, increase our business scale, develop economies of scope by incorporating new financially related products and services, optimize our branch network, enhance our remote transactional channels, improve our credit processes, develop a higher level of automation in our internal processes and consolidate our cost control policy and monitoring procedures.

 

We are continuously developing and optimizing internal processes in order to reduce and manage our expenses. During 2018 we continued to enhance our IT infrastructure in order to increase stability and efficiency for all of our customers. Over the last three years we invested a total of approximately Ch$89,244 million in information technology, mainly related to the acquisition of software and hardware, as well as internal developments to enhance current platforms or building new systems. Particularly, in 2018, we disbursed important financial resources in order to reinforce our IT infrastructure in respect of cybersecurity matters, which included the purchase of systems and equipment. We firmly believe that investment in IT is one of the best ways to improve our operating efficiency and enhance cybersecurity standards while properly meeting customers’ needs, which are increasingly linked to digital channels. For more information see “Item 4. Information on the Company—Capital Expenditures.”

 

In terms of cost control, during 2018 our cost base posted a 7.3% annual increase when compared to 2017, mainly as a result of non-recurring effects such as collective bargaining agreements achieved with our unions, internal projects related to risk modeling, enhancement of our cybersecurity architecture and standards, among others. When isolating those effects, our cost base is aligned with our strict cost control policy that has been deployed across our corporate structure. With respect to operating efficiency, our cost-to-income ratio improved from 46.5% in 2017 to 45.4% in 2018. For more information, see “Item 5. Operating and Financial Review and Prospects—Results of Operations for the Years Ended December 31, 2016, 2017 and 2018—Operating Expenses.”

 

·                  Main Achievements in 2018

 

(1)         Business & Risk Intelligence

 

Over the last years we have focused on developing diverse business intelligence tools in order to better serve current customers while attracting new potential clients. During 2018, we continued to develop this strategic pillar by deploying new and enhancing existing analytic tools, which have permitted us to optimize and make our commercial processes and campaigns more efficient while providing our customers with tailored and timely value service and product offerings.

 

Throughout 2018, we continued to develop our new CRM system and sales platform, which includes Pricing 360°, a pricing tool that enables us to personalize and accelerate the credit approval process for individuals by using digital tools that optimize our use of and access to client information. This new system is intended to be our main analytical platform in the future for sales and postsales management and, accordingly, we are increasingly introducing new functionalities designed to meet our needs.

 

Additionally, we have significantly increased our productivity in certain commercial processes. For example, in 2018 we increased the amount of monthly current accounts sales by employee, from 3.5% in 2017 to 3.9% in 2018, an annual increase of 11%.

 

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In 2018, we also successfully re-launched our pre-approved consumer loan program pursuant to which we target a selected group of retail customers in order to meet their borrowing needs based on their risk profile, financial condition and spending patterns. During 2018, 37.6% of our total sale of consumer loans (including the upper, medium and lower income segment) was associated with pre-approved loans. We expect to spread this model to other lending products and clusters of customers as we believe it can continue to have a positive impact on productivity.

 

(2)    Branch Network Optimization

 

We firmly believe that remote channels are the future of banking, particularly amid new regulatory requirements, intensified competition, the entry of new banking players and higher reputational exposure, all of which translates into higher costs. Similarly, customers are increasingly demanding new and innovative distribution channels and visiting branches less, given lack of time, but mostly due to the massive use of internet and the fast adoption of smartphones. These trends led us to revise our entire branch network in terms of location, layout and services offered through these channels. Therefore, during 2018 we continued developing the concept of “dual branches” intended to serve both CrediChile’s and Banco de Chile’s customers, targeting certain locations. As a result, and based on financial and strategic analyses, we reduced our branch network from 399 locations in 2017 to 390 locations in 2018. Most of this decrease was related to the closure of eight Banco de Chile branches and one CrediChile branch. We expect to continue revising and optimizing our nationwide branch network during 2019 and 2020.

 

(3)    Enhancement of Cybersecurity Capabilities

 

In 2018, approximately 70% of our customers’ transactions were carried out through our digital platforms (including smartphones and website). This imposes new challenges related to cybersecurity. As part of the efforts to improve our cybersecurity risk management, we created the Cybersecurity Division in June 2018, which replaces our former Technological Security Area. The new division is the first line of defense and is in charge of mitigating and managing cybersecurity threats. The new division’s mission is to build the new Banco de Chile Cybersecurity Center, which is expected to enable the division to undertake actions and develop projects that were formerly outsourced. The division is composed of two areas, the Cybersecurity Engineering Area and the Cyberdefense Area, in addition to diverse units that are focused on managing projects aimed at improving our cybersecurity protocols and procedures.

 

During 2018, the Cybersecurity Division took various actions in order to promote a cybersecurity culture across the company while spreading the knowledge and developing competences that all of our employees should have in respect of cybersecurity.

 

·                 Commitment to Chile

 

Banco de Chile is devoted to the progress of its customers by means of providing them with a wide array of services while supporting their funding needs. As an extension of this view, Banco de Chile is committed to the development of Chile and its individuals and companies by providing innovative tools that contribute to improve their quality of life. In this regard, we firmly believe that modern companies need to create effective mechanisms to build positive connections with all of their stakeholders and the society in which they carry out their business activities. This has become increasingly important in the midst of societal changes in Chile and worldwide.

 

This view is shared by the Bank and its employees, who support the development of Chile through diverse methods such as promoting social progress, contributing to environmental protection, decreasing extreme poverty, providing high-quality education to needy people, assisting disabled young people, fostering cultural development and embracing campaigns intended to overcome the effects of specific adverse events such as natural disasters.

 

·                  Main Achievements in 2018

 

(1)         Entrepreneurship Support and Financial Literacy

 

During 2018, we continued to support diverse social endeavors by collaborating with “Desafío Levantemos Chile”, which is a non-profit organization that aims to promote entrepreneurship throughout Chile and especially within lower income segments. Based on this partnership, we assist people and microbusiness affected by natural disasters occurred in Chile by donating both monetary and non-monetary resources to help re-establish entrepreneurs’ and families’ working capacity.

 

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Furthermore, during 2018 we held the third “Entrepreneur Challenge Contest”, which was a joint venture between Banco de Chile and “Desafío Levantemos Chile”. This nationwide contest aims to promote those initiatives that incorporate social factors as drivers of entrepreneurship rather than only maximizing earnings. Accordingly, we convened microentrepreneurs who incorporate a social and sustainable vision as part of their business activities through creativity and innovation. In 2018, more than 30,000 entrepreneurs participated in the contest, of which the five most innovative business concepts were rewarded.

 

Also, with the aim of improving the quality of life of people and supporting microentrepreneurs in their ventures, we held several workshops across the country, together with the Financial Literacy Program promoted by the SBIF, gathering over 10,000 participants during 2018. The main objective of this program is to motivate people to change their consumption behavior, when necessary. Thus, we provide them with specific information and knowledge intended to improve their economic situation by promoting savings and avoiding over-borrowing.

 

Finally, during 2018, through CrediChile, we held diverse on-site workshops attended by approximately 1,170 people throughout the country. We supplemented these activities with e-learning programs to train approximately 10,196 individuals and entrepreneurs.

 

(2)         Disability Inclusion

 

Our commitment to disabled people is permanent. During 2018 we worked once again alongside Teleton for its annual fund-raising campaign by putting our nationwide distribution network including branches, ATMs, internet-based platforms and mobile applications for smartphones, in addition to other technological resources at Teleton’s disposal. At the same time, we also made an important monetary donation. We have been supporting the Teleton Foundation since its establishment 40 years ago, supporting disabled athletes and artists.

 

During 2018 we continued to promote our Inclusion Policy across the corporation. This policy is intended to improve our knowledge of physical disability and develop higher sensitivity concerning the treatment of disabled people. We believe this is the first step to improve the service we render to customers who experience this reality while providing our disabled employees with supportive workplace conditions and benefits. We also improved accessibility of many branches for disabled customers and held the “Expo Inclusión 2018”, a recruitment fair through which we aim to strengthen our commitment to the disabled. As a result, since 2018 over 1% of our staff identify as disabled employees, which is above the minimum required by the Chilean law. In addition, we launched a new plan of special benefits for our current disabled collaborators while implementing inclusive recruitment processes.

