Earnings Release • Aug 14, 2014
Earnings Release
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National Storage Mechanism | Additional information You don't have Javascript enabled. For full functionality this page requires javascript to be enabled. RNS Number : 0919P Santander UK Plc 14 August 2014 Top 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 2014, senior management focused on certain top and emerging risks and their causes. These are described in the following section, including how they link to our strategic business priorities which are described in more detail on page 4, as well as the change in importance for each of them in the first half of 2014. http://www.rns-pdf.londonstockexchange.com/rns/0919P_-2014-8-14.pdf http://www.rns-pdf.londonstockexchange.com/rns/0919P_1-2014-8-14.pdf Top risks A top risk is defined as being a current risk within our business that could potentially have a material impact on our financial results, reputation and the sustainability of our business model. http://www.rns-pdf.londonstockexchange.com/rns/0919P_2-2014-8-14.pdf Emerging and future risks Emerging and future risks An emerging and future risk is defined as being a risk with largely uncertain outcomes which may develop or crystallise in the future. Crystallisation of an emerging risk could have a material effect on long-term strategy. http://www.rns-pdf.londonstockexchange.com/rns/0919P_3-2014-8-14.pdf Credit risk highlights The Santander UK group's main credit portfolios are its UK residential mortgage portfolio and its Corporate Banking portfolio, as follows: http://www.rns-pdf.londonstockexchange.com/rns/0919P_4-2014-8-14.pdf Mortgage NPLs During the first half of 2014, the mortgage asset NPL stock decreased to £2,657m (2013: £2,788m). This reduction resulted largely from improvements in the economic environment and prolonged low interest rates, coupled with improved collections efficiencies introduced both in 2013 and the first half of 2014. The NPL ratio decreased to 1.79% (2013: 1.88%) due to a reduction in NPL stock and a more stable mortgage asset stock. Commercial Banking NPLs During the first half of 2014, the Commercial Banking NPL ratio increased to 3.15% (2013: 3.02%), largely due to a single long-standing loan of £89m which moved to non-performance. A successful restructuring of this loan is anticipated and a conservative provision is held against it. The underlying NPL ratio excluding this case reduced to 2.76%. The improving economy also helped to contribute to a reduction in the level of early arrears (31-90 days), as well as in the proportion of impaired loans. However, the economic recovery remains at an early stage, and a conservative stance was therefore maintained in the provisioning policy. This included allowances made for losses which could stem from factors including regional variation in the risk profile, changes to regulation and contractual maturity defaults. Credit quality remains strong as we continued to adhere to our prudent lending criteria and as we further deliver on our business plan to grow Commercial Banking lending. http://www.rns-pdf.londonstockexchange.com/rns/0919P_5-2014-8-14.pdf Detailed Business Review Group and Divisional Results GROUP SUMMARY SUMMARISED CONSOLIDATED INCOME STATEMENT Six months ended 30 June 2014 £m Six months ended 30 June 2013(1) £m Net interest income 1,673 1,391 Non-interest income 519 570 Total operating income 2,192 1,961 Administrative expenses (876) (992) Depreciation, amortisation and impairment (347) (121) Total operating expenses excluding impairment losses, provisions and charges (1,223) (1,113) Impairment losses on loans and advances (172) (235) Provisions for other liabilities and charges (252) (152) Total operating impairment losses, provisions and charges (424) (387) Profit on continuing operations before tax 545 461 Tax on profit on continuing operations (107) (90) Profit on continuing operations after tax 438 371 Loss from discontinued operations after tax - (12) Profit after tax for the period 438 359 (1) Adjusted to reflect the adoption of IFRIC 21, as described in Note 1 to the Condensed Consolidated Interim Financial Statements. Six months ended 30 June 2014 compared to six months ended 30 June 2013 Profit on continuing operations before tax increased by £84m to £545m in the first half of 2014 (2013: £461m). By income statement line, the movements were: > Net interest income increased by £282m to £1,673m in the first half of 2014 (2013: £1,391m). This was largely due to the lower cost of retail liabilities following the maturity of several tranches of higher cost eSaver products in the second half of 2013, the reduced cost of new ISA liabilities originated in the first half of 2014, as well as increased lending in Commercial Banking. These increases were partly offset by reduced mortgage stock margins reflecting the lower customer rates available on incentive products as the current environment for mortgage lending led to increased activity. This activity, combined with UK Government schemes (such as Help to Buy), led to an increase in customers moving from SVR mortgages. We have been successful in the targeted retention of customers into new Santander UK mortgages. In addition, the returns on our structural hedge strategy were lower than in the first half of 2013 following the maturity of historic contracts that benefited from higher returns. > Non-interest income decreased by £51m to £519m in the first half of 2014 (2013: £570m), largely reflecting a significantly reduced credit arising from the debit valuation adjustments on derivatives written by Santander UK. The decrease was also driven by lower banking fees, including higher cashback on 1|2|3 World products and lower overdraft fees, partially offset by an increase in credit cards business and new product promotions, and continued growth in 1|2|3 World product balances. These decreases were partially offset by a recovery of non-interest income to more normalised levels in our Equity Derivatives and Securities Financing businesses. > Administrative expenses decreased by £116m to £876m in the first half of 2014 (2013: £992m) principally due to a net gain of £218m which arose as a result of scheme changes that limit future defined benefit pension entitlements and provide for the longer term sustainability of our staff pension arrangements. Costs remained tightly controlled, and the decrease was also driven by on-going efficiencies including the consolidation of multi-branch locations. These decreases were partially offset by major investment programmes, including a continued investment in the growth of the businesses serving SME and corporate customers, as well as branch network and digital systems. These support the business transformation and will continue to improve the customer experience across all our distribution channels. > Depreciation, amortisation and impairment costs increased by £226m to £347m in the first half of 2014 (2013: £121m). This was principally due to software write-offs of £206m for the decommissioning of redundant systems following the implementation of our new digital platform and the completion of our product simplification programme. The write-offs will reduce our future depreciation charge. The increase also reflected continued investment in business growth, including branch network systems and digital channels as well as the commencement of depreciation on a new data centre. > Impairment losses on loans and advances decreased by £63m to £172m in the first half of 2014 (2013: £235m). This was largely due to the reduction in impairment losses on mortgages as a result of improving economic conditions, rising house prices, prolonged low interest rates and collections efficiencies introduced both in 2013 and the first half of 2014. > Provisions for other liabilities and charges increased by £100m to £252m in the first half of 2014 (2013: £152m), principally due to a charge of £50m relating to the costs for our on-going branch de-duplication programme. There was also an additional provision of £70m, including related costs, for conduct remediation, of which £65m related to PPI, following a review of recent claims activity which indicates that claims are now expected to continue for longer than originally anticipated; the remaining net £5m charge was for other retail products. In addition, the first half of 2014 benefitted from a reduced provision for restructuring, while 2013 benefitted from a reassessment of the provision for non-PPI retail customer remediation payments. Provision for other liabilities and charges included regulatory costs relating to the FSCS of £100m (2013: £88m). > The taxation charge was higher by 19% largely due to higher profits. The effective tax rate for 2014, based on profit on continuing operations before tax was 19.6% (2013: 19.5%). Loss from discontinued operations after tax of £nil in the first half of 2014 (2013: £12m) reflected the sale of the co-brand credit cards business in 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 and 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 on page 229 of the 2013 Annual Report 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. PROFIT BEFORE TAX BY SEGMENT 30 June 2014 Retail Banking £m Commercial Banking £m Markets £m Corporate Centre £m Total £m Net interest income/(expense) 1,685 264 1 (277) 1,673 Non-interest income 306 131 57 25 519 Total operating income 1,991 395 58 (252) 2,192 Administration expenses (719) (181) (56) 80 (876) Depreciation, amortisation and impairment (112) (13) (1) (221) (347) Total operating expenses excluding impairment losses, provisions and charges (831) (194) (57) (141) (1,223) Impairment losses on loans and advances (107) (56) - (9) (172) Provisions for other liabilities and charges - - - (252) (252) Total operating impairment losses, provisions and charges (107) (56) - (261) (424) Profit/(loss) on continuing operations before tax 1,053 145 1 (654) 545 Loss from discontinued operations after tax - - - - - 30 June 2013 Retail Banking £m Commercial Banking £m Markets £m Corporate Centre(1) £m Total(1) £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 impairment losses, provisions and charges (867) (156) (49) (41) (1,113) Impairment losses on loans and advances (184) (51) - - (235) Provisions for other liabilities and charges - - - (152) (152) Total operating impairment losses, provisions and charges (184) (51) - (152) (387) Profit/(loss) on continuing operations before tax 659 129 (10) (317) 461 Loss from discontinued operations after tax - - - (12) (12) (1) Adjusted to reflect the adoption of IFRIC 21, as described in Note 1 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 and ATMs, as well as through telephony, e-commerce and intermediary channels. It principally serves personal banking customers, but also services small businesses with a turnover of less than £250,000 per annum. Retail Banking products include residential mortgage loans, savings and current accounts, credit cards and personal loans as well as a range of insurance policies. Summarised income statement Six months ended 30 June 2014 £m Six months ended 30 June 2013 £m Net interest income 1,685 1,382 Non-interest income 306 328 Total operating income 1,991 1,710 Administration expenses (719) (772) Depreciation, amortisation and impairment (112) (95) Total operating expenses excluding impairment losses, provisions and charges (831) (867) Impairment losses on loans and advances (107) (184) Total operating impairment losses, provisions and charges (107) (184) Profit on continuing operations before tax 1,053 659 Six months ended 30 June 2014 compared to six months ended 30 June 2013 Profit on continuing operations before tax increased by £394m to £1,053m in the first half of 2014 (2013: £659m). By income statement line, the movements were: > Net interest income increased by £303m to £1,685m in the first half of 2014 (2013: £1,382m). This was largely due to the lower cost of retail liabilities following the maturity of several tranches of higher cost eSaver savings products in the second half of 2013 and the reduced cost of new ISA liabilities originated in the first half of 2014. These increases were partly offset by reduced mortgage stock margins reflecting the lower customer rates available on incentive products as the current environment for mortgage lending led to increased activity. This activity, combined with UK Government schemes (such as Help to Buy), led to an increase in customers moving from SVR mortgages. We have been successful in the targeted retention of customers into new Santander UK mortgages. > Non-interest income decreased by £22m to £306m in the first half of 2014 (2013: £328m). The decrease was driven by lower banking fees, including higher cashback on 1|2|3 World products and lower overdraft fees, partially offset by an increase in credit cards business and new product promotions, and continued growth in 1|2|3 World product balances. > Administration expenses decreased by £53m to £719m in the first half of 2014 (2013: £772m). The decrease was driven by on-going efficiencies including the consolidation of multi-branch locations. > Depreciation, amortisation and impairment expenses increased by £17m to £112m in the first half of 2014 (2013: £95m). The increase reflected continued investment in business growth, including branch network systems and digital channels as well as the commencement of depreciation on a new data centre. > Impairment losses on loans and advances decreased by £77m to £107m in the first half of 2014 (2013: £184m). This was largely due to the reduction in impairment losses on mortgages as a result of improving economic conditions, rising house prices, prolonged low interest rates and collections efficiencies introduced both in 2013 and the first half of 2014. Balances and ratios 30 June 2014 £bn 31 December 2013 £bn Total assets 161.9 160.5 Customer loans 156.6 155.6 - of which