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Santander UK plc

Business Review and Forward-looking Statements

Forward looking Statements

Santander UK plc (the 'Company') and its subsidiaries (together 'Santander UK' or the 'Group') may from time to time make written or oral forward-looking statements. Examples of such forward-looking statements include, but are not limited to:

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 page 52 and the Risk Factors section on page 186 and they include:

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 Half Yearly Financial Report, reports to shareholders and other communications. The US Private Securities Litigation Reform Act of 1995 contains a safe harbour for forward-looking statements on which Santander UK relies in making such disclosures.

General Information

This announcement is not a form of statutory accounts. The information for the year ended 31 December 2011 does not constitute statutory accounts, as defined in section 434 of the Companies Act 2006. A copy of the statutory accounts for that year has been delivered to the Registrar of Companies. The auditor's report on those accounts was unqualified, did not draw attention to any matters by way of emphasis and did not contain a statement under section 498(2) or (3) of the Companies Act 2006.

This report is also available on the Santander UK corporate website (www.aboutsantander.co.uk).

British Bankers' Association Code for Financial Reporting Disclosure

Santander UK voluntarily adopted the British Bankers' Association Code on Financial Reporting Disclosure (the 'BBA Code') with effect from its 2010 Annual Report on Form 20-F. The BBA Code sets out five disclosure principles together with supporting guidance. These principles have been applied, as appropriate, in the context of the 2012 Half Yearly Financial Report.

Chief Executive Officer's Review

Overview

In the first half of 2012 we continued to focus on the development of our UK retail and corporate banking services. We delivered a solid business performance, with profit before tax up 32% to £725m, from £549m in the first half of 2011; the first half results of 2011 included a £731m provision for customer remediation, principally in relation to payment protection insurance ('PPI'). Our financial results continued to be impacted by low interest rates, increased term funding costs and higher liquidity costs. Despite these challenges, the uncertain prospects for economic growth and the evolving regulatory environment, Santander UK strengthened its balance sheet with an increase in its Core Tier 1 capital ratio to 12.2%.

Santander UK maintained its reputation for offering customers innovative new products with the launch of our market leading current account in March as part of the '1|2|3 World' range which has been well received and seen a good take-up by new customers and existing current account holders. We also delivered an excellent performance in the cross-tax year ISA campaign and an increase in lending to small and medium-sized enterprises ('SMEs') which grew by 18%. Mortgage lending demand remained weak but we continued to support UK households with £8.7bn of gross mortgage lending, a level consistent with our mortgage stock market share. Improved levels of service satisfaction were achieved in our retail, corporate banking and intermediaries businesses.

The planned acquisition of certain Royal Bank of Scotland Group ('RBS') retail and corporate banking businesses, announced in 2010, is progressing, albeit at a slower pace than initially expected. The transaction will further accelerate the delivery of our strategic goals.

Strategic focus

Santander UK's strategy is to transform its business into a market-leading retail and corporate bank. Underpinning each of the goals is our focus on making Santander UK the best for our customers, our people and our investors:

In parallel with these commercial goals, our financial priority in 2012 has been to ensure that we further enhance Santander UK's balance sheet strength, in terms of funding, credit quality and capital. This sound financial underpinning will provide the foundations for sustainable growth in the future as we continue to transform the business.

Business performance

With a distribution network across more than 1,300 branches and 33 regional Corporate Business Centres, Santander UK has a firm foundation on which to build a full-service commercial bank. Notwithstanding weaker demand in key markets, increased competitive pressures and a fragile economic outlook we achieved solid growth in lending to SMEs, a good level of mortgage lending and performed strongly in our 2012 cross-tax year ISA campaign. The launch of our new 1|2|3 Current Account in March 2012 and a joint marketing campaign with the 1|2|3 Credit Card produced good demand for both products, with customers responding well to the broad range of benefits these products offer.

