Philip Hampton, Chairman d Watch or listen to Philip Hampton at www.rbs.com/annualreport2009
“I hope that the Group’s results give you the clarity about our performance and direction that enables you to share the confidence I have in the brighter future for RBS.”
“RBS is being restructured and run to serve customers well, to be safe and stable and to restore sustainable shareholder value for all.”
• to rebuild sustainable value for all shareholders and in so doing to enable the UK Government to sell its shareholding profitably over time.
UK Corporate & Commercial We are a leading provider of banking, finance and risk management services to the corporate and
Non-Core Our Non-Core Division manages assets that are no longer core to our strategy and the continuing operations of RBS, and which we plan to sell or to run down.
Our NatWest and RBS brands serve more than 15 million retail customers, making us the number two player in the UK banking market. We offer a full range of products, including current accounts, mortgages, credit /charge cards and deposit accounts. We also help our customers with their financial planning.
UK Retail offers a comprehensive range of banking products and related financial services to the personal market. It serves customers through the RBS and NatWest networks of branches and ATMs, and also through telephone and internet channels.
We continued to provide advice to customers and other people who are concerned about their personal finances through our flagship MoneySense programme. Through MoneySense for Adults, 1,000 trained advisers helped nearly 26,000 people through a MoneySense interview. Our MoneySense for Schools Programme, which we’ve been running for 16 years, teaches children how to manage their money. In 2009, more than 28,000 lessons were delivered in over 1,500 schools. Scottish Financial Enterprise recognised the success of MoneySense and gave us their Innovation for Investment in the Community Award in 2009. For customers who find themselves in financial difficulty, we have invested in more people to help them, and also developed an income and expenditure toolkit which is already being used to help 40,000 customers a month better understand how they can manage their money.
We have compelling strengths in the markets in which we choose to compete and it is rewarding when others recognise that, too. IFR named us “Sterling Bond House”, The Banker magazine gave us the award as “Most Innovative in Loans & Leveraged Finance 2009” and Euromoney named us “Best Structured Products House”.
As part of the Group’s Strategic Plan, our Support team focused on the implementation of the common, cross-divisional operating model for Support in Europe and the Middle East, as well as major property and staff moves with the Stamford office in the US and our Bankside building in London opening for business in 2009.
Following the acquisition of ABN AMRO’s wholesale banking businesses, good progress has been made in integrating performance and development across the division. We have enhanced the input into performance assessments from our Risk function and have further strengthened assessment practices for senior business leaders.
Despite the significant impact of bodily injury claims to RBS Insurance’s 2009 results, its underlying performance remained strong. Own brand motor policies increased by 8% on 2008, while non-motor own brand policies were up 13% on 2008.
The key measures of success for our Division are our ability to manage down Third Party Assets (TPAs) and Risk Weighted Assets (RWAs), while reducing our trading and credit losses through robust risk management and credit stewardship as well as managing asset disposals efficiently.
Participation in the UK Government’s APS provided RBS with a capital injection of £25.5 billion and catastrophe insurance for the riskiest assets we currently hold on our balance sheet in the event of a prolonged economic downturn. The progress we have made against our strategic plan, as well as improvements in financial markets and the economic outlook, mean we do not anticipate claiming under the scheme. However, this insurance provides us with financial strength in the event of major economic and market stress and gives us the confidence we need to navigate the years ahead.
Global Restructuring Group Our Global Restructuring Group is responsible for supporting our customers through business and financial restructuring when they are facing difficulties during the current economic downturn. To meet increased demand GRG has significantly increased its resourcing levels, more than doubling staffing levels across the year, especially its regional presence across the UK, and this trend is expected to continue in 2010. Its primary aim is to return our customers to sound financial health and to the core divisions within RBS they originated from. During 2009 over 800 UK based small to medium sized businesses were restructured safeguarding the future of several thousand jobs and GRG is currently acting as either lead or coordinator in around 140 restructurings globally.
Corporate Sustainability is the catch-all phrase that we use to describe our efforts to address a range of issues that relate to our broader impact on society. This section outlines the key developments in this important area of our business in 2009, based around five key themes: • Fair banking
• We launched a unique on-line tool which is designed to encourage customers to save. Launched in December 2009, the tool allows customers to work out a savings plan for their specific goal and shows customers the progress made and if they are saving enough.
• In August 2009 we commenced a programme to replace all Maestro, Solo and Laser debit cards with Visa Debit cards. Customers are benefiting from a higher level of purchase protection.
• We announced a £5 million loan fund, ring-fenced to support third sector providers of affordable credit to help individuals.
2.5 million The number of customers who downloaded Rapport, a fraud prevention software package we introduced in 2009, free of charge.
Risks relating to the company The company and its UK bank subsidiaries may face the risk of full nationalisation or other resolution procedures under the Banking Act. Under the provisions of the Banking Act, substantial powers have been granted to the Authorities as part of the Special Resolution Regime to stabilise banks that are in financial difficulties (the “SRR”). The SRR confers powers on the Bank of England: (i) to transfer to the private sector all or part of the business of a UK incorporated institution with permission to accept deposits pursuant to Part IV of the Financial Services and Markets Act 2000 (FSMA) (a “relevant entity”); (ii) to transfer all or part of the business of the relevant entity to a “bridge bank” established by the Bank of England; and also confers a power on HM Treasury to transfer into temporary public ownership (nationalisation) the relevant entity or its UK-incorporated holding company. The Banking Act also provides for two new insolvency and administration procedures for relevant entities.