mortgages 148.7 148.1 - of which unsecured consumer and vehicle finance 7.9 7.5 Risk-weighted assets 37.3 36.3(1) Customer deposits 126.9 123.2 - of which current accounts 35.1 27.9 NPL ratio(2) (3) 1.77% 1.89% Coverage ratio (4) 32% 31% Mortgage NPL ratio(2)(5) 1.79% 1.88% Mortgage coverage ratio(2)(6) 22% 21% (1) Adjusted for consistency to reflect the CRD IV rules as if they had applied on 31 December 2013 as described in 'Risk-weighted assets' in the Balance Sheet Review on page 32. (2) The balances include interest charged to the customer's account, but exclude interest accrued but not yet charged to the account. (3) NPLs as a percentage of customer loans. (4) Impairment loss allowance as a percentage of NPLs. (5) Mortgage NPLs as a percentage of mortgage assets. (6) Mortgage impairment loss allowance as a percentage of mortgage NPLs. 30 June 2014 compared to 31 December 2013 > Total assets increased to £161.9bn at 30 June 2014 (2013: £160.5bn), mainly due to the rise in customer loans described below. > Customer loans increased to £156.6bn at 30 June 2014 (2013: £155.6bn). Mortgage customer loans increased by £0.6bn as a result of higher new business lending. Increased gross mortgage lending is resulting in modest growth of the mortgage book, and growth is expected to be in line with our internal estimate for the market outlook for 2014 of approximately 1%. SVR mortgage loan balances decreased by £4.2bn in the first half of 2014 to £48.1bn. We have been successful in the targeted retention of customers into new Santander UK mortgages. Unsecured consumer and vehicle finance balances, which include bank overdrafts, unsecured personal loans, credit cards and consumer finance, increased £0.4bn largely in line with our 1|2|3 World loyalty strategy. > Risk-weighted assets increased by 3% to £37.3bn at 30 June 2014 (2013: £36.3bn), reflecting increased mortgage loan approvals and the unsecured personal lending balances growth described above. > Customer deposits increased 3% to £126.9bn at 30 June 2014 (2013: £123.2bn) as current account balances continued to grow. The 1|2|3 Current Account remains central to our retail customer relationship model and was the main driver of a 26% increase in current account balances during the period, partially offset by a managed reduction in other deposit balances without a broader customer relationship, as we continued to focus on retaining and originating accounts held by more loyal customers. > The NPL ratio decreased to 1.77% at 30 June 2014 (2013: 1.89%), with an improvement across both the secured and unsecured lending portfolios. There was a particular improvement in unsecured personal lending and 1|2|3 Credit Cards which benefitted from the better risk profile of 1|2|3 World customers. > The mortgage NPL ratio decreased to 1.79% at 30 June 2014 (2013: 1.88%) as a result of a decrease in mortgage NPLs, which reflected the good credit quality of the portfolio, supported by the improving economic environment for UK households, with low interest rates, rising house prices and falling unemployment. We remain aware that these trends may not continue and we take account of this in setting our provisions. Business volumes Six months ended 30 June 2014 £bn Six months ended 30 June 2013 £bn Mortgage gross lending 12.8 7.9 Mortgage net lending 0.6 (4.3) Retail deposit flows 3.7 (0.5) 30 June 2014 31 December 2013 Number of 1I2I3 World customers 3.0 million 2.4 million Number of loyal customers 3.0 million 2.7 million Six months ended 30 June 2014 > Mortgage gross lending increased to £12.8bn in the first half of 2014, due to improved markets, including gross lending driven by the UK Government-backed Help to Buy scheme. We maintained our prudent lending criteria with an average LTV of 65% (2013: 62%) on new lending in the first half of 2014, including the effect of higher LTV Help to Buy business. > The number of 1|2|3 World customers increased 25% to 3.0 million in the first half of 2014 (2013: 2.4 million), with a continued growing transactional primary customer base. In the first half of 2014, we further expanded the 1|2|3 World by launching the 1|2|3 Mini, a simple current account for children and a 1|2|3 Student account. This makes 1|2|3 World accessible to the whole family and is helping us to deepen customer relationships. Our 1|2|3 World products are competitively priced, and are attracting new customers through our advertising campaigns, positive media feedback, and benefits from other 1|2|3 World products. 1|2|3 World customers tend to have higher balances, more products with us, transact more frequently and with a higher average credit card spend than other customers. COMMERCIAL BANKING Commercial Banking offers a wide range of products and financial services to customers through a network of regional CBCs and through telephony and e-commerce channels. Commercial Banking products and services include loans, bank accounts, deposits, treasury services, invoice discounting, cash transmission and asset finance. The management of our customers is organised according to the annual turnover of their business, enabling us to offer a differentiated service to small and medium enterprises ('SMEs'), mid and large corporate customers. The SME and mid corporate business principally serves SMEs with an annual turnover of more than £250,000 up to £50m, 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 2014 £m Six months ended 30 June 2013 £m Net interest income 264 199 Non-interest income 131 137 Total operating income 395 336 Administration expenses (181) (147) Depreciation, amortisation and impairment (13) (9) Total operating expenses excluding impairment losses, provisions and charges (194) (156) Impairment losses on loans and advances (56) (51) Total operating impairment losses, provisions and charges (56) (51) Profit on continuing operations before tax 145 129 Six months ended 30 June 2014 compared to six months ended 30 June 2013 Profit on continuing operations before tax increased by £16m to £145m in the first half of 2014 (2013: £129m). By income statement line, the movements were: > Net interest income increased by £65m to £264m in the first half of 2014 (2013: £199m), principally as a result of continued growth in customer loans and improved new business margins in the core SME segments, with margins on deposits also improving. Much of this growth was generated through the network of regional CBCs. > Non-interest income decreased by £6m to £131m in the first half of 2014 (2013: £137m) reflecting lower income from Large Corporates, primarily as a result of lower demand for interest rate risk management products in a relatively stable, low interest rate environment, partially offset by increased client short-term market activity. > Administration expenses increased by £34m to £181m in the first half of 2014 (2013: £147m). The increase reflected the continued investment in the growth of the businesses serving SME and corporate customers through the increasing number of relationship managers in our growing network of CBCs as we open new financial centres across the UK. We are investing further in our Commercial Banking business by building on the expertise and presence of the wider Banco Santander group. In the first half of 2014, we launched a new corporate internet banking capability ('Connect'), a new trade portal, the Santander Passport and a range of other international financial services. > Depreciation, amortisation and impairment increased by £4m to £13m in the first half of 2014 (2013: £9m) due to the continued investment in systems to improve and support new transactional capabilities for our customers and the increase in our growing network of CBCs. > Impairment losses on loans and advances increased by £5m to £56m in the first half of 2014 (2013: £51m). Credit quality in the loan books continued to be good, supported by the improving economic environment. Balances and ratios 30 June 2014 £bn 31 December 2013 £bn Total assets 28.6 32.7 Total customer loans 23.1 22.1 - of which corporate SMEs 11.9 11.7 Risk-weighted assets 28.4 26.8(1) Customer deposits 14.6 12.6 NPL ratio(2) (3) 3.15% 3.02% Coverage ratio(2) (4) 49% 53% (1) Adjusted for consistency to reflect the CRD IV rules as if they had applied on 31 December 2013 as described in 'Risk-weighted assets' in the Balance Sheet Review on page 32. (2) The balances include interest charged to the customer's account, but exclude interest accrued but not yet charged to the account. (3) NPLs as a percentage of customer loans. (4) Impairment loss allowance as a percentage of NPLs. 30 June 2014 compared to 31 December 2013 > Total assets comprise customer loans and assets relating to short-term markets activities including repos and derivatives. Total assets decreased by 13% to £28.6bn at 30 June 2014 (2013: £32.7bn) driven by the net of an increase in customer loans (described below), and a decrease in repo and securities financing activities in short-term markets. > Customer loans increased by 5% to £23.1bn at 30 June 2014 (2013: £22.1bn) maintaining growth momentum. Corporate lending growth continues to be subject to prudent risk management criteria. This growth was predominantly driven by our network of CBCs as we continue to invest in growing our SME market share. Following a periodic review in the first quarter of 2014, the management of a number of customers was transferred from the SME portfolio to the large corporate portfolio as the annual turnover of their businesses had increased; prior periods have not been restated. The balance associated with these loans was £327m. Excluding this transfer, SME lending growth amounted to 6% in the first half of the year. > Risk-weighted assets increased by 6% to £28.4bn at 30 June 2014 (2013: £26.8bn) due to higher lending to customers, described above. > Customer deposits increased by 16% to £14.6bn at 30 June 2014 (2013: £12.6bn) principally reflecting strong inflows during the period as we continued to develop deeper relationships with our clients, and build on our new enhanced corporate cash management and liability capabilities. > The NPL ratio increased to 3.15% at 30 June 2014 (2013: 3.02%), largely due to a single long-standing loan of £89m which moved to non-performance. A successful restructure of this loan is still anticipated and a conservative provision is held against it. Credit quality remains strong as we continue to adhere to our prudent lending criteria and as we further deliver on our business plan to expand Commercial Banking lending. 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. Summarised income statement Six months ended 30 June 2014 £m Six months ended 30 June 2013 £m Net interest income/(expense) 1 (1) Non-interest income 57 40 Total operating income 58 39 Administration expenses (56) (48) Depreciation, amortisation and impairment (1) (1) Total operating expenses excluding impairment losses, provisions and charges (57) (49) Provisions for other liabilities and charges - - Total operating impairment losses, provisions and charges - - Profit on continuing operations before tax 1 (10) Six months ended 30 June 2014 compared to six months ended 30 June 2013 Profit on continuing operations before tax increased by £11m to £1m in the first half of 2014 (2013: loss of £10m). By income statement line, the movements were: > Net interest income/(expense) increased by £2m to £1m in the first half of 2014 (2013: expense of £1m), primarily due to a decrease in funding costs. > Non-interest income increased by £17m to £57m in the first half of 2014 (2013: £40m). Following a refocusing of the Equity Derivatives and Securities Financing businesses in 2013, non-interest income recovered to more normalised levels. > Administration expenses increased by £8m to £56m in the first half of 2014 (2013: £48m), reflecting investment in developing interest rate and fixed income product capabilities offset by tight cost control. > Depreciation, amortisation and impairment remained unchanged at £1m in the first half of 2014 (2013: £1m). Balances 30 June 2014 £bn 31 December 2013 £bn Total assets (1) 17.3 19.3 Risk-weighted assets 6.7 6.7(2) (1) Primarily comprises derivative assets (2) Adjusted for consistency to reflect the CRD IV rules as if they had applied on 31 December 2013 as described in 'Risk-weighted assets' in the Balance Sheet Review on page 32. 