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Annual Financial Report - Part 4

15 Mar 2013 07:30

RNS Number : 0885A
Santander UK Plc
15 March 2013
 



Financial Statements

 

Contents to Financial Statements 

Financial Statements

200

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

201

Consolidated Income Statement for the years ended 31 December 2012, 2011 and 2010

201

Consolidated Statement of Comprehensive Income for the years ended 31 December 2012, 2011 and 2010

202

Consolidated Balance Sheet at 31 December 2012 and 2011

203

Consolidated Statement of Changes in Equity for the years ended 31 December 2012, 2011 and 2010

204

Consolidated Cash Flow Statement for the years ended 31 December 2012, 2011 and 2010

205

Company Balance Sheet at 31 December 2012 and 2011

206

Company Statement of Changes in Equity for the years ended 31 December 2012, 2011 and 2010

207

Company Cash Flow Statement for the years ended 31 December 2012, 2011 and 2010

208

Notes to the Financial Statements

 

INDEPENDENT AUDITOR'S REPORT TO THE MEMBERS OF SANTANDER UK PLC

 

We have audited the financial statements of Santander UK plc (the "Company" and together with its subsidiaries the "Group") for the year ended 31 December 2012 which comprise the Consolidated Income Statement, the Consolidated Statement of Comprehensive Income, the Consolidated and Company Balance Sheets, the Consolidated and Company Statements of Changes in Equity, the Consolidated and Company Cash Flow Statements, the related Notes 1 to 48 to the financial statements and the information on pages 74 to 134 and 140 to 162 of the Risk Management Report except for those items marked as unaudited. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the Companies Act 2006.

 

This report is made solely to the company's members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company's members those matters we are required to state to them in an auditor's report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company's members as a body, for our audit work, for this report, or for the opinions we have formed.

 

Respective responsibilities of directors and auditor

As explained more fully in the Directors' Responsibilities Statement, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board's Ethical Standards for Auditors.

 

Scope of the audit of the financial statements

An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the Group's and the Company's circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements. In addition, we read all the financial and non-financial information in the annual report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.

 Opinion on financial statements

In our opinion:

the financial statements give a true and fair view of the state of the Group's and of the Company's affairs as at 31 December 2012 and of the Group's profit for the year then ended;

the Group financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union;

the Company financial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and

the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation.

 

Separate opinion in relation to IFRSs as issued by the IASB

As explained in Note 1 to the Group financial statements, the Group in addition to complying with its legal obligation to apply IFRSs as adopted by the European Union, has also applied IFRSs as issued by the International Accounting Standards Board (IASB). In our opinion the Group financial statements comply with IFRSs as issued by the IASB.

 

Opinion on other matter prescribed by the Companies Act 2006

In our opinion the information given in the Directors' Report for the financial year for which the financial statements are prepared is consistent with the financial statements.

 

Matters on which we are required to report by exception

We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in our opinion:

adequate accounting records have not been kept by the Company, or returns adequate for our audit have not been received from branches not visited by us; or

the parent company financial statements are not in agreement with the accounting records and returns; or

certain disclosures of directors' remuneration specified by law are not made; or

we have not received all the information and explanations we require for our audit.

 

 

 

 

Caroline Britton (Senior statutory auditor)

for and on behalf of Deloitte LLP

Chartered Accountants and Statutory Auditor

London, UK

14 March 2013

 

Financial Statements

Primary Financial Statements

CONSOLIDATED INCOME STATEMENT

 

For the years ended 31 December 2012, 2011 and 2010

 

 

 

 

Notes

2012

£m

2011

£m

2010

£m

Interest and similar income

3

7,621

7,618

7,047

Interest expense and similar charges

3

(4,706)

(3,788)

(3,233)

Net interest income

2,915

3,830

3,814

Fee and commission income

4

1,164

1,138

902

Fee and commission expense

4

(264)

(220)

(203)

Net fee and commission income

900

918

699

Net trading and other income

5

1,086

437

521

Total operating income

4,901

5,185

5,034

Administration expenses

6

(1,976)

(1,995)

(1,793)

Depreciation, amortisation and impairment

7

(246)

(447)

(275)

Total operating expenses excluding provisions and charges

(2,222)

(2,442)

(2,068)

Impairment losses on loans and advances

9

(1,009)

(565)

(712)

Provisions for other liabilities and charges

9

(439)

(917)

(129)

Total operating provisions and charges

(1,448)

(1,482)

(841)

Profit before tax

1,231

1,261

2,125

Taxation charge

10

(292)

(358)

(542)

Profit for the year

939

903

1,583

Attributable to:

Equity holders of the parent

939

903

1,544

Non-controlling interest

-

-

39

 

All profits during each year were generated from continuing operations.

 

 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

 

For the years ended 31 December 2012, 2011 and 2010

 

 

 

Notes

2012

£m

2011

£m

2010

£m

Profit for the year

939

903

1,583

Other comprehensive (expense)/income:

Actuarial (losses)/gains on retirement benefit obligations

37

(183)

(37)

25

Gains/(losses) on available-for-sale securities

22

6

(3)

(1)

Tax on above items

10

41

11

(9)

Net (loss)/gain recognised directly in other comprehensive income

(136)

(29)

15

Gains on available-for-sale securities transferred to profit or loss on sale

(17)

-

(2)

Tax on items transferred to profit or loss

10

4

-

1

Net transfers to profit

(13)

-

(1)

Total other comprehensive (expense)/income for the year before tax

(194)

(40)

22

Tax relating to components of other comprehensive (expense)/income

10

45

11

(8)

Total comprehensive income for the year

790

874

1,597

Attributable to:

Equity holders of the parent

790

874

1,558

Non-controlling interest

-

-

39

 

The accompanying Notes on pages 208 to 309 and the audited sections of the Risk Management Report on pages 62 to 162 form an integral part of these Consolidated Financial Statements.

 

CONSOLIDATED BALANCE SHEET

 

At 31 December 2012 and 2011

 

 

 

 

Notes

2012

£m

2011

£m

Assets

Cash and balances at central banks

12

29,282

25,980

Trading assets

14

22,498

21,891

Derivative financial instruments

15

30,146

30,780

Financial assets designated at fair value

16

3,811

5,005

Loans and advances to banks

17

2,438

4,487

Loans and advances to customers

18

191,907

201,069

Available-for-sale securities

22

5,483

46

Loans and receivables securities

23

1,259

1,771

Macro hedge of interest rate risk

1,222

1,221

Intangible assets

25

2,325

2,142

Property, plant and equipment

26

1,541

1,596

Current tax assets

50

-

Deferred tax assets

27

60

257

Retirement benefit assets

37

254

241

Other assets

28

768

1,088

Total assets

293,044

297,574

Liabilities

Deposits by banks

29

9,935

11,626

Deposits by customers

30

149,037

148,342

Derivative financial instruments

15

28,861

29,180

Trading liabilities

31

21,109

25,745

Financial liabilities designated at fair value

32

4,002

6,837

Debt securities in issue

33

59,621

52,651

Subordinated liabilities

34

3,781

6,499

Other liabilities

35

2,526

2,571

Provisions

36

914

970

Current tax liabilities

4

271

Retirement benefit obligations

37

305

216

Total liabilities

280,095

284,908

Equity

Share capital and other equity instruments

39

3,999

3,999

Share premium

39

5,620

5,620

Retained earnings

3,312

3,021

Other reserves

18

26

Total shareholders' equity

12,949

12,666

Total liabilities and equity

293,044

297,574

 

The accompanying Notes on pages 208 to 309 and the audited sections of the Risk Management Report on pages 62 to 162 form an integral part of these Consolidated Financial Statements.

 

The Financial Statements on pages 201 to 309 were approved and authorised for issue by the Board on 14 March 2013 and signed on its behalf by:

 

 

 

Stephen Jones

Chief Financial Officer

 

Company Registered Number: 2294747

 

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

 

For the years ended 31 December 2012, 2011 and 2010

 

Other reserves

 

 

Notes

Share capital

£m

Share premium

£m

Available for sale reserve

£m

Foreign currency translation reserve

£m

Retained earnings

£m

Total

£m

Non-controlling interest

£m

Total

£m

 

1 January 2012

3,999

5,620

9

17

3,021

12,666

-

12,666

 

Total comprehensive income/(expense):

 

- Profit for the year

-

-

-

-

939

939

-

939

 

- Other comprehensive income/(expense) for the year

-

-

(11)

-

(183)

(194)

-

(194)

 

- Tax on other comprehensive income

-

-

3

-

42

45

45

 

-

-

(8)

-

798

790

-

790

 

Dividends and other distributions

13

-

-

-

-

(507)

(507)

-

(507)

 

31 December 2012

3,999

5,620

1

17

3,312

12,949

-

12,949

 

 

1 January 2011

3,999

5,620

10

17

2,628

12,274

-

12,274

 

Total comprehensive income/(expense):

 

- Profit for the year

-

-

-

-

903

903

-

903

 

- Other comprehensive income/(expense) for the year

-

-

(3)

-

(37)

(40)

-

(40)

 

- Tax on other comprehensive income/(expense)

-

-

2

-

9

11

-

11

 

-

-

(1)

-

875

874

-

874

 

Dividends and other distributions

13

-

-

-

-

(482)

(482)

-

(482)

 

31 December 2011

3,999

5,620

9

17

3,021

12,666

-

12,666

 

 

1 January 2010

2,709

1,857

12

17

1,911

6,506

716

7,222

 

Total comprehensive income/(expense):

 

- Profit for the year

-

-

-

-

1,544

1,544

39

1,583

 

- Other comprehensive income/(expense) for the year

-

-

(3)

-

25

22

-

22

 

- Tax on other comprehensive income/(expense)

-

-

1

-

(9)

(8)

-

(8)

 

-

-

(2)

-

1,560

1,558

39

1,597

 

Dividends and other distributions

13

-

-

-

-

(815)

(815)

(17)

(832)

 

Issue of preference shares

300

-

-

-

-

300

-

300

 

Redemption of A&L preference shares

-

-

-

-

-

-

(294)

(294)

 

Reclassification of Perpetual Preferreds

297

-

-

-

-

297

(297)

-

 

Issue of ordinary shares

693

3,763

-

-

-

4,456

-

4,456

 

Acquisition of non-controlling interest

45

-

-

-

-

(28)

(28)

(147)

(175)

 

31 December 2010

3,999

5,620

10

17

2,628

12,274

-

12,274

 

The accompanying Notes on pages 208 to 309 and the audited sections of the Risk Management Report on pages 62 to 162 form an integral part of these Consolidated Financial Statements.

 

CONSOLIDATED CASH FLOW STATEMENT

 

For the years ended 31 December 2012, 2011 and 2010

 

 

 

 

Notes

2012

£m

2011

£m

2010

£m

Cash flows from/(used in) operating activities

Profit for the year

939

903

1,583

Adjustments for:

Non cash items included in profit

1,008

3,668

3,136

Change in operating assets

8,363

2,219

6,239

Change in operating liabilities

(4,094)

(12,015)

1,557

Corporation taxes (paid)/received

(231)

(165)

(131)

Effects of exchange rate differences

(1,961)

(1,662)

(1,000)

Net cash flow from/(used in) operating activities

40

4,024

(7,052)

11,384

Cash flows (used in)/from investing activities

Acquisition of businesses, net of cash acquired

40,45

-

-

(1,418)

Investment in associates

(6)

-

-

Disposal of subsidiaries, net of cash disposed

40

-

76

250

Purchase of property, plant and equipment and intangible assets

25,26

(454)

(397)

(873)

Proceeds from sale of property, plant and equipment and intangible assets

80

93

91

Purchase of non-trading securities

(6,338)

-

(1,225)

Proceeds from sale of non-trading securities

910

124

1,851

Net cash flow used in investing activities

(5,808)

(104)

(1,324)

Cash flows from/(used in) financing activities

Issue of ordinary share capital

39

-

-

4,456

Issue of loan capital

37,219

48,449

21,409

Repayment of loan capital

(35,636)

(43,070)

(15,973)

Dividends paid on ordinary shares

13

(425)

(375)

(900)

Dividends paid on preference shares classified in equity

13

(19)

(19)

(19)

Dividends paid on Reserve Capital Instruments

13

(21)

(21)

(21)

Interest paid on Perpetual Preferred Securities classified in non-controlling interest

-

-

(17)

Dividends paid on Perpetual Preferred Securities

13

(17)

(17)

-

Net cash flow from financing activities

1,101

4,947

8,935

Net (decrease)/increase in cash and cash equivalents

(683)

(2,209)

18,995

Cash and cash equivalents at beginning of the year

42,946

45,500

26,364

Effects of exchange rate changes on cash and cash equivalents

(624)

(345)

141

Cash and cash equivalents at the end of the year

40

41,639

42,946

45,500

 

The accompanying Notes on pages 208 to 309 and the audited sections of the Risk Management Report on pages 62 to 162 form an integral part of these Consolidated Financial Statements.

 

COMPANY BALANCE SHEET

 

At 31 December 2012 and 2011

 

 

 

 

Notes

2012

£m

2011

£m

Assets

Cash and balances at central banks

12

28,883

18,958

Derivative financial instruments

15

4,899

6,001

Financial assets designated at fair value

16

44

45

Loans and advances to banks

17

97,846

90,716

Loans and advances to customers

18

171,697

181,972

Available-for-sale securities

22

357

34

Loans and receivables securities

23

5,941

5,202

Macro hedge of interest rate risk

15

32

Investment in subsidiary undertakings

24

6,969

6,995

Intangible assets

25

1,647

1,458

Property, plant and equipment

26

1,157

1,182

Current tax assets

240

154

Deferred tax assets

27

72

275

Retirement benefit assets

37

250

237

Other assets

28

716

965

Total assets

320,733

314,226

Liabilities

Deposits by banks

29

109,170

112,278

Deposits by customers

30

188,884

175,067

Derivative financial instruments

15

2,051

1,207

Financial liabilities designated at fair value

32

-

1

Debt securities in issue

33

645

1,609

Subordinated liabilities

34

3,846

6,564

Other liabilities

35

2,139

2,121

Provisions

36

859

912

Retirement benefit obligations

37

305

216

Total liabilities

307,899

299,975

Equity

Share capital and other equity instruments

39

3,999

3,999

Share premium

39

5,620

5,620

Retained earnings

3,217

4,625

Available for sale reserve

(2)

7

Total shareholders' equity

12,834

14,251

Total liabilities and equity

320,733

314,226

 

The accompanying Notes on pages 208 to 309 and the audited sections of the Risk Management Report on pages 62 to 162 form an integral part of these Financial Statements.

 

The Financial Statements on pages 201 to 309 were approved and authorised for issue by the Board on 14 March 2013 and signed on its behalf by:

 

 

 

Stephen Jones

Chief Financial Officer

 

Company Registered Number: 2294747

 

  COMPANY STATEMENT OF CHANGES IN EQUITY

 

For the years ended 31 December 2012, 2011 and 2010

 

Notes

Share Capital

£m

Share Premium

£m

Available for sale reserve

£m

Retained earnings

£m

Total

£m

1 January 2012

3,999

5,620

7

4,625

14,251

Total comprehensive income/(expense):

- Profit for the year

-

-

-

(760)

(760)

- Other comprehensive income/(expense) for the year

-

-

(12)

(183)

(195)

- Tax on other comprehensive income/(expense)

-

-

3

42

45

-

-

(9)

(901)

(910)

Dividends

13

-

-

-

(507)

(507)

31 December 2012

3,999

5,620

(2)

3,217

12,834

1 January 2011

3,999

5,620

7

1,983

11,609

Total comprehensive income/(expense):

- Profit for the year

-

-

-

3,153

3,153

- Other comprehensive income/(expense) for the year

-

-

(2)

(38)

(40)

- Tax on other comprehensive income/(expense)

-

-

2

9

11

-

-

-

3,124

3,124

Dividends

13

-

-

-

(482)

(482)

31 December 2011

3,999

5,620

7

4,625

14,251

1 January 2010

2,709

1,857

7

1,350

5,923

Total comprehensive income/(expense):

- Profit for the year

-

-

-

1,391

1,391

- Other comprehensive income/(expense) for the year

-

-

-

67

67

- Tax on other comprehensive income/(expense)

-

-

-

(20)

(20)

-

-

-

1,438

1,438

Issue of preference shares

300

-

-

-

300

Reclassification of Perpetual Preferred Securities

297

-

-

-

297

Issue of ordinary shares

693

3,763

-

-

4,456

Other movements

-

-

-

10

10

Dividends

13

-

-

-

(815)

(815)

31 December 2010

3,999

5,620

7

1,983

11,609

 

The accompanying Notes on pages 208 to 309 and the audited sections of the Risk Management Report on pages 62 to 162 form an integral part of these Financial Statements.

 

COMPANY CASH FLOW STATEMENT

 

For the years ended 31 December 2012, 2011 and 2010

 

 

 

 

Notes

2012

£m

2011

£m

2010

£m

Cash flows from/(used in) operating activities

Profit for the year

(760)

3,153

1,391

Adjustments for:

Non cash items included in profit

422

1,760

2,580

Change in operating assets

2,473

5,712

(35,575)

Change in operating liabilities

11,002

(29,053)

43,708

Corporation taxes paid

(149)

(121)

(99)

Effects of exchange rate differences

(530)

(47)

(27)

Net cash flow from/(used in) operating activities

40

12,458

(18,596)

11,978

Cash flows used in investing activities

Increase in investment in subsidiaries

24, 45

-

-

(1,451)

Disposal of subsidiaries, net of cash disposed

-

-

772

Purchase of property, plant and equipment and intangible assets

25,26

(354)

(340)

(783)

Proceeds from sale of property, plant and equipment and intangible assets

3

5

47

Purchase of non-trading securities

(348)

-

-

Proceeds from sale and redemption of non-trading securities

46

-

-

Net cash flow used in investing activities

(653)

(335)

(1,415)

Net cash flow (used in)/from financing activities

Issue of ordinary share capital

39

-

-

4,456

Repayment of loan capital

(2,394)

(1,957)

(2,804)

Dividends paid on ordinary shares

13

(425)

(375)

(900)

Dividends paid on Perpetual Preferred Securities

13

(17)

(17)

-

Dividends paid on preference shares classified in equity

13

(19)

(19)

(19)

Dividends paid on Reserve Capital Instruments

13

(21)

(21)

(21)

Net cash flow (used in)/from financing activities

(2,876)

(2,389)

712

Net increase/(decrease) in cash and cash equivalents

8,929

(21,320)

11,275

Cash and cash equivalents at beginning of the year

45,353

66,673

55,398

Effects of exchange rate changes on cash and cash equivalents

-

-

-

Cash and cash equivalents at the end of the year

40

54,282

45,353

66,673

 

The accompanying Notes on pages 208 to 309 and the audited sections of the Risk Management Report on pages 62 to 162 form an integral part of these Financial Statements.

 

NOTES TO THE FINANCIAL STATEMENTS

 

ACCOUNTING POLICIES 

These financial statements are prepared for Santander UK plc (the 'Company') and the Santander UK plc group (the 'Santander UK group') under the Companies Act 2006. The principal activity of the Santander UK group is the provision of an extensive range of personal financial services, and a wide range of banking and financial services to business and public sector customers.

 

Santander UK plc is a public limited company, incorporated in England and Wales, having a registered office in England and is the holding company of the Santander UK group as well as undertaking banking and financial services transactions as an operating company.

 

BASIS OF PREPARATION

 

These consolidated financial statements incorporate the financial statements of the Company and entities controlled by the Company (its subsidiaries) made up to 31 December each year. The financial statements have been prepared under the historical cost convention, as modified by the revaluation of available-for-sale financial assets, financial assets and financial liabilities held at fair value through profit or loss and all derivative contracts, and on the going concern basis of accounting as disclosed in the Directors' statement of going concern set out in the Directors' Report on pages 182 and 183. a) Compliance with International Financial Reporting Standards

The Santander UK group consolidated financial statements have been prepared in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board ('IASB'), including interpretations issued by the IFRS Interpretations Committee ('IFRIC') of the IASB (together 'IFRS'). The Santander UK group has also complied with its legal obligation to comply with International Financial Reporting Standards as adopted by the European Union as there are no applicable differences between the two frameworks for the periods presented.

 

The Company financial statements have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union, as applied in accordance with the provision of the Companies Act 2006.

 

Disclosures required by IFRS 7 'Financial Instruments: Disclosure' relating to the nature and extent of risks arising from financial instruments can be found in the Risk Management Report on pages 62 to 162 which form an integral part of these financial statements.

 

Recent accounting developments

In 2012, the Santander UK group adopted the following amendments to standards which became effective for financial years beginning on 1 January 2012.

 

a)

IFRS 7 'Financial Instruments: Disclosures' - In October 2010, the IASB issued amendments to IFRS 7 that increase the disclosure requirements for transactions involving transfers of financial assets. The amendments are intended to provide greater transparency around risk exposures when a financial asset is transferred but the transferor retains some level of continuing exposure in the asset. The amendments also require disclosures where transfers of financial assets are not evenly distributed throughout the period. The amendments to IFRS 7 are effective for annual periods beginning on or after 1 July 2011, with earlier application permitted. Disclosures are not required for comparative periods before the date of initial application of the amendments. The disclosures required by the amendment to IFRS 7 may be found on page 251.

 

b)

There are a number of other changes to IFRS that were effective from 1 January 2012. Those changes did not have a significant impact on the Santander UK group's financial statements.

 

Future accounting developments

The Santander UK group has not yet adopted the following significant new or revised standards and interpretations, and amendments thereto, which have been issued but which are not yet effective for the Santander UK group:

 

a)

IAS 1 'Presentation of Financial Statements' - In June 2011, the IASB issued amendments to IAS 1 that retain the option to present profit or loss and other comprehensive income in either a single statement or in two separate but consecutive statements. However, the amendments to IAS 1 require additional disclosures to be made in the other comprehensive income section such that items of other comprehensive income are grouped into two categories: (i) items that will not be reclassified subsequently to profit or loss; and (ii) items that will be reclassified subsequently to profit or loss when specific conditions are met. Income tax on items of other comprehensive income is required to be allocated on the same basis. The amendments to IAS 1 are effective for annual periods beginning on or after 1 July 2012.

The Santander UK group anticipates that IAS 1 (2011) will be adopted in the Santander UK group's financial statements for the annual period beginning on 1 January 2013 and that the application of the new Standard will modify the presentation of items of other comprehensive income accordingly. Retrospective application is required. The Santander UK group does not anticipate that these amendments to IAS 1 will have a significant impact on the Santander UK group's disclosures.

b)

IFRS 10 'Consolidated Financial Statements', IFRS 11 'Joint Arrangements', IFRS 12 'Disclosure of Interests in Other Entities', IAS 27 'Separate Financial Statements' and IAS 28 'Investments in Associates and Joint Ventures' - In May 2011, the IASB issued new and amended guidance on consolidated financial statements and joint arrangements. IFRS 10, IFRS 11 and IFRS 12 were new standards issued while IAS 27 and IAS 28 were amended. Each of the standards issued is effective for annual periods beginning on or after 1 January 2013 with earlier application permitted as long as each of the other standards is also applied earlier.

Under IFRS 10 'Consolidated Financial Statements', control is the single basis for consolidation, irrespective of the nature of the investee; this standard therefore eliminates the risks-and-rewards approach. IFRS 10 identifies the three elements of control as power over the investee, exposure, or rights, to variable returns from involvement with the investee and the ability to use power over the investee to affect the amount of the investor's returns. An investor must possess all three elements to conclude that it controls an investee. The assessment of control is based on all facts and circumstances, and the conclusion is reassessed if there are changes to at least one of the three elements. Retrospective application is required subject to certain transitional provisions.

IFRS 11 applies to all entities that are parties to a joint arrangement. A joint arrangement is an arrangement of which two or more parties have joint control. IFRS 11 establishes two types of joint arrangements, joint operations and joint ventures, which are distinguished by the rights and obligations of the parties to the arrangement. In a joint operation, the parties to the joint arrangement (referred to as 'joint operators') have rights to the assets and obligations for the liabilities of the arrangement. By contrast, in a joint venture, the parties to the arrangement (referred to as 'joint venturers') have rights to the net assets of the arrangement. IFRS 11 requires that a joint operator recognise its share of the assets, liabilities, revenues and expenses in accordance with applicable IFRSs; however, a joint venturer would account for its interest by using the equity method of accounting under IAS 28 (2011). Transitional provisions vary depending on how an interest is accounted for under IAS 31 and what its nature is under IFRS 11.

IFRS 12 integrates the disclosure requirements on interests in other entities, currently included in several standards to make it easier to understand and apply the disclosure requirements for subsidiaries, joint arrangements, associates and unconsolidated structured entities. The standard also contains additional requirements on a number of topics. Under IFRS 12, an entity should disclose information about significant judgements and assumptions (and any changes to those assumptions) made in determining whether it has control, joint control, or significant influence over another entity and the type of joint arrangement. IFRS 12 also requires additional disclosures to provide information to enable users to assess the nature of, and risks associated with the Company's interests in other entities and the effect of those interests on the Company's financial position, performance and cash flow. Disclosures shall be aggregated or disaggregated so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have different characteristics. The standard applies prospectively from the beginning of the annual period in which it is adopted.

In June 2012, the IASB issued amendments to IFRS 10, IFRS 11 and IFRS 12 that clarify the transitional guidance in IFRS 10, IFRS 11 and IFRS 12. The amendments provide additional transition relief in IFRS 10, IFRS 11 and IFRS 12 by limiting the requirement to provide adjusted comparative information to only the preceding comparative period, and are in response to constituent requests for clarification on certain aspects of the transition guidance.

The Santander UK group anticipates that IFRS 10, IFRS 11 and IFRS 12 will be adopted in the Santander UK group's financial statements for the annual period beginning on 1 January 2013. The Santander UK group is still completing its analysis but does not anticipate that the application of the new standards will have a significant impact on its profit or loss or financial position but expects to enhance its disclosures around holdings of structured entities as a result of IFRS 12.

IAS 27 was amended for the issuance of IFRS 10 but retains the current guidance on separate financial statements.

IAS 28 was amended for conforming changes on the basis of the issuance of IFRS 10 and IFRS 11.

The Santander UK group anticipates that IAS 27 (2011) and IAS 28 (2011) will be adopted in the Company's financial statements for the annual period beginning on 1 January 2013. The Santander UK group is still completing its analysis but does not anticipate that these amendments to IAS 27 and IAS 28 will have a significant impact on its disclosures and on amounts reported in respect of the Santander UK group's profit or loss, financial position or disclosures.

c)

IFRS 13 'Fair Value Measurement' - In May 2011, the IASB issued IFRS 13, which establishes a single source of guidance for fair value measurement. IFRS 13 defines fair value, establishes a framework for measuring fair value, and requires disclosures about fair value measurements. IFRS 13 applies to both financial instrument items and non-financial instrument items for which other IFRSs require or permit fair value measurements and disclosures about fair value measurements, except in specified circumstances. In general, the disclosure requirements in IFRS 13 are more extensive than those required in the current accounting standards. IFRS 13 is effective for annual periods beginning on or after 1 January 2013, with early adoption permitted, and applies prospectively from the beginning of the annual period in which it is adopted.

The Santander UK group anticipates that IFRS 13 will be adopted in the Santander UK group's financial statements for the annual period beginning on 1 January 2013. The Santander UK group is still completing its analysis but does not anticipate that the application of the new standards will have a significant impact on its profit or loss, financial position or disclosures.  

d)

IFRS 9 'Financial Instruments' - In November 2009, the IASB issued IFRS 9 'Financial Instruments ('IFRS 9') which introduced new requirements for the classification and measurement of financial assets. In October 2010, the IASB issued an amendment to IFRS 9 incorporating requirements for financial liabilities. Together, these changes represent the first phase in the IASB's planned replacement of IAS 39 'Financial Instruments: Recognition and Measurement' ('IAS 39') with a less complex and improved standard for financial instruments.

Following the IASB's decision in December 2011 to defer the effective date, the standard is effective for annual periods beginning on or after 1 January 2015 with early adoption permitted. IFRS 9 is required to be applied retrospectively but prior periods need not be restated.

The second and third phases in the IASB's project to replace IAS 39 will address impairment of financial assets measured at amortised cost and hedge accounting.

The IASB re-opened the requirements for classification and measurement in IFRS 9 in 2012 to address practice and other issues, with an exposure draft of revised proposals issued in November 2012.

The Santander UK group anticipates that IFRS 9 will be adopted in the Santander UK group's financial statements for the annual period beginning on 1 January 2015 and that the application of the new Standard may have a significant impact on amounts reported in respect of the Santander UK group's financial assets and financial liabilities. However, it is not practicable to provide a reasonable estimate of that effect until a detailed review has been completed.

 

e)

IAS 19 'Employee Benefits' - In June 2011, the IASB issued amendments to IAS 19 that change the accounting for defined benefit plans and termination benefits. The most significant change relates to the accounting for changes in defined benefit obligations and plan assets. The amendments require the recognition of changes in defined benefit obligations and in fair value of plan assets when they occur, and hence eliminate the 'corridor approach' permitted under the previous version of IAS 19, accelerate the recognition of past service costs and changes in the assessment of interest revenue from plan assets in profit and loss. The amendments require all actuarial gains and losses to be recognised immediately through other comprehensive income in order for the net pension asset or liability recognised in the consolidated statement of financial position to reflect the full value of the plan deficit or surplus. The amendments to IAS 19 are effective for annual periods beginning on or after 1 January 2013 and require retrospective application with certain exceptions.

The Santander UK group adopted IAS 19 with effect from 1 January 2004 and has since that date recognised all actuarial gains and losses immediately through other comprehensive income and all past service costs immediately when changes to benefits were made. No change to prior periods is required in respect of the elimination of the corridor approach or recognition of past service costs.

The Santander UK group anticipates that IAS 19 (2011) will be adopted in the Santander UK group's financial statements for the annual period beginning on 1 January 2013. The Santander UK group does not anticipate that these amendments to IAS 19 will have a significant impact on its profit or loss or financial position as the Santander UK group does not utilise the 'corridor approach'.

 

f)

In December 2011, the IASB issued amendments to IFRS 7 'Disclosures - Offsetting Financial Assets and Financial Liabilities' which requires the disclosures about the effect or potential effects of offsetting financial assets and financial liabilities and related arrangements on an entity's financial position. The amendments are effective for annual periods beginning on or after 1 January 2013 and interim periods within those annual periods. The amendments are required to be applied retrospectively.

 

g)

In December 2011, the IASB issued amendments to IAS 32 'Offsetting Financial Assets and Financial Liabilities' which clarified the requirements for offsetting financial instruments and addressed inconsistencies in current practice when applying the offsetting criteria in IAS 32 'Financial Instruments: Presentation'. The amendments are effective for annual periods beginning on or after 1 January 2014 with early adoption permitted and are required to be applied retrospectively.

The Santander UK group is currently assessing the impact of these clarifications but it is not practicable to quantify the effect as at the date of the publication of these financial statements.

 

h)

There are a number of other standards which have been issued or amended that are expected to be effective in future periods. However, it is not practicable to provide a reasonable estimate of their effects on the Santander UK group's financial statements until a detailed review has been completed.

 

b) Comparative information

As required by US public company reporting requirements, these Consolidated Financial Statements include two years of comparative information for the consolidated income statement, consolidated statement of comprehensive income, consolidated statement of changes in equity, consolidated statement of cash flows and related Notes.

 

CONSOLIDATION

 

a) Subsidiaries

Subsidiaries, which are those companies and other entities (including Special Purpose Entities ('SPEs')) over which the Santander UK group, directly or indirectly, has power to govern the financial and operating policies, are consolidated. The existence and effect of potential voting rights that are currently exercisable or currently convertible are considered when assessing whether the Santander UK group controls another entity. The Company recognises investments in subsidiaries at cost less impairment.

 

Subsidiaries are consolidated from the date on which control is transferred to the Santander UK group and are no longer consolidated from the date that control ceases. The acquisition method of accounting is used to account for the acquisition of subsidiaries. The cost of an acquisition is measured at the fair value of the assets given up, shares issued or liabilities undertaken at the date of acquisition. Acquisition related costs are expensed as incurred. The excess of the cost of acquisition, as well as the fair value of any interest previously held, over the fair value of the Santander UK group's share of the identifiable net assets of the acquired subsidiary, associate or business at the date of acquisition is recorded as goodwill. Inter-company transactions, balances and unrealised gains on transactions between Santander UK group companies are eliminated; unrealised losses are also eliminated unless the cost cannot be recovered. The accounting reference date of the Company and its subsidiary undertakings is 31 December, with the exception of those leasing, investment, insurance and funding companies which, because of commercial considerations, have various accounting reference dates. The financial statements of these subsidiaries have been consolidated on the basis of interim financial statements for the period to 31 December.

 

In the context of SPE's, the following circumstances may indicate a relationship in which, in substance, the Santander UK group controls and consequently consolidates an SPE:

 

the activities of the SPE are being conducted on behalf of the Santander UK group according to the Santander UK group's specific business needs so that it obtains benefits from the SPE's operation;

the Santander UK group has the decision-making powers to obtain the majority of the benefits of the activities of the SPE or, by setting up an 'autopilot' mechanism, the Santander UK group has delegated those decision-making powers;

the Santander UK group has rights to obtain the majority of the benefits of the SPE and therefore may be exposed to risks arising from the activities of the SPE; or

the Santander UK group retains the majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities.

 

Assessments of control are made based on the initial arrangements in place, but are reconsidered if there are subsequent changes to the substance of the arrangements, such as the nature of the Santander UK group's involvement, the contractual arrangements or the governing rules of the SPE.

 

Transactions between entities under common control, i.e. fellow subsidiaries of Banco Santander, S.A. (the "ultimate parent") are outside the scope of IFRS 3 - "Business Combinations", and there is no other guidance for such situations under IFRS. The Santander UK group elects to account for transactions between entities under common control for cash consideration in a manner consistent with the approach under IFRS 3R, except for the continued disclosure of those IBNO provisions for a portfolio that cannot easily be allocated to individual loans, unless the transaction represents a reorganisation of entities within the Santander UK group, in which case the transaction is accounted for at its historical cost. Business combinations between entities under common control transacted for non-cash consideration are accounted for by the Santander UK group in a manner consistent with group reconstruction relief under UK GAAP (merger accounting).

 

b) Associates and joint ventures

Associates are entities over which the Santander UK group has significant influence, but which it does not control. A holding by the Santander UK group of between 20% and 50% of the voting rights is a usual indicator of this influence. The existence and effect of potential voting rights that are presently exercisable or presently convertible are considered when assessing whether the Santander UK group has significant influence over another entity. Unrealised gains on transactions between the Santander UK group and its associates are eliminated to the extent of the Santander UK group's interest in the associates; unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. The Santander UK group's investment in associates includes goodwill on acquisition. Joint ventures are entities over which the Santander UK group has joint control under a contractual arrangement with other parties.

 

The Santander UK group's investments in associates and joint ventures are accounted for by the equity method of accounting and are initially recorded at cost and adjusted each year to reflect the Santander UK group's share of the post-acquisition results of the joint venture or associate. The share of any losses is restricted to a level that reflects an obligation to fund such losses. The Santander UK group does not hold significant investments in associates or joint ventures.

 

FOREIGN CURRENCY TRANSLATION

 

Items included in the financial statements of each entity (including foreign branch operations) in the Santander UK group are measured using the currency that best reflects the economic substance of the underlying events and circumstances relevant to that entity (the 'functional currency'). The Consolidated Financial Statements are presented in pounds sterling, which is the functional currency of the parent.

 

Income statements and cash flows of foreign entities are translated into the Santander UK group's reporting currency at average exchange rates for the year and their balance sheets are translated at the exchange rates ruling on 31 December.

 

Exchange differences arising from the translation of the net investment in foreign entities are recognised in other comprehensive income. When a foreign entity is sold, such exchange differences are recognised in the income statement as part of the gain or loss on sale.

 

Foreign currency transactions are translated into the functional currency of the entity involved at the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation of monetary assets and liabilities denominated in foreign currencies are recognised in the income statement unless recognised in other comprehensive income in connection with a cash flow hedge.

 

Exchange rate differences recognised in profit or loss on items not at fair value through profit and loss were £1,631m income (2011: £1,814m income, 2010: £1,356m income). This was partially offset by income/charges on items held at fair value.

 

REVENUE RECOGNITION

 

a) Interest income and expense

Income on financial assets that are classified as loans and receivables or available-for-sale, and interest expense on financial liabilities other than those at fair value through profit and loss are determined using the effective interest method. The effective interest rate is the rate that discounts the estimated future cash payments or receipts over the expected life of the instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the future cash flows are estimated after considering all the contractual terms of the instrument excluding future credit losses. The calculation includes all amounts paid or received by the Santander UK group that are an integral part of the overall return, direct incremental transaction costs related to the acquisition, issue or disposal of the financial instrument and all other premiums or discounts. Interest income on assets classified as loans and receivables, available-for-sale, or income on investments in equity shares, interest expense on liabilities other than those at fair value through profit and loss, and interest income and expense on hedging derivatives are recognised in interest and similar income and interest expense and similar charges in the income statement. In accordance with IFRS, the Santander UK group recognises interest income on assets after they have been written down as a result of an impairment loss. Interest continues to be accrued on all loans and the element of interest that is not anticipated to be recovered is provided for.

 

b) Fee and commission income and expense

Fees and commissions that are not an integral part of the effective interest rate are recognised when the service is provided. For retail products, fee and commission income consists principally of collection services fees, commission on foreign currencies, commission and other fees received from retailers for processing credit card transactions, fees received from other credit card issuers for providing cash advances for their customers through the Santander UK group's branch and ATM networks, annual fees payable by credit card holders and fees for non-banking financial products. Revenue from these income streams is recognised when the service is provided.

 

For insurance products, fee and commission income consists principally of commissions earned on the sale of building and contents insurance, life protection insurance and payment cover insurance. Revenue from these income streams is recognised when the service is provided.

 

Asset management fee and commission income comprises portfolio and other management advisory and service fees, investment fund management fees, and fees for private banking, financial planning and custody services. Portfolio and other management advisory and service fees are recognised based on the applicable service contracts. Asset management fees related to investment funds are recognised rateably over the period the service is provided. The same principle is applied for private banking, financial planning and custody services that are continuously provided over an extended period of time.

 

Fee and commission income which forms an integral part of the effective interest rate of a financial instrument (e.g., certain loan commitment fees) is recognised as an adjustment to the effective interest rate and recorded in "Interest income".

 

c) Dividend income

Except for equity securities classified as trading assets or financial assets held at fair value through profit or loss, described below, dividend income is recognised when the right to receive payment is established. This is the ex-dividend date for equity securities.

 

d) Net trading and other income

Net trading and other income comprises all gains and losses from changes in the fair value of financial assets and liabilities held at fair value through profit or loss (including financial assets and financial liabilities held for trading and designated as fair value through profit or loss), together with related interest income, expense and dividends. It also includes income from operating lease assets, and profits/(losses) on the sales of property, plant and equipment and subsidiary undertakings.

 

Changes in the fair value of financial assets and liabilities held for trading, including trading derivatives, are recognised in the income statement as net trading and other income together with dividends and interest income and expense. Changes in the fair value of assets and liabilities designated as fair value through profit or loss are recognised in net trading and other income together with dividends, accrued interest income and expense and changes in fair value of derivatives managed in conjunction with these assets and liabilities. Changes in fair value of derivatives in a hedging relationship are recognised in net trading and other income along with the fair value of the hedged item if designated in a fair value hedge or macro hedging relationship.

 

BORROWING COSTS

 

Borrowing costs directly attributable to the acquisition, construction or production of qualifying assets, including computer software, which are assets that necessarily take a substantial period of time to develop for their intended use, are added to the cost of those assets, until such time as the assets are substantially ready for their intended use. All other borrowing costs are recognised in profit or loss in the period in which they occur.

 PENSIONS AND OTHER POST RETIREMENT BENEFITS

 

The Santander UK group operates various pension schemes. The schemes are generally funded through payments to insurance companies or trustee-administered funds, as determined by periodic actuarial calculations. A defined benefit plan is a pension plan that guarantees an amount of pension benefit to be provided, usually as a function of one or more factors such as age, years of service or compensation. A defined contribution plan is a pension plan under which the Santander UK group pays fixed contributions as they fall due into a separate entity (a fund). The pension paid to the member at retirement is based on the amount in the separate fund for each member. The Santander UK group has no legal or constructive obligations to pay further contributions into the fund to "top up" benefits to a certain guaranteed level. Pension costs are charged to the line item 'Administration expenses', with the interest cost on liabilities and the expected return on scheme assets included within 'Net interest income' in the income statement.

 

a) Defined benefit plans

The asset or liability recognised in respect of defined benefit pension plans is the present value of the defined benefit obligation at the balance sheet date, less the fair value of plan assets. The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The assets of the schemes are measured at their fair values at the balance sheet date. Full actuarial valuations of the Santander UK group's principal defined benefit schemes are carried out on a triennial basis. Each scheme's Trustee is responsible for the actuarial valuations and in doing so considers or relies in part on a report of a third party expert.

 

The present value of the defined benefit obligation is estimated by projecting forward the growth in current accrued pension benefits to reflect inflation and salary growth to the date of pension payment, then discounted to present value using an interest rate applicable to high-quality AA rated corporate bonds of the same currency and which have terms to maturity closest to the terms of the scheme liabilities, adjusted where necessary to match those terms. In determining the value of scheme liabilities, demographic and financial assumptions are made by management about mortality, inflation, discount rates, pension increases and earnings growth, based on past experience. Financial assumptions are based on market conditions at the balance sheet date and can generally be derived objectively. Demographic assumptions require a greater degree of estimation and judgement to be applied to externally derived data. Any surplus or deficit of scheme assets over liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). An asset is only recognised to the extent that the surplus can be recovered through reduced contributions in the future or through refunds from the scheme.

 

The income statement includes the current service cost of providing pension benefits, the expected return on schemes' assets net of expected administration costs, and the interest cost on the schemes' liabilities. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are recognised in other comprehensive income. Past-service costs are charged immediately to the income statement, unless the charges are conditional on the employees remaining in service for a specified period of time, known as the vesting period. In this case, the past-service costs are amortised on a straight-line basis over the average period until the benefits vest. Gains and losses on curtailments are recognised when the curtailment occurs. This is when there is a demonstrable commitment to make a significant reduction in the number of employees covered by the plan, or amendments have been made to the terms of the plan so that a significant element of future service will no longer qualify for benefits or will qualify only for reduced benefits. The gain or loss comprises any resulting change in the present value of the defined benefit obligation, any resulting change in the fair value of the plan assets and any related actuarial gain or loss. Curtailment gains and losses on sold businesses that meet the definition of discontinued operations are included in operating expenses in profit or loss for the year from discontinued operations.

 

b) Defined contribution plans

For defined contribution plans, the Santander UK group pays contributions to publicly or privately administered pension insurance plans on a mandatory, contractual or voluntary basis. Once the contributions have been paid, the Santander UK group has no further payment obligation. The regular contributions constitute net periodic costs for the year in which they are due and are included in staff costs.

 

c) Post-retirement medical benefit plans

Post-retirement medical benefit liabilities are determined using the Projected Unit Credit Method, with actuarial valuations updated at each yearend. The expected benefit costs are accrued over the period of employment using an accounting methodology similar to that for the defined benefit pension scheme.

 SHARE-BASED PAYMENTS

 

The Santander UK group engages in cash-settled and equity-settled share-based payment transactions in respect of services received from certain of its employees. Shares of the Santander UK group's parent, Banco Santander, S.A. are purchased in the open market by the Santander UK group (for the Employee Sharesave scheme) or are purchased by Banco Santander, S.A. or another Banco Santander group company (for awards granted under the Long Term Incentive Plan and the Deferred Shares Bonus Plan) to satisfy share options as they vest.

 

Options granted under the Employee Sharesave scheme are accounted for as cash-settled share-based payment transactions. Awards granted under the Long-Term Incentive Plan and Deferred Shares Bonus Plan are accounted for as equity-settled share-based payment transactions.

 

The fair value of the services received is measured by reference to the fair value of the shares or share options initially on the date of the grant for both the cash and equity settled share-based payments and then subsequently at each reporting date for the cash settled share-based payments. The cost of the employee services received in respect of the shares or share options granted is recognised in the income statement within administration expenses, over the period that the services are received, which is the vesting period.

 

A liability equal to the portion of the goods or services received is recognised at the current fair value determined at each balance sheet date for cash-settled, share-based payments. A liability equal to the amount to be reimbursed to Banco Santander, S.A. is recognised at the current fair value determined at the grant date for equity-settled share-based payments.

 

The fair value of the options granted under the Employee Sharesave scheme is determined using an option pricing model, which takes into account the exercise price of the option, the current share price, the risk free interest rate, the expected volatility of the Banco Santander, S.A. share price over the life of the option and the dividend growth rate. The fair value of the awards granted for the Long Term Incentive Plan was determined at the grant date using an option pricing model, which takes into account the share price at grant date, the risk free interest rate, the expected volatility of the Banco Santander, S.A. share price over the life of the award and the dividend growth rate. Vesting conditions included in the terms of the grant are not taken into account in estimating fair value, except for those that include terms related to market conditions. Non-market vesting conditions are taken into account by adjusting the number of shares or share options included in the measurement of the cost of employee service so that ultimately, the amount recognised in the income statement reflects the number of vested shares or share options.

 

Where an award has been modified, as a minimum, the expense of the original award continues to be recognised as if it had not been modified. Where the effect of a modification is to increase the fair value of an award or increase the number of equity instruments, the incremental fair value of the award or incremental fair value of the extra equity instruments is recognised in addition to the expense of the original grant, measured at the date of modification, over the modified vesting period.

 

A cancellation that occurs during the vesting period is treated as an acceleration of vesting, and recognised immediately for the amount that would otherwise have been recognised for services over the vesting period.

 GOODWILL AND OTHER INTANGIBLE ASSETS

 

Goodwill represents the excess of the cost of an acquisition, as well as the fair value of any interest previously held, over the fair value of the Santander UK group's share of the identifiable net assets of the acquired subsidiary, associate, or business at the date of acquisition. Goodwill on the acquisition of subsidiaries and businesses is included in Intangible assets. Goodwill on acquisitions of associates is included as part of Investment in associates. Goodwill is tested for impairment at each balance sheet date, or more frequently when events or changes in circumstances dictate, and carried at cost less accumulated impairment losses. Gains and losses on the disposal of an entity or business include the carrying amount of goodwill relating to the entity or business sold.

 

Other intangible assets are recognised if they arise from contracted or other legal rights or if they are capable of being separated or divided from the Santander UK group and sold, transferred, licensed, rented or exchanged. The value of such intangible assets is amortised on a straight-line basis over the useful economic life of the assets in question, which ranges from three to seven years. Other intangible assets are reviewed annually for impairment indicators and tested for impairment where indicators are present.

 

Marketing rights are capitalised when they are separately identifiable contractual agreements that are expected to provide future economic benefits and the costs are separately identifiable. The value of the marketing rights is classified in intangible assets on the balance sheet and amortised on a straight-line basis over their useful life of five to seven years.

 

Software development costs are capitalised when they are direct costs associated with identifiable and unique software products that are expected to provide future economic benefits and the cost of these products can be measured reliably. These costs include payroll, the costs of materials and services and directly attributable overheads. Internally developed software meeting these criteria and externally purchased software are classified in intangible assets on the balance sheet and amortised on a straight-line basis over their useful life of three to seven years, unless the software is an integral part of the related computer hardware, in which case it is treated as property, plant and equipment as described below. Capitalisation of costs ceases when the software is capable of operating as intended. Costs associated with maintaining software programmes are expensed as incurred.

 PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment include owner-occupied properties (including leasehold properties), office fixtures and equipment and computer software. Property, plant and equipment are carried at cost less accumulated depreciation and accumulated impairment losses. A review for indications of impairment is carried out at each reporting date. Gains and losses on disposal are determined by reference to the carrying amount and are reported in net trading and other income. Repairs and renewals are charged to the income statement when the expenditure is incurred. Internally developed software meeting the criteria set out in "Goodwill and other intangible assets" above and externally purchased software are classified in property, plant and equipment on the balance sheet where the software is an integral part of the related computer hardware.

 

Classes of property, plant and equipment are depreciated on a straight-line basis over their useful life, as follows:

 

Owner-occupied properties

Not exceeding 50 years

Office fixtures and equipment

3 to 15 years

Computer software

3 to 7 years

 

Depreciation is not charged on freehold land and assets under construction.

 FINANCIAL ASSETS

 

The Santander UK group classifies its financial assets as: financial assets at fair value through profit or loss, loans and receivables, available-for-sale and held to maturity financial assets. Management determines the classification of its investments at initial recognition. Financial assets that are classified at fair value through profit or loss, which have not been designated as such or are not accounted for as derivatives, or assets classified as available-for-sale, may subsequently in rare circumstances, be reclassified from the fair value through profit or loss category to the loans and receivables, available-for-sale or held to maturity categories. In order to meet the criteria for reclassification, the asset must no longer be held for the purpose of selling or repurchasing in the near term and must also meet the definition of the category into which it is to be reclassified had it not been required to classify it at fair value through profit or loss at initial recognition. The reclassified value is the fair value of the asset at the date of reclassification. The Santander UK group has not utilised this option and therefore has not reclassified any assets from the fair value through profit or loss category that were classified as such at initial recognition.

 

a) Financial assets at fair value through profit or loss

Financial assets are classified as fair value through profit or loss if they are either held for trading or otherwise designated at fair value through profit or loss on initial recognition. A financial asset is classified as held for trading if it is a derivative or it is acquired principally for the purpose of selling in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking.

 

In certain circumstances financial assets other than those that are held for trading are designated at fair value through profit or loss where this results in more relevant information because it significantly reduces a measurement inconsistency that would otherwise arise from measuring assets or recognising the gains or losses on them on a different basis, where the assets are managed and their performance evaluated on a fair value basis, or where a financial asset contains one or more embedded derivatives which are not closely related to the host contract.

 

Trading assets, derivative financial instruments (except where in a hedging relationship) and financial assets designated at fair value are classified as fair value through profit or loss. They are derecognised when the rights to receive cash flows from the asset have expired or when the Santander UK group has transferred substantially all the risks and rewards of ownership.

 

b) Loans and receivables

Loans and receivables are non-derivative financial assets with fixed or determinable payments, that are not quoted in an active market and which are not classified as available-for-sale or fair value through profit or loss. They arise when the Santander UK group provides money or services directly to a customer with no intention of trading the loan. Loans and receivables are initially recognised at fair value including direct and incremental transaction costs. They are subsequently valued at amortised cost, using the effective interest method. They are derecognised when the rights to receive cash flows have expired or the Santander UK group has transferred substantially all of the risks and rewards of ownership. Loans and receivables consist of Loans and advances to banks, Loans and advances to customers and Loans and receivables securities.

 

c) Available-for-sale financial assets

Available-for-sale financial assets are non-derivative financial assets that are designated as available-for-sale and are not categorised into any of the other categories described. They are initially recognised at fair value including direct and incremental transaction costs. They are subsequently held at fair value. Gains and losses arising from changes in fair value are recognised in other comprehensive income until sale when the cumulative gain or loss is transferred to the income statement. Where the financial asset is interest-bearing, interest is determined using the effective interest method.

 

Income on investments in equity shares, debt instruments and other similar interests is recognised in the income statement as and when dividends are declared and interest is accrued. Impairment losses and foreign exchange translation differences on monetary items are recognised in the income statement. The investments are derecognised when the rights to receive cash flows have expired or the Santander UK group has transferred substantially all the risks and rewards of ownership.

 

d) Held to maturity investments

Held to maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturity that an entity has the positive intention and ability to hold to maturity. Held to maturity investments are initially recognised at fair value including direct and incremental transaction costs. They are subsequently valued at amortised cost, using the effective interest method. They are derecognised when the rights to receive cash flows have expired or the Santander UK group has transferred substantially all of the risks and rewards of ownership. Were the Santander UK group to sell other than an insignificant amount of held to maturity assets, the entire category would be tainted and reclassified as available-for-sale.

 

The Santander UK group does not hold any held to maturity financial assets.

 

VALUATION OF FINANCIAL INSTRUMENTS

 

Financial instruments that are classified at fair value through profit or loss, including those held for trading purposes, or available-for-sale, and all derivatives are stated at fair value. The fair value of such financial instruments is the estimated amount at which the instrument could be exchanged in a current transaction between willing, knowledgeable parties, other than in a forced or liquidation sale.

 

Changes in the valuation of such financial instruments, including derivatives, are included in the line item 'Net trading and other income' in the income statement or in 'Other comprehensive income' in the statement of comprehensive income as applicable.

 

a) Initial measurement

The best evidence of the fair value of a financial instrument at initial recognition is the transaction price unless the valuation is evidenced by comparison with other observable current market transactions in the same instrument or based on a valuation technique whose variables include significant data from observable markets. Any difference between the transaction price and the value based on a valuation technique where the inputs are not based on data from observable current markets is not recognised in profit or loss on initial recognition. Subsequent gains or losses are only recognised to the extent that they arise from a change in a factor that market participants would consider in setting a price.

 

b) Subsequent measurement

The Santander UK group applies the following fair value hierarchy that prioritises the inputs to valuation techniques used in measuring fair value. The hierarchy establishes three categories for valuing financial instruments, giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The three categories are: quoted prices in active markets (Level 1), internal models based on observable market data (Level 2) and internal models based on other than observable market data (Level 3). If the inputs used to measure an asset or a liability fall to different levels within the hierarchy, the classification of the entire asset or liability will be based on the lowest level input that is significant to the overall fair value measurement of the asset or liability.

 

The Santander UK group categorises assets and liabilities measured at fair value within the fair value hierarchy based on the inputs to the valuation techniques as follows:

 

Level 1:

Unadjusted quoted prices for identical assets or liabilities in an active market that the Santander UK group has the ability to access at the measurement date. Level 1 positions include debt securities, equity securities, exchange traded derivatives and short positions in securities.

Level 2:

Quoted prices in markets that are not active, quoted prices for similar assets or liabilities, recent market transactions, inputs other than quoted market prices for the asset or liability that are observable either directly or indirectly for substantially the full term, and inputs to valuation techniques that are derived principally from or corroborated by observable market data through correlation or other statistical means for substantially the full term of the asset or liability. Level 2 positions include loans and advances to banks, loans and advances to customers, equity securities, exchange rate derivatives, interest rate derivatives, equity and credit derivatives, debt securities, deposits by banks, deposits by customers and debt securities in issue.

Level 3:

Inputs to the pricing or valuation techniques that are significant to the overall fair value measurement of the asset or liability are unobservable. Level 3 positions include exchange rate derivatives, equity and credit derivatives, loans and advances to customers, debt securities, and debt securities in issue.

 

The Santander UK group assesses active markets for equity instruments based on the average daily trading volume both in absolute terms and relative to the market capitalisation for the instrument. The Santander UK group assesses active markets for debt instruments based on both the average daily trading volume and the number of days with trading activity. The Santander UK group assesses active markets for exchange traded derivatives based on the average daily trading volume both in absolute terms and relative to the market capitalisation for the instrument.

 

Market activity and liquidity is discussed in the relevant monthly Risk Forum as well as being part of the daily update given by each business at the start of the trading day. This information, together with the observation of active trading and the magnitude of the bid-offer spreads allow consideration of the liquidity of a financial instrument.

 

Underlying assets and liabilities are reviewed to consider the appropriate adjustment to mark the mid price reported in the trading systems to a realisable value. This process takes into account the liquidity of the position in the size of the adjustment required. These liquidity adjustments are presented and discussed at the monthly Risk Forum.

 

In determining the appropriate measurement levels, the Santander UK group performs regular analyses on the assets and liabilities. Underlying assets and liabilities are regularly reviewed to determine whether a position should be regarded as illiquid; the most important practical consideration being the observability of trading. Where the bid-offer spread is observable, this is tested against actual trades. Changes in the observability of significant valuation inputs during the reporting period may result in a reclassification of assets and liabilities within the fair value hierarchy.

 

Financial instruments valued using observable market prices

If a quoted market price in an active market is available for an instrument, the fair value is calculated as the current bid price multiplied by the number of units of the instrument held.

 

Financial instruments valued using a valuation technique

In the absence of a quoted market price in an active market, management uses internal models to make its best estimate of the price that the market would set for that financial instrument. In order to make these estimations, various techniques are employed, including extrapolation from observable market data and observation of similar financial instruments with similar characteristics. Wherever possible, valuation parameters for each product are based on prices directly observable in active markets or that can be derived from directly observable market prices. Valuation parameters for each type of financial instrument are discussed in Note 46.

 

Unrecognised gains as a result of the use of valuation models using unobservable inputs ('Day One profits')

The timing of recognition of deferred day one profit and loss is determined individually. It is deferred until either the instrument's fair value can be determined using market observable inputs or is realised through settlement. The financial instrument is subsequently measured at fair value, adjusted for the deferred day one profit and loss. Subsequent changes in fair value are recognised immediately in the consolidated income statement without immediate reversal of deferred day one profits and losses.

 "REGULAR WAY" PURCHASES OF FINANCIAL ASSETS AND ISSUES OF FINANCIAL LIABILITIES

 

A regular way purchase is a purchase of a financial asset under a contract whose terms require delivery of the asset within the timeframe established generally by regulation or convention in the market place concerned.

 

Regular way purchases of financial assets classified as loans and receivables are recognised on settlement date; all other regular way purchases are recognised on trade date. The assets are derecognised when the rights to receive cash flows have expired or the Santander UK group has transferred substantially all the risks and rewards of ownership.

 

Issues of equity or financial liabilities measured at amortised cost are recognised on settlement date; all other regular way issues are recognised on trade date. The liabilities are derecognised when extinguished.

 OFFSETTING FINANCIAL ASSETS AND LIABILITIES

 

Financial assets and liabilities including derivatives are offset and the net amount reported in the balance sheet when there is a legally enforceable right to set off the recognised amounts and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously.

 

The Santander UK group is party to a number of arrangements, including master netting arrangements under industry standard agreements which facilitate netting of transactions in 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.

 

SALE AND REPURCHASE AGREEMENTS (INCLUDING STOCK BORROWING AND LENDING)

 

Securities sold subject to a commitment to repurchase them at a predetermined price ('repos') under which substantially all the risks and rewards of ownership are retained by the Santander UK group remain on the balance sheet as trading assets and a liability is recorded in trading liabilities in respect of the consideration received. Securities purchased under commitments to resell ('reverse repos') are not recognised on the balance sheet and the consideration paid is recorded in trading assets. The difference between the sale and repurchase price is treated as trading income in the income statement.

 

Securities lending and borrowing transactions are generally secured, with collateral taking the form of securities or cash advanced or received. Securities lent or borrowed are not reflected on the balance sheet. Collateral in the form of cash received or advanced is recorded as a deposit or a loan. Collateral in the form of securities is not recognised.

 

DERIVATIVE FINANCIAL INSTRUMENTS

 

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. Transactions are undertaken in 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.

 

Derivatives are held for trading or for risk management purposes. Derivatives are classified as held for trading unless they are designated as being in a hedge relationship. The Santander UK group chooses to designate certain derivatives as in a hedging relationship if they meet specific criteria, as further described within 'hedge accounting' below.

 

Derivatives are recognised initially (on the date on which a derivative contract is entered into), and are subsequently remeasured, at their fair value. Fair values of exchange-traded derivatives are obtained from quoted market prices. Fair values of over-the-counter derivatives are obtained using valuation techniques, including discounted cash flow and option pricing models.

 

Derivatives may be embedded in other financial instruments, such as the conversion option in a convertible bond. Embedded derivatives are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the host contract; the terms of the embedded derivative would meet the definition of a stand-alone derivative if they were contained in a separate contract; and the combined contract is not held for trading or designated at fair value. These embedded derivatives are measured at fair value with changes in fair value recognised in the income statement. Contracts containing embedded derivatives are not subsequently reassessed for separation unless either there has been a change in the terms of the contract which significantly modifies the cash flows (in which case the contract is reassessed at the time of modification) or the contract has been reclassified (in which case the contract is reassessed at the time of reclassification).

 

All derivatives are carried as assets when their fair value is positive and as liabilities when their fair value is negative, except where netting is permitted. The method of recognising fair value gains and losses depends on whether derivatives are held for trading or are designated as hedging instruments and, if the latter, the nature of the risks being hedged. All gains and losses from changes in the fair value of derivatives held for trading are recognised in the income statement, and included within net trading and other income.

 

HEDGE ACCOUNTING

 

In certain circumstances, derivatives may be designated as hedges and classified as: (i) hedges of the change in fair value of recognised assets or liabilities or firm commitments ('fair value hedges'); (ii) hedges of the variability in highly probable future cash flows attributable to a recognised asset or liability, or a forecast transaction ('cash flow hedges'); or (iii) a hedge of a net investment in a foreign operation ('net investment hedges'). The Santander UK group enters into derivatives as fair value hedges, but not as cash flow hedges or net investment hedges. Hedge accounting is used for derivatives designated in this way provided certain criteria are met.

 

At the time a financial instrument is designated as a hedge (i.e., at the inception of the hedge), the Santander UK group formally documents the relationship between the hedging instrument(s) and hedged item(s), its risk management objective and strategy for undertaking the hedge. The documentation includes the identification of each hedging instrument and respective hedged item, the nature of the risk being hedged (including the benchmark interest rate being hedged in a hedge of interest rate risk) and how the hedging instrument's effectiveness in offsetting the exposure to changes in the hedged item's fair value attributable to the hedged risk is to be assessed. Accordingly, the Santander UK group formally assesses, both at the inception of the hedge and on an ongoing basis, whether the hedging derivatives have been and will be highly effective in offsetting changes in the fair value attributable to the hedged risk during the period that the hedge is designated. A hedge is normally regarded as highly effective if, at inception and throughout its life, the Santander UK group can expect, and actual results indicate, that changes in the fair value of the hedged items are effectively offset by changes in the fair value of the hedging instrument.

 

The main derivatives held for risk management purposes 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.

