SANTANDER UK PLC

National Storage Mechanism | Additional information You don't have Javascript enabled. For full functionality this page requires javascript to be enabled. RNS Number : 7359L Santander UK Plc 15 August 2013 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 2013 Half Yearly Financial Report 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: Retail Banking(1) Steve Pateman Head of UK 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. Corporate Banking Steve Pateman Head of UK 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. Jacques Ripoll(2) Head of Santander UK Global Banking & Markets 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. Markets Jacques Ripoll(2) Head of Santander UK Global Banking & Markets Markets offers risk management and other services to financial institutions, as well as to other Santander UK divisions. Its main product areas are fixed income and foreign exchange, equity, capital markets and institutional sales. Corporate Centre Stephen Jones Chief Financial Officer Corporate Centre includes Financial Management & Investor Relations ('FMIR') headed by Justo Gomez, Finance Director, 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 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-brand credit cards business were completed in the first half of 2013. (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: Retail Products and Marketing Rami Aboukhair Director, UKB Product Marketing and Segments Responsible for developing Santander UK's products, marketing and brand communications to serve customers better. Manufacturing Juan Olaizola Chief Operating Officer Responsible for all information technology and operations, including service centres. Risk José María Nus Chief Risk Officer Responsible for ensuring Santander UK is provided with an appropriate risk policy and control framework and to report any material risk issues to the Board Risk Committee and the Board. 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 MARKET SHARE OF STOCK(1) BUSINESS MIX(3) Mortgages SME lending(2) 12.6% 5.5% Retail deposits Bank accounts 9.1% 9.4% http://www.rns-pdf.londonstockexchange.com/rns/7359L_1-2013-8-14.pdf http://www.rns-pdf.londonstockexchange.com/rns/7359L_2-2013-8-14.pdf (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 Net interest income £1,391m Down 5% on H1 2012, up 10% on H2 2012. Net interest income in Q2 2013 was at its highest for the last five quarters. Profit after tax £440m Profit after tax from continuing operations was down 16% from £524m in H1 2012, but up 25% from £353m in H2 2012. Banking net interest margin 1.46% Recovered to the level of H1 2012 reflecting easing structural pressures and stronger customer interest margins. Cost-to-income ratio 57% Up from 51% in H1 2012 and up from 56% in H2 2012 (excluding the gain from the capital management exercise). Costs remain well controlled, but are increasing due to regulatory costs and ongoing investment in the business. The cost-to-income ratio is under pressure from reduced income. Core Tier 1 capital ratio 12.4% Up from 12.2% at 31 December 2012. Robust capital position after declaring a £215m dividend, in line with our policy of paying approximately 50% of attributable earnings. The estimated Capital Requirements Directive IV ('CRD IV') end point Common Equity Tier 1 ('CET 1') Capital ratio at 30 June 2013 was 11.4%. Loan-to-deposit ratio 125% Improved four percentage points from 129% at 31 December 2012, due to strong retail and corporate deposits gathering and mortgage deleveraging. Gross mortgage lending £7.9bn Down from £8.7bn in H1 2012, but up from £5.9bn in H2 2012. Overall mortgage balances decreased due to a managed reduction in selected higher risk elements of the mortgage portfolio. 1I2I3 World >1.9m customers 600,000 customers joined the 1I2I3 World in H1 2013, including 130,800 new customers who switched their bank accounts from other providers. Lending to SMEs 12% growth We continued to build our SME franchise, with loans up 12% since H1 2012. 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 and satisfied customers: We are undertaking a commercial transformation, to put the customer at the centre of everything we do and deliver best-in-class customer experience. We are segmenting our customer base, building our new commercial model and developing products and services that are simple, personal and fair for our customers. Our key opportunity is to attract and retain loyal customers(1) by developing primary relationships with them. 2. 'Bank of Choice' for UK companies: We are building a more balanced business mix by organically growing a full service commercial bank. We are further developing our corporate banking capabilities, enhancing our products and systems and expanding our network. The Breakthrough programme continues to be a core part of this journey, providing growth capital to UK businesses. 3. Consistent profitability and strong balance sheet: We are focused on generating consistent profits supported by our commercial franchise, strong cost discipline, and prudent risk management while sustaining our strong liquidity, funding, and capital positions. (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 OVERVIEW Santander UK is transforming its business into a relationship-centred retail and commercial bank. Our first half performance shows consistent and tangible progress against our strategic objectives. Profits are rising, we have a strong balance sheet and are attracting new customers at an unprecedented rate with our successful 1|2|3 World which now has 1.9m retail customers. We continue to invest in our operational capabilities and as a result our customer service performance is steadily improving and business growth is ahead of our expectations. Our commitment to support the UK economy is demonstrated through increased SME lending - up 12% in the year - and I am proud that our support for UK SMEs via our Breakthrough programme has helped to create more than 550 jobs. Helping communities prosper through providing simple, personal, and fair banking for UK households and businesses is at the heart of our strategy and we look forward to continuing to help our customers thrive. 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 Loyal and satisfied customers http://www.rns-pdf.londonstockexchange.com/rns/7359L_4-2013-8-14.pdf The 1|2|3 World is driving our commercial transformation with innovative, personal products that put the customer at the heart of everything we do. We have grown our loyal customer base to 2.5 million and have approximately 13 million other active customers with each of whom we are working to deepen our relationship. We now have 1.9 million 1|2|3 World customers, an increase of 600,000 customers to our growing primary customer base since the year-end. In the first six months of 2013, 130,800 customers switched their bank account to Santander UK from other providers. 1|2|3 Current Account customers have 3x higher average account balances, nearly double the number of products, significantly lower attrition and a much better risk profile than non-1|2|3 customers. Customer experience is a high priority. Independent consumer surveys show improved satisfaction, with our FRS score rising to 57%. Santander UK saw a significant reduction in the gap to the top three competitor average over the last year(1). We continue to transform our branch network by optimising its geographic footprint, refurbishing our branches, and enhancing our commercial model by focusing on customers and investing in remote channels and self-service terminals to increase productivity. We are on track to achieve our 2015 targets of 4 million loyal customers and of being ranked as one of the top three banks for customer satisfaction (as measured by FRS). 2 'Bank of Choice' for UK companies http://www.rns-pdf.londonstockexchange.com/rns/7359L_5-2013-8-14.pdf Corporate Banking customer loans grew 11% in the last year, including SME-lending growth of 12%. This growth was supported by the continued expansion of our customer-facing network of 538 relationship managers in 37 Corporate Business Centres. We continued to enhance our corporate banking capabilities, our products and our systems. We developed a new model for companies with an annual turnover above £500m, served by specific sector and product capabilities, and we expect acceleration in the use of our new cash management services in the second half of the year. Our Breakthrough programme continued to gather momentum with a total of 12 deals now completed, representing £11m of growth capital investments to support the UK economy. We are on track to achieve our 2015 targets of an 8% SME market share and a Corporate Banking business loan mix share of 20% without compromising our prudent risk profile. (1) At 90% confidence interval. See page 11 for further details. 3 Consistent profitability and strong balance sheet http://www.rns-pdf.londonstockexchange.com/rns/7359L_6-2013-8-14.pdf We delivered strong results due to our diversified retail and growing corporate banking business underpinned by prudent risk management. Our profit after tax from continuing operations for the first half of 2013 was £440m, up 25% on the second half of 2012. Banking net interest margin ('Banking NIM') of 1.46% recovered to the level of the first half of 2012, supported by improved customer margins and reduced structural pressures. We maintained our focus on cost discipline as we managed increased regulatory compliance and control costs and continued to invest in the business. Our business is underpinned by strong capital ratios and prudent liquidity levels, with PRA eligible liquid assets of £35.0bn, more than 1.5x wholesale funding of less than one year. Furthermore, the PRA announced that Santander UK was not required to undertake any additional capital raising. Santander UK was one of only three banks to pass the PRA capital stress test. Return on tangible book value ('RoTBV') is expected to increase with an improved income momentum (net interest income in Q2 2013 was the highest for the last five quarters), and a low retail and corporate loan loss rate (H1 2013: 0.26% annualised). We are on track to achieve our financial targets for 2015. 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 OVERVIEW We delivered profit before tax from continuing operations of £549m and profit after tax of £440m in the first six months of 2013. This was supported by a continued recovery in net interest margin, strong cost discipline and resilient credit quality. Banking net interest margin improved slightly to 1.46% (H1 2012: 1.45%), but was much higher than in the second half of 2012 when it was 1.27%. This reflected easing structural and deposit pressures as well as stronger customer asset margins. Operating expenses continue to be well-controlled with broadly flat business as usual costs. The cost-to-income ratio of 57% (H1 2012: 51%) reflects our ongoing investment in business growth and income pressures from structural market conditions experienced in 2012 that carried through into the first half of 2013. We maintained good credit quality across the Retail Banking and Corporate Banking portfolios. Our return on tangible book value of 8.3% (H1 2012: 10.6%) decreased largely as a result of the cost of our strong capital and liquidity position. Return on tangible book value is expected to increase with an improved income momentum. Income Statement HIGHLIGHTS(1) Six months ended 30 June 2013 Six months ended 30 June 2012 £m £m Profit before tax from continuing operations 549 690 Profit after tax from continuing operations 440 524 Profit for the period 428 550 Banking net interest margin ('NIM')(2) 1.46% 1.45% Cost-to-income ratio 57% 51% Return on tangible book value ('RoTBV') 8.3% 10.6% (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 30 June 2013 31 December 2012 £bn £bn Total customer assets 191.0 194.7 Total customer deposits 150.5 148.6 Loan-to-deposit ratio(1) 125% 129% (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 30 June 2013 31 December 2012 % % Mortgage NPL ratio(1) 1.87 1.74 Corporate Banking NPL ratio(1) 3.58 4.26 Corporate Centre NPL ratio(1) 3.75 4.49 Total NPL ratio(1) 2.17 2.16 (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 30 June 2013 31 December 2012 £bn £bn Core Tier 1 Capital 9.4 9.3 Total Capital 13.9 14.0 Risk-Weighted Assets 75.4 76.5 Core Tier 1 Capital ratio 12.4% 12.2% Total Capital ratio 18.4% 18.2% CRD IV end point Common Equity Tier 1 ('CET 1') Capital ratio 11.4% 11.1% Internal leverage ratio 5.1% 5.2% CRD IV end point CET 1 leverage ratio 3.2% 3.3% 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"). STRATEGIC PRIORITY: LOYAL AND SATISFIED CUSTOMERS KPI 2015 TARGET 30.06.13 31.12.12 Loyal customers (1) 4.0 million 2.5 million 2.2 million Number of 1|2|3 World customers 4.0 million 1.9 million 1.3 million KPI 2015 TARGET 30.06.13 30.06.12 Customer satisfaction - FRS (2) Top 3 (3) 57% 53% STRATEGIC PRIORITY: 'BANK OF CHOICE' FOR UK COMPANIES KPI 2015 TARGET 30.06.13 31.12.12 SME market share 8% 5.5% 5.3% Business mix - Corporate Banking loans percentage 20% 11% 10% STRATEGIC PRIORITY: CONSISTENT PROFITABILITY AND STRONG BALANCE SHEET KPI 2015 TARGET 30.06.13 30.06.12 Cost-to-income ratio <50% 57% 51% Return on tangible book value ('RoTBV') 13% - 15%(4) 8.3% 10.6% KPI 2015 TARGET 30.06.13 31.12.12 Core Tier 1 capital ratio CET 1(5) >10.5% 12.4% 12.2% Loan-to-deposit ratio <130% 125% 129% (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: > Maintain a predictable medium-low risk profile in our business; > Employ effective and advanced risk management techniques; and > Deliver robust financial performance, and ultimately build sustainable value for all our stakeholders. 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 Risk is defined as the uncertainty around Santander UK's ability to achieve its business objectives, and specifically equates to a number of risk factors that have the potential to adversely impact on profitability. The key risk types for the Santander UK group are defined in the 2012 Annual Report. As set out in the diagram opposite, the key risk types are classified as: > Financial, and > Non-financial. 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): Capital risk Capital risk is the risk that Santander UK does not have an adequate amount, or quality of capital to meet internal and external requirements. The CRD IV regulatory capital rules in the European Union will be implemented on 1 January 2014, although the rules have not yet been finalised. This has ramifications for the level of capital we are required to hold. Areas of uncertainty over the eligibility of Tier 2 capital instruments still remain and the PRA recently applied a new regulatory Leverage Ratio test that could become a permanent capital constraint. The PRA announced the results of its UK bank capital requirements exercise in June 2013. Santander UK was not required to undertake any additional capital raising and also exceeded the PRA's 3% Common Equity Tier 1 stressed leverage threshold. The results of this exercise showed Santander UK was then the strongest and best capitalised bank in the UK. Details of Santander UK's capital management and resources are set out in Note 29 to the Condensed Consolidated Interim Financial Statements. Conduct risk Conduct risk is a key risk to Santander UK in view of the evolving regulatory environment and the requirement to make significant conduct remediation provisions. Changes have been made to specific business processes, as well as to the way the business considers, manages and reports conduct risks. Santander UK is continuing to place significant focus in seeking to ensure that customers receive the right outcome in every instance and that the necessary controls are in place to mitigate the associated risks. This has been embodied in Santander UK's approach of ensuring that its products and its dealings with customers are simple, personal and fair. See "Conduct Risk" in the Risk Management Report for more information. Details of Santander UK's provision for conduct remediation are set out in Note 21 to the Condensed Consolidated Interim Financial Statements. Further information on conduct remediation provision sensitivities is set out in "Critical accounting policies and Areas of Significant Management Judgement" in Note 1 to the Condensed Consolidated Interim Financial Statements. Credit risk Credit risk is a key risk to Santander UK as lending represents our most significant activity and because of the consequent risk of loss. Details of Santander UK's credit risk exposures (by business segment and key product), how credit risk is mitigated, higher risk loans, credit quality, arrears, non-performing loans and forbearance activities are set out in the Credit Risk sections of the Risk Management Report starting on pages 37 and 78. Information on impairment loss sensitivities is set out in "Critical Accounting Policies and Areas of Significant Management Judgement" in Note 1 to the Condensed Consolidated Interim Financial Statements. Liquidity risk Liquidity risk is the risk that Santander UK, although solvent, either does not have available sufficient financial resources to meet its obligations as they fall due, or can secure them only at excessive cost. See "Liquidity Risk" in the Risk Management Report for more information. Pension risk Pension risk is both the risk of the change in the accounting position and the risk of an unplanned increase in funding required by Santander UK's defined benefit pension schemes. Pension risk can also directly affect Santander UK's capital position. Key risk factors that affect pension risk include long term interest rates, inflation expectations, salary growth, longevity of the scheme members, investment performance as well as changes in the regulatory environment. Further information on pension obligations can be found in 'Critical Accounting Policies and Areas of Significant Management Judgement' in Note 1 and in Note 22 to the Condensed Consolidated Interim Financial Statements. Strategic risk Strategic risk is the risk of material deviations in expected/target shareholder value as a result of poor definition or implementation of Santander UK's strategy. Senior management assesses the strategic risks which might emerge as a consequence of the growth plans for Santander UK's corporate business over the next few years. Management's strategy is set out on page 5 of the Chief Executive Officer's Review. 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 30 June 2013 £m 31 December 2012 £m 31 December 2011 £m Mortgage non-performing loans ('NPLs')(1)(2) 2,849 2,719 2,434 Mortgage loans and advances to customers(2) 152,294 156,583 166,201 Mortgage impairment loan loss allowances 579 552 478 % % % NPLs ratio(3) 1.87 1.74 1.46 Coverage ratio(4) 20 20 20 (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 30 June 2013 £m 31 December 2012 £m 31 December 2011 £m Corporate Banking NPLs(1)(2)(3) 754 835 745 Corporate Banking loans and advances to customers 21,036 19,605 18,856 Corporate Banking impairment loan loss allowances 405 407 296 % % % NPLs ratio(4) 3.58 4.26 3.95 Coverage ratio(5) 54 49 40 (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 Six months ended 30 June 2013 £m Six months ended 30 June 2012(1) £m Net interest income 1,391 1,465 Non-interest income 570 654 Total operating income 1,961 2,119 Administrative expenses (992) (959) Depreciation, amortisation and impairment (121) (118) Total operating expenses excluding provisions and charges (1,113) (1,077) Impairment losses on loans and advances (235) (350) Provisions for other liabilities and charges (64) (2) Total operating provisions and charges (299) (352) Profit on continuing operations before tax 549 690 Taxation on profit on continuing operations (109) (166) Profit for the period from continuing operations 440 524 (Loss)/profit from discontinued operations after tax (12) 26 Profit for the period 428 550 (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: > Net interest income decreased by £74m to £1,391m (2012: £1,465m) mainly due to the continued impact of structural market conditions, the continued managed reduction in selected higher risk elements of the residential mortgage portfolio and higher customer deposit funding costs. This was partially offset by a higher residential mortgage stock interest margin and continued growth in Corporate Banking customer loans. In Corporate Centre, net interest income decreased by £87m as a consequence of continued low interest rates which reduced income earned on the structural hedges put in place in 2008 and 2009, and now maturing in a much lower, static rate environment. In Retail Banking, net interest income decreased by £31m, principally due to higher customer deposit funding costs and the continued managed reduction in the residential mortgage portfolio. This decrease was partially offset by increased interest income on mortgages due to more customers remaining on standard variable rate products for longer in the current low interest rate environment. In Corporate Banking, net interest income increased by £42m principally as a result of the continued growth in customer loans. Much of this growth was generated through the network of regional Corporate Business Centres which serve our SME clients. Growth in customer loans was also generated through our trade finance business with Large Corporates. Net interest income also benefitted from the impact of improving new business margins. > Non-interest income decreased by £84m to £570m (2012: £654m) principally due to a decrease of £97m in non-interest income in Markets compared to a particularly strong first half of 2012. This reflected a return to more normalised levels of market making activity with reduced corporate and institutional sales in a relatively stable, low interest rate environment. In addition, non-interest income in Corporate Banking decreased by £52m, reflecting lower ancillary fees from Large Corporates, notably as a result of lower demand for interest rate and foreign exchange risk management products. These decreases were partially offset by a £60m increase in non-interest income in Corporate Centre largely related to the £44m credit arising from the debit valuation adjustment on derivatives written by Santander UK. This adjustment was introduced in 2013, in accordance with the requirements of IFRS 13. > Administrative expenses increased by £33m to £992m (2012: £959m). The increase principally reflected the continued investment in the growth of the SME business and selective investment in growth opportunities for Large Corporates. We further developed our capacity to support our SME customers, with more customer-facing staff in our growing regional Corporate Business Centre network, as we expand into new financial centres across the UK. The increase was partially offset by effective cost control. > Depreciation, amortisation and impairment costs increased by £3m to £121m (2012: £118m). Investment in systems continued to support the business transformation and underpin future efficiency improvements. This was partially offset by the effects of deleveraging of the non-core corporate and legacy portfolios. > Impairment losses on loans and advances decreased by £115m to £235m (2012: £350m) mainly due to lower provisions on the non-core corporate and legacy portfolios but also the continued 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 (2012: £2m). This reflected an increase in restructuring provisions, partially offset by 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 UK corporation tax rate. (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 30 June 2013 Retail Banking £m Corporate Banking £m Markets £m Corporate Centre £m Total £m Net interest income/(expense) 1,382 199 (1) (189) 1,391 Non-interest income 328 137 40 65 570 Total operating income 1,710 336 39 (124) 1,961 Administration expenses (772) (147) (48) (25) (992) Depreciation, amortisation and impairment (95) (9) (1) (16) (121) Total operating expenses excluding provisions and charges (867) (156) (49) (41) (1,113) Impairment losses on loans and advances (184) (51) - - (235) Provisions for other liabilities and charges (6) - - (58) (64) Total operating provisions and charges (190) (51) - (58) (299) Profit/(loss) on continuing operations before tax 653 129 (10) (223) 549 Loss on discontinued operations after tax - - - (12) (12) 30 June 2012 Retail Banking(1) £m Corporate Banking £m Markets £m Corporate Centre(1) £m Total £m Net interest income/(expense) 1,413 157 (3) (102) 1,465 Non-interest income 323 189 137 5 654 Total operating income/(expense) 1,736 346 134 (97) 2,119 Administration expenses (763) (121) (54) (21) (959) Depreciation, amortisation and impairment (88) (7) (1) (22) (118) Total operating expenses excluding provisions and charges (851) (128) (55) (43) (1,077) Impairment losses on loans and advances (221) (56) - (73) (350) Provisions for other liabilities and charges 1 - - (3) (2) Total operating provisions and charges (220) (56) - (76) (352) Profit/(loss) on continuing operations before tax 665 162 79 (216) 690 Profit on discontinued operations after tax - - - 26 26 (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 Six months ended 30 June 2013 £m Six months ended 30 June 2012(1) £m Net interest income 1,382 1,413 Non-interest income 328 323 Total operating income 1,710 1,736 Administration expenses (772) (763) Depreciation, amortisation and impairment (95) (88) Total operating expenses excluding provisions and charges (867) (851) Impairment losses on loans and advances (184) (221) Provisions for other liabilities and charges (6) 1 Total operating provisions and charges (190) (220) Profit on continuing operations before tax 653 665 (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 30 June 2013 £bn 31 December 2012 £bn Total assets 165.1 168.3 Customer assets 159.6 164.1 Risk-weighted assets ('RWAs') 37.1 37.6 Customer deposits 126.7 127.2 Mortgage NPLs ratio(1)(2) 1.87% 1.74% Mortgage coverage ratio(1)(3) 20% 20% (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 Six months ended 30 June 2013 Six months ended 30 June 2012 Year ended 31 December 2012 Mortgage gross lending (1) £7.9bn £8.7bn £14.6bn Mortgage net lending (1) £(4.3)bn £(2.8)bn £(9.4)bn UPL gross lending £0.5bn £0.6bn £1.1bn Retail deposit flows £(0.5)bn £3.0bn £5.8bn Residential retail mortgage loans £152.3bn £163.2bn £156.6bn Unsecured personal loans ('UPLs') £2.1bn £2.6bn £2.3bn Bank account openings (2) (000's) 466 448 895 Credit card sales (000's) 279 356 618 Market share (3) Mortgage gross lending 10.6% 12.7% 10.2% Mortgage stock 12.6% 13.6% 13.0% Bank account stock(2) 9.4% 9.2% 9.3% (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: > Net interest income decreased by £31m to £1,382m in 2013 (2012: £1,413m). The key drivers of the decrease were higher customer deposit funding costs and the continued managed reduction in selected higher risk elements of the residential mortgage portfolio. The decreases were partially offset by increased interest income on mortgages due to more customers remaining on standard variable rate products for longer in the current low interest rate environment. > Non-interest income increased by £5m to £328m in 2013 (2012: £323m). The increase reflected a change to the pricing structure for current accounts, partially offset by a decrease in investment fees as we begin to operate under new regulatory rules resulting in lower volumes of business. > Administration expenses increased by £9m to £772m in 2013 (2012: £763m). The increase was driven by ongoing investment in business growth, partially offset by the consolidation of multi-branch locations. > Depreciation and amortisation expenses increased by £7m to £95m in 2013 (2012: £88m). The increase reflected continued investment in systems. > Impairment losses on loans and advances decreased by £37m to £184m in 2013 (2012: £221m). This was largely due to the reduction in impairment loss charges on unsecured products. The reduction was partly offset by an increased charge arising from the continued effect of higher levels of non-performing mortgage loans due to regulatory-driven policy and reporting changes implemented in early 2012. This effect is expected to stabilise by the end of 2014. Secured coverage was unchanged at 20%, whilst the stock of properties in possession ('PIP') decreased slightly to 867 cases (2012: 924). This level represented only 0.06% (2012: 0.06%) of the portfolio. > Provisions for other liabilities and charges increased by £7m to £6m in 2013 (2012: £(1)m). This was due to increased compliance requirements. Retail Banking balances and ratios 30 June 2013 compared to 31 December 2012 > Total assets decreased by 2% to £165.1bn in 2013 (2012: £168.3bn) driven by the decrease in customer assets described below. > Customer assets decreased by 3% to £159.6bn in 2013 (2012: £164.1bn), due to ongoing management actions to tighten the lending criteria associated with higher loan-to-value and interest-only mortgages. > Risk-weighted assets decreased by 1% to £37.1bn in 2013 (2012: £37.6bn), reflecting the decline in mortgage balances. > Customer deposits remained broadly stable at £126.7bn in 2013 (2012: £127.2bn), but with a qualitative shift towards accounts offering better customer relationships. The 1|2|3 Current Account is central to our retail customer relationship model and was the main driver of the 60% increase in current account balances from a year ago. > The mortgage NPL ratio increased to 1.87% in 2013 (2012: 1.74%) 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 stable over the last year excluding the impact of the policy and reporting changes. The NPL ratio is expected to stabilise by the end of 2014. > The mortgage coverage ratio was unchanged at 20% in 2013 (2012: 20%), with the increase in NPL offset by a corresponding increase in the loan loss allowance balance. Retail Banking business volumes Six months ended 30 June 2013 > Mortgage gross lending in the first half of 2013 was £7.9bn, equivalent to a market share of 10.6%, with £4.3bn negative net lending due to the continued managed reduction in selected elements of the residential mortgage portfolio. In particular, a 50% loan-to-value ('LTV') cap placed on new interest-only mortgages in early 2012 drove a decrease in interest-only mortgages, which continued in the first half of 2013, falling a further £3.0bn. The average LTV on new business completions in 2013 was broadly unchanged at 62% (2012: 63%). > Total gross unsecured personal lending ('UPL') in the first half of 2013 decreased by approximately 16% to £0.5bn, due to a continued focus on higher credit quality customers and competitive market pricing. The continued de-leveraging of the unsecured personal loans book resulted in an 8% reduction in the portfolio to £2.1bn (2012: £2.3bn). > Customer deposit balances were £0.5bn lower in the first half of 2013, resulting from a continued reduction in rate-sensitive deposits and a smaller cross tax year ISA campaign, reflecting our lower funding requirement. This was partially offset by growth in current account balances as a result of the continued development of the 1|2|3 Current Account launched in March 2012. > Bank account openings increased 4% to 466,000 in the first half of 2013, primarily due to the continued strong uptake of the 1|2|3 Current Account. This included 130,800 switchers from other UK banks. > Credit card sales through the Santander brand of approximately 279,000 cards (including 251,000 new 1|2|3 credit cards) increased by 6% from 262,000 in the second half of 2012, building on the 356,000 cards issued in the first half of 2012. 