We continue to seek new opportunities to build and broaden the Group’s business in the UK, US, Europe and Asia Pacific.
�No.4 Bookrunner for Syndicated Loans in Europe, Middle East & Africa, up from No.7 in 2003
The Group’s property portfolio is managed, maintained and refurbished by Manufacturing which also oversees the property investment programme.
Wealth Management provides services to clients through premier brands in UK private banking and UK offshore banking, and through a network of more than 50 offices globally. Coutts, Adam & Company and Coutts Bank von Ernst in Switzerland offer private, corporate and expatriate client services including banking, wealth management, investment management, financial planning and trust and fiduciary services. The offshore banking business offers retail banking services to local and expatriate customers and corporate banking and treasury services to corporate, intermediary and institutional clients.
Banking services for UK businesses ��� In the mid-market, in the UK, CBFM serves the full spectrum of corporate and commercial customers and is the UK’s No.1 corporate relationship bank, with 33% market share.
��� With the role of Joint Bookrunner and Joint Lead Manager, we provided Lloyd’s of London with a debut subordinated issue, the first time Lloyd’s have raised funds in the bond market in their 300+ year history.
Current Bank Account. James Walker, a sprightly 76 year old enjoys, amongst other hobbies, hand painting table cloths. He has taken advantage of a range of our retail banking products available in his local branch in Edinburgh, including an interest bearing current account and a deposit and interest savings tracker account.
��� Lombard Direct and Direct Line Financial Services increased their personal loan balances.
The Kroger Co. We have expanded our distribution capability in the US through our partnership with The Kroger Co., which is the second largest supermarket in the US, with 3,774 stores.
��� We launched a new e-purchasing system, which provides a “one-stop-shop” for goods and services purchased by employees across the Group. The new on-line ordering process has already been used by 10,000 employees.
��� Adam & Company continued its ten year record of profit growth, benefiting from continued investment in additional private bankers.
��� Outside the UK, Coutts completed the integration of Bank von Ernst, which was acquired in 2003, to create Coutts Bank von Ernst, which is now the third largest foreign-owned bank in Switzerland.
��� Direct Line – voted Best Insurance Call Centre by readers
Ulster Bank is the third largest bank in Ireland. During 2004 Ulster Bank completed the acquisition of First Active, which strengthened its position in the Republic of Ireland and enhanced its capabilities in mortgages. As a result of organic growth and the acquisition of First Active, Ulster Bank’s total income increased by 28% to £743 million.
��� Various innovative products were introduced during 2004. Ulster Bank launched U First Gold, a premium current account with a range of financial and lifestyle benefits, and an award-winning switcher mortgage service. First Active launched tracker mortgages and 100% mortgages for professionals.
The Group ranked 2nd equal in the Dow Jones Sustainability World Index for the banking sector, bringing our overall score to 64%, an increase of 5%. Our score was 22% above the global average for the sector.
In this report, the terms ‘UK GAAP’ and ‘US GAAP’ refer to generally accepted accounting principles (“GAAP”) in the UK and the US, respectively.
In other international markets, principally in continental Europe, the Group faces competition from the leading domestic and international institutions active in the relevant national markets.
Securities carried at fair value include government, assetbacked and corporate debt obligations and corporate equity shares. Fair value for a substantial proportion of these instruments is based on observable market prices or derived from observable market parameters. Determining fair value for such instruments does not involve significant judgement. Where observable prices are not available or if a position could be liquidated only at an unfavourable price or over an extended period, fair value is based on appropriate valuation techniques or management estimates.
Goodwill The Group capitalises goodwill arising on the acquisition of businesses, as disclosed in the Accounting policies. Goodwill is the excess of the cost of an acquisition and the fair value of its net assets. The determination of the fair value of assets and liabilities of businesses acquired requires the exercise of management judgement; for example those financial assets and liabilities for which there are no quoted prices, and those non-financial assets where valuations reflect estimates of market conditions such as property. Different fair values would result in changes to the goodwill arising and to the postacquisition performance of the acquisition. Under UK GAAP goodwill is amortised and there is a rebuttable presumption that the useful economic life of purchased goodwill does not exceed 20 years from the date of acquisition. The useful economic life of acquired goodwill is assessed on the basis of the type and diversity of the business, its location and the markets in which it operates. Under US GAAP goodwill is not amortised but is subject to annual review for impairment.