As a result of the First Placing and Open Offer (approved as part of the Commission’s approval of a package of measures to the banking industry in the UK in October 2008), the Group was required to cooperate with HM Treasury to submit a forward plan to the Commission. This plan was submitted and detailed discussions took place between HM Treasury, the Group and the Commission. The plan submitted not only had regard to the First Placing and Open Offer, but also the B share issue (including the Contingent Subscription) and the Group’s participation in the UK Government’s Asset Protection Scheme (APS). As part of its review, the Commission was required to assess the State aid and to consider whether the Group’s long-term viability will be assured, that the Group makes a sufficient contribution to the costs of its restructuring and that measures are taken to limit any distortions of competition arising from the State aid provided to the Group by the UK Government. The Group, together with HM Treasury, agreed in principle with the Commission the terms of the State aid and the terms of a restructuring plan (the “State aid restructuring plan”). Formal EC approval was granted on 14 December 2009. The prohibition on the making of discretionary dividend (including preference shares and B shares) or coupon payments on existing hybrid capital instruments for a two-year period commencing no later than 30 April 2010 will prevent the company from paying dividends on its ordinary shares and preference shares and coupons on other Tier 1 capital securities for the same duration, and it may impair the Group’s ability to raise new Tier 1 Capital through the issuance of ordinary shares and other securities.
Furthermore, if the Group is unable to comply with the terms of the State aid approval it could constitute a misuse of aid. In circumstances where the Commission doubts that the Group is complying with the terms of the State aid approval, it may open a formal investigation. At the conclusion of this investigation, if the Commission decides that there has been misuse of aid, it can issue a decision requiring HM Treasury to recover the misused aid which could have a material adverse impact on the Group.
Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of the Group’s businesses. Whilst some economies stabilised over the course of 2009, the Group may continue to see adverse changes in the credit quality of its borrowers and counterparties, for example, as a result of their inability to refinance their indebtedness, with increasing delinquencies, defaults and insolvencies across a range of sectors (such as the personal and banking and financial institution sectors) and in a number of geographies (such as the United Kingdom, the United States, the Middle East and the rest of Europe, particularly Ireland). This trend has led and may lead to further and accelerated impairment charges, higher costs, additional write-downs and losses for the Group or result in a loss of value in its securities.
The Group’s earnings and financial condition have been, and its future earnings and financial condition may continue to be, affected by depressed asset valuations resulting from poor market conditions. Financial markets continue to be subject to significant stress conditions, where steep falls in perceived or actual asset values have been accompanied by a severe reduction in market liquidity, as exemplified by recent events affecting asset-backed collateralised debt obligations, residential mortgage-backed securities and the leveraged loan market. In dislocated markets, hedging and other risk management strategies have proven not to be as effective as they are in normal market conditions due in part to the decreasing credit quality of hedge counterparties, including monoline and other insurance companies and credit derivative product companies. Severe market events have resulted in the Group recording large write-downs on its credit market exposures in 2007, 2008 and 2009. Any further deterioration in economic and financial market conditions could lead to further impairment charges and write-downs. Moreover, market volatility and illiquidity make it difficult to value certain of the Group’s exposures. Valuations in future periods, reflecting, among other things, then-prevailing market conditions and changes in the credit ratings of certain of the Group’s assets, may result in significant changes in the fair values of the Group’s exposures, even in respect of exposures, such as credit market exposures, for which the Group has previously recorded write-downs. In addition, the value ultimately realised by the Group may be materially different from the current or estimated fair value. Any of these factors could require the Group to recognise further significant write-downs or realise increased impairment charges, any of which may adversely affect its capital position, its financial condition and its results of operations or result in a loss of value in its securities.
Recent consolidation among banking institutions in the United Kingdom, the United States and throughout Europe is changing the competitive landscape for banks and other financial institutions. If financial markets continue to be volatile, more banks may be forced to consolidate. This consolidation, in combination with the introduction of new entrants into the US and UK markets from other European and Asian countries, could increase competitive pressures on the Group. In addition, certain competitors may have access to lower cost funding and be able to offer retail deposits on more favourable terms than the Group and may have stronger multi-channel and more efficient operations as a result of greater historical investments. Furthermore, the Group’s competitors may be better able to attract and retain clients and talent, which may have a negative impact on the Group’s relative performance and future prospects.
The Group’s operations have inherent reputational risk. Reputational risk, meaning the risk to earnings and capital from negative public opinion, is inherent in the Group’s business. Negative public opinion can result from the actual or perceived manner in which the Group conducts its business activities, from the Group’s financial performance, from the level of direct and indirect government support or from actual or perceived practices in the banking and financial industry. Negative public opinion may adversely affect the Group’s ability to keep and attract customers and, in particular, corporate and retail depositors. The Group cannot ensure that it will be successful in avoiding damage to its business from reputational risk.
The Scheme Conditions may be modified by HM Treasury in certain prescribed circumstances, which could result in a loss or reduction in the protection provided under the APS in relation to certain Covered Assets, increased costs to the Group in respect of the APS or limitations on the Group’s operations.
HM Treasury to other government agencies, the UK Parliament, the European Commission, and more widely if HM Treasury determines that doing so is required, for example, to protect the stability of the UK financial system.
2009 compared with 2008 – pro forma Impairment losses were £13,899 million compared with £7,432 million. Impairment losses in the Core divisions increased by £2,182 million, while Non-Core losses increased by £4,285 million.
• The gross exposure to monoline counterparties has decreased primarily due to a combination of higher prices of underlying reference instruments and restructuring certain exposures.
Business review 2009 compared with 2008 Operating profit of £229 million was £494 million lower than in 2008. Profit before impairments was up £166 million or 10%, but impairments rose by £660 million as the economic environment deteriorated, albeit with signs of conditions stabilising in the second half of the year.
