20-F 1 d309924d20f.htm FORM 20-F Form 20-F
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 20-F

(Mark One)

 

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                    

OR

 

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                     to                    

Commission file number 001-14928

Santander UK plc

(Exact name of Registrant as specified in its charter)

England

(Jurisdiction of incorporation or organization)

2 Triton Square, Regent’s Place, London NW1 3AN, England

(Address of principal executive offices)

Julian Curtis

2 Triton Square, Regent’s Place, London NW1 3AN, England

Tel +44 (0) 870 607 6000

Fax +44 (0) 20 7756 5628

(Name, Telephone, Email and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act.

 

4.000% Notes due 2016, issued by Abbey National Treasury Services plc *

     New York Stock Exchange   

2.875% Notes due 2014, issued by Abbey National Treasury Services plc *

     New York Stock Exchange   

Floating Rate Notes due 2014, issued by Abbey National Treasury Services plc *

     New York Stock Exchange   

* Guaranteed by Santander UK plc

  

Securities registered or to be registered pursuant to Section 12 (g) of the Act.

None

Securities registered or to be registered pursuant to Section 15 (d) of the Act.

7.95% Term Subordinated Securities due October 26, 2029

Subordinated Guarantee by Santander UK plc (as successor in interest to Abbey National plc) of the 8.963% Non-Cumulative Perpetual Preferred Limited Partnership Interests issued by Abbey National Capital LP I

Subordinated Guarantee by Santander UK plc (as successor in interest to Abbey National plc) of the 8.963% Non-Cumulative Trust Preferred Securities issued by Abbey National Capital Trust I

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

10 3/8% Non-cumulative Preference Shares of nominal value of £1 each    200,000,000
8 5/8% Non-cumulative Preference Shares of nominal value of £1 each    125,000,000
Series A Fixed/Floating Rate Non-cumulative Preference Shares of nominal value £1 each           300,002

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

    Yes  x    No  ¨

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨        Accelerated filer  ¨         Non-accelerated filer  x

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

¨ U.S. GAAP  x International Financial Reporting Standards as issued by the International Accounting Standards Board   ¨ Other

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

Item 17  ¨    Item 18  ¨

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

    Yes  ¨    No  x

 

 

 


Table of Contents

 

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Table of Contents

 

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Table of Contents

Santander UK plc

2011 Annual Report on Form 20-F

Contents

 

Chief Executive Officer’s Review and Forward-looking Statements

  

Chief Executive Officer’s Review

     2   

Forward-looking Statements

     6   

Business and Financial Review

  

Business Overview

     7   

Business Review - Summary

     12   

Business Review - Key Performance Indicators

     17   

Business Review - Divisional results

     19   

Other Material Items

     30   

Balance Sheet Business Review

     32   

Risk Management Report

     62   

Report of the Directors

  

Directors

     136   

Directors’ Report

     138   

FSA Remuneration Disclosures

     152   

Financial Statements

  

Report of Independent Registered Public Accounting Firm - US opinion

     159   

Primary Financial Statements

     160   

Notes to the Financial Statements

     167   

Selected Financial Data

  

Selected Financial Data

     275   

Shareholder Information

  

Risk Factors

     278   

Taxation for US Investors

     291   

Share Information

     291   

Contact Information

     292   

Articles of Association

     293   

Glossary of Financial Services Industry Terms

     294   

Directors’ Responsibility Statement

     302   

Cross-reference to Form 20-F

  

Cross-reference to Form 20-F

     303   

 

Santander UK plc 2011 Annual Report    1


Table of Contents

Business Review and Forward-looking Statements

Chief Executive Officer’s Review

OVERVIEW

In 2011, Santander UK maintained its solid track record with a statutory profit after tax of £903m and with a robust balance sheet, despite a fragile economic recovery as well as a challenging regulatory and market environment. In common with other UK banks, a provision for payment protection insurance remediation was made, which was the most significant driver of the 43% reduction in statutory profit compared to 2010. Excluding this item, Santander UK’s trading profit before tax for 2011 was 4% lower than 2010, impacted by greater regulatory costs including liquidity requirements, the impact of higher funding costs as well as persistently low interest rates.

Despite weaker demand, Santander UK continued to be a consistent lender to homeowners with a market share of gross mortgage lending of more than 17% in 2011. In addition, lending to small and medium-sized enterprises (‘SMEs’) grew by 25% in 2011 and our share of lending commitments made under the UK Government’s Project Merlin agreement were exceeded with £4.3bn of lending. The planned acquisition of the Royal Bank of Scotland retail and corporate banking businesses, which we announced in 2010, is well underway, and upon completion will further accelerate the delivery of our strategic goals and the transformation of the businesses.

Santander UK continues to offer good value and innovative products for retail customers, and is achieving improved levels of service satisfaction as well as an improved performance in the treatment of complaints. We have acted upon customer feedback and have repatriated our international call centres to improve our services and continue to support the UK economy through job creation.

On 6 March 2012 Santander UK announced changes in its executive management structure. We appointed a Chief Financial Officer, promoting Stephen Jones to the position which includes responsibilities for the Finance, Pension and Group Infrastructure functions, and with a key role in managing the relationships with regulators and investors. We have extended the existing responsibilities of Steve Pateman, now Head of UK Banking, to also include Retail Banking and Retail Products and Marketing. This aligns the responsibilities for UK retail and corporate banking operations. In addition, we have formalised the role of the Chief Operating Officer, Juan Olaizola, and have added the responsibility for operational Human Resources. Javier Maldonado has been appointed to take responsibility for Strategy and Corporate Development, including key parts of the Royal Bank of Scotland acquisition. Overall, these changes reflect the next stage of development for the management team structure at Santander UK and will provide the best support for the ambitious development plans we have in place to build the business.

STRATEGIC FOCUS

On 29 September 2011, at the Banco Santander group Investor Day, Santander UK management presented its three year strategic plan. The strategy is directed towards the commercial turnaround of the businesses and Santander UK’s transformation into a market-leading retail and corporate bank in the UK.

Our goal remains to develop Santander UK into a full service, diversified, customer-centred franchise and we intend to make further progress against this goal in 2012. The strategy has three principles:

 

   

shifting to a customer focus rather than a product focus;

 

   

diversifying to a more balanced business mix, particularly growth of SME and business banking; and

 

   

maintaining operating efficiency hand-in-hand with good service levels to customers.

Our proprietary market-leading IT platform is integral to meeting these goals. We plan to invest £490m over the next three years to further improve its functionality and capabilities, at which point the ability to differentiate and grow the businesses faster will be in place.

In 2012 the first priority will be to ensure that we further strengthen Santander UK’s balance sheet, in terms of funding, credit quality and capital. This will provide the foundations for sustainable profit growth in the future through the commercial transformation of the business.

BUSINESS PERFORMANCE

With a distribution network of almost 1,400 branches and agencies and 28 regional corporate banking centres, Santander UK has a firm foundation on which to build a full-service commercial bank. Despite weaker demand in key markets, increased competitive pressures and a fragile economic outlook, we achieved good levels of new business in both SME and mortgage lending. SME lending balances were £2.1bn higher than at the end of 2010 at £10.7bn, whilst mortgage gross lending was £23.7bn in the year ended 31 December 2011. This equated to a gross mortgage market share of more than 17%, which was in excess of our stock market share of around 14%, totalling £173.5bn. Risk management and affordability measures are an important part of our lending decisions and the success of our focus on low LTV and prime segments is demonstrated by our ongoing low levels of mortgage arrears relative to the market.

In 2011 we opened 836,000 new bank accounts and 543,000 credit cards through our retail network, broadly maintaining our market share of stock. As part of the transformation to a customer focus, our Retail Banking proposition is seeking to develop and build deeper customer relationships through increased current account primacy and customer segmentation.

 

2    Santander UK plc 2011 Annual Report


Table of Contents

Business Review and Forward-looking Statements

Chief Executive Officer’s Review continued

 

Customer loyalty is being rewarded through a range of special deals and incentives and was supported by the launch of new products and campaigns during the year. These were well received by the market and in the final four months of 2011 included:

 

   

the innovative fixed-rate Upfront Interest Bond, where customers receive their interest at the start rather than at the end of their three-year term. From launch to the end of 2011, more than 7,500 bonds were opened with an average balance of more than £22,000;

 

   

the fee-paying 123 Cashback Credit Card which offers valuable rewards for customers using the card on a day-to-day basis. More than 145,000 of these cards were opened between September and December; and

 

   

a high-profile switcher campaign offering enhanced incentives for existing customers to switch their primary bank account to Santander UK; more than 82,000 customers used the service between September and December 2011.

Competition in the deposit acquisition market intensified and margins were at very low levels as a result. We continued to offer a mix of best-buy products and special offers targeted at existing customers and continued to reward our customers for doing more business with us. We restricted our exposure to negative margin deposit acquisition, preferring medium-term wholesale funding of a higher liquidity value. As a result, net deposit flows in the year were negative and commercial deposits were 3% lower than at 31 December 2010. This was possible due to a successful funding programme where we were able to issue over £25bn of medium-term wholesale funding at attractive rates, exceeding our internal target for the year.

The organic growth of Corporate Banking continued through 2011, supported by the opening of new business centres. Lending to our SME customers continued to grow with loan balances 25% ahead of 31 December 2010; this underlines our commitment to this sector as well as helping fulfil our commitments to the UK Government under the Project Merlin agreement. Merlin-related SME gross lending totalled £4.3bn, exceeding our share of the commitment of £4.0bn. The ongoing growth of the Corporate Banking business was supported by the launch of several new initiatives in 2011, notably, our £200m ‘Breakthrough’ programme which provides fast-growth small companies with the resources and knowledge they need to develop, including access to mezzanine funding and a support framework of expert advice. In addition, the launch of our new business banking proposition, with new product offerings being supported by the recruitment of 200 new advisors who are integral to our relationship management based model.

Markets produced a satisfactory result in the year ended 31 December 2011, reflecting transaction volumes lower than in 2010 and in line with the reduced activity levels seen in the market in 2011.

IMPROVING CUSTOMER SERVICE

We remain committed to tackling service issues within our business and a management priority is to improve the customer service experience. To this end, 1,100 new UK based customer-facing roles were announced in 2010. The new staff were in place by March 2011, ahead of the repatriation of our overseas Retail Banking call centres to the UK in July 2011. Complaints handling processes were re-engineered and a range of other initiatives and processes introduced to address the root cause of service quality issues.

The impact of these actions was evident, notwithstanding the greater impact of PPI related complaints in the second half of 2011. The overall number of FSA reportable complaints received in the full year 2011 was 19% lower than in 2010. The Santander UK share of Financial Ombudsman Service customer complaints in the second half of 2011 remained below its general market share of retail banking services whilst Santander UK had a lower share of cases upheld against it than the UK financial service market as a whole. Internal monthly customer surveys also indicate an improvement in service levels; by the end of the 2011 almost 90% of customers were satisfied or better and 80% of complaints were resolved within 48 hours.

Whilst we have made some progress, there remains more to do if all areas of the business are to reach the high levels of customer service and satisfaction which we are consistently delivering in the intermediary and Corporate Banking businesses.

FUNDING, LIQUIDITY AND CAPITAL

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

In the year ended 31 December 2011, the commercial asset stock increased 2% to £206bn, driven by modest growth in residential mortgages, of 1%, and strong growth in SME loans, of 25%. The commercial liability stock of £149bn fell 3% compared to 31 December 2010. The combined effect of these flows was a 6 percentage point rise in the customer loan-to-deposit ratio to 138%.

The increase in the customer loan to deposit ratio reflected our commitment to profitability whilst maintaining loan availability in the UK. Intense competition in the retail deposits market throughout 2011 led to significantly increased acquisition costs and negative margins. In this context the relative cost and duration of medium-term wholesale funding has at times compared more favourably to commercial deposits. Our conscious decision to reduce our holdings of rate-sensitive and shorter term commercial deposits was more than offset by an increase in medium-term wholesale funding. During 2011, £25bn was raised through new issues at attractive rates across a range of products and geographies, compared to £21bn in 2010, with the average residual duration for wholesale funding extended to almost three years from approximately two years.

 

Santander UK plc 2011 Annual Report    3


Table of Contents

Business Review and Forward-looking Statements

Chief Executive Officer’s Review continued

 

The ratio of customer assets to customer deposits plus medium-term funding was 99%, an increase from 95% at the end of 2010. The ratio continued to reflect the strength of the commercial franchise and the focus of our business. Deleveraging of the legacy portfolios also continued in 2011, with asset balances down by £3.6bn in total.

Sovereign exposures to eurozone countries at 31 December 2011 were not significant, at less than 0.1% of total assets. Other sovereign exposures primarily related to UK, US and Swiss government securities. Total exposure to periphery eurozone countries (excluding group companies) was less than 0.4% of total assets. Total gross exposures to other Santander group entities amounted to only 1.7% of total assets at 31 December 2011, the greater part of which was mitigated by collateral held. These exposures to other Santander group entities arose in the ordinary course of business and are within limits acceptable to the UK Financial Services Authority.

Total liquid assets reduced from £62bn to £56bn with core liquid assets falling from £40bn to £28bn. The decrease was primarily due to a reduction in short term funding against which core liquid assets need to be held. Capital ratios remained strong with a Core Tier 1 of 11.4%, a Total Tier 1 capital ratio of over 14.8% and a Total capital ratio in excess of 20%.

KEY FINANCIAL HIGHLIGHTS

For 2011, Santander UK’s trading profit before tax (management’s preferred profit measure, described in the Business Review - Summary on page 12) was £2,112m, 4% lower than 2010. Statutory profit after tax of £903m for 2011 was £680m lower than in 2010, primarily due to the customer remediation provision in relation to payment protection insurance raised in June 2011.

 

   

Trading income decreased by 5%, largely due to the new regulatory liquidity requirements, excluding which revenues were broadly stable. Increased lending margins were offset by higher costs of funding and deposit acquisition;

 

   

Trading expenses were marginally higher than in 2010, primarily due to the investment in growth initiatives in Corporate Banking and in Markets and additional branch and call centre staff in Retail Banking. In the last year 1,100 new customer-facing staff were recruited, to improve customer service and to allow the repatriation of overseas Retail Banking call centres to the UK;

 

   

The Trading cost-to-income ratio of 44% was higher than the same period last year. However, excluding the adverse impact on income from additional liquid asset holdings, the cost-to-income ratio was around 40%; and

 

   

Impairment losses on loans and advances were 38% lower than in 2010, largely due to improvements in the mortgage and unsecured banking portfolios. The low interest rate environment and better than expected unemployment trends in the UK also contributed to our low arrears and repossession levels, which remained significantly better than industry benchmarks from the Council of Mortgage Lenders. This was partially offset by increases in charges relating to the growing corporate book, in particular on older commercial real estate exposures written before 2008.

THE ECONOMY AND UK REGULATION

After quite rapid quarterly growth in most of 2010, UK economic activity slowed markedly in 2011. Initial official figures showed that GDP fell by 0.2% in the final quarter of 2011, and although output in the year was 0.9% higher than a year earlier this was slower growth than was achieved in 2010. The unemployment rate, which had held relatively steady through 2010 and into 2011, started to rise in the second half of 2011, reaching 8.4% in December. During the year consumer price inflation ran above earlier expectations and significantly above the 2% target level, reaching a high of 5.2% in September 2011. This high rate of price inflation meant that the real value of average earnings fell and, as a result, consumer spending was very subdued. Subsequently, the rate of inflation eased, falling to 3.6% annualised in January 2012.

As a consequence, the economic environment remains challenging. Public expenditure cuts are being implemented as part of the process of reducing the high level of public sector borrowing and demand for credit has remained subdued. In the housing market, the number of loans approved for house purchase has picked up from its low point in the recession, with activity up by just under 4% in 2011. The mortgage market also saw stronger remortgage activity. Overall, the level of housing market activity remains low relative to the experience of the previous decade.

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

 

4    Santander UK plc 2011 Annual Report


Table of Contents

Business Review and Forward-looking Statements

Chief Executive Officer’s Review continued

 

LOOKING AHEAD

We believe that 2012 is likely to be a tough year for the UK banking industry. Macro-economic prospects have deteriorated markedly in recent months, and even since the Investor Day last September. This has inevitably affected the outlook for our profitability in 2012. Notably increased regulatory burdens, continued low interest rates and funding costs are expected to impact our results further. Management will seek to mitigate the effects of these challenges as well as tackle costs in the forthcoming quarters. A priority of our strategy for 2012 will be to build further on our balance sheet strength and stability. We will be focused on maintaining the high quality of our lending, improving further our capital base and tightly managing the liquidity and funding positions.

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

We also continue to innovate. In March 2012 we launched a new retail banking product, the 123 current account offering both cashback and in-credit interest. This product is designed to build and reinforce a long-term primary account relationship with retail customers.

We continue to work on the execution of our planned acquisition of 314 bank branches, 44 SME banking centres and 4 corporate banking centres from the Royal Bank of Scotland group. We expect to acquire some 2 million personal and corporate and business banking customers as a result of this transaction. This is a key step in fulfilling our ambition to be a full-service commercial bank as we complement our strong retail offering with an increased presence for SMEs and mid-sized companies. UK SME businesses are an important part of Santander UK’s strategy and a vital sector for the growth of the economy. Our aim is to increase our lending to UK SMEs and create new jobs as we open more business centres to serve them. The transfer is complex and it is important that we seek to minimise disruption. With this in mind the current expectation is that the transaction will not complete before the fourth quarter of 2012, subject to certain conditions.

Putting customers at the forefront of our business is a key part of our focus and we plan to further improve and deepen our customer relationships by providing a tailored proposition and a competitive product range. We have made significant investment in improving our service quality and have further initiatives planned for the second half of the year and hope to see further improvements to customer satisfaction as a result.

