SANTANDER UK PLC

National Storage Mechanism | Additional information You don't have Javascript enabled. For full functionality this page requires javascript to be enabled. RNS Number : 7360L Santander UK Plc 15 August 2013 Governance Directors The Directors of Santander UK plc are listed in the 2012 Annual Report. In addition to those listed, Michael Amato was appointed as a Non-Executive Director of Santander UK plc with effect from 1 August 2013. Michael Amato's biographical details are shown below. NON-EXECUTIVE DIRECTORS Michael Amato Michael Amato (age 56) was appointed Non-Executive Director on 1 August 2013. He is currently President and Chief Executive of Cimarron Inc. (since 2012). Previously, he was Global Chief Distribution and Product Management Director of Barclays Bank plc (2006 - 2012). Michael was also previously at Washington Mutual Bank (1982 - 2006) in a number of senior positions. Directors' Responsibility Statement The Half Yearly Financial Report is the responsibility of the Directors who confirm to the best of their knowledge: (a) the condensed set of financial statements, prepared in accordance with IAS 34 'Interim Financial Reporting' as adopted by the European Union, gives a true and fair view of the assets, liabilities, financial position and profit or loss of Santander UK plc and the undertakings included in the consolidation taken as a whole; (b) the interim management report includes a fair review of the information required by DTR 4.2.7R (indication of important events during the first six months and description of principal risks and uncertainties for the remaining six months of the year); and (c) the interim management report includes a fair review of the information required by DTR 4.2.8R (disclosure of related party transactions and changes therein). Approved by the Board of Santander UK plc and signed on its behalf by: Ana Botín Chief Executive Officer 14 August 2013 Review Report INDEPENDENT REVIEW REPORT TO SANTANDER UK PLC We have been engaged by Santander UK plc (the 'Company') to review the condensed set of financial statements in the half-yearly financial report for the six months ended 30 June 2013 comprising the Condensed Consolidated Income Statement, the Condensed Consolidated Statement of Comprehensive Income, the Condensed Consolidated Balance Sheet, the Condensed Consolidated Statement of Changes in Equity, the Condensed Consolidated Cash Flow Statement, the related Notes 1 to 30, the information on pages 36 to 95 of the Risk Management Report in the Business Review except for those items marked as unreviewed, together the Condensed Consolidated Interim Financial Statements. We have read the other information contained in the half-yearly financial report and considered whether it contains any apparent misstatements or material inconsistencies with the information in the condensed set of financial statements. This report is made solely to the Company in accordance with International Standard on Review Engagements (UK and Ireland) 2410 "Review of Interim Financial Information Performed by the Independent Auditor of the Entity" issued by the Auditing Practices Board. Our work has been undertaken so that we might state to the Company those matters we are required to state to it in an independent review report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company, for our review work, for this report, or for the conclusions we have formed. Directors' responsibilities The half-yearly financial report is the responsibility of, and has been approved by, the directors. The directors are responsible for preparing the half-yearly financial report in accordance with the Disclosure and Transparency Rules of the United Kingdom's Financial Conduct Authority. As disclosed in Note 1, the annual financial statements of the Company are prepared in accordance with IFRSs as adopted by the European Union. The condensed set of financial statements included in this half-yearly financial report has been prepared in accordance with International Accounting Standard 34, "Interim Financial Reporting," as adopted by the European Union. Our responsibility Our responsibility is to express to the Company a conclusion on the condensed set of financial statements in the half-yearly financial report based on our review. Scope of Review We conducted our review in accordance with International Standard on Review Engagements (UK and Ireland) 2410 "Review of Interim Financial Information Performed by the Independent Auditor of the Entity" issued by the Auditing Practices Board for use in the United Kingdom. A review of interim financial information consists of making inquiries, primarily of persons responsible for financial and accounting matters, and applying analytical and other review procedures. A review is substantially less in scope than an audit conducted in accordance with International Standards on Auditing (UK and Ireland) and consequently does not enable us to obtain assurance that we would become aware of all significant matters that might be identified in an audit. Accordingly, we do not express an audit opinion. Conclusion Based on our review, nothing has come to our attention that causes us to believe that the condensed set of financial statements in the half-yearly financial report for the six months ended 30 June 2013 is not prepared, in all material respects, in accordance with International Accounting Standard 34 as adopted by the European Union and the Disclosure and Transparency Rules of the United Kingdom's Financial Conduct Authority. Deloitte LLP Chartered Accountants and Statutory Auditor London, United Kingdom 14 August 2013 Financial Statements Primary Financial Statements Condensed Consolidated Income Statement (unaudited) For the six months ended 30 June 2013 and 2012 Notes Six months ended 30 June 2013 £m Six months ended 30 June 2012(1) £m Interest and similar income 3,624 3,730 Interest expense and similar charges (2,233) (2,265) Net interest income 1,391 1,465 Fee and commission income 532 519 Fee and commission expense (143) (102) Net fee and commission income 389 417 Net trading and other income 3 181 237 Total operating income 1,961 2,119 Administration expenses (992) (959) Depreciation, amortisation and impairment (121) (118) Total operating expenses excluding provisions and charges (1,113) (1,077) Impairment losses on loans and advances 4 (235) (350) Provisions for other liabilities and charges 4 (64) (2) Total operating provisions and charges (299) (352) Profit on continuing operations before tax 549 690 Tax on profit on continuing operations 5 (109) (166) Profit for the period from continuing operations 440 524 (Loss)/profit from discontinued operations before tax (16) 35 Taxation credit/(charge) on discontinued operations 4 (9) (Loss)/profit from discontinued operations 6 (12) 26 Profit for the period 428 550 Attributable to: Equity holders of the parent 428 550 (1) Adjusted to reflect the presentation of discontinued operations, as set out in Note 6. Condensed Consolidated Statement of Comprehensive Income (unaudited) For the six months ended 30 June 2013 and 2012 Notes Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Profit for the period 428 550 Other comprehensive (expense)/income: Other comprehensive income that may be reclassified to profit or loss subsequently: Gains/(losses) on available-for-sale securities 28 (16) Losses on cash flow hedges (429) - Exchange differences on translation of foreign operations (2) - Tax on above items 7 4 Net other comprehensive expense that may be reclassified to profit or loss subsequently (396) (12) Items not to be reclassified to profit or loss subsequently: Remeasurement of defined benefit pension schemes 22 (233) 302 Tax on above item 54 (71) Net other comprehensive (expense)/income that will not be reclassified to profit or loss subsequently (179) 231 Profits on available-for-sale securities transferred to profit or loss on sale (53) (22) Gains on cash flow hedges transferred to profit or loss 370 - Tax on items transferred to profit or loss 13 5 Net transfers to profit 330 (17) Total other comprehensive (expense)/income for the period before tax (319) 264 Tax relating to components of other comprehensive income/(expense) 74 (62) Total comprehensive income for the period 183 752 Attributable to: Equity holders of the parent 183 752 The accompanying Notes on pages 102 to 137 and the reviewed sections of the Risk Management Report on pages 36 to 95 form an integral part of these Condensed Consolidated Interim Financial Statements. Condensed Consolidated Balance Sheet (unaudited) At 30 June 2013 and 31 December 2012 Notes 30 June 2013 £m 31 December 2012(1) £m Assets Cash and balances at central banks 34,372 29,282 Trading assets 8 31,163 22,498 Derivative financial instruments 9 25,924 30,146 Financial assets designated at fair value 10 2,821 3,811 Loans and advances to banks 11 2,340 2,438 Loans and advances to customers 12 188,065 190,782 Available-for-sale securities 13 5,178 5,483 Loans and receivables securities 1,269 1,259 Macro hedge of interest rate risk 872 1,222 Intangible assets 14 2,328 2,325 Property, plant and equipment 15 1,481 1,541 Current tax assets 58 50 Deferred tax assets 16 51 60 Retirement benefit assets 22 203 254 Other assets 1,746 1,893 Total assets 297,871 293,044 Liabilities Deposits by banks 17 9,242 9,935 Deposits by customers 150,878 149,037 Derivative financial instruments 9 23,629 28,861 Trading liabilities 18 34,790 21,109 Financial liabilities designated at fair value 19 5,277 4,002 Debt securities in issue 20 53,542 59,621 Subordinated liabilities 3,710 3,781 Other liabilities 2,706 2,526 Provisions 21 774 914 Current tax liabilities 3 4 Retirement benefit obligations 22 460 305 Total liabilities 285,011 280,095 Equity Share capital and other equity instruments 3,999 3,999 Share premium 5,620 5,620 Retained earnings 3,289 3,312 Other reserves (48) 18 Total shareholders' equity 12,860 12,949 Total liabilities and equity 297,871 293,044 (1) Adjusted to reflect the presentation of the assets held for sale prior to the completion of the sale as set out in Note 6 to the Condensed Consolidated Interim Financial Statements. The accompanying Notes on pages 102 to 137 and the reviewed sections of the Risk Management Report on pages 36 to 95 form an integral part of these Condensed Consolidated Interim Financial Statements. Condensed Consolidated Statement of Changes in Equity (unaudited) For the six months ended 30 June 2013 and 2012 Other reserves Notes Share capital £m Share premium £m Available for sale reserve £m Cash flow hedging reserve £m Foreign currency translation reserve £m Retained earnings £m Total £m 1 January 2013 3,999 5,620 1 - 17 3,312 12,949 Total comprehensive income/(expense): - Profit for the period - - - - - 428 428 - Other comprehensive income/(expense) for the period - - (25) (59) (2) (233) (319) - Tax on other comprehensive income/(expense) - - 6 14 - 54 74 - - (19) (45) (2) 249 183 Dividends and other distributions - - - - - (272) (272) 30 June 2013 3,999 5,620 (18) (45) 15 3,289 12,860 1 January 2012 3,999 5,620 9 - 17 3,021 12,666 Total comprehensive income/(expense): - Profit for the period - - - - - 550 550 - Other comprehensive income/(expense) for the period - - (38) - - 302 264 - Tax on other comprehensive income/(expense) - - 10 - - (72) (62) (28) 780 752 Dividends and other distributions - - - - - (57) (57) 30 June 2012 3,999 5,620 (19) - 17 3,744 13,361 The accompanying Notes on pages 102 to 137 and the reviewed sections of the Risk Management Report on pages 36 to 95 form an integral part of these Condensed Consolidated Interim Financial Statements. Condensed Consolidated Cash Flow Statement (unaudited) For the six months ended 30 June 2013 and 2012 Notes Six months ended 30 June 2013 £m Six months ended 30 June 2012 (1) £m Cash flows from operating activities Profit for the period 440 524 Adjustments for: Non cash items included in profit 767 132 Change in operating assets (1,696) 5,078 Change in operating liabilities 8,774 7,451 Corporation taxes (paid)/received (31) (149) Effects of exchange rate differences 2,021 (1,220) Net cash flow from operating activities 24 10,275 11,816 Cash flows (used in)/from investing activities Investment in associates (3) - Purchase of property, plant and equipment and intangible assets 14,15 (145) (192) Proceeds from sale of property, plant and equipment and intangible assets 80 43 Purchase of available-for-sale securities (2,415) (4,830) Proceeds from sale of available-for-sale securities 2,765 20 Net cash flow from/(used in) investing activities 282 (4,959) Cash flows from/(used in) financing activities Issue of debt securities 13,997 22,711 Repayment of debt securities (20,314) (14,826) Dividends paid on ordinary shares 7 (450) (425) Dividends paid on preference shares classified in equity 7 (19) (19) Dividends paid on Reserve Capital Instruments 7 (21) (21) Dividends paid on Perpetual Preferred Securities 7 (17) (17) Net cash flow (used in)/ from financing activities (6,824) 7,403 Net increase in cash and cash equivalents 3,733 14,260 Cash and cash equivalents at beginning of the period 41,305 42,946 Effects of exchange rate changes on cash and cash equivalents 516 (305) Cash and cash equivalents at the end of the period 24 45,554 56,901 (1) Adjusted to reflect the presentation of discontinued operations, as set out in Note 6 to the Condensed Consolidated Interim Financial Statements. The accompanying Notes on pages 102 to 137 and the reviewed sections of the Risk Management Report on pages 36 to 95 form an integral part of these Condensed Consolidated Interim Financial Statements. Notes to the Financial Statements 1. ACCOUNTING POLICIES These Condensed Consolidated Interim Financial Statements are prepared for Santander UK plc (the 'Company') and the Santander UK plc group (the 'Santander UK group') under the Companies Act 2006. The principal activity of the Santander UK group is the provision of an extensive range of personal financial services, and a wide range of banking and financial services to business and public sector customers. Santander UK plc is a public limited company, incorporated in England and Wales, having a registered office in England and is the holding company of the Santander UK group as well as undertaking banking and financial services transactions as an operating company. BASIS OF PREPARATION These Condensed Consolidated Interim Financial Statements are not a form of statutory accounts. The information for the year ended 31 December 2012 does not constitute statutory accounts as defined in section 434 of the Companies Act 2006. A copy of the statutory accounts for that financial year has been delivered to the Registrar of Companies. The auditor's report on those accounts was unqualified, did not draw attention to any matters by way of emphasis and did not contain a statement under section 498(2) or (3) of the Companies Act 2006. a) Compliance with International Financial Reporting Standards The Condensed Consolidated Interim Financial Statements have been prepared in accordance with International Accounting Standard ('IAS') 34 'Interim Financial Reporting', as issued by the International Accounting Standards Board ('IASB'), including interpretations issued by the IFRS Interpretations Committee ('IFRIC') of the IASB (together 'IFRS'). The Santander UK group has also complied with its legal obligation to comply with International Financial Reporting Standards as adopted by the European Union as there are no applicable differences between the two frameworks for the periods presented. Accordingly, certain information and disclosures normally required to be included in the notes to the annual financial statements have been omitted or condensed. The Condensed Consolidated Interim Financial Statements should be read in conjunction with the Consolidated Financial Statementsof the Santander UK plc group for the year ended 31 December 2012 which were prepared in accordance with International Financial Reporting Standards ('IFRS') as issued by the IASB in addition to being consistent with IFRS as adopted for use in the European Union. The same accounting policies, presentation and methods of computation are followed in these Condensed Consolidated Interim Financial Statements as were applied in the presentation of the Santander UK plc group's 2012 Annual Report except as described below: Recent accounting developments In 2013, the Santander UK group adopted the following amendments to standards which became effective for financial years beginning on 1 January 2013. a) IAS 1 'Presentation of Financial Statements' - In June 2011, the IASB issued amendments to IAS 1 that retain the option to present profit or loss and other comprehensive income in either a single statement or in two separate but consecutive statements. However, the amendments to IAS 1 require additional disclosures to be made in the other comprehensive income section such that items of other comprehensive income are grouped into two categories: (i) items that will not be reclassified subsequently to profit or loss; and (ii) items that may be reclassified subsequently to profit or loss when specific conditions are met. Income tax on items of other comprehensive income is required to be allocated on the same basis. The amendments to IAS 1 are effective for annual periods beginning on or after 1 July 2012. The amendments have been applied retrospectively and hence the presentation of items of other comprehensive income has been modified to reflect the changes. Other than the above mentioned presentation changes, the application of the amendments to IAS 1 does not result in any impact on profit or loss, other comprehensive income and total comprehensive income. b) IAS 19 'Employee Benefits' - In June 2011, the IASB issued amendments to IAS 19 that change the accounting for defined benefit plans and termination benefits. The most significant change relates to the accounting for changes in defined benefit obligations and plan assets. The amendments require the recognition of changes in defined benefit obligations and in the fair value of plan assets when they occur, and hence eliminate the 'corridor approach' permitted under the previous version of IAS 19 and accelerate the recognition of past service costs. All actuarial gains and losses are recognised immediately through other comprehensive income in order for the net pension asset or liability recognised in the consolidated statement of financial position to reflect the full value of the plan deficit or surplus. Furthermore, the interest cost and expected return on plan assets used in the previous version of IAS 19 are replaced with a 'net interest' amount under IAS 19 (as revised in 2011), which is calculated by applying the discount rate to the net defined benefit liability or asset. In addition, IAS 19 (as revised in 2011) introduces certain changes in the presentation of the defined benefit cost including more extensive disclosures. The Santander UK group adopted IAS 19 with effect from 1 January 2004 and has since that date recognised all actuarial gains and losses immediately through other comprehensive income and all past service costs immediately when changes to benefits were made. No change to prior periods is required in respect of the elimination of the corridor approach or recognition of past service costs. In the six months ended 30 June 2013, Santander UK has presented a 'net interest' amount, determined in accordance with IAS 19 (as revised in 2011). Comparative amounts have not been restated as the impact has been assessed as not