 

(3)         Corporate Volunteer Program

 

We continued to promote the participation of our staff in assisting people and organizations during emergencies through our Corporate Volunteer Program. Together with Desafío Levantemos Chile, we provide assistance to people and non-governmental organizations in the event of an emergency or natural disaster in our country by arranging fundraising campaigns, donating both monetary and non-monetary resources to help re-establish entrepreneurs’ and families’ working capacity or establishing working plans to aid affected areas. Our volunteers received basic training in various first aid techniques, were instructed in rescue procedures, protection and guidance for citizens, mitigation of losses in the emergency and providing support in reconstruction activities.

 

Based on this partnership, in October 2018, and after 11 hard-working months, we inaugurated a new educational establishment located in Santa Olga, one of the communities most affected by wildfires in 2017. This achievement was coupled with the building of more than 240 houses in the same area.

 

Also, in association with Desafío Levantemos Chile we committed to building a new school in Callaqui, within the Bio Bio Region (Central Chile), since the former school was completely destroyed by a devastating fire in early 2018.

 

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Overall, during 2018 we carried out more than 150 activities of voluntary service related to diverse topics ranging from Teleton to environmental conservation, which were attended by more than 11,000 participants.

 

(4)         Other Initiatives

 

We continued to make charitable contributions to improve the quality of education across lower income segments through the Astoreca Foundation.

 

Also, we have reinforced our commitment to the wellness of our employees through the “BiciChile Program”, which provides our staff located in the city center with bicycle parking racks. As a result of this initiative, for the fourth year in a row we ranked first in the competition Cool Place to Bike, which aims to encourage the use of bikes while recognizing companies that promote this practice among their collaborators.

 

Bici Chile, in addition to other initiatives such as a paperless program for diverse documents, permitted us to motivate our staff in order to help reduce our carbon footprint.

 

·                  Teamwork

 

One of the main goals of any corporation is to align employees’ perspectives with the company’s culture. In Banco de Chile, every worker has a crucial role in allowing us to achieve our strategic goals. In exchange for that, we believe all of our staff receives fair compensation and have access to benefits and policies that enable them to expand their professional capabilities in a work environment is committed to remain free of accidents, professional illnesses, work harassment, mobbing and discrimination. This strategy allowed us to be one of the Best Places to Work in 2018 according to Forbes.

 

In order to consolidate profitable growth, achieve high standards of service quality, attain operating efficiency and maintain a commitment to the country over the long run, we must have a motivated and highly qualified workforce committed to our corporate values. Accordingly, we strive to develop a distinctive culture among our employees by promoting:  (i) a clear focus on the customer, (ii) confidence and responsibility, (iii) leadership and empowerment, (iv) collaboration and teamwork and (v) innovation and continuous improvement.

 

·   Main Achievements in 2018

 

(1)         Collective Bargaining Processes

 

During 2018 we successfully completed a collective bargaining negotiation with all of our unions by entering into medium-term agreements that provide a wide range of monetary and non-monetary benefits to our employees. As of December 2018, we and our subsidiaries had 9,876 unionized employees. For more information, see “Item 6. Directors, Senior Management and Employees—Employees.”

 

(2)         Collaboration

 

During 2018 we carried out an internal campaign to recognize those employees who significantly contribute to our collaboration efforts. As a result, more than 1,000 employees were rewarded and publicly congratulated by their colleagues.

 

(3)  Other initiatives

 

We also seek to remain one of the most respected employers in Chile. We continue to strengthen our connection to our employees in order to align corporate values and goals with their career development and personal goals. In this regard, we have continued to focus on developing leadership capabilities and overall technical skills through approximately 1,100 training activities that were attended by approximately 28,000 attendees. We believe these initiatives are aligned with our strategy and the professional development that our team aspires to achieve.

 

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Ownership Structure(1)

 

The following diagram shows our ownership structure as of April 18, 2019:

 

 


(1)         The ownership structure diagram reflects share ownership and not voting rights.  See “Item 7.  Major Shareholders and Related Party Transactions—Major Shareholders.”

 

SAOS will fully repay the Central Bank subordinated debt in April 2019. See “Item 4. Information on the Company—History and Development of the Bank—The 1982-1983 Economic Crisis and the Central Bank Subordinated Debt.” As a consequence of such full payment, SAOS and SM-Chile will be liquidated and SM-Chile’s  shareholders will become our direct shareholders, which will significantly increase our public float. Also, LQ Inversiones Financieras S.A. and Inversiones LQ SM Ltda. will increase their direct shareholdings in our ordinary shares from current direct participations of 27.18% and 0.29%, respectively, to 46.34% and 4.81% in each case. See Item 7. Major Shareholders and Related Party Transactions—Major Shareholders.

 

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Principal Business Activities

 

We are a full-service financial institution that provides, directly and indirectly through our subsidiaries and affiliates, a wide variety of lending and non-lending products and services to all segments of the Chilean financial market.  Accordingly, for management purposes we organize our operations in the following four business segments:

 

 

The information related to our business segments presented in this section has been prepared in accordance with our internal reporting policies.  See “Item 5.  Operating and Financial Review and Prospects—Operating Results—Results of Operations for the Years Ended December 31, 2016, 2017 and 2018—Business Segments” and “Item 5.  Operating and Financial Review and Prospects—Operating Results—Results of Operations for the Years Ended December 31, 2016, 2017 and 2018—Summary of Differences between Internal Reporting Policies and IFRS” for a description of the most significant differences between our internal reporting policies and IFRS.

 

The following table sets forth information on the composition of our loan portfolio and our consolidated income before income tax in accordance with our internal reporting policies for the year ended December 31, 2018, allocated among our principal business segments:

 

 

 

For the Year Ended December 31, 2018

 

 

 

Total Loans

 

 

 

Income before
Income Tax(1)

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

 

 

Retail market

 

17,251,289

 

61.8

%

324,947

 

Wholesale market

 

10,639,057

 

38.1

%

311,925

 

Treasury and money market operations

 

 

 

52,819

 

Operations through subsidiaries

 

23,976

 

0.1

%

61,713

 

Other (adjustments and eliminations)

 

 

 

 

Total

 

27,914,322

 

100.0

%

751,404

 

 


(1)         This net income breakdown is used for internal reporting and planning purposes and it is based on, among other things, our estimated funding cost and direct and indirect cost allocations.  This breakdown may differ in some extents from breakdowns of our operating income for financial reporting and regulatory purposes.  Separate information on the operations, assets and income of our financial services subsidiaries and affiliates is provided below under “—Operations through Subsidiaries.”

 

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The following table sets forth our consolidated operating revenues in accordance with our internal reporting policies, allocated among our principal business segments, for the years indicated:

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

(in millions of Ch$)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

 

 

Retail market

 

Ch$

1,137,333

 

Ch$

1,133,683

 

Ch$

1,197,745

 

Wholesale market

 

422,353

 

400,586

 

462,993

 

Treasury and money market operations

 

46,488

 

30,853

 

57,484

 

Operations through subsidiaries

 

140,969

 

158,535

 

170,050

 

Other (adjustments and eliminations)

 

(12,349

)

(14,387

)

(14,989

)

Total Operating Revenues

 

Ch$

1,734,794

 

Ch$

1,709,270

 

Ch$

1,873,283

 

 

The following table sets forth a geographic market breakdown of our operating revenues in accordance with our internal reporting policies, for the years indicated:

 

 

 

For the Year Ended December 31,

 

 

 

2016

 

2017

 

2018

 

 

 

(in millions of Ch$)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

 

 

Chile

 

Ch$

1,747,143

 

Ch$

1,723,657

 

Ch$

1,888,272

 

Banking operations

 

1,606,174

 

1,565,122

 

1,718,222

 

Operations through subsidiaries

 

140,969

 

158,535

 

170,050

 

Foreign operations

 

 

 

 

Operations through subsidiaries

 

 

 

 

Other (adjustments and eliminations)

 

(12,349

)

(14,387

)

(14,989

)

Total Operating Revenues

 

Ch$

1,734,794

 

Ch$

1,709,270

 

Ch$

1,873,283

 

 

Retail Banking Segment

 

Our retail banking segment serves the financial needs of individuals and small and medium sized companies through our branch network.  As of December 30, 2018, our retail banking segment managed 286 branches operating under our “Banco de Chile” and “Banco Edwards-Citi” brand names and 104 branches within the “Banco CrediChile” network.  As of December 31, 2018, loans granted by our retail banking segment amounted to Ch$17,251,289 million and represented 61.8% of our total loans as of the same date.

