In the 1990s RBS re-engineered its retail banking business, removing processing activities from branches, and segmenting the Bank’s customers and associated service propositions. Over the same period RBS developed and implemented its multibrand, multiple channel strategy, launching direct banking in 1994, and the UK’s first comprehensive internet banking service in 1997, together with financial services operations in partnership with Virgin and Tesco in the same year.
Since the acquisition of NatWest, RBS has continued to grow the business through the combination of strong organic growth and acquisitions. In the US, Citizens’ footprint has been expanded from New England into the Mid-Atlantic states through the acquisition of the Mellon Bank regional franchise, and into the Midwest though the acquisition of Charter One, completed in 2004. Citizens is now one of the top ten US commercial banking organisations by deposits. In insurance, the acquisition of Churchill broadened the product and distribution channel capabilities of Direct Line and created the second largest general insurer in the UK. In corporate banking, RBS has entered the US, Continental European and Asia Pacific markets.
� Profit before tax, goodwill amortisation and integration costs up 15% to £8.1 billion
C or po ra te re sp on si bi lit y
Corporate responsibility 50 Corporate responsibility 51 Supporting international principles 51 Benchmarking 53 Our 2004 performance 53 Community investment
The Group’s profit before tax, rose by 14% to £6,917 million in 2004.
Earnings per share increased by 10% to 172.5p for 2004, adjusted for goodwill amortisation and integration costs, and in 2001 – 2003 for the AVS dividend.
The Group’s cost:income ratio in 2004 improved to 40.8% from 42.6% in 2003. The cost:income ratio is based on operating expenses excluding goodwill amortisation and integration costs, and after netting operating lease depreciation against rental income.
� Final dividend of 41.2p giving a total for the year of 58.0p per share, up 15%
The Group’s market capitalisation at 31 December 2004 was £55.6 billion compared with £48.8 billion a year earlier.
C ha ir m an ’s s ta te m en t
Dividends The Board has recommended a final ordinary dividend for the year of 41.2p per share which, with the interim dividend of 16.8p per share, makes a total for the year of 58.0p per share, an increase of 15%. The total amount payable to shareholders in the form of ordinary dividends for 2004 is £1,837 million.
Staff profit sharing Due to the strong financial performance of the Group, we have again set the staff profit share for the year at 10% of basic salaries.
In Continental Europe we acquired Bibit, the internet payment specialist. In Ireland, we completed the acquisition of First Active, announced in 2003.
Board of directors At the forthcoming annual general meeting in April 2005, Sir Angus Grossart and Lord Vallance will retire from the Board, after 19 and 12 years service respectively. Both Vice-chairmen have served the Board extremely well during a period of unparalleled development of our Group. Their contribution, wisdom and guidance has been greatly valued, and their experience through the ups and downs of economic cycles will be missed.
Outlook Economic growth during 2004 was strong in virtually all of the economies in which we operate, and this trend is expected to continue in 2005, though at a slightly lower rate.
We remain confident that the strength, diversity and flexibility of our business will enable us to continue to deliver superior performance for our shareholders.
In addition to delivering strong organic growth, we completed several acquisitions during 2004. The largest of these was the US bank Charter One, which enabled Citizens to expand into several adjacent Midwestern states around the important cities of Cleveland, Chicago and Detroit. As a result of organic growth and acquisitions, Citizens is now the 8th largest commercial banking organisation in the United States, by deposits.
Through smaller acquisitions, we have established a presence in credit card issuing and merchant acquisition in the United States, and a strengthened position in Continental Europe. These extensions to our capabilities enhance the options for the Group to expand its activities outside the United Kingdom. During 2004 we reached agreement to distribute credit cards to the customers of The Kroger Co., the second largest supermarket group in the United States, and to distribute consumer loan products to the customers of Tchibo, a leading German retailer.
Our customers We aim to deliver value for our customers. Our success in achieving this in 2004 is shown by increased customer numbers in each of our divisions, as well as by positive surveys of customer satisfaction. In Retail Banking for NatWest, the option to call branches direct and the appointment of over 1,000 additional branch staff have led to significant improvements in customer satisfaction. During 2004 we again won many awards for our products and services.
Our shareholders Our principal goal is to create value for our shareholders. A key measure of our success towards this goal is the rate of increase in our dividend per share. This is the 12th consecutive year in which we have increased our dividend per share by 15% or more. Our 2004 dividend per share was covered nearly three times by adjusted earnings.
As a consequence, we remain confident that we can deliver superior value for our shareholders, our customers and our people in 2005.
D iv is io na l p ro fil e Divisional profile
Chief Executive Geography Johnny Cameron UK, US, Europe and Asia Pacific
Corporate Banking & Financial Markets (CBFM) is the leading corporate bank in the UK, providing banking services and integrated financial solutions to medium-sized and large businesses.
CBFM is also a major provider of financing and risk management solutions to international corporate and institutional clients through operations across Europe, the US and Asia Pacific.
With all clients, CBFM focuses on building long-term relationships and meeting their specific needs.
In 2004 CBFM continued to grow in the UK whilst expanding its operations in other markets.
Manufacturing’s diverse range of services supports the customer facing operations of the Group’s multiple brands. It provides customer support via telephony, account management, lending, mortgage processing and money transmission.
Purchasing is responsible for the vast majority of purchasing undertaken by the Group, leveraging its scale to maximise cost efficiencies.
Chief Executive Geography Gordon Pell UK, Europe, Asia Pacific and offshore locations
RBS Insurance is the second largest general insurer in the UK. It sells and underwrites general insurance via the telephone, the internet, partnerships and a network of brokers. Its brands, including Direct Line, Churchill, Privilege, Green Flag and NIG, are some of the best known in the UK.
Ulster Bank is the third largest bank in Ireland. During 2004 Ulster Bank completed the acquisition of First Active, which strengthened its position in the Republic of Ireland and enhanced its capabilities in mortgages. Ulster Bank provides a full range of banking and financial products and services, for personal customers and corporates, via branches, telephone and the internet.
Corporate Banking & Financial Markets (CBFM) provides banking services and integrated financial solutions to corporate and institutional customers in the UK and around the world through its presence in the major financial centres across the globe.
��� Operating through three principal businesses – Core Corporate Bank, Structured Finance and Financial Markets – CBFM focuses on addressing client needs in two broad groupings: banking services for UK businesses, and banking services for global corporates and institutions.
��� In a highly competitive market, CBFM achieved strong growth in its core UK mid-market business. We have broadened and deepened our product range to be as relevant as possible to our customers. We have enhanced our service model to ensure our relationship managers spend more time with them, understanding their businesses and addressing their domestic and international needs, and less time undertaking administrative tasks.
��� Amongst our specialist businesses, Lombard is the leading provider of asset finance to UK businesses, catering for a wide range of financing options ranging from traditional hire purchase, leasing and contract hire through to complex, bespoke solutions.
Transmanche Ferries. Transmanche Ferries operates cross-channel ferries between the Seine Maritime region of France and the south coast of England, carrying both trade and tourists. Our Corporate Banking team in Paris joined forces with a series of specialist teams from across Europe to arrange the €100 million credit facility to allow Transmanche to purchase two new state-of-the-art ferries.
Examples of our delivery to clients in 2004 include: ��� With a groundbreaking finance structure, we were able to act as Sole Bookrunner and Mandated Lead Arranger for the £530 million debt package supporting the secondary buyout of Baxi, one of the leading providers of heating products and services in Europe.
��� We provided Songbird Estates plc, a special purpose acquisition vehicle, with £901 million of acquisition financing for their purchase of Canary Wharf Group plc.
��� We acted as Lead Arranger for award winning care and services provider Barchester Healthcare in their £525 million acquisition of nursing home group, Westminster Healthcare.
��� We provided an export loan facility for Hammersmith-based XPAP Recycling Ltd, an exporter of pulp from the UK and Europe to SE Asia.
��� In the voluntary sector CBFM has provided ongoing assistance to Acevo – the professional organisation for voluntary sector chief executives that seeks to influence national policy concerning the charities sector.
Banking services for GlobaI Corporates and Institutions ��� A key feature of CBFM in the global debt/financing markets is our focus on long-term relationships, backed by our strong balance sheet and suite of value-added product capabilities.
��� CBFM has been building its presence in selected markets in Asia Pacific as well as growing the business in Australia where we now offer a wide range of products to both corporate and institutional customers. In 2004 we opened branches in Australia and Shanghai and gained approval for new offices in Korea and Labuan, Malaysia.
Deals undertaken in 2004 include: ��� RBS was Joint Bookrunner and Liquidity Provider for Aviva’s £418.5 million UK equity release mortgage securitisation, a new fast-growing sector in the UK mortgage market.
Mel Secure Systems Mel Secure Systems is one of the UK's leading providers of wireless CCTV technology. Commercial Banking and RBS Commercial Services helped finance a move to new premises and provided factoring facilities.
� ��� Pendragon Pendragon is the UK’s leading motor vehicle retailer. Selling a wide range of marques from Porsche to Ford, it turned to our Midlands Corporate Banking team as Joint Mandated Lead Arranger for a £450 million Syndicated Facility.
��� We were the only bank to be appointed on every sterling bond transaction that Network Rail executed in 2004. These included a £2.25 billion deal, the largest ever single tranche sterling bond issue outside the gilt market.
��� The strength of our UK/German links was demonstrated when RBS was awarded the biggest banking tender in the UK corporate marketplace in 2004 when gaining the sole UK transmission banking contract for RWE Group AG, one of Europe’s largest utility groups.
��� We acted as Bookrunner and Mandated Lead Arranger in the €4.5 billion financing of Auna Group, the second largest telecommunications group in Spain. The deal was the largest structured syndicated transaction in Spain in 2004.
��� We acted as a Joint Bookrunner for Wal-Mart, the largest retailer in the world, in a £1 billion sterling bond issue, equal to the largest ever long-dated corporate bond issue.
��� We completed our first securitisation-related transaction in South Korea – a US$100 million warehouse loan for Samsung Card Co.
��� Average loans and advances to customers grew by 17%. Average mortgage balances increased by 21%, personal loans by 14% and small business loans by 13%. Average customer deposits grew by 8%.
Customer service ��� We continue to provide our customers with a choice of ways to contact us, including telephoning the branches direct.
��� We have stepped up our efforts to protect our customers from increasingly sophisticated attempted frauds. We have introduced new processes to make it easier for customers to report suspected fraudulent activity on their accounts, and improved protection against wrongful transfer of funds.
Retail Banking provides a wide range of financial products and services to both the personal and small business markets through a combination of its branches, telephone banking, the internet and its network of ATMs.
��� Customers can now top up their mobile phones through our 4,600 NatWest and Royal Bank of Scotland ATMs. Customers simply insert their cash card and select the “mobile phone top-up” option to credit their prepay phones. 1.2 million transactions have taken place since the service was launched in April 2004.
��� The Flexible Business Loan, launched in August, is a market-leading product which allows customers to customise their loan. They can pick the options that suit them best at the start of the loan, and then change them if their circumstances alter.
��� Royal Bank of Scotland’s Agricultural Services team have offered their general farm insurance product in conjunction with Farmweb insurance brokers for their first full year during 2004. This product can be tailored to meet the individual needs of farm businesses under one policy, including an increasing range of diversification activities.
Business Customer SJ Solicitors in Ilford is a NatWest business banking customer. Our flexible business loan offers them a range of payment options and the ability to match their outgoings with available cash flow.
� ��� Offset Mortgage An offset mortgage from his local branch of The Royal Bank of Scotland has provided James Sheriff with the financial flexibility he needed to realise his dream of flying.
– Best Bank for a record eleventh time – Best Offset Lender
Lenders and Packagers category – Most Improved Mortgage in the Mortgage
��� Royal Bank of Scotland – Best Current Account Provider (voted by readers for the second year running)
��� Royal Bank of Scotland named Mortgage Lender of the Year.
��� Royal Bank of Scotland voted Best Provider of Commercial Mortgages for Small Businesses.
Lynk. Lynk Systems of Atlanta was acquired by RBS during 2004. Lynk provides electronic payment, cash dispensing and e-commerce services across the US to over 75,000 merchants. Already a top 4 global player through Streamline, RBS now has access to the world’s largest credit card market and the opportunity to offer state of the art technology to its business customers in Citizens, Charter One and RBS Corporate Banking. The City of Boston is both a Citizens and Lynk customer.
Retail Direct has leading positions in the UK in credit card issuing, merchant acquiring, consumer finance and supermarket banking. During 2004 Retail Direct built on its position, through its range of strong brands and direct channels, and expanded its activities outside the UK. Retail Direct increased its total income by 16% to £2,129 million.
��� During 2004 Retail Direct increased its total customer accounts by 14% to 18.9 million. Retail Direct achieved organic growth in its credit card, personal loan and mortgage customers, and in its merchant acquiring relationships. Retail Direct also increased its customer base through acquisitions in the Netherlands and the US.
��� Average loans to customers grew by 19%. Average card balances grew by 24%, reflecting the launch of the MINT card and the acquisition of the credit card business of People’s Bank. Personal loan balances grew by 17% and mortgage lending by 16%.
Cards business ��� Our credit card issuing businesses combine to make one of the largest in the UK. In merchant acquiring, RBS is number one in the UK, and ranks fourth globally.
��� During 2004 Retail Direct continued to grow the number of UK credit card accounts through The Royal Bank of Scotland, NatWest and newlyestablished MINT brands.
��� Retail Direct continued to achieve strong growth in its commercial card business. The innovative commercial ‘One’ Card product, which offers an expense and payment management solution for businesses, continued to grow and strengthen our relationships with SMEs, corporate and commercial enterprises.
We respond to our customers’ evolving needs by making diverse and innovative products accessible through a variety of convenient channels.
TPF – Life Insurance. Tesco Personal Finance is the most successful supermarket bank in the UK with close to 5 million customers. Our award-winning Life Insurance product provides the security and peace of mind that family and loved ones are protected.
��� Retail Direct is an industry leader in the Chip and PIN programme which provides customers with enhanced security against fraud. Almost all our terminals in retailers are now equipped with the new technology, and by the end of 2004 80% of our customers’ credit cards and debit cards had been replaced with chip-enabled cards.
��� In June 2004, First Active mortgages were launched in the UK, building on the Group’s acquisition of First Active in Ireland in January 2004. First Active mortgages were offered initially through intermediaries, and subsequently by telephone and the internet. By the end of 2004, mortgage applications amounted to £1 billion.
��� Primeline, our direct banking business, increased its customers by 8% through new affiliate relationships with partners such as BA Executive Club.
Tesco Personal Finance ��� Tesco Personal Finance extended its position as the most successful supermarket bank in the UK. It achieved a further increase of more than 10% in its customer accounts, to 4.8 million, including 2.4 million motor and other insurance policies and 1.7 million credit cards.
��� Tesco Personal Finance extended its activities in Tesco stores in Hungary and Ireland.
International ��� In Continental Europe, Retail Direct continued significant organic growth in volumes, both in its traditional business and increasingly in direct loans. Retail Direct also established a presence in the US.
� ��� Streamline International Winner of the Queen’s Award for Enterprise within the International Trade Category.
We have continued to seek new opportunities to build Retail Direct’s business through organic growth, strategic acquisitions and new partnerships in the UK, US and Europe.
��� Retail Direct established a partnership with The Kroger Co. to distribute credit cards to its customers. The Kroger Co. is the second largest supermarket in the United States, with 3,774 stores. During the second half of 2004, a Kroger credit card with a Kroger rewards feature was launched in Ohio, and will be expanded to other states during 2005.
Awards ��� Streamline International – The Queen’s Award for Enterprise within the International Trade category
��� Tesco Personal Finance – Best Direct Life Insurance Provider – Best Online Motor Insurance Provider – Best Direct Motor Insurance Provider – Best Online Personal Loan Provider
��� During 2004 Manufacturing opened 893,000 new personal accounts. This was equivalent to 491 new accounts per working hour.
��� During 2004 Manufacturing printed and despatched 349 million bank statements and insurance documents to RBS customers, an increase of almost 7% over the previous year.
��� Our network of over 6,100 ATMs processed 576 million transactions during 2004. The daily average volume was 1.6 million transactions, dispensing £96 million.
��� We established dedicated corporate service centres to deal exclusively with our corporate and commercial customers.
��� The IT operations of seven businesses were consolidated onto the Group Technology IT platform in 2004 – Direct Line, Green Flag, Retail Investment Services, Lombard Direct, The One account, Wealth Management and Lombard Asset Management.
Often referred to as ‘The Engine Room’, Manufacturing enables the Group to function 24 hours a day, 365 days a year.
�� Image and Workflow Our new Image and Workflow system captures customer letters and turns them into electronic images, which can be processed efficiently by service centre staff.
�� TNT Group Purchasing continue to develop strategic partnerships with a number of suppliers – for example, TNT now make over 9,400 deliveries and collections on behalf of the Group every day.
��� Group Technology upgraded the technology serving the branch networks – delivering highspeed bandwidth capability to 2,273 branches.
��� Manufacturing completed over 215,000 new mortgage applications for Group customers.
��� Group Property manages 3,384 properties for the Group, including 2,273 branches. The combined floor area of these properties is 2.2 million square metres.
��� During 2004 Manufacturing invested in developing new properties for the Group. Over 4,000 employees moved into new premises in Manchester and Birmingham.
��� We received an “excellent” rating from BREEAM (Building Research Establishment Environmental Assessment Method) for the design, construction and building management of the Group’s new headquarters at Gogarburn, which is nearing completion.
��� Our e-sourcing programme continues to be one of the largest of any financial services company in the world. More than 100 on-line bidding events, with a total value in excess of £2.5 billion, have taken place since the inception of the programme in 2001.
��� We donate the use of our call centres to national charity campaigns. During Children in Need in November, three of our centres took over 22,000 pledge calls contributing over £610,000 to the total raised.
��� Best use of IT in Retail Banking (for ATM mobile phone top-up project)
Wealth Management provides private banking and investment services to its global clients through a number of leading UK and overseas private banking subsidiaries and offshore banking businesses. It has a network of more than 50 offices globally. During 2004 Wealth Management expanded its business in the UK and internationally and completed the integration of Bank von Ernst. Its total income increased by 17% to £948 million.
��� Wealth Management expanded its client base – particularly in the UK, where client numbers grew by 8%.
��� Average loans to clients grew by 9%, while average client deposits grew by 4%.
��� Coutts continued to enhance its position as the leading private bank in the UK. Coutts increased the number of private bankers across its regional network by 38%.
��� Coutts Asia celebrated ten years in Hong Kong in 2004. Coutts continues to expand its team of private bankers in Hong Kong, to take advantage of rapid economic growth in the region.
– Best UK bank for wealthy entertainers – Best UK bank for wealthy sports players – Best for super affluent
RBS Insurance Field Team. RBS Insurance has field teams based all over the country, visiting homes to assess damage and authorise claims to proceed, so our customers can return their lives to normal just as quickly as possible.
RBS Insurance is the second largest general insurer in the United Kingdom. Its brands include Direct Line, Churchill, Privilege, Green Flag and NIG. As a result of organic growth and the full year impact of Churchill, which was acquired in September 2003, RBS Insurance increased its total income by 52% to £4,934 million.
��� In the United Kingdom, RBS Insurance is the No.1 motor insurer, with over 8 million policies, and the No. 2 home insurer, with over 5 million policies.
��� In Continental Europe, RBS Insurance increased its motor insurance policies by 15% to 1.6 million.
��� RBS Insurance now has almost 5 million motor rescue policies sold through Direct Line, Churchill and Privilege and through many partners under their brands.
��� RBS Insurance increased its travel insurance policies to 1.65 million to become the No.2 travel insurer, and its pet insurance policies to almost 500,000.
��� The Privilege brand was re-launched in August with a new TV campaign, featuring Joanna Lumley. The marketing campaign is targeted at customers with 4 or more years no claims discount.
�� Motor Rescue Green Flag is called out to help motorists over 100 times an hour.