We have taken actions in the first half of 2012 to manage the risks associated with higher loan-to-value and interest-only mortgages and to constrain balance sheet growth, whilst maintaining lending to key segments of UK individuals and businesses. Mortgage gross lending was £8.7bn in the six months ended 30 June 2012 equating to a gross lending market share of 13%, which was consistent with our stock market share of around 14%. SME lending balances were 18% higher than at the same time last year. Risk management and affordability measures are an important part of our lending decisions and our focus on low LTV and prime segments continues to feed through into relatively low levels of arrears in our mortgage portfolio and in Corporate Banking.

In the first six months of 2012 our retail customers opened 448,000 bank accounts and acquired 356,000 credit cards. In Retail Banking, we are seeking to develop and build deeper customer relationships through increased current account primacy and customer segmentation. The 1|2|3 World is a growing range of products which gives customers access to a broad range of benefits when the products are used on a day-to-day basis.

Competition in the deposit market continued to be intense and, as a consequence, margins remained at very low levels. We continued to offer a mix of best-buy products and special offers targeted at new and existing customers and continued to reward our customers for doing more business with us. Retail deposit net inflows were £3.0bn over the period. This included a strong cross-tax year ISA campaign, with net inflows of ISAs amounting to £6.9bn. Flows were also supported by current account growth where total balances rose by £1.3bn. Offsetting these, we reduced short-term and rate-sensitive deposits that offered limited long term relationship opportunities. The cost of medium term funding ('MTF') issuance was high compared to historic levels, but given its duration and relative cost remained an attractive and important source of funding. In the first half of 2012, £11.8bn of medium term funding was raised across a mix of sources and geographies and at good rates, reflecting the market's confidence in Santander UK.

Our SME balances were up 18% with £1.7bn of new facilities made available. The organic growth of Corporate Banking continued in the first half of 2012 during which five new regional Corporate Business Centres were opened to improve coverage and customer service, taking the number of centres to 33, with plans in place for more openings in the second half of the year. Our innovative Breakthrough programme, launched in 2011, continued to support fast growth small companies in their development. In business banking, we launched a new fee-paying account in the second half of 2011. In total, over 23,000 bank accounts were opened in the first half of 2012.

Our Markets business continued to perform well in the first six months of 2012 and, despite the volatile environment, profits increased compared to the same period last year. Investment in staff and technology enabled us to offer an expanded range of products in 2012, particularly in the Institutional and Foreign Exchange businesses where we continued to show growth in challenging markets.

Improving customer service

We remain committed to improving customer service within our businesses. The roll-out of a comprehensive behavioural change programme for our staff, designed to improve customer experience across our branch network, was completed in June 2012. We also finalised the recruitment of almost 200 additional telephony agents. This enabled us to launch an in-depth training and development initiative to further improve the service offered through this channel. Results from our internal monthly customer survey, Customer First, reflected the positive impact of our initiatives on customer satisfaction.

Our efforts are being recognised by the industry, as we have recently won awards from Moneywise for 'Most Improved Service', Your Money for 'Best National Branch Network' and Euromoney for 'Best Bank in the UK' for 2012. We were awarded the 'UK Bank of the Year 2011' by The Banker magazine for the third year running. We also received Moneyfacts 2012 awards for 'Best Personal Finance Provider of the Year' for the third consecutive year; 'Best Current Account Provider' for the new 1|2|3 Current Account and 'Best Cash ISA Provider'; Card & Payments Trailblazer Awards 2012 'Best New Credit Card'; and Your Mortgage 2010-2011 'Best Direct Mortgage Lender'.

Funding, liquidity and capital

Santander UK remained firmly focused on the UK with approximately 99% of its customer assets UK-related and approximately 85% of customer assets consisting of prime residential mortgages to UK customers. The non-UK element of our balance sheet related primarily to the United States. Our balance sheet has a minimal net exposure after collateral to eurozone peripheral countries, amounting to approximately 0.5% of total assets.