 

LOGO

Ana Botín

Chief Executive Officer

 

Santander UK plc 2011 Annual Report    5


Table of Contents

Business Review and Forward-looking Statements

Forward looking Statements

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

 

   

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 Santander UK’s behalf. Some of these factors, which could affect the Group’s business, financial condition and/or results of operations, are considered in detail in the Risk Management Report on page 62 and the Risk Factors section on page 278 and they include:

 

   

the effects of UK economic conditions (e.g. housing market correction, rising unemployment, increased taxation and reduced consumer and public spending) and particularly the UK real estate market;

 

   

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 effects of the ongoing economic and sovereign debt crisis in the eurozone;

 

   

the credit quality of borrowers and the soundness of other financial institutions;

 

   

the Group’s ability to access liquidity and funding on financial terms acceptable to it;

 

   

the extent to which regulatory capital and liquidity requirements and any changes to these requirements may limit the Group’s operations;

 

   

the effects of any changes to the credit rating assigned to the Group, any member of the 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 the Group may be required to record negative fair value adjustments for its financial assets due to changes in market conditions;

 

   

the ability of the Group 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 the Group to realise the anticipated benefits of its business combinations and the exposure, if any, of the Group to any unknown liabilities or goodwill impairments relating to the acquired businesses;

 

   

the effects of competition, or intensification of such competition, in the financial services markets in which the Group conducts business and the impact of customer perception of the Group’s customer service levels on existing or potential business;

 

   

the extent which the Group may be exposed to operational losses (e.g. failed internal or external processes, people and systems);

 

   

the ability of the Group to recruit, retain and develop appropriate senior management and skilled personnel;

 

   

the effects of any changes to the reputation of the Group, any member of the Group or any affiliate operating under the Group’s brands;

 

   

the effects of the financial services laws, regulations, administrative actions and policies and any changes thereto in each location or market in which the Group operates;

 

   

the effects of taxation requirements and any changes thereto in each location in which the Group operates;

 

   

the effects of the proposed reform and reorganisation of the structure of the UK Financial Services Authority and of the UK regulatory framework that applies to members of the Group;

 

   

the effects of any new reforms to the UK mortgage lending market;

 

   

the power of the UK Financial Services Authority (or any overseas regulator) to intervene in response to attempts by customers to seek redress from financial service institutions, including the Group, in case of industry-wide issues;

 

   

the extent to which members of the 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 Financial Services Authority exercise their powers under this Act in the future against the Company;

 

   

the Group’s dependency on its information technology systems;

 

   

the risk of third parties using the Group as a conduit for illegal activities without the Group’s knowledge;

 

   

the effects of any changes in the pension liabilities and obligations of the Group; and

 

   

Santander UK’s success at managing the risks to which the Group 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.

Written forward-looking statements may appear in documents filed with the US Securities and Exchange Commission, including this Annual Report and Accounts, reports to shareholders and other communications. The US Private Securities Litigation Reform Act of 1995 contains a safe harbour for forward-looking statements on which Santander UK relies in making such disclosures.

 

6    Santander UK plc 2011 Annual Report


Table of Contents

Business and Financial Review

Business Overview

This Business and Financial Review contains forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in such forward-looking statements. See “Forward-looking Statements” on page 6.

GENERAL

Santander UK plc (the ‘Company’) and its subsidiaries (together, ‘Santander UK’ or the ‘Group’) operate primarily in the UK, under UK law and regulation and are part of the Banco Santander, S.A. group (together with its subsidiaries, ‘Santander’). Santander UK is a significant financial services provider in the UK, being the second largest residential mortgage lender and a top three savings brand, operating across the full range of personal financial services, as well as being active in corporate and commercial banking services.

The principal executive office and registered office of Santander UK plc is 2 Triton Square, Regent’s Place, London NW1 3AN. Santander UK’s telephone number is +44 (0) 870-607-6000. 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. See “Business and Financial Review - Tangible fixed assets” for information on our properties.

SUMMARY HISTORY

The Abbey National Building Society (the ‘Society’) was formed in 1944 with the merger of two long-standing building societies. Abbey National plc was incorporated in 1988 and in 1989 the Society transferred its business to Abbey National plc as part of the conversion and listing on the London Stock Exchange. In 2003, the brand name was shortened to Abbey. In 2010, the Company changed its name to Santander UK plc and now operates under the Santander brand name. A list of the Company’s principal subsidiaries and their country of incorporation can be found on page 216.

On 12 November 2004, Banco Santander, S.A. completed the acquisition of the entire issued ordinary share capital of the Company, implemented by means of a scheme of arrangement under Section 425 of the Companies Act 1985, making the Company a wholly-owned subsidiary of Banco Santander, S.A., a company incorporated in Spain. Banco Santander, S.A. is one of the largest banks in the world by market capitalisation. Founded in 1857, Banco Santander, S.A., at the close of 2011, had more than 102 million customers and over 14,760 branches.

In September 2008, following the announcement by HM Treasury to take Bradford & Bingley plc into public ownership, the retail deposits, branch network and related employees transferred, under the provisions of the Banking (Special Provisions) Act 2008, to the Company. All of Bradford & Bingley plc’s customer loans and treasury assets, including all its mortgage assets, were taken into public ownership.

The transfer to the Company consisted of the £20bn retail deposit base with 2.7 million customers, as well as Bradford & Bingley plc’s direct channels including 197 retail branches, 141 agencies (distribution outlets in third party premises) and related employees. The acquisition price was £612m, including the transfer of £208m of capital relating to offshore entities. The transfer further strengthened the Group’s retail customer deposit base and franchise.

In December 2008, following the acquisition by Banco Santander, S.A. of Alliance & Leicester plc, the Company injected £950m of capital into Alliance & Leicester plc through a subscription for new Alliance & Leicester plc ordinary shares and undated subordinated notes. Previously, in October 2008, the Company subscribed for US$100m undated floating rate subordinated notes issued by Alliance & Leicester plc. As a result of the subscription for ordinary shares, the Company held 35.6% of the issued ordinary share capital of Alliance & Leicester plc at 31 December 2008.

On 9 January 2009, in order to optimise the capital, liquidity, funding and overall financial efficiency of the enlarged Santander group, Banco Santander, S.A. transferred all of its Alliance & Leicester plc shares to the Company in exchange for newly issued ordinary shares of the Company. Accordingly, the Company became the immediate parent company of Alliance & Leicester plc. The Company accounted for the transfer of Alliance & Leicester plc with effect from 10 October 2008, the date on which Alliance & Leicester plc was acquired by Banco Santander, S.A.

These business combinations allow the Group to deliver increased critical mass in the UK through a greater market share in key financial products such as mortgages and savings, and an expanded branch network. In January 2010, the Company was rebranded as Santander. In December 2010, the rebranding of Alliance & Leicester branches was completed. The change reflected Santander’s policy to operate under a single brand.

On 28 May 2010, Alliance & Leicester plc transferred its business and certain associated liabilities to the Company pursuant to a court-approved business transfer scheme under Part VII of the Financial Services and Markets Act 2000.

On 3 August 2010, Banco Santander S.A., through a wholly-owned Spanish-based subsidiary Santusa Holding, S.L., injected £4,456m of equity capital into Santander UK plc. The capital was used to support the reorganisation of certain Banco Santander, S.A. group companies in the UK and will be used to support further growth, including the transaction with the Royal Bank of Scotland group described below.

 

Santander UK plc 2011 Annual Report    7


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Business and Financial Review

Business Overview continued

 

On 4 August 2010, the Company announced its agreement to acquire (subject to certain conditions) bank branches and business banking centres and associated assets and liabilities from the Royal Bank of Scotland group for a premium of £350m to net assets at closing. The consideration will be paid in cash and is subject to certain closing adjustments. The transaction now includes: 308 Royal Bank of Scotland branches in England and Wales; 6 NatWest branches in Scotland; the retail and SME customer accounts attached to these branches; the Direct SME business; and certain mid-corporate businesses. EC/UK merger control clearance was received on 15 October 2010 and HMRC clearance was also received during the fourth quarter. The separation and transfer process is underway with the current expectation that the transaction will not complete before the fourth quarter of 2012, subject to certain conditions.

The acquisition will be a key step in fulfilling our ambition to be a full-service commercial bank as we complement our strong retail offering with an increased presence with SMEs. For Santander UK, the result over the medium term will be a far more balanced business mix, with approximately 70% of our business being retail banking, against 80% currently, and the balance being an expanded business and corporate banking presence along with the existing Markets business. The acquisition will add to our retail banking business but importantly will double our market share in SMEs and in mid-corporate banking.

In October and November 2010, the Group acquired for a total consideration of £1,451m:

 

   

Santander Cards Limited and Santander Cards (UK) Limited (and its subsidiaries), which conduct Santander’s provision of credit cards and related financial products, store cards and other unsecured consumer finance products in the UK, and Santander Cards Ireland Limited, which conducts Santander’s provision of credit finance by way of store cards and credit cards in the Republic of Ireland;

 

   

Santander Consumer (UK) plc (of which the Group already held 49.9%), which carries on Santander’s provision of finance facilities and the contract purchase of motor vehicles and equipment in the UK and also provides wholesale funding facilities to preferential dealers in the UK; and

 

   

Santander PB UK (Holdings) Limited (and its subsidiaries) (of which the Group already held 51% of its subsidiary, Santander Private Banking UK Limited), which carries on Santander’s provision of private banking services in the UK.

The principal purpose of the acquisitions was to bring these interests of Banco Santander, S.A. in the UK under the corporate structure of the Group in furtherance of the Group’s objective. Our goal remains to develop Santander UK into a full-service, diversified, customer-centred commercial bank and we intend to make further progress against this goal in 2012.

In 2011, the Company was awarded ‘Bank of the Year in the UK’ by The Banker for the third year in succession, as well as Moneyfacts awards for ‘Best Personal Finance Provider of the Year’, ‘Best Service from a Commercial Mortgage Lender’ and ‘Best Business Bank 2011’. Additionally, Abbey for Intermediaries won 10 awards in 2011, including the ‘Most Improved’ award from FT Adviser magazine for the quality of service they provide to customers. In 2011, the Company was also included in the list of ‘The Times Top 50 Employers for Women’.

CORPORATE PURPOSE AND STRATEGY

Santander UK’s purpose is to maximise value for its shareholders, Banco Santander, S.A. and its subsidiary company Santusa Holding, S.L., by focusing on offering a diversified, customer-centred, full commercial banking service in the UK. A key feature of our strategy is to develop and build deeper customer relationships through increased current account primacy and customer segmentation. With the continuing support of Banco Santander, S.A., Santander UK aims to be the best commercial bank in the UK for our customers, our shareholders and our people.

The Santander group operates a ‘subsidiary model’ under which the Group is autonomous and self-sufficient in capital, funding and liquidity. The subsidiary model gives Santander UK considerable financial flexibility, yet enables it to continue to take advantage of the significant operational synergies and strengths that come from being part of Santander group, in brand, products, systems, platforms and management capability. The Santander UK corporate governance model ensures that the Board and the management of Santander UK make their own decisions on liquidity, funding and capital, having regard to what is appropriate for Santander UK’s business and strategy.

EXECUTIVE RESPONSIBILITY

Santander UK’s management structure is headed by Ana Botín, Chief Executive Officer. The management structure consists of a number of business and support divisions. The business divisions consist of:

 

   

Retail Banking - offers residential mortgages, savings and banking and other personal financial products to customers throughout the UK, as well as private banking and other specialist services. The division is headed by Charlotte Hogg, reporting to Steve Pateman in his capacity as Head of UK Banking.

 

   

Corporate Banking - offers banking services principally to small and medium-sized (‘SME’) UK companies and also to mid and large corporate clients. It also contains certain legacy portfolios in run-off. This division is headed by Steve Pateman with the exception of banking services to large corporate clients where there is a global relationship, which is headed by Luis de Sousa.

 

   

Markets - provides financial markets sales, trading and risk management services. This division is headed by Luis de Sousa.

 

   

Group Infrastructure - consists of Asset & Liability Management, which is responsible for the Group’s capital and funding, Investor Relations and Economics. This division is headed by Justo Gómez, reporting to Stephen Jones in his capacity as Chief Financial Officer.

 

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Business and Financial Review

Business Overview continued

 

The support divisions consist of:

 

   

Retail Products and Marketing - responsible for integrating and gaining the maximum value from Santander UK’s products, marketing and brand communications to serve Santander UK’s customers better. This division is headed by Rami Aboukhair, reporting to Steve Pateman in his capacity as Head of UK Banking.

 

   

Human Resources - responsible for delivering the human resources strategy and personnel support. This division is headed by Simon Lloyd, reporting to Juan Olaizola in his capacity as Chief Operating Officer, for operational Human Resources. Simon Lloyd reports to Ana Botín, Chief Executive Officer, for all other Human Resource matters.

 

   

Manufacturing - responsible for all information technology, cost control and operations activity, including service centres. This division is headed by Juan Olaizola.

 

   

Risk - responsible for ensuring that the board of directors (the ‘Board’) and senior management team are provided with an appropriate risk policy and control framework, and to report any material risk issues to the Board Risk Committee and the Board. This division is headed by José María Nus.

 

   

Internal Audit - responsible for supervising the compliance, effectiveness and efficiency of Santander UK’s internal control systems to manage its risks. This division is headed by Ramón Sanchez.

In addition there are a number of corporate units:

 

   

Financial Management Information, Financial Reporting and Tax, Cost Management & Control - This unit is headed by Mónica Cueva, reporting to Stephen Jones in his capacity as Chief Financial Officer.

 

   

Legal and Secretariat - This unit is headed by Karen Fortunato.

 

   

Strategy and Corporate Development - This unit is currently headed by Stephen Jones. Responsibility for this unit will transfer shortly to Javier Maldonado.

 

   

Regulatory Affairs and Pensions - This unit is headed by Stephen Jones.

 

   

Service Quality - This unit is headed by Stephen Jones, with Chief Executive Officer oversight given the importance of service quality.

 

   

Communications - This unit includes corporate social responsibility and public policy and is headed by Jennifer Scardino.

 

   

Santander Universities in the UK - This unit is headed by Charlotte Hogg, reporting to Steve Pateman in his capacity as Head of UK Banking.

COMPETITIVE ENVIRONMENT, FUTURE TRENDS AND OUTLOOK

The economic environment in the UK in 2011 remained challenging, with UK GDP growing by 0.9%, a lower rate than in 2010. Inflation rose, however, in part due to the increase in value added tax at the start of the year. In the second half of the year the unemployment rate started to rise again, reaching 8.4% in December, up from 7.9% a year earlier. House prices were relatively stable, with the Halifax index showing house prices ending the year 1.3% lower than a year earlier.

2012 is expected to be another challenging year for the UK economy, but one in which lower inflation is expected to support the real earnings growth of households compared to 2011 as the year progresses. However, unemployment is predicted to remain high, resulting in continuing challenges for banks, homeowners and savers. The Bank of England’s Base Rate has remained at a record low of 0.5% since March 2009 and, at the present time, markets expect interest rates to remain very low, and monetary policy to continue to be supportive of the economy, for an extended period.

In terms of the competitive landscape, Santander UK’s main competitors are other UK retail banks, building societies and other financial services providers such as insurance companies, supermarket chains and large retailers. The market remains competitive, driven largely by market incumbents but with new entrants emerging. Management expects that such competition will continue in response to consumer demand, technological changes, the impact of consolidation within the financial sector, regulatory developments and actions and other factors.

Management remains confident of Santander UK’s strength despite continuing challenging conditions in some of its core personal financial services markets. A detailed description of management’s basis for concluding that Santander UK remains a going concern is set out in the “Directors’ Report – Going Concern” on page 140.

 

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Business and Financial Review

Business Overview continued

 

BUSINESS DIVISIONS

The information below reflects the reporting structure in place at the reporting date in accordance with which the segmental information in the Business and Financial Review and in Note 2 to the Consolidated Financial Statements has been presented.

Retail Banking

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

Residential Mortgages

Santander UK is the second largest provider of residential mortgages in the UK measured by outstanding balancesi, providing mortgage loans for house purchases as well as home improvement loans to new and existing mortgage customers.

Mortgage loans are offered in two payment types. Repayment mortgages require both principal and interest to be repaid in monthly instalments over the life of the mortgage. Interest-only mortgages require monthly interest payments and the repayment of principal at the end of the mortgage term. This can be arranged via a number of investment products including Individual Savings Accounts and pension policies, or by the sale of the property.

Santander UK’s mortgage loans are usually secured by a first ranking mortgage over property and are typically available over a 25-year term, although there is no minimum term. Variable rate products charge interest at variable rates, including trackers which track the Bank of England base rate and those determined at the discretion of Santander UK by reference to the general level of market interest rates and competitive forces in the UK mortgage market. Fixed rate products offer a predetermined interest rate, generally fixed for between two and five years, after which they bear interest at standard variable rates. In 2011, almost half of the new mortgage business was variable rate products, typically with an incentive period for the first two to five years. In line with the rest of the UK market, a significant proportion of mortgages are repaid at the end of the fixed or incentive period, with the customer moving to a new incentive product. The remainder stay on Santander UK’s standard variable rate.

Savings

Santander UK is a top three deposit taker in the UKi and provides a wide range of retail savings accounts in the UK, including on-demand, notice and investment accounts, Individual Savings Accounts (‘ISAs’) and capital guaranteed products. Interest rates on savings in the UK are primarily set with reference to the general level of market interest rates and the level of competition for such funds.

Banking and Consumer Credit

Santander UK offers a range of personal banking services including current accounts, credit cards and unsecured personal loans. Credit scoring is used for initial lending decisions. Behavioural scoring is used for certain products for further lending decisions. In November 2010, the Group acquired Santander Consumer (UK) plc (in which the Group already held a 49.9% shareholding), which carries on Santander’s provision of finance facilities and the contract purchase of motor vehicles and equipment in the UK and provides wholesale funding facilities to preferential dealers in the UK.

