Performance evaluation An external review of the effectiveness of the Board and senior committees, including the Board Risk Committee, during 2012 was conducted. The Committee has considered and discussed the report on the outcomes of the evaluation and is satisfied with the way in which the evaluation has been conducted, the conclusions and the recommendations for action. Overall, the review concluded that the Board Risk Committee continued to operate effectively. The outcomes of the evaluation have been reported to the Board, and during 2013, the Committee will place focus on driving further improvements to risk reporting and prioritisation of Committee time.
Philip Scott Chairman of the Board Risk Committee 27 February 2013
Letter from Penny Hughes Chair of the Group Performance and Remuneration Committee
There is no doubt that 2012 has been another challenging year and events such as attempts to manipulate LIBOR and the IT incident have had a direct impact on the Group, both from a financial and a reputational point of view. The Board has acknowledged the serious shortcomings in systems and controls which were uncovered as part of the investigations into LIBOR and deeply regrets the lack of integrity shown by a small group of employees.
Against this backdrop, we should not lose sight of the fact that the vast majority of employees at RBS continue to do their jobs well and are not responsible for the events that have made headlines. Around one third of our employees joined after the financial crisis. During the IT incident, there was a very positive illustration of the loyalty and determination of staff to support customers during a difficult and regrettable period. It is vital that we retain and motivate good people as the foundation upon which we will generate a valuable business for shareholders and a bank that society can respect.
Considerable progress has been made over the past four years and the Committee remains focused on delivering remuneration structures that complement our goal of rebuilding a safer and more sustainable business, capable of serving customers and shareholders well in the long term. It is a difficult but important balance that we are trying to achieve, reducing overall spend on pay and increasing accountability whilst nurturing the business from which future profits can flow. We have sought to strike this balance fairly, whilst demonstrating our ongoing commitment to restraint, reflecting the nature of our ownership.
I have set out below a summary of how the Committee approached the year: how performance has been assessed; the decisions that have been reached on pay for 2012 and how past mistakes have been taken into account; and changes that we are making to ensure a fair and transparent remuneration policy.
Review of Group Performance A number of significant milestones were reached during the year as part of the Group’s turnaround plan including: Repayment of the liquidity support to UK Government in May 2012; The successful flotation of more than one third of our stake in Direct
ROE at 10% or 14% excluding Ulster Bank. The ROE for Markets was 10% in challenging market conditions; Group expenses were 6% lower than in 2011 with staff costs down 6%; and
Whilst the Group made significant progress across a range of measures in 2012, the Committee, in conjunction with the Board, agreed that the reduction to shareholder value and reputational damage caused by incidents such as the LIBOR settlement should result in a reduction of this year’s variable pools and the application of clawback. Further details of the impact of these incidents on remuneration is set out on page 341. Some of the key outcomes on pay are as follows: Total variable compensation has been reduced from 2011 by 14% at a Group level and 20% for Markets (the reductions are 23% and 40% respectively after the application of clawback) as further evidence of the action that has been taken to bring down overall levels of pay; Variable compensation (pre clawback) as a percentage of operating profit before variable compensation decreased from 28% to 16% for 2012 for the Group and from 25% to 16% for Markets. Full details can be found in Note 3 to the consolidated accounts on pages 379 and 380; Since 2010, total variable compensation for the Group has been reduced by over 50%; Within the context of reduced variable pools, incentive awards continue to be targeted towards high performers and, as a consequence, 40% of employees eligible for an award will receive zero for 2012; Of those employees who do receive an award for 2012, 68% will receive less than £2,000 in total and 81% will receive less than £5,000; and
Average salary increases across the Group for 2013 will be less than 2%.
We will continue to monitor external developments and, where appropriate, refine our remuneration policy, for example, in light of the requirements of CRD IV.
Enhancements to remuneration governance and reporting In recognition that the Committee considers issues wider than just remuneration, the name of the Committee was changed to the Group Performance and Remuneration Committee. This reflects the Committee’s broader oversight role to consider performance in the round in supporting the Group’s purpose, vision and values aspirations. During 2012, the Committee has worked closely with the Board Risk Committee and Group Audit Committee, both of which have provided valuable input on key risk and control issues.
Report of the Group Performance and Remuneration Committee The role and responsibilities of the Committee The Committee is responsible for setting the Group’s policy on remuneration and overseeing its implementation. It reviews performance and makes recommendations to the Board in respect of the Group’s variable incentive pools and the remuneration arrangements of the executive directors of the Group. No director is involved in decisions regarding his or her own remuneration.
The Committee is also responsible for approving remuneration and severance arrangements for members of the Group’s Executive and Management Committees, FSA ‘Code Staff’, as well as overseeing arrangements for employees who are ‘In-Scope’ under the Asset Protection Scheme (APS). Details of the FSA Remuneration Code can be found at www.fsa.gov.uk and a definition of Code Staff is provided on page 325.
Summary of the principal activity of the Committee during 2012 Set out below is a summary of the activity of the Committee on a quarterly basis: First quarter Year end performance reviews and remuneration arrangements for members of the Group’s Executive and Management Committees and objectives for 2012. The year end performance reviews included input from the Board Risk Committee on the risk management performance of Executive and Management Committee members; Year end performance reviews and remuneration arrangements for
APS in scope employees, Code Staff, and High Earners; Approval of Group and Divisional variable pay pools; Approval of the Directors’ remuneration report; Outcomes of the annual performance evaluation of the Committee; Remuneration arrangements for executive directors which included a reduction to the LTIP award level for executive directors; Introduction of a new accountability review process which informs clawback decisions; and
Update on LTIP performance conditions and vesting outcomes for executive directors 2009 long term incentive awards.
Executive and Management Committee members; Outcomes of the second quarter accountability reviews; Formal remuneration strategy session to discuss and agree remuneration approach and priorities for the forthcoming year; Presentation from Markets and International Banking on business and strategic priorities and people plan; and
Fourth quarter Approval of remuneration approach for the most senior and highest paid employees in the Group (including executive directors and Group Executive and Management Committee members); Outcomes of the third quarter accountability reviews; Assessed and affirmed accountability review decision making principles; 2012 preliminary variable pay pool discussions for Group and
Divisions; Content for shareholder consultations undertaken in December 2012 and January 2013; Review of Committee remit and name; Review of incentive plans; Approval of revised shareholding requirements for executive directors and the introduction of new shareholding requirements for Group Executive Committee members; and
Improved review of performance across key areas of customer; risk; people and financial.
The review concluded that the Committee continued to operate effectively and the continued importance of the remuneration agenda and the commitment of the Committee members was recognised. The outcomes of the evaluation have been reported to the Board. As Board interest in remuneration matters remains intense and all directors understand the sensitivities involved, reporting on remuneration matters to the Board will be further enhanced during 2013.
How risk is reflected in our remuneration process Focus on risk is achieved through clear risk input into incentive plan design and target setting, as well as thorough risk review of performance, variable pools and clawback. The Committee is supported in this by the Group Audit Committee, the Board Risk Committee and the Group’s risk management function.
Risk is taken into account in the performance assessment through a thorough risk analysis carried out by the Group’s risk management function to a pre-agreed framework. Performance assessments may be adjusted in situations where risk performance is outside risk appetite or strategic plans. Non-financial factors such as progress on customer issues, turnover, succession planning, market environment and franchise development are then taken into account in developing a final variable pay proposal. Variable pay proposals are reviewed in the context of key compensation framework ratios including: compensation to revenues, compensation to pre-compensation profit and variable pay to pre- variable pay profit. These ratios help to ensure appropriate sharing of value between employees and shareholders. Finally, variable pay proposals are reviewed against our capital adequacy framework to ensure that regulatory requirements are met.
The process for review assessments (which consider material risk management, control and general policy breach failures, accountability for those events and appropriate action against individuals) is operated across divisions and functions. Divisional reviews are undertaken on a quarterly basis.
Actions may include recommendations for compensation adjustments (e.g. current year variable pay reduction, clawback) disciplinary investigations and performance adjustments (e.g. a change to performance rating).
Clawback may be up to 100% of unvested awards and can be applied regardless of whether or not disciplinary action has been undertaken.
The accountability review process is now fully embedded and during 2012 a number of issues were considered under the framework.
The outcomes for the 2012 performance year cover a range of actions and have included: reduction of current year variable pay awards; dismissal; clawback of previously awarded deferred and LTIP awards; and suspended vesting pending further investigation.
Key inputs to the Group Performance and Remuneration Committee to assist its decision-making The Committee receives regular updates on regulatory developments and general remuneration issues, as well as market and benchmarking data to support its decisions. It also received information from a number of external and internal sources during 2012. The diagram below illustrates this: Directors’ remuneration report Remuneration Governance continued
Extensive shareholder consultation and reporting to the Committee so that members are aware of shareholder views.
Accountability Review Panels review risk management, control and policy breach issues and make recommendations on actions which can include disciplinary investigations, current year annual incentive reduction and clawback.
The Committee regularly receives presentations from the divisions to obtain an insight into wider people issues beyond pay.
Reviews incentive plan design and target setting and provides risk review of divisional/individual performance.
Reviews annual incentive plans operated Group-wide, ensuring compliance with the Group’s design principles for short term incentives, and reports annually to the Committee.
Policy Report Our Group-wide Remuneration Policy The remuneration policy supports the Group’s business strategy and is designed to: attract, retain, motivate and reward high-calibre employees to deliver long term business performance within acceptable risk parameters; and provide clear alignment between annual and long-term targets for individuals and Group/divisional strategic plans.
Consultation on remuneration policy takes place with our social partners, including representatives from UNITE. The National Living Wage and London Living Wage are important benchmarks that we monitor each year as part of the annual pay review process. An annual Group-wide employee opinion survey takes place which includes a number of pay related questions.
The remuneration policy applies the same principles to all employees including Code Staff (1). The current key principles underpinning the Group-wide remuneration policy are set out below: Element of pay Objective Operation
To attract and retain employees by being competitive in the specific market in which the individual works.
The annual incentive pool is based on a balanced scorecard of measures including customer, financial, risk and people measures. Allocation from the pool depends on divisional, functional and individual performance. Individual performance assessment is supported by a structured performance management framework.
Our policy is that awards are subject to individual performance. Guaranteed awards are only used in very limited circumstances in accordance with the FSA Remuneration Code. Immediate cash awards are limited to a maximum of £2,000.
Under the Group-wide deferral arrangements a significant proportion of annual incentive awards for our more senior employees are deferred over a three year period. Deferred awards are subject to clawback. For Code Staff, 50% of any annual incentive is delivered in the form of Group shares and subject to an additional six month retention period post vesting.
The Group provides certain employees in senior roles with long-term incentive awards.
Other share plans To offer employees in certain jurisdictions the opportunity to acquire Group shares.
Note: (1) The following groups of employees have been identified as meeting the FSA’s criteria for Code Staff: - Members of the Group Board and Group Executive and Management Committees; - Staff performing a Significant Influence Function within RBS Group; - Employees who have approval authorities such that their decision-making could have a material impact on the RBS Group income statement; - Employees who are responsible for a business or businesses whose performance could have a material impact on the RBS Group income statement; and - Key control function roles.
Summary of remuneration policy for executive directors for 2013 The remuneration policy for executive directors follows the Group-wide policy applicable to other employees but with greater emphasis on variable performance-related pay. This is to ensure that delivery of total remuneration to executive directors is more dependent on performance and can only be achieved if specific strategic targets and other measures are met. The structure of remuneration for executive directors involves greater delivery in shares in order to align further their reward with the long-term interests of shareholders. A summary is set out below: Element of pay Operation Maximum potential Performance metrics and period Changes to policy since last approved
Rate at 1 January 2013: Stephen Hester: £1,200,000 Bruce Van Saun: £750,000
Shares vest in two equal tranches on the first and second anniversary of the date of grant.
Long-term incentive Awards granted over shares which vest at the end of a three year period subject to performance conditions being met.
Each of the four performance elements has the potential to deliver shares worth 100% of salary at grant.
The notional value of these awards would be 45% of face value, which is 135% of salary.
Recruitment policy The policy on the recruitment of new executive directors aims to structure pay broadly in line with the framework and quantum applicable to current executive directors, taking into account that some variation may be necessary to secure the preferred candidate and to reflect the skills and experience required. Any awards granted to replace awards forfeited on leaving a previous employer will be on a comparable basis taking account of anticipated performance outcomes and the proportion of time elapsed. Full details will be disclosed in the next remuneration report following recruitment.
Group Finance Director - Bruce Van Saun 2010-2012 average compensation outcome for Group Chief Executive The preceding charts are based on target/expected values of total compensation. Press commentary tends to focus either on these values, or on maximum values assuming all performance conditions are met. However, in practice over the period 2010 to 2012, the value received will be significantly less than the maximum or even target value of incentives, in light of waivers, performance conditions and share price changes over the period. The chart below shows the likely average pay-out to the Group Chief Executive over the 2010-2012 period.
Revise original Strategic Plan to respond to significant changes in the macro environment. Deliver execution of revised strategy including focus on brand values and fair outcomes for customers. Develop strategy for implementation of ring-fencing. Progress plans towards Government exit.
Monitor and improve the Group and divisional strategic plans. Drive effective design and implementation of revised plan.
Ensure statutory, regulatory and management reporting is compliant with all external and internal standards. Continue to improve ‘best in class’ external reporting. Provide strong Group Finance Director role to the business through strategic planning, budgeting, forecasting and reporting. Monitor and control Group budget. Ensure a robust capital and funding planning framework. Drive efficiency. Successful further Direct Line Insurance Group plc ‘selldown’ and re-plan of EU mandated branch disposals.
Delivery of measures relating to wholesale funding reliance, liquidity reserves and leverage ratio. Further progress on risk appetite, risk frameworks and conduct risk, in support of the continued culture change across the Group.
Progress on key risk requirements. Implementation of effective regulatory changes impacting capital, funding, and liquidity. Improve quality of risk and financial data. Continue development of Group Internal Audit function.
Lead upgraded team and build positive culture and sense of purpose. Contribute to overall Group management. Partner colleagues in leading the Group’s purpose, vision and values to support culture change.
The Committee will determine the actual value of any award by reference to the extent to which executive directors have met the performance targets. Awards will be paid entirely in shares and will vest in two equal tranches on the first and second anniversaries of the date of grant. Clawback provisions will apply prior to the vesting of the shares. An additional six month holding period will apply post vesting.
Core bank economic profit (25%) The Economic Profit measure is focused on the Core bank to ensure that performance reflects enduring earnings for the bank. Economic Profit, being a risk-adjusted financial measure, is consistent with the FSA Code and also provides a balance between measuring growth and the cost of capital employed in delivering that growth. Core bank Economic Profit is defined as Core bank Operating Profit after Tax less attributed equity multiplied by the cost of equity, where: Core bank Operating Profit after Tax is Core Operating Profit taxed at a standard tax rate.
Attributed Equity is defined as equity allocated to the Core businesses, calculated as a function of the Core businesses risk-weighted asset base.
Current Cost of Equity is 11.5%, which is subject to review at least annually.
Relative TSR Comparator Group Weighting 1 Barclays 200% 2 Lloyds Banking Group 3 HSBC 150% 4 Standard Chartered
Bank of America, BBVA, BNP Paribas, Citigroup, Credit Agricole, Credit Suisse Group, Deutsche Bank, JP Morgan Chase, National Australia Bank Limited, Royal Bank of Canada, Santander, Societe Generale, The Toronto-Dominion Bank Group, UBS, Unicredito, Wells Fargo & Company 20% of the award will vest if the Group’s TSR is at the median of the companies in the comparator group.
100% of the award will vest if the Group’s TSR is at the upper quartile of the companies in the comparator group.
Balance Sheet & Risk (25%) The Balance Sheet & Risk measures have a particular focus on risk reduction, the resolution of the Non-Core business and the building of a sustainable and responsible franchise for the Group.
Strategic Scorecard (25%) The balanced Strategic Scorecard rewards management for delivering a robust basis for future growth in terms of the strength of our franchise, efficiency, reputation, and the engagement of employees.
Non-Core Run-Down Core Tier 1 capital ratio Wholesale funding Liquidity reserves Leverage ratio Loan:deposit ratio
Both quantitative and qualitative strategic measures are used, including measures relating to reputation, customer excellence, organisational capability and sustainability, given that these will support the long-term goals of the business. Targets for each measure are set at the start of the performance period and, where applicable, are aligned with the Group’s Strategic Plan targets. Commentary will be provided on an annual basis in relation to progress against the targets, where these are not commercially sensitive.
Shareholders views and their impact on remuneration policy In late 2012 and early 2013, an extensive consultation was undertaken with institutional shareholders and other stakeholders on the Group’s remuneration approach.
The consultation process involved one-to-one meetings, a roundtable session hosted by the Association of British Insurers and National Association of Pension Funds and a number of follow-up letters and meetings. Meetings have taken place involving around 20 institutional shareholders and shareholder bodies representing a substantial proportion of the non-UKFI shareholding. Topics discussed included financial progress and building a sustainable business, our remuneration strategy to date and the future shape of pay. UKFI were also consulted and as with other shareholders, the Committee received their input.
The support received from shareholders during the consultation period has been greatly encouraging. Shareholders have played a key role in developing remuneration practices that support the long-term goals of the business. Our remuneration approach of delivering a significant proportion of variable pay for senior executives in shares with deferral periods and clawback provisions provides strong alignment with the interests of shareholders.
Service contracts and exit payment policy The company's policy in relation to the duration of contracts with directors is that executive directors' contracts generally continue until termination by either party, subject to the required notice, or until retirement. The notice period under the service contracts of executive directors will not normally exceed twelve months.
Any compensation payment made in connection with the departure of an executive director will be subject to approval by the Committee, having regard to the terms of the service contract and the reasons for termination.
Information regarding the executive directors' service contracts is shown below: Date of current contract
Except as noted below, in the event of severance where any contractual notice period is not worked, the employing company may pay a sum to the executive in lieu of the notice period. In the event of situations involving breach of the employing company's policies resulting in dismissal, reduced or no payments may be made to the executive. Depending on the circumstances of the termination of employment, the executive may be entitled, or the Committee may allow, outstanding awards under long-term incentive arrangements to vest, subject to the rules of the relevant plan.
Stephen Hester In the event of his personal underperformance, the company is entitled, after giving reasonable opportunity to remedy any failure, to terminate Stephen Hester’s contract by giving written notice with immediate effect and without making any payment in lieu of notice and Stephen Hester will forfeit any unvested stock awards. In the event that Stephen Hester's employment is terminated by the company (other than by reason of his personal underperformance or in circumstances where the company is entitled to dismiss without notice), or if he resigns in response to a fundamental breach of contract by the company, he will be entitled to receive a payment in lieu of notice to the value of base salary, annual incentive and benefits (including pension contributions). If he resigns voluntarily and the company does not require him to work out his notice period, Stephen Hester may receive a payment in lieu of notice based on salary only (i.e. no annual incentive or benefits). In both cases the treatment of any other unvested stock awards will be determined by the Committee and the Board, having due regard to the circumstances of the departure.
Notes (1) Stephen Hester waived any annual incentive entitlement for the 2012 performance year. Bruce Van Saun has been awarded an annual incentive of £980,000 which will be granted as an award entirely in shares in March 2013 and will vest in March 2014 and 2015. For subsequent reporting years, the shares awarded to Bruce Van Saun will be detailed in the Deferred Awards table (see page 340). Further details of the performance assessment of the executive directors in 2012 is outlined on pages 333 and 334.
(2) The nil value under the LTIP column reflects awards granted under the Medium-term Performance Plan and Executive Share Option Plan in 2009. The awards did not vest in 2012 as a result of the performance conditions not being met.
Notes: (1) Board Committee fee includes membership of the Asset Protection Scheme Senior Oversight Committee. (2) Art Ryan is a non-executive director of RBS Citizens Financial Group, Inc. for which he received fees of US$131,000 during 2012. (3) Retired from the Board with effect from 31 March 2012.
The continued challenges in the economic and regulatory environment prompted revision of the Group’s strategy, including a restructured wholesale business. The revised strategy continues to deliver on safety and soundness, whilst rebalancing the Group towards retail and commercial business and delivering economic returns for the Core Bank by the end of plan period. The revised strategy for the investment banking business was implemented successfully, with restructuring targets for 2012 broadly met. The Asset Protection Scheme was successfully exited in October; this was at the earliest opportunity post payment of the minimum fee.