Customer assets were £0.5bn higher than at 30 June 2011. Increases in SME and corporate lending were partially offset by managed reductions in the retail mortgage and unsecured personal loan portfolios. Customer liabilities of £149.3bn increased relative to the year-end but were lower than at 30 June 2011, with outflows resulting from a management decision to switch funding away from rate-sensitive and shorter term deposits. This was offset by a successful ISA cross-tax year campaign, securing deposits with an attractive liquidity profile at relatively favourable margins in the first half of 2012. The loan-to-deposit ratio of 134% was 2 percentage points better than at 31 December 2011.

In the first half of 2012, £11.8bn of medium term funding was raised across a mix of sources and geographies, with only limited further issuance expected to be required in the second half. The cost of MTF issuance remains high compared to historic levels, but continues to be an attractive and important source of our diversified funding profile. We continued to be able to raise funds in wholesale markets even at times of great market uncertainty regarding the eurozone. Total liquid assets rose 23% in the half year to £69bn. This strengthened the conservative liquidity position of the balance sheet. Short-term funding balances have been actively reduced as part of the process of strengthening the balance sheet and reflecting our prudent liquidity profile.

The Core Tier 1 capital ratio increased to 12.2% at 30 June 2012. In July 2012, Santander UK launched an offer to buy back £1.9bn of certain debt capital instruments. The rate of take-up of this offer exceeded expectations and the scope of the offer was increased to meet demand.

Key financial highlights

For the six months ended 30 June 2012, Santander UK's profit before tax was £725m, 32% higher than the equivalent period in 2011 which included a provision of £731m for customer remediation, principally in relation to PPI.

The economy and UK regulation

The decline in economic activity ('GDP') in late 2011 continued into 2012, with GDP falling by 0.3% in the first quarter. The preliminary reading for the second quarter has shown a larger fall, of 0.5%, although the additional bank holiday in the quarter and the wet weather are reported to have a played a role in this and make the underlying trend more difficult to ascertain. The output figures are somewhat at variance with the employment figures so far in 2012. Over the period when output is reported to have fallen, employment has risen and the unemployment rate reduced to 8.0% in the three months to June.

With falling activity and heightened economic uncertainty, especially with regard to the prospects for the eurozone, additional quantitative easing was announced by the Monetary Policy Committee. Whilst the economic environment remains very challenging, the process of reducing the high level of public sector borrowing is continuing and demand for credit has remained subdued, prompting new policy measures. In the housing market, the number of loans approved for house purchase for the first half of 2012 was over 9% ahead of a year earlier, but part of this was due to the timing of the ending of the stamp duty relief for first-time buyers. In contrast, the mortgage market saw weaker remortgage activity in the first half of 2012, down 9% compared to a year ago. Overall, the level of housing market activity remains low relative to the experience of the previous decade.

The UK Government's recent announcements on regulatory reform, particularly the Independent Commission on Banking ('ICB'), imply considerable change is likely to be ahead for the banking industry. We believe that Santander UK is well placed to respond to these challenges.

Looking ahead

We believe that the remainder of 2012 and 2013 are likely to be tough for the UK banking industry. Macro-economic prospects have deteriorated markedly in recent months, and show little sign of recovery in the short term. This has inevitably affected the outlook for our profitability. Increased regulatory burdens, continued low interest rates and higher funding costs are expected to impact our results further. We will seek to mitigate the effects of these challenges and continue to tightly control costs in the coming years. A priority for 2012 is to further enhance the strength of our balance sheet. To that end we will continue to focus on maintaining the high quality of our lending, improving further our capital base and tightly managing the liquidity and funding positions.

We will continue to invest in the commercial transformation of the UK business. Our strategy remains for Santander UK to be a full-service, diversified, customer-centred commercial banking franchise and to emerge as the best bank in the country for our customers, our people and our investors. The progress we have made in becoming a full-service commercial bank is due to the effort and commitment of all our staff and I would like to extend my thanks for their hard work.