Merger accounting – IFRS require all business combinations to be accounted for as acquisitions by applying the purchase method. UK GAAP requires business combinations meeting certain criteria to be accounted for using merger accounting.
Pensions – the Group has implemented FRS 17 'Retirement Benefits' (FRS 17) for 2004. The measurement principles of this standard are similar to those required by IFRS. IFRS, like FRS 17, allow actuarial gains and losses to be recognised outside the profit and loss account. However IFRS allow as alternatives actuarial gains and losses to be recognised in profit or loss either in the period in which they occur or on a deferred basis.
In the opening balance sheet the entity: • recognises all assets and liabilities whose recognition is required by IFRS, but not any assets or liabilities not permitted by IFRS to be recognised; • reclassifies items recognised under previous GAAP in accordance with IFRS requirements; • applies IFRS in measuring all recognised assets and liabilities.
Balance sheet Total assets were £454 billion at 31 December 2003, 11% higher than total assets of £411 billion at 31 December 2002.
Acquisitions In January 2003, Citizens completed the acquisition of Pennsylvania-based commercial bank, Commonwealth Bancorp, Inc. for a cash consideration of US$450 million.
(3) Interest receivable and interest payable on trading assets and liabilities are included in dealing profits.
Increase/(decrease) due to changes in: Increase/(decrease) due to changes in: Average Average Net Average Average Net volume rate change volume rate change £m £m £m £m £m £m
Within non-interest income, fees and commissions receivable increased by 17% or £941 million, to £6,634 million. This reflected strong growth in lending, transmission and card related fees together with increased insurance brokerage and ATM income.
Dealing profits at £1,988 million were up £195 million, 11% on 2003. Growth was achieved across all customer segments and product classes with further diversification of dealing revenues in the US to compensate for lower residential refinancing volume than the previous year.
2003 compared with 2002 Non-interest income increased by 20%, or £1,813 million, to £10,980 million. Non-interest income represented 57% of total income. Excluding general insurance premium income, noninterest income rose by 9% or £643 million to £7,857 million reflecting strong performances in CBFM, up 18% or £670 million and Retail Direct, up 17%, or £145 million.
Operating expenses (excluding goodwill amortisation and integration costs) 2004 2003* 2002*
Total balance sheet provisions for bad and doubtful debts amounted to £3,929 million compared with £3,927 million at 31 December 2002. Total provision coverage (the ratio of total balance sheet provisions to total risk elements in lending) was 76% compared with 80% at 31 December 2002.
Net interest income, excluding the cost of funding rental assets, increased 12% or £306 million to £2,959 million. Average loans and advances to customers of the banking business increased by 10% or £9.5 billion to £103.8 billion. The second half of 2004 saw a modest recovery in large corporate lending. Average customer deposits within the banking business increased by 8% or £5.0 billion to £66.0 billion. An improvement in margins was achieved through strong growth in our UK mid-corporate relationships.
Net interest income 3,112 2,959 2,849 Non-interest income 1,630 1,514 1,430
Net interest income rose by 5% or £153 million to £3,112 million, reflecting strong growth in lending and deposits which more than offset the impact of business mix – particularly strong growth in low risk mortgage lending – and the impact of lower margin in some areas, especially unsecured lending. Average loans to customers, excluding mortgages, grew by 12% or £2.8 billion to £26.5 billion. Average mortgage lending grew by 21% or £7.0 billion to £40.7 billion. Both mortgage and non-mortgage lending have evidenced a slowdown in growth in the second half of the year. Average customer deposits increased by 8% or £4.9 billion to £66.0 billion.
