Sant Uk.10te% Regulatory News (SAN)

Santander UK plc

15 August 2013

2013 Half Yearly Financial Report

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

In fulfilment of its obligations under the Disclosure and Transparency Rules, Santander UK plc hereby releases the unedited full text of its 2013 Half Yearly Financial Report. Accordingly, page references in the text refer to page numbers in the 2013 Half Yearly Financial Report.

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

www.aboutsantander.co.uk

For further details, please contact:

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

020 7756 4886

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

020 7756 5014

Bojana Flint (Deputy Head of Investor Relations)

020 7756 6474

The full text of the accounts follows:

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

Santander UK plc

http://www.rns-pdf.londonstockexchange.com/rns/7359L_-2013-8-14.pdf 

OUR CORPORATE PURPOSE

Santander UK's purpose is to help people improve their lives and businesses grow, so our communities prosper.

This Half Yearly Financial Report contains forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in such forward-looking statements. See "Forward-looking Statements" on page 139.

Santander UK plc

2013 Half Yearly Financial Report

Index

Our Business and our Strategy

Our Business 2

Our Strategy 4

Chief Executive Officer's Review 5

Chief Financial Officer's Review 7

Key Performance Indicators 11

Summary Risk Report 12

Business Review

Group and Divisional Results 15

Balance Sheet Review 26

Risk Management Report 36

Governance

Directors 96

Directors' Responsibility Statement 96

Financial Statements

Independent Review Report to Santander UK plc 97

Primary Financial Statements 98

Notes to the Financial Statements 102

Shareholder Information

Risk Factors 138

Contact Information 138

Glossary of Financial Services Industry Terms 138

Forward-looking Statements 139

Business Review

Our Business

SANTANDER UK AT A GLANCE

Santander UK plc (the 'Company') and its subsidiaries ('Santander UK' or the 'Santander UK group') operate primarily in the UK, are regulated by the UK Prudential Regulation Authority ('PRA') and the Financial Conduct Authority ('FCA') and are part of the Banco Santander, S.A. group (the 'Banco Santander group'). Santander UK is a major financial services provider, offering a wide range of personal financial products and services, and is a growing participant in the corporate banking market. Santander UK is well positioned to continue to grow, with a distribution capability across an extensive branch and corporate business centre network.

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

(1) Charlotte Hogg, Head of Retail Distribution & Intermediaries left the Company with effect from 30 June 2013.

(2) Appointment subject to regulatory approval.

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

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

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

SANTANDER UK - A KEY UK MARKET PLAYER

(1) Market share sources: Residential mortgages, SME lending and deposits (Bank of England), Bank accounts (CACI).

(2) SME lending market share includes assets managed in Corporate Banking and Corporate Centre.

(3) Customer loan balances at 30 June 2013. Profit before tax for the six months ended 30 June 2013 excludes Markets and Corporate Centre.

HY 2013 RESULTS HIGHLIGHTS

Our Strategy

OUR VISION AND STRATEGIC PRIORITIES

Our vision is to be the best bank in the United Kingdom for our people, our customers and our shareholders.

Our strategy is based on three strategic priorities. These have been updated in the first half of 2013 to strengthen further our focus on customers:

 http://www.rns-pdf.londonstockexchange.com/rns/7359L_3-2013-8-14.pdf

(1) 'Loyal customers' are primary current account customers who hold a debit card and an additional product. Primary current account customers have a minimum credit turnover of at least £500 per month and at least two direct debits set up on the account.

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

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

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

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

Chief Executive Officer's Review

DELIVERING ON OUR COMMITMENTS

Our performance is showing a progressive improvement towards our medium-term targets. We are becoming a stronger retail bank, demonstrated by greater customer loyalty and satisfaction, and we are diversifying the business through the growth of our corporate banking capability.

(1) At 90% confidence interval. See page 11 for further details.

THE ECONOMY

GDP growth of 0.3% in the first quarter of 2013 was followed by stronger growth (initial estimate of 0.6%) in the second quarter. The consensus view during the first half of the year was that the UK economy is likely to see growth of around 1% in the year, stronger than the 0.2% recorded in 2012 but below the pace seen in the years before the recession. The Bank of England's Base Rate has been held at 0.5% since March 2009 to support economic recovery and in April 2013 the Bank of England extended the Funding for Lending Scheme to boost lending to the economy for an additional year.

LOOKING AHEAD

The economic environment is stabilising and indications of increased confidence lead us to be cautiously optimistic. We are in a strong position, and throughout the rest of the year, we will continue to invest in transforming our business, both commercially and culturally.

We will focus on attracting customers, deepening our relationships with them, and earning their trust and loyalty. We will grow our corporate banking business organically by recruiting additional relationship managers and expanding our presence around the UK. We will maintain the strength and stability of our balance sheet while generating consistent profits. Driving our strategic priorities will be our culture change programme to transform Santander UK into a bank that is simple, personal and fair for our people, our customers and our shareholders.

Lastly, the PRA announced the results of its UK bank capital requirements exercise in June 2013. We were not required to undertake any additional capital raising and exceeded the PRA's 3% CET 1 stressed leverage threshold. The results of this exercise showed that Santander UK was then the strongest and best capitalised bank in the UK, which will allow us to benefit from future opportunities as growth strengthens.

Ana Botín

Chief Executive Officer

14 August 2013

Chief Financial Officer's Review

Income Statement HIGHLIGHTS(1)

(1) Income Statement highlights statistics reflect continuing operations, and therefore exclude the results and loss on sale of discontinued operations. See Note 6 to the Condensed Consolidated Interim Financial Statements.

(2) Banking NIM comprises annualised net interest income divided by average commercial assets.