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 Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Net interest income 199 157 Non-interest income 137 189 Total operating income 336 346 Administration expenses (147) (121) Depreciation, amortisation and impairment (9) (7) Total operating expenses excluding provisions and charges (156) (128) Impairment losses on loans and advances (51) (56) Provisions for other liabilities and charges - - Total operating provisions and charges (51) (56) Profit on continuing operations before tax 129 162 Balances 30 June 2013 £bn 31 December 2012 £bn Total assets 49.5 35.7 Total customer assets 21.0 19.6 - of which Corporate SMEs 10.9 10.6 Risk-weighted assets 25.4 24.1 Customer deposits 13.8 12.8 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: > Net interest income increased by £42m to £199m in 2013 (2012: £157m), principally as a result of continued growth in customer loans. Much of this growth was generated through the network of regional Corporate Business Centres which serve our SME clients. Growth in customer loans was also generated through our trade finance business (invoice discounting programmes) with Large Corporates. Net interest income also benefitted from the impact of improving new business margins. > Non-interest income decreased by £52m to £137m in 2013 (2012: £189m) reflecting lower ancillary fees from Large Corporates, notably as a result of lower demand for interest rate and foreign exchange risk management products. > Administration expenses increased by £26m to £147m in 2013 (2012: £121m). The increase reflected the continued investment in the growth of the SME business and selective investment in growth opportunities for Large Corporates. We further developed our capacity to support our SME customers, with more customer-facing staff in our growing regional Corporate Business Centre network, as we expand into new financial centres across the UK. The increase was partially offset by effective cost control. > Depreciation and amortisation increased by £2m to £9m in 2013 (2012: £7m) due to the continued investment in systems to support new transactional capabilities for our customers. > Impairment losses on loans and advances decreased by £5m to £51m in 2013 (2012: £56m) with the credit quality of business written from 2009 onwards continuing to perform well, and provisions in the first half of 2013 largely related to business written before 2009. Corporate Banking balances 30 June 2013 compared to 31 December 2012 > Total assets increased by 39% to £49.5bn in 2013 (2012: £35.7bn) driven by the growth in customer assets described below and increased government securities repo activity. > Customer assets increased by 7% to £21.0bn in 2013 (2012: £19.6bn) principally as a result of continued growth in customer loans. Much of this growth was generated through the network of regional Corporate Business Centres which support our SME customers. Increased customer loans to Large Corporate clients were also generated through our trade finance business (invoice discounting programmes) in our global transactional banking services unit where we continued to develop product capabilities. Growth was also seen in credit markets acquisition finance deals with large corporate clients. > Risk-weighted assets of £25.4bn (2012: £24.1bn) increased by 5% in the first six months of 2013 due to higher lending to customers, described above. The increase in RWAs was lower than the increase in customer assets which includes the drawdown of facilities arranged in 2012. > Customer deposits increased by 8% to £13.8bn in 2013 (2012: £12.8bn) with strong inflows during the period as we continued to develop deeper relationships with our clients, following the expansion of our customer base. 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 Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Net interest expense (1) (3) Non-interest income 40 137 Total operating income 39 134 Administration expenses (48) (54) Depreciation, amortisation and impairment (1) (1) Total operating expenses excluding provisions and charges (49) (55) Provision for other liabilities and charges - - Total operating provisions and charges - - (Loss)/profit on continuing operations before tax (10) 79 Balances 30 June 2013 £bn 31 December 2012 £bn Total assets (1) 24.9 28.2 Risk-weighted assets 4.5 4.9 (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: > Net interest expense was broadly unchanged at £1m in 2013 (2012: £3m). > Non-interest income decreased by £97m to £40m in 2013 (2012: £137m), compared to a particularly strong first half of 2012. This reflected a return to more normalised levels of market making activity with reduced corporate and institutional sales in a relatively stable, low interest rate environment. > Administration expenses decreased by £6m to £48m in 2013 (2012: £54m), reflecting tight cost control partially offset by investment in developing interest rate and foreign exchange product capabilities. > Depreciation and amortisation was unchanged at £1m (2012: £1m). Markets balances 30 June 2013 compared to 31 December 2012 > Total assets comprise derivatives for fixed income and equity products. Total assets decreased by 12% to £24.9bn in 2013 (2012: £28.2bn) primarily reflecting a decrease in the fair values of interest rate derivative assets. There was a corresponding decrease in derivative liabilities. > Risk-weighted assets decreased by 8% to £4.5bn in 2013 (2012: £4.9bn) due to lower levels of trading activity. 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 Six months ended 30 June 2013 £m Six months ended 30 June 2012 (1) £m Net interest expense (189) (102) Non-interest income 65 5 Total operating expense (124) (97) Administration expenses (25) (21) Depreciation, amortisation and impairment (16) (22) Total operating expenses excluding provisions and charges (41) (43) Impairment losses on loans and advances - (73) Provision for other liabilities and charges (58) (3) Total operating provisions and charges (58) (76) Loss on continuing operations before tax (223) (216) (Loss)/profit on discontinued operations after tax (12) 26 (1) Adjusted to reflect the presentation of discontinued operations, as set out in Note 6 to the Condensed Consolidated Interim Financial Statements. Balances 30 June 2013 £m 31 December 2012 £m Total assets 58.3 60.8 Core liquid assets 35.0 36.9 Total customer assets 10.4 11.0 Risk-weighted assets 8.4 9.9 Customer deposits 10.0 8.6 Non-core assets 30 June 2013 £bn 31 December 2012 £bn Social Housing 7.4 7.5 Commercial mortgages 1.3 1.4 Shipping 0.5 0.7 Aviation 0.5 0.6 Other 0.7 0.8 Non-core customer assets 10.4 11.0 Treasury asset portfolio 1.9 1.9 Total non-core assets 12.3 12.9 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: > Net interest expense increased by £87m to £189m in 2013 (2012: £102m) as a consequence of continued low interest rates which reduced income earned on the structural hedges put in place in 2008 and 2009 and now maturing in a much lower, static environment. This has been partially offset by the same static interest rate environment reducing the costs of maintaining the liquid asset portfolio. > Non-interest income increased by £60m to £65m (2012: £5m) largely related to the £44m credit arising from the debit valuation adjustment on derivatives written by Santander UK. This adjustment was introduced in accordance with the requirements of IFRS 13. > Administration expenses increased by £4m to £25m in 2013 (2012: £21m), reflecting increased regulatory compliance and control costs, partially offset by the effects of deleveraging of the non-core corporate and legacy portfolios. > Depreciation and amortisation decreased by £6m to £16m in 2013 (2012: £22m), due to the effects of deleveraging of the non-core corporate and legacy portfolios. > Impairment losses on loans and advances in the non-core corporate and legacy portfolios declined in 2013 by £73m to £nil (2012: £73m). During the first half of 2012, provisions of £73m were required primarily as a result of increased stress in certain elements of the legacy portfolios (shipping, structured finance and real estate, as well as other legacy commercial real estate exposures written before 2009, particularly within the care home and leisure industry sectors). A further review was undertaken of the portfolio in the third quarter of 2012 and additional credit provisions raised relating to the non-core corporate and legacy portfolios. No further provisions were required in 2013. > Provision for other liabilities and charges increased by £55m to £58m in 2013 (2012: charge of £3m). The increase was principally due to a provision for restructuring, partially offset by a reassessment of the provision required to cover non-PPI retail customer remediation payments. 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 > Total assets decreased by 4% to £58.3bn (2012: £60.8bn) driven by the reduction in customer assets described below, and a decrease in core liquid assets. PRA-eligible liquid assets decreased by £1.9bn to £35.0bn (2012: £36.9bn) reflecting a reduction in government bonds held, partially offset by an increase in cash held at central banks. Balances were managed more efficiently, given stability in capital markets and as a consequence of the actions taken to strengthen the balance sheet by reducing short-term wholesale funding. Surplus liquidity was also utilised to fund maturing medium term funding. 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. > Customer assets decreased by 5% to £10.4bn in 2013 (2012: £11.0bn) due to the run down of the non-core portfolios as we successfully implemented our ongoing exit strategy from individual loans and leases. > Risk-weighted assets decreased by 15% to £8.4bn (2012: £9.9bn) due to the reduction in non-core customer assets and the completion of the deals to sell the co-brand credit cards business. > Customer deposits increased by 16% to £10.0bn in 2013 (2012: £8.6bn), reflecting deposit acquisitions at attractive margins. 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 Page Summarised condensed consolidated balance sheet ………………………………………………………………… 26 Short-term borrowings……………... ………………………………………………………………..…………………….. 28 Capital management and resources ………………………………………………………………..…………………….. 29 Liquidity and funding ………………………………………………………………………..…………………………..… 33 Interest rate sensitivity……………... ………………………………………………………………..……………………. 34 Average balance sheet……………... ………………………………………………………………..……………………. 35 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 30 June 2013 £m 31 December 2012(1) £m Assets Cash and balances at central banks 34,372 29,282 Trading assets 31,163 22,498 Derivative financial instruments 25,924 30,146 Financial assets designated at fair value 2,821 3,811 Loans and advances to banks 2,340 2,438 Loans and advances to customers 188,065 190,782 Available for sale securities 5,178 5,483 Loans and receivables securities 1,269 1,259 Macro hedge of interest rate risk 872 1,222 Property, plant and equipment 1,481 1,541 Retirement benefit assets 203 254 Tax, intangibles and other assets 4,183 4,328 Total assets 297,871 293,044 Liabilities Deposits by banks 9,242 9,935 Deposits by customers 150,878 149,037 Derivative financial instruments 23,629 28,861 Trading liabilities 34,790 21,109 Financial liabilities designated at fair value 5,277 4,002 Debt securities in issue 53,542 59,621 Subordinated liabilities 3,710 3,781 Retirement benefit obligations 460 305 Tax, other liabilities and provisions 3,483 3,444 Total liabilities 285,011 280,095 Equity Total shareholders' equity 12,860 12,949 Total equity 12,860 12,949 Total liabilities and equity 297,871 293,044 (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. Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Securities sold under repurchase agreements - Period-end balance 23,664 32,742 - Period-end interest rate 0.35% 0.46% - Average balance(1) 19,740 32,552 - Average interest rate(1) 0.39% 0.40% - Maximum balance(1) 23,664 37,621 Commercial paper - Period-end balance 4,687 3,701 - Period-end interest rate 0.47% 0.82% - Average balance(1) 4,223 3,803 - Average interest rate(1) 0.53% 0.87% - Maximum balance(1) 4,687 3,921 Borrowings from banks (Deposits by banks)(2) - Period-end balance 2,374 2,779 - Period-end interest rate 0.00% 0.71% - Average balance(1) 2,592 3,488 - Average interest rate(1) 0.03% 0.88% - Maximum balance(1) 3,401 4,910 Negotiable certificates of deposit - Period-end balance 2,336 2,054 - Period-end interest rate 1.96% 1.67% - Average balance(1) 2,299 2,345 - Average interest rate(1) 1.77% 1.73% - Maximum balance(1) 2,724 2,576 Other debt securities in issue - Period-end balance 4,661 4,548 - Period-end interest rate 2.92% 2.65% - Average balance(1) 6,578 5,283 - Average interest rate(1) 2.90% 2.64% - Maximum balance(1) 8,308 5,518 (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. 30 June 2013 £m 31 December 2012 £m Shareholders' equity: Shareholders equity per consolidated balance sheet 12,860 12,949 Preference shares (597) (597) Other equity instruments (297) (297) 11,966 12,055 Regulatory adjustments: Own credit (53) (6) Defined benefit pension adjustment (6) (164) Cash flow hedging 45 - Unrealised profits on available-for-sale securities 18 (1) Other 9 6 13 (165) Core Tier 1 deductions: Goodwill and intangible assets (2,328) (2,325) 50% of excess of regulatory expected losses over impairment (net of tax) (1) (249) (224) 50% of securitisation positions (43) (39) (2,620) (2,588) Core Tier 1 capital 9,359 9,302 Other Tier 1 capital: Preference shares 850 859 Innovative/hybrid Tier 1 securities 947 969 50% of tax benefit on excess of regulatory expected losses over impairment (1) 75 73 1,872 1,901 Total Tier 1 capital 11,231 11,203 Qualifying Tier 2 capital: Undated subordinated debt 2,184 2,199 Dated subordinated debt 602 632 Collective provisions on standardised portfolios in accordance with regulatory requirements 257 261 3,043 3,092 Tier 2 deductions: 50% of securitisation positions (43) (39) 50% of excess of regulatory expected losses over impairment (gross of tax) (1) (324) (297) (367) (336) Total regulatory capital 13,907 13,959 (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 risk 30 June 2013 £m 31 December 2012 £m Credit risk 60,906 62,034 Counterparty risk 2,146 2,243 Market risk 4,084 4,071 Operational risk 8,247 8,176 Total risk-weighted assets 75,383 76,524 Risk-weighted assets by division 30 June 2013 £bn 31 December 2012 £bn Retail Banking 37.1 37.6 Corporate Banking 25.4 24.1 Markets 4.5 4.9 Corporate Centre 8.4 9.9 Total risk-weighted assets 75.4 76.5 Risk-weighted assets by division may be further analysed as follows: 30 June 2013 31 December 2012 Balance sheet amount £bn Regulatory exposure £bn Risk weighting % Risk weighted assets £bn Balance sheet amount £bn Regulatory exposure £bn Risk weighting % Risk weighted assets £bn Retail Banking - Secured lending 152.3 161.6 14.5 23.4 156.6 164.4 14.4 23.6 - Unsecured lending 7.3 10.8 79.6 8.6 7.5 10.7 82.2 8.8 - Operational risk 5.1 5.2 Corporate Banking - Customer assets 21.0 26.3 83.5 22.0 19.6 24.6 85.8 21.1 - Non-customer assets(1) 28.5 1.4 24.1 0.3 16.0 1.3 33.8 0.4 - Market risk 1.8 1.3 - Operational risk 1.3 1.3 Markets - Credit risk 0.1 0.1 33.0 - 0.1 0.1 39.8 - - Counterparty risk 24.8 5.3 35.8 1.9 28.1 6.2 29.5 1.8 - Market risk 2.2 2.7 - Operational risk 0.4 0.4 Corporate Centre - Customer assets(2) 10.4 11.8 26.3 3.1 11.0 13.3 29.3 3.9 - Core liquid assets(3) 35.0 38.0 - - 36.9 34.8 - - - Operational risk 1.1 1.0 Intangible assets & securitisation deductions 2.3 2.4 Other assets(4) 16.2 9.5 44.2 4.2 14.8 9.8 51.0 5.0 297.9 264.8 75.4 293.0 265.2 76.5 (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: 30 June 2013 % 31 December 2012 % Core Tier 1 12.4 12.2 Total capital 18.4 18.2 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: 30 June 2013 £m 31 December 2012 £m Core Tier 1 capital Opening amount 9,302 8,861 Contribution to Core Tier 1 capital from profit for the period/year: - Consolidated profits attributable to shareholders of the Company 428 939 - Other comprehensive income for the period/year (319) (183) - Tax on comprehensive income 74 42 - Removal of own credit spread (net of tax) (47) 64 - Removal of comprehensive income available-for-sale reserves and cash flow hedging 64 - Net dividends (272) (507) Increase in goodwill and intangible assets deducted (3) (100) Pensions 158 52 Other: - Increase in securitisation positions (4) (1) - (Increase)/decrease in regulatory expected losses (25) 129 Other 3 6 Closing amount 9,359 9,302 Other Tier 1 capital Opening amount 1,901 2,637 Other: - Decrease in preference shares (9) (1) - Decrease in innovative/hybrid Tier 1 securities (22) (690) - Increase/(decrease) in tax benefit on regulatory expected losses 2 (45) Closing amount 1,872 1,901 Tier 2 capital Opening amount 2,756 4,489 Other: - Decrease in undated subordinated debt (15) (51) - Decrease in dated subordinated debt (30) (2,106) - Decrease in unrealised gains and losses on available-for-sale equity securities - (9) - (Decrease)/increase in collective provisions on standardised portfolios (4) 261 Tier 2 deductions: - Increase in securitisation positions (4) (1) - (Increase)/decrease in regulatory expected losses (27) 173 Closing amount 2,676 2,756 Total regulatory capital 13,907 13,959 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 Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Net cash inflow from operating activities 10,275 11,816 Net cash flow from/(used in) investing activities 282 (4,959) Net cash flow (used in)/from financing activities (6,824) 7,403 Net Increase in cash and cash equivalents 3,733 14,260 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. Six months ended 30 June 2013 compared to Six months ended 30 June 2012 Six months ended 30 June 2012 compared to Six months ended 30 June 2011 Total change Changes due to increase/(decrease) in Total change Changes due to increase/(decrease) in £m Volume £m Rate £m £m Volume £m Rate £m Interest income Loans and advances to banks: - UK 2 10 (8) 18 35 (17) - Non-UK 2 3 (1) (8) (19) 11 Loans and advances to customers: - UK (127) (380) 253 (213) 169 (382) - Non-UK - - - - - - Other interest earning financial assets: - UK 16 37 (21) - 20 (20) - Non-UK 1 - 1 - - - Total interest income - UK (109) (333) 224 (195) 224 (419) - Non-UK 3 3 - (8) (19) 11 (106) (330) 224 (203) 205 (408) Interest expense Deposits by banks: - UK (12) (64) 52 10 87 (77) - Non-UK - - - (4) (4) - Deposits by customers - retail demand deposits: - UK 168 39 129 149 29 120 - Non-UK (10) (6) (4) (7) (21) 14 Deposits by customers - retail time deposits: - UK (58) 46 (104) (118) (95) (23) - Non-UK (37) (72) 35 8 (3) 11 Deposits by customers - wholesale deposits: - UK 14 8 6 30 13 17 Subordinated debt: - UK 16 (53) 69 2 12 (10) - Non-UK (18) (36) 18 1 1 - Debt securities in issue: - UK (95) (101) 6 246 224 22 - Non-UK (4) 8 (12) (8) (29) 21 Other interest-bearing liabilities: - UK 4 8 (4) 4 - 4 Total interest expense - UK 37 (117) 154 323 270 53 - Non-UK (69) (106) 37 (10) (56) 46 (32) (223) 191 313 214 99 Net interest income (74) (107) 33 (516) (9) (507) AVERAGE BALANCE SHEET As period-end statements may not be representative of Santander UK's activity throughout the period, average balance sheets for Santander UK are presented below. The average balance sheets summarise the significant categories of assets and liabilities, together with average interest rates. Six months ended 30 June 2013 Six months ended 30 June 2012 Average Balance(1) £m Interest(4, 5) £m Average rate % Average Balance(1) £m Interest(4, 5) £m Average rate % Assets Loans and advances to banks: - UK 29,770 70 0.47 27,806 68 0.49 - Non-UK 4,862 8 0.33 3,863 6 0.31 Loans and advances to customers:(3) - UK 190,736 3,506 3.68 201,263 3,633 3.61 - Non-UK 6 - 8.94 7 - 2.90 Other interest earning financial assets: - UK 6,143 39 1.27 3,404 23 1.35 -Non-UK 289 1 0.69 Total average interest-earning assets, interest income(2) 231,806 3,624 3.13 236,343 3,730 3.16 Impairment loss allowances (1,792) - - (1,591) - - Trading business 26,320 - - 27,700 - - Assets designated at fair value through profit and loss 3,507 - - 4,848 - - Other non-interest-earning assets 41,621 - - 42,412 - - Total average assets 301,462 - - 309,712 - - Non-UK assets as a % of total 1.71% - - 1.25% - - Liabilities Deposits by banks: - UK (9,052) (84) 1.86 (13,570) (96) 1.41 - Non-UK (2) - - (128) - - Deposits by customers - retail demand: - UK (74,472) (947) 2.54 (72,644) (779) 2.14 - Non-UK (1,262) (11) 1.74 (1,468) (21) 2.86 Deposits by customers - retail time: - UK (49,419) (299) 1.21 (46,442) (357) 1.54 - Non-UK (3,549) (46) 2.59 (6,270) (83) 2.65 Deposits by customers - wholesale: - UK (22,148) (177) 1.60 (21,603) (163) 1.51 Bonds and medium-term notes: - UK (51,720) (554) 2.14 (56,094) (649) 2.31 - Non-UK (4,357) (11) 0.50 (3,415) (15) 0.88 Dated and undated subordinated liabilities: - UK (3,539) (84) 4.75 (5,824) (68) 2.34 - Non-UK (243) (11) 9.05 (643) (29) 9.02 Other interest-bearing liabilities UK (324) (9) 5.56 (176) (5) 4.52 Total average interest-bearing liabilities, interest expense(2) (220,087) (2,233) 2.03 (228,277) (2,265) 1.98 Trading business (31,460) - - (30,499) - - Liabilities designated at fair value through profit and loss (4,902) - - (5,226) - - Non-interest-bearing liabilities: - Other (31,921) - - (32,713) - - - Shareholders' funds (13,092) - - (12,997) - - Total average liabilities and shareholders' funds (301,462) - - (309,712) - - Non-UK liabilities as a % of total 3.12% - - 3.85% - - (1) Average balances are based upon monthly data. (2) The ratio of average interest-earning assets to interest-bearing liabilities for the six months ended 30 June 2013 was 105.32% (Six months ended 30 June 2012: 103.53%). (3) Loans and advances to customers include non-performing loans. See the "Credit Risk" section of the Risk Management Report. (4) The net interest margin for the six months ended 30 June 2013 was 1.20% (Six months ended 30 June 2012: 1.24%). Net interest margin is calculated as annualised net interest income divided by average interest earning assets. This differs from the Banking Net Interest Margin, discussed on page 7, which is calculated as annualised net interest income divided by average commercial assets (including mortgages, unsecured personal loans, corporate loans and overdrafts). (5) The interest spread for the six months ended 30 June 2013 was 1.10% (Six months ended 30 June 2012: 1.17%). Interest spread is the difference between the rate of interest earned on average interest-earning assets and the rate of interest paid on average interest-bearing liabilities. Risk Management Report THE RISK MANAGEMENT REPORT This Risk Management Report contains information that forms an integral part of the Condensed Consolidated Interim Financial Statements. The information on pages 36 to 95 is within the scope of the review report of Deloitte LLP except for those items marked as unreviewed. The Risk Management Report consists of: > A description of Santander UK's approach to the management of risk, including its Risk Framework; and > Further detail on Santander UK's key risks, with separate discussions of: > Financial risks; and > Non-financial risks. This Risk Management Report focuses on those areas that have changed significantly during the first half of 2013, and represents an update to the Risk Management Report in the 2012 Annual Report, with which it should be read in conjunction. The Risk Management Report in the 2012 Annual Report contains more detailed narrative explanations on the framework, methodologies and processes used which were unchanged during the first half of 2013. INDEX Page RISK MANAGEMENT (unreviewed) > Introduction ………………………………………………………………………………………………………… 37 > Risk framework ……………………………………………………………………………………………………… 37 FINANCIAL RISKS > Credit Risk……….. …………………………………………………………………………………………………… 37 > Retail Banking …………………………….…….…………………………………………….………… 38 > Corporate Banking…………………………….…….………………………………………..………… 51 > Markets …..…………………………….…….……………………………………………….………… 58 > Corporate Centre …………………………….…….…………………………………………………… 60 > Market Risk…………………………………………………………………………………………………………… 65 > Traded market risk ……………………….…….……….…………………………………………… 66 > Structural Risk………………………………………………………………………………………………………… 68 > Non-traded market risk …………………. ………………………………………………………… 68 > Liquidity and funding risk……………………………………………………………………………. 69 NON-FINANCIAL RISKS (unreviewed) > Conduct Risk………….….…………………………………………………………………………………………… 73 > Operational Risk ………. .……………….…….…………………………………………………………………… 74 > Other Risks ……………..……………….…….……………………………………………………………………… 76 ADDITIONAL FINANCIAL RISK DISCLOSURES > Credit Risk - Areas of focus and other items………………………………………………………………... 78 > Country risk exposure.............................................................................................................. 78 > Peripheral eurozone countries………………………………………………………… 83 > Balances with other Banco Santander group companies……………………………. 85 > Redenomination risk………………………………………………………………………. 89 > Loans and advances……………………………………………………………………………………. 90 > Impairment loss allowances on loans and advances to customers and non-performing loans…… 95 RISK MANAGEMENT Introduction (unreviewed) 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. Santander UKaims to employ a prudent approach and advanced risk management techniques to facilitate the delivery of robust financial performance, and ultimately build sustainable value for all our stakeholders, including our staff, customers, fixed income investors, shareholders and the communities in which we operate. Santander UK aims to maintain a predictable medium-low risk profile, consistent with its business model, which is key to the successful achievement of our strategic objectives set out in the 2012 Annual Report. Risk framework (unreviewed) During 2012, the Board approved a new Risk Framework, setting out enhancements to the management, control and oversight of all risk types in Santander UK. The Risk Framework aims to continue to ensure that risk is managed and controlled on behalf of all our stakeholders. There were no changes to the Risk Framework during the first half of 2013. The key components of this framework include: > Risk definition and structure; > Core principles; > Governance, roles and responsibilities; and > Systems of internal control. Refer to the 2012 Annual Report for full details of the Risk Framework. FINANCIAL RISKS CREDIT RISK INTRODUCTION Credit risk is the risk of financial loss arising from the default or credit quality deterioration of a customer or counterparty to which Santander UK has directly provided credit, or for which Santander UK has assumed a financial obligation. Refer to the 2012 Annual Report for full details of credit risk classification and measurement across the credit cycle which are unchanged during 2013. Approach to forbearance To support customers that encounter actual or apparent financial difficulties, Santander UK may enter into forbearance arrangements (previously described as restructuring/refinancing). Forbearance arrangements include the granting of temporary or permanent concessions to customers to amend contractual payment amounts or timings. These are made where a customer's financial position indicates the possibility that satisfactory repayment may not be made within the original terms and conditions of the contract but where analysis suggests that repayment is possible based on revised terms of the loan. A range of forbearance strategies are employed in order to improve the management of customer relationships, maximise collection opportunities and, if possible, avoid foreclosure or repossession. Santander UK's policies and practices are based on criteria which, in the judgement of management, indicate that repayment is likely to continue and that after the initial period of financial difficulties the customer can revert to the previous terms, with appropriate support where necessary. These agreements may be initiated by the customer, Santander UK or by a third party. Further detail on the approaches and extent of forbearance in each business segment is set out in the subsequent sections of this report. There have been no changes to the definition of forbearance (previously described as restructuring/refinancing in NPL) during the period. CREDIT RISK - RETAIL BANKING INTRODUCTION 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. Credit risk is the risk of financial loss arising from the default of a customer or counterparty to which Santander UK has directly provided credit, or for which Santander UK has assumed a financial obligation, after realising collateral held. This section sets out further detail on credit risk in Retail Banking as follows: > Customer assets; > Residential mortgages: > Managing credit risk; > Higher risk loans; > Credit quality and credit risk mitigation; > Arrears, including non-performing loans; > Forbearance; and > Litigation and recovery. > Banking and consumer credit; > Finance leases; and > Non-performing loans and advances, and forbearance. Tables within this section have been adjusted, where appropriate, to reflect the presentation of discontinued operations, as set out in Note 6 to the Condensed Consolidated Interim Financial Statements. MANAGEMENT'S APPROACH TO CREDIT RISK IN RETAIL BANKING Management's approach to credit risk in Retail Banking has not changed during 2013. For further details refer to page 80 of the 2012 Annual Report. RETAIL BANKING - CUSTOMER ASSETS An analysis of Retail Banking customer assets is presented below. 30 June 2013 £bn 31 December 2012 £bn Advances secured on residential properties(1) 152.3 156.6 Unsecured loans: - Overdrafts(2) 0.5 0.5 - Unsecured lending(2) 2.2 2.3 - Credit cards (2) (4) 1.5 1.4 Finance leases(3) 2.0 1.9 Other loans 1.1 1.4 Total 159.6 164.1 (1) Excludes loans to UK Social Housing associations, which are managed within Corporate Banking and Corporate Centre, accrued interest and other items. (2) Overdrafts, UPLs and other loans relating to cards are disclosed within unsecured loans and other loans. (3) Additional finance leases of £1.1bn (31 December 2012: £1.1bn) are managed and classified within Corporate Banking. (4) Adjusted to reflect the removal of the assets presented as held for sale prior to the completion of the sale as set out in Note 6 to the Condensed Consolidated Interim Financial Statements. RESIDENTIAL MORTGAGES Retail Banking grants mortgage loans for house purchases as well as home improvement loans to new and existing mortgage customers. The property on which the mortgage is secured must always be located within the UK regardless of the destination of the funds. Geographically, whilst Santander UK has a diverse footprint across the UK, our mortgage exposure is more prevalent in Greater London and Southeast England, representing approximately 50% by value of the total book. Regional house price indices continued to show robust property values in certain areas. RESIDENTIAL MORTGAGE LENDING(1) An analysis of movements in Retail Banking mortgage balances is presented below. 30 June 2013 £bn 31 December 2012 £bn 30 June 2012 £bn At 1 January 156.6 166.2 166.2 Gross mortgage lending in the period/year 7.9 14.4 8.6 Redemptions and repayments in the period/year (12.2) (24.0) (11.6) At 30 June / 31 December 152.3 156.6 163.2 (1) Excludes loans to UK Social Housing associations, which are managed in Corporate Banking and Corporate Centre and accrued interest. HIGHER RISK LOANS Santander UK is principally a retail prime lender and does not originate sub-prime or second charge mortgages, or lend on original LTV of over 90% (except in support of UK Government mortgage schemes to a maximum LTV of 95%).The portfolio's arrears performance has continued to be relatively stable with arrears and loss rates remaining low. Nonetheless, there are some mortgage types that present higher risks than others. These products consist of: > Interest-only mortgages; > Flexible loans; > Loans with loan-to-value >100%; and > Buy-to-let loans. PRODUCT DESCRIPTION Interest-only Performance of interest-only mortgages While the risks with respect to interest-only mortgages are higher than capital repayment mortgages, they are only modestly so. The performance of this significant sub-portfolio has been below that of our standard capital repayment mortgage sub-portfolio, but in line with expectations, as described on pages 42 to 45. On maturity of interest-only mortgages, a significant majority are repaid in full. The remaining mortgages are forborne, with only a small proportion remaining as interest-only. In addition, there are loans which have been forborne as interest-only loans as part of our forbearance strategy for customers in financial difficulty. Accordingly, the performance of these mortgages is significantly worse than other interest-only mortgages. Forbearance of interest-only mortgages For interest-only mortgages that are performing prior to maturity, the Santander UK group may offer the facility to convert to a standard capital repayment mortgage. For interest-only mortgages that are in arrears or where the customer is up-to-date but has indicated that they are experiencing financial difficulties, the most likely option is a reduced payment arrangement. Such agreements are typically for only a short-term duration, not exceeding 12 months. For interest-only mortgages reaching maturity, Santander UK may consider a range of options subject to an affordability assessment (i.e. evidence that the customer has the financial resources available to meet the proposed payments). These options can include conversion to a standard capital repayment mortgage or temporarily extending the maturity of the loan in order to reach a solution, such as to allow the sale of the property or await the maturity of a repayment vehicle. At 30 June 2013, 37% (2012: 31%) of loans which enter forbearance were originally an interest-only mortgage. Whilst the inflows of forbearance decreased across all forbearance types in the first half of 2013 compared to 2012, the change in the mix of forbearance changed, increasing the proportion of accounts that were originally interest-only. In the first half of 2013, a lower proportion of new forbearance arose from interest-only conversions and higher proportion arose from forbearance to interest-only accounts at maturity compared to 2012. > Flexible loans Performance of flexible loans While the risks with respect to flexible loans can be higher than more traditional capital repayment mortgage loans, the performance of this significant sub-portfolio has been stable and has exhibited a lower level of defaults than Santander UK's other mortgage loans. Typically, in each month of 2013, less than 1% (2012: less than 1%) of flexible loan customers will have taken a payment holiday and approximately 1.0% (2012: 0.8%) of flexible loan customers are categorised as NPL. > Loans with loan-to-value >100% Since 2009, progressively stricter lending criteria have been applied to mortgages at LTVs above 75%. Since 2009, no loans were made with a loan-to-value of more than 100%. In the first half of 2013, 0.7% of new secured loan advances were made with a loan-to-value of more than 90% (0.3% in 2012 and less than 0.1% prior to this) with the introduction of the UK Government-backed New Buy scheme. This is a guarantee scheme that aims to help buyers who have a deposit of at least 5% to buy a new-build home, designed to help more borrowers to secure up to a 95% loan-to-value mortgage on new-build properties (houses and flats) from participating builders in England. > Buy-to-let In December 2011, Santander UK re-entered the buy-to-let market via the intermediary channel only, targeting new or small volume investor landlords. The buy-to-let proposition has its own suite of policies against which every application is manually assessed by an underwriter unless it is declined by an automated system decision, and the general principle behind the proposition is that it is self-financing. Buy-to-let mortgages accounted for only 2.7% by value of new mortgages during 2013 (2012: 1.4%). The increase reflected the market trend in the growth of the buy-to-let market. Mortgage credit quality and credit risk mitigation Loan-to-value analysis(1) (2) Six months ended 30 June 2013 Year ended 31 December 2012 % % New business Up to 60% 37 29 >60% - 75% 37 37 >75% - 85% 17 22 >85% - 90% 8 11 >90% - 100% 1 1 100 100 Simple average(3) loan-to-value of new business (at inception) 62 63 Value weighted average(4) loan-to-value of new business (at inception) 57 59 30 June 2013 % 31 December 2012 % Stock Up to 60% 40 39 >60% - 75% 27 27 >75% - 85% 16 16 >85% - 90% 6 6 >90% - 100% 6 7 >100% i.e. negative equity 5 5 100 100 Simple average loan-to-value of stock (indexed) 52 52 Value weighted average loan-to-value of stock (indexed) 48 49 Simple average loan-to-value of impaired loans (indexed) 64 64 Value weighted average loan-to-value of impaired loans (indexed) 61 62 Simple average loan-to-value of unimpaired loans (indexed) 52 52 Value weighted average loan-to-value of unimpaired loans (indexed) 48 48 (1) Excludes any fees added to the loan, and only includes the drawn loan amount, not drawdown limits. (2) Based on HPI indexed values or the results of automated valuation modelling, as appropriate. (3) Unweighted average of loan-to-value of all accounts. (4) Sum of all loan values divided by sum of all valuations. 30 June 2013 compared to 31 December 2012 During the first half of 2013, the percentage of new business with an LTV of greater than 75% decreased from 34% to 26%, reflecting continued emphasis on rebalancing the LTV mix. Similarly, the average LTV on all completions decreased from 63% to 62%. The value weighted average LTV (calculated by taking the sum of all loan amounts and dividing by the sum of all the valuations) is lower than the simple average at 57% (2012: 59%). At 30 June 2013, 5% of the retail mortgage portfolio was over 100% LTV. This was unchanged from 2012 due to relatively stable house prices across the country as a whole. Consistent with this, the percentage of the portfolio with a >90%-100% LTV decreased slightly to 6% (2012: 7%), while the percentage of the portfolio with >75% - 85% and >85% - 90% LTVs were unchanged from 2012. At 30 June 2013, the simple average indexed stock LTV remained unchanged at 52%, and the value weighted average LTV reduced slightly to 48% (2012: 49%). The simple average LTV of impaired loans was unchanged at 64%. Interest rate structure 30 June 2013 31 December 2012 £m % £m % Stock Term product- fixed rate 52,353 35 52,583 34 Term product - tracker 12,273 8 17,390 11 Standard variable rate ('SVR') 53,325 35 51,419 33 Base rate linked 15,264 10 15,957 10 Flexi(1) 16,646 11 16,894 11 Buy-to-let 2,171 1 2,056 1 Other 262 - 284 - 152,294 100 156,583 100 (1) In addition, there were £8,315m (2012: £9,348m) of legacy Alliance & Leicester flexible loan products included in other categories as the product functionality is more limited than the current Santander UK flexi loan product. 30 June 2013 compared to 31 December 2012 During the first half of 2013, the reduction in incentive tracker balances was due to loans coming to the end of the incentive period, with new loans largely on fixed rates. Borrower profile(1) Six months ended 30 June 2013 Year ended 31 December 2012 £m % £m % New business First-time buyers 1,586 20 3,013 23 Home movers 3,886 49 7,059 54 Remortgagers 2,458 31 2,964 23 7,930 100 13,036 100 Of which:(2) - Full interest-only loans 1,019 13 2,435 19 - Part interest-only, part repayment loans 608 8 274 2 - Flexi loans 998 13 1,778 14 - Loans with original LTV >100% - - - - - Buy-to-let 196 2 210 2 30 June 2013 31 December 2012 £m % £m % Stock First-time buyers 29,152 19 29,744 19 Home movers 64,079 42 65,355 42 Remortgagers 58,183 38 60,509 38 Other 880 1 975 1 152,294 100 156,583 100 Of which: (2) - Full interest-only loans 52,775 35 55,422 36 - Part interest-only, part repayment loans 16,011 11 16,783 11 - Flexi loans 16,646 11 16,894 11 - Other flexible loans(3) 8,315 6 9,348 6 - Loans with original LTV >100% 372 - 386 - - Buy-to-let 2,171 1 2,056 1 (1) Excludes any fees added to the loan, and only includes the drawn loan amount, not drawdown limits. (2) Where a loan exhibits more than one of the higher risk criteria, it is included in all the applicable categories. (3) Legacy Alliance & Leicester flexible loan products with more limited functionality than the current Santander UK flexi loan product. 30 June 2013 compared to 31 December 2012 During the first half of 2013, pricing strategies increased the proportion of new business with remortgagers from 23% to 31%, more in line with historic levels and the market. Consequently, the proportion of lending to first-time buyers and home movers decreased. Following LTV restrictions implemented in 2012, the proportion of new interest-only lending remained low compared to historic levels. In addition, the decision was taken to reduce the percentage of new business flexible loans which has now decreased to 8% (2012: 14%). Further, the percentage of new mortgages that were both interest-only and flexible decreased to 2.5% (2012: 5.3%) again reflecting business strategy. The percentage of the mortgage stock that is both interest-only and flexible remained broadly unchanged at 9.9% (2012: 10.0%). Mortgages - Arrears The following table analyses mortgage arrears status at 30 June 2013 and 31 December 2012 by volume and value. 30 June 2013 31 December 2012 Volume '000 Value(1) £m Volume '000 Value(1) £m Performing 1,423 146,723 1,468 151,084 Early arrears(2) 25 2,661 26 2,733 Late arrears(3) 26 2,781 26 2,638 Properties in possession 1 129 1 128 1,475 152,294 1,521 156,583 (1) Excludes accrued interest. (2) Early arrears refer to mortgages that are typically between 31 days and 90 days in arrears. (3) Late arrears refer to mortgages that are typically over 90 days in arrears. 30 June 2013 compared to 31 December 2012 During the first half of 2013, arrears levels increased slightly by £71m or 1% to £5,442m (2012: £5,371m) primarily due to regulatory-driven policy and reporting changes implemented in early 2012. These changes resulted in a tightening of forbearance policies leading to an increase in arrears stock. The following table shows mortgage arrears by volume of accounts (separately for higher risk loans and the remaining loan portfolio) at 30 June 2013 and 31 December 2012. Higher risk loans Interest-only Flexible Original LTV>100% Buy-to-let Remaining portfolio Total (Percentage of total mortgage loans by number) % % % % % % 31 to 60 days in arrears: 31 December 2012 0.49 0.07 - 0.01 0.53 1.10 30 June 2013 0.45 0.07 - 0.01 0.50 1.04 61 to 90 days in arrears: 31 December 2012 0.28 0.04 - - 0.32 0.63 30 June 2013 0.31 0.05 - - 0.33 0.67 3 to 6 months in arrears: 31 December 2012 0.43 0.06 - 0.01 0.41 0.89 30 June 2013 0.48 0.07 - 0.01 0.45 0.97 6 to 12 months in arrears: 31 December 2012 0.25 0.04 - - 0.20 0.50 30 June 2013 0.26 0.05 - - 0.22 0.52 Over 12 months in arrears: 31 December 2012 0.14 0.03 - - 0.09 0.29 30 June 2013 0.15 0.03 - - 0.10 0.30 (1) Where a loan exhibits more than one of the higher risk criteria, it is included in all the applicable categories. As a result, the total of the mortgage arrears for higher risk loans and remaining loan portfolio will not agree to the total mortgage arrears percentages. (2) Interest-only loan segment contains both full interest-only and part-interest-only loans as both of these are considered to be higher risk. 30 June 2013 compared to 31 December 2012 During the first half of 2013, early arrears rates decreased for interest-only mortgages following tightening of new business policy in 2012, but increased slightly across most other categories, in line with expectations. Ongoing de-leveraging and process changes in Collection & Recoveries continued to, and will continue to, contribute to arrears rate trends over the short to medium term. Accounts that are in early arrears (31-90 days) and have a bankruptcy indicator are considered to be NPLs, but for the purposes of the table above these accounts remained in their actual arrears category. Mortgages - Non-performing loans and advances ('NPLs') (1) (2) 30 June 2013 £m 31 December 2012 £m Mortgage NPLs - impaired(3) 770 727 Mortgage NPLs - not impaired 2,079 1,992 Mortgage NPLs 2,849 2,719 Mortgage loans and advances to customers 152,294 156,583 Mortgage impairment loan loss allowances 579 552 % % NPLs ratio(4) 1.87 1.74 Coverage ratio(5) 20 20 (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) NPLs against which an impairment loss allowance has been established. (4) Mortgage NPLs as a percentage of mortgage loans and advances to customers (5) Impairment loan loss allowances as a percentage of NPLs. 30 June 2013 compared to 31 December 2012 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%). At 30 June 2013, the mortgage NPLs balance of £2,849m (2012: £2,719m) included £497m (2012: £356m) arising from the regulatory-driven policy and reporting changes referred to above. Mortgages - NPLs by higher risk loan type(1) 30 June 2013 £m 31 December 2012 £m Total mortgages NPLs 2,849 2,719 Of which: - Interest only loans 1,805 1,736 - Flexi loans 262 232 - Loans with original LTV > 100% 12 13 - Buy-to-let 23 23 (1) Where a loan exhibits more than one of the higher risk criteria, it is included in all the applicable categories. 30 June 2013 compared to 31 December 2012 The additional NPLs arose from interest-only cases past maturity, where the mortgage, or part of the mortgage, was outstanding. This increase reflected the growing number of such cases reaching maturity. FORBEARANCE - MORTGAGES Forbearance on mortgage accounts occurs where the business grants a temporary or permanent concession of contractually agreed terms and conditions to a borrower who has been identified as being in financial difficulty. The aim of this concession is to bring the account back on to sustainable terms where the mortgage can be fully serviced over its lifetime. Concessions are only granted where the customer is able to meet contractual interest payments. In certain limited circumstances, it may be possible for a customer to have their loan forborne more than once. However, the impairment loss allowance on these accounts is calculated based on their highest arrears status in the forbearance period, just by reference to the original contractual terms. The factors considered when concluding whether a borrower is experiencing financial difficulties can include significant changes in economic circumstances such as the loss of income or employment, and significant changes in personal circumstances such as divorce. A range of forbearance strategies are employed in order to improve the management of customer relationships, maximise collection opportunities and, if possible, avoid foreclosure or repossession. In the retail portfolios, forbearance strategies can include approved debt counselling plans, payment arrangements, capitalisation, term extensions and switches from capital and interest repayments to interest-only payments. Santander UK's policies and practices are based on criteria which, in the judgement of management, indicate that repayment is likely to continue and that after the initial period of financial difficulties the customer can revert to the previous terms, with appropriate support where necessary. These agreements may be initiated by the customer, by Santander UK or by a third party. Debt management strategies, which include affordability assessment, use of collection tools, negotiation of appropriate repayment arrangements and debt counselling, can start prior to actual payment default or as early as the day after a repayment is past due and can continue until legal action. Different collection strategies are applied to different segments of the portfolio subject to the perceived levels of risk. Many of these accounts remain in the performing portfolio but are separately reported and subject to higher provisioning rates. Once forbearance activity has been carried out, the account will exit the forbearance state once sustainability has been evidenced and no incremental material maturity risk has resulted from the forbearance activity. The aim of this concession is to bring the account back onto sustainable terms where the mortgage can be fully serviced over its lifetime. Outstanding arrears can be added to the loan balance to be repaid over the remaining loan term. This is known as capitalisation, and can be offered to borrowers under the forms of payment arrangements and refinancing (either a term extension or an interest only concession). Term extensions, interest-only conversions and capitalisations, excluding those where a party to the mortgage is deceased, are only granted due to financial difficulties and are reported as forbearance. There are other loan modifications that have been carried out historically, however these are not included as forbearance as there was no financial difficulty evident at the time of modification and the majority of those modified subsequently continue to perform satisfactorily. ACTION DESCRIPTION > Payment arrangements Discretion exists to vary the repayment schedule to allow customers to bring the account up to date. The objective is to bring the account up to date as soon as possible. > Refinancing Collections & Recoveries may offer to pay off an existing mortgage and replace it with a new one, only to accounts in arrears or with significant financial difficulties or if a customer is up to date but states they are experiencing financial difficulties. Alternatively, Collections & Recoveries may offer a term extension or interest only concession. The eligibility criteria for restructuring/refinancing are: (i) If the account is at least one instalment in arrears; or (ii) If the customer has been consistently underpaying their instalment; or (iii) If the customer claims a medium-term temporary change in financial circumstances has caused financial difficulties. > Term extensions The repayment period/program may be extended to reduce monthly repayments if all other collections tools have been exhausted. Customers may be offered a term extension where they are up-to-date but showing evidence of financial difficulties, or are already in the Collections & Recoveries process. The term can be extended to no more than 40 years and the customer must be no more than 75 years old at the end of the revised term of the mortgage. > Interest-only concessions The monthly repayment may be reduced to interest payment only with capital repayment deferred if all other collections tools have been exhausted and a term extension is either not possible or affordable. Customers may be offered an interest only concession where they are up-to-date but showing evidence of financial difficulties, or are already in the Collections & Recoveries process. Interest only concessions are offered up to a two year maximum period, after which a review is carried out. The expectation is that the customer will return to repayment on a capital and interest basis after the expiry of this concession. Agreements are made through the use of a data driven tool including such factors as affordability and customer indebtedness. Periodic reviews of the customer financial situation are undertaken to assess when the customer can afford to return to the repayment method. > Capitalisations The customer's arrears may be capitalised and added to the mortgage balance where the customer is consistently repaying the agreed monthly amounts (typically for a minimum period of 6 months) but where they are unable to increase repayments to repay these arrears over a reasonable period. Term extensions and interest-only concessions can be combined with capitalisation. Forbearance commenced during the period(1) (2) (3) The incidence of the main types of mortgage forbearance arrangements described above which commenced during the six months ended 30 June 2013 and the year ended 31 December 2012 was: 30 June 2013 30 June 2013 31 December 2012 31 December 2012 £m % of loans by value £m % of loans by value Capitalisation 37 16 147 21 Term extensions 131 58 355 49 Interest only concessions 59 26 219 30 227 100 721 100 Of which(4): - Interest only loans(5) 137 60 337 47 - Flexi loans 32 14 132 18 - Loans with original LTV >100% 1 - 1 - - Buy-to-let 2 1 5 1 (1) All mortgages originated by Santander UK are first charge. (2) Mortgages are included within the year that they were forborne. (3) The figures by year reflect the amount of forbearance activity undertaken during the year irrespective of whether any forbearance activity has previously been undertaken on the forborne accounts. (4) Where a loan exhibits more than one of the higher risk criteria, it is included in all the applicable categories. (5) Only loans which are fully interest-only are included. Forbearance cumulative number and value of accounts a) Payment status when entering forbearance The status of the cumulative number of accounts in forbearance at 30 June 2013 when they originally entered forbearance, analysed by type of forbearance applied, was: 30 June 2013(1) Interest only Term extension Capitalisation Total No. £m No. £m No. £m No. £m Forbearance of NPL 3,166 332 1,100 77 3,233 281 7,499 690 Forbearance of Non-NPL 10,218 1,104 20,059 956 15,206 1,474 45,483 3,534 Total 13,384 1,436 21,159 1,033 18,439 1,755 52,982 4,224 31 December 2012(1) Interest only Term extension Capitalisation Total No. £m No. £m No. £m No. £m Forbearance of NPL (2) 3,227 341 1,057 78 3,219 280 7,503 699 Forbearance of Non-NPL (3) 10,390 1,131 19,440 953 14,878 1,466 44,708 3,550 Total 13,617 1,472 20,497 1,031 18,097 1,746 52,211 4,249 (1) Forbearance type categorisation is based on the first forbearance activity undertaken on the accounts. Tables contain only open accounts at the end of the year. (2) Previously described as Restructuring/refinancing in NPL. (3) Previously described as Other restructuring/refinancing. b) Payment status at the period-end The current status of accounts in forbearance analysed by type of forbearance applied at 30 June 2013 and 31 December 2012 was: 30 June 2013(1) Interest only Term extension Capitalisation Total Impairment allowance No. £m No. £m No. £m No. £m £m In arrears 4,834 540 2,565 198 5,796 544 13,195 1,282 68 Performing 8,550 896 18,594 835 12,643 1,211 39,787 2,942 67 Total 13,384 1,436 21,159 1,033 18,439 1,755 52,982 4,224 135 Proportion of portfolio 0.9% 0.9% 1.4% 0.7% 1.3% 1.2% 3.6% 2.8% - 31 December 2012(1) Interest only Term extension Capitalisation Total Impairment allowance No. £m No. £m No. £m No. £m £m In arrears 5,005 555 2,627 206 5,527 514 13,159 1,275 68 Performing 8,612 917 17,870 825 12,570 1,232 39,052 2,974 51 Total 13,617 1,472 20,497 1,031 18,097 1,746 52,211 4,249 119 Proportion of portfolio 0.9% 0.9% 1.4% 0.7% 1.2% 1.1% 3.4% 2.7% - (1) Forbearance type categorisation is based on the first forbearance activity undertaken on the accounts. Tables contain only open accounts at the end of the period. 30 June 2013 compared to 31 December 2012 The incidence of forbearance commencing in the period reduced following a tightening of forbearance policies, primarily due to regulatory-driven policy and reporting changes implemented in early 2012. At 30 June 2013, the stock of mortgage accounts that had either had their term extended or converted to interest-only was broadly unchanged and amounted to less than 3% of all mortgage accounts, both by number and value (2012: less than 3%). Levels of adherence to revised payment terms agreed under Santander UK's forbearance arrangements stabilised during the first half of 2013, in line with the rate seen during 2012 at approximately 66% by value (2012: 67%) and 75% by volume (2012: 75% by volume) of the accounts in forbearance. When forbearance activities began, only 58% (2012: 58%) of these accounts, including other accounts that were in early arrears (rather than in NPL) when they entered forbearance, were performing in accordance with the original contractual terms. The improvement in the percentage of accounts performing supports Santander UK's view that its forbearance arrangements provide an important tool to improve the prospects of recovery of amounts owed. In addition, it is likely that some of the accounts which were in early arrears at the time of the initial forbearance would have otherwise deteriorated into NPL. A customer's ability to adhere to any revised terms agreed is an indicator of the sustainability of Santander UK's forbearance arrangements. At 30 June 2013, the proportion of accounts that had been in forbearance for more than six months that had made their last six months' contractual payments improved slightly to 80% (2012: 77%). Furthermore, the accounts in forbearance classified as performing remained stable at just under £3.0bn or 70% by value (2012: £3.0bn or 70% by value). The weighted average LTV of all accounts in forbearance was 42.7% (2012: 43.5%) compared to the weighted average portfolio LTV of 48.1% (2012: 48.5%). Those accounts that reach the end of the concessionary forbearance period continue to show a good propensity to return to full repayments in accordance with the original contractual terms after the period of financial difficulty has passed. At 30 June 2013, impairment loss allowances as a percentage of the balance of accounts for the overall mortgage portfolio was 0.38% (2012: 0.35%). The equivalent ratio for accounts in forbearance which were performing was 2.28% (2012: 1.71%), and for accounts in forbearance which were in arrears was 5.30% (2012: 5.33%). The higher ratios for accounts in forbearance reflected the higher levels of impairment loss allowances held, as a result of the higher risk characteristics inherent in such accounts. c) Performing accounts by duration of forbearance activities The tables below provide a further analysis of the accounts in forbearance at 30 June 2013 and 31 December 2012 that are classified as performing by length of time since they entered forbearance. 30 June 2013 - Values 0 to 6 months > 6 to 12 months > 12 to 18 months > 18 to 24 months More than 24 months Total £m £m £m £m £m £m Capitalisation 14 12 40 94 1,051 1,211 Term extensions 82 88 113 88 464 835 Interest only concessions 21 35 74 57 709 896 Total 117 135 227 239 2,224 2,942 Proportion of forborne performing accounts (%) 4% 5% 8% 8% 75% 100% 30 June 2013 - Volumes 0 to 6 months > 6 to 12 months > 12 to 18 months > 18 to 24 months More than 24 months Total No. No. No. No. No. No. Capitalisation 132 133 345 850 11,183 12,643 Term extensions 2,740 1,837 2,355 1,846 9,816 18,594 Interest only concessions 172 313 702 532 6,831 8,550 Total 3,044 2,283 3,402 3,228 27,830 39,787 Proportion of forborne performing accounts (%) 8% 6% 9% 8% 69% 100% 31 December 2012 - Values 0 to 6 months > 6 to 12 months > 12 to 18 months > 18 to 24 months More than 24 months Total £m £m £m £m £m £m Capitalisation 11 36 110 147 928 1,232 Term extensions 85 131 114 101 394 825 Interest only concessions 18 68 70 74 687 917 Total 114 235 294 322 2,009 2,974 Proportion of forborne performing accounts (%) 4% 8% 10% 11% 67% 100% 31 December 2012 - Volumes 0 to 6 months > 6 to 12 months > 12 to 18 months > 18 to 24 months More than 24 months Total No. No. No. No. No. No. Capitalisation 122 306 981 1,294 9,867 12,570 Term extensions 2,041 2,870 2,443 2,315 8,201 17,870 Interest only concessions 152 632 634 709 6,485 8,612 Total 2,315 3,808 4,058 4,318 24,553 39,052 Proportion of forborne performing accounts (%) 6% 10% 10% 11% 63% 100% The sustainability of Santander UK's forbearance arrangements at 30 June 2013 was further demonstrated by the fact that 78% by volume and 84% by value, of the accounts in forbearance classified as performing arose from forbearance undertaken more than 18 months previously (2012: 74% by volume and 78% by value). MORTGAGES - LITIGATION AND RECOVERY The account is escalated to the litigation and recovery phase when a customer is unwilling or unable to adhere to an acceptable agreement regarding arrears. Santander UK will consider delaying referral to litigation, or delaying action once in litigation under certain circumstances, such as where the customer presents evidence that the mortgage will be redeemed or the arrears cleared, or where the mortgage has a very low balance and arrears, or where the customer is making a regular payment of at least the instalment amount. These policies exist to ensure that repossession is only used as a last resort. Repossessed properties (collateral) The following tables set forth information on properties in possession at 30 June 2013 and 31 December 2012 as well as the carrying amount of assets obtained as collateral. Two independent valuations are requested on all possessions and form the basis for impairment reserving. Where the valuations are still pending, the latest losses experienced are used to assess the impairment reserves. This, together with the additional disposal costs considered, ensures that anticipated losses inherent in the stock of possession are appropriate in relation to the current economic conditions. Properties in possession Number of properties No. Value £m Percentage of total mortgage loans by number % 31 December 2012 924 128 0.06 30 June 2013 867 129 0.06 Application of impairment loss methodology to accounts in arrears and collection A detailed description of the application of Santander UK's impairment loss methodology to accounts in arrears and collection is set out in Note 1 of the 2012 Annual Report. BANKING AND CONSUMER CREDIT Santander UK also provides current account facilities, including overdrafts, together with unsecured personal loans ('UPLs'), credit cards (excluding the co-brand credit cards business), finance leases, unsecured business loans, and other forms of consumer finance. UNSECURED LENDING Santander UK uses a range of systems, risk tools and information sources to manage the risks involved in unsecured personal lending. These include the use of application and behavioural scoring systems as part of the assessment and granting of credit facilities as well as regular monitoring of scorecard performance and the quality of the unsecured lending portfolios. Non-performing loans and advances (1) (2) The following table presents NPLs in respect of overdrafts, UPLs, unsecured business loans, and other forms of consumer finance (excluding finance leases). Credit cards and finance leases are presented separately below. 30 June 2013 £m 31 December 2012 £m Unsecured lending NPLs - impaired(3) 84 94 Unsecured lending NPLs - not impaired 19 18 Unsecured lending NPLs 103 112 Unsecured loans and advances to customers(4) 3,813 4,214 Unsecured lending impairment loan loss allowances 225 228 % % NPLs ratio(5) 2.70 2.65 Coverage ratio (6) 218 204 (1) Unsecured lending is classified as non-performing when the customer fails to make a payment when contractually due for three months or longer. (2) All unsecured lending NPL balances are UK and continue accruing interest. The data presented excludes accrued interest. (3) NPLs against which an impairment loss allowance has been established. (4) Includes unsecured personal loan balances of £2.1bn (2012: £2.3bn) consisting of gross lending in the period of £0.5bn (2012: £1.1bn) and redemptions/repayments in the period of £0.7bn (2012: £1.7bn). (5) Impairment loan loss allowances as a percentage of NPLs. (6) The coverage ratio, as recognised across the unsecured lending industry, is based on the total impairment loan loss allowances relative to the stock of NPLs. Total loan loss allowances will relate to early arrears as well as performing assets and hence, the ratio exceeds 100%. 30 June 2013 compared to 31 December 2012 During the first half of 2013, NPLs as a percentage of UPLs and advances to customers increased to 2.70% (2012: 2.65%) as a result of the lower asset base. The level of NPLs decreased to £103m at 30 June 2013 (2012: £112m), as the older vintage portfolio with higher loss levels has almost matured, with most of the asset base consisting of recent higher credit quality vintage. The coverage ratio increased slightly to 218% at 30 June 2013 (2012: 204%). Forbearance At 30 June 2013 and 31 December 2012, the proportion of the stock of UPLs for which term extensions had been agreed was less than 1% by number and value. Forbearance options for the unsecured portfolio are focused on agreeing an affordable repayment plan taking into account an individual customer's particular circumstances. See the accounting policy "Impairment of Financial Assets" in Note 1 to the 2012 Annual Report for details of how impairment losses are calculated for the unsecured portfolio subject to forbearance. CREDIT CARDS Credit card applications are assessed via a combination of credit policy rules and scoring models to determine acceptance decisions and assign appropriate credit limits. Behavioural scoring and trigger events identified through a wide variety of internal performance and credit bureau data are utilised to inform ongoing portfolio management decisions such as credit line management and transaction authorisation. Non-performing loans and advances(1) (2) The following table presents NPLs in respect of Santander and cahoot brand credit cards, but excludes co-brand credit cards, which were managed in Corporate Centre prior to the completion of deals to sell the business in 2013. 30 June 2013 £m 31 December 2012(6) £m Credit cards NPLs - impaired(3) 36 30 Credit cards NPLs - not impaired 7 12 Credit cards NPLs 43 42 Credit cards loans and advances to customers 1,500 1,420 Credit card impairment loan loss allowances 88 86 % % NPLs ratio(4) 2.87 2.96 Coverage ratio(5) 204 204 (1) Credit card 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) All credit card NPL balances are UK and continue accruing interest. The data presented excludes accrued interest. (3) NPLs against which an impairment loss allowance has been established. (4) Credit cards NPLs as a percentage of credit cards loans and advances to customers. (5) The coverage ratio as recognised across the credit card industry is based on the total impairment loan loss allowances relative to the stock of NPLs. Total loan loss allowances will relate to early arrears as well as performing assets and hence, the ratio exceeds 100%. (6) 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. 30 June 2013 compared to 31 December 2012 During the first half of 2013, the value of NPLs was stable, while advances increased by 6% resulting in a reduction of the NPLs as a percentage of loans and advances to customers to 2.87% (2012: 2.96%). Forbearance At 30 June 2013, accounts in forbearance were broadly unchanged at 1.13% by volume and 2.32% by value (2012: 1.15% by volume and 2.27% by value). FINANCE LEASES Santander UK enters into finance leasing arrangements primarily for the financing of motor vehicles. The leasing arrangements are collateralised on the vehicles themselves. In addition, customers pay a cash deposit, so the majority of the loans are over-collateralised. In arrangements where Santander UK retains an interest in the residual value of a vehicle then industry standard valuations for the value of the vehicle at the end of the lease period are used to ensure that the collateral value is appropriate. Non-performing loans and advances (1) (2) 30 June 2013 £m 31 December 2012 £m Finance leases NPLs - impaired(3) 7 7 Finance leases NPLs - not impaired 2 2 Finance leases NPLs 9 9 Finance leases loans and advances to customers 1,997 1,908 Finance leases impairment loan loss allowances 41 42 % % NPLs ratio(4) 0.46 0.48 Coverage ratio(5) 445 457 (1) Finance leases are classified as non-performing when the counterparty fails to make a payment when contractually due for three months or longer. (2) All finance lease NPL balances are UK and continue accruing interest. The data presented excludes accrued interest. (3) NPLs against which an impairment loss allowance has been established. (4) Finance leases NPLs as a percentage of finance leases loans and advances to customers. (5) The coverage ratio as recognised across the finance leases industry is based on the total impairment loan loss allowances relative to the stock of NPLs. Total loan loss allowances will relate to early arrears as well as performing assets and hence, the ratio exceeds 100%. 30 June 2013 compared to 31 December 2012 During the first half of 2013, NPLs as a percentage of loans and advances to customers reduced slightly to 0.46% (2012: 0.48%). The coverage ratio reduced to 445% (2012: 457%) due to the reduction in impairment loan loss allowances. This reduction was attributed to a decrease in the residual value provision reflecting the continued improvement in used car prices in the period. Forbearance There is no significant forbearance activity within the finance lease business. RETAIL BANKING - NON-PERFORMING LOANS AND ADVANCES (1) (2) An analysis of Retail Banking NPLs is presented below. 30 June 2013 £m 31 December 2012(6) £m Retail Banking NPLs that are impaired(3) 896 858 Retail Banking NPLs that are not impaired 2,108 2,024 Retail Banking NPLs 3,004 2,882 Retail Banking loans and advances to customers 159,605 164,126 Retail Banking impairment loan loss allowances 932 908 % % NPLs ratio(4) 1.88 1.76 Coverage ratio(5) 31 32 (1) Loans and advances are classified as non-performing typically when the counterparty fails to make payments when contractually due for three months or longer. See earlier NPL tables for mortgages, unsecured lending, credit cards, and finance leases for definitions for specific products. (2) All Retail Banking NPL balances are UK and continue accruing interest. The data presented excludes accrued interest. (3) NPLs against which an impairment loss allowance has been established. (4) Retail Banking NPLs as a percentage of Retail Banking loans and advances to customers. (5) Impairment loan loss allowances as a percentage of NPLs. (6) 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. Movements in NPLs during the period are set out in the table below. Transfers 'in' represent loans which have fallen into arrears during the year and have missed three or more monthly payments. Transfers 'out' represent loans that have returned to performing status, or have been redeemed in full, or have proceeded to litigation and the property repossessed and sold, and the loan written off. £m At 1 January 2013 2,882 Transfers in to NPL 990 Transfers out of NPL: - Forbearance (15) - Change in arrears/return to performing status (663) - Loan repayments/redemptions (136) - Write-offs (255) Effect of changes in policies (1) 201 At 30 June 2013 3,004 (1) The effect in 2013 of regulatory-driven policy and reporting changes implemented in early 2012, of which £141m relates to changes in mortgages collections policy and £60m relates to reporting changes. 30 June 2013 compared to 31 December 2012 During the first half of 2013, the NPL ratio increased to 1.88% (2012: 1.76%), in part reflecting the decrease in the stock of loans and advances in the period. 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 coverage ratio remained stable at 31% (2012: 32%) as higher impairment loss allowances were offset by the increase in NPL balances. Performance reflected a stable secured and unsecured portfolio, a result of both the quality of the portfolio and stable economic variables. The coverage ratio reflects the fact that mortgages, which inherently have a lower coverage ratio than unsecured products, represented 95% of Retail Banking loans and advances to customers at 30 June 2013. Interest income recognised on impaired loans amounted to £43m during the six months ended 30 June 2013 (six months ended 30 June 2012: £43m). RETAIL BANKING - FORBEARANCE At 30 June 2013, the carrying amount of financial assets that are currently performing and have been forborne was £2,963m (2012: £3,007m). CREDIT RISK - CORPORATE BANKING INTRODUCTION 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. Credit risk arises by Corporate Banking making loans, investing in other financial instruments or entering into financing transactions or derivatives. This section sets out further detail on credit risk in Corporate Banking as follows: > Assets; > Committed exposures; > Credit risk mitigation; > Monitoring and recovery management; > Arrears; > Forbearance; and > Non-performing loans and advances, and forbearance. MANAGEMENT'S APPROACH TO CREDIT RISK IN CORPORATE BANKING Management's approach to credit risk in Corporate Banking has not changed during 2013. For further details refer to page 98 of the 2012 Annual Report. CORPORATE BANKING - ASSETS 30 June 2013 £bn 31 December 2012 £bn 30 June 2012 £bn Large Corporate - repos 18.5 9.9 16.7 Sovereign 7.3 3.8 5.4 Structured Finance - 0.4 0.4 Customer Assets: - Large Corporate loans (excluding repos) 2.8 2.2 3.4 - Mid Corporate and SME(1) 14.3 13.2 9.5 - Social Housing(2) 0.3 0.2 0.1 - Real estate(1) 3.6 3.7 3.9 Other(1)(3) 2.7 2.2 2.8 Total (4) 49.5 35.6 42.2 (1) Includes corporate loans classified as Loans and advances to customers. (2) Consists of bonds classified as financial assets designated at fair value and new loans accounted for at amortised cost. Excludes historic Social Housing loan balances managed in Corporate Centre. (3) Includes finance leases classified as Loans and advances to customers. (4) Includes Operating lease assets. In Corporate Banking, credit risk arises on asset balances and off-balance sheet transactions such as committed and undrawn credit facilities or guarantees. Consequently, committed exposures are typically higher than asset balances. However, in the following committed exposures tables, Sovereigns are presented net of short positions, and Large Corporate repos are presented net of repo liabilities. As a result, the committed exposures are smaller than the asset balances above. In addition, in the committed exposures tables, commercial mortgages are included within Real Estate, which reflects the type of risk being monitored, whereas in the asset table above they are classified as SME to reflect the status of the borrower. CORPORATE BANKING - COMMITTED EXPOSURES COMMITTED EXPOSURES BY CREDIT RATING OF THE ISSUER OR COUNTERPARTY(1)(2) 30 June 2013 Sovereign £m Large Corporate £m Structured Finance £m Mid Corporate and SME £m Real Estate £m Social Housing £m Total £m AAA 1,104 - - - 1 - 1,105 AA 3,847 1,125 21 117 185 291 5,586 A 48 3,803 - 1,211 1,198 320 6,580 BBB 502 5,396 38 4,304 2,640 115 12,995 BB - 569 90 5,820 4,219 - 10,698 B - 2 173 289 511 - 975 CCC - - 40 109 276 - 425 D - - 5 156 159 - 320 Other(3) - - - 1,100 395 - 1,495 Total 5,501 10,895 367 13,106 9,584 726 40,179 31 December 2012 Sovereign £m Large Corporate £m Structured Finance £m Mid Corporate and SME £m Real Estate £m Social Housing £m Total £m AAA 1,132 25 - - - - 1,157 AA 960 361 - 197 164 39 1,721 A 66 3,324 - 1,033 1,321 261 6,005 BBB - 5,244 32 4,863 2,981 115 13,235 BB - 471 158 4,168 3,592 - 8,389 B - 1 72 277 277 - 627 CCC - - 101 69 113 - 283 D - - - 157 389 - 546 Other(3) - - - 1,586 963 - 2,549 Total 2,158 9,426 363 12,350 9,800 415 34,512 (1) The committed exposure includes OTC derivatives. (2) All exposures are internally rated. External ratings are taken into consideration in the rating process, where available. (3) Individual exposures of £1m or less. COMMITTED EXPOSURES BY GEOGRAPHICAL AREA(1) 30 June 2013 Sovereign £m Large Corporate £m Structured Finance £m Mid Corporate and SME £m Real Estate £m Social Housing £m Total £m UK - 8,288 143 12,683 9,584 726 31,424 Peripheral eurozone 502 356 23 65 - - 946 Rest of Europe 2,728 1,335 88 96 - - 4,247 US - 324 92 - - - 416 Other, including non-OECD 2,271 592 21 262 - - 3,146 Total 5,501 10,895 367 13,106 9,584 726 40,179 31 December 2012 Sovereign £m Large Corporate £m Structured Finance £m Mid Corporate and SME £m Real Estate £m Social Housing £m Total £m UK - 7,519 153 11,948 9,800 415 29,835 Peripheral eurozone - 263 22 78 - - 363 Rest of Europe 1,132 1,269 82 96 - - 2,579 US - 266 106 - - - 372 Other, including non-OECD 1,026 109 - 228 - - 1,363 Total 2,158 9,426 363 12,350 9,800 415 34,512 (1) The geographic location is classified by country of domicile of the counterparty. 30 June 2013 compared to 31 December 2012 During the first half of 2013, total commitments increased by £5.7bn or 16% to £40.2bn reflecting continued development of a UK corporate banking franchise. The increase in sovereign holdings reflected the development of the business in this area. The increased exposures were mainly in the AA category (Japan and France). The increase in BBB exposures reflected the purchase of Italian Government bonds with less than one year maturity as part of short-term markets trading activity. Large Corporates exposures increased by 16% as a result of the development of the franchise. Growth was focused on the UK, with some diversification in other European and non-European countries with counterparties with good credit quality. In the Mid Corporate and SME portfolio growth was primarily due to new lending. The increase in exposures in the Social Housing portfolio was primarily due to refinancing. The Real Estate portfolio decreased by 2% reflecting exits and restructurings. Commercial Real Estate loans The Real Estate portfolio at 30 June 2013 was well diversified by sector. Real estate non-performing loans at 30 June 2013 and 31 December 2012 may be further analysed between loans originated pre-2009 and thereafter as follows: 30 June 2013 Original vintage Pre-2009 2009 onwards Total Total loans £1,870m £7,714m £9,584m NPLs ratio 21.3% 0.3% 4.4% 31 December 2012 Original vintage Pre-2009 2009 onwards Total Total loans £2,463m £7,337m £9,800m NPLs ratio 19.5% 0.2% 5.0% 95% of the NPL balance relates to deals originated pre-2009. The pre-2009 vintage loans were written on terms prevailing in the market at that time which, compared to more recent times, included higher original LTVs, lower interest coverage and exposure to development or letting risk. Following the significant downturn in the commercial real estate market in 2008 and 2009, some of these customers suffered financial stresses resulting in their inability to meet the contractual payment terms or to comply with covenants or to achieve refinancing/repayment at maturity. As a result, the pre-2009 sub-portfolio has experienced higher NPL rates in recent years. In light of the market deterioration, Santander UK's lending criteria were significantly tightened from 2009 onwards, with lower LTVs and the avoidance of transactions with material letting or development risks (at 30 June 2013, this element of the portfolio represented only 4% of the total Real Estate portfolio). In addition, while the market remains challenging, prices have not declined significantly further since Santander UK's lending criteria were tightened. As a result, the sub-portfolio representing loans originating from 2009 onwards continues to perform significantly better than the pre-2009 sub-portfolio. The weighted average LTV of new deals written in the first half of 2013 was 54% with no deals written with an LTV of 70% or more. CORPORATE BANKING - CREDIT RISK MITIGATION At 30 June 2013, the estimated value of collateral held against impaired loans amounted to 42% (2012: 52%) of the carrying amount of impaired loan balances. CORPORATE BANKING - Monitoring and recovery management Cases exhibiting potentially higher risk characteristics are subject to risk monitoring under the Watchlist (FEVE) process. There are a range of indicators that may trigger a case being added to Watchlist (FEVE), including downturn in trade, covenant breaches, major contract loss, and resignation of key management etc. Such cases are assessed to determine the potential financial implications of these trigger events and in consultation with the borrower, a range of options available is considered which may include temporary forbearance. In addition, cases that require specialist risk management expertise, including all NPLs, are transferred to a dedicated restructuring team. Cases subject to risk monitoring under the Watchlist (FEVE) process or classified as NPL by portfolio at 30 June 2013 and 31 December 2012 were: 30 June 2013 Watchlist (FEVE) Observed impairment loss allowances Portfolio Enhanced monitoring Proactive monitoring Total NPL NPL Watchlist NPL £m £m % £m % £m £m % £m £m Large Corporate (including Sovereign) 16,447 274 1.7 - - 274 - - - - Structured Finance 367 51 13.9 143 39.0 194 26 7.1 66 12 Mid Corporate and SME 13,106 851 6.5 234 1.8 1,085 332 2.5 12 131 Real Estate 9,584 299 3.1 445 4.6 744 420 4.4 18 154 Social Housing 726 - - - - - - - - - Total 40,230 1,475 3.7 822 2.0 2,297 778 1.9 96 297 31 December 2012 Watchlist (FEVE) Observed impairment loss allowances Portfolio Enhanced monitoring Proactive monitoring Total NPL NPL Watchlist NPL £m £m % £m % £m £m % £m £m Large Corporate (including Sovereign) 11,584 163 1.4 - - 163 - - - - Structured Finance 363 72 19.8 161 44.4 233 18 5.0 73 4 Mid Corporate and SME 12,350 798 6.5 397 3.2 1,195 347 2.8 22 129 Real Estate 9,800 376 3.8 397 4.1 773 496 5.1 29 130 Social Housing 415 - - - - - - - - - Total 34,512 1,409 4.1 955 2.8 2,364 861 2.5 124 263 NPLs in the tables above include committed facilities and derivative exposures and therefore are larger than the NPLs in the tables on page 57 which only include drawn balances. 30 June 2013 compared to 31 December 2012 During the first half of 2013, exposures across the majority of Watchlist categories decreased, as older cases were either successfully returned to performing status or were restructured, in some cases through to an exit. In the Large Corporates portfolio, there were no exposures in proactive monitoring status. In the Real Estate portfolio, the overall level of Watchlist cases decreased slightly with a migration of cases subject to enhanced monitoring into proactive monitoring reflecting a small number of cases where concerns have risen, rather than any wider trend of deterioration across the portfolio. In the Mid Corporate and SME portfolio, the overall level of Watchlist cases decreased by approximately 9% overall and by 41% in proactive monitoring as cases have been successfully managed through the process. During the first half of 2013, NPLs reduced as cases continued to be worked out, particularly within the Real Estate portfolio. CORPORATE BANKING - ARREARS (1) 30 June 2013 £m 31 December 2012 £m Total Corporate Banking loans and advances to customers in arrears 751 795 Total Corporate Banking loans and advances to customers(2) 21,036 19,605 Corporate Banking loans and advances to customers in arrears as a % of Corporate Banking loans and advances to customers 3.57% 4.06% (1) Accrued interest is excluded for purposes of these analyses. (2) Corporate Banking loans and advances to customers include Social Housing loans and finance leases. 30 June 2013 compared to 31 December 2012 Loans and advances to customers in arrears decreased to £751m (2012: £795m) as older NPL cases were either successfully returned to performing status or were restructured, in some cases through to an exit. Early arrears levels remained at a consistent level. Consequently, loans and advances to customers in arrears as a percentage of loans and advances to customers decreased to 3.57% (2012: 4.06%). Forbearance Forbearance commenced during the period/year No arrangements have been entered into with respect to sovereign or large corporate counterparties. The accounts that entered forbearance during the period ended 30 June 2013 and year ended 31 December 2012 were: 30 June 2013 Mid Corporate and SMEs Real Estate Total £m £m £m Forbearance of NPL 8 3 11 Forbearance of Non-NPL 32 61 93 40 64 104 31 December 2012 Mid Corporate and SMEs Real Estate Total £m £m £m Forbearance of NPL 46 21 67 Forbearance of Non-NPL 94 161 255 140 182 322 Forbearance cumulative number and value of accounts a) Performance status when entering forbearance The status of the cumulative number of accounts in forbearance at 30 June 2013 and 31 December 2012 when they originally entered forbearance, analysed by their payment status, was: 30 June 2013 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing - - 339 942 339 942 126 In arrears 70 143 - - 70 143 34 Total 70 143 339 942 409 1,085 160 31 December 2012 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing - - 371 956 371 956 89 In arrears 75 144 - - 75 144 32 Total 75 144 371 956 446 1,100 121 Debt-for-equity swaps In addition to the forbearance above, Santander UK has entered into a small number of debt-for-equity swaps where, on occasion, Santander UK may agree to exchange a proportion of the amount owed by the borrower for equity in that borrower. In circumstances where a borrower's balance sheet is materially over-leveraged but the underlying business is viewed as capable of being turned around, Santander UK may agree to reduce the debt by exchanging a portion of it for equity in the company. This will typically only be done alongside new cash equity being raised, the implementation of a detailed business plan to effect a turnaround in the prospects of the business, and satisfaction with management's ability to deliver the strategy. These debt-for-equity swaps amounted to £39m at 30 June 2013 (2012: £46m) and in view of their small size are not included in these analyses. b) Performance status at the period/year-end The current status of accounts in forbearance analysed by their payment status, at 30 June 2013 and 31 December 2012 was: 30 June 2013 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing 36 72 265 652 301 724 20 In arrears 34 71 74 290 108 361 140 Total 70 143 339 942 409 1,085 160 31 December 2012 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing 38 76 290 644 328 720 13 In arrears 37 68 81 312 118 380 108 Total 75 144 371 956 446 1,100 121 This data may be further analysed by portfolio, as follows: Mid Corporate and SME 30 June 2013 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing 16 47 144 161 160 208 9 In arrears 20 42 49 82 69 124 53 Total 36 89 193 243 229 332 62 31 December 2012 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing 16 40 160 228 176 268 7 In arrears 16 42 54 98 70 140 38 Total 32 82 214 326 246 408 45 Commercial Real Estate 30 June 2013 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing 20 26 121 492 141 518 12 In arrears 14 28 25 207 39 235 86 Total 34 54 146 699 180 753 98 31 December 2012 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing 22 36 130 416 152 452 7 In arrears 21 26 27 214 48 240 69 Total 43 62 157 630 200 692 76 30 June 2013 compared to 31 December 2012 The incidence of forbearance that commenced in the period, which principally related to cases originated in the pre-2009 vintage, decreased as businesses became more effective in adapting to the challenging trading environment without the need to seek forbearance. This was consistent with the trend in Watchlist (FEVE) cases which also reduced during the period. The volume of forbearancedecreased both in the Real Estate and Mid Corporate and SME portfolios as the number of pre-2009 cases continued to work their way through the process. Accounts that are in forbearance continue to be closely monitored, to ensure that the forbearance arrangements are sustainable. At 30 June 2013, 74% (2012: 74%) of the accounts in forbearance were performing in accordance with the revised terms agreed under the forbearance arrangements. At 30 June 2013, 51% (2012: 51%) of the accounts that were in NPL's at the time of forbearance, were performing in accordance with the revised terms agreed under the forbearance arrangements. Not all restructures will prove effective, and in certain circumstances, the current market conditions may lead to a second term extension, for example in the case of commercial real estate where it remains difficult to sell or refinance the property. The level of compliance with revised terms agreed under forbearance arrangements is in line with expectations, recognising the impact of the current challenging market conditions as a consequence of which it is taking longer for cases to return to performing status after forbearance. Those cases where forbearance occurs prior to default, which represent 86% (2012: 86%) of cases, are generally more effective as highlighted in the tables above. These loans are individually assessed for observed impairment loss allowances. The greater probability of ultimate loss in these circumstances is reflected in the calculation of impairment loss allowances. A customer's ability to adhere to any revised terms agreed is an indicator of the sustainability of Santander UK's forbearance arrangements, although the forbearance is unlikely to be successful in all cases. Corporate Banking - non-performing loans and advances(1) (2) (3) An analysis of Corporate Banking NPLs is presented below. 30 June 2013 £m 31 December 2012 £m Corporate Banking NPLs - impaired(4) 754 835 Corporate Banking NPLs 754 835 Corporate Banking loans and advances to customers 21,036 19,605 Corporate Banking impairment loan loss allowances 405 407 % % NPLs ratio(5) 3.58 4.26 Coverage ratio(6) 54 49 (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) NPLs against which an impairment loss allowance has been established. (5) Corporate Banking NPLs as a percentage of Corporate Banking loans and advances to customers. (6) Impairment loan loss allowances as a percentage of NPLs. Movements in NPLs during the period are set out in the table below. Transfers 'in' represent loans which have fallen into arrears during the period and have missed three or more monthly payments. Transfers 'out' represent loans that have returned to performing status, or have been redeemed in full, or have proceeded to litigation and the property repossessed and sold, and the loan written off. 2013 £m At 1 January 2013 835 Transfers in to NPL 190 Transfers out of NPL: - Loan repayments/redemptions (219) - Write-offs (52) At 30 June 2013 754 30 June 2013 compared to 31 December 2012 During the first half of 2013, the NPLs ratio decreased to 3.58% (2012: 4.26%) reflecting lower levels of NPLs as a result of several older vintage cases in the Real Estate portfolio having been successfully restructured during the period, combined with the overall growth in the portfolio. The deal vintage of total NPL stock of £754m at 30 June 2013 comprised pre-2005 (and up to 31 December 2005) vintage of £60m, 2006 vintage of £195m, 2007 vintage of £213m, 2008 vintage of £165m in 2008, 2009 vintage of £29m, 2010 vintage of £73m, 2011 vintage of £15m, 2012 vintage of £4m and 2013 vintage of £nil. In the first half of 2013, interest income recognised on impaired loans amounted to £7m (six months ended 30 June 2012: £7m). CORPORATE BANKING - FORBEARANCE As previously described, loans may be forborne. At 30 June 2013, the carrying amount of financial assets that would otherwise be past due or impaired whose terms have been forborne was £75m (2012: £76m). CREDIT RISK - MARKETS INTRODUCTION 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. Credit risk arises by Markets entering into derivatives or financing transactions, or investing in other financial instruments. This section sets out further detail on credit risk in Markets as follows: > Assets; > Committed exposures; > Credit risk mitigation; > Monitoring and recovery management; and > Forbearance. MANAGEMENT'S APPROACH TO CREDIT RISK IN MARKETS Management's approach to credit risk in Markets has not changed during 2013. For further details refer to page 108 of the 2012 Annual Report. MARKETS - ASSETS 30 June 2013 £bn 31 December 2012 £bn Derivatives 22.5 26.3 UK Treasury bills, equities and other 2.4 1.9 Total 24.9 28.2 Derivative risk exposures are set out in the tables below. Derivatives in the asset table above relate to the derivative assets held on the balance sheet, where only netting permitted by IAS 39 is applied. The derivative risk exposures in the tables below are lower than the balance sheet position because the overall risk exposure is monitored and therefore consideration is taken of margin posted, Credit Support Annexes within ISDA Master Agreements, and master netting agreements and instruments such as reverse repos which reduce the Santander UK group's exposures. Markets - commitTED EXPOSURES DERIVATIVE committed Exposures by credit rating of the issuer or counterparty (1) 30 June 2013 £m 31 December 2012 £m AAA 43 38 AA 1,856 222 A 2,625 4,135 BBB and below 640 357 Total 5,164 4,752 (1) External ratings are applied to all exposures where available. DERIVATIVE committed exposures by geographical area 30 June 2013 £m 31 December 2012 £m UK 2,249 1,635 Peripheral eurozone 516 364 Rest of Europe 1,128 1,409 US 1,112 1,012 Rest of the world 159 332 Total 5,164 4,752 30 June 2013 compared to 31 December 2012 The change in the mix of exposures from A to AA during the first half of 2013 principally reflected a continued focus on counterparties with higher credit quality. MARKETS - CREDIT RISK MITIGATION Markets continued to focus its activities on derivative products, supported by increased collateralisation and use of central counterparties. PORTFOLIO DESCRIPTION > Derivatives Collateralisation Cash collateral in respect of derivatives held at 30 June 2013 was £0.7bn (2012: £0.9bn), not all derivative arrangements being subject to collateral agreements. Collateral obtained during the period in respect of purchase and resale agreements (including securities financing) is equal to at least 100% of the amount of the exposure. Use of Central Counterparties ('CCPs') Santander UK continues to use CCPs as an additional means to mitigate counterparty credit risk in derivative transactions. At 30 June 2013, CCPs were used in connection with 16.3% (2012: 6.3%) of Santander UK's OTC derivatives. This increase was a result of regulatory requirements and market convention driving more business through CCPs. MARKETS - Monitoring and recovery management Cases exhibiting potentially higher risk characteristics are subject to risk monitoring under the Watchlist (FEVE) system. At 30 June 2013, there were no impaired or non-performing loans or exposures (2012: none) and the assets in the Watchlist (FEVE) Active category amounted to only £33m (2012: £33m). MARKETS - FORBEARANCE At 30 June 2013 and 31 December 2012, there were no financial assets that would otherwise be past due or impaired whose terms have been forborne. CREDIT RISK - CORPORATE CENTRE INTRODUCTION 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 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-brand credit cards business were completed in the first half of 2013. Credit risk arises by Corporate Centre making loans (including to other businesses within Santander UK) and investing in debt securities. Credit risk also arises by Corporate Centre investing in other financial instruments (including assets held for liquidity purposes) or entering into financing transactions or derivative contracts. This section sets out further detail on credit risk in Corporate Centre as follows: > Assets; > Committed exposures; > Credit risk mitigation; > Monitoring and recovery management; > Arrears; > Forbearance; and > Non-performing loans and advances, and forbearance. MANAGEMENT'S APPROACH TO CREDIT RISK IN CORPORATE CENTRE Management's approach to credit risk in Corporate Centre has not changed during 2013. For further details refer to page 111 of the 2012 Annual Report. Corporate Centre - assets 30 June 2013 £bn 31 December 2012 (5) £bn Sovereign - Balances at central banks (UK and US) 33.1 27.9 - other 4.4 5.1 Structured Products(1) 1.9 1.9 Derivatives 2.5 3.2 Collateral(2) 2.7 4.5 Other assets(3) 3.3 7.2 Customer assets(4) 10.4 11.0 Total 58.3 60.8 (1) Comprises the Treasury Asset Portfolio. These assets were acquired as part of the transfer of Alliance & Leicester plc to Santander UK in 2008 and as part of an alignment of portfolios across the Banco Santander group in 2010 and are being run down. The assets in the Treasury Asset Portfolio are principally classified as loan and receivable securities, and debt securities designated at fair value through profit or loss. (2) Includes inter-segmental collateral balances. This balance represents collateral held and therefore is not included in the tables of exposures below. (3) Other assets consist primarily of cash, trading assets and the assets of the co-brand credit cards business classified as discontinued operations. (4) See customer assets table below for additional detail of the portfolios within this balance. (5) 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. Corporate Centre customer assets 30 June 2013 £bn 31 December 2012 £bn 30 June 2012 £bn Social Housing(1) 7.4 7.5 7.5 Commercial mortgages 1.3 1.4 1.7 Legacy portfolios in run-off: - Aviation 0.5 0.6 0.8 - Shipping 0.5 0.7 0.9 - Other 0.7 0.8 1.0 Total 10.4 11.0 11.9 (1) Social Housing includes loans held at amortised cost and loans designated at fair value through profit or loss. Excludes Social Housing bonds of £0.2bn (2012: £0.2bn) designated at fair value through profit or loss. In 2013, Santander UK completed deals to sell its co-brand credit cards business, as described in Note 6 to the Condensed Consolidated Interim Financial Statements. The co-brand credit cards business is accounted for as discontinued operations, and was classified as other assets in the Condensed Consolidated Balance Sheet prior to its sale, and is therefore excluded from the customer assets tables above. The Corporate Centre assets tables above comprise gross asset balances. The exposure tables below shows the exposures in Corporate Centre after taking into account the credit mitigation procedures described in Markets on page 59 above. In addition, on lending to customers, credit risk arises on assets and off-balance sheet transactions. Consequently, the credit risk exposure below arises from on balance sheet assets, and off-balance sheet transactions such as committed and undrawn credit facilities or guarantees. Corporate Centre - COMMITTED exposureS Corporate Centre COMMITTED exposure by credit rating of the issuer or counterparty(1) 30 June 2013 Sovereign £m Structured Products £m Derivatives £m Legacy Portfolios in run-off £m Social Housing £m Total £m AAA 9,457 222 - - - 9,679 AA 28,782 859 133 - 2,296 32,070 A - 1,087 1,574 39 5,623 8,323 BBB and below - 395 - 2,190 1,386 3,971 Other - - - 1,279 - 1,279 Total 38,239 2,563 1,707 3,508 9,305 55,322 31 December 2012 Sovereign £m Structured Products £m Derivatives £m Legacy Portfolios in run-off £m Social Housing £m Total £m AAA 32,740 257 - - - 32,997 AA 283 305 - - 2,305 2,893 A - 599 1,443 64 6,049 8,155 BBB and below - 412 126 2,724 1,258 4,520 Other - - - 1,385 - 1,385 Total 33,023 1,573 1,569 4,173 9,612 49,950 (1) All exposures are internally rated. External ratings are taken into consideration in the rating process, where available. Corporate Centre COMMITTED exposure by geographical area(1) 30 June 2013 Sovereign £m Structured Products £m Derivatives £m Legacy Portfolios in run-off £m Social Housing £m Total £m UK 28,659 812 457 2,609 9,305 41,842 Peripheral eurozone - 355 - 82 - 437 Rest of Europe - 636 740 184 - 1,560 US 9,457 428 510 112 - 10,507 Rest of world 123 332 - 521 - 976 Total 38,239 2,563 1,707 3,508 9,305 55,322 31 December 2012 Sovereign £m Structured Products £m Derivatives £m Legacy Portfolios in run-off £m Social Housing £m Total £m UK 31,350 423 437 2,991 9,612 44,813 Peripheral eurozone - 355 - 90 - 445 Rest of Europe 627 376 676 292 - 1,971 US 763 382 456 193 - 1,794 Rest of world 283 37 - 607 - 927 Total 33,023 1,573 1,569 4,173 9,612 49,950 (1) The geographic location is classified by country of domicile of the counterparty. 30 June 2013 compared to 31 December 2012 The committed exposures to Sovereigns principally reflect cash at central banks and holdings of highly rated liquid assets as part of normal liquid asset portfolio management, and are concentrated in UK and US exposures. During the first half of 2013, there was a migration of Sovereign exposure from AAA to AA as a result of the UK's Sovereign downgrade in early 2013. In addition, AAA Sovereign exposure increased to £9.5bn reflecting US Sovereign holdings at 30 June 2013. Similarly, exposures to Structured Products reflect holdings of highly rated corporate bonds and floating rate notes as part of normal liquid asset portfolio management. The legacy portfolio in run-off continued to reduce in line with the strategy to exit these exposures where the opportunity arises. Commitments reduced by £0.7bn during the period, reflecting decreases across all sub-portfolios, especially shipping, aviation and Infrastructure. The Social Housing portfolio reduced as a result of successful refinancings. CORPORATE CENTRE - CREDIT RISK MITIGATION The specialist businesses in Corporate Centre service customers in various business sectors including Social Housing and certain legacy portfolios in run-off, including aviation and shipping. At 30 June 2013, the estimated value of collateral held against impaired loans amounted to 60% (2012: 62%) of the carrying amount of impaired loan balances. CORPORATE CENTRE - MONITORING AND RECOVERY MANAGEMENT Cases exhibiting potentially higher risk characteristics are subject to risk monitoring under the Watchlist (FEVE) process. There are a range of indicators that may trigger a case being added to Watchlist (FEVE), including deteriorating rating, security value concerns, declining trends, debt service under pressure, downturn in trade, covenant breaches, major contract loss, and resignation of key management. Such cases are assessed to determine the potential financial implications of these trigger events and in consultation with the borrower, a range of options available is considered which may include temporary forbearance. In addition, cases that require specialist risk management expertise, including all NPLs, are transferred to a dedicated restructuring team. Cases subject to risk monitoring under the Watchlist (FEVE) process or classified as NPL by portfolio and assessment of risk at 30 June 2013 and 31 December 2012 were: 30 June 2013 Watchlist (FEVE) Observed impairment loss allowances Portfolio Enhanced monitoring Proactive monitoring Total NPL NPL Watchlist NPL £m £m % £m % £m £m % £m £m Sovereign 38,239 - - - - - - - - - Structured Products 2,563 302 11.8 - - 302 - - - - Derivatives 1,707 - - - - - - - - - Legacy portfolios in run-off 3,509 154 4.4 204 5.8 358 404 11.5 68 213 Social Housing 9,305 83 0.9 - - 83 - - - - Total 55,323 539 1.0 204 0.4 743 404 0.7 68 213 31 December 2012 Watchlist (FEVE) Observed impairment loss allowances Portfolio Enhanced monitoring Proactive monitoring Total NPL NPL Watchlist NPL £m £m % £m % £m £m % £m £m Sovereign 33,023 - - - - - - - - - Structured Products 1,573 188 12.0 - - 188 - - - - Derivatives 1,569 - - - - - - - - - Legacy portfolios in run-off 4,173 283 6.8 207 5.0 490 518 12.4 152 218 Social Housing 9,612 632 6.6 - - 632 - - - - Total 49,950 1,103 2.2 207 0.4 1,310 518 1.0 152 218 NPLs in the tables above include committed facilities and derivative exposures and therefore are larger than the NPLs in the tables on page 64 which only include drawn balances. 30 June 2013 compared to 31 December 2012 During the first half of 2013, exposure in the legacy portfolios in run-off subject to Watchlist monitoring and NPLs reduced as a consequence of the strategy to exit these exposures. Similarly, the level of provision decreased during the first half of the year reflecting disposal of assets. In Social Housing, the value of cases in enhanced monitoring decreased as a result of a small number of large value cases returning to performing status following resolution of governance issues as anticipated. Corporate Centre - arrears 30 June 2013 £m 31 December 2012 £m Corporate Centre loans and advances to customers in arrears 439 490 Corporate Centre loans and advances to customers(1) 10,353 11,002 Corporate Centre loans and advances to customers in arrears as a % of Corporate Centre loans and advances to customers 4.24% 4.45% (1) Includes Social Housing loans and finance leases. (2) Accrued interest is excluded for purposes of these analyses. In the first half of 2013, loans and advances to customers in arrears decreased to £439m (2012: £490m) as Santander UK continued to execute the strategy of exiting problem cases through sale of the debt or through sale of the collateral. Loans and advances to customers in arrears as a percentage of loans and advances to customers decreased to 4.24% (2012: 4.45%) as a result of the decrease in arrears described above. Forbearance Forbearance allows a customer, by negotiation, to vary the terms of their contractual obligations for an agreed period (such as interest-only period or term extensions). Santander UK also aims to ensure that after the initial period of financial difficulties the customer can revert to the previous terms, with appropriate support where necessary. These agreements may be initiated by the customer, Santander UK or by a third party. No forbearance arrangements have been entered into with respect to sovereign, structured products, derivatives or Social Housing counterparties. Forbearance commenced during the period/year The accounts that entered forbearance during the period ended 30 June 2013 and year ended 31 December 2012 were: 30 June 2013 31 December 2012 £m £m Forbearance of NPL 25 4 Forbearance of Non-NPL 14 160 39 164 Forbearance cumulative number and value of accounts a) Performance status when entering forbearance The status of the cumulative number of accounts in forbearance at 30 June 2013 and 31 December 2012 when they originally entered forbearance, analysed by their payment status, was: Legacy Portfolios in run-off 30 June 2013 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing - - 422 412 422 412 90 In arrears 57 89 - - 57 89 37 Total 57 89 422 412 479 501 127 31 December 2012 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing - - 436 551 436 551 71 In arrears 56 63 - - 56 63 28 Total 56 63 436 551 492 614 99 b) Performance status at the period/year-end The current status of accounts in forbearance analysed by their payment status at 30 June 2013 and 31 December 2012 was: Legacy Portfolios in run-off 30 June 2013 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing 25 29 337 281 362 310 11 In arrears 32 60 85 131 117 191 116 Total 57 89 422 412 479 501 127 31 December 2012 Forbearance of NPL Forbearance of Non-NPL Total Impairment allowance No. £m No. £m No. £m £m Performing 23 10 349 410 372 420 8 In arrears 33 53 87 141 120 194 91 Total 56 63 436 551 492 614 99 30 June 2013 compared to 31 December 2012 In the first half of 2013, the balance of cases in forbearance reduced as the strategy to exit these cases continued to be executed where the opportunity arose. An element of the residual forborne cases are expected to take longer to exit given their higher risk profile and as a consequence the more limited market appetite for the purchase or refinancing of such assets. The level of impairment allowance held against these cases at 30 June 2013 increased to reflect this. Accounts that are in forbearance continue to be closely monitored, to ensure that the forbearance arrangements are sustainable. At 30 June 2013, 76% (2012: 76%) of the accounts in forbearance were performing in accordance with the revised terms agreed under Santander UK's forbearance arrangements. A customer's ability to adhere to any revised terms agreed is an indicator of the sustainability of Santander UK's forbearance arrangements. Corporate Centre - non-performing loans and advances (1) (2) (3) An analysis of Corporate Centre NPLs is presented below. 30 June 2013 £m 31 December 2012 £m Corporate Centre NPLs - impaired (4) 388 494 Corporate Centre NPLs - not impaired - - Corporate Centre NPLs(2) 388 494 Corporate Centre loans and advances to customers 10,328 11,002 Corporate Centre impairment loan loss allowances 393 488 % % NPLs ratio(5) 3.75 4.49 Coverage ratio(6) 101 99 (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 Centre loans and advances to customers include Social Housing loans and finance leases. (3) All Corporate Centre NPL balances are UK and continue accruing interest. The data presented excludes accrued interest. (4) NPLs against which an impairment loss allowance has been established. (5) Corporate Centre NPLs as a percentage of Corporate Centre loans and advances to customers. (6) Impairment loan loss allowances as a percentage of NPLs. Movements in NPLs during the period are set out in the table below. Transfers 'in' represent loans which have fallen 90 days past due during the year or are judged to be unlikely to meet their obligations to Santander UK. Transfers 'out' represent loans that have returned to performing status, or have been redeemed in full, or have proceeded to litigation and the collateral repossessed and sold, and the residual loan written off. £m At 1 January 2013 494 Transfers in to NPL 132 Transfers out of NPL: - Loan repayments/redemptions (137) - Write-offs (101) At 30 June 388 30 June 2013 compared to 31 December 2012 At 30 June 2013, the NPLs ratio decreased to 3.75% (2012: 4.49%). This decrease reflected the continuing strategy to exit exposures where possible for this portfolio. This was in part through debt sales or realisation of collateral but also involved an increased level of write-offs in the year to date. There was a further significant portfolio exit during July 2013, reducing NPLs by £92m which is equivalent to a reduction of approximately 1% in the NPL ratio for Corporate Centre. In the first half of 2013, coverage remained largely unchanged at 101% (2012: 99%) with the profile of cases exited in the period being broadly in line with the profile of the wider portfolio. In 2013, interest income recognised on impaired loans amounted to £7m (six months ended 30 June 2012: £6m). CORPORATE CENTRE - FORBEARANCE As previously described, loans may be forborne. At 30 June 2013, the carrying amount of financial assets that would otherwise be past due or impaired whose terms have been forborne was £32m (2012: £10m). MARKET RISK INTRODUCTION Market risk is the risk of a variation to the capital, economic value or reported income resulting from changes in the variables of financial instruments including interest rate, inflation, equity, credit spread, property and foreign currency. Traded market risk is the risk of losses in on- and off-balance sheet positions arising from movements in market prices. Non-traded market risk includes exposures arising as a result of the structure of portfolios of assets and liabilities, or where the liquidity of the market is such that the exposure could not be closed out over a short-time horizon. This section sets out further detail on: > Traded market risk; and > Non-traded market risk (which is classified as a structural risk and presented in the Structural Risks section). MANAGEMENT'S APPROACH TO MARKET RISK > Santander UK actively manages and controls traded market risk within clearly defined parameters by limiting the impact of adverse market movements whilst seeking to enhance earnings. The organisational structure ensures a segregation of responsibilities between the functions responsible for market risk origination, risk management and control, and risk oversight. > A comprehensive set of Santander UK-wide policies, procedures and processes have been developed and implemented to identify, monitor and manage market risk. > All material risk exposures must be measured and subject to monitoring against limits and triggers for management action and/or escalation. Market risk limits are approved under Board-delegated authority, and within the market risk appetite. Balance sheet allocation by market risk classification Where appropriate, the Risk Framework applies to both traded and non-traded market risks. Santander UK's assets and liabilities that are subject to market risk may be analysed between traded and non-traded market risks classification as follows: Market risk (measure) Market risk (measure) Balance sheet 30 June 2013 £m Traded risk (VaR) £m Non-traded Risk (Other measures) £m Balance sheet 31 December 2012 £m Traded risk (VaR) £m Non-traded Risk (Other measures) £m Non-traded risk primary risk sensitivity Assets subject to market risk Cash and balances at central banks 34,372 - 34,372 28,161 - 28,161 Interest rate Trading assets 31,163 31,163 - 22,498 22,498 - - Derivatives 25,924 22,717 3,207 30,146 28,064 2,082 Equity, foreign exchange, interest rate Financial assets designated at FV 2,821 - 2,821 3,811 - 3,811 Interest rate, credit spread Loans and advances to banks 2,340 - 2,340 2,438 - 2,438 Foreign exchange, interest rate Loans and advances to customers 188,065 - 188,065 191,907 - 191,907 Interest rate Available-for-sale securities 5,178 - 5,178 5,483 - 5,483 Foreign exchange, interest rate Loans and receivables securities 1,269 - 1,269 1,259 - 1,259 Equity, foreign exchange, interest rate Macro hedge of interest rate risk 872 - 872 1,222 - 1,222 Interest rate Retirement benefit assets 203 - 203 254 - 254 Equity, foreign exchange, interest rate, inflation, longevity 292,207 53,880 238,327 287,179 50,562 236,617 Liabilities subject to market risk Deposits by banks 9,242 - 9,242 9,935 - 9,935 Foreign exchange, interest rate Deposits by customers 150,878 - 150,878 149,037 - 149,037 Interest rate Derivatives 23,629 22,331 1,298 28,861 27,415 1,446 Equity, foreign exchange, interest rate Trading liabilities 34,790 34,790 - 21,109 21,109 - - Financial liabilities designated at FV 5,277 - 5,277 4,002 - 4,002 Interest rate, credit spread Debt securities in issue 53,542 - 53,542 59,621 - 59,621 Foreign exchange, interest rate Subordinated liabilities 3,710 - 3,710 3,781 - 3,781 Foreign exchange, interest rate Retirement benefit liabilities 460 - 460 305 - 305 Equity, foreign exchange, interest rate, inflation, longevity 281,528 57,121 224,407 276,651 48,524 228,127 TRADED MARKET RISK INTRODUCTION Traded market risk arises in connection with financial services for customers and the buying, selling and positioning mainly in fixed income, equities, foreign exchange and property markets. This trading activity may lead to a potential decline in net income due to variations in market factors including interest rates, inflation rates, equity, exchange rates, credit spreads and bond prices, property and other instruments.The most significant risk exposures in traded market risk are sensitivities to moves in interest rates, interest rate basis and the equities market. The key areas where traded market risk is generated, controlled and managed are: > Corporate Banking (in the short-term markets business); and > Markets. Market risks arising from structured products, including exposure to changes in levels of equity markets are managed in Markets. TRADED MARKET RISK - CORPORATE BANKING For trading activities (in the short-term markets business), market risk is measured using Value-At-Risk ('VaR') as well as complementary sensitivity and stress testing metrics. Risks not captured in the VaR model are reported and monitored using non-VaR based limits and controls. The following table shows the 1 day 99% VaR-based consolidated exposures for the major risk classes at 30 June 2013 and 31 December 2012, together with the highest, lowest and average exposures for the period. Exposures within each risk class reflect a range of exposures associated with movements in that financial market. The main exposure is due to interest rate risks, e.g. the impact of absolute rate movements, and movements between interest rate bases. The amounts below represent the potential change in market values of trading instruments. Since trading instruments are recorded at market value, these amounts also represent the potential effect on income. Actual Exposure Trading instruments 30 June 2013 £m 31 December 2012 £m Interest rate risks 3.4 2.3 Equity risks 0.8 1.0 Correlation offsets(1) (0.6) (0.6) Total correlated one-day VaR 3.6 2.7 Exposure for the period ended Average exposure Highest exposure Lowest exposure Trading instruments 30 June 2013 £m 31 December 2012 £m 30 June 2013 £m 31 December 2012 £m 30 June 2013 £m 31 December 2012 £m Interest rate risks 3.0 2.3 4.3 3.8 1.9 1.7 Equity risks 0.8 1.0 1.2 1.4 0.6 0.6 Spread risks - 0.2 - 0.8 - - Correlation offsets(1) (0.9) (0.9) - - - - Total correlated one-day VaR 2.9 2.6 4.3 3.9 1.7 1.9 (1) The highest and lowest exposure figures reported for each risk type did not necessarily occur on the same day as the highest and lowest total correlated one-day Value-at-Risk. A corresponding correlation offset effect cannot be calculated and is therefore omitted from the above tables. Corporate Banking daily VaR (short-term markets business) (unreviewed) http://www.rns-pdf.londonstockexchange.com/rns/7359L_10-2013-8-14.pdf The principal component of the movements in Total VaR was changes in Interest Rate risks. Movements in Interest Rates risks in the first half of 2013 were driven by changing interest rate views taken by the trading desks. The increase in 2013 was due to increased risk positioning in line with business plans. TRADED MARKET RISK - MARKETS Market risk-taking is performed only within the constraints of the Market Risk Framework. The majority of the exposure is due to interest rate and equity exposure. Interest rate exposure is generated through trading activities. The current equity exposures are generated by risk management of two types of client business: vanilla risk through the flow business and more exotic risk from structured products. Spread exposure arises indirectly from trading activities within Markets. For trading activities, market risk is measured using VaR as well as complementary sensitivity and stress testing metrics. Risks not captured in the VaR model are reported and monitored using non-VaR based limits and controls. The following table shows the 1 day 99% VaR-based consolidated exposures for the major risk classes at 30 June 2013 and 31 December 2012, together with the highest, lowest and average exposures for the period. Exposures within each risk class reflect a range of exposures associated with movements in that financial market. The amounts below represent the potential change in market values of trading instruments. Since trading instruments are recorded at market value, these amounts also represent the potential effect on income. Actual Exposure Trading instruments 30 June 2013 £m 31 December 2012 £m Interest rate risks 1.8 3.3 Equity risks 2.6 4.4 Property risks 0.1 2.3 Spread risks 0.4 0.2 Other risks(1) - 0.5 Correlation offsets(2) (2.1) (1.9) Total correlated one-day VaR 2.8 8.8 Exposure for the period ended Average exposure Highest exposure Lowest exposure Trading instruments 30 June 2013 £m 31 December 2012 £m 30 June 2013 £m 31 December 2012 £m 30 June 2013 £m 31 December 2012 £m Interest rate risks 2.8 3.0 4.4 5.2 1.8 1.7 Equity risks 2.2 5.0 4.6 8.0 1.4 3.5 Property risks 0.1 2.1 0.2 2.5 - 1.3 Spread risks 0.5 0.1 1.0 0.4 0.2 - Other risks(1) 0.2 0.9 0.5 2.3 - 0.4 Correlation offsets(2) (2.2) (2.4) - - - - Total correlated one-day VaR 3.6 8.7 6.5 12.9 2.3 6.9 (1) Other risks include foreign exchange risk. (2) The highest and lowest exposure figures reported for each risk type did not necessarily occur on the same day as the highest and lowest total correlated one-day Value-at-Risk. A corresponding correlation offset effect cannot be calculated and is therefore omitted from the above tables. With effect from 1 January 2013, the tables above consist of VaR-based metrics. In prior years, the tables consisted of both VaR and non-VaR-based metrics. If the current year presentation were applied to the 2012 data, the total correlated one-day VaR would decrease by £5.1m to £3.6m. Markets daily VaR (unreviewed) http://www.rns-pdf.londonstockexchange.com/rns/7359L_11-2013-8-14.pdf The principal components of the movements in Total VaR were changes in Interest Rate risks and Equity risks. Movements in Interest Rate risks and Equity risks in the first half of 2013 were driven by changing interest rate views taken by the trading desks and also changing trading volumes within the Equity Derivatives desk. STRUCTURAL RISK INTRODUCTION Structural risk includes exposures arising as a result of the structure of portfolios of assets and liabilities, or where the liquidity of the market is such that the exposure could not be closed out over a short-time horizon. The risk exposure is generated by features inherent in either a product or portfolio and normally presented over the life of the product or portfolio. Such exposures are a result of the decision to undertake specific business activities, can take a number of different forms, and are generally managed over a longer-time horizon. Through the internal transfer pricing mechanism, material structural risks arising from divisions are transferred from the originating business to FMIR in Corporate Centre where they are monitored, controlled and managed holistically in conjunction with exposures arising from the funding, liquidity or capital management activities of FMIR. There are four key areas of structural risk within Santander UK, which are discussed in the sections that follow. These are: > Non-traded market risk; > Pensions risk; > Liquidity and funding risk; and > Capital risk. NON-TRADED MARKET RISK Non-traded market risk mainly arises through the provision of banking products and services to personal and corporate/business customers, as well as structural exposures arising in Santander UK's balance sheet. The most significant non-traded market risk on a gross basis is interest rate risk, which includes both yield curve and basis risks. Yield curve risk arises from the timing mismatch in the re-pricing of fixed and variable rate assets, liabilities and off-balance sheet instruments, as well as the investment of non-interest-bearing liabilities in interest-bearing assets. Basis risk arises, to the extent that the underlying market rates impacting pricing within variable rate assets and liabilities are not precisely matched. This exposes the balance sheet to changes in the relationship between market rates, for example between LIBOR and Bank of England Base Rate. Santander UK is also exposed to behavioural risks arising from features in retail products that give customers the right to alter the expected cash flows of a financial contract. For example, prepayment risk, where customers may prepay loans before their contractual maturity. Santander UK is also exposed to product launch risk, where the customers may not take the expected volume of new mortgages or other products. There are three areas where non-traded market risk is permitted, controlled and managed: > Retail Banking; > Corporate Banking; and > Corporate Centre. All non-traded market risks arising from Retail Banking and Corporate Banking are substantially transferred from the originating business to FMIR in Corporate Centre. NON-TRADED MARKET RISK - RETAIL BANKING Non-traded market risks are originated in Retail Banking only as a by-product of writing customer business and are transferred from the originating business to FMIR in Corporate Centre. Funds received with respect to deposits taken are lent on to Corporate Centre on matching terms as regards interest rate re-pricing and maturity; in a similar manner loans are funded through matching borrowings. Market risks arising from structured products, including exposure to changes in the levels of equity markets, are hedged with Markets. Only short-term mismatches due to forecasting variances in prepayment and launch risk exposures are retained within Retail Banking. As these behavioural risks are influenced by internal marketing and pricing activity, they are managed by the Head of Products and Marketing. NON-TRADED MARKET RISK - CORPORATE BANKING Non-traded market risks originated in Corporate Banking are transferred from the originating business to FMIR in Corporate Centre. Funds received with respect to deposits taken are lent on to Corporate Centre on matching terms as regards interest rate re-pricing and maturity; in a similar manner loans are funded through matching borrowings. Any permitted retained market risk exposure is minimal, and is monitored against limits approved through the Market Risk Framework. NON-TRADED MARKET RISK - CORPORATE CENTRE As a consequence of the transfer processes described above, all material non-trading market risk exposures are substantially transferred to and reside within Corporate Centre. Non-traded market risk is managed in line with the Risk Framework. The exposures at 30 June 2013 and 31 December 2012 are outlined below. Analysis of non-traded market risk exposures Net Interest Margin ('NIM') and Economic Value of Equity ('EVE') measures are two of the key measures used by Santander UK that illustrate its exposure to yield curve risk. The following table reflects how the base case valuations would be affected by a 100 basis point parallel shift applied instantaneously to the yield curve. For comparison purposes these measures are shown at 30 June 2013 and 31 December 2012: 30 June 2013 £m 31 December 2012 £m NIM sensitivity to +100 basis points shift in yield curve 298 343 EVE sensitivity to +100 basis points shift in yield curve 282 405 The reduction in sensitivities during the first half of 2013 was due to the net addition of fixed rate assets onto the balance sheet which reduced the positive impact from an interest rate rise but also provide protection in the event of rates remaining lower than currently expected. Due to the protracted period of historically low interest rates, Santander UK remains exposed to a degree of margin compression. This is attributable to the combination of the historically low level of central bank base rates and to reduced earnings from the assets funded by Santander UK's non-dated liabilities. LIQUIDITY AND FUNDING RISK LIQUIDITY RISK LIQUID ASSETS Santander UK holds, at all times, a portfolio of unencumbered liquid assets to mitigate liquidity risk. The size and composition of this portfolio is determined both by internal stress tests as well as the PRA's regulatory regime for liquidity. The table below shows the carrying value and liquidity value of liquid assets held by Santander UK at 30 June 2013 and 31 December 2012 and the weighted average carrying value during the period: Carrying value Liquidity value Weighted average carrying value during the period 30 June 2013 31 December 2012 30 June 2013 31 December 2012 30 June 2013 31 December 2012 £bn £bn £bn £bn £bn £bn Cash at central banks 33 28 33 28 31 28 Government bonds 2 9 2 9 5 7 Core liquid assets (PRA eligible) 35 37 35 37 36 35 High quality bonds 3 2 2 2 2 2 Other liquid assets: - Whole loans and own debt securities(1)(2) 39 36 23 21 37 25 - Other securities 1 1 1 - 2 2 Total liquid assets 78 76 61 60 77 64 (1) Whole loans are loans acceptable on an unsecuritised basis to the Bank of England as collateral for its various funding arrangements. (2) Includes own debt securities (i.e. retained issuances) held by Santander UK of £1bn at 30 June 2013 (2012: £1bn). The classification of the assets in the liquid asset portfolio in the Consolidated Balance Sheet, or their treatment as off-balance sheet at 30 June 2013 and 31 December 2012 was as follows: On balance sheet Off balance sheet 30 June 2013 Total liquid assets Cash Loans and advances to customers Trading Assets Available-for-sale securities Loans and receivables securities Collateral received/ (pledged) Retained issuances of own debt securities £bn £bn £bn £bn £bn £bn £bn £bn Cash at central banks 33 33 - - - - - - Government bonds 2 - - 2 4 - (4) - Core liquid assets (PRA eligible) 35 33 - 2 4 - (4) - High quality bonds 3 - - 1 1 1 - - Other liquid assets: - Whole loans and own debt securities 39 - 38 - - - - 1 - Other securities 1 - - 1 - - - - Total liquid assets 78 33 38 4 5 1 (4) 1 On balance sheet Off balance sheet 31 December 2012 Total liquid assets Cash Loans and advances to customers Trading Assets Available- for-sale securities Loans and receivables securities Collateral received/ (pledged) Retained issuances of own debt securities £bn £bn £bn £bn £bn £bn £bn £bn Cash at central banks 28 28 - - - - - - Government bonds 9 - - - 5 - 4 - Core liquid assets (PRA eligible) 37 28 - - 5 - 4 - High quality bonds 2 - - - 1 1 - - Other liquid assets: - Whole loans and own debt securities 36 - 35 - - - - 1 - Other securities 1 - - - - 1 - - Total liquid assets 76 28 35 - 6 2 4 1 The following tables set out liquid assets by the geographic location of the issuer or counterparty at 30 June 2013 and 31 December 2012: 30 June 2013 £bn 31 December 2012 £bn Core liquid assets (PRA eligible): Cash at central banks: - UK 24 28 - US 9 - 33 28 Government bonds: - UK 1 4 - US - 3 - Japan - 1 - Germany - 1 - Other countries, each less than £1bn(1) 1 - 2 9 Total core liquid assets (PRA eligible) 35 37 High quality(2) corporate bonds and asset-backed securities: - UK 2 1 - US - 1 - Other countries, each less than £1bn(3) 1 - 3 2 Other liquid assets: - UK - Whole loans and own debt securities 39 36 - UK - Other debt securities, bonds, and equities included in major indices 1 1 - Other countries, each less than £1bn - - 43 39 Total liquid assets 78 76 (1) Consists of Belgium, Switzerland, Japan, France, Denmark and designated multilateral development banks. (2) A- rated or above. (3) Consists of Austria, Switzerland, Germany, France, Ireland, Luxembourg and Netherlands. Liquidity developments in the first half of 2013 The first half of 2013 saw the continuation of the improvement in funding rates and market confidence observed in late 2012. Sentiment was driven primarily by the view that the current easing in monetary policy by central banks will continue into the medium term. Santander UK experienced this improvement both in terms of market-wide reduced wholesale, unsecured medium-term and secured medium-term funding rates and, as with other UK banks, in terms of confidence in its own current credit ratings. Throughout 2012, Santander UKcontinued to strengthen its liquidity position. Following the beneficial conditions prevailing in late 2012 and in the first half of 2013 Santander UK reduced its liquidity position whilst maintaining a conservative balance sheet structure (i.e. maintaining high levels of high quality liquid assets) and risk management controls to monitor and manage the levels of the liquid asset portfolio and encumbrance. During the first half of 2013,Santander UK: > Maintained a conservative portfolio of liquid assets that can be utilised to counter the potential impact of a liquidity stress on Santander UK's balance sheet whilst avoiding the holding of excess liquidity that could be better utilised in meeting strategic objectives and business plans. > Maintained the level of medium term funding in the mix at 20.3% which continues to be balanced with the management of encumbrance risk. > Improved the mix of retail and corporate liabilities available for funding, backed by a strategy of rewarding the most stable and behaviourally long-term deposits. > Continued to improve and refine Santander UK's liquidity management capabilities and contingency planning framework, following the revision of its risk management framework in 2012. FUNDING RISK WHOLESALE FUNDING The tables below show Santander UK's primary wholesale funding sources, excluding short-term repurchase agreements. The tables are prepared taking into account scheduled repayments, not the final contractual maturity of the funding. 30 June 2013 On demand Within 1 month Over 1m but not more than 3m Over 3m but not more than 1 year Sub total less than 1 year Over 1 year but not more than 3 years Over 3 years but not more than 5 years Over 5 years Total £bn £bn £bn £bn £bn £bn £bn £bn £bn Deposits by banks - - - 0.8 0.8 3.1 1.9 0.8 6.6 Deposits by customers - - - - - 0.4 0.5 - 0.9 Debt securities in issue: - securitisations - 0.8 0.1 5.7 6.6 11.3 4.5 0.7 23.1 - covered bonds - - 0.5 - 0.5 4.3 5.9 5.8 16.5 - other debt securities 0.3 2.0 1.9 3.5 7.7 3.0 1.3 - 12.0 0.3 2.8 2.5 10.0 15.6 22.1 14.1 7.3 59.1 Financial liabilities at fair value - 1.0 0.5 1.4 2.9 0.7 0.4 1.0 5.0 Trading liabilities 1.3 0.6 0.2 0.5 2.6 - - - 2.6 Subordinated liabilities - - - - - - 0.1 3.6 3.7 Total wholesale funding 1.6 4.4 3.2 11.9 21.1 22.8 14.6 11.9 70.4 31 December 2012 On demand Within 1 month Over 1m but not more than 3m Over 3m but not more than 1 year Sub total less than 1 year Over 1 year but not more than 3 years Over 3 years but not more than 5 years Over 5 years Total £bn £bn £bn £bn £bn £bn £bn £bn £bn Deposits by banks - 0.5 0.7 0.6 1.8 1.7 3.7 0.2 7.4 Deposits by customers - - - - - 0.4 - 0.6 1.0 Debt securities in issue: - securitisations - 1.4 - 5.1 6.5 11.3 5.5 0.7 24.0 - covered bonds - - 1.4 3.6 5.0 4.8 5.1 6.9 21.8 - other debt securities - 4.7 1.0 2.7 8.4 4.4 1.0 - 13.8 - 6.6 3.1 12.0 21.7 22.6 15.3 8.4 68.0 Financial liabilities at fair value - 0.7 0.3 0.6 1.6 1.0 0.6 0.8 4.0 Trading liabilities 0.1 0.5 0.1 0.3 1.0 - 0.1 - 1.1 Subordinated liabilities - - - - - - - 3.8 3.8 Total wholesale funding 0.1 7.8 3.5 12.9 24.3 23.6 16.0 13.0 76.9 Reconciliation of wholesale funding to the balance sheet 30 June 2013 Funding analysis Repos Other Balance sheet £bn £bn £bn £bn Deposits by banks 6.6 0.1 2.4(1) 9.1 Deposits by customers(2) 0.9 - - 0.9 Debt securities in issue: - securitisations 23.1 - 0.4 23.5 - covered bonds 16.5 - 1.5 18.0 - other debt securities 12.0 - - 12.0 59.1 0.1 4.3 63.5 Financial liabilities at fair value 5.0 - 0.3 5.3 Trading liabilities 2.6 22.7 9.5(3) 34.8 Subordinated liabilities 3.7 - - 3.7 Total wholesale funding 70.4 22.8 14.1 107.3 31 December 2012 Funding analysis Repos Other Balance sheet £bn £bn £bn £bn Deposits by banks 7.4 0.1 2.4(1) 9.9 Deposits by customers(2) 1.0 - - 1.0 Debt securities in issue: - securitisations 24.0 - - 24.0 - covered bonds 21.8 - - 21.8 - other debt securities 13.8 - - 13.8 68.0 0.1 2.4 70.5 Financial liabilities at fair value 4.0 - - 4.0 Trading liabilities 1.1 11.7 8.3(3) 21.1 Subordinated liabilities 3.8 - - 3.8 Total wholesale funding 76.9 11.8 10.7 99.4 (1) Principally consists of items in the course of transmission and other deposits. See Note 17 to the Condensed Consolidated Interim Financial Statements. (2) Included in the balance sheet total of £150,878m (2012: £149,037m). (3) Consists of short positions in securities and unsettled trades, cash collateral and short-term deposits. See Note 18 to the Condensed Consolidated Interim Financial Statements. Funding developments in the first half of 2013 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. The return of stable markets meant that in the full year 2013 medium term funding issuance is expected to be a more balanced mix of secured and unsecured issuance. 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 debt and equity. Our funding position remains solid and we reduced our medium term wholesale funding requirement to £2.5bn in the first half of 2013 (2012: £13.9bn) against maturities of approximately £9.3bn. Term issuance In the first half of 2013, Santander UK continued to attract deposits in unsecured money markets and raise additional secured and unsecured term funding in a variety of markets. During the period, Santander UK's term issuance (sterling equivalent) comprised: 30 June 2013 31 December 2012 £bn £bn Securitisations 1.2 7.2 Covered bonds 0.2 3.7 Structured notes 0.2 0.9 Private placements 0.1 - Senior unsecured 0.8 0.6 Structured issuance - 1.5 Total gross issuances 2.5 13.9 At 30 June 2013, 70% (2012: 67%) of wholesale funding had a maturity of greater than one year, with an overall residual duration for wholesale funding of 1,030 days (2012: 1,039 days). NON-FINANCIAL RISKS (unreviewed) The key non-financial risks consist of: > Conduct risk; > Operational risk; > Regulatory risk; > Strategic risk; > Reputational risk; > Human Resources risk; > Accounting and reporting risk; and > Legal risk. CONDUCT RISK (unreviewed) Conduct risk is the risk that the business and operational decisions Santander UK takes and the behaviours displayed lead to poor outcomes for our customers. This is a key risk to Santander UK in view of the evolving regulatory environment and the requirement to make significant conduct remediation provisions principally related to payment protection insurance, other retail products, and interest rate derivative products sold to corporate customers. The Santander UK group engages in discussion, and co-operates, with the FCA in its supervision of the Santander UK group, including reviews exercised under statutory powers, regarding its interaction with past and present customers and policyholders, both as part of the FCA's general thematic work and in relation to specific products and services. The position is monitored with particular reference to those reviews currently in progress where it is not yet possible to reliably determine their outcome. MANAGEMENT'S APPROACH TO CONDUCT RISK > Santander UK takes a robust approach to managing conduct risk in accordance with the risk framework. > Santander UK has noted the significant change in the regulatory environment in recent years. Furthermore, with the transition to the FCA from the FSA there is a further increase in the attention of the regulators on conduct risk to ensure firms demonstrate that they are providing appropriate outcomes for customers. Specific focus is being seen on how firms evidence that they actually deliver the right outcomes for customers and that this is in line with expectations, moving away from a focus on processes and procedures. > In line with all other banks, Santander UK initiated a series of activities to enhance the management of its conduct risks, which culminated in the Conduct Risk Programme. This has focused on the development of four key elements: Risk Policy, Products, Governance and Reporting and Culture. Changes have been made to specific business processes, as well as to the way the business considers, manages and reports conduct risks. In particular, all new products have to be approved by the Product Approval and Oversight Committee which seeks to ensure that new products are appropriately designed. > Santander UK will continue to place significant attention and resource on seeking to ensure that customers receive the right outcome in every instance and that the necessary controls are in place to mitigate the associated risks and this has been embodied in Santander UK's approach of ensuring that its products and its dealings with customers are simple, personal and fair. Details of Santander UK's provision for conduct remediation are set out in Note 21 to the Condensed Consolidated Interim Financial Statements. Further information on conduct remediation provision sensitivities is set out in "Critical accounting policies and Areas of Significant Management Judgement" in Note 1 to the Condensed Consolidated Interim Financial Statements. OPERATIONAL RISK (unreviewed) Operational risk is the risk of loss to Santander UKresulting from inadequate or failed internal processes, people and systems, or from external events. As operational risk is inherent in the processes Santander UK operates, in order to provide services to customers and generate profit for investors, an objective of operational risk management is not to remove operational risk altogether, but to manage the risk to an acceptable level, taking into account the cost/benefits of minimisation as opposed to the inherent risk levels. When such risks materialise they can have not only immediate financial consequences for Santander UK, but also an effect on its business objectives, customer service and regulatory responsibilities. Examples of operational risks include fraud, process failures, system downtime or damage to assets due to fire or floods. The Operational Risk Framework Operational risk exposures arise across Santander UK's business divisions and operating units, and are managed on a consistent basis. Santander UK aims to identify, measure/assess, control/mitigate and inform regarding this risk. Santander UK's priority is to identify and minimise the risk of loss wherever appropriate, irrespective of whether losses have occurred. Measurement of the risk contributes to the establishment of priorities in operational risk management. The Operational Risk Framework creates the consistent approach to how Santander UK controls and manages its operational risks and helps everyone understand their responsibilities within this approach. It is a core component of the overall Risk Framework and facilitates the ongoing reassessment of risk, appetites and controls, in order to ensure that Santander UK manages its risks at all times in line with its business objectives. The Operational Risk Framework defines the operational risk requirements and adopts the following principles: > The Board must understand the main aspects of operational risk and approve and review the management framework. > The operational risk framework must be subject to reviews by the Internal Audit Department. > Operational risk management is part of senior management's responsibility across the business. They must ensure it is introduced into management frameworks throughout Santander UK. > All Santander UK's personnel are managers of the operational risk that is intrinsic to the products, processes and systems they work with every day. > Directly and actively managing operational risk is the responsibility of all Santander UK's entities, divisions and areas. > Operational risk control is a separate function from operational risk management. Operational risk control is carried out by operational risk areas, which use qualitative and quantitative tools to identify, assess, track, measure and mitigate operational risk. > Operational risk managers must have adequate organisation, policies, methodologies and support to hedge the risks. > Business areas must have contingency plans in place to ensure continued operations and minimise losses should their business be interrupted. > Business areas must ensure they have the information available that is needed by the Board and the rest of the business. Santander UK obtains assurance that the appropriate standards of risk management are being maintained through the application of its "three lines of defence" Risk Governance Framework. The management and oversight of Operational Risk is also covered by the "three lines of defence" model as described in the Risk Framework in the Risk Management Report of the 2012 Annual Report. Within the first line of defence, all heads of business and management support units are accountable to the Chief Executive Officer for managing operational risks inherent in their products, activities, processes and systems and from external events. This is further supported by operational risk managers within the business areas and a specialised Operational Risk Unit under the office of the Chief Operating Officer. Within the second line there is the Operational Risk Control Unit ('ORC'). The executive responsibility for the management of the ORC lies with the Head of Strategy & Internal Control who has responsibility for the overall Internal Control Unit. The Internal Control Unit is responsible for effectively controlling risks and ensuring they are managed within the risk limits and mandates approved by the Board and Chief Executive Officer. Operational Risks are reported in conjunction with all key non financial risk information firstly through to the Internal Control Committee which then escalates though to the Executive Risk, Risk Oversight and Board Risk Committees. Operational risk management The "three lines of defence" model applies throughout Santander UK and is implemented taking account of the materiality and perceived risk of the different business areas by following the Operational Risk Management process and using the following key operational risk management tools: KEY TOOLS DESCRIPTION > Scenario Analysis Santander UK performs simulations of control failures that may cause the most extreme loss events. Simulations are developed around high impact risks likely to exceed Santander UK's future appetite. The analysis allows management to better understand the potential impacts and remediate issues by: > identifying the high impact events that would cause most damage to Santander UK, both from a financial and reputational perspective; > ensuring that the business is focused on its most critical risks; and > facilitating the assessment of capital adequacy. > Risk and Control Self Assessments Business units identify and assess their operational risks to ensure they are being effectively managed and controlled, and actions prioritised and aligned to Santander UK's risk appetite. > Key Risk Indicators Key Risk Indicator performance is monitored against tolerances and trigger points that prompt an early warning to potential exposures, whilst the creation of mitigation strategies help address potential concerns. Indicator metrics are used to provide insight into the changing risk profile of the organisation and are also used to assess the performance of key controls. > Loss Data Management Loss data capture and analysis processes exist to capture all operational risk loss events. The data is used to identify and correct control weaknesses using events as opportunities to prevent or reduce the impacts of recurrence, identify emerging themes, inform risk and control assessments, scenario analysis and risk reporting. Escalation of single or aggregated events to senior management and appropriate committees is determined by threshold breaches. > Reporting Reporting forms an integral part of operational risk management ensuring that issues are identified, escalated and managed on a timely basis. Exposures for each business area are reported through monthly risk and control reports which include details on risk exposures and mitigating plans. Events that have a material impact on Santander UK's finances, reputation, or customers are prioritised and reported immediately to key executives. During the first half of 2013, Santander UK continued to manage its key operational risks in the interest of all its stakeholders, responding to critical developments both within Santander UK and in the environment in which it operates. Risk and any required changes to management controls are reported through the Risk Committee governance structure. KEY RISKS DESCRIPTION > Operations and Technology Risk Santander UK continues to invest in electronic information systems to protect customer, employee and other information to effectively manage the evolving risks associated with the loss of confidentiality, integrity and of availability of this information. Appropriate security is applied to protect all customer, employee and other data. Measures taken to reduce the risks include staff education, data encryption and the deployment of specialist software which identifies when customers are at risk of disclosing information to unauthorised parties. > Fraud Risk Santander UK has continued to invest in staff education and improved fraud detection and prevention systems, in order to counter the increasing threat of financial crime and to safeguard the investments of Santander UK's customers and assets. The introduction of sophisticated internet fraud prevention solutions and use of mandatory identification numbers for payments has reduced the risk of fraudulent account takeovers by organised criminals, enhancing our customer identification protocols in a customer friendly manner. The fraud oversight functions continually monitor emerging fraud trends and losses on a case by case basis. Action plans are formulated and tracked to ensure root causes have been identified and effective remediation conducted. > Supplier Risk Supplier risk is the risk of reductions in earnings and/or value, through financial or reputational loss associated with the failure of a service or goods provision by a third party organisation. Santander UK has arrangements with both Banco Santander group companies (including the provision of IT infrastructure, software development and banking operations) and external outsourced service providers. A comprehensive supplier risk management and control framework applies to the management of all suppliers contracted by Santander UK to provide services or goods. Santander UK uses written service level agreements with these entities that include key service performance metrics to support this governance. The high-level governance processes include relationship management, service delivery management and contract management. Across these, there are a number of more detailed processes. Santander UK works closely, and continues to enhance its interaction with outsourced service providers via the application of appropriate risk frameworks. These frameworks include processes and procedures designed to ensure continuity of critical services up to and including disaster scenarios and that these plans are regularly validated through testing. REGULATORY RISK (unreviewed) Regulatory risk is the risk of reductions in earnings and/or value, through financial or reputational loss, from failing to comply with applicable codes and regulatory rules. Santander UK seeks to ensure it fully meets all of its regulatory obligations. There are a number of legislative and regulatory developments both in the UK and abroad, going through a consultation and implementation process, which may have some effect on Santander UK's approach to regulatory risk. Details of the changes expected to have the greatest impact on the Santander UK group's operations are set out in the Supervision and Regulation section of the Directors' Report on page 187 of the 2012 Annual Report. There has been continued regulatory change following the financial crisis and the regulatory landscape continues to evolve. Santander UK maintains a proactive approach to regulation and aims to provide constructive feedback on policy consultations and engage across the banking sector. Santander UK takes compliance with regulatory requirements seriously and manages its arrangements accordingly. STRATEGIC RISK (unreviewed) Strategic Risk is the risk of material deviations in expected/target shareholder value as a result of poor definition or implementation of Santander UK's strategy. Santander UK takes a robust approach to managing strategic risk in full alignment with the Strategic Risk Framework. In setting the business's strategy, risk policies are taken into consideration at all times and the strategy is stress tested against risk appetite statements. Both the strategy and Risk Appetite are approved by the Santander UK Board. Strategic risk is managed on a monthly basis through the risk governance structure including the Strategic Risk and Financial Management Committee and the Board. Management assessment takes into consideration any relevant information across the whole business which may highlight either risks to the implementation of the bank's strategy or where risks are being created due to poor definition of the strategy in order to inform the Executive Committee and Board of what further actions may be required. REPUTATIONAL RISK (unreviewed) Santander UK rigorously manages risks that may affect Santander UK's reputation and which may in turn impact upon its ability to achieve its strategic objectives. Reputational considerations are built into all the key risk and issue assessment tools. HUMAN RESOURCES RISK (unreviewed) Human Resources ('HR') risk is defined in Santander UK as the risk of not having the sufficient number and quality of people to deliver Santander UK's strategy, whilst complying with legislative requirements. In managing HR risk, Santander UK has established a set of policies which outline our minimum standards in relation to the management of people issues. ACCOUNTING AND REPORTING RISK (unreviewed) Accounting and reporting risk is defined as the failure to comply with regulatory and legal requirements for accounting and reporting of financial disclosures, which may lead to fines and/or restrictions and/or reputational damage. In order to facilitate the identification, measurement, monitoring and reporting of accounting and reporting risks, a comprehensive business-wide framework of controls has been established, supported by a programme of regular assessment and reporting designed to identify and remedy any deficiencies in process or practice. This includes the systems and controls developed to support management's attestation on the effectiveness of disclosure controls and controls over financial reporting. LEGAL RISK (unreviewed) Santander UK takes a robust approach to managing legal risk in full alignment with the Legal Risk Framework. This framework has been developed through Santander UK's overall Risk Framework and Operational Risk Framework, which include the core principles of risk management and control activities. The Legal Risk Framework defines the overriding principles and responsibilities for the identification, management, measurement, monitoring, control, reporting and oversight of legal risk. It is the operation of, and outputs from, these risk management activities that enables Santander UK to manage legal risk exposures within the tolerances outlined in the Santander UK Risk Appetite, Limits and Triggers Statement. It is expected that all Business Units will manage their team activities and processes to follow the principles and guidelines set out in the Legal Risk Framework, and with those detailed in the Santander UK Risk and Operational Risk Frameworks. Santander UK continues to monitor, assess and respond to developments concerning legal requirements intended to prevent future financial crises or otherwise assure the stability of financial institutions. CREDIT RISK - AREAS OF FOCUS AND OTHER ITEMS Certain areas and/or specific views of credit risk deserve specialist attention, complementary to global risk management. These consist of country risk exposure, significant concentrations of credit risk, financial instruments of special interest, loans and advances, and impairment loss allowances, and are described on pages 140 to 162 of the 2012 Annual Report. The areas and/or specific views which have changed significantly during the first half of 2013 are described in the following section and consist of: 1. Country risk exposure; 2. Loans and advances; and 3. Impairment loss allowances on loans and advances, and NPLs. 1. COUNTRY RISK EXPOSURE Santander UK manages its country risk exposure under its global limits framework. Within this framework, Santander UK 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, Santander UK 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. Banco Santander group-related risk is considered separately. The country risk tables below show Santander UK's exposures to central and local governments, government guaranteed counterparties, banks, other financial institutions, retail customers and corporate customers at 30 June 2013 and 31 December 2012. 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 Santander UK 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. 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 Banco Santander group companies, which are presented separately on pages 85 to 88. 30 June 2013 Central and local governments £bn Government guaranteed £bn Banks (2) £bn Other financial institutions £bn Retail £bn Corporate £bn Total(1) £bn Eurozone: Peripheral eurozone countries: Italy 0.5 - 0.2 - - 0.1 0.8 Ireland - - - - - 0.3 0.3 Spain (excluding Santander) - - 0.2 - - - 0.2 Portugal - - - - - 0.1 0.1 Other eurozone countries: France 1.4 - 2.6 - - 0.2 4.2 Germany 0.1 - 2.5 - - 0.2 2.8 Luxembourg 0.1 - 0.3 - - 0.7 1.1 The Netherlands - - 0.3 - - 0.7 1.0 Belgium - - 0.2 - - 0.1 0.3 Finland - - 0.1 - - - 0.1 All other eurozone, each < £50m(3) - - - - - - - 2.1 - 6.4 - - 2.4 10.9 All other countries: UK 29.7 - 13.7 16.9 177.2 35.1 272.6 US 9.4 0.1 11.2 1.9 0.1 0.9 23.6 Switzerland 0.6 - 1.3 0.4 - 0.5 2.8 Denmark 1.8 - 0.3 - - 0.2 2.3 Japan 2.3 - 0.3 - - - 2.6 Australia - - 0.1 - 0.1 0.4 0.6 Isle of Man - - - - 0.2 0.3 0.5 Canada - - 0.3 - - 0.1 0.4 Norway - - 0.3 - - 0.1 0.4 Guernsey - - - - - 0.2 0.2 Jersey - - - - - 0.2 0.2 Liberia - - - - - 0.1 0.1 Lichtenstein - - - - - 0.1 0.1 Singapore - - - - - 0.1 0.1 All others, each < £50m - - - - 0.2 0.8 1.0 43.8 0.1 27.5 19.2 177.8 39.1 307.5 (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 £nil and Cyprus of £nil. 31 December 2012 Central and local governments £bn Government guaranteed £bn Banks (2) £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Eurozone: Peripheral eurozone countries: Ireland - - - - - 0.3 0.3 Spain (excluding Santander) - - 0.2 - - 0.1 0.3 Italy - - 0.2 - - - 0.2 Portugal - - - - - 0.1 0.1 Other eurozone countries: Germany 1.3 - 3.5 - - 0.2 5.0 France - - 2.2 - - 0.2 2.4 The Netherlands - - 0.3 0.1 - 0.6 1.0 Luxembourg - - - 0.1 - 0.9 1.0 Belgium - - 0.5 - - - 0.5 All other eurozone, each < £50m(3) - - - - - 0.1 0.1 1.3 - 6.9 0.2 - 2.5 10.9 All other countries: UK 33.5 0.4 14.5 11.8 180.6 43.8 284.6 US 0.8 - 15.2 - 0.1 0.7 16.8 Switzerland 0.5 - 1.8 0.5 - 0.5 3.3 Denmark - - 2.3 - - - 2.3 Japan 1.2 - 0.2 - - 0.2 1.6 Australia - - 0.1 - 0.1 0.3 0.5 Canada - - 0.4 - - - 0.4 Isle of Man - - - - 0.2 0.1 0.3 Norway - - 0.1 - - 0.1 0.2 Cayman Islands - - - - - 0.1 0.1 Lichtenstein - - - - - 0.1 0.1 Guernsey - - - - - 0.1 0.1 Liberia - - - - - 0.1 0.1 All others, each < £50m - - 0.1 - 0.1 0.6 0.8 36.0 0.4 34.7 12.3 181.1 46.7 311.2 (2) Excludes balances with central banks. (3) Includes Greece of £3m and Cyprus of £nil. 30 June 2013 compared to 31 December 2012 Key changes in sovereign and other country risk exposures during the six months ended 30 June 2013 were as follows: > A decrease of £12.0bn in exposure to the UK to £272.6bn. This was due to a reduction in deposits with the Bank of England with deposits instead placed at the US Federal Reserve as part of liquid asset portfolio management activity, partially offset by lower retail business. > An increase of £6.8bn in exposure to the US to £23.6bn. This was primarily due to increased deposits at the US Federal Reserve as part of liquid asset portfolio management activity. This was partially offset by increased securities purchased under resale activity. > An increase of £1.8bn in exposure to France to £4.2bn. This was primarily due to new holdings of government securities as part of the Santander UK group's liquidity position. > A decrease of £0.5bn in exposure to Switzerland to £2.8bn. This was primarily due to reduced holdings of government securities as alternative securities were held. > A decrease of £2.2bn in exposures to Germany to £2.8bn. This was primarily due to reduced holdings of government securities as alternative securities were held. > An increase of £1.0bn in exposures to Japan to £2.6bn. This was primarily due to new holdings of government securities as part of the Santander UK group's liquidity position. > An increase of £0.6bn in exposures to Italy to £0.8bn. This principally reflected the purchase of Italian Government bonds with less than one year maturity as part of short-term markets trading activity. > Movements in the remaining country risk exposures were minimal and exposures to these countries remained at low levels. Further analysis of sovereign debt, other country risk exposures, including peripheral eurozone countries 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 amortised cost are principally classified as loans to banks, loans to customers and loans and receivables securities. Santander UK has no held-to-maturity securities. 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, with the exception of government debt held for liquidity purposes, which are classified as available-for-sale securities. Santander UK has made no reclassifications to/from the assets which are held at fair value from/to any other category. Sovereign debt 30 June 2013 Assets held at Amortised Cost Assets held at Fair Value Central and local governments £bn Government guaranteed £bn Total at amortised cost £bn Central and local governments(1) £bn Government guaranteed £bn Total at fair value £bn Total on Balance Sheet Asset £bn Commitments and undrawn facilities £bn Total(1) £bn Eurozone countries: France - - - 1.4 - 1.4 1.4 - 1.4 Italy - - - 0.5 - 0.5 0.5 - 0.5 Germany - - - 0.1 - 0.1 0.1 - 0.1 Luxembourg - - - 0.1 - 0.1 0.1 - 0.1 - - - 2.1 - 2.1 2.1 - 2.1 All other countries: UK 24.2 - 24.2 5.5 - 5.5 29.7 - 29.7 US 9.2 - 9.2 0.2 0.1 0.3 9.5 - 9.5 Japan - - - 2.3 - 2.3 2.3 - 2.3 Denmark - - - 1.8 - 1.8 1.8 - 1.8 Switzerland - - - 0.6 - 0.6 0.6 - 0.6 33.4 - 33.4 10.4 0.1 10.5 43.9 - 43.9 (1) There are no sovereign debt commitments and undrawn facilities. (2) There are no impairment losses against sovereign debt at amortised cost. 31 December 2012 Assets held at Amortised Cost Assets held at Fair Value Central and local governments £bn Government guaranteed £bn Total at amortised cost £bn Central and Local governments(1) £bn Government guaranteed £bn Total at fair value £bn Total on Balance Sheet Asset £bn Commitments and undrawn facilities £bn Total(1)£bn Eurozone countries: Germany - - - 1.3 - 1.3 1.3 - 1.3 - - - 1.3 - 1.3 1.3 - 1.3 All other countries: UK 27.8 - 27.8 5.7 0.4 6.1 33.9 - 33.9 Japan - - - 1.2 - 1.2 1.2 - 1.2 US 0.4 - 0.4 0.4 - 0.4 0.8 - 0.8 Switzerland - - - 0.5 - 0.5 0.5 - 0.5 28.2 - 28.2 7.8 0.4 8.2 36.4 - 36.4 (1) There are no sovereign debt commitments and undrawn facilities. (2) There are no impairment losses against sovereign debt at amortised cost. Santander UK has no direct sovereign exposures to any other countries. Santander UK has not recognised any impairment losses against sovereign debt which is held at amortised cost, as all of this sovereign debt was issued by the UK Government and US Government. Santander UK has no exposures to credit default swaps (either written or purchased) which are directly referenced to sovereign debt or other instruments that are directly referenced to sovereign debt. Other country risk exposures(1) 30 June 2013 Assets held at Amortised Cost Assets held at Fair Value(2) Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Banks £bn Other financial institutions £bn Corporate £bn Total £bn Total Balance Sheet Asset £bn Commitments and undrawn facilities(3) £bn Total £bn Eurozone: Peripheral eurozone countries: Ireland - - - 0.1 0.1 - - - - 0.1 0.1 0.2 Spain 0.2 - - - 0.2 - - - - 0.2 - 0.2 Italy 0.1 - - 0.1 0.2 0.1 - - 0.1 0.3 - 0.3 Portugal - - - 0.1 0.1 - - - - 0.1 - 0.1 Other eurozone countries: Germany - - - 0.2 0.2 2.5 - - 2.5 2.7 - 2.7 France - - - 0.1 0.1 2.6 - 0.1 2.7 2.8 - 2.8 The Netherlands - - - 0.1 0.1 0.2 - - 0.2 0.3 0.6 0.9 Luxembourg - - - 0.6 0.6 0.3 - - 0.3 0.9 0.1 1.0 Belgium - - - - - 0.2 - - 0.2 0.2 0.1 0.3 Finland - - - - - 0.1 - - 0.1 0.1 - 0.1 Other<£50m - - - - - - - - - - - - 0.3 - - 1.3 1.6 6.0 - 0.1 6.1 7.7 0.9 8.6 All other countries: UK 1.1 5.6 159.2 19.9 185.8 12.6 11.3 5.0 28.9 214.7 28.2 242.9 US 1.0 0.2 0.1 0.8 2.1 10.1 1.7 - 11.8 13.9 0.1 14.0 Switzerland - - - 0.5 0.5 1.3 0.4 - 1.7 2.2 - 2.2 Australia - - 0.1 0.3 0.4 0.1 - - 0.1 0.5 0.1 0.6 Denmark - - - - - 0.3 - - 0.3 0.3 0.2 0.5 Isle of Man - - 0.2 0.3 0.5 - - - - 0.5 - 0.5 Canada - - - 0.1 0.1 0.3 - - 0.3 0.4 - 0.4 Norway - - - - - 0.3 - - 0.3 0.3 0.1 0.4 Japan - - - - - 0.3 - - 0.3 0.3 - 0.3 Guernsey - - - 0.1 0.1 - - 0.1 0.1 0.2 - 0.2 Jersey - - - 0.2 0.2 - - - - 0.2 - 0.2 Liberia - - - 0.1 0.1 - - - - 0.1 - 0.1 Lichtenstein - - - 0.1 0.1 - - - - 0.1 - 0.1 Singapore - - - 0.1 0.1 - - - - 0.1 - 0.1 Other<£50m - - 0.2 0.5 0.7 - - 0.1 0.1 0.8 0.2 1.0 2.1 5.8 159.8 23.0 190.7 25.3 13.4 5.2 43.9 234.6 28.9 263.5 (1) Excluding other Banco Santander group companies. (2) The assets held at fair value were classified as either trading assets or designated as held at fair value through profit or loss. Santander UK did not hold any significant available-for-sale securities, with the exception of government debt held for liquidity purposes, as described on the previous page. (3) Of which £18.0bn is classified as Retail Banking and the remainder is classified as Corporate Banking. 31 December 2012 Assets held at Amortised Cost Assets held at Fair Value(2) Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Banks £bn Other financial institutions £bn Corporate £bn Total £bn Total Balance Sheet Asset £bn Commitments and undrawn facilities(3) £bn Total £bn Eurozone: Peripheral eurozone countries: Ireland - - - 0.2 0.2 - - - - 0.2 0.1 0.3 Spain 0.2 - - 0.1 0.3 - - - - 0.3 - 0.3 Italy 0.1 - - - 0.1 0.1 - - 0.1 0.2 - 0.2 Portugal - - - 0.1 0.1 - - - - 0.1 - 0.1 Other eurozone countries: Germany - - - 0.2 0.2 3.5 - - 3.5 3.7 - 3.7 France - - - 0.1 0.1 2.2 - 0.1 2.3 2.4 - 2.4 The Netherlands - 0.1 - 0.1 0.2 0.3 - - 0.3 0.5 0.5 1.0 Luxembourg - 0.1 - 0.8 0.9 - - - - 0.9 0.1 1.0 Belgium - - - - - 0.5 - - 0.5 0.5 - 0.5 Other<£50m - - - 0.1 0.1 - - - - 0.1 - 0.1 0.3 0.2 - 1.7 2.2 6.6 - 0.1 6.7 8.9 0.7 9.6 31 December 2012 (continued) Assets held at Amortised Cost Assets held at Fair Value(2) Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Banks £bn Other financial institutions £bn Corporate £bn Total £bn Total on Balance Sheet Asset £bn Commitments and undrawn facilities(3) £bn Total £bn All other countries: UK 0.8 4.8 154.5 30.7 190.8 13.4 7.0 3.4 23.8 214.6 36.1 250.7 US 1.3 - 0.1 0.6 2.0 13.9 - 0.1 14.0 16.0 - 16.0 Switzerland - - - 0.3 0.3 1.8 0.5 - 2.3 2.6 0.2 2.8 Denmark - - - - - 2.3 - - 2.3 2.3 - 2.3 Japan - - - - - 0.2 - 0.2 0.4 0.4 - 0.4 Australia - - 0.1 0.2 0.3 0.1 - - 0.1 0.4 0.1 0.5 Canada 0.1 - - - 0.1 0.3 - - 0.3 0.4 - 0.4 Isle of Man - - 0.2 0.1 0.3 - - - - 0.3 - 0.3 Cayman Is. - - - 0.1 0.1 - - - - 0.1 - 0.1 Lichtenstein - - - 0.1 0.1 - - - - 0.1 - 0.1 Norway - - - - - 0.1 - - 0.1 0.1 0.1 0.2 Guernsey - - - - - - - 0.1 0.1 0.1 - 0.1 Liberia - - - 0.1 0.1 - - - - 0.1 - 0.1 Other<£50m - - 0.1 0.5 0.6 - - - - 0.6 0.2 0.8 2.2 4.8 155.0 32.7 194.7 32.1 7.5 3.8 43.4 238.1 36.7 274.8 (1) Excluding other Banco Santander group companies. (2) The assets held at fair value were classified as either trading assets or designated as held at fair value through profit or loss. Santander UK did not hold any significant available-for-sale securities, with the exception of government debt held for liquidity purposes, as described on the previous page. (3) Of which £21.9bn is classified as Retail Banking and the remainder is classified as Corporate Banking. Commitments and undrawn facilities principally consist of formal standby facilities and credit lines in Santander UK's Retail Banking and Corporate Banking operations. Within Retail Banking, these represent credit card, mortgage and overdraft facilities. Within Corporate Banking, these represent standby loan facilities. A summary of the key terms and a maturity analysis of formal standby facilities, credit lines and other commitments are set out in Note 38 to the 2012 Annual Report. Peripheral eurozone countries The tables below further analyse Santander UK's direct exposure to peripheral eurozone countries at 30 June 2013 and 31 December 2012 by type of financial instrument. The tables below exclude balances with other Banco Santander group companies which are presented separately on pages 85 to 88. This section also discusses our indirect exposures to peripheral eurozone countries Direct and indirect risk exposures via large multinational companies and financial institutions are monitored on a regular basis by the Wholesale Credit Risk Department as part of the overall risk management process. Indirect exposures via other corporates are monitored on a regular basis by the Corporate Credit Risk Department. The Large Corporates portfolio is mainly comprised of multinational UK companies which are considered to be geographically well diversified in terms of their assets, operations and profits. This enables them to mitigate any country risk concentration that they may have in peripheral eurozone countries. In addition, the risk is further mitigated by the fact that credit agreements are underpinned by both financial and non-financial covenants. The risk arising from indirect exposures from our transactions with financial institutions is mitigated by the short-term tenor of the transactions, and by the fact that many such transactions contain margin calls and/or collateral requirements, and are subject to standard ISDA Master Agreements permitting offsetting. The risk arising from indirect exposures from our transactions with other corporates is mitigated by standard financial and non-financial guarantees and the fact that the companies are geographically well diversified in terms of their assets, operations and profits. Direct exposures to peripheral eurozone countries (i) Italy 30 June 2013 Central and local governments £bn Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Trading assets 0.5 0.1 - - - 0.6 Loans and receivables securities - 0.1 - - - 0.1 Loans and advances to customers - - - - 0.1 0.1 Derivatives - Derivative assets - 0.1 - - - 0.1 - Derivative liabilities - (0.1) - - - (0.1) Net derivatives position - - - - - - Total 0.5 0.2 - - 0.1 0.8 31 December 2012 Central and local governments £bn Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Loans and receivables securities - 0.1 - - - 0.1 Derivatives - Derivative assets - 0.1 - - - 0.1 - Derivative liabilities - (0.1) - - - (0.1) Net derivatives position - - - - - - Total - 0.1 - - - 0.1 (ii) Spain 30 June 2013 Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Loans and receivables securities 0.2 - - - 0.2 31 December 2012 Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Loans and advances to customers - - - 0.1 0.1 Loans and receivables securities 0.2 - - - 0.2 Total 0.2 - - 0.1 0.3 (iii) Ireland 30 June 2013 Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Loans and advances to customers - - - 0.1 0.1 Loans and receivables securities - - - 0.1 0.1 Total - - - 0.2 0.2 Commitments and undrawn facilities - - - 0.1 0.1 31 December 2012 Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Loans and advances to banks - - - 0.1 0.1 Loans and receivables securities - - - 0.1 0.1 Total - - - 0.2 0.2 Commitments and undrawn facilities - - - 0.1 0.1 (iv) Portugal 30 June 2013 Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Loans and advances to customers - - - 0.1 0.1 31 December 2012 Banks £bn Other financial institutions £bn Retail £bn Corporate £bn Total £bn Loans and advances to customers - - - 0.1 0.1 Indirect exposures to peripheral eurozone countries Indirect exposures to peripheral eurozone countries are considered to exist where our direct counterparties outside the peripheral eurozone countries themselves have a direct exposure to one or more peripheral eurozone countries. Indirect exposures are identified as part of our ongoing credit analysis and monitoring of our counterparty base by the review of available financial information to determine the countries where the material parts of a counterparty's assets, operations or profits arise. Our indirect exposures to peripheral eurozone countries consist of: > A small number of corporate loans to large multinational companies based in the UK that derive a proportion of their profits from one or more peripheral eurozone countries. > Trading transactions and hedging transactions with financial institutions based in the UK and Europe that derive a proportion of their profits from or have a proportion of their assets in one or more peripheral eurozone countries. > A small number of loans to other corporate entities which have either a proportion of their operations within, or profits from, one or more peripheral eurozone countries. > We have no significant indirect exposure to peripheral eurozone countries in our retail business. Balances with other Banco Santander group companies Santander UK enters into transactions with other Banco Santander group companies in the ordinary course of business. Such transactions are undertaken in areas of business where Santander UK has a particular advantage or expertise and where other Banco Santander group companies can offer commercial opportunities, substantially on the same terms as for comparable transactions with third party counterparties. These transactions also arise in support of the activities of, or with, larger multinational corporate clients and financial institutions which may have relationships with a number of entities in the Banco Santander group. At 30 June 2013 and 31 December 2012, Santander UK had gross balances (without taking account of netting, collateral or any other credit risk mitigants) with other Banco Santander group companies as follows: 30 June 2013 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Assets: - Spain 2.1 0.1 - 2.2 - UK - 0.5 - 0.5 - Chile 0.1 - - 0.1 - Other < £50m - 0.1 - 0.1 2.2 0.7 - 2.9 Liabilities: - Spain (2.4) (0.8) (0.1) (3.3) - UK - (1.8) (0.1) (1.9) - Italy - (0.7) - (0.7) - Germany - (0.7) - (0.7) - Ireland - (0.2) - (0.2) - Chile (0.1) - - (0.1) - Other < £50m (0.1) - - (0.1) (2.6) (4.2) (0.2) (7.0) 31 December 2012 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Assets: - Spain 2.5 0.1 - 2.6 - UK - 0.3 - 0.3 - Chile 0.1 - - 0.1 - Other < £50m - 0.1 - 0.1 2.6 0.5 - 3.1 Liabilities: - Spain (4.9) (1.0) (0.1) (6.0) - UK - (1.7) (0.1) (1.8) - Ireland - (0.2) - (0.2) - Chile (0.1) - - (0.1) - USA (0.1) - - (0.1) - Italy - (0.6) - (0.6) - Germany - (0.8) - (0.8) - Other < £50m (0.1) (0.1) - (0.2) (5.2) (4.4) (0.2) (9.8) The above balances with other Banco Santander group companiesat 30 June 2013 principally consisted of: > Reverse repos of £235m (2012: £233m), all of which were collateralised by OECD Government (but not peripheral eurozone) securities. The reverse repos were classified as "Loans and Advances to banks" in the balance sheet. See Note 11 to the Condensed Consolidated Interim Financial Statements. This was partially offset by repo liabilities of £124m (2012: £140m). See Note 17 'Deposits by banks' to the Condensed Consolidated Interim Financial Statements. > Derivative assets of £1,875m (2012: £2,197m) subject to International Swaps and Derivatives Association ('ISDA') Master Agreements including the Credit Support Annex. These balances were partially offset by derivative liabilities of £1,782m (2012: £2,033m) and cash collateral received, as described below. These derivatives are included in Note 9 to the Condensed Consolidated Interim Financial Statements. > Cash collateral of £169m (2012: £206m) given in relation to derivatives futures contracts. The cash collateral was classified as "Trading assets" in the balance sheet. This was more than offset by cash collateral received in relation to other derivatives of £171m (2012: £225m) which was classified as "Trading liabilities" in the balance sheet. See Notes 8 and 18 to the Condensed Consolidated Interim Financial Statements. > Floating rate notes of £23m (2012: £23m), which were classified within "Trading assets" and "Loans and receivables securities" in the balance sheet. See Note 8 to the Condensed Consolidated Interim Financial Statements. > Asset-backed securities of £56m (2012: £47m), which were classified as "Financial assets designated at fair value" in the balance sheet. See Note 10 to the Condensed Consolidated Interim Financial Statements. > Deposits by customers of £1,266m (2012: £1,520m), which were classified as "Deposits by Customers" in the balance sheet. > Debt securities in issue of £1,439m (2012: £3,290m), which were classified as "Debt Securities in Issue" in the balance sheet. See Note 20 to the Condensed Consolidated Interim Financial Statements. These balances represent holdings of debt securities by