Banco Santander Chile (BSAC) 2007 Q4 法說會逐字稿

Good day, everyone, and welcome to our fourth quarter earnings release conference call. Today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Raimundo Monge. Please go ahead, sir.

Thank you very much. Good morning, ladies and gentlemen. Welcome to Banco Santander-Chile's fourth quarter and full year 2007 results conference call. I am Raimundo Monge, Director of Strategic Planning, and I'm joined today by Robert Moreno, Manager of Investor Relations and Strategy. Thank you for joining us to discuss the bank results and recent operating trends. Afterwards, we will be happy to answer your questions.

Next two slides. You should be on page three of the presentation. 2007 was a challenging year for banks, but on an operating level, Santander-Chile showed a solid operating performance reflecting its strong positioning in the market, leading retail banking franchise and its strict focus on recurring profitability. Net income increased 8.1% in 2007 and totaled CLP308,647 million, which is equivalent to CLP1.64 per share and $3.43 per ADR.

It is worth mentioning the high quality of our earnings as annual results were led by a 26.1% year-on-year increase in net interest income after provision expense. Core revenues, that is net interest income plus fees, increased 28.1% while net operating income increased 14.6% in 2007. During the year, the positive impact of higher core revenues and contained operating costs was partially offset by lower trading gains and a higher negative price level restatement compared to 2006.

Next slide. The bank achieved record margins and efficiency levels in 2007. The net interest margin reached 5.4%, that is 80 basis points above 2006 level. Despite higher provision in the year, as retail banking activities continued to grow, the higher spread more than compensated for this. As a consequence, net interest margin after provisions increased 60 basis points to 4.2%, the highest for the larger -- for any larger -- any of the larger banks in Chile.

The bank's ROE in 2007 reached 23.5% with a slight decrease compared to the previous year, but more than doubling our cost of capital. In addition, the efficiency ratio improved again in 2007, reaching 36.5% compared to 39% in 2006. Santander-Chile has the best efficiency ratio among the top banks in Chile and Latin America.

Next slide. In the fourth quarter of 2007, net income totaled CLP70,775 million. That is CLP38 per share -- CLP0.38 per share and $0.79 per ADR, increasing 16.3% year on year. Core revenues increased 50.8% year on year and net operating income increased 59.7% year on year as a consequence of strong results in our retail banking business, reflecting the bank's continued focus on increasing the quality of its earnings and maximizing recurring earnings growth.

This strong operating performance was partially offset by lower non-operating income and a higher negative price level restatement. Compared to 3Q 2006, net income decreased 16.9%, mainly as a result of a fall in quarterly inflation and lower trading gains. As we will detail in the rest of this presentation, 4Q results, while below market expectation due to one-time effects, showed underlying trends in terms of client activity and recurring profitability that should positively contribute to our profitability going forward. Next slide.

One of these positive trends is a continuous increase in the bank's client base and cross-selling standards. The total number of clients increased 14.1% year on year to 2.8 million. That is 345,000 new clients were captured during 2007. We continue to gain market share in checking accounts and credit cards, two key retail products. The amount of retail clients with a checking account increased 13.9% in 2007. As of November 2007, the latest market data available, market share in checking accounts reached 27.9% compared to 27.1% at the end of November 2006. In this 12-month period, Santander opened 35% of all the new checking accounts in the Chile market. However, only 20% of our clients, retail clients, have this product nowadays. A client with a checking account tends to be four times more profitable on average than one without this product.

Another area of strong growth in 2007 was credit cards. According to information published by Transbank, the industry credit card processor, as of December 2007, Santander-Chile's market share in banking credit cards reached 36% compared to 35.8% as of December 2006. This represents an increase of 16% year on year in the number of credit card accounts outstanding. Purchases with Santander credit cards in monetary terms grew 16.4% in 2007 and our market share in terms of purchases reached 35.4% in 2007. That is 40 basis points higher than in 2006.

A greater amount of clients with checking and credit cards coupled with continuous improvement in client service has led to higher cross-selling ratios. The amount of middle upper income individual clients that have a checking account and use at least three other products increased 16.2% in 2007. In Santander Banefe, our unit aimed at the lower and middle lower income segments, the amount of clients that use at least two or more products rose 17.8% in the year. Despite this improvement, less than 30% of our clients have two or more products, reflecting the high cross-selling potential of the bank's client base.