Credit Cards

Santander UK credit cards are issued through Santander Cards Limited. Prior to October 2010, Santander Cards Limited was a Banco Santander, S.A. subsidiary outside the Group and the Retail Banking division earned a commission from Santander Cards Limited on every credit card sold. In October 2010, Santander Cards Limited was acquired by the Group.

cahoot

cahoot is the Group’s separately branded, e-commerce retail banking and financial services provider.

General Insurance

The range of non-life insurance products distributed by Santander UK includes property (buildings and contents) and payment protection. Residential home insurance remains the primary type of policy offered and is sold through the branch network, the internet and over the telephone, as well as being sold by mortgage intermediaries, often at the time a mortgage is taken out.

Private Banking

Santander UK offers private banking and other specialist banking services in the UK, through Cater Allen and Abbey Sharedealing, and international banking through Abbey National International Limited and Alliance & Leicester International Limited. In August 2011, the international banking business previously offered through Bradford & Bingley International Limited was transferred to Alliance & Leicester International Limited, after which Bradford & Bingley International Limited changed its name to A&L Services Limited.

 

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Business Overview continued

 

Prior to 2010, Santander UK also offered other specialist banking services in the UK through James Hay. On 10 March 2010, Santander Private Banking UK Limited completed the disposal of James Hay Holdings Limited, together with its five subsidiary companies, by the sale of 100% of James Hay Holdings Limited’s shares to IFG UK Holdings Limited, a subsidiary of IFG Group plc, for a cash consideration of approximately £29m. The IFG Group provides independent financial advisory, fund management and pension administration services in Ireland, the UK and internationally.

On 17 December 2007, Santander UK sold 49% of its shareholding in Santander Private Banking UK Limited (consisting of James Hay, Cater Allen Limited and Abbey Stockbrokers Limited) to Santander PB UK (Holdings) Limited, a direct subsidiary of Banco Santander, S.A., for a total cash consideration of £203m. The companies affected were Cater Allen Limited, Abbey Stockbrokers Limited, James Hay Holdings Limited and their subsidiaries. Subsequently, on 29 October 2010, Santander UK plc acquired 100% of Santander PB UK (Holdings) Limited.

Asset Management

Retail Banking earns a commission on products sold through its agreement with another subsidiary of Banco Santander, S.A. outside of the Group, Santander Asset Management UK Limited.

Corporate Banking

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

Corporate Banking provides a range of banking services principally to UK companies, with a focus on services for SMEs, providing a broad range of banking products including loans, bank accounts, deposits, treasury services, invoice discounts, cash transmission and asset finance. Small businesses with a turnover of less than £250,000 are serviced through the Business Banking division, while a network of 28 regionally-based Corporate Business Centres offers services to businesses with a turnover of £250,000 to £150m. In addition, Corporate Banking includes specialist teams servicing Real Estate, Social Housing and UK infrastructure clients.

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

Legacy portfolios in run-off are also managed within Corporate Banking.

Markets

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

Group Infrastructure

Group Infrastructure consists of Asset and Liability Management (‘ALM’), which is responsible for the Group capital and funding, the Treasury asset portfolio and Investor Relations for the Group. ALM is responsible for managing the Group’s structural balance sheet composition and strategic and tactical liquidity risk management. This includes short-term and medium-term funding, covered bond and securitisation programmes. ALM’s responsibilities also include Santander UK’s banking product and structural exposure to interest rates. ALM recommends and helps to implement Board, Strategic Risk & Financial Management Committee, Asset and Liability Management Committee and Risk Committee (For further information, see the Risk Management Report) policies for all aspects of balance sheet management - formulating guidance for, and monitoring, the overall balance sheet shape, including maturity profile. It is also responsible for the return on the Group’s capital, reserves, preference shares and subordinated debt. The Treasury asset portfolio assets were acquired as part of the transfer of Alliance & Leicester plc to the Group in 2008 and as part of an alignment of portfolios across the Banco Santander, S.A. group in 2010. The Treasury asset portfolio is being run down. Furthermore, Group Infrastructure is responsible for managing the Investor Relations activities of the Group.

Santander UK plc, as guarantor, and its subsidiary Abbey National Treasury Services plc, as issuer, have a shelf registration statement on file with the US Securities and Exchange Commission in relation to issuances of SEC-registered debt securities. Additionally, as part of its prudent contingent funding arrangements, ALM ensures that Santander UK has access to the central bank facilities made available by the Bank of England, the Swiss National Bank, and the US Federal Reserve. Further information is set out in “Sources of Funding and Liquidity” in the Balance Sheet Business Review on page 57.

 

i 

Source: Analysis of published competitor data.

 

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Business and Financial Review

Business Review – Summary

The results discussed below are not necessarily indicative of Santander UK’s results in future periods. The following information contains certain forward-looking statements. See “Forward-looking Statements” on page 6. The following discussion is based on and should be read in conjunction with the Consolidated Financial Statements elsewhere in this Annual Report and Accounts.

EXECUTIVE SUMMARY

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

 

   

Business Review - Summary - this contains an explanation of the basis of our results and any potential changes to that basis in the future; a description of the critical factors affecting the results, a summarised consolidated income statement with commentary thereon by line item; and a summary of the nature of adjustments between the statutory basis of accounting (as described in Note 1 to the Consolidated Financial Statements) and our management basis of accounting (known as the “trading” basis and described in Note 2 to the Consolidated Financial Statements);

 

   

Key Performance Indicators - this contains a description of the key measures we use in assessing the success of the business against our strategies and objectives;

 

   

Divisional Results - this contains a supplementary summary of the results, and commentary thereon, for each segment;

 

   

Other Material Items - this contains information about the statutory to trading basis adjustments; and

 

   

Balance Sheet Business Review - this contains a description of our significant assets and liabilities and our strategy and reasons for entering into such transactions, including:

 

   

Summarised consolidated balance sheet - together with commentary on key movements, as well as analyses of the principal assets and liabilities;

 

   

Off-Balance Sheet disclosures - a summary of our off-balance sheet arrangements, their business purpose, and importance to us;

 

   

Capital disclosures - an analysis of our capital needs and composition; and

 

   

Liquidity disclosures - an analysis of our sources and uses of liquidity and cash flows.

Basis of results presentation

The information in this Business and Financial Review reflects the reporting structure in place at the reporting date in accordance with which the segmental information in Note 2 to the Consolidated Financial Statements has been presented. There were no changes to that basis in the year ended 31 December 2011 except that, as the Group moves towards becoming a full-service commercial bank, management wanted a fuller view in Corporate Banking of the results of the range of services offered to corporate customers; a view which management sees as increasingly valuable. As a result Santander Business Banking, which offers a range of banking services to small businesses in the UK, was managed and reported as part of Corporate Banking in 2011 rather than Retail Banking as in 2010. In addition, large multinationals were also managed and reported as part of Corporate Banking in 2011, rather than Global Banking & Markets as in 2010. As a result of the changes, Global Banking & Markets was renamed Markets.

Critical Factors Affecting Results

Critical accounting policies and areas of significant management judgement

The preparation of our Consolidated Financial Statements requires management to make estimates and judgements that affect the reported amount of assets and liabilities at the balance sheet date and the reported amount of income and expenses during the reporting period. Management evaluates its estimates and judgements on an ongoing basis. Management bases its estimates and judgements on historical experience and other factors believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Estimates and judgements that are considered important to the portrayal of our financial condition including, where applicable, quantification of the effects of reasonably possible ranges of such estimates are set out in “Critical Accounting Policies” in Note 1 to the Consolidated Financial Statements.

Financial instruments of special interest

Further information about financial instruments of special interest is set out in the Risk Management Report on page 135.

Profit on part sale and revaluation of subsidiaries

No profits arose on sales of Group undertakings in the year (2010: £39m, 2009: £nil). In 2010, a gain of £87m arose on the revaluation of the Group’s original holding in Santander Consumer (UK) plc on the Group’s acquisition of the remaining shares.

Significant acquisitions and disposals

The results were not materially affected by the acquisition of the Santander Cards and Santander Consumer businesses acquired in October and November 2010, respectively, as described in “Business Overview”.

Current and future accounting developments under IFRS

Details can be found in Note 1 to the Consolidated Financial Statements.

 

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Business Review – Summary continued

 

GROUP SUMMARY

SUMMARISED CONSOLIDATED INCOME STATEMENT AND SELECTED RATIOS

 

     2011
£m
    2010
£m
    2009
£m
 

Net interest income

     3,830        3,814        3,412   

Non-interest income

     1,355        1,220        1,284   
  

 

 

   

 

 

   

 

 

 

Total operating income

     5,185        5,034        4,696   
  

 

 

   

 

 

   

 

 

 

Administrative expenses

     (1,995     (1,793     (1,848

Depreciation, amortisation and impairment

     (447     (275     (260
  

 

 

   

 

 

   

 

 

 

Total operating expenses excluding provisions and charges

     (2,442     (2,068     (2,108
  

 

 

   

 

 

   

 

 

 

Impairment losses on loans and advances

     (565     (712     (842

Provisions for other liabilities and charges

     (917     (129     (56
  

 

 

   

 

 

   

 

 

 

Total operating provisions and charges

     (1,482     (841     (898
  

 

 

   

 

 

   

 

 

 

Profit before tax

     1,261        2,125        1,690   

Taxation charge

     (358     (542     (445
  

 

 

   

 

 

   

 

 

 

Profit for the year

     903        1,583        1,245   
  

 

 

   

 

 

   

 

 

 

Attributable to:

      

Equity holders of the parent

     903        1,544        1,190   

Non-controlling interest

     —          39        55   
  

 

 

   

 

 

   

 

 

 

Core Tier 1 capital ratio (%)

     11.4     11.5     6.8

Tier 1 capital ratio (%)

     14.7     14.8     9.5

Risk weighted assets

     77,455        73,563        67,438   
  

 

 

   

 

 

   

 

 

 

2011 compared to 2010

Profit before tax decreased by £864m to £1,261m (2010: £2,125m). In common with other UK banks, a provision for customer remediation of £751m before tax has been made, principally in relation to payment protection insurance. Notwithstanding this, Santander UK remained profitable in 2011, maintaining the strong track record of profitability and strengthening of the balance sheet. Profit before tax was also impacted by the full year effects of UK regulatory requirements to hold higher levels of liquid assets introduced in June 2010, higher funding costs and the low interest rate environment.

Material movements by line include:

 

   

Net interest income increased by £16m to £3,830m (2010: £3,814m). Net interest income increased by £397m as a result of the inclusion of the additional ten months in 2011 of net interest income of the Santander Cards, Santander Consumer and Santander Private Banking businesses (the ‘Perimeter companies’) that were acquired in October and November 2010, as described in Note 46 to the Consolidated Financial Statements.

The remaining decrease of £381m was largely due to the full year impact of the cost of higher liquid asset balances in response to UK regulatory requirements introduced in June 2010, higher cost of retail deposits and new wholesale medium-term funding, and the ongoing impact of a low interest rate environment. In addition, interest on overdraft accounts was lower with interest charges replaced by daily fees, which are accounted for as non-interest income. There was also a reduced contribution from the run-down Treasury asset portfolio. These decreases were partly offset by the favourable impact of improved lending margins and growth in customer loans. The improved lending margins were due to an increased proportion of customers reverting to standard variable rate mortgages in the current low interest rate environment, and improved margins on new business in both Retail Banking and Corporate Banking.

 

   

Non-interest income increased by £135m to £1,355m (2010: £1,220m). Of the total increase, £36m represented the inclusion of the Perimeter companies’ non-interest income for the full year in 2011.

The remaining increase of £99m was principally due to an increase in banking fees of £99m as a result of a new pricing structure for current accounts, replacing overdraft net interest income with daily fees. In addition, Corporate Banking non-interest income increased, generated by growing the loan markets and SME business, supported by the short-term markets business and interest rate related sales. Hedge ineffectiveness also resulted in gains in 2011 compared to losses reported in 2010. There were also lower losses on disposals of assets in the Treasury asset portfolio which is being run down.

These positive drivers were partially offset by the non-recurrence in 2011 of an £87m gain reported in 2010 arising on the revaluation of the Group’s original holding in Santander Consumer (UK) plc on the acquisition of the remaining shares by the Group, and profits of £39m on the sale of certain businesses, including James Hay, in 2010. In addition, investment fees were lower driven by a decline in the market for investment products, a shift in the mix of sales, and lower margins on structured investment products. The Markets business reported lower income largely due to reduced market activity.

 

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Business Review – Summary continued

 

   

Administrative expenses increased by £202m to £1,995m (2010: £1,793m). Of the total increase, £170m represented the inclusion of the Perimeter companies’ administrative expenses for the full year in 2011.

The remaining increase of £32m was largely due to investment in the business, offset by further efficiencies. In Retail Banking, the investment included increased headcount costs due to the recruitment of additional customer-facing staff relating to customer service initiatives, whilst in Corporate Banking, investment focused on extending the Corporate Business Centre network and product capability for customers. This increase was partly offset by a reduction in costs driven by further ongoing efficiency initiatives. In addition, the Corporate Banking legacy portfolios in run-off reported lower costs as a result of activity being reduced and disposals.

 

   

Depreciation, amortisation and impairment costs increased by £172m to £447m (2010: £275m). Of the total increase, £12m represented the inclusion of the Perimeter companies’ depreciation and amortisation costs for the full year in 2011. The remaining increase of £160m was largely due to the write-off of £112m of software assets as a result of a reduction in the related expected future economic benefits, and the write-off of Cater Allen Private Bank goodwill of £60m as a result of a reassessment of the value of certain parts of the business in light of recent market conditions and regulatory developments.

 

   

Impairment losses on loans and advances decreased by £147m to £565m (2010: £712m). Impairment losses on loans and advances increased by £132m as a result of the inclusion of the Perimeter companies’ impairment losses on loans and advances in 2011.

The remaining decrease of £279m was due to lower retail product charges due to largely stable arrears resulting from the continued low interest rate environment, a high quality mortgage book and effective collection handling, as well as the higher quality of business written on unsecured personal loans and a stable banking portfolio.

The decrease with respect to retail products was partially offset by higher impairment losses in the corporate portfolios primarily a result of increased stress in the legacy portfolios in run-off of shipping, structured finance and real estate, as well as other legacy commercial real estate exposures written before 2008, particularly within the care home and leisure industry sectors.

 

   

Provisions for other liabilities and charges increased by £788m to £917m (2010: £129m). Of the total increase, £11m represented the inclusion of the Perimeter companies’ provisions for other liabilities and charges for the full year in 2011.

The remaining increase of £777m primarily reflected a £751m charge for customer remediation principally in relation to payment protection insurance as described in Note 36 to the Consolidated Financial Statements and in “Shareholder Information - Risk Factors”. The increase also reflected the introduction of the UK Bank Levy of £48m and the inclusion here of Financial Services Compensation Scheme fees.

2010 compared to 2009

Profit before tax increased by £435m to £2,125m (2009: £1,690m). Material movements by line include:

 

   

Net interest income increased by £402m to £3,814m (2009: £3,412m). Of the total increase, £75m represented the inclusion of the net interest income of the Perimeter companies that were acquired in October and November 2010.

The remaining increase of £327m was largely driven by balanced growth in customer lending and deposits across a mix of products (especially SME lending). Customer assets increased by £12.0bn or 6% (of which £5.7bn or 3% reflected the inclusion of the Perimeter companies). Customer liabilities increased by £9.6bn or 7%.

These increases more than offset a higher cost of retail deposits, the impact of low interest rates, the cost of new term funding and higher liquid asset balances (the latter in response to regulatory requirements introduced in June 2010). There was also a decrease in net interest income from the James Hay business which was sold in March 2010 and a reduced contribution from the run-down Treasury asset portfolio in Group Infrastructure and legacy portfolios in run-off in Corporate Banking as balances in these portfolios continued to be actively reduced.

 

14    Santander UK plc 2011 Annual Report


Table of Contents

Business and Financial Review

Business Review – Summary continued

 

   

Non-interest income decreased by £64m to £1,220m (2009: £1,284m). Non-interest income increased by £8m as a result of the inclusion of the Perimeter companies’ non-interest income following their acquisition in 2010.

The remaining decrease of £72m was largely due to lower investment fees as a result of the mix of sales shifting away from structured investment products towards managed funds, reduced unsecured lending related fees (driven by lower volumes), lower mortgage fees (also adversely affected by lower redemption volumes in line with the market), lower banking fees (driven by the introduction of the Santander Zero account), and lower fees from legacy portfolios in run-off in Corporate Banking due to the continued reduction of balances in the portfolios. In addition, non-interest income was lower due to hedge ineffectiveness in 2010, the inclusion of certain one-off benefits in 2009 not repeated in 2010 (including profits earned on the buy-back of securitisation debt in 2009) and higher losses on disposals of assets in the Treasury asset portfolio which is being run down.

These reductions were partially offset by increased Markets income principally reflecting the strong development of underlying customer revenue streams and a number of non-recurring releases of fair value adjustments following the successful de-risking of underlying positions. In addition, non-interest income increased due to growth in the funding and liquidity management of the wholesale business, asset growth in the SME business and strong sales of Markets’ products. 2010 also reflected non-recurring gains including a profit of £87m on the revaluation of the Group’s original holding in Santander Consumer (UK) plc on the acquisition of the remaining shares by the Group, and the profit of £39m on the sale of certain businesses, including James Hay.

 

   

Administrative expenses decreased by £55m to £1,793m (2009: £1,848m). Administrative expenses increased by £35m as a result of the inclusion of the Perimeter companies’ administrative expenses following their acquisition in 2010.