��� The integration of Churchill is on track, with the major stages in IT conversion completed.
��� In response to emergency situations such as the floods at Boscastle, our Assistance business put dedicated teams on the ground to deal with claims promptly and efficiently.
��� Direct Line and Green Flag Motoring Assistance continue to be headline sponsors of Road Safety Week. This is an annual event, in November, to address road safety issues, organised by the national road safety charity Brake. In 2004 Green Flag Motoring Assistance supported ‘Beep Beep’ day – an event aimed at providing road safety education for pre-school children.
��� Direct Line Pet Insurance has been working with the Scottish Society for the Prevention of Cruelty to Animals (SSPCA) since 1998. So far this has raised over £70,000 for the charity.
��� Green Flag Motoring Assistance – Best Direct Breakdown Cover Provider 2004 Your Money – Direct Awards
��� Churchill – Best Online Pet Insurance Provider 2004 Your Money – Direct Awards
��� Churchill – Best Online Home Contents Insurance Provider 2004 Your Money – Direct Awards
New Branch. Our €887 million acquisition of First Active was completed in January 2004, consolidating our position as one of the top 3 providers of financial services across Ireland. First Active plc is a niche provider of mortgage and investment products offering specialist advice to consumers. We continued the extensive investment programme in First Active’s distribution network with the opening of an additional four mortgage and investment stores in the Republic of Ireland.
��� Average loans to customers grew by 72%, while average customer deposits grew by 35%. Excluding First Active, average loans to customers grew by 27%, and average customer deposits by 8%.
��� A principal reason for the growth in lending was rapid expansion of the combined mortgage book. In the Republic of Ireland, mortgage sales across the Ulster Bank and First Active brands increased by 60%. In Northern Ireland, Ulster Bank increased its mortgage sales by over 30%.
��� Ulster Bank continued to expand its credit card business. Ulster Bank is now the leading provider of credit cards in Northern Ireland and is growing rapidly in the Republic of Ireland.
��� Ulster Bank achieved strong growth in commercial lending in both the Republic of Ireland and in Northern Ireland. Notable transactions included the first Public Private Partnership for the regeneration of a central Dublin public housing complex, and the financing of Tynagh Power, one of the largest deals of its type in Ireland in 2004.
��� 2004 was a very successful growth year for Business Centres in the Republic of Ireland, demonstrating the strength of the operating model. Its loan book increased by 43% driven by drawdowns which were up 65% on 2003.
��� Ulster Bank has worked closely with Manufacturing to plan and implement the integration of First Active. In connection with this, the IT platforms supporting both Ulster Bank and First Active will be converted to RBS’s main IT platform which already supports both the Royal Bank of Scotland and NatWest.
Charter One. In 2004 Citizens Financial Group acquired Charter One in a US$10.1 billion transaction, our largest to date in the US. It extends our footprint in the US into the Midwest, giving us a presence in 13 of the US states and reaching around a third of the country’s population. On completion, Citizens Financial Group, with US$131 billion in assets, became the 8th largest commercial banking organisation in the US by deposits.
��� In 2004, Citizens increased its personal customer base by 2.0 million to 4.4 million. Excluding Charter One, personal customers increased by over 200,000. Organic growth was achieved by Citizens in both its New England and Mid-Atlantic regions.
��� Citizens’ supermarket banking programme almost doubled through the acquisition of Charter One. Citizens is now the 3rd largest supermarket bank in the United States, with almost 500 in-store branches and 30 different partnerships with retailers including Stop & Shop, Giant Eagle, Acme, Kroger, Tops and Wal-Mart.
��� Including the impact of the acquisition of Charter One, total year end loans to customers grew by 91%, while total year end customer deposits grew by 58%. Excluding Charter One, total year end loans to customers grew by 17%, and total year end customer deposits by 13%.
Organic growth and acquisitions have taken Citizens to the top 10 rankings in deposits among US commercial banking organisations.
��� In addition to lending at the community banking, middle market and large corporate levels, Citizens supplements its Corporate Banking with additional services and expertise sourced from RBS Corporate Banking and Financial Markets. Services include interest rate protection, foreign exchange, cash management, asset finance and administration.
��� Charter One opened 48 new branches, 31 of them at in-store locations, after its acquisition by Citizens.
��� The conversion of Charter One accounts to the Citizens platform is well under way. The first group of deposit customers and nearly 475,000 indirect auto loans were converted to Citizens systems in November 2004.
��� In the autumn of 2004, Citizens initiated a “Switch Support” programme with an automated concierge service designed to smooth the transition of customers switching to Citizens and Charter One from other banks.
��� During 2004, the number of Citizens’ online banking customers grew by 58% to almost 724,000. Including Charter One, Citizens Financial Group now has more than 1.4 million enrolled online banking users.
��� Branch automation was enhanced during 2004 in every Citizens Bank branch in the New England and Mid-Atlantic regions, enabling branch staff to serve customers faster and more efficiently.
��� Citizens is introducing internet-based paperless loan documentation, online pipeline reporting and electronic processing to its Consumer Finance operations, maintaining their top tier position in the United States.
��� Citizens and the Commonwealth of Pennsylvania announced a partnership offering US$100 million in loan funds over the next two years at a low interest rate to companies that agree to create jobs in Pennsylvania. The Citizens Job Bank hopes to create 4,000 new jobs across the state.
Two new innovative community initiatives in the Mid-Atlantic and New England, the Citizens Jobs Bank and the Citizens Housing Bank, are helping create new jobs and affordable housing within the company’s footprint.
�� Yankee Candle Yankee Candle Company is the leading designer, manufacturer and retailer of premium scented candles in the US. Citizens’ Corporate Banking was the lead agent in a US$200 million syndicated deal, providing additional funding for future growth.
Awards ��� Citizens Bank New Hampshire – 2004 Business of the Year
��� Citizens Bank – Best Places to Work in Pittsburgh. It was also named “best” in the large company category.
Money Advice Trust. The RBS Group has given £1.8 million over three years to the Money Advice Trust to promote and improve free, confidential and impartial money advice. The charity offers a structured approach to managing personal debt, so helping individuals gain control of their finances. The increased funding from the RBS Group goes towards a number of projects, including the production of self-help materials for clients, improved training for advisers and the development of an 'e-learning resource'.
The first responsibility of any company to society is to be successful. Success requires us to balance the differing interests of our stakeholders. We must provide the high quality products and services our customers want, at a price they can afford. Our shareholders demand and deserve a healthy return on the capital they entrust to us, which we achieve through growth and profit. We owe our employees stable, safe and fair employment. We must work productively with government and regulators. We attach importance to managing our environmental impact and making a genuine contribution to the communities in which we operate.
Successful companies must not only conduct their business in a manner that goes beyond legal compliance. They must satisfy the increasing demand to define, implement and report the “non-financial” elements of their business practice. We respect the need to assure our key stakeholders that an organisation of the scale and complexity of the RBS Group is managed with integrity and consistency. Our first Corporate Responsibility Report is available from
Supporting international principles The Equator Principles and UN Global Compact In 2003 we adopted the Equator Principles of socially responsible investment and became a signatory to the Ten Principles of the UN Global Compact. Our work in 2004 has focused on implementing the Equator Principles within our business and incorporating the UN Global Compact Principles into our policies and procedures.
Business in the Environment The most recent annual Business in the Environment (BiE) FTSE 350 Index of Corporate Environmental Engagement survey showed a further 1% improvement on the previous year.
�� Community Cashback Awards This scheme supports employees who give their time and skills to help local community projects. In 2004, 5,518 employees participated, generating contributions of £1.9 million across the UK.
Community investment There are three principal elements to the Group’s Community Investment Programme: Education, Employment & Enterprise, and Employee Giving. The Programme focuses on helping excluded young people and communities realise their potential. The value of the Programme overall was £46 million in 2004, making it one of the largest in Europe.
Education In 2004, our financial education programme, Face 2 Face With Finance, provided more than 5,000 lessons in financial education to over 150,000 pupils in 780 schools across the UK. We are the largest individual supporter to the Money Advice Trust, donating £1.8 million over three years to provide advice for 800,000 people in financial hardship.
40,000 single parents accessed free, confidential money advice through the RBS funded Lone Parent Helpline.
Employee giving The RBS Give As You Earn scheme, which ‘double matches’ monthly donations from our employees, raised £6.4 million for 2,800 charities. Together with the Community Cashback Awards totalling £1.9 million, and the £1 million Christmas donation, the three schemes generated a record £9.3 million in charitable donations.
Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to: general economic conditions in the UK and in other countries in which the Group has significant business activities or investments, including the United States; the monetary and interest rate policies of the Bank of England, the Board of Governors of the Federal Reserve System and other G-7 central banks; inflation; deflation; unanticipated turbulence in interest rates, foreign currency exchange rates, commodity prices and equity prices; changes in UK and foreign laws, regulations and taxes; changes in competition and pricing environments; natural and other disasters; the inability to hedge certain risks economically; the adequacy of loss reserves; acquisitions or restructurings; technological changes; changes in consumer spending and saving habits; and the success of the Group in managing the risks involved in the foregoing.
The Group had total assets of £583 billion and ordinary shareholders ’ equity of £27.3 billion at 31 December 2004. It is strongly capitalised with a total capital ratio of 11.7% and tier 1 capital ratio of 7.0% as at 31 December 2004.
Organisational structure and business overview The Group’s activities are organised in the following business divisions: Corporate Banking and Financial Markets, Retail Banking, Retail Direct, Manufacturing, Wealth Management, RBS Insurance, Ulster Bank and Citizens. A description of each of the divisions is given below.
Corporate Banking and Financial Markets (“CBFM”) is the largest provider of banking services to medium and large businesses in the UK with growing presence in the US, Europe and Asia. It provides an integrated range of products and services including corporate and commercial banking, treasury and capital markets products, structured and leveraged finance, trade finance, leasing and factoring.
Within CBFM, Financial Markets provides corporate and institutional customers with treasury services, including global interest rate derivatives trading, bond origination and trading, sovereign debt trading, futures brokerage, foreign exchange, money market, currency derivative and rate risk management services. RBS Greenwich Capital, with headquarters in Connecticut, US, delivers debt market solutions tailored to meet the needs of companies and institutions around the world.
Manufacturing drives optimum efficiencies in high volume processing activities, leverages the Group's purchasing power and has become a centre of excellence for managing large scale and complex change programmes such as integration.
Wealth Management provides private banking and investment services to its clients through a number of leading UK and overseas private banking subsidiaries and offshore banking businesses. Coutts is one of the world’s leading international wealth managers with over 50 offices worldwide, including Switzerland, Dubai, Monaco, Hong Kong and Singapore, as well as its premier position in the UK. Adam & Company is the major private bank in Scotland. The offshore banking businesses – The Royal Bank of Scotland International and NatWest Offshore – deliver retail banking services to local and expatriate customers, and corporate banking and treasury services to corporate, intermediary and institutional clients, principally in the Channel Islands, the Isle of Man and Gibraltar.
RBS Insurance is the second largest general insurer in the UK, by gross earned premiums. Through the Direct Line, Churchill and Privilege brands it sells and underwrites personal insurance over the telephone and the internet in the UK. Through the red phone brand, RBS Insurance also sells and
Citizens is the second largest commercial banking organisation in New England and the eighth largest commercial banking organisation in the US measured by deposits. Citizens provides retail and corporate banking services under the Citizens brand in the states of Connecticut, Delaware, Massachusetts, New Hampshire, New Jersey, Pennsylvania and Rhode Island, and the Charter One brand in the states of Illinois, Indiana, Michigan, New York, Ohio and Vermont. Through its branch network Citizens provides a full range of retail and corporate banking services, including personal banking, residential mortgages and cash management. In addition, Citizens engages in a wide variety of commercial lending, consumer lending, commercial and consumer deposit products, merchant credit card services, insurance products, trust services and retail investment services.
Competition The Group faces intense competition in all the markets it serves. In the UK, the Group’s principal competitors are the other UK retail and commercial banks, building societies (which are similar to savings and loans associations in the US) and the other major international banks represented in London.
In the small business banking market, the Group competes with other UK clearing banks, with specialist finance providers and building societies.
In Ireland, Ulster Bank and First Active compete in retail and commercial banking with the major Irish banks and building societies, and with other UK and international banks and building societies active in the market. Competition is intensifying as both UK, Irish and other European institutions seek to expand their businesses.
In the United States, Citizens competes in the New England, Mid-Atlantic and Mid-West retail and mid-corporate banking markets with local and regional banks and other financial institutions. The Group also competes in the US in large corporate lending and specialised finance markets, and in fixed-income trading and sales. Competition is principally with the large US commercial and investment banks and international banks active in the US.
The Group’s insurance businesses are subject to inherent risks involving claims Future claims in the Group’s general and life assurance business may be higher than expected as a result of changing trends in claims experience resulting from catastrophic weather conditions, demographic developments, changes in mortality and other causes outside the Group’s control. Such changes would affect the profitability of current and future insurance products and services. The Group re-insures some of the risks it has assumed.
Each of the Group’s businesses is subject to substantial regulation and regulatory oversight. Any significant regulatory developments could have an effect on how the Group conducts its business and on the results of operations The Group is subject to financial services laws, regulations, administrative actions and policies in each location in which the Group operates. This supervision and regulation, in particular in the UK, if changed could materially affect the Group’s business, the products and services offered or the value of assets.
The judgements and assumptions involved in the Group’s accounting policies that are considered by the Board to be the most important to the portrayal of its financial condition are discussed below. The use of estimates, assumptions or models that differ from those adopted by the Group would affect its reported results.
For certain homogeneous portfolios, including credit card receivables and other personal advances including mortgages, specific provisions are established on a portfolio basis, taking into account the level of arrears, security, past loss experience, credit scores and defaults based on portfolio trends. The most significant factors in establishing these provisions are the expected loss rates and the related average life. These factors are kept under constant review by the Group.
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. Claims are recognised in the accounting period in which the loss occurs.
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. 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. 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.
The Accounting Standards Board issued FRS 27 ‘Life Assurance’ which introduces a new ‘realistic’ method of measuring life assurance liabilities and related assets. The present value of in-force polices can continue to be recognised provided that future investment margins are not included. The standard is applicable under UK GAAP for years ending on or after 31 December 2005 and is not expected to have a material effect on the Group.
IFRS differ in certain significant respects from the Group’s accounting policies under UK GAAP. The summary below outlines the important differences for the Group in respect of recognition and measurement on the basis of extant IFRS that will be effective for 2005, including revised IAS 32 and IAS 39: Goodwill – IFRS require goodwill arising on the acquisition of subsidiaries or associates to be capitalised. Amortisation of goodwill is prohibited but it must be tested annually for impairment (and whenever changes in circumstances indicate impairment). Under the Group's UK GAAP accounting policy, goodwill arising on acquisitions after 1998 is recognised as an asset and amortised on a straight-line basis over its useful economic life. Impairment tests are carried out at the end of the first full accounting period after its acquisition, and whenever there are indications of impairment. Goodwill arising on acquisitions before 1 October 1998 was deducted from reserves immediately. Certain amounts that would be included as goodwill under UK GAAP are recognised as intangibles under IFRS. Such intangibles are amortised over their useful lives unless they are regarded as having an indefinite useful life in which case they are not amortised but tested for impairment annually (and whenever changes in circumstances indicate impairment).
Financial instruments: financial assets – under UK GAAP, loans are measured at cost less provisions for bad and doubtful debts, derivatives held for trading are carried at fair value and hedging derivatives are accounted for in accordance with the treatment of the item being hedged (see ‘Derivatives and hedging’ below), and securities are classified as being held as investment securities, or held for dealing purposes. Investment debt securities are stated at cost less provision for any permanent diminution in value. Premiums and discounts on dated securities are amortised to interest income over the period to maturity. Other securities are carried at fair value. Under IFRS, financial assets are classified into held-to-maturity; available-for-sale; held for trading; designated as fair value through profit or loss; and loans and receivables. Financial assets classified as held-to-maturity or as loans and receivables are carried at amortised cost. Other financial assets are measured at fair value. Changes in the fair value of available-for-sale financial assets are reported in a separate component of shareholders’ equity. Changes in the fair value of financial assets held for trading or designated as fair value are taken to the profit and loss account. Financial assets can be classified as held-to-maturity only if they have a fixed maturity and the reporting entity has the positive intention and ability to hold to maturity. Trading financial assets are held for the purpose of selling in the near term. IFRS allow any financial asset to be designated as fair value through profit and loss on initial recognition. Unquoted debt financial assets that are not classified as held-to-maturity, held for trading or designated as fair value through profit or loss are categorised as loans and receivables. All other financial assets are classified as available-for-sale.
Effective interest rate and lending fees – under UK GAAP, loan origination fees are recognised when receivable unless they are charged in lieu of interest. IFRS require origination fees to be deferred and recognised as an adjustment to the effective interest rate on the related financial asset. The effective interest rate is the rate that discounts estimated future cash flows over
Derivatives and hedging – under UK GAAP, non-trading derivatives are accounted for on an accruals basis in accordance with the accounting treatment of the underlying transaction or transactions being hedged. If a non-trading derivative transaction is terminated or ceases to be an effective hedge, it is re-measured at fair value and any gain or loss amortised over the remaining life of the underlying transaction or transactions being hedged. If a hedged item is derecognised the related non-trading derivative is remeasured at fair value and any gain or loss taken to the profit and loss account. Under IFRS, all derivatives are measured at fair value. Hedge accounting is permitted for three types of hedge relationship: fair value hedge – the hedge of changes in the fair value of a recognised asset or liability or firm commitment; cash flow hedge – the hedge of variability in cash flows from a recognised asset or liability or a forecast transaction; and the hedge of a net investment in a foreign operation. In a fair value hedge the gain or loss on the derivative is recognised in the profit and loss account as it arises offset by the corresponding gain or loss on the hedged item attributable to the risk hedged.
In a cash flow hedge and in the hedge of a net investment in a foreign operation, the element of the derivative’s gain or loss that is an effective hedge is recognised directly in equity. The ineffective element is taken to the profit and loss account. Certain conditions must be met for a relationship to qualify for hedge accounting. These include designation, documentation and prospective and actual hedge effectiveness.
Leasing – under UK GAAP, finance lease income is recognised so as to give a level rate of return on the net cash investment in the lease. IFRS require a level rate of return on the net investment in the lease. This means that under UK GAAP tax cash flows are taken into account in allocating income but they are not under IFRS.
• Fair value or revaluation as deemed cost – the fair value of an item of property, plant or equipment, or a previous GAAP revaluation (that approximates fair value) of such an item, may be treated as though it were the cost basis for the asset, with subsequent depreciation and impairment based on that amount.
• Cumulative translation differences – cumulative translation differences on the net investment in a foreign operation prior to the transition date need not be calculated but set at zero.
• Compound financial instruments – split accounting required by IAS 39 need not be applied for a compound financial instrument if the liability component is no longer outstanding at the date of transition.
• Designation of financial instruments – an entity is allowed to designate a financial instrument as financial asset or financial liability at fair value through profit or loss on the date of transition rather than on initial recognition as required by IAS 39.
• Share-based payment transactions – IFRS 2 ‘Share-based Payment’ must be applied to equity instruments granted on or after 7 November 2002 that had not vested before the later of the transition date and 1 January 2005.
IFRS 1 prohibits retrospective application of some aspects of IFRS: • Derecognition of financial assets and financial liabilities – the derecognition requirements of IAS 39 are to be applied prospectively for transactions occurring on or after 1 January 2004. However, an entity is permitted to apply the derecognition requirements retrospectively from a date of its choice.
IFRS require at least one year of comparative data. However this data need not comply with IAS 32, IAS 39 and IFRS 4 ‘Insurance Contracts’. If comparatives that do not comply with IAS 32, IAS 39 and IFRS 4 are presented, then the date of transition for these standards will be the beginning of the first IFRS reporting period.