Next slide. You should be on page seven. Future growth in the bank will also be sustained by the regular investment made in distribution in 2007. The bank's branch network totaled 467 branches and 2,004 ATMs at year end 2007, increasing 13.1% and 26.2% year on year respectively. One-third of the bank branches have been opened in the last three years, so have not, on average, reached their breakeven point. Branch opening has been focused in all different customer segments.

Focus on the fourth quarter of 2007 was placed on the new Banco Prime Network, an exclusive branch network for upper income individuals. These new branches are located in the upper floors of wealthy neighborhoods and include WiFi access to Internet, underground parking, a coffee shop and personalized customer service. This new segmentation of the branch network should help improve our competitive stance in the upper income market. Next slide.

As we have discussed in previous calls, our strategy has been centered in four basic drivers. First, we're focusing on profitable growth, allocating our capital to its most productive uses, which during the last four years has meant expanding our retail banking activities and focusing on non-lending corporate activities. At the same time, as market has been [wrought] by the subprime crisis, we will be more cautious than ever with our funding mix, liquidity levels and capitalization ratios. The recent event in international financial markets reaffirms more than ever our focus on profitable growth, with a pricing strategy that supersedes market share goals.

Secondly, we have been developing a number of actions to have more clients, to increase cross-selling and to expand the product usage of -- by our clients. We believe this is a safe and very efficient mechanism to fuel growth, especially given the bank has Chile's largest client base. We envision strong cross-selling potential by improving client services and using more segmented commercial approaches. Cross-selling ratios should also improve as more people develop deeper relationship with the bank.

Finally, creating incentives for our customers to prefer and use our products has been at the center of our marketing efforts. Simultaneously, we have continued to be focused on proactively managing asset quality in order to balance growth in retail banking with a normalization of the provision levels on our loan book. In 2007, as will be discussed, we continue to improve our consumer provision models, which has a short-term impact in terms of provisions, but we believe help to ensure that we can adequately price our risks.

Finally, we maintain our leadership in cost control and efficiency. We expect to continue growing at a solid pace, investing in expanding our distribution capabilities. Part of this growth has been and is going to be financed with productivity gains, which will allow us to sustain our world class efficiency levels.

Next slide. In 4Q 2007, loan growth accelerated in most of our business segments. Total loans increased 5.2% q-on-q. In 4Q '07, retail lending expanded at its fastest pace in the year, growing 5.1% q-on-q. Lending to the middle market and the large corporations was also strong in the quarter. The rise in international borrowing costs have led many local companies to finance more of their projects locally at attractive spreads, pushing loan growth in this segment. This acceleration in loan growth has been achieved in a higher spread environment. Thus the bank concluded 2007 with an increasing loan growth coupled with a positive evolution of margins.

Next slide. The surge in inflation in the second half of 2007 resulted in rising short-term and falling long-term real rates. The overnight reference rate set by the Central Bank is currently at 6.25%, 50 basis points higher than at the end of the third quarter of 2007. Despite this fact, our funding mix improved, reflecting the proactive management of our balance sheet in order to expand margins. In 4Q '07, customer funds increased 5.2% q-on-q and 17.2% year on year. Time deposits increased 8.5% q-on-q, reflecting the healthy liquidity of the Chilean market and the rising short-term rate environment.

During the quarter, inflation continued to exceed market expectation, fueling further rises in short-term interest rates. The balance of non-interest bearing liabilities increased 10.4% q-on-q and 18.1% year on year. The positive performance of checking account balances reflects our strong growth in checking account holders and the bank's solid positioning in the cash management business. This also helps to reduce the negative impact of rising rates on funding costs as the yield on checking accounts rises with the rate hikes.

In the quarter, the bank local peso deposit rating were increased to AAA. The only bank, either public or state owned, with this rating. At the same time, the bank's foreign long-term ratings were also increased to A+ by Standard & Poor's in the quarter along with Chile's sovereign rating. We view this as a positive sign, especially given the fact that many financial markets were affected by the aftershocks of the subprime crisis. We believe this reflects the stability of the Chilean economy, the strength of the local financial system and the leading market position of Santander Chile. Let it be said that Santander has the best risk rating for any issuer in Latin America.

Next slide. You should be on page 11. The improved assets, the high inflation rate in the quarter and the positive evolution of non-interest bearing liability has resulted in record high net interest income and a solid margin expansion. In the quarter, net interest income increased 0.3% q-on-q and 59.9% year on year. The net interest margin adjusted for inflation hedge reached a high level of 5.9%, increasing 180 basis points since the fourth quarter of 2006.