The remaining decrease of £90m was largely due to the removal of duplication across back office and support functions due to the integration of Alliance & Leicester and the Bradford & Bingley savings business. Within this framework, synergy benefits realised were partly utilised to fund growth initiatives across the Group, including the ongoing recruitment in Retail Banking operations to support business growth and improve customer service. The decrease was partially offset by investment in the Corporate Business Centre network, including hiring additional staff and an increase of 70% in the floor space of the network. In addition, administration expenses increased, reflecting ongoing investment in growth initiatives related to new products, markets and customer segments, and significant headcount growth.

 

   

Depreciation, amortisation and impairment costs increased by £15m to £275m (2009: £260m). The increase resulted from the continued investment in IT systems in 2009 and 2010 including the integration of Alliance & Leicester and the Bradford and Bingley savings business. The increase was partly offset by lower operating lease depreciation due to lower balances in the Corporate Banking legacy portfolio in run-off following the continued de-leveraging process.

 

   

Impairment losses on loans and advances decreased by £130m to £712m (2009: £842m). Impairment losses on loans and advances increased by £33m as a result of the inclusion of the Perimeter companies’ impairment losses on loans and advances following their acquisition in 2010.

The remaining decrease of £163m was principally related to unsecured personal lending. This improving performance in difficult economic conditions was delivered as a result of significant improvement in the new business written since the last quarter of 2009, effective collection handling and higher than expected recoveries on written-off debt. Similarly, performance across the mortgage portfolio also improved in 2010. In addition, in 2010 losses and recoveries on disposals of assets in the Treasury asset portfolio offset each other whereas in 2009, there were overall losses on disposal.

These decreases were partially offset by higher Corporate Banking impairment losses on loans and advances reflecting growth and maturity in asset balances over the last two years and some deterioration arising from market conditions.

 

   

Provisions for other liabilities and charges increased by £73m to £129m (2009: £56m), principally reflecting ongoing restructuring costs in relation to the integration of the Alliance & Leicester business, and customer remediation administration costs and payments in respect of settlement of certain claims.

 

Santander UK plc 2011 Annual Report    15


Table of Contents

Business and Financial Review

Business Review – Summary continued

 

Taxation

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

 

     2011
£m
    2010
£m
    2009
£m
 

Profit before tax

     1,261        2,125        1,690   
  

 

 

   

 

 

   

 

 

 

Tax calculated at a tax rate of 26.5% (2010: 28%, 2009: 28%)

     334        595        473   

Non taxable gain on sale of subsidiary undertakings

     —          (11     (5

Non deductible preference dividends paid

     8        8        8   

Non taxable gain on revaluation of investment in Santander Consumer (UK) plc

     —          (24     —     

Non deductible UK Bank Levy

     13        —          —     

Other non-equalised items

     (4     —          51   

Non-taxable dividend income

     —          —          (4

Effect of non-UK profits and losses

     (7     (6     (8

Utilisation of capital losses for which credit not previously recognised

     —          —          (3

Effect of change in tax rate on deferred tax provision

     21        11        —     

Adjustment to prior year provisions

     (7     (31     (67
  

 

 

   

 

 

   

 

 

 

Tax expense

     358        542        445   
  

 

 

   

 

 

   

 

 

 

Effective tax rate

     28.4     25.5     26.3
  

 

 

   

 

 

   

 

 

 

2011 compared to 2010

The effective tax rate for 2011, based on profit before tax was 28.4% (2010: 25.5%). The effective tax rate differed from the UK corporation tax rate of 26.5% (2010: 28%) principally because of the reduction in the deferred tax asset as a result of the change in the UK corporation tax rate and the impact of the non-deductible UK Bank Levy.

2010 compared to 2009

The effective tax rate for 2010, based on profit before tax was 25.5% (2009: 26.3%). The effective tax rate differed from the UK corporation tax rate of 28% (2009: 28%) principally because of the non-taxable profit of £87m that arose on the revaluation of the Group’s original holding in Santander Consumer (UK) plc on the acquisition of the remaining shares by the Group, adjustment to prior year provisions, non-taxable gains on sales of subsidiary undertakings, and the reduction in deferred tax asset as a result of the change in the UK corporation tax rate.

CAPITAL

Discussion and analysis of the Core Tier 1 capital ratio, the Tier 1 capital ratio and risk-weighted assets is set out in the “Balance Sheet Business Review – Capital management and resources” on pages 54 to 56.

ADJUSTMENTS BETWEEN THE STATUTORY BASIS AND THE TRADING BASIS

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

The nature of the adjustments is described in Note 2 to the Consolidated Financial Statements. For a detailed explanation of movements in the adjustments, see “Other Material Items” in the Business and Financial Review.

Note 2 to the Consolidated Financial Statements provides a reconciliation of the segment measures to the consolidated totals and totals the income statement line items for individual segments as part of the reconciliation required under IFRS 8, such as trading profit before tax. These total segment measures are also presented and discussed as part of the supplementary summary of the results in the “Business Review – Divisional results” section that follows. Outside the reconciliation required by IFRS 8 in Note 2 to the Consolidated Financial Statements, these totals are non-GAAP financial measures. A body of generally accepted accounting principles such as IFRS is commonly referred to as ‘GAAP’. A non-GAAP financial measure is defined as one that measures historical or future financial performance, financial position or cash flows but which excludes or includes amounts that would not be so adjusted in the most comparable GAAP measures. These non-GAAP financial measures are not a substitute for GAAP measures, for which management has responsibility.

 

16    Santander UK plc 2011 Annual Report


Table of Contents

Business and Financial Review

Business Review – Key Performance Indicators

During 2011, the strategic objectives and key performance indicators for the Group for the medium term were set. The information below reflects the Group’s performance as measured by those key performance indicators for the years ended, and at, 31 December 2011, 2010 and 2009. This information describes the key measures used by management in assessing the success of the business against its strategies and objectives.

The management objectives set forth below are subject to significant change and uncertainties including as described in “Shareholder Information - Risk Factors” and may not be achieved. In particular, macro-economic factors such as UK unemployment and property values, and regulatory changes are outside of management’s control, and could prevent achievement of these objectives.

 

Key performance indicator

   Note      2011     2010     2009  

Trading income

     1       £ 5,045m      £ 5,293m      £ 4,658m   

Trading cost:income ratio

     2         44     41     42

Commercial Banking margin

     3         1.85     2.06     1.76

Non performing loans ratio

     4         1.93     1.84     1.90

Profit for the year

     5       £ 903m      £ 1,583m      £ 1,245m   

Return on average tangible common equity

     6         16     23     29

Core Tier 1 ratio

     7         11.4     11.5     6.8

Loan to deposit ratio

     8         138     132     132

Total number of employees

     9         21,371        19,978        19,483   

 

1.

Trading income

Trading income comprises net interest income and non-interest income of Santander UK’s businesses on a trading basis. Discussion and analysis of this data is set out in the “Business Review – Divisional results” on pages 19 to 29.

Management reviews trading income in order to assess the Group’s effectiveness in obtaining and retaining customers and business. Management’s target was historically for growth of between 5% and 10% per annum, albeit with weaker performance in 2011, as noted at the half-year. Trading revenue declined by 5% in 2011 compared to 2010. Performance was adversely impacted by the full year effect of the cost of higher liquid asset balances as a result of UK regulatory requirements introduced in June 2010, the higher cost of funding and the prolonged low interest rate environment. These impacts are expected to increase in future periods resulting in continued downward pressure on revenues. Management monitors trading income, although no specific target range has been set for future periods.

 

2.

Trading cost:income ratio

Trading cost:income ratio is defined as total trading expenses divided by total trading income. Discussion and analysis of trading income and expenses for each business division is set out in the “Business Review – Divisional results” on pages 19 to 29.

Management reviews the trading cost:income ratio in order to measure the operating efficiency of the Group. In 2011 the trading cost:income ratio increased to 44% from 41%, largely reflecting pressure on revenues (as noted above) and investment in Retail Banking and Corporate Banking. Despite this deterioration, we believe that this ratio continues to compare well to other UK banks. Due to continued revenue pressures, the ratio is expected to rise to over 50%, before trending downwards in the medium term. Management actions on the cost base are expected to partly mitigate pressure on revenues.

 

3.

Commercial Banking margin

Commercial Banking margin is defined as the trading net interest income (adjusted to remove net interest income from the Treasury asset portfolio) divided by average commercial assets (mortgages, unsecured personal loans, corporate loans and overdrafts). Discussion and analysis of this data is set out in the “Business Review – Divisional results” on pages 19 to 29.

Management reviews the Commercial Banking margin in order to assess the economic sustainability of its commercial banking products and operations. Management’s target is to ensure that the Commercial Banking margin is appropriate for the current market conditions and profit targets. The Commercial Banking margin of 1.85% in 2011 was 21 basis points lower year on year, negatively impacted by the increased cost of holding higher liquid asset balances as a result of UK regulatory requirements introduced in June 2010 and higher costs of term funding and customer deposits, as well as the ongoing impact of base rates remaining low. The expectation is for further downward pressure in 2012.

 

4.

Non-performing loans (‘NPL’) ratio

NPL ratio is defined as non-performing loans as a percentage of customer assets. Loans and advances are classified as non-performing typically when the counterparty fails to make payments when contractually due for three months or longer. However, accrued interest is excluded for the purposes of this analysis.

Management reviews the NPL ratio in order to assess the credit quality of commercial lending. Management’s target is to ensure that the NPL ratio is better than the market average. In 2011, the NPL ratio increased to 1.93% (2010: 1.84%). The increase in the NPL ratio was due to an increase in NPLs as a result of further stress in the legacy portfolios of shipping, structured finance and real estate, as well as other legacy commercial real estate exposures written before 2008, and residential mortgages, where a technical definition change resulted in more cases being classified as NPLs. Before this change, the NPL ratio was broadly in stable. In the current economic environment, the expectation is for deterioration in the NPL ratio in 2012, whilst continuing to reflect the quality of the lending portfolio.

 

Santander UK plc 2011 Annual Report    17


Table of Contents

Business and Financial Review

Business Review – Key Performance Indicators continued

 

5.

Profit for the year

Profit for the year is the statutory consolidated profit after tax for the year. Discussion and analysis of this data is set out in the Group Summary in the “Business Review – Summary” on pages 12 to 16.

Management reviews the profit for the year in order to monitor the effectiveness of the Group’s strategy and ability to increase the strength of its capital base and its capacity to pay dividends. Management’s target was to achieve sustained growth over the previous year. Profit for the year of £903m in 2011 was £680m lower than in 2010 mainly due to a provision charge for customer remediation, principally payment protection insurance, of £751m (£553m post tax). Despite this charge, Santander UK still reported a positive statutory profit after tax in 2011, albeit lower than in the prior year. Santander UK continues to operate a robust, low-risk business, delivering strong recurring earnings through the financial crisis. The expectation is for lower profit in 2012 due to the revenue pressures outlined above.

 

6.

Return on average tangible common equity (‘ROTE’)

ROTE is defined as the trading profit after taxation divided by average tangible common equity (average shareholders’ equity less preference shares and goodwill).

Management reviews ROTE in order to measure the overall profitability of the Group. In 2011, ROTE declined to 16% from 23%, but compared favourably to other UK banks. The decline was largely driven by lower trading profit after taxation (which is discussed in the “Business Review – Divisional results” on pages 19 to 29).

Further information about the calculation of ROTE is contained in “Selected Financial Data” on page 277.

 

7.

Core Tier 1 ratio

Core Tier 1 ratio is defined by the UK Financial Services Authority as tangible shareholders’ funds less certain capital deductions, divided by risk weighted assets. Further discussion and analysis is set out in “Capital Management and Resources” on pages 54 to 56 of the Balance Sheet Business Review.

Management reviews the Core Tier 1 ratio to ensure the Group maintains sufficient capital resources to: ensure the Group is well capitalised relative to the minimum regulatory capital requirements set by the UK Financial Services Authority; ensure locally regulated subsidiaries can meet their minimum regulatory capital requirements; support the Group’s risk appetite and economic capital requirements; and support the Group’s credit rating. During 2011, the Group’s Core Tier 1 ratio remained strong at over 11%.

 

8.

Loan-to-deposit ratio

The loan-to-deposit ratio represents the book value of the Group’s customer assets (i.e. retail and corporate assets) divided by its customer liabilities (i.e. retail and corporate deposits). The ratio is measured at the year end. The methodology has been refined for all periods presented. Discussion and analysis of the loan-to-deposit ratio is set out in the Chief Executive’s Review on page 3.

Management reviews the loan-to-deposit ratio in order to assess the Group’s ability to fund its commercial operations with commercial borrowings, reducing reliance on sourcing funding from the short and medium-term wholesale markets while improving customer product holdings. During 2011, the loan-to-deposit ratio increased by six percentage points to 138%, largely due to the managed outflow of rate-sensitive deposits in the second half of 2011 given unattractive pricing in the market. Medium-term funding issuance of £25bn strengthened the balance sheet position, offsetting the deposit outflow while protecting profitability. During 2010, commercial net lending growth was matched by the increase in net deposit flows, resulting in a flat loan-to-deposit ratio of 132%. Management’s target is sustained improvements in the loan-to-deposit ratio in future years subject to competitive conditions.

 

9.

Total number of employees

Total number of employees is measured at the year-end and calculated on a full-time equivalent basis. Further information about employees on a segmental basis is contained in Note 2 to the Consolidated Financial Statements.

Management reviews the total number of employees in order to support the continuing overall control of the Group’s cost base and the trading cost:income ratio. Management’s targets for the total number of employees are to ensure that staffing levels are optimal for the nature and size of the Group’s business. In 2011, headcount increased by 1,393 full-time equivalents, principally as a result of continued investment in Retail Banking operations, in branches and in call centres, to support business growth and improve customer service. This included the transfer of Retail call centre operations from India back to the United Kingdom. In 2010, headcount increased by 495 full-time equivalents, principally as a result of investment in Retail Banking operations to support business growth and improve customer service, together with the acquisition of the Perimeter companies in October and November 2010. This growth was partially offset by further headcount reductions from removing duplicated back office and support functions following the transfer of Alliance & Leicester plc and the acquisition of the Bradford & Bingley savings business, and the sale of James Hay in 2010.

 

18    Santander UK plc 2011 Annual Report


Table of Contents

Business and Financial Review

Business Review – Divisional Results

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

TRADING PROFIT BEFORE TAX BY SEGMENT

 

31 December 2011

   Retail
Banking
£m
    Corporate
Banking

£m
    Markets
£m
    Group
Infrastructure

£m
    Total
£m
 

Net interest income/(expense)

     3,399        427        (3     (51     3,772   

Non-interest income/(expense)

     753        411        162        (53     1,273   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total trading income/(expense)

     4,152        838        159        (104     5,045   

Total trading expenses

     (1,788     (262     (111     (50     (2,211

Impairment losses on loans and advances

     (339     (226     —          —          (565

Provisions for other liabilities and charges

     —          (3     (3     (151     (157
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Trading profit/(loss) before tax

     2,025        347        45        (305     2,112   

Adjust for:

          

- Reorganisation, customer remediation and other costs

     (937     —          —          —          (937

- Hedging and other variances

     (31     —          —          117        86   

- Capital and other charges

     (141     (35     —          176        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit/(loss) before tax

     916        312        45        (12     1,261   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

31 December 2010

   Retail
Banking
£m
    Corporate
Banking

£m
    Markets
£m
    Group
Infrastructure

£m
    Total
£m
 

Net interest income

     3,494        357        —          302        4,153   

Non-interest income/(expense)

     652        347        221        (80     1,140   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total trading income

     4,146        704        221        222        5,293   

Total trading expenses

     (1,790     (257     (76     (48     (2,171

Impairment losses on loans and advances

     (703     (168     —          (40     (911
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Trading profit before tax

     1,653        279        145        134        2,211   

Adjust for:

          

- Perimeter companies pre-acq.n trading basis results

     (95     —          —          25        (70

- Reorganisation, customer remediation and other costs

     (155     —          —          40        (115

- Profit on part sale and revaluation of subsidiaries

     —          —          —          126        126   

- Hedging and other variances

     (31     —          —          4        (27

- Capital and other charges

     (81     (32     —          113        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit before tax

     1,291        247        145        442        2,125   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

31 December 2009

   Retail
Banking
£m
    Corporate
Banking

£m
    Markets
£m
    Group
Infrastructure

£m
    Total
£m
 

Net interest income

     2,746        359        —          236        3,341   

Non-interest income

     694        332        204        87        1,317   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total trading income

     3,440        691        204        323        4,658   

Total trading expenses

     (1,554     (284     (60     (46     (1,944

Impairment losses on loans and advances

     (672     (73     —          (57     (802
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Trading profit before tax

     1,214        334        144        220        1,912   

Adjust for:

          

- Reorganisation, customer remediation and other costs

     (146     —          —          (40     (186

- Hedging and other variances

     (17     —          —          (19     (36

- Capital and other charges

     (47     (34     —          81        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Profit before tax

     1,004        300        144        242        1,690   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Santander UK plc 2011 Annual Report    19


Table of Contents

Business and Financial Review

Business Review – Divisional Results continued

 

BUSINESS VOLUMES

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

 

     2011     2010     2009  

Mortgages:(1)

      

Gross mortgage lending in the year(2)

   £ 23.7bn      £ 24.2bn      £ 26.4bn   

Capital repayments in the year

   £ 22.6bn      £ 18.6bn      £ 18.8bn   
  

 

 

   

 

 

   

 

 

 

Net mortgage lending in the year

   £ 1.1bn      £ 5.6bn      £ 7.6bn   
  

 

 

   

 

 

   

 

 

 

Mortgage stock balance

   £ 173.5bn      £ 172.4bn      £ 166.9bn   

Market share – gross mortgage lending(3)

     17.3     18.0     18.4

Market share – capital repayments(3)

     17.5     14.6     14.3

Market share – mortgage stock balance(3)

     13.9     13.9     13.5

Unsecured personal lending:

      

Total gross unsecured personal lending in the year

   £ 1.5bn      £ 1.3bn      £ 1.5bn   

Total unsecured personal lending stock(4)

   £ 2.9bn      £ 3.3bn      £ 4.2bn   

Market share – unsecured personal lending stock

     7.3     7.4     7.3

SME lending:

      

SME lending stock balance

   £ 10.7bn      £ 8.6bn      £ 6.8bn   

Market share – SME lending stock balance(5)

     4.3     3.6     2.7

Customer Assets:

      

Total commercial asset stock

   £ 206.3bn      £ 202.1bn      £ 190.1bn   

Customer Deposits:

      

Commercial net deposit flows in the year

   £ (4.3 )bn    £ 9.6bn      £ 14.9bn   

Total commercial liability stock

   £ 149.2bn      £ 153.5bn      £ 143.9bn   

Investment and pensions annual premium income(6)

   £ 2.8bn      £ 3.5bn      £ 3.5bn   

Banking:

      

Bank account openings (000’s)

     836        1,005        1,093   

Market share – bank account stock balance(7)

     9.1     9.2     8.9

Credit card sales (000’s)(8)

     543        435        387   

 

(1)

Includes Social Housing loans.