Profit before tax, goodwill amortisation and integration costs 8,101 7,068 6,540 Profit before tax 6,917 6,076 4,852 Profit attributable to ordinary shareholders 4,256 2,254 2,034
Basic earnings per share (pence) 138.0 76.9 70.6 Adjusted earnings per share (pence) (2) 172.5 157.2 146.3
(2) Adjusted earnings per share is based on earnings per share adjusted for goodwill amortisation, integration costs and the Additional Value Shares dividend in 2002 and 2003.
(4) Adjusted after-tax return on equity is based on profit attributable to ordinary shareholders before goodwill amortisation, integration costs and the Additional Value Shares dividend in 2002 and 2003, and average equity shareholders’ funds.
Summary consolidated profit and loss account for the year ended 31 December 2004 The profit and loss account set out below shows goodwill amortisation and integration costs separately. In the statutory profit and loss account on page 143, these items are included in the captions prescribed by the Companies Act.
Additional Value Shares dividend – non-equity — 1,463 798 Profit attributable to ordinary shareholders 4,256 2,254 2,034
Adjusted earnings per ordinary share 172.5p 157.2p 146.3p * restated (see page 139)
Profit before tax was up 14%, from £6,076 million to £6,917 million.
In August 2004, Citizens completed the acquisition of Charter One Financial, Inc. for a cash consideration of US$10.1 billion.
The Group has adopted Financial Reporting Standard 17 ‘Retirement Benefits’ (“FRS 17”) – the standard that replaces SSAP24 ‘Pension Costs’. The effect on prior years of adopting FRS 17 is shown on page 139.
Total income The Group achieved strong growth in income during 2004. Total income was up 18% or £3,473 million to £22,754 million. Excluding acquisitions and at constant exchange rates, total income was up by 11%, £2,004 million.
Net interest income increased by 11% to £9,208 million and represents 40% of total income (2003 – 43%). Excluding acquisitions and at constant exchange rates, net interest income was up 8%. Average loans and advances to customers and average customer deposits grew by 19% and 10% respectively.
Net interest margin The Group's net interest margin at 2.92% was in line with expectations. Excluding the acquisition of First Active, the Group's net interest margin was down 0.03% from 2.97% in 2003, principally as a result of strong organic growth in mortgage lending and the increased funding cost of rental assets, the income from which is included in other income.
Cost:income ratio The Group's ratio of operating expenses (excluding goodwill amortisation and integration costs and after netting operating lease depreciation against rental income) to total income improved further to 40.8% from 42.6%. Excluding Charter One, the Group's cost:income ratio was 40.6%.
Net insurance claims General insurance claims, after reinsurance, increased by 59% to £3,480 million. Excluding Churchill, the increase was 20%, consistent with volume growth and business mix.
Integration Integration costs in 2004 were £269 million principally relating to the integration of Churchill and the acquisitions by Citizens.
Lending to customers, excluding repurchase agreements and stock borrowing (“reverse repos”), increased in 2004 by 28% or £64.8 billion to £293.3 billion. Excluding acquisitions and reverse repos, lending increased by 18%. Customer deposits, excluding repurchase agreements and stock lending (“repos”), grew in 2004 by 16% or £33.0 billion to £242.9 billion. Excluding acquisitions and repos, deposits increased by 7%.
Although the adoption of FRS 17 has reduced shareholders' funds by £3,220 million (2003 – £2,001 million), this has no effect on the Group's regulatory capital at 31 December 2004.
2003 compared with 2002 Profit Profit before tax, goodwill amortisation and integration costs increased by 8% or £528 million, from £6,540 million to £7,068 million.
Profit before tax was up 25%, from £4,852 million to £6,076 million.
Total income The Group achieved strong growth in income during 2003. Total income was up 13% or £2,265 million to £19,281 million. Non-interest income accounted for 57% of total income. Excluding acquisitions, total income rose by 10%.
Operating expenses Operating expenses, excluding goodwill amortisation and integration costs, rose by 10% to £8,524 million. Excluding acquisitions, operating expenses were up 7% in support of higher business volumes and 10% income growth.
Integration Integration costs in the year were £229 million, of which, £143 million related to the final elements of the NatWest integration and £86 million related to other acquisitions, including Citizens’ acquisitions and Churchill.
The final dividend of 55p per share amounting to £1.5 billion was paid on 1 December 2003 to the holders of the AVS issued in connection with the acquisition of NatWest. A total of £1 per AVS amounting to £2.7 billion in aggregate was paid over three years to shareholders in accordance with the original schedule.
Lending to customers, excluding repurchase agreements and stock borrowing (“reverse repos”), increased by 13% or £27 billion to £228 billion. Customer deposits, excluding repurchase agreements and stock lending (“repos”), grew by 8% or £16 billion to £210 billion.
Capital ratios at 31 December 2003 were 7.4% (tier 1) and 11.8% (total), against 7.3% (tier 1) and 11.7% (total) at 31 December 2002.
In July 2003, Citizens announced the acquisition of Community Bancorp, Inc., the holding company for Community National Bank, for a cash consideration of US$116 million. This transaction was completed on 31 October 2003.
On 3 February 2004, RBS announced that it had agreed terms with People’s Bank of Connecticut to purchase their credit card portfolio. This transaction was completed on 5 March 2004.
Disposals In May 2003, RBS announced the sale of the Miami-based Latin American private banking operations of Coutts Group to Santander Central Hispano. The cash consideration was US$81 million. This transaction was completed on 31 July 2003.
(2) Interest spread is the difference between the gross yield and the interest rate paid on average interest-bearing liabilities of the banking business.
2004 compared with 2003 Group – The net interest margin decreased from 2.97% to 2.92%. The interest spread declined reflecting principally a change in mix towards relatively lower margin mortgage business including the acquisition of First Active. This was partially offset by an increase in the benefit from interest-free funds due to increased volumes and movements in interest rates.
UK – The UK net interest margin increased slightly from 2.95% to 2.96%. An increase in the benefit from interest-free funds, due to movements in interest rates, and improvements in corporate lending margins were largely offset by growth in the mortgage business.
Overseas – The Overseas net interest margin decreased from 3.02% to 2.83%. This reduction reflected the continued tightening of asset spreads in the US, together with the growth in mortgage business following the acquisition of First Active. Higher volumes together with movements in interest rates led to an increase in the benefit of interest-free funds.
Within this, average loans and advances to customers were up 12%, £23.3 billion, to £213.3 billion due to growth in both corporate and personal lending.
Interest spread for the Group as a whole decreased from 2.71% to 2.68%. Interest-free balances fell partly due to the outcome of the Competition Commission inquiry into SME banking. This, together with the lower interest rate environment contributed to the reduction in the benefit of interest-free funds from 0.42% to 0.29% giving a decline in net interest margin from 3.13% to 2.97%.
Assets Treasury and other eligible bills – UK 835 34 4.07 1,378 48 3.48
Loans and advances to banks – UK 13,528 527 3.90 13,724 459 3.34
Loans and advances to customers – UK 184,837 11,152 6.03 168,390 9,519 5.65
Customer accounts: savings deposits – UK 24,147 673 2.79 18,653 503 2.70
Debt securities in issue – UK 37,097 1,229 3.31 29,977 914 3.05
Internal funding of trading business – UK (35,317) (920) 2.60 (21,258) (497) 2.34
Total interest-bearing liabilities – banking business 276,931 7,488 2.70 245,099 5,697 2.32
Total interest-bearing liabilities 408,674 338,565 Non-interest-bearing liabilities Demand deposits – UK 17,765 17,589
(2) Loans and advances to customers include non-accrual loans. Interest income includes income on non-accruing loans only to the extent cash payments have been received.
Assets Treasury and other eligible bills – UK 910 24 2.64 Treasury and other eligible bills – Overseas 351 6 1.71 Loans and advances to banks – UK 13,439 532 3.96 Loans and advances to banks – Overseas 9,811 304 3.10 Loans and advances to customers – UK 154,202 9,141 5.93 Loans and advances to customers – Overseas 35,759 1,963 5.49 Debt securities – UK 17,950 675 3.76 Debt securities – Overseas 18,188 916 5.04 Total interest-earning assets – banking business 250,610 13,561 5.41
Total interest-bearing liabilities 286,747 Non-interest-bearing liabilities Demand deposits – UK 21,848 Demand deposits – Overseas 6,401 Other liabilities 52,047 Shareholders’ funds – equity 23,075 Shareholders’ funds – non-equity 3,739
General insurance premium income, after reinsurance, rose by 58%, or £1,821 million to £4,944 million reflecting organic growth and the acquisition of Churchill. Excluding Churchill, the growth was 17% reflecting volume growth in motor and home insurance products.
General insurance premium income, after reinsurance, rose by 60%, or £1,170 million to £3,123 million. Excluding the acquisition of Churchill Insurance the growth was 25% or £490 million reflecting volume growth in motor and home insurance products.
Premises and equipment expenses increased by £108 million, 10% to £1,150 million reflecting investment to upgrade the property portfolio in major UK centres to support the core business.
The Group's ratio of operating expenses (excluding goodwill amortisation and integration costs and after netting operating lease depreciation against rental income) to total income improved further to 40.8% from 42.6%.
2003 compared with 2002 Operating expenses excluding goodwill amortisation and integration costs rose by 10% or £743 million to £8,524 million. This increased expenditure was in support of strong organic growth and customer service improvements. Excluding acquisitions, operating expenses were up 7%, £544 million in support of higher business volumes and 13% income growth.
Premises and equipment expenses increased by £163 million, 19% to £1,042 million reflecting the continuing upgrade of the property portfolio in major UK centres to support the core business.
Continued income growth coupled with a rigorous approach to cost management further improved the Group’s cost:income ratio, to 42.6% from 44.2%. Excluding the effect of acquisitions the cost:income ratio improved to 43.9%.
Integration costs in 2004 comprise £87 million relating to the integration of Churchill, £91 million relating to the integration of Charter One and £91 million in respect of other acquisitions.
Integration costs in 2002 comprise £810 million relating to the integration of NatWest and £147 million relating to the integration of Citizens' acquisitions.
Contributions to employee share schemes (32) (35) (40) Non-deductible items 227 248 179 Non-taxable items (251) (207) (188) Capital allowances in excess of depreciation (415) (626) (340)
Bad debt provisions amounted to £1,428 million compared with £1,461 million in 2003, a decrease of 2%. Amounts written off fixed asset investments were up from £33 million in 2003 to £83 million.
Total balance sheet provisions for bad and doubtful debts amounted to £4,228 million compared with £3,929 million at 31 December 2003. Total provision coverage (the ratio of total balance sheet provisions to total risk elements in lending) remained stable at 76%.
The ratio of total balance sheet provisions to total risk elements in lending and potential problem loans increased to 73% compared with 68% at 31 December 2003.
2003 compared with 2002 Gross new provisions were up 11%, £158 million to £1,566 million. Recoveries of amounts previously written off were up £9 million, 14%, to £72 million. Consequently the net charge to the profit and loss account was up £149 million, 11% to £1,494 million.
Bad debt provisions amounted to £1,461 million compared with £1,286 million in 2002, an increase of 14%. The increased charge was in line with the growth in lending during 2003. Amounts written off fixed asset investments, largely in the second half of the year, were down £26 million to £33 million compared with £59 million in 2002.
The ratio of total balance sheet provisions to total risk elements in lending and potential problem loans increased to 68% compared with 65% at 31 December 2002.
Net new provisions 1,658 1,566 1,408 less: recoveries of amounts previously written off (147) (72) (63) Charge to profit and loss account 1,511 1,494 1,345
The performance of each of the divisions is reviewed on pages 80 to 91.
Weighted risk assets – banking 160.9 140.0 125.2 Weighted risk assets – trading 16.9 12.6 11.3 * excluding repos and reverse repos 2004 compared with 2003 Contribution increased by 18%, £645 million to £4,265 million reflecting growth in all business areas.
Total income was up 12% or £812 million to £7,509 million. Strong growth in all locations was partially masked by the effect of stronger sterling on the translation of income from Europe and North American businesses. At constant exchange rates, income grew by 14% and contribution was up 20%.
Dealing profits, which is income (before associated direct costs) arising from our role in providing customers with debt and risk management products in interest rate, currency and credit asset classes, rose by 12% to £1,855 million. Growth was achieved across all our customer segments and product classes with further diversification of dealing revenues in the US to compensate for lower residential mortgage refinancing volume than in 2003. The Group's trading value-at-risk (VaR) remains modest and the average VaR was £10.8 million (2003 – £9.4 million).
O pe ra tin g an d fin an ci al r ev ie w 2003 compared with 2002 Contribution increased by 11% or £359 million to £3,620 million. As well as in the UK, the division also achieved good growth in Europe and North America.
Average loans and advances to customers of the banking business increased by 9% or £7.5 billion to £94.3 billion. Lending margin was maintained. Average customer deposits within the banking businesses increased by 7% or £4.1 billion to £61.0 billion; however, the lower interest rate environment adversely affected deposit margins as it reduced the benefit of interest free funds. Net interest income was further impacted by the effect of implementing from 1 January 2003 the pricing remedies agreed following the Competition Commission inquiry into SME banking and by lower money market income, due to less favourable market conditions.
The asset rental business comprising operating leases and investment properties, grew strongly. Rental assets increased to £10.1 billion and net income after deducting funding costs and operating lease depreciation increased by 28%, £53 million to £241 million.
Dealing profits which is income (before associated direct costs) arising from our role in providing customers with debt and risk management products in interest rate, currency and credit asset classes, rose by 24% to £1,661 million providing incremental profit contribution of some £170 million. There was steady growth in underlying customer volumes in all product areas. While first half performance was particularly strong given the unusually high levels of demand for mortgage backed securities in the United States, dealing revenues in the second half were up 10% on the prior year period, in line with the growth in income for the division as a whole.
Other operating income was up £110 million, 56% to £307 million partially due to the full year effect of the inclusion of Dixon Motors’ gross profit.
Direct expenses increased by 12% or £256 million to £2,322 million. Excluding the effect of the acquisition of Nordisk Renting and Dixon Motors and operating lease depreciation, operating expenses were up 10%, £161 million. This was due to performance related costs associated with the strong growth in trading revenues, expansion in all business areas and continued investment in capital market activities and in the growing overseas franchise.
The charge for provisions for bad debts and amounts written off fixed asset investments amounted to £755 million, an increase of £30 million. The charge in the second half of the year was £351 million, 13% lower than the first half. The increase in provisions of 4% over last year was less than the growth in lending of 9%, reflecting an improvement in credit quality and the economic environment during 2003.
Weighted risk assets 49.7 42.9 38.8 * prior periods have been restated to reflect the transfer in 2004 of certain activities from Wealth Management.
2004 compared with 2003 The division continued to achieve strong volume growth across all key product areas – in particular mortgages, loans and savings – supported by increased customer numbers. As a result, income increased by 6% or £269 million to £4,742 million, and contribution by 3% or £109 million to £3,279 million.
The overall quality of the loan portfolio, the majority of which is mortgage lending, as measured by probability of default, remained in line with expectations.
O pe ra tin g an d fin an ci al r ev ie w 2003 compared with 2002 The division achieved strong volume growth across all personal product areas - current accounts, mortgages and loans and savings. Despite lower interest rates and the adverse effect of the pricing remedies agreed following the Competition Commission inquiry into SME banking which were implemented from 1 January 2003, income increased by 5% or £194 million to £4,473 million, and contribution by 3% or £96 million to £3,170 million.
Net interest income rose by 4% or £110 million to £2,959 million, reflecting the continued strong growth in customer advances and deposits which was partially offset by the implementation of the Competition Commission pricing remedies and the impact of a lower interest rate environment. Excluding the effect of the Competition Commission the increase was 8%. Average loans to customers, excluding mortgages, grew by 9% or £1.9 billion to £23.7 billion. Average mortgage lending grew by 12% or £3.6 billion to £33.7 billion. Average customer deposits increased by 6% or £3.7 billion to £60.9 billion.
Non-interest income rose by 6% or £84 million to £1,514 million. This reflected further growth in the customer base and a 15% growth in general insurance income to £301 million. Embedded value profits of the life assurance business increased by 14%, or £7 million to £57 million.
Other expenses decreased 10% or £26 million to £237 million, as a result of our rigorous approach to management of nonstaff costs.
Net interest income 938 849 749 Non-interest income 1,191 986 841
2004 compared with 2003 Contribution increased by 18% or £159 million to £1,040 million.
Total income was up 16% or £294 million to £2,129 million, reflecting continued strong growth across all products, particularly credit cards. Excluding acquisitions income rose by 9%, £155 million, and contribution was up by 14%, £125 million. Net interest income was up 10% or £89 million to £938 million. Average lending rose by 19% to £24.2 billion, of which average mortgage lending was 16% higher at £8.8 billion, mainly in The One account. Average customer deposits were stable. The new MINT branded credit card was launched in December 2003 and while the 0% introductory interest rate for nine months on MINT cards depressed net interest margin, over 711,000 MINT credit cards have been issued and attracted significant balances. During 2004, the total number of customer accounts increased by 2.3 million.
Non-interest income was up 21% or £205 million to £1,191 million, reflecting increased volumes and acquisitions.
The charge for provisions for bad debts increased by £80 million or 27% to £377 million, reflecting the growth in lending volumes and the acquisition of the credit card business from People's Bank.
Excluding acquisitions, provisions for bad debts were up 14%, £41 million. Credit metrics across the portfolio remain broadly stable, however consistent with the market there was some increase in the levels of arrears towards the end of the year in credit cards.
Direct expenses increased by 9% or 7% excluding acquisitions, and other expenses increased by £35 million, 9% (7% excluding acquisitions), with increased processing and operational costs in support of the higher business levels.
The charge for provisions for bad debts increased by £16 million or 6% to £297 million, reflecting growth in lending volumes offset by higher recoveries. The indicators of credit quality remained stable.
The cost base of Group Purchasing and Property Operations rose by 11% or £69 million to £718 million, largely as a result of the continuing upgrade of the property portfolio in major UK centres to support the Group’s core business.
Net interest income 497 457 451 Non-interest income 451 352 370
Investment management assets were stable at £22.3 billion. Excluding the acquisition and disposal and at constant exchange rates, investment assets increased 7%.
Total income was down by 1% or £12 million to £809 million.
Non-interest income declined by 5% or £18 million to £352 million. Excluding the acquisition and disposals the decrease was 1%. This reflected the impact of lower equity markets adversely affecting fees and commissions.
Insurance premium income 4,944 3,123 1,953 Net fees and commissions (488) (161) 6
– Motor: Continental Europe 1,639 1,425 1,165 – Other (including home, rescue, pet): UK 10,919 10,518 6,697
Expenses increased by 34% or £151 million to £592 million. Excluding Churchill, expenses increased by 10%, £37 million, to support higher business volumes.
The UK combined operating ratio, which includes manufacturing costs, was 93.7% compared with 91.2% for 2003. This deterioration is attributable in part to a change in business mix due to the full year impact of commissions payable to brokers and intermediaries in Churchill. Excluding Churchill, the UK ratio was broadly in line with the prior year 2003 compared with 2002 Contribution increased by 34% or £153 million to £609 million. Excluding Churchill, contribution increased by 22% or £99 million.
Total income was up 52% or £1,106 million to £3,245 million. Excluding Churchill, total income grew by 25% or £525 million.
Other income net of commissions payable was down from £186 million to £122 million. Excluding Churchill, which included £148 million commissions payable to brokers and intermediaries, other income was up 19% or £35 million due to higher investment income, embedded value profits and share of associates profits.
UK combined operating ratio was 91.2%. Excluding Churchill, the UK ratio was 88.6% compared with 88.2% for 2002.
2004 compared with 2003 Contribution increased by 32% or £114 million to £468 million.
The charge for provisions for bad debts increased by £8 million to £40 million, reflecting the growth in lending business. Excluding First Active and NCB provisions for bad and doubtful debts were up £4 million. Asset quality remains strong.
