2008 Held-for-trading 5,372 9,859 37,518 10,947 39,879 11,013 1,571 116,159 Designated as at fair value through profit or loss 2,085 510 456 — 236 1,551 456 5,294 Available-for-sale 11,330 6,145 21,735 11,650 62,067 4,588 1,207 118,722 Loans and receivables — — — 114 8,961 3,749 160 12,984 Group before RFS MI 18,787 16,514 59,709 22,711 111,143 20,901 3,394 253,159 RFS MI — 7 10,762 1,652 — 885 1,084 14,390 Group 18,787 16,521 70,471 24,363 111,143 21,786 4,478 267,549
Key point Debt securities continued to decline during 2010, primarily in GBM’s European sovereign exposures as well as in ABS. Reduction in ABS in US Retail & Commercial and Non-Core reflects balance sheet reduction strategies whereas GBM’s sell down followed increased liquidity in US RMBS market, primarily in the first half of the year.
AQ1 30,840 10,755 17,554 135,311 214,029 408,489 389,019 AQ2 319 105 212 1,561 462 2,659 11,550 AQ3 1,284 391 626 610 406 3,317 10,791 AQ4 989 155 240 1,726 281 3,391 8,296 AQ5 1,016 81 201 1,447 2,115 4,860 8,270 AQ6 134 46 71 653 166 1,070 2,548 AQ7 150 29 44 375 259 857 2,181 AQ8 2 1 10 118 272 403 1,448 AQ9 104 8 39 110 189 450 2,030 AQ10 170 11 52 353 995 1,581 2,026 Accruing past due — — — — — — 40 35,008 11,582 19,049 142,264 219,174 427,077 438,199 RFS MI — 3,255 Group 427,077 441,454 Counterparty mtm netting (330,397) (358,917) Cash collateral held against derivative exposures (1) (31,096) (33,667)
The tables below analyse the Group’s derivative assets by contract type and residual maturity and the effect of position netting and collateral.
Net exposure £m 2010 Exchange rate 28,938 7,820 9,360 23,174 13,961 83,253 (69,509) 13,744 Interest rate 4,822 3,533 7,927 104,026 191,423 311,731 (236,513) 75,218 Credit derivatives 497 99 313 12,374 13,589 26,872 (22,728) 4,144 Equity and commodity 751 130 1,449 2,690 201 5,221 (1,647) 3,574 35,008 11,582 19,049 142,264 219,174 427,077 (330,397) 96,680
RFS MI 3,255 — 3,255 Group 441,454 (358,917) 82,537 Cash collateral held against derivative exposures (1) (33,667) Net exposure 48,870
Note: (1) As at 31 December 2010, in addition to cash collateral the Group holds collateral in the form of securities of £2.9 billion (2009 - £3.6 billion) against derivative positions.
In a year of significant quarterly interest rate volatility, the overall annual interest rate trend was downwards, with all major rate indices moving down by at least 30 basis points in the medium to long end, with USD and GBP dropping approximately 70 basis points in the 5 year yield curve. The increase in gross asset values caused by the drop in interest rates was offset by the greater use of London Clearing House (LCH) as a counterparty, up from 56% at the end of 2009 to 60% by end of 2010. Reduction in non-LCH related netting increased the net exposure, excluding the effect of collateral arrangements. *
REIL, provisions and reserves All the disclosures in this section (pages 181 to 192) are audited. The Group classifies impaired assets as either risk elements in lending (REIL) or potential problem loans (PPL). REIL represents impaired loans, and loans that are accruing but are past due 90 days. PPL represents impaired assets which are not included in REIL, but where information about possible credit problems cause management to have serious doubts about the future ability of the borrower to comply with loan repayment terms.
RFS MI Group £m £m £m £m £m £m £m £m £m £m
Accruing loans past due 90 days or more (2) UK 1,434 939 2,373 1,146 1,089 2,235 — 2,235 1,201 1,201 Overseas 262 262 524 212 731 943 46 989 508 581 1,696 1,201 2,897 1,358 1,820 3,178 46 3,224 1,709 1,782 Total REIL 15,207 23,391 38,598 12,089 22,900 34,989 3,260 38,249 18,791 21,261
REIL as a % of gross loans to customers (4) 3.7% 20.7% 7.3% 2.8% 15.1% 6.1% 2.4% 5.4% 2.7% 2.5% REIL and PPL as a % of gross loans to customers (4) 3.8% 20.8% 7.4% 2.9% 15.5% 6.2% 2.5% 5.5% 2.7% 2.5% Closing provision for impairment as a % of total REIL 51% 44% 47% 56% 37% 44% 65% 46% 50% 52% Closing provision for impairment as a % of total REIL and PPL 49% 44% 46% 55% 36% 43% 63% 45% 50% 51%
Risk management: Credit risk continued REIL, provisions and reserves continued Movement in REIL and PPL The table below details the movement in REIL and PPL during the year ended 31 December 2010.
REIL PPL Total Core Non-Core Total Core Non-Core Total Core Non-Core Total £m £m £m £m £m £m £m £m £m
In UK Corporate impaired loans increased reflecting a number of specific cases which resulted in REIL/PPL as a % of loans increasing from 2.2% to 3.7%.
Provisions, REIL and related coverage ratios in Ulster Bank increased reflecting a deterioration in customer credit quality due to a fall in Irish property prices.
Increase in provisions and related REIL in Non-Core reflected difficult conditions in specific sectors, particularly UK and Irish commercial property.
Past due analysis The table below shows loans and advances to customers that were past due at the balance sheet date but not considered impaired: Core Non-Core Total Core Non-Core
Past due 1-29 days 6,401 822 7,223 5,101 1,486 6,587 1,209 7,796 9,517 Past due 30-59 days 1,725 392 2,117 1,943 357 2,300 424 2,724 2,941 Past due 60-89 days 922 271 1,193 2,203 207 2,410 177 2,587 1,427 Past due 90 days or more 1,696 1,201 2,897 1,358 1,820 3,178 46 3,224 1,782 10,744 2,686 13,430 10,605 3,870 14,475 1,856 16,331 15,667
Loans, REIL and impairments by industry and geography The tables below analyse gross loans and advances to customers and banks (excluding reverse repos and disposal groups), REIL, provisions, impairment charge and amounts written-off relating to these loans, by industry and geography (by location of office). Total
Risk management: Credit risk continued REIL, provisions and reserves continued Total
Central and local government 6,128 — — — — — — — Finance - banks 47,574 168 135 0.4 80 0.3 12 — - other 50,673 1,038 259 2.0 25 0.5 256 113 Residential mortgages 127,975 2,670 341 2.1 13 0.3 305 146 Personal lending 35,313 3,344 2,560 9.5 77 7.2 1,816 1,398 Property 49,054 1,766 468 3.6 27 1.0 417 37 Construction 9,502 457 131 4.8 29 1.4 58 30 Manufacturing 30,272 491 191 1.6 39 0.6 136 93 Service industries and business activities 100,438 1,762 669 1.8 38 0.7 500 365 Agriculture, forestry and fishing 3,726 90 46 2.4 51 1.2 24 4 Finance leases and instalment credit 8,147 303 116 3.7 38 1.4 52 100 Interest accruals 1,179 — — — — — — — Latent — — 2,005 — — — 991 — 469,981 12,089 6,921 2.6 57 1.5 4,567 2,286 of which: UK 315,254 7,704 4,209 2.4 55 1.3 2,884 1,645 Europe 66,707 2,607 1,709 3.9 66 2.6 750 46 US 64,526 1,497 876 2.3 59 1.4 813 576 RoW 23,494 281 127 1.2 45 0.5 120 19 Group before RFS MI 469,981 12,089 6,921 2.6 57 1.5 4,567 2,286 185RBS Group 2010
Central and local government 1,671 — — — — — — — Finance - banks 1,003 1 1 0.1 100 0.1 (8) 11 - other 7,651 562 193 7.3 34 2.5 7 88 Residential mortgages 6,142 277 184 4.5 66 3.0 436 426 Personal lending 3,891 413 349 10.6 85 9.0 213 306 Property 47,651 16,297 5,918 34.2 36 12.4 3,943 911 Construction 3,352 1,854 653 55.3 35 19.5 341 108 Manufacturing 6,520 644 237 9.9 37 3.6 (211) 1,423 Service industries and business activities 22,383 2,682 1,337 12.0 50 6.0 606 473 Agriculture, forestry and fishing 135 58 29 43.0 50 21.5 7 1 Finance leases and instalment credit 8,529 603 414 7.1 69 4.9 189 71 Interest accruals 278 — — — — — — — Latent — — 1,001 — — — (116) — 109,206 23,391 10,316 21.4 44 9.4 5,407 3,818 of which: UK 62,930 8,774 3,740 13.9 43 5.9 1,678 752 Europe 28,245 12,531 5,243 44.4 42 18.6 2,942 1,552 US 13,345 1,303 819 9.8 63 6.1 595 1,104 RoW 4,686 783 514 16.7 66 11.0 192 410 Group before RFS MI 109,206 23,391 10,316 21.4 44 9.4 5,407 3,818
Central and local government 1,532 — — — — — — — Finance - banks 1,360 38 22 2.8 58 1.6 22 — - other 9,713 501 160 5.2 32 1.6 630 579 Residential mortgages 12,932 614 210 4.7 34 1.6 604 496 Personal lending 6,358 596 366 9.4 61 5.8 701 604 Property 50,372 12,552 2,954 24.9 24 5.9 2,879 613 Construction 5,258 1,775 388 33.8 22 7.4 421 257 Manufacturing 14,402 2,640 1,897 18.3 72 13.2 1,384 691 Service industries and business activities 33,638 3,546 1,191 10.5 34 3.5 1,464 916 Agriculture, forestry and fishing 553 47 27 8.5 57 4.9 6 1 Finance leases and instalment credit 11,956 591 302 4.9 51 2.5 219 35 Interest accruals 549 — — — — — — — Latent — — 735 — — — 193 — 148,623 22,900 8,252 15.4 36 5.6 8,523 4,192 of which: UK 79,043 8,400 2,713 10.6 32 3.4 2,709 1,279 Europe 41,096 10,783 3,740 26.2 35 9.1 2,520 381 US 19,546 2,618 1,144 13.4 44 5.9 2,460 2,080 RoW 8,938 1,099 655 12.3 60 7.3 834 452 Group before RFS MI 148,623 22,900 8,252 15.4 36 5.6 8,523 4,192
Risk elements in lending and potential problem loans by division The tables below analyse the Group’s loans and advances to banks and customers (excluding reverse repos and disposal groups) and related REIL, PPL, provisions, impairments, amounts written-off and related ratios by division.
Impairment loss provision methodology Provisions for impairment losses are assessed under three categories: Individually assessed provisions: provisions required for individually significant impaired assets which are assessed on a case by case basis, taking into account the financial condition of the counterparty and any guarantee and other collateral held after being stressed for downside risk. This incorporates an estimate of the discounted value of any recoveries and realisation of security or collateral. The asset continues to be assessed on an individual basis until it is repaid in full, transferred to the performing portfolio or written-off; Collectively assessed provisions: provisions on impaired credits below an agreed threshold which are assessed on a portfolio basis, to reflect the homogeneous nature of the assets, such as credit cards or personal loans. The provision is determined from a quantitative review of the relevant portfolio, taking account of the level of arrears, security and average loss experience over the recovery period. It incorporates loss experience adjustments, where appropriate, in the light of current economic and credit conditions. These include review of current cash collections profile performance against historic trends, updates to metric inputs - including model recalibrations and monitoring of operational processes used in managing exposure - including the time taken to process nonperforming exposures; and
Recoverable cash flows or proceeds are estimated using two parameters: loss given default (LGD) - this is the estimated loss amount, expressed as a percentage, that will be incurred if the borrower defaults; and the probability that the borrower will default (PD).