The main drivers of the movement in profit after tax from continuing operations are:

Net interest income in the first half of 2013 was 5% lower at £1,391m (H1 2012: £1,465m), primarily due to the continued impact of structural market conditions and higher customer deposit funding costs. This was in part mitigated by a higher residential mortgage stock interest margin and an increased contribution from Corporate Banking loans. However, positive net interest income trends, evident in the first quarter of 2013, continued with net interest income in the first half up 10% to £1,391m compared to £1,269m for the second half of 2012. This is being driven by improving asset margins and lower wholesale funding costs.

Non-interest income decreased by 13% or £84m, to £570m (H1 2012: £654m), largely due to lower income from Markets compared to a particularly strong first half of the year in 2012 and lower ancillary fee income from Large Corporate clients in Corporate Banking.

We continue to deliver a good cost performance, with total operating expenses up slightly to £1,113m (H1 2012: £1,077m), despite our ongoing investment in business growth and increased regulatory compliance and control costs. Investment in systems continued to support the business transformation and underpin future efficiency improvements.

Impairment losses on loans and advances decreased by 33% to £235m (H1 2012: £350m), mainly due to lower provisions on the non-core corporate and legacy portfolios but also continued the resilient credit quality in the Retail Banking and Corporate Banking loan books. In Retail Banking, the decrease was largely due to the reduction in impairment loss charges on unsecured products.

Provisions for other liabilities and charges increased by £62m to £64m. This reflected an increase in restructuring provisions, partially offset by a release following a reassessment of the provision required to cover non-PPI retail customer remediation payments.

The taxation charge was 34% lower than for the first half of 2012, in line with lower profits from continuing operations and the impact of the continued reduction in the main corporation tax rate.

The loss from discontinued operations after tax of £12m comprised the loss on sale before tax of £16m and a tax credit of £4m.

CUSTOMEr Balance Sheet HIGHLIGHTS

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

We continued with our focus on improving the strength of our balance sheet. Customer loans decreased £3.7bn in the first six months of 2013 to £191.0bn. This reflected a continued managed reduction in selected higher risk segments of the residential mortgage portfolio, partially offset by increases in SME and corporate lending. Interest-only mortgage loan balances reduced by £3bn, following the targeted deleveraging of the book which we undertook during 2012.

Loans to SMEs were up 3% since the year-end, and up 12% from 30 June 2012, as we continued with the diversification of our business mix. All lending remains consistent with our conservative credit risk policies.

Total customer deposits increased £1.9bn in the first six months of 2013 to £150.5bn. The success of the 1I2I3 World proposition increased current account balances by 34% since December 2012 to £21.3bn, or 60% from a year ago, while we continued with the reduction in short-term, rate sensitive deposits and executed a smaller cross tax year ISA campaign in support of the overall funding plan. Corporate Centre customer deposits rose in the first six months of 2013, reflecting improved market activity.

The loan-to-deposit ratio improved four percentage points to 125%, although this ratio may increase in the course of the year as we seek to reduce further higher cost, low relationship deposits. We remain comfortable with the current position, given that it is underpinned by the mix of loans on our balance sheet which mostly consist of prime UK residential mortgages.

Credit Quality

(1) NPL balance as a percentage of the asset balance.

We remain firmly focused on the UK with approximately 98% of customer assets UK-related and approximately 80% of customer assets consisting of UK residential mortgages. Furthermore, we have minimal net exposure after collateral to peripheral eurozone countries at only 0.6% of total assets (2012: 0.4%).

The total NPL ratio increased slightly to 2.17%. The increase in the mortgage NPL ratio, to 1.87%, was partially offset by a reduction in the Corporate Banking and Corporate Centre NPL ratios to 3.58% and 3.75%, respectively. The rise in the mortgage NPL ratio remains largely due to regulatory-driven policy and reporting changes, as well as the impact of lower mortgage balances. These policy and reporting changes are not expected to result in significant additional write-offs. Mortgage NPL balances were broadly unchanged in the last year, excluding the impact of the policy and reporting changes. The mortgage NPL ratio is expected to stabilise by the end of 2014. The Corporate Banking NPL ratio decreased to 3.58% from the end of 2012. This largely arose from the exit of a small number of older vintage loans which were acquired with Alliance & Leicester. Corporate Banking lending in the last four years has performed well with a much lower NPL ratio in these vintages.

Liquidity AND Funding

Our overall funding strategy is to develop and maintain a diversified funding base, which allows us access to a variety of funding sources. In 2012 we primarily focused on secured issuance, in particular residential mortgage backed securities and covered bonds, two forms of financing that permit us to benefit from our prime UK mortgage assets. This strategy minimised the cost of funding and provided protection against an uncertain and volatile market funding environment. In the second half of 2012 stability returned to the wholesale funding markets, which meant that in 2013 medium term funding issuance will be a more balanced mix of secured and unsecured issuance. The issues of a euro 1bn, 5-year senior unsecured note in January 2013, and a £500m and US$750m, 3-year Residential Mortgage Backed Securities ('RMBS') note in May 2013 were well received and with significantly lower spreads than similar issues in the first half of 2012. Additionally, in July 2013 we issued a euro 750m 7-year senior unsecured note. This was the longest public senior unsecured maturity we had issued since 2010, again pricing considerably lower than for similar issuance in previous years.

Within our balance sheet management strategy, we aim to align the sources and uses of funding. Customer loans and advances are largely funded by customer deposits, with any excess being funded by long-term wholesale secured debt and equity.

Our funding position remains solid and we reduced our wholesale funding requirement in the first half of the year.

Throughout 2012, we continued to strengthen our liquidity position; following the more beneficial conditions prevailing in late 2012 and in the first half of 2013 we reduced our liquidity position. At the end of 2012, total liquid assets amounted to £76.0bn, including PRA-eligible liquid assets of £36.9bn. Liquid assets coverage was in excess of 150% of our wholesale funding maturing in less than one year. In the first six months of 2013, PRA-eligible liquid assets decreased by £1.9bn to £35.0bn and total liquid assets increased by £2.4bn to £78.4bn. PRA-eligible balances have been managed down given improved stability in capital markets and as a consequence of the actions taken to strengthen the balance sheet with a reduced reliance on short-term funding markets. This trend is expected to continue into the second half.

