Sant Uk.10te% Regulatory News (SAN)

Santander UK plc

Half Yearly Financial Report for the six months ended 30 June 2011

Business Review and Forward-looking Statements

Chief Executive Officer's Review

Overview

Santander UK has delivered profit in the first six months of 2011 maintaining its strong track record of profitability and balance sheet strength. In line with other UK banks, a further provision for payment protection insurance remediation has also been made, resulting in statutory profit after tax attributable to equity shareholders declining by 51% to £413m. Santander UK's trading profit before tax was £1,142m, 2% lower than the first half of 2010, impacted by the cost of liquidity, term funding and low interest rates.

Santander UK has maintained its industry-leading range of "best buy" products for our retail customers, and is achieving improved levels of service satisfaction in its retail, corporate banking and intermediaries businesses. By returning its retail banking call centres onshore, we have acted upon customer feedback to improve our services and have continued to support the UK economy through job creation.

Santander UK continues to be a consistent lender to homeowners, despite weaker demand. In relation to small and medium-sized enterprises ('SMEs'), our lending grew by 27% and we continue to exceed our lending commitments made under the UK Government's Project Merlin agreement. In 2010, we announced that we had reached an agreement to acquire 318 branches and more than 40 banking centres from Royal Bank of Scotland. On completion, which is expected in the second half of 2012, this will increase our SMEs lending market share from its current level of about 4% to more than 8% and provide us with a strong platform to continue to challenge in this market.

We are well on our way to implementing our strategic plan in which Santander UK has four specific areas of focus, as set out below, as we progress further towards becoming a full-service commercial bank.

Strategic focus

Santander UK has four specific areas of focus: to become a more customer-driven bank, to improve customer satisfaction and service quality, to diversify our business mix and to become the SME Bank of Choice. Underpinning each of these goals is our desire to be the best employer for our people.

Business performance

With a distribution network across more than 1,400 branches and 25 regional corporate banking centres, Santander UK has a firm foundation on which to build a full-service commercial bank. Despite weaker demand in key markets, increased competitive pressure and a fragile economic outlook we have achieved good levels of new business in both SME and mortgage lending. SME lending balances were 27% higher than the same period last year and mortgage gross lending was £9.7bn in the six months ended 30 June 2011. This equated to a market share of more than 15% which was in excess of our stock market share of around 14%. Risk management and affordability measures are an important part of our lending decisions and the success of our focus on low LTV and prime segments is demonstrated by our ongoing low levels of mortgage arrears.

In the first six months of 2011 we opened 409,000 new bank accounts and 274,000 credit cards through our retail network maintaining our market share of stock. In 2010, more than one million new bank accounts were opened of which the proportion of primary accounts increased during the second half of 2010 and into the first half of 2011. Competition in the deposit acquisition market has intensified and margins are at very low levels as a result. We continue to offer a mix of best-buy products and special offers targeted at existing customers but have restricted our exposure to negative margin deposit acquisition, preferring instead to reward our customers for doing more business with us. As a result, net deposit flows in the first six months of the year were slightly negative, although commercial deposits were 3% higher than at 30 June 2010 due to strong inflows during the second half of 2010. In addition, we were able to issue over £17bn of medium-term funding in the first six months at attractive rates, broadly equivalent to our target for the full year.

The Corporate Banking business continued to grow organically in the first half of 2011. SME lending balances of £9.6bn were 27% higher than at 30 June 2010 and corporate deposit flows in the last 12 months have exceeded growth in core corporate lending. Our network of branches and regional business centres offer a tailored banking service and a range of products, advice and support to small businesses, SMEs and large corporate clients. We have supported the SME and corporate sectors of the UK economy in parallel to Project Merlin as well as through our own initiatives. In the first six months of 2011 gross lending to SMEs exceeded £2bn. In March 2011, we were awarded "Business Bank of the Year" by the Business Moneyfacts awards 2011.

Global Banking & Markets produced a satisfactory result in the six months ended 30 June, reflecting transaction volumes lower than in 2010 but in line with the activity levels seen in the market in 2011.

