Annual Financial Report - Part 1

Anthony Frost

(Head of UK Corporate Communications)

020 7756 5536

Israel Santos

(Head of Investor Relations)

020 7756 4275

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Trading income increased by 5% largely due to balanced growth in customer loans and deposits and effective margin management. Higher lending margins and healthy underlying new business activity were partially offset by the increased costs of deposit acquisition, market funding and liquid asset balances to meet new regulatory requirements;

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Trading expenses were only 2% higher than last year (flat excluding the impact of acquired businesses) as a result of a successful and ongoing cost management strategy. The synergy benefits realised from the Alliance & Leicester integration have been re-invested to fund growth initiatives across the bank, including the ongoing recruitment in Retail operations to support business growth and improve customer service;

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The combination of tightly controlled costs and revenue growth resulted in a further improvement in the trading cost:income ratio to 41% from 42% a year earlier; and

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Trading provisions of £752m were £50m lower than last year. This was a reflection of the low interest rate environment and better than expected unemployment trends in the UK, as well as our continued collection efforts and the overall quality of our mortgage portfolio. We have preserved conservative levels of coverage, and our arrears and repossession levels have remained significantly better than industry benchmarks from the Council of Mortgage Lenders.

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launched the Santander Zero Current Account to reward eligible customers with the lowest fees in the market, no overdraft charges and fee-free access to ATMs worldwide. Originally available to mortgage customers the offering was subsequently expanded to eligible customers with an investment or savings product and by the end of the year almost 200,000 customers held a Santander Zero Current Account;

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introduced the Loyalty Tracker Bond which offered market-leading fixed-term rates to eligible customers, attracting deposit flows of £1.3bn during the year;

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waived the 3% balance transfer fee on the Zero Credit Card for all existing customers with a mortgage or a current account with Santander UK or Alliance & Leicester;

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kept the Flexi-ISA open for Santander UK Current Account customers; and

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increased the loan to value ('LTV') to 90% on mortgages exclusively available to customers who hold their primary current account with Santander UK, while maintaining prudent lending policies.

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projections or expectations of revenues, costs, profit (or loss), earnings (or loss) per share, dividends, capital structure or other financial items or ratios;

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statements of plans, objectives or goals of Santander UK or its management, including those related to products or services;

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statements of future economic performance; and

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statements of assumptions underlying such statements.

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the effects of UK economic conditions (e.g. recent decline in housing market, rising unemployment, increased taxation and reduced public spending);

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the effects of conditions in global financial markets (e.g. increased market volatility, reduced credit availability and increased commercial and consumer loan delinquencies);

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

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

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

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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;

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the effects of fluctuations in interest rates, foreign exchange rates, basis spreads, bond and equity prices and other market factors;

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the extent to the Group may be required to record negative fair value adjustments for its financial assets due to changes in market conditions;

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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);

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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;

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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 new business;

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

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

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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;

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

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the effects of taxation requirements and any changes thereto in each location in which the Group operates (e.g. the bank levy in the UK);

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the effects of the proposed reform and reorganisation of the structure of the UK financial regulatory authorities and of the UK regulatory framework that applies to members of the Group;

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

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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;

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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;

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the effects which the UK Banking Act 2009 may have, should the HM Treasury, the Bank of England and/or the FSA exercise their powers under this Act in the future against the Company;

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the Group's dependency on its information technology systems;

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

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

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Santander UK's success at managing the risks to which the Group is exposed, including the items above.

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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;

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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 which is a facility that offers preferential dealers funding in the UK; and

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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.

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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. Alison Brittain heads retail distribution, business banking, e-commerce and the intermediary channel, while Rami Aboukhair is responsible for private banking.

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Corporate Banking - offers banking services principally to small and medium-sized ('SME') UK companies. It also contains certain non-core portfolios. This division is headed by Steve Pateman.

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Global Banking & Markets - provides financial markets sales, trading and risk management services, as well as manufacturing retail structured products. This division is headed by Luis de Sousa.

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Group Infrastructure - This unit includes Asset & Liability Management, Economics, Group Capital and Funding and is headed by Justo Gómez.

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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 Miguel-Ángel Rodríguez-Sola.

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Human Resources - responsible for delivering the human resources strategy and personnel support. This division is headed by Karen Fortunato.

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

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

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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 Jorge de la Vega.

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Financial Planning, Financial Reporting and Tax, Cost Management & Control - This unit is headed by Mónica Cueva.

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Corporate Services - This unit includes Legal, Secretariat, Compliance and Regulatory Risk Management is headed by Karen Fortunato.

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Service Quality - This unit is headed by Miguel-Ángel Rodríguez-Sola, with Chief Executive Officer oversight given the importance of service quality.

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Communications - This unit reports to Ana Botín.

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Santander Universities in the UK - This unit reports to Rami Aboukhair, with Chief Executive Officer oversight in line with the global Universities structure.

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Business Review Summary - this contains an explanation of the basis of Santander UK's results and any potential changes to that basis in the future; a summarised consolidated income statement with commentary thereon by line item for each segment; a summary of the nature of adjustments between Santander UK's statutory basis of accounting (as described in Note 1 to the Consolidated Financial Statements) and Santander UK's management basis of accounting (known as the "trading" basis);

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Key Performance Indicators - this contains a description of the key measures used by management in assessing the success of the business against its strategies and objectives;

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Divisional results - this contains a supplementary summary of the results, and commentary thereon, for each segment. Additional information is provided for the Retail Banking segment due to its significance to the Group's results;

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

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

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

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Off-Balance Sheet disclosures - a summary of Santander UK's off-balance sheet arrangements, their business purpose, and importance to Santander UK;

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Capital disclosures - an analysis of Santander UK's capital needs and composition; and

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Liquidity disclosures - an analysis of Santander UK's sources and uses of liquidity and cash flows.

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Retail Banking;

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Corporate Banking;

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Global Banking & Markets; and

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Group Infrastructure.

2010

£m

2009

£m

2008

£m

Net interest income

3,814

3,412

1,772

Non-interest income

1,220

1,284

1,232

Total operating income

5,034

4,696

3,004

Administrative expenses

(1,793)

(1,848)

(1,343)

Depreciation and amortisation

(275)

(260)

(202)

Total operating expenses excluding provisions and charges

(2,068)

(2,108)

(1,545)

Impairment losses on loans and advances

(712)

(842)

(348)

Provisions for other liabilities and charges

(129)

(56)

(17)

Total operating provisions and charges

(841)

(898)

(365)

Profit before tax

2,125

1,690

1,094

Taxation charge

(542)

(445)

(275)

Profit for the year

1,583

1,245

819

Attributable to:

Equity holders of the parent

1,544

1,190

811

Non-controlling interest

39

55

8

Core Tier 1 capital ratio (%)

11.5%

6.8%

6.2%

Tier 1 capital ratio (%)

14.8%

9.5%

8.5%

Risk weighted assets(1)

73,563

67,438

63,425

2010

£m

2009

£m

2008

£m

Retail Banking

3,138

2,840

1,606

Corporate Banking

191

182

(3)

Global Banking & Markets

6

7

2

Group Infrastructure

479

383

167

3,814

3,412

1,772

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Retail Banking net interest income of £3,138m increased by £298m from £2,840m in 2009, an increase of 10%. The increase was largely driven by balanced growth in customer lending and deposits across a mix of products combined with effective margin management. Retail Banking customer assets increased by £10.1bn or 6% (of which £5.7bn or 3% reflected the inclusion of the Santander Cards and Santander Consumer businesses acquired in October and November 2010, respectively). Retail Banking customer liabilities increased by £6.8bn or 5%.

The key drivers of the increase in 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 in response to new regulatory requirements. Retail Banking net interest income also included £75m relating to the Santander Cards and Santander Consumer businesses which were acquired in October and November 2010, respectively.

