UK Retail provided over 80,000 start-up business introductions to UK Corporate.
• rebuilt its financial resilience. Core Tier 1 ratio increased to 10.6%, total assets reduced by £712 billion from peak levels, short-term wholesale borrowing reduced by £195 billion, converting a £207 billion deficit versus liquid assets to a £53 billion surplus. Balance sheet leverage reduced from 21.2x to 16.9x and the loan:deposit ratio improved to 108% (94% in Core). In each case the 2011 position is well ahead of that originally forecast.
Strategy The new RBS is built upon customer-driven businesses with substantial competitive strengths in their respective markets; together our ‘Core’ business. Each unit is being reshaped to provide improved and enduring performance and to meet new external challenges. The businesses are managed to add value in their own right but to provide a stronger, more balanced and valuable whole through vital cross-business linkages.
However, all banks, and especially in the UK, must adjust to much higher capital and liquidity requirements, and substantially changed wholesale funding markets. There are particular pressures on the funding, profitability and capital intensity of crossborder, wholesale and investment banking business lines.
Approximately three quarters of Group profit and revenue to come from retail and commercial banking.
In 2009, we announced clearly defined financial targets and in 2011 we re-visited these targets in light of significantly changed economic and regulatory environments. We remain committed to reducing risk and increasing sustainable returns in customer-driven businesses. Our quarterly reporting provides updates on our progress.
Unemployment averaged more than 14%. House prices dropped to a point where they were close to 50% below their peak level at the year’s end.
Potential to cause the Group to fail to meet the supervisory requirements of regulators.
Market risk The risk arising from changes in interest rates, exchange rates, credit spreads, equity prices and risk related factors such as market volatilities.
Financial cost of adapting to changes in laws, rules and regulations or of penalties for non-compliance.
Customer deposit balances fell by 4% in constant currency terms largely driven by the outflow of wholesale customer balances due to rating downgrades. Our loan:deposit ratio improved from 152% to 143%.
We have also built Citizens into a leading commercial bank. We want to meet the growing needs of our clients, and we want people to know us for our innovative thinking and global capabilities. Commercial Banking invested in and developed a number of specialty channels, including healthcare, technology, not-for-profits, franchise finance and sponsor finance, to help achieve these goals.
Our progress was recognized by Standard and Poors, which upgraded our credit rating from A- to A in late November.
We used technology to provide new services to our clients. RBS AgileTM uses criteria that clients specify to undertake foreign exchange trades automatically on their behalf. That allows them to manage currency risks and strategy during difficult market conditions. The trading app we created for the Apple iPad gives people on the move access to our analysis, commentary and trading ideas.
We launched Select from Direct Line, which is a new product for customers who need higher levels of cover for their home insurance. It was also our first product in the premium segment of the market. After the launch of Select from Direct Line, we also began providing premium home, motor and travel insurance for the clients of Coutts & Co.
We remained the largest personal lines motor and home insurer in the UK, all built around strong brands such as Direct Line, Churchill and Privilege and we continued to provide support and reassurance to millions of UK motorists through our Green Flag breakdown recovery service. Direct Line Italy is also now the number one direct insurer in the country, partly assisted by the first full year of its sales agreements with FGA Capital, a joint venture between Fiat and Credit Agricole.
The performance of our ongoing businesses improved. We reduced our cost base from £2.3 billion last year to £1.3 billion in 2011, mainly because our headcount fell through country and business exits.
Movement in net interest income UK (198) 1,850 1,652 (151) 1,824 1,673
Fees and commissions receivable 6,384 8,194 8,738 6,384 8,193 8,738 Fees and commissions payable (1,460) (2,211) (2,790) (1,460) (2,211) (2,790) Income from trading activities - excluding Asset Protection Scheme 3,381 6,138 3,999 3,607 6,067 3,761 - Asset Protection Scheme — — — (906) (1,550) — Gain on redemption of own debt — — — 255 553 3,790 Other operating income 2,527 1,213 787 4,122 1,479 873 Non-interest income (excluding insurance net premium income) 10,832 13,334 10,734 12,002 12,531 14,372 Insurance net premium income 4,256 5,128 5,266 4,256 5,128 5,266 Total non-interest income 15,088 18,462 16,000 16,258 17,659 19,638
A gain on movements in the fair value of own debt of £1,846 million was recorded as a result of Group credit spreads widening, partially offset by the 2011 charges. This compares with a smaller gain of £174 million in 2010.
In May 2011, following the decision of the British Bankers’ Association not to appeal the judgement of the judicial review, the Group recorded a provision of £850 million in respect of the costs of Payment Protection Insurance redress.
Innovation has supported the delivery of Helpful Banking by focusing on solutions that make it easier for customers to bank with RBS and NatWest. An important example has been giving customers access to 24 hour emergency cash from NatWest and RBS ATMs when their cards are lost or stolen. We also updated our market-leading iPhone application and by the end of the year 1 million customers had downloaded the application. With successful apps also launched for iPad, Android and Blackberry, RBS is now the leading mobile bank in the UK.
The division continued to focus on growing secured lending while at the same time building customer deposits, thereby reducing the Group’s reliance on wholesale funding. Loans and advances to customers grew 2%, with a change in mix from unsecured to secured as the Group actively sought to improve its risk profile. Mortgage balances grew by 5%, while unsecured lending contracted by 11%.
Net interest income 718 609 663 Net fees and commissions 375 376 363 Other non-interest income 84 71 83 Non-interest income 459 447 446 Total income 1,177 1,056 1,109 Direct expenses
Operating profit before impairment losses 909 1,097 1,012 Impairment losses (166) (9) (39)
2010 compared with 2009 Operating profit increased 12%, or 10% on a constant foreign exchange basis, driven by a robust income performance (which has more than compensated for the loss of Global Merchant Services (GMS) income), good cost control and lower impairments. Adjusting for the disposal operating profit increased 21%.
