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________________________________________________________________________________________________________________ Professor Gunnar Trumbull and from HBS Europe Research Center, Research Associate Elena Corsi and Research Assistant Andrew Barron prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2010 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

G U N N A R T R U M B U L L

E L E N A C O R S I

A N D R E W B A R R O N

Santander Consumer Finance Centralization only makes sense if the final result is better than the simple sum of the parts.

— Magda Salarich, CEO, Santander Consumer Finance

Introduction

On March 25, 2008, Magda Salarich Fernández de Valderrama, the Chief Executive Officer (CEO) of Santander Consumer Finance (SCF), a division of Grupo Santander, looked out across the bank’s shining new campus, the Ciudad Financiera, just south of Madrid. Salarich had been appointed CEO in January 2008 after working for 28 years for the French car producer Citroën, where she had risen through the ranks to the position of international marketing and sales manager for Europe and CEO for Spain. SCF had grown rapidly in the past five years under its former CEO, Juan Rodríguez Inciarte. Salarich’s job would be to chart the way forward for the next ten years.

While the United States remained the largest market in the world for consumer finance, the sector had also been growing in the last 20 years within Europe. Inciarte had captured this trend. Under his helm (2002-2008) SCF had grown from a small group of units operating in Spain, Germany and Italy, into one of the largest consumer finance companies. Also, since 2006, Inciarte had invested outside the EU: in the United States, Latin America and Eastern Europe.

In four months, Salarich would have to present a new strategy and direction for SCF to Santander’s Chairman and Executive Director, Emilio Botín-Sanz de Sautuola y García de los Ríos, as well as to the other members of the group’s Executive Committee, including Inciarte himself. Important decisions had to be made. Could the high profitability of the consumer lending activities be sustained? Was it time to focus more attention on consolidation, or should she further invest in new markets and products? There were also important questions of organizational strategy to address. Which functions should be led to national affiliates to decide, and which should be centralized at headquarters? What processes should be standardized, and which left to local initiatives? And all of these decisions would be set against a background of growing concern about the sustainability of household debt levels in Europe and the United States.

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History of the Santander Group

The Santander Group was founded in 1857, when the Queen of Spain authorized through Royal decree the creation of a bank in the city of Santander, in Cantabria, northern Spain. Seventy-two local businessmen subscribed to the bank’s capital. Through the years the bank increased its business in Spain and in the 1950’s it opened offices in a few Latin America countries and in London. Under the leadership of Emilio Botín, who succeeded his father as Chairman and CEO of the group in 1986, the bank reinforced its position in Spain launching products such as Supercuenta that doubled the bank’s market share on deposits and with the 1994 acquisition of Banco Español de Crédito (Banesto) and the 1999 merger with Banco Central Hispano (BCH). Botín also expanded to foreign markets, acquiring banks and opening new offices in Latin America, Europe and the United States.

To keep pace with its rapid growth, in 2004 the Group re-located operations from downtown Madrid to the Ciudad Financiera Santander, a 160-hectare financial campus in the suburbs, with also education and training facilities, sports facilities including an 18-hole golf course, on-site childcare amenities and an art gallery. By 2007, when the Group celebrated its 150th anniversary, the Santander Group was one of the largest banks in the world in terms of market capitalization and net profit. It operated the largest network of retail banks in the western world. (See Exhibit 1 for the Group’s financials and breakdowns by business division.) The Group also operated in the wholesale banking, private banking, credit cards, asset management, and insurance businesses and, through SCF, in the consumer finance sector.

The History of Santander Consumer Finance

Santander Consumer Finance had its roots in 1987, when Banco Santander acquired Bankhaus Centrale Credit AG (CC Bank), a German bank operating since the 1950s with 51 branches and specialized in the vehicle financing business. One year later, the Santander Group partnered with the Royal Bank of Scotland to jointly control, strengthen and expand CC Bank. New branches were opened and in 1994 CC Bank also launched Direkt Bank, a branchless, direct telephone bank that also offered credit card services. The shared ownership agreement with Royal Bank of Scotland continued until 1996, when Santander bought out its partner and assumed full control of CC Bank. Remembering those years, Inciarte, at the time CFO at Santander, explained:

Under the terms of the shared ownership agreement Emilio Botín and I sat on Royal Bank of Scotland’s board. This partnership was very influential on the development of Santander’s consumer finance business. It helped us to understand the growth of the consumer finance market in the United Kingdom and gave us many useful insights into this business. What was happening in the United Kingdom, we believed, could spread to the rest of Europe.

Subsequent mergers gave them more exposure to consumer lending. In 1997, Santander entered the Italian market by assuming joint control with the bank Banco San Paolo IMI of Finconsumo—a consumer finance company. In 1999, Santander’s merger with BCH brought to the group Hispamer Banco Financiero and Hispamer Financieros. In the meantime, CC-Bank had expanded into Hungary and Austria. In 2002, the collection of national consumer lending groups was brought together under a new division within Santander, SCF.

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Expansion of SCF

Under the leadership of Inciarte, Santander Consumer Finance focused on growth. He recalled, “When our Chairman and Chief Executive asked me to head up the new division, I was afraid that the Group wanted to get rid of me because it was a very small business. It did not even have a common global brand.” Inciarte first moved to expand the business to the major European markets. He explained:

Germany, the United Kingdom, Spain, France, Italy, and Poland are the European markets that count in terms of GDP and population. It’s like in the United States: if you are not in Texas, Florida, New York, Chicago and California you are not there. We wanted to become European. All Europeans drink Coca Cola, buy furniture from IKEA, and like cars. It seemed relatively easy to create a pan-European franchise for financing consumers. We were already in Germany and Spain, we looked at Italy, and we bought a stake in San Paolo IMI in 2003.

Between 2003 and 2006, other acquisitions followed in other European countries. In 2006, SCF started investing outside the European Union (EU), first in the United States with the acquisition of Drive U.S., then, in 2007, in Mexico and Russia. In 2007 Inciarte also invested in a Greenfield operation in Chile, which started operations in 2008. (See Exhibit 2 for a summary of SCF’s acquisitions.)