(2)

Gross mortgage lending in the year comprises only new loan contracts and does not include loan modifications.

(3)

Estimated by the Group for each year having regard to individual lending data published by the Bank of England for the first eleven months of each year.

(4)

Excludes overdrafts and credit cards.

(5)

Market share of SME lending stock determined on an asset basis of SME businesses with turnover of up to £150m, is estimated by the Group for each year having regard to corporate lending data published by the Bank of England for the first eleven months of each year.

(6)

Annualised equivalent of monthly premiums generated from new business during the year.

(7)

Market share of bank account stock is estimated by the Group for each year having regard to market research published by CACI Ltd.

(8)

Santander-branded cards only.

Mortgages

2011 compared to 2010

Gross mortgage lending in 2011 was £23.7bn, representing an estimated market share of 17.3%. During 2011, focus remained on the quality of new lending, based on affordability and lower loan-to-value (‘LTV’) segments. The average LTV on new business completions in 2011 was 64% compared to 62% in 2010.

Capital repayments of £22.6bn were higher than in 2010, with an estimated market share of repayments of 17.5%. This performance reflected a significant increase in maturing assets, reflecting gross lending two years previously and was against a market backdrop of continued heightened competition in low LTV segments. Net mortgage lending of £1.1bn was lower (2010: £5.6bn), largely reflecting a weaker performance in the first half of 2011 stemming from a lower pipeline in the last quarter of 2010 when market pricing became less attractive in the lower LTV segments.

2010 compared to 2009

Gross mortgage lending in 2010 was £24.2bn, representing an estimated market share of 18%. The average LTV on new business completions in 2010 was 62% compared to 61% in 2009.

Capital repayments of £18.6bn were broadly in line with 2009, with an estimated market share of capital repayments of 14.6%. This performance reflected a market backdrop of continued heightened competition in low LTV segments, offset by effective retention strategies in key segments. Net mortgage lending of £5.6bn was lower (2009: £7.6bn).

 

20    Santander UK plc 2011 Annual Report


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Business and Financial Review

Business Review – Divisional Results continued

 

Unsecured Personal Lending

2011 compared to 2010

The unsecured personal lending (‘UPL’) stock balance decreased by 13% to £2.9bn at 31 December 2011. Despite this overall deleveraging, UPL gross lending was up 14% and £1.5bn of new loans were issued at good risk-adjusted margins to high quality customer segments.

2010 compared to 2009

Total gross UPL lending decreased by 15% to £1.3bn at 31 December 2010 as a result of our ongoing focus of restricting unsecured lending to high quality customer segments. The deleveraging of the UPL portfolio resulted in a 22% reduction in the stock balance to £3.3bn.

SME Lending

2011 compared to 2010

SME lending balances were higher than at the end of 2010 as a result of a strong performance via our 28 Corporate Business Centres. Lending stock balances totalled £10.7bn at 31 December 2011, up 25% in the year equating to an estimated 4.3% market share. SME lending commitments to the UK Government under our share of the Project Merlin agreement were exceeded.

2010 compared to 2009

SME lending issued through the Corporate Business Centres (25 by the year-end) was higher than 2009. SME lending balances were £8.5bn, up more than 26% in the year, equating to a 3.6% market share.

Deposits and Investments

2011 compared to 2010

Customer deposit flows were £(4.3)bn. In 2011, the acquisition of deposits slowed in what was a smaller market and where increased competition led to unattractive pricing and negative margins. A managed outflow of these more rate sensitive and shorter term deposits was more than offset through the issuance of additional medium-term wholesale funding. Investments and pensions performance was down 21% largely reflecting market conditions.

2010 compared to 2009

Net deposit inflows of £9.6bn were achieved through a strong performance across all business units. Retail Banking delivered strong inflows, in increasingly competitive market conditions, including a 22% increase in private banking deposits and a 7% increase in bank account liabilities. Corporate Banking net inflows were lower than in 2009, though still positive despite a difficult economic environment, and benefitted from longer term deposits being taken and an improvement in customer mix.

Banking

2011 compared to 2010

Approximately 836,000 bank accounts were opened in 2011, building on the success of the last two years where more than 2 million accounts were opened. The focus in 2011 was on improving the proportion of new bank accounts that represent the customer’s primary account, leading to an improvement in overall primacy. The decline in bank account balances reflected pressures on “real” income in the UK, with inflation running ahead of earnings growth.

2010 compared to 2009

More than 1 million bank accounts were opened in each of 2010 and 2009. Strong Retail Banking personal bank account balance growth of approximately 9% was a result of not only the larger stock of accounts but also a focus on increasing the quality of account openings and more primary account customers.

Credit Card sales

2011 compared to 2010

Credit card sales through the Santander brand of approximately 543,000 cards grew by 25% with a continued focus on existing customers, and benefitting from approximately 145,000 new “123” credit cards which have been opened since the product’s launch in the latter part of the year.

2010 compared to 2009

Credit card sales through the Santander brand were 12% higher than in 2009, driven by a strong performance in the telephone and internet channels, and the success achieved with the Zero credit card.

 

Santander UK plc 2011 Annual Report    21


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Business and Financial Review

Business Review – Divisional Results continued

 

RETAIL BANKING

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

 

     2011
£m
    2010
£m
    2009
£m
 

Trading net interest income

     3,399        3,494        2,746   

Trading non-interest income

     753        652        694   
  

 

 

   

 

 

   

 

 

 

Total trading income

     4,152        4,146        3,440   

Total trading expenses

     (1,788     (1,790     (1,554

Trading impairment losses on loans and advances

     (339     (703     (672
  

 

 

   

 

 

   

 

 

 

Trading profit before tax

     2,025        1,653        1,214   

Adjust for:

      

- Perimeter companies pre-acquisition trading basis results

     —          (95     —     

- Reorganisation, customer remediation and other costs

     (937     (155     (146

- Hedging and other variances

     (31     (31     (17

- Capital and other charges

     (141     (81     (47
  

 

 

   

 

 

   

 

 

 

Statutory profit before tax

     916        1,291        1,004   
  

 

 

   

 

 

   

 

 

 

Segment balances

   2011
£bn
    2010
£bn
    2009
£bn
 

Customer assets

     175.4        175.4        165.4   

Risk weighted assets

     40.1        38.1        32.6   

Customer deposits

     120.1        125.7        119.4   

Mortgage NPLs ratio(1)(2)

     1.46     1.41     1.52

Mortgage coverage ratio(1)(3)

     20     22     20
  

 

 

   

 

 

   

 

 

 

 

(1)

Accrued interest is excluded for purposes of these analyses.

(2)

Mortgage NPLs as a percentage of mortgage assets.

(3)

Mortgage impairment loss allowances as a percentage of mortgage NPLs.

Retail Banking trading profit before tax

2011 compared to 2010

Trading profit before tax increased by £372m to £2,025m (2010: £1,653m). By income statement line, the movements were:

 

   

Trading net interest income decreased by £95m to £3,399m (2010: £3,494m). The key drivers of the decrease in net interest income were the higher cost of retail deposits, the ongoing impact of a low interest rate environment and the higher cost of new term funding applied to the business. In addition, interest on overdraft accounts was lower with interest charges replaced by daily fees, which are accounted for as non-interest income. These decreases were partly offset by the favourable impact of improved lending margins as more customers reverted to standard variable rate mortgages in the current low interest rate environment, and improved margins on new business in both the mortgage and unsecured loan portfolios.

 

   

Trading non-interest income increased by £101m to £753m (2010: £652m), principally due to an increase in banking fees of £99m as a result of a new pricing structure for current accounts, replacing overdraft net interest income with daily fees. This was partially offset by lower investment fees driven by a decline in the market and the mix of sales shifting away from structured investment products towards managed funds (which will yield a trail income in future periods rather than an upfront commission), and lower margins on structured investment products.

 

   

Trading expenses decreased by £2m to £1,788m (2010: £1,790m). The decrease reflected reduced costs driven by further efficiencies largely offset by increased headcount costs due to the recruitment of additional customer-facing staff relating to customer service initiatives, including an additional 1,100 full time employees.

 

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Business Review – Divisional Results continued

 

   

Trading impairment losses on loans and advances decreased by £364m to £339m (2010: £703m), with the most significant reduction relating to mortgages and unsecured loans. The lower mortgage charge resulted from largely stable arrears due to the continued low interest rate environment, a high quality mortgage book and effective collection handling. Similarly, performance across the unsecured portfolios improved in the year due to the higher quality of business written on unsecured personal loans over the last two years, and a stable banking portfolio.

Secured coverage remained conservative at 20%, whilst the stock of properties in possession (‘PIP’) increased to 965 cases from 873 at 31 December 2010. This level of PIP still only represented 0.06% of the book and remained well below the industry average. The mortgage non-performing loan ratio increased slightly to 1.46% from 1.41% at 31 December 2010.

2010 compared to 2009

Trading profit before tax increased by £439m to £1,653m (2009: £1,214m). Of the total increase, £109m represented the inclusion of the Perimeter companies trading profit before tax in 2010. By income statement line, the movements were:

 

   

Trading net interest income increased by £748m to £3,494m (2009: £2,746m). Of the total increase, £471m represented the inclusion of the Perimeter companies’ full-year trading net interest income in 2010. The remaining increase of £277m was largely driven by balanced growth in customer lending and deposits across a mix of products. Customer assets increased by £10.0bn or 6% (of which £5.7bn or 3% reflected the inclusion of the Perimeter companies). Customer liabilities increased by £6.3bn or 5%.

The key drivers of the increase in trading net interest income were improved margins on existing mortgage balances as more customers reverted to standard variable rate mortgages in the current low interest rate environment, and improved margins on new and retained business in both the mortgage and unsecured loan portfolios. These increases more than offset a higher cost of retail deposits, the impact of low interest rates, the cost of new term funding and higher liquid asset balances (the latter in response to UK regulatory requirements introduced in June 2010).

 

   

Trading non-interest income decreased by £42m to £652m (2009: £694m). Trading non-interest income increased by £60m as a result of the inclusion of the Perimeter companies’ full year trading non-interest income in 2010. However, this was more than offset by a decrease of £102m which was largely due to lower investment fees as a result of the mix of sales shifting away from structured investment products towards managed funds (which will yield a trail income in future periods rather than an upfront commission). In addition, unsecured lending-related fees reduced, driven by lower volumes (which decreased by 20%). Mortgage fees were also adversely affected by lower redemption volumes in line with the market and banking fees were affected by the introduction of the Santander Zero account.

 

   

Trading expenses increased by £236m to £1,790m (2009: £1,554m). Of the total increase, £230m represented the inclusion of the Perimeter companies’ trading expenses in 2010. Furthermore, depreciation and amortisation increased by £32m as a result of the continued investment in IT systems in 2009 and 2010, including the integration of Alliance & Leicester and the Bradford & Bingley savings business. The removal of duplication across back office and support functions due to the integration of Alliance & Leicester and the Bradford & Bingley savings business has resulted in further cost savings. Within this framework, the synergy benefits realised were partly utilised to fund growth initiatives across the Group, including the ongoing recruitment in Retail Banking operations to support business growth and improve customer service.

 

   

Trading impairment losses on loans and advances increased by £31m to £703m (2009: £672m). Trading impairment losses on loans and advances increased by £192m as a result of the inclusion of the Perimeter companies’ trading impairment losses on loans and advances in 2010. This increase was partially offset by decreases in the core retail portfolio. Of the remaining decrease, the most significant reduction related to unsecured personal lending. This improving performance in difficult economic conditions was delivered as a result of significant improvement in the new business written since the last quarter of 2009, effective collection handling and higher than expected recoveries on written-off debt. Similarly, performance across the mortgage portfolio also improved in 2010.

 

Santander UK plc 2011 Annual Report    23


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Business and Financial Review

Business Review – Divisional Results continued

 

Retail Banking segment balances

2011 compared to 2010

 

   

Customer assets of £175.4bn remained flat year on year largely reflecting modest mortgage book growth, offset by the continued reduction in unsecured personal lending (‘UPL’) balances, which decreased by 13%.

 

   

Risk weighted assets increased by 5% to £40.1bn (2010: £38.1bn). Although the total portfolio remained largely unchanged, the mix of business moved from old legacy internal risk models (with lower risk weightings) to newer higher risk weighted models.

 

   

Customer deposits decreased by 5% to £120.1bn (2010: £125.7bn). This decrease was due to lower acquisition of deposits in 2011 driven by a smaller market in the UK combined with increased competition which led to unattractive pricing and negative margins in the market relative to medium-term wholesale funding.

 

   

The mortgage NPL ratio increased slightly to 1.46% (2010: 1.41%). However, the underlying performance remained stable, with the overall increase due to a change in NPL definition resulting in more cases classified as NPLs. Excluding the impact of the change in NPL definition, which is discussed in the Risk Management Report, the mortgage NPL ratio would have been 1.39%, reflecting stable underlying performance. The mortgage NPL ratio of 1.46% remained considerably below the UK industry average based on Council of Mortgage Lenders (‘CML’) published data. The mortgage non-performing loan and advances performance reflects the high quality of the mortgage book, a lower than anticipated increase in unemployment and prolonged low interest rates.

 

   

The mortgage coverage ratio remained strong at 20% (2010: 22%) as a result of stable non-performing loans.

2010 compared to 2009

 

   

Customer assets increased by 6% to £175.4bn (2009: £165.4bn) reflecting the growth in mortgage balances and acquired businesses. Of the increase, £5.7bn, or 3%, related to the companies acquired in 2010. The remaining growth was driven by mortgages (balances up 3%) underpinned by strong gross mortgage lending and success in retention activities. Partly offsetting this growth was the continued reduction in UPL balances, which decreased by 22%.

 

   

Risk weighted assets increased by 17% to £38.1bn (2009: £32.6bn). Excluding the impact of acquisitions, risk weighted assets were broadly flat.

 

   

Customer deposits increased by 5% to £125.7bn (2009: £119.4bn), a strong performance given the increasingly competitive market, reflecting a successful ISA season and bank account growth.

 

   

The mortgage NPL ratio decreased to 1.41% (2009: 1.52%) despite the growth in the mortgage asset, as a result of effective collection processes, the high quality of the mortgage portfolio, stable unemployment and persistently low interest rates. The mortgage NPL ratio of 1.41% remained considerably below the industry average.

 

   

The mortgage coverage ratio increased to 22% (2009: 20%) as a result of decline in mortgage non-performing loans and advances.

 

24    Santander UK plc 2011 Annual Report


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Business and Financial Review

Business Review – Divisional Results continued

 

CORPORATE BANKING

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

Corporate Banking provides a range of banking services principally to UK companies, with a focus on services for SMEs, providing a broad range of banking products including loans, bank accounts, deposits, treasury services, invoice discounts, cash transmission and asset finance. Small businesses with a turnover of less than £250,000 are serviced through the Business Banking division, while a network of 28 regionally-based Corporate Business Centres offers services to businesses with a turnover of £250,000 to £150m. In addition, Corporate Banking includes specialist teams servicing Real Estate, Social Housing and UK infrastructure clients.

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

Legacy portfolios in run-off are also managed within Corporate Banking.

 

     2011
£m
    2010
£m
    2009
£m
 

Trading net interest income

     427        357        359   

Trading non-interest income

     411        347        332   
  

 

 

   

 

 

   

 

 

 

Total trading income

     838        704        691   

Total trading expenses

     (262     (257     (284

Trading impairment losses on loans and advances

     (226     (168     (73

Provision for other liabilities and charges

     (3     —          —     
  

 

 

   

 

 

   

 

 

 

Trading profit before tax

     347        279        334   

Adjust for:

      

- Capital and other charges

     (35     (32     (34
  

 

 

   

 

 

   

 

 

 

Statutory profit before tax

     312        247        300   
  

 

 

   

 

 

   

 

 

 

Segment balances

   2011
£bn
    2010
£bn
    2009
£bn
 

Total customer assets

     30.9        26.7        24.6   

Core customer assets(1)

     27.7        23.2        20.1   

Risk weighted assets

     24.9        23.1        19.1   

Customer deposits

     29.1        27.8        24.5   

Total SMEs

     10.7        8.6        6.8   

 

(1)

Excludes legacy portfolios in run-off

Corporate Banking trading profit before tax

2011 compared to 2010

Trading profit before tax increased by £68m to £347m (2010: £279m). By income statement line, the movements were:

 

   

Trading net interest income increased by £70m to £427m (2010: £357m). Net interest income increased as a result of growth in customer loans and deposits, with much of this growth generated through our network of 28 Corporate Business Centres which serve clients in the UK SME market (SME lending balances increased by 25% and total deposit balances increased by 5% compared to 31 December 2010). Interest margins on loans continued to improve as market pricing better reflected incremental higher funding and liquidity costs.