Investing for growth and improving customer service

We remain committed to tackling service issues within our business and a key management priority is to improve customer service. To this end, over 1,000 new UK based customer-facing roles were announced in 2010. The new staff were in place by March 2011, in part allowing the repatriation of our overseas retail banking call centres to the UK in July 2011. Complaints handling processes have been re-engineered and a range of other initiatives and processes have been introduced to address the root cause of service quality issues.

We survey 20,000 customers each month to measure customer satisfaction and the results of this analysis show that we have made progress in the last 12 months, including a reduction in queue times. The way we handle complaints was overhauled in 2010; we now typically resolve around 80% of complaints within 48 hours and the volume of complaints reportable to the FSA in the second half of the year was around 20% lower than in the first half. Despite this progress, there remains further scope for improvement.

Funding, liquidity and capital

Santander UK remains a UK-focused institution with approximately 85% of the balance sheet UK-related and over 85% of customer loans made up of residential mortgages to UK customers.

Over the last 12 months, commercial asset stock increased 1% to £202bn driven by growth in residential mortgages of 1% and SMEs loans of 27%. Commercial liability stock of £153bn grew 3% compared to the first half 2010. The commercial loan-to-deposit ratio improved to 132% compared to 134% at the same time last year.

In the first half of 2011, Santander UK raised £17bn of medium-term funding achieved across a range of products and geographies at attractive rates. The ratio of customer deposits plus medium-term funding to customer assets is now 106%. Deleveraging of non-core assets continued in the first half of 2011 with balances down by approximately £3bn in total, further improving the funding position.

Holdings of high quality liquid assets have increased during the first half of 2011 to £44bn, an increase of approximately £30bn since December 2009 as a response to higher regulatory liquidity requirements. This increase, though a positive from a balance sheet strength perspective, has had a detrimental impact on revenues as highlighted earlier.

Sovereign exposures to the European Union (excluding UK where they are held for liquidity purposes) at 30 June 2011 were not significant at approximately 0.3% of total assets (of which 0.06% related to periphery countries).

Capital ratios remained strong with a Core Tier 1 of approximately 11%.

Key financial highlights

For the six months ended 30 June 2011, Santander UK's trading profit before tax (management's preferred profit measure, described in the Business Review - Summary on page 9) was £1,142m, 2% lower than 2010. Statutory profit after tax attributable to equity shareholders of £413m for the first half of 2011 was £430m lower than the equivalent period in 2010, due to the customer remediation provision which was primarily in relation to payment protection insurance.

The outlook for earnings remains difficult, with pressure on revenues, driven by the lower interest rate environment and competition for deposits. In relation to credit provisions, the speed of economic recovery is critical, combined with rising interest rates in the future.

The economy and UK regulation

After quite rapid quarterly growth in most of 2010, UK economic activity has slowed appreciably. Preliminary official figures show that in the second quarter of 2011, output was 0.7% higher than a year earlier. The unemployment rate has held relatively steady through the past year. With inflation running above earlier expectations and significantly above the 2% target level, leading to reduced real value of earnings, the economic environment remains challenging. Public expenditure cuts are being implemented as part of the process of reducing the high level of public sector borrowing. Demand for credit has remained subdued. In the housing market, the number of loans approved for house purchase has picked up from its low point in the recession although in the first half of 2011 demand was slightly weaker than a year earlier, while remortgage activity has been stronger. Overall, the level of housing market activity remains low relative to the experience of the past decade.

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

Looking ahead

We continue to make progress in becoming a full-service commercial bank due to the effort and commitment of all our staff and I would like to extend my thanks for their hard work. Despite the continued challenges within the UK economy and the stricter regulatory environment, we expect to make further progress in the second half of the year as we implement our strategic priorities.

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.

We are working towards completing the acquisition of 318 branches and more than 40 banking centres from Royal Bank of Scotland. This is a key step in fulfilling our ambition to be a full-service commercial bank as we complement our strong retail offering with an increased presence for SMEs. An important part of Santander UK's strategy and a vital sector for the growth of the economy, our aim is to increase our lending to UK businesses and create new jobs as we open more business centres to serve them. The transfer is complex and it is important that we seek to minimise disruption. With this in mind the current expectation is that the transaction will not complete before the second half of 2012, subject to certain conditions and regulatory approvals.