material. c) In December 2011, the IASB issued amendments to IFRS 7 'Disclosures - Offsetting Financial Assets and Financial Liabilities' which requires the disclosures about the effect or potential effects of offsetting financial assets and financial liabilities and related arrangements on an entity's financial position. The amendments are effective for annual periods beginning on or after 1 January 2013 but not for interim periods within those annual periods. d) IFRS 10 'Consolidated Financial Statements', IFRS 11 'Joint Arrangements', IFRS 12 'Disclosure of Interests in Other Entities', IAS 27 'Separate Financial Statements' and IAS 28 'Investments in Associates and Joint Ventures' - In May 2011, the package of five standards on consolidation, joint arrangements, associates and disclosures was issued. Subsequent to the issue of these standards, amendments to IFRS 10, IFRS 11 and IFRS 12 were issued to clarify certain transitional guidance on the first-time application of the standards. > Under IFRS 10, control is the single basis for consolidation, irrespective of the nature of the investee; this standard therefore eliminates the risks-and-rewards approach. IFRS 10 identifies the three elements of control as power over the investee, exposure, or rights, to variable returns from involvement with the investee and the ability to use power over the investee to affect the amount of the investor's returns. An investor must possess all three elements to conclude that it controls an investee. The assessment of control is based on all facts and circumstances, and the conclusion is reassessed if there are changes to at least one of the three elements. Retrospective application is required subject to certain transitional provisions. The Santander UK group has reviewed its control assessments from 1 January 2013 in accordance with IFRS 10 and determined that the adoption of IFRS 10 did not result in any change in the consolidation status of any of its subsidiaries and investees held during the period or comparative periods covered by these financial statements apart from the deconsolidation of the finance subsidiaries which have issued trust preferred securities as detailed in Note 34 to the 2012 Annual Report. The deconsolidation of these entities had no material impact on the income statement, balance sheet or cash flow statement in current or prior periods. The other amendments to IAS 27 did not affect the Company. > IFRS 11 applies to all entities that are parties to a joint arrangement. A joint arrangement is an arrangement of which two or more parties have joint control. IFRS 11 establishes two types of joint arrangements, joint operations and joint ventures, which are distinguished by the rights and obligations of the parties to the arrangement. In a joint operation, the parties to the joint arrangement (referred to as 'joint operators') have rights to the assets and obligations for the liabilities of the arrangement. By contrast, in a joint venture, the parties to the arrangement (referred to as 'joint venturers') have rights to the net assets of the arrangement. IFRS 11 requires that a joint operator recognise its share of the assets, liabilities, revenues and expenses in accordance with applicable IFRSs; however, a joint venturer would account for its interest by using the equity method of accounting under IAS 28 (2011). The amendments to IAS 28 did not affect the Company. Santander UK group has reassessed its joint arrangement and concluded that the adoption of IFRS 11 did not result in any changes in the accounting for its joint arrangement. > IFRS 12 integrates the disclosure requirements on interests in other entities, currently included in several standards to make it easier to understand and apply the disclosure requirements for subsidiaries, joint arrangements, associates and unconsolidated structured entities. The standard also contains additional requirements on a number of topics. Under IFRS 12, an entity should disclose information about significant judgements and assumptions (and any changes to those assumptions) made in determining whether it has control, joint control, or significant influence over another entity and the type of joint arrangement. IFRS 12 also requires additional disclosures to provide information to enable users to assess the nature of, and risks associated with the Company's interests in other entities and the effect of those interests on the Company's financial position, performance and cash flow. Disclosures shall be aggregated or disaggregated so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have different characteristics. The standard has been applied prospectively from 1 January 2013. Disclosures for the six months ended 30 June 2013 as a result of the adoption of IFRS 12 can be found in Note 28. e) IFRS 13 'Fair Value Measurement' - In May 2011, the IASB issued IFRS 13, which establishes a single source of guidance for fair value measurements and disclosures about fair value measurements. IFRS 13 defines fair value, establishes a framework for measuring fair value, and requires disclosures about fair value measurements. IFRS 13 applies to both financial instrument items and non-financial instrument items for which other IFRSs require or permit fair value measurements and disclosures about fair value measurements, except in specified circumstances. IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date under current market conditions. Fair value under IFRS is an exit price regardless of whether that price is directly observable or estimated using another valuation technique. IFRS 13 requires prospective application from 1 January 2013. In addition, specific transitional provisions were given to entities such that they need not apply the disclosure requirements set out in the Standard in comparative information provided for periods before the initial application of the Standard. In accordance with these transitional provisions, the Santander UK group has not made any new disclosures required by IFRS 13 for the 2012 comparative period. The application of IFRS 13 for the six months ended 30 June 2013 resulted in the recognition of a debit valuation adjustment in respect of derivative liabilities of £44m. The required disclosures can be found in Note 27. f) There are a number of other changes to IFRS that were effective from 1 January 2013. Those changes did not have a significant impact on the Santander UK group's financial statements. Future accounting developments The Santander UK group has not yet adopted the following significant new or revised standards and interpretations, and amendments thereto, which have been issued but which are not yet effective for the Santander UK group: a) IFRS 9 'Financial Instruments' - In November 2009, the IASB issued IFRS 9 'Financial Instruments ('IFRS 9') which introduced new requirements for the classification and measurement of financial assets. In October 2010, the IASB issued an amendment to IFRS 9 incorporating requirements for financial liabilities. Together, these changes represent the first phase in the IASB's planned replacement of IAS 39 'Financial Instruments: Recognition and Measurement' ('IAS 39') with a less complex and improved standard for financial instruments. Following the IASB's decision in December 2011 to defer the effective date, the standard is effective for annual periods beginning on or after 1 January 2015 with early adoption permitted. IFRS 9 is required to be applied retrospectively but prior periods need not be restated. The second and third phases in the IASB's project to replace IAS 39 will address impairment of financial assets measured at amortised cost and hedge accounting. The IASB re-opened the requirements for classification and measurement in IFRS 9 in 2012 to address practice and other issues, with an exposure draft of revised proposals issued in November 2012. The proposals have yet to be finalised and it is therefore not yet possible to estimate the financial effects. The current effective date is 1 January 2015, but may be delayed. b) In December 2011, the IASB issued amendments to IAS 32 'Offsetting Financial Assets and Financial Liabilities' which clarified the requirements for offsetting financial instruments and addressed inconsistencies in current practice when applying the offsetting criteria in IAS 32 'Financial Instruments: Presentation'. The amendments are effective for annual periods beginning on or after 1 January 2014 with early adoption permitted and are required to be applied retrospectively. The Santander UK group is currently assessing the impact of these clarifications but it is not practicable to quantify the effect as at the date of the publication of these financial statements. c) There are a number of other standards which have been issued or amended that are expected to be effective in future periods. However, it is not practicable to provide a reasonable estimate of their effects on the Santander UK group's financial statements until a detailed review has been completed. The Condensed Consolidated Interim Financial Statements reflect all adjustments that, in the opinion of management of the Santander UK group, are necessary for a fair presentation of the results of operations for the interim period. All such adjustments to the financial information are of a normal, recurring nature. Because the results from common banking activities are so closely related and responsive to changes in market conditions, the results for any interim period are not necessarily indicative of the results that can be expected for the year. GOING CONCERN The Directors have assessed the ability of the Santander UK group to continue as a going concern, in the light of uncertain current and anticipated economic conditions, including analysing the financial resources available to it and stress testing performance forecasts through various scenarios. The Directors confirm they are satisfied that the Santander UK group has adequate resources to continue in business for the foreseeable future. For this reason, they continue to adopt the 'going concern' basis of accounting for preparing financial statements. CONSOLIDATION a) Subsidiaries The Condensed Consolidated Interim Financial Statements incorporate the financial statements of Santander UK plc and entities (including structured entities) controlled by the Company and its subsidiaries. Control is achieved where the Company has (i) power over the investee; (ii) is exposed, or has rights, to variable returns from its involvement with the investee; and (iii) has the ability to use its power to affect its returns. The Company reassesses whether or not it controls an investee if facts and circumstances indicate that there are changes to one or more of the three elements of control listed above. Consolidation of a subsidiary begins when the Company obtains control over the subsidiary and ceases when the Company loses control of the subsidiary. Specifically, the results of a subsidiary acquired or disposed of during the year are included in the consolidated statement of profit or loss and other comprehensive income from the date the Company gains control until the date when the Company ceases to control the subsidiary. Inter-company transactions, balances and unrealised gains on transactions between Santander UK group companies are eliminated; unrealised losses are also eliminated unless the cost cannot be recovered. The acquisition method of accounting is used to account for the acquisition of subsidiaries. The cost of an acquisition is measured at the fair value of the assets given up, shares issued or liabilities undertaken at the date of acquisition. Acquisition related costs are expensed as incurred. The excess of the cost of acquisition, as well as the fair value of any interest previously held, over the fair value of the Santander UK group's share of the identifiable net assets of the acquired subsidiary, associate or business at the date of acquisition is recorded as goodwill. When the Group loses control of a subsidiary, the profit or loss on disposal is calculated as the difference between (i) the aggregate of the fair value of the consideration received and the fair value of any retained interest and (ii) the previous carrying amount of the assets (including goodwill), less liabilities of the subsidiary and any non-controlling interests. Amounts previously recognised in other comprehensive income in relation to the subsidiary are accounted for (i.e. reclassified to profit or loss or transferred directly to retained earnings) in the same manner as would be required if the relevant assets or liabilities are disposed of. The fair value of any investment retained in the former subsidiary at the date when control is lost is regarded as the fair value on initial recognition for subsequent accounting under IAS 39 "Financial Instruments: Recognition and Measurement" or, when applicable, the costs on initial recognition of an investment in an associate or jointly controlled entity. Transactions between entities under common control, i.e. fellow subsidiaries of Banco Santander, S.A. (the "ultimate parent") are outside the scope of IFRS 3 - "Business Combinations", and there is no other guidance for such situations under IFRS. The Santander UK group elects to account for transactions between entities under common control for cash consideration in a manner consistent with the approach under IFRS 3R, except for the continued disclosure of those IBNO provisions for a portfolio that cannot easily be allocated to individual loans, unless the transaction represents a reorganisation of entities within the Santander UK group, in which case the transaction is accounted for at its historical cost. Business combinations between entities under common control transacted for non-cash consideration are accounted for by the Santander UK group in a manner consistent with group reconstruction relief under UK GAAP (merger accounting). b) Associates and joint ventures Associates are entities over which the Santander UK group has significant influence and that is neither a subsidiary nor an interest in a joint venture. Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies. Unrealised gains on transactions between the Santander UK group and its associates are eliminated to the extent of the Santander UK group's interest in the associates; unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. The Santander UK group's investment in associates includes goodwill on acquisition. Joint ventures are joint arrangements whereby the parties that have joint control of the arrangement have rights to the net assets of the joint arrangement. Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require unanimous consent of the parties sharing control. The Santander UK group's investments in associates and joint ventures are accounted for by the equity method of accounting and are initially recorded at cost and adjusted each year to reflect the Santander UK group's share of the post-acquisition results of the joint venture or associate. The share of any losses is restricted to a level that reflects an obligation to fund such losses. The Santander UK group does not hold significant investments in associates or joint ventures. HEDGE ACCOUNTING Santander UK plc group applies hedge accounting to represent, to the maximum possible extent permitted under accounting standards, the economic effects of its risk management strategies. Derivatives are used to hedge interest rate, exchange rate and exposures to certain indices such as retail price indices. At the time a financial instrument is designated as a hedge (i.e., at the inception of the hedge), the Santander UK group formally documents the relationship between the hedging instrument(s) and hedged item(s), its risk management objective and strategy for undertaking the hedge. The documentation includes the identification of each hedging instrument and respective hedged item, the nature of the risk being hedged (including the benchmark interest rate being hedged in a hedge of interest rate risk) and how the hedging instrument's effectiveness in offsetting the exposure to changes in the hedged item's fair value attributable to the hedged risk is to be assessed. Accordingly, the Santander UK group formally assesses, both at the inception of the hedge and on an ongoing basis, whether the hedging derivatives have been and will be highly effective in offsetting changes in the fair value attributable to the hedged risk during the period that the hedge is designated. A hedge is normally regarded as highly effective if, at inception and throughout its life, the Santander UK group can expect, and actual results indicate, that changes in the fair value or cash flow of the hedged items are effectively offset by changes in the fair value or cash flow of the hedging instrument. If at any point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued. Where derivatives are held for risk management purposes, and when transactions meet the required criteria for documentation and hedge effectiveness, the derivatives may be designated as either: (i) hedges of the change in fair value of recognised assets or liabilities or firm commitments ('fair value hedges'); (ii) hedges of the variability in highly probable future cash flows attributable to a recognised asset or liability, or a forecast transaction ('cash flow hedges'); or (iii) a hedge of a net investment in a foreign operation ('net investment hedges'). The Santander UK group applies fair value hedge accounting and cash flow hedge accounting but not hedging of a net investment in a foreign operation. a) Fair value hedge accounting Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. Where the hedged item is measured at amortised cost, the fair value changes adjust the carrying amount of the hedged asset or liability. Changes in the fair value of portfolio hedged items are presented separately in the statement of financial position and recognised in the statement of comprehensive income as gains or losses on financial assets and liabilities held for trading. If the hedge no longer meets the criteria for hedge accounting, changes in the fair value of the hedged item attributable to the hedged risk are no longer recognised in the income statement. For fair value hedges of interest rate risk, the cumulative adjustment that has been made to the carrying amount of the hedged item is amortised to the income statement using the effective interest method over the period to maturity. For portfolio hedged items, the cumulative adjustment is amortised to the income statement using the straight line method over the period to maturity. b) Cash flow hedge accounting The effective portion of changes in the fair value of qualifying cash flow hedges is recognised in other comprehensive income in the cash flow hedging reserve. The gain or loss relating to the ineffective portion is recognised immediately in the income statement. Amounts accumulated in equity are reclassified to the income statement in the periods in which the hedged item affects profit or loss. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised in the income statement when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the income statement. CRITICAL ACCOUNTING POLICIES AND AREAS OF SIGNIFICANT MANAGEMENT JUDGEMENT The preparation of the Santander UK group's Condensed Consolidated Interim Financial Statements requires management to make estimates and judgements that affect the reported amount of assets and liabilities at the date of the Condensed Consolidated Interim Financial Statements and the reported amount of income and expenses during the reporting period. Management evaluates its estimates and judgements on an ongoing basis. Management bases its estimates and judgements on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The following accounting estimates and judgements are considered important to the portrayal of the Santander UK group's financial results and financial condition because: (i) they are highly susceptible to change from period to period as assumptions are made to calculate the estimates, and (ii) any significant difference between the Santander UK group's estimated amounts and actual amounts could have a material impact on the Santander UK group's future financial results and financial condition. In calculating each estimate, a range of outcomes was calculated based principally on management's conclusions regarding the input assumptions relative to historic experience. The actual estimates were based on what management concluded to be the most probable assumptions within the range of reasonably possible assumptions. a) Impairment loss allowances for loans and advances The Santander UK group estimates impairment losses for loans and advances to customers, loans and receivables securities, and loans and advances to banks as described in the accounting policy "Impairment of financial assets" on page 219 of the 2012 Annual Report. The Santander UK group's assumptions about estimated losses are based on past performance, past customer behaviour, the credit quality of recent underwritten business and general economic conditions, which are not necessarily an indication of future losses. The net impairment loss (i.e. after recoveries) for loans and advances to customers in the Retail Banking segment recognised in the first half of 2013 was £184m (six months ended 30 June 2012: £221m), in the Corporate Banking segment was £51m (six months ended 30 June 2012: £56m) and in the Corporate Centre segment was £nil (six months ended 30 June 2012: £73m). In calculating the Retail Banking and Corporate Banking impairment loss allowances, a range of outcomes was calculated, either for each individual loan or by portfolio, based on management's conclusions regarding the estimated number of accounts that will be written off or repossessed (the 'loss propensity'), the estimated proportion of such cases that will result in a loss (the 'loss factor') and the average loss incurred (the 'loss per case') relative to historic experience. Had management used different assumptions, a larger or smaller impairment loss allowance would have resulted that could have had a material impact on the Santander UK group's reported profit before tax. Specifically, if management's conclusions as to the loss propensity, the loss factor and the estimated loss per case were different, but within the range of what management deemed to be reasonably possible, the impairment loss for loans and advances in the Retail Banking segment could have decreased in the first half of 2013 from an actual impairment loss of £184m (six months ended 30 June 2012: £221m) by up to £31m (six months ended 30 June 2012: £51m), with a potential corresponding increase in the Santander UK group's profit before tax in the first half of 2013 of up to 7% (six months ended 30 June 2012: 7%), or increased by up to £18m (six months ended 30 June 2012: £28m), with a potential corresponding decrease in the Santander UK group's profit before tax in the first half of 2013 of up to 5% (six months ended 30 June 2012: 4%). Similarly, the impairment loss for loans and advances in the Corporate Banking segment could have decreased in 2013 from an actual impairment loss of £51m (six months ended 30 June 2012: £56m) by up to £44m (six months ended 30 June 2012: £9m), with a potential corresponding increase in the Santander UK group's profit before tax in the first half of 2013 of up to 8% (six months ended 30 June 2012: 1%), or increased by up to £23m (six months ended 30 June 2012: £8m), with a potential corresponding decrease in the Santander UK group's profit before tax in the first half of 2013 of up to 4% (six months ended 30 June 2012: 1%). Similarly, the impairment loss for loans and advances in the Corporate Centre segment could have decreased in the first half of 2013 from an actual impairment loss of £nil (six months ended 30 June 2012: £73m) by up to £50m (six months ended 30 June 2012: £12m), with a potential corresponding increase in the Santander UK group's profit before tax in the first half of 2013 of up to 9% (six months ended 30 June 2012: 2%), or increased by up to £25m (six months ended 30 June 2012: £11m), with a potential corresponding decrease in the Santander UK group's profit before tax in the first half of 2013 of up to 5% (six months ended 30 June 2012: 2%). b) Valuation of financial instruments The Santander UK group trades in a wide variety of financial instruments in the major financial markets. When estimating the value of its financial instruments, including derivatives where quoted market prices are not available, management therefore considers a range of interest rates, volatility, exchange rates, counterparty credit ratings, valuation adjustments and other similar inputs, all of which vary across maturity bands. These are chosen to best reflect the particular characteristics of each transaction. Had management used different assumptions, a larger or smaller change in the valuation of financial instruments including derivatives where quoted market prices are not available would have resulted that could have had a material impact on the Santander UK group's reported profit before tax. Detailed disclosures on financial instruments, including sensitivities, can be found in Note 46 of the 2012 Annual Report. Further information about sensitivities to market risk (including Value-at-Risk ('VaR')) arising from financial instrument trading activities can be found in the Risk Management Report on page 66. c) Goodwill impairment A goodwill impairment loss of £nil was recognised in the first half of 2013 (six months ended 30 June 2012: £nil). The carrying amount of goodwill was £1,834m at 30 June 2013 (2012: £1,834m). The Santander UK group evaluates whether the carrying value of goodwill is impaired and performs impairment testing annually or more frequently if there are impairment indicators present. Details of the Santander UK group's approach to identifying and quantifying impairment of goodwill are set out in Note 14. Assumptions about the measurement of the estimated recoverable amount of goodwill are based on management's estimates of future cash flows and growth rates of the cash-generating units. The Santander UK group's assumptions about estimated future cash flows and growth rates are based on management's view of future business prospects at the time of the assessment and are subject to a high degree of uncertainty. Had management used different assumptions, a larger or smaller goodwill impairment loss would have resulted that could have had a material impact on the Santander UK group's reported profit before tax. Detailed disclosures on the assumptions used, including sensitivities, can be found in Note 14. d) Provision for conduct remediation Detailed disclosures on the provision for conduct remediation can be found in Note 21. The provision represents management's best estimate of the anticipated costs of related customer contact and/or redress, including administration expenses. However, with respect to payment protection insurance ('PPI'), there are still a number of uncertainties as to the eventual costs from any such contact and/or redress given the inherent difficulties in assessing the impact of detailed implementation of the FSA Policy Statement of 10 August 2010 for all PPI complaints, uncertainties around the ultimate emergence period for complaints, the availability of supporting evidence and the activities of claims management companies, all of which will significantly affect complaints volumes, uphold rates and redress costs. Similar uncertainty arises with respect to other products for which provision has been required in the first half of 2013. The provision requires significant judgement by management in determining appropriate assumptions, which include the level of complaints, of those, the number that will be upheld, as well as redress costs for each of the different populations of customers identified by the Santander UK group in its analyses used to determine the best estimate of the anticipated costs of redress. Had management used different assumptions, a larger or smaller provision release would have resulted that could have had a material impact on the Santander UK group's reported profit before tax. Specifically, if the level of PPI complaints had been one percentage point higher/(lower) than estimated for all policies written then the provision at 30 June 2013 would have increased/(decreased) by approximately £32m (2012: £32m). There are a large number of inter-dependent assumptions under-pinning the provision; this sensitivity assumes that all assumptions, other than the level of complaints, remain constant. Other factors are more observable as the provision is based on current levels with respect to uphold rates and redress costs. With respect to products for which provision was required in 2013, while similar uncertainties arise, it is too early to provide a meaningful range. The Santander UK group will re-evaluate the assumptions underlying its analysis at each reporting date as more information becomes available. As noted above, there is inherent uncertainty in making estimates; actual results in future periods may differ from the amount provided. e) Pensions The Santander UK group operates a number of defined benefit pension schemes as described in Note 22 and estimates their fair values as described in the accounting policy "Pensions and other post retirement benefits" on page 213 of the 2012 Annual Report. The defined benefit service cost recognised in the six months ended 30 June 2013 was £20m (six months ended 30 June 2012: £15m). The defined benefit pension schemes which were in a net asset position had a surplus of £203m (2012: surplus of £254m) and the defined benefit pension schemes which were in a net liability position had a deficit of £460m (2012: deficit of £305m). Accounting for defined benefit pension schemes requires management to make assumptions, principally about mortality, but also about price inflation, discount rates, pension increases, and earnings growth. Management's assumptions are based on past experience and current economic trends, which are not necessarily an indication of future experience. Detailed disclosures on the current year service cost and deficit, including sensitivities, can be found in Note 22. 2. SEGMENTS The principal activity of the Santander UK group is financial services. TheSantander UK group's business is managed and reported on the basis of the following segments: > Retail Banking; > Corporate Banking; > Markets; and > Corporate Centre. In the first half of 2013, the Company completed deals to sell its co-brand credit cards business, and the business was managed and reported as part of Corporate Centre, rather than Retail Banking as in 2012. The segmental analysis for the prior period has been adjusted to reflect the fact that reportable segments have changed. The Santander UK group's segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. The Santander UK grouphas four segments: > Retail Banking offers a wide range of products and financial services to customers through a network of branches, agencies and ATMs, as well as through telephony, e-commerce and intermediary channels. It principally serves personal banking customers, but also services small businesses with an annual turnover of up to £250,000. Retail Banking products include residential mortgage loans, savings and current accounts, credit cards (excluding the co-brand credit cards business) and personal loans as well as a range of insurance products. > Corporate Banking offers a wide range of products and financial services to customers through a network of regional business centres and through telephony and e-commerce channels. Corporate Banking products and services include loans, bank accounts, deposits, treasury services, invoice discounting, cash transmission and asset finance. The SME and mid corporate business principally serves small and medium enterprises with an annual turnover of more than £250,000 up to £50m ('SMEs'), and other corporate customers with an annual turnover of up to £500m. This also includes real estate lending. The Large Corporates business offers specialist treasury services in fixed income and foreign exchange, lending, transactional banking services, capital markets and money markets to large multinational corporate customers with an annual turnover of more than £500m. Lending includes syndicated loans and structured finance. Transactional banking includes trade finance and cash management. Money market activities include securities lending/borrowing and repos. > Markets offers risk management and other services to financial institutions, as well as to other Santander UK divisions. Its main product areas are fixed income and foreign exchange, equity, capital markets and institutional sales. > Corporate Centre includes Financial Management & Investor Relations ('FMIR') and the non-core corporate and legacy portfolios, as well as the co-brand credit cards business. FMIR is responsible for managing capital and funding, balance sheet composition, structural market risk and strategic liquidity risk for the Santander UK group. The non-core corporate and legacy portfolios include aviation, shipping, infrastructure, commercial mortgages, Social Housing loans and structured credit assets, all of which are being run-down and/or managed for value. Deals to sell the co-brand credit cards business were completed in the first half of 2013. The Company's board of directors (the 'Board') is the chief operating decision maker for the Santander UK group. The segment information below is presented on the basis used by the Board to evaluate performance and allocate resources. The Board reviews discrete financial information for each segment of the business, including measures of operating results, assets and liabilities. The segment information reviewed by the Board is prepared on a statutory basis of accounting. Transactions between the business segments are on normal commercial terms and conditions. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Internal charges and internal UK transfer pricing adjustments have been reflected in the performance of each business. Revenue sharing agreements are used to allocate external customer revenues to a business segment on a reasonable basis. Funds are ordinarily reallocated between segments, resulting in funding cost transfers disclosed in total trading income. Interest charged for these funds is based on the Santander UK group's cost of wholesale funding. Interest income and interest expense have not been reported separately. The majority of the revenues from the segments presented below are interest income in nature and the Board relies primarily on net interest income to both assess the performance of the segment and to make decisions regarding allocation of segmental resources. 30 June 2013 Retail Banking £m Corporate Banking £m Markets £m Corporate Centre £m Total £m Net interest income/(expense) 1,382 199 (1) (189) 1,391 Non-interest income 328 137 40 65 570 Total operating income 1,710 336 39 (124) 1,961 Administration expenses (772) (147) (48) (25) (992) Depreciation, amortisation and impairment (95) (9) (1) (16) (121) Total operating expenses excluding provisions and charges (867) (156) (49) (41) (1,113) Impairment losses on loans and advances (184) (51) - - (235) Provisions for other liabilities and charges (6) - - (58) (64) Total operating provisions and charges (190) (51) - (58) (299) Profit/(loss) from continuing operations before tax 653 129 (10) (223) 549 Loss from discontinued operations after tax - - - (12) (12) Revenue from external customers 2,024 640 39 (742) 1,961 Inter-segment revenue (314) (304) - 618 - Total operating income 1,710 336 39 (124) 1,961 Customer assets 159,605 21,036 - 10,353 190,994 Total assets(1) 165,140 49,513 24,873 58,345 297,871 Customer deposits 126,697 13,847 - 9,928 150,472 Total liabilities 131,914 40,874 19,020 93,203 285,011 Average number of staff(2) 17,940 1,754 356 255 20,305 (1) Includes customer assets, net of impairment loss allowances. (2) Full-time equivalents 30 June 2012 Retail Banking (1) £m Corporate Banking £m Markets £m Corporate Centre (1) £m Total £m Net interest income/(expense) 1,413 157 (3) (102) 1,465 Non-interest income 323 189 137 5 654 Total operating income 1,736 346 134 (97) 2,119 Administration expenses (763) (121) (54) (21) (959) Depreciation, amortisation and impairment (88) (7) (1) (22) (118) Total operating expenses excluding provisions and charges (851) (128) (55) (43) (1,077) Impairment losses on loans and advances (221) (56) - (73) (350) Provisions for other liabilities and charges 1 - - (3) (2) Total operating provisions and charges (220) (56) - (76) (352) Profit/(loss) from continuing operations before tax 665 162 79 (216) 690 Profit from discontinued operations after tax - - - 26 26 Revenue from external customers 2,403 478 134 (896) 2,119 Inter-segment revenue (667) (132) - 799 - Total operating income 1,736 346 134 (97) 2,119 31 December 2012 Customer assets 164,126 19,605 - 11,002 194,733 Total assets(2) 168,305 35,736 28,173 60,830 293,044 Customer deposits 127,178 12,812 - 8,582 148,572 Total liabilities 128,404 24,040 28,695 98,956 280,095 Average number of staff(3) 18,264 2,136 382 307 21,089 (1) Adjusted to reflect the presentation of discontinued operations, as set out in Note 6 to the Condensed Consolidated Interim Financial Statements. (2) Includes customer assets, net of impairment loss allowances. (3) Full-time equivalents. 3. NET TRADING AND OTHER INCOME Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Net trading and funding of other items by the trading book 206 181 Income from operating lease assets 21 27 Losses on assets designated at fair value through profit or loss (181) (175) Expense on liabilities designated at fair value through profit or loss (12) (14) Gains /(losses) on derivatives managed with assets/liabilities held at fair value through profit or loss 179 (88) Share of profit from associates and joint ventures 1 - Profit on sale of available-for-sale assets 53 22 Hedge ineffectiveness and other (86) 284 181 237 "Net trading and funding of other items by the trading book" includes fair value gains/(losses) of £137m (six months ended 30 June 2012: £(57)m) on embedded derivatives bifurcated from certain equity index-linked deposits. The embedded derivatives are economically hedged internally with the equity derivatives trading desk. These internal transactions are managed as part of the overall positions of the equity derivatives trading desk, the results of which are also included in this line item, and amounted to £136m (six months ended 30 June 2012: £(58)m). As a result, the net fair value movements recognised on the equity index-linked deposits and the related economic hedges were £1m (six months ended 30 June 2012: £1m). 