 

   

Trading non-interest income increased by £64m to £411m (2010: £347m), generated by growing the loan markets and SME business, supported by the short-term markets business and interest rate related sales. In addition, underlying volume growth in core businesses, particularly new business activity in relation to SMEs, resulted in increased income from the sale of ancillary products such as treasury services, banking and cash transmission services, invoice discounting and asset finance.

 

   

Trading expenses increased by £5m to £262m (2010: £257m). The increase reflected investment focused on extending the Corporate Business Centre network and product capability for customers, partially offset by reductions in costs related to the legacy portfolios in run-off as a result of activity being reduced, and disposals.

 

Santander UK plc 2011 Annual Report    25


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Business and Financial Review

Business Review – Divisional Results continued

 

   

Trading impairment losses on loans and advances increased by £58m to £226m (2010: £168m). The increase was primarily a result of increased stress in the legacy portfolios in run-off of shipping, structured finance and real estate, as well as other legacy commercial real estate exposures written before 2008, particularly within the care home and leisure industry sectors. Restructuring options generally became more difficult against a backdrop of weakening markets and reducing commercial property prices, giving rise to higher losses. The credit quality of business written in the past two years remains very strong.

 

   

Trading provisions for other liabilities and charges of £3m remained at a very low level (2010: £nil).

2010 compared to 2009

Trading profit before tax decreased by £55m to £279m (2009: £334m). By income statement line, the movements were:

 

   

Trading net interest income decreased by £2m to £357m (2010: £359m), which was broadly in line with the prior year. Trading net interest income decreased due to a reduced contribution of £20m from the legacy portfolios in run-off as balances in these portfolios continued to be actively reduced. This was largely offset by growth in customer loans and deposits to the UK SME market through the network of 25 Corporate Business Centres (SME lending balances increased by 26% and total deposit balances increased by 13%). Trading net interest margins on loans continued to improve during 2010 as market pricing better reflected incremental higher funding and liquidity costs applied to the business unit.

 

   

Trading non-interest income increased by £15m to £347m (2010: £332m). Non-interest income increased due to growth in the funding and liquidity management of the wholesale business, asset growth in the SME business and strong sales of Markets’ products. However, this was partially offset by lower income from the legacy portfolios in run-off as we continued to reduce balances in these portfolios.

 

   

Trading expenses decreased by £27m to £257m (2009: £284m). The decrease was due to operational efficiencies arising from the integration of the Alliance & Leicester business, partially offset by investment in the Corporate Business Centre network including hiring additional staff and an increase of 70% in the floor space of the network, and ongoing investment in growth initiatives relating to new products and customer segments.

 

   

Trading impairment losses on loans and advances increased by £95m to £168m (2009: £73m). The increase reflected growth and maturity in asset balances over the last two years and some deterioration arising from market conditions.

Corporate Banking segment balances

2011 compared to 2010

 

   

Total customer assets increased by 16% to £30.9bn (2010: £26.7bn) driven by the increase in core customer assets described below, partially offset by continued deleveraging of the legacy portfolios in run-off.

 

   

Core customer assets increased by 19% to £27.7bn (2010: £23.2bn) driven by a strong performance via the 28 Corporate Business Centres and a broader product offering. We continued to build our growing SME franchise, with lending to this group increasing 25% to £10.7bn (2010: £8.6bn).

 

   

Risk weighted assets increased by 8% to £24.9bn (2010: £23.1bn) reflecting the asset growth described above.

 

   

Customer deposits increased by 5% to £29.1bn (2010: £27.8bn), despite increased competition in the market, with net inflows achieved while increasing our proportion of deposits from SME customers.

2010 compared to 2009

 

   

Total customer assets increased by 9% to £26.7bn (2009: £24.6bn) driven by the increase in core customer assets described below, partially offset by deleveraging of the legacy portfolios in run-off.

 

   

Core customer assets increased by 15% to £23.2bn (2009: £20.1bn) driven by a strong performance via the 25 Corporate Business Centres and a broader product offering. We continued to build our growing SME franchise, with lending to this group increasing 26% to £8.6bn (2009: £6.7bn).

 

   

Risk weighted assets increased by 21% to £23.1bn (2009: £19.1bn) reflecting the asset growth described above.

 

   

Customer deposits increased by 13% to £27.8bn (2009: £24.5bn) despite increased competition in this market, with the net flows achieved while improving the average term.

 

26    Santander UK plc 2011 Annual Report


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Business and Financial Review

Business Review – Divisional Results continued

 

MARKETS

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

 

     2011
£m
    2010
£m
    2009
£m
 

Trading net interest (expense)/income

     (3     —          —     

Trading non-interest income

     162        221        204   
  

 

 

   

 

 

   

 

 

 

Total trading income

     159        221        204   

Total trading expenses

     (111     (76     (60

Provision for other liabilities and charges

     (3     —          —     
  

 

 

   

 

 

   

 

 

 

Trading and statutory profit before tax

     45        145        144   
  

 

 

   

 

 

   

 

 

 

Segment balances

   2011
£bn
    2010
£bn
    2009
£bn
 

Total assets

     28.7        22.1        16.4   

Risk weighted assets

     5.7        5.2        6.5   

Markets trading profit before tax

2011 compared to 2010

Trading profit before tax decreased by £100m to £45m (2010: £145m). By income statement line, the movements were:

 

   

Trading net interest expense increased by £3m to £3m (2010: £nil) due to increased funding costs reflecting the higher cost of new wholesale medium-term funding and holding higher liquid asset balances.

 

   

Trading non-interest income decreased by £59m to £162m (2010: £221m), largely due to reduced results in the market making desks and weak trading activities. A weaker trading environment reduced the results of the Rates derivatives and Equity business due to reduced volumes (linked to sale of retail structured products through the branch network). This was partially offset by growth with institutional clients.

 

   

Trading expenses increased by £35m to £111m (2010: £76m), reflecting ongoing investment in growth initiatives relating to new products, markets and customer segments. There was a 42% headcount increase across the customer transaction businesses compared to 31 December 2010.

 

   

Trading provisions for other liabilities and charges of £3m remained at a very low level (2010: £nil).

2010 compared to 2009

Trading profit before tax increased by £1m to £145m (2009: £144m). By income statement line, the movements were:

 

   

Trading non-interest income increased by £17m to £221m (2009: £204m) reflecting the strong performance of underlying customer revenue streams and a number of releases of fair value adjustments following the successful de-risking of underlying positions in 2009 not repeated in 2010. These benefits were partly offset by a less favourable trading environment resulting from lower spread volatility.

 

   

Trading expenses increased by £16m to £76m (2009: £60m), reflecting ongoing investment in growth initiatives relating to new products, markets and customer segments, and significant headcount growth.

Markets segment balances

2011 compared to 2010

 

   

Total assets increased by 30% to £28.7bn (2010: £22.1bn), primarily reflecting an increase in the fair values of interest rate derivatives due to a flattening of the yield curve.

 

   

Risk weighted assets increased by 10% to £5.7bn (2010: £5.2bn) reflecting the asset growth described above.

2010 compared to 2009

 

   

Total assets increased by 35% to £22.1bn (2009: £16.4bn), primarily reflecting increases in the fair values of derivatives.

 

   

Risk-weighted assets decreased by 20% to £5.2bn (2009: £6.5bn) due to the decreased share of the Counterparty and Market Risk charges. Counterparty risk decreased due to the Group enhancing the application method of applying collateral to the credit exposure.

 

Santander UK plc 2011 Annual Report    27


Table of Contents

Business and Financial Review

Business Review – Divisional Results continued

 

GROUP INFRASTRUCTURE

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

 

     2011
£m
    2010
£m
    2009
£m
 

Trading net interest (expense)/ income

     (51     302        236   

Trading non-interest (expense)/income

     (53     (80     87   
  

 

 

   

 

 

   

 

 

 

Total trading (expense)/income

     (104     222        323   

Total trading expenses

     (50     (48     (46

Trading impairment losses on loans and advances

     —          (40     (57

Provisions for other liabilities and charges

     (151     —          —     
  

 

 

   

 

 

   

 

 

 

Trading (loss)/profit before tax

     (305     134        220   

Adjust for:

      

- Perimeter companies pre-acquisition trading basis results

     —          25        —     

- Reorganisation, customer remediation and other costs

     —          40        (40

- Profit on part sale and revaluation of subsidiaries

     —          126        —     

- Hedging and other variances

     117        4        (19

- Capital and other charges

     176        113        81   
  

 

 

   

 

 

   

 

 

 

Statutory (loss)/profit before tax

     (12     442        242   
  

 

 

   

 

 

   

 

 

 

Group Infrastructure trading profit before tax

2011 compared to 2010

Trading (loss)/profit before tax decreased by £439m to £(305)m (2010: £134m). By income statement line, the movements were:

 

   

Trading net interest (expense)/income decreased by £353m to £(51)m (2010: £302m). The key drivers of the decrease were the increased cost of new term funding (issuances of £25bn in 2011) and the full year effect of higher liquid asset balances (an increase of over 30% in average liquid asset balances in 2011) in response to UK regulatory requirements introduced in June 2010. This was partially offset by the allocation of these impacts to business units in line with the ongoing customer repricing. In addition, sustained lower interest rates have reduced net interest income as the structural hedging yield has decreased. Further, there was a reduced contribution from the run-down Treasury asset portfolio as we continued to reduce balances of the assets in this portfolio.

 

   

Trading non-interest expense decreased by £27m to £(53)m (2010: £(80)m), principally due to lower losses on disposals of assets in the Treasury asset portfolio. This was partially offset by a decrease in non-interest income as a result of the sales of the James Hay and ATM businesses in 2010.

 

   

Trading expenses increased by £2m to £50m (2010: £48m), broadly in line with 2010.

 

   

Trading impairment losses on loans and advances decreased by £40m to £nil (2010: £40m) due to the non-recurrence of losses on disposals of assets in the Treasury asset portfolio.

 

   

Trading provisions for other liabilities and charges increased by £151m to £151m (2010: £nil), as a result of the introduction of the UK Bank Levy and the inclusion here of the Financial Services Compensation Scheme fees.

2010 compared to 2009

Trading profit before tax decreased by £86m to £134m (2009: £220m). Of the total decrease, £25m represented the removal of income produced by the Santander Consumer which was accounted for as an associate in our statutory accounts prior to becoming a wholly-owned subsidiary in November 2010, due to the inclusion of the Perimeter companies’ pre-acquisition trading profit before tax in 2010 in Retail Banking. By income statement line, the movements were:

 

   

Trading net interest income increased by £66m to £302m (2009: £236m). The income reflected benefit of higher historic medium-term interest rates being earned on capital, and the impact of the application of marginal medium-term funding rates to new business and an increasing proportion of the back book to the extent that there has been customer repricing activity by the business units.

This was partially offset by a decrease in trading net interest income from the James Hay business which was sold in March 2010. In addition, net interest income from the run-down Treasury asset portfolio decreased due to the continued de-leveraging process, with balances reduced by 46% in the year, to £5.1bn at the year end.

 

28    Santander UK plc 2011 Annual Report


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Business and Financial Review

Business Review – Divisional Results continued

 

   

Trading non-interest (expense)/income decreased by £167m to £(80)m (2009: £87m). The decrease was principally due to 2009 including certain benefits not repeated in 2010 (including profits earned on the buy-back of securitisation debt in 2009) and higher losses on disposals of assets in the Treasury asset portfolio which is being run down.

In addition, there was a decrease in trading non-interest income from the James Hay business which was sold in March 2010.

 

   

Trading expenses increased slightly by £2m to £48m (2009: £46m). Non-recurring expenditure was incurred relating to the rebranding of Abbey and the Bradford & Bingley savings business as Santander in January 2010. In addition, higher expenses resulted from the process of transferring the business of Alliance & Leicester plc to Santander UK plc under Part VII of the Financial Services and Markets Act 2000 in May 2010. However, these additional expenses were offset in part by lower costs due to the sale of the James Hay business in March 2010.

 

   

Trading impairment losses on loans and advances decreased by £17m to £40m (2009: £57m). The loss of £40m in 2010 was due to losses on disposals of assets in the Treasury asset portfolio.

 

Santander UK plc 2011 Annual Report    29


Table of Contents

Business and Financial Review

Other Material Items

ADJUSTMENTS BETWEEN THE STATUTORY BASIS AND THE TRADING BASIS

Santander UK’s Board reviews discrete financial information for each of its segments that includes measures of operating results, assets and liabilities, which are measured on a ‘trading’ basis. The trading basis differs from the statutory basis as a result of the application of various adjustments, as presented below, and described in Note 2 to the Consolidated Financial Statements. Management considers that the trading basis provides the most appropriate way of reviewing the performance of the business.

The trading adjustments consist of:

Perimeter companies pre-acquisition trading basis results

 

     

2011

£m

   2010
£m
     2009
£m
 
   —        70         —     

The pre-acquisition trading basis results of the Perimeter companies for the year ended 31 December 2010 are included in the trading basis results discussed in the “Business Review - Divisional Results” as described in Note 2 to the Consolidated Financial Statements. The pre-acquisition non-trading adjustments of the Perimeter companies for the year ended 31 December 2010 have not been included. This adjustment applies only to 2010.

Reorganisation, customer remediation and other costs

 

     2011
£m
     2010
£m
    2009
£m
 

Reorganisation and customer remediation costs

     765         155        146   

Impairment losses

     172         (40     40   
  

 

 

    

 

 

   

 

 

 
     937         115        186   
  

 

 

    

 

 

   

 

 

 

These costs comprise implementation costs in relation to the strategic change and cost reduction process, costs in respect of customer remediation, certain write-offs and impairment losses taken centrally.

2011 compared to 2010

Total reorganisation, customer remediation and other costs of £937m increased by £822m (2010: £115m).

Reorganisation and customer remediation costs increased by £610m largely reflecting the charge for customer remediation, principally payment protection insurance, as described in Note 36 to the Consolidated Financial Statements and in “Shareholder Information - Risk Factors”.

Non-trading impairment losses of £172m in 2011 principally resulted from the write-off of software assets of £112m as a result of a reduction in the related expected future economic benefits, and the write-off of Cater Allen Private Bank goodwill of £60m as a result of a reassessment of the value of certain parts of the business in light of recent market conditions and regulatory developments. In 2010, releases of £40m represented the release of impairment losses recognised in prior years, with assets previously held in the Group’s conduit vehicles sold at better than expected prices.

2010 compared to 2009

Total reorganisation, customer remediation and other costs decreased by £71m to £115m (2009: £186m).

Reorganisation and customer remediation costs increased by £9m reflecting a decrease in costs relating to the strategic change and cost reduction process as it nears completion being more than offset by an increase in customer remediation costs.

Other non-trading items of £40m in 2010 represented the release of impairment losses recognised in prior years, with assets previously held in the Group’s conduit vehicles sold at better than expected prices.

Profit on part sale and revaluation of subsidiaries

 

     

2011

£m

   2010
£m
     2009
£m
 
   —        126         —     

These profits are excluded from the trading results to allow management to understand the underlying performance of the business. In 2010, the £87m gain that arose on the revaluation of the Group’s original holding in Santander Consumer (UK) plc on the acquisition of the remaining shares by the Group was excluded from the trading results. In addition, profits of £39m on the sale of certain businesses, including James Hay, were excluded. In 2011 and 2009, there were no such profits.

 

30    Santander UK plc 2011 Annual Report


Table of Contents

Business and Financial Review

Other Material Items continued

 

Hedging and other variances

 

     2011
£m
    2010
£m
     2009
£m
 

(Gains)/losses

     (86     27         36   

The Balance Sheet and Income Statement are subject to mark-to-market volatility including that arising from the accounting for elements of derivatives deemed under IFRS rules to be ineffective as hedges. Volatility also arises on certain assets previously managed on a fair value basis, and hence classified as fair value through profit or loss under IFRS, that are now managed on an accruals basis. In addition, other variances include the reversal of coupon payments on certain equity instruments which are treated as an interest expense in the trading results but are reported below the profit after tax line for statutory purposes.

2011 compared to 2010

In 2011, hedging and other variance gains of £86m were excluded from the trading basis results, compared with losses of £27m that were excluded from the trading basis results in 2010. In 2011, hedge ineffectiveness resulted in gains compared to losses reported in 2010. In addition, other variances include £57m reversal of coupon payments on certain preference shares, Perpetual Preferred Securities and Reserve Capital Instruments, which were treated as an interest expense in the trading results but were accounted for as dividends for statutory purposes in both 2011 and 2010.

2010 compared to 2009

In 2010 and 2009, hedging and other variance losses of £27m and £36m, respectively, were excluded from the trading basis results. In 2010 and 2009, this largely consisted of hedge ineffectiveness, partially offset by the reversal of £57m of coupon payments on certain preference shares, Perpetual Preferred Securities and Reserve Capital Instruments, which were treated as interest expense in the trading results but were accounted for as dividends for statutory purposes in both 2010 and 2009. In addition, in 2009 substantial mark-to-market gains which arose in the second half of 2008 from movements in interest rates reversed.

Capital and other charges

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

LEGAL PROCEEDINGS

Santander UK is party to various legal proceedings in the ordinary course of business, the ultimate resolution of which is not expected to have a material adverse effect on the financial position or the results of operations of Santander UK. See Notes 36 and 38 to the Consolidated Financial Statements.

MATERIAL CONTRACTS

Santander UK is party to various contracts in the ordinary course of business. For the three years ended 31 December 2011 there have been no material contracts entered into outside the ordinary course of business, except for the contracts described below.

On 9 January 2009, in order to optimise the capital, liquidity funding and overall financial efficiency of the enlarged group, Banco Santander, S.A. transferred all of its Alliance & Leicester plc shares to the Company in exchange for newly issued ordinary shares of the Company.