In terms of mortgage lending, the Group achieved an 18% share of the gross mortgage lending market in the UK in 2010, similar to 2009 and significantly ahead of our market share of mortgage stock of 14%. Lending was written at margins above stock margin and with a continued emphasis on lower loan-to-value segments. In total, net lending was £5.6bn.

The growth of customer deposits benefited from a 22% increase in private banking deposits, and a 9% increase in personal bank account liability balances, as well as a good performance in core savings underpinned by a strong tax year and "loyalty" offers.

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Corporate Banking net interest income of £191m increased by £9m from £182m in 2009. The increase was primarily driven by growth in customer loans and deposits to the UK SME market through our network of 25 Corporate Business Centres (SME lending balances increased by 26% and total deposit balances increased by 14%). 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.

This was in part offset by a reduced contribution of £20m from the non-core portfolio as Corporate Banking continued to reduce balances of the non-core assets.

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Global Banking & Markets net interest income of £6m decreased by £1m from £7m in 2009. The decrease was due to increased funding costs offsetting customer asset growth.

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Group Infrastructure net interest income of £479m increased by £96m from £383m in 2009. The income reflected the 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.

This was partially offset by a decrease in 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.

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Retail Banking net interest income of £2,840m increased by £1,234m from £1,606m in 2008. Of the total increase, £690m represented the inclusion of the net interest income in 2009 of Alliance & Leicester. The remaining increase of £544m was largely driven by balanced growth in customer lending and deposits across a mix of products combined with effective margin management, as well as a 17% growth in bank account liability balances and hedging strategies which helped to offset the impact of lower interest rates.

In terms of lending, unsecured lending balances continued to decline, but were more than offset by net mortgage lending of £7.6bn in 2009. The increase in mortgage lending resulted in the Group taking an 18% share of the gross mortgage lending market in the UK in 2009, with new lending written at margins above the existing loan stock margin and with an emphasis on lower Loan-to-Value segments.

In addition, income from existing mortgage balances increased as more customers reverted to standard variable rate mortgages, and margins improved in both the mortgage and unsecured loan portfolios in the low interest rate environment which more than offset the cost of new deposits.

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Corporate Banking net interest income of £182m increased by £185m from (£3m) in 2008. Of the total increase, £88m represented the inclusion of the net interest income in 2009 of Alliance & Leicester. The remaining increase of £97m reflected in part the sale of the Porterbrook businesses early in December 2008 (net interest income in 2008 included interest expense of £76m incurred by the Porterbrook businesses, whereas its associated leasing income was classified as non-interest income).

In addition, 2009 reflected some benefit from higher asset margins as new business lending and pricing was altered to reflect the market environment in terms of increased funding costs. Net interest income also improved as a result of robust growth of both assets and liabilities. However, this was partly offset by the adverse impact of changes to transfer pricing arrangements to reflect higher costs of new term funding and liquid asset balances.

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Global Banking & Markets net interest income of £7m increased by £5m from £2m in 2008. Net interest income increased by £6m as a result of the inclusion of the net interest income in 2009 of Alliance & Leicester. However, this was partially offset by a reduction in loan balances during the year.

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Group Infrastructure net interest income of £383m increased by £216m from £167m in 2008. Of the total increase, £56m represented the inclusion of the net interest income in 2009 of Alliance & Leicester. The remaining increase of £160m reflected the 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.

2010

£m

2009

£m

2008

£m

Retail Banking

596

689

611

Corporate Banking

194

202

249

Global Banking & Markets

412

382

326

Group Infrastructure

18

11

46

1,220

1,284

1,232

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Retail Banking non-interest income of £596m decreased by £93m from £689m in 2009. The decrease 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%), while mortgage fees were adversely affected by lower redemption volumes in line with the market and banking fees were affected by the introduction of the Santander Zero account.

Retail Banking non-interest income included £8m relating to the Santander Cards and Santander Consumer businesses which were acquired in October and November 2010, respectively.

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Corporate Banking non-interest income of £194m decreased by £8m from £202m in 2009. Asset growth in the core business and strong sales of Global Banking & Markets products resulted in higher fees. However, this was more than offset by lower fees in non-core businesses as Corporate Banking continued to reduce balances in the non-core portfolio.

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Global Banking & Markets non-interest income of £412m increased by £30m from £382m in 2009, 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. These benefits were partly offset by a less favourable trading environment resulting from lower spread volatility.

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Group Infrastructure non-interest income of £18m increased by £7m from £11m in 2009. The increase reflected non-recurring gains reported in 2010. These gains included 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 on disposal of certain businesses in the period of approximately £39m, including James Hay.

This was largely offset by hedge ineffectiveness in 2010. In 2009, mark-to-market gains that arose in 2008 reversed but credit spreads did not change significantly, resulting in the recognition of losses. In addition, 2009 included certain one-off 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 non interest income from the James Hay business which was sold in March 2010.

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Retail Banking non-interest income of £689m increased by £78m from £611m in 2008. Of the total increase, £174m represented the inclusion of the non-interest income in 2009 of Alliance & Leicester. The remaining decrease of £96m was largely due to lower fees on unsecured lending products, as part of our stated strategy to reduce unsecured lending exposures, as well as lower fees from current accounts due to repricing.

In addition, mortgage fees were adversely impacted by a reduction in the volume of mortgage redemptions given decreased activity in the market as a result of declining house prices and lower levels of supply.

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Corporate Banking non-interest income of £202m decreased by £47m from £249m in 2008. Non-interest income increased by £161m as a result of the inclusion of the non-interest income in 2009 of Alliance & Leicester. However, this was more than offset by a decrease of £265m reflecting the inclusion in non-interest income in 2008 of the leasing income relating to the Porterbrook businesses which were sold early in December 2008.

In addition, new business lending generated increases in both fees and cross-selling of Global Banking & Markets products.

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Global Banking & Markets non-interest income of £382m increased by £56m from £326m in 2008. Non-interest income increased by £1m as a result of the inclusion of the non-interest income of Alliance & Leicester. The remaining increase of £55m reflected strong performances in the equity business (linked to sales of retail products through the branch network) and short term markets business, which benefited from a favourable trading environment available from wider spreads in an illiquid market.

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Group Infrastructure non-interest income of £11m decreased by £35m from non interest income of £46m in 2008. Alliance & Leicester contributed £77m of non-interest income in 2009. The remaining decrease of £112m in the year reflected mark-to-market losses and lower gains in 2009 on the buy-back of debt securities compared to 2008.

Substantial mark-to-market gains arose in the second half of 2008 from movements in interest rates, which were more than offset by losses due to widening asset spreads. In 2009, the mark-to-market gains reversed, but the credit spreads did not change significantly, resulting in the recognition of losses. In addition, 2008 included the profit on disposal of the Porterbrook business not repeated in 2009.

2010

£m

2009

£m

2008

£m

Retail Banking

1,473

1,533

1,151

Corporate Banking

144

168

45

Global Banking & Markets

128

101

104

Group Infrastructure

48

46

43

1,793

1,848

1,343

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Retail Banking administrative expenses of £1,473m decreased by £60m from £1,533m in 2009. The decrease 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, the synergy benefits realised have been re-invested to fund growth initiatives across the Group, including the ongoing recruitment in Retail Banking operations to support business growth and improve customer service. Retail Banking administrative expenses included £35m of expenses relating to the Santander Cards and Santander Consumer businesses which were acquired in October and November 2010, respectively.

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Corporate Banking administrative expenses of £144m decreased by £24m from £168m in 2009. The decrease was due to operational efficiencies arising from the integration of Alliance & Leicester, partially offset by investment in the Corporate Business Centre network. The investment included hiring an additional 136 staff over the last twelve months and an increase of 70% in the floor space of the Corporate Business Centre network.