Ana Botín

Chief Executive Officer

Business Review and Forward-looking Statements

Forward looking Statements

Santander UK plc (the 'Company') and its subsidiaries (together 'Santander UK' or the 'Group') caution that this Half Yearly Financial Report may contain forward-looking statements. Section 27A of the U.S. Securities Act of 1933, as amended, and Section 21E of the U.S. Securities Exchange Act of 1934, as amended, contain a safe harbour for forward-looking statements on which we rely in making such statements in documents filed with the U.S. Securities and Exchange Commission. Forward-looking statements include, without limitation, financial projections or expectations, statements concerning our future business development and economic performance. Words such as "believes", "anticipates", "expects", "intends", "aims", "plans", "targets" and other similar expressions are intended to identify forward-looking statements, but they 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. These forward-looking statements are based on management's current expectations, estimates and projections and Santander UK cautions that these statements are not guarantees of future performance. We also caution 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. Some of these factors, which could affect Santander UK's business, financial condition and/or results of operations are described under 'Risk Factors' in Santander UK's Annual Report on Form 20-F for 2010. A more detailed cautionary statement is also given on page 5 of Santander UK's Annual Report on Form 20-F for 2010. 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 factors mentioned above. 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. Santander UK does not undertake any obligation to update or revise any of them, whether as a result of new information, future events or otherwise. 

General Information

This announcement is not a form of statutory accounts. The information for the year ended 31 December 2010 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 2011 Half Yearly Financial Report.

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 2011.

The results discussed below are not necessarily indicative of Santander UK's results in future periods. The following information contains certain forward-looking statements. See 'Forward-looking Statements' on page 5. The following discussion is based on and should be read in conjunction with the Condensed Consolidated Interim Financial Statements elsewhere in this Half Yearly Financial Report.

Executive Summary

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

Basis of results presentation

The segmental basis of presentation of the Group's results is set out in 'Basis of results presentation' in the 2010 Annual Report. There were no changes to that basis in the six months ended 30 June 2011 except that Santander Business Banking, which offers a range of banking services to small businesses in the UK, was managed and reported as part of Corporate Banking rather than Retail Banking as in 2010. The prior period's segmental analysis has been adjusted to reflect the fact that reportable segments have changed.

Group Summary

Summarised consolidated statutory income statement and selected ratios

Profit before tax of £549m decreased from £1,161m in the first half of 2010. In line with other UK banks, a further provision for customer remediation of £731m has also been made, primarily in relation to payment protection insurance. Notwithstanding this, Santander UK delivered profit in the first six months of 2011 - maintaining its strong track record of profitability and strengthening its balance sheet. Trading profit before tax (which excludes non-trading items, particularly the customer remediation provision) of £1,142m, compared to £1,168m was impacted by new UK regulatory requirements to hold high levels of liquidity and higher costs of term funding. The first half trading results were positive relative to the second half of 2010, and excluding regulatory impacts, the business delivered double-digit growth in trading profit before tax compared to the first half of 2010. Material movements by line include:

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:

The effective tax rate for the first six months of 2011 based on profit before tax was 24.8% (30 June 2010: 25.2%). The effective tax rate differed from the UK corporation tax rate of 26.5% (30 June 2010: 28%) principally because of the effect of non-allowable impairment losses, provisions and other non-equalised items, and the reduction in the deferred tax asset as a result of the change in the tax rate.

Capital

Discussion and analysis of the Core Tier 1 capital ratio, the Tier 1 capital ratio and risk-weighted assets is set out in the 'Balance Sheet Business Review - Capital management and resources' on pages 32 to 34.

Adjustments between the statutory basis and the trading basis

Santander UK's Board reviews discrete financial information for each of its reporting segments that includes measures of operating results, assets and liabilities which are measured on a 'trading' basis. The trading basis differs from the statutory basis as a result of the application of various adjustments, as presented below. Management considers that the trading basis provides the most appropriate way of reviewing the performance of the business.

The adjustments are described in Note 2 to the Condensed Consolidated Interim Financial Statements. For a detailed explanation of these items, see 'Other Material Items' in the Business and Financial Review.