The Group's retail business segment their performing loan books into homogenous portfolios such as mortgages, credit cards or unsecured loans, to reflect their different credit characteristics. Latent provisions are computed by applying portfolio-level LGDs,
Impairment losses are recognised when there is objective evidence of impairment. The Group reviews its portfolios of available-for-sale financial assets for such evidence which includes: default or delinquency in interest or principal payments; significant financial difficulty of the issuer or obligor; and it becoming probable that the issuer will enter bankruptcy or other financial reorganisation. However, the disappearance of an active market because an entity’s financial instruments are no longer publicly traded is not evidence of impairment. Furthermore, a downgrade of an entity’s credit rating is not, of itself, evidence of impairment, although it may be evidence of impairment when considered with other available information. A decline in the fair value of a financial asset below its cost or amortised cost is not necessarily evidence of impairment. Determining whether objective evidence of impairment exists requires the exercise of management judgment. The unrecognised losses on the Group’s available-for-sale debt securities are concentrated in its portfolios of mortgage-backed securities. The losses reflect the widening of credit spreads as a result of the reduced market liquidity in these securities and the current uncertain macroeconomic outlook in the US and Europe. The underlying securities remain unimpaired.
At 1 January 2,677 1,271 55 189 962 478 5,632 1,289 6,921 8,252 2,110 17,283 Intra-group transfers — — — — (351) — (351) (217) (568) 568 — — Transfer to disposal groups — — — — — — — — — (72) — (72) Currency translation and other adjustments — 71 4 (2) (22) 19 70 (86) (16) 59 — 43 Disposal of subsidiaries — — — — — — — — — (20) (2,152) (2,172)
Recoveries of amounts previously written-off 97 20 — 2 1 58 178 11 189 136 74 399 Charged to the income statement - continuing operations 1,679 923 33 39 649 702 4,025 542 4,567 8,523 — 13,090 - discontinued operations — — — — — — — — — — 1,044 1,044 Unwind of discount (102) (21) (1) — (36) — (160) (3) (163) (238) (7) (408)
2,677 1,271 55 189 962 478 5,632 1,289 6,921 8,252 2,110 17,283 Notes: (1) Global Transaction Services. (2) Retail & Commercial. (3) Global Banking & Markets.
Singapore 649 — 209 858 — 564 13 105 682 — Switzerland 657 — 156 813 11 653 — 28 681 11 Denmark 629 — 172 801 2 659 — 256 915 2 South Korea 261 429 — 690 (2) — 526 — 526 (3)
The £500 million reductions in both Greek and Portuguese exposures primarily reflect disposals.
Market risk arises from changes in interest rates, foreign currency, credit spread, equity prices and risk related factors such as market volatilities. The Group manages market risk centrally within its trading and nontrading portfolios through a comprehensive market risk management framework. This framework includes limits based on, but not limited to, value-at-risk (VaR), stress testing, positions and sensitivity analyses.
The majority of market risk exposure is in GBM and Non-Core. The Group is also exposed to market risk through interest rate risk on its nontrading activities. There are additional non-trading market risks in the Retail and Commercial businesses of the Group, principally interest rate risk and foreign exchange risk. These aspects are discussed in more detail in Balance sheet management - Interest rate risk on page 143 and structural foreign currency exposures on page 144.
Model validation governance Pricing models are developed and owned by the front office. Where pricing models are used as the basis of books and records valuations, they are all subject to independent review and sign-off. Models are assessed by the Group Model Product Review Committee (GMPRC) as having either immaterial or material model risk (valuation uncertainty arising from choice of modelling assumptions), the assessment being made on the basis of expert judgement. Those models assessed as having material model risk are prioritised for independent quantitative review. Independent quantitative review aims to quantify model risk (i.e. the impact of missing risk factors in the front office model or the possibility that we may be mismarking these products relative to other market participants who may be using an alternative model) by comparing model outputs against alternative independently developed models. The results of the independent quantitative review are used by Market Risk to inform risk limits and by Finance to inform reserves. Governance over this process is provided by GMPRC, a forum which brings together Front Office Quantitative Analysts, Market Risk, Finance and Quantitative Research Centre (QuaRC), Group Risk’s independent quantitative model review function.
Risk (market risk, incremental default risk, counterparty credit risk) models are developed both within business units and by Group functions. Risk models are also subject to independent review and sign-off. Meetings are held with the FSA every quarter to discuss the traded market risk, including changes in models, management, back testing results, risks not included in the VaR framework and other model performance statistics.
As part of the ongoing review and analysis of the suitability of the VaR model, a methodology enhancement to the ABS VaR was approved and incorporated into the regulatory model in 2010. The credit crisis in 2007 - 2009 caused large price changes for some structured bonds and the spread based approach to calculating VaR for these instruments started to give inaccurate risk levels, particularly for bonds trading at a significant discount to par. The methodology enhancement harmonised the VaR approach in the US and Europe by replacing the absolute spread-based approach with a more reliable and granular relative price-based mapping scheme. The enhancement better reflects the risk in the context of position changes, downgrades and vintage as well as improving differentiation between prime, Alt-A and sub-prime exposures.
The VaR disclosure is broken down into trading and non-trading portfolios. Trading VaR relates to the main trading activities of the Group and nontrading reflects the risk associated with reclassified assets, money market business and the management of internal funds flow within the Group’s businesses.
The Group has disclosed separately the Counterparty Exposure Management (CEM) trading book exposure and the exposure of Core without CEM. CEM manages the OTC derivative counterparty credit risk on behalf of GBM, by actively controlling risk concentrations and reducing unwanted risk exposures. The hedging transactions CEM enters into are booked in the trading book, and therefore contribute to the market risk VaR exposure of the Group. The counterparty exposures themselves are not captured in VaR for regulatory capital. In the interest of transparency and to more properly represent the trading book exposure, CEM trading book exposure is disclosed separately.
The table below analyses the VaR for the Group’s trading portfolios segregated by type of market risk exposure.
The Group’s maximum and average credit and Non-Core VaR were higher in 2010 than in 2009 due to Non-Core exiting several highly structured positions which, due to their complexity and layering, required unwinding with different counterparties over different periods. The timing of the unwind led to an increased VaR, until the exit was completed in October and the VaR then reduced back to the levels held earlier in the year.
Commodity VaR decreased during the year since a significant part of the Group’s interest in RBS Sempra Commodities JV was sold during the year.
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An analysis of the frequency distribution of daily revenue shows that there were 22 days with negative revenue during 2010 compared with 16 days in 2009. The most frequent result is daily revenue of between £25 million and £30 million with 37 occurrences in 2010 compared with 26 occurrences in 2009.
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In order to better represent the risk of the non-traded portfolios, the table below analyses the VaR for the non-trading portfolios but excludes Structured Credit Portfolios (SCP) in Non-Core. These assets are shown separately on a drawn notional and fair value basis by maturity profile and asset class and are managed on both an asset and RWA basis.
The table below analyses the risk for the Group’s non-trading portfolios.
Non-trading VaR Average £m Period end £m Maximum £m Minimum £m Average £m Period end £m Maximum £m Minimum £m
Key points The non-traded credit spread, Core and total VaR have decreased significantly due to the implementation of the relative price-based mapping scheme in the VaR methodology discussed above and the sales of available-for-sale securities in the US mortgage business.
The business model for the US mortgage business has focussed its activity on client facilitation flow trading during 2010. This has encompassed the disposal of a large portfolio of illiquid available-forsale securities that were sold throughout the year, resulting in the non-traded VaR reducing. In parallel, the risk management of the business has been significantly enhanced to ensure that the business remains focussed on client facilitation flow trading of liquid assets. Tools have been implemented to monitor the liquidity of trading volumes, asset aged inventory controls have been tightened and granular asset concentration risk limits imposed, to complement the existing VaR and stress testing market risk frameworks.
All the disclosures in this section (pages 199 to 203) are unaudited and are marked with an asterisk (*).
Most general insurance contracts are written on an annual basis, which means that the Group's liability extends for a twelve month period, after which the Group is entitled to decline to renew the policy or can impose renewal terms by amending the premium, terms and conditions. An analysis of gross and net insurance claims can be found in the notes on the financial statements (see page 347).
GPF is owned and managed by the Group’s operational risk function and relies upon the operational risk framework for effective implementation and ongoing maintenance.
Three lines of defence model To ensure appropriate responsibility is allocated for the management, reporting and escalation of operational risk, the Group operates a three lines of defence model which outlines principles for the roles, responsibilities and accountabilities for operational risk management.
1st line of defence The business 2nd line of defence Operational risk 3rd line of defence Group Internal Audit
Responsible for the implementation and maintenance of the operational risk framework, tools and methodologies.
Responsible for oversight and challenge on the adequacy of the risk and control processes operating in the business.
The Group’s Operational Risk Policy Standards (ORPS) are incorporated in the GPF. They provide the direction for delivering effective operational risk management and are designed to enable the consistent identification, assessment, management, monitoring and reporting of operational risk across the Group.
Operational risk metrics Reporting forms an integral part of operational risk management. The Group’s risk management processes are designed to ensure that issues are identified, escalated and managed on a timely basis. Exposures for each division are reported through monthly risk and control reports, which provide details on the risk exposures and action plans. Events that have a material, actual or potential impact on the Group’s finances, reputation or customers, are escalated and reported to divisional and Group executives.
The charts below show a similar distribution of losses by value across the risk categories, captured at the date the event occurred and updated as losses crystallise.
Regulatory risk arises from the non-adherence to international and national rules and regulations. The Group manages regulatory risk through a regulatory risk and compliance framework that seeks to ensure the Group is in compliance with all banking, securities, insurance and anti-money laundering regulations defined by more than 120 different regulatory bodies and central banks across the world. This framework comprises global regulatory risk policies, tracking of regulatory developments, training and awareness, assurance and monitoring and regulatory relationship management.
Assurance and monitoring Assurance and monitoring activities are key to ensuring that the Group can demonstrate ongoing compliance with existing rules and regulations. Such activities are conducted in both the first line and second line of defence. Work to design, implement and embed enhanced monitoring tools was undertaken in 2010 and will continue into 2011.
Reputation risk can arise from actions taken by the Group or a failure to take action, such as failing to assess the environmental, social or ethical impacts of clients or projects that the Group has provided products or services to.
Currently the Group manages reputational risk through a number of functions, such as divisions, Group Communications, Group Sustainability and an Environmental, Social and Ethical (ESE) risk management function. The latter function is responsible for assessing ESE risks associated with business engagements and business divisions.
The Board has ultimate responsibility for managing any impact on the reputation of the Group arising from its operations. The Group Sustainability Committee (established at the beginning of 2010) sets the overall strategy and approach for the management of Group sustainability, however all parts of the Group take responsibility for reputation management.
The risk is viewed as material given the central nature of the Group’s market reputation in the strategic risk objectives.
The Group is exposed to risk from its defined benefit pension schemes to the extent that the assets of the schemes do not fully match the timing and amount of the schemes’ liabilities. Pension scheme liabilities vary with changes to long-term interest rates, inflation, pensionable salaries and the longevity of scheme members as well as changes in legislation. The Group is exposed to the risk that the market value of the schemes’ assets, together with future returns and any additional future contributions could be considered insufficient to meet the liabilities as they fall due. In such circumstances, the Group could be obliged, or may choose, to make additional contributions to the schemes.
The Group maintains an independent review of risk within its pension funds. The Group Risk Committee now monitors pension obligation risk on an ongoing basis with a monthly report illustrating the funding positions and key sensitivities of the Group’s pension schemes. Additionally, as part of the Internal Capital Adequacy Assessment Process (ICAAP) process, the change in asset and liability values is modelled over a twelve-month time horizon under a stressed scenario.
The table below shows the impact on the Main schemes assets and liabilities (measured according to IAS 19 ‘Employee Benefits’) of changes in interest rates and equity values at the year end, taking account of the current asset allocation and hedging arrangements.
Explanatory note These disclosures provide information on certain elements of the Group's credit market activities, the majority of which are in Non-Core and, to a lesser extent, Global Banking & Markets, US Retail & Commercial and Group Treasury. For credit valuation adjustments (CVA), leveraged finance and conduits disclosures, the information presented has been analysed between the Group's Core and Non-Core businesses.
Definitions of acronyms used in this section can be found in the Glossary on pages 434 to 439.
Asset-backed securities The Group structures, originates, distributes and trades debt in the form of loan, bond and derivative instruments in all major currencies and debt capital markets in North America, Western Europe, Asia and major emerging markets. The carrying value of the Group's debt securities is detailed below.
