Northern Rock plc, Registered O�ce: Northern Rock House, Gosforth, Newcastle upon Tyne NE3 4PLRegistered in England and Wales under Company Number 06952311   www.northernrock.co.uk

CONTENTSExecutive Chairman’s Statement 1

The Board 3

Corporate Governance 4

Directors’ Remuneration Report 8

Corporate Social Responsibility Report 12

Operating and Financial Review 14

Directors’ Report 19

Independent Auditors’ Report to the Shareholder of Northern Rock plc 22

Consolidated Income Statement 23

Consolidated Statement of Comprehensive Income 24

Consolidated Balance Sheet 25

Company Balance Sheet 26

Consolidated Statement of Changes in Equity 27

Company Statement of Changes in Equity 28

Consolidated Cash Flow Statement 29

Company Cash Flow Statement 30

Notes to the Accounts 31

Presentation of Information

On 17 February 2008, the Chancellor of the Exchequer announced that the Government had decided to take Northern Rock into a period of temporary pub-lic ownership and on 22 February 2008 the Banking (Special Provisions) Bill received Royal Assent. HM Treasury made an order on 22 February 2008 which transferred all of the Ordinary, Preference and Foundation Shares in Northern Rock to the Treasury Solicitor as the Treasury’s nominee.

The legislation includes provisions such that Change of Control provisions in any of the Company’s contractual arrangements have not been triggered. Details of the impact of temporary public ownership are given throughout this Annual Report and Accounts as it affects the Company’s operations and finan-cial disclosures.

As Northern Rock has previously published financial statements which have been prepared in accordance with EU endorsed International Financial Reporting Standards (“IFRS”), IFRIC interpretations and with those parts of the Companies Act 1985 applicable to companies reporting under IFRS, it continues to do so.

1

EXECUTIVE CHAIRMAN’S STATEMENT

Northern Rock plc (the “Company”) commenced trading on

1 January 2010 following completion of the legal and capital

restructuring of the former Northern Rock business, which created

two separate entities:

• Northern Rock plc, a new retail bank authorised by the FSA, and

• Northern Rock (Asset Management) plc (NRAM), now one of

the companies under the control of UK Asset Resolution Limited

Northern Rock plc is authorised and regulated by the Financial

Services Authority (FSA) as a mortgage provider and deposit taker.

The Company remains in Government ownership, but the intention

remains to return it to the private sector when conditions are right

to do so.

FINANCIAL AND OPERATIONAL PERFORMANCE

2010 represented Northern Rock plc’s first year of trading.

The Company has made good progress in its first year and its

financial performance is in line with expectations for the twelve

months to 31 December 2010. Reflecting the low interest

rate environment, along with significant non‑recurring costs, a

loss of £223.5 million was reported for the year, with a loss

of £80.9 million in the second half compared with a loss of

£142.6 million in the first half of the year.

The loss incurred reflects the difficult trading environment for

a small bank, dependent upon retail funding, which continued

throughout 2010. This included the prevailing low interest rate and

subdued mortgage market. The Company also incurred significant

costs relating to the Government’s retail and wholesale guarantees,

which have now been removed, and the high level of liquidity held.

Significant non‑recurring costs were also incurred as the Company

was separated from NRAM. However, the loss in the second half of

the year was £61.7 million less than in the first half demonstrating

that progress is being made.

The Company continued to support capacity in the UK mortgage

market, with gross mortgage lending (including retention

business) during the year of £4.2 billion. Net residential lending

of £1.9 billion in 2010 increased balances to £12.2 billion at

31 December 2010. The quality of new lending remained high,

with an average loan‑to‑value (LTV) ratio of new lending at

62% compared with the average for the book of 59%. Careful

underwriting processes and affordability for customers are key

considerations in our mortgage lending.

Northern Rock plc is predominantly funded by retail deposits. Retail

balances were £16.7 billion at 31 December 2010, compared

with £17.6 billion at 30 June 2010 and remained within the

cap imposed under EC State Aid rules. The reduction in retail

deposit balances over the year is as expected and reflects active

management of the retail savings book, such as the commercial

decision to close the Guernsey savings operation, as well as the

release of the Government’s savings guarantee.

The Government’s guarantee of retail deposits was lifted on

24 May 2010 for variable rate accounts, reflecting the Company’s

strong capital and liquidity position. Fixed rate accounts opened

before 24 February 2010 keep the guarantee for the life of the

product. Northern Rock plc remains a member of the UK Financial

Services Compensation Scheme (FSCS), which provides protection

of up to £85,000 per person for eligible depositors.

Guarantees on certain wholesale deposits of Northern Rock plc

were lifted on 2 November 2010. Fixed term wholesale deposits

existing on 1 January 2010 will retain the guarantee to maturity.

The Company is strongly capitalised, with both a Tier 1 and Total

Capital ratio of 31.6%, and holds a high level of liquidity to support

the retail deposit book and new lending activity.

During the year the workforce was reduced to align the number

of staff with the smaller size of the Company and a lower level

of new business activity. As a result of this, approximately 650

jobs were made redundant. In addition, as part of the separation

of Northern Rock plc from Northern Rock (Asset Management)

plc, approximately 1,250 staff were transferred to Bradford &

Bingley plc.

GOVERNANCE

The Board contains strong banking and operational expertise which

are considered essential to oversee the activities of Northern Rock

plc and its ultimate return to the private sector.

Following the departure of Gary Hoffman as Chief Executive, who

stepped down from the Board on 4 November 2010, I reverted

from Non Executive to Executive Chairman. I was previously

appointed to this role by the Government, in February 2008, when

the former business entered public ownership. The Board and UKFI

considered that this would provide continuity of leadership and

management required at this time.

Rick Hunkin, Chief Risk Officer (CRO), stepped down from the

Board and left the Company on 31 December 2010. Keiran Foad

has been appointed as the new CRO and joined the Company on

1 March 2011.

The Board has five Non Executive Directors; Laurie Adams, Richard

Coates, Mike Fairey, Mark Pain and Mary Phibbs. Jim McConville,

Chief Financial Officer, also sits on the Board as an Executive

Director of the Company.

REMUNERATION

Northern Rock plc needs to attract and retain colleagues with the

appropriate skills and experience to drive company performance

and deliver value for taxpayers. Therefore it is essential that an

appropriate remuneration framework is in place.

For 2010 performance, the Remuneration Committee have agreed a

bonus scheme for all colleagues, including senior management, with

the approval of UKFI. Bonus awards for all colleagues will be made

2

EXECUTIVE CHAIRMAN’S STATEMENT (continued)

in accordance with the FSA Remuneration Code requirements as

appropriate, including relevant deferral conditions.

NORTHERN ROCK IN THE COMMUNITY

Northern Rock has been a substantial contributor to the wider

community over many years, both through the Northern Rock

Foundation and through a wide and varied programme of charitable

work, undertaken by colleagues throughout the business.

During 2010, Northern Rock’s community strategy has been

refocused towards helping communities in financial difficulty,

utilising the skills and experience inherent within the Company.

We have engaged with The Northern Rock Foundation and more

widely to ensure our programme is focused on the areas of

greatest need.

In line with the commitment made when first taken into public

ownership, the Foundation received a donation of £15 million

from NRAM in 2010. Such donations enable the Foundation to

support community and charitable causes, mainly in the North

East of England and Cumbria. Going forward, Northern Rock plc

has entered into a two year rolling agreement to donate 1% of

profits before tax to the Foundation. This maintains the Company’s

commitment to corporate and social responsibility and allows the

Foundation to continue its valuable work.

OUTLOOK

Economic conditions remain challenging. The mortgage market in

the UK continues to be relatively subdued, and the interest rate

environment continues to act as a headwind for retail banks and

building societies.

As anticipated, Northern Rock plc was loss making for the full

year but with a significantly improved financial performance in the

second half of 2010. The Board looks forward to the maintenance

of that momentum in 2011, through providing customers with

attractive products and high standards of service, exploring

opportunities for cautiously and prudently expanding the product

range, and continuing to focus on cost control.

A key objective of Northern Rock plc is a return to the private

sector when the time is right, in the taxpayers best interests. The

selection process for corporate finance advisers to work with the

Company and UKFI on the evaluation of strategic options for

Northern Rock is ongoing.

My colleagues across the business remain committed to delivering

the highest standards of service and fair treatment of our customers

and I pay tribute to the quality of what they have delivered.

Ron Sandler

Executive Chairman

8 March 2011

3

THE BOARD

During 2010, the number of meetings attended by each Director was as follows:

Board Audit Remuneration Risk

Number of meetings held in 2010 16 8 10 8

Executive Chairman

R A Sandler CBE 16/16 10/10

Non – Executive Directors

L P Adams 14/16 10/10 8/8

J R Coates 16/16 8/8 7/8

M A Pain 15/16 6/6 7/8

M C Phibbs 16/16 7/8 7/8

M E Fairey 12/16 4/8 10/10

Executive Directors

G A Hoffman (resigned 4 November 2010) 13/13

R D Hunkin (resigned 31 December 2010) 15/16

J McConville (appointed 8 April 2010) 13/13

During 2010 the Chairman of each Committee was as follows:

Risk Committee – Mr Adams

Audit Committee – Mr Coates

Remuneration Committee – Mr Fairey

Nominations Committee – Mr Sandler.

The Nominations Committee did not meet during 2010. All matters with regard to Board membership and succession were discussed and agreed at meetings of the Board.

The current membership of the Committees is set out on pages 6 and 7.

4

CORPORATE GOVERNANCE

The Company’s shares are held by the Treasury Solicitor as

nominee for Her Majesty’s Treasury and consequently, the full

requirements of the UKLA’s Listing Rules and the regulations under

the Companies Act 2006 governing Director’s remuneration

(the Regulations), now known as the UK Corporate Governance

Code (the Code), do not apply to the Company.

This corporate governance section summarises:

• The composition of the Board at the date of this report; and

• The governance regime in place at the date of this report.

The Operating and Financial Review on pages 14 to 18 also

addresses certain governance matters in relation to events in 2010.

COMPOSITION OF THE BOARD

The Directors in office at the date of this report are:

Ron Sandler – Executive Chairman

Ron was Executive Chairman of the former Northern Rock between

February 2008 and October 2008, and was Chairman of that

company until January 2010, when it became Northern Rock

(Asset Management) plc. He was appointed Chairman of Northern

Rock plc in January 2010 and appointed as Executive Chairman

in November 2010. Ron was previously Chief Executive of Lloyd’s

of London from 1995 to 1999, and was subsequently Chief

Operating Officer of Natwest Group. He is Chairman of Phoenix

Group Holdings and Ironshore Inc.

Laurie Adams – Non‑Executive Director

Laurie is a Non‑Executive Director of Novae Group plc and Citadele

Bank, as the EBRD nominee. He was formerly a Non‑Executive

Director of Siblu Holdings Limited (formerly Haven Europe Limited)

and Managing Director and Global Head of Legal and Compliance of

the Investment Banking Wholesale Division at ABN Amro Bank. He is

a qualified solicitor and mediator.

Richard Coates – Non‑Executive Director

Richard was Managing Director of Baseline Capital Limited from

2003 to 2008, a specialist mortgage data analysis and modelling

organisation. For the previous 30 years he was at KPMG UK, rising

through various appointments to become Senior Partner, UK Head

of Financial Services. He is a Non‑Executive Director for Police

Mutual Assurance Society Limited.

Mark Pain – Non‑Executive Director

Mark is Chairman of London Square Developments (Holdings)

Limited and a Non‑Executive Director of Punch Taverns Plc,

Johnston Press Plc, Aviva Insurance UK Limited, Aviva Life Holdings

UK Limited and LSL Property Services Plc. He is also a trustee at

Somerset House. Mark was previously Group Finance Director of

Barratt Developments Plc, and held a number of senior Executive

and Board positions at Abbey National Plc including Group Finance

Director and Group Sales Director.

Mary Phibbs – Non‑Executive Director

Mary is a Non‑Executive Director and Trustee for the Charity Bank

Limited. She is a Senior Advisor for Alvarez and Marsal and acting

on their behalf as the interim Chief Risk Officer for Allied Irish

Bank. In a 30 year career in Banking and Finance she has held a

variety of senior executive positions with Standard Chartered Bank,

the Australia and New Zealand Bank, the National Australia Bank,

Bankers Trust Australia and the Commonwealth Bank Group. She is

a Chartered Accountant.

Mike Fairey – Non‑Executive Director

Mike was the Deputy Group Chief Executive of Lloyds TSB Group

PLC from 1998 until his retirement in June 2008. Mike is Chairman

of the Lloyds TSB pension funds, a Non‑Executive Director of the

Energy Saving Trust and Vertex Data Sciences and president of the

British Quality Foundation.

Jim McConville – Chief Financial Officer

Jim has more than 20 years experience in the UK retail banking

and insurance sectors, having held a number of senior finance and

strategy related roles in Lloyds Banking Group, including Finance

Director of the Insurance and Investments Division and Scottish

Widows Group. Jim is responsible for Finance and Treasury at

Northern Rock plc.

The Company does not have a Chief Executive at the date of this

report. Mr Hoffman was appointed as Chief Executive on 1 January

2010 and served until his resignation on 4 November 2010.

5

CORPORATE GOVERNANCE (continued)

GOVERNANCE STRUCTURE

OVERVIEW

Since the restructuring of Northern Rock

on 1 January 2010, the governance has

been regulated principally by a framework

document (the “Framework Document”)

agreed between the Company and UK

Financial Investments Limited (UKFI) as

manager of HM Treasury’s shareholding

in the Company. This sets out how the

relationship between the Company and

UKFI works in practice.

BASIC PRINCIPLES

The basic relationship between the

Company and UKFI operates according to

the following principles under which UKFI:

• Appoints the Chairman of the Board

and is entitled to appoint one or more

Non‑Executive Directors

• Is required to give its consent for the

appointment of other members of the

Board proposed for appointment by

the Nominations Committee and agrees

the terms on which the Directors are

appointed and incentivised

• Agrees with the Board the high level

objectives of the business plan and any

revisions to it

• Reviews with the Board from time to

time the Company’s strategic options

• Requires that the Board is accountable

to it for delivering the agreed business

plan

• Gives the Board the freedom to take

the action necessary to deliver the

business plan

• Monitors the Company’s performance

to satisfy itself that the business plan is

on track

• Must give its consent for certain

significant actions.

IMPLEMENTATION OF BASIC

PRINCIPLES

BOARD STRUCTURE AND GOVERNANCE

In accordance with the Framework

Document, the Company operates a

corporate governance structure which, so

far as practicable and in light of the other

provisions of the Framework Document,

or as otherwise may be agreed with UKFI,

takes appropriate account of best practice

for a company listed on the Official List,

including the Code.

The Board operates the following main

committees:

• Audit Committee

• Risk Committee

• Remuneration Committee

• Nominations Committee.

The work of these committees is

described below.

BOARD APPOINTMENTS AND

MONITORING

It is a key principle of the Framework

Document that UKFI and the Chairman

share a common view about Board

composition (including size, balance

of experience and background) and

succession. To achieve this:

• The Chairman and either the Chairman

of UKFI or a senior employee

nominated by the Chairman of UKFI

(the Nominated Official) will discuss

and confirm Board composition and

succession regularly in the light of

performance and the requirements of

the business plan

• One or more senior representatives

of UKFI will, if so requested by UKFI,

attend meetings of the Board and

Committees in an observer capacity

• The Chairman will discuss with the

Nominated Official any impending

changes to Board membership

• The Chairman of the Nominations

Committee will meet with the

Nominated Official as necessary to

obtain UKFI’s approval to any proposed

Board changes before they become

subject to the formal appointment/

consent procedure

• The Company’s Articles of Association

require that each Director stands for

re‑election at least every three years and

that Directors appointed by the Board

should be subject to election at the first

opportunity after their appointment.

The Directors to retire by rotation

would be those in office longest since

their previous re‑election. Non‑Executive

Directors are appointed for a

specified term subject to re‑election in

accordance with the above procedures

• The Board ensure that suitably rigorous

appraisals are made of the effectiveness

of the Chairman, the Board and its

Committees

• UKFI has certain monitoring and

information access rights, and its

consent has to be obtained for certain

material transactions.

THE BOARD

The Board met 16 times during 2010 and

the details of attendance at the Board and

Committee meetings are given on page 3.

Where Directors were absent from Board or

Committee meetings, on each occasion the

Board or respective Committee was satisfied

with the apologies that were offered.

The Board has a written schedule of matters

reserved for its determination. Reserved

matters include corporate governance

arrangements and the relationship with

UKFI, responsibility for overall management

of the Company’s long‑term objectives and

commercial strategy, financial reporting and

control, setting an appropriate risk appetite

and maintaining a sound system of internal

control and risk management, and the approval

of half yearly, interim management statements

and the Annual Report and Accounts.

BALANCE OF EXECUTIVE AND

NON‑EXECUTIVE DIRECTORS

More than half of the Board comprises

Non‑Executive Directors, all of whom have

experience in a range of commercial or

banking activities.

BOARD COMMITTEES

In accordance with the requirements in

the Framework Document the Board has a

number of Committees. The Chairman and

membership of each Committee are set

out below.

Each Committee has detailed terms of

reference clearly setting out its remit

and authority. The terms of reference

6

CORPORATE GOVERNANCE (continued)

are regularly reviewed by the Board

and were updated and re‑approved in

September 2010.

The following paragraphs set out details

of the Committees and the particular work

that they undertake.

AUDIT COMMITTEE

The Audit Committee currently comprises

Messrs Coates (Chairman), Pain, Fairey and

Ms Phibbs.

The Committee considers and, where

appropriate, advises the Board on all

matters relating to regulatory, prudential

and accounting requirements that affect

the Company. It reports to the Board on

both financial and non‑financial controls

and monitors the integrity of the financial

statements of the Company and any formal

announcements relating to the Company’s

financial performance. As part of its remit it

oversees anti‑money laundering and whistle

blowing procedures.

An important aspect of its role is to

ensure that an objective and professional

relationship is maintained with the

external auditors. The Audit Committee

has responsibility for recommending the

appointment, re‑appointment and removal

of the external auditors.

The Audit Committee reviews the scope

and results of the annual external audit, its

cost effectiveness, and the independence

and objectivity of the external auditors.

It also reviews the nature and extent of any

non‑audit services provided by the external

auditors. The external auditors can attend

all meetings of the Audit Committee, have

direct access to the Committee and its

Chairman at all times and are invited at

least annually to meet with the Committee

in the absence of management.

The Head of Internal Audit provides further

assurance that the significant risks identified

by the business are properly managed

through attendance at key committees

and delivery of the risk based audit plan.

The Head of Internal Audit also has direct

access to the Audit Committee and its

Chairman. The Committee regularly receives

reports of reviews conducted throughout

the Company by the Internal Audit function.

The Audit Committee met eight times

in 2010. In February 2010, the Audit

Committee reviewed and confirmed the

effectiveness of the external auditors.

The external auditors were consequently

re‑appointed at the 2010 Annual General

Meeting until the conclusion of the next

Annual General Meeting.

RISK COMMITTEE

The Risk Committee currently comprises

Messrs Adams (Chairman), Coates, Pain and

Ms Phibbs.

The main role of the Risk Committee is to

review, on behalf of the Board, the key risks

inherent in the business, the systems of

control necessary to manage such risks, and

to present its findings to the Board.

This responsibility requires the Risk Committee

to keep under review the effectiveness of the

Company’s risk management frameworks and

systems of internal control, which includes

financial, operational, compliance and risk

management controls and to foster a culture

that emphasises and demonstrates the benefits

of a risk‑based approach to internal control

and management of the Company. The Risk

Committee fulfils this remit by reinforcing

management’s risk management awareness

and making appropriate recommendations to

the Board on all significant matters relating

to the Company’s risk appetite, strategy and

policies. It is also responsible for considering

the current and prospective macroeconomic

and financial environment.

The Risk Committee regularly reviews reports

from Compliance including regulatory

risks and issues and is also responsible for

approval, and ongoing review and oversight of

progress of the compliance monitoring plan.

The Committee also receives reports from

Compliance in relation to its responsibility to

consider any major findings of the Financial

Services Authority and management’s

response to any risk management review

undertaken by the Chief Risk Officer, Internal

Audit or the external auditors.

The Risk Committee terms of reference

were revised in September 2010 to

delegate to the Committee authority from

the Board to approve new risk policies and

amendments to existing policies. To assist

the Board in discharging its responsibilities

for the setting of risk policy, the Risk

Committee regularly reviews the Company’s

material risk exposures in relation to the

Board’s risk appetite and the Company’s

capital adequacy.

The Risk Committee also ensures that the

public disclosure of information regarding

the Company’s risk management policies

and key risk exposures is in accordance

with statutory requirements and financial

reporting standards.

The Risk Committee met eight times during

2010.

NOMINATIONS COMMITTEE

The Nominations Committee currently

comprises Messrs Sandler (Chairman) and

Adams.

Subject to compliance with the

requirements of the Framework Document

(as set out above), the Committee monitors

and reviews the membership of, and

succession to, the Board of Directors and

the Committee makes recommendations

to the Board in this regard. One of its

functions is to identify potential Executive

and Non‑Executive Directors taking into

account the requirement for the members

of the Board to have an appropriate range

of skills and experience.

The Committee did not meet during 2010

as all matters in relation to the composition

of the Board were considered by the Board.

REMUNERATION COMMITTEE

The Remuneration Committee currently

comprises Messrs Fairey (Chairman),

Sandler and Adams.

Subject to compliance with the requirements

of the Framework Document (as set out

above), the Committee is responsible for

considering and advising the Board on the

remuneration policy for Executive Directors

and the Chairman, and for determining

their remuneration packages. In discharging

its responsibilities, the Remuneration

7

CORPORATE GOVERNANCE (continued)

Committee can take professional advice from

within and outside the Company.

It is the Board’s responsibility to determine

the remuneration policy for Non‑Executive

Directors within the limits set out in the

Articles of Association. The Remuneration

Committee also determines the level of

remuneration for the Company’s Executive

Committee Directors (comprising management

at the level immediately below the Board).

The Committee met ten times during 2010.

EXECUTIVE COMMITTEE

The Board delegates authority to the

Executive Committee to oversee the

prudent day to day management of

the Company’s affairs. The Committee

comprises Mr Sandler (Executive Chairman),

Ms Belsham (Director of Transition

Management), Mr Fitzpatrick (General

Counsel and Company Secretary), Mr Foad

(Chief Risk Officer), Ms Lauder (Customer

Service & Sales Director), Mr McConville

(Chief Financial Officer), Mr Parker (Chief

Operating Officer), Mr Tate (Customer &

Commercial Director) and Mrs Thompson

(HR Director).

The Committee considers, in the first

instance, all reports made to the Board

and Board Committees, except in relation

to matters reserved to the Board for

its own determination. The function of

the Committee and its sub‑committees,

together with a description of the role and

responsibilities of the Committee members, is

set out in the Executive Governance Manual.

A Delegated Authorities Manual which

specifies the level of authority to be

exercised by the Executive Committee and

various individuals also exists.

The following sub‑committees which report

to the Executive Committee are in place.

• Operating Plan Committee

• Capital Management Committee

• Retail Products and Limits Committee

• Asset and Liability Committee

• Retail Credit Risk Committee

• Operational Risk and Compliance

Committee

• Customer Performance Committee

INDUCTION AND TRAINING

It is the Company’s policy that every Director

should receive appropriate training when

appointed to the Board, and subsequently

as necessary. The Company’s personalised

induction process is designed to ensure

that every new Director understands their

responsibilities as a Director of the Company.

The Board Governance Manual supports this

process. The process also enables Directors

to build an understanding of the Company, its

business and the market in which it operates.