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Global Banking & Markets administrative expenses of £128m increased by £27m from £101m in 2009, reflecting ongoing investment in growth initiatives relating to new products, markets and customer segments. There was a 38% increase in headcount across the customer transaction businesses including the new Gilt Edge Market Making desk.

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Group Infrastructure administrative expenses of £48m increased by £2m from £46m in 2009, reflecting non-recurring expenditure 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 partially offset by savings due to the sale of the James Hay business in March 2010.

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Retail Banking administrative expenses of £1,533m increased by £382m from £1,151m in 2008. Of the total increase, £373m represented the inclusion of the administrative expenses in 2009 of Alliance & Leicester. A further £61m of the increase was due to expenses related to the Bradford & Bingley savings business since its acquisition in September 2008. The remaining administrative expenses decrease was largely due to the removal of duplications across back office and support functions due to the integration of Alliance & Leicester and the Bradford & Bingley savings business.

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Corporate Banking administrative expenses of £168m increased by £123m from £45m in 2008. Of the total increase, £128m represented the inclusion of the administrative expenses in 2009 of Alliance & Leicester. The remaining decrease of £5m was due to operational efficiencies arising from the integration of Alliance & Leicester and the sale of the Porterbrook business.

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Global Banking & Markets administrative expenses of £101m were slightly lower than £104m in 2008, reflecting strong expense management while increasing income.

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Group Infrastructure administrative expenses of £46m increased by £3m from £43m in 2008, reflecting a slight increase in central costs following the Transfer of Alliance & Leicester and the acquisition of the Bradford & Bingley savings business.

2010

£m

2009

£m

2008

£m

Retail Banking

201

170

82

Corporate Banking

72

87

117

Global Banking & Markets

2

3

3

275

260

202

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Retail Banking depreciation and amortisation of £201m increased by £31m from £170m in 2009. The increase resulted from the continued investment in IT systems in Santander UK in 2009 and 2010 and the integration of Alliance & Leicester and the Bradford & Bingley savings business.

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Corporate Banking depreciation and amortisation of £72m decreased by £15m from £87m in 2009. The decrease reflected lower operating lease depreciation due to lower balances in the non-core portfolio following the continued de-leveraging process.

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Global Banking & Markets depreciation and amortisation of £2m was broadly flat compared with 2009.

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Retail Banking depreciation and amortisation of £170m increased by £88m from £82m in 2008. Of the total increase, £35m represented the inclusion of the depreciation and amortisation in 2009 of Alliance & Leicester. The remaining increase of £53m was largely driven by a full year of depreciation of, and further investment in, our IT platform Partenon and increased depreciation costs as a result of growing our lending to SMEs.

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Corporate Banking depreciation and amortisation of £87m decreased by £30m from £117m in 2008. Alliance & Leicester contributed £87m in 2009. The remaining decrease reflected the sale of the Porterbrook businesses which had contributed depreciation expense of £117m in 2008.

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Global Banking & Markets depreciation and amortisation of £3m was unchanged from £3m in 2008.

2010

£m

2009

£m

2008

£m

Retail Banking

615

714

309

Corporate Banking

97

31

(6)

Group Infrastructure

-

97

45

712

842

348

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Retail Banking impairment losses on loans and advances of £615m decreased by £99m from £714m in 2009, with the most significant reduction relating to mortgages. This improving performance in difficult economic conditions has been delivered as a result of a high quality mortgage book, effective collection handling and reductions in arrears levels, particularly in the second half of 2010.

Similarly, performance across the unsecured portfolios improved during the year. However, the commercial mortgages book demonstrated some stress from adverse market conditions with the charge for the year increasing to £63m (2009: £31m). Retail Banking impairment losses on loans and advances included £33m relating to the Santander Cards and Santander Consumer businesses which were acquired in October and November 2010, respectively.

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Corporate Banking impairment losses on loans and advances of £97m increased by £66m from £31m in 2009. The increase reflected growth and maturity in asset balances over the last two years and some deterioration arising from market conditions. The non-core Corporate Banking portfolios continued to perform in line with our original expectations, with existing impairment loss allowances expected to be sufficient to cover losses inherent in the portfolios.

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Group Infrastructure impairment losses on loans and advances decreased to £nil from £97m in 2009. The overall loss of £nil in 2010 was due to losses and recoveries on disposals of assets in the Treasury asset portfolio offsetting each other whereas in 2009 there were overall losses on disposal.

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Retail Banking impairment losses on loans and advances of £714m increased by £405m from £309m in 2008. Of the total increase, £94m represented the inclusion of Alliance & Leicester's impairment losses in 2009. The remaining increase of £311m was distributed across all products with the largest increase relating to mortgages, as the impact of falling house prices and the lagging effect of unemployment, as expected, started to emerge. Most of the impact came through in the first half of the year, with the second half performance stabilising and in some areas improving.

With respect to mortgages, the second half of the year saw a slower rate of growth in arrears, with fewer losses than observed earlier in the year, in part as a result of collection activities and mitigating actions taken, but also due to the low interest rate environment and the slight upturn in house prices. A strong mortgage coverage ratio of close to 20% was preserved.

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Corporate Banking impairment losses on loans and advances of £31m increased by £37m from a £6m release in 2008. Of the total increase, £4m represented the inclusion of Alliance & Leicester's impairment losses in 2009. The low level of impairment losses was a reflection of prudent lending criteria on the relatively immature growth businesses and portfolios (such as SME lending within Corporate Banking). It also reflected impairment loss allowances made on acquisition relating to the non-core portfolios (including aviation and shipping) to reflect expected losses in those portfolios as required under acquisition accounting. The remaining increase of £33m reflected the non-recurrence in 2009 of Corporate Banking impairment loss allowance releases in 2008 relating to non-core businesses and some deterioration arising from market conditions.

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Group Infrastructure impairment losses on loans and advances of £97m increased by £52m from £45m in 2008. Alliance & Leicester contributed £97m in 2009 in respect of the Treasury asset portfolio. The remaining decrease of £45m principally relates to the non-recurrence in 2009 of other impairment loss charges incurred in 2008.

2010

£m

2009

£m

2008

£m

Total non-performing loans ('NPLs')

3,717

3,613

2,378

Total Group customer assets(1, 2)

202,090

190,067

183,345

Total impairment loss allowances

1,655

1,299

1,001

%

%

%

NPLs as a % of customer assets

1.84

1.90

1.30

Coverage ratio(3)

44.53

35.95

42.09

Mortgages:

NPLs as a % of customer assets

1.41

1.52

0.97

Coverage ratio(3)

22.45

19.87

24.03

2010

£m

2009

£m

2008

£m

Retail Banking

129

56

17

129

56

17

2010

£m

2009

£m

2008

£m

Profit before tax

2,125

1,690

1,094

Tax calculated at a tax rate of 28% (2009: 28%, 2008: 28.5%)

595

473

310

Non taxable gain on sale of subsidiary undertakings

(11)

(5)

(11)

Non deductible preference dividends paid

8

8

8

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

(24)

-

-

Effect of non-allowable impairment losses, provisions and other non-equalised items

-

51

19

Non-taxable dividend income

-

(4)

(5)

Effect of non-UK profits and losses

(6)

(8)

(8)

Utilisation of capital losses for which credit not previously recognised

-

(3)

-

Effect of change in tax rate on deferred tax provision

11

-

-

Adjustment to prior year provisions

(31)

(67)

(38)

Tax expense

542

445

275

Effective tax rate

25.5%

26.3%

25.1%

> 

Alliance & Leicester pre-acquisition trading basis results - Following the transfer of Alliance & Leicester plc to the Company in January 2009, the statutory results for the years ended 31 December 2010 and 2009 include the results of the Alliance & Leicester business, whereas the statutory results for the year ended 31 December 2008 do not. In order to enhance the comparability of the results for the three periods, management reviews the 2008 results including the pre-acquisition results of the Alliance & Leicester business for that period.