The following tables summarise the gross and net exposures and carrying values of these securities by geography of the underlying assets at 31 December 2010, 2009 and 2008. Gross exposures represent the principal amounts relating to ABS. G10 government RMBS comprises securities that are: (a) guaranteed or effectively guaranteed by the US government, by way of its support for US federal agencies and government sponsored enterprises or (b) guaranteed by the Dutch government. Net exposures represent the carrying value after taking account of the hedge protection purchased from monoline insurers and other counterparties, but exclude the effect of counterparty credit valuation adjustments. The hedge provides credit protection of both principal and interest cash flows in the event of default by the counterparty. The value of this protection is based on the underlying instrument being protected. The tables at 31 December 2009 exclude RMBS covered bonds in RFS MI, comprising gross exposure - £558 million, carrying value - £579 million, and net exposure - £579 million.
Carrying value RMBS: G10 government 24,390 16 5,958 — 30,364 13,765 — 16,599 — RMBS: covered bond 142 208 7,522 — 7,872 — — 7,872 — RMBS: prime 1,624 3,000 931 192 5,747 1,384 1 4,249 113 RMBS: non-conforming 1,084 1,959 92 — 3,135 605 — 1,102 1,428 RMBS: sub-prime 638 255 120 205 1,218 681 — 344 193 CMBS 2,936 1,338 638 38 4,950 2,262 118 1,281 1,289 CDOs 3,135 69 254 — 3,458 1,341 — 2,021 96 CLOs 5,334 102 635 3 6,074 691 — 4,958 425 Other ABS 2,780 945 2,615 1,667 8,007 1,259 — 4,089 2,659 42,063 7,892 18,765 2,105 70,825 21,988 119 42,515 6,203
Risk management: Other risk exposures continued Asset-backed securities by product, geography and measurement classification continued
Europe RoW (2) Total HFT (3) DFV (4) AFS (5) LAR (6) 2009 £m £m £m £m £m £m £m £m £m
Gross exposure RMBS: G10 government 26,644 17 7,016 94 33,771 13,536 — 20,235 — RMBS: covered bond 49 297 9,019 — 9,365 — — 9,365 — RMBS: prime 2,965 5,276 4,567 222 13,030 6,274 147 5,761 848 RMBS: non-conforming 1,341 2,138 128 — 3,607 635 — 1,498 1,474 RMBS: sub-prime 1,668 724 195 561 3,148 1,632 17 1,020 479 CMBS 3,422 1,781 1,420 75 6,698 2,936 209 1,842 1,711 CDOs 12,382 329 571 27 13,309 9,080 1 3,923 305 CLOs 9,092 166 2,169 1,173 12,600 5,346 — 6,581 673 Other ABS 3,587 1,980 5,031 1,569 12,167 2,912 18 5,252 3,985 61,150 12,708 30,116 3,721 107,695 42,351 392 55,477 9,475
Carrying value RMBS: G10 government 26,984 17 6,870 33 33,904 13,397 — 20,507 — RMBS: covered bond 50 288 8,734 — 9,072 — — 9,072 — RMBS: prime 2,696 4,583 4,009 212 11,500 5,133 141 5,643 583 RMBS: non-conforming 958 1,957 128 — 3,043 389 — 1,180 1,474 RMBS: sub-prime 977 314 146 387 1,824 779 17 704 324 CMBS 3,237 1,305 924 43 5,509 2,279 216 1,637 1,377 CDOs 3,275 166 400 27 3,868 2,064 1 1,600 203 CLOs 6,736 112 1,469 999 9,316 3,296 — 5,500 520 Other ABS 2,886 1,124 4,369 1,187 9,566 1,483 19 4,621 3,443 47,799 9,866 27,049 2,888 87,602 28,820 394 50,464 7,924
Net exposure RMBS: G10 government 26,984 17 6,870 33 33,904 13,397 — 20,507 — RMBS: covered bond 50 288 8,734 — 9,072 — — 9,072 — RMBS: prime 2,436 3,747 3,018 172 9,373 3,167 142 5,480 584 RMBS: non-conforming 948 1,957 128 — 3,033 379 — 1,180 1,474 RMBS: sub-prime 565 305 137 290 1,297 529 17 427 324 CMBS 2,245 1,228 595 399 4,467 1,331 203 1,556 1,377 CDOs 743 124 382 26 1,275 521 1 550 203 CLOs 1,636 86 1,104 39 2,865 673 — 1,672 520 Other ABS 2,117 839 4,331 1,145 8,432 483 19 4,621 3,309 37,724 8,591 25,299 2,104 73,718 20,480 382 45,065 7,791
AAA AA to AA+ A to AA- BBB- to A- Non-investment grade Unrated Total 2010 £m £m £m £m £m £m £m
RMBS: G10 government 28,835 1,529 — — — — 30,364 RMBS: covered bond 7,107 357 408 — — — 7,872 RMBS: prime 4,355 147 67 82 900 196 5,747 RMBS: non-conforming 1,754 144 60 316 809 52 3,135 RMBS: sub-prime 317 116 212 39 458 76 1,218 CMBS 2,789 392 973 500 296 — 4,950 CDOs 444 567 296 203 1,863 85 3,458 CLOs 2,490 1,786 343 527 332 596 6,074 Other ABS 3,144 1,297 885 1,718 265 698 8,007 51,235 6,335 3,244 3,385 4,923 1,703 70,825 2009 RMBS: G10 government 33,779 125 — — — — 33,904 RMBS: covered bond 8,645 360 67 — — — 9,072 RMBS: prime 9,211 676 507 547 558 1 11,500 RMBS: non-conforming 1,981 197 109 160 594 2 3,043 RMBS: sub-prime 578 121 306 87 579 153 1,824 CMBS 3,441 599 1,022 298 147 2 5,509 CDOs 615 944 254 944 849 262 3,868 CLOs 2,718 4,365 607 260 636 730 9,316 Other ABS 4,099 1,555 1,014 1,947 152 799 9,566 65,067 8,942 3,886 4,243 3,515 1,949 87,602
CDO and CLO portfolios declined by £3.7 billion reflecting asset reductions in Non-Core; however, some CDO exposures were downgraded during the year resulting in increased noninvestment grade positions.
RMBS: prime 354 535 11 900 196 — — 196 RMBS: non-conforming 389 414 6 809 52 — — 52 RMBS: sub-prime 437 21 — 458 76 — — 76 CMBS 198 17 81 296 — — — —
2009 RMBS: prime 120 430 8 558 — 1 — 1 RMBS: non-conforming 253 341 — 594 — 2 — 2 RMBS: sub-prime 339 240 — 579 153 — — 153 CMBS 89 3 55 147 1 — 1 2 CDOs 487 300 62 849 143 119 — 262 CLOs 269 359 8 636 207 523 — 730 Other ABS 78 63 11 152 270 134 395 799 1,635 1,736 144 3,515 774 779 396 1,949
RMBS: G10 government — — — — 9 — — 9 RMBS: prime 59 47 — 106 2 — — 2 RMBS: non-conforming 69 74 3 146 1 1 — 2 RMBS: sub-prime 636 124 30 790 1 — — 1 CMBS 38 — — 38 — — 1 1 CDOs 1,219 869 — 2,088 173 142 66 381 CLOs 80 188 — 268 165 279 5 449 Other ABS 122 49 71 242 115 404 810 1,329 2,223 1,351 104 3,678 466 826 882 2,174
The Group classifies RMBS as sub-prime or Alt-A based on industry standard criteria, including Fair Isaac Corporation scores (FICO), level of documentation and loan-to-value (LTV) ratios of the underlying mortgage loans. RMBS are classified as sub-prime if the mortgage portfolio comprises loans with FICO scores between 500 and 650 with full or limited documentation. Mortgages in Alt-A RMBS portfolios have FICO scores of 640 to 720, limited documentation and an original LTV of 70% to 95%. The FICO score is the determining factor in the classification of the Group’s RMBS as sub-prime or Alt-A.
The table below analyses the vintage of the Group's carrying value of RMBS portfolios by geography and classification.
Europe RoW Total G10 government Covered bond Prime Nonconforming Sub-prime 2010 £m £m £m £m £m £m £m £m £m £m
Credit valuation adjustments (CVA) CVA represents an estimate of the adjustment to arrive at fair value that a market participant would make to incorporate the credit risk inherent in counterparty derivative exposures.
The gross mark-to-market of the monoline protection depends on the value of the instruments against which protection has been bought. A positive fair value, or a valuation gain, in the protection is recognised if the fair value of the instrument it references decreases. For the majority of trades the gross mark-to-market of the monoline protection is determined directly from the fair value price of the underlying reference instrument, however for the remainder of the trades, the gross mark-tomarket is determined using industry standard models.
The methodology employed to calculate the monoline CVA uses market implied probability of defaults and internally assessed recovery levels to determine the level of expected loss on monoline exposures of different maturities. The probability of default is calculated with reference to market observable credit spreads and recovery levels. CVA is calculated at a trade level by applying the expected loss, corresponding to each trade’s expected maturity, to the gross mark-to-market of the monoline protection. The expected maturity of each trade reflects the scheduled notional amortisation of the underlying reference instruments and whether payments due from the monoline are received at the point of default or over the life of the underlying reference instruments.
The table below summarises the Group's exposure to monolines, all of which are in Non-Core.
The net income statement effect relating to monoline exposures is detailed below. 2010 2009 2008 £m £m £m
Note: (1) Comprises the following elements for the year ended 2010 and 2009: - a loss of £5 million (2009 - £2,387 million) in income from trading activities; - impairment reversals/(losses) of £71 million (2009 - (£239) million); and - other income of £138 million (2009 - £60 million) relating to reclassified debt securities.
Risk management: Other risk exposures continued Monoline insurers continued A number of debt instruments with monoline protection were reclassified from HFT to AFS in 2008. Changes in the fair value since the reclassification are recognised in the income statement to the extent that they are considered to be impaired. Changes in the fair value of the related monoline CDSs continue to be recorded in the income statement.
The fair value of these reclassified debt securities at 31 December 2010 was £5,572 million (1 July 2008 - £6,293 million after adjusting for both principal based cash flows and foreign exchange effects between 1 July 2008 and 31 December 2010). As a result of these reclassifications, total cumulative losses of £331 million have not been recognised in the income statement.
A to AA- 6,336 5,503 833 272 — 561 Non-investment grade 8,555 5,365 3,190 2,171 71 948 14,891 10,868 4,023 2,443 71 1,509 Of which: CMBS 4,149 2,424 1,725 1,253 CDOs 1,133 256 877 593 CLOs 6,724 6,121 603 210 Other ABS 2,393 1,779 614 294 Other 492 288 204 93 14,891 10,868 4,023 2,443
Of which: CMBS 4,253 2,034 2,219 1,562 CDOs 2,284 797 1,487 1,059 CLOs 10,007 8,584 1,423 641 Other ABS 2,688 1,861 827 412 Other 509 295 214 122 19,741 13,571 6,170 3,796
Key points Exposure to monolines decreased over the period due to a combination of restructuring certain exposures and higher prices of underlying reference instruments, partially offset by the strengthening of the US dollar against sterling.
During the year there was a significant increase in the RWA requirements of RBS N.V. following its migration to the Basel II regime. Regulatory intervention at certain monoline counterparties triggered International Swaps and Derivative Association (ISDA) credit events in the period. At the point of trigger the exposure to these counterparties was excluded from the RWA calculations and capital deductions of £171 million were taken instead. The impact of this together with restructuring certain exposures and an improvement in the rating of underlying reference bonds held by the Group to investment grade status were the main drivers of the reduction in RWA requirements during the second half of the year. *
The Group also has indirect exposures to monoline insurers through wrapped securities and other assets with credit enhancement from monoline insurers. These securities are traded with the benefit of this credit enhancement. Any deterioration in the credit rating of the monoline is reflected in the fair value of these assets.
The gross mark-to-market of the CDPC protection is determined using industry standard models. The methodology employed to calculate the CDPC CVA is different to that outlined above for monolines, as there are no market observable credit spreads and recovery levels for these entities. The level of expected loss on CDPC exposures is estimated with reference to recent market events impacting CDPCs, including communication activity, and by analysing the underlying trades and the cost of hedging expected default losses in excess of the capital in each vehicle.
Credit valuation adjustment as a % of gross exposure 39% 39% 27%
Risk management: Other risk exposures continued Credit derivative product companies continued
The table below details the net income statement effect arising from CDPC exposures. 2010 2009 2008 £m £m £m
The CVA decrease for the year reflected exposure reductions, due to trade commutations, tighter credit spreads of the underlying reference portfolios, partially offset by an increase in the relative value of senior tranches compared with the underlying reference portfolios and foreign currency movements.