Short-term funding decreased 13% in the first six months of 2013 and was 23% lower than a year ago, further strengthening the balance sheet. Both total and PRA-eligible liquid assets significantly exceeded short-term wholesale funding requirements. PRA-eligible liquid assets amounted to 166% of total short-term wholesale funding, but this may decrease over the rest of the year subject to market conditions.

We remain comfortably ahead of all of our key liquidity metrics. Based on the current CRD IV definitions regarding the Liquidity Coverage Ratio, we expect to be fully compliant by the end of 2014, well ahead of the timetable proposed under CRD IV.

CAPITAL

Our Core Tier 1 Capital ratio rose to 12.4% (after the declaration of an interim ordinary dividend of £215m), from 12.2% at the end of 2012, driven by organic profit generation and lower risk-weighted assets. Risk-weighted assets decreased to £75.4bn, with a reduction in customer loans partly offset by the increased proportion of the book represented by corporate lending. Our estimated CRD IV end point Common Equity Tier 1 Capital ratio at 30 June 2013 was 11.4% (2012: 11.1%). We expect that the strength of our Core Tier 1 and CET 1 Capital ratios, our ability to generate capital organically and rebalancing of our business mix will enable us to meet our targeted capital ratios even once the capital requirements of CRD IV are phased in.

Our internal measure of leverage excludes liquid assets eligible for the regulatory liquid asset portfolio as they are readily realisable at a point of stress, and allows for derivatives and securities financing transaction netting. On this measure, our leverage ratio was 5.1% (20x) at 30 June 2013. Our CRD IV end point-based Tier 1 leverage ratio as defined by the PRA was 3.2% without the benefit of Tier 1 instruments that will become ineligible over the CRD IV transition period, or 3.8% if these instruments are added back. The equivalent end point-based CET 1 leverage ratio is equal to the end point-based Tier 1 leverage ratio as all current Other Tier 1 instruments are assumed to be ineligible. As the capital requirements of CRD IV are phased in, we will manage our regulatory capital position to meet leverage requirements.

Lastly, on 30 July 2013, we launched a cash tender offer for up to approximately £0.8bn equivalent of certain US dollar and sterling-denominated Tier 1 and Tier 2 capital securities with a view to optimising our capital position. The transaction is expected to generate Core Tier 1 and CET 1 capital and will involve an initial modest reduction in total capital levels pending further Tier 2 and Additional Tier 1 issuance in due course.

REGULATORY ENVIRONMENT

We continue to maintain a conservative approach to conduct issues and to customer redress. Whilst potential issues remain under review it has not been necessary to increase the overall level of conduct provisions in the first half of 2013.

We support and have participated in the Funding for Lending Scheme ('FLS') and welcome the increased focus on SME lending in the extended scheme. FLS has helped to improve funding conditions for UK banks and lending to the wider economy. Furthermore, recent initiatives from the UK Government to help first time buyers and support the wider UK mortgage market, including the Help to Buy equity loan and mortgage guarantee schemes, are welcome, and we will work to support these efforts.

We engaged constructively with the work of the Parliamentary Commission on Banking Standards ('PCBS') and welcome the comprehensive and wide reaching final report published in June. We will work with the Government and the regulators as they seek to implement the recommendations of the Commission.

Lastly, we support the objectives of the Banking Reform Bill in ensuring that the UK has a stable and competitive banking system that supports the needs of the wider economy. We remain committed to engaging constructively with the Government and policymakers to ensure that these objectives are met in the best interest of our customers and shareholders.

OUTLOOK

In the first half of 2013, we delivered a resilient profit after tax from continuing operations of £440m, maintained credit quality, and strengthened the balance sheet and our capital position.

For the rest of the year, we expect operating income to stabilise further, particularly as the pressures on net interest income continue to ease.

Going forward, Banking NIM is expected to benefit from diminishing funding costs, lower liquidity holdings and reduced drag from the run-off of the structural hedge. Our disciplined management of business-as-usual costs will be maintained, whilst investing in the growth of our corporate and retail propositions. The cost-to-income ratio has been under pressure from lower income. With an improvement in the income environment experienced in the first half of the year, and our continued focus on costs, we expect this to improve in the second half of 2013 and for the full year relative to 2012. Impairment charges are expected to be lower than in 2012, after adjusting the impact of the credit provision for the non-core corporate and legacy portfolios taken in the third quarter of 2012.

We believe that our performance over time should continue to demonstrate the underlying stability of our business.

Stephen Jones

Chief Financial Officer

14 August 2013

Key Performance Indicators

The information below reflects Santander UK's performance as measured by key performance indicators ('KPIs') in the context of our strategic priorities.

The KPIs presented reflect the way in which the performance of the Group has been measured and the key targets to which the performance of the businesses is directed. These are updated from time to time, adopting new or refined measures. In addition, targets are revised or updated consistent with our strategic objectives.

Definitions of the KPIs, targets and explanations of why the chosen indicators are important to management are set out on pages 12 to 15 of the Company's Annual Report and Accounts for the year ended 31 December 2012 ("2012 Annual Report").

(1) Identified as a KPI during the first half of 2013.

(2) Financial Research Survey ('FRS') is an independent monthly survey of circa 5,000 consumers covering the personal finance sector, run by GfK. Satisfaction score refers to proportion of extremely and very satisfied customers across mortgages, savings, main current accounts, home insurance, UPLs and credit cards, based on a weighting of those products calculated to reflect the average product distribution across Santander and competitor brands. 3 months ending data June 2012 and June 2013. Competitor set includes Barclays, Halifax, HSBC, Lloyds TSB, and NatWest

(3) Top 3 competitor average at 30 June 2013 was 62% (30 June 2012: 61%).

