Sant Uk.10te% Regulatory News (SAN)

Santander UK plc 15 March 2013

Annual Report and Accounts 2012

The Company announces that a copy of the above document has been submitted to the National Storage Mechanism and will shortly be available for inspection at www.Hemscott.com/nsm.do

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. Accordingly, page references in the text refer to page numbers in the Annual Report and Accounts 2012.

A printer-friendly PDF version of the accounts will also be made available on the Company's website:

www.aboutsantander.co.uk

For further details, please contact:

Jennifer Scardino (Director of Communications, Public Policy and CSR)

020 7756 4886

Dr. James S Johnson (Head of Investor Relations):

020 7756 5014

Bojana Flint (Deputy Head of Investor Relations)

020 7756 6474

The full text of the accounts follows:

(due to size please refer to the website or request a copy from Secretariat)

Santander UK plc

OUR CORPORATE PURPOSE

Santander UK's purpose is to be the best bank in the United Kingdom, supporting the financial needs of individuals, families and businesses. By drawing on its mutual building society heritage and the expertise of its parent, a leading global commercial bank, Santander UK is driving a commercial transformation that will deliver even greater value to its customers and make it the bank of choice for Small and Medium Enterprises in the UK.

2012 AWARDS

http://www.rns-pdf.londonstockexchange.com/rns/0708A_-2013-3-14.pdf 

Index

This Annual Report 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 336.

Our Business and our Strategy

Our Business 2

Our Strategy 4

Chairman's Statement 6

Chief Executive Officer's Review 7

Chief Financial Officer's Review 9

Key Performance Indicators 12

Summary Risk Report 16

Business Review

Divisional Results 19

Balance Sheet Review 36

Risk Management Report 62

Governance

Directors 163

Corporate Governance Report 165

Directors' Remuneration Report 171

Directors' Report 181

Directors' Responsibilities Statement 193

FSA Remuneration Disclosures 194

Financial Statements

Independent Auditor's Report to the Members of Santander UK plc 200

Primary Financial Statements 201

Notes to the Financial Statements 208

Shareholder Information

Risk Factors 310

Contact Information 326

Articles of Association 327

Glossary of Financial Services Industry Terms 328

Forward-looking Statements 336

Other Information for US Investors 337

Business Review

Our Business

SANTANDER UK AT A GLANCE

Santander UK plc and its subsidiaries ('Santander UK' or the 'Santander UK group') operate primarily in the UK, are regulated by the UK Financial Services Authority ('FSA') and are part of the Banco Santander, S.A. group (the 'Banco Santander group'). Santander UK is a major financial services provider, offering a wide range of personal financial products and services, and is a growing participant in the corporate banking market. Santander UK is well positioned to continue to grow, with a distribution capability across some 1,200 branches (including agencies) and 35 regional Corporate Business Centres ('CBCs').

Santander UK is headed by Ana Botín, Chief Executive Officer, and operates four business divisions as follows:

The business segments detailed above are supported by various divisions, including:

Internal Audit is responsible for supervising the compliance, effectiveness and efficiency of Santander UK's internal control systems to manage its risks, and is headed by Ramón Sanchez, Chief Internal Auditor. Human Resources is responsible for delivering the human resources strategy and personnel support, and is headed by Simon Lloyd, HR Director.

In addition there are a number of corporate units including Financial Control, Legal and Secretariat, Strategy, Internal Control and Compliance, Regulatory Affairs and Pensions, Customer Experience, Communications and Santander Universities in the UK.

OUR HISTORY

Key dates for Santander UK: 

http://www.rns-pdf.londonstockexchange.com/rns/0708A_1-2013-3-14.pdf 

SANTANDER UK - KEY UK MARKET PLAYER

http://www.rns-pdf.londonstockexchange.com/rns/0708A_2-2013-3-14.pdf 

2012 RESULTS HIGHLIGHTS

OUR FINANCIAL OBJECTIVES AND STRATEGIC PRIORITIES

http://www.rns-pdf.londonstockexchange.com/rns/0708A_3-2013-3-14.pdf 

Our strategy is based on four financial objectives:

The execution of these objectives rests on our three strategic priorities:

These three pillars are underpinned by our balance sheet strength. Our Core Tier 1 capital ratio stood at 12.2% at the year end; our loan to deposit ratio improved to 130% and FSA eligible liquid assets amounted to £36.9bn.