> 

Reorganisation and other costs - These comprise implementation costs in relation to strategic change and cost reduction projects, including integration-related expenses, certain impairment losses taken centrally, as well as costs in respect of customer remediation. Management needs to understand the underlying drivers of the cost base that will remain after these exercises are complete, and does not want this view to be clouded by these costs, which are managed independently.

> 

Depreciation of operating lease assets - The operating lease businesses are managed as financing businesses and, therefore, management needs to see the margin earned on the businesses. Residual value risk is separately managed. As a result, the depreciation is netted against the related income.

> 

Profit on part sale and revaluation of subsidiaries - These profits are excluded from the results to allow management to understand the underlying performance of the business. In 2010, the profit 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 on the sale of James Hay and certain other businesses were excluded. In 2009 there were no such profits. In 2008, the profit on the sale of the Porterbrook businesses was excluded from the trading results.

> 

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

> 

Capital and other charges - These principally comprise internal nominal charges for capital invested in the Group's businesses. Management implemented this charge to assess the effectiveness of capital investments.

Key performance indicator

Note

2010

2009

2008

Trading income

1

£4,870m

£4,658m

£3,894m

Trading cost:income ratio

2

41%

42%

50%

Profit for the year

3

£1,583m

£1,245m

£819m

Commercial Banking margin

4

1.91%

1.76%

1.33%

Total number of employees

5

19,848

19,483

22,669

Market share of mortgage stock

6

13.88%

13.50%

12.90%

Loan-to-deposit ratio

7

123%

126%

136%

Loan-to-value ratio of mortgage stock (indexed)

8

51%

52%

51%

Risk-weighted assets (1)

9

£73,563m

£67,438m

£63,425m

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 25 to 38.

Management reviews trading income in order to assess the Group's effectiveness in obtaining new customers and business. Management's target for trading income has historically been growth of between 5% and 10% per annum. Trading revenue growth in 2010 compared with 2009 was just under 5%, and in 2009 compared with 2008 was 20%. Performance has been adversely impacted by the prolonged low interest rate environment, cost of medium term funding and cost of higher liquidity holdings as a result of new regulatory requirements. This impact is expected to increase in future periods resulting in slower revenue growth relative to recent trends.

2.

Trading cost:income ratio

Trading cost:income ratio is defined as trading expenses divided by 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 25 to 38.

Management reviews the trading cost:income ratio in order to measure the operating efficiency of the Group. Management's target for the trading cost:income ratio is to achieve sustained improvements from the level of 50% (including the impact of Alliance & Leicester) achieved in 2008. In 2009 and 2010, this target was met and the cost:income ratio decreased to 42% and 41% respectively. Management expects to maintain the cost:income ratio at similar levels, although the recently acquired Santander Cards and Santander Consumer businesses are expected to initially increase this ratio, as is the adverse impact of increased regulatory liquid asset balances on revenue performance.

3.

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 11 to 21.

Management reviews the profit for the year in order to monitor the effectiveness of the Group's strategy and to increase the strength of its capital base and its capacity to pay dividends. Management's target for the profit for the year is to achieve sustained growth over the previous year, and this was achieved in 2010, 2009 and 2008.

In order to ensure that targets related to the above three key performance indicators were met, management also evaluated other measures which are set out below as critical drivers towards achieving the three key performance indicators above on a sustainable basis.

4.

Commercial Banking margin

Commercial Banking margin is defined as the trading net interest income (adjusted to remove net interest income from the run-down Treasury asset portfolio) over 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 25 to 38.

Management reviews the Commercial Banking margin in order to assess the economic sustainability of its commercial banking products and operations. Management's target for the Commercial Banking margin is to ensure that it is appropriate for the current market conditions and profit targets. This target was met in 2010, 2009 and 2008 given the improvements in the margin and strong reported profit growth, despite margins in the second half of 2010 being negatively impacted by the increased cost of holding higher liquid asset balances in response to new regulatory requirements, which is expected to continue in 2011.

5.

Total number of employees

Total number of employees is measured at the year-end and calculated on a full-time equivalent basis. As part of the planning process, headcount targets are set for each division and reviewed on a monthly 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 2010, headcount was increased by 365 full-time equivalents, principally as a result of the investment in Retail Banking operations to support business growth and improve customer service together with the acquisition of the Santander Cards and Santander Consumer businesses 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, the acquisition of the Bradford & Bingley savings business and the sale of James Hay in March 2010. In 2009, headcount was reduced by 3,186 full-time equivalents in line with our stated intentions to remove duplicated back office and support functions following the transfer of Alliance & Leicester plc and the acquisition of the Bradford & Bingley savings business.

6.

Market share of mortgage stock

Market share of mortgage stock represents the book value of the Group's mortgage assets as a percentage of the total book value of mortgages in the UK market, and is measured at the year-end. Market share of mortgage stock is calculated by reference to data on the size of the UK mortgage market produced by the Bank of England. Discussion and analysis of this data is set out in the "Business Review - Divisional results" on pages 25 to 38.

Management reviews market share of mortgage stock as one of the measures to assess the Group's effectiveness in obtaining new customers. Management's target for market share of mortgage stock in 2008 was to maintain the Group's historical market share of mortgage stock of approximately 10%, subject to earning an appropriate margin. Following the transfer of Alliance & Leicester plc to the Group in 2009, the Group's target for market share of mortgage stock was updated to 15% over the medium term, to reflect the Group's combined market share (approximately 13% at 31 December 2009). In 2010 and 2009, market share increased by 0.38% and 0.6%, respectively, driven by profitable new business acquisition and successful retention strategies.

7.

Loan-to-deposit ratio

Management places a significant emphasis on the loan-to-deposit ratio as part of its focus on maintaining a sustainable funding model. The loan-to-deposit ratio represents the book value of the Group's commercial assets (i.e. retail and corporate assets) divided by its commercial liabilities (i.e. retail and corporate deposits) and shareholders' equity, and is measured at the year-end. Discussion and analysis of the loan-to-deposit ratio is set out in the Chief Executive Officer's Review on page 2 and in the Directors' Report on page 138.

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 wholesale markets while improving its customer product holdings. Management's target for the Loan-to-Deposit ratio is sustained improvements in future years subject to competitive conditions. During 2010 and 2009, Santander UK continued to achieve strong commercial net lending growth which was more than matched by a larger increase in net deposit flows, resulting in further improvements in our Loan-to-Deposit ratio to 123% (2009: 126%, 2008: 136%).

8.

Loan-to-value ('LTV') ratio on mortgage stock (indexed)

As a result of the difficult economic environment, management placed a significant emphasis on the LTV ratio on mortgage stock in order to ensure that the profit target be achieved. The LTV ratio is calculated as the book value of the Group's residential mortgages as a percentage of the estimated current market value of the properties against which the mortgages are secured. The current market value is estimated from house price indices by adjusting the value of the property at the time of the origination of the mortgage for changes in house prices from that date to the balance sheet date. The LTV ratio is a measure of the estimated current level of security that the Group possesses on its mortgage loans.

Management reviews the LTV ratio in order to assess the Group's potential resilience to future declines in property prices. Management's target for the LTV ratio is, subject to market conditions, to sustain a LTV ratio of less than 60%. During 2010 and 2009, the Group has continued to focus on the quality of new lending based on affordability and lower LTV segments.

The average LTV on stock value at 31 December 2010 of 51% was slightly lower than at the end of the previous year (2009: 52%) due to the continuing focus on managing the portfolio in line with Santander UK's risk appetite. The average LTV on mortgage stock at 31 December 2009 was slightly higher than at the end of 2008 at 52% (2008: 51%), due to the effects of falling house prices more than offsetting lower LTVs on new business.