Business and Financial Review

Business Review - Divisional Results

This section contains a summary of the results, and commentary thereon, by Income Statement line item on a trading basis for each segment within the business, together with reconciliations from the trading basis to the statutory basis. Additional information is provided on the adjustments between the trading basis and the statutory basis in the 'Business Review - Other Material Items'.

Trading profit before tax by segment

Trading profit before tax of £1,142m decreased by £26m compared to the previous year (2010: £1,168m). Discussion and analysis of the movements by business division can be found on pages 12 to 17.

Business volumes

Business volumes are used by management to assess the sales performance of the Group, both absolutely and relative to its UK Retail Banking peer group, and to inform management of product trends in the market.

(1) Includes Social Housing loans.

(2) Mortgage stock balance has been rounded.

(3) Mortgage market shares are estimated internally by reference to data on the size of the UK mortgage market produced by the Bank of England.

(4) Includes UPLs, overdrafts and cahoot and excludes consumer finance and Santander Cards credit cards.

(5) Comprises Retail Banking, Corporate Banking and Global Banking & Markets customer deposits.

(6) Represents new cards issued through Santander UK sales channels.

(7) Annualised equivalent of monthly premiums generated from new business during the period.

Main highlights for the six months to 30 June 2011 (compared to the same period in 2010 unless otherwise stated) include:

Mortgages

Gross mortgage lending was £9.7bn, representing an estimated market share of 15.4%, well ahead of our market share of mortgage stock of 13.9%. We continued to focus on the quality of new lending, based on affordability and lower LTV segments. The average LTV on new business completions in the first half of 2011 was 63% compared to 61% in the first half of 2010.

Capital repayments of £10.1bn were higher than in 2010. Our estimated market share of repayments increased to 16.6%. This performance reflected a significant increase in our maturing assets with LTV less than 75%, reflecting our gross lending two years previously and was against a market backdrop of heightened competition in low LTV segments.

Net mortgage lending of £0.4bn negative in the first half of 2011 (2010: £3.3bn positive) reflected a weaker pipeline in the last quarter of 2010 during which market pricing became less attractive in the lower LTV segments of the market. The business returned to positive net lending of £0.2bn in the second quarter of 2011.

Unsecured Personal Lending

Unsecured personal lending comprises unsecured personal loans, credit cards and overdrafts. Total gross unsecured personal lending in the period was in line with 2010 lending at £0.7bn as a result of the bank's ongoing focus on only lending to high quality customer segments focusing on existing customers. Credit cards and overdrafts performance is broadly consistent period on period. The de-leveraging of the unsecured personal loans book (i.e. excluding credit cards and overdrafts) has resulted in an 18% reduction in the asset to £3.1bn.

SME Lending

SME lending balances were higher than at the end of 2010 driven by a strong performance via our 25 Corporate Business Centres and a broader product offering. Lending stock balances totalled £9.6bn at 30 June 2011, up over 27% compared to 30 June 2010, equating to an estimated 4.1% market share. In 2011 to date we have exceeded our lending commitments made under the Merlin agreement.

Deposits and Investments

Customer deposits were slightly lower than at the end of 2010, with Retail customer deposits of £124.0bn, 1% lower than at the end of 2010. Acquisition of deposits slowed in the first half of 2011 as a result of a weaker market in the UK and extremely negative pricing and margins in the market, resulting in a small outflow.

Investment annual premium income was approximately 14% lower than in 2010. Growth in sales was impacted by a market which decreased by an estimated 17% in the same period.

Banking

Over 400,000 bank accounts were opened in the first half of 2011, building on the success of the last two years where more than 1 million accounts were opened in each year. Improving the proportion of new bank accounts that represent the customer's primary account has been a particular focus in 2010 and 2011, rising from 29% in June 2010 to approximately 38% in June 2011.

Credit Card sales

Credit card sales through the Santander UK brand were 18% higher than in the same period in 2010 driven by a strong performance in the telephone and internet channels, as well as direct mail activity. The Zero Credit Card, of which approximately 270,000 have been opened in the first half of the year, was a particular success. Further initiatives are planned in this area.

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 our private banking business which offers private banking and other specialist banking services in the UK and offshore banking.