THE STRUCTURAL RELATIONSHIP OF SANTANDER UK WITH THE BANCO SANTANDER GROUP - THE 'SUBSIDIARY MODEL'

The Banco Santander group operates a 'subsidiary model'. This model involves autonomous units, such as Santander UK, operating in core markets with each unit being responsible for its own liquidity, funding and capital management on an ongoing basis. The model is designed to minimise the risk to the Banco Santander group and all its units from problems arising elsewhere in the Banco Santander group. The subsidiary model means that Banco Santander, S.A. has no obligation to provide any liquidity, funding or capital assistance, although it enables Banco Santander, S.A. to selectively take advantage of opportunities. As an FSA regulated entity, Santander UK is expected to satisfy the FSA liquidity and capital requirements on a standalone basis.

Under the subsidiary model, Santander UK primarily generates funding and liquidity through UK retail and corporate deposits, as well as in the financial markets through its own debt programmes and facilities to support its business activities and liquidity requirements. It does this in reliance on the strength of its own balance sheet and profitability and its own network of investors. It does not rely on a guarantee from Banco Santander, S.A. or any other member of the Banco Santander group (other than certain of Santander UK plc's own subsidiaries) to generate this funding or liquidity . Santander UK does not raise funds to finance other members of the Banco Santander group or guarantee the debts of other members of the Banco Santander group (other than certain of Santander UK plc's own subsidiaries).

Exposures to other Banco Santander group members are established and managed on an arm's length commercial basis. All intergroup transactions are monitored by the Board Risk Committee of Santander UK and transactions which are not in the ordinary course of business must be pre-approved by the Board. In addition, Santander UK is subject to UK FSA limits on exposures to, and on liquidity generated from, other members of the Banco Santander group.

CHAIRMAN'S STATEMENT

2012 REVIEW

Against a backdrop of subdued economic activity and considerable regulatory uncertainties, Santander UK delivered a robust financial performance in 2012 whilst maintaining a strong balance sheet. We continued to make good progress against our strategic priorities and maintained our focus on providing straightforward, tailored, and transparent products to our customers, alongside improved customer experience. In 2012, we gave our 1|2|3 current account and credit card holders over £90m in interest and cashback including new opportunities such as mortgage, transport and utility bills. We are also focusing on the needs of business customers where we are looking to increase our presence and market share. We have developed a good platform and product capability to support our growth ambitions for corporate and SME banking. In order to promote SME growth and support the UK economy, we are looking at new solutions for more flexible cash flow and how to offer SMEs the necessary support to invest and grow.

In the interests of all of the customers involved we felt unable to agree a further extension to the implementation timetable of the planned transaction to acquire certain assets, liabilities and branches from The Royal Bank of Scotland Group ('RBS'). We needed to be confident that the transfer would be seamless for customers and could be completed within a reasonable timeframe. During 2012, it became apparent that the already revised target date would not be achieved. We concluded that we were not willing to extend again the final deadline by which the deal's remaining conditions were required to be met. The agreement subsequently terminated.

We are committed to making a positive contribution to society and in 2012 we donated over £19m to projects focused on supporting education, enterprise and employment, building on our long history of support for local communities. We continued our support for higher education through Santander Universities which expanded its reach to 65 institutions, to which we provided £6.5m in scholarships and research grants. As a signatory to the UK Government's Business Compact, we are committed to providing employment opportunities to people from diverse backgrounds and in 2012 we launched 'Workwise' which supports youth employment through a range of partnerships including with Career Academies and The Prince's Trust. The Santander UK Foundation made over 2,000 donations to charities in 2012, supporting projects for disadvantaged people.