Innovation will continue be important to Santander UK. The 1|2|3 World product suite is designed to build and reinforce a long-term primary account relationship with retail customers. Putting customers at the forefront of our business is a key part of our focus and we plan to further improve and deepen our customer relationships by providing a tailored proposition and a competitive product range. We have made significant investment in improving our service quality and have further initiatives planned for the second half of the year and hope to see further improvements to customer satisfaction as a result.

A seamless handover for the retail and corporate customers involved in the planned RBS transaction is a core deliverable for both Santander UK and RBS. This is, however, a large and exceptionally complex migration. This complexity and our concern to ensure that the transfer happens smoothly for customers means that some aspects of the programme are taking longer than originally anticipated. Whilst final dates are not yet confirmed, we continue to work constructively with RBS on the detail of implementation, which will require FSA approval prior to formal implementation and completion.

Santander UK welcomes and will support recent initiatives announced by the UK Government and Bank of England to improve the flow of liquidity to UK banks to support lending to consumers and businesses.

Santander UK will continue to build on its record of strong corporate governance in risk management and compliance and to foster a professional culture that upholds high standards of ethical behaviour and puts customers' interests first.

Ana Botín

Chief Executive Officer

Business Overview

This Business and Financial Review contains forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in such forward-looking statements. See "Forward-looking Statements" on page 2.

GENERAL

Santander UK plc (the 'Company') and its subsidiaries (together, 'Santander UK' or the 'Group') operate primarily in the UK, under UK law and regulation and are part of the Banco Santander, S.A. group (together with its subsidiaries, 'Santander'). Santander UK is a significant financial services provider in the UK.

The structural relationship of Santander UK with the Santander group - the 'subsidiary model'

The 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 subsidiary model means that Banco Santander, S.A. has no obligation to provide any liquidity, funding or capital assistance, although it enables Banco Santander, S.A. to selectively take advantage of opportunities.

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 balance sheet and profitability and its own network of investors. It does not rely on a guarantee from Santander or any other member of the Santander group to generate this funding or liquidity. Santander UK does not raise funds to finance other members of the Santander group or guarantee the debts of other members of the Santander group (other than certain of its own subsidiaries).

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

Planned acquisition of RBS branches ('Project Rainbow')

On 4 August 2010, the Company announced its agreement to acquire (subject to certain conditions) certain bank branches and business banking centres and associated assets and liabilities from RBS for a premium of £350m to net assets at closing. The consideration will be paid in cash and is subject to certain closing adjustments. The planned acquisition will further accelerate the delivery of the Company's strategic goals. A seamless transfer of the retail and corporate customers involved is a core deliverable of the transaction for both the Company and RBS. The Company has progressed extensive work on its systems and products in preparation for the transfer and integration and is satisfied with the progress it has made. This is, however, a large and exceptionally complex migration. This complexity and concern to ensure that the transfer happens smoothly for customers means that some aspects of the integration programme are taking longer than originally anticipated. Whilst final dates are not yet confirmed, the Company continues to work constructively with RBS on the detail of implementation, which will require FSA approval prior to formal implementation and completion.

Business Review - Summary

Santander UK plc ('the Company' and its subsidiaries, together the 'Group' or 'Santander UK') sets out below its Interim Management Report for the six months ended 30 June 2012.

The results discussed below are not necessarily indicative of Santander UK's results in future periods. The following information contains certain forward-looking statements. See "Forward-looking Statements" on page 2. The following discussion is based on and should be read in conjunction with the Condensed Consolidated Interim Financial Statements elsewhere in this Half Yearly Financial Report.

INTRODUCTION

Santander UK has prepared this Business and Financial Review in a manner consistent with the way management views the business as a whole. As a result, we present the following key sections to the Business and Financial Review:

Basis of results presentation

The information in this Business and Financial Review 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 the 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 which follows the Group's normal accounting policies and principles, including measures of operating results, assets and liabilities.