 

The Santander UK group discontinues hedge accounting when it is determined that: a derivative is not, or has ceased to be, highly effective as a hedge; when the derivative expires, or is sold, terminated or exercised; or when the hedged item matures or is sold or repaid. On discontinuance of hedge accounting, amortisation of the adjustment to the hedged item is included in net trading and other income.

 

The hedge adjustment for fair value hedges is classified in the balance sheet in the same category as the hedged item, unless it relates to a macro hedging relationship where the hedge adjustment is recognised as a macro hedge on the face of the balance sheet. For fair value hedges, changes in the fair value of the hedging instrument and hedged item are recognised in net trading and other income. Hedge ineffectiveness represents the amount by which the changes in the fair value of the hedging derivative differ from changes in the fair value of the hedged item. Such gains and losses are recorded in current period profit and loss within net trading and other income.

 

Gains and losses on components of a hedging derivative that are not part of the hedging relationship and are therefore excluded from the hedge effectiveness assessment are also included in net trading and other income.

 SECURITISATION TRANSACTIONS

 

The Santander UK group has entered into certain arrangements where undertakings have issued mortgage-backed and other asset-backed securities or have entered into funding arrangements with lenders in order to finance specific loans and advances to customers. As the Santander UK group has retained substantially all the risks and rewards of the underlying assets, such financial instruments continue to be held on the Santander UK group balance sheet, and a liability recognised for the proceeds of the funding transaction.

 

IMPAIRMENT OF FINANCIAL ASSETS

 

At each balance sheet date the Santander UK group assesses whether, as a result of one or more events occurring after initial recognition, there is objective evidence that a financial asset or group of financial assets classified as loans and receivables, available-for-sale or loans and receivables securities have become impaired. Evidence of impairment varies across different portfolios and may include indications that the borrower or group of borrowers have defaulted, are experiencing significant financial difficulty, or the debt has been restructured/refinanced potentially reducing the burden to the borrower. Impairment losses are recorded as charges in the income statement and the carrying amount of the financial asset or group of financial assets is reduced by establishing an impairment loss allowance. Impairment loss allowances are maintained at the level that management deems sufficient to absorb probable incurred losses in the Santander UK group's loans. Losses expected from future events are not recognised.

 

Impairment losses are assessed individually for financial assets that are individually significant and individually or collectively for assets that are not individually significant. An impairment loss allowance for incurred observed losses is established for all past due loans after a specified period of repayment default where it is probable that some of the capital or interest will not be repaid or recovered through enforcement of any applicable security. An allowance for incurred inherent losses is established for loans for which no evidence of loss has been specifically identified on an individual basis because the loans are not yet past due (i.e. incurred but not observed ('IBNO')) but are known from past experience to have deteriorated since the initial decision to lend was made. An example of this situation is where a borrower has not yet missed a payment but is experiencing financial difficulties at the reporting date, e.g. due to loss of employment or divorce. In these circumstances, an inherent loss had been incurred at the reporting date.

 

Impairment loss allowances for loans and advances, less amounts released and recoveries of amounts written off are charged to the line item 'Impairment losses on loans and advances' in the income statement. The impairment loss allowances are deducted from the 'Loans and advances to banks', 'Loans and advances to customers' and 'Loans and receivables securities' line items on the balance sheet.

 

a) Loans and receivables

 

i) Retail assets

 

Retail assets are assessed either individually or collectively for impairment. An impairment loss is incurred if there is objective evidence that a loss event has occurred since initial recognition of the assets that has an impact on the estimated future cash flows of the assets.

 

Potential indicators of loss events

Potential indicators of loss events which may be evidence of financial difficulty for a retail borrower may include a request from a borrower to change contractual terms; the borrower notifying the Santander UK group of current or likely financial distress; contact from a debt management company; a change in payment source, lump sum payments and changes in activity or arrears on other accounts held by the borrower.

 

Individual assessment

For individually assessed assets, the Santander UK group measures the amount of the loss as the difference between the carrying amount of the asset and the present value of the estimated future cash flows from the asset discounted at the original effective interest rate of the asset.

 

Collective assessment

Impairment is assessed on a collective basis in two circumstances to cover losses which have been:

 

Incurred but have not yet been identified (i.e. IBNO losses); and

Observed.

 

In making a collective assessment for impairment, financial assets are grouped together according to their credit risk characteristics. These can include grouping by product, loan-to-value, brand, geography, type of customer and previous insolvency events. For each such portfolio or sub-segment of the portfolio, future cash flows are estimated through the use of historical loss experience. The historical loss experience is adjusted for current observable data, including estimated current property prices to reflect the effects of current conditions not affecting the period of historical experience. The loss is discounted at the effective interest rate, except where portfolios meet the criteria for short-term receivables. The unwind of the discount over time is reported through interest receivable within the income statement, with the impairment loss allowances on the balance sheet increasing.

 

For each portfolio, the impairment loss allowance is calculated as the product of the number of accounts in the portfolio, the estimated proportion of accounts that will be written off, or repossessed in the case of mortgage loans (the 'loss propensity'), the estimated proportion of such cases that will result in a loss (the 'loss factor') and the average loss incurred (the 'loss per case'). Separate assessments are performed with respect to observed losses and IBNO losses.

 

The loss propensity for the observed segment represents the percentage of cases that will ultimately be written off. For the IBNO segment (i.e. where the account is currently up to date), the loss propensity represents the percentage of such cases that are expected to miss a payment in the appropriate emergence period and which will ultimately be written off. The loss propensities are based on recent historical experience, typically covering a period of no more than the most recent six months in the year under review.

 

The loss per case is based on actual cases using the most recent six month average data of losses that have been incurred during the most recent month for which data is available in the year under review (typically December), and is then discounted using an appropriate rate. Based on historical experience, the gross loss per case is realised in cash several months after the customer first defaults, during which time interest and fees and charges continue to accrue on the account. The future fees and charges included in the gross loss per case are removed and the balance discounted so as to calculate the present value of the loss per case. The discounted loss per case for accounts where a payment has already been missed (i.e. observed losses) is higher than for accounts that are up to date (i.e. IBNO losses) because the discounting effect is lower reflecting the fact that the process to recover the funds is further advanced.

 

Incurred but not observed impairment loss allowances

Individually assessed loans for which no evidence of loss has been specifically identified on an individual basis are grouped together according to their credit risk characteristics for the purpose of calculating an estimated allowance for IBNO losses. Such losses will only be individually identified in the future. As soon as information becomes available which identifies incurred losses on individual loans within the group, those loans are removed from the group and assessed for observed losses.

 

The allowance for IBNO losses is determined on a portfolio basis by applying the impairment loss allowances methodology outlined above to these accounts after taking into account:

 

historical loss experience in portfolios of similar credit risk characteristics (for example, by product);

the estimated period between an impairment event occurring and the loss being identified and evidenced by the establishment of an observed loss allowance against the individual loan (known as the emergence period, as discussed below); and

management's judgement as to whether current economic and credit conditions are such that the actual level of inherent losses at the balance sheet date is likely to be greater or less than that suggested by historical experience.

 

The emergence period

This is the period which the Santander UK group's statistical analysis shows to be the period in which losses that had been incurred but have not been separately identified at the balance sheet date, become evident as the loans turn into past due. Based on the Santander UK group's statistical analysis at 31 December 2012 and 2011, the emergence period was two to three months for unsecured lending and 12 months for secured lending. The longer emergence period for secured lending reflects the fact that a customer is more likely to default on unsecured debt before defaulting on secured lending. The factors considered in determining the length of the emergence period for unsecured lending are recent changes in customers' debit/credit payment profiles and credit scores. The factors considered for secured lending are the frequency and duration of exceptions from adherence to the contractual payment schedule.

 

Observed impairment loss allowances

An impairment loss allowance for observed losses is established for all past due loans where it is probable that some of the capital will not be repaid or recovered through enforcement of any applicable security. Loans for which evidence of potential loss has been specifically identified are grouped together according to their credit risk characteristics for the purpose of calculating an estimated allowance for observed losses.

 

The allowance for observed losses is determined on a collective (or 'portfolio') basis by applying the impairment loss allowances methodology outlined above for IBNO losses to these accounts, with the exception that no consideration is given to an emergence period, as the losses are already observed.

 

Generally, the length of time before an asset is placed on default status for an impairment loss review is when at least one payment is missed. Repayment default periods vary depending on the nature of the collateral that secures the advances. On advances secured by residential or commercial property, the default period is three months. For advances secured by consumer goods such as cars or computers, the default period is less than three months, the exact period being dependent on the particular type of loan. On unsecured advances, such as personal term loans, the default period is generally four missed payments (three months in arrears). Exceptions to the general rule exist with respect to revolving facilities, such as bank overdrafts, which are placed on default upon a breach of the contractual terms governing the applicable account, and on credit card accounts where the default period is three months.

 

Reversals of impairment

If in a subsequent period, the amount of an impairment loss reduces and the reduction can be related objectively to an event occurring after the impairment was recognised, the excess is written back by reducing the impairment loss allowance account accordingly. The write-back is recognised in the income statement.

 

Write-off

For secured loans, a write-off is only made when all collection procedures have been exhausted and the security has been sold or from claiming on any mortgage indemnity guarantee or other insurance. Security is realised in accordance with the Santander UK group's internal debt management programme. There is no threshold based on past due status beyond which all secured loans are written off as there can be significant variations in the time needed to enforce possession and sale of the security, especially due to the different legal frameworks that apply in different regions of the UK. For unsecured loans, a write-off is only made when all internal avenues of collecting the debt have been exhausted and the debt is passed over to external collection agencies. A past due threshold is applied to unsecured debt where accounts that are 180 days past due are written off unless there is a dispute awaiting resolution. 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.

 

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 exception to this is in cases where fraud has occurred, where the exposure is written off once full investigations have been completed and the probability of recovery is minimal. The time span between discovery and write-off will be short and may not result in an impairment loss allowance being raised. The write-off policy is regularly reviewed. Write-offs are charged against previously established impairment loss allowances.

 

Recoveries

Recoveries of impairment losses are not included in the impairment loss allowance, but are taken to income and offset against impairment losses. Recoveries are classified in the income statement as 'Impairment losses on loans and advances'.

 

Impairment losses on restructured/refinanced retail assets (forbearance)

To support retail customers that encounter actual or apparent financial difficulties, the Santander UK group may grant a concession, whether temporary or permanent, to amend contractual amounts or timings where a customer's financial distress indicates a potential that satisfactory repayment may not be made within the original terms and conditions of the contract. These arrangements are known as forbearance.

 

There are different risk characteristics associated with loans that are subject to forbearance as compared to loans that are not. A range of forbearance arrangements may be entered into by the Santander UK group, reflecting the different risk characteristics of such loans. The Santander UK group's forbearance programmes are described in the credit risk section in the Risk Management Report.

 

- Mortgages

On advances secured by residential property, the main types of forbearance offered are capitalisation, under the forms of payment arrangements, term extension or an interest only concession, subject to customer negotiation and vetting. Such accounts are classified in the "collections" category and, if they are in arrears, continue to be reported in arrears until the arrears are capitalised, at which point the accounts will be transferred to the "performing" category. The impairment provision on these accounts is based on the delinquency cycle in which the account was classified when it entered forbearance, unless the account's status has further deteriorated since then, in which case the impairment provision will be based on the current status.

 

The impairment loss allowances on these accounts are calculated in the same manner as on any other account, using the Santander UK group's collective assessment methodology. In making a collective assessment for impairment, loans that are subject to forbearance are grouped together according to their credit risk characteristics.

 

Separate assessments are performed for loans in forbearance that are performing (and have never been in arrears), performing (and previously were in arrears) and non-performing, and for each type of forbearance applied, to reflect their differing risk profiles. The loss propensities are based on recent historical experience of each sub category, typically covering a period of no more than the most recent six months in the year under review. For each sub category of loans in forbearance, the loss propensity factor applied in the collective assessment calculation is higher than for other performing loans reflecting the higher risk of default attached to these accounts. Similarly, for each sub category of loans in forbearance the loss factor applied is higher reflecting the higher risk of loss attached to these accounts.

 

It is not expected that all accounts in the collections category will default, particularly as the Santander UK group's lending policies only permit a mortgage restructure/refinance in circumstances where the customer is expected to be able to meet the related requirements and ultimately repay in full.

 

- Unsecured Personal Loans

For unsecured personal loans ('UPLs'), the main types of forbearance offered are reduced repayments and reduced settlement arrangements. Where accounts undergoing forbearance are in arrears, these continue to be reported in the delinquency cycle, until all arrears are capitalised or paid up, at which point the accounts will be transferred to the "performing" category. The impairment provision on these accounts is based on the delinquency cycle in which the account was classified when it entered forbearance, unless the account's status has further deteriorated since then, in which case the impairment provision will be based on the current status. Where the accounts reside in "performing" category as a result of forbearance, the impairment allowance requirements are based on default probability that take account of the higher inherent risk in the forborne asset relative to other performing assets.

 

- Credit Cards

For credit card lending, the main types of forbearance offered are reduced repayment arrangements and reduced settlement arrangements. Reduced settlement arrangements have no impact on the provisioning level as the agreed remaining balance is written off at the point of settlement. The impairment loss allowance takes into consideration the potential recoverable value on the debt sale market.

 

ii) Corporate assets

 

Corporate assets are assessed either individually or collectively for impairment. An impairment loss is incurred if there is objective evidence that a loss event has occurred since initial recognition of the assets that has an impact on the estimated future cash flows of the assets.

 

Potential indicators of loss events

Potential indicators of loss events which may be evidence of financial difficulty for a corporate borrower may include the borrower notifying the Santander UK group of current or likely financial distress; corporate results not meeting forecasts, missed repayments, requests for additional funding; breaches of covenants and changes in business plans.

 

Individual assessment

Impairment reviews are conducted monthly for individually significant assets:

 

where an asset has a payment default which has been outstanding for 90 days or more;

where non-payment defaults have occurred and/or where it has become evident that a restructuring/refinancing exercise will be undertaken; or

where it has become evident that the value of any security is no longer considered adequate.

 

In such situations the asset is transferred to the Corporate Banking Restructuring & Recoveries team. As part of their impairment reviews, an assessment is undertaken of the expected future cash flows (including a revaluation of collateral held) in relation to the relevant asset, appropriately discounted. The result is compared to the current net book value of the asset. Any shortfall evidenced as a result of such a review will be assessed against the opportunities to enhance future cash flows and the need for an observed impairment loss allowance established.

 

Collective assessment

A collective impairment loss allowance is established for all loans that have experienced a loss event. For individually significant loans this is undertaken as detailed above. Loans which are not individually significant but are not performing are grouped together according to their credit risk characteristics and the allowance for observed losses is determined on a collective basis by applying an estimated loss given default. Loans for which evidence of potential loss has been specifically identified and that are on the Santander UK group's watchlist are grouped together according to their credit risk characteristics for the purpose of calculating an estimated allowance for observed losses. This is assessed on a collective basis using an estimate of the propensity for these loans to enter non performing loan status and the potential loss per case.

 

Incurred but not observed impairment loss allowances

Loans for which no evidence of loss has been specifically identified on an individual basis are grouped together according to their credit risk characteristics for the purpose of calculating an estimated allowance for incurred inherent losses. Such losses will only be individually identified in the future. As soon information becomes available which identifies incurred losses on individual loans within the group, those loans are removed from the group and assessed for observed losses.

 

The allowance for IBNO losses is determined on a portfolio basis using the following factors:

historical loss experience in portfolios of similar credit risk characteristics (for example, similar sector or product);

the estimated period between an impairment event occurring and establishment of the loss event (known as the emergence period, as discussed below); and

management's judgement as to whether current economic and credit conditions are such that the actual level of inherent losses at the balance sheet date is likely to be greater or less than that suggested by historical experience.

 

The emergence period

This is the period in which losses that had been incurred but have not been separately identified become evident. The emergence period of six months is estimated having regard to historic experience and loan characteristics across the portfolio. The factors considered in determining the length of the emergence period include the frequency of the management information received or any change in account utilisation behaviour.

 

Reversals of impairment

If in a subsequent period, the amount of an impairment loss reduces and the reduction can be related objectively to an event occurring after the impairment was recognised, the excess is written back by reducing the impairment loss allowance account accordingly. The write-back is recognised in the income statement.

 

Write-off

For secured loans, a write-off is made when all collection procedures have been exhausted and the security has been sold. For unsecured loans, a write-off is made when all avenues for collecting the debt have been exhausted. There may be occasions where a write-off occurs for other reasons, for example, following a consensual restructure/refinance of the debt or where the debt is sold for strategic reasons into the secondary market at a value lower than the face value of the debt. Write-offs are charged against previously established impairment loss allowances. There are no thresholds based on past due status beyond which all secured or unsecured loans are written off.

 

Recoveries

Recoveries of impairment losses are not included in the impairment loss allowance, but are taken to income and offset against impairment losses. Recoveries are classified in the income statement as 'Impairment losses on loans and advances'.

 

Impairment losses on restructured/refinanced corporate assets (forbearance)

To support corporate customers that encounter actual or apparent financial difficulties, the Santander UK group may grant a concession, whether temporary or permanent, to amend contractual amounts or timings where a customer's financial distress indicates the potential that satisfactory repayment may not be made within the original terms and conditions of the contract. These arrangements are known as forbearance.

 

There are different risk characteristics associated with loans that are subject to forbearance as compared to loans that are not. A range of forbearance arrangements may be entered into by the Santander UK group, reflecting the different risk characteristics of such loans. The Santander UK group's forbearance programmes are described in the credit risk section in the Risk Management Report.

 

For corporate borrowers, the main types of forbearance offered are term extensions or interest only concessions and in limited circumstances, other forms of restructuring/refinancing options (including debt-for-equity swaps), subject to customer negotiation and vetting.

 

If such accounts were classified in the "non-performing" loan category prior to the restructuring/refinancing, they continue to be classified as non-performing until evidence of compliance with the new terms is demonstrated (typically over a period of at least three months) before being reclassified as "substandard". If the account was not categorised as non-performing at the time the revised arrangements were agreed, the case is reclassified to "substandard" upon completion of the restructuring/refinancing agreement.

 

Once a substandard asset has demonstrated continued compliance with the new terms and the risk profile is deemed to have improved it may be reclassified as a "performing asset". When such accounts are reclassified as performing assets, they continue to be assessed for impairment collectively for inherent losses under the Santander UK group's normal collective assessment methodology. Until then, impairment loss allowances for such restructured/refinanced loans are assessed individually, taking into account the value of collateral held as confirmed by third party professional valuations and the available cash flow to service debt over the period of the restructuring/refinancing. These impairment loss allowances are assessed and reviewed regularly. In the case of a debt for equity conversion, the converted debt is written off against the existing impairment loss allowance upon completion of the restructuring/refinancing. The value of the equity acquired is reassessed periodically in light of subsequent performance of the restructured company.

 

iii) Loans and receivables securities

 

Loans and receivables securities are assessed individually for impairment. An impairment loss is incurred if there is objective evidence that a loss event has occurred since initial recognition of the assets that has an impact on the estimated future cash flows of the loans and receivables securities. Potential indicators of loss events include significant financial distress of the issuer and default or delinquency in interest and principal payments (breach of contractual terms).

 

Loans and receivables securities are monitored for potential impairment through a detailed expected cash flow analysis taking into account the structure and underlying assets of each individual security. 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.

 

b) Available-for-sale financial assets

 

The Santander UK group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. In assessing whether assets are impaired, a significant or prolonged decline in the fair value of the security below its cost is considered evidence. The cumulative loss is measured as the difference between the acquisition cost and the current fair value, less any impairment loss previously reported in the income statement and is removed from other comprehensive income and recognised in the income statement.

 

If in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase is due to an event occurring after the impairment loss was recognised in the income statement (with objective evidence to support this), the impairment loss is reversed through the income statement.

 

If in a subsequent period, the fair value of an equity instrument classified as available-for-sale increases, all such increases in the fair value are treated as a revaluation, and are recognised in other comprehensive income. Impairment losses recognised on equity instruments are not reversed through the income statement.

 

IMPAIRMENT OF NON-FINANCIAL ASSETS

 

At each balance sheet date, or more frequently when events or changes in circumstances dictate, property plant and equipment (including operating lease assets) and intangible assets (including goodwill) are assessed for indicators of impairment. If indications are present, these assets are subject to an impairment review.

 

The impairment review comprises a comparison of the carrying amount of the asset or cash generating unit with its recoverable amount: the higher of the asset's or cash-generating unit's fair value less costs to sell and its value in use. The cash-generating unit represents the lowest level at which goodwill is monitored for internal management purposes and is not larger than an operating segment.

 

The fair value is calculated by reference to the amount at which the asset could be disposed of in a binding sale agreement in an arm's length transaction evidenced by an active market or recent transactions for similar assets, less costs to sell. Value in use is calculated by discounting management's expected future cash flows obtainable as a result of the asset's continued use, including those resulting from its ultimate disposal, at a market based discount rate on a pre tax basis. The recoverable amounts of goodwill have been based on value in use calculations.

 

The carrying values of property, plant and equipment and goodwill are written down by the amount of any impairment and the loss is recognised in the income statement in the period in which it occurs. A previously recognised impairment loss relating to property, plant and equipment may be reversed in part or in full when a change in circumstances leads to a change in the estimates used to determine the property, plant and equipment's recoverable amount. The carrying amount of the fixed asset will only be increased up to the amount that would have been had the original impairment not been recognised. Impairment losses on goodwill are not reversed. For conducting goodwill impairment reviews, cash generating units are the lowest level at which management monitors the return on investment on assets.

 

LEASES

 

a) The Santander UK group as lessor

Operating lease assets are recorded at deemed cost and depreciated over the life of the asset after taking into account anticipated residual values. Operating lease rental income and depreciation is recognised on a straight-line basis over the life of the asset. Amounts due from lessees under finance leases and hire purchase contracts are recorded as receivables at the amount of the Santander UK group's net investment in the leases. Finance lease income is allocated to accounting periods so as to reflect a constant periodic rate of return on the Santander UK group's net investment outstanding in respect of the leases and hire purchase contracts.

 

b) The Santander UK group as lessee

The Santander UK group enters into operating leases for the rental of equipment or real estate. Payments made under such leases are charged to the income statement on a straight-line basis over the period of the lease. When an operating lease is terminated before the lease period has expired, any payment to be made to the lessor by way of penalty is recognised as an expense in the period in which termination takes place.

 

If the lease agreement transfers the risk and rewards of the asset, the lease is recorded as a finance lease and the related asset is capitalised. At inception, the asset is recorded at the lower of the present value of the minimum lease payments or fair value and depreciated over the lower of the estimated useful life and the life of the lease. The corresponding rental obligations are recorded as borrowings. The aggregate benefit of incentives, if any, is recognised as a reduction of rental expense over the lease term on a straight-line basis.

 

INCOME TAXES, INCLUDING DEFERRED TAXES

 

The tax expense represents the sum of the income tax currently payable and deferred income tax.

Income tax payable on profits, based on the applicable tax law in each jurisdiction, is recognised as an expense in the period in which profits arise. Taxable profit differs from net profit as reported in the income statement because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The liability for current tax is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.

 

Deferred income tax is the tax expected to be payable or recoverable on income tax losses available to carry forward and on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the Consolidated Financial Statements and is accounted for using the balance sheet liability method. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that taxable profits will be available against which the assets may be utilised as they reverse. Such deferred tax liabilities are not recognised if the temporary difference arises from the initial recognition of goodwill. Deferred tax assets and liabilities are not recognised from the initial recognition of other assets (other than in a business combination) and liabilities in a transaction that affects neither the taxable profit nor the accounting profit.

 

Deferred tax is calculated at the tax rates that are expected to apply in the period when the liability is settled or the asset is realised based on rates enacted or substantively enacted at the balance sheet date. Deferred tax is charged or credited in the income statement, except when it relates to items recognised in other comprehensive income or directly in equity, in which case the deferred tax is also recognised in other comprehensive income or directly in equity. Deferred tax liabilities are recognised for taxable temporary differences arising on investments in subsidiaries except where the Santander UK group is able to control reversal of the temporary difference and it is probable that it will not reverse in the foreseeable future. The Santander UK group reviews the carrying amount of deferred tax assets at each balance sheet date and reduces it to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered.

 

Deferred and current tax assets and liabilities are only offset when they arise in the same tax reporting group and where there is both the legal right and the intention to settle on a net basis or to realise the asset and settle the liability simultaneously.

 CASH AND CASH EQUIVALENTS

 

For the purposes of the cash flow statement, cash and cash equivalents comprise balances with less than three months' maturity from the date of acquisition, including cash and non-restricted balances with central banks, treasury bills and other eligible bills, loans and advances to banks and short-term investments in securities.

 FINANCIAL LIABILITIES

 

Financial liabilities are initially recognised when the Santander UK group becomes contractually bound to the transfer of economic benefits in the future. Financial liabilities are derecognised when extinguished.

 

a) Financial liabilities at fair value through profit or loss

Financial liabilities are classified as fair value through profit or loss if they are either held for trading or otherwise designated at fair value through profit or loss on initial recognition. A financial liability is classified as held for trading if it is a derivative or it is incurred principally for the purpose of repurchasing or being unwound in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking.

 

In certain circumstances financial liabilities other than those that are held for trading are designated at fair value through profit or loss where this results in more relevant information because it significantly reduces a measurement inconsistency that would otherwise arise from measuring assets and liabilities or recognising the gains or losses on them on a different basis, or where a financial liability contains one or more embedded derivatives which are not closely related to the host contract. These liabilities are initially recognised at fair value and transaction costs are taken directly to the income statement. Gains and losses arising from changes in fair value are included directly in the income statement. Derivative financial instruments, Trading liabilities and Financial liabilities designated at fair value are classified as fair value through profit or loss.

 

b) Other financial liabilities

All other financial liabilities are initially recognised at fair value net of transaction costs incurred. They are subsequently stated at amortised cost and the redemption value recognised in the income statement over the period of the liability using the effective interest method. Deposits by banks, Deposits by customers, Debt securities in issue (unless designated at fair value) and Subordinated liabilities are classified as amortised cost.

 

Equity index-linked deposits

Contracts involving the receipt of cash on which customers receive an index-linked return are accounted for as equity index-linked deposits. The principal products are Capital Guaranteed/Protected Products which give the customers a limited participation in the upside growth of an equity index. In the event the index falls in price, a cash principal element is guaranteed/protected. The equity index-linked deposits contain embedded derivatives. These embedded derivatives, in combination with the principal cash deposit element, are designed to replicate the investment performance profile tailored to the return agreed in the contracts with customers.

 

Until 2009, equity index-linked deposits were managed within the equity derivatives trading book as an integral part of the equity derivatives portfolio, and classified as deposits by customers within trading liabilities. For products sold until 2009, the embedded derivatives are not separated from the host instrument and are not separately accounted for as a derivative financial instrument, as the entire contract embodies both the embedded derivative and the host instrument and is remeasured at fair value at each reporting date. As such, there is no requirement to bifurcate the embedded derivatives in those equity index-linked deposits.

 

Following a change in management's trading strategy in 2009, products sold subsequently are not accounted for as fair value through profit and loss, nor classified as trading liabilities. These products are accounted for as deposits by customers at amortised cost. The embedded derivatives are separated from the host instrument and are separately accounted for as a derivative financial instrument. The embedded derivatives are economically hedged internally with the equity derivatives trading desk. These internal transactions are managed as part of the overall positions of the equity derivatives trading desk. This activity is managed and recorded on a fair value trading basis, with exposures managed on a value-at-risk basis, as described in "Traded market risk" in the Risk Management Report.

 

There is no difference between the products sold until 2009 which are accounted for as fair value through profit and loss and classified as trading liabilities, and the subsequent products sold that are accounted for as deposits by customers and related embedded derivatives.

 BORROWINGS

 

Borrowings (which include deposits by banks, deposits by customers, debt securities in issue and subordinated liabilities) are recognised initially at fair value, being their issue proceeds (fair value of consideration received) net of transaction costs incurred. Borrowings are subsequently stated at amortised cost or fair value dependent on designation at initial recognition.

 

Preference shares which carry a contractual obligation to transfer economic benefits are classified as financial liabilities and are presented in subordinated liabilities. The coupon on these preference shares is recognised in the income statement as interest expense on an amortised cost basis using the effective interest method.

 PROVISIONS 

Provisions are recognised for present obligations arising as consequences of past events where it is more likely than not that a transfer of economic benefits will be necessary to settle the obligation, and it can be reliably estimated.

 

Conduct provisions are made for the estimated cost of making redress payments with respect to the past sales of products, based on conclusions regarding the number of claims that will be received, including the number of those that will be upheld, and the estimated average settlement per case. Provision is made for the anticipated cost of restructuring, including redundancy costs, when an obligation exists. An obligation exists when the Santander UK group has a detailed formal plan for restructuring a business, has raised valid expectations in those affected by the restructuring, and has started to implement the plan or announce its main features.

 

When a leasehold property ceases to be used in the business, provision is made where the unavoidable costs of the future obligations relating to the lease are expected to exceed anticipated rental income. The net costs are discounted using market rates of interest to reflect the long-term nature of the cash flows.

 

Provision is made for loan commitments, other than those classified as held for trading, within impairment loss allowances if it is probable that the facility will be drawn and the resulting loan will be recognised at a value less than the cash advanced. Contingent liabilities are possible obligations whose existence will be confirmed only by certain future events or present obligations where the transfer of economic benefit is uncertain or cannot be reliably measured. Contingent liabilities are not recognised but are disclosed unless they are remote.

 FINANCIAL GUARANTEE CONTRACTS

 

Financial guarantee contracts are contracts that require the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payments when due in accordance with the terms of a debt instrument. The Santander UK group accounts for guarantees that meet the definition of a financial guarantee contract at fair value on initial recognition. In subsequent periods, these guarantees are measured at the higher of the initial fair value less cumulative amortisation and the amount that would be recognised as an impairment loss allowance as described in the accounting policies above.

 SHARE CAPITAL 

Incremental external costs directly attributable to the issue of new shares are deducted from equity net of related income taxes.

 

DIVIDENDS

 

Dividends on ordinary shares are recognised in equity in the period in which the right to receive payment is established.

 

CRITICAL ACCOUNTING POLICIES AND AREAS OF SIGNIFICANT MANAGEMENT JUDGEMENT

 

The preparation of the Santander UK group'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 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 various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

 

The following accounting estimates and judgements are considered important to the portrayal of the Santander UK group's financial results and financial condition because: (i) they are highly susceptible to change from period to period as assumptions are made to calculate the estimates, and (ii) any significant difference between the Santander UK group's estimated amounts and actual amounts could have a material impact on the Santander UK group's future financial results and financial condition.

 

In calculating each estimate, a range of outcomes was calculated based principally on management's conclusions regarding the input assumptions relative to historic experience. The actual estimates were based on what management concluded to be the most probable assumptions within the range of reasonably possible assumptions.

 

a) Impairment loss allowances for loans and advances

 

The Santander UK group estimates impairment losses for loans and advances to customers, loans and receivables securities, and loans and advances to banks as described in the accounting policy "Impairment of financial assets" on page 219. The Santander UK group's assumptions about estimated losses are based on past performance, past customer behaviour, the credit quality of recent underwritten business and general economic conditions, which are not necessarily an indication of future losses.

 

The net impairment loss (i.e. after recoveries) for loans and advances to customers in the Retail Banking segment recognised in 2012 was £440m (2011: £345m, 2010: £551m), and in the Corporate Banking segment was £109m (2011: £120m, 2010: £103m). In calculating the Retail Banking and Corporate Banking impairment loss allowances, a range of outcomes was calculated, either for each individual loan or by portfolio, based on management's conclusions regarding the estimated number of accounts that will be written off or repossessed (the 'loss propensity'), the estimated proportion of such cases that will result in a loss (the 'loss factor') and the average loss incurred (the 'loss per case') relative to historic experience.

 

Had management used different assumptions, a larger or smaller impairment loss allowance would have resulted that could have had a material impact on the Santander UK group's reported profit before tax. Specifically, if management's conclusions as to the loss propensity, the loss factor and the estimated loss per case were different, but within the range of what management deemed to be reasonably possible, the impairment loss for loans and advances in the Retail Banking segment could have decreased in 2012 from an actual impairment loss of £440m (2011: £345m, 2010: £551m) by up to £80m (2011: £120m, 2010: £99m), with a potential corresponding increase in the Santander UK group's profit before tax in 2012 of up to 6% (2011: 10%, 2010: 5%), or increased by up to £50m (2011: £41m, 2010: £49m), with a potential corresponding decrease in the Santander UK group's profit before tax in 2012 of up to 4% (2011: 3%, 2010: 3%).

 

Similarly, the impairment loss for loans and advances in the Corporate Banking segment could have decreased in 2012 from an actual impairment loss of £109m (2011: £120m, 2010: £103m) by up to £27m (2011: £29m, 2010: £25m), with a potential corresponding increase in the Santander UK group's profit before tax in 2012 of up to 2% (2011: 4%, 2010: 1%), or increased by up to £25m (2011: £28m, 2010: £19m), with a potential corresponding decrease in the Santander UK group's profit before tax in 2012 of up to 2% (2011: 4%, 2010: 1%).

 

Similarly, the impairment loss for loans and advances in the Corporate Centre segment could have decreased in 2012 from an actual impairment loss of £460m (2011: £100m, 2010: £58m) by up to £58m (2011: £24m, 2010: £13m), with a potential corresponding increase in the Santander UK group's profit before tax in 2012 of up to 5% (2011: 2%, 2010: 1%), or increased by up to £29m (2011: £22m, 2010: £9m), with a potential corresponding decrease in the Santander UK group's profit before tax in 2012 of up to 2% (2011: 2%, 2010: nil).

 

b) Valuation of financial instruments

 

The Santander UK group trades in a wide variety of financial instruments in the major financial markets. When estimating the value of its financial instruments, including derivatives where quoted market prices are not available, management therefore considers a range of interest rates, volatility, exchange rates, counterparty credit ratings, valuation adjustments and other similar inputs, all of which vary across maturity bands. These are chosen to best reflect the particular characteristics of each transaction.

 

Had management used different assumptions, a larger or smaller change in the valuation of financial instruments including derivatives where quoted market prices are not available would have resulted that could have had a material impact on the Santander UK group's reported profit before tax.

Detailed disclosures on financial instruments, including sensitivities, can be found in Note 46. Further information about sensitivities to market risk (including Value-at-Risk ('VaR')) arising from financial instrument trading activities can be found in the Risk Management Report on page 117.

 

c) Goodwill impairment

 

A goodwill impairment loss of £nil was recognised in 2012 (2011: £60m, 2010: £nil). The carrying amount of goodwill was £1,834m at 31 December 2011 (2011: £1,834m). The Santander UK group evaluates whether the carrying value of goodwill is impaired and performs impairment testing annually or more frequently if there are impairment indicators present. Details of the Santander UK group's approach to identifying and quantifying impairment of goodwill are set out in Note 25. Assumptions about the measurement of the estimated recoverable amount of goodwill are based on management's estimates of future cash flows and growth rates of the cash-generating units. The Santander UK group's assumptions about estimated future cash flows and growth rates are based on management's view of future business prospects at the time of the assessment and are subject to a high degree of uncertainty.

 

Had management used different assumptions, a larger or smaller goodwill impairment loss would have resulted that could have had a material impact on the Santander UK group's reported profit before tax. Detailed disclosures on the assumptions used, including sensitivities, can be found in Note 25.

 

d) Provision for conduct remediation

 

The provision charge for conduct remediation relating to past activities and products sold recognised in 2012 was £232m (2011: £753m, 2010: £131m) before tax. The balance sheet provision amounted to £659m (2011: £747m, 2010: £132m). Detailed disclosures on the provision for conduct remediation can be found in Note 36.

 

The provision represents management's best estimate of the anticipated costs of related customer contact and/or redress, including administration expenses. However, with respect to payment protection insurance ('PPI'), there are still a number of uncertainties as to the eventual costs from any such contact and/or redress given the inherent difficulties in assessing the impact of detailed implementation of the FSA Policy Statement of 10 August 2010 for all PPI complaints, uncertainties around the ultimate emergence period for complaints, the availability of supporting evidence and the activities of claims management companies, all of which will significantly affect complaints volumes, uphold rates and redress costs. Similar uncertainty arises with respect to other products for which provision has been required in 2012.

 

The provision requires significant judgement by management in determining appropriate assumptions, which include the level of complaints, of those, the number that will be upheld, as well as redress costs for each of the different populations of customers identified by the Santander UK group in its analyses used to determine the best estimate of the anticipated costs of redress.

 

Had management used different assumptions, a larger or smaller provision charge would have resulted that could have had a material impact on the Santander UK group's reported profit before tax. Specifically, if the level of PPI complaints had been one percentage point higher/(lower) than estimated for all policies written then the provision at 31 December 2012 would have increased/(decreased) by approximately £32m (2011: £36m). There are a large number of inter-dependent assumptions under-pinning the provision; this sensitivity assumes that all assumptions, other than the level of complaints, remain constant. Other factors are more observable as the provision is based on current levels with respect to uphold rates and redress costs. With respect to products for which provision was required in 2012, while similar uncertainties arise, it is too early to provide a meaningful range.

 

The Santander UK group will re-evaluate the assumptions underlying its analysis at each reporting date as more information becomes available. As noted above, there is inherent uncertainty in making estimates; actual results in future periods may differ from the amount provided.

 

e) Pensions

 

The Santander UK group operates a number of defined benefit pension schemes as described in Note 37 and estimates their fair values as described in the accounting policy "Pensions and other post retirement benefits" on page 213.

 

The defined benefit service cost recognised in 2012 was £38m (2011: £34m, 2010: £35m). The defined benefit pension schemes which were in a net asset position had a surplus of £254m (2011: surplus of £241m) and the defined benefit pension schemes which were in a net liability position had a deficit of £305m (2011: deficit of £216m). The current year service cost increased from the previous year due to a reduction in the net discount rate.

 

Accounting for defined benefit pension schemes requires management to make assumptions, principally about mortality, but also about price inflation, discount rates, pension increases, and earnings growth. Management's assumptions are based on past experience and current economic trends, which are not necessarily an indication of future experience.

 

Detailed disclosures on the current year service cost and deficit, including sensitivities and the date of the last formal actuarial valuations of the assets and liabilities of the schemes can be found in Note 37.

 

2. SEGMENTS

 

The principal activity of the Santander UK group is financial services. The Santander UK group's business is managed and reported on the basis of the following segments:

 

Retail Banking;

Corporate Banking;

Markets; and

Corporate Centre (formerly known as Group Infrastructure).

 

In the first half of 2012, certain non-core portfolios were transferred to Corporate Centre where this was felt to be more appropriate for the management of these assets and liabilities. The non-core portfolios transferred into Corporate Centre included certain Social Housing assets and Commercial Mortgage loans, previously managed within Corporate Banking. With respect to the former, even though there are no credit concerns the terms of these loans are unfavourable in the current funding environment. The latter are typically medium- to long-term arrangements primarily written via agents or intermediaries. The Santander UK group's intention is to hold these assets to maturity and as such the balances will gradually decrease over time. The corporate legacy portfolio in run-off (largely relating to assets acquired as part of the acquisition of Alliance & Leicester) was also transferred to Corporate Centre from Corporate Banking. Non-core customer deposits are financial intermediary/institutional deposits which are managed centrally for liquidity purposes, most of which were previously managed within Corporate Banking or Markets. In addition, the management of reorganisation, conduct remediation and other costs, and hedging and other variances was transferred to Corporate Centre, principally from Retail Banking.

 

In the second half of 2012, Santander Business Banking, which offers a range of banking services to small businesses in the UK, was managed and reported as part of Retail Banking rather than Corporate Banking as in 2011. In addition, a new internal UK transfer pricing mechanism was implemented in the second half of 2012 to calculate the profitability of customer assets and deposits in each business segment to reflect the current market environment and rates.

 

The segmental analyses for prior years have been adjusted to reflect the fact that reportable segments have changed.

 

The Santander UK group's segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. The Santander UK group has four segments:

 

Retail Banking offers a wide range of products and financial services to customers through a network of branches, agencies and ATMs, as well as through telephony, e-commerce and intermediary channels. It principally serves personal banking customers, but also services small businesses with a turnover of less than £250,000 per annum. Retail Banking products include residential mortgage loans, savings and current accounts, credit cards and personal loans as well as a range of insurance policies.

 

Corporate Banking offers a wide range of products and financial services to customers through a network of 35 regional CBCs and through telephony and e-commerce channels. It principally serves companies with annual turnover of more than £250,000 including Small and Medium Enterprises ('SMEs'). Corporate Banking products and services include loans, bank accounts, deposits, treasury services, invoice discounting, cash transmission and asset finance.

The Large Corporates business offers specialist treasury services in fixed income and foreign exchange, lending, transactional banking services, capital markets and money markets to large multinational corporate customers. Lending includes syndicated loans and structured finance. Transactional banking includes trade finance and cash management. Money market activities include securities lending/borrowing and repos.

 

Markets offers risk management and other services to financial institutions, as well as other Santander UK divisions. Its main product areas are fixed income and foreign exchange, equity, capital markets and institutional sales.

 

Corporate Centre (formerly known as Group Infrastructure), includes Financial Management & Investor Relations ('FMIR', formerly known as Asset and Liability Management) and the non-core corporate and legacy portfolios. FMIR is responsible for managing capital and funding, balance sheet composition, structural market risk and strategic liquidity risk for the rest of the Santander UK group. The non-core corporate and legacy portfolios include aviation, shipping, infrastructure, commercial mortgages, social housing loans and structured credit assets, all of which are being run-down and/or managed for value.

 

The Company's board of directors (the 'Board') is the chief operating decision maker for the Santander UK group. The segment information below is presented on the basis used by the Board to evaluate performance and allocate resources. The Board reviews discrete financial information for each segment of the business, including measures of operating results, assets and liabilities. The segment information reviewed by the Board is prepared on a statutory basis of accounting rather than on an adjusted internal management basis as in prior periods.

 

Transactions between the business segments are on normal commercial terms and conditions. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Internal charges and internal UK transfer pricing adjustments have been reflected in the performance of each business. Revenue sharing agreements are used to allocate external customer revenues to a business segment on a reasonable basis. Funds are ordinarily reallocated between segments, resulting in funding cost transfers disclosed in total trading income. Interest charged for these funds is based on the Santander UK group's cost of wholesale funding.

 

Interest income and interest expense have not been reported separately. The majority of the revenues from the segments presented below are interest income in nature and the Board relies primarily on net interest income to both assess the performance of the segment and to make decisions regarding allocation of segmental resources.

 

 

2012

Retail

Banking

£m

Corporate Banking

£m

 Markets

£m

Corporate Centre

£m

Total

£m

Net interest income/(expense)

2,855

329

(6)

(263)

2,915

Non-interest income

720

381

184

701

1,986

Total operating income

3,575

710

178

438

4,901

Administration expenses

(1,604)

(255)

(98)

(19)

(1,976)

Depreciation, amortisation and impairment

(186)

(15)

(2)

(43)

(246)

Total operating expenses excluding provisions and charges

(1,790)

(270)

(100)

(62)

(2,222)

Impairment losses on loans and advances

(440)

(109)

-

(460)

(1,009)

Provisions for other liabilities and charges

(5)

(2)

(2)

(430)

(439)

Total operating provisions and charges

(445)

(111)

(2)

(890)

(1,448)

Profit/(loss) before tax

1,340

329

76

(514)

1,231

Revenue from external customers

4,392

1,206

178

(875)

4,901

Inter-segment revenue

(817)

(496)

-

1,313

-

Total operating income

3,575

710

178

438

4,901

Customer assets

165,343

19,605

-

11,002

195,950

Total assets(1)

169,522

35,736

28,173

59,613

293,044

Customer deposits

127,178

12,812

-

8,582

148,572

Total liabilities

128,404

24,040

28,695

98,956

280,095

Average number of staff(2)

18,407

2,136

382

165

21,090

 

(1) Includes customer assets, net of impairment loss allowances.

(2) Full-time equivalents

 

 

2011

Retail

Banking

£m

Corporate Banking

£m

 Markets

£m

Corporate

Centre

£m

Total

£m

Net interest income/(expense)

3,192

296

(3)

345

3,830

Non-interest income

776

358

162

59

1,355

Total operating income

3,968

654

159

404

5,185

Administration expenses

(1,615)

(212)

(109)

(59)

(1,995)

Depreciation, amortisation and impairment

(208)

(11)

(2)

(226)

(447)

Total operating expenses excluding provisions and charges

(1,823)

(223)

(111)

(285)

(2,442)

Impairment losses on loans and advances

(345)

(120)

-

(100)

(565)

Provisions for other liabilities and charges

-

(3)

(3)

(911)

(917)

Total operating provisions and charges

(345)

(123)

(3)

(1,011)

(1,482)

Profit/(loss) before tax

1,800

308

45

(892)

1,261

Revenue from external customers

5,305

1,030

159

(1,309)

5,185

Inter-segment revenue

(1,337)

(376)

-

1,713

-

Total operating income

3,968

654

159

404

5,185

Customer assets

175,509

18,856

-

11,946

206,311

Total assets(1)

180,443

38,110

28,652

50,369

297,574

Customer deposits

121,389

12,118

-

15,685

149,192

Total liabilities

126,153

24,857

32,760

101,138

284,908

Average number of staff(2)

18,681

1,743

346

148

20,919

 

(1) Includes customer assets, net of impairment loss allowances.

(2) Full-time equivalents

 

 

 

2010

Retail

Banking

£m

Corporate Banking

£m

 Markets

£m

Corporate

Centre

£m

Total

£m

Net interest income

2,768

238

-

808

3,814

Non-interest income

619

300

221

80

1,220

Total operating income

3,387

538

221

888

5,034

Administration expenses

(1,464)

(210)

(74)

(45)

(1,793)

Depreciation, amortisation and impairment

(165)

(10)

(2)

(98)

(275)

Total operating expenses excluding provisions and charges

(1,629)

(220)

(76)

(143)

(2,068)

Impairment losses on loans and advances

(551)

(103)

-

(58)

(712)

Provisions for other liabilities and charges

-

-

-

(129)

(129)

Total operating provisions and charges

(551)

(103)

-

(187)

(841)

Profit before tax

1,207

215

145

558

2,125

Revenue from external customers

5,795

994

221

(1,976)

5,034

Inter-segment revenue

(2,408)

(456)

-

2,864

-

Total operating income

3,387

538

221

888

5,034

Customer assets

175,510

14,615

-

11,965

202,090

Total assets(1)

180,672

37,673

22,070

62,445

302,860

Customer deposits

126,392

10,465

-

16,641

153,498

Total liabilities

136,975

44,032

22,835

86,744

290,586

Average number of staff(2)

16,878

1,656

265

148

18,947

 

(1) Includes customer assets, net of impairment loss allowances.

(2) Full-time equivalents

 

Revenue by products and services

Details of revenue by product or service are disclosed in Notes 3 to 5.

 

Geographical information

A geographical analysis of total operating income is presented below:

 

Group

2012

£m

2011

£m

2010

£m

United Kingdom

4,858

5,124

4,989

Other

43

61

45

4,901

5,185

5,034

 

A geographical analysis of total assets other than financial instruments, current and deferred tax assets and post-employment benefit assets is presented below:

 

2012

£m

2011

£m

United Kingdom

3,951

3,796

Other

7

6

3,958

3,802

 

 

3. NET INTEREST INCOME

 

Group

2012

£m

2011

£m

2010

£m

Interest and similar income:

Loans and advances to banks

167

120

154

Loans and advances to customers

7,376

7,425

6,799

Other interest-earning financial assets

78

73

94

Total interest and similar income

7,621

7,618

7,047

Interest expense and similar charges:

Deposits by banks

(195)

(168)

(87)

Deposits by customers

(2,924)

(2,711)

(2,424)

Subordinated debt

(174)

(214)

(276)

Debt securities in issue

(1,399)

(694)

(360)

Other interest-bearing financial liabilities

(14)

(1)

(86)

Total interest expense and similar charges

(4,706)

(3,788)

(3,233)

Net interest income

2,915

3,830

3,814

 

4. NET FEE AND COMMISSION INCOME

 

Group

2012

£m

2011

£m

2010

£m

Fee and commission income:

Retail and corporate products

921

896

662

Insurance products

153

169

134

Asset management

90

73

106

Total fee and commission income

1,164

1,138

902

Fee and commission expense:

Other fees paid

(264)

(220)

(203)

Total fee and commission expense

(264)

(220)

(203)

Net fee and commission income

900

918

699

 

 

5. NET TRADING AND OTHER INCOME

 

Group

2012

£m

2011

£m

2010

£m

Net trading and funding of other items by the trading book

513

255

391

Income from operating lease assets

54

68

84

Income on assets designated at fair value through profit or loss

271

530

245

Expense on liabilities designated at fair value through profit or loss

(180)

(105)

(111)

(Losses)/gains on derivatives managed with assets/liabilities held at fair value through profit or loss

(439)

(458)

(154)

Share of (loss)/profit from associates and joint ventures

(4)

1

25

Profit on sale of available-for-sale assets

24

-

-

Profit on revaluation of associate (See Note 45)

-

-

87

Profit on sale of subsidiary undertakings

-

-

39

Profit/(loss) on sale of property, plant and equipment and intangible fixed assets

-

(2)

(2)

Hedge ineffectiveness and other

142

148

(83)

Profit on repurchase of debt issuance (See Note 34)

705

-

-

1,086

437

521

 

"Net trading and funding of other items by the trading book" includes fair value gains/(losses) of £(149)m (2011: £(125)m, 2010: £(250)m) on embedded derivatives bifurcated from certain equity index-linked deposits, as described in the Accounting Policies. The embedded derivatives are economically hedged internally with the equity derivatives trading desk. These internal transactions are managed as part of the overall positions of the equity derivatives trading desk, the results of which are also included in this line item, and amounted to £150m (2011: £127m, 2010: £263m). As a result, the net fair value movements recognised on the equity index-linked depositsand the related economic hedges were £1m (2011: £2m, 2010: £13m).

 

In July 2012, as part of a capital management exercise, the Company purchased certain of its debt capital instruments pursuant to a tender offer, as described in Note 34. The net impact of the purchase and crystallisation of mark-to-market positions on associated derivatives resulted in a pre-tax gain of £705m.

 

 

6. ADMINISTRATION EXPENSES

 

Group

2012

£m

2011

£m

2010

£m

Staff costs:

Wages and salaries

649

608

508

Performance-related payments: - cash

131

111

126

- shares

19

21

15

Social security costs

83

77

65

Pensions costs: - defined contribution plans

35

30

42

- defined benefit plans

29

24

25

Other share-based payments

-

(1)

(3)

Other personnel costs

54

86

57

1,000

956

835

Property, plant and equipment expenses

187

190

214

Information technology expenses

381

413

337

Other administration expenses

408

436

407

1,976

1,995

1,793

 

"Performance-related payments - shares" consist of bonuses paid in the form of shares and awards granted under the Long- Term Incentive Plan, as described in Note 42. Included in "performance-related payments - shares" is £19m (2011: £21m, 2010: £15m) which arose from equity-settled share-based payments, none of which related to option-based schemes. "Other share-based payments" consist of options granted under the Employee Sharesave scheme, as described in Note 42, which comprise the Santander UK group's cash-settled share-based payments.

 

Performance-related payments above include amounts related to deferred performance awards as follows:

 

Costs recognised in 2012

Costs expected to be recognised in 2013 or later

Arising from awards in current year

Arising from awards in prior year

Total

Arising from awards in current year

Arising from awards in prior year

Total

£m

£m

£m

£m

£m

£m

Cash

3

2

5

8

2

10

Shares

2

11

13

4

7

11

Total

5

13

18

12

9

21

 

The following table shows the amount of bonus awarded to employees for the performance year 2012. In the case of deferred cash and share awards, the final amount paid to an employee is influenced by forfeiture provisions and any performance conditions to which these awards are subject. The deferred share award amount is based on the fair value of these awards at the date of grant.

 

 

Expenses charged in the year

Expenses deferred to future periods

Total

2012

£m

2011

£m

2012

£m

2011

£m

2012

£m

2011

£m

Cash award - not deferred

126

108

-

-

126

108

- deferred

5

3

10

4

15

7

Shares award - not deferred

6

4

-

-

6

4

- deferred

13

17

11

18

24

35

Total discretionary bonus

150

132

21

22

171

154

 

 

7. DEPRECIATION, AMORTISATION AND IMPAIRMENT

 

Group

2012

£m

2011

£m

2010

£m

Depreciation of property, plant and equipment

211

224

220

Amortisation and impairment of intangible assets

35

223

55

246

447

275

 

In 2011, amortisation and impairment of intangible assets included £112m and £60m in respect of the impairment of software and goodwill, respectively, as set out in Note 25.

 

 

8. AUDIT AND OTHER SERVICES

 

The fees for audit and other services payable to the Company's auditor, Deloitte LLP, are analysed as follows:

 

Group

2012

£m

2011

£m

2010

£m

Audit fees:

- Fees payable to the Company's auditor for audit of the Santander UK group's annual accounts

2.4

2.1

2.1

 - Fees payable to the Company's auditor and its associates for audit of the Company's subsidiaries pursuant to legislation

1.8

1.9

1.7

Total audit fees

4.2

4.0

3.8

Non-audit fees:

Other assurance services

- Other services pursuant to legislation

0.6

0.8

-

- Other assurance

3.0

0.8

0.9

Total other assurance services

3.6

1.6

0.9

Other services

- Tax services

0.1

0.5

0.5

- Other services

-

-

0.1

Total other services

0.1

0.5

0.6

Total non-audit fees

3.7

2.1

1.5

 

Other services pursuant to legislation relate to services performed in connection with statutory and regulatory filings of the Company and its associates. Of this category, £0.5m (2011: £0.8m, 2010: £nil) accords with the definition of 'Audit fees' per US Securities and Exchange Commission ('SEC') guidance. The remaining £0.1m (2011: £nil, 2010: £nil) accords with the definition of 'Audit related fees' per that guidance. Other assurance relates to services performed in connection with securitisation, debt issuances and prudential related work which is in accordance with the definition 'Audit related fees' per SEC guidance.

 

No information technology, internal audit, valuation and actuarial, litigation, recruitment and remuneration or corporate finance services were provided by the external auditor during these years. A framework for ensuring auditor's 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 by the Board Audit Committee. Services provided by the Santander UK group's external auditor are subject to approval by the Board Audit Committee.

 

 

9. IMPAIRMENT LOSSES AND PROVISIONS

 

 

Group

2012

£m

2011

£m

2010

£m

Impairment losses on loans and advances:

- loans and advances to customers (Note 18)

1,083

639

746

- loans and advances to banks (Note 17)

-

-

-

- loans and receivables securities (Note 23)

-

-

-

Recoveries of loans and advances (Note 18)

(74)

(74)

(34)

1,009

565

712

Impairment losses on available-for-sale financial assets (Note 22)

-

-

-

Provisions for other liabilities and charges: (Note 36)

- New and increased allowances

446

929

131

- Provisions released

(7)

(12)

(2)

439

917

129

Total impairment losses and provisions charged to the income statement

1,448

1,482

841

 

 

10. TAXATION CHARGE

 

Group

2012

£m

2011

£m

2010

£m

Current tax:

UK corporation tax on profit of the year

163

232

185

Adjustments in respect of prior years

(113)

(3)

(33)

Total current tax

50

229

152

Deferred tax:

Origination and reversal of temporary differences

134

112

377

Change in rate of UK corporation tax

5

21

11

Adjustments in respect of prior years

103

(4)

2

Total deferred tax

242

129

390

Tax on profit for the year

292

358

542

 

UK corporation tax is calculated at 24.5% (2011: 26.5%, 2010: 28%) of the estimated assessable profits for the year. The standard rate of UK corporation tax was reduced from 26% to 24% with effect from 1 April 2012. Taxation for other jurisdictions is calculated at the rates prevailing in the relevant jurisdictions. The Finance Act 2012, which provides for a reduction in the main rate of UK corporation tax to 23% effective from 1 April 2013 was enacted on 17 July 2012. As this change in rate was substantively enacted prior to 31 December 2012, it has been reflected in the deferred tax balance at 31 December 2012. The UK Government has also indicated that it intends to enact a further reduction in the main tax rate down to 21% by 1 April 2014. These changes in the rate had not been substantively enacted at the balance sheet date and, therefore, are not included in these financial statements. The estimated financial effect of these changes is insignificant.

 

The effective tax rate for 2012, based on profit before tax, was 23.7% (2011: 28.4%, 2010: 25.5%). The tax on profit before tax differs from the theoretical amount that would arise using the basic corporation tax rate of the Company as follows:

 

Group

2012

£m

2011

£m

2010

£m

Profit before tax

1,231

1,261

2,125

Tax calculated at a tax rate of 24.5% (2011: 26.5%, 2010: 28%)

302

334

595

Non taxable gain on sale of subsidiary undertakings

-

-

(11)

Non deductible preference dividends paid

7

8

8

Non taxable gain on revaluation of investment in Santander Consumer (UK) plc

-

-

(24)

Non deductible UK Bank Levy

12

13

-

Other non-equalised items

(12)

(4)

-

Effect of non-UK profits and losses

(4)

(7)

(6)

Utilisation of capital losses for which credit was not previously recognised

(8)

-

-

Effect of change in tax rate on deferred tax provision

5

21

11

Adjustment to prior year provisions

(10)

(7)

(31)

Tax expense

292

358

542

 

In addition to the corporation tax expense charged to profit or loss, tax of £45m (2011: £11m, 2010: £(8)m) has been credited/(charged) in other comprehensive income in the year, as follows:

 

2012

Group

Before tax amount

£m

Total tax

£m

After tax amount

£m

Actuarial losses on retirement benefit obligations

(183)

42

(141)

Movements in available-for-sale financial assets:

- Gains due to changes in fair value

6

(1)

5

- Gains transferred to profit or loss on sale

(17)

4

(13)

Other comprehensive income

(194)

45

(149)

 

2011

Group

Before tax amount

£m

Total tax

£m

After tax amount

£m

Actuarial losses on retirement benefit obligations

(37)

9

(28)

Movements in available-for-sale financial assets:

- Losses due to changes in fair value

(3)

2

(1)

Other comprehensive income

(40)

11

(29)

 

2010

Group

Before tax amount

£m

Total tax

£m

After tax amount

£m

Actuarial gains on retirement benefit obligations

25

(9)

16

Movements in available-for-sale financial assets:

- Losses due to changes in fair value

(1)

-

(1)

- Gains transferred to profit or loss on sale

(2)

1

(1)

Other comprehensive income

22

(8)

14

 

Further information about deferred tax is presented in Note 27.

 

 

11. PROFIT ON ORDINARY ACTIVITIES AFTER TAX

 

The (loss)/profit after tax of the Company attributable to the shareholders was £(760)m (2011: £3,153m, 2010: £1,391m). As permitted by Section 408 of the UK Companies Act 2006, the Company's individual income statement has not been presented. The significant increase in profit in 2011 was attributable to temporary mark-to-market gains of £2,669m on derivatives with other entities in the Santander UK group which eliminate on consolidation within Santander UK. £1,224m of these gains reversed in 2012. Excluding this mark-to-market volatility, there would have been a profit of £464m in 2012 (2011: £484m).

 

 

12. CASH AND BALANCES AT CENTRAL BANKS

 

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

Cash in hand

1,121

1,024

1,110

1,016

Balances with central banks

28,161

24,956

27,773

17,942

29,282

25,980

28,883

18,958

 

For regulatory purposes, certain minimum cash balances are required to be maintained with the Bank of England. At 31 December 2012, these amounted to £203m (2011: £195m) for the Santander UK group and £179m (2011: £178m) for the Company. Balances with central banks above represent amounts held at the Bank of England and the US Federal Reserve as part of the Santander UK group's liquidity management activities. This is described further in the Risk Management Report.

13. DIVIDENDS

 

Ordinary dividends declared and authorised during the year were as follows:

 

Group and Company

Group and Company

 

 

 

2012

Pence per

share

2011

Pence per

share

2010

Pence per

share

2012

£m

2011

£m

2010

£m

Ordinary shares (equity):

In respect of current year - first interim

-

1.37

1.29

-

425

400

In respect of current year - second interim

1.45

-

1.21

450

-

375

1.45

1.37

2.50

450

425

775

 

In addition, £19m (2011: £19m) of dividends were declared and paid on the £300m fixed/floating rate non-cumulative callable preference shares, £21m (2011: £21m) of dividends were declared and paid on the Step-up Callable Perpetual Reserve Capital Instruments and £17m (2011: £17m) of dividends were declared and paid on the £300m Step-up Callable Perpetual Preferred Securities. In 2010, the £300m Step-up Callable Perpetual Preferred Securities were classified as non-controlling interests.

 

 

14. TRADING ASSETS

 

Group

 

 

2012

£m

2011

£m

Loans and advances to banks - securities purchased under resale agreements

7,245

3,056

- other(1)

2,743

3,088

Loans and advances to customers - securities purchased under resale agreements

7,463

6,338

- other(2)

89

349

Debt securities

4,494

8,711

Equity securities

464

349

22,498

21,891

(1) Comprises short-term loans of £2m (2011: £84m) and cash collateral of £2,741m (2011: £3,004m).

(2) Comprises short-term loans.

 

Debt securities can be analysed by type of issuer as follows:

 

Group

 

 

2012

£m

2011

£m

Issued by public bodies:

- Government securities

3,917

2,943

Issued by other issuers:

- Fixed and floating rate notes(1): Government guaranteed

426

5,754

- Fixed and floating rate notes(1): Other

138

14

- Bank and building society certificates of deposit: Other

13

-

4,494

8,711

(1) The FRNs are rated 75% AAA, 18% A and above, 7% BBB and below (2011: all AAA rated).

 

Debt securities and equity securities can be analysed by listing status as follows:

 

Group

 

 

2012

£m

2011

£m

Debt securities:

- Listed in the UK

2,145

5,904

- Listed elsewhere

687

1,165

- Unlisted

1,662

1,642

4,494

8,711

Equity securities:

- Listed in the UK

372

335

- Listed elsewhere

92

14

464

349

 

The Company has no trading assets (2011: £nil). Included in the above balances are amounts owed to the Santander UK group by Banco Santander S.A. and other subsidiaries of Banco Santander S.A. outside the Santander UK group of £206m (2011: £270m) and £nil (2011: £14m) respectively.

 

15. DERIVATIVE FINANCIAL INSTRUMENTS

 

Derivatives are financial instruments whose value is derived from the price of one or more underlying items such as equities, equity indices, interest rates, foreign exchange rates, property indices, commodities and credit spreads. Derivatives enable users to manage exposure to credit or market risks. The Santander UK group sells derivatives to its customers and uses derivatives to manage its own exposure to credit and market risks.

 

a) Use of derivatives

 

The Santander UK group transacts derivatives for four primary purposes:

to create risk management solutions for customers;

to manage the portfolio risks arising from customer business;

to manage and hedge the Santander UK group's own risks; and

to generate profits through sales activities.

 

Under IAS 39, all derivatives are classified as "held for trading" (except for derivatives which are designated as effective hedging instruments in accordance with the detailed requirements of IAS 39) even if this is not the purpose of the transaction. The held for trading classification therefore includes two types of derivatives:

 

those used in sales activities; and

those used for risk management purposes but, for various reasons, either the Santander UK group does not elect to claim hedge accounting for or they do not meet the qualifying criteria for hedge accounting. These consist of:

non-qualifying hedging derivatives (known as "economic hedges"), whose terms match other on-balance sheet instruments but do not meet the technical criteria for hedge accounting, or which use natural offsets within other on-balance sheet instruments containing the same risk features as part of an integrated approach to risk management, and hence do not require the application of hedge accounting to achieve a reduction in income statement volatility;

derivatives managed in conjunction with financial instruments designated at fair value (known as the "fair value option"). The fair value option is described more fully in the Accounting Policy "Financial assets" and Notes 16 and 32. The Santander UK group's business model is primarily structured to maximise use of the fair value option, rather than electing to apply hedge accounting, in order to reduce the administrative burden on the Santander UK group associated with complying with the detailed hedge accounting requirements of IAS 39;

derivatives that do not meet the qualifying criteria for hedge accounting, including ineffective hedging derivatives and any components of hedging derivatives that are excluded from assessing hedge effectiveness; and

derivative contracts that represent the closing-out of existing positions through the use of matching deals.

 

The following table summarises the activities undertaken, the related risks associated with such activities and the types of 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.

 

Activity

Risk

Type of derivative

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 investments.

Sensitivity to weakening credit quality.

Purchase credit default swaps and total return swaps.

Borrowing funds in foreign currencies

Sensitivity to changes in foreign exchange rates

Cross currency swaps

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.

 

The Santander UK group's derivative activities do not give rise to significant open positions in portfolios of derivatives. Any residual position is managed to ensure that it remains within acceptable risk levels, with matching deals being utilised to achieve this where necessary. When entering into derivative transactions, the Santander UK group employs the same credit risk management procedures to assess and approve potential credit exposures that are used for traditional lending.

 

The hedging classification consists of derivatives that the Santander UK group has chosen to designate as in a hedging relationship because they meet the specific criteria in IAS 39. 

 

All derivatives are required to be held at fair value through profit or loss, and shown in the balance sheet as separate totals of assets and liabilities. A description of how the fair values of derivatives are derived is set out in Note 46. This is described in more detail in the accounting policies "Derivative financial instruments" and "Hedge accounting" on pages 217 and 218. Derivative assets and liabilities on different transactions are only set off if the transactions are with the same counterparty, a legal right of set-off or netting exists and the cash flows are intended to be settled on a net basis.

 

b) Trading derivatives

 

Most of the Santander UK group's derivative transactions relate to sales activities and derivative contracts that represent the closing-out of existing positions through the use of matching deals. Sales activities include the structuring and marketing of derivative products to customers to enable them to take, transfer, modify or reduce current or expected risks. Limited positions may be traded actively or be held over a period of time to benefit from expected changes in exchange rates, interest rates, equity prices or other market parameters. Trading includes market-making, positioning and arbitrage activities. Market-making entails quoting bid and offer prices to other market participants for the purpose of generating revenues based on spread and volume; positioning means managing market risk positions in the expectation of benefiting from favourable movements in prices, rates or indices; arbitrage involves identifying and profiting from price differentials between markets and products.

 

Trading derivatives include interest rate, cross currency, equity, 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 options and equity index options.

 

Corporate Banking deals with commercial customers who wish to enter into derivative contracts. Any market risk arising from such transactions is hedged by Markets. Markets is responsible for implementing Santander UK group derivative hedging with the external market together with its own trading activities. For trading activities, its 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 Santander UK group's balance sheet.

 

As mentioned above, other derivatives classified as held for trading include non-qualifying hedging derivatives (economic hedges), ineffective hedging derivatives and any components of hedging derivatives that are excluded from assessing hedge effectiveness, derivatives managed in conjunction with financial instruments designated at fair value and derivative contracts that represent the closing-out of existing positions through the use of matching deals.

 

c) Hedging derivatives

 

The Santander UK group uses derivatives (principally interest rate swaps and cross-currency swaps) for hedging purposes in the management of its own asset and liability portfolios, including fixed-rate lending, fixed-rate asset purchases, medium-term note issues, capital issues, and structural positions. This enables the Santander UK group to optimise the overall cost to it of accessing debt capital markets, and to mitigate the market risk which would otherwise arise from structural imbalances in the maturity and other profiles of its assets and liabilities.

 

The accounting for these derivatives is described in the accounting policy "Hedge accounting" in Note 1. Such risks may also be managed using natural offsets within other on-balance sheet instruments as part of an integrated approach to risk management.

 

Derivative products which are combinations of more basic derivatives (such as swaps with embedded option features), or which 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 hedged.

 

The fair values of derivative instruments classified as held for trading and hedging purposes are set out in the following tables. The tables show the contract or underlying principal amounts, and positive and negative fair values of derivatives analysed by contract. The contract/notional amounts of derivatives indicate the nominal value of transactions outstanding at the balance sheet date; they do not represent actual exposures. The fair values represent the amount at which a contract could be exchanged in an arm's length transaction, calculated at market rates at the balance sheet date.

 

As described above, derivatives classified as held for trading in the table below consist of those used in sales and trading activities, and those used for risk management purposes but which, for various reasons, either for which the Santander UK group does not elect to claim hedge accounting or which do not meet the qualifying criteria for hedge accounting. Derivatives classified as held for hedging in the table below consist of those that have been designated as in a hedging relationship in accordance with IAS 39.

 

2012

 

Derivatives held for trading

Group

Contract/notional amount

£m

Fair value assets

£m

Fair value liabilities

£m

Exchange rate contracts:

- Cross-currency swaps

117,658

2,101

2,195

- Foreign exchange swaps, options and forwards

19,568

962

654

137,226

3,063

2,849

Interest rate contracts:

- Interest rate swaps

457,430

20,072

18,977

- Caps, floors and swaptions

61,015

3,584

3,626

- Futures

19,273

54

31

- Forward rate agreements

123,132

9

13

660,850

23,719

22,647

Equity and credit contracts:

- Equity index swaps and similar products

44,077

1,086

1,816

- Equity index options

29,652

152

89

- Credit default swaps and similar products

335

37

7

74,064

1,275

1,912

Commodity contracts:

- OTC swaps

227

7

7

227

7

7

Total derivative assets and liabilities held for trading

872,367

28,064

27,415

 

 2012

 

Derivatives held for fair value hedging

Group

Contract/notional amount£m

Fair value assets

£m

Fair value liabilities

£m

Exchange rate contracts:

- Cross-currency swaps

5,024

76

168

Interest rate contracts:

- Interest rate swaps

77,592

2,006

1,278

Total derivative assets and liabilities held for fair value hedging

82,616

2,082

1,446

Total recognised derivative assets and liabilities

954,983

30,146

28,861

 

2011

 

Derivatives held for trading

Group

Contract/notional amount

£m

Fair value assets

£m

Fair value liabilities

£m

Exchange rate contracts:

- Cross-currency swaps

89,457

1,556

1,077

- Foreign exchange swaps, options and forwards

19,866

155

253

109,323

1,711

1,330

Interest rate contracts:

- Interest rate swaps

475,853

20,625

20,221

- Caps, floors and swaptions

62,907

3,485

3,523

- Futures

32,503

54

41

- Forward rate agreements

78,090

21

31

649,353

24,185

23,816

Equity and credit contracts:

- Equity index swaps and similar products

32,421

1,285

2,597

- Equity index options

43,708

156

12

- Credit default swaps and similar products

440

45

21

76,569

1,486

2,630

Commodity contracts:

- OTC swaps

542

12

11

542

12

11

Total derivative assets and liabilities held for trading

835,787

27,394

27,787

 

 2011

 

Derivatives held for fair value hedging

Group

Contract/notional amount£m

Fair value assets

£m

Fair value liabilities

£m

Exchange rate contracts:

- Cross-currency swaps

7,992

1,094

61

Interest rate contracts:

- Interest rate swaps

46,447

2,292

1,332

Total derivative assets and liabilities held for fair value hedging

54,439

3,386

1,393

Total recognised derivative assets and liabilities

890,226

30,780

29,180

 

 

 2012

 

Derivatives held for trading

Company

Contract/notional amount

£m

Fair value assets

£m

Fair value liabilities

£m

Exchange rate contracts:

- Cross-currency swaps

2,153

728

737

- Foreign exchange swaps, options and forwards

501

36

35

2,654

764

772

Interest rate contracts:

- Interest rate swaps

75,341

3,257

1,047

- Caps, floors and swaptions(1)

2,461

13

25

77,802

3,270

1,072

Equity and credit contracts:

- Equity index swaps and similar products

16

26

205

- Credit default swaps and similar products

61

1

-

77

27

205

Total derivative assets and liabilities held for trading

80,533

4,061

2,049

 

2012

 

Derivatives held for fair value hedging

Company

Contract/notional amount

£m

Fair value assets

£m

Fair value liabilities

£m

Exchange rate contracts:

- Cross-currency swaps

564

381

-

Interest rate contracts:

- Interest rate swaps

2,590

457

2

Total derivative assets and liabilities held for fair value hedging

3,154

838

2

Total recognised derivative assets and liabilities

83,687

4,899

2,051

 

2011

 

Derivatives held for trading

Company

Contract/notional amount£m

Fair value assets

£m

Fair value liabilities

£m

Exchange rate contracts:

- Cross-currency swaps

915

44

33

- Foreign exchange swaps, options and forwards

386

7

6

1,301

51

39

Interest rate contracts:

- Interest rate swaps

59,612

3,952

939

- Caps, floors and swaptions(1)

2,190

21

21

61,802

3,973

960

Equity and credit contracts:

- Equity index swaps and similar products

309

20

208

- Credit default swaps and similar products

62

-

-

371

20

208

Total derivative assets and liabilities held for trading

63,474

4,044

1,207

 

 

2011

 

Derivatives held for fair value hedging

Company

Contract/notional amount

£m

Fair value assets

£m

Fair value liabilities

£m

Exchange rate contracts:

- Cross-currency swaps

1,496

1,259

-

Interest rate contracts:

- Interest rate swaps

3,398

698

-

Total derivative assets and liabilities held for fair value hedging

4,894

1,957

-

Total recognised derivative assets and liabilities

68,368

6,001

1,207

(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.

 

Included in the above balances are amounts owed to the Santander UK group by Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £2,028m (2011: £2,644m) and £169m (2011: £66m) respectively and amounts owed by the Santander UK group to Banco Santander S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £1,916m (2011: £2,144m) and £117m (2011: £35m). The net exposures after collateral to the ultimate parent undertaking and fellow subsidiaries at 31 December 2012 amounted to £138m (2011: £149m) and £7m (2011: £nil) respectively.

 

Net gains or losses arising from fair value hedges included in net trading and other income

 

Group

2012

£m

2011

£m

2010

£m

Net (losses)/gains:

- on hedging instruments

(294)

1,454

38

- on hedged items attributable to hedged risks

464

 (1,438)

(13)

170

16

25

 

The Santander UK group hedges its exposures to various risks, including interest rate risk and foreign currency risk, in connection with certain mortgage assets, covered bond issuances, and subordinated and senior debt securities in issue. The gains/(losses) arising on these assets and liabilities are presented in the table above on a combined basis.

 

In addition, in the ordinary course of business, the Santander UK group entered into long-term interest rate contracts as economic hedges 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 2012 was £50m (31 December 2011: £67m). These long-term interest rate contracts are included within "derivatives held for trading - interest rate contracts" shown above.

 

 

16. FINANCIAL ASSETS DESIGNATED AT FAIR VALUE

 

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

Loans and advances to customers

3,248

4,376

44

45

Debt securities

563

629

-

-

3,811

5,005

44

45

 

Financial assets are designated at fair value through profit or loss where this results in more relevant information because it significantly reduces a measurement inconsistency that would otherwise arise from measuring the assets or liabilities or recognising gains or losses on them on a different basis, or where the assets are managed and their performance evaluated on a fair value basis, or where a contract contains one or more embedded derivatives which would otherwise require bifurcation and separate recognition as derivatives.

 

The following assets have been designated at fair value through profit or loss:

 

Loans and advances to customers, representing loans secured on residential property to housing associations of £3,187m (2011: £4,318m) and other loans of £61m (2011: £58m).

Loans secured on residential property to housing associations of £3,187m (2011: £4,318m) which, at the date of their origination, were managed, and their performance evaluated, on a fair value basis in accordance with a documented investment strategy, and information about them was provided on that basis to management. Since 2009, the Santander UK group's policy has been not to designate similar new loans at fair value through profit or loss.

Other loans of £61m (2011: £58m), representing a portfolio of roll-up mortgages, are managed, and their performance evaluated, on a fair value basis in accordance with a documented investment strategy, and information about them is provided on that basis to management.

Debt securities, representing holdings of asset-backed securities of £328m (2011: £379m) and other debt securities of £235m (2011: £250m):

Mortgage-backed securities of £250m (2011: £279m), other asset-backed securities of £31m (2011: £49m), and other debt securities of £235m (2011: £250m) principally representing reversionary UK property securities. These securities are managed and their performance evaluated on a fair value basis in accordance with a documented strategy, and information about them is provided on that basis to management.

Other asset-backed securities of £47m (2011: £51m) which, at the date of their acquisition, were managed, and their performance evaluated, on a fair value basis in accordance with a documented investment strategy, and information about them was provided on that basis to management. Almost all of these securities are now managed on an accruals basis, but are not eligible for reclassification under IAS 39. These securities were issued by Banco Santander entities.

 

Included in the above balances are amounts owed to the Santander UK group by Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £nil (2011: £nil) and £47m (2011: £51m) respectively.

 

The maximum exposure to credit risk on loans and advances designated as held at fair value through profit or loss at the balance sheet date was £3,248m (2011: £4,376m) for the Santander UK group and £44m (2011: £45m) for the Company. The maximum exposure was mitigated by a charge over the residential properties in respect of lending to housing associations amounting to £3,377m (2011: £4,609m) for the Santander UK group and £34m (2011: £47m) for the Company.

 

The net movement during the year attributable to changes in credit risk for loans and advances designated at fair value was £(99)m (2011: net loss of £26m). The cumulative net loss attributable to changes in credit risk for loans and advances designated at fair value at 31 December 2012 was £356m (2011: cumulative net loss of £257m).

 

 

Debt securities can be analysed by type of issuer as follows:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Mortgage-backed securities

250

279

-

-

Other asset-backed securities

78

100

-

-

328

379

-

-

 Other securities

235

250

-

-

563

629

-

-

 

Debt securities can be analysed by listing status as follows:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Listed in the UK

237

256

-

-

Listed elsewhere

80

107

-

-

Unlisted(1)

246

266

-

-

563

629

-

-

(1) Includes Social Housing.

 

Asset-backed securities can be analysed by the geographical location of the issuer or counterparty as follows:

 

31 December 2012

31 December 2011

Income statement

Nominal value

Book value

Fair

value

Fair value as

% of nominal

Nominal value

Book value

Fair

value

Fair value as

% of nominal

2012

2011

Country

£m

£m

£m

%

£m

£m

£m

%

£m

£m

UK

MBS

171

238

238

139

187

263

263

141

8

26

171

238

238

139

187

263

263

141

8

26

US

MBS

8

11

11

138

8

9

9

113

4

(4)

8

11

11

138

8

9

9

113

4

(4)

Rest of Europe (principally Spain)

ABS

98

78

78

80

105

100

100

94

(13)

11

MBS

1

1

1

100

10

7

7

160

-

1

99

79

79

80

115

107

107

93

(13)

12

Total

278

328

328

118

310

379

379

122

(1)

34

 

Asset-backed securities can be analysed by the credit rating of the issuer or counterparty as follows:

 

31 December 2012

31 December 2011

Income statement

Nominal value

Book value

Fair

value

Fair value as

% of nominal

Nominal value

Book value

Fair

value

Fair value as

% of nominal

2012

2011

Credit rating(1)

£m

£m

£m

%

£m

£m

£m

%

£m

£m

AAA

ABS

-

-

-

-

28

16

16

57

-

-

MBS

159

222

222

140

175

247

247

141

10

18

159

222

222

140

203

263

263

130

10

18

AA+

ABS

-

-

-

-

46

30

30

65

-

1

-

-

-

-

46

30

30

65

-

1

AA

ABS

54

49

49

91

28

52

52

186

(15)

10

MBS

20

27

27

135

21

27

27

129

2

5

74

76

76

103

49

79

79

161

(13)

15

A

ABS

42

28

28

67

3

2

2

67

2

-

MBS

1

1

1

100

-

-

-

-

-

-

43

29

29

67

3

2

2

67

2

-

BBB

ABS

2

1

1

50

-

-

-

-

-

-

MBS

-

-

-

-

-

-

-

-

-

-

2

1

1

50

-

-

-

-

-

-

Below BBB

MBS

-

-

-

-

9

5

5

56

-

-

-

-

-

-

9

5

5

56

-

-

Total

278

328

328

118

310

379

379

122

(1)

34

(1) All exposures are internally rated. External ratings are taken into consideration in the rating process, where available.

 

17. LOANS AND ADVANCES TO BANKS

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Placements with other banks(1)

2,201

2,405

707

1,192

Amounts due from Banco Santander - securities purchased under resale agreements

233

2,071

-

-

- other

4

11

-

-

Amounts due from Santander UK group undertakings - securities purchased under resale agreements

-

-

991

-

- other

-

-

96,148

89,524

2,438

4,487

97,846

90,716

(1) Principally comprises primarily time deposits, cash in the course of collection, cash held with foreign banks and unsettled financial transactions.

 

During the year, no impairment losses were incurred (2011: £nil, 2010: £nil). Loans and advances to banks are repayable as follows:

 

Group

Company

 

Repayable:

2012

£m

2011

£m

2012

£m

2011

£m

On demand

1,172

1,467

6,223

5,395

In not more than 3 months

276

1,952

19,431

21,178

In more than 3 months but not more than 1 year

122

149

19,621

19,030

In more than 1 year but not more than 5 years

70

63

33,410

30,267

In more than 5 years

798

856

19,161

14,846

2,438

4,487

97,846

90,716

 

Loans and advances to banks can be analysed by the geographical location of the issuer or counterparty as follows:

 

Group

Country

2012

£m

2011

£m

UK

686

1,727

Spain

237

2,071

France

13

-

Rest of Europe

149

117

US

1,273

257

Rest of world

80

315

Total

2,438

4,487

 

Loans and advances to banks can be analysed by the credit rating of the issuer or counterparty as follows:

 

Group

Credit rating(1)

2012

£m

2011

£m

AAA

5

235

AA

7

2

AA-

264

3,265

A+

167

34

A

745

54

A-

1,004

896

BB+

237

1

D

9

-

Total

2,438

4,487

(1) All exposures are internally rated. External ratings are taken into consideration in the rating process, where available.

 

18. LOANS AND ADVANCES TO CUSTOMERS

 

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

Advances secured on residential properties

157,310

166,847

157,305

166,820

Corporate loans:

- SME

9,282

7,571

7,351

5,849

- Social housing

4,738

3,287

15

16

- Real estate

3,732

3,954

97

114

- Large Corporates

2,278

3,026

1,265

1,769

- Other

1,234

1,314

579

739

- Legacy portfolios in run-off:

- Aviation

620

762

-

-

- Shipping

677

944

-

-

- Other

750

1,044

-

-

23,311

21,902

9,307

8,487

Finance leases:

- Consumer finance

1,914

1,765

-

-

- Other corporate

818

697

-

-

- Legacy portfolios in run-off: Other

330

482

-

-

3,062

2,944

-

-

Secured advances:

- SME

1,299

1,432

1,299

1,432

Other secured advances

1,710

2,278

1,281

1,714

Other unsecured loans:

- Overdrafts

894

762

893

762

- UPLs

3,151

3,655

2,358

2,902

- Other loans

2,718

2,780

94

68

6,763

7,197

3,345

3,732

Amounts due from fellow Banco Santander group subsidiaries and joint ventures

347

32

13

27

Amounts due from subsidiaries

-

-

462

971

Loans and advances to customers

193,802

202,632

173,012

183,183

Less: impairment loss allowances

(1,895)

(1,563)

(1,315)

(1,211)

Loans and advances to customers, net of impairment loss allowances

191,907

201,069

171,697

181,972

 

Group

Company

 

 Repayable:

2012

£m

2011

£m

2012

£m

2011

£m

On demand

1,314

1,170

974

1,153

In no more than 3 months

4,372

5,489

3,130

3,634

In more than 3 months but not more than 1 year

7,492

6,424

5,319

4,160

In more than 1 year but not more than 5 years

35,025

32,322

25,636

23,093

In more than 5 years

145,599

157,227

137,953

151,143

Loans and advances to customers

193,802

202,632

173,012

183,183

Less: impairment loss allowances

(1,895)

(1,563)

(1,315)

(1,211)

Loans and advances to customers, net of impairment loss allowances

191,907

201,069

171,697

181,972

 

Finance lease and hire purchase contract receivables may be analysed as follows:

 

Group

Company

 

Gross investment:

2012

£m

2011

£m

2012

£m

2011

£m

Within 1 year

1,221

1,388

-

-

Between 1-5 years

1,884

1,814

-

-

In more than 5 years

696

624

-

-

3,801

3,826

-

-

Less: unearned future finance income

(739)

(882)

-

-

Net investment

3,062

2,944

-

-

 

The net investment in finance leases and hire purchase contracts represents amounts recoverable as follows:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Within 1 year

1,050

1,142

-

-

Between 1-5 years

1,600

1,436

-

-

In more than 5 years

412

366

-

-

3,062

2,944

-

-

 

The Santander UK group enters into finance leasing arrangements primarily for the financing of motor vehicles and a range of assets to its corporate customers. Included in the carrying value of net investment in finance leases and hire purchase contracts is £54m (2011: £47m) of unguaranteed residual value at the end of the current lease terms, which is expected to be recovered through re-letting or sale. Contingent rent income of £14m (2011: £16m) was earned during the year, which was classified in "Interest and similar income".

 

Finance lease receivable balances are secured over the asset leased. The Santander UK group is not permitted to sell or repledge the asset in the absence of default by the lessee. The Directors consider that the carrying amount of the finance lease receivables approximates to their fair value.

 

Included within loans and advances to customers are advances assigned to bankruptcy remote special purpose entities and Abbey Covered Bonds LLP. These loans provide security to issues of covered bonds and asset or mortgage backed securities made by the Santander UK group. See Note 19 for further details.

 

Loans and advances to customers have the following interest rate structures:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Fixed rate

64,661

75,352

56,610

69,418

Variable rate

129,141

127,280

116,402

113,765

Less: impairment loss allowances

(1,895)

(1,563)

(1,315)

(1,211)

191,907

201,069

171,697

181,972

 

Movement in impairment loss allowances:

 

Group

2012

Loans secured

on residential

property

£m

 

Corporate

Loans

£m

 

Finance

leases

£m

Other

secured

advances

£m

Other

unsecured

advances

£m

 

 

Total

£m

At 1 January 2012:

- Observed

- Individual

59

324

-

83

-

466

- Collective

322

-

6

-

330

658

- Incurred but not yet observed

97

103

31

24

183

438

478

427

37

107

513

1,562

Charge/(release) to the income statement:

- Observed

- Individual

(1)

382

-

50

11

442

- Collective

80

58

12

79

368

597

- Incurred but not yet observed

70

22

4

(14)

(38)

44

149

462

16

115

341

1,083

Write offs

(75)

(162)

(13)

(53)

(447)

(750)

At 31 December 2012:

- Observed

- Individual

58

544

-

80

11

693

- Collective

327

58

6

79

251

721

- Incurred but not yet observed

167

125

34

10

145

481

552

727

40

169

407

1,895

 

Group

2011

Loans secured

on residential

property

£m

 

Corporate

Loans

£m

 

Finance

leases

£m

Other

secured

advances

£m

Other

unsecured

advances

£m

 

 

Total

£m

At 1 January 2011:

- Observed

- Individual

62

268

2

55

-

387

- Collective

307

-

-

-

384

691

- Incurred but not yet observed

157

121

17

22

256

577

526

389

19

77

637

1,655

Charge/(release) to the income statement:

- Observed

- Individual

(4)

173

8

76

-

259

- Collective

108

-

6

-

412

520

- Incurred but not yet observed

(60)

(19)

13

2

(76)

(140)

44

160

27

78

336

639

Write offs

(92)

(116)

(9)

(48)

(466)

(731)

At 31 December 2011:

- Observed

- Individual

59

324

-

83

-

466

- Collective

322

-

6

-

330

658

- Incurred but not yet observed

97

103

31

24

179

439

478

427

37

107

514

1,563

 

Group

2010

Loans secured

on residential

property

£m

 

Corporate

Loans

£m

 

Finance

leases

£m

Other

secured

advances

£m

Other

unsecured

advances

£m

 

 

Total

£m

At 1 January 2010

- Observed

- Individual

51

185

1

50

-

287

- Collective

262

-

-

-

341

603

- Incurred but not yet observed

171

172

1

12

53

409

484

357

2

62

394

1,299

Charge/(release) to the income statement:

- Observed

- Individual

53

154

6

53

-

266

- Collective

45

-

-

-

488

533

- Incurred but not yet observed

(14)

(47)

(1)

10

(1)

(53)

84

107

5

63

487

746

Write offs

(42)

(68)

(5)

(48)

(448)

(611)

Assumed via transfers of entities under common control

-

-

17

-

204

221

At 31 December 2010:

- Observed

- Individual

62

271

2

55

-

390

- Collective

307

-

-

-

381

688

- Incurred but not yet observed

157

125

17

22

256

577

526

396

19

77

637

1,655

 

Company

 

 

 

 

Loans secured on residential

property

£m

Amounts

due from

subsidiaries

£m

Corporate Loans

£m

 

Finance

leases

£m

Other

secured

advances

£m

Other

unsecured

advances

£m

 

 

Total

£m

At 1 January 2012

477

244

134

-

107

249

1,211

Charge/(release) to the income statement

149

-

89

-

115

233

586

Write offs

(75)

(12)

(45)

-

(53)

(297)

(482)

At 31 December 2012

551

232

178

-

169

185

1,315

At 1 January 2011

524

316

140

-

77

399

1,456

Charge/(release) to the income statement

45

(72)

39

-

78

162

252

Write offs

(92)

-

(45)

-

(48)

(312)

(497)

At 31 December 2011

477

244

134

-

107

249

1,211

At 1 January 2010

395

98

-

-

55

351

899

Charge/(release) to the income statement

53

(43)

16

-

63

437

526

Transfer from Alliance & Leicester plc

118

261

146

-

-

46

571

Write offs

(42)

-

(22)

-

(41)

(435)

(540)

At 31 December 2010

524

316

140

-

77

399

1,456

 

Recoveries:

 

Group

Loans secured on residential

property

£m

 

Corporate

Loans

£m

 

Finance

leases

£m

Other

secured

advances

£m

Other

unsecured

advances

£m

 

 

Total

£m

2012

2

-

2

6

64

74

2011

3

2

3

10

56

74

2010

1

12

1

-

20

34

 

Assets held for sale

 

In 2012, the Company reached an agreement in principle for the sale of the £1.2bn of loans and advances to customers in its store card business. Discussions continue with all parties to complete the transaction, which is expected to close in the first quarter of 2013.

 

19. SECURITISATIONS AND COVERED BONDS

 

The Santander UK group uses Special Purpose Entities ('SPEs') to securitise some of the mortgage and other loans to customers that it originated. The Santander UK group also issues covered bonds, which are guaranteed by a pool of the Santander UK group's mortgage loans that it has transferred into Abbey Covered Bonds LLP. The Santander UK group issues mortgage-backed securities, other asset-backed securities and covered bonds mainly in order to obtain diverse, low cost funding, but also to be used as collateral for raising funds via third party bilateral secured funding transactions or for creating collateral which could in the future be used for liquidity purposes. The Santander UK group has successfully used bilateral secured transactions as an additional form of medium term funding; this has allowed the Santander UK group to further diversify its medium term funding investor base. The Santander UK group's principal securitisation programmes and covered bond programme, together with the balances of the advances subject to securitisation and the carrying value of the notes in issue at 31 December 2012 and 2011 are listed below. The related notes in issue are set out in Note 33.

 

Loans and advances to customers include portfolios of residential mortgage loans, and receivables derived from credit agreements with retail customers for the purchases of financed vehicles, which are subject to non-recourse finance arrangements. These loans and receivables have been purchased by, or assigned to, SPEs or Abbey Covered Bonds LLP, and have been funded primarily through the issue of mortgage-backed securities, asset backed securities or covered bonds. No gain or loss has been recognised as a result of these sales. The SPEs and Abbey Covered Bonds LLP are consolidated in the Santander UK group financial statements as subsidiaries. The Company and its subsidiaries do not own directly, or indirectly, any of the share capital of any of the SPEs.

 

a) Securitisations

The balances of loans and advances to customers subject to securitisation at 31 December 2012 and 2011 under the structures described below were:

 

2012

2011

 

 

Gross assets

securitised

£m

Gross assets

securitised

£m

Master Trust Structures:

- Holmes

13,815

10,247

- Fosse

18,756

18,717

- Langton

13,161

45,449

Other securitisation structures:

- Motor

1,184

813

46,916

75,226

 

i) Master Trust Structures

The Santander UK group makes use of a type of securitisation known as a master trust structure. In this structure, a pool of assets is assigned to a trust company by the asset originator. A funding entity acquires a beneficial interest in the pool of assets held by the trust company with funds borrowed from qualifying SPEs, which at the same time issue asset-backed securities to third-party investors or the Santander UK group. The trust company holds the pool of assets on trust for the funding entity and the originator. The originator holds a beneficial interest over the share of the pool of assets not purchased by the funding entity, known as the seller share.

 

The Company and its subsidiaries are under no obligation to support any losses that may be incurred by the securitisation companies or holders of the securities and do not intend to provide such further support. Holders of the securities are only entitled to obtain payment of principal and interest to the extent that the resources of the securitisation companies are sufficient to support such payments, and the holders of the securities have agreed in writing not to seek recourse in any other form.

 

The Company and its subsidiaries receive payments from the securitisation companies in respect of fees for administering the loans, and payment of deferred consideration for the sale of the loans. The Company and its subsidiaries have no right or obligation to repurchase any securitised loan, except if certain representations and warranties given by the Company or its subsidiaries at the time of transfer are breached and, in certain cases, if there is a product switch.

 

Holmes

Outstanding balances of assets securitised and notes in issue (non-recourse finance) under the Holmes securitisation structure at 31 December 2012 and 2011 were:

 

2012

2011

 

 

Securitisation company

 

Closing date

of securitisation

Gross assets

securitised

£m

Notes in issue

£m

Issued to Santander UK plc as collateral

£m

Gross

 assets

securitised

£m

Notes in issue

£m

Issued to Santander UK plc as collateral

£m

Holmes Master Issuer plc - 2007/1

28 March 2007

-

-

-

515

644

-

Holmes Master Issuer plc - 2007/2

20 June 2007

-

-

-

377

483

-

Holmes Master Issuer plc - 2010/1

12 November 2010

2,377

1,846

602

2,623

2,035

600

Holmes Master Issuer plc - 2011/1

9 February 2011

2,081

1,692

451

2,194

2,070

450

Holmes Master Issuer plc - 2011/2

24 March 2011

244

251

-

250

251

-

Holmes Master Issuer plc - 2011/3

21 September 2011

1,968

2,027

-

2,399

2,437

-

Holmes Master Issuer plc - 2012/1

24 January 2012

2,657

2,125

612

-

-

-

Holmes Master Issuer plc - 2012/2

17 April 2012

920

771

176

-

-

-

Holmes Master Issuer plc - 2012/3

7 June 2012

618

636

-

-

-

-

Holmes Master Issuer plc - 2012/4

24 August 2012

689

528

181

-

-

-

Beneficial interest in mortgages held by Holmes Trustees Ltd

2,261

-

-

1,889

-

-

13,815

9,876

2,022

10,247

7,920

1,050

Less: Held by the Santander UK group

-

(91)

Total securitisations (See Note 33)

9,876

7,829

 

 

Using a master trust structure, the Company has assigned portfolios of residential mortgages and their related security to Holmes Trustees Limited, a trust company that holds the portfolios of mortgages on trust for the Company and Holmes Funding Limited. Proceeds from notes issued to third party investors or the Santander UK group by SPE's under the Holmes master trust structure have been loaned to Holmes Funding Limited, which in turn used the funds to purchase its referred beneficial interests in the portfolio of assets held by Holmes Trustees Limited. As part of a restructure in October 2010 to return the Holmes securitisation structure to a third party issuance programme a £5.7bn existing note redemption reserve fund with Holmes Trustees Limited was created. The existing note redemption reserve fund can in certain circumstances be used to fund any shortfall of principal receipts in relation to the scheduled redemption of the Holmes Master Issuer plc Series 2007-1 and Series 2007-2 notes on an interest payment date. As these issues were fully redeemed in the year, the associated redemption reserve has also been released.

 

The minimum value of assets required to be held by Holmes Trustee Limited is a function of the notes in issue under the Holmes master trust structure and the Company's required minimum share. The Holmes securitisation companies have placed cash deposits totalling £0.1bn (2011: £0.1bn), which have been accumulated to finance the redemption of a number of securities issued by the Holmes securitisation companies. The share of Holmes Funding Limited in the trust assets is therefore reduced by this amount.

 

Holmes Funding Limited has a beneficial interest of £11.6bn (2011: £8.4bn) in the residential mortgage loans held by Holmes Trustees Limited, the remaining share of the beneficial interest in residential mortgage loans held by Holmes Trustees Limited belongs to Santander UK plc.

 

In 2012, £5.1bn (2011: £5.1bn) of mortgage-backed notes were issued from Holmes Master Issuer plc. Mortgage-backed securities totalling £1.6bn (2011: £5.1bn) equivalent were redeemed during the year.

 

Fosse

Outstanding balances of assets securitised and notes in issue (non-recourse finance) under the Fosse securitisation structure at 31 December 2012 and 2011 were:

 

2012

2011

 

 

Securitisation company

 

Closing date

of securitisation

Gross assets

securitised

£m

Notes in issue

£m

Issued to Santander UK plc as collateral

£m

Gross

assets

securitised

£m

Notes in issue

£m

Issued to Santander UK plc as collateral

£m

Fosse Master Issuer plc - 2006/1

28 November 2006

401

415

-

652

601

-

Fosse Master Issuer plc - 2007/1

1 August 2007

-

-

-

1,713

1,579

-

Fosse Master Issuer plc - 2008/1

21 August 2008

-

-

-

218

201

-

Fosse Master Issuer plc - 2010/1

12 March 2010

1,701

1,371

390

1,509

1,391

390

Fosse Master Issuer plc - 2010/2

3 June 2010

1,221

1,012

252

1,439

1,326

252

Fosse Master Issuer plc - 2010/3

27 July 2010

3,695

3,322

501

3,810

3,510

502

Fosse Master Issuer plc - 2010/4

9 September 2010

1,070

1,108

-

1,372

1,265

-

Fosse Master Issuer plc - 2011/1

25 May 2011

3,952

3,124

967

4,162

3,835

968

Fosse Master Issuer plc - 2011/2

6 December 2011

1,054

856

235

1,207

1,113

234

Fosse Master Issuer plc - 2012/1

22 May 2012

2,455

2,254

286

-

-

-

Beneficial interest in mortgages held by Fosse Master Trust Ltd

3,207

-

-

2,635

-

-

18,756

13,462

2,631

18,717

14,821

2,346

Less: Held by the Santander UK group

(75)

(102)

Total securitisations (See Note 33)

13,387

14,719

 

The Fosse Master Trust securitisation structure was established in 2006. Notes were issued by Fosse Master Issuer plc to third party investors and the proceeds loaned to Fosse Funding (No. 1) Limited, which in turn used the funds to purchase beneficial interests in mortgages held by Fosse Trustee Limited.

 

Both Fosse Funding (No. 1) Limited and the Company have a beneficial interest in the mortgages held in trust by Fosse Trustee Limited. The minimum value of assets required to be held by Fosse Trustee Limited is a function of the notes in issue under the Fosse master trust structure and the Company's required minimum share.

 

Fosse Master Issuer plc has cash deposits totalling £807m (2011: £350m), which have been accumulated to finance the redemption of a number of securities issued by Fosse Master Issuer plc. Fosse Funding (No.1) Limited's beneficial interest in the assets held by Fosse Trustee Limited is therefore reduced by this amount.

 

In 2012, £2.6bn (2011: £6.1bn) of mortgage-backed notes were issued from Fosse Master Issuer plc. Mortgage-backed notes totalling £3.2bn (2011: £1.1bn) equivalent were redeemed during the year.

 

Langton

Outstanding balances of assets securitised and notes in issue (non-recourse finance) under the Langton securitisation structure at 31 December 2012 and 2011 were:

 

2012

2011

 

 

Securitisation company

 

Closing date

of securitisation

Gross assets

securitised

£m

Notes in issue

£m

Issued to Santander UK plc as collateral

£m

Gross

 assets

securitised

£m

Notes in issue

£m

Issued to Santander UK plc as collateral

£m

Langton Securities (2010-1) plc (1)

1 October 2010

1,642

-

1,599

7,726

-

7,928

Langton Securities (2010-1) plc (2)

12 October 2010

1,316

-

1,282

9,895

-

10,153

Langton Securities (2010-2) plc (1)

12 October 2010

1,545

-

1,504

5,591

-

5,737

Langton Securities (2008-1) plc (2)

23 March 2011

2,136

-

2,080

15,999

-

16,417

Langton Securities (2010-2) plc (2)

28 July 2011

1,517

-

1,477

1,661

-

1,704

Beneficial interest in mortgages held by Langton Master Trust Ltd

5,005

-

-

4,577

-

-

13,161

-

7,942

45,449

-

41,939

 

The Langton Master Trust securitisation structure was established on 25 January 2008. Notes were issued by Langton Securities (2008-1) plc, Langton Securities (2010-1) plc and Langton Securities (2010-2) plc to the Company for the purpose of creating collateral to be used for funding and liquidity.

 

Each entity loaned the proceeds of the Notes issued to Langton Funding (No.1) Limited, which in turn used the funds to purchase a beneficial interest in the mortgages held by Langton Mortgages Trustee Limited.

 

Both Langton Funding (No. 1) Limited and the Company have a beneficial interest in the mortgages held in trust by Langton Mortgages Trustee Limited. The minimum value of assets required to be held by Langton Mortgages Trustee Limited is a function of the notes in issue under the Langton master trust structure and the Company's required minimum share.

 

In 2012, there were no issuances from any of the Langton issuing companies (2011: £18.2bn). Mortgage-backed notes totalling £33.8bn (2011: £12.3bn) equivalent were redeemed during the year. The redemption of the mortgage-backed notes in 2012 was pursuant to the Bank of England's decision to accept loans on an unsecuritised basis ("whole loans") as collateral for its various funding schemes as described in "Liquid assets" in the "Liquidity risk" section of the Risk Management Report. It was more efficient for the Company to use whole loans rather than securitisations as the Company is required to include the effect of a credit rating downgrade on its securitisation structures for the purposes of calculating liquidity requirements which is not the case with whole loans.

 

ii) Other securitisation structures

 

Motor

In 2012, the Santander UK group issued £1.0bn notes (2011: £1.3bn) through pass-through stand-alone vehicles for the securitisation of receivables derived from credit agreements with retail customers for the purchases of financed vehicles.

 

Outstanding balances of assets securitised and notes in issue (non-recourse finance) under the Motor securitisation structure at 31 December 2012 and 2011 were:

 

2012

2011

 

Securitisation company

 

Closing date

of securitisation

Gross assets

securitised

£m

Notes in issue

£m

Issued to Santander Consumer (UK) plc as collateral

£m

Gross

assets

securitised

£m

Notes in issue

£m

Issued to Santander Consumer (UK) plc as collateral

£m

Motor 2011 plc

21 April 2011

339

29

334

813

268

583

Motor 2012 plc

19 September 2012

845

733

221

-

-

-

1,184

762

555

813

268

583

Less: Held by the Santander UK group

-

-

Total securitisations (See Note 33)

762

268

 

b) Covered Bonds

The Santander UK group also issues covered bonds. In this structure, Abbey National Treasury Services plc (the 'Issuer') issues covered bonds, which are a direct, unsecured and unconditional obligation of the Issuer. The covered bonds benefit from a guarantee from the Company and Abbey Covered Bonds LLP. The Issuer makes a term advance to Abbey Covered Bonds LLP equal to the sterling proceeds of each issue of covered bonds. Abbey Covered Bonds LLP uses the proceeds of the term advance to purchase portfolios of residential mortgage loans and their security from the Company. Under the terms of the guarantee, Abbey Covered Bonds LLP has agreed to pay an amount equal to the guaranteed amounts when the same shall become due for payment but which would otherwise be unpaid by the Issuer or the Company.

 

Outstanding balances of loans and advances assigned to the covered bond programme at 31 December 2012 and 2011 were:

2012

2011

 

 

 

 

Gross assets

assigned

£m

Notes in issue

£m

Issued to Santander UK plc as collateral

£m

Gross

assets

assigned

£m

Notes in issue

£m

Issued to Santander UK plc as collateral

£m

Euro 35bn Global Covered Bond Programme

35,123

21,757

-

25,081

18,191

-

Less: Held by the Santander UK group

-

-

Total Covered Bonds (See Note 33)

21,757

18,191

 

For further information on the euro 35bn Global Covered Bond Programme, see Note 33.

 

 

20. SPECIAL PURPOSE ENTITIES

 

Special Purpose Entities are formed by the Santander UK group to accomplish specific and well-defined objectives. The Santander UK group consolidates these SPEs when the substance of the relationship indicates control, as described in Note 1.

 

Consolidated special purpose entities

 

In addition to the SPEs disclosed in Note 19 which are used for securitisation and covered bond programmes, the only other SPEs sponsored and consolidated by the Santander UK group are described below. All the external assets in these entities are included in the relevant Notes in these Consolidated Financial Statements.

 

a) Guaranteed Investment Products 1 PCC

Guaranteed Investment Products 1 PCC Limited is a Guernsey-incorporated, closed-ended, protected cell company. The objective of each cell is to achieve capital growth. In order to achieve the investment objective, Guaranteed Investment Products 1 PCC Limited, on behalf of the respective cells, has entered into transactions with theSantander UK group. Santander Guarantee Company, a Santander UK group company, also guarantees the shareholders of cells a fixed return on their investment and/or the investment amount. Guaranteed Investment Products 1 PCC Limited has no third party assets.

 

b) Santander UK Foundation Limited

Santander UK Foundation Limited supports disadvantaged people throughout the UK through the charitable priorities of education and financial capability. The Foundation's only third party assets consist of available-for-sale assets of £12m (2011: £11m).

 

c) Trust Preferred entities

Abbey National Capital Trust I and Abbey National Capital LP I are 100%-owned finance subsidiaries of the Company. These entities issue debt to third parties and lend the funds on to other Santander UK group companies. The Trust Preferred entities have no third party assets. Further information about these entities is set out in Note 34.

 

Off balance sheet special purpose entities

 

The only SPEs sponsored but not consolidated by the Santander UK group are as follows:

 

a) SPEs which issue shares that back retail structured products.

At 31 December 2012, the total value of products issued by these SPEs was £25m (2011: £36m). The Santander UK 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 maximum exposure to the SPEs sponsored but not consolidated by the Santander UK group consists of trading assets (Repurchases held by the Santander UK group) of £10m (2011: £17m).

 

b) Santander (UK) Common Investment Fund

In 2008, a common investment fund was established to hold the assets of the Santander UK Group Pension Scheme. The Santander (UK) Common Investment Fund is not consolidated by theSantander UK group, but its assets are accounted for as part of the defined benefit assets and obligations recognised on the Santander UK group's balance sheet. See Note 37 for further information.

 

21. TRANSFERS OF FINANCIAL ASSETS NOT QUALIFYING FOR DERECOGNITION

 

The Santander UK group enters into transactions in the normal course of business by which it transfers recognised financial assets directly to third parties or to SPEs. These transfers may give rise to the full or partial derecognition of the financial assets concerned.

 >

Full derecognition occurs when the Santander UK group transfers its contractual right to receive cash flows from the financial assets, or retains the right but assumes an obligation to pass on the cash flows from the asset, and transfers substantially all the risks and rewards of ownership. The risks include credit, interest rate, currency, prepayment and other price risks.

 >

Partial derecognition occurs when the Santander UK group sells or otherwise transfers financial assets in such a way that some but not substantially all of the risks and rewards of ownership are transferred but control is retained. These financial assets are recognised on the balance sheet to the extent of the Santander UK group's continuing involvement.

 

Financial assets that do not qualify for derecognition consist of (i) securities held by counterparties as collateral under repurchase agreements, (ii) securities lent under securities lending agreements, and (iii) loans that have been securitised under arrangements by which the Santander UK groupretains a continuing involvement in such transferred assets.

 

As the substance of the sale and repurchase and securities lending transactions is secured borrowings, the asset collateral continues to be recognised in full and the related liability reflecting the Santander UK group's obligation to repurchase the transferred assets for a fixed price at a future date is recognised in deposits from banks or customers, as appropriate. As a result of these transactions, the Santander UK group is unable to use, sell or pledge the transferred assets for the duration of the transaction. The Santander UK group remains exposed to interest rate risk and credit risk on these pledged instruments. The counterparty's recourse is not limited to the transferred assets.

 

The Santander UK group securitisation transfers do not qualify for derecognition. The Santander UK group remains exposed to credit risks arising from the mortgage loans and has retained control of the transferred assets. Circumstances in which the Santander UK group has continuing involvement in the transferred assets may include retention of servicing rights over the transferred assets, entering into a derivative transaction with the securitisation vehicle, retaining an interest in the securitisation vehicle or providing a cash reserve fund. Where the Santander UK group has continuing involvement it continues to recognise the transferred assets to the extent of its continuing involvement and recognises an associated liability. The net carrying amount of the transferred assets and associated liabilities reflects the rights and obligations that the Santander UK group has retained.

 

The following table analyses the carrying amount of financial assets that did not qualify for derecognition and their associated financial liabilities:

Group

2012

£m

2012

£m

2011

£m

2011

£m

Nature of transaction

Carrying amount of transferred assets

Carrying amount of associated liabilities

Carrying amount of transferred assets

Carrying amount of associated liabilities

Sale and repurchase agreements (See Note 41)

1,367

1,510

3,678

3,905

Securities lending agreements

2,422

2,754

2,913

2,964

Securitisations (See Notes 19 and 33)

46,916

24,025

75,226

22,816

50,705

28,289

81,817

29,685

 

 

22. AVAILABLE-FOR-SALE SECURITIES

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Debt securities

5,459

-

347

-

Equity securities

24

46

10

34

5,483

46

357

34

 

Debt securities and equity securities can be analysed by listing status as follows:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Debt securities:

- Listed in the UK

4,026

-

183

-

- Listed elsewhere

704

-

81

-

- Unlisted

729

-

83

-

5,459

-

347

-

Equity securities:

- Listed in the UK

20

11

7

-

- Listed elsewhere

1

25

-

25

- Unlisted

3

10

3

9

24

46

10

34

 

Debt securities at 31 December 2012 by contractual maturity and the related weighted average yield for the year:

 

2012

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 five years but not more than ten years

£m

In more than ten years

£m

Total

£m

Issued by public bodies:

- UK Government

-

-

995

2,849

-

-

3,844

- Other OECD

-

-

905

-

-

364

1,269

- Banks

-

-

-

301

-

-

301

- Building societies

-

-

-

45

-

-

45

-

-

1,900

3,195

-

364

5,459

Weighted average yield

-

-

0.75%

1.20%

-

0.24%

2.19%

 

 

The movement in available-for-sale securities can be summarised as follows:

Group

Company

2012

£m

2011

£m

2010

£m

2012

£m

2011

£m

2010

£m

At 1 January

46

175

797

34

38

30

Additions

6,338

-

1,225

348

-

-

Transfer from Alliance & Leicester plc

-

-

-

-

-

8

Redemptions and maturities

(877)

(126)

(1,846)

(25)

(2)

-

Amortisation of discount

(18)

-

-

-

-

-

Exchange adjustments

(12)

-

-

(2)

-

-

Movement in fair value

6

(3)

(1)

2

(2)

-

At 31 December

5,483

46

175

357

34

38

 

 

23. LOANS AND RECEIVABLES SECURITIES

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Floating rate notes

174

521

174

521

Asset-backed securities

978

1,142

5,542

4,454

Collateralised loan obligations

85

90

85

90

Other(1)

28

24

146

143

Loans and receivables securities

1,265

1,777

5,947

5,208

Less: Impairment allowances

(6)

(6)

(6)

(6)

Loans and receivables securities, net of impairment allowances

1,259

1,771

5,941

5,202

(1) Comprises £27m principal protected notes (2011: £21m) and £1m collateralised debt obligations (2011: £3m).

 

These assets were acquired as part of the transfer of Alliance & Leicester plc to the Santander UK groupin 2008 and as part of an alignment of portfolios across the Banco Santander, S.A. group in 2010 and are being run down. Detailed analysis of these securities is set out below. There were no movements in impairment allowances in 2012 or 2011.

 

Included in the above balances are amounts owed to the Santander UK group by Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £nil (2011: £nil) and £23m (2011: £109m) respectively.

 

Floating rate notes

Floating rate notes can be analysed by the geographic location of the issuer or counterparty as follows:

 

31 December 2012

31 December 2011

Income statement

Nominal value

Book value

Fair

value

Fair value as

% of nominal

Nominal value

Book value

Fair

value

Fair value as

% of nominal

2012

2011

Country

£m

£m

£m

%

£m

£m

£m

%

£m

£m

UK

-

-

-

-

37

37

27

73

(4)

1

Italy

74

73

71

96

80

80

71

89

1

1

Spain

26

27

23

88

256

255

247

96

2

4

Rest of Europe

50

49

43

86

123

115

101

82

2

3

US

26

25

24

92

30

28

26

87

1

1

Total

176

174

161

91

526

515

472

90

2

10

 

Floating rate notes can be analysed by the credit rating of the issuer or counterparty as follows:

 

31 December 2012

31 December 2011

Income statement

Nominal value

Book value

Fair

value

Fair value as

% of nominal

Nominal value

Book value

Fair

value

Fair value as

% of nominal

2012

2011

Credit rating(1)

£m

£m

£m

%

£m

£m

£m

%

£m

£m

AA

47

46

46

98

165

165

159

96

1

4

A

118

116

107

91

273

270

252

92

4

5

BBB

-

-

-

-

75

73

61

81

(3)

1

Below BBB

11

12

10

91

13

7

-

-

-

-

Total

176

174

163

93

526

515

472

90

2

10

(1) All exposures are internally rated. External ratings are taken into consideration in the rating process, where available.

 

Asset-backed securities

Asset-backed securities can be analysed by the geographic location of the issuer or counterparty as follows:

 

31 December 2012

31 December 2011

Income statement

Nominal value

Book value

Fair

value

Fair value as

% of nominal

Nominal value

Book value

Fair

value

Fair value as

% of nominal

2012

2011

Country

£m

£m

£m

%

£m

£m

£m

%

£m

£m

UK

ABS

74

75

75

101

74

74

74

100

-

-

MBS

168

156

139

83

223

211

169

76

6

3

242

231

214

88

297

285

243

82

6

3

US

ABS

321

292

271

84

330

304

273

83

4

3

MBS

26

23

20

77

49

41

33

67

1

1

347

315

291

84

379

345

306

81

5

4

Rest of Europe(1)

ABS

96

95

85

89

112

112

99

88

-

1

MBS

333

313

267

80

377

364

305

81

(1)

10

429

408

352

82

489

476

404

83

(1)

11

Rest of world

ABS

11

8

9

82

17

15

15

88

2

4

MBS

16

16

15

94

22

21

18

82

-

1

27

24

24

89

39

36

33

85

2

5

Total

1,045

978

881

84

1,204

1,142

986

82

12

23

(1) For details, see "Country Risk Exposures" in the Risk Management Report.

 

Asset-backed securities can be analysed by the credit rating of the issuer or counterparty as follows:

 

31 December 2012

31 December 2011

Income statement

Nominal value

Book value

Fair

value

Fair value as

% of nominal

Nominal value

Book value

Fair

value

Fair value as

% of nominal

2012

2011

Credit rating(1)

£m

£m

£m

%

£m

£m

£m

%

£m

£m

AAA

ABS

334

312

285

85

367

346

305

83

4

6

MBS

385

368

325

84

416

396

324

78

12

9

719

680

610

85

783

742

629

80

16

15

AA+

ABS

2

2

2

100

-

-

-

-

-

-

MBS

17

15

14

82

102

97

94

92

-

3

19

17

16

84

102

97

94

92

-

3

AA

ABS

8

7

4

50

9

8

5

56

-

-

MBS

114

102

84

74

109

103

75

69

(1)

1

122

109

88

72

118

111

80

68

(1)

1

A

ABS

91

89

89

98

88

86

86

98

1

2

MBS

16

12

8

50

35

31

27

77

(3)

-

107

101

97

91

123

117

113

92

(2)

2

BBB

MBS

6

6

5

83

6

5

4

67

-

-

6

6

5

83

6

5

4

67

-

-

Below BBB

ABS

67

60

60

90

69

65

65

94

1

1

MBS

5

5

5

100

3

5

1

33

(2)

1

72

65

65

90

72

70

66

92

(1)

2

Total

1,045

978

881

84

1,204

1,142

986

82

12

23

(1) All exposures are internally rated. External ratings are taken into consideration in the rating process, where available.

 

Asset-backed securities include the following:

 >

ALT-A US asset-backed securities - securities with book values of £20m (31 December 2011: £22m) and fair values of £15m (31 December 2011: £16m).

Monoline insurer exposures - The Santander UK group has a £57m (31 December 2011: £73m) exposure to corporate bonds and 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.

 

Collateralised Loan Obligations ('CLOs')

The Santander UK group acquired a portfolio of CLOs as part of the acquisition of Alliance & Leicester plc in 2008. This portfolio is being run down. At 31 December 2012, the Santander UK group had an exposure to CLOs with a nominal value of £94m (2011: £99m), a book value of £85m (2011: £90m) and a fair value of £75m (2011: £72m). In 2012, impairment losses of £nil (2011: £nil) were recognised in the income statement. The geographical locations of the issuer or counterparty of the CLO exposures are the UK, the rest of Europe and the US. 51% of the nominal values are rated BBB (2011: 51%) with 1% rated AAA (2011: 2%), 26% rated AA (2011: 25%), 20% rated A (2011: 20%) and 2% related below BBB (2011: 2%).

 

24. INVESTMENT IN SUBSIDIARY UNDERTAKINGS

 

Investments in subsidiaries are held at cost subject to impairment. The movement in investments in subsidiaries was as follows:

 

Company

 

 

Cost

£m

Impairment

£m

Net book value

£m

At 1 January 2012

7,360

(365)

6,995

Additions

244

-

244

Reversal

-

32

32

Capital reduction of subsidiary

(302)

-

(302)

At 31 December 2012

7,302

(333)

6,969

 

Company

 

 

Cost

£m

Impairment

£m

Net book value

£m

At 1 January 2011

7,234

(365)

6,869

Additions

198

-

198

Disposals

(72)

-

(72)

At 31 December 2011

7,360

(365)

6,995

 

In 2012 and 2011, the movements on investments in subsidiaries represented changes in the capital invested in certain subsidiaries as a result of an internal reorganisation within theSantander UK group.

 

The principal subsidiaries of the Company that comprise related undertakings under the UK Companies Act 2006 (and so exclude certain securitisation companies) at 31 December 2012 are shown below. The Directors consider that to give full particulars of all subsidiary undertakings would lead to a statement of excessive length. In accordance with Section 410(2) of the UK Companies Act 2006, the following information relates to those subsidiary undertakings whose results or financial position, in the opinion of the Directors, principally affect the results of the Santander UK group. Full particulars of all subsidiary undertakings will be annexed to the Company's next annual return in accordance with Section 410(3)(b) of the UK Companies Act 2006.

 

 Principal subsidiary

Nature of business

% Interest held

Country of incorporation or registration

Abbey National International Limited

Personal finance

100

Jersey

Alliance & Leicester International Limited*

Offshore deposit taking

100

Isle of Man

Abbey National North America LLC*

Commercial paper issue

100

United States

Abbey National Treasury Services plc

Treasury operations

100

England and Wales

Cater Allen Limited*

Bank, deposit taker

100

England and Wales

* Held indirectly through subsidiary companies.

 

All the above companies are included in the Consolidated Financial Statements. The Company holds directly or indirectly 100% of the issued ordinary share capital of its principal subsidiaries. All companies operate principally in their country of incorporation or registration. Abbey National Treasury Services plc also has a branch office in the US and the Cayman Islands. The Company has branches in the Isle of Man and in Jersey. The ability of Alliance & Leicester International Limited to pay dividends to the Company is restricted by regulatory capital requirements.

 

 

25. INTANGIBLE ASSETS

 

a) Goodwill

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Cost

At 1 January and 31 December

1,916

1,916

1,194

1,194

Accumulated impairment

At 1 January

82

22

-

-

Impairment charge

-

60

-

-

At 31 December

82

82

-

-

Net book value

1,834

1,834

1,194

1,194

 

Impairment of goodwill

During the year no impairment of goodwill was recognised (2011: £60m, 2010: £nil).

 

Impairment testing in respect of goodwill allocated to each cash-generating unit is performed annually or more frequently if there are impairment indicators present. For the purpose of impairment testing, the cash-generating units are based on customer groups within the relevant business divisions.

 

The cash flow projections for each cash-generating unit are based on the five year plan prepared for regulatory purposes, based on the Santander UK group's 3-Year Plan and approved by the Company's Board. The assumptions included in the expected future cash flows for each cash-generating unit take into consideration the UK economic environment and financial outlook within which the cash-generating unit operates. Key assumptions include projected GDP growth rates, the level of interest rates and the level and change in unemployment rates in the UK. The discount rate used to discount the cash flows is based on a pre-tax rate that reflects the weighted average cost of capital allocated by the Santander UK group to investments in the business division within which the cash-generating unit operates. The growth rate used reflects management's five-year forecasts, with a terminal growth rate of 2% applied thereafter, in line with the estimated long-term average UK GDP growth rate.

 

Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions described above would not cause an impairment to be recognised in respect of goodwill arising on the Santander UK group's business combinations.

 

The following cash-generating units include in their carrying values goodwill that comprises the goodwill reported by theSantander UK group. The cash-generating units do not carry on their balance sheets any other intangible assets with indefinite useful lives.

 

2012

 

Business Division

 

Cash-Generating Unit

Goodwill

£m

 

Basis of valuation

Key

assumptions

Discount

rate

Growth

rate(1)

Retail Banking

Personal financial services

1,169

Value in use: cash flow

5 year plan

11.4%

2%

Retail Banking

Credit cards

456

Value in use: cash flow

5 year plan

11.4%

4%

Retail Banking

Consumer finance

175

Value in use: cash flow

5 year plan

11.4%

-%

Retail Banking

Private banking

30

Value in use: cash flow

5 year plan

11.4%

7%

Retail Banking

Other

4

Value in use: cash flow

5 year plan

11.4%

2%

1,834

 

(1) Average growth rate based on the five year plan for the first five years and a growth rate of 2% applied thereafter.

 

2011

 

Business Division

 

Cash-Generating Unit

Goodwill

£m

 

Basis of valuation

Key

assumptions

Discount

rate

Growth

rate(1)

Retail Banking

Personal financial services

1,169

Value in use: cash flow

5 year plan

11.2%

2%

Retail Banking

Credit cards

456

Value in use: cash flow

5 year plan

11.2%

9%

Retail Banking

Consumer finance

175

Value in use: cash flow

5 year plan

11.2%

2%

Retail Banking

Private banking

30

Value in use: cash flow

5 year plan

11.2%

2%

Retail Banking

Other

4

Value in use: cash flow

5 year plan

11.2%

2%

1,834

(1) Average growth rate based on the five year plan for the first five years and a growth rate of 2% applied thereafter.

 

In 2012, the discount rate increased by 0.2 percentage points to 11.4% (2011: 11.2%). The increase reflected changes in current market and economic conditions. In 2012, the change in growth rates reflected the revised strategic priorities for the Santander UK group in the context of forecast economic conditions.

 

b) Other intangibles

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Cost

At 1 January

550

368

515

320

Additions

224

192

217

202

Disposals

(12)

(10)

-

(7)

At 31 December

762

550

732

515

Accumulated amortisation / impairment

At 1 January

242

84

251

107

Impairment

-

112

-

112

Disposals

(6)

(5)

-

(4)

Charge for the year

35

51

28

36

At 31 December

271

242

279

251

Net book value

491

308

453

264

 

Other intangible assets of the Santander UK group and the Company consist of computer software, and marketing rights acquired by the Santander UK group during 2010. The marketing rights had a cost of £16m. Accumulated amortisation at the start of the year was £5m and amortisation of £2m (2011: £4m) was charged in the year, giving a net book value of £9m (2011: £11m) at the year end.

 

In 2011, an impairment loss charge of £112m was recognised in respect of software as a result of a reduction in the related expected future economic benefits.

 

26. PROPERTY, PLANT AND EQUIPMENT

 

Group

 

 

 

 

Property

£m

Office fixtures

and equipment

£m

Computer

software

£m

Operating lease assets

£m

 

Total

£m

Cost:

At 1 January 2012

1,052

770

390

183

2,395

Additions

93

82

-

55

230

Disposals

(2)

(70)

-

(120)

(192)

At 31 December 2012

1,143

782

390

118

2,433

Accumulated depreciation:

At 1 January 2012

95

426

260

18

799

Charge for the year

36

89

43

43

211

Disposals

(1)

(68)

-

(49)

(118)

At 31 December 2012

130

447

303

12

892

Net book value

1,013

335

87

106

1,541

 

Group

 

 

 

 

Property

£m

Office fixtures

and equipment

£m

Computer

software

£m

Operating lease assets

£m

 

Total

£m

Cost:

At 1 January 2011

1,012

698

400

252

2,362

Additions

55

86

-

64

205

Disposals

(15)

(14)

(10)

(133)

(172)

At 31 December 2011

1,052

770

390

183

2,395

Accumulated depreciation:

At 1 January 2011

71

350

219

17

657

Charge for the year

35

90

45

54

224

Disposals

(11)

(14)

(4)

(53)

(82)

At 31 December 2011

95

426

260

18

799

Net book value

957

344

130

165

1,596

 

Company

 

 

 

 

Property

£m

Office fixtures

and equipment

£m

Computer

software

£m

 

Total

£m

Cost:

At 1 January 2012

952

920

322

2,194

Additions

59

78

-

137

Disposals

(2)

(70)

-

(72)

At 31 December 2012

1,009

928

322

2,259

Accumulated depreciation:

At 1 January 2012

237

583

192

1,012

Charge for the year

31

85

43

159

Disposals

(1)

(68)

-

(69)

At 31 December 2012

267

600

235

1,102

Net book value

742

328

87

1,157

 

Company

 

 

 

 

Property

£m

Office fixtures

and equipment

£m

Computer

software

£m

 

Total

£m

Cost:

At 1 January 2011

916

838

322

2,076

Additions

44

94

-

138

Disposals

(8)

(12)

-

(20)

At 31 December 2011

952

920

322

2,194

Accumulated depreciation:

At 1 January 2011

215

510

147

872

Charge for the year

30

84

45

159

Disposals

(8)

(11)

-

(19)

At 31 December 2011

237

583

192

1,012

Net book value

715

337

130

1,182

 

At 31 December 2012, capital expenditure contracted but not provided for in respect of property, plant and equipment was £70m (2011: £nil). Of the carrying value at the balance sheet date, £293m (2011: £176m) related to assets under construction.

 

Operating lease assets

The Santander UK group's operating lease assets consist of motor vehicles and other assets leased to its corporate customers. The Company has no operating lease assets. Future minimum lease receipts under non-cancellable operating leases are due over the following periods:

 

Group

 

 

2012

£m

2011

£m

In no more than 1 year

29

36

In more than 1 year but no more than 5 years

57

57

In more than 5 years

1

1

87

94

 

No contingent rent income (2011: £nil) for the Santander UK group was recognised in the year.

 

 

27. DEFERRED TAX

 

Deferred taxes are calculated on temporary differences under the liability method using the tax rates expected to apply when the liability is settled or the asset is realised. The movement on the deferred tax account was as follows:

 

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

At 1 January

257

357

275

379

Income statement charge

(242)

(129)

(248)

(113)

(Charged)/credited to other comprehensive income:

- retirement benefit obligations

42

9

42

9

- available-for-sale financial assets

3

2

3

2

45

11

45

11

Acquired through business combinations

-

-

-

(2)

Disposal of subsidiary undertaking

-

18

-

-

At 31 December

60

257

72

275

 

Deferred tax balances are presented in the balance sheet after offsetting assets and liabilities where the Santander UK group and Company has the legal right to off set and intends to settle on a net basis. The deferred tax assets and liabilities are attributable to the following items:

 

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

Deferred tax assets/ (liabilities)

Pensions and other post retirement benefits

9

(5)

9

(5)

Accelerated book depreciation

(43)

(4)

23

39

IAS 32 and IAS 39 transitional adjustments

53

73

26

38

Other temporary differences

(22)

37

(49)

47

Tax losses carried forward

63

156

63

156

60

257

72

275

 

The deferred tax assets scheduled above have been recognised in both the Company and the Santander UK group on the basis that sufficient future taxable profits are forecast within the foreseeable future, in excess of the profits arising from the reversal of existing taxable temporary differences, to allow for the utilisation of the assets as they reverse. Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions underlying the estimated future taxable profits in theSantander UK group's five year plan (described in Note 25) would not cause a reduction in the deferred tax assets recognised.

 

The Santander UK group and the Company recognise deferred tax assets in respect of trading losses relating to the former Alliance & Leicester plc business which was transferred to Santander UK plc in May 2010 under Part VII of the Financial Services and Markets Act 2000. HM Revenue & Customs confirmed in 2010 that the availability of losses was unaffected by the transfer. Under current UK tax legislation, the tax losses do not time expire and the benefit of the tax losses carried forward may only be realised by the utilisation against the future taxable profits of the former Alliance & Leicester plc business. The tax losses will be utilised as soon as practical taking into account discussions with HM Revenue & Customs over the level of profits attributable to the former Alliance & Leicester business. Management currently expect that these tax losses will be fully utilised during 2013.

 

At 31 December 2012, the Santander UK group had UK capital losses carried forward of £28m (2011: £66m). These losses are available for offset against future UK chargeable gains and under current UK tax legislation do not time expire. No deferred tax asset has been recognised in respect of these capital losses on the basis that future capital gains required to utilise the losses are not considered probable.

 

The deferred tax charge in the income statement comprises the following temporary differences:

 

Group

 

 

2012

£m

2011

£m

2010

£m

Accelerated tax depreciation

(39)

(37)

(32)

Pensions and other post-retirement benefits

(28)

(64)

(223)

Impairment loss allowances and other provisions

-

-

(1)

IFRS transition adjustments

(20)

(18)

(21)

Tax losses carried forward

(93)

(90)

(38)

Other temporary differences

(62)

80

(75)

(242)

(129)

(390)

 

 

28. OTHER ASSETS

 

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

Trade and other receivables

602

933

569

842

Prepayments

84

62

76

49

Accrued income

11

19

-

-

General insurance assets

71

74

71

74

768

1,088

716

965

 

 

29. DEPOSITS BY BANKS

 

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

Items in the course of transmission

340

1,045

319

1,028

Deposits by banks - securities sold under agreements to repurchase

7,382

5,574

2,584

620

Amounts due to Santander UK subsidiaries

-

-

105,591

110,119

Amounts due to ultimate parent - securities sold under repurchase agreements

- other

140

20

2,517

-

-

20

-

-

Amounts due to fellow Banco Santander subsidiaries - securities sold under

repurchase agreements

- other

 

-

64

 

565

40

 

-

1

 

2

-

Other deposits

1,989

1,885

655

509

9,935

11,626

109,170

112,278

 

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

Repayable:

On demand

2,324

2,980

28,280

19,251

In not more than 3 months

1,338

3,030

41,328

40,087

In more than 3 months but not more than 1 year

636

-

13,117

9,625

In more than 1 year but not more than 5 years

5,431

5,616

25,052

35,284

In more than 5 years

206

-

1,393

8,031

9,935

11,626

109,170

112,278

 

30. DEPOSITS BY CUSTOMERS

 

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

Current and demand accounts:

- interest-bearing

33,145

30,843

28,657

24,677

- non interest-bearing

1,437

948

1,333

879

Savings accounts(1)

76,260

72,729

75,268

71,319

Time deposits

35,769

42,873

26,415

30,851

Securities sold under repurchase agreements

906

418

500

-

Amounts due to Santander UK subsidiaries

-

-

55,356

47,155

Amounts due to fellow Banco Santander subsidiaries

1,520

531

1,355

186

149,037

148,342

188,884

175,067

 

Repayable:

On demand

111,603

104,113

106,470

97,127

In no more than 3 months

6,842

9,888

6,067

8,411

In more than 3 months but no more than 1 year

17,725

20,902

13,854

15,507

In more than 1 year but not more than 5 years

12,091

13,000

9,268

9,157

In more than 5 years

776

439

53,225

44,865

149,037

148,342

188,884

175,067

(1) Includes equity index-linked deposits of £5,002m (2011: £5,794m). The capital amount guaranteed/protected and the amount of return guaranteed in respect of the equity index-linked deposits were £5,002m and £336m, respectively (2011: £5,794m and £277m, respectively).

 

Savings accounts and time deposits are interest-bearing.

 

 

31. TRADING LIABILITIES

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Deposits by banks - securities sold under repurchase agreements

6,833

10,105

-

-

- other(1)

2,909

4,403

-

-

Deposits by customers - securities sold under repurchase agreements

4,847

5,519

-

-

- other(2)

2,401

4,963

-

-

Short positions in securities and unsettled trades

4,119

755

-

-

21,109

25,745

-

-

(1) Comprises cash collateral of £2,269m (2011: £2,401m) and short-term deposits of £640m (2011: £2,002m).

(2) Comprises short-term deposits of £1,702m (2011: £3,662m) and equity index-linked deposits of £699m (2011: £1,301m). The capital amount guaranteed/protected and the amount of return guaranteed in respect of the equity index-linked deposits were £559m and £109m, respectively (2011: £1,005m and £207m, respectively).

 

Included in the above balances are amounts owed by the Santander UK group to Banco Santander, S.A. of £180m (2011: £620m) and to other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £45m (2011: £51m).

 

 

32. FINANCIAL LIABILITIES DESIGNATED AT FAIR VALUE

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Debt securities in issue - US$10bn Euro Commercial Paper Programme

1,403

429

-

-

- US$20bn Euro Medium Term Note Programme

655

4,594

-

-

- Euro 10bn Structured Notes

1,740

1,744

-

-

- Other bonds

-

62

-

1

Warrants

204

8

-

-

4,002

6,837

-

1

 

Financial liabilities are designated at fair value through profit or loss where this results in more relevant information because it significantly reduces a measurement inconsistency that would otherwise arise from measuring assets and liabilities or recognising the gains or losses on them on a different basis, or where a contract contains one or more embedded derivatives that would otherwise require separate recognition.

 

The 'fair value option' has been used where deposits by banks, deposits by customers, debt securities in issue and warrants would otherwise be measured at amortised cost, and any embedded derivatives or associated derivatives used to economically hedge the risk are held at fair value. Where the Santander UK grouprecords its own debt securities in issue at fair value, the fair value is based on quoted prices in an active market for the specific instrument concerned, if available.

 

When quoted market prices are unavailable, the own debt security in issue is valued using valuation techniques, the inputs for which are either based upon quoted prices in an inactive market for the instrument, or are estimated by comparison with quoted prices in an active market for similar instruments. In both cases, the fair value includes the effect of applying the credit spread which is appropriate to the Santander UK group's liabilities. The change in fair value of issued debt securities attributable to the Santander UK group's own credit spread is computed as follows: for each security at each reporting date, an externally verifiable price is obtained or a price is derived using credit spreads for similar securities for the same issuer or credit default swaps. Each security is then valued using discounted cash flows, incorporating a LIBOR-based discount curve. The difference in the valuations is attributable to the Santander UK group's own credit spread. This methodology is applied consistently across all securities where it is believed that counterparties would consider the Santander UK group's creditworthiness when pricing trades.

 

Gains and losses arising from changes in the credit spread of liabilities issued by the Santander UK group reverse over the contractual life of the debt, provided that the debt is not repaid at a premium or a discount. The net loss during the year attributable to changes in the Santander UK group's own credit risk on the above debt securities in issue was £86m (2011: net gain of £64m). The cumulative net gain attributable to changes in the Santander UK group's own credit risk on the above debt securities in issue at 31 December 2012 was £7m (2011: net gain of £93m).

 

The amount that would be required to be contractually paid at maturity of the deposits by banks, deposits by customers, and debt securities in issue above is £531m (2011: £366m) higher than the carrying value.

 

US$10bn Euro Commercial Paper Programme

Abbey National Treasury Services plc may from time to time issue commercial paper under the US$10bn Euro Commercial Paper Programme that may be denominated in any currency as agreed between Abbey National Treasury Services plc and the relevant dealer. The commercial paper ranks at least pari passu with all other unsecured and unsubordinated obligations of Abbey National Treasury Services plc. The payments of all amounts due in respect of the commercial paper have been unconditionally and irrevocably guaranteed by the Company.

 

The commercial paper is issued in bearer form, subject to a minimum maturity of 1 day and a maximum maturity of 364 days. The commercial paper may be issued on a discounted basis or may bear fixed or floating rate interest or a coupon calculated by reference to an index or formula. The maximum aggregate nominal amount of all commercial paper outstanding from time to time under the Programme will not exceed US$10bn (or its equivalent in other currencies). This was increased from US$4bn in January 2011. The commercial paper is not listed on any stock exchange.

 

US$20bn Euro Medium Term Note Programme

Abbey National Treasury Services plc and the Company may from time to time issue notes denominated in any currency as agreed between the issuer and the relevant dealer under the US$20bn Euro Medium Term Note Programme. The payment of all amounts payable in respect of the notes is unconditionally and irrevocably guaranteed by the Company. The programme provides for issuance of fixed rate notes, floating rate notes, variable interest notes and zero-coupon/discount notes.

 

The maximum aggregate nominal amount of all notes outstanding under the programme may not exceed US$20bn (or its equivalent in other currencies) subject to any modifications in accordance with the terms of the programme agreement. Notes may be issued in bearer or registered form and can be listed on the London Stock Exchange or any other stock exchange(s) or may be unlisted, as agreed.

 

Euro 10bn Note, Certificate and Warrant Programme

Abbey National Treasury Services plc may from time to time issue structured notes and redeemable certificates (together the 'N&C Securities') and warrants (together with the N&C Securities, the 'Securities') denominated in any currency as agreed between Abbey National Treasury Services plc and the relevant dealers under the euro 10bn note, certificate and warrant programme (the 'Omnibus Programme'). The securities are direct, senior and unsecured obligations of Abbey National Treasury Services plc that rank pari passu without preference among themselves and, subject as to any applicable statutory provisions or judicial order, at least equally with all other present and future senior and unsecured obligations of Abbey National Treasury Services plc. The payment of all amounts due in respect of the Securities has been unconditionally and irrevocably guaranteed by the Company.

 

The Omnibus Programme provides for the issuance of commodity linked N&C Securities, credit-linked N&C Securities, currency-linked Securities, equity-linked Securities, equity index-linked Securities, fixed rate notes, floating rate N&C Securities, floating rate N&C Securities, fund-linked Securities, inflation-linked Securities, property-linked Securities, zero-coupon/discount N&C Securities and any other structured Securities as agreed between Abbey National Treasury Services plc and the relevant dealers. Securities issued under the Omnibus Programme are governed by English law.

 

The maximum aggregate outstanding nominal amount of all N&C Securities and the aggregate issue prices of outstanding warrants from time to time issued under the Omnibus Programme will not exceed euro 10bn (or its equivalent in other currencies).

 

Warrants programme

Abbey National Treasury Services plc established a warrants programme (the 'Warrants Programme') in 2009 for the issuance of structured warrants denominated in any currency as agreed between Abbey National Treasury Services plc and the relevant dealers under the Warrants Programme. Warrants are direct, unsecured and unconditional obligations of Abbey National Treasury Services plc that rank pari passu without preference among themselves and, subject as to any applicable statutory provisions or judicial order, rank at least equally with all other present and future unsecured and unsubordinated obligations of Abbey National Treasury Services plc.

 

As at the date of this report, Abbey National Treasury Services plc has discontinued the issue of new warrants under the Warrants Programme as new issuances are being made under the Omnibus Programme. The payments of all amounts due in respect of the previously issued warrants have been unconditionally and irrevocably guaranteed by the Company.

 

 

33. DEBT SECURITIES IN ISSUE

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Bonds and medium term notes:

- Euro 35bn Global Covered Bond Programme

21,757

18,191

-

-

- US$20bn Euro Medium Term Note Programme (See Note 32)

6,396

4,295

-

-

- US$40bn Euro Medium Term Note Programme

645

1,609

645

1,609

- US$20bn Commercial Paper Programme

2,289

3,069

-

-

- Certificates of deposit in issue

4,509

2,671

-

-

35,596

29,835

645

1,609

Securitisation programmes:

- Holmes

9,876

7,829

-

-

- Fosse

13,387

14,719

-

-

- Motor

762

268

-

-

59,621

52,651

645

1,609

 

Included in the above balances are amounts owed by the Santander UK group to Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £2,058m (2011: £107m) and £1,232m (2011: £137m) respectively.

 

Euro 35bn Global Covered Bond Programme

Abbey National Treasury Services plc issues covered bonds under the euro 35bn Global Covered Bond Programme that may be denominated in any currency as agreed between Abbey National Treasury Services plc and the relevant dealers. The programme provides that covered bonds may be listed or admitted to trading, on the official list of the UK Listing Authority and on the London Stock Exchange's Regulated Market or any other stock exchanges or regulated or unregulated markets. Abbey National Treasury Services plc may also issue unlisted covered bonds and/or covered bonds not admitted to trading on any regulated or unregulated market.

 

The payments of all amounts due in respect of the covered bonds have been unconditionally guaranteed by the Company. Abbey Covered Bonds LLP (the 'LLP'), together with the Company, has guaranteed payments of interest and principal under the covered bonds pursuant to a guarantee which is secured over the LLP's portfolio of mortgages and its other assets. Recourse against the LLP under its guarantee is limited to its portfolio of mortgages and such assets.

 

Covered bonds may be issued in bearer or registered form. The maximum aggregate nominal amount of all covered bonds from time to time outstanding under the programme will not exceed euro 35bn (or its equivalent in other currencies), subject to any modifications in accordance with the programme.

 

On 11 November 2008, Abbey National Treasury Services plc was admitted to the register of issuers and the programme and the covered bonds issued previously under the programme were admitted to the register of regulated covered bonds, pursuant to Regulation 14 of the Regulated Covered Bonds Regulations 2008 (SI 2008/346).

 

US$20bn Commercial Paper Programme

Abbey National North America LLC may from time to time issue unsecured notes denominated in United States dollars as agreed between Abbey National North America LLC and the relevant dealers under the US$20bn commercial paper programme. The Notes will rank at least pari passu with all other unsecured and unsubordinated indebtedness of Abbey National North America LLC and the Company. The payments of all amounts due in respect of the Notes have been unconditionally and irrevocably guaranteed by the Company. The Notes are not redeemable prior to maturity or subject to voluntary prepayment. The maximum aggregate nominal amount of all Notes from time to time outstanding under the Programme will not exceed US$20bn (or its equivalent in other currencies).

 

US$40bn Euro Medium Term Note Programme

In January 2009, it was decided that no further issuance would be made under the US$40bn Euro Medium Term Note Programme. Alliance & Leicester plc issued both senior notes and subordinated notes and from time to time issued notes denominated in any currency as agreed with the relevant dealer under the US$40bn Euro Medium Term Note Programme. The Programme provided for issuance of fixed rate Notes, floating rate notes, index linked notes, dual currency notes and zero-coupon notes. The notes are listed on the London Stock Exchange or may be listed on any other or further stock exchange(s) or may be unlisted, as agreed. The notes were issued in bearer form. The maximum aggregate nominal amount of all notes from time to time outstanding under the Programme did not exceed US$40bn (or its equivalent in other currencies), subject to any modifications in accordance with the terms of the Programme agreement.

 

The notes were direct, unsecured and unconditional obligations of Alliance & Leicester plc. The notes transferred to the Company with effect from 28 May 2010 under a business transfer scheme under Part VII of the Financial Services and Markets Act 2000. As a result, the notes are now direct, unsecured and unconditional obligations of the Company.

 

US SEC registered debt shelf

Abbey National Treasury Services plc issues notes in the US from time to time pursuant to a shelf registration statement on Form F-3 filed with the US Securities and Exchange Commission. The notes may be issued in any currency agreed between Abbey National Treasury Services plc and the relevant underwriters in any particular issuance under the registration statement.

 

Securitisation programmes

The Santander UK group has provided prime retail mortgage-backed securitised products and other asset-backed securitised products to a diverse investor base through its mortgage and other asset-backed funding programmes, as described in Note 19.

Funding has historically been raised via mortgage-backed notes, both issued to third parties and retained. In addition, the Santander UK group has provided other asset-backed securitised products to investors through the securitisation of auto loan receivables.

 

An analysis of the above debt securities in issue by issue currency, interest rate and maturity is as follows:

 

Group

Company

 

 Issue currency

 

Interest rate

 

Maturity

2012

£m

2011

£m

2012

£m

2011

£m

Euro

0.00% - 3.99%

Up to 2012

-

1,591

-

836

2012 - 2013

4,003

2,889

484

499

2014 - 2019

8,451

8,319

41

40

2020 - 2029

2,631

221

-

-

2030 - 2059

5,974

5,325

-

-

4.00% - 4.99%

2012 - 2013

-

23

-

-

2014 - 2019

1,824

945

-

-

2020 - 2029

2,111

1,948

-

-

2030 - 2039

178

106

-

-

5.00% - 7.99%

2014 - 2019

19

-

-

-

US dollar

0.00% - 3.99%

Up to 2012

-

4,833

2012 - 2013

3,934

592

-

-

2014 - 2019

1,900

1,348

-

-

2020 - 2029

412

456

-

-

2030 - 2039

-

579

-

-

2040 - 2059

7,690

6,579

-

-

4.00% - 5.99%

2014 - 2019

687

712

34

36

2040 - 2059

157

161

-

-

Pounds sterling

0.00% - 3.99%

Up to 2012

-

1,927

-

70

2012 - 2013

3,322

516

-

-

2014 - 2019

1,708

943

-

1

2020 - 2029

395

-

-

-

2040 - 2059

8,148

7,284

-

-

4.00% - 5.99%

2014 - 2019

1,023

1,013

-

-

2020 - 2029

3,455

2,658

-

-

2040 - 2059

535

933

-

-

6.00% - 6.99%

2014 - 2019

86

88

86

88

Other currencies

0.00% - 5.99%

Up to 2012

-

39

-

39

2012 - 2013

245

251

-

-

2014 - 2019

190

194

-

-

2020 - 2029

191

178

-

-

2040 - 2060

256

-

-

-

6.00% - 6.99%

2050 - 2059

96

-

-

-

59,621

52,651

645

1,609

 

34. SUBORDINATED LIABILITIES

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

£325m Sterling Preference Shares

344

344

344

344

£175m Fixed/Floating Rate Tier One Preferred Income Capital Securities

216

216

216

216

US$1,000m Non-Cumulative Trust Preferred Securities

374

1,065

-

-

Undated subordinated liabilities

2,199

2,250

2,199

2,250

Dated subordinated liabilities

648

2,624

1,087

3,754

3,781

6,499

3,846

6,564

 

The securities in this Note will, in the event of the winding-up of the issuer, be subordinated to the claims of depositors and all other creditors of the issuer, other than creditors whose claims rank equally with, or are junior to, the claims of the holders of the subordinated liabilities. The subordination of specific subordinated liabilities is determined in respect of the issuer and any guarantors of that liability. The claims of holders of preference shares and preferred securities are generally junior to those of the holders of undated subordinated liabilities, which in turn are junior to the claims of holders of the dated subordinated liabilities. The subordination of the preference shares and preferred securities ranks equally with that of the £300m fixed/floating rate non-cumulative callable preference shares, £300m Step-up Callable Perpetual Preferred Securities and £300m Step-up Callable Perpetual Reserve Capital Instruments classified as share capital, as described in Note 39.

 

The Santander UK group has not had any defaults of principal, interest or other breaches with respect to its subordinated liabilities during the year (2011: none). No repayment or purchase by the issuer of the subordinated liabilities may be made prior to their stated maturity without the consent of the UK Financial Services Authority.

 

Included in the above balances are amounts owed by the Santander UK group to Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £276m (2011: £919m) and £1,603m (2011: £1,778m) respectively.

 

£325m Sterling Preference Shares

Holders of sterling preference shares are entitled to receive a biannual non-cumulative preferential dividend payable in sterling out of the distributable profits of the Company. The rate per annum will ensure that the sum of the dividend payable on such date and the associated tax credit (as defined in the terms of the sterling preference shares) represents an annual rate of 8 5/8% per annum of the nominal amount of shares issued in 1997, and an annual rate of 10 3/8% for shares issued in 1995 and 1996.

 

On a return of capital or on a distribution of assets on a winding up, the sterling preference shares shall rank pari passu with any other shares that are expressed to rank pari passu therewith as regards participation in assets, and otherwise in priority to any other share capital of the Company. On such a return of capital or winding up, each sterling preference share shall, out of the surplus assets of the Company available for distribution amongst the members after payment of the Company's liabilities, carry the right to receive an amount equal to the amount paid up or credited as paid together with any premium paid on issue and the full amount of any dividend otherwise due for payment. Other than as set out above, no sterling preference share confers any right to participate on a return of capital or a distribution of assets of the Company.

 

Holders of the sterling preference shares are not entitled to receive notice of or attend, speak and vote at general meetings of the Company unless the business of the meeting includes the consideration of a resolution to wind up the Company or any resolution varying, altering or abrogating any of the rights, privileges, limitations or restrictions attached to the sterling preference shares or if the dividend on the sterling preference shares has not been paid in full for the three consecutive dividend periods immediately prior to the relevant general meeting. In any such case, the sterling preference shareholders are entitled to receive notice of and attend the general meeting at which such resolution is proposed and will be entitled to speak and vote on such a resolution but not on any other resolution.

 

£175m Fixed/Floating Rate Tier One Preferred Income Capital Securities

The Tier One Preferred Income Capital Securities were issued on 9 August 2002 by the Company and have no fixed redemption date. The Company has the right to redeem the Tier One Preferred Income Capital Securities whole but not in part on 9 February 2018 or on any coupon payment date thereafter, subject to the prior approval of the UK Financial Services Authority. The Tier One Preferred Income Capital Securities bear interest at a rate of 6.984% per annum, payable semi-annually in arrears. From (and including) 9 February 2018, the Tier One Preferred Income Capital Securities will bear interest, at a rate reset semi-annually of 1.86% per annum above the six-month sterling LIBOR rate, payable semi-annually in arrears. Interest payments may be deferred in limited circumstances, such as when the payment would cause the Company to become insolvent or breach applicable Capital Regulations.

 

The Tier One Preferred Income Capital Securities are not redeemable at the option of the holders and the holders do not have any rights against other Santander UK group companies. Where interest payments have been deferred, the Company may not declare or pay dividends on or redeem or repurchase any junior securities until it next makes a scheduled payment on the Tier One Preferred Income Capital Securities and the Reserve Capital Instruments.

 

The Tier One Preferred Income Capital Securities are unsecured securities of the Company and are subordinated to the claims of unsubordinated creditors and subordinated creditors holding loan capital of the Company. Upon the winding up of the Company, holders of Tier One Preferred Income Capital Securities will rank pari passu with the holders of the most senior class or classes of preference shares (if any) of the Company then in issue and in priority to all other Company shareholders.

 

US$1,000m Non-Cumulative Trust Preferred Securities

Abbey National Capital Trust I and Abbey National Capital LP I are 100% owned finance subsidiaries of the Company. On 7 February 2000, Abbey National Capital Trust I issued US$1bn of 8.963% Non-cumulative Trust Preferred Securities, which have been registered under the US Securities Act of 1933, as amended. Abbey National Capital Trust I serves solely as a passive vehicle holding the partnership preferred securities issued by Abbey National Capital LP I and each has passed all the rights relating to such partnership preferred securities to the holders of trust preferred securities issued by Abbey National Capital Trust I. All of the trust preferred securities and the partnership preferred securities have been fully and unconditionally guaranteed on a subordinated basis by the Company. The terms of the securities do not include any significant restrictions on the ability of the Company to obtain funds, by dividend or loan, from any subsidiary. After 30 June 2030, the distribution rate on the preferred securities will be 2.825% per annum above the three-month US dollar LIBOR rate for the relevant distribution period.

 

The trust preferred securities are not redeemable at the option of the holders and the holders do not have any rights against other Santander UK group companies. There is no fixed redemption date for the partnership preferred securities. The partnership preferred securities may be redeemed by the partnership, in whole or in part, on 30 June 2030 and on each distribution payment date thereafter. Redemption by the partnership of the partnership preferred securities may also occur in the event of a tax or regulatory change. Generally, holders of the preferred securities will have no voting rights.

 

Upon the return of capital or distribution of assets in the event of the winding up of the partnership, holders of the partnership preferred securities will be entitled to receive, for each partnership preferred security, a liquidation preference of US $1,000, together with any due and accrued distributions and any additional amounts, out of the assets of the partnership available for distribution.

 

In July 2012, as part of a capital management exercise, 63% of the trust preferred securities were purchased by the Company pursuant to a tender offer. The gain on these repurchases is disclosed in Note 5.

 

Undated subordinated liabilities

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

10.0625% Exchangeable subordinated capital securities

205

205

205

205

5.56% Subordinated guaranteed notes (Yen 15,000m)

120

145

120

145

5.50% Subordinated guaranteed notes (Yen 5,000m)

40

48

40

48

Fixed/Floating Rate Subordinated notes (Yen 5,000m)

40

48

40

48

10 Year step-up perpetual callable subordinated notes

340

336

340

336

7.50% 15 Year step-up perpetual callable subordinated notes

499

513

499

513

7.375% 20 Year step-up perpetual callable subordinated notes

239

235

239

235

7.125% 30 Year step-up perpetual callable subordinated notes

391

385

391

385

Fixed to floating rate perpetual callable subordinated notes

325

335

325

335

2,199

2,250

2,199

2,250

 

The 10.0625% exchangeable subordinated capital securities are exchangeable into fully paid 10.375% non-cumulative non-redeemable sterling preference shares of £1 each, at the option of the Company. Exchange may take place on any interest payment date providing that between 30 and 60 days notice has been given to the holders. The holders will receive one new sterling preference share for each £1 principal amount of capital securities held.

 

The 5.56% Subordinated guaranteed notes are redeemable at par, at the option of the Company, on 31 January 2015 and each fifth anniversary thereafter.

 

The 5.50% Subordinated guaranteed notes are redeemable at par, at the option of the Company, on 27 June 2015 and each fifth anniversary thereafter.

 

The Fixed/Floating Rate Subordinated notes are redeemable at par, at the option of the Company, on 27 December 2016 and each interest payment date (quarterly) thereafter.

 

The 10 Year step-up perpetual callable subordinated notes are redeemable at par, at the option of the Company, on 28 September 2010 and each fifth anniversary thereafter. The Company did not exercise its option to call the notes on 28 September 2010. The coupon payable on the notes is 4.8138% from 28 September 2010 to 28 September 2015.

 

The 7.50% 15 Year step-up perpetual callable subordinated notes are redeemable at par, at the option of the Company, on 28 September 2015 and each fifth anniversary thereafter.

 

The 7.375% 20 Year step-up perpetual callable subordinated notes are redeemable at par, at the option of the Company, on 28 September 2020 and each fifth anniversary thereafter.

 

The 7.125% 30 Year step-up perpetual callable subordinated notes are redeemable at par, at the option of the Company, on 30 September 2030 and each fifth anniversary thereafter.

 

The Fixed to Floating rate perpetual callable subordinated notes are redeemable at par, at the option of the Company, on 28 September 2010 and each interest payment date thereafter. The Company did not exercise its options to call the notes during the year.

 

In common with other debt securities issued by Santander UK group companies, the undated subordinated liabilities are redeemable in whole at the option of the Company, on any interest payment date, in the event of certain tax changes affecting the treatment of payments of interest on the subordinated liabilities in the UK, at their principal amount together with any accrued interest.

 

Dated subordinated liabilities

Group

Company

2012

£m

2011

£m

2012

£m

2011

£m

10.125% Subordinated guaranteed bond 2023

110

231

110

231

11.50% Subordinated guaranteed bond 2017

78

230

78

230

7.95% Subordinated notes 2029 (US$1,000m)

256

1,038

256

1,038

6.50% Subordinated notes 2030

42

213

42

213

Subordinated notes 2030 (US$1,000m)

-

-

374

1,065

Subordinated floating rate EURIBOR notes 2016

-

-

65

65

5.875% Subordinated notes 2031

10

127

10

127

5.25% Subordinated notes 2023

-

148

-

148

Subordinated floating rate EURIBOR notes 2017

-

125

-

125

Subordinated floating rate EURIBOR notes 2017

-

84

-

84

9.625% Subordinated notes 2023

152

428

152

428

648

2,624

1,087

3,754

 

The subordinated floating rate notes pay a rate of interest related to the LIBOR of the currency of denomination.

 

The dated subordinated liabilities are redeemable in whole at the option of the Company, on any interest payment date, in the event of certain tax changes affecting the treatment of payments of interest on the subordinated liabilities in the UK, at their principal amount together with any accrued interest.

 

In July 2012, as part of a capital management exercise, all of the outstanding Subordinated Floating Rate EURIBOR Notes 2017, 99% of the 5.25% Subordinated Notes 2023, and 99.5% of the Subordinated Floating Rate EURIBOR Notes 2017, 65% of the 11.50% Subordinated guaranteed bond 2017, 74% of the 7.95% Subordinated notes 2029 (US$1,000m), 80% of the 6.50% Subordinated notes 2030, 93% of the 5.875% Subordinated notes 2031, 51% of the 10.125% Subordinated guaranteed bond 2023 and 65% of the 9.625% Subordinated notes 2023 were purchased by the Company pursuant to a tender offer. The gain on these repurchases is disclosed in Note 5.

 

Subordinated liabilities are repayable:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

In more than 1 year but no more than 5 years

78

-

78

-

In more than 5 years

570

2,624

1,009

3,754

Undated

3,133

3,875

2,759

2,810

3,781

6,499

3,846

6,564

 

 

35. OTHER LIABILITIES

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Trade and other payables

1,711

1,815

1,570

1,624

Accrued expenses

795

706

566

495

Deferred income

20

50

3

2

2,526

2,571

2,139

2,121

 

Included in the above balances are amounts owed by the Santander UK group to Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £352m (2011: £337m) and £110m (2011: £127m) respectively.

 

Finance lease obligations

Trade and other payables for the Santander UK group and the Company include £29m (2011: £38m) and £nil (2011: £nil), respectively, of finance lease obligations mainly relating to a lease and leaseback of Santander UK group property.

 

2012

Group

Company

Future minimum payments

Future interest charges

Present value of minimum lease payments

Future minimum payments

Future interest charges

Present value of minimum lease payments

Leases which expire

£m

£m

£m

£m

£m

£m

Within 1 year

7

(2)

5

-

-

-

Between 1-5 years

27

(3)

24

-

-

-

34

(5)

29

-

-

-

 

2011

Group

Company

Future minimum payments

Future interest charges

Present value of minimum lease payments

Future minimum payments

Future interest

charges

Present value of minimum lease payments

Leases which expire

£m

£m

£m

£m

£m

£m

Within 1 year

8

(2)

6

-

-

-

Between 1-5 years

31

(4)

27

-

-

-

In more than 5 years

6

(1)

5

-

-

-

45

(7)

38

-

-

-

 

During the year, £2m (2011: £3m) was incurred as a finance lease interest charge. The contingent rent expense recognised during the year was £nil (2011: £nil).

 

At the balance sheet date, the Santander UK group had contracted with lessees for future minimum lease payments expected to be received on non-cancellable sub-leases of £nil (2011: £4m).

 

 

36. PROVISIONS

 

Group

Conduct remediation(1)

£m

Other(2)

£m

Total

£m

At 1 January 2012

747

223

970

Additional provisions

232

214

446

Provisions released

-

(7)

(7)

Used during the year

(320)

(175)

(495)

At 31 December 2012

659

255

914

 

To be settled:

Within 12 months

400

169

569

In more than 12 months

259

86

345

659

255

914

(1) Includes a provision of £382m in respect of payment protection insurance at 31 December 2012 (2011: £688m).

(2) Includes regulatory-related provisions of £185m in respect of the FSCS and the UK Bank Levy at 31 December 2012 (2011: £176m).

 

Group

Conduct remediation(1)

£m

Other(2)

£m

Total

£m

At 1 January 2011

139

46

185

Additional provisions

753

176

929

Provisions released

-

(12)

(12)

Used during the year

(145)

(33)

(178)

Reclassifications

-

46

46

At 31 December 2011

747

223

970

 

To be settled:

Within 12 months

231

170

401

In more than 12 months

516

53

569

747

223

970

(1) Includes a provision of £688m in respect of payment protection insurance at 31 December 2011.

(2) Includes regulatory-related provisions of £176m in respect of the FSCS and the UK Bank Levy at 31 December 2011.

 

 

Company

Conduct remediation

£m

Other

£m

Total

£m

At 1 January 2012

730

182

912

Additional provisions

228

185

413

Provisions released

-

-

-

Used during the year

(312)

(154)

(466)

At 31 December 2012

646

213

859

 

To be settled:

Within 12 months

392

123

515

In more than 12 months

254

90

344

646

213

859

 

Company

Conduct

remediation

£m

 

Other

£m

 

Total

£m

At 1 January 2011

124

32

156

Additional provisions

749

142

891

Provisions released

-

(4)

(4)

Used during the year

(143)

(34)

(177)

Reclassifications

-

46

46

At 31 December 2011

730

182

912

 

To be settled:

Within 12 months

226

139

365

In more than 12 months

504

43

547

730

182

912

 

The charge disclosed in the income statement in respect of provisions for other liabilities and charges of £439m (2011: £917m), comprises the additional provisions of £446m (2011: £929m), less the provisions released of £7m (2011: £12m) in the table above. Provisions principally comprise amounts in respect of conduct remediation, regulatory-related provisions, litigation and related expenses, restructuring expenses and vacant property costs.

 

Conduct remediation including Payment Protection Insurance ('PPI'), other retail products and interest rate swaps sold to corporate customers

The amounts in respect of customer remediation comprise the estimated cost of making redress payments with respect to the past sales of products. In calculating the customer remediation provision, management's best estimate of the provision was calculated based on conclusions regarding the number of claims, of those, the number that will be upheld, and the estimated average settlement per case. Sensitivities relating to the provision for customer remediation can be found in "Critical Accounting Policies and Areas of Significant Management Judgement" in Note 1.

 

Payment protection insurance is an insurance product offering payment protection on unsecured personal loans (and credit cards). The nature and profitability of the product has changed materially since 2008, in part due to customer and regulatory pressure. The product was sold by UK banks - the mis-selling issues are predominantly related to business written before 2009.

 

On 1 July 2008, the UK Financial Ombudsman Service ('FOS') referred concerns regarding the handling of PPI complaints to the UK Financial Services Authority ('FSA') as an issue of wider implication. On 29 September 2009 and 9 March 2010, the FSA issued consultation papers on PPI complaints handling. The FSA published its Policy Statement on 10 August 2010, setting out evidential provisions and guidance on the fair assessment of a complaint and the calculation of redress, as well as a requirement for firms to reassess historically rejected complaints which had to be implemented by 1 December 2010.

 

On 8 October 2010, the British Bankers' Association ('BBA'), the principal trade association for the UK banking and financial services sector, filed an application for permission to seek judicial review against the FSA and the FOS. The BBA sought an order quashing the FSA Policy Statement and an order quashing the decision of the FOS to determine PPI sales in accordance with the guidance published on its website in November 2008. The judicial review was heard in January 2011 and on 20 April 2011 judgement was handed down by the High Court dismissing the BBA's application.

 

Santander UK did not participate in the legal action undertaken by other UK banks and has been consistently making a provision and settling claims with regards to PPI complaints liabilities since they began to increase in recent years. However, a detailed review of the provision was performed in the first half of 2011 in light of prevailing conditions, including the High Court ruling in April 2011, the BBA's subsequent decision not to appeal it and the consequent increase in actual claims levels. As a result, the provision was revised to reflect the new information. The overall effect of the above was a substantial increase in the provision requirement for 2011.

 

The provision represents management's best estimate of the anticipated costs of related customer contact and/or redress, including administration expenses. The provision is calculated based on a number of key assumptions which involve significant management judgement. These are as follows:

 

Claim volumes - the estimated number of customer complaints received,

Uphold rate - the estimated percentage of complaints that are, or will be, upheld in favour of the customer, and

Average cost of redress - the estimated payment to customers, including compensation for any direct loss plus interest.

 

The assumptions have been based on the following:

 

Analysis completed of the causes of complaints, and uphold rates, and how these are likely to vary in the future,

Actual claims activity registered to date,

The level of redress paid to customers, together with a forecast of how this is likely to change over time,

The impact on complaints levels of proactive customer contact, and

The effect of media coverage on the issue.

 

The assumptions are kept under review, and regularly reassessed and validated against actual customer data, e.g. claims received, uphold rates, the impact of any changes in approach to uphold rates etc, and any re-evaluation of the estimated population.

 

The most critical factor in determining the level of provision is the volume of claims. The uphold rate is a reasonably consistent function of the sales process and the average cost of redress can be predicted reasonably accurately given that management is dealing with a high volume and reasonably homogeneous population. In setting the provision, management estimated the total claims that were likely to be received. Previous experience has indicated that claims could be received over a number of years. While initial claim levels at the beginning of the process were quite low, this has increased in line with our initial expectations as a result of press coverage and the activities of the claims management companies ("CMC's"). The CMC's facilitate customer claims in return for a share of the redress payment and advertise heavily thereby resulting in an increase in the volume of claims experienced.

 

The table below sets out the actual claims received to date.

 

Number of PPI claims outstanding

 

Movements in the number of PPI claims outstanding during the years ended 31 December 2012, 2011 and 2010 were as follows:

 

2012

'000

2011

'000

2010

'000

Outstanding at 1 January

1

-

2

Claims received

437

111

37

Claims paid (1)

(258)

(90)

(38)

Claims rejected as invalid (1)

(149)

(20)

(1)

Outstanding at 31 December

30

1

-

(1) The customer has the right to appeal to the Financial Ombudsman Service ('FOS') if their claim is rejected. FOS may uphold or reject the appeal and if upheld Santander UK is required to provide redress to the customer. Claims paid or rejected above reflect the results of any appeals.

 

2012 compared with 2011

As anticipated, PPI complaints rose significantly in 2012, due to higher press coverage and increased focus by CMCs. The increase was partly driven by invalid complaints (which also drove an increase in the level of claims rejected) and claims originated by CMCs. In addition, Santander UK proactively contacted more than 300,000 customers during the year, which led to an increase in claims received. The number of claims settled in 2012 increased, reflecting both the increase in claims received and continued prompt settlement of claims.

 

2011 compared with 2010

Press coverage on PPI reached significant levels in 2011, following the High Court's dismissal of the BBA's application for a judicial review, as highlighted above. The focus of the CMCs also started to be directed at PPI in 2011. This led to a marked increase in complaints in 2011. Complaint volumes were also driven by pro-active customer contact made by Santander UK. The number of claims settled in 2011 increased as well, reflecting both the increase in claims received and prompt settlement of claims.

 

Management reassess the level of provision required at each reporting period, taking account of the latest available information as well as past experience. The provision necessarily incorporates predictions of complaint levels for a number of periods into the future. Although complaint levels rose substantially in 2012, this increase was consistent with management's estimates which reflected previous conduct remediation experience. Consequently, no change to the provision was required in 2012. This will continue to be kept under review.

 

The assumptions and consequent level of provision remain subjective. This relates particularly to the uncertainty associated with the level of future claims. It is therefore possible that the level of payments to be made may differ from current estimates, resulting in an increase or decrease to the required provision.

 

The Santander UK group engages in discussion, and co-operates, with the FSA in its supervision of the Santander UK group, including reviews exercised under statutory powers, regarding its interaction with past and present customers and policyholders, both as part of the FSA's general thematic work and in relation to specific products and services, including payment protection insurance. As a consequence of these reviews, and reviews concluded in respect of retail products and interest rate derivatives sold to corporate customers, a net provision of £232m has been recognised for customer conduct issues in 2012. This position will be monitored with particular reference to those reviews currently in progress where it is not yet possible to reliably determine their outcome.

 

Financial Services Compensation Scheme ('FSCS')

The FSCS is the UK's independent statutory compensation fund for customers of authorised financial services firms and pays compensation if a firm is unable to pay claims against it. The FSCS is funded by levies on the industry (and recoveries and borrowings where appropriate). The levies raised comprise both management expenses levies and, where necessary, compensation levies on authorised firms.

 

Following the default of a number of deposit takers since 2008, the FSCS borrowed funds from HM Treasury to meet the compensation costs for customers of those firms. The borrowings with HM Treasury, which total approximately £18bn, were on an interest-only basis until 31 March 2012 and, with effect from 1 April 2012, the interest on the borrowings will increase to 12 month LIBOR plus 100 basis points. Each deposit-taking institution contributes towards the management expenses levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year, which runs from 1 April to 31 March. In determining an appropriate accrual in respect of the management expenses levy, certain assumptions have been made including the proportion of total protected deposits held by the Santander UK group.

 

Whilst it is expected that the substantial majority of the principal will be repaid from funds the FSCS receives from asset sales, surplus cash flow or other recoveries in relation to the assets of the firms that defaulted, to the extent that there remains a shortfall, the FSCS expects to recover any shortfall of the principal by levying the deposit-taking sector in three approximately equal instalments beginning in scheme year 2013/14. The FSCS and HM Treasury have agreed that the terms of the repayment of the borrowings will be reviewed every three years in light of market conditions and of the actual repayment from the estates of failed banks. The ultimate amount of any compensation levies to be charged in future years also depends on a number of factors including the level of protected deposits and the population of deposit-taking participants and will be determined at a later date.

 

For the year ended 31 December 2012, the Santander UK group charged £50m (2011: £108m) to the income statement in respect of the costs of the FSCS. The 2012 charge is net of payments made in relation to prior years and adjustments to provisions made in prior years as a result of more accurate information now being available.

 

In accordance with IFRS, the FSCS levy is not accrued over each year but is recognised on 31 December of each year.

 

UK Bank Levy

The Finance Act 2011 introduced an annual bank levy in the UK which is collected through the existing quarterly Corporation Tax collection mechanism. The first chargeable period for the Santander UK group was the year ended 31 December 2011.

 

The UK Bank Levy is based on the total chargeable equity and liabilities as reported in the balance sheet at the end of a chargeable period. In determining the chargeable equity and liabilities the following amounts are excluded: adjusted Tier 1 capital; certain "protected deposits" (for example those protected under the FSCS); liabilities that arise from certain insurance business within banking groups; liabilities in respect of currency notes in circulation; FSCS liabilities; liabilities representing segregated client money; and deferred tax liabilities, current tax liabilities, liabilities in respect of the UK Bank Levy, revaluation of property liabilities, liabilities representing the revaluation of business premises and defined benefit retirement liabilities.

 

It is also permitted in specified circumstances to reduce certain liabilities: by netting them against certain assets; offsetting assets on the relevant balance sheets that would qualify as high quality liquid assets (in accordance with the FSA definition); and repo liabilities secured against sovereign and supranational debt.

 

The UK Bank Levy will be set at a rate of 0.130% from 2013. During 2012 a rate of 0.088% was applied and three different rates applied during 2011 which averaged to 0.075%. Certain liabilities are subject to only a half rate, namely any deposits not otherwise excluded, (except for those from financial institutions and financial traders) and liabilities with a maturity greater than one year at the balance sheet date. The UK Bank Levy is not charged on the first £20bn of chargeable liabilities.

 

The cost of the UK Bank Levy to the Santander UK group for 2012 was £48m (2011: £48m). The Santander UK group paid £49m in 2012 (2011: £26m) and provided for a liability of £21m at 31 December 2012 (2011: £22m).

 

In accordance with IFRS, the UK Bank Levy is not accrued over each year but is recognised on 31 December of each year.

 

37. RETIREMENT BENEFIT ASSETS AND OBLIGATIONS

 

The amounts recognised in the balance sheet were as follows:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Assets/(liabilities)

Funded defined benefit pension scheme

254

241

250

237

Funded defined benefit pension scheme

(266)

(180)

(266)

(180)

Unfunded defined benefit pension scheme

(39)

(36)

(39)

(36)

Total net (liabilities)/assets

(51)

25

(55)

21

 

Actuarial losses recognised in other comprehensive income during the year were as follows:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Actuarial losses on defined benefit schemes

183

37

183

54

 

a) Defined Contribution pension schemes

The Santander UK group operates a number of defined contribution pension schemes. The assets of the defined contribution pension schemes are held and administered separately from those of the Company. The Santander Retirement Plan, an occupational defined contribution scheme, is the plan into which eligible employees are enrolled automatically. The assets of the Santander Retirement Plan are held in separate trustee-administered funds. The defined contribution section of the Alliance & Leicester Pension Scheme was closed to new members employed from 29 May 2010, and was merged on a segregated basis with the Santander UK Group Pension Scheme on 1 July 2012.

 

An expense of £35m (2011: £30m, 2010: £42m) was recognised for defined contribution plans in the year, and is included in staff costs classified within administration expenses in the Income Statement. None of this amount was recognised in respect of key management personnel for the years ended 31 December 2012, 2011 and 2010.

 

b) Defined Benefit pension schemes

The Santander UK group operates a number of defined benefit pension schemes. The main pension scheme is the Santander UK Group Pension Scheme, formerly the Abbey National Group Pension scheme. The Abbey National Amalgamated Pension Fund, Abbey National Associated Bodies Pension Fund, the National & Provincial Building Society Pension Fund, the Scottish Mutual Assurance Staff Pension Scheme, the Scottish Provident Institution Staff Pension Fund and the Alliance & Leicester Pension Scheme were merged into the Santander UK Group Pension scheme on a segregated basis on 1 July 2012.

 

The scheme covers 20% (2011: 20%, 2010: 20%) of the Santander UK group's employees, and is a closed funded defined benefit scheme. Under the projected unit method, the current service cost when expressed as a percentage of pensionable salaries will gradually increase over time.

 

Formal actuarial valuations of the assets and liabilities of the defined benefit schemes are carried out on at least a triennial basis by independent professionally qualified actuaries and valued for accounting purposes at each balance sheet date. The latest formal actuarial valuation for the Santander UK Group Pension scheme was made as at 31 March 2010, with the next valuation due as at 31 March 2013.

 

The total amount (credited)/charged to the income statement, including amounts classified as redundancy costs was as follows:

Group

 

 

2012

£m

2011

£m

2010

£m

Expected return on pension scheme assets

(350)

(388)

(317)

Interest cost

346

362

357

Current service cost

38

34

35

Past service cost

-

1

5

Gain on settlements or curtailments

-

(1)

-

34

8

80

 

The net (liability)/asset recognised in the balance sheet is determined as follows:

 

Group

2012

£m

2011

£m

2010

£m

2009

£m

2008

£m

Present value of defined benefit obligation

(7,554)

(7,072)

(6,729)

(6,318)

(5,185)

Fair value of plan assets

7,503

7,097

6,556

5,248

4,372

Net defined benefit (obligation)/asset

(51)

25

(173)

(1,070)

(813)

 

 

Company

2012

£m

2011

£m

2010

£m

2009

£m

2008

£m

Present value of defined benefit obligation

(7,542)

(7,061)

(6,718)

(4,805)

(3,944)

Fair value of plan assets

7,487

7,082

6,541

3,883

3,147

Net defined benefit (obligation)/asset

(55)

21

(177)

(922)

(797)

 

Movements in the present value of defined benefit obligations during the year were as follows:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Balance at 1 January

(7,072)

(6,729)

(7,061)

(6,718)

Current service cost

(27)

(22)

(26)

(22)

Current service cost paid by subsidiaries

(2)

(2)

(2)

(3)

Current service cost paid by fellow Banco Santander group subsidiaries

(9)

(10)

(10)

(9)

Interest cost

(346)

(362)

(345)

(361)

Employee contributions

(7)

(3)

(7)

(3)

Employer salary sacrifice contributions

-

(4)

-

(4)

Past service cost

-

(1)

-

(1)

Settlement

-

1

-

1

Actuarial loss

(300)

(144)

(300)

(145)

Actual benefit payments

209

204

209

204

Balance at 31 December

(7,554)

(7,072)

(7,542)

(7,061)

 

Movements in the fair value of scheme assets during the year were as follows:

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Balance at 1 January

7,097

6,556

7,082

6,541

Expected return on scheme assets

350

388

349

388

Actuarial gain on scheme assets

117

105

117

105

Company contributions paid

129

237

129

237

Contributions paid by subsidiaries and fellow Banco Santander group subsidiaries

12

12

12

12

Employee contributions

7

3

7

3

Actual benefit payments

(209)

(204)

(209)

(204)

Balance at 31 December

7,503

7,097

7,487

7,082

 

The amounts recognised in the Statement of Comprehensive Income for each of the five years indicated were as follows:

 

Group

 

 

2012

£m

2011

£m

2010

£m

2009

£m

2008

£m

Actuarial (gain)/loss on scheme assets

(117)

(105)

(235)

(330)

862

Experience (gain)/loss on scheme liabilities

(28)

138

(76)

(34)

51

Loss/(gain) from changes in actuarial assumptions

328

6

283

969

(869)

Actuarial loss/(gain) on scheme liabilities

300

144

207

935

(818)

Total net actuarial loss/(gain)

183

39

(28)

605

44

 

Cumulative net actuarial losses are £963m (2011: £780m, 2010: £741m). The annual movement is recognised in the Consolidated Statement of Comprehensive Income. The actual gains on scheme assets for the Santander UK group and the Company were £467m (2011: £493m, 2010: £552m) and £466m (2011: £493m, 2010: £547m), respectively.

 

The Santander UK group's pension schemes did not directly hold any equity securities of the Company or any of its related parties at 31 December 2012, 2011 and 2010. The Santander UK group's pension scheme assets do not include any property or other assets that are occupied or used by the Santander UK group. In addition, the Santander UK group does not hold insurance policies over the schemes, and has not entered into any significant transactions with the schemes.

 

The assets of the funded plans are held independently of the Santander UK group's assets in separate trustee administered funds. The principal duty of the trustees is to act in the best interests of the members of the schemes. The corporate trustee of the Santander UK Group Pension Scheme is Santander (UK) Group Pension Scheme Trustee Limited, a private limited company incorporated in 1996 and a wholly-owned subsidiary of Santander UK plc. The Trustee board comprises seven Directors selected by Santander UK plc, plus seven member-nominated Directors selected from eligible members who apply for the role.

 

Investment strategy across the schemes remains under regular review. Investment decisions are delegated by the Santander (UK) Group Pension Scheme Trustees to a common investment fund, managed by Santander (CF) Trustee Limited, a private limited company owned by seven Trustee directors, four appointed by Santander UK plc and three by Santander (UK) Group Pension Trustee Limited. The Trustee directors' principal duty, within the investment powers delegated to them is to act in the best interest of the members of the Santander UK Group Pension Scheme. Ultimate responsibility for investment strategy rests with the Trustees of the schemes who are required under the Pensions Act 2004 to prepare a statement of investment principles.

 

The Trustees of the Santander UK Group Pension Scheme have developed the following investment principles:

 

To maintain a portfolio of suitable assets of appropriate quality, suitability and liquidity which will generate income and capital growth to meet, together with new contributions from members and the employers, the cost of current and future benefits which the pension scheme provides, as set out in the trust deed and rules;

To limit the risk of the assets failing to meet the liabilities, over the long term and on a shorter-term basis as required by prevailing legislation; and

To minimise the long-term costs of the pension scheme by maximising the return on the assets whilst having regard to the objectives shown above.

 

The categories of the assets in the scheme by value and as a percentage of scheme assets, and the expected rates of return were:

 

Group

Fair value of scheme assets

Expected rate

 of return

Fair value of scheme assets

Expected rate of return

 

 

2012

£m

2012

%

2012

%

2011

£m

2011

%

2011

%

UK equities

579

8

7

631

9

8

Overseas equities

1,434

19

8

1,480

21

8

Corporate bonds

1,878

25

4

1,519

21

5

Government fixed interest bonds

473

6

3

730

10

4

Government index linked bonds

1,843

25

3

1,544

22

4

Property funds

208

3

7

137

2

6

Cash

717

9

2

663

9

4

Other assets

371

5

7

393

6

8

7,503

100

7,097

100

 

 Company

Fair value of scheme assets

Expected rate

 of return

Fair value of scheme assets

Expected rate of return

 

 

2012

£m

2012

%

2012

%

2011

£m

2011

%

2011

%

UK equities

575

8

7

629

9

8

Overseas equities

1,432

19

8

1,478

21

8

Corporate bonds

1,875

25

4

1,516

21

5

Government fixed interest bonds

471

6

3

728

10

4

Government index linked bonds

1,843

25

3

1,544

22

4

Property funds

208

3

7

137

2

6

Cash

717

9

2

662

9

4

Other assets

366

5

7

388

6

8

7,487

100

7,082

100

 

Other assets consist of asset-backed securities, annuities, funds (including private equity funds) and derivatives that are used to protect against exchange rate, equity market, inflation and interest rate movements.

 

The expected return on plan assets is determined by considering the expected returns available on the assets underlying the current investment policy, as follows:

 

Equities

Long-term median real rate of return experienced after considering projected moves in asset indices

Corporate bonds

Gross redemption yields at the balance sheet date, less a margin for default risk

Government bonds

Gross redemption yields at the balance sheet date

Property funds

Average of returns for UK equities and government bonds

Cash

Expected long-term bank rate, after considering projected inflation rate

 

The following tables summarise the fair values at 31 December 2012 and 2011 of the financial asset classes accounted for at fair value, by the valuation methodology used by the investment managers of the schemes assets to determine their fair value. The tables also disclose the percentages that the recorded fair values of financial assets represent of the schemes total financial assets that are recorded at fair value.

 

At 31 December 2012

Group

 

Quoted prices in active markets

Prices not quoted in active markets

 

Total

Category of plan assets

£m

%

£m

%

£m

%

UK equities

579

8

-

-

579

8

Overseas equities

1,434

21

-

-

1,434

21

Corporate bonds

1,878

28

-

-

1,878

28

Government fixed interest bonds

473

7

-

-

473

7

Government index linked bonds

1,843

27

-

-

1,843

27

Property funds

-

-

208

3

208

3

Other

188

3

183

3

371

6

Total

6,395

94

391

6

6,786

100

 

 

At 31 December 2011

Group

 

Quoted prices in active markets

Prices not quoted in active markets

 

Total

Category of plan assets

£m

%

£m

%

£m

%

UK equities

614

10

17

-

631

10

Overseas equities

1,480

23

-

-

1,480

23

Corporate bonds

1,519

24

-

-

1,519

24

Government fixed interest bonds

730

11

-

-

730

11

Government index linked bonds

1,544

24

-

-

1,544

24

Property funds

-

-

137

2

137

2

Other

378

6

15

-

393

6

Total

6,265

98

169

2

6,434

100

 

At 31 December 2012

Company

 

Quoted prices in active markets

Prices not quoted in active markets

 

Total

Category of plan assets

£m

%

£m

%

£m

%

UK equities

575

8

-

-

575

8

Overseas equities

1,432

21

-

-

1,432

21

Corporate bonds

1,875

28

-

-

1,875

28

Government Fixed Interest

471

7

-

-

471

7

Government Index Linked

1,843

27

-

-

1,843

27

Property funds

-

-

208

3

208

3

Other

183

3

183

3

366

6

Total

6,379

94

391

6

6,770

100

 

At 31 December 2011

Company

 

Quoted prices in active markets

Prices not quoted in active markets

 

Total

Category of plan assets

£m

%

£m

%

£m

%

UK equities

612

10

17

-

629

10

Overseas equities

1,478

23

-

-

1,478

23

Corporate bonds

1,516

24

-

-

1,516

24

Government Fixed Interest

728

11

-

-

728

11

Government Index Linked

1,544

24

-

-

1,544

24

Property funds

-

-

137

2

137

2

Other

378

6

10

-

388

6

Total

6,256

98

164

2

6,420

100

 

Plan assets are stated at fair value based upon quoted prices in active markets with the exception of property funds and those classified under "Other". The property funds were valued using market valuations prepared by an independent expert. Of the assets in the "Other" category, investments in absolute return funds and foreign exchange, equity and interest rate derivatives were valued by investment managers by reference to market observable data. Private equity funds were valued by reference to their latest published accounts whilst the insured annuities were valued by scheme actuaries based on the liabilities insured.

 

Actuarial assumptions

The principal actuarial assumptions used for the defined benefit schemes were as follows:

 

 

 

Group and Company

2012

%

2011

%

2010

%

To determine benefit obligations:

- Discount rate for scheme liabilities

4.5

5.0

5.4

- General price inflation

2.9

3.1

3.5

- General salary increase

2.9

3.1

3.5

- Expected rate of pension increase

2.8

3.0

3.4

To determine net periodic benefit cost:

- Discount rate

5.0

5.4

5.8

- Expected rate of pension increase

3.0

3.4

3.4

- Expected rate of return on plan assets

5.0

5.7

6.1

 

Years

Years

Years

Longevity at 60 for current pensioners, on the valuation date:

- Males

28.9

28.8

28.7

- Females

29.5

29.4

29.3

Longevity at 60 for future pensioners currently aged 40, on the valuation date:

- Males

31.3

31.1

31.0

- Females

31.1

31.0

30.9

 

The rate used to discount the retirement benefit obligation is determined to reflect duration of the liabilities based on the annual yield at 31 December of the sterling 15+ year AA Corporate Bond iBoxx Index, representing the market yield of high quality corporate bonds on that date, adjusted to match the terms of the scheme liabilities. The inflation assumption is set based on the Bank of England projected inflation rates over the duration of scheme liabilities weighted by projected scheme cash flows.

 

In 2012, the mortality assumption used in the preparation of the valuation was based on the Continuous Mortality Investigation Table S1 Light with a future improvement underpin of 1.5% for males and 1% for females (2011 and 2010: Continuous Mortality Investigation Table PXA 92MCC 2009 with a future improvement underpin of 1.5% for males and 1% for females). The table above shows that a participant retiring at age 60 at 31 December 2012 is assumed to live for, on average, 28.9 years in the case of a male and 29.5 years in the case of a female. In practice, there will be variation between individual members but these assumptions are expected to be appropriate across all participants. It is assumed that younger members will live longer in retirement than those retiring now. This reflects the expectation that mortality rates will continue to fall over time as medical science and standards of living improve. To illustrate the degree of improvement assumed the table also shows the life expectancy for members aged 40 now, when they retire in 20 years' time at age 60.

 

The Santander UK group determined its expense measurements above based upon long-term assumptions taking into account target asset allocations of assets set at the beginning of the period, offset by actual returns during the period. Period-end obligation measurements are determined by reference to market conditions at the balance sheet date. Assumptions are set in consultation with third party advisors and in-house expertise.

 

Actuarial assumption sensitivities

 

The discount rate is sensitive to changes in market conditions arising during the reporting period. The mortality rates used are sensitive to experience from the plan member profile. The following table shows the potential effect of changes in these and the other key assumptions on the principal pension schemes of the Santander UK group:

 

Increase/(decrease)

 

 

2012

£m

2011

£m

Discount rate

Change in pension obligation at year end from a 25 bps increase

(362)

(365)

Change in pension cost for the year from a 25 bps increase

-

(4)

General price inflation

Change in pension obligation at year end from a 25 bps increase

343

332

Change in pension cost for the year from a 25 bps increase

18

20

Expected rate of return on plan assets

Change in pension cost for the year from a 25 bps increase

18

18

Mortality

Change in pension obligation at year end from each additional year of longevity assumed

184

242

 

The benefits expected to be paid in each of the next five years, and in the aggregate for the five years thereafter are:

 

Year ending 31 December:

£m

2013

223

2014

238

2015

254

2016

271

2017

290

Five years ended 2022

1,780

 

 

Funding

In 2010, in compliance with the Pensions Act 2004, the Santander UK group and the trustees agreed a scheme-specific funding target, statement of funding principles, and a schedule of contributions for the principal pension schemes. This agreement forms the basis of the Santander UK group's commitment that the schemes have sufficient assets to make payments to members in respect of their accrued benefits as and when they fall due. In accordance with the terms of the agreement, the Santander UK group contributed £95m (2011: £209m) to the schemes in the year. The agreed schedule of the Santander UK group's remaining contributions to the schemes comprises contributions of £64m in 2013, £64m in 2014, and £70m each year from 2015 to 2019.

 

 

38. CONTINGENT LIABILITIES AND COMMITMENTS

 

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Guarantees given to subsidiaries

-

-

109,888

118,714

Guarantees given to third parties

857

553

338

79

Formal standby facilities, credit lines and other commitments with original term to maturity of:

- One year or less

4,211

3,841

2,740

2,666

- More than one year

32,727

29,153

7,537

6,206

Other contingent liabilities

8

8

8

8

37,803

33,555

120,511

127,673

 

4liability may arise when the representations and warranties are breached. In the event of a breach of these representations and warranties, the Santander UK group may be required to either repurchase the mortgage loans (generally at unpaid principal balance plus accrued interest) with the identified defects or reduce its share in the trust holding the mortgage loans by an amount equivalent to the repurchase price. In the case of a repurchase, the Santander UK group may bear any subsequent credit loss on the mortgage loan. The Santander UK group manages and monitors its securitisation activities closely to minimise potential claims. To date, the Santander UK group has only identified a small number of non-compliant mortgage loans in its securitisation transactions.

 

Overseas tax claim

A claim was filed against Abbey National Treasury Services plc by tax authorities abroad in relation to the refund of certain tax credits and other associated amounts. A favourable judgement at first instance was handed down in September 2006, although the judgement was appealed against by the tax authorities in January 2007 and the court found in favour of the latter in June 2010. Abbey National Treasury Services plc appealed against this decision at a higher court and in December 2011 the tax authorities confirmed their intention to file the related pleadings. Although the matter remained in dispute, in January 2012, following a demand from the tax authorities, Abbey National Treasury Services plc paid £67m, for which it already held a provision. The higher court hearing took place in April 2012 and the judgement found in favour of the tax authorities upholding their appeal. There is no recourse for further appeal.

 

Regulatory

The Santander UK group engages in discussion, and co-operates, with the FSA in its supervision of the Santander UK group, including reviews exercised under statutory powers, regarding its interaction with past and present customers and policyholders, both as part of the FSA's general thematic work and in relation to specific products and services, including payment protection insurance. As a consequence of these reviews, a net provision of £232m has been recognised for customer conduct issues, as described in Note 36. This position will be monitored with particular reference to those reviews currently in progress where it is not yet possible to reliably determine their outcome.

 

Other

As part of the sale of subsidiaries, and as is normal in such circumstances, the Santander UK group has given warranties and indemnities to the purchasers.

 

Obligations under stock borrowing and lending agreements

Obligations under stock borrowing and lending agreements represent contractual commitments to return stock borrowed. These obligations are offset by a contractual right to receive stock under other contractual agreements. See Note 41.

 

Other off-balance sheet commitments

The Santander UK group has commitments to lend at fixed interest rates which expose it to interest rate risk. For further information, see the Risk Management Report.

 

Operating lease commitments

Group

Company

 

 

2012

£m

2011

£m

2012

£m

2011

£m

Rental commitments under non-cancellable operating leases:

- No later than 1 year

87

83

77

73

- Later than 1 year but no later than 5 years

291

255

255

232

- Later than 5 years

257

234

223

215

635

572

555

520

 

Under the terms of these leases, the Santander UK group has the opportunity to extend its occupation of properties by a minimum of three years subject to 12 months' notice and lease renewal being available from external landlords during the term of the lease. At expiry, the Santander UK group has the option to reacquire the freehold of certain properties. Santander UK group rental expense comprises:

Group

2012

£m

2011

£m

2010

£m

In respect of minimum rentals

75

77

108

Less: sub-lease rentals

-

-

-

75

77

108

 

Included in the above Santander UK group rental expense was £6m (2011: £4m) relating to contingent rent expense.

 

39. SHARE CAPITAL AND OTHER EQUITY INSTRUMENTS

 

Group and Company

 

2012

£m

2011

£m

 

Ordinary share capital

3,105

3,105

£300m fixed/floating rate non-cumulative callable preference shares

300

300

£300m Step-up Callable Perpetual Reserve Capital Instruments

297

297

£300m Step Up Callable Perpetual Preferred Securities

297

297

3,999

3,999

 

 

a) Share capital

 

Group and Company

Issued and fully paid share capital

Ordinary shares

of £0.10 each

£300m Preference shares of £1 each

£325m Preference shares of £1 each

Total

£m

No. '000s

£m

No. '000s

£m

No. '000s

£m

£m

At 1 January 2011, 31 December 2011 and 31 December 2012

31,051,769

3,105

300,000

300

325,000

325

3,730

 

The Company's £325m sterling preference shares are classified as Subordinated Liabilities as described in Note 34.

 

Group and Company

Share premium

2012

£m

2011

£m

At 1 January and 31 December

5,620

5,620

 

The Company has one class of ordinary shares which carries no right to fixed income.

 

£300m Fixed/Floating Rate Non-Cumulative Callable Preference Shares

The preference shares entitle the holders to a fixed non-cumulative dividend, at the discretion of the Company, of 6.22% per annum payable annually from 24 May 2010 until 24 May 2019 and quarterly thereafter at a rate of 1.13% per annum above three month sterling LIBOR. The preference shares are redeemable only at the option of the Company on 24 May 2019 or on each quarterly dividend payment date thereafter. No such redemption may be made without the consent of the FSA.

 

b) Other equity instruments

 

£300m Step-up Callable Perpetual Reserve Capital Instruments

The £300 million Step-up Callable Perpetual Reserve Capital Instruments were issued in 2001 by the Company. Reserve Capital Instruments are redeemable by the Company on 14 February 2026 or on any coupon payment date thereafter, subject to the prior approval of the FSA and provided that the auditors have reported to the trustee within the previous six months that the solvency condition is met. The Reserve Capital Instruments bear interest at a rate of 7.037% per annum, payable annually in arrears, from 14 February 2001 to 14 February 2026. Thereafter, the reserve capital instruments will bear interest at a rate, reset every five years, of 3.75% per annum above the gross redemption yield on the UK five-year benchmark gilt rate. Interest payments may be deferred by the Company.

 

The Reserve Capital Instruments are not redeemable at the option of the holders and the holders do not have any rights against other Santander UK group companies. Upon the occurrence of certain tax or regulatory events, the Reserve Capital Instruments may be exchanged, their terms varied, or redeemed. Where interest payments have been deferred, the Company may not declare or pay dividends on or redeem or repurchase any junior securities until it next makes a scheduled payment on the Reserve Capital Instruments and Tier One Preferred Income Capital Securities.

 

The Reserve Capital Instruments are unsecured securities of the Company and are subordinated to the claims of unsubordinated creditors and subordinated creditors holding loan capital of the Company. Upon the winding up of the Company, holders of Reserve Capital Instruments will rank pari passu with the holders of the most senior class or classes of preference shares (if any) of the Company then in issue and in priority to all other Company shareholders.

 

£300m Step-up Callable Perpetual Preferred Securities

The £300m Step Up Callable Perpetual Preferred Securities are perpetual securities and pay a coupon on 22 March each year. At each payment date, the Company can decide whether to declare or defer the coupon indefinitely. If a coupon is deferred then the Company may not pay a dividend on any share until it next makes a coupon payment (including payment of any deferred coupons). The Company can be obliged to make payment in the event of winding up. The coupon is 5.827% per annum until 22 March 2016. Thereafter the coupon steps up to a rate, reset every five years, of 2.13% per annum above the gross redemption yield on a UK Government Treasury Security. The Perpetual Preferred securities are redeemable at the option of the Company on 22 March 2016 or on each payment date thereafter. No such redemption may be made without the consent of the FSA.

 

40. CASH FLOW STATEMENT

 

a) Reconciliation of profit after tax to net cash inflow/(outflow) from operating activities:

 

Group

Company

 

 

2012

£m

2011

£m

2010

£m

2012

£m

2011

£m

2010

£m

Profit for the year

939

903

1,583

(760)

3,153

1,391

Non-cash items included in net profit:

Depreciation and amortisation

246

447

275

187

307

185

(Increase)/decrease in prepayments and accrued income

(23)

(24)

(43)

(27)

85

(243)

(Decrease)/increase in accruals and deferred income

(479)

(250)

1,212

(604)

(648)

1,425

Profit on sale of subsidiary and associated undertakings

-

-

(39)

-

-

-

Amortization of premiums/(discounts) on debt securities

18

-

-

-

-

-

Provisions for liabilities and charges

439

917

129

413

886

130

Impairment losses

1,082

639

746

860

227

829

Corporation tax charge

292

358

542

337

179

247

Other non-cash items

(567)

1,581

314

(744)

724

7

Net cash flow from trading activities

1,947

4,571

4,719

(338)

4,913

3,971

Changes in operating assets and liabilities:

Net (increase)/decrease in cash and balances held at central banks

(8)

3

(14)

(1)

7

(47)

Net (increase)/decrease in trading assets

(2,789)

11,021

(1,453)

-

-

-

Net decrease/(increase) in derivative assets

634

(6,403)

(1,550)

1,102

(3,007)

(455)

Net decrease/(increase) in financial assets designated at fair value

1,194

1,770

5,609

1

5,081

32,020

Net decrease in debt securities, treasury bills and other eligible bills

-

7

-

-

7

-

Net decrease/(increase) in loans and advances to banks & customers

8,757

(4,915)

2,810

854

3,119

(66,921)

Net decrease/(increase) in other assets

575

736

837

517

505

(172)

Net (decrease)/increase in deposits by banks and customers

(484)

(327)

5,705

11,222

(29,040)

40,146

Net (decrease)/increase in derivative liabilities

(319)

6,775

3,442

845

108

(2,253)

Net (decrease)/increase in trading liabilities

(4,629)

(17,068)

(3,323)

-

-

-

Net (decrease)/increase in financial liabilities designated at fair value

(21)

(187)

(723)

-

(3)

24

Net increase/(decrease) in debt securities in issue

2,332

(1,223)

(1,258)

(1)

14

6,238

Net (decrease)/increase in other liabilities

(973)

15

(2,286)

(1,064)

(132)

(447)

Effects of exchange rate differences

(1,961)

(1,662)

(1,000)

(530)

(47)

(27)

Net cash flow from/(used in) operating activities before tax

4,255

(6,887)

11,515

12,607

(18,475)

12,077

Corporation tax (paid)/received

(231)

(165)

(131)

(149)

(121)

(99)

Net cash flow from/(used in) operating activities

4,024

(7,052)

11,384

12,458

(18,596)

11,978

 

b) Analysis of the balances of cash and cash equivalents in the balance sheet

 

Group

Company

 

 

2012

£m

2011

£m

2010

£m

2012

£m

2011

£m

2010

£m

Cash and balances with central banks

29,282

25,980

26,502

28,883

18,958

21,408

Less: regulatory minimum cash balances (See Note 12)

(203)

(195)

(198)

(179)

(178)

(185)

29,079

25,785

26,304

28,704

18,780

21,223

Debt securities

1,196

4,093

2,604

-

-

-

Net trading other cash equivalents

9,788

9,500

13,814

-

-

-

Net non trading other cash equivalents

1,576

3,568

2,778

25,578

26,573

45,450

Cash and cash equivalents

41,639

42,946

45,500

54,282

45,353

66,673

 

c) Sale of subsidiaries

 

In 2011, a subsidiary of the Company completed the disposal of certain leasing companies for cash consideration of approximately £3m. The net assets disposed of consisted of net investment in finance leases of £93m and provisions for liabilities and charges of £18m. In addition, debt of £72m was repaid.

 

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 plc, for a cash consideration of approximately £29m. In addition, in 2010 the Santander UK group completed the disposal of certain leasing companies for cash consideration of approximately £221m. The net assets disposed of consisted of loans and advances to customers of £510m, deposits by customers of £222m, deferred tax liabilities of £96m and other net assets and liabilities of £19m:

 

d) Acquisitions of subsidiaries and businesses

 

Acquisition of Santander Cards and Santander Consumer in 2010

Details of the assets and liabilities acquired, the consideration paid and the resulting goodwill identified, together with the cash payment made to satisfy the consideration are set out in Note 45.

 

41. ASSETS CHARGED AS SECURITY FOR LIABILITIES AND COLLATERAL ACCEPTED AS SECURITY FOR ASSETS

 

The following transactions are conducted under terms that are usual and customary to collateralised transactions, including, where relevant, standard securities lending and repurchase agreements.

 

a) Financial assets pledged to secure liabilities

 

The financial assets below are analysed between those assets accounted for on the balance sheet and off-balance sheet in accordance with IFRS.

 

Group

2012

£m

2011

£m

On balance sheet:

Treasury bills and other eligible securities

2,924

6,141

Cash

2,863

3,004

Loans and advances to customers - securitisations and covered bonds (See Note 19)

82,039

100,307

Loans and advances to customers

1,722

-

Debt securities

556

129

Equity securities

309

321

90,413

109,902

Off balance sheet:

Treasury bills and other eligible securities

17,666

16,245

Debt securities

662

7,779

Equity securities

105

195

18,433

24,219

 

 

The Santander UK group provides assets as collateral in the following areas of the business.

 

Sale and repurchase agreements

Subsidiaries of the Company enter into sale and repurchase agreements and similar transactions of equity and debt securities, which are accounted for as secured borrowings. Upon entering into such transactions, the subsidiaries provide collateral equal to 100%-131% of the borrowed amount. The carrying amount of assets that were so provided at 31 December 2012 was £20,306m (2011: £26,232m), of which £8,082m (2011: £6,160m) were classified within "loans and advances to customers - securitisations and covered bonds" in the table above.

 

Securitisations and covered bonds

As described in Note 19, the Company and certain of its subsidiaries enter into securitisation transactions whereby portfolios of residential mortgage loans and other loans are purchased by or assigned to special purpose securitisation companies, and have been funded through the issue of mortgage-backed securities and other asset-backed securities. Holders of the securities are only entitled to obtain payments of principal and interest to the extent that the resources of the securitisation companies are sufficient to support such payments and the holders of the securities have agreed in writing not to seek recourse in any other form. At 31 December 2012, £46,916m (2011: £75,226m) of loans were so assigned by the Santander UK group.

 

A subsidiary of the Company has also established a covered bond programme, whereby securities are issued to investors and are secured by a pool of ring-fenced residential mortgages. At 31 December 2012, the pool of ring-fenced residential mortgages for the covered bond programme was £35,123m (2011: £25,081m).

 

At 31 December 2012, total notes issued externally from secured programmes (securitisations and covered bonds) increased to £43,322m (2011: £41,007m), reflecting gross issuance of £10.9bn (2011: £17.2bn) in 2012. At 31 December 2012, a total of £17,634m (2011: £46,111m) of notes issued under securitisation and covered bond programmes had also been retained internally, a proportion of which had been used as collateral for raising funds via third party bilateral secured funding transactions, which totalled £11.0bn at 31 December 2012 (2011: £6.6bn), or for creating collateral which could in the future be used for liquidity purposes.

 

Stock borrowing and lending agreements

Asset balances under stock borrowing and lending agreements represent stock lent by the Santander UK group. These balances amounted to £11,723m at 31 December 2012 (2011: £14,380m) and are offset by contractual commitments to return stock borrowed or cash received.

 

Derivatives business

In addition to the arrangements described above, collateral is also provided in the normal course of derivative business to counterparties. At 31 December 2012, £2,863m (2011: £2,642m) of such collateral in the form of cash had been provided by the Santander UK group and is included in the table above.

 

b) Collateral held as security for assets

Group

2012

£m

2011

£m

On balance sheet:

Trading liabilities

3,652

2,401

3,652

2,401

Off balance sheet:

Trading liabilities

24,862

22,831

Deposits by banks

233

2,054

25,095

24,884

 

Purchase and resale agreements

Subsidiaries of the Company also enter into purchase and resale agreements and similar transactions of equity and debt securities, which are accounted for as collateralised loans. Upon entering into such transactions, the subsidiaries receive collateral equal to 100%-105% of the loan amount. The level of collateral held is monitored daily and if required, further calls are made to ensure the market values of collateral remains equal to the loan balance. The subsidiaries are permitted to sell or repledge the collateral held in the absence of default. At 31 December 2012 the fair value of such collateral received was £14,788m (2011: £11,776m). Of the collateral received, almost all was sold or repledged. The subsidiaries have an obligation to return collateral that they have sold or pledged.

 

Stock borrowing and lending agreements

Obligations under stock borrowing and lending agreements represent contractual commitments to return stock borrowed. These obligations totalling £10,307m at 31 December 2012 (2011: £13,109m) and are offset by a contractual right to receive stock lent by the Santander UK group.

 

Derivatives business

In addition to the arrangements described above, collateral is also received in the normal course of derivative business from counterparties. At 31 December 2012, £3,652m (2011: £2,401m) of such collateral in the form of cash had been received by the Santander UK group and is included in the table above.

 

Lending activities

In addition to the above collateral held as security for assets, the Santander UK group may obtain a charge over a customer's property in connection with its lending activities. See the "Credit Risk" section of the Risk Management Report for each business segment.

 

 

42. SHARE-BASED COMPENSATION

 

The Santander UK group operates share schemes and arrangements for eligible employees. The main current schemes are the Sharesave Schemes, the Long-Term Incentive Plan and the Deferred Shares Bonus Plan. The Santander UK group's other current arrangement and scheme, respectively, are free shares awarded to eligible employees and partnership shares. In addition, a small number of arrangements remain outstanding under the closed Executive Share Option scheme and the closed Alliance & Leicester Share Incentive Plan. All the share options and awards relate to shares in Banco Santander, S.A.

 

The amount charged to the income statement in respect of share-based payment transactions is set out in Note 6. The total carrying amount at the end of the period for liabilities arising from share-based payment transactions was £1m (2011: £0.2m, 2010: £2m), none of which had vested at 31 December 2012 (2011: nil). Cash received from the exercise of share options was £nil (2011: £0.2m, 2010: £2m).

 

The main schemes are:

 

Sharesave Schemes

 

The Santander UK group launched its fifth HM Revenue & Customs approved Sharesave Scheme under Banco Santander, S.A. ownership in September 2012. The first four Sharesave Schemes were launched in September 2008, 2009, 2010 and 2011 under similar terms as the 2012 Scheme. Under these schemes, eligible employees may enter into contracts to save between £5 and £250 per month. At the expiry of a fixed term of three or five years after the grant date, the employees have the option to use these savings to acquire shares in Banco Santander, S.A. at a discount, calculated in accordance with the rules of the scheme. The discount is currently 20% of the average middle market quoted price of Banco Santander, S.A. shares over the first three dealing days prior to invitation. The vesting of awards under the scheme depends on continued employment with the Banco Santander, S.A. group. Participants in the scheme have six months from the date of vest in which the option can be exercised.

 

Prior to the Company's acquisition by Banco Santander, S.A. in 2004, the Company operated similar Sharesave schemes. All the remaining options granted under those schemes were exercised or forfeited during 2011. The options previously outstanding under those Sharesave schemes were included in the disclosures below.

 

The fair value of each Sharesave option for 2012, 2011 and 2010 has been estimated at the date of acquisition or grant using a partial differential equation model with the following assumptions:

 

2012

2011

2010

Risk free interest rate

0.75%-5.2%

1.7%-5.2%

1.7%-5.2%

Dividend growth

4.6%

(2.6%)

8%

Expected volatility of underlying shares based upon historical volatility over 5 years

20.3%-44.6%

20.3%-42.2%

20.3%-39.4%

Expected lives of options granted under 3 and 5 year schemes

3 & 5 years

3 & 5 years

3 & 5 years

 

With the exception of vesting conditions that include terms related to market conditions, vesting conditions included in the terms of the grant are not taken into account in estimating fair value. Non-market vesting conditions are taken into account by adjusting the number of shares or share options included in the measurement of the cost of the employee service so that ultimately, the amount recognised in the income statement reflects the number of vested shares or share options.

 

Where vesting conditions are related to market conditions, the charges for the services received are recognised regardless of whether or not the market related vesting conditions are met, provided that the non-market vesting conditions are met. Share price volatility has been based upon the range of implied volatility for the Banco Santander, S.A. shares at the strikes and tenors in which the majority of the sensitivities lie.

 

The following table summarises the movement in the number of share options during the year, together with the changes in weighted average exercise price over the same period.

 

 

 

 

 

 

 Number of options

'000s

Weighted average

exercise price

£

 

2012

 

Options outstanding at the start of the year

11,261

5.37

 

Options granted during the year

10,012

3.66

 

Options exercised during the year

(3)

4.56

 

Options forfeited during the year

(6,468)

5.34

 

Options outstanding at the end of the year

14,802

4.23

 

Options exercisable at the end of the year

592

7.22

2011

Options outstanding at the start of the year

8,927

7.09

Options granted during the year

7,725

4.46

Options exercised during the year

(43)

4.09

Options forfeited during the year

(5,348)

6.92

Options outstanding at the end of the year

11,261

5.37

Options exercisable at the end of the year

1,205

7.69

2010

Options outstanding at the start of the year

8,713

7.24

Options granted during the year

3,360

6.46

Options exercised during the year

(73)

7.54

Options forfeited during the year

(3,073)

6.82

Options outstanding at the end of the year

8,927

7.09

Options exercisable at the end of the year

-

-

 

The weighted average grant-date fair value of options granted under the Employee Sharesave scheme during the year was £0.42 (2011: £0.79, 2010: £1.70). The weighted average share price at the date the share options were exercised was £4.84 (2011: £7.36, 2010: £8.01).

 

The following table summarises the range of exercise prices and weighted average remaining contractual life of the options outstanding at 31 December 2012 and 2011.

 

Options outstanding

 

Range of exercise prices

Weighted average remaining contractual life

years

Weighted average exercise price

£

2012

Between £3 and £4

4

3.66

Between £4 and £5

3

4.46

Between £6 and £7

2

6.46

Between £7 and £8

1

7.41

2011

Between £4 and £5

4

4.46

Between £6 and £7

3

6.46

Between £7 and £8

1

7.53

 

Long-Term Incentive Plan

 

No new awards were granted under the Santander Long-Term Incentive Plan in 2012. Under the Santander Long-Term Incentive Plans granted on 1 July 2011, 1 July 2010, 1 July 2009, 21 June 2008 and 31 July 2007, certain Executive Directors, Key Management Personnel (as defined in Note 44) and other nominated individuals were granted conditional awards of shares in Banco Santander, S.A..

 

The deferred share-based variable remuneration is implemented through a multiannual incentive plan, which is payable in shares of Banco Santander, S.A.. This plan involves successive three-year cycles of share deliveries to the beneficiaries, so that each year one cycle will begin and, from 2009 onwards, another cycle will end. The aim was to establish an appropriate sequence between the end of the incentive programme linked to the previous plan and the successive cycles of this plan.

 

The first two cycles commenced in July 2007, the first cycle having a duration of two years, known as Incentivos Largo Plazo ('ILP') 09 and the second cycle having a standard three year term (ILP10). The first cycle (ILP09) vested in July 2009, the second cycle (ILP10) vested in July 2010. In June 2008, June 2009, July 2010 and July 2011 the third, fourth, fifth and sixth cycles of the performance share plan (ILP11, ILP12, ILP13 and ILP14 respectively), all of which were to run for three years, were approved.

 

For each cycle, a maximum number of shares was established for each beneficiary who remains in the Santander UK group's employment for the duration of the plan. The targets, which, if met, will determine the number of shares to be delivered with respect to the cycles approved until June 2008, were defined by comparing the Banco Santander, S.A. group's performance with that of a benchmark group of financial institutions and were linked to two parameters, namely Banco Santander, S.A. TSR and growth in Banco Santander, S.A. EPS. The targets, which, if met, will determine the number of shares to be delivered under Plan ILP12, ILP13 and ILP14 are defined by comparing the Banco Santander, S.A. group's performance with that of a benchmark group of financial institutions and are linked to only one parameter, namely Banco Santander, S.A. TSR.

 

The ultimate number of shares to be delivered will be determined in each of the cycles by the degree of achievement of the targets on the third anniversary of commencement of each cycle (with the exception of the first cycle, for which the second anniversary was considered), and the shares will be delivered within a maximum period of seven months from the end of the cycle. At the end of the cycles of Plans ILP10 and ILP11, the TSR and the EPS growth will be calculated for Banco Santander, S.A. and each of the benchmark entities and the results will be ranked from first to last. Each of the two criteria (TSR and EPS growth) will be weighted at 50% in the calculation of the percentage of shares to be delivered, based on the following scale and in accordance with Banco Santander, S.A.'s relative position among the group of benchmark financial institutions:

 

Banco Santander, S.A.'s place in the TSR ranking

Percentage of maximum

shares to be delivered

%

Banco Santander, S.A.'s place in the EPS growth ranking

Percentage of maximum shares to be delivered

%

1st to 6th

50

1st to 6th

50

7th

43

7th

43

8th

36

8th

36

9th

29

9th

29

10th

22

10th

22

11th

15

11th

15

12th and below

-

12th and below

-

 

In the case of Plans ILP13 and ILP14, the TSR criterion will determine the percentage of shares to be delivered, based on the following scale and in accordance with Banco Santander, S.A.'s relative position among the group of benchmark financial institutions:

 

Banco Santander, S.A.'s place in the

TSR ranking

Percentage of maximum shares to be delivered

%

1st to 5th

100.0

6th

82.5

7th

65.0

8th

47.5

9th

30.0

10th and below

-

 

Any benchmark group entity that is acquired by another company, or whose shares cease trading or that ceases to exist will be excluded from the benchmark group. In an event of this or any similar nature, the comparison with the benchmark group will be performed in such a way that, for each of the measures considered (TSR and EPS growth, as appropriate), the maximum percentage of shares will be delivered if Banco Santander, S.A. ranks within the first quartile (including the 25th percentile) of the benchmark group; no shares will be delivered if Banco Santander, S.A. ranks below the median (50th percentile); 30% of the maximum amount of shares will be delivered if Banco Santander, S.A. is placed at the median. The linear interpolation method will be used for calculating the corresponding percentage for positions between the median and the first quartile.

 

Plans ILP10, ILP11 and ILP12 matured in 2010, 2011 and 2012, respectively. As established in the plans, the number of shares received by each beneficiary was determined by the degree of achievement of the targets to which each plan was tied and, since they fell short of the maximum number established, the unearned options were cancelled.

 

The fair value of each award under the Long-Term Incentive Plans has been estimated at the date of acquisition or grant using the same methodology used to value the Sharesave options. The expected lives of awards granted have been estimated as three years.

 

The following table summarises the movement in the number of conditional share awards during 2012 and 2011.

 

 

Long Term Incentive Plan

Number of awards

000s

2012

Conditional awards outstanding at the beginning of the year

5,627

Conditional awards exercised during the year

(525)

Conditional awards forfeited or cancelled during the year

(1,474)

Conditional awards outstanding at the end of the year

3,628

2011

Conditional awards outstanding at the beginning of the year

6,185

Conditional awards granted during the year

1,586

Conditional awards exercised during the year

(1,300)

Conditional awards forfeited or cancelled during the year

 (844)

Conditional awards outstanding at the end of the year

5,627

 

See Note 44 for details of conditional share awards made to certain Executive Directors, Other Key Management Personnel and other nominated individuals under the Long-Term Incentive Plan.

 

The weighted average grant-date fair value of conditional share awards granted during the year was £nil (2011: £3.78). At 31 December 2012, the weighted average remaining contractual life was 1 year (2011: two years).

 

Deferred Shares Bonus Plan

 

Deferred incentive awards are designed to align employee performance with shareholder value and encourage increased retention of senior employees. During 2011, in compliance with the FSA remuneration Code, Santander UK introduced the First Cycle of the Deferred Bonus Share Plan which includes Conditional Awarding. Employees who are awarded an annual performance incentive over a threshold level receive part of the incentive as a deferred award. Any deferred awards, including those in Banco Santander, S.A. shares, are dependant on future service. Deferral of the award is over a 3 year period, with delivery taking place on or around the anniversary of the initial incentive. For Code Staff, shares are subject to an additional one year retention period from the point of delivery.

 

Code Staff are required to defer either 40% or 60% of any incentive award (40% for annual performance incentives of no more than £500,000, 60% for incentives above this amount). Non-Code Staff employees are subject to a graduated system which ensures that those who receive higher value annual performance incentives are required to defer a greater proportion of the annual performance incentive award. Certain employees have a lower threshold, meaning that a higher portion of variable pay is subject to deferral.

 

Vesting of both deferred incentive awards and long-term incentive awards is subject to claw back in the event of deficient performance and prudent financial control provisions in accordance with the FSA Code.

 

Other arrangements and schemes

 

Partnership Shares

The Santander UK group also operates a Partnership Shares scheme for eligible employees under the SIP umbrella. Participants can elect to invest up to £1,500 per tax year from pre-tax salary to purchase Banco Santander, S.A. shares. Shares are held in trust for the participants. There are no vesting conditions attached to these shares, and no restrictions as to when the shares can be removed from the trust. However, if a participant chooses to sell the shares before the end of five years, they will be liable for the taxable benefit received when the shares are taken out of the trust. The shares can be released from trust after five years free of income tax and national insurance contributions. 658,028 shares were outstanding at 31 December 2012 (2011: 614,126 shares).

 

Closed schemes

In addition, 12,000 options (2011: 12,000) remain outstanding and exercisable under the closed Executive Share Option Scheme with a weighted average exercise price of £4.54 (2011: £4.54), and 91,438 shares (2011: 98,641) remain outstanding under the closed Alliance & Leicester SIP partnership share scheme.

 

43. DIRECTORS' EMOLUMENTS AND INTERESTS

 

Ex gratia pensions paid to former Directors of the Company in 2012, which have been provided for previously, amounted to £14,211 (2011: £14,211, 2010: £14,211). In 1992, the Board decided not to award any new such ex gratia pensions.

 

There were no loans, quasi loans and credit transactions entered into or agreed by the Company or its subsidiaries with persons who are or were Directors, Other Key Management Personnel and each of their connected persons during the year except as described below:

 

 

 

Number of

Persons

No.

Aggregate amount

outstanding

£000

Other Key Management Personnel* - loans

2012

16

3,833

2011

10

3,889

* Other Key Management Personnel are defined as the Board and the Executive Committee of the Company who served during the year. The above excludes any overdraft facilities provided to Directors, Other Key Management Personnel and their connected persons in the ordinary course of business.

 

Secured and unsecured loans are made to Directors, Other Key Management Personnel and their connected persons in the ordinary course of business, with terms prevailing for comparable transactions and on the same terms and conditions as applicable to other employees within the Santander UK group. Such loans do not involve more than the normal risk of collectability or present any unfavourable features.

 

 

44. RELATED PARTY DISCLOSURES

 

a) Transactions with Directors, Other Key Management Personnel and each of their connected persons

 

Directors, Other Key Management Personnel and their connected persons have undertaken the following transactions with the Santander UK group in the course of normal banking and life assurance business.

 

 

 

2012

Number of directors

and Other Key Management Personnel(1)

No.

Amounts in respect of directors,

Other Key Management Personnel(1)

and their connected persons

£000

Secured loans, unsecured loans and overdrafts

At 1 January

10

3,889

Net movements in the year

6

(56)

At 31 December

16

3,833

Deposit, bank and instant access accounts and investments

At 1 January

19

7,716

Net movements in the year

-

(805)

At 31 December

19

6,911

 

 2011

Secured loans, unsecured loans and overdrafts

At 1 January

3

678

Net movements in the year

7

3,211

At 31 December

10

3,889

Deposit, bank and instant access accounts and investments

At 1 January

13

10,100

Net movements in the year

6

(2,384)

At 31 December

19

7,716

(1) Other Key Management Personnel are defined as the Board and the Executive Committee of the Company who served during the year.

 

During the year ended 31 December 2012, one Director undertook sharedealing transactions through the Santander UK group's execution-only stockbroker (2011: no Directors) with an aggregate net value of £194,279 (2011: £nil). Any transactions were on normal business terms and standard commission rates were payable.

 

Secured and unsecured loans are made to Directors, Other Key Management Personnel and their connected persons, in the ordinary course of business, with terms prevailing for comparable transactions and on the same terms and conditions as applicable to other employees within the Santander UK group. Such loans do not involve more than the normal risk of collectability or present any unfavourable features. Amounts deposited by Directors, Other Key Management Personnel and their connected persons earn interest at the same rates as those offered to the market or on the same terms and conditions applicable to other employees within the Santander UK group. Investments are entered into by Directors, Other Key Management Personnel and their connected persons on normal market terms and conditions, or on the same terms and conditions as applicable to other employees within the Santander UK group.

 

b) Remuneration of Key Management Personnel

 

The remuneration of the Directors, and Other Key Management Personnel of the Santander UK group, is set out in aggregate for each of the categories specified in IAS 24 Related Party Disclosures. Further information about the aggregate remuneration of the Directors is provided in the 'Directors' Remuneration' table in the Directors' Report on page 179.

 

 

Key management compensation

2012

£

2011

£

2010

£

Short-term employee benefits

26,874,911

19,208,174

9,388,377

Post employment benefits

-

210,910

342,575

Other long-term benefits

-

-

-

Termination benefits

-

-

-

Share-based payments

220,904

619,888

1,745,747

27,095,815

20,038,972

11,476,699

 

c) Santander Long-Term Incentive Plan

 

In 2012, no Executive Directors (2011: none, 2010: one) or Other Key Management Personnel (2011: none, 2010: six) were granted conditional awards of shares in Banco Santander, S.A. under the Santander Long-Term Incentive Plan (2010: total fair value of £610,656 based on a share price of euro 5.57). Under the Santander Long-Term Incentive Plans granted on 1 July 2010, 1 July 2009, 21 June 2008 and 31 December 2007, certain Executive Directors, Key Management Personnel (as defined in Note 44) 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. The vesting of awards under the Santander Long-Term Incentive Plan depends 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 and 90.79% of the remaining 60% of the 2007 conditional award vested in July 2010. Subject to performance conditions being met, 100% of the 2008 conditional award vested in July 2011, 100% of the 2009 conditional award vested in July 2012 and 100% of the 2010 conditional award will vest in July 2013. In 2012, Long-Term Incentive Plan shares awarded in 2009 vested for two Directors (2011: one).

 

d) Parent undertaking and controlling party

 

The Company's immediate and ultimate parent and controlling party is Banco Santander, S.A.. The smallest and largest group into which the Santander UK group's results are included is the group accounts of Banco Santander, S.A., copies of which may be obtained from the Santander Shareholder Relations, 2 Triton Square, Regent's Place, London NW1 3AN.

 

e) Transactions with related parties

 

Transactions with related parties during the year and balances outstanding at the year end:

 

Group

Interest, fees and

other income received

Interest, fees and

other expenses paid

Amounts owed by

related parties

Amounts owed

to related parties

 

 

2012

£m

2011

£m

2010

£m

2012

£m

2011

£m

2010

£m

2012

£m

2011

£m

2012

£m

2011

£m

Parent company

(54)

(163)

(326)

207

87

96

2,473

4,995

(4,942)

(6,644)

Fellow subsidiaries

(319)

(281)

(325)

717

709

674

267

272

(4,689)

(3,265)

Associates & joint ventures

(3)

(1)

(40)

4

-

-

328

-

(2)

-

(376)

(445)

(691)

928

796

770

3,068

5,267

(9,633)

(9,909)

 

Company

Interest, fees and

other income received

Interest, fees and

other expenses paid

Amounts owed by

related parties

Amounts owed

to related parties

2012

£m

2011

£m

2010

£m

2012

£m

2011

£m

2010

£m

2012

£m

2011

£m

2012

£m

2011

£m

Parent company

(1)

-

(4)

51

64

66

3

4

(650)

(1,371)

Subsidiaries

(2,333)

(2,686)

(3,284)

4,574

4,777

5,278

105,598

99,535

(162,028)

(159,062)

Fellow subsidiaries

(208)

(205)

(243)

492

524

476

46

135

(3,067)

(2,320)

Associates & joint ventures

-

(1)

-

-

-

-

-

-

-

-

(2,542)

(2,892)

(3,531)

5,117

5,365

5,820

105,647

99,674

(165,745)

(162,753)

 

Further information on balances due from/(to) other Banco Santander group companies is set out in the section "Balances with other Banco Santander group companies" in the Risk Management Report on pages 147 to 150. In addition, transactions with pension schemes operated by the Santander UK group are described in Note 37. The above transactions were made in the ordinary course of business and substantially on the same terms as for comparable transactions with third party counterparties and within limits acceptable to the UK Financial Services Authority. Such transactions do not involve more than the normal risk of collectability or present any unfavourable features.

 

 

45. ACQUISITIONS 

 

In October and November 2010, the Santander UK group acquired certain UK businesses owned by Banco Santander, S.A. as follows:

Santander Cards Limited and Santander Cards (UK) Limited (and its subsidiaries), which conduct the Banco Santander, S.A. group's provision of store cards to retailers, credit cards and related financial products and other unsecured consumer finance products in the UK, and Santander Cards Ireland Limited, which conducts the Banco Santander group's provision of credit card finance by way of credit cards and store cards in the Republic of Ireland;

 

Santander Consumer (UK) plc (of which the Santander UK group already held 49.9%), which carries on the Banco Santander group's provision of finance facilities and the contract purchase of motor vehicles and equipment in the UK and also provides wholesale funding facilities to preferential dealers in the UK; and

 

Santander PB UK (Holdings) Limited (and its subsidiaries), (of which the Santander UK group already held 51% of its subsidiary Santander Private Banking UK Limited) which carries on the Santander UK group's provision of private banking services in the UK;

 

The aggregate consideration paid by the Santander UK group for these businesses was £1,451m. At the acquisition date, the fair value of identifiable net assets acquired was £831m (Santander Cards business: £635m, Santander Consumer (UK) plc: £196m). The Santander UK group transferred a total cash consideration of £1,243m for the two businesses being the agreed cash consideration of £1,276m less cash and cash equivalents in businesses acquired of £33m. Goodwill of £631m was recognised as a result of these acquisitions.

 

In 2010, the Santander UK group recognised a gain of £87m on the revaluation of its original 49.9% holding in Santander Consumer (UK) plc as a result of re-measuring this equity interest at fair value on the date of acquisition. The gain was included in 'Net trading and other income' in the Consolidated Income Statement.

 

The total operating income and profit before tax, included in the Consolidated Statement of Comprehensive Income in 2010 contributed by the Santander Cards and Santander Consumer businesses since their acquisition, were £82m and £9m respectively. Had these entities been consolidated from 1 January 2010, the Santander UK group would have included total operating income of £512m and profit before tax of £82m for the year.

 

No financial information has been presented for acquisition of the remaining 49% of Santander Private Banking UK Limitedfor £175m as the Santander UK group previously consolidated 100% of this entity and recognised a non-controlling interest reflecting the 49% owned by Santander PB UK (Holdings) Limited. The effect of the acquisition of the remaining 49% of Santander Private Banking UK Limited (by way of the purchase of 100% of Santander PB UK (Holdings) Limited) was only to remove the non-controlling interest. The difference of £28m between the consideration paid and the book value of the non-controlling interest was recognised in equity reflecting the change in the Santander UK group's ownership interest.

 

46. FINANCIAL INSTRUMENTS

 

a) Measurement basis of financial assets and liabilities

 

Financial assets and financial liabilities are measured on an ongoing basis either at fair value or at amortised cost. Note 1 describes how the classes of financial instruments are measured, and how income and expenses, including fair value gains and losses, are recognised. The following tables analyse the Santander UK group's financial instruments into those measured at fair value and those measured at amortised cost in the balance sheet:

 

Group

Held at fair value

Held at amortised cost

Non-financial assets/ liabilities

Total

 

31 December 2012

Trading

Derivatives designated as hedges

Designated

at fair value through P&L

Available-

for-sale

Financial

assets at

amortised cost

Financial liabilities at amortised cost

£m

£m

£m

£m

£m

£m

£m

£m

Assets

Cash & balances at central banks

-

-

-

-

29,282

-

-

29,282

Trading assets

22,498

-

-

-

-

-

-

22,498

Derivative financial instruments

28,064

2,082

-

-

-

-

-

30,146

Financial assets designated at FVTPL

-

-

3,811

-

-

-

-

3,811

Loans and advances to banks

-

-

-

-

2,438

-

-

2,438

Loans and advances to customers

-

-

-

-

191,907

-

-

191,907

Available-for-sale securities

-

-

-

5,483

-

-

-

5,483

Loans and receivables securities

-

-

-

-

1,259

-

-

1,259

Macro hedge of interest rate risk

-

-

-

-

1,222

-

-

1,222

Intangible assets

-

-

-

-

-

-

2,325

2,325

Property, plant and equipment

-

-

-

-

-

-

1,541

1,541

Current tax assets

-

-

-

-

-

-

50

50

Deferred tax assets

-

-

-

-

-

-

60

60

Retirement benefit assets

-

-

-

-

-

-

254

254

Other assets

-

-

-

-

-

-

768

768

50,562

2,082

3,811

5,483

226,108

-

4,998

293,044

Liabilities

Deposits by banks

-

-

-

-

-

9,935

-

9,935

Deposits by customers

-

-

-

-

-

149,037

-

149,037

Derivative financial liabilities

27,415

1,446

-

-

-

-

-

28,861

Trading liabilities

21,109

-

-

-

-

-

-

21,109

Financial liabilities designated at FVTPL

-

-

4,002

-

-

-

-

4,002

Debt securities in issue

-

-

-

-

-

59,621

-

59,621

Subordinated liabilities

-

-

-

-

-

3,781

-

3,781

Other liabilities

-

-

-

-

-

-

2,526

2,526

Provisions

-

-

-

-

-

-

914

914

Current tax liabilities

-

-

-

-

-

-

4

4

Retirement benefit obligations

-

-

-

-

-

-

305

305

48,524

1,446

4,002

-

-

222,374

3,749

280,095

 

Company

Held at fair value

Held at amortised cost

Non-

Total

 

31 December 2012

Trading

 

Derivatives designated as hedges

Designated at fair value through P&L

Available-for-sale

Financial

assets at

amortised cost

Financial liabilities at amortised cost

financial assets/ liabilities

£m

£m

£m

£m

£m

£m

£m

£m

Assets

Cash and balances at central banks

-

-

-

-

28,883

-

-

28,883

Derivative financial instruments

4,061

838

-

-

-

-

-

4,899

Financial assets designated at FVTPL

-

-

44

-

-

-

-

44

Loans and advances to banks

-

-

-

-

97,846

-

-

97,846

Loans and advances to customers

-

-

-

-

171,697

-

-

171,697

Available for sale securities

-

-

-

357

-

-

-

357

Loans and receivables securities

-

-

-

-

5,941

-

-

5,941

Macro hedge of interest rate risk

-

-

-

-

15

-

-

15

Investment in subsidiary undertakings

-

-

-

-

-

-

6,969

6,969

Intangible assets

-

-

-

-

-

-

1,647

1,647

Property, plant and equipment

-

-

-

-

-

-

1,157

1,157

Current tax assets

-

-

-

-

-

-

240

240

Deferred tax assets

-

-

-

-

-

-

72

72

Retirement benefit assets

-

-

-

-

-

-

250

250

Other assets

-

-

-

-

-

-

716

716

4,061

838

44

357

304,382

-

11,051

320,733

Liabilities

Deposits by banks

-

-

-

-

-

109,170

-

109,170

Deposits by customers

-

-

-

-

-

188,884

-

188,884

Derivative financial liabilities

2,049

2

-

-

-

-

-

2,051

Debt securities in issue

-

-

-

-

-

645

-

645

Subordinated liabilities

-

-

-

-

-

3,846

-

3,846

Other liabilities

-

-

-

-

-

-

2,139

2,139

Provisions

-

-

-

-

-

-

859

859

Retirement benefit obligations

-

-

-

-

-

-

305

305

2,049

2

-

-

-

302,545

3,303

307,899

 

 

Group

Held at fair value

Held at amortised cost

Non-financial assets/ liabilities

Total

31 December 2011

Trading

Derivatives designated as hedges

Designated

at fair value through P&L

Available-

for-sale

Financial

assets at

amortised cost

Financial liabilities at amortised cost

£m

£m

£m

£m

£m

£m

£m

£m

Assets

Cash & balances at central banks

-

-

-

-

25,980

-

-

25,980

Trading assets

21,891

-

-

-

-

-

-

21,891

Derivative financial instruments

27,394

3,386

-

-

-

-

-

30,780

Financial assets designated at FVTPL

-

-

5,005

-

-

-

-

5,005

Loans and advances to banks

-

-

-

-

4,487

-

-

4,487

Loans and advances to customers

-

-

-

-

201,069

-

-

201,069

Available-for-sale securities

-

-

-

46

-

-

-

46

Loans and receivables securities

-

-

-

-

1,771

-

-

1,771

Macro hedge of interest rate risk

-

-

-

-

1,221

-

-

1,221

Intangible assets

-

-

-

-

-

-

2,142

2,142

Property, plant and equipment

-

-

-

-

-

-

1,596

1,596

Deferred tax assets

-

-

-

-

-

-

257

257

Retirement benefit assets

-

-

-

-

-

-

241

241

Other assets

-

-

-

-

-

-

1,088

1,088

49,285

3,386

5,005

46

234,528

-

5,324

297,574

Liabilities

Deposits by banks

-

-

-

-

-

11,626

-

11,626

Deposits by customers

-

-

-

-

-

148,342

-

148,342

Derivative financial liabilities

27,787

1,393

-

-

-

-

-

29,180

Trading liabilities

25,745

-

-

-

-

-

-

25,745

Financial liabilities designated at FVTPL

-

-

6,837

-

-

-

-

6,837

Debt securities in issue

-

-

-

-

-

52,651

-

52,651

Subordinated liabilities

-

-

-

-

-

6,499

-

6,499

Other liabilities

-

-

-

-

-

-

2,571

2,571

Provisions

-

-

-

-

-

-

970

970

Current tax liabilities

-

-

-

-

-

-

271

271

Retirement benefit obligations

-

-

-

-

-

-

216

216

53,532

1,393

6,837

-

-

219,118

4,028

284,908

 

Company

 

Held at fair value

Held at amortised cost

Non-financial assets/ liabilities

Total

 

31 December 2011

Trading

Derivatives designated as hedges

Designated

at fair value through P&L

Available-

for-sale

Financial

assets at

amortised cost

Financial liabilities at amortised cost

£m

£m

£m

£m

£m

£m

£m

£m

 

Assets

 

Cash and balances at central banks

-

-

-

-

18,958

-

-

18,958

 

Derivative financial instruments

4,044

1,957

-

-

-

-

-

6,001

 

Financial assets designated at FVTPL

-

-

45

-

-

-

-

45

 

Loans and advances to banks

-

-

-

-

90,716

-

-

90,716

 

Loans and advances to customers

-

-

-

-

181,972

-

-

181,972

 

Available for sale securities

-

-

-

34

-

-

-

34

 

Loans and receivables securities

-

-

-

-

5,202

-

-

5,202

 

Macro hedge of interest rate risk

-

-

-

-

32

-

-

32

 

Investment in subsidiary undertakings

-

-

-

-

-

-

6,995

6,995

 

Intangible assets

-

-

-

-

-

-

1,458

1,458

 

Property, plant and equipment

-

-

-

-

-

-

1,182

1,182

 

Current tax assets

-

-

-

-

-

-

154

154

 

Deferred tax assets

-

-

-

-

-

-

275

275

 

Retirement benefit assets

-

-

-

-

-

-

237

237

 

Other assets

-

-

-

-

-

-

965

965

 

4,044

1,957

45

34

296,880

-

11,266

314,226

 

 

Liabilities

 

Deposits by banks

-

-

-

-

-

112,278

-

112,278

 

Deposits by customers

-

-

-

-

-

175,067

-

175,067

 

Derivative financial liabilities

1,207

-

-

-

-

-

-

1,207

 

Financial liabilities designated at FVTPL

-

-

1

-

-

-

-

1

 

Debt securities in issue

-

-

-

-

-

1,609

-

1,609

 

Subordinated liabilities

-

-

-

-

-

6,564

-

6,564

 

Other liabilities

-

-

-

-

-

-

2,121

2,121

 

Provisions

-

-

-

-

-

-

912

912

 

Retirement benefit obligations

-

-

-

-

-

-

216

216

 

1,207

-

1

-

-

295,518

3,249

299,975

 

 

b) Fair values of financial instruments carried at amortised cost

 

The following tables analyse the fair value of financial instruments not measured at fair value in the balance sheet:

 

Group

31 December 2012

Carrying value

£m

Fair value

£m

Surplus/(deficit)

£m

Assets

Cash and balances at central banks

29,282

29,282

-

Loans and advances to banks

2,438

2,133

(305)

Loans and advances to customers

191,907

193,355

1,448

Loans and receivables securities

1,259

1,139

(120)

Liabilities

Deposits by banks

9,935

10,212

(277)

Deposits by customers

149,037

150,191

(1,154)

Debt securities in issue

59,621

61,163

(1,542)

Subordinated liabilities

3,781

3,597

184

 

Group

31 December 2011

Carrying value

£m

Fair value

£m

Surplus/(deficit)

£m

Assets

Cash and balances at central banks

25,980

25,980

-

Loans and advances to banks

4,487

4,487

-

Loans and advances to customers

201,069

206,725

5,656

Loans and receivables securities

1,771

1,553

(218)

Liabilities

Deposits by banks

11,626

11,644

(18)

Deposits by customers

148,342

149,424

(1,082)

Debt securities in issue

52,651

52,420

231

Subordinated liabilities

6,499

7,305

(806)

 

Company

 31 December 2012

Carrying value

£m

Fair value

£m

Surplus/(deficit)

£m

Assets

Cash and balances at central banks

28,883

28,883

-

Loans and advances to banks

97,846

101,248

3,402

Loans and advances to customers

171,697

174,787

3,090

Loans and receivables securities

5,941

5,830

(111)

Liabilities

Deposits by banks

109,170

109,707

(537)

Deposits by customers

188,884

190,024

(1,140)

Debt securities in issue

645

660

(15)

Subordinated liabilities

3,846

3,697

149

 

Company

 31 December 2011

Carrying value

£m

Fair value

£m

Surplus/(deficit)

£m

Assets

Cash and balances at central banks

18,958

18,958

-

Loans and advances to banks

90,716

91,440

724

Loans and advances to customers

181,972

187,619

5,647

Loans and receivables securities

5,202

4,996

(206)

Liabilities

Deposits by banks

112,278

113,983

(1,705)

Deposits by customers

175,067

176,014

(947)

Debt securities in issue

1,609

1,629

(20)

Subordinated liabilities

6,564

7,370

(806)

 

The surplus/(deficit) in the table above represents the surplus/(deficit) of fair value compared to the carrying amount of those financial instruments for which fair values have been estimated. The carrying value above of any financial assets and liabilities that are designated as hedged items in a portfolio (or macro) fair value hedge relationship excludes gains and losses attributable to the hedged risk, as this is presented as a single separate line item on the balance sheet.

 

Valuation methodology

The fair value of financial instruments is the estimated amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. If a quoted market price is available for an instrument, the fair value is calculated based on the market price. Where quoted market prices are not available, fair value is determined using pricing models which use a mathematical methodology based on accepted financial theories, depending on the product type and its components. Further information on fair value measurement can be found in Note 1 and the valuation techniques section below.

 

Fair value management

The fair value exposures set out in the tables above are managed by using a combination of hedging derivatives and offsetting on balance sheet positions. The approach to specific categories of financial instruments is described below.

 

a) Assets:

Cash and balances at central banks

This consists of demand deposits with the Bank of England and the US Federal Reserve, together with cash in tills and ATMs. The carrying amount of cash and balances at central banks is deemed a reasonable approximation of the fair value.

 

Loans and advances to banks 

These comprise secured loans, short term placements with banks including collateral, and unsettled financial transactions. The secured loans have been valued on the basis of spreads on credit default swaps for the term of the loans. The carrying amount of the other items is deemed a reasonable approximation of their fair value, as the transactions are very short-term in duration.

 

Loans and advances to customers

The approach to estimating the fair value of the principal products and portfolios of loans and advances to customers was as follows:

 

i) Mortgages

The fair values have been estimated by replacing existing contractual credit spreads with an estimation of current par value rates for each mortgage asset class using current market rates for each class. Current market rates were obtained using competitor market information and where available split by factors for weighting Santander UK's book, such as secured or unsecured, loan-to-value structure, and front-loaded incentivisation. Adjustments were also made to reflect term premia. New business rates are suitable for the expected behavioural life of a new-to-book asset, however an adjustment is required given Santander UK's seasoned retail asset portfolio.

 

ii) Credit cards and unsecured lending

Unsecured lending consists of unsecured personal loans, overdrafts and consumer credit (car loans). The weighted average lives of these portfolios are short, and the business was written relatively recently. As a result, contractual interest rates approximate current interest rates, and therefore no mark-to-market surplus or deficit has been recorded.

 

iii) Corporate lending

Following the transfer of the non-core corporate and legacy portfolios to Corporate Centre, the remaining corporate assets are written at current interest rates and margins and are considered appropriately provided for. A shortfall in Large Corporates relates to certain infrastructure assets which have not been transferred to Corporate Centre.

 

With respect to the non-core corporate and legacy portfolios, an exercise has been undertaken to estimate their market value, based on an orderly disposal process over a period of three years. This portfolio is well provided for, and this is reflected in a relatively small mark-to-market deficit.

 

iv) Social housing

Part of this portfolio is held for historic reasons at fair value and the methodology used to value the fair value part of the portfolio has been used to calculate the market value of the amortised cost part of the portfolio.

 

v) Commercial mortgages

The market value has been estimated using the same process as for the other non-core corporate and legacy portfolios, again assuming an orderly disposal process over a period of three years.

 

Loans and receivables securities

These debt securities consist primarily of floating rate notes, asset-backed securities and collateralised loan obligations. The fair values of the floating rate notes have been determinedusing ''valuation technique A'' as described in the valuation technique section below. The asset-backed securities and collateralised loan obligations are more complex products and are valued with the assistance of an independent, specialist valuation firm. These fair values are determined using industry-standard valuation techniques, including discounted cash-flow models. The inputs to these models used in these valuation techniques include quotes from market makers, prices of similar assets, adjustments for differences in credit spreads, and additional quantitative and qualitative research. Disposals of these securities since 2008 have demonstrated that actual sales prices achieved have been close to fair values estimated under this method.

 

b) Liabilities:

Deposits by banks

The fair value of deposits by banks, including repos, has been estimated using ''valuation technique A'' as described in the valuation technique section below.

 

Deposits by customers

The majority of deposit liabilities are payable on demand and therefore can be deemed short-term in nature with the fair value equal to the carrying value. However, given the long-term and continuing nature of the relationships with the Santander UK group's customers, the Directors believe there is significant value to the Santander UK group in this source of funds. Certain of the deposit liabilities are at a fixed rate until maturity. The deficit of fair value over carrying value of these liabilities has been estimated by reference to the market rates available at the balance sheet date for similar deposit liabilities of similar maturities. The fair value of such deposits liabilities has been estimated using ''valuation technique A'' as described in the valuation technique section below.

 

Debt securities in issue and subordinated liabilities

Where reliable prices are available, the fair value of debt securities in issue and subordinated liabilities has been calculated using quoted market prices. Other market values have been determined using ''valuation technique A'' as described in the valuation technique section below.

 

c) Fair value valuation bases of financial instruments carried at fair value

 

The following tables summarise the fair values at 31 December 2012 and 2011 of the financial asset and liability classes accounted for at fair value, analysed by the valuation methodology used by the Santander UK group to determine their fair value. The tables also disclose the percentages that the recorded fair values of financial assets and liabilities represent of the total assets and liabilities, respectively, that are recorded at fair value in the balance sheet:

 

Group

31 December 2012

Internal models based on

Balance sheet category

Quoted prices in active markets

(Level 1)

Market

observable data

(Level 2)

Significant unobservable data

(Level 3)

 

Total

Valuation technique

£m

%

£m

%

£m

%

£m

%

Assets

Trading assets

Loans and advances to banks

-

-

9,988

16

-

-

9,988

16

A

Loans and advances to customers

-

-

7,552

12

-

-

7,552

12

A

Debt securities

4,494

7

-

-

-

-

4,494

7

-

Equity securities

464

1

-

-

-

-

464

1

-

Derivative assets

Exchange rate contracts

-

-

3,103

5

36

-

3,139

5

A

Interest rate contracts

54

-

25,671

41

-

-

25,725

41

A & C

Equity and credit contracts

152

-

944

2

179

-

1,275

2

B & D

Commodity contracts

-

-

7

-

-

-

7

-

A

Financial assets at FVTPL

Loans and advances to customers

-

-

3,187

5

61

-

3,248

5

A

Debt securities

-

-

279

1

284

1

563

2

A & B

Available-for-sale financial

Equity securities

23

-

-

-

-

-

23

-

-

assets

Debt securities

5,460

9

-

-

-

-

5,460

9

-

Total assets at fair value

10,647

17

50,731

82

560

1

61,938

100

Liabilities

Trading liabilities

Deposits by banks

-

-

9,742

18

-

-

9,742

18

A

Deposits by customers

-

-

7,248

13

-

-

7,248

13

A

Short positions

4,119

8

-

-

-

-

4,119

8

-

Derivative liabilities

Exchange rate contracts

-

-

3,017

6

-

-

3,017

6

A

Interest rate contracts

31

-

23,894

45

-

-

23,925

45

A & C

Equity and credit contracts

89

-

1,766

3

57

-

1,912

3

B & D

Commodity contracts

-

-

7

-

-

-

7

-

A

Financial liabilities at FVTPL

Debt securities in issue

-

-

3,916

7

86

-

4,002

7

A

Total liabilities at fair value

4,239

8

49,590

92

143

-

53,972

100

 

 

Group

31 December 2011

Internal models based on

Balance sheet category

Quoted prices in active markets

(Level 1)

Market

observable data

(Level 2)

Significant unobservable data

(Level 3)

 

Total

Valuation technique

£m

%

£m

%

£m

%

£m

%

Assets

Trading assets

Loans and advances to banks

-

-

6,144

11

-

-

6,144

11

A

Loans and advances to customers

-

-

6,687

12

-

-

6,687

12

A

Debt securities

8,711

15

-

-

-

-

8,711

15

-

Equity securities

349

1

-

-

-

-

349

1

-

Derivative assets

Exchange rate contracts

-

-

2,735

4

70

-

2,805

4

A

Interest rate contracts

54

-

26,423

46

-

-

26,477

46

A & C

Equity and credit contracts

156

-

1,159

2

171

-

1,486

2

B & D

Commodity contracts

-

-

12

-

-

-

12

-

A

Financial assets at FVTPL

Loans and advances to customers

-

-

4,318

7

58

-

4,376

7

A

Debt securities

-

-

328

1

301

1

629

2

A & B

Available-for-sale financial

Equity securities

36

-

10

-

-

-

46

-

B

assets

Total assets at fair value

9,306

16

47,816

83

600

1

57,722

100

Liabilities

Trading liabilities

Deposits by banks

-

-

14,508

24

-

-

14,508

24

A

Deposits by customers

-

-

10,482

17

-

-

10,482

17

A

Short positions

755

1

-

-

-

-

755

1

-

Derivative liabilities

Exchange rate contracts

-

-

1,391

2

-

-

1,391

2

A

Interest rate contracts

41

-

25,107

41

-

-

25,148

41

A & C

Equity and credit contracts

12

-

2,545

4

73

-

2,630

4

B & D

Commodity contracts

-

-

11

-

-

-

11

-

A

Financial liabilities at FVTPL

Debt securities in issue

-

-

6,696

11

141

-

6,837

11

A

Total liabilities at fair value

808

1

60,740

99

214

-

61,762

100

 

 

Company

31 December 2012

Internal models based on

Balance sheet category

Quoted prices in active markets

(Level 1)

Market

observable data

(Level 2)

Significant unobservable data

(Level 3)

 

Total

Valuation technique

£m

%

£m

%

£m

%

£m

%

Assets

Derivative assets

Exchange rate contracts

-

-

1,145

22

-

-

1,145

22

A

Interest rate contracts

-

-

3,727

70

-

-

3,727

70

A & C

Equity and credit contracts

-

-

27

1

-

-

27

1

B & D

Financial assets at FVTPL

Loans and advances to customers

-

-

44

1

-

-

44

1

A

Available-for-sale financial

Equity securities

10

-

-

-

-

-

10

-

-

assets

Debt securities

347

7

-

-

-

-

347

7

-

Total assets at fair value

357

7

4,943

93

-

-

5,300

100

Liabilities

Derivative liabilities

Exchange rate contracts

-

-

772

38

-

-

772

38

A

Interest rate contracts

-

-

1,074

52

-

-

1,074

52

A & C

Equity and credit contracts

-

-

205

10

-

-

205

10

B

Total liabilities at fair value

-

-

2,051

100

-

-

2,051

100

 

Company

31 December 2011

Internal models based on

Balance sheet category

Quoted prices in active markets

(Level 1)

Market

observable data

(Level 2)

Significant unobservable data

(Level 3)

 

Total

Valuation technique

£m

%

£m

%

£m

%

£m

%

Assets

Derivative assets

Exchange rate contracts

-

-

1,310

21

-

-

1,310

21

A

Interest rate contracts

-

-

4,671

77

-

-

4,671

77

A & C

Equity and credit contracts

-

-

20

-

-

-

20

-

B & D

Financial assets at FVTPL

Loans and advances to customers

-

-

45

1

-

-

45

1

A

Available-for-sale financial

Equity securities

25

1

9

-

-

-

34

1

B

assets

Total assets at fair value

25

1

6,055

99

-

-

6,080

100

Liabilities

Derivative liabilities

Exchange rate contracts

-

-

39

3

-

-

39

3

A

Interest rate contracts

-

-

960

80

-

-

960

80

A & C

Equity and credit contracts

-

-

208

17

-

-

208

17

B & D

Financial liabilities at FVTPL

Debt securities in issue

-

-

1

-

-

-

1

-

A

Total liabilities at fair value

-

-

1,208

100

-

-

1,208

100

 

 

During 2012, 2011 and 2010, there were no transfers between Level 1, Level 2 and Level 3 financial instruments.