To strengthen retail alignment and improve efficiencies, US R&C formed a consolidated Consumer Banking division by combining management of the retail banking franchise with the consumer lending division during H2 2011. This continued focus on alignment is expected to further contribute to the improved penetration of loan products to deposit households, which has already increased in ten consecutive quarters. The penetration of on-line banking customers, a key indicator of customer retention, also continued to improve during 2011.
Overall, RBS Insurance has powerful brands, improved earnings, a robust balance sheet and is executing the second phase of its transformation plan to rebuild competitive advantage.
2010 benefited from c.£300 million of accounting gains on hybrid securities, c.£150 million of which was amortised during 2011.
UK Corporate Manufacturing and infrastructure 76 26 87 Property and construction 224 437 651 Transport 52 3 10 Banking and financial institutions 5 69 102 Lombard 75 129 95 Other 96 166 732 Total UK Corporate 528 830 1,677
Other Wealth 0.2 0.4 2.6 Global Transaction Services 0.2 0.3 0.8 RBS Insurance — 0.2 0.2 Central items (0.2) (1.0) (3.2)
Debt securities were down £8.4 billion, 4%, to £209.1 billion driven mainly by a reduction in holdings of government and financial institution bonds in Global Banking & Markets and Group Treasury.
Introduction*: Stress testing Stress testing describes the evaluation of a bank’s financial position under severe but plausible stress scenarios. Stress testing refers to the application of individual stress tests and the broader framework under which these tests are developed, evaluated and used within the Group’s decision-making process in the context of the wider economic environment.
Maintaining the structural integrity of the Group’s balance sheet requires active management of both asset and liability portfolios as necessary. Strong term debt issuance and planned reductions in the funded balance sheet enabled the Group to strengthen its liquidity and funding position as market conditions worsened. Refer to pages 116 to 130.
All country exposures are covered by the Group’s country risk management framework. This includes active management of portfolios either when these have been identified as exhibiting signs of stress through the Group’s country Watchlist process or when it is otherwise considered appropriate. Portfolio reviews are undertaken to align country risk profiles to the Group’s country risk appetite in light of economic and political developments.
Potential to put the entire business at risk. Otherwise, could lead to negative publicity, loss of revenue, costly litigation or a decline in customer base.
Undated subordinated debt 1,838 1,852 4,950 4,200 Dated subordinated debt - net of amortisation 14,527 16,745 20,063 18,120 Reserves arising on revaluation of property — — 73 73 Unrealised gains on AFS equity shares 108 25 134 134 Collectively assessed impairment provisions 635 778 796 796 Non-controlling Tier 2 capital 11 11 11 11
At beginning of the year 49,604 Attributable loss net of movements in fair value of own debt (3,449) Foreign currency reserves (363) Decrease in non-controlling interests (485) Decrease in capital deductions including APS first loss 1,128 Other movements (94) At end of the year 46,341
Following the accession to the APS, HM Treasury provides loss protection against potential losses arising in a pool of assets. HM Treasury also subscribed to £25.5 billion of capital in the form of B shares and a Dividend Access Share, with a further £8 billion of capital in the form of B shares potentially available as contingent capital. The Group pays fees in respect of the protection and contingent capital. The Group has the option, subject to HM Treasury consent, to pay the premium, contingent capital and the exit fee payable in connection with any termination of the Group’s participation in the APS in whole or in part, by waiving the entitlements of members of the Group to certain UK tax reliefs.
Should the uncapped amount be higher than the capital requirements for the underlying assets calculated as normal, ignoring the Scheme, the capital requirements for the Scheme are capped at the level of the requirements for the underlying assets (‘capped amount’). Where capped, the Group apportions the capped amount up to the level of the first loss as calculated above; any unused capped amount after the first loss capital deduction will be taken as RWAs for the Group’s share of covered losses.
Future regulatory capital effects As impairments or write-downs on the pool of assets are recognised, they reduce Core Tier 1 capital in the normal way. This will reduce the first loss deduction for the Scheme, potentially leading to a position where the capital requirement on the uncapped basis would no longer, for the assets covered by the APS, exceed the non-APS requirement and as a result, the Group would expect to start reporting the regulatory capital treatment on the uncapped basis.
Net stable funding ratio* The table below shows the Group’s net stable funding ratio (NSFR), estimated by applying the Basel III guidance issued in December 2010. The Group is aiming to meet the minimum required NSFR of 100% over the longer term. This measure seeks to show the proportion of structural term assets which are funded by stable funding, including customer deposits, long-term wholesale funding and equity. One of the main components of the ratio entails categorising retail and SME deposits as either ‘more stable’ or ‘less stable’. The Group’s NSFR will also continue to be refined over time in line with regulatory developments. It may be calculated on a basis that is not consistent with that used by other financial institutions.
Balance sheet management: Liquidity and funding risk continued Special purpose entities The Group arranges securitisations to facilitate client transactions and undertakes securitisations to sell financial assets or to fund specific portfolios of assets. The Group also acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. In a securitisation, assets, or interests in a pool of assets, are transferred generally to a special purpose entity (SPE) which then issues liabilities to third party investors. SPEs are vehicles established for a specific, limited purpose, usually do not carry out a business or trade and typically have no employees. They take a variety of legal forms - trusts, partnerships and companies - and fulfil many different functions. As well as being a key element of securitisations, SPEs are also used in fund management activities to segregate custodial duties from the fund management advice provided by the Group.