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

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

Retail Banking trading profit before tax

Six months ended 30 June 2011 compared to six months ended 30 June 2010

Trading profit before tax increased by £228m to £989m (2010: £761m). By income statement line, the movements were:

Retail Banking segment balances and other data

Corporate Banking

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 25 regionally-based Corporate Business Centres offers services to businesses with a turnover of £250,000 to £150m. The Wholesale area is responsible for larger corporate clients, in addition to specialist teams servicing Real Estate, Social Housing and UK infrastructure clients. Non Core portfolios, where activities are being reduced, are also managed within Corporate Banking.

(1) Excludes non-core portfolios

Corporate Banking trading profit before tax

Six months ended 30 June 2011 compared to six months ended 30 June 2010

Trading profit before tax increased by £10m to £98m (2010: £88m). By income statement line, the movements were:

Corporate Banking segment balances

Global Banking & Markets

Global Banking & Markets is a financial markets business focused on providing value added financial services to large corporates not serviced by Corporate Banking (being, in general, large multinationals) and financial institutions, as well as to the rest of Santander UK's business (including the Retail Banking and Corporate Banking divisions). It is structured into five main product areas: Rates, Foreign exchange and money markets, Equity, Credit and Transaction Banking. In addition, large and complex clients are covered by teams organised along industry lines. Rates covers sales and trading activity for fixed income products. Equity covers equity derivatives, property derivatives and commodities. Foreign exchange offers a range of foreign exchange products and money markets runs the securities lending/borrowing and repo businesses. Equity derivatives activities include the manufacture of structured products sold to retail and corporate customers of both the Group and of other financial institutions who sell them on to their customers. Credit originates loan and bond transactions in primary markets as well as their intermediation in secondary markets. Transaction Banking provides lending and cash management services, including deposit taking and trade finance.

Global Banking & Markets trading profit before tax

Six months ended 30 June 2011 compared to six months ended 30 June 2010

Trading profit before tax decreased by £47m to £116m (2010: £163m). By income statement line, the movements were:

Global Banking & Markets segment balances

Group Infrastructure

Group Infrastructure consists of Asset and Liability Management ('ALM'), which is also responsible for Group capital and funding, and the Treasury asset portfolio that is being run down. ALM is responsible for managing the Group's structural balance sheet composition and strategic and tactical liquidity risk management. This includes short-term, medium-term, covered bond and securitisation funding programmes. ALM's responsibilities also include management of Santander UK's banking products and structural exposure to interest rates.

Group Infrastructure trading profit before tax

Six months ended 30 June 2011 compared to six months ended 30 June 2010

Trading profit before tax decreased by £217m to a loss of £(61)m (2010: £156m). By income statement line, the movements were:

Business and Financial Review

Other Material Items

Adjustments between the statutory basis and the trading basis

Santander UK's Board reviews discrete financial information for each of its segments that includes measures of operating results, assets and liabilities, which are measured on a 'trading' basis. The trading basis differs from the statutory basis as a result of the application of various adjustments, as presented below, and described in the Business Review - Summary. Management considers that the trading basis provides the most appropriate way of reviewing the performance of the business.

The trading adjustments consist of:

Perimeter companies pre-acquisition trading basis results

The pre-acquisition trading basis results of the Perimeter companies for the period ended 30 June 2010 are included in the results discussed in the 'Business Review - Divisional Results'. The pre-acquisition non-trading adjustments of the Perimeter companies for the period ended 30 June 2010 have not been included. This adjustment applies only to 2010.

Reorganisation, customer remediation and other costs

These costs comprise implementation costs in relation to the strategic change and cost reduction process, costs in respect of customer remediation and costs relating to certain UK Government levies including the new UK bank levy.

Total reorganisation, customer remediation and other costs of £632m increased by £607m compared to the first half of 2010 (2010: £25m).

Reorganisation and customer remediation costs increased by £674m reflecting the charge for customer remediation, principally payment protection insurance.

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

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

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

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

The overall effect of the above is a substantial increase in the provision requirement with a charge for the six months ended 30 June 2011.