Direct expenses increased by 4% or £38 million to £1,030 million. Staff expenses increased 9% or £64 million to £793 million reflecting further investment in customer facing staff.
Non-interest income increased by 28% or £99 million to £451 million, reflecting higher fee income as a result of the improved equity markets and the acquisition of Bank von Ernst.
Net claims, after reinsurance, increased by 63% or £845 million to £2,195 million. Excluding Churchill, net claims increased by 29% or £393 million.
Net interest income 1,540 1,310 1,248 Non-interest income 601 514 468
Non-interest income rose by 31% or $261 million to $1,102 million. Excluding the acquisitions, non-interest income increased 6% or $47 million before a reduction in mortgage fees, down from $53 million to $24 million in 2004.
Reverse repurchase agreements and stock borrowing Loans and advances to banks 29,975 26,522 Loans and advances to customers 52,184 24,069
The major factors contributing to the net cash inflow of £6,307 million from operating activities in 2004 were the profit before tax of £6,917 million, increases in deposits and debt securities in issue of £70,580 million, increases in short positions and settlement balances of £8,796 million, partially offset by increases in treasury and other eligible bills of £1,264 million, increases in securities of £10,367 million and increases in loans and advances of £72,913 million.
The major factors contributing to the net cash inflow of £13,737 million from operating activities in 2002 were the profit before tax of £4,852 million and an increase in deposits, debt securities in issue and other liabilities of £40,981 million, which were partially offset by the increase in loans and advances of £35,426 million.
All credit risk exposures require approval by authorised individuals or credit committees, independent of business revenue generation. Existing credit risk exposures are monitored and reviewed periodically against approved risk limits. Review occurs at least annually with the lower quality exposures being subject to greater frequency of analysis and assessment. Exposures below specified thresholds and meeting specific criteria can be approved through authorised, largely automated, processes.
Notes: (1) The classification of a loan as non-accrual, past due 90 days or troubled debt restructuring does not necessarily indicate that the principal of the loan is uncollectable in whole or in part. Collection depends in each case on the individual circumstances of the loan, including the adequacy of any collateral securing the loan and therefore classification of a loan as non-accrual, past due 90 days or troubled debt restructuring does not always require that a provision be made against such a loan. In accordance with the Group’s provisioning policy for bad and doubtful debts, it is considered that adequate provisions for the above risk elements in lending have been made.
(2) The Group’s UK banking subsidiary undertakings account for loans on a non-accrual basis from the point in time at which the collectability of interest is in significant doubt. Certain subsidiary undertakings of the Group, principally Citizens, generally account for loans on a non-accrual basis when interest or principal is past due 90 days.
(1) Excludes specific provisions against loans and advances to banks of £6 million (2003 – £7 million; 2002 – £7 million)
In prevailing economic conditions and with interest rates at relatively low historical levels in the UK, US and Europe, it is anticipated that the growth in demand for further borrowing by customers may, in the medium term, continue to exceed customer deposits received, thus increasing net customer lending further and increasing gradually over time the Group’s dependence on the wholesale market for funding. The Group has evaluated a range of balance sheet management strategies to address the consequent impact on its liquidity risk position and has developed and implemented plans to contain that within its normal prudent liquidity risk policy parameters.
• VaR using a one-day time horizon does not fully capture the market risk of positions that cannot be liquidated or hedged within one day.
The Group largely computes the VaR of trading portfolios at the close of business and positions may change substantially during the course of the trading day. Controls are in place to limit the Group’s intra-day exposure; such as the calculation of the VaR for selected portfolios. These limitations and the nature of the VaR measure mean that the Group cannot guarantee that losses will not exceed the VaR amounts indicated.