During 2011, both multi-seller and own-asset conduit assets decreased, as deals terminated and Non-Core assets were sold. The total assets held by Group-sponsored conduits were £13.1 billion at 31 December 2011 (2010 - £20.0 billion; 2009 - £27.4 billion).
Auto loans 4,293 356 4,649 2,526 — 7,175 Corporate loans 106 7,695 7,801 161 — 7,962 Credit card receivables 4,083 — 4,083 1,058 — 5,141 Trade receivables 806 — 806 1,351 — 2,157 Student loans 915 — 915 263 (132) 1,046 Consumer loans 1,686 — 1,686 222 — 1,908 Mortgages - prime 2,739 3 2,742 750 — 3,492 - non-conforming 1,548 — 1,548 193 — 1,741 - commercial 413 458 871 155 (22) 1,004 Other 872 1,393 2,265 232 (12) 2,485 17,461 9,905 27,366 6,911 (166) 34,111
The following table shows the sensitivity of NII, over the next twelve months, to an immediate upward or downward change of 100 basis points to all interest rates. In addition, the table includes the impact of a gradual 400 basis point steepening and a gradual 300 basis point flattening of the yield curve at tenors greater than a year. This scenario differs from that applied in the previous year in both the severity of the rate shift and the tenors to which this is applied.
GCR is additionally responsible for verifying compliance by the divisions with all Group credit policies.
Variation in margin 12 Payment holidays and loan rescheduling 87 Forgiveness of all or part of the outstanding debt 31 Other 8
Note: (1) The total above exceeds 100% as an individual case can involve more than one type of arrangement.
The customer’s financial position, anticipated prospects and the likely effect of the restructuring, including any concessions granted, are considered in order to establish whether an impairment provision is required.
Interest only conversions 1,269 795 — 3 2,067 Term extensions - capital repayment and interest only 1,805 58 — 97 1,960 Payment concessions/holidays 198 876 180 — 1,254 Capitalisation of arrears 864 101 — — 965 Other 517 — — 23 540 Total 4,653 1,830 180 123 6,786
Real estate - the Group takes collateral in the form of real estate, which includes residential and commercial properties. The loan amount will typically exceed the market value of the collateral at origination date. The market value is defined as the estimated amount for which the asset could be sold in an arms length transaction by a willing seller to a willing buyer.
Internal reporting and oversight of risk assets is principally differentiated by credit grades. Customers are assigned credit grades, based on various credit grading models that reflect the key drivers of default for the customer type. All credit grades across the Group map to both a Group level asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures, used for internal management reporting across portfolios. Accordingly, measures of risk exposure may be readily aggregated and reported at increasing levels of granularity depending on stakeholder or business need.
Personal 8,398 7,620 6,955 Property 25,558 23,672 20,145 Banks and financial institutions 1,934 1,981 1,928 Transport and storage 1,720 1,689 1,026
The majority of Ulster Bank Group’s commercial real estate portfolio is categorised as < 1 year, including on demand assets, owing to the high level of non-performing assets in the portfolio. Ulster Bank places most restructured facilities on demand rather than extending the maturity date.
14,584 10,042 4,344 68.9 43 29.8 2,682 — Ulster Bank Group Mortgages 21,162 1,566 439 7.4 28 2.1 336 7 Personal unsecured 1,282 185 158 14.4 85 12.3 48 30 Commercial real estate - investment 8,138 2,989 1,332 36.7 45 16.4 889 — - development 9,850 6,406 2,820 65.0 44 28.6 1,875 — Other corporate 11,009 2,515 1,228 22.8 49 11.2 695 11 51,441 13,661 5,977 26.6 44 11.6 3,843 48
Key points The residential mortgage portfolio across Ulster Bank Group totalled £20 billion at 31 December 2011, with 89% in the Republic of Ireland and 11% in Northern Ireland. At constant exchange rates the portfolio decreased by 4% from 2010, as a result of natural amortisation and limited growth due to low market demand.
The following tables provide an analysis of credit concentration of financial assets by sector, geography and internal credit quality gradings. Credit risk assets analysed on the pages 144 to 149 are reported internally to senior management. However, they exclude certain exposures, primarily securities, and take account of legal netting agreements, that provide a right of legal set-off but do not meet the criteria for offset in IFRS. The analysis below is therefore provided to supplement the credit risk assets analysis and to reconcile to the consolidated balance sheet.
Cross border exposures Cross border exposures are loans and advances including finance leases and instalment credit receivables and other monetary assets, such as debt securities, including non-local currency claims of overseas offices on local residents.
Securities issued by central and local governments 125.5 127.5 138.8 151.6 Securities issued by corporates 6.0 8.0 12.5 13.3 Securities issued by banks and other financial institutions 77.6 82.0 97.8 102.4 209.1 217.5 249.1 267.3
The decrease in AAA rated debt securities mainly relates to the downgrading of US government and agencies to AA+ by S&P during the year.
Note: (1) Credit hedging in the banking book principally relates to portfolio management in Non-Core.
The reduction in the Group’s RWA requirements was driven by the decrease in exposure to monolines.*
Credit valuation adjustment at 1 January (1,714) (1,588) (1,738) Credit valuation adjustment at 31 December (2,254) (1,714) (1,588) (Increase)/decrease in credit valuation adjustment (540) (126) 150 Net credit/(debit) relating to realisations, hedges, foreign exchange and other movements 244 (19) (841) Loss from trading activities (296) (145) (691)
Potential problem loans Potential problem loans (PPL) are loans for which an impairment event has taken place but no impairment provision is required. This category is used for fully collateralised advances which are not past due 90 days or revolving credit facilities where identification as 90 days overdue is not feasible.
- residential mortgages 20,311 526 120 2.6 23 0.6 162 164 - personal lending 7,505 136 59 1.8 43 0.8 66 85 - property 2,413 111 24 4.6 22 1.0 16 43 - other 36,054 443 584 1.2 132 1.6 26 101 RoW
- residential mortgages 502 33 12 6.6 36 2.4 3 — - personal lending 1,510 1 1 0.1 100 0.1 — — - property 304 62 42 20.4 68 13.8 (87) — - other 17,396 214 140 1.2 65 0.8 (37) 17 Group before RFS MI 437,988 16,862 8,414 3.8 50 1.9 3,403 2,137
- residential mortgages 203 — — — — — 4 1 - personal lending 2 — — — — — 98 129 - property 1,205 241 81 20.0 34 6.7 (33) 182 - other 3,276 542 433 16.5 80 13.2 123 98 Group before RFS MI 109,206 23,391 10,316 21.4 44 9.4 5,407 3,818
Management of country risk was further strengthened in 2011 with intensified stress testing, portfolio actions on a number of countries and enhancements to risk appetite setting and management systems, contributing inter alia to a reduction in exposures to a range of countries.
Credit default swap (CDS) under CDS contract the credit risk on the reference entity is transferred from the buyer to the seller. The fair value, or mtm, represents the balance sheet carrying value. The mtm value of CDSs is included within derivatives against the counterparty of the trade, as opposed to the reference entity. The notional is the par amount of the credit protection bought or sold and is included against the reference entity of the CDS contract.
India - strong economic growth in 2011 resulted in increased exposure across most product types until the fourth quarter, when a decline took place, driven by a Global Transaction Services (GTS) exercise in the region to manage down risk-weighted assets, natural run-offs/maturities and a sharp rupee depreciation. Year-on-year increases in lending to corporate clients (£0.3 billion) and the central bank (£0.3 billion) were offset by reductions in lending to banks (£0.7 billion) and other financial institutions (£0.3 billion).
Banks 67,624 5,585 1,085 131 198 23 — — 68,907 5,739 Other financial institutions 79,824 5,605 759 89 2,094 278 147 14 82,824 5,986 Total 147,448 11,190 1,844 220 2,292 301 147 14 151,731 11,725
The Ulster Bank retail portfolio mainly consists of mortgages (approximately 95% of Ulster Bank personal lending at 31 December 2011), with the remainder comprising credit card and other personal lending. Overall personal lending exposure fell approximately £1.4 billion over the year as a result of exchange rate movements, amortisation, a small amount of write-offs and a lack of demand in the market.
Activity with Greek financial companies is under close scrutiny; exposure is minimal.
Luxembourg - lending to non-bank financial institutions increased by £1.0 billion during 2011 reflecting collateral relating to derivatives and repos.
A number of VaR model and methodology enhancements were introduced during 2011. The quality of the market data time series used in the ABS mortgage trading business was improved, moving from interpolated weekly data to daily observed time series. This change has improved the accuracy of the correlation between the different time series in the daily data. Additionally, the basis modelling between cash and derivatives has been refined by introducing additional time series for the sub-prime and subordinated residential bonds, reducing the over-reliance on the commercial mortgage basis which was used as a conservative proxy.
Following the implementation of CRD III, three new models - for stressed VaR, incremental risk charge and all price risk (see more below) - have been fully approved by the UK regulator and form part of the capital and risk management framework from 31 December 2011 onwards.
Sensitivity analysis measures the sensitivity of the current portfolio of positions to defined market risk factor movements. These stresses are of a smaller magnitude compared to historical or bottom-up stress testing and are subject to the Group Market Risk limit framework.
At the end of 2010, the commodity VaR was materially lower than the average for that year as a result of the completion of the sale of the Group’s interest in the RBS Sempra Commodities joint venture. The commodity VaR increased slightly from mid-September 2011, due to improvements in capturing risk for commodity futures and indices.
Mitigation The business has well-defined procedures in place to address any issues, such as breaches of risk appetite, that are identified through monitoring and reporting activities. In such cases, an action plan to address the issue is developed, implemented and monitored through the appropriate bodies, with a view to ensuring the risk is adequately mitigated or a considered decision at the correct levels is taken to accept it.
The impact of the FSA Anchor II scenario on the Group's operational risk capital, as calculated under the standardised approach, was also projected based on the outputs of the Group’s stress-testing exercises.
CEC provides a twice-yearly assessment of the robustness of the Group’s internal control environment including: compliance with the GPF and key divisional/functional policy standards; compliance with the requirements of the UK Corporate Governance Code; and effectiveness of the risk frameworks, culture and governance structures for each division or function.
Global regulatory developments The global agenda continues to be guided by the G20, drawing on the original action plan for strengthening financial stability agreed by G20 leaders at the November 2008 Washington summit. During 2011, G20 countries continued to implement various elements of this action plan, culminating in the G20 leaders’ summit held in Cannes in November 2011.
The names of the initial list of G-SIBs (though not their ranking) were published by the FSB at the end of the summit: RBS is included in the 29 names.
Reporting and internal communications activity expanded in 2011 in response to the growing regulatory change agenda. This included: The enhancement of quarterly reporting to the Group Audit Committee, with a particular focus on tracking progress on compliance readiness programmes implementing new requirements; Six-monthly reporting to the Board Risk Committee, in addition to the standard monthly risk reports produced for the Board and other governance committees; and
Regulatory relationship management The Regulatory Relations Forum, chaired by Group Regulatory Affairs, meets fortnightly and now has global coverage with representatives from all divisions and regions. It facilitates the sharing of key regulatory engagements and the lessons learned from them.
Previously chairman of J Sainsbury plc and group finance director at Lloyds TSB Group, BT Group plc, BG Group plc, British Gas and British Steel plc, an executive director of Lazards and a non-executive director of RMC Group plc and Belgacom SA. He is also a former chairman of UK Financial Investments Limited, which manages the UK Government’s shareholdings in banks.
Stephen Hester (age 51) Date of appointment: appointed to the Board on 1 October 2008 and to the position of Group Chief Executive on 21 November 2008
Group Sustainability Committee (Chair) Board Risk Committee Group Nominations Committee Group Remuneration Committee
An experienced director on UK listed company boards with extensive and varied political and public sector experience. A qualified chartered accountant, she previously headed KPMG’s European and International Government practices and has been President of the Institute of Chartered Accountants in England and Wales. She was appointed to the House of Lords in 2000 and has served on the Conservative front bench in various roles including as shadow treasury minister between 2003 and May 2010. Previously held nonexecutive roles on the Court of the Bank of England, Hanson, ICI, John Laing and SThree.
Paul Geddes (age 42) Chief Executive, RBS Insurance Paul Geddes was appointed as Chief Executive of RBS Insurance in August 2009, and is leading a significant transformation of the business ahead of its planned divestment from the Group. Prior to his move to Insurance, Paul was CEO of RBS Group's UK retail banking business, having joined RBS Retail in 2004 as Managing Director with responsibility for products and marketing. Before financial services, Paul held a number of senior roles in multi-channel retailing in the GUS and Kingfisher groups. Paul started his career in Marketing with Procter & Gamble in UK and European roles. Paul read PPE at Oxford, graduating in 1990, and remains a supporter of his college through music scholarships. He is a Fellow of the Chartered Institute of Bankers in Scotland, a member of the ABI Board and a member of the FSA Practitioner Panel.
The Board has established procedures for ensuring that the Board’s powers for authorising directors’ conflicts of interest are being operated effectively. With effect from 1 October 2008, the Companies Act 2006 introduced a statutory duty on directors to avoid conflicts of interest unless authorised. Since that date, the Board has considered, and where appropriate authorised, any actual or potential conflicts of interest that directors may have. The Board reviews its conflicts register annually.
Drawing on the previous experiences of the new directors appointed to the Group Board in 2011, the Group Secretary created tailored induction programmes for each of Alison Davis, Baroness Noakes and Tony Di Iorio which were designed to give them an in-depth insight into the range of businesses of the Group. Each induction programme included a mandatory element which comprised 12 meetings, visits and sessions. The remainder of the induction programme included in excess of 30 meetings with key executives and their teams, stakeholders and visits to divisions, businesses and Group Functions, both in the UK and overseas.
the Chairman independently meets with the Group’s largest institutional shareholders annually to hear their feedback on management, strategy, business performance and corporate governance. Additionally, the Chairman, Senior Independent Director and chairs of the Board Committees met with the governance representatives of a number of institutional shareholders during the year.
I am pleased to report the recent appointment of Nicholas Crapp as our new Head of Group Internal Audit. Nicholas joined the Group at the beginning of 2012 and I look forward to his contribution to this challenging agenda. Overall, I am confident that with the continued commitment of my fellow colleagues and the support of the Group executive, the Committee is well placed to meet the challenges of 2012.
The Group Audit Committee approves the terms of engagement of the External Auditors. The Group Audit Committee also fixes the remuneration of the External Auditors as authorised by shareholders at the Annual General Meeting.
As well as the financial achievements above, the Committee takes into account the Group's performance against a range of broader strategic objectives, including support to personal and business customers in the communities in which it operates. In 2011 gross new lending to business increased by 22%, with lending to SMEs up 4%, exceeding the Group's Merlin targets. The Committee also considers the scale of the businesses our leadership team are managing. For example, during 2011, our 2,000 UK retail branches served 18 million customers; our corporate banking division accounted for almost half of all new lending to UK SMEs; and our investment bank operated in 38 countries and arranged €12 billion of loans and €10 billion of bonds for UK corporates.
(1) The following groups of employees have been identified as meeting the FSA’s criteria for Code Staff: Members of the Group Board and Group Executive and Management Committees; Staff performing a Significant Influence Function within RBS Group; Employees who have approval authorities such that their decision-making could have a material impact on the RBS Group income statement; Employees who are responsible for a business or businesses whose performance could have a material impact on the RBS Group income statement; and Key control function roles.
LTIP Awards to executive directors have a normal maximum limit of 400% of salary.
Benefits are available from a flexible account on a similar basis to other employees.
Group Finance Director - Bruce Van Saun 2009-2011 average compensation outcome for Group Chief Executive The preceding charts are based on target/expected values of total compensation. Press commentary tends to focus either on these values, or on maximum values assuming all performance conditions are met. However, in practice over the period 2009 to 2011, the value received will be significantly less than the maximum or even target value incentives, in light of bonus waivers, performance conditions and share price fall over the period. The chart below shows the likely average pay-out to the Group Chief Executive from salary, pension and incentives from awards made over the 2009-2011 period. The average maximum award is shown on the left, but is then adjusted allowing for the impact of LTIP performance conditions, bonus conditions and voluntary waivers and finally the impact of the share price fall on the remaining value of awards.
The Group Remuneration Committee has reviewed executive directors’ performance against targets set at the beginning of the year as summarised in the table below. Accordingly, the Committee recommended, and the Group Board (excluding executive directors) approved, that the Group Chief Executive should receive an award of 60% and the Group Finance Director an award of 80% of their maximum allocation for the 2011 performance year, which equates to 3.6 million and 3.0 million shares respectively into Share Bank in 2012. The Group Chief Executive has waived his allocation. The shares vest in two equal tranches on the first and second anniversaries of the date of grant and are subject to a holding period of six months after vesting. Clawback provisions will apply prior to the vesting of shares.
Significant progress made on the Group’s cost-reduction programme, with further progress targeted for 2012.
Total Shareholder Return performance The first graph below shows the performance of the company over the past five years in terms of TSR compared with that of the companies comprising the FTSE 100 Index. This index has been selected because it represents a cross-section of leading UK companies. The TSR for FTSE banks for the same period has been added for comparison.
Lead delivery of overall performance, including measures relating to ROE, cost management, Core Tier 1 capital ratio, funding and risk profile, lending, EU mandated disposals and restructuring of the wholesale business.
Arrangements for the Group Chairman Philip Hampton is entitled to receive a cash payment in lieu of notice if his appointment is terminated as a result of the Group's majority shareholder seeking to effect the termination of his appointment. The applicable notice period is twelve months. In the event that the company terminates Philip Hampton's appointment without good reason, or his re-election is not approved by shareholders in General Meeting resulting in the termination of his appointment, he will be entitled to receive a cash payment in lieu of notice of twelve months' fees.
Internal control over financial reporting The Group is required to comply with Section 404 of the US Sarbanes-Oxley Act of 2002 and assess the effectiveness of internal control over financial reporting as of 31 December 2011.
Business review Activities The Group is engaged principally in providing a wide range of banking, insurance and other financial services. Further details of the organisational structure and business overview of the Group, including the products and services provided by each of its divisions and the competitive markets in which they operate, are contained in the Business review on pages 36 to 38. Details of the strategy for delivering the company’s objectives can be found on pages 14 and 15.
Shares beneficially owned at 1 January 2011 or date of appointment, if later
Consolidated statement of changes in equity for the year ended 31 December 2011
Equity preference dividends paid — (105) (878) Paid-in equity dividends paid, net of tax — (19) (57) Transfer from paid-in equity - gross — 2 200 - tax — (1) — Equity owners gain on withdrawal of non-controlling interest
There are a number of changes to IFRS that were effective from 1 January 2011. They have had no material effect on the financial statements of the Group or the company: IFRIC 19 ‘Extinguishing Financial Liabilities with Equity Instruments’ provides guidance on the accounting treatment when financial liabilities are settled with equity instruments.
2. Basis of consolidation The consolidated financial statements incorporate the financial statements of the company and entities (including certain special purpose entities) that are controlled by the Group. Control exists where the Group has the power to govern the financial and operating policies of the entity; generally conferred by holding a majority of voting rights. On acquisition of a subsidiary, its identifiable assets, liabilities and contingent liabilities are included in the consolidated accounts at their fair value. A subsidiary acquired is included in the consolidated financial statements from the date it is controlled by the Group up until the date the Group ceases to control it through a sale or a significant change in circumstances. Changes in interest that do not result in a loss of control are accounted for as equity transactions.
The results of discontinued operations - comprising the post-tax profit or loss of discontinued operations and the post-tax gain or loss recognised either on measurement to fair value less costs to sell or on the disposal of the discontinued operation - are shown as a single amount on the face of the income statement. A discontinued operation is a cash-generating unit or a group of cash-generating units that either has been disposed of, or is classified as held for sale, and (a) represents a separate major line of business or geographical area of operations, (b) is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations or (c) is a subsidiary acquired exclusively with a view to resale.
5. Employee benefits Short-term employee benefits, such as salaries, paid absences, and other benefits are accounted for on an accruals basis over the period in which the employees provide the related services. Group employees may receive variable compensation satisfied by cash, by debt instruments issued by the Group or by shares in The Royal Bank of Scotland Group plc. The treatment of share-based compensation is set out in Accounting policy 25. Variable compensation that is settled in cash or debt instruments is charged to profit or loss over the period from the start of the year to which the variable compensation relates to the expected settlement date taking account of forfeiture and claw back criteria.
Impairment losses are assessed individually for financial assets that are individually significant and individually or collectively for assets that are not individually significant. In making collective assessment of impairment, financial assets are grouped into portfolios on the basis of similar risk characteristics. Future cash flows from these portfolios are estimated on the basis of the contractual cash flows and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted, on the basis of observable data, to reflect current conditions not affecting the period of historical experience. Impairment losses are recognised in profit or loss and the carrying amount of the financial asset or group of financial assets reduced by establishing an allowance for impairment losses. If, in a subsequent period, the amount of the impairment loss reduces and the reduction can be ascribed to an event after the impairment was recognised, the previously recognised loss is reversed by adjusting the allowance. Once an impairment loss has been recognised on a financial asset or group of financial assets, interest income is recognised on the carrying amount using the rate of interest at which estimated future cash flows were discounted in measuring impairment.
These amendments are effective for annual periods beginning on or after 1 January 2013. Earlier application is permitted. The Group is reviewing the amendments to determine their effect on the Group’s financial reporting.
Major classes of plan assets as a percentage of total plan assets 2011
Notes: (1) In the Budget on 22 June 2010, the UK Government proposed, amongst other things, to reduce Corporation Tax rates in four annual decrements of 1% with effect from 1 April 2011. An additional 1%
Earnings Loss attributable to ordinary and B shareholders (1,997) (1,125) (3,607) (Profit)/loss from discontinued operations attributable to ordinary and B shareholders (5) 28 72 Gain on redemption of preference shares and paid-in equity — 610 200 Loss from continuing operations attributable to ordinary and B shareholders (2,002) (487) (3,335)
The following table provides information for reclassifications made in 2009. 2009 2008 2009 - on reclassification 31 December 2009 After reclassification
Reclassified from HFT to LAR Loans 1,740 5.9 2,640 887 924 (103) (44) (251) (256) 39 (62)
Assets Loans and advances 0.8 120 (70) 0.8 70 (60) 1.1 80 (40) c, k Debt securities Corporate 0.5 30 (30) 1.2 210 (170) 1.2 180 (60) c Financial institutions 7.4 560 (180) 7.0 540 (180) 2.9 290 (170) a, c, d, i, j, m, n, o, p 7.9 590 (210) 8.2 750 (350) 4.1 470 (230) Equity shares 1.0 140 (130) 1.0 160 (160) 1.5 280 (220) h Derivatives Foreign exchange 1.6 100 (100) 0.1 — — 0.2 10 — a, q Interest rate 1.1 80 (80) 1.7 150 (140) 1.5 80 (100) a, q Equities and commodities 0.2 — — 0.2 — — 0.3 20 (20) a, f Credit - APS — — — 0.6 860 (940) 1.4 1,370 (1,540) a, c, e, g, l Credit - other 3.8 680 (400) 3.1 320 (170) 3.0 420 (360) a, b, q
For the purpose of the APS, a loss is deemed to have arisen on a covered asset when that asset has experienced a trigger event which comprises of failure to pay subject to grace periods, bankruptcy and restructuring.
The option to exit the APS is not usually present in such tranched trades and consequently, there is no standard market practice for reflecting this part of the trade within the standard model framework. The approach that has been adopted assumes that the Group will not exit the trade before the minimum level of fees have been paid and at this point it will be clear whether it should exit the trade or not. The APS derivative is valued as the payment of the minimum level of fees in return for protection receipts which are in excess of both the first loss and the total future premiums.
AFS Debt securities 4,379 2 3 2,097 (21) — 98 (817) (47) 3 5,697 2 Equity shares 279 2 59 82 — — 7 (1) (29) (4) 395 (4)
Assets FVTPL (2) Loans and advances 1,059 169 — 10 — 169 (451) (165) 52 843 38 Debt securities 2,782 294 — 1,770 — 1,973 (386) (2,682) 33 3,784 154 Equity shares 711 414 — (26) — 654 — (1,027) (10) 716 54 Derivatives 6,429 (1,561) — 1,728 — 948 (299) (1,534) 26 5,737 (1,556)
Assets Cash and balances at central banks 79,269 — 79,269 56,997 17 57,014 52,229 32 52,261 Loans and advances to banks 80,905 2,405 83,310 98,789 1,729 100,518 89,622 2,131 91,753 Loans and advances to customers 197,338 318,268 515,606 199,626 355,634 555,260 227,745 500,648 728,393 Debt securities 45,311 163,769 209,080 42,678 174,802 217,480 69,197 198,057 267,254 Equity shares — 15,183 15,183 — 22,198 22,198 — 19,528 19,528 Settlement balances 7,767 4 7,771 11,605 — 11,605 12,022 11 12,033 Derivatives 60,250 469,368 529,618 65,639 361,438 427,077 70,537 370,917 441,454
Interest rate contracts Interest rate swaps 29,976 346,682 333,968 29,792 251,312 243,807 30,956 265,528 253,793
Gross gains of £152 million (2010 - £83 million; 2009 - £385 million) and gross losses of £2 million (2010 - £63 million; 2009 - £123 million) were realised on the sale of available-for-sale equity shares.
The fair value of investment properties includes £146 million of depreciation since purchase (2010 - £248 million depreciation; 2009 - £84 million appreciation).
Rental income from investment properties was £270 million (2010 - £279 million; 2009 - £233 million). Direct operating expenses of investment properties were £67 million (2010 - £42 million; 2009 - £16 million).
(2) Includes property provisions and other provisions arising in the normal course of business.
Claims management risk The risk that claims are handled or paid inappropriately is managed using a range of IT system controls and manual processes conducted by experienced staff. These, together with a range of detailed policies and procedures ensure that all claims are handled in a timely, appropriate and accurate manner.
Seven years later (14) 28 (14) — Eight years later 14 (9) 5 Nine years later (29) (29) Current estimate of cumulative claims 3,017 3,276 3,351 3,917 3,880 4,582 4,149 4,464 4,393 3,318 38,347 Cumulative payments to date (2,992) (3,162) (3,168) (3,729) (3,582) (4,092) (3,494) (3,458) (3,096) (1,600) (32,373) 25 114 183 188 298 490 655 1,006 1,297 1,718 5,974 Liability in respect of earlier years 88 Claims handling costs 157 Gross general insurance claims liability 6,219
First Active plc £60 million 6.375% subordinated bonds 2018 (callable April 2013) 64 66 66
At 1 January 2010 56,365,721 Shares issued 2,092,410 At 1 January 2011 58,458,131 Shares issued 770,281 At 31 December 2011 59,228,412
Litigation Set out below are descriptions of the material legal proceedings involving the Group.
MasterCard appealed against the decision to the European Court of First Instance (subsequently re-named the General Court) on 1 March 2008, and the Group has intervened in the appeal proceedings. In addition, in summer 2008, MasterCard announced various changes to its scheme arrangements. The EC was concerned that these changes might be used as a means of circumventing the requirements of the infringement decision. In April 2009, MasterCard agreed an interim settlement on the level of cross-border MIF with the EC pending the outcome of the appeal process and, as a result, the EC has advised it will no longer investigate the non-compliance issue (although MasterCard is continuing with its appeal). The appeal was heard on 8 July 2011 by the General Court and judgment is awaited. This could be delivered in spring or summer 2012, although it may take longer.
On 19 December 2011 the UK Government published a response to the Final Report (the “Response”), reaffirming its intention to accept the majority of the ICB’s recommendations. The Government agreed that “vital banking services - in particular the taking of retail deposits – should only be provided by ‘ring-fenced banks’, and that these banks should be prohibited from undertaking certain investment banking activities.” It also broadly accepted the ICB’s recommendations on loss absorbency and on competition.