30 June 2014 compared to 31 December 2013 > Total assets comprise derivatives for fixed income and equity products. Total assets decreased by 10% to £17.3bn at 30 June 2014 (2013: £19.3bn). The decrease was mainly driven by the maturity of trades which were economically hedging a portfolio which also matured in the period. This was partially offset by movements in yield curves. > Risk-weighted assets were broadly flat at £6.7bn at 30 June 2014 (2013: £6.7bn) as the reduction in derivatives, which are subject to netting and collateral, did not impact risk-weighted assets. CORPORATE CENTRE Corporate Centreincludes Financial Management & Investor Relations ('FMIR') and the non-core corporate and legacy portfolios, as well as the co-brand credit cards business sold in 2013 which has been presented as discontinued operations. FMIR is responsible for managing capital and funding, balance sheet composition and structure, 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. Summarised income statement Six months ended 30 June 2014 £m Six months ended 30 June 2013(1) £m Net interest expense (277) (189) Non-interest income 25 65 Total operating expense (252) (124) Administration expenses 80 (25) Depreciation, amortisation and impairment (221) (16) Total operating expenses excluding impairment losses, provisions and charges (141) (41) Impairment losses on loans and advances (9) - Provisions for other liabilities and charges (252) (152) Total operating impairment losses, provisions and charges (261) (152) Loss on continuing operations before tax (654) (317) Loss on discontinued operations after tax - (12) (1) Adjusted to reflect the adoption of IFRIC 21, as described in Note 1 to the Condensed Consolidated Interim Financial Statements. Six months ended 30 June 2014 compared to six months ended 30 June 2013 Loss on continuing operations before tax increased by £337m to £654m in the first half of 2014 (2013: £317m). By income statement line, the movements were: > Net interest expense increased by £88m to £277m in the first half of 2014 (2013: £189m) as the returns on our structural hedge strategy were lower than in the first half of 2013 following the maturity of historic contracts that benefited from higher returns. > Non-interest income decreased by £40m to £25m in the first half of 2014 (2013: £65m) largely reflecting a significantly reduced credit arising from the debit valuation adjustments on derivatives written by Santander UK. > Administration expenses decreased by £105m to a benefit of £80m in the first half of 2014 (2013: expense of £25m). This was largely due to a net gain of £218m which arose as a result of scheme changes that limit future defined benefit pension entitlements and provide for the longer term sustainability of our staff pension arrangement. This was partially offset by additional project costs, including those relating to our investment programme, which were borne centrally. > Depreciation, amortisation and impairment increased by £205m to £221m in the first half of 2014 (2013: £16m). This was principally due to software write-offs of £206m for the decommissioning of redundant systems following the implementation of our new digital platform and the completion of our product simplification programme. The write-offs will reduce our future depreciation charge. > Impairment losses on loans and advances increased by £9m to £9m in the first half of 2014 (2013: £nil) due to modest provisions raised in relation to the non-core corporate and legacy portfolios in run-off. > Provision for other liabilities and charges increased by £100m to £252m in the first half of 2014 (2013: £152m), principally due to a charge of £50m relating to the costs for our on-going branch de-duplication programme. There was also an additional provision of £70m, including related costs, for conduct remediation, of which £65m related to PPI, following a review of recent claims activity which indicates that claims are now expected to continue for longer than originally anticipated; the remaining net £5m charge related to other retail products. In addition, the first half of 2014 benefitted from a reduced provision for restructuring, while 2013 benefitted from a reassessment of the provision for non-PPI retail customer remediation payments. Provision for other liabilities and charges included regulatory costs relating to the FSCS of £100m (2013: £88m). Following the adoption of IFRIC 21 on 1 January 2014, the charge for the FSCS is now recognised in the first half of the year as set out in Note 1 to the Condensed Consolidated Interim Financial Statements. IFRIC 21 has been applied retrospectively and prior periods have been adjusted. Loss from discontinued operations after tax of £nil in the first half of 2014 (2013: £12m) reflected the sale of the co-brand credit cards business in 2013. Balances and ratios 30 June 2014 £bn 31 December 2013 £bn Total assets 62.4 57.8 Eligible liquid assets(1) 32.2 29.5 Total customer loans (non-core) 8.7 9.4 Risk-weighted assets 7.5 7.9(2) Customer deposits 9.2 10.6 NPL ratio(3) (4) 2.10% 2.36% Coverage ratio(3) (5) 132% 125% (1) Includes off balance sheet items per liquid assets table on page 70. (2) Adjusted for consistency to reflect the CRD IV rules as if they had applied on 31 December 2013 as described in 'Risk-weighted assets' in the Balance Sheet Review on page 32. (3) The balances include interest charged to the customer's account, but exclude interest accrued but not yet charged to the account. (4) NPLs as a percentage of customer loans. (5) Impairment loan loss allowance as a percentage of non-performing loans. The impairment loan loss allowance includes provisions against both non-performing loans and other loans where a provision is required. As a result the ratio can exceed 100% Non-core assets 30 June 2014 £bn 31 December 2013 £bn Social housing 7.0 7.1 Commercial mortgages 1.0 1.2 Shipping 0.3 0.4 Aviation 0.2 0.4 Other 0.2 0.3 Non-core customer loans 8.7 9.4 Legacy Treasury asset portfolio 1.3 2.0 Total non-core assets 10.0 11.4 30 June 2014 compared to 31 December 2013 > Total assets increased by 8% to £62.4bn at 30 June 2014 (2013: £57.8bn) driven by the increase in eligible liquid assets, partially offset by the reduction in non-core customer loans described below. Eligible liquid asset balances continued to be managed against liquidity requirements with a focus on efficiency, given stability in capital markets and as a consequence of historic actions taken to strengthen the balance sheet. As in 2013, surplus liquidity was also utilised to fund maturing medium term funding and to invest in the ALCO portfolio. > Customer loans decreased by 7% to £8.7bn at 30 June 2014 (2013: £9.4bn) due to the rundown of the non-core corporate and legacy portfolios as we continued to successfully implement our on-going exit strategy from individual loans and leases. Disposals of assets continued across the portfolios with no significant impact on the income statement. The Social Housing loan portfolio remained relatively stable, reflecting its long-term, low risk nature. > Risk-weighted assets decreased by 5% to £7.5bn at 30 June 2014 (2013: £7.9bn) principally due to the reduction in customer loans due to the continued run-down of the non-core corporate and legacy portfolios. > Customer deposits decreased by 13% to £9.2bn at 30 June 2014 (2013: £10.6bn), as part of a plan for the management of our less relationship driven deposit base. > The NPL ratio decreased to 2.10% at 30 June 2014 (2013: 2.36%), reflecting the on-going sale and run-off of the non-core corporate and legacy assets which continue with no significant impact on the income statement. Social Housing comprised 80% of customer loans in Corporate Centre at 30 June 2014, and this portfolio is fully performing. Balance Sheet Review Index 25 Summarised condensed consolidated balance sheet 27 Short-term borrowings 28 Capital management and resources 34 Liquidity and funding 35 Average balance sheet This Balance Sheet Review describes Santander UK's significant assets and liabilities and its strategy and reasons for entering into such transactions. Throughout this section, references to UK and non-UK, in the geographic analysis, refer to the location of the office where the transaction is recorded. This Balance Sheet Review focuses on those areas that have changed significantly during the first half of 2014, and represents an update to the Balance Sheet Review in the 2013 Annual Report, with which it should be read in conjunction. The Balance Sheet Review in the 2013 Annual Report contains additional disclosures which have not changed significantly during the first half of 2014. SUMMARISED CONDENSED CONSOLIDATED BALANCE SHEET 30 June 2014 £m 31 December 2013(1) £m Assets Cash and balances at central banks 26,568 26,374 Trading assets 18,701 22,294 Derivative financial instruments 19,159 20,049 Financial assets designated at fair value 2,754 2,747 Loans and advances to banks 2,325 2,347 Loans and advances to customers 186,094 184,587 Loans and receivables securities 869 1,101 Available for sale securities 7,755 5,005 Macro hedge of interest rate risk 727 769 Interest in other entities 36 27 Property, plant and equipment 1,530 1,521 Retirement benefit assets 235 118 Tax, intangibles and other assets 3,467 3,347 Total assets 270,220 270,286 Liabilities Deposits by banks 8,234 8,696 Deposits by customers 150,734 147,167 Trading liabilities 17,848 21,278 Derivative financial instruments 19,030 18,863 Financial liabilities designated at fair value 3,252 3,407 Debt securities in issue 50,258 50,870 Subordinated liabilities 4,272 4,306 Retirement benefit obligations 408 672 Tax, other liabilities and provisions 2,586 2,437 Total liabilities 256,622 257,696 Equity Total shareholders' equity 13,598 12,590 Total equity 13,598 12,590 Total liabilities and equity 270,220 270,286 (1) Adjusted to reflect the adoption of IFRIC 21, as described in Note 1 to the Condensed Consolidated Interim Financial Statements. A more detailed consolidated balance sheet is contained in the Condensed Consolidated Interim Financial Statements. 30 June 2014 compared to 31 December 2013 Assets Trading assets Trading assets decreased by 16% to £18,701m at 30 June 2014 (2013: £22,294m), reflecting lower levels of activity relating to securities purchased under resale agreements to both banks and customers partially offset by increased holdings of £2,507m of equity instruments as part of short-term markets trading activity. Derivative financial instruments - assets Derivative assets decreased by 4% to £19,159m at 30 June 2014 (2013: £20,049m). The decrease was mainly driven by the maturity of trades which were economically hedging a portfolio which also matured in the period. This was partially offset by movements in yield curves. Loans and advances to customers Loans and advances to customers increased by 1% to £186,094m at 30 June 2014 (2013: £184,587m) principally due to increased mortgage lending and Commercial Banking loans. We remain focused on increasing new mortgage lending in line with the market. Available for sale securities Available for sale securities increased by 55% to £7,755m at 30 June 2014 (2013: £5,005m) largely due to the purchase of Government bonds as part of normal liquid asset portfolio management activity. Retirement benefit assets Retirement benefit assets increased by 99% to £235m at 30 June 2014 (2013: £118m). For those sections of the Santander UK Group Pension Scheme which had surpluses, the key drivers of the increase were scheme changes that limit future defined benefit pension entitlements and provide for the longer term sustainability of our staff pension arrangements. In remeasurement of the defined benefit pension schemes during the period, the return on plan assets (excluding net interest income) exceeded the actuarial losses arising from changes in financial assumptions. Tax, intangibles and other assets Tax, intangibles and other assets increased by 3% to £3,467m at 30 June 2014 (2013: £3,347m). The increase primarily reflected an increase in prepayments, partially offset by a reduction in intangible software assets as a result of write-offs for the decommissioning of redundant systems following the implementation of our new digital platform and the completion of our product simplification programme. Liabilities Deposits by customers Deposits by customers increased by 2% to £150,734m at 30 June 2014 (2013: £147,167m) as we focused on retaining and originating accounts held by more loyal Retail Banking customers. Current account balances increased, partially offset by lower savings deposit balances as we focused on reducing short-term retail deposits without a broader customer relationship. Trading liabilities Trading liabilities decreased by 16% to £17,848m at 30 June 2014 (2013: £21,278m). A decrease in securities sold under repurchase activities and the cash collateral received as part of normal trading activity were offset by an increase in short-term deposits and short positions in securities. Derivative financial instruments - liabilities Derivative liabilities were broadly unchanged at £19,030m at 30 June 2014 (2013: £18,863m). Debt securities in issue Debt securities in issue decreased by 1% to £50,258m at 30 June 2014 (2013: £50,870m) as new issuances during the period were broadly offset by maturities and changes in foreign exchange rates. Subordinated liabilities Subordinated liabilities decreased by 1% to £4,272m at 30 June 2014 (2013: £4,306m) due to changes in foreign exchange rates. Retirement benefit obligations Retirement benefit obligations decreased by 39% to £408m at 30 June 2014 (2013: £672m). The explanation for the movement is the same as that given for retirement benefit assets above. Tax, other liabilities and provisions Tax, other liabilities and provisions increased by 6% to £2,586m at 30 June 2014 (2013: £2,437m). The increase principally reflected provisions for vacant property and conduct remediation, partially offset by utilisation during the period. Equity Total shareholders' equity increased by 9% to £13,598m at 30 June 2014 (2013: £12,590m). The increase was principally attributable to the issuance of £500m Perpetual Capital Securities to our immediate parent company, actuarial gains and the retained profit for the period. 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 (the '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 2014 and 2013. Six months ended 30 June 2014 £m Six months ended 30 June 2013 £m Securities sold under repurchase agreements - Period-end balance 14,673 23,664 - Period-end interest rate 0.65% 0.35% - Average balance(1) 24,479 19,740 - Average interest rate(1) 0.47% 0.39% - Maximum balance(1) 27,396 23,664 Commercial paper - Period-end balance 3,862 4,687 - Period-end interest rate 0.61% 0.47% - Average balance(1) 4,043 4,223 - Average interest rate(1) 0.39% 0.53% - Maximum balance(1) 4,610 4,687 Borrowings from banks (Deposits by banks)(2) - Period-end balance 3,213 2,374 - Period-end interest rate 0.08% 0.00% - Average balance(1) 1,485 2,592 - Average interest rate(1) 0.03% 0.03% - Maximum balance(1) 3,213 3,401 Negotiable certificates of deposit - Period-end balance 4,119 2,336 - Period-end interest rate 2.00% 1.96% - Average balance(1) 3,588 2,299 - Average interest rate(1) 2.51% 1.77% - Maximum balance(1) 4,119 2,724 Other debt securities in issue - Period-end balance 4,864 4,661 - Period-end interest rate 2.86% 2.92% - Average balance(1) 4,967 6,578 - Average interest rate(1) 3.09% 2.90% - Maximum balance(1) 5,975 8,308 (1) Calculated using monthly data. (2) The period-end deposits by banks balance includes non-interest bearing items in the course of transmission of £315m (30 June 2013: £586m). 