BOARD CHANGES

The Board took the decision in 2012 to strengthen its composition. We were delighted to appoint Stephen Jones as Chief Financial Officer in March, and welcome two new Non-Executive Directors, Bruce Carnegie-Brown and Antonio Escámez, in October. These new directors have brought extensive knowledge, insight and objectivity to the Board and we look forward to working with them as we strive to be the best bank for our people, customers and shareholders. We will continue to review the composition of the Board and its effectiveness to ensure that Santander UK has the best possible stewardship.

The Banco Santander group remains committed to a strategy to float minority stakes of its subsidiaries including Santander UK. However, the timing of this will remain subject to market conditions and to the emergence of a more positive outlook towards UK banks from investors. In any case, an Initial Public Offering ('IPO') remains a medium-term prospect.

REGULATORY LANDSCAPE

The recent economic crisis has also given rise to serious challenges for UK banks. Restoring credibility, along with customer and investor trust, is rightly at the top of the industry's agenda. Despite the setbacks of 2012, there are some signs that UK banks are moving in the right direction. The regulation of UK banks continues to evolve and the level of scrutiny remains intense. Considerable work remains to be done, domestically and internationally, to provide the detailed regulatory clarity we need to shape the development of our business. We will continue to contribute significantly to the process. Furthermore, we strongly believe that all stakeholders have an interest in making the banking sector both stronger and safer. However, we need to ensure that in the detail of implementing regulatory change we can continue to serve our customers well and that we have a strong and robust business that can contribute to the economy and wider community.

THANK YOU

Finally, I would like to offer a word of thanks to all my colleagues, who have responded admirably to the challenges we have faced, and their commitment to doing the right thing for our customers, their contribution to the effort to grow our business sustainably, their pride in their work, and their dedication to delivering value for all our stakeholders.

Lord Burns

Chairman

14 March 2013

Chief Executive Officer's Review

OVERVIEW

In 2012, we made good progress in our transformation into a full service retail and corporate bank that puts customers at the heart of everything it does. Customers have been - and will remain - the focus of all our efforts. Last year, public perception of our customer experience began to change for the better and we were recognised by the GfK Financial Research Survey ('FRS') as the bank with the biggest improvement in overall customer satisfaction compared to our competitors.

At the same time, our innovative and award-winning 1|2|3 World products offered our customers outstanding value for money, which drove an annual percentage increase in our banking balances of 32%. We reached other key milestones, like the segmentation of our customers, which will enable us to allocate them with relationship managers and build even deeper relationship in the years to come. We also continued to support the UK economy in 2012. We helped more than 100,000 households to finance their homes through £14.6bn of residential mortgage lending, including £3.0bn to first time buyers.

We continued to grow our lending to UK businesses and have increased our lending to SMEs by an average of 25% per annum over the last four years, a period when other banks have scaled back their corporate lending. Furthermore, the financing that we have provided through our Breakthrough programme is expected to create around 230 new jobs in the UK. We have also agreed to support 500 internships in a joint undertaking with Santander Universities.

In 2012 we decided not to proceed with the acquisition of RBS businesses. This was not a decision we took lightly, but we believe it was in the best interests of the customers and staff of both Santander UK and RBS. The investment we made in our systems and processes in preparation for the acquisition will form the cornerstone of our organic growth strategy for our corporate business. Thanks to this investment, both our new and existing customers will have access to the full range of corporate banking services.

STRATEGIC FOCUS

In 2012, we made good progress in executing our strategic priorities:

BUSINESS PERFORMANCE

We are pleased to report good levels of new business activity in our core lending businesses despite a muted market and a subdued economic outlook.

In Retail Banking, residential mortgage gross lending of £14.6bn was equivalent to a market share of 10.2%. This was lower than in 2011 and follows the tightening of lending criteria on higher loan-to-value ('LTV') and interest-only mortgages. In particular, a 50% LTV cap on interest-only mortgages, introduced in February 2012, resulted in a £6.2bn reduction in these loans. Our focus on primary banking relationships increased the number of bank accounts opened in 2012 by 7% to 895,000, with over 240,000 bank accounts switching to Santander UK from other providers. Over 600,000 credit cards were opened in 2012, largely made up of fee paying 1|2|3 Credit Cards with high levels of transactions. Despite deposit margin rates at historically low levels, there were indications that the intense competition for deposits eased somewhat in the second half of 2012. Our cross tax year ISA campaign was very successful, with net inflows of £9.1bn including a good proportion of two year fixed rate accounts.

