Last checked at 27 Apr 2010 15:00
Santander UK plc
Annual Report and Accounts 2009
A copy of the above document has been submitted to the UK Listing Authority and will shortly be available for inspection at the UK Listing Authority's Document Viewing Facility, which is situated at:
Financial Services Authority
25 The North Colonnade
Canary Wharf
London
E14 5HS
In fulfilment of its obligations under the Disclosure and Transparency Rules, Santander UK plc hereby releases the unedited full text of its Annual Report & Accounts.
A printer-friendly PDF version of the accounts is now available on the Company's website:
www.aboutsantander.co.uk
The full text of the accounts follows:
Business Review and Forward-looking Statements
Chief Executive's Review
Overview
We have seen an excellent performance from all business areas in 2009 despite continued turbulent market conditions. Our personal financial services revenue and profit growth improved considerably and were significantly ahead of our UK peer group on these measures. We also continue to transfer best practices and create synergies with other Santander group units and to manage our costs well.
We have delivered an increase of 52% in statutory profit after tax, which was underpinned by sustained but prudent lending and continued growth in retail and corporate deposits. At the same time we have improved overall margins in a low interest rate environment, through pricing and hedging strategies reflecting the increased cost of funding. Each of the businesses strengthened and advanced, allowing us to achieve double digit trading income growth for the second year in succession. As in 2008, this was balanced against controlled costs, despite on-going investment, which meant that we achieved double digit operating jaws (operating income growth less operating cost growth) for the fifth consecutive year. Our trading cost:income ratio has improved further to 42% (2008: 50% including Alliance & Leicester) and is now 'best in class' when compared to our UK peers.
Business Performance
Our business continues to thrive and our market position has been strengthened by the additions of Alliance & Leicester plc and the Bradford & Bingley savings business. We now have market shares in our retail business of around 10% across our core markets of mortgages, savings and bank accounts. The business combination with Alliance & Leicester also accelerated our growth into the small and medium-sized enterprises (SMEs) market to an estimated market share of 3%, a key step forward as we continue to develop the range of services we provide and move towards our ambition of being a full service commercial bank.
Our core business strategy continues to serve us well and has not changed. We continue to focus on our customers, driving efficiencies across the combined businesses and reinvesting these cost savings in growth projects for the future and new innovative and value-for-money products and service to our customers. This, together with excellent service, will drive cross-sales to our 25 million UK customers, and increase customer loyalty. In 2009, our ability to offer better value-for-money products resulted in more 'best-buy' mentions in the UK press than any other UK bank, and has supported a significant uplift in new business.
Highlights in 2009 (relative to 2008 on a trading basis including Alliance & Leicester) include:
| > | opening 1.1 million new current accounts, which exceeded our target of 1 million new current accounts, and represented a 21% increase from 2008; |
| > | increasing investment sales by 25% compared to a wider market decline estimated at 13%, driven by a combination of improved advisor coverage across the network and competitive offers; |
| > | our commitment to remain a consistent mortgage lender in difficult times, with a gross lending market share of 18.4% (2008: 13.9%) and £7.6bn of net lending in 2009 (2008: £6.1bn), increasing our estimated market share of mortgage stock by 0.6% to 13.5%; |
| > | increasing lending to SMEs by 16% compared to 2008. This has been possible through leveraging relationships via the 20 regional corporate centres acquired as part of Alliance & Leicester, and extending the product range and number of small business advisers; |
| > | growth in net deposits of £14.9bn across Retail, Corporate and Private Banking customers, demonstrating that Santander UK is seen as a "safe haven" for UK savers; and |
| > | strong revenue performance in Global Banking & Markets, taking advantage of favourable market conditions in interest rate and equity markets, as well as further building its client-focused franchise. |
Integration and Rebrand
In January 2010, we completed the rebranding of Abbey and Bradford & Bingley's savings business to Santander, and our customers are already seeing the benefit of the increased number of Santander branches (now around 1,000). In addition, we have extended the range of our value-for-money products and services available to customers of Bradford & Bingley's savings business.
The integration of Alliance & Leicester is on track and we expect to complete the transfer of its branches and customers onto Partenon, Santander's IT system, by the end of the year, which will coincide with the rebranding of Alliance & Leicester to Santander. By the end of the year, our customers will have access to approximately 1,300 branches. We are on target to deliver by 2011 the £180m of cost savings that we identified when we acquired Alliance & Leicester.
Funding, Liquidity and Capital
We have continued to manage our balance sheet prudently, having reduced our reliance on short-term funding over the course of 2009 by increasing our customer deposits and by further reducing non-core assets, such as the Treasury asset portfolio acquired with Alliance & Leicester plc. At the same time, Santander UK has been able to support the UK economy with continued strong commercial net lending growth which has been more than matched by a larger increase in net deposit flows. In doing so this has improved our loan to deposit ratio, including equity, to 126% (136% in 2008).
From the start of 2009, Santander UK has raised all of the wholesale funding needs of the enlarged Santander UK Group via Abbey National Treasury Services plc, the Group's face to the wholesale markets.
Although the global financial system has experienced difficult credit and liquidity conditions since August 2007, recent months have seen an improvement in market conditions with wholesale funding spreads tightening, albeit not to levels pre-turmoil. Santander UK has taken advantage of improving market conditions to raise additional wholesale funding, in particular, two well received benchmark sized transactions to wholesale investors in the second half of 2009, and in March 2010 the first publicly-placed mortgage-backed securitisation transaction from a UK bank since 2007 (other recent transactions from UK banks had included an investor put). The transaction was denominated in both pounds sterling and euro and raised approximately £1.4bn. Whilst the various UK Government schemes to support the banking sector were welcomed by Santander UK we have chosen not to participate in them.
In 2009, the UK Financial Services Authority, our main UK regulator announced its new liquidity regime. Implementation of this regime has begun, and we will work closely with the regulator to ensure that a balance between prudent liquid asset holdings and continued lending growth is maintained. Over the course of 2009, Santander UK's liquidity policy has seen its holdings of liquid assets further increase compared to the end of 2008, which was itself greatly increased compared to the holdings at the start of 2008.
During the course of 2009, we strengthened our capital ratios. Our Core Tier 1 capital ratio increased to 6.8% (2008: 6.2%), and our Tier 1 capital ratio increased to 9.5% (2008: 8.5%). These improvements have been delivered without the need to raise capital, and were achieved through retained earnings after a dividend payout of £500m, de-risking of non-growth Alliance & Leicester portfolios and our unsecured personal loan portfolio, and some improvement to capital models.
Key Financial Highlights
Santander UK has delivered statutory profit after tax of £1,245m, an increase of 52% over £819m in 2008. We have achieved the financial targets for 2009, with trading income growth of 20% and a further improvement in the trading cost:income ratio from 50% (including Alliance & Leicester) to 42% in the year.
Summary Highlights
Personal Financial Services trading profit before tax (management's preferred profit measure, described in the Business Review - Summary on page 16) increased by £447m, 31% to £1,912m compared to £1,465m in 2008.
| > | Personal Financial Services trading income was up 20%, driven by a strong performance across all business divisions, with the commercial banking spread improving to 1.82% (2008: 1.44%). | |
|
| > | Retail Banking income benefited from both asset and deposit growth driven by competitively-priced, low risk lending with deposit acquisition across a broad range of products (savings, banking and structured products). In addition, mortgage margins improved throughout 2009 as a result of lower interest rates and sustained new business margins in excess of stock margin, and increased standard variable rate asset. |
|
| > | Corporate Banking income was ahead of 2008 driven by SME customer lending for the combined businesses up 16%, with targeted lending through the 20 regional centres acquired as part of Alliance & Leicester. This lending was more than offset by deposit inflows as companies sought to diversify their banking relationships. |
|
| > | Private Banking income was also ahead of 2008 reflecting growth in all business areas, in particular Cater Allen and Abbey International due to increased customer deposits. |
|
| > | Global Banking & Markets had a good year, driven by sustained growth in customer activity. Results benefited from growth in equity products activity linked to the sales of investments through retail channels as customers sought improved returns in the low interest rate environment. In addition, there was an increase in Short Term Markets activity mainly during the first half of the year when spreads were volatile in the market. |
| > | Personal Financial Services trading expenses were in line with the prior year. Increases in the cost base as a result of the acquisition of Bradford & Bingley's savings business in September 2008, and investments in growth businesses, have been offset by savings achieved on the removal of duplicated back office and support functions across the business. Excluding Bradford & Bingley's savings business, costs were down by 3% and Alliance & Leicester costs decreased by 17%. | |
| > | The combination of tightly controlled costs and strong revenue growth resulted in a further improvement in the trading cost:income ratio to 42%. | |
|
> | As expected in light of the recessionary conditions experienced in the UK for much of 2009, the trading provisions charge increased, up 64% reflecting the effects of falls in house prices and increased unemployment. However, the second half of the year saw a flattening of recent trends, most noticeably in relation to mortgages with a slower growth in arrears. This reflects, in part, the better than expected unemployment trends and the persistent low interest rate environment, but also collection efforts and the overall quality of the book. We have preserved conservative levels of coverage (provisions as a proportion of non-performing loans), and our arrears and repossession levels have remained significantly better than industry benchmarks from the Council of Mortgage Lenders. | |
| > | The Alliance & Leicester corporate and treasury asset portfolios are performing in line with expectations at the time of acquisition. Balances in the run down portfolios have been reduced by 19% and 36% respectively, through natural maturities and some disposals of assets, with a focus on those considered to be higher risk. | |
Strategic context
We have made tremendous progress transforming our UK business and our 2009 results are the culmination of five years' hard work. Since becoming part of the Santander Group in November 2004, we have:
| > | introduced Santander's IT system, Partenon, one of the most significant banking IT programmes seen in the UK; |
| > | improved our profitability and revenue generation so that today we believe that we are the most profitable personal financial services provider in the UK; |
| > | reduced the trading cost:income ratio from 73% to 42%, now well below the sector average of approximately 57% and best in class when compared to our UK peers; |
| > | used our competitive cost advantage to rejuvenate our product range to deliver more competitive value-for-money products than our peer group in the UK; |
| > | introduced and maintained a measured and prudent approach to lending; |
| > | increased the scale of our UK operations with the combination of Santander UK, Alliance & Leicester and Bradford & Bingley's savings business; and |
| > | completed the rebranding of Abbey and Bradford & Bingley branches, with Alliance & Leicester to be rebranded by the end of 2010. |
While we have seen a significant increase in new business in 2009, our strategy going forward will be to reward our existing 25 million customers with even better value-for-money products, giving them a compelling reason to do more business with us. In this context, we launched a zero fee current account targeting existing and new mortgage and investment customers, and we have further plans for 2010.
In 2009 and 2008, we won Euromoney's 'Best UK Bank' award. Banco Santander, S.A. won Euromoney's 'Best Bank in Western Europe' award in 2009 and its 'Best Global Bank' award in 2008. In addition, in 2009 we won The Banker Award for 'Best Bank in the UK' and Banco Santander, S.A. won its 'Best Bank in the World' award. The focus on customers and service are core Santander values against which good progress has been made - and efforts remain channeled to deliver further improvements in 2010.
Looking ahead
Rebranding to Santander is a significant step towards achieving our vision of becoming the best commercial bank in the UK, and we expect to be able to demonstrate further progress in 2010.
More recent data indicates that the UK economy is starting to emerge from recession and both the Bank of England and the UK Government are expecting that the UK economy will grow in 2010. The pace of that growth may well be slow and economic prospects, both in the UK and globally, remain subject to considerable uncertainty.
Our business model will not change and we expect to reduce our cost to income ratio even further. We will continue to focus on managing risk and prudent lending while growing our business and transferring best practices to and from other units of the Santander group. We will continue to prioritise improving our service and putting our customers at the heart of everything we do. Customer service remains a priority, to build on the improvements made in 2009.
Over the next few years we want to increase the number of products each of our customers holds through increasingly competitive and market-leading products. We'll launch similar products and initiatives to the Zero current account to reward our 25 million customers and we are confident this approach will continue to set us apart from other UK banks.
Summary
2009 has been a very successful year for Santander UK, which would not have been possible without the continued support, dedication and commitment of our staff as well as from many people and units of the Santander group, of which I am very proud. Together, we have built a great business and I would like to take this opportunity to thank them for their outstanding contribution in 2009.
As the UK emerges from recession, we remain cautiously optimistic about our business prospects. We believe that 2010 will mark a further significant step in our business as we complete the integration and rebranding of Alliance & Leicester. Against this background, and with the ongoing benefit from our Group strength, we believe that our UK business continues to be well-positioned for the challenges and opportunities ahead.
António Horta-Osório
Chief Executive
Forward looking Statements
Santander UK plc (formerly Abbey National plc) (the 'Company') and its subsidiaries (together 'Santander UK' or the 'Group') may from time to time make written or oral forward-looking statements. Examples of such forward-looking statements include, but are not limited to:
| > | projections or expectations of revenues, costs, profit (or loss), earnings (or loss) per share, dividends, capital structure or other financial items or ratios; |
| > | statements of plans, objectives or goals of Santander UK or its management, including those related to products or services; |
| > | statements of future economic performance; and |
| > | statements of assumptions underlying such statements. |
Words such as 'believes', 'anticipates', 'expects', 'intends', 'aims', 'plans', 'targets' and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
By their very nature, forward-looking statements cannot be objectively verified, are speculative and involve inherent risks and uncertainties, both general and specific, and risks exist that the predictions, forecasts, projections and other forward-looking statements will not be achieved. Santander UK cautions readers that a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements made by Santander UK or on Santander UK's behalf. Some of these factors are considered in detail in the Risk Management section on page 49 and the Risk Factors section on page 192 and may include:
| > | inflation, interest rate, exchange rate, basis spread, market and monetary fluctuations; |
| > | lack of liquidity in funding markets and sources of funding in periods of economic and political crisis; |
| > | the effect of, and changes to, government supervision and regulation of financial services institutions in response to recent market conditions and turmoil in the broader financial services industry; |
| > | extraordinary governmental actions, including nationalisation of financial services institutions in response to recent market conditions and turmoil in the broader financial services industry; |
| > | the effects of market conditions and extent of economic activity in the UK and other geographical markets; |
| > | the length and severity of current market turmoil and its impact on credit quality, consumer confidence, market volatility, loan delinquencies and defaults; |
| > | the effects of counterparty defaults on the financial services industry; |
| > | the effects of competition in the geographic and business areas in which Santander UK conducts operations; |
| > | changes in consumer spending, saving and borrowing habits in the UK; |
| > | illiquidity and volatility in UK real estate markets; |
| > | the impact of lower than expected investment returns on the funding of private and public sector defined benefit pensions; |
| > | the effects of changes in laws, regulations, taxation or accounting standards or practices, or the effects of the interpretation of laws by the courts; |
| > | the ability to increase market share and control expenses; |
| > | the timely development and acceptance of new Santander UK products and services and the perceived overall value of these products and services by customers; |
| > | acquisitions and disposals; |
| > | the ability to integrate recently acquired businesses and to realise anticipated saving and operational benefits from such integration; |
| > | technological changes; |
| > | the possibility of foreign exchange controls, expropriation, nationalisation or confiscation of assets in countries in which Santander UK conducts operations; |
| > | consumer perception as to the continuing availability of credit and price competition; and |
| > | Santander UK's success at managing the risks of the foregoing. |
Santander UK cautions that the foregoing list of important factors is not exhaustive. When relying on forward-looking statements to make decisions with respect to Santander UK, investors and others should carefully consider the foregoing factors and other uncertainties and events. Such forward-looking statements speak only as of the date on which they are made and are based on the knowledge, information available and views taken on the date on which they are made; such knowledge, information and views may change at any time. Santander UK does not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
Written forward-looking statements may appear in documents filed with the US Securities and Exchange Commission, including this Annual Report and Accounts, reports to shareholders and other communications. The US Private Securities Litigation Reform Act of 1995 contains a safe harbour for forward-looking statements on which Santander UK relies in making such disclosures.
Business and Financial ReviewBusiness Overview
This Business and Financial Review contains forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in such forward-looking statements. See "Forward-looking Statements" on page 5.
General
Santander UK plc (formerly Abbey National plc) (the 'Company') and its subsidiaries (together, 'Santander UK' or the 'Group') operate primarily in the UK, under UK law and regulation and are part of Banco Santander, S.A. (together with its subsidiaries, 'Santander'). Santander UK is a significant financial services provider in the UK, being the second largest residential mortgage lender and the third largest savings brand following the combinations with Alliance & Leicester plc and Bradford and Bingley's savings business, operating across the full range of personal financial services.
The principal executive office and registered office of Santander UK plc and Abbey National Treasury Services plc is 2 Triton Square, Regent's Place, London NW1 3AN. Santander UK's telephone number is +44 (0) 870-607-6000. The designated agent for service of process on Santander UK in the United States is CT, 111 Eighth Avenue, New York, NY 10011. See "Business and Financial Review - Tangible fixed assets" for further information on Santander UK's properties.
Summary history
The Abbey National Building Society ('the Society') was formed in 1944 with the merger of two long-standing building societies. In 1988, Abbey National plc was incorporated as a bank and in 1989 the Society transferred business to Abbey National plc as part of the conversion and listing on the London Stock Exchange. In 2003, the brand name was shortened to Abbey. A list of the Company's principal subsidiaries and their country of incorporation can be found on page 139.
On 12 November 2004, Banco Santander, S.A. completed the acquisition of the entire issued ordinary share capital of the Company, implemented by means of a scheme of arrangement under Section 425 of the Companies Act 1985, making the Company a wholly-owned subsidiary of Banco Santander, S.A.. Banco Santander, S.A. is one of the largest banks in the world by market capitalisation. Founded in 1857, Banco Santander, S.A. has more than 90 million customers and over 14,000 branches.
In September 2008, following the announcement by HM Treasury to take Bradford & Bingley plc into public ownership, the retail deposits, branch network and its related employees transferred, under the provisions of the Banking (Special Provisions) Act 2008, to the Company. All of Bradford & Bingley plc's customer loans and treasury assets, including all its mortgage assets, were taken into public ownership. The transfer to the Company consisted of the £20bn retail deposit base with 2.7 million customers, as well as Bradford & Bingley plc's direct channels including 197 retail branches, 141 agencies (distribution outlets in third party premises) and related employees. The acquisition price was £612m, including the transfer of £208m of capital relating to offshore entities. The transfer of Bradford & Bingley plc's customers and their retail deposits further strengthened the Group's retail customer deposit base and franchise.
In December 2008, following the acquisition by Banco Santander, S.A. of Alliance & Leicester plc, the Company injected £950m of capital into Alliance & Leicester plc through a subscription for: (i) 234,113,712 new Alliance & Leicester plc ordinary shares for cash at £2.99 per ordinary share; (ii) US$220m undated subordinated notes issued by Alliance & Leicester plc; and (iii) euro 115m undated subordinated notes issued by Alliance & Leicester plc. Previously, in October 2008, the Company subscribed for US$100m undated floating rate subordinated notes issued by Alliance & Leicester plc. As a result of the subscription for ordinary shares, the Company held 35.6% of the issued ordinary share capital of Alliance & Leicester plc at 31 December 2008.
On 9 January 2009, in order to optimise the capital, liquidity funding and overall financial efficiency of the enlarged Santander group, Banco Santander, S.A. transferred all of its Alliance & Leicester plc shares to the Company in exchange for newly issued ordinary shares of the Company. Accordingly, the Company is now the immediate parent company of Alliance & Leicester plc. As described in Note 47 to the Consolidated Financial Statements, the Company has accounted for the transfer of Alliance & Leicester plc with effect from 10 October 2008, the date on which Alliance & Leicester plc was acquired by Banco Santander, S.A..
These business combinations allow the Group to deliver increased critical mass in the UK through greater market share.
In 2009 and 2008, the Company won Euromoney's 'Best UK Bank' award. Banco Santander, S.A. won Euromoney's 'Best Bank in Western Europe' award in 2009 and its 'Best Global Bank' award in 2008. In addition, in 2009 the Company won The Banker Award for 'Best Bank in the UK' and Banco Santander, S.A. won its 'Best Bank in the World' award.
As of 11 January 2010, the Company, which includes the Bradford & Bingley savings business, changed its name to Santander UK plc and now operates under the Santander brand name. Alliance & Leicester will also be rebranded as Santander by the end of the year, as information technology changes ensure any Santander customer in the UK can transact in all its UK branches. The move is delivering a significant advantage for customers as they have been able to use 1,000 branches from early 2010 and will be able to use up to 1,300 branches by the end of the year. The change also reflects Santander group's policy to operate under a single brand.
Corporate purpose and strategy
Santander UK's purpose is to maximise value for its shareholder, Banco Santander, S.A., by focusing on offering a full commercial banking service in the UK providing value-for-money products to customers. With the continuing support of Banco Santander, S.A., Santander UK aims to be the best commercial bank in the UK.
Executive responsibility
Santander UK's management structure is headed by António Horta-Osório, Chief Executive, and consists of a number of business and support divisions. The business divisions consist of:
| > | Retail Banking - offers residential mortgages, savings and banking and other personal financial products to customers throughout the UK. Alison Brittain heads Retail Distribution as well as business banking and e-commerce, while Antonio Lorenzo is responsible for the Intermediary channel. |
| > | Corporate Banking - offers banking services principally to small and mid-sized ('SME') UK companies. It also contains operations in run down. This division is headed by Steve Pateman. |
| > | Global Banking & Markets - provides financial markets sales, trading and risk management services, as well as manufacturing retail structured products. This division is headed by Luis de Sousa. |
| > | Private Banking - offers private banking and other specialist banking services. On 10 March 2010, the self-invested personal pension plan and the WRAP portfolio management service businesses were sold. This division is headed by Antonio Lorenzo. |
The support divisions consist of:
| > | Retail Products and Marketing - responsible for integrating and gaining the maximum value from Santander UK's products, marketing and brand communications to serve Santander UK's customers better. This division is headed by Miguel-Ángel Rodríguez-Sola. |
| > | Human Resources - responsible for delivering the human resources strategy and personnel support. This division is headed by Karen Fortunato. |
| > | Manufacturing - responsible for all information technology, cost control and operations activity, including service centres. This division is headed by Juan Olaizola. |
| > | Risk - responsible for ensuring that the board of directors ("Board") and senior management team of Santander UK are provided with an appropriate risk policy and control framework, and to report any material risk issues to the Risk Committee and the Board. This division is headed by Juan Colombás. |
| > | Internal Audit - responsible for supervising the compliance, effectiveness and efficiency of Santander UK's internal control systems to manage its risks. This division is headed by Jorge de la Vega. |
In addition there are a number of corporate units:
| > | Group Infrastructure - This unit includes Asset & Liability Management, Group Capital and Funding and reports to Antonio Lorenzo. |
| > | Strategy & Planning, Financial Accounting & Economics - This unit reports to Antonio Lorenzo. |
| > | Corporate Services - This unit includes Legal, Secretariat, Compliance and Regulatory Risk Management and reports to Karen Fortunato. |
| > | Service Quality - This unit reports to Miguel-Ángel Rodríguez-Sola. |
| > | Communications - This unit is headed by Matthew Young. |
| > | Santander Universities in the UK - This unit is headed by Miguel-Ángel Rodríguez-Sola, with oversight in line with the global Universities structure. |
Competitive environment, future trends and outlook
The economic environment in 2009 remained very difficult, with falling house prices, volatile share prices, rising unemployment, and difficulties facing banks, homeowners and savers. The UK's retail banks underwent further significant changes, with the UK Government increasing its holdings of shares in The Royal Bank of Scotland Group plc and Lloyds Banking Group plc. The UK Government continues to support UK banks during the current market turmoil through the Special Liquidity Scheme, the Asset Protection Scheme, the Credit Guarantee Scheme and the UK Banking Act 2009.
Santander UK's main competitors are other UK retail banks, building societies and other financial services providers such as insurance companies, supermarket chains and large retailers. The market remains highly competitive, driven largely by market incumbents. Management expects such competition to continue in response to competitor behaviour, consumer demand, technological changes, the impact of consolidation, regulatory actions and other factors.
2010 is expected to be another difficult year for the UK economy. Although the UK economy has begun to show signs of emerging from recession, unemployment is predicted to remain high, resulting in continuing difficulties for banks, homeowners and savers. The outcome of the European Union's review of the UK Government's support for The Royal Bank of Scotland Group plc and Lloyds Banking Group plc may also trigger further restructuring of the retail banking sector in the UK. Santander UK continues to benefit from the strength of its parent company, Banco Santander, S.A. and, as part of Santander, management remains confident of Santander UK's strength and potential to continue growing despite continuing challenging conditions in some of its core personal financial services markets. A detailed description of management's basis for concluding that Santander UK remains a going concern is set out in the Directors' Report - Going Concern on page 89.
Personal Financial Services ('PFS')
The overview below reflects the reporting structure in place during 2009 in accordance with which the segmental information in the Business and Financial Review has been presented. In this report, the Retail Banking, Corporate Banking, Global Banking & Markets, Private Banking, and Group Infrastructure segments are referred to as the Personal Financial Services businesses.
Retail Banking
Retail Banking consists of residential mortgages, savings, banking and consumer credit, online banking and financial services through cahoot, general insurance, Santander Business Banking (formerly known as Abbey Business), asset management and credit cards.
Residential Mortgages
Following the transfer of Alliance & Leicester plc to the Company in January 2009, Santander UK is now the second largest provider of residential mortgages in the UK measured by outstanding balances, providing mortgage loans for house purchases as well as home improvement loans to new and existing mortgage customers.
Mortgage loans are offered in two payment types. Repayment mortgages require both principal and interest to be repaid in monthly instalments over the life of the mortgage. Interest-only mortgages require monthly interest payments and the repayment of principal at the end of the mortgage term. This can be arranged via a number of investment products including Individual Savings Accounts and pension policies, or by the sale of the property.
Santander UK's mortgage loans are usually secured by a first mortgage over property and are typically available over a 25-year term, although there is no minimum term. Variable rate products charge interest at variable rates, including trackers which track the Bank of England base rate and those determined at the discretion of Santander UK by reference to the general level of market interest rates and competitive forces in the UK mortgage market. Fixed rate products offer a predetermined interest rate, generally fixed for between two and five years, after which they bear interest at standard variable rates. The majority of new mortgage business is through fixed rate business, normally with an incentive period for the first two to five years. In line with the rest of the UK market, a significant proportion (although reduced compared with the previous year) of mortgages are repaid at the end of the fixed or incentive period, with the customer moving to a new incentive product. The remainder stay on Santander UK's standard variable rate.
Savings
Following the acquisition of Bradford & Bingley's savings business in September 2008 and the transfer of Alliance & Leicester plc to the Company in January 2009, Santander UK is now the third largest deposit taker in the UK and provides a wide range of retail savings accounts in the UK, including on-demand, notice, and investment accounts, Individual Savings Accounts, and capital guaranteed products. Interest rates on savings in the UK are primarily set with reference to the general level of market interest rates and the level of competition for such funds.
Banking and Consumer Credit
Santander UK offers a range of personal banking services including current accounts, credit cards and unsecured personal loans. Credit scoring is used for initial lending decisions. Behavioural scoring is used for certain products for further lending decisions.
cahoot
cahoot is the Group's separately branded, e-commerce retail banking and financial services provider.
General Insurance
The range of non-life insurance products distributed by Santander UK includes property (buildings and contents) and payment protection. Residential home insurance remains the primary type of policy offered and is sold through the branch network, the internet and over the telephone, as well as being sold by mortgage intermediaries, often at the time a mortgage is taken out.
Santander Business Banking
Santander Business Banking offers a range of banking services to small businesses in the UK.
Asset Management
Retail Banking earns a commission on products sold through its agreement with a sister company, Santander Asset Management UK Limited.
Credit Cards
Santander UK credit cards are issued through a sister company outside the Group, Santander Cards Limited. Retail Banking earns a commission from Santander Cards Limited on every credit card sold.
Corporate Banking
Corporate Banking provides a range of banking services through its network of Regional Business Centres and specialist businesses. Following the transfer of Alliance and Leicester plc to Santander UK plc by Banco Santander, S.A. a broad range of banking products is now offered including loans, current accounts, deposits, treasury services, asset finance, cash transmission, trade finance and invoice discounting. The Regional Business Centres have seen significant growth in their customer base in 2009 and primarily service small and medium-sized UK companies. The specialist businesses within Corporate Banking service customers in various business sectors including Real Estate, Social Housing, and Infrastructure.
Corporate Banking is also responsible for managing the run down of certain portfolios, including aviation and shipping. Prior to its disposal on 8 December 2008, it was also responsible for Porterbrook, its rolling stock leasing business. 100% of Porterbrook Leasing Company Limited and its subsidiaries were sold to a consortium of investors including Antin Infrastructure Partners (the BNP Paribas sponsored infrastructure fund), Deutsche Bank AG, London Branch and Lloyds Banking Group plc, for a cash consideration of approximately £1.6bn with Santander UK providing £0.6bn medium-term, senior loan funding to the acquisition vehicle.
Global Banking & Markets
Global Banking & Markets is principally structured into two business areas: Rates and Equity. Rates cover sales and trading activity for fixed income derivatives. Equity comprises the Equity Derivatives, Property Derivatives and Short Term Markets areas. Equity and residential property derivatives activities include the manufacture of structured products sold to retail customers both by Santander UK and by other financial institutions. Short Term Markets runs the securities lending/borrowing and repurchase agreement ('repo') businesses and retains a US branch for funding purposes.
In 2008, the US securities financing business was closed. Previously, Global Banking & Markets also operated a credit derivatives business, but given the lack of activity in the credit markets beginning in 2007, the business was closed and its activities consolidated in Spain with the equivalent Banco Santander, S.A. unit with effect from 1 January 2008.
Private Banking
Private Banking consists of Abbey National International Limited, Alliance & Leicester International Limited, Bradford & Bingley International Limited and Santander UK's majority interest in Santander Private Banking UK Limited. On 17 December 2007, Santander UK sold 49% of its shareholding in Santander Private Banking UK Limited (consisting of James Hay, Cater Allen Limited and Abbey Stockbrokers Limited) to Santander PB UK (Holdings) Limited, a direct subsidiary of Banco Santander, S.A., for a total cash consideration of £203m. The companies affected were Cater Allen Limited, Abbey Stockbrokers Limited, James Hay Holdings Limited, and their subsidiaries. On 10 March 2010, Santander Private Banking UK Limited completed the disposal of James Hay Holdings Limited, together with its five subsidiary companies, by the sale of 100% of James Hay Holdings Limited's shares to IFG UK Holdings Limited, a subsidiary of IFG Group for a cash considerationof approximately £39m. The IFG Group provides independent financial advisory, fund management and pension administration services in Ireland and the UK.
Offshore Deposit-Taking Businesses: Abbey, Alliance & Leicester and Bradford & Bingley International
Abbey National International Limited uses the Abbey International brand. Its office is in Jersey, with a focus on attracting deposits by offering a range of savings accounts denominated in sterling, US dollars and euro. Alliance & Leicester International Limited is based in the Isle of Man, with a focus on attracting deposits from both retail and corporate customers via savings accounts denominated in sterling, US dollars and euro. Bradford & Bingley International Limited is also based in the Isle of Man with a focus on attracting deposits from both retail and corporate customers via savings accounts predominantly denominated in sterling.
Cater Allen
Cater Allen Limited, trading as Cater Allen Private Bank, provides financial services products to individuals and businesses. The business attracts clients by marketing to introducers, including independent financial advisers.
Abbey Stockbrokers
Abbey Stockbrokers Limited, trading as Abbey Sharedealing, provides a direct share trading service for customers. Customers buy and sell shares on their account with the help of the dealers at Abbey Sharedealing. No advice is provided and all trades are on an execution-only basis.
James Hay
James Hay provided administration services for self-invested pension plans and the WRAP portfolio management product (which combines all of a client's investments into a single manageable account) to end customers mainly via independent financial advisers and branded financial service providers. As noted above, this business was sold on 10 March 2010.
Group Infrastructure
Group Infrastructure consists of Asset and Liability Management ('ALM'), which is also responsible for Group Capital and Funding, and the Treasury asset portfolio of the Alliance & Leicester group. ALM is responsible for managing the Group's structural balance sheet shape and, in conjunction with the Risk Division, tactical liquidity risk management. This includes short-term and medium-term funding, covered bond and securitisation programmes. ALM's responsibilities also include Retail Banking's product and structural exposure to interest rates and, in that role, it is a link between Retail Banking and Global Banking & Markets. ALM recommends and helps to implement Board, Asset and Liability Management Committee and Risk Committee policies for all aspects of balance sheet management - formulating guidance for, and monitoring, the overall balance sheet shape, including maturity profile. Group Capital is responsible for the return on the Group's capital, reserves, preference shares and subordinated debt. Funding is responsible for the provision of funding, both to other businesses within the Group and to fellow subsidiaries of Banco Santander, S.A..
Santander UK plc and Abbey National Treasury Services plc had a shelf registration statement with the US Securities and Exchange Commission, which expired in December 2008. The possibility of filing a new registration statement is being kept under review. Additionally, as part of its prudent contingent funding arrangements, ALM ensures that Santander UK has access to the central bank facilities made available by the Bank of England, the Swiss National Bank, the US Federal Reserve and indirectly the European Central Bank. Further information is set out in detail in the Balance Sheet Business Review - Sources of Liquidity on page 45.
Business Review - Summary
The results discussed below are not necessarily indicative of Santander UK's results in future periods. The following information contains certain forward-looking statements. See "Forward-looking Statements" on page 5. The following discussion is based on and should be read in conjunction with the Consolidated Financial Statements elsewhere in this Annual Report and Accounts.
Executive Summary
Santander UK has prepared this Business and Financial Review in a manner consistent with the way management views the business as a whole. As a result, Santander UK presents the following key sections to the Business and Financial Review:
| > | Business Review Summary - this contains an explanation of the basis of Santander UK's results and any potential changes to that basis in the future; a summary Income Statement with commentary; a summary of the nature of adjustments between Santander UK's statutory basis of accounting (as described in the Accounting Policies section on pages 109 to 123 and Santander UK's management basis of accounting (known as the "trading" basis); | |
| > | Key Performance Indicators - this contains a description of the key measures used by management in assessing the success of the business against its strategies and objectives; | |
| > | Personal Financial Services - this contains a supplementary summary of the results, and commentary thereon, by Income Statement line item on a trading basis, for each segment. Additional information is provided for the Retail Banking segment due to its significance to the Group's results; | |
| > | Other Material Items - this contains information about the statutory to trading basis adjustments; and | |
| > | Balance Sheet Business Review - this contains an analysis of Santander UK's balance sheet, including: | |
|
| > | Off-Balance Sheet disclosures - a summary of Santander UK's off-balance sheet arrangements, their business purpose, and importance to Santander UK; |
|
| > | Capital disclosures - an analysis of Santander UK's capital needs and availability; and |
|
| > | Liquidity disclosures - an analysis of Santander UK's sources and uses of liquidity and cash flows. |
Basis of results presentation
The Group's business is managed and reported on the basis of the following segments:
| > | Retail Banking; |
| > | Corporate Banking; |
| > | Global Banking & Markets; |
| > | Private Banking; and |
| > | Group Infrastructure. |
In 2009, the Bradford & Bingley offshore deposit-taking business was managed and reported as part of Private Banking rather than Retail Banking as in 2008. The segmental analysis of the Group's results for 2008 has been amended to reflect this change. In addition, in 2009, the Group's transfer pricing arrangements were updated to reflect the greater benefit of retail deposits in a period of higher funding costs. Prior years' segmental analyses have been adjusted for consistency. In this report, the Retail Banking, Corporate Banking, Global Banking & Markets, Private Banking and Group Infrastructure segments are referred to as the Personal Financial Services ("PFS") businesses.
Critical Factors Affecting Results
Critical accounting policies and areas of significant management judgement
The preparation of Santander UK's Consolidated Financial Statements requires management to make estimates and judgements that affect the reported amount of assets and liabilities at the date of the Consolidated Financial Statements and the reported amount of income and expenses during the reporting period. Management evaluates its estimates and judgements on an ongoing basis. Management bases its estimates and judgements on historical experience and on other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Estimates and judgements that are considered important to the portrayal of Santander UK's financial condition including, where applicable, quantifications of the effects of reasonably possible ranges of such estimates and judgements are set out in the Accounting Policies in the Consolidated Financial Statements.
Impact of the current credit environment
Further information about the impact of the current credit environment is contained in the Risk Management Report on page 77, in addition to information relating to the valuation of financial instruments included in the Group's critical accounting policies disclosures referred to above.
Profit on disposal of Group undertakings
No profits or losses were made on the disposal of Group undertakings (2008: £40m, 2007: £7m) or on the sale of non-controlling interests in subsidiary undertakings (2008: £nil, 2007: £105m) during the year.
Significant acquisitions and disposals
The 2009 results included significant contributions from Alliance & Leicester, (which was transferred to the Company on 9 January 2009) and the Bradford & Bingley savings business (acquired in September 2008), as described in the Business Overview.
Current and future accounting developments under IFRS
Details can be found in the Accounting Policies on page 109 of the Consolidated Financial Statements.
Group Summary
On 9 January 2009, in order to optimise the capital, liquidity funding and overall financial efficiency of the enlarged Santander group,Banco Santander, S.A. transferred all of its Alliance & Leicester plc shares to the Company in exchange for Santander UK plc newly issued ordinary shares. Accordingly, Santander UK plc is now the immediate parent company of Alliance & Leicester. As described in Note 47 to the Consolidated Financial Statements, in the absence of authoritative guidance under International Financial Reporting Standards ('IFRS') for accounting for transactions between entities under common control, the transfer has been accounted for in a manner consistent with group reconstruction relief under UK Generally Accepted Accounting Practice ('UK GAAP'). As a result, the transfer of Alliance & Leicester has been accounted for by the Company with effect from 10 October 2008, the date on which Banco Santander, S.A. acquired Alliance & Leicester. The Group's Consolidated Financial Statements for the year ended, and as at 31 December 2008 have been amended to reflect this treatment, where significant, as described in Note 47.
Summarised consolidated statutory income statement and selected ratios
|
| 2009 £m | 2008 £m | 2007 £m |
| Net interest income | 3,412 | 1,772 | 1,499 |
| Non-interest income | 1,284 | 1,232 | 1,283 |
| Total operating income | 4,696 | 3,004 | 2,782 |
| Administrative expenses | (1,848) | (1,343) | (1,369) |
| Depreciation and amortisation | (260) | (202) | (205) |
| Total operating expenses excluding provisions and charges | (2,108) | (1,545) | (1,574) |
| Impairment losses on loans and advances | (842) | (348) | (344) |
| Provisions for other liabilities and charges | (56) | (17) | - |
| Total operating provisions and charges | (898) | (365) | (344) |
| Profit before tax | 1,690 | 1,094 | 864 |
| Taxation charge | (445) | (275) | (179) |
| Profit for the year | 1,245 | 819 | 685 |
|
|
|
|
|
| Attributable to: |
|
|
|
| Equity holders of the parent | 1,190 | 811 | 685 |
| Non-controlling interest | 55 | 8 | - |
|
|
|
|
|
| Core Tier 1 capital ratio(1) (%) | 6.8% | 6.2% | 5.4% |
| Tier 1 capital ratio(1) (%) | 9.5% | 8.5% | 7.3% |
| Risk weighted assets(2) | 67,438 | 63,425 | 68,562 |
(1) From 1 January 2008, the Group has managed its capital requirements on a Basel II basis, as described in Note 50 to the Consolidated Financial Statements. 2007 has been presented on a Basel I basis.
(2) In accordance with the requirements of the UK Financial Services Authority, this includes 35.6% of Alliance & Leicester plc's risk weighted assets at 31 December 2008, reflecting Santander UK's ownership of that percentage of Alliance & Leicester plc's ordinary share capital on that date, as described in Business Overview - Summary History.
Profit before tax of £1,690m increased from £1,094m in 2008 (2007: £864m). Material movements by line include:
Net interest income
|
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking |
| 3,090 | 1,587 | 1,449 |
| Corporate Banking |
| 208 | (28) | (42) |
| Private Banking |
| 139 | 105 | 89 |
| Group Infrastructure |
| (25) | 108 | 3 |
|
|
| 3,412 | 1,772 | 1,499 |
2009 compared to 2008
Net interest income of £3,412m compared to £1,772m in 2008 increased by £1,640m. Of the total increase, £840m represented the inclusion of the net interest income in 2009 of Alliance & Leicester. By segment, the movements were:
| > | Retail Banking net interest income of £3,090m increased by £1,503m from £1,587m in 2008. Of the total increase, £760m represented the inclusion of the net interest income in 2009 of Alliance & Leicester. The remaining increase of £743m was largely driven by balanced growth in customer lending and deposits across a mix of products combined with effective margin management, as well as a 17% growth in bank account liability balances and hedging strategies which helped to offset the impact of lower interest rates. In terms of lending, unsecured lending balances continued to decline, but were more than offset by net mortgage lending of £7.6bn in 2009. The increase in mortgage lending resulted in the Group taking an 18% share of the gross mortgage lending market in the UK in 2009, with lending written at margins above stock margin and with an emphasis on targeting lower loan-to-value segments. In addition, income from existing mortgage balances increased as more customers reverted to standard variable rate, and margins improved in both the mortgage and unsecured loan portfolios. |
| > | Corporate Banking net interest income of £208m increased by £236m from £(28)m in 2008. Of the total increase, £92m represented the inclusion of the net interest income in 2009 of Alliance & Leicester. The remaining increase of £144m reflected in part the sale of the Porterbrook businesses early in December 2008 (net interest income in 2008 included interest expense of £76m incurred by the Porterbrook businesses, whereas its associated leasing income was classified as non-interest income). The balance of the increase in net interest income in 2009 reflected continued benefit from higher asset margins as new business lending and pricing was altered to reflect the market environment in terms of funding cost and competitors' de-leveraging. Net interest income also improved as a result of robust growth of both assets and liabilities. |
| > | Private Banking net interest income of £139m increased by £34m from £105m in 2008. Of the total increase, £8m represented the inclusion of the net interest income in 2009 of Alliance & Leicester. The remaining increase of £26m was primarily due to the benefit of new transfer pricing arrangements on deposits acquired in the year combined with balance growth, more than offsetting an increased cost of acquisition. |
| > | Group Infrastructure net interest income/(expense) of £(25)m decreased by £133m from £108m in 2008. Of the total decrease, £20m represented the inclusion of the net interest expense in 2009 of Alliance & Leicester. The remaining decrease of £113m reflected an increase in funding costs during the year, a lower return on liquid assets, and changes to transfer pricing arrangements to reflect current market conditions that benefited the operating business units. |
2008 compared to 2007
Net interest income of £1,772m compared to £1,499m in 2007 increased by £273m, driven by a combination of asset growth and improved Commercial Banking spread up four basis points:
| > | Retail Banking net interest income of £1,587m increased by £138m from £1,449m in 2007, which benefited from strong asset growth of 10% in challenging market conditions, and our continued focus on effective margin management for both mortgages and customer deposits. Lending growth was focused on high quality prime residential lending at lower LTV and improved retention at attractive margins. |
| > | Corporate Banking net interest income/(expense) of £(28)m increased by £14m from £(42)m in 2007, driven by continued prudent growth in lending whilst taking advantage of opportunities in the market to improve margins. Furthermore, there was significant growth in deposits from corporate clients, further strengthening the Group's balance sheet. Overall, net interest income/(expense) for 2007 and 2008 was a net charge as it included interest expense incurred by the Porterbrook businesses that were sold early in December 2008, whereas its leasing income and depreciation were classified as non-interest income. |
| > | Private Banking net interest income of £105m increased by £16m from £89m in 2007, reflecting growth in all business areas, in particular Cater Allen and Abbey International which were driven by increased customer deposits. |
| > | Group Infrastructure net interest income of £108m increased by £105m from £3m in 2007 benefiting from higher earnings within Group Infrastructure on retained profits and the additional share capital injection of £1bn in October 2008, prior to its transfer into Alliance & Leicester plc in December 2008. |
Non-interest income
|
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking |
| 683 | 609 | 635 |
| Corporate Banking |
| 237 | 290 | 266 |
| Global Banking & Markets |
| 380 | 327 | 260 |
| Private Banking |
| 34 | 35 | 34 |
| Group Infrastructure |
| (50) | (29) | 88 |
|
|
| 1,284 | 1,232 | 1,283 |
2009 compared to 2008
Non-interest income of £1,284m increased by £52m compared to £1,232m in 2008. The inclusion of the non-interest income in 2009 of Alliance & Leicester resulted in an increase of £413m. By segment, the movements were:
| > | Retail Banking non-interest income of £683m increased by £74m from £609m in 2008. Of the total increase, £179m represented the inclusion of the non-interest income in 2009 of Alliance & Leicester. The remaining decrease of £105m was largely due to lower fees on unsecured lending products, as part of our stated strategy to reduce unsecured lending exposures, as well as lower fees from current accounts due to repricing. In addition, mortgage fees were adversely impacted by a reduction in the volume of mortgage redemptions given decreased activity in the market as a result of declining house prices and lower levels of supply. |
| > | Corporate Banking non-interest income of £237m decreased by £53m from £290m in 2008. Non-interest income increased by £184m as a result of the inclusion of the non-interest income in 2009 of Alliance & Leicester. However, this was more than offset by a decrease of £265m reflecting the inclusion in non-interest income in 2008 of the leasing income relating to the Porterbrook businesses which were sold early in December 2008. In addition, new business lending has generated increases in both fees and cross-selling of Global Banking & Markets products. |
| > | Global Banking & Markets non-interest income of £380m increased by £53m from £327m in 2008, reflecting strong performances in the equity business (linked to sales of retail products through the branch network) and short term markets business, which benefited from a favourable trading environment available from wider spreads in an illiquid market. |
|
> | Private Banking non-interest income of £34m decreased slightly from £35m in 2008. Alliance & Leicester contributed £1m in 2009. The remaining decrease was principally due to lower annual, transaction and new business fees. |
| > | Group Infrastructure non-interest expense of £50m increased by £21m from £29m in 2008. Alliance & Leicester contributed £49m of non-interest income in 2009. The remaining decrease of £70m in the year reflected mark-to-market losses. Substantial mark-to-market gains arose in the second half of 2008 from movements in interest rates, which were more than offset by losses due to widening asset spreads. In 2009, the mark-to-market gains reversed, but the credit spreads did not change significantly, resulting in the recognition of losses. |
2008 compared to 2007
Non-interest income of £1,232m compared to £1,283m in 2007 decreased by £51m. The decrease is largely due to the profit on sale received in 2007 from the part sale of PFS subsidiaries, not repeated in 2008.
| > | Retail Banking non-interest income of £609m decreased slightly by £26m from £635m in 2007. Despite difficult market conditions, Retail Banking continued to broaden its cross-selling activity, with increased commission from credit cards and investments. Growth in these areas was offset by lower mortgage redemption volumes, lower unsecured lending and continued pressure on current account charges. |
| > | Corporate Banking non-interest income of £290m increased by £24m from £266m in 2007 as new business lending generated increases in both fees and cross-selling of Global Banking & Markets products, which were partly offset by the cessation of operating lease rental income as a result of the sale of the Porterbrook businesses early in December 2008. |
| > | Global Banking & Markets non-interest income of £327m increased by £67m from £260m in 2007 reflecting strong performances in both Rates and Equity business, due to increased transactional flow arising from close co-operation with other parts of Santander UK and the beneficial trading environment available from diverging spreads in an illiquid market. |
| > | Private Banking non-interest income of £35m was broadly in line with £34m in 2007, reflecting increased fees in James Hay offsetting lower income in Abbey International due to the one-off property sales in 2007. |
| > | Group Infrastructure non-interest income/(expense) of £(29)m decreased by £117m from £88m in 2007, principally due to a decrease in gains on the part sale of PFS subsidiaries of £70m. In addition, Group Infrastructure non-interest income decreased due to a decline in income caused by the termination of the protection business reported in this segment in 2007. |
Administrative expenses
|
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking |
| 1,332 | 996 | 1,063 |
| Corporate Banking |
| 168 | 45 | 30 |
| Global Banking & Markets |
| 101 | 104 | 111 |
| Private Banking |
| 66 | 58 | 60 |
| Group Infrastructure |
| 181 | 140 | 105 |
|
|
| 1,848 | 1,343 | 1,369 |
2009 compared to 2008
Administrative expenses of £1,848m (2008: £1,343m) increased by £505m. Of the total increase, £501m represented the inclusion of the administrative expenses in 2009 of Alliance & Leicester. By segment, the movements were:
| > | Retail Banking administrative expenses of £1,332m increased by £336m from £996m in 2008. Of the total increase, £301m represented the inclusion of the administrative expenses in 2009 of Alliance & Leicester. A further £60m of the increase was due to costs related to the Bradford & Bingley savings business since its acquisition in September 2008. The remaining administrative expenses decrease was largely due to the removal of duplications across back office and support functions due to the integration of Alliance & Leicester and the Bradford & Bingley savings business. |
| > | Corporate Banking administrative expenses of £168m increased by £123m from £45m in 2008. Of the total increase, £128m represented the inclusion of the administrative expenses in 2009 of Alliance & Leicester. The remaining decrease was due to operational efficiencies arising from the integration of Alliance & Leicester and the sale of the Porterbrook business. |
| > | Global Banking & Markets administrative expenses of £101m were slightly lower than £104m in 2008, reflecting strong cost management while increasing income. |
| > | Private Banking administrative expenses of £66m increased by £8m from £58m in 2008. Of the total increase, £4m represented the inclusion of the administrative expenses in 2009 of Alliance & Leicester International Limited. The remaining increase of £4m was principally due to costs (including systems and other integration costs) related to Bradford & Bingley International since its acquisition in 2008. |
| > | Group Infrastructure administrative expenses of £181m increased by £41m from £140m in 2008. Alliance & Leicester contributed £68m in 2009. The remaining decrease of £27m was largely due to savings resulting from integration benefits relating to the combination with Alliance & Leicester, partly offset by higher central costs, including pension contributions and early retirement costs. |
2008 compared to 2007
Administrative expenses of £1,343m (2007: £1,369m) decreased by £26m due to continuing cost reduction activity partially offset by costs relating to the Bradford & Bingley savings business.