9.

Risk-weighted assets

Risk-weighted assets are a measure of a bank's assets adjusted for their associated risks. Risk weightings are established in accordance with the Basel Capital Accord as implemented by the UK Financial Services Authority. In accordance with those requirements, risk-weighted assets at 31 December 2008 included 35.6% of Alliance & Leicester plc's risk weighted assets at that date, reflecting Santander UK's ownership of that percentage of Alliance & Leicester plc's ordinary share capital on that date.

Management reviews risk-weighted assets in order to determine how the regulatory capital of the Group is being utilised, and to understand the risk-adjusted trends of the Group's assets. Management's target for risk-weighted assets is for modest growth consistent with maintaining a strong Tier 1 ratio.

At 31 December 2010, risk-weighted assets of £73,563m increased by 9.1% from 31 December 2009. In 2010, although core business volumes increased, these increases were offset by de-leveraging of certain non-core portfolios. There was an additional increase in risk weighted assets due to the acquisition of the Santander Cards and Santander Consumer businesses. At 31 December 2009, risk-weighted assets of £67,438m increased by 6.3% from 31 December 2008. Although core business volumes increased, the increases were offset by de-leveraging of certain non-core portfolios and enhancements to retail IRB models.

Retail Banking

£m

Corporate Banking

£m

Global Banking

& Markets

£m

Group Infrastructure

£m

Total

£m

Net interest income

3,237

212

6

302

3,757

Non-interest income

627

129

412

(55)

1,113

Total trading income

3,864

341

418

247

4,870

Total trading expenses

(1,649)

(151)

(130)

(48)

(1,978)

Impairment losses on loans and advances

(615)

(97)

-

(40)

(752)

Provisions for other liabilities and charges

1

-

-

-

1

Trading profit before tax

1,601

93

288

159

2,141

Adjust for:

- Reorganisation 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

(99)

(21)

-

120

-

Profit before tax

1,316

72

288

449

2,125

Retail

Banking

£m

Corporate Banking

£m

Global Banking

& Markets

£m

Group Infrastructure

£m

Total

£m

Net interest income

2,886

212

7

236

3,341

Non-interest income

720

128

382

87

1,317

Total trading income

3,606

340

389

323

4,658

Total trading expenses

(1,613)

(181)

(104)

(46)

(1,944)

Impairment losses on loans and advances

(714)

(31)

-

(57)

(802)

Trading profit before tax

1,279

128

285

220

1,912

Adjust for:

- Reorganisation and other costs

(146)

-

-

(40)

(186)

- Hedging and other variances

(17)

-

-

(19)

(36)

- Capital and other charges

(60)

(30)

-

90

-

Profit before tax

1,056

98

285

251

1,690

Retail

 Banking

£m

Corporate Banking

£m

Global Banking

& Markets

£m

Group Infrastructure

£m

Total

£m

Net interest income/(expense)

2,253

149

11

(24)

2,389

Non-interest income

848

240

327

90

1,505

Total trading income

3,101

389

338

66

3,894

Total trading expenses

(1,551)

(239)

(107)

(43)

(1,940)

Impairment losses on loans and advances

(442)

(44)

-

(3)

(489)

Trading profit before tax

1,108

106

231

20

1,465

Adjust for:

- A&L pre-acquisition trading basis results

(254)

(2)

(10)

102

(164)

- Reorganisation and other costs

(121)

-

-

(42)

(163)

- Profit on part sale and revaluation of subsidiaries

-

-

-

40

40

- Hedging and other variances

(8)

-

-

(76)

(84)

- Capital and other charges

(67)

(14)

-

81

-

Profit before tax

658

90

221

125

1,094

Trading profit before tax of £2,141m increased by £229m on the previous year (2009: £1,912m), driven by strong income growth and reduced impairment losses.

> 

Retail Banking trading profit before tax increased by £322m to £1,601m (2009: £1,279m) driven by a strong increase in trading income and reduced impairment losses, with the most significant reduction in impairment losses relating to mortgages. Trading income benefited from balanced growth in customer lending and deposits, combined with effective margin management. In addition, more customers reverted to standard variable rate mortgages, and margins on new business improved in both the mortgage and unsecured loan portfolios in the low interest rate environment. This more than offset the higher cost of retail deposits, the impact of low interest rates, the cost of new term funding and higher costs of liquidity under the UK's new liquidity regime.

These positive income trends were partly offset by lower investment fees combined with lower volume-driven fees on unsecured lending products and mortgage redemptions, and lower banking fees due to the introduction of the Santander Zero account. Retail Banking trading profit before tax includes £14m relating to the Santander Cards and Santander Consumer businesses which were acquired in October and November 2010 respectively.

> 

Corporate Banking trading profit before tax decreased by £35m to £93m (2009: £128m). This movement was due to higher impairment losses reflecting the growth and maturity in asset balances over the last two years and some deterioration arising from market conditions, partially offset by lower operating expenses benefiting from integration synergies. Trading income was flat, largely due to the reduction in the non-core portfolio which resulted in income £30m lower than the prior year. This was offset by growth in lending balances to SMEs, and deposits from core corporate customers.

> 

Global Banking & Markets trading profit before tax increased by £3m to £288m (2009: £285m). Trading income increased, 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. These benefits were partly offset by a less favourable trading environment resulting from lower spread volatility. Trading expenses reflected ongoing investment in growth initiatives relating to new products, markets and customer segments.

> 

Group Infrastructure trading profit before tax decreased by £61m to £159m (2009: £220m). This movement reflected the sale of James Hay in March 2010, and less income earned on the run-down Treasury asset portfolio due to the continued de-leveraging process, with balances reduced by 46% in the year. In addition, certain one-off benefits in 2009 were not repeated in 2010, including profits earned on the buy-back of securitisation debt in 2009. This was offset by the 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.

Trading profit before tax of £1,912m increased by £447m on the previous year (2008: £1,465m), driven by strong income growth which exceeded the increase in impairment losses, as well as continued cost control. Trading expenses showed a small increase, due to the inclusion of £98m of Bradford & Bingley savings business related costs following its acquisition in September 2008, which was partially offset by a reduction in other trading expenses resulting from integration benefits from Alliance & Leicester. Santander UK remains on track to deliver targeted cost savings of £180m by 2011.

> 

Retail Banking trading profit before tax increased by £171m to £1,279m (2008: £1,108m) driven by a strong increase in trading income, partly offset by higher trading expenses and impairment losses. Trading income benefited from a significant improvement in mortgage margins both in terms of new lending and retention of existing business, as well as increased retention levels on standard variable rate and other longer term products. In addition, the Retail Banking business delivered strong growth in customer deposits, together with effective management of deposit margins in a low interest rate environment. There was also a significant increase in bank account openings and investment product sales. These positive income trends were partly offset by lower fee income from current accounts, a reduction in the volume of mortgage redemptions and lower unsecured lending volumes. Trading expenses increased mainly due to the inclusion of a full year of Bradford & Bingley savings business related expenses. The increase in impairment losses was largely attributable to the residential mortgage and unsecured personal loans portfolios reflecting the impact of market conditions, albeit with mortgage arrears tracking better than expectations and significantly better than our UK peers.

> 

Corporate Banking trading profit before tax increased by £22m to £128m (2008: £106m). This movement was due to lower operating expenses benefiting from integration synergies and lower impairment losses. Trading income benefitted from higher asset margins as well as robust growth of both assets and liabilities of the core business, albeit this was more than offset by a reduction of £29m caused by reduced balances in the non-core book and the significant increase in the cost of funding being incurred on both the core and non-core books.