Counterparty and credit RWAs and capital deductions decreased in line with the exposure.
Certain CDPCs, where the Group has hedges in place to cap the exposure, are excluded from the RWA calculations with capital deduction taken instead.
Credit valuation adjustment at 1 January (1,588) (1,738) Credit valuation adjustment at 31 December (1,714) (1,588) (Increase)/decrease in credit valuation adjustment (126) 150 Net debit relating to realisations, hedges, foreign exchange and other movements (19) (841) Income from trading activities - net losses (145) (691)
Risk management: Other risk exposures continued Leveraged finance Leveraged finance is commonly employed to facilitate corporate finance transactions, such as acquisitions or buy-outs, and is so called due to the high ratio of debt to equity (leverage) common in such transactions. A bank acting as a lead manager for a leveraged finance transaction will typically underwrite a loan, alone or with others, and then syndicate the loan to other participants. The Group typically held a portion of these loans as part of its long-term portfolio once primary syndication is completed. Most of the leveraged finance loans held as part of the syndicated lending portfolio were reclassified from HFT to LAR in 2008.
The gross exposure represents the total amount of leveraged finance committed by the Group. The net exposure represents the balance sheet carrying values of drawn leveraged finance and the total undrawn amount. The difference between gross and net exposures is principally due to the cumulative effect of impairment provisions and historic write-downs on assets prior to reclassification.
The table below shows the Groups global markets sponsor-led leveraged finance exposures, all of which are in Non-Core, by industry and geography.
The table below shows the Group’s movement in leveraged finance exposures during the year. 2010 2009
Balance at 1 January 10,540 2,280 12,820 12,619 3,150 15,769 Transfers (out)/in (from credit trading business) (38) 12 (26) 563 41 604 Sales and restructurings (3,575) (273) (3,848) (247) (144) (391)
In addition to the above, UK Corporate and Ulster Bank have leveraged finance exposures as set out below. 2010 2009 2008 £m £m £m - senior debt transactions (2) 2,604 3,034 2,330 Total UK Corporate 6,268 7,075 6,826 Ulster Bank 597 621 694 6,865 7,696 7,520
Special purpose entities The Group arranges securitisations to facilitate client transactions and undertakes securitisations to sell financial assets or to fund specific portfolios of assets. The Group also acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. In a securitisation, assets, or interests in a pool of assets, are transferred generally to a special purpose entity (SPE) which then issues liabilities to third party investors. SPEs are vehicles established for a specific, limited purpose, usually do not carry out a business or trade and typically have no employees. They take a variety of legal forms - trusts, partnerships and companies - and fulfil many different functions. As well as being a key element of securitisations, SPEs are also used in fund management activities to segregate custodial duties from the fund management advice provided by the Group.
It is primarily the extent of risks and rewards assumed that determines whether these entities are consolidated in the Group's financial statements. The following section aims to address the significant exposures which arise from the Group's activities through specific types of SPEs.
The Group sponsors own-asset securitisations primarily as a way of diversifying funding sources. The Group purchases the securities issued in own asset securitisations. During 2008, the Group was able to pledge AAA rated asset-backed securities as collateral for repurchase agreements with major central banks under schemes such as the Bank of England's Special Liquidity Scheme, launched in April 2008, which allowed banks to temporarily swap high-quality mortgage-backed and other securities for liquid UK treasury bills. This practice contributed to the Group's sources of funding in the face of the contraction in the UK market for inter-bank lending, particularly during 2008 and 2009, and investor base for securitisations.
Assets are significantly greater than liabilities, as all notes issued by funding related own asset securitisation SPEs are purchased by Group companies.
Notes: (1) Includes £0.7 billion of ABCP issued to RBS plc at 31 December 2010. (2) Programme-wide credit enhancement. (3) Maximum exposure to loss is determined as the Group’s total liquidity commitments to the conduits and additionally programme-wide credit support which would absorb first loss on transactions where liquidity support is provided by a third party.
Information relating to assets in the conduits is set out on pages 219 to 220.
Multi-seller conduits accounted for 44% of the total liquidity and credit enhancements committed by the Group at 31 December 2010 (2009 - 43%; 2008 - 69%). The Group’s multi-seller conduits have continued to fund the vast majority of their assets solely through ABCP issuance. There have been no significant systemic failures within the financial markets similar to that experienced in the second half of 2008 following Lehman Brothers bankruptcy filing in September 2008. The improvement in market conditions has allowed these conduits to move to normal ABCP funding conditions and reduced the need for backstop funding from the Group.
The average maturity of ABCP issued by the Group’s conduits has risen throughout 2010, to 69.4 days (2009 - 58.4 days; 2008 - 72.1 days).
The maturity of the commercial paper issued by the Group’s conduits to mitigate the short-term contingent liquidity risk of providing back-up facilities. The Group’s limits sanctioned for such liquidity facilities in 2010 totalled approximately £22.6 billion for multi-seller conduits (2009 - £25.0 billion; 2008 - £42.9 billion). For a very small number of transactions within one multi-seller conduit the liquidity facilities have been provided by third-party banks. This typically occurs on transactions where the third-party bank does not use, or have, its own conduit vehicles.
The Group’s maximum exposure to loss on its multi-seller conduits is £22.8 billion (2009 - £25.2 billion; 2008 - £43.2 billion), being the total amount of the Group’s liquidity commitments plus the extent of PWCE of conduit assets for which liquidity facilities were not provided by third parties.
Additionally the Group established an own-asset conduit in 2009 with a committed liquidity of £26.0 billion (2009 - £25.1 billion) to access the Bank of England’s open market operations for contingent funding purposes.
Collateral analysis, profile, credit ratings and weighted average lives relating to the Group’s consolidated conduits are detailed below.
Auto loans 4,943 346 5,289 2,964 — 8,253 Corporate loans 115 2,340 2,455 106 — 2,561 Credit card receivables 2,088 — 2,088 1,209 — 3,297 Trade receivables 761 — 761 1,090 — 1,851 Student loans 757 — 757 532 (132) 1,157 Consumer loans 1,889 — 1,889 111 — 2,000 Mortgages - prime 2,569 3 2,572 752 — 3,324 - non-conforming 1,371 — 1,371 20 — 1,391 - sub-prime residential mortgages 103 — 103 19 — 122 - commercial 210 450 660 76 (21) 715 Other 1,072 997 2,069 (8) (10) 2,051 15,878 4,136 20,014 6,871 (163) 26,722
The Group has the right to terminate the Scheme at any time provided that the Financial Services Authority has confirmed in writing to HMT that it has no objection. On termination, the Group is liable to pay HMT a termination fee. The termination fee comprises the difference between £2.5 billion (or, if higher, a sum related to the economic benefit of regulatory capital relief obtained from APS) and the aggregate fees paid. In addition, the Group would have to repay any amounts received from HMT under the terms of APS. In consideration for the protection provided by the APS, the Group paid an initial premium of £1.4 billion on 31 December 2009. A further premium of £700 million was paid on 31 December 2010. Quarterly premiums of £125 million are payable from 31 December 2011 and subsequently until the earlier of 31 December 2099 and the termination of the agreement.
Losses are recognised when a covered asset has experienced a trigger event which comprises of failure to pay subject to grace periods, bankruptcy and restructuring.
HMT has the right to appoint step-in managers to carry out any oversight, management or additional functions on behalf of HMT to ensure that the covered assets are managed and administered in compliance with the agreed terms and conditions. This right is exercisable if certain step-in triggers occur. These include: losses on covered assets in total exceed 125% of the first loss amount or losses on an individual covered asset class exceed specified thresholds; a breach of specified obligations in the APS rules or the accession agreement; the Group has failed or is failing to comply with any of the conditions in the APS rules in relation to asset management, monitoring and reporting, and governance and oversight, and such failure is persistent and material or it is evidence of a systematic problem; and material or systematic data deficiencies in the information provided to HMT in accordance with the terms of the APS.
Risk management: Asset Protection Scheme* continued Covered assets: roll forward to 31 December 2010
As part of the Group’s risk reduction strategy significant disposals were made from the Structured Credit Portfolio (2010 - £3.0 billion). The Group took advantage of market conditions and executed sales from its derivative, loan and leveraged finance portfolios (2010 - £6.7 billion).
The APA and the Group reached agreement for the purposes of the Scheme, on the classification of some structured credit assets which has resulted in adjustments to credit impairments and write downs mainly between debt securities and derivatives.
First loss utilisation The triggered amount is equivalent to the aggregate outstanding principal amount on the trigger date excluding interest, fees, premium or any other non-principal sum that is accrued or payable, except where it was capitalised on or before 31 December 2008. At the trigger date, in economic terms, there is an exchange of assets, with the Group receiving a two year interest-bearing government receivable in exchange for the asset.
The Scheme rules are designed to allow for data correction over the life of the Scheme.
38,718 26,602 Notes: (1) The triggered amount on a covered asset is calculated when an asset is triggered (due to bankruptcy, failure to pay after a grace period or restructuring with an impairment) and is the lower of the covered amount and the outstanding amount for each covered asset. The Group expects additional assets to trigger upon expiry of relevant grace periods based on the current risk rating and level of impairments on covered assets.
(2) Following the reclassification of some structured credit assets from derivatives to debt securities, the APA and the Group also reached agreement on an additional implied write down trigger in respect of these assets. This occurs if (a) on two successive relevant payment dates, the covered asset has a rating of Caa2 or below by Moody’s, CCC or below by Standard & Poor’s or Fitch or a comparable rating from an internationally recognised credit rating agency and/or (b) on any two successive relevant payment dates, the mark-to-market value of the covered asset is equal to or less than 40 per cent of the par value of the covered asset, in each case as at such relevant payment date.
(5) The Scheme rules contain provision for on-going revision of data.
Key points The Group received loss credits in relation to some of the withdrawals and disposals of £1.2 billion in 2010.
The Group currently expects recoveries on triggered amounts to be approximately 45% over the life of the relevant assets. On this basis, the expected loss on triggered assets at 31 December 2010 is approximately £25 billion (42%) of the £60 billion first loss threshold under APS.
Risk management: Asset Protection Scheme* continued Risk-weighted assets The table below analyses by division, risk-weighted assets (RWAs) covered by APS. 2010 2009 £bn £bn
Key points The decrease of £22.0 billion in RWAs reflects disposals and early repayments as well as changes in risk parameters.
In Non-Core, disposals and early repayments were offset by changes in risk parameters.
226 Board of directors and secretary 228 Executive Committee 230 Report of the directors 235 Corporate governance 246 Letter from the Chair of the Remuneration Committee 248 Directors’ remuneration report 264 Directors’ interests in shares 265 Statement of directors’ responsibilities
Stephen Hester (age 50) Group Chief Executive Appointed to the Board on 1 October 2008 and to the position of Group Chief Executive on 21 November 2008, Stephen Hester was chief executive of The British Land Company PLC. He was previously chief operating officer of Abbey National plc and prior to that he held positions with Credit Suisse First Boston including Chief Financial Officer, Head of Fixed Income and co-Head of European Investment Banking. From February 2008 to October 2008 he served as a nonexecutive deputy chairman of Northern Rock plc. He is also a trustee of The Foundation and Friends of the Royal Botanical Gardens, Kew.
Sandy Crombie* (age 62) Senior Independent Director, N, R, Ri Appointed to the Board in June 2009, Sandy Crombie was previously Group Chief Executive of Standard Life Plc. He was also previously a director of the Association of British Insurers and a member of the Chancellor of the Exchequer’s High Level Group. In 2007, he was the Prince of Wales’ Ambassador for Corporate Social Responsibility in Scotland. He currently serves as Chairman of the Edinburgh UNESCO City of Literature Trust and Creative Scotland, as Vice Chairman of the Board of Governors of the Royal Scottish Academy of Music and Drama, and President of The Cockburn Association.
Penny Hughes* (age 51) N, R (Chair) Penny Hughes joined the Board on 1 January 2010 and is currently a non-executive director of Home Retail Group plc, Cable & Wireless Worldwide plc and Wm Morrison Supermarkets plc. She is a former non-executive director of Gap Inc, Vodafone PLC and Reuters PLC. Penny chairs the Remuneration Committee of Home Retail Group. Penny was a director and chairman of the Remuneration Committee of Skandinaviska Enskilda Banken AB until she stepped down on 20 October 2009. Penny spent the majority of her executive career at Coca-Cola where she held a number of leadership positions. In 1992, she was appointed as President, Coca-Cola Great Britain and Ireland. She is also a Trustee of the British Museum and President of the Advertising Association.