In the first half of 2012, certain non-core portfolios were transferred to Corporate Centre (formerly known as Group Infrastructure) 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 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, customer remediation, and other costs, and hedging and other variances has been transferred to Corporate Centre, principally from Retail Banking.

The prior period's segmental analysis has been adjusted to reflect the fact that reportable segments have changed.

GROUP SUMMARY

SUMMARISED CONSOLIDATED INCOME STATEMENT AND SELECTED RATIOS

Six months ended 30 June 2012 compared to six months ended 30 June 2011

Profit before tax increased by £176m to £725m (2011: £549m), benefiting from the non-recurrence of the significant customer remediation provision, principally in relation to payment protection insurance ('PPI'), of £731m before tax made in the first half of 2011. Profit before tax continued to be adversely impacted by structural changes in the market including holding higher levels of liquid assets, higher funding costs and the low interest rate environment. By income statement line, the movements were:

Taxation

The tax on the Group's profit before tax differs from the theoretical amount that would arise using the basic corporation tax rate of the Company as follows:

Six months ended 30 June 2012 compared to six months ended 30 June 2011

The effective tax rate for the first six months of 2012, based on profit before tax was 24.1% (2011: 24.8%). The effective tax rate differed from the UK corporation tax rate of 24.5% (2011: 26.5%) principally because of the effect of non-equalised items, the reduction in deferred tax asset as a result of the change in the tax rate and the impact of the non-deductible UK Bank Levy.

Customer assets and liabilities

Lending and Deposit Flows

CAPITAL

Discussion and analysis of the Core Tier 1 capital ratio, the total capital ratio and risk-weighted assets is set out in the "Balance Sheet Business Review - Capital management and resources" on pages 40 to 44.

Business Review - Divisional Results

This section contains a summary of the results, and commentary thereon, by Income Statement line item for each segment.

PROFIT BEFORE TAX BY SEGMENT

RETAIL BANKING

Retail Banking offers a comprehensive range of banking products and related financial services (residential mortgages, savings and banking, and other personal financial services products) to customers throughout the UK. It serves customers through the Santander UK network of branches and ATMs, as well as through telephone, internet channels and intermediaries. It also includes the private banking business which offers private banking and other specialist banking services to our customers.

Summarised income statement

Segment balances

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

(2) Mortgage impairment loss allowances as a percentage of mortgage NPLs.

Business volumes

(1) Includes Social Housing loans held within Corporate Centre, to align with CML reporting.

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

(3) Credit card sales only include personal credit cards distributed through the branches.

(4) 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 2012 compared to six months ended 30 June 2011

Profit before tax decreased by £196m to £801m (2011: £997m). By income statement line, the movements were:

Retail Banking segment balances

Retail Banking business volumes

CORPORATE BANKING

Santander UK started to develop its corporate banking capability in 2006 and, with the acquisition of Alliance & Leicester plc, significantly increased this capacity from 2008. The investment in, and development of, these operations has been significant, with good progress being made ahead of the acquisition of certain customers from RBS.

Corporate Banking provides a range of banking services principally to UK companies, with a focus on services for SMEs, providing a broad range of banking products including loans, bank accounts, deposits, treasury services, invoice discounts, cash transmission and asset finance. Small businesses with a turnover of less than £250,000 are serviced through the Business Banking division, while a network of 33 regionally-based Corporate Business Centres offers services to businesses with a turnover of £250,000 to £150m. In addition, Corporate Banking includes specialist teams servicing Real Estate, Social Housing and UK infrastructure clients.

Within Corporate Banking, the Large Corporates business is responsible for larger multinational corporate clients, including related activities principally comprising foreign exchange, money market and credit activities. These related activities are structured into two main product areas: Foreign exchange and money markets, and Credit. Foreign exchange offers a range of foreign exchange products and money markets runs the securities lending/borrowing and repo businesses. Credit originates loan and bond transactions in primary markets as well as their intermediation in secondary markets.