Bruce Van Saun Bruce Van Saun’s performance is also measured against a number of strategic and business objectives. He continues to perform as a world class Group Finance Director, providing both a strong strategic contribution for the Group together with the broader finance contribution to the Group’s priority to strengthen the balance sheet and reduce risk. Group Treasury has facilitated a significant reduction in the Group’s reliance on short-term funding. Bruce Van Saun has displayed strong leadership on a number of key strategic projects, notably the Group’s successful divestment of Direct Line Group and exit from the Asset Protection Scheme at the earliest opportunity. He showed early commitment to taking forward the Group’s cultural change within Finance. The Committee recommended, and the Board (excluding executive directors) approved, that the Group Finance Director receive an award of 65% of the maximum allocation for the 2012 performance year, which equates to £980,000. The award will be made entirely in shares, vesting in two equal tranches on the first and second anniversary of the date of grant and subject to clawback provisions prior to vesting.
Strategic progress Monitor and improve the Group and divisional strategic plans. Drive effective design and implementation of revised plan. Work with CEO on Group Strategy/M&A/APS.
Revised strategy agreed by the Board, with rigour of process acknowledged by Board and regulators. Continued challenge and good progress made on 2012 costs, capital resource usage, and targets for 2013 budgets. Strong leadership displayed on key strategic projects; APS exit at the earliest opportunity and with minimum fee payment.
Ensure statutory, regulatory and management reporting is compliant with all external and internal standards. Continue to improve ‘best in class’ external reporting. Provide strong Group Finance Director role to the business through strategic planning, budgeting, forecasting and reporting. Ensure a robust capital and funding planning framework. Drive efficiency. Successful completion of EU mandated disposals.
Direct Line Insurance Group plc divestment well received by investors and the market, and is widely viewed as a “textbook” execution due to the uptake and price behaviour; branch disposal did not proceed due to unexpected withdrawal of Santander. The DLG IPO is a particular credit to the Group Finance Director’s exceptional abilities and leadership.
Risk and control Implementation of effective regulatory changes impacting capital, funding, liquidity. Improve quality of risk and financial data. Continue development of Internal Audit function. Deliver against agreed APS objectives.
Excellent contribution to external relations, articulating results with clarity and credibility. Successful engagement with equity and debt investors; good engagement with the new UK regulators, US regulators and ratings agencies. Significant success in achieving narrower funding and certificates of deposits spreads, and diversification of the debt investor base. Under the Group Finance Director’s leadership, RBS has effectively withstood a ratings downgrade of ‘one notch’, whilst other peers were downgraded by ‘two notches’. Effective working with the Group Audit Committee.
People management Lead upgraded team and build positive culture. Contribute to overall Group management.
Economic profit 50% Ensures that performance reflects enduring earnings for the Bank.
Maximum vesting of the economic profit measure will be triggered by early delivery of Core business profitability, well ahead of the range implied by the published Strategic Plan targets and also in excess of the cost of capital.
Analysis of economic profit outcome is currently under review and decision on vesting level will be taken before the awards vest in May 2013.
Performance conditions for outstanding LTIP share awards granted in 2011 and 2012 The table below summarises the assessment of performance to date against the three year performance period. Each measure has the ability to deliver a number of shares worth up to 100% of salary. However, the number of shares that vest will be subject to an overall cap in value of 375% of salary for the 2011 awards and 300% of salary for the 2012 awards. Awards are due to vest in 2014 and 2015 respectively. An assessment of performance of each relevant element is provided by the control functions and an external firm assesses relative TSR performance. The Committee determines overall vesting based on these assessments including consideration of the drivers of performance and the context against which it was delivered. The assessment is analytical and if any discretion is used in the final assessment, it will be explained. The table below represents an early indication of potential vesting outcomes only.
Performance measure Weighting Rationale Vesting 2011 LTIP Current assessment of performance 2012 LTIP Current assessment of performance
Core Bank economic profit 25% Ensures that performance reflects risk adjusted enduring earnings for the Bank.
Maximum: 100% vesting for performance ahead of the Group’s Strategic Plan.
Threshold: 20% vesting if the Group’s TSR is at the median of the companies in the comparator group.
Vesting will be qualified by Group Performance and Remuneration Committee discretion. Indicative vesting levels are: Over half of objectives not met: 0%; Half of objectives met: 25%; Two-thirds of objectives met: Objectives met or exceeded in all material respects: 100%.
Good progress on brand franchises (e.g. ‘Helpful Banking’ in UK), sustainability and employee engagement measures. Further work needed on cost:income ratio.
Total Shareholder Return performance The graph below shows the performance of the company over the past five years in terms of TSR compared with that of the companies comprising the FTSE 100 Index. This index has been selected because it represents a cross-section of leading UK companies. The TSR for FTSE banks for the same period has been added for comparison. The TSR for the company and the indices have been rebased to 100 for 1 January 2008. The second graph shows the same performance of the company during 2012.
Total Shareholder Return – one year RBS shares had a strong start and outperformed the market for the majority of the first half of the year partly due to a continuing reduction in size and de-risking of non-core helping to re-balance the balance sheet and the announced re-structuring of our investment bank. The Eurozone economies were in focus throughout the year in terms of concerns over their financial health and stability. Fiscal instability within peripheral Eurozone countries, particularly Spain and Greece, increased investor concerns on UK and European banks and their exposure to these countries. This impacted the RBS share price in line with other UK and European peers. Towards the end of the year sentiment on the Eurozone improved, with RBS shares outperforming the market.
Implementation of the Group’s recovery plan started in January 2009 with the publication of the preliminary 2008 losses. The share price reached a closing low point of 10.3p per share (103p per share on a post share consolidation basis) on the news.
From January 2009 to 27 February 2013, the day the Group’s 2012 results announcement was approved, the Group’s share price has risen 237% which compares to 104% and 55% respectively for the FTSE banks index and the FTSE 100 index as a whole.
Resolution 1 To approve the Report and Accounts for the year ended 31 December 2011.
* A vote Withheld is not a vote in law and is not counted in the calculation of the proportion of votes “For” and “Against” a resolution.
FSA Remuneration Code compliance The Group has been fully compliant throughout 2012 with all aspects of the FSA Remuneration Code.
Shareholder dilution During the ten year period to 31 December 2012, awards made that could require new issue shares under the company's share plans represented 3.9% of the company's issued ordinary share capital (including the B share capital), leaving an available dilution headroom of 6.1%. The company meets its employee share plan obligations through a combination of new issue shares and market purchase shares.
Directors’ shareholding requirements During 2012, the Committee agreed that it would be appropriate to strengthen the shareholding requirements for executive directors and to introduce new shareholding requirements for members of the Group’s Executive Committee. The target shareholding level for the Group Chief Executive is 250% of salary and 125% of salary for other executive directors and members of the Group Executive Committee, in each case excluding any unvested share awards in the calculation. A period of five years is allowed in which to build up shareholdings to meet the required levels. To date, the executive directors have not sold any shares that they have received under the Group’s share plans, other than to meet tax liabilities on vesting.
Executive director Stephen Hester 541,135 651,177 2,113,069 Bruce Van Saun — 118,680 385,117
Notes: (1) Stephen Hester has agreed to a voluntary holding period of two further years beyond the vesting date for the net post-tax number of vested shares in respect of at least one third of the award. (2) Bruce Van Saun has agreed to a voluntary holding period of two further years beyond the vesting date for the net post-tax number of vested shares for the amount over 300% of his salary.
Performance conditions for LTIP awards made in prior years Summaries of the performance targets for each year and current assessment of performance can be found on pages 335 and 336. Full details of the performance conditions can also be found in the Report and Accounts for each year on www.rbs.com/annualreport.
Options held at 1 January 2012 Number of options lapsed in 2012
Medium-Term Performance Plan (MPP) The MPP was approved by shareholders in April 2001. No further awards will be made under the MPP as it has been replaced by the LTIP. No variation was made to any of the terms of the plan during the year. The awards below lapsed during 2012 as a result of the relative and absolute TSR measures not being met. The figures shown below have been adjusted to reflect the share sub-division and consolidation, which took effect in June 2012.
Stephen Hester 480,000 3.72 480,000 — — Bruce Van Saun 181,061 5.67 181,061 — —
Note: (1) Philip Hampton waived his right to the above award which was made in 2009 and due to vest in 2012 and therefore the award was lapsed.
Penny Hughes Chair of the Group Performance and Remuneration Committee 27 February 2013
Saun Executive 1 Executive 2 Executive 3 Executive 4 Executive 5 Executive 6 Executive 7 Executive 8 £000 £000 £000 £000 £000 £000 £000 £000 £000 £000
Long Term Incentive Awards (subject to future performance) (2) 1,620 1,013 994 1,125 675 — 969 — 270 —
Notes: (1) Differs to 2011 disclosure with exclusion of prior year Long Term Incentive Awards which vested during 2012. (2) The Long Term Incentive Award (subject to future performance) is made following the end of the 2012 financial year. The amounts shown reflect an approximate notional value, verified by external advisers. The actual value of the award which will vest in 2016 will be dependent on actual performance and share price.
The RBS Board has acknowledged that there were serious shortcomings in our risk and control systems, and also in the integrity of a small group of our employees, and has taken action to ensure full and proper accountability: All 21 wrongdoers referred to in the regulatory findings have left the organisation or been subject to disciplinary action.
Individuals found culpable have left the bank with no 2012 variable compensation awards and full clawback of any outstanding past variable compensation applied.
The cumulative impact of the Board’s actions is a deduction from employee incentive pay of over £300 million, with the Markets division bearing the greatest cost. A breakdown of how this figure has been reached is set out below: £m
Variable compensation award reduction 110 Long term incentive award reduction 30 Clawback of prior year awards (including LTIP) 112 Committed future reduction 2013/2014 50 Total 302
Rest of RBS Group £m 2. Amounts and form of fixed and variable remuneration
Fixed Remuneration Consisted of salaries, pensions and benefits paid during the year.
Long term incentives Long term incentive awards made each year are paid three years after the date of award based on the extent to which performance conditions are met, and can result in zero payment if performance is not at the threshold level.
Others £m 3. Outstanding deferred remuneration through 2012 The table below includes deferred remuneration awarded or paid out in 2012. Deferred remuneration reduced during the year relates to long term incentives lapsing when performance conditions are not met, long term incentives and deferred awards forfeited on leaving, options lapsing and clawback of prior year deferred awards and long term incentives.
Notes on the presentation of remuneration In the relevant tables above, assumptions have been made for the notional value of long term incentives (verified by external advisors) and, forfeitures through resignation for deferred awards.
Throughout the year ended 31 December 2012, the company has complied with all of the provisions of the UK Corporate Governance Code issued by the Financial Reporting Council dated June 2010 (the “Code”) except in relation to provision (D.2.2) that the Group Performance and Remuneration Committee should have delegated responsibility for setting remuneration for the Chairman and executive directors. The company considers that this is a matter which should rightly be reserved for the Board and this is an approach the company has adopted for a number of years. Remuneration for the Chairman and executive directors is first considered by the Group Performance and Remuneration Committee which then makes recommendations to the Board for consideration. This approach allows all non-executive directors, and not just those who are members of the Group Performance and Remuneration Committee, to participate in decisions on the executive directors’ and the Chairman’s remuneration and also allows the executive directors to input to the decision on the Chairman’s remuneration. The Board believes this approach is very much in line with the spirit of the Code and no director is involved in decisions regarding his or her own remuneration. We do not anticipate any changes to our approach on this aspect of the Code. Information on how the company has applied the main principles of the Code can be found in the Corporate governance report on pages 294 to 342. The company has also complied early with a number of the new provisions included in the new edition of the UK Corporate Governance Code issued by the Financial Reporting Council dated September 2012 (the “2012 Code”). A copy of both the Code and the 2012 Code can be found at www.frc.org.uk
Based on its assessment, management has concluded that, as of 31 December 2012, the Group's internal control over financial reporting is effective.
As stated at the start of this Compliance report, in the case of the company, the Group Board, rather than the Group Performance and Remuneration Committee, reserves the authority to make the final determination of the remuneration of the Group Chief Executive.
Group structure The company is a holding company owning the entire issued ordinary share capital of The Royal Bank of Scotland plc, the principal direct operating subsidiary undertaking of the company. The Group comprises the company and all its subsidiary and associated undertakings, including the Royal Bank and NatWest. Details of the principal subsidiary undertakings of the company are shown in Note 8 on page 482.
At 31 December 2012, HMT’s holding in the company’s ordinary shares had reduced to 65.3% as a consequence of share issues during the year.
Results and dividends The loss attributable to the ordinary and B shareholders of the company for the year ended 31 December 2012 amounted to £5,971 million compared with a loss of £1,997 million for the year ended 31 December 2011, as set out in the consolidated income statement on page 353.
On 4 May 2012, RBS determined that it was in a position to recommence payments on RBS Group instruments. The Core Tier 1 capital impact of discretionary amounts payable in 2012 on RBSG instruments on which payments have previously been stopped is c.£330 million. The Board of RBSG decided to neutralise any impact on Core Tier 1 capital through equity issuance. Approximately 65% of this is ascribed to equity funding of employee incentive awards through the sale of surplus shares held by the Group’s Employee Benefit Trust, which was completed in June 2012. The remaining 35% was raised through the issue of new ordinary shares which was completed in September 2012.
Business review Activities The Group is engaged principally in providing a wide range of banking, insurance and other financial services. Further details of the organisational structure and business overview of the Group, including the products and services provided by each of its divisions and the competitive markets in which they operate, are contained in the Business review on pages 40 to 42. Details of the strategy for delivering the company’s objectives can be found on pages 16 and 17.
The Group’s approach to risk management, including its financial risk management objectives and policies and information on the Group’s exposure to price, credit, liquidity and cash flow risk, is discussed in the Risk and balance sheet management section of the Business review on pages 107 to 293.
Diversity and inclusion During 2012, the Group executive renewed its commitment to making workplace policies, processes and experiences inclusive for staff, customers and stakeholders. In support of this, Group HR has set inclusion within its top priorities for 2013.
The Group also supports employee led networks such as Focused Women and Rainbow who provide personal and career development opportunities through networking and training events.
This approach to inclusion extends to the marketplace with the RBS Women in Business specialists supporting and guiding more and more women to take the step of starting their own business.
This year the Group has been recognised for its work on Equality, Diversity and Inclusion by retaining our Gold standard ranking from Opportunity Now (gender), achieving Silver for Race for Opportunity (race), attaining the Top Employers award for employee engagement from workingmums.co.uk as well as securing a position in the Working Families Top 10.
The Group is committed to ensuring legal compliance and managing health and safety risks. During 2012, increased focus on leadership, governance and the effectiveness of controls delivered improvements in health and safety performance.
A wide range of health benefits and services are in place to help employees maintain good physical and psychological health, and support them if they do become unwell. A number of these services have been enhanced and promoted in response to the impact of the economic environment. For example, in 2012 we launched an online toolkit which provides easy access to a range of resources, provided through our Employee Assistance Programme, to help employees deal with stress, build resilience and manage personal finances.
Corporate governance The company is committed to high standards of corporate governance. Details are given in the Corporate governance report on pages 294 to 342. The Corporate governance report and compliance report (pages 343 and 344) form part of this Report of the directors.
Following approval at the Group’s Annual General Meeting on 30 May 2012, the sub-division and consolidation of the Group’s ordinary shares on a one-for-ten basis took effect on 6 June 2012. The nominal value of the ordinary shares was amended to £1. The sub-division and consolidation of the Group’s ordinary shares resulted in the creation of 59,554,319,127 deferred shares of 15p each, which were cancelled on 6 June 2012.
The cumulative preference shares represent less than 0.015% and the non-cumulative preference shares represent less than 0.675% of the total voting rights of the company respectively, the remainder being represented by the ordinary shares.
The rules governing the powers of directors, including in relation to issuing or buying back shares and their appointment are set out in the company’s Articles of Association. It will be proposed at the 2013 Annual General Meeting that the directors be granted authorities to allot shares under the Companies Act 2006. The company’s Articles of Association may only be amended by a special resolution at a general meeting of shareholders.
All of the current directors served throughout the year and to the date of signing of the financial statements.
Shareholdings The table below shows shareholders that have notified the Group that they hold more than 3% of the total voting rights of the company at 31 December 2012.
Solicitor For The Affairs of Her Majesty’s Treasury as Nominee for Her Majesty’s Treasury
On 1 February 2013, the Group was notified that Her Majesty’s Treasury’s shareholding of ordinary shares represented 65.28% of the total voting rights. The increase was as a result of a change in the total voting rights.
Charitable contributions In 2012, the Group’s overall community contribution was £57.3 million (2011 - £72.0 million). The total amount given for charitable purposes by the company and its subsidiary undertakings during the year ended 31 December 2012 was £25.8 million (2011 - £39.1 million).
Policy and practice on payment of creditors The Group is committed to maintaining a sound commercial relationship with its suppliers. Consequently, it is the Group’s policy to negotiate and agree terms and conditions with its suppliers, which include the giving of an undertaking to pay suppliers within 30 days of receipt of a correctly prepared invoice submitted in accordance with the terms of the contract or such other payment period as may be agreed.
We, the directors listed below, confirm that to the best of our knowledge: the financial statements, prepared in accordance with International
Financial Reporting Standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and the undertakings included in the consolidation taken as a whole; and the Business review, which is incorporated into the Directors' report, includes a fair review of the development and performance of the business and the position of the company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.
Bruce Van Saun Sandy Crombie Alison Davis Tony Di Iorio Penny Hughes Joe MacHale Brendan Nelson Baroness Noakes Arthur ‘Art’ Ryan Philip Scott
Independent auditor’s report to the members of The Royal Bank of Scotland Group plc
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 2012 which comprise the accounting policies, the consolidated and company balance sheets as at 31 December 2012, the consolidated income statement, the consolidated statement of comprehensive income, the consolidated and company statements of changes in equity and the consolidated and company cash flow statements for the year ended 31 December 2012, the related Notes 1 to 42 on the consolidated financial statements, the related Notes 1 to 17 on the company financial statements and the information identified as 'audited' in the Risk and balance sheet management section of the Business review. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRS) as adopted by the European Union and, as regards the company financial statements, as applied in accordance with the provisions of the Companies Act 2006.
This report is made solely to the company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the company's members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company's members as a body, for our audit work, for this report, or for the opinions we have formed.
Scope of the audit of the financial statements An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: the reasonableness of significant accounting estimates made by the directors in the preparation of the financial statements; whether the accounting policies are appropriate to the circumstances of the company and the Group and have been consistently applied and adequately disclosed; and the overall presentation of the financial statements. In addition, we read all the financial and non-financial information in the annual report to identify material inconsistencies with the audited financial statements. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
Opinion In our opinion: the financial statements give a true and fair view of the state of the
Separate opinion in relation to IFRS as issued by the IASB As explained in the accounting policies, the Group has prepared financial statements that comply with IFRS as adopted by the European Union, and with IFRS as issued by the International Accounting Standards Board (IASB).
Opinion on other matters prescribed by the Companies Act 2006 In our opinion: the part of the Directors' remuneration report described as having been audited has been properly prepared in accordance with the Companies Act 2006; and the information given in the Report of the directors for the financial year for which the financial statements are prepared is consistent with the financial statements.
Kari Hale (Senior Statutory Auditor) for and on behalf of Deloitte LLP Chartered Accountants and Statutory Auditor London, United Kingdom 27 February 2013
Net interest income 1 11,402 12,303 13,782 Fees and commissions receivable 2 5,709 6,379 8,193 Fees and commissions payable 2 (834) (962) (1,892) Income from trading activities 2 1,675 2,701 4,517 Gain on redemption of own debt 2 454 255 553 Other operating income 2 (465) 3,975 1,355 Insurance net premium income — — 114 Non-interest income 6,539 12,348 12,840 Total income 17,941 24,651 26,622 Staff costs (8,076) (8,356) (9,379) Premises and equipment (2,232) (2,423) (2,380) Other administrative expenses (5,593) (4,436) (3,571) Depreciation and amortisation (1,802) (1,839) (2,125) Write-down of goodwill and other intangible assets (124) (80) (1)
Profit before insurance net claims and impairment losses 114 7,517 9,166 Insurance net claims — — (85)
Per ordinary and B share (1,2) Basic and diluted loss from continuing operations 9 (53.7p) (21.3p) (2.9p)
Basic and diluted loss from continuing and discontinued operations 9 (54.3p) (18.5p) (4.8p)
Notes: (1) B shares rank pari-passu with ordinary shares. (2) Prior years have been adjusted for the sub-division and one-for-ten consolidation of ordinary shares in 2012.