John McFarlane* (age 63) N, R Appointed to the Board on 1 October 2008, John McFarlane is former chief executive officer of Australia and New Zealand Banking Group Limited. Previously he was a group executive director of Standard Chartered and was head of Citicorp/Citibank in the UK and Ireland. He is currently a non-executive director of Westfield Holdings Limited and a director of Old Oak Holdings Limited. He is a former president of the International Monetary Conference and a former chairman of the Australian Bankers Association. He has previously served as a director of the London Stock Exchange and a member of the Auditing Practices Board.
Brendan Nelson* (age 61) A (Chairman), N, Ri Appointed to the Board on 1 April 2010, Brendan Nelson is the former global chairman, Financial Services for KPMG. Previously, he held a range of senior leadership roles within KPMG including as a member of the KPMG UK board from 1999 until 2006 and as vice chairman from 2006. He has been a board member of the Financial Services Skills Council since 2008 and was chairman of the Audit Committee of the Institute of Chartered Accountants of Scotland from 2005 until 2008. He joined the Board of BP plc in November 2010.
Key to pictures 1 Stephen Hester, Group Chief Executive 2 Bruce Van Saun, Group Finance Director 3 Ellen Alemany, Chief Executive, Citizens and Head of Americas 4 Nathan Bostock, Head of Restructuring & Risk 5 Paul Geddes, Chief Executive, RBS Insurance 6 Brian Hartzer, Chief Executive, UK Retail, Wealth and Ulster Bank 7 John Hourican, Chief Executive, Global Banking & Markets 8 Chris Sullivan, Chief Executive, UK Corporate 9 Ron Teerlink, Chief Administrative Officer
It is responsible for managing Group wide issues and those operational issues material to the broader Group.
Ellen Alemany (age 55) Chief Executive, Citizens and Head of Americas Ellen Alemany joined the RBS Group in June 2007 as Chief Executive Officer of Citizens Financial Group, Inc. and Head of RBS Americas. She became Chairman of Citizens Financial Group, Inc. in March 2009. Prior to this appointment, Ellen was the CEO for Global Transaction Services at Citigroup, one of Citi’s 12 publicity reported product lines. Ellen joined Citibank in 1987 and has held various positions including EVP for Commercial Business Group, Chairman and CEO for Citibank International plc and Citibank’s European Bank.
Brian Hartzer (age 44) Chief Executive, UK Retail, Wealth and Ulster Bank Brian Hartzer has been the Chief Executive Officer for Retail, Wealth and Ulster Bank since August 2009. He joined RBS from ANZ in Australia, where he was Chief Executive Officer Australia, as well as Global Segment Lead for Retail and Wealth. Brian joined ANZ in 1999 as Managing Director, Consumer Finance, and later ran ANZ’s Personal Banking division. Prior to joining ANZ, Brian spent ten years as a financial services consultant in New York, San Francisco, and Melbourne. Brian is a graduate of Princeton University and holds joint US and Australian citizenship.
John Hourican (age 40) Chief Executive, Global Banking & Markets John Hourican was appointed Chief Executive of Global Banking & Markets in October 2008. Prior to this John held a variety of positions across the RBS Group, including CFO of ABN AMRO Group, Head of Leveraged Finance and Chief Operating Officer of Global Banking & Markets. John was educated at the National University of Ireland and received his Postgraduate Diploma from Dublin City University before starting his career at Price Waterhouse, where he worked in Dublin, London and Hong Kong. He is a fellow of the Institute of Chartered Accountants in Ireland.
Group structure The company is a holding company owning the entire issued ordinary share capital of The Royal Bank of Scotland plc, the principal direct operating subsidiary undertaking of the company. The Group comprises the company and all its subsidiary and associated undertakings, including the Royal Bank and NatWest. Details of the principal subsidiary undertakings of the company are shown in Note 18 on the accounts.
During the year, the company converted certain non-cumulative convertible preference shares into ordinary shares in the company. As a result, HM Treasury’s holding in the company’s ordinary shares reduced to 67.8%.
The company did not pay a dividend on ordinary shares in 2009 or 2010.
Business review Activities The Group is engaged principally in providing a wide range of banking, insurance and other financial services. Further details of the organisational structure and business overview of the Group, including the products and services provided by each of its divisions and the competitive markets in which they operate, are contained in the Business review on pages 53 and 54.
The reported results of the Group are also sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. Details of the Group’s critical accounting policies and key sources of accounting judgments are included in Accounting policies on pages 275 to 285.
The Group’s approach to risk management, including its financial risk management objectives and policies and information on the Group’s exposure to price, credit, liquidity and cash flow risk, is discussed in the Risk and balance sheet management section of the Business review on pages 119 to 224.
Financial performance A review of the Group's performance during the year ended 31 December 2010, including details of each division, and the Group's financial position as at that date is contained in the Business review on pages 56 to 112.
The shareholdings of RFS Holdings B.V. were amended on 31 December 2010, resulting in approximately 98% of its issued share capital now being held by the Group.
Business divestments Significant progress has been made on the Group’s European Commission-mandated disposal programme, with three of the four disposals largely agreed. In August 2010, agreement was reached on the sale of the Group’s RBS branches in England and Wales and NatWest branches in Scotland to Santander UK plc. The sale remains subject to regulatory and other approvals.
The sale of RBS Sempra Commodities’ Metals, Oil and European Energy business lines to J.P.Morgan completed in July 2010. The sale of Sempra Energy Solutions to Noble Americas Gas & Power Corp completed in November 2010, while the sale of Sempra North American Power and Gas to J.P.Morgan completed in December 2010.
Diversity and inclusion The Group recognises that the diversity of its workforce is a significant and necessary asset to the business. During 2010, the Group executive renewed its commitment to ensuring a working environment that is inclusive to all and one that will enable all employees to develop to their full potential.
The Group has a range of policies and processes that extend through the employee life-cycle including recruitment, flexible working and support for ill-health and disability-related absence. Diversity performance is monitored and reviewed at Group and divisional executive level. This commitment extends beyond the Group including support of external charitable networks and fora and as part of the community engagement and supplier relationships. Internally, the Group supports initiatives such as the Women in Business network.
The Group continues to do significant work and address challenges across five key themes: Fair banking, Supporting enterprise, Employee engagement, Safety and security, and Citizenship and environmental sustainability. For more information on the Group Sustainability programme, see pages 43 to 47.
Corporate governance The company is committed to high standards of corporate governance. Details are given on pages 235 to 245. The corporate governance statement forms part of this Report of the directors.
The cumulative preference shares represent less than 0.01% and the non-cumulative preference shares represent less than 0.73% of the total voting rights of the company respectively, the remainder being represented by the ordinary shares.
The rules governing the appointment of directors are set out in the company’s Articles of Association and on page 236. The company’s Articles of Association may only be amended by a special resolution at a general meeting of shareholders.
The rights and obligations of holders of non-cumulative preference shares are set out in Note 29 on the accounts.
Colin Buchan, Sandy Crombie, Philip Hampton, Stephen Hester, Penny Hughes, Joe MacHale, John McFarlane, Art Ryan, Philip Scott and Bruce Van Saun all served throughout the year and to the date of signing of the financial statements.
Brendan Nelson was appointed as a non-executive director on 1 April 2010.
Archie Hunter retired as a non-executive director on 28 April 2010.
All directors of the company will stand for re-election by shareholders at the 2011 Annual General Meeting and annually thereafter. Colin Buchan will stand down as a non-executive director on 5 August 2011 following the announcement of the Group’s interim results, having served just over nine years on the Board.
In terms of section 236 of the Companies Act, Qualifying Pension Scheme Indemnity Provisions have been issued to all trustees of the Group’s pension schemes.
Shareholdings The table below shows shareholders that have notified the Group that they hold more than 3% of the total voting rights of the company at 31 December 2010.
Ordinary shares 39,644,835,194 67.8 B shares (non-voting) 51,000,000,000 100.0 233RBS Group 2010
RBS Services Australia Limited, a company acquired by the Group through its acquisition of ABN AMRO, made donations of AUS$126,552 (£75,397) during 2010 to Australian political parties and Australian partyaffiliated fundraising vehicles. These payments were fully compliant with ABN AMRO policy and Australian electoral law. No further donations will be made and it is not proposed that the Group’s longstanding policy of not making contributions to any political party be changed.
At 31 December 2010, the Group’s trade creditors represented 29 days (2009 - 30 days) of amounts invoiced by suppliers.
Throughout the year ended 31 December 2010, the company has complied with all of the provisions of the Combined Code issued by the Financial Reporting Council in June 2008 (the "Code") except in relation to the provision that the Remuneration Committee should have delegated responsibility for setting remuneration for the Chairman and executive directors. The company considers that this is a matter which should rightly be reserved for the Board. No director is involved in decisions regarding his or her own remuneration.
Although not applicable to the current accounting period, the company has also complied with the main provisions of the UK Corporate Governance Code issued by the Financial Reporting Council in May 2010 (the “new Code”) except as noted above. The company has also taken steps to implement the recommendations arising from the review of governance in banks and financial institutions undertaken by Sir David Walker (the “Walker Review”), details of which are described in this section. A copy of the new Code can be found at
Under the US Sarbanes-Oxley Act of 2002 (the "Act"), specific standards of corporate governance and business and financial disclosures apply to companies with securities registered in the US. The company complies with all applicable sections of the Act.
Board of directors The Board is the main decision-making forum for the company. It has overall responsibility for management of the business and affairs of the Group, the establishment of Group strategy and the allocation and raising of capital, and is accountable to shareholders for financial and operational performance. The Board considers strategic issues and ensures the Group manages risk effectively through approving and monitoring the Group’s risk appetite, considering Group stress scenarios and agreed mitigants and identifying longer term strategic threats to the Group’s business operations. The Board has a formal schedule of matters detailing key aspects of the company’s affairs reserved to it for its decision. This schedule is reviewed bi-annually.
The roles of Chairman and Group Chief Executive are distinct and separate, with a clear division of responsibilities. The Chairman leads the Board and ensures the effective engagement and contribution of all executive and non-executive directors. The Group Chief Executive has responsibility for all Group businesses and acts in accordance with the authority delegated by the Board. Responsibility for the development of policy and strategy and operational management is delegated to the Group Chief Executive and the Group Finance Director.
For 2010, eleven Board meetings were scheduled. Individual attendance at these meetings is set out on page 238. The directors were supplied with comprehensive papers in advance of each Board meeting. The Group Chief Executive provides a written report on business activities at each Board meeting. Members of executive management attend and make regular presentations at meetings of the Board. The Chairman and the non-executive directors meet at least once per year without executive directors present.
The Board is aware of the other commitments of its directors and has established procedures for ensuring that the Board’s powers for authorising directors’ conflicts of interest are being operated effectively. With effect from 1 October 2008, the Companies Act introduced a statutory duty on directors to avoid conflicts of interest unless authorised. Since that date, the Board has considered, and where appropriate authorised, any actual or potential conflicts of interests that directors may have.
The Board considers that the Chairman was independent on appointment and all non-executive directors are independent for the purposes of the Code. The standard terms and conditions of the appointment of nonexecutive directors are available on the Group’s website (www.rbs.com) and copies are available on request.
Information, induction and professional development All directors receive accurate, timely and clear information on all relevant matters, and 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.
In line with recommendations of the Walker Review and the new Code, the company has reviewed the induction programme for new directors. Each new director receives a formal induction on joining the Board, including visits to the Group’s major businesses and meetings with directors and senior management and key stakeholders. The induction is tailored to the director’s specific requirements.
The company has undertaken a comprehensive review of the ongoing professional development programme for directors. Directors are advised of appropriate training and professional development opportunities and undertake the training and professional development they consider necessary in assisting them to carry out their duties as a director.
Separate in-depth evaluations were carried out for each of the Audit Committee, Board Risk Committee and Remuneration Committee by the Group Secretary, where appropriate in conjunction with the Committee Chair. Further information on the evaluations carried out in relation to the Audit Committee, Board Risk Committee and Remuneration Committee is set out on pages 243, 245 and 249 respectively.