2003 compared with 2002 Contribution increased by 11% or £36 million to £354 million driven by strong volume growth in both loan and deposit products. The number of customers increased in 2003 by 36,000.
Total income increased by 12% or £61 million to £581 million reflecting the strong volume growth, in particular residential mortgages.
Average exchange rate – $/£ 1.832 1.635 1.503 Spot exchange rate – $/£ 1.935 1.786 1.613 2004 compared with 2003 Contribution was affected by the weak US dollar relative to sterling and at £1,037 million was up 21%, £180 million. In US dollar terms, contribution increased by 36% or $499 million to $1,900 million. Excluding the acquisitions, contribution increased by 13% or $183 million to $1,570 million.
Net interest income increased by 32% or $678 million to $2,821 million, reflecting the acquisitions and strong organic growth in both personal loans and deposits. Excluding the acquisitions, net interest income increased by 11% or $228 million, average loans were up 24% or $8.8 billion and average deposits were up 14% or $8.0 billion. The benefit from higher volumes more than offset the impact of interest rates on margins.
Expenses increased by 31% or $439 million to $1,877 million. Excluding acquisitions, expenses were up 7% due to additional costs to support higher business volumes, investment in branch automation and the expansion of traditional and supermarket banking in Mid Atlantic and New England.
Expenses increased by 12% or $153 million to $1,438 million. Excluding the acquisitions, expenses increased by 8% or $102 million (£62 million), to support higher business volumes and expansion of Citizens’ supermarket banking programme.
2004 compared with 2003 Total Central items increased by £168 million to £879 million.
Changes in net pension costs on the adoption of FRS 17 are reported in Central items. These comprise higher pension cost of £81 million partially offset by the expected return on pension scheme assets less interest on scheme liabilities of £33 million.
Central departmental costs and other corporate items at £496 million were £213 million or 75% higher than 2002. Net pension costs increased by £172 million reflecting lower returns on pension scheme assets together with increased pension costs. This was also partly due to staff costs and other costs relating to certain departments such as Customer Relations which have been centralised and additional resources devoted to Group wide projects such as preparations for the implementation of Basel II and International Accounting Standards.
Acquisitions in the year 10,500 9,700 5,600 * prior periods have been restated to reflect the transfer in 2004 of certain activities from Wealth Management to Retail Banking and from RBS Insurance and Ulster Bank to Manufacturing.
2004 compared with 2003 The number of employees increased by 15,700, 13% to 136,600. The acquisitions in the year added 10,500 staff, including over 8,100 relating to Charter One.
2003 compared with 2002 The number of employees increased by 9,100, 8% to 120,900. The acquisition of Churchill added 8,500 staff in RBS Insurance.
Consolidated balance sheet at 31 December 2004 2004 2003* £m £m
Assets Cash and balances at central banks 4,293 3,822 Items in the course of collection from other banks 2,629 2,501 Treasury bills and other eligible bills 6,110 4,846 Loans and advances to banks 58,260 51,891 Loans and advances to customers 345,469 252,531 Debt securities 91,211 79,949 Equity shares 2,960 2,300 Intangible fixed assets 17,576 13,131 Tangible fixed assets 16,294 13,927 Settlement balances 5,682 2,857 Other assets 22,255 17,807 Prepayments and accrued income 6,928 5,309
Long-term assurance liabilities attributable to policyholders 3,800 3,557 Total liabilities 583,467 454,428
Repurchase agreements and stock lending Deposits by banks 43,342 27,044 Customer accounts 42,134 27,021 * restated (see page 139)
Overview of consolidated balance sheet Total assets of £583.5 billion at 31 December 2004 were up £129.0 billion, 28%, compared with 31 December 2003, reflecting business growth and acquisitions.
Treasury bills and other eligible bills increased by £1.3 billion, 26%, to £6.1 billion, reflecting trading activity.
Loans and advances to banks rose £6.4 billion, 12%, to £58.3 billion. Bank placings were up £2.9 billion, 11% to £28.3 billion, and reverse repurchase agreements and stock borrowing (“reverse repos”), were up £3.5 billion, 13%, to £30.0 billion.
Loans and advances to customers were up £92.9 billion, 37%, to £345.5 billion. Within this, reverse repos increased by £28.1 billion to £52.2 billion reflecting growth in trading activities. Excluding reverse repos, lending increased by £64.8 billion, 28% to £293.3 billion reflecting organic growth across all divisions and £23.4 billion arising from acquisitions, principally Charter One, £18.0 billion, First Active, £4.1 billion, and the People's Bank credit card business, £1.0 billion. In $ terms, Citizens grew US$39.5 billion, 92%, including US$32.7 billion related to acquisitions.
Settlement balances increased by £2.8 billion to £5.7 billion as a result of increased levels of customer activity.
Debt securities in issue increased by £17.9 billion, 44%, to £59.0 billion primarily to meet the Group's funding requirements.
The increase in settlement balances and short positions reflected growth in customer activity.
Provisions for liabilities and charges increased £0.8 billion, 37% to £3.1 billion principally due to higher provisions for deferred tax.
Subordinated liabilities were up £3.4 billion, 20% to £20.4 billion. This reflected the issue of £1.3 billion (US$2,425 million), £0.7 billion (€1,000 million) and £0.4 billion (AUD1,000 million) dated loan capital, and £1.1 billion (£1,100 million), £1.0 billion (€1,500 million) and £0.1 billion (JPY25 billion) undated loan capital, together with £0.1 billion of dated and undated loan capital arising from the acquisition of First Active and £0.2 billion dated loan capital arising from the acquisition of Charter One. This was partially offset by the redemption of dated loan capital, £0.7 billion (US$1,050 million and £140 million), the conversion of £0.5 billion (US$850 million) undated loan capital into US$ preference shares and the effect of exchange rate movements, £0.4 billion.
Shareholders' funds increased by £5.8 billion, 22% to £31.9 billion including £2.6 billion from the placing of 165 million ordinary shares in connection with the acquisition of Charter One, the issue of £1.3 billion preference share capital and conversion of £0.5 billion (US$850 million) undated loan capital into US$ preference shares. The remainder reflects retentions of £2.4 billion and the issue of £0.6 billion of ordinary shares in respect of scrip dividends and the exercise of share options and revaluation of premises, £0.1 billion, which were partly offset by £1.1 billion actuarial losses, net of deferred tax, recognised in post-retirement benefit schemes and the adverse effect of exchange rate movements on share premium account, £0.2 billion and profit and loss account, £0.4 billion.
Net cash inflow from operating activities 6,307 19,708 13,737 Dividends received from associated undertakings 9 9 1 Returns on investments and servicing of finance (1,070) (956) (1,103)
Interest on subordinated liabilities of £613 million and dividends of £457 million to preference and minority shareholders were paid during the year.
The issue of £1,075 million trust preferred securities and £4,624 million subordinated debt, partially offset by the repayment of £718 million of subordinated debt were the main contributors to the net cash inflow from financing of £9,369 million.
Net purchases of investment securities of £3,056 million and fixed assets of £3,909 million, including operating lease assets and investment properties, comprised the net cash outflow from capital expenditure and financial investment.
The issue of £883 million trust preferred securities and £3,817 million subordinated debt, partially offset by the redemption of preference shares of £364 million and repayment of £336 million of subordinated debt were the main contributors to the net cash inflow from financing of £4,128 million.
Interest on subordinated liabilities of £674 million and dividends of £429 million to preference and minority shareholders were paid during the year.
The issue of £1,242 million trust preferred securities and £2,157 million subordinated debt, partially offset by the redemption of preference shares of £600 million and repayment of £202 million of subordinated debt were the main contributors to the net cash inflow from financing of £2,711 million.
• A net decrease in net income of £261 million relating to capitalisation and amortisation of software development costs that meet certain criteria under US GAAP. Such costs are generally charged to the profit and loss account under UK GAAP.
Capital resources The following table analyses the Group’s regulatory capital resources at the period end: £m £m £m £m £m
Weighted risk assets Banking book: It is the Group’s policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the Group has regard to the supervisory requirements of the Financial Services Authority (“FSA”). The FSA uses Risk Asset Ratio (“RAR”) as a measure of capital adequacy in the
Framework A number of high-level committees support the Board in the effective measurement and management of risk. Board subcommittees have the following roles and responsibilities: • Group Audit Committee – is a non-executive committee that supports the Board in carrying out its responsibilities for financial reporting including accounting policies, and in respect of internal control and risk assessment. The Group Audit Committee monitors the ongoing process of the identification, evaluation and management of all significant risks throughout the Group. The Committee is supported by Group Internal Audit which provides an independent assessment of the adequacy and effectiveness of the Group’s internal controls.
• Group Asset and Liability Management Committee (“GALCO”) which is responsible for reviewing the balance sheet, funding and capital implications of the Group's strategy and operations. In addition, GALCO monitors and reviews legal, regulatory and accounting developments affecting balance sheet risks and capital. It also reviews the effect of external, economic and environmental changes on the Group's balance sheet, risks, margins and capital.
GRM and GT also respond to various regulatory developments affecting risk, capital and liquidity management. This includes working with international and domestic trade associations, being active with various regulators, especially the FSA, and encouraging discussions with the main regulatory and political groups, such as the Basel Committee and the EU Commission.
The principal risks that the Group manages are as follows: • Credit risk
Credit risk Credit risk is the risk arising from the possibility that the Group will incur losses from the failure of customers to meet their obligations.
Different credit approval processes exist for each customer type in order to ensure appropriate skills and resources are employed in credit assessment and approval. Corporate risk exposures are aggregated to determine the appropriate level of credit approval required and to facilitate consolidated credit risk management: • Retail and personal businesses employ market best practice credit scoring techniques to process small scale, large volume credit decisions. Scores from such systems are combined with management judgement to ensure an effective ongoing process of approval, review and enhancement. Credit decisions for loans above specified thresholds, including lending to SMEs, are individually assessed.
• Assessments of corporate borrower and transaction risk are undertaken using a range of credit rating models supplemented by the judgement of relationship managers. Specialist internal credit risk departments independently oversee the credit process and make decisions or recommendations to the appropriate credit committee. Credit authority is not extended to relationship managers.
• Financial Markets counterparties are approved by a dedicated credit function which specialises in the traded market product risk.
Credit risk (continued) Risk asset quality Internal reporting and oversight of risk assets is principally differentiated by credit ratings. Internal ratings are used to assess the credit quality of borrowers. Customers are assigned credit ratings, based on statistical and judgemental rating systems that map to a Group asset quality scale reflecting the probability of default. Over the past year, RBS has made significant strides in updating its credit grading models to take account of the new Basel Capital Accord (see page 219).
As at December 2004, exposure to investment grade counterparties (AQ1) accounted for over half of risk assets. Over 97% of exposures were to counterparties rated AQ4 or higher.
Loans and advances The Group’s loan portfolio consists of loans (including overdraft facilities), instalment credit and finance lease receivables. The value of loans and advances to customers at 31 December 2004 was £349,691 million (2003 – £256,453 million), representing an increase of £93,238 million (36%) over the year, of which £23,468 million relates to the largest three acquisitions (Charter One, First Active & Peoples Bank Cards) and £28,115 million relates to growth in reverse repo activity. Including banks, total loans and advances at 31 December 2004 was £407,957 million (2003 – £308,351 million), an increase of 32%.
Other commercial and industrial comprising: Service industries and business activities 57,305 50,772 48,155 Agriculture, forestry and fishing 3,024 3,081 3,026
Together, corporates, financial institutions and sovereigns, account for 61% of loans and advances. The remaining exposures, accounting for 39% of loans and advances, relate to personal and retail customers, especially mortgage lending and other small loans that are intrinsically highly diversified.
O pe ra tin g an d fin an ci al r ev ie w Operating and financial review continued l Cross border exposures Cross border exposures are defined as loans to banks and customers (including finance lease and instalment credit receivables) and other monetary assets, including non-local currency claims of overseas offices on local residents.
The table below sets out the Group’s cross border outstandings in excess of 0.75% of Group total assets (including acceptances), which totalled £583.8 billion (2003 – £455.0 billion; 2002 – £413.6 billion). None of these countries has experienced repayment difficulties that have required refinancing of outstanding debt.
Geographic analysis: * Less than 0.75% of Group total assets (including acceptances).
Rest of the World 2,891 1,693 1,733 Total loans and advances to customers – gross 349,691 256,453 227,244
Notes: (1) The geographic analysis is based on location of office. The UK includes domestic transactions and transactions conducted through the offices in the UK which service international banking transactions.
Credit risk (continued) l Geographic analysis Although the Group is active in 27 different countries, its principal focus is on the UK, US and Europe.
Risk elements in lending and potential problem loans The table below sets out the Group’s loans that are classified as non-accrual, accruing past due and restructured loans (together risk elements in lending (REIL)) or potential problem loans (PPL) as defined by the SEC in the US. The figures incorporate estimates and are stated before deducting the value of security held or related provisions.
(3) Overdrafts generally have no fixed repayment schedule and consequently are not included in this category.
(4) Loans which are current as to the payment of principal and interest but in respect of which management have serious doubts about the ability of the borrowers to comply with contractual repayment terms. Substantial security is held in respect of these loans and appropriate provisions are made in accordance with the Group’s provisioning policy for bad and doubtful debts.
management, growth in lower risk portfolios and improvements in the economic environment in the Group’s key markets.
REIL and PPL in aggregate, as a proportion of loans and advances also shows an improving trend, accounting for 1.66% of loans and advances to customers in 2004 (2003 – 2.24%; 2002 – 2.66%).
Provisions The Group provides for losses in its loan portfolio so as to record impaired loans and advances at their expected ultimate net realisable value. The objective is to set provisions based on the current understanding of the portfolio. To reach this understanding, retail and corporate loans and advances are treated separately.
Corporate portfolios consist of higher value, lower volume credits, which tend to be structured to meet individual customers requirements. These portfolios do not have an automated provisioning process, relying on individual expert judgement and provisioning committees to provide the necessary controls and oversight to identify problems.
Early and proactive management of problem exposures ensures that credit losses are minimised. Specialised units are used for different customer types to ensure that the appropriate risk mitigation is taken in a timely manner.
The coverage ratio of closing provisions as a percentage of REIL remained stable at 76% while the coverage ratio of total closing provisions as a percentage of REIL and PPL increased to 73% from 68% at the end of 2003.
Closing provisions for bad and doubtful debts expressed as a: % of REIL and PPL 73% 68% 65%
Provisions for bad and doubtful debts charged to the profit and loss account in 2004 were £1,428 million, down £33 million (2%) from £1,461 million in 2003. Expressed as a percentage of average loans and advances to customers, the bad and doubtful debt charge improved to 0.48%, from 0.59% in 2003.
Analysis of specific provisions The table below shows specific provisions by industry and geographic area.
Notes: (1) Excludes specific provisions against loans and advances to banks of £6 million (2003 – £7 million; 2002 – £7 million).
Amounts written off and recovered The table below shows the amounts written off by industry and geographical area.
Notes: (1) Excludes amounts written off in respect of banks of nil (2003 – nil; 2002 – £1 million).
The management of liquidity risk within the Group is undertaken within limits and other policy parameters set by GALCO, who review monthly and receive, on an exception basis, reports detailing compliance with those policy parameters. A weekly report is also provided to the GEMC. Compliance is monitored and co-ordinated daily under the stewardship of the Group Treasury function, both in respect of internal policy and the regulatory requirements of the FSA. Detailed liquidity position reports are compiled each day by Group Treasury and reviewed daily and weekly with Financial Markets, who manage day-to-day and intra-day market execution within the policy parameters set.
The structure of the Group’s balance sheet is managed to maintain substantial diversification, to minimise concentration across its various deposit sources, and to contain the level of reliance on total and net short-term wholesale sources of funds within prudent levels.
Customer accounts, excluding repo agreements, grew by £32,986 million (16%), and represent 51% of the Group’s funding excluding capital and other liabilities. Excluding the Charter One acquisition the growth would have been £18,381 million (9%). The proportion of funding from wholesale sources has increased reflecting the higher rate of growth in customer loans and advances (excluding reverse repos), up £65,123 million (28%) – £48,405 million (21%) excluding Charter One.
Repo agreements with corporate and institutional customers are undertaken primarily by RBS Greenwich Capital in the US and by Financial Markets. Repo activity with customers represented 9% of the Group’s funding excluding capital and other liabilities at 31 December 2004.
Deposits by banks including repos increased by £31,758 million (£27,240 million excluding Charter One) to represent 21% of the Group’s funding, excluding capital and other liabilities. Deposits by banks are taken from a wide range of counterparties, with the largest single depositor continuing to represent less than 1% of the Group’s total funding.
Debt securities in issue increased by £17,944 million to represent 13% of the Group’s funding, excluding capital and other liabilities, at 31 December 2004. Total debt securities in issue at 31 December 2004 includes £9,589 million (2003 – £9,187 million) with a maturity of over one year, reflecting the activity of the Group in raising term funds through its Euro and US Medium Term Note programmes and other term issues.
Deposits by banks (excluding repos) 55,739 12 40,279 11 34,623 11
The FSA also sets an absolute minimum level for the stock of qualifying liquid assets that the Group is required to maintain each day. The Group has exceeded that minimum stock requirement at all times during 2004.
The Group’s operational processes are actively managed to ensure that both the minimum sterling liquidity ratio and the minimum stock requirement are achieved or exceeded at all times.
Liquidity in non-sterling currencies For non-sterling currencies, no specific regulatory liquidity requirement is set for the Group by the FSA. However, the importance of managing prudently the liquidity risk in its nonsterling activities is recognised and the Group manages its non-sterling liquidity risk daily within net mismatch limits set for the 0-8 calendar day and 0-1 month periods as a percentage of the Group’s total deposit liabilities.
The level of contingent risk from the potential drawing of undrawn or partially drawn commitments, back-up lines, standby lines and other similar facilities is also actively monitored and reflected in the measures of the Group’s nonsterling liquidity risk. Particular attention is given to the US$ commercial paper market and the propensity of the Group’s corporate counterparties (who are active in raising funds from that market) to switch to utilising facilities offered by the Group in the event of either counterparty specific difficulties or a significant widening of interest spreads generally in the commercial paper market.
The Group also provides liquidity back-up facilities to both its own conduits and certain other conduits which take funding from the US$ commercial paper market. Limits sanctioned for such facilities totalled less than £7,500 million at 31 December 2004. The short-term contingent liquidity risk in providing such back-up facilities is also mitigated by the spread of maturity dates of the commercial paper taken by the conduits.
The VaR for the Group’s trading portfolios segregated by type of market risk exposure is presented in the table below.
Treasury The Group’s treasury activities include its money market business and the management of internal funds flow within the Group’s businesses. Money market portfolios include cash instruments (principally debt securities, loans and deposits) and related hedging derivatives. VaR for the Group’s treasury portfolios, which relates mainly to interest rate risk was £5.5 million at 31 December 2004 (2003 – £8.1 million). During the year the maximum VaR was £8.6 million (2003 – £11.0 million), the minimum £5.5 million (2003 – £5.6 million) and the average
A static maturity gap report is produced as at the month-end for each division, in each functional currency based on the behaviouralised repricing for each product. It is Group policy to include in the gap report, non-financial assets and liabilities, mainly tangible fixed assets and the Group’s capital and reserves, spread over medium and longer term maturities. This report also includes hedge transactions, principally derivatives.
O pe ra tin g an d fin an ci al r ev ie w Operating and financial review continued
Market risk (continued) Non-trading (continued) Non-trading interest rate VaR Non-trading interest rate VaR for the Group’s treasury and retail and corporate banking activities was £72.4 million at 31 December 2004 (2003 – £78.1 million) with the major exposure being to changes in longer term US dollar interest rates. During the year, the maximum VaR was £89.7 million (2003 – £78.1 million), the minimum £51.5 million (2003 – £29.9 million) and the average £71.2 million (2003 – £51.7 million).