(4) Assuming short-term and long-term interest rates increase by at least 150 basis points over the period.

(5) CRD IV end point CET 1 Capital ratio.

Summary Risk Report

RISK MANAGEMENT

As a significant financial services provider, risk is at the core of Santander UK's day-to-day activities. The understanding and control of risk is critical for the effective management of the business.

In managing risk, Santander UKaims to:

RISK FRAMEWORK

Santander UK's risk framework aims to ensure that risk is properly managed and controlled on behalf of all stakeholders, and is described in the "Risk Framework" section of the Risk Management Report in the 2012 Annual Report. There have been no significant changes to the Risk Framework in 2013.

ALLOCATION OF RISKS ACROSS SANTANDER UK

A main facet of Santander UK's business model is a focus on retail and commercial lending. As such, the Santander UK group's key source of risk is credit risk. The allocation of risk across the Santander UK group based on the economic capital requirement for each risk type is described in the Risk Framework section in the Risk Management Report in the 2012 Annual Report. There have been no significant changes to the allocation of risk in 2013.

Risk definition and structure

http://www.rns-pdf.londonstockexchange.com/rns/7359L_7-2013-8-14.pdf

TOP AND EMERGING RISKS

A 'top risk' is defined as being a current, emerged risk within our business which could potentially have a material impact on our financial results, reputation and the sustainability of the long-term business model. It may develop or crystallise within one year. An 'emerging risk' is defined as being one with large uncertain outcomes and may develop or crystallise beyond one year. Crystallisation of an emerging risk could have a material effect on long term strategy.

Santander UK uses risk factors to identify and monitor top and emerging risks. All of our activities involve, to varying degrees, identification, assessment, management and reporting of risk or combinations of risks. During the first half of 2013, senior management focused on certain top and emerging risks and their causes. The top and emerging risks were unchanged from those at the previous year-end. These consisted of (in alphabetical order):

The Santander UK group aims to maintain a predictable medium-low risk profile in its business. As a financial services provider, credit risk is the most significant risk to which the Santander UK group is exposed. The Santander UK group's main credit portfolios are its UK residential mortgage portfolio and its Corporate Banking portfolio, as follows:

Credit risk highlights - residential mortgages

(1) Mortgages are classified as non-performing when the counterparty fails to make a payment when contractually due for typically three months or longer or where the account is in early arrears (31 - 90 days) and has a bankruptcy indicator.

(2) All mortgage NPL balances are UK and continue accruing interest. The data presented excludes accrued interest.

(3) Mortgage NPLs as a percentage of mortgage loans and advances to customers.

(4) Impairment loan loss allowances as a percentage of NPLs.

During the first half of 2013, the mortgage NPLs ratio increased to 1.87% (2012: 1.74%), in part reflecting the decrease in the stock of mortgage loans and advances in the period, which was due to managed reductions in selected higher risk elements of the residential mortgage portfolio to drive a more balanced mix of lending. The impact of the regulatory-driven policy and reporting changes implemented in early 2012 continued, and is expected to stabilise by the end of 2014.

The mortgage NPLs performance reflected the high quality of the mortgage book, a slight reduction in unemployment levels, (although they remained high), and prolonged low interest rates.

At 30 June 2013, impairment loss allowances increased to £579m (2012: £552m) in line with the small increase in NPL balances, maintaining consistent coverage levels at 20% (2012: 20%).

http://www.rns-pdf.londonstockexchange.com/rns/7359L_8-2013-8-14.pdf

Credit risk highlights - Corporate Banking

(1) Loans and advances are classified as non-performing typically when the counterparty fails to make payments when contractually due for three months or where it is deemed probable that this will occur in the near future.

(2) Corporate Banking loans and advances to customers include Social Housing loans and finance leases.

(3) All Corporate Banking NPL balances are UK and continue accruing interest. The data presented excludes accrued interest. 

(4) Corporate Banking NPLs as a percentage of Corporate Banking loans and advances to customers.

(5) Impairment loan loss allowances as a percentage of NPLs.

During the first half of 2013, the Corporate Banking NPLs ratio decreased to 3.58% (2012: 4.26%) reflecting lower levels of NPLs as a result of several older vintage real estate cases having been successfully exited during the period combined with the overall growth in the portfolio.

The graph opposite shows Corporate Banking NPL stock by deal vintage from 2006 onwards. This demonstrates that Corporate Banking lending in the last four years has performed well.

http://www.rns-pdf.londonstockexchange.com/rns/7359L_9-2013-8-14.pdf 

Group and Divisional Results

GROUP SUMMARY

SUMMARISED CONSOLIDATED INCOME STATEMENT

(1) Adjusted to reflect the presentation of discontinued operations, as set out in Note 6 to the Condensed Consolidated Interim Financial Statements.

Six months ended 30 June 2013 compared to six months ended 30 June 2012

Profit on continuing operations before tax decreased by £141m to £549m (2012: £690m). By income statement line, the movements were:

(Loss)/profit from discontinued operations after tax of £(12)m (2012: £26m) comprises the profit before tax of the discontinued operations of £nil (2012: £35m), a loss on sale before tax of £16m, and a tax credit of £4m (2012: tax charge of £9m). The decrease in profit before tax of the discontinued operations principally reflected the reduction in the size of the business prior to the completion of the deals to sell it in the first half of 2013.

Critical factors affecting results

The preparation of our Condensed Consolidated Interim Financial Statements requires management to make estimates and judgements that affect the reported amount of assets and liabilities at the balance sheet date 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 other factors believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Estimates and judgements that are considered important to the portrayal of our financial condition including, where applicable, quantification of the effects of reasonably possible ranges of such estimates are set out in "Critical Accounting Policies and Areas of Significant Management Judgement" in Note 1 to the Condensed Consolidated Interim Financial Statements.