Capital and balance sheet Loans and advances to customers – gross
Capital and balance sheet Total assets 121.3 127.8 Loans and advances to customers – gross
Analysis of income by product Motor own-brand 2,005 1,942 Household and Life own-brands 849 806 Motor partnerships and broker 577 686 Household and Life, partnerships and broker 330 354 Other (international, commercial and central) 699 642
Central items not allocated 292 1,025 2009 compared with 2008 Funding and operating costs have been allocated to operating divisions, based on direct service usage, requirement for market funding and other appropriate drivers where services span more than one division.
Analysis of income Banking & Portfolio (1,338) 2,324 International Businesses & Portfolios 2,262 2,980
Performance ratios Net interest margin 0.69% 0.87% Cost:income ratio (106.3%) (88.5%)
Total third party assets (including derivatives (2)) 220.9 342.9 Loans and advances to customers – gross 149.5 191.4 Customer deposits 12.6 27.4 Risk elements in lending 22.9 11.1 Loan:deposit ratio 1,121% 683% Risk-weighted assets (3) 171.3 170.9
(3) Includes Sempra: 31 December 2009 Third Party Assets (TPAs) £14.2 billion, RWAs £10.2 billion (31 December 2008 TPAs £17.8 billion, RWAs £10.6 billion).
Net cash flows from operating activities (992) (75,338) Net cash flows from investing activities 54 16,997 Net cash flows from financing activities 18,791 15,102 Effects of exchange rate changes on cash and cash equivalents (8,592) 29,209 Net increase/(decrease) in cash and cash equivalents 9,261 (14,030)
Prepayments, accrued income and other assets 18,604 2,381 20,985 Assets of disposal groups 18,432 110 18,542
Group Asset and Liability Identifies, manages and controls the Group Group Finance Director Management Committee balance sheet risks. Deputy Group Finance Director (GALCO) Head of Restructuring and Risk
• Qualitative: ensuring that the Group applies the correct principles, policies and procedures.
Group Treasury and GALCO monitor available capital and its utilisation across divisions. GALCO makes the necessary decisions around reallocation of budget and changes in RWA allocations.
Tier 1 Ordinary and B shareholders' equity 69,890 45,525 Minority interests 16,895 21,619 Adjustments for: – Goodwill and other intangible assets – continuing (17,847) (20,049) – Goodwill and other intangible assets of discontinued businesses (238) — – Unrealised losses on available-for-sale debt securities 1,888 3,687 – Reserves arising on revaluation of property and unrealised gains on available-for-sale equities (207) (984) – Reallocation of preference shares and innovative securities (656) (1,813) – Other regulatory adjustments (1,184) (362)
Tier 2 Reserves arising on revaluation of property and unrealised gains on available-for-sale equities 207 984 Collective impairment allowances 796 666 Perpetual subordinated debt 4,950 9,829 Term subordinated debt 20,063 23,162 Minority and other interests in Tier 2 capital 11 11 Less deductions from Tier 2 capital (5,532) (2,429) Less APS first loss (5,106) —
In April 2009, £5 billion of preference shares were redeemed and replaced by ordinary shares using the proceeds of the Second Placing and Open Offer. This strengthened the Group’s Core Tier 1 capital, enhancing its financial stability during a tough economic and market period.
The subscription for £25.5 billion of B shares improved the Group’s Core Tier 1 capital ratio by 580 basis points at 31 December 2009.
Insurance risk The risk of financial loss through fluctuations in the Frequent small losses. timing, frequency and/or severity of insured events, relative to the expectations at the time of underwriting. Infrequent material losses.
Operational risk The risk of financial, customer or reputational loss Frequent small losses. resulting from inadequate or failed internal processes or systems; from improper behaviour; or from Infrequent material losses. external events.
Retail collections and recoveries There are collections and recoveries functions in each of the consumer businesses. Their role is to provide support and assistance to customers who are currently experiencing difficulties meeting their financial obligations. Where possible, the aim of the collections and recoveries teams is to return the customer to a satisfactory position, by working with them to restructure their finances. If this is not possible, the team has the objective of reducing the loss to the Group.
UK Retail 103,029 97,069 UK Corporate 109,908 126,736 Wealth 15,951 17,604 Global Banking & Markets 224,355 450,321 Global Transaction Services 7,152 8,995 Ulster Bank 42,042 64,695 US Retail & Commercial 52,104 82,862 Other 2,981 6,594 Core(1) 557,522 n/a Non-Core 151,264 n/a
Personal Sovereign institutions Corporate Total Core Non-Core Personal Sovereign institutions Corporate Total £m £m £m £m £m £m £m £m £m £m £m £m
(2) Excludes net investment in operating leases in Shipping and Aviation portfolios as they are accounted for as part of property, plant and equipment; however operating leases are included in the monitoring and management of these portfolios.
The arrears rate (three or more payments missed) on the combined Royal Bank of Scotland and NatWest brands was 1.8% at 31 December 2009. After a period of deterioration driven by the economic environment this stabilised in the second half of 2009 (arrears rate stood at 1.8% at 30 June 2009 and 1.5% at 31 December 2008). The arrears rate on the buy-to-let portfolio was 1.6% at 31 December 2009 (1.6% at 30 June
Charge as a % of customer loans and advances – gross (3) 1.1% 5.7% 2.3% 0.8% 2.0% 0.9% 0.8% 0.4% 0.3%
Notes: (1) Excludes loan impairment charge against loans and advances to banks of £34 million (2008 – £118 million; 2007 – nil).
Charge as a % of AFS assets 0.6% 0.6% 0.7% 0.8% — —
(3) Loans made by the Group’s consolidated conduits to asset owning companies are included within finance.