Next slide. The bank has also achieved a solid result in the second strategic driver, client base and product usage. The larger client base and the higher cross-selling and product usage standards were important drivers for fee income growth. Net fees increased 2.4% q-on-q and 20.7% year on year in 4Q '07. As previously mentioned, the bank continues to expand its client activity, especially in retail banking, and this is driving fee income growth. Notable in the quarter was the rise in credit cards, which grew 27.5% q-on-q and 51.9% year on year.

Next slide. In 4Q '07, the bank's net provision expenses increased 19.2% q-on-q and 38.8% year on year. Excluding a one-time provision expense that we will discuss later, provision expense increased 29% year on year and 10.7% q-on-q. This rise was mainly due to an increase in net provision in retail banking in line with loan growth in this business segment. This is the main explanation also for the rise in charge-offs in the period.

The 6.2 q-on-q rise in gross provisions was due to high provision recognized as a result of the implementation of a more conservative credit model for consumer lending in -- consumer lending. In 2007, the most important modification was an extension of the back testing period of our clients' credit behavior from 12 to 21 months. In December 2007, this change required further provisions of CLP3,918 million. The increase in net provision expense was also due to the 19.4% reduction of -- in loan loss recoveries q-on-q. In the quarter, the bank was negotiating the sale of charge-off loans. Therefore, the amount assigned to collection agents did not include those charge-off loans that had been sold, reducing recovery in the quarter.

As a result of the proactive management of asset quality and the strengthening of credit policy, the banks continue to display sound asset quality indicators. The cost of credit, that is net provision for loan losses over total loans, reached 1.63% in the fourth quarter of 2007 and 1.51%, excluding the one-time provision expense that we comment before, compared to 1.44% as of 3Q 2007, and 1.34% in 4Q 2006.

Coverage of past due loans, that is reserves over past due loans, reached almost 200% in December 2007, up from 188% by the end of 2006. The past due loan ratio of December 31, 2007 remain at 0.87%. Going forward, the bank expects the cost of credit to rise in line with the shift in asset mix toward retail banking. Next slide.

Core revenue net of provision expense increased 54.2% year on year, reflecting that despite the rise in provision expense, the higher margins of the bank's retail activity have positively contributed to its profitability. Next slide.

Efficiency continued to be a differentiating factor for Santander-Chile. The efficiency ratio reached a record low of 36.5% for the full year 2007 compared to 39% in 2006. In the fourth quarter of 2007, the efficiency ratio reached 37.7% compared to 46.5% in 4Q 2006. In the same period, operating expenses increased 4% q-on-q and 5.8% year on year. The growth, of course, has been mainly driven by the expansion of the distribution network and the increase in commercial activity. Additionally in the quarter, the spark in inflation boosted wage expenses. In 2008, we expect to continue controlling costs and improving efficiency to sustain profitability. Next slide.

In summary, 2007 results, we believe, were of high -- were high-quality results, especially considering the adverse environment that affected the global financial industry. This solid operating performance maintains the trends of the past five years where Santander has outperformed its peers. Our high margins, ample liquidity, improved funding mix and conservative asset quality policies, strong fee income growth and efficiency give us a clear competitive advantage in the local market. Next slide.

Going forward, we have a relatively positive outlook for the bank. The Chilean economy is in a solid stance and we expect a relatively high expansion of internal demand. We are keeping our focus on profitability by maintaining a strict control over spread. We also expect cross-selling to grow at -- from current levels. These should boost our net interest income and fees. We expect also that asset quality should remain sound, but as mentioned, loan losses provisions should increase in line with the rise of retail banking activities. Finally, we will continue to invest in our distribution capabilities and in other IT projects, but efficiency ratio should improve throughout the year.

At this time, we will gladly answer any questions you might have. Operator, do we have any questions?

(Operator Instructions) And our first question will come from Jason Mollin with Goldman Sachs.

Hi. Good morning. Hello, everyone. My question is really related to the net financial losses, I guess, or net result from financial transactions as you define it. If you can help us understand how the bank was positioned and why we saw this acceleration in losses. Obviously, it was a volatile market, but the acceleration in losses from trading and mark-to-market. And then, if you can give us a sense that your -- how you're positioned going forward, what we should be looking for here.