These limits are set to parallel movements of +/-1% and +/-2%. The EVE methodology captures deposit re-pricing strategies and the embedded option risks that exists within both the investment portfolio of mortgage-backed securities and the consumer loan portfolio. EVE is the present value of the cash flows generated by the current balance sheet. EVE sensitivity to a 2% parallel movement upwards and downwards in US interest rates is shown below.
Note 40 on the accounts includes, on pages 175 and 176, tables that summarise the Group’s interest rate sensitivity gap for its non-trading book at 31 December 2004 and 31 December 2003. The tables show the contractual re-pricing for each category of asset, liability and for off-balance sheet items and do not reflect the behaviouralised repricing used in the Group’s asset and liability management methodology and the nontrading interest rate VaR presented above.
Insurance risk The Group is exposed to insurance risk, either directly through its businesses or through using insurance as a tool to reduce other risk exposures: • Insurance is a source of risk where the Group sells and underwrites general insurance and life assurance. The essence of an insurance contract is the transfer of risk from the policyholder to the insurer for the payment of a sum on the occurrence of an insured event.
Investment strategy reflects the maturity of underwriting liabilities and is governed through Investment Management Committees, with involvement and oversight from Group Treasury. The Group’s underwriting experience, the level of retained risk and solvency are monitored at divisional and Group level.
• The Insurance Sourcing Department is responsible for the Group-wide purchase of insurance as a means of reducing other risk exposures. As such, it is a key component of the Group’s risk management process and reports its activities to the GEMC.
Enterprise risk In order to adequately identify and manage the full range of Enterprise risk, the Group has separately defined operational and external risk: Operational risk is defined as the risk arising from within the organisation from: • People – risks arising from an inappropriate level of staff, inadequately skilled or managed people.
• Environment – risks arising due to demographic, macro economic, technical, cultural or environmental change.
Enterprise risk management is achieved through monitoring the Group’s exposure to direct or indirect loss using a range of policies, procedures, data, analytical tools and reporting techniques. In particular, Group-wide risk management processes ensure that Enterprise risk issues are quickly escalated and resolved, that the risks inherent in new products are fully evaluated, and that emerging external risks are actively monitored.
Operational risk exposures and loss events for each division are captured through monthly Risk and Control returns, which provide details on the change of risk exposures for each risk category in the light of improving/deteriorating trends and the risk profile of each division.
B oa rd o f di re ct or s an d se cr et ar y G
Chairman Sir George Mathewson (age 64) CBE, DUniv, LLD, FRSE, FCIBS C (Chairman), N (Chairman) Appointed to the Board in September 1987 and as Chairman in April 2001, Sir George Mathewson has a wide background in finance, technology and management and spent some of his career in the United States. He became Group Chief Executive in January 1992 and in March 2000, he was appointed Executive Deputy Chairman. He is a director of The Scottish Investment Trust PLC and the Institute of International Finance, Inc. He is also vicepresident of the International Monetary Conference, a member of the Advisory Committee of Bridgepoint Capital Limited and a member of the Financial Reporting Council. He was chief executive of the Scottish Development Agency from 1981 to 1987 and is a former president of the British Bankers’ Association.
Vice-chairmen Lord Vallance of Tummel (age 61) FCIBS C Appointed to the Board in January 1993 and as ViceChairman in March 1994, Lord Vallance is an experienced businessman who is currently chairman of the European Services Forum and a director of the supervisory board of Siemens AG. He is also a member of the European Advisory Council of the Rothschild Group and the European Advisory Committee of the NYSE. He held a range of other positions including president of the CBI, chairman of British Telecommunications Plc and deputy chairman of the Financial Reporting Council. He was also a member of the board of directors of the Mobil Corporation.
Fred Watt (age 44) FCIBS C Group Finance Director Appointed to the Board in September 2000, Fred Watt is a Chartered Accountant. He was formerly finance director of Wassall plc.
Jim Currie* (age 63) D.Litt R Appointed to the Board in November 2001, Jim Currie is a highly experienced senior international civil servant who spent many years working in Brussels and Washington. He was formerly director general at the European Commission with responsibility for the EU’s environmental policy and director general for Customs and Excise and Indirect Taxation. He is also a director of British Nuclear Fuels PLC and Total Holdings UK Limited, an international adviser to Eversheds and a consultant to Butera & Andrews UK Limited.
Archie Hunter* (age 61) A (Chairman Designate) Appointed to the Board in September 2004, Archie Hunter is a Chartered Accountant. He was Scottish senior partner of KPMG between 1992 and 1999 and President of The Institute of Chartered Accountants of Scotland in 1997/8. He has extensive professional experience in the UK and North and South America. He is currently chairman of Macfarlane Group plc, a director of Edinburgh US Tracker Trust plc, Convenor of Court at the University of Strathclyde and a governor of the Beatson Cancer Research Institute.
Charles ‘Bud’ Koch (age 58) Appointed to the Board in September 2004, Bud Koch is an American national. He has extensive professional experience in the USA and is currently chairman of the board of the Federal Home Loan Bank of Cincinnati, chairman of the board of John Carroll University and a trustee of Case Western Reserve University. He was the chairman, president and chief executive officer of Charter One Financial, Inc. and its wholly owned subsidiary, Charter One Bank, N.A between 1973 and 2004.
Joe MacHale* (age 53) A Appointed to the Board in September 2004, Joe MacHale is currently a non-executive director and chairman of the audit committee of Morgan Crucible plc and a trustee of MacMillan Cancer Relief. He held a number of senior executive positions with J P Morgan between 1979 and 2001 and was latterly chief executive of J P Morgan Europe, Middle East and Africa Region.
Eileen Mackay* (age 61) CB, FCIBS A, R Appointed to the Board in May 1996, Eileen Mackay is a former senior UK civil servant who held posts in Scotland, HM Treasury and the Cabinet Office and was principal finance officer at The Scottish Office. She is a director of Edinburgh Investment Trust plc, Scottish Financial Enterprise and The British Library. She is also chairman of the trustees of the David Hume Institute and a trustee of the Carnegie Trust for the Universities of Scotland.
Sir Steve Robson* (age 61) A Appointed to the Board in July 2001, Sir Steve Robson is a former senior UK civil servant, who had responsibility for a wide variety of Treasury matters. His early career included the post of Private Secretary to the Chancellor of the Exchequer and secondment to ICFC, (now 3i). He was also a Second Permanent Secretary of HM Treasury, where he was managing director of the Finance and Regulation
Directorate. He is a nonexecutive director of Cazenove Group Plc, Xstrata Plc and Partnerships UK plc, and a member of the Chairman’s Advisory Committee of KPMG.
Profit and dividends The profit attributable to the ordinary shareholders of the company for the year ended 31 December 2004 amounted to £4,256 million (after preference dividends of £256 million) compared with £2,254 million for the year ended 31 December 2003, as set out in the consolidated profit and loss account on page 143.
In January 2004, Ulster Bank completed the acquisition of First Active plc.
In May 2004, NatWest completed the acquisition of Bibit, a leading international internet payment specialist.
Ordinary share capital During the year ended 31 December 2004, the ordinary share capital was increased by the following issues: (a) 165 million ordinary shares placed at an issue price of £16.20 per share; (b) 12.9 million ordinary shares allotted as a result of the exercise of options under the company’s executive, sharesave and option 2000 schemes and a further 5.6 million ordinary shares allotted in respect of the exercise of options under the NatWest executive and sharesave schemes which had been exchanged for options over the company’s shares following the acquisition of NatWest in 2000; (c) 23.4 million ordinary shares allotted in lieu of cash dividends; and
(d) 2.4 million ordinary shares allotted under the company’s employee share ownership plan.
Details of the authorised and issued ordinary share capital at 31 December 2004 are shown in Note 33.
Preference share capital Details of issues of preference shares during the year and the authorised and issued share capital at 31 December 2004 are shown in Note 33.
Trust preferred securities Details of issues of trust preferred securities by subsidiaries of the Group are shown in Note 32.
Subordinated liabilities Details of issues and redemptions of dated and undated loan capital and the subordinated liabilities at 31 December 2004 are shown in Notes 30 and 31.
• Emilio Botin and Juan Inciarte, who resigned from the Board on 12 November 2004, served throughout the year and to the date of signing of the financial statements.
Employee proposition The Group recognises that the performance of its people is central to the successful delivery of its overall business strategy. Accordingly, the Group focuses on maintaining a compelling employee proposition that attracts, engages and then retains the best available talent. It is the breadth and depth of that employee talent which has cemented the Group’s standing as one of the world's leading financial institutions.
In addition, employees can participate in bonus incentive plans specific to their business and share in the Group's success through profit sharing, Buy As You Earn and Sharesave schemes, which align their interests with those of shareholders. UK employees participate in profit sharing that is directly related to the annual performance of the Group. For the last six years this has amounted to a further 10 percent of basic salary.
The Group acknowledges the importance of developing and maintaining strong leadership capability across the organisation, proactively developing future leaders and creating succession plans for senior and executive management roles. A core component of this ongoing activity is the Executive Leadership Programme developed in conjunction with the Harvard Business School and the establishment of an on-site business school at the Group
Headquarters at Gogarburn, Edinburgh which is due to open in Spring 2005. The introduction of emerging leader workshops, which included employee representatives from Citizens Bank, is further evidence of the Group’s commitment to global executive development.
In addition, through Learning Awards, the Group provides financial incentives to employees who take the banking qualifications offered by the Chartered Institute of Bankers in Scotland and The Institute of Financial Services.
Employee communication Employee engagement is encouraged through a transparent process of communication and consultation. This is achieved through a corporate Intranet, divisional magazines, team meetings led by line managers, briefings held by senior managers and regular dialogue with employees and employee representatives.
Employee consultation The Group recognises that the key to becoming (and remaining) an employer of choice is to ensure that employees are able to maximise their contribution to the Group. Each year an independent specialist company conducts a global Employee Opinion Survey on behalf of the Group to measure how employees feel about a number of important issues.
With an overall response rate of 84 percent (some 20 percent higher than the industry average) the Group remains confident that employees value the survey as a method of expressing their views and as a way of initiating change throughout the organisation. Since the last Group-wide survey in January 2003, there were significant improvements in 14 out of 15 question categories. The RBS Group performs very well against ISR’s Global Financial Services comparison companies, which includes many of the Group’s key competitors in the UK and abroad. The Group outperforms this comparison group in all but one category.
The Group is also committed to ensuring that all prospective applicants for employment are treated fairly and equitably throughout the recruitment process. Our comprehensive resourcing standards cover the attraction and retention of individuals with disabilities. Reasonable adjustments are provided to support the applicant in the recruitment process where these are required. The Group provides reasonable workplace adjustments for new entrants into the Group and also for existing employees who become disabled during their employment.
Corporate responsibility Business excellence requires that the Group meets changing customer, shareholder, investor, employee and supplier expectations. The Group believes that meeting high standards of environmental, social and ethical responsibility is key to the way it does business.
Charitable contributions In 2004 the contribution to the Group’s Community Investment programmes increased to £45.8 million (2003 – £40.1 million). The total amount given for charitable purposes by the company and its subsidiary undertakings during the year ended 31 December 2004 was £20.1 million (2003 – £14.7 million).
Corporate governance The company is committed to high standards of Corporate governance. Details are given on pages 120 to 123.
At the annual general meeting in 2002 shareholders gave authority for the company and certain of its subsidiaries to make political donations and incur political expenditure up to a maximum aggregate sum of £675,000 as a precautionary measure in light of the wide definitions in The Political Parties, Elections and Referendums Act 2000, for a period of four years. These authorities have not been used and it is not proposed that the Group’s longstanding policy of not making contributions to any political party be changed.
The company has also complied with the Smith Guidance on Audit Committees in all material respects.
The non-executive directors combine broad business and commercial experience with independent and objective judgement. The balance between non-executive and executive directors enables the Board to provide clear and effective leadership and maintain the highest standards of integrity across the company’s business activities. The names and biographies of all Board members are set out on page 115.
• Bud Koch who was formerly Chairman, President and Chief Executive Officer of Charter One Financial, Inc. which was acquired by Citizens Financial Group, Inc.
Re-election of directors At each annual general meeting, one third of the directors retire and offer themselves for re-election and each director must stand for re-election at least once every three years. Any non-executive directors who have served for more than nine years will also stand for annual re-election and the Board may consider their independence at that time. The proposed reelection of directors is subject to prior review by the Board.
The names of directors standing for re-election at the 2005 annual general meeting are contained on page 117 and further information will be given in the Chairman’s letter to shareholders in relation to the company’s annual general meeting.
The Group Secretary is responsible for advising the Board, through the Chairman, on all governance matters. All directors have access to the advice and services of the Group Secretary who is responsible to the Board for ensuring that Board procedures are followed and that applicable rules and regulations are complied with. In addition, all directors are able, if necessary, to obtain independent professional advice at the company’s expense.
Performance evaluation The annual performance evaluation of the Board and its Committees was undertaken in the autumn of 2004. The evaluation, which focused particularly on the Board Committees, was conducted by the Group Secretary using a detailed questionnaire and meetings with each of the Board Committee members and attendees to discuss the performance of the Committees.
Board Committees In order to provide effective oversight and leadership, the Board has established a number of Board Committees with particular responsibilities. The Committee chairmanship and membership are reviewed on a regular basis. The names and biographies of all Board Committee members are set out on page 115.
The Audit Committee also undertakes an annual evaluation to assess the independence and objectivity of the external auditors and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements. The results of the evaluation were reported to the Board.
Remuneration Committee All members of the Remuneration Committee are independent non-executive directors. The Remuneration Committee has three meetings each year.
Nominations Committee The Nominations Committee comprises independent nonexecutive directors, under the chairmanship of the Chairman of the Board. The Nomination Committee meets as required.
The Nominations Committee is responsible for assisting the Board in the formal selection and appointment of directors. It considers potential candidates and recommends appointments of new directors to the Board. The appointments are based on merit and against objective criteria including the time available, and commitment which will be required of, the potential director.
In addition, the Nominations Committee considers succession planning for the Chairman, Group Chief Executive and nonexecutive directors. The Nominations Committee takes into account the knowledge, mix of skills, experience and networks of contacts which will be needed on the Board in the future. The Chairman, Group Chief Executive and non-executive directors meet to consider executive succession planning. No director is involved in decisions regarding his or her own succession.
The Board is aware of the other commitments of its directors and is satisfied that these do not conflict with their duties as nonexecutive directors of the company.
Total number of meetings in 2004 10 5 4 1 Number of meetings attended in 2004
* Mr Hunter and Mr MacHale were appointed to the Board and the Audit Committee on 1 September 2004. Mr Koch was appointed to the Board on 29 September 2004.
***Mr Botin and Mr Inciarte resigned from the Board on 12 November 2004, the effective date of the acquisition of Abbey National plc by Banco Santander Central Hispano SA. They did not attend any Board meetings from June 2004 during the relevant public offer period.
C or po ra te g ov er na nc e G
Relations with shareholders The company communicates with shareholders through the annual report and by providing information in advance of the annual general meeting. Individual shareholders can raise matters relating to their shareholdings and the business of the Group at any time throughout the year. Shareholders are given the opportunity to ask questions at the annual general meeting or submit written questions in advance. The chairmen of the Audit, Remuneration and Nominations Committees are available to answer questions at the annual general meeting.
The terms of reference of the Audit, Remuneration and Nominations Committees and the standard terms and conditions of the appointment of non-executive directors are available on the Group’s website (www.rbs.com) and copies are available on request.
The Board has established a process for the identification, evaluation and management of the significant risks faced by the Group, which operated throughout the year ended 31 December 2004 and to 23 February 2005, the date the directors approved the Report and Accounts. This process is regularly reviewed by the Board and meets the requirements of the guidance ‘Internal Control: Guidance for Directors on the Combined Code’ issued by the Institute of Chartered Accountants in England and Wales in 1999.
Disclosure controls and procedures As required by US regulations, the Group Chief Executive and the Group Finance Director have evaluated the effectiveness of the company’s disclosure controls and procedures (as defined in the rules under the US Securities Exchange Act). This evaluation has been considered and approved by the Board which has authorised the Group Chief Executive and the Group Finance Director to certify that as at 31 December 2004, the company’s disclosure controls and procedures were adequate and effective and designed to ensure that material information relating to the company and its consolidated subsidiaries would be made known to them by others within those entities.
In addition to advising the Remuneration Committee, Ernst & Young provided professional services in the ordinary course of business including actuarial and corporate recovery advice. Mercer Human Resource Consulting provided advice and support in connection with a range of benefits, pension actuarial and investment matters.
Short-term annual incentives These typically focus from year to year on the delivery of a combination of appropriate Group and individual financial and operational targets approved by the Remuneration Committee. Individual UK-based executive directors normally have a maximum annual bonus potential of one times salary (one and a half times in the case of the Group Chief Executive), although for exceptional performance, as measured by the achievement of significant objectives, bonuses of up to two times salary may be awarded.
Long-term incentives The company provides long-term incentives in the form of share options and share or share equivalent awards. Their objective is to encourage the creation of value over the long-term and to align the rewards of the executive directors with the returns to shareholders. Directors are encouraged to hold shares in the company and a culture of voluntary shareholding has been fostered, which has resulted in a number of executive directors building up substantial shareholdings over time.
The plan is highly geared to the company’s relative performance. All awards under the plan are subject to threeyear performance targets. First, the annual growth in the company’s earnings per share (‘EPS’) must exceed the annualised growth of the Retail Prices Index (‘RPI’) plus three per cent. If this condition is satisfied, the company’s total shareholder return (‘TSR’) is compared with the TSR of a comparator group of certain companies in the financial services sector, referred to below. Awards under the plan will not vest if the company’s TSR is below the median of the comparator group. Achievement of the EPS target and median TSR performance against the comparator companies will result in vesting of 25 per cent of the award, increasing on a sliding scale up to 100 per cent at upper quartile performance and up to 200 per cent at upper decile performance. Vesting at 200 per cent can only occur if the company achieves a TSR ranking at 1st position in the comparator group and exceeds the TSR of the 2nd placed comparator company by at least 34%.This combination of EPS and TSR performance targets measures the underlying financial performance of the company and ensures a direct link between the value delivered to shareholders and the levels of incentive payment.
For awards made since 2002, the companies in the comparator group are Abbey National plc; Aviva plc; Barclays PLC; Citigroup; HBOS plc; HSBC Holdings plc; Legal & General Group plc; Lloyds TSB Group plc; Prudential plc and Standard Chartered PLC. Following the takeover of Abbey National plc by Banco Santander Central Hispano SA (‘BSCH’) in November 2004, Abbey National plc has been replaced by BSCH in the comparator group for awards made from 2003 onwards.
Options The executive share option scheme was approved by shareholders in January 1999. Each executive director is eligible for the annual grant of an option, typically of one and a quarter times salary with an upper maximum in appropriate circumstances of two and a half times salary, over shares at the market value at date of grant. Under the terms of his appointment, the Chairman is also eligible to participate in the executive share option scheme. No payment is made by the executive director on the grant of an option award.
All executive share options are subject to a performance target, which is currently that the options are exercisable only if, over a three year period, the growth in the company’s EPS has exceeded the growth in the RPI plus nine per cent. This EPS performance target, which is consistent with market practice, measures underlying financial performance and represents a long-term test of performance. For awards made in 2004 onwards, there is no re-testing of the performance condition. The condition is reviewed annually. All previous awards have vested without re-testing.
US based director – Lawrence Fish Lawrence Fish's total remuneration package was reviewed in 2004 by the Remuneration Committee as a result of the acquisition of Charter One and his changing RBS responsibilities in North America. In the review the Remuneration Committee confirmed its overall policy in relation to his package is to ensure competitiveness with the market levels of total remuneration for chairmen and executives of US banks of similar size and complexity.