| > | Retail Banking administrative expenses of £996m decreased by £67m from £1,063m in 2007, due to continuing cost reduction activity partially offset by costs relating to the Bradford & Bingley savings business. |
| > | Corporate Banking administrative expenses of £45m increased by £15m from £30m in 2007, largely driven by investment in growing the business. |
| > | Global Banking & Markets administrative expenses of £104m decreased by £7m from £111m in 2007, reflecting strong cost management while increasing income. |
| > | Private Banking administrative expenses of £58m decreased by £2m from £60m in 2007 due to continuing cost reduction activity. |
| > | Group Infrastructure administrative expenses of £140m increased by £35m from £105m in 2007, reflecting investment costs not allocated to the business units. |
Depreciation and amortisation
|
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking |
| 163 | 80 | 72 |
| Corporate Banking |
| 88 | 117 | 129 |
| Global Banking & Markets |
| 3 | 3 | 2 |
| Private Banking |
| 2 | 1 | 2 |
| Group Infrastructure |
| 4 | 1 | - |
|
|
| 260 | 202 | 205 |
2009 compared to 2008
Depreciation and amortisation of £260m (2008: £202m) increased by £58m. Of the total increase, £122m represented the inclusion of the depreciation and amortisation in 2009 of Alliance & Leicester. By segment, the movements were:
| > | Retail Banking depreciation and amortisation of £163m increased by £83m from £80m in 2008. Of the total increase, £30m represented the inclusion of the depreciation and amortisation in 2009 of Alliance & Leicester. The remaining increase of £53m was largely driven by a full year of depreciation of, and further investment in, our IT platform Partenon and increased depreciation costs as a result of growing our lending to small and medium sized enterprises (SMEs). |
| > | Corporate Banking depreciation and amortisation of £88m decreased by £29m from £117m in 2008. Alliance & Leicester contributed £87m in 2009. The remaining decrease reflected the sale of the Porterbrook businesses which had contributed depreciation expense of £116m in 2008. |
2008 compared to 2007
Depreciation and amortisation of £202m (2007: £205m) was in line with the previous year, principally because Porterbrook was only sold at the end of the year.
| > | Retail Banking depreciation and amortisation of £80m increased by £8m from £72m in 2007 due to the commencement of depreciation of our IT platform Partenon. |
| > | Corporate Banking depreciation and amortisation of £117m decreased by £12m from £129m in 2007. This represents depreciation on the operating lease assets in the Porterbrook train leasing business, which was only sold at the end of 2008. |
Impairment losses on loans and advances
|
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking |
| 712 | 309 | 239 |
| Corporate Banking |
| 32 | (5) | (29) |
| Private Banking |
| 2 | 2 | 2 |
| Group Infrastructure |
| 96 | 42 | 132 |
|
|
| 842 | 348 | 344 |
2009 compared to 2008
Impairment losses on loans and advances of £842m (2008: £348m) increased by £494m. Of the total increase, £195m represented the inclusion of the Impairment losses on loans and advances in 2009 of Alliance & Leicester. By segment, the movements were:
| > | Retail Banking impairment losses on loans and advances of £712m increased by £403m from £309m in 2008. Of the total increase, £92m represented the inclusion of Alliance & Leicester's impairment losses in 2009. The remaining increase of £311m was distributed across all products with the largest increase relating to mortgages, as the impact of falling house prices and the lagging effect of unemployment, as anticipated, started to emerge. Most of the impact came through in the first half of the year, with the second half performance stabilising and in some areas improving. |
|
| With respect to mortgages, the second half of the year saw a slower rate of growth in arrears, with fewer losses than observed earlier in the year, in part as a result of collection activities and mitigating actions taken, but also due to the low interest rate environment and the slight upturn in house prices. The improvement in performance across all portfolios in the second half of the year exceeded set expectations. A very strong mortgage coverage ratio of close to 21% has been preserved. |
| > | Corporate Banking impairment losses on loans and advances of £32m increased by £37m from a £5m release in 2008. Of the total increase, £4m represented the inclusion of Alliance & Leicester's impairment losses in 2009. The low level of impairment losses is a reflection of prudent lending criteria relating to the growth businesses and portfolios as well as provisions made on acquisition relating to the non-growth portfolios to reflect expected losses in those portfolios as required under acquisition accounting. The remaining increase of £33m reflected the non-recurrence in 2009 of Corporate Banking provision releases in 2008 relating to run down businesses and some deterioration arising from market conditions. |
| > | Private Banking impairment losses on loans and advances of £2m were in line with £2m in 2008. |
| > | Group Infrastructure impairment losses on loans and advances of £96m increased by £54m from £42m in 2008. Alliance & Leicester contributed £98m in 2009 in respect of the treasury asset portfolio. The remaining decrease of £45m principally relates to the non-recurrence in 2009 of other credit provision charges incurred in 2008. |
2008 compared to 2007
Impairment losses on loans and advances were broadly unchanged at £348m (2007: £344m), as credit quality remained strong, with a continued reduction in the size of the unsecured personal lending book, offset by a further general deterioration in economic conditions affecting the mortgage portfolio provision.
| > | Retail Banking impairment losses on loans and advances of £309m increased by £70m from £239m in 2007, largely driven by signs of deterioration in the mortgage portfolio. The performance of the mortgage portfolio remained strong, and was better than Council of Mortgage Lenders ('CML') averages for 2008. In addition, the level of secured coverage appropriately reflected the current economic conditions and benchmarked well ahead of our UK peers for 2008. At the same time, there was a reduction in the unsecured lending charge, driven by the tightening in lending policies in 2007 and the reduction in the unsecured loan portfolio. |
| > | Corporate Banking provision releases of £5m decreased by £24m from £29m in 2007 reflecting an increased level of impairment on the new corporate portfolios more than offset by final provision releases from the successful run down of the legacy portfolios. |
| > | Private Banking impairment losses on loans and advances of £2m were in line with £2m in 2007. |
| > | Group Infrastructure impairment losses on loans and advances of £42m decreased by £90m from £132m in 2007. The impairment charge is split for segmental reporting purposes on the basis set out in "Other Material Items" on page 27 between Retail Banking and Group Infrastructure. The reduction in the charge in Group Infrastructure in 2008 compared to 2007 reflects lower provisions held centrally. |
Provisions for other liabilities and charges
|
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking |
| 56 | 17 | - |
|
|
| 56 | 17 | - |
2009 compared to 2008
Provisions for other liabilities and charges in Retail Banking of £56m compared to £17m in 2008, principally representing redundancy costs relating to the integration of Alliance & Leicester and the Bradford & Bingley savings business.
2008 compared to 2007
Provisions for other liabilities and charges in Retail Banking of £17m compared to £nil in 2007, relating to the integration of the acquired Bradford & Bingley savings business, partially offset by a release of the misselling provision.
Adjustments between the statutory basis and the trading basis
Santander UK's Board reviews discrete financial information for each of its segments that includes measures of operating results and assets. The segments are managed primarily on the basis of their results, which are measured on a 'trading' basis. The trading basis differs from the statutory basis as a result of the application of various adjustments, as described below.
Management considers that the trading basis provides the most appropriate way of reviewing the performance of the business. The adjustments are:
| > | Alliance & Leicester pre-acquisition trading basis results - Following the transfer of Alliance & Leicester plc to the Company in January 2009, the statutory results for the year ended 31 December 2009 include the results of the Alliance & Leicester group, whereas the statutory results for the year ended 31 December 2008 do not. In order to enhance the comparability of the results for the two periods, management reviews the 2008 results including the pre-acquisition results of the Alliance & Leicester group for that period.
|
| > | Reorganisation and other costs - These comprise implementation costs in relation to the cost reduction projects, including integration-related expenses, as well as certain remediation administration expenses and credit provisions. Management needs to understand the underlying drivers of the cost base that will remain after these exercises are complete, and does not want this view to be clouded by these costs, which are managed independently.
|
| > | Depreciation of operating lease assets - The operating lease businesses are managed as financing businesses and, therefore, management needs to see the margin earned on the businesses. Residual value risk is separately managed. As a result, the depreciation is netted against the related income.
|
| > | Profit on part sale of PFS subsidiaries - These profits are excluded from the results to allow management to understand the underlying performance of the business. In 2009 there were no such profits. In 2008, the profit on the sale of the Porterbrook businesses was excluded. In 2007, the profit on the sale of 49% of James Hay, Cater Allen and Abbey Sharedealing, and small recoveries on certain other transactions were similarly excluded.
|
| > | Hedging and other variances - The Balance Sheet and Income Statement are subject to mark-to-market volatility including that arising from the accounting for elements of derivatives deemed under IFRS rules to be ineffective as hedges. Volatility also arises on certain assets previously managed on a fair value basis, and hence classified as fair value through profit or loss under IFRS, that are now managed on an accruals basis. Where appropriate, such volatility is separately identified to enable management to view the underlying performance of the business. In addition, other variances include the reversal of coupon payments on certain equity instruments which are treated as interest expense in the trading results but are reported below the profit after tax line for statutory purposes.
|
| > | Capital and other charges - These principally comprise internal nominal charges for capital invested in the Group's businesses. Management implemented this charge to assess the effectiveness of capital investments.
|
For a detailed explanation of these items, see "Other Material Items" in the Business and Financial Review.
Business Review - Key Performance Indicators
Key performance indicators relevant to the Group during the years ended, and as at, 31 December 2009, 2008 and 2007 are set out below. This information describes the key measures used by management in assessing the success of the business against its strategies and objectives.
| Key performance indicator | Note | 2009 | 2008 | 2007 |
| PFS trading revenues | 1 | £4,658m | £3,894m | £2,615m |
| PFS trading cost:income ratio | 2 | 42% | 50% | 50% |
| Profit for the year | 3 | £1,245m | £819m | £685m |
| Commercial Banking spread | 4 | 1.82% | 1.44% | 1.40% |
| Total number of employees | 5 | 19,483 | 22,669 | 15,236 |
| Market share of mortgage stock | 6 | 13.5% | 12.9% | 9.3% |
| Loan-to-deposit ratio | 7 | 126% | 136% | 146% |
| Loan-to-value ratio of mortgage stock (indexed) | 8 | 52% | 51% | 46% |
| 1. | PFS trading revenues PFS trading revenues comprise net interest income and non-interest income of the Personal Financial Services businesses. Discussion and analysis of this data is set out in the Business Review - Personal Financial Services on pages 19 and 20. Management reviews PFS trading revenues in order to assess the Group's effectiveness in obtaining new customers and business. Management's target for PFS trading revenues from 2007 to 2009 was growth of between 5% and 10% per annum, which was exceeded. PFS trading revenue growth in 2009 compared with 2008 was 20%. Management's target for PFS trading revenues is growth of between 5% and 10% per annum from 2010 to 2012.
|
| 2. | PFS trading cost:income ratio The PFS trading cost:income ratio is defined as trading expenses divided by trading income of the Personal Financial Services businesses. Discussion and analysis of trading income and expenses is set out in the Business Review - Personal Financial Services on pages 19 to 26. Further information about the calculation of the PFS trading cost:income ratio is contained in Selected Financial Data on page 190. Management reviews the PFS trading cost:income ratio in order to measure the operating efficiency of the Group. Management's original target for the PFS trading cost:income ratio, set in 2005, was to reduce it to 45% by 2008. This was achieved in 2008 prior to impact of the transfer of Alliance & Leicester plc. Management's new target for the PFS trading cost:income ratio is to achieve sustained further improvements from this level. In 2009, this target was met and the PFS trading cost:income ratio was reduced to 42%.
|
| 3. | Profit for the year Profit for the year is the statutory consolidated profit after tax for the year. Discussion and analysis of this data is set out in the Group Summary in this Business Review - Summary section on pages 11 to 15. Management reviews the profit for the year in order to monitor the effectiveness of the Group's strategy and decisions to maximise the value of the business, and increase the strength of its capital base and its capacity to pay dividends to its shareholder Banco Santander, S.A.. Management's target for the profit for the year is to achieve sustained growth over the previous year, and this was achieved in 2009.
|
| In order to ensure that targets related to the above three key performance indicators are met, management also focuses on other measures which are set out below as critical drivers towards achieving the three key performance indicators above on a sustainable basis.
| |
| 4. | Commercial Banking spread Commercial Banking spread is defined as the trading net interest income over average customer loans (mortgages, unsecured personal loans, corporate loans and overdraft interest). Discussion and analysis of this data is set out in the Business Review - Personal Financial Services on pages 19 to 26. Management reviews the Commercial Banking spread in order to assess the economic sustainability of its commercial banking products and operations. Management's target for the Commercial Banking spread is to ensure that it is appropriate for the current market conditions and profit targets. This target has been met given the improvements in the spread and strong reported profit growth.
|
| 5. | Total number of employees Total number of employees is measured at the year-end and calculated on a full-time equivalent basis. The 19,483 employees at 31 December 2009 included 5,228 employees of Alliance & Leicester plc as a result of the transfer of Alliance & Leicester plc to the Company in January 2009. The 22,669 employees at 31 December 2008 include 6,755 employees of Alliance & Leicester plc. 2007 data do not include such employees. 2009 and 2008 data includes 1,155 (2008: 1,556) employees who transferred to the Company in September 2008 as part of the acquisition of the Bradford & Bingley savings business. 2007 data do not include such employees. As part of the planning process, headcount targets are set for each division and reviewed on a monthly basis. Further information about employees on a segmental basis is contained in Note 1 to the Consolidated Financial Statements.
|
|
| Management reviews the total number of employees in order to support the continuing overall control of the Group's cost base and the trading cost:income ratio. Management's targets for the total number of employees are to ensure that staffing levels are optimal for the nature and size of the Group's business. Headcount was reduced by 1,603 full-time equivalents in line with our stated intentions to remove duplicated back office and support functions following the acquisitions of Alliance & Leicester plc and the Bradford & Bingley savings business. Further, more modest, reductions in headcount are expected in 2010.
|
| 6. | Market share of mortgage stock Market share of mortgage stock represents the book value of the Group's mortgage asset as a percentage of the total book value of mortgages in the UK market, and is measured at the year-end. Market share of mortgage stock is calculated by reference to data on the size of the UK mortgage market produced by the Bank of England. Discussion and analysis of this data is set out in the Business Review - Personal Financial Services on pages 21 and 22. Management reviews market share of mortgage stock as one of the measures to assess the Group's effectiveness in obtaining new customers. Management's target for market share of mortgage stock in 2007 and 2008 was to maintain the Group's historical market share of mortgage stock of approximately 10%, subject to earning an appropriate margin. Following the transfer of Alliance & Leicester plc to the Group in 2009, the Group's target for market share of mortgage stock was updated to reflect the Group's combined historical market share of approximately 12.9%. In 2009, market share increased by 0.6% driven by profitable new business and retention.
|
| 7. | Loan-to-deposit ratio During 2009, management placed a greater focus on the loan-to-deposit ratio as part of its focus on maintaining a sustainable funding model. The loan-to-deposit ratio represents the book value of the Group's commercial assets (i.e. retail, corporate and private banking assets) divided by its commercial liabilities (i.e. retail, corporate and private banking deposits, and shareholders' funds), and is measured at the year-end. Discussion and analysis of the loan-to-deposit ratio is set out in the Chief Executive's Review on page 2 and in the Directors' Report on page 90. Management reviews the loan-to-deposit ratio in order to assess the Group's ability to fund its commercial operations with commercial borrowings, reducing reliance on sourcing funding from the wholesale markets whilst improving its customer product holdings. Management's target for the loan-to-deposit ratio is sustained improvements in future years. During 2009, Santander UK has continued to achieve strong commercial net lending growth which has been more than matched by a larger increase in net deposit flows, in doing so improving our loan deposit ratio to 126% (2008: 136% including Alliance & Leicester).
|
| 8. | Loan-to-value ('LTV') ratio on mortgage stock During 2009, as a result of the difficult economic environment, management placed a greater focus on the LTV ratio on mortgage stock in order to ensure that the profit target be achieved. The LTV ratio is calculated as the book value of the Group's residential mortgages as a percentage of the estimated current market value of the properties against which the mortgages are secured. The current market value is estimated from house price indices by adjusting the value of the property at the time of the origination of the mortgage for changes in house prices from that date to the balance sheet date. The LTV ratio is a measure of the estimated current level of security that the Group possesses on its mortgage loans. Management reviews the LTV ratio in order to assess the Group's potential resilience to future declines in property prices. Management's target for the LTV ratio is, subject to market conditions, to sustain a LTV ratio of less than 60%. During 2009, the Group has continued to focus on the quality of new lending based on affordability and lower LTV segments. The average LTV on stock value at 31 December 2009 was slightly higher than the previous year at 52% (2008: 51%) as expected, due to the effects of falling house prices more than offsetting lower LTVs on new business.
|
This section contains a summary of the results, and commentary thereon, by Income Statement line item on a trading basis for each segment within the Personal Financial Services businesses, together with reconciliations from the trading basis to the statutory basis. Additional information is provided on the adjustments between the trading basis and the statutory basis in the Business Review - Other Material Items.
Personal Financial Services profit before tax by segment
| 31 December 2009 | Retail Banking £m | Corporate Banking £m | Global Banking & Markets £m | Private Banking £m | Group Infrastructure£m | Total£m |
| Net interest income/(expense) | 3,257 | 294 | - | 130 | (340) | 3,341 |
| Non-interest income | 707 | 163 | 380 | 34 | 33 | 1,317 |
| Total trading income | 3,964 | 457 | 380 | 164 | (307) | 4,658 |
| Total trading expenses | (1,442) | (181) | (104) | (68) | (149) | (1,944) |
| Impairment losses on loans and advances | (712) | (31) | - | (2) | (57) | (802) |
| Trading profit/(loss) before tax | 1,810 | 245 | 276 | 94 | (513) | 1,912 |
| Adjust for: |
|
|
|
|
|
|
| - Reorganisation and other costs | (79) | - | - | - | (107) | (186) |
| - Hedging and other variances | (11) | - | - | - | (25) | (36) |
| - Capital and other charges | (180) | (86) | - | 8 | 258 | - |
| Profit/(loss) before tax | 1,540 | 159 | 276 | 102 | (387) | 1,690 |
| 31 December 2008 | Retail Banking £m | Corporate Banking £m | Global Banking & Markets £m | Private Banking £m | Group Infrastructure£m | Total£m |
| Net interest income/(expense) | 2,282 | 134 | - | 99 | (126) | 2,389 |
| Non-interest income | 836 | 264 | 326 | 37 | 42 | 1,505 |
| Total trading income | 3,118 | 398 | 326 | 136 | (84) | 3,894 |
| Total trading expenses | (1,358) | (239) | (107) | (64) | (172) | (1,940) |
| Impairment losses on loans and advances | (442) | (44) | - | (3) | - | (489) |
| Trading profit/(loss) before tax | 1,318 | 115 | 219 | 69 | (256) | 1,465 |
| Adjust for: |
|
|
|
|
|
|
| - A&L pre-acquisition trading basis results | (300) | (34) | - | (8) | 178 | (164) |
| - Reorganisation and other costs | (121) | - | - | - | (42) | (163) |
| - Profit on part sale of PFS subsidiaries | - | 40 | - | - | - | 40 |
| - Hedging and other variances | - | - | - | - | (84) | (84) |
| - Capital and other charges | (103) | (14) | - | 16 | 101 | - |
| Profit/(loss) before tax | 794 | 107 | 219 | 77 | (103) | 1,094 |
| 31 December 2007 | Retail Banking £m | Corporate Banking £m | Global Banking & Markets £m | Private Banking £m | Group Infrastructure£m | Total£m |
| Net interest income/(expense) | 1,538 | (31) | - | 70 | (78) | 1,499 |
| Non-interest income | 635 | 132 | 260 | 34 | 55 | 1,116 |
| Total trading income | 2,173 | 101 | 260 | 104 | (23) | 2,615 |
| Total trading expenses | (996) | (30) | (107) | (61) | (105) | (1,299) |
| Impairment losses on loans and advances | (239) | 29 | - | (2) | - | (212) |
| Trading profit/(loss) before tax | 938 | 100 | 153 | 41 | (128) | 1,104 |
| Adjust for: |
|
|
|
|
|
|
| - Reorganisation and other costs | (139) | - | (6) | (1) | (132) | (278) |
| - Profit on part sale of PFS subsidiaries | - | 5 | - | - | 105 | 110 |
| - Hedging and other variances | - | - | - | - | (72) | (72) |
| - Capital and other charges | (89) | (11) | - | 19 | 81 | - |
| Profit/(loss) before tax | 710 | 94 | 147 | 59 | (146) | 864 |
2009 compared to 2008
| Personal Financial Services trading profit before tax of £1,912m increased by £447m on the previous year (2008: £1,465m), driven by strong income growth across all businesses which exceeded the increase in impairment losses, as well as continued cost control. Trading income was 20% higher, well above the targeted range. In absolute terms the increase in trading income was twice as large as the increase in trading provisions. Trading expenses showed a small increase, due to the inclusion of £98m of Bradford & Bingley savings business related costs following its acquisition in September 2008, which was partially offset by a reduction in other trading expenses resulting from integration benefits from Alliance & Leicester. Santander UK remains on track to deliver targeted cost savings of £180m by 2011. |
| > | Retail Banking trading profit before tax increased by £492m to £1,810m (2008: £1,318m) driven by a strong increase in trading income, partly offset by higher trading expenses and impairment losses. Trading income benefited from a significant improvement in mortgage margins both in terms of new lending and retention of existing business, as well as increased retention levels on standard variable rate and other longer term products. In addition, the Retail Banking business delivered strong growth in customer deposits, together with effective management of deposit margins in a low interest rate environment. There was also a significant increase in bank account openings and investment product sales. These positive income trends were partly offset by lower fee income from current accounts, a reduction in the volume of mortgage redemptions and lower unsecured lending volumes. Trading expenses increased mainly due to the inclusion of a full year of Bradford & Bingley savings business related expenses. The increase in impairment losses was largely attributable to the residential mortgage and unsecured personal loans portfolios reflecting the impact of market conditions, albeit with mortgage arrears tracking better than expectations and significantly better than our UK peers. |
| > | Corporate Banking trading profit before tax increased by £130m to £245m (2008: £115m). This movement was due to strong income performance, lower operating expenses benefiting from integration synergies and lower impairment losses. Trading income growth benefited from higher asset margins as well as robust growth on both assets and deposits - assets not in run down grew by 12% and deposits more than doubled. |
| > | Global Banking & Markets trading profit before tax increased by £57m to £276m (2008: £219m) due predominantly to a strong income performance. During the first half of 2009, Global Banking & Markets was able to take advantage of wider spreads, particularly in the short term markets business. In addition, Global Banking & Markets benefited from integrated sales efforts across the Santander group, including equities linked to investment sales in the branch network. |
| > | Private Banking trading profit before tax increased by £25m to £94m (2008: £69m) reflecting higher trading income as a result of higher deposits in Cater Allen and improved margins in both Cater Allen and Abbey International. |
| > | Group Infrastructure trading loss before tax increased by £257m to £513m (2008: £256m) reflecting an increase in funding costs during the year, a lower return on liquid assets, and changes to transfer pricing arrangements to reflect current market conditions. |
2008 compared to 2007
| Personal Financial Services trading profit before tax of £1,465m increased by £361m on the previous year (2007: £1,104m). Of the total increase, £164m represented the inclusion of Alliance & Leicester's pre-acquisition trading profit before tax in 2008. The remaining increase of £197m was driven by a strong income performance across all four business divisions. This was balanced against controlled costs, up 3.2%, as we continued to invest in our Corporate Banking and Private Banking businesses, and additional costs relating to Bradford & Bingley's savings business acquired in September 2008. As a result, our trading cost:income ratio was further reduced to 45%, and was better than the average of our UK peers. | |
| > | Retail Banking trading profit before tax increased by £380m to £1,318m (2007: £938m). Of the total increase, £299m represented the inclusion of Alliance & Leicester's pre-acquisition trading profit before tax in 2008. The remaining increase of £81m was driven by an increase in trading income and lower expenses partly offset by higher credit provisions. Trading income benefited from a 10% growth in both assets and deposits and better mortgage new business margins throughout 2008. At the same time, we maintained our focus on high quality prime residential lending at lower LTV and improved retention at attractive margins. Trading provisions increased, largely reflecting an increase in mortgage arrears, driven by the change in economic conditions. The level of secured coverage remained strong at 25% and was ahead of our UK peers for 2008. |
| > | Corporate Banking trading profit before tax increased by £15m to £115m (2007: £100m). The inclusion of Alliance & Leicester's pre-acquisition trading profit before tax in 2008 added £34m to the overall Corporate Banking trading profit before tax. This increase was more than offset by a £49m decrease reflecting lower provisions, in part due to releases from positions in run down, and increased expenses largely driven by investment in growing the business, partially offset by higher trading income. |
| > | Global Banking & Markets trading profit before tax increased by £66m to £219m (2007: £153m) reflecting strong performances in both the Rates and Equity business, due to increased transactional flow arising from close co-operation with other parts of the Group and the beneficial trading environment available from diverging spreads in an illiquid market. |
| > | Private Banking trading profit before tax increased by £28m to £69m (2007: £41m). Of the total increase, £8m represented the inclusion of Alliance & Leicester's pre-acquisition trading profit before tax in 2008. The remaining increase of £20m reflected growth in all businesses, particularly Cater Allen and Abbey International driven by increased customer deposits attracted by competitive rates. |
| > | Group Infrastructure trading loss before tax increased by £128m to £256m (2007: £128m). The inclusion of Alliance & Leicester's pre-acquisition trading loss before tax in 2008 added £178m to the overall Group Infrastructure trading loss before tax. The remaining decrease of £50m reflected higher earnings on retained profits and earnings on the additional share capital injection of £1bn in October 2008, prior to its transfer into Alliance & Leicester plc in December 2008. |
Personal Financial Services business volumes
Business volumes relating to the Personal Financial Services businesses are set out below. These volumes are used by management to assess the sales performance of the Group, both absolutely and relative to its UK peers, and to inform management of product trends in the Personal Financial Services market.
Balances in the 2008 column in the table below have been amended for the Transfer of Alliance & Leicester plc to the Company as described in Note 47 to the Consolidated Financial Statements. The business volumes for 2008 were unaffected by the Transfer and therefore have not been amended in the 2008 column. However, in order to provide more meaningful and relevant comparatives between 2009 and 2008, Alliance & Leicester pre-acquisition business volumes for the year ended 31 December 2008 have been combined with Santander UK and presented together in the Combined Volumes 2008 column. These measures are non-GAAP financial measures. A body of generally accepted accounting principles such as IFRS is commonly referred to as 'GAAP'. A non-GAAP financial measure is defined as one that measures historical or future financial performance, financial position or cash flows but which excludes or includes amounts that would not be so adjusted in the most comparable GAAP measures. These non-GAAP financial measures are not a substitute for GAAP measures, for which management has responsibility.
In addition, information related to market share and bank account openings for 2008 have also been presented on a combined basis in the Combined Volumes 2008 column.
|
| 2009 | 2008(1) | Combined volumes(2) 2008 | 2007 |
| Mortgages: |
|
|
|
|
| Gross mortgage lending in the year | £26.4bn | £31.8bn | £35.2bn | £35.6bn |
| Capital repayments in the year | £18.8bn | £20.7bn | £29.1bn | £26.9bn |
| Net mortgage lending in the year | £7.6bn | £11.1bn | £6.1bn | £8.7bn |
| Mortgage stock balance(1): | £166.7bn | £159.2bn | - | £110.5bn |
| - Retail | £160.4bn | £153.2bn | - | £105.0bn |
| - Housing Association(3) | £6.3bn | £6.0bn | - | £5.5bn |
| Market share - gross mortgage lending(4) | 18.4% | 12.4% | 13.9% | 9.8% |
| Market share - capital repayments(4) | 14.3% | 9.5% | 13.7% | 10.5% |
| Market share - net mortgage lending(4) | 65.5% | 28.9% | 15.2% | 8.1% |
| Market share - mortgage stock(1) (4) | 13.5% | 12.9% | - | 9.3% |
| Customer deposits: |
|
|
|
|
| Total net deposit flows(5) | £14.9bn | £9.5bn | £12.6bn | £2.7bn |
| Deposit stock(1) (6) | £143.9bn | £129bn | - | £67.3bn |
| Investment and pensions annual premium income | £3.5bn | £2.2bn | £2.8bn | £1.7bn |
| Banking: |
|
|
|
|
| Bank account openings (000's) |
|
|
|
|
| - Retail | 1,032 | 548 | 846 | 400 |
| - Other | 61 | 24 | 58 | 30 |
|
| 1,093 | 572 | 904 | 430 |
| Bank account liability balance: |
|
|
|
|
| - Retail | £11.2bn | £9.7bn | - | £5.5bn |
| - Other | £4.7bn | £4.7bn | - | £4.8bn |
|
| £15.9bn | £14.4bn | - | £10.3bn |
| Gross unsecured personal lending in the year: |
|
|
|
|
| - Retail | £1.4bn | £0.8bn | £2.3bn | £0.9bn |
| - Other, including cahoot | £0.1bn | £0.1bn | £0.1bn | £0.1bn |
|
| £1.5bn | £0.9bn | £2.4bn | £1.0bn |
| Unsecured lending asset balance(1) (7): |
|
|
|
|
| - Retail | £4.5bn | £5.8bn | - | £2.5bn |
| - Other, including cahoot | £0.3bn | £0.4bn | - | £0.8bn |
|
| £4.8bn | £6.2bn | - | £3.3bn |
| Credit card sales (000's) | 387 | 395 | 475 | 261 |
(1) Balances at 31 December 2008 have been amended for the Transfer of Alliance & Leicester plc to the Company as described in Note 47 to the Consolidated Financial Statements. Business volumes have not been amended.
(2) Includes Alliance & Leicester pre-acquisition business volumes for the year ended 31 December 2008 in order to provide more meaningful comparatives.
(3) Housing Association mortgages are classified in the Corporate Banking segment and exclude contingent liabilities and commitments. See Note 37 to the Consolidated Financial Statements.
(4) Mortgage market shares are estimated internally by reference to data on the size of the UK mortgage market produced by the Bank of England.
(5) Includes Bradford & Bingley savings business net deposit flows from its acquisition in September 2008.
(6) Includes Bradford & Bingley deposits acquired in September 2008 and subsequent net inflows. 2007 has been amended to include retail structured product flows.
(7) Comprises unsecured personal loans, credit cards and overdrafts.
2009 compared to 2008
Mortgages
Gross mortgage lending was £26.4bn, representing an estimated market share of 18.4%, an increase in market share of 4.5% compared to 2008 (on a combined basis including Alliance & Leicester) and ahead of our mortgage stock share.
Our mortgage performance remained strong against a backdrop of a much smaller re-mortgage market, in part due to the decline in house prices, and continued to be driven by a competitive pricing strategy, targeting high quality new lending based on affordability and lower loan-to-value ('LTV') segments with good margins. In particular, there was no lending at LTV greater than 90% during the year. The average LTV on new business completions in 2009 was slightly lower at 61% (2008: 65%).
Capital repayments were £18.8bn, considerably lower than the level of repayments in 2008, as more customers reverted to standard variable rate loans, and successful retention activity. Our estimated market share of capital repayments increased slightly to 14.3% compared to 2008 (on a combined basis including Alliance & Leicester), reflecting the smaller size of the market in 2009. Net mortgage lending of £7.6bn represented a market share of 65.5% of mortgage lending in the UK during the year as the Group continued to be a consistent lender in difficult times. This performance was achieved against a market backdrop of heightened competition in lower LTV segments, demonstrating our effective pricing and retention strategies.
Deposits and Investments
Deposit flows of £14.9bn were underpinned by strong performances from the Retail, Corporate and Private Banking businesses. Retail and Private Banking inflows benefitted from the alignment of product marketing and pricing strategies across the brands, including the introduction of Abbey products, such as fixed rate bonds and Individual Savings Accounts, and promotional activity in Bradford & Bingley branches. Corporate Banking saw further growth in flows, driven by strong levels of re-investment by customers with maturing capital-protected investments and savings bonds, as investors sought to invest with banks with strong credit ratings.
Investment sales of £3.5bn were up 25% in the year (on a combined basis including Alliance & Leicester) compared to a wider market decline estimated at 13% for the same period. This strong performance primarily reflected the ongoing attractiveness of offering capital guaranteed investment products as customers continue to seek lower risk alternatives, but has also been driven by increased coverage of specialist bancassurance advisors across the branch network.
Banking
Current account openings in the year increased by 21%, to 1.1 million accounts, which exceeded our target of 1 million new current accounts.
Unsecured Personal Lending
Total gross unsecured personal lending in the year decreased to £1.5bn, representing a 38% decrease from 2008 (on a combined basis including Alliance & Leicester) following the same trend as the previous year, reflecting our continued cautious stance, with the unsecured loan portfolio balance down 23% on 2008. Our continued focus on existing customers and decreased unsecured lending in line with our stated policy again contributed to higher margins on the overall portfolio resulting in an increase in the average margin on the portfolio of 182 basis points over 2008.
Credit Card Sales
Credit card sales decreased in 2009, as 2008 benefited from the launch of the Abbey Zero card. In addition, we saw a decline in sales via direct mail as we focused on selling to existing customers through our direct channels to improve cross-selling initiatives.
2008 compared to 2007
Mortgages
Gross mortgage lending increased to £31.8bn, representing an estimated market share of 12.4% compared to 9.8% in 2007. Our mortgage performance remained strong in a market that continued to contract, impacted by falling customer confidence, particularly in the purchase market. This strong performance was driven by a competitive pricing strategy, targeting high quality lower LTV lending at good margins.
Net mortgage lending of £11.1bn increased 28%, and was largely achieved in the first half of 2008 when gross lending increased, reflecting the strength of our franchise during challenging market conditions, and reduced capital repayments through excellent retention activity. This restored our mortgage stock market share to its historical level of approximately 10%.
Deposits and Investments
Retail, Corporate and Private Banking net deposit flows increased by £6.8bn to £9.5bn. Retail and Private Banking flows increased significantly driven by the Direct Individual Savings Accounts, the Instant Access Saver account and the eSaver Direct, together with the launch of innovative new products promoted through the branches and an excellent performance from Bradford & Bingley's branches since their acquisition in September 2008. We also saw a strong performance in bonds, driven by a contribution from both the Abbey-branded and cahoot offerings. Corporate Banking flows increased significantly, driven by a focus on relationship managers driving volumes from new business and existing clients, and attracting substantial deposits from corporate clients, further strengthening Santander UK's balance sheet.
Investment sales increased 34%, despite the market decreasing by 8%, reflecting the attractiveness of offering capital guaranteed investment products as customers seek lower risk alternatives. The second half of the year also benefited from the continued expansion of the number of sales advisors and high levels of re-investment by customers.
Banking
Bank account openings continued to increase, and were up 33%, achieving a record number of openings in the second half of the year and a strong market share performance. This was underpinned by innovative new products and propositions such as the market-leading 8% rate offered on credit balances.
Unsecured Personal Lending
Total gross unsecured personal lending in 2008 decreased by 10% reflecting our continued cautious stance. The unsecured loan portfolio balance increased from 2007 as a result of the Transfer of Alliance & Leicester plc to the Company, which more than offset a 17% decrease in Abbey balances as we focused the lending mix towards existing customers, which made up 94% of new lending, and through the branch channel.
Credit Card Sales
Credit card sales increased by 51% in 2008 benefiting from the launch of the Abbey Zero card and improved cross-selling initiatives during the year.
Personal Financial Services trading net interest income by segment
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking | 3,257 | 2,282 | 1,538 |
| Corporate Banking | 294 | 134 | (31) |
| Private Banking | 130 | 99 | 70 |
| Group Infrastructure | (340) | (126) | (78) |
| PFS trading net interest income | 3,341 | 2,389 | 1,499 |
| Adjust for: |
|
|
|
| - A&L pre-acquisition trading basis results | - | (617) | - |
| - Hedging and other variances | 71 | - | - |
| PFS net interest income | 3,412 | 1,772 | 1,499 |
2009 compared to 2008
Retail Banking net interest income increased by £975m to £3,257m (2008: £2,282m) largely driven by balanced growth in customer lending and deposits across a mix of products combined with effective margin management, as well as a 17% growth in bank account liability balances and hedging strategies which helped to offset the impact of lower interest rates. In addition, income from existing mortgage balances increased as more customers reverted to standard variable rate mortgages and margins improved in both the mortgage and unsecured loan portfolios in the low interest environment.
Corporate Banking net interest income improved by £160m to £294m (2008: £134m). This reflected in part the sale of the Porterbrook businesses early in December 2008 (net interest income in 2008 included interest expense of £76m incurred by the Porterbrook businesses, whereas its associated leasing income and depreciation were classified as non-interest income). The balance of the increase in net interest income in 2009 reflected continued benefit from higher asset margins as new business lending and pricing was altered to reflect the market environment in terms of funding cost and competitors' de-leveraging. Net interest income also improved as a result of robust growth of both assets and liabilities.
Private Banking net interest income increased by £31m to £130m (2008: £99m). The increase was primarily due to the benefit of new transfer pricing arrangements on deposits acquired in the year which increased overall balances, more than offsetting competitive market pressures on pricing.
Group Infrastructure net interest expense increased by £214m to £340m (2008: £126m), reflecting an increase in funding costs during the year, a lower return on liquid assets, and changes to transfer pricing arrangements to reflect current market conditions that benefited the operating business units. This was partly offset by the unwind of the discount on acquisition of the Alliance & Leicester Treasury asset portfolio.
2008 compared to 2007
Retail Banking net interest income increased by £744m to £2,282m (2007: £1,538m). Of the total increase, £592m represented the inclusion of Alliance & Leicester's pre-acquisition trading net interest incomein 2008. The remaining increase of £152m reflected a 10% growth in both assets and deposits and better mortgage new business margins throughout 2008.
Corporate Banking net interest income charge improved by £165m to £134m (2007: £(31)m). Of the total increase, £147m represented the inclusion of Alliance & Leicester's pre-acquisition trading net interest income in 2008. The remaining increase of £18m was driven by a continued prudent growth in lending whilst taking advantage of opportunities in the market to improve margins. The Group also saw significant growth in deposits from corporate clients, further strengthening the Group's balance sheet. Overall, net interest income for 2007 and 2008 was a net charge as it included interest expense incurred by the Porterbrook businesses that were sold early in December 2008, whereas its leasing income and depreciation were classified as non-interest income.
Private Banking net interest income increased by £29m to £99m (2007: £70m). Of the total increase, £10m represented the inclusion of Alliance & Leicester's pre-acquisition trading net interest income in 2008. The remaining increase of £19m reflected growth in all business areas, particularly Cater Allen and Abbey International driven by increased customer deposits attracted by competitive rates.
Group Infrastructure net interest expense increased by £48m to £126m (2007: £78m). The inclusion of the pre-acquisition trading net interest expense in 2008 of Alliance & Leicester increased the overall Group Infrastructure net interest expense by £132m. The remaining decrease of £84m reflected higher earnings on shareholder's funds in 2008.
Personal Financial Services trading non-interest income by segment
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking | 707 | 836 | 635 |
| Corporate Banking | 163 | 264 | 132 |
| Global Banking & Markets | 380 | 326 | 260 |
| Private Banking | 34 | 37 | 34 |
| Group Infrastructure | 33 | 42 | 55 |
| PFS trading non-interest income | 1,317 | 1,505 | 1,116 |
| Adjust for: |
|
|
|
| - A&L pre-acquisition trading basis results | - | (330) | - |
| - Reorganisation and other costs | - | (16) | - |
| - Depreciation of operating lease assets | 74 | 117 | 129 |
| - Profit on part sale of PFS subsidiaries | - | 40 | 110 |
| - Hedging and other variances | (107) | (84) | (72) |
| PFS non-interest income | 1,284 | 1,232 | 1,283 |
2009 compared to 2008
Retail Banking trading non-interest income decreased by £129m to £707m (2008: £836m), largely due to lower fees on unsecured lending products, as part of our stated strategy to reduce unsecured lending exposures, and lower fees from current accounts due to repricing. In addition, mortgage fees were adversely impacted by a reduction in the volume of mortgage redemptions given decreased activity in the market as a result of declining house prices and lower levels of supply.
Corporate Banking non-interest income decreased by £101m to £163m (2008: £264m), reflecting the inclusion in non-interest income in 2008 of the leasing income and depreciation relating to the Porterbrook businesses which were sold early in December 2008. New business lending has generated increases in both fees and cross-selling of Global Banking & Markets products.
Global Banking & Markets non-interest income increased by £54m to £380m (2008: £326m) reflecting strong performances in the equity business (linked to sales of retail products through the branch network) and short term markets business, which benefited from a favourable trading environment available from wider spreads in an illiquid market.
Private Banking non-interest income decreased slightly by £3m to £34m (2008: £37m), principally due to lower annual, transaction and new business fees.
Group Infrastructure non-interest income decreased slightly to £33m (2008: £42m), principally due to the non-recurrence in 2009 of gains on the buy-back of debt securities in 2008.
2008 compared to 2007
Retail Banking trading non-interest income increased by £201m to £836m (2007: £635m). The inclusion of the pre-acquisition trading non-interest income in 2008 of Alliance & Leicester added £211m to the overall Retail Banking trading non-interest income. The remaining decrease of £10m reflected lower mortgage redemption volumes, lower unsecured lending and continued pressure on current account charges more than offsetting increased commission from credit cards and investments.
Corporate Banking non-interest income increased by £132m to £264m (2007: £132m). Of the total increase, £131m represented the inclusion of Alliance & Leicester's pre-acquisition trading non-interest incomein 2008. The remaining increase of £1m reflected new business lending generating increases in both fees and cross-selling of Global Banking & Markets products, which were offset by the cessation of operating lease rental income and depreciation as a result of the sale of the Porterbrook businesses early in December 2008.
Global Banking & Markets non-interest income increased by £66m to £326m (2007: £260m) reflecting strong performance in both Rates and Equity business, due to increased transactional flow arising from close co-operation with other parts of Santander UK and the beneficial trading environment available from diverging spreads in an illiquid market.
Private Banking non-interest income was broadly in line with 2007 at £37m (2007: £34m). Of the total increase, £2m represented the inclusion of Alliance & Leicester's pre-acquisition trading non-interest income in 2008. The remaining fees were unchanged as increased fees in James Hay offset lower income in Abbey International due to one-off property sales in 2007.
Group Infrastructure non-interest income decreased by £13m to £42m (2007: £55m). The inclusion of the pre-acquisition trading non-interest expense in 2008 of Alliance & Leicester decreased the overall Group Infrastructure non-interest income by £14m.The remaining increase of £1m was due to an increase in income from short-term funding, partly offset by a decline in income caused by the termination of the protection business reported in this segment in 2007.
Personal Financial Services total trading expenses by segment
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking | 1,442 | 1,358 | 996 |
| Corporate Banking | 181 | 239 | 30 |
| Global Banking & Markets | 104 | 107 | 107 |
| Private Banking | 68 | 64 | 61 |
| Group Infrastructure | 149 | 172 | 105 |
| PFS total trading expenses | 1,944 | 1,940 | 1,299 |
| Adjust for: |
|
|
|
| - A&L pre-acquisition trading basis results | - | (600) | - |
| - Reorganisation and other costs | 90 | 88 | 146 |
| - Depreciation of operating lease assets | 74 | 117 | 129 |
| PFS expenses | 2,108 | 1,545 | 1,574 |
2009 compared to 2008
Trading expenses increased by £4m to £1,944m (2008: £1,940m). The increase reflected the full year impact of the Bradford & Bingley savings business and investments in the business being largely offset by savings from the integration of Alliance & Leicester.
Retail Banking trading expenses of £1,442m increased by £84m (2008: £1,358m). £94m of the increase was due to costs related to Bradford & Bingley's savings business since its acquisition in September 2008. The remaining administrative expenses decrease was largely due to the removal of duplications across back office and support functions due to the integration of Alliance & Leicester and Bradford & Bingley's savings business.
Corporate Banking trading expenses of £181m were £58m lower than the previous year (2008: £239m). The decrease was due to operational efficiencies arising from the integration of Alliance & Leicester, and the sale of the Porterbrook business.
Global Banking & Markets trading expenses of £104m were slightly lower than the previous year (2008: £107m) reflecting strong cost management whilst increasing income.
Private Banking trading expenses of £68m increased by £4m (2008: £64m) due to business growth.
Group Infrastructure trading expenses of £149m were £23m lower than the previous year (2008: £172m). The decrease was due to savings resulting from integration benefits from the combination with Alliance & Leicester.
2008 compared to 2007
Trading expenses increased by £641m to £1,940m (2007: £1,299m). Of the total increase, £600m represented the inclusion of Alliance & Leicester's pre-acquisition trading expenses in 2008. The remaining increase of £41m reflected theimpact of the acquisition of the Bradford & Bingley savings business in September 2008, as well as investment in customer facing operations and growth businesses such as Corporate Banking and Private Banking which contributed to good income growth.
Retail Banking trading expenses of £1,358m increased by £362m (2007: £996m). The inclusion of the pre-acquisition trading expenses in 2008 of Alliance & Leicester increased the overall Retail Banking trading expenses by £370m. The remaining decrease of £8mwas principally due to savings and efficiencies as a result of the strategic change cost reduction projects, partly offset by the costs related to Bradford & Bingley's savings business since its acquisition in September 2008.
Corporate Banking trading expenses of £239m were £209m higher than the previous year (2007: £30m). Of the total increase, £194m represented the inclusion of Alliance & Leicester's pre-acquisition trading expenses in 2008. The remaining increase of £15m was largely driven by investment in growing the business.
Global Banking & Markets trading expenses of £107m were in line with the previous year (2007: £107m) reflecting strong cost management whilst increasing income.
Private Banking trading expenses of £64m increased by £3m (2007: £61m). The inclusion of the pre-acquisition trading expenses in 2008 of Alliance & Leicester increased the overall Private Banking trading expenses by £4m.The remaining decrease of £1m was driven by reduced employment costs in James Hay and Abbey Sharedealing due to operational efficiencies.
Group Infrastructure trading expenses of £172m increased by £67m (2007: £105m). Of the total increase, £32m represented the inclusion of Alliance & Leicester's pre-acquisition trading expenses in 2008. The remaining increase of £35m in part reflected costs related to Bradford & Bingley's savings business since its acquisition in September 2008.
Personal Financial Services trading impairment losses on loans and advances by segment
|
| 2009 £m | 2008 £m | 2007 £m |
| Retail Banking | 712 | 442 | 239 |
| Corporate Banking | 31 | 44 | (29) |
| Private Banking | 2 | 3 | 2 |
| Group Infrastructure | 57 | - | - |
| PFS trading impairment losses on loans and advances | 802 | 489 | 212 |
| Adjust for: |
|
|
|
| - A&L pre-acquisition trading basis results | - | (183) | - |
| - Reorganisation and other costs | 40 | 42 | 132 |
| PFS impairment losses on loans and advances | 842 | 348 | 344 |
2009 compared to 2008
The PFS trading impairment losses on loans and advances increased by £313m to £802m (2008: £489m) as general economic conditions continued to deteriorate.