And secondly, if you can just talk about the growth outlook for 2008, particularly on the loan front. The system-wide loans have -- or actually, the rate of growth has declined. If you can talk about your expectations for the full year, particularly with what's going on, on the interest rate front and in the global markets.

Okay. Regarding our net financial transaction results, as you know, this is a line that has volatility. And as you've seen in our figures, we have had very strong quarters followed by a negative and followed by positive quarters again. So I agree that it's difficult to predict the results. There the main explanation is that, contrary to most market expectations, because this has been kind of a system-wide situation, people were expecting that the long-term rates should be increasing in line with -- sorry, long term rates should be increasing in line with short-term rates. But has happened the opposite, so that has affected the mark-to-market of some investment positions.

And the other kind of passing situation was that, contrary to what is going on in the main and financial market were spreads over government securities or central bank security has been widening. In the case of Chile and specifically in the derivative market, the spread has not only widened, but has been narrowing and, in some case, in some days has been negative. So in the derivative market, you have a situation where instead of having higher spread because of the volatility coming from abroad, you are having even negative spread as compared to the base -- central bank papers.

So we think that that is a transitory situation that should reverse whenever (inaudible) start moving, but as you see, as you know, condition has been kind of shaky and therefore that could take some time. So it's simply that a reflection of the external volatility has been seen locally and the good news is that we have -- the market has been very liquid and, up to now, we haven't had major complications. So there has been a shaky environment and therefore that is reflected in this line.

Going forward will depend -- and this is a line that, as I mentioned before, should be moving, are going to attempt, but it's very likely that rate should be following the growth of the economy and the spreads should start to normalize. In our case, we have been taking actions to reduce exposure, but most of these positions, especially the ones with derivatives are, in order -- are taken in order to reduce our exposure to interest rate sensibility or our positions taken on behalf of clients' activity.

Therefore, we think that as long as the spreads normalize, that situation should reverse. What we are seeing today is the mark-to-market of some client -- derivative position taken for clients and therefore, although it's difficult to predict whether spreads will be compressed for how long, eventually, that situation should start reversing in Chile following the path of spread expansion that we have seen in other markets. So our basic scenario is that that line should be normalizing throughout the year, but again, with all the uncertainties coming from abroad, it's difficult to have a firm position.

Concerning your second question, growth of -- loan growth during the year, our -- the basic scenario is of growth between 4.5% and 5% of GDP with external demand outpacing that level. Internal demand is more important than total GDP because, especially if you are focusing the retail market. That means that we should see some deceleration in the growth rate, probably approaching something similar to what we saw on average this year. Remember that in the 4Q we saw a certain acceleration of the growth across the board, but probably something between 11%, 12% on real terms for the whole lending.

And there, the -- our growth will be, as usual, determined by two factors. One is retail lending, we think that we will be outpacing the market and gaining marginally market share in consumer lending and mortgages. And in corporate lending, it's a situation that will depend on the spreads, but we can charge for those loans. Liquidity is a concern. Spreads should normalize sooner or later and therefore we are pricing our capital according to those expected -- respective cost of funding, not the actual cost of funding. That means that growth will be only achieved if you have the proper price conditions. That situation happened in the 4Q, as many companies came back to the local market to finance their projects and their growth.

And so again, as long as those conditions prevail, we should see fairly good growth in the corporate book as well. But it's uncertain because it will depend if -- on what type of profitability we can get on those loans. To remember, more than 60% of our revenues on the corporate side comes from non-lending businesses. Those businesses are related to cash management, to fee based income, which are very recurrent and therefore our focus on corporate activity has been on the non-lending side more than on the lending side. And that's why our market share in terms of total lending can go up and down because it will depend, at the end of the day, on the pricing conditions that we see in the market.

In the 4Q, we saw much higher spreads because the rest of the competition start increasing their spreads in line with what we have been doing since the beginning of the year and reflecting the higher risks and the higher cost of funding that was happening throughout the year. So we think that we'll outpace the growth of the system in retail and in corporate lending, it's an open issue. As long as the conditions that we saw in the 4Q prevail, we think we can expand at more or less the same rate of the market or slightly above and very much in line with the growth of retail. So everything should be growing at 10%, 12% on real terms next year.

Thank you very much, Raimundo.

Thank you. (Operator Instructions) And our next question comes from Juan Partida from JPMorgan.