As SCF’s geographical coverage expanded, Inciarte turned his attention to the organization of the division and the impact of their brand. Javier San Félix, SCF’s former Chief Operating Officer and now the head of one of SCF’s business areas, explained:

When I joined in 2004, SCF was a mere sum of different units placed in different countries, with different business models, operations, IT platforms and marketing approaches. We wanted to make it worth more than the sum of the parts. First we integrated the different brands. The SCF brand was not known outside of the [Santander] Group as each affiliated company maintained its name. We changed their names into SCF. Secondly, we centralized the decisions concerning funding, and thirdly we centralized the customer data centers.

By June 2008, SCF operated in 20 countries. Within Santander, SCF accounted for 5% of the Group’s total workforce and generated almost 8% of the bank’s total profits. The largest market remained Germany. (See Exhibit 3 for SCF’s financials.)

The European Market for Consumer Finance

There are still big differences between European countries in terms of consumer credit market size, consumer credit to GDP ratios (penetration) and consumer product mix. These differences are due to different levels of market maturity, economic developments, local regulations and cultural factors.

— Salarich

Consumer finance included any kind of lending to finance consumer’s purchases outside of mortgage for real estate. It was certainly not an invention of the 20th century. Stores in the 19th century had offered sales credit to their regular customers; and pawn shops had been active in Europe since the middle Ages. But it was the growth of the consumer durables manufacturing sector in the interwar and post-World War II era that made consumer credit an accepted feature of modern society. Innovations in risk assessment, data processing, and financing all contributed to a boom in consumer lending starting in the late 1980s. By the end of 2007, retail lending to consumers— excluding mortgages—accounted for $6 trillion in outstanding balances, of which 51.5% was in the D o

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Americas, 30% in Europe and 18.6% in Asia.1 The United States long had been and remained the largest market, with $2.5 trillion in outstanding loans. (See Exhibit 4 for U.S. market figures.)

Since the 1980s, Europe’s consumer lending sector had grown in economic importance and sophistication.2 (See Exhibit 5 on consumer credit in Europe.) San Félix described this change, “The main driving force is that Europeans are becoming more like the Americans in terms of consumption patterns. We are consuming more and this leads to the growth of consumer credit. Yet, in Europe the penetration of consumer lending started from a much lower level than in the United States. It is hard to predict if we will reach 100% of America’s levels”. As SCF’s Director of Investment Analysis, stressed, “The average American still has more than twice the amount of consumer debt than the average European (EU15).”

By the end of 2006, consumer lending in Europe represented roughly €1 trillion of outstanding loans.3 While smaller than in the United States, the European consumer credit market also had distinctive features that made it qualitatively different. First, the average default risk on consumer loans in Europe tended to be lower. One area manager commented, “Compared to the United States we are like in a dreamland in Europe. We can sleep well every night because our risk is very predictable.”

Second, consumer lending in Europe was based less on sub-prime borrowers. Interest rates were not commonly adjusted to account for individual risk, and a smaller share of lending was on revolving accounts.i An area manager explained, “Europeans do not play with interest rates. Revolving credit tends to be applied only to credit cards and to current accounts’ overdraft facilities. Personal loans (and mortgages) tend to have fixed rates. This is fair to the client. We want to give the client who has to face 16 months of instalments a clear picture. We do not want surprises.”

Institutional features of Europe’s national credit markets also limited the possibilities for managing risky products. Credit bureaus worked at the national level, and each country imposed different standards about how data could be collected, processed, and distributed. None of the national bureaus offered credit scores. Some countries, like France, had centralized credit rating databases that recorded only negative credit episodes. New loans could be checked against this ‘black list’, but no centralized positive data, including total volume of outstanding loans, was available. Germany provided slightly more information, but not enough to assess the riskiness of new customers. An area manager said, “The agency tells you if the customer is overdue and if he has not finished paying his past loans. It does not give us current and positive information. It is thus hard for us to adjust the price of the loan to the customer’s risk profile.” In the United Kingdom, where consumer lenders provided credit to riskier borrowers than in most other European countries, three private credit reference agencies provided lenders with positive information.4 Yet, by contrast, they were explicitly banned from creating a lending black list, and could not themselves process the raw data to generate a credit score. This left lenders to determine the riskiness of potential borrowers based on their own internal risk models.

Other features of national economies drove dramatic differences in national consumer credit markets.5 The cost of credit varied from 6% in Finland to 12% in Portugal; outstanding loans to GDP ranged from 3% in Hungary, Switzerland, and the Check Republic to more than 10% in Germany, Norway, Sweden and the United Kingdom (2004);6 default rates ranged from around 7% in Eastern Europe to around 1% in Germany, Denmark, Austria and the Netherlands.7 While the German and

i Sub prime lending was lending at a higher rate than the prime rate, a reference interest rate used by banks to lend to clients. Risk based pricing was the practice of determining the interest rate on a loan, also by looking at the credit risk profile of the borrower. Revolving credit was a type of credit which did not have a fixed number of payments. D

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the UK markets seemed to be approaching maturity, others markets, in Greece and Scandinavia, were now booming. (See Exhibit 6 for country comparisons.) A former SCF Business Area Manager added:

European consumer credit markets are very different from each other also in terms of products. For example in Germany there are no credit cards and Germans tend to rely heavily on bank overdraft facilities, which are instead rare in Spain and France where credit cards are mostly payment cards. In the UK, where debt is more of the unsecured type (with variable rates), credit cards are mainly of the revolving type. Italy and Belgium instead are markets where credit cards are less used. Here people tend to buy less on credit and save more.

While the 1992 Single Europe Act formally removed barriers to capital flows within Europe, cross- border consumer lending remained tiny; it was estimated at between 2% and 5% of all European consumer loans in 2002.8 Banks and institutions that operated in foreign markets had done so by acquiring local institutions, opening local branches, or through joint ventures.

The low level of intra-European lending had been attributed to cultural, natural and regulatory barriers.9 On the demand side, customers seemed to place greater trust in national, proximate providers with which they shared the same language and culture. National differences in consumer protection standards and remedies across Europe reinforced customers’ preference for local providers in so far as it raised the uncertainty of comparing credit offers across different countries.