the wider Santander group as a result of market purchases and for liability management purposes. The decrease in the period reflected contractual maturities. > Other liabilities of £336m (2012: £459m), principally represented dividends payable which were classified as "Other Liabilities" in the balance sheet. > Subordinated liabilities of £1,927m (2012: £1,879m), which were classified as "Subordinated Liabilities" in the balance sheet. These balances represent holdings of debt securities by the wider Banco Santander group as a result of market purchases and for liability management purposes. The above activities are conducted in a manner that appropriately manages the credit risk arising against such other Banco Santander group companies within limits acceptable to the PRA. The tables below further analyse the balances with other Banco Santander group companies at 30 June 2013 and 31 December 2012 by type of financial instrument and country of the counterparty, including the additional mitigating impact of collateral arrangements (which are not included in the summary tables above, as they are accounted for off-balance sheet) and the resulting net credit exposures: (i) Spain 30 June 2013 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Repurchase agreements - Asset balance - reverse repo 0.3 - - 0.3 - Impact of collateral held (off balance sheet) (0.2) - - (0.2) - Net repo asset 0.1 - - 0.1 - Liability balance - repo (0.1) - - (0.1) - Impact of collateral placed (off balance sheet) 0.1 - - 0.1 - Net repo liability - - - - Net repurchase agreement position 0.1 - - 0.1 Derivatives - Derivative assets 1.7 - - 1.7 - Derivative liabilities (1.6) - - (1.6) Cash collateral in relation to derivatives: - placed 0.1 - - 0.1 - held (0.2) - - (0.2) Net derivatives position - - - - Asset-backed securities - 0.1 - 0.1 Total assets, after the impact of collateral 0.1 0.1 - 0.2 Deposits by customers - (0.7) (0.1) (0.8) Debt securities in issue (0.1) (0.1) - (0.2) Other liabilities (0.1) - - (0.1) Subordinated liabilities (0.3) - - (0.3) Total liabilities (0.5) (0.8) (0.1) (1.4) Net balance (0.4) (0.7) (0.1) (1.2) 31 December 2012 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Repurchase agreements - Asset balance - reverse repo 0.3 - - 0.3 - Impact of collateral held (off balance sheet) (0.2) - - (0.2) - Net repo asset 0.1 - - 0.1 - Liability balance - repo (0.1) - - (0.1) - Impact of collateral placed (off balance sheet) 0.1 - - 0.1 - Net repo liability - - - - Net repurchase agreement position 0.1 - - 0.1 Derivatives - Derivative assets 2.0 - - 2.0 - Derivative liabilities (1.9) - - (1.9) Cash collateral in relation to derivatives: - placed 0.2 - - 0.2 - held (0.2) - - (0.2) Net derivatives position 0.1 - - 0.1 Asset-backed securities - 0.1 - 0.1 Total assets, after the impact of collateral 0.2 0.1 - 0.3 Deposits by customers - (0.8) (0.1) (0.9) Debt securities in issue (2.1) (0.1) - (2.2) Other liabilities (0.3) (0.1) - (0.4) Subordinated liabilities (0.3) - - (0.3) Total liabilities (2.7) (1.0) (0.1) (3.8) Net balance (2.5) (0.9) (0.1) (3.5) (ii) Ireland 30 June 2013 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Deposits by customers - (0.2) - (0.2) 31 December 2012 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Deposits by customers - (0.2) - (0.2) (iii) UK 30 June 2013 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Other assets - 0.5 - 0.5 Deposits by customers - (0.2) - (0.2) Other liabilities - - (0.1) (0.1) Subordinated liabilities - (1.6) - (1.6) Total liabilities - (1.8) (0.1) (1.9) Net balance - (1.3) (0.1) (1.4) 31 December 2012 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Other assets - 0.3 - 0.3 Deposits by customers - (0.1) (0.1) (0.2) Subordinated liabilities - (1.6) - (1.6) Total liabilities - (1.7) (0.1) (1.8) Net balance - (1.4) (0.1) (1.5) (iv) Chile 30 June 2013 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Derivatives - Derivative assets 0.1 - - 0.1 - Derivative liabilities (0.1) - - (0.1) Net derivatives position - - - - 31 December 2012 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Derivatives - Derivative assets 0.1 - - 0.1 - Derivative liabilities (0.1) - - (0.1) Net derivatives position - - - - (v) US At 30 June 2013, the Santander UK group had no balances with the US. 31 December 2012 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Deposits by banks (0.1) - - (0.1) (vi) Italy 30 June 2013 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Debt securities in issue (purchased in secondary market) - (0.7) - (0.7) 31 December 2012 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Debt securities in issue (purchased in secondary market) - (0.6) - (0.6) (vii) Germany 30 June 2013 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Deposits by customers - (0.1) - (0.1) Debt securities in issue - (0.6) - (0.6) Total liabilities - (0.7) - (0.7) 31 December 2012 Banks £bn Other financial institutions £bn Corporate £bn Total £bn Deposits by customers - (0.3) - (0.3) Debt securities in issue - (0.5) - (0.5) Total liabilities - (0.8) - (0.8) Redenomination risk Santander UK considers the total dissolution of the eurozone to be extremely unlikely and therefore believes widespread redenomination of its euro-denominated assets and liabilities to be highly improbable. However, for contingency planning purposes Santander UK has analysed the redenomination risk that might arise from an exit of a member state from the euro or a total dissolution of the euro and how that exit or dissolution would be implemented. It is not possible to predict what the total financial impact on Santander UK might be of a eurozone member state exit or the dissolution of the euro. The determination of which assets and liabilities would be legally redenominated is complex and depends on a numbers of factors, including the precise exit scenario, as the consequences on external contracts of a disorderly exit or one sanctioned under EU law may be different. Santander UK has already identified and is monitoring these risks and has taken steps to mitigate them and/or reduce Santander UK's overall exposure to losses that might arise in the event of a redenomination by reducing its balances and funding mismatches. As part of its objective of maintaining a diversified funding base, Santander UK raises funding in a number of currencies, including euro, and converts these back into sterling to fund its commercial assets which are largely sterling denominated. Santander UK's net asset position denominated in euro, reflecting assets and liabilities and associated swaps (which primarily comprise cross-currency derivatives entered into to swap funding raised in euro back into sterling for reasons set out above) arising in connection with contracts denominated in euro, amounted to £0.1bn at 30 June 2013 (2012: net assets of £0.1bn). This comprised debt securities (covered bonds and securitisations) of £26.1bn (2012: 26.1bn) issued by Santander UK as part of its medium term funding activities, medium-term repo liabilities of £7.4bn (2012: £3.0bn), other deposit liabilities of £1.7bn (2012: £0.9bn), other loans and securities of £2.6bn (2012: £2.8bn), net trading repo liabilities of £2.8bn (2012: assets of £2.2bn) and related cross-currency swap assets of £35.5bn (2012: £25.1bn) which swap the resultant euro exposures back into sterling in order to ensure that assets and liabilities are currency matched in sterling. Disclosures of Santander UK's exposure to individual eurozone countries and total exposures to counterparties in those countries, which amounts include any euro-denominated contracts with those counterparties, are set out on pages 79 to 88. 2. LOANS AND ADVANCES The following tables categorise Santander UK's loans and advances at 30 June 2013 and 31 December 2012 into three categories: > neither past due nor impaired; > past due but not individually impaired; or > individually impaired. For certain homogeneous portfolios of loans and advances, impairment is assessed on a collective basis and each loan is not individually assessed for impairment. Loans in this category are classified as neither past due nor impaired, or past due but not individually impaired, depending upon their arrears status. The impairment loss allowances include allowances against financial assets that have been individually assessed for impairment and those that are subject to collective assessment for impairment. 30 June 2013 Neither past due nor impaired Past due but not individually impaired Individually impaired Total Impairment loss allowances Total carrying value Statutory balance sheet line items £m £m £m £m £m £m Trading assets - Loans and advances to banks 9,826 - - 9,826 - 9,826 - Loans and advances to customers 11,906 - - 11,906 - 11,906 Financial assets designated at fair value through P&L - Loans and advances to customers 2,272 - - 2,272 - 2,272 Loans and advances to banks - Placements with other banks 2,106 - - 2,106 - 2,106 - Amounts due from parent 234 - - 234 - 234 Loans and advances to customers - Advances secured on residential property 149,634 4,465 1,220 155,319 (582) 154,737 - Corporate loans 19,334 - 3,027 22,361 (553) 21,808 - Finance leases 3,160 - 9 3,169 (41) 3,128 - Other secured advances 2,586 - 438 3,024 (244) 2,780 - Other unsecured advances 5,082 93 192 5,367 (311) 5,056 - Amounts due from fellow subsidiaries 554 - - 554 - 554 Loans and receivables securities 1,250 - 26 1,276 (7) 1,269 Total loans and advances 207,944 4,558 4,912 217,414 (1,738) 215,676 31 December 2012 Neither past due nor impaired Past due but not individually impaired Individually impaired Total Impairment loss allowances Total carrying value Statutory balance sheet line items £m £m £m £m £m £m Trading assets - Loans and advances to banks 9,988 - - 9,988 - 9,988 - Loans and advances to customers 7,552 - - 7,552 - 7,552 Financial assets designated at fair value through P&L - Loans and advances to customers 3,248 - - 3,248 - 3,248 Loans and advances to banks - Placements with other banks 2,201 - - 2,201 - 2,201 - Amounts due from parent 237 - - 237 - 237 Loans and advances to customers - Advances secured on residential property 151,784 4,384 1,142 157,310 (552) 156,758 - Corporate loans 19,801 - 3,510 23,311 (727) 22,584 - Finance leases 3,053 - 9 3,062 (40) 3,022 - Other secured advances 2,527 - 482 3,009 (169) 2,840 - Other unsecured advances 5,222 127 196 5,545 (314) 5,231 - Amounts due from fellow subsidiaries 347 - - 347 - 347 Loans and receivables securities 1,240 - 25 1,265 (6) 1,259 Total loans and advances 207,200 4,511 5,364 217,075 (1,808) 215,267 31 December 2011 Neither past due nor impaired Past due but not individually impaired Individually impaired Total Impairment loss allowances Total carrying value Statutory balance sheet line items £m £m £m £m £m £m Trading assets - Loans and advances to banks 6,144 - - 6,144 - 6,144 - Loans and advances to customers 6,687 - - 6,687 - 6,687 Financial assets designated at fair value through P&L - Loans and advances to customers 4,376 - - 4,376 - 4,376 Loans and advances to banks - Placements with other banks 2,405 - - 2,405 - 2,405 - Amounts due from parent 2,082 - - 2,082 - 2,082 Loans and advances to customers - Advances secured on residential property 161,767 4,143 937 166,847 (478) 166,369 - Corporate loans 20,746 306 850 21,902 (432) 21,470 - Finance leases 2,937 - 7 2,944 (37) 2,907 - Other secured advances 3,411 144 155 3,710 (107) 3,603 - Other unsecured advances 5,412 147 203 5,762 (376) 5,386 - Amounts due from fellow subsidiaries 32 - - 32 - 32 Loans and receivables securities 1,756 - 21 1,777 (6) 1,771 Total loans and advances 217,755 4,740 2,173 224,668 (1,436) 223,232 Further discussion and analysis of the preceding tables, including cross references to more granular disclosures on a segmental basis elsewhere in the financial statements, including this Risk Management Report, are set out on the following pages. Credit quality of loans and advances that are neither past due nor individually impaired The credit quality of loans and advances that are neither past due nor individually impaired as set out in the table on page 90 is as follows: 30 June 2013 Good Satisfactory Higher Risk Total £m £m £m £m Trading assets - Loans and advances to banks 9,605 163 58 9,826 - Loans and advances to customers 11,906 - - 11,906 Financial assets designated at fair value through profit and loss - Loans and advances to customers 2,272 - - 2,272 Loans and advances to banks - Placements with other banks 2,106 - - 2,106 - Amounts due from parent 234 - - 234 Loans and advances to customers - Advances secured on residential property 129,221 19,876 537 149,634 - Corporate loans 10,188 9,130 16 19,334 - Finance leases 2,811 312 37 3,160 - Other secured advances 690 1,895 1 2,586 - Other unsecured advances 635 4,329 118 5,082 - Amounts due from fellow subsidiaries 554 - - 554 Loans and receivables securities 1,089 21 140 1,250 Total loans and advances 171,311 35,726 907 207,944 31 December 2012 Good Satisfactory Higher Risk Total £m £m £m £m Trading assets - Loans and advances to banks 9,781 190 17 9,988 - Loans and advances to customers 7,552 - - 7,552 Financial assets designated at fair value through profit and loss - Loans and advances to customers 3,248 - - 3,248 Loans and advances to banks - Placements with other banks 2,201 - - 2,201 - Amounts due from parent 237 - - 237 Loans and advances to customers - Advances secured on residential property 130,768 20,515 501 151,784 - Corporate loans 12,633 7,099 69 19,801 - Finance leases 2,701 350 2 3,053 - Other secured advances 517 1,991 19 2,527 - Other unsecured advances 666 4,449 107 5,222 - Amounts due from fellow subsidiaries 347 - - 347 Loans and receivables securities 995 70 175 1,240 Total loans and advances 171,646 34,664 890 207,200 31 December 2011 Good Satisfactory Higher Risk Total £m £m £m £m Trading assets - Loans and advances to banks 5,647 486 11 6,144 - Loans and advances to customers 6,678 9 - 6,687 Financial assets designated at fair value through profit and loss - Loans and advances to customers 4,376 - - 4,376 Loans and advances to banks - Placements with other banks 2,405 - - 2,405 - Amounts due from parent 2,082 - - 2,082 Loans and advances to customers - Advances secured on residential property 148,799 12,537 431 161,767 - Corporate loans 12,831 7,701 214 20,746 - Finance leases 2,582 351 4 2,937 - Other secured advances 1,662 1,671 78 3,411 - Other unsecured advances 780 4,477 155 5,412 - Amounts due from fellow subsidiaries 32 - - 32 Loans and receivables securities 1,208 153 395 1,756 Total loans and advances 189,082 27,385 1,288 217,755 During the first half of 2013, there was an increase in corporate loan assets in the "satisfactory" category. This was due to a combination of factors. A majority of the increase was due to new lending to SMEs, which was rated at the top end of the "satisfactory" range (mainly equivalent to BB and BB+). This was in accordance with our strategy and risk appetite. Approximately half of the remaining increase reflected the adoption of an enhanced mapping from our internal ratings to the external equivalent used to determine "good" or "satisfactory". The balance related to rating migrations undertaken in the normal course of business. Internal measures of credit quality have been used in the table analysing credit quality, above. Different measures are applied to retail and corporate lending, as follows: Retail Lending Corporate Lending Expected loss Probability of default Probability of default Financial statements description Unsecured(1) Secured(2) Good 0.0 - 0.5% 0.0 - 0.5%(3) 0.0 - 0.5% Satisfactory 0.5 - 12.5% 0.5 - 12.5% 0.5 - 12.5% Higher Risk 12.5%+ 12.5%+ 12.5%+ (1) Unsecured consists of other unsecured advances to individuals. (2) Secured consists of advances to individuals secured on residential property. (3) Or a loan-to-value ('LTV') ratio of less than 75%. Summarised descriptions of credit quality used in the financial statements relating to retail and corporate lending are as follows: RATING DESCRIPTION Good There is a very high likelihood that the asset will not default and will be recovered in full. The exposure has a negligible or low probability of default. Such exposure also exhibits a strong capacity to meet financial commitments and only exceptionally shows any period of delinquency. Satisfactory There is a high likelihood that the asset will be recovered and is therefore of no cause for concern to Santander UK. The asset has low to moderate probability of default, strong recovery rates and may typically show only short periods of delinquency. Moderate to high application scores, credit bureau scores or behavioural scores characterise this credit quality. Higher Risk All rated accounts that are not viewed as Good or Satisfactory are rated as Higher Risk. The assets are characterised by some concern over the obligor's ability to make payments when due. There may also be doubts over the value of collateral or security provided. However, the borrower or counterparty is continuing to make payments when due i.e. the assets have not yet converted to actual delinquency and is expected to settle all outstanding amounts of principal and interest. Maturity analysis of loans and advances that are past due but not individually impaired A maturity analysis of loans and advances that are past due but not individually impaired as set out in the table on page 90 is set out below. In the retail loan portfolio, a loan or advance is considered past due when any contractual payments have been missed and for secured loans, when they are more than 30 days in arrears. The amounts disclosed in the table are the total financial asset of the account, not just the past due payments. All retail accounts are classified as non-impaired as impairment loss allowances are raised collectively with the exception of properties in possession, where an impairment loss allowance is raised on a case by case basis and hence are not included in the table below. In the corporate loan portfolio, a loan or advance is considered past due when it is 90 days or more in arrears, and also when Santander UK has reason to believe that full repayment of the loan is in doubt. 30 June 2013 Past due up to 1 month Past due 1-2 months Past due 2-3 months Past due 3-6 months Past due 6 months and over Total £m £m £m £m £m £m Loans and advances to customers - Advances secured on residential property - 1,458 901 1,245 861 4,465 - Other unsecured advances 32 36 8 10 7 93 Total loans and advances 32 1,494 909 1,255 868 4,558 31 December 2012 Past due up to 1 month Past due 1-2 months Past due 2-3 months Past due 3-6 months Past due 6 months and over Total £m £m £m £m £m £m Loans and advances to customers - Advances secured on residential property - 1,545 908 1,141 790 4,384 - Other unsecured advances 33 66 10 11 7 127 Total loans and advances 33 1,611 918 1,152 797 4,511 31 December 2011 Past due up to 1 month Past due 1-2 months Past due 2-3 months Past due 3-6 months Past due 6 months and over Total £m £m £m £m £m £m Loans and advances to customers - Advances secured on residential property - 1,451 899 1,121 672 4,143 - Corporate loans - - - 306 - 306 - Other secured advances - 24 25 71 24 144 - Other unsecured advances 37 65 18 18 9 147 Total loans and advances 37 1,540 942 1,516 705 4,740 Individually impaired loans A summary of the key movements in individually impaired loans as set out in the table on page 90 is set out below. Advances secured on Residential property, Finance leases, and Other unsecured advances Advances secured on residential property, Finance leases, and Other unsecured advances are managed in Retail Banking. During the six months ended 30 June 2013, the total "individually impaired" loans increased slightly to £1,422m (2012: £1,390m) primarily due to regulatory-driven policy and reporting changes for mortgages implemented in early 2012. These changes resulted in a tightening of forbearance policies leading to an increase in arrears stock. In 2012, the total "individually impaired" loans increased to £1,390m (2011: £1,099m) primarily due to collections and recoveries process and policy changes made to meet regulatory guidance. Corporate loans and Other secured advances Corporate loans and Other secured advances are managed in Corporate Banking and Corporate Centre. These balances consist of loans classified as NPLs and loans that have experienced a loss event and have been transferred to risk monitoring under the Watchlist (FEVE) process. Cases in the earliest stages of enhanced monitoring on the Watchlist (FEVE) which have not exhibited signs of a loss event are not classified as individually impaired. As a result, the balance of "individually impaired" Corporate loans and Other secured advances of £3,465m (2012: £3,992m) represents a sub-set of the NPL and Watchlist (FEVE) data presented in the Corporate Banking and Corporate Centre tables on pages 54 and 62, respectively, totalling £4,222m (2012: £5,053m) which also include cases in the earliest stages of enhanced monitoring on the Watchlist (FEVE) which have not exhibited signs of a loss event, as well as undrawn commitments and off balance sheet exposures. During the six months ended 30 June 2013, the total "individually impaired" loans decreased to £3,465m (2012: £3,992m) principally reflecting the decrease in balances in the legacy portfolio in run-off, especially shipping, aviation and Infrastructure, which continued to reduce in line with the strategy to exit these exposures where the opportunity arises. In 2012, the total "individually impaired" loans increased to £3,992m (2011: £1,005m) principally due to a refinement of the provision approach applied in the year, as a result of: > Santander UK's longer track record of historic loss experience on which to base impairment loss calculations as a result of the prolonged economic downturn, particularly impacting the residual legacy portfolio acquired with A&L and the heightened risk of cases in this portfolio ultimately moving to default; and > A change in business mix driven by growth in the SME portfolio, resulting in an increasing proportion of smaller (i.e. SME) loans within the Corporate portfolio. This enhanced track record of historic loss data in 2012 enabled Santander UK to reliably extend the definition of loans considered to be individually impaired to include loans exhibiting earlier signs of stress (i.e. have experienced a loss event prior to missing a payment) than was previously possible. In the past, such loans were typically assessed as part of the incurred but not observed ('IBNO') provision. The effects of this change were that loans which have missed a payment (and are therefore "past due"), and loans that have not missed payments (and therefore are not "past due") but are exhibiting other earlier signs of stress (i.e. Watchlist (FEVE) loans), are now all assessed under a collective observed provision and therefore classified as "Individually impaired". Applying the enhanced provision approach to the 2011 data did not result in a material change year on year i.e. there was not a significant deterioration in credit quality in 2012. Further information on Corporate Banking NPLs is set out in the section "Corporate Banking - Non-performing loans and advances" on page 57. Further information on Corporate Banking cases subject to risk monitoring under the Watchlist (FEVE) system by portfolio is set out in the section "Corporate Banking - Monitoring and recovery management" on page 53. Further information on Corporate Centre NPLs is set out in the section "Corporate Centre - Non-performing loans and advances" on page 64. Further information on Corporate Centre cases subject to risk monitoring under the Watchlist (FEVE) system by portfolio is set out in the section "Corporate Centre - Monitoring and recovery management" on page 62. Impairment loss allowances on loans and advances to customers Santander UK's impairment loss allowances policy is set out in Note 1 of the Condensed Consolidated Interim Financial Statements. Forbearance loans and advances to customers The following tables provide a breakdown of the population of loans and advances to customers which have been subject to forbearance programmes and are included in the previous tables. 30 June 2013 Neither past due nor impaired Past due but not individually impaired Individually impaired Total Impairment loss allowances Total carrying value £m £m £m £m £m £m Loans and advances to customers - Advances secured on residential property 2,942 1,071 211 4,224 (135) 4,089 - Corporate loans 511 - 770 1,281 (235) 1,046 - Finance leases - - 6 6 - 6 - Other secured advances 219 - 80 299 (52) 247 - Other unsecured advances 17 12 26 55 (35) 20 Total forbearance loans and advances to customers 3,689 1,083 1,093 5,865 (457) 5,408 31 December 2012 Neither past due nor impaired Past due but not individually impaired Individually impaired Total Impairment loss allowances Total carrying Value £m £m £m £m £m £m Loans and advances to customers - Advances secured on residential property 2,974 1,108 167 4,249 (119) 4,130 - Corporate loans 548 - 807 1,355 (188) 1,167 - Finance leases 11 - - 11 - 11 - Other secured advances 218 66 64 348 (32) 316 - Other unsecured advances 25 21 41 87 (32) 55 Total forbearance loans and advances to customers 3,776 1,195 1,079 6,050 (371) 5,679 31 December 2011 Neither past due nor impaired Past due but not individually impaired Individually impaired Total Impairment loss allowances Total carrying value £m £m £m £m £m £m Loans and advances to customers - Advances secured on residential property 718 1,617 261 2,596 (71) 2,525 - Corporate loans 532 278 359 1,169 (123) 1,046 - Finance leases 1 10 - 11 - 11 - Other secured advances 140 47 43 230 (20) 210 - Other unsecured advances 25 31 57 113 (48) 65 Total forbearance loans and advances to customers 1,416 1,983 720 4,119 (262) 3,857 References to "past due" in the tables above refer to compliance with the revised contractual terms agreed with the customer as part of the Santander UK group's forbearance programmes. Further details regarding forbearance programmes including discussion and analysis of movements in the period are presented by business segment in the earlier Credit Risk sections for Retail Banking, Corporate Banking, and Corporate Centre. 3. impairment loss allowances on loans and advances to customers, and NPLs Non-performing loans and advances(1) (3) An analysis of Santander UK's NPLs is presented below. 30 June 2013 £m 31 December 2012 (7) £m NPLs that are impaired - UK 2,038 2,185 NPLs that are not impaired - UK 2,107 2,025 Total NPLs(2) 4,145 4,210 Total loans and advances to customers(3) (4) 190,968 194,733 Total impairment loss allowances 1,731 1,803 % % NPL ratio(5) 2.17 2.16 Coverage ratio(6) 42 43 (1) Loans and advances are classified as non-performing typically when the counterparty fails to make payments when contractually due for three months or longer. (2) All NPLs continue accruing interest. (3) Accrued interest is excluded for purposes of these analyses. (4) Loans and advances to customers include Social Housing loans and finance leases, and exclude trading assets. (5) NPLs as a percentage of loans and advances to customers (6) Impairment loan loss allowances as a percentage of NPLs. (7) 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. Movements in NPLs during the period are set out in the table below. Transfers 'in' represent loans which have fallen into arrears during the year and have missed three or more monthly payments. Transfers 'out' represent loans that have returned to performing status, or have been redeemed in full, or have proceeded to litigation and the property repossessed and sold, and the loan written off. £m At 1 January 2013 4,210 Transfers in to NPL 1,312 Transfers out of NPL: - Forbearance (15) - Change in arrears/return to performing status (663) - Loan repayments/redemptions (492) - Write-offs (408) Effect of changes in policies (1) 201 At 30 June 2013 4,145 (1) The effect in 2013 of regulatory-driven policy and reporting changes implemented in early 2012, of which £141m relates to changes in mortgages collections policy and £60m relates to reporting changes. 30 June 2013 compared to 31 December 2012 During the first half of 2013, the value of NPLs decreased to £4,145m (2012: £4,210m) attributable to the return to performing status of certain NPLs, loan redemptions and write-offs. This was offset by changes in arrears status of retail NPLs and loan repayments indicating the successful restructuring of older cases in Corporate Banking. The highlevel of write-offs in the period was driven by the continuing strategy to exit exposures where possible. This was in part through debt sales or realisation of collateral but also involved an increased level of write-offs in the year to date. 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 NPL ratio increased to 2.17% (2012: 2.16%) reflecting the decrease in the stock of loans and advances in the period. The coverage ratio remained stable at 42% (2012: 43%). Performance reflected a stable secured and unsecured portfolio, a result of both the quality of the portfolio and stable economic variables. Forbearance loans At 30 June 2013, the carrying amount of financial assets that would otherwise be past due or impaired whose terms have been forborne was £3,070m (2012: £3,093m). Ratio of write-offs to average loans 30 June 2013 % 31 December 2012 % Ratio of write-offs to average loans during the period 0.19 0.34 This information is provided by RNS The company news service from the London Stock Exchange END IR SFWESLFDSEFA

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