 

In terms of composition, as set forth in the following table, as of December 31, 2018 our retail segment’s loan portfolio was principally focused on residential mortgage loans, which represented 46.6% of the segment’s loan book.  The remaining loans were distributed between commercial loans (27.7%) and consumer (25.7%).

 

 

 

As of December 31, 2018

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

Commercial loans

 

Ch$

4,786,082

 

27.7

%

Residential mortgage loans

 

8,035,543

 

46.6

 

Consumer loans

 

4,429,664

 

25.7

 

Total

 

Ch$

17,251,289

 

100.0

%

 

We serve the retail market through two different and specialized areas:  (i) the Individual and SME Area and (ii) the Consumer Finance Area (or Banco CrediChile).

 

Individual and SME Area

 

The Individual and SME Area is responsible for offering financial services to individuals with monthly incomes over Ch$500,000 (or Ch$6.0 million per year) and to small and medium sized companies with annual sales of up to approximately Ch$1,600 million.  This area manages the portion of our branch network operating under the brand names “Banco de Chile” and “Banco Edwards Citi” and had 286 branches as of December 31, 2018.

 

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The strategy followed by the Individual and SME Area is mainly focused on sub segmentation, multi brand positioning, cross sell of lending and non-lending products and service quality based on customized service models for specific customer needs.  Also, loyalty programs have been increasingly incorporated into our commercial targets for each sub segment and they have enabled us to increase the use of our credit cards and our fee-based income.  In addition, the area’s operations count on the support of specialized call centers, mobile and internet banking services, along with a wide range of management tools that allow us to measure returns, the performance of cross sold products and the effectiveness of marketing campaigns.

 

During 2018, the Individual and SME Area continued to focus on targeted growth opportunities while developing new business solutions and benefits for its clients in order to improve our customers’ experience. We also improved existing applications by introducing new functionalities. For instance, we expanded our RedGiro service (an electronic money transfer that allows the recipient to withdraw money from our ATM network), formerly available on our website only, to permit our clients to perform transactions through their smartphones. Similarly, in 2018 we added new functionalities to our MiInversion application for smart phones, launched in 2017, through which our customers are able to invest in time deposits while exchanging foreign currency from their mobile device. In addition, our enhanced loyalty program added new alliances with entertainment service providers, allowing our customers to make use of discounts and receive other benefits over the next three years at various music shows and festivals. We believe that comprehensive value offerings are crucial to both improving customer experience and attracting new customers.

 

In 2018, the Individual and SME Area achieved significant sales goals in terms of lending and saving products. In this regard, throughout the year it increased its customer base by approximately 120,000 new current account holders and attained record sales of new installment and residential mortgage loans granted to its customers.

 

As of December 31, 2018, the Individual and SME Area served approximately 1,056,991 core customers (those holding a current account or a loan outstanding) of which 896,746 were individuals and 160,245 were small and medium sized Chilean companies. This customer base resulted jointly in total loans granted to 894,889 borrowers, which included 126,987 residential mortgage loans debtors, 114,291 commercial loan debtors, 452,978 utilized lines of credit and 367,324 installment loans. As of the same date, the Individual and SME Area held 913,970 current accounts, 114,561 savings accounts and 262,211 time deposits.

 

As of December 31, 2018, loans granted by the Individual and SME Area amounted to Ch$16,580,142 million, which represented 59.4% and 96.1% of our total loans and loans granted by our retail market segment, respectively, as a whole.  The following table sets forth a breakdown of the unit’s loan portfolio by lending product in accordance with our internal reporting policies, as of December 31, 2018:

 

 

 

As of December 31, 2018

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

Commercial loans

 

 

 

 

 

Commercial credits

 

Ch$

3,868,445

 

23.3

%

Leasing contracts

 

498,290

 

3.0

 

Other loans

 

381,293

 

2.3

 

Total Commercial Loans

 

4,748,028

 

28.6

 

Residential Mortgage Loans

 

7,982,358

 

48.1

 

Consumer Loans

 

 

 

 

 

Installment loans

 

2,447,904

 

14.8

 

Credit cards

 

1,089,632

 

6.6

 

Lines of credit and other loans

 

312,220

 

1.9

 

Total Consumer Loans

 

3,849,756

 

23.2

%

Total

 

Ch$

16,580,142

 

100.0

%

 

We offer a variety of financial services to individuals and small and medium-sized companies, directly through the Individual and SME Area or indirectly through our subsidiaries, such as current accounts, automatic bill payment, debit cards, credit cards, revolving credit lines, residential mortgage loans, consumer loans, commercial loans, mortgage loans for general purposes, leasing agreements, factoring services, mutual funds management and stock brokerage, trade finance, payments and collections, insurance brokerage (which includes life and casualty insurance), savings instruments and foreign currency services.

 

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Installment Loans

 

Our consumer installment loans are generally incurred, up to a customer’s approved credit limit, to afford purchases of goods and/or services, such as cars, travels, household furnishings and education, among others.  Consumer loans may be denominated in both pesos and UF, bear fixed or variable interest rates and are generally repayable in installments over a period of up to 36 months.

 

As of December 31, 2018, we had Ch$2,447,904 million in installment loans granted by our Individual and SME Area, which accounted for 55.3% of the retail market business segment’s consumer loans.  Most of these installment loans are denominated in Chilean pesos and are payable on a monthly basis.

 

Residential Mortgage Loans

 

As of December 31, 2018, we had outstanding residential mortgage loans of Ch$8,047,708 million (under internal reporting policies considering the Bank as a whole), which represented 28.8% of our total loan book as of the same date.  According to information published by the SBIF, as of December 31, 2018, we were Chile’s third largest private sector bank in terms of year-end mortgage loans balances, accounting for approximately 16.8% of mortgage loans granted by the Chilean banking industry, excluding operations of banks’ subsidiaries operating abroad.

 

Our residential mortgage loans are generally denominated in UF and have maturities ranging from five to 30 years.  As of December 31, 2018, the average residual maturity of our residential mortgage loan portfolio was 18.2 years.  Originally, we funded our residential mortgage loans through the issuance of mortgage finance bonds, which are recourse obligations only to us with payment terms that are matched to the residential loans.  Also, the mortgage finance bonds bear real market interest rates plus a fixed spread over the variable rate of the UF, which permits us to reduce our exposure to interest rate fluctuations and inflation.  Chilean banking regulations allow us to finance up to 100% of a residential mortgage loan with mortgage finance bonds, based on the purchase price of the property securing the loan or the appraised value of such property.  In addition, we generally require that the monthly payments on a residential mortgage loan not exceed 25% of the borrower’s household after tax monthly income, when the customer belongs to the low income population segment.  However, that limit may be adjusted for the middle and high income population segments.

 

Over the last decade, we have also promoted the expansion of Mutuos Hipotecarios, a mortgage lending product, which is not financed by mortgage finance bonds, but instead through our general funds. As of December 31, 2018, our residential mortgage loan portfolio was principally composed of Mutuos Hipotecarios, as customers have preferred them due to their flexibility and simplicity (for instance the interest rate is known in advance by the customer, which is not the case for mortgage finance bonds that are traded in the secondary market and, therefore, subject to discounts), as they are easier to prepay and permit financing of up to 100% of the purchase price (as stated by the applicable local regulation), although banks may limit such maximum financing portion based on internal credit policies and economic cycles, among others.