On 30 August 2011, the Company entered into an amended sale and purchase agreement with the Royal Bank of Scotland plc, National Westminster Bank plc, National Westminster Home Loans Limited which replaced the sale and purchase agreement between the same parties dated 4 August 2010. Under this contract the Company has agreed to acquire (subject to certain conditions) bank branches and business banking centres and associated assets and liabilities from the Royal Bank of Scotland group. For further information see Note 46 to the Consolidated Financial Statements.

AUDIT FEES

See Note 8 to the Consolidated Financial Statements.

 

Santander UK plc 2011 Annual Report    31


Table of Contents

Business and Financial Review

Balance Sheet Business Review

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

SUMMARY

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

 

     Page  

Summarised consolidated balance sheet

     33   

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

  

Reconciliation to classifications in the Consolidated Balance Sheet

     37   

Securities:

     38   

•      Analysis by type of issuer

     38   

•      Significant exposures

     39   

Loans and advances to banks:

  

•      Geographical analysis

     39   

•      Maturity analysis

     40   

Loans and advances to customers:

     40   

•      Geographical analysis

     40   

•      Maturity analysis

     41   

•       Impairment loss allowances on loans and advances to customers

     41   

•      Risk elements in the loan portfolio

     42   

Country risk exposure

     44   

•      Sovereign debt

     46   

•      Other country risk exposures

     46   

•      Balances with other Santander companies

     47   

Derivative assets and liabilities

     49   

Tangible fixed assets

     49   

Deposits by banks

     49   

Deposits by customers

     50   

Short-term borrowings

     51   

Debt securities in issue

     52   

Retirement benefit assets and obligations

     52   

Contractual obligations

     53   

Off-balance sheet arrangements

     53   

Capital management and resources

     54   

Funding and Liquidity

     57   

•      Sources and uses of funding and liquidity

     57   

•      Cash flows

     58   

Interest rate sensitivity

     60   

Average balance sheet

     61   

 

32    Santander UK plc 2011 Annual Report


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Business and Financial Review

Balance Sheet Business Review continued

 

SUMMARISED CONSOLIDATED BALANCE SHEET

 

     2011
£m
     2010
£m
     2009
£m
 

Assets

        

Cash and balances at central banks

     25,980         26,502         4,163   

Trading assets

     21,891         35,461         33,290   

Derivative financial instruments

     30,780         24,377         22,827   

Financial assets designated at fair value

     5,005         6,777         12,358   

Loans and advances to banks

     4,487         3,852         9,151   

Loans and advances to customers

     201,069         195,132         186,804   

Available for sale securities

     46         175         797   

Loans and receivables securities

     1,771         3,610         9,898   

Macro hedge of interest rate risk

     1,221         1,091         1,127   

Property, plant and equipment

     1,596         1,705         1,250   

Retirement benefit assets

     241         —           —     

Tax, intangibles and other assets

     3,487         4,178         3,626   
  

 

 

    

 

 

    

 

 

 

Total assets

     297,574         302,860         285,291   
  

 

 

    

 

 

    

 

 

 

Liabilities

        

Deposits by banks

     11,626         7,784         5,811   

Deposits by customers

     148,342         152,643         143,893   

Derivative financial instruments

     29,180         22,405         18,963   

Trading liabilities

     25,745         42,827         46,152   

Financial liabilities designated at fair value

     6,837         3,687         4,423   

Debt securities in issue

     52,651         51,783         47,758   

Subordinated liabilities

     6,499         6,372         6,949   

Retirement benefit obligations

     216         173         1,070   

Tax, other liabilities and provisions

     3,812         2,912         3,050   
  

 

 

    

 

 

    

 

 

 

Total liabilities

     284,908         290,586         278,069   
  

 

 

    

 

 

    

 

 

 

Equity

        

Total shareholders’ equity

     12,666         12,274         6,506   

Non-controlling interests

     —           —           716   
  

 

 

    

 

 

    

 

 

 

Total equity

     12,666         12,274         7,222   
  

 

 

    

 

 

    

 

 

 

Total liabilities and equity

     297,574         302,860         285,291   
  

 

 

    

 

 

    

 

 

 

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

31 December 2011 compared to 31 December 2010

Assets

Cash and balances at central banks

Cash and balances held at central banks decreased slightly by 2% to £25,980m (2010: £26,502m).

Trading assets

Trading assets decreased by 38% to £21,891m (2010: £35,461m). The decrease principally reflected changes in holdings of UK and Organisation of Economic Co-operation and Development (‘OECD’) government securities as part of the Group’s liquidity management activity, including the maturity of approximately half of the Group’s holdings of Government guaranteed fixed and floating rate notes.

Derivative assets

Derivative assets increased by 26% to £30,780m (2010: £24,377m). The increase was driven by an increase in the fair values of interest rate derivatives as a result of downward moves in yield curves. There was a corresponding increase in derivative liabilities.

Financial assets designated at fair value through profit and loss

Financial assets designated at fair value through profit and loss decreased by 26% to £5,005m (2010: £6,777m). The decrease was primarily attributable to the maturity of loans to UK Social Housing associations, as new loans are no longer designated at fair value, in accordance with Group policy.

Loans and advances to banks

Loans and advances to banks increased by 16% to £4,487m (2010: £3,852m). The increase was due to higher reverse repurchase agreement activity with Banco Santander S.A. as disclosed in Note 17 to the Consolidated Financial Statements.

Loans and advances to customers

Loans and advances to customers increased by 3% to £201,069m (2010: £195,132m), principally due to growth in corporate lending, particularly SMEs, as a result of a strong performance via the 28 Corporate Business Centres and modest growth in mortgage lending.

 

Santander UK plc 2011 Annual Report    33


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Business and Financial Review

Balance Sheet Business Review continued

 

Available for sale securities

Available for sale securities decreased by 74% to £46m (2010: £175m). The decrease reflected the sale of available-for-sale debt securities as part of the restructuring of the Company’s contributions to the defined benefit pension schemes.

Loans and receivable securities

Loans and receivable securities decreased by 51% to £1,771m (2010: £3,610m). The decrease principally reflected the continuing run-down of the Treasury asset portfolio.

Macro hedge of interest rate risk

The macro (or portfolio) hedge increased by 12% to £1,221m (2010: £1,091m). The increase was mainly due to decreases in LIBOR interest rates.

Property, plant and equipment

Property, plant and equipment decreased by 6% to £1,596m (2010: £1,705m). The decrease was principally due to the depreciation charge for the year.

Retirement benefit assets

Retirement benefit assets increased to £241m (2010:£nil). For the Group’s defined benefit pension schemes which had surpluses, the key drivers of the increase were Company contributions during the year together with some improvements in asset values, partly offset by a reduction in the net discount rate which generated an actuarial loss on liabilities.

Tax, intangibles and other assets

Tax, intangibles and other assets decreased by 17% to £3,487m (2010: £4,178m). The decrease was primarily driven by depreciation and amortisation of intangible and tangible assets combined with a decrease in tax assets.

Liabilities

Deposits by banks

Deposits by banks increased by 49% to £11,626m (2010: £7,784m). The increase was driven by the increase in medium term repurchase agreements as part of the Group’s funding strategy.

Deposits by customers

Deposits by customers decreased by 3% to £148,342m (2010: £152,643m). The decrease reflected the slower acquisition of deposits in what was a smaller market and where increased competition led to negative pricing and margins. A managed outflow of more rate-sensitive and shorter-term deposits was more than offset by the additional issuance of medium-term funding described below.

Derivatives

Derivative liabilities increased by 30% to £29,180m (2010: £22,405m). The increase was driven by an increase in the fair values of interest rate derivatives as a result of downward moves in yield curves.

Trading liabilities

Trading liabilities decreased by 40% to £25,745m (2010: £42,827m). The decrease reflected lower repo activity and the funding of lower holdings of UK and OECD government securities as part of the Group’s liquidity management activity.

Financial liabilities designated at fair value

Financial liabilities designated at fair value increased by 85% to £6,837m (2010: £3,687m). The increase reflected new issuances in the US$20bn Euro Medium Term Note Programme and the euro 10bn Structured Notes Programme.

Debt securities in issue

Debt securities in issue increased by 2% to £52,651m (2010: £51,783m). The increase reflected the Group’s strategy of increasing the level of medium-term funding through the issuance of debt under the Fosse securitisation and Covered Bond programmes. These increases were partially offset by significant decreases in short-term funding in the US$20bn Commercial Paper Programme and in Certificates of Deposit in issue. In addition, there were further maturities of debt outstanding under the US$40bn EMTN programme.

Subordinated liabilities

Subordinated liabilities increased by 2% to £6,499m (2010: £6,372m). The increase was primarily driven by increases of fair value hedge adjustments on the subordinated debt in issue as a result of downward moves in yield curves partially offset by the scheduled redemption of the euro 500m 4.625% Subordinated Notes.

 

34    Santander UK plc 2011 Annual Report


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Business and Financial Review

Balance Sheet Business Review continued

 

Retirement benefit obligations

Retirement benefit obligations increased by 25% to £216m (2010: £173m). For the Group’s defined benefit pension schemes which had deficits, the key driver of the increase was a reduction in the net discount rate which generated an actuarial loss on liabilities, partly offset by Company contributions during the year and some improvements in asset values.

Tax, other liabilities and provisions

Tax, other liabilities and provisions increased by 31% to £3,812m (2010: £2,912m). The increase principally reflected the additional provision in the year for customer remediation, including payment protection insurance, as described in Note 36 to the Consolidated Financial Statements.

Equity

Total shareholders equity increased by 3% to £12,666m (2010: £12,274m). The increase was principally attributable to the retained profit for the year of £903m, partly offset by dividends declared of £482m.

31 December 2010 compared to 31 December 2009

Assets

Cash and balances at central banks

Cash and balances held at central banks increased by 537% to £26,502m (2009: £4,163m). Higher balances were maintained with the Bank of England and the US Federal Reserve as part of the increase in the Group’s stock of liquid assets.

Trading assets

Trading assets increased by 7% to £35,461m (2009: £33,290m). The increase reflected higher holdings of debt securities and even greater repurchase agreement (‘reverse repo’) activity relating to OECD government securities as part of the Group’s liquidity management activities. Other reverse repo activity reduced in view of the focus on government security repo activity.

Derivative assets

Derivative assets increased by 7% to £24,377m (2009: £22,827m). The increase was driven by an increase in interest rate derivatives as a result of downward shifts in yield curves.

Financial assets designated at fair value through profit and loss

Financial assets designated at fair value through profit and loss decreased by 45% to £6,777m (2009: £12,358m). The decrease principally reflected the maturity of £2,220m of bank certificates of deposit and the sale of euro 3,265m of Santander UK’s holdings of AAA-rated prime mortgage-backed securities.

Loans and advances to banks

Loans and advances to banks decreased by 58% to £3,852m (2009: £9,151m) due to the repayment of substantially all of Santander UK’s loans to other members of the Santander group.

Loans and advances to customers

Loans and advances to customers increased by 4% to £195,132m (2009: £186,804m), reflecting net mortgage lending of £5.6bn, growth in corporate lending of £1.3bn and the impact of the acquisition of the Perimeter companies with aggregate customer balances of £5.7bn. In addition, loans to non-bank Santander group companies decreased by 99% to £57m (2009: £4,457m). This was due to the acquisition of the Perimeter companies which resulted in the loans funding these companies in 2009 being eliminated on consolidation.

Available for sale securities

Available for sale securities decreased by 78% to £175m (2009: £797m). The decrease was due to the sale of the available-for-sale securities as part of the injection of funds directly into the defined benefit pension scheme in 2010.

Loans and receivable securities

Loans and receivable securities decreased by 64% to £3,610m (2009: £9,898m). The decrease principally reflected the run-down of the Treasury asset portfolio as part of the ongoing de-leveraging process.

Macro hedge of interest rate risk

The macro (or portfolio) hedge decreased by 3% to £1,091m (2009: £1,127m) mainly due to increases in interest rates.

 

Santander UK plc 2011 Annual Report    35


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Business and Financial Review

Balance Sheet Business Review continued

 

Property, plant and equipment

Property, plant and equipment increased by 36% to £1,705m (2009: £1,250m). The increase principally reflected the Group’s acquisition of freehold and leasehold properties for a consideration of £526m in the year. The properties consisted of retail branches that the Group had previously leased. See Note 26 to the Consolidated Financial Statements. The remaining capital expenditure during the year was principally incurred by Retail Banking (mostly consisting of computer infrastructure, computer software and furniture and fittings for branches) and by Corporate Banking (consisting of operating lease assets). These increases were partly offset by the depreciation charge for the year.

Tax, intangibles and other assets

Tax, intangibles and other assets increased by 15% to £4,178m (2009: £3,626m). The increase was principally driven by higher goodwill as a result of the acquisition of the Perimeter companies. This was partly offset by a reduction in tax assets associated with the retirement benefit obligation liability.

Liabilities

Deposits by banks

Deposits by banks increased by 34% to £7,784m (2009: £5,811m). The increase was driven by the issuance of new medium term repurchase agreements as part of the Group’s medium to long term funding.

Deposits by customers

Deposits by customers increased by 6% to £152,643m (2009: £143,893m) due to inflows across core savings, banking, private banking and corporate customers.

Derivatives

Derivative liabilities increased by 18% to £22,405m (2009: £18,963m). The increase was driven by an increase in interest rate derivatives as a result of downward shifts in yield curves.

Trading liabilities

Trading liabilities decreased by 7% to £42,827m (2009: £46,152m). The decrease reflected lower non government security repo activity.

Financial liabilities designated at fair value

Financial liabilities designated at fair value decreased by 17% to £3,687m (2009: £4,423m). The decrease reflected repayments in the US$20bn euro Medium Term Note (‘EMTN’) programme partly offset by currency movements.

Debt securities in issue

Debt securities in issue increased by 8% to £51,783m (2009: £47,758m). The increase reflected the Group’s strategy of increasing the level of medium-term funding through the issuance of debt in the Fosse securitisation and Covered Bond programmes. These increases were partially offset by the maturity of debt within the former Alliance & Leicester US$40bn EMTN programme as a decision was taken in 2009 that no further issuances would be made under this programme.

Subordinated liabilities

Subordinated liabilities decreased by 8% to £6,372m (2009: £6,949m). The decrease reflected the scheduled redemption of subordinated notes.

Retirement benefit obligations

Retirement benefit obligations decreased by 84% to £173m (2009: £1,070m). The principal reason for the reduction was the payment of contributions to the defined benefit pension schemes of £955m by the Group and fellow Santander subsidiaries, with significant improvements in market values since June 2010.

Tax, other liabilities and provisions

Tax, other liabilities and provisions decreased by 5% to £2,912m (2009: £3,050m). The decrease reflected a reduction in trade and other payables, partly offset by an increase in current tax liabilities.

Equity

Total shareholders equity, including non-controlling interests, increased by 70% to £12,274m (2009: £7,222m), primarily as a result of the injection of equity of £4,456m by the Santander group, as well as the inclusion of profits after tax of £1,583m. This was partly offset by dividends declared of £832m.

 

36    Santander UK plc 2011 Annual Report


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Business and Financial Review

Balance Sheet Business Review continued

 

RECONCILIATION TO CLASSIFICATIONS IN THE CONSOLIDATED BALANCE SHEET

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

 

31 December 2011         Balance sheet business review section              

Balance sheet line item and note

  Note     Loans and
advances

to banks
£m
    Loans and
advances
to
customers
£m
    Securities
£m
    Derivatives
£m
    Tangible
fixed

assets
£m
    Retirement
benefit
assets
£m
    Other
£m
    Balance
sheet total
£m
 

Assets

                 

Cash and balances at central banks

    12        —          —          —          —          —          —          25,980        25,980   

Trading assets

    14        6,144        6,687        9,060        —          —          —          —          21,891   

Derivative financial instruments

    15        —          —          —          30,780        —          —          —          30,780   

Financial assets designated at fair value

    16        —          4,376        629        —          —          —          —          5,005   

Loans and advances to banks

    17        4,487        —          —          —          —          —          —          4,487   

Loans and advances to customers

    18        —          201,069        —          —          —          —          —          201,069   

Available for sale securities

    22        —          —          46        —          —          —          —          46   

Loans and receivables securities

    23        957        814        —          —          —          —          —          1,771   

Macro hedge of interest rate risk

      —          —          —          —          —          —          1,221        1,221   

Property, plant and equipment

    26        —          —          —          —          1,596        —          —          1,596   

Retirement benefit assets

    37        —          —          —          —          —          241        —          241   

Tax, intangibles and other assets

      —          —          —          —          —          —          3,487        3,487   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

      11,588        212,946        9,735        30,780        1,596        241        30,688        297,574   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
                Deposits by
banks
£m
    Deposits by
customers
£m
    Debt
securities

in issue
£m
    Derivatives
£m
    Retirement
benefit
obligations
£m
    Other
£m
    Balance
sheet total
£m
 

Liabilities

                 

Deposits by banks

    29          11,626        —          —          —          —          —          11,626   

Deposits by customers

    30          —          148,342        —          —          —          —          148,342   

Derivative financial instruments

    15          —          —          —          29,180        —          —          29,180   

Trading liabilities

    31          14,508        10,482        755        —          —          —          25,745   

Financial liabilities designated at fair value

    32          —          —          6,837        —          —          —          6,837   

Debt securities in issue

    33          —          —          52,651        —          —          —          52,651   

Subordinated liabilities

    34          —          —          6,499        —          —          —          6,499   

Retirement benefit obligations

    37          —          —          —          —          216        —          216   

Tax, other liabilities and provisions

        —          —          —          —          —          3,812        3,812   
     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

        26,134        158,824        66,742        29,180        216        3,812        284,908   
     

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

31 December 2010         Balance sheet business review section              

Balance sheet line item and note

  Note     Loans and
advances

to banks
£m
    Loans and
advances to
customers
£m
    Securities
£m
    Derivatives
£m
    Tangible
fixed

assets
£m
    Other
£m
    Balance
sheet total
£m
 

Assets

               

Cash and balances at central banks

    12        —          —          —          —          —          26,502        26,502   

Trading assets

    14        8,281        8,659        18,521        —          —          —          35,461   

Derivative financial instruments

    15        —          —          —          24,377        —          —          24,377   

Financial assets designated at fair value

    16        11        5,468        1,298        —          —          —          6,777   

Loans and advances to banks

    17        3,852        —          —          —          —          —          3,852   

Loans and advances to customers

    18        —          195,132        —          —          —          —          195,132   

Available for sale securities

    22        —          —          175        —          —          —          175   

Loans and receivables securities

    23        1,535        2,075        —          —          —          —          3,610   

Macro hedge of interest rate risk

      —          —          —          —          —          1,091        1,091   

Property, plant and equipment

    26        —          —          —          —          1,705        —          1,705   

Tax, intangibles and other assets

      —          —          —          —          —          4,178        4,178   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

      13,679        211,334        19,994        24,377        1,705        31,771        302,860   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          Deposits
by banks
£m
    Deposits by
customers
£m
    Debt
securities

in issue
£m
    Derivatives
£m
    Retirement
benefit
obligations
£m
    Other
£m
    Balance
sheet total
£m
 

Liabilities

               

Deposits by banks

    29        7,784        —          —          —          —          —          7,784   

Deposits by customers

    30        —          152,643        —          —          —          —          152,643   

Derivative financial instruments

    15        —          —          —          22,405        —          —          22,405   

Trading liabilities

    31        25,738        15,971        1,118        —          —          —          42,827   

Financial liabilities designated at fair value

    32        —          5        3,682        —          —          —          3,687   

Debt securities in issue

    33        —          —          51,783        —          —          —          51,783   

Subordinated liabilities

    34        —          —          6,372        —          —          —          6,372   

Retirement benefit obligations

    37        —          —          —          —          173        —          173   

Tax, other liabilities and provisions

      —          —          —          —          —          2,912        2,912   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

      33,522        168,619        62,955        22,405        173        2,912        290,586   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Santander UK plc 2011 Annual Report    37


Table of Contents

Business and Financial Review

Balance Sheet Business Review continued

 

SECURITIES

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

Securities analysis by type of issuer

The following table sets out the book and market values of securities at 31 December 2011, 2010 and 2009. For further information, see the Notes to the Consolidated Financial Statements.