(2) The Group has given commitments to provide funds to customers under undrawn formal facilities, credit lines and other commitments to lend subject to certain conditions being met by the counterparty. The Group does not expect all facilities to be drawn, and some may lapse before drawdown.
The tables on the previous page show the timing of cash inflows and outflows to settle financial assets and liabilities. They have been prepared on the following basis: Financial assets have been reflected in the time band of the latest date on which they could be repaid, unless earlier repayment can be demanded by the Group. Financial liabilities are included at the earliest date on which the counterparty can require repayment regardless of whether or not such early repayment results in a penalty. If the repayment of a financial asset or liability is triggered by, or is subject to, specific criteria, such as market price hurdles being reached, the asset is included in the latest date on which it can repay regardless of early repayment, the liability is included at the earliest possible date that the conditions could be fulfilled without considering the probability of the conditions being met.
The total level of the Group’s wholesale funding has reduced year on year by £99 billion with the majority of the reduction attributable to a reduced reliance on inter-bank funding.
Risk, capital and liquidity management 159RBS Group Annual Report and Accounts 2009
The 2009 data in the tables on the previous page also excludes the exposures relating to CDPCs from the end of August 2009 when they were excluded from VaR and were capitalised under a Pillar II approach.
Back-testing, stress testing and sensitivity analysis The Group undertakes a programme of daily back-testing, which compares the actual profit or loss realised in trading activity to the VaR estimation. The results of the back-testing process are one of the methods by which the Group monitors the ongoing suitability of its VaR model.
The Group undertakes daily stress testing to identify the potential losses in excess of VaR. Stress testing is used to calculate a range of trading book exposures which result from exceptional, but plausible market events. Stress testing measures the impact of abnormal changes in market rates and prices on the fair value of the Group’s trading portfolios. The Group calculates historical stress tests and hypothetical stress tests.
Non-traded portfolios Risks in non-traded portfolios mainly arise in retail and commercial banking assets and liabilities and financial investments designated as available-for-sale and held-to-maturity.
Financial control functions are required to confirm to Group Treasury that returns materially capture all balance sheet items and thus reconcile to core source systems.
Group Market Risk exercise independent oversight and governance of the interest rate and foreign exchange exposures managed in Group Treasury by granting market risk limits in addition to authorising Group Treasury to deal in specific instruments for the purpose of managing the Group's non-trading interest rate and foreign exchange exposures. All market risk methodologies that relate to limits specified under this delegated authority are applied under the direction of Group Market Risk.
Insurance risk arises through fluctuations in the timing, frequency and/or severity of insured events, relative to the expectations at the time of underwriting. Insurance risk is managed in four distinct ways: • Underwriting and pricing risk management: is managed through the use of underwriting guidelines which detail the class, nature and type of business that may be accepted, pricing policies by product line and brand and centralised control of wordings and any subsequent changes; • Claims risk management: is handled using a range of automated controls and manual processes; • Reserving risk management: is applied to ensure that sufficient funds have been retained to handle and pay claims as the amounts fall due, both in relation to those claims which have already occurred or will occur in future periods of insurance. Reserving risk is managed through detailed analysis of historical and industry claims data and robust control procedures around reserving models; and
Events that have a material, actual or potential impact on the Group’s finances, reputation or customers, are escalated and reported to divisional and Group executive.
Key aspects of the Scheme On 22 December 2009, the Group acceded to the Asset Protection Scheme (‘APS’ or ‘the Scheme’) with HM Treasury (HMT) acting on behalf of the UK Government. Under the Scheme, the Group purchased credit protection over a portfolio of specified assets and exposures (“covered assets”) from HMT. The portfolio of covered assets had a par value of approximately £282 billion as at 31 December 2008 and the protection is subject to a first loss of £60 billion and covers 90% of subsequent losses. Once through the first loss, when a covered asset has experienced a trigger event(1) losses and recoveries in respect of that asset are included in the balance receivable under the APS. Receipts from HMT will, over time, amount to 90% of cumulative losses (net of cumulative recoveries) on the portfolio of covered assets less the first loss amount.
The selection of assets was carried out primarily between February and April 2009 and was driven by three principal criteria: (1) Risk and degree of impairment in base case and stressed scenarios; (2) Liquidity of exposure; and
The approach for high volume commercial and retail exposures was on a portfolio basis. Selection for large corporates and GBM was at the counterparty/asset level. Set out below are the selection criteria for the contributing divisions.
UK Corporate (1) Commercial & corporate real estate: all defaulted assets in the work-out/restructuring unit or in high risk bands.
Sector analysis The table below analyses covered assets by sector and division; and by sector and HMT asset class at 31 December 2009 and 31 December 2008.
Non-performing loans 31,811 22,335 17,082 12,679 Other REIL 3,178 2,092 1,709 1,498 Total REIL 34,989 24,427 18,791 14,177 PPL 924 580 226 187 REIL and PPL 35,913 25,007 19,017 14,364
Market turmoil exposures All the disclosures in this section (pages 184 to 206) are audited unless otherwise indicated with an asterisk (*).
This section focuses on asset-backed securities, an area of interest following the market dislocations in 2007 and 2008. Asset-backed securities (ABS) are securities with an interest in an underlying pool of referenced assets. The risks and rewards of the referenced pool are passed onto investors by the issue of securities with varying seniority, by a special purpose entity.
The Group has exposures to ABS which are predominantly debt securities but can also be held in derivative form. These positions had been acquired primarily through the Group’s activities in the US leveraged finance market which expanded during 2007. These include residential mortgage backed securities (RMBS), commercial mortgage backed securities (CMBS), ABS collateralised debt obligations (CDOs) and collateralised loan obligations (CLOs) and other ABS. In many cases the risk on these assets is hedged by way of credit derivative protection purchased over the specific asset or relevant ABS indices. The counterparty to some of these hedge transactions are monoline insurers (see monoline insurers on page 194).