 

The following table sets forth the composition of our residential mortgage loan portfolio by product type:

 

 

 

As of December 31, 2018

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

Secured Residential Mortgage Loans(1)

 

 

 

 

 

Loans financed with Mortgage Bonds

 

Ch$

21,397

 

0.3

%

Mutuos Hipotecarios

 

8,026,311

 

99.7

 

Total Secured Residential Mortgage Loans

 

Ch$

8,047,708

 

100.0

%

 


(1)         Corresponds to the Bank’s total secured residential mortgage loans and not only those associated with the Individual and SME Area.

 

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As shown above, as of December 31, 2018 residential mortgage loans related to Mutuos Hipotecarios represented 99.7% of our total residential mortgage loan portfolio, while the remaining 0.3% corresponded to mortgage loans financed with Mortgage Bonds.  As of the same date, the Mutuos Hipotecarios portfolio had an average origination period of 5 years (the period from the date when the loans were granted to the specified date) and 6.1% of these loans had been granted by CrediChile.  Conversely, as of December 31, 2018, loans financed with Mortgage Bonds had an average origination period of 17 years (the period from the date when the loans were granted) and 4.8% of these loans had been granted by CrediChile.  In terms of credit risk, in 2018, loans related to Mutuos Hipotecarios, as well as those financed with Mortgage Bonds, had low gross (before recoveries) credit risk ratios of (0.05)% and 0.00 %, respectively. The difference between both ratios is explained by the previously mentioned factors, particularly by the average origination period, and also by the Bank’s stricter requirements to grant Mutuos Hipotecarios.  It is important to mention that the residential mortgage loan portfolio financed with Mortgage Bonds is annually decreasing in amount and as a proportion of the total residential mortgage loan portfolio because it is composed of old loans and the instrument is no longer used by customers that prefer Mutuos Hipotecarios.  Accordingly, the portfolio of residential mortgage loans financed with Mortgage Bonds is expected to have misleadingly increasing gross credit risk ratios over time until its expiration, as the portion of non-performing loans becomes higher as long as creditworthy borrowers pay their outstanding liabilities to the bank, such that the portion of past due loans remaining in the portfolio increase.

 

Regarding Mortgage Bonds that finance residential mortgage loans, the Bank is solely responsible for the payment of the Mortgage Bond obligation to the mortgage bond holders, regardless of the payment behavior of the residential mortgage borrower.  Accordingly, in the ordinary course of business, none of our residential mortgage loans serves as a guarantee or collateral for our mortgage bonds.

 

For those loans that finance a higher portion of the property appraised value, we demand that customers comply with stricter requirements, which are verified during the credit assessment stage.  These requirements are related to:  (i) the history of the relationship between the Bank and the customer (new or current client), (ii) credit risk scores, (iii) monthly income, (iv) type of job (employed or self-employed) and (v) years employed.  In order to illustrate the above mentioned, the table below sets forth an example of requirements for residential mortgage loans that finance up to 80% and more than 80% of the property value, with a common term and granted to employed as well as self-employed new customers.

 

Credit—granting Requirements
(in millions of Ch$, except percentages)

 

 

 

Requirements
(in millions of Ch$, except percentages)

 

Loan—to—Value Ratio

 

< 80%

 

> 80%

 

New Customers (1)

 

 

 

 

 

Employed

 

 

 

 

 

Years employed

 

> 1 year

 

> 1 year

 

Monthly Income

 

> Ch$0.5

 

> Ch$2.2

 

Self-Employed

 

 

 

 

 

Years Employed (2)

 

> 2 years

 

> 2 year

 

Monthly Income

 

> Ch$0.5

 

> Ch$2.2

 

New Customers with a University degree (3)

 

 

 

 

 

Employed

 

 

 

 

 

Years employed

 

> 1 year

 

> 1 year

 

Monthly Income

 

> Ch$0.5

 

> Ch$1.8

 

Self-Employed

 

 

 

 

 

Years Employed(2)

 

> 2 years

 

> 2 year

 

Monthly Income

 

> Ch$0.5

 

> Ch$1.8

 

 


(1)         Refers to customers with or without university degree, who do not supplement income with a guarantor’s income.

(2)         In the case of self-employed customers, years employed refers to the minimum period of time in which the customer has filed annual tax bills with the Chilean Internal Revenue Service.

(3)         Refers to customers with university degree awarded by a group of universities according to our internal credit approval process.

 

During 2018, only 0.5% of the residential mortgage loans granted to our customers financed between 90% and 100% of the property value.  Similarly, during 2018, loans financing between 75% and 90% of the property appraised value represented 45.0% of these loans, loans financing between 50% and 75% of the property value represented 41.0% of these loans, and loans financing less than 50% of the property value represented 13.5% of these loans.  According to our prudent risk approach, we continued tightening our credit granting policy for residential mortgage loans by restricting the loan financing limit as a percentage of the property’s value, although higher financing may be granted to longstanding customers within specific segments. This explains the decrease in the share of residential mortgage loans that financed between 90% and 100% of the property value over the last years, from 14.9% in 2015 to 0.5% in 2018.

 

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An additional feature of our mortgage loans is that mortgaged property typically secures all of the mortgagor’s credit with us, including installment loans and due balances associated with credit cards and credit lines.  Our total amount of loans secured by real estate guarantees, their loan—to—value (LTV) ratio and their relative share in our total loan portfolio, as of December 31, 2018, are depicted in the table below:

 

 

 

As of December 31, 2018

 

 

 

Outstanding
Balance

 

LTV(2)(3)

 

% of Bank’s Total
Loans

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

 

 

Secured Loans(1)

 

 

 

 

 

 

 

Residential Mortgage Loans

 

8,047,709

 

65.6

%

28.8

%

Other than mortgage loans

 

999,382

 

23.7

 

3.6

 

Total Secured Loans

 

9,047,091

 

73.7

%

32.4

%

 


(1)         Corresponds to the Bank’s total secured loans and not only those associated with the Individual and SME Area.

(2)         LTV ratio is computed as the amount of secured loans divided by the value of their associated collateral.

(3)         For other-than-mortgage loans, the LTV ratio is computed as the amount of the excess guarantee (after deductions) of the balance of the associated residential mortgage loans, as those guarantees are initially established in order to secure the residential mortgage loan.

 

The LTV ratios provided above are based on estimated property values that we update monthly with the collateral valuation models managed by our Retail Credit Risk Division. These models determine a rate of depreciation that provides an updated collateral value, based on variables such as geographic location, last appraisal date, type of property and type of customer.  Accordingly, the LTV ratios set forth above take into account the most recent available data regarding collateral values.

 

In addition, the following table sets forth the composition of the other-than-mortgage loans secured by real estate guarantees:

 

 

 

As of December 31, 2018

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

Secured Other-than-Mortgage Loans(1)

 

 

 

 

 

Consumer Loans

 

677,485

 

67.8

%

Credit Cards

 

249,020

 

24.9

 

Credit Lines

 

72,876

 

7.3

 

Total Secured Other-than-Mortgage Loans

 

999,381

 

100

%

 


(1)         Corresponds to the Bank’s total secured Other-than-Mortgage Loans and not only those associated with the Individual and SME Area.

 

Unlike in other countries, in addition to the specific legal rights afforded by the mortgage loan (including foreclosure rights), the Bank may collect the pending balance of the mortgage loan over other assets of the mortgage debtor based on certain legal liens provided by law (derecho de prenda general).  Regarding the foreclosure processes, as permitted by Chilean regulations we may write-off secured loans (such as residential mortgage loans) the earlier of 48 months from the date the loans become overdue and once we have made all efforts for recovering the past due loans without success.  This applies to residential mortgage loans financed with mortgage finance bonds as well as for Mutuos Hipotecarios.  Our foreclosure processes comply with the procedures specified by Chilean regulation.  However, as we strive to continuously improve our collection processes, we have achieved average terms of 11 months for foreclosures associated with residential mortgage loans.