 

The following tables present the fair values at 31 December 2012 and 2011 of the above financial assets and liabilities by product, analysed by the valuation methodology used by the Santander UK group to determine their fair value. The tables also disclose the percentages that the recorded fair values of products represent of the total assets and liabilities, respectively, that are recorded at fair value in the balance sheet:

 

Group

 

31 December 2012

Internal models based on

 

Product

Quoted prices in

active markets

Market observable data

Significant unobservable data

Total

 

 

£m

%

£m

%

£m

%

£m

%

 

 

Assets

 

 

Government and government-guaranteed debt securities

3,917

6

-

-

-

-

3,917

6

 

 

Asset-backed securities

-

-

279

1

284

1

563

2

 

 

Certificates of deposits

13

-

-

-

-

-

13

-

 

 

Floating rate notes

564

1

-

-

-

-

564

1

 

 

Other debt securities

5,460

9

-

-

-

-

5,460

9

 

 

UK Social housing association loans

-

-

3,187

5

-

-

3,187

5

 

 

Other loans

-

-

-

-

61

-

61

-

 

 

Term deposits and money market instruments

-

-

17,540

28

-

-

17,540

28

 

 

Exchange rate derivatives

-

-

3,103

5

36

-

3,139

5

 

 

Interest rate derivatives

54

-

25,671

41

-

-

25,725

41

 

 

Equity & credit derivatives

152

-

944

2

179

-

1,275

2

 

 

Commodity derivatives

-

-

7

-

-

-

7

-

 

 

Ordinary shares and similar securities

487

1

-

-

-

-

487

1

 

 

10,647

17

50,731

82

560

1

61,938

100

 

 

Liabilities

 

 

Exchange rate derivatives

-

-

3,017

6

-

-

3,017

6

 

 

Interest rate derivatives

31

-

23,894

45

-

-

23,925

44

 

 

Equity & credit derivatives

89

-

1,766

3

57

-

1,912

4

 

 

Commodity derivatives

-

-

7

-

-

-

7

-

 

 

Deposits

-

8

16,990

31

-

-

16,990

31

 

 

Debt securities in issue

4,119

-

3,916

7

86

-

8,122

15

 

4,239

8

49,590

92

143

-

53,972

100

 

 

 

 

Group

 

31 December 2011

Internal models based on

 

Product

Quoted prices in

active markets

Market observable data

Significant unobservable data

Total

 

 

£m

%

£m

%

£m

%

£m

%

 

 

Assets

 

 

Government and government-guaranteed debt securities

2,943

5

-

-

-

-

2,943

5

 

 

Asset-backed securities

-

-

328

1

301

1

687

2

 

 

Floating rate notes

5,768

10

-

-

-

-

5,768

10

 

 

UK Social housing association loans

-

-

4,318

7

-

-

4,318

7

 

 

Other loans

-

-

-

-

58

-

58

-

 

 

Term deposits and money market instruments

-

-

12,831

22

-

-

12,831

22

 

 

Exchange rate derivatives

-

-

2,735

5

70

-

2,805

5

 

 

Interest rate derivatives

54

-

26,423

46

-

-

26,477

46

 

 

Equity & credit derivatives

156

1

1,159

1

171

-

1,486

2

 

 

Commodity derivatives

-

-

12

-

-

-

12

-

 

 

Ordinary shares and similar securities

385

1

10

-

-

-

395

1

 

 

9,306

17

47,816

82

600

1

57,722

100

 

 

Liabilities

 

 

Exchange rate derivatives

-

-

1,391

2

-

-

1,391

2

 

 

Interest rate derivatives

41

-

25,107

41

-

-

25,148

41

 

 

Equity & credit derivatives

12

-

2,545

4

73

-

2,630

4

 

 

Commodity derivatives

-

-

11

-

-

-

11

-

 

 

Deposits

755

1

24,990

12

-

-

24,990

41

 

 

Debt securities in issue

-

-

6,696

40

141

-

7,592

12

 

808

1

60,740

99

214

-

61,762

100

 

 

 

Company

 

31 December 2012

Internal models based on

 

Product

Quoted prices in

active markets

Market observable data

Significant unobservable data

Total

 

 

£m

%

£m

%

£m

%

£m

%

 

 

Assets

 

 

Other debt securities

347

7

-

-

-

-

347

7

 

 

UK Social housing association loans

-

-

44

1

-

-

44

1

 

 

Exchange rate derivatives

-

-

1,145

22

-

-

1,145

22

 

 

Interest rate derivatives

-

-

3,727

70

-

-

3,727

70

 

 

Equity & credit derivatives

-

-

27

1

-

-

27

-

 

 

Ordinary shares and similar securities

10

-

-

-

-

-

10

-

 

 

357

7

4,943

93

-

-

5,300

100

 

 

Liabilities

 

 

Exchange rate derivatives

-

-

772

38

-

-

772

38

 

 

Interest rate derivatives

-

-

1,074

52

-

-

1,074

52

 

 

Equity & credit derivatives

-

-

205

10

-

-

205

10

 

 

Deposits and debt securities in issue

-

-

-

-

-

-

-

-

 

-

-

2,051

100

-

-

2,051

100

 

 

 

Company

 

31 December 2011

Internal models based on

 

Product

Quoted prices in

active markets

Market observable data

Significant unobservable data

Total

 

 

£m

%

£m

%

£m

%

£m

%

 

 

Assets

 

 

UK Social housing association loans

-

-

45

1

-

-

45

1

 

 

Exchange rate derivatives

-

-

1,310

22

-

-

1,310

22

 

 

Interest rate derivatives

-

-

4,671

77

-

-

4,671

77

 

 

Equity & credit derivatives

-

-

20

-

-

-

20

-

 

 

Ordinary shares and similar securities

25

-

9

-

-

-

34

-

 

 

25

-

6,055

100

-

-

6,080

100

 

 

Liabilities

 

 

Exchange rate derivatives

-

-

39

3

-

-

39

3

 

 

Interest rate derivatives

-

-

960

80

-

-

960

80

 

 

Equity & credit derivatives

-

-

208

17

-

-

208

17

 

 

Deposits and debt securities in issue

-

-

1

-

-

-

1

-

 

-

-

1,208

100

-

-

1,208

100

 

 

d) Valuation techniques

 

The main valuation techniques employed in the Santander UK group's internal models to measure the fair value of the financial instruments disclosed above at 31 December 2012 and 2011 are set out below. In substantially all cases, the principal inputs into these models are derived from observable market data. The Santander UK group did not make any material changes to the valuation techniques and internal models it used during the years ended 31 December 2012, 2011 and 2010.

 

A

In the valuation of financial instruments requiring static hedging (for example interest rate, currency derivatives and commodity swaps) and in the valuation of loans and advances and deposits, the 'present value' method is used. Expected future cash flows are discounted using the interest rate curves of the applicable currencies or forward commodity prices as appropriate. The interest rate curves are generally observable market data and reference yield curves derived from quoted interest rates in appropriate time bandings, which match the timings of the cash flows and maturities of the instruments. The forward commodity prices are generally observable market data.

 

B

In the valuation of equity financial instruments requiring dynamic hedging (principally equity securities, options and other structured instruments), proprietary local volatility and stochastic volatility models are used. These types of models are widely accepted in the financial services industry. Observable market inputs used in these models include the bid-offer spread, foreign currency exchange rates, volatility and correlation between indices. In limited circumstances, other inputs may be used in these models that are based on data other than observable market data, such as the Halifax's UK House Price Index ('HPI') volatility, HPI forward growth, HPI spot rate, and mortality.

 

C

In the valuation of financial instruments exposed to interest rate risk that require either static or dynamic hedging (such as interest rate futures, caps and floors, and options), the present value method (futures), Black's model (caps/floors) and the Hull/White and Markov functional models (Bermudan options) are used. These types of models are widely accepted in the financial services industry. The significant inputs used in these models are observable market data, including appropriate interest rate curves, volatilities, correlations and exchange rates. In limited circumstances, other inputs may be used in these models that are based on data other than observable market data, such as HPI volatility, HPI forward growth, HPI spot rate and mortality.

 

D

In the valuation of linear instruments such as credit risk and fixed-income derivatives, credit risk is measured using dynamic models similar to those used in the measurement of interest rate risk. In the case of non-linear instruments, if the portfolio is exposed to credit risk such as credit derivatives, the probability of default is determined using the par spread level. The main inputs used to determine the underlying cost of credit of credit derivatives are quoted credit risk premiums and the correlation between the quoted credit derivatives of various issuers.

 

The fair values of the financial instruments arising from the Santander UK group's internal models take into account, among other things, contract terms and observable market data, which include such factors as bid-offer spread, interest rates, credit risk, exchange rates, the quoted market price of raw materials and equity securities, volatility and prepayments. In all cases, when it is not possible to derive a valuation for a particular feature of an instrument, management uses judgement to determine the fair value of the particular feature. In exercising this judgement, a variety of tools are used including proxy observable data, historical data and extrapolation techniques. Extrapolation techniques take into account behavioural characteristics of equity markets that have been observed over time, and for which there is a strong case to support an expectation of a continuing trend in the future. Estimates are calibrated to observable market prices when they become available.

The estimates thus obtained could vary if other valuation methods or assumptions were used. The Santander UK group believes its valuation methods are appropriate and consistent with other market participants. Nevertheless, the use of different valuation methods or assumptions, including imprecision in estimating unobservable market inputs, to determine the fair value of certain financial instruments could result in different estimates of fair value at the reporting date and the amount of gain or loss recorded for a particular instrument. Most of the valuation models are not significantly subjective, because they can be tested and, if necessary, recalibrated by the internal calculation of and subsequent comparison to market prices of actively traded securities, where available.

 

e) Fair value adjustments

 

The internal models incorporate assumptions that the Santander UK group believes would be made by a market participant to establish fair value. Fair value adjustments are adopted when the Santander UK group considers that there are additional factors that would be considered by a market participant in the determination of fair value of the instrument that are not incorporated in the valuation model. The magnitude of fair value adjustments depends upon many entity-specific factors, including modelling sophistication, the nature of products traded, and the size and type of risk exposures. For this reason, fair value adjustments may not be comparable across the banking industry.

 

The Santander UK group classifies fair value adjustments as either 'risk-related' or 'model-related'. The fair value adjustments form part of the portfolio fair value and are included in the balance sheet values of the product types to which they have been applied. The majority of these adjustments relate to Markets. The magnitude and types of fair value adjustment adopted by Markets are listed in the following table:

 

 

 

2012

£m

2011

£m

Risk-related:

- Bid-offer and trade specific adjustments

26

71

- Uncertainty

22

47

- Credit risk adjustment

107

70

155

188

Model-related:

- Model limitation

17

23

Day One profits

-

-

172

211

 

Risk-related adjustments

'Risk-related' adjustments are driven, in part, by the magnitude of the Santander UK group's market or credit risk exposure, and by external market factors, such as the size of market spreads.

 

(i) Bid-offer and trade specific adjustments

IAS 39 requires that portfolios are marked at bid or offer, as appropriate. Bid prices represent the price at which a long position could be sold and offer prices represent the price at which a short position could be bought back. Valuation models will typically generate mid market values. The bid-offer adjustment reflects the cost that would be incurred if substantially all residual net portfolio market risks were closed using available hedging instruments or by disposing of or unwinding the actual position.

 

The majority of the bid-offer adjustment relates to OTC derivative portfolios. For each portfolio, the major risk types are identified. These may include, inter alia, delta (the sensitivity to changes in the price of an underlying), vega (the sensitivity to changes in volatilities) and basis risk (the sensitivity to changes in the spread between two rates). For each risk type, the net portfolio risks are first classified into buckets, and then a bid-offer spread is applied to each risk bucket based upon the market bid-offer spread for the relevant hedging instrument.

 

The granularity of the risk bucketing is determined by reference to several factors, including the actual risk management practice undertaken by the Santander UK group, the granularity of risk bucketing within the risk reporting process, and the extent of correlation between risk buckets. Within a risk type, the bid-offer adjustment for each risk bucket may be aggregated without offset or limited netting may be applied to reflect correlation between buckets. There is no netting applied between risk types or between portfolios that are not managed together for risk management purposes. There is no netting across legal entities.

 

As bid-offer spreads vary by maturity and risk type to reflect different spreads in the market, for positions where there is no observable quote, a trade specific adjustment is further made. This is to reflect widened spreads in comparison to proxies due to reduced liquidity or observability. Trade specific adjustments can also be made to incorporate liquidity triggers whereby wider spreads are applied to risks above pre-defined thresholds or on exotic products to ensure overall reserves match market close-out costs. These market close-out costs inherently incorporate risk decay and cross-effects which are unlikely to be adequately reflected in the static hedge based on vanilla instruments.

 

(ii) Uncertainty

Certain model inputs may be less readily determinable from market data, and/or the choice of model itself may be more subjective, with less market evidence available from which to determine general market practice. In these circumstances, there exists a range of possible values that the financial instrument or market parameter may assume and an adjustment may be necessary to reflect the likelihood that in estimating the fair value of the financial instrument, market participants would adopt rather more conservative values for uncertain parameters and/or model assumptions than those used in the valuation model. Uncertainty adjustments are derived by considering the potential range of derivative portfolio valuation given the available market data. The objective of an uncertainty adjustment is to arrive at a fair value that is not overly prudent but rather reflects a level of prudence believed to be consistent with market pricing practice.

 

Uncertainty adjustments are applied to various types of exotic OTC derivative. For example, the mean reversion speed of interest rates may be an important component of an exotic derivative value and an uncertainty adjustment may be taken to reflect the range of possible values that market participants may assume for this parameter.

 

(iii) Credit risk adjustment

The Santander UK group adopts a credit risk adjustment (also frequently known as a 'credit valuation adjustment') against OTC derivative transactions to reflect within fair value the possibility that the counterparty may default, and the Santander UK group may not receive the full market value of the transactions. The Santander UK group calculates a separate credit risk adjustment for each Santander UK legal entity, and within each entity for each counterparty to which the entity has exposure. The Santander UK group attempts to mitigate credit risk to third parties by entering into netting and collateral arrangements. The net counterparty exposure (i.e. counterparty positions netted by offsetting transactions and both cash and securities collateral) is then assessed for counterparty creditworthiness. The Santander UK group has only a limited exposure to monolines, consisting of 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, as described in Note 23. The description below relates to the credit risk adjustment taken against counterparties other than monolines.

 

The Santander UK group calculates the credit risk adjustment by applying the probability of default of the counterparty to the expected positive exposure to the counterparty, and multiplying the result by the loss expected in the event of default (i.e. the loss given default ('LGD')). The timing of the expected losses is reflected by using a discount factor. The calculation is performed over the life of the potential exposure i.e. the credit risk adjustment is measured as a lifetime expected loss.

 

The expected positive exposure is calculated at a trade level. The main drivers of the expected positive exposure are the size of the risk position with the counterparty along with the prevailing market environment. Probabilities of default are calculated using credit default swap prices where available. Where these are not available, probabilities of default are based upon analysis of historic default rates. The credit rating used for a particular counterparty is that determined by the Santander UK group's internal credit process. The LGD is calculated at the facility level and takes into account the counterparty characteristics. Credit ratings and LGD are updated by the credit team as new relevant information becomes available and at periodic reviews performed at least annually.

 

The Santander UK group also considers its own creditworthiness when determining the fair value of an instrument, including OTC derivative instruments and financial liabilities held at fair value through profit or loss if the Santander UK group believes market participants would take that into account when transacting the respective instrument. The approach to measuring the impact of the Santander UK group's credit risk on an instrument is done in the same manner as for third party credit risk. The impact of the Santander UK group's credit risk is considered when calculating the fair value of an instrument, even when credit risk is not readily observable such as in OTC derivatives. The Santander UK group has not realised any profit or loss on revaluing fair values of derivatives to reflect its own creditworthiness. If the Santander UK group had reflected such adjustments it would not have had a material impact on the valuations. Consequently, the Santander UK group does not derive the adjustment on a bilateral basis and has a zero adjustment against derivative liabilities, often referred to as a 'debit valuation adjustment'.

 

For certain types of exotic derivatives where the products are not currently supported by the standard methodology, the Santander UK group adopts an alternative methodology. Alternative methodologies used by the Santander UK group fall into two categories. One method maps transactions against the results for similar products which are accommodated by the standard methodology. Where such a mapping approach is not appropriate, a bespoke methodology is used, generally following the same principles as the standard methodology, reflecting the key characteristics of the instruments but in a manner that is computationally less intensive. The calculation is applied at a trade level, with more limited recognition of credit mitigants such as netting or collateral agreements than used in the standard methodology described previously.

 

The methodologies do not, in general, account for 'wrong-way risk'. Wrong-way risk arises where the underlying value of the derivative prior to any credit risk adjustment is related to the probability of default of the counterparty. A more detailed description of wrong-way risk is set out below.

 

The Santander UK group includes all third-party counterparties in the credit risk adjustment calculation and the Santander UK group does not net credit risk adjustments across Santander UK group entities.

 

Wrong-way risk

Wrong-way risk arises when there is a strong correlation between the counterparty's probability of default and the mark-to-market value of the underlying transaction. Wrong-way risk can be seen in the following examples:

 

when the counterparty is resident and/or incorporated in an emerging market and seeks to sell a non-domestic currency in exchange for its home currency;

> 

when the trade involves the purchase of an equity put option from a counterparty whose shares are the subject of the option;

> 

the purchase of credit protection from a counterparty who is closely associated with the reference entity of the credit default swap or total return swap; and

> 

the purchase of credit protection on an asset type which is highly concentrated in the exposure of the counterparty selling the credit protection.

 

Exposure to 'wrong way risk' is limited via internal governance processes and deal pricing. The Santander UK group considers that an appropriate adjustment to reflect wrong way risk is currently nil (2011: nil).

 

Model-related adjustments

These adjustments are primarily related to internal factors, such as the ability of the Santander UK group's models to incorporate all material market characteristics. A description of each adjustment type is given below:

 

(i) Model limitation

Models used for portfolio valuation purposes, particularly for exotic derivative products, may be based upon a simplifying set of assumptions that do not capture all material market characteristics or may be less reliable under certain market conditions. Additionally, markets evolve, and models that were adequate in the past may require development to capture all material market characteristics in current market conditions. In these circumstances, model limitation adjustments are adopted outside the core valuation model. The adjustment methodologies vary according to the nature of the model. The Quantitative Risk Group ('QRG'), an independent quantitative support function reporting into the Risk Department, highlights the requirement for model limitation adjustments and develops the methodologies employed. Over time, as model development progresses, model limitations are addressed within the core revaluation models and a model limitation adjustment is no longer needed.

 

Day One profits adjustments

Day One profit adjustments are adopted where the fair value estimated by a valuation model is based on one or more significant unobservable inputs, in accordance with IAS 39. Day One profits adjustments are amounts that have yet to be recognised in the income statement, which represent the difference between a transaction price (i.e. the fair value at initial recognition) and the amount that would have arisen had valuation models using unobservable inputs been used on initial recognition), less amounts subsequently recognised. Day One profits adjustments are calculated and reported on a portfolio basis. At 31 December 2012 and 2011, the Day One profits adjustments were less than £1m.

 

f) Control framework

 

Fair values are subject to a control framework designed to ensure that they are either determined or validated by a function independent of the risk-taker. To this end, ultimate responsibility for the determination of fair values lies jointly with the Risk Department and the Finance Department. For all financial instruments where fair values are determined by reference to externally quoted prices or observable pricing inputs to models, independent price determination or validation is utilised. In inactive markets, direct observation of a traded price may not be possible. In these circumstances, the Santander UK group will source alternative market information to validate the financial instrument's fair value, with greater weight given to information that is considered to be more relevant and reliable.

The factors that are considered in this regard include:

 

the extent to which prices may be expected to represent genuine traded or tradeable prices;

the degree of similarity between financial instruments;

the degree of consistency between different sources;

the process followed by the pricing provider to derive the data;

the elapsed time between the date to which the market data relates and the balance sheet date; and

the manner in which the data was sourced.

 

 

The source of pricing data is considered as part of the process that determines the classification of the level of a financial instrument. Consideration is given to the quality of the information available that provides the current mark-to-model valuation and estimates of how different these valuations could be on an actual trade, taking into consideration how active the market is. For spot assets that cannot be sold due to illiquidity, forward estimates are discounted to provide an estimate of a realisable value over time. All adjustments for illiquid positions are regularly reviewed to reflect changing market conditions.

 

Internal valuation model review

Models provide a logical framework for the capture and processing of necessary valuation inputs. For fair values determined using a valuation model, the control framework may include, as applicable, independent development or validation of:

 

the logic within valuation models;

the inputs to those models;

any adjustments required outside the valuation models; and

where possible, model outputs.

 

All internal valuation models are validated independently by QRG. A validation report is produced for each model-derived valuation that assesses the mathematical assumptions behind the model and the implementation of the model and its integration within the trading system. Where there is observable market data, the models calibrate to market. Where pricing data is unobservable then the input parameters are regularly reviewed by QRG.

 

The results of the independent valuation process are presented to the Models Committee UK for formal approval. Various Risk functions are represented including QRG and Trading Market Risk in addition to senior management. The members of the Models Committee UK consider the appropriateness of the model and whether model risk fair value adjustments are required. Any changes to the fair value adjustments methodology must also be approved by the Models Committee UK.

 

g) Internal models based on observable market data (Level 2)

 

1. Trading Assets

 

Loans and advances to banks and loans and advances to customers - securities purchased under resale agreements

These instruments consist of reverse repos with both professional non-bank customers and bank counterparties as part of the Santander UK group's trading activities. The fair value of reverse repos is estimated by using the 'present value' method. Future cash flows are evaluated taking into consideration any derivative features of the reverse repos and are then discounted using the appropriate market rates for the applicable maturity and currency. Under these agreements, the Santander UK group receives collateral with a market value equal to, or in excess of, the principal amount loaned. The level of collateral held is monitored daily and if required, further calls are made to ensure the market values of collateral remains at least equal to the loan balance. As a result, there would be no adjustment, or an immaterial adjustment, to reflect the credit quality of the counterparty related to these agreements. As the inputs used in the valuation are based on observable market data, these reverse repos are classified within level 2 of the valuation hierarchy.

 

Loans and advances to banks and loans and advances to customers - other

These instruments consist of term deposits placed which are short-term in nature and are both utilised and managed as part of the funding requirements of the trading book. The fair value of loans and advances to banks and loans and advances to customers is estimated using the 'present value' method. Expected future cash flows are discounted using the interest rate curves of the applicable currencies. The interest rate curves are generally observable market data and reference yield curves derived from quoted interest rates in appropriate time bandings, which match the timings of the cashflows and maturities of the instruments. As the inputs used in the valuation are based on observable market data, these loans are classified within level 2 of the valuation hierarchy.

 

2. Derivative assets and liabilities

 

These instruments consist of exchange rate contracts, interest rate contracts, equity and credit contracts and equity derivatives. The models used in estimating the fair value of these derivatives do not contain a high level of subjectivity as the methodologies used in the models do not require significant judgement, and the inputs used in the models are observable market data such as plain vanilla interest rate swaps and option contracts. As the inputs used in the valuation are based on observable market data, these derivatives are classified within level 2 of the valuation hierarchy.

 

Certain derivatives which represent cross currency swaps, reversionary property interests, credit default swaps and options and forwards contain significant unobservable inputs or are traded less actively or traded in less-developed markets, and so are classified within level 3 of the valuation hierarchy. The valuation of such instruments is further discussed in the 'internal models based on information other than market data' section below.

 

3. Financial assets at fair value through profit or loss ('FVTPL')

 

Loans and advances to customers

These instruments consist of loans secured on residential property to housing associations. The fair value of these social housing loans is estimated using the 'present value' model based on a credit curve derived from current market spreads observable in the social housing loan data. Observable market data include current market spreads for new accepted mandates and bids for comparable loans and are used to support or challenge the benchmark level. This provides a range of reasonably possible estimates of fair value. As the inputs used in the valuation are based on market observable data, these loans are classified within level 2 of the valuation hierarchy.

 

Certain loans and advances to customers which represent a portfolio of roll-up mortgages contain significant unobservable inputs and so are classified within level 3 of the valuation hierarchy. The valuation of such instruments is further discussed below.

 

Debt securities

These instruments consist of holdings of asset-backed securities. A significant portion of these securities are priced using the 'present value' models, based on observable market data e.g. LIBOR, credit spreads. Where there are quoted prices for these instruments, the model value is checked against the quoted prices for reference purposes, but is not used as the fair value as the market for these instruments are lacking in liquidity and depth. As the inputs used in the valuation are based on observable market data, these debt securities are classified within level 2 of the valuation hierarchy.

 

Certain debt securities which represent reversionary property securities and securities issued by Santander entities contain significant unobservable inputs, and so are classified within level 3 of the valuation hierarchy. The valuation of such instruments is further discussed below.

 

4. Available-for-sale financial assets - Equity securities

 

These instruments consist of unquoted equity investments in companies providing infrastructure services to the financial services industry and a small portfolio held within the Santander UK Foundation (which is consolidated by the Santander UK group). In the valuation of equity financial instruments requiring dynamic hedging, proprietary local volatility and stochastic volatility models are used. These types of models are widely accepted in the financial services industry.

 

Observable market inputs used in these models include the bid-offer spread, foreign currency exchange rates, volatility and correlation between indices. As the inputs used in the valuation are based on observable market data, these equity securities are classified within level 2 of the valuation hierarchy.

 

5. Trading liabilities

 

Deposits by banks and deposits by customers - securities sold under repurchase agreements

These instruments consist of repos with both professional non-bank customers and bank counterparties as part of the Santander UK group's trading activities. The fair value of repos is estimated using the same technique as those reverse repos in trading assets discussed above. Under these agreements, the Santander UK group is required to provide and maintain collateral with a market value equal to, or in excess of, the principal amount borrowed. As a result, there would be no adjustment, or an immaterial adjustment, to reflect the credit quality of the Santander UK group related to these agreements. As the inputs used in the valuation are based on observable market data, these repos are classified within level 2 of the valuation hierarchy.

 

Deposits by banks and deposits by customers - other

These instruments consist of certain term and time deposits which tend to be short-term in nature and are both utilised and managed as part of the funding requirements of the trading book. These instruments are valued using the same techniques as those instruments in trading assets - loans and advances to banks and loans and advances to customers discussed above. As the inputs used in the valuation are based on observable market data, these deposits are classified within level 2 of the valuation hierarchy.

 

6. Financial liabilities at FVTPL

 

Debt securities in issue

These instruments include commercial paper, medium term notes and other bonds and are valued using the same techniques as those instruments in financial assets at FVTPL - debt securities discussed above. As the inputs used in the valuation are based on observable market data, these debt securities are classified within level 2 of the valuation hierarchy.

 

Certain debt securities in issue which represent the more exotic senior debt issuances, consisting of power reverse dual currency ('PRDC') notes contain significant unobservable inputs and so are classified within level 3 of the valuation hierarchy. The valuation of such instruments is further discussed below.

 

h) Internal models based on information other than market data (Level 3)

 

The table below provides an analysis of financial instruments valued using internal models based on information other than market data together with the subsequent valuation technique used for each type of instrument. Each instrument is initially valued at transaction price:

 

Balance sheet

value

Amount recognised in income/(expense)

2012

2011

2012

2011

2010

Balance sheet line item

Category

Financial instrument product type

£m

£m

£m

£m

£m

1. Derivative assets

Exchange rate contracts

Cross-currency swaps

36

70

(5)

6

42

2. Derivative assets

Equity and credit contracts

Reversionary property interests

76

78

2

15

(6)

3. Derivative assets

Credit contracts

Credit default swaps

17

16

1

1

-

4. Derivative assets

Equity contracts

Options and forwards

86

77

-

(7)

(8)

5. FVTPL

Loans and advances to customers

Roll-up mortgage portfolio

61

58

3

8

5

6. FVTPL

Debt securities

Reversionary property securities

235

250

10

37

2

7. FVTPL

Debt securities

Mortgage-backed securities

49

51

4

(8)

53

8. Derivative liabilities

Equity contracts

Options and forwards

(57)

(73)

3

(3)

99

9. FVTPL

Debt securities in issue

Non-vanilla debt securities

(86)

(141)

7

(6)

(42)

Total net assets

417

386

-

-

-

Total income/(expense)

-

-

25

43

145

 

Valuation technique

 

1. Derivative assets - Exchange rate contracts

These cross currency swaps are used to hedge the foreign currency risks arising from the power reverse dual currency ('PRDC') notes issued by the Santander UK group, as described in Instrument 9 below. These derivatives are valued using a standard valuation model valuing each leg of the swap, with expected future cash flows less notional amount exchanged at maturity date discounted using an appropriate floating rate. The floating rate is adjusted by the relevant cross currency basis spread. Interest rates, foreign exchange rates, cross currency basis spread and long-dated foreign exchange ('FX') volatility are used as inputs to determine fair value. Interest rates, foreign exchange rates are observable on the market.

 

Cross currency spreads may be market observable or unobservable depending on the liquidity of the cross currency pair. As the Japanese Yen-US dollar cross currency pair related to the PRDC notes is liquid, the cross currency spreads (including long-dated cross currency spread) for these swaps are market observable. The significant unobservable inputs for the valuation of these financial instruments are the long-dated FX volatility and the correlation between the underlying assets.

 

The correlation between the underlying assets is assumed to be zero, as there are no actively traded options from which correlations between the underlying assets could be implied. Furthermore, the zero correlation assumption implies that the sources of the long-dated FX volatility are independent.

 

Long-dated FX volatility

Long-dated FX volatility is extrapolated from shorter-dated FX volatilities which are directly observable on the market. Short-dated FX volatility is observable from the trading of FX options. As there is no active market for FX options with maturities greater than five years (long-dated FX options), long-dated FX volatility is not market observable. Furthermore, as historical prices are not relevant in determining the cost of hedging long-dated FX risk, long-dated FX volatility cannot be inferred from historical volatility. The Santander UK group extrapolates the long-dated FX volatility from the shorter-dated FX volatilities using Black's model.

 

FX volatility is modelled as the composition of the domestic interest rate, foreign interest rates and FX spot volatilities using standard Hull-White formulae. The Hull-White approach is used for estimating the future distribution of domestic and foreign zero-coupon rates, constructed from the relevant yield curves. Using short-dated FX options, the FX spot volatility is calculated which is then extrapolated to derive the long-dated FX volatility.

 

2. Derivative assets - Equity and credit contracts

These reversionary property derivatives are valued using a probability weighted set of HPI forward prices, which are assumed to be a reasonable representation of the increase in value of the Santander UK group's reversionary interest portfolio underlying the derivatives. The probability used reflects the likelihood of the home owner vacating the property and is calculated from mortality rates and acceleration rates which are a function of age and gender, obtained from the relevant mortality tables. Indexing is felt to be appropriate due to the size and geographical dispersion of the Santander UK group's reversionary interest portfolio. These are determined using HPI Spot Rates adjusted to reflect estimated forward growth. Launched in 1984, the Halifax's UK HPI is the UK's longest running monthly house price data series covering the whole country. The indices calculated are standardised and represent the price of a typically transacted house. Both national and regional HPI are published. The national HPI is published monthly. The regional HPI reflects the national HPI disaggregated into 12 UK regions and is published quarterly. Both indices are published on two bases, including and excluding seasonal adjustments in the housing market. The Santander UK group uses the non-seasonally adjusted ('NSA') national and regional HPI in its valuation model to avoid any subjective judgement in the adjustment process which is made by Halifax.

 

The inputs used to determine the value of the reversionary property derivatives are HPI spot, HPI forward growth and mortality rates. The principal pricing parameter is HPI forward growth.

 

HPI Spot Rate

The HPI spot rate used in the model is a weighted average of NSA regional HPI spot rates i.e. adjusted for difference in the actual regional composition of the property underlying the Santander UK group's reversionary interest portfolio and the composition of the published regional indices. The regional HPI spot rate (which is observable market data) is only published on specific quarterly dates. In between these dates, its value is estimated by applying the growth rate over the relevant time period inferred from the national HPI spot rates (which are observable market data and published monthly) to the most recently calculated weighted average regional HPI spot rate based on published regional indices.

 

An adjustment is also made to reflect the specific property risk i.e. possible deviation between the actual growth in the house prices underlying the Santander UK group's reversionary interest portfolio and their assumed index-linked growth, which is based on the regional HPI. This adjustment is based on the average historical deviation of price changes of the Santander UK group's actual property portfolio from that of the published indices over the time period since the last valuation date.

 

HPI Forward Growth Rate

Long-dated HPI forward growth rate is not directly observable in the market but is estimated from broker quotes and traded forward contracts. A specific spread is applied to the long-dated forward growth rate to reflect the uncertainty surrounding long dated data. This spread is calculated by analysing the historical volatility of the HPI, whilst incorporating mean reversion. An adjustment is made to reflect the specific property risk as for the HPI spot rate above.

 

Mortality Rate

Mortality rates are obtained from the PNMA00 and PNFA00 Continuous Mortality Investigation Tables published by the UK Institute and Faculty of Actuaries. These mortality rates are adjusted by acceleration rates to reflect the mortality profile of the holders of Santander UK group's reversionary property products underlying the derivatives.

 

3. Derivative assets - Equity and credit contracts

These derivative assets are credit default swaps held against certain bonds. The credit default swaps are valued using the credit spreads of the referenced bonds. These referenced bonds are valued with the assistance of valuations prepared by an independent, specialist valuation firm as a deep and liquid market does not exist.

 

In valuing the credit default swaps, the main inputs used to determine the underlying cost of credit are quoted risk premiums and the correlation between the quoted credit derivatives of various issuers. The assumptions relating to the correlation between the values of quoted and unquoted assets are based on historical correlations between the impact of adverse changes in market variables and the corresponding valuation of the associated unquoted assets. The measurement of the assets will vary depending on whether a more or less conservative scenario is selected. The other main input is the probability of default of the referenced bonds. The significant unobservable input for the valuation of these financial instruments is the probability of default.

 

Probability of default

The probability of default is assessed by considering the credit quality of the underlying referenced bonds. However, as no deep and liquid market exists for these assets the assessment of the probability of default is not directly observable and instead an estimate is calculated using the Standard Gaussian Copula model.

 

4. Derivative assets - Equity contracts

There are three types of derivatives within this category:

 

European options - These derivatives are valued using a modified Black-Scholes model where the HPI is log-normally distributed with the forward rates determined from the HPI forward growth.

Asian options - Asian (or average value) options are valued using a modified Black-Scholes model, with an amended strike price and volatility assumption to account for the average exercise period, through a closed form adjustment that reflects the strike price relative to the distribution of stock prices at each relevant date. This is also known as the Curran model.

Forward contracts - Forward contracts are valued using a standard forward pricing model.

 

The inputs used to determine the value of the above instruments are HPI spot rate, HPI forward growth rate and HPI volatility. The principal pricing parameter is HPI forward growth rate.

 

HPI Spot Rate

The HPI spot rate used is the NSA national HPI spot rate which is published monthly and directly observable in the market. This HPI rate used is different from the weighted average regional HPI spot rate used in the valuation of Instrument 2 above, as the underlying of these derivatives is the UK national HPI spot rate.

 

HPI Forward Growth Rate

The HPI forward growth rate used is unobservable and is the same as used in the valuation of Instrument 2 above.

 

HPI Volatility

Long-dated HPI volatility is not directly observable in the market but is estimated from the most recent traded values. An adjustment is applied to the long-dated HPI volatility rate to reflect the uncertainty surrounding long-dated data. This adjustment is based on the empirical standard deviation of historical volatility over a range of time horizons.

 

5. FVTPL - Loans and advances to customers

These loans and advances to customers represent roll-up mortgages, which are an equity release scheme under which a property owner takes out a loan secured against their home. The owner does not make any interest payments during their lifetime and the fixed interest payments are rolled up into the mortgage. The loan or mortgage (capital and rolled-up interest) is repaid upon the owner's vacation of the property and the value of the loan is only repaid from the value of the property. This is known as a 'no negative pledge'. The Santander UK group suffers a loss if the sale proceeds from the property are insufficient to repay the loan, as it is unable to pursue the homeowner's estate or beneficiaries for the shortfall.

 

The value of the mortgage 'rolls up' or accretes until the owner vacates the property. In order to value the roll-up mortgages, the Santander UK group uses a probability-weighted set of European option prices (puts) determined using the Black-Scholes model, in which the 'no negative pledges' are valued as short put options. The probability weighting applied is calculated from mortality rates and acceleration rates as a function of age and gender, taken from mortality tables.

 

The inputs used to determine the value of these instruments are HPI spot, HPI forward growth, HPI volatility, mortality rates and repayment rates. The principal pricing parameter is HPI forward growth. The HPI forward growth rate used is unobservable and is the same as used in the valuation of Instrument 2 above. The other parameters do not have a significant effect on the value of the instruments.

 

6. FVTPL - Debt securities

These debt securities consisting of reversionary property securities are an equity release scheme, where the property owner receives an upfront lump sum in return for paying a fixed percentage of the sales proceeds of the property when the owner vacates the property. These reversionary property securities are valued using a probability-weighted set of HPI forward prices which are assumed to be a reasonable representation of the increase in value of the Santander UK group's reversionary interest portfolio underlying the derivatives. The probability weighting used reflects the probability of the home owner vacating the property through death and is calculated from death rates and acceleration factors which are a function of age and gender, obtained from the relevant mortality table.

 

The inputs used to determine the value of these instruments are HPI spot, HPI forward growth and mortality rates. The principal pricing parameter is HPI forward growth. Discussion of the HPI spot rate, HPI forward growth rate and mortality rates for this financial instrument is the same as Instrument 3 above. An adjustment is also made to reflect the specific property risk. Discussion of the specific property risk adjustment is the same as Instrument 2 above.

 

7. FVTPL - Debt securities

These securities consist of residential mortgage-backed securities issued by Santander entities. Each instrument is valued with reference to the price from a consensus pricing service. This is then corroborated against the price from another consensus pricing service due to the lack of depth in the number of available market quotes. An average price is used where there is a more than insignificant difference between the two sources. The significant unobservable input is the adjustment to the credit spread embedded in the pricing consensus quotes.

 

8. Derivative liabilities - Equity contracts

These derivatives are the same as Instrument 4 with the exception that they have a negative fair value.

 

9. FVTPL - Debt securities in issue

These debt securities in issue are power reverse dual currency notes. These notes are financials where an investor is seeking a better return and a borrower/issuer a lower rate by taking advantage of the differential between two countries. The note pays a foreign interest rate in the investor's domestic currency. The power component of the name denotes higher initial coupons and the fact that coupons rise as the domestic/foreign exchange rate depreciates. The power feature comes with a higher risk for the investor. Cash flows may have a digital cap feature where the rate gets locked once it reaches a certain threshold. Other add-on features are barriers such as knockouts and cancellation provisions for the issuer.

 

These debt securities in issue are valued using a three-factor Gaussian Model. The three factors used in the valuation are domestic interest rates, foreign interest rates and foreign exchange rates. The correlations between the factors are assumed to be zero within the valuation.

 

The Hull-White approach is used for estimating the future distribution of domestic and foreign zero-coupon rates, constructed from the relevant yield curves. A Geometric Brownian Motion model is used for estimating the future distribution of spot foreign exchange rates. The foreign exchange and interest rate volatilities are the most crucial pricing parameters; the model calibrates to the relevant swaption volatility surface.

 

The significant unobservable inputs for the valuation of these financial instruments are the long dated FX volatility and the correlation between the underlying assets and are the same as Instrument 1.

 

Reconciliation of fair value measurements in Level 3 of the fair value hierarchy

The following table provides a reconciliation of the movement between opening and closing balances of Level 3 financial instruments, measured at fair value using a valuation technique with significant unobservable inputs:

 

Assets

Liabilities

Derivatives

Fair value through P&L

Total

Derivatives

Fair value through P&L

Total

£m

£m

£m

£m

£m

£m

At 1 January 2012

241

359

600

(73)

(141)

(214)

Total gains/(losses) recognised in profit/(loss):

- Fair value movements

(2)

17

15

3

7

10

- Foreign exchange and other movements

(12)

(1)

(13)

-

16

16

Purchases

10

-

10

-

-

-

Sales

-

(25)

(25)

-

-

-

Settlements

(22)

(5)

(27)

13

32

45

At 31 December 2012

215

345

560

(57)

(86)

(143)

Gains/(losses) recognised in profit/(loss) relating to assets and liabilities held at the end of the year

(14)

16

2

3

23

26

 

 

Assets

Liabilities

Derivatives

Fair value

through P&L

Total

Derivatives

Fair value through P&L

Total

£m

£m

£m

£m

£m

£m

At 1 January 2011

231

359

590

(102)

(137)

(239)

Total gains/(losses) recognised in profit/(loss):

- Fair value movements

15

37

52

(3)

(6)

(9)

- Foreign exchange and other movements

4

(2)

2

-

(7)

(7)

Purchases

27

-

27

(6)

-

(6)

Sales

(23)

(27)

(50)

-

-

-

Settlements

(13)

(8)

(21)

38

9

47

At 31 December 2011

241

359

600

(73)

(141)

(214)

Gains/(losses) recognised in profit/(loss) relating to assets and liabilities held at the end of the year

19

35

54

(3)

(13)

(16)

 

Financial instrument assets and liabilities at 31 December 2012

Financial instrument assets valued using internal models based on information other than market data were 0.9% (2011: 1%) of total assets measured at fair value and 0.2% (2011: 0.2%) of total assets at 31 December 2012. Derivative assets decreased in 2012 principally due to settlements and foreign exchange movements offset by purchases. Assets designated at fair value through profit or loss decreased in 2012 as primarily due to sales offset by increases in fair value movements.

 

Financial instrument liabilities valued using internal models based on information other than market data were 0.3% (2011: 0.3%) of total liabilities measured at fair value and 0.1% (2011: 0.1%) of total liabilities at 31 December 2012.

 

Derivative liabilities decreased in 2012 primarily due to settlements. Liabilities designated at fair value through profit or loss decreased due to fair value and foreign exchange movements and settlements.

 

Financial instrument assets and liabilities at 31 December 2011

Financial instrument assets valued using internal models based on information other than market data were 1% (2010: 1%) of total assets measured at fair value and 0.2% (2010: 0.2%) of total assets at 31 December 2011.

 

Derivative assets increased in 2011 principally due to purchases, partially offset by sales. Assets designated at fair value through profit or loss were unchanged in 2011 as increases due to fair value movements were offset by sales and settlements.

 

Financial instrument liabilities valued using internal models based on information other than market data were 0.3% (2010: 0.3%) of total liabilities measured at fair value and 0.1% (2010: 0.1%) of total liabilities at 31 December 2011.

 

Derivative liabilities decreased in 2011 due to settlements. Liabilities designated at fair value through profit or loss were broadly unchanged in 2011 as increases due to fair value and foreign exchange movements were mostly offset by settlements..

 

Gains and losses for the year ended 31 December 2012

Losses of £14m in respect of derivative assets principally reflected changes in credit spreads and the HPI Index, and unfavourable movements in foreign exchange rates. Gains of £16m in respect of assets designated at fair value through profit or loss principally reflected the mark-to-market volatility on the reversionary property securities arising from a continued low interest rate environment, changes in the HPI index and a maturing portfolio.

 

Gains of £3m in respect of derivative liabilities principally reflected changes in credit spreads and the HPI Index. Gains of £23m in respect of liabilities designated at fair value through profit or loss principally reflected changes in foreign exchange. They are fully matched with derivatives.

 

Gains and losses for the year ended 31 December 2011

Gains of £19m in respect of derivative assets principally reflected changes in credit spreads and the HPI Index, and favourable movements in foreign exchange rates. Gains of £35m in respect of assets designated at fair value through profit or loss principally reflected the mark-to-market volatility on the reversionary property securities arising from a continued low interest rate environment, changes in the HPI index and a maturing portfolio.

 

Losses of £3m in respect of derivative liabilities principally reflected changes in credit spreads and the HPI Index. Losses of £13m in respect of liabilities designated at fair value through profit or loss principally reflected changes in foreign exchange and interest rates. They are fully matched with derivatives.

 

Effect of changes in significant unobservable assumptions to reasonably possible alternatives (Level 3)

As discussed above, the fair value of financial instruments are, in certain circumstances, measured using valuation techniques that incorporate assumptions that are not evidenced by prices from observable current market transactions in the same instrument and are not based on observable market data and, as such require the application of a degree of judgement. Changing one or more of the inputs to the valuation models to reasonably possible alternative assumptions would change the fair values significantly. The following table shows the sensitivity of these fair values to reasonably possible alternative assumptions.

 

Favourable and unfavourable changes are determined on the basis of changes in the value of the instrument as a result of varying the levels of the unobservable input as described in the table below. The potential effects do not take into effect any offsetting or hedged positions.

 

At 31 December 2012

Reflected in income statement

Balance sheet note line item and product

Fair value

Assumptions

Shift

Favourable changes

Unfavourable changes

£m

£m

£m

2. Derivative assets - Equity and credit contracts:

- Reversionary property derivatives

 

76

HPI Forward growth rate

HPI Spot rate

Mortality rate

1%

10%

2 yrs

11

8

1

(11)

(8)

(1)

3. Derivative assets - Equity and credit contracts:

- Credit default swaps

17

Probability of default

20%

3

(3)

4. Derivative assets - Equity and credit contracts:

- Options and forwards

86

HPI Forward growth rate

HPI Spot rate

HPI Volatility

1%

10%

1%

7

12

1

(7)

(11)

(1)

5. FVTPL - Loans and advances to customers:

- Roll-up mortgage portfolio

61

HPI Forward growth rate

1%

 

2

(2)

6. FVTPL - Debt securities:

- Reversionary property securities

 

235

HPI Forward growth rate

HPI Spot rate

Mortality rate

1%

10%

2 yrs

19

22

-

(19)

(22)

(1)

7. FVTPL - Debt securities:

- Mortgage-backed securities

49

Credit spread

10%

5

(5)

8. Derivative liabilities - Equity and credit contracts:

- Options and forwards

(57)

HPI Forward growth rate

HPI Spot rate

HPI Volatility

1%

10%

1%

3

6

1

(3)

(9)

(1)

 

At 31 December 2011

Reflected in income statement

Balance sheet note line item and product

Fair value

Assumptions

Shift

Favourable changes

Unfavourable changes

£m

£m

£m

2. Derivative assets - Equity and credit contracts:

- Reversionary property derivatives

 

78

HPI Forward growth rate

HPI Spot rate

Mortality rate

1%

10%

2 yrs

11

8

-

(11)

(8)

-

3. Derivative assets - Equity and credit contracts:

- Credit default swaps

16

Probability of default

20%

3

(3)

4. Derivative assets - Equity and credit contracts:

- Options and forwards

77

HPI Forward growth rate

HPI Spot rate

HPI Volatility

1%

10%

1%

7

4

1

(7)

(3)

(1)

5. FVTPL - Loans and advances to customers:

- Roll-up mortgage portfolio

58

HPI Forward growth rate

1%

 

2

 

(2)

 

6. FVTPL - Debt securities:

- Reversionary property securities

 

250

HPI Forward growth rate

HPI Spot rate

Mortality rate

1%

10%

2 yrs

20

23

1

(20)

(23)

(1)

7. FVTPL - Debt securities:

- Mortgage-backed securities

51

Credit spread

10%

5

(5)

8. Derivative liabilities - Equity and credit contracts:

- Options and forwards

(73)

HPI Forward growth rate

HPI Spot rate

HPI Volatility

1%

10%

1%

4

13

2

(4)

(17)

(2)

 

No sensitivities are presented for the FVTPL - debt securities in issue (instrument 9) and related exchange rate derivatives (instrument 1), as the terms of these instruments are fully matched. As a result, any changes in the valuation of the debt securities in issue would be exactly offset by an equal and opposite change in the valuation of the exchange rate derivatives.

 

i) Maturities of financial assets, liabilities and off-balance sheet commitments

 

The table below analyses the maturities of the undiscounted cash flows relating to financial assets, liabilities and off-balance sheet commitments of the Santander UK 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.

There are no significant financial liabilities related to financial guarantee contracts. This table is not intended to show the liquidity of the Santander UK group.

 

At 31 December 2012

Group

On

demand

£m

Within

1 month

£m

 1-3

months

£m

3-12

months

£m

1-3

years

£m

3-5

years

£m

Over 5

years

£m

 Total

£m

Assets by balance sheet category

Cash and balances at central banks

29,079

-

-

203

-

-

-

29,282

Trading assets

1

13,013

4,802

3,391

30

485

868

22,590

Derivative financial instruments

496

592

1,067

893

3,406

2,894

22,289

31,637

Financial assets designated at fair value

-

1

13

9

-

124

3,972

4,119

Loans and advances to banks

1,172

273

5

123

44

27

818

2,462

Loans and advances to customers

1,314

2,166

2,226

7,666

18,921

19,998

172,630

224,921

Available-for-sale securities

-

-

-

1,902

150

3,139

419

5,610

Loans and receivables securities

-

-

-

1

161

86

1,099

1,347

Macro hedge of interest rate risk

-

20

18

12

156

192

824

1,222

Total financial assets

32,062

16,065

8,131

14,200

22,868

26,945

202,919

323,190

Other assets

4,998

-

-

-

-

-

-

4,998

Total assets

37,060

16,065

8,131

14,200

22,868

26,945

202,919

328,188

Liabilities by balance sheet category

Deposits by banks

2,324

691

666

683

1,846

3,840

218

10,268

Deposits by customers

111,603

981

5,977

17,999

10,960

1,565

829

149,914

Derivative financial instruments

232

645

512

1,291

2,632

4,248

20,731

30,291

Trading liabilities

4,707

5,574

4,670

1,993

982

375

3,070

21,371

Financial liabilities designated at fair value

-

735

341

628

954

616

836

4,110

Debt securities in issue

-

5,659

2,580

5,319

11,517

7,667

50,865

83,607

Subordinated liabilities

-

77

38

176

466

518

4,751

6,026

Total financial liabilities

118,866

14,362

14,784

28,089

29,357

18,829

81,300

305,587

Other liabilities

-

2,526

-

-

-

-

-

2,526

Equity (1)

-

-

-

-

-

-

12,949

12,949

Total liabilities and shareholders equity

118,866

16,888

14,784

28,089

29,357

18,829

94,249

321,062

Off-balance sheet commitments given

20,317

352

897

3,051

3,173

4,501

7,055

39,346

 

(1) Equity has no maturity and therefore has been classified in the "over five years" column.

 

At 31 December 2011

Group

On

demand

£m

Within

1 month

£m

 1-3

months

£m

3-12

months

£m

1-3

years

£m

3-5

years

£m

Over 5

years

£m

 Total

£m

Assets by balance sheet category

Cash and balances at central banks

25,785

-

-

195

-

-

-

25,980

Trading assets

-

11,654

5,183

3,851

215

13

1,138

22,054

Derivative financial instruments

2,161

170

306

1,458

4,165

3,025

20,910

32,195

Financial assets designated at fair value

-

-

-

-

-

-

5,684

5,684

Loans and advances to banks

1,467

1,253

700

149

33

30

876

4,508

Loans and advances to customers

1,170

3,117

2,397

6,575

20,170

15,586

186,645

235,660

Available-for-sale securities

-

-

-

-

-

-

52

52

Loans and receivables securities

-

55

67

210

120

133

1,358

1,943

Macro hedge of interest rate risk

-

1

10

104

247

122

737

1,221

Total financial assets

30,583

16,250

8,663

12,542

24,950

18,909

217,400

329,297

Other assets

5,324

-

-

-

-

-

-

5,324

Total assets

35,907

16,250

8,663

12,542

24,950

18,909

217,400

334,621

Liabilities by balance sheet category

Deposits by banks

2,980

1,966

1,083

45

2,690

3,169

-

11,933

Deposits by customers

104,113

865

9,151

21,186

11,148

2,280

467

149,210

Derivative financial instruments

351

238

255

1,221

4,073

3,018

22,476

31,632

Trading liabilities

7,781

9,697

4,786

1,415

1,121

433

656

25,889

Financial liabilities designated at fair value

-

1,445

187

1,635

2,406

668

1,015

7,356

Debt securities in issue

-

3,017

2,116

4,177

9,966

8,279

48,156

75,711

Subordinated liabilities

-

130

64

293

777

777

9,023

11,064

Total financial liabilities

115,225

17,358

17,642

29,972

32,181

18,624

81,793

312,795

Other liabilities

-

2,571

-

-

-

-

-

2,571

Equity (1)

-

-

-

-

-

-

12,666

12,666

Total liabilities and shareholders equity

115,225

19,929

17,642

29,972

32,181

18,624

94,459

328,032

Off-balance sheet commitments given

16,013

536

1,311

4,044

2,558

5,228

7,730

37,480

(1) Equity has no maturity and therefore has been classified in the "over five years" column.

 

At 31 December 2012

Company

On

demand

£m

Within

1 month

£m

 1-3

months

£m

3-12

months

£m

1-3

years

£m

3-5

years

£m

Over 5

years

£m

 Total

£m

Assets by balance sheet category

Cash and balances at central banks

28,704

-

-

179

-

-

-

28,883

Derivative financial instruments

15

32

22

29

450

751

3,864

5,163

Financial assets designated at fair value

-

-

-

-

-

-

48

48

Loans and advances to banks

6,223

3,049

16,398

19,687

18,452

15,488

19,684

98,981

Loans and advances to customers

974

1,835

1,308

5,338

13,570

14,936

163,561

201,522

Available-for-sale securities

-

-

-

-

150

204

11

365

Loans and receivables securities

-

-

-

1

161

266

5,980

6,408

Macro hedge of interest rate risk

-

-

1

3

5

3

3

15

Total financial assets

35,916

4,916

17,729

25,237

32,788

31,648

193,151

341,385

Other assets

11,051

-

-

-

-

-

-

11,051

Total assets

46,967

4,916

17,729

25,237

32,788

31,648

193,151

352,436

Liabilities by balance sheet category

Deposits by banks

28,280

4,095

37,438

13,413

19,328

6,570

1,473

110,597

Deposits by customers

106,470

600

5,728

14,538

8,246

4,886

56,862

197,330

Derivative financial instruments

44

2

26

7

54

120

1,921

2,174

Debt securities in issue

-

16

106

448

169

-

-

739

Subordinated liabilities

-

78

40

185

492

557

4,914

6,266

Total financial liabilities

134,794

4,791

43,338

28,591

28,289

12,133

65,170

317,106

Other liabilities

-

2,156

-

-

-

-

-

2,156

Equity (1)

-

-

-

-

-

-

15,102

15,102

Total liabilities and shareholders equity

134,794

6,947

43,338

28,591

28,289

12,133

80,272

334,364

Off-balance sheet commitments given

3,332

203

704

2,016

645

668

5,116

12,684

(1) Equity has no maturity and therefore has been classified in the "over five years" column.

 

At 31 December 2011

Company

On

demand

£m

Within

1 month

£m

 1-3

months

£m

3-12

months

£m

1-3

years

£m

3-5

years

£m

Over 5

years

£m

 Total

£m

Assets by balance sheet category

Cash and balances at central banks

18,780

-

-

178

-

-

-

18,958

Derivative financial instruments

56

3

73

131

1,108

779

4,138

6,288

Financial assets designated at fair value

-

-

-

-

-

-

51

51

Loans and advances to banks

5,395

3,684

17,509

19,086

14,715

15,990

15,199

91,578

Loans and advances to customers

1,153

2,229

1,421

4,257

15,022

10,482

179,422

213,986

Available-for-sale securities

-

-

-

-

-

-

39

39

Loans and receivables securities

-

53

184

210

114

167

5,094

5,822

Macro hedge of interest rate risk

-

-

7

10

6

6

3

32

Total financial assets

25,384

5,969

19,194

23,872

30,965

27,424

203,946

336,754

Other assets

11,266

-

-

-

-

-

-

11,266

Total assets

36,650

5,969

19,194

23,872

30,965

27,424

203,946

348,020

Liabilities by balance sheet category

Deposits by banks

19,251

15,774

24,544

10,051

31,224

5,568

8,524

114,936

Deposits by customers

97,127

380

8,259

16,082

8,115

4,084

47,694

181,741

Derivative financial instruments

14

6

1

6

161

26

1,105

1,319

Financial liabilities designated at fair value

-

-

-

1

-

-

-

1

Debt securities in issue

-

8

46

915

557

112

-

1,638

Subordinated liabilities

-

130

64

293

779

843

9,023

11,132

Total financial liabilities

116,392

16,298

32,914

27,348

40,836

10,633

66,346

310,767

Other liabilities

-

2,121

-

-

-

-

-

2,121

Equity

-

-

-

-

-

-

14,251

14,251

Total liabilities and shareholders equity

116,392

18,419

32,914

27,348

40,836

10,633

80,597

327,139

Off-balance sheet commitments given

1,788

515

1,265

3,189

539

718

5,343

13,357

(1) Equity has no maturity and therefore has been added to the "over five years" column.

 

As the above table is based on contractual maturities, no account is taken of a customer's ability to repay early where it exists or call features related to subordinated liabilities. The repayment terms of debt securities may be accelerated in line with the covenants described in Note 34 to the Consolidated Financial Statements. In addition, no account is taken of the possible early repayment of the Santander UK group's mortgage-backed non-recourse finance which is redeemed by the Santander UK group as funds become available from redemptions of the residential mortgages. The Santander UK group has no control over the timing and amount of redemptions of residential mortgages.

 

 

47. CAPITAL MANAGEMENT AND RESOURCES

 

This note reflects the transactions and amounts reported on a basis consistent with the Santander UK group's regulatory filings.

 

Capital management and capital allocation

 

Santander UK plc and its subsidiaries are a UK banking group effectively subject to two tiers of supervision. Santander UK is subject to prudential supervision by both the FSA (as a UK authorised bank) and Banco de España (the Bank of Spain) (as a member of the Banco Santander group). As an FSA-regulated entity, Santander UK is expected to satisfy the FSA liquidity and capital requirements on a standalone basis. Similarly, Santander UK must demonstrate to the FSA that it can withstand liquidity and capital stress tests without parental support. Reinforcing the corporate governance framework adopted by Santander UK, the FSA exercises oversight through its rules and regulations on the Santander UK Board and senior management appointments.

 

The Board is responsible for capital management strategy and policy and ensuring that capital resources are appropriately monitored and controlled within regulatory and internal limits. Authority for capital management flows to the Chief Executive Officer and from her to specific individuals who are members of the Santander UK Capital Committee.

 

The Capital Committee adopts a centralised capital management approach that is driven by the Santander UK group's corporate purpose and strategy. This approach takes into account the regulatory and commercial environment in which the Santander UK group operates, the Santander UK group's risk appetite, the management strategy for each of the Santander UK group's material risks (including whether or not capital provides an appropriate risk mitigant) and the impact of appropriate adverse scenarios and stresses on the Santander UK group's capital requirements. This approach is reviewed annually as part of the Santander UK group's Internal Capital Adequacy Assessment Process ('ICAAP').

 

The Santander UK group manages its capital requirements, debt funding and liquidity on the basis of policies and plans reviewed regularly by the Capital Committee. Capital requirements are also reviewed as part of the ICAAP while debt funding and liquidity are also reviewed as part of the Internal Liquidity Adequacy Assessment ('ILAA') process. To support its capital and senior debt issuance programmes, Santander UK plc is rated on a stand alone basis from Banco Santander, S.A..

 

On an ongoing basis, and in accordance with the latest ICAAP review, the Santander UK group forecasts its regulatory and internal capital requirements based on the approved capital volumes allocated to business units as part of the corporate planning process which generates the strategic 3-Year Plan. Alongside this plan, the Santander UK group develops a series of macro economic scenarios to stress test its capital requirements and confirm that it has adequate regulatory capital resources to meet its projected and stressed regulatory capital requirement and to meet its obligations as they fall due. Internally assigned buffers augment the various regulatory minimum capital criteria. Buffers are held in order to ensure there is sufficient time for management actions to be implemented against unexpected movements.

 

Decisions on the allocation of capital resources are conducted as part of the Santander UK group's strategic three year planning process based on the relative returns on capital using both economic and regulatory capital measures.Capital allocations are reviewed in response to changes in risk appetite and risk management strategy, changes to the commercial environment, changes in key economic indicators or when additional capital requests are received.

 

This combination of regulatory and economic capital ratios and limits, internal buffers and restrictions, together with the relevant costs of differing capital instruments and a consideration of the various other capital management techniques are used to shape the most cost-effective structure to fulfil the Santander UK group's capital needs.

 

Capital adequacy

 

The Santander UK group manages its capital on a Basel II basis. During the years ended 31 December 2012 and 2011, the Santander UK group held capital over and above its regulatory requirements, and managed internal capital allocations and targets in accordance with its capital and risk management policies.

 

Group Capital

 

 

 

 2012

£m

 2011

£m

Core Tier 1 capital

11,890

11,477

Deductions from Core Tier 1 capital

(2,588)

(2,616)

Total Core Tier 1 capital after deductions

9,302

8,861

Other Tier 1 capital

1,901

2,637

Total Tier 1 capital after deductions

11,203

11,498

Tier 2 capital

3,092

4,997

Deductions from Tier 2 capital

(336)

(508)

Total Tier 2 capital after deductions

2,757

4,489

Total Capital Resources

13,960

15,987

 

Tier 1 includes audited profits for the years ended 31 December 2012 and 2011 respectively after adjustment to comply with UK Financial Services Authority rules. Tier 1 deductions primarily relate to goodwill and expected losses. In addition, the Santander UK 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 Santander UK group's Retail Internal Rating-Based ('IRB') and Advanced Internal Rating-Based ('AIRB') models, and the impairment loss allowances calculated in accordance with IFRS. The Santander UK group's accounting policy for impairment loss allowances is set out in Note 1. Expected losses are calculated using risk parameters based on either through-the-cycle, or economic downturn estimates, and are subject to conservatism due to the imposition of regulatory floors. They are therefore currently higher than the impairment loss allowances under IFRS which only reflect losses incurred at the balance sheet date. Tier 2 deductions also represent expected losses and securitisation positions described above.

 

During 2012, Core Tier 1 capital increased by £441m to £9,302m (2011: £8,861m). This increase was largely due to audited profits for the year of £939m, less dividends declared of £507m. During 2011, Core Tier 1 capital increased by £365m to £8,861m (2010: £8,496m). This increase was largely due to audited profits for the year of £903m, less dividends declared of £482m. The significant reduction in the Santander UK group's Other Tier 1 capital and Tier 2 capital during 2012 principally reflected the capital management exercise undertaken in July 2012.

 

 

48. EVENTS AFTER THE BALANCE SHEET DATE

 

None.

 

Shareholder Information

 

Risk Information

 

An investment in Santander UK plc and its subsidiaries ("us" or "we") involves a number of risks, the material ones of which are set forth below.

 

Our operating results, financial condition and prospects may be materially impacted by economic conditions in the UK.

 

Our business activities are concentrated in the UK and on the offering of mortgage, loan and savings-related products and services. As a consequence, our operating results, financial condition and prospects are significantly affected by economic conditions in the UK generally, and by the UK property market in particular.

 

The outlook for the UK economy has remained challenging over the last year, with the UK economy dipping back into recession in the course of 2012. Though the economy returned to growth in the third quarter of 2012, this was in part due to one-off factors (such as the Olympics) and prospects for the 2013-2014 financial year remain challenging. Uncertainty surrounding the future of the eurozone, although less acute than before, may continue to pose a risk of further slowdown in economic activity in the UK's principal export markets which would have an effect on the broader UK economy. Domestically, both public and household spending are being constrained by austerity measures, and there is a risk of higher levels of unemployment combined with a decline in real disposable incomes.

 

Adverse changes in the credit quality of our borrowers and counterparties or a general deterioration in UK or global economic conditions could reduce the recoverability and value of our assets and require an increase in our level of provisions for bad and doubtful debts. Likewise, a significant reduction in the demand for our products and services could negatively impact our business and financial condition. UK economic conditions and uncertainties may have an adverse effect on the quality of our loan portfolio and may result in a rise in delinquency and default rates. There can be no assurance that we will not have to increase our provisions for loan losses in the future as a result of increases in non-performing loans or for other reasons beyond our control. Material increases in our provisions for loan losses and write-offs/charge-offs could have an adverse effect on our operating results, financial condition and prospects.

 

As in several other economies, the UK Government has taken measures to address the exceptionally high level of national debt, including tax increases and public spending cuts. These measures have contributed to a slower recovery than other recent recessions. Political involvement in the regulatory process, in the behaviour and governance of the UK banking sector and in the major financial institutions in which the UK Government has a direct financial interest is set to continue. Credit quality could be adversely affected by a further increase in unemployment. This, plus the combination of slow economic recovery and UK Government intervention, together with any related significant reduction in the demand for our products and services, could have a material adverse effect on our operating results, financial condition and prospects.

 

We are vulnerable to the current disruptions and volatility in the global financial markets.

 

In the past five years, the financial systems worldwide have experienced difficult credit and liquidity conditions and disruptions leading to less liquidity, greater volatility, a general widening of spreads and, in some cases, lack of price transparency on interbank lending rates. Global economic conditions deteriorated significantly between 2007 and 2009 and many countries, including the United Kingdom, have been in recession. Many major financial institutions, including some of the world's largest global commercial banks, investment banks, mortgage lenders, mortgage guarantors and insurance companies, experienced significant difficulties. Around the world, there have also been runs on deposits at several financial institutions, numerous institutions have sought additional capital or have been assisted by central banks and governments providing liquidity, whilst many lenders and institutional investors have reduced or ceased providing funding to borrowers (including to other financial institutions). The global economic slowdown, and the downturn in the UK in particular, have had a negative impact on the UK economy and adversely affected our business.

In particular, we may face, among others, the following risks related to the economic downturn:

 

> We potentially face increased regulation of our industry. Compliance with such regulation may increase our costs, may affect the pricing for our products and services, and limit our ability to pursue business opportunities.

> Reduced demand for our products and services.

> Inability of our borrowers to comply fully or in a timely manner with their existing obligations.

> The process we use to estimate losses inherent in our credit exposure requires complex judgements, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The degree of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates, which may, in turn, impact the reliability of the process and the quality of our assets.

> The value and liquidity of the portfolio of investment securities that we hold may be adversely affected.

> A worsening of the global economic conditions may delay the recovery of the international financial industry and impact our financial condition and results of operations.

 

Uncertainty remains concerning the future economic environment and there is no assurance when conditions will significantly improve. While certain segments of the global economy are currently experiencing some modest recovery, we expect conditions to continue to have an ongoing negative impact on our business and results of operations. Investors remain cautious and downgrades of the sovereign debt of certain eurozone countries have induced greater volatility in the capital markets. A slowing or failing of the economic recovery would likely aggravate the adverse effects of these difficult economic and market conditions on us and on others in the financial services industry.

 

Continued or worsening disruption and volatility in the global financial markets could have a material adverse effect on us, including our ability to access capital and liquidity on financial terms acceptable to us, if at all. If capital markets financing ceases to become available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits to attract more customers and become unable to maintain certain liability maturities. Any such increase in capital markets funding costs or deposit rates could have a material adverse effect on our interest margins.

 

If all or some of the foregoing risks were to materialise, this could have a material adverse effect on us.

 

We are subject to regulatory capital requirements that could limit our operations, and changes to these requirements may further limit and adversely affect our operating results, financial condition and prospects.

 

As a bank we are subject to capital adequacy requirements adopted by the Financial Services Authority ("FSA") which provide for a minimum ratio of total capital to risk-adjusted assets both on a consolidated basis and on a solo-consolidated basis (the basis used by the FSA solely for the purpose of the calculation of capital resources and capital resources requirements, which measure the capital of the Company and certain subsidiaries) and a minimum ratio of Core Tier 1 capital to risk-adjusted assets on a consolidated basis. Any failure by us to maintain our ratios may result in administrative actions or sanctions which may affect our ability to fulfil our obligations.

 

In response to the recent financial crisis, the FSA has imposed more stringent capital adequacy requirements, and the FSA or its prudential regulation successor, the Prudential Regulation Authority ("PRA"), may continue to require more stringent adequacy standards including increasing the minimum regulatory capital requirements demanded of us. For instance, the FSA has adopted a supervisory approach in relation to certain UK banks, including us, under which those banks are expected to maintain Core Tier 1 capital in excess of the minimum levels required by the existing rules and guidance of the FSA. In future, the FSA or the PRA may also impose higher capital requirements and target capital ratios as part of the implementation of UK macroprudential tools.

In December 2010, the Basel Committee on Banking Supervision (the "Basel Committee") proposed comprehensive changes to the capital adequacy framework, known as Basel III. A revised version of these proposals was issued in June 2011. The reforms to the regulatory capital framework were proposed to raise the resilience of the banking sector, through increasing both the quality and quantity of the regulatory capital base and enhancing the risk coverage of the capital framework. As part of these, the amount and quality of Tier 1 capital that institutions are required to hold was raised, innovative Tier 1 capital instruments with an incentive to redeem are to be phased out and the rules for determining Tier 2 capital instruments are harmonised. Basel III also requires institutions to build counter-cyclical capital buffers that may be drawn upon in stress periods and to hold a capital conservation buffer above minimum capital ratio levels, which have the effect of raising the minimum level of tangible common equity capital from 2 per cent. to 7 per cent. of risk-weighted assets. In addition a leverage ratio was proposed for institutions as a backstop, which would be applied alongside current risk-based regulatory capital requirements. The changes in Basel III are proposed to be phased in gradually between January 2013 and January 2022.

 

The implementation of Basel III in the European Union is being performed through the Capital Requirements Directive IV and Capital Requirements Regulation ("CRDIV/CRR") legislative package. In early 2013 the draft legislation remains under discussion between the European Parliament, the European Commission and the Council of Ministers. The final capital framework to be established in the EU under CRDIV/CRR is likely to differ from Basel III in certain areas and the implementation date is still subject to uncertainty.

 

In addition to Basel III, regulators in the UK and world-wide have produced a range of proposals for future legislative and regulatory changes which could force us to comply with certain operational restrictions or take steps to raise further capital, or could increase our expenses, or otherwise adversely affect our operating results, financial condition and prospects. These include

 

> the introduction of recovery and resolution planning requirements (popularly known as 'living wills') for banks and other financial institutions as contingency planning for the failure of a financial institution that may affect the stability of the financial system;

> implementation of the Financial Services Act 2012, which enhances the FSA's disciplinary and enforcement powers;

> the introduction of more regular and detailed reporting obligations;

> a move to pre-funding of the deposit protection scheme in the UK;

> a proposal in the Independent Commission on Banking's recommendations to require large UK retail banks to hold a minimum Core Tier 1 to risk-weighted assets ratio of at least 10 per cent., which is broadly 3 per cent. higher than the minimum capital levels required under Basel III, and to have a minimum primary loss-absorbing capacity of 17 per cent. of risk-weighted assets, and

> proposed revisions to the approaches for determining trading book capital requirements and banking book risk-weighted assets from the Basel Committee.

 

These measures could have a material adverse effect on our operating results, financial condition and prospects. There is a risk that changes to the UK's capital adequacy regime (including any introduction of a minimum leverage ratio) may result in increased minimum capital requirements, which could reduce available capital and thereby adversely affect our profitability and ability to pay dividends, continue organic growth (including increased lending), or pursue acquisitions or other strategic opportunities (alternatively we could restructure our balance sheet to reduce the capital charges incurred pursuant to the FSA's rules in relation to the assets held, or raise additional capital but at increased cost and subject to prevailing market conditions). In addition, changes to the eligibility criteria for Tier 1 and Tier 2 capital may affect our ability to raise Tier 1 and Tier 2 capital and impact the recognition of existing Tier 1 and Tier 2 capital resources in the calculation of our capital position.

 

Our business could be affected if our capital is not managed effectively or if these measures limit our ability to manage our balance sheet and capital resources effectively or to access funding on commercially acceptable terms. Effective management of our capital position is important to our ability to operate our business, to continue to grow organically and to pursue our business strategy.

 

We are subject to liquidity requirements that could limit our operations, and changes to these requirements may further limit and adversely affect our operating results, financial condition and prospects.

 

On 5 October 2009, the FSA published liquidity rules which significantly broadened the scope of the existing liquidity regime. These were designed to enhance regulated firms' liquidity risk management practices. As part of these reforms, the FSA has implemented requirements for financial institutions to hold prescribed levels of specified liquid assets and have in place other sources of liquidity to address the institution-specific and market-wide liquidity risks that institutions may face in short-term and prolonged stress scenarios. These rules have applied to us since June 2010 with some subsequent technical revisions.

 

In addition to the changes to the capital adequacy framework published in December 2010 described above, the Basel Committee also published its global quantitative liquidity framework, comprising the Liquidity Coverage Ratio ("LCR") and Net Stable Funding Ratio ("NSFR") metrics, with objectives to (1) promote the short-term resilience of banks' liquidity risk profiles by ensuring they have sufficient high-quality liquid assets to survive a significant stress scenario; and (2) promote resilience over a longer time horizon by creating incentives for banks to fund their activities with more stable sources of funding on an ongoing basis. The LCR has subsequently been revised by the Basel Committee in January 2013 which amended the definition of high-quality liquid assets and agreed a revised timetable for phase-in of the standard from 2015 to 2019, as well as making some technical changes to some of the stress scenario assumptions.

 

As with the Basel Committee's proposed changes to the capital adequacy framework, the draft liquidity framework remains under discussion within the EU and the final framework to be established could differ from Basel III in certain areas. The implementation date is still subject to uncertainty.

 

There is also a risk that implementing and maintaining enhanced liquidity risk management systems may incur significant costs, and more stringent requirements to hold liquid assets may materially affect our lending business as more funds may be required to acquire or maintain a liquidity buffer, thereby reducing future profitability.

 

Exposure to UK Government debt could have a material adverse effect on us.

 

Like many other UK banks, we invest in debt securities of the UK Government largely for liquidity purposes. As of 31 December 2012, approximately 2% of our total assets and 51% of our securities portfolio were comprised of debt securities issued by the UK Government. Any failure by the UK Government to make timely payments under the terms of these securities, or a significant decrease in their market value, will have a material adverse effect on us.

 

We may suffer adverse effects as a result of the continued economic and sovereign debt tensions in the eurozone.

 

Eurozone markets and economies continue to show signs of fragility and volatility, with recession in several economies and only sporadic access to capital markets in others. Interest rate differentials among eurozone countries indicate continued doubts about some governments' ability to fund themselves and affect borrowing rates in those economies.

 

The European Central Bank and European Council took actions in 2012 to aim to reduce the risk of contagion throughout and beyond the eurozone. These included the creation of the Open Market Transaction facility of the ECB and the decision by eurozone governments to create a banking union. Nonetheless, a significant number of financial institutions throughout Europe have substantial exposures to sovereign debt issued by nations which are under financial pressure. Should any of those nations default on their debt, or experience a significant widening of credit spreads, major financial institutions and banking systems throughout Europe could be destabilised, resulting in the further spread of the ongoing economic crisis.

 

The continued high cost of capital for some European governments was felt in the wholesale markets in the UK, which has resulted in an increase in the cost of retail funding and greater competition in a savings market that is growing slowly by historical standards. In the absence of a permanent resolution of the eurozone crisis, conditions could deteriorate. 

 

Although we conduct the majority of our business in the UK, we have direct and indirect exposure to financial and economic conditions throughout the eurozone economies. For further description of our country risk exposures, including eurozone and peripheral eurozone exposures and redenomination risk, see the "Country Risk Exposure" section in the Risk Management Report on pages 140 to 150. In addition, general financial and economic conditions in the UK, which directly affect our operating results, financial condition and prospects, may deteriorate as a result of conditions in the eurozone.

 

Though the possibility may be more remote following the measures taken in 2012, a wide-scale break-up of the eurozone would most likely be associated with a deterioration in the economic and financial environment in the UK and could have a material adverse impact on the whole financial sector, creating new challenges in sovereign and corporate lending and resulting in significant disruptions in financial activities at both the market and retail levels. This could materially and adversely affect our operating results, financial position and prospects.

 

We may suffer adverse effects should eurozone member states exit the euro or the euro be totally abandoned.

 

The departure or risk of departure from the euro by one or more eurozone countries and/or the abandonment of the euro as a currency could have negative effects on both existing contractual relations and the fulfilment of obligations by us, our counterparties and/or our customers, which would have a significant negative impact on our activity, operating results and capital and financial position.

 

There is currently no established legal framework within the European treaties to facilitate a member state exiting from the euro; consequently, it is not possible to predict the course of events and legal consequences that would ensue. Uncertainties that heighten the risk of re-denomination include how an exiting member state would deal with its existing euro-denominated assets and liabilities, the valuation of any newly-adopted currency against the euro and the process of exiting the euro. These uncertainties make it impossible to predict what our losses might be as a result of any country's decision to exit the euro. The significant upheaval in the eurozone that might arise from any such member state exit, or from the wholesale abandonment of the euro by the eurozone states, could materially and adversely affect our operating results, financial condition and prospects.

 

We are exposed to risks faced by other financial institutions.

 

We routinely transact with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual funds, hedge funds and other institutional clients. Defaults by, and even rumours or questions about the solvency of, certain financial institutions and the financial services industry generally have led to market-wide liquidity problems and could lead to losses or defaults by other institutions. Many of the routine transactions we enter into expose us to significant credit risk in the event of default by one of our significant counterparties. The European sovereign debt crisis and the risk it poses to financial institutions throughout Europe have had, and may continue to have, an adverse effect on interbank financial transactions in general. A default by a significant financial counterparty, or liquidity problems in the financial services industry generally, could have a material adverse effect on us.

 

Liquidity and funding risks are inherent in our business and could have a material adverse effect on us.

 

Liquidity risk is the risk that we, although solvent, either do not have available sufficient financial resources to meet our obligations as they fall due or can secure them only at excessive cost. This risk is inherent in any retail and commercial banking business and can be heightened by a number of enterprise-specific factors, including over-reliance on a particular source of funding, changes in credit ratings or market-wide phenomena such as market dislocation. While we implement liquidity management processes to seek to mitigate and control these risks, unforeseen systemic market factors in particular make it difficult to eliminate completely these risks. Adverse and continued constraints in the supply of liquidity, including inter-bank lending, has affected and may again materially and adversely affect the cost of funding our business, and extreme liquidity constraints may affect our current operations as well as limit growth possibilities.

 

Continued or worsening disruption and volatility in the global financial markets could have a material adverse effect on our ability to access capital and liquidity on financial terms acceptable to us.

 

Our cost of obtaining funding is directly related to prevailing market interest rates and to our credit spreads. Increases in interest rates and our credit spreads can significantly increase the cost of our funding. Changes in our credit spreads are market-driven, and may be influenced by market perceptions of our creditworthiness. Changes to interest rates and our credit spreads occur continuously and may be unpredictable and highly volatile.

 

If wholesale markets financing ceases to become available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits, with a view to attracting more customers, and/or to sell assets, potentially at depressed prices. The persistence or worsening of these adverse market conditions or an increase in base interest rates could have a material adverse effect on our ability to access liquidity and cost of funding (whether directly or indirectly).

 

Although central banks around the world have made coordinated efforts to increase liquidity in the financial markets, by taking measures such as increasing the amounts they lend directly to financial institutions, lowering interest rates and significantly increasing temporary reciprocal currency arrangements (or swap lines), it is not known how long central bank schemes will continue or on what terms. The Bank of England's Special Liquidity Scheme expired at the end of January 2012, although the Bank of England has implemented the Extended Collateral Term Repo facility ('ECTR') which aims to increase liquidity in the market, and the Funding for Lending Scheme (the "FLS") which aims to reduce cost of funding for participating financial institutions, like us. As at 31 December 2012, we had drawn £1.0bn of UK treasury bills under the FLS and we may make further usage of the FLS before the drawdown period ends on 31 January 2014.

 

The availability of Bank of England facilities for UK financial institutions, to the extent that they provide us with access to cheaper and more attractive funding than other sources, reduces our reliance on retail or wholesale markets. To the extent that we make use of Bank of England facilities, any significant reduction or withdrawal of those facilities would increase our funding costs. In addition, other financial institutions who have relied significantly on Government support to meet their funding needs will also need to find alternative sources of funding and, in such a scenario, we would expect to face increased competition for funding, particularly retail funding on which we rely. This competition could further increase our funding costs and so adversely impact our results of operations and financial position. Our cost of funding could also increase as a result of an increase in interest rates by the Bank of England.

 

Each of the factors described above - the persistence or worsening of adverse market conditions, and the lack of availability, or withdrawal, of such central bank schemes or an increase in base interest rates - could have a material adverse effect on our ability to access liquidity and cost of funding (whether directly or indirectly).

 

We aim for a funding structure that is consistent with our assets, avoids excessive reliance on short term wholesale funding, attracts enduring commercial deposits and provides diversification in products and tenor. We therefore rely, and will continue to rely, on commercial deposits to fund a significant proportion of lending activities. The ongoing availability of this type of funding is sensitive to a variety of factors outside our control, such as general economic conditions and the confidence of commercial depositors in the economy, in general, and the financial services industry in particular, and the availability and extent of deposit guarantees, as well as competition between banks for deposits. Any of these factors could significantly increase the amount of commercial deposit withdrawals in a short period of time, thereby reducing our ability to access commercial deposit funding on appropriate terms, or at all, in the future.

 

We anticipate that our customers will continue to make short-term deposits (particularly demand deposits and short-term time deposits), and we intend to maintain our emphasis on the use of banking deposits as a source of funds. The short-term nature of this funding source could cause liquidity problems for us in the future if deposits are not made in the volumes we expect or are not renewed. If a substantial number of our depositors withdraw their demand deposits or do not roll over their time deposits upon maturity, we may be materially and adversely affected. For additional information about our liquidity position and other liquidity matters, including the policies and procedures we use to manage our liquidity risks, see 'Balance Sheet Review - Capital Management and Resources' on pages 53 to 56, 'Balance Sheet Review - Liquidity and Funding' on pages 57 to 59 and 'Risk Management Report - Liquidity and Funding risk' on pages 124 to 133.

 

A sudden or unexpected shortage of funds in the banking system could lead to increased funding costs, a reduction in the term of funding instruments or require us to liquidate certain assets. If these circumstances were to arise, this could have a material adverse effect on our operating results, financial condition and prospects.

 

Credit, market and liquidity risk may have an adverse effect on our credit ratings and our cost of funds. A downgrade of our credit rating would likely increase our cost of funding, require us to post additional collateral or take other actions under some of our derivative contracts and adversely affect our interest margins and results of operations.

 

Credit ratings can in some instances affect the cost and other terms upon which we are able to obtain funding. Credit rating agencies regularly evaluate us, and their credit ratings of our institution and our debt in issue are based on a number of factors, including our financial strength as well as conditions affecting the financial services industry generally.

 

Any downgrade in our credit ratings could increase our borrowing costs and could require us to post additional collateral or take other actions under some of our derivative contracts, and could limit our access to capital markets and adversely affect our commercial business. For example, a credit rating downgrade could adversely affect our ability to sell or market certain of our products, engage in certain longer-term and derivatives transactions and retain our customers, particularly customers who need a minimum rating threshold in order to invest. In addition, under the terms of certain of our derivative contracts, we may be required to maintain a minimum credit rating or otherwise terminate such contracts. Any of these results of a credit rating downgrade could, in turn, reduce our liquidity and have an adverse effect on us, including our operating results and financial condition.

 

For example, we estimate that as at 31 December 2012, if all the rating agencies were to downgrade our long-term credit ratings by one notch, and thereby trigger a short-term credit rating downgrade, this could result in outflows from our total liquid assets of £2.0bn of cash and £6.6bn in additional collateral that we would be required to post under the terms of our secured funding and derivative contracts. A hypothetical two notch downgrade would result in an additional outflow of £0.4bn of cash and £1.4bn of collateral under our secured funding and derivative contracts. However, while certain potential impacts are contractual and quantifiable, the full consequences of a credit rating downgrade are inherently uncertain, as they depend upon numerous dynamic, complex and inter-related factors and assumptions, including market conditions at the time of any downgrade, whether any downgrade of a firm's long-term credit rating precipitates downgrades to its short-term credit rating, and assumptions about the potential behaviours of various customers, investors and counterparties. Actual outflows could be higher or lower than this hypothetical example, depending upon certain factors including which credit rating agency had downgraded our credit rating, any management or restructuring actions that could be taken to reduce cash outflows and the potential liquidity impact from loss of unsecured funding (such as from money market funds) or loss of secured funding capacity.

 

Although unsecured and secured funding stresses are included in our stress testing scenarios and a portion of our total liquid assets is held against these risks, it is still the case that a credit rating downgrade could have a material adverse effect on us. In addition, if we were required to cancel our derivatives contracts with certain counterparties and were unable to replace such contracts, our market risk profile could be altered.

 

Likewise, a downgrade of the UK sovereign credit rating, or the perception that such a downgrade may occur, may have a material adverse effect on our operating results, financial condition, prospects and the marketability and trading value of our securities. This might also impact on our own credit rating, borrowing costs and our ability to secure funding. A UK sovereign credit rating downgrade or the perception that such a downgrade may occur could also have a material effect in depressing consumer confidence, restricting the availability, and increasing the cost, of funding for individuals and companies, further depressing economic activity, increasing unemployment and/or reducing asset prices.

 

In light of the difficulties in the financial services industry and the financial markets, there can be no assurance that the credit rating agencies will maintain our current credit ratings or outlooks. Our failure to maintain favourable credit ratings and outlooks would likely increase our cost of funding and adversely affect our interest margins, which could have a material negative effect on us.

 

Our financial results are constantly exposed to market risk. We are subject to fluctuations in interest rates and other market risks, which may materially adversely affect us.

 

Market risk refers to the probability of variations in our net interest income or in the market value of our assets and liabilities due to volatility of interest rate, exchange rate or equity price. Changes in interest rates affect the following areas, among others, of our business:

 

> net interest income;

> the volume of loans originated;

> the market value of our securities holdings; and

> gains from sales of loans and securities.

 

Variations in short-term interest rates could affect our net interest income, which comprises the majority of our revenue. When interest rates rise, we may be required to pay higher interest on our floating-rate borrowings while interest earned on our fixed-rate assets does not rise as quickly, which could cause profits to grow at a reduced rate or decline in some parts of our portfolio. Interest rate variations could adversely affect us, including our net interest income, reducing its growth rate or even resulting in losses. Interest rates are highly sensitive to many factors beyond our control, including increased regulation of the financial sector, monetary policies, domestic and international economic and political conditions and other factors.

 

Increases in interest rates may reduce the volume of loans we originate. Sustained high interest rates have historically discouraged customers from borrowing and have resulted in increased delinquencies in outstanding loans and deterioration in the quality of assets. Increases in interest rates may also reduce the propensity of our customers to prepay or refinance fixed-rate loans, reduce the value of our financial assets and reduce gains or require us to record losses on sales of our loans or securities.

 

If interest rates decrease, although this is likely to reduce our funding costs, it is likely to adversely impact the income we receive arising from our investments in securities as well as loans with similar maturities.

 

The market value of a security with a fixed interest rate generally decreases when the prevailing interest rates rise, which may have an adverse effect on our earnings and financial condition. In addition, we may incur costs (which, in turn, will impact our results) as we implement strategies to reduce future interest rate exposure. The market value of an obligation with a floating interest rate can be adversely affected when interest rates increase, due to a lag in the implementation of repricing terms or an inability to refinance at lower rates.

 

We are also exposed to foreign exchange rate risk as a result of mismatches between assets and liabilities denominated in different currencies. Fluctuations in the exchange rate between currencies may negatively affect our earnings and value of our assets and securities. Our capital is stated in pound sterling and we do not fully hedge our capital position against changes in currency exchange rates. Although we seek to hedge most of our currency risk through hedging and purchase of cross-currency swaps, these hedges do not eliminate currency risk and we can make no assurance that we will not suffer adverse financial consequences as a result of currency fluctuations. Significant exchange rate volatility and the depreciation of the pound sterling in particular could have an adverse impact on our results of operations and our ability to meet our US dollar and euro-denominated obligations, and could have a material adverse effect on our operating results, financial condition and prospects.

 

We are also exposed to equity price risk in connection with our trading investments in equity securities as part of our normal course of business as a commercial bank. The performance of financial markets may cause changes in the value of our investment and trading portfolios. The volatility of world equity markets, due to the continued economic uncertainty and sovereign debt tensions, has had a particularly strong impact on the financial sector. Continued volatility may affect the value of our investments in entities in this sector and, depending on their fair value and future recovery expectations, could become a permanent impairment which would be subject to write-offs against our results. To the extent any of these risks materialise, our net interest income or the market value of our assets and liabilities could be adversely affected.

 

Market conditions have, and could result, in material changes to the estimated fair values of our financial assets. Negative fair value adjustments could have a material adverse effect on our operating results, financial condition and prospects.

 

In the past five years, financial markets have been subject to significant stress resulting in steep falls in perceived or actual financial asset values, particularly due to volatility in global financial markets and the resulting widening of credit spreads. We have material exposures to securities and other investments that are recorded at fair value and are therefore exposed to potential negative fair value adjustments . Asset valuations in future periods, reflecting then prevailing market conditions, may result in negative changes in the fair values of our financial assets and these may also translate into increased impairments. In addition, the value ultimately realised by us on disposal may be lower than the current fair value. Any of these factors could require us to record negative fair value adjustments, which may have a material adverse effect on our operating results, financial condition or prospects.

 

In addition, to the extent that fair values are determined using financial valuation models, such values may be inaccurate or subject to change, as the data used by such models may not be available or may become unavailable due to changes in market conditions, particularly for illiquid assets, and particularly in times of economic instability. In such circumstances, our valuation methodologies require us to make assumptions, judgements and estimates in order to establish fair value.

 

This is a challenging task as reliable assumptions are difficult to make and are inherently uncertain. Moreover valuation models are complex, making them inherently imperfect predictors of actual results. Any consequential impairments or write-downs could have a material adverse effect on our operating results, financial condition and prospects.

 

Failure to successfully implement and continue to improve our credit risk management system could materially and adversely affect us.

 

As a commercial bank one of the main types of risks inherent in our business is credit risk. For example, an important feature of our credit risk management system is to employ our own credit rating system to assess the particular risk profile of a customer. This system is primarily generated internally but, in the case of counterparties with a global presence, also builds off the credit assessment assigned by other Banco Santander group members. As this process involves detailed analyses of the customer or credit risk, taking into account both quantitative and qualitative factors, it is subject to human error. In exercising their judgement, our employees may not always be able to assign an accurate credit rating to a customer or credit risk, which may result in our exposure to higher credit risks than indicated by our risk rating system.

 

In addition, we have been trying to refine our credit policies and guidelines to address potential risks associated with particular industries or types of customers, such as affiliated entities and group customers. However, we may not be able to timely detect these risks before they occur, or due to limited tools available to us, our employees may not be able to effectively implement them, which may increase our credit risk. Failure to effectively implement, consistently follow or continuously refine our credit risk management system may result in an increase in the level of non-performing loans and a higher risk exposure for us, which could have a material adverse effect on us.

 

We are subject to market, operational and other related risks associated with our derivative transactions that could have a material adverse effect on us.

 

We enter into derivative transactions for trading purposes as well as for hedging purposes. We are subject to market and operational risks associated with these transactions, including basis risk (the risk of loss associated with variations in the spread between the asset yield and the funding and/or hedge cost) and credit or default risk (the risk of insolvency or other inability of the counterparty to a particular transaction to perform its obligations thereunder, including providing sufficient collateral). Any downgrade in our ratings could increase our borrowing costs and require us to post additional collateral or take other actions under some of our derivative contracts, and could limit our access to capital markets and adversely affect our commercial business.

 

Market practices and documentation for derivative transactions in the UK may differ from those in other countries. In addition, the execution and performance of these transactions depends on our ability to develop adequate control and administration systems and to hire and retain qualified personnel. Moreover, our ability to adequately monitor, analyse and report derivative transactions continues to depend, to a great extent, on our information technology systems. This factor further increases the risks associated with these transactions and could have a material adverse effect on us.

 

Operational risks, including risks relating to data collection, processing and storage systems are inherent in our business.

 

Our businesses depend on the ability to process a large number of transactions efficiently and accurately, and on our ability to rely on our digital technologies, computer and email services, software and networks, as well as on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. The proper functioning of financial control, accounting or other data collection and processing systems is critical to our businesses and to our ability to compete effectively. Losses can result from inadequate personnel, human error, inadequate or failed internal control processes and systems, or from external events that interrupt normal business operations. We also face the risk that the design of our controls and procedures prove to be inadequate or are circumvented. Although we work with our clients, vendors, service providers, counterparties and other third parties to develop secure transmission capabilities and prevent against cyber attacks, we routinely exchange personal, confidential and proprietary information by electronic means, and we may be the target of attempted cyber attacks. If we cannot maintain an effective data collection, management and processing system, we may be materially and adversely affected.

 

We take protective measures and continuously monitor and develop our systems to protect our technology infrastructure and data from misappropriation or corruption, but our systems, software and networks nevertheless may be vulnerable to unauthorised access, misuse, computer viruses or other malicious code and other events that could have a security impact. An interception, misuse or mishandling of personal, confidential or proprietary information sent to or received from a client, vendor, service provider, counterparty or third party could result in legal liability, regulatory action and reputational harm. Furthermore, these may require us to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures. There can be no assurance that we will not suffer material losses from operational risk in the future, including relating to cyber attacks or other such security breaches. Further, as cyber attacks continue to evolve, we may incur significant costs in our attempt to modify or enhance our protective measures or investigate or remediate any vulnerabilities.

 

We manage and hold confidential personal information of customers in the conduct of our banking operations. Although we have procedures and controls to safeguard personal information in our possession, unauthorised disclosures could subject us to legal actions and administrative sanctions as well as damages that could materially and adversely affect our results of operations and financial condition.

 

In addition, our businesses are exposed to risk from potential non-compliance with policies, employee misconduct or negligence and fraud, which could result in regulatory sanctions and serious reputational or financial harm. In recent years, a number of multinational financial institutions have suffered material losses due to the actions of 'rogue traders' or other employees. It is not always possible to deter employee misconduct and the precautions we take to prevent and detect this activity may not always be effective.

 

We are required to report every event related to information security issues, such as hacking or hacking attempts, events where customer information may be compromised, unauthorised access and other security breaches, to the Information Commissioner. As of the date of this report, we have not experienced information security problems and we have not had to report any such events to the Information Commissioner. Any material disruption or slowdown of our systems could cause information, including data related to customer requests, to be lost or to be delivered to our clients with delays or errors, which could reduce demand for our services and products and could materially and adversely affect us.

 

Despite our risk management policies, procedures and methods, we may nonetheless be exposed to unidentified or unanticipated risks.

 

The management of risk is an integral part of our activities. We seek to monitor and manage our risk exposure through a variety of separate but complementary financial, credit, market, operational, compliance and legal reporting systems. For further description of our risk management policies see the Risk Management Report on pages 62 to 162. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, such techniques and strategies may not be fully effective in mitigating our risk exposure in all economic market environments or against all types of risk, including risks that we fail to identify or anticipate.

 

Some of our qualitative tools and metrics for managing risk are based upon our use of observed historical market behaviour. We apply statistical and other tools to these observations to arrive at quantifications of our risk exposures. These qualitative tools and metrics may fail to predict future risk exposures. These risk exposures could, for example, arise from factors we did not anticipate or correctly evaluate in its statistical models. This would limit our ability to manage our risks. Our losses thus could be significantly greater than the historical measures indicate. In addition, our quantified modelling does not take all risks into account. Our more qualitative approach to managing those risks could prove insufficient, exposing us to material unanticipated losses. If existing or potential customers believe our risk management is inadequate, they could take their business elsewhere. This could harm our reputation as well as our revenues and profits.

 

Competition with other financial institutions could adversely affect us.

 

We face substantial competition in all parts of our business, including in originating loans and in attracting deposits. The competition in originating loans comes principally from other domestic and foreign banks, mortgage banking companies, consumer finance companies, insurance companies and other lenders and purchasers of loans. The market for UK financial services is highly competitive and the recent financial crisis has reshaped the banking landscape in the UK, particularly the financial services and mortgage markets, reinforcing both the importance of a retail deposit funding base and strong capitalisation. Lenders have moved increasingly towards a policy of concentrating on the highest quality customers, judged by credit score and loan to value criteria, and there is strong competition for these customers. The supply of credit is much more limited for those potential customers without a large deposit or good credit history.

 

We expect competition to intensify in response to consumer demand, technological changes, the impact of consolidation, regulatory actions and other factors. If financial markets remain unstable, financial institution consolidation may continue (whether as a result of the UK Government taking ownership and control over other financial institutions in the UK or otherwise). Financial institution consolidation could also result from the UK Government disposing of its stakes in those financial institutions it currently controls. Such consolidation could adversely affect our operating results, financial condition and prospects. There can be no assurance that this increased competition will not adversely affect our growth prospects, and therefore our operations. We also face competition from non-bank competitors, such as supermarkets and department stores for some credit products and generally from other loan providers.

 

Increasing competition could require that we increase our rates offered on deposits or lower the rates we charge on loans, which could also have a material adverse effect on us, including our profitability. It may also negatively affect our business results and prospects by, among other things, limiting our ability to increase our customer base and expand our operations and increasing competition for investment opportunities.

 

In addition, if our customer service levels were perceived by the market to be materially below those of our competitor financial institutions, we could lose existing and potential business. If we are not successful in retaining and strengthening customer relationships, we may lose market share, incur losses on some or all of our activities or fail to attract new deposits or retain existing deposits, which could have a material adverse effect on our operating results, financial condition and prospects.

 

Our ability to maintain our competitive position depends, in part, on the success of new products and services we offer our customers and our ability to continue offering products and services from third parties, and we may not be able to manage various risks we face as we expand our range of products and services that could have a material adverse effect on us.

 

The success of our operations and our profitability depends, in part, on the success of new products and services we offer our customers. However, we cannot guarantee that our new products and services will be responsive to customer demands or successful once they are offered to our customers, or that they will be successful in the future. In addition, our customers' needs or desires may change over time, and such changes may render our products and services obsolete, outdated or unattractive and we may not be able to develop new products that meet our customers' changing needs. If we cannot respond in a timely fashion to the changing needs of our customers, we may lose customers, which could in turn materially and adversely affect us.

 

As we expand the range of our products and services, some of which may be at an early stage of development in the UK market, we will be exposed to new and potentially increasingly complex risks and development expenses, with respect to which our experience and the experience of our partners may not be helpful. Our employees and our risk management systems may not be adequate to handle such risks. In addition, the cost of developing products that are not launched is likely to affect our results of operations. Any or all of these factors, individually or collectively, could have a material adverse effect on us.

 

If we are unable to effectively control the level of non-performing or poor credit quality loans in the future, or if our loan loss reserves are insufficient to cover future loan losses, this could have a material adverse effect on us.

 

Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of our businesses. Non-performing or low credit quality loans can negatively impact our results of operations. We cannot be sure that we will be able to effectively control the level of the impaired loans in our total loan portfolio. In particular, the amount of our reported non-performing loans may increase in the future as a result of growth in our total loan portfolio, including as a result of loan portfolios that we may acquire in the future, or factors beyond our control, such as adverse changes in the credit quality of our borrowers and counterparties or a general deterioration in the UK or global economic conditions, impact of political events, events affecting certain industries or events affecting financial markets and global economies.

 

Our current loan loss reserves may not be adequate to cover an increase in the amount of non-performing loans or any future deterioration in the overall credit quality of our total loan portfolio. Our loan loss reserves are based on our current assessment of and expectations concerning various factors affecting the quality of our loan portfolio. These factors include, among other things, our borrowers' financial condition, repayment abilities and repayment intentions, the realisable value of any collateral, the prospects for support from any guarantor, government macroeconomic policies, interest rates and the legal and regulatory environment. As the recent global financial crisis has demonstrated, many of these factors are beyond our control. As a result, there is no precise method for predicting loan and credit losses, and we cannot assure you that our loan loss reserves will be sufficient to cover actual losses.

 

If our assessment of and expectations concerning the above mentioned factors differ from actual developments, if the quality of our total loan portfolio deteriorates, for any reason, including the increase in lending to individuals and small and medium enterprises, the volume increase in the credit card portfolio and the introduction of new products, or if the future actual losses exceed our estimates of incurred losses, we may be required to increase our loan loss reserves, which may adversely affect us. If we are unable to control or reduce the level of our non-performing or poor credit quality loans, this could have a material adverse effect on us

 

Interest rates payable on a significant portion of our outstanding mortgage loan products fluctuate over time due to, among other factors, changes in the Bank of England base rate. As a result borrowers with variable interest rate mortgage loans are exposed to increased monthly payments when the related mortgage interest rate adjusts upward. Similarly, borrowers of mortgage loans with fixed or introductory rates adjusting to variable rates after an initial period are exposed to the risk of increased monthly payments at the end of this period. Over the last few years both variable and fixed interest rates have been at relatively low levels, which has benefited borrowers of new loans and those repaying existing variable rate loans regardless of special or introductory rates. Future increases in borrowers' required monthly payments may result in higher delinquency rates and losses in the future. Borrowers seeking to avoid these increased monthly payments by refinancing their mortgage loans may no longer be able to find available replacement loans at comparably low interest rates. Recent declines in housing prices and/or any further declines in housing prices may also leave borrowers with insufficient equity in their homes to permit them to refinance. These events, alone or in combination, may contribute to higher delinquency rates and losses.

 

Our loan portfolio is subject to risk of prepayment, which could have a material adverse effect on us.

 

Our loan portfolio is subject to prepayment risk, which results from the ability of a borrower or issuer to pay a debt obligation prior to maturity. Generally, in a declining interest rate environment, prepayment activity increases, which reduces the weighted average lives of our earning assets and could have a material adverse effect on us. We would also be required to amortise net premiums into income over a shorter period of time, thereby reducing the corresponding asset yield and net interest income. Prepayment risk also has a significant adverse impact on credit card and collateralised mortgage loans, since prepayments could shorten the weighted average life of these assets, which may result in a mismatch in our funding obligations and reinvestment at lower yields. Prepayment risk is inherent to our commercial activity and an increase in prepayments could have a material adverse effect on us.

 

The value of the collateral, including real estate, securing our loans may not be sufficient, and we may be unable to realise the full value of the collateral securing our loan portfolio.

 

The value of the collateral securing our loan portfolio may significantly fluctuate or decline due to factors beyond our control, including macroeconomic factors affecting the UK's economy. The real estate market is particularly vulnerable in the current economic climate and the residential mortgage loan portfolio is one of our principal assets, comprising 85% of our loan portfolio as of 31 December 2012. As a result, we are highly exposed to developments in the residential property market in the UK.

 

The UK housing market has remained muted throughout 2012, with transaction levels well below historic norms and house prices broadly flat for the past two years. An increase in house prices may be limited by the high level of prices relative to household earnings and the more restricted availability of mortgage credit relative to pre-crisis levels. The depth of the previous house price declines as well as the continuing uncertainty as to the timing and extent of the economic recovery will mean that losses could be incurred on loans should they go into possession. The UK commercial property market conditions remain extremely challenging. After some recovery, commercial property capital values have seen further steady declines since Q4 2011 and the investment market has had lower transaction levels in 2012 as a result of weak demand. These developments mean that the outlook for the UK commercial property market remains uncertain.

 

The continued effect of margin pressure and exposure to both retail and commercial loan impairment charges resulting from the impact of general economic conditions means that we may continue to experience low levels of profitability and growth, and there remains the possibility of further downward pressure on profitability depending on a number of external influences, such as the consequences of a more austere economic environment. The value of the collateral securing our loan portfolio may also be adversely affected by force majeure events, such as natural disasters like floods or landslides which may cause widespread damage, could have an adverse impact on the economy of the affected region and may impair the asset quality of our loan portfolio in that area.

 

We may also not have sufficiently recent information on the value of collateral, which may result in an inaccurate assessment for impairment losses of our loans secured by such collateral. If this were to occur, we may need to make additional provisions to cover actual impairment losses of our loans, which may materially and adversely affect our results of operations and financial condition.

 

The credit card industry is highly competitive and entails significant risks, including the possibility of over-indebtedness of customers, which could have a material adverse effect on us.

 

Our credit card business is subject to a number of risks and uncertainties, including the possibility of over-indebtedness of our customers, despite our focus on low-risk, medium- and high-income customers.

 

The credit card industry is characterised by higher consumer default than other credit industries, and defaults are highly correlated with macroeconomic indicators that are beyond our control. Part of our current growth strategy is to increase volume in the credit card portfolio which may increase our exposure to risk in our loan portfolio. If UK economic growth slows or declines, or if we fail to effectively analyse the creditworthiness of our customers (including by targeting certain sectors), we may be faced with unexpected losses that could have a material adverse effect on us.

 

We have a core strategy to grow our operations but if we are unable to manage such growth effectively, this could have an adverse impact on our profitability.

 

We allocate management and planning resources to develop strategic plans for organic growth, and to identify possible acquisitions and disposals and areas for restructuring our businesses. We cannot provide assurance that we will, in all cases, be able to manage our growth effectively or deliver our strategic growth objectives. Challenges that may result from our strategic growth decisions include our ability to:

 

> manage efficiently the operations and employees of expanding businesses;

> maintain or grow our existing customer base;

> assess the value, strengths and weaknesses of investment or acquisition candidates;

> finance strategic opportunities, investments or acquisitions;

> fully integrate strategic investments, or newly-established entities or acquisitions, in line with our strategy;

> align our current information technology systems adequately with those of an enlarged Group;

> apply our risk management policy effectively to an enlarged Group; and

> manage a growing number of entities without over-committing management or losing key personnel.

 

Any failure to manage growth effectively, including relating to any or all of the above challenges associated with our growth plans, could have a material adverse effect on our operating results, financial condition and prospects.

 

Our future acquisitions may not be successful and maybe disruptive to our business.

 

We have acquired controlling interests in various companies, such as Alliance & Leicester plc with effect from 2008, and have engaged in other strategic ventures, such as the acquisition of certain retail assets of Bradford & Bingley plc in 2008. From time to time, we evaluate acquisition and partnership opportunities that we believe could offer additional value to our shareholders and are consistent with our business strategy. However, we may not be able to identify suitable acquisition or partnership candidates, and we may not be able to acquire promising targets or form partnerships on favourable terms or at all. Furthermore preparations for acquisitions which do not complete can be disruptive. We base our assessment of potential acquisitions and partnerships on limited and potentially inexact information and on assumptions with respect to value, operations, profitability and other matters that may prove to be incorrect. Our ability to benefit from any such acquisitions and partnerships will depend in part on our successful integration of those businesses. We can give no assurances that our expectations with regards to integration and synergies will materialise. The integration of acquired businesses or partners' businesses entails significant risks, including:

 

> unforeseen difficulties in integrating operations and systems;

> inability to modify accounting standards rapidly;

> problems assimilating or retaining the employees of acquired businesses or partners' businesses;

> challenges retaining customers of acquired businesses or partners' businesses;

> unexpected liabilities or contingencies relating to the acquired businesses, including legal claims;

> the possibility that management may be distracted from day-to-day business concerns by integration activities and related problem-solving; and

> the possibility of regulatory restrictions that prevent us from achieving the expected benefits of the acquisition or venture.

 

In addition, an acquisition or venture could result in the loss of key employees and inconsistencies in standards, controls, procedures and policies. Moreover, the success of the acquisition or venture will at least in part be subject to a number of political, economic and other factors that are beyond our control. Any or all of these factors, individually or collectively, could have a material adverse effect on us.

 

Goodwill impairments may be required in relation to acquired businesses.

 

We have made business acquisitions in recent years and may make further in the future. It is possible that the goodwill which has been attributed, or may be attributed, to these businesses may have to be written-down if our valuation assumptions are required to be reassessed as a result of any deterioration in their underlying profitability, asset quality and other relevant matters. Although no impairment of goodwill was recognised in 2012, in 2011 there was a £60m impairment as a result of a reassessment of the value of certain parts of the business in light of market conditions and regulatory developments. Impairment testing in respect of goodwill is performed annually, more frequently if there are impairment indicators present, and comprises a comparison of the carrying amount of the cash-generating unit with its recoverable amount. Goodwill impairment does not however affect our regulatory capital. There can be no assurances that we will not have to write down the value attributed to goodwill in the future, which would adversely affect our results and net assets.

 

We are subject to substantial regulation and governmental oversight which could adversely affect our business and operations.

 

As a financial institution, we are subject to extensive financial services laws, regulations, administrative actions and policies in the UK and each location in which we operate (including in the US and, indirectly, in Spain by the Banco de España (the Bank of Spain) as a result of being part of the Banco Santander, S.A. group) which materially affects our businesses. Statutes, regulations and policies to which we are subject, in particular those relating to the banking sector and financial institutions, may be changed at any time, and the interpretation and the application of those laws and regulations by regulators is also subject to change. Any legislative or regulatory actions and any required changes to our business operations resulting from such legislation and regulations could result in significant loss of revenue, limit our ability to pursue business opportunities in which we might otherwise consider engaging, affect the value of assets that we hold, require us to increase our prices and therefore reduce demand for our products, impose additional costs on us or otherwise adversely affect our businesses. Accordingly, there can be no assurance that future changes in regulations or in their interpretation or application will not adversely affect us.

 

During the recent market turmoil, there have been unprecedented levels of government and regulatory intervention and scrutiny, and changes to the regulations governing financial institutions and the conduct of business. In addition, in light of the financial crisis, regulatory and governmental authorities are considering, or may consider, further enhanced or new legal or regulatory requirements intended to prevent future crises or otherwise assure the stability of institutions under their supervision. It is anticipated that this intensive approach to supervision will be continued by the successor regulatory authorities to the FSA.

 

Recent proposals and measures taken by governmental, tax and regulatory authorities and future changes in supervision and regulation, in particular in the UK, which are beyond our control, could materially affect our business, value of assets and operations, and result in significant increases in operational costs. Products and services offered by us could also be affected. Changes in UK legislation and regulation to address the stability of the financial sector may also affect the competitive position of the UK banks, including the Company, particularly if such changes are implemented before international consensus is reached on key issues affecting the industry, for instance in relation to the FSA's regulations on liquidity risk management and also the UK Government's introduction of the bank levy. Although we work closely with our regulators and continually monitor the situation, future changes in law, regulation, fiscal or other policies can be unpredictable and are beyond our control. No assurance can be given generally that laws or regulations will be adopted, enforced or interpreted in a manner that will not have an adverse effect on our business.

 

On 16 June 2010, the Chancellor of the Exchequer announced the creation of the Independent Commission on Banking (the 'ICB'), chaired by Sir John Vickers. The ICB was asked to consider structural and related non-structural reforms to the UK banking sector to promote financial stability and competition, and to make recommendations to the UK Government. The ICB gave its recommendations on 12 September 2011 and proposed: (i) implementation of a retail ring fence; (ii) increased capital requirements; and (iii) improvement of competition - which were broadly endorsed by the Government in its response published on 19 December 2011. A White Paper was published on 14 June 2012 detailing how the Government intends to implement the recommendations of the ICB. A draft of the initial bill to implement the ICB recommendations was published on 12 October 2012, in the format of framework legislation to put in place the architecture to effect the reforms, with detailed policy being provided for through secondary legislation. On 4 February 2013, the Financial Services (Banking Reform) Bill was introduced to Parliament. The Government expects the legislation to be in place by 2015 and to take effect by 2019. Implementation of the proposals may require us to make changes to our structure and business.

 

In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted 21 July 2010 (the "Dodd-Frank Act"), has been implemented in part and continues to be implemented by various US federal regulatory agencies. The Dodd-Frank Act, among other things, imposes a new regulatory framework on swap transactions, including swaps of the sort that we enter into, requires regulators to adopt new rules governing the retention of credit risk by securitisers or originators of securitisations, significantly expands the coverage and scope of regulations that limit affiliate transactions within a banking organisation and prohibits certain forms of proprietary trading. Each of these aspects of the Dodd-Frank Act, as well as others, may directly and indirectly impact various aspects of our business. The full spectrum of risks that the Dodd-Frank Act poses to us is not yet known, however, such risks could be material and we could be materially and adversely affected by them.

 

The resolution of a number of issues, including regulatory reforms, investigations and reviews and court cases, affecting the UK financial services industry could have an adverse effect on our operating results, financial condition and prospects, or our relations with our customers and potential customers.

 

The structure of the financial regulatory authorities in the UK and the UK regulatory framework that applies to us is the subject of reform and reorganisation.

 

Under the Financial Services Act (the "Act") which received Royal Assent on 19 December 2012 the Government has announced a range of structural reforms to UK financial regulatory bodies to be implemented in early 2013, as follows:

 

> the FSA will cease to exist in its current form;

> a new Financial Policy Committee will be established in the Bank of England which will be responsible for macroprudential regulation, or regulation of stability and resilience of the financial system as a whole;

> an independent subsidiary of the Bank of England, the Prudential Regulation Authority ("PRA"), will be established to oversee micro-prudential regulation of financial institutions that manage significant risks on their balance sheets; and

> the Financial Conduct Authority ("FCA") will be established and will have the responsibility for conduct of business and markets regulation.

 

 

In addition, the Act, also contains provisions enabling consumer credit regulation to be transferred from the OFT to the FCA. This decision will be subject to further consultation. The FCA will also represent the UK's interests in markets regulation at the new European Securities and Markets Authority.

 

This substantial reorganisation of the regulatory framework could cause administrative and operational disruption for the regulatory authorities concerned. This disruption could impact on the resources which the FSA or the successor authorities are able to devote to the supervision of regulated financial services firms, the nature of their approach to supervision and accordingly, the ability of regulated financial sector firms (including us) to deal effectively with their supervisors and to anticipate and respond appropriately to developments in regulatory policy.

 

It is anticipated that future changes in the nature of, or policies for, prudential and conduct of business supervision, as performed by the successor authorities to the FSA, will differ from the current approach taken by the FSA and that this could lead to a period of some uncertainty for us. The implementation of the Act could result both in further increased regulatory oversight of our activities as a financial services firm, resulting in constraints in our business activities and/or increases in regulatory capital requirements, and/or increased amounts of our time and resources required to be committed to compliance with the requirements of two new regulators with separate approaches and objectives, which could result in a material increase in compliance costs. No assurance can be given that further changes will not be made to the regulatory regime in the UK generally, our particular business sectors in the market or specifically in relation to us. Any or all of these factors could have a material adverse effect on the conduct of our business and, therefore, also on our strategy and profitability, and ability to respond to and satisfy the supervisory requirements of the relevant UK regulatory authorities.

 

Various reforms to the mortgage lending and personal loans market have been proposed which could require significant implementation costs or changes to our business strategy.

 

In March 2009, the Turner Review, "A regulatory response to the global banking crisis", was published and set out a detailed analysis of how the global financial crisis began along with a number of recommendations for future reforms and proposals for consultation. As part of the Turner Review, the FSA published a discussion paper outlining proposals for reform of the mortgage market. Subsequently the FSA commenced a wide ranging consultation on mortgage lending - the FSA's Mortgage Market Review ("MMR"). The MMR concluded with the publication of Final Rules by the FSA on 25 October 2012 that will amend existing conduct rules for mortgage lending in the FSA Handbook. The new rules will come into effect on 26 April 2014. Principal changes centre upon responsible lending and include:

 

> more thorough verification of borrowers income (no self-certification of income, mandatory third party evidence of income required);

> assessment of affordability of interest-only loans on a capital and interest basis unless there is a clearly understood and believable alternative source of capital repayment;

> application of interest rate stress tests - lenders must consider likely interest rate movements over a minimum period of 5 years from the start of the mortgage term;

> when making underwriting assessments lenders must take account of future changes to income and expenditure that a lender knows of or should have been aware of from information gathered in the application process; and

> lenders may base their assessment of customers' income on actual expected retirement age rather than state pension age. Lenders will be expected to assess income into retirement to judge whether the affordability tests can be met.

 

There are also significant changes to mortgage distribution and advice requirements in sales, arrears management and requirements on contract variations such as when additional borrowing is requested. The impact of the changes is now clear and the reforms have presaged a period of significant change for our mortgage lending business which will mean reforms to our mortgage sales delivery systems, changes to our mortgage documentation and significant reform of our approach to risk assessment of prospective mortgage customers. These could have an adverse effect on our operating results, financial condition and prospects.

 

Separately, throughout 2012, HM Treasury announced a number of measures with the aim of enhancing consumer protection in unsecured and secured credit lending. The measures provide for the transfer of responsibility for consumer credit control and supervision from the OFT to the new Financial Conduct Authority. The intention of HM Treasury is that transfer of control will take place in April 2014. It is expected that HM Treasury will publish results of a Regulatory Impact Assessment together with a consultation on legislative change and the details of the high level regime in early 2013. The FSA will also commence a consultation on the new FCA consumer credit regime and high level conduct of business rules in early 2013.  

 

A likely consequence of these pending changes is that we will have to review and reform the sales processes and documentation of our consumer credit products including our credit card and unsecured personal loan products before April 2014. This review and the changes we may have to make could adversely affect our business.

 

We are exposed to risk of loss from legal and regulatory proceedings.

 

We face various issues that may give rise to risk of loss from legal and regulatory proceedings. These issues, including appropriately dealing with potential conflicts of interest, and legal and regulatory requirements, could increase the amount of damages asserted against us or subject us to regulatory enforcement actions, fines and penalties. The current regulatory environment, with its increased supervisory focus on enforcement, combined with uncertainty about the evolution of the regulatory regime, may lead to material operational and compliance costs. These risks include that:

 

> certain aspects of our business may be determined by the Bank of England, the FSA (and in due course, PRA and the FCA), HM Treasury, the OFT, the Financial Ombudsman Service ('FOS') or the courts as not being conducted in accordance with applicable laws or regulations, or, in the case of the FOS, with what is fair and reasonable in the Ombudsman's opinion;

> the alleged misselling of financial products, such as payment protection insurance, including as a result of having sales practices and/or rewards structures that are deemed to have been inappropriate, resulting in disciplinary action (including significant fines) or requirements to amend sales processes, withdraw products, or provide restitution to affected customers, all of which may require additional provisions to be recorded in our financial statements and could adversely impact future revenues from affected products;

> we hold accounts for entities that might be or are subject to interest from various regulators, including the UK's Serious Fraud Office, regulators in the US and elsewhere. We are not aware of any current investigation into us as a result of any such enquiries, but cannot exclude the possibility of our conduct being reviewed as part of any such investigation; and

> we may be liable for damages to third parties harmed by the conduct of our business.

 

We are from time to time subject to certain claims and party to certain legal proceedings incidental to the normal course of our business, including in connection with our lending activities, relationships with our employees and other commercial or tax matters. These can be brought against us under UK regulatory processes or in the UK courts, or those in other jurisdictions where we operate including other European countries and the United States. In view of the inherent difficulty of predicting the outcome of legal matters, particularly where the claimants seek very large or indeterminate damages, or where the cases present novel legal theories, involve a large number of parties or are in the early stages of discovery, we cannot state with confidence what the eventual outcome of these pending matters will be or what the eventual loss, fines or penalties related to each pending matter may be. We believe that we have made adequate reserves related to the costs anticipated to be incurred in connection with these various claims and legal proceedings. However, the amount of these reserves is substantially less than the total amount of the claims asserted against us and in light of the uncertainties involved in such claims and proceedings, there is no assurance that the ultimate resolution of these matters will not significantly exceed the reserves currently accrued by us. As a result, the outcome of a particular matter may be material to our operating results for a particular period, depending upon, among other factors, the size of the loss or liability imposed and our level of income for that period.

 

The FSA carries out regular and frequent reviews of the conduct of business by financial institutions including banks. An adverse finding by the regulator could result in the need for extensive changes in systems and controls, business policies, and practices coupled with customer redress, fines and reputational damage.

 

Failure to manage these risks adequately could have a material adverse effect on our reputation, operating results, financial condition and prospects.

 

Potential intervention by the UK Financial Services Authority (or an overseas regulator) may occur, particularly in response to customer complaints.

 

Following the onset of the recent financial crisis, the FSA has adopted a more intrusive and direct style of regulation which it has termed "intensive supervision". This strategy, combined with the FSA's outcome focused regulatory approach, more proactive enforcement and more punitive penalties for infringements means that FSA-authorised firms are facing increasing supervisory intrusion and scrutiny (resulting in increasing internal compliance costs and FSA supervision fees) and in the event of a breach of their regulatory obligations are likely to face more stringent penalties. It is anticipated that this intensive approach to supervision will be continued by the PRA and FCA.

 

The regulatory regime requires us to be in compliance across all aspects of our business, including the training, authorisation and supervision of personnel, systems, processes and documentation. If we fail to be compliant with relevant regulations, there is a risk of an adverse impact on our business from sanctions, fines or other action imposed by the regulatory authorities. Customers of financial services institutions, including our customers, may seek redress if they consider that they have suffered loss as a result of the misselling of a particular product, or through incorrect application of the terms and conditions of a particular product. Given the inherent unpredictability of litigation and the evolution of judgements by the FOS, it is possible that an adverse outcome in some matters could have a material adverse effect on our operating results, financial condition and prospects arising from any penalties imposed or compensation awarded, together with the costs of defending such an action.

 

The Financial Services Act 2010 provided a new power for the FSA which enables the FSA to require authorised firms, including us, to establish a consumer redress scheme if it considers that consumers have suffered loss or damage as a consequence of a widespread or regular regulatory failing, including misselling.

 

In recent years there have been several industry-wide issues in which the FSA has intervened directly. One such issue is the misselling of payment protection insurance ('PPI'). In August 2010, the FSA published a policy statement entitled "The assessment and redress of Payment Protection Insurance complaints". This policy statement contained rules from the FSA which altered the basis on which FSA regulated firms (including the Company and certain members of the Group) must consider and deal with complaints in relation to the sale of PPI and potentially increased the amount of compensation payable to customers whose complaints are upheld. A legal challenge of these rules by the British Bankers' Association (the 'BBA') was unsuccessful. In light of this and the consequential increase in claims levels we performed a detailed review of our provision requirements and as a result, revised our provision for PPI complaint liabilities to reflect the new information. The overall effect of the above was a substantial increase in the provision requirement for 2011.

 

The ultimate financial impact on us of the claims arising from PPI complaints is uncertain and will depend on a number of factors, including the implementation of the FSA's Policy Statement, the rate at which new complaints arise, the content and quality of the complaints (including the availability of supporting evidence), the role of claims management companies and the average uphold rates and redress costs. We can make no assurance that expenses associated with PPI complaints will not exceed the provision we have made relating to these claims. More generally, we can make no assurance that our estimates for potential liabilities are correct, and the reserves taken as a result may prove inadequate. If we were to incur additional expenses that exceed provisions for PPI liabilities or other provisions, these expenses could have a material adverse effect on our operating results, financial condition and prospects. For further information about the provisions for PPI complaint liabilities and other conduct remediation see Note 36 to the Financial Statements.

 

All the above is similarly relevant to any future industry-wide misselling or other issues that could affect us, such as the sale of other retail products and interest-rate derivative products sold to SMEs. This may lead from time to time to: (i) significant direct costs or liabilities (including in relation to misselling); and (ii) changes in the practices of such businesses which benefit customers at a cost to shareholders.

 

Decisions taken by the FOS (or any overseas equivalent that has jurisdiction) could, if applied to a wider class or grouping of customers, have a material adverse effect on our operating results, financial condition and prospects.

 

The Banking Act, and similar European Union legislation, may adversely affect our business.

 

The Banking Act came into force on 12 February 2009. The special resolution regime set out in the Banking Act provides HM Treasury, the Bank of England and the FSA with a variety of powers for dealing with UK deposit taking institutions that are failing or likely to fail, including: (i) to take a bank or bank holding company into temporary public ownership; (ii) to transfer all or part of the business of a bank to a private sector purchaser; or (iii) to transfer all or part of the business of a bank to a "bridge bank". The special resolution regime also comprises a separate insolvency procedure and administration procedure each of which is of specific application to banks. These insolvency and administration measures may be invoked prior to the point at which an application for insolvency proceedings with respect to a relevant institution could be made.

 

If an instrument or order were made under the Banking Act in respect of the Company, such instrument or order (as the case may be) may (among other things): (i) result in a compulsory transfer of shares or other securities or property of the Company; (ii) impact on the rights of the holders of shares or other securities in the Company or result in the nullification or modification of the terms and conditions of such shares or securities; or (iii) result in the de-listing of the Company's shares and/or other securities. In addition, such an order may affect matters in respect of the Company and/or other aspects of the Company's shares or other securities which may negatively affect the ability of the Company to meet its obligations in respect of such shares or securities.

 

At present, no instruments or orders have been made under the Banking Act relating to us and there has been no indication that any such order will be made, but there can be no assurance that holders of shares or other securities in the Company would not be adversely affected by any such order if made in the future.

 

In June 2012, the European Commission published a legislative proposal for a directive providing for the establishment of an EU-wide framework for the recovery and resolution of credit institutions and investment firms (the "CMD"). The stated aim of the draft CMD is to provide authorities with common tools and powers to address banking crises pre-emptively in order to safeguard financial stability and minimise taxpayers' exposure to losses. The draft CMD currently contains similar resolution tools and powers to the Banking Act, including a 'bail-in' power which gives resolution authorities the power to write down the claims of unsecured creditors of a failing institution and to convert unsecured debt claims to equity (subject to certain parameters). The draft CMD currently contemplates that it will be applied by Member States from 1 January 2015 except for the bail-in tool (in relation to certain instruments) which is to be applied from 1 January 2018.

 

The powers currently set out in the draft CMD would impact how credit institutions and investment firms are managed as well as, in certain circumstances, the rights of creditors. However, the proposed directive is not in final form and changes may be made to it in the course of the legislative process. In addition, many of the proposals contained in the draft CMD have already been implemented in the Banking Act and it is currently unclear as to what extent, if any, the provisions of the Banking Act may need to change once the draft CMD is implemented. Accordingly, it is not yet possible to assess the full impact of the draft CMD on us and there can be no assurance that, once it is implemented, the fact of its implementation or the taking of any actions currently contemplated in it would not materially and adversely affect our operating results, financial position and prospects.

 

We are responsible for contributing to compensation schemes in the UK in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers.

 

In the UK, the Financial Services Compensation Scheme ('FSCS') was established under the Financial Services and Markets Act 2000 and is the UK's statutory fund of last resort for customers of authorised financial services firms. The FSCS can pay compensation to customers if an FSA-authorised firm is unable, or likely to be unable, to pay claims against it (for instance, an authorised bank is unable to pay claims by depositors). The FSCS is funded by levies on firms authorised by the FSA, including the Company and other members of the Group.

 

In the event that the FSCS raises funds from authorised firms, raises those funds more frequently or significantly increases the levies to be paid by such firms, the associated cost to us may have a material adverse effect on our operating results, financial condition and prospects. The recent measures taken to protect the depositors of deposit-taking institutions involving the FSCS have resulted in a significant increase in the levies made by the FSCS on the industry and such levies may continue to go up if similar measures are required to protect depositors of other institutions.

 

In addition, regulatory reform initiatives in the UK and internationally may result in further changes to the FSCS, which could result in additional costs and risks for us. For instance, the FSA announced in October 2011 that it was restarting its review of the funding of the FSCS and on 25 July 2012 it announced a consultation on proposed changes to the funding of the FSCS, with comments due by 25 October 2012. Following this consultation, whilst most of the proposals will be taken forward and will come into effect from 1 April 2013, other proposals relating to intermediaries and investment providers were revised and a consultation on these revised proposals closed on 18 February 2013. Changes as a result of this may affect the profitability of the Company (and other members of the Group required to contribute to the FSCS).

 

As a result of the structural reorganisation and reform of the UK financial regulatory authorities, it is proposed that the FSCS levies will be collected by the FCA under the new regime. It is possible that future policy of the FSCS and future levies on the firms authorised by the FSA may differ from those at present and that this could lead to a period of some uncertainty for members of the Group. In addition, it is possible that other jurisdictions where we operate could introduce or amend their similar compensation, contributory or reimbursement schemes. As a result of any such developments, we may incur additional costs and liabilities which may adversely affect our operating results, financial condition and prospects.

 

We may not be able to detect money laundering and other illegal or improper activities fully or on a timely basis, which could expose us to additional liability and could have a material adverse effect on us.

 

We are required to comply with applicable anti-money laundering, anti-terrorism and other laws and regulations in the jurisdictions in which we operate. These laws and regulations require us, among other things, to adopt and enforce "know-your-customer" policies and procedures and to report suspicious and large transactions to the applicable regulatory authorities. These laws and regulations have become increasingly complex and detailed, require improved systems and sophisticated monitoring and compliance personnel and have become the subject of enhanced government supervision.

 

While we have adopted policies and procedures aimed at detecting and preventing the use of our banking network for money laundering and related activities, such policies and procedures have in some cases only been recently adopted and may not completely eliminate instances where we may be used by other parties to engage in money laundering and other illegal or improper activities. In addition, the personnel we employ in supervising these activities may not have experience that is comparable to the level of sophistication of criminal organisations. To the extent we fail to fully comply with applicable laws and regulations, the relevant government agencies to which we report have the power and authority to impose fines and other penalties on us, including the revocation of licenses. In addition, our business and reputation could suffer if customers use our banking network for money laundering or illegal or improper purposes.

 

In addition, while we review our relevant counterparties' internal policies and procedures with respect to such matters, we, to a large degree, rely upon our relevant counterparties to maintain and properly apply their own appropriate anti-money laundering procedures. Such measures, procedures and compliance may not be completely effective in preventing third parties from using our (and our relevant counterparties) as a conduit for money laundering (including illegal cash operations) without our (and our relevant counterparties') knowledge. If we are associated with, or even accused of being associated with, or become a party to, money laundering, then our reputation could suffer and/or we could become subject to fines, sanctions and/or legal enforcement (including being added to any "black lists" that would prohibit certain parties from engaging in transactions with us), any one of which could have a material adverse effect on our operating results, financial condition and prospects.

 

Changes in taxes and other assessments may adversely affect us.

 

The tax and other assessment regimes to which we and our customers are subject are regularly reformed, or subject to proposed reforms. Such reforms include changes in the rate of assessments and, occasionally, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. The effects of these changes and any other changes that result from enactment of additional tax reforms have not been, and cannot be, quantified and there can be no assurance that these reforms will not, once implemented, have an adverse effect upon our business. Furthermore, such changes may produce uncertainty in the financial system, increasing the cost of borrowing and contributing to the increase in our non-performing credit portfolio.

 

The following paragraphs discuss three major reforms (the UK bank levy, FATCA and possible future changes in the taxation of banking groups in the European Union) which could have a material adverse effect on our operating results, financial condition and prospects, and the competitive position of UK banks, including the Company.

 

UK Bank Levy: HM Treasury introduced an annual UK bank levy ("the Bank Levy") via legislation in the Finance Act 2011. The Bank Levy is imposed on (amongst other entities) UK banking groups and subsidiaries, and therefore applies to us. The amount of the Bank Levy is based on a bank's total liabilities, excluding (amongst other things) Tier 1 Capital, insured retail deposits and repos secured on sovereign debt. A reduced rate is applied to longer-term liabilities. The UK Government intends that the Bank Levy should raise at least £2.5bn each year. To offset the shortfall in Bank Levy receipts, and also to take account of the benefit to the banking sector of reductions in the rate of corporation tax, there was an increase in the rates of Bank Levy from 1 January 2012 with a further increase from 1 January 2013.

 

FATCA: Sections 1471 through 1474 of the US Internal Revenue Code ("FATCA") impose a new reporting regime and potentially a 30% withholding tax with respect to certain payments to any non-US financial institution (a "foreign financial institution" or "FFI" (as defined by FATCA)) that (i) does not become a "Participating FFI" by entering into an agreement with the US Internal Revenue Service (the "IRS") to provide the IRS with certain information in respect of its account holders and investors; or (ii) is not otherwise exempt from or in deemed compliance with FATCA. The Company is classified as an FFI.

 

Final regulations implementing FATCA were promulgated in January 2013. The new reporting and withholding regime will be phased in over time (with withholding beginning 1 January 2014 for certain payments from sources within the United States and 1 January 2017 for payments of gross proceeds on assets that could generate US source dividend or interest and "foreign pass thru payments" (a term not yet defined)).

 

The United States and the United Kingdom have entered into an agreement (the "US-UK IGA") under which we expect to be treated as a Reporting FI and accordingly do not anticipate being required to deduct any tax under FATCA. We will, however, be required to comply with certain due diligence and reporting requirements to HMRC. There can be no assurance that we will be treated as a Reporting FI or that in the future we would not be required to deduct tax under FATCA from payments we make on certain financial products. The Regulations implementing the UK-US IGA and accompanying guidance on their application were published in draft form in December 2012 and remain subject to further consultation and revision.

 

European Taxation: In September 2011, the European Commission (the "Commission") tabled a proposal for a common system of financial transactions taxes ("FTT"). Despite intense discussions on this proposal there was no unanimity amongst the 27 Member States. Eleven Member States ("participating Member State") requested enhanced cooperation on a FTT based upon the Commission's original proposal. The Commission presented a Decision to this effect and this Decision was adopted by the EU's Council of Finance Ministers at its committee meeting on 22 January 2013. The formal Directive was published on 14 February 2013, under which participating Member States may charge a FTT on all financial transactions with effect from 1 January 2014 where (i) at least one party to the transaction is established in the territory of a participating Member State and (ii) a financial institution established in the territory of a participating Member State is a party to the transaction acting either for its own account or for the account of another person, or is acting in the name of a party to the transaction. Whilst the UK is not a participating Member State, the Directive proposals are broad and as such may impact transactions completed by financial institutions operating in non-participating Member States. We are still assessing the proposals to determine the likely impact on us.

 

Changes in our pension liabilities and obligations could have a materially adverse effect on us.

 

We provide retirement benefits for many of our former and current employees in the United Kingdom through a number of defined benefit pension schemes established under trust. We have only limited control over the rate at which we pay into such schemes. Under the UK statutory funding requirements, employers are usually required to contribute to the schemes at the rate they agree with the scheme trustees, although if they cannot agree, such rate can be set by the Pensions Regulator. The scheme trustees may, in the course of discussions about future valuations, seek higher employer contributions. The scheme trustees' power in relation to the payment of pension contributions depends on the terms of the trust deed and rules governing the pension schemes.

 

The UK Pensions Regulator has the power to issue a financial support direction to companies within a group in respect of the liability of employers participating in the UK defined benefit pension plans where that employer is a service company, or is otherwise "insufficiently resourced" (as defined for the purposes of the relevant legislation). As some of the employers within the Group are service companies, if they become insufficiently resourced, other companies within the Group which are connected with or an associate of those employers are at risk of a financial support direction in respect of those employers' liabilities to the defined benefit pension schemes in circumstances where the Pensions Regulator properly considers it reasonable to issue one. Such a financial support direction could require the companies to guarantee or provide security for the pension liabilities of those employers, or could require additional amounts to be paid into the relevant pension schemes in respect of them.

 

The UK courts have decided that liabilities under financial support directions issued by the Pensions Regulator against companies after they have gone into administration were payable as an expense of the administration, and did not rank as provable debts. This means that such liabilities will have to be satisfied before any distributions to unsecured creditors could be made. It is understood that leave to appeal to the Supreme Court has been requested and therefore it is likely that there will be a further decision to come.

 

The Pensions Regulator can also issue contribution notices if it is of the opinion that an employer has taken actions, or failed to take actions, deliberately designed to avoid meeting its pension promises or which are materially detrimental to the scheme's ability to meet its pension promises. A contribution notice can be moved to any company which is connected with or an associate of such employer in circumstances where the Regulator considers it reasonable to issue. The risk of a contribution notice being imposed may inhibit our freedom to restructure or to undertake certain corporate activities.

 

Changes in the size of the deficit in the defined benefit schemes operated by us, due to reduction in the value of the pension fund assets (depending on the performance of financial markets) or an increase in the pension fund liabilities due to changes in mortality assumptions, the rate of increase of salaries, discount rate assumptions, inflation, the expected rate of return on plan assets, or other factors, could result in us having to make increased contributions to reduce or satisfy the deficits which would divert resources from use in other areas of our business and reduce the Company's capital resources. While we can control a number of the above factors, there are some over which we have no or limited control. Although the trustees of the defined benefit pension schemes are obliged to consult with us before changing the pension schemes' investment strategy, the trustees have the final say. Increases in our pension liabilities and obligations could have a material adverse effect on our operating results, financial condition and prospects.

 

The ongoing changes in the UK supervision and regulatory regime and particularly the implementation of the ICB's recommendations may require us to make changes to its structure and business which could have an impact on our pension schemes or liabilities. For a discussion of the ICB's recommendations see "We are subject to substantial regulation and governmental oversight which could adversely affect our business and operations" on pages 318 to 319.

 

We rely on recruiting, retaining and developing appropriate senior management and skilled personnel.

 

Our continued success depends in part on the continued service of key members of our management team. The ability to continue to attract, train, motivate and retain highly qualified and talented professionals is a key element of our strategy. The successful implementation of our growth strategy depends on the availability of skilled management, both at our head office and at each of our business units. If we or one of our business units or other functions fails to staff its operations appropriately or loses one or more of its key senior executives and fails to replace them in a satisfactory and timely manner, our business, financial condition and results of operations, including control and operational risks, may be adversely affected.

 

In addition, the financial industry has and may continue to experience more stringent regulation of employee compensation, which could have an adverse effect on our ability to hire or retain the most qualified employees. If we fail or are unable to attract and appropriately train, motivate and retain qualified professionals, our business may also be adversely affected.

 

Damage to our reputation could cause harm to our business prospects.

 

Maintaining a positive reputation is critical to our attracting and maintaining customers, investors and employees and conducting business transactions with counterparties. Damage to our reputation, the reputation of Banco Santander, S.A. (as the majority shareholder in the Company), or the reputation of affiliates operating under the "Santander" brand or any of our other brands, can therefore cause significant harm to our business and prospects. Harm to our reputation can arise from numerous sources, including, among others, employee misconduct, litigation, failure to deliver minimum standards of service and quality, compliance failures, breach of legal or regulatory requirements, unethical behaviour (including giving adopted inappropriate sales and trading practices), and the activities of customers and counterparties. Further, negative publicity regarding us, whether or not true, may result in harm to our operating results, financial condition and prospects.

 

Actions by the financial services industry generally or by certain members of, or individuals in, the industry can also affect our reputation. For example, the role played by financial services firms in the financial crisis and the seeming shift toward increasing regulatory supervision and enforcement has caused public perception of us and others in the financial services industry to decline.

We could suffer significant reputational harm if we fail to properly identify and manage potential conflicts of interest. Management of potential conflicts of interest has become increasingly complex as we expand our business activities through more numerous transactions, obligations and interests with and among our customers. The failure to adequately address, or the perceived failure to adequately address, conflicts of interest could affect the willingness of customers to deal with us, or give rise to litigation or enforcement actions against us. Therefore, there can be no assurance that conflicts of interest will not arise in the future that could cause material harm to us.

 

Our financial statements are based in part on assumptions and estimates which, if inaccurate, could cause material misstatement of the results of our operations and financial position.

 

The preparation of financial statements requires management to make judgements, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognised in the period in which the estimate is revised and in any future periods affected. The accounting policies deemed critical to our results and financial position, based upon materiality and significant judgements and estimates, include impairment of loans and advances, valuation of financial instruments, goodwill impairment, provision for conduct remediation and pensions.

 

The valuation of financial instruments measured at fair value can be subjective, in particular where models are used which include unobservable inputs. Given the uncertainty and subjectivity associated with valuing such instruments it is possible that the results of our operations and financial position could be materially misstated if the estimates and assumptions used prove to be inaccurate.

 

If the judgement, estimates and assumptions we use in preparing our consolidated financial statements are subsequently found to be incorrect, there could be a material effect on our results of operations and a corresponding effect on our funding requirements and capital ratios.

 

Changes in accounting standards could impact reported earnings.

 

The accounting standard setters and other regulatory bodies periodically change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. These changes can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.

 

Different disclosure and accounting principles between the UK and the US may provide you with different or less information about us than you expect.

 

There may be less publicly available information about us than is regularly published about companies in the United States. Issuers of securities in the UK are required to make public disclosures that are different from, and that may be reported under presentations that are not consistent with, disclosures required in countries with more developed capital markets, including the United States. While we are subject to the periodic reporting requirements of the Securities Exchange Act of 1934 (the "Exchange Act"), the disclosure required from foreign private issuers under the Exchange Act is more limited than the disclosure required from US issuers. In addition, for regulatory purposes, we currently prepare and will continue to prepare and make available to our shareholders statutory financial statements in accordance with UK GAAP, which differs from IFRS in a number of respects. In addition, as a foreign private issuer, we are not subject to the same disclosure requirements in the United States as a domestic US registrant under the Exchange Act, including the requirements to prepare and issue quarterly reports, or the proxy rules applicable to domestic US registrants under Section 14 of the Exchange Act or the insider reporting and short-swing profit rules under Section 16 of the Exchange Act. Accordingly, the information about us available to you will not be the same as the information available to shareholders of a US company and may be reported in a manner that you are not familiar with.

 

Any failure to effectively improve or upgrade our information technology infrastructure and management information systems in a timely manner could have a material adverse effect on us.

 

Our ability to remain competitive depends to a significant extent upon the functionality of our information technology systems (including Partenon, the global banking informational technology platform utilised by Banco Santander, S.A and the Group), and on our ability to upgrade and expand the capacity of our information technology on a timely and cost-effective basis. The proper functioning of our financial control, risk management, credit analysis and reporting, accounting, customer service and other information technology systems, as well as the communication networks between its branches and main data processing centres, are critical to our business and our ability to compete. We must continually make significant investments and improvements in our information technology infrastructure in order to remain competitive. We cannot assure you that in the future we will be able to maintain the level of capital expenditures necessary to support the improvement, expansion or upgrading of our information technology infrastructure as effectively as its competitors, this may result in a loss of the competitive advantages that we believe our information technology systems provide. Any failure to effectively improve, expand or upgrade our information technology infrastructure and management information systems in a timely manner could have a material adverse effect on us.

 

We rely on third parties for important infrastructure support products and services.

 

Third party vendors provide key components of our business infrastructure such as loan and deposit servicing systems, internet connections and network access. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to customers and otherwise to conduct business. Replacing these third party vendors could also entail significant delays and expense.

 

We engage in transactions with our subsidiaries or affiliates that others may not consider to be on an arm's-length basis.

 

We and our subsidiaries and affiliates have entered into a number of services agreements pursuant to which we render services, such as administrative, accounting, finance, treasury, legal services and others. We rely upon certain outsourced services (including information technology support, maintenance and consultancy services in connection with Partenon) provided by certain other members of the Banco Santander, S.A. group.

 

English law applicable to public companies and financial groups and institutions, as well as our articles of association, provide for several procedures designed to ensure that the transactions entered into with or among our financial subsidiaries do not deviate from prevailing market conditions for those types of transactions, including the requirement that our board of directors approve such transactions. We are likely to continue to engage in transactions with our subsidiaries or affiliates (including our controlling shareholder). Future conflicts of interests between us and any of our subsidiaries or affiliates, or among our subsidiaries and affiliates, may arise, which conflicts are not required to be and may not be resolved in our favour.

 

Risks concerning enforcement of judgements made in the United States.

 

Santander UK plc is a public limited company registered in England and Wales. All of the Company's Directors live outside the United States of America. As a result, it may not be possible to serve process on such persons in the United States of America or to enforce judgements obtained in US courts against them or us based on the civil liability provisions of the US federal securities laws or other laws of the United States of America or any state thereof. The Directors' Report on pages 181 to 192 of our 2012 Annual Report has been prepared and presented in accordance with and in reliance upon English company law and the liabilities of the Directors in connection with that Report shall be subject to the limitations and restrictions provided by such law. Under the UK Companies Act 2006, a safe harbour limits the liability of Directors in respect of statements in and omissions from the Directors' Report on pages 181 to 192 of our 2012 Annual Report. Under this safe harbour, the Directors would be liable to the Company (but not to any third party) if the Directors' Report contains errors as a result of recklessness or knowing misstatement or dishonest concealment of a material fact, but would not otherwise be liable.

 

Contact Information

 

Santander UK plc principal executive office and registered office, principal office and investor relations department

 

2 Triton Square

Regent's Place

London

NW1 3AN

 

Phone number:

0870-607-6000

 

Santander shareholder department

 

Santander Shareholder Relations

2 Triton Square

Regent's Place

London

NW1 3AN

Phone numbers:

0871-384-2000

+44 (0) 121-415-7188 (outside the UK)

 

Email: shareholders@santander.com

 

 

Designated agent

 

The designated agent for service of process on Santander UK in the United States is Abbey National Treasury Services plc (Connecticut branch), 400 Atlantic Street, Stamford, CT 06901.

 

 

Other information

 

Documents on display

The Company is subject to the information requirements of the US Securities Exchange Act of 1934. In accordance with these requirements, the Company files its Annual Report and Accounts and other related documents with the US Securities and Exchange Commission. These documents may be inspected by US investors at the US Securities and Exchange Commission's public reference rooms, which are located at 100 F Street NE, Room 1580, Washington, DC 20549-0102. Information on the operation of the public reference rooms can be obtained by calling the US Securities and Exchange Commission on +1-202-551-8090 or by looking at the US Securities and Exchange Commission's website at www.sec.gov.

 

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 Notes 36 and 38 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 2012 there have been no material contracts entered into outside the ordinary course of business, except for the contract described below.

 

On 30 August 2011, the Company entered into an amended sale and purchase agreement with The Royal Bank of Scotland plc, National Westminster Bank plc, National Westminster Home Loans Limited which replaced the sale and purchase agreement between the same parties dated 4 August 2010. Under this contract the Company had agreed to acquire (subject to certain conditions) bank branches and business banking centres and associated assets and liabilities from The Royal Bank of Scotland group. This contract was terminated by mutual agreement of the parties on 12 October 2012.

 

Audit fees

See Note 8 to the Consolidated Financial Statements

 

Profit on part sale and revaluation of subsidiaries

No profits arose on sales of Santander UK group undertakings in the year (2011: £nil, 2010: £39m). In 2010, a gain of £87m arose on the revaluation of the Santander UK group's original holding in Santander Consumer (UK) plc on the Santander UK group's acquisition of the remaining shares.

 

Significant acquisitions and disposals

The results were not materially affected by the acquisition of the Santander Cards and Santander Consumer businesses acquired in October and November 2010, respectively, as described in Note 45 to the Consolidated Financial Statements.

 

Current and future accounting developments under IFRS

Details can be found in Note 1 to the Consolidated Financial Statements.

 

Articles of Association

 

The following is a summary of the Articles of Association (the 'Articles') of the Company.

 

Santander UK plc is a public company registered in England and Wales, registered number 2294747. The Articles do not specifically state or limit the objects of the Company which are therefore unrestricted.

 

A Director shall not vote on, or be counted in the quorum in relation to any resolution of the Directors in respect of any contract in which he has an interest, or any resolution of the Directors concerning his own appointment, or the settlement or variation of the terms or the termination of his or her appointment.

 

Preference shares entitle the holder to receive a preferential dividend payment at a fixed or variable rate, such dividend to be payable on a date determined by the Board prior to the allotment of the shares. The Board will also determine whether these dividend rights are cumulative or non-cumulative. If dividends are unclaimed for twelve years, the right to the dividend ceases. The holders of any series of preference shares will only be entitled to receive notice of and to attend any general meeting of the Company if the preference dividend on the preference shares of such series has not, at the date of the notice of the general meeting, been paid in full in respect of such dividend periods as the Board may prior to allotment determine, in which case the holders of the preference shares will be entitled to speak and/or vote upon any resolution proposed; or, if a resolution is proposed at the general meeting, for, or in relation to, the winding-up of the Company; or varying, altering or abrogating any of the rights, privileges, limitations or restrictions attached to the preference shares of such series, in which case the holders of the preference shares of such series will be entitled to speak and/or vote only upon such resolution; or in such other circumstances, and upon and subject to such terms, as the Board may determine prior to allotment.

 

Unless the Board determines, prior to allotment, that the series of preference shares shall be non-redeemable, each series shall be redeemable at the option of the Company on any date as the Board may determine prior to the date of allotment. On redemption the Company shall pay the amount due. The formula for calculation of any relevant redemption premium is set out in the Articles of Association.

 

There are no sinking fund provisions. Where the preference shares are partly paid, the Board may make further calls upon the holders. There are no provisions discriminating against any existing or prospective shareholder as a result of such shareholder owning a substantial number of shares.

 

Dividends are payable to the holders of ordinary shares. These ordinary shares are transferable. If dividends are unclaimed for twelve years, the right to the dividend ceases.

 

Subject to any special terms as to voting upon which any ordinary shares may be issued or may for the time being be held or any suspension or any abrogation of voting rights as set out in the Articles of Association, on a show of hands every member who is present in person at a general meeting of the Company shall have one vote and every proxy present who has been duly appointed by a member shall have one vote. On a poll every member who is present in person or by proxy shall have one vote for every share of which he is the holder.

 

Subject to the prior rights of holders of preference shares, the Company pays dividends on its ordinary shares only out of its distributable profits and not out of share capital. Dividends are determined by the Board.

 

The Company's Articles of Association authorise it to issue redeemable shares, but the Company's ordinary shares are not redeemable. There are no sinking fund provisions. The Board may from time to time make calls upon the members in respect of any monies unpaid on their shares. There are no provisions discriminating against any existing or prospective shareholder as a result of such shareholder owning a substantial number of ordinary shares.

 

Subject to the provisions of the UK Companies Act 2006, all or any of the rights attached to any class of shares (whether or not the Company is being wound up) may be varied with the consent in writing of the holders of not less than three-fourths in nominal value of the issued shares of that class or with the sanction of a special resolution passed at a separate general meeting of the holders of those shares. Additional quorum and voting requirements apply to such meeting.

 

General meetings shall be called by at least 14 clear days' notice (that is, excluding the day of the General Meeting and the day on which the notice is given). A general meeting may be called by shorter notice if it is so agreed, in the case of an annual general meeting, by all the shareholders having a right to attend and vote, or in other cases, by a majority in number of the shareholders having a right to attend and vote, being a majority together holding not less than 95 per cent in nominal value of the shares giving the right. The notice shall specify the date, time and place of the meeting and the general nature of the business to be transacted.

 

There are no restrictions on the rights to own securities for either resident or non-resident shareholders, other than those to which they may be subject as a result of the laws and regulations in their home jurisdiction.

 

Glossary of Financial Services Industry Terms

 

Term used in the Annual Report

US equivalent or brief description of meaning

Accounts

Financial statements

Allotted

Issued

Articles of Association

Bylaws

Attributable profit

Net income

Balance sheet

Statement of financial position

Bills

Notes

Called up share capital

Ordinary shares or common stock and preferred stock, issued and fully paid

Capital allowances

Tax depreciation allowances

Creditors

Payables

Current account

Checking account

Dealing

Trading

Debtors

Receivables

Deferred tax

Deferred income tax

Depreciation

Amortisation

Fees and commissions payable

Fees and commissions expense

Fees and commissions receivable

Fees and commissions income

Finance lease

Capital lease

Freehold

Ownership with absolute rights in perpetuity

Interest payable

Interest expense

Interest receivable

Interest income

Loans and advances

Lendings

Loan capital

Long-term debt

Members

Shareholders

Nominal value

Par value

One-off

Non-recurring

Ordinary shares

Common stock

Preference shares

Preferred stock

Premises

Real estate

Profit

Income

Provisions

Liabilities

Share capital

Ordinary shares, or common stock, and preferred stock

Shareholders

Stockholders

Share premium account

Additional paid-in capital

Shares in issue

Shares outstanding

Undistributable reserves

Restricted surplus

Write-offs

Charge-offs

 

 

Term used in the Annual Report

Definition

Alternative A-paper ('Alt-A')

A US description for loans regarded as better risk than sub-prime, but with higher risk characteristics than lending under normal criteria.

 

Arrears

Customers are said to be in arrears when they are behind in fulfilling their obligations with the result that an outstanding loan is unpaid or overdue. Such a customer is also said to be in a state of delinquency. When a customer is in arrears, his entire outstanding balance is said to be delinquent, meaning that delinquent balances are the total outstanding loans on which payments are overdue.

 

Asset Backed Securities ('ABS')

Securities that represent an interest in an underlying pool of referenced assets. The referenced pool can comprise any assets which attract a set of associated cash flows but are commonly pools of residential or commercial mortgages but could also include leases, credit card receivables, motor vehicles or student loans.

 

Bank Levy ('UK Bank Levy')

The levy that applies to certain UK banks, UK building societies and the UK operations of foreign banks from 1 January 2011. The levy is payable based on a percentage of the chargeable equity and liabilities of the bank at the balance sheet date.

 

Banking net interest margin

Net interest income (adjusted to remove net interest income from the Treasury asset portfolio) divided by average commercial assets (mortgages, unsecured personal loans, credit cards, corporate loans and overdrafts).

 

Basel II

The capital adequacy framework issued by the Basel Committee on Banking Supervision in June 2006 in the form of the 'International Convergence of Capital Measurement and Capital Standards'.

 

Basel III

In December 2010, the Basel Committee on Banking Supervision issued the Basel III rules text, which presents the details of strengthened global regulatory standards on bank capital adequacy and liquidity. The standards are expected to be implemented beginning in January 2014.

 

Basis point

One hundredth of a per cent (i.e. 0.01%), so 100 basis points is 1%. Used in quoting movements in interest rates or yields on securities.

 

BIPRU

The prudential sourcebook for banks, building societies and investment firms which sets out the UK Financial Services Authority's capital requirements.

 

Collateralised Bond Obligation ('CBO')

A security backed by the repayments from a pool of bonds, some of which may be sub-investment grade but because of their different types of credit risk, they are considered to be sufficiently diversified to be of investment grade.

 

Collateralised Debt Obligation ('CDO')

Securities issued by a third party which reference ABS and/or certain other related assets purchased by the issuer. Santander UK has not established any programmes creating CDOs but acquired instruments issued by other banking groups as a result of the acquisition of Alliance & Leicester. The CDO portfolio has been run down.

 

Collateralised Loan Obligation ('CLO')

A security backed by the repayments from a pool of commercial loans. The payments may be made to different classes of owners (in tranches).

 

Collectively assessed loan impairment provisions

Impairment losses assessment on a collective basis for loans that are part of homogeneous pools of similar loans and that are not individually significant, using appropriate statistical techniques. See "Impairment of financial assets" in Note 1 "Accounting Policies" to the Consolidated Financial Statements.

 

Commercial lending

Loans secured on UK commercial property, and corporate loans.

 

Commercial Mortgage-Backed Securities ('CMBS')

Securities that represent interests in a pool of commercial mortgages. Investors in these securities have the right to cash received from future mortgage payments (interest and/or principal).

 

Commercial Paper

An unsecured promissory note issued to finance short-term credit needs. It specifies the face amount paid to investors on the maturity date. Commercial paper can be issued as an unsecured obligation of the Santander UK group and is usually issued for periods ranging from one week up to nine months. However, the depth and reliability of some CP markets means that issuers can repeatedly roll over CP issuance and effectively achieve longer term funding. CP can be issued in a range of denominations and can be either discounted or interest-bearing.

 

Commercial Real Estate

Includes office buildings, industrial property, medical centres, hotels, malls, retail stores, shopping centres, farm land, multifamily housing buildings, warehouses, garages and industrial properties.

 

Common Equity Tier 1 Capital

Called-up share capital and eligible reserves less deductions specified in the CRD IV legislative package, including transitional provisions.

 

Common Equity Tier 1 Capital Ratio Assets

 

Common Equity Tier 1 capital as a percentage of risk weighted assets.

Contractual maturity

The final payment date of a loan or other financial instrument, at which point all the remaining outstanding principal will be repaid and interest is due to be paid.

 

 

Term used in the Annual Report

Definition

Core Tier 1 capital

Called up share capital and eligible reserves plus equity non-controlling interests, less intangible assets and deductions relating to the excess of expected loss over regulatory impairment loss allowance and securitisation positions as specified by the UK Financial Services Authority.

 

Core Tier 1 capital ratio

Core Tier 1 capital as a percentage of risk weighted assets.

 

Cost:income ratio

Operating expenses as a percentage of total income.

 

Coverage ratio

Impairment loss allowances as a percentage of total non-performing loans and advances.

 

Covered bonds

 

Debt securities backed by a portfolio of mortgages that is segregated from the issuer's other assets solely for the benefit of the holders of the covered bonds. The Santander UK group issues covered bonds as part of its funding activities.

 

Credit Default Swap ('CDS')

A credit derivative contract where the protection seller receives premium or interest-related payments in return for contracting to make payments to the protection buyer in the event of a defined credit event. Credit events normally include bankruptcy, payment default on a reference asset or assets, or downgrades by a rating agency.

 

Credit derivative

A contractual agreement whereby the credit risk of an asset (the reference asset) is transferred from the buyer to the seller of protection. The buyer of the credit derivative pays a periodic fee in return for a payment by the protection seller upon the occurrence, if any, of a credit event defined at the inception of the transaction. Credit events normally include bankruptcy, payment default on a reference asset or assets, or downgrades by a rating agency. Credit derivatives include credit default swaps, total return swaps and credit swap options.

 

Credit risk

The risk of financial loss arising from the default of a customer or counterparty to which the Santander UK group has directly provided credit, or for which the Santander UK group has assumed a financial obligation, after realising collateral held. Credit risk includes residual credit risk and concentration risk.

 

Credit risk adjustment

An adjustment to the valuation of OTC derivative contracts to reflect the creditworthiness of OTC derivative counterparties. It is measured as a lifetime expected loss for each counterparty based on the probability of default, the loss given default and the expected exposure of the OTC derivative position with the counterparty.

 

Credit risk mitigation

A technique to reduce the credit risk associated with an exposure by application of credit risk mitigants such as collateral, guarantee and credit protection.

 

Credit risk spread

The yield spread between securities with the same coupon rate and maturity structure but with different associated credit risks, with the yield spread rising as the credit rating worsens. It is the premium over the benchmark or risk-free rate required by the market to accept a lower credit quality.

 

Credit Valuation Adjustment ('CVA')

Adjustments to the fair values of derivative assets to reflect the creditworthiness of the counterparty.

 

Currency swap

An arrangement in which two parties exchange specific principal amounts of different currencies at inception and subsequently interest payments on the principal amounts. Often, one party will pay a fixed interest rate, while the other will pay a floating exchange rate (though there are also fixed-fixed and floating-floating arrangements). At the maturity of the swap, the principal amounts are usually re-exchanged.

 

Customer accounts/customer deposits

Money deposited by all individuals and companies that are not credit institutions. Such funds are recorded as liabilities in the Santander UK group's balance sheet under Deposits by Customers, Trading Liabilities or Financial Liabilities designated at Fair Value.

 

Debt restructuring

This occurs when the terms and provisions of outstanding debt agreements are changed. This is often done in order to improve cash flow and the ability of the borrower to repay the debt. It can involve altering the repayment schedule as well as reducing the debt or interest charged on the loan.

 

Debt securities

Transferable instruments creating or acknowledging indebtedness. They include debentures, bonds, certificates of deposit, notes and commercial paper. The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as the right to receive certain information. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities can be secured or unsecured.

 

Debt securities in issue

Transferable certificates of indebtedness of the Santander UK group to the bearer of the certificates. These are liabilities of the Santander UK group and include commercial paper, certificates of deposit, bonds and medium-term notes.

 

Deferred tax asset

Income taxes that are recoverable in future periods as a result of deductible temporary differences and the carry-forward of tax losses and unused tax credits. Temporary differences arise due to timing differences between the accounting value of an asset or liability recorded and its value for tax purposes (tax base) that result in tax deductible amounts in future periods.

 

 

Term used in the Annual Report

Definition

Deferred tax liability

Income taxes that are payable in future periods as a result of taxable temporary differences. Temporary differences arise due to timing differences between the accounting value of an asset or liability and its value for tax purposes (tax base) that result in taxable amounts in future periods.

 

Defined benefit obligation

The present value of expected future payments required to settle the obligations of a defined benefit plan resulting from employee service.

 

Defined benefit plan

A pension plan that defines an amount of pension benefit to be provided, usually as a function of one or more factors such as age, years of service or compensation. The employer's obligation can be more or less than its contributions to the fund.

 

Defined contribution plan

A pension plan under which the Santander UK group pays fixed contributions as they fall due into a separate entity (a fund) and will have no legal or constructive obligations to pay further contributions, i.e. the employer's obligation is limited to its contributions to the fund.

 

Delinquency

See 'Arrears'.

 

Deposits by banks

Money deposited by banks and other credit institutions. They include money-market deposits, securities sold under repurchase agreements, and other short-term deposits. Such funds are recorded as liabilities in the Santander UK group's balance sheet under Deposits by Banks Trading Liabilities or Financial Liabilities designated at Fair Value.

 

Derivative

A contract or agreement whose value changes with changes in an underlying index such as interest rates, foreign exchange rates, share prices or indices and which requires no initial investment or an initial investment that is smaller than would be required for other types of contracts with a similar response to market factors. The principal types of derivatives are: swaps, forwards, futures and options.

 

Discount Window Facility ('DWF')

 

The Discount Window Facility ('DWF') is a bilateral facility introduced by the Bank of England designed to address short-term liquidity requirements without distorting banks' incentives for prudent liquidity management. Eligible banks and building societies may borrow gilts, for 30 or 364 days, against a wide range of collateral in return for a fee, which varies with the collateral used and the total size and maturity of borrowings.

 

Economic capital

An internal measure of the minimum equity and preference capital required for the Santander UK group to maintain its credit rating based upon its risk profile.

 

Effective Interest rate method

 

A method of calculating the amortised cost or carrying value of a financial asset or financial liability (or group of financial assets or liabilities) and of allocating the interest income or interest expense over the expected life of the asset or liability.

 

Effective tax rate

The actual tax on profits on ordinary activities as a percentage of profit on ordinary activities before taxation.

 

Expected loss

The Santander UK group measure of anticipated loss for exposures captured under an internal ratings-based credit risk approach for capital adequacy calculations. It is measured as the Santander UK group-modelled view of anticipated loss based on Probability of Default, Loss Given Default and Exposure at Default, with a one-year time horizon.

 

Exposure

The maximum loss that a financial institution might suffer if a borrower, counterparty or group fails to meet their obligations or assets and off-balance sheet positions have to be realised.

 

Exposure at default ('EAD')

The estimation of the extent to which the Santander UK group may be exposed to a customer or counterparty in the event of, and at the time of, that counterparty's default. At default, the customer may not have drawn the loan fully or may already have repaid some of the principal, so that exposure is typically less than the approved loan limit.

 

Extended Collateral Term Repo ('ECTR') Facility

 

Contingency liquidity facility introduced by the Bank of England to mitigate risks to financial stability arising from a market-wide shortage of short-term sterling liquidity.

 

Fair value adjustment

 

An adjustment to the fair value of a financial instrument which is determined using a valuation technique (level 2 and level 3) to include additional factors that would be considered by a market participant that are not incorporated within the valuation model.

 

Financial Services Compensation Scheme ('FSCS')

The UK's statutory fund of last resort for customers of authorised financial services firms, established under the Financial Services and Markets Act ('FSMA') 2000. The FSCS can pay compensation to customers if a UK FSA authorised firm is unable, or likely to be unable, to pay claims against it (for instance, an authorised bank is unable to pay claims by depositors). The FSCS is funded by levies on firms authorised by the UK FSA, including Santander UK plc and other members of the Santander UK group.

 

Term used in the Annual Report

Definition

First/Second Charge

First charge (also known as first lien): debt that places its holder first in line to collect compensation from the sale of the underlying collateral in the event of a default on the loan. Second charge (also known as second lien): debt that is issued against the same collateral as a higher charge debt but that is subordinate to it. In the case of default, compensation for this debt will only be received after the first charge has been repaid and thus represents a riskier investment than the first charge.

 

Forbearance

 

A term generally applied to arrangements provided to support borrowers experiencing temporary financial difficulty. Such arrangements include reduced or nil payments, term extensions, transfers to interest only and the capitalisation of arrears.

 

Foundation Internal Ratings-based ('IRB') approach

A method for calculating credit risk capital requirements using the Santander UK group's internal Probability of Default models but with supervisory estimates of Loss Given Default and conversion factors for the calculation of Exposure at Default.

 

Full time equivalent

Full time equivalent employee units are the on-job hours paid for employee services divided by the number of ordinary-time hours normally paid for a full-time staff member when on the job (or contract employee where applicable).

 

Funded/unfunded

Exposures where the notional amount of the transaction is either funded or unfunded. Represents exposures where a commitment to provide future funding has been made and the funds have been released/not released.

 

Funding for Lending Scheme ('FLS')

A scheme designed by the Bank of England and HM Treasury to incentivise banks and building societies to boost their lending to UK households and non-financial companies. It aims to do this by providing funding to banks and building societies for an extended period, with both the price and quantity of funding provided linked to their performance in lending to the UK non-financial sector.

 

Gain on acquisition

The amount by which the acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities, recognised in a business combination, exceeds the cost of the combination.

 

Home loan (Residential mortgage)

A loan to purchase a residential property which is then used as collateral to guarantee repayment of the loan. The borrower gives the lender a lien against the property and the lender can foreclose on the property if the borrower does not repay the loan per the agreed terms. Also known as a residential mortgage.

 

Impaired loans

Loans where an individual identified impairment loss allowance has been raised and also include loans which are fully collateralised or where indebtedness has already been written down to the expected realisable value. The impaired loan category may include loans, which, while impaired, are still performing.

 

Impairment allowance (Loan impairment provisions)

 

A loss allowance held on the balance sheet as a result of the raising of a charge against profit for the incurred loss inherent in the lending book. An impairment loss allowance may either be identified or unidentified and individual or collective.

 

Impairment losses

 

The raising of a charge against profit for the incurred loss inherent in the lending book following an impairment review. For financial assets carried at amortised cost, impairment losses are recognised in the income statement and the carrying amount of the financial asset or group of financial assets is reduced by establishing an allowance for impairment losses. For available-for-sale financial assets, the cumulative loss including impairment losses is removed from equity and recognised in the income statement.

 

Individually assessed loan impairment provisions

Impairment is measured individually for assets that are individually significant. For these assets, the Santander UK group measures the amount of the impairment loss as the difference between the carrying amount of the asset or group of assets and the present value of the estimated future cash flows from the asset or group of assets discounted at the original effective interest rate of the asset.

 

Interest spread

The difference between the gross yield on average interest-earning assets and the interest rate paid on average interest-bearing liabilities.

 

Internal Capital Adequacy Assessment Process ('ICAAP')

The Santander UK groups own assessment of its regulatory capital requirements, as part of Basel II. It takes into account the regulatory and commercial environment in which the Santander UK group operates, the Santander UK group's risk appetite, the management strategy for each of the Santander UK group's material risks and the impact of appropriate adverse scenarios and stresses on the Santander UK group's capital requirements.

 

Internal ratings-based approach ('IRB')

 

The Santander UK group's method, under Basel II framework, of calculating credit risk capital requirements using internal, rather than supervisory, estimates of risk parameters. It is a more sophisticated technique in credit risk management and can be Foundation IRB or Advanced IRB.

 

Investment grade

A debt security, treasury bill or similar instrument with a credit rating measured by external agencies of AAA to BBB.

 

 

Term used in the Annual Report

Definition

ISDA (International Swaps and Derivatives Association) Master agreement

 

Standardised contract developed by ISDA used as an umbrella under which bilateral derivatives contracts are entered into.

 

Level 1 - quoted market prices

The fair value of these financial instruments is based on unadjusted quoted prices for identical assets or liabilities in an active market that the Santander UK group has the ability to access at the measurement date.

 

Level 2 - valuation techniques using observable inputs

The fair value of these financial instruments is based on quoted prices in markets that are not active or quoted prices for similar assets or liabilities, recent market transactions, inputs other than quoted market prices for the asset or liability that are observable either directly or indirectly for substantially the full term, and inputs to valuation techniques that are derived principally from or corroborated by observable market data through correlation or other statistical means for substantially the full term of the asset or liability.

 

Level 3 - valuation techniques with significant unobservable inputs

 

The fair value of these financial instruments is based on inputs to the pricing or valuation techniques that are significant to the overall fair value measurement of the asset or liability are unobservable.

 

Liquidity and Credit enhancements

Credit enhancement facilities are used to enhance the creditworthiness of financial obligations and cover losses due to asset default. Two general types of credit enhancement are third-party loan guarantees and self-enhancement through over collateralisation. Liquidity enhancement makes funds available if required, for other reasons than asset default, e.g. to ensure timely repayment of maturing commercial paper.

 

Loan loss rate

Defined as total credit impairment charge (excluding available for sale assets and reverse repurchase agreements) divided by gross loans and advances to customers and banks (at amortised cost).

 

Loan to deposit ratio

The ratio of the book value of the Santander UK group's customer assets (i.e. retail and corporate assets) divided by its customer liabilities (i.e. retail and corporate deposits).

 

Loan to value ratio ('LTV')

The amount of a first mortgage charge as a percentage of the total appraised value of real property. The LTV ratio is used in determining the appropriate level of risk for the loan and therefore the price of the loan to the borrower. LTV ratios may be expressed in a number of ways, including origination LTV and indexed LTV.

 

Loss Given Default ('LGD')

The fraction of Exposure at Default (defined above) that will not be recovered following default. LGD comprises the actual loss (the part that is not recovered), together with the economic costs associated with the recovery process.

 

Master netting agreement

An industry standard agreement which facilitates netting of transactions (such as financial assets and liabilities including derivatives) in 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.

 

Medium-Term Notes ('MTNs')

Corporate notes (or debt securities) continuously offered by a company to investors through a dealer. Investors can choose from differing maturities, ranging from nine months to 30 years. They can be issued on a fixed or floating coupon basis or with an exotic coupon; with a fixed maturity date (non-callable) or with embedded call or put options or early repayment triggers. MTNs are most generally issued as senior, unsecured debt.

 

Monoline insurers

An entity which specialises in providing credit protection to the holders of debt instruments in the event of default by a debt security counterparty. This protection is typically held in the form of derivatives such as credit default swaps referencing the underlying exposures held.

 

Mortgage-Backed Securities ('MBS')

Securities that represent interests in groups of mortgages, which may be on residential or commercial properties. Investors in these securities have the right to cash received from future mortgage payments (interest and/or principal). When the MBS references mortgages with different risk profiles, the MBS is classified according to the highest risk class.

 

Mortgage vintage

The year the mortgage was issued.

 

Net interest income

The difference between interest received on assets and interest paid on liabilities.

 

Net interest margin

 

Net interest income as a percentage of average interest-earning assets.

 

Non-performing loans

In the Retail Banking business, loans and advances are classified as non-performing typically when the counterparty fails to make payments when contractually due for three months or longer. In the Corporate Banking business, loans and advances are classified as non-performing either when payments are more than three months past due or where there are reasonable doubts about full repayment (principal and interest) under the contractual terms.

 

 

Term used in the Annual Report

Definition

Over the counter ('OTC') derivatives

Contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. They offer flexibility because, unlike standardised exchange-traded products, they can be tailored to fit specific needs.

 

Own credit

The effect of the Santander UK group's own credit standing on the fair value of financial liabilities.

 

Past due

 

A financial asset such as a loan is past due when the counterparty has failed to make a payment when contractually due. In the Santander UK group's retail loans book, a loan or advance is considered past due when any contractual payments have been missed. In the Santander UK group's corporate loans book, a loan or advance is considered past due when 90 days past due, and also when the Santander UK group has reason to believe that full repayment of the loan is in doubt.

 

Potential problem loans

 

Loans other than non-accrual loans, accruing loans which are contractually overdue 90 days or more as to principal or interest and troubled debt restructurings where known information about possible credit problems of the borrower causes management to have serious doubts about the borrower's ability to meet the loan's repayment terms.

 

Prime/ prime mortgage loans

 

A US description for mortgages granted to the most creditworthy category of borrowers.

 

Private equity investments

Equity holdings in operating companies not quoted on a public exchange.

 

Probability of default ('PD')

The likelihood that a loan will not be repaid and will fall into default. PD may be calculated for each client who has a loan (normally applicable to wholesale customers/clients) or for a portfolio of clients with similar attributes (normally applicable to retail customers). To calculate PD, the Santander UK group assesses the credit quality of borrowers and other counterparties and assigns them an internal risk rating. Multiple rating methodologies may be used to inform the rating decision on individual large credits, such as internal and external models, rating agency ratings, and for wholesale assets market information such as credit spreads. For smaller credits, a single source may suffice such as the result from an internal rating model.

 

Project Merlin

Encompasses statements made by the major UK banks (Barclays, HSBC, Lloyds Banking Group, The Royal Bank of Scotland and Santander UK plc) and the UK Government to demonstrate their clear and shared intent to work together to help the UK economy recover and grow particularly with regard to promoting lending to business.

 

Regulatory capital

 

The amount of capital that the Santander UK group holds, determined in accordance with rules established by the UK Financial Services Authority for the consolidated Santander UK group and by local regulators for individual Santander UK group companies.

 

Repurchase agreement ('Repo')

In a sale and repurchase agreement one party, the seller, sells a financial asset to another party, the buyer, under commitments to reacquire the asset at a later date. The buyer at the same time agrees to resell the asset at the same later date. From the seller's perspective such agreements are securities sold under repurchase agreements ('repos') and from the buyer's securities purchased under commitments to resell ('reverse repos').

 

Residential Mortgage-Backed Securities ('RMBS')

Securities that represent interests in a group of residential mortgages. Investors in these securities have the right to cash received from future mortgage payments (interest and/or principal).

 

Restructured/refinanced loans (in NPL and Other)

 

Loans where, for economic or legal reasons related to the debtor's financial difficulties, a concession has been granted to the debtor that would not otherwise be considered. Where the concession results in the expected cash flows discounted at the original effective interest rate being less than the loan's carrying value, an impairment allowance will be raised. When the restructure/refinancing takes place when the loan is already classified as NPL, then the loan is termed "Restructured/refinanced loans in NPL". When the restructure/refinancing takes place when the loan is not classified as NPL, then the loan is termed "Other restructured/refinanced loans".

 

Retail IRB approach

The Santander UK group's internal method of calculating credit risk capital requirements for its key retail portfolios. The UK Financial Services Authority approved the Santander UK group's application of the Retail IRB approach to the Santander UK group's credit portfolios with effect from 1 January 2008.

 

Retail loans

Loans to individuals rather than institutions, including residential mortgage lending and banking and consumer credit.

 

Return on average tangible book value

The profit attributable to equity shareholders divided by average tangible book value.

Risk appetite

 

The level of risk (types and quantum) that the Santander UK group is willing to accept (or not accept) to safeguard the interests of shareholders whilst achieving business objectives.

 

Term used in the Annual Report

Definition

Risk weighted assets

A measure of a bank's assets adjusted for their associated risks. Risk weightings are established in accordance with the Basel Capital Accord as implemented by the UK Financial Services Authority.

 

Securitisation

Securitisation is a process by which a group of assets, usually loans, are aggregated into a pool, which is used to back the issuance of new securities. Securitisation is the process by which ABS (asset backed securities) are created. A company sells assets to an SPE (special purpose entity) which then issues securities backed by the assets, based on their value. This allows the credit quality of the assets to be separated from the credit rating of the original company and transfers risk to external investors. Assets used in securitisations include mortgages to create mortgage-backed securities or residential mortgage-backed securities ('RMBS') as well as commercial mortgage-backed securities. The Santander UK group has established several securitisation structures as part of its funding and capital management activities.

 

Small and medium-sized enterprises ('SMEs')

Businesses with a turnover of up to £150m per annum.

Special Purpose Entities ('SPEs') or Special Purpose Vehicles ('SPVs')

Entities that are created to accomplish a narrow and well defined objective. There are often specific restrictions or limits around their ongoing activities. Transactions with SPEs/SPVs take a number of forms, including (i) The provision of financing to fund asset purchases, or commitments to provide finance for future purchases; (ii) Derivative transactions to provide investors in the SPE/SPV with a specified exposure; (iii) The provision of liquidity or backstop facilities which may be drawn upon if the SPE/SPV experiences future funding difficulties; and (iv) Direct investment in the notes issued by SPEs/SPVs.

 

Standardised approach

In relation to credit risk, a method for calculating credit risk capital requirements under Basel II, using External Credit Assessment Institutions ratings and supervisory risk weights. The Standardised approach is less risk-sensitive than IRB (see 'IRB' above). In relation to operational risk, a method of calculating the operational capital requirement under Basel II, by the application of a supervisory defined percentage charge to the gross income of eight specified business lines.

 

Structured finance/notes

A structured note is an instrument which pays a return linked to the value or level of a specified asset or index and sometimes offers capital protection if the value declines. Structured notes can be linked to a range of underlying assets, including equities, interest rates, funds, commodities and foreign currency.

 

Structured Investment Vehicles ('SIVs')

Special Purpose Entities which invest in diversified portfolios of interest earning assets to take advantage of the spread differentials between the assets in the SIV and the funding cost.

 

Subordinated liabilities

Liabilities which, in the event of insolvency or liquidation of the issuer, are subordinated to the claims of depositors and other creditors of the issuer.

 

Subordination

The state of prioritising repayments of principal and interest on debt to a creditor lower than repayments to other creditors by the same debtor. That is, claims of a security are settled by a debtor to a creditor only after the claims of securities held by other creditors of the same debtor have been settled.

 

Sub-prime

Loans to borrowers typically having weakened credit histories that include payment delinquencies and potentially more severe problems such as court judgements and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, high debt-to-income ratios, or other criteria indicating heightened risk of default.

 

Tier 1 capital

A measure of a bank's financial strength defined by the UK FSA. It captures Core Tier 1 capital plus other Tier 1 securities in issue, but is subject to a deduction in respect of material holdings in financial companies.

 

Tier 1 capital ratio

 

The ratio expresses Tier 1 capital as a percentage of risk weighted assets.

Tier 2 capital

Defined by the UK Financial Services Authority. Broadly, it includes qualifying subordinated debt and other Tier 2 securities in issue, eligible collective impairment allowances, unrealised available for sale equity gains and revaluation reserves. It is subject to deductions relating to the excess of expected loss over regulatory impairment allowance, securitisation positions and material holdings in financial companies.

 

Total operating income

Total operating income comprises net interest and similar income, net fee and commission income and net trading and other income, as described in Notes 3, 4 and 5, respectively, of the Consolidated Financial Statements.

 

Traded market risk

See 'Market risk'

 

Troubled debt restructurings

 

A US description for restructuring a debt whereby the creditor for economic or legal reasons related to a debtor's financial difficulties grants a concession to the debtor that it would not otherwise consider.

 

Value at Risk ('VaR')

An estimate of the potential loss which might arise from market movements under normal market conditions, if the current positions were to be held unchanged for one business day, measured to a confidence level.

 

Write-down

After an advance has been identified as impaired and is subject to an impairment allowance, the stage may be reached whereby it is concluded that there is no realistic prospect of further recovery. Write-downs will occur when, and to the extent that, the whole or part of a debt is considered irrecoverable.

 

Wrong-way risk

An aggravated form of concentration risk and arises when there is an adverse correlation between the counterparty's probability of default and the mark-to-market value of the underlying transaction.

 

Forward-looking Statements

 

Santander UK plc (the 'Company') and its subsidiaries (together 'Santander UK' or the 'Santander UK 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 are not statements of historical or current facts; they 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, which could affect the Group's business, financial condition and/or results of operations, are considered in detail in the Risk Management Report on pages 62 to 162 and the Risk Factors section on pages 310 to 325 and they include:

the effects of UK economic conditions (e.g. lack of growth in the UK economy, rising unemployment, increased taxation and reduced consumer and public spending) and particularly the UK real estate market;

the effects of conditions in global financial markets (e.g. increased market volatility and disruption, reduced credit availability and increased commercial and consumer loan delinquencies);

the extent to which regulatory capital and liquidity requirements and any changes to these requirements may limit the Group's operations;

the Group's ability to access liquidity and funding on acceptable financial terms ;

the Group's exposure to UK Government debt and to the risks faced by other financial institutions;;

the effects of the ongoing economic and sovereign debt tensions in the eurozone;

the effects of any changes to the credit rating assigned to the Group, any member of the Group or any of their respective debt securities;

the effects of fluctuations in interest rates, currency exchange rates, basis spreads, bond and equity prices and other market factors;

the extent to which the Group may be required to record negative fair value adjustments for its financial assets due to changes in market conditions;

the credit quality of borrowers, the Group's ability to assess this and control the level of non-performing loans, loan prepayment and the enforceability of collateral, including real-estate securing such loans;

the extent which the Group may be exposed to operational losses (e.g. failed internal or external processes, people and systems);

risks associated with the Group's derivative transactions;

the effects of competition, or intensification of such competition, in the financial services markets in which the Group conducts business and the impact of customer perception of the Group's customer service levels on existing or potential business;

the Group's exposure to certain sectors or customers, such as SMEs and individuals;

the ability of the Group to manage any future growth effectively (e.g. efficiently managing the operations and employees of expanding businesses and maintaining or growing its existing customer base);

the ability of the Group to realise the anticipated benefits of its business combinations and the exposure, if any, of the Group to any unknown liabilities or goodwill impairments relating to acquired businesses;

the effects of the financial services laws, regulations, governmental oversight, administrative actions and policies and any changes thereto in each location or market in which the Group operates;

the effects of the proposed reform and reorganisation of the structure of the UK Financial Services Authority and of the UK regulatory framework that applies to members of the Group;

the effects of any new reforms to the UK mortgage lending and the personal loans market.

the power of the UK Financial Services Authority (or any overseas regulator) to intervene in response to attempts by customers to seek redress from financial service institutions, including the Group, in case of industry-wide issues;

the extent to which members of the Group may be responsible for contributing to compensation schemes in the UK in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers;

the effects which the UK Banking Act 2009 may have, should the HM Treasury, the Bank of England and/or the FSA exercise their powers under this Act in the future against the Company;

the risk of third parties using the Group as a conduit for illegal activities without the Group's knowledge;

the effects of taxation requirements and other assessments and any changes thereto in each location in which the Group operates;

the effects of any changes in the pension liabilities and obligations of the Group;

the ability of the Group to recruit, retain and develop appropriate senior management and skilled personnel;

the effects of any changes to the reputation of the Group, any member of the Group or any affiliate operating under the Group's brands;

the basis of the preparation of the Company's and Group's financial statements and information available about the Group;

the Group's dependency on its information technology systems and on other group companies and third parties for essential services; and

The Group's success at managing the risks to which it is exposed, including the items above.

Undue reliance should not be placed on forward-looking statements when making decisions with respect to Santander UK and/or its securities. Investors and others should take into account the inherent risks and uncertainties of forward-looking statements and should carefully consider the foregoing non-exhaustive list of important factors. 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 disclosure.

 

 

This information is provided by RNS
The company news service from the London Stock Exchange
 
END
 
 
FR GGUWGWUPWUCA
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