 

     2011
£m
     2010
£m
     2009
£m
 

Trading portfolio

        

Debt securities:

        

UK Government

     1,078         3,120         968   

US Treasury and other US Government agencies and corporations

     65         130         628   

Other OECD governments

     1,800         3,380         1,273   

Bank and building society:

        

- Certificates of deposit - Government guaranteed

     —           —           205   

- Certificates of deposit - Other

     —           290         1,730   

Other issuers:

        

- Fixed and floating rate notes – Government guaranteed

     5,666         10,586         8,090   

- Fixed and floating rate notes

     102         315         3,038   

Ordinary shares and similar securities

     349         700         1,478   
  

 

 

    

 

 

    

 

 

 
     9,060         18,521         17,410   
  

 

 

    

 

 

    

 

 

 

Available for sale securities

        

Debt securities:

        

UK Government

     —           125         405   

Other issuers - Other

     —           —           342   

Ordinary shares and similar securities

     46         50         50   
  

 

 

    

 

 

    

 

 

 
     46         175         797   
  

 

 

    

 

 

    

 

 

 

Financial assets designated at fair value through profit and loss

        

Debt securities:

        

Bank and building society certificates of deposit

     —           —           2,220   

Other issuers:

        

- Mortgage-backed securities

     328         859         574   

- Other asset-backed securities

     51         187         2,872   

- Other securities

     250         252         313   
  

 

 

    

 

 

    

 

 

 
     629         1,298         5,979   
  

 

 

    

 

 

    

 

 

 

Total

     9,735         19,994         24,186   
  

 

 

    

 

 

    

 

 

 

UK Government securities

The holdings of UK Government securities represent Treasury Bills and UK Government guaranteed issues by other UK banks. These securities are held for trading and liquidity purposes. For further information, see “Country Risk Exposure”.

US Treasury and other US Government agencies and corporations

The holdings of US Treasury and other US Government agencies’ and corporations’ securities represent US Treasury Bills, including cash management bills. These securities are held for trading and liquidity purposes. For further information, see “Country Risk Exposure”.

Other OECD governments

This category comprises issues by OECD governments other than the US and UK Governments, principally Switzerland. These securities are held for trading and liquidity purposes. For further information, see “Country Risk Exposure”.

Bank and building society certificates of deposit and bonds

Bank and building society certificates of deposit are fixed-rate securities with relatively short maturities. These are managed within the overall position for the relevant book. These securities are held for trading and liquidity purposes.

Fixed and floating rate notes

Fixed and floating rate notes have regular interest rate profiles and are either managed within the overall position for the relevant book or are hedged into one of the main currencies. Government-guaranteed fixed and floating rate notes almost all relate to the UK Government. These securities are held for trading and yield purposes. For further information on Government-guaranteed fixed and floating rate notes, see “Country Risk Exposure”.

 

38    Santander UK plc 2011 Annual Report


Table of Contents

Business and Financial Review

Balance Sheet Business Review continued

 

Mortgage-backed securities

This category principally comprises UK residential mortgage-backed securities. These securities are of good quality and contain no sub-prime element. These securities are held as part of the Asset and Liability Management portfolio. See Note 16 to the Consolidated Financial Statements.

Other asset-backed securities

This category comprises a range of mostly floating-rate asset-backed securities including home equity loans, commercial mortgages, loans to car dealers, lease and credit card debtors and student loans, as well as a small balance of collateralised synthetic obligations. Some credit card debtors incorporate cap features. These securities are held as part of the Asset and Liability Management portfolio. See Note 16 to the Consolidated Financial Statements.

Other securities

This category comprises a number of structured transactions which are hedged, as appropriate, either on an individual basis or as part of the overall management of the portfolios. See Note 16 to the Consolidated Financial Statements.

Contractual maturities of securities

At 31 December 2011, the Group held no available-for-sale debt securities. Contractual maturities of investments held for trading or classified as fair value through profit or loss are not presented because these securities are held principally for the purpose of selling in the near term or are managed on a fair value basis; in both cases contractual maturity is not reviewed by management.

Significant exposures

The following table sets forth the book value (which equals market value) of securities of individual counterparties where the aggregate amount of those securities exceeded 10% of the Group’s shareholders’ funds at 31 December 2011 as set out in the Consolidated Balance Sheet on page 161. The table also sets forth the classification of the securities in the Consolidated Balance Sheet.

 

     Trading assets
£m
     Available-for-sale
£m
     Total
£m
 

UK Government and UK Government guaranteed

     6,285         —           6,285   
  

 

 

    

 

 

    

 

 

 

LOANS AND ADVANCES TO BANKS

Loans and advances to banks include loans to banks and building societies and balances with central banks (excluding those central bank balances which can be withdrawn on demand).

Loans and advances to banks geographical analysis

The geographical analysis of loans and advances presented in the following table is based on the location of the office from which the loans and advances are made, rather than the domicile of the borrower. The balances below include loans and advances to banks that are classified in the balance sheet as trading assets, financial assets designated at fair value, or loans and receivables securities.

 

     2011
£m
     2010
£m
     2009
£m
     2008
£m
     2007
£m
 

UK

     10,727         13,561         21,606         28,859         12,066   

Non-UK

     861         118         87         3,031         222   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     11,588         13,679         21,693         31,890         12,288   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Further geographical analysis of loans and advances to banks based on the country of domicile of the borrower rather than the office of lending is contained in “Country Risk Exposure” below, including details of balances with other Santander companies.

 

Santander UK plc 2011 Annual Report    39


Table of Contents

Business and Financial Review

Balance Sheet Business Review continued

 

Loans and advances to banks maturity analysis

The following table sets forth loans and advances to banks by maturity at 31 December 2011.

 

     On
demand

£m
     In not more
than three
months

£m
     In more than
three months
but not more
than one year

£m
     In more than
one year but
not more than
five years

£m
     In more than
five years but
not more than
ten years

£m
     In more
than ten

years
£m
     Total
£m
 

UK

     7,421         2,120         75         76         531         504         10,727   

Non-UK

     9         91         59         242         42         418         861   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     7,430         2,211         134         318         573         922         11,588   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Of which:

                    

– Fixed interest rate

     1,100         2,106         —           2         117         188         3,513   

– Variable interest rate

     5,074         101         134         316         456         734         6,815   

– Non interest-bearing

     1,256         4         —           —           —           —           1,260   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     7,430         2,211         134         318         573         922         11,588   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

LOANS AND ADVANCES TO CUSTOMERS

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

Loans and advances to customers geographical analysis

The geographical analysis of loans and advances presented in the following table is based on the location of the office from which the loans and advances are made. Further geographical analysis of loans and advances to customers based on the country of domicile of the borrower rather than the office of lending is contained in “Country Risk Exposure” below, including details of balances with other Santander companies.

The balances below are stated before the deduction for impairment loss allowances and include loans and advances to customers that are classified in the balance sheet as trading assets, financial assets designated at fair value, or loans and receivables securities.

 

     2011
£m
    2010
£m
    2009
£m
    2008
£m
    2007
£m
 

UK

          

Advances secured on residential property

     166,841        166,065        160,457        159,168        110,857   

Corporate loans

     26,278        21,796        18,886        13,181        1,247   

Finance leases

     2,944        2,653        1,602        1,792        —     

Other secured advances

     3,710        3,941        4,079        4,206        2,960   

Other unsecured advances

     7,545        7,734        5,249        6,745        3,263   

Purchase and resale agreements

     6,150        8,641        8,827        1,310        3,711   

Loans and receivables securities

     814        2,075        4,147        5,663        —     

Amounts due from fellow group subsidiaries

     32        57        4,457        2,652        55   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total UK

     214,314        212,962        207,704        194,717        122,093   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-UK

          

Advances secured on residential property

     6        8        9        12        13   

Corporate loans

     —          —          2        103        —     

Other secured advances

     1        1        2        3        2   

Other unsecured advances

     —          —          1        2        2   

Purchase and resale agreements

     188        18        —          —          13,544   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-UK

     195        27        14        120        13,561   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     214,509        212,989        207,718        194,837        135,654   

Less: impairment loss allowances

     (1,563     (1,655     (1,299     (1,001     (551
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total, net of impairment loss allowances

     212,946        211,334        206,419        193,836        135,103   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Detailed analysis of the loans and receivables securities included in the table above is set out in Note 23 to the Consolidated Financial Statements. Further analysis of the impairment loss allowance is set out on page 84 of the Risk Management Report.

No single concentration of loans and advances, with the exception of advances secured on residential properties and corporate loans, as disclosed above, accounts for more than 10% of total loans and advances and no individual country, other than the UK accounts for more than 5% of total loans and advances.

 

40    Santander UK plc 2011 Annual Report


Table of Contents

Business and Financial Review

Balance Sheet Business Review continued

 

Loans and advances to customers maturity analysis

The following table sets forth loans and advances to customers by maturity at 31 December 2011. Overdrafts are included in the “on-demand” category. Advances secured by residential properties are included at their contractual maturity; however, such advances may be repaid early.

 

    On
demand

£m
    In not
more than
three
months

£m
    In more than
three months
but not more
than one year

£m
    In more than
one year but
not more than
five years

£m
    In more than
five years but
not more than
ten years

£m
    In more
than ten
years

£m
    Total
£m
 

UK

             

Advances secured on residential property

    28        904        2,517        15,229        19,612        128,551        166,841   

Corporate loans

    3        3,350        1,318        12,035        2,280        7,292        26,278   

Finance leases

    —          380        762        1,435        150        217        2,944   

Other secured advances

    532        83        254        443        642        1,756        3,710   

Other unsecured advances

    606        900        1,775        3,547        461        256        7,545   

Purchase and resale agreements

    —          6,150        —          —          —          —          6,150   

Loans and receivables securities

    3        95        2        47        62        605        814   

Amounts due from fellow group subsidiaries

    —          32        —          —          —          —          32   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total UK

    1,172        11,894        6,628        32,736        23,207        138,677        214,314   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-UK

             

Advances secured on residential property

    —          —          —          —          2        4        6   

Other secured advances

    —          —          —          1        —          —          1   

Purchase and resale agreements

    —          188        —          —          —          —          188   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-UK

    —          188        —          1        2        4        195   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    1,172        12,082        6,628        32,737        23,209        138,681        214,509   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Of which:

             

– Fixed interest rate

    3        7,739        3,144        11,157        9,679        52,657        84,379   

– Variable interest rate

    1,169        4,343        3,484        21,580        13,530        86,024        130,130   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    1,172        12,082        6,628        32,737        23,209        138,681        214,509   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Group’s policy is to hedge all fixed-rate loans and advances to customers using derivative instruments, or by matching with other on-balance sheet interest rate exposures.

Impairment loss allowances on loans and advances to customers

Details of the Group’s impairment loss allowances policy are set out in Note 1 to the Consolidated Financial Statements. An analysis of end-of-year impairment loss allowances on loans and advances to customers, movements in impairment loss allowances, and Group non-performing loans and advances are set out in the “Loans and Advances” section of the Risk Management Report on page 84 and Note 18 to the Consolidated Financial Statements.

 

Santander UK plc 2011 Annual Report    41


Table of Contents

Business and Financial Review

Balance Sheet Business Review continued

 

Risk elements in the loan portfolio

The disclosure of credit risk elements in this section reflects US accounting practice and classifications. The purpose of the disclosure is to present within the US disclosure framework those elements of the loan portfolios with a greater risk of loss. The main classifications of credit risk elements presented are:

 

   

Impaired loans;

 

   

Unimpaired loans contractually past due 90 days or more as to interest or principal;

 

   

Forbearance;

 

   

Troubled debt restructurings;

 

   

Potential problem loans and advances; and

 

   

Cross border outstandings.

Impaired loans

Loans are classified as impaired when there is objective evidence that not all contractual cash flows will be received. Under IFRS, separate disclosure is required of loans that are neither past due nor impaired, past due but not impaired and impaired. This disclosure may be found in Loans and advances section on page 79 in the “Credit Risk” section of the Risk Management Report.

In accordance with IFRS, the Group recognises interest income on assets after they have been written down as a result of an impairment loss. Interest continues to be accrued on all loans and the element of interest that is not anticipated to be recovered is provided for. Interest income recognised on impaired loans is set out in the Consolidated Financial Statements. The income adjustment in respect of interest that is not anticipated to be recovered was £51m (2010: £60m, 2009: £46m).

Unimpaired loans contractually past due 90 days or more as to interest or principal

In the Retail Banking business, loans and advances are classified as non-performing typically when the customer fails to make payments when contractually due for three months or longer. In the Corporate Banking business, loans and advances are classified as non-performing either when payments are three months or more past due or where there are reasonable doubts about full repayment (principal and interest) under the contractual terms.

Details of the Group’s non-performing loans and advances, including separate disclosure about unimpaired loans contractually past due 90 days or more as to interest or principal, are set out on page 85 in the “Group Non-performing loans and advances” table in the “Credit Risk” section of the Risk Management Report.

Forbearance

To support customers that encounter difficulties, the Group operates forbearance programmes to amend contractual amounts or timings where a customer’s financial distress indicates the potential that satisfactory repayment may not be made within the original terms and conditions of the contract. A range of forbearance strategies are employed in order to improve the management of customer relationships, maximise collection opportunities and, if possible, avoid foreclosure or repossession. Further information can be found on page 85 and in the “Credit Risk - Retail Banking” and “Credit Risk - Corporate Banking” sections of the Risk Management Report.

Troubled debt restructurings

The US Securities and Exchange Commission requires separate disclosure of any loans whose terms have been modified by the lender because of the borrower’s financial difficulties, as a concession that the lender would not otherwise consider. These are classified as troubled debt restructurings (‘TDR’s). Under IFRS, disclosure is required of loans that would otherwise have been classified as past due or impaired whose terms have been renegotiated. This disclosure may be found on page 86 in the “Credit Risk” section of the Risk Management Report.

Potential problem loans and advances

Credit risk elements also cover potential problem loans. These are loans where information on possible credit problems among borrowers causes management to seriously doubt their ability to comply with the loan repayment terms. There are no potential problem loans other than those discussed above, and as discussed in disclosures by division given in the “Credit Risk” section of the Risk Management Report.

Cross border outstandings

Cross border outstandings, as defined by bank regulatory rules, are amounts payable to Santander UK by residents of foreign countries, regardless of the currency in which the claim is denominated, and local country claims in excess of local country obligations. Cross border outstandings consist mainly of loans and advances to customers and banks, finance lease debtors, interest-bearing investments and other monetary assets.

In addition to credit risk, cross border outstandings have the risk that, as a result of political or economic conditions in a country, borrowers may be unable to meet their contractual payment obligations of principal and or interest when due because of the unavailability of, or restrictions on, foreign exchange needed by borrowers to repay their obligations. These cross border outstandings are controlled through a well-developed system of country limits, which are reviewed to avoid concentrations of transfer, economic or political risks.

 

42    Santander UK plc 2011 Annual Report


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Business and Financial Review

Balance Sheet Business Review continued

 

(i) Cross border outstandings exceeding 1% of total assets

At 31 December 2011, 2010 and 2009, the Group had cross border outstandings exceeding 1% of total assets as follows:

 

31 December 2011

   Governments and
official  institutions

£bn
     Banks and other
financial  institutions

£bn
     Other
£bn
     Total
£bn
 

US

     7.1         11.0         1.4         19.5   

Spain

     —           5.5         0.1         5.6   

Switzerland

     1.2         2.7         0.5         4.4