Other US UK Europe (4) RoW Total HFT AFS LAR DFV
The table below summarises the ratings and valuation hierarchy levels of ABS carrying values: Ratings (1) Of which carried at fair value (2)
The following table shows the composition of the Group’s CMBS portfolios (carrying value) by geography and sector.
Gross exposure to monolines 6,170 11,581 3,409 Hedges with financial institutions (531) (789) — Credit valuation adjustment (3,796) (5,988) (862) Net exposure to monolines 1,843 4,804 2,547
The Group also has indirect exposures to monoline insurers through wrapped securities and other assets with credit enhancement provided by monoline insurers. These securities are traded with the benefit of this credit enhancement. Any deterioration in the credit rating of the monoline is reflected in the fair value of these assets.
At 31 December 2007 the carrying value of the Group’s syndicated loan book was £14,582 million, comprised of £12,041 million of held-fortrading positions and £2,541 million classified as loans and receivables.
• £0.4 billion (2008 – £1.1 billion) in various derivative instruments with the objective of providing returns linked to the performance of underlying equity indices.
In terms of section 236 of the Companies Act 2006, Qualifying Pension Scheme Indemnity Provisions have been issued to all pension trustees of the Group’s pension schemes during 2009.
At 31 December 2009, the Group’s trade creditors represented 30 days (2008 – 30 days) of amounts invoiced by suppliers.
Re-election of directors Directors must stand for re-election by shareholders at least once every three years. Any non-executive directors who have served for more than nine years will also stand for annual re-election and the Board will consider their independence at that time.
The Audit Committee holds at least six scheduled meetings each year. A meeting is held immediately prior to submission of the interim and annual financial statements to the Board and the quarterly Interim Management Statements. This core programme is supplemented by additional meetings as required. A total of ten meetings were held in 2009. Audit Committee meetings are attended by relevant executive directors, the internal and external auditors and finance and risk management executives. At least twice per annum the Audit Committee meets privately with the external auditors. Since 2000, the Audit Committee has undertaken an annual programme of visits to the Group's business divisions and control functions. The object of the programme is to allow the Audit Committee to gain a better understanding of the Group and an invitation to attend is extended to all non-executive directors. The programme of future visits is considered annually and the norm is for two to three visits to be undertaken each year. The Group Audit Committee undertook three visits in 2009.
Specific design principles for short-term incentives are in place, with strict governance procedures that ensure that all existing and future incentive schemes support the Group’s business strategy and risk appetite. All short-term incentives are subject to appropriate governance, including review by the risk management, finance and human resources functions.
The Deputy Group Chief Executive, Gordon Pell, has also requested to waive his annual bonus for 2009, and in light of his request the Board has agreed that no bonus will be awarded to him in respect of 2009 performance.
In 2009, executive directors received long-term incentives under two plans, the Medium Term Performance Plan (MPP) and the Executive Share Option Plan (ESOP). Both plans contain clawback provisions that allow the Remuneration Committee to exercise its discretion over the vesting of awards made in 2009. More information on both of the plans can be found on pages 233 to 235.
For executive directors, the proposed performance conditions focus on shareholder value, while factoring in the growing regulatory emphasis on risk-adjusted financial metrics. The proposal for awards in 2010 is that 50% of each award vesting is based on improvement in economic profit, 25% is based on relative Total Shareholder Return (TSR) and 25% is based on absolute TSR. There will also be an underpin whereby vesting levels may be adjusted depending on risk performance and achievements related to the strategic plan objectives.
Joe MacHale 1 September 2004 2010 John McFarlane 1 October 2008 2012 Art Ryan 1 October 2008 2012 Philip Scott 1 November 2009 2010
Notes: (1) Appointed as Senior Independent Director on 1 June 2009. His fee is inclusive and covers all Board and Board Committee work.
Disclosure of these benefits has been made in accordance with the United Kingdom Listing Authority’s Listing Rules and with the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008.
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 Group’s pension schemes.
Other comprehensive (loss)/income after tax (3,835) 7,062 2,376 Total comprehensive (loss)/income for the year (6,158) (27,480) 10,088
Statements of changes in equity for the year ended 31 December 2009
Equity withdrawn and disposals (2,445) (13,579) (553) — — — Transfer to retained earnings (629) — — — — —
Rental income from operating leases is credited to the income statement on a receivable basis over the term of the lease. Operating lease assets are included within Property, plant and equipment and depreciated over their useful lives (see accounting policy 7).
13. Provisions The Group recognises a provision for a present obligation resulting from a past event when it is more likely than not that it will be required to transfer economic benefits to settle the obligation and the amount of the obligation can be estimated reliably.
18. Loan commitments Provision is made for loan commitments, other than those classified as held-for-trading, if it is probable that the facility will be drawn and the resulting loan will be recognised at a value less than the cash advanced. Syndicated loan commitments in excess of the level of lending under the commitment approved for retention by the Group are classified as held-for-trading and measured at fair value.
The IASB reissued IAS 24, ‘Related Party Disclosures’, in November 2009 clarifying the existing standard and to provide certain exemptions for entities under government control. The revised standard is effective for annual periods beginning on or after 1 January 2011.
The International Financial Reporting Interpretations Committee (IFRIC) issued interpretation IFRIC 17 ‘Distributions of Non-Cash Assets to Owners’ and the IASB made consequential amendments to IFRS 5 ‘NonCurrent Assets Held for Sale and Discontinued Operations’ in December 2008. The interpretation requires distributions to be presented at fair value with any surplus or deficit recognised in income. The amendment to IFRS 5 extends the definition of disposal groups and discontinued operations to disposals by way of distribution. The interpretation is effective for annual periods beginning on or after 1 July 2009, to be adopted at the same time as IFRS 3 ‘Business Combinations’ (revised 2008), and is not expected to have a material effect on the company. The interpretation may affect the accounting treatment in the Group's financial statements of the ABN AMRO businesses to be acquired by the State of Netherlands following the reorganisation of ABN AMRO Bank N.V. described in Note 16.