 

As for our historical loss rates, we periodically review our collateral pricing models by adjusting the parameters that support them, such as appreciation and depreciation rates, as well as updated recovery and loss rates, based on historical and empirical data.  Thus, we normally revise our collateral pricing models by incorporating updated information from re-appraised assets or foreclosure processes that have been completed by the Bank in the past.

 

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In addition, the valuation of guarantees is based on a prudent approach, which aims to anticipate and cover unexpected reductions in their market price as a result of changes in market variables, such as an unforeseen slowdown in the global or local economy, lack of liquidity of real estate assets or decrease in real salaries.  Accordingly, our collateral pricing models depreciate the value of the guarantee regarding the market value determined by an independent appraiser.  This approach has allowed us to minimize the loss rates, as the value obtained from auctions (if foreclosure applies) generally exceeds the value assigned to the asset as guarantee.

 

Credit Cards

 

As of December 31, 2018, we issued both individual and corporate Visa and MasterCard credit cards. In addition to traditional credit cards, our portfolio also includes co-branded cards.  As of December 31, 2018, we had two loyalty programs or cobranding agreements, namely “Travel Club” and “Entel Visa”. Credit cards issued under these cobranding agreements supplemented the credit cards that we issued under the brand names Banco de Chile, Banco Edwards-Citi and Banco CrediChile. In addition, as of December 31, 2018, we offered seven types of credit cards, targeting diverse types of segments and encompassing different benefits, including: Visa Corporate, Visa Dorada, Visa Infinite, Visa Internacional, Visa Platinum, Visa Platinum Pyme, Visa Pyme/Empresarial, Visa Signature, Visa Signature Corporate, Visa Signature Entel, MasterCard Black, MasterCard Dorada, MasterCard Internacional, MasterCard Platinum, MasterCard Corporate and MasterCard Corporate Executive.

 

Two of our affiliates, Transbank S.A. and Nexus S.A., provide us with merchant acquisition and credit card processing services.  As of December 31, 2018, Transbank S.A. had 12 shareholders (including us) and Nexus S.A. had six shareholders (including us), all of which were banks. As of the same date, our equity ownership in Transbank S.A. was 26.16% and our equity ownership in Nexus S.A. was 25.81%.

 

As of December 31, 2018, we had 1,451,994 valid credit card accounts, with 1,641,607 credit cards issued to individuals and small and medium sized companies, held by 1,089,782 customers (including credit cards issued by CrediChile). Total charges on our credit cards during 2018 amounted to approximately Ch$4,385,687 million, with Ch$3,925,840 million corresponding to purchases in Chile and abroad and Ch$459,847 million corresponding to cash withdrawals both within Chile and abroad.  The amount of purchases made by our customers in Chile (which include charges associated with credit cards issued by CrediChile) accounted for 19.0% of the total purchase volume of banks’ credit cards in Chile in 2018, according to statistics provided by Transbank S.A.

 

As of December 31, 2018, our credit card loans to individuals and small and medium sized companies amounted to Ch$1,089,633 million and represented 24.6% of our retail market business segment’s consumer loans.

 

We believe that the Chilean market for credit cards has a high growth potential, especially among lower and middle income customer segments, as the average merchant fees should continue to decline due to increasing competition from other banks that operate in Chile, as well as large department stores and other non-banking competitors that are involved in the issuance of credit cards.  As a result, we strive to develop customized commercial strategies to reinforce this payment channel by applying business intelligence tools that enable us to satisfy the needs of our diverse customer base.

 

Commercial Credits

 

Commercial loans granted by our Individual and SME Area mainly consist of project financing and working capital loans granted to small and medium sized companies, which are denominated in Chilean pesos, UF and U.S. dollars and may bear fixed or variable rates of interest and generally mature between one and three months.  As of December 31, 2018, our Individual and SME Area had outstanding commercial loans of Ch$3,868,445 million, representing 22.4% of the retail banking segment’s total loans and 13.9% of our total loans as of the same date.

 

Leasing Contracts

 

Leasing contracts are financial leases for capital equipment and property.  Leasing contracts may bear fixed or variable interest rates and they generally have terms that range from one to five years for equipment and from five to 20 years for properties.  Most of these contracts are denominated in UF. As of December 31, 2018, our Individual and SME Area had outstanding leasing contracts of Ch$498,290 million, representing 2.9% of the retail banking segment’s total loans and 1.8% of our total loans as of the same date.

 

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Lines of Credit

 

As of December 31, 2018 the Individual and SME Area had approximately 783,703 approved lines of credit to individual customers and small and medium sized companies.  Also, the unit had outstanding advances to 452,978 individual customers and small and medium sized companies that totaled Ch$311,568 million, or 1.8% of the retail banking segment’s total loans and 1.1% of our total loans.

 

Our lines of credit for individual customers are generally available on a revolving basis, up to an approved credit limit, and may be used for any purpose.  Advances under lines of credit are denominated in Chilean pesos and bear an interest rate that is set monthly.

 

Debit Cards

 

We offer different types of debit cards to our customers.  Depending on their specifications, these cards can be used for banking transactions at ATMs that operate on the local network provided by Redbanc and the local network of merchants participating in the local Redcompra debit program. Also, our debit cards can be used internationally through the Visa International PLUS network or the international network of merchants associated with the Electron program. We name these debit cards depending on the card’s specific features and the link between the brand and target market which they serve.  During 2018, we offered the following debit cards: Visa Infinite, Visa Estándar, Visa Signature, Visa Platinum, Chilecard and debit cards for companies.  As of December 31, 2018, according to monthly statistics provided by Transbank S.A., the Individual and SME Area held a 12.4% market share of debit card transactions (not including debit cards issued by Banco CrediChile, as those are reported under our Consumer Finance Area), which corresponds to approximately 149 million transactions throughout the year.

 

Deposit Products

 

We strategically offer deposit products to increase our deposit-taking activities as a means of diversifying our sources of funding.  We believe that the deposits of our individual customers provide us with a relatively low-cost, stable source of funding, as well as an opportunity to cross-market our other products and services.  In this regard, we offer current accounts, time deposits and savings accounts to our individual customers.  Current accounts are Chilean peso-denominated and the majority bear no interest (approximately 0.07% or 657 of our total current accounts are interest-bearing), and savings accounts are denominated in UF and bear a fixed-interest rate. Time deposits may be denominated in Chilean pesos, UF and U.S. dollars and most of them bear interest at a fixed rate with terms that range between seven to 360 days.

 

While demand has historically been focused on UF-denominated deposits during periods of high inflation, demand for Chilean peso-denominated deposits has increased in recent years as a consequence of lower and more stable inflation rates in Chile.

 

In the last few years, we have seen an important increase in demand deposits. In fact, amid the high volatility and low interest rates observed in the financial markets throughout 2008 and 2009 (in line with monetary stimulus undertaken by central banks worldwide to overcome the financial crisis), we benefited from a flight-to-quality effect, since customers increasingly deposited their funds in their current accounts managed by us, particularly those denominated in Chilean pesos, as they preferred liquidity to investing in products with low profitability. A similar phenomenon has taken place over the last four years as a result of the Central Bank’s monetary stimulus plan in response to (i) Chile’s economic slowdown towards the end of 2013 and (ii) inflation below the Central Bank’s target. Hence, as low interest rates have prevailed in Chile between 2014 and 2018, interest rates paid on Chilean peso-denominated saving accounts and time deposits have remained low. This trend has encouraged investors to opt for current accounts over interest-bearing deposits. As a result, according to our management information system, annual average balances of current accounts and demand deposits managed by our Individual and SME Area increased by 7.7% and 7.2% in 2017 and 2018, respectively.