Summarised income statement

Segment balances

(1) Total SMEs includes assets held within Corporate Centre

Corporate Banking profit before tax

Six months ended 30 June 2012 compared to six months ended 30 June 2011

Profit before tax increased by £11m to £182m (2011: £171m). By income statement line, the movements were:

Corporate Banking segment balances

MARKETS

Markets is a financial markets business focused on providing value added financial services to financial institutions, as well as to the rest of Santander UK's business. It is structured into two main product areas: Fixed income and Equity. Fixed Income covers sales and trading activity for fixed income products. Equity covers equity derivatives, property derivatives and commodities. Equity derivatives activities include the manufacture of structured products sold to both the Group and other financial institutions who sell or distribute them on to their customers.

Summarised income statement

Segment balances

Markets profit before tax

Six months ended 30 June 2012 compared to six months ended 30 June 2011

Profit before tax increased by £47m to £79m (2011: £32m). By income statement line, the movements were:

Markets segment balances

CORPORATE CENTRE

Corporate Centre (formerly known as Group Infrastructure) consists of Asset and Liability Management ('ALM'), which is responsible for the Group's capital, and certain non-core and legacy portfolios being run-down and/or managed for value. ALM is responsible for managing the Group's structural balance sheet composition and strategic and tactical liquidity risk management. This includes short-term and medium-term funding, covered bond and securitisation programmes. ALM's responsibilities also include management of Santander UK's banking products and structural exposure to interest rates.

Summarised income statement

Segment balances

Corporate Centre loss before tax

Six months ended 30 June 2012 compared to six months ended 30 June 2011

Loss before tax decreased by £314m to £337m (2011: £651m). By income statement line, the movements were:

Corporate Centre segment balances

Balance Sheet Business Review

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

SUMMARY

This balance sheet business review describes the Group's significant assets and liabilities and its strategy and reasons for entering into such transactions. The balance sheet business review is divided into the following sections:

SUMMARISED CONSOLIDATED BALANCE SHEET

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

Assets

Cash and balances at central banks

Cash and balances held at central banks increased by 16% to £30,067m at 30 June 2012 (31 December 2011: £25,980m) due to increased holdings of liquid assets maintained with the Bank of England as part of the Group's liquidity management activity.

Trading assets

Trading assets increased by 50% to £32,833m at 30 June 2012 (31 December 2011: £21,891m). The increase principally reflected the higher repurchase agreements activity during the period.

Derivative assets

Derivative assets decreased by 1% to £30,549m at 30 June 2012 (31 December 2011: £30,780m). The decrease was driven by a decrease in fair values of interest rate derivatives as a result of upward shifts in yield curves. There was a corresponding decrease in derivatives liabilities.

Financial assets designated at fair value through profit and loss

Financial assets designated at fair value through profit and loss decreased by 16% to £4,221m at 30 June 2012 (31 December 2011: £5,005m). The decrease was primarily attributable to the maturity of, and changes in credit spreads on loans to UK Social Housing associations. New loans are not designated at fair value.

Loans and advances to banks

Loans and advances to banks decreased by 44% to £2,496m at 30 June 2012 (31 December 2011: £4,487m). The decrease was due to lower reverse repurchase agreement activity with Banco Santander, S.A..

Loans and advances to customers

Loans and advances to customers decreased by 1% to £198,323m at 30 June 2012 (31 December 2011: £201,069m), primarily due to a managed reduction in the mortgage stock.

Available for sale securities

Available for sale securities increased substantially to £4,851m at 30 June 2012 (31 December 2011: £46m). The increase reflected the purchase of government securities for liquidity management purposes.

Loans and receivable securities

Loans and receivable securities decreased by 21% to £1,399m at 30 June 2012 (31 December 2011: £1,771m). The decrease principally reflected the continuing run-down of the Treasury Asset Portfolio.

Macro hedge of interest rate risk

The macro (or portfolio) hedge decreased by less than 1% to £1,215m at 30 June 2012 (31 December 2011: £1,221m). The decrease was mainly due to increases in interest rates.

Property, plant and equipment

Property, plant and equipmentdecreased by 3% to £1,544m at 30 June 2012 (31 December 2011: £1,596m). The decrease was principally due to the depreciation charge for the period, partially offset by property acquired during the period.

Retirement benefit assets

Retirement benefit assets increased by 71% to £411m at 30 June 2012 (31 December 2011: £241m). For the Group's defined benefit pension schemes which had surpluses, the key drivers of the increase were Company contributions during the period together with an increase in the net discount rate which generated a reduction in the present value of scheme liabilities.

Tax, intangibles and other assets

Tax, intangibles and other assets increased by 4% to £3,625m at 30 June 2012 (31 December 2011: £3,487m). The increase was primarily driven by capitalisation of software development costs partially offset by a slight decrease in tax assets.

Liabilities

Deposits by banks

Deposits by banks increased by 31% to £15,249m at 30 June 2012 (31 December 2011: £11,626m). The increase was driven by the increase in medium-term repurchase agreements as part of the Group's funding strategy.

Deposits by customers

Deposits by customers increased by 1% to £149,340m at 30 June 2012 (31 December 2011: £148,342m). The increase is a result of a strong cross tax year campaign with the major ISA, as well as the launch of the keystone 1|2|3 current account.

Derivatives

Derivative liabilities decreased by 2% to £28,639m at 30 June 2012 (31 December 2011: £29,180m). The decrease was driven by a decrease in the fair values of interest rate derivatives as a result of upward shifts in yield curves.

Trading liabilities

Trading liabilities increased by 10% to £28,235m at 30 June 2012 (31 December 2011: £25,745m. The increase was mainly attributable to higher repurchase agreements activity during the period.

Financial liabilities designated at fair value

Financial liabilities designated at fair value decreased by 27% to £4,977m at 30 June 2012 (31 December 2011: £6,837m). The decrease reflected the maturity of debt securities from the medium term note programme that had been designated at fair value. These were replaced by longer medium term funding via the issuance of debt from the securitisation and Covered Bond programmes that are recorded at amortised cost. This resulted in a corresponding increase in Debt Securities in Issue.

Debt securities in issue

Debt securities in issue increased by 18% to £62,176m at 30 June 2012 (31 December 2011: £52,651m). The increase reflected the Group's strategy of increasing the level of medium-term funding principally through the issuance of debt in the Covered Bond programme. These increases were partially offset by significant decreases in short term funding in the US$20bn Commercial Paper Programme and in Certificates of Deposit in issue. In addition, there were further maturities of debt outstanding under the US $40bn Euro Medium Term Note programme.

Subordinated liabilities

Subordinated liabilities increased by 1% to £6,558m at 30 June 2012 (31 December 2011: £6,499m). The small increase was primarily attributable to foreign exchange movements.

Retirement benefit obligations

Retirement benefit obligations decreased by 83% to £36m at 30 June 2012 (31 December 2011: £216m). For the Group's defined benefit pension schemes which had deficits, the key driver of the decrease in obligations was an increase in the net discount rate which generated a reduction in the present value of scheme liabilities.

Tax, other liabilities and provisions

Tax, other liabilities and provisions decreased by 22% to £2,963m at 30 June 2012 (31 December 2011: £3,812m). The decrease principally reflected the payment of the dividend held in other liabilities at 31 December 2011 and the higher balance of accruals at the year end than the current period end and utilisation of provisions during the period in respect of customer remediation.