In Corporate Banking, our SME lending balances increased, with £3.4bn of new facilities made available in the year, despite a fall in demand for corporate lending in 2012. In addition, deposits increased by £0.7bn despite the impact of credit rating downgrades and the decision to reduce short-term balances.

Markets delivered a solid performance, with a much improved performance in the fixed income and equity businesses, partly offset by lower market volumes principally affecting the financial institutions business. We expanded our ancillary business to new and existing large corporate customers. We also developed our supply-chain finance service, an area we expect to grow further in 2013.

In Corporate Centre, medium-term funding issuance of approximately £14bn was raised across a number of sources and currencies. The cost of new funding in the market fell during the year, most noticeably towards the end of 2012, a trend which continued into early 2013. Changes in the guidance from regulators and more clarity in the environment in the final quarter of 2012 meant that we were better able to align customer balances and liquidity with our business requirements.

THE ECONOMY

The UK economy experienced a volatile quarterly pattern of headline GDP during 2012, with almost no economic growth over the year as a whole. There was, however, a more positive employment picture, with total employment rising by 584,000 in the year and the unemployment rate falling from 8.4% to 7.8% over the same period.

In a year of continued economic uncertainty, especially with regards to the prospects for the eurozone, and with growth below expectations, additional quantitative easing was announced during the year by the Bank of England's Monetary Policy Committee to support the economy. With a contraction in GDP of 0.3% in the final quarter of the year, the process of reducing the high level of public sector borrowing continuing and demand for credit remaining subdued, the Bank of England also announced a new policy measure in the form of the Funding for Lending Scheme ('FLS'). The consensus view at the start of 2013 is that the UK economy is likely to see growth of around 1%, giving another year of below trend growth, so this is likely to continue to be a challenging environment for households, companies and the banking sector.

LOOKING AHEAD

Despite significant economic and regulatory headwinds, we believe Santander UK is well placed for the year ahead. In 2013, we will continue to invest in transforming our business to improve customer experience alongside our focus on efficiency. We are determined to work even harder to earn our customers' trust and win and retain their loyalty. Our commitment to improving customer experience is paramount.

We will continue to deepen our relationships with our customers, developing a proposition that is simple, personal and fair. Our aim is to have 4 million loyal and satisfied primary banking customers by 2015, whilst continuing to focus on profitability ahead of volume growth.

We are committed to growing our corporate banking business organically, by expanding its presence around the UK, hiring additional relationship managers and improving its capabilities. Our aim is to increase our market share to 8% in the medium-term. Alongside this, we will maintain our focus on improving productivity and efficiency.

We look forward to greater clarity on regulatory requirements regarding capital, liquidity, conduct and governance, as this will give us the certainty we need to continue to serve our customers and support the UK economy.

Ana Botín

Chief Executive Officer

14 March 2013

Chief Financial Officer's Review

OVERVIEW

Santander UK delivered profit after tax of £939m in 2012, up 4%, and profit before tax of £1,231m, down 2% on 2011. This was a sound financial performance given the economic and regulatory backdrop in the United Kingdom.

Net interest income was lower than in 2011 due to the continued impact of structural market conditions and increased funding costs, which resulted in banking net interest margin narrowing to 1.44% (2011: 1.88%). We expect this impact to stabilise in the second half of 2013.

Expenses were well controlled, despite inflation and continued investment in our business with a cost-to-income ratio of 45% (2011: 47%) and 53% if the pre-tax gain of £705m on the capital management exercise described below is excluded. We reported a small increase to our return on tangible book value of 9.1% (2011: 9.0%).

We declared an ordinary dividend of £450m in October 2012, in accordance with our dividend policy of paying our ordinary shareholders 50% of profit after tax.

Income Statement HIGHLIGHTS

(1) Banking NIM was previously named the Commercial Banking Margin and comprises net interest income (adjusted to exclude net interest income from the Treasury asset portfolio) divided by average commercial assets.

(2) Income for 2012 included gains of £705m resulting from the capital management exercise described below. Without this, the cost-to-income ratio for 2012 was 53%.

The financial results for 2012 and 2011 included a number of significant items:

Total operating income in 2012 was down 5% to £4,901m. Excluding the CME gain, total operating income declined 19%, with net interest income 24% lower and non-interest income down 5%.

The net interest income fall in 2012 reflected the impact of structural market conditions, primarily low interest rates and increased medium term funding ('MTF') costs. Low interest rates impacted the contribution from the structural hedges put in place in 2008-09 which are now maturing in a much lower, static rate environment. Income was also affected by lower mortgage balances, as we reduced our exposure to higher LTV and interest-only loans. Whilst margins continued to improve in most asset classes, deposit margins continued to be impacted by strong competition especially in the early part of 2012.

Overall, Banking NIM was lower, at 1.44% (2011: 1.88%). The non-interest income fall of 5% reflected lower personal current account fees partially offset by improved fees and ancillary income associated with the increase in SME and other corporate lending.

We delivered another good cost performance, with total operating expenses down 9%, despite inflation and our ongoing business investment programme. Administrative expenses were down 1%. Depreciation, amortisation and impairment costs fell by £201m, largely due to charges related to the impairment of intangible assets in 2011 which were not repeated in 2012. We have strong cost management discipline, a key element of our strategy, and we continue to seek efficiencies as we transform the business. Our cost-to-income ratio was 45% in 2012 (2011: 47%), or 53% if the benefit of the gain from the CME is excluded.

Operating provisions and charges fell by 2% including the impact of the significant items described above. The impairment charge on the retail mortgage portfolio increased reflecting our view of the uncertain economic environment. Within Corporate Banking, increased provisions arose from the performance of a small number of older vintage loans which were acquired with Alliance & Leicester. Provisions for the costs of the Financial Services Compensation Scheme ('FSCS') and the UK Bank Levy decreased to £98m (2011: £156m), largely due to a lower provision for FSCS charges.

The taxation charge of £292m was £66m lower than 2011. This was primarily due to the impact of the continued reduction in the main rate of UK corporation tax on profits.

CUSTOMEr Balance Sheet HIGHLIGHTS

(1) Calculated as loans and advances to customers (excl. reverse repos) divided by deposits by customers (excluding repos).

We continued to focus on improving the strength of our balance sheet. Customer loans reduced 5% to £195.9bn, largely reflecting a reduction in Retail Banking assets, particularly residential mortgages, where the outstanding stock declined £9.6bn including £6.2bn of interest-only mortgages. Loans to SMEs were up 18%, as we continued the diversification of our business mix. All lending is consistent with our conservative credit risk policies.

Total customer deposits were relatively flat at £148.6bn. The success of the 1I2I3 World increased current account balances by 32% to £15.9bn while a strong cross tax year ISA campaign added £9.1bn of largely term deposits. This was offset by a targeted reduction in some higher cost, short-term retail and corporate deposits which lacked the potential to develop deeper customer relationships.

Our loan-to-deposit ratio improved to 130% (2011: 136%). We remain comfortable with this position given it is underpinned by the mix of loans on our balance sheet which mostly consist of prime UK mortgages.

Credit Quality

Our business mix provides us with a predictable and conservative risk profile, and Santander UK remains firmly focused on the UK with approximately 99% of customer assets UK-related and approximately 85% of customer assets consisting of prime UK residential mortgages. Furthermore, we have minimal net exposure after collateral to peripheral eurozone countries at only 0.4% of total assets.

The total NPL ratio increased to 2.17%, and the mortgage NPL ratio to 1.74% at the end of 2012. The rise in the mortgage NPL ratio was largely attributable to regulatory-driven policy and reporting changes which are not expected to result in significant additional write offs. In 2012, write offs fell to £87m in 2012 from £103m in 2011. The mortgage NPL ratio was also adversely affected by the impact of the managed reduction of the mortgage portfolio over the year, which decreased by £9.6bn. Excluding these policy and reporting changes, mortgage NPL balances remained broadly stable over the year. The Corporate Banking NPL ratio increased to 4.26% at the end of 2012. This largely arose from the performance of a small number of older vintage loans which were acquired with Alliance & Leicester. Corporate Banking lending in the last four years has performed well with a much lower NPL ratio in these vintages.

Liquidity AND Funding

Our overall funding strategy is to develop a diversified funding base and maintain access to a variety of funding sources. In 2012 we focused on secured issuance, in particular mortgage-backed securities and covered bonds, two forms of financing that permit us to benefit from our prime UK mortgage mix. This strategy minimised the cost of funding and provides protection against unexpected variations in the market funding environment.

Within our balance sheet management strategy we aim to align the sources and uses of funding. Customer loans and advances are largely funded by customer deposits, with any excess being funded by long-term wholesale secured debt and equity. We maintain significant headroom to issue further mortgage-backed securities and covered bonds given the underlying mix of our assets.

Our funding position remains solid and we reduced our wholesale funding requirement to £14bn in 2012 (2011: £21bn) against scheduled maturities of approximately £10bn. Our planned MTF issuance for 2012 was largely completed in the first half of the year.

We built up our liquidity portfolio in the first half of 2012, and following regulatory developments and the affirmation of our credit ratings by the main credit rating agencies we started to reduce liquidity balances in the fourth quarter of 2012. At the year end, total liquid assets amounted to £76bn, including FSA-eligible liquid assets of £37bn. Liquid assets coverage was over 150% of our wholesale funding maturing in less than one year.

CAPITAL

Our Core Tier 1 Capital ratio rose to 12.2% at the end of 2012 from 11.4% in 2011, through a combination of organic profit generation and the CME gain, largely offset by the £450m ordinary dividend and small increase in the pension deficit requirement. Risk-weighted assets were broadly flat at £76.5bn, despite the customer loan reduction, reflecting the growth in our core corporate book. Total capital decreased by £2.1bn as a result of the repurchase of certain debt capital instruments that were not expected to qualify as Total Capital once the requirements of Basel III have been finalised and become applicable.

We expect that the strength of our Core Tier 1 Capital ratio, our ability to generate capital organically and our optimal use of risk weighted assets will enable us to meet our targeted capital ratios even once the capital requirements of Basel III are phased in. We will continue to manage our regulatory capital resources to maintain our capital ratios above the industry average as we transition towards Basel III.

Rating AGENCY ACTIONS

There was an unprecedented level of rating actions across the global banking industry in 2012. Like many UK banks, we faced multiple rating reviews from our credit rating agencies. Most of the rating reviews took place in the first half of the year with more limited actions in the last quarter of 2012. Standard & Poor's, Moody's and Fitch reviewed and affirmed all Santander UK's credit ratings in the fourth quarter of 2012.

Conclusion

We delivered resilient profit after tax of £939m despite income declining largely as a result of structural impacts. We managed costs well, maintained credit quality, strengthened the balance sheet and built capital post payment of a dividend. We have remained profitable through the economic cycle and are well placed to deliver our commercial transformation, deepening customer relationships and diversifying our business mix towards corporate and SME lending. We are confident that we have the resources in place to deliver our strategy and improve returns, thus benefiting our many stakeholders.

Stephen Jones

Chief Financial Officer

14 March 2013

Key Performance Indicators

During 2012, our key performance indicators ('KPIs') were reviewed and aligned to our strategic priorities for the medium term. The information below reflects Santander UK's performance as measured by those key performance indicators for the years ended, and at, 31 December 2012, 2011 and 2010.

The objectives set out below are subject to significant uncertainties, as described in "Shareholder Information - Risk Factors", and may not be achieved, or may be changed. In particular, macro-economic factors such as UK unemployment and property values and regulatory changes are outside of management's control, and could prevent attainment of these objectives.