Short term performance rewards will take the form of an annual incentive plan which rewards the achievement of Group, business unit and individual financial and non-financial targets. The normal maximum annual bonus potential will be two times salary, although additional amounts to a maximum of two times salary may be awarded, at the discretion of the Board, for exceptional performance as measured by the achievement of significant objectives.
Long term incentives will consist of the following components: • The two grants made under the Citizens Phantom 2000 Plan vested and will vest on 1 January 2005 and 1 January 2006, respectively. The value of units at the time of vesting is performance-linked and is based on the cumulative economic profit generated by Citizens, the trend in economic profit and on the external market trends in the US banking sector, using price/earnings ratios of comparator US banks. This measure was chosen to establish a clear link between the potential incentive and the performance of Citizens. No other grants will be made under this plan.
• A grant under the new Citizens Long Term Incentive Plan. Performance will be measured on a combination of Growth in Profit before Tax and Relative Return on Equity based on a comparison of Citizens with comparator US banks. The targets for this plan will be set on an annual basis over the three year term of the grant.
In the event that the proposed new Citizens Long Term Incentive Plan is not approved, Mr Fish will participate in existing approved short and long term cash plans already operating in Citizens.
The existing approved Citizens Long Term Incentive Plan is a cash compensation plan designed to reward participants for achieving long-term financial results. A separate three-year cycle commences each year. The maximum award payable to Mr Fish annually is 105 per cent of his average salary over the previous three-year period. Each three-year performance target is based on the annual pre-tax income target for Citizens. For the maximum award to be paid in respect of each three-year target, Citizens must achieve 130 per cent of the three-year aggregate budgeted profit figure. This performance target is measured by taking the pre-tax income for Citizens, which is a simple and transparent method of measuring a profit figure target.
The performance graph The undernoted performance graph illustrates the performance of the company over the past five years in terms of total shareholder return compared with that of the companies comprising the FTSE 100 index. This index has been selected because it represents a cross-section of leading UK companies. The total shareholder return for the company and the FTSE 100 have been rebased to 100 for 1999.
Mr McLuskie* 9 October 1997 60 3 months 3 months The Royal Bank of Scotland plc
Except as noted below, in the event of severance of contract where any contractual notice period is not worked, the employing company may pay a sum to the executive in lieu of this period of notice. Any such payment would, at maximum, comprise base salary and a cash value in respect of fixed benefits (including pension plan contributions). 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 Remuneration Committee may exercise its discretion to allow, the executive to exercise outstanding awards under longterm incentive arrangements. Exceptions to these severance arrangements are as follows: • Gordon Pell was recruited to the board of NatWest from Lloyds Bank plc at a time when NatWest was subject to a contested takeover. His recruitment to take management responsibility for NatWest’s retail operations was seen by the NatWest board at the time as an essential step to strengthen the management of NatWest. The terms of his service contract, which reflected these circumstances, were entered into after consultation with the Takeover Panel as required by The City Code on Takeovers and Mergers. If Mr Pell’s contract is terminated by NatWest without notice, he is entitled to a compensation payment of base salary relating to the contractual 12 months’ notice period, his annual bonus to the date of termination, a payment equal to his average annual bonus over the previous three years, payment in lieu of contractual benefits and allowances including pension and extra payments by way of funded or unfunded pension and death in service contributions relating to the notice period.
The Remuneration Committee has reviewed, with the benefit of legal advice, Mr Pell’s contract, and the circumstances under which it was entered into. As the exceptional severance provisions would apply only if NatWest were to breach the contract by terminating it without notice, the Committee considers that the contract’s terms, entered into in good faith by the NatWest board and Mr Pell, should be honoured.
• If Lawrence Fish's contract is terminated without cause, or if he terminates the contract for good reason (as defined in the contract), he is entitled to a lump sum payment to compensate him for the loss of 12 months salary plus annual bonus. Mr Fish would also be entitled to receive for this period health, life insurance and long term disability coverage and any other benefits determined in accordance with the plans, policies and practices of Citizens at the time of termination. The Remuneration Committee have been advised that these termination provisions are less generous than the current market practice in the US.
Chairman and non-executive directors The original date of appointment as a director of the company and the scheduled date for the next re-election is as follows: Date first appointed Next re-election
Sir George Mathewson 1 September 1987 2007 Lord Vallance 14 January 1993 Retires 20 April 2005 Sir Angus Grossart 30 September 1985 Retires 20 April 2005 Mr Buchan 1 June 2002 2006 Dr Currie 28 November 2001 20 April 2005 Mr Hunter 1 September 2004 20 April 2005 Mr Koch 29 September 2004 20 April 2005 Mr MacHale 1 September 2004 20 April 2005 Miss Mackay 16 May 1996 2006 Mr Robertson 14 January 1993 Retires 20 April 2005 Sir Steve Robson 25 July 2001 20 April 2005 Mr Scott 31 January 2001 2006 Mr Sutherland 31 January 2001 2006
Other than Iain Robertson, the non-executive directors do not have service contracts or notice periods although they have letters of engagement reflecting their responsibilities and commitments. Under the company’s articles of association, all directors must retire by rotation and seek re-election by shareholders at least every three years. No compensation would be paid to the Chairman or to any non-executive director in the event of early termination.
The tables and explanatory notes on pages 130 to 133 report the remuneration of each director for the year ended 31 December 2004 and have been audited by the company’s auditors, Deloitte & Touche LLP.
Vice-chairmen Lord Vallance of Tummel 100 — 100 100 Sir Angus Grossart 100 — 100 100
D ire ct or s’ re m un er a tio n re po rt G
** Mr McLuskie retired from the Group Board on 23 August 2004. The figures quoted above are as at cessation. Subsequently, Mr McLuskie exercised his Sharesave 2001 grant of 335 options, and has since been granted a Sharesave award in 2004 of 439 options.
The executive share options which are exercisable from March 2002 onwards are subject to the satisfaction of an EPS growth target which provides that options are excercisable only if, over a three year period, the growth in the company’s EPS has exceeded the growth in the RPI plus 9%. In respect of executive share options exercisable before March 2002 the performance condition is that the growth in the company’s EPS over three years has exceeded the growth in the RPI plus 6%.
The market price of the company’s ordinary shares at 31 December 2004 was £17.52 and the range during the year to 31 December 2004 was £14.64 to £17.64.
In the ten year period to 31 December 2004, awards made using new issue shares under the company’s share plans represented 4.3% of the company’s issued ordinary share capital, leaving an available dilution headroom of 5.7%.
Market Market Value of Market Share interest End of period Scheme interests Awards price on Awards price on interests Awards price on (share for qualifying
Sir Fred Goodwin 93,040 16.35 93,040 vested 31.12.03 * Awards were granted on 11 April 2002 and vested at 76.29% at the end of the performance period on 31 December 2004.
** The exercise and vesting of awards in 2004 for Mr McLuskie occurred after his retirement from the Board on 23 August 2004. Note: The vesting of option-based awards under the MPP does not trigger any payment to participants. Values shown at the time of vesting in the above table illustrate the potential value of the award at that time. For any awards that have vested, participants holding option-based awards can exercise their right over the underlying share equivalents at any time up to ten years from the date of grant.
No variation was made to any of the terms of the plan during the year. The performance measures are detailed on page 125.
Interests at 1 January 2004 Awards granted during year during year Interests at 31 December 2004
Mr Fish LTIP* awards for the LTIP award for the LTIP award for the LTIP* awards for the 3 year periods: 3 year period: 3 year period: 3 year periods: * Under the cash LTIP, target payment is 60% of average salary over the three year period, maximum payment is 105% of average salary. No variation was made to any of the terms of the plan during the year. The performance measures are detailed on page 126.
Directors’ pension arrangements During the year, Sir Fred Goodwin, Norman McLuskie, Gordon Pell, Iain Robertson and Fred Watt participated in The Royal Bank of Scotland Group Pension Fund (‘the RBS Fund’). The RBS Fund is a defined benefit fund which provides pensions and other benefits within Inland Revenue limits.
As in the 2003 Report and Accounts, disclosure of these benefits has been made in accordance with the Stock Exchange Listing Rules and the Combined Code and with the Directors’ Remuneration Report Regulations 2002.
Transfer value Additional Additional for the additional pension pension Increase pension earned earned in transfer earned
(2) Mr McLuskie retired on 23 August 2004 at his normal pension age. The figures for him above have been calculated as at his retirement date rather than 31 December 2004.
On both 7 January 2005 and 7 February 2005, seven ordinary shares of 25p each were acquired by Sir Fred Goodwin under the Group’s Buy As You Earn share scheme.
Loan notes No director had an interest in loan notes during the year.
This report is made solely to the company’s members, as a body, in accordance with section 235 of the Companies Act 1985. 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 auditors’ 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.
Respective responsibilities of directors and auditors As described in the ‘Statement of directors’ responsibilities’, the company’s directors are responsible for the preparation of the financial statements in accordance with applicable United Kingdom law and accounting standards. They are also responsible for the preparation of the other information contained in the 2004 Annual Report including the directors’ remuneration report. Our responsibility is to audit the financial statements and the part of the directors’ remuneration report described as having been audited in accordance with relevant United Kingdom legal and regulatory requirements and auditing standards.
UK opinion In our opinion the financial statements give a true and fair view of the state of affairs of the company and the Group as at 31 December 2004 and of the profit and cash flows of the Group for the year then ended and the financial statements and the part of the directors’ remuneration report described as having been audited have been properly prepared in accordance with the Companies Act 1985.
US opinion In our opinion, the financial statements present fairly, in all material respects, the financial position of the Group as at 31 December 2004 and 2003 and the results of its operations and its cash flows for each of the three years in the period ended 31 December 2004 in conformity with accounting principles generally accepted in the United Kingdom.
The accounts of the company are prepared in accordance with section 226 of, and Schedule 4 to, the Act and, as permitted by section 230(3) of the Act, no profit and loss account is presented.
The effect of this change of policy on the profit and loss account has been to credit £85 million (2003 – £52 million; 2002 – £201 million) to Other operating income and to increase Administrative expenses – staff costs by £217 million (2003 – £135 million; 2002 – £112 million). Profit before tax has been reduced by £132 million (2003 – £83 million; 2002 – increased by £89 million). A deficit, net of deferred tax, of £1,901 million (2003 – £1,445 million) has been recognised on the balance sheet; Prepayments and accrued income of £1,079 million (2003 – £112 million), Other assets of £654 million (2003 – £735 million) and Accruals and deferred income of £26 million (2003 – £18 million) have been eliminated; the liability for deferred taxation has reduced by £315 million (2003 – £230 million) and the Deferred tax asset (within Other assets) has increased by £19 million (2003 – £20 million). Other provisions have decreased by £73 million (2003 – £43 million) and shareholders’ funds by £3,220 million. A prior year adjustment of £2,001 million is shown in the Statement of consolidated total recognised gains and losses. The prior year adjustment comprises: the recognition of the pension deficit at 31 December 2003 of £1,414 million (£1,968 million less deferred tax of £554 million); the elimination of pension prepayments less accruals of £58 million (net of deferred tax); and the elimination of the pension surplus recognised on the acquisition of NatWest amounting to £529 million (net of deferred tax and amortisation).
Fees in respect of services are recognised as the right to consideration accrues through performance to customers. Services are in respect of financial services related products, the arrangement is generally contractual, the cost of providing this service is incurred as the service is rendered and the price is usually fixed and always determinable. The application of the Group’s policy to significant fee types is outlined below.
Loan origination fees: up-front lending fees are recognised as income when receivable except where they are charged in lieu of interest or charged to cover the cost of a continuing service to the borrower, in which case they are credited to income over the life of the advance.
Commitment and utilisation fees: these are generally determined as a percentage of the outstanding used or unused facility. They are usually charged to the customer in arrears and recognised when charged.
Card related services: fees from credit card business include: Commission received from retailers for processing credit and debit card transactions: income is accrued to the profit and loss account as the service is performed.
5 Pensions and other post-retirement benefits The Group provides retirement benefits, in the form of pensions and healthcare plans, to eligible employees. Defined benefit scheme liabilities are measured on an actuarial basis using the projected unit method and discounted at a rate that equals the current rate of return on a high quality corporate bond of equivalent term and currency to the scheme liabilities. Scheme assets are measured at their fair value. Any surplus or deficit of scheme assets over liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit), net of related notional deferred tax. An asset is only recognised to the extent that the surplus can be recovered through reduced contributions in the future or through refunds from the scheme.
6 Leases Contracts to lease assets and hire purchase agreements are classified as finance leases if they transfer substantially all the risks and rewards of ownership of the asset to the customer. Other contracts are classified as operating leases. Total gross earnings under finance leases are allocated to accounting periods using the actuarial after tax method to give a constant periodic rate of return on the net cash investment. Finance lease receivables are stated in the balance sheet at the amount of the net investment in the lease. Rental income from operating leases is credited to the profit and loss account on a receivable basis over the term of the lease. Balance sheet carrying values of finance lease receivables and operating lease assets include amounts in respect of the residual values of the leased assets. Unguaranteed residual values are subject to regular review to identify potential impairments. Provisions are made for impairment arising on specific asset categories.
Claims (net of reinsurance) are recognised in the accounting period in which the loss occurs. Provision is made for the full cost (net of reinsurance) of settling outstanding claims at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date, and claims handling expenses.
The value placed on the Group’s long-term life assurance business comprises the net assets of the Group’s life assurance subsidiaries, including its interest in the surpluses retained within the long-term assurance funds, and the present value of profits inherent in in-force policies. In calculating the value of in-force policies, future surpluses expected to emerge are estimated using appropriate assumptions as to future mortality, persistency and levels of expenses, which are then discounted at a risk-adjusted rate. Changes in this value, which is determined on a post-tax basis, are included in operating profit, grossed up at the underlying rate of taxation. Long-term assurance assets attributable to policyholders are valued on the following bases: equity shares and debt securities at market price; investment properties and loans at valuation. These assets are held in the life funds of the Group’s life assurance companies, and although legally owned by them, the Group only benefits from these assets when surpluses are declared. To reflect the distinct nature of the long-term assurance assets, they are shown separately on the consolidated balance sheet, as are liabilities attributable to policyholders.
The general provision is made to cover bad and doubtful debts that have not been separately identified at the balance sheet date but are known to be present in any portfolio of advances. The level of general provision is determined in the light of past experience, current economic and other factors affecting the business environment and the Group’s monitoring and control procedures, including the scope of specific provisioning procedures.
Specific and general provisions are deducted from loans and advances. When there is significant doubt that interest receivable can be collected, it is excluded from the profit and loss account and credited to an interest suspense account. Loans and advances and suspended interest are written off in part or in whole when there is no realistic prospect of recovery.
10 Taxation Provision is made for taxation at current enacted rates on taxable profits taking into account relief for overseas taxation where appropriate. Timing differences arise where gains and losses are accounted for in different periods for financial reporting purposes and for taxation purposes. Deferred taxation is accounted for in full for all such timing differences, except in relation to revaluations of fixed assets where there is no commitment to dispose of the asset, taxable gains on sales
A cc ou nt in g po lic ie s of fixed assets that are rolled over into the tax cost of replacement assets, and unremitted overseas earnings. Deferred tax assets are only recognised to the extent that it is considered more likely than not that they will be recovered. Deferred tax amounts are not discounted.
11 Debt securities and equity shares Debt securities and equity shares intended for use on a continuing basis in the Group’s activities are classified as investment securities and are stated at cost less provision for any permanent diminution in value. The cost of dated investment securities is adjusted for the amortisation of premiums or discounts over periods to redemption and the amortisation is included in interest receivable. Other debt securities and equity shares are carried at fair value, with changes in fair value recognised in the profit and loss account.
12 Shares in subsidiary undertakings The company’s shares in subsidiary undertakings are stated in the balance sheet of the company at directors’ valuation that takes account of the subsidiary undertakings’ net asset values.
13 Tangible fixed assets Freehold and long leasehold properties are revalued on a rolling basis, each property being revalued at least every five years. Other tangible fixed assets are stated at cost less depreciation and provisions for impairment. Costs of adapting premises for the use of the Group are separately identified and depreciated.
Tangible fixed assets are depreciated to their residual value over their estimated useful economic lives on a straight-line basis, as follows: Freehold and long leasehold buildings 50 years
Assets on operating leases are depreciated over their estimated useful lives on a straight-line or reverse-annuity basis. Land has an unlimited life and is not depreciated.
Trading Derivatives held for trading purposes are recognised in the accounts at fair value. Gains or losses arising from changes in fair value are included in dealing profits in the consolidated profit and loss account. Fair value is based on quoted market prices. Where representative market prices are not available, the fair value is determined from current market information using appropriate pricing or valuation models. Adjustments are made to quoted market prices where appropriate to cover credit risk, liquidity risk and future operational costs. In the consolidated balance sheet, positive fair values (assets) of trading derivatives are included in Other assets and negative fair values (liabilities) in Other liabilities. Positive and negative fair values of trading derivatives are offset where the contracts have been entered into under master netting agreements or other arrangements that give a legally enforceable right of set-off.
Non-trading Non-trading derivatives are entered into by the Group to hedge exposures arising from transactions entered into in the normal course of banking activities. They are recognised in the accounts in accordance with the accounting treatment of the underlying transaction or transactions being hedged. To be classified as non-trading, a derivative must match or eliminate the risk inherent in the hedged item from potential movements in interest rates, exchange rates or market values. In addition, there must be a demonstrable link to an underlying transaction, pool of transactions or specified future transaction or transactions. Specified future transactions must be reasonably certain to arise for the derivative to be accounted for as a hedge. In the event that a non-trading derivative transaction is terminated or ceases to be an effective hedge, the derivative is re-measured at fair value and any resulting profit or loss amortised over the remaining life of the underlying transaction or transactions being hedged. If a hedged item is derecognised, or a specified future transaction is no longer likely to occur, the related non-trading derivative is remeasured at fair value and the resulting profit or loss taken to the profit and loss account.
15 Sale and repurchase transactions Securities which have been sold with an agreement to repurchase continue to be shown on the balance sheet and the sale proceeds recorded as a deposit. Securities acquired in reverse sale and repurchase transactions are not recognised in the balance sheet and the purchase price is treated as a loan. The difference between the sale price and repurchase price is accrued evenly over the life of the transaction and charged or credited to the profit and loss account as interest payable or receivable.
Consolidated profit and loss account for the year ended 31 December 2004 2004 2003* 2002* Note £m £m £m
Additional Value Shares dividend – non-equity 6 — 1,463 798 Profit attributable to ordinary shareholders 4,256 2,254 2,034
Per 25p ordinary share: Additional Value Shares dividend — 49.9p 27.7p
Profit on ordinary activities before taxation and the retained profit for the year on a historical cost basis were not materially different from the reported amounts.