Equity

Total shareholders equity increased by 5% to £13,361m at 30 June 2012 (31 December 2011: £12,666m). The increase was principally attributable to retained profits for the period of £550m and an actuarial gain on retirement benefit obligations.

RECONCILIATION TO CLASSIFICATIONS IN THE CONSOLIDATED BALANCE SHEET

The classifications of assets and liabilities in the Group's consolidated balance sheet, including the note reference, and in the balance sheet business review may be reconciled as follows:

SECURITIES

The Group's holdings of securities only represent a small proportion of its total assets. The Group holds securities principally in its trading portfolio. These securities primarily consist of Government and Government-guaranteed securities held for liquidity purposes.

Securities analysis by type of issuer

The following table sets out the book and market values of securities at 30 June 2012 and 31 December 2011. For further information, see the Notes to the Condensed Consolidated Interim Financial Statements.

LOANS AND ADVANCES TO CUSTOMERS

The Group provides lending facilities primarily to personal customers in the form of mortgages secured on residential properties and lending facilities to corporate customers. Purchase and resale agreements represent sale and repurchase activity with professional non-bank customers by the Markets, Short Term Markets business.

Impairment loss allowances on loans and advances to customers

Details of the Group's impairment loss allowances policy are set out in Note 1 to the Consolidated Financial Statements in the Group's 2011 Annual Report. An analysis of period-end impairment loss allowances on loans and advances to customers, movements in impairment loss allowances, and Group non-performing loans and advances are set out in the "Loans and Advances" section of the Risk Management Report on page 71 and Note 11 to the Condensed Consolidated Interim Financial Statements.

COUNTRY RISK EXPOSURE (reviewed)

The Group manages its country risk exposure under its global limits framework. Within this framework, the Group sets its individual risk appetite for each country, taking into account any factors that may influence the risk profile of each country, including political events, the macro-economic situation and the nature of the risk incurred. Exposures are actively managed if it is considered appropriate. Accordingly, and over recent years, the Group has intensified its monitoring of exposures to sovereigns and counterparties in eurozone countries, and has proceeded to selectively divest assets directly or indirectly affected by events in those countries. As a result, the Group has insignificant exposure to Greece (30 June 2012: £3m, 31 December 2011: £3m) and Cyprus (30 June 2012: £nil, 31 December 2011: £nil). Spanish exposure is subject to ongoing monitoring, with reductions in non-parent related risk. Parent-related risk is considered separately.

The country risk tables below show the Group's exposures to central and local governments, government guaranteed counterparties, banks, other financial institutions, retail customers and corporate customers at 30 June 2012 and 31 December 2011. Total exposures consist of the total of balance sheet values and off-balance sheet values. Balance sheet values are calculated in accordance with IFRS (i.e. after the effect of netting agreements recognised in accordance with the requirements of IFRS, principally with respect to derivatives) except for credit provisions which have been added back. Off balance sheet values consist of undrawn facilities and letters of credit.

The country of exposure has been assigned based on the counterparty's country of incorporation except where the Group is aware that a guarantee is in place, in which case the country of incorporation of the guarantor has been used. The exposures are presented by type of counterparty other than where the specific exposures have been guaranteed by a sovereign counterparty in which case they are presented within the "Government guaranteed" category.

Separate disclosure is presented individually for each country where the exposure exceeds £50m, and aggregated for exposures of less than £50m. The domicile of an exposure is based on the country location of the ultimate risk, wherever possible. Given the ongoing interest in eurozone economies, disclosures relating to those economies are presented first and highlighted separately.

The tables exclude credit risk exposures to other Santander group companies, which are presented separately on pages 33 to 36.

(1) Credit exposures exclude the macro hedge of interest rate risk, intangible assets, property, plant and equipment, current and deferred tax assets, retirement benefit assets and other assets. Loans and advances to customers are included gross of loan loss allowances.

(2) Excludes balances with central banks.

(3) Includes Greece of £3m and Cyprus of £nil.