On the supply side, cross country regulatory differences led to high market entry costs and complicated the organization of the business for consumer credit companies with global aspirations. One manager explained, “In some countries, like France, the government sets interest rate caps. Thus here we would not be able to aggressively promote our personal loans as we could not compensate for the higher risks. You need to adapt to the field.”

The Consumer Credit Directive

The sooner the integration process advances the better for us. At present, we operate in several European countries and that positioning would allow us to offer... pan European products.

— Salarich

In an effort to promote integration, in 1987, the European Commission introduced the first European Union (EU) consumer credit directive. Its goal was to set some basic standards regarding procedures and reporting. In January 2008, after six years of negotiation, a new and more complete EU directive on consumer credit was approved. Covering all types of consumer loans between €500 and €50,000,ii the directive made three steps toward market integration. It harmonized the method used for calculating the annual percentage rates (APR) applied to loans, thereby allowing consumers easily to compare the cost of one loan with another. It gave consumers the right to receive information on fees, monthly repayments and APR before signing the contract, and the right to withdraw from any credit contract within the first 14 days. It banned prepayment fees, which imposed an additional cost on consumers who wished to repay loans before they reached maturity. Finally, it gave consumers the right to withdraw from credit contracts if the purchase they were associated with was canceled.

The EU directive generated negative reactions. The Bureau Européen des Unions de Consommateurs (BEUC), a European consumer’s organization, welcomed the steps taken in the ii Loans secured on property (house purchase or home improvement) were excluded as they would be dealt with separately in a Mortgage Credit Directive. D o

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directive to improve transparency, but regretted that it did nothing to address consumer over- indebtedness.10 Eurofinas, the European federation representing the national associations of consumer credit providers, claimed that the new EU Directive was a missed opportunity for integration.11 The European Banking Federation criticized the new legislation as it introduced a heavy burden of bureaucracy but did not improve consumer choice.12

The EU directive also received a mixed reaction at SCF. They were disappointed that it did not do more to integrate Europe’s credit markets. One manager remarked, “Since SCF operates in so many countries, an integrated market for consumer credit would deliver commercial, tax and operational benefits. We could establish a single platform for doing business.” Transparency could only go so far. The head of the German operation noted:

Providing consumers with more information does not necessarily improve things. The consumer wants to know: the prices of his new and old car, the number of instalments, the interest rate, the amount of the loan, and perhaps the option of life insurance. Any other information does not increase protection, but generates confusion. You arrive at a situation where you need to trust that the Porsche you want has 6 cylinders if the salesperson says so.

For the near future, SCF would make its plans based on the assumption that Europe’s credit markets would remain fragmented. One former business manager summarized:

An integrated market remains for now a distant reality. I would even question the figure that cross-border lending accounts for 2% of total consumer lending. It probably only reflects the lending of English people to buy homes in France or Spain. I am skeptical about how far European consumer credit markets can be integrated. Consumer credit companies need to be near their customers. Therefore, I really cannot see any capacity for cross-border activity.

Santander Consumer Finance’s Business Model

Santander Consumer Finance’s largest lending activity was auto finance: the provision of loans for car dealer’s clients to acquire cars (i.e. retail car loans), sometimes tied to loans for dealers to finance stock. (See Exhibit 7 for a breakdown of SCF’s sales by product.) In a few markets, SCF served also retailers by financing credit for their clients (i.e. durable loans)iii and, sometimes, for their stock.iv In addition to these core products, and depending on the market, SCF provided related financial services: payment-protection insurance, credit and debit cards, co-branded credit cards, on- line banking, personal loans, deposits, debt-consolidation servicesv and mortgages. (See Exhibit 8 for SCF’s product portfolio by country.)

SCF’s approach to the market varied depending on the product. For the retail car and consumer durable loans, SCF used an indirect approach and relied on car dealers and retailers—including supermarkets, electronics shops, and jewelers—to attract new customers and market its credit. This point of sale (POS) strategy kept SCF one step removed from individual consumers, but it also placed a lot of emphasis on their POS clients. One , “It is very important for us to find good partnerships

iii Consumer durable loans were loans to finance consumer products that were expected to last at least three years and to be purchased in a store (such as televisions, fridges and so on).

iv Stock finance loans were loans to finance dealers and retailers’ inventories of cars or long term (i.e. durable) consumer goods.

v Debt-consolidation services enabled consumers to take out a new personal or secured loan to cover their several existing debts incurred for example from credit cards, store cards, or personal loans D

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with car dealers and retailers. First of all it is through them that we offer our car and durables loans. It’s the car dealer or the retailer who proposes to the client our loans, not our sales team. POS clients do not even know that we are behind their loan.”

For all of their other products, SCF had a direct approach that relied on its own sales teams. Their primary strategy was to sell direct products mainly to its indirect car loan and durable goods loan clients. (See Exhibit 9 on SCF’s business model.) SCF referred to this process as ‘conversion’. “Once the first (indirect) contact is established,” said José Luis Castañeda, former SCF’s Director of Investment Analysis, “then we start contacting the customer to offer our other products.”

SCF had developed a credit-approval system that car dealers and retailers could access online. The process worked in one of two ways. In the first arrangement, dealers entered information on line about the client, the purchased car or durable, and the desired loan. SCF then allowed dealers to view in real time the commission they would earn from different variation on loan contracts they might conclude with the client. In the second approach, SCF and the dealer agreed only on a baseline interest rate: if the dealers secured loan agreements with interest rates exceeding the set baseline, they received the difference as commission; if it was below, they paid the difference to SCF.

In both arrangements, SCF paid the commissions upfront. This created room for manipulation by dealers. Thomas Hanswillemenke, Director of Importer Business & Dealer Care Centers in Germany, commented, “If customers terminate their auto loans early we bear the losses. If dealers develop a business model that encourages customers to pay back early, we ask them to stop or we put an end to our collaboration.”