 

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Consumer Finance Area (Banco CrediChile)

 

The Consumer Finance Area provides loans and other financial services to low and middle income segments (individuals whose monthly incomes range from Ch$180,000 to Ch$500,000), which historically have only been partially served by financial institutions.  Also, our Consumer Finance Area serves micro businesses.  Banco CrediChile represents an alternative delivery channel for our products and services to these segments, maintaining a separate brand supported by a network of 104 Banco CrediChile branches as of December 31, 2018.  Banco CrediChile was established in 2004 from what was formerly our consumer banking area.  During 2008, Banco CrediChile was merged with the consumer area of Citibank Chile (Corporación Financiera Atlas S.A.) as a consequence of our merger with Citibank Chile.

 

Banco CrediChile offers its customers a variety of banking products, such as consumer loans, credit cards, residential mortgage loans and a demand deposit account (see “—CuentaChile Demand Accounts”) targeted at lower income customers.  As of December 31, 2018, Banco CrediChile had approximately 308,036 core customers (those holding either a current account or a loan with us) and 497,713 active demand accounts. As of the same date, total loans outstanding managed by CrediChile amounted to Ch$671,147 million, representing 2.4% of our total loans outstanding as of the same date.

 

The following table sets forth the composition of Banco CrediChile’s loan portfolio in accordance with our internal reporting policies, as of December 31, 2018:

 

 

 

As of December 31, 2018

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

Consumer loans

 

 

 

 

 

Installment loans

 

507,785

 

75.7

%

Credit cards

 

71,949

 

10.7

 

Lines of credit and other consumer loans

 

174

 

0.0

 

Total consumer loans

 

579,908

 

86.4

 

Residential mortgage loans

 

53,185

 

7.9

 

Commercial loans

 

38,054

 

5.7

 

Total

 

671,147

 

100.0

%

 

Our Consumer Finance Area focuses on developing and marketing innovative and customized products targeted to satisfy the needs of its customers while introducing them to the banking system.  Banco CrediChile complements the services offered by our other business segments, especially our wholesale market segment, by offering services to employers, such as direct deposit capabilities for payroll payment purposes, which in turn enable employees to use our deposit services.

 

In recent years, CrediChile has strived to improve its value offering services by designing and implementing two new financial services, ‘Caja Chile’ and ‘Microbusiness Banking’.  The former consists of a limited range of basic financial services (e.g. deposits, withdrawals and bill payments) offered to customers and non-customers through remote IT platforms located in small convenience stores within socially and/or geographically isolated areas of Chile.  On the other hand, the ‘Microbusiness Banking’ is a specialized portfolio of financial services designed for Microbusiness (generally personal businesses) that includes financial advisory, lending and non-lending products and general financial solutions for a segment that has been traditionally uncovered by the banking services.

 

During 2018, Banco CrediChile continued to enhance these service models in order to penetrate those segments by offering innovative banking solutions.  As of December 31, 2018, Banco CrediChile had 683 ‘CajaChile’ locations at various convenience stores located throughout geographically and/or socially isolated areas.  Through these networks, CrediChile provides its customers with a basic array of financial services including bill payments, deposits, installments loan payments and cash withdrawals.  As of the same date, commercial loans granted to microbusinesses accounted for approximately Ch$48,758 million, associated with 16,997 borrowers. Given the moderate recovery in the Chilean economy during 2018, in particular during the last quarter, Banco CrediChile continued to focus on operational efficiency, productivity and cost control. However, notwithstanding the tempered economic recovery, unemployment recorded a slight deterioration, which translates into a higher perception of risk for these types of customers. This element, combined with the prevailing interest rates caps, led us to achieve moderate loan growth in our consumer finance division. In this context, during 2018, CrediChile continued to focus on the promotion of remote contact channels such as internet-based services and mobile banking applications in order to improve productivity and efficiency by reducing on-site operations at branches. At the same time, we have launched a “dual attention” model by optimizing our branch network and combining branches in certain locations for Banco de Chile and CrediChile customers.

 

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Banco CrediChile employs a specific credit scoring system, developed by our corporate risk division, as well as other criteria to evaluate and monitor credit risk.  Thus, in order to ensure the quality of its loan portfolio, Banco CrediChile adheres to our general loan origination procedures, particularly with regard to the use of our credit scoring system and credit management policies, including the use of credit bureaus and the services of the SBIF.  In addition, Banco CrediChile carries out rigorous procedures for the collection of past due loans through Socofin S.A., our specialized collection subsidiary.  We believe that we have suitable procedures and infrastructure in place to manage the risk exposure of Banco CrediChile.  These procedures allow us to take advantage of the attractive growth and earnings potential of this market segment while at the same time managing our exposure to a higher risk segment.  See “Item 3.  Key Information—Risk Factors—Risks Relating to our Operations and the Chilean Banking Industry—The growth of our loan portfolio may expose us to increased loan losses” and “Item 3.  Key Information—Risk Factors—Risks Relating to our Operations and the Chilean Banking Industry—Our loan portfolio may not continue to grow at the same or similar rate.”

 

Consumer Lending

 

Banco CrediChile provides short to medium term consumer loans and credit card services.  As of December 31, 2018, Banco CrediChile had approximately 308,020 consumer loan debtors related to installment loans amounting to Ch$507,785 million. As of the same date, Banco CrediChile had outstanding loan balances related to credit cards of Ch$71,949 million.

 

CuentaChile Demand Accounts

 

Banco CrediChile launched CuentaChile Demand Accounts in 2014, offering its customers a deposit product that is flexible and easy to use.  This product allows us to tap into a section of the consumer market that otherwise would not be able to access and participate in the banking system because of its risk profile.  The CuentaChile Demand Account is a non-interest bearing demand deposit account without checking privileges that targets customers who want a secure and comfortable means of managing and accessing their money.  Customers holding this account may use an ATM card linked to their CuentaChile Demand Account to make deposits or automatic payments to other Banco CrediChile accounts through a network of 7,254 ATMs available throughout Chile as of December 31, 2018.  CuentaChile Demand Account holders may execute transactions in all CrediChile branches and carry out basic banking operations in the CajaChile’s nationwide network, which is present in most Chilean regions and communities.  CuentaChile Demand Account holders are entitled to make use of internet-based banking platforms and mobile applications provided by Banco CrediChile while also receiving electronic money transfers and benefiting from diverse loyalty programs designed by Banco CrediChile, under the Cuenta Chile Club, which include discounts and special offers for a wide array of stores and services. Banco CrediChile previously offered its customers traditional demand accounts (each known as a CrediChile Demand Account) that entitled its holders to receive payroll deposits, withdraw money from ATMs and perform basic purchasing transactions.  The CuentaChile Demand Account replaced and improved the former product offered by CrediChile by increasing benefits to its holders.

 

As of December 31, 2018, Banco CrediChile had approximately 497,713 active CuentaChile Demand accounts.  Holders of these accounts pay an annual fee, based on the number of withdrawals on the account line of credit and interest on any outstanding balance under the line of credit.  All fees and interest due on a CuentaChile Demand Account are withdrawn automatically on a monthly basis from funds available in the account.  In addition, CuentaChile Demand Accounts allow us to offer our wholesale customers the ability to pay their employees by direct deposit of funds sent to the individual employee’s account at Banco CrediChile, thereby increasing the potential for stronger long term relationships with our wholesale customers and their employees.

 

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Wholesale Banking Segment

 

Our wholesale banking segment serves the needs of corporate customers.  In 2018, this business segment recorded annual operating revenues of approximately Ch$462,993 million, which represented 24.7% of our total operating revenues. Also, for the year ended December 31, 2018 this segment recorded an income before income tax of Ch$311,925 million, which represented 41.5% of our consolidated income before income tax.  As of December 31, 2018, loans granted by this business segment amounted to Ch$10,639,057 million and represented 38.1% of our total loan portfolio.