C on so lid a te d ba la nc e sh ee t 2004 2003* Note £m £m
Intangible fixed assets 19 17,576 13,131 Tangible fixed assets 20 16,294 13,927 Settlement balances 5,682 2,857
Long-term assurance assets attributable to policyholders 22 3,800 3,557 Total assets 583,467 454,428
Liabilities Deposits by banks 23 99,081 67,323 Items in the course of transmission to other banks 802 958
Called up share capital 33 822 769 Share premium account 34 12,964 8,175
Long-term assurance liabilities attributable to policyholders 22 3,800 3,557 Total liabilities 583,467 454,428
Commitments (standby facilities, credit lines and other) 41 180,777 139,693 * restated (see page 139)
The accounts were approved by the Board of directors on 23 February 2005 and signed on its behalf by: Sir George Mathewson Sir Fred Goodwin Fred Watt Chairman Group Chief Executive Group Finance Director
S ta te m en t of co ns ol id a te d to ta l r ec og ni se d ga in s an d lo ss es
R ec on ci lia tio n of m ov em en ts in c on so lid a te d sh ar eh ol de rs ’f un ds
Statement of consolidated total recognised gains and losses for the year ended 31 December 2004 2004 2003* 2002* £m £m £m
Actuarial (losses)/gains (1,598) 69 (2,392) Current tax relief 56 — — Deferred tax asset/(liability) 408 (33) 700 Actuarial (losses)/gains recognised in post-retirement benefit schemes (1,134) 36 (1,692)
Currency translation adjustments and other movements (399) 48 37 Revaluation of premises 56 (69) (33) Other recognised (losses)/gains (343) (21) 4
Total recognised gains and losses in the year 2,779 2,269 346 Prior year adjustment arising from the implementation of FRS 17 (2,001) Total recognised gains and losses since 31 December 2003 778 2004 2003* 2002* £m £m £m
Opening shareholders’ funds as previously reported 28,099 27,052 26,668 Prior year adjustment arising from the implementation of FRS 17 (2,001) (1,981) (353) Opening shareholders’ funds as restated 26,098 25,071 26,315 Net increase/(decrease) in shareholders funds 5,767 1,027 (1,244) Closing shareholders’ funds 31,865 26,098 25,071 * restated (see page 139)
Consolidated cash flow statement for the year ended 31 December 2004
Interest paid on subordinated liabilities (613) (557) (674) Net cash outflow from returns on investments and servicing of finance (1,070) (2,419) (1,901) Taxation UK tax paid (812) (933) (833) Overseas tax paid (582) (521) (274) Net cash outflow from taxation (1,394) (1,454) (1,107) Capital expenditure and financial investment Purchase of investment securities (41,790) (44,861) (32,701) Sale and maturity of investment securities 43,022 41,805 26,072 Purchase of tangible fixed assets (4,354) (5,017) (3,367) Sale of tangible fixed assets 1,596 1,108 811 Net cash outflow from capital expenditure and financial investment (1,526) (6,965) (9,185) Acquisitions and disposals Purchase of businesses and subsidiary undertakings
(net of cash acquired) 44 (7,648) (1,748) (308) Investment in associated undertakings (48) (2) (2) Sale of subsidiary and associated undertakings
(2) Includes equities, equity derivatives, commodity contracts and related hedges and funding.
2 Administrative expenses – staff costs 2004 2003* 2002* £m £m £m
The average number of persons employed by the Group during the year, excluding temporary staff, was 133,300 (2003 – 119,500; 3 Pension costs
The total net pension costs are included in the profit and loss account as follows: £m £m £m
Other operating income (85) (52) (201) Staff costs – pension costs (see Note 2) 506 408 344 Total net pension costs 421 356 143
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts
For the purposes of FRS 17, interim valuations of the Group’s schemes were prepared to 31 December by independent actuaries, using the following assumptions: Main UK Other Group Main UK Other Group Main UK Other Group scheme schemes* scheme schemes* scheme schemes*
Rate of increase in salaries (per annum) 3.95% 3.6% 3.95% 3.8% 3.50% 3.2% Rate of increase in pensions in payment (per annum) 2.70% 2.5% 2.70% 2.3% 2.25% 1.7%
The assets and liabilities of the schemes were as follows: Main UK Other Group Main UK Other Group Main UK Other Group scheme schemes scheme schemes schemes schemes £m £m £m £m £m £m
Total market value of assets 13,598 1,229 11,822 1,065 10,682 1,010 Present value of scheme liabilities (16,051) (1,626) (13,594) (1,261) (12,418) (1,130) Net deficit in the schemes (2,453) (397) (1,772) (196) (1,736) (120)
The assumptions for long-term rates of return on the principal classes of assets at 31 December 2004 were equities 8.1%, gilts 4.5%, other bonds 5.4%, property 6.3% and cash and other assets 4.6% (2003 – equities 8.4%, gilts 4.8%, other bonds 5.6%, property 6.6% and cash and other assets 4.9%; 2002 – equities 8.4%, gilts 4.5%, other bonds 5.75%, property 6.5% and cash 4.5%).
Amount recognised in the statement of consolidated total recognised gains and losses £m £m £m
Movement in pension schemes (deficits) /surpluses during the year £m £m £m
Deficit in schemes at 31 December (2,850) (1,968) (1,856) Deferred tax asset 983 554 541 Net pension deficit (1,867) (1,414) (1,315) Other unfunded liabilities (net) (34) (31) (26) Post-retirement benefit liabilities (1,901) (1,445) (1,341)
Following the latest formal valuation carried out by independent actuaries as at 31 March 2004, the contribution rate with effect from 1 April 2004 for the main UK scheme is 21.5% of pensionable salaries (2003 and 2002 – 6.8% based on the valuation as at 31 March 2001). Contributions for 2004 include a lump sum of £750 million paid into the Main Fund in addition to the monthly contributions.
Auditors’ remuneration Amounts paid to the auditors for statutory audit and other services were as follows: £m £m
The auditors’ remuneration for statutory audit work for the company was £0.1 million (2003 – £0.1 million). Non–audit fees paid to the auditors and their associates in the UK was £6.4 million (2003 – £6.2 million).
Current taxation: UK corporation tax charge for the year at 30% 1,305 1,095 909 Over provision in respect of prior periods (66) (66) (13) Relief for overseas taxation (212) (211) (26)
Overseas taxation: Current year charge 786 538 370 Over provision in respect of prior periods (102) (11) (2)
Share of associated undertakings 11 2 2 Current tax charge for the year 1,722 1,347 1,240 Deferred taxation: Origination and reversal of timing differences 482 576 398 Over provision in respect of prior periods (49) (35) (56) Tax charge for the year 2,155 1,888 1,582
Contributions to employee share schemes (32) (35) (40) Non-deductible items 227 248 179 Non-taxable items (251) (207) (188) Capital allowances in excess of depreciation (415) (626) (340) Taxable foreign exchange movements (10) 5 4 Foreign profits taxed at other rates 49 26 2 Unutilised losses brought forward and carried forward 6 (15) — Current taxation adjustments relating to prior periods (168) (77) (15) Current tax charge for the year 1,722 1,342 1,241 Deferred taxation: Origination and reversal of timing differences 482 581 397 Adjustments in respect of prior periods (49) (35) (56) Actual tax charge 2,155 1,888 1,582
(3) The fair values of certain financial assets are disclosed in Note 40. The tax that could be payable if these assets were disposed of at the values shown is estimated at £910 million (2003 – £561 million). Because of the nature of these financial assets which are held as part of the banking business, it is not possible to determine the amount that may become payable in the foreseeable future.
(5) No provision has been made for deferred tax on certain gains realised on disposals of property and other assets as there is an expectation of rolling over such gains into replacement assets. Expenditure to date on valid replacement assets together with forecasts of future such expenditure indicate that these gains will be available for rollover relief. The tax that could be payable if the conditions for rollover relief were not met is estimated at £16 million (2003 – £68 million).
Notes: (1) Dividends for the year ended 31 December 2004 amounted to £55,000 (2003 and 2002 – £55,000).
(2) Dividends for the year ended 31 December 2004 amounted to £22,000 (2003 and 2002 – £22,000).
Total dividends on equity shares 58.0 50.3 43.7 1,837 1,490 1,267 8 Profit dealt with in the accounts of the company Of the profit attributable to shareholders, £2,878 million (2003 – £2,619 million; 2002 – £1,955 million) has been dealt with in the accounts of the company.
Treasury and other eligible bills are principally of short-term maturity and their market value is not materially different from carrying value.
– three months or less 89,784 64,281 – one year or less but over three months 38,461 27,465 – five years or less but over one year 53,543 40,908 – over five years 116,669 98,952
The cost of assets acquired during the year for the purpose of letting under finance leases and hire purchase agreements was
The Group’s exposure to risk from its lending activities is widely diversified both geographically and industrially. Lending to the services sector, house mortgage lending, loans to financial institutions, other personal loans and lending to property companies exceeded 10% of total loans and advances to customers (before provisions).
Residual value exposures The table below gives details of the unguaranteed residual values included in the carrying value of finance lease receivables (see above) and operating lease assets (see Note 20).
After 1 year After 2 years Within but within but within After 1 year 2 years 5 years 5 years Total 2003 £m £m £m £m £m
Linked presentation (i) Leveraged leases – as part of the purchase of Charter One, the Group acquired a portfolio of lease receivables that qualify as leveraged leases under US GAAP. Leveraged leases involve the Group as lessor obtaining non-recourse funding from third parties. This financing is secured on the underlying leases and the provider of the finance has no recourse whatsoever to the other assets of the Group. The Group is not obliged, and does not intend, to support losses that may be suffered by these third-party providers of funding. They have agreed in writing that they will be paid, as to interest and principal, only out of lease cash flows. At 31 December 2004, the gross value of leveraged leases amounted to £1,897 million and non-recourse financing received was £1,502 million. During the year the Group recognised net income of £13 million comprising interest receivable of £35 million less interest payable and other expenses of £22 million.
Specific General Total Specific General Total £m £m £m £m £m £m
Loans and advances on which interest is being placed in suspense: – before specific provisions 2,558 1,938 – after specific provisions 1,203 930
Loans and advances on which interest is not being applied: – before specific provisions 2,225 2,494 – after specific provisions 850 980
(iii) Securitisation of housing association loans – the Group has arranged the securitisation of housing association loans. The loans were acquired by special purpose vehicles, held ultimately by charitable trusts, funded principally through the issue of floating and fixed rate notes. The Group is not obliged, and does not intend, to support losses that may be suffered by the note holders. The note holders have agreed that they will be paid, as to interest and principal, only to the extent that sufficient funds are generated by the loans and their underlying security. Any proceeds from the loans in excess of the amounts required to service and repay the notes are payable to the Group after deduction of expenses. At 31 December 2004, gross loans amounted to £1,412 million (2003 – £1,450 million) and notes held by third parties were £1,012 million (2003 – £861 million).
(iv) Mortgage banking activities - the Group sells originated mortgage loans to US Agencies in return for securities backed by these loans and guaranteed by the Agency whilst retaining the rights to service the mortgages. These securities may be subsequently sold. The purchaser has recourse to the Group for losses up to pre-determined levels on certain designated mortgages. The Group is not obliged, and does not intend, to support losses that may be suffered by the Agencies. Under the terms of the sale agreements, the Agencies have agreed to seek repayment only from the cash from the mortgage loans. Once the securities exchanged for the loans have been sold the Group's exposure is restricted to the amount of the recourse and the transaction qualifies for the linked presentation. At 31 December 2004 mortgages amounting to £472 million had been sold with recourse and the related securities sold. Recourse is limited to a maximum of £6 million. No amounts were recognised in the profit and loss account except for income from the servicing of the mortgages.
Investment securities: Other debt securities: Banking business 36,485 42,374 Trading business 54,726 37,575 Amounts above include: Subordinated debt securities 664 890 Unamortised discounts less premiums on investment securities 1 3
US treasury and other US government 254 1.4 326 2.2 944 2.6 11,185 3.0 12,709 3.0
Gross gains of £101 million (2003 – £158 million) and gross losses of £30 million (2003 – £47 million) were realised on the sale and redemption of investment debt securities.
The cost of securities carried at market value is not disclosed because it cannot be determined without unreasonable expense.
Amounts written off (10) 10 –– Provisions made net of write backs –– (12) (12)
N ot es o n th e ac co un ts Notes on the accounts continued 17 Shares in Group undertakings Movements in shares in Group undertakings during the year were as follows: £m
The principal subsidiary undertakings of the company are shown below. Their capital consists of ordinary and preference shares which are unlisted with the exception of certain preference shares issued by NatWest. The Royal Bank and RBS Insurance Group Limited are directly owned by the company, and all of the other subsidiary undertakings are owned directly, or indirectly through intermediate holding companies, by these companies and are all wholly-owned. All of these subsidiaries are included in the Group’s consolidated financial statements and have an accounting reference date of 31 December.
The Royal Bank of Scotland plc Banking Great Britain National Westminster Bank Plc (1) Banking Great Britain Citizens Financial Group, Inc. Banking US Coutts & Co (2) Private banking Great Britain Greenwich Capital Markets, Inc. Broker dealer US RBS Insurance Group Limited Insurance Great Britain Ulster Bank Limited (3) Banking Northern Ireland
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts 18 Loans to Group undertakings
Amortisation: Currency translation and other adjustments (35) Charge for the year 915 Disposals (4)
Net book value of assets held under finance leases 18 90
Depreciation for the year of assets held under finance leases 2 20
Trading derivatives (see Note 39) 17,884 14,087 *restated (see page 139)
The increase in the shareholders’ interest in the long-term assurance business included in the profit and loss account is calculated as follows: £m £m
– three months or less 53,296 42,300 – one year or less but over three months 10,474 2,268 – five years or less but over one year 3,675 122 – over five years 1,357 1,638
N ot es o n th e ac co un ts Notes on the accounts continued 24 Customer accounts £m £m
Repayable on demand 193,988 160,574 With agreed maturity dates or periods of notice, by remaining maturity
Settlement balances 4,067 2,241 Short positions: Debt securities – Government 24,619 16,631 Debt securities – Other issuers 4,002 2,423 Treasury bills and other eligible bills 302 74 27 Other liabilities £m £m
Notes in circulation 1,351 1,394 Trading derivatives (see Note 39) 19,034 15,173 Current taxation 677 700
As previously reported 2,238 Prior year adjustment arising on implementation of FRS 17 (250) At 1 January 2004 as restated 1,988 Currency translation and other adjustments (66) Acquisition of subsidiaries 514 Disposal of lease receivables (43) Charge to profit and loss account 433
29 Other provisions Pensions and other similar Property(1) obligations Other(2) Total £m £m £m £m
Acquisition of subsidiaries — — 12 12 Charge to profit and loss account 18 — 2 20
Notes: (1) The Group has a number of leasehold properties where rents payable and other unavoidable costs exceed the value to the Group. Such costs arise over the period of the lease or to the expected termination date, and the provision has been discounted due to the long-term nature of certain of these obligations.
N ot es o n th e ac co un ts Notes on the accounts continued 30 Dated loan capital £m £m
The company £200 million floating rate (minimum 5.25%) notes 2005 (1,2) 40 80
DEM500 million (redesignated €255 million) 5.25% subordinated notes 2008 180 180
US$500 million floating rate subordinated notes 2016 (issued October 2004; callable October 2011) (10) 258 — €500 million 4.5% subordinated notes 2016 (callable January 2011) 351 351 €100 million floating rate subordinated notes 2017 71 70 US$125.6 million floating rate subordinated notes 2020 65 70 €1,000 million 4.625% subordinated notes 2021 (issued September 2004; callable September 2016) (11) 695 —
US$35 million 7.24% subordinated bonds 2012 (callable December 2007) 22 — £60 million 6.375% subordinated bonds 2018 (callable April 2013) 65 —
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts £m £m
Dated loan capital in issue, by remaining maturity is repayable as follows: – in one year or less 371 709 – in two years or less but over one year 355 388 – in five years or less but over two years 3,035 1,337 – in more than five years 7,252 6,878 * In addition, the company issued 1.25 million subordinated loan notes of €1,000 each in June 2002, 750,000 subordinated loan notes of US$1,000 each in December 2002, 850,000 subordinated loan notes of US$1,000 each in May 2003, 650,000 subordinated loan notes of US$1,000 each in December 2003, 1.5 million subordinated loan notes of US$1,000 each in August 2004 and 450,000 subordinated loan notes of US$1,000 each in September 2004 to subsidiaries of the Group. These loan notes are included in the company balance sheet within loan capital but are reclassified as non-equity minority interests on consolidation (see Note 32).
(17) In the event of certain changes in the tax laws of the UK, all of the dated loan capital issues are redeemable in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior approval of the UK Financial Services Authority.
N ot es o n th e ac co un ts Notes on the accounts continued 31 Undated loan capital including convertible debt 2004 2003 £m £m
The company US$350 million undated floating rate primary capital notes (callable on any interest payment date) (1,2) 181 196 US$200 million 8.5% exchangeable capital securities, Series A (callable June 2004) (1,3) 103 112 US$50 million undated 7.993% capital securities (callable November 2005) (1) 26 28 US$35 million undated 7.755% capital securities (callable December 2005) (1) 18 19 US$200 million undated 7.375% reset capital securities (callable April 2006) (1) 103 112 US$75 million floating rate perpetual capital securities (callable September 2007) (1) 39 42 US$850 million 5.75% exchangeable capital securities, Series B (4) — 464 US$1,200 million 7.648% perpetual regulatory tier one securities (callable September 2031) (1,5) 615 666
The Royal Bank of Scotland plc £125 million 9.25% undated subordinated step-up notes (callable April 2006) 125 125 £150 million undated subordinated floating rate step-up notes (callable March 2007) 150 150 FRF1,000 million (redesignated €152 million) 5.875% undated subordinated notes (callable October 2008) 107 107 £175 million 7.375% undated subordinated notes (callable August 2010) 174 173 £350 million 6.25% undated subordinated notes (callable December 2012) 348 348 €500 million 5.125% subordinated notes (issued July 2004; callable July 2014) (6) 350 — €1,000 million floating rate subordinated notes (issued July 2004; callable July 2014) (7) 701 — £500 million 6.0% subordinated notes (issued June 2004; callable September 2014) (8) 496 — £500 million 5.125% undated subordinated notes (callable March 2016) 491 491 £200 million 9.5% undated subordinated bonds (callable August 2018) (9) 198 198 £600 million 5.5% subordinated notes (issued December 2004; callable December 2019) (10) 595 — £500 million 6.2% undated subordinated notes (callable March 2022) 497 497 £300 million 5.625% undated subordinated notes (callable September 2026) 298 298 £200 million 5.625% undated subordinated notes (callable September 2026) 210 211 £400 million 5.625% undated subordinated notes (callable September 2026) 397 396 £350 million 5.625% undated subordinated notes (callable June 2032) 346 346 £150 million 5.625% undated subordinated notes (callable June 2032) 144 144 JPY25 billion 2.605% subordinated notes (issued November 2004; callable November 2034) (11) 126 ––
£20 million 11.75% perpetual tier two capital 24 — IR£30 million 11.375% perpetual tier two capital 38 — £1.3 million floating rate perpetual tier two capital 2 —
(13) Exchangeable at the option of the issuer into 200 million 8.392% (gross) non-cumulative preference shares of £1 each of National Westminster Bank Plc at any time.
(16) Except as stated above, interest payable on Group floating rate undated issues is at a margin over London interbank rates. Interest on £4,875 million, US$1,668 million, €1,052 million and JPY25 billion of fixed rate undated issues is swapped into floating rates at a margin over London interbank rates.
Non-equity shares issued by NatWest: Non-cumulative preference shares of US$25 (1) 278 299 Non-cumulative preference shares of £1 (2) 166 166
Non-equity shares issued by other subsidiaries: Non-cumulative trust preferred securities of €1,000 (3) 875 875 Non-cumulative trust preferred securities of US$1,000 (3) 2,152 1,245 Other non-equity minority interests 200 139
The US$300 million non-cumulative preference shares, Series C, of US$25 each carry a gross dividend of 8.625% inclusive of associated tax credit. They are redeemable at the option of NatWest from 9 April 2002 to 8 April 2008 inclusive, at a premium per share of US$0.60 in 2005 reducing by US$0.30 in each successive year. There is no redemption premium if the date of redemption falls after 8 April 2007.