Separately, the Senior Independent Director canvassed the views of the executive directors and met with the non-executive directors as a group, without the Chairman present, to consider the Chairman’s performance. Feedback was sought on governance and stewardship of the Group, relationships with key external and internal stakeholders, execution of the Group’s Strategic Plan and delivery of value and return to shareholders. The Senior Independent Director also canvassed views from United Kingdom Financial Investments Limited (UKFI) and the FSA. The results of this were then shared with the Chairman who agreed to consider the points raised and provide separate responses in due course.
Audit Committee The Audit Committee is comprised of at least three independent nonexecutive directors. The Audit Committee held seven scheduled meetings in 2010.
The Audit Committee is responsible for assisting the Board in discharging its responsibilities in relation to the disclosure of the financial affairs of the Group. The Audit Committee reviews the accounting policies, financial reporting and regulatory compliance practices of the Group, the Group’s system and standards of internal controls, monitors the Group’s processes for internal audit and external audit and reviews the practices of the Divisional Risk and Audit Committees. The Audit Committee report is set out on pages 240 to 243.
Board Risk Committee The Board Risk Committee is comprised of at least three independent non-executive directors. The Board Risk Committee held six scheduled meetings and three additional meetings in 2010.
The Remuneration Committee is responsible for the overview of the Groups remuneration policy and remuneration governance framework, ensuring that remuneration arrangements are consistent with and promote effective risk management. The committee also makes recommendations to the Board on the remuneration arrangements for executive directors.
Nominations Committee All non-executive directors are members of the Nominations Committee which is chaired by the Chairman of the Group. The Group Chief Executive is invited to attend meetings. The Nominations Committee holds at least two scheduled meetings per year, and also meets on an ad hoc basis as required.
Further details of the Group’s sustainability policies are available on www.rbs.com/sustainability and in the Annual Sustainability Report.
Meetings The number of scheduled meetings of the Board and the Audit, Board Risk, Remuneration and Nominations Committees and individual attendance at these meetings by members in 2010 is shown below.
In addition to scheduled meetings, 15 additional meetings of the Board and Committees of the Board were held during 2010, including meetings to consider and approve financial statements. There were also three additional meetings of the Board Risk Committee and six additional meetings of the Remuneration Committee during 2010.
Total number of scheduled meetings in 2010 11 7 6 9 2 Number of meetings attended in 2010 Philip Hampton 11 2 Stephen Hester 11
Relations with shareholders The company communicates with shareholders through the Annual Report and Accounts 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 primarily by letter, telephone or email via the Group’s website (www.rbs.com/ir).
The Chair of the Remuneration Committee consults with institutional shareholders in respect of the Group’s remuneration policy.
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 2010 and to 23 February 2011, the date the directors approved the Report and Accounts. This is confirmed by a process which requires senior members of the executive and management to certify that they have assessed the adequacy and effectiveness of their internal control framework and the compliance of their business with Group policies and associated standards (in accordance with the Group Policy Framework), and they meet the requirements of Sarbanes-Oxley Section 404 and the UK Corporate Governance Code Section C2. The policies that govern these processes, and reports on internal controls arising from them, are regularly reviewed by the Board and meet the requirements of the guidance ‘Internal Control: Revised Guidance for Directors on the Combined Code’ issued by the Financial Reporting Council in October 2005. Enhancements have been made to the Risk Management framework throughout 2010 and further improvements will be made in 2011.
The Group’s independent auditors present to the Audit Committee reports that include details of any significant internal control matters which they have identified. The system of internal controls of the authorised institutions and other regulated entities in the Group is also subject to regulatory oversight in the UK and overseas. Additional details of the Group’s regulatory oversight are given in the Supervision and Regulatory developments and reviews sections on pages 397 to 399.
Internal control over financial reporting The Group is required to comply with Section 404 of the US SarbanesOxley Act of 2002 and assess the effectiveness of internal control over financial reporting as of 31 December 2010.
The Board is satisfied that all Audit Committee members have recent and relevant financial experience, and that each member of the Audit Committee is an ‘Audit Committee Financial Expert’ and is independent, each as defined in the SEC rules under the Exchange Act and related guidance. I am a Chartered Accountant, a member of the Institute of Chartered Accountants of Scotland and a former Vice Chairman of KPMG in the UK; Philip Scott is a fellow of the Institute of Actuaries and a former Group Finance Director of Aviva plc; and Colin Buchan is a Fellow of the Chartered Institute of Bankers of Scotland and was a member of the group management board at UBS AG. The members of the Audit Committee are selected with a view to the expertise and experience of the Audit Committee as a whole, and the Audit Committee reports to the Board as a single entity.
Meetings and visits A total of seven meetings of the Audit Committee were held in 2010, including meetings held immediately prior to the submission of the interim and annual financial statements to the Boards and the quarterly Interim Management Statements. Audit Committee meetings are attended by relevant executive directors, the internal and external auditors and Finance and Risk management executives. Other executives, subject matter experts and external advisers are also invited to attend the Audit Committee, as required, to present and advise on reports commissioned by the Committee. At least twice per annum the Audit Committee meets privately with the external auditors.
Work in 2010 During 2010, the work of the Audit Committee focused on a number of key areas, including: accounting, financial reporting and regulatory compliance; impairments and fair values; standards of internal control, including the work of the internal and external auditors; provisioning and credit exposures; general insurance reserves; and the work and role of Divisional Risk and Audit Committees in so far as they relate to the work of the Committee.
In addition the external auditors provided the Audit Committee with reports summarising their main observations and conclusions arising from their year end audit, their half year review and their work in connection with the first and third quarters, inter alia, inclusive of their comments on the issues set out below; and their recommendations for enhancements to the Group’s reporting and controls.
The Audit Committee oversees the work of Group Internal Audit, and receives a quarterly report from the Head of Group Internal Audit. This report rates the quality of the control environment of all the Group’s divisions and of management’s level of awareness on these matters. Group Internal Audit report to the Committee on areas where improvements are required to the control environment. The Audit Committee actively monitors these reports and ensures relevant matters raised are dealt with in a timely and appropriate manner. These reports offer the Audit Committee oversight of Group Internal Audit’s work, and allow the Audit Committee to monitor the level of internal control within the Group.
The Audit Committee oversees the Group’s compliance with the rules of the APS, and reviews regular progress reports from RBS Risk Management.
Relevant management also presented on a number of specific reporting, compliance and internal control matters.
As far as it can determine, the Audit Committee received all the information and material it required to allow it to meet its obligations in respect of the 2010 financial statements.
The Audit Committee 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 annual evaluation is carried out following completion of the annual accounts and audit.
The outcomes of the evaluation were considered by the Audit Committee and Board.
In addition to the annual evaluation performed by the Audit Committee, the external auditors conduct their own annual review of audit quality.
The Audit Committee approves the terms of engagement of the external auditors. The Audit Committee also fixes the remuneration of the external auditors as authorised by shareholders at the Annual General Meeting.
Annual audit services include all services detailed in the annual engagement letter including the annual audit and interim reviews (including US reporting requirements) and periodic profit verifications.
Prospectively approved non-audit services include the following classes of service: capital raising, including consents, comfort letters and relevant reviews of registration statements; provision of accounting opinions relating to the financial statements of the Group; provision of reports that, according to law or regulation, must be rendered by the external auditors; tax compliance services; permissible services relating to companies that will remain outside the Group; restructuring services relating to the Group's customers; and reports providing assurance to third parties over certain of the Group's internal controls prepared under US Statement of Auditing Standards 70 or similar auditing standards in other jurisdictions.
For all other permitted non-audit services, Audit Committee approval must be sought, on a case by case basis, before the provision of the service commences. In August 2010, the Audit Committee approved changes to the existing non-audit services policy. The new streamlined process allows for the Chairman of the Audit Committee (or, in his absence, a designated delegate) to approve any non-audit services request with a value under £100,000. Any request with a value above this amount must be approved by the full Audit Committee. To ensure good governance all requests, regardless of financial limits, have to be approved by the Group Chief Accountant and Group Sourcing and Vendor Management. At each Audit Committee meeting, any non-audit services requests which have been approved since the previous meeting are considered for ratification.
Performance evaluation An external review of the effectiveness of the Audit Committee takes place every three to five years, with internal reviews by the Board continuing in the intervening years. An internal review of the effectiveness of the Audit Committee during 2010 was conducted. The evaluation used detailed questionnaires and individual meetings were held with each member. Amongst the areas reviewed were the role of the Committee, composition, meetings and processes, performance and reporting, policy and procedures, divisional committees, induction and continuing professional development and communication.
The evaluation concluded that the Audit Committee operated effectively throughout 2010. The Committee was seen as effective in meeting its objectives, with members willing to spend the time necessary to do a good job. It was agreed that the new Chairman was a strong addition to the Committee, in particular given his strong financial background. The evaluation concluded that, whilst the Committee was of the appropriate size to discharge its responsibilities and the members had the appropriate skills and experience, Committee composition should be kept under review to ensure that the correct balance of skills and experience is maintained. The training and specific sessions on individual businesses and divisions were highly rated.
The Committee has considered and discussed the report on the outcomes of the evaluation and is satisfied with the way in which the evaluation has been conducted, the conclusions and the recommendations for action. The outcomes of the evaluation have been reported to the Board and the actions are being progressed.
An external review of the effectiveness of Group Internal Audit takes place every three to five years, in line with best practice, with internal reviews continuing in the intervening years. In 2010, an external review was conducted by Ernst & Young. In May 2010, the Audit Committee was presented with the final report by Ernst & Young. The report found that Group Internal Audit was compliant with all relevant professional standards.
Brendan Nelson Chairman of the Audit Committee 23 February 2011 243RBS Group 2010
Archie Hunter was a member of the Board Risk Committee until 28 April 2010 when he stood down as a non-executive director at the end of his existing term.
Colin Buchan, Brendan Nelson and I are also members of the Audit Committee. This common membership ensures effective governance across all Finance and Risk issues, and that agendas are aligned and overlap is avoided. The Board Risk Committee and Audit Committee also have strong links with the Remuneration Committee, with particular regard to ensuring that relevant Finance and Risk matters are factored in to the determination of appropriate levels of compensation.
Meetings and visits A total of nine meetings of the Board Risk Committee were held during 2010. Meetings are held as soon as practicable prior to Audit Committee meetings to ensure that the work of the two Committees is coordinated and consistent. A meeting is held immediately prior to submission of the interim and annual financial statements to the Board and the quarterly Interim Management Statements. This core programme is supplemented by additional meetings as required. Board Risk Committee meetings are attended by relevant executive directors, risk management, finance executives and the internal auditors. External advice may be sought by the Board Risk Committee where considered appropriate.
Work in 2010 During 2010, the work of the Board Risk Committee focused on a wide range of matters, including the following key areas: risk strategy and policy; risk profile; risk appetite, framework and limits; risk management operating model; and remuneration.
At each meeting of the Board Risk Committee, the Group Chief Risk Officer provided the Committee with a presentation on the key risk issues faced by the Group. An update was also given on the key issues discussed at the Group’s Executive Risk Forum. In 2010 the Board Risk Committee considered a range of matters including: the Group’s economic capital model; the structured credit portfolio; the output of stress testing and scenario planning; the operational plan for the Group’s risk management function including organisation, resource and budget; treating customers fairly and customer complaints; and remuneration strategy and policy, including recommendations to the Remuneration Committee.
The Board Risk Committee considered the Group's risk profile relative to current and future Group strategy. The Committee reported to the Board following each meeting on its consideration of the risk profile of the Group and any longer term macro or perceived strategic threats to the Group and made recommendations as appropriate.
The Group Policy Framework provides a basis for ongoing selfassessment of appropriate risk appetite. The Board Risk Committee received regular reports on the development of the Group Policy Framework during 2010.
The Group risk appetite framework was developed significantly during 2010 and continues to be enhanced. Risk appetite was regularly reviewed by the Board Risk Committee, which makes recommendations to the Board on risk appetite and tolerance as part of this ongoing process. This includes the Risk Management Operating Model, including the frameworks for credit, operational, regulatory, market, insurance and business continuity risk.
The Committee also considered the Group's exposure to country, single name and sector concentration risk and ensured rigorous stress and scenario testing of the Group's business was undertaken. The output of this testing was reviewed by the Board Risk Committee throughout 2010 with a view to ensuring appropriate actions were taken where necessary. It made recommendations to the Group Board regarding related authorities, limits and mandates.