Non-trading The principal market risks arising from the Group's non-trading activities are interest rate risk, currency risk and equity risk. Treasury activity and mismatches between the repricing of assets and liabilities in its retail and corporate banking operations account for most of the non-trading interest rate risk. Non-trading currency risk derives from the Group's investments in overseas subsidiaries, associates and branches. The Group's venture capital portfolio, investments held by its general insurance business and its strategic equity investments are the principal sources of non-trading equity price risk. The Group's portfolios of non-trading financial instruments mainly comprise loans (including finance leases), debt securities, equity shares, deposits, certificates of deposits and other debt securities issued, loan capital and derivatives. To reflect their distinct nature, the Group's long-term assurance assets and liabilities attributable to policyholders have been excluded from these market risk disclosures.
O pe ra tin g an d fin an ci al r ev ie w O
Peter Sutherland* (age 58) KCMG N Appointed to the Board in January 2001, Peter Sutherland is an Irish national. He is a former attorney general of Ireland and from 1985 to 1989 was the European commissioner responsible for competition policy. He is chairman of BP Plc and Goldman Sachs International and a director of Investor AB. He was formerly chairman of Allied Irish Bank and a director general of GATT and the World Trade Organisation.
Group Secretary and General Counsel Miller McLean (age 55) FCIBS C Miller McLean was appointed Group Secretary in August 1994. He is a trustee of the Industry and Parliament Trust, a non-executive chairman of The Whitehall and Industry Group and a director of The Scottish Parliament and Business Exchange.
R ep or t of th e di re ct or s
Business developments In January 2004, Citizens completed the acquisition of Thistle Group Holdings, Co., the holding company of Pennsylvaniabased Roxborough Manayunk Bank.
Details of the service agreement for Sir Fred Goodwin are set out on page 128. No other director seeking election or re-election has a service agreement.
Company Limited 51,510 10.30 Mr W. T. Hardison Jr. 13,532 3.38 Mr S. J. and Mrs J. A. Cockburn 30,810 6.16 Ms C. L. Allen 13,200 3.30 Cleaning Tokens Limited 25,500 5.10 Ms J. C. Allen 12,750 3.18 * Notification has been received on behalf of Mr A. W. R. Medlock and Mrs H. M. Medlock that they each have an interest in the holding of 51⁄2% cumulative preference shares registered in the name of Bassett-Patrick Securities Limited noted above and that there are further holdings of 5,300 and 5,000 shares, respectively, of that class registered in each of their names.
The Board regularly considers corporate responsibility issues and receives a formal report on these matters twice each year. Further details of the Group’s corporate responsibility policies will be contained in the 2004 Corporate Responsibility Report.
The Royal Bank of Scotland Group plc is registered in Scotland No. 45551.
As a result, in terms of the Code, the Board currently comprises eight independent and eight non-independent directors (including executive directors), in addition to the Chairman.
Information, induction and professional development All directors receive accurate, timely and clear information on all relevant matters. Any requests for further information or clarification are dealt with or co-ordinated by the Group Secretary.
In 2004, the Audit Committee commissioned KPMG to conduct an external review of the effectiveness of Group Internal Audit. It is intended that there will be an external review of Group Internal Audit every three years with internal reviews continuing in the intervening years.
The Remuneration Committee is responsible for assisting the Board in discharging its responsibilities and making all relevant disclosures in relation to the formulation and review of the Group’s executive remuneration policy. The Remuneration Committee makes recommendations to the Board on the remuneration arrangements for its executive directors and the Chairman. The Directors’ Remuneration Report is contained on pages 124 to 133.
** Mr McLuskie retired from the Board on 23 August 2004.
All new service contracts for executive directors will be subject to approval by the Remuneration Committee. It will be the norm to include in those contracts standard clauses covering the performance review process, the company’s normal disciplinary procedure, and terms for dismissal in the event of failure to perform or in situations involving actions in breach of the Group’s policies.
Date of current contract/ Notice period – Notice period – Name Employing company Normal retirement age from company from executive
Share options Options to subscribe for ordinary shares of 25p each in the company granted to, and exercised by, directors during the year to 31 December 2004 are included in the table below: Options exercised in 2004
Notes: (1) There is a significant difference in the form of disclosure required by the Combined Code and the Directors’ Remuneration Report Regulations 2002. The former requires the disclosure of the additional pension earned during the year and the transfer value equivalent to this pension based on stock market conditions at the end of the year. The latter requires the disclosure of the difference between the transfer value at the start and end of the year and is therefore dependent on the change in stock market conditions over the course of the year. The above disclosure has been made in accordance with the Combined Code and the Directors’ Remuneration Report Regulations 2002.
(4) The transfer values disclosed above do not represent a sum paid or payable to the individual director. Instead they represent a potential liability of the company /pension scheme.
The directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Group and to enable them to ensure that the accounts comply with the Companies Act 1985. 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.
We have audited the financial statements of The Royal Bank of Scotland Group plc ("the company") and its subsidiaries (together "the Group") for the year ended 31 December 2004 which comprise the accounting policies, the profit and loss account, the balance sheets, the cash flow statement, the statement of total recognised gains and losses, the reconciliation of movements in shareholders’ funds and the related Notes 1 to 54. These financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the part of the directors’ remuneration report that is described as having been audited.
Acquisition expenses relating to new and renewed business for all classes are deferred over the period during which the premiums are unearned. The principal acquisition costs so deferred are commissions payable, direct advertising expenditure, costs associated with the telesales and underwriting staff and prepaid claims handling costs in respect of delegated claims handling arrangements for claims which are expected to occur after the balance sheet date.
C on so lid a te d pr of it an d lo ss a cc ou nt
Creditors Amounts falling due within one year: Due to banks 66 71 Dated loan capital 30 40 40 Debt securities in issue 1,608 1,877 Other creditors 247 217 Proposed final dividend 7 1,308 1,059
Audit services – Statutory audit 8.2 7.2 – Audit related regulatory reporting 1.1 0.6
7 Ordinary dividends p per share p per share p per share £m £m £m
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts 13 Provisions for bad and doubtful debts
Consisting of: At valuation – 2003 and prior 821 134 — — — 955
Interest on the PROs is payable semi-annually in arrears at a fixed rate of 7.648% per annum until 30 September 2031 and thereafter quarterly in arrears at a variable rate of 2.5% per annum above three month dollar LIBOR. The company can satisfy interest payment obligations by issuing ordinary shares to appointed Trustees sufficient to enable them, on selling these shares, to settle the interest payment.
(17) Where the issuer has the ability to redeem the undated loan capital, this is subject to prior approval of the UK Financial Services Authority.
Notes: (1) The US$250 million non-cumulative preference shares, Series B, of US$25 each carry a gross dividend of 8.75% inclusive of associated tax credit. They are redeemable at the option of NatWest at US$25 per share.
The non-cumulative preference shares are redeemable at the option of the company, in whole or in part from time to time at the rates detailed below plus dividends otherwise payable for the then current dividend period accrued to the date of redemption.
Redemption of preference shares — — 150 — Transfer of increase in value of long-term life assurance business 38 32 25 —
N ot es o n th e ac co un ts Notes on the accounts continued 38 Assets charged as security for liabilities
Exchange traded contracts are excluded from the above table. Such contracts generally involve lower credit risk than OTC contracts as they are cleared through exchanges that require margin from participants and the daily settlement of gains and losses.
(2) Fair values of derivatives are determined by market prices where available. Otherwise fair value is based on current market information using appropriate valuation models.
During the year to 31 December 2004, gains of £249 million (2003 – £58 million) and losses of £166 million (2003 – £95 million) arising in previous periods were taken directly to the profit and loss account on financial instruments no longer accounted for as hedges.
(a) Charter One Charter One Financial, Inc. was acquired by Citizens in August 2004 for a cash consideration of US$10.1 billion. The acquisition has extended Citizen's coverage to North Eastern and Mid Western States of the US and will enable Citizens to achieve a significant increase in the scale of its activities.
The estimated contribution to the Group’s results, before funding costs of Charter One, for the year ended 31 December 2004 is shown below: Four months ended £m
48 Analysis of changes in cash during the year £m £m £m
Under UK GAAP, provisional fair value adjustments made in the accounting year in which the acquisition occurs may be amended in the subsequent accounting year. Under US GAAP, the allocation of the cost of acquisition to the fair values of assets and liabilities is generally completed within 12 months of the date of acquisition.
Net income under US GAAP: Adjusted to include stock compensation 3,909 2,503 2,978
(5) Population consists of only investment grade senior tranches; therefore, no credit losses are included in the assumptions at deal settlement.
(2) Includes integration expenditure of £269 million for the year ended 31 December 2004 (2003 – £229 million; 2002 – £957 million; 2001 – £875 million; 2000 – £389 million).
Total dividends on equity shares 111.1 58.0 50.3 43.7 38.0 33.0
Notes: (1) Includes closing provisions against loans and advances to banks of £6 million (2003 – £7 million; 2002 – £7 million; 2001 – £8 million; 2000 – £14 million).
(2) Closing customer provisions exclude closing provisions against loans and advances to banks.
As a % of average loans and advances to customers during the period: Total customer provisions charged to profit and loss 0.48% 0.59% 0.61% 0.54% 0.39%
Gross income not recognised but which would have been recognised under the original terms of non-accrual and restructured loans
Firms must also meet standards relating to senior management and internal systems and controls and must comply with rules designed to reduce the scope for firms to be used for money laundering. Revised Joint Money Laundering Steering Group Guidance Notes came into force in 2004. The EU published its draft Third Money Laundering Directive which aims to consolidate the two previous Anti Money Laundering Directives.
The statements and practices set forth below regarding US and UK tax laws, including the US/UK double taxation convention relating to income and capital gains which entered into force on 31 March 2003 (the “New Treaty”), the prior US/UK double tax convention relating to income and capital gains (the “Prior Treaty”) and the US/UK double taxation convention relating to estate and gift taxes (the “Estate Tax Treaty”), are based on those laws and practices as in force and as applied in practice on the date of this Report. This summary is not exhaustive of all possible tax considerations and holders are advised to satisfy themselves as to the overall tax consequences, including specifically the consequences under US federal, state, local and other laws, and possible changes in taxation law, of the acquisition, ownership and disposition of non-cumulative dollar preference shares, ADSs, X-CAPs or PROs by consulting their own tax advisers.
New Treaty Because payments of dividends by the company to non-UK investors are not subject to UK withholding tax, it is not necessary to apply the New Treaty in order to receive a reduced rate of withholding. Since there is no UK withholding tax on payments of dividends to US Holders, US Holders will not be entitled to a foreign tax credit for foreign taxes paid as a result of the payment of dividends by the company.
United Kingdom Taxation of payments of interest Payments on the X-CAPs will constitute interest rather than dividends for UK withholding tax purposes. However, the X-CAPs will constitute ‘quoted eurobonds’ within the meaning of section 349 of the Income and Corporation Taxes Act 1988, and therefore payments of interest will not be subject to withholding or deduction for or on account of UK taxation as long as X-CAPs remain at all times listed on the New York Stock Exchange or some other recognised stock exchange within the meaning of section 841 of the Income and Corporation Taxes Act 1988. In all other cases an amount must be withheld on account of UK income tax at the lower rate (currently 20%) subject to any direction to the contrary by the Inland Revenue under the Treaty and except that the withholding obligation is disapplied in respect of payments to persons who the company reasonably believes are within the charge to corporation tax or fall within various categories enjoying a special tax status (including charities and pension funds), or are partnerships consisting of such persons (unless the Inland Revenue directs otherwise).
Interest on the PROs constitutes UK source income for UK tax purposes and, as such, may be subject to income tax by direct assessment even where paid without withholding. However, interest with a UK source received without deduction or withholding on account of UK tax will not be chargeable to UK tax in the hands of a US Holder unless, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a UK permanent establishment or in the case of other US Holders, such persons carry on a trade, profession or vocation in the UK through a UK branch or agency in connection with which the interest is received or to which the PROs are attributable. There are exemptions for interest received by certain categories of agent (such as some brokers and investment managers).