Once dealers had filled out their customers’ loan application, the data was sent to SCF for processing. Typically, an individual loan request could be approved or rejected by SCF in just over three minutes. Francisco J. Gimeno Jiménez, former SCF Chief Information Officer, explained, “Speed is crucial in the auto-loan business. If dealers cannot process loan requests quickly, customers will walk off their car lots and take their business elsewhere.”

Converting Indirect to Direct business

In a few cases, with the car or durable loan, the car dealer or retailer would also offer other complementary products, such as insurance. Yet, explained one area manager, “Auto dealers and retailers’ sales personnel sell to their own interests and to their abilities. We provide them training, but dealer and lender interests are not always aligned. We need face-to-face contact with customers.” In addition, the POS would ask for an extra commission to sell the other products which were also more profitable for SCF. (See Exhibit 10 on the profitability of SCF’s products.) Castañeda commented:

Competition in the POS business is very fierce, with dealers continually demanding higher commissions. This is why our margins are low there. Thus, once we have reached the clients through the POS and tested that they are good clients, we try to convert them from indirect to direct ones by proposing our other products with higher margins.

Once the customer signed the car or durable loan, SCF’s would start sending promotional mailings about other products. The former head of the German operation explained:

Each car dealer or retailer is a multiplier, capable of providing us with up to 5,000 sales tickets per year. Through our indirect sales channels, we secure over 100,000 new clients every month. We have a clause in the car loan contract asking permission to send promotional mailings. If they agree, then we send letters every four to six weeks to inform the customers D o

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about our other products. We send out around 30 million mailings per year. In the past, we preferred to have little contact with our clients, as we thought it increased costs. We were almost relieved when the loan reached maturity. Today, we see the typical 60-month lifespan of a car loan as an opportunity to build a relationship with our clients.

According to one area manager, it was often easy to decide which type of complementary products to offer indirect customers. He said, “For example, if customers borrow money to buy a TV, they automatically set themselves out as loan customers. Their behavior suggests that it would not make sense to offer them savings products.” Locally-engaged data analysts also mined the data collected by dealers and retailers to rate indirect customers as either prime, near-prime or sub-prime customers.

In Spain and Germany, SCF was also using their networks of branches to convert indirect clients to direct ones. The head of the German group explained, “It is very important to sit down with potential customers in one of our 81 branches and give them face-to-face contact with our sales personnel.” Other tools were developed to assist the conversion. In Germany, for example, the company developed the AutoDispoPlus, a co-branded credit-card, which provided auto-loan customers with credit facilities for spare parts, vehicle inspections, repairs, and insurance and could also be used to withdraw money. The card was offered as a gift by the dealer to the less risky clients. As one manager explained, “The dealer offers the card to the customers after having filled in the online loan request. The first time the clients use the card they become direct customers. We do not really make money with this card, but we establish a link. Dealers also see the advantage of distributing this card”.

Conversion rates differed depending on the business and the country. “For example, in Germany we manage to convert roughly three out of every 100 car-loan customers into direct ones. Among durables-loan customers, the conversion rate is closer to six out of 100”.

Main Competitors

SCF’s main competitors in Europe were the American GE Money, and the French BNP Paribas (Cetelem), as well as the consumer-finance divisions of Crédit Agricole (Sofinco and Finaref). (See Exhibit 11 on SCF’s competitors.) The division competed also with local banks and financial institutions and, in some countries, with Santander’s own network of retail banks. A former manager explained, “Nothing prevents a British consumer from obtaining a loan from Abbey, a bank part of Santander Group, and using that money to buy a car rather than securing auto financing from the British SCF. Similarly, Spanish customers are free to finance their auto purchases either through SCF España, or with loans from a Santander retail bank.”

In the auto financing business, the company operated in parallel with car manufacturer’s captives—finance companies usually wholly owned by the car manufacturers and used to provide credit to car dealers for acquiring stocks and financing customers (such as Volkswagen Bank, GMAC Bank, FordBank or Peugeot Financement). Hanswillemenke explained, “In the car industry, captives are marketing tools. For the car manufacturers it is very expensive to reduce capacity in production or to take back an unsold car. Captives thus provide dealers with incentives such as cheap loans or sales premiums to boost sales of new cars or less requested models.”

Another area manager explained, “Take a Ford dealer that sells around 500 new cars and 5,000 used cars per year. Each year Ford has to convince the dealer to buy its new cars and needs to come up with incentives. Through their captives, car manufacturers can offer very interesting stock-finance arrangements to the car dealers.” D

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Faced with this competition, SCF’s goal was not to replace captives but to be the number two financer of new cars after captives, and the number one financer of used cars. One area manager explained, “We encourage dealers to take full advantage of car manufacturers’ incentives to finance their stock of new cars if the offer is economically interesting. Dealers should turn to us only after having exploited such incentives, or if they are not interested in acquiring new cars”. Similarly, SCF did not compete with captives in the new cars retail financing business. He continued:

In this business, captives can offer the POS client loans at very low rates. We cannot compete against them. This is a sort of subsidized credit. Yet these offers are usually limited to specific car models and ask the customer to provide a down payment. The dealer will present our offer to a customer who cannot afford the deposit or does not like that particular car.

In the used car business, SCF competed directly with the captives. “Car manufacturers are less interested in this market. Here captives use weapons similar to ours”.

SCF’s Structure

To be close to the local markets, Santander Consumer Finance had adopted a decentralized structure. A manager explained:

We build on the strengths of diversity and avoid a business model that offers the same identical product to everyone. From a marketing and pricing perspective, we need to adjust to the local territory. Of course, we can supervise, give advice and provide capital and technology from Madrid. But a critical factor for success is having people who understand local needs. It’s difficult to identify local needs from Madrid.

The importance of focusing on local needs was echoed by a former manager:

SCF’s growth has been driven by acquisitions and joint ventures with local companies, with the result that our national teams are staffed by local employees. We would not have been able to grow so quickly if we had headed up our local operations with Spanish people who would have needed at least a year to get to grips with the local environment and regulations.

SCF was organized in four geographical areas, each headed by a manager: Spain, Portugal, Chile, and Italy; Eastern Europe and the Scandinavian countries, United Kingdom and Mexico; Germany and Austria; and North America. Still, the local branches enjoyed considerable autonomy.

Each local branch had a person in charge of legal issues to monitor local regulations and data collection centers. Recently, SCF had introduced in most of the local branches a manager in charge of promoting the insurance business. Local branches were also in charge of product development. If a new product entailed new risks, it needed the approval of a central committee. Collections were treated differently depending on the setting: “soft” collections were outsourced in Spain but kept in- house in Germany and Russia. “Hard” collections, for which national legal standards differed considerably, were always outsourced.

Despite the local branches’ large autonomy, certain functions were centralized: risk management, cost control, the IT platform, monitoring of customer’s (i.e. dealers’) satisfaction and funding. Customer information databases had been partly centralized, but the process was complicated by differences in national data privacy standards. Gimeno remembered, “In 2004, SCF centralized the European data-center operations by relocating its 11 data centers to two new locations in Madrid and London. It took us quite a long time and lots of paper work.” Provisions of the 1995 EU Data Privacy D o

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Directive blocked European companies from sending customer data to countries without adequate data protections. This would make it hard for SCF’s Latin American, U.S. and Russian databases.

Funding

To finance its loans, Santander Consumer Finance drew on a number of sources, including senior debt, commercial paper, asset-backed securitization, and customer deposits. (See Exhibit 12 on the sources of funding.) When possible, SCF encouraged funding from local deposits. By 2006, customer deposits—from banking operations in Germany, Spain, Portugal and Italy— represented the division’s largest source of funding. SCF’s Chief Financial Officer (CFO) explained that, “Local funding is cheaper because we can avoid doing currency swaps.”

SCF also securitized pools of car loans, and this was becoming an increasingly important source of funding for the division. Here again, though, the European market remained fragmented. The CFO explained, “Owing to regulatory restrictions, loans can be securitized on a country-by-country basis only; we are not allowed to perform cross-country securitizations, even if this would be better for us as it would allow pooling risk across different countries.”

SCF’s country offices also obtained funding from the Santander Group. The CFO argued, “Securing funding from the Group provides SCF with an advantage over our local competitors in terms of cost of funding. The cost of funding would be higher for local operations if the branches did not belong to the Group”. Interest rates for country branches were adjusted based on business and country risk criteria: whether it carried the Santander brand name; the size of the market in relation to SCF’s business; per capita GDP; and the country’s sovereign credit rating.

SCF’s Approach to New Countries

Santander Consumer Finance’s wide geographical coverage allowed it to spread risk. In addition, SCF hoped to learn from its different businesses. San Félix gave the example of the United States:

We are exporting know-how from our U.S. operations to Europe. Not only do we learn how to price the product to the consumer’s risk, a practice that Drive has been doing for years and that it is something that Europeans are starting to do just now. We also learn that the business model needs to be well aligned to the needs of the segment of risk that we are serving. If you build a business focused on a particular segment of risk-- if you have clear ideas about your likely rate of default, the number of cars you are going to repossess, and how you will remarket the cars—then you will make a lot of money. If your business model does not make sense, even if you price your products high, you stand to lose a lot, even in the United States.

SCF’s approach had been to cover the main European countries in terms of GDP per capita and population. Castañeda explained, “SCF invests in countries with a large population or with high GDP per capita growth rates (or good expectations of growth). Of course countries that meet both of these prerequisites are better, but here competition is in general higher.”

A former manager noted that the entrance into the new EU member states had not posed any major difficulties for SCF:

In Eastern Europe credit is something new. They still have the mentality that if you owe something you have to give it back. In addition, they want to be part of the EU. They want to D o

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catch up and be good citizens. If you go to Poland or the Czech Republic today, you can see that they are less rich than Western European countries, but they’ve adopted a similar financial culture.

Yet, the fact that credit was new in former communist countries also meant that some institutions were missing. He continued, “Institutions as important as collection agencies did not exist or were less developed. So in some cases we had to do it in house, like for example in Poland or Russia. But just for the first years.”

Efforts to gain a footing in countries outside the EU posed additional challenges. When Santander entered Russia, in 2007, the banking sector was still in transition. Under Russian financial regulation, the banking authorities had the right to revoke the license of any bank that lost money for three consecutive months. For a new consumer lender, this provision posed clear problems, and Santander chose to enter Russia as a financial firm rather than a bank.

Despite these challenges, SCF saw Russia as a market with strong potential. Most Russians owned their apartment in the wake of post-Communist privatizations. Salaries were still not high, but the property gave them a high level of wealth. And borrower risk seemed to be low.

One manager added, “Each European country presents SCF with its own specific set of regulatory constraints. We have to be extremely flexible: we cannot apply the exact same model in all countries. When deciding whether or not to enter a country, we consider what we can and cannot do, and then work out which business model to apply.” (See Exhibit 13 on SCF’s product sales by country.) In Germany for example, SCF was less focused on mortgages. Hanswillemenke explained, “Mortgages are not convenient for us. Interest rates are low. Also, they limit our possibilities to sell other products as mortgage clients have to pay large installments and for a long time”.

Looking to the Future

Consumer Finance is a cyclical business. You see that in the US and in Europe. The consumer business goes up and down. We are in a down period. We see liquidity problems worldwide, , automobile sales are flat or descending and we will soon have a new EU directive. There is a pressure on margins, decreasing financing volumes and worsening of credit. But SCF sees good opportunities vs. competitors in this environment due to know-how and belonging to a large and solid financial group.

--Salarich

As Salarich contemplated the future of Santander Consumer Finance, three big questions laid ahead. The first dealt with expansion. New consumer credit markets were emerging around the globe. Should Santander move to operate in these new markets? A manager at SCF had noted both the promise and the challenge these new markets might pose for SCF:

Some people look at GDP per capita to understand where consumer finance will go. I look at cars per inhabitant. In Brazil you have 4 times the population than in Spain but the same number of cars. Growth will come from emerging countries such as Brazil, India, and China. [See Exhibit 14 for some figures]. Yet they are very different from the countries where we are now. Before investing here we need to make sure that our core business is strong enough.

The second challenge was in consolidation. Which functions should be centralized in order to gain efficiencies, and which should be left decentralized? A manager noted: D o

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Inciarte managed to find all these new opportunities and make the bank’s board accept them. We identified four areas that need to be improved: stock finance, client’s conversion, payments’ collection, and insurance. The discussion is how do we do that? Do we set up a central department that tells local managers what to do or should we hire them locally? Some countries already complain that HQs exercise pressure on them. Yet, products succeed when you have someone dedicated to them and we have a lot to learn at a cross country level.

Finally, Salarich had to decide on SCF’s product mix. Historically, its strength and competitive advantage was in the auto loan business, a low risk business but with lower margins. Yet recent experiences both in the United States and with non-auto consumer lending had shown potential for expanding into higher-return businesses. To what extent should they move into direct personal lending? And could they apply the loan pricing strategies they learned from their US subsidiary, Drive, to European car markets? Salarich had four more months to decide.

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Exhibit 1 Santander Group Key Data

a) Santander Group’s Balance Sheet, Income Statement and Employees 2005-2007

Data in € million unless otherwise specified

2005 2006 2007

Total assets 809 107 833,873 912,915 Customer loans 435 829 523,346 565,477 Customer funds under management 651 360 739,223 784,995 Shareholders’ equity 35 841 40,062 51,945 Total managed funds 961 953 1,00,996 1,063,892 Net interest income 10,324 12,076 14,882 Commercial revenue 17,541 20,184 24,096 Gross operating income 19,076 22,333 27,095 Net operating income 8,765 11,218 14,842 Net profit from ordinary activity 5,411 6,674 8,518 Attributable profits to the group 6,220 7,596 9,060 Number of employees 120,047 123,731 131,819 N° Branches in Continental Europe 5,389 5,772 5,976 N° UK 712 712 704 N° Latin America 4,100 4,368 4,498 Total N° of branches 10,201 10,852 11,178

Notes: all data was in € million unless otherwise indicated.

b) Santander Group Key Data by Geographical Area, 2007

Group Key Data by Geographical Area Gross Operating

Income (€million)

Net Operating

Income

Profit to the Group

Employees Branches ROE

Continental Europe 12,843 7,736 4,423 47,838 5,976 21.3 Santander Branch Network 4,747 2,863 1,806 19,392 2,887 22.7 Banesto 2,282 1,312 668 10,776 1,946 18.3 Santander Consumer Finance 2,638 1,867 719 7,221 285 34.1 Portugal 718 672 511 6,405 763 28.6 United Kingdom (Abbey) 3,780 1,913 1,201 16,827 704 32.3 Latin America 10,386 5,308 2,666 65,628 4,498 29.1 Financial Management and Equity Stakes

86 (665) (180) 1,526

Total Group 14,842 8,111 131,819 11,178 19.61

Source: Company data.

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Exhibit 2 Santander Consumer Finance's Key Dates

1987 Acquisition of Bankhaus Centrale Credit AG (CC-Bank)- Germany 1990 Acquisition of Hispamer following the merger Banco Santander / Banco Central Hispano 1996 Full control of CC-Bank 1997 Joint ownership of Fininconsumo- Italy- with Banco San Paolo IMI 2001 Creation of the Santander Consumer Finance Division from Hispamer, CC Bank and Finconsumo 2002 Acquisition of AKB-Germany 2004 Acquisition of Finconsumo – Italy (remaining 50%) 2004 Acquisition of Elcon & Bankia- Norway 2004 Acquisition of PTF-Poland 2004 Acquisition of Abfin- Netherlands 2005 Acquisition of SC-UK (start-up) 2006 Acquisition of Unifin-Italy 2006 Acquisition of Interbanco- Portugal 2006 Acquisition of Drive-USA 2007 Acquisition of Mexico (start-up) 2007 Acquisition of Extrobank- Russia 2007 Chile (start-up, operative 2008)

Source: Company data.

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Exhibit 3 Financial Information on Santander Consumer Finance (Total €26.7 billion)

a) Distribution of Business by Geographical Area

b) SCF’s growth

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Exhibit 3 (continued)

c) 2007 Balance Sheet and Income Statements (€ million)

Balance Sheet 2007 Loans and Credits 45,731 Due from credit institutions 2912 Intangible Assets 839 Other 1,781 Total Assets 51,263 Customer Deposits 13,883 Marketable debt securities 18,080 Due to credit institutions 14,493 Shareholders’ equity 2,079 Other 2,728 Total liabilities 51,263 d) Key Figures (December 2007)

Costumers Customers More than 10 millions Number of Dealers 106,904 Cars financed 1.3 million cars Employees 6,573 Branches 282 Total Outstandings €46 billion PBT 1.05 billion Net Profit €737 million Cost of Income 29.6% ROA Before Taxes 2.42%

Source: Company data.

Note: Delinquency ratio stands for: Delinquency (90 days)/ Total Loans.

Income Statement 2007 Net Interest Income 2,085 Gross Operating Income 2,638 Operating Costs (803) Net Operating Income 1,867 Net Loan Loss Provisions (842) Income Before Taxes (ordinary) 1,052 Net Consolidated Income (ordinary) 737 Attributable Income to the Group 719

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Exhibit 4 Consumer Credit in the United States

2003 2004 2005 2006 2007

Consumer Credit Outstanding (seasonally adjusted) % Change at annual rate Total 5.3 5.5 4.3 4.5 5.5 Revolving 2.9 3.8 3.1 6.1 7.6 Non-revolving 6.7 6.4 4.9 3.6 4.2

Amount: Total 2 078.0 2 191.3 2 284.9 2 387.5 2 517.6 Revolving 770.5 800.0 825.0 875.4 941.8 Non-revolving 1 307.5 1 391.3 1 459.9 1,512.1 1 575.7

Terms of Credit at Commercial Banks and Finance Companies: not seasonally adjusted Institution, terms and type of loan a) Commercial banks: Interest rates (in %) for: 48-mo. New car 6.9 6.6 7.1 7.7 7.8 24 mo. Personal credit card plan 11.9 11.9 12.0 12.4 12.4 All accounts 12.3 12.7 12.5 13.2 13.4 Accounts assessed interest (%) 12.7 13.2 15.6 14.7 14.7 b) New car loans at auto finance companies

Interest rates (%) 3.4 4.4 5.5 5.0 4.5 Maturity (months) 61.4 60.5 60.0 62.3 61.0 Loan to Value ratio 95 89 88 91 93 Amount financed (dollars) 26 295 24 888 24 133 25 958 27 911

Source: “Consumer Credit”, U.S. Federal reserve statistical releases, Federal Reserve’s Web site, http://www.federalreserve.gov/releases/g19/Current/, accessed on July 16, 2008.

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Exhibit 5 Consumer Credit in Europe

a) Development of Consumer Credit in Europe since 1995 (outstanding loans in € millions)

Dec 1995

Dec 1996

Dec 1997

Dec 1998

Dec 1999

Dec 2000

Dec 2001

Dec 2002

Dec 2003

Dec 2004

Austria 14,810 16,525 23,927 23,310 22,143 20,610 23,535 Belgium 9,321 9,532 10,149 11,180 11,958 12,739 13,231 13,505 13,723 14,078 Cyprus 499 604 675 729 875 964 952 960 925 936 Czech Republic

150 496 622 561 828 1,675 1,902 2,231

Denmark 9,103 9,363 9,862 10,855 11,308 12,496 12,243 11,877 12,339 13,084 Estonia 96 75 111 29 54 75 95 172 Finland 3,256 3,275 3,014 3,123 6,386 6,706 7,324 8,048 France 63,757 69,333 74,859 80,836 90,708 97,848 103,006 105,719 110,716 115,507 Germany 197,198 200,713 202,181 216,145 215,695 222,554 222,405 224,343 230,913 236,957 Greece 5,511 7,852 9,755 12,050 17,054 Hungary 658 565 619 724 1,131 1,546 2,209 2,883 3,190 4,431 Ireland 2,995 3,336 3,752 5,040 6,811 7,751 9,300 10,462 11,330 14,701 Italy 21,557 23,828 27,139 32,312 37,112 41,181 45,244 51,298 60,980 Latvia 51 84 107 148 220 282 Lithuania 31 30 29 41 94 218

Luxembourg 500 700 1,091 1,250 1,301 1,360 1,185 1,269 Malta 50 88 83 102 120 133 121 104 84 187 Netherlands 9,365 9,893 10,864 12,266 12,848 13,831 13,903 18,647 20,442 22,523 Poland 2,926 4,080 5,044 6,878 9,757 11,115 10,369 9,199 11,209 Portugal 5,013 6,191 6,770 8,177 8,074 7,872 8,691 9,059 Slovakia 91 75 119 160 217 509 Slovenia 1,100 1,086 1,073 1,174 1,410 Spain 29,182 36,652 43,326 48,498 48,739 53,733 55,529 62,269 Sweden 22,725 20,992 22,558 22,146 26,310 29,843 29,090 31,828 32,327 34,462 UK 79,186 101,954 130,585 146,134 183,016 209,506 225,388 244,558 239,063 259,987

Source: “Statistics, Consumer Credit in the EU25 by member states”, European Savings Banks Group (ESBG) Web site, http://www.esbg.eu/uploadedFiles/Publications_and_Research_(ESBG_only)/Statistics/08%20Consumer%20credit %20in%20the%20EU.xls, accessed on July 15, 2008.

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Exhibit 5 (continued)

b) Consumer Credit per Capita in Selected Developed Countries in 2007

Source: Company data.

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Exhibit 6 Consumer Credit in Europe: Country Comparison

a) 2006: Market Penetration per Consumer Credit Product in Europe

Source: Jean Coumaros, Enrico Sanna and Luca Zuccoli, Consumer Finance in Europe: Back to Reality, Oliver Wyman/Santander Consumer Finance/ EFMA: London, 2008, available at http://www.oliverwyman.com/ow/pdf_files/ OW_En_FS_2008_ConsumerFinanceInEurope.pdf.pdf, accessed in September 2010.

b) Country grouped by consumer finance growth rates and type of regulation

Note: These countries were classified as Dynamic, Unrestrained, Constrained, Saturated and Dormant according to their consumer finance market growth rates and regulations.

Source: Jean Coumaros, Enrico Sanna, Mark Weil and Luca Zuccoli, Consumer Credit in Europe: Riding the Wave, Mercer Oliver Wyman/ European Credit Research Institute: London, 2005, p.6, http://www.ecri.be/new/system/files/Consumer+ Finance+Report+MercerOliverWyman+ECRI.pdf, accessed on July 16, 2008. D o

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Exhibit 7 Breakdown of SCF’s Sales by Product

a) Santander Consumer Finance's Breakdown of Sales By Product Type from 2004 to 2006 (in € Million)

SCF’s Sales by Product 2004 2005 2006 Auto finance 9,615.2 11,684.8 13,779.9 Consumer loans 1,582.4 1,750.0 2,010.3 Credit cards 2,080.3 2,727.8 3,252.8 Direct finance 1,243.3 1,695.7 2,299.3 Mortgages 631.3 981.1 1,393.8 Others 137.1 146.3 234.6 Total new business 15,289.6 18,985.7 22,970.7

b) Breakdown of Santander Consumer Finance’s New Business by Product in 2007 (Total = €26.7bn)

Source: Company data.

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Exhibit 8 Santander Consumer Finance’s Product Portfolio in February 2008

Source: Company data.

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Exhibit 9 Business Model of Santander Consumer Finance

Source: Company data.

Exhibit 10 Profitability of Santander Consumer Finance’s Different Products

Source: Company data.

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Exhibit 11 Comparison between Santander Consumer Finance and its Main Competitors, 1H’07

Outstanding Loans Net Income

Source: Company data.

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Exhibit 12 Santander Consumer Finance’s Sources of Funding

a) Breakdown of Deposits from Credit Institutions by Type and Currency (in € Thousands)

2006 2005 Type: Reciprocal accounts 593,494 113,989 Time deposits 8,948,628 9,143,656 Other demand accounts 175,582 54,385 9,717,704 9,312,030

Currency: Euro 5,117,470 6,446,610 Foreign currency 4,600,234 2,865,420 Total financial liabilities 9,717,704 9,312,030

b) Breakdown of Customer Deposits by Type, Geographical Area, and Currency (in € Thousands)

2006 2005 Type: Public sector – local government 11,833 263,788 Demand deposits Current accounts 6,578,928 7,655,314 Savings accounts 2,323,685 2,666,719 Other demand deposits 31,035 5,954 Time deposits Fixed-term deposits 4,350,917 2,811,435 Home-purchase savings accounts 65,743 55,673 Other financial liabilities associated with transferred financial assets

- 20,347

Other time deposits 1,893 2,353,707 13,364,034 15,832,937

Geographical area: Spain and Portugal 4,001,418 3,843,275 Germany 8,787,073 11,415,178 Italy 490,656 492,855 Scandinavia 74,234 75,953 Rest of Europe 10,653 5,676 13,364,034 15,832,937

Currency: Euros 13,284,141 15,750,255 Foreign currency 79,893 82,682 13,364,034 15,832,937

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Exhibit 12 (continued)

c) Marketable Debt Securities by Type (in € Thousands)

2005 2006 Type: Bonds and debentures outstanding1 956,169 5,565,655 Mortgage bonds2 - 1,193,952 Notes and other securities2 4,731,556 5,737,974 5,687,725 12,497,581

Add – valuation adjustments 46,368 122,103 Of which: Accrued interest 46,368 152,768 Other items - (30,665) 5,687,725 12,497,581

Source: Company data.

1 Of this amount, €1.39 billion and €2.81 billion related to bonds and debentures issued by Santander Consumer Bank, S.p.A. and Santander Consumer Bank A.G., respectively, in 2006 (€996 million and €6.1 million, respectively, in 2005). Additionally, at December 31, 2006, €1,350,000 thousand and €13,125 thousand related to bonds and debentures issued by FTA Santander Consumer Spain Auto 06 and Altair Finance, plc, respectively (Appendix I). 2 Securities admitted to listing on the Spanish AIAF bond market, fully issued by the Bank. The annual interest rate on the mortgage bonds is 3.875% and the notes, which were issued at a discount, bore average annual interest of 2.80% in 2006.

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Exhibit 13 Santander Consumer Finance’s Lending per Country in 2006 ( € millions)

Germany Spain Italy Scandina via

USA Poland Portugal Other Units

Total

Total Portfolio 15,988 10,950 5,033 2,831 2,230 1,529 883 1,219 40,663 Auto Finance 10,676 6,101 3,635 2,546 2,230 645 706 950 27,490 New vehicles 4,145 5,520 3,146 1,448 361 385 526 405 15,936 Used vehicles 6,531 581 488 1,098 1,869 261 180 545 11,553 Cons. Loans & Credit Cards 1,054 1,045 544 112 0 0 53 20 2,827 Consumer Loans 937 500 364 0 0 0 44 1 1,845 Credit Cards 117 545 180 112 0 0 9 19 983 Direct 2,631 565 768 18 0 51 0 31 4,065 Mortgages 3 2,478 0 0 0 787 0 38 3,305 Others 108 492 80 155 0 0 1 7 843 Stock Finance 1,517 269 6 0 0 46 123 172 2,133 % of the Total (in %) 39.3 26.9 12.4 7.0 5.5 3.8 2.2 3.0 100

Source: Company data

Exhibit 14 Car sales and Purchasing Power in Emerging Markets

Source: Company data.

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Endnotes

1 “Global Consumer Finance”, Industry Profile, Datamonitor, April 2008, accessed via OneSource on June 8, 2008. The Americas comprised Argentina, Brazil, Canada, Chile, Colombia, Mexico, Venezuela and the United States. Europe comprised: Belgium, the Czech Republic, Denmark, France, Germany, Hungary, Italy, the Netherlands, Norway, Poland Russia, Spain Sweden and the United Kingdom. Asia comprised Australia, China, Japan, India, Singapore, South Korea, and Taiwan.

2 ‘Paying the price of consumerism’, in El Pais, English Edition, Herald Tribune, 25 July 2005, accessed via Factiva on June 8, 2008.

3 Jean Coumaros, Enrico Sanna, Mark Weil and Luca Zuccoli, Consumer Credit in Europe: Riding the Wave, Mercer Oliver Wyman/ European Credit Research Institute: London, 2005.

4 These were Experian, Equifax, and Callcredi 5 Karl Lannoo and Almudena de la Mata Muñoz (2003) Integration of the EU Consumer Credit Market – Proposal

for a More Efficient Regulatory Model, Centre for European Policy Studies: Brussels 6 Jean Coumaros, Enrico Sanna, Mark Weil and Luca Zuccoli, Consumer Credit in Europe: Riding the Wave,

Mercer Oliver Wyman/ European Credit Research Institute: London, 2005 7 Ibid. 8 “Cross-border lending promoted by EU plans”, International Herald Tribune, January 14, 2008,

at<http://www.iht.com/articles/2008/01/14/business/credit.php> , accessed April 9, 2008. 9 Karl Lannoo and Almudena de la Mata Muñoz (2004) Integration of the EU Consumer Credit Market – Proposal

for a More Efficient Regulatory Model, CEPS Working Document No 213/November 2004, Centre for European Policy Studies: Brussels, available at http://aei.pitt.edu/6647/01/1174_213.pdf , accessed July 2008.

10 ‘BEUC Statement on Consumer Credit’, 18 January 2008, at <http://www.beuc.eu/Content/Default.asp?PageID=701&LanguageCode=EN>, accessed April 14, 2008.

11 ‘Consumer credit’ EurActiv, January 21, 2008, at <http://www.euractiv.com/en/financial- services/consumer-credit/article-146529> , accessed April 14, 2008.

12 Ibid.

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