The Committee considered the adequacy and effectiveness of the technology infrastructure supporting the finance and risk management framework.
As required under the Walker Review, the Committee will meet as required to review the due diligence of any proposed strategic transaction (involving a merger, acquisition or disposal) prior to the Group Board approval of the transaction.
Performance evaluation An internal review of the effectiveness of the Board Risk Committee during 2010 was conducted. The evaluation used detailed questionnaires and individual meetings were held with each member. Amongst the areas reviewed were the Role of the Committee, Composition, Meetings and Processes, Performance and Reporting, Policy and Procedures, Divisional Committees, Induction and Continuing Professional Development and Communication.
Philip Scott Chairman of the Board Risk Committee 23 February 2011
Across the Group we operate a range of incentive structures which are designed to reinforce messages about what employees are being asked to achieve, and deliver pay for performance. Our key objective in determining bonus awards is not to pay more than is warranted given business performance. In this context performance includes financial and non financial measures, risk performance and any other relevant factors. Our aggregate bonus awards for 2010 are lower than prior year as a result of lower profits and bonuses in the investment banking division and our recognition of the need for moderation. There is clear focus on differentiation, so that individually and by business, the best performers and the best performance will continue to be rewarded. There is strong central governance and oversight of both bonus pools and individual awards, and each year a significant proportion of staff will receive zero bonus.
The key elements of our remuneration policy are: Pay for performance Performance related pay is designed to reflect success or failure against the range of targets which we set for our people, taking into account the context in which results were achieved. By way of example, the pay arrangements for executive directors are aligned to the performance of the Group and performance related pay is paid entirely in shares over several years. Executive directors have “no reward for failure” provisions in their service contracts. Further information on the company’s business performance and progress towards achievement of its strategic objectives can be found on pages 12 to 13.
Risk adjustment Focus on risk is achieved through clear risk input into incentive plan design and target setting, as well as a thorough risk review of performance, bonus pools and clawback. The Remuneration Committee has been supported in this by the Board Risk Committee and the RBS Risk Management function.
While the primary focus of the remuneration policy clearly has to be to support the business to deliver the Strategic Plan, some shareholders asked for reassurance that the Remuneration Committee had in place sufficient tools to be able to adjust remuneration appropriately should another financial crisis occur. I am pleased to confirm that a huge amount of progress has been made in this respect.
The starting point is making sure we set the right objectives in the first place. Risk is a key factor when setting annual and long term objectives and an independent review of risk objectives is undertaken by the RBS Risk Management function and the Board Risk Committee. At the end of each performance period, performance outcomes and bonus pool proposals are subject to rigorous review by the control functions, independent of the businesses/divisions. Our LTIP also has a risk underpin whereby awards will not vest unless the Remuneration Committee is satisfied on risk performance. Both annual and long term awards are subject to clawback and, accordingly, the Remuneration Committee has discretion to reduce the number of shares under award or determine that no shares will vest.
External developments A number of external developments have impacted remuneration and remuneration policy in 2010, including the publication of the FSA’s revised Remuneration Code (the “FSA Code”). In light of the FSA Code, a review was undertaken of the remuneration policy and governance arrangements. I am pleased to report that the Group has been fully compliant with all aspects of the FSA Code from 1 January 2011.
Throughout 2010 we continued to work through a period of unprecedented restructuring. The Group has delivered remuneration arrangements that are FSA compliant, take proper account of the public mood and call for restraint and support the overarching objective of maximising shareholder returns and delivering a profit for the taxpayer. Importantly, these arrangements are consistent with the Project Merlin agreement.
Membership of the Remuneration Committee The current members of the Remuneration Committee are Penny Hughes (Chair since 1 June 2010), Sandy Crombie, and John McFarlane. The members of the Remuneration Committee are all independent nonexecutive directors. Colin Buchan stepped down as Chairman and member of the Remuneration Committee on 1 June 2010. Attendance of each member at meetings of the Remuneration Committee in 2010 is shown on page 238.
The Remuneration Committee is also responsible for setting the remuneration arrangements for members of the Group’s Executive Committee and Management Committee, as well as all higher-earning employees and any employees falling within the definition of “Code Staff” under the FSA Code. Details of the FSA Code can be found at www.fsa.gov.uk.
The Remuneration Committee undertakes a regular review of the adequacy and effectiveness of the remuneration policy to ensure it is fully aligned with the Group's long-term objectives. The Committee receives a number of reports to assist it in its oversight of remuneration policy, such as on risk and financial performance across the Group.
In December 2010, the Asset Protection Scheme Performance and Reward Committee (APSPRC) was formed. It is responsible for reviewing, reporting and, in certain cases, making recommendations to the Remuneration Committee in respect of (i) collective overall and individual performance of individuals who manage business units or assets which are assigned to or participate in the Asset Protection Scheme (APS), and members of the Group executive against the APS performance targets; (“APS In-Scope employees”) (ii) the individual proportion of the incentive and bonus components of the remuneration of those employees to be evaluated against APS performance targets for each calendar year and (iii) whether clawback should be applied to any deferred compensation elements of the remuneration of those employees prior to their vesting.
During the year, as well as advice received from Towers Watson and PwC, the Committee took account of the views of the Group Chairman, Philip Hampton; Group Chief Executive, Stephen Hester; Group Human Resources Directors, Neil Roden (until October 2010) and Elaine Arden (from October 2010); the Group General Counsel and Group Secretary, Miller McLean (until April 2010); and the Group Secretary, Aileen Taylor (from May 2010). Advice was received from Nathan Bostock, Head of Restructuring and Risk, on risk-adjustment of measures for bonus pool funding and a risk review of individual performance evaluations for the Management Committee. The Chairman of the Board Risk Committee, Philip Scott, also attended a Remuneration Committee meeting to advise the Committee on matters relating to risk adjustment.
Generally, the Committee was considered to be effective and meeting its objectives, with members willing to spend the time necessary to discharge their responsibilities. Whilst the Committee was viewed as being of the right size and headed by a strong Chair, composition will be kept under review to maintain the correct balance of skills and experience. Improvement in the quality of Committee papers was acknowledged, although work is being undertaken to deliver further improvements. The importance of a strong link between the Committee and the Board Risk Committee was recognised and, whilst it was acknowledged that this relationship was working well, it was agreed that further improvements should be actively considered.
The Committee has considered and discussed the report on the outcomes of the evaluation and is satisfied with the way in which the evaluation has been conducted, the conclusions and the recommendations for actions. The outcomes of the evaluation have been reported to the Board and the actions are being progressed.
Group-wide remuneration policy The Remuneration Committee has reviewed the Group's remuneration policy which is anticipated will apply in 2011 and in subsequent years.
The remuneration policy supports the Group's business strategy and is designed to: attract, retain, motivate and reward high calibre employees to deliver superior long-term business performance; and ensure that the Group's metrics, reward structures and governance processes as a whole provide coverage of the key risks in an appropriate way.
The key principles underpinning the remuneration policy are set out below: Pay-for-performance Reward is linked to business and individual performance and appropriate account is taken of risk factors associated with that business, including where appropriate risks associated with the sustainability agenda.
Allow for customisation The composition of reward generally allows for customisation through individual choice, in order to maximise value delivered to employees.
Overall expenditure on annual incentives is reviewed by the Remuneration Committee at the end of each year taking into account the performance of the business on the basis described above. This is further scrutinised on a divisional and functional basis based on a range of different efficiency and risk adjusted profit measures including changes in Economic Profit for shareholders.
Allocation of any variable reward from the pool depends on divisional, functional and individual performance against the performance measures set at the beginning of the year. Individual performance assessment is supported by a structured performance management framework. Targets should be specific, measurable, set at the beginning of the year and communicated to the employees.
The Group only uses guaranteed bonuses in limited circumstances in accordance with the FSA Code.
Deferred awards The purpose of deferred awards is to support a performance culture where employees recognise the importance of sustainable Group, business and individual performance. Under the Group-wide deferral arrangements a significant proportion of annual incentive awards for our more senior employees will be deferred over a three year period. Deferred awards are subject to clawback.
A new deferral plan was approved by shareholders on 15 December 2009. Under this plan, annual incentives are deferred into awards vesting over a three year period. A significant portion of deferral is in a form which meets regulatory requirements.
In addition to salary and benefits, executive directors receive variable remuneration in the form of annual and long-term incentives.
Annual incentives Following consultation with UKFI and other institutional shareholders, a Share Bank arrangement has been put in place for the executive directors’ annual incentive awards for 2010 and 2011. The Share Bank arrangement replaces the previous annual incentive arrangement and means that the executive directors will receive no cash bonus.
The Remuneration Committee has reviewed the annual incentive awards for the executive directors for 2010 performance, taking into account performance against targets set at the beginning of 2010. Performance was assessed across a broad range of quantitative and qualitative measures and was supported by a robust performance management framework including a formal half year review.
During 2010, performance has been strong and all the Group's main performance indicators are ahead of the Strategic Plan both in terms of timing and outcomes. More information on the Group’s performance can be found on pages 12 and 13. There are, however, a small number of areas where the Group is not performing well ahead of the targets which have been set. Accordingly, the Remuneration Committee has recommended, and the Board (excluding executive directors) has agreed, that the Group Chief Executive and Group Finance Director should receive annual incentive awards of 170% and 186% of salary respectively.
The Remuneration Committee will determine the actual allocation to Share Bank by reference to the extent to which executive directors have met the performance targets. Shares allocated in respect of 2011 performance will vest in two equal tranches in March 2013 and 2014 respectively. Clawback provisions will apply to shares allocated to Share Bank for the period prior to their vesting.
As in 2010, awards in 2011 will be granted under the LTIP, and will be entirely in the form of shares (rather than share options).
Awards to executive directors have a normal maximum limit of 400% of salary. Whilst the award policy for executive directors may be increased in exceptional circumstances, prior shareholder consultation would be undertaken.
Awards granted to executive directors in 2011 will be capped at 375% of agreed salary.
Performance criteria for awards granted to executive directors under the LTIP in 2011 Performance conditions for the 2011 LTIP awards have been chosen not only to align executive directors directly with outcomes for shareholders but also with those key actions required to deliver shareholder value over the long term and factor in the growing regulatory emphasis on riskadjusted financial metrics. The four performance measurement areas set out below are equally weighted: Relative Total Shareholder Return (TSR) (25%); Core Bank Economic Profit (25%); Balance Sheet & Risk (25%); and
The four performance conditions attached to the awards (see description of performance conditions on pages 252 to 254) will each have the ability to deliver a number of shares worth up to 100% of salary (based on agreed salary at date of grant and share price based on a five day average prior to grant); however, the number of shares that vest will be subject to an overall cap in value of 375% of salary (again, based on agreed salary and share price at the time the award was made).
The relative TSR performance condition is identical to that applying for 2010 LTIP awards. The relative TSR measure compares the Group’s performance over a three year performance period against a basket of banks from the UK and overseas, weighted towards those companies most similar to the Group.
current cost of equity is 12%, which is subject to review at least annually.
Targets have been set so that maximum vesting under the awards is only achieved for performance ahead of the Group’s refreshed Strategic Plan. 25% of this portion of the award will vest at threshold performance. Threshold vesting requires average return on tangible equity over the performance period at a reasonable margin above the cost of capital.
Performance measures Non-Core assets Cumulative Non-Core loss Group Core Tier 1 Capital Wholesale funding Liquidity reserves Leverage ratio Loan to deposit ratio Risk Appetite Framework Funded assets
Attributes driving credit rating UK Retail and Commercial franchise US Retail and Commercial franchise Investment Banking franchise Measures from Group’s customer dashboard Cost:income ratio in Core bank European Commission divestments Sustainability Relative Economic Profit Growth Progress in people issues Embed strategic thinking, balanced business evolution
Majority of Group’s divisions to have met the ‘5 tests’ at heart of the Strategic Plan
To avoid unintended consequences, the scorecard will not be set in a formulaic manner, but will provide a framework for structured Remuneration Committee discretion, which will be supported by disclosure at the end of the performance period justifying the vesting decision arrived at. In addition, commentary will be provided on an annual basis in relation to progress against targets (where not commercially sensitive).