Liabilities Deposits by banks 10 101,405 108,804 98,790 Customer accounts 10 521,279 502,955 510,693 Debt securities in issue 10 94,592 162,621 218,372 Settlement balances 5,878 7,477 10,991 Short positions 21 27,591 41,039 43,118 Derivatives 14 434,333 523,983 423,967 Accruals, deferred income and other liabilities 22 14,801 23,125 23,089 Retirement benefit liabilities 4 3,884 2,239 2,288 Deferred tax 23 1,141 1,945 2,142 Insurance liabilities — 6,312 6,794 Subordinated liabilities 24 26,773 26,319 27,053 Liabilities of disposal groups 20 10,170 23,995 9,428 Total liabilities 1,241,847 1,430,814 1,376,725
Non-controlling interests 25 2,318 1,234 1,719 Owners’ equity 26,27 68,130 74,819 75,132 Total equity 70,448 76,053 76,851
Share premium account At 1 January 24,001 23,922 23,523 Ordinary shares issued 360 79 281 Redemption of preference shares classified as debt — — 118 At 31 December 24,361 24,001 23,922
Merger reserve At 1 January 13,222 13,272 25,522 Transfer to retained earnings — (50) (12,250)
Cash flow hedging reserve At 1 January 879 (140) (252) Amount recognised in equity 2,093 2,417 180 Amount transferred from equity to earnings (1,087) (993) (59)
Recycled to profit or loss on disposal of businesses (3) — — 58 At 31 December 1,666 879 (140)
Retained earnings At 1 January 18,929 21,239 12,134 Transfer to non-controlling interests (361) — — (Loss)/profit attributable to ordinary and B shareholders and other equity owners - continuing operations (5,623) (2,303) (797)
Own shares held At 1 January (769) (808) (121) Disposal/(purchase) of own shares 441 20 (700) Shares issued under employee share schemes 115 19 13 At 31 December (213) (769) (808)
Non-controlling interests (see Note 25) At 1 January 1,234 1,719 16,895 Currency translation adjustments and other movements (18) (54) (466) (Loss)/profit attributable to non-controlling interests - continuing operations (11) (14) (60)
Total comprehensive loss recognised in the statement of changes in equity is attributable to: Non-controlling interests (116) (24) (197) Preference shareholders 273 — 105 Paid-in equity holders 15 — 19 Ordinary and B shareholders (7,269) (756) (598)
Operating activities Operating loss before tax (5,165) (1,190) (154) Operating (loss)/profit before tax on discontinued operations (111) 482 (786) Adjustments for: Depreciation and amortisation 1,854 1,875 2,220 Write-down of goodwill and other intangible assets 518 91 10 Interest on subordinated liabilities 841 740 500 Charge for defined benefit pension schemes 446 349 540 Pension scheme curtailment and settlement gains (41) — (78) Cash contribution to defined benefit pension schemes (977) (1,059) (832) Gain on redemption of own debt (454) (255) (553) Provisions for impairment losses 5,283 8,709 9,298 Loans and advances written-off net of recoveries (3,925) (4,000) (5,631) Elimination of foreign exchange differences 7,140 2,702 (691) Other non-cash items (1,491) (1,491) (2,212) Net cash flows from trading activities 3,918 6,953 1,631 Changes in operating assets and liabilities (48,736) (3,444) 17,095 Net cash flows from operating activities before tax (44,818) 3,509 18,726 Income taxes (paid)/received (295) (184) 565 Net cash flows from operating activities 33 (45,113) 3,325 19,291
Interest on subordinated liabilities (746) (714) (639) Net cash flows from financing activities 2,017 (1,741) (14,380) Effects of exchange rate changes on cash and cash equivalents (3,893) (1,473) 82
Net (decrease)/increase in cash and cash equivalents (19,814) 125 8,344 Cash and cash equivalents at 1 January 152,655 152,530 144,186 Cash and cash equivalents at 31 December 37 132,841 152,655 152,530
In accordance with IFRS 5, Direct Line Group has been classified as a discontinued operation, and prior periods represented.
Depreciation is charged to profit or loss on a straight-line basis so as to write-off the depreciable amount of property, plant and equipment (including assets owned and let on operating leases) over their estimated useful lives. The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. The estimated useful lives of the Group’s property, plant and equipment are: Freehold and long leasehold buildings 50 years Short leaseholds unexpired period of the lease Property adaptation costs 10 to 15 years Computer equipment up to 5 years Other equipment 4 to 15 years
Non-monetary items denominated in foreign currencies that are stated at fair value are translated into the relevant functional currency at the foreign exchange rates ruling at the dates the values are determined. Translation differences arising on non-monetary items measured at fair value are recognised in profit or loss except for differences arising on available-for-sale non-monetary financial assets, for example equity shares, which are recognised in other comprehensive income unless the asset is the hedged item in a fair value hedge.
11. Leases As lessor Contracts with customers to lease assets are classified as finance leases if they transfer substantially all the risks and rewards of ownership of the asset to the customer; all other contracts with customers to lease assets are classified as operating leases.
Insurance claims - insurance claims are recognised in the accounting period in which the loss occurs. Provision is made for the full cost of settling outstanding claims at the balance sheet date, including claims incurred but not yet reported at that date. Outstanding claims provisions are not discounted for the time value of money except for claims to be settled by periodical payments. Claims handling expenses are also included.
15. Financial assets On initial recognition, financial assets are classified into held-to-maturity investments; held-for-trading; designated as at fair value through profit or loss; loans and receivables; or available-for-sale financial assets. Regular way purchases of financial assets classified as loans and receivables are recognised on settlement date; all other regular way transactions in financial assets are recognised on trade date.
Designated as at fair value through profit or loss - financial assets may be designated as at fair value through profit or loss only if such designation (a) eliminates or significantly reduces a measurement or recognition inconsistency; or (b) applies to a group of financial assets, financial liabilities or both, that the Group manages and evaluates on a fair value basis; or (c) relates to an instrument that contains an embedded derivative which is not evidently closely related to the host contract. Financial assets that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss, and are subsequently measured at fair value. Gains and losses on financial assets that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.
Overdrafts and other unsecured loans: write offs occur within 6 years.
Fair value - fair value for a net open position in a financial liability that is quoted in an active market is the current offer price times the number of units of the instrument issued. Fair values for financial liabilities not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial liabilities (see Note 11 Financial instruments - valuation).
23. Capital instruments The Group classifies a financial instrument that it issues as a liability if it is a contractual obligation to deliver cash or another financial asset, or to exchange financial assets or financial liabilities on potentially unfavourable terms and as equity if it evidences a residual interest in the assets of the Group after the deduction of liabilities. The components of a compound financial instrument issued by the Group are classified and accounted for separately as financial assets, financial liabilities or equity as appropriate.
24. Derivatives and hedging Derivative financial instruments are initially recognised, and subsequently measured, at fair value. Derivative fair values are determined from quoted prices in active markets where available. Where there is no active market for an instrument, fair value is derived from prices for the derivative's components using appropriate pricing or valuation models (see Note 11 Financial instruments - valuation).
Accounting policies continued 25. Share-based compensation The Group operates a number of share-based compensation schemes under which it awards RBSG shares and share options to its employees. Such awards are generally subject to vesting conditions: conditions that vary the amount of cash or shares to which an employee is entitled. Vesting conditions include service conditions (requiring the employee to complete a specified period of service) and performance conditions (requiring the employee to complete a specified period of service and specified performance targets to be met). Other conditions to which an award is subject are non-vesting conditions (such as a requirement to save throughout the vesting period).
A pension asset of £144 million and a liability of £3,884 million were recognised on the balance sheet at 31 December 2012 (2011 - asset £188 million, liability £2,239 million; 2010 - asset £105 million, liability £2,288 million).
Goodwill The Group capitalises goodwill arising on the acquisition of businesses, as discussed in Accounting policy 6. The carrying value of goodwill as at 31 December 2012 was £11,266 million (2011 - £12,424 million; 2010 - £12,528 million).
For the purposes of impairment testing, goodwill acquired in a business combination is allocated to each of the Group’s cash generating units or groups of cash-generating units expected to benefit from the combination. Goodwill impairment testing involves the comparison of the carrying value of a cash-generating unit or group of cash-generating units with its recoverable amount. The recoverable amount is the higher of the unit’s fair value and its value in use. Value in use is the present value of expected future cash flows from the cash generating unit or group of cash-generating units. Fair value is the amount obtainable for the sale of the cash-generating unit in an arm’s length transaction between knowledgeable, willing parties.
General insurance claims The Group makes provision for the full cost of settling outstanding claims arising from its general insurance business at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date and claims handling expenses. General insurance claims provisions amounted to £6,090 million at 31 December 2012 (2011 - £6,219 million; 2010 - £6,726 million).
Provisions are determined by management based on experience of claims settled and on statistical models which require certain assumptions to be made regarding the incidence, timing and amount of claims and any specific factors such as adverse weather conditions. Management use the work of internal and external actuaries to assess the level of gross and net outstanding claims provisions required to adopt a measurement basis of reserves which result in a provision in excess of actuarial best estimates. In order to calculate the total provision required, the historical development of claims is analysed using statistical methodology to extrapolate, within acceptable probability parameters, the value of outstanding claims at the balance sheet date. Also included in the estimation of outstanding claims are other assumptions such as the inflationary factor used for bodily injury claims which is based on historical trends and, therefore, allows for some increase due to changes in common law and statute; and the incidence of periodical payment orders and the rate at which payments under them are discounted. Costs for both direct and indirect claims handling expenses are also included. Outward reinsurance recoveries are accounted for in the same accounting period as the direct claims to which they relate. The outstanding claims provision is based on information available to management and the eventual outcome may vary from the original assessment. Actual claims experience may differ from the historical pattern on which the estimate is based and the cost of settling individual claims may exceed that assumed.
Provisions for liabilities As set out in Note 22, at 31 December 2012 the Group recognised provisions for liabilities in respect of Payment Protection Insurance, £895 million (2011 - £745 million; 2010 - nil), Interest Rate Hedging Products, £676 million (2011 and 2010 - nil), LIBOR investigations, £381 million (2011 and 2010 - nil) and other regulatory proceedings and litigation, £368 million (2011 - £241 million; 2010 - £192 million). Provisions are liabilities of uncertain timing or amount, and are recognised when there is a present obligation as a result of a past event, the outflow of economic benefit is probable and the outflow can be estimated reliably. Judgement is involved in determining whether an obligation exists, and in estimating the probability, timing and amount of any outflows. Where the Group can look to another party such as an insurer to pay some or all of the expenditure required to settle a provision, any reimbursement is recognised when, and only when, it is virtually certain that it will be received.
The Group has recognised deferred tax assets in respect of losses, principally in the UK, and temporary differences. Deferred tax assets are recognised in respect of unused tax losses to the extent that it is probable that there will be future UK taxable profits against which the losses can be utilised. Business projections indicate that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within six years (2011 - six years). The Group's cumulative losses are principally attributable to the recent unparalleled market conditions. Deferred tax assets of £3,827 million (2011 - £3,246 million; 2010 - £2,008 million) have not been recognised in respect of tax losses carried forward in jurisdictions where doubt exists over the availability of future taxable profits. Further details about the Group’s deferred tax assets are given in Note 23.
Loan impairment provisions The Group's loan impairment provisions are established to recognise incurred impairment losses in its portfolio of loans classified as loans and receivables and carried at amortised cost. A loan is impaired when there is objective evidence that events since the loan was granted have affected expected cash flows from the loan. Such objective evidence, indicative that a borrower’s financial condition has deteriorated, can include for loans that are individually assessed: the non-payment of interest or principal; debt renegotiation; probable bankruptcy or liquidation; significant reduction in the value of any security; breach of limits or covenants; and deteriorating trading performance and, for collectively assessed portfolios: the borrowers’ payment status and observable data about relevant macroeconomic measures.
Individual component - all impaired loans that exceed specific thresholds are individually assessed for impairment. Individually assessed loans principally comprise the Group's portfolio of commercial loans to medium and large businesses. Impairment losses are recognised as the difference between the carrying value of the loan and the discounted value of management's best estimate of future cash repayments and proceeds from any security held. These estimates take into account the customer's debt capacity and financial flexibility; the level and quality of its earnings; the amount and sources of cash flows; the industry in which the counterparty operates; and the realisable value of any security held. Estimating the quantum and timing of future recoveries involves significant judgement. The size of receipts will depend on the future performance of the borrower and the value of security, both of which will be affected by future economic conditions; additionally, collateral may not be readily marketable. The actual amount of future cash flows and the date they are received may differ from these estimates and consequently actual losses incurred may differ from those recognised in these financial statements.
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. Fair values are determined from quoted prices in active markets for identical financial assets or financial liabilities where these are available. Fair value for a net open position in a financial instrument in an active market is the number of units of the instrument held times the current bid price (for financial assets) or offer price (for financial liabilities). In determining the fair value of derivative financial instruments gross long and short positions measured at current mid market prices are adjusted by bid-offer reserves calculated on a portfolio basis. Credit valuation adjustments are made when valuing derivative financial assets to incorporate counterparty credit risk. Adjustments are also made when valuing financial liabilities to reflect the Group’s own credit standing. Where the market for a financial instrument is not active, fair value is established using a valuation technique. These valuation techniques involve a degree of estimation, the extent of which depends on the instrument’s complexity and the availability of market-based data. More details about the Group’s valuation methodologies and the sensitivity to reasonably possible alternative assumptions of the fair value of financial instruments valued using techniques where at least one significant input is unobservable are given in Note 11 on pages 393 to 411.
Accounting developments International Financial Reporting Standards A number of IFRSs and amendments to IFRS were in issue at 31 December 2012 that had effective dates of 1 January 2013 or later.
IFRS 11 ‘Joint Arrangements’, which supersedes IAS 31’ Interests in Joint Ventures’, distinguishes between joint operations and joint ventures. Joint operations are accounted for by the investor recognising its assets and liabilities including its share of any assets held and liabilities incurred jointly and its share of revenues and costs. Joint ventures are accounted for in the investor’s consolidated accounts using the equity method. IFRS 11 requires retrospective application. Implementation of IFRS 11 will not have a material effect on the Group’s financial statements.
IFRS 12 ‘Disclosure of Interests in Other Entities’ covers disclosures for entities reporting under IFRS 10 and IFRS 11 replacing those in IAS 28 and IAS 27. Entities are required to disclose information that helps financial statement readers evaluate the nature, risks and financial effects associated with an entity’s interests in subsidiaries, in associates and joint arrangements and in unconsolidated structured entities.
IAS 27 ‘Separate Financial Statements’ comprises those parts of the existing IAS 27 that deal with separate financial statements. IAS 28 ‘Investments in Associates and Joint Ventures’ covers joint ventures as well as associates; both must be accounted for using the equity method. The mechanics of the equity method are unchanged. These two revised standards will have no material effect on the Group’s financial statements.
Although IFRS 10-12 (as amended) and revised IAS 27 and IAS 28 have an effective date of 1 January 2013, they have been endorsed by the EU for application from 1 January 2014. However, early adoption is permitted and the Group implemented these standards from 1 January 2013.
‘Disclosures - Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7)’ amended IFRS 7 to require disclosures about the effects and potential effects on an entity’s financial position of offsetting financial assets and financial liabilities and related arrangements.
Amendments to IAS 1 ‘Presentation of Items of Other Comprehensive Income’ require items that will never be recognised in profit or loss to be presented separately in other comprehensive income from those items that are subject to subsequent reclassification.
‘Annual Improvements 2009-2011 Cycle’ makes a number of minor changes to IFRSs. These will not have a material effect on the Group’s financial statements.
Effective after 2013 In October 2012, the IASB issued ‘Investment Entities (amendments to IFRS 10, IFRS 12 and IAS 27)’. The amendments apply to ‘investment entities’: entities whose business is to invest funds solely for returns from capital appreciation, investment income or both and which evaluate the performance of their investments on a fair value basis. The amendments provide an exception to IFRS 10 by requiring investment entities to measure their subsidiaries (other than those that provide services related to the entity’s investment activities) at fair value through profit or loss, rather than consolidate them. The amendments are effective from 1 January 2014.
Fees and commissions receivable Payment services 1,368 1,498 1,638 Credit and debit card fees 1,088 1,093 2,432 Lending (credit facilities) 1,480 1,707 1,863 Brokerage 548 631 652 Trade finance 314 410 423 Investment management 471 525 568 Other 440 515 617 5,709 6,379 8,193
Income from trading activities (1) Foreign exchange 654 1,327 1,491 Interest rate 1,932 760 1,862 Credit 737 (308) 48 Changes in fair value of own debt and derivative liabilities attributable to own credit - debt securities in issue (1,473) 225 (75) - derivative liabilities (340) 68 68 Equities 164 606 643 Commodities (1) 3 390 Other 2 20 90 1,675 2,701 4,517
Other operating income Operating lease and other rental income 876 1,307 1,394 Changes in the fair value of own debt designated as at fair value through profit or loss attributable to own credit (3) - debt securities in issue (2,531) 1,259 284 - subordinated liabilities (305) 362 (35) Changes in the fair value of securities and other financial assets and liabilities 146 150 (180) Changes in the fair value of investment properties (153) (139) (405) Profit on sale of securities 1,146 829 432 Profit on sale of property, plant and equipment 34 22 50 Profit/(loss) on sale of subsidiaries and associates 95 (30) (107) Life business profits 1 1 98 Dividend income 59 54 59 Share of profits of associated entities 29 26 70 Other income (4) 138 134 (305)
(2) In March 2012 and September 2012, the Group redeemed certain notes resulting in net gains totalling £454 million being credited to profit or loss. In June 2011, the Group redeemed certain mortgage backed debt securities in exchange for cash, resulting in gains totalling £255 million being credited to profit or loss. In a series of exchange and tender offers in May 2010, the Group redeemed certain subordinated debt securities and equity preference shares in exchange for cash or senior debt. Gains of £553 million were credited to profit or loss in 2010. The exchanges involving instruments classified as liabilities all met the criteria in IFRS for treatment as the extinguishment of the original liability and the recognition of a new financial liability.
Wages, salaries and other staff costs 6,984 7,112 7,737 Bonus tax — 27 99 Social security costs 562 615 617 Share-based compensation 126 197 397 Pension costs - defined benefit schemes (see Note 4) 416 348 519 - curtailment and settlement gains (see Note 4) (41) — (78) - defined contribution schemes 29 57 88 Staff costs 8,076 8,356 9,379
Premises and equipment 2,232 2,423 2,380 Other administrative expenses (1) 5,593 4,436 3,571
Write-down of goodwill and other intangible assets (see Note 17) (2) 124 80 1 17,827 17,134 17,456
Notes: (1) Includes Bank levy, Payment Protection Insurance costs, Interest Rate Hedging Products redress and related costs and regulatory fines, which are discussed in more detail below. (2) Excludes goodwill of £394 million written-off in 2012 in respect of Direct Line Group. Refer to Note 20 for further information.
The levy is based on the total chargeable equity and liabilities as reported in the balance sheet at the end of a chargeable period. The levy is not charged on the first £20 billion of chargeable liabilities.
Payment Protection Insurance (PPI) To reflect current experience of PPI complaints received, the Group increased its provision for PPI by £1,110 million in 2012 (2011 - £850 million), bringing the cumulative charge taken to £2.2 billion, of which £1.3 billion (59%) in redress had been paid by 31 December 2012. Of the £2.2 billion cumulative charge, £2 billion relates to redress and £0.2 billion to administrative expenses. The eventual cost is dependent upon complaint volumes, uphold rates and average redress costs.
Assumptions relating to these are inherently uncertain and the ultimate financial impact may be different from the amount provided. The Group will continue to monitor the position closely and refresh its assumptions as more information becomes available.
Interest Rate Hedging Products redress and related costs Following an industry-wide review conducted in conjunction with the Financial Services Authority, a charge of £700 million has been booked for redress in relation to certain interest-rate hedging products sold to small and medium-sized businesses, classified as retail clients under FSA rules. Of the £700 million charge, £575 million relates to redress and the cost of closing out hedging positions, and £125 million to administrative expenses.
Regulatory fines On 6 February, 2013 the Group reached agreement with the Financial Services Authority, the US Department of Justice and the Commodity Futures Trading Commission in relation to the setting of LIBOR and other trading rates, including financial penalties of £381 million. The Group continues to co-operate with these and other bodies in this regard and expects it will incur some additional financial penalties related to these matters.
Notes on the consolidated accounts continued 3 Operating expenses continued Integration costs included in operating expenses comprise expenditure incurred in respect of cost reduction and revenue enhancement programmes connected with acquisitions made by the Group. 2012 2011 2010 £m £m £m
Staff costs — 38 210 Premises and equipment (2) 6 3 Other administrative expenses 2 51 143 Depreciation and amortisation — 11 20 Continuing operations — 106 376
Share-based payments As described in the Remuneration report on pages 320 to 342, the Group grants share-based awards to employees principally on the following bases: Award plan Eligible employees Nature of award (1) Vesting conditions (2) Issue dates
Notes on the consolidated accounts continued 3 Operating expenses continued Deferred performance awards
The awards granted in 2012 vest evenly over the following three anniversaries.
Note: (1) Adjusted for the sub-division and one-for-ten consolidation of ordinary shares in 2012.
The market value of awards exercised in 2012 was £10 million (2011 - £5 million; 2010 - less than £1 million). There are vested options over 18 million shares exercisable up to 2019 (2011 - 4.8 million shares up to 2019; 2010 - 3.3 million shares up to 2020).
Non-deferred cash awards (2) 73 70 4 10 9 11 Non-deferred share awards 27 34 (21) 17 21 (19) Total non-deferred variable compensation 100 104 (4) 27 30 (10)
Operating profit for the Group increased by 90% and for Markets by 68% in 2012. Variable compensation as a proportion of operating profit before variable compensation decreased to 16% from 28% in 2011 for the Group and to 16% from 25% for Markets. At a constant proportion as for 2011 variable compensation for 2012 would have been c.£500 million and c.£160 million higher for the Group and Markets, respectively.
Reconciliation of variable compensation awards to income statement charge 2012 £m
Notes: (1) The tables above relate to continuing businesses only. Discontinued businesses in 2012 amount to £24 million (2011 - £32 million). In addition 2011 has been restated to include sales incentive and long-term incentive plan expense of £12 million which has been reclassified in 2012, as well as £6 million for the UK branch-based businesses which was included in disposal groups in 2011. (2) Cash payments to all employees are limited to £2,000. (3) Excludes other performance related compensation. (4) Relates to the clawback of prior year variable compensation awards which forms part of the LIBOR actions taken by management detailed on page 380. (5) Reported operating profit before one-off and other items. (6) Reported operating profit pre variable compensation expense and before one-off and other items.
Supervisors with accountability for the business but no knowledge or involvement in the wrongdoing have received zero variable compensation awards for 2012 and a range of clawback from prior years depending on specific findings.
The Group’s defined benefit schemes generally provide a pension of onesixtieth of final pensionable salary for each year of service prior to retirement up to a maximum of 40 years. Employees do not make contributions for basic pensions but may make voluntary contributions to secure additional benefits on a money-purchase basis. Since October 2006, the Main scheme has been closed to new entrants who have instead been offered membership of The Royal Bank of Scotland Retirement Savings Plan, a defined contribution pension scheme.
With effect from 1 October 2012, employees in the Main scheme and certain other UK schemes were offered a choice between accepting an increase in the charge made for membership of 5% of salary, or a retirement age of 65 for future benefits.
Major classes of plan assets as a percentage of total plan assets 2012
Quoted equities 23.4 20.9 25.9 25.0 23.3 28.2 Private equity 5.4 5.8 5.4 4.7 4.9 4.5 Index-linked bonds 30.7 26.1 27.0 28.7 24.3 24.1 Government fixed interest bonds 1.9 0.9 — 2.9 2.8 1.9 Corporate and other bonds 21.1 23.9 26.2 21.0 22.2 24.8 Hedge funds 2.2 2.5 3.2 2.5 2.4 3.5 Property 4.3 3.5 3.4 4.2 3.6 3.6 Derivatives 2.2 2.4 0.9 2.0 2.1 1.2 Cash and other assets 8.7 13.8 7.8 9.0 13.7 8.1 Equity exposure of equity futures 9.0 17.7 25.6 8.4 15.7 21.4 Cash exposure of equity futures (8.9) (17.5) (25.4) (8.4) (15.0) (21.3)
The Main scheme also employs derivative instruments, where appropriate, to achieve a desired asset class exposure or to match assets more closely to liabilities. The value of assets shown reflects the actual physical assets held by the scheme, with any derivative holdings valued on a mark-to-market basis. The return on assets on the total scheme has been based on the asset exposure created allowing for the net impact of the derivatives on the risk and return profile of the holdings.
Notes on the consolidated accounts continued 4 Pensions continued The Main scheme’s holdings of derivative instruments are summarised in the table below: Fair value Fair value Fair value
Ordinary shares of the company with a fair value of £4 million (2011 - £3 million; 2010 - £9 million) are held by the Group's Main scheme which also holds other financial instruments issued by the Group with a value of £610 million (2011 - £424 million; 2010 - £264 million).
The expected return on plan assets at 31 December is based upon the weighted average of the following assumed returns on the major classes of plan assets, allowing for the net impact of derivatives on the risk and return profile: Main scheme All schemes
Longevity at age 60 for current pensioners (years) Males 27.5 27.3 27.2 Females 29.8 29.6 29.6
At 1 January 2011 19,110 21,092 1,982 22,816 24,999 2,183 Currency translation and other adjustments — — — (30) (33) (3) Income statement Expected return 1,258 (1,258) 1,488 (1,488) Interest cost 1,150 1,150 1,354 1,354 Current service cost 327 327 440 440 Past service cost 39 39 43 43 1,258 1,516 258 1,488 1,837 349 Statement of comprehensive income - Actuarial gains and losses 759 1,096 337 636 1,217 581 Contributions by employer 733 — (733) 1,059 — (1,059) Contributions by plan participants and other scheme members — — — 10 10 — Benefits paid (698) (698) — (840) (840) — Expenses included in service cost (51) (51) — (53) (53) — At 1 January 2012 21,111 22,955 1,844 25,086 27,137 2,051 Currency translation and other adjustments — — — (65) (77) (12) Income statement Expected return 1,178 (1,178) 1,390 (1,390) Interest cost 1,137 1,137 1,330 1,330 Current service cost 319 319 426 426 Past service cost 80 80 80 80 Gains on curtailments and settlements — — (41) (41) 1,178 1,536 358 1,390 1,795 405 Statement of comprehensive income - Actuarial gains and losses 210 1,988 1,778 373 2,643 2,270 Contributions by employer 773 — (773) 977 — (977) Contributions by plan participants and other scheme members — — — 10 10 — Benefits paid (772) (772) — (910) (910) — Assets and obligations extinguished on settlements — — — (360) (360) — Expenses included in service cost (59) (59) — (67) (67) — Transfer to disposal groups — — — (64) (61) 3 At 31 December 2012 22,441 25,648 3,207 26,370 30,110 3,740
Notes on the consolidated accounts continued 4 Pensions continued The pension charge to the income statement comprises: £m
The Group and the Trustees of the Main scheme agreed the funding valuation as at 31 March 2010 in 2011. It showed that the value of liabilities exceeded the value of assets by £3.5 billion as at 31 March 2010, a ratio of assets to liabilities of 84%. In order to eliminate this deficit, the Group will pay additional contributions each year over the period 2011 to 2018. Contributions started at £375 million per annum in 2011, increasing to £400 million per annum in 2013 and from 2016 onwards will be further increased in line with price inflation. These contributions are in addition to the regular annual contributions of around £250 million for future accrual of benefits.
in pension cost for year in obligation at 31 December in pension cost for year in obligation 0.25% increase in the discount rate (66) (13) (17) (1,199) (1,019) (925) (79) (20) (25) (1,392) (1,181) (1,079) 0.25% increase in inflation 58 60 59 995 911 799 67 71 69 1,129 1,040 918 0.25% additional rate of increase in pensions in payment 39 39 37 690 618 527 45 45 43 782 691 599 0.25% additional rate of increase in deferred pensions 18 20 21 297 285 265 21 23 25 342 322 304 0.25% additional rate of increase in salaries 9 6 6 95 56 56 12 9 11 125 79 78 Longevity increase of 1 year 35 33 34 647 566 519 39 41 40 727 671 588 5 Auditor’s remuneration Amounts paid to the Group's auditors for statutory audit and other services are set out below. All audit-related and other services are approved by the Audit Committee and are subject to strict controls to ensure the external auditor’s independence is unaffected by the provision of other services. The Audit Committee recognise that for certain assignments the auditors are best placed to perform the work economically; for other work the Group selects the supplier best placed to meet its requirements. The Group’s auditors are permitted to tender for such work in competition with other firms where the work is permissible under audit independence rules.
Fees payable for the audit of the Group’s annual accounts 4.0 4.0 Fees payable to the auditor and its associates for other services to the Group - the audit of the company’s subsidiaries 24.4 24.6 - audit-related assurance services (1) 4.6 4.7 Total audit and audit-related assurance services fees 33.0 33.3
Taxation compliance services 0.2 0.1 Taxation advisory services 0.1 0.2 Other assurance services 2.2 1.8 Corporate finance services (2) 5.7 1.7 Consulting services 1.5 3.6 Total other services 9.7 7.4
Fees payable to the auditor and its associates in respect of audits of associated pension schemes 0.5 0.4
Current tax Charge for the year (495) (168) (321) (Under)/over provision in respect of prior years (63) 141 31 (558) (27) (290) Deferred tax Credit/(charge) for the year 73 (1,158) (737) Over provision in respect of prior year 16 58 324 Tax charge for the year (469) (1,127) (703)
The actual tax charge differs from the expected tax credit computed by applying the standard rate of UK corporation tax of 24.5% (2011 - 26.5%; 2010 - 28%) as follows: Expected tax credit 1,265 315 44 Sovereign debt impairment where no deferred tax asset recognised — (275) — Other losses in year where no deferred tax asset recognised (511) (530) (450) Foreign profits taxed at other rates (383) (417) (517) UK tax rate change impact (1) (149) (112) (83) Unrecognised timing differences 59 (20) 11 Non-deductible goodwill impairment — (24) (3) Items not allowed for tax - losses on disposal and write-downs (49) (72) (311) - UK bank levy (43) (80) — - regulatory fines (93) — — - employee share schemes (9) (113) (32)
Notes: (1) In recent years the UK Government has steadily reduced the rate of UK corporation tax, with the latest enacted rate standing at 23% with effect from 1 April 2013. A further reduction of the rate to 21% with effect from 1 April 2014 was announced on 5 December 2012 but not substantively enacted at the balance sheet date. Accordingly, the closing deferred tax assets and liabilities have been calculated at 23%.
(2) Prior year tax adjustments include releases of tax provisions in respect of structured transactions and investment disposals and adjustments to reflect submitted tax computations in the UK and overseas.
Earnings Loss attributable to ordinary and B shareholders (5,971) (1,997) (1,125) Loss/(profit) from discontinued operations attributable to ordinary and B shareholders 60 (306) 204 Gain on redemption of preference shares and paid-in equity — — 610 Loss from continuing operations attributable to ordinary and B shareholders (5,911) (2,303) (311)
Weighted average number of shares (millions) Ordinary shares in issue during the year 5,902 5,722 5,625 Effect of convertible B shares in issue during the year 5,100 5,100 5,100 Weighted average number of ordinary shares and effect of convertible B shares in issue during the year (1) 11,002 10,822 10,725
Assets Cash and balances at central banks — — — 79,290 79,290 Loans and advances to banks - reverse repos 33,394 — — 1,389 34,783 - other (1) 13,265 — — 15,903 29,168 Loans and advances to customers - reverse repos 70,025 — — 22 70,047 - other (2) 24,841 189 — 397,824 7,234 430,088 Debt securities 78,340 873 73,737 4,488 157,438 Equity shares 13,329 533 1,370 15,232 Settlement balances — — — 5,741 5,741 Derivatives 433,264 8,639 441,903 Intangible assets 13,545 13,545 Property, plant and equipment 9,784 9,784 Deferred tax 3,443 3,443 Prepayments, accrued income and other assets — — — — 7,820 7,820 Assets of disposal groups 14,013 14,013 666,458 1,595 8,639 75,107 504,657 7,234 48,605 1,312,295
Liabilities Deposits by banks - repos 23,342 — 16,349 39,691 - other (3) 34,172 — 34,941 69,113 Customer accounts - repos 65,526 — 23,286 88,812 - other (4) 14,286 5,627 394,230 414,143 Debt securities in issue (5) 11,492 35,747 115,382 162,621 Settlement balances — — 7,477 7,477 Short positions 41,039 — 41,039 Derivatives 518,102 5,881 523,983 Accruals, deferred income and other liabilities — — 1,683 19 21,423 23,125 Retirement benefit liabilities 2,239 2,239 Deferred tax 1,945 1,945 Insurance liabilities 6,312 6,312 Subordinated liabilities — 903 25,416 26,319 Liabilities of disposal groups 23,995 23,995 707,959 42,277 5,881 618,764 19 55,914 1,430,814 Equity 76,053 1,506,867
Assets Cash and balances at central banks — — — 57,014 57,014 Loans and advances to banks - reverse repos 38,215 — — 4,392 42,607 - other (1) 26,082 — — 31,829 57,911 Loans and advances to customers - reverse repos 41,110 — — 11,402 52,512 - other (2) 19,903 1,100 — 471,308 10,437 502,748 Debt securities 98,869 402 111,130 7,079 217,480 Equity shares 19,186 1,013 1,999 22,198 Settlement balances — — — 11,605 11,605 Derivatives 421,648 5,429 — 427,077 Intangible assets 14,448 14,448 Property, plant and equipment 16,543 16,543 Deferred tax 6,373 6,373 Prepayments, accrued income and other assets — — — 1,306 11,270 12,576 Assets of disposal groups 12,484 12,484 665,013 2,515 5,429 113,129 595,935 10,437 61,118 1,453,576
Notes: (1) Includes items in the course of collection from other banks of £1,531 million (2011 - £1,470 million; 2010 - £1,958 million). (2) The change in fair value of loans and advances to customers designated as at fair value through profit or loss attributable to changes in credit risk was a £22 million credit for the year and cumulatively a credit of £44 million (2011 - £31 million charge, cumulative £71 million credit; 2010 - £20 million charge, cumulative £82 million credit). (3) Includes items in the course of transmission to other banks of £521 million (2011 - £506 million; 2010 - £577 million). (4) The carrying amount of other customer accounts designated as at fair value through profit or loss is £305 million (2011 - £166 million; 2010 - £233 million) higher than the principal amount. No amounts have been recognised in profit or loss for changes in credit risk associated with these liabilities as the changes are immaterial, measured as the change in fair value from movements in the period in the credit risk premium payable. The amounts include investment contracts with a carrying value of nil (2011 - £38 million; 2010 - £41 million).
(5) Comprises bonds and medium term notes of £88,723 million (2011 - £129,780 million; 2010 - £154,282 million) and certificates of deposit and other commercial paper of £5,869 million (2011 - £32,841 million; 2010 - £64,090 million).
Reclassified from HFT to LAR Loans 2,892 2,546 42 15 517 460 Debt securities 1,671 1,333 (120) (6) 251 377 4,563 3,879 (78) 9 768 837
Notes on the consolidated accounts continued 10 Financial instruments - classification continued
Reclassified from HFT to LAR Loans 5,378 4,428 234 (146) 491 403 Debt securities 3,530 3,121 48 (17) 424 393 8,908 7,549 282 (163) 915 796
Notes: (1) The amount taken to AFS reserves was £171 million (2011 - £152 million; 2010 - £326 million). (2) The amount that would have been taken to AFS reserves if reclassification had not occurred is £1 million (2011 - £24 million; 2010 - £98 million).
11 Financial instruments - valuation Valuation of financial instruments carried at fair value Control environment The Group's control environment for the determination of the fair value of financial instruments includes formalised protocols for the review and validation of fair values independent of the businesses entering into the transactions. There are specific controls to ensure consistent pricing policies and procedures, incorporating disciplined price verification. The Group ensures that appropriate attention is given to bespoke transactions, structured products, illiquid products and other instruments which are difficult to price.
A key element of the control environment is the independent price verification (IPV) process. Valuations are first performed by the business which entered into the transaction. Such valuations may be directly from available prices, or may be derived using a model and variable model inputs. These valuations are reviewed, and if necessary amended, by a team independent of those trading the financial instruments, in light of available pricing evidence.
Valuation issues, adjustments and reserves are reported to Markets, Non-Core and Group Audit Committees. Key judgmental issues are described in the reports submitted to these Audit Committees.
Market risk metrics such as value-at-risk (VaR) and stressed value-at-risk (SVaR) cover financial instruments in Markets and Non-Core. The Group has a framework for quantify those market risks not adequately captured by standard market risk framework such as VaR and SVaR - Risks not in VaR. Refer to page 245 for details.
Inputs to valuation models Values between and beyond available data points are obtained by interpolation and extrapolation. When utilising valuation techniques, the fair value can be significantly affected by the choice of valuation model and by underlying assumptions concerning factors such as the amounts and timing of cash flows, discount rates and credit risk. The principal inputs to these valuation techniques are as follows: Bond prices - quoted prices are generally available for government bonds, certain corporate securities and some mortgage-related products.
Counterparty credit spreads - adjustments are made to market prices (or parameters) when the creditworthiness of the counterparty differs from that of the assumed counterparty in the market price (or parameters).
Valuation reserves When valuing financial instruments in the trading book, adjustments are made to mid-market valuations to cover bid-offer spread, liquidity and credit risk. The following table shows credit valuation adjustments and other reserves.
Credit valuation adjustments Valuation adjustments represent an estimate of the adjustment to fair value that a market participant would make to incorporate the risk inherent in derivative exposures. Certain credit derivative product company (CDPC) exposures were restructured during the first half of the year and the credit valuation adjustment methodology applied to these exposures was updated to reflect the revised risk mitigation strategy that is now in place. There were no other changes to valuation methodologies.
Key points Restructuring of certain monoline exposures resulted in gross exposure reducing from £1.9 billion at 31 December 2011 to £0.6 billion at 31 December 2012 and the CVA decreasing. Tighter credit spreads also contributed to the reduction in credit valuation adjustments.
Notes on the consolidated accounts continued 11 Financial instruments - valuation continued Monoline insurers The Group has purchased protection from monoline insurers (‘monolines’), mainly against specific asset-backed securities. Monolines specialise in providing credit protection against the principal and interest cash flows due to the holders of debt instruments in the event of default by the debt instrument counterparty. This protection is typically held in the form of derivatives such as credit default swaps (CDSs) referencing underlying exposures held directly or synthetically by the Group.
The gross mark-to-market of the monoline protection depends on the value of the instruments against which protection has been bought. A positive fair value, or a valuation gain, in the protection is recognised if the fair value of the instrument it references decreases. For the majority of trades the gross mark-to-market of the monoline protection is determined directly from the fair value price of the underlying reference instrument. However, for the remainder of the trades the gross mark-tomarket is determined using industry standard models.
The Group has purchased credit protection from CDPCs through tranched and single name credit derivatives. The Group's exposure to CDPCs is predominantly due to tranched credit derivatives (“tranches”). A tranche references a portfolio of loans and bonds and provides protection against total portfolio default losses exceeding a certain percentage of the portfolio notional (the attachment point) up to another percentage (the detachment point).
The Group has predominantly traded senior tranches with CDPCs, the average attachment and detachment points are 16% and 49% respectively (2011 - 13% and 47%; 2010 - 13% and 49%), and the majority of the loans and bonds in the reference portfolios are investment grade.
The gross mark-to-market of the CDPC protection is determined using industry standard models. Trade restructurings during the second half of 2012 provided market evidence of the fair value of certain CDPC exposures resulting in valuation adjustments of £279 million at 31 December 2012. These adjustments are also included in the table above. For trades facing other CDPCs, the methodology employed to calculate the CDPC CVA is different to that outlined above for monolines, as there are no market observable credit spreads and recovery levels for these entities. The level of expected loss on these CDPC exposures is estimated with reference to risk mitigation strategies.
Other counterparties The CVA for all other counterparties is calculated on a portfolio basis reflecting an estimate of the amount a third party would charge to assume the credit risk.
Notes: (1) The OCA does not alter cash flows and is not used for performance management. It is disregarded for regulatory capital reporting purposes and will reverse over time as the liabilities mature. (2) Consists of wholesale and retail note issuances. (3) The reserve movement between periods will not equate to the reported profit or loss for own credit. The balance sheet reserves are stated by conversion of underlying currency balances at spot rates for each period, whereas the income statement includes intra-period foreign exchange sell-offs.
Key points The own credit adjustment decreased significantly during the year primarily due to tightening of credit spreads, reflecting improved investor perception of RBS.
Significant tightening of credit spreads, buy-backs exceeding issuances and the impact of buying back certain securities at lower spreads than at issuance, resulted in cumulative own credit adjustment of £29 million at 31 December 2012.
Derivative liability own credit adjustment decreased as credit default swap spreads tightened.
Equity shares 13.1 1.3 0.8 15.2 12.4 1.8 1.0 15.2 18.4 2.8 1.0 22.2 Derivatives Foreign exchange — 61.7 1.4 63.1 — 72.9 1.6 74.5 — 83.2 0.1 83.3 Interest rate 0.1 362.7 0.6 363.4 0.2 420.8 1.1 422.1 1.7 308.3 1.7 311.7 Credit — 9.3 1.7 11.0 — 23.1 3.8 26.9 — 23.2 3.7 26.9 Equities and commodities — 4.3 0.1 4.4 — 5.9 0.2 6.1 0.1 4.9 0.2 5.2 0.1 438.0 3.8 441.9 0.2 522.7 6.7 529.6 1.8 419.6 5.7 427.1 96.8 644.6 10.4 751.8 127.4 738.4 16.4 882.2 130.5 639.9 15.7 786.1
AFS debt securities included above UK government 8.0 — — 8.0 13.4 — — 13.4 8.4 — — 8.4 US government 15.5 3.5 — 19.0 18.1 2.7 — 20.8 17.8 4.4 — 22.2 Other government 10.7 5.3 — 16.0 21.6 4.0 — 25.6 26.5 6.4 — 32.9 Corporate — 0.1 0.1 0.2 — 2.3 0.2 2.5 — 1.4 0.1 1.5 Financial institutions 0.5 27.1 2.9 30.5 0.2 39.3 5.5 45.0 0.4 41.4 4.3 46.1 34.7 36.0 3.0 73.7 53.3 48.3 5.7 107.3 53.1 53.6 4.4 111.1
Notes on the consolidated accounts continued 11 Financial instruments - valuation continued 2012 2011 2010 Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
Of which AFS ABS RMBS — 23.3 0.2 23.5 — 30.9 0.2 31.1 — 29.9 0.2 30.1 CMBS — 2.3 — 2.3 — 0.7 — 0.7 — 1.2 0.1 1.3 CDO — 0.1 0.5 0.6 — 0.2 1.4 1.6 — 0.6 1.4 2.0 CLO — 0.4 1.9 2.3 — 1.0 3.3 4.3 — 3.5 1.5 5.0 Other — 1.3 0.2 1.5 — 2.3 0.7 3.0 — 3.0 1.1 4.1
Equity shares 0.3 0.7 0.4 1.4 0.3 1.3 0.4 2.0 0.3 1.4 0.3 2.0 Total AFS assets 35.0 36.7 3.4 75.1 53.6 49.6 6.1 109.3 53.4 55.0 4.7 113.1
Assets Loans and advances - banks 0.4 50 (30) 0.4 40 (50) 0.4 40 (40)
Of which AFS debt securities Corporate 0.1 10 — 0.2 10 (10) 0.1 20 (20)
Of which AFS ABS RMBS 0.2 10 — 0.2 10 (10) 0.2 — — CMBS — — — — — — 0.1 10 — CDO 0.5 70 (10) 1.4 170 (10) 1.4 100 (10)
Liabilities Deposits by bank 0.1 — (20) — — — — — — Customer accounts 0.1 30 (30) — 20 (20) 0.1 60 (60)
Assets Valuation basis/technique Main assumptions (2) Loans and advances Proprietary model credit spreads, indices Debt securities RMBS Industry standard model prepayment rates, probability of default, loss severity and yield, recovery rates CMBS Proprietary model prepayment rates, probability of default, loss severity and yield, recovery rates CDO Proprietary model credit spreads, default rates, housing prices, implied collateral valuation CLO Industry standard simulation model credit spreads, default rates, loss severity and yield, recovery rates Other ABS Proprietary model credit spreads Other debt securities Proprietary model credit spreads Equity securities Fund valuation statements, fundamentals valuation performance of funds and issuers
Liabilities Customer accounts Proprietary model correlation, credit spreads Debt securities in issue Proprietary model correlation, volatility, model uncertainty risk Short positions Proprietary model correlation, credit spreads Derivatives Foreign exchange Proprietary model correlation, volatility Interest rate Proprietary model correlation, volatility Equities and commodities Proprietary model correlation, long dated volatility, dividends Credit Proprietary CVA model, industry option and correlation model correlation, counterparty credit risk, volatility
Total liabilities carried at fair value decreased by £91.0 billion, with decreases in derivative liabilities (£89.7 billion), short positions (£13.4 billion), debt securities in issue (£12.7 billion) and collateral (£4.4 billion), partially offset by increases in repos (£29.8 billion).
Level 3 instruments in Markets comprise instruments held in the normal course of business and those in Non-Core primarily relate to legacy ABS and derivative positions.
There were no significant transfers between level 1 and level 2.
Active and inactive markets A key input in the decision making process for the allocation of assets to a particular level is liquidity. In general, the degree of valuation uncertainty depends on the degree of liquidity of an input. For example, a derivative can be placed into level 2 or level 3 dependent upon its liquidity.
Notes on the consolidated accounts continued 11 Financial instruments - valuation continued For some instruments with a wide number of available price sources, there may be differing quality of available information and there may be a wide range of prices from different sources. In these situations an assessment is made as to which source is the highest quality and this will be used to determine the classification of the asset. For example, a tradable quote would be considered a better source than a consensus price.
Loans and advances to customers Loans in level 3 primarily comprise loans to emerging market counterparties and, legacy commercial and residential mortgages.
Loans to emerging market counterparties The trades in each loan structure are valued using curves using a proxy methodology. Each curve consists of the independent proxy value and various basis adjustments, such as those relating to loan-CDS basis, credit basis, tenor and liquidity. For the low and high valuation scenarios for the structures, these different bases are flexed up and down within the range that each one is deemed to span. The resultant maximum and minimum scenario curves are used to value the assets and liabilities in the structure separately. The low valuation scenario is the one that minimises the assets and maximises the liabilities. The high valuation scenario is the converse.
The Group primarily uses an industry standard model to project the expected future cash flows to be received from the underlying mortgages and to forecast how these cash flows will be distributed to the various holders of the RMBS. This model utilises data provided by the servicer of the underlying mortgage portfolio, layering on assumptions for mortgage prepayments, probability of default, expected losses and yield. The Group uses data from third-party sources to calibrate its assumptions, including pricing information from third party pricing services, independent research, broker quotes, and other independent sources. An assessment is made of third party data source to determine its applicability and reliability. The Group adjusts the model price with a liquidity premium to reflect the price that the instrument could be traded in the market and may also make adjustments for model deficiencies.
Commercial mortgage-backed securities (CMBS) CMBS are valued using an industry standard model and the inputs, where possible, are corroborated using observable market data.
Notes on the consolidated accounts continued 11 Financial instruments - valuation continued Credit derivatives The Group's other credit derivatives include vanilla and bespoke portfolio tranches, gap risk products and certain other unique trades.
Equity hybrids have payouts based on the performance of a basket of underlyings where underlyings are from different asset classes. Correlations between these different underlyings are typically unobservable with no market information on closely related assets available. Where no market for the correlation input exists, these inputs are based on historical time series.
Exotic options do not trade in active markets except in a small number of cases. Consequently, the Group uses models to determine fair value using valuation techniques typical for the industry. These techniques can be divided firstly into modelling approaches and secondly, into methods of assessing appropriate levels for model inputs. The Group uses a variety of proprietary models for valuing exotic trades.
CVA is calculated by applying expected losses to potential future exposures whilst DVA is calculated by applying expected gains to potential future liabilities. Expected losses and gains are determined from market implied probability of defaults and internally assessed recovery levels. The probability of default is calculated with reference to observable credit spreads and observable recovery levels. For counterparties where observable data do not exist, the probability of default is determined from the credit spreads and recovery levels of similarly rated entities. A weighting is applied to arrive at the expected loss or gain. The weighting reflects portfolio churn and varies according to counterparty credit quality and hedging considerations.
The unobservable inputs include certain inputs used in the calculation of potential future exposures and liabilities, probabilities of default, and recovery levels together with the weightings applied. Reasonably possible alternative assumptions of unobservable inputs result in a favourable valuation movement of £68 million and an unfavourable valuation movement of £216 million.
Own credit - issued debt For issued debt and structured notes the own credit adjustment is based on debt issuance spreads above average inter-bank rates (at a range of tenors). Whilst certain debt issuance spreads are not based on observable market data, these inputs are not considered to have a significant effect on the valuation of individual trades. The classification of issued debt and structured notes is not determined by the observability of the debt issuance spreads applied, and any related sensitivity does not form part of the level 3 sensitivities presented.
Notes on the consolidated accounts continued 11 Financial instruments - valuation continued Level 3 movement table
At 1 January Income statement (1) SOCI (2) In Out Issuances Purchases Settlements Sales Foreign exchange At 31 December Changes in fair value Other 2012 £m £m £m £m £m £m £m £m £m £m £m £m £m
Assets FVTPL (3) Loans and advances - banks 444 5 — 28 (1) — — (64) (30) — 382 5 — - customers 316 3 — 20 (15) — 589 (323) (15) (13) 562 (12) 3 Debt securities 2,243 136 — 619 (81) — 1,118 (188) (1,886) (23) 1,938 (54) 72 Equity shares 573 (26) — 32 (61) — 158 (73) (198) (9) 396 (21) 4 Derivatives 6,732 (2,078) — 425 (495) — 441 (990) (183) (63) 3,789 (1,761) 34 FVTPL assets 10,308 (1,960) — 1,124 (653) — 2,306 (1,638) (2,312) (108) 7,067 (1,843) 113
AFS Debt securities 5,697 100 13 391 (472) — 37 (1,004) (1,808) (6) 2,948 (106) 39 Equity shares 395 74 64 74 — — 15 (1) (218) (13) 390 55 12 AFS assets 6,092 174 77 465 (472) — 52 (1,005) (2,026) (19) 3,338 (51) 51 16,400 (1,786) 77 1,589 (1,125) — 2,358 (2,643) (4,338) (127) 10,405 (1,894) 164
Of which ABS - FVTPL (3) 1,304 — 162 576 (32) — 1,050 (188) (1,515) (7) 1,350 (23) 29 - AFS 5,622 (12) 86 317 (457) — 36 (955) (1,778) (4) 2,815 (131) 34
Debt securities in issue 2,199 158 — 9 (1) 530 — (1,521) — (11) 1,363 169 — Short positions 291 (269) — — — — 3 — (23) — 2 — — Derivatives 3,811 (375) — 877 (513) 12 161 (636) 24 (44) 3,317 (593) — Other financial liabilities — — — — — — — — — — — — — 6,323 (399) — 936 (514) 542 171 (2,157) 1 (53) 4,850 (346) (2)
Assets FVTPL (3) Loans and advances - banks 383 3 — 60 — — 51 (36) (18) 1 444 2 - customers 460 (18) — 85 — — 650 (820) (46) 5 316 (13)
Assets FVTPL (3) Loans and advances - banks — — — 359 — 24 — — — 383 — - customers 1,059 169 — (349) — 145 (451) (165) 52 460 38 Debt securities 2,782 294 — 1,770 — 1,973 (386) (2,682) 33 3,784 154 Equity shares 711 414 — (26) — 654 — (1,027) (10) 716 54 Derivatives 6,429 (1,561) — 1,728 — 948 (299) (1,534) 26 5,737 (1,556)
Fair value of financial instruments not carried at fair value The following table shows the carrying value and fair value of financial instruments carried at amortised cost on the balance sheet.
Financial liabilities Deposits by banks 34.5 34.5 51.3 50.7 50.0 50.4 Customer accounts 420.7 421.0 417.5 417.6 438.5 438.6 Debt securities in issue 60.1 59.8 115.4 112.7 167.2 163.8 Settlement balances 5.9 5.9 7.5 7.5 11.0 11.0 Notes in circulation 1.7 1.7 1.7 1.7 1.8 1.8 Subordinated liabilities 25.6 24.3 25.4 19.2 25.9 21.9
Loans and advances to banks and customers In estimating the fair value of loans and advances to banks and customers measured at amortised cost, the Group’s loans are segregated into appropriate portfolios reflecting the characteristics of the constituent loans. Two principal methods are used to estimate fair value: (a) Contractual cash flows are discounted using a market discount rate that incorporates the current spread for the borrower or where this is not observable, the spread for borrowers of a similar credit standing. This method is used for portfolios where counterparties have external ratings: large corporate loans in UK Corporate and institutional and corporate lending in International Banking and Markets.
(b) Expected cash flows (unadjusted for credit losses) are discounted at the current offer rate for the same or similar products. This approach is adopted for lending portfolios in UK Retail, Ulster Bank, US Retail & Commercial and Wealth and SME loans in UK Corporate reflecting the homogeneous nature of these portfolios.
For certain portfolios where there are very few or no recent transactions, such as Ulster Bank’s commercial real estate portfolio, and high loan to value mortgages, a bespoke approach is used based on available market data.
The discount to amortised cost predominantly reflects stressed markets for commercial real estate loans, in both Non-Core and Core as well as high loan to value tracker mortgages.
More than 12 months Total £m £m £m £m £m £m £m £m £m
Held-for-trading assets and liabilities- held-for-trading assets of £666.5 billion and liabilities of £628.2 billion (2011 - £763.3 billion assets and £708.0 billion liabilities; 2010 - £665.0 billion assets and £586.1 billion liabilities) have been excluded from the following tables in view of their short-term nature.
0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years 2012 £m £m £m £m £m £m
Assets by contractual maturity Cash and balances at central banks 79,290 — — — — — Loans and advances to banks 15,592 1,393 272 27 20 62 Debt securities 6,320 4,505 13,330 19,369 25,772 10,644 Settlement balances 5,741 — — — — — Total maturing assets 106,943 5,898 13,602 19,396 25,792 10,706 Loans and advances to customers 73,590 57,403 93,445 65,569 76,682 87,450 Derivatives held for hedging 571 1,878 3,909 1,879 429 67 181,104 65,179 110,956 86,844 102,903 98,223
Guarantees and commitments notional amount Guarantees (1) 19,025 — — — — — Commitments (2) 215,808 — — — — — 234,833 — — — — —
For the notes relating to this table refer to page 415.
0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years 2010 £m £m £m £m £m £m
Assets by contractual maturity Cash and balances at central banks 56,988 — — 1 — 25 Loans and advances to banks 33,809 1,377 711 120 193 79 Debt securities 11,247 9,816 25,059 22,400 40,600 22,128 Settlement balances 11,334 231 — — 41 — Other financial assets 458 221 207 15 405 — Total maturing assets 113,836 11,645 25,977 22,536 41,239 22,232 Loans and advances to customers 112,465 86,592 120,139 69,304 78,131 63,015 Derivatives held for hedging 530 1,588 2,612 638 210 101 226,831 99,825 148,728 92,478 119,580 85,348
At 1 January 12,757 5,140 1,986 — 19,883 18,182 17,283 Transfers from/(to) disposal groups 153 548 63 — 764 (773) (72) Currency translation and other adjustments (506) 211 (15) — (310) (283) 43 Disposals — — (1) (4) (5) 8 (2,172)
Recoveries of amounts previously written-off 122 219 — — 341 527 411 Charge to income statement - continuing operations 3,192 2,196 (73) — 5,315 7,241 9,144 - discontinued operations — — — 4 4 (8) 42 Unwind of discount (recognised in interest income) (336) (140) — — (476) (484) (455)
Carrying Carrying Carrying value value value 2012 2011 2010 £m £m £m
Available-for-sale securities Debt securities 225 873 580 Equity shares 31 57 43
Loans and receivables Debt securities 1,008 234 230 1,264 1,164 853
Cash flow hedging Interest rate contracts 4,854 1,276 3,985 1,445 2,903 995
Available-for-sale Gross unrealised gains 944 1,092 1,185 56 650 19 3,946 748 Gross unrealised losses — (1) (14) (498) (1,319) — (1,832) (1,816)
Available-for-sale Gross unrealised gains 1,428 1,311 1,180 52 913 94 4,978 1,001 Gross unrealised losses — — (171) (838) (2,386) (13) (3,408) (3,158)
Held-for-trading 5,097 15,648 42,828 5,486 23,711 6,099 98,869 21,988 Designated as at fair value through profit or loss 1 117 262 4 8 10 402 119 Available-for-sale 8,377 22,244 32,865 16,982 29,148 1,514 111,130 42,515 Loans and receivables 11 — — 1 6,686 381 7,079 6,203 13,486 38,009 75,955 22,473 59,553 8,004 217,480 70,825
Available-for-sale Gross unrealised gains 349 525 700 143 827 51 2,595 1,057 Gross unrealised losses (10) (2) (618) (786) (2,626) (55) (4,097) (3,396)
Gross gains of £1,883 million (2011 - £739 million; 2010 - £572 million) and gross losses of £901 million (2011 - £60 million; 2010 - £159 million) were realised on the sale of available-for-sale securities in continuing operations. Gross gains of £78 million (2011 - £87 million; 2010 - £63 million) and gross losses of £12 million (2011 - £34 million; 2010 - nil) were realised on the sale of available-for-sale securities in discontinued operations.
Central and local governments - UK — — 1,559 2.0 4,105 3.3 2,286 3.5 7,950 3.1 - US 139 2.4 10,633 2.3 6,022 2.4 2,246 2.5 19,040 2.3 - other 3,346 0.6 5,849 3.0 5,273 3.0 1,527 3.4 15,995 2.6 Banks 1,764 1.6 3,294 2.8 1,685 1.2 484 1.6 7,227 2.1 Other financial institutions 741 3.0 5,289 2.5 4,378 3.0 12,886 1.4 23,294 2.0 Corporate 25 2.5 140 2.4 66 1.2 — — 231 2.0 6,015 1.2 26,764 2.5 21,529 2.7 19,429 2.0 73,737 2.3
16 Equity shares 2012 2011 2010 Listed Unlisted Total Listed Unlisted Total Listed Unlisted Total £m £m £m £m £m £m £m £m £m
Dividend income from available-for-sale equity shares was £59 million (2011 - £54 million; 2010 - £59 million).
Unquoted equity investments whose fair value cannot be reliably measured are carried at cost and classified as available-for-sale financial assets. They include capital stock (redeemable at cost) in the Federal Home Loan Bank and the Federal Reserve Bank of £0.7 billion (2011 - £0.7 billion; 2010 - £0.8 billion) that the Group's banking subsidiaries in the US are required to hold; and a number of individually small shareholdings in unlisted companies. Disposals in the year generated a gain of £2 million (2011 - £2 million gain; 2010 - £2 million loss).
Cost At 1 January 26,843 620 2,432 5,448 35,343 Transfers to disposal groups (984) — (15) (341) (1,340) Currency translation and other adjustments (486) (16) (74) (368) (944) Acquisition of subsidiaries — — — 5 5 Additions — — 39 909 948 Disposals and write-off of fully amortised assets (85) (426) (1,552) (643) (2,706)
Net book value at 31 December 11,266 95 234 1,950 13,545
Accumulated amortisation and impairment At 1 January 14,611 462 1,822 3,441 20,336 Transfers to disposal groups (80) — — — (80) Currency translation and other adjustments (203) (5) (55) 13 (250) Disposals and write-off of fully amortised assets — — — (220) (220) Charge for the year - continuing operations — 38 184 363 585 - discontinued operations — — — 23 23 Write down of goodwill and other intangible assets - continuing operations 80 — — — 80 - discontinued operations 11 — — — 11 At 31 December 14,419 495 1,951 3,620 20,485
Cost At 1 January 42,643 2,553 4,139 4,815 54,150 Currency translation and other adjustments (374) (59) (63) (21) (517)
UK Retail Value in use 2,770 UK Corporate Value in use 2,821 Wealth Value in use 611 International Banking Value in use 980 US Retail & Commercial Value in use 3,827 Direct Line Group (1) Value in use 934
The analysis of goodwill by operating segment is shown in Note 38. The change in reportable segments in 2012 disclosed in Note 38 did not impact the impairment tests performed in 2011.
Impairment testing involves the comparison of the carrying value of a CGU or group of CGUs with its recoverable amount. The recoverable amount is the higher of the unit's fair value and its value in use. Value in use is the present value of expected future cash flows from the CGU or group of CGUs. Fair value is the amount obtainable from the sale of the CGU in an arm's length transaction between knowledgeable, willing parties.
The recoverable amounts for all CGUs at 30 September 2012 were based on the value in use test, using management's latest five-year forecasts. The carrying amount of each CGU is assumed to be its capital contribution as a proxy for equity, where a divisional balance sheet is not available. The long-term growth rates have been based on respective country nominal GDP growth rates. The risk discount rates are based on observable market long-term government bond yields and average industry betas adjusted for an appropriate risk premium based on independent analysis.
2012 The results of the annual impairment test for 2012 and comparative periods are presented separately as a result of the changes to the Group’s structure implemented during 2012.
The recoverable amount of UK Retail, based on a 4.7% terminal growth rate and a 13.5% pre tax discount rate, exceeded its carrying value by £13.8 billion. A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £2.5 billion and £2.4 billion respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £1.3 billion.
The recoverable amount of UK Corporate, based on a 4.7% terminal growth rate and a 13.5% pre tax discount rate, exceeded its carrying value by £6.3 billion. A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £2.3 billion and £1.8 billion respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £1.4 billion.
The recoverable amount of Wealth, based on a 4.7% terminal growth rate and a 14.8% pre tax discount rate, exceeded its carrying value by £1.9 billion. A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £0.5 billion and £0.4 billion respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.3 billion.
The recoverable amount of US Retail & Commercial, based on a 5.3% terminal growth rate and a 16.9% pre tax discount rate, exceeded its carrying value by £2.0 billion. A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.2 billion and £0.8 billion respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.7 billion.
The Group has been considering various strategies for its investment in Citizens Financial Group (CFG). The Group has announced plans for a partial IPO of CFG over the medium term, likely two years. Notwithstanding this planned course of action, the recoverable amount of the US Retail & Commercial CGU remains its value in use.
The recoverable amount of Global Transaction Services, based on a 3% (2010 - 3%) terminal growth rate and an 11.4% (2010 - 12.8%) pre tax discount rate, exceeded its carrying value by more than 100% (2010 - 100%) and was insensitive to a reasonably possible change in key assumptions.
Notes on the consolidated accounts continued 17 Intangible assets continued The recoverable amount of US Retail & Commercial, based on a 5% (2010 - 5%) terminal growth rate and a 14.4% (2010 - 14.9%) pre tax discount rate, exceeded its carrying value by £0.2 billion (2010 - £1.6 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.1 billion (2010 - £1.6 billion) and £0.5 billion (2010 - £0.8 billion) respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.6 billion (2010 - £0.7 billion).
The recoverable amount of Direct Line Group, based on a 3% (2010 - 3%) terminal growth rate and a 12.3% (2010 - 13.1%) pre tax discount rate, exceeded the carrying amount by £0.8 billion (2010 - £2.4 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £0.5 billion and £0.2 billion respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.3 billion.
Operating lease assets Total 2012 £m £m £m £m £m £m £m
Cost or valuation At 1 January 4,468 2,855 273 1,823 4,479 3,892 17,790 Transfers (to)/from disposal groups (129) 101 11 95 (135) — (57) Currency translation and other adjustments (51) 21 13 (124) (182) (53) (376) Reclassifications 24 (47) 21 (6) 8 — — Additions 372 153 8 121 519 402 1,575 Expenditure on investment properties 10 — — — — — 10 Change in fair value of investment properties - continuing operations (153) — — — — — (153)
Accumulated impairment, depreciation and amortisation At 1 January — 702 118 793 2,700 1,849 6,162 Transfers to disposal groups — (43) (6) (66) (26) (730) (871) Currency translation and other adjustments — 6 4 (1) (28) 15 (4) Reclassifications — 3 (9) 7 — (1) — Write down of property, plant and equipment - continuing operations — — 3 1 1 — 5 Disposals and write-off of fully depreciated assets — (29) — (32) (110) (466) (637) Charge for the year - continuing operations — 95 4 148 487 520 1,254 - discontinued operations — 2 — — 11 — 13 At 31 December — 736 114 850 3,035 1,187 5,922
Net book value at 31 December 4,468 2,119 159 973 1,444 2,705 11,868
Accumulated impairment, depreciation and amortisation At 1 January — 553 87 641 2,396 1,764 5,441 Currency translation and other adjustments — 62 1 75 199 17 354 Disposal of subsidiaries — (24) — (30) (197) (141) (392) Reclassifications — (17) 17 — — — — Write down of property, plant and equipment - continuing operations — 32 4 1 4 — 41 Disposals and write-off of fully depreciated assets — (10) (2) (48) (261) (435) (756) Charge for the year - continuing operations — 104 11 148 525 627 1,415 - discontinued operations — 2 — 6 34 17 59 At 31 December — 702 118 793 2,700 1,849 6,162
Valuations are carried out by qualified surveyors who are members of the Royal Institution of Chartered Surveyors, or an equivalent overseas body. The valuation as at 31 December 2012 for a significant majority of the Group's investment properties was undertaken with the support of external valuers.
Direct Line Group Insurance premium income 4,044 4,526 5,192 Reinsurer’s share (326) (270) (178) Net premium income 3,718 4,256 5,014 Fees and commissions (430) (493) (319) Instalment income 126 145 194 Investment income 243 302 309 Other income 45 76 48 Total income 3,702 4,286 5,246 Staff costs (447) (322) (292) Premises and equipment (118) (28) (22) Other administrative expenses (395) (495) (424) Depreciation and amortisation (52) (36) (25) Goodwill and other intangible write-offs (394) (11) (9)
Profit before tax 22 45 427 Gain on disposals before recycling of reserves — — 113 Recycled reserves — — (1,076) Operating profit/(loss) before tax 22 45 (536)
Businesses acquired exclusively with a view to disposal (Loss)/profit after tax (2) 13 (5) Profit/(loss) from other discontinued operations, net of tax 12 47 (633)
(b) Cash flows attributable to discontinued operations Included within the Group's cash flows are the following amounts attributable to discontinued operations: 2012 2011 2010 £m £m £m
(d) Other comprehensive income relating to Direct Line Group 2012 2011 2010 £m £m £m
Derivatives 4 — — Insurance liabilities 6,193 6,233 6,716 Subordinated liabilities 529 — — Accruals, deferred income and other liabilities 2,541 2,739 2,905 Liabilities of disposal group 9,267
Notified claims 3,805 3,872 4,023 Incurred but not reported claims 1,647 1,939 2,316
The principal assumptions underlying the Group’s provision in respect of PPI sales are: assessment of the total number of complaints that the Group will receive; the proportion of these that will result in redress; and the average cost of such redress. The number of complaints has been estimated from an analysis of the Group’s portfolio of PPI policies sold by vintage and by product. Estimates of the percentage of policyholders that will lodge complaints (the take up rate) and of the number of these that will be upheld (the uphold rate) have been established based on recent experience, guidance in the FSA policy statements and expected rate of responses from proactive customer contact. The average redress assumption is based on recent experience and the calculation rules in the FSA statement.
Interest that will be payable on successful complaints has been included in the provision as has the estimated cost to the Group of administering the redress process. The Group expects the majority of the cash outflows associated with this provision to have occurred by the end of 2013. There are uncertainties as to the eventual cost of redress which will depend on actual complaint volumes, take up and uphold rates and average redress costs.
On 31 January 2013, the FSA announced the results of pilot studies by the Group and other UK banks. The FSA announcement also clarified the tests to be applied to determine whether a customer qualifies as ‘sophisticated’ and created a set of redress principles.
The Group has estimated £700 million for its liability based on the FSA’s guidance, an analysis of its portfolio of interest rate hedging products and the results of the pilot exercise. The provision includes redress that will be paid to customers, interest payable on customer redress: the cost to the Group of exiting the hedging positions; and the cost of undertaking the review.
The principal assumptions that underlie the estimate are: the number of transactions that meet the criteria for redress; the nature of the redress; in particular whether a product is terminated or replaced with an alternative product and/or a different profile; and the cost of the review.
(5) The Group is subject to a number of investigations by regulatory and other authorities. Details of these investigations and a discussion of the nature of the associated uncertainties are given in Note 32.
(7) In June 2012, the Group experienced a technology incident that affected its transaction batch processing. Provisions of £175 million were charged during 2012 to meet the waiver of fees and interest; redress for customers of the Group; and other costs principally staff costs. These costs have been substantially settled and there is minimal uncertainty as to the final cost.
(8) The property provisions principally comprise provisions for onerous lease contracts. Provision is made for future rentals payable in respect of vacant leasehold property and for any shortfall where leased property is sub-let at a rental lower than the lease rentals payable by the Group.
(Credit)/charge to other comprehensive Income (380) — — (10) — — 200 — 155 5 (170) — (200) Currency translation and other Adjustments — (43) 46 49 (25) 6 7 (10) — — 8 (20) 18 At 31 December 2012 (803) 1,744 (1,071) 385 (160) (8) 135 227 577 (12) (3,231) (85) (2,302)
UK tax losses Under UK tax rules, tax losses do not expire and can be carried forward indefinitely.
The Royal Bank of Scotland plc and the UK branch of RBS N.V.- the deferred tax assets in respect of tax losses brought forward at 1 January 2012 relate wholly to trading losses that arose in the UK branch of RBS N.V. Some were transferred on 1 January 2011 following the transfer of the majority of the activities of the UK Branch of RBS N.V. to The Royal Bank of Scotland plc and the balance is expected to transfer once the remaining activities have been transferred. The UK Branch tax losses attributable to credit market write-downs during the financial crisis were principally incurred between 2007 and 2009.
Overseas tax losses Ulster Bank Ireland - a deferred tax asset has been recognised in respect of £575 million of total tax losses of £7,627 million carried forward at 31 December 2012. These losses arose principally as a result of significant impairment charges reflecting deteriorating economic conditions in the Republic of Ireland. Impairment charges are expected to reduce in the future. Based on the Group’s strategic plan, the losses on which a deferred tax asset has been recognised will be utilised against future taxable profits of the company by the end of 2019. A 20% reduction in forecast profits would extend the recovery period by one year to 2020.
Unrecognised deferred tax Deferred tax assets of £3,827 million (2011 - £3,246 million; 2010 - £2,008 million) have not been recognised in respect of tax losses carried forward of £20,432 million (2011 - £16,691 million; 2010 - £9,869 million) in jurisdictions where doubt exists over the availability of future taxable profits. Of these losses, £37 million expire within one year, £1 million within five years and £11,068 million thereafter. The balance of tax losses carried forward has no time limit.
Deferred tax liabilities of £214 million (2011 - £249 million; 2010 - £279 million) have not been recognised in respect of retained earnings of overseas subsidiaries and held-over gains on the incorporation of overseas branches. Retained earnings of overseas subsidiaries are expected to be reinvested indefinitely or remitted to the UK free from further taxation. No taxation is expected to arise in the foreseeable future in respect of held-over gains. Changes to UK tax legislation largely exempts from UK tax, overseas dividends received on or after 1 July 2009.
Tax loss waiver On 26 November 2009, the company entered into three agreements (together comprising the tax loss waiver) which provide the right, at the company’s option, subject to HM Treasury consent, to satisfy all or part of the annual fee in respect of the asset protection scheme (APS) or the contingent subscription arrangement, and the exit fee payable in connection with any termination of the Group’s participation in the APS (but not the refund of the net payments it has received from HM Treasury under the APS), by waiving entitlement to relief for certain UK tax losses carried forward (principally tax losses carried forward under s393 of the Income and Corporation Taxes Act 1988 (now s45 of the Corporation Tax Act 2009)) recognised as deferred tax assets. The tax loss waiver contains undertakings designed to prevent the Group from engaging in arrangements which have a main purpose of reducing the net cost to the Group of any waiver of tax reliefs pursuant to the tax loss waiver. The Group has not satisfied any fees in respect of the APS or the Contingent Subscription arrangement by way of tax loss waiver. The Group exited the APS on 18 October 2012.
Dated loan capital 20,210 19,654 20,658 Undated loan capital 2,479 2,558 2,552 Preference shares 1,075 1,116 1,112 Trust preferred securities 3,009 2,991 2,731 26,773 26,319 27,053
The Group undertook that, unless otherwise agreed with the European Commission, neither the company nor any of its direct or indirect subsidiaries (excluding companies in the RBS Holdings N.V. Group, which are subject to different restrictions, see below) would pay external investors any dividends or coupons on existing hybrid capital instruments (including preference shares, B shares and upper and lower tier 2 instruments) from 30 April 2010 for a period of two years thereafter (“the Deferral Period”), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the Deferral Period, unless there was a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 were generally not subject to the restriction on dividend or coupon payments or call options. On 30 April 2012, the Deferral Period for RBS Group instruments ended and in May 2012, the Group determined that it was in a position to recommence payments on these instruments. Future coupons and dividends will only be paid subject to, and in accordance with, the terms of the relevant instruments.
The following tables analyse the remaining contractual maturity of subordinated liabilities by the final redemption date; and by the next call date.
Sterling 214 — 630 464 — 994 2,302 US dollar 611 664 2,388 3,722 177 4,409 11,971 Euro 1,478 — 3,035 3,814 397 806 9,530 Other 48 425 790 1,381 — 326 2,970 2,351 1,089 6,843 9,381 574 6,535 26,773 2012 - call date Currently £m £m £m £m £m Thereafter £m Perpetual £m Total £m
Sterling 24 429 60 826 715 36 212 2,302 US dollar 2,577 3,546 664 1,767 2,408 1,009 — 11,971 Euro — 3,509 289 2,863 2,427 397 45 9,530 Other — 1,192 — 1,214 564 — — 2,970 2,601 8,676 1,013 6,670 6,114 1,442 257 26,773 £m £m £m £m Thereafter £m Perpetual £m Total £m 2011 - call date Currently £m £m £m £m £m Thereafter £m Perpetual £m Total £m £m £m £m £m Thereafter £m Perpetual £m Total £m 2010 - call date Currently £m £m £m £m £m Thereafter £m Perpetual £m Total £m
The Royal Bank of Scotland Group plc US$300 million 6.375% subordinated notes 2011 (1) — — 199 US$750 million 5% subordinated notes 2013 (1) Lower Tier 2 485 522 532 US$750 million 5% subordinated notes 2014 (1) Lower Tier 2 520 558 559 US$250 million 5% subordinated notes 2014 (1) Lower Tier 2 152 163 162 US$675 million 5.05% subordinated notes 2015 (1) Lower Tier 2 463 494 492 US$350 million 4.7% subordinated notes 2018 (1) Lower Tier 2 262 271 252 US$2,250 million 6.125% subordinated notes 2022 (issued December 2012) (1) Lower Tier 2 1,398 — —
€564 million 10.5% subordinated notes 2022 (issued March 2012) callable March 2017 Lower Tier 2 497 — —
US$2,132 million 9.5% subordinated notes 2022 (issued March 2012) callable March 2017 Lower Tier 2 1,350 — —
First Active plc £60 million 6.375% subordinated bonds 2018 (callable quarterly from April 2013) Lower Tier 2 63 64 66
RBS NV and subsidiaries €250 million 4.70% CMS linked subordinated notes 2019 Lower Tier 2 199 136 181 €100 million 5.13% flip flop Bermudan callable subordinated notes 2017 (callable annually from December 2012) Lower Tier 2 72 78 69 €13 million zero coupon subordinated notes 2029 (callable annually from June 2009) Lower Tier 2 11 14 9 €170 million floating rate sinkable subordinated notes 2041 Lower Tier 2 166 81 240 €15 million CMS linked floating rate subordinated notes 2020 Lower Tier 2 10 7 10 €1,500 million floating rate Bermudan callable subordinated notes 2015 (callable quarterly from June 2010) Lower Tier 2 1,215 1,246 1,283 €5 million floating rate Bermudan callable subordinated notes 2015 (callable quarterly from October 2010) Lower Tier 2 4 4 4 US$129 million (2011 and 2010 - US$165 million) 6.14% subordinated notes 2019 Lower Tier 2 75 76 104 US$72 million 5.98% subordinated notes 2019 Lower Tier 2 57 47 42 US$500 million 4.65% subordinated notes 2018 Lower Tier 2 347 354 326 US$1,500 million floating rate Bermudan callable subordinated notes 2015 (callable quarterly from March 2010) Lower Tier 2 892 930 927 AUD575 million 6.50% Bermudan callable subordinated notes 2018 (callable quarterly from May 2013) Lower Tier 2 366 378 371 AUD175 million floating rate Bermudan callable subordinated notes 2018 (callable quarterly from May 2013) Lower Tier 2 109 111 111 €26 million 7.42% subordinated notes 2016 Lower Tier 2 25 25 26 €7 million 7.38% subordinated notes 2016 Lower Tier 2 7 7 7 £25 million amortising MTN subordinated notes 2011 — — 3 US$136 million (2011 and 2010 - US$ 250 million) 7.75% fixed rate subordinated notes 2023 Lower Tier 2 85 90 163 US$150 million 7.13% fixed rate subordinated notes 2093 Lower Tier 2 94 100 98
The Royal Bank of Scotland Berhad MYR200 million 4.15% subordinated notes 2017 (4) Ineligible 42 42 42
Notes: (1) On-lent to The Royal Bank of Scotland plc on a subordinated basis. (2) Unconditionally guaranteed by the Royal Bank of Scotland. (3) Partially repurchased following completion of an exchange offer in March 2012. (4) Issuing entity transferred from being a subsidiary of RBS N.V. to RBS Group in October 2012. (5) In the event of certain changes in tax laws, dated loan capital issues may be redeemed in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior regulatory approval. (6) Except as stated above, claims in respect of the Group's dated loan capital are subordinated to the claims of other creditors. None of the Group's dated loan capital is secured. (7) Interest on all floating rate subordinated notes is calculated by reference to market rates.
Notes on the consolidated accounts continued 24 Subordinated liabilities continued Undated loan capital 2012 2011 2010
The Royal Bank of Scotland Group plc US$106 million undated floating rate primary capital notes (callable semi-annually from December 1990) (1,2) Upper Tier 2 66 69 69 US$762 million 7.648% perpetual regulatory (callable quarterly from September 2031) (1,3,4) Tier 1 477 497 494
National Westminster Bank Plc US$193 million primary capital floating rate notes, Series A (callable semi-annually from July 1990) (1) Upper Tier 2 119 124 124 US$229 million primary capital floating rate notes, Series B (callable semi-annually from August 1990) (1) Upper Tier 2 142 148 148 US$285 million primary capital floating rate notes, Series C (callable quarterly from November 1990) (1) Upper Tier 2 177 184 184 €178 million 6.625% fixed/floating rate undated subordinated notes (callable quarterly from October 2009) Upper Tier 2 146 150 154 €10 million floating rate undated step-up notes (callable quarterly from October 2009) Upper Tier 2 9 9 9 £87 million floating undated subordinated step-up notes (callable every five years from January 2010) (1) Upper Tier 2 92 91 89 £53 million 7.125% undated subordinated step-up notes (callable every five years from October 2022) (1) Upper Tier 2 55 56 54 £35 million 11.5% undated subordinated notes (callable any time from December 2022) (1,2,5) Upper Tier 2 38 42 42
First Active plc £20 million 11.75% perpetual Lower Tier 2 25 26 26 €38 million 11.375% perpetual Lower Tier 2 46 48 50 £1.3 million floating rate perpetual Lower Tier 2 2 2 2 2,479 2,558 2,552
Notes: (1) Partially repurchased following completion of the exchange and tender offers in May 2010. (2) On-lent to The Royal Bank of Scotland plc on a subordinated basis (3) The company can satisfy interest payment obligations by issuing sufficient ordinary shares to appointed Trustees to enable them, on selling these shares, to settle the interest payment. (4) Guaranteed by the company. (5) Exchangeable at the option of the issuer into 8.392% (gross) non-cumulative preference shares of £1 each of National Westminster Bank Plc at any time. (6) Except as stated above, claims in respect of the Group's undated loan capital are subordinated to the claims of other creditors. None of the Group's undated loan capital is secured. (7) In the event of certain changes in tax laws, undated loan capital issues may be redeemed in whole, but not in part, at the option of the Group, at the principal amount thereof plus accrued interest, subject to prior regulatory approval. (8) Interest on all floating rate subordinated notes is calculated by reference to market rates.
National Westminster Bank Plc Non-cumulative preference shares of £1 Series A £140 million 9% (not callable) Tier 1 145 145 144
Trust preferred securities treatment £m £m £m €391 million 6.467% (callable quarterly from June 2012) (1) Tier 1 319 340 339 US$486 million 6.8% (callable quarterly from March 2008) (1) Tier 1 302 309 289 US$318 million 4.709% (callable quarterly from July 2013) (1,2) Tier 1 199 210 190 US$394 million 6.425% (callable quarterly from January 2034) (1) Tier 1 365 382 291
RBS NV and subsidiaries (3) US$1,285 million 5.90% Trust Preferred V (callable any time from July 2008) (3) Tier 1 713 684 633 US$200 million 6.25% Trust Preferred VI (callable any time from September 2008) Tier 1 112 108 100 US$1,800 million 6.08% Trust Preferred VII (callable any time from February 2009) Tier 1 999 958 889
(2) Partially repurchased following completion of the exchange and tender offers in May 2010. (3) Dividends are non-cumulative. They cannot be declared if RBS Holdings N.V. has not paid dividends on any parity securities. Distributions must be made, subject to the restrictions described in (4)
below, if RBS Holdings N.V. pays a dividend on its ordinary shares or on its parity securities or redeems or repurchases such securities. (4) The trust preferred securities are subject to restrictions on dividend payments agreed with the European Commission (see page 434).
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 agreed to acquire.
US$357 million 5.512% (redeemable September 2014) 198 198 198 US$276 million 3 month US$ LIBOR plus 0.80% (redeemable September 2014) (1) 153 153 153 €166 million 4.243% (redeemable January 2016) 112 112 112 £93 million 5.6457% (redeemable June 2017) 93 93 93 556 556 556
Services Authority, be redeemed, in whole or in part, by the issuer on the dates specified above or on any interest payment date thereafter. They may also be redeemed in whole, but not in part, upon the occurrence of certain tax and regulatory events. Dividends are non-cumulative and discretionary. Distributions are not made if dividends are not paid on any series of the company’s noncumulative preference shares. The company classifies its obligations to these subsidiaries as dated loan capital.
Allotted, called up and fully paid Number of shares - thousands 2012 2011 2010
Ordinary shares of 25p (1) — 59,228,412 58,458,131 Ordinary shares of £1 (1) 6,070,765 — — B shares of £0.01 51,000,000 51,000,000 51,000,000 Dividend access share of £0.01 (2) — — — Non-cumulative preference shares of US$0.01 209,609 209,609 209,609 Non-cumulative convertible preference shares of US$0.01 65 65 65 Non-cumulative preference shares of €0.01 2,044 2,044 2,044 Non-cumulative convertible preference shares of £0.01 15 15 15 Non-cumulative preference shares of £1 54 54 54 Cumulative preference shares of £1 900 900 900
Notes: (1) In June 2012, the ordinary shares of 25p each were initially sub-divided into 59,554,319,127 ordinary shares of 10p each and 59,554,319,127 deferred shares of 15p each. The deferred shares created by virtue of the sub-division were cancelled with the nominal value transferred to capital redemption reserve. The 59,554,319,127 ordinary shares of 10p were consolidated into 5,955,431,912 ordinary shares of £1 each.
The contingent capital commitment agreement can be terminated in whole or in part by the company, with the FSA's consent, at any time. It expires at the end of five years or, if earlier, on its termination in full.
Non-cumulative preference shares of US$0.01 Series F 6.3 million 7.65% 31 March 2007 US$25 Debt Series H 9.7 million 7.25% 31 March 2004 US$25 Debt Series L 30.0 million 5.75% 30 September 2009 US$25 Debt Series M 23.1 million 6.4% 30 September 2009 US$25 Equity Series N 22.1 million 6.35% 30 June 2010 US$25 Equity Series P 9.9 million 6.25% 31 December 2010 US$25 Equity Series Q 20.6 million 6.75% 30 June 2011 US$25 Equity Series R 10.2 million 6.125% 30 December 2011 US$25 Equity Series S 26.4 million 6.6% 30 June 2012 US$25 Equity Series T 51.2 million 7.25% 31 December 2012 US$25 Equity Series U 10,130 7.64% 29 September 2017 US$100,000 Equity
Under existing arrangements, no redemption or purchase of any noncumulative preference shares may be made by the company without the prior consent of the UK Financial Services Authority.
Notes on the consolidated accounts continued 26 Share capital continued On a winding-up or liquidation of the company, the holders of the noncumulative preference shares will be entitled to receive, out of any surplus assets available for distribution to the company's shareholders (after payment of arrears of dividends on the cumulative preference shares up to the date of repayment) pari passu with the cumulative preference shares and all other shares of the company ranking pari passu with the non-cumulative preference shares as regards participation in the surplus assets of the company, a liquidation distribution per share equal to the applicable redemption price detailed in the table above, together with an amount equal to dividends for the then current dividend period accrued to the date of payment, before any distribution or payment may be made to holders of the ordinary shares as regards participation in the surplus assets of the company.
The Group had undertaken that, unless otherwise agreed with the European Commission, neither the company nor any of its direct or indirect subsidiaries (excluding companies in the RBS Holdings N.V. Group, which are subject to different restrictions) would pay external investors any dividends or coupons on existing hybrid capital instruments (including preference shares, B shares and upper and lower tier 2 instruments) from 30 April 2010 for a period of two years thereafter ("the Deferral Period"), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the Deferral Period, unless there was a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 were generally not subject to the restriction on dividend or coupon payments or call options. On 30 April 2012, the Deferral Period for RBS Group instruments ended and in May 2012, the Group determined that it was in a position to recommence payments on these instruments. Future coupons and dividends will only be paid subject to, and in accordance with, the terms of the relevant instruments.
27 Other equity Paid-in equity - notes issued under the company's euro medium term note programme with an initial par value of US$1,600 million and CAD600 million are classified as equity under IFRS. The notes attract coupons of 6.99% and 6.666% respectively until October 2017 when they change to 2.67% above the London interbank offered rate for 3-month US dollar deposits and 2.76% above the Canadian dollar offered rate respectively. Paid-in equity of US$1,036 million was repurchased in April 2009 and CAD279 million was repurchased in May 2010 as part of liability management exercises.
Contingent capital reserve - in December 2009, HM Treasury agreed to subscribe for up to 16 billion B shares of 1p each at 50p per share subject to certain conditions including the Group's Core Tier 1 capital ratio falling below 5%. The fair value of the consideration payable by the company on entering into this agreement amounted to £1,458 million; of this £1,208 million was debited to the contingent capital reserve.
Within 1 year 3,559 (309) (20) 3,230 997 After 1 year but within 5 years 7,833 (795) (245) 6,793 2,388 After 5 years 7,843 (2,763) (263) 4,817 998 Total 19,235 (3,867) (528) 14,840 4,383
Notes on the consolidated accounts continued 28 Leases continued Residual value exposures The table below gives details of the unguaranteed residual values included in the carrying value of finance lease receivables (see pages 388 to 391) and operating lease assets (see pages 424 to 426).
29 Securitisations, asset transfers and other collateral given Secured funding The Group has access to secured funding markets through own-asset securitisation and covered bond funding programmes to complement existing wholesale funding programmes and access to the repo markets. The Group monitors and manages encumbrance levels related to these secured funding programmes. This includes the potential encumbrance of Group assets that could be used in own-asset securitisations and/or covered bonds that could be used as contingent liquidity.
Own-asset securitisations The Group has a programme of own-asset securitisations where assets are transferred to bankruptcy remote SPEs funded by the issue of debt securities. The majority of the risks and rewards of the portfolio are retained by the Group and these SPEs are consolidated and all of the transferred assets retained on the Group’s balance sheet. In some ownasset securitisations, the Group may purchase all the issued securities which are available to be pledged as collateral for repurchase agreements with major central banks.
2012 2011 2010 Debt securities in issue Debt securities in issue Debt securities in issue
Mortgages - UK (RMBS) 16,448 6,462 11,963 18,425 49,549 10,988 47,324 58,312 53,132 13,047 50,028 63,075 - UK (covered bonds) 15,990 10,139 — 10,139 15,441 9,107 — 9,107 8,046 4,100 — 4,100 - Irish 10,587 3,217 7,634 10,851 12,660 3,472 8,670 12,142 15,034 5,101 11,152 16,253 UK credit cards 3,019 1,243 1,736 2,979 4,037 500 110 610 3,993 34 1,500 1,534 UK personal loans 4,658 — 4,283 4,283 5,168 — 4,706 4,706 5,795 — 5,383 5,383 Other loans (4) 18,008 1,059 18,064 19,123 19,778 4 20,577 20,581 25,193 974 23,186 24,160 68,710 22,120 43,680 65,800 106,633 24,071 81,387 105,458 111,193 23,256 91,249 114,505 Cash deposits (5) 5,823 11,998 13,068 74,533 118,631 124,261
Notes: (1) Assets that have been pledged to the SPEs which itself is a subset of the total portfolio of eligible assets within a collateral pool. (2) Debt securities that have been sold to third party investors and represents a source of external wholesale funding. (3) Debt securities issued pursuant to own-asset securitisations where the debt securities are retained by the Group as a source of contingent liquidity where those securities can be used in repurchase agreements with central banks. (4) Comprises corporate, social housing and student loans. (5) At 31 December 2012, cash deposits comprised £4.7 billion from mortgage repayments and £1.1 billion from other loan repayments held in the SPEs, to repay debt securities issued by the ownasset securitisation vehicles (2011 - £11.2 billion and £0.8 billion; 2010 - £12.3 billion and £0.8 billion respectively).
Notes on the consolidated accounts continued 29 Securitisation, asset transfers and other collateral given continued Continuing involvement In certain securitisations of US residential mortgages, substantially all the risks and rewards have been neither transferred nor retained, but the Group has retained control of the assets and continues to recognise the assets to the extent of its continuing involvement, as defined by IAS 39, which takes the form of retaining certain subordinated bonds issued by the securitisation SPEs.
Securities sold under repurchase transactions are not derecognised if the Group retains substantially all the risks and rewards of ownership. The fair value (and carrying value) of securities transferred under such repurchase transactions included on the balance sheet, are set out below. All of these securities could be sold or repledged by the holder.
Assets subject to securities repurchase agreements or security lending transactions 2012 £m
Loans and advances to banks 12,784 19,691 27,271 Loans and advances to customers 25,186 52,225 46,352 Debt securities 24,236 3,713 7,200 62,206 75,629 80,823
Liabilities secured by assets Deposits by banks 12,309 6,369 10,565 Customer accounts 3,000 2,663 3,599 Derivatives 60,434 82,356 93,570 75,743 91,388 107,734
30 Special purpose entities The Group arranges securitisations to facilitate client transactions and undertakes securitisations to sell financial assets or to fund specific portfolios of assets. The Group also acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. In a securitisation, assets, or interests in a pool of assets, are transferred generally to a special purpose entity (SPE) which then issues liabilities to third party investors. SPEs are vehicles established for a specific, limited purpose, usually do not carry out a business or trade and typically have no employees. They take a variety of legal forms - trusts, partnerships and companies - and fulfil many different functions. As well as being a key element of securitisations, SPEs are also used in fund management activities to segregate custodial duties from the fund management advice provided by the Group.
The Group applies the guidance in IAS 27 ‘Consolidated and Separate Financial Statements’ and SIC 12 ‘Consolidation - Special Purpose Entities’ in determining whether or not to consolidate an SPE. SPEs are consolidated where the substance of the relationship between the Group and the SPE is such that the SPE is controlled by the Group. In determining whether the SPE is controlled by the Group, the Group considers whether the activities of the SPE are being conducted on its behalf so that it obtains benefits from its operation; whether the Group has the decision-making powers to obtain the majority of the benefits of the SPE’s activities; whether the Group has rights to obtain the majority of the benefits of the SPE; and whether the Group retains the majority of the residual or ownership risks related to the SPE or its assets so as to obtain benefits from its activities. As a result of applying these principles, the Group does not consolidate those SPEs where its interests in the SPE do not provide the Group with a majority of the benefits and/or residual or ownership risks and therefore the SPE is not controlled by the Group. SPEs that are in substance controlled by the Group are consolidated. The Group accounts for its interests, for example, holdings of securities issued and liquidity commitments, in SPEs it does not consolidate in accordance with its accounting policy for these items.
The Group also employs synthetic structures, where assets are not sold to the SPE, but credit derivatives are used to transfer the credit risk of the assets to an SPE. Securities may then be issued by the SPE to investors, on the back of the credit protection sold to the Group by the SPE.
The Group sponsors own-asset securitisations primarily as a way of diversifying funding sources. The Group purchases the securities issued in own-asset securitisations and may pledge as collateral for repurchase agreements with major central banks.
Refer to Note 29 on page 447 for the asset categories, together with the carrying value of the assets and associated liabilities for those securitisations and other asset transfers, other than conduits, where the assets continue to be recorded on the Group's balance sheet.
The ways the Group may be involved with conduits and other special purpose entities are described above.
Notes on the consolidated accounts continued 30 Special purpose entities continued Total assets and other aspects relating to the Group’s consolidated conduits are set out below.
Core £m Non-Core £m Total £m Core £m Non-Core £m Total £m Core £m Non-Core £m Total £m
Liquidity and credit enhancements Deal specific liquidity - drawn 2,122 781 2,903 321 1,051 1,372 868 1,109 1,977 - undrawn 1,521 17 1,538 15,324 1,144 16,468 21,935 2,980 24,915 PWCE (2) 60 — 60 795 193 988 1,025 257 1,282 3,703 798 4,501 16,440 2,388 18,828 23,828 4,346 28,174
Shareholders’ equity per balance sheet 68,130 74,819 75,132 Preference shares - equity (4,313) (4,313) (4,313) Other equity instruments (431) (431) (431)
Regulatory adjustments and deductions Own credit 691 (2,634) (1,182) Defined benefit pension adjustment 913 — — Unrealised losses on AFS debt securities 409 1,065 2,061 Unrealised gains on AFS equity shares (63) (108) (25) Cash flow hedging reserve (1,666) (879) 140 Other adjustments for regulatory purposes (197) 571 204 Goodwill and other intangible assets (13,545) (14,858) (14,448) 50% excess of expected losses over impairment provisions (net of tax) (1,904) (2,536) (1,900)
Undated subordinated debt 2,194 1,838 1,852 Dated subordinated debt, net of amortisation 13,420 14,527 16,745 Unrealised gains on AFS equity shares 63 108 25 Collectively assessed impairment provisions 399 635 778 Non-controlling Tier 2 capital — 11 11 16,076 17,119 19,411
Supervisory deductions Unconsolidated investments - Direct Line Group (2,081) (4,354) (3,962)
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 2012. 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.
Commitments (1) Undrawn formal standby facilities, credit lines and other commitments to lend - less than one year 83,461 — — — 83,461 100,092 117,581 - one year and over 12,703 39,185 64,901 15,558 132,347 139,871 149,241 Other commitments 1,753 101 121 1 1,976 2,912 4,154 97,917 39,286 65,022 15,559 217,784 242,875 270,976
Contracts to purchase goods or services (4) 959 1,130 950 4,934 8,407 8,591
The Financial Services Compensation Scheme The Financial Services Compensation Scheme (FSCS), the UK's statutory fund of last resort for customers of authorised financial services firms, pays compensation if a firm is unable to meet its obligations. The FSCS funds compensation for customers by raising management expenses levies and compensation levies on the industry. In relation to protected deposits, each deposit-taking institution contributes towards these levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year (which runs from 1 April to 31 March), subject to annual maxima set by the Financial Services Authority. In addition, the FSCS has the power to raise levies on a firm that has ceased to participate in the scheme and is in the process of ceasing to be authorised for the costs that it would have been liable to pay had the FSCS made a levy in the financial year it ceased to be a participant in the scheme.
The FSCS has borrowed from HM Treasury to fund compensation costs associated with the failure of Bradford & Bingley, Heritable Bank, Kaupthing Singer & Friedlander, Landsbanki ‘Icesave’ and London Scottish Bank plc. The interest rate on these borrowings increased from 12 month LIBOR plus 30 basis points to 12 month LIBOR plus 100 basis points from April 2012. The FSCS and HM Treasury have agreed that the period of these loans will reflect the expected timetable for recoveries from the estates of Bradford & Bingley and the other failed banks. The FSCS expects to levy the deposit taking sector for the balance of the principal on the non-Bradford & Bingley loans over three scheme years to repay the principal by March 2016 with a first instalment of £363 million in the 2013/14 scheme year.
Litigation Shareholder litigation RBS and certain of its subsidiaries, together with certain current and former individual officers and directors were named as defendants in purported class actions filed in the United States District Court for the Southern District of New York involving holders of RBS preferred shares (the Preferred Shares litigation) and holders of American Depositary Receipts (the ADR claims).
In the Preferred Shares litigation, the consolidated amended complaint alleged certain false and misleading statements and omissions in public filings and other communications during the period 1 March 2007 to 19 January 2009, and variously asserted claims under Sections 11, 12 and 15 of the US Securities Act of 1933, as amended (Securities Act). The putative class is composed of all persons who purchased or otherwise acquired Group Series Q, R, S, T and/or U non-cumulative dollar preference shares issued pursuant or traceable to the 8 April 2005 US Securities and Exchange Commission (SEC) registration statement. Plaintiffs sought unquantified damages on behalf of the putative class. The defendants moved to dismiss the complaint and briefing on the motions was completed in September 2011. On 4 September 2012, the Court dismissed the Preferred Shares litigation with prejudice. The plaintiffs have appealed the dismissal to the United States Court of Appeals for the Second Circuit.
With respect to the ADR claims, a complaint was filed in January 2011 and a further complaint was filed in February 2011 asserting claims under Sections 10 and 20 of the US Securities Exchange Act of 1934, as amended (Exchange Act) on behalf of all persons who purchased or otherwise acquired the Group’s American Depositary Receipts (ADRs) between 1 March 2007 and 19 January 2009. On 18 August 2011, these two ADR cases were consolidated and lead plaintiff and lead counsel were appointed. On 1 November 2011, the lead plaintiff filed a consolidated amended complaint asserting ADR-related claims under Sections 10 and 20 of the Exchange Act and Sections 11, 12 and 15 of the Securities Act. The defendants moved to dismiss the complaint in January 2012 and briefing on the motions was completed in April 2012. The Court heard oral argument on the motions on 19 July 2012. On 27 September 2012, the Court dismissed the ADR claims with prejudice. The plaintiffs have filed motions for reconsideration and for leave to replead their case.
The Group has also received notification of similar prospective claims in the United Kingdom and elsewhere but no court proceedings have been commenced in relation to these claims. In October 2011, the Group submitted a detailed response to a letter before action from one purported plaintiff group in the United Kingdom.
Other securitisation and securities related litigation in the United States There continues to be a high level of litigation activity in the financial services industry focused on residential mortgage and credit crisis related matters. As a result, the Group has become the subject of claims for damages and other relief regarding mortgages and related securities and expects that it may become the subject of additional such claims in the future.
Among these MBS lawsuits are six cases filed on 2 September 2011 by the US Federal Housing Finance Agency (FHFA) as conservator for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The primary FHFA lawsuit is pending in the federal court in Connecticut, and it relates to approximately US$32 billion of MBS for which Group entities acted as sponsor/depositor and/or lead underwriter or co-lead underwriter. The defendants’ motion to dismiss FHFA’s amended complaint in this case is pending, but the court has permitted discovery to commence. The other five FHFA lawsuits (against Ally Financial Group, Countrywide Financial Corporation, JP Morgan, Morgan Stanley, and Nomura) name RBS Securities Inc. as a defendant by virtue of the fact that it was an underwriter of some of the securities at issue. Four of these cases are part of a coordinated proceeding in federal court in New York in which discovery is underway. The fifth case (the Countrywide matter) is pending in federal court in California, and is currently the subject of a motion to dismiss.
Other MBS lawsuits against Group companies include two cases filed by the National Credit Union Administration Board (on behalf of US Central Federal Credit Union and Western Corporate Federal Credit Union) and eight cases filed by the Federal Home Loan Banks of Boston, Chicago, Indianapolis, Seattle and San Francisco.
The purported MBS class actions in which Group companies are defendants include New Jersey Carpenters Vacation Fund et al. v. The Royal Bank of Scotland plc et al.; New Jersey Carpenters Health Fund v. Novastar Mortgage Inc. et al.; In re IndyMac Mortgage-Backed Securities Litigation; Genesee County Employees’ Retirement System et al. v. Thornburg Mortgage Securities Trust 2006-3, et al. (the Thornburg Litigation); and Luther v. Countrywide Financial Corp. et al. and related cases. On 25 February 2013, the federal district court overseeing the Thornburg Litigation entered a final order approving a settlement of the litigation, involving a US$11.25 million payment by the defendants.
London Interbank Offered Rate (LIBOR) Certain members of the Group have been named as defendants in a number of class actions and individual claims filed in the US with respect to the setting of LIBOR. The complaints are substantially similar and allege that certain members of the Group and other panel banks individually and collectively violated various federal laws, including the US commodities and antitrust laws, and state statutory and common law by manipulating LIBOR and prices of LIBOR-based derivatives in various markets through various means. The Group considers that it has substantial and credible legal and factual defences to these and prospective claims. It is possible that further claims may be threatened or brought in the US or elsewhere relating to the setting of interest rates or interest rate-related trading.
Details of LIBOR investigations affecting the Group are set out under ‘Investigations and reviews’ on page 457.
Madoff In December 2010, Irving Picard, as trustee for the bankruptcy estates of Bernard L. Madoff and Bernard L. Madoff Investment Securities LLC., filed a clawback claim against RBS N.V. in New York bankruptcy court. In the operative complaint, filed in August 2012, the trustee seeks to recover US$75.8 million in redemptions that RBS N.V. allegedly received from certain Madoff feeder funds and US$162.1 million that RBS N.V. allegedly received from its swap counterparties at a time when RBS N.V. allegedly ‘knew or should have known of Madoff’s possible fraud’. The Trustee alleges that those transfers were preferences or fraudulent conveyances under the US bankruptcy code and New York law and he asserts the purported right to claw them back for the benefit of Madoff’s estate. A further claim, for US$21.8 million, was filed in October 2011. The Group considers that it has substantial and credible legal and factual defences to these claims and intends to defend itself vigorously.
Investigations and reviews The Group’s businesses and financial condition can be affected by the fiscal or other policies and actions of various governmental and regulatory authorities in the United Kingdom, the European Union, the United States and elsewhere. The Group has engaged, and will continue to engage, in discussions with relevant governmental and regulatory authorities, including in the United Kingdom and the United States, on an ongoing and regular basis regarding operational, systems and control evaluations and issues including those related to compliance with applicable anti-bribery, anti-money laundering and sanctions regimes. It is possible that any matters discussed or identified may result in investigatory or other action being taken by governmental and regulatory authorities, increased costs being incurred by the Group, remediation of systems and controls, public or private censure, restriction of the Group’s business activities or fines. Any of these events or circumstances could have a material adverse effect on the Group, its business, authorisations and licences, reputation, results of operations or the price of securities issued by it.
The Group is co-operating fully with the investigations and reviews described below.
LIBOR and other trading rates On 6 February 2013 the Group announced settlements with the Financial Services Authority in the United Kingdom, the United States Commodity Futures Trading Commission and the United States Department of Justice (DOJ) in relation to investigations into submissions, communications and procedures around the setting of the London Interbank Offered Rate (LIBOR). RBS agreed to pay penalties of £87.5 million, US$325 million and US$150 million to these authorities respectively to resolve the investigations. As part of the agreement with the DOJ, RBS plc entered into a Deferred Prosecution Agreement in relation to one count of wire fraud relating to Swiss Franc LIBOR and one count for an antitrust violation relating to Yen LIBOR. RBS Securities Japan Limited agreed to enter a plea of guilty to one count of wire fraud relating to Yen LIBOR. The Group continues to co-operate with investigations by these and various other governmental and regulatory authorities, including in the US and Asia, into its submissions, communications and procedures relating to the setting of LIBOR and other trading rates. The Group is also under investigation by competition authorities in a number of jurisdictions, including the European Commission and Canadian Competition Bureau, stemming from the actions of certain individuals in the setting of LIBOR and other trading rates, as well as interest rate-related trading. The Group is also cooperating with these investigations.
Technology incident On 19 June 2012 the Group was affected by a technology incident, as a result of which the processing of certain customer accounts and payments were subject to considerable delay. The cause of the incident has been investigated by independent external counsel with the assistance of third party advisors. The Group has agreed to reimburse customers for any loss suffered as a result of the incident. The Group provided £175 million in 2012 for this matter. Additional costs may arise once all redress and business disruption items are clear.
Notes on the consolidated accounts continued 32 Memorandum items continued Interest rate hedging products In June 2012, following an industry wide review, the FSA announced that the Group and other UK banks had agreed to a redress exercise and past business review in relation to the sale of interest rate hedging products to some small and medium sized businesses who were classified as retail clients under FSA rules. On 31 January 2013, the FSA issued a report outlining the principles to which it wishes the Group and other UK banks to adhere in conducting the review and redress exercise.
Retail banking Since initiating an inquiry into retail banking in the European Union (EU) in 2005, the European Commission (EC) continues to keep retail banking under review. In late 2010 the EC launched an initiative pressing for greater transparency of bank fees and is currently proposing to legislate for increased harmonisation of terminology across Member States, with proposals expected in the first quarter of 2013. The Group cannot predict the outcome of these actions at this stage.
Multilateral interchange fees In 2007, the EC issued a decision that, while interchange is not illegal per se, MasterCard’s multilateral interchange fee (MIF) arrangements for cross border payment card transactions with MasterCard and Maestro branded consumer credit and debit cards in the EEA were in breach of competition law. MasterCard was required to withdraw the relevant crossborder MIF (i.e. set these fees to zero) by 21 June 2008. MasterCard appealed against the decision to the General Court in March 2008, with the Group intervening in the appeal proceedings. The General Court heard MasterCard’s appeal in July 2011 and issued its judgment in May 2012, upholding the EC’s original decision. MasterCard has appealed further to the Court of Justice and the Group has intervened in these appeal proceedings.
In the UK, the Office of Fair Trading (OFT) has carried out investigations into Visa and MasterCard domestic credit card interchange rates. The OFT has not made any finding of an infringement of competition law and has not issued a Statement of Objections to any of the parties under investigation. In February 2013 the OFT confirmed that while reserving its right to do so, it does not currently expect to issue Statements of Objections (if at all) prior to the handing down of the Court of Justice judgment in the matter of MasterCard's appeal against the EC’s 2007 infringement decision.
The FSA published a final policy statement in August 2010 imposing significant changes with respect to the handling of complaints about the mis-selling of PPI. In October 2010, the British Bankers’ Association (BBA) filed an application for judicial review of the FSA’s policy statement and of related guidance issued by the FOS. In April 2011 the High Court issued judgment in favour of the FSA and the FOS and in May 2011 the BBA announced that it would not appeal that judgment. The Group then reached agreement with the FSA on a process for implementation of its policy statement and for the future handling of PPI complaints. Implementation of the agreed processes is currently under way. Following agreement with the FSA in 2011, the Group increased its provision of £215 million at 31 December 2010 by £850 million in respect of PPI. In 2012 a further provision of £1,110 million was recorded. This strengthened the cumulative provision for PPI to £2.2 billion, from which £1.3 billion in redress had been paid by 31 December 2012.
Additionally, in May 2010, the OFT announced its review of barriers to entry. The review concerned retail banking and banking for small and medium size enterprises (SMEs) (up to £25 million turnover) and looked at products which require a banking licence to sell mortgages, loan products and, where appropriate, other products such as insurance or credit cards where cross-selling may facilitate entry or expansion. The OFT published its report in November 2010. It advised that it expected its review to be relevant to the ICB, the FSA, HM Treasury and the Department for Business, Innovation and Skills and to the devolved governments in the UK. The OFT did not indicate whether it would undertake any further work. The report maintained that barriers to entry remain, in particular regarding switching, branch networks and brands. At this stage, it is not possible to estimate the effect of the OFT’s report and recommendations regarding barriers to entry upon the Group.
The OFT’s PCA report was published on 25 January 2013. The OFT acknowledged some specific improvements in the market since its last review but concluded that further changes are required to tackle ongoing concerns, including a lack of switching, the ability of consumers to compare products and the complexity of overdraft charges. However, the OFT recognises that a number of major developments are expected over the coming months including divestment of branches and improvements in account switching and assistance to customers to compare products and services. Therefore the OFT has provisionally decided not to refer the market to the CC at this stage but expects to return to the question of a referral to the CC in 2015, or before. The OFT also announced that it will be carrying out behavioural economic research on the way consumers make decisions and engage with retail banking service, and will study the operation of payment systems as well as the SME banking market.
At this stage it is not possible to estimate the effect of these OFT reviews which may be material.
Notes on the consolidated accounts continued 32 Memorandum items continued Securitisation and collateralised debt obligation business In the United States, the Group is involved in reviews, investigations and proceedings (both formal and informal) by federal and state governmental law enforcement and other agencies and self-regulatory organisations relating to, among other things, mortgage-backed securities, collateralised debt obligations (CDOs), and synthetic products. In connection with these inquiries, Group companies have received requests for information and subpoenas seeking information about, among other things, the structuring of CDOs, financing to loan originators, purchase of whole loans, sponsorship and underwriting of securitisations, due diligence, representations and warranties, communications with ratings agencies, disclosure to investors, document deficiencies, and repurchase requests.
US mortgages - loan repurchase matters The Group’s Markets & International Banking N.A. or M&IB N.A. business (formerly Global Banking & Markets N.A.) has been a purchaser of nonagency US residential mortgages in the secondary market, and an issuer and underwriter of non-agency residential mortgage-backed securities (RMBS). M&IB N.A. did not originate or service any US residential mortgages and it was not a significant seller of mortgage loans to government sponsored enterprises (GSEs) (e.g. the Federal National Mortgage Association and the Federal Home Loan Mortgage Association).
In issuing RMBS, M&IB N.A. generally assigned certain representations and warranties regarding the characteristics of the underlying loans made by the originator of the residential mortgages; however, in some circumstances, M&IB N.A. made such representations and warranties itself. Where M&IB N.A. has given those or other representations and warranties (whether relating to underlying loans or otherwise), M&IB N.A. may be contractually required to repurchase such loans or indemnify certain parties against losses for certain breaches of such representations and warranties. In certain instances where it is required to repurchase loans or related securities, M&IB N.A. may be able to assert claims against third parties who provided representations or warranties to M&IB N.A. when selling loans to it; although the ability to recover against such parties is uncertain. Between the start of 2009 and the end of December 2012, M&IB N.A. received approximately US$606 million in repurchase demands in respect of loans made primarily from 2005 to 2008 and related securities sold where obligations in respect of contractual representations or warranties were undertaken by M&IB N.A.. However, repurchase demands presented to M&IB N.A. are subject to challenge and rebuttal by M&IB N.A..
RBS Citizens has not been an issuer or underwriter of non-agency RMBS. However, RBS Citizens is an originator and servicer of residential mortgages, and it routinely sells such mortgage loans in the secondary market and to GSEs. In the context of such sales, RBS Citizens makes certain representations and warranties regarding the characteristics of the underlying loans and, as a result, may be contractually required to repurchase such loans or indemnify certain parties against losses for certain breaches of the representations and warranties concerning the underlying loans. Between the start of 2009 and the end of 2012, RBS Citizens received US$141.9 million in repurchase demands in respect of loans originated primarily since 2003. However, repurchase demands presented to RBS Citizens are subject to challenge and rebuttal by RBS Citizens.
Although there has been disruption in the ability of certain financial institutions operating in the United States to complete foreclosure proceedings in respect of US mortgage loans in a timely manner (or at all) over the last year (including as a result of interventions by certain states and local governments), to date, RBS Citizens has not been materially impacted by such disruptions and the Group has not ceased making foreclosures.
The volume of repurchase demands is increasing and is expected to continue to increase, and the Group cannot currently estimate what the ultimate exposure of M&IB N.A. or RBS Citizens may be. Furthermore, the Group is unable to estimate the extent to which the matters described above will impact it, and future developments may have an adverse impact on the Group’s net assets, operating results or cash flows in any particular period.
U.S. operations, a plan to oversee compliance by the Group’s U.S. operations with all applicable U.S. laws, rules, regulations, and supervisory guidance, a Bank Secrecy Act/anti-money laundering compliance programme for the RBS plc and RBS N.V. branches in the U.S. (the U.S. Branches) on a consolidated basis, a plan to improve the U.S. Branches’ compliance with all applicable provisions of the Bank Secrecy Act and its rules and regulations as well as the requirements of Regulation K of the Federal Reserve, a customer due diligence programme designed to reasonably ensure the identification and timely, accurate, and complete reporting by the U.S. Branches of all known or suspected violations of law or suspicious transactions to law enforcement and supervisory authorities, as required by applicable suspicious activity reporting laws and regulations, and a plan designed to enhance the U.S. Branches’ compliance with
The Group may become subject to formal and informal supervisory actions and may be required by its US banking supervisors to take further actions and implement additional remedial measures with respect to these and additional matters. The Group's activities in the United States may be subject to significant limitations and/or conditions.
In March 2008, the Group was advised by the SEC that it had commenced a non-public, formal investigation relating to the Group’s United States sub-prime securities exposures and United States residential mortgage exposures. In September 2012, SEC staff communicated that it had completed this investigation as to RBS and that it did not, as of the date of that communication and based upon the information then in its possession, intend to recommend any enforcement action against RBS. In December 2010, the SEC contacted the Group and indicated that it would also examine valuations of various RBS N.V. structured products, including CDOs. In March 2012, the SEC communicated to the Group that it had completed this investigation and that it did not, as of the date of that communication and based upon the information then in its possession, intend to recommend any enforcement action against RBS.
35 Interest received and paid £m 36 Analysis of changes in financing during the year
Comprising: Cash and balances at central banks 79,290 79,269 56,590 Treasury bills and debt securities 772 3,172 5,672 Loans and advances to banks 52,779 70,214 90,268 Cash and cash equivalents 132,841 152,655 152,530
Notes on the consolidated accounts continued 38 Segmental analysis (a) Divisions The directors manage the Group primarily by class of business and present the segmental analysis on that basis. This includes the review of net interest income for each class of business - interest receivable and payable for all reportable segments is therefore presented net. Segments charge market prices for services rendered to other parts of the Group; funding charges between segments are determined by Group Treasury, having regard to commercial demands. The segment measure is operating profit/(loss).
In January 2012, the Group announced the reorganisation of its wholesale businesses into 'Markets' and 'International Banking'. Divisional results and the number of persons employed in the divisions (Note 3) have been presented based on the new organisational structure. The Group has also reviewed the allocation of funding and liquidity costs and capital for the new divisional structure as well as for a new methodology. The new methodology is designed to ensure that the allocated funding and liquidity costs more fully reflect each division’s funding requirement. In addition, the Group had previously included movements in the fair value of own derivative liabilities within the Markets operating segment. These movements have now been combined with movements in the fair value of own debt in a single measure, ‘own credit adjustments’ and presented as a reconciling item. Comparatives have been restated accordingly.
International Banking serves the world’s largest companies with a leading client proposition focussed on financing, transaction services and risk management. International Banking serves as the delivery channel for Markets products to corporate clients and serves international subsidiaries of both International Banking and clients from UK Corporate, Ulster Bank and US Retail & Commercial through its international network.
US Retail & Commercial provides financial services primarily through the Citizens and Charter One brands. US Retail & Commercial is engaged in retail and corporate banking activities through its branch network in 12 states in the United States and through non-branch offices in other states.
Markets is a leading origination, sales and trading business across debt finance, fixed income, currencies and investor products. The division offers a unified service to the Group’s corporate and institutional clients. The Markets’ sales and research teams build strong ongoing client partnerships, provide market perspective and access, and work with the division’s trading and structuring teams to meet the client’s objectives across financing, risk management, investment, securitisation and liquidity.
Direct Line Group is a retail general insurer with leading market positions in the United Kingdom, a strong presence in the direct motor channel in Italy and Germany and a focused position in UK SME commercial insurance. The Group operates under highly recognised brands such as Direct Line and Churchill and is comprised of five primary segments: motor, home, rescue and other personal lines, commercial and international.
Non-Core manages separately assets that the Group intends to run off or dispose of. The division contains a range of businesses and asset portfolios primarily from the legacy GBM businesses, higher risk profile asset portfolios including excess risk concentrations, and other illiquid portfolios. It also includes a number of other portfolios and businesses including regional markets businesses that the Group has concluded are no longer strategic.
UK Retail 3,990 979 4,969 (2,549) — (529) 1,891 UK Corporate 2,974 1,749 4,723 (1,916) (173) (838) 1,796 Wealth 720 450 1,170 (852) (19) (46) 253 International Banking 913 1,209 2,122 (1,417) — (111) 594 Ulster Bank 649 196 845 (521) — (1,364) (1,040) US Retail & Commercial 1,948 1,143 3,091 (2,143) (103) (91) 754 Markets 111 4,372 4,483 (2,707) (230) (37) 1,509 Direct Line Group (1) 280 3,437 3,717 (3,225) (51) — 441 Central items (134) 513 379 512 (708) (40) 143 Core 11,451 14,048 25,499 (14,818) (1,284) (3,056) 6,341 Non-Core 244 44 288 (694) (250) (2,223) (2,879)
Reconciling items Own credit adjustments — (4,649) (4,649) — — — (4,649) Asset Protection Scheme — (44) (44) — — — (44) Payment Protection Insurance costs — — — (1,110) — — (1,110) Interest Rate Hedging Products redress and related costs — — — (700) — — (700) Regulatory fines — — — (381) — — (381) Amortisation of purchased intangible assets — — — — (178) — (178) Integration and restructuring costs — — — (1,408) (142) — (1,550) Gain on redemption of own debt — 454 454 — — — 454 Strategic disposals — 113 113 — — — 113 Bank levy — — — (175) — — (175) Write-down of goodwill and other intangible assets — — — (518) — — (518)
Gain on redemption of own debt — 255 255 — — — 255 Strategic disposals — (24) (24) (80) — — (104) Bank levy — — — (300) — — (300) Bonus tax — — — (27) — — (27) Write-down of goodwill and other intangible assets — — — (11) — — (11)
Note: (1) Included within Direct Line Group discontinued operations are the managed basis divisional results of Direct Line Group (DLG), certain DLG related activities in Central items and Non-Core; and related one-off and other items including integration and restructuring costs and strategic disposals. Refer to Note 20 for further information.
UK Retail 4,054 1,422 5,476 (2,967) (1) (1,160) 1,348 UK Corporate 3,000 1,796 4,796 (1,963) (173) (767) 1,893 Wealth 588 447 1,035 (723) (11) (18) 283 International Banking 1,316 1,961 3,277 (1,875) (5) (86) 1,311 Ulster Bank 839 214 1,053 (573) (2) (1,161) (683) US Retail & Commercial 1,902 1,160 3,062 (2,095) (99) (519) 349 Markets 581 5,652 6,233 (3,328) (116) (65) 2,724 Direct Line Group (1) 381 4,135 4,516 (4,788) (23) — (295) Central items 66 326 392 1,094 (852) (4) 630 Core 12,727 17,113 29,840 (17,218) (1,282) (3,780) 7,560 Non-Core 1,473 1,281 2,754 (2,513) (480) (5,476) (5,715)
Reconciling items Own credit adjustments — 242 242 — — — 242 Asset Protection Scheme — (1,550) (1,550) — — — (1,550) Amortisation of purchased intangible assets — — — — (369) — (369) Integration and restructuring costs — — — (1,012) (20) — (1,032) Gain on redemption of own debt — 553 553 — — — 553 Strategic disposals — 171 171 — — — 171 Bonus tax — — — (99) — — (99) Write-down of goodwill and other intangible assets — — — (10) — — (10)
UK Retail 5,054 (85) 4,969 5,550 (42) 5,508 5,499 (23) 5,476 UK Corporate 5,247 (524) 4,723 5,373 (510) 4,863 5,251 (455) 4,796 Wealth 492 678 1,170 492 612 1,104 541 494 1,035 International Banking 2,329 (207) 2,122 2,720 (165) 2,555 3,629 (352) 3,277 Ulster Bank 768 77 845 968 (21) 947 943 110 1,053 US Retail & Commercial 2,966 125 3,091 2,842 195 3,037 2,783 279 3,062 Markets 3,864 619 4,483 4,072 343 4,415 5,653 580 6,233 Direct Line Group (1) 3,784 (67) 3,717 4,133 (61) 4,072 4,565 (49) 4,516 Central items 245 134 379 (900) 920 20 (434) 826 392 Core 24,749 750 25,499 25,250 1,271 26,521 28,430 1,410 29,840 Non-Core 1,104 (816) 288 2,459 (1,271) 1,188 4,172 (1,418) 2,754 Managed basis 25,853 (66) 25,787 27,709 — 27,709 32,602 (8) 32,594
Reconciling items Own credit adjustments (4,649) — (4,649) 1,914 — 1,914 242 — 242 Asset Protection Scheme (44) — (44) (906) — (906) (1,550) — (1,550) Integration and restructuring costs — — — (5) — (5) — — — Gain on redemption of own debt 454 — 454 255 — 255 553 — 553 Strategic disposals 113 — 113 (24) — (24) 171 — 171 RFS Holdings minority interest (16) (2) (18) (6) — (6) (150) 8 (142) Statutory basis including Direct Line Group discontinued operations 21,711 (68) 21,643 28,937 — 28,937 31,868 — 31,868 Direct Line Group discontinued operations (1) (3,770) 68 (3,702) (4,286) — (4,286) (5,246) — (5,246)
UK Retail 6,524 869 7,393 6,804 441 7,245 7,008 401 7,409 UK Corporate 4,933 121 5,054 4,985 120 5,105 4,870 134 5,004 Wealth 1,043 839 1,882 1,026 731 1,757 957 617 1,574 International Banking 2,652 470 3,122 3,193 394 3,587 4,826 426 5,252 Ulster Bank 1,076 — 1,076 1,298 104 1,402 1,386 134 1,520 US Retail & Commercial 3,411 133 3,544 3,479 205 3,684 3,795 291 4,086 Markets 5,298 5,582 10,880 5,757 7,025 12,782 7,297 6,847 14,144 Direct Line Group 4,501 7 4,508 4,724 9 4,733 5,072 10 5,082 Central items 2,916 14,142 17,058 2,942 13,129 16,071 2,856 9,900 12,756 Core 32,354 22,163 54,517 34,208 22,158 56,366 38,067 18,760 56,827 Non-Core 2,164 815 2,979 3,959 378 4,337 5,555 1,049 6,604 Managed basis 34,518 22,978 57,496 38,167 22,536 60,703 43,622 19,809 63,431