(3) Wholly-owned subsidiaries of the Group have issued the following non-cumulative trust preferred securities: Number Distribution Redemption of securities rate per Distribution Redemption date price per
Trust preferred securities of €1.000 1,250,000 6,467% Annually 30 June 2012 €1,000 Trust preferred securities of US$1.000 750,000 6.8% Quarterly 31 March 2008 US$1,000 Trust preferred securities of US$1.000 850,000 4.709% Semi-annually 1 July 2013 US$1,000 Trust preferred securities of US$1.000 650,000 6.425% Semi-annually 3 January 2034 US$1,000 Trust preferred securities of US$1.000* 950,000 5.512% Semi-annually 30 September 2014 US$1,000 Trust preferred securities of US$1.000* 1,000,000 0.80% above Quarterly 30 September 2014 US$1,000 three month US$ LIBOR
Non-cumulative preference shares of £1 — — — 300 300 Total non-equity share capital 2 — 2 555 555
N ot es o n th e ac co un ts Notes on the accounts continued 33 Share capital (continued) Allotted, called up and fully paid Authorised
Non-equity shares Additional Value Shares of £0.01 — — 2,700,000 2,700,000 Non-cumulative preference shares of US$0.01 153,000 82,000 348,500 238,500 Non-cumulative convertible preference shares of US$0.01 1,900 1,900 3,900 3,900 Non-cumulative preference shares of €0.01 1,250 — 66,000 66,000 Non-cumulative convertible preference shares of €0.01 750 750 3,000 3,000 Non-cumulative convertible preference shares of £0.25 — — 900,000 900,000 Non-cumulative convertible preference shares of £0.01 200 200 1,000 1,000
Ordinary shares The following issues of ordinary shares were made during the year to 31 December 2004: (a) 165 million ordinary shares were placed at an issue price of £16.20 per share; (b) 12.9 million ordinary shares following the exercise of options under the company’s executive, sharesave and option 2000 schemes and a further 5.6 million ordinary shares in respect of the exercise of options under the NatWest executive and sharesave schemes which had been exchanged for options over the company’s shares following the acquisition of NatWest; (c) 23.4 million ordinary shares in lieu of cash in respect of the final dividend for the year ended 31 December 2003 and the interim dividend for the year ended 31 December 2004; and
(d) 2.4 million ordinary shares under the company’s profit sharing (share ownership) scheme.
During the year to 31 December 2004, options were granted over 16.7 million ordinary shares under the company’s executive, sharesave and option 2000 schemes. At 31 December 2004, options granted under the company’s various schemes, exercisable up to 2014 at prices ranging from 461p to 1841p per share, were outstanding in respect of 70.1 million ordinary shares.
In addition, options granted under the NatWest schemes were outstanding in respect of 1.6 million ordinary shares exercisable up to 2009 at prices ranging from 373p to 924p per share. As permitted by UITF 17 ‘Employee share schemes’ applicable to SAYE schemes, no cost has been recognised in respect of sharesave options.
In September 2004, the company exchanged all of the outstanding US$850 million 5.75% exchangeable capital securities, Series B, into 34 million Series L non-cumulative preference shares of US$0.01 each, at US$25 per share.
Non-cumulative preference shares of US$0.01 Series D 7 million 14 September 2005 US$25.00 Series E 8 million 17 October 2006 US$25.00 Series F 8 million 31 March 2007 US$25.00 Series G 10 million 31 March 2003 US$25.00 Series H 12 million 31 March 2004 US$25.00 Series I 12 million 30 September 2004 US$25.00 Series J 9 million 31 December 2004 US$25.00 Series K 16 million 30 June 2006 US$25.00 Series L 34 million 30 September 2009 US$25.00 Series M 37 million 30 September 2009 US$25.00
Non-cumulative convertible preference shares of €0.01 Series 1 0.75 million 31 March 2005 €1,000 Non-cumulative preference shares of €0.01 Series 1 1.25 million 31 December 2009 €1,000 Non-cumulative convertible preference shares of £0.01 Series 1 0.2 million 31 December 2010 £1,000
In the event that the non-cumulative convertible preference shares are not redeemed on or before the redemption date, the holder may convert the non-cumulative convertible preference shares into ordinary shares in the company.
Exchange gains of £1,024 million (2003 – £604 million) arising on foreign currency borrowings have been offset in the Group’s profit and loss account reserves against differences on retranslating the net investment in overseas subsidiary and associated undertakings financed by these borrowings.
shares of 25p each of the company were held by the 1992 Employee Share Trust and 63,098 (2003 – nil) ordinary shares of 25p each were held by the 2001 Employee Share Trust in respect of options under the executive option scheme and awards under the medium term performance plan.
The Group The Group The Group The company £m £m £m £m
Merger reserve At 1 January 10,881 11,455 12,029 — Transfer to profit and loss account (574) (574) (574) —
Currency translation adjustments and other movements (409) 38 28 (1) Retention for the year 2,419 764 767 785 Employee share option payments — — (136) — Redemption of preference shares — (364) (332) — Actuarial (losses)/gains recognised in post-retirement benefit schemes (1,134) 36 (1,692) — Own shares held in relation to employee share schemes (7) — — (7) Goodwill previously written off — 40 — — Transfer from merger reserve 574 574 574 — Transfer of increase in value of long-term life assurance business (38) (32) (25) — Transfer (to)/from revaluation reserve (29) 4 — —
Non-cumulative preference shares of US$0.01 1,951 1,140 Non-cumulative convertible preference shares of US$0.01 978 1,058 Non-cumulative preference shares of €0.01 864 – Non-cumulative convertible preference shares of €0.01 529 528 Non-cumulative convertible preference shares of £0.01 197 196 Cumulative preference shares of £1 1 1 35 Lease commitments The annual rental commitments of the Group under non-cancellable operating leases were as follows: Premises Equipment Premises Equipment £m £m £m £m
Expiring within one year 10 3 7 6 Expiring between one and five years 57 12 39 9 Expiring after five years 201 45 200 1 36 Analysis of total assets and liabilities £m £m
Liabilities: denominated in sterling 271,410 233,493 denominated in currencies other than sterling 312,057 220,935 37 Collateral given and received under repurchase transactions The Group enters into securities repurchase agreements and securities lending transactions under which it receives or transfers cash or securities as collateral in accordance with normal market practice. Securities transferred under repurchase transactions included within securities on the balance sheet were as follows: £m £m
Included above are assets pledged with overseas government agencies and banks, and margin deposits placed with exchanges.
Deposits by banks 5,628 3,000 Customer accounts 2,001 92 Debt securities in issue 1,522 1,550 39 Derivatives In the normal course of business, the Group enters into a variety of derivative transactions principally in the foreign exchange and interest rate markets. These are used to provide financial services to customers and to take, hedge and modify positions as part of trading activities. Derivatives are also used to hedge or modify risk exposures arising on the balance sheet from a variety of activities including lending and securities investment.
Options Currency and interest rate options confer the right, but not the obligation, on the buyer to receive or pay a specific quantity of an asset or financial instrument for a specified price at or before a specified date. Options may be exchange traded or OTC agreements. The Group principally buys and sells currency and interest rate options.
Maturity of replacement cost of over-the-counter contracts (trading and non-trading) Replacement cost indicates the Group’s derivatives credit exposure. The following table sets forth the gross positive fair values by maturity. The net replacement cost of internal trades is not included as there is no credit risk associated with them.
Within One to Two to Over 2004 Within One to Two to Over 2003 one year two years five years five years Total one year two years five years five years Total £m £m £m £m £m £m £m £m £m £m
Options purchased 5,797 –– 4,620 — Options written — 5,324 — 4,295
Interest rate contracts: Options purchased 3,168 –– 2,799 — Options written — 3,274 — 2,829
Gains and losses on exchange traded contracts subject to daily margining requirements are settled daily. The fair value of such contracts included above reflects the last day’s variation margin.
The following table analyses, by maturity and contract type, the notional principal amounts of the Group’s trading derivatives: Within One to Two to Over 2004 Within One to Two to Over 2003 one year two years five years five years Total one year two years five years five years Total £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
Within but within but within but within After bearing book book 3 months 6 months 1 year 5 years 5 years funds total total Total 2004 £m £m £m £m £m £m £m £m £m
Assets Loans and advances to banks 14,645 5,140 1,367 77 482 643 22,354 35,906 58,260 Loans and advances to customers 189,366 16,202 11,379 35,370 28,612 2,304 283,233 62,236 345,469 Treasury bills and debt securities 11,912 4,088 3,656 6,133 13,548 337 39,674 57,647 97,321
N ot es o n th e ac co un ts Notes on the accounts continued 40 Financial instruments (continued) After After After 3 months 6 months 1 year Non-interest Banking Trading Within but within but within but within After bearing book book 3 months 6 months 1 year 5 years 5 years funds total total Total 2003* £m £m £m £m £m £m £m £m £m
Currency risk The Group does not maintain material non-trading open currency positions other than the structural foreign currency translation exposures arising from its investment in overseas subsidiary and associated undertakings and their related funding.
Functional currency of net investment £m £m £m £m £m £m
Trading book market risk An explanation of the value-at-risk (“VaR”) methodology of estimating potential losses arising from the Group’s exposure to market risk in its trading book and the main assumptions and parameters underlying it is given in ‘Risk management – market risk’ in the Operating and financial review.
Assets Treasury bills and other eligible bills (1) 2,921 2,921 1,869 1,869 Loans and advances to banks and customers (1) 98,142 98,142 59,608 59,608
Assets Cash and balances at central banks (1) 4,293 4,293 3,822 3,822 Items in the course of collection from other banks (1) 2,629 2,629 2,501 2,501 Treasury bills and other eligible bills (1) 3,189 3,189 2,977 2,977 Loans and advances to banks and customers (4) 305,587 307,805 244,814 246,244
Liabilities Items in the course of transmission to other banks (1) 802 802 958 958 Deposits by banks and customer accounts (3) 303,328 303,210 251,986 252,360
Notes: (1) Financial assets and financial liabilities carried at fair value or where carrying value approximates to fair value because they are of short maturity or repricing date.
(3) The fair value of deposits repayable on demand is equal to their carrying value. The fair values of term deposits and time certificates of deposit are estimated by discounting expected future cash flows using rates currently offered for deposits of similar remaining maturities.
(6) The fair value of short-term debt securities in issue is approximately equal to their carrying value. The fair value of other debt securities in issue is based on quoted market prices where available, or where these are unavailable, is estimated using other valuation techniques.
(8) Fair values are not given for financial commitments and contingent liabilities. The diversity of the fee structures, the lack of an established market and the difficulty of separating the value of the instruments from the value of the overall relationship involve such uncertainty that it is not meaningful to provide an estimate of their fair value. (The principal amounts of these instruments are given in Note 41).
N ot es o n th e ac co un ts Notes on the accounts continued 40 Financial instruments (continued)
Unrecognised Deferred Unrecognised Deferred gains and gains and gains and gains and losses losses losses losses £m £m £m £m
Recognised gains that arose in previous periods (781) (65) (659) (72) Recognised losses that arose in previous periods 537 4 636 12 Unrecognised gains and losses arising in the year 224 — (208) — Unrecognised gains and losses deferred in the year 61 (61) 2 (2) Unrecognised gains and losses deferred and taken to profit and loss in the year — (30) — —
Gains expected to be recognised in the year to 31 December 2005 (year to 31 December 2004) 318 171 532 66
Gains expected to be recognised in the year to 31 December 2006 or later (year to 31 December 2005 or later) 1,253 312 1,704 147
Losses expected to be recognised in the year to 31 December 2005
41 Memorandum items Contingent liabilities and commitments The amounts shown in the table below are intended only to provide an indication of the volume of business outstanding at 31 December. Although the Group is exposed to credit risk in the event of non-performance of the obligations undertaken by customers, the amounts shown do not, and are not intended to, provide any indication of the Group’s expectation of future losses.
Contingent liabilities: Acceptances and endorsements 362 595 Guarantees and assets pledged as collateral security 10,438 8,787 Other contingent liabilities 5,293 5,482
Commitments: Documentary credits and other short-term trade related transactions 182 605 Undrawn formal standby facilities, credit lines and other commitments to lend
Endorsements – in endorsing a bill of exchange a bank accepts liability for payment of any shortfall on the bill at maturity. Unlike acceptances, the endorsing bank receives value for the bill, which is then rediscounted.
Guarantees – the Group gives guarantees on behalf of customers. A financial guarantee represents an irrevocable undertaking that the Group will meet a customer’s obligations to third parties if the customer fails to do so. The maximum amount that the Group could be required to pay under a guarantee is its principal amount as disclosed in the table above. The Group expects most guarantees it provides to expire unused.
Commitments to lend – under a loan commitment the Group agrees to make funds available to a customer in the future. Loan commitments, which are usually for a specified term may be unconditionally cancellable or may persist, provided all conditions in the loan facility are satisfied or waived. Commitments to lend include commercial standby facilities and credit lines, liquidity facilities to commercial paper conduits and unutilised overdraft facilities.
Other commitments – these include forward asset purchases, forward forward deposits placed and undrawn note issuance and revolving underwriting facilities.
N ot es o n th e ac co un ts Notes on the accounts continued 42 Acquisitions The Group made a number of acquisitions during the year, all of which were accounted for using acquisition accounting principles.
Cash and balances at central banks 330* — 330 Loans and advances to customers 18,287 (274) 18,013
Equity shares 381 — 381 Tangible fixed assets 699 — 699
Satisfied by: Payment of cash 5,611 Fees and expenses relating to the acquisition 12 * Reduced by £307 million (US$553 million) paid out by Charter One immediately prior to closing principally in respect of the buyout of employee stock options. Gross of this amount, consideration was £5,930 million (US$10,677 million) and the book value of net assets acquired £1,627 million (US$2,929 million).
(b) Other acquisitions The provisional fair values of the assets and liabilities of all other acquisitions made during the year and the consideration paid are shown in the table below: Book value of net assets Fair value Fair value to acquired adjustments the Group At respective dates of acquisition £m £m £m
Cash and balances at central banks 106 2 108 Loans and advances to banks 768 — 768 Loans and advances to customers 5,491 (70) 5,421
Net interest income 165 Non-interest income 88 Total income 253 Operating expenses (125) Operating profit 128 Provisions (42) Contribution before goodwill amortisation 86 Goodwill amortisation (45) Contribution 41 * From the dates of acquisition. The contribution above is after charging goodwill amortisation and includes the post-acquisition effect of fair value adjustments.
Increase in prepayments and accrued income (1,609) (514) (636) Interest on subordinated liabilities 681 551 659 Increase in accruals and deferred income 2,300 1,455 872 Amortisation of and provisions against investment securities 92 60 99 Provisions for bad and doubtful debts 1,428 1,461 1,286 Loans and advances written off net of recoveries (1,321) (1,447) (973) Profit on sale of tangible fixed assets (69) (30) (32) Profit on sale of subsidiaries and associates (4) (63) (13) Profit from associated undertakings (35) (12) (2) Profit on sale of investment securities (167) (172) (85) Charge for pensions 381 330 127
N ot es o n th e ac co un ts Fi na nc ia l st at em en ts 44 Analysis of the net outflow of cash in respect of the purchase of businesses and subsidiary undertakings £m £m £m
(including share premium) Loan capital £m £m £m £m £m £m
Cash and balances at central banks 4,293 3,822 3,481 Loans and advances to banks repayable on demand 19,430 17,115 6,792
Certain subsidiary undertakings are required to maintain balances with the Bank of England which, at 31 December 2004, amounted to £260 million (2003 – £231 million). Certain subsidiary undertakings are required by law to maintain reserve balances with the Federal Reserve Bank in the US. Such reserve balances amounted to US$132 million at 31 December 2004 (2003 – US$190 million).
Net and other ordinary interest Non-interest Total operating activities income income income charges Provisions* before tax 2004 £m £m £m £m £m £m
Profit before goodwill amortisation and integration costs 9,208 13,546 22,754 (13,142) (1,511) 8,101 Goodwill amortisation –– –– –– (915) –– (915) Integration costs –– –– –– (269) –– (269) Profit on ordinary activities before tax 9,208 13,546 22,754 (14,326) (1,511) 6,917
Corporate Banking and Financial Markets 2,324 4,373 6,697 (2,322) (755) 3,620
Corporate Banking and Financial Markets 2,349 3,703 6,052 (2,066) (725) 3,261
Profit before goodwill amortisation and integration costs 7,849 9,167 17,016 (9,131) (1,345) 6,540 Goodwill amortisation — — — (731) — (731) Integration costs — — — (957) — (957) Profit on ordinary activities before tax 7,849 9,167 17,016 (10,819) (1,345) 4,852 * comprises provisions for bad and doubtful debts and amounts written off fixed asset investments.
The prior year data in the tables below have been restated to reflect the transfer in 2004 of certain activities from Wealth Management to Retail Banking and from other divisions, principally RBS Insurance and Ulster Bank, to Manufacturing.
Corporate Banking and Financial Markets 346,823 268,523 13,035 11,726 * restated (see page 139)
Segmental analysis of goodwill is as follows: Retail Retail Wealth RBS Ulster
Net book value: (b) Geographical segments The geographical analyses in the tables below have been compiled on the basis of location of office where the transactions are recorded.
Rest of UK USA Europe the World Total 2004 £m £m £m £m £m
N ot es o n th e ac co un ts Notes on the accounts continued 49 Segmental analysis (continued) Rest of
UK USA Europe the World Total 2003* £m £m £m £m £m
Profit on ordinary activities before tax 4,456 1,159 315 146 6,076 2002*
Chairman and executive directors – amounts receivable under long-term incentive plans 2,189 6,056 Chairman and executive directors – gains on exercise of share options 5 2
Retirement benefits are accruing to five directors (2003 – six) under defined benefit schemes, two (2003 – two) of whom also accrued benefits under defined contribution schemes.
(a) At 31 December 2004, the amounts outstanding in relation to transactions, arrangements and agreements entered into by authorised institutions in the Group were £234,265 in respect of loans to eight persons who were directors of the company (or persons connected with them) at any time during the financial period and £30,926 to one person who was an officer of the company at any time during the financial period.
(b) There were no contracts of significance to the business of the company and its subsidiaries which subsisted at 31 December 2004, or during the year then ended, in which any director of the company had a material interest.
Investments Group members provide development and other types of capital support to businesses in their roles as providers of finance. These investments are made in the normal course of business and on arm’s-length terms depending on their nature. In some instances, the investment may extend to ownership or control over 20% or more of the voting rights of the investee company. However, these investments are not considered to give rise to transactions of a materiality requiring disclosure under FRS 8.
(b) Intangible assets Under the Group’s UK GAAP accounting policy, goodwill arising on acquisitions after 1 October 1998 is recognised as an asset and amortised on a straight-line basis over its estimated useful economic life. Impairment tests on goodwill are carried out at the end of the first full accounting period after its acquisition, and whenever there are indications of impairment. Goodwill arising on acquisitions before 1 October 1998 was deducted from reserves immediately. Under US GAAP, goodwill is recognised as an asset, and is not amortised. Under the transition rules of SFAS 142 ‘Goodwill and Other Intangible Assets’, no amortisation is charged on acquisitions made after 30 June 2001; amortisation is charged up to 31 December 2001 for other goodwill. All goodwill and intangible assets with indefinite lives are tested for impairment at least annually. Certain amounts included in goodwill under UK GAAP are classified as intangible assets under US GAAP and amortised over their useful economic lives.
(c) Property revaluation and depreciation The Group’s freehold and leasehold properties are carried at original cost or subsequent valuation. The surplus or deficit on revaluation is included in the Group’s reserves. Under US GAAP, revaluations of property are not permitted to be reflected in the financial statements.
(e) Dividends Under UK GAAP, dividends are recorded in the period to which they relate, whereas under US GAAP dividends are recorded in the period in which they are declared.
scheme assets compared with liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). An asset is only recognised to the extent that the surplus can be recovered through reduced contributions in the future or through refunds from the scheme. US GAAP requires a similar method but allows a certain portion of actuarial gains and losses to be deferred and allocated in equal amounts over the average remaining service lives of current employees. A minimum additional liability must be recognised if the accumulated benefit obligation (the current value of accrued benefits without allowance for future salary increases) exceeds the fair value of plan assets and the Group has recorded a prepaid pension costs or has an accrued liability that is less than the unfunded accumulated benefit. Movements in the minimum additional liability, together with the related deferred tax, are recognised through other comprehensive income.
(i) Extinguishment of liabilities Under UK GAAP, recognition of a financial liability ceases once any transfer of economic benefits to the creditor is no longer likely. Under US GAAP, a financial liability is derecognised only when the creditor is paid or the debtor is legally released from being the primary obligator under the liability, either judicially or by the creditor.