Retail Banking trading impairment losses on loans and advances increased by £270m to £712m (2008: £442m) and were distributed across all products, with the largest increase relating to mortgages as the impact of falling house prices and the lagging effect of unemployment, as expected, started to emerge. Most of the impact came in the first half of the year, with the second half performance stabilising and in some areas improving. With respect to mortgages,the second half of the year saw a slower rate of growth in arrears, with fewer losses than observed earlier in the year, in part as a result of collection activities and mitigating actions taken, but also due to the low interest rate environment and the slight upturn in house prices. The improvement in performance across all portfolios in the second half of the year exceeded expectations. A strong mortgage coverage ratio of close to 21% has been preserved.
Corporate Banking trading impairment losses on loans and advances decreased by £13m to £31m (2008: £44m). The low level of impairment losses is a reflection of prudent lending criteria relating to the growth businesses and provisions made on acquisition with respect to the non-growth portfolios to reflect expected losses in those portfolios as required under acquisition accounting. The decrease of £13m reflected the non-recurrence in 2009 of Corporate Banking provision releases in 2008 relating to run down businesses more than offset by some deterioration arising from market conditions.
Private Banking impairment losses on loans and advances of £2m were broadly in line with £3m in 2008.
Group Infrastructure trading impairment losses on loans and advances increased by £57m to £57m (2008: £nil) due to the inclusion of the Alliance & Leicester treasury asset portfolio. These losses are offset by the income on the portfolio, which is classified in net interest income.
2008 compared to 2007
Trading impairment losses on loans and advances increased by £277m to £489m (2007: £212m). Of the total increase, £183m represented the inclusion of Alliance & Leicester's pre-acquisition trading impairment losses on loans and advances in 2008. The remaining increase of £94m was largely driven by deterioration in the mortgage portfolio. The performance of the mortgage portfolio remained strong, and was better than Council of Mortgage Lenders ('CML') averages for 2008. In addition, the level of secured coverage appropriately reflected the economic conditions and benchmarked well ahead of UK peers for 2008. At the same time, there was a reduction in the unsecured lending charge, driven by the tightening in lending policies in 2007 and the reduction in the unsecured loan portfolio.
Corporate Banking impairment losses on loans and advances increased by £73m to £44m (2007: release of £29m). Of the total increase, £50m represented the inclusion of Alliance & Leicester's pre-acquisition trading impairment losses on loans and advances in 2008. The remaining increase of £23m reflected an increased level of impairment on the new corporate portfolios more than offsetting provision releases from the successful run down of the legacy portfolios.
Private Banking impairment losses on loans and advances of £3m were broadly in line with £2m in 2007.
Personal Financial Services non-performing loans
|
|
| 2009 £m | 2008(1) £m | 2007 £m |
| Total non-performing loans ('NPLs') |
| 3,613 | 2,378 | 892 |
| Total loans and advances to customers (excluding trading assets) |
| 194,087 | 185,989 | 118,399 |
| Total provisions (on a statutory basis) |
| 1,299 | - | 551 |
| NPLs as a % of loans and advances |
| 1.86% | 1.28% | 0.75% |
| Provisions as a % of NPLs |
| 35.95% | 42.10% | 61.77% |
(1) Amended for the transfer of Alliance & Leicester plc to the Company as described in Note 47 to the Consolidated Financial Statements.
2009 compared to 2008
In 2009, the value of non-performing loans increased to £3,613m (2008: £2,378m) and non-performing loans as a percentage of loans and advances increased to 1.86% (2008: 1.28%). The non-performing loan ratio increased due to rising secured (residential and commercial properties) and corporate arrears reflecting continued market deterioration. However, the retail unsecured arrears decreased by £114m.
The overall coverage ratio decreased from 42.10% to 35.95%, impacted by the mix of the non-performing assets, due to the increase in the secured mortgage component which has a lower provisioning requirement because of inherent security.
2008 compared to 2007
In 2008, the value of non-performing loans increased to £2,378m (2007: £892m) and non-performing loans as a percentage of loans and advances increased to 1.28% (2007: 0.75%). The inclusion of Alliance & Leicester in 2008 represents non-performing loans of £873m. Most of the remaining increase in the non-performing loan was due to arise in secured arrears given market deterioration.
The overall coverage ratio decreased from 61.77% to 42.10%, largely due to a change in the mix of arrears, which shifted towards the secured portfolio, resulting in a reduction in coverage due to the lower reserving requirements on this portfolio because of inherent security.
Other Material Items
Adjustments between the statutory basis and the trading basis
Santander UK's Board reviews discrete financial information for each of its segments that includes measures of operating results and assets, which are measured on a 'trading' basis. The trading basis differs from the statutory basis as a result of the application of various adjustments, as presented below, and described in the Business Review - Summary. Management considers that the trading basis provides the most appropriate way of reviewing the performance of the business.
The trading adjustments consist of:
A&L pre-acquisition trading basis results
|
| 2009 £m | 2008 £m | 2007 £m |
|
| - | 164 | - |
The pre-acquisition trading basis results of Alliance & Leicester for the year ended 31 December 2008 are included in the results discussed in the section 'Personal Financial Services profit before tax by segment'. The pre-acquisition non-trading adjustments of Alliance & Leicester for the year ended 31 December 2008 of £(1,288)m have not been included. This adjustment applies only to 2008 as the results of Alliance & Leicester are fully consolidated in the 2009 statutory results.
Reorganisation and other costs
|
| 2009 £m | 2008 £m | 2007 £m |
| Cost reduction programme | 131 | 100 | 109 |
| Credit provisions | 40 | 42 | 132 |
| Misselling remediation administration costs | 15 | 21 | 37 |
|
| 186 | 163 | 278 |
These costs comprise implementation costs in relation to the strategic change and cost reduction process, certain credit provisions taken centrally, as well as remediation administration costs in respect of product misselling.
2009 compared to 2008
Total reorganisation and other costs of £186m increased by £23m compared to the previous period (2008: £163m).
Cost reduction programme expenses of £131m increased by £31m compared to the previous period (2008: £100m) reflecting the cost of restructuring and rebranding following the transfer of Alliance & Leicester plc to the Company in 2009 and the acquisition of the Bradford & Bingley savings business in September 2008.
Non-trading credit provisions of £40m in 2009 represent impairment losses recognised on the consolidation of the assets of the Group's Conduit vehicles, as described in 'Exposure to Off-Balance Sheet Entities sponsored by the Group' in the Risk Management Report on page 84. The 2008 charge of £42m relates to retail credit provisions. In accordance with IFRS, the charge for credit provisions adjusts the balance sheet provisions to the level that management deems adequate to absorb actual and inherent losses in Santander UK's loan portfolio from homogeneous portfolios of assets and individually identified loans, as described more fully in the Risk Management Report - Provisions on loans and advances to customers, and in the Accounting Policies in the Consolidated Financial Statements. The required charge is generally determined using statistical techniques developed on previous experience and on projections of current market conditions to the time the loss is expected to crystallise. For management reporting purposes, the total charge is then split between the charge that would be required based on conditions that persist at the balance sheet date, and the adjustment to that charge in order to reflect the change in conditions when the loss is expected to crystallise. The charge that would be required based on conditions that persist at the balance sheet date is used in the day to day running of the business, and is therefore included in provisions on the trading basis. The adjustment to the charge is excluded from the results on a trading basis and is classified as non-trading. No adjustment to the charge was required in 2009 as conditions that persisted at the balance sheet date reflected the conditions when the loss is expected to crystallise.
Misselling remediation administration costs decreased to £15m (2008: £21m) reflecting a reduction in complaints handling charges.
2008 compared to 2007
Total reorganisation and other costs of £163m decreased by £115m compared to the previous period (2007: £278m).
Cost reduction programme expenses of £100m decreased by £9m compared to the previous period (2007: £109m) reflecting the end of the cost reduction programme initiated in 2004 and reduced project reorganisation costs.
Non-trading credit provisions of £42m decreased £90m compared to the previous period (2007: £132m). The reduction in 2008 compared to 2007 reflects the fact that the conditions at the balance sheet date were more closely aligned at 31 December 2008 than 31 December 2007 to the conditions that were expected to persist when the losses crystallise.
Misselling remediation administration costs decreased to £21m (2007: £37m) reflecting a reduction in complaints handling charges.
Profit on part sale of PFS subsidiaries
|
| 2009 £m | 2008 £m | 2007 £m |
|
| - | 40 | 110 |
These profits are excluded from the results to allow management to understand the underlying performance of the business. In 2009, there were no such profits. In 2008, the profit on the sale of the Porterbrook businesses was excluded.
In 2007, the profit on the sale of 49% ofJames Hay, Cater Allen and Abbey Sharedealing, and small recoveries on certain other transactions were similarly excluded.
Hedging and other variances
|
| 2009 £m | 2008 £m | 2007 £m |
|
| 36 | 84 | 72 |
The Balance Sheet and Income Statement are subject to mark-to-market volatility including that arising from the accounting for elements of derivatives deemed under IFRS rules to be ineffective as hedges. Volatility also arises on certain assets previously managed on a fair value basis, and hence classified as fair value through profit or loss under IFRS, that are now managed on an accruals basis. In addition, other variances include the reversal of coupon payments on certain equity instruments which are treated as an interest expense in the trading results but are reported below the profit after tax line for statutory purposes.
2009 compared to 2008
In 2009, substantial mark-to-market gains which arose in the second half of 2008 from movements in interest rates reversed. These were partly offset by the reversal of losses due to widening asset spreads in 2008 as credit spreads narrowed. In addition, 2009 includes a credit of £57m relating to non-controlling interests and Reserve Capital Instruments which are treated as interest expense on a trading basis.
2008 compared to 2007
In 2008, there was substantial mark-to-market volatility which affected asset and liability positions and related derivatives. The impact of this volatility was a loss of £84m (2007: £72m), largely due to increasing asset credit spreads. Losses were incurred due to an increase in credit spreads on the Group's holdings of prime mortgage-backed securities (almost all of which are AAA rated), which are accounted for as fair value through profit or loss and ineligible for reclassification in accordance with IAS 39. However, this was partially offset by other mark-to-market volatility, principally arising on swaps which do not meet the IAS 39 requirements for hedge accounting.
Capital and other charges
Capital charges principally comprise internal nominal charges for capital invested in the Group's businesses. Management implemented this charge to assess if capital is invested effectively. On a consolidated basis, the total of these internal reallocations is £nil.
Legal proceedings
Santander UK is party to various legal proceedings in the ordinary course of business, the ultimate resolution of which is not expected to have a material adverse effect on the financial position or the results of operations of Santander UK. See Note 37 to the Consolidated Financial Statements.
Material contracts
Santander UK is party to various contracts in the ordinary course of business. For the three years ended 31 December 2009 there have been no material contracts entered into outside the ordinary course of business, except for the contracts described below.
On 9 January 2009, in order to optimise the capital, liquidity funding and overall financial efficiency of the enlarged group, Banco Santander, S.A. transferred all of its Alliance & Leicester plc shares to the Company in exchange for newly issued ordinary shares of the Company.
On 19 March 2009, the Company gave a full and unconditional guarantee in respect of the unsubordinated liabilities of Alliance & Leicester plc incurred prior to 31 July 2012 under a deed poll guarantee entered into by the Company. Alliance & Leicester plc has given a reciprocal guarantee in respect of the unsubordinated liabilities of the Company incurred prior to 31 July 2012.
Audit fees
See Note 7 to the Consolidated Financial Statements.
Balance Sheet Business Review
Throughout this section, references to UK and non-UK refer to the location of the office where the transaction is recorded. 2008 data has been updated to reflect the transfer of Alliance & Leicester plc to the Company as described in Note 47 to the Consolidated Financial Statements.
Summary
This balance sheet business review describes the Group's significant assets and liabilities and its strategy and reasons for entering into such transactions. The principal assets and liabilities are summarised by their nature, rather than by their classification in the balance sheet. The balance sheet business review is divided into the following sections:
| > | Securities - The Group's strategies and reasons for holding securities are described on pages 31 and 32, as well as: | |
|
| > | Analysis by type of issuer. |
|
| > | Maturity analysis for available-for-sale debt securities. |
|
| > | Significant exposures exceeding 10% of the Group's shareholders' funds. |
|
|
| |
| > | Loans and advances to banks - These assets are described on pages 32 and 33, consisting of: | |
|
| > | Geographical analysis between UK and non-UK. |
|
| > | Maturity analysis further analysed between UK and non-UK. |
|
| > | Interest rate sensitivity analysed between fixed rate and floating rate. |
|
|
| |
| > | Loans and advances to customers - These assets are described on pages 33 to 35, consisting of: | |
|
| > | Geographical analysis between UK and non-UK, further analysed by product. |
|
| > | Maturity analysis further analysed geographically and by product. |
|
| > | Interest rate sensitivity analysed between fixed rate and floating rate. |
|
| > | Provisions on loans and advances to customers - The Group's policies are described on pages 34 and 35, together with disclosures related to potential problem loans and advances, potential credit risk elements in loans and advances, exposures to countries experiencing liquidity problems and cross border outstandings. |
|
|
| |
| > | Derivatives - The Group's derivative positions are summarised on page 35. Cross references are provided to other disclosures about the Group's strategies and reasons for entering into derivative transactions and further detailed analysis of derivative notional amounts and assets and liabilities by type of contract. | |
|
|
| |
| > | Tangible fixed assets - A summary of the Group's capital expenditure during the year by segment, together with details of the Group's property interests and principal sites are described on page 36. | |
|
|
| |
| > | Deposits by banks - These liabilities are summarised on page 36, including average balances and maximum balances during the year, with further analysis geographically. | |
|
|
| |
| > | Deposits by customers - These liabilities are summarised on pages 37 and 38, including average balances and maximum balances during the year, with further analyses geographically and by customer type. | |
|
|
| |
| > | Debt securities in issue - The Group's debt securities in issue are summarised on pages 38 and 39, including commentary on the movements in the major debt issuance programmes during the year and cross references to detailed descriptions of the programmes. | |
|
|
| |
| > | Retirement benefit obligations - Details of the movements in the Group's pension deficit are set out on page 39. | |
|
|
| |
| > | Contractual obligations - A contractual maturity analysis of the Group's obligations is set out on page 40. | |
|
|
| |
| > | Off balance sheet arrangements - The Group's off-balance sheet arrangements, including guarantees, commitments, contingencies, and exposures to off-balance sheet entities sponsored by the Group are described on page 40. | |
|
|
| |
| > | Capital management and resources - A summary of the Group's approach to capital management and resources is set out on pages 41 to 43, as well as disclosures required by Pillar 3, details of the Group's capital ratios and regulatory capital resources and requirements. | |
|
|
| |
| > | Liquidity - The Group's liquidity arrangements are described on pages 43 to 46, including a summary of the sources and uses of liquidity, together with commentary on the Group's cash flows for the past three years. | |
|
|
| |
| > | Other | |
|
| > | Changes in net interest income - An analysis of changes in the Group's interest income, interest expense and net interest income between changes in volume and changes in rate is presented on page 47. |
|
| > | Average balance sheets - As period-end statements may not be representative of the Group's activity throughout the year, average balance sheets for the Group are presented on page 48. The average balance sheets summarise the significant categories of assets and liabilities, including all major categories of interest-earning assets and interest-bearing liabilities, together with average interest rates. |
Reconciliation to classifications in the consolidated balance sheet
The classifications of assets and liabilities in the Group's consolidated balance sheet, including the Note reference, and in the balance sheet business review may be reconciled as follows:
| 31 December 2009 |
| Balance sheet business review section |
|
| |||||
| Balance sheet line item and note | Note | Securities | Loans and advances to banks | Loans and advances to customers | Derivatives | Tangible fixed assets | Other | Balance sheet total | |
|
|
| £m | £m | £m | £m | £m | £m | £m | |
| Assets |
|
|
|
|
|
|
|
| |
| Cash and balances at central banks | 11 | - | - | - | - | - | 4,163 | 4,163 | |
| Trading assets | 12 | 17,410 | 5,252 | 10,628 | - | - | - | 33,290 | |
| Derivative financial instruments | 13 | - | - | - | 22,827 | - | - | 22,827 | |
| Financial assets designated at fair value | 14 | 5,979 | - | 6,379 | - | - | - | 12,358 | |
| Loans and advances to banks | 15 | - | 9,151 | - | - | - | - | 9,151 | |
| Loans and advances to customers | 16 | - | - | 186,804 | - | - | - | 186,804 | |
| Available for sale securities | 18 | 797 | - | - | - | - | - | 797 | |
| Loans and receivables securities | 19 | - | 7,208 | 2,690 | - | - | - | 9,898 | |
| Macro hedge of interest rate risk |
| - | - | - | - | - | 1,127 | 1,127 | |
| Property, plant and equipment | 23 | - | - | - | - | 938 | - | 938 | |
| Operating lease assets | 24 | - | - | - | - | 312 | - | 312 | |
| Tax, intangibles and other assets |
| - | - | - | - | - | 3,626 | 3,626 | |
| Total assets |
| 24,186 | 21,611 | 206,501 | 22,827 | 1,250 | 8,916 | 285,291 | |
|
|
| Deposits by banks | Deposits by customers | Debt securities in issue | Derivatives | Retirement benefit obligations | Other | Balance sheet total |
|
|
|
| £m | £m | £m | £m | £m | £m | £m |
|
| Liabilities |
|
|
|
|
|
|
|
|
|
| Deposits by banks | 27 | 5,811 | - | - | - | - | - | 5,811 |
|
| Deposits by customers | 28 | - | 143,893 | - | - | - | - | 143,893 |
|
| Derivative financial instruments | 13 | - | - | - | 18,963 | - | - | 18,963 |
|
| Trading liabilities | 29 | 40,824 | 4,115 | 1,213 | - | - | - | 46,152 |
|
| Financial liabilities designated at fair value | 30 | 45 | 12 | 4,366 | - | - | - | 4,423 |
|
| Debt securities in issue | 31 | - | - | 47,758 | - | - | - | 47,758 |
|
| Other borrowed funds | 32 | - | - | 1,352 | - | - | - | 1,352 |
|
| Subordinated liabilities | 33 | - | - | 5,597 | - | - | - | 5,597 |
|
| Retirement benefit obligations | 36 | - | - | - | - | 1,070 | - | 1,070 |
|
| Tax, other liabilities and provisions |
| - | - | - | - | - | 3,050 | 3,050 |
|
| Total liabilities |
| 46,680 | 148,020 | 60,286 | 18,963 | 1,070 | 3,050 | 278,069 |
|
| 31 December 2008 |
| Balance sheet business review section |
|
| ||||
| Balance sheet line item and note |
| Securities | Loans and advances to banks | Loans and advances to customers | Derivatives | Tangible fixed assets | Other | Balance sheet total |
|
|
| £m | £m | £m | £m | £m | £m | £m |
| Assets |
|
|
|
|
|
|
|
|
| Cash and balances at central banks | 11 | - | - | - | - | - | 4,017 | 4,017 |
| Trading assets | 12 | 17,509 | 7,445 | 1,310 | - | - | - | 26,264 |
| Derivative financial instruments | 13 | - | - | - | 35,125 | - | - | 35,125 |
| Financial assets designated at fair value | 14 | 4,690 | - | 6,687 | - | - | - | 11,377 |
| Loans and advances to banks | 15 | - | 16,001 | - | - | - | - | 16,001 |
| Loans and advances to customers | 16 | - | - | 180,176 | - | - | - | 180,176 |
| Available for sale securities | 18 | 2,663 | - | - | - | - | - | 2,663 |
| Loans and receivables securities | 19 | - | 8,444 | 5,663 | - | - | - | 14,107 |
| Macro hedge of interest rate risk |
| - | - | - | - | - | 2,188 | 2,188 |
| Property, plant and equipment | 23 | - | - | - | - | 854 | - | 854 |
| Operating lease assets | 24 | - | - | - | - | 348 | - | 348 |
| Tax, intangibles and other assets |
| - | - | - | - | - | 4,190 | 4,190 |
| Total assets |
| 24,862 | 31,890 | 193,836 | 35,125 | 1,202 | 10,395 | 297,310 |
|
|
| Deposits by banks | Deposits by customers | Debt securities in issue | Derivatives | Retirement benefit obligations | Other | Balance sheet total |
|
|
| £m | £m | £m | £m | £m | £m | £m |
| Liabilities |
|
|
|
|
|
|
|
|
| Deposits by banks | 27 | 14,488 | - | - | - | - | - | 14,488 |
| Deposits by customers | 28 | - | 130,245 | - | - | - | - | 130,245 |
| Derivative financial instruments | 13 | - | - | - | 27,810 | - | - | 27,810 |
| Trading liabilities | 29 | 34,341 | 4,622 | 1,024 | - | - | 751 | 40,738 |
| Financial liabilities designated at fair value | 30 | 153 | 252 | 5,268 | - | - | - | 5,673 |
| Debt securities in issue | 31 | - | - | 58,511 | - | - | - | 58,511 |
| Other borrowed funds | 32 | - | - | 2,076 | - | - | - | 2,076 |
| Subordinated liabilities | 33 | - | - | 6,787 | - | - | - | 6,787 |
| Retirement benefit obligations | 36 | - | - | - | - | 813 | - | 813 |
| Tax, other liabilities and provisions |
| - | - | - | - | - | 3,472 | 3,472 |
| Total liabilities |
| 48,982 | 135,119 | 73,666 | 27,810 | 813 | 4,223 | 290,613 |
Securities
The Group holds securities for a variety of purposes:
| > | As part of its trading activities in the Short Term Markets business of Global Banking & Markets; |
| > | For yield and liquidity purposes, including the Asset and Liability Management Committee investment portfolio of Group mortgage-backed securities and other asset-backed securities, in Group Infrastructure; and |
| > | In the Alliance & Leicester Treasury asset portfolio in Group Infrastructure which is being run down. The securities in this portfolio are accounted for as loans and receivables as described in Note 19 to the Consolidated Financial Statements and are therefore disclosed in the Loans and advances to banks and Loans and advances to customers sections of this Balance Sheet Business Review. |
The following table sets out the book and market values of securities at 31 December 2009, 2008 and 2007. For further information, see the Notes to the Consolidated Financial Statements.
|
| 2009 £m | 2008 £m | 2007 £m |
| Trading portfolio |
|
|
|
| Debt securities: |
|
|
|
| UK Government | 968 | 191 | 1,168 |
| US treasury and other US Government agencies and corporations | 628 | 574 | - |
| Other OECD governments | 1,260 | 2,374 | 2,554 |
| Bank and building society: |
|
|
|
| - Certificates of deposit - Government guaranteed | 205 | 3,119 | 9,679 |
| - Certificates of deposit - Other | 1,730 | 5,266 | - |
| Other issuers: |
|
|
|
| - Floating rate notes | 3,038 | 4,724 | - |
| - Floating rate notes - Government guaranteed | 8,090 | 553 | 2,805 |
| - Mortgage-backed securities | - | - | 2 |
| - Other asset-backed securities | - | - | 2,368 |
| - Other | 13 | - | 10,255 |
| Ordinary shares and similar securities | 1,478 | 708 | 1,494 |
|
| 17,410 | 17,509 | 30,325 |
| Available for sale securities |
|
|
|
| Debt securities: |
|
|
|
| UK Government | 405 | 2,383 | - |
| Other issuers - other | 342 | 235 | 8 |
| Ordinary shares and similar securities | 50 | 45 | 32 |
|
| 797 | 2,663 | 40 |
| Financial assets designated at fair value through profit and loss |
|
|
|
| Debt securities: |
|
|
|
| Bank and building society certificates of deposit | 2,220 | - | 15 |
| Other issuers: |
|
|
|
| - Mortgage-backed securities | 3,355 | 4,362 | 4,093 |
| - Other asset-backed securities | 50 | 63 | 1,460 |
| - Synthetic floating rate notes and structured debt securities | 354 | 265 | 514 |
|
| 5,979 | 4,690 | 6,082 |
| Total | 24,186 | 24,862 | 36,447 |
UK Government securities
The holdings of UK Government securities represent Treasury Bills and UK Government guaranteed issues by other UK banks. These securities are held for trading and liquidity purposes, including meeting the FSA's stock liquidity ratio requirements. The Group's holdings remain at levels required by the liquidity ratio. The aggregate Group holding of UK Government securities has risen with the acquisition of the Bradford & Bingley savings business and with the transfer of Alliance & Leicester plc.
US treasury and other US Government agencies and corporations
The holdings of US treasury and other US Government agencies' and corporations' securities represent US Treasury Bills, including cash management bills. These securities are held for trading and liquidity purposes.
Other OECD governments
This category comprises issues by Organisation of Economic Co-operation and Development ('OECD') governments other than the US and UK Governments. These securities are held for trading and liquidity purposes.
Bank and building society certificates of deposit and bonds
Bank and building society certificates of deposit are fixed-rate securities with relatively short maturities. These are managed within the overall position for the relevant book. These securities are held for trading and liquidity purposes.
Floating rate notes
Floating rate notes have regular interest rate profiles and are either managed within the overall position for the relevant book or are hedged into one of the main currencies. These securities are held for trading and liquidity purposes.
Mortgage-backed securities
This category comprises highly rated, European residential mortgage-backed securities. The securities are of high quality, contain no sub-prime element and consist almost entirely of AAA-rated prime exposures.This category includes mortgage-backed securities issued by other Santander group companies. These securities are held as part of the investment portfolio.
Other asset-backed securities
This category comprises a range of mostly floating-rate asset-backed securities including home equity loans, commercial mortgages, car dealer, lease and credit card debtors and student loans, as well as a small balance of collateralised synthetic obligations. Some credit card debtors incorporate cap features. These securities are held as part of the investment portfolio.
Other securities
This category comprised mainly synthetic floating-rate notes (which are fixed-rate bonds packaged into floating-rate by means of swaps tailored to provide a match to the characteristics of the underlying bond), along with a number of structured transactions which were hedged, as appropriate, either on an individual basis or as part of the overall management of the books. The synthetic floating-rate notes comprised bonds issued by banks, financial institutions and corporations, the latter being largely guaranteed by banks and financial institutions. These securities are held for trading and liquidity purposes.
The following table sets forth available for sale debt securities by contractual maturity at 31 December 2009. Contractual maturities of investments held for trading or classified as fair value through profit or loss are not presented.
|
| On demand £m | In not more than 3 months £m | In more than 3 months but not more than 1 year £m | In more than 1 year but not more than 5 years £m | In more than 5 years £m | Total £m |
| UK Government | - | - | 405 | - | - | 405 |
| Other | - | 75 | - | 267 | - | 342 |
| Weighted average yield for year % | - | 1.30% | 4.13% | 2.45% | - | 3.24% |
Significant exposures
The following table sets forth the book and market values of securities of individual counterparties where the aggregate amount of those securities exceeded 10% of the Group's shareholders' funds at 31 December 2009 as set out in the Consolidated Balance Sheet on page 103.
|
| £m |
| Lloyds Banking Group plc | 5,432 |
| The Royal Bank of Scotland Group plc | 2,523 |
| Grupo Monte dei Paschi di Siena | 2,290 |
| Barclays Bank PLC | 2,015 |
| UK Government | 1,373 |
| Hipototta No.3 plc | 1,092 |
| Hipototta No.2 plc | 837 |
Trading portfolio 2009 compared to 2008
The size of the total trading portfolio has remained largely unchanged at 31 December 2009 compared to 31 December 2008, although there has been a shift from bank certificates of deposit to government-guaranteed bank paper due to the enhanced risk-adjusted yield.
Available for sale securities 2009 compared to 2008
Available for sale securities decreased at 31 December 2009 compared to 31 December 2008 as a larger proportion of the overall securities portfolio was held on a trading basis reflecting more active management of the liquidity portfolio.
Financial assets designated at fair value through profit and loss 2009 compared to 2008
The increase in the portfolio at 31 December 2009 compared to 31 December 2008 was due to certain bank certificates of deposit being included here as they were held on a yield basis, rather than a trading basis, partly offset by scheduled repayments of mortgage-backed securities.
Loans and advances to banks
Loans and advances to banks include loans to banks and building societies and balances with central banks (excluding those central bank balances which can be withdrawn on demand). The geographical analysis of loans and advances presented in the following table is based on the location of the office from which the loans and advances are made, rather than the domicile of the borrower. The balances below include loans and advances to banks that are classified in the balance sheet as trading assets, financial assets designated at fair value, or loans and receivables securities.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| UK | 21,524 | 28,859 | 12,066 | 11,943 | 8,060 |
| Non-UK | 87 | 3,031 | 222 | 93 | 1,036 |
|
| 21,611 | 31,890 | 12,288 | 12,036 | 9,096 |
The balances above include loans and advances to other Santander companies from UK offices of £7,546m (2008: £9,353m, 2007: £1,640m).
The following table sets forth loans and advances to banks by maturity at 31 December 2009.
|
| On demand £m | In not more than three months £m | In more than three months but not more than one year £m | In more than one year but not more than five years £m | In more than five years £m | Total £m |
| UK | 4,145 | 7,772 | 4,334 | 4,270 | 1,003 | 21,524 |
| Non-UK | 22 | 18 | 47 | - | - | 87 |
|
| 4,167 | 7,790 | 4,381 | 4,270 | 1,003 | 21,611 |
The following table sets forth loans and advances to banks by interest rate sensitivity at 31 December 2009.
|
| Fixed rate £m | Variable rate £m | Total £m |
| Interest-bearing loans and advances to banks(1): |
|
|
|
| UK | 16,747 | 3,847 | 20,594 |
| Non-UK | 47 | 40 | 87 |
|
| 16,794 | 3,887 | 20,681 |
(1) Excludes non interest-bearing accounts
Loans and advances to banks 2009 compared to 2008
Loans and advances to banks decreased at 31 December 2009 compared to 31 December 2008 due to the 2008 balance including the temporary investment of surplus liquidity which in 2009 was used to reduce short-term borrowings.
Loans and advances to customers
The Group provides lending facilities primarily to personal customers in the form of mortgages secured on residential properties and a limited number of lending facilities to corporate customers. Purchase and resale agreements represent sale and repurchase activity with professional non-bank customers by the Global Banking & Markets Short Term Markets business. The geographical analysis of loans and advances presented in the following table is based on the location of the office from which the loans and advances are made. The balances below are stated before the deduction for loan loss allowances and include loans and advances to customers that are classified in the balance sheet as trading assets, financial assets designated at fair value, or loans and receivables securities.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| UK |
|
|
|
|
|
| Advances secured on residential property | 167,172 | 159,168 | 110,857 | 102,096 | 94,330 |
| Corporate loans | 12,171 | 13,181 | 1,247 | 666 | 334 |
| Finance leases | 1,602 | 1,792 | - | 1 | 3 |
| Other secured advances | 3,817 | 4,206 | 2,960 | 2,305 | 1,882 |
| Other unsecured advances | 5,249 | 6,745 | 3,263 | 4,104 | 3,845 |
| Purchase and resale agreements | 10,628 | 1,310 | 3,711 | 5,427 | 4,789 |
| Loans and receivables securities | 2,690 | 5,663 | - | - | - |
| Amounts due from fellow group subsidiaries | 4,457 | 2,652 | 55 | - | - |
| Total UK | 207,786 | 194,717 | 122,093 | 114,599 | 105,183 |
| Non-UK |
|
|
|
|
|
| Advances secured on residential property | 9 | 12 | 13 | 19 | 26 |
| Corporate loans | 2 | 103 | - | - | - |
| Other secured advances | 2 | 3 | 2 | - | - |
| Other unsecured advances | 1 | 2 | 2 | 35 | 31 |
| Purchase and resale agreements | - | - | 13,544 | 14,375 | 13,152 |
| Total non-UK | 14 | 120 | 13,561 | 14,429 | 13,209 |
| Total | 207,800 | 194,837 | 135,654 | 129,028 | 118,392 |
| Less: credit provisions | (1,299) | (1,001) | (551) | (536) | (394) |
| Total, net of provisions | 206,501 | 193,836 | 135,103 | 128,492 | 117,998 |
The balances above include loans and advances to other Santander group companies of £4,457m (2008: £2,652m, 2007: £55m). Detailed analysis of the loans and receivables securities included in the table above is set out in the Impact of the Current Credit Environment in the Risk Management Report on page 77.
No single concentration of loans and advances, with the exception of advances secured on residential properties, as disclosed above, accounts for more than 10% of total loans and advances and no individual country, other than the UK and US, accounts for more than 5% of total loans and advances.
The following tables set forth loans and advances to customers by maturity and interest rate sensitivity at 31 December 2009. In the maturity analysis, overdrafts are included in the "on-demand" category. Advances secured by residential properties are included in the maturity analysis at their stated maturity; however, such advances may be repaid early.
|
|
On demand £m | In not more than three months £m | In more than three months but not more than one year £m | In more than one year but not more than five years £m | In more than five years £m |
Total £m |
| UK |
|
|
|
|
|
|
| Advances secured on residential property | 70 | 995 | 2,907 | 17,164 | 146,036 | 167,172 |
| Corporate loans | 172 | 1,471 | 710 | 5,959 | 3,859 | 12,171 |
| Finance leases | 19 | 137 | 89 | 435 | 922 | 1,602 |
| Other secured advances | - | 106 | 65 | 401 | 3,245 | 3,817 |
| Other unsecured advances | 667 | 559 | 1,145 | 2,447 | 431 | 5,249 |
| Purchase and resale agreements | 1,801 | 8,827 | - | - | - | 10,628 |
| Loans and receivables securities | 62 | 21 | - | 184 | 2,423 | 2,690 |
| Amounts due from fellow group subsidiaries | 54 | 3,327 | 5 | 1,071 | - | 4,457 |
| Total UK | 2,845 | 15,443 | 4,921 | 27,661 | 156,916 | 207,786 |
| Non-UK |
|
|
|
|
|
|
| Advances secured on residential property | - | - | - | 1 | 8 | 9 |
| Corporate loans | - | 2 | - | - | - | 2 |
| Other secured advances | - | - | - | - | 2 | 2 |
| Other unsecured advances | - | 1 | - | - | - | 1 |
| Total non-UK | - | 3 | - | 1 | 10 | 14 |
| Total | 2,845 | 15,446 | 4,921 | 27,662 | 156,926 | 207,800 |
The interest rate sensitivity table below analyses loans between fixed rate and variable rate as at 31 December 2009.
|
| Fixed rate £m | Variable rate £m | Total £m |
| UK | 80,912 | 126,874 | 207,786 |
| Non-UK | 1 | 13 | 14 |
|
| 80,913 | 126,887 | 207,800 |
The Group's policy is to hedge all fixed-rate loans and advances to customers using derivative instruments, or by matching with other on-balance sheet interest rate exposures.
Loans and advances to customers - 2009 compared to 2008
Loans and advances to customers increased at 31 December 2009 compared to 31 December 2008 due to increased mortgage lending, as planned, and increased repurchase agreement ('repo') activity with non-bank counterparties. New corporate lending was offset by repayments from the non-growth corporate portfolios.
Provisions on loans and advances to customers
Details of the Group's provisioning policy are set out on page 64 and in the Accounting Policies section on pages 116 to 118. An analysis of end-of-year provisions on loans and advances to customers, movements in provisions for bad and doubtful debts, and Group non-performing loans and advances are set out in the Risk Management Report on page 56 and Note 16 to the Consolidated Financial Statements.
In Retail Banking, due to the homogenous nature of the loans, the assessment of impairment existing at the reporting date is undertaken on a collective basis through the use of statistical techniques. The collective assessment takes due consideration of the time in arrears, with longer periods in arrears indicating a higher probability of the loans going into possession. Individual assessments are only undertaken when the collateral on a secured residential loan is repossessed or on commercial loans, where the loan is overdue.
These techniques are equally used to establish the amount of provisions for bad and doubtful debts. In addition, the Group's policy of initiating prompt contact with customers in arrears, together with the nature of the security held, which in the case of some advances secured on residential property may have increased in value over the life of the loans, means that some non-performing loans will not result in a loss.
Non-performing loans and advances are statistically more likely to result in losses the longer they have been in arrears. Losses on cases for which the property securing the loan has been taken into possession are evaluated individually with the amounts expected to be lost on realisation of the security being established with a high degree of certainty.
Provisions on loans and advances to customers - 2009 compared to 2008
Provisions for impairment losses on loans and advances for Retail Banking increased from £698m to £940m as at 31 December 2009. This primarily reflects the impact of increased observed provisions driven by the unsecured personal advances portfolio acquired from Alliance & Leicester in 2008. This was also partly affected by the increase in observed provisions over the residential mortgage portfolio due to the continued challenging economic conditions in 2009.
Provisions for impairment on loans and advances for Corporate Banking increased by £56m to £359m as at 31 December 2009. The observed provision charge was £177m due to losses in the property sector. This was partly offset by a £117m release of the IBNO provision as losses were observed.
Provisions on loans and advances to customers - 2008 compared to 2007
As at 31 December 2008, total provisions for impairment losses on loans and advances increased from £551m to £698m. This primarily reflects the impact of increased observed provisions over the residential mortgage portfolio, where declining property prices resulted in losses from higher mortgage repossession cases. The reduction in the provision charged against unsecured personal advances is due to a reduction in risk appetite on this portfolio and a more stringent credit approval process.
The increase in the provisions during the year is largely due to the inclusion of the incurred but not yet observed ('IBNO') provision related to Alliance & Leicester's Corporate Banking portfolio.
The following table sets forth arrears on advances secured on residential properties included in the Group non-performing loans and advances within the Risk Management Report on page 66 to the Consolidated Financial Statements for each of the last five years.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| 6 months to 12 months in arrears | 717 | 429 | 163 | 155 | 172 |
| 12 months or more in arrears | 281 | 72 | 30 | 27 | 26 |
| Properties in possession | 111 | 129 | 64 | 42 | 44 |
Potential credit risk elements in loans and advances
Interest continues to be accrued on all loans and the element of interest that is not anticipated to be recovered is derecognised. Interest income recognised on impaired loans is set out in the Consolidated Financial Statements. The income adjustment in respect of interest that is not anticipated to be recovered was £46m (2008: £21m, 2007: £16m).
Country risk exposure
Despite another turbulent year for the global economy that has lead some countries to experience severe difficulties, the Group is not exposed to sovereign debt of countries currently experiencing liquidity problems. The Group has exposure to banks in those countries limited to a £13m (2008: £13m) exposure through a Floating Rate Note issued by a bank in Dubai and a £36m exposure to a bank in Greece (2008: £187m). Since the balance sheet date, exposure to banks in Greece has reduced to £5m.
Cross border outstandings
The operations of the Group involve operations in non-local currencies. These cross border outstandings are controlled through a well-developed system of country limits, which are reviewed to avoid concentrations of transfer, economic or political risks. Cross border outstandings, which exclude finance provided within the Group, are based on the country of domicile of the borrower or guarantor of ultimate risk and comprise loans and advances to customers and banks, finance lease debtors, interest-bearing investments and other monetary assets denominated in currencies other than the borrower's local currency.
Cross border outstandings exceeding 1% of total assets
At 31 December 2009 and 2008, the Group had no cross border outstandings exceeding 1% of total assets.
| At 31 December 2007 | As % of total assets % | Total £m | Banks and other financial institutions £m | Governments and official institutions £m | Commercial, industrial and other private sector entities £m |
| United States | 1.19 | 2,369 | 2,369 | - | - |
Cross border outstandings between 0.75% and 1% of total assets
At 31 December 2009, 2008 and 2007, the Group had no cross border outstandings between 0.75% and 1% of total assets.
Derivative assets and liabilities
|
|
| 2009 £m | 2008 £m | 2007 £m |
| Assets |
|
|
|
|
| Derivative financial instruments: |
|
|
|
|
| - held for trading |
| 21,472 | 31,713 | 9,519 |
| - held for hedging |
| 1,355 | 3,412 | 432 |
|
|
| 22,827 | 35,125 | 9,951 |
| Liabilities |
|
|
|
|
| Derivative financial instruments: |
|
|
|
|
| - held for trading |
| 16,775 | 25,420 | 9,728 |
| - held for hedging |
| 2,188 | 2,390 | 203 |
|
|
| 18,963 | 27,810 | 9,931 |
Derivatives are held by the Group for trading or for risk management purposes. All derivatives are classified as held at fair value through profit or loss. For accounting purposes, the Group chooses to designate certain derivatives as in a hedging relationship if they meet specific criteria. The main hedging derivatives are interest rate and cross-currency swaps, which are used to hedge fixed-rate lending and structured savings products and medium-term note issuances, capital issuances and other capital markets funding.
Global Banking & Markets is the only area of the Group actively trading derivative products and is additionally responsible for implementing Group derivative hedging with the external market. In Group Infrastructure, derivatives are used for economic hedging. Further details about Market Risk in Global Banking & Markets and in Group Infrastructure are set out in the Risk Management Report. This information includes a summary of the activities undertaken, the related risks associated with such activities and the types of hedging derivatives used in managing such risks.
Further detailed analysis of the derivatives held by the Group, both for trading and hedging purposes, including derivative notional amounts and assets and liabilities analysed by type of contract is contained in Note 13 of the Consolidated Financial Statements.
Tangible fixed assets
|
| 2009 £m | 2008 £m | 2007 £m |
| Property, plant and equipment | 938 | 854 | 528 |
| Operating lease assets | 312 | 348 | 2,164 |
|
| 1,250 | 1,202 | 2,692 |
| Capital expenditure incurred during the year | 343 | 197 | 407 |
Capital expenditure during each of the years ended 31 December 2009, 2008 and 2007 was principally incurred by Retail Banking (mostly consisting of computer infrastructure, computer software and furniture and fittings for branches) and by Corporate Banking (consisting of operating lease assets). Details of capital expenditure contracted but not provided for in respect of tangible fixed assets are set out in Note 23 to the Consolidated Financial Statements.
The Group had 1,565 unique property interests at 31 December 2009, including the properties acquired as a result of the transfer of Alliance & Leicester plc to the Company in January 2009 and the properties acquired from Bradford & Bingley plc in September 2008. The total consisted of 209 freeholds and 1,356 operating lease interests, occupying a total floor space of 1,064,421 square metres. The number of unique property interests owned by the Group is more than the number of individual properties as the Group has more than one interest in some properties. The majority of the Group's property interests are retail branches. Included in the above total are 36 properties that were not occupied by the Group as at 31 December 2009. Of the Group's individual properties, 1,262 are located in the UK, 1 in Europe and 2 in the US. There are no material environmental issues associated with the use of the above properties.
The Group has eight principal sites consisting of its headquarters and Treasury operations; the banking back office and Human Resources functions; Corporate Banking; Private Banking and the telephone distribution operations; Credit Cards, Debt Management, Finance, Compliance and Marketing. These properties are held under operating leases, except for the Group's headquarters and one of the banking back offices. The registered office of the Company is located at 2 Triton Square, Regent's Place, London NW1 3AN.
Management believes its existing properties and those under construction, in conjunction with those it leases, are adequate and suitable for its business as presently conducted and to meet future business needs. All properties are adequately maintained.
Deposits by banks(1)
The balances below include deposits by banks that are classified in the balance sheet as trading liabilities and financial liabilities designated at fair value.
|
| 2009 £m | 2008 £m | 2007 £m |
| Year-end balance(2) | 46,680 | 48,982 | 27,555 |
| Average balance(3) | 48,907 | 34,064 | 36,574 |
| Maximum balance | 57,845 | 49,194 | 48,278 |
(1) The Group's policy is to mark-to-market the majority of its deposits by banks balances including interest. Mark-to-market movements are recorded in net trading and other income rather than net interest income. As a result, it has not been possible to calculate average or year-end interest rates.
(2) The year-end deposits by banks balance includes non-interest bearing items in the course of transmission of £652m (2008: £922m, 2007: £786m).
(3) Average balances are based upon monthly data.
At 31 December 2009, deposits by foreign banks amounted to £15,282m (2008: £13,031m, 2007: £7,922m).
The following tables set forth the average balances of deposits by banks by location.
|
| Average: year ended 31 December | ||
|
| 2009 £m | 2008 £m | 2007 £m |
| UK | 45,152 | 31,661 | 34,120 |
| Non-UK | 3,755 | 2,403 | 2,454 |
|
| 48,907 | 34,064 | 36,574 |
Deposits by customers
The balances below include deposits by customers that are classified in the balance sheet as trading liabilities and financial liabilities designated at fair value.
|
| 2009 £m | 2008 £m | 2007 £m |
| Year-end balance | 148,020 | 135,119 | 90,148 |
| Average balance(1) | 141,312 | 99,056 | 92,046 |
| Maximum balance | 148,020 | 143,998 | 92,344 |
(1) Average balances are based upon monthly data.
The following tables set forth the average balances of deposits by geography.
|
| Average: year ended 31 December | ||
|
| 2009 £m | 2008 £m | 2007 £m |
| UK | 134,209 | 93,712 | 85,701 |
| Non-UK | 7,103 | 5,344 | 6,345 |
|
| 141,312 | 99,056 | 92,046 |
The following tables set forth the average balances of deposits by geography and customer type.
|
| Average: year ended 31 December | ||
|
| 2009 £m | 2008 £m | 2007 £m |
| UK |
|
|
|
| Retail demand deposits | 73,060 | 55,096 | 56,563 |
| Retail time deposits | 42,873 | 23,590 | 6,033 |
| Wholesale deposits | 18,276 | 15,026 | 23,105 |
|
| 134,209 | 93,712 | 85,701 |
| Non-UK |
|
|
|
| Retail demand deposits | 3,170 | 1,742 | 1,811 |
| Retail time deposits | 3,724 | 2,063 | 1,532 |
| Wholesale deposits | 209 | 1,539 | 3,002 |
|
| 7,103 | 5,344 | 6,345 |
|
| 141,312 | 99,056 | 92,046 |
Retail demand and time deposits are obtained either through the branch network, cahoot or remotely (such as postal accounts). Retail demand and time deposits are also obtained outside the UK, principally through Abbey International. They are all interest bearing and interest rates are varied from time to time in response to competitive conditions.
Demand deposits
Demand deposits consist of savings and current accounts. Savings products comprise Individual Savings Accounts, instant saver savings accounts, remote access accounts, such as those serviced by post, and a number of other accounts which allow the customer a limited number of notice-free withdrawals per year depending on the balance remaining in the account. These accounts are treated as demand deposits because the entire account balance may be withdrawn on demand without penalty as one of the notice-free withdrawals.
Time deposits
Time deposits consist of notice accounts, which require customers to give notice of an intention to make a withdrawal, and bond accounts, which have a minimum deposit requirement. In each of these accounts, early withdrawal incurs an interest penalty.
Wholesale deposits
Wholesale deposits are those which either are obtained through the money markets or for which interest rates are quoted on request rather than being publicly advertised. These deposits are of fixed maturity and bear interest rates that reflect the inter-bank money market rates.
Commercial paper
Issuances of commercial paper and certificates of deposit were used to fund commercial banking operations in 2008 and 2009. As a result, such issuances have been classified as deposits by customers. In 2007 and previous years, similar debt issuances were used to fund the Group's trading operations and therefore were classified as trading liabilities.
|
| 2009 £m | 2008 £m | 2007 £m |
| Year-end balance | 7,210 | 5,120 | 7,283 |
| Year-end interest rate(1) | 1.83% | 1.78% | - |
| Average balance(2) | 5,669 | 4,550 | 6,610 |
| Average interest rate(1) (2) | 1.64% | 3.35% | - |
| Maximum balance | 7,506 | 6,405 | 8,784 |
(1) Prior to 2008, the majority of commercial paper balances including interest were marked-to-market rather than accounted for on an accruals basis. Mark-to-market movements were recorded in net trading and other income rather than net interest income. As a result, it was not possible to calculate average or year-end interest rates for 2007.
(2) Average balances are based upon monthly data.
The Group issues commercial paper generally in denominations of not less than US$50,000, with maturities of up to 365 days. Commercial paper is issued by Abbey National Treasury Services plc and Abbey National North America LLC.
Negotiable certificates of deposit
Issuances of commercial paper and certificates of deposit were used to fund commercial banking operations in 2008 and 2009. As a result, such issuances have been classified as deposits by customers. In 2007 and previous years, similar debt issuances were used to fund the Group's trading operations and therefore were classified as trading liabilities.
|
| 2009 £m | 2008 £m | 2007 £m |
| Year-end balance | 9,188 | 9,638 | 11,326 |
| Year-end interest rate(1) | 1.73% | 4.17% | - |
| Average balance(2) | 7,519 | 12,729 | 13,037 |
| Average interest rate(1) (2) | 2.69% | 4.9% | - |
| Maximum balance | 9,188 | 15,807 | 14,821 |
(1) Prior to 2008, the majority of negotiable certificates of deposit balances including interest were marked-to-market rather than accounted for on an accruals basis. Mark-to-market movements were recorded in net trading and other income rather than net interest income. As a result, it was not possible to calculate average or year-end interest rates for 2007.
(2) Average balances are based upon monthly data.
Certificates of deposit and certain time deposits
The following table sets forth the maturities of the Group's certificates of deposit and other large wholesale time deposits from non-bank counterparties in excess of £50,000 (or the non-sterling equivalent of £50,000) at 31 December 2009. A proportion of the Group's retail time deposits also exceeds £50,000 at any given date; however, the ease of access and other terms of these accounts means that they may not have been in excess of £50,000 throughout 2009.