Hi. Good morning. My question is related to charge-offs during the year. We've seen the pace of charge-offs accelerating during the year versus 2006, whereas for many of your competitors that -- those rates have remained relatively flat or even declined a little bit as a result of the very strong growth in loans. So I wanted to know if you have any theory or you know why this is the case. Also, if you could give us an idea as to what the profitability overall for the Banefe business was in 2007 compared to 2006. Thank you.

Well, charge-offs, as you know, not necessarily mean a loss. It means that in Chile the rules regarding charge-offs are very demanding. You have to write off completely a consumer loan that has been unpaid for six months or more. So that's why, at the end of the day, what really matters is the -- what we call the cost of credit. That is provisions plus charge-offs minus recoveries. And that figure has been fairly stable at around 1.5%, 1.6% with a slight increase, simply because of the mix, the higher [weight] that retail loans have in our book.

So that is important to mention that, at the end of the day, what really matters -- because sometimes you have movement, especially in a period such as 2006 or 2007 when you are seeing a normalization of the provision expense and because we have been strengthening our provision models. Sometimes you see changes between those two lines. And that's why it's better to look them combined because the more provisions you set, the less charge-offs that you can reflect or vise versa. It's -- you kind of move the two lines in tandem.

And that's why we believe that the relevant metric to follow is not the absolute level of charge-off, but how much of the spread has been consumed by net provisions. And as we put in our press release, that figure then, the adjusted or the net interest margin adjusted by provision -- net provision expense has increased 60 basis points compared to previous years. So this is an issue and that's why it's one of our four basic focal point in our strategy. But up to now we don't have a sense that delinquency levels are increasing. It's simply that the more consumer lending you have, the more top-line growth that you see and, of course, at the cost of more provisions. So it's something that we are very aware. That's why we have been systematically upgrading our admission models and our scoring processes. But up to now we don't have the feeling that this is gathering momentum.

Here the relevant factors are wage increases, which have been growing at around 2% or 3% in real terms in the last two or three years and the absolute level of employment, how many people have a job. And there we have seen good news, especially because the absolute number of people employed has been increased, but also among those that are employed, the amount -- the percentage that is salaried -- is working for a fixed salary because sometimes you have employment. People are employed, but are self-employed and they're basically struggling to go -- to get until the end of the month.

So the amount of people with a stable salary has been continuously risen and the absolute number of people employed also. So that's why those which usually are the early alerts that you have to follow in a consumer lending, we believe that up to now we haven't seen any major deterioration. But it's an issue, of course. That is why it is one of our four focal points for the remaining year. But again, we have a relatively comfortable position on that.

Concerning Banefe, Banefe's cost of credit or net charge-off ratio has been stable in 2006 as compared -- in 2007 as compared to 2006. It's higher than it was the case in 2004, 2005, but that is simply a reflection of -- that the credit cards and consumer lending has been growing faster in Banefe than mortgage lending, another sort of lending. So Banefe, within Banefe we also have a mix that is more profitable, but has a relatively more high level of risk. So that's why the profitability of Banefe is steadily going up, but the cost of credit is also slightly higher than what it was the case three or four years ago.

So again, this is -- one of the business of the bank is to lend money and to charge for the use of your capital. And up to now, we think we have done a good job. Our spreads have increased in line with the higher funding cost and the higher cost of credit that we have seen. And as a consequence, we have seen fairly strong top-line growth, even adjusting for the higher level of provision. And that -- as long as that situation prevails and we're taking a lot of actions to assure that, we think that the situation shouldn't be concerning.

Thank you and our next question comes from Jorge Chang from Larrain Vial.

Hello, Raimundo and Robert. My first question is regarding your exposure to inflation. What kind of measures did you take during 2007 to lower your exposure to the risk of inflation? And in your opinion, how effective were those measures? At the same time, looking forwards 2008, how do you observe the outlook regarding inflation and how could it affect on Santander's financials?

My second question is regarding your market share. I was noting that on early 2005 you were on the vicinity of 23% of market share. And now you are around 21%. My question is whether you feel comfortable or not with these figures. Thank you.

Okay. Well, regarding inflation and the effect that has for the bank, it is worth mentioning that there are basically three lines or four lines that are affected by inflation. One is margins because, given that the Chilean economy is very indexed, all the contracts or all the assets or securities less than -- usually more than one year are indexed to inflation. So -- and usually banks have a mismatch, not only in Chile, in most of the markets, an interest rate mismatch where usually your assets are longer than -- the duration of the asset is longer than the duration of the liability. In Chile, that coincides with assets that are expressed in U.S. indexed inflation.

So usually you have a situation where your assets benefit with higher inflation because you have a positive gap. And also interest rate mismatch is happening at the same time. So last -- in the last year when we have been -- or actually, last year when the most likely scenario was of interest rate increases, we started shortening the length of our assets and increasing the length of our liabilities. That's why we have been very active in issuing long-term bonds and length -- and extending the length of our deposit. And on the income side -- or on the asset side, sorry, we have been taking opposite positions, a short position on the derivative market in the U.S. -- peso derivative market, to reduce the length of the asset.

As a consequence of that, also we have been reducing our exposure to inflation because those derivative are usually with the pesos. So you are reducing your exposure to inflation. That, in simple terms, that means that we have a balance sheet that is less exposed to inflation and a balance sheet that is less exposed to interest rate movements. Part of the result that we saw in the 4Q were linked to these two trends because rates, instead of increasing have been decreasing and inflation also instead of maintaining the level of the 3Q are going down. So bottom line, inflation is reflected in our financial transaction line, in our net interest margin line and in the restatement of the -- price level restatement.

Net-net, the bank has benefited from the high inflation scenario, but much less than what you would expect simply by looking at the net interest margin because you have higher cost. There is the fourth impact that you receive when inflation increases. So [face] in 2008, where inflation probably will go down to 3.5% to 4% level, we think it will have an impact in the margins, no doubt.

It will have a positive impact on the financial transaction line because this contrary position in the derivative market will start having positive results contrary to '07. We'll have an impact also in the price restatement line because you won't have a loss as we saw or a high loss as we saw in 2007. So net-net, it will have a negative impact, but not as large as you would expect because, of course, the bank has taken actions to be prepared for that scenario.

Instead of market share -- in terms of market share, as we have mentioned a number of times, the bank does not have a target for market share -- total market share. We do have, internally, targets for retail market share. We do have targets internally for market share in terms of key lines in the profit and loss statement. We want to have a high market share in terms of net interest income, in terms of fee income, in terms of a low market share in terms of cost, et cetera.

So our internal metrics are focused in terms of recurring profitability. We would like to have a very high market share in terms of profitability and a very low market share in terms of loans -- total loans, especially corporate loans -- because they are very low yielding. They consume capital. They consume liquidity and, given the condition of the market, we prefer to be more liquid and to allocate capital only when you have adequate returns. That's why our strategy in the last five or six years has been merely to focus on profitability, even at the cost of losing market share on the corporate side, which is really -- you can increase your profitability in some cases by reducing the market share in that line.

So we are not concerned about losing total market share. We were concerned about losing retail market share at the beginning of the year. By the end of the year, we are growing at similar level of the rest of the players and we expect a way to grow slightly above the rest of the players in terms of retail lending. And as we mentioned before, in terms of corporate lending, it will depend on the price conditions and the margins that we can achieve. We're not concerned because only 40% of the revenues in the corporate side comes from lending activities. The bulk of the revenue comes from non-lending activities where we have a clear position and we can have a very profitable relationship with the corporate client.

Thank you and our next question comes from Sorine Roibu from BlackRock.

Hi. How are you?

Fine.

I have two questions. First, on the cost of your wholesale funding and, I guess, the mix of it. How much is it domestic and how much is foreign, like from outside? And then what's been happening with cost there? And the second question is on the credit quality. I want to understand better your provision increase in retail banking. You said it's in line with growth, but there was also a one-time because you implemented a more conservative credit model. And then I couldn't hear well on the call. You said that you extended the period from 12 to 21 months.

I guess my question is what did you see there that made you nervous or caused you to take this one-time charge. And yes, that's basically one. Can I understand better why that? And then you also had the reduction in recovery. You said you weren't able to sell the charge-off loans. I guess who are the buyers and why was it so hard to sell these charge-off loans this quarter?

Okay. In terms of funding cost, I would say that the bulk of -- I mean, close to over 90% of our deposits are local, even more than that. It's difficult to know sometimes because you have mutual funds or things that -- or investment vehicles, which are from abroad. But I would say that the bulk is local in terms of deposit. And in terms of borrowing, more or less the same. We have a subordinated debt of 200 and something million dollars, so roughly speaking, above 90%, 95% of our funding comes locally, from local place. We have some activity in foreign trade, but very limited because, as we mentioned before, these are short-term line of credit, which has their spread that the bank has been charged abroad. It's much higher than what you can get -- what you can pay locally.

The Chilean market nowadays is very liquid and it's -- the spreads have been narrowing and, in some cases, being negative. So it's a very -- today it's a very liquid market and that's why we have been mostly financing locally. Extending the length when it is institutional investor and reducing the exposure to higher sources -- the higher sources of funding. So there we have been taking a lot of actions to increase the length of our deposit base and increase the length of our overall funding by means of issuing subordinated debt and senior bonds at a fairly rapid pace.

Concerning credit quality, the point here is that we are in a risky business and as long as you are aware of that and you take early precautions, well, you can have a much more comfortable living. So that's why early in 2006 we start putting more stringent standards for our credit granting process, our scoring process. Which is simply a reflection that people were more in debt, the economy was -- has been reducing its -- the speed of growth, et cetera. Still it's an economy that is expected to grow at 4.5%, 5% with salaries growing fast, the employment growing fast. But you kind of work in the second derivative type of adjustment.

And we start doing a number of things to expand the amount of information that we collected of our clients including not only the performance that the client has, but also how in debt, how leveraged it is, how it's behaving for the -- with the rest of the market and some demographic information that we believe are good predictors of the future payment capacity of the client.

What we did in 2007 was, in addition to those changes that have been gradually adapted, to extend the back testing period. What means is this is that the -- usually you have a situation of a client and you say, okay, how has been this client behaving in a certain period of time? And we have been extended that period of time in order to include more information and therefore to hopefully, to have a more accurate view of the client risk profile. As a consequence of that and given that your length in the period that you are tracking, well, you have more negative information of some clients and therefore you take more provisions. Especially what you're trying to do is to determine the expected loss in the future with those clients.

And given that you have more and more information about the client, in some cases you have a more demanding spread, so you have to charge the client in order to compensate for the expected losses. So it's part of the natural credit cycle that the banks follow and, therefore, when you see that the economy and especially the outside economic situation is less expansive, well, you start taking actions before.

So we have been working on two lines. One is strengthening our approval credit models. And secondly, increasing our spreads in order to anticipate the income that will allow us to support higher level of provisions and charge-offs. That's why we think we are comfortable that our growth, adjusted by the provisions and other measures, are sound and the bank has managed to have fairly strong operating trends.

And regarding recoveries, the bank has followed, in the last year-and-a-half, a policy of selling the majority of charge-off loans that are more than six months old. That means that we are focusing our agents in the near or the relatively new charge-off loans because from the month six on, your cost effectiveness goes rapidly down. If somebody that was charging in month one, after six months of talking to him, trying to arrange some kind of situation, is not able or willing to pay you, it's better to get rid of that client, sell it to a third party and focus your people in the short -- in the first six months after the loan has been charged off.

Regarding who's buying this loan, there are some external buyers and local buyers that I'm not sure what they're doing. I believe that they're trying to do a good business and they believe they have to have advantages vis-a-vis ourselves in terms of collecting that unpaid money. In our case, we are trying to get rid of that because it releases -- you get a down payment for that loans here you sell. Those loans are valued at zero in your book, so it's a net gain for the bank. And especially you focus your team in that timeframe where they are more productive. And more or less that has been our philosophy.

And what happened in the 1Q is that, because of some of the -- in the last Q, because of the other priorities, the sale that we were planning didn't went through and we're doing it probably in the 1Q. So it was something that was kind of anecdotal, has nothing serious behind. Simply that the philosophy, policy is to get rid of loans after six months, more or less, sell it to third parties and focus your attention on those loans that have been charged more recently.

Thank you and our next question comes from Mario Pierry from Deutsche Bank.

Hi. Good morning. Could you just give us a sense of what are you expecting in fee income growth and also in expenses for 2008? Thanks.

Okay. In terms of fee income, we closed the year with a growth of around 20%. We think that the higher -- and that with the higher client base, the cross selling and product usage, should result in a growth in 2008 in -- around the higher teens or 20% as we saw last year. Here the important factor is that we have been increasing mostly fees that are associated with the use of products -- ATMs, credit cards, mutual fund fees, et cetera. So contrary to the other type of fees, which are more the plus type of fees where you charge whenever a client, for example, doesn't have a minimum balance, we believe that those fees are associated with the use of our product and more recurring. So basically, although we are not giving clear guidance, something between 15% to 20% could be a good range.