The rest of this section contains a summary of the results, and commentary thereon, by income statement line item for each segment.

Basis of results presentation

The segmental information in this Half Yearly Financial Report reflects the reporting structure in place at the reporting date in accordance with which the segmental information in Note 2 to the Condensed Consolidated Interim Financial Statements has been presented. 

The Company's board of directors (the 'Board') is the chief operating decision maker for Santander UK. The segmental 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 which follows Santander UK's normal accounting policies and principles, including measures of operating results, assets and liabilities.

The prior period's segmental analyses have been adjusted to reflect the fact that reportable segments have changed, as described in Note 2 to the Condensed Consolidated Interim Financial Statements.

PROFIT BEFORE TAX BY SEGMENT

(1) Adjusted to reflect the presentation of discontinued operations, as set out in Note 6 to the Condensed Consolidated Interim Financial Statements.

RETAIL BANKING

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 an annual turnover of up to £250,000. Retail Banking products include residential mortgage loans, savings and current accounts, credit cards (excluding the co-brand credit cards business) and personal loans as well as a range of insurance products.

Summarised income statement

(1) Adjusted to reflect the presentation of discontinued operations, as set out in Note 6 to the Condensed Consolidated Interim Financial Statements.

Balances and ratios

(1) Accrued interest is excluded for purposes of these analyses.

(2) Mortgage NPL's as a percentage of mortgage assets.

(3) Mortgage impairment loss allowance as a percentage of mortgage NPL's.

Business volumes

(1) Includes Social Housing loans managed in Corporate Centre.

(2) Bank account openings and stock include personal, SME and private banking current accounts.

(3) Market share of mortgage gross lending and mortgage stock estimated by Santander UK for each half, having regard to individual lending data published by the Bank of England for the first five months of each half year. Historic data is adjusted to reflect actual data published for the period. Market share of bank account stock estimated by Santander UK for each half year, having regard to market research published by CACI.

Retail Banking profit before tax

Six months ended 30 June 2013 compared to six months ended 30 June 2012

Profit on continuing operations before tax decreased by £12m to £653m (2012: £665m). By income statement line, the movements were:

Retail Banking balances and ratios

30 June 2013 compared to 31 December 2012

Retail Banking business volumes

Six months ended 30 June 2013

CORPORATE BANKING

Corporate Banking offers a wide range of products and financial services to customers through a network of regional business centres and through telephony and e-commerce channels. Corporate Banking products and services include loans, bank accounts, deposits, treasury services, invoice discounting, cash transmission and asset finance.

The SME and mid corporate business principally serves small and medium enterprises with an annual turnover of more than £250,000 up to £50m ('SMEs'), and other corporate customers with an annual turnover of up to £500m. This also includes real estate lending.

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 with an annual turnover of more than £500m. Lending includes syndicated loans and structured finance. Transactional banking includes trade finance and cash management. Money market activities include securities lending/borrowing and repos.

Summarised income statement

Balances

Corporate Banking profit before tax

Six months ended 30 June 2013 compared to six months ended 30 June 2012

Profit on continuing operations before tax decreased by £33m to £129m (2012: £162m). By income statement line, the movements were:

Corporate Banking balances

30 June 2013 compared to 31 December 2012

MARKETS

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.

Summarised income statement

Balances

(1) Primarily comprises derivative assets

Markets (loss)/profit before tax

Six months ended 30 June 2013 compared to six months ended 30 June 2012

Profit on continuing operations before tax decreased by £89m to a loss of £10m (2012: £79m). By income statement line, the movements were:

Markets balances

30 June 2013 compared to 31 December 2012

CORPORATE CENTRE

Corporate Centre includes Financial Management & Investor Relations ('FMIR') and the non-core corporate and legacy portfolios, as well as the co-brand credit cards business. 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. Deals to sell the co-brands credit cards business were completed in the first half of 2013.

Summarised income statement

(1) Adjusted to reflect the presentation of discontinued operations, as set out in Note 6 to the Condensed Consolidated Interim Financial Statements.

Balances

Non-core assets

Corporate Centre loss on continuing operations before tax

Six months ended 30 June 2013 compared to six months ended 30 June 2012

Loss on continuing operations before tax increased by £7m to £223m (2012: £216m). By income statement line, the movements were:

Corporate Centre (loss)/profit on discontinued operations after tax

Six months ended 30 June 2013 compared to six months ended 30 June 2012

(Loss)/profit from discontinued operations after tax of £(12)m (2012: £26m) comprises the profit before tax of the discontinued operations of £nil (2012: £35m), a loss on sale before tax of £16m, and a tax credit of £4m (2012: tax charge of £9m). The decrease in profit before tax of the discontinued operations principally reflected the reduction in the size of the business prior to the completion of the deals to sell it in 2013.

Corporate Centre balances

30 June 2013 compared to 31 December 2012

Balance Sheet Review

Throughout this Balance Sheet Review, references to UK and non-UK, in the geographic analysis, refer to the location of the office where the transaction is recorded.

The Balance Sheet Review is divided into the following sections:

INDEX

This Balance Sheet Review focuses on those areas that have changed significantly during the first half of 2013, and represents an update to the Balance Sheet Review in the 2012 Annual Report, with which it should be read in conjunction. The Balance Sheet Review in the 2012 Annual Report contains additional disclosures which have not changed significantly during the first half of 2013.

SUMMARISED CONDENSED CONSOLIDATED BALANCE SHEET

 (1) Adjusted to reflect the presentation of the assets held for sale prior to the completion of the sale as set out in Note 6 to the Condensed Consolidated Interim Financial Statements.

A more detailed consolidated balance sheet is contained in the Condensed Consolidated Interim Financial Statements.