Furthermore, the customers may withdraw their funds on demand upon payment of an interest penalty. For these reasons, no maturity analysis is presented for such deposits.
|
| Not more than three months £m | In more than three months but not more than six months £m | In more than six months but not more than one year £m | In more than one year £m | Total £m |
| Certificates of deposit: |
|
|
|
|
|
| UK | 418 | 48 | 20 | 1 | 487 |
| Non-UK | 4,958 | 983 | 2,735 | 20 | 8,696 |
| Wholesale time deposits: |
|
|
|
|
|
| UK | 1,918 | - | 43 | 299 | 2,260 |
|
| 7,294 | 1,031 | 2,798 | 320 | 11,443 |
At 31 December 2009, an additional £10m (2008: £71m) of wholesale deposits were repayable on demand.
Debt securities in issue
The Group has issued debt securities in a range of maturities, interest rate structures and currencies, for purposes of meeting liquidity, funding and capital needs.
|
| Note | 2009 £m | 2008 £m | 2007 £m |
| Trading liabilities | 29 | 1,213 | 1,775 | 12,534 |
| Financial liabilities designated at fair value | 30 | 4,366 | 5,268 | 7,538 |
| Debt securities in issue | 31 | 47,758 | 58,511 | 35,712 |
| Other borrowed funds | 32 | 1,352 | 2,076 | 1,419 |
| Subordinated liabilities | 33 | 5,597 | 6,787 | 4,732 |
|
|
| 60,286 | 74,417 | 61,935 |
Most of the debt securities that the Group has issued are classified as "Debt securities in issue" in the balance sheet. The remaining debt securities issued by the Group are classified separately in the balance sheet, either because they qualify as Trading liabilities or were designated upon initial recognition as Financial liabilities designated at fair value, or there are key differences in the legal terms of the securities, such as liquidation preferences ("Other borrowed funds"), or subordination of the rights of holders to the rights of holders of certain other liabilities ("Subordinated liabilities").
Trading liabilities - The debt securities in issue classified as trading liabilities are set out in Note 29 to the Consolidated Financial Statements and include short positions in securities.
In 2009, there was no significant change in trading liabilities. In 2008, the balance decreased because in 2007, issuances of commercial paper and certificates of deposit were used to fund the Group's trading operations and were classified as trading liabilities. From 2008, such issuances have been used to fund commercial banking operations and therefore have been classified as debt securities in issue.
Financial liabilities designated at fair value - Details of the securities classified as Financial liabilities designated at fair value are set out in Note 30 to the Consolidated Financial Statements.
In 2009, balances decreased due to repayments, with new issues not being designated at fair value. In 2008, the balance decreased primarily due to redemptions during the year, partly offset by the effect of the consolidation of debt securities issued by Alliance & Leicester plc reflecting the transfer of Alliance & Leicester plc to the Group which has been accounted for with effect from 10 October 2008.
Debt securities in issue - Details of the Group's main debt securities issuance programmes are set out in Note 31 to the Consolidated Financial Statements.
In 2009, debt securities in issue decreased as part of Santander UK's strategy of reducing the level of short-term wholesale funding. In 2008, Debt securities in issue increased primarily due to the consolidation of approximately £17,477m of debt securities issued by Alliance & Leicester plc reflecting the transfer of Alliance & Leicester plc to the Group which has been accounted for with effect from 10 October 2008. The debt securities in issue balance also increased due to the issuances of relatively short-term debt denominated principally in US dollars and euro.
Other borrowed funds - Details of the individual securities classified as Other borrowed funds are set out in Note 32 to the Consolidated Financial Statements.
In 2009, Other borrowed funds decreased due to the effect of changes in the sterling-US dollar exchange rate on the Group's US$1,000m Non-Cumulative Trust Preferred Securities. In addition, during 2009, the £300m Step Up Callable Perpetual Reserve Capital Instruments were reclassified to equity as described in Note 39 to the Consolidated Financial Statements.
In 2008, Other borrowed funds increased due to the effect of changes in the sterling-US dollar exchange rate on the Group's US$1,000m Non-Cumulative Trust Preferred Securities.
Subordinated liabilities - Details of the individual securities classified as Subordinated liabilities are set out in Note 33 to the Consolidated Financial Statements.
In 2009, Subordinated liabilities decreased due to the redemption of the 5.00% subordinated bonds 2009 (euro 511m). The subordinated liabilities also decreased due to the effect of changes in the sterling-US dollar, sterling-euro and sterling-Japanese yen exchange rates on the Group's securities denominated in those foreign currencies.
In 2008, Subordinated liabilities increased due to the consolidation of approximately £1,436m of notes issued by Alliance & Leicester plc, reflecting the transfer of Alliance & Leicester plc to the Group which has been accounted for with effect from 10 October 2008. The subordinated liabilities also increased due to the effect of changes in the sterling-US dollar, sterling-euro and sterling-Japanese yen exchange rates on the Group's securities denominated in those foreign currencies.
Retirement benefit obligations
|
| 2009 £m | 2008 £m |
| Total net liabilities | (1,070) | (813) |
The Group operates a number of defined contribution and defined benefit pension schemes, and post retirement medical benefit plans. Detailed disclosures of the Group's retirement benefit obligations are contained in Note 36 to the Consolidated Financial Statements.
The total net deficit on the Group's defined benefit schemes, and other post retirement medical benefit plans, increased from £813m at 31 December 2008 to £1,070m at 31 December 2009. The key reason for the increase was a reduction of 100 basis points in the net discount rate (i.e. the discount rate less the inflation rate) used to value the defined benefit scheme liabilities. The increase in assumed inflation also impacted the expected rate of pension increase, in turn leading to a further increase in scheme liabilities. These increases were partly offset by employer contributions made and improvements in asset values.
Contractual obligations
The amounts and maturities of contractual obligations in respect of guarantees are described in Note 37 to the Consolidated Financial Statements. Other contractual obligations are:
|
| Payments due by period | ||||
| Total £m | Less than 1 year £m | 1-3 years £m | 3-5 years £m | Over 5 years £m | |
| Deposits by banks(1) | 46,680 | 46,241 | 206 | 189 | 44 |
| Deposits by customers(1) | 148,020 | 132,312 | 11,284 | 3,612 | 812 |
| Derivative financial instruments | 18,963 | 4,004 | 268 | 6,563 | 8,128 |
| Debt securities in issue(2) | 53,337 | 22,111 | 3,467 | 4,026 | 23,733 |
| Other borrowed funds | 1,352 | - | - | - | 1,352 |
| Subordinated liabilities | 5,597 | - | 478 | - | 5,119 |
| Retirement benefit obligations | 1,070 | 3 | 116 | 82 | 869 |
| Operating lease obligations | 968 | 115 | 303 | 81 | 469 |
| Purchase obligations | 867 | 317 | 301 | 168 | 81 |
| Total | 276,854 | 205,103 | 16,423 | 14,721 | 40,607 |
(1) Includes deposits by banks and deposits by customers that are classified in the balance sheet as trading liabilities.
(2) Includes debt securities in issue that are classified in the balance sheet as trading liabilities and financial liabilities designated at fair value.
As the above table is based on contractual maturities, no account is taken of call features related to subordinated liabilities. The repayment terms of the debt securities may be accelerated in line with the covenants contained within the individual loan agreements. Details of deposits by banks and deposits by customers can be found in Notes 27 and 28 to the Consolidated Financial Statements.
The Group has entered into outsourcing contracts where, in some circumstances, there is no minimum specified spending requirement. In these cases, anticipated spending volumes have been included within purchase obligations.
Under current conditions, the Group's working capital is expected to be sufficient for its present requirements and to pursue its planned business strategies.
Off-Balance Sheet Arrangements
In the ordinary course of business, the Group issues guarantees on behalf of customers. The significant types of guarantees are:
| > | It has been normal in the UK to issue cheque guarantee cards to current account customers holding chequebooks, as historically retailers did not generally accept cheques without such form of guarantee. The guarantee was not automatic but depends on the retailer having sight of the cheque guarantee card at the time the purchase is made. The issuing bank is liable to honour these cheques even where the customer does not have sufficient funds in his or her account. The issuing bank's guarantee liability is in theory the number of cheques written and deposited with retailers multiplied by the amount guaranteed per cheque, which can be between £50 and £100. In practice most customers will only write cheques when they have funds in their account to meet the cheque, and cheques are frequently presented without the benefit of the cheque guarantee. Following years of declining cheque usage, extensive research and reducing acceptance amongst retailers, the UK Payments Council has agreed to a UK industry-wide withdrawal of the UK Cheque Guarantee Scheme from 30 June 2011. In line with this announcement, from October 2009 we started phasing out cheque guarantee cards on replacement cards and card renewals. Customers can continue to use unguaranteed cheques, and cheque books will continue to be available in the usual way. As a result the Group's guarantee liability is decreasing as new cards are issued without the guarantee, meaning that the Group will no longer be liable to honour cheques where the customer does not have sufficient funds in his or her account. On this basis management have assessed the risk with respect to this guarantee as highly remote and decreasing. We consider the risk of loss as part of the provisioning requirement on bank accounts.
|
| > | Standby letters of credit also represent the taking on of credit on behalf of customers when actual funding is not required, normally because a third party is not prepared to accept the credit risk of the Group's customer. These are also included in the normal credit provisioning assessment alongside other forms of credit exposure.
|
| > | The Group, as is normal in such activity, gives representations, indemnities and warranties on the sale of subsidiaries and businesses. The maximum potential amount of any claims made against these is usually significantly higher than actual settlements. Appropriate provision is made with respect to management's best estimate of the likely outcome, either at the time of sale, or subsequently if additional information becomes available. |
Further information regarding off-balance sheet arrangements can be found in the Risk Management Report - Impact of the Current Credit Environment on page 77. See Note 37 to the Consolidated Financial Statements for additional information regarding the Group's guarantees, commitments and contingencies. In the ordinary course of business, the Group also enters into securitisation transactions as described in Note 17 to the Consolidated Financial Statements. The securitisation companies are consolidated. The mortgage assets continue to be administered by the Group. The securitisation companies provide the Group with an important source of long-term funding.
Capital management and resources
Capital management and capital allocation
The Group adopts a centralised capital management approach, based on an assessment of both regulatory requirements and the economic capital impacts of our businesses. Details of the Group's objectives, policies and processes for managing capital, including the group capital table, can be found in Note 50 to the Consolidated Financial Statements.
Capital and risk management disclosures required by Pillar 3
Santander is supervised by the Banco de España on a consolidated basis. The Group has applied Santander's approach to capital measurement and risk management in its implementation of Basel II. As a result, the Group has been classified as a significant sub-group of Santander at 31 December 2009. The relevant Pillar 3 disclosure requirements for the Group are set out below. Further information on the Basel II risk measurement of the Group's exposures is included in Santander's Pillar 3 report.
Scope of the Group's capital adequacy
Santander UK plc and its subsidiaries are a UK banking group regulated by the UK Financial Services Authority. The basis of consolidation for prudential purposes is the same as the basis of consolidation for financial statement purposes. Consequently, the results of significant subsidiaries regulated by the UK Financial Services Authority are included in the Group's capital adequacy disclosures.
The Group and Santander recognise the additional security inherent in Tier 1 capital in the current commercial and regulatory environment. As a result, on 12 October 2008, Banco Santander, S.A. agreed to inject capital of £1bn into the combined businesses fulfilling its agreed commitment to the UK Government's banking support scheme announced on 8 October 2008. Consequently, on 12 October 2008, the Company issued ten billion ordinary shares of 10 pence each and these shares were issued at par to Banco Santander, S.A. on the same date. These ordinary shares qualified as Tier 1 capital for the Group. This capital was, in turn, transferred to Alliance & Leicester plc in late December 2008 as planned.
At 31 December 2008, the Company held 35.6% of the issued ordinary share capital of Alliance & Leicester plc as described in Business Overview - Summary history. As a result, the Group's capital adequacy disclosures at 31 December 2008 include 35.6% of Alliance & Leicester plc's capital resources requirement on a proportional consolidation basis in accordance with the UK Financial Services Authority's rules. This amounted to £676m at 31 December 2008.
On 9 January 2009, in order to optimise the capital, liquidity funding and overall financial efficiency of the enlarged Santander group, Banco Santander, S.A. transferred all of its Alliance & Leicester plc shares to the Company in exchange for newly issued ordinary shares of the Company. Accordingly, the Company is now the immediate parent company of Alliance & Leicester plc.
Capital transferability between the Group's subsidiaries is managed in accordance with the Group's corporate purpose and strategy, its risk and capital management policies and with regard to UK legal and regulatory requirements. There are no other current or foreseen material practical or legal impediments to the prompt transfer of capital resources or repayment of liabilities when due between the Company and its subsidiaries and associates.
Capital ratios
The calculations of Group capital are prepared on a basis consistent with the Group's regulatory filings, and therefore the comparatives have not been amended to reflect application of group reconstruction relief to account for the transfer of Alliance & Leicester plc to the Company, as described in Note 47.
The table below summarises the Group's capital ratios:
|
| 2009 | 2008 |
| Core Tier 1 (after deductions) | 6.8% | 6.2% |
| Tier 1 | 9.5% | 8.5% |
| Total capital | 17.6% | 14.0% |
Ratios are calculated by taking the relevant capital resources as a percentage of risk weighted assets.
Regulatory capital resources
The table below analyses the composition of the Group's regulatory capital resources. The calculations reflect the amounts prepared on a basis consistent with the Group's regulatory filings, and therefore the comparatives have not been amended to reflect application of group reconstruction relief to account for the transfer of Alliance & Leicester plc to the Company, as described in Note 47 to the Consolidated Financial Statements.
|
| 2009 £m | 2008 £m |
| Core Tier 1 capital: |
|
|
| Called up share capital | 2,412 | 1,148 |
| Share premium | 1,857 | 1,857 |
| Retained earnings and other reserves | 2,251 | 1,689 |
|
| 6,520 | 4,694 |
|
| 2009 £m | 2008 £m |
| Deductions from Core Tier 1 capital: |
|
|
| Intangible Assets | (1,541) | (508) |
| Securitisation positions | (75) | (21) |
| Expected Losses | (325) | (257) |
| Material Holdings | - | (6) |
|
| (1,941) | (792) |
|
|
|
|
| Total Core Tier 1 capital after deductions | 4,579 | 3,902 |
| Non cumulative Preference Shares | 833 | 603 |
| Innovative Tier 1 instruments | 1,332 | 1,095 |
| Excess on limits for including innovative Tier 1 capital in total Tier 1 capital | (306) | (213) |
| Total Tier 1 Capital after deductions | 6,438 | 5,387 |
|
|
|
|
| Tier 2 capital: |
|
|
| Subordinated debt | 5,516 | 4,543 |
| Excess innovative tier 1 capital | 306 | 213 |
| Other | 10 | 10 |
|
| 5,832 | 4,766 |
|
|
|
|
| Deductions from Tier 2 capital: |
|
|
| Securitisation positions | (75) | (21) |
| Expected Losses | (325) | (257) |
| Material Holdings | - | (6) |
| Total Tier 2 capital after deductions | 5,432 | 4,482 |
| Deductions from Tier 1 and 2 | - | (988) |
| Total Capital Resources | 11,870 | 8,881 |
The Group's Core Tier 1 capital consists of ordinary share capital, share premium and audited profits for the years ended 31 December 2009 and 2008 after adjustment to comply with the UK Financial Services Authority's rules. A reconciliation to the statutory reserves is set out below:
|
| 2009 £m |
| Total shareholders equity (accounting basis) | 7,222 |
| Less: Reserve Capital Instruments (See Note 39) | (297) |
| Less: non-cumulative preference shares and Innovative Tier 1 Capital Securities (See Note 38) | (591) |
| Less: available for sale reserves | (12) |
| Pensions adjustment | 217 |
| Changes in liabilities designated as fair value through profit or loss from changes in Group's own credit risk | (19) |
| Core Tier 1 capital | 6,520 |
The IAS19 pension deficit is deducted from shareholders' equity. In the Group's regulatory filings the next five years' deficit contributions are treated as a deduction.
Valuation adjustments relating to liabilities designated at fair value through profit or loss which are not attributable to changes in benchmark interest rates are excluded from regulatory capital resources.
The increase in Core Tier 1 capital primarily relates to additional share capital subscribed for and retained profits for the period. Non cumulative preference shares and Innovative Tier 1 are shown separately in the above table. Details of the Innovative Tier 1 capital instruments are set out in Note 32 to the Consolidated Financial Statements. For capital management purposes and in accordance with the UK Financial Services Authority's rules, Innovative Tier 1 is treated as Tier 1 capital. The UK Financial Services Authority's capital gearing rules restrict the amount of Innovative Tier 1 capital included in Tier 1 capital to 15% of Core Tier 1 capital after deductions. The excess is classified as Tier 2.
For details of the subordinated debt issues that meet the UK Financial Services Authority's definition of Tier 2 capital see Note 33 to the Consolidated Financial Statements. In accordance with the UK Financial Services Authority's rules, in the last five years to maturity, dated subordinated debt issues are amortised on a straight line basis.
During 2009, accounting valuation adjustments to Tier 1 and Tier 2 instruments were also included in capital as permitted in accordance with UK Financial Services Authority rules. The Group has elected to deduct certain securitisation positions from capital rather than treat these exposures as a risk weighted asset.
The expected losses deduction represents the difference between expected loss calculated in accordance with the Group's Retail Internal Rating-Based ('IRB') and Advanced Internal Rating-Based ('AIRB') models, and the impairment provisions calculated in accordance with IFRS. Details of the Group's accounting policy for credit provisions are set out in the Accounting Policies in the Consolidated Financial Statements on pages 116 to 118. Expected losses are calculated using risk parameters based on either through-the-cycle, or economic downturn estimates, and which are subject to conservatism due to the imposition of regulatory floors. They are therefore currently higher than the impairment provision which accounts for losses incurred at the balance sheet date.
Intangible assets represent goodwill arising on the transfer of Alliance & Leicester plc, the acquisition of the savings business of Bradford & Bingley plc, and certain capitalised computer software costs.
Material holdings deductions and other Tier 1 and Tier 2 deductions principally represent investments in and loans to other banks in the Santander group which were repaid during 2009.
Regulatory capital requirement
The table below analyses the composition of the Group's regulatory capital requirements. The calculations reflect the amounts prepared on a basis consistent with the Group's regulatory filings, and therefore the comparatives have not been amended to reflect application of group reconstruction relief to account for the transfer of Alliance & Leicester plc to the Company, as described in Note 47 to the Consolidated Financial Statements.
|
| 2009 £m | 2008 £m |
| Credit Risk - Standardised approach: |
|
|
| Institutions | 16 | 34 |
| Corporates | 602 | 564 |
| Retail | 208 | 167 |
| Secured on real estate property | 210 | 187 |
| Past due items | 38 | 14 |
| Securitisation positions | - | 65 |
| Other items | 254 | 193 |
|
| 1,328 | 1,224 |
| Credit Risk - IRB approach: |
|
|
| Retail exposures secured by real estate collateral | 1,732 | 1,989 |
| Qualifying revolving retail | 149 | 169 |
| Other retail | 298 | 293 |
| Institutions | 188 | 124 |
| Corporates | 581 | 280 |
| Other | 62 | 21 |
|
| 3,010 | 2,876 |
|
|
|
|
| Counterparty risk capital component | 213 | 215 |
|
|
|
|
| Operational risk - standardised approach: | 529 | 398 |
|
|
|
|
| Market Risk: | 315 | 361 |
| Interest rate Position Risk Requirement ('PRR') | 34 | 75 |
| Equity PRR | 37 | 39 |
| Commodity PRR | 45 | 56 |
| FX PRR | 33 | 30 |
| Internal models | 166 | 161 |
|
|
|
|
| Total Pillar 1 capital requirement | 5,395 | 5,074 |
|
|
|
|
| Risk weighted assets (based on an 8% capital charge) | 67,438 | 63,425 |
From 1 January 2008, the Group applied Basel II to the calculation of its capital requirement. In addition, the UK Financial Services Authority approved the Group's application of the Retail IRB and AIRB approaches to the Group's credit portfolios with effect from 1 January 2008. Residential lending capital resources requirement include securitised residential mortgages.
On 9 January 2009, Banco Santander, S.A. transferred all of its Alliance & Leicester plc shares to the Company in exchange for newly issued ordinary shares of the Company. 100% of the Pillar 1 capital requirement was included from this date, which amounted to £1,899m.
Although core business volumes have increased, these increases have been offset by de-leveraging of certain non-core portfolios and enhancements to retail IRB models. During the course of 2009, regulatory approval was received to apply a refined approach to the retail exposures secured by real estate collateral which addressed the effects of pro-cyclicality evident in the estimates for probability of default (PD).
Liquidity
Liquidity risk is the potential that, although remaining in operation, the Group does not have sufficient liquid financial resources to enable it to meet its obligations as they fall due, or can secure them only at excessive cost.
The Board is responsible for the Group's liquidity management and control framework and has approved key liquidity limits in setting the Group's liquidity risk appetite. Along with its internal Liquidity Risk Manual, which sets out the liquidity risk control framework and policy, the Group abides by the "Sound Practices for Managing Liquidity in Banking Organisations" set out by the Basel Committee as its standard for liquidity risk management and control. The Group also complies with the UK Financial Services Authority's liquidity requirements, and has appropriate liquidity controls in place.
See "Business and Financial Review - Risk Management" for more information.
Cash flows
|
| 2009 £m | 2008 £m | 2007 £m |
| Net cash inflow/(outflow) from operating activities | 2,929 | (21,444) | (9,332) |
| Net cash inflow/(outflow) from investing activities | 1,433 | 19,402 | (196) |
| Net cash (outflow)/inflow from financing activities | (4,621) | (7,381) | 4,776 |
| Decrease in cash and cash equivalents | (259) | (9,423) | (4,752) |
For the years ended 31 December 2009, 2008 and 2007, cash and cash equivalents decreased £259m, £9,423m and £4,752m respectively. The following discussion highlights the major activities and transactions that affected the Group's cash flows during 2009, 2008 and 2007.
In 2009, the net inflow from investing activities of £1,433m reflected the cash arising from the sale and redemption of debt securities. Due to ongoing market volatility only a portion of the cash generated was used to acquire new debt securities during the year. In 2008, the net inflow from investing activities of £19,402m primarily arose as a result of the acquisition of Bradford & Bingley plc's savings business in September 2008 to strengthen the Group's retail customer deposit base and franchise, which generated £18,001m of cash. This, plus additional inflows from customer deposits, was invested in new lending.
In 2009, the net outflow from financing activities of £4,621m reflected the repayment of loan capital that matured during the year, which was partially offset by new issues of loan capital. In 2008, the cash outflow from financing activities of £7,381m to repay loan capital reflected the maturity of some existing issues, which was not offset by new issues of loan capital given market conditions at the time.
In 2009, net cash and cash equivalents decreased by £259m, largely reflecting cash dividends on ordinary shares paid during the year. In 2008, the decrease in cash and cash equivalents of £9,423m wasprincipally a result of reducing cash and cash equivalents in the Global Banking & Markets operations to fund our Retail Banking lending.
Cash Flows from Operating Activities
For the years ended 31 December 2009, 2008 and 2007, net cash inflow/(outflow) from operating activities was £2,929m, £(21,444)m and £(9,332)m, respectively. The Group's operating assets and liabilities support the Group's lending activities, including the origination of mortgages and unsecured personal loans. During 2008 and 2007, net cash was used to fund the Group's core business of origination of mortgages in Retail Banking. During 2009, customer deposits exceeded net lending as a consequence of an increase in customer confidence.
In 2009, the net cash inflow related largely to an increase in deposits by banks and deposits by customers. Our stability in the current environment which contributed to an increase in customer confidence resulted in the increase in deposits by banks and customer accounts. The UK Government's efforts on quantitative easing and reduced activity in Global Banking & Markets also contributed to this increase. This increase was partially offset by a substantial adverse foreign exchange movement which is a consequence of sterling weakening against foreign currencies.
In 2008, in addition to the movement related to the acquisition of Bradford & Bingley plc's savings business, other strong customer deposit inflows were partially offset by a reduction in deposits by banks. The remaining significant changes relate to the reduction of activity in Global Banking & Markets.
The amount and timing of cash flows related to the Group's operating activities may vary significantly in the normal course of business as a result of market conditions and trading strategies in Cater Allen International Limited.
Cash Flows from Investing Activities
The Group's investing activities primarily involve the acquisition and disposal of businesses, and the purchase of tangible and intangible assets.
In 2009, net cash of £1,433m was generated by investing activities, primarily as a result of proceeds of £3,001m in respect of available-for-sale securities that were sold or matured during the year. In line with the Group's strategy to reduce balance sheet assets in light of prevailing market conditions, only part of the above cash inflows was used to purchase new securities in an amount of £1,134m.
Cash of £463m was used during the year to fund the acquisition of tangible and intangible fixed assets. Of the £463m invested, £120m was invested in furniture and fittings for the Retail Banking branch network as part of branch refurbishments; a further £120m was invested in the continuing development of Partenon, the Santander Group's IT platform; £115m was used to acquire the head office building in London which had previously been leased; and £81m represented the purchase of operating lease assets.
In 2008, net cash of £19,402m was generated by investing activities, primarily as a result of the acquisition of Bradford & Bingley plc's savings business in September 2008 to strengthen the Group's retail customer deposit base and franchise, which generated £18,001m of cash, and the sale of the Porterbrook operating lease business which generated £1,605m of cash. These sources of cash were partially offset by uses of cash of £278m to fund purchases of tangible and intangible fixed assets, and £1,222m to invest in non-trading securities. Of the £278m invested in tangible and intangible fixed assets, £120m was invested in computer infrastructure and software, primarily reflecting investment in systems to support our expansion in lending to small and medium-sized enterprises, and further investment in elements of Partenon; £59m was invested in furniture and fittings for the Retail Banking branch network, mainly as a result of continuing branch refurbishments; and £88m was invested by the Porterbrook operating lease business in the construction of rail assets prior to its sale early in December 2008. The £1,222m invested in non-trading securities represented the purchase of assets pledged related to the Group's obligations with respect to pensions funding.
In 2007, net cash of £196m was used in investing activities. £407m was invested in tangible fixed assets, principally consisting of the investment of £215m by Porterbrook in rolling stock; £103m in Partenon, reflecting the costs of migrating many of our core products onto the new platform; and £66m in refurbishments in the Retail Banking branch network. These uses of cash were partially offset by cash proceeds of £203m on the sale of 49% of the Group's shareholding in Santander Private Banking UK Limited (consisting of James Hay, Cater Allen and Abbey Sharedealing) to Santander PB UK (Holdings) Limited, a direct subsidiary of Banco Santander, S.A., as part of a reorganisation of Santander's Private Banking businesses.
Cash Flows from Financing Activities
The Group's financing activities reflect transactions involving the issuance and repayment of long-term debt, and the issuance of, and payment of dividends on, the Company's shares.
In 2009, net cash outflow from financing activities was £4,621m, principally due to repayment of loan capital. There were new issues for £1,556m of long-term debt (specifically mortgage covered bonds) in 2009. In addition, £225m of cash dividends on ordinary shares were paid.
In 2008, net cash outflow from financing activities was £7,381m, principally due to repayment of loan capital. There were no external issuances of long-term debt in 2008, reflecting the difficult conditions in the credit markets. The net cash used was partially offset by the issuance of £1bn of ordinary share capital. In addition, cash dividends on ordinary shares of £595m were paid.
In 2007, net cash provided by financing activities was £4,776m principally due to new issuances of mortgage-backed securities under the Group's securitisation programme classified as long-term debt. The effect was partially offset by redemption of securities issued by the securitisation companies. For further information on the Group's securitisation programme, see Note 18 to the Consolidated Financial Statements. No cash dividends were paid on ordinary shares.
Sources of liquidity
The Group is primarily funded by retail deposits. This, together with corporate deposits, forms its Commercial Bank franchise, which attracts deposits through a variety of entities. More than three quarters of Commercial Bank customer lending is financed by Commercial Bank customer deposits. The retail sources primarily originate from the Retail Banking savings business. Although largely callable, these funds provide a stable and predictable core of liquidity due to the nature of the retail accounts and the breadth of personal customer relationships.
Additionally, the Group has a strong wholesale funding base, which is diversified across funding types and geography. Through the wholesale markets, the Group has active relationships with more than 500 counterparties across a range of sectors, including banks, central banks, other financial institutions, corporates and investment funds. Other sources of funding include collateralised borrowings, mortgage securitisations and long-term debt issuance. While there is no certainty regarding money market lines of credit extended to the Group, they are actively managed as part of the ongoing business. No guaranteed lines of credit have been purchased as such arrangements are not common practice in the European banking industry.
Short-term funding is accessed through money market instruments, including time deposits, certificates of deposit and commercial paper. Medium to long-term funding is accessed primarily through the stand-alone bond markets. In addition, the Group utilises its euro medium-term note programme. The major debt issuance programmes are managed by Abbey National Treasury Services plc on its own behalf, except for the US commercial paper programme, which is managed for Abbey National North America LLC, a guaranteed subsidiary of the Company, and are set out in Note 31 to the Consolidated Financial Statements.
The ability to sell assets quickly is also an important source of liquidity for the Group. The Group holds marketable investment securities, such as central bank, eligible government and other debt securities, which could be disposed of, either by entering into sale and repurchase agreements, or by being sold to provide additional funding should the need arise. The Group also makes use of asset securitisation arrangements to provide alternative funding sources.
Along with other major UK banks and building societies, the Company participated in the Bank of England's Special Liquidity Scheme whereby it swapped self-subscribed-for asset-backed security issuances for highly liquid Treasury Bills. All major UK banks and building societies were required to participate as part of the measures designed to improve the liquidity position of the UK banking system in general. The Company did not participate in the other UK Government backed schemes; namely the Credit Guarantee Scheme and the Asset Purchase Scheme.
Within the framework of prudent funding and liquidity management, the Group manages its commercial banking activities to minimise liquidity risk. As at 31 December 2009, the Group's loan to deposit ratio was 126% (2008: 136%) and this improvement was mainly driven by organic growth in net deposit inflows which exceeded net lending growth. The Group aims to further reduce this ratio strategically over the course of 2010.
Securitisation of assets
The Group has provided prime retail mortgage-backed securitised products to a diverse investor base through its mortgage backed funding programmes. Funding has historically been raised via mortgage-backed notes, both issued to third parties and retained (the latter being central bank eligible collateral, both via the Bank of England's Special Liquidity Scheme facility and for contingent funding purposes in other Bank of England, European Central Bank, Swiss National Bank, and US Federal Reserve facilities). It is expected that issues to third parties and retained issuances will together represent a similar proportion of the Group's overall funding in 2010 and 2011. During 2008 and 2009, as a result of market conditions, the main means of raising wholesale medium-term funding was through retained issuances. In March 2010 the Group issued through the Fosse Master Trust the first publicly-placed mortgage-backed securitisation transaction from a UK bank since 2007; other recent transactions from UK banks had included an investor put. The transaction was denominated in both pounds sterling and euro and raised approximately £1.4bn.
UK Government 2008 Credit Guarantee Scheme
In October 2008, the UK Government announced measures intended to ensure the stability of the financial system and to protect ordinary savers, depositors, businesses and borrowers, including the details of its 2008 Credit Guarantee Scheme for UK incorporated banks and building societies debt issuance (the 'Scheme').
The Scheme provided for HM Treasury to guarantee specific debt instruments issued by eligible institutions during the extended period ending on 31 December 2009 and with a maturity not exceeding 9 April 2014. The Company was the eligible institution for the Group. The Company did not issue any debt guaranteed by the Scheme.
Uses of liquidity
The principal uses of liquidity for the Group are the funding of Retail and Corporate Banking lending, payment of interest expense, dividends paid to shareholders, and the repayment of debt. The Group's ability to pay dividends depends on a number of factors, including the Group's regulatory capital requirements, distributable reserves and financial performance.
For further information on liquidity, including liquidity risk management and developments during the year, see Risk Management - Liquidity Risk - Group wide on page 58 and Risk Management - Impact of the Current Credit Environment on page 77.
Current market conditions
After a difficult start to the year, funding and liquidity conditions improved during 2009. This was the result of on-going liquidity support schemes through increased liquidity within the financial system; strengthened deposit protection insurance; and bank support through increased capital and guarantees. More recently, signs of macroeconomic recovery, although still fragile, have seen further improvements in debt markets. From the Group's perspective, short-term unsecured money-market funding has been continuously available. However, investor demand for unsecured and mortgage-backed issuance has been much reduced since 2007 and at significantly wider spreads. These markets have traditionally been important sources of funding. Funding issues also came to the fore in the banking sector more generally, resulting in the introduction of government-backed funding initiatives, including the UK Government Credit Guarantee Scheme.
During this time, the Group kept its main stress scenarios under review upon which the Board's risk appetite is based, in light of market developments. At all times, the Group sought to maintain a buffer of securities that are eligible for discount in open market operations with the central banks to which the Group has access including highly rated central government debt. This buffer was at least sufficient to survive either an acute Group-specific stress during stressed market conditions, or a prolonged loss of unsecured wholesale funding during stressed market conditions. The underlying analysis of customer deposit behaviour under stressed conditions is aligned with the assumptions made in operational contingency planning.
The UK Government initiative announced in early October 2008, including the provision of liquidity and funding support and facilities to enable banks to raise new capital to strengthen their capital base, was welcomed by the Group. The Group did not use the UK Government recapitalisation scheme, nor does it expect to in the future. The Group believes that the current arrangements with the Bank of England, European Central Bank, Swiss National Bank and US Federal Reserve, as well as the UK Credit Guarantee Scheme that are available to the UK banking industry will help the banking sector to meet liquidity and funding needs.
Interest rate sensitivity
Interest rate sensitivity refers to the relationship between interest rates and net interest income resulting from the periodic repricing of assets and liabilities. The largest administered rate items in the Group's balance sheet are residential mortgages and retail deposits, the majority of which bear interest at variable rates. The Group is able to mitigate the impact of interest rate movements on net interest income in Retail Banking by repricing separately the variable rate mortgages and variable rate retail deposits, subject to competitive pressures.
The Group also offers fixed-rate mortgages and savings products on which the interest rate paid by or to the customer is fixed for an agreed period of time at the start of the contract. The Group manages the margin on fixed-rate products by the use of derivatives matching the fixed-rate profiles. The risk of prepayment is reduced by imposing early termination charges if the customers terminate their contracts early.
The Group seeks to manage the risks associated with movements in interest rates as part of its management of the overall non-trading position. This is done within limits as described in the Risk Management Report beginning on page 49.
Changes in net interest income - volume and rate analysis
The following table allocates changes in interest income, interest expense and net interest income between changes in volume and changes in rate for the Group for the years ended 31 December 2009, 2008 and 2007. Volume and rate variances have been calculated on the movement in the average balances and the change in the interest rates on average interest-earning assets and average interest-bearing liabilities. The variance caused by changes in both volume and rate has been allocated to rate changes.
|
|
| 2009/2008 |
| 2008/2007 | ||
|
| Total change | Changes due to increase/(decrease) in | Total change | Changes due to increase/(decrease) in | ||
|
|
£m | Volume £m | Rate £m |
£m | Volume £m | Rate £m |
| Interest income |
|
|
|
|
|
|
| Loans and advances to banks |
|
|
|
|
|
|
| UK | (284) | 93 | (377) | 198 | 538 | (340) |
| Non-UK | (9) | 10 | (19) | 24 | 17 | 7 |
| Loans and advances to customers |
|
|
|
|
|
|
| UK | (625) | 2,664 | (3,289) | 650 | 881 | (231) |
| Non-UK | 2 | - | 2 | - | - | - |
| Debt securities |
|
|
|
|
|
|
| UK | 319 | 244 | 75 | - | - | - |
| Total interest income |
|
|
|
|
|
|
| UK | (590) | 3,001 | (3,591) | 848 | 1,419 | (571) |
| Non-UK | (7) | 10 | (17) | 24 | 17 | 7 |
|
| (597) | 3,011 | (3,608) | 872 | 1,436 | (564) |
| Interest expense |
|
|
|
|
|
|
| Deposits by banks |
|
|
|
|
|
|
| UK | (25) | (5) | (20) | 19 | (25) | 44 |
| Deposits by customers - retail demand deposits |
|
|
|
|
|
|
| UK | (1,361) | 770 | (2,131) | 4 | (261) | 265 |
| Non-UK | 12 | 40 | (28) | (48) | (18) | (30) |
| Deposits by customers - retail time deposits |
|
|
|
|
|
|
| UK | (318) | 447 | (765) | 208 | 959 | (751) |
| Non-UK | (17) | 74 | (91) | 30 | 15 | 15 |
| Deposits by customers - wholesale deposits |
|
|
|
|
|
|
| UK | 823 | 210 | 613 | 31 | 25 | 6 |
| Non-UK | - | - | - | (3) | - | (3) |
| Bonds and medium-term notes |
|
|
|
|
|
|
| UK | (1,224) | 148 | (1,372) | 282 | 816 | (534) |
| Non-UK | (281) | 77 | (358) | 48 | 152 | (104) |
| Dated and undated loan capital and other subordinated liabilities |
|
|
|
|
|
|
| UK | 147 | 90 | 57 | 12 | 15 | (3) |
| Non-UK | (7) | 10 | (17) | 17 | 4 | 13 |
| Other interest-bearing liabilities UK | 14 | 5 | 9 | (1) | 3 | (4) |
| Total interest expense |
|
|
|
|
|
|
| UK | (1,944) | 1,665 | (3,609) | 555 | 1,532 | (977) |
| Non-UK | (293) | 201 | (494) | 44 | 153 | (109) |
|
| (2,237) | 1,866 | (4,103) | 599 | 1,685 | (1,086) |
| Net interest income | 1,640 | 1,145 | 495 | 273 | (249) | 522 |
Average balance sheet (1) (2)
|
|
|
| 2009 |
|
| 2008 |
|
| 2007 |
|
| Average balance £m | Interest £m | Average rate % | Average balance £m | Interest £m | Average rate % | Average balance £m | Interest £m | Average rate % |
| Assets |
|
|
|
|
|
|
|
|
|
| Loans and advances to banks |
|
|
|
|
|
|
|
|
|
| UK | 15,477 | 139 | 0.90 | 12,702 | 424 | 3.34 | 3,731 | 226 | 6.06 |
| Non-UK | 646 | 15 | 2.32 | 454 | 24 | 5.29 | 30 | 1 | 3.33 |
| Loans and advances to customers(3) |
|
|
|
|
|
|
|
|
|
| UK | 182,800 | 6,821 | 3.73 | 134,557 | 7,445 | 5.53 | 107,709 | 6,815 | 6.33 |
| Non-UK | 18 | 2 | 6.11 | 18 | 1 | 5.56 | 22 | 1 | 4.55 |
| Debt securities |
|
|
|
|
|
|
|
|
|
| UK | 12,141 | 340 | 2.80 | 962 | 21 | 2.18 | 8 | - | - |
| Total average interest-earning assets, | 211,082 | 7,317 | 3.47 | 148,693 | 7,915 | 5.32 | 111,500 | 7,043 | 6.32 |
| interest income |
|
|
|
|
|
|
|
|
|
| Provision for loan losses | (1,464) | - | - | (562) | - | - | (458) | - | - |
| Trading business | 27,586 | - | - | 35,394 | - | - | 68,612 | - | - |
| Assets designated at fair value through profit and loss | 12,278 | - | - | 12,769 | - | - | 9,152 | - | - |
| Non-interest-earning assets: |
|
|
|
|
|
|
|
|
|
| Other | 36,774 | - | - | 22,885 | - | - | 15,162 | - | - |
| Total average assets | 286,256 |
|
| 219,179 |
|
| 203,968 |
|
|
| Non-UK assets as a % of total | 0.23% |
|
| 0.22% |
|
| 0.03% |
|
|
| Liabilities |
|
|
|
|
|
|
|
|
|
| Deposits by banks |
|
|
|
|
|
|
|
|
|
| UK | (6,911) | (193) | 2.79 | (7,079) | (218) | 3.08 | (5,169) | (199) | 3.85 |
| Deposits by customers: retail demand(4) |
|
|
|
|
|
|
|
|
|
| UK | (73,060) | (1,002) | 1.37 | (55,096) | (2,363) | 4.29 | (56,563) | (2,359) | 4.17 |
| Non-UK | (3,170) | (61) | 1.92 | (1,742) | (49) | 2.81 | (1,811) | (97) | 5.36 |
| Deposits by customers: retail time(4) |
|
|
|
|
|
|
|
|
|
| UK | (42,836) | (932) | 2.18 | (23,590) | (547) | 2.32 | (6,033) | (339) | 5.62 |
| Non-UK | (3,723) | (75) | 2.01 | (2,063) | (92) | 4.46 | (1,532) | (62) | 4.05 |
| Deposits by customers: wholesale(4) |
|
|
|
|
|
|
|
|
|
| UK | (12,796) | (222) | 1.73 | (4,180) | (102) | 2.44 | (2,080) | (71) | 3.41 |
| Non-UK | - | - | - | - | - | - | (58) | (3) | 5.17 |
| Bonds and medium-term notes |
|
|
|
|
|
|
|
|
|
| UK | (41,659) | (733) | 1.76 | (38,721) | (1,957) | 5.05 | (27,776) | (1,675) | 6.03 |
| Non-UK | (10,077) | (44) | 0.44 | (8,154) | (325) | 3.99 | (5,293) | (277) | 5.23 |
| Dated and undated loan capital and other subordinated liabilities |
|
|
|
|
|
|
|
|
|
| UK | (7,622) | (547) | 7.18 | (6,221) | (400) | 6.43 | (5,778) | (388) | 6.72 |
| Non-UK | (651) | (55) | 8.45 | (560) | (62) | 11.07 | (511) | (45) | 8.81 |
| Other interest-bearing liabilities UK | (1,083) | (42) | 3.88 | (918) | (28) | 3.05 | (825) | (29) | 3.52 |
| Total average interest-bearing liabilities, interest expense | (203,588) | (3,906) | 1.92 | (148,324) | (6,143) | 4.14 | (113,429) | (5,544) | 4.89 |
| Trading business | (48,236) | - | - | (41,538) | - | - | (64,342) | - | - |
| Liabilities designated at fair value through profit and loss | (63) | - | - | (6,650) | - | - | (7,847) | - | - |
| Non-interest-bearing liabilities: | - | - | - |
|
|
|
|
|
|
| Other | (28,789) | - | - | (18,663) | - | - | (15,248) | - | - |
| Shareholders' funds | (5,580) | - | - | (4,004) | - | - | (3,102) | - | - |
| Total average liabilities and shareholders' funds | (286,256) |
|
| (219,179) |
|
| (203,968) |
|
|
| Non-UK liabilities as a % of total | 6.16% |
|
| 5.71% |
|
| 4.51% |
|
|
| Interest spread | - | - | 1.55 | - | - | 1.18 | - | - | 1.43 |
| Net interest margin | - | - | 1.62 | - | - | 1.19 | - | - | 1.34 |
(1) Average balances are based upon monthly data.
(2) The ratio of average interest-earning assets to interest-bearing liabilities for the year ended 31 December 2009 was 103.68% (2008: 100.25%, 2007: 98.30%).
(3) Loans and advances to customers include non-performing loans. See "Analysis of provisions on loans and advances to customers" in the Risk Management Report on page 56.
(4) Demand deposits, time deposits and wholesale deposits are defined under "Deposits by customers" above.
Risk Management
The Risk Management report contains audited financial information except for the discussion of Operational Risk on page 52 that, in accordance with the guidance in paragraph BC65 of IFRS 7, is unaudited. 2008 data has been updated to reflect the transfer of Alliance & Leicester plc to the Company as described in Note 47 to the Consolidated Financial Statements.
Summary
This Risk Management report describes the Risk Governance Framework of Santander UK plc (formerly Abbey National plc) (the 'Company', and together with its subsidiaries, the 'Group'), and includes more detail on the Group's key risks, on a segmental basis or aggregated where relevant. It is divided into the following sections:
Introduction - A description of the Group's Risk Governance Framework, including the three tiers of the Risk Governance structure.
Financial Risks and Risk Management - Group-wide disclosures about specific risks which do not originate in any single operating segment, such as operational risk and pension obligation risk, as well as Group-wide disclosures about market risk and credit risk are described on pages 51 to 58.
Liquidity Risk - A description of the liquidity risks the Group faces, along with their management and activity in 2009 and 2008, can be found on pages 58 to 60.
Discussion of Key Risks by Operating Segment- Detailed discussions about risk exposures, measurement information and management policies presented by operating segment can be found on pages 61 to 76:
| > | Risks in Retail Banking - The risks in this segment are described on pages 61 to 67, comprising: | |
|
| > | Credit risk, including its management, an analysis of types and credit quality of retail lending and disclosures relating to provisioning, arrears and recoveries. |
|
| > | Market risk, including its management. |
|
|
|
|
| > | Risks in Corporate Banking - The risks in this segment are described on pages 67 to 70, comprising: | |
|
| > | Credit risk, including its management, mitigation and the disclosure of exposure by rating of counterparty. |
|
| > | Market risk, including its management. |
|
|
|
|
| > | Risks in Global Banking & Markets - The risks in this segment are described on pages 70 to 73, comprising: | |
|
| > | Credit risk, including its management, mitigation and the disclosure of exposure by rating of counterparty. |
|
| > | Market risk, including its management and disclosures on short-term market risk, structural market risk and trading market risk. |
|
|
|
|
| > | Risks in Private Banking - The risks in this segment are described on page 73 to 74, comprising a description of credit risk and market risk in the entities which this segment incorporates. | |
|
|
|
|
| > | Risks in Group Infrastructure - The risks in this segment are described on pages 74 to 76, comprising: | |
|
| > | Credit risk, including its management and the disclosure of exposure by rating of counterparty. |
|
| > | Market risk, including its management and disclosure of Net Interest Margin Sensitivity and the Market Value of Equity sensitivity. |
|
| > | A description of the types of derivative contracts used to hedge risks in this segment. |
The Impact of the Current Credit Environment - Detailed disclosures can be found on pages 77 to 85, including a description of the Group's exposures to certain classes of financial assets and off-balance sheet entities.
Introduction
The Group accepts that risk arises from its full range of activities, and actively manages and controls it. The management of risk is an integral part of the Group's activities. Risk is defined as the uncertainty around the Group's ability to achieve its business objectives and execute its strategy effectively. Risk constitutes the Group's exposure to uncertainty and the consequent variability of return. Specifically, risk equates to the adverse impacts on profitability arising from different sources of uncertainty. The key risks Santander UK is exposed to are Credit (Retail, Corporate & Commercial, Wholesale), Market (Traded and Non-Traded), Operational, Pension Obligation, Concentration, Residual Value, Liquidity, Asset Backed Funding (including Encumbrance), Reputational and Business Strategic. Risk measurement is used to capture the source of the uncertainty and the magnitude of its potential effect on the profitability and solvency of the Group. Effective risk management and control is therefore of fundamental importance to the Group's long-term success.
Understanding and controlling risk is critical for the effective management of the business. The Group's Risk Framework aims to ensure that risk is managed and controlled on behalf of shareholders, customers, depositors, employees and the Group's regulators. Effective and efficient risk governance and oversight provide management with assurance that the Group's business activities will not be adversely impacted by risks that could have been reasonably foreseen. This in turn reduces the uncertainty of achieving the Group's strategic objectives.
Authority for Risk Management flows from the Santander UK plc Board of Directors (the 'Board') to the Chief Executive and from him to specific individuals. Formal standing committees are maintained for effective management or oversight. Their authority is derived from the person they are intended to assist.
Risk Governance Framework
The diagram below shows the Risk Governance Framework in operation in respect of risk management and oversight.
FEVE is a Spanish acronym for "Firmas En Vigilancia Especial", which means business under special watch.
The Risk Division at Banco Santander, S.A. reports to the President of the Comisión Delegada de Riesgos ('CDR' or Delegated Risk Committee).
The main elements of risk governance within the Group are as follows:
First tier of risk governance
Risk management is provided by the Board. It approves the Group's risk appetite in consultation with Banco Santander, S.A. as appropriate, approves the strategy for managing risk and is responsible for the Group's system of internal control. The Board is supported by the Chief Executive and Executive Management, who have primary responsibility for understanding, identifying, and owning the risks generated by their lines of business and establishing a framework for managing those risks within the Board-approved risk appetite of the Group. In addition, understanding, identifying, and owning the risks generated by the Group's operations are the responsibility of the Divisional Heads and central functions. These functions provide technical support and advice to assist in the management and control of risk. Within this tier, there is a process for transaction review and approval within certain thresholds, discharged by the Credit Approval Committee. Transactions reviewed which exceed the threshold limits set are subject to prior review by Banco Santander, S.A.'s Risk Division before final approval by the Credit Approval Committee.