Regarding expenses, expenses will increase probably at a higher pace as compared to 2007, mainly because of the higher level of inflation that we had in 2007, which will have a lag effect in 2008. So if this year we closed with growth, of course, of 10%, more or less, we should expect something a little bit higher than that for 2008, mainly because we will keep on having high commercial activities, more clients, but also because we have this one-time increase due to a higher inflation of 2007.

The point is that we are very committed to keeping cost under control and to finance part of the branch expansion and the client activities with internal savings. So if we see that market conditions deteriorate and on the income side the growth is more subdued, no doubt we will start tackling costs, not by means of slashing fixed or heads, et cetera, but by means by increasing our productivity. We have space. We have been doing major changes in our computer platforms in the last two or three years and still there is a lot of benefit to be reaped from that process.

All right. Thank you. And just another question. How are you -- I mean, just potential impact from the merger between Banco de Chile and Citibank, how do you think that would affect you in any way? Thanks.

Well, we think that the short-term could be, because opportunity usually mergers are very distractive. You have to do a lot of homework, internal homework, and sometimes you get less focus on the market, on the clients, which could be a short-term opportunity, something that we are not counting and we're hoping that that merger goes very smoothly. In the medium and long term, we believe that it's good for the market.

What happened is the following. We are, at Santander, very committed to increasing the [bankerization] in Chile and throughout Latin America. That means that more people comes and have ample relationship with banks. In that effort, we need other strong partners to expand the market because, again, sometimes people believe that this is a zero sum game where whenever somebody is strong it's because of the other players. When you have an expanding market and when you are taking actions to expand the market, you can have both players to win in the process than to expand.

The example I have in my head is what happened with retail. In Chile, retailers has been concentrating -- supermarkets, department stores -- and at the same time dramatically expanding the size of the market because there were, instead of very fragmented operators, you have a bunch of very strong operators that can and are willing to expand the market. And that's why we believe that medium term we will have -- the size of the market could be expanding more rapidly than if you have weak -- weaker players. And that's why we think it's good.

Of course, the other factor is that we used to compete both with Banco de Chile and Citibank on a standalone basis and, therefore, the merger doesn't change too much the nature of the game that we were playing. It would be good probably on this cost side for the new entity, but not necessarily we will see changes on the commercial side because we already knew what they were doing by -- on a standalone basis. So -- but on a more fundamental point, we think that at the end it will be good for the bankerization process that we are trying to push to have stronger players, to do investments and have the medium term view that it's one that's resulting in increased bankerization levels as we have seen in other markets.

Thank you.

And our next question comes from Juan Partida with JPMorgan.

Hi. I have a follow-up question on Banefe. In particular, the charge-off levels there are also significantly higher, sometimes two or three times higher than other comparable consumer finance companies in Chile. Is that purely a reflection of the mix of the business versus the competitors? Is it that you're more conservative? Is it that you're less efficient? If you could give us an idea there.

Okay. Well, first of all, Banefe is aimed at the low to middle low income segments. And therefore, the absolute level of delinquencies and the absolute levels of charge-off is much higher than lending money to the high end of the consumer market. But if you compare, the units are comparable with other banks and some banks are related to retailers. I would say that the comparisons are very favorable for Banefe in terms of delinquency levels are very similar and Banefe has levels of ROE compared, for example, to the banks of -- belonging to department stores, which are much higher than them. It's simply that you have to compare banks or units within banks that are operating in the same market.

We think that Banefe is outstanding in terms of efficiency, in terms of asset quality and in terms of profitability as compared to the units that are granting loans to this segment and compared to the banks of the retailers. So, of course, the level of delinquencies in Banefe is much higher than for the rest of the bank but the same is true for the spreads that you can charge in that segment. So again, the game is very similar whether you are aiming at the low end of the consumer market or at high end of the consumer market.

It's the relationship between the income you can generate, the fees, the spreads, et cetera, vis-a-vis the risks that you are following and the cost that you have to pay for processing and for operating with those segments. In Banefe, you have high unit cost, high provision, unitary provisions per loan, but the spreads are proportionately very high. Net-net, Banefe is much more profitable than the rest of the bank.

Thank you.

Thank you. And Mr. Monge, there are no further questions at this time. I'll turn the conference back over to you, sir.

Okay. Well, thank you very much for attending today's call. We look forward to see you, to hear about you again. Thank you very much.

Ladies and gentlemen, that concludes today's conference. We appreciate your attendance and have a wonderful day.