Notes on the accounts 261RBS Group Annual Report and Accounts 2009 3 Operating expenses Group
Premises and equipment 3,087 2,593 1,703 Other administrative expenses 5,584 5,464 2,969
– Issued to UK Financial Investments Limited (1) 274 — —
Assets Cash and balances at central banks — — — 52,261 52,261 Loans and advances to banks (1) 45,449 — — 46,304 91,753 Loans and advances to customers (2,3) 42,277 1,981 — 671,037 13,098 728,393
Deferred taxation 3 3 Prepayments, accrued income and other assets — — 489 489
Accruals, deferred income and other liabilities — — 47 47 Subordinated liabilities — 10,314 10,314
The table below shows the carrying value and fair value and the effect on profit or loss of reclassification undertaken by the Group in 2008 and 2009.
In order to determine a reliable fair value, where appropriate, management applies valuation adjustments to the pricing information gathered from the above sources. These adjustments reflect the Group’s assessment of factors that market participants would consider in setting a price, to the extent that these factors are not reflected in that pricing information. Furthermore, on an ongoing basis, the Group assesses the appropriateness of any model used. To the extent that the price provided by internal models does not represent the fair value of the instrument, for instance in highly stressed market conditions, the Group makes adjustments to the model valuation to calibrate to other available pricing sources. Where unobservable inputs are used, the Group may determine a range of possible valuations derived from differing stress scenarios to determine the sensitivity associated with the valuation. When establishing the fair value of a financial instrument using a valuation technique, the Group considers certain adjustments to the modelled price which market participants would make when pricing that instrument. Such adjustments include the credit quality of the counterparty and adjustments to compensate for any known model limitations.
Other financial liabilities (4) 1.3 — 1.3 — — — n/a 11 Financial instruments continued
Additionally, £1,533 million of non-G10 government debt securities, foreign exchange derivatives (assets – £1,846 million, liabilities – £1,836 million) were transferred from level 1 to level 2 reflecting refinements of hierarchy level classification in 2009.
Fair value of financial instruments not carried at fair value The following table shows the carrying values and the fair values of financial instruments carried on the balance sheet at amortised cost.
The fair values of intangible assets, such as core deposits, credit card and other customer relationships are not included in the calculation of these fair values since these are not financial instruments.
The assumptions and methodologies underlying the calculation of fair values of financial instruments at the balance sheet date are set out below: The fair value of financial instruments which are of short maturity (3 months or less) approximates their carrying value. This applies mainly to cash and balances at central banks, items in the course of collection from other banks, settlement balances, items in the course of transmission to other banks and demand deposits.
RBS Group Annual Report and Accounts 2009292 12 Financial assets – impairments The following table shows the movement in the provision for impairment losses for loans and advances.
Net investment hedging: Hedge ineffectiveness recognised in other operating income comprised: £m £m £m
Fair value hedging: Gains/(losses) on the hedged items attributable to the hedged risk 512 (965) 81 (Losses)/gains on the hedging instruments (455) 884 (87)
Gross gains of £393 million (2008 – £190 million; 2007 – £475 million) and gross losses of £132 million (2008 – £70 million; 2007 – £9 million) were realised on the sale of available-for-sale equity shares.
Transfers to disposal groups (238) — — — (238) Currency translation and other adjustments (2,743) (225) (281) (65) (3,314)
During the year an impairment charge of £363 million was recorded principally in relation to NatWest and ABN AMRO goodwill allocated to Non-Core businesses following the restructure of the Group.
Rental income from investment properties was £233 million (2008 – £257 million; 2007 – £300 million). Direct operating expenses of investment properties were £16 million (2008 – £22 million; 2007 – £49 million).
Accumulated depreciation and amortisation: At 1 January 2007 — 446 96 374 1,670 2,680 5,266 Currency translation and other adjustments — (4) — (1) (1) 2 (4) Transfers to disposal groups — — — — — (52) (52)
Disposals and write-off of fully depreciated assets — (122) (32) (25) (132) (610) (921) Charge for the year – continuing operations — 66 8 87 409 727 1,297 Charge for the year – discontinued operations — 7 — 1 6 — 14
20 Discontinued operations and assets and liabilities of disposal groups (a) (Loss)/profit from discontinued operations, net of tax £m £m £m
To comply with EC State Aid requirements the Group has agreed to make a series of divestments over the next four years. Sempra was the only such divestment that met the criteria for classification as a disposal group at 31 December 2009. The other assets and associated liabilities classified as disposal groups include certain non-core interests in Asia and Latin America.
Movement in the year (105) (38) (143) Exchange differences 64 — 64
Note: (1) New business contribution represents the present value of future profits on new insurance contract business written during the year.
There are no options and guarantees relating to life assurance contracts that could in aggregate have a material effect on the amount, timing and uncertainty of the Group’s future cash flows.