Risk Committee
The Risk Committee is a management committee, established under the authority of and chaired by the Chief Executive. The Risk Committee reviews risk issues, gives advice and recommendations to the Chief Executive, the Executive Committee, or other parties as appropriate and makes decisions on risk issues within its sphere of responsibility.
Second tier of risk governance
Risk control is provided by the Board independently supported by the Risk Division. The roles of the Chief Risk Officer, the Head of Wholesale Risk, and the Risk Division include development of risk measurement methodologies, risk approval, risk monitoring, risk reporting and escalation of risk issues in line with the relevant risk policy for all risks across all lines of Retail Banking, Corporate Banking, Global Banking & Markets, Private Banking and Group Infrastructure business.
Dedicated Business ROFs advise and support the Chief Risk Officer in fulfilling his risk control responsibilities and help to ensure that risks are suitably understood, managed and controlled.
The Risk Division provides independent challenge to all business areas in respect of risk management and compliance with policies and advises the business when they are approaching the limits of the Group's risk appetite.
The Board, as supported by the Risk Division, is responsible for ensuring compliance with Group policies and limits imposed by Banco Santander, S.A. including:
| > | Group-wide risk policies; |
| > | Group-wide risk limits/parameters; |
| > | Approval processes relating to transactions that exceed local risk limits; |
| > | The systematic review of large exposures to clients, sectors, geographical areas and different risk types; and |
| > | Reporting to Banco Santander, S.A.. |
Third tier of risk governance
Risk assurance provides independent objective assurance on the effectiveness of the management and control of risk across the Group. This is provided through the Non-Executive Directors, the Audit and Risk Committee and the Internal Audit function.
Non-Executive Directors
The Non-Executive Directors are members of the Board who have a particular responsibility for constructively challenging and contributing to the development of strategy, scrutinising the performance of management in meeting agreed goals and objectives and monitoring reporting performance, and assuring themselves that the financial controls and systems of risk management are robust and defensible.
Audit and Risk Committee
The Audit and Risk Committee is made up of Non-Executive Directors, and is a committee of the Board. The Committee has responsibility for:
| > | The oversight of the risk governance framework; |
| > | Review of the effectiveness of the Group's internal and external audit processes; |
| > | Review of control policies and procedures including regulatory compliance and financial reporting; |
| > | The identification, assessment and reporting of risks; and |
| > | The risk governance structure and associated compliance with risk control policies and procedures. |
Internal Audit
The Internal Audit function supports the Audit and Risk Committee by providing independent and objective opinions on the effectiveness and integrity of the Group's risk governance arrangements. It does this via a systematic programme of risk-based audits of the controls established and operated by the "first tier" risk management functions and those exercised by the "second tier" risk control functions.
The audit opinions and underlying rationale of findings and recommendations form the basis upon which the Audit and Risk Committee can take reasonable (but not absolute) assurance that the risk governance arrangements are fit for purpose and working properly. The Audit and Risk Committee also receive reports from management, the risk control functions and the external auditors to help them to discharge their risk governance oversight responsibilities.
Financial Risks and Risk Management
The financial risks affecting the Group are discussed below. Risks are generally managed through tailored management policies within the business division or operating segment in which they are originated.
Group-wide disclosures including those relating to specific risks which do not originate in any single operating segment, are described separately at the beginning of this section, apart from liquidity risk which is discussed at the end of the section, following the detailed disclosures about the impact of the current credit environment.
The Group-wide disclosures are followed by detailed discussions about risk exposures, measurement information and management policies presented by operating segment, being Retail Banking, Corporate Banking, Global Banking & Markets, Private Banking, and Group Infrastructure (which includes Asset and Liability Management ('ALM') and the Treasury asset portfolio).
The risk exposure and management information relating to the Company principally arise in Retail Banking, Corporate Banking and Group Infrastructure. Following the outsourcing of key IT and operations processes to group companies, risk governance of these entities is crucial. The use of service level agreements and key metrics support this governance.
Financial Instruments
The Group uses financial instruments to manage the structural balance sheet exposures that arise from its banking activities, in accordance with Risk policies and the Asset and Liability Management Committee's direction. The Group also trades in financial instruments where it takes positions in exchange-traded and over the counter instruments, including derivatives, to take advantage of short-term market movements in the equity and bond markets and in currency and interest rates.
Operational Risk - Group-wide (unaudited)
Operational risk is the risk of loss to the Group, resulting from inadequate or failed internal processes, people and systems, or from external events. Such risks can materialise as frauds, process failures, system downtime or damage to assets due to fire, floods etc. When such risks materialise they have not only immediate financial consequences for the Group but also an effect on its business objectives, customer service, regulatory responsibilities and reputation. Operational risk exposures arise across the Group's business divisions and operating segments, and are managed on a consistent basis.
Managing operational risk (unaudited)
The Group undertakes extensive activity to minimise the impacts operational risks may have on business areas. An independent central operational risk function (Enterprise and Operational Risk) has responsibility for establishing the framework within which these risks are managed and is aligned to operational risk professionals within business areas to ensure consistent approaches are applied across the Group. The primary purpose of the framework, which is approved by the Risk Committee and Board, is to define and articulate the Group-wide policy, processes, roles and responsibilities. The framework incorporates industry practice and regulatory requirements, particularly those emanating from the Basel Committee, European Union Directives, the UK Financial Services Authority and the parent regulator (Banco d'Espana or The Bank of Spain).
The day-to-day management of operational risk is the responsibility of business managers who identify, assess and monitor the risks, in line with the processes described in the framework. The operational risk function ensures that all key risks are regularly reported to Risk Fora, the Risk Committee and Board.
Key operational risk activity in 2009 (unaudited)
During 2009, the Group has continued to respond to the developing operational risk environment with coordinated responses, and the Group continues to perform detailed control reviews in response to major industry events.
Following many high profile customer data security lapses experienced by other organisations in the UK, the Group has continued to take proactive steps to minimise similar risks. A corporate information security programme was established which involved the strengthening of controls for the management of sensitive data and included the implementation of encryption standards across the Group.
The Group continues to strengthen its point of sale compliance and control procedures to minimise risk and serve its customers. To this end, work continues to progress in implementing new systems which are already successfully operating in Banco Santander, S.A.. In 2009, implementations have concentrated on integrating Bradford & Bingley savings business and Alliance & Leicester group systems, with further focus on Alliance & Leicester throughout 2010.
Internet frauds were greatly reduced throughout 2009 by developing and implementing improvements to fraud detection rates and introducing a Santander Group transactional model which increased the volume of cases that were intercepted. As part of integration activity, these controls were replicated throughout all Santander UK companies.
In line with UK Financial Services Authority guidance and industry practice, the Group has crisis management and disaster recovery arrangements to ensure that critical business processes are maintained in the event of an unforeseen interruption. Insurance policies are also purchased to provide cover for a range of potential operational risk losses. In response to the increased threats of terrorism, flooding, and pandemic disasters, contingency strategies continue to be refined and key progress has included the development of dispersed contingency sites and automated system switch over facilities.
Corporate operational risk frameworks have been implemented throughout all Santander companies during the year, integrating approaches across the Bradford & Bingley savings business, Alliance & Leicester and Santander UK. To highlight awareness of Operational Risk issues, appropriate training is available for management and staff involved in control functions throughout the Group.
Credit Risk - Group-wide
Credit risk is the risk that counterparties will not meet their financial obligations resulting in the Group losing the monies lent, including any interest accrued, or having to close out transactions prematurely, which may incur losses after realising collateral held.
Significant concentrations of credit risk
During 2009, the Group's most significant exposures to credit risk derived from:
| > | the residential mortgage portfolio and unsecured personal lending businesses in Retail Banking; |
| > | secured lending and derivatives exposures to companies, real estate entities and social housing associations in Corporate Banking; |
| > | unsecured lending and derivatives exposure to banks and other financial institutions in Global Banking & Markets; and |
| > | portfolios of assets in Group Infrastructure inconsistent with the Group's future strategy such as shipping, aviation, and the Treasury asset portfolio acquired as a result of the transfer of Alliance & Leicester plc to the Company. |
The residential mortgage portfolio comprises loans to private individuals secured against residential properties in the UK. This is a prime portfolio with total exposure of £161bn at 31 December 2009 (2008: £152bn). The Unsecured Personal Loan portfolio comprises unsecured loans to private individuals issued in the UK. Total exposure stood at £4.9bn at 31 December 2009 (2008: £6.3bn). The commercial loan, real estate and social housing portfolios in Corporate Banking comprise loans secured on UK property, corporate loans and associated derivatives. The total committed facilities exposure to these portfolios was £24.9bn at 31 December 2009 (2008: £24.8bn).
Although Global Banking & Markets', Corporate Banking's and Group Infrastructure's operations are based mainly in the UK, they have built up exposures to various entities around the world and are therefore exposed to concentrations of risk related to geographic area. At 31 December 2009, 2% (2008: 9%) of Global Banking & Markets' credit exposures were to counterparties from the United States, and 77% (2008: 47%) were to counterparties from the UK. 2% (2008: 1%) of Global Banking & Markets' exposures were to countries that are not members of the Organisation for Economic Co-operation and Development ('OECD'). The remaining exposures were mainly to European counterparties. At 31 December 2009, 87% (2008: 81%) of Corporate Banking's credit exposures were to counterparties from the UK, and 2% (2008: 3%) were to counterparties from the United States, and 11% (2008: 16%) of Corporate Banking's exposures were to other countries. Group Infrastructure's exposures result from its asset portfolios, including the Treasury asset portfolio. At 31 December 2009, treasury investment securities stood at £9.9bn (2008: £14.1bn). Details of credit ratings and geographic analysis can be found on pages 78 to 85.
Geographical exposures are governed by country limits set by Banco Santander, S.A. ('Santander') centrally and determined according to the classification of the country (whether it is a developed OECD country or not), the rating of the country and its gross domestic product. The Group is further constrained in its country risk exposure, within the group limits, and by its capital base.
Maximum exposure to credit risk
The following table presents the amount that best represents the Group's estimated maximum exposure to credit risk at the reporting date without taking account of any collateral held or other credit enhancements:
|
| 2009 £m | 2008 £m |
| Trading assets | 21,688 | 25,008 |
| Purchase and resale agreements | 14,685 | 1,256 |
| Derivative financial instruments | 22,827 | 35,125 |
| Financial assets designated at fair value | 12,358 | 11,377 |
| Available-for-sale securities | 797 | 2,663 |
| Loan and receivable securities | 9,898 | 14,107 |
| Loans and advances to customers | 186,804 | 180,176 |
| Loans and advances to banks | 6,069 | 16,001 |
| Other | 4,334 | 3,977 |
| Third party exposures(1) (2) | 279,460 | 289,690 |
(1) In addition, the Group is exposed to credit risk in respect of guarantees granted, loan commitments and stock borrowing and lending agreements. The estimated maximum exposure to credit risk is described in Note 37 to the Consolidated Financial Statements on page 157.
(2) Excludes loan to other members of the Santander UK and Santander groups.
In managing the gross exposures, the Group uses the policies and processes described in the Credit Risk sections below. Collateral, when received, can be held in the form of security over the mortgaged property, full debentures over a company's assets and through market standard collateral agreements in its treasury business.
Loans and advances
The following tables categorise the Group's loans and advances into three categories as: neither past due nor impaired, past due but not individually impaired, or individually impaired. For certain homogeneous portfolios of loans and advances, impairment is assessed on a collective basis and each loan is not individually assessed for impairment. Loans in this category are classified as neither past due nor impaired, or past due but not individually impaired, depending upon their arrears status. The impairment allowance includes allowances against financial assets that have been individually assessed for impairment and those that are subject to collective assessment for impairment.
|
|
|
|
|
|
| Group |
| 2009 | Neither past due nor impaired | Past due but not individually impaired | Individually Impaired | Total | Impairment Allowance | Total Carrying Value |
| Statutory balance sheet line items | £m | £m | £m | £m | £m | £m |
| Trading assets |
|
|
|
|
|
|
| - Loans and advances to banks | 5,252 | - | - | 5,252 | - | 5,252 |
| - Loans and advances to customers | 10,628 | - | - | 10,628 | - | 10,628 |
| Financial assets designated at fair value through profit and loss |
|
|
|
|
|
|
| - Loans and advances to customers | 6,379 | - | - | 6,379 | - | 6,379 |
| Loans and advances to banks |
|
|
|
|
|
|
| - Placements with other banks | 1,606 | - | - | 1,606 | - | 1,606 |
| - Amounts due from parent | 5,995 | - | - | 5,995 | - | 5,995 |
| - Amounts due from associates | 1,551 | - | - | 1,551 | - | 1,551 |
| Loans and advances to customers |
|
|
|
|
|
|
| - Advances secured on residential property | 155,619 | 4,107 | 1,076 | 160,802 | (484) | 160,318 |
| - Corporate Loans | 11,500 | 166 | 507 | 12,173 | (357) | 11,816 |
| - Finance Leases | 1,566 | 19 | 17 | 1,602 | (2) | 1,600 |
| - Other secured advances | 3,571 | 127 | 121 | 3,819 | (62) | 3,757 |
| - Other unsecured advances | 4,505 | 220 | 525 | 5,250 | (394) | 4,856 |
| - Amounts due from fellow subsidiaries | 4,457 | - | - | 4,457 | - | 4,457 |
| Loans and receivables securities | 9,870 | - | 34 | 9,904 | (6) | 9,898 |
| Total loans and advances | 222,499 | 4,639 | 2,280 | 229,418 | (1,305) | 228,113 |
|
|
|
|
|
|
| Company |
| 2009 | Neither past due nor impaired | Past due but not individually impaired | Individually Impaired | Total | Impairment Allowance | Total Carrying Value |
| Statutory balance sheet line items | £m | £m | £m | £m | £m | £m |
| Financial assets designated at fair value through profit and loss |
|
|
|
|
|
|
| - Loans and advances to banks | 160 | - | - | 160 | - | 160 |
| - Loans and advances to customers | 45 | - | - | 45 | - | 45 |
| Loans and advances to banks |
|
|
|
|
|
|
| - Placements with other banks | 995 | - | - | 995 | - | 995 |
| - Amounts due from parent | 1 | - | - | 1 | - | 1 |
| - Amounts due from associates | 1 | - | - | 1 | - | 1 |
| - Amounts due from subsidiaries | 108,659 | - | - | 108,659 | - | 108,659 |
| Loans and advances to customers |
|
|
|
|
|
|
| - Advances secured on residential property | 118,240 | 3,626 | 880 | 122,746 | (395) | 122,351 |
| - Other secured advances | 3,530 | 117 | 112 | 3,759 | (55) | 3,704 |
| - Other unsecured advances | 4,362 | 188 | 486 | 5,036 | (351) | 4,685 |
| - Amounts due from fellow subsidiaries | 71 | - | - | 71 | - | 71 |
| - Amounts due from subsidiaries | 938 | - | 98 | 1,036 | (98) | 938 |
| Total loans and advances | 237,002 | 3,931 | 1,576 | 242,509 | (899) | 241,610 |
Credit quality of loans and advances that are neither past due nor individually impaired
The credit quality of loans and advances that are neither past due nor individually impaired is as follows:
|
|
|
|
| Group |
|
| Good | Satisfactory | Higher Risk | Total |
|
| 2009 £m | 2009 £m | 2009 £m | 2009 £m |
| Trading assets |
|
|
|
|
| - Loans and advances to banks | 5,071 | 181 | - | 5,252 |
| - Loans and advances to customers | 10,628 | - | - | 10,628 |
| Financial assets designated at fair value in P&L |
|
|
|
|
| - Loans and advances to customers | 6,379 | - | - | 6,379 |
| Loans and advances to banks |
|
|
|
|
| - Placements with other banks | 1,606 | - | - | 1,606 |
| - Amounts due from parent | 5,995 | - | - | 5,995 |
| - Amounts due from associates | 1,551 | - | - | 1,551 |
| Loans and advances to customers |
|
|
|
|
| - Advances secured on residential property | 142,116 | 13,050 | 453 | 155,619 |
| - Corporate Loans | 6,940 | 4,444 | 116 | 11,500 |
| - Finance Leases | 1,452 | 114 | - | 1,566 |
| - Other secured advances | 1,412 | 2,065 | 94 | 3,571 |
| - Other unsecured advances | 1,212 | 3,184 | 109 | 4,505 |
| - Amounts due from fellow subsidiaries | 4,457 | - | - | 4,457 |
| Loans and receivables securities | 4,217 | 5,645 | 8 | 9,870 |
| Total loans and advances | 193,036 | 28,683 | 780 | 222,499 |
|
|
|
|
| Company |
|
| Good | Satisfactory | Higher Risk | Total |
|
| 2009 £m | 2009 £m | 2009 £m | 2009 £m |
| Financial assets designated at fair value in P&L |
|
|
|
|
| - Loans and advances to banks | 160 | - | - | 160 |
| - Loans and advances to customers | 45 | - | - | 45 |
| Loans and advances to banks |
|
|
|
|
| - Placements with other banks | 995 | - | - | 995 |
| - Amounts due from parent | 1 | - | - | 1 |
| - Amounts due from associates | 1 | - | - | 1 |
| - Amounts due from subsidiaries | 108,659 | - | - | 108,659 |
| Loans and advances to customers |
|
|
|
|
| - Advances secured on residential property | 105,848 | 11,939 | 453 | 118,240 |
| - Other secured advances | 1,531 | 1,912 | 87 | 3,530 |
| - Other unsecured advances | 1,172 | 3,084 | 106 | 4,362 |
| - Amounts due from fellow subsidiaries | 71 | - | - | 71 |
| - Amounts due from subsidiaries | 938 | - | - | 938 |
| Total loans and advances | 219,421 | 16,935 | 646 | 237,002 |
Internal measures of credit quality have been used in the table analysing credit quality, above. Different measures are applied to retail and wholesale lending, as follows:
|
|
|
| Retail Lending | Wholesale Lending |
|
| Probability of default | Probability of default | Expected loss | Probability of default |
| Financial statements description | Secured(1) | Commercial(2) | Unsecured(3) |
|
| Good | 0.0 - 0.5%(4) | 0.0 - 0.5% | 0.0 - 0.5% | 0.0 - 0.5% |
| Satisfactory | 0.5 - 12.5% | 0.5 - 35% | 0.5 - 12.5% | 0.5 - 12.5% |
| Higher Risk | 12.5%+(5) | 35%+ | 12.5%+ | 12.5%+ |
(1) "Secured" consists of Advances secured on residential property.
(2) "Commercial" consists of Other secured advances and certain unsecured advances.
(3) "Unsecured" consists of Other unsecured advances excluding those included within the "Commercial" category.
(4) Or a loan-to-value ratio of less than 75%.
(5) Or a loan-to-value ratio exceeding 75%.
Summarised descriptions of credit quality used in the financial statements relating to retail and wholesale lending are as follows:
| Good | There is a very high likelihood that the asset will not default and will be recovered in full. The exposure has a negligible or low probability of default. Such exposure also exhibits a strong capacity to meet financial commitments and only exceptionally shows any period of delinquency. |
| Satisfactory | There is a high likelihood that the asset will be recovered and is therefore of no cause for concern to the Group. The asset has low to moderate probability of default, strong recovery rates and may typically show only short periods of delinquency. Typically these are high loan to value mortgages or most unsecured lending. Moderate to high application scores, credit bureau scores or behavioural scores characterise this credit quality. |
| Higher Risk | All rated accounts that not viewed as "Good" or "Satisfactory" are rated as "Higher Risk". The assets are characterised by some concern over the obligor's ability to make payments when due. However, the assets have not yet converted to actual delinquency. There may also be doubts over the value of collateral or security provided. However, the borrower or counterparty is continuing to make payments when due and is expected to settle all outstanding amounts of principal and interest. |
Maturity analysis of loans and advances that are past due but not individually impaired
A maturity analysis of loans and advances that are past due but not individually impaired is set out below.
In the retail loans book, a loan or advance is considered past due when any contractual payments have been missed, and for secured loans when they are more than 30 days in arrears. The amounts disclosed in the table are the total financial asset of the account, not just the past due payments. All retail accounts are classified as non-impaired as they are provisioned collectively with the exception of properties in possession, which are provisioned on a case by case basis and hence are not included in the table below.
In the corporate loans book a loan or advance is considered past due when 90 days past due, and also when the Group has reason to believe that full repayment of the loan is in doubt.
|
|
|
|
|
|
| Group |
| 2009 | Past due up to 1 month | Past due 1-2 months | Past due 2-3 months | Past due 3-6 months | Past due 6 months and over | Total |
|
| £m | £m | £m | £m | £m | £m |
| Loans and advances to customers |
|
|
|
|
|
|
| - Advances secured on residential property | - | 1,536 | 889 | 1,113 | 569 | 4,107 |
| - Corporate Loans | - | - | - | 166 | - | 166 |
| - Finance Leases | - | - | - | 19 | - | 19 |
| - Other secured advances | - | 41 | 13 | 17 | 56 | 127 |
| - Other unsecured advances | 99 | 43 | 20 | 30 | 28 | 220 |
| Total loans and advances | 99 | 1,620 | 922 | 1,345 | 653 | 4,639 |
|
|
|
|
|
| Company | |
| 2009 | Past due up to 1 month | Past due 1-2 months | Past due 2-3 months | Past due 3-6 months | Past due 6 months and over | Total |
|
| £m | £m | £m | £m | £m | £m |
| Loans and advances to customers |
|
|
|
|
|
|
| - Advances secured on residential property | - | 1,369 | 803 | 992 | 462 | 3,626 |
| - Other secured advances | - | 38 | 12 | 16 | 51 | 117 |
| - Other unsecured advances | 94 | 39 | 19 | 24 | 12 | 188 |
| Total loans and advances | 94 | 1,446 | 834 | 1,032 | 525 | 3,931 |
Analysis of provisions on loans and advances to customers
An analysis of the Group's provisions on loans and advances to customers is presented below.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| Observed provisions |
|
|
|
|
|
| Advances secured on residential properties - UK | 313 | 174 | 74 | 45 | 21 |
| Corporate advances - UK | 185 | 13 | - | - | - |
| Finance leases - UK | 1 | - | - | 1 | 3 |
| Other secured advances - UK | 50 | 37 | 32 | 73 | 123 |
| Unsecured personal advances - UK | 341 | 227 | 250 | 243 | 158 |
| Total observed provisions | 890 | 451 | 356 | 362 | 305 |
| Incurred but not yet observed provisions |
|
|
|
|
|
| Advances secured on residential properties - UK | 171 | 184 | 102 | 60 | 35 |
| Corporate advances - UK | 172 | 289 | - | - | - |
| Finance leases - UK | 1 | 1 | - | - | - |
| Other secured advances - UK | 12 | 11 | 8 | 3 | - |
| Unsecured personal advances - UK | 53 | 65 | 85 | 111 | 54 |
| Total incurred but not yet observed provisions | 409 | 550 | 195 | 174 | 89 |
| Total provisions | 1,299 | 1,001 | 551 | 536 | 394 |
Movements in provisions for impairment losses on loans and advances
An analysis of movements in the Group's provisions for impairment losses on loans and advances is presented below.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 (1) £m |
| Provisions at 31 December | 1,001 | 551 | 536 | 394 | 467 |
| IFRS reclassifications | - | - | - | - | (40) |
| Provisions at 1 January | 1,001 | 551 | 536 | 394 | 427 |
| Amounts written off |
|
|
|
|
|
| Advances secured on residential properties - UK | (84) | (32) | (9) | (11) | (5) |
| Finance leases UK | (4) | - | (1) | - | - |
| Other secured advances - UK | (17) | (9) | (24) | (27) | (36) |
| Unsecured personal advances - UK | (425) | (262) | (339) | (205) | (247) |
| Total amounts written off | (530) | (303) | (373) | (243) | (288) |
| Observed provisions charged against profit |
|
|
|
|
|
| Advances secured on residential properties - UK | 223 | 132 | 38 | 35 | 12 |
| Corporate advances - UK | 172 | 13 | - | - | - |
| Finance leases UK | 5 | - | - | - | - |
| Other secured advances - UK | 30 | 14 | (17) | (25) | 11 |
| Unsecured personal advances - UK | 539 | 239 | 346 | 289 | 218 |
| Total observed provisions charged against profit | 969 | 398 | 367 | 299 | 241 |
| Incurred but not yet observed provisions charged against profit | (141) | (4) | 21 | 86 | 14 |
| Total provisions charged against profit (including discontinued operations) | 828 | 394 | 388 | 385 | 255 |
| Acquisition of business | - | 359 | - | - | - |
| Provisions at the end of the year | 1,299 | 1,001 | 551 | 536 | 394 |
(1) IFRS reclassifications related primarily to provisions on certain corporate loans in businesses and portfolios that were inconsistent with the Group's strategy, and were sold during 2005 or transferred to Corporate Banking.
Group recoveries
An analysis of the Group's recoveries is presented below.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| Advances secured on residential properties - UK | 1 | 1 | 2 | 2 | 3 |
| Corporate advances - UK | 23 | - | - | - | - |
| Finance leases - UK | 1 | - | - | - | - |
| Other secured advances - UK | - | 12 | 6 | 7 | 7 |
| Unsecured personal advances - UK | 30 | 33 | 36 | 32 | 27 |
| Total amount recovered | 55 | 46 | 44 | 41 | 37 |
Group non-performing loans and advances (1)
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| Group non-performing loans and advances that are impaired | 1,833 | 1,142 | 296 | 375 | 314 |
| Group non-performing loans and advances that are not impaired | 1,780 | 1,236 | 596 | 451 | 568 |
| Total non-performing loans and advances(2) | 3,613 | 2,378 | 892 | 826 | 882 |
|
| % | % | % | % | % |
| Non-performing loans and advances as a % of loans and advances to customers(3) | 1.86 | 1.28 | 0.75 | 0.76 | 0.88 |
| Provision as a percentage of total non-performing loans and advances | 35.95 | 42.10 | 61.77 | 64.89 | 44.67 |
(1) Loans and advances are classified as non-performing typically when the counterparty fails to make payments when contractually due for three months or longer.
(2) All non-performing loans are UK and continue accruing interest.
(3) Loans and advances to customers include social housing loans and finance leases, and exclude trading assets.
Group restructured loans
Loans have been restructured or renegotiated by capitalising the arrears where customers in arrears have maintained an agreed monthly repayment for a specified period. For further information, refer to the discussions of restructured loans in the Retail Banking and Corporate Banking sections.
Basel II (unaudited)
Throughout 2009, the Group applied the retail internal ratings-based (IRB) approach for credit risk to its key retail portfolios. During the course of 2009, regulatory approval was received to apply a refined approach to the residential mortgage portfolio which addressed the effects of procyclicality evident in the estimates for probability of default (PD).
A combination of the advanced and foundation internal ratings-based approaches was employed for the principal wholesale and corporate portfolios. For the remaining credit exposures, currently on the Basel II standardised approach, a rolling programme of transition to the appropriate IRB approach is underway. The standardised approach for Operational Risk continued to be applied during 2009.
The Group applied Basel II to its Internal Capital Adequacy Assessment Process (ICAAP) and to the risk and capital disclosures made to the market. The Group has applied Banco Santander S.A.'s approach to risk management in its application of Basel II. Further information on the Group's capital position under Basel II is included in Note 50 to the Consolidated Financial Statements. Further information on the Basel II risk measurement of the Group's exposures will be included in Banco Santander S.A.'s Pillar 3 report. The Group's Pillar 3 disclosures are set out in the Balance Sheet Business Review on pages 41 to 43.
Market risk - Group-wide
Market risk is the potential for loss of income or decrease in the value of net assets caused by movements in the levels and prices of financial instruments including interest rate and foreign currency risks. The Group accepts that market risk arises from its full range of activities. The Group aims to actively manage and control market risk by limiting the adverse impact of market movements whilst seeking to enhance earnings within clearly defined parameters. The Market Risk Manual, which is reviewed and approved by the Head of Wholesale Risk on an annual basis, sets the framework under which market risks are managed and controlled. Business area policies, risk limits and mandates are established within the context of the Market Risk Manual.
Executive directors are responsible for ensuring that they have sufficient expertise to manage the risks originated and retained within their business divisions. The business areas are responsible for ensuring that they have sufficient expertise to manage the risks associated with their operations. The independent Risk function, under the direction of the Head of Wholesale Risk, aims to ensure that risk-taking and risk control occur within the framework prescribed by the Market Risk Manual. The Risk function also provides oversight of all risk-taking activities through a process of reviews.
The Group aims to ensure that exposure to market risks is measured and reported on an accurate and timely basis to senior management. In addition to the regular reporting for the purposes of active risk management, the Board also receives reporting of all significant market risk exposures on a monthly basis where actual exposure levels are measured against limits. Senior management recognise that different risk measures are required to best reflect the risks faced in different types of business activities. In measuring exposure to market risk, the Group uses a range of complementary measures, covering both value and income as appropriate.
Pension obligation risk - Group-wide
The Group has statutory funding obligations as the sponsoring employer for a number of defined benefit staff pension schemes. The schemes are managed by independent trustees in accordance with legislation and trust deeds and rules, for the benefit of members. The Group accepts that it is exposed to pension obligation risk that could give rise to an unexpected increase in the Group's obligations to fund the schemes, either because of a loss of net asset value or because of changes in legislation or regulatory action. The principal risks to the net asset value of the schemes are an increase in the value of the liabilities arising from adverse changes in the longevity assumptions, increases in inflation or reductions in the discount rate used, and scheme assets being adversely affected by market movements. Further information on pensions can be found in "Critical Accounting Policies" within the Accounting Policies on page 122 and in Note 36 to the Consolidated Financial Statements.
Risk management
The Chief Financial Officer is responsible for managing the Group's exposure to pension obligation risk, in conjunction with the trustees. Further details of the funding arrangements for the pension schemes can be found on page 122.
Liquidity risk - Group wide
Liquidity risk is the potential that the Group has insufficient financial resources to meet its payment and collateral obligations (to the extent that they will be settled by delivering cash or another financial asset) as they fall due, or can do so only at excessive cost. Liquidity risks arise throughout the Group. Its primary business activity is commercial banking and, as such, it engages in maturity transformation, whereby callable and short-term commercial deposits are invested in longer-term customer loans.
The majority of funding is raised from retail deposits with the balance raised in wholesale markets. The traditional sources of wholesale funding were:
| > | Secured and unsecured money-market funding (including unsecured cash, repo, CD and CP issuance); |
| > | Senior debt issuance (including discrete bond issues and MTNs); |
| > | Mortgage-backed funding (including securitisation and covered bond issuance); and |
| > | Subordinated debt and capital issuance (although the primary purpose is not funding). |
For accounting purposes, wholesale funding is classified as deposits by banks, deposits by customers, debt securities in issue, other borrowed funds and subordinated liabilities.
As a result of market conditions, the mortgage-backed funding markets, which have traditionally been important sources of funding and had been effectively closed to new external issuances since the end of 2007, except for private placements with a small number of investors, have started to reopen. Despite these difficult market conditions, in October 2009, the Group issued a 7-year euro 1.75bn covered bond, followed in March 2010 with a 3-year euro 1bn transaction. In March 2010 the Group issued a £1.4bn mortgage backed securitisation transaction using Fosse Master Trust. This was the first publicly-placed mortgage-backed securitisation transaction from a UK bank since 2007; other recent transactions from UK banks had included an investor put. The Group benefited both from the conservative proportion of retail assets that are funded in wholesale markets, as well as having entered the period of market stress in a strong liquidity position. All internal and external liquidity ratios were maintained during this period.
The Group has access to the Bank of England's, the Swiss National Bank's and the US Federal Reserve's lending facilities. In addition, it can access indirectly the European Central Bank's repo facilities. The key on-going liquidity risks are:
| > | Loss of customer deposits; |
| > | Loss of access to wholesale funding markets (including foreign exchange swaps) or counterparties; |
| > | Intra-day payments systems dislocation; and |
| > | Contingent liabilities arising from mortgage-backed or other funding, such as collateral calls or early amortisation. |
Liquidity risk management
The Board is responsible for the liquidity risk management and control framework and defines the liquidity risk appetite. Funding and liquidity risk management are the responsibility of the Chief Financial Officer who delegates day-to-day responsibility to the Treasurer, Head of ALM. The Group has a centralised liquidity risk management approach whereby all liquidity/funding is managed centrally by the Treasurer, Head of ALM, under the direction of the Asset & Liability Management Committee and within the framework of the Liquidity Risk Manual. In addition to daily reporting of business level and consolidated liquidity risk information to senior management, the Asset and Liability Management Committee and the Risk Committee monitor the Group's liquidity position on a monthly basis. The Board also receives a monthly update on key liquidity issues and the Group's liquidity position is reported to the UK Financial Services Authority on a weekly basis.
The Group views the essential elements of funding and liquidity management as controlling potential cash outflows, maintaining prudent levels of highly liquid assets and ensuring that access to funding is available from a diversity of sources. A management and monitoring process, and a series of liquidity limits within which liquidity is managed, underpin these elements. The Board targets a funding strategy that avoids excessive reliance on wholesale funding and attracts enduring commercial deposits by understanding the liquidity persistence of customer deposits under different scenarios, appropriately reflecting product features and types of customers. The funding strategy aims to provide effective diversification in the sources and tenor of funding as well as establishing the capacity to raise additional unplanned funding from those sources quickly. An excessive concentration in either liquid assets or contractual liabilities also contributes to potential liquidity risk, and so limits have been defined under the Liquidity Risk Appetite. Management also monitors the Group's compliance with limits set by the UK Financial Services Authority. In addition to such limits, liquidity ratios have trigger-review levels that require the Treasurer, Head of ALM and Head of Wholesale Risk to initiate appropriate reviews of current exposure when such levels are exceeded.
In line with the policy of Banco Santander, S.A., the Group manages its funding and maintains adequate liquidity on a stand-alone basis. Nevertheless, the Group co-ordinates issuance plans with Banco Santander, S.A., where appropriate. While the Group's liquidity risk is consolidated and centrally controlled, liquidity risk is also measured, monitored and controlled within the specific business area or the subsidiary where it arises.
The Group holds, at all times, an unencumbered liquid asset buffer to mitigate liquidity risk. The size and composition of this buffer is determined both by internal stress tests as well as the appropriate UK Financial Services Authority liquidity regime; a surplus is maintained in both cases. Since 31 December 2008, the Group has increased its holding of Individual Liquidity Adequacy Standards (ILAS) eligible assets (as defined within the UK Financial Services Authority liquidity regime), held exclusively for liquidity purposes, by 44% to £15.3bn. This excludes other ILAS-eligible assets which are being held for trading purposes.
The Group benefitted both from the conservative proportion of retail assets that are funded in wholesale markets, as well as having entered the period of market stress in a strong liquidity position. All internal and external liquidity ratios were maintained during this period.
Within the framework of prudent funding and liquidity management, the Group manages its activities to minimise liquidity risk. The key elements of the Group's liquidity risk management are:
Short-term, tactical liquidity management:
| > | Liquid assets - a buffer of liquid assets is held to cover unexpected demands on cash in extreme but plausible stress scenarios. In the Group's case, the largest stress events include large and unexpected deposit withdrawals by retail customers and a loss of unsecured wholesale funding. |
| > | Intra-day collateral management - to ensure that adequate collateral is available to support payments in each payment or settlement system in which the Group participates, as they fall due. |
Strategic liquidity management:
| > | Structural balance sheet shape - to manage the extent of maturity transformation (investment of shorter term funding in longer term assets), the funding of non-marketable assets with wholesale funding and the extent to which non-marketable assets can be used to generate liquidity. |
| > | Wholesale funding strategy - to avoid over-reliance on any individual counterparty, currency, market or product, or group of counterparties, currencies, markets or products that may become highly correlated in a stress scenario; and to avoid excessive concentrations in the maturity of wholesale funding. |
| > | Wholesale funding capacity - to maintain and promote counterparty relationships, monitor line availability and ensure funding capacity is maintained through ongoing use of lines and markets. |
Collateral calls on derivatives positions can pose a significant liquidity risk. Collateral calls may arise at times of market stress and when asset liquidity may be tightening. The timing of the cashflows on a derivative hedging an asset may be different to the timing of the cashflows of the asset being held, even if they are similar in all other respects. Collateral calls may be triggered by a credit downgrading. The Group manages these risks by including collateral calls in stress tests on liquidity, and by maintaining a portfolio of assets held for managing liquidity risk.
The Contingency Funding Plan becomes operational when the demand for cash, whether from demands for repayment, from wholesale funding or from retail deposits, exceeds the normal liquidity management process capacity. The circumstances that cause this to happen will tend to be sudden, unexpected events that trigger demands for cash that cannot be managed within the procedures, limits and controls defined in the Liquidity Risk Manual.
To be effective, the management of liquidity in a crisis must be timely, proactive and flexible enough to respond to a variety of different circumstances. The management structure for the Contingency Funding Plan, which is structured around a small team of individuals with the authority to agree, co-ordinate and implement actions that will control a volatile, dynamic situation, has two key elements:
| > | the Treasurer, Head of ALM is responsible for the rapid assessment of the implications of a sudden, unexpected event on the day-to-day liquidity of the Group, and for the decision to activate the Contingency Funding Plan; and; |
| > | the liquidity crisis management team, under the chairmanship of the Chief Financial Officer, is the decision-making authority in the event of a liquidity crisis, and is responsible for implementing the Liquidity Contingency Plan. |
Risk limits or triggers are set for the key tactical and strategic liquidity risk drivers. These are monitored by the Treasurer, Head of ALM and Risk Division and reported monthly to the Asset & Liability Management Committee, Risk Committee and the Board.
Maturities of financial liabilities
The table below analyses the maturities of the undiscounted cash flows relating to financial liabilities of the Group based on the remaining period to the contractual maturity date at the balance sheet date. Deposits by customers are largely made up of Retail Deposits. In particular the 'Demand' grouping includes current accounts and other variable rate savings products. The 'Up to 3 months' grouping largely constitutes wholesale funding of wholesale assets of a similar maturity. There are no significant financial liabilities related to financial guarantee contracts. This table is not intended to show the liquidity of the Group.
|
| Group | |||||
| At 31 December 2009
| Demand £m | Up to 3 months £m | 3-12 months £m | 1-5 years £m | Over 5 years £m | Total £m |
| Deposits by banks | 3,716 | 1,918 | 25 | 159 | - | 5,818 |
| Deposits by customers | 105,157 | 7,169 | 18,228 | 13,476 | 654 | 144,684 |
| Trading liabilities | 2,864 | 37,554 | 3,204 | 2,430 | 443 | 46,495 |
| Financial liabilities designated at fair value | - | 1,012 | 619 | 2,318 | 487 | 4,436 |
| Debt securities in issue | - | 12,327 | 7,313 | 5,856 | 23,859 | 49,355 |
| Loan commitments | 35,723 | 11,835 | 963 | 1,734 | 2,323 | 52,578 |
| Other borrowed funds | - | 54 | 72 | 382 | 3,184 | 3,692 |
| Subordinated liabilities | - | 206 | 258 | 1,368 | 7,222 | 9,054 |
|
| 147,460 | 72,075 | 30,682 | 27,723 | 38,172 | 316,112 |
| Derivative financial instruments | - | 54 | 341 | 1,723 | 255 | 2,373 |
| Total financial liabilities | 147,460 | 72,129 | 31,023 | 29,446 | 38,427 | 318,485 |
|
| Company | |||||
| At 31 December 2009
| Demand £m | Up to 3 months £m | 3-12 months £m | 1-5 years £m | Over 5 years £m | Total £m |
| Deposits by banks | 3,333 | 24,000 | 10,564 | 73,944 | 7,567 | 119,408 |
| Deposits by customers | 77,240 | 15,933 | 12,468 | 15,302 | 44,581 | 165,524 |
| Loan commitments | 8,441 | - | 34 | - | - | 8,475 |
| Other borrowed funds | - | 40 | 30 | 161 | 678 | 909 |
| Subordinated liabilities | - | 158 | 260 | 1,379 | 7,316 | 9,113 |
|
| 89,014 | 40,131 | 23,356 | 90,786 | 60,142 | 303,429 |
| Derivative financial instruments | - | - | - | - | 437 | 437 |
| Total financial liabilities | 89,014 | 40,131 | 23,356 | 90,786 | 60,579 | 303,866 |
|
| Group | |||||
| At 31 December 2008
|
Demand £m | Up to 3 months £m | 3-12 months £m | 1-5 years £m | Over 5 years £m | Total £m |
| Deposits by banks | 2,375 | 8,537 | 691 | 3,123 | - | 14,726 |
| Deposits by customers | 102,170 | 9,430 | 15,294 | 3,519 | 834 | 131,247 |
| Trading liabilities | 5,071 | 31,253 | 1,817 | 1,667 | 1,554 | 41,362 |
| Financial liabilities designated at fair value | - | 1,816 | 1,330 | 1,858 | 1,230 | 6,234 |
| Loan commitments | 40,082 | 689 | 337 | 836 | 792 | 42,736 |
| Debt securities in issue | - | 13,350 | 9,650 | 14,254 | 55,282 | 92,536 |
| Other borrowed funds | - | 60 | 93 | 493 | 4,110 | 4,756 |
| Subordinated liabilities | - | 234 | 308 | 2,428 | 8,322 | 11,292 |
|
| 149,698 | 65,369 | 29,520 | 28,178 | 72,124 | 344,889 |
| Derivative financial instruments | 80 | 319 | 412 | 746 | 1,521 | 3,078 |
| Total financial liabilities | 149,778 | 65,688 | 29,932 | 28,924 | 73,645 | 347,967 |
|
| Company | |||||
| At 31 December 2008
|
Demand £m | Up to 3 months £m | 3-12 months £m | 1-5 years £m | Over 5 years £m | Total £m |
| Deposits by banks | 2,907 | 18,354 | 19,638 | 58,758 | 36,477 | 136,134 |
| Deposits by customers | 67,856 | 14,944 | 14,516 | 14,001 | 59,490 | 170,807 |
| Trading liabilities | 4 | 22 | 748 | - | - | 774 |
| Loan commitments | 9,732 | - | 35 | - | - | 9,767 |
| Other borrowed funds | - | 45 | 46 | 245 | 1,247 | 1,583 |
| Subordinated liabilities | - | 232 | 288 | 2,316 | 8,651 | 11,487 |
|
| 80,499 | 33,597 | 35,271 | 75,320 | 105,865 | 330,552 |
| Derivative financial instruments | 56 | - | - | 660 | 1,678 | 2,394 |
| Total financial liabilities | 80,555 | 33,597 | 35,271 | 75,980 | 107,543 | 332,946 |
As the above table is based on contractual maturities, no account is taken of call features related to subordinated liabilities. The repayment terms of the debt securities may be accelerated in line with the covenants contained within the individual loan agreements, as described in Note 33 to the Consolidated Financial Statements.
In addition, no account is taken of the possible early repayment of the Group's mortgage-backed non-recourse finance which is redeemed by the Group as funds become available from redemptions of the residential mortgages. The Group has no control over the timing and amount of redemptions of residential mortgages.
The maturity analyses above for derivative financial liabilities include the remaining contractual maturities for those derivative financial liabilities for which contractual maturities are essential for an understanding of the timing of the cash flows. These consist of interest rate swaps and cross-currency swaps which are used to hedge the Group's exposure to interest rates and exchange rates, and all loan commitments.
Risk Management in Retail Banking
Credit risk in Retail Banking
Credit risk is the risk that counterparties will not meet their financial obligations, which may result in Retail Banking losing the principal amount lent, the interest accrued and any unrealised gains (less any security held). Credit risk occurs mainly in Retail Banking's loan and investment assets (including residential mortgages and secured lending, personal and business banking). Retail Banking actively manages and controls credit risk.
Managing credit risk
The Board has approved a set of risk appetite limits to cover credit risk arising in Retail Banking. The management of Retail Banking credit risk is aligned with the processes and procedures used within Santander UK's Retail Banking and is managed on a Group basis. Within these limits, credit mandates and policies are approved with respect to products sold by the Santander UK group.
Residential mortgages and secured lending
Retail Banking lends on many types of property but only after a credit risk assessment of the borrower, including affordability modelling and an assessment of the property is undertaken. The systems used to manage and monitor the quality of the mortgage assets are reviewed in accordance with policy to ensure they perform as expected. Residential lending is subject to lending policy and lending authority levels, which are used to structure lending decisions to the same standard across the retail network, a process further improved by mortgage credit scoring, underwriter accreditation and regular compliance reviews. Details concerning the prospective borrower and the mortgage are subject to a criteria-based decision-making process. Criteria for assessment include credit references, loan-to-value ratio, borrower status and the mortgage credit score.
All mortgages provided by Retail Banking are secured on UK properties. All properties must be permanent in construction; mobile homes are not generally acceptable. The Group can provide a loan for the purchase of properties outside the UK where the property is a second home and the loan is secured on the main property located in the UK.
Prior to granting any first mortgage loan on a property, the Group has the property valued by an approved and qualified surveyor. The valuation is based on set Group guidelines, which build upon the Royal Institution of Chartered Surveyors guidance on valuation methods. In the case of re-mortgages, where the loan-to-value ('LTV') is 75% or lower, and the risk judged by the size of the advance requested and the credit score of the applicant is considered medium or low, and an accurate, reputable automated valuation is available, this may substitute for a surveyor's valuation.
For existing mortgages, the current values of the properties on which individual mortgages are secured are estimated quarterly. For each individual property, details such as address, type of property and number of bedrooms are supplied to an independent agency that estimates current property valuations using information from recent property transactions and valuations.
Until 2008, for additional lending where a first-charge mortgage is already held with the Group and the loan-to-value is less than 90%, the original property value used to be subject to indexation and no further survey carried out. During 2008, this practice was phased-out, with all additional loans requiring an automated valuation or surveyor's valuation. The use of an automated valuation depends upon the availability of a reliable automated valuation, and the level of credit risk posed by the proposed loan.
Higher risk loans
The Group is principally a retail prime lender and does not originate second charge mortgages. A £37m portfolio of second charge mortgages was acquired as a result of the transfer of Alliance & Leicester plc to the Company as described in Note 47 to the Consolidated Financial Statements. This portfolio is in run-down.
Certain mortgage products may be considered higher risk. Operating as a prime lender in the UK mortgage market, the Group does not have any material sub-portfolio demonstrating very poor performance. The portfolio's arrears performance has remained relatively stable and favourable to industry benchmarks. Arrears rates and loss rates remain very low. Nonetheless, there are some mortgage types that present higher risks than others. These products consist of:
Interest-only loans - Interest-only mortgages require monthly interest payments and the repayment of principal at maturity. This can be arranged via investment products including Individual Savings Accounts and pension policies, or by the sale of the property. It is the customer's responsibility to ensure that they have sufficient funds to repay the principal in full at maturity.
Interest-only mortgages are well-established and common in the UK market. Lending policies to mitigate the risks inferred by this repayment structure are in place and mature. While the risks are higher than capital repayment mortgages, they are only modestly so. The performance of this significant sub-portfolio has been quite acceptable and stable.
Flexible loans - Flexible mortgages allow the customers to vary their monthly payment, or take payment holidays, within predetermined criteria and/or up to an agreed credit limit. Customers are also permitted to draw down additional funds at any time up to the limit or redraw amounts that have been previously overpaid.
Loans with original LTV >100% - Progressively stricter lending criteria are applied to mortgages above a loan-to-value of 75%. Historically, in limited circumstances, customers were able to borrow more than 100% of the value of the property against which the loan was secured, within certain limits. However, in 2009 no loans were made with a loan-to-value of more than 100% (2008 and 2007: less than 0.1%). In 2009, less than 0.1% of new secured loan advances were made with a loan-to-value of more than 90% (2008: 2%, 2007: 3%).
Loans with higher loan-to-value ratios carry a higher risk due to the increased likelihood that liquidation of the collateral will not yield sufficient funds to cover the loan advanced, arrears and the costs of liquidation. These loans generally attract higher margins as a result.
Sub-prime lending - The Group has no appetite or product offering for sub-prime business. The Group's credit policy explicitly prohibits such lending and is designed to ensure that any business written is responsible, affordable (both initially and an on-going basis) and of a good credit quality.
Mortgage credit quality and credit risk mitigation(1)
|
| 2009 | 2008 | 2007 |
| Loan-to-value analysis: |
|
|
|
| New business |
|
|
|
| < 75% | 83% | 62% | 52% |
| 75% - 90% | 17% | 36% | 45% |
| > 90% | - | 2% | 3% |
|
| 100% | 100% | 100% |
| Average loan-to-value of new business (at inception) | 61% | 65% | 64% |
| Stock |
|
|
|
| < 75% | 61% | 67% | 76% |
| 75% - 90% | 22% | 22% | 20% |
| 90% - 100% | 10% | 7% | 4% |
| >100% i.e. negative equity | 7% | 4% | - |
|
| 100% | 100% | 100% |
|
|
|
|
|
| Average loan-to-value of stock | 52% | 51% | 46% |
|
|
|
|
|
| Borrower profile: |
|
|
|
| New business |
|
|
|
| First-time buyers | 17% | 11% | 13% |
| Home movers | 37% | 25% | 37% |
| Remortgagers | 46% | 64% | 50% |
|
| 100% | 100% | 100% |
|
|
|
|
|
| Of which:(2) |
|
|
|
| - Interest-only loans | 36% | 53% | 53% |
| - Flexi loans | 9% | 14% | 8% |
| - Loans with original LTV >100% | - | - | - |
|
|
|
|
|
| Stock |
|
|
|
| First-time buyers | 17% | 16% | 15% |
| Home movers | 38% | 39% | 42% |
| Remortgagers | 45% | 45% | 43% |
|
| 100% | 100% | 100% |
|
|
|
|
|
| Of which: (2) |
|
|
|
| - Interest-only loans | 43% | 43% | 41% |
| - Flexi loans | 18% | 18% | 14% |
| - Loans with original LTV >100% | - | - | 1% |
|
|
|
|
|
| Average earnings multiple (at inception) | 2.8 | 3.0 | 3.0 |
(1) Excludes any fees added to the loan, and only includes the drawn loan amount, not drawdown limits.
(2) Where a loan exhibits more than one of the "higher risk" criteria, it is included in all the applicable categories.
Loan-to-value analysis
The residential mortgage portfolio showed an increasing trend of payment arrears with the deterioration in economic conditions, which has stabilised in the second half of the year. During 2009, LTV on new business completions declined during the first half of the year. However, this slightly increased during the second half of the year, with the fourth quarter 2009 LTV at 64% (Q3 09: 62%, Q4 08: 60%). The indexed stock LTV increased to 52% from 2008 (Q3 09: 52%, Q4 08: 50%) due to net lending mix, and mitigated by rising house prices evidenced by portfolio revaluation towards the end of the year. Although credit criteria continued to be tightened for higher risk segments, targeted policy relaxation and competitive pricing at higher LTV began to result in a slight uplift in new business average LTV in 2009.
| > | Arrears more than 90 days past due have increased from 0.93% in December 2008 to 1.37% at the end of 2009. |
| > | Monthly mortgage completions in excess of 75% LTV fell from 14% in December 2008 to 23% in December 2009. |
7% (2008: 4%) of the retail mortgage portfolio was over 100% LTV, based on the re-evaluation performed in December 2009. The increase was due to the general decline in property prices during the year. However, the impact was partly mitigated by the reduced LTV profile of new business and increased control of the retention process.
Borrower profile
During 2009, the proportion of new business from remortgages decreased. This trend was seen across the UK market as lower interest rates and stricter lending criteria reduced the incentives for customers to remortgage to another lender.
Mortgage arrears and repossessions
The Collections & Recoveries Department is responsible for all debt management initiatives on the secured portfolio for Retail Banking. Debt management strategies, which include negotiating repayment arrangements and concessions and debt counselling, can start as early as the day after a repayment is past due and will continue until legal action. Different collection strategies are applied to different segments of the portfolio subject to the perceived levels of risk for example, loan-to-value, collections score and account characteristics.
If the agreed repayment arrangement is not maintained, legal proceedings may be taken and may result in the property being taken into possession. The Group sells the repossessed property at market price and uses the sale proceeds, net of costs, to pay off the outstanding value of the mortgage. The stock of repossessed properties held by the Group varies according to the number of new possessions and the buoyancy of the housing market.
A programme of forbearance designed to enable borrowers experiencing short to medium term repayment difficulties to remain in their home has been in place during 2009. On average, each month less than 1% of accounts in arrears either have their term extended or convert to interest only. Levels of adherence to revised payment terms are currently high at approximately 70%.
The following tables set forth information on UK residential mortgage arrears at 31 December 2009, 2008, and 2007 for Retail Banking compared to the industry average as provided by the Council of Mortgage Lenders ('CML').
|
| Group(1) | CML(2) (unaudited) | ||||
|
| Higher risk loans(3) | Remaining loan portfolio |
|
| ||
| Mortgage arrears | Interest-only loans | Flexible loans | Loans with original LTV > 100% | Total(3) |
| |
|
| (Percentage of total mortgage loans by number) | |||||
| 31 to 60 days in arrears: |
|
|
|
|
|
|
| 31 December 2007 | 0.61 | 0.13 | - | 0.80 | 1.48 | - |
| 31 December 2008 | 0.57 | 0.11 | - | 0.56 | 1.19 | - |
| 31 December 2009 | 0.45 | 0.07 | 0.01 | 0.51 | 1.00 | - |
| 61 to 90 days in arrears: |
|
|
|
|
|
|
| 31 December 2007 | 0.25 | 0.06 | - | 0.31 | 0.59 | - |
| 31 December 2008 | 0.32 | 0.06 | - | 0.30 | 0.65 | - |
| 31 December 2009 | 0.27 | 0.04 | - | 0.29 | 0.58 | - |
| 3 to 5 months in arrears: |
|
|
|
|
|
|
| 31 December 2007 | 0.21 | 0.04 | - | 0.24 | 0.49 | 0.62 |
| 31 December 2008 | 0.31 | 0.06 | - | 0.28 | 0.62 | 1.01 |
| 31 December 2009 | 0.41 | 0.05 | 0.01 | 0.36 | 0.80 | 0.97 |
| 6 to 11 months in arrears: |
|
|
|
|
|
|
| 31 December 2007 | 0.08 | 0.02 | - | 0.08 | 0.17 | 0.35 |
| 31 December 2008 | 0.13 | 0.03 | - | 0.11 | 0.26 | 0.62 |
| 31 December 2009 | 0.22 | 0.04 | - | 0.16 | 0.40 | 0.81 |
| 12 months or more in arrears: |
|
|
|
|
|
|
| 31 December 2007 | 0.02 | - | - | 0.01 | 0.03 | 0.13 |
| 31 December 2008 | 0.02 | - | - | 0.02 | 0.05 | 0.25 |
| 31 December 2009 | 0.09 | 0.03 | - | 0.07 | 0.17 | 0.60 |
(1) Group data is not readily available for arrears less than 31 days.
(2) Council of Mortgage Lenders data is not available for arrears less than 3 months.
(3) Where a loan exhibits more than one of the "higher risk" criteria, it is included in all the applicable categories. As a result, the total of the mortgage arrears for "higher risk" loans and remaining loan portfolio will not agree to the total mortgage arrears percentages.
The following tables set forth information on UK properties in possession, at 31 December 2009, 2008, and 2007 for Retail Banking compared to the industry average as provided by the Council of Mortgage Lenders, as well as the carrying amount of assets obtained as collateral.
|
| Group | CML (unaudited) |
| Properties in possession | (Percentage of total mortgage loans by number) | |
| 31 December 2007 | 0.05 | 0.10 |
| 31 December 2008 | 0.06 | 0.21 |
| 31 December 2009 | 0.05 | 0.14 |
| Group | |
| Carrying amount of assets obtained as collateral | £m |
| 31 December 2007 | 64 |
| 31 December 2008 | 130 |
| 31 December 2009 | 110 |
The table below analyses Residential mortgages thathave been restructured or renegotiated by capitalising the arrears where customers in arrears have maintained an agreed monthly repayment for an agreed period.
|
| 2009 | 2009 | 2008 | 2008 |
|
| £m | % | £m | % |
| Mortgages restructured during the year (1) | 325 | 100 | 348 | 100 |
| Of which(3): |
|
|
|
|
| - Interest only loans | 157 | 48 | 156 | 45 |
| - Flexi loans | 15 | 5 | 24 | 7 |
| - Loans with original LTV >100% | 1 | - | 1 | - |
(1) All mortgages originated by the Group are first charge.
(2) Mortgages are included within the year that they were restructured.
(3) Where a loan exhibits more than one of the "higher risk" criteria, it is included in all the applicable categories.
Banking and Consumer Credit. Retail Banking uses systems and processes to manage the risks involved in providing unsecured personal loans and overdraft lending or in granting bank account facilities. These include the use of application and behavioural scoring systems to assist in the granting of credit facilities as well as regular monitoring of scorecard performance and the quality of the unsecured lending portfolios. Behavioural scoring examines the lending relationships that a customer has with Retail Banking and how the customer uses their bank account. This information generates a score that is used to assist in deciding the level of risk (in terms of overdraft facility amount, card facilities granted and preferred unsecured personal loan value) for each customer that Retail Banking is willing to accept. Individual customer scores are normally updated on a monthly basis. Retail Banking has successfully extended the use of behavioural scoring into other areas of the business, including the refinement of debt management strategies and bank account transaction processing.
Personal Financial Services banking and unsecured personal loan arrears
|
| 2009 £m | 2008 £m | 2007 £m |
| Total banking and unsecured personal loan arrears(1,2) | 257 | 371 | 134 |
| Total banking and unsecured personal loan asset | 4,830 | 6,225 | 3,119 |
| Banking and unsecured personal loan arrears as a % of asset | 5.31% | 5.96% | 4.30% |
(1) From 2008, banking arrears is defined as customers that had been in arrears for greater than 90 days. In prior years, it was defined as customers whose borrowings exceed their overdraft by over £100. If the prior year definition were applied to 2008 data, the total arrears would increase by £53m.
(2) Unsecured personal loan and credit card arrears are defined as the balances of accounts that are three or more months in arrears (> 4 instalments).
Provisions on loans and advances to customers
The charge for provisions on loans and advances to customers adjusts the balance sheet provisions to the level that management deems adequate to absorb actual and inherent losses in Retail Banking's loan portfolio from homogeneous portfolios of assets and individually identified loans. A proportion of Retail Banking's provisions on loans and advances to customers relate to loans and advances secured either by a first charge on residential property in the UK, or by other appropriate security depending on the nature of the loan.
The Group's provisioning policy is as follows. Further information is set out in the Accounting Policies in the Consolidated Financial Statements:
| > | Observed provision - an observed provision is established for all past due loans after a specified period of repayment default where it is likely that some of the capital will not be repaid or recovered through enforcement of any applicable security. The length of the default period depends on the nature of the advance and is generally no more than three months. Once a loan misses a payment (breach of contractual terms) an assessment of the likelihood of collecting the principal and overdue payments is made. This assessment is generally made using statistical techniques developed on previous experience and on projections of current market conditions to the time the loss is expected to crystallise. These techniques estimate the propensity of loans to go to write-off and, as a separate exercise, the loss incurred on written off debt is monitored. For advances secured on residential property, the propensity of loans to reach repossession is determined with repossessed properties assessed on an individual basis through the use of an external valuation, anticipated disposal costs and the current exposure. |
| > | Incurred but not yet observed provision - an incurred but not yet observed provision is made against loans, which have not missed a payment but are known from past experience to have deteriorated since the initial decision to lend was made. Based on historical evidence, the number of accounts likely to default in the future as a result of events present at the balance sheet date are identified through use of statistical techniques. Further detailed examination is performed on the losses that emerge over a defined period of time after the reporting date called the emergence period. This period is determined to ensure that only those accounts which have credit deterioration at the reporting date are captured and excludes accounts which will suffer credit deterioration after the reporting period. The emergence period is two to three months for unsecured lending and 12 months for secured lending. The provision methodology outlined for observed provisions is then applied to accounts identified as impaired in the performing portfolios. |
| > | Amounts written off - unsecured loans are written off when all internal avenues of collecting the debt have failed and the debt is passed onto external collection agencies. On secured loans, the write-off takes place on ultimate realisation of collateral value, or from claiming on any mortgage indemnity guarantee or other insurance. All write-offs are on a case by case basis, taking account of the exposure at the date of write-off, after accounting for the value from any collateral or insurance held against the loan. The write-off policy is regularly reviewed. |
Security is realised in accordance with the Group's internal debt management programme. Contact is made with customers with the aim to achieve a realistic and sustainable repayment arrangement. Litigation and/or enforcement of security is usually carried out only when the steps described above have been undertaken without success. As a result of the write-off policy, the provisions will be made significantly in advance of the related write-off on all products. The exception to this rule is the discovery of fraud, where the exposure is written off once full investigations have been completed and the probability of recovery is minimal. The time span between the discovery and write-off will be short and may not result in a provision being raised.
Retail Banking analysis of provisions on loans and advances to customers
An analysis of the Retail Banking provisions on loans and advances to customers is presented below.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| Observed provisions |
|
|
|
|
|
| Advances secured on residential properties - UK | 313 | 175 | 74 | 45 | 21 |
| Finance leases - UK | - | - | - | 1 | 3 |
| Other secured advances - UK | 50 | 36 | 32 | 73 | 123 |
| Unsecured personal advances - UK | 341 | 227 | 250 | 243 | 158 |
| Total observed provisions | 704 | 438 | 356 | 362 | 305 |
| Incurred but not yet observed provisions |
|
|
|
|
|
| Advances secured on residential properties - UK | 171 | 184 | 102 | 60 | 35 |
| Finance leases - UK | - | - | - | - | - |
| Other secured advances - UK | 12 | 11 | 8 | 3 | - |
| Unsecured personal advances - UK | 53 | 65 | 85 | 111 | 54 |
| Total incurred but not yet observed provisions | 236 | 260 | 195 | 174 | 89 |
| Total provisions | 940 | 698 | 551 | 536 | 394 |
Retail Banking movements in provisions for impairment losses on loans and advances
An analysis of movements in the Retail Banking provisions for impairment losses on loans and advances is presented below.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| Provisions at 31 December | 698 | 551 | 536 | 394 | 467 |
| IFRS reclassifications | - | - | - | - | (40) |
| Provisions at 1 January | 698 | 551 | 536 | 394 | 427 |
| Amounts written off |
|
|
|
|
|
| Advances secured on residential properties - UK | (84) | (32) | (9) | (11) | (5) |
| Other secured advances - UK | (17) | (9) | (25) | (27) | (36) |
| Unsecured personal advances - UK | (399) | (262) | (339) | (205) | (247) |
| Total amounts written off | (500) | (303) | (373) | (243) | (288) |
| Observed provisions charged against/(released into) profit |
|
|
|
|
|
| Advances secured on residential properties - UK | 223 | 132 | 38 | 35 | 12 |
| Other secured advances - UK | 30 | 14 | (17) | (25) | 11 |
| Unsecured personal advances - UK | 513 | 239 | 346 | 289 | 221 |
|
| 766 | 385 | 367 | 299 | 244 |
| Advances secured on residential properties - non-UK | - | - | - | - | (3) |
| Total observed provisions charged against profit | 766 | 385 | 367 | 299 | 241 |
| Incurred but not yet observed provisions (released into)/charged against profit | (24) | (17) | 21 | 86 | 14 |
| Total provisions charged against profit (including discontinued operations) | 742 | 368 | 388 | 385 | 255 |
| Acquired through business combinations | - | 82 | - | - | - |
| Provisions at the end of the year | 940 | 698 | 551 | 536 | 394 |
IFRS reclassifications related primarily to provisions on certain corporate loans in businesses and portfolios that were inconsistent with the Group's strategy, and were sold during 2005 or transferred to Corporate Banking.
Retail Banking recoveries
An analysis of the Retail Banking recoveries is presented below.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| Advances secured on residential properties - UK | 1 | 1 | 2 | 2 | 3 |
| Other secured advances - UK | - | 12 | 6 | 7 | 7 |
| Unsecured personal advances - UK | 30 | 33 | 36 | 32 | 27 |
| Total amount recovered | 31 | 46 | 44 | 41 | 37 |
Retail Banking non-performing loans and advances (1)
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| Retail Banking non-performing loans and advances that are impaired(2) | 1,343 | 745 | 296 | 375 | 314 |
| Retail Banking non-performing loans and advances that are not impaired | 1,561 | 1,236 | 596 | 451 | 568 |
| Total non-performing loans and advances(3) | 2,904 | 1,981 | 892 | 826 | 882 |
|
| % | % | % | % | % |
| Non-performing loans and advances as a % of loans and advances to customers(4) | 1.67 | 1.19 | 0.80 | 0.80 | 0.92 |
| Provision as a percentage of total non-performing loans and advances | 32.37 | 35.24 | 61.77 | 64.89 | 44.67 |
(1) Loans and advances are classified as non-performing typically when the counterparty fails to make payments when contractually due for three months or longer
(2) Non-performing loans against which a provision for impairment losses has been established.
(3) All non-performing loans are UK and continue accruing interest
(4) Loans and advances to customers exclude trading assets and finance leases.
Retail Banking non-performing loans and advances by higher risk loan type(1) (2)
|
| 2009 £m | 2008 £m | 2007 £m |
| Total non-performing loans and advances | 2,904 | 1,981 | 892 |
| Of which: |
|
|
|
| - Interest only loans | 1,665 | 1,001 | 375 |
| - Flexi loans | 251 | 218 | 76 |
| - Loans with original LTV > 100% | 25 | 11 | 1 |
(1) No reliable data is available prior to 2007.
(2) Where a loan exhibits more than one of the "higher risk" criteria, it is included in all the applicable categories.
In 2009, non-performing loans and advances as a percentage of loans and advances to customers increased from 1.19% to 1.67%. This primarily reflects the impact of the continued market deterioration on the performance of the residential mortgage portfolio. This has also further increased the proportion of non-performing loans secured against residential property in the non-performing loan balance, which has in turn further reduced the overall provision coverage as the distribution shifts towards mortgages that require a lower level of coverage due to inherent securities held against the non-performing loans.
In 2008, non-performing loans and advances as a percentage of loans and advances to customers increased from 0.80% to 1.19%. This primarily reflects the impact of the deteriorating market environment on the performance of the residential mortgage portfolio. This has also increased the proportion of non-performing loans secured against residential property in the non-performing loan balance, which has in turn further reduced the average provision coverage required in respect of the eventual credit losses that are expected to emerge from these loans.
In 2007, non-performing loans and advances as a percentage of loans and advances to customers remained unchanged at 0.80%. This is a reflection of the continued strength in the credit quality of the Group's loans. The overall provision coverage ratio decreased from 64.89% to 61.77% due to the change in the proportions of mortgages and unsecured loans in the non-performing loan balance, where a greater proportion represented mortgages (which have a lower provision as a percentage of the asset).
In 2006, non-performing loans and advances as a percentage of loans and advances to customers decreased from 0.92% to 0.80%. This reflected the continuing strength of the credit quality of the Group's loans, particularly on the secured mortgages. Provisions as a percentage of total non-performing loans and advances increased from 44.67% to 64.89% in 2006, which reflected the change in macro-economic factors such as interest rate rises.
Interest income recognised on impaired loans amounted to £101m (2008: £51m, 2007: £36m).
Retail Banking restructured loans
Loans have been restructured or renegotiated by capitalising the arrears where customers in arrears have maintained an agreed monthly repayment for a specified period. The value of capitalised arrears on these loans during 2009 was £6m (2008: £7m).
The table below shows the Group's loans not included in non-performing loans that have been restructured or renegotiated by capitalising the arrears.
|
| 2009 £m | 2008 £m |
| Restructured loans | 377 | 371 |
Santander Business Banking (formerly known as Abbey Business)
Santander Business Banking provides a range of products to assist with the finance requirements of small businesses, including overdrafts and loans. Risk management policies are specific to and reflect the risks inherent in each product set. Approval processes for credit risk include the use of judgement, assisted by the use of probability of default and loss given default data, and the use of credit scoring. Business Banking operates within policies and authority levels approved by the Chief Risk Officer. Business Banking has a dedicated risk team, reflecting the desire for risk control to be close to the business needs and risks. Business Banking provides mortgages to borrowers on a range of mainly non-residential property. Agreed credit assessment criteria include serviceability ratios, loan-to-value ratios, and quality of tenants, with stress testing against interest rate movements. Concentration limits per borrower and business sector are also employed to ensure a balanced loan portfolio. The management of defaulting accounts and the repossession and sale of properties is handled by a dedicated function within the risk operation.
The strategic plan to extend the customer proposition into the SME market is being supported by a workstream which aims to manage all risks within this market and throughout the risk cycle. The development of the risk framework is overseen by the Chief Risk Officer.
Market risk in Retail Banking
Market risks are originated in Retail Banking only as a by-product of writing customer business and are transferred out of Retail Banking insofar as possible. Only prepayment and launch risk exposures are retained within Retail Banking, as these behavioural risks are influenced by internal marketing and pricing activity and are managed by Asset Business and Customer Funds Committees. Other market risks are transferred to the Asset and Liability Management ('ALM') operation within Group Infrastructure, where they can be managed in conjunction with exposures arising from the funding, liquidity or capital management activities of ALM. Funds received with respect to deposits taken are lent on to Group Infrastructure on matching terms as regards interest rate re-pricing and maturity. Similarly, loans are funded through matching borrowings from Group Infrastructure. Market risks arising from structured products, including exposure to changes in the levels of equity markets, are hedged within Global Banking & Markets.
Risk Management in Corporate Banking
Credit risk in Corporate Banking
Credit risk is the risk that counterparties will not meet their financial obligations resulting in Corporate Banking losing the monies lent, including any interest accrued, or having to close out transactions prematurely, which may result in losses even after realising the value of any collateral held. Credit risk arises by Corporate Banking making loans, investing in other financial instruments or entering into financing transactions or derivative contracts. Corporate Banking actively manages and controls credit risk.
Managing credit risk
The Board has approved a set of risk appetite limits to cover different types of risk, including credit risk, arising in Corporate Banking. The Group's credit risk appetite is measured and controlled by a maximum Economic Capital value, which is defined as the maximum level of unexpected loss that the Group is willing to sustain over a one-year period. Within these limits, credit mandates and policies are approved to cover detailed industry, sector and product limits. All transactions falling within these mandates and policies are accommodated under credit limits approved by the appropriate credit authority. Specific approval is usually required by the Credit Approval Committee (a specific committee established under the authority of the Chief Executive) for any transaction that falls outside the mandates.
Analysis of credit exposures and credit risk trends are provided each month to the Corporate and Commercial Banking Risk Oversight Forum, with key issues escalated to the Risk Committee as required. Large Exposures (as defined by the UK Financial Services Authority) are reported quarterly to the Risk Committee and the UK Financial Services Authority.
Credit risk on derivative instruments is calculated using the potential future mark-to-market exposure of the instruments at a 97.5% statistical confidence level and adding this value to the current value. The resulting "loan equivalent" or credit risk is then included against credit limits, along with other non-derivative exposures. In addition, there is a policy framework to enable the collateralisation of derivative instruments including swaps. If collateral is deemed necessary to reduce credit risk, any unsecured risk threshold, and the nature of any collateral to be accepted, is determined by management's credit evaluation of the counterparty.
Corporate Banking has been targeted as an area where the Group aims to achieve controlled growth, mainly through the expansion of a regional network supporting lending to the Real Estate, Corporate (including SME), Education and Health sectors. Focus is being given to the control of credit risks within this expansion with, amongst other things, the development and implementation of robust Credit Policy Mandates and models covering both risk appetite and ratings.
Corporate Banking loans
|
| Gross loans & advances £m | Impairment allowance £m | Loans & advances net of impairment allowance £m | Impaired loans £m | Impaired loans as % of gross loans & advances % | Impairment charge for the period £m | % Collateral held against impaired loans % |
| Group:(1) |
|
|
|
|
|
|
|
| - 2009 | 20,122 | (359) | 19,763 | 618 | 3.07 | 60 | 47 |
| - 2008 | 19,888 | (302) | 19,586 | 882 | 4.43 | 26 | 43 |
| Company: |
|
|
|
|
|
|
|
| - 2009 | - | - | - | - | - | - | - |
| - 2008 | 24 | - | 24 | - | - | - | - |
(1) Excludes social housing bonds and operating lease assets
Corporate Banking committed facilities exposure by credit rating of the issuer or counterparty(1)
|
2009 | Corporate £m | Real Estate £m | Social housing £m | Non-growth £m | Total £m |
| AAA | - | 60 | - | - | 60 |
| AA | 206 | - | 997 | 310 | 1,513 |
| A | 799 | 463 | 5,484 | 639 | 7,385 |
| BBB | 2,688 | 1,585 | 1,791 | 3,027 | 9,091 |
| BB | 1,462 | 2,043 | 100 | 1,726 | 5,331 |
| B | 124 | 180 | - | 204 | 508 |
| CCC | 16 | 5 | - | 66 | 87 |
| D | 111 | 95 | - | 199 | 405 |
| Other(2) | 921 | - | - | - | 921 |
| Total | 6,327 | 4,431 | 8,372 | 6,171 | 22,301 |
| 2008 | Corporate £m | Real Estate £m | Social housing £m | Non-growth £m | Total £m |
| AAA | 30 | 95 | - | - | 125 |
| AA | 182 | - | 1,008 | 939 | 2,129 |
| A | 247 | 270 | 5,222 | 711 | 6,450 |
| BBB | 2,372 | 1,792 | 1,821 | 3,488 | 9,473 |
| BB | 1,309 | 1,724 | 100 | 1,895 | 5,028 |
| B | 176 | - | 9 | 221 | 406 |
| CCC | 1 | - | - | 136 | 137 |
| D | 197 | 49 | - | 322 | 568 |
| Other(2) | 1,088 | - | - | - | 1,088 |
| Total | 5,601 | 3,931 | 8,160 | 7,712 | 25,404 |
(1) All exposures are internally rated. External ratings are taken into consideration in the rating process, where available.
(2) Individual exposures of £1m or less.
Corporate Banking committed facilities exposure by geographical area
|
2009 | Corporate £m | Real Estate £m | Social Housing £m | Non-growth £m | Total £m |
| United Kingdom | 6,019 | 4,202 | 8,372 | 3,353 | 21,946 |
| US | - | 65 | - | 511 | 576 |
| Rest of the world | 308 | 164 | - | 2,307 | 2,779 |
| Total | 6,327 | 4,431 | 8,372 | 6,171 | 25,301 |
|
2008 | Corporate £m | Real Estate £m | Social Housing £m | Non-growth £m | Total £m |
| United Kingdom | 5,408 | 3,598 | 8,160 | 3,576 | 20,742 |
| US | - | 72 | - | 617 | 689 |
| Rest of the world | 193 | 261 | - | 3,519 | 3,973 |
| Total | 5,601 | 3,931 | 8,160 | 7,712 | 25,404 |
The increase in Corporate and Real Estate exposures in 2009 arose from the continued development of a UK corporate banking franchise and was offset by a reduction in the non growth portfolios, both in the UK and overseas. There are no significant exposures to Dubai, Portugal, Greece, Spain, Argentina and Iceland within the Corporate Banking book.
Corporate Banking - Watchlist
The entire corporate risk portfolio of new, emerging and serious circumstances relating to the portfolio (i.e. those loans on a 'Watchlist') and those in Collections are managed at the FEVE Corporate Risk forum. FEVE is a Spanish acronym for "Firmas En Vigilancia Especial", which means businesses under special watch.
A summary of the Watchlist cases at 31 December 2009 by portfolio and assessment of risk is as follows:
| 2009 | Portfolio £m | Watch £m | Watch % | Workout £m | Workout % | NPL £m | NPL % |
| Corporate | 5,895 | 377 | 6 | 204 | 3 | 135 | 2 |
| Real Estate | 4,431 | 672 | 15 | 331 | 7 | 206 | 5 |
| Non-growth | 6,172 | 1,232 | 20 | 502 | 8 | 368 | 6 |
| Total | 16,498 | 2,281 | 14 | 1,037 | 6 | 709 | 4 |
Exposures are classified as "workout" if they are being actively managed by the Risk Division.
Corporate Banking arrears
|
| 2009 £m | 2008 £m | 2007 £m |
| Total Corporate lending arrears | 533 | 143 | - |
| Total Corporate lending assets | 20,707 | 20,516 | 7,003 |
| Corporate lending arrears as a % of assets | 2.57% | 0.70% | - |
Corporate Banking analysis of provisions on loans and advances to customers
An analysis of the Corporate Banking provisions on loans and advances to customers is presented below.
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| Observed provisions |
|
|
|
|
|
| Corporate advances - UK | 185 | 13 | - | - | - |
| Finance leases - UK | 1 | - |
|
|
|
| Total observed provisions | 186 | 13 | - | - | - |
| Incurred but not yet observed provisions |
|
|
|
|
|
| Corporate advances - UK | 172 | 289 | - | - | - |
| Finance leases - UK | 1 | 1 |
|
|
|
| Total incurred but not yet observed provisions | 173 | 290 | - | - | - |
| Total provisions | 359 | 303 | - | - | - |
Corporate Banking movements in provisions for impairment losses on loans and advances:
|
| 2009 £m | 2008 £m | 2007 £m | 2006 £m | 2005 £m |
| Provisions at the start of the year | 303 | - | - | - | - |
| Amounts written off: |
|
|
|
|
|
| - Corporate Loans | - | - | - | - | - |
| - Finance Leases | (4) | - | - | - | - |
| Total amounts written off | (4) | - | - | - | - |
| Observed provisions charged against profit: |
|
|
|
|
|
| - Corporate Loans | 172 | 13 | - | - | - |
| - Finance Leases | 5 | - | - | - | - |
| Total observed provisions charged against profit | 177 | 13 | - | - | - |
| Incurred but not yet observed provisions charged against profit | (117) | 13 | - | - | - |
| Total provisions charged against profit | 60 | 26 | - | - | - |
| Acquired through business combinations | - | 277 |
|
|
|
| Provisions at the end of the year | 359 | 303 | - | - | - |
Corporate Banking recoveries
|
| 2009 £m | 2008 £m | 2007 £m |
| Secured | 1 | - | - |
| Unsecured | 23 | - | - |
| Total amount recovered | 24 | - | - |
Corporate Banking non-performing loans and advances(1)
|
| 2009 £m | 2008 £m | 2007 £m |
| Non-performing loans and advances that are impaired | 490 | 397 | - |
| Non-performing loans and advances that are not impaired | 219 | - | - |
| Total non-performing loans and advances(2) | 709 | 397 | - |
|
|
|
|
|
| Non-performing loans and advances as a percentage of loans and advances to customers(3) | 3.52% | 2.00% | - |
| Provision as a percentage of total non-performing loans and advances | 51% | 76% | - |
(1) Loans and advances are classified as non-performing typically when the counterparty fails to make payments when contractually due for three months or longer
(2) All non-performing loans are UK and continue accruing interest.
(3) Loans and advances to customers include social housing loans and finance leases.
In 2009, non-performing loans and advances as a percentage of loans and advances to customers increased to 3.52 as market conditions continued to deteriorate. This reflects the consolidation of the Alliance & Leicester Corporate Lending business which included assets with generally higher risk characteristics as well as the more challenging economic environment on customers especially in the Real Estate and shipping markets.
In 2008, non-performing loans and advances as a percentage of loans and advances to customers increased to 2.00%. This reflects the impact of the deteriorating market environment on the performance of the corporate and real estate portfolios, and the transfer of Alliance & Leicester's Corporate Banking portfolio.
Interest income recognised on impaired loans amounted to £4m (2008: £2m). In 2007, there were no impaired loans.
Credit risk mitigation
Collateralisation
The corporate portfolio is largely unsecured but typically incorporates guarantee structures underpinned by both financial and non-financial covenants. The Social Housing portfolio is secured on residential real estate owned and let by UK Housing Associations. In the real estate portfolio, collateral is in the form of commercial real estate assets. Within the non-growth portfolios of assets inconsistent with the Group's future strategy, collateral is regularly held through a charge over the underlying asset and in some circumstances, cash. There are also a small number of PFI transactions where collateral is held in the form of a charge over the underlying concession contract.
Restructured loans
Loans may be restructured or renegotiated by capitalising the arrears where customers in arrears have maintained an agreed monthly repayment for a specified period. Loans have been restructured during 2009 by way of debt for equity swaps, through new equity being raised or in some cases an exit has been achieved through the sale of debt.
Market risk in Corporate Banking
Market risks arising in the Corporate Banking division are transferred from the originating business to ALM within Group Infrastructure, where they can be managed in conjunction with exposures arising from the funding, liquidity or capital management activities of ALM. Funds received with respect to deposits taken are lent on to Group Infrastructure on matching terms as regards interest rate repricing and maturity. Similarly, loans are funded though matching borrowings from Group Infrastructure. Any permitted retained market risk exposure is minimal, and is monitored against limits approved by the Head of Wholesale Risk.
Risk Management in Global Banking & Markets
Credit risk in Global Banking & Markets
Credit risk is the risk that counterparties will not meet their financial obligations resulting in Global Banking & Markets losing the monies lent, including any interest accrued, or having to close out transactions prematurely, which may incur losses after realising collateral held. Credit risk arises by Global Banking & Markets making loans, investing in debt securities or other financial instruments or entering into financing transactions or derivative contracts. Global Banking & Markets actively manages and controls credit risk.
Managing credit risk
The Board has approved a set of risk appetite limits to cover different types of risk, including credit risk, arising in Global Banking & Markets. The Group's credit risk appetite is measured and controlled by a maximum Economic Capital value, which is defined as the maximum level of unexpected loss that the Group is willing to sustain over a one-year period. Within these limits, credit mandates and policies are approved to cover detailed industry, sector and product limits.
All transactions are accommodated under credit limits approved by the appropriate credit authority. Specific approval is usually required from the Credit Approval Committee (a specific committee established under the authority of the Chief Executive) for any transaction that falls outside the mandates.
Analysis of credit exposures and credit risk trends are provided each month to the Wholesale Risk Oversight and Control Forum with key issues escalated to the Risk Committee as required. Large Exposures (as defined by the UK Financial Services Authority) are reported monthly to the Risk Committee and the UK Financial Services Authority.
Credit risk on derivative instruments is calculated using the potential future mark-to-market exposure of the instruments at a 97.5% statistical confidence level and adding this value to the current value. The resulting "loan equivalent" or credit risk is then included against credit limits, along with other non-derivative exposures.
In addition, there is a policy framework to enable the collateralisation of derivative instruments including swaps. If collateral is deemed necessary to reduce credit risk, any unsecured risk threshold, and the nature of any collateral to be accepted, is determined by management's credit evaluation of the counterparty.
Credit risk mitigation
(i) Netting arrangements
The Group restricts its credit risk by entering into transactions under industry standard agreements which facilitate netting of transactions in the jurisdictions where netting agreements are recognised and have legal force. The netting arrangements do not generally result in an offset of balance sheet assets and liabilities for accounting purposes, as transactions are usually settled on a gross basis.
However, there is scope for the credit risk associated with favourable contracts to be reduced by netting arrangements embodied in the agreements to the extent that if an event of default occurs, all amounts with the counterparty under the specific agreement can be terminated and settled on a net basis. Derivatives, repurchase and reverse repurchase transactions, stock borrowing/lending transactions and securities financing transactions are governed by industry standard agreements that facilitate netting.
(ii) Collateralisation
The Group also mitigates its credit risk to counterparties with which it primarily transacts financial instruments through collateralisation, using industry standard collateral agreements. Under these agreements, net exposures with counterparties are collateralised with cash, securities or equities. Exposures and collateral are generally revalued daily and collateral is adjusted accordingly to reflect deficits/surpluses. Collateral taken must comply with the Group's collateral parameters policy. This policy is designed to control the quality and concentration risk of collateral taken such that collateral held can be liquidated when a counterparty defaults. Cash collateral in respect of derivatives held at the year-end was £1.5bn (2008: £3.4bn), not all derivative arrangements being subject to collateral agreements. Collateral obtained during the year in respect of purchase and resale agreements (including securities financing) is equal to at least 100% of the amount of the exposure.
Global Banking & Markets net exposure by credit rating of the issuer or counterparty(1)
|
| 2009 £m | 2008 £m |
| AAA | 12,068 | 5,904 |
| AA | 512 | 5,905 |
| A | 2,596 | 2,326 |
| BBB | 403 | 251 |
| BB | 172 | 91 |
| B | - | 1 |
| Total | 15,751 | 14,478 |
(1) External ratings are applied to all exposures where available.
In the securities financing businesses, credit risk arises on both assets and liabilities and on both on and off-balance sheet transactions. Consequently, the above credit risk exposure arises not only from the on balance sheet assets, but also from securities financing trades classified as liabilities and off-balance sheet assets.
Market risk in Global Banking & Markets
Market risk-taking is performed within the framework established by the Market Risk Manual. A major portion of the market risk arises from exposures to changes in the levels of interest rates, equity markets and credit spreads. Interest rate exposure is generated from trading activities. Exposure to equity markets is generated by the creation and risk management of structured products by Global Banking & Markets for the Personal Financial Services market and trading activities. Credit spread exposure arises from credit risk management and trading activities within Global Banking & Markets.
Managing market risk
Risks are managed within limits approved by the Head of Wholesale Risk or Banco Santander, S.A.'s Board Risk Committee and within the risk control framework defined by the Market Risk Manual. For trading activities the primary risk exposures for Global Banking & Markets are interest rate, equity, credit spread and residual exposure to property indices. Interest rate risks are managed via interest rate swaps, futures and options (caps, floors and swaptions). Equity risks are managed via equity stock, index futures, options and structured equity derivatives. Credit-spread risks are managed via credit derivatives (credit default swaps, total return swaps). Property index risk is managed via insurance contracts and property derivatives.
To facilitate understanding and communication of different risks, risk categories have been defined. Exposure to all market risk factors is assigned to one of these categories. The Group considers two categories:
| > | Short-term liquid market risk covers activities where exposures are subject to frequent change and could be closed out over a short-time horizon. Most of the exposure is generated by Global Banking & Markets.
|
| > | Structural market risk includes exposures arising as a result of the structure of portfolios of assets and liabilities, or where the liquidity of the market is such that the exposure could not be closed out over a short-time horizon. The risk exposure is generated by features inherent in either a product or portfolio and normally presented over the life of the portfolio or product. Such exposures are a result of the decision to undertake specific business activities, can take a number of different forms, and are generally managed over a longer-time horizon. |
Global Banking & Markets operates within a market risk framework designed to ensure that it has the capability to manage risk in a well-controlled manner. A comprehensive set of policies, procedures and processes have been developed and implemented to identify, measure, report, monitor and control risk across Global Banking & Markets.
Trading market risk
For trading activities the standardised risk measure adopted is Value at Risk. From 1 January 2010, this has been calculated at a 99% confidence level over a one-day time horizon in accordance with the standard used throughout Santander. Prior to this date, a 95% confidence level was used. On a daily basis, market risk factor sensitivities, Value at Risk measures and stress tests are produced, reported and monitored against limits for each major activity and at the aggregate Global Banking & Markets level. These limits are used to align risk appetite with the business' risk-taking activities and are reviewed on a regular basis.
Measurement of risks can involve the use of complex quantitative methods and mathematical principles to model and predict the changes in instruments and portfolio valuation. These methods are essential tools to understand the risk exposures. Trading market riskexposurearises only in the Abbey National Treasury Services plc group. Exposures are managed on a continuous basis, and are marked to market daily.
The following table shows the Value at Risk-based consolidated exposures for the major risk classes as at 31 December 2009, together with the highest, lowest and average exposures for the year. Exposures within each risk class reflect a range of exposures associated with movements in that financial market. For example, interest rate risks include the impact of absolute rate movements, movements between interest rate bases and movements in implied volatility on interest rate options. The range of possible statistical modelling techniques and assumptions mean these measures are not precise indicators of expected future losses, but are estimates of the potential change in the value of the portfolio over a specified time horizon and within a given confidence interval. Historical simulation models are used with appropriate add-ons to reflect unobservable inputs.
From time to time, losses may exceed the amounts stated where the movements in market rates fall outside the statistical confidence interval used in the calculation of the value at risk analysis. The 95% confidence interval means that the theoretical loss at a risk factor level is likely to be exceeded in one period in twenty. This risk is addressed by monitoring stress-testing measures across the different business areas. For trading instruments the actual, average, highest and lowest value at risk exposures shown below are all calculated to a 95% level of confidence using a simulation of actual one day market movements over a one-year period. The effect of historic correlations between risk factors is additionally shown below. The use of a one-day time horizon for all risks associated with trading instruments reflects the horizon over which market movements will affect the measured profit and loss of these activities.
The amounts below represent the potential change in market values of trading instruments. Since trading instruments are recorded at market value, these amounts also represent the potential effect on income.
|
| Actual Exposure at 31 December | ||
|
Group trading instruments | 2009 £m | 2008 £m | 2007 £m |
| Interest rate risks | 2.4 | 5.3 | 3.0 |
| Equity risks | 1.0 | 1.2 | 2.2 |
| Spread risks | 1.1 | 1.9 | 1.9 |
| Property risks | 6.0 | 6.8 | 3.4 |
| Other risks(1) | 0.4 | 0.9 | 0.3 |
| Correlation offsets(2) | (2.3) | (2.5) | (2.3) |
| Total correlated one-day Value at Risk | 8.6 | 13.6 | 8.5 |
|
| Exposure for the year ended 31 December | ||||||||
|
| Average exposure | Highest exposure | Lowest exposure | ||||||
| Group trading instruments | 2009 £m | 2008 £m | 2007 £m | 2009 £m | 2008 £m | 2007 £m | 2009 £m | 2008 £m | 2007 £m |
| Interest rate risks | 3.9 | 3.6 | 1.7 | 6.2 | 5.6 | 3.7 | 1.6 | 2.5 | 0.9 |
| Equity risks | 1.4 | 2.0 | 2.4 | 2.7 | 3.5 | 3.7 | 0.8 | 1.0 | 1.6 |
| Spread risks | 2.5 | 1.3 | 0.9 | 3.4 | 2.8 | 2.0 | 1.1 | 0.5 | 0.4 |
| Property risks | 6.1 | 4.7 | 2.3 | 6.9 | 7.4 | 3.5 | 5.5 | 3.2 | 1.0 |
| Other risks(1) | 0.7 | 0.6 | 0.3 | 1.0 | 1.0 | 1.2 | 0.3 | 0.2 | 0.1 |
| Correlation offsets(2) | (3.1) | (2.2) | (1.6) | - | - | - | - | - | - |
| Total correlated one-day Value at Risk | 11.5 | 10.0 | 6.0 | 14.0 | 14.5 | 8.8 | 8.3 | 8.0 | 4.1 |
(1) Other risks include foreign exchange risk.
(2) The highest and lowest exposure figures reported for each risk type did not necessarily occur on the same day as the highest and lowest total correlated one-day Value-at-Risk. A corresponding correlation offset effect cannot be calculated and is therefore omitted from the above table.
Property risks have increased over the last two years. The largest factor in the Value at Risk increase is from an equity release business funded by the Group, as total equity advances increased over the three-year period. A secondary factor is the significant fall in interest rates in the same period. The present value of all the cash flows has increased significantly as a result of the lower discount rates, increasing sensitivity and hence Value at Risk.
Derivatives held for Trading Purposes
Global Banking & Markets is the only area of the Group actively trading derivative products and is additionally responsible for implementing most Group derivative hedging with the external market. For trading activities, Global Banking & Markets objectives are to gain value by marketing derivatives to end users and hedging the resulting exposures efficiently; and the management of trading exposure reflected on the Group's balance sheet. Trading derivatives include interest rate, cross currency, equity, residential property and other index related swaps, forwards, caps, floors, swaptions, as well as credit default and total return swaps, equity index contracts and exchange traded interest rate futures and equity index options.
Credit Derivatives
Previously, Global Banking & Markets also operated a credit derivatives business. The business traded in single-name credit derivatives, credit derivative indices and a limited number of portfolio credit derivative transactions. The credit derivatives trading function operated within the same framework as other trading functions. Risk limits were established and monitored. Given the lack of activity in the credit markets in 2007 and early 2008, the business was closed and its activities consolidated in Spain with the equivalent Banco Santander, S.A. business area with effect from 1 January 2008. Any residual positions have been hedged with Banco Santander, S.A..
Risk Management in Private Banking
Credit risk in Private Banking
Cater Allen
Cater Allen provides a limited range of products to assist with the finance requirements of individuals and businesses. Risk management policies are specific to and reflect the risks inherent in each product set. Approval processes for credit risk include the use of judgement, assisted by the use of credit scoring and credit ratings. Cater Allen operates within policies and authority levels approved by the Chief Risk Officer. Cater Allen has a dedicated risk team, reflecting the desire for risk control to be close to the business needs and risks.
The following table presents Cater Allen's estimated maximum exposure to credit risk at the reporting date without taking account of any collateral held or other credit enhancements:
|
| 2009 £m | 2008 £m |
| Loans and advances to customers | 3.1 | 3.8 |
| Other | 0.2 | 0.2 |
| Third party exposures | 3.3 | 4.0 |
Abbey International
Abbey International's office is in Jersey, with a focus on attracting deposits by offering a range of savings accounts denominated in sterling, US dollars and euros. There is no credit risk associated in taking deposits.
Alliance & Leicester International
Alliance & Leicester International's office is in the Isle of Man, with a focus on attracting deposits by offering a range of savings accounts denominated in sterling, US dollars and euros. There is no credit risk associated in taking deposits.
Bradford & Bingley International
Bradford & Bingley International Limited is based in the Isle of Man with a focus on attracting deposits from both retail and corporate customers via savings accounts predominantly denominated in sterling. There is no credit risk associated in taking deposits.
James Hay
James Hay provides administration services for self-invested pension plans and the WRAP portfolio management product to end customers mainly via independent financial advisers and branded financial service providers. With the exception of fees receivable, there is no credit risk associated with this type of service. On 10 March 2010, Santander Private Banking UK Limited completed the disposal of James Hay Holdings Limited, together with its five subsidiary companies, by the sale of 100% of James Hay Holdings Limited's shares to IFG UK Holdings Limited, a subsidiary of IFG Group for a cash considerationof approximately £39m. The IFG Group provides independent financial advisory, fund management and pension administration services in Ireland and the UK.
Abbey Stockbrokers
Abbey Stockbrokers Limited, trading as Abbey Sharedealing, provides a direct share dealing service to customers. Customers buy and sell shares on their account with the help of the dealers at Abbey Stockdealing. No advice is provided and all trades are on an execution only basis, account customers are required to provide funds before settlement. As such there is no credit risk associated with this type of activity.
Market risk in Private Banking
Market risk arises from exposures to changes in the levels of interest rates, foreign exchange rates and equity markets. Market risk arises through the provision of retail and other banking products and services, as well as structural exposures arising in the balance sheet of the entities in Private Banking.
Managing market risk
Market risks in Private Banking arising from exposure to changes in the levels of interest rates and foreign exchanges rates are substantially transferred from the original business to ALM. Risks not transferred are managed within a series of market risk mandates, which set triggers for reporting on the extent of market risk that may be retained. These limits are defined in terms of nominal amounts, sensitivity, earnings-at-risk or value-at-risk. The permitted retained market risk exposure is minimal. Market risks arising from structured products, including exposure to changes in the levels of equity markets, are hedged with Global Banking & Markets. It is the current intention for market risk from some structured products to be retained within Private Banking, after the implementation of further market risk controls and processes.
Risk Management in Group Infrastructure
Group Infrastructure consists of ALM, which is also responsible for Group Capital and Funding, as well as the Treasury asset portfolio. ALM is responsible for managing the Group's structural balance sheet shape and, in conjunction with Risk Division, tactical liquidity risk management. This includes short-term and medium-term funding, covered bond and securitisation programmes. ALM's responsibilities also include Retail Banking's product and structural exposure to interest rates and, in that role, is a link between the Retail Banking and Global Banking & Markets. ALM recommends and helps to implement Board, Asset and Liability Management Committee and Risk Committee policies for all aspects of balance sheet management - formulating guidance for, and monitoring, the overall balance sheet shape, including maturity profile. Group Capital represents the return on the Group's capital, reserves, preference shares and subordinated debt. Funding represents the provision of funding, both to other businesses within the Group and to fellow subsidiaries of Banco Santander, S.A..
Credit risk in Group Infrastructure
Credit risk is the risk that counterparties will not meet their financial obligations resulting in Group Infrastructure losing the monies lent, including any interest accrued, or having to close out transactions prematurely, which may incur losses after realising collateral held. Credit risk arises by Group Infrastructure making loans, investing in debt securities or other financial instruments or entering into financing transactions or derivative contracts.
Managing credit risk
Credit risk arises in Group Infrastructure with respect to the division's holdings of externally rated asset-backed securities and residential mortgage-backed securities principally issued by Santander Group entities, bank floating rate notes, other assets held for liquidity purposes, and lending to fellow subsidiaries of the Santander Group.
All credit risk meets the criteria approved by the Board in respect to risk appetite parameters and all exposure, including intra-group, is captured on the global risk management systems and falls within limits approved by Santander Risk Division. The exposure is managed by the Group´s Wholesale Risk Team.