> 

Global Banking & Markets trading profit before tax increased by £54m to £285m (2008: £231m) due predominantly to strong income performances in the equity business (linked to sales of retail products through the branch network) and short term markets business, which benefited from a favourable trading environment available from wider spreads in an illiquid market.

> 

Group Infrastructure trading profit before tax increased by £200m to £220m (2008: £20m) reflecting the 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.

2010

2009

2008(1)

Combined volumes(2)

 2008

Mortgages:(3)

Gross mortgage lending in the year

£24.2bn

£26.4bn

£31.8bn

£35.2bn

Capital repayments in the year

£18.6bn

£18.8bn

£20.7bn

£29.1bn

Net mortgage lending in the year

£5.6bn

£7.6bn

£11.1bn

£6.1bn

Mortgage stock balance

£172.4bn

£166.9bn

£159.3bn

-

Market share - gross mortgage lending(4)

18.0%

18.4%

12.4%

13.9%

Market share - capital repayments(4)

14.6%

14.3%

9.5%

13.7%

Market share - mortgage stock(4)

13.9%

13.5%

12.9%

-

Unsecured personal lending:

Gross unsecured personal lending in the year

£1.3bn

£1.5bn

£0.9bn

£2.4bn

  Unsecured personal lending stock balance(5)

£4.0bn

£5.0bn

£6.3bn

-

SME lending:

SME lending stock balance

£8.5bn

£6.7bn

£5.8bn

-

Market share - SME lending stock balance

3.6%

2.7%

2.3%

-

Deposits and investments:

Customer deposits flows:

Net deposit flows in the year(6)

£9.6bn

£14.9bn

£9.5bn

£12.6bn

- Of which Retail Banking

£6.8bn

£5.6bn

£5.3bn

£7.2bn

Customer(6, 7) assets and deposits:

Customer asset stock balance (8)

£202.1bn

£190.1bn

£183.3bn

-

Customer deposit stock balance(9)

£153.5bn

£143.9bn

£129.0bn

-

£3.5bn

£3.5bn

£2.2bn

£2.8bn

Banking:

Bank account openings (000's)

1,005

1,093

606

904

Market share - Bank account stock balance

9.1%

8.9%

8.5%

-

Credit card sales(8) (000's)

773

387

395

475

2010

£m

2009

£m

2008

£m

Net interest income

3,237

2,886

2,253

Non-interest income

627

720

848

Total trading income

3,864

3,606

3,101

Total trading expenses

(1,649)

(1,613)

(1,551)

Impairment losses on loans and advances

(615)

(714)

(442)

Provisions for other liabilities and charges

1

-

-

Trading profit before tax

1,601

1,279

1,108

Adjust for:

 - A&L pre-acquisition trading basis results

-

-

(254)

 - Reorganisation and other costs

(155)

(146)

(121)

 - Hedging and other variances

(31)

(17)

(8)

 - Capital and other charges

(99)

(60)

(67)

Statutory profit before tax

1,316

1,056

658

Segment balances

2010

£bn

2009

£bn

2008

£bn

Risk weighted assets

40.0

34.6

42.1

Customer assets

177.8

167.7

161.9

Customer deposits

131.9

125.1

119.5

> 

Trading net interest income increased by £351m to £3,237m (2009: £2,886m), largely driven by balanced growth in customer lending and deposits across a mix of products combined with effective margin management. Customer assets increased by £10.1bn or 6% (which includes £5.7bn or 3% from the Santander Cards and Santander Consumer businesses, acquired in October and November 2010, respectively). Customer liabilities increased by £6.8bn or 5%.

The key drivers of the increase in 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 in response to new regulatory requirements. Net interest income included £75m relating to the Santander Cards and Santander Consumer businesses, which were acquired in October and November 2010, respectively.

In terms of mortgage lending, the Group achieved an 18% share of the gross mortgage lending market in the UK in 2010, similar to 2009 and significantly ahead of our market share of mortgage stock of 14%. Lending was written at margins above stock margin and with a continued emphasis on lower loan-to-value segments. In total net lending was £5.6bn.

The growth of customer deposits benefited from a 22% increase in private banking deposits, and a 9% increase in personal bank account liability balances, as well as a good performance in core savings underpinned by a strong tax year and "loyalty" offers.

> 

Trading non-interest income decreased by £93m to £627m (2009: £720m), 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 adversely affected by lower redemption volumes in line with the market and banking fees were affected by the introduction of the Santander Zero account. Non-interest income included £8m relating to the Santander Cards and Santander Consumer businesses which were acquired in October and November 2010, respectively.

> 

Trading expenses increased by £36m to £1,649m (2009: £1,613m). The increase was largely due to the inclusion of £37m of expenses relating to the Santander Cards and Santander Consumer businesses which were acquired in October and November 2010, respectively. In addition, depreciation and amortisation increased by £32m as a result of the continued investment in IT systems in Santander UK 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 have been re-invested 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 decreased by £99m to £615m (2009: £714m), with the most significant reduction relating to mortgages. This improving performance in difficult economic conditions has been delivered as a result of a high quality mortgage book, effective collection handling and reductions in arrears levels, particularly in the second half of 2010.

Similarly, performance across the unsecured portfolios also improved in the year. However, the commercial mortgages book demonstrated some stress from the adverse market conditions. Impairment losses on loans and advances included £33m relating to the Santander Cards and Santander Consumer businesses which were acquired in October and November 2010, respectively.

> 

Trading net interest income increased by £633m to £2,886m (2008: £2,253m) largely driven by balanced growth in customer lending and deposits across a mix of products combined with effective margin management, as well as a 17% growth in bank account liability balances and hedging strategies which helped to offset the impact of lower interest rates.

In terms of lending, unsecured lending balances continued to decline, but were more than offset by net mortgage lending of £7.6bn in 2009. The increase in mortgage lending resulted in the Group taking an 18% share of the gross mortgage lending market in the UK in 2009, with new lending written at margins above the existing loan stock margin and with an emphasis on lower Loan-to-Value segments.

In addition, income from existing mortgage balances increased as more customers reverted to standard variable rate mortgages, and margins improved in both the mortgage and unsecured loan portfolios in the low interest environment.

> 

Trading non-interest income decreased by £128m to £720m (2008: £848m), largely due to lower fees on unsecured lending products, as part of our stated strategy to reduce unsecured lending exposures, as well as lower fees from current accounts due to repricing. In addition, mortgage fees were adversely impacted by a reduction in the volume of mortgage redemptions given decreased activity in the market as a result of declining house prices and lower levels of supply.

> 

Trading expenses increased by £62m to £1,613m (2008: £1,551m). £98m of the increase was due to costs related to Bradford & Bingley's savings business since its acquisition in September 2008. The remaining decrease of £36m was largely due to the removal of duplications across back office and support functions due to the integration of Alliance & Leicester and Bradford & Bingley's savings business.

> 

Trading impairment losses on loans and advances increased by £272m to £714m (2008: £442m) and were distributed across all products, with the largest increase relating to mortgages as the impact of falling house prices and the lagging effect of unemployment, as expected, started to emerge. Most of the impact came through in the first half of the year, with the second half performance stabilising and in some areas improving.

With respect to mortgages, the second half of the year saw a slower rate of growth in arrears, with fewer losses than observed earlier in the year, in part as a result of collection activities and mitigating actions taken, but also due to the low interest rate environment and the slight upturn in house prices. A strong mortgage coverage ratio of close to 20% was preserved.

> 

At 31 December 2010, risk weighted assets of £40.0bn were 16% higher than the previous year reflecting the growth in assets described below. Excluding the impact of acquisitions, the decrease in the year was broadly flat.

> 

At 31 December 2010, customer assets of £177.8bn were 6% higher than the previous year reflecting the growth in mortgage balances and acquired businesses. Of the increase, £5.7bn or 3% related to the Santander Cards and Santander Consumer businesses which were acquired in October and November 2010, respectively. 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 unsecured personal lending ('UPL') balances, which decreased by 19%, where the focus continued to be on lending to existing customers with proven repayment track records.

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At 31 December 2010, customer deposits of £131.9bn were 5% higher than the previous year, a strong performance given the increasingly competitive market. The ISA season in 2010 was particularly successful, while a focus on bank accounts, and specifically higher value, primary accounts, resulted in a 9% increase in personal bank account liabilities. In addition, private banking customer deposits increased by 22% with strong performance in our onshore and offshore operations.

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At 31 December 2009, risk weighted assets of £34.6bn were 18% lower than the previous year reflecting enhancements to Retail IRB models.

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At 31 December 2009, customer assets of £167.7bn were 4% higher than the previous year reflecting the growth in mortgage balances. This was partly offset by the continuing reduction in UPL balances, which decreased by 26%.

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At 31 December 2009, customer deposits increased by 5% to £125.1bn. Net inflows benefitted from the alignment of product marketing and pricing strategies across the brands, including the introduction of Abbey products, such as fixed rate bonds and Individual Savings Accounts, and promotional activity in Bradford & Bingley branches.

2010

£m

2009

£m

2008

£m

Net interest income

212

212

149

Non-interest income

129

128

240

Total trading income

341

340

389

Total trading expenses

(151)

(181)

(239)

Impairment losses on loans and advances

(97)

(31)

(44)

Trading profit before tax

93

128

106

Adjust for:

 - A&L pre-acquisition trading basis results

-

-

(2)

 - Capital and other charges

(21)

(30)

(14)

Statutory profit before tax

72

98

90

Segment balances

2010

£bn

2009

£bn

2008

£bn

Risk weighted assets

19.3

17.0

17.4

Total customer assets

22.5

21.2

20.6

Core customer assets(1)

18.7

16.3

14.4

Customer deposits

16.4

14.4

7.1

Total SMEs (2)

8.5

6.7

5.8

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Trading net interest income of £212m was in line with the prior year. Net interest income increased as a result of growth in customer loans and deposits to the UK SME market through our network of 25 Corporate Business Centres (SME lending balances increased by 26% and total deposit balances increased by 15%). 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. This was offset by a reduced contribution of £20m from the non-core portfolio as Corporate Banking continued to reduce the balances of non-core assets.

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Trading non-interest income of £129m was broadly in line with prior year. Asset growth in the core business and strong sales of Global Banking & Markets products resulted in higher fees. However, this was offset by lower fees in non-core businesses as Corporate Banking continued to reduce balances in the non-core portfolio.

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Trading expenses decreased by £30m to £151m (2009: £181m). The decrease was due to operational efficiencies arising from the integration of Alliance & Leicester, partially offset by investment in the Corporate Business Centre network. The investment included hiring an additional 136 staff over the last twelve months and an increase of 70% in the floor space of the Corporate Business Centre network.

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Trading impairment losses on loans and advances increased by £66m to £97m (2009: £31m). The increase reflected growth and maturity in asset balances over the last two years and some deterioration arising from market conditions. The non-core Corporate Banking portfolios continued to perform in line with our original expectations, with existing impairment loss allowances expected to be sufficient to cover losses inherent in the portfolios.

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Trading net interest income improved by £63m to £212m (2008: £149m). This increase reflected the impact of the sale of the Porterbrook businesses early in December 2008 (net interest income in 2008 included interest expense of £76m incurred by the Porterbrook businesses, whereas its associated leasing income and depreciation were classified as non-interest income). In addition, 2009 reflected some benefit from higher asset margins as new business lending and pricing was altered to reflect the market environment in terms of increased funding costs. Net interest income also improved as a result of robust growth of both assets and liabilities. However, these were offset by the adverse impact of changes to transfer pricing arrangements to reflect higher costs of new term funding and liquid asset balances.

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Trading non-interest income decreased by £112m to £128m (2008: £240m), reflecting the inclusion in non-interest income in 2008 of the leasing income and depreciation relating to the Porterbrook businesses which were sold early in December 2008. In addition, new business lending generated increases in both fees and cross-selling of Global Banking & Markets products.

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Trading expenses decreased by £58m to £181m (2008: £239m). The decrease was due to operational efficiencies arising from the integration of Alliance & Leicester, and the sale of the Porterbrook business.

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Trading impairment losses on loans and advances decreased by £13m to £31m (2008: £44m). The low level of impairment losses was a reflection of prudent lending criteria on the relatively immature growth businesses and portfolios (such as SME lending within Corporate Banking). It also reflected the impairment loss allowances made on acquisition relating to the non-core portfolios (including aviation and shipping) to reflect expected losses in those portfolios as required under acquisition accounting. The decrease of £13m also reflected the non-recurrence in 2009 of Corporate Banking impairment loss allowance releases in 2008 relating to non-core businesses offset by some deterioration arising from market conditions.

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At 31 December 2010, risk weighted assets of £19.3bn were 14% higher than the previous year reflecting the growth in assets described below.

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At 31 December 2010, core customer assets of £18.7bn were 15% higher than the previous year driven by a strong performance via our 25 Corporate Business Centres and a broader product offering. We continued to build our growing SME franchise, with lending to this group totalling £8.5bn (including £2.2bn recorded in Retail Banking), an increase of 26% compared to 31 December 2009.

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Customer deposits increased 14% to £16.4bn compared to 31 December 2009 despite increased competition in this market, with the net flows achieved while improving the average term.

> 

At 31 December 2009, risk weighted assets of £17.0bn were 2% lower than the previous year reflecting a reduction in non-core assets.

> 

At 31 December 2009, core customer assets of £16.3bn were 13% higher than the previous year driven by a strong performance via our 25 Corporate Business Centres. Lending to SMEs amounted to £6.7bn (including £2.2bn recorded in Retail Banking), an increase of more than 16% compared to 31 December 2008.

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Customer deposits more than doubled to £14.4bn compared to 31 December 2008 driven by strong levels of investment by customers seeking to invest with banks with strong credit ratings.

2010

£m

2009

£m

2008

£m

Net interest income

6

7

11

Non-interest income

412

382

327

Total trading income

418

389

338

Total trading expenses

(130)

(104)

(107)

Trading profit before tax

288

285

231

Adjust for:

- A&L pre-acquisition trading basis results

-

-

(10)

Statutory profit before tax

288

285

221

Segment balances

2010

£bn

2009

£bn

2008

£bn

Risk weighted assets

7.1

6.8

7.8

Customer assets

1.8

1.1

0.9

Total assets

50.0

44.8

44.5

Customer deposits

5.1

4.4

2.4

> 

Trading net interest income decreased by £1m to £6m (2009: £7m) due to increased funding costs offsetting customer asset growth.

> 

Trading non-interest income increased by £30m to £412m (2009: £382m) reflecting the strong performance of underlying customer revenue streams and a number of non-recurring releases of fair value adjustments following the successful de-risking of underlying positions. These benefits were partly offset by a less favourable trading environment resulting from lower spread volatility.

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Trading expenses increased by £26m to £130m (2009: £104m), reflecting ongoing investment in growth initiatives relating to new products, markets and customer segments. There was a 38% increase in headcount across the customer transaction businesses, including the new Gilt Edge Market Making desk.

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Trading net interest income decreased by £4m to £7m (2008: £11m) reflecting a reduction in loan balances during the year.

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Trading non-interest income increased by £55m to £382m (2008: £327m) reflecting strong performances in the equity business (linked to sales of retail products through the branch network) and short term markets business, which benefited from a favourable trading environment available from wider spreads in an illiquid market.

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Trading expenses of £104m were slightly lower than the previous year (2008: £107m) reflecting strong expense management whilst increasing income.