To enable the Board to function effectively,

all Directors have full and timely access to

all information which may be relevant to the

discharge of their duties and obligations. The

Company also arranges additional, specific

training and support for any Director who

requests it. The Chairman ensures that all

Directors are properly briefed on issues to

be discussed at Board meetings. All Directors

are able to obtain further advice or seek

clarity on issues raised at Board meetings

from within the Company or from external

professional sources. All Directors have access

to the advice and services of the Company

Secretary who is responsible for ensuring that

Board procedures and applicable rules and

regulations are observed.

Where necessary, Directors are able to

take independent professional advice at the

Company’s expense.

BOARD EVALUATION

In November 2010, a Board effectiveness

appraisal was conducted by the Chairman

with assistance from the Company

Secretary. All Executive Directors,

Non‑Executive Directors and the Chairman

participated in an evaluation of the Board

and its Committees to ensure that their

operation continued to be of the highest

standard. The evaluation process consisted

of a series of meetings with Directors that

canvassed their views on a wide range of

matters including the effectiveness of the

Board, its Committees and the Chairman. In

addition, the evaluation also considered the

Board meeting process, the composition of

the Board and the interaction between the

Board and its Committees.

The outcome of the evaluation exercise

was reported to the Board and showed

that the Board and its Committees were

discharging their responsibilities effectively.

The appraisal produced a number of

recommendations to further improve

effectiveness of the Board which will be

implemented during 2011.

INTERNAL CONTROL AND RISK

MANAGEMENT

A description of the Company’s approach

to all aspects of financial and other risk

management and the related use of

derivatives is set out in notes 16 and 31 to

the Accounts. Material risk exposures are

maintained within the Board approved risk

appetite and are subject to Board policy

statements which further define specific

exposure limits and controls, appropriate to

each of the risks concerned.

The Board of Directors is responsible for

the Company’s system of risk management,

regulatory compliance and internal control.

The systems are designed to ensure that

the key risks taken by the Company in the

conduct of its business are identified and

evaluated so that appropriate controls are

put in place to manage those risks. Such

systems are designed to manage rather than

eliminate the risk of failure to achieve business

objectives and can only provide reasonable,

but not absolute, assurance against material

misstatement or loss. The Board of Directors

has reviewed the system of internal control

and is not aware of any significant failures in

internal control that arose in the business of

the Company during 2010 and up to the

date of approval of the accounts that have

not been dealt with in accordance with the

internal control procedures of the Company.

The Company’s Internal Audit function

provides a degree of assurance as to the

operation and validity of the system of

internal control through the delivery of a

risk based audit plan. The agreed corrective

actions arising as a result of that plan

are independently monitored for timely

completion.

8

DIRECTORS’ REMUNERATION REPORT

The issued shares of the Company are

held by the Treasury Solicitor and the

requirements of both the Companies Act

2006 governing disclosure of Directors’

remuneration (the Regulations) and the

UK Corporate Governance Code (the Code)

do not apply to the Company. However,

throughout 2010 and in preparing this

report, the Company has voluntarily

complied in all material respects with both

the Regulations and the provisions of the

Code relating to Directors’ remuneration.

This report is divided into three

sections. The first section reports on

the remuneration policies applied by the

Company during 2010 and the application

of these to specific Directors. The second

section reports on the remuneration

arrangements to be applied by the

Company for 2011. The third section

sets out detail of Directors’ individual

remuneration for 2010.

REMUNERATION POLICIES AND

THEIR APPLICATION TO DIRECTORS

DURING 2010

THE REMUNERATION COMMITTEE

The Remuneration Committee (the

Committee) operated within agreed terms

of reference and consisted of Mr Fairey

(Chairman) and Mr Adams, and the

Chairman of the Company, Mr Sandler.

It met on 10 occasions during 2010.

The Committee was responsible for

making recommendations to the Board

on the Company’s general policy relating

to executive remuneration and for

determining, on behalf of the Board, specific

remuneration packages for the Chairman,

the Executive Directors and the members of

the Executive Committee, being the most

senior tier of management of the Company.

The Chairman and the Chief Executive were

not present when their own remuneration

was under consideration.

The Committee took advice from both

inside and outside the Company on a

range of matters, including the scale and

composition of the total remuneration

package payable in comparable financial

institutions to people with similar

qualifications, skills and experience.

The following persons and advisors

provided advice or services to the

Committee during 2010:

• Internal support was provided by

the Company Secretary and Human

Resources Director;

• The Chief Executive (and Executive

Chairman after 4 November 2010)

provided advice in relation to the

Executive Committee members;

• Hewitt New Bridge Street LLP provided

advice on various matters, including

the design of the Long Term Incentive

Scheme which is to be implemented

during 2011;

• Mercer Limited, who are the consulting

actuaries to the Company, advised

on various pension issues relating to

Directors and employees; and

• Freshfields Bruckhaus Deringer

LLP, being the Company’s principal

legal advisers, advised on various

remuneration and service contract

matters and on compliance with the

Regulations.

REMUNERATION POLICIES FOR

EXECUTIVE DIRECTORS

During 2010, the Board adopted a

company‑wide remuneration policy with

the aim of attracting, developing and

retaining people with the appropriate

skills, knowledge and expertise to run

the company effectively. This policy

also applied to the Company’s Executive

Directors whose remuneration packages

comprised basic salary, bonus, pension

benefits and certain other benefits in kind.

During the year, Mr Hoffman, Mr Hunkin

and Mr McConville served the Company as

Executive Directors. On 4 November 2010,

Mr Hoffman stood down as Chief Executive

and was placed on “gardening leave” until

30 April 2011 with full contractual benefits

being paid. On 5 November, Mr Hoffman

voluntarily waived all remuneration that

was to be paid to him whilst on “gardening

leave”. No lump sum termination payment

was made to Mr Hoffman. Mr Hunkin

resigned as a Director and left the

Company on 31 December 2010 without

any compensation being paid.

BASIC SALARY:

The Committee’s objective was that

Executive Directors’ basic salaries should be

paid at an appropriately competitive level.

During 2010, the Committee undertook

an extensive benchmarking exercise on

Executive Director remuneration and

concluded that no basic salary increases

should take effect during 2010. Relevant

salary information is as follows:

Mr Hoffman was paid a salary of £700,000

per annum;

Mr Hunkin was paid a salary of £275,000

per annum; and

Mr McConville was paid a salary of

£350,000 per annum.

BONUS SCHEME:

In order to encourage a high performance

culture with close alignment to corporate

values and with the approval of UKFI, the

Committee established a company‑wide

bonus scheme for 2010 which linked

a proportion of remuneration to the

performance of the Company.

Under the scheme, the payment of any

bonus was subject to the Company

achieving a financial threshold evidenced by

a sustained improvement in the Company’s

financial and operational performance over

the relevant financial year within a prudent

risk management framework. The quantum

of the bonus pool made available was

determined by the Board following an

assessment of corporate performance

against a series of scorecard objectives

that were set in February 2010.

The level of individual bonus award under

the scheme was based on an assessment of

achievement against personal objectives.

The maximum level of bonus payable to

Executive Directors was 120% of basic

annual salary, with “on target” performance

resulting in a bonus level of 84%.

If individual performance was deemed to be

unacceptable, no bonus was payable.

9

DIRECTORS’ REMUNERATION REPORT (continued)

Mr McConville received a bonus award of

£185,000. No awards were made to either

Mr Hoffman or Mr Hunkin.

Under the scheme rules, any bonuses

for Executive Directors for the financial

year ended 31 December 2010 will

be paid in accordance with the FSA

Remuneration Code.

PENSION BENEFITS:

The Company paid an amount equal to

40% of Mr Hoffman’s annual salary towards

pension arrangements maintained by him and,

in respect of Mr Hunkin and Mr McConville,

15% of their annual salary towards pension

arrangements maintained by them.

BENEFITS IN KIND:

Executive Directors were also entitled to a

car and fuel allowance and the benefit of

income protection and medical insurance

arranged by the Company on their behalf.

In addition, Mr Hoffman and Mr McConville

were entitled to the reimbursement of

certain accommodation and travel expenses.

EXECUTIVE DIRECTORS’ SERVICE

CONTRACTS

Mr McConville serves under a service

contract dated 14 December 2010.

The contract is terminable by the Company

on 24 months’ notice if notice is served

prior to 8 April 2011 or on 12 months’

notice if served thereafter. Mr McConville

may terminate the contract on giving

6 months notice. Mr McConville’s contract

may be terminated immediately by the

Company on payment of an amount equal

to the salary (excluding other benefits) that

he would have received during his notice

period. The contract contains provisions

under which the termination amount would

be paid in monthly instalments, with such

instalments reduced by an amount equal

to the monthly remuneration derived

by Mr McConville from other activities

commencing during the notice period.

Mr Hoffman served under a service contract

dated 23 July 2008, terminable by either

party on 12 months’ notice given at any

time after 1 October 2009. Mr Hoffman’s

contract contained a provision whereby if

terminated other than for gross misconduct,

he would remain entitled to any outstanding

payments to which he was entitled as

compensation for the loss of his long term

incentive arrangements with his previous

employer (as set out in the footnote to the

Directors’ Individual Remuneration table on

page 11). As referred to above, Mr Hoffman

stood down as Chief Executive and resigned

from the Board on 4 November 2010.

Mr Hunkin served the Company under a

service contract dated 18 August 2008,

terminable by the Company serving

12 months’ notice or by Mr Hunkin

giving 6 months’ notice. Mr Hunkin

resigned as a Director with effect from

31 December 2010.

Under the terms of a services agreement

between Northern Rock (Asset

Management) plc (NRAM) and the

Company dated 7 December 2009, the

Company was required to provide certain

services to NRAM for a period of time

following its restructuring. In accordance

with the services agreement, the Company

invoiced NRAM monthly in arrears for the

cost of services rendered to it plus a margin

of ten per cent. On this basis, 50 per

cent of employment costs relating to

Mr Hoffman, Mr McConville and Mr Hunkin

were charged to NRAM, plus the margin.

POLICY ON EXTERNAL NON‑EXECUTIVE

DIRECTORSHIPS HELD BY EXECUTIVE

DIRECTORS

Executive Directors were permitted to hold

one external non‑executive directorship

unrelated to the Company’s business,

provided that the time commitment was not

material. Executive Directors were permitted

to retain any fees arising from such a non‑

executive directorship. Mr Hoffman was

permitted to continue with all non‑executive

directorships held by him at the date of his

appointment to the Board, and to retain

the fees arising from these.

REMUNERATION POLICIES FOR THE

CHAIRMAN AND NON‑EXECUTIVE

DIRECTORS

The fees for the Chairman and Non‑

Executive Directors described below were

set with reference to external benchmarks

and at levels sufficient to attract the calibre

of individual needed to oversee the strategy

and management of the Company whilst in

Temporary Public Ownership. The Executive

Chairman and the Non‑Executive Directors

were entitled to fees from the Company but

were not permitted to participate in bonus,

incentive or pension schemes or receive

benefits in kind, other than reimbursement

for travel and other reasonable expenses

incurred in the furtherance of their

duties and in attending Board and

Committee meetings.

Mr Sandler commenced his appointment

as Non‑Executive Chairman on 1 January

2010 and served the Company under a

letter of appointment dated 22 December

2009. On 4 November 2010, Mr Sandler

was appointed Executive Chairman with

no increase to his fee of £250,000 per

annum. Unless otherwise extended by the

Company, his appointment terminates on

31 December 2012 or on either party

serving four months’ notice at any time.

In anticipation of a return to the private

sector, the Company may also provide

notice at any time that it considers

appropriate so that the appointment may

terminate on the day that the Company is

returned to the private sector.

The fees paid to Non‑Executive Directors

during 2010 were as follows:

Non‑Executive Director’s

Basic Fee £50,000

Additional Fee for Membership

of a Board Committee £5,000

Additional Fee for Chairman

of the Risk Committee £20,000

Additional Fee for Chairman

of other Board Committees £15,000

All Non‑Executive Directors referred to

below served under letters of appointment

terminable by either party serving three

10

DIRECTORS’ REMUNERATION REPORT (continued)

months’ notice at any time. The Company

may also provide notice at any time such

that the appointment may terminate on the

day that the Company is returned to the

private sector.

Set out below are details of the fee

arrangements of the Non‑Executive

Directors who served the Company

during 2010:

(a) Mr Adams and Mr Coates were

appointed as Non‑Executive Directors

of the Company by letters of

appointment dated 26 November

2009 expiring on 19 November

2011. Mr Adams and Mr Coates were

entitled to the basic fee of £50,000

per annum. Mr Adams was entitled

to an additional fee of £20,000 per

annum for chairing the Risk Committee

and a further additional fee of

£10,000 per annum for membership

of the Remuneration and Nominations

Committee. Mr Coates was entitled

to an additional fee of £15,000 per

annum for chairing the Audit Committee

and a further additional fee of £5,000

for membership of the Risk Committee.

(b) Mr Pain, Ms Phibbs and Mr Fairey

were appointed as Non‑Executive

Directors of the Company under letters

of appointment dated 14 December

2009, 11 December 2009 and

14 December 2009, respectively.

The appointments were for a fixed term

of 2 years commencing on 1 January

2010 and expiring on 1 January 2012.

Mr Pain, Ms Phibbs and Mr Fairey were

each entitled to a basic fee of £50,000

per annum. Mr Pain and Ms Phibbs were

entitled to an additional fee of £5,000

per committee per annum in respect

of their membership of each of the

Audit and Risk Committees. Mr Fairey

was entitled to receive an additional

fee of £15,000 as Chairman of the

Remuneration Committee and £5,000

per annum in respect of his membership

of the Audit Committee.

REMUNERATION ARRANGEMENTS FOR

THE COMPANY IN 2011

COMPLIANCE

The Company intends to continue to

comply in all material respects with the

relevant regulations and the provisions

of the Code relating to Directors’

remuneration throughout 2011.

THE REMUNERATION COMMITTEE

The Committee will continue to operate

pursuant to its terms of reference

and will remain responsible for making

recommendations to the Board on

the Company’s general policy relating

to executive remuneration and for

determining, on behalf of the Board, specific

remuneration terms for the Chairman and

any Executive Directors employed in the

future. It will also remain responsible for

oversight of the remuneration for Executive

Committee members.

REMUNERATION OF EXECUTIVE

DIRECTORS

During 2011, the remuneration policies

(including the policy on executive service

contracts) will remain closely aligned

to achievement of the objectives of the

business plan.

To reflect the additional responsibilities

undertaken by Mr McConville following the

departure of Mr Hoffman, Mr McConville’s

basic salary will be increased by 10% from

1 January 2011 until either a new CEO is

appointed or the Company exits Temporary

Public Ownership. This additional allowance

is non‑pensionable and will not be

taken into account when calculating any

bonus payment that may become due to

Mr McConville.

A bonus scheme will operate in 2011 on

similar terms to that which operated during

2010. The Remuneration Committee

considers that the terms of this bonus

scheme provide an appropriate link between

reward and performance whilst reflecting

emerging best practice relating to bonus

payments. As in 2010, this scheme will

allow Executive Directors to earn up

to 120% of their annual salary if the

maximum level of corporate and individual

performance is achieved. “On target”

performance would allow Executive

Directors to earn up to 84%. Bonuses

will only become payable where the

Board has clear evidence that a sustained

improvement in the Company’s financial and

operational performance within a prudent

risk framework has been achieved over the

course of the year.

In addition to the short term bonus scheme,

the Company will operate a Long Term

Incentive Plan (LTIP) for senior employees

that will deliver financial rewards if the

Company achieves certain targets over

a three year performance period. As the

Company did not make LTIP awards in

2010, it is the Company’s intention to

make awards in 2011 covering 2010 and

2011. The 2010 award will vest in March

2013 and the 2011 award in March 2014,

or upon successful exit from Temporary

Public Ownership, if earlier.

The Remuneration Committee will be

responsible for setting the performance

conditions that will apply to awards made

under this scheme which will include a

financial performance target and a quality of

earnings assessment. The quality of earnings

assessment will seek to establish the extent

to which the financial performance of the

Company over the three year period was

attributable to the efforts of management,

as opposed to external market factors.

At the outset, the Remuneration Committee

will set a “threshold”, “target” and “stretch”

level of financial performance for the

Company, and the LTIP will operate for

Executive Directors as follows:‑

• At the “threshold level” of performance,

the LTIP award will be 11.25%;

• At the “target level” of performance,

the LTIP award will be 50% of basic

salary; and

• At the “stretch level” of performance,

the LTIP award will be 75% of

basic salary.

Between these levels of performance,

vesting will occur on a “straight line”

11

DIRECTORS’ REMUNERATION REPORT (continued)

basis. Application of the “quality of

earnings” assessment by the Remuneration

Committee could cause the LTIP award to

increase or decrease by up to one third.

It has also been agreed that 2010 LTIP

awards for Executive Directors will be

increased by up to 50% to reflect the

additional responsibilities undertaken

following the departure of Mr Hoffman.

REMUNERATION OF THE EXECUTIVE

CHAIRMAN AND NON‑EXECUTIVE

DIRECTORS

There will be no change to the fees of the

Chairman and Non‑Executive Directors in

2011.

DIRECTORS’ INDIVIDUAL REMUNERATION IN 2010

Details of Directors’ individual remuneration are set out below:

Salary/ Pension 2010 Benefits in Total for fees contributions Bonus Kind2 Other 2010 £000 £000 £000 £000 £000 £000ChairmanR A Sandler CBE 250 9 259

Executive DirectorsG A Hoffman 591 237 90 4001 1,318R D Hunkin 275 41 13 329J McConville 256 38 185 22 153 516

Non‑Executive Directors L P Adams 80 5 85J R Coates 70 6 76M E Fairey 70 5 75M Pain 60 3 63M Phibbs 60 7 67

1,712 316 185 160 415 2,788

1 As disclosed in the announcement of his appointment, Mr Hoffman was entitled to three annual payments of £400,000 (less deductions) as compensation for the loss of

entitlements under long term incentive arrangements with his previous employer. The first payment was made on 1 October 2008 and the second made on 25 January 2010,

having been deferred from 1 October 2009. The final payment was due on 1 October 2010 and was paid on 25 October 2010.

2 Benefits in kind includes £27,612 travel and accommodation costs paid to Mr Hoffman plus an associated charge to taxation of £25,121, and £6,853 travel and

accommodation costs paid to Mr McConville plus an associated charge to taxation of £6,853.

3 Mr McConville waived his contractual entitlement to a relocation allowance and was provided with an accommodation allowance of £20,000 for the period from

6 November 2010 to 5 November 2011, of which a portion has been paid in advance.

4 £1,088,000 was reimbursed by Northern Rock (Asset Management) plc to the Company under the Services Agreement pursuant to a provision which entitles the Company

to be reimbursed 50% of the aggregate employment costs relating to Mr Hoffman, Mr McConville and Mr Hunkin plus a margin of 10%.

For 2010, the remuneration of the highest paid Director was £1,081,000 plus personal pension arrangements of £237,000.

M E Fairey

Chairman of the Remuneration Committee

8 March 2011

12

CORPORATE SOCIAL RESPONSIBILITY REPORT

INTRODUCTION

At Northern Rock plc we recognise

the importance of acting correctly as a

company and as such Corporate Social

Responsibility (CSR) is a fundamental

element of the way we do business.

From the way we treat our customers and

colleagues, work with our suppliers and

engage with our community we believe in

doing our utmost to behave responsibly.

CUSTOMERS

We have over one million customers and

our aim is to offer products and services in

an open, honest and fair way. As our market

and customers’ environment changes we

are investing more time and resource in

understanding customer needs. This is

helping us to design product features and

benefits that respond to these changes

especially in the way that customers want

to purchase from us.

We regularly gauge customer opinion

monitoring satisfaction and advocacy

ratings and also how our brand is perceived

by consumers in general. In addition, we

invest a considerable amount of time and

energy in ensuring that we Treat Customers

Fairly day in, day out. This is demonstrated

in our vision and culture.

BUSINESS ETHICS AND HUMAN

RIGHTS

COMPETITIVE FRAMEWORK

Northern Rock plc is determined to ensure

that it does not take unfair advantage of

Government support during the period

of public ownership. The Company has

agreed to and complied with a revised set

of compensatory measures as part of the

EC State aid process, approval for which

was granted on 28 October 2009, and has

actively managed its product range during

the year to maintain balances and pricing

within the parameters of the measures.

TREASURY

Treasury dealing takes place in accordance

with the rules and guidance in the Financial

Services Authority (FSA) Handbook. Any

treasury dealing outside the detailed scope

of the FSA regulation, such as money

market deposits and foreign exchange, is

covered by the Non Investment Products

Code (NIPs Code). This is a voluntary code,

endorsed by the FSA, that lays down what

is generally considered to be good market

practice. The Company does not deal with

counterparties who are on sanctions lists

published by HM Treasury. In addition,

all potential new counterparties, and their

beneficial owners, are reviewed to ensure

they are not classified as Politically Exposed

Persons. We conduct periodic reviews to

assess how our policies, procedures and

practices compare to FSA regulations and

best practice in the NIPs Code.

BETTER PAYMENT PRACTICE

The Company recognises the importance

of making supplier payments on time,

thereby ensuring that our suppliers do

not encounter unnecessary cash flow

problems as a result of late payments

being made. The provisions of the relevant

legislation have been fully communicated

and implemented to ensure that we will

not incur risks to reputation as a result

of non‑compliance. The only invoices not

meeting the agreed payment date should be

those subject to query or dispute.

PENSION SCHEME

The investments of the Company’s pension

schemes are held by the Trustees in pooled

funds. The Trustees expect the managers

of pooled funds used for such purposes to

adhere to the UK Stewardship Code.

WORKPLACE

COLLEAGUE ENGAGEMENT

It is essential that the Company maintains

a highly engaged workforce. It makes our

Company a more attractive place to join,

work in and do business with. It is proven that

those companies with a high engagement

score have colleagues that display pride

and loyalty to the Company which leads

to enhanced performance and improved

customer satisfaction. The benefits can be

reduced absences and sickness, greater job

satisfaction, improved performance and

greater achievement.

To ensure we understand the levels of

colleague engagement we regularly survey

colleagues and the results are used to identify

any areas affecting colleague engagement and

determine required actions.

HEALTH AND SAFETY

HEALTH & SAFETY POLICY

Our Health and Safety Policy is approved

by the Board and includes Executive

responsibility for leadership on Health and

Safety issues.

A comprehensive accident reporting and

investigation process is in place and we

have worked closely with our insurers to

ensure that we continue to apply best

practice. In 2010 there were 2 RIDDOR

reportable accidents. Occupational Health

and Physiotherapy Services are provided

to support colleagues as part of our

attendance management programme.

The work force is predominantly sedentary

in nature. Workstation assessments are

undertaken annually or where a colleague is

relocated. During the year a total of 2,083

workstation assessments were completed

and 56% of these resulted in minor

adjustments or additional equipment being

provided.

ENVIRONMENT

The key environmental impacts arising from

our corporate operations are the use of

energy and water, carbon dioxide emissions

from corporate transport and waste. Where

practical we are committed to ensuring that

environmental awareness and best practice

form an integral part of our decision

making process.

ENERGY

The Company is committed to controlling

the environmental impact from its use of

energy and this is demonstrated by its

accreditation to the “Energy Efficiency

Scheme” which is operated by The

Carbon Trust. This is an area where we seek

continuous improvement and during 2010

“smart meters” have been fitted in all of our

sites. This will improve our ability to manage

consumption by providing on‑line data.

13

CORPORATE SOCIAL RESPONSIBILITY REPORT (continued)

WASTE

We continue to operate successful recycling

facilities throughout the Company.

We recycle plastic and waxed cups, plastic

bottles and cans, paper, cardboard, toner

cartridges, surplus furniture and waste

electrical equipment.

WATER

We benchmark and target our water use

against the DEFRA corporate environmental

reporting guidance for offices, which is

0.05m3 per employee per working day.

During 2010 our equivalent figure was

0.054m3 per employee (averaged over

the year).

TRAVEL

In 2010 the CO2 emissions per employee

arising from corporate travel (rail, air,

cars/vans for business purposes) was

0.198 tonnes. A corporate travel plan

manager was appointed this year with

responsibility for mitigating our impact

on the environment from corporate and

personal travel with particular reference to

reducing single person car trips to work.

COMMUNITY

THE NORTHERN ROCK FOUNDATION

The Northern Rock Foundation, which

has enjoyed a long relationship with the

former Northern Rock business, supports

community and charitable causes,

mainly in the North East of England and

Cumbria. The Foundation received a

donation of £15 million from Northern

Rock (Asset Management) plc in 2010

and this represented the final payment

under the terms of the original three‑year

commitment made when the former

Northern Rock business entered Temporary

Public Ownership.

Northern Rock plc has entered into a new

two year rolling agreement to donate 1%

of pre tax profits to the Foundation and we

look forward to working together in support

of the many good causes it assists.

Further information on The Northern Rock

Foundation can be obtained from:

The Northern Rock Foundation

The Old Chapel

Woodbine Road

Gosforth

Newcastle upon Tyne

NE3 1DD

Telephone: 0191 284 8412

Fax: 0191 284 8413

Minicom: 0191 284 5411

email: generaloffice@nr‑foundation.org.uk

STAFF MATCHED GIVING

The Staff Matched Giving Scheme, which is

funded by the Northern Rock Foundation,

supports individual colleagues who wish to

raise money for, or give money to, UK and

Ireland registered charities or to exempt

and excepted charities. The Foundation

Trustees have set an annual limit of

£500 per person per year.

COLLEAGUE CHOICE OF ANNUAL

CHARITY

The colleague choice of charity for 2010

was Samaritans in line with our focus on

helping communities and individuals in

financial difficulties. One in eight calls to

Samaritans are concerned with financial

difficulty. In 2010, a total of £71,000

was raised by colleagues for Samaritans,

including matching from The Northern Rock

Foundation.

A further £427,000 was also given to a

wide range of national and local charities

and organisations as a result of fundraising

by colleagues over the year. This sum also

includes matched giving from The Northern

Rock Foundation.

COMMUNITY VOLUNTEERING

The volunteering policy allows all Northern

Rock plc colleagues two days per year paid

leave to volunteer for community activity.

In 2010 the programme was refocused

on communities in financial difficulties and

colleagues have volunteered for a number of

good causes which are aligned to this goal

including Samaritans, Crisis and Shelter.

In addition, our community flagship

programme focuses on financial inclusion

in the North East of England with the

objective of making a tangible improvement

to the availability of affordable credit

and savings products for financially

excluded people in the region. In 2010

we have commenced programmes with

South Tyneside Credit Union, the largest

community‑based credit union in the

region, and The Five Lamps Organisation,

a Community Development Finance

Institution. We provided our time, skills and

expertise to help them build their capability

and capacity.

14

OPERATING AND FINANCIAL REVIEW

OVERVIEW

This is the first set of annual results for Northern Rock plc. The Company was formed through the successful legal and capital restructure of

the former Northern Rock business, which took effect on 1 January 2010 and created two separate trading companies in January 2010 –

Northern Rock plc and Northern Rock (Asset Management) plc (“NRAM”). The restructuring of the former business delivered a capital efficient

structure, providing value for taxpayers by minimising the level of new capital required. It also ensured that Northern Rock plc could continue

to provide new lending and sustain consumer choice following consolidation in the mortgage market.

As a new company, Northern Rock plc did not trade in the period to 31 December 2009 and the comparatives, where shown, reflect this.

KEY POINTS

BUSINESS RESTRUCTURE

• Northern Rock plc made good progress in 2010 – a year of significant restructuring

• The legal and capital restructure was designed to minimise the level of capital required, so providing value for money to taxpayers by

adopting different regulatory frameworks. Whilst Northern Rock plc is regulated as a bank, NRAM (which holds the majority of the

assets of the former company) is regulated as a mortgage provider. This capital efficient structure limited the amount of new capital

required to £1.4 billion

• The restructure created Northern Rock plc, a new, small, highly liquid and well capitalised bank that could continue to provide new

lending and sustain consumer choice following consolidation in the mortgage market

• The Government guarantees for retail savings and wholesale funding were released in 2010, ahead of the original plan

• During the second half of the year, the operational separation of Northern Rock plc from NRAM was completed successfully, enabling

NRAM to be managed alongside Bradford & Bingley plc in UK Asset Resolution Limited

EARNINGS

• The Company’s financial performance is in line with expectations

• For the twelve months to 31 December 2010, the Company reported an underlying loss of £232.4 million. The underlying loss

excludes hedge accounting volatility of £8.9 million, an item which management does not consider to form part of the Company’s

underlying performance

• The statutory loss (including hedge accounting volatility) was £223.5 million. The loss reported reflects the significant costs incurred

relating to the Government’s retail and wholesale guarantees, the high level of liquidity held and other exceptional costs incurred as the

Company was restructured

• It remains a difficult trading environment for a small bank, dependent upon retail funding, with a combination of low interest rates,

subdued mortgage market demand and high competition for retail savings

• The underlying loss in the second half of the year was £92.4 million, compared with an underlying loss of £140.0 million in the first half

of 2010 demonstrating that progress is being made

• During the course of the year, mortgage lending increased and excess liquidity reduced – to the benefit of interest income – and

operating costs were controlled

INCOME

• Total income, including recharges to NRAM, was £104.9 million in 2010. Total income in the second half of the year was £76.4 million,

compared with £28.5 million in the first half

• The improvement in income in part reflected growth of the mortgage book, which resulted in a lower drag from holding surplus liquidity

• Guarantee fees reduced, reflecting the lower level of guaranteed balances following the release of the retail and wholesale guarantees.

This, combined with a reduction in retail savings balances, also improved net interest margin

• The relatively high level of liquidity held – which is invested in low yielding, high quality assets – continues to act as a drag on total income

LENDING AND CREDIT QUALITY

• The Company has continued to support capacity in the mortgage market and offer consumer choice

• Gross residential lending (including retention business) was £4.2 billion in the twelve months to 31 December 2010 and net residential

lending was £1.9 billion

15

OPERATING AND FINANCIAL REVIEW (continued)

• The quality of mortgage lending remains high, with an average loan to value (LTV) for new lending completed during the year of 62%

• The number of mortgage accounts more than three months in arrears at 31 December 2010 represented 0.17% of the book

FUNDING

• Retail deposit balances were £16.7 billion at 31 December 2010, compared with £17.6 billion at 30 June 2010 and £19.5 billion at

the start of 2010

• This reduction was in line with expectations and reflected active management of the savings book to improve margin, including the

closure of the Company’s offshore savings operation in Guernsey

• The Company successfully managed the release of the Government’s 100% guarantee of Northern Rock plc’s retail savings deposits on

24 May 2010, following the announcement by HM Treasury on 24 February 2010

• The decision to remove the Government guarantees reflected the Company’s strong capital and liquidity position and, as a result,

Northern Rock plc competes on the same terms as other banks and building societies who are also members of the Financial Services

Compensation Scheme

• Guarantees relating to wholesale funding were removed in November 2010

COSTS

• Operating expenses in 2010 were £326.5 million, with £155.8 million incurred in the second half of the year, 9% lower than in the

first half

• During 2010, significant costs were incurred in separating Northern Rock plc from NRAM and in ensuring that it has the appropriate

operating structures and capabilities to support the business going forward

• Services provided by Northern Rock plc to NRAM were recharged, with the income from the recharges recognised under fee and

commission income

CAPITAL AND LIQUIDITY

• The Company is strongly capitalised, with both a Tier 1 and Total Capital ratio of 31.6%

• The capital ratio at 30 June 2010 of 37.3% has been restated from the position reported in the half year results due to a change in the

method of calculation agreed with the FSA

• Northern Rock plc holds a high level of liquidity to support the retail deposit book and new lending activity

• Liquid assets of £5.9 billion were held at the end of the year

• The Company’s loan book is fully funded by customer deposits, with a loans to deposits ratio of 72%

FUTURE

• As anticipated, Northern Rock plc was loss‑making for the full year. Whilst the Company has made solid progress, a number of factors

continue to affect financial performance

• The relatively high level of liquidity held continues to act as a drag on income and the Company continues to explore ways of deploying

surplus liquidity

• Economic conditions remain challenging. The mortgage market in the UK is relatively subdued, and the interest rate environment

continues to act as a headwind for retail banks and building societies, particularly those funded mainly from retail savings

• Following the separation of Northern Rock plc from NRAM, the Company has entered 2011 with a higher retained cost base than in

2010, when recharges to NRAM for services provided were offset against 2010 operating costs

• Cost management will remain a key area of focus for the Company in 2011 and beyond

• The Company remains committed to its customers, providing them with attractive savings, competitive mortgages and a high standard

of service

• Northern Rock plc continues to be in Government ownership. The Company is being prepared for a return to the private sector, when

conditions are right to do so, in the best interests of taxpayers

• The selection process for corporate finance advisers to work with the Company and UKFI on the evaluation of strategic options for

Northern Rock is ongoing

16

OPERATING AND FINANCIAL REVIEW (continued)

BUSINESS REVIEW

EARNINGS

The financial performance of the Company for the twelve months to 31 December 2010 was in line with expectations. An underlying loss of

£232.4 million was recorded for the year, which reflects the low interest rate environment along with significant non‑recurring costs incurred.

This represents an underlying loss of £92.4 million in the second half of the year, compared with an underlying loss of £140.0 million in the

first half, demonstrating the progress made during the year. On a statutory basis, a loss of £80.9 million was recorded in the second half of

the year, compared with a loss of £142.6 million in the first half of 2010.

The improvement in the second half of the year compared with the first half was driven by an increase in total income, along with a

reduction in both recurring and non‑recurring expenses.

INCOME

Total income in the year to 31 December 2010 was £104.9 million. Total income in the second half of 2010 was £76.4 million, compared

with £28.5 million in the first half.

This improvement in total income was driven by an increase in high quality mortgage lending which replaced some of the lower yield excess

liquidity that the Company held following the legal and capital restructure, as well as a planned reduction in retail deposit balances to

improve margin.

Costs related to the Government’s funding guarantees – which are included within net interest income – amounted to £33.2 million for the

full year, comprising £27.7 million in the first half and £5.5 million in the second half. The reduction in these costs is due to the level of

funding covered by Government guarantees reducing over the course of the year, following the removal of the retail guarantees in May 2010.

As a result of the improvement in income, interest margin improved in the second half of the year. Underlying interest margin (excluding

accounting volatility on derivatives) was (0.28)% for the full year, compared with (0.54)% for the first half of 2010. Interest margin

remains low, however, due to the interest rate environment and the impact of holding high levels of liquidity.

Fee and commission income comprises the income from NRAM and Bradford & Bingley plc relating to the recharge of services provided

under service level agreements, plus commission income generated on sales of third party products such as building and contents insurance

and fees receivable on redemption of mortgages. Fee and commission income was £76.1 million in the second half of the year, 23% lower

than the first half, reflecting the reduction in income from the recharge following the completion of operational separation of Northern Rock

plc from NRAM.

Fee and commission expense represents third party administration and other fees payable not included in interest expense. Fee and

commission expense was £11.3 million in the second half of 2010, 18% lower than the first half mainly reflecting lower treasury and other

fees in the second half.

OPERATING EXPENSES

The Company incurred total operating expenses of £326.5 million during 2010. Of this, £170.7 million was incurred in the first half of

the year and £155.8 million in the second half. Costs were lower in the second half, partly as a result of the separation of NRAM from

Northern Rock plc from NRAM, with associated costs, on 1 November 2010.

The operating expenses figure includes £59.9 million of exceptional expenses (comprising £32.4 million in the first half of the year and

£27.5 million in the second half), which were related to the operational separation of Northern Rock plc from NRAM, and a restructuring

of the Company. This restructuring was necessary in order to align better the number of staff with the smaller size of the Company and

the lower level of new business activity. As a result of this, approximately 650 jobs were made redundant, with compulsory redundancies

avoided where possible.

Following the legal and capital restructure of the former Northern Rock, all employees of the former business (circa 4,500) were transferred

to Northern Rock plc on 1 January 2010. In November 2010, as part of the separation of Northern Rock plc from NRAM, approximately

1,250 employees were transferred to Bradford & Bingley plc. Prior to this, Northern Rock plc incurred the full costs for both Northern Rock

plc and NRAM, with costs allocated between both companies and those relating to NRAM recharged through a service level agreement.

This recharge is recognised within fee and commission income. From November 2010, this recharge reduced reflecting the lower level of

services provided by Northern Rock plc to NRAM following the separation.

Of the £59.9 million total exceptional expenses, £10.3 million related to Northern Rock plc with the balance being recharged to NRAM and

Bradford & Bingley plc.

17

OPERATING AND FINANCIAL REVIEW (continued)

RESIDENTIAL LENDING

An analysis of the movement in residential lending balances is set out in the following table:

£bn

Balance at 1 January 2010 10.3

Gross lending (including retention business) 4.2

Redemptions and repayments (including retention business) (2.3)

Balance at 31 December 2010 12.2

Note: Lending flows represent cash flows excluding fair value adjustments. Balances are stated including fair value adjustments.

Mortgage balances at 31 December 2010 were £12.2 billion, 18% higher than at the start of the year (1 January 2010 – £10.3 billion).

Gross mortgage lending (including retention business) in the second half of 2010 was £2.2 billion, 10% higher than in the first six months of

the year (six months to 30 June 2010 – £2.0 billion). Gross mortgage lending in 2010 included mortgage retention business of £0.6 billion.

Net residential lending was £1.9 billion in 2010.

All mortgage lending is carefully managed with affordability for customers as the key consideration to minimise risk and maximise returns for

taxpayers. The average LTV of new lending in 2010 was 62% (six months to 30 June 2010 – 60%).

CREDIT QUALITY

An analysis of residential arrears is set out in the following table:

31 December

2010

30 June

2010

Cases % Cases %

Over 3 – 6 months 136 0.12 76 0.07

Over 6 – 12 months 51 0.04 5 0.00

Over 12 months 10 0.01 1 0.00

Total 197 0.17 82 0.07

CML average 2.11 2.17

Source: Northern Rock plc and Council of Mortgage Lenders (CML)

Residential mortgage accounts over three months in arrears were 0.17% at 31 December 2010 (30 June 2010 – 0.07%). The low level

of arrears reflects the high quality of the Company’s mortgage balances, with an average indexed LTV on the mortgage book of 59% at

31 December 2010. The stock of unsold repossessed properties was six at 31 December 2010.

The charge for loan loss impairment for 2010 amounted to £1.9 million. The charge in the second half of the year was £1.5 million, compared

with £0.4 million in the first half. The increase in the second half of the year primarily related to enhanced modelling techniques implemented

during that period. Loan loss impairment balances were £2.4 million at 31 December 2010, compared with £0.9 million at 30 June 2010.

FUNDING

An analysis of funding flow and balances is set out in the following table:

Retail Wholesale Total

£m £m £m

2010

Balance at 1 January 2010 19.5 1.3 20.8

Movement in balances (2.8) (1.1) (3.9)

Balance at 31 December 2010 16.7 0.2 16.9

Northern Rock plc is predominantly funded by retail deposits. Retail deposit balances were £16.7 billion at 31 December 2010, compared

with £17.6 billion at 30 June 2010. The reduction in retail deposits balances is as expected and reflects active management of the retail

savings book, such as the decision to close the Guernsey savings operation, as well as release of the Government’s savings guarantee.

18

OPERATING AND FINANCIAL REVIEW (continued)

Following consultation with the Company and the FSA, on 24 February 2010 HM Treasury announced that it would lift the 100%

guarantee of Northern Rock plc’s retail savings deposits, reflecting the Company’s strong capital and liquidity position. Variable rate

accounts retained the guarantee until 24 May 2010, and fixed rate accounts opened before 24 February 2010 will keep the guarantee for

the life of the product.

As announced in June 2010, the Company decided to close its banking operations in Guernsey following a strategic review. This decision

was taken in order to deliver value to the taxpayer, as the subsidiary no longer met the long‑term commercial objectives of the Company.

All customers were informed of the decision, and the operation was closed in September 2010.

On 2 August 2010, HM Treasury announced that it would lift the guarantees on certain wholesale deposits of Northern Rock plc on

2 November 2010. Fixed term wholesale deposits existing on 1 January 2010 will retain the guarantee to maturity. Wholesale balances

have fallen during the year due to time deposit maturities.

CAPITAL AND LIQUIDITY

The Company is strongly capitalised having received £1.4 billion of equity capital upon completion of the legal and capital restructure at

the start of 2010. As the Company’s capital base is comprised entirely of ordinary share capital, its Tier 1 ratio and Total Capital ratio are

equal at 31.6% at 31 December 2010 (30 June 2010 – 37.3%).

The capital ratio at 30 June 2010 has been restated from the position reported in the half year results due to a change in the method

of calculation agreed with the FSA. Capital requirements are now calculated using the Through the Cycle methodology, which will reduce

volatility in capital requirements going forward. This change does not alter the strength of the capital base of Northern Rock plc – it remains

very well capitalised with capital ratios in excess of industry norms.

The Company held liquid assets of £5.9 billion at 31 December 2010, held in low risk assets such as deposits with the Bank of England.

NORTHERN ROCK IN THE COMMUNITY

Information regarding Northern Rock’s involvement in the community is set out in the Corporate Social Responsibility Report.

FUTURE DEVELOPMENTS

Northern Rock plc remains committed to its customers, providing them with attractive savings, competitive mortgages and a high standard

of service.

While Northern Rock plc remains in Government ownership, the Company continues to prepare the business for an eventual return to the

private sector, when conditions are right to do so, in the best interests of taxpayers. The selection process for corporate finance advisers to

work with the Company and UKFI on the evaluation of strategic options for Northern Rock is ongoing.

The economic environment remains challenging for retail banks in the UK. The mortgage market in the UK is relatively subdued, and the

interest rate environment continues to act as a headwind for retail banks and building societies, particularly for those funded mainly from

retail savings. The relatively high level of liquidity held acts as a drag on income and the Company continues to explore ways of deploying

surplus liquidity.

Following the separation of Northern Rock plc from NRAM, the Company as entered 2011 with a higher retained cost base than in 2010,

when recharges to NRAM for services provided were offset against 2010 operating costs. Cost management will remain a key area of focus

for the Company in 2011 and beyond.

Against this background, Northern Rock plc aims to provide customers with a combination of products and service that positions the

Company as an attractive retail banking alternative, and ultimately deliver value for the taxpayer.

19

DIRECTORS’ REPORT

The Directors present their report and the audited financial statements for the year ended 31 December 2010.

For the purposes of section 417 Companies Act 2006, the information set out under Corporate Governance (pages 4 to 7), the

Corporate Social Responsibility Report (pages 12 and 13) and the Operating and Financial Review (pages 14 to 18) are incorporated by

reference in this report.

PRINCIPAL ACTIVITIES

The principal activities of the Group are discussed in the Operating and Financial Review on pages 14 to 18.

KEY PERFORMANCE INDICATORS

Measure

First half

2010

Second half

2010

Full year

2010

Gross mortgage lending (including retention business) £2.0bn £2.2bn £4.2bn

Retail deposit balances £17.6bn £16.7bn £16.7bn

Total assets £19.8bn £18.6bn £18.6bn

Administrative expenses and depreciation as a % of mean total assets 1.36% 1.34% 1.35%

Underlying profit/(loss) before tax (£140.0m) (£92.4m) (£232.4m)

Mortgage accounts over 3 months in arrears 0.07% 0.17% 0.17%

PRINCIPAL RISKS AND UNCERTAINTIES

The principal risks and uncertainties that the Group faces are as follows:

• Credit risk: the current or prospective loss to earnings and capital (expected and unexpected loss) arising from lending as a result of

debtors or counterparties defaulting on their obligations due to the Group

• Market risk: the risk that changes in the level of interest rates, the rate of exchange between currencies or the price of securities or

other financial contracts, including derivatives, will have an adverse impact on the results of operations or financial condition of the

Group

• Liquidity risk: the risk that the Group is unable to meet its obligations as they fall due

• Operational risk: the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events

including legal risk

• Legal risk: the risk of legal sanction, material financial loss or loss to reputation the Group may suffer as a result of its failure to

comply with the law, inadequately document its contractual arrangements or inadequately assess and implement changes required by

forthcoming legislation or emerging case law

• Regulatory risk: the risk of the Group failing to comply with the legal and regulatory requirements applying to its arrangements and

activities, with the potential consequences of:

• Customers being unfairly treated or suffering financial or other detriment

• Legal or regulatory sanctions

• Reputational loss and the associated financial and business impacts

• Risks to market confidence or stability, and

• Northern Rock plc being used for the purposes of financial crime

• Strategic risks: risks to the Group’s Business Plan arising from prolonged low Bank Base Rate, timing of return to sustainable profitability,

double dip recession and timing of exit from Temporary Public Ownership

A review of the management of the principal risks and uncertainties is set out in note 31 to the Accounts.

REVIEW OF BUSINESS AND FUTURE DEVELOPMENTS

A review of the business, future developments and objectives are set out in the Operating and Financial Review on pages 14 to 18 and the

Executive Chairman’s Statement on pages 1 and 2.

20

DIRECTORS’ REPORT (continued)

DIVIDENDS

The Directors do not propose the

payment of any dividends on the Ordinary

shares in respect of the year ended

31 December 2010.

TANGIBLE FIXED ASSETS

Land and buildings, which are included

in the balance sheet at cost less

accumulated depreciation and impairment

losses, amounted to £16.3 million at

31 December 2010. In the Directors’

opinion, based on valuations carried out by

the Group’s qualified chartered surveyors,

the total market value of land and buildings

at 31 December 2010 was not significantly

different to the carrying value on the

balance sheet.

Details of changes to tangible fixed assets

are included in note 22 to the Accounts.

DIRECTORS

The current composition of the Board of

Directors together with brief biographical

details of each Director is shown on page 4.

The following table shows details of Board

appointments and resignations up to the

date of this report.

J McConville appointed 8 April 2010

G A Hoffman resigned 4 November 2010

R D Hunkin resigned 31 December 2010

Mr Sandler, Mr Adams, Mr Coates, Mr Pain,

Mr Fairey and Ms Phibbs were Directors

of the Company for the year ended

31 December 2010.

No Director had any interest in the shares

of the Company.

The powers of the Directors, along with

provisions relating to their appointment

and replacement, are set out in the Articles

of Association and are also governed by

UK company law. Any alteration to the

Articles of Association must be approved

by shareholders.

The Company’s Articles of Association

provide an indemnity to Directors against

certain liabilities incurred as a result of their

office. The indemnities extend to defending

any proceedings in which judgment is given

in the Directors’ favour or in which they are

acquitted or in any proceedings in which

relief is granted by a court from liability

for negligence, default, breach of duty or

breach of trust in relation to the affairs of

the Company.

The Company has also provided each

Director with a Deed of Indemnity

indemnifying them to the fullest extent

permitted by law against all losses suffered

or incurred in respect of acts and omissions

arising as a result of holding office. The

indemnity also extends to reimbursing each

Director with the costs of defending any

proceedings, regulatory investigation or

proposed action by a regulator brought

in connection with any alleged negligence,

default, misfeasance, breach of duty or

breach of trust against the Director in

relation to the Group. Reimbursement

is subject to the Director’s obligation to

repay the Company in accordance with

the provisions of the Companies Act

2006. The payment obligations of the

Company under each Deed of Indemnity

are backed by a specific guarantee in favour

of the Director entered into between the

Company and HM Treasury.

The Company has also arranged Director’s

and Officer’s Insurance on behalf of the

Directors in accordance with the provisions

of the Companies Act 2006.

SHARES

Details of the structure of the Company’s

authorised and issued share capital as at

the year end, as well as any movements in

and changes to the authorised and issued

share capital during the year, are provided

in note 29 to the Accounts.

Further details regarding the rights and

obligations attaching to the current share

classes are contained in the Company’s

Articles of Association.

EMPLOYEES

The Company believes that colleagues

are fundamental to our success and that

capitalising on what is unique about

individuals and drawing on their different

perspectives and experiences will add value

to the way Northern Rock plc does business.

Using fair, objective and innovative

employment practices, the Company’s aim

is to ensure that:

• All colleagues and potential colleagues

are treated fairly and with dignity and

respect at all times;

• All colleagues have the right to be free

from harassment, victimisation and

bullying of any description, or any other

form of unwanted behaviour, whether

based on age; colour of skin; disability;

ethnic origin/race; gender/trans‑gender

status; marital/civil partnership status;

sexual orientation, religion or belief;

• All colleagues have an equal

opportunity to contribute to and

achieve their potential, irrespective of

any defining feature that may give rise

to unfair discrimination.

Under the terms of The Northern Rock

Transfer Order 2009, SI 2009/3226

all employees of Northern Rock (Asset

Management) plc were transferred to

Northern Rock plc on 1 January 2010.

As part of the integration of Northern Rock

(Asset Management) plc with Bradford &

Bingley plc (under the UK Asset Resolution

Limited holding company), the Northern

Rock plc employees performing Northern

Rock (Asset Management) plc activities

were transferred to Bradford & Bingley plc

under Transfer of Undertakings (Protection

of Employment) Regulations.

FINANCIAL INSTRUMENTS

The Group’s financial risk management

objectives and policies, including its

governance framework and approach to the

management of key risks including credit

risk, market risk, operational risk, regulatory

risk and liquidity risk, are discussed in

note 31 to the Accounts.

SIGNIFICANT SHAREHOLDINGS

As at the date of this report, all of the

issued share capital is held by the Treasury

Solicitor as nominee for HM Treasury.

BRANCH OFFICES

As at 31 December 2010 the Company’s

branch network included an office in

21

DIRECTORS’ REPORT (continued)

Ireland and a subsidiary in Guernsey,

Northern Rock (Guernsey) Limited.

Northern Rock (Guernsey) Limited has

been under the control of the liquidator

since 30 September 2010. Northern Rock

(Guernsey) Limited has reserves of £5.2m

which are being used to pay liquidator fees

and any other expenses that may arise

during liquidation.

CREDITOR PAYMENT POLICY

The Company’s policy with regard to the

payment of suppliers is to negotiate and

agree terms and conditions with all its

suppliers, which include the giving of an

undertaking to pay them within an agreed

payment period.

The average creditor payment period at

31 December 2010 was 17 days.

SIGNIFICANT AGREEMENTS

The Company, or other members of the

Group, are party to certain non‑material

agreements that contain change of control

provisions in the event of the takeover of

the Company but these are not considered

to be significant on an individual basis.

CHARITABLE CONTRIBUTIONS

Details of charitable contributions relating

to 2010 are included within the Corporate

Social Responsibility Report on pages 12

and 13.

GOING CONCERN

The Directors are satisfied at the time of

approval of the financial statements that

the Group has adequate resources to

continue in business for the foreseeable

future. For this reason, they continue to

adopt the going concern basis in preparing

the accounts.

STATEMENT OF DIRECTORS’

RESPONSIBILITIES

The Directors are responsible for preparing

the Annual Report and the financial

statements in accordance with applicable law

and regulations.

Company law requires the Directors to

prepare financial statements for each

financial year. Under that law the Directors

have elected to prepare the Group and

parent company financial statements in

accordance with International Financial

Reporting Standards (IFRSs) as adopted by

the European Union. Under company law

the Directors must not approve the financial

statements unless they are satisfied that

they give a true and fair view of the state

of affairs of the Group and the Company

and of the profit or loss of the Group for

that period. In preparing these financial

statements, the Directors are required to:

• select suitable accounting policies and

then apply them consistently

• make judgements and accounting

estimates that are reasonable and

prudent

• state whether applicable IFRSs as

adopted by the European Union have

been followed, subject to any material

departures disclosed and explained in

the financial statements.

The Directors are responsible for keeping

adequate accounting records that

are sufficient to show and explain the

Company’s transactions and disclose

with reasonable accuracy at any time the

financial position of the Company and

the Group and enable them to ensure

that the financial statements comply with

the Companies Act 2006. They are also

responsible for safeguarding the assets

of the Company and the Group and

hence for taking reasonable steps for the

prevention and detection of fraud and other

irregularities.

The maintenance and integrity of

the Northern Rock plc website is the

responsibility of the Directors.

Legislation in the United Kingdom governing

the preparation and dissemination of

financial statements may differ from

legislation in other jurisdictions.

AUDITORS AND DISCLOSURE OF

INFORMATION TO AUDITORS

So far as every Director at the date of this

report is aware, there is no relevant audit

information needed in preparation of the

auditors’ report of which the auditors are

not aware. The Directors have taken the

steps they need to have taken as Directors

to make themselves aware of any relevant

audit information and to establish that the

auditors are also aware of that information.

By order of the Board

J Fitzpatrick,

Company Secretary

8 March 2011

22

INDEPENDENT AUDITORS’ REPORT TO THE SHAREHOLDER OF NORTHERN ROCK PLC

We have audited the group and parent

company financial statements (the

‘‘financial statements’’) of Northern Rock

plc for the year ended 31 December

2010 which comprise the Consolidated

Income Statement, the Consolidated

Statement of Comprehensive Income,

the Consolidated and Company Balance

Sheets, the Consolidated and Company

Statements of Changes in Equity, the

Consolidated and Company Cash Flow

Statements and the related notes. The

financial reporting framework that has been

applied in their preparation is applicable

law and International Financial Reporting

Standards (IFRSs) as adopted by the

European Union and, as regards the parent

company financial statements, as applied

in accordance with the provisions of the

Companies Act 2006.

RESPECTIVE RESPONSIBILITIES OF

DIRECTORS AND AUDITORS

As explained more fully in the Directors’

Responsibilities Statement set out on

page 21, the directors are responsible for

the preparation of the financial statements

and for being satisfied that they give a true

and fair view. Our responsibility is to audit

and express an opinion on the financial

statements in accordance with applicable

law and International Standards on Auditing

(UK and Ireland). Those standards require

us to comply with the Auditing Practices

Board’s Ethical Standards for Auditors.

This report, including the opinions,

has been prepared for and only for the

company’s shareholder in accordance with

Chapter 3 of Part 16 of the Companies Act

2006 and for no other purpose. We do

not, in giving these opinions, accept or

assume responsibility for any other purpose

or to any other person to whom this report

is shown or into whose hands it may come

save where expressly agreed by our prior

consent in writing.

SCOPE OF THE AUDIT OF THE FINANCIAL

STATEMENTS

An audit involves obtaining evidence about

the amounts and disclosures in the financial

statements sufficient to give reasonable

assurance that the financial statements are

free from material misstatement, whether

caused by fraud or error. This includes an

assessment of: whether the accounting

policies are appropriate to the group’s and

parent company’s circumstances and have

been consistently applied and adequately

disclosed; the reasonableness of significant

accounting estimates made by the directors;

and the overall presentation of the financial

statements.

OPINION ON FINANCIAL STATEMENTS

In our opinion:

• the financial statements give a true and

fair view of the state of the group’s and

of the parent company’s affairs as at

31 December 2010 and of the group’s

loss and group’s and parent company’s

cash flows for the year then ended;

• the group financial statements have

been properly prepared in accordance

with IFRSs as adopted by the European

Union;

• the parent company financial

statements have been properly

prepared in accordance with IFRSs

as adopted by the European Union

and as applied in accordance with

the provisions of the Companies Act

2006; and

• the financial statements have been

prepared in accordance with the

requirements of the Companies Act

2006.

OPINION ON OTHER MATTER

PRESCRIBED BY THE COMPANIES

ACT 2006

In our opinion the information given in the

Directors’ Report for the financial year for

which the financial statements are prepared

is consistent with the financial statements.

MATTERS ON WHICH WE ARE REQUIRED

TO REPORT BY EXCEPTION

We have nothing to report in respect of the

following matters where the Companies Act

2006 requires us to report to you if, in our

opinion:

• adequate accounting records have not

been kept by the parent company, or

returns adequate for our audit have not

been received from branches not visited

by us; or

• the parent company financial

statements are not in agreement with

the accounting records and returns; or

• certain disclosures of directors’

remuneration specified by law are not

made; or

• we have not received all the information

and explanations we require for our

audit.

David Roper (Senior Statutory Auditor)

for and on behalf of

PricewaterhouseCoopers LLP

Chartered Accountants and

Statutory Auditors

Newcastle upon Tyne

8 March 2011

23

CONSOLIDATED INCOME STATEMENTFor the year ended 31 December 2010

Note 2010

3 July to

31 December

2009

£m £m

Interest and similar income 5 406.8 –

Interest and similar expense 6 (447.8) –

Net interest income / (expense) (41.0) –

Fee and commission income 7 174.6 –

Fee and commission expense (25.1) –

Other operating income 0.8 –

Net trading expense 11 (4.4) –

145.9 –

Total income 104.9 –

Administrative expenses 8 (250.7) –

Depreciation and amortisation (15.9) –

Exceptional restructuring costs 8 (59.9) –

Operating expenses (326.5) –

Impairment losses on loans and advances 10 (1.9) –

Loss before taxation (223.5) –

Taxation 12 – –

Loss for the year attributable to owners (223.5) –

The notes on pages 31 to 64 form an integral part of these financial statements.

24

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOMEFor the year ended 31 December 2010

Note 2010

3 July to

31 December

2009

£m £m

Loss for the year attributable to owners (223.5) –

Other comprehensive income

Net movement in available for sale reserve 30 9.3 –

Net movement in cash flow hedge reserve 30 1.4 –

Actuarial gains and losses 9 (0.6) –

10.1 –

Total comprehensive income for the year attributable to owners (213.4) –

25

CONSOLIDATED BALANCE SHEETAt 31 December 2010

Note 2010 2009

£m £mAssetsCash and balances with central banks 15 4,646.0 1,400.0Derivative financial instruments 16 149.0 –Loans and advances to banks 17 585.2 –Loans and advances to customers 18 12,197.5 –Fair value adjustments of portfolio hedging 18 176.9 –Investment securities 19 661.0 –Intangible assets 21 11.1 –Property, plant and equipment 22 34.7 –Retirement benefit asset 9 3.1 –Other assets 83.9 0.1Prepayments and accrued income 13.4 –

Total assets 18,561.8 1,400.1

LiabilitiesLoans from HM Treasury 24 – 1,400.0Deposits by banks 25 0.7 –Customer accounts 26 16,903.2 –Derivative financial instruments 16 255.0 –Other liabilities 43.4 –Accruals and deferred income 27 164.6 –Provisions for liabilities and charges 28 7.4 –

17,374.3 1,400.0Equity

Share capital 29 1,400.0 0.1Other reserves 30 (5.5) –Retained earnings (207.0) –

Total equity 1,187.5 0.1

Total equity and liabilities 18,561.8 1,400.1

The notes on pages 31 to 64 form an integral part of these financial statements.

Approved by the Board on 8 March 2011 and signed on its behalf by:

R A Sandler J McConville

Executive Chairman Chief Financial Officer

Northern Rock plc is registered in England and Wales under Company Number 06952311.

26

COMPANY BALANCE SHEETAt 31 December 2010

Note 2010 2009

£m £mAssetsCash and balances with central banks 15 4,646.0 1,400.0Derivative financial instruments 16 149.0 –Loans and advances to banks 17 579.7 –Loans and advances to customers 18 12,197.5 –Fair value adjustments of portfolio hedging 18 176.9 –Investment securities 19 661.0 –Intangible assets 21 11.1 –Property, plant and equipment 22 34.7 –Retirement benefit asset 9 3.1 –Other assets 83.4 0.1Prepayments and accrued income 13.4 –

Total assets 18,555.8 1,400.1

LiabilitiesLoans from HM Treasury 24 – 1,400.0Deposits by banks 25 0.7 –Customer accounts 26 16,903.2 –Derivative financial instruments 16 255.0 –Other liabilities 42.6 –Accruals and deferred income 27 164.6 –Provisions for liabilities and charges 28 7.4 –

17,373.5 1,400.0Equity

Share capital 29 1,400.0 0.1Other reserves 30 (5.5) –Retained earnings (212.2) –

Total equity 1,182.3 0.1

Total equity and liabilities 18,555.8 1,400.1

The notes on pages 31 to 64 form an integral part of these financial statements.

Approved by the Board on 8 March 2011 and signed on its behalf by:

R A Sandler J McConville

Executive Chairman Chief Financial Officer

Northern Rock plc is registered in England and Wales under Company Number 06952311.

27

CONSOLIDATED STATEMENT OF CHANGES IN EQUITYFor the year ended 31 December 2010

Note

Share

capital

£m

Other

reserves

£m

Retained

earnings

£m

Total

equity

£m

Balance at 1 January 2010 0.1 – – 0.1

Transfer of reserves from Northern Rock (Asset Management) plc – (16.2) 17.1 0.9

Issuance of ordinary shares 29 1,399.9 – – 1,399.9

Loss for the year – – (223.5) (223.5)

Other comprehensive income

Net movement in available for sale reserve 30 – 9.3 – 9.3

Net movement in cash flow hedge reserve 30 – 1.4 – 1.4

Actuarial gains and losses 9 – – (0.6) (0.6)

Total other comprehensive income – 10.7 (0.6) 10.1

Balance at 31 December 2010 1,400.0 (5.5) (207.0) 1,187.5

CONSOLIDATED STATEMENT OF CHANGES IN EQUITYFor the period 3 July 2009 to 31 December 2009

Note

Share

capital

£m

Other

reserves

£m

Retained

earnings

£m

Total

equity

£m

Balance at 3 July 2009 – – – –

Issuance of ordinary shares 29 0.1 – – 0.1

Balance at 31 December 2009 0.1 – – 0.1

28

COMPANY STATEMENT OF CHANGES IN EQUITYFor the year ended 31 December 2010

Note

Share

capital

£m

Other

reserves

£m

Retained

earnings

£m

Total

equity

£m

Balance at 1 January 2010 0.1 – – 0.1

Transfer of reserves from Northern Rock (Asset Management) plc – (16.2) – (16.2)

Issuance of ordinary shares 29 1,399.9 – – 1,399.9

Loss for the year – – (211.6) (211.6)

Other comprehensive income

Net movement in available for sale reserve 30 – 9.3 – 9.3

Net movement in cash flow hedge reserve 30 – 1.4 – 1.4

Actuarial gains and losses 9 – – (0.6) (0.6)

Total other comprehensive income – 10.7 (0.6) 10.1

Balance at 31 December 2010 1,400.0 (5.5) (212.2) 1,182.3

COMPANY STATEMENT OF CHANGES IN EQUITYFor the period 3 July 2009 to 31 December 2009

Note

Share

capital

£m

Other

reserves

£m

Retained

earnings

£m

Total

equity

£m

Balance at 3 July 2009 – – – –

Issuance of ordinary shares 29 0.1 – – 0.1

Balance at 31 December 2009 0.1 – – 0.1

29

CONSOLIDATED CASH FLOW STATEMENTFor the year ended 31 December 2010

Note 2010

3 July to 31 December

2009

£m £m

Net cash inflow from operating activities

Loss before taxation (223.5) –

Adjusted for:

Depreciation and amortisation 15.9 –

Impairment losses on loans and advances 10 1.9 –

Fair value adjustments on financial instruments (101.4) –

Other non cash movements (19.3) –

Net cash outflow from operating losses before changes in operating assets and liabilities (326.4) –

Changes in operating assets and liabilities

Net increase in deposits held for regulatory or monetary control purposes (30.1) –

Net increase in loans and advances (12,175.2) –

Net increase in derivative financial instruments receivable (149.0) –

Net increase in other assets (83.8) (0.1)

Net increase in prepayments and accrued income (13.4) –

Net (decrease)/increase in loans from HM Treasury (1,400.0) 1,400.0

Net increase in deposits from other banks 0.7 –

Net increase in amounts due to customers 16,827.7 –

Net increase in derivative financial instruments payable 255.0 –

Net increase in other liabilities 43.4 –

Net increase in accruals and deferred income 164.6 –

Net cash inflow from operating activities 3,113.5 1,399.9

Net cash inflow from investing activities

Net investment in intangible assets (23.8) –

Net investment in property, plant and equipment (37.9) –

Purchase of investment securities (including transfer from Northern Rock (Asset Management) plc) (1,455.4) –

Proceeds from sale and redemption of investment securities 794.8 –

(722.3) –

Net cash outflow from financing activities

Issuance of ordinary shares 1,399.9 0.1

1,399.9 0.1

Net increase in cash and cash equivalents 3,791.1 1,400.0

Opening cash and cash equivalents 1,400.0 –

Closing cash and cash equivalents 34 5,191.1 1,400.0

30

COMPANY CASH FLOW STATEMENTFor the year ended 31 December 2010

Note 2010

3 July to 31 December

2009

£m £m

Net cash inflow from operating activities

Loss before taxation (211.6) –

Adjusted for:

Depreciation and amortisation 15.9 –

Impairment losses on loans and advances 10 1.9 –

Fair value adjustments on financial instruments (101.4) –

Other non cash movements (36.4) –

Net cash outflow from operating losses before changes in operating assets and liabilities (331.6) –

Changes in operating assets and liabilities

Net increase in deposits held for regulatory or monetary control purposes (30.1) –

Net increase in loans and advances (12,175.2) –

Net increase in derivative financial instruments receivable (149.0) –

Net increase in other assets (83.3) (0.1)

Net increase in prepayments and accrued income (13.4) –

Net (decrease)/increase in loans from HM Treasury (1,400.0) 1,400.0

Net increase in deposits from other banks 0.7 –

Net increase in amounts due to customers 16,827.7 –

Net increase in derivative financial instruments payable 255.0 –

Net increase in other liabilities 42.6 –

Net increase in accruals and deferred income 164.6 –

Net cash inflow from operating activities 3,108.0 1,399.9

Net cash inflow from investing activities

Net investment in intangible assets (23.8) –

Net investment in property, plant and equipment (37.9) –

Purchase of investment securities (including transfer from Northern Rock (Asset Management) plc) (1,455.4) –

Proceeds from sale and redemption of investment securities 794.8 –

(722.3) –

Net cash outflow from financing activities

Issuance of ordinary shares 1,399.9 0.1

1,399.9 0.1

Net increase in cash and cash equivalents 3,785.6 1,400.0

Opening cash and cash equivalents 1,400.0 –

Closing cash and cash equivalents 34 5,185.6 1,400.0

31

NOTES TO THE ACCOUNTS

1. Basisofpreparation

The financial statements have been prepared on a going concern basis.

Northern Rock plc (Northern Rock, the Company, the Group) was incorporated on 3 July 2009 as Gosforth Subsidiary No. 1 Limited, a company domiciled in the United Kingdom. The Company changed its name to Gosforth Subsidiary No. 1 plc on 10 November 2009 and then to Northern Rock plc on 31 December 2009 ahead of the legal and capital restructure of the former Northern Rock, which subsequently took place on 1 January 2010.

The Company did not trade in the period to 31 December 2009. On 1 January 2010 Northern Rock plc became a savings and mortgage bank under the terms of the Statutory Instrument 2009/3226 (“The Northern Rock Transfer Order”), which was a legal and capital restructuring of Northern Rock into two companies. Under the terms of this order Northern Rock plc acquired certain elements of the business of Northern Rock (Asset Management) plc, including its entire retail savings book of £19.5 billion and a residential mortgage book of £10.3 billion.

2. Principalaccountingpolicies

a) AccountingconventionThese financial statements have been prepared in accordance with EU endorsed International Financial Reporting Standards (“IFRS”), IFRIC interpretations and with those parts of the Companies Act 2006 applicable to companies reporting under IFRS. The financial statements have been prepared under the historical cost convention as modified by the revaluation of available for sale investments, financial assets and liabilities held at fair value. A summary of the more important group accounting policies is set out below. The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although these estimates are based on management’s best knowledge of the amount, event or actions, actual results ultimately may differ from those estimates (see note 4).

b) BasisofconsolidationThe financial information of the Group incorporates the assets, liabilities and results of Northern Rock plc and its subsidiary undertakings (including Special Purpose Entities). Entities are regarded as subsidiaries where the Group has the power to govern financial and operating policies so as to obtain benefits from their activities. Inter-company transactions and balances are eliminated upon consolidation.

Subsidiaries are consolidated from the date on which control is transferred from the Group and are deconsolidated from the date that control ceases. Uniform accounting policies are applied consistently across the Group.

c) InterestincomeandexpenseInterest income and expense are recognised in the income statement for all instruments measured at amortised cost using the effective interest method.

The effective interest method calculates the amortised cost of a financial asset or a financial liability, and allocates the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash receipts or payments through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the Group estimates cash flows considering all contractual terms of the financial instrument (for example prepayment options) but does not consider future credit losses. The calculation includes all amounts received or paid by the Group that are an integral part of the overall return, direct incremental transaction costs related to the acquisition or issue of a financial instrument and all other premiums and discounts.

Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss.

d) FeesandcommissionsWhere they are not included in the effective interest calculation, fees and commissions are generally recognised on an accruals basis when the service has been provided. Loan commitment fees for loans that are likely to be drawn down are deferred (together with related incremental direct costs) and recognised as an adjustment to the effective interest rate on the loan. Insurance commissions are recognised in the period in which they are earned.

e) FinancialinstrumentsFinancial assets can be classified in the following categories: loans and receivables, available for sale, held to maturity or financial assets at fair value through profit and loss. Management determines the classification of its financial instruments at initial recognition. The Group measures all of its financial liabilities at amortised cost, other than derivatives and those instruments which have been designated as part of a hedging relationship (see below). Regular way purchases and sales of financial assets at fair value through profit or loss, held to maturity and available for sale are recognised on trade date – the date on which the Group commits to purchase or sell the asset.

i) Loans and receivables and financial liabilities at amortised cost

The Group’s loans and advances to banks and customers are classified as loans and receivables. Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, whose recoverability is based solely on the credit risk of the customer and where the Group has no intention of trading the loan. Both loans and receivables and financial liabilities are initially recognised at fair value including direct and incremental transaction costs. Subsequent recognition is at amortised cost using the effective interest method, less any provision for impairment.

ii) Available for sale financial assets

Available for sale financial assets are assets that are either designated as available for sale or are assets that do not meet the definition of loans and receivables and are not derivatives or assets held at fair value through profit and loss. These are principally but not exclusively investment securities intended to be held for an indefinite period of time which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. They are initially measured at fair value including direct and incremental transaction costs. Subsequent measurement is at fair value, with changes in fair value being recognised in equity except for impairment losses and translation differences, which are recognised in the income statement. Upon derecognition of the asset, or where there is objective evidence that the investment security is impaired, the cumulative gains and losses recognised in equity are removed from equity and recycled to the income statement.

iii) Held to maturity financial assets

Held to maturity financial assets are non-derivative financial assets with fixed or determinable payments that the Group has the ability and intention to hold to maturity. They are initially measured at fair value including direct and incremental transaction costs. Subsequent measurement is at amortised cost using the effective interest method. No financial assets were classified as held to maturity during either 2010 or 2009.

32

NOTES TO THE ACCOUNTS (continued)

2. Principalaccountingpolicies(continued)

iv) Financial assets and liabilities at fair value through profit or loss

A financial asset or liability is classified in this category if it is held for trading or is so designated by management on initial recognition. A financial asset or liability is classified as held for trading if it is a derivative not in an IAS 39 compliant accounting hedge relationship, or if it is acquired for the purpose of selling or repurchasing in the near term. In certain circumstances other assets and liabilities may be designated as held at fair value through profit or loss on initial recognition. These are when:

a) Doing so significantly reduces measurement inconsistencies that would arise if the asset or liability were carried at amortised cost but a related derivative was treated as held for trading;

b) Certain investments are managed and evaluated on a fair value basis in accordance with a documented risk management strategy and are reported to management on that basis;

c) Financial instruments contain significant embedded derivatives that significantly modify the cash flows from the instruments.

The assets are initially measured at fair value, with transaction costs taken directly to the income statement. Subsequent measurement is at fair value including interest cash flows and accruals, with changes in fair value included directly in the income statement within other income, except for derivative instruments where interest cash flows and accruals are recorded within net interest income.

The fair values of quoted investments in active markets are based on current bid prices. If the market for a financial asset is not active (and for unlisted securities), the Group establishes fair value using valuation techniques. These include the use of recent arm’s length transactions, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants.

No financial assets or liabilities were held at fair value through the income statement in 2010.

f) OffsettingfinancialinstrumentsFinancial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously.

g) DerivativefinancialinstrumentsandhedgeaccountingThe Group is authorised to undertake the following types of derivative financial instrument transactions for non-trading purposes: cross currency swaps, interest rate swaps, equity swaps, interest rate caps, forward rate agreements, options, foreign exchange contracts and similar instruments.

The Group’s derivative activities are entered into for the purpose of matching or eliminating risk from potential movements in interest and foreign exchange rates inherent in the Group’s assets, liabilities and positions. All derivative transactions are for economic hedging purposes and so it is therefore decided at the outset which position the derivative will be hedging. Derivatives are reviewed regularly for their effectiveness as hedges and corrective action taken, if appropriate. Derivatives are measured initially at fair value and subsequently remeasured to fair value. Fair values are obtained from quoted market prices in active markets and, where these are not available, from valuation techniques including discounted cash flow models and option pricing models. Where derivatives are not designated as part of a hedging relationship, changes in fair value are recorded in the income statement. Where derivatives are designated within hedging relationships, the treatment of the changes in fair value depends on the nature of the hedging relationship as explained below.

Hedge accounting is used for derivatives designated in this way provided certain criteria are met. The Group documents at inception of the hedge relationship the link between the hedging instrument and the hedged item as well as its risk management objective and strategy for undertaking various hedge transactions. The Group also documents its assessment both at hedge inception and on an ongoing basis of whether the derivatives used in hedging transactions are highly effective in offsetting changes in the fair values or cash flows of hedged items.

i) Cash flow hedges

A cash flow hedge is used to hedge exposures to variability in cash flows, such as variable rate financial assets and liabilities. The effective portion of changes in the derivative fair value is recognised in equity, and recycled to the income statement in the periods when the hedged item will affect profit and loss. The fair value gain or loss relating to the ineffective portion is recognised immediately in the income statement.

ii) Fair value hedges

A fair value hedge is used to hedge exposures to variability in the fair value of financial assets and liabilities, such as fixed rate loans. Changes in fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. If the hedge no longer meets the criteria for hedge accounting, the adjustment to the carrying amount of the hedged item is amortised to the income statement over the period to maturity.

If derivatives are not designated as hedges then changes in fair values are recognised immediately in the income statement.

iii) Embedded derivatives

Certain derivatives are embedded within other non-derivative host instruments to create a hybrid instrument. Where the economic characteristics and risks of the embedded derivatives are not closely related to the economic characteristics and risk of the host instrument, and where the hybrid instrument is not measured at fair value, the Group separates the embedded derivative from the host instrument and measures it at fair value with the changes in fair value recognised in the income statement.

h) SaleandrepurchaseagreementsSecurities sold subject to repurchase agreements (‘repos’) are reclassified in the financial statements as assets pledged when the transferee has the right by contract or custom to sell or repledge the collateral; the counterparty liability is included in amounts due to other banks, deposits from banks, other deposits or deposits due to customers, as appropriate. Securities purchased under agreements to resell, (‘reverse repos’), are recorded as loans and advances to banks or customers as appropriate. The difference between sale and repurchase price is treated as interest and accrued over the life of the agreements using the effective interest method. Securities lent to counterparties are also retained in the financial statements.

i) ImpairmentlossesThe Group assesses its financial assets or groups of financial assets for objective evidence of impairment at each balance sheet date. An impairment loss is recognised if, and only if, there is a loss event (or events) that has occurred after initial recognition and before the balance sheet date and has a reliably measurable impact on the estimated future cash flows of the financial assets or groups of financial assets. Losses that are incurred as a result of events occurring after the balance sheet date are not recognised in these financial statements.

33

NOTES TO THE ACCOUNTS (continued)

2. Principalaccountingpolicies(continued)

i) Assets held at amortised cost

The Group first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. Objective evidence that a financial asset is impaired includes observable data that comes to the attention of the Group about the following loss events:

a) significant financial difficulty of the issuer or obligor;

b) a breach of contract, such as a default or delinquency in interest or principal repayments;

c) the lender, for economic or legal reasons relating to the borrower’s financial difficulty, granting to the borrower a concession that the lender would not otherwise consider;

d) it becomes probable that the borrower will enter bankruptcy or other financial reorganisation;

e) the disappearance of an active market for that financial asset because of financial difficulties; or

f) observable data indicating that there is a measurable decrease in the estimated future cash flows from a portfolio of assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the portfolio, including:

i. adverse changes in the payment status of borrowers in the portfolio;

ii. national or local economic conditions that correlate with defaults on the assets in the portfolio.

If the Group determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment. Assets that are individually assessed and for which an impairment loss is or continues to be recognised are not included in a collective assessment of impairment.

If there is objective evidence that an impairment loss on loans and receivables has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of the estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate. The carrying amount of the asset is reduced through the use of an impairment allowance and the amount of the loss is recognised in the income statement. In future periods the unwind of the discount is recognised within interest income.

When a loan is uncollectible, it is written off against the related provision for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of the provision for loan impairment in the income statement. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised (such as an improvement in the customer’s credit rating), the previously recognised impairment loss is reversed by adjusting the impairment allowance. The amount of the reversal is recognised in the income statement.

ii) Available for sale financial assets

For available for sale financial assets, the Group assesses at each balance sheet date whether there is objective evidence that a financial asset, or group of financial assets are impaired. The amount of the loss is measured as the difference between the asset’s acquisition cost less principal repayments and amortisation and the current fair value. The amount of the impairment loss is recognised in the income statement. This includes cumulative gains and losses previously recognised in equity which are recycled from equity to the income statement. If, in a subsequent period, the fair value of a debt instrument classified as available for sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit or loss, the impairment loss is reversed through the income statement.

iii) Renegotiated loans

Loans to customers whose terms have been renegotiated are no longer considered past due but are treated as fully performing loans only after at least three monthly payments under the new arrangements have been received. In subsequent years, the asset is considered to be past due and disclosed only if renegotiated again within that year.

j) DerecognitionoffinancialassetsandliabilitiesDerecognition is the point at which the Group removes an asset or liability from its balance sheet. The Group’s policy is to derecognise financial assets only when the contractual right to the cash flows from the financial asset expires. The Group also derecognises financial assets that it transfers to another party provided the transfer of the asset also transfers the right to receive the cash flows of the financial asset or where the Group has transferred substantially all the risks and rewards of ownership. Where the transfer does not result in the Group transferring the right to receive the cash flows of the financial assets, but it does result in the Group assuming a corresponding obligation to pay the cash flows to another recipient, the financial assets are also accordingly derecognised.

The Group derecognises financial liabilities only when the obligation specified in the contract is discharged, cancelled or has expired.

k) SecuritisationtransactionsThe Group has entered into self issuance of securitised debt which may be used as collateral for repurchase or similar transactions. Investments in self issued debt and the equivalent deemed loan, together with the related income, expense and cash flows, are not recognised in the financial statements.

l) ForeigncurrencytranslationThe Group’s financial statements are presented in sterling, which is the functional currency of the parent company.

Foreign currency transactions are translated into functional currency using the exchange rates prevailing at the dates of the transactions. Monetary items denominated in foreign currencies are translated at the rate prevailing at the balance sheet date. Foreign exchange gains and losses resulting from the restatement and settlement of such transactions are recognised in the income statement. Non-monetary items measured at amortised cost and denominated in foreign currencies are translated at the exchange rate at the date of the transaction. Non-monetary items measured at fair value are translated at the exchange rate at the date of valuation. Where these are held at fair value through the income statement, exchange differences are reported as part of the fair value gain or loss.

m) IntangibleassetsComputer software

Costs incurred in acquiring and developing computer software for internal use are capitalised as intangible assets where the software leads to the creation of an identifiable non-monetary asset and it is probable that the expected future economic benefits that are attributable to the asset will flow to the Group from its use for a period of over one year. The software is classified as an intangible asset where it is not an integral part of the related hardware and amortised over its estimated useful life on a straight line basis which is generally 3 to 5 years.

Costs associated with maintaining software are expensed as they are incurred.

34

NOTES TO THE ACCOUNTS (continued)

2. Principalaccountingpolicies(continued)

n) CashandcashequivalentsFor the purposes of the cash flow statement, cash and cash equivalents comprise balances with less than three months’ maturity from the date of acquisition, including cash and non-restricted balances with central banks.

o) Taxationi) Current income tax

Income tax payable/(receivable) is calculated on taxable profits/(losses) based on the applicable tax law in each jurisdiction where the Company operates and is recognised as an expense/(income) for the period except to the extent that it relates to items that are charged or credited to other comprehensive income or to equity.

Where tax losses can be relieved only by carry forward against taxable profits of future periods, a deductible temporary difference arises. Those losses carried forward, if provided for, are set off against deferred tax liabilities carried in the balance sheet.

ii) Deferred income tax

Deferred income tax is calculated using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. Deferred income tax is determined using tax rates and laws that have been enacted or substantially enacted by the date of the balance sheet and are expected to apply when the related deferred income tax asset is realised or the deferred income tax liability is settled.

The principal temporary differences arise from depreciation of property, plant and equipment, revaluation of certain financial assets and liabilities including derivative contracts, provisions for pensions and other post-retirement benefits, the carry forward of unused losses, and change in accounting basis on adoption of IFRS.

Deferred income tax assets are recognised when it is probable that future taxable profits will be available against which these temporary differences can be utilised.

The tax effects of carry forwards of unused losses or unused tax credits are recognised as an asset when it is probable that future taxable profits will be available against which these losses can be utilised.

p) PensionsandemployeebenefitsIn 2010, the Company operated the Northern Rock (2010) Pension Scheme (the “Scheme”) to provide retirement benefits for staff. The Scheme had defined benefit and defined contribution sections. Staff who joined the previous scheme, the Northern Rock Pension Scheme, before 1 July 1999 participated in the funded, contracted out, defined benefit section of the Scheme unless they opted out. Other staff, including those employed at 1 July 1999 but not members of the defined benefit section at that date, together with staff employed from 1 July 1999, participated in the defined contribution section of the scheme unless they opted out. The assets of both sections of the Scheme are held in a trustee-administered fund separate from the assets of Northern Rock plc.

In June 2010 it was announced that the defined benefit section would be closed to future accrual effective from 1 January 2011. In addition no further contributions could be made to the defined contribution section of the Scheme from the same date. All employees have transferred to the Northern Rock (2011) Pension Scheme which has a defined contribution section only.

A full actuarial valuation of the Group’s defined benefit section of the Scheme is undertaken every three years with interim reviews in the intervening years; these valuations are updated to 31 December each year by qualified independent actuaries. For the purpose of these annual updates, Scheme assets are included at their fair value and Scheme liabilities are measured on an actuarial basis using the projected unit credit method. Liabilities in the defined benefit section of the Scheme are discounted using rates equivalent to the market yields at the balance sheet date on high quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension liability. The resulting net surplus or deficit is included in the Group’s balance sheet. Surpluses are only recognised to the extent that they are recoverable through reduced contributions in the future or through refunds from the Scheme.

The Group’s income statement includes the current service cost of providing pension benefits, the expected return on the Scheme’s assets, net of administration costs, and the interest cost on the Scheme’s liabilities. Cumulative actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are recognised immediately through other comprehensive income.

Past service costs are recognised immediately in the income statement, unless the changes to the Scheme are conditional on the employees remaining in service for a specified period of time (the vesting period). In this case, the past service costs are amortised on a straight line basis over the average vesting period.

For defined contribution plans, the Company has no further payment obligations once the contributions have been paid. The contributions are recognised as an employee benefit expense when they are due. Prepaid contributions are recognised as an asset to the extent that a cash refund or a reduction in the future payments is available.

q) Property,plantandequipmentProperty, plant and equipment are stated at cost less accumulated depreciation and provision for impairment, as appropriate. Cost includes the original purchase price of the asset and the costs attributable to bringing the asset to its working condition for its intended use. Additions and subsequent expenditure are included in the asset’s carrying value or are recognised as a separate asset only when they improve the expected future economic benefits to be derived from the asset. All other repairs and maintenance are charged to the income statement in the period in which they are incurred.

Depreciation is provided using the straight line method to allocate costs less residual values over estimated useful lives, as follows:

Freehold property 100 years

Leasehold property Unexpired period of the lease

Plant, equipment, fixtures and fittings

– plant 30 years

– furniture 10 years

– other 5 years

Computer equipment

– PCs 3 years

– other 5 years

Motor vehicles 4 years

Assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.

35

NOTES TO THE ACCOUNTS (continued)

2. Principalaccountingpolicies(continued)

Where the cost of freehold land can be identified separately from buildings, the land value is not depreciated. Fixed assets are subject to impairment testing, if deemed appropriate.

r) Impairmentofproperty,plantandequipmentandintangibleassetsProperty, plant and equipment and intangible assets are assessed for indications of impairment at each balance sheet date, or more frequently where required by events or changes in circumstances. If indications of impairment are found, these assets are subject to an impairment review. The impairment review compares the carrying value of the assets with their recoverable amounts, which are defined as the higher of the net selling price and their value in use. Net selling price is the amount at which the asset could be sold in a binding agreement in an arm’s length transaction. Value in use is calculated as the discounted cash flows generated as a result of the asset’s continued use including those generated by its ultimate disposal, discounted at a market rate of interest on a pre-tax basis.

Where impairments are indicated, the carrying values of fixed assets are written down by the amount of the impairment and the charge is recognised in the income statement in the period in which it occurs. A previously recognised impairment charge on a fixed asset may be reversed in full or in part where a change in circumstances leads to a change in the estimates used to determine its recoverable amount. The carrying value of the fixed asset will only be increased to the carrying value at which it would have been held had the impairment not been recognised.

s) LeasesIf the lease agreement, in which the Group is a lessee, transfers the risks and rewards of the asset, the lease is recorded as a finance lease and the related asset is capitalised. At inception, the asset is recorded at the lower of the present value of the minimum lease payments or fair value and is depreciated over the estimated useful life. The lease obligations are recorded as borrowings.

If the lease does not transfer the risks and rewards of the asset, the lease is recorded as an operating lease.

Operating lease payments are charged to the income statement on a straight line basis unless a different systematic basis is more appropriate. Where an operating lease is terminated before the lease period has expired, any payment required to be made to the lessor in compensation is charged to the income statement in the period in which termination is made.

t) ProvisionsProvisions are recognised for present obligations arising from past events where it is more likely than not that outflows of resources will be required to settle the obligations and they can be reliably estimated.

Contingent liabilities are possible obligations whose existence depends upon the outcome of uncertain future events or are present obligations where the outflows of resources are uncertain or cannot be reliably measured. Contingent liabilities are not recognised in the financial statements but are disclosed unless they are remote.

u) Sharecapitali) Share issue costs

Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds.

ii) Dividends on shares

Dividends on shares are recognised in equity in the period in which they are approved by the Company’s shareholders or paid.

v) Implementationofnewstandardsandamendmentstopublishedstandardsandinterpretationseffectiveduring2010The following new standards, amendments to standards or interpretations are also mandatory for the first time for financial years during 2010 and have been endorsed for adoption by the EU, but have no material financial impact on the Group. These are applicable from 1 January 2010 unless otherwise stated:

• IFRS 2, Share-based payment – Group cash-settled share-based payment transactions

• Improvements to IFRSs (2009)

• Amendments to IFRS 1, on first time adoption of IFRS additional exemptions.

w) Standards,interpretationsandamendmentstopublishedstandardsthatarenotyeteffectiveandtheearlyadoptionofstandardsThe Group has not early adopted any standards or interpretations during 2010.

The following new standards, amendments to standards or interpretations that are relevant to the Group have been issued and have been endorsed by the EU but are not effective for financial years beginning 1 January 2010:

• Amendment to IAS 24, Related party disclosures

The following new standards, amendments to standards or interpretations that are relevant to the Group have been issued but are not effective for financial years beginning 1 January 2010 and have not been endorsed by the EU:

• Annual improvements 2010

• IFRS 9, Financial instruments

• Amendment to IFRS 7, Financial Instruments: Disclosures on derecognition

The following new standards, amendments to standards or interpretations are not effective for financial years beginning 1 January 2010 and have been endorsed by the EU, but have no material impact on the Group:

• Amendment to IFRIC 14, IAS 19 – Prepayments of a minimum funding requirement

• Amendment to IAS 32 Financial instruments: Presentation on classification of rights issues

• Amendment to IFRS 1, First time adoption of IFRS

• IFRIC 19, Extinguishing financial liabilities with equity instruments

36

NOTES TO THE ACCOUNTS (continued)

3. Transferofassetsandliabilities

On 1 January 2010 the following assets and liabilities were transferred to Northern Rock plc from Northern Rock (Asset Management) plc under the terms of The Northern Rock Transfer Order 2009, SI 2009/3226:

£m

AssetsCash and balances with central banks 9.9Loans and advances to banks 865.6Loans and advances to customers 10,343.3Fair value adjustments of portfolio hedging 160.3Investment securities 424.0Intangible assets 23.1Property, plant and equipment 32.7Other assets 4.4Prepayments and accrued income 13.7Totaltransferredassets

11,877.0LiabilitiesDeposits by banks 235.3Customer accounts 20,607.6Other liabilities 19.2Accruals and deferred income 188.4

EquityOther reserves (16.2)Retained earnings 17.1

Totaltransferredequityandliabilities 21,051.4

Balance owed by Northern Rock (Asset Management) plc 9,174.4

The amounts transferred were recognised in Northern Rock plc under the principles of predecessor accounting at book value.

There was no profit or loss associated with this transaction. The balance owed by Northern Rock (Asset Management) plc was paid in full by instalments made to the Company on 4 January, 6 January and 10 February 2010.

As part of the transaction, some tax attributes were transferred to the Company; these related to tax losses arising in Northern Rock (Asset Management) plc in earlier accounting periods, certain transitional adjustments arising from the original conversion of the Northern Rock (Asset Management) plc’s accounts to IFRS, and capital allowances. In each case, these had no impact on the transfer balance sheet as deferred tax assets were not previously recognised in Northern Rock (Asset Management) plc for these.

In addition to the transfer of the assets and liabilities set out above, all employees of Northern Rock (Asset Management) plc transferred to Northern Rock plc on 1 January 2010. The two companies entered into various agreements under which services are provided primarily by Northern Rock plc to Northern Rock (Asset Management) plc.

As part of the transfer of assets and liabilities to Northern Rock plc, Northern Rock (Asset Management) plc has agreed to indemnify Northern Rock plc against potential claims arising from past business up to a maximum of £100m.

On 1 January 2010 the loan from HM Treasury was used to settle the partly paid shares and the remainder was converted into share capital (see note 29).

On 24 February 2010 the Company confirmed that the Government, in consultation with the Financial Services Authority (FSA), had completed a review of the retail savings guarantee put in place in September 2007, and concluded that the guarantee could be released subject to the relevant notice period for customers. This reflected Northern Rock plc’s good progress and the Company’s strong capital and liquidity position. It also ensures that the Company can compete on the same terms as other banks and building societies for savings. Going forward the Company’s retail savers are covered by the Financial Services Compensation Scheme, which, from 31 December 2010, provides up to £85,000 per person (see note 31).

4. Criticalaccountingestimates

a) ImpairmentlossesonloansandadvancesIndividual impairment losses on loans and advances are calculated based on an individual valuation of the underlying asset. Collective impairment losses on loans and advances are calculated using a statistical model. The key assumptions used in the model are the probability of any balance entering into default in the next twelve months as a result of an event that had occurred prior to the balance sheet date; the probability of this default resulting in possession or write off; and the subsequent loss incurred. These key assumptions are based on observed data trends and are updated on a monthly basis within agreed methodology to ensure the impairment allowance is entirely reflective of the current portfolio. The accuracy of the impairment calculation would therefore be affected by unanticipated changes to the economic situation and assumptions which differ from actual outcomes. To the extent that the loss given default differs by +/- 10%, the impairment allowance would be an estimated £0.2m higher or £0.2m lower respectively.

37

NOTES TO THE ACCOUNTS (continued)

4. Criticalaccountingestimates(continued)

b) FairvaluecalculationsFair value is defined as the value at which assets, liabilities or positions could be closed out or sold in a transaction with a willing and knowledgeable counterparty. For the majority of instruments carried at fair value, these are determined by reference to quoted market prices. Where these are not available, fair value is based upon cash flow models, which use wherever possible independently sourced market parameters such as interest rate yield curves, currency rates and option volatilities. Other factors are also considered, such as counterparty credit quality and liquidity. Management must use judgement and estimates where not all necessary data can be externally sourced or where factors specific to Northern Rock plc’s holdings need to be considered. The accuracy of the fair value calculations would therefore be affected by unexpected market movements, inaccuracies within the models used compared to actual outcomes and incorrect assumptions. For example, if management were to use a tightening in the credit spread of 10 basis points, the fair values of liabilities (including derivatives) would increase from the reported fair values by £1.5m.

c) AveragelifeofsecuredlendingIAS 39 requires interest earned from mortgage lending to be measured under the effective interest method. The effective interest rate is the rate that exactly discounts estimated future cash receipts or payments through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset.

Management must therefore use judgement to estimate the expected life of each instrument and hence the expected cash flows relating to it. The accuracy of the effective interest rate would therefore be affected by unexpected market movements resulting in altered customer behaviour, inaccuracies in the models used compared to actual outcomes and incorrect assumptions. If the estimated average life of secured loans were increased or reduced by one month, the value of such loans on the balance sheet would be increased or decreased by £3.9m and £3.6m respectively.

d) PensionbenefitsThe present value of the pension obligations is dependent upon an actuarial calculation which includes a number of assumptions. These assumptions include the discount rate, which is used to determine the present value of the estimated future cash outflows that will be required to meet the pension obligation. In determining the appropriate discount rate to use, the Group considers market yields of high quality corporate bonds denominated in sterling that have terms to maturity approximating the terms of the pension liability. Were this discount rate to reduce by 0.1% or increase by 0.1% from the current management estimate, the carrying value of the pension obligations would be an estimated £0.2m higher or £0.2m lower respectively.

Other key assumptions for pensions benefits including mortality tables are based in part upon current market conditions or published data. Additional information is included in note 9.

e) UnrecogniseddeferredtaxassetsSignificant management judgement is required to determine the amount of deferred tax assets that can be recognised. Management reassesses unrecognised deferred tax assets at each balance sheet date. Based on their interpretation of the timing and level of reversal of existing taxable temporary differences, in line with relevant accounting standards, management have concluded that it is not appropriate to recognise a deferred tax asset at the balance sheet date. The amount of unrecognised deferred tax assets at 31 December 2010 was £259.1m (2009: £nil) in both the Group and Company.

Management will closely monitor the opportunities for the recoverability of these deferred tax assets and will reassess the need to recognise them at subsequent balance sheet dates.

5. Interest and similar

2010£m

3 July to 31 December

2009£m

On secured advances 365.7 –On other lending 0.9 –On investment securities and deposits 40.2 –

406.8 –

Interest accrued on individually impaired assets was less than £0.1m (2009 £nil).

6. Interestandsimilarexpense

2010£m

3 July to 31 December

2009£m

On retail customer accounts 414.0 –Retail and wholesale guarantee costs 33.2 –Other 0.6 –

447.8 –

income

38

NOTES TO THE ACCOUNTS (continued)

7. Feeandcommissionincome

2010£m

3 July to 31 December

2009£m

Service level agreements with Northern Rock (Asset Management) plc and Bradford & Bingley plc 168.3 –Other fee and commission income 6.3 –

174.6 –

8. Administrativeexpenses

2010£m

3 July to 31 December

2009£m

AdministrativeexpensesWages and salaries 121.7 –Social security costs 12.2 –Other pension costs 10.9 –

Total staff costs 144.8 –Other administrative expenses 105.9 –

250.7 –

Other administrative expenses include:Hire of equipment 3.5 –Property rentals 11.7 –Remuneration of auditors (see below) 0.6 –

In 2010 administrative expenses of £102.9m were recharged to Northern Rock (Asset Management) plc via the service level agreement.

Exceptionalrestructuringcosts

2010£m

3 July to 31 December

2009£m

Redundancy and other staff costs 25.4 –Professional fees recharged by the Tripartite Authorities 1.8 –Strategic project development 32.7 –

59.9 –

In 2010 exceptional restructuring costs of £49.6m were recharged to Northern Rock (Asset Management) plc and Bradford & Bingley plc via the service level agreement.

The monthly average number of persons (including Directors) employed by the Group and Company was as follows:

2010

3 July to 31 December

2009

Full time 3,371 –Part time 939 –

In 2010 aggregate Directors’ emoluments including taxable benefits were £2,788k. The remuneration of the highest paid Director was £1,081k plus personal pension arrangements of £237k.

39

NOTES TO THE ACCOUNTS (continued)

8. Administrativeexpenses (continued)

ServicesprovidedbytheGroup’sauditorandnetworkfirmsDuring the year the Group obtained the following services from the Group’s auditor, as detailed below:

2010£m

3 July to 31 December

2009£m

AdministrativeexpensesFees payable to Company auditor for the audit of parent Company and consolidated financial statements 0.4 –Fees payable to Company auditor and its associates for other services– Other services pursuant to legislation (including review of half year Interim Statement) 0.1 –– Other services (see note i) 0.1 –

0.6 –

i) Other services comprise assurance work in respect of the legal and capital restructure and taxation services.

9. Retirementbenefitobligations

The Company operates one main employee benefit scheme which came into existence on 1 January 2010 when all employees of Northern Rock (Asset Management) plc were transferred to Northern Rock plc and became members of the Northern Rock (2010) Pension Scheme (“the Scheme”). A past service cost of £9.0m was recognised on transfer. The Scheme has both defined benefit and defined contribution sections.

On 8 June 2010, it was announced that the defined benefit section of the Scheme would be closed to future accrual from January 2011. This resulted in a curtailment gain of £9.8m.

The defined benefit section of the Scheme provided benefits based on final salary for certain employees. The assets of the Scheme are held in a separate trustee-administered fund. Contributions to the defined benefit section were assessed in accordance with the advice of an independent qualified actuary using the projected unit method.

The Company’s policy for recognising actuarial gains and losses is to recognise them immediately on the balance sheet through the statement of comprehensive income.

The overall costs of the Scheme have been recognised in the Company’s accounts in accordance with IAS19. As the Scheme came into existence on 1 January 2010 there are no comparative figures given.

Summaryofassumptions2010

%

Price inflation 3.75Rate of increase in salaries N/ARate of increase for pre 6 April 2006 pensions in payment (in excess of any Guaranteed Minimum Pension (GMP) element) 3.80Rate of increase for post 6 April 2006 pensions in payment 3.55Rate of increase for deferred pensions 3.75Discount rate 5.35Expected rate of return on assets 4.10

The most significant non financial assumption is the assumed rate of longevity. The table below shows the life expectancy assumptions used in the accounting assessments based on the life expectancy of a member aged 60.

2010Pensioner Non‑pensioner

Male 27.9years 29.6yearsFemale 30.5years 32.1years

The expected return on assets has been derived as the weighted average of the expected returns from each of the main asset classes. The expected return for each asset class reflects a combination of historical performance analysis, the forward looking views of the financial markets (as suggested by the yields available), and the views of investment organisations.

Categoriesofassetsheld2010

%

Debt securities 94Other 6

Total 100

40

NOTES TO THE ACCOUNTS (continued)

9. Retirementbenefitobligations(continued)

Fundedstatus2010

£m

Present value of defined benefit obligation (12.3)Assets at fair value 15.4

Defined benefit asset 3.1

Disclosedpensionexpenseforyear:

a)Componentsofdefinedbenefitpensionexpense2010

£m

Current service cost 6.2Interest cost 1.1Expected return on assets (0.4)Past service cost 9.0Curtailment gain (9.8)

Total pension expense 6.1

The pension expense is recorded within administrative expenses in the income statement.

b)Statementofcomprehensiveincome

2010£m

Actuarial loss recognised in statement of comprehensive income 0.6Cumulative actuarial (gain)/loss recognised at 1 January 2010 –

Cumulative actuarial loss recognised at 31 December 2010 0.6

Movementsinpresentvalueofdefinedbenefitobligationduringtheyear2010

£m

Present value of defined benefit obligation at 1 January 2010 –Employer service cost 6.2Interest cost 1.1Plan participants’ contributions 1.2Actuarial loss 0.8Past service cost 9.0Curtailment gain (9.8)Other adjustments (transfer of money purchase guarantee reserve) 3.8

Present value of defined benefit obligation at 31 December 2010 12.3

Movementsinfairvalueofdefinedbenefitassetsduringtheyear2010

£m

Fair value of assets at 1 January 2010 –Expected return on assets 0.4Actuarial gain 0.2Employer contributions (including transfer of assets from the Northern Rock pension scheme) 9.8Plan participants’ contributions 1.2Other adjustments (transfer of money purchase guarantee reserve) 3.8

Fair value of assets at 31 December 2010 15.4

The actual return on plan assets in 2010 was £0.6m.

41

NOTES TO THE ACCOUNTS (continued)

9. Retirementbenefitobligations(continued)

Experiencegainsandlosses2010

£m

Defined benefit obligation 12.3Fair value of assets 15.4Surplus 3.1Actuarial loss on defined benefit obligation (0.8)Experience gain on assets 0.2

Estimated total contributions for the year ending 31 December 2011 are £nil.

Pension costs for the defined contribution section of the Scheme were £3.9m and are recorded within administrative expenses in the income statement.

10.Impairmentlossesonloansandadvances

On advances

secured on residential

property £m

On advances

secured on residential buy to let property

£m

On unsecured

loans £m

Total £m

2010Group and CompanyAt 1 January 2010 – – – –

Transferred from Northern Rock (Asset Management) plc 0.4 – 0.2 0.6Increase in allowance during the year net of recoveries 1.7 0.1 0.1 1.9Amounts written off during the year – – (0.1) (0.1)

At 31 December 2010 2.1 0.1 0.2 2.4

There were no impairment losses on loans and advances in 2009 and the impairment allowance at 31 December 2009 was £nil.

11.Nettradingexpense

2010£m

3 July to 31 December

2009

Fair value movements of future cash flows, excluding accruals, on derivatives not in hedge accounting relationships (4.6) –Translation gains on underlying instruments 0.2 –

(4.4) –

12.Taxation

The tax on the Group’s loss before tax differs from the theoretical amount that would arise using the standard weighted average rate of UK corporation tax of 28% (2009 28%) as follows:

2010£m

3 July to 31 December

2009

Loss before taxation (223.5) –

Tax calculated at rate of 28% (2009 28%) 62.6 –Deferred income tax asset arising not recognised (64.6) –Expenses not deductible for tax purposes (4.3) –Adjustment in respect of assets transferred from Northern Rock (Asset Management) plc 6.3 –

Taxation – –

A number of changes to the UK corporation tax system were announced in the June 2010 budget statement. The Finance (No 2) Act 2010, which was substantively enacted on 20 July 2010, includes legislation reducing the main rate of corporation tax from 28% to 27% from 1 April 2011. Further reductions to the main rate are proposed to reduce the rate by 1% per annum to 24% by 1 April 2014. The changes had not been substantively enacted at the balance sheet date and therefore are not included in these financial statements.

13.Lossattributabletoequityshareholders

Of the loss attributable to equity shareholders, £211.6m (3 July to 31 December 2009 profit of less than £0.1m) has been dealt with in the accounts of the Company. As permitted by section 408 of the Companies Act 2006, the Company’s income statement has not been presented separately.

42

NOTES TO THE ACCOUNTS (continued)

14.Analysisoffinancialassetsandfinancialliabilitiesbymeasurementbasis

2010

Group Derivatives in IAS 39 hedges

Financial liabilities at

amortised cost £m

Loans and receivables

£m

Available for sale

securities £m

Investment securities

held as loans and

receivables £m

Derivatives not in IAS 39

hedges £m

Fair value hedge

£m

Cash flow hedge

£mTotal

£m

FinancialassetsCash and balances with central banks – 4,646.0 – – – – – 4,646.0Derivative financial instruments – – – – 4.7 141.1 3.2 149.0Loans and advances to banks – 585.2 – – – – – 585.2Loans and advances to customers – 12,374.4 – – – – – 12,374.4Investment securities – – 363.2 297.8 – – – 661.0Accrued income – 1.9 – – – – – 1.9

– 17,607.5 363.2 297.8 4.7 141.1 3.2 18,417.5Non financial assets 144.3

18,561.8

FinancialliabilitiesDeposits by banks 0.7 – – – – – – 0.7Customer accounts 16,903.2 – – – – – – 16,903.2Derivative financial instruments – – – – 14.2 240.8 – 255.0Accruals 120.4 – – – – – – 120.4

17,024.3 – – – 14.2 240.8 – 17,279.3Non financial liabilities 95.0

Total liabilities 17,374.3Equity 1,187.5

18,561.8

2009

Group Derivatives in IAS 39 hedges

Financial liabilities at

amortised cost £m

Loans and receivables

£m

Available for sale

securities £m

Investment securities

held as loans and

receivables £m

Derivatives not in IAS 39

hedges £m

Fair value hedge

£m

Cash flow hedge

£mTotal

£m

FinancialassetsCash and balances with central banks – 1,400.0 – – – – – 1,400.0Derivative financial instruments – – – – – – – –Loans and advances to banks – – – – – – – –Loans and advances to customers – – – – – – – –Investment securities – – – – – – – –Accrued income – 0.1 – – – – – 0.1

– 1,400.1 – – – – – 1,400.1Non financial assets –

1,400.1

FinancialliabilitiesLoans from HM Treasury 1,400.0 – – – – – – 1,400.0Deposits by banks – – – – – – – –Customer accounts – – – – – – – –Derivative financial instruments – – – – – – – –Accruals – – – – – – – –

1,400.0 – – – – – – 1,400.0Non financial liabilities –

Total liabilities 1,400.0E quity 0.1

1,400.1

43

NOTES TO THE ACCOUNTS (continued)

15.Cashandbalanceswithcentralbanks

Group and Company

2010£m

2009 £m

Cash in hand 8.1 –Other balances with central banks 4,607.8 1,400.0

Included in cash and cash equivalents 4,615.9 1,400.0Mandatory reserve deposits with central banks 30.1 –

4,646.0 1,400.0

Mandatory reserve deposits with central banks are not available for use in day to day operations.

16.Derivativefinancialinstruments

StrategyinusingderivativefinancialinstrumentsThe Board has authorised the use of derivative instruments for the purpose of supporting the strategic and operational business activities of the Group and reducing the risk of loss arising from changes in interest rates and exchange rates. All use of derivative instruments within the Group is to hedge risk exposure, and the Group takes no trading positions in derivatives.

The objective, when using any derivative instrument, is to ensure that the risk to reward profile of any transaction is optimised. The intention is to only use derivatives to create economically effective hedges. However, because of the specific requirements of IAS 39 to obtain hedge accounting, not all economic hedges are designated as accounting hedges, either because natural accounting offsets are expected or because obtaining hedge accounting would be especially onerous.

a) Fair value hedges

The Group designates a number of derivatives as fair value hedges. In particular the Group has three approaches establishing relationships for:

i) Hedging the interest rate and foreign currency exchange rate risk of non-prepayable, foreign currency denominated fixed rate assets or liabilities on a one-for-one basis with fixed/floating or floating/fixed cross currency interest rate swaps.

ii) Hedging of interest rate risk of a single currency portfolio of sterling or Euro non-prepayable fixed rate assets/liabilities on a one-for-one basis with vanilla fixed/floating or floating/fixed interest rate swaps.

iii) Hedging the interest rate risk of a portfolio of prepayable fixed rate assets with interest rate derivatives. This solution is used to establish a macro fair value hedge for derivatives hedging fixed rate mortgages. The Group believes this solution is the most appropriate as it is consistent with its policy for hedging fixed rate mortgages on an economic basis.

The total fair value of derivatives included within fair value hedges at 31 December 2010 was a net liability of £99.7m (2009 £nil).

b) Cash flow hedges

The Group designates a number of derivatives as cash flow hedges. In particular, the Group adopts an approach of using fixed interest rate swaps in a cash flow hedge strategy to economically hedge the interest rate risk associated with the mortgage pipeline. The accounting hedge relationship is to hedge floating rate sterling liabilities. The total fair value of derivatives included within cash flow hedges at 31 December 2010 was a net asset of £3.2m (2009 £nil).

c) Net investment hedges

The Group has not designated any derivatives as net investment hedges in 2010 or 2009.

All derivative financial instruments are held for economic hedging purposes, although not all derivatives are designated as hedging instruments under the terms of IAS 39. The analysis below therefore splits derivatives between those in accounting hedge relationships and those in economic hedge relationships but not in accounting hedge relationships.

2010 2009

Group and Company

Contract/notionalamount

£m

Fairvalues Contract/ notional amount

£m

Fair values

Assets £m

Liabilities £m

Assets£m

Liabilities£m

DerivativesinaccountinghedgerelationshipsDerivatives designated as fair value hedgesInterest rate swaps 15,826.5 141.1 (240.8) – – –

Derivatives designated as cashflow hedgesInterest rate swaps 163.5 3.2 – – – –

15,990.0 144.3 (240.8) – – –

DerivativesineconomichedgingrelationshipsbutnotinaccountinghedgerelationshipsInterest rate derivativesInterest rate swaps 4,852.5 4.7 (14.2) – – –

Total recognised derivative assets/(liabilities) 20,842.5 149.0 (255.0) – – –

44

NOTES TO THE ACCOUNTS (continued)

16.Derivativefinancialinstruments(continued)

Gains on fair value hedges:

2010£m

2009 £m

On hedging instruments 5.3 –On the hedged items attributable to the hedged risk 8.0 –

Fair value hedge ineffectiveness 13.3 –

Fair value hedge ineffectiveness recorded within interest income in the income statement amounted to a credit of £27.5m (2009 £nil). Fair value hedge ineffectiveness recorded within interest expense in the income statement amounted to a charge of £14.2m (2009 £nil).

Cash flow hedges

Periods when cash flows are expected to occur and affect the income statement:

2010£m

2009 £m

Within one year 1.4 –

1.4 –

Cash flow hedge ineffectiveness recorded within interest expense in the income statement amounted to a charge of less than £0.1m in 2010 (2009 £nil).

17.Loansandadvancestobanks

Group Company

2010£m

2009 £m

2010£m

2009 £m

Fixed rate 101.4 – 101.4 –Variable rate 483.8 – 478.3 –

585.2 – 579.7 –

18.Loansandadvancestocustomers

Group and Company

2010£m

2009 £m

Advances secured on residential property 11,407.9 –Residential buy to let loans 791.5 –

Total advances secured on residential property 12,199.4 –

Unsecured loans 0.5 –

Gross loans and advances to customers 12,199.9 –

Impairment allowance (2.4) –

Net loans and advances to customers 12,197.5 –

Fixed rate 6,893.2 –Variable rate 5,304.3 –

12,197.5 –

Fair value adjustments of portfolio hedging amounting to £176.9m (2009 £nil) relate to fair value adjustments of loans and advances to customers in relation to interest rate risk as a result of their inclusion in a fair value portfolio hedge relationship.

45

NOTES TO THE ACCOUNTS (continued)

19.Investmentsecurities

Group and Company

2010£m

2009 £m

Available for sale securities 363.2 –Investment securities held as loans and receivables 297.8 –

661.0 –

a)Availableforsalesecurities Group and Company

2010£m

2009 £m

At fair valueListed 363.2 –Unlisted – –

363.2 –

Fixed rate 363.2 –Variable rate – –

363.2 –

The movement in available for sale securities was as follows: 2010£m

2009 £m

At 1 January 2010 / 3 July 2009 – –Transferred from Northern Rock (Asset Management) plc 55.4 –Additions 1,028.6 –Disposals (sales and redemptions) (710.5) –Exchange differences (9.8) –Net losses on changes in fair value (0.5) –

At 31 December 363.2 –

b)Investmentsecuritiesheldasloansandreceivables Group and Company

2010£m

2009 £m

Carrying value 297.8 –Fair value 299.4 –

Listed 297.8 –Unlisted – –

297.8 –

Fixed rate – –Variable rate 297.8 –

297.8 –

46

NOTES TO THE ACCOUNTS (continued)

20.Sharesingroupundertakings

The principal subsidiary of Northern Rock plc at 31 December 2010 is listed below. It operates in its country of incorporation and is directly held and wholly owned by the Company:

Natureofbusiness CountryofincorporationNorthern Rock (Guernsey) Limited Retail deposit taker Guernsey

The Board of Northern Rock plc decided to close its banking operation in Guernsey as of 2 September 2010 as it no longer met the long term commercial objectives of the Company. Northern Rock (Guernsey) Limited was placed in voluntary liquidation on 30 September 2010. Northern Rock (Guernsey) Limited was considered to be part of the overall business of Northern Rock plc and therefore does not require further disclosure as a discontinued operation.

The investment is in the ordinary shares of Northern Rock (Guernsey) Limited and the cost at 31 December 2010 is less than £0.1m. The Directors consider the value of the investment to be supported by the underlying assets.

The following companies are special purpose entities (SPEs) established in connection with the Group’s securitisation programme. Although the Company has no direct or indirect ownership interest in these companies, they are regarded as legal subsidiaries under UK companies legislation. This is because they are principally engaged in providing a source of long term funding to the Group, which in substance has the rights to all benefits from the activities of the SPEs. They are therefore effectively controlled by the Group.

Natureofbusiness Countryofincorporation DateofincorporationGosforth Funding plc Issue of securitised notes England & Wales 3 December 2009Gosforth Funding 2010-1 plc Issue of securitised notes England & Wales 30 October 2009Gosforth Mortgages Trustee Limited Trust England & Wales 12 October 2009Gosforth Mortgages Trustee 2010-1 Limited Trust England & Wales 5 January 2010Gosforth Holdings Limited Holding company England & Wales 12 October 2009Gosforth Holdings 2010-1 Limited Holding company England & Wales 4 January 2010

21. Intangibleassets

GroupandCompany Software£m

2010CostAt 1 January 2010 –Transfer from Northern Rock (Asset Management) plc 23.1Additions 2.8Disposals (4.5)

At 31 December 2010 21.4

Impairment and amortisationAt 1 January 2010 –Transfer from Northern Rock (Asset Management) plc 0.1Amortisation charged in year 11.6Adjustment arising on disposals (1.4)

At 31 December 2010 10.3

Net book amount:At 31 December 2010 11.1

At 31 December 2009, the cost, impairment and amortisation and net book amount of intangible assets was £nil in both Group and Company.

47

NOTES TO THE ACCOUNTS (continued)

22.Property,plantandequipment

GroupandCompany2010

Land and buildings

£m

Plant, equipment,

fixtures,fittings and

vehicles£m

Total£m

CostAt 1 January 2010 – – –Transfer from Northern Rock (Asset Management) plc 15.8 16.9 32.7Additions 1.2 10.9 12.1Disposals – (1.5) (1.5)

At 31 December 2010 17.0 26.3 43.3

DepreciationAt 1 January 2010 – – –Charged in year 0.7 8.2 8.9Adjustment arising on disposals – (0.3) (0.3)

At 31 December 2010 0.7 7.9 8.6

Net book amount:At 31 December 2010 16.3 18.4 34.7

At 31 December 2009, the cost, depreciation and net book amount of property, plant and equipment was £nil in both Group and Company.

23.Deferredincometaxassetsandliabilities

Based on their interpretation of the timing and level of reversal of existing taxable temporary differences, in line with relevant accounting standards, management have concluded that it is not appropriate to recognise a deferred tax asset at the balance sheet date. Accordingly, deferred tax assets have not been recognised in respect of the following items:

Group and Company

2010£m

2009£m

Excess of depreciation over capital allowances (gross) 34.8 –

Unused tax losses (gross) 200.0 –

Pensions and other employee benefits (gross) (3.1) –

Change in accounting basis on adoption of IFRS (gross) 27.4 –

259.1 –

Under current tax legislation these unprovided deductible temporary differences and unused tax losses do not have an expiry date and can therefore be recognised in the future as taxable profits arise.

24.LoansfromHMTreasury

Group and Company

2010£m

2009£m

Amount due to HM Treasury – 1,400.0

On 1 January 2010 the loan from HM Treasury was used to settle the partly paid shares and the remainder was converted into share capital (see note 29).

25.Depositsbybanks

Group and Company

2010£m

2009£m

Fixed rate – –Variable rate 0.7 –

0.7 –

48

NOTES TO THE ACCOUNTS (continued)

26.Customeraccounts

Group and Company

2010£m

2009£m

Retail funds and deposits 16,691.3 –Other customer accounts 211.9 –

16,903.2 –

Fixed rate 10,347.9 –Variable rate 6,555.3 –

16,903.2 –

27.Accrualsanddeferredincome

Group and Company

2010£m

2009£m

Accrued interest 119.7 –Other accruals 44.9 –

164.6 –

28.Provisionsforliabilitiesandcharges

Group and Company

2010£m

2009£m

The movement in provisions was as follows:At 1 January 2010 / 3 July 2009 – –Charged in the year 25.4 –Utilised in the year (18.0) –

At 31 December 7.4 –

The provision charged and utilised in the year is in respect of restructuring costs and is expected to be fully utilised within the next twelve months. At 31 December 2009, provisions for liabilities and charges were £nil in both Group and Company.

29.Sharecapital

2010Number

2010£m

2009Number

2009£m

Authorised share capital

Ordinary shares of £1 each 1,400,000,000 1,400.0 50,000 0.1

1,400,000,000 1,400.0 50,000 0.1

2010Number

2010£m

2009Number

2009£m

Issued and fully paid share capitalOrdinary shares of £1 each 1,400,000,000 1,400.0 2 –Issued and partly paid share capitalOrdinary shares of £1 each – – 49,998 0.1

1,400,000,000 1,400.0 50,000 0.1

49

NOTES TO THE ACCOUNTS (continued)

29.Sharecapital(continued)

2010Number

2009£m

Balance at 1 January 2010 / 3 July 2009 50,000 –Issuance of ordinary shares 1,399,950,000 50,000

Balance at 31 December 1,400,000,000 50,000

No dividends were paid in 2010 or 2009.

30.Otherreserves

a)Revaluationreserve–availableforsaleinvestments 2010£m

Balance at 1 January 2010 –Transfer from Northern Rock (Asset Management) plc (16.2)Net losses from changes in fair value (1.6)Amortisation of fair value differences in respect of securities transferred to loans and receivables 10.9

Balance at 31 December 2010 (6.9)

b)Hedgingreserve–cashflowhedges 2010£m

Balance at 1 January 2010 –Amounts recognised in equity 1.5Amounts transferred to interest payable (0.1)

Balance at 31 December 2010 1.4

TotalotherreservesAt 31 December 2010 (5.5)

At 31 December 2009 the balance on other reserves was £nil.

31.Financialriskmanagement

A)FinancialRiskManagementGovernanceThe Board of Directors is responsible for determining strategies and policies for the Group. The Group maintains a risk governance structure that strengthens risk evaluation and management, in addition to positioning the Group to manage the changing regulatory environment in an efficient and effective manner.

The Group works within the terms of the Shareholder Framework, and has the primary responsibilities of:

• Developing and recommending a business plan aligned to the objectives of the Shareholder; and,

• Delivering the plan.

The diagram below shows the governance structure in operation at Northern Rock plc.

50

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

BOARD

Board Level Governance

Management Level GovernanceEXECUTIVE

COMMITTEE

AUDITCOMMITTEE

REMUNERATIONCOMMITTEE

RISKCOMMITTEE

NOMINATIONCOMMITTEE

ASSET ANDLIABILITY

COMMITTEE

RETAILCREDIT RISKCOMMITTEE

OPERATIONALRISK AND

COMPLIANCECOMMITTEE

CUSTOMERPERFORMANCE

COMMITTEE

OPERATINGPLAN

COMMITTEE

CAPITALMANAGEMENT

COMMITTEE

RETAIL PRODUCTSAND LIMITSCOMMITTEE

Details of the operation of Management Level Governance and its committees are set out below.

ExecutiveCommittee(ExCo) is the most senior management operating committee, chaired by the Executive Chairman. ExCo is responsible for developing and delivering against a Board approved strategy, and for ensuring the effective and smooth running of the business within Board approved risk appetites. It is responsible for putting in place effective monitoring and control mechanisms, which enable it to have appropriate oversight of business activities. ExCo has seen several membership changes with a number of new and external appointments during the year. The team periodically reviews and refines its governance and operating framework to ensure that there are effective relationships with the Board and strong management oversight and control of all operations. As part of this framework, ExCo has seven sub committees which provide for greater focus in respect of risk management (Asset and Liability Committee, Retail Credit Risk Committee and Operational Risk and Compliance Committee), capital management (Capital Management Committee), business change (Retail Products and Limits and Operating Plan Committees) and customer experience (Customer Performance Committee).

OperatingPlanCommittee(OPC) is responsible for overseeing, reviewing and challenging the progress towards delivery of the Operating Plan. OPC monitors Business Plan variances and recommends changes to the Operating Plan where necessary. It also manages the discretionary investment budget and oversees progress of all major projects.

Capital Management Committee (CMC) is the executive level committee through which all aspects of capital management are monitored, reported and controlled. It is responsible for overseeing the adequacy of capital resources to meet internal, rating agency and regulatory requirements. It is ultimately responsible for recommending to the Board for its approval, policies and strategies to ensure that capital management is optimised to meet internal and external stakeholder requirements.

RetailProductsandLimitsCommittee(RPLC) is responsible for establishing and maintaining an effective framework within which new products are reviewed and approved. This includes conformance with the New Product Approval policy and the Delegated Authorities Framework for product development. It is also responsible for establishing limits and boundaries within which new products are sold and monitoring actual performance against these limits.

AssetandLiabilityCommittee(ALCO) is responsible for overseeing the asset, liquidity, liability and other solvency risks, specifically market risk, wholesale credit risk and liquidity risk (referred to as ‘financial risk’). ALCO is ultimately responsible for recommending to the Risk Committee for its approval, policies and frameworks that ensure optimal risk processes and outcomes for the Group and that liquidity positions are optimised to meet internal and external stakeholder requirements. ALCO manages the Group’s liquidity resources to meet internal and regulatory liquidity requirements, and it monitors the Group’s secured funding activities and vehicles.

RetailCreditRiskCommittee(RCRC) is the principal body through which all aspects of Retail Credit Risk are monitored, reported and controlled. It is the most senior retail credit decision making authority below the Board. It primarily acts as the formal designated Committee to manage all retail credit related aspects of Basel II – Capital Requirement Directive. RCRC develops and recommends a Retail Credit Risk Appetite for approval by ExCo and the Board (via Risk Committee). It also reviews and approves Credit Risk Strategy and Policy. In addition, RCRC ensures that the Company has policies and processes which support Responsible Lending and the fair treatment of customers at all times.

RCRC reviews detailed portfolio monitoring reports to ensure that the performance and quality of credit risk portfolios remains within agreed risk appetite, submitting appropriate summary information to the Risk Committee. RCRC reviews and recommends any necessary changes to credit risk models and established a credit sanctioning and approval framework, within which formal lending authorities are delegated and controlled throughout the organisation. It establishes lower level working groups to ensure suitably skilled cross functional experts have the opportunity to review specific matters in detail before submission to RCRC.

Operational Risk and Compliance Committee (ORCC) is the executive level committee through which all aspects of the high level operational risk and control environment are monitored. ORCC develops and recommends the Operational Risk Policies and Risk Appetite for approval by ExCo and the Board. ORCC regularly reviews all operational losses in line with risk appetite and budgets. It also reviews other significant risk events and failures in order to enhance operational risk management. ORCC develops and recommends legal and regulatory risk policies, considers new/revised regulatory requirements and reviews regulated product complaint trends.

Customer Performance Committee (CPC) is responsible for the Customer Experience Framework and Treating Customers Fairly (TCF). It directs the identification and implementation of customer improvements, and the ongoing sustainability and improvement in delivering fair customer outcomes.

51

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

RiskManagementDefinitionsThe principal risks that the Group manages are as follows:

• Credit risk: the current or prospective loss to earnings and capital (expected and unexpected loss) arising from lending as a result of debtors or counterparties defaulting on their obligations due to the Group

• Market risk: the risk that changes in the level of interest rates, the rate of exchange between currencies or the price of securities or other financial contracts, including derivatives, will have an adverse impact on the results of operations or financial condition of the Group

• Liquidity risk: the risk that the Group is unable to meet its obligations as they fall due

• Operational risk: the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events including legal risk

• Legal risk: the risk of legal sanction, material financial loss or loss to reputation the Group may suffer as a result of its failure to comply with the law, inadequately document its contractual arrangements or inadequately assess and implement changes required by forthcoming legislation or emerging case law

• Regulatory risk is defined in this document as the risk of the Group failing to comply with the legal and regulatory requirements applying to its arrangements and activities, with the potential consequences of:

• Customers being unfairly treated or suffering financial or other detriment

• Legal or regulatory sanctions

• Reputational loss and the associated financial and business impacts

• Risks to market confidence or stability, and

• Northern Rock plc being used for the purposes of financial crime.

Strategic Risk ManagementThe Group maintains a Strategic Risk Radar to assess and monitor its material macroeconomic and event specific risks. This report is subject to regular review by ExCo, Risk Committee and the Board. It is used to support strategic planning, refine operational priorities and ensure that mitigants and contingency plans are in place.

At the end of 2010 and beginning of 2011, the principal strategic risks and uncertainties faced by the Group can be broadly summarised as follows:

i) Prolonged low Bank Base Rate – the Group’s Business Plan has been formulated to address this directly.

ii) Timing of return to sustainable profitability – the Group’s Business Plan has been formulated to address this directly.

iii) Double dip recession – the Group has run stress tests to model its business for this adverse macroeconomic environment and to ensure it has appropriate mitigants and contingency plans in the event of the downturn materially impacting the housing market for a second time. The Business Plan is based on a prudent view of market expectations for house prices, unemployment and Bank Base Rate.

iv) Exit from Temporary Public Ownership (TPO) – the Business Plan is developed to maximise the value of the Group but makes no assumptions around the timing of TPO exit.

Developments in Risk ManagementDuring 2010, the Group has continued to make significant progress in its Risk Management capabilities. The CRO has an independent reporting line directly to the Executive Chairman and reports on a dotted line basis to the Chair of the Risk Committee. As the independent second line of defence, the Risk function takes an integrated, holistic view of risks and ensures that a joined-up and consistent approach to the aggregation and management of risks is in place, and is integrated into business management and decision making.

Key developments in 2010 include:

• Enhancing the Governance Framework and Policies

• Recruitment of additional Risk specialists and development of existing colleagues

• Continued development of Internal Ratings Basis (IRB) models for Credit Risk

• Enhancing Operational Risk processes and reporting

• Improved Liquidity Risk monitoring processes, systems and controls

• Strengthening Regulatory Risk monitoring processes, controls, resources and overall capability.

Each of the major risk categories is listed below together with a brief description of the risk management framework.

i) CreditriskRisk appetiteCredit risk appetite is an expression of boundaries (qualitative and quantitative) that provide clear guidance on the level of risk exposure that the Board considers acceptable and in line with the corporate strategy. A revised credit risk appetite aligned to the current business strategy and external environment was approved by the Board in November 2010. Risk appetite is subject to an annual review process and limits are regularly monitored and reported to the Risk Committee.

The Board’s high level expression of a desired credit risk appetite is also translated into specific maximum risk limits in relation to product and lending policy parameters within which management must operate. In addition there are whole book parameters reflecting the inherent risks of previous lending, with trigger levels above which specific control actions may be initiated. Monitoring and reporting against the risk appetite and the associated limits and triggers were in place for both new lending and whole book during 2010.

Lending policy criteriaNew lending is tightly controlled using an appropriate mix of statistical and experiential analysis. New business quality is constantly monitored and controlled by the Credit Decisioning team using sophisticated scoring techniques and a number of other core control components as follows:

• Credit scoring. Automated statistically-based credit scoring methods are used in the decision making process for new and existing customers. These are subject to regular monitoring, review and approval

• Affordability, underwriting and mandates. To lend responsibly, the Group employs affordability models based upon customers’ income and outgoings, and experienced underwriters to determine customers’ overall financial situation and ability to repay credit. The ability to agree a credit agreement with a customer is prescribed in Board delegated authority levels to specific individuals who have been proven to have the requisite credit skills

52

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

• Valuations. Property assets are independently valued at mortgage inception. Where a revaluation is required, this is led by specialist Property Risk personnel using a range of valuation methods

• Monitoring and performance. The credit portfolios are monitored regularly, with a range of prescribed reports distributed to key stakeholders. Detailed management information is provided to the Retail Credit Risk Committee, Executive Committee and Risk Committee

• Collections and recoveries. The Group’s debt management process is led by the Chief Operating Officer. A team of specialists manage all aspects of collections and recoveries with the aim of helping customers who encounter financial difficulties to achieve a positive outcome for the customer and the Group

• Stress testing and scenario analysis, to simulate a range of outcomes and calculate the risk impact of adverse macroeconomic conditions.

Credit Risk MeasurementThe credit risk of lending to customers is a factor of three components:

• The probability of default (PD) by the customer on contractual obligations

• The exposure at default (EAD) by the customer on contractual obligations

• The likely recovery of defaulted obligations (loss given default (LGD)).

Internal rating based models are used to assess customer probability of default, exposure at default and loss given default. The rating models use statistical analysis combined with external data and are subject to rigorous internal monitoring and change control.

These credit risk models are used throughout the Group to support the analytical elements of the credit risk management framework, in particular the quantitative risk assessment part of the credit approval process, ongoing credit monitoring as well as portfolio level analysis and reporting.

Credit risk models used by the Group can be grouped broadly into two categories:

• PD/customer credit grade – these models assess the probability that a customer will fail to make full and timely repayment of credit obligations over a time horizon. There are a number of different credit rating models in use across the Group, each of which considers particular customer characteristics. The credit rating models use a combination of quantitative inputs, such as transaction characteristics, recent financial performance, credit bureau data and customer behaviour.

• LGD – these models estimate the expected loss that may be suffered by the Group on a credit facility in the event of default. The Group’s LGD models take into account the type of borrower and any security held.

Corporate and Wholesale Credit RiskCorporate Credit Counterparty risk arises through Treasury hedging and investment activities and related balance sheet management requirements.

Credit risk can be broken down into two elements:

• Counterparty risk (the risk of default or rating migration of derivative counterparties)

• Wholesale credit risk (the risk of default or rating migration of issuers in the Treasury investment portfolio).

The Board has approved a framework for maximum credit counterparty limits against which total exposures are continually monitored and controlled. The credit  limit structure adopts a risk based matrix whereby lower rated counterparties are afforded lower overall levels of limit. Single counterparties are assigned maximum limits in accordance with the ratings matrix, based on the lowest rating afforded to any part of the counterparty group.

Maximum credit risk exposure at 31 December before collateral and other credit enhancements:

2010£m

2009 £m

On balance sheetCash and balances with central banks 4,646.0 1,400.0Derivative financial instruments 149.0 –Loans and advances to banks 585.2 –Loans and advances to customers 12,199.9 –Investment securities 661.0 –

18,241.1 1,400.00

Off balance sheetLoan commitments 1,168.3 –

Loans and advances by credit quality:

2010

Loans and advances to banks

£m

Residential mortgage

loans£m

Unsecured personal

loans£m

Neither past due nor impaired 585.2 12,097.1 0.5Past due but not impaired – 102.0 –Impaired – 0.3 –

585.2 12,199.4 0.5

53

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

2009

Loans and advances to banks

£m

Residential mortgage

loans£m

Unsecured personal

loans£m

Neither past due nor impaired – – –Past due but not impaired – – –Impaired – – –

– – –

The credit quality of loans neither past due nor impaired may be assessed by reference to the internal ratings and probability of default bandings allocated to loans by the Company’s internal credit assessment models as set out in the tables below:

2010 2009

Loansandadvancesto

banks£m

Loans and advances to

banks£m

AA 8.3 –AA– 145.1 –A+ 365.3 –A 61.4 –BB 5.1 –

585.2 –

2010 2009

Residentialmortgage

loans£m

Unsecuredpersonal

loans£m

Residential mortgage

loans£m

Unsecured personal

loans£m

PD bandRisk 1 – very low risk 11,805.1 0.5 – –Risk 2 – low risk 104.2 – – –Risk 3 – medium risk 137.9 – – –Risk 4 – high risk 49.9 – – –

12,097.1 0.5 – –

Available for sale securities and investment securities held as loans and receivables by credit quality:

2010 2009

Availableforsale

securities£m

Investmentsecuritiesheld

asloansandreceivables

£m

Available for sale

securities£m

Investment securities held

as loans and receivables

£m

Neither past due nor impaired 363.2 297.8 – –Past due but not impaired – – – –Impaired – – – –

363.2 297.8 – –

54

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

The credit quality of available for sale securities and investment securities held as loans and receivables by reference to credit ratings is set out in the table below:

2010 2009

Availableforsale

securities£m

Investmentsecuritiesheld

asloansandreceivables

£m

Available for sale

securities£m

Investment securities held

as loans and receivables

£m

AAA 363.2 234.0 – –AA – 31.0 – –AA– – 19.8 – –A+ – 13.0 – –

Total 363.2 297.8 – –

Past due not impaired loans:

2010 Loans and advances to

banks£m

Residential mortgage loans

£m

Unsecured personal loans

£m

Up to one month – – –In one to three months – 73.2 –In three to six months – 21.5 –Over six months – 7.3 –

– 102.0 –

2009 Loans and advances to

banks£m

Residential mortgage loans

£m

Unsecured personal loans

£m

Up to one month – – –In one to three months – – –In three to six months – – –Over six months – – –

– – –

Renegotiated loans that would otherwise be past due or impaired at 31 December 2010 amounted to £1.7m (2009 £nil).

CollateralDue to the nature of the Group’s exposures (comprising primarily residential mortgages), the only collateral held against credit risk was that in respect of the counterparty risk arising on derivative transactions (in the form of cash) and in respect of residential lending (in the form of mortgage charges over residential property). Valuations on residential property are carried out on a quarterly basis. Cash collateral held against counterparty credit risk at 31 December 2010 amounted to £0.7m (2009 £nil), residential property held amounted to £25,722.0m (2009 £nil). The table below shows an estimate of the fair value of collateral held against financial assets.

2010 Loans and advances to

banks£m

Residential mortgage loans

£m

Derivative financial

instruments£m

Neither past due nor impairedProperty – 25,556.7 –Cash – – 0.7Other – – –

Past due but not impairedProperty – 164.5 –Cash – – –Other – – –

ImpairedProperty – 0.8 –Cash – – –Other – – –

Total – 25,722.0 0.7

55

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

2009 Loans and advances to

banks£m

Residential mortgage loans

£m

Derivative financial

instruments£m

Neither past due nor impairedProperty – – –Cash – – –Other – – –

Past due but not impairedProperty – – –Cash – – –Other – – –

ImpairedProperty – – –Cash – – –Other – – –

Total – – –

ImpairmentAll credit portfolios are regularly reviewed to assess for impairment. A loan or portfolio of loans is considered to be impaired if there is any observable data indicating that there has been a measurable decrease in the estimated future cash flow or their timings. This will include identification of:

• Significant financial difficulty of the customer,

• Default or delinquency in interest or principal payments,

• The borrower entering bankruptcy or other financial reorganisation, and

• Adverse changes in the payment status of borrowers.

In the retail mortgage portfolio, individual impairments may occur where the Group has taken possession of the property or where specific circumstances indicate that a loss is likely to be incurred. In addition, collective impairment allowances across the retail credit portfolios are calculated on a portfolio basis using formulae which take into account the probability of default, the roll to possession and write-off and the loss given default, less the value of any security held. These parameters are kept under regular review to ensure that, as far as possible, they reflect current economic circumstances and risk profile.

ConcentrationriskConcentration risk is managed at portfolio, product, and counterparty levels. This is carried out through the application of limits relating to geographical spread, the size of loan relative to property value (at counterparty and portfolio levels) and the concentration of borrowers in each risk band.

The following table breaks down the Group’s main credit exposures by geographical region at their carrying amounts. Exposures are allocated to regions based on the country of domicile of the counterparty:

2010 UK£m

Europe£m

US£m

Other countries£m

Total£m

Derivative financial instruments 116.5 8.6 17.1 6.8 149.0Loans and advances to banks 507.2 74.8 – 3.2 585.2Loans and advances to customer Residential mortgage lending 12,197.2 – – – 12,197.2 Unsecured lending 0.3 – – – 0.3Available for sale securities – 363.2 – – 363.2Investment securities held as loans and receivables 230.1 47.8 – 19.9 297.8

As at 31 December 2010 13,051.3 494.4 17.1 29.9 13,592.7

2009 UK£m

Europe£m

US£m

Other countries£m

Total£m

Derivative financial instruments – – – – –Loans and advances to banks – – – – –Loans and advances to customer Residential mortgage lending – – – – – Unsecured lending – – – – –Available for sale securities – – – – –Investment securities held as loans and receivables – – – – –

As at 31 December 2009 – – – – –

56

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

LTV(%) – Indexed value as of financial year end Residential mortgage loans2010

£m2009

£m

<70% 7,981.4 –70%-75% 1,544.7 –75%-80% 1,254.1 –80%-85% 780.0 –85%-90% 424.8 –90%-95% 149.3 –95%-100% 51.7 –>100% 13.4 –

12,199.4 –

Loan size by outstanding balance

Outstandingbalance Residential mortgage loans2010

£m2009

£m

£0-£100k 3,681.2 –£100k-£250k 5,520.6 –£250k-£500k 1,953.9 –£500k-£1m 816.3 –£1m-£2.5m 213.1 –>£2.5m 14.3 –

12,199.4 –

ii) MarketRiskMarket risk is the risk that changes in the level of interest rates, the rate of exchange between currencies or the price of securities or other financial contracts, including derivatives, will have an adverse impact on the results of operations or financial condition of the company. Northern Rock plc does not trade or make markets in any areas and market risk arises only as a consequence of carrying out and supporting core business activities.

Market risk within the Group can be subdivided into the following risks:

• Mismatch. The effect that variations in the relationship between different points on the yield curve have on the value of fixed rate assets and liabilities

• Prepayment. The effect that variations in early repayment have on expected run off profiles of fixed rate loans and therefore on the effectiveness of hedging transactions

• Basis. Created where balance sheet assets and liabilities are sensitive to different underlying base reference measures e.g. indices or rates. Basis risk arises for example where mortgage interest rates are linked to Bank Base but the liabilities funding them are linked to LIBOR

• Reset. Exposure to the timing of repricing of assets and liabilities or to a sudden spike in a key underlying base reference measure

• Foreign Exchange (FX). Volatility in earnings resulting from movements in exchange rates altering the sterling value of unmatched foreign currency income streams, assets and liabilities (principally Euro positions).

The Bank offers predominantly banking, mortgage and savings products with varying interest rate features and maturities which create potential interest rate risk exposures. Primary risks arise as a result of timing differences on the repricing of assets and liabilities, unexpected changes in yield curves and changes in the correlation of interest rates between different financial instruments. In addition, structural interest rate risk arises in the Group’s consolidated balance sheet as a result of fixed, variable rate and non interest bearing assets and liabilities.

Risk exposures are controlled using position limits which require the Group’s Treasury function to manage exposure to movements in the market.

Interest Rate Risk Interest rate sensitivity arises from the relationship between interest rates and net interest income resulting from the periodic repricing of assets and liabilities. The Group offers fixed rate residential mortgages and savings products on which the interest rate paid by or to the customer is fixed for an agreed period of time at the start of the contract. The Group closely monitors mortgage redemption and repayment patterns and reduces the mismatch of the expected maturity profiles of its interest earning assets and interest bearing liabilities through the use of hedging strategies.

The Group uses a number of measures to monitor and control interest rate risk and sensitivity. One such measure evaluates the difference in principal value between assets and liabilities repricing in various gap periods. Risk weights are assigned to each gap period which reflect potential losses for a given change in rates and based on these an economic value impact of a positive 200 basis point interest rate shock is calculated for each period on the retail banking book. The economic impact of this shock on the income statement was a reduction of net interest income of £11.2m as at 31 December 2010.

The following table gives an analysis of the repricing periods of assets and liabilities on the Bank balance sheet at 31 December.

57

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

Items are allocated to time bands in the table below by reference to the earlier of the next contractual interest rate repricing date and the residual maturity date. Amounts shown in respect of loans and advances to customers include fair value adjustments of portfolio hedging.

2010

Within3 months

£m

After3 months

but within6 months

£m

After6 months

but within1 year

£m

After1 year

but within5 years

£m

After5 years

£m

Noninterestbearing

funds£m

Total£m

AssetsCash and balances with central banks 4,619.7 – – – – 26.3 4,646.0Loans and advances to banks 576.7 – – – – 8.5 585.2Loans and advances to customers 5,544.0 572.6 1,218.2 4,302.9 528.0 208.7 12,374.4Investment securities 372.7 216.4 51.4 25.0 – (4.5) 661.0Other assets – – – – – 295.2 295.2

Totalassets 11,113.1 789.0 1,269.6 4,327.9 528.0 534.2 18,561.8

LiabilitiesDeposits by banks 0.7 – – – – – 0.7Customer accounts 7,348.8 1,305.0 4,002.6 4,161.6 9.7 75.5 16,903.2Other liabilities – – – – – 470.4 470.4Shareholders’ equity – – – – – 1,187.5 1,187.5

Totalliabilities 7,349.5 1,305.0 4,002.6 4,161.6 9.7 1,733.4 18,561.8Notional values of derivatives affecting interest rate sensitivity 2,334.1 (409.5) (2,810.5) 348.4 537.5 – –

9,683.6 895.5 1,192.1 4,510.0 547.2 1,733.4 18,561.8

Totalinterestratesensitivitygap 1,429.5 (106.5) 77.5 (182.1) (19.2) (1,199.2) –

Cumulativeinterestratesensitivitygap 1,429.5 1,323.0 1,400.5 1,218.4 1,199.2 – –

2009

Within3 months

£m

After3 months

but within6 months

£m

After6 months

but within1 year

£m

After1 year

but within5 years

£m

After5 years

£m

Noninterestbearing

funds£m

Total£m

AssetsCash and balances with central banks 1,400.0 – – – – – 1,400.0Loans and advances to banks – – – – – – –Loans and advances to customers – – – – – – –Investment securities – – – – – – –Other assets – – – – – 0.1 0.1

Totalassets 1,400.0 – – – – 0.1 1,400.1

LiabilitiesLoans from HM Treasury 1,400.0 – – – – – 1,400.0Deposits by banks – – – – – – –Customer accounts – – – – – – –Other liabilities – – – – – – –Shareholders’ equity – – – – – 0.1 0.1

Totalliabilities 1,400.0 – – – – 0.1 1,400.1Notional values of derivatives affecting interest rate sensitivity – – – – – – –

1,400.0 – – – – 0.1 1,400.1

Totalinterestratesensitivitygap – – – – – – –

Cumulativeinterestratesensitivitygap – – – – – – –

In addition to the calculation of the sensitivity of the total balance sheet to a positive 200 basis point interest rate shock, a separate sensitivity calculation is carried out for the fixed rate mortgage book. The calculation measures the sensitivity of each portfolio to a 200 basis point parallel shift in rates. The economic impact of this shift on the income statement was a reduction of net interest income of £15.4m as at 31 December 2010 (2009 £nil).

58

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

Use of DerivativesThe Board has authorised the use of derivative instruments where their use is appropriate in reducing the risk of loss arising from changes in interest rates and exchange rates. All use of derivative instruments within the Group is to hedge financial risk exposure, and the Group takes no trading positions in derivatives.

The Group uses a number of derivative instruments to reduce interest rate risk and currency risk. These have, from time to time, included interest rate swaps, interest rate options, forward rate agreements, interest rate and bond futures, currency swaps and forward foreign exchange contracts. The Group will select the instrument that optimises the following conditions:

• Minimises capital utilisation

• Minimises overall cost

• Maximises impact on liquidity

• Minimises administrative and accounting complexity.

The benefit of using derivative instruments is measured by examining the anticipated consequences of not hedging the perceived risk. The vast majority of the Group’s derivatives activity is contracted with major banks and financial institutions.

Derivative instruments will be used by the Group for the following purposes:

• To reduce the interest rate risk (and any FX risk) in the Group’s balance sheet

• To protect the Group’s earnings from unexpected movements caused by market risks

• To develop retail products without creating unacceptably high structural risk for the Group.

OffbalancesheetitemsLoan commitmentsContractual amounts to which the Group is committed for extension of credit to customers are summarised in the table below.

Operating lease commitmentsMinimum future lease payments under non-cancellable operating leases are summarised in the table below.

Capital commitmentsCapital commitments for the acquisition of buildings and equipment are summarised in the table below.

2010 Within one year

£m

In one to five years

£m

Over five years

£mTotal

£m

Loan commitments 337.8 – 830.5 1,168.3Operating lease commitments Land and buildings 0.2 8.2 2.7 11.1 Other operating leases – 4.0 – 4.0Capital commitments Software 4.1 – – 4.1

342.1 12.2 833.2 1,187.5

At 31 December 2009 commitments were £nil.

CurrencyriskCurrency risk arises as a result of the Group having assets, liabilities and derivative items that are denominated in currencies other than sterling as a result of normal banking activities, including wholesale funding.

In addition to raising funds through sterling money markets, capital markets and the domestic retail savings market, the Group raises Euro denominated retail funds through its branch in Ireland. The Group’s policy is to minimise exchange rate exposures by using cross currency swaps and forward foreign exchange contracts, or to match exposures with assets denominated in the same currency.

At 31 December 2010, liabilities exceeded assets denominated in € by €1.2m, or £1.0m after taking into account foreign currency derivatives. The Group was sensitive to exchange rate gains and losses of less than £0.1m for each 1cent movement in the £: € exchange rate at 31 December 2010.

59

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

The table below gives values of assets and liabilities at sterling carrying values denominated in different currencies at the balance sheet date.

2010 US$£m

€£m

Other£m

Total£m

AssetsCash and balances with central banks – 0.8 – 0.8Loans and advances to banks – 334.1 – 334.1Investment securities – 309.6 – 309.6Other assets – 0.1 – 0.1

Totalassets – 644.6 – 644.6

LiabilitiesCustomer accounts – 644.2 – 644.2Other liabilities – 1.4 – 1.4

Totalliabilities – 645.6 – 645.6

Netposition – (1.0) – (1.0)

At 31 December 2009 all balances were in sterling.

FairvaluesoffinancialassetsandliabilitiesThe following table summarises the carrying amounts and fair values of those financial assets and liabilities not presented on the Group’s balance sheet at their fair value. Assets are presented at bid prices, whereas offer prices are used for liabilities. The accounting policy note sets out the key principles for estimating the fair values of financial instruments. This note provides some additional information in respect of financial instruments carried at amortised cost. Similar additional information in respect of instruments carried at fair value is included in the respective note for the instrument.

Carrying value Fair value

2010£m

2009£m

2010£m

2009£m

FinancialassetsCash and balances with central banks 4,646.0 1,400.0 4,646.0 1,400.0Loans and advances to banks 585.2 – 585.2 –Loans and advances to customers 12,197.5 – 12,218.2 –Investment securities held as loans and receivables 297.8 – 299.4 –

FinancialliabilitiesLoans from HM Treasury – 1,400.0 – 1,400.0Deposits by banks 0.7 – 0.7 –Customer accounts 16,903.2 – 17,202.2 –

Valuation methods for calculations of fair values in this table are set out below:

Cash and balances with central banksFair value approximates to carrying value because they have minimal credit losses and are either short term in nature or reprice frequently.

Loans and advances to banksFair value was estimated by using discounted cash flows applying either market rates where practicable or rates offered by other financial institutions for loans with similar characteristics. The fair value of floating rate placements, fixed rate placements with less than six months to maturity and overnight deposits is their carrying amount.

Loans and advances to customersThe Group provides loans of varying rates and maturities to customers. The fair value of loans with variable interest rates is considered to approximate to carrying value. For loans with fixed interest rates, fair value was estimated by discounting cash flows using market rates or rates normally offered by the Group. The change in interest rates since the majority of these loans were originated means that their fair value can vary significantly from their carrying value. However, as the Group’s policy is to hedge fixed rate loans in respect of interest rate risk, this does not indicate that the Group has an exposure to this difference in value.

Investment securities held as loans and receivablesFair values are based on quoted prices where available or by using discounted cash flows applying market rates.

Deposits by banks and customer accountsFair values of deposit liabilities repayable on demand or with variable interest rates are considered to approximate to carrying value. The fair value of fixed interest deposits with less than six months to maturity is their carrying amount. The fair value of all other deposit liabilities was estimated using discounted cash flows, applying either market rates or rates currently offered by the Group for deposits of similar remaining maturities.

The table below summarises the fair value measurement basis used for assets and liabilities held on the balance sheet at fair value. There are three levels to the hierarchy as follows:

Level 1 – Quoted prices (unadjusted) in active markets for identical assets and liabilities

Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, whether directly (i.e. as prices) or indirectly (i.e. derived from prices)

Level 3 – Inputs for the asset or liability that are not based on observable market data (unobservable inputs)

60

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

2010 Level 1£m

Level 2£m

Level 3£m

Total£m

FinancialassetsDerivative financial instruments – 149.0 – 149.0Available for sale securities – 363.2 – 363.2

FinancialliabilitiesDerivative financial instruments – 255.0 – 255.0

2009 Level 1£m

Level 2£m

Level 3£m

Total£m

FinancialassetsDerivative financial instruments – – – –Available for sale securities – – – –

FinancialliabilitiesDerivative financial instruments – – – –

iii) LiquidityriskLiquidity risk represents the risk of being unable to pay liabilities as they fall due and arises from the mismatch in cashflows generated from current and expected assets, liabilities and derivatives. The Group has a robust liquidity management framework which was in place throughout 2010.

Under the framework, liquidity management had two key segments as follows:

• Back book liquidity. Cashflows are generated from repayments and redemptions of retail customer loans and from maturities of Treasury investments. These cashflows are used to repay liabilities as they fall due.

• Front book liquidity. New lending to customers is required to be funded from new retail or new wholesale funding. Liquidity levels are maintained to meet expected and unexpected levels of liquidity outflows, with any permanent surplus liquidity used to fund asset growth.

The liquidity framework governance structure operates within the Board’s delegated authorities and reports into the Liquidity Management Group (LMG), Asset and Liability Committee (ALCO), Risk Committee, Executive Committee and Board.

The Treasury and Finance functions monitor liquidity on a daily basis, using daily cash flow liquidity reports, together with daily movement reports, liquidity performance indicators, portfolio analyses and maturity profiles.

LMG reviews on a weekly basis the projected daily cash flows, to ensure that the key liquidity performance indicators are met. Any changes in legislation, regulation or other guidance which may affect the Group’s liquidity position are reported directly to the Chief Financial Officer.

ALCO and the Risk Committee receive monthly liquidity analyses and profiles. ALCO generates policies and strategies to ensure that capital and liquidity management are optimised to meet internal and external stakeholder requirements. ALCO reports directly to the Executive Committee, which makes recommendations to the Board for its approval, and, similarly, the Risk Committee reports directly to the Board.

The table below analyses the Group’s assets and liabilities into relevant maturity groupings based on the remaining period at the balance sheet date to the contractual maturity date. Amounts shown in respect of loans and advances to customers include fair value adjustments of portfolio hedging.

2010

Within3 months

£m

After3 months

but within6 months

£m

After6 months

but within1 year

£m

After1 year

but within5 years

£m

After5 years

£mTotal

£m

AssetsCash and balances with central banks 4,615.1 – – – 30.9 4,646.0Derivative financial instruments 2.3 7.8 26.3 112.2 0.4 149.0Loans and advances to banks 575.2 10.0 – – – 585.2Loans and advances to customers 113.1 109.8 222.2 1,946.8 9,982.5 12,374.4Investment securities 105.0 219.4 71.3 27.4 237.9 661.0Other assets 93.4 – 2.1 – 50.7 146.2

Totalassets 5,504.1 347.0 321.9 2,086.4 10,302.4 18,561.8

LiabilitiesDeposits by banks 0.7 – – – – 0.7Customer accounts 9,348.0 959.1 3,472.5 3,123.6 – 16,903.2Derivative financial instruments 2.2 7.8 18.0 159.4 67.6 255.0Other liabilities 124.6 23.6 53.9 13.3 – 215.4

Totalliabilities 9,475.5 990.5 3,544.4 3,296.3 67.6 17,374.3

Netliquiditygap (3,971.4) (643.5) (3,222.5) (1,209.9) 10,234.8 1,187.5

61

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

2009

Within3 months

£m

After3 months

but within6 months

£m

After6 months

but within1 year

£m

After1 year

but within5 years

£m

After5 years

£mTotal

£m

AssetsCash and balances with central banks 1,400.0 – – – – 1,400.0Derivative financial instruments – – – – – –Loans and advances to banks – – – – – –Loans and advances to customers – – – – – –Investment securities – – – – – –Other assets 0.1 – – – – 0.1

Totalassets 1,400.1 – – – – 1,400.1

LiabilitiesLoans from HM Treasury 1,400.0 – – – – 1,400.0Deposits by banks – – – – – –Customer accounts – – – – – –Derivative financial instruments – – – – – –Other liabilities – – – – – –

Totalliabilities 1,400.0 – – – – 1,400.0

Netliquiditygap 0.1 – – – – 0.1

Non derivative cash flowsThe table below analyses the Group’s non derivative cash flows payable into relevant maturity groupings based on the remaining period at the balance sheet date to the contractual maturity date. The amounts disclosed are the contractual undiscounted cash flows. These differ from balance sheet values due to the effects of discounting on certain balance sheet items and due to the inclusion of contractual future interest flows.

2010

Within3 months

£m

After3 months

but within6 months

£m

After6 months

but within1 year

£m

After1 year

but within5 years

£m

After5 years

£mTotal

£m

LiabilitiesDeposits by banks 0.7 – – – – 0.7Customer accounts 9,369.9 998.0 3,660.9 3,327.1 – 17,355.9

9,370.6 998.0 3,660.9 3,327.1 – 17,356.6

2009

Within3 months

£m

After3 months

but within6 months

£m

After6 months

but within1 year

£m

After1 year

but within5 years

£m

After5 years

£mTotal

£m

LiabilitiesLoans from HM Treasury 1,400.0 – – – – 1,400.0Deposits by banks – – – – – –Customer accounts – – – – – –

1,400.0 – – – – 1,400.0

62

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

Derivative cash flowsThe following table analyses cash flows for the Group’s derivative financial liabilities that will be settled on a net basis into relevant maturity groupings based on the remaining period at the balance sheet date to the contractual maturity date. The amounts disclosed are the contractual undiscounted cash flows. Derivatives included within this analysis are single currency interest rate swaps.

2010

Within3 months

£m

After3 months

but within6 months

£m

After6 months

but within1 year

£m

After1 year

but within5 years

£m

After5 years

£mTotal

£m

Derivatives in economic but not accounting hedges (2.7) (4.4) (6.4) (9.3) 0.1 (22.7)Derivatives in accounting hedge relationships (42.2) (36.6) (50.7) (114.1) (6.2) (249.8)

(44.9) (41.0) (57.1) (123.4) (6.1) (272.5)

2009

Within3 months

£m

After3 months

but within6 months

£m

After6 months

but within1 year

£m

After1 year

but within5 years

£m

After5 years

£mTotal

£m

Derivatives in economic but not accounting hedges – – – – – –Derivatives in accounting hedge relationships – – – – – –

– – – – – –

iv) OperationalriskThe Group defines operational risk as “the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events including legal risk”. This accords with the Basel Committee’s definition of operational risk. In managing operational risk, the Group considers indirect financial costs and regulatory, reputational and customer impacts.

The Group adopts the Standardised Approach to Operational Risk management and external benchmarking has confirmed that the Group is in line with the FSA’s related qualifying criteria. The Group has a well documented risk management framework with appropriate reporting of risk events and risk exposures to the Executive Committee and the Risk Committee.

Business units and functions formally assess their operational risks on an ongoing basis via a prescribed Risk Control Self Assessment (RCSA) process. The RCSA analysis is reviewed and updated to reflect changes to the risk and control environment arising from changes in products, processes and systems.

The management of operational risk has been further strengthened during 2010 by:

• Upgraded mortgage fraud and Anti Money Laundering systems

• Strengthening of Business Continuity capability through syndicated third party recovery sites

• Aligning the Information Security policy framework standards to ISO27001.

The Group calculates its capital requirement for operational risk using the Basel II Standardised Approach.

v) LegalriskThe Group defines legal risk as “the risk of legal sanction, material financial loss or loss to reputation the Group may suffer as a result of its failure to comply with the law, inadequately document its contractual arrangements or inadequately assess and implement changes required by forthcoming legislation or emerging case law”.

To manage the risk, the Group has a dedicated Legal function headed by an independent Legal professional who reports to the Executive Chairman. The Risk Management Framework includes a Legal Risk Policy within which the Board has set a zero risk appetite (i.e. full compliance) in relation to legal risk, and standards that the business is expected to operate within. The framework also includes the governance and policy controls to enable identification of key legal risks, and of prevailing and emerging legal risk developments, issues and trends. The impacts of these developments on the Group are then assessed by the business and Legal function.

vi) RegulatoryriskRegulatory risk is defined as the “risk of the Group failing to comply with the legal and regulatory requirements applying to its arrangements and activities, with the potential consequences of:

• Customers being unfairly treated or suffering financial or other detriment

• Legal or regulatory sanctions

• Reputational loss and the associated financial and business impacts

• Risks to market confidence or stability, and

• Northern Rock plc being used for the purposes of financial crime”.

To manage the risk, the Group has a dedicated Compliance function reporting to the Chief Risk Officer. The Risk Management Framework includes a Regulatory Risk Policy within which the Board has set a zero risk appetite (i.e. full compliance) in relation to regulatory risk, and standards that the business is expected to operate within. The framework also includes the governance and policy controls to enable identification of key regulatory risks, and of prevailing and emerging regulatory risk developments, issues and trends. The impacts of these developments on the Group are then assessed by the business and Compliance function.

In addition to ensuring compliance with new developments, the framework requires ongoing review and challenge of the Group’s compliance related processes and practices. It also requires the monitoring of consistent application of policies, on a risk based approach. The results of the reviews are reported to the Executive Committee, Risk Committee and Audit Committee on a regular basis.

63

NOTES TO THE ACCOUNTS (continued)

31.Financialriskmanagement (continued)

B) CapitalManagementThe Group manages its capital resources to meet the regulatory requirements established by its regulator, the FSA. Capital adequacy is monitored on an ongoing basis by the Group’s executive management and Board, based on the regulations established by the FSA. The required capital information is filed with the FSA on a quarterly basis.

During 2010, the Group applied the Advanced Internal Ratings Based (AIRB) approach for residential mortgages and the Standardised approach for treasury portfolios and operational risk.

Northern Rock plc’s total available capital resources are shown in the table below. Total capital resources of the Company are available without restriction in order to meet its regulatory capital requirement. The Company complied with all of the externally imposed capital requirements to which it is subject.

2010£m

2009 £m

CoreTier1Ordinary share capital 1,400.0 0.1Retained earnings (211.6) –Pension scheme (2.8) –

Total Core Tier 1 capital 1,185.6 0.1

Regulatory deductions from Tier 1 (42.5) –

Tier 1 capital after deductions 1,143.1 0.1

Total available capital resources 1,143.1 0.1

C) ContingentLiabilitiesThe Financial Services Compensation SchemeThe Financial Services Compensation Scheme (“FSCS”) is the UK’s statutory fund of last resort for customers of authorised financial services firms and pays compensation if a firm is unable to pay claims against it. The FSCS has borrowed from HM Treasury to fund the compensation costs associated with institutions that failed in 2008 and will receive the receipts from asset sales, surplus cash flows and other recoveries from these institutions in the future.

The FSCS meets its obligations by raising management expense levies. These include amounts to cover the interest on its borrowings and compensation levies on the industry. Each deposit-taking institution contributes in proportion to its share of total protected deposits.

In 2010, the Group has accrued £7.6m in respect of its current obligation to meet management expense levies (2009 £nil).

If the FSCS does not receive sufficient funds from the failed institutions to repay HM Treasury in full, it will raise compensation levies. At this time, it is not possible to estimate the amount or timing of any shortfall resulting from the cash flows received from the failed institutions and, accordingly, no provision for compensation levies, which could be significant, has been made in these financial statements.

32.Collateralpledgedandreceived

Cash collateral is given and received as part of normal derivative operations. At 31 December 2010, £91.0m (2009 £nil) had been pledged and £0.7m (2009 £nil) had been received as cash collateral. In addition the Group has pledged securities collateral with a value of £27.9m (2009 £nil).

All collateral balances are the same in Group and Company.

64

NOTES TO THE ACCOUNTS (continued)

33.Relatedpartytransactions

A number of banking transactions are entered into with related parties as part of normal banking business. These include loans and deposits. The volumes of related party transactions, outstanding balances at the year end and related income and expense for the year are set out below.

Directors and key management personnel

2010£m

2009 £m

LoansLoans outstanding at 1 January 2010 / 3 July 2009 – –Transfer of loans from Northern Rock (Asset Management) plc 1.0 –Net amounts repaid (0.8) –

Loans outstanding at 31 December 0.2 –

Interest income paid – –

At 31 December 2010, directors and key management personnel held deposits of less than £0.1m (2009 £nil).

2010£m

2009 £m

Directors and key management personnelSalaries and other short term benefits 5.0 –Post-employment benefits 0.6 –

5.6 –

The Company regards the Government as a related party. Details of loan facilities with the Government are set out in note 24 above.

In addition to these loans and guarantees the Group has transactions with numerous Government bodies on an arm’s length basis in relation to the payment of corporation tax, value added tax and employment taxes and the payment of regulatory fees and levies. Transactions with these entities are not disclosed owing to the volume of transactions conducted.

At 31 December 2010, the Company holds cash with the Bank of England of £4,607.0m (2009 £1,400.0m). In addition the Company has made loans and advances to banks under government control of £265.0m (2009 £nil) and has derivative financial instrument assets with counterparties under government control of £50.3m (2009 £nil).

There are service level agreements in place between the Company and Northern Rock (Asset Management) plc and Bradford & Bingley plc. Under the terms of the agreement, the Company provides a number of services to Northern Rock (Asset Management) plc and Bradford & Bingley plc, including IT and various administrative services, and as a result received income in 2010 of £168.3m (2009 £nil). In addition Northern Rock (Asset Management) plc provides certain treasury services to the Company for which the Company paid £0.7m in 2010.

At 31 December 2010, the balance owing to the Company from Northern Rock (Asset Management) plc is £74.4m (2009 £nil). This amount is unsecured and is recorded in other assets in the balance sheet.

Northern Rock (Asset Management) plc provides an indemnity to the Company against potential claims arising from past business up to a maximum of £100m.

34.Cashandcashequivalents

For the purposes of the cash flow statement, cash and cash equivalents comprise the following balances with less than three months maturity from the date of acquisition:

Group Company2010

£m2009

£m2010

£m2009

£m

Cash and balances with central banks 4,615.9 1,400.0 4,615.9 1,400.0Loans and advances to banks 575.2 – 569.7 –

5,191.1 1,400.0 5,185.6 1,400.0

35.Ultimatecontrollingparty

The Company considers Her Majesty’s Government to be the ultimate controlling party.

CONTENTSExecutive Chairman’s Statement 1

The Board 3

Corporate Governance 4

Directors’ Remuneration Report 8

Corporate Social Responsibility Report 12

Operating and Financial Review 14

Directors’ Report 19

Independent Auditors’ Report to the Shareholder of Northern Rock plc 22

Consolidated Income Statement 23

Consolidated Statement of Comprehensive Income 24

Consolidated Balance Sheet 25

Company Balance Sheet 26

Consolidated Statement of Changes in Equity 27

Company Statement of Changes in Equity 28

Consolidated Cash Flow Statement 29

Company Cash Flow Statement 30

Notes to the Accounts 31

Presentation of Information

On 17 February 2008, the Chancellor of the Exchequer announced that the Government had decided to take Northern Rock into a period of temporary pub-lic ownership and on 22 February 2008 the Banking (Special Provisions) Bill received Royal Assent. HM Treasury made an order on 22 February 2008 which transferred all of the Ordinary, Preference and Foundation Shares in Northern Rock to the Treasury Solicitor as the Treasury’s nominee.

The legislation includes provisions such that Change of Control provisions in any of the Company’s contractual arrangements have not been triggered. Details of the impact of temporary public ownership are given throughout this Annual Report and Accounts as it affects the Company’s operations and finan-cial disclosures.

As Northern Rock has previously published financial statements which have been prepared in accordance with EU endorsed International Financial Reporting Standards (“IFRS”), IFRIC interpretations and with those parts of the Companies Act 1985 applicable to companies reporting under IFRS, it continues to do so.

Northern Rock plc, Registered O�ce: Northern Rock House, Gosforth, Newcastle upon Tyne NE3 4PLRegistered in England and Wales under Company Number 06952311   www.northernrock.co.uk