Insurance claims – gross £m £m £m £m £m £m £m £m £m £m
US$500 million floating rate subordinated notes 2016 (callable October 2011) 308 346 252 US$1,500 million floating rate subordinated notes 2016 (callable April 2011) 926 1,038 757 €500 million 4.5% subordinated notes 2016 (callable January 2011) 476 511 379 CHF200 million 2.75% subordinated notes 2017 (callable December 2012) 120 129 89 €100 million floating rate subordinated notes 2017 89 97 73 €500 million floating rate subordinated notes 2017 (callable June 2012) 445 482 371 €750 million 4.35% subordinated notes 2017 (callable January 2017) 728 770 548 AUD450 million 6.5% subordinated notes 2017 (callable February 2012) 255 217 202 AUD450 million floating rate subordinated notes 2017 (callable February 2012) 250 214 199 US$1,500 million floating rate subordinated callable step up notes 2017 (callable August 2012) 925 1,029 752 €2,000 million 6.93% subordinated notes 2018 (callable April 2018) 2,017 2,136 — US$125.6 million floating rate subordinated notes 2020 78 87 64 €1,000 million 4.625% subordinated notes 2021 (callable September 2016) 962 1,019 724 €300 million CMS linked floating rate subordinated notes 2022 292 303 228 €144.4 million floating rate subordinated notes 2022 (callable June 2022) 143 152 —
ABN AMRO and subsidiaries €9 million 4.650% perpetual convertible financing preference shares — — 7 €1,000 million 4.310% perpetual Bermudan callable subordinated tier 1 notes (callable March 2016) 834 824 598 €800 million 10.00% fixed perpetual mandatory convertible tier 1 notes 2099 (issued July 2009) 716 — — €967 million 10.00% fixed perpetual mandatory convertible tier 1 notes 2072 (issued December 2009) 866 — — €833 million 10.00% fixed perpetual mandatory convertible tier 1 notes 2073 (issued December 2009) 746 — —
ABN AMRO represents the other consortium members’ interests in RFS Holdings B.V. The capital and income rights of shares issued by RFS Holdings B.V. are linked to the net assets and income of the ABN AMRO business units which the individual consortium members have agreed to acquire. The distribution to other consortium members of their respective interests is expected in 2010. Other minority interests include trust preferred securities of £664 million (2008 – £1,821 million; 2007 – £1,821 million) and in prior years RBS China Sarl (2008 – £1,898 million; 2007 – £2,438 million). Equity withdrawn in respect of ABN AMRO relates to distributions to consortium members.
The B shares do not generally carry voting rights at general meetings of ordinary shareholders. Each B share is entitled to the same cash dividend as an ordinary share (subject to anti–dilution adjustments). The B shares may be converted into ordinary shares at a fixed ratio of issue price (50p) divided by the conversion price (50p subject to anti-dilution adjustments) at the option of the holder at any time after issue.
Loans and advances to banks 13 13 Loans and advances to customers 147,150 125,463 Debt securities 8,723 15,490
Contingent liabilities Guarantees – the Group gives guarantees on behalf of customers. A financial guarantee represents an irrevocable undertaking that the Group will meet a customer’s obligations to third parties if the customer fails to do so. The maximum amount that the Group could be required to pay under a guarantee is its principal amount as disclosed in the table above. The Group expects most guarantees it provides to expire unused.
32 Memorandum items Contingent liabilities and commitments The amounts shown in the table below are intended only to provide an indication of the volume of business outstanding at 31 December. Although the Group is exposed to credit risk in the event of non-performance of the obligations undertaken by customers, the amounts shown do not, and are not intended to, provide any indication of the Group’s expectation of future losses.
Satisfied by: Issue of 531 million ordinary shares of the company 2,719 Cash 45,786 Fees and expenses relating to the acquisition 70 Consideration 48,575
The Group’s activities are organised as follows: UK Retail offers a comprehensive range of banking products and related financial services to the personal market. It serves customers through the Royal Bank and NatWest networks of branches and ATMs in the United Kingdom, and also through telephone and internet channels.
Amortisation of purchased intangible assets — — — — (272) — (272) Write-down of goodwill — — — (363) — — (363) Integration and restructuring costs — — — (1,268) (18) — (1,286) Gain on redemption of own debt — 3,790 3,790 — — — 3,790
• US dollar repo operations – these commenced in September 2008 taking the form of an auction. Eligible collateral consists of securities routinely eligible in the Bank of England’s short-term repo open market operations together with conventional US Treasuries.
(d) The captions in the primary financial statements of the parent company include amounts attributable to subsidiaries. These amounts have been disclosed in aggregate in the relevant notes to the financial statements.
Notes: (1) Includes gains on strategic disposals of £132 million in 2009 (2008 – £442 million; 2007 and 2006 – nil; 2005 – £333 million).
(3) Closing customer provisions exclude closing provisions against loans and advances to banks.
Loans accounted for on a non-accrual basis (2): Accruing loans which are contractually overdue 90 days or more as to principal or interest (3): Loans not included above which are classified as ‘troubled debt restructurings’ by the SEC: Domestic — — — — 2 Foreign — — — — —
Other short-term borrowings Outstanding at year end 138,951 194,346 280,526 Maximum outstanding at any month end during the year 202,812 395,132 312,557 Approximate average amount during the year 162,235 299,513 188,326 Approximate weighted average interest rate during the year 1.4% 3.2% 4.6% Approximate weighted average interest rate at year end 0.4% 2.5% 4.1%
Overseas based companies and branches Certificates of deposit 24,157 8,503 2,567 218 35,445 Other time deposits 45,157 12,469 6,264 13,215 77,105 Total 133,556 35,728 16,110 38,282 223,676
Anti-money laundering, anti-terrorism and economic sanctions regulations are a major focus of the US government for financial institutions and are rigorously enforced by US government agencies.
In December 2008, The Solicitor for the Affairs of Her Majesty’s Treasury (HM Treasury) acquired 22,854 million ordinary shares representing 57.92% of the company’s issued ordinary share capital. During 2009, HM Treasury acquired a further 16,791 million ordinary shares raising their holding to 70.3% of the company’s issued ordinary share capital.