Group Infrastructure net exposure by credit rating of the issuer or counterparty(1)
|
| 2009 £m | 2008 £m |
| AAA | 10,130 | 17,994 |
| AA | 7,540 | 10,662 |
| A | 10,531 | 12,429 |
| BBB+ | 2,507 | 1,174 |
| BBB | 375 | 789 |
| Below BBB | 430 | 440 |
| D | - | 10 |
| Total | 31,513 | 43,498 |
(1) External ratings are applied to all exposures where available.
Risks are managed in accordance with limits, asset quality plans and criteria set out in the relevant policy statement. Decisions are based on independent credit risk analysis, supplemented by the output of internal ratings tools and external rating agency analysis. An internal ratings model is used to grade financial institution exposures and to generate probability of default and expected loss. The Group uses external ratings supplemented by internal analysis to assess the risks associated with structured credit and securitisation investments. Individual exposures are reviewed at least annually. Asset quality monitoring is reported by regular executive and management reporting, and exception reporting against a range of asset quality triggers, which include expected loss analysis.
The Treasury asset portfolio is monitored for potential impairment as soon as an event occurs to suggest a counterparty's creditworthiness merits attention. Once specific events give rise to a reasonable expectation that future anticipated cash flows may not be received, the asset originating these doubtful cash flows will be deemed to be impaired.
For structured investment vehicles ('SIVs'), Collateralised Debt Obligations ('CDOs') and Collateralised Loan Obligations ('CLOs') impairment is deemed to have occurred when one or more of the following events have occurred:
| > | the vehicle has realised losses arising from sale of assets that make it probable that the note-holders will not receive principal and base coupon in full; |
| > | the vehicle has been restructured and the terms of the restructuring make it probable that the note-holders will not receive principal and base coupon in full; |
| > | the Group expects to participate in a restructuring or refinancing of the vehicle which has been proposed by the vehicle's manager or sponsor and the likely terms make it probable that the note-holders will not receive principal and base coupon in full; |
| > | the vehicle has entered into enforcement; or |
| > | the funding and market conditions are such that the vehicle is expected either to sell assets or restructure such that it is probable that the note-holders will not receive principal and base coupon in full. |
CDOs containing sub-prime US mortgage assets and other structured credit assets are deemed impaired if estimated losses on the underlying assets exceed the level of credit support. Asset backed securities are assessed on an individual basis.
Market risk in Group Infrastructure
Most market risks arising from the Retail Banking, Corporate Banking, and Private Banking divisions are transferred from the originating business to the ALM function within Group Infrastructure, where they can be managed in conjunction with exposures arising from the funding, liquidity or capital management activities of ALM. As a consequence, non-trading risk exposures are substantially transferred to Group Infrastructure. Market risks mainly arise through the provision of banking products and services to personal and corporate/business customers, as well as structural exposures arising in the Group's balance sheet. These risks impact the Group's current earnings and economic value.
The most significant market risks in Group Infrastructure are interest rate and credit spread risks. Yield curve risk arises from the timing mismatch in the repricing of fixed and variable rate assets, liabilities and off-balance sheet instruments, as well as the investment of non-interest-bearing liabilities in interest-bearing assets. Credit spread risk arises principally on Group Infrastructure's holdings of mortgage-backed securities.
Basis risk arises, to the extent that the volume of administered variable rate assets and liabilities are not precisely matched, which exposes the balance sheet to changes in the relationship between administered rates and market rates.
The Group is also exposed to risks arising from features in retail products that give customers the right to alter the expected cash flows of a financial contract. This creates prepayment risk, for example where customers may prepay loans before their contractual maturity. In addition, the Group is exposed to product launch risk, for example where the customers may not take up the expected volume of new fixed rate mortgages or other loans.
Managing market risk
The Asset and Liability Management Committee is responsible for managing the Group's overall balance sheet position. Natural offsets are used as far as possible to mitigate yield curve exposures but the overall balance sheet position is generally managed using derivatives that are transacted through Global Banking & Markets. The Treasurer, Head of ALM is responsible for managing risks in accordance with the Asset and Liability Management Committee's direction.
Risks are managed within limits approved either by the Head of Wholesale Risk or Banco Santander, S.A.'s Board Risk Committee, and within the risk control framework defined by the Market Risk Manual. The key risk limits relate to yield curve risk. They are:
| > | Net Interest Margin sensitivity: the sensitivity of annual net interest margin to an instantaneous and unexpected adverse 100 basis point parallel shock to the yield curve. |
| > | Market Value of Equity sensitivity: the sensitivity of the net present value of interest rate sensitive positions to an instantaneous and unexpected adverse 100 basis point parallel shock to the yield curve. |
These two measures provide complementary views of potential losses from interest rate movements. Market Value of Equity sensitivity provides a long-term view covering the present value of all future cash flows, whereas Net Interest Margin sensitivity considers only the impact on net interest margin over the next 12 months. Calculation of these two measures requires modelling of expected customer and other behaviours. These models are regularly reviewed and updated.
The following table shows the results of these measures as at 31 December 2009 and 2008:
|
| 2009 £m | 2008 £m |
| Net interest margin sensitivity (100 basis points adverse parallel shock) | (38) | (64) |
| Market value of equity sensitivity (100 basis points adverse parallel shock) | 2 | (153) |
Market risk on the Group's Santander-issued mortgage-backed securities portfolio is managed against credit spread triggers approved by the Head of Wholesale Risk and sensitivity analysis is disclosed in Note 49 to the Consolidated Financial Statements.
Derivatives
Derivative financial instruments ('derivatives') are contracts or agreements whose value is derived from one or more underlying indices or asset values inherent in the contract or agreement, which require no or little initial net investment and are settled at a future date. They include interest rate, cross-currency and equity related swaps, forward rate agreements, caps, floors, options and swaptions (see below). In Group Infrastructure, derivatives are used for economic hedging.
All derivatives are classified as held at fair value through profit or loss. For accounting purposes under IFRS, the Group chooses to designate certain derivatives as in a hedging relationship if they meet specific criteria set out in IAS 39 "Financial Instruments: Recognition and measurement".
The main hedging derivatives are interest rate and cross-currency swaps, which are used to hedge fixed-rate lending and structured savings products and medium-term note issuances, capital issuances and other capital markets funding.
Derivative products that are combinations of more basic derivatives (such as swaps with embedded option features), or that have leverage features, may be used in circumstances where the underlying position being hedged contains the same risk features. In such cases the derivative used will be structured to match the risks of the underlying asset or liability. Exposure to market risk on such contracts is therefore economically hedged.
The following table summarises the activities undertaken within Group Infrastructure, the related risks associated with such activities and the types of hedging derivatives used in managing such risks. These risks may also be managed using on-balance sheet instruments as part of an integrated approach to risk management. Further information is contained in Note 13 to the Consolidated Financial Statements.
|
Activity | Risk | Type of hedge |
| Management of the return on variable rate assets financed by shareholders' funds and net non-interest-bearing liabilities. | Reduced profitability due to falls in interest rates. | Receive fixed interest rate swaps. |
| Management of the basis between administered rate assets and liabilities and wholesale market rates. | Reduced profitability due to adverse changes in the basis spread. | Basis swaps. |
| Management of repricing profile of wholesale funding. | Reduced profitability due to adverse movement in wholesale interest rates when large volumes of wholesale funding are repriced. | Forward rate agreements. |
| Fixed rate lending and investments. | Sensitivity to increases in interest rates. | Pay fixed interest rate swaps. |
| Fixed rate retail and wholesale funding. | Sensitivity to falls in interest rates. | Receive fixed interest rate swaps. |
| Equity-linked retail funding. | Sensitivity to increases in equity market indices. | Receive equity swaps. |
| Management of other net interest income on retail activities. | Sensitivity of income to changes in interest rates. | Interest rate swaps. |
| Issuance of products with embedded equity options. | Sensitivity to changes in underlying index and index volatility causing option exercise. | Interest rate swaps combined with equity options. |
| Lending and issuance of products with embedded interest rate options. | Sensitivity to changes in underlying rate and rate volatility causing option exercise. | Interest rate swaps plus caps/floors. |
| Investment in, and issuance of, bonds with put/call features. | Sensitivity to changes in rates causing option exercise. | Interest rate swaps combined with swaptions(1) and other matched options. |
(1) A swaption is an option on a swap that gives the holder the right but not the obligation to buy or sell a swap.
Impact of the Current Credit Environment
The Group aims to actively manage its exposure to financial institutions and non-bank financial institutions such as pension and investment funds, monoline insurers and general insurers. This exposure arises from investment in floating rate notes, short-term money market placements, derivative transactions and margin posting on securities borrowing transactions.
At 31 December 2009, the Group is not exposed to sovereign debt of countries currently experiencing liquidity problems. The Group has exposure to banks in those countries limited to a £13m (2008: £13m) exposure through a Floating Rate Note issued by a bank in Dubai and a £36m exposure to a bank in Greece (2008: £187m). Since the balance sheet date, exposure to banks in Greece has reduced to £5m.
Details of the Group's investing and lending arrangements with respect to floating rate notes ('FRNs'), asset-backed securities ('ABS') including mortgage-backed securities ('MBS'), Collateralised Debt Obligations ('CDOs'), Collateralised Loan Obligations ('CLOs'), Structured Investment Vehicles ('SIVs'), monoline insurers, off-balance sheet entities, other holdings for liquidity purposes, and lending activities are set out below.
Classification in the Consolidated Balance Sheet
The classification of these assets in the Group consolidated balance sheet is as follows:
| 2009 |
| Type of Financial Instrument analysed further | Sub-total | OECD Govt debts | Bank & building society CDs | Total | ||||
| Balance sheet line item | Note | FRNs | ABS | CDO | CLO | Other | ||||
|
| £m | £m | £m | £m | £m | £m | £m | £m | £m | |
| Trading assets - debt securities | 12 | 11,128 | - | - | - | 13 | 11,141 | 2,856 | 1,935 | 15,932 |
| Financial assets designated at fair value - debt securities | 14 | - | 3,446 | 50 | - | 263 | 3,759 | - | 2,220 | 5,979 |
| Available for sale - debt securities | 18 | - | - | - | - | - | - | 749 | - | 749 |
| Loans and receivables securities | 19 | 6,749 | 2,245 | 80 | 639 | 185 | 9,898 | - | - | 9,898 |
|
|
| 17,877 | 5,691 | 130 | 639 | 461 | 24,798 | 3,605 | 4,155 | 32,558 |
| 2008 |
| Type of Financial Instrument analysed further | Sub-total | OECD Govt debts | Bank and building society CDs | Total | ||||
| Balance sheet line item | Note | FRNs | ABS | CDO | CLO | Other | ||||
|
| £m | £m | £m | £m | £m | £m | £m | £m | £m | |
| Trading assets - debt securities | 12 | 5,277 | - | - | - | - | 5,277 | 3,139 | 8,385 | 16,801 |
| Financial assets designated at fair value - debt securities | 14 | - | 4,690 | - | - | - | 4,690 | - | - | 4,690 |
| Available for sale - debt securities | 18 | - | - | - | - | - | - | 2,618 | - | 2,618 |
| Loans and receivables securities | 19 | 9,936 | 3,507 | 164 | 321 | 179 | 14,107 | - | - | 14,107 |
|
|
| 15,213 | 8,197 | 164 | 321 | 179 | 24,074 | 5,757 | 8,385 | 38,216 |
Additional analysis is presented below of the above financial instruments, except for the category "OECD Govt debts" and "Bank & building society CDs". Further detail on those assets is set out in Note 12 to the Consolidated Financial Statements.
Summary
| 2009 | Nominal | Book value | Fair value | 2009 movement(1) | |||
| Income statement | Reserves | Provisions(1) |
| ||||
|
| £m | £m | £m | £m | £m | £m | |
| Floating rate notes | 17,932 | 17,877 | 17,787 | 137 | (89) | (4) | |
| Asset backed securities | 5,893 | 5,691 | 5,424 | 103 | (118) | (15) | |
| Collateralised debt obligations | 215 | 130 | 130 | (11) | (4) | (3) | |
| Collateralised loan obligations | 703 | 639 | 606 | (1) | (20) | - | |
| Other investments | 466 | 461 | 462 | 16 | - | (4) | |
|
| 25,209 | 24,798 | 24,409 | 244 | (231) | (26) | |
| 2008 | Nominal | Book value | Fair value | 2008 movement(1) | ||
| Income statement | Reserves | Provisions(1) | ||||
|
| £m | £m | £m | £m | £m | £m |
| Floating rate notes | 15,234 | 15,213 | 14,731 | (25) | - | - |
| Asset backed securities | 8,373 | 8,197 | 7,167 | (328) | - | - |
| Collateralised debt obligations | 366 | 164 | 130 | - | - | - |
| Collateralised loan obligations | 352 | 321 | 247 | - | - | - |
| Other investments | 197 | 179 | 187 | (2) | - | - |
|
| 24,522 | 24,074 | 22,462 | (355) | - | - |
(1) Amounts in respect of assets held at the balance sheet date i.e. not including amounts relating to assets sold during the year.
Fair value of debt securities by credit rating of the issuer or counterparty(1)
| 2009 | FRNs £m | Other £m | Total £m |
| AAA | 10,486 | 4,474 | 14,960 |
| AA+ | 83 | - | 83 |
| AA | 2,271 | 749 | 3,020 |
| A | 3,803 | 778 | 4,581 |
| BBB | 550 | 168 | 718 |
| Below BBB | 594 | 191 | 785 |
| Unrated | - | 262 | 262 |
| Total | 17,787 | 6,622 | 24,409 |
(1) External ratings are applied to all exposures, where available.
| 2008 | FRNs £m | Other £m | Total £m |
| AAA | - | 6,993 | 6,993 |
| AA+ | - | 266 | 266 |
| AA | 6,475 | 289 | 6,764 |
| A | 7,307 | 94 | 7,401 |
| BBB | 661 | 30 | 691 |
| Below BBB | 288 | 59 | 347 |
| Total | 14,731 | 7,731 | 22,462 |
(1) External ratings are applied to all exposures, where available.
Floating Rate Notes
(a) Fair value movements by geographical location of issuer or counterparty
|
| 2009 |
|
|
| 2009 movement | |||||||||
|
| Nominal value | Book value | Fair value | Fair value as % of nominal | Income statement | Reserves | Provisions |
| ||||||
| Country | £m | % | £m | £m | % | £m | £m | £m |
| |||||
| UK | 9,578 | 53 | 9,611 | 9,596 | 100 | 95 | (11) | (4) |
| |||||
| Italy | 653 | 4 | 650 | 650 | 100 | 1 | (4) | - |
| |||||
| Spain | 1,546 | 9 | 1,527 | 1,510 | 98 | 4 | (20) | - |
| |||||
| Rest of Europe | 3,943 | 22 | 3,910 | 3,897 | 99 | 30 | (29) | - |
| |||||
| US | 699 | 4 | 651 | 633 | 91 | (4) | (20) | - |
| |||||
| Rest of the world | 1,513 | 8 | 1,528 | 1,501 | 99 | 11 | (5) | - |
| |||||
| Total | 17,932 | 100 | 17,877 | 17,787 | 99 | 137 | (89) | (4) |
| |||||
|
| 2008 |
|
|
| 2008 Movement | |||||||||
|
| Nominal value | Book value | Fair value | Fair value as % of nominal | Income statement | Reserves | Provisions |
| ||||||
| Country | £m | % | £m | £m | % | £m | £m | £m |
| |||||
| UK | 3,093 | 20 | 3,107 | 3,069 | 99 | (4) | - | - |
| |||||
| Italy | 1,316 | 9 | 1,314 | 1,288 | 98 | (1) | - | - |
| |||||
| Spain | 2,860 | 19 | 2,831 | 2,744 | 96 | (2) | - | - |
| |||||
| Rest of Europe | 5,115 | 34 | 5,160 | 5,016 | 98 | (15) | - | - |
| |||||
| US | 1,102 | 7 | 1,057 | 934 | 85 | - | - | - |
| |||||
| Rest of the world | 1,748 | 11 | 1,744 | 1,680 | 96 | (3) | - | - |
| |||||
| Total | 15,234 | 100 | 15,213 | 14,731 | 97 | (25) | - | - |
| |||||
(b) Fair value movements by credit rating of issuer or counterparty
|
| 2009 |
|
|
| 2009 movement | |||||||||
|
| Nominal value | Book value | Fair value | Fair value as % of nominal | Income statement | Reserves | Provisions |
| ||||||
| Credit rating | £m | % | £m | £m | % | £m | £m | £m |
| |||||
| AAA | 10,422 | 58 | 10,486 | 10,486 | 101 | 136 | - | - |
| |||||
| AA+ | 83 | - | 83 | 83 | 100 | - |
|
|
| |||||
| AA | 2,297 | 13 | 2,270 | 2,271 | 99 | 3 | (19) | - |
| |||||
| A | 3,925 | 22 | 3,865 | 3,802 | 97 | (1) | (51) | - |
| |||||
| BBB | 589 | 3 | 570 | 551 | 94 | - | (16) | - |
| |||||
| Below BBB | 616 | 4 | 603 | 594 | 96 | (1) | (3) | (4) |
| |||||
| Total | 17,932 | 100 | 17,877 | 17,787 | 99 | 137 | (89) | (4) |
| |||||
|
| 2008 |
|
|
| 2008 Movement | |||||||||
|
| Nominal value | Book value | Fair value | Fair value as % of nominal | Income statement | Reserves | Provisions |
| ||||||
| Credit rating | £m | % | £m | £m | % | £m | £m | £m |
| |||||
| AA and above | 6,433 | 42 | 6,574 | 6,475 | 101 | (17) | - | - |
| |||||
| A | 7,722 | 51 | 7,635 | 7,307 | 95 | (8) | - | - |
| |||||
| BBB | 735 | 5 | 712 | 661 | 90 | - | - | - |
| |||||
| Below BBB | 344 | 2 | 292 | 288 | 84 | - | - | - |
| |||||
| Total | 15,234 | 100 | 15,213 | 14,731 | 97 | (25) | - | - |
| |||||
The FRNs held are principally issued by banks and other financial institutions. On average, the FRNs have 18 months to maturity (2008: 23 months).
Structured Investment Vehicles
The Group has insignificant holdings in SIVs, with a nominal value of £14m (2008: £17m) against which provisions of £11m (2008: £12m) are held, giving a book value of £3m (2008: £5m). The SIVs are classified as floating rate notes in the balance sheet and included in the tables above.
Asset-Backed Securities
The Group has a portfolio of structured assets, which is diversified by issuer, underlying asset type and geography. Further details on structured asset exposures are set out in the tables below.
(a) Fair value movements by geographical location of issuer or counterparty
| 2009 |
|
|
|
| 2009 movement | |||
| Nominal value | Book value | Fair value | Fair value as % of nominal | Income Statement | Reserves | Provisions | ||
| Country | £m | % | £m | £m | % | £m | £m | £m |
| UK |
|
|
|
|
|
|
|
|
| ABS | 142 | 2 | 141 | 140 | 99 | - | - | - |
| MBS | 912 | 16 | 878 | 791 | 87 | 2 | (28) | - |
|
| 1,054 | 18 | 1,019 | 931 | 88 | 2 | (28) | - |
| US |
|
|
|
|
|
|
|
|
| ABS | 553 | 9 | 506 | 483 | 87 | (8) | (37) | - |
| MBS | 292 | 5 | 218 | 125 | 43 | (8) | (29) | (9) |
|
| 845 | 14 | 724 | 608 | 72 | (16) | (66) | (9) |
| Rest of Europe |
|
|
|
|
|
|
|
|
| ABS | 300 | 5 | 288 | 283 | 94 | 14 | (2) | (6) |
| MBS | 3,542 | 60 | 3,511 | 3,463 | 98 | 104 | (20) | - |
|
| 3,842 | 65 | 3,799 | 3,746 | 98 | 118 | (22) | (6) |
| Rest of the world |
|
|
|
|
|
|
|
|
| MBS | 152 | 3 | 149 | 139 | 91 | (1) | (2) | - |
| Total | 5,893 | 100 | 5,691 | 5,424 | 92 | 103 | (118) | (15) |
| 2008 |
|
|
| Fair value as % of nominal | 2008 movement | |||
| Nominal value | Book value | Fair value | Income Statement | Reserves | Provisions | |||
| Country | £m | % | £m | £m | % | £m | £m | £m |
| UK |
|
|
|
|
|
|
|
|
| ABS | 31 | - | 31 | 28 | 90 | - | - | - |
| MBS | 1,156 | 14 | 1,531 | 950 | 82 | - | - | - |
|
| 1,187 | 14 | 1,562 | 978 | 82 | - | - | - |
| US |
|
|
|
|
|
|
|
|
| ABS | 962 | 11 | 881 | 732 | 76 | - | - | - |
| MBS | 393 | 5 | 277 | 191 | 49 | - | - | - |
|
| 1,355 | 16 | 1,158 | 923 | 68 | - | - | - |
| Rest of Europe |
|
|
|
|
|
|
|
|
| ABS | 461 | 6 | 432 | 426 | 92 | (23) | - | - |
| MBS | 5,084 | 61 | 4,764 | 4,568 | 90 | (305) | - | - |
|
| 5,545 | 67 | 5,196 | 4,994 | 90 | (328) | - | - |
| Rest of the world |
|
|
|
|
|
|
|
|
| ABS | 36 | - | 36 | 34 | 94 | - | - | - |
| MBS | 250 | 3 | 245 | 238 | 95 | - | - | - |
|
| 286 | 3 | 281 | 272 | 95 | - | - | - |
| Total | 8,373 | 100 | 8,197 | 7,167 | 86 | (328) | - | - |
(b) Vintage of asset-backed securities by geographical location of issuer or counterparty
| 2009 | Nominal | Original credit enhancements | Original sub-prime exposure | Original vintage | |||||
| Pre-2005 | 2005 | 2006 | 2007 | 2008 | 2009 | ||||
| Country | £m | £m | £m | % | % | % | % | % | % |
| UK |
|
|
|
|
|
|
|
|
|
| ABS | 142 | 3 | - | 27 | 4 | 54 | 15 | - | - |
| MBS | 912 | 68 | - | 35 | 10 | 26 | 29 | - | - |
|
| 1,054 | 71 | - | 34 | 9 | 30 | 27 | - | - |
| US |
|
|
|
|
|
|
|
|
|
| ABS | 553 | 31 | - | 27 | 66 | 6 | 1 | - | - |
| MBS | 292 | 35 | 11 | 23 | 37 | 26 | 14 | - | - |
|
| 845 | 66 | 11 | 26 | 56 | 13 | 5 | - | - |
| Rest of Europe |
|
|
|
|
|
|
|
|
|
| ABS | 300 | 5 | - | 25 | 3 | 42 | 30 | - | - |
| MBS | 3,542 | 46 | - | 80 | 1 | 9 | 10 | - | - |
|
| 3,842 | 51 | - | 76 | 1 | 11 | 12 | - | - |
| Rest of the world |
|
|
|
|
|
|
|
|
|
| MBS | 152 | 6 | - | 34 | 3 | 3 | 60 | - | - |
| Total | 5,893 | 194 | 11 | 60 | 11 | 15 | 14 | - | - |
(c) Fair value movements by credit rating of issuer or counterparty
| 2009 |
|
|
| 2009 movement | |||||
| Nominal value | Book value | Fair value | Fair value as % of nominal | Income statement | Reserves | Provisions | |||
| Credit rating | £m | % | £m | £m | % | £m | £m | £m | |
| AAA |
|
|
|
|
|
|
|
| |
| ABS | 803 | 14 | 761 | 734 | 91 | 8 | (32) | - | |
| MBS | 3,730 | 63 | 3,667 | 3,553 | 95 | 100 | (42) | - | |
|
| 4,533 | 77 | 4,428 | 4,287 | 95 | 108 | (74) | - | |
| AA |
|
|
|
|
|
|
|
| |
| ABS | 10 | - | 8 | 7 | 70 | - | (1) | - | |
| MBS | 364 | 6 | 348 | 313 | 86 | 2 | (10) | - | |
|
| 374 | 6 | 356 | 320 | 86 | 2 | (11) | - | |
| A |
|
|
|
|
|
|
|
| |
| ABS | 56 | 1 | 51 | 50 | 89 | (1) | (3) | - | |
| MBS | 582 | 10 | 574 | 564 | 97 | 1 | (6) | - | |
|
| 638 | 11 | 625 | 614 | 96 | - | (9) | - | |
| BBB |
|
|
|
|
|
|
|
| |
| ABS | 67 | 1 | 66 | 65 | 98 | - | (1) | - | |
| MBS | 51 | 1 | 42 | 34 | 67 | (1) | (6) | - | |
|
| 118 | 2 | 108 | 99 | 84 | (1) | (7) | - | |
| Below BBB |
|
|
|
|
|
|
|
| |
| ABS | 59 | 1 | 49 | 49 | 83 | (1) | (2) | (6) | |
| MBS | 171 | 3 | 125 | 55 | 32 | (5) | (15) | (9) | |
|
| 230 | 4 | 174 | 104 | 45 | (6) | (17) | (15) | |
| Total | 5,893 | 100 | 5,691 | 5,424 | 92 | 103 | (118) | (15) | |
| 2008 |
|
|
| Fair value as % of nominal | 2008 movement | |||
| Nominal value | Book value | Fair value | Income statement | Reserves | Provisions | |||
| Credit rating | £m | % | £m | £m | % | £m | £m | £m |
| AAA |
|
|
|
|
|
|
|
|
| ABS | 1,404 | 17 | 1,316 | 1,163 | 83 | (23) | - | - |
| MBS | 6,336 | 75 | 6,084 | 5,544 | 88 | (266) | - | - |
|
| 7,740 | 92 | 7,400 | 6,707 | 87 | (289) | - | - |
| AA+ |
|
|
|
|
|
|
|
|
| ABS | 11 | - | 10 | 10 | 91 | (1) | - | - |
| MBS | 300 | 4 | 256 | 256 | 85 | (38) | - | - |
|
| 311 | 4 | 266 | 266 | 86 | (39) | - | - |
| AA |
|
|
|
|
|
|
|
|
| ABS | 18 | - | 15 | 12 | 67 | - | - | - |
| MBS | 91 | 1 | 107 | 50 | 55 | - | - | - |
|
| 109 | 1 | 122 | 62 | 57 | - | - | - |
| A |
|
|
|
|
|
|
|
|
| ABS | 83 | 1 | 67 | 59 | 71 | - | - | - |
| MBS | 38 | - | 283 | 18 | 47 | - | - | - |
|
| 121 | 1 | 350 | 77 | 64 | - | - | - |
| BBB |
|
|
|
|
|
|
|
|
| ABS | 17 | - | 12 | 12 | 71 | - | - | - |
| MBS | 33 | 1 | 22 | 12 | 36 | - | - | - |
|
| 50 | 1 | 34 | 24 | 48 | - | - | - |
| Below BBB |
|
|
|
|
|
|
|
|
| MBS | 42 | 1 | 25 | 31 | 74 | - | - | - |
|
| 42 | 1 | 25 | 31 | 74 | - | - | - |
| Total | 8,373 | 100 | 8,197 | 7,167 | 86 | (328) | - | - |
80
The fair value movements above exclude the effects of changes in foreign exchange rates.
(d) Vintage of asset-backed securities by credit rating of issuer or counterparty
| 2009 | Nominal | Original credit enhancements | Original sub-prime exposure | Original vintage | |||||
| Pre-2005 | 2005 | 2006 | 2007 | 2008 | 2009 | ||||
| Credit rating | £m | £m | £m | % | % | % | % | % | % |
| AAA |
|
|
|
|
|
|
|
|
|
| ABS | 803 | 37 | - | 27 | 45 | 18 | 10 | - | - |
| MBS | 3,730 | 115 | - | 71 | 4 | 9 | 16 | - | - |
|
| 4,533 | 152 | - | 63 | 11 | 11 | 15 | - | - |
| AA |
|
|
|
|
|
|
|
|
|
| ABS | 10 | 1 | - | 29 | 41 | 30 | - | - | - |
| MBS | 364 | 15 | 6 | 5 | 6 | 65 | 24 | - | - |
|
| 374 | 16 | 6 | 6 | 7 | 63 | 24 | - | - |
| A |
|
|
|
|
|
|
|
|
|
| ABS | 56 | 1 | - | - | - | 100 | - | - | - |
| MBS | 582 | 3 | - | 95 | 3 | - | 2 | - | - |
|
| 638 | 4 | - | 86 | 3 | 9 | 2 | - | - |
| BBB |
|
|
|
|
|
|
|
|
|
| ABS | 67 | - | - | 55 | - | 11 | 34 | - | - |
| MBS | 51 | 4 | - | 49 | 40 | 11 | - | - | - |
|
| 118 | 4 | - | 53 | 17 | 11 | 19 | - | - |
| Below BBB |
|
|
|
|
|
|
|
|
|
| ABS | 59 | - | - | - | 27 | 47 | 26 | - | - |
| MBS | 171 | 18 | 6 | 22 | 23 | 35 | 20 | - | - |
|
| 230 | 18 | 6 | 16 | 24 | 38 | 22 | - | - |
| Total | 5,893 | 194 | 12 | 60 | 11 | 15 | 14 | - | - |
Included in the tables above are holdings of ALT-A US asset-backed securities of £107m.
The following table shows the vintages of the collateral assets supporting the Group's holdings of asset-backed securities and mortgage-backed securities at 31 December 2009.
|
|
|
|
| Original vintage | |||
| Asset Type | Nominal | Pre-2005 | 2005 | 2006 | 2007 | 2008 | 2009 |
|
| £m | % | % | % | % | % | % |
| Prime lending | 5,663 | 61 | 10 | 15 | 14 | - | - |
| ALT-A | 224 | 34 | 40 | 17 | 9 | - | - |
| Sub-prime | 6 | - | - | - | 100 | - | - |
| Total | 5,893 | 60 | 11 | 15 | 14 | - | - |
Monoline Insurers
The Group has a £219m (2008: £255m) exposure to securitisations which are wrapped by monoline insurers. The principal risk exposures are recorded against the securitisations, with the monoline wraps being viewed as contingent exposures. The exposures to monoline insurers are classified as asset-backed securities in the balance sheet and are included in the tables above.
Collateralised Debt Obligations
(a) Fair value movements by geographical location of issuer or counterparty
| 2009 |
|
|
|
| Fair value as % of nominal | 2009 movement | Original exposure to sub-prime | Original Credit enhancement | ||
| Nominal value | Book value | Fair value | Income statement | Reserves | Provision | |||||
| Country | £m | % | £m | £m | % | £m | £m | £m | % | % |
| UK | - | - | - | - | - | - | - | - | - | - |
| Rest of Europe | 2 | 1 | 2 | 2 | 100 | (1) | - | - | - | - |
| US | 212 | 99 | 127 | 127 | 60 | (10) | (4) | (3) | 11 | 30 |
| Rest of the world | 1 | - | 1 | 1 | 100 | - | - | - | - | - |
| Total | 215 | 100 | 130 | 130 | 60 | (11) | (4) | (3) | 11 | 30 |
| 2008 |
|
|
|
|
| 2008 movement |
|
| |||
| Nominal value | Book value | Fair value | Fair value as % of nominal | Income statement | Reserves | Provision | Original exposure to sub-prime | Original Credit enhancement | |||
| Country | £m | % | £m | £m | % | £m | £m | £m | % | % | |
| UK | 24 | 7 | 17 | 13 | 54 | - | - | - | - | 27 | |
| Rest of Europe | 3 | 1 | 3 | 4 | 133 | - | - | - | - | - | |
| US | 339 | 92 | 144 | 113 | 33 | - | - | - | 21 | 28 | |
| Rest of the world | - | - | - | - | - | - | - | - | - | - | |
| Total | 366 | 100 | 164 | 130 | 36 | - | - | - | 19 | 27 | |
(b) Vintage of collateralised debt obligations by geographical location of issuer or counterparty
| 2009 | Nominal | Original credit enhancements | Original sub-prime exposure | Original vintage | |||||
| Pre-2005 | 2005 | 2006 | 2007 | 2008 | 2009 | ||||
| Country | £m | £m | £m | % | % | % | % | % | % |
| ABS CDO |
|
|
|
|
|
|
|
|
|
| UK | - | - | - | - | - | - | - | - | - |
| Rest of Europe | 2 | - | - | 50 | 50 | - | - | - | - |
| US | 48 | 15 | 14 | 33 | 65 | 2 | - | - | - |
|
| 50 | 15 | 14 | 34 | 64 | 2 |
|
|
|
| Synthetic CDO |
|
|
|
|
|
|
|
|
|
| US | 95 | 11 | - | 100 | - | - | - | - | - |
|
| 95 | 11 | - | 100 | - | - | - | - | - |
| Other CDO |
|
|
|
|
|
|
|
|
|
| US | 70 | 8 | 1 | 38 | 5 | 24 | 33 | - | - |
|
| 70 | 8 | 1 | 38 | 5 | 24 | 33 | - | - |
| Total | 215 | 34 | 15 | 64 | 17 | 8 | 11 | - | - |
(c) Fair value movements by credit rating of issuer or counterparty
| 2009 |
|
|
|
| Fair value as % of nominal | 2009 movement | Original exposure to sub-prime | Original credit enhancement | ||
| Nominal value | Book value | Fair Value | Income statement | Reserves | Provisions | |||||
| Credit rating | £m | % | £m | £m | % | £m | £m | £m | % | % |
| AAA | 16 | 7 | 8 | 8 | 50 | (1) | - | - | - | 26 |
| AA | 64 | 30 | 48 | 48 | 75 | (1) | (4) | - | 1 | 13 |
| A | 17 | 8 | 7 | 7 | 41 | (1) | - | - | 10 | - |
| BBB | 23 | 11 | 15 | 15 | 65 | (1) | - | - | 1 | 1 |
| Below BBB | 95 | 44 | 52 | 52 | 55 | (7) | - | (3) | 6 | 2 |
| Total | 215 | 100 | 130 | 130 | 60 | (11) | (4) | (3) | 4 | 7 |
| 2008 |
|
|
|
| Fair value as % of nominal | 2008 movement | Original exposure to sub-prime | Original credit enhancement | ||
| Nominal value | Book value | Fair Value | Income statement | Reserves | Provisions | |||||
| Credit rating | £m | % | £m | £m | % | £m | £m | £m | % | % |
| AAA | 147 | 40 | 91 | 75 | 51 | - | - | - | 1 | 34 |
| AA | 38 | 10 | 18 | 17 | 45 | - | - | - | 10 | 35 |
| A | 11 | 3 | 4 | 4 | 36 | - | - | - | 13 | 23 |
| BBB | 18 | 5 | 7 | 6 | 33 | - | - | - | 14 | 8 |
| Below BBB | 152 | 42 | 44 | 28 | 18 | - | - | - | 41 | 21 |
| Total | 366 | 100 | 164 | 130 | 36 | - | - | - | 19 | 27 |
(d) Vintage of collateralised debt obligations by credit rating of issuer or counterparty
| 2009 | Nominal | Original credit enhancements | Original sub-prime exposure | Original vintage | |||||
| Pre-2005 | 2005 | 2006 | 2007 | 2008 | 2009 | ||||
| Credit rating | £m | £m | £m | % | % | % | % | % | % |
| ABS CDO |
|
|
|
|
|
|
|
|
|
| AAA | 12 | 6 | - | - | 100 | - | - | - | - |
| AA | 12 | 3 | 2 | 100 | - | - | - | - | - |
| A | 1 | - | - | 100 | - | - | - | - | - |
| BBB | 5 | 1 | 2 | 100 | - | - | - | - | - |
| Below BBB | 20 | 5 | 10 | - | 95 | 5 | - | - | - |
|
| 50 | 15 | 14 | 35 | 63 | 2 | - | - | - |
| Synthetic CDO |
|
|
|
|
|
|
|
|
|
| AAA | - | - | - | - | - | - | - | - | - |
| AA | - | - | - | - | - | - | - | - | - |
| A | 15 | 1 | - | 100 | - | - | - | - | - |
| BBB | 16 | 3 | - | 100 | - | - | - | - | - |
| Below BBB | 64 | 7 | - | 100 | - | - | - | - | - |
|
| 95 | 11 | - | 100 | - | - | - | - | - |
| Other CDO |
|
|
|
|
|
|
|
|
|
| AAA | 3 | 1 | - | 67 | - | 33 | - | - | - |
| AA | 51 | 7 | 1 | 39 | - | 11 | 50 | - | - |
| A | 1 | - | - | - | 100 | - | - | - | - |
| BBB | 2 | - | - | 50 | 50 | - | - | - | - |
| Below BBB | 13 | - | - | 31 | - | 69 | - | - | - |
|
| 70 | 8 | 1 | 39 | 3 | 22 | 36 | - | - |
| Total | 215 | 34 | 15 | 64 | 17 | 8 | 11 | - | - |
In addition, in the ordinary course of business, the Group entered into long-term interest rate hedging contracts with five investment vehicles whose underlying assets comprise debt securities, bank loans and energy and infrastructure financings. Although the vehicles themselves are not externally rated, the counterparty exposure ranks super-senior to the most senior notes issued by the vehicles and these notes are rated AAA or AA. The total mark-to-market exposure at 31 December 2009 was £100m (2008: £186m).
Collateralised Loan Obligations
(a) Fair value movements by geographical location of issuer or counterparty
| 2009 |
|
| Fair value | Fair value as % of nominal | 2009 movement | |||
| Nominal value | Book value | Income statement | Reserves | Provisions | ||||
| Country | £m | % | £m | £m | % | £m | £m | £m |
| UK | 93 | 13 | 87 | 82 | 88 | (1) | (4) | - |
| Rest of Europe | 42 | 6 | 36 | 28 | 67 | - | (5) | - |
| US | 568 | 81 | 516 | 496 | 87 | - | (11) | - |
| Total | 703 | 100 | 639 | 606 | 86 | (1) | (20) | - |
| 2008 |
|
|
|
| 2008 movement | |||
| Nominal value | Book value | Fair value | Fair value as % of nominal | Income statement | Reserves | Provisions | ||
| Country | £m | % | £m | £m | % | £m | £m | £m |
| UK | 115 | 33 | 108 | 94 | 82 | - | - | - |
| Rest of Europe | 47 | 13 | 41 | 30 | 64 | - | - | - |
| US | 190 | 54 | 172 | 123 | 65 | - | - | - |
| Total | 352 | 100 | 321 | 247 | 70 | - | - | - |
(b) Vintage of collateralised loan obligations by geographical location of issuer or counterparty
| 2009 | Nominal | Original credit enhancements | Original sub-prime exposure | Original vintage | |||||
| Pre-2005 | 2005 | 2006 | 2007 | 2008 | 2009 | ||||
| Country | £m | £m | £m | % | % | % | % | % | % |
| UK | 93 | 13 | - | 14 | 59 | 14 | 13 | - | - |
| Rest of Europe | 42 | 8 | - | 22 | 5 | 42 | 31 | - | - |
| US | 568 | 122 | - | 82 | 4 | 10 | 4 | - | - |
| Total | 703 | 143 | - | 70 | 11 | 12 | 7 | - | - |
(c) Fair value movements by credit rating of issuer or counterparty
| 2009 |
|
|
| 2009 movement | ||||||
| Nominal value | Book value | Fair value | Fair Value as % of nominal | Income statement | Reserves | Provisions | ||||
| Credit rating | £m | % | £m | £m | % | £m | £m | £m | ||
| AAA | 202 | 29 | 185 | 176 | 87 | (1) | (6) | - | ||
| AA | 254 | 36 | 225 | 218 | 86 | - | (1) | - | ||
| A | 181 | 26 | 161 | 157 | 87 | - | (4) | - | ||
| BBB | 56 | 8 | 49 | 39 | 70 | - | (7) | - | ||
| Below BBB | 10 | 1 | 19 | 16 | 160 | - | (2) | - | ||
| Total | 703 | 100 | 639 | 606 | 86 | (1) | (20) | - | ||
| 2008 |
|
|
|
| 2008 movement | |||
| Nominal value | Book value | Fair value | Fair Value as % of nominal | Income Statement | Reserves | Provisions | ||
| Credit rating | £m | % | £m | £m | % | £m | £m | £m |
| AAA | 276 | 78 | 257 | 211 | 76 | - | - | - |
| AA | 42 | 12 | 36 | 23 | 55 | - | - | - |
| A | 30 | 9 | 26 | 13 | 43 | - | - | - |
| BBB | 4 | 1 | 2 | - | - | - | - | - |
| Below BBB | - | - | - | - | - | - | - | - |
| Total | 352 | 100 | 321 | 247 | 70 | - | - | - |
(d) Vintage of collateralised loan obligations by credit rating of issuer or counterparty
| 2009 | Nominal | Original credit enhancements | Original sub-prime exposure | Original vintage | |||||
| Pre-2005 | 2005 | 2006 | 2007 | 2008 | 2009 | ||||
| Credit rating | £m | £m | £m | % | % | % | % | % | % |
| AAA | 202 | 40 | - | 43 | 28 | 24 | 5 | - | - |
| AA | 254 | 50 | - | 92 | 6 | 2 | - | - | - |
| A | 181 | 38 | - | 84 | - | 8 | 8 | - | - |
| BBB | 56 | 12 | - | 24 | - | 34 | 42 | - | - |
| Below BBB | 10 | 1 | - | 70 | 30 | - | - | - | - |
| Total | 703 | 141 | - | 70 | 11 | 12 | 7 | - | - |
Other investments
|
| Book value | Fair value | Book value | Fair value |
|
| 2009 £m | 2009 £m | 2008 £m | 2008 £m |
| Principal Protected Notes | 24 | 26 | 34 | 31 |
| Other | 437 | 436 | 145 | 156 |
|
| 461 | 462 | 179 | 187 |
The Principal Protected Notes are backed by highly rated bank counterparties and are due to mature by the end of 2016. Other investments of £437m (2008: £145m) consisted primarily of Corporate lending transactions that were completed by Corporate Banking.
Exposure to Off-Balance Sheet Entities sponsored by the Group
Secured Loan to Conduit
The Group's Conduit facility is funded by the Group via secured loans. Prior to 2009, the Conduit was not consolidated into the Group accounts on the basis that the Special Purpose Entities ('SPEs') within the Conduit were not controlled by the Group. However, in the second half of 2009, the Group took an active role in the management of the Conduit's assets. Although there has been no change in the terms and conditions of the Group's loans to the Conduit, management has concluded that the Group is now required to consolidate the assets of the Conduit vehicles, rather than recognising the loans to the Conduit vehicles and treating the assets of the Conduit vehicles as off-balance sheet.
Consolidation of the assets of the Conduit vehicles has not had a significant impact on the Group's income statement and balance sheet. The assets of the Conduit vehicles consist of ABS (including Alt-A US residential mortgage-backed securities), CLOs and CDOs, and are consolidated in the respective tables above as at 31 December 2009.
The underlying assets within the Conduit vehicles at 31 December 2008 analysed by asset type and credit rating were as follows:
31 December 2008
| Asset Type | Credit rating | Nominal | Cumulative Impairment | Original credit enhancement | Original sub-prime exposure | Original vintage | |||
| Pre-2005 | 2005 | 2006 | 2007 | ||||||
|
|
| £m | £m | % | % | % | % | % | % |
| ABS |
|
|
|
|
|
|
|
|
|
| US RMBS | AAA | 46 | - | 32 | - | 39 | 61 | - | - |
| (ALT-A) | AA | 5 | - | 18 | - | 100 | - | - | - |
|
| Below BBB | - | - | - | - | - | - | - | - |
| Total ABS |
| 51 | - | 30 | - | 45 | 55 | - | - |
| CLO |
|
|
|
|
|
|
|
|
|
|
| AAA | 442 | - | 24 | - | 99 | - | - | 1 |
|
| AA | 33 | - | 29 | - | 82 | 18 | - | - |
|
| A | 30 | - | 26 | - | 100 | - | - | - |
| Total CLO |
| 505 | - | 24 | - | 98 | 1 | - | 1 |
| CDO |
|
|
|
|
|
|
|
|
|
| ABS CDO | AAA | 19 | - | 24 | 36 | 100 | - | - | - |
|
| AA | 26 | - | 28 | 44 | 100 | - | - | - |
|
| BBB | 28 | 4 | 26 | 45 | 100 | - | - | - |
|
| Below BBB | 45 | 17 | 30 | 65 | 100 | - | - | - |
|
|
| 118 | 21 | 28 | 51 | 100 | - | - | - |
| Synthetic CDO |
|
|
|
|
|
|
|
| |
|
| AAA | 27 | - | 19 | - | - | 100 | - | - |
|
| A | 76 | 6 | 10 | - | 32 | 68 | - | - |
|
| BBB | 17 | 14 | 10 | - | - | 100 | - | - |
|
| Below BBB | 34 | 31 | 5 | - | - | 100 | - | - |
|
|
| 154 | 51 | 10 | - | 16 | 84 | - | - |
| Other |
|
|
|
|
|
|
|
|
|
|
| AAA | 73 | - | 45 | - | 45 | - | 55 | - |
|
| AA | 17 | - | 61 | - | - | 41 | 59 | - |
|
| A | 11 | - | 49 | - | - | 100 | - | - |
|
|
| 101 | - | 48 | - | 32 | 18 | 50 | - |
| Total CDO |
| 373 | 72 | 26 | 16 | 47 | 40 | 13 | - |
| Total Conduit assets | 929 | 72 |
|
| 74 | 19 | 6 | 1 | |
The only other SPEs sponsored but not consolidated by the Group are SPEs which issue shares that back retail structured products. The Group's arrangements with these entities comprise the provision of equity derivatives and a secondary market-making service to those retail customers who wish to exit early from these products. The total value of products issued by the SPEs is £5,798m (2008: £3,213m), and the total value of repurchases held by the Group is £234m (2008: £254m).
Credit Derivatives
As noted above, previously, Global Banking & Markets operated a credit derivatives business. The business traded in single-name credit derivatives, credit derivative indices and a limited number of portfolio credit derivative transactions. The credit derivatives trading function operated within the same framework as other trading functions. Risk limits were established and monitored. There is a limited number of remaining credit derivative transactions with a nominal value of £772m (2008: £1.1bn) where the Group faces external counterparties and the risk has been hedged with Banco Santander, S.A. in Spain.
Lending Activities
The Group is principally a retail prime lender and has no appetite or product offering for sub-prime business. The Group's credit policy explicitly prohibits such lending and is specifically designed to ensure that any business written is responsible, affordable (both initially and an on-going basis) and of a good credit quality. The Group's principal lending activities arise in the Retail Banking division. For further information, see Risk Management in Retail Banking.
Liquidity
In addition to funding customer loans and advances, the Group also holds available liquid assets, in the form of cash and short-term deposits, to manage the day-to-day requirements of the business. The Group holds a higher level of liquid assets than in 2008, in recognition of the current market conditions.
Report of the Directors
Directors
Board of Directors
As at 31 December 2009
Chairman
Lord Burns
Lord Burns (age 66) was appointed Joint Deputy Chairman on 1 December 2001 and Chairman on 1 February 2002. He is also Chairman of Alliance & Leicester plc, Channel 4 Television Corporation, and Glas Cymru Cyfyngedig (Welsh Water) and a Non-Executive Director of Pearson plc and Banco Santander, S.A.. His current professional roles include President of the Society of Business Economists, Fellow of the London Business School, Companion of the Institute of Management, President of the National Institute of Economic and Social Research and Vice President of the Royal Economic Society. He was formerly Permanent Secretary to the Treasury and chaired the Parliamentary Financial Services and Markets Bill Joint Committee. He was a Non-Executive Director of British Land plc (2000-2005) and Legal & General Group plc (1991-2001). He was also Chairman of the National Lottery Commission (2000-2001) and Marks and Spencer Group plc (2006-2008).
Executive Directors
António Horta-Osório
Chief Executive
António Horta-Osório (age 46) was appointed Chief Executive on 21 August 2006. He was a Non-Executive Director from 1 December 2004 until his appointment as Chief Executive. He joined from Banco Santander Totta in Portugal where he was Chief Executive Officer since 1999. He is also Chief Executive of Alliance & Leicester plc, Executive Vice President of Banco Santander, S.A. and a member of its management committee as well as Non-Executive Chairman of Banco Santander Totta and a Non-Executive Director to the Court of The Bank of England. He was previously Chief Executive Officer of Banco Santander Brasil (1996-1999). António started his career at Citibank Portugal, where he was head of Capital Markets and at the same time was an assistant professor at the Universidade Católica Portuguesa. He then worked for Goldman Sachs in New York and London, focusing on corporate finance activities in Portugal and, in 1993, joined the Santander group as Chief Executive Officer of Banco Santander de Negócios Portugal. He is a graduate in Management and Business Administration at Universidade Católica Portuguesa, has an MBA from INSEAD, where he was awarded the Henry Ford II Prize, and an AMP from Harvard Business School.