30 June 2013 compared to 31 December 2012

Assets

Cash and balances at central banks

Cash and balances held at central banks increased by 17% to £34,372m at 30 June 2013 (2012: £29,282m), principally reflecting an increase in the element of the liquid asset portfolio held as cash at central banks as part of the rebalancing of the portfolio.

Trading assets

Trading assets increased by 39% to £31,163m at 30 June 2013 (2012: £22,498m), reflecting increased trading activity relating to securities purchased under resale agreements to customers and increased holdings of debt securities, although securities purchased under resale agreements remained lower than at 30 June 2012.

Derivative assets

Derivative assets decreased by 14% to £25,924m at 30 June 2013 (2012: £30,146m). The decrease was attributable to a decrease in the fair values of interest rate derivative assets as a result of upward moves in longer term yield curves. There was a corresponding decrease in derivative liabilities.

Financial assets designated at fair value through profit and loss

Financial assets designated at fair value through profit and loss decreased by 26% to £2,821m at 30 June 2013 (2012: £3,811m). The decrease was primarily attributable to the maturity and refinancing of loans to UK Social Housing associations and new loans not being designated at fair value, in accordance with Santander UK's policy.

Loans and advances to customers

Loans and advances to customers decreased by 1% to £188,065m at 30 June 2013 (2012: £190,782m) principally due to managed reductions in selected higher risk elements of the residential mortgage portfolio and continued deleveraging of the non-core corporate and legacy portfolios. These reductions were partially offset by increases in SME lending, and increased customer loans to large corporate clients through our trade finance business.

Available for sale securities

Available for sale securities decreased by 6% to £5,178m at 30 June 2013 (2012: £5,483m). The movement reflected both purchases and sales as part of the rebalancing of the liquid asset portfolio.

Property, plant and equipment

Property, plant and equipment decreased by 4% to £1,481m at 30 June 2013 (2012: £1,541m). The decrease was attributable to the depreciation charge for the period, partially offset by additions during the period.

Retirement benefit assets

Retirement benefit assets decreased by 20% to £203m at 30 June 2013 (2012: £254m). For Santander UK's defined benefit pension schemes which had surpluses, the key driver of the decrease was actuarial losses on liabilities as a result of an increase in RPI inflation market levels. This followed a decision by the Office of National Statistics, in early 2013, not to rebase RPI.

Tax, intangibles and other assets

Tax, intangibles and other assets decreased by 3% to £4,183m at 30 June 2013 (2012: £4,328m). The decrease primarily reflected the reduction in assets in the co-brand credit cards business as a result of the completion of the deals to sell the business in the first half of 2013.

Liabilities

Deposits by banks

Deposits by banks decreased by 7% to £9,242m at 30 June 2013 (2012: £9,935m). The decrease was driven by lower repurchase agreement activity with Banco Santander, S.A..

Deposits by customers

Deposits by customers increased by 1% to £150,878m at 30 June 2013 (2012: £149,037m), principally reflecting deposit acquisitions at attractive margins. Corporate deposits increased with strong inflows as we continued to develop deeper relationships with our clients. Retail deposits decreased slightly, but with a qualitative shift towards accounts offering better quality relationships.

Derivative liabilities

Derivative liabilities decreased by 18% to £23,629m at 30 June 2013 (2012: £28,861m). The decrease was attributable to a decrease in the fair values of interest rate derivative liabilities as a result of upward moves in longer term yield curves.

Trading liabilities

Trading liabilities increased by 65% to £34,790m at 30 June 2013 (2012: £21,109m). The increase was attributable to increased trading activity relating to securities sold under resale agreements to both banks and customers.

Financial liabilities designated at fair value

Financial liabilities designated at fair value increased by 32%to £5,277m at 30 June 2013 (2012: £4,002m). The increase principally reflected new issuances in the US$4bn Commercial Paper Programme.

Debt securities in issue

Debt securities in issue decreased by 10% to £53,542m at 30 June 2013 (2012: £59,621m) as surplus liquidity was utilised to fund maturing medium term funding.

Retirement benefit obligations

Retirement benefit obligations increased by 51% to £460m at 30 June 2013 (2012: £305m). For Santander UK's defined benefit pension schemes which had deficits, the key driver of the increase was actuarial losses on liabilities as a result of an increase in RPI inflation market levels. This followed a decision by the Office of National Statistics, in early 2013, not to rebase RPI.

Equity

Total shareholders equity decreased by less than 1% to £12,860m at 30 June 2013 (2012: £12,949m). The decrease was principally attributable to actuarial losses, broadly offset by the retained profit for the period and dividends declared.

SHORT-TERM BORROWINGS

Santander UK includes short-term borrowings within deposits by banks, trading liabilities, financial liabilities designated at fair value and debt securities in issue and does not show short-term borrowings separately on the balance sheet. Short-term borrowings are defined by the US Securities and Exchange Commission ('SEC') as amounts payable for short-term obligations that are US Federal funds purchased and securities sold under repurchase agreements, commercial paper, borrowings from banks, borrowings from factors or other financial institutions and any other short-term borrowings reflected on Santander UK's balance sheet. Santander UK's only significant short-term borrowings are securities sold under repurchase agreements, commercial paper, borrowings from banks, negotiable certificates of deposit, and certain other debt securities in issue. Additional information on short-term borrowings is provided in the table below for the six months ended 30 June 2013 and 2012.

(1) Calculated using monthly data.

(2) The period-end deposits by banks balance includes non-interest bearing items in the course of transmission of £586m (30 June 2012: £423m).

Santander UK issues commercial paper generally in denominations of not less than US$50,000, with maturities of up to 365 days. Commercial paper is issued by Abbey National Treasury Services plc and Abbey National North America LLC.