4. IMPAIRMENT LOSSES AND PROVISIONS Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Impairment losses on loans and advances: - loans and advances to customers (Note 12) 295 374 - loans and advances to banks - - - loans and receivables securities - - Recoveries of loans and advances (Note 12) (60) (24) 235 350 Impairment losses on available-for-sale financial assets - - Provisions for other liabilities and charges (Note 21) 64 2 Total impairment losses and provisions charged to the income statement 299 352 5. TAXATION CHARGE Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Current tax: UK corporation tax on profit of the period 45 131 Adjustments in respect of prior years (13) (4) Total current tax 32 127 Deferred tax: Origination and reversal of temporary differences 79 32 Change in rate of UK corporation tax - 7 Adjustments in respect of prior years (2) - Total deferred tax 77 39 Tax on profit for the period 109 166 Interim period corporation tax is accrued based on the estimated average annual effective corporation tax rate for the year of 23% (2012: 23.5%). The standard rate of UK corporation tax was 23.25% (2012: 24.5%). The standard rate of UK corporation tax was reduced from 24% to 23% with effect from 1 April 2013. Taxation for other jurisdictions is calculated at the rates prevailing in the relevant jurisdictions. The Finance Act 2012, which provided for a reduction in the main rate of UK corporation tax to 23% effective from 1 April 2013 was enacted on 17 July 2012. The UK Government has also indicated that it intends to enact a further reduction in the main tax rate down to 21% on1 April 2014 and then to 20% on 1 April 2015. These changes in the rate were substantively enacted on 2 July 2013 after the balance sheet date and, therefore, are not included in these Condensed Consolidated Interim Financial Statements. The estimated financial statement impact of these changes is insignificant. The tax expense differs from the theoretical amount that would arise using the UK statutory rate as follows: Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Profit before tax 549 690 Tax calculated at a tax rate of 23.25% (2012: 24.5%) 128 169 Non deductible preference dividends paid 1 1 Non deductible UK Bank Levy 8 10 Other non-equalised items (10) (16) Effect of non-UK profits and losses (1) (1) Utilisation of capital losses for which credit was not previously recognised (2) - Effect of change in tax rate on deferred tax provision - 7 Adjustment to prior year provisions (15) (4) Tax expense 109 166 Further information about deferred tax is presented in Note 16. 6. DISCONTINUED OPERATIONS In the first half of 2013, the Company completed deals to sell its co-brand credit cards business for a cash consideration of £660m. The net assets disposed of consisted of loans to customers of £672m, at 31 December 2012 assets of £1.2bn were classified as held for sale, during 2013 these have been removed from Loans and Advances to Customers and presented within Other Assets within the Corporate Centre segment. The results, and loss on sale, of the discontinued operations were as follows: Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Total operating income 63 111 Total operating expenses (30) (53) Impairment losses on loans and advances (12) (18) Provisions for other liabilities and charges (21) (5) Loss on sale of discontinued operations (16) - (Loss)/profit of discontinued operations before tax (16) 35 Taxation credit/(charge) 4 (9) (Loss)/profit for the period from discontinued operations (12) 26 7. DIVIDENDS Dividends of £450m (2012: £425m) were paid on Santander UK plc's ordinary shares in issue during the period. The annual dividend of £21m on the Step-Up Callable Perpetual Reserve Capital Instruments was paid on 14 February 2013, the annual dividend of £17m on the £300m Step-up Callable Perpetual Preferred Securities, was paid on 22 March 2013, and the annual dividend of £19m on the £300m fixed/floating rate non-cumulative callable preference shares was paid on 24 May 2013. An interim dividend of £215m was declared on 25 June 2013 on the Company's ordinary shares in issue. 8. TRADING ASSETS 30 June 2013 £m 31 December 2012 £m Loans and advances to banks - securities purchased under resale agreements 7,632 7,245 - other(1) 2,194 2,743 Loans and advances to customers - securities purchased under resale agreements 11,802 7,463 - other(2) 104 89 Debt securities 8,985 4,494 Equity securities 446 464 31,163 22,498 (1) Comprises short-term loans of £1m (2012: £2m) and cash collateral of £2,193m (2012: £2,741m). (2) Comprises short-term loans. Included in the above balances are amounts owed to the Santander UK group by Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £128m (2012: £206m) and £41m (2012: £nil) respectively. 9. DERIVATIVE FINANCIAL INSTRUMENTS Derivatives are financial instruments whose value is derived from the price of one or more underlying items such as equities, equity indices, interest rates, foreign exchange rates, property indices, commodities and credit spreads. Derivatives enable users to manage exposure to credit or market risks. The Santander UK group sells derivatives to its customers and uses derivatives to manage its own exposure to credit and market risks. Details of the Santander UK group's uses of derivatives are set out in Note 15 of the 2012 Annual Report. 30 June 2013 Derivatives held for trading Contract/notional amount £m Fair value assets £m Fair value liabilities £m Exchange rate contracts: - Cross-currency swaps 98,954 1,439 1,706 - Foreign exchange swaps, options and forwards 27,972 513 302 126,926 1,952 2,008 Interest rate contracts: - Interest rate swaps 470,088 15,679 14,757 - Caps, floors and swaptions(1) 58,981 3,234 3,297 - Futures (exchange traded) 37,127 58 - - Forward rate agreements 65,387 1 6 631,583 18,972 18,060 Equity and credit contracts: - Equity index swaps and similar products 30,263 1,446 2,254 - Equity index options (exchange traded) 30,655 307 1 - Credit default swaps and similar products 224 35 3 61,142 1,788 2,258 Commodity contracts: - OTC swaps 144 5 5 144 5 5 Total derivative assets and liabilities held for trading 819,795 22,717 22,331 Derivatives held for hedging Contract/notional amount £m Fair value assets £m Fair value liabilities £m Derivatives designated as fair value hedges: Exchange rate contracts: - Cross-currency swaps 487 185 - Interest rate contracts: - Interest rate swaps 113,741 1,875 1,293 114,228 2,060 1,293 Derivatives designated as cash flow hedges: Exchange rate contracts: - Cross-currency swaps 8,356 1,147 5 8,356 1,147 5 Total derivative assets and liabilities held for hedging 122,584 3,207 1,298 Total recognised derivative assets and liabilities 942,379 25,924 23,629 (1) A swaption is an option on a swap that gives the holder the right but not the obligation to buy or sell a swap. 31 December 2012 Derivatives held for trading Contract/notional amount £m Fair value assets £m Fair value liabilities £m Exchange rate contracts: - Cross-currency swaps 117,658 2,101 2,195 - Foreign exchange swaps, options and forwards 19,568 962 654 137,226 3,063 2,849 Interest rate contracts: - Interest rate swaps 457,430 20,072 18,977 - Caps, floors and swaptions(1) 61,015 3,584 3,626 - Futures (exchange traded) 19,273 54 31 - Forward rate agreements 123,132 9 13 660,850 23,719 22,647 Equity and credit contracts: - Equity index swaps and similar products 44,077 1,086 1,816 - Equity index options (exchange traded) 29,652 152 89 - Credit default swaps and similar products 335 37 7 74,064 1,275 1,912 Commodity contracts: - OTC swaps 227 7 7 227 7 7 Total derivative assets and liabilities held for trading 872,367 28,064 27,415 Derivatives held for hedging Contract/notional amount £m Fair value assets £m Fair value liabilities £m Derivatives designated as fair value hedges: Exchange rate contracts: - Cross-currency swaps 5,024 76 168 Interest rate contracts: - Interest rate swaps 77,592 2,006 1,278 82,616 2,082 1,446 Total derivative assets and liabilities held for hedging 82,616 2,082 1,446 Total recognised derivative assets and liabilities 954,983 30,146 28,861 (1) A swaption is an option on a swap that gives the holder the right but not the obligation to buy or sell a swap. Included in the above balances are amounts owed to the Santander UK group by Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £1,726m (2012: £2,028m) and £148m (2012: £169m) respectively and amounts owed by the Santander UK group to Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £1,600m (2012: £1,916m) and £181m (2012: £117m). The net exposures after collateral to the ultimate parent undertaking and fellow subsidiaries at 30 June 2013 amounted to £84m (2012: £138m) and £7m (2012: £7m), respectively. Net gains or losses arising from fair value and cash flow hedges included in net trading and other income Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Fair value hedging: Gains on hedging instruments (199) 640 Losses on hedged items attributable to hedged risks 216 (364) Fair value hedging ineffectiveness 17 276 Cash flow hedging ineffectiveness (98) - (81) 276 The Santander UK group hedges its exposures to various risks, including interest rate risk and foreign currency risk, in connection with certain mortgage assets, covered bond issuances, and subordinated and senior debt securities in issue. The gains/(losses) arising on these assets and liabilities are presented in the table above on a combined basis. In addition, in the ordinary course of business, the Santander UK group entered into long-term interest rate contracts as economic hedges with five investment vehicles whose underlying assets comprise debt securities, bank loans and energy and infrastructure financings. Although the vehicles themselves are not externally rated, the counterparty exposure ranks super-senior to the most senior notes issued by the vehicles and these notes are rated AAA or AA. The total mark-to-market exposure at 30 June 2013 was £42m (2012: £50m). These long-term interest rate hedging contracts are included within "derivatives held for trading - interest rate contracts" shown above. Hedged cash flows The following tables show when the Santander UK group's hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges. 0-1 years 1 - 2 years 2 - 3 years 3 - 4 years 4 - 5 years 5 - 10 years 10 - 20 years Over 20 years Total 30 June 2013 £m £m £m £m £m £m £m £m £m Hedged forecast cash flows expected to occur: Forecast receivable cash flows 109 123 124 132 109 249 105 - 951 Forecast payable cash flows (876) (2,434) (200) (1,698) (2,071) (2,092) (380) - (9,751) Hedged forecast cash flows affect profit or loss: Forecast receivable cash flows 109 122 124 131 101 247 104 - 938 Forecast payable cash flows (874) (2,430) (200) (1,671) (2,048) (2,075) (377) - (9,675) There were no hedging instruments designated as cash flow hedges during the year ended 31 December 2012. There were no transactions for which cash flow hedge accounting had to be ceased during the six months ended 30 June 2013 as a result of the highly probable cash flows no longer being expected to occur. Gains and losses transferred from the cash flow hedging reserve in the current period to net interest income was a £14m gain (year ended 31 December 2012: £nil) and net trading and other income was a £356m gain (year ended 31 December 2012: £nil). 10. FINANCIAL ASSETS DESIGNATED AT FAIR VALUE 30 June 2013 £m 31 December 2012 £m Loans and advances to customers 2,272 3,248 Debt securities 549 563 2,821 3,811 Financial assets are designated at fair value through profit or loss where this results in more relevant information because it significantly reduces a measurement inconsistency that would otherwise arise from measuring the assets or liabilities or recognising gains or losses on them on a different basis, or where the assets are managed and their performance evaluated on a fair value basis, or where a contract contains one or more embedded derivatives which would otherwise require bifurcation and separate recognition as derivatives. Included in the above balances are amounts owed to the Santander UK group by Banco Santander, S.A. and other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £nil (2012: £nil) and £56m (2012: £47m) respectively. The maximum exposure to credit risk on loans and advances designated as held at fair value through profit or loss at the balance sheet date was £2,272m (2012: £3,248m). The maximum exposure was mitigated by a charge over the residential properties in respect of lending to housing associations amounting to £2,426m (2012: £3,377m) for the Santander UK group. The net gain during the period attributable to changes in credit risk for loans and advances designated at fair value was £7m (six months ended 30 June 2012: net loss of £19m). The cumulative net loss attributable to changes in credit risk for loans and advances designated at fair value at 30 June 2013 was £349m (2012: cumulative net loss of £356m). 11. LOANS AND ADVANCES TO BANKS 30 June 2013 £m 31 December 2012 £m Placements with other banks(1) 2,106 2,201 Amounts due from Banco Santander - securities purchased under resale agreements 234 233 - other - 4 2,340 2,438 (1) Principally comprises time deposits, cash in the course of collection, cash held with foreign banks and unsettled financial transactions. 12. LOANS AND ADVANCES TO CUSTOMERS 30 June 2013 £m 31 December 2012 £m Loans and advances to customers 189,242 193,455 Amounts due from fellow Banco Santander group subsidiaries and joint ventures 554 347 Loans and advances to customers 189,796 192,584 Less: impairment loss allowances (1,731) (1,802) Loans and advances to customers, net of impairment loss allowances 188,065 190,782 Movement in impairment loss allowances: 30 June 2013 Loans secured on residential property £m Corporate Loans £m Finance leases £m Other secured advances £m Other unsecured advances £m Total £m At 1 January 2013: - Observed - Individual 58 544 - 80 11 693 - Collective 327 58 6 79 197 667 - Incurred but not yet observed 167 125 34 10 106 442 552 727 40 169 314 1,802 Charge/(release) to the income statement: - Observed - Individual (2) 46 - 19 (11) 52 - Collective 40 (32) 7 26 164 205 - Incurred but not yet observed 33 (69) (2) 58 18 38 71 (55) 5 103 171 295 Write offs and other items (44) (119) (4) (27) (172) (366) At 30 June 2013: - Observed - Individual 56 471 - 72 - 599 - Collective 323 26 9 105 150 613 - Incurred but not yet observed 200 56 32 68 163 519 579 553 41 245 313 1,731 31 December 2012 Loans secured on residential property £m Corporate Loans £m Finance leases £m Other secured advances £m Other unsecured advances £m Total £m At 1 January 2012: - Observed 381 324 6 83 267 1,061 - Incurred but not yet observed 97 103 31 24 113 368 478 427 37 107 380 1,429 Charge/(release) to the income statement: - Observed 79 440 12 129 318 978 - Incurred but not yet observed 70 22 4 (14) (7) 75 149 462 16 115 311 1,053 Write offs and other items (75) (162) (13) (53) (377) (680) At 31 December 2012 - Observed 385 602 6 159 208 1,360 - Incurred but not yet observed 167 125 34 10 106 442 552 727 40 169 314 1,802 Recoveries: Loans secured on residential property £m Corporate Loans £m Finance leases £m Other secured advances £m Other unsecured advances £m Total £m 30 June 2013 - 1 1 - 58 60 30 June 2012 2 - 2 2 18 24 13. AVAILABLE-FOR-SALE SECURITIES 30 June 2013 £m 31 December 2012 £m Debt securities 5,154 5,459 Equity securities 24 24 5,178 5,483 14. INTANGIBLE ASSETS a) Goodwill 30 June 2013 £m 31 December 2012 £m Cost At 1 January, 30 June and 31 December 1,916 1,916 Accumulated impairment At 1 January, 30 June and 31 December 82 82 Net book value 1,834 1,834 Impairment of goodwill During the period, no impairment of goodwill was recognised (six months ended 30 June 2012: £nil). Impairment testing in respect of goodwill allocated to each cash-generating unit is performed annually or more frequently if there are impairment indicators present. For the purpose of impairment testing, the cash-generating units are based on customer groups within the relevant business divisions. Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions described above would not cause an impairment to be recognised in respect of goodwill arising on theSantander UK group's business combinations. The following cash-generating units include in their carrying values goodwill that comprises the goodwill reported by the Santander UK group. The cash-generating units do not carry on their balance sheets any other intangible assets with indefinite useful lives. 30 June 2013 Business Division Cash-Generating Unit Goodwill £m Basis of valuation Key assumptions Discount rate Growth rate(1) Retail Banking Personal financial services 1,169 Value in use: cash flow 5 year plan 11.4% 2% Retail Banking Credit cards 456 Value in use: cash flow 5 year plan 11.4% 4% Retail Banking Consumer finance 175 Value in use: cash flow 5 year plan 11.4% -% Retail Banking Private banking 30 Value in use: cash flow 5 year plan 11.4% 7% Retail Banking Other 4 Value in use: cash flow 5 year plan 11.4% 2% 1,834 (1) Average growth rate based on the five year plan for the first five years and a growth rate of 2% applied thereafter. 31 December 2012 Business Division Cash-Generating Unit Goodwill £m Basis of valuation Key assumptions Discount rate Growth rate(1) Retail Banking Personal financial services 1,169 Value in use: cash flow 5 year plan 11.4% 2% Retail Banking Credit cards 456 Value in use: cash flow 5 year plan 11.4% 4% Retail Banking Consumer finance 175 Value in use: cash flow 5 year plan 11.4% -% Retail Banking Private banking 30 Value in use: cash flow 5 year plan 11.4% 7% Retail Banking Other 4 Value in use: cash flow 5 year plan 11.4% 2% 1,834 (1) Average growth rate based on the five year plan for the first five years and a growth rate of 2% applied thereafter. In the first half of 2013, there were no significant movements in the discount rate and the growth rate applied. b) Other intangibles During the period, the Santander UK group spent approximately £49m (six months ended 30 June 2012: £102m) on additions to its computer software. The Santander UK group disposed of £39m (six months ended 30 June 2012: £9m) of computer software. 15. PROPERTY, PLANT AND EQUIPMENT During the period, the Santander UK group spent approximately £34m (six months ended 30 June 2012: £29m) on the refurbishment of its branches and office premises, £9m (six months ended 30 June 2012: £30m) on additions to its office fixtures and equipment, £nil (six months ended 30 June 2012: £nil) on computer software and £53m (six months ended 30 June 2012: £31m) on the acquisition of operating lease assets. The Santander UK group disposed of £30m (six months ended 30 June 2012: £6m) of property, £14m (six months ended 30 June 2012: £nil) of office fixtures and equipment and £56m (six months ended 30 June 2012: £30m) of operating lease assets during the period. At 30 June 2013, capital expenditure contracted, but not provided for was £10m (2012: £70m) in respect of property, plant and equipment. Assets under construction with a total value of £376m (2012: £293m) are included in the total carrying value of property, plant and equipment at the balance sheet date. 16. DEFERRED TAX Deferred taxes are calculated on temporary differences under the liability method using the tax rates expected to apply when the liability is settled or the asset is realised. The movement on the deferred tax account was as follows: 30 June 2013 £m 31 December 2012 £m At 1 January 60 257 Income statement charge (77) (242) Credited to other comprehensive income: - retirement benefit obligations 54 42 - available-for-sale financial assets - 3 - cash flow hedges 14 - 68 45 At 30 June/ 31 December 51 60 Deferred tax balances are presented in the balance sheet after offsetting assets and liabilities where the Santander UK groupand Company has the legal right to offset and intends to settle on a net basis. The deferred tax assets and liabilities are attributable to the following items: 30 June 2013 £m 31 December 2012 £m Deferred tax assets/ (liabilities) Pensions and other post retirement benefits 56 9 Accelerated book depreciation (40) (43) IAS 32 and IAS 39 transitional adjustments 45 53 Other temporary differences (41) (22) Tax losses carried forward 31 63 51 60 The deferred tax assets scheduled above have been recognised in the Santander UK group on the basis that sufficient future taxable profits are forecast within the foreseeable future, in excess of the profits arising from the reversal of existing taxable temporary differences, to allow for the utilisation of the assets as they reverse. Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions underlying the estimated future taxable profits in the Santander UK group's five year plan would not cause a reduction in the deferred tax assets recognised. The Santander UK grouprecognised deferred tax assets in respect of trading losses relating to the former Alliance & Leicester plc business which was transferred to Santander UK plc in May 2010 under Part VII of the Financial Services and Markets Act 2000. Management currently expect that these tax losses will be fully utilised during 2013. At 30 June 2013, the Santander UK grouphad UK capital losses carried forward of £20m (2012: £28m). These losses are available for offset against future UK chargeable gains and under current UK tax legislation do not time expire. No deferred tax asset has been recognised in respect of these capital losses on the basis that future capital gains required to utilise the losses are not considered probable. The deferred tax charge in respect of continuing and discontinued operations in the income statement comprises the following temporary differences: Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Accelerated tax depreciation (7) 11 Pensions and other post-retirement benefits 3 (12) IFRS transition adjustments (8) (11) Tax losses carried forward (33) (39) Other temporary differences (32) 7 (77) 44 17. DEPOSITS BY BANKS 30 June 2013 £m 31 December 2012 £m Items in the course of transmission 586 340 Deposits by banks - securities sold under agreements to repurchase 6,452 7,382 Amounts due to ultimate parent - securities sold under repurchase agreements - other 119 3 140 20 Amounts due to fellow Banco Santander subsidiaries 1 64 Other deposits 2,081 1,989 9,242 9,935 18. TRADING LIABILITIES 30 June 2013 £m 31 December 2012 £m Deposits by banks - securities sold under repurchase agreements 11,185 6,833 - other(1) 3,974 2,909 Deposits by customers - securities sold under repurchase agreements 11,516 4,847 - other(2) 2,212 2,401 Short positions in securities and unsettled trades 5,903 4,119 34,790 21,109 (1) Comprises cash collateral of £1,914m (2012: £2,269m) and short-term deposits of £2,060m (2012: £640m). (2) Comprises short-term deposits of £1,831m (2012: £1,702m) and equity index-linked deposits of £381m (2012: £699m). The capital amount guaranteed/protected and the amount of return guaranteed in respect of the equity index-linked deposits were £283m and £44m, respectively (2012: £559m and £109m, respectively). Included in the above balances are amounts owed by the Santander UK group to Banco Santander, S.A. of £170m (2012: £180m) and to other subsidiaries of Banco Santander, S.A. outside the Santander UK group of £1m (2012: £45m). 19. FINANCIAL LIABILITIES DESIGNATED AT FAIR VALUE 30 June 2013 £m 31 December 2012 £m Debt securities in issue - US$10bn Euro Commercial Paper Programme 2,619 1,403 - US$20bn Euro Medium Term Note Programme 474 655 - Euro 10bn Structured Notes 1,986 1,740 Warrants 198 204 5,277 4,002 Financial liabilities are designated at fair value through profit or loss where this results in more relevant information because it significantly reduces a measurement inconsistency that would otherwise arise from measuring assets and liabilities or recognising the gains or losses on them on a different basis, or where a contract contains one or more embedded derivatives that would otherwise require separate recognition. Gains and losses arising from changes in the credit spread of liabilities issued by the Santander UK group reverse over the contractual life of the debt, provided that the debt is not repaid at a premium or a discount. The net gain during the period attributable to changes in the Santander UK group's own credit risk on the above debt securities in issue was £18m (six months ended 30 June 2012: net loss of £23m). The cumulative net gain attributable to changes in the Santander UK group's own credit risk on the above debt securities in issue at 30 June 2013 was £25m (2012: net gain of £7m). The amount that would be required to be contractually paid at maturity of the deposits by banks, deposits by customers, and debt securities in issue above at 30 June 2013 is £359m (2012: £531m) higher than the carrying value. 20. DEBT SECURITIES IN ISSUE 30 June 2013 £m 31 December 2012 £m Bonds and medium term notes: - Euro 35bn Global Covered Bond Programme 17,963 21,757 - US$20bn Euro Medium Term Note Programme 7,474 6,396 - US$40bn Euro Medium Term Note Programme 166 645 - US$20bn Commercial Paper Programme 3,346 2,289 - Certificates of deposit in issue 1,051 4,509 30,000 35,596 Securitisation programmes: - Holmes 10,521 9,876 - Fosse 11,688 13,387 - Motor 1,333 762 53,542 59,621 Included in the above balances are amounts owed by the Santander UK group to the ultimate parent undertaking and to fellow subsidiaries of £91m (2012: £2,058m) and £1,348m (2012: £1,232m) respectively. 21. PROVISIONS Conduct remediation(1) £m Other(2) £m Total £m At 1 January 2013 659 255 914 Additional provisions - 109 109 Used during the period (140) (64) (204) Provisions released and other (45) - (45) At 30 June 2013 474 300 774 To be settled: Within 12 months 409 201 610 In more than 12 months 65 99 164 474 300 774 (1) Includes a provision of £250m in respect of payment protection insurance at 30 June 2013 (2012: £382m). (2) Includes regulatory-related provisions of £170m in respect of the FSCS and the UK Bank Levy at 30 June 2013 (2012: £185m). Conduct remediation(1) £m Other(2) £m Total £m At 1 January 2012 747 223 970 Additional provisions 232 207 439 Used during the year (320) (175) (495) At 31 December 2012 659 255 914 To be settled: Within 12 months 400 169 569 In more than 12 months 259 86 345 659 255 914 (1) Includes a provision of £156m in respect of payment protection insurance at 30 June 2012. Provisions principally comprise amounts in respect of conduct remediation, regulatory-related provisions, litigation and related expenses, restructuring expenses and vacant property costs. Conduct remediation including Payment Protection Insurance ('PPI'), other retail products and interest rate swaps sold to corporate customers The amounts in respect of customer remediation comprise the estimated cost of making redress payments with respect to the past sales of products. In calculating the customer remediation provision, management's best estimate of the provision was calculated based on conclusions regarding the number of claims, of those, the number that will be upheld, and the estimated average settlement per case. Sensitivities relating to the provision for customer remediation can be found in "Critical Accounting Policies and Areas of Significant Management Judgement" in Note 1. Payment protection insurance is an insurance product offering payment protection on unsecured personal loans (and credit cards). The nature and profitability of the product has changed materially since 2008, in part due to customer and regulatory pressure. The product was sold by UK banks - the mis-selling issues are predominantly related to business written before 2009. The provision represents management's best estimate of the anticipated costs of related customer contact and/or redress, including administration expenses. The provision is calculated based on a number of key assumptions which involve significant management judgement. These are as follows: > Claim volumes - the estimated number of customer complaints received; > Uphold rate - the estimated percentage of complaints that are, or will be, upheld in favour of the customer; and > Average cost of redress - the estimated payment to customers, including compensation for any direct loss plus interest. The assumptions have been based on the following: > Analysis completed of the causes of complaints, and uphold rates, and how these are likely to vary in the future; > Actual claims activity registered to date; > The level of redress paid to customers, together with a forecast of how this is likely to change over time; > The impact on complaints levels of proactive customer contact; and > The effect of media coverage on the issue. The assumptions are kept under review, and regularly reassessed and validated against actual customer data, e.g. claims received, uphold rates, the impact of any changes in approach to uphold rates etc, and any re-evaluation of the estimated population. The most critical factor in determining the level of provision is the volume of claims. The uphold rate is a reasonably consistent function of the sales process and the average cost of redress can be predicted reasonably accurately given that management is dealing with a high volume and reasonably homogeneous population. In setting the provision, management estimated the total claims that were likely to be received. Previous experience has indicated that claims could be received over a number of years. While initial claim levels at the beginning of the process were quite low, this increased in line with our initial expectations as a result of press coverage and the activities of the claims management companies ("CMCs"), and then began to decrease after reaching a peak in the second half of 2012, again as expected. The CMCs facilitate customer claims in return for a share of the redress payment and advertise heavily thereby resulting in an increase in the volume of claims experienced. The table below sets out the actual claims received to date. Number of PPI claims outstanding Movements in the number of PPI claims outstanding during the six months ended 30 June 2013 and the year ended 31 December 2012 were as follows: 30 June 2013 '000 31 December 2012 '000 Outstanding at 1 January 31 1 Complaints received(1) 190 437 Complaints rejected as invalid(2) (64) (149) Complaints closed - upheld (142) (258) Outstanding at end of period/year 15 31 (1) Includes complaints that were deemed invalid, as there is no record of a relevant PPI policy being held by the customer. (2) The customer has the right to appeal to the FOS if their claim is rejected. FOS may uphold or reject the appeal and if upheld Santander UK is required to provide redress to the customer. Claims upheld or rejected above reflect the results of any appeals. 30 June 2013 compared with 31 December 2012 In line with expectations, the volume of activity observed and number of complaints received decreased over the period. Although Santander UK continues to receive a significant number of complaints via CMCs, these are declining in line with overall volumes. In addition, a high proportion of invalid complaints continues to be observed in the period. Average run rates decreased from approximately £26m per month for the year ended 31 December 2012 to £22m per month for the six months ended 30 June 2013. In addition, the average for the six months ended 30 June 2013 was increased by a clearance of the majority of the pipeline of complaints. Current run rates have continued the downward trend with current claim levels well below the six month average. The payments for the month of June 2013 were approximately £16m. The PPI provision remains adequate and will continue to be monitored. Bank Levy The Finance Act 2011 introduced an annual bank levy in the UK, for which legislation was enacted in July 2011. The current year impact of the UK bank levy has not been reflected in these results in accordance with International Financial Reporting Standards. Under IFRS, these charges for a year may only be recognised on the last day of the year, not accrued over the period. The total cost for 2013 is expected to be approximately £68m. Financial Services Compensation Scheme ('FSCS') The FSCS is the UK's independent statutory compensation fund for customers of authorised financial services firms and pays compensation if a firm is unable to pay claims against it. The FSCS is funded by levies on the industry (and recoveries and borrowings where appropriate). The levies raised comprise both management expenses levies and, where necessary, compensation levies on authorised firms. The current year impact of the FSCS has not been reflected in these results in accordance with International Financial Reporting Standards. Under IFRS, these charges for a year may only be recognised on the last day of the year, not accrued over the period. 22. RETIREMENT BENEFIT ASSETS AND OBLIGATIONS The amounts recognised in the balance sheet were as follows: 30 June 2013 £m 31 December 2012 £m Assets/(liabilities) Funded defined benefit pension scheme 203 254 Funded defined benefit pension scheme (415) (266) Unfunded defined benefit pension scheme (45) (39) Total net (liabilities)/assets (257) (51) Amounts recognised in other comprehensive income during the period were as follows: Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Remeasurement of defined benefit pension schemes 233 (302) a) Defined Contribution pension schemes An expense of £19m (six months ended 30 June 2012: £17m) was recognised for defined contribution plans in the period, and is included in staff costs classified within administration expenses in the Income Statement. None of this amount was recognised in respect of key management personnel for the six months ended 30 June 2013 and 30 June 2012. b) Defined Benefit pension schemes The total amount charged to the income statement, including amounts classified as redundancy costs was as follows: Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Net interest income/(expense) 1 (2) Current service cost 20 15 Administration cost 3 2 24 15 The net liability recognised in the balance sheet was determined as follows: 30 June 2013 £m 31 December 2012 £m Present value of defined benefit obligation (7,899) (7,554) Fair value of plan assets 7,642 7,503 Net defined benefit obligation (257) (51) Movements in the present value of defined benefit obligations during the period were as follows: 30 June 2013 £m 31 December 2012 £m Balance at 1 January (7,554) (7,072) Current service cost (14) (27) Current service cost paid by subsidiaries (1) (2) Current service cost paid by fellow Banco Santander group subsidiaries (5) (9) Interest cost (168) (346) Employer salary sacrifice contributions (4) (7) Actuarial loss (252) (300) Actual benefit payments 99 209 Balance at 30 June/31 December (7,899) (7,554) Movements in the fair value of scheme assets during the period were as follows: 30 June 2013 £m 31 December 2012 £m Balance at 1 January 7,503 7,097 Expected return on scheme assets 167 350 Actuarial gain on scheme assets 19 117 Company contributions paid 46 136 Contributions paid by subsidiaries and fellow Banco Santander group subsidiaries 6 12 Actual benefit payments (99) (209) Balance at 30 June/31 December (7,642) 7,503 The amounts recognised in the Statement of Comprehensive Income for the period were as follows: Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Actuarial gain on scheme assets (19) (22) Experience loss on scheme liabilities 2 42 Loss/(gain) from changes in actuarial assumptions 250 (322) Actuarial loss/(gain) on scheme liabilities 252 (280) Total remeasurement of defined benefit pension schemes 233 (302) At 30 June 2013, cumulative net actuarial losses were £1,196m (2012: £963m). The movement for the period is recognised in the Consolidated Statement of Comprehensive Income. The actual gain on scheme assets for the Santander UK group was £186m (six months ended 30 June 2012: £197m). The Santander UK group's pension schemes did not directly hold any equity securities of the Company or any of its related parties at 30 June 2013 and 31 December 2012. The Santander UK group's pension scheme assets do not include any property or other assets that are occupied or used by the Santander UK group. In addition, the Santander UK group does not hold insurance policies over the schemes, and has not entered into any significant transactions with the schemes. The assets of the funded plans are held independently of the Santander UK group's assets in separate trustee administered funds. The principal duty of the trustees is to act in the best interests of the members of the schemes. The corporate trustee of the Santander UK Group Pension Scheme is Santander (UK) Group Pension Scheme Trustee Limited, a private limited company incorporated in 1996 and a wholly-owned subsidiary of Santander UK plc. The Trustee board comprises seven Directors selected by Santander UK plc, plus seven member-nominated Directors selected from eligible members who apply for the role. Actuarial assumption sensitivities The discount rate is sensitive to changes in market conditions arising during the reporting period. The mortality rates used are sensitive to experience from the plan member profile. For details of the principal assumptions used for the defined benefit schemes refer to page 274 of the 2012 Annual Report. The following table shows the potential effect of changes in these and the other key assumptions on the principal pension schemes of theSantander UK group: Increase/(decrease) 30 June 2013 £m 31 December 2012 £m Discount rate Change in pension obligation at period end from a 25 bps increase (375) (362) Change in pension cost for the period from a 25 bps increase - - General price inflation Change in pension obligation at period end from a 25 bps increase 355 343 Change in pension cost for the period from a 25 bps increase 7 18 Expected rate of return on plan assets Change in pension cost for the period from a 25 bps increase 19 18 Mortality Change in pension obligation at period end from each additional year of longevity assumed 190 184 23. CONTINGENT LIABILITIES AND COMMITMENTS 30 June 2013 £m 31 December 2012 £m Guarantees given to third parties 813 857 Formal standby facilities, credit lines and other commitments with original term to maturity of: - One year or less 3,674 4,211 - More than one year 25,397 32,727 Other contingent liabilities 8 8 29,892 37,803 Regulatory The Santander UK group engages in discussion, and co-operates, with the FCA in their supervision of the Santander UK group, including reviews exercised under statutory powers, regarding its interaction with past and present customers and policyholders, both as part of the FCA's general thematic work and in relation to specific products and services, including payment protection insurance. The position is monitored with particular reference to those reviews currently in progress and where greater clarity can now be ascertained as to the eventual outcome. 24. CASH FLOW STATEMENT a) Reconciliation of profit after tax to net cash inflow/(outflow) from operating activities: Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Profit for the period 440 524 Non-cash items included in net profit: Depreciation and amortisation 121 118 Increase in prepayments and accrued income (191) (189) Increase/(decrease) in accruals and deferred income 219 (464) Profit on sale of subsidiary and associated undertakings - - Amortization of premiums/(discounts) on debt securities (12) - Provisions for liabilities and charges 43 2 Impairment losses 382 379 Corporation tax charge 109 166 Other non-cash items 96 120 Net cash flow from trading activities 1,207 656 Changes in operating assets and liabilities: Net increase in cash and balances held at central banks (120) (6) Net increase in trading assets (8,540) 1,200 Net decrease in derivative assets 4,223 231 Net decrease in financial assets designated at fair value 988 783 Net decrease in debt securities, treasury bills and other eligible bills 12 - Net decrease in loans and advances to banks & customers 1,362 2,833 Net decrease in other assets 379 37 Net increase in deposits by banks and customers 1,229 5,359 Net decrease in derivative liabilities (5,232) (541) Net increase in trading liabilities 13,682 2,495 Net decrease in financial liabilities designated at fair value (153) (226) Net (decrease)/increase in debt securities in issue (338) 977 Net decrease in other liabilities (414) (613) Effects of exchange rate differences 2,021 (1,220) Net cash flow from/(used in) operating activities before tax 10,306 11,965 Net corporation tax paid (31) (149) Net cash flow from/(used in) operating activities 10,275 11,816 b) Analysis of the balances of cash and cash equivalents in the balance sheet 30 June 2013 £m 31 December 2012 £m Cash and balances with central banks 34,372 29,282 Less: regulatory minimum cash balances (323) (203) 34,049 29,079 Debt securities 3,143 1,196 Net trading other cash equivalents 6,928 9,454 Net non trading other cash equivalents 1,434 1,576 Cash and cash equivalents 45,554 41,305 c) Sale of subsidiaries, associated undertakings and businesses In the first half of 2013, the Company completed deals to sell its co-brand credit cards business for cash consideration of £660m. The net assets disposed of consisted of loans to customers of £672m. d) Discontinued operations The co-brand credit cards business for which deals were completed to sell in the first half of 2013 qualifies as discontinued operations. The net cash flows attributable to the operating, investing and financing activities of discontinued operations were £907m (six months ended 30 June 2012: £206m), £nil (six months ended 30 June 2012: £nil), and £nil (six months ended 30 June 2012: £nil), respectively. 25. ASSETS CHARGED AS SECURITY FOR LIABILITIES AND COLLATERAL ACCEPTED AS SECURITY FOR ASSETS The following transactions are conducted under terms that are usual and customary to collateralised transactions, including, where relevant, standard securities lending and repurchase agreements. a) Financial assets pledged to secure liabilities The financial assets below are analysed between those assets accounted for on the balance sheet and off-balance sheet in accordance with IFRS. 30 June 2013 £m 31 December 2012 £m On balance sheet: Treasury bills and other eligible securities 5,705 2,924 Cash 2,292 2,863 Loans and advances to customers - securitisations and covered bonds 72,089 82,039 Loans and advances to customers 172 1,722 Debt securities 898 556 Equity securities 434 309 81,590 90,413 Off balance sheet: Treasury bills and other eligible securities 19,891 17,666 Debt securities 2,845 662 Equity securities 389 105 23,125 18,433 The Santander UK group provides assets as collateral in the following areas of the business. Sale and repurchase agreements Subsidiaries of the Company enter into sale and repurchase agreements and similar transactions of equity and debt securities, which are accounted for as secured borrowings. Upon entering into such transactions, the subsidiaries provide collateral equal to 100%-131% of the borrowed amount. The carrying amount of assets that were so provided at 30 June 2013 was £32,423m (2012: £20,306m), of which £8,021m (2012: £8,082m) were classified within "loans and advances to customers - securitisations and covered bonds" in the table above. Securitisations and covered bonds The Company and certain of its subsidiaries enter into securitisation transactions whereby portfolios of residential mortgage loans and other loans are purchased by or assigned to special purpose securitisation companies, and have been funded through the issue of mortgage-backed securities and other asset-backed securities. Holders of the securities are only entitled to obtain payments of principal and interest to the extent that the resources of the securitisation companies are sufficient to support such payments and the holders of the securities have agreed in writing not to seek recourse in any other form. At 30 June 2013, £43,191m (2012: £46,916m) of loans were so assigned by the Santander UK group. A subsidiary of the Company has also established a covered bond programme, whereby securities are issued to investors and are secured by a pool of ring-fenced residential mortgages. At 30 June 2013, the pool of ring-fenced residential mortgages for the covered bond programme was £28,898m (2012: £35,123m). At 30 June 2013, total notes issued externally from secured programmes (securitisations and covered bonds) decreased to £39,603m (2012: £43,322m), reflecting gross redemption of £3.7bn (2012: £10.9bn) in 2013. At 30 June 2013, a total of £15,377m (2012: £17,634m) 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 £8.3bn at 30 June 2013 (2012: £11.0bn), or for creating collateral which could in the future be used for liquidity purposes. Stock borrowing and lending agreements Asset balances under stock borrowing and lending agreements represent stock lent by the Santander UK group. These balances amounted to £5,934m at 30 June 2013 (2012: £11,723m) and are offset by contractual commitments to return stock borrowed or cash received. Derivatives business In addition to the arrangements described above, collateral is also provided in the normal course of derivative business to counterparties. At 30 June 2013, £2,292m (2012: £2,863m) of such collateral in the form of cash had been provided by the Santander UK group and is included in the table above. b) Collateral held as security for assets The collateral held as security for assets below are analysed between those liabilities accounted for on the balance sheet and off-balance sheet in accordance with IFRS. 30 June 2013 £m 31 December 2012 £m On balance sheet: Trading liabilities 3,080 3,652 3,080 3,652 Off balance sheet: Trading liabilities 30,000 24,862 Deposits by banks 119 233 30,119 25,095 Purchase and resale agreements Subsidiaries of the Company also enter into purchase and resale agreements and similar transactions of equity and debt securities, which are accounted for as collateralised loans. Upon entering into such transactions, the subsidiaries receive collateral equal to 100%-105% of the loan amount. The level of collateral held is monitored daily and if required, further calls are made to ensure the market values of collateral remains at least equal to the loan balance. The subsidiaries are permitted to sell or repledge the collateral held in the absence of default. At 30 June 2013, the fair value of such collateral received was £24,989m (2012: £14,788m), almost all of which was sold or repledged. The subsidiaries have an obligation to return collateral that they have sold or pledged. Stock borrowing and lending agreements Obligations under stock borrowing and lending agreements represent contractual commitments to return stock borrowed. These obligations totalling £5,130m at 30 June 2013 (2012: £10,307m) and are offset by a contractual right to receive stock lent by the Santander UK group. Derivatives business In addition to the arrangements described above, collateral is also received in the normal course of derivative business from counterparties. At 30 June 2013, £3,037m (2012: £3,652m) of such collateral in the form of cash had been received by the Santander UK group and is included in the table above. Lending activities In addition to the above collateral held as security for assets, the Santander UK groupmay obtain a charge over a customer's property in connection with its lending activities. Details of these arrangements are set out in the "Credit Risk" section of the Risk Management Report. 26. RELATED PARTY DISCLOSURES The financial position and performance of Santander UK group have not been materially affected in the first six months of the year by any related party transactions, or changes to related party transactions, except as disclosed in Note 20 "Debt securities in issue". Information on balances due from/(to) other Banco Santander group companies is set out in the section "Balances with other Banco Santander group companies" in the Risk Management Report on pages 85 to 88. In addition, transactions with pension schemes operated by the Santander UK group are described in Note 22. These transactions were made in the ordinary course of business and substantially on the same terms as for comparable transactions with third party counterparties andwithin limits acceptable to the UK Prudential Regulatory Authority. Such transactions do not involve more than the normal risk of collectability or present any unfavourable features. 27. FINANCIAL INSTRUMENTS a) Fair values of financial instruments measured at amortised cost on a recurring basis The following tables analyse the fair value of financial instruments not measured at fair value in the balance sheet: 30 June 2013 Carrying value £m Fair value £m Surplus/(deficit) £m Assets Cash and balances at central banks 34,372 34,372 - Loans and advances to banks 2,340 2,254 (86) Loans and advances to customers 188,065 190,981 2,916 Loans and receivables securities 1,269 1,189 (80) Liabilities Deposits by banks 9,242 9,524 (282) Deposits by customers 150,878 152,575 (1,697) Debt securities in issue 53,542 55,792 (2,250) Subordinated liabilities 3,710 3,291 419 31 December 2012 Carrying value £m Fair value £m Surplus/(deficit) £m Assets Cash and balances at central banks 29,282 29,282 - Loans and advances to banks 2,438 2,133 (305) Loans and advances to customers 190,782 192,230 1,448 Loans and receivables securities 1,259 1,139 (120) Liabilities Deposits by banks 9,935 10,212 (277) Deposits by customers 149,037 150,191 (1,154) Debt securities in issue 59,621 61,163 (1,542) Subordinated liabilities 3,781 3,597 184 The surplus/(deficit) in the table above represents the surplus/(deficit) of fair value compared to the carrying amount of those financial instruments for which fair values have been estimated. The carrying value above of any financial assets and liabilities that are designated as hedged items in a portfolio (or macro) fair value hedge relationship excludes gains and losses attributable to the hedged risk, as this is presented as a single separate line item on the balance sheet. b) Fair values of financial instruments measured at fair value on a recurring basis The following tables summarise the fair values at 30 June 2013 and 31 December 2012 of the financial asset and liability classes accounted for at fair value, analysed by the valuation methodology used by the Santander UK groupto determine their fair value. The tables also disclose the percentages that the recorded fair values of financial assets and liabilities represent of the total assets and liabilities, respectively, that are recorded at fair value in the balance sheet: 30 June 2013 Internal models based on Balance sheet category Quoted prices in active markets (Level 1) Market observable data (Level 2) Significant unobservable data (Level 3) Total Valuation technique £m % £m % £m % £m % Assets Trading assets Loans and advances to banks - - 9,826 15 - - 9,826 15 A Loans and advances to customers - - 11,906 18 - - 11,906 18 A Debt securities 8,985 14 - - - - 8,985 14 - Equity securities 446 1 - - - - 446 1 - Derivative assets Exchange rate contracts - - 3,269 5 15 - 3,284 5 A Interest rate contracts 58 - 20,789 32 - - 20,847 32 A&C Equity and credit contracts 307 1 1,341 2 140 - 1,788 3 B&D Commodity contracts - - 5 - - - 5 - A Financial assets at FVTPL Loans and advances to customers - - 2,220 3 52 - 2,272 3 A Debt securities - - 270 - 279 1 549 1 A&B AFS financial assets Equity securities 5,154 8 - - - - 5,154 8 - Debt securities 24 - - - - - 24 - - Total assets at fair value 14,974 24 50,305 75 486 1 65,086 100 Liabilities Trading liabilities Deposits by banks - - 15,159 24 - - 15,159 24 A Deposits by customers - - 13,728 22 - - 13,728 22 A Short positions 5,903 9 - - - - 5,903 9 - Derivative liabilities Exchange rate contracts - - 2,013 3 - - 2,013 3 A Interest rate contracts - - 19,353 30 - - 19,353 30 A&C Equity and credit contracts 1 - 2,210 4 47 - 2,258 4 B&D Commodity contracts - - 5 - - - 5 - A Financial liabilities at FVTPL Debt securities in issue - - 5,217 8 60 - 5,277 8 A Total liabilities at fair value 5,904 9 57,685 91 107 - 63,696 100 31 December 2012 Internal models based on Balance sheet category Quoted prices in active markets (Level 1) Market observable data (Level 2) Significant unobservable data (Level 3) Total Valuation technique £m % £m % £m % £m % Assets Trading assets Loans and advances to banks - - 9,988 16 - - 9,988 16 A Loans and advances to customers - - 7,552 12 - - 7,552 12 A Debt securities 4,494 7 - - - - 4,494 7 - Equity securities 464 1 - - - - 464 1 - Derivative assets Exchange rate contracts - - 3,103 5 36 - 3,139 5 A Interest rate contracts 54 - 25,671 41 - - 25,725 41 A & C Equity and credit contracts 152 - 944 2 179 - 1,275 2 B & D Commodity contracts - - 7 - - - 7 - A Financial assets at FVTPL Loans and advances to customers - - 3,187 5 61 - 3,248 5 A Debt securities - - 279 1 284 1 563 2 A & B AFS financial assets Equity securities 24 - - - - - 24 - - Debt securities 5,459 9 - - - - 5,459 9 - Total assets at fair value 10,647 17 50,731 82 560 1 61,938 100 Liabilities Trading liabilities Deposits by banks - - 9,742 18 - - 9,742 18 A Deposits by customers - - 7,248 13 - - 7,248 13 A Short positions 4,119 8 - - - - 4,119 8 - Derivative liabilities Exchange rate contracts - - 3,017 6 - - 3,017 6 A Interest rate contracts 31 - 23,894 45 - - 23,925 45 A & C Equity and credit contracts 89 - 1,766 3 57 - 1,912 3 B & D Commodity contracts - - 7 - - - 7 - A Financial liabilities at FVTPL Debt securities in issue - - 3,916 7 86 - 4,002 7 A Total liabilities at fair value 4,239 8 49,590 92 143 - 53,972 100 During the six months ended 30 June 2013 and the year ended 31 December 2012, there were no transfers between Level 1, Level 2 and Level 3 financial instruments. c) Valuation techniques The main valuation techniques employed in the Santander UK group's internal models to measure the fair value of the financial instruments disclosed above at 30 June 2013 and 31 December 2012 are set out below. In substantially all cases, the principal inputs into these models are derived from observable market data. From 1 January 2013, the Santander UK grouprevised its valuation techniques and internal models to include own credit risk in the valuation of derivatives. A In the valuation of financial instruments requiring static hedging (for example interest rate, currency derivatives and commodity swaps) and in the valuation of loans and advances and deposits, the 'present value' method is used. Expected future cash flows are discounted using the interest rate curves of the applicable currencies or forward commodity prices as appropriate. The interest rate curves are generally observable market data and reference yield curves derived from quoted interest rates in appropriate time bandings, which match the timings of the cash flows and maturities of the instruments. The forward commodity prices are generally observable market data. B In the valuation of equity financial instruments requiring dynamic hedging (principally equity securities, options and other structured instruments), proprietary local volatility and stochastic volatility models are used. These types of models are widely accepted in the financial services industry. Observable market inputs used in these models include the bid-offer spread, foreign currency exchange rates, volatility and correlation between indices. In limited circumstances, other inputs may be used in these models that are based on data other than observable market data, such as the Halifax's UK House Price Index ('HPI') volatility, HPI forward growth, HPI spot rate, and mortality. C In the valuation of financial instruments exposed to interest rate risk that require either static or dynamic hedging (such as interest rate futures, caps and floors, and options), the present value method (futures), Black's model (caps/floors) and the Hull/White and Markov functional models (Bermudan options) are used. These types of models are widely accepted in the financial services industry. The significant inputs used in these models are observable market data, including appropriate interest rate curves, volatilities, correlations and exchange rates. In limited circumstances, other inputs may be used in these models that are based on data other than observable market data, such as HPI volatility, HPI forward growth, HPI spot rate and mortality. D In the valuation of linear instruments such as credit risk and fixed-income derivatives, credit risk is measured using dynamic models similar to those used in the measurement of interest rate risk. In the case of non-linear instruments, if the portfolio is exposed to credit risk such as credit derivatives, the probability of default is determined using the par spread level. The main inputs used to determine the underlying cost of credit of credit derivatives are quoted credit risk premiums and the correlation between the quoted credit derivatives of various issuers. The fair values of the financial instruments arising from theSantander UK group's internal models take into account, among other things, contract terms and observable market data, which include such factors as bid-offer spread, interest rates, credit risk (including own credit risk), exchange rates, the quoted market price of raw materials and equity securities, volatility and prepayments. In all cases, when it is not possible to derive a valuation for a particular feature of an instrument, management uses judgement to determine the fair value of the particular feature. In exercising this judgement, a variety of tools are used including proxy observable data, historical data and extrapolation techniques. Extrapolation techniques take into account behavioural characteristics of equity markets that have been observed over time, and for which there is a strong case to support an expectation of a continuing trend in the future. Estimates are calibrated to observable market prices when they become available. The estimates thus obtained could vary if other valuation methods or assumptions were used. The Santander UK groupbelieves its valuation methods are appropriate and consistent with other market participants. Nevertheless, the use of different valuation methods or assumptions, including imprecision in estimating unobservable market inputs, to determine the fair value of certain financial instruments could result in different estimates of fair value at the reporting date and the amount of gain or loss recorded for a particular instrument. Most of the valuation models are not significantly subjective, because they can be tested and, if necessary, recalibrated by the internal calculation of and subsequent comparison to market prices of actively traded securities, where available. d) Fair value adjustments The internal models incorporate assumptions that the Santander UK groupbelieves would be made by a market participant to establish fair value. Fair value adjustments are adopted when the Santander UK group considers that there are additional factors that would be considered by a market participant in the determination of fair value of the instrument that are not incorporated in the valuation model. The magnitude of fair value adjustments depends upon many entity-specific factors, including modelling sophistication, the nature of products traded, and the size and type of risk exposures. For this reason, fair value adjustments may not be comparable across the banking industry. The Santander UK group classifies fair value adjustments as either 'risk-related' or 'model-related'. The fair value adjustments form part of the portfolio fair value and are included in the balance sheet values of the product types to which they have been applied. The majority of these adjustments relate to Markets. The magnitude and types of fair value adjustment adopted by Markets are listed in the following table: 30 June 2013 £m 31 December 2012 £m Risk-related: - Bid-offer and trade specific adjustments 31 26 - Uncertainty 21 22 - Credit risk adjustment(1) 52 107 104 155 Model-related: - Model limitation 13 17 Day One profits - - 117 172 (1) In accordance with the requirements of IFRS 13, with effect from 1 January 2013 this includes the debit valuation adjustment described below Risk-related adjustments 'Risk-related' adjustments are driven, in part, by the magnitude of the Santander UK group's market or credit risk exposure, and by external market factors, such as the size of market spreads. Following the implementation of IFRS 13, the credit risk adjustments are as follows. The Santander UK group adopts a credit risk adjustment (also frequently known as a 'credit valuation adjustment') against OTC derivative transactions to reflect within fair value the possibility that the counterparty may default, and the Santander UK group may not receive the full market value of the transactions. The Santander UK group calculates a credit risk adjustment for each counterparty to which the entity has exposure. The Santander UK group attempts to mitigate credit risk to third parties by entering into netting and collateral arrangements. The net counterparty exposure (i.e. counterparty positions netted by offsetting transactions and both cash and securities collateral) is then assessed for counterparty creditworthiness. The Santander UK group has only a limited exposure to monolines, consisting of exposure to securitisations which are wrapped by monoline insurers. The principal risk exposures are recorded against the securitisations, with the monoline wraps being viewed as contingent exposures, as described in Note 23 of the 2012 Annual Report. The description below relates to the credit risk adjustment taken against counterparties other than monolines. The Santander UK group calculates the credit risk adjustment by applying the probability of default of the counterparty to the expected positive exposure to the counterparty, and multiplying the result by the loss expected in the event of default (i.e. the loss given default ('LGD')). The timing of the expected losses is reflected by using a discount factor. The calculation is performed over the life of the potential exposure i.e. the credit risk adjustment is measured as a lifetime expected loss. The expected positive exposure is calculated at a trade level. The main drivers of the expected positive exposure are the size of the risk position with the counterparty along with the prevailing market environment. Probabilities of default are calculated using credit default swap prices where available. Where these are not available, probabilities of default are based upon analysis of historic default rates. The credit rating used for a particular counterparty is that determined by the Santander UK group's internal credit process. The LGD is calculated at the facility level and takes into account the counterparty characteristics. Credit ratings and LGD are updated by the credit team as new relevant information becomes available and at periodic reviews performed at least annually. The Santander UK group also considers its own creditworthiness when determining the fair value of an instrument, including OTC derivative instruments and financial liabilities held at fair value through profit or loss if the Santander UK groupbelieves market participants would take that into account when transacting the respective instrument. In accordance with the requirements of IFRS 13, with effect from 1 January 2013, the approach to measuring the impact of the Santander UK group's credit risk on an instrument is done in the same manner as for third party credit risk. The impact of theSantander UK group's credit risk is considered when calculating the fair value of an instrument, even when credit risk is not readily observable such as in OTC derivatives. Consequently, the Santander UK group's adjustment against derivative liabilities, often referred to as a 'debit valuation adjustment' was £44m at 30 June 2013. For certain types of exotic derivatives where the products are not currently supported by the standard methodology, the Santander UK groupadopts an alternative methodology. Alternative methodologies used by the Santander UK group fall into two categories. One method maps transactions against the results for similar products which are accommodated by the standard methodology. Where such a mapping approach is not appropriate, a bespoke methodology is used, generally following the same principles as the standard methodology, reflecting the key characteristics of the instruments but in a manner that is computationally less intensive. The calculation is applied at a trade level, with more limited recognition of credit mitigants such as netting or collateral agreements than used in the standard methodology described previously. The methodologies do not, in general, account for 'wrong-way risk'. Wrong-way risk arises where the underlying value of the derivative prior to any credit risk adjustment is related to the probability of default of the counterparty. A more detailed description of wrong-way risk is set out in the 2012 Annual Report. The Santander UK group includes all third-party counterparties in the credit risk adjustment calculation. e) Internal models based on information other than market data (Level 3) The table below provides an analysis of financial instruments valued using internal models based on information other than market data together with the subsequent valuation technique used for each type of instrument. Each instrument is initially valued at transaction price: Balance sheet value Amount recognised in income/(expense) 30 June 2013 31 December 2012 H1 2013 H1 2012 Balance sheet line item Category Financial instrument product type £m £m £m £m 1. Derivative assets Exchange rate contracts Cross-currency swaps 15 36 (6) (2) 2. Derivative assets Equity and credit contracts Reversionary property interests 72 76 (2) 1 3. Derivative assets Credit contracts Credit default swaps 16 17 (1) (3) 4. Derivative assets Equity contracts Options and forwards 52 86 - 1 5. Assets at FVTPL Loans and advances to customers Roll-up mortgage portfolio 52 61 (3) 1 6. Assets at FVTPL Debt securities Reversionary property securities 221 235 (2) 5 7. Assets at FVTPL Debt securities Mortgage-backed securities 58 49 9 - 8. Derivative liabilities Equity contracts Options and forwards (47) (57) 3 2 9. Liabilities at FVTPL Debt securities in issue Non-vanilla debt securities (60) (86) 5 2 Total net assets 379 417 - - Total income - - 3 7 Valuation techniques 1. Derivative assets - Exchange rate contracts These cross currency swaps are used to hedge the foreign currency risks arising from the power reverse dual currency ('PRDC') notes issued by the Santander UK group, as described in Instrument 9 below. These derivatives are valued using a standard valuation model valuing each leg of the swap, with expected future cash flows less notional amount exchanged at maturity date discounted using an appropriate floating rate. The floating rate is adjusted by the relevant cross currency basis spread. Interest rates, foreign exchange rates, cross currency basis spread and long-dated foreign exchange ('FX') volatility are used as inputs to determine fair value. Interest rates, foreign exchange rates are observable on the market. Cross currency spreads may be market observable or unobservable depending on the liquidity of the cross currency pair. As the Japanese Yen-US dollar cross currency pair related to the PRDC notes is liquid, the cross currency spreads (including long-dated cross currency spread) for these swaps are market observable. The significant unobservable inputs for the valuation of these financial instruments are the long-dated FX volatility and the correlation between the underlying assets. The correlation between the underlying assets is assumed to be zero, as there are no actively traded options from which correlations between the underlying assets could be implied. Furthermore, the zero correlation assumption implies that the sources of the long-dated FX volatility are independent. Long-dated FX volatility Long-dated FX volatility is extrapolated from shorter-dated FX volatilities which are directly observable on the market. Short-dated FX volatility is observable from the trading of FX options. As there is no active market for FX options with maturities greater than five years (long-dated FX options), long-dated FX volatility is not market observable. Furthermore, as historical prices are not relevant in determining the cost of hedging long-dated FX risk, long-dated FX volatility cannot be inferred from historical volatility. The Santander UK group extrapolates the long-dated FX volatility from the shorter-dated FX volatilities using Black's model. FX volatility is modelled as the composition of the domestic interest rate, foreign interest rates and FX spot volatilities using standard Hull-White formulae. The Hull-White approach is used for estimating the future distribution of domestic and foreign zero-coupon rates, constructed from the relevant yield curves. Using short-dated FX options, the FX spot volatility is calculated which is then extrapolated to derive the long-dated FX volatility. 2. Derivative assets - Equity and credit contracts These reversionary property derivatives are valued using a probability weighted set of HPI forward prices, which are assumed to be a reasonable representation of the increase in value of the Santander UK group's reversionary interest portfolio underlying the derivatives. The probability used reflects the likelihood of the home owner vacating the property and is calculated from mortality rates and acceleration rates which are a function of age and gender, obtained from the relevant mortality tables. Indexing is felt to be appropriate due to the size and geographical dispersion of the Santander UK group's reversionary interest portfolio. These are determined using HPI Spot Rates adjusted to reflect estimated forward growth. Launched in 1984, the Halifax's UK HPI is the UK's longest running monthly house price data series covering the whole country. The indices calculated are standardised and represent the price of a typically transacted house. Both national and regional HPI are published. The national HPI is published monthly. The regional HPI reflects the national HPI disaggregated into 12 UK regions and is published quarterly. Both indices are published on two bases, including and excluding seasonal adjustments in the housing market. The Santander UK groupuses the non-seasonally adjusted ('NSA') national and regional HPI in its valuation model to avoid any subjective judgement in the adjustment process which is made by Halifax. The inputs used to determine the value of the reversionary property derivatives are HPI spot, HPI forward growth and mortality rates. The principal pricing parameter is HPI forward growth. HPI Spot Rate The HPI spot rate used in the model is a weighted average of NSA regional HPI spot rates i.e. adjusted for difference in the actual regional composition of the property underlying the Santander UK group's reversionary interest portfolio and the composition of the published regional indices. The regional HPI spot rate (which is observable market data) is only published on specific quarterly dates. In between these dates, its value is estimated by applying the growth rate over the relevant time period inferred from the national HPI spot rates (which are observable market data and published monthly) to the most recently calculated weighted average regional HPI spot rate based on published regional indices. An adjustment is also made to reflect the specific property risk i.e. possible deviation between the actual growth in the house prices underlying the Santander UK group's reversionary interest portfolio and their assumed index-linked growth, which is based on the regional HPI. This adjustment is based on the average historical deviation of price changes of theSantander UK group's actual property portfolio from that of the published indices over the time period since the last valuation date. HPI Forward Growth Rate Long-dated HPI forward growth rate is not directly observable in the market but is estimated from broker quotes and traded forward contracts. A specific spread is applied to the long-dated forward growth rate to reflect the uncertainty surrounding long dated data. This spread is calculated by analysing the historical volatility of the HPI, whilst incorporating mean reversion. An adjustment is made to reflect the specific property risk as for the HPI spot rate above. Mortality Rate Mortality rates are obtained from the PNMA00 and PNFA00 Continuous Mortality Investigation Tables published by the UK Institute and Faculty of Actuaries. These mortality rates are adjusted by acceleration rates to reflect the mortality profile of the holders of Santander UK group's reversionary property products underlying the derivatives. 3. Derivative assets - Equity and credit contracts These derivative assets are credit default swaps held against certain bonds. The credit default swaps are valued using the credit spreads of the referenced bonds. These referenced bonds are valued with the assistance of valuations prepared by an independent, specialist valuation firm as a deep and liquid market does not exist. In valuing the credit default swaps, the main inputs used to determine the underlying cost of credit are quoted risk premiums and the correlation between the quoted credit derivatives of various issuers. The assumptions relating to the correlation between the values of quoted and unquoted assets are based on historical correlations between the impact of adverse changes in market variables and the corresponding valuation of the associated unquoted assets. The measurement of the assets will vary depending on whether a more or less conservative scenario is selected. The other main input is the probability of default of the referenced bonds. The significant unobservable input for the valuation of these financial instruments is the probability of default. Probability of default The probability of default is assessed by considering the credit quality of the underlying referenced bonds. However, as no deep and liquid market exists for these assets the assessment of the probability of default is not directly observable and instead an estimate is calculated using the Standard Gaussian Copula model. 4. Derivative assets - Equity contracts There are three types of derivatives within this category: European options - These derivatives are valued using a modified Black-Scholes model where the HPI is log-normally distributed with the forward rates determined from the HPI forward growth. Asian options - Asian (or average value) options are valued using a modified Black-Scholes model, with an amended strike price and volatility assumption to account for the average exercise period, through a closed form adjustment that reflects the strike price relative to the distribution of stock prices at each relevant date. This is also known as the Curran model. Forward contracts - Forward contracts are valued using a standard forward pricing model. The inputs used to determine the value of the above instruments are HPI spot rate, HPI forward growth rate and HPI volatility. The principal pricing parameter is HPI forward growth rate. HPI Spot Rate The HPI spot rate used is the NSA national HPI spot rate which is published monthly and directly observable in the market. This HPI rate used is different from the weighted average regional HPI spot rate used in the valuation of Instrument 2 above, as the underlying of these derivatives is the UK national HPI spot rate. HPI Forward Growth Rate The HPI forward growth rate used is unobservable and is the same as used in the valuation of Instrument 2 above. HPI Volatility Long-dated HPI volatility is not directly observable in the market but is estimated from the most recent traded values. An adjustment is applied to the long-dated HPI volatility rate to reflect the uncertainty surrounding long-dated data. This adjustment is based on the empirical standard deviation of historical volatility over a range of time horizons. 5. Assets at FVTPL - Loans and advances to customers These loans and advances to customers represent roll-up mortgages, which are an equity release scheme under which a property owner takes out a loan secured against their home. The owner does not make any interest payments during their lifetime and the fixed interest payments are rolled up into the mortgage. The loan or mortgage (capital and rolled-up interest) is repaid upon the owner's vacation of the property and the value of the loan is only repaid from the value of the property. This is known as a 'no negative pledge'. The Santander UK group suffers a loss if the sale proceeds from the property are insufficient to repay the loan, as it is unable to pursue the homeowner's estate or beneficiaries for the shortfall. The value of the mortgage 'rolls up' or accretes until the owner vacates the property. In order to value the roll-up mortgages, the Santander UK group uses a probability-weighted set of European option prices (puts) determined using the Black-Scholes model, in which the 'no negative pledges' are valued as short put options. The probability weighting applied is calculated from mortality rates and acceleration rates as a function of age and gender, taken from mortality tables. The inputs used to determine the value of these instruments are HPI spot, HPI forward growth, HPI volatility, mortality rates and repayment rates. The principal pricing parameter is HPI forward growth. The HPI forward growth rate used is unobservable and is the same as used in the valuation of Instrument 2 above. The other parameters do not have a significant effect on the value of the instruments. 6. Assets at FVTPL - Debt securities These debt securities consisting of reversionary property securities are an equity release scheme, where the property owner receives an upfront lump sum in return for paying a fixed percentage of the sales proceeds of the property when the owner vacates the property. These reversionary property securities are valued using a probability-weighted set of HPI forward prices which are assumed to be a reasonable representation of the increase in value of the Santander UK group's reversionary interest portfolio underlying the derivatives. The probability weighting used reflects the probability of the home owner vacating the property through death and is calculated from death rates and acceleration factors which are a function of age and gender, obtained from the relevant mortality table. The inputs used to determine the value of these instruments are HPI spot, HPI forward growth and mortality rates. The principal pricing parameter is HPI forward growth. Discussion of the HPI spot rate, HPI forward growth rate and mortality rates for this financial instrument is the same as Instrument 3 above. An adjustment is also made to reflect the specific property risk. Discussion of the specific property risk adjustment is the same as Instrument 2 above. 7. Assets at FVTPL - Debt securities These securities consist of residential mortgage-backed securities issued by Santander entities. Each instrument is valued with reference to the price from a consensus pricing service. This is then corroborated against the price from another consensus pricing service due to the lack of depth in the number of available market quotes. An average price is used where there is a more than insignificant difference between the two sources. The significant unobservable input is the adjustment to the credit spread embedded in the pricing consensus quotes. 8. Derivative liabilities - Equity contracts These derivatives are the same as Instrument 4 with the exception that they have a negative fair value. 9. Liabilities at FVTPL - Debt securities in issue These debt securities in issue are power reverse dual currency notes. These notes are financial structured products where an investor is seeking a better return and a borrower/issuer a lower rate by taking advantage of the interest rate differential between two countries. The note pays a foreign interest rate in the investor's domestic currency. The power component of the name denotes higher initial coupons and the fact that coupons rise as the domestic/foreign exchange rate depreciates. The power feature comes with a higher risk for the investor. Cash flows may have a digital cap feature where the rate gets locked once it reaches a certain threshold. Other add-on features are barriers such as knockouts and cancellation provisions for the issuer. These debt securities in issue are valued using a three-factor Gaussian Model. The three factors used in the valuation are domestic interest rates, foreign interest rates and foreign exchange rates. The correlations between the factors are assumed to be zero within the valuation. The Hull-White approach is used for estimating the future distribution of domestic and foreign zero-coupon rates, constructed from the relevant yield curves. A Geometric Brownian Motion model is used for estimating the future distribution of spot foreign exchange rates. The foreign exchange and interest rate volatilities are the most crucial pricing parameters; the model calibrates to the relevant swaption volatility surface. The significant unobservable inputs for the valuation of these financial instruments are the long dated FX volatility and the correlation between the underlying assets and are the same as Instrument 1. Reconciliation of fair value measurements in Level 3 of the fair value hierarchy The following table provides a reconciliation of the movement between opening and closing balances of Level 3 financial instruments, measured at fair value using a valuation technique with significant unobservable inputs: Assets Liabilities Derivatives Fair value through P&L Total Derivatives Fair value through P&L Total £m £m £m £m £m £m At 1 January 2013 215 345 560 (57) (86) (143) Total gains/(losses) recognised in profit/(loss): - Fair value movements (9) 4 (5) 3 5 8 - Foreign exchange and other movements (8) 2 (6) - 6 6 Sales - (12) (12) - - - Settlements (43) (8) (51) 7 15 22 At 30 June 2013 155 331 486 (47) (60) (107) Gains/(losses) recognised in profit/(loss) relating to assets and liabilities held at end of the period (17) 6 (11) 3 11 14 Assets Liabilities Derivatives Fair value through P&L Total Derivatives Fair value through P&L Total £m £m £m £m £m £m At 1 January 2012 241 359 600 (73) (141) (214) Total gains/(losses) recognised in profit/(loss): - Fair value movements (2) 17 15 3 7 10 - Foreign exchange and other movements (12) (1) (13) - 16 16 Purchases 10 - 10 - - - Sales - (25) (25) - - - Settlements (22) (5) (27) 13 32 45 At 31 December 2012 215 345 560 (57) (86) (143) Gains/(losses) recognised in profit/(loss) relating to assets and liabilities held at end of the year (14) 16 2 3 23 26 Effect of changes in significant unobservable assumptions to reasonably possible alternatives (Level 3) The fair value of financial instruments are, in certain circumstances, measured using valuation techniques that incorporate assumptions that are not evidenced by prices from observable current market transactions in the same instrument and are not based on observable market data and, as such require the application of a degree of judgement. Changing one or more of the inputs to the valuation models to reasonably possible alternative assumptions would change the fair values significantly. There have been no significant changes to the sensitivity of these fair values to reasonably possible alternative assumptions from those shown in the 2012 Annual Report on page 305. 28. INTERESTS IN OTHER ENTITIES a) Interests in subsidiaries The Santander UK group consists of a parent company, Santander UK plc, incorporated in the United Kingdom and a number of subsidiaries and associates held directly and indirectly by Santander UK plc, which operate principally in their country of incorporation or registration. Details of the material interests in subsidiaries are set out in the 2012 Annual Report. All of the Santander UK group's subsidiaries are wholly-owned and do not have any non-controlling interests, except for the special purpose entities described in the 2012 Annual Report. There are no significant restrictions on the ability of the Santander UK group to access or use assets and settle liabilities. As a result of the adoption of IFRS 10 with effect from 1 January 2013, as described in Note 1, the finance subsidiaries Abbey National Capital Trust 1 and Abbey National Capital LP which have issued trust preferred securities have been de-consolidated. As a result of the deconsolidation Santander UK now recognises the subordinated notes issued to these entities instead of the preferred securities which were issued by the entities and recognised as subordinated liabilities. The deconsolidation of these entities had no material impact on the income statement, balance sheet or cash flow statement in current or prior periods. b) Interests in associates The Santander UK group does not have any material interests in associates. As set out in the accounting policies in Note 1, investments in associates are accounted for using the equity method. Financial information on individually immaterial associates 30 June 2013 £m 31 December 2012 £m Profit before tax 2 6 Total comprehensive income 2 6 Carrying amount of interest in associate 12 10 c) Interests in joint ventures Details of the Santander UK group's joint venture at 30 June 2013 and 31 December 2012 were as follows: Name of joint venture Principal activity Country of incorporation and principal place of business Proportion of ownership interest and voting rights held by the Santander UK group Hyundai Capital UK Ltd Automobile financing England and Wales 50.01% As set out in the accounting policies in Note 1, investments in joint ventures are accounted for using the equity method. Summarised financial information in respect of the Santander UK group's joint venture is set out below. The summarised financial information below represents amounts shown in the joint venture's financial statements prepared in accordance with IFRS. 30 June 2013 £m 31 December 2012 £m Current assets 326 223 Non-current assets 229 125 Current liabilities (537) (336) Net assets of the joint venture 18 12 The above amounts of assets and liabilities include the following: 30 June 2013 £m 31 December 2012 £m Cash and cash equivalents 31 13 Current financial liabilities (excluding trade and other payables and provisions) (529) (331) Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Revenue 12 - Profit before tax for the period 2 - Other comprehensive income for the period - - Total comprehensive income for the period 2 - Dividends received from the joint venture during the period - - The above profit for the period includes the following: Six months ended 30 June 2013 £m Six months ended 30 June 2012 £m Interest income 12 - Interest expense (2) - Income tax (expense)/income (1) - The Santander UK group's unrecognised share of cumulative losses of the joint venture at 30 June 2013 was £3m (2012: £4m). The Santander UK group's unrecognised share of losses of the joint venture for the six months ended 30 June 2013 was £nil (six months ended 30 June 2012: £nil). There are no restrictions on the ability of Santander UK to access or use the assets and settle the liabilities of the joint venture. 29. CAPITAL MANAGEMENT AND RESOURCES This note reflects the transactions and amounts reported on a basis consistent with the Santander UK group's regulatory filings. Capital adequacy The Santander UK group manages its capital on a Basel II basis. During the six months ended 30 June 2013 and the year ended 31 December 2012, the Santander UK groupheld capital over and above its regulatory requirements, and managed internal capital allocations and targets in accordance with its capital and risk management policies. Group Capital 30 June 2013 £m 31 December 2012 £m Core Tier 1 capital 11,979 11,890 Deductions from Core Tier 1 capital (2,620) (2,588) Total Core Tier 1 capital after deductions 9,359 9,302 Other Tier 1 capital 1,872 1,901 Total Tier 1 capital after deductions 11,231 11,203 Tier 2 capital 3,043 3,092 Deductions from Tier 2 capital (367) (336) Total Tier 2 capital after deductions 2,676 2,756 Total capital resources 13,907 13,959 During the first half of 2013, Core Tier 1 capital increased by £57m to £9,359m (2012: £9,302m). This increase was largely due to profits for the period of £428m, other comprehensive expense after tax of £245m, regulatory pension adjustments of £158m and dividends declared of £272m. 30. EVENTS AFTER THE BALANCE SHEET DATE None. Shareholder Information Risk Factors An investment in Santander UK plc and its subsidiaries ("us" or "we") involves a number of risks, the material ones of which are set forth in the 2012 Annual Report on pages 310 to 325. These risk factors are unchanged except that references to the "FSA" or "Financial Services Authority" shall, where appropriate and where the context so permits, be deemed to be references to any relevant body or bodies which, pursuant to the Financial Services Act 2012 (as described in the risk factor on page 319 of the 2012 Annual Report), exercise any function previously exercised by the Financial Services Authority. Contact Information Santander UK plc principal executive office and registered office, principal office and investor relations department 2 Triton Square Regent's Place London NW1 3AN Phone number: 0870-607-6000 Santander shareholder department Santander Shareholder Relations 2 Triton Square Regent's Place London NW1 3AN Phone numbers: 0871-384-2000 +44 (0) 121-415-7188 (outside the UK) Email: [email protected] Designated agent The designated agent for service of process on Santander UK in the United States is Abbey National Treasury Services plc (Connecticut branch), 400 Atlantic Street, Stamford, CT 06901. Glossary A glossary of financial services industry terms is set out on pages 328 to 335 of the 2012 Annual Report. The following additional terms arose in the first half of 2013. Term used in the Annual Report Definition Financial Conduct Authority ('FCA') A UK quasi-governmental agency formed as one of the successors to the Financial Services Authority ('FSA'). The FCA regulates financial firms providing services to UK consumers and maintains the integrity of the UK's financial markets. It focuses on the regulation of conduct by both retail and wholesale financial services firms. Prudential Regulation Authority ('PRA') The UK financial services regulator formed as one of the successors to the FSA. The PRA is a part of the Bank of England and responsible for the prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms. It sets standards and supervises financial institutions at the level of the individual firm. Forward-looking Statements Santander UK plc (the 'Company') and its subsidiaries (together 'Santander UK' or the 'Santander UK group') may from time to time make written or oral forward-looking statements. The Company makes written forward-looking statements in this Half-Yearly Financial Report and may also make forward-looking statements in its periodic reports to the SEC on Forms 20-F and 6-K, in its annual report to shareholders, in its offering circulars and prospectuses, in press releases and other written materials and in oral statements made by its officers, directors or employees to third parties. Examples of such forward-looking statements include, but are not limited to: > Projections or expectations of revenues, costs, profit (or loss), earnings (or loss) per share, dividends, capital structure or other financial items or ratios; > Statements of plans, objectives or goals of Santander UK or its management, including those related to products or services; > Statements of future economic performance; and > Statements of assumptions underlying such statements. Words such as 'believes', 'anticipates', 'expects', 'intends', 'aims', 'plans', 'targets' and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. By their very nature, forward-looking statements are not statements of historical or current facts; they cannot be objectively verified, are speculative and involve inherent risks and uncertainties, both general and specific, and risks exist that the predictions, forecasts, projections and other forward-looking statements will not be achieved. Santander UK cautions readers that a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements made by Santander UK or on its behalf. Some of these factors, which could affect Santander UK's business, financial condition and/or results of operations, are considered in detail in the 2012 Annual Report under the Risk Management Report on pages 62 to 162 and in the Risk Factors section on pages 310 to 325 under such sections as updated in this Half-Yearly Financial Report. They include: > The effects of UK economic conditions; > The effects of conditions in global financial markets (e.g. increased market volatility and disruption, reduced credit availability and increased commercial and consumer loan delinquencies); > The extent to which regulatory capital and liquidity requirements and any changes to these requirements may limit Santander UK's operations; > Santander UK's ability to access liquidity and funding on acceptable financial terms; > Santander UK's exposure to UK Government debt and to the risks faced by other financial institutions; > The effects of the ongoing economic and sovereign debt tensions in the eurozone; > The effects of any changes to the credit rating assigned to Santander UK, any member of the Santander UK group or any of their respective debt securities; > The effects of fluctuations in interest rates, currency exchange rates, basis spreads, bond and equity prices and other market factors; > The extent to which Santander UK may be required to record negative fair value adjustments for its financial assets due to changes in market conditions; > The credit quality of borrowers, Santander UK's ability to assess this and control the level of non-performing loans, loan prepayment and the enforceability of collateral, including real-estate securing such loans; > The extent which Santander UK may be exposed to operational losses (e.g. failed internal or external processes, people and systems); > Risks associated with the Santander UK's derivative transactions; > The effects of competition, or intensification of such competition, in the financial services markets in which Santander UK conducts business and the impact of customer perception of Santander UK's customer service levels on existing or potential business; > Santander UK's exposure to certain sectors or customers, such as SMEs and individuals; > The ability of Santander UK to manage any future growth effectively (e.g. efficiently managing the operations and employees of expanding businesses and maintaining or growing its existing customer base); > The ability of Santander UK to realise the anticipated benefits of its business combinations and the exposure, if any, of Santander UK to any unknown liabilities or goodwill impairments relating to acquired businesses; > The effects of the financial services laws, regulations, governmental oversight, administrative actions and policies and any changes thereto in each location or market in which Santander UK operates; > The effects of the proposed reform and reorganisation of the structure of the UK Prudential Regulatory Authority and of the UK regulatory framework that applies to members of the Santander UK group; > The effects of any new reforms to the UK mortgage lending and the personal loans market; > The power of the UK Prudential Regulatory Authority (or any overseas regulator) to intervene in response to attempts by customers to seek redress from financial service institutions, including Santander UK, in case of industry-wide issues; > The extent to which members of the Santander UK group may be responsible for contributing to compensation schemes in the UK in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers; > The effects which the UK Banking Act 2009 may have, should the HM Treasury, the Bank of England and/or the PRA exercise their powers under this Act in the future against the Company; > The risk of third parties using Santander UK as a conduit for illegal activities without Santander UK's knowledge; > The effects of taxation requirements and other assessments and any changes thereto in each location in which Santander UK operates; > The effects of any changes in the pension liabilities and obligations of Santander UK; > The ability of Santander UK to recruit, retain and develop appropriate senior management and skilled personnel; > The effects of any changes to the reputation of Santander UK, any member of the Santander UK group or any affiliate operating under Santander UK's brands; > The basis of the preparation of the Company's and Santander UK's financial statements and information available about Santander UK; > Santander UK's dependency on its information technology systems and on other Santander UK group companies and third parties for essential services; and > Santander UK's success at managing the risks to which it is exposed, including the items above. Undue reliance should not be placed on forward-looking statements when making decisions with respect to Santander UK and/or its securities. Investors and others should take into account the inherent risks and uncertainties of forward-looking statements and should carefully consider the foregoing non-exhaustive list of important factors. Forward-looking statements speak only as of the date on which they are made and are based on the knowledge, information available and views taken on the date on which they are made; such knowledge, information and views may change at any time. Santander UK does not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. This information is provided by RNS The company news service from the London Stock Exchange END IR SFIESLFDSEEA

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