> 

At 31 December 2010, risk-weighted assets of £7.1bn were 4% higher than the previous year reflecting the increased asset balances set out below.

> 

Total assets increased by 12% to £50.0bn compared to 31 December 2009, primarily reflecting increases in the fair values of derivatives, as well as increased customer business in the year.

> 

Customer assets increased by 64% to £1.8bn compared to 31 December 2009, primarily due to customer drawings on revolving credit facilities towards the end of the year.

> 

Customer deposits increased 16% to £5.1bn compared to 31 December 2009. Net flows for the year were positive, with an improvement in quality and term.

> 

At 31 December 2009, risk-weighted assets of £6.8bn were 13% lower than the previous year reflecting a reduction in market risk positions.

> 

Total assets increased by 1% to £44.8bn compared to 31 December 2008, reflecting increased secured lending in the repo market as a result of increased liquidity in the Group.

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Customer assets decreased 22% to £1.1bn compared to 31 December 2008, reflecting lower customer drawings on revolving credit facilities.

> 

Customer deposits increased by 84% to £4.4bn compared to 31 December 2008 reflecting strong levels of reinvestment by customers, as investors sought to invest in banks with strong credit ratings.

2010

£m

2009

£m

2008

£m

Net interest income/(expense)

302

236

(24)

Non-interest (expense)/income

(55)

87

90

Total trading income

247

323

66

Total trading expenses

(48)

(46)

(43)

Impairment losses on loans and advances

(40)

(57)

(3)

Trading profit before tax

159

220

20

Adjust for:

 - A&L pre-acquisition trading basis results

-

-

102

 - Reorganisation and other costs

40

(40)

(42)

 - Profit on part sale and revaluation of subsidiaries

126

-

40

 - Hedging and other variances

4

(19)

(76)

 - Capital and other charges

120

90

81

Statutory profit before tax

449

251

125

> 

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.

This was partially offset by a decrease in 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.

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Trading non-interest (expense)/income decreased by £142m to £(55)m (2009: £87m), principally due to 2009 including certain one-off 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 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 savings 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.

> 

Trading net interest income/(expense) increased by £260m to £236m (2008: £(24)m), reflecting the 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.

> 

Trading non-interest income decreased by £3m to £87m (2008: £90m), principally due to lower gains in 2009 on the buy-back of debt securities compared to 2008.

> 

Trading expenses increased by £3m to £46m (2008: £43m) reflecting a slight increase in central costs following the Transfer of Alliance & Leicester and the acquisition of the Bradford & Bingley savings business.

> 

Trading impairment losses on loans and advances increased by £54m to £57m (2008: £3m) due to the inclusion of the Treasury asset portfolio. These losses were offset by the income on the portfolio, which was classified in net interest income.

2010

£m

2009

£m

2008

£m

-

-

164

2010

£m

2009

£m

2008

£m

Reorganisation and customer remediation costs

155

146

121

Impairment losses on loans and advances

(40)

40

42

115

186

163

2010

£m

2009

£m

2008

£m

126

-

40

2010

£m

2009

£m

2008

£m

27

36

84

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Summarised consolidated balance sheet - A summarised consolidated balance sheet is presented with commentary on key movements. A more detailed consolidated balance sheet is contained in the Consolidated Financial Statements.

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Securities - The Group's strategies and reasons for holding securities are described on pages 48 and 49, as well as:

> 

Analysis by type of issuer, as well as a maturity analysis for available-for-sale debt securities

> 

Significant exposures exceeding 10% of the Group's shareholders' funds.

> 

Loans and advances to banks - These assets are described on pages 49 and 50, consisting of:

> 

Geographical analysis further analysed between UK and non-UK.

> 

Maturity analysis further analysed geographically and by interest rate sensitivity.

> 

Loans and advances to customers - These assets are described on pages 50 to 54, consisting of:

> 

Geographical analysis between UK and non-UK, further analysed by product.

> 

Maturity analysis further analysed geographically, by product and by interest rate sensitivity.

> 

Impairment loss allowances on loans and advances to customers - cross references are provided to detailed disclosures about the Group's policy and analyses of impairment loss allowances.

> 

Risk elements in the loan portfolio - including potential problem loans and cross border outstandings.

> 

Country risk exposures analysed between central and local governments, government guaranteed, bank and financial institutions, retail and corporate customers.

> 

Derivative assets and liabilities - The Group's derivative positions are summarised on page 54. Cross references are provided to other disclosures about the Group's strategies and reasons for entering into derivative transactions and further detailed analysis of derivative notional amounts and assets and liabilities by type of contract.

> 

Tangible fixed assets - A summary of the Group's capital expenditure during the year, together with details of the Group's property interests and principal sites are described on pages 54 and 55.

> 

Deposits by banks - These liabilities are summarised on page 55, including average balances during the year, with further analysis geographically.

> 

Deposits by customers - These liabilities are summarised on pages 55 and 56, including average balances during the year, with further analyses geographically and by customer type.

> 

Short-term borrowings - These liabilities are summarised on pages 56 and 57, including average balances, maximum balances during the year and related average interest rates.

> 

Debt securities in issue - The liabilities are summarised on page 57, including cross references to detailed descriptions of the major issuance programmes.

> 

Retirement benefit obligations - The Group's pension deficit is set out on page 57. Cross references are provided to other disclosures about the Group's retirement benefit obligations.

> 

Contractual obligations - A contractual maturity analysis of the Group's obligations is set out on page 58.

> 

Off-balance sheet arrangements - The Group's off-balance sheet arrangements, including guarantees, commitments, contingencies, and exposures to off-balance sheet entities sponsored by the Group are described on pages 58 and 59.

> 

Capital management and resources - The Group's approach to capital management and resources is set out on pages 59 to 61, as well as Pillar 3 disclosures, capital ratios, regulatory capital resources and requirements.

> 

Funding and Liquidity - These arrangements are described on pages 61 to 64, including a summary of the sources and uses, together with commentary on the Group's cash flows for the past three years.

> 

Interest rate sensitivity - An analysis of changes in the Group's interest income, interest expense and net interest income between changes in volume and changes in rate is presented on page 65.

> 

Average balance sheets - As period-end statements may not be representative of the Group's activity throughout the year, average balance sheets for the Group are presented on page 66. The average balance sheets summarise the significant categories of assets and liabilities, together with average interest rates.

2010

£m

2009

£m

2008

£m

Cash and balances at central banks

26,502

4,163

4,017

Trading assets

35,461

33,290

26,264

Derivative financial instruments

24,377

22,827

35,125

Financial assets designated at fair value

6,777

12,358

11,377

Loans and advances to banks

3,852

9,151

16,001

Loans and advances to customers

195,132

186,804

180,176

Available for sale securities

175

797

2,663

Loans and receivables securities

3,610

9,898

14,107

Macro hedge of interest rate risk

1,091

1,127

2,188

Property, plant and equipment

1,705

1,250

1,202

Tax, intangibles and other assets

4,178

3,626

4,190

Total assets

302,860

285,291

297,310

Liabilities

Deposits by banks

7,784

5,811

14,488

Deposits by customers

152,643

143,893

130,245

Derivative financial instruments

22,405

18,963

27,810

Trading liabilities

42,827

46,152

40,738

Financial liabilities designated at fair value

3,687

4,423

5,673

Debt securities in issue

51,783

47,758

58,511

Subordinated liabilities

6,372

6,949

8,863

Retirement benefit obligations

173

1,070

813

Tax, other liabilities and provisions

2,912

3,050

3,472

Total liabilities

290,586

278,069

290,613

Equity

Total shareholders' equity

12,274

6,506

5,986

Non-controlling interests

-

716

711

Total equity

12,274

7,222

6,697

Total liabilities and equity

302,860

285,291

297,310