CAPITAL MANAGEMENT AND RESOURCES

Capital management and capital allocation

Santander UK adopts a centralised capital management approach, based on an assessment of both regulatory requirements and the economic capital impacts of our businesses. Details of Santander UK's objectives, policies and processes for managing capital, including the capital table, can be found in Note 29 to the Condensed Consolidated Interim Financial Statements.

Capital and risk management disclosures required by Pillar 3

Banco Santander, S.A. is supervised by the Banco de España (the Bank of Spain) on a consolidated basis. Santander UK has applied Banco Santander, S.A.'s approach to capital measurement and risk management in its implementation of Basel II. As a result, Santander UK has been classified as a significant subsidiary of Banco Santander, S.A. at 30 June 2013. Further information on the Basel II risk measurement of Santander UK's exposures is included in Banco Santander, S.A.'s Pillar 3 report.

Additional Capital Disclosures

In addition, further disclosures on capital can be found in Santander UK's "Additional Capital Disclosures" on www.aboutsantander.co.uk.

Scope of Santander UK's capital adequacy

Santander UK is a UK banking group effectively subject to two tiers of supervision. Santander UK is subject to prudential supervision by both the Prudential Regulation Authority ('PRA') as one of the successors to the Financial Services Authority ('FSA') (as a UK authorised bank) and the Banco de España (as a member of the Banco Santander group). As a PRA regulated entity, Santander UK is expected to satisfy the PRA capital requirements on a standalone basis. Similarly, Santander UK must demonstrate to the PRA that it can withstand capital stress tests without parental support. Reinforcing the corporate governance framework adopted by Santander UK, the PRA exercises oversight through its rules and regulations on the Santander UK plc Board and senior management appointments.

The basis of consolidation for prudential purposes is the same as the basis of consolidation for financial statement purposes. Consequently, the results of significant subsidiaries regulated by the PRA are included in Santander UK's capital adequacy disclosures. Capital transferability between Santander UK's subsidiaries is managed in accordance with Santander UK's corporate purpose and strategy, its risk and capital management policies and with regard to UK legal and regulatory requirements. There are no other current or foreseen material practical or legal impediments to the prompt transfer of capital resources or repayment of liabilities when due between the Company and its subsidiaries.

Regulatory capital resources

The table below analyses the composition of Santander UK's regulatory capital resources. The calculations are consistent with Santander UK's regulatory filings.

(1) The excess of regulatory expected losses over impairment losses and the related tax effect are treated for capital purposes as follows: 50% of regulatory expected losses over impairment net of tax (£249m) is treated as a Core Tier 1 deduction, 50% of the tax effect of regulatory expected losses over impairment (£75m) is treated as other Tier 1 capital and 50% of regulatory expected losses over impairment gross of tax (£324m) is treated as a Tier 2 deduction.

Movements in regulatory capital during the period are described on page 32.

Risk-weighted assets

The tables below analyse the composition of Santander UK's risk-weighted assets. The calculations are consistent with Santander UK's regulatory filings.

Risk-weighted assets by division may be further analysed as follows:

(1) Non-customer assets principally consist of the securities lending/borrowing and repo businesses of the money markets product area.

(2) Customer assets in Corporate Centre largely comprise Social Housing.

(3) Regulatory exposure of liquid assets includes reverse repurchase agreements collateralised by UK Government securities.

(4) The balance sheet amounts of other assets have not been allocated segmentally, although the RWA's have been allocated to Corporate Centre.

Regulatory exposure represents the Exposure at Default ('EAD') calculated in accordance with the PRA Prudential sourcebook for Banks, Building Societies and Investment Firms (known as 'BIPRU'). EAD for customer assets includes unutilised credit facilities and is adjusted for a credit conversion factor ('CCF'). EAD for repurchase, reverse repurchase, securities financing and derivative transactions are calculated net of any associated collateral and are adjusted for regulatory changes and potential future exposure adjustments ('PFE') where applicable.

Santander UK applies Basel II to the calculation of its capital requirement. In addition, Santander UK applies the Retail Internal Ratings-Based ('IRB') and Advanced Internal Ratings-Based ('AIRB') approaches to certain of its credit portfolios. Residential lending capital resources requirements include securitised residential mortgages.

During the six months ended 30 June 2013, risk-weighted assets ('RWAs') reduced slightly. This reflected a decrease in credit risk RWA's as a result of managed reductions in selected higher risk elements of the residential mortgage portfolio and other customer loans, partially offset by an increase in Corporate Banking credit risk RWA's.

Key capital ratios

The calculations of capital are consistent with Santander UK's regulatory filings. Ratios are calculated by taking the relevant capital resources as a percentage of risk-weighted assets.

The table below summarises Santander UK's capital ratios under Basel II:

Movements in regulatory capital

Movements in regulatory capital under Basel II during the six months ended 30 June 2013 and the year ended 31 December 2012 were as follows:

The changes in Santander UK's Core Tier 1 capital reflect movements in ordinary share capital, share premium and profits for the six months ended 30 June 2013 and the year ended 31 December 2012 after adjustment to comply with the PRA's rules. Santander UK complied with the PRA's capital adequacy requirements during the first half of 2013 and the capital adequacy requirements of its predecessor the FSA in 2012.

During the six months ended 30 June 2013, Core Tier 1 capital increased by £57m to £9,359m (2012: £9,302m). This increase was largely due to profits for the period of £428m, other comprehensive expense after tax of £245m, regulatory pension adjustments of £158m and dividends declared of £272m. The decreases in Santander UK's Other Tier 1 capital and Tier 2 capital during the six months ended 30 June 2013 principally reflected foreign exchange movements.

During the year ended 31 December 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. The significant reduction in Santander UK's Other Tier 1 capital and Tier 2 capital during 2012 principally reflected the capital management exercise undertaken in July 2012.