 

The following table sets forth the composition of our portfolio of loans to the wholesale market in accordance with our internal reporting policies, as of December 31, 2018:

 

 

 

As of December 31, 2018

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

Commercial credits

 

Ch$

7,612,333

 

71.6

%

Foreign trade loans

 

1,205,329

 

11.3

 

Leasing loans

 

1,073,235

 

10.1

 

Factoring loans

 

608,430

 

5.7

 

Other loans

 

139,730

 

1.3

 

Total

 

Ch$

10,639,057

 

100.0

%

 

As of December 31, 2018, we had 10,222 debtors out of a total of 27,427 core customers (those holding either a loan or a current account with us). Our wholesale customers are engaged in a wide range of economic sectors.  As of December 31, 2018, loans granted by our wholesale banking segment were mainly related to:

 

·                  financial services (approximately 21.7% of all loans granted by this business segment);

 

·                  manufacturing (approximately 10.9% of all loans granted by this business segment);

 

·                  construction (approximately 9.7% of all loans granted by this business segment);

 

·                  commerce and trade (approximately 9.4% of all loans granted by this business segment);

 

·                  communication and transportation (approximately 8.7% of all loans granted by this business segment);

 

·                  agriculture, forestry and fishing (approximately 5.5% of all loans granted by this business segment);

 

·                  utilities (approximately 3.4% of all loans granted by this business segment);

 

·                  community, social and personal services (approximately 2.3% of all loans granted by this business segment); and

 

·                  mining (approximately 1.4% of all loans granted by this business segment).

 

In line with our strategy of identifying and differentiating market segments in order to provide improved value propositions for a diversified customer base, three of our areas provide our wholesale customer base with banking and financial products and services:  (i) the Corporate Area and (ii) the Large Companies and Real Estate Area and (iii) the Special Businesses Area.

 

Corporate Area

 

The Corporate Area provides banking products and services to corporations with annual sales exceeding approximately Ch$70,000 million. This area’s customers consist of a large proportion of Chile’s publicly-traded and non-listed companies, subsidiaries of multinational companies and conglomerates operating in Chile (including those operating in the financial, commercial, manufacturing, industrial and infrastructure sectors), and projects and concessions.

 

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As of December 31, 2018, we had 958 corporations as debtors out of a total of approximately 7,606 core customers (those holding either a current account or a loan with us). Also, this area managed total outstanding loans of Ch$3,652,527 million, which represented 13.1% of our total loan book as of the same date.

 

The following table sets forth the composition of our Corporate Area’s loan portfolio in accordance with our internal reporting policies, as of December 31, 2018:

 

 

 

As of December 31, 2018

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

Commercial credits

 

Ch$

2,836,779

 

77.7

%

Foreign trade loans

 

428,913

 

11.7

 

Factoring loans

 

204,963

 

5.6

 

Leasing loans

 

110,323

 

3.0

 

Other loans

 

71,549

 

2.0

 

Total

 

Ch$

3,652,527

 

100.0

%

 

We offer a wide range of products to large corporations that include short- and long-term financing, working capital loans, mortgage loans, leasing, long-term syndicated loans and factoring, as well as investment banking services offered by our subsidiary Banchile Asesoría Financiera S.A.  We also offer cash management, including payment services (payrolls, suppliers, pensions, dividends, etc.), collection services and connections to international funds transfer networks, as well as traditional deposit products, in particular current accounts.

 

In cash management, as of December 31, 2018, we were party to approximately 8,640 payment service contracts and approximately 964 collection service agreements with corporations.  We believe that cash management and payment service contracts, in particular, provide us with a source of low cost deposits and the opportunity to cross sell our products and fees to payees, many of whom maintain accounts with us.  Under our collection contracts, we act as a collection agent for our corporate customers, providing centralized collection services for their accounts receivable and other similar payments.  For the year ended December 31, 2018, joint volumes associated with collection and payment agreements increased by approximately 16.6%.

 

In order to provide highly competitive and differentiated services, our Corporate Area has the direct support of our Treasury and Money Market Operations segment, which directly fulfills our corporate customers’ liquidity, short-term loans and hedging needs.  We have also improved our technology to facilitate connections with customers and enhance their self-service practices.  Similarly, we offer derivative products, which we believe have become increasingly important, especially those associated with Chilean peso-U.S. dollar and UF-U.S. dollar forward contracts, cross currency swaps, interest rate swaps and options, among other derivative products.

 

In recent years, the market for loans to corporations in Chile has been characterized by reduced margins due to increasing competition and moderate expansion in terms of borrowing.  This fierce competition has involved not only local banking players but also, increasingly, overseas lenders who are eager to lend to Chilean companies that hold high credit ratings supported by a high sovereign credit rating. For this reason, we have focused on optimizing the profitability in this segment by enhancing our cross selling through the generation and enhancement of fee-based services, such as payroll processing, dividend payments and billing services, as well as computer banking services. This strategy has enabled us to maintain profitable and long-term relationships with our corporate customers while preserving the ability to grant loans when appropriate business opportunities arise.

 

Accordingly, during 2018, our Corporate Area continued to focus on: (i) maximizing cross-selling and profitability at the business relationship level, (ii) improving the customer experience with the bank’s diverse distribution channels and (iii) promoting and motivating the area’s team to encourage “innovation” in all the business aspects managed by account officers. These initiatives are intended to optimize the risk-return relationship of this segment through non-lending revenues and customer proximity. In all of these areas, but particularly in cross-selling, the synergies that arise from the Global Connectivity Agreement with Citigroup have been important when assisting our corporate customers with off shore transactions, derivatives structuring and financial advisory services.

 

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The slowdown evidenced in the local economy over the last four years and, in particular, the significant decrease in overall investment spending across the country, significantly affected the corporate lending business. In 2018, however, driven by the rebound in local investment spending, our Corporate Area began to record quarterly improvements to its loan growth and ended the year with a 10.8% increase in loan balances. In addition, the Corporate Area was able to deal with the effect of increased competition on lending margins by focusing on cross-selling, such as investment banking services offered through our investment banking subsidiary. During 2018, this subsidiary carried out approximately 28 transactions, an increase from the 21 transactions executed in 2017. Also, the subsidiary ranked first in terms of equity and international debt placement deals in the local market while being distinguished as the Best Investment Bank of the Year in Chile by LatinFinance.

 

The foreign trade business is also managed by our Corporate Area, although balances and results are allocated to different business areas depending on the customer who performs the transaction. It is worth mentioning that during 2018, the foreign trade business recorded a 33.4% increase in loan balances for the Bank as a whole and a 72.2% expansion in the Corporate Area in particular.

 

Large Companies and Real Estate Area

 

Our Large Companies and Real Estate Area provides companies — with annual sales that range from approximately Ch$1,600 million to approximately Ch$70,000 million — with a broad range of financial products and services. Customers served by this area are those related to the commercial, manufacturing, agricultural, forestry, fishing, infrastructure and real estate sectors, among others.

 

As of December 31, 2018, we had 9,155 large companies and real estate debtors out of a total of 19,241 core customers (those holding either a current account or a loan with us). Loans granted by the Large Companies and Real Estate Area amounted to Ch$6,410,947 million as of the same date, which represented 23.0% of our total loans.

 

The following table sets forth the loan portfolio composition of the Large Companies and Real Estate Area, in accordance with our internal reporting policies, as of December 31, 2018:

 

 

 

As of December 31, 2018

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

Commercial credits

 

Ch$

4,200,059

 

65.5

%

Leasing loans

 

962,904

 

15.0

 

Foreign trade loans

 

776,416

 

12.1

 

Factoring loans

 

403,467

 

6.3

 

Other loans

 

68,101

 

1.1

 

Total

 

Ch$

6,410,947

 

100.0

%

 

Products and services offered by this area are mainly related to commercial loans, lines of credit, trade finance and foreign currency transactions, factoring services, leasing, non-residential mortgage loans, syndicated loans, investment banking and financial advisory services for mergers and acquisitions, debt restructuring assistance, payments and collections services, current accounts and related saving services, corporate credit cards, cash and investment management, derivative contracts to hedge against currency or interest rate fluctuations, insurance brokerage, among other traditional and tailored services.