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 can be found in Note 47 in the 2013 Annual Report. Details of Santander UK's capital at 30 June 2014 can be found in Note 33 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. The European Central Bank ('ECB') will commence supervision of the Banco Santander group from late 2014 as part of the Single Supervisory Mechanism ('SSM'). 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 2014. 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, in previous periods further disclosures on capital could be found in Santander UK's "Additional Capital and Risk Management Disclosures" on www.santander.co.uk. This information principally consisted of transitional disclosures about CRD IV. Following the adoption of CRD IV with effect from 1 January 2014, such transitional disclosures are no longer required, and the remaining disclosures have been incorporated into the following sections. Consequently, a separate "Additional Capital and Risk Management Disclosures" document has not been published at this half year. 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 PRA (as a UK authorised bank) and the Banco de España (as a member of the Banco Santander group). The ECB will commence supervision of the Banco Santander group from late 2014 as part of the SSM. 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. Santander UK Group Holdings Limited became the holding company of Santander UK plc with effect from 10 January 2014. From this date, Santander UK Group Holdings Limited became the head of the Santander UK group for regulatory capital and leverage purposes. The basis of consolidation used for capital-related disclosures in this document reflects the Santander UK group, which corresponds to the basis of consolidation of the financial statements. At 30 June 2014, the capital and leverage ratios of the Santander UK Group Holdings Limited consolidated group were substantially the same as those of the Santander UK group. 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. Key capital ratios The calculations of capital are prepared on a basis consistent with Santander UK's regulatory filings at 30 June 2014, following the adoption of CRD IV with effect from 1 January 2014. The amounts presented for 31 December 2013 have been prepared on a consistent basis, to aid comparability, as described above. 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 CRD IV: 30 June 2014 % 31 December 2013 % CET 1 capital ratio 11.8 11.6 Total capital ratio 17.8 17.1 Regulatory capital resources The table below analyses the composition of Santander UK's regulatory capital resources. The calculations reflect the amounts prepared on a basis consistent with Santander UK's regulatory filings at 30 June 2014, following the adoption of CRD IV with effect from 1 January 2014. The amounts presented for 31 December 2013 have been prepared on a consistent basis, to aid comparability. The amounts presented for 2013 have not been adjusted to reflect the adoption of IFRIC 21, as set out in Note 1 to the Condensed Consolidated Interim Financial Statements. The adjustment would not have had a material effect on Santander UK's regulatory position. 30 June 2014 £m 31 December 2013 £m Common Equity Tier 1 ('CET 1') capital instruments and reserves: - Capital instruments and related share premium accounts 8,725 8,725 - Retained earnings 3,640 3,307 - Accumulated other comprehensive income and other reserves 129 (116) CET 1 capital before regulatory adjustments 12,494 11,916 CET 1 regulatory adjustments: - Additional value adjustments (85) (75) - Intangible assets (net of tax) (2,085) (2,319) - Fair value reserves related to gains or losses on cash flow hedges (104) 110 - Negative amounts resulting from the calculation of regulatory expected loss amounts (545) (544) - Gains or losses on liabilities valued at fair value resulting from changes in own credit standing (25) (25) - Defined benefit pension fund assets (185) (94) Total regulatory adjustments to CET 1 (3,029) (2,947) CET 1 capital 9,465 8,969 Additional Tier 1 ('AT1') capital instruments: - Capital instruments and the related share premium accounts 500 - - Amounts of qualifying items and related share premium accounts subject to phase out from AT1 1,297 1,298 AT1 capital before regulatory adjustments 1,797 1,298 Total regulatory adjustments to AT1 - - AT1 capital 1,797 1,298 Tier 1 capital 11,262 10,267 Tier 2 capital instruments: - Capital instruments and related share premium accounts 1,737 1,767 - Amounts of qualifying items and related share premium accounts subject to phase out from Tier 2 1,253 1,253 Tier 2 capital before regulatory adjustments 2,990 3,020 Total regulatory adjustments to Tier 2 - - Tier 2 capital 2,990 3,020 Total capital 14,252 13,287 Total regulatory capital consists of: CET 1 capital instruments and reserves Capital instruments and related share premium accounts comprise ordinary share capital of £3,105m (2013: £3,105m) and share premium of £5,620m (2013: £5,620m). Also included within CET 1 capital before regulatory adjustments are retained earnings of £3,640m (2013: £3,307m) and other reserves of £129m (2013: deduction of £116m), as per the Condensed Consolidated Balance Sheet. CET 1 regulatory adjustments CET1 regulatory adjustments represent adjustments to capital and reserves attributable to ordinary shareholders required under CRD IV. The adjustments applicable to Santander UK are as follows: > Additional value adjustments: Prudent valuation adjustments of £85m (2013: £75m) assessed using a PRA-defined approach. > Intangible assets: Goodwill and intangible assets of £2,085m (2013: £2,319m) net of deferred tax of £20m (2013: £16m) represent goodwill arising on the acquisition of businesses and certain capitalised computer software costs. > Fair value reserves relating to gains or losses on cash flow hedges: Gains/(losses) on cash flow hedges of £104m (2013: £110m loss) which have been recognised in reserves. > Negative amounts resulting from the calculation of regulatory expected loss amounts: Excess expected losses deduction of £545m (2013: £544m) representing the difference between expected loss calculated in accordance with Santander UK's Internal Rating-Based ('IRB') and Advanced Internal Rating-Based ('AIRB') models, and impairment loss allowances calculated in accordance with IFRS. Santander UK's accounting policy for impairment loss allowances is set out in Note 1 to the Consolidated Financial Statements in the 2013 Annual Report. Regulatory expected losses are calculated using risk parameters based on either through-the-cycle or economic downturn estimates, and are subject to conservatism due to the imposition of regulatory floors. They are therefore currently higher than the impairment loss allowances under IFRS which only reflect losses incurred at the balance sheet date. > Gains or losses on liabilities valued at fair value resulting from changes in own credit standing: This consists of a debit valuation adjustment of £29m (2013: £29m) relating to changes in OTC derivatives and changes in liabilities designated at fair value through profit and loss of £4m (2013: £4m) relating to resulting from changes in Santander UK's own credit risk. > Defined benefit pension fund assets: Removal or the defined benefit pension scheme assets of £185m (2013: £94m) net of deferred tax of £50m (2013: £22m). AT1 capital instruments AT1 capital consists of preference shares and innovative/hybrid Tier 1 securities. All such instruments issued by the Santander UK group prior to 1 January 2014 do not fully meet the CRD IV requirements for AT1 capital which became effective on that date. These instruments are subject to transitional phase out provisions under CRD IV which restrict their recognition as capital. The £500m Perpetual Capital Securities issued in June 2014 meet the CRD IV AT1 rules and are fully recognised as AT1 capital. Tier 2 capital Tier 2 capital consists of fully CRD IV eligible Tier 2 instruments and grandfathered Tier 2 instruments whose capital recognition is subject to CRD IV transitional phase out provisions. A reconciliation of Core Tier 1 capital at 31 December 2013, calculated in accordance with PRA rules in force at that date, and CET 1 capital calculated in accordance with CRD IV rules which came into force on 1 January 2014 is set out below: 31 December 2013 £m Core Tier 1 capital - PRA rules 9,680 CRD IV adjustments to Core Tier 1: - Excess of regulatory expected losses over impairment losses (335) - Defined benefit pension adjustment (310) - Other(1) (66) CET 1 capital - CRD IV rules 8,969 (1) Other adjustments to Core Tier 1 capital include the effect of additional valuation adjustments, deferred tax, securitisation and unrealised losses on available-for-sale securities. Movements in regulatory capital Movements in regulatory capital during the six months ended 30 June 2014 and the year ended 31 December 2013 are set out below. The calculations are prepared on a basis consistent with Santander UK's regulatory filings at 30 June 2014, following the adoption of CRD IV with effect from 1 January 2014. The amounts presented for 2013 have been prepared on a consistent basis, to aid comparability, as described above. 30 June 2014 £m 31 December 2013 £m CET 1 capital Opening amount 8,969 9,302 Contribution to CET 1 capital from profit for the period/year: - Increase in retained earnings 333 (5) - Increase/(decrease) in comprehensive income 245 (134) - Decrease in additional value adjustments (10) - - (Increase)/decrease in intangible assets (net of tax) 234 (10) - (Increase)/decrease in fair value reserves related to gains and losses on cash flow hedges (214) 110 - Decrease in negative amounts resulting from the calculation of regulatory expected loss amounts (1) 15 - Gain on liabilities valued at fair value resulting from changes in own credit standing - (19) - (Increase)/decrease in defined benefit pension fund assets (91) 382 Additional filters and deductions required pre-CRR - 39 Basel II to CRD IV impact - (711) Closing amount 9,465 8,969 AT1 capital Opening amount 1,298 1,901 - Increase/(decrease) in capital instruments and related share premium accounts 499 (512) - Decrease in amount of qualifying items and related share premium amounts subject to phase out from AT1 - (10) Basel II to CRD IV impact - (81) Closing amount 1,797 1,298 Tier 2 capital Opening amount 3,020 2,756 - Decrease/(increase) in capital instruments (30) 735 - Increase in qualifying items subject to phase out from Tier 2 - 22 Basel II to CRD IV impact - (493) Closing amount 2,990 3,020 Total regulatory capital 14,252 13,287 The changes in Santander UK's CET 1 capital reflect movements in ordinary share capital, share premium and profits for the six months ended 30 June 2014 and the year ended 31 December 2013 after adjustment to comply with the PRA's rules. Santander UK complied with the PRA's capital adequacy requirements during the first half of 2014 and the year ended 31 December 2013. During the six months ended 30 June 2014, CET 1 capital increased by £496m to £9,465m. This was largely due to profits for the period of £438m, less an interim ordinary dividend approved of £237m and a decrease in intangible assets due to the write-off of software of £206m. During the first half of 2014, the increase in AT1 capital was due to the issuance of £500m Perpetual Capital Securities to Santander UK plc's immediate parent company as set out in Note 31 to the Condensed Consolidated Interim Financial Statements. During the year ended 31 December 2013: CET 1 capital decreased by £333m to £8,969m comprising an increase in Core Tier 1 capital of £378m combined with a decrease of £711m from the impact of moving from Basel II Core Tier 1 to CRD IV CET1. Regulatory Leverage - using PRA definition The Basel III and CRD IV rules include proposals for the use of a leverage ratio as a backstop measure to risk-based capital ratios. The methodology for calculation of the leverage ratio has continued to evolve, with the Basel Committee in January 2014 producing a revised definition of the exposure measure in the 'Basel III leverage ratio framework and disclosure requirements' document. The PRA has requested that UK banking groups disclose leverage ratios using a methodology based on the January 2014 Basel Committee framework for exposure measurement, and an end-point definition of Tier 1 capital at 30 June 2014. The table below presents the Santander UK group leverage ratio calculated using the approach requested by the PRA. This is the same as the leverage ratio for the Santander UK Group Holdings Limited prudential consolidation group. The position at 31 December 2013 below has been restated to reflect the same basis as that used for the presentation of the position at 30 June 2014. Santander UK exceeded the proposed minimum 3% leverage ratio at both 30 June 2014 and 31 December 2013. 30 June 2014 £m 31 December 2013 £m Regulatory exposure 273,157 272,084 End-point Tier 1 capital 9,965 9,037 PRA end-point Tier 1 leverage ratio 3.6% 3.3% The Basel leverage ratio framework requires certain adjustments to be made to total assets per the consolidated balance sheet to arrive at regulatory exposure for leverage purposes. A reconciliation of total assets per the consolidated balance sheet to the regulatory exposure for leverage purposes at 30 June 2014 and 31 December 2013 is as follows: 30 June 2014 £m 31 December 2013 £m Total assets per consolidated balance sheet 270,220 270,286 Derivatives netting adjustment and potential future exposure (10,516) (11,367) Securities financing current exposure add-on 1,825 1,963 Removal of IFRS netting 2,006 2,085 Commitments calculated in accordance with Basel Committee Leverage Framework 12,507 12,114 CET 1 regulatory adjustments (2,885) (2,997) 273,157 272,084 The adjustments are as follows: > Derivatives netting and potential future exposure: Where derivative netting is allowed in the calculation of regulatory risk weights for derivatives, this is also allowed for the purposes of the leverage ratio. This is partially offset by the inclusion of the potential future exposure as used in the calculation of regulatory risk-weighted assets for derivatives. > Securities financing current exposure add-on: An add-on for securities financing transactions to reflect current exposure is included for the purposes of the leverage ratio. > Removal of IFRS netting: Where netting of assets and liabilities is permitted under IFRS, this is removed for the purposes of the leverage ratio. > Commitments calculated in accordance with Basel Committee Leverage Framework: The gross value of undrawn commitments is added to total assets for leverage purposes after applying regulatory credit conversion factors. > CET 1 regulatory adjustments: Where assets are deducted from CET 1, they can be deducted from total assets for the purposes of the leverage ratio. Risk-weighted assets ('RWAs') The tables below analyse the composition of Santander UK's RWAs. The calculations reflect the amounts prepared on a basis consistent with Santander UK's regulatory filings at 30 June 2014, following the adoption of CRD IV with effect from 1 January 2014. The amounts presented for 2013 have been prepared on a consistent basis, to aid comparability. The amounts presented for 31 December 2013 have not been adjusted to reflect the adoption of IFRIC 21, as set out in Note 1 to the Condensed Consolidated Interim Financial Statements. The adjustment would not have had a material effect on Santander UK's regulatory position. RWAs by risk 30 June 2014 £bn 31 December 2013 £bn Credit risk 63.0 61.1 Counterparty risk 4.7 4.8 Market risk 5.1 4.8 Operational risk 7.1 7.0 Total 79.9 77.7 RWAs by division 30 June 2014 £bn 31 December 2013 £bn Retail Banking 37.3 36.3 Commercial Banking 28.4 26.8 Markets 6.7 6.7 Corporate Centre 7.5 7.9 Total 79.9 77.7 A reconciliation of RWAs at 31 December 2013, calculated in accordance with PRA rules in force at that date, and calculated in accordance with CRD IV rules which came into force on 1 January 2014 is set out below: 31 December 2013 £bn Pillar 1 RWAs - PRA rules 75.2 CRD IV adjustments to RWAs: - Securitisation 1.1 - Counterparty Risk and Other(1) 1.4 RWAs - CRD IV rules 77.7 (1) The counterparty risk adjustments to RWAs include credit valuation adjustment, central counterparty clearing, asset value correlation, operational risk and changes to credit risk from provision treatment and SME risk weight reduction. RWAs by division may be further analysed into the balance sheet amount, the equivalent regulatory exposure measured under the standardised and IRB approaches, the risk-weighting applied to those regulatory exposures, and the resulting risk-weighted assets calculated, as follows: 30 June 2014 Regulatory exposure Risk-weighting applied RWAs Balance sheet amount £bn Standardised approach £bn IRB approach £bn Total £bn Standardised approach % IRB approach % Total % Standardised approach £bn IRB approach £bn Total £bn Retail Banking - Secured lending 148.7 - 158.8 158.8 - 14.8 14.8 - 23.5 23.5 - Unsecured lending 7.9 5.3 6.8 12.1 79.2 63.2 70.2 4.2 4.3 8.5 - Operational risk - - - - - - - 5.3 - 5.3 Commercial Banking - Customer assets 23.1 16.2 14.4 30.6 80.9 75.7 78.4 13.1 10.9 24.0 - Non-customer assets(1) 7.5 1.6 1.0 2.6 46.4 34.9 41.9 0.7 0.4 1.1 - Market risk(2) - - - - - - - 1.8 - 1.8 - Operational risk - - - - - - - 1.5 - 1.5 Markets - Credit risk 0.1 0.1 - 0.1 - - - - - - - Counterparty risk 17.2 1.1 4.0 5.1 63.6 60.0 60.8 0.7 2.4 3.1 - Market risk(2) - - - - - - - 3.3 - 3.3 - Operational risk - - - - - - - 0.3 - 0.3 Corporate Centre - Customer assets(3) 8.7 1.8 7.9 9.7 55.6 12.7 20.6 1.0 1.0 2.0 - Eligible liquid assets (4) 33.5 30.6 - 30.6 - - - - - - - Counterparty Risk - - - - - - - - 0.4 0.4 Intangible assets & securitisation deductions 2.1 - - - - - - - - - Other assets(5) 21.4 8.4 3.3 11.7 39.3 54.5 43.6 3.3 1.8 5.1 270.2 65.1 196.2 261.3 35.2 44.7 79.9 (1) Non-customer assets principally consist of the securities lending/borrowing and repo businesses of the Short Term Markets business. (2) Market Risk RWAs are determined using both internal model-based and standardised approaches. See the Market Risk section. (3) Customer assets in Corporate Centre largely comprise social housing. (4) Eligible liquid assets include reverse repurchase agreements collateralised by eligible sovereign securities. (5) The balance sheet amounts of other assets have not been allocated segmentally, although the RWAs have been allocated to Corporate Centre. The RWAs cover Credit Risk, Market Risk and Operational Risk. 31 December 2013 Regulatory exposure Risk-weighting applied RWAs Balance sheet amount £bn Standardised approach £bn IRB approach £bn Total £bn Standardised approach % IRB approach % Total % Standardised approach £bn IRB approach £bn Total £bn Retail Banking - Secured lending 148.1 0.2 157.3 157.5 77.1 14.5 14.5 0.1 22.8 22.9 - Unsecured lending 7.5 4.8 6.5 11.3 78.2 65.1 70.7 3.8 4.2 8.0 - Operational risk - - - - - - - 5.4 - 5.4 Commercial Banking - Customer assets 22.1 13.5 14.6 28.1 90.4 72.6 81.1 12.2 10.6 22.8 - Non-customer assets(1) 13.4 0.8 1.5 2.3 100.0 26.7 52.2 0.8 0.4 1.2 - Market risk(2) - - - - - - - 1.4 - 1.4 - Operational risk - - - - - - - 1.4 - 1.4 Markets - Credit risk 0.1 - 0.1 0.1 - - - - - - - Counterparty risk 19.2 2.0 3.8 5.8 100.0 31.6 55.2 2.0 1.2 3.2 - Market risk(2) - - - - - - - 3.3 - 3.3 - Operational risk - - - - - - - 0.2 - 0.2 Corporate Centre - Customer assets(3) 9.4 2.0 9.1 11.1 77.2 21.5 31.5 1.5 2.0 3.5 - Eligible liquid assets (4) 31.5 28.1 - 28.1 - - - - - - - Operational risk - - - - - - - - - - Counterparty risk - - - - - - - 0.5 - 0.5 Intangible assets & securitisation deductions 2.3 - - - - - - - - - Other assets(5) 16.7 7.0 3.6 10.6 42.2 26.4 36.8 3.0 0.9 3.9 270.3 58.4 196.5 254.9 35.6 42.1 77.7 (1) Non-customer assets principally consist of the securities lending/borrowing and repo businesses of the Short Term Markets business. (2) Market Risk RWAs are determined using both internal model-based and standardised approaches. See the Market Risk section. (3) Customer assets in Corporate Centre largely comprise social housing. (4) Eligible liquid assets include reverse repurchase agreements collateralised by eligible sovereign securities. (5) The balance sheet amounts of other assets have not been allocated segmentally, although the RWAs have been allocated to Corporate Centre. The RWAs cover Credit Risk, Market Risk and Operational Risk. Regulatory exposure represents the Exposure at Default ('EAD') calculated in accordance with CRR and related PRA supervisory statements. EAD for customer loans includes unutilised credit facilities and is adjusted for a credit conversion factor. 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 III to the calculation of its capital requirement. In addition, Santander UK applies the Retail IRB and AIRB approaches to its credit portfolios. Residential lending capital resources requirements include securitised residential mortgages. During the six months ended 30 June 2014, RWAs increased in line with the growth in Retail Banking mortgage lending and Commercial Banking lending. LIQUIDITY AND FUNDING The Board's risk objective is 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 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 Santander UK'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. See the "Liquidity and Funding Risk" section of the Risk Management Report for more information. Sources of liquidity and funding Santander UK is primarily funded by retail deposits. This, together with corporate deposits, forms its commercial bank franchise, which attracts deposits through a variety of entities. More than three quarters of Santander UK's customer lending is financed by customer deposits. 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 many 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 Note 33 to the Consolidated Financial Statements in the 2013 Annual Report. 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 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. Within the framework of prudent funding and liquidity management, Santander UK manages its commercial banking activities to minimise liquidity risk. Encumbrance - securitisation of assets and covered bonds Santander UK has provided prime retail mortgage-backed products to a diverse investor base through its mortgage-backed funding programmes, as described in Note 15 to the Condensed Consolidated Interim Financial Statements. Funding has historically been raised via mortgage-backed notes, both issued directly to third parties and retained for repo with third parties (the latter being eligible collateral for liquidity purposes under certain central bank facilities). Santander UK, via its subsidiary Abbey National Treasury Services plc, has an established covered bond programme, whereby securities are issued to investors and are guaranteed by a pool of ring-fenced residential mortgages. Santander UK's level of encumbrance arising from external issuance of mortgage-backed funding decreased in the first half of 2014 as planned, reflecting both the overall reduction in wholesale funding and the desire to better balance new wholesale funding issuance between secured and unsecured markets where possible. At 30 June 2014, total notes issued externally from secured programmes (securitisations and covered bonds) decreased to £34,585m (2013: £36,307m), reflecting gross issuance of £2.6bn in the first half of 2014 (2013: £3.1bn) and maturities/redemptions of £4.3bn. At 30 June 2014, a total of £14,440m (2013: £14,599m) of notes issued under securitisation and covered bond programmes had also been retained internally, a proportion of which had been used as collateral for raising funds via third party bilateral secured funding transactions, which totalled £7.2bn at 30 June 2014 (2013: £7.6bn). Cash flows Six months ended 30 June 2014 £m Six months ended 30 June 2013 £m Net cash (outflow)/inflow from operating activities (252) 10,275 Net cash (outflow)/inflow from investing activities (2,905) 282 Net cash outflow from financing activities (813) (6,824) (Decrease)/increase in cash and cash equivalents (3,970) 3,733 The major activities and transactions that affected Santander UK's cash flows during the first six months of 2014 were as follows: The net cash outflow from operating activities of £252m resulted from the reduction in trading balances offset by increased customer savings and deposits from other banks. The net cash outflow from investing activities of £2,905m principally reflected the purchase and sale of available-for-sale securities. The net cash outflow from financing activities of £813m reflected the repayment of debt securities maturing in the period of £12,046m offset by new issues of debt securities of £10,983m and the issuance of £500m capital securities. Further outflows of cash occurred in the payment of interim dividends of £210m on ordinary shares and £40m of dividends on other equity instruments. 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 2014 Six months ended 30 June 2013 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 20,851 61 0.59 29,770 70 0.47 - Non-UK 11,302 14 0.25 4,862 8 0.33 Loans and advances to customers:(3) - UK 186,180 3,297 3.54 190,736 3,506 3.68 - Non-UK 5 - - 6 - - Debt securities: - UK 7,933 49 1.24 6,143 39 1.27 - Non-UK - - - 289 1 0.69 Total average interest-earning assets, interest income(2) 226,271 3,421 3.02 231,806 3,624 3.13 Impairment loss allowances (1,523) - - (1,792) - - Trading business 19,321 - - 26,320 - - Assets designated at FVTPL 2,815 - - 3,507 - - Other non-interest-earning assets 33,026 - - 41,621 - - Total average assets 279,910 - - 301,462 - - Non-UK assets as a % of total 4.04% - - 1.71% - - Liabilities Deposits by banks: - UK (7,242) (46) 1.27 (9,052) (84) 1.86 - Non-UK (2) - - (2) - - Deposits by customers - retail demand: - UK (88,696) (593) 1.34 (83,951) (663) 1.58 - Non-UK (698) (2) 0.57 (1,262) (11) 1.74 Deposits by customers - retail time: - UK (33,436) (427) 2.55 (39,940) (583) 2.92 - Non-UK (1,378) (12) 1.74 (3,549) (46) 2.59 Deposits by customers - wholesale: - UK (25,299) (90) 0.71 (22,148) (177) 1.60 - Non-UK - - - - - - Bonds and medium-term notes: - UK (46,764) (485) 2.07 (51,720) (554) 2.14 - Non-UK (4,287) (5) 0.23 (4,357) (11) 0.50 Dated and undated loan capital and other subordinated liabilities: - UK (4,390) (66) 3.01 (3,539) (84) 4.75 - Non-UK - - - (243) (11) 9.05 Other interest-bearing liabilities: - UK (627) (22) 7.02 (324) (9) 5.56 Total average interest-bearing liabilities, interest expense(2) (212,819) (1,748) 1.64 (220,087) (2,233) 2.03 Trading business (25,339) - - (31,460) - - Liabilities designated at FVTPL (4,085) - - (4,902) - - Non-interest-bearing liabilities: - Other (24,686) - - (31,921) - - Shareholders' funds (12,981) - - (13,092) - - Total average liabilities and shareholders' funds (279,910) - - (301,462) - - Non-UK liabilities as a % of total 2.27% - - 3.12% - - (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 2014 was 106.32% (Six months ended 30 June 2013: 105.32%). (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 2014 was 1.48% (Six months ended 30 June 2013: 1.20%). Net interest margin is calculated as net interest income divided by average interest earning assets. This differs from the Banking Net Interest Margin, discussed on page 8, which is calculated as net interest income divided by average customer assets. (5) The interest spread for the six months ended 30 June 2014 was 1.38% (Six months ended 30 June 2013: 1.10%). 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 Index 37 Risk Management 37 Introduction (unreviewed) 37 Risk Framework 38 Credit Risk 38 - Credit Risk Review 38 - Santander UK group exposure 43 - Retail Banking 54 - Commercial Banking 61 - Markets 62 - Corporate Centre 66 Market Risk 67 - Traded Market risk 69 Balance Sheet Management Risk 69 - Banking Market risk 70 - Liquidity and Funding risk 76 - Capital risk (unreviewed) 76 - Pension risk (unreviewed) 76 Operational Risk (unreviewed) 77 Conduct Risk (unreviewed) 77 Regulatory Risk (unreviewed) 77 Legal Risk (unreviewed) 78 Areas of focus and other items 78 - Country Risk exposure This Risk Management Report contains information that forms an integral part of the Condensed Consolidated Interim Financial Statements, except as otherwise marked as unreviewed. This Risk Management Report focuses on those areas that have changed significantly during the first half of 2014, and represents an update to the Risk Management Report in the 2013 Annual Report, with which it should be read in conjunction. The Risk Management Report in the 2013 Annual Report contains additional disclosures which have not changed significantly during the first half of 2014. This Risk Management Report contains information that forms an integral part of the Condensed Consolidated Interim Financial Statements. The information on pages 36 to 82 is within the scope of the review report of Deloitte LLP except for those items marked as unreviewed. This Risk Management Report should be read in conjunction with the Summary Risk Report on pages 11 to 14, which forms part of this Risk Management Report. 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 UK aims 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 people, customers, 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 "Our Strategy and Business Model" on page 4, and pages 4 and 5 of the 2013 Annual Report. Risk framework The Risk Framework in place at 30 June 2014 was based upon the following key components: > Risk definition and structure; > Risk Culture, overriding principles and minimum standards; > Governance, roles and responsibilities; and > System of internal control for risk. In December 2013, the Board approved an updated Risk Framework which operated throughout the first half of 2014. The key risk types were simplified and the lines of defence model streamlined. There was no change to the overriding principles. The main changes were: > With respect to risk definition and structure, the key risk types were reorganised as: Credit, Traded Market, Balance Sheet Management (previously known as Structural) including Banking Market (previously known as Non-traded Market), Operational, Conduct, Regulatory and Legal, as set out diagrammatically below; and > The additional classification of financial / non-financial risks was removed; > With respect to governance, roles and responsibilities, a Conduct & Regulatory Risk Committee was created which reports to the Executive Risk Committee; and > A Risk Culture statement was included. Risk definition and structure http://www.rns-pdf.londonstockexchange.com/rns/0919P_6-2014-8-14.pdf CREDIT RISK REVIEW SANTANDER UK GROUP EXPOSURE Maximum exposure and net exposure to credit risk The tables below set out the main differences between the Santander UK group's maximum exposure and net exposure to credit risk. They show the effects of collateral, netting, and risk transfer to mitigate the Santander UK group's exposure. For balance sheet assets, the maximum exposure to credit risk represents the carrying value, including accrued interest, after allowance for impairment losses. Off-balance sheet exposures comprise guarantees, formal standby facilities, credit lines and other commitments. For off-balance sheet guarantees, the maximum exposure is the maximum amount that Santander UK would have to pay if the guarantees were to be called upon. For formal standby facilities, credit lines and other commitments that are irrevocable over the life of the respective facilities, the maximum exposure is the full amount of the committed facilities. The tables presented below include only those financial assets subject to credit risk, and therefore exclude equity securities. Subsequent analyses of credit risk in this section cover loans and advances to customers and banks, at carrying value. 30 June 2014 Maximum exposure Balance sheet asset £bn Off-balance sheet £bn Collateral(1) £bn Netting(2) £bn Risk Transfer(3) £bn Net Exposure £bn Cash and balances at central banks 26.6 - - - - 26.6 Trading assets: - Loans and advances to banks 6.2 - (2.3) (1.1) - 2.8 - Loans and advances to customers 1.8 - (1.2) - - 0.6 - Debt securities 7.5 - - - - 7.5 Total trading assets 15.5 - (3.5) (1.1) - 10.9 Financial assets designated at fair value: - Loans and advances to customers 2.2 0.2 (2.2) - - 0.2 - Debt securities 0.5 - - - - 0.5 Financial assets designated at fair value 2.7 0.2 (2.2) - - 0.7 Available-for-sale debt securities 7.7 - - - - 7.7 Derivative financial instruments 19.2 - (1.1) (15.3) - 2.8 Loans and advances to banks 2.3 1.5 - - (0.1) 3.7 Loans and advances to customers: - Advances secured on residential property 148.4 6.7 (155.0) - - 0.1 - Corporate loans 26.3 13.7 (19.3) - - 20.7 - Finance leases 3.2 - (2.3) - - 0.9 - Other secured advances 2.2 0.2 (2.2) - - 0.2 - Other unsecured advances 5.2 10.5 - - - 15.7 - Amounts due from fellow subsidiaries, associates and joint ventures 0.8 - - - - 0.8 Total loans and advances to customers 186.1 31.1 (178.8) - - 38.4 Loans and receivables securities 0.9 - - - (0.1) 0.8 Total 261.0 32.8 (185.6) (16.4) (0.2) 91.6 31 December 2013 Maximum exposure Balance sheet asset £bn Off-balance sheet £bn Collateral(1) £bn Netting(2) £bn Risk Transfer(3) £bn Net Exposure £bn Cash and balances at central banks 26.4 - - - - 26.4 Trading assets: - Loans and advances to banks 9.3 - (0.8) (3.4) - 5.1 - Loans and advances to customers 4.4 - (4.2) - - 0.2 - Debt securities 7.9 - - - - 7.9 Total trading assets 21.6 - (5.0) (3.4) - 13.2 Financial assets designated at fair value: - Loans and advances to customers 2.2 0.2 (2.3) - - 0.1 - Debt securities 0.5 - - - - 0.5 Financial assets designated at fair value 2.7 0.2 (2.3) - - 0.6 Available-for-sale debt securities 5.0 - - - - 5.0 Derivative financial instruments 20.0 - (1.7) (15.4) - 2.9 Loans and advances to banks 2.3 - (0.3) - (0.1) 1.9 Loans and advances to customers: - Advances secured on residential property 147.8 6.8 (154.3) - - 0.3 - Corporate loans 24.9 13.2 (18.6) - - 19.5 - Finance leases 3.1 - (2.2) - - 0.9 - Other secured advances 2.7 0.2 (2.4) - - 0.5 - Other unsecured advances 5.3 9.6 - - - 14.9 - Amounts due from fellow subsidiaries, associates and joint ventures 0.8 - - - - 0.8 Total loans and advances to customers 184.6 29.8 (177.5) - - 36.9 Loans and receivables securities 1.1 - - - - 1.1 Total 263.7 30.0 (186.8) (18.8) (0.1) 88.0 (1) The forms of collateral which Santander UK takes to mitigate credit risk include: residential and commercial property; other physical assets, including motor vehicles; liquid securities, including those transferred under reverse repurchase agreements; cash, including that which is used to collateralise derivative transactions and receivables. In terms of exposure, charges on residential property represent the majority of collateral taken. (2) Credit risk exposures can be reduced by applying netting and set-off. Santander UK uses this approach mainly for derivative and repurchase transactions with financial institutions. For derivatives transactions, Santander UK uses standard master netting agreements (e.g. ISDA). These agreements allow for netting of credit risk exposure to a counterparty resulting from a derivative transaction against Santander UK's obligations to the counterparty in the event of default, to produce a lower net credit exposure. They may also reduce settlement exposure. (3) Certain financial instruments can be used to transfer credit risk from one counterparty to another. The main form of risk transfer employed by Santander UK is through the use of credit default swaps. Credit quality Santander UK uses a single rating scale to provide a consistent approach for reporting default risk across all the credit risk portfolios. The scale is comprised of eight grades for non-defaulted exposures numbered from 9 (lowest risk) to 2 (highest risk). Each grade is defined by an upper and lower probability of default ('PD') value and is scaled so that the default risk increases by a factor of 10 for every 2 step reduction in the grade number. For example, risk grade 9 equates to an average PD of 0.01%, and risk grade 7 equates to an average PD of 0.1%. Defaulted exposures are assigned to grade 1 and a PD value of 100%. An approximation to the equivalent credit rating grade used by Standard and Poor's Rating Services ('S&P') is shown in the final column of the table. PD range Santander UK risk grade Mid % Lower % Upper % S&P equivalent 9 0.010 0.000 0.021 AAA to AA- 8 0.032 0.021 0.066 A+ to A 7 0.100 0.066 0.208 A- to BBB+ 6 0.316 0.208 0.658 BBB to BBB- 5 1.000 0.658 2.081 BB+ to BB- 4 3.162 2.081 6.581 B+ to B 3 10.000 6.581 20.811 B- to CCC 2 31.623 20.811 99.999 CC TO C 1 Default 100.000 100.000 100.000 D The tables below set out the distribution across the credit rating scale for loans and advances to banks and customers. For further detail and commentary on the credit rating profiles of key portfolios, see pages 54 and 62 for Commercial Banking and Corporate Centre, respectively. 30 June 2014 Santander UK rating guide 9 8 7 6 5 4 1 to 3 Other(1) Total (AAA to AA-) (A+ to A) (A- to BBB+) (BBB to BBB-) (BB+ to BB-) (B+ to B) (B- to D) £m £m £m £m £m £m £m £m £m Loans and advances to banks 384 726 1,205 1 - 9 - - 2,325 Loans and advances to customers: - Advances secured on residential property 2,525 15,584 62,732 43,705 8,301 8,191 7,379 19 148,436 - Corporate loans 1,722 3,234 3,171 9,033 5,652 2,562 700 264 26,338 - Finance leases 2 13 259 789 797 898 401 33 3,192 - Other secured advances 2 7 9 87 381 270 24 1,392 2,172 - Other unsecured advances - 25 162 767 1,793 746 335 1,367 5,195 - Amounts due from fellow subsidiaries, associates & joint ventures 576 - - 78 107 - - - 761 Loans and advances to customers 4,827 18,863 66,333 54,459 17,031 12,667 8,839 3,075 186,094 Total 5,211 19,589 67,538 54,460 17,031 12,676 8,839 3,075 188,419 31 December 2013 Santander UK rating guide 9 8 7 6 5 4 1 to 3 Other(1) Total (AAA to AA-) (A+ to A) (A- to BBB+) (BBB to BBB-) (BB+ to BB-) (B+ to B) (B- to D) £m £m £m £m £m £m £m £m £m Loans and advances to banks 600 571 1,024 - 152 - - - 2,347 Loans and advances to customers: - Advances secured on residential property 3,376 15,229 61,014 43,050 8,514 8,816 7,805 21 147,825 - Corporate loans 1,824 3,050 3,658 8,215 4,807 2,435 623 223 24,835 - Finance leases 2 13 410 747 726 805 371 40 3,114 - Other secured advances 7 12 41 163 361 218 286 1,628 2,716 - Other unsecured advances - 40 120 709 1,907 963 516 1,029 5,284 - Amounts due from fellow subsidiaries, associates & joint ventures 648 - - - 153 - - 12 813 Loans and advances to customers 5,857 18,344 65,243 52,884 16,468 13,237 9,601 2,953 184,587 Total 6,457 18,915 66,267 52,884 16,620 13,237 9,601 2,953 186,934 (1) Represents smaller cases predominantly within the commercial mortgages portfolio which are subject to scorecards rather than a rating model. Non-performing loans and advances (1)(2) An analysis of Santander UK's NPLs is presented below. 30 June 2014 £m 31 December 2013 £m Loans and advances to customers of which:(2) 188,470 187,048 Customers in Arrears(3) 3,172 3,431 NPLs - impaired(3)(4) 1,643 1,467 NPLs - not impaired(3) 2,048 2,356 Total NPLs 3,691 3,823 Total impairment loss allowances 1,499 1,555 % % Arrears ratio(5) 1.68 1.83 NPL ratio(6) 1.96 2.04 Coverage ratio(7) 41 41 (1) Loans and advances are classified as non-performing as described in the footnotes to the tables on pages 47, 56 and 64 for Mortgage loans, Commercial Banking loans and Corporate Centre loans, respectively. (2) Loans and advances to customers include social housing loans and finance leases, and exclude trading assets. (3) All balances are UK and continue accruing interest. For the data presented, the balances include interest charged to the customer's account, but exclude interest accrued but not yet charged to the account. (4) NPLs against which an impairment loss allowance has been established. (5) Loans and advances to customers in arrears as a percentage of loans and advances to customers. (6) NPLs as a percentage of loans and advances to customers. (7) Impairment loss allowances as a percentage of NPLs. 30 June 2014 compared to 31 December 2013 (unreviewed) During the first half of 2014, the NPL ratio of 1.96% (2013: 2.04%), continued to improve, with retail and corporate loans performing in line with our expectations. The reduction in the NPL ratio resulted largely from improvements in the economic environment and prolonged low interest rates. In Retail Banking, this was coupled with improved collections efficiencies introduced both in 2013 and the first half of 2014, a decrease in mortgage NPLs and increase in mortgage asset, higher credit quality in the newer 1|2|3 Current Account customers and unsecured personal loans. These decreases were partially offset by the increase in NPL stock in Commercial Banking largely due to a single long-standing loan of £89m which moved to non-performance. A successful restructure of this loan is still anticipated and a conservative provision is held against it. Loans and advances to customers in arrears and the arrears ratio decreased to £3,172m (2013: £3,431m) and 1.68% (2013: 1.83%), respectively, as a result of the improving economy and as Santander UK continued to execute the strategy of exiting problem exposures through sale of the debt or through the realisation of the collateral. This decrease was partially offset by the increase in customers in arrears in Commercial Banking due to the same single long-standing loan noted above. The coverage ratio remained unchanged at 41% (2013: 41%). Ratio of write-offs to average loans (annualised) 30 June 2014 % 31 December 2013 % Ratio of write-offs to average loans during the period/year 0.29 0.43 Concentrations of credit risk exposures The management of risk concentration is a key part of risk management. Santander UK tracks the degree of concentration of its credit risk portfolios using various criteria, including geographic areas and countries, economic sectors, products and groups of customers. Although Santander UK's operations are based mainly in the UK, it has built up exposures to various entities around the world and is therefore exposed to concentrations of risk related to geographic area. These are further analysed below: Geographic concentrations As part of its approach to credit risk management and risk appetite, Santander UK sets exposure limits to countries and certain geographic areas. These limits are set by Santander UK with reference to the country limits set by Banco Santander, S.A. These are determined according to the classification of the country (whether it is a developed OECD country or not), the rating of the country, its gross domestic product and the type of business activities and products the Banco Santander group wishes to engage in within that country. The tables below set out the distribution, by geographic area, of loans and advances to banks and customers. 30 June 2014 UK Peripheral eurozone(1) Rest of eurozone Rest of Europe US Rest of world Total £m £m £m £m £m £m £m Loans and advances to banks 1,882 16 8 12 359 48 2,325 Loans and advances to customers: - Advances secured on residential property 148,436 - - - - - 148,436 - Corporate loans 24,236 400 345 635 134 588 26,338 - Finance leases 3,189 - - 3 - - 3,192 - Other secured advances 2,172 - - - - - 2,172 - Other unsecured advances 5,195 - - - - - 5,195 - Amounts due from fellow subsidiaries, associates and joint ventures 761 - - - - - 761 Loans and advances to customers 183,989 400 345 638 134 588 186,094 Total 185,871 416 353 650 493 636 188,419 31 December 2013 UK Peripheral eurozone(1) Rest of eurozone Rest of Europe US Rest of world Total £m £m £m £m £m £m £m Loans and advances to banks 1,528 68 62 222 415 52 2,347 Loans and advances to customers: - Advances secured on residential property 147,825 - - - - - 147,825 - Corporate loans 22,705 263 157 734 159 817 24,835 - Finance leases 3,106 4 - 4 - - 3,114 - Other secured advances 2,716 - - - - - 2,716 - Other unsecured advances 5,284 - - - - - 5,284 - Amounts due from fellow subsidiaries, associates and joint ventures 813 - - - - - 813 Loans and advances to customers 182,449 267 157 738 159 817 184,587 Total 183,977 335 219 960 574 869 186,934 (1) Peripheral eurozone comprises Cyprus, Greece, Ireland, Italy, Portugal and Spain. For additional geographic information and commentary, see "Country Risk Exposures" on pages 78 to 82. Credit risk exposures by industry As part of its approach to credit risk management and risk appetite, Santander UK sets exposure limits to certain key industry sectors. The tables below set out the distribution, by industry sector, of loans and advances to banks and customers. The data is presented gross of impairment loss allowances, with the total impairment loss allowance shown separately. 30 June 2014 Social Housing Banks SME(1) Real estate(1) Transport Residential Cards and unsecured personal lending Other Total £m £m £m £m £m £m £m £m £m Loans and advances to banks - 2,325 - - - - - - 2,325 Loans and advances to customers: - Advances secured on residential property - - - - - 149,022 - - 149,022 - Corporate loans 5,523 - 10,237 3,369 519 - - 7,098 26,746 - Finance leases - - - - 1,076 - - 2,164 3,240 - Other secured advances - - 881 - - - - 1,480 2,361 - Other unsecured advances - - - - - - 5,463 - 5,463 - Amounts due from fellow subsidiaries, associates & joint ventures - - - - - - - 761 761 Loans and advances to customers (gross) 5,523 - 11,118 3,369 1,595 149,022 5,463 11,503 187,593 Less: impairment loss allowance (1,499) Loans and advances to customers (net) 186,094 Total 188,419 31 December 2013 Social Housing Banks SME(1) Real estate(1) Transport Residential Cards and unsecured personal lending Other Total £m £m £m £m £m £m £m £m £m Loans and advances to banks - 2,347 - - - - - - 2,347 Loans and advances to customers: - Advances secured on residential property - - - - - 148,418 - - 148,418 - Corporate loans 5,763 - 10,372 3,602 746 - - 4,756 25,239 - Finance leases - - - - 1,110 - - 2,048 3,158 - Other secured advances - - 1,001 - - - - 1,944 2,945 - Other unsecured advances - - - - - - 5,569 - 5,569 - Amounts due from fellow subsidiaries, associates & joint ventures - - - - - - - 813 813 Loans and advances to customers (gross) 5,763 - 11,373 3,602 1,856 148,418 5,569 9,561 186,142 Less: impairment loss allowance (1,555) Loans and advances to customers (net) 184,587 Total 186,934 (1) Real estate SMEs are included in the 'Real estate' column. For additional industry information, see "Country Risk Exposures" on pages 78 to 82. Forbearance summary The following tables provide a summary of the population of loans and advances to customers which have been subject to forbearance programmes and are included in the previous tables. Discussion and analysis of forbearance activities for mortgages in Retail Banking are set out on page 49. Discussion and analysis of forbearance activities in Commercial Banking and Corporate Centre are set out on pages 57 and 65 respectively. 30 June 2014 Forbearance of NPL Forbearance of non-NPL Total £m £m £m Retail Banking: - Mortgages 710 3,287 3,997 - Unsecured loans 2 4 6 - Credit cards 34 - 34 - Bank accounts 1 13 14 Commercial Banking 161 666 827 Corporate Centre 51 312 363 Total 959 4,282 5,241 31 December 2013 Forbearance of NPL Forbearance of non-NPL Total £m £m £m Retail Banking: - Mortgages 691 3,396 4,087 - Unsecured loans 2 7 9 - Credit cards 33 - 33 - Bank accounts 2 15 17 Commercial Banking 196 728 924 Corporate Centre 58 322 380 Total 982 4,468 5,450 CREDIT RISK - RETAIL BANKING RESIDENTIAL MORTGAGES In the following chart, gross lending includes both new business and, shown separately, further advances and any flexible mortgage drawdown against available limits. The redemptions and paydowns refer to customer payments, over-payments, clearing mortgage balances or re-financing away from Santander UK. The data excludes accrued interest and is presented gross of impairment loss allowances. The following is a pictorial representation of the data in the table below. http://www.rns-pdf.londonstockexchange.com/rns/0919P_7-2014-8-14.pdf An analysis of mortgage asset movements during the first half of 2014 is presented below: £m At 1 January 2014 148,079 New business 12,246 Further advances/flexi drawdowns 601 Redemptions/paydowns (12,246) At 30 June 2014 148,680 In addition, during the first half of 2014 there were internal transfers of £8.0bn (six months ended 31 December 2013: £10.1bn; six months ended 30 June 2013: £8.3bn) where we were successful in the targeted retention of customers on new Santander UK mortgages. BORROWER AND PRODUCT PROFILE In the following chart, the category 'home movers' includes both existing customers moving house and taking out a new mortgage with us, and customers who move their mortgage to us at the point they move home. The category 're-mortgagers' comprises external customers re-mortgaging to Santander UK only. Internal re-mortgages, further advances and any flexible mortgages drawdowns are not included in the new business figures below. http://www.rns-pdf.londonstockexchange.com/rns/0919P_8-2014-8-14.pdf http://www.rns-pdf.londonstockexchange.com/rns/0919P_9-2014-8-14.pdf 30 June 2014 compared to 31 December 2013 (unreviewed) During the first half of 2014, the proportion of new business arising from first-time buyers increased from 20% to 22% driven by the Help to Buy scheme, under which Santander UK lent £450m in the period. The Help to Buy scheme supports borrowers who have smaller deposits by guaranteeing a proportion of their loan, enabling lenders taking part to offer home buyers more higher LTV mortgages (from 80% to 95% LTV) without increasing the credit risk profile of the lending. In addition, the proportion of remortgagers increased from 28% to 29%, balanced by a corresponding decrease in the proportion of home movers. The remortgage trend seen in 2013 continued, as borrowers seek to move to incentive products ahead of anticipated increases in market interest rates. Buy-to-let new business increased from 3% to 4%, in line with the strategy to expand this line of business in a controlled manner. The average earnings multiple of new business (at inception) remained stable during the first half of 2014 at 3.07 (2013: 3.04). There were smaller movements in the mix of buyer type in the mortgage asset stock figures, which was also influenced by redemptions and repayments. Overall, the mix was relatively stable, with only a slight decrease in the remortgagers. Product and interest rate profile 30 June 2014 31 December 2013 £m % £m % Term Product - Fixed Rate 63,232 42 56,672 39 Term Product - Tracker 4,357 3 5,956 4 Standard Variable Rate ('SVR') (1) 47,320 32 51,490 35 Base Rate Linked 15,319 10 15,260 10 Flexi(2) 15,706 11 16,245 11 Buy-to-let 2,511 2 2,201 1 Other 235 - 255 - Total 148,680 100 148,079 100 (1) Excludes Buy-to-let on SVR of £807m (2013: £841m) included in the Buy-to-let line. (2) In addition, there were £6,804m (2013: £7,469m) of legacy Alliance & Leicester flexible loan products included in other categories as the product flexibility is more limited than the current Santander UK flexi loan product. 30 June 2014 compared to 31 December 2013 (unreviewed) During the first half of 2014, the migration away from tracker mortgages to fixed rate products witnessed in 2013 continued. This reflectedpotential borrowers' concerns over future interest rate movements, and the increased availability of competitively priced fixed rate products. This was also reflected in the proportion of existing customers paying the standard variable rate decreasing by 3 percentage points to 32% at 30 June 2014 (2013: 35%). Geographic distribution The new business data in the following tables corresponds to new business originated during each of the reported periods. For the first half of 2014, the Council of Mortgage Lenders ('CML') new business data in the table below covers the three months ended 31 March 2014, due to timing of data availability. For 2013, the CML new business data covers the twelve months ended 31 December 2013. The percentage shown is on a value weighted basis. 30 June 2014 Stock New business (unreviewed) CML new business UK Region % % % North East 3 3 3 North West 8 7 7 Yorkshire and the Humber 5 5 6 East Midlands 4 4 6 West Midlands 6 5 6 East of England 4 4 3 Greater London 27 31 23 South East excluding Greater London 24 25 28 South West 8 9 8 Wales 3 2 3 Scotland 5 4 6 Northern Ireland 3 1 1 100 100 100 31 December 2013 Stock New business (unreviewed) CML new business UK Region % % % North East 3 2 3 North West 8 7 7 Yorkshire and the Humber 5 5 6 East Midlands 4 4 6 West Midlands 6 5 6 East of England 4 4 3 Greater London 27 32 23 South East excluding Greater London 24 25 27 South West 8 9 8 Wales 3 2 3 Scotland 5 4 7 Northern Ireland 3 1 1 100 100 100 30 June 2014 compared to 31 December 2013 (unreviewed) Geographically, whilst Santander UK has a diverse footprint across the UK, our mortgage exposure continues to reflect a concentration around the South East including Greater London, representing approximately half the value of the total portfolio. The concentration is a result of both the natural effect of a greater housing density and higher than average house prices in this area, coupled with a new business market share around 10% higher than the industry average as a whole. During the first half of 2014, the mortgage asset stock distribution by region was broadly unchanged, whilst for new business there was a marginal decrease in the proportion of lending in Greater London. Exposures to larger loans Exposures to larger loans across the UK remain at a low level with the total mortgage asset stock of larger mortgage loans at 30 June 2014 and 31 December 2013, as follows: Stock South East including Greater London UK 30 June 2014 31 December 2013 30 June 2014 31 December 2013 Individual mortgage loan size £m £m £m £m £0.5m - £1m 4,530 3,809 5,449 4,683 £1m - £2m 627 461 685 510 > £2m 86 59 93 66 Average loan size for new business The average loan size for new business during the six months ended 30 June 2014 and the year ended 31 December 2013 was as follows: New business Six months ended 30 June 2014 Year ended 31 December 2013 UK Region £'000 £'000 South East including Greater London 226 205 Rest of the UK 123 118 UK as a whole 166 155 Loan-to-value analysis The following table sets out the Loan-to-Value distribution for mortgage asset stock, non-performing stock and new business. The LTV calculation includes fees added to the loan, and, where the product is on flexible terms, only includes the drawn loan amount, not undrawn limits. The valuation is based on the results of an automated valuation modelling or HPI indexed values, as appropriate. This re-valuation of the book is undertaken on a quarterly basis. Of the loans in negative equity, the total which is effectively uncollateralised, before taking account of any loan loss allowances, was £640m at 30 June 2014 (2013: £838m). The collateral value shown excludes the impact of over-collateralisation i.e. where the collateral held is of a higher value than the loan balance outstanding. 30 June 2014 Stock of which: % NPL Stock % New Business % <=50% 32 21 17 >50 - 55% 7 5 5 >55 - 60% 8 6 6 >60 - 65% 9 7 7 >65 - 70% 10 7 11 >70 - 75% 9 8 13 >75 - 80% 7 8 16 >80 - 85% 6 8 10 >85 - 90% 4 6 11 >90 - 95% 3 6 4 >95 - 100% 2 4 - > 100% i.e. negative equity 3 14 - 100 100 100 Collateral value of residential properties(1) £148,040m £2,572m £12,246m % % % Simple average(2) loan-to-value (indexed) 49 57 65 Value weighted average(3) loan-to-value (indexed) 45 52 60 31 December 2013 Stock of which: % NPL Stock % New Business % <=50% 29 18 19 >50 - 55% 7 4 6 >55 - 60% 7 5 6 >60 - 65% 9 6 8 >65 - 70% 10 6 12 >70 - 75% 9 8 14 >75 - 80% 8 8 13 >80 - 85% 7 8 10 >85 - 90% 5 8 12 >90 - 95% 3 6 - >95 - 100% 2 6 - > 100% i.e. negative equity 4 17 - 100 100 100 Collateral value of residential properties(1) £147,241m £2,678m £17,234m % % % Simple average(2) loan-to-value (indexed) 51 61 62 Value weighted average(3) loan-to-value (indexed) 47 57 58 (1) Includes collateral against loans in negative equity of £4,190m at 30 June 2014 (2013: £5,394m). (2) Unweighted average of loan-to-value of all accounts. (3) Sum of all loan values divided by sum of all valuations. 30 June 2014 compared to 31 December 2013 (unreviewed) During the first half of 2014, the LTV profile of new business marginally shifted towards higher LTVs primarily as a consequence of the positive market conditions and propositions such as the UK Government's Help to Buy scheme. The Help to Buy scheme was a significant factor in the increase of 90% to 95% LTV new business from 0% to 4% in the period, in line with our plans. During the first half of 2014, the LTV profile of mortgage asset stock improved primarily as a result of house price increases, although there were regional variations, as well as the effect of regular capital repayments. House price increases positively impacted LTV by more than 1% in the Midlands, East and South East of England, Northern Ireland and Greater London. CREDIT PERFORMANCE 30 June 2014 31 December 2013 £m £m Mortgage loans and advances to customers 148,680 148,079 Performing loans(1) 143,791 142,806 Early arrears: (2) (4) 2,140 2,394 - 31 to 60 days 1,282 1,424 - 61 to 90 days 858 970 Performing loans that are impaired(5) 386 354 Loans in early arrears that are impaired excluding NPLs(5) 174 149 Non-performing loans: (3) (4) 2,657 2,788 - By Arrears 2,346 2,558 - By Bankruptcy 48 55 - By Maturity default 201 146 - By Forbearance 62 29 Properties In Possession ('PIP')(5) 92 91 (1) Includes £4,535m of mortgages (2013: £5,040m) where the counterparty failed to make a payment when contractually due for 30 days or less and excludes bankruptcy, maturity default and forbearance NPL. (2) Includes maturity default balances that are 1 or 2 months past the end of their term. Excludes bankruptcy, maturity default and forbearance NPL. (3) 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, or if the account is a maturity default where the loan or part thereof contractually matured over three months ago and a balance remains, or if the account has been forborne whilst in a non-performing state but which has yet to make sufficient payments to merit exit from NPL, or certain multiple forbearance. (4) All mortgage balances are UK and continue accruing interest. The balances include interest charged to the customer's account, but exclude interest accrued but not yet charged to the account. The interest accrued for accounts in early arrears (31 - 90 days) and non-performing loans are included in performing loans. (5) Retail loans are generally collectively assessed for impairment. Assets reported as impaired represent, for collective assessment, that portion of the loan portfolio where it is estimated that a loss has been incurred, plus those assets individually impaired (i.e. PIP). Non-performing loans and advances (1) (2) An analysis of mortgage NPLs is presented below. 30 June 2014 £m 31 December 2013 £m Mortgage loans and advances to customers of which:(2) 148,680 148,079 Mortgage Arrears excluding NPLs(3) 2,140 2,394 Mortgage NPLs - impaired(3)(4) 640 468 Mortgage NPLs - not impaired(3) 2,017 2,320 Mortgage NPLs 2,657 2,788 Impairment loss allowances 586 593 % % Arrears ratio(5) 1.44 1.62 NPL ratio(6) 1.79 1.88 Coverage ratio(7) 22 21 (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, or if the account is a maturity default where the loan or part thereof contractually matured over three months ago and a balance remains, or if the account has been forborne whilst in a non-performing state but which has yet to make sufficient payments to merit exit from NPL, or certain multiple forbearance. (2) Mortgage loans and advances to customers include Social Housing loans and finance leases. (3) All mortgage balances are UK and continue accruing interest. The balances include interest charged to the customer's account, but exclude interest accrued but not yet charged to the account. The interest accrued for account in early arrears (31 - 90 days) and non-performing loans are included in performing loans. (4) NPLs against which an impairment loss allowance has been established. (5) Mortgage loans and advances to customers in arrears as a percentage of mortgage loans and advances to customers. (6) Mortgage NPLs as a percentage of mortgage loans and advances to customers. (7) Impairment loss allowances as a percentage of NPLs. Movements in NPLs during the period are set out in the graph below. > 'Transfers in' represent loans which have become classified as NPLs during the year, comprising: > Entries: cases where the arrears increased to 91 days or more past due, specific types of maturity default, bankruptcy or forbearance; and > Policy entries: cases that entered the NPL classification due to a change in policy in the year. > 'Transfers out' represent loans which have left the NPL classification during the year, comprising: > Exits: cases where the arrears reduced to less than 91 days past due, as well as loan repayments/redemptions; and > PIP exits: cases that moved from non-performing and into possession, including any written-off portion. Write-offs represent the unrecovered element of a loan where recovery options, including realisation of any collateral, have been exhausted. Forbearance activity does not result in a change in the NPL status. The following is a pictorial representation of the data in the table below. http://www.rns-pdf.londonstockexchange.com/rns/0919P_10-2014-8-14.pdf An analysis of the NPL movements during the first half of 2014 is presented below: £m At 1 January 2014 2,788 Transfers in to NPL: - Entries 772 - Policy entries 24 Transfers out of NPL: - PIP exits (100) - Exits (827) At 30 June 2014 2,657 30 June 2014 compared to 31 December 2013 (unreviewed) During the first half of 2014, the mortgage asset NPL stock decreased to £2,657m (2013: £2,788m). This reduction resulted largely from improvements in the economic environment and prolonged low interest rates, coupled with improved collections efficiencies introduced both in 2013 and the first half of 2014. The mortgage NPL ratio decreased to 1.79% at 30 June 2014 (2013: 1.88%) reflecting a decrease in mortgage NPLs and increase in mortgage asset. The decrease in mortgage NPLs reflected the good credit quality of the portfolio, supported by the improving economic environment for UK households, with low interest rates, rising house prices and falling unemployment. We remain aware that these trends may not continue and we take account of this in setting our provisions. There was a small increase in mortgage NPLs on maturity defaults (i.e. interest-only mortgages that remain outstanding more than 90 days after contractual maturity), in line with our expectations. The improving economy also helped to contribute to a reduction in the level of early arrears (31-90 days), as well as in the proportion of impaired loans. However, the economic recovery remains at an early stage, and a conservative stance was therefore maintained in the provisioning policy. This included allowances made for losses which could stem from factors including regional variation in the risk profile, changes to regulation and contractual maturity defaults. In the first half of 2014, interest income recognised on impaired loans amounted to £42m (six months ended 30 June 2013: £43m). FORBEARANCE Forbearance commenced during the period/year (1) (2) The balances that entered forbearance during the period ended 30 June 2014 and year ended 31 December 2013 analysed by type of forbearance applied, were: 30 June 2014 30 June 2014 31 December 2013 31 December 2013 £m % £m % Capitalisation 141 41 130 31 Term extensions 137 40 168 39 Interest-only 63 19 128 30 341 100 426 100 (1) Mortgages are included within the period/year that they were forborne. (2) The figures by period/year reflect the amount of forbearance activity undertaken during the period/year irrespective of whether any forbearance activity has previously been undertaken on the forborne accounts. Forbearance cumulative position a) Performance status when entering forbearance The forborne balancesat 30 June 2014 and 31 December 2013 when they originally entered forbearance, analysed by type of forbearance applied, were: 30 June 2014(1) Capitalisation Term extension Interest-only Total £m £m £m £m Forbearance of NPL 311 85 314 710 Forbearance of Non-NPL 1,387 858 1,042 3,287 Total 1,698 943 1,356 3,997 31 December 2013(1) Capitalisation Term extension Interest-only Total £m £m £m £m Forbearance of NPL 290 77 324 691 Forbearance of Non-NPL 1,426 892 1,078 3,396 Total 1,716 969 1,402 4,087 (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/year. b) Performance status at the period/year-end The forborne balances analysed by type of forbearance applied at 30 June 2014 and 31 December 2013 were: 30 June 2014(1) Capitalisation Term extension Interest-only Total Impairment allowance £m £m £m £m £m In arrears (including NPLs) 453 162 445 1,060 71 Performing (2) 1,245 781 911 2,937 42 Total 1,698 943 1,356 3,997 113 Proportion of portfolio 1.1% 0.6% 0.9% 2.7% - 31 December 2013(1) Capitalisation Term extension Interest-only Total Impairment allowance £m £m £m £m £m In arrears (including NPLs) 499 181 495 1,175 68 Performing (2) 1,217 788 907 2,912 62 Total 1,716 969 1,402 4,087 130 Proportion of portfolio 1.2% 0.7% 0.9% 2.8% - (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/year. (2) Where a loan has been classed as performing it will be continue to be classed as forborne for the duration of the life of the account. 30 June 2014 compared to 31 December 2013 (unreviewed) The average monthly level of forbearance commenced in the first half of 2014 increased due to a higher level of capitalisations. The level of capitalisations increased due to improvements in the efficiency of the capitalisation process, enabling decisions on capitalisation to be made more rapidly, but the levels of inflows were still significantly below that observed prior to 2013. At 30 June 2014, the stock of mortgage accounts that had their term extended or converted to interest-only was relatively stable, amounting to 1.5% of all mortgage accounts by value (2013: 1.6%). Levels of adherence to revised payment terms agreed under Santander UK's forbearance arrangements improved during the first half of 2014 to approximately 78% by value (2013: 75%) and 79% by volume (2013: 77%) of the accounts in forbearance. The high percentage of these 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 a non-performing state. At 30 June 2014, the proportion of accounts that had been in forbearance for more than six months that had made their last six months' contractual payments increased slightly to 83% (2013: 82%). Furthermore, the accounts in forbearance classified as performing remained stable at just over £2.9bn or 73.5% by value (2013: £2.9bn or 71% by value). The weighted average LTV of all accounts in forbearance was 39.8% (2013: 42.0%) compared to the weighted average portfolio LTV of 43.6% (2013: 46.7%). 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 2014, impairment loss allowances as a percentage of the balance of accounts for the overall mortgage portfolio was 0.39% (2013: 0.40%). The equivalent ratio for accounts in forbearance which were performing was 1.42% (2013: 2.13%), and for accounts in forbearance which were in arrears was 6.68% (2013: 5.79%). 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. Multiple forbearance is intended to recognise when an agreed plan to mitigate the customer's financial difficulty has failed and an alternative plan is required. Customers that have more than one forbearance event in a given year or more than three events in any rolling five year period are classified as multiple forbearance. At 30 June 2014, the carrying value of mortgage loans classified as multiple forbearance increased to £78m (2013: £67m) mainly due to increased capitalisation activities and on-going activities on interest-only accounts that have reached maturity with a balance still remaining. Other changes in contractual terms In addition, £6.8bn (2013: £7.3bn) of loans have been modified since January 2008. On these accounts, the modifications are not considered to have been forbearance as the borrowers were not exhibiting signs of being in financial difficulty. These modifications were entered into in order to retain the customer relationship. The performance and profile of the additional modifications is kept under review. At 30 June 2014: > The average LTV was 46% (2013: 49%) and 96% (2013: 93%) of accounts had paid their contractual monthly payment during the previous six months. > The proportion of accounts three or more monthly payments in arrears was 1.65% (2013: 1.68%), which continued to be consistent with the rest of the portfolio. Financial assets that would otherwise be past due or impaired At 30 June 2014, the carrying amount of financial assets that would otherwise be past due or impaired whose terms have been forborne was £2,952m (2013: £2,930m). This information is provided by RNS The company news service from the London Stock Exchange END IR SFFSFLFLSEIA
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