LIQUIDITY AND FUNDING

The Board's risk objective is for Santander UK to be a risk resilient institution at all times, and to be perceived as such by stakeholders, preserving the short and long-term viability of Santander UK. While recognising that a bank engaging in maturity transformation cannot hold sufficient liquidity to cover all possible stress scenarios, the Board requires Santander UK to hold sufficient liquidity to cover extreme but plausible situations. The requirements arising from the PRA's regulatory liquidity regime are reflected in the Board's Liquidity Risk Appetite. Liquidity risk is the risk that Santander UK,although solvent, either does not have available sufficient financial resources to enable it to meet its obligations as they fall due, or can secure them only at excessive cost.In the Board's opinion, working capital is sufficient for its present requirements.

Santander UK primarily generates funding and liquidity through UK retail and corporate deposits, as well as in the financial markets through its own debt programmes and facilities to support its business activities and liquidity requirements. It does this with reliance on the strength of its balance sheet and profitability and its own network of investors. It does not rely on a guarantee from Banco Santander, S.A. or any other member of the Banco Santander group to generate this funding or liquidity. Santander UK does not raise funds to finance other members of the Banco Santander group or guarantee the debts of other members of the Banco Santander group (other than certain of Santander UK plc's own subsidiaries). As a PRA regulated group, Santander UK is expected to satisfy the PRA liquidity and capital requirements on a standalone basis. Similarly, Santander UK must demonstrate to the PRA that it can withstand liquidity and capital stress tests without parental support.

Sources and uses of liquidity and funding

Santander UK is primarily funded by retail and corporate deposits, rather than by the wholesale markets. We review our loan-to-deposit ratio in order to assess Santander UK's ability to fund its commercial operations with commercial borrowings, reducing reliance on wholesale markets while improving customer product holdings. The loan-to-deposit ratio represents customer assets (i.e. retail and corporate assets) excluding reverse repos divided by customer liabilities (i.e. retail and corporate deposits) excluding repos. At 30 June 2013, the loan-to-deposit ratio was 125% (2012: 129%). The retail sources primarily originate from the Retail Banking savings business. Although largely callable, these funds provide a stable and predictable core of funding due to the nature of the retail accounts and the breadth of personal customer relationships. Additionally, Santander UK has a strong wholesale funding base, which is diversified across product types and geography.

Through the wholesale markets, Santander UK has active relationships with more than 300 counterparties across a range of sectors, including banks, other financial institutions, corporates and investment funds. Other sources of funding include collateralised borrowings, mortgage securitisations and long-term debt issuance. Short-term funding is accessed through money market instruments, including time deposits, certificates of deposit and commercial paper. Medium to long-term funding is accessed primarily through asset securitisation and covered bond arrangements and Santander UK's euro medium-term note programmes. The major debt issuance programmes are managed by, and in the name of, Abbey National Treasury Services plc on its own behalf (except for the US commercial paper programme, which is managed by, and in the name of, Abbey National North America LLC, a guaranteed subsidiary of Santander UK plc) and are set out in Notes 19 and 20 to the Condensed Consolidated Interim Financial Statements.

The ability to sell assets quickly is also an important source of liquidity for Santander UK. Santander UK holds marketable investment securities, such as central bank, eligible government and other debt securities, which could be disposed of either by entering into sale and repurchase agreements or by being sold to provide additional funding should the need arise. In addition Santander UK has a significant portfolio of whole loans pre-positioned with the Bank of England, which can be converted into additional sources of liquidity at very short notice.

Within the framework of prudent funding and liquidity management, Santander UK manages its commercial banking activities to minimise liquidity risk whilst maintaining its stock of medium-term funding issuance.

Cash flows

The major activities and transactions that affected Santander UK's cash flows during the first six months of 2013 were as follows:

In the six months ended 30 June 2013, the net cash inflow from operating activities of £10,275m resulted from managed reductions in selected higher risk elements of the residential mortgage portfolio and continued deleveraging of the non-core corporate and legacy portfolios. These reductions were partially offset by increases in SME lending, and increased customer loans to large corporate clients through our trade finance business.

In the six months ended 30 June 2013, the net cash inflow from investing activities of £282m resulted primarily from purchases and sales of available-for-sale securities as part of the rebalancing of the liquid asset portfolio.

In the first six months ended 30 June 2013, the net cash outflow from financing activities of £6,824m reflected primarily the issue of debt securities of £13,997m and repayments of debt securities of £20,314m.

Lower activity relating to securities purchased under resale agreements also meant that cash and cash equivalents were lower at 30 June 2013 than at 30 June 2012.

INTEREST RATE SENSITIVITY

Interest rate sensitivity refers to the relationship between interest rates and net interest income resulting from the periodic repricing of assets and liabilities. The largest administered rate items in Santander UK's balance sheet are residential mortgages and retail deposits, the majority of which bear interest at variable rates. Santander UK is able to mitigate the impact of interest rate movements on net interest income in Retail Banking by repricing separately the variable rate mortgages and variable rate retail deposits, subject to competitive pressures.

Santander UK also offers fixed-rate mortgages and savings products on which the interest rate paid by or to the customer is fixed for an agreed period of time at the start of the contract. Santander UK manages the margin on fixed-rate products by the use of derivatives matching the fixed-rate profiles. The risk of prepayment is reduced by imposing early termination charges if the customers terminate their contracts early.

Santander UK seeks to manage the risks associated with movements in interest rates as part of its management of the overall non-trading position. This is done within limits as described in the Risk Management Report beginning on page 36.

Changes in net interest income - volume and rate analysis

The following table allocates changes in interest income, interest expense and net interest income between changes in volume and changes in rate for Santander UK for the six months ended 30 June 2013 and 30 June 2012. Volume and rate variances have been calculated on the movement in the average balances and the change in the interest rates on average interest-earning assets and average interest-bearing liabilities. The variance caused by changes in both volume and rate has been allocated to rate changes.