In consideration of its services under the First Placing and Open Offer Agreement, HM Treasury was paid (i) a commission of 0.5 per cent. of the aggregate value of the new shares at the issue price of 65.5 pence per new share payable on Admission (as defined in the First Placing and Open Offer Agreement) and the second business day after the day on which the First Placing and Open Offer Agreement terminated and (ii) a further commission of 1 per cent. of the aggregate value of the new shares acquired by placees (including HM Treasury) at the issue price of 65.5 pence per new share payable on Admission (as defined in the First Placing and Open Offer Agreement). The company paid all legal and other costs and expenses of HM Treasury, those of UBS and Merrill Lynch International properly incurred and the costs and expenses of HM Treasury’s financial advisers incurred in connection with the First Placing and Open Offer and the preference share issue.
First Subscription and Transfer Agreements In connection with the First Placing and Open Offer, the company, Merrill Lynch International, UBS, Computershare and Encuentro Limited entered into several agreements dated 4 November 2008, in respect of the subscription and transfer of ordinary shares and redeemable preference shares in Encuentro Limited. Under the terms of these agreements: (i) the company and UBS and/or Merrill Lynch International agreed to acquire ordinary shares in Encuentro Limited and enter into put and call options in respect of the ordinary shares in Encuentro Limited subscribed for by UBS and/or Merrill Lynch that were exercisable if the First Placing and Open Offer did not proceed; (ii) Merrill Lynch International or UBS, as applicable, agreed to apply monies received from qualifying shareholders, placees or HM Treasury under the First Placing and Open Offer to subscribe for redeemable preference shares in Encuentro Limited to an aggregate value equal to such monies, after deduction of the amount of certain commissions and expenses; and
The Royal Bank undertook to HM Treasury, among other things, to: (i) provide all such assistance and information and data as is reasonably requested which is pertinent to the implementation of the APS and the Royal Bank’s potential participation in the APS; (ii) provide, as soon as practicable, an indicative list of the assets, commitments and exposures that the Royal Bank propose to include within the APS with a view to agreeing such list by 30 April 2009; GRA_6_Add_Info_09_349-369.qxp:GRA_6_Add_Info_09 15/3/10 09:36 Page 365
HM Treasury has agreed that it shall not be entitled to vote the B shares or the Dividend Access Share to the extent that votes cast on such B shares and the Dividend Access Share, together with any other votes which HM Treasury is entitled to cast in respect of any other ordinary shares held by or on behalf of HM Treasury, would exceed 75 per cent. of the total votes eligible to be cast on a resolution proposed at a general meeting of the company.
There are material restrictions on the form and substance of announcements or public statements (including any required by law or the rules of any securities exchange) made by the Group in relation to the APS or to HM Treasury in connection with the APS without HM Treasury’s consent.
At 31 December 2009, there were 99 registered shareholders of Series F ADSs, 66 registered shareholders of Series H ADSs, 29 registered shareholders of Series L ADSs, 7 registered shareholders of Series M ADSs, 39 registered shareholders of Series N ADSs, 42 registered shareholders of Series P ADSs, 14 registered shareholders of Series Q ADSs, 2 registered shareholders of Series R ADSs, 5 registered shareholders of Series S ADSs, 24 registered shareholders of Series T ADSs and 1 registered shareholder of Series U ADSs.
The ADSs described in the above paragraph were issued pursuant to a Deposit Agreement, among the company, The Bank of New York Mellon, as depository, and all owners and holders from time to time of ADSs issued thereunder. The ordinary shares of the company are listed and traded on the London Stock Exchange. All ordinary shares are deposited with the principal London office of The Bank of New York Mellon, as custodian for the depository.
On 23 February 2010, the closing price of the ordinary ADSs on the New York Stock Exchange was $11.00.
UK stamp duty and stamp duty reserve tax (SDRT) The following is a summary of the UK stamp duty and SDRT consequences of transferring an ADS or ADR in registered form (otherwise than to the custodian on cancellation of the ADS) or of transferring an ordinary share or a non-cumulative dollar preference share. A transfer of a registered ADS or ADR executed and retained in the United States will not give rise to stamp duty and an agreement to transfer a registered ADS or ADR will not give rise to SDRT. Stamp duty or SDRT will normally be payable on or in respect of transfers of ordinary shares or non-cumulative dollar preference shares and accordingly any holder who acquires or intends to acquire ordinary shares or non-cumulative dollar preference shares is advised to consult its own tax advisers in relation to stamp duty and SDRT.
Credit derivatives are contractual agreements that provide protection against a credit event on one or more reference entities or financial assets. The nature of a credit event is established by the protection buyer and protection seller at the inception of a transaction, and such events include bankruptcy, insolvency or failure to meet payment obligations when due. The buyer of the credit derivative pays a periodic fee in return for a payment by the protection seller upon the occurrence, if any, of a credit event. Credit derivatives include credit default swaps, total return swaps and credit swap options.
Defined contribution plan – pension or other post-retirement benefit plan where the employer’s obligation is limited to its contributions to the fund.
Loss given default (LGD) – the economic loss that may occur in the event of default i.e. the actual loss – that part of the exposure that is not expected to be recovered – plus any costs of recovery.
Mortgage servicing rights are the rights of a mortgage servicer to collect mortgage payments and forward them, after deducting a fee, to the mortgage lender.
Risk asset ratio (RAR) – total regulatory capital as a percentage of riskweighted assets.
Troubled debt restructurings – comprise those loans that are troubled debt restructurings but that are not included in either non-accrual loans or in accruing loans which are contractually overdue 90 days or more as to principal or interest. A restructuring of a loan is a troubled debt restructuring if the lender, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider.