The financial comparisons are with 2004 pro forma results which have been prepared on the basis set out on page 57.
Financial performance In 2005, Group operating profit increased by 16% to £8,251 million (2004 – £7,108 million). Total income grew by 14% to £25,569 million (2004 – £22,515 million), while operating expenses also grew by 14% to £11,298 million (2004 – £9,871 million).
Board of directors The past year has seen significant change for our Board.
Our results for 2005 demonstrate the strength and momentum of the Group and the capabilities of our diverse business platform. We increased our total income by 14% and held our cost:income ratio, before acquisitions, steady at 41.8%. Group operating profit increased by 16% to £8,251 million. All our divisions increased their income and contribution to Group profit.
�1.6 million personal and business customers across the island of Ireland
UK Corporate Banking provides customers with a full suite of banking products and specialist services to meet domestic and international needs. We continue to be the UK’s No.1 corporate and commercial relationship bank and market leader in the UK in payments, card transaction processing, deposits, lending, asset finance, invoice finance, foreign exchange and sterling interest rate derivatives.
��� We acted as an Underwriter and Bookrunner for Premier Foods, one of the largest suppliers of grocery products in the UK, in a £780 million financing package to support the acquisition of Marlow Foods Limited, owner of the Quorn brand, the UK’s leading meat alternative.
� � Bloomsbury Publishing is one of Britain’s most successful publishing houses. It is best known for titles such as Harry Potter and the Pru Leith Cookery books and is a long-standing UK Corporate Banking customer.
Pernod Ricard. In April 2005 Pernod Ricard completed the acquisition of Allied Domecq. RBS was one of four Bookrunners for the €9.2 billion facility offering specialist expertise in €/£ foreign exchange hedging and structured loans.
��� When RBS co-arranged the US$1.2 billion private placement for Wolseley, the world’s largest distributor of heating and plumbing products, it set a market record for private placements.
��� The UK Debt Management Office and Her Majesty’s Treasury mandated RBS to act as one of four Bookrunners in the UK Government’s first ever syndicated offering in sterling bonds and the first 50 year inflation bond in the world.
��� Partly through its network of 54 campus branches, NatWest yet again achieved No.1 status for student accounts. Of first-year students in England and Wales, 44% chose to open a student account with us.
Ulster Bank Group saw sustained growth in 2005 and the launch of market-leading mortgage and current account products. A branch improvement programme and a new Ulster Bank brand identity moved us towards our vision of becoming the best bank on the island of Ireland. Ulster Bank Group’s total income increased by 15% to £858 million.
��� In its first year of Citizens ownership, Charter One’s new Business Banking team grew its SBA lending to No.1 in the Midwest in both the number of loans written and total dollars loaned during 2005. Charter One became top SBA lender in Illinois, Indiana, Michigan and Ohio.
��� Our network of over 7,400 ATMs processed 690 million transactions during 2005. The daily average volume was 1.9 million transactions, dispensing £119 million.
��� Broadening the skills of our teams in our telephone and service centres, and changing their incentives, has generated a more responsive working culture. Customers enjoy better service because we try to solve as many issues for them as we can in a single phone call.
Toynbee Hall is based in the east end of London. Through our partnership RBS has created an innovative programme of modules to help adults better understand and manage their finances, including the material for Services Against Financial Exclusion which will be rolled out across the UK.
The environment ��� In 2005 66.9% of the Group’s electricity in the UK and Ireland came from renewable sources, one of the highest percentages in the Financial Services sector.
��� The Group’s commitment to the Money Advice Trust led to the take up of 5,324 free training places by personal money advisers, improving the quality of advice given to people in greatest financial hardship.
Operating expenses Operating expenses, excluding intangibles amortisation, integration costs and loss on sale of subsidiaries, rose by 15% to £11,298 million. The effect of implementing the requirements of IAS 39 and IFRS 4 in 2004 would have been to increase operating expenses by £74 million for the year ended 31 December 2004.
Customer accounts were up £59.5 billion, 21% at £342.9 billion with £31.7 billion arising from the implementation of IAS 32 and IAS 39, largely reflecting the grossing up of previously netted deposits. Excluding this and repos, which decreased £5.7 billion, 11% to £48.8 billion, deposits rose by £33.5 billion, 13%, to £294.1 billion with good growth in all divisions.
Operating expenses Operating expenses, excluding intangibles amortisation and integration costs, rose by 14% to £11,298 million. Excluding acquisitions and at constant exchange rates, operating expenses were up by 10%, £962 million.
Integration Integration costs were £458 million compared with £520 million in 2004. Included are software costs relating to the integration of NatWest which were written-off as incurred under UK GAAP but on transition to IFRS were capitalised and amortised. All such software is now fully amortised. The balance principally relates to the integration of Churchill, First Active and Citizens’ acquisitions, including Charter One which was acquired in August 2004.
Profitability The adjusted after-tax return on ordinary equity, which is based on profit attributable to ordinary shareholders before intangibles amortisation, integration costs and net gain on sale of strategic investments and subsidiaries, and average ordinary equity, was 18.2%.
The Royal Bank of Scotland plc base rate (average) 4.65 4.38 4.38 London inter-bank three month offered rates (average): Notes: (1) Interest-earning assets and interest-bearing liabilities exclude the Retail bancassurance long-term assets and liabilities attributable to policyholders, in view of their distinct nature. As a result, net interest income has been adjusted by £59 million (2004 – £47 million).
Overseas – The Overseas net interest margin was down 48 basis points from 2.83% to 2.35% of which 12 basis points would have been attributable to the effect of implementing IAS 32 and IAS 39 in 2004.
Fees and commissions receivable 6,750 6,473 6,071 Fees and commissions payable (1,841) (1,926) (1,920) Income from trading activities 2,343 1,988 1,956 Other operating income 2,620 2,138 1,882
Net claims in bancassurance, which under IFRS include maturities, surrenders and liabilities to policyholders, were £486 million compared with £398 million in 2004, reflecting higher levels of bond maturities and increases in liabilities to policyholders as a result of strong investment returns.
Total assets 158.8 141.7 Loans and advances to customers – gross 104.6 91.7 Customer deposits 106.3 99.2 Weighted risk assets 106.4 93.5
Corporate Markets 15,700 16,800 Retail Banking 33,100 32,200 Retail Direct 6,800 7,000 Wealth Management 4,200 4,100 Ulster Bank 4,400 4,100
The framework is defined in detail in the Group’s ‘Principles for Managing Credit Risk’.
Wholesale risk exposures are aggregated to determine the appropriate level of credit approval required and to facilitate consolidated credit risk management.
Every customer credit grade across all grading scales in the Group can be mapped to a Group level credit grade (see page 90).
Reverse repurchase agreements as at 31 December 2005 were £90.7 billion (1 January 2005 – £99.1 billion), a decrease of £8.4 billion (8%) during the year.
For the Group, the other major structural interest rate risk arises from a low interest rate environment, particularly in sterling, sustained for a number of years. In such a scenario, deposit pricing may reach effective floors below which it is not practical to reduce rates further whilst variable rate asset pricing continues to decline. A sustained low rate scenario would also generate progressively reduced income from the medium and long term hedging of non-interest bearing liabilities. GALCO regularly reviews the impact of stress scenarios including the impact of substantial declines in rates to ensure that appropriate risk management strategies are employed. Resulting action may involve execution of derivatives, product development and tactical pricing changes.
There are many sources of uncertainty that will impact the Group's experience under motor insurance, including operational risk, reserving risk, premium rates not matching claims inflation rates, the social, economic and legislative environment and reinsurance failure risks.
Sir Steve Robson* (age 62) A Appointed to the Board in July 2001, Sir Steve Robson is a former senior UK civil servant, who had responsibility for a wide variety of Treasury matters. His early career included the post of private secretary to the Chancellor of the Exchequer and secondment to ICFC (now 3i). He was also a second permanent secretary of HM Treasury, where he was managing director of the Finance and Regulation Directorate. He is a nonexecutive director of JP Morgan Cazenove Holdings, Xstrata Plc and Partnerships UK plc, and a member of the Chairman’s Advisory Committee of KPMG.
Employee consultation The Group’s confidential global Employee Opinion Survey is externally designed, undertaken and analysed annually on behalf of the Group by International Survey Research (“ISR”).
Board balance and independence The Board currently comprises the Chairman, four executive directors and ten non-executive directors. The Board functions effectively and efficiently, and is considered to be of an appropriate size in view of the scale of the company and the diversity of its businesses. The directors provide the Group with the knowledge, mix of skills, experience and networks of contacts required. The Board Committees contain directors with a variety of relevant skills and experience so that no undue reliance is placed on any individual.
The effectiveness of the Group’s internal control system is reviewed regularly by the Board and the Audit Committee. Executive management committees or boards of directors in each of the Group’s businesses receive quarterly reports on significant risks facing their business and how they are being controlled. These reports are combined and submitted to the Board as quarterly risk and control assessments. Additional details of the Group’s approach to risk management are given in the ‘Risk management’ section of the ‘Operating and financial review’ on pages 86 to 106. The Audit Committee also receives regular reports from Group Risk Management and Group Internal Audit. In addition, the Group’s independent auditors present to the Audit Committee reports that include details of any significant internal control matters which they have identified. The system of internal controls of the authorised institutions and other regulated entities in the Group is also subject to regulatory oversight in the UK and overseas. Additional details of the Group’s regulatory oversight are given in the Supervision and Regulation section on pages 253 to 256.
The above diagram has been prepared to illustrate the use of performance metrics in the total compensation package. For the Group Chief Executive 22% of the package is fixed and 78% is performance related. For the other executive directors, 28% is fixed and 72% is performance related. Values are entered on the basis of on target performance; long term incentives are shown at the approximate expected value at grant. Pension and other benefits have been excluded. Financial metrics include profit growth, cost control and ROE.
Components of executive remuneration UK based directors Salary Salaries are reviewed annually as part of total remuneration, having regard to remuneration packages received by executives of comparable companies. The Remuneration Committee uses a range of survey data from remuneration consultants and reaches individual salary decisions taking account of the remuneration environment and the performance and responsibilities of the individual director.
During 2005, the Remuneration Committee reviewed all elements of the plan including the performance conditions, the vesting schedule and the comparator group. As a result, it is intended that for awards made from 2006, 50% of the award will vest on a relative TSR measure and 50% will vest on growth in adjusted EPS over the three year performance period.
Total shareholder return performance The undernoted performance graph illustrates the performance of the company over the past five years in terms of total shareholder return 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 total shareholder return for the company and the FTSE 100 have been rebased to 100 for 2000.
Mr Fish LTIP* awards for the LTIP award for the LTIP award for the LTIP* awards for the 3 year periods: 3 year period: 3 year period: 3 year periods: * A new cash LTIP was approved by shareholders at the company’s Annual General Meeting in April 2005. Details are given on page 123. This replaces the previous LTIP which provided for a target payment of 60% of average salary over the three year period and a maximum payment of 105% of average salary.
C as h flo w s ta te m en ts
(1) Deferred tax assets of £51 million (2004 – £110 million) resulting from tax losses carried forward of £150 million (2004 – £291 million) have not been recognised as it is currently not certain that the assets will be recoverable. These assets may be recoverable if the losses can be offset against suitable future taxable profits arising in the same tax jurisdiction.
Notes: (1) In the year ended 31 December 2005, dividends of £55,000 (2004 – £55,000) were paid on the 11% cumulative preference shares of £1 and dividends of £22,000 (2004 – £22,000) were paid on the 5.5% cumulative preference shares of £1.
The Group recognised net pre-tax gains of approximately £182 million (2004 – £111 million) relating to these securitisations. Net pre-tax gains are based on the difference between the sales prices and previous carrying values of assets prior to date of sale, are net of transaction costs, and exclude any results attributable to hedging activities, interest income, funding costs, and changes in asset values prior to, and in retained interest values subsequent to, the securitisation date.
The following table shows the Group’s available-for-sale debt securities by remaining maturity and the related yield (based on weighted averages) as at 31 December 2005.
(1) Amounts written-off during the year include £2 million relating to banks (2004 – nil).
Long Short Computers Operating Investment Freehold leasehold leasehold and other lease properties premises premises premises equipment assets Total 2005 £m £m £m £m £m £m £m
Cost: Currency translation and other adjustments 2 (18) — (10) (42) (184) (252)
Accumulated depreciation and amortisation: Currency translation and other adjustments — (1) 3 (3) (17) (29) (47)
Annual Report and Accounts 2005 21 Deposits by banks Group Company £m £m £m £m
Held-for-trading 34,645 — Designated as at fair value through profit or loss (1) 3,683 — Amortised cost 304,539 55
26 Deferred taxation Provision for deferred taxation has been made as follows: Group Company £m £m £m £m
Increase in the year 423 — 423 Release in the year — 27 27
Ordinary shares The following issues of ordinary shares were made during the year ended 31 December 2005: (a) 13.5 million ordinary shares following the exercise of options under the company’s executive, sharesave and option 2000 schemes and a further 0.7 million ordinary shares in respect of the exercise of options under the NatWest executive and sharesave schemes which had been exchanged for options over the company’s shares following the acquisition of NatWest in 2000; (b) 7.4 million ordinary shares in lieu of cash in respect of the final dividend for the year ended 31 December 2004 and the interim dividend for the year ended 31 December 2005; and
Finance lease receivables Unearned finance income 5,947 7,004 Accumulated allowance for uncollectable minimum lease receivables 72 68
Securities repurchase agreements and lending transactions The Group enters into securities repurchase agreements and securities lending transactions under which it receives or transfers collateral in accordance with normal market practice. Under standard terms for repurchase transactions in the UK and US markets, the recipient of collateral has an unrestricted right to sell or repledge it, subject to returning equivalent securities on settlement of the transaction.
Treasury and other eligible bills 896 1,593 Debt securities 53,485 32,129
• Credit risk authority must be specifically granted in writing to all individuals involved in the granting of credit approval, whether this is exercised personally or collectively as part of a credit committee. These individuals must act independently and with balanced commercial judgement in exercising credit authority.
Trading The principal focus of the Group’s trading activities is client facilitation – providing products to the Group’s client base at competitive prices. The Group also undertakes: market making – quoting firm bid (buy) and offer (sell) prices with the intention of profiting from the spread between the quotes; arbitrage – entering into offsetting positions in different but closely related markets in order to profit from market imperfections; and proprietary activity – taking positions in financial instruments as principal in order to take advantage of anticipated market conditions. The main risk factors are interest rates, credit spreads and foreign exchange. Financial instruments held in the Group’s trading portfolios include, but are not limited to, debt securities, loans, deposits, securities sale and repurchase agreements and derivative financial instruments (futures, forwards, swaps and options). For a discussion of the Group’s accounting policies for derivative financial instruments, see Accounting policies.
Claims management risk The risk that claims are paid inappropriately is managed using a range of IT system controls and manual processes conducted by experienced staff, to ensure that claims are handled in a timely and accurate manner. Detailed policies and procedures exist to ensure that all claims are handled appropriately.
Claims reserves It is the Group’s policy to hold undiscounted claims reserves (including reserves to cover claims which have occurred but not been reported (IBNR reserves)) for all classes at a sufficient level to meet all liabilities as they fall due.
Annual Report and Accounts 2005 d) Creditor insurance Creditor insurance contracts are designed to cover payments on secured or unsecured lending. These contracts will be for a maximum term of 5 years. The causes of creditor insurance claims are loss of income through accident, sickness or unemployment or, in some circumstances, loss of life.
Interest rate sensitivity The following tables summarise the interest rate sensitivity gap for the Group and the company at 31 December 2005 and 31 December 2004. The tables show the contractual repricing for each category of asset, liability and off-balance sheet items in the banking book. A liability (or negative) gap position exists when liabilities reprice more quickly or in greater proportion than assets during a given period and tends to benefit net interest income in a declining interest rate environment. An asset (or positive) gap position exists when assets reprice more quickly or in greater proportion than liabilities during a given period and tends to benefit net interest income in a rising interest rate environment. Contractual repricing terms do not reflect the potential impact of early repayment or withdrawal. Positions may not be reflective of those in subsequent periods. Major changes in positions can be made promptly as market outlooks change. In addition, significant variations in interest rate sensitivity may exist within the re-pricing periods presented and among the currencies in which the Group has interest rate positions.
Service industries and business activities 10,440 661 113 — 11,214 11 Agriculture, forestry and fishing 92 — — — 92 —
Annual Report and Accounts 2005 36 Net cash inflow from operating activities Group Company £m £m £m £m
The directors manage the Group primarily by class of business and present the segmental analysis on that basis. Segments charge market prices for services rendered to other parts of the Group with the exception of Manufacturing and central resources. The expenditure incurred by Manufacturing relates to shared costs principally in respect of the Group's UK and Ireland banking and insurance operations. These costs reflect activities that are shared between the various customer-facing divisions and consequently cannot be directly attributed to individual divisions. Funding charges between segments are determined by Group Treasury, having regard to commercial demands.
Retirement benefits are accruing to four directors (2004 – five) under defined benefit schemes, two (2004 – two) of whom also accrued benefits under defined contribution schemes.
(a) At 31 December 2005, the amounts outstanding in relation to transactions, arrangements and agreements entered into by authorised institutions in the Group, as defined by UK Law, were £149,537 in respect of loans to six persons who were directors of the company (or persons connected with them) at any time during the financial period and £2,055 to one person who was an officer of the company at any time during the financial period.
Investment property is stated at fair value. Any gain or loss arising from a change in fair value is recognised in profit or loss.
Accruals, deferred income and other assets 17,648 (29) (2,346) (60) 32 (32) — (636) 130 224 (162) (49) — (2,928) 14,720
Certain trusts and partnerships that are subsidiaries under IFRS are not consolidated under US GAAP because the Group is not their primary beneficiary. As a result securities issued by them are reclassified from minority interests to subordinated liabilities.
(k) Offset arrangements Debit and credit balances with the same counterparty are aggregated into a single item where there is a right to insist on net settlement and the debit balance matures no later than the credit balance.
A trust fund has been established under the plan, to which payments are made, determined on an actuarial basis, designed to build up reserves during the working life of fulltime employees to pay such employees or their dependants a pension after retirement. Such pensions are based on final pensionable salaries and are related to the length of service prior to retirement. Pensions are limited to a maximum of two-thirds of final salary for 40 years service or more. Staff do not make contributions for basic pensions but may make voluntary contributions on a regular basis to purchase additional service qualification where less than 40 years service will have been completed by normal retirement age.
Disclosures required by SFAS 132R for the Group’s main scheme are set out below.
Weighted average allocations of market value of plan assets at 31 December: % %
(2) Includes loss on sale of subsidiaries of £93 million for the year ended 31 December 2005 (2004 – nil).
Customer charge to income statement as a % of gross loans and advances to customers Domestic 0.59% 0.49%
Specific provisions – customers 3,607 Specific provisions – banks 6 General provision 561
(3) Loans where an impairment event has taken place but no impairment recognised. This category is used for over-collateralised non-revolving credit facilities.
Risk elements in lending as a % of gross loans and advances to customers excluding reverse repos 1.86% 2.22% 2.37% 2.46%
Analysis of deposits – currency analysis The following table shows the distribution of deposits by banks and customer accounts by sterling and other currencies: UK GAAP
Noon Buying Rate Period end rate 1.7188 1.9160 1.7842 1.6095 1.4543 Average rate for the period (1) 1.8147 1.8356 1.6450 1.5043 1.4396
US securitisations – in the US, RBS Greenwich Capital securitises commercial and residential mortgage loans, commercial and residential mortgage related securities, US Government agency collateralised mortgage obligations, and other types of financial assets. It also acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. The majority of proprietary securitisations undertaken by RBS Greenwich Capital result in sales treatment under IFRS and US GAAP. Certain transactions may not result in derecognition of the assets under IFRS or US GAAP: under US GAAP, transactions involving vehicles that are not qualifying special purpose entities and where the Group is the primary beneficiary; under IFRS, those where the Group has retained substantially all the risks and rewards of the assets.
When disposing of shares, shareholders are also entitled to indexation allowance (to April 1998 only in the case of individuals and non-corporate holders), which is calculated on the 31 March 1982 value, on the cost of subsequent purchases from the date of purchase and on the subscription for rights from the date of that payment. Further adjustments must be made where a shareholder has chosen to receive shares instead of cash for dividends. Individuals and non-corporate shareholders may also be entitled to some taper relief to reduce the amount of any chargeable gain on disposal of shares.
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 the 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 HM Revenue & Customs 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 HM Revenue & Customs directs otherwise).
HM Revenue & Customs has confirmed that a company holding an interest in X-CAPs which incidentally has banking facilities with any company associated with the company will not be a ‘funded company’ by virtue of such facilities.
No UK stamp duty will be payable in respect of any instrument of transfer of depositary interests representing X-CAPs, provided that any instrument relating to such transfer is not executed in the UK, and remains at all times outside the UK. Depositary interests representing X-CAPs will not be “chargeable securities” for SDRT purposes, and consequently a transfer of such depositary interests will not be subject to SDRT. Although the position is not clear, the transfer on the sale of X-CAPs in registered form may attract ad valorem UK stamp duty or (if an unconditional agreement to transfer X-CAPs is not completed by a duly stamped transfer) UK SDRT, generally at the rate of 0.5% of the consideration paid, which, in the case of stamp duty, will be rounded up to £5 or multiples thereof. The transfer of X-CAPs in registered form to, or to a nominee or agent for, a person whose business (i) is or includes issuing depositary receipts or (ii) is or includes the provision of clearance services, may give rise to a liability to UK stamp duty or (to the extent that UK stamp duty is not paid on an instrument of transfer) UK SDRT, generally at the rate of 1.5% of the price of the X-CAPs transferred, which, in the case of stamp duty, will be rounded up to £5 or multiples thereof. Such transfer of X-CAPs in bearer form may give rise to a charge to UK SDRT generally at the rate of 1.5% of the price of the X-CAPs transferred. A charge to UK SDRT may also arise on the issue of X-CAPs whether in registered or bearer form to, or to a nominee or agent for, a person whose business is or includes issuing depositary receipts or includes the provision of clearance services, generally at the rate of 1.5% of the price of the X-CAPs issued.
A US Holder will, upon the sale, exchange or redemption of a PRO, generally recognise capital gain or loss for US federal income tax purposes (assuming that in the case of a redemption, such US Holder does not own, and is not deemed to own, any ordinary shares of the company) in an amount equal to the difference between the amount realised (excluding any amount in respect of mandatory interest and any Missed Payments which are to be satisfied on a Missed Payment Satisfaction Date, which would be treated as ordinary income) and the US Holder’s tax basis in the PRO.