Other non-trading items represent the reversal of accruals for UK Government levies of £95m (2010: £28m) including for the new bank levy. For management accounting purposes, these charges were included in the trading basis results to provide a more complete view of half year income statement trends, but were removed from the statutory results in order to comply with IFRS. Under IFRS, these charges for a year may only be recognised on the last day of the year, not accrued over the period.

Profit on part sale and revaluation of subsidiaries

These profits are excluded from the trading results to allow management to understand the underlying performance of the business. In 2011, there were no such profits. In 2010, profits on the sale of James Hay and certain other businesses were excluded from the trading results.

Hedging and other variances

The Balance Sheet and Income Statement are subject to mark-to-market volatility including that arising from the accounting for elements of derivatives deemed under IFRS rules to be ineffective as hedges. Volatility also arises on certain assets previously managed on a fair value basis, and hence classified as fair value through profit or loss under IFRS, that are now managed on an accruals basis.

In addition, other variances include the reversal of coupon payments on certain equity instruments which are treated as an interest expense in the trading results but are reported below the profit after tax line for statutory purposes.

In 2011 and 2010, the total largely consisted of the reversal of coupon payments on certain Preference Shares, Perpetual Preferred Securities and Reserve Capital Instruments which were treated as interest expense in the trading results but were accounted for as dividends for statutory purposes, partially offset by hedge ineffectiveness.

Capital and other charges

Capital charges/(credits) principally comprise internal nominal charges/(credits) for capital invested in the Group's businesses. Management implemented this charge/(credit) to assess if capital is invested effectively. On a consolidated basis, the total of these internal reallocations is £nil.

Business and Financial Review

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:

In the remaining sections of the Balance Sheet Business Review, the principal assets and liabilities are summarised by their nature, rather than by their classification in the balance sheet.

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 34% to £35,627m at 30 June 2011 (31 December 2010: £26,502m) as part of the Group's liquidity management activity. This reflected the increase in the Group's holdings of liquid assets maintained with the Bank of England and the US Federal Reserve as part of the Group's liquidity buffer while repaying amounts under the Bank of England's UK Special Liquidity Scheme, which are accounted for in part off-balance sheet.

Trading assets

Trading assets increased by 12% to £39,815m at 30 June 2011 (31 December 2010: £35,461m). The increase reflected higher holdings of UK and OECD Government securities as part of the Group's liquidity management activity.

Derivative assets

Derivative assets decreased by 3% to £23,530m at 30 June 2011 (31 December 2010: £24,377m). The decrease was driven by a decrease in interest rate derivatives as a result of upward moves in yield curves.

Financial assets designated at fair value through profit and loss

Financial assets designated at fair value through profit and loss decreased by 19% to £5,474m at 30 June 2011 (31 December 2010: £6,777m). The decrease was primarily attributable to the maturity of loans to UK Social Housing associations, as new loans are no longer designated at fair value.

Loans and advances to banks

Loans and advances to banks increased slightly by 3% to £3,960m at 30 June 2011 (31 December 2010: £3,852m).

Loans and advances to customers

Loans and advances to customers increased slightly to £195,925m at 30 June 2011 (31 December 2010: £195,132m), principally due to growth in corporate lending.

Available-for-sale securities

Available for sale securities decreased by 75% to £43m at 30 June 2011 (31 December 2010: £175m). The decrease reflected the sale of available-for-sale debt securities as part of the restructuring of the Company's contributions to the defined benefit pension schemes.

Loans and receivable securities 

Loans and receivable securities decreased by 43% to £2,065m at 30 June 2011 (31 December 2010: £3,610m). The decrease principally reflected the run-down of the Treasury asset portfolio as part of the ongoing de-leveraging process.

Macro hedge of interest rate risk

The macro (or portfolio) hedge decreased by 12% to £961m at 30 June 2011 (31 December 2010: £1,091m) mainly due to increases in interest rates.

Property, plant and equipment

Property, plant and equipmentdecreased by 6% to £1,611m at 30 June 2011 (31 December 2010: £1,705m). The decrease was principally due to the depreciation charge for the period.

Retirement benefit assets

Retirement benefit assets increased to £152m at 30 June 2011 (31 December 2010: £nil). The key drivers of the reversal of the deficit at 31 December 2010 were the Company contributions during the period together with slightly more favourable economic conditions.