 

The Large Companies and Real Estate Area aims to provide its customers with excellent service based on proactive financial support that enhances long term relationships with customers.  Over time, the area has developed service models intended to take advantage of synergies arising from the interaction of account and specialized support executives responsible for ensuring comprehensive customer service. These models have enabled the Large Companies and Real Estate Area to strengthen customer relationships and product offerings.

 

In 2018, the Large Companies and Real Estate Area continued to prioritize a customer centric approach in order to maintain a market-leading position in commercial banking. In addition, during 2018, the Large Companies and Real Estate Area benefited from the moderate recovery in local investment spending and an improvement in business sentiment and consumer confidence, all of which resulted in an increase of 12.0% or Ch$684,728 million, in year-end loan balances granted by the Large Companies and Real Estate Area, especially increasing such balances over the last two quarters, as compared to the decrease of approximately 5.9% in 2017.

 

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In addition to economic recovery, a solid strategy aimed at finding new business opportunities while maintaining a high level of customer satisfaction also contributed to loan growth achieved by the Large Companies and Real Estate Area, with an increase of 18.0% in foreign trade loans balances on an annual basis and an increase of 11.7% in commercial credits.

 

Our leasing and factoring businesses are part of the Large Companies and Real Estate Area. During 2018, we were particularly active in factoring loans as demonstrated by the 12.3% annual increase in year-end balances recorded by the Bank as a whole, which was primarily due to the 12.9% annual increase posted by the Large Companies and Real Estate area in particular.

 

Special Businesses Area

 

Our Special Businesses Area aims to provide tailored financial products and services to family offices representing the interests of the wealthiest local families. Thus, in addition to traditional lending products, this area offers a wide range of non-lending services related to project finance, deal structuring associated with business acquisitions, cash management, deposits and funds administration, financial advisory, among others. Also, this area is in charge of coordinating and overseeing our Trade Finance Unit and our International Private Banking Unit.

 

As of December 31, 2018, our Special Businesses Area had approximately 109 borrowers out of a total of 580 core customers (those holding either a current account or a loan with us). In addition, as of the same date, loans granted by this area accounted for Ch$575,583 million, which represented 2.1% of our total loans.

 

The following table displays the loan portfolio composition of the Special Businesses Area, in accordance with our internal reporting policies, as of December 31, 2018:

 

 

 

As of December 31, 2018

 

 

 

(in millions of Ch$, except percentages)

 

BANK’S INTERNAL REPORTING POLICIES:

 

 

 

 

 

Commercial credits

 

Ch$

575,495

 

100.0

%

Other loans

 

88

 

0.0

 

Total

 

Ch$

575,583

 

100.0

%

 

During 2018 the Special Businesses Area continued to focus on strengthening a comprehensive strategy intended to take advantage of opportunities that arise in the local market within the family office sub-segment. In this group of customers, relationships are crucial and, therefore, this area has concentrated on reinforcing the team’s capabilities while establishing a collaborative work relationship with our subsidiaries Banchile Administradora General de Fondos and Banchile Corredora de Bolsa (jointly Banchile Inversiones) in order to put their wide range of wealth management services and products at the disposal of these customers. As a result, the number of customers managed by the Special Businesses Area that hold commercial relationship with Banchile Inversiones increased by 2.4% on an annual basis. In addition, the Special Businesses Area managed to record an annual increase of 11.5% in total loans during 2018, particularly concentrated in commercial credits and lines of credit.

 

Treasury and Money Market Operations

 

Our Treasury and Money Market Operations business segment provides a wide range of financial services to our customers, including currency intermediation, forward contracts, interest rate swaps, transactions under repurchase agreements and investment products based on bonds, mortgage finance bonds and deposits.

 

In addition, our Treasury and Money Market Operations business segment is focused on managing our currency, interest rate and maturity gaps, ensuring adequate liquidity levels, managing our investment portfolio and  performing the intermediation of fixed-income instruments, currencies and derivatives.  Interest rate gap management is aimed at generating an adequate funding structure, prioritizing our capitalization and asset and liability cost structure and funding source diversification.

 

The Treasury and Money Market Operations business segment is also responsible for:  (i) the issuance of short- and long-term senior bonds, as well as long-term subordinated bonds, in Chile or abroad, (ii) monitoring compliance with regulatory deposit limits, technical reserves and maturity and rate matches/mismatches, (iii) monitoring our adherence to the security margins defined by regulatory limits, and risk limits for interest rate, currency and investment gaps.  This segment continually monitors the Bank’s cost of funding by benchmarking with the rest of the local financial system and financing alternatives in Chile or abroad.

 

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Regarding funding functions carried out by our Treasury, during 2018, we continued to develop a funding diversification strategy by conducting important transactions in Chile and abroad.  This strategy is aimed at maintaining a competitive cost of funding that supports the value offerings we provide to our wide customer base and improving our liquidity by issuing debt of longer maturities that match long-term assets. For that reason, we are continually seeking alternative sources, types of instruments and markets. We generally conduct international bond issuances only if the cost (including costs of interest rate swaps and other transactional expenses) is below the cost of raising funds locally and the currency or interest rate exposure is fully hedged via cross currency swaps.

 

We are constantly striving to diversify our liability structure in terms of sources, types of instruments and markets with the aim of maintaining a competitive cost of funding and improving our liquidity. Thus, given the tempered recovery shown by our total loan book by the end of the year, we were more cautious and less active than previous years in terms of long-term debt placements, particularly in overseas markets in view of the steady increase in foreign interest rates. Instead, we continued to strengthen our liability structure by taking advantage of specific windows of opportunity abroad while prioritizing issuances in the local debt market, against a low interest rate environment given the expansionary policy set by the Chilean Central Bank. As a result, in 2018 we carried out the following debt placements:

 

·             Approximately U.S.$1,580 million (mostly denominated in UF) within the local market. These debt placements had maturities ranging from four to 12 years (eight years on average) while bearing premium spreads over the relevant benchmark (Central Bank UF-denominated bonds or BCU rates).

 

·             A 10-year fixed rate U.S. dollar-denominated unsecured bond in Japan for approximately U.S.$50 million  and

 

·             A 5-year fixed rate CHF-denominated unsecured bond in Switzerland for approximately U.S.$115 million.

 

The debt placements carried out in foreign markets above were accompanied by cross currency swap hedge arrangements in order to neutralize any effects associated with changes in foreign exchange that could impact our cost of funding.

 

In addition, we continued to utilize short-term funding associated with our commercial paper program, which provides us with premium funding for Trade Finance transactions, and during 2018, we issued a total amount of approximately U.S.$1,450 million. As of December 31, 2018 we had an outstanding balance of approximately U.S.$367.1 million.

 

The funding functions carried out by our Treasury area are complemented by our international area, namely International Financial Institutions (“IFI”), which manages relations with correspondent banks worldwide, facilitating international payments and obtaining foreign currency financing for us.  As of December 31, 2018, we have established a network of approximately 600 foreign banks, among which we maintained credit relationships with approximately 140 correspondent banks, from which we maintained 25 account relationships.  IFI played an important role in structuring international transactions aimed at diversifying our funding.

 

Regarding the management of our securities portfolio, as of December 31, 2018, the portfolio amounted to Ch$2,798,487 million and was composed of available-for-sale securities that totaled Ch$1,053,191 million and securities held for trading amounting to Ch$1,745,366 million. As for the type of instruments included in our securities portfolio, as of December 31, 2018, 60.3 % consisted of securities issued by the Central Bank and the Chilean government, 27.8% consisted of securities issued by local financial institutions, and 11.9% consisted of securities issued by non-financial Chilean corporate issuers and other securities. Our investment strategy is designed to supplement our expected profitability, risks and economic variable projections while adhering to the regulatory guidelines and internal limits defined by our finance committee.  In this regard, neither proprietary trading nor speculation on equity holdings are business goals for us and, therefore, equity instruments only represented 0.3% of our investment portfolio as of December 31, 2018.

 

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Operations through Subsidiaries</