Global Banking & Markets (GBM) is a leading banking partner to major corporations and financial institutions around the world, providing an extensive range of debt and equity financing, risk management and investment services to its customers. The division is organised along six principal business lines: money markets; rates flow trading; currencies; equities; credit and mortgage markets and portfolio management and origination.
Reconciling items Fair value of own debt — 174 174 — — — 174 Asset Protection Scheme — (1,550) (1,550) — — — (1,550) Amortisation of purchased intangible assets — — — — (369) — (369) Integration and restructuring costs — — — (1,012) (20) — (1,032) Gain on redemption of own debt — 553 553 — — — 553 Strategic disposals — 171 171 — — — 171 Bonus tax — — — (99) — — (99) Write-down of goodwill and other intangible assets — — — (10) — — (10)
HM Treasury has the right to appoint step-in managers to carry out any oversight, management or additional functions on behalf of HM Treasury to ensure that the covered assets are managed and administered in compliance with the agreed terms and conditions. This right is exercisable if certain step-in triggers occur. These include: losses on covered assets in total exceed 125% of the first loss amount or losses on an individual covered asset class exceed specified thresholds; a breach of specified obligations in the APS rules or the accession agreement; the Group has failed or is failing to comply with any of the conditions in the APS rules in relation to asset management, monitoring and reporting, and governance and oversight and such failure is persistent and material or it is evidence of a systematic problem; and material or systematic data deficiencies in the information provided to HM Treasury in accordance with the terms of APS.
Called-up share capital At 1 January 15,125 14,630 9,898 Ordinary shares issued in respect of placing and open offer — — 4,227 B shares issued — — 510 Ordinary shares issued 193 523 — Preference shares redeemed — (1) (5) Cancellation of non-voting deferred shares — (27) — At 31 December 15,318 15,125 14,630
Total comprehensive loss is attributable to: Preference shareholders — 105 878 Paid-in equity holders — 19 57 Ordinary and B shareholders (107) (4,677) (2,435)
Fair value hedging Assets £m Liabilities £m Assets £m Liabilities £m Assets £m Liabilities £m 7 Debt securities The company holds debt securities issued by a Group undertaking of £1,568 million (2010 - £1,454 million; 2009 - £1,286 million) classified as loans and receivables.
Operating (loss)/profit before tax (766) (399) (2,647) (25,691) 9,636 Tax (charge)/credit (1,250) (634) 429 2,167 (2,011) (Loss)/profit from continuing operations (2,016) (1,033) (2,218) (23,524) 7,625 Profit/(loss) from discontinued operations, net of tax 47 (633) (105) (11,018) 87 (Loss)/profit for the year (1,969) (1,666) (2,323) (34,542) 7,712
Loans are classified as accruing loans past due 90 days or more where they are past due 90 days but where no impairment provision is required because they are fully collateralised.
Rest of the World 75,194 77,966 237,553 Total overseas offices 211,113 213,608 363,628
Netherlands The consolidated supervisor of RBS N.V. is the Dutch Central Bank, De Nederlandsche Bank (DNB). The DNB operates as prudential supervisor of banks, insurance companies, pension funds and securities firms, and also as part of the European System of Central Banks.
In order to eliminate this deficit, the Group will pay additional contributions each year over the period 2011 until 2018. These contributions started at £375 million per annum in 2011, will increase to £400 million per annum in 2013 and from 2016 onwards be further increased in line with price inflation. These contributions are in addition to the regular contributions of around £300 million for future accrual of benefits.
As a result of the significant volume, variety and complexity of assets and exposures and the resulting complexity and extensive governance, asset management, disclosure and information requirements of the APS documents, there is a risk that the Group may have included assets or exposures within the Covered Assets which are, or may later become (including by reason of failure to comply with the requirements of the APS or resulting from the disposal of an asset or exposure), ineligible for protection under the APS or for which the protection is limited, which would reduce the anticipated benefits to the Group of the APS. Further, there is no ability to nominate additional or alternative assets or exposures in place of any which may turn out not to be covered under the APS. In addition, HM Treasury may, following consultation with the Group, modify or replace certain of the UK APS terms and conditions (the “Scheme Conditions”) in such a manner as it considers necessary (acting reasonably) in certain circumstances. Such modifications or replacements may be retrospective and may have a material adverse effect on the expected benefits of the APS and, therefore, the Group’s financial condition and results of operations.
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Collateralised debt obligations (CDOs) - asset-backed securities for which the underlying asset portfolios are debt obligations: either bonds (collateralised bond obligations) or loans (collateralised loan obligations) or both. The credit exposure underlying synthetic CDOs derives from credit default swaps. The CDOs issued by an individual vehicle are usually divided in different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are borne first by the equity securities, next by the junior securities, and finally by the senior securities; junior tranches offer higher coupons (interest payments) to compensate for their increased risk.
Credit default swap (CDS) - a contract where the protection seller receives premium or interest-related payments in return for contracting to make payments to the protection buyer upon a defined credit event in relation to a reference financial asset or portfolio of financial assets. Credit events usually include bankruptcy, payment default and rating downgrades.
Discontinued operation - a component of the Group that either has been disposed of or is classified as held for sale. A discontinued operation is either: a separate major line of business or geographical area of operations or part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations; or a subsidiary acquired exclusively with a view to resale.
Government Sponsored Enterprises (GSEs) - a group of financial services corporations created by the US Congress. Their function is to improve the efficiency of capital markets and to overcome statutory and other market imperfections which otherwise prevent funds from moving easily from suppliers of funds to areas of high loan demand. They include Fannie Mae and Freddie Mac.
Intangible assets Accounting policies 316 Segmental analysis of goodwill 415 Notes on the consolidated accounts 370
Share capital Shareholder information 468 Notes on the consolidated accounts 391