Tax, intangibles and other assets

Tax, intangibles and other assets decreased by 7% to £3,891m at 30 June 2011 (31 December 2010: £4,178m). This decrease was primarily attributable to a reduction in trade and other receivables.

Liabilities

Deposits by banks

Deposits by banks increased by 34% to £10,464m at 30 June 2011 (31 December 2010: £7,784m). The increase was driven by the issuance of new medium term repurchase agreements as part of the Group's funding strategy.

Deposits by customers

Deposits by customers were broadly flat at £152,255m at 30 June 2011 (31 December 2010: £152,643m).

Derivatives

Derivative liabilities decreased by 3% to £21,693m at 30 June 2011 (31 December 2010: £22,405m). The decrease was driven by a decrease in interest rate derivatives as a result of upward moves in yield curves.

Trading liabilities

Trading liabilities decreased by 4% to £41,158m at 30 June 2011 (31 December 2010: £42,827m). The decrease reflected lower non-government repo activity.

Financial liabilities designated at fair value

Financial liabilities designated at fair value increased by 119% to £8,081m at 30 June 2011 (31 December 2010: £3,687m). The increase reflected new issuances in the US$4bn Commercial Paper and US$20bn and US$40bn Medium Term notes programmes.

Debt securities in issue

Debt securities in issue increased by 11% to £57,683m at 30 June 2011 (31 December 2010: £51,783m). The increase reflected the Group's strategy of increasing the level of medium-term funding through the issuance of debt in the Holmes, Fosse and Motor securitisation and Covered Bond programmes. These increases were partially offset by the maturity of debt within the former Alliance & Leicester US$40bn EMTN programme.

Subordinated liabilities

Subordinated liabilities decreased by 6% to £5,971m at 30 June 2011 (31 December 2010: £6,372m). The decrease reflected the scheduled redemption of euro 500m 4.625% Subordinated Notes.

Retirement benefit obligations

Retirement benefit obligations decreased to £54m at 30 June 2011 (31 December 2010: £173m). The key drivers of the reduction of the deficit were the Company contributions during the period together with slightly more favourable economic conditions.

Tax, other liabilities and provisions

Tax, other liabilities and provisions increased by 19% to £3,455m at 30 June 2011 (31 December 2010: £2,912m). This increase principally reflected a £731m provision charge for customer remediation, including payment protection insurance.

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

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

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

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

The overall effect of the above is a substantial increase in the provision requirement with a charge for the six months ended 30 June 2011.

Equity

Total shareholders equity was broadly flat at £12,240m at 30 June 2011 (31 December 2010: £12,274m). The slight decrease was principally attributable to the inclusion of profits of £413m offset by dividends declared of £482m.

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 holds securities for a variety of purposes:

The following table sets out the book and market values of securities at 30 June 2011 and 31 December 2010. 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. The Group enters into purchase and resale agreements which represent sale and repurchase activity with professional non-bank customers by the Global Banking & Markets Short Term Markets business. Securities in the Treasury asset portfolio that are accounted for as Loans and advances to customers are also included.

Impairment loss allowances on loans and advances to customers

Details of the Group's impairment loss allowances policy are set out in Note 1 of the Group's 2010 Annual Report. An analysis of end-of-period 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 Risk Management Report on page 56 and Note 10 to the Condensed Consolidated Interim Financial Statements.

Country risk exposure

The country risk exposure table below shows the total credit risk exposures to central and local governments, government guaranteed, bank and financial institutions, retail and corporate customers at 30 June 2011 and 31 December 2010. The table excludes credit risk exposures to other Santander group companies, which are presented separately.

(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 the exposure on margin given with respect to the Bank of England's Special Liquidity Scheme.

Presented below separately for sovereign debt and other country risk exposures is additional analysis of exposures into those that are accounted for on-balance sheet (further analysed into those measured at amortised cost and those measured at fair value) and those that are off-balance sheet. The assets held at fair value are classified as either trading assets or have been designated as held at fair value through profit or loss. The Group has made no reclassifications from the assets which are held at fair value to any other category.

Sovereign Debt