Antonio Lorenzo
Chief Financial Officer
Antonio Lorenzo (age 43) was appointed as an Executive Director and Chief Finance Officer on 1 June 2009, following his appointment as Financial Controller and Head of Private Banking in November 2004. He is also an Executive Director of Alliance & Leicester plc and his additional responsibilities include heading up the Intermediary division. Antonio first joined the Banco Santander, S.A. group as a Financial Controller of the Global Wholesale division (Spain) in 1998. In 2003, Antonio moved to Chile to head Latam and Global Wholesale Banking MI division. Before he joined the Santander group, Antonio worked at Arthur Andersen (Spain). He was part of the Financial Services Audit Team and was an advisor in the Treasury and Capital Markets area. At that time he taught Auditing at the European University of Madrid. He is a member of the official Registry of Auditors of Spain and holds two Bachelors degrees, in Economics (Universidad Complutense de Madrid) and Law (UNED).
Juan Colombás Chief Risk Officer
Juan Colombás (age 47) was appointed as an Executive Director on 31 July 2009 and is responsible for the Risk division. He is also an Executive Director of Alliance & Leicester plc. Juan joined in 2006 as Chief Risk Officer and has over 23 years of experience in a range of Risk, Control and Business Management roles across the Corporate Banking, Investment Banking, Retail Distribution and Risk Divisions of the Santander group. Juan joined the Commercial Banking Division and Internal Audit Division of Banco Hispano Americano as a trainee in 1986. He graduated top of his class in BSc Industrial Chemical Engineering and has a Financial Management Degree and an MBA.
Alison Brittain Executive Director, Retail Distribution Alison Brittain (age 45) was appointed Executive Director, Retail Distribution on 2 January 2008. She is responsible for Branch Distribution, Telephone Distribution, e-commerce, Business Banking and Commercial Mortgages. She was previously Managing Director of the Barclays and Woolwich Retail Network and the Small Business Banking division of Barclays Bank plc. She is also an Executive Director of Alliance & Leicester plc.
Non-Executive Directors Juan Rodríguez Inciarte
Deputy Chairman
Juan Inciarte (age 57) was appointed Non-Executive Director on 1 December 2004. He joined Banco Santander, S.A. in 1985. After holding various positions, he was appointed to the Board of Directors in 1991, holding this office until 1999. He is currently a Board Member and Head of Strategy of Banco Santander, S.A., a Director of Santander Consumer Finance, S.A., Non-Executive Director of Alliance & Leicester plc, Director of ABN AMRO Holding N.V. and Director of RFS Holdings B.V.. In addition, he is a director of Banco Banif S.A. and of Vista Capital de Expansion S.A.. For several years he served on the Board of Directors of First Union Corporation (now Wachovia Bank) in the US, the Board of Directors and Executive Committee of San Paolo - IMI in Italy and the Boards of the Royal Bank of Scotland plc and National Westminster Bank plc (from 1998 - 2004). He also held the positions of Executive Director of NIBC Bank N.V. in the Netherlands (from 2005 - 2007), Director and Member of the Executive Committee of Sovereign Bancorp in the US (from 2006 - 2008) and Director of Compañía Española de Petróleos (from 1999 - 2009). He is also Chairman of the US-Spain Council and a Fellow of The Chartered Institute of Bankers in Scotland.
Jane Barker
Jane Barker (age 60) was appointed Non-Executive Director on 21 October 2008. She is Chief Executive Officer of Equitas Limited, the company set up to re-insure and run-off the 1992 and prior years' non-life liabilities of Lloyd's of London syndicates and a Non-Executive Director of Alliance & Leicester plc. She is Deputy Chairman of the Royal College of Music and was previously a member of the council and chair of the Audit Committee of the Open University. Her previous roles have included being Finance Director of the London Stock Exchange.
Roy Brown
Roy Brown (age 63) was appointed Non-Executive Director on 21 October 2008. He is a Chartered Engineer and is Chairman of GKN plc and a Non-Executive Director of Alliance & Leicester plc. Formerly, he was a Senior Independent Director of HMV Group plc, Executive Director of Unilever plc and NV, a Non-Executive Director of Brambles Industries plc, the British United Provident Association Ltd (BUPA) and the Franchise Board of Lloyd's of London.
José María Carballo
José María Carballo (age 66) was appointed Non-Executive Director on 1 December 2004. He is a Non-Executive Director of Alliance & Leicester plc, Chairman of La Unión Resinera Española, Chairman of Vista Desarrollo, Director of Vista Capital Expansion S.A. S.G.E.C.R., Director of Teleférico Pico del Teide S.A. and Director of Santander Banif Inmobiliario F.I.I.. He is also Vice President and Honorary Treasurer of the Iberoamerican Benevolent Society (UK). He was Executive Vice President of Banco Santander, S.A. from 1989-2001 and Chief Executive Officer of Banco Santander de Negocios from 1989 to 1993. Until 1989 he was Executive Vice President responsible for Europe at Banco Bilbao Vizcaya. He was also Executive Vice President of Banco de Bilbao in New York until 1983.
José María Fuster
José María Fuster (age 51) was appointed Non-Executive Director on 1 December 2004. He is Executive Vice President of Operations and Technology, and Chief Information Officer of Banco Santander, S.A., Non-Executive Director of Banesto and Non-Executive Director of Alliance & Leicester plc. He joined Banesto in 1998 and was appointed as Chief Information Officer of Banco Santander, S.A. in 2003. He started his professional career with International Business Machines, S.A. and Arthur Andersen as a consultant. He has also worked for Citibank España, S.A. and National Westminster Bank plc.
Rosemary Thorne
Rosemary Thorne (age 58) was appointed Non-Executive Director on 1 July 2006. She is also a Non-Executive Director on the Board of Smurfit Kappa Group plc and a Non-Executive Director of Alliance & Leicester plc. She was Group Finance Director of Ladbrokes plc until April 2007, Non-Executive Director of Cadbury Schweppes plc until September 2007 and Senior Independent Director on the Board of Virgin Radio Holdings Limited until June 2008. Previously, she was Group Financial Controller of Grand Metropolitan Public Limited Company (prior to its merger with Guinness plc to become Diageo plc) and spent almost eight years as the Group Finance Director of J Sainsbury plc. She joined the Board of Bradford & Bingley plc in 1999 as Group Finance Director, initially working on its demutualisation and flotation, resulting in a place in the FTSE 100 in December 2000. She remained in this role for a further five years. She was a member of the Financial Reporting Council and Financial Reporting Review Panel for nine years and a member of The Hundred Group of Finance Directors Main Committee for 15 years.
Keith Woodley
Keith Woodley (age 70) was appointed Non-Executive Director on 5 August 1996. He was made Senior Independent Non-Executive Director in April 1999 and was Deputy Chairman from 6 April 1999 until November 2004. He is a Non-Executive Director of Alliance & Leicester plc, former Non-Executive Director of National and Provincial Building Society and a former partner of Deloitte Haskins & Sells. A past President of the Institute of Chartered Accountants in England and Wales, he is a Council Member and Pro-Chancellor of the University of Bath.
Corporate Structure
Santander UK plc (formerly Abbey National plc) (the 'Company') is a wholly-owned subsidiary of Banco Santander, S.A.. The ordinary shares of the Company are not traded on the London Stock Exchange. Banco Santander, S.A. is incorporated in Spain and has its registered office at Paseo de Pereda 9-12, Santander, Spain. Note 20 to the Consolidated Financial Statements provides a list of the principal subsidiaries of the Company, the nature of each subsidiary's business and details of branches.
Corporate Governance
The Company is subject to the Listing Rules and the Disclosure & Transparency Rules of the UK Financial Services Authority, because it has preference shares listed on the London Stock Exchange. As it does not have listed ordinary shares, the Company is exempt from the requirement to make certain disclosures that are normally part of the continuing obligations of listed companies in the UK. This exemption applies, among other things, to corporate governance and certain Directors' remuneration disclosures.
Principal Activities and Business Review
The principal activity of Santander UK plc, company number 2294747, and its subsidiaries (together 'Santander UK' or the 'Group') continues to be the provision of an extensive range of personal financial services. In addition, Santander UK provides a wide range of banking and financial services to business and public sector customers. The Company is authorised and regulated by the UK Financial Services Authority.
The Company is required to set out in this report a fair review of the development and performance of the business of the Group during the year ended 31 December 2009 and of the position of the Group at the end of the year. The information that fulfils this requirement can be found in the Chief Executive's Review on pages 2 to 4. The Chief Executive's Review also contains a description of the likely future developments for the Group. When reading the Chief Executive's Review, reference should be made to the Forward-looking Statements section on page 5.
Further information on the development and performance of the business of the Group, both at a consolidated level and analysed by division can be found in the following sections:
| > | An analysis of the Group's development and performance during the year is contained in the Business Review - Summary on pages 10 to 16. |
| > | A further detailed analysis of the Personal Financial Services businesses is contained in the Business Review - Personal Financial Services on pages 19 to 26. |
Further information on the position of the Group at the end of the year can be found in the following sections:
| > | An analysis of the Personal Financial Services business volumes is contained in the Business Review - Personal Financial Services on pages 21 to 23. |
| > | The Balance Sheet Business Review can be found on pages 29 to 48, including a review of capital management and resources on page 41, details of capital expenditure on page 36, off-balance sheet arrangements on page 40, liquidity on pages 43 to 46, and contractual obligations on page 40. |
| > | The Group's key performance indicators are described in the Business Review - Summary on page 17. |
The Company is also required to describe the principal risks and uncertainties facing the Group. Financial risks are described in the Risk Management Report for each segment of the business by type of risk on pages 49 to 85, and material risk factors are described in the Risk Factors section on pages 192 to 197.
Results and Dividends
The results of the Group are discussed in the Principal Activities and Business Review above. The Directors do not recommend the payment of a final dividend (2008: £nil). An interim dividend of £500m was declared on 22 December 2009 on the Company's ordinary shares in issue and this will be paid during 2010. An Interim dividend of £225m was declared in 2008 and paid in 2009.
Events after the balance sheet date
On 25 February 2010 it was announced that Alliance & Leicester plc intends to transfer its business into the Company later this year under a scheme allowed by Part VII of the Financial Services and Markets Act 2000. This transfer is subject to UK Financial Services Authority support and Court approval. The transfer will provide benefits for Alliance & Leicester plc customers and for the Company. For Alliance & Leicester plc customers this includes access to Santander UK's full product range plus use of over 1,300 branches, four times as many branches currently available for Alliance & Leicester plc customers. By rationalising systems and improving the sales and risk management processes through having a single view of customers' dealings, the Company will also benefit from the significant synergies that were announced to the market at the time of the acquisition of Alliance & Leicester plc by Banco Santander, S.A. in 2008.
On 26 February 2010 it was announced that as the Alliance & Leicester plc preference shares will not transfer to the Company under the proposed Part VII Transfer, Alliance & Leicester plc and Santander UK plc have agreed that the holders of the Alliance & Leicester plc preference shares should be given the opportunity to exchange their Alliance & Leicester plc preference shares for new preference shares to be issued by the Company. It is intended that the exchange will be carried out by a scheme of arrangement under Part 26 of the Companies Act 2006, which, if approved by the Court as well as holders of the Alliance & Leicester plc preference shares and the Company (as holder of the ordinary shares of Alliance & Leicester plc), the Alliance & Leicester plc preference shares would be substituted with a new issue of preference shares by Santander UK plc on substantially similar terms.
In March 2010 the Group issued through the Fosse Master Trust the first publicly-placed mortgage-backed securitisation transaction from a UK bank since 2007; other recent transactions from UK banks had included an investor put. The transaction was denominated in both pounds sterling and euro and raised approximately £1.4bn.
There were no other significant events after the balance sheet date.
Going Concern
The Directors confirm that they are satisfied that the Group has adequate resources to continue in business for the foreseeable future. For this reason, they continue to adopt a going concern basis in preparing the financial statements.
As outlined above, the Group's business activities, together with the factors likely to affect its future development, performance and position are set out in the Chief Executive's Review on pages 2 to 4 and in the Business Review on pages 10 to 26. The financial position of the Group, its cash flows, liquidity position and borrowing facilities are described in the Balance Sheet Business Review on pages 29 to 48. In addition, Note 50 to the Consolidated Financial Statements includes the Group's objectives, policies and processes for managing its capital; its financial risk management objectives; details of its financial instruments and hedging activities; and its exposures to credit risk and liquidity risk. As also outlined above, in respect of the principal risks and uncertainties facing the Group, financial risks are described in the Risk Management Report on pages 49 to 85, and material risk factors are described in the Risk Factors section on page 192 to 197.
In assessing going concern, the Directors take account of all information of which they are aware about the future, which is at least, but is not limited to, twelve months from the date that the balance sheet is signed. This information includes the Group's results forecasts and projections, estimated capital, funding and liquidity requirements as well as contingent liabilities, and possible economic, market and product developments, taking account of reasonably possible changes in trading performance.
| > | Budgets and forecasts Since the acquisition of the Company by Banco Santander, S.A., the Group has a history of profitable operations. Management prepares a 3-year plan (the '3-Year Plan') that forecasts balance sheet, income and margin, by product, with a particular focus on the forthcoming year. | |||
|
| > | Review and reforecast The 3-Year Plan, its assumptions, forecast results and key sensitivities are reviewed by senior management and presented to the Executive Committee, the Board of Directors and to senior executives of Banco Santander, S.A.. The budget is reforecast frequently and reviewed by the Executive Committee and the Board of Directors. As part of the budgets and planning process, a particular emphasis is placed on ensuring the sustainability of earnings, and achieving and maintaining a high level of operating efficiency in the Group (measured by the PFS trading cost:income ratio) to enable competitive products to be developed for customers. | ||
|
| > | Stress testing To assess the Group's ability to adapt to various market challenges, the budgets are "stress tested" as part of the Group's internal capital adequacy assessment process ('ICAAP') under Basel II. Several scenarios are modelled, including a severe scenario, and senior management makes an assessment of how this would affect the Group's profit and funding plans.
| ||
| > | Borrowing requirements and liability management The Group's financial plans are constructed to ensure that they allow the Group to meet its financial obligations as they fall due, both with respect to maturing existing liabilities and future borrowing requirements. The Group's funding requirements are met from a variety of sources, with a significant majority being sourced from retail and corporate deposits (i.e. the commercial bank's customers). At 31 December 2009, commercial bank customer assets as a percentage of commercial bank customer liabilities stood at 126% (2008: 136%). The balance of the Group's funding is sourced from the wholesale markets with reference to prevailing and expected market conditions and the desired balance sheet structure. The Board considers it appropriate to balance cost effective short-term financing with medium and long-term funds, which have less refinancing risk, all within the context of maintaining a diverse range of sources of wholesale funding. Asset and Liability Management produce strategic and tactical funding plans as part of the Group's planning process. These funding plans are approved by the Board and the Asset & Liability Management Committee and are controlled on a day-to-day basis by the Treasurer, Head of ALM and within the framework of the Liquidity Risk Manual. The plans are stressed to ensure adverse conditions can be accommodated via a range of management levers. Funding and liquidity management is the responsibility of the Chief Financial Officer who delegates day-to-day responsibility to the Treasurer, Head of ALM. Liquidity risk control and oversight are provided by the Chief Risk Officer, supported by the Risk Division. See the Risk Management Report for further details on Liquidity Risk Management.
| |||
| > | Contingent liabilities The Directors, via the Audit and Risk Committee, also consider the Group's exposure to contingent liabilities. This consideration addresses contingent liabilities experienced by the Group in the past, such as legal proceedings, guarantees, operating lease commitments, product misselling liabilities, and those arising in respect of the UK Financial Services Compensation Scheme, but also considers whether there are any new contingencies. | |||
|
| Contingent liabilities are captured on a timely basis for purposes of disclosure in the Annual Report and Accounts, and the interim financial statements. Information about guarantees to third parties, tax contingencies and other contingencies are gathered and disclosed. Data about the Group's operating lease commitments are also captured. Non-trading guarantees require the approval of the Chief Executive or the Chief Financial Officer or, in their absence, any two Company Executive Directors or one Company Executive Director and the Company Secretary. This provision forms part of the Company's Corporate Governance Framework (other Financial Delegated Authorities).
| |||
| > | Products and markets The Directors review information about the major aspects of the economic environment within which the Group operates at monthly Board meetings. This information includes an economic update which contains data on key economic and market trends. In addition, the Group's Economic Analysis team monitors and provides information to the Board on current and prospective economic and market developments. Retail financial markets, such as the housing market, are a major focus for analysing current trends and potential developments. The Directors also receive regular briefings on market share for the Group's major products and six-monthly competitor analyses. Wholesale market conditions are reviewed daily by the Treasurer, Head of ALM and presented monthly to the Asset & Liability Management Committee by way of an update. The tactical and strategic funding plans are updated, if necessary, with reference to current and expected market conditions.
| |||
| > | Financial risk management The Group's risk management focuses on major areas of risk, namely credit risk, market risk, liquidity risk, and operational risk. The Risk Management Report sets out in detail how the Group manages these risks.
| |||
| > | Financial adaptability The Directors also consider the ability of the Group to take effective action to alter the amounts and timing of cash flows so that it can respond to unexpected needs or opportunities. Such financial adaptability mitigates the areas of financial risk above in considering the appropriateness of the going concern presumption in relation to the Group. In determining the financial adaptability of the Group, the Directors have considered the ability of the Group to: | |||
|
| > | Obtain new sources of finance The Group minimises refinancing risk by sourcing funds from a variety of markets as appropriate and subject to consideration of the appropriate leverage ratio and funding mix for the Group, and in particular customer deposit levels and medium-term financing. The Group actively manages its relationships with existing providers of funding and considers new sources of funds as and when they arise. Day-to-day sources of finance consist primarily of retail deposits. To the extent that wholesale funding is required, a variety of sources are usually available from a range of markets, including: | ||
|
|
| - | money markets: both unsecured (including interbank and customer deposits, and issuances of certificates of deposit and commercial paper) and secured (including repos in open market operations); | |
|
|
| - | debt capital markets (including discrete bond issues and medium term notes); | |
|
|
| - | mortgage-backed funding (including securitisation and covered bond issuance); and | |
|
|
| - | capital instruments (although primarily issued to maintain capital ratios). | |
|
|
| In addition to day-to-day funding sources, the Group has access to contingent sources from Central Banks, including the Bank of England, the Swiss National Bank, the US Federal Reserve and indirectly the European Central Bank. The Group ensures that it has access to these contingent facilities as part of its prudent liquidity risk management. See the Risk Management Report for further details on Liquidity Risk Management. The Group minimises reliance on any one market by maintaining a diverse funding base, and avoiding concentrations by maturity, currency and institutional type. It is expected that the next year may see some improvement in the wholesale markets compared to 2009, although this may well be slow and fragile. However, the Group is well positioned for the coming year given the improved loan to deposit ratio of 126% (136% in 2008) and the continuing de-leveraging of non-growth areas following the acquisition of Alliance & Leicester plc. | ||
|
| > | Obtain financial support from other group companies For liquidity purposes, the Group operates on a stand-alone basis. However, in case of stress conditions, it would consult with its parent company, Banco Santander, S.A., about financial support. | ||
|
| > | Continue business by making limited reductions in the level of operations or by making use of alternative resources The Group maintains and regularly updates a Contingency Funding Plan to cover potential extreme scenarios. In addition, the 3-Year Plan is stressed, as part of the ICAAP process, to ensure that the Group can accommodate extreme scenarios and the impact this would have on the 3-Year Plan and profits. In accommodating these extreme scenarios, various management levers would be utilised, including the encashment of certain liquid assets and a reduction in new business in Retail and Corporate Banking. | ||
After making enquiries, the Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis of accounting in preparing the Annual Report and Accounts.
Directors
The members of the Company's board (the 'Board') at 31 December 2009 are named on pages 86 to 87. For each Director, the date of appointment is shown. As at 31 December 2009, the Board comprised a Chairman, four Executive Directors including the Chief Executive, and seven Non-Executive Directors. At the date of publication of this report, the Board composition remains the same. The roles of Chairman and Chief Executive are separated and clearly defined. The Chairman is primarily responsible for the working of the Board and the Chief Executive for the running of the business and implementation of Board strategy and policy. The following Executive Directors resigned on 30 April 2009 and 31 May 2009 respectively; David Bennett and Nathan Bostock.
Non-Executive Directors have been appointed for an indefinite term (other than Jane Barker, Roy Brown, Rosemary Thorne and Keith Woodley, who have been appointed for a three-year term, after which their appointments may be extended upon mutual agreement).
When they were appointed, the appointments of António Horta-Osório, Antonio Lorenzo, Juan Colombás, Juan Rodríguez Inciarte, José María Fuster and José María Carballo were all proposed by Banco Santander, S.A.. The Company may pay an Executive Director instead of allowing them to work during their notice period.
Committees of the Board
The Board maintains two standing committees, which operate within written terms of reference.
Audit and Risk Committee
Membership of the Audit and Risk Committee is restricted to Non-Executive Directors. The Audit and Risk Committee's primary tasks are to review the scope of external and internal audit, to receive reports from the external auditors (currently Deloitte LLP) and the Chief Internal Auditor, and to review the interim information, annual financial statements and any other significant financial reports before they are presented to the Board, focusing in particular on accounting policies, compliance and areas of management judgement and estimates. The Audit and Risk Committee's scope also includes risk management and oversight and the review of the procedures in place for employees to raise concerns about possible wrongdoing in financial reporting and other matters. For a further discussion of the risk-control responsibilities of the Audit and Risk Committee, see the Risk Management sectionof the Annual Report and Accounts on page 51.
The Audit and Risk Committee more generally acts as a forum for discussion of internal control issues and contributes to the Board's review of the effectiveness of the Group's internal control and risk management systems and processes. The Audit and Risk Committee also conducts a review of the remit and reports of the internal audit function (which is a Banco Santander S.A. group function) in so far as it relates to the Group as well as the internal audit function's effectiveness, authority, resources and standing within the Group and management's response to their findings and recommendations.
The Group's relationship with the external auditors and the experience and qualifications of the external auditors are monitored by the Audit and Risk Committee and external auditor's audit plans and audit findings are reviewed by the Audit and Risk Committee. A framework for ensuring auditor independence has been adopted, which defines unacceptable non-audit assignments, pre-approval of acceptable non-audit assignments and procedures for approval of acceptable non-audit assignments.
The Audit and Risk Committee may make any recommendations to the Board as it sees fit and the Chairperson of the Audit and Risk Committee reports formally to the Board after each meeting. The Chairperson, Rosemary Thorne, has over 15 years of experience as Finance Director of FTSE 100 companies and was a member of the Financial Reporting Council, The Financial Reporting Review Panel and The Hundred Group of Finance Directors Main Committee. The Board has determined that Rosemary Thorne has the necessary qualifications and experience to qualify as an audit committee financial expert as defined in the rules promulgated under the US Securities Exchange Act of 1934, as amended, and the Board considers that she is independent in accordance with Section 303A.02 of the New York Stock Exchange Corporate Governance Rules.
The other members of the Audit and Risk Committee are José María Carballo, Keith Woodley, Roy Brown and Jane Barker. Pursuant to SEC Rule 10A-3(c)(2), which provides a general exemption from the requirement to have an audit committee for subsidiaries that are listed on a national securities exchange or market where the parent satisfies the requirement of SEC Rule 10A-3, the Company is exempt from the requirements of SEC Rule 10A-3. According to SEC Rule 10A-3(c)(2), additional listings of an issuer's securities are exempt from the audit committee requirements if the issuer is already subject to them as a result of listing any class of securities on any market subject to SEC Rule 10A-3. This exemption extends to listings of non-equity securities by a direct or indirect subsidiary that is consolidated or at least 50% beneficially owned by a parent company, if the parent is subject to the requirements as a result of the listing of a class of its equity securities. Consequently, as applied to the current shareholding structure of the Company, (as the wholly-owned subsidiary of Banco Santander, S.A.), the Company is exempt from the audit committee requirements of SEC Rule 10A-3 since: (i) the Company is a wholly-owned subsidiary of Banco Santander, S.A., (ii) Banco Santander, S.A. has equity securities listed on the New York Stock Exchange and is therefore subject to SEC Rule 10A-3, and (iii) the Company does not have any equity securities listed on the New York Stock Exchange or any other national securities exchange in the United States of America.
Remuneration Oversight Committee
Establishment of the Remuneration Oversight Committee was approved by the Board on 22 December 2009, with effect from 1 January 2010. The Remuneration Oversight Committee is primarily responsible for overseeing and supervising the Group's policies and frameworks covering remuneration and reward as applied in, or devolved to the UK. The members of the Remuneration Oversight Committee are Roy Brown (Chairman), José María Carballo, Keith Woodley, Rosemary Thorne and Jane Barker.
Directors' Remuneration (audited)
The aggregate remuneration received by the Directors of the Company in 2009 was:
| £ | |
| Salaries and fees | 3,714,844 |
| Performance-related payments | 3,476,749 |
| Other taxable benefits | - |
| Total remuneration excluding pension contributions | 7,191,593 |
| Pension contributions | 108,031 |
| Compensation for loss of office | 1,162,500 |
|
| 8,462,124 |
These totals exclude emoluments received by Directors in respect of their primary duties as Directors or Officers of Banco Santander, S.A. in respect of which no apportionment has been made.
Long-Term Incentive Plan (audited)
In 2009, four Executive Directors (2008: two) were granted conditional awards of shares in Banco Santander, S.A. under the Santander Long-Term Incentive Plan for a total fair value of £944,404 (2008: £702,952) based on a share price on 1 July 2009 of euro 8.14 (2008: euro 11.96). Under the Santander Long-Term Incentive Plans granted on 1 July 2009, 21 June 2008 and 31 December 2007, certain Executive Directors, Key Management Personnel (as defined in Note 44 to the Consolidated Financial Statements) and other nominated individuals were granted conditional awards of shares in Banco Santander, S.A.. The number of shares participants will receive depends on the performance of Banco Santander, S.A. during this period. All awards under the Santander Long-Term Incentive Plan will depend on Santander's Total Shareholder Return performance against a competitor benchmark group. Awards made prior to 2009 also depend on Santander's Earnings Per Share performance against a competitor benchmark group. 90.79% of the 40% of the 2007 conditional award of shares vested in July 2009. Subject to performance conditions being met, the remaining 60% of the 2007 conditional award will vest in July 2010, 100% of the 2008 conditional award will vest in July 2011 and 100% of the 2009 conditional award will vest in July 2012.
Remuneration of Highest Paid Director (audited)
In 2009, the remuneration, excluding pension contributions, of the highest paid Director was £3,440,436 (2008: £3,563,784) of which £2,589,259 (2008: £2,742,908) was performance related. There was no accrued pension benefit for the highest paid Director (2008: nil), other than that accrued by, or treated to be accrued by a Spanish subsidiary of Banco Santander, S.A.. A conditional award of shares was made to the highest paid Director under the Long-Term Incentive Plan during 2009 and 2008.
Bank Payroll Tax
In December 2009, the UK Government announced that the Finance Bill 2010 will introduce a bank payroll tax of 50% applicable to discretionary bonuses over £25,000 awarded to UK bank employees between 9 December 2009 and 5 April 2010. Draft legislation and guidance on its application has been published. The estimated cost of the payroll tax is £16m, which was provided in full in 2009.
Retirement Benefits (audited)
Defined benefit pension plans are provided to certain of the Group's employees. See Note 36 to the Consolidated Financial Statements for a description of the plans and the related costs and obligations. No retirement benefits are accruing for any directors under a defined benefit scheme (2008: one) in respect of their qualifying services to the Group.
In July 2009, as part of the Group's periodic review of its pension schemes, updated funding arrangements were agreed with the pension scheme trustees of one scheme.
Non-Executive Directors (audited)
Fees were paid to Non-Executive Directors in 2009 totalling £500,360 (2008: £390,710); this amount is included above in the table of Directors' remuneration.
Directors' Interests and Related Party Transactions (audited)
In 2009, loans were made to two Directors, with a principal amount of £3,000 outstanding at 31 December 2009. No directors had any loans in 2008. In 2009, loans were made to two members of the Group's Key Management Personnel, with a principal amount of £834,730 outstanding at 31 December 2009. See Notes 44 and 45 to the Consolidated Financial Statements included elsewhere in this Annual Report and Accounts for disclosures of deposits and investments made and insurance policies entered into by the Directors, Key Management Personnel and their connected persons with the Group at 31 December 2009. Note 45 to the Consolidated Financial Statements also includes details of other related party transactions.
In 2009, there were no other transactions, arrangements or agreements with the Group in which Directors or Key Management Personnel or persons connected with them had a material interest. No Director had a material interest in any contract of significance other than a service contract with the Group at any time during the year.
No Director held any interest in the shares of any company within the Group at any time during the year and no Director exercised or was granted any rights to subscribe for shares in any company within the Group. During 2009, no Directors exercised share options over shares in Banco Santander, S.A., the parent company of the Company (2008: one).
Third Party Indemnities
Enhanced indemnities are provided to the Directors of the Company by Santander UK plc against liabilities and associated costs which they could incur in the course of their duties to the Company. All of the indemnities remain in force as at the date of this Annual Report and Accounts. A copy of each of the indemnities is kept at the registered address shown on page 199.
Financial Risk Management Objectives
The financial risk management objectives and policies of the Group; the policy for hedging each major type of forecasted transaction for which hedge accounting is used; and the exposure of the Group to price risk, credit risk, liquidity risk and cash flow risk are outlined in the Risk Management Report on pages 49 to 85.
Pension Funds
The assets of the pension schemes are held separately from those of the Group and are under the control of trustees.
Three of the Group's pension schemes have a common corporate trustee which, at 31 December 2009, had nine directors, comprising six Group-appointed directors (one of whom is an independent trustee director) and three member-elected directors. The National & Provincial Building Society Pension Fund has a different corporate trustee, the Board of which at 31 December 2009 comprised three Group-appointed directors (one of whom is an independent trustee director), and three member-elected directors. The above four pension schemes were, as at 31 December 2009, invested in a Common Investment Fund which has a corporate trustee, comprising four Group-appointed directors and two scheme trustee appointed directors.
As at 31 December 2009 the Scottish Mutual Assurance plc Staff Pension Scheme had six trustees, of whom four are selected by the Group (two of whom are members and one of whom is an independent trustee) and two are elected by eligible members. In the case of the Scottish Provident Institution Staff Pension Fund, as at 31 December 2009 there were eight trustees, of whom five (one of whom is a member and one of whom is an independent trustee) are selected by the Group and the remaining three are elected by eligible members.
As at 31 December 2009 the Alliance & Leicester Pension Scheme had nine trustees, of whom five are selected by the Group (one of whom is an independent trustee) and four are elected by eligible members.
Asset management of the schemes is delegated to a number of fund managers and the trustees receive independent professional advice on the performance of the managers. Legal advice to the trustees of the various schemes is provided by external firms of solicitors. The audits of the pension schemes are separate from that of the Group. The audits of the Amalgamated, Associated Bodies, Group and The National & Provincial Building Society Pension schemes are undertaken by Grant Thornton UK LLP. The audits of the Scottish Mutual Assurance plc Staff Pension Scheme, the Scottish Provident Institution Staff Pension Fund and the Alliance & Leicester Pension Scheme are undertaken by KPMG LLP.
In July 2009, as part of the Group's periodic review of its pension schemes, updated funding arrangements were agreed with the pension scheme trustees of one scheme. Further information is provided in Note 36 to the Consolidated Financial Statements.
Market Value of Land and Buildings
On the basis of a periodic review process, the estimated aggregate market value of the Group's land and buildings was not significantly different from the fixed asset net book value of £420m (2008: £316m), as disclosed in Note 23 to the Consolidated Financial Statements. It is considered that, except where specific provisions have been made, the land and buildings have a value in use to the Group that exceeds the estimated market value, and the net book value is not impaired.
Disability
The Group is committed to equality of access and quality of service for disabled people and embraces the spirit of the UK Disability Discrimination Acts 1995 and 2005 throughout its business operations. The Group has processes in place to help recruit, train, develop, retain and promote employees with disabilities and is committed to giving full and fair consideration to applications for employment made by disabled persons, for continuing the employment of, and arranging appropriate training for, existing employees who have become disabled.
Employee Involvement
Employee share ownership
In January 2006, the Group introduced a Partnership Shares scheme, which also operates under the SIP umbrella. Employees are able to invest up to a maximum of £1,500 of pre-tax salary in Banco Santander, S.A. shares per tax year. These shares will be held in trust on the employees' behalf.
In recognition of the Banco Santander, S.A. 150th anniversary, all Group and Banco Santander, S.A. employees were given 100 free shares in Banco Santander, S.A. on 6 August 2007. These shares were granted under an existing SIP for Group employees and a new SIP was set up for UK-based Banco Santander, S.A. employees.
Following the acquisition of the Bradford & Bingley savings business in September 2008, the related employees who transferred to the Group were given 100 free shares in Banco Santander, S.A. on 8 April 2009. The free shares will be held in trust on the employees' behalf for a minimum of three years.
In recognition of the Banco Santander, S.A. acquisition of Alliance & Leicester plc, all Alliance & Leicester employees were given 100 free shares in Banco Santander, S.A. on 1 December 2008. These shares were granted using an HM Revenue & Customs approved Share Incentive Plan. The free shares will be held in trust on the employee's behalf for a minimum of three years.
In response to employee feedback, and in support of the Human Resources strategy, the Group introduced its first Sharesave Scheme under Banco Santander, S.A. ownership. The HM Revenue & Customs approved Sharesave Scheme was launched in September 2008. Employees were given the option of saving between £5 and £250 per month for a three or five-year savings period. The option price was set at a 20% discount on the average middle market quotation of Banco Santander, S.A. shares over the first three dealing days of September 2008.
A subsequent invitation under the Sharesave Scheme was made in September 2009, as part of which the scheme was extended to other UK companies within the Santander Group. The option price for the 2009 invitation was set at a 20% discount to the average middle market quotation of Banco Santander S.A. shares over the first three dealing days of September 2009.
Communication
The Group wants to involve and inform employees on matters that affect them. The Group publishes a magazine every quarter for employees, and almost all employees have access to the Company intranet. The Group also uses face-to-face communication, such as team meetings, regional roadshows and an annual staff convention. All these channels are designed to keep employees fully informed of news and developments which may have an impact on them, and also to keep them up to date on financial, economic and other factors which affect the Group's performance. The Group considers employees' opinions and asks for their views on a range of issues through regular company-wide surveys.
Consultation
The Group has a long history of trade union recognition governed by a partnership agreement with Advance, the independent trade union that it recognises to act as the voice of Santander UK employees. Advance is affiliated to the Trade Union Congress and operates from its own offices in Hertfordshire. Advance is involved in major Santander UK initiatives, and the Company consults it on significant proposals within the business. Consultation takes place at both national and local levels. Santander UK holds regular Joint Consultative and Negotiating Committee meetings to enable collaborative working and ensure that communication is open and two-way.
In May 2009 UBAC, the union recognised for Bradford & Bingley savings business staff, successfully completed a Transfer of Engagement to Advance following a ballot of members in which 83% of UBAC members voted in favour of the merger.
Within Alliance & Leicester we also work closely with the independent trade unions we recognise: the Communication Workers Union (CWU) and the Public & Commercial Services Union (PCS). Both unions are affiliated with the Trade Union Congress. Alliance & Leicester holds regular National Union Consultation Meetings to enable collaborative working and ensure that communication is open and two-way.
Donations
Santander UK Foundation Limited (formerly Abbey National Charitable Trust Limited) (the 'Foundation') supported disadvantaged people throughout the UK through the following three charitable priorities: education, financial capability and community regeneration. In 2009, Santander UK made total cash donations through the Foundation of £3,281,596 (2008: £2,316,701). Through the Staff Matched Donation Scheme, 1,150 staff donations to charities were matched during the year amounting to £1,025,634 (2008: £778,407).
Political Contributions
No contributions were made for political purposes and no political expenditure was incurred.
Suppliers
The Group has a Cost Management & Procurement Policy and process that is enforced across all significant purchases from suppliers to provide a consistent approach. Corporate and social responsibility is a key factor throughout the purchasing process. All new suppliers must adhere to the Group's Corporate & Social Responsibility Protocol, unless it is not relevant to the type of work being undertaken. The protocol covers human rights, labour standards, environment and anti-corruption, in line with the principles in the UN Global Compact.
Policy and Practice on Payment of Creditors
It is the Group's policy to ensure payments are made in accordance with the terms and conditions agreed, except where the supplier fails to comply with those terms and conditions. The Group's practice on payment of creditors has been quantified under the terms of Schedule 7 of The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008. Based on the ratio of the aggregate amounts owed to trade creditors at the end of the year to the aggregate amounts invoiced by suppliers during the year at 31 December 2009, trade creditor days for the Group were 17 days (2008: 27 days).
Code of Conduct
The Group is committed to maintaining high ethical standards - adhering to laws and regulations, conducting business in a responsible way and treating all stakeholders with honesty and integrity. The Group's policies in this regard are set out in 'How we do business'. This document, which was established in 1999 and reviewed and updated by the Board in 2003, was the subject of a review in 2008. This has resulted in the adoption of Banco Santander, S.A.'s General Code of Conduct.
Under the Code of Conduct, staff are required to act at all times with the highest standards of business conduct in order to protect the Group's reputation and ensure a company culture which is free from any risk of corruption, compromise or conflicts of interest.
The Core Principles outlined in the Code of Conduct state that employees must:
| > | Abide by all relevant laws and regulations. |
| > | Act with integrity in all their business actions on the Group's behalf. |
| > | Not use their authority or office for personal gain. |
| > | Conduct business relationships in a transparent manner. |
| > | Reject all improper practices or dealings they may be exposed to. |
| > | Be individually responsible for keeping to the Code of Conduct. |
The Group's ethical policies include ethical investment guidelines, which are an integral part of the risk management processes for investment decision making. Procedures are also in place for employees to follow if they feel that there has been a breach of our ethical policies.
The Group also complies with the applicable code of ethics regulations of the United States Securities and Exchange Commission promulgated under the US Securities Exchange Act of 1934, as amended. Among other things, these regulations aim to protect investors by improving the accuracy and reliability of information that companies disclose. The rules require companies to disclose whether they have a code of ethics that applies to the Chief Executive and senior financial officers that promotes honest and ethical conduct; full, fair, accurate, timely and understandable disclosures; compliance with applicable governmental laws, rules and regulations; prompt internal reporting of violations; and accountability for adherence to such a code of ethics. The Group meets these requirements through the Code of Conduct, the whistleblowing policy, the UK Financial Services Authority's Principles for Businesses, and the UK Financial Services Authority's Principles and Code of Practice for Approved Persons (together, the 'Code of Ethics'), with which the Chief Executive and senior financial officers must comply. These include requirements to manage conflicts of interest appropriately and to disclose any information the UK Financial Services Authority may want to know about. The Group provides a copy of its ethical policy to anyone, free of charge, on application to the address on page 199.
Supervision and Regulation
As a firm authorised by the UK Financial Services Authority, the Company is subject to UK financial services laws and regulations, which are discussed below. Recent significant regulatory developments which will affect the Group are also highlighted below.
UK
In the UK, the Financial Services Authority is the single independent regulator for the regulation of deposit taking, investment business, mortgages and insurance. The UK Financial Services Authority was set up by the government and exercises statutory powers under the UK Financial Services and Markets Act 2000 ('FSMA'). The Company, together with several of its subsidiaries, is authorised by the UK Financial Services Authority to carry on a range of regulated activities in the UK, which include mortgages, banking, insurance and investment business. The UK Financial Services Authority must adhere to four regulatory objectives, as prescribed in FSMA, which set out the parameters of regulation: market confidence; public awareness; the protection of consumers; and the reduction of financial crime. Based on these regulatory objectives, the UK Financial Services Authority has formulated an extensive handbook of rules and guidance to which authorised firms are subject.
Banks, insurance companies and other financial institutions in the UK are subject to the UK Financial Services Compensation Scheme (the 'FSCS'). The FSCS covers claims made against authorised firms (or any participating EEA firms) where they are unable, or likely to be unable, to pay claims against them. In relation to each of: deposits; investments; and mortgage advice and arranging, the FSCS provides cover for 100% of the first £50,000 of a claim, with £50,000 being the maximum amount payable per customer. The FSCS also extends (up to various amounts) to certain long-term and general insurance contracts, including general insurance advice and arranging.
UK Government Asset Protection Scheme
On 19 January 2009, the UK Government announced the implementation of a new asset protection scheme (the 'APS') pursuant to which, in return for a fee, the UK HM Treasury will provide to each participating institution protection against credit losses incurred on one or more portfolios of defined assets to the extent that credit losses exceed a"first loss"amount to be borne by the institution. The APS aims to target those assets where there is the greatest amount of uncertainty about their future performance including commercial and residential property loans and structured credit assets.
It was further announced on 26 February 2009 that UK HM Treasury protection will cover 90% of the credit losses which exceed the "first loss"amount, with each participating institution retaining a further residual exposure of 10% of any credit losses exceeding this amount. The APS is being offered, in the first instance, to those UK incorporated authorised deposit-takers (including UK subsidiaries of foreign institutions) with more than £25 billion of eligible assets. Following a detailed assessment of the potential benefits and costs of participation in the APS, Santander UK has determined that it does not wish to participate in the APS at this time.
European Union
The Group is directly affected by laws emanating from the European Union, primarily through directives that must be implemented by the UK as a Member State of the European Union.
Basel IIBasel II is a supervisory framework for the risk and capital management of banks and is structured around three pillars. Pillar 1 specifies minimum capital requirements for banks and new methodologies for calculating risk weighted assets. Pillar 2 describes the supervisory review process and outlines the internal capital adequacy assessment process ('ICAAP') required by banks applying Pillar 1 methodologies. Pillar 3 requires disclosure of risk and capital information. The Group's capital and risk management disclosures are set out in Note 50 to the Consolidated Financial Statements on page 185.
In the European Union, Basel II was implemented by the Capital Requirements Directive ('CRD') with effect from 1 January 2007. In the UK, the Financial Services Authority implemented the CRD by including it in UK Financial Services Authority rules. These new UK Financial Services Authority rules took effect from 1 January 2007. Throughout 2009 the Group has applied the Basel II framework to its capital calculations, its ICAAP and to its risk and capital disclosures to the market.
Other Changes to Capital Adequacy and Liquidity Arrangements
In October 2008, the UK Government announced a UK banking support scheme that addressed both capital and liquidity requirements of the UK banking industry. To fulfil its agreed commitment to this scheme, Banco Santander, S.A. subscribed for £1bn of the Company's Core Tier 1 capital issued on 12 October 2008. This capital was, in turn, transferred to Alliance & Leicester plc in December 2008 as planned. As part of the UK Government's banking support scheme, the Group has participated in the UK Special Liquidity Scheme.
During 2009 Santander UK commenced a comprehensive programme of work to ensure compliance with the requirements of the UK Financial Services Authority's new liquidity regime as laid out in PS09/16. The work is carried out with sponsorship from an Executive Director, by a dedicated project team complemented by relevant external resources where appropriate. During 2010 Santander UK is required to complete an Individual Liquidity Adequacy Assessment as part of the UK Financial Services Authority's Supervisory Liquidity Review Process. This includes an assessment of liquidity requirements using the UK Financial Services Authority prescribed stresses. The sources of liquidity risk that are currently analysed within the liquidity risk and control framework are covered by the UK Financial Services Authority stresses, although precise calibration may differ in the final liquidity guidance to be set by the UK Financial Services Authority.
A number of consultations are currently underway on proposals to change regulatory capital requirements in both a UK and international context. These include proposals from the Basel Committee on Banking Supervision in respect of capital and liquidity as well as the proposition for recovery and resolution plans in the UK. Taken in aggregate, there is a potential for these reforms to have a significant effect. The Group is currently engaged in the assessment of their possible impact and any response that could be required.
Other Regulatory Developments
There are a number of other regulatory developments going through a consultation and implementation process which may have some effect on the Group's business. These include the Financial Services Compensation Scheme arrangements, consumer credit regulations, financial stability, and conduct of business arrangements such as those resulting from the Retail Distribution review, Mortgage Market review and payment protection insurance.
Disclosure Controls and Procedures
The Group evaluated with the participation of its Chief Executive and Chief Financial Officer, the effectiveness of the Group's disclosure controls and procedures as of 31 December 2009. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
Based upon the Group's evaluation, the Chief Executive and the Chief Financial Officer concluded that, as of 31 December 2009, the Group's disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Group in the reports that the Group files and submits under the US Securities Exchange Act of 1934 is recorded, processed, summarised and reported within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to the Group's management, including the Group's Chief Executive and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure.
There has been no change in the Group's internal control over financial reporting during the Group's 2009 fiscal year that has materially affected, or is reasonably likely to materially affect the Group's internal controls over financial reporting.
Management's Report on Internal Control over Financial Reporting
Internal control over financial reporting is a component of an overall system of internal control. The Group's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting, the preparation and fair presentation of financial statements for external purposes in accordance with International Financial Reporting Standards ('IFRS') as issued by the International Accounting Standards Board, and as endorsed by the European Union.
The Group's internal control over financial reporting includes:
| > | Policies and procedures that relate to the maintenance of records that fairly and accurately reflect the transactions and disposition of assets. |
| > | Controls providing reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with IFRS, and that receipts and expenditures are being made only as authorised by management. |
| > | Controls providing reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use or disposition of assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or because the degree of compliance with policies or procedures may deteriorate.
Management is responsible for establishing and maintaining adequate internal control over the financial reporting of the Group. Management assessed the effectiveness of the Group's internal control over financial reporting as of 31 December 2009 based on the criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, Management believes that, as of 31 December 2009, the Group's internal control over financial reporting is effective.
This Annual Report and Accounts does not include an attestation report of the Group's registered public accounting firm regarding internal control over financial reporting. The Group's internal controls over financial reporting were not subject to attestation by the Group's registered public accounting firm pursuant to temporary rules of the US Securities and Exchange Commission that permit the Group to provide only management's report in this Annual Report and Accounts.
Relevant Audit Information
Each of the Directors as at the date of approval of this report confirms that:
| > | so far as the Director is aware, there is no relevant audit information of which the Group's auditors are unaware; and |
| > | the Director has taken all steps that he/she ought to have taken as a Director to make himself/herself aware of any relevant audit information and to establish that the Group's auditors are aware of that information. |
This confirmation is given and should be interpreted in accordance with the provisions of Section 418 of the UK Companies Act 2006.
British Bankers' Association draft Code for Financial Reporting Disclosure
In October 2009, the British Bankers' Association published a draft Code for Financial Reporting Disclosure. The draft Code sets out five disclosure principles together with supporting guidance. The principles are that UK banks will: provide high quality, meaningful and decision-useful disclosures; review and enhance their financial instrument disclosures for key areas of interest; assess the applicability and relevance of good practice recommendations to their disclosures acknowledging the importance of such guidance; seek to enhance the comparability of financial statement disclosures across the UK banking sector; and clearly differentiate in their annual reports between information that is audited and information that is unaudited.
The Group and other major UK banks have voluntarily adopted the draft Code in their 2009 financial statements. The Group's 2009 financial statements have therefore been prepared in compliance with the draft Code's principles.
Statement of Directors' Responsibilities
The Directors are responsible for preparing the Annual Report and Accounts including the financial statements in accordance with applicable law and regulations.
Company law requires the Directors to prepare financial statements for each financial year. The Directors are required by the International Accounting Standards ('IAS') Regulation to prepare the group financial statements under IFRS, as adopted by the European Union, and have also elected to prepare the parent company financial statements in accordance with IFRS, as adopted by the European Union. The financial statements are also required by law to be properly prepared in accordance with the UK Companies Act 2006 and Article 4 of the IAS Regulation. In addition, in order to meet certain US requirements, the Directors are required to prepare the Group financial statements in accordance with IFRS, as issued by the International Accounting Standards Board.
The Directors acknowledge their responsibility to ensure the financial statements give a true and fair view of the assets, liabilities, financial position and profit or loss presented and that the management report, which is incorporated into this report, includes a fair review of the development and performance of the business and a description of the principal risks and uncertainties the business faces.
International Accounting Standard 1 requires that financial statements present fairly for each financial year the Company's financial position, financial performance and cash flows. This requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the International Accounting Standards Board's 'Framework for the preparation and presentation of financial statements'.
In virtually all circumstances, a fair presentation will be achieved by compliance with all applicable IFRS. However, the Directors are also required to:
| > | properly select and apply accounting policies; |
| > | present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information; |
| > | provide additional disclosures when compliance with the specific requirements in IFRS are insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity's financial position and financial performance; and |
| > | make an assessment of the Company's ability to continue as a going concern. |
The Directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements comply with the UK Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
Auditors
Deloitte LLP have expressed their willingness to continue in office as auditors and a resolution to reappoint them will be proposed at the Company's forthcoming Annual General Meeting.
By Order of the Board
Karen M. Fortunato
Company Secretary
27 April 2010
2 Triton Square, Regent's Place, London NW1 3AN