Does not meet 0% Over half of objectives not met Partially meets 25% Half of objectives met Significantly meets 62.5% Two-thirds of objectives met Fully meets 100% Objectives met or exceeded in all material respects Qualified by Remuneration Committee discretion taking into account changes in circumstances over the performance period, the relative importance of the measures, the margin by which individual targets have been missed or exceeded, and any other relevant factors.
Risk underpin and clawback The Remuneration Committee will also review financial and operational performance against the Strategic Plan and risk performance prior to agreeing vesting of awards.
If the Remuneration Committee considers that the vesting outcome calibrated in line with the performance conditions outlined above does not reflect the Group's underlying financial results or if the Committee considers that the financial results have been achieved with excessive risk, then the terms of the awards allow for an underpin to be used to reduce vesting of an award, or to allow the award to lapse in its entirety.
2011 compensation framework The chart below summarises the 2011 compensation framework (illustration for the Group Chief Executive): In order to comply with the FSA Code, shares will be subject to a holding period of six months after vesting.
Total shareholder return performance The performance graph below 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 FTSE banks for the same period has been added for comparison. The total shareholder return for the company and the indices have been rebased to 100 for 2005. The second graph below illustrates the same performance of the company during 2010. Salary
Service contracts The company's policy in relation to the duration of contracts with directors is that executive directors' contracts generally continue until termination by either party, subject to the required notice, or until retirement. The notice period under the service contracts of executive directors will not normally exceed twelve months. In relation to newly recruited executive directors, subject to the prior approval of the Remuneration Committee, the notice period may be extended beyond twelve months if there is a clear case for this. Where a longer period of notice is initially approved on appointment, it will normally be structured such that it will automatically reduce to twelve months in due course.
Stephen Hester If Stephen Hester's employment is terminated by reason of his personal underperformance, the company is entitled to terminate by giving written notice with immediate effect and without making any payment in lieu thereof and Stephen Hester will forfeit any unvested stock awards.
The company has agreed that, provided certain conditions are met, on leaving employment, Bruce Van Saun will not forfeit awards under the rules of the Deferral Plan, the Medium-term Performance Plan and the Executive Share Option Plan.
Gordon Pell Gordon Pell retired from employment of the Group on 31 March 2010 on attaining his normal retirement age. In line with the rules of the Group Pension Fund, no discount applied on payment of his pension.
Sandy Crombie 1 June 2009 2011 Penny Hughes 1 January 2010 2011 Joe MacHale 1 September 2004 2011 John McFarlane 1 October 2008 2011 Brendan Nelson 1 April 2010 2011 Art Ryan 1 October 2008 2011 Philip Scott 1 November 2009 2011
Note: (1) Colin Buchan will stand down as a non-executive director of the Group on 5 August 2011 following the announcement of the Group’s interim results, having served just over nine years on the Board.
No compensation would be paid to any non-executive director in the event of termination of appointment.
Executive directors Stephen Hester (2) 1,219 2,040 8 3,267 1,227 Bruce Van Saun (2,3,4) 725 1,349 224 2,298 700
The table below sets out the remuneration paid to non-executive directors for the year ended 31 December 2010. No changes were made in relation to non-executive director fees during 2010 except to standardise the Board Risk Committee, Audit Committee and Remuneration Committee membership fee at £25,000 with effect from 1 January 2010. Fees paid to the Chairs of the Board Risk, Audit and Remuneration Committees have also been standardised at £150,000. This constitutes an increase in the fee payable to the Chair of the Remuneration Committee, reflecting the increased workload of that Committee and the time commitment required from the Committee Chair. For individual directors, differences in remuneration between 2009 and 2010 reflect any change in Committee responsibilities and, where applicable, the date they were appointed to the Board during 2009 or 2010, as set out in the notes below.
Notes: (1) Stepped down as a member and Chairman of the Remuneration Committee on 1 June 2010. (2) Appointed as Senior Independent Director on 1 June 2009. Fee is inclusive and covers all Board and Board Committee work. (3) Appointed on 1 January 2010 and became Chair of the Remuneration Committee on 1 June 2010. From 1 June 2010 fee is inclusive and covers all Board and Board Committee work. (4) Stepped down as a member of the Audit Committee on 30 April 2010. Member of the Asset Protection Scheme Senior Oversight Committee from January 2010. (5) Appointed on 1 April 2010 and became Chairman of the Audit Committee on 28 April 2010. Fee is inclusive and covers all Board and Board Committee work. (6) Fee is inclusive and covers all Board and Board Committee work. (7) Retired with effect from 28 April 2010.
Stephen Hester (1) 8,578,432 0.49 8,578,432 14.05.13 Bruce Van Saun (2) 5,182,803 0.49 5,182,803 14.05.13
Performance criteria for awards granted to executive directors under the LTIP in 2010 Awards to executive directors under the LTIP in 2010 are subject to improvement in Economic Profit (50%) as well as relative TSR (25%) and absolute TSR (25%).
In respect of the absolute TSR performance measure for the LTIP awards in 2010, vesting is on a straight-line basis and is determined as follows: to receive vesting of 100% of the shares, the share price would need to reach 77.5 pence or more; to receive 20% of the award (threshold), the share price would need to reach 57.5 pence or more; and below 57.5p, vesting would be zero.
Risk underpin and clawback If the Remuneration Committee consider that the vesting outcome calibrated in line with the performance conditions outlined above does not reflect the Group's underlying financial results, or if the Committee considers that the financial results have been achieved with excessive risk, then the terms of the awards allow for an underpin to be used to reduce vesting of an award, or to allow the award to lapse in its entirety.
No options had their terms and conditions varied during the year ended 31 December 2010. No payment is required on the award of an option.
The plan was amended in 2009 to introduce a clawback provision for grants made in 2009. In respect of the grant of options in 2009, the performance conditions for executive directors are based on a combination of relative and absolute Total Shareholder Return (TSR) measures.
Notes: (1) Awards to replace bonus and share awards Stephen Hester forfeited on leaving The British Land Company PLC, which reflect the vesting dates of the original awards. Initially Stephen Hester was awarded 10,407,081 restricted shares on joining the Group. (2) These awards vest as to 1/3 on each of the first, second and third anniversary of award, subject to their terms. (3) The Remuneration Committee can amend the award made to Philip Hampton as it considers appropriate. However, shareholder approval will be required to amend certain provisions to his advantage. These provisions relate to the basis for determining his entitlement to, and the terms of shares or other benefits and for the adjustment thereof (if any) if there is a capitalisation issue, rights issue or open offer, sub-division or consolidation of shares or reduction of capital or any other variation of capital and the amendment power itself. The Remuneration Committee may, without shareholder approval, make minor amendments to facilitate the administration of the award, to comply with or take account of any proposed or existing legislation or to obtain or maintain favourable tax, exchange control or regulatory treatment for Philip Hampton or his employer. The benefit of the award is not pensionable. In assessing the performance to determine the vesting of this award, the Remuneration Committee will consider a number of factors which demonstrate whether Philip Hampton has led the successful and sustainable rebuilding of the Group. The Committee will also require to be satisfied that the vesting level is commensurate with the underlying financial performance of the Group.
Directors' pension arrangements During 2010, Gordon Pell accrued pensionable service in The Royal Bank of Scotland Group Pension Fund (the RBS Fund) until his retirement date of 31 March 2010. The RBS Fund is a defined benefit fund registered with HM Revenue & Customs under the Finance Act 2004.
Gordon Pell was provided with additional pension benefits on a defined benefit basis outwith the RBS Fund. The figures shown below include the accrual in respect of these arrangements.
Transfer value for the additional pension earned during the year ended *Net of statutory revaluation applying to deferred pensions.
Notes: (1) Gordon Pell retired on 31 March 2010. The figures in the table above show his cash equivalent transfer value (CETV) as at the end of the year, using the appropriate factors that would apply at that date. Prior to his retirement and subsequent exchange of part of his pension for a lump sum his accrued pension was £590,940 p.a. at 31 March 2010. The equivalent CETV of this pre-commutation amount was £13,394,000 as at 31 March 2010.
Gordon Pell retired from the Group on 31 March 2010, shortly after his normal pension age of 60. His pension at retirement was based on his 39 years of service with Lloyds TSB and with the Group, part of which has been funded by a transfer payment from a Lloyds TSB pension plan. As required by the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008, the value shown above is the value at the end of the year of the residual pension.
There is a significant difference in the form of disclosure required by the Listing Rules and the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008. The former requires disclosure of the additional pension earned during the period and the transfer value equivalent to this pension based on financial conditions at the end of the period. The latter requires the disclosure of the difference between the transfer value at the start and end of the period and is therefore dependent on the change in financial conditions over that time.
Stephen Hester and Bruce Van Saun are provided with a cash allowance in place of pension benefits or have contributions made to a defined contribution pension arrangement, as detailed below: Cash allowances in place of pension Stephen Hester 420 420 Bruce Van Saun — 80
Pension contributions to a defined contribution pension arrangement Bruce Van Saun 321 —
The data below relates to the five members of the Group’s Executive Committee with the highest total remuneration for 2010. For consistency, figures are shown in GBP. Where applicable, currency conversion was based on the 2010 average exchange rate for fixed remuneration and the 31 December 2010 spot rate for bonus figures, in line with the approach taken in this Report.
Notes: (1) In addition, the total value of pension and other allowances paid during 2010 for each individual shown in the table above was: Pension and other allowances £000
(2) Executive Reward Schemes (shares) include long-term incentive awards made following the end of the relevant financial year. The amounts shown reflect two thirds of the grant-date face value of the underlying shares to reflect an approximate performance factor applicable to these awards. The exact number of shares under each award will be based on the share price prior to grant and will therefore be determined at the time of grant.
Shares beneficially owned at 1 January 2010 or date of appointment, if later
267 Independent auditors’ report 268 Consolidated income statement 269 Consolidated statement of comprehensive income 270 Balance sheets 271 Statements of changes in equity 274 Cash flow statements 275 Accounting policies 287 Notes on the accounts 1 Net interest income 287 2 Non-interest income
(excluding insurance premium income) 288 3 Operating expenses 289 4 Pension costs 292 5 Auditors’ remuneration 296 7 Profit attributable to preference shareholders and paid-in equity holders 297 8 Ordinary dividends 298 9 Profit dealt with in the accounts of the company 298 10 Earnings per ordinary and B share 299 11 Financial instruments – classification 300 12 Financial instruments – valuation 310 13 Financial instruments – maturity analysis 325 14 Financial assets – impairments 328 16 Debt securities 332 17 Equity shares 333 18 Investments in Group undertakings 334 19 Intangible assets 335 20 Property, plant and equipment 338 21 Prepayments, accrued income and other assets 340 22 Discontinued operations and assets and liabilities of disposal groups 340 23 Short positions 342 24 Accruals, deferred income and other liabilities 342 25 Deferred tax 342 26 Insurance business 344 27 Subordinated liabilities 349 28 Non-controlling interests 357 29 Share capital 358 32 Collateral and securitisations 364 33 Capital resources 365 34 Memorandum items 366 35 Net cash inflow/(outflow) from operating activities 374 36 Analysis of the net investment in business interests and intangible assets 375 37 Interest received and paid 375 38 Analysis of changes in financing during the year 376 39 Analysis of cash and cash equivalents 376 40 Segmental analysis 377 41 Directors’ and key management remuneration 383 42 Transactions with directors and key management 383 43 Related parties 383 44 Post balance sheet events 385
Opinion In our opinion: the financial statements give a true and fair view of the state of the Group's and of the company’s affairs as at 31 December 2010 and of the Group’s loss for the year then ended; the Group financial statements have been properly prepared in accordance with IFRS as adopted by the European Union; the company financial statements have been properly prepared in accordance with IFRS as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation.
Matters on which we are required to report by exception We have nothing to report in respect of the following: Under the Companies Act 2006 we are required to report to you if, in our opinion: adequate accounting records have not been kept by the company, or returns adequate for our audit have not been received from branches not visited by us; or the company financial statements and the part of the Directors' remuneration report described as having been audited are not in agreement with the accounting records and returns; or certain disclosures of directors' remuneration specified by law are not made; or we have not received all the information and explanations we require for our audit.
Under the Listing Rules we are required to review: the directors' statement contained within the Report of the directors in relation to going concern; the part of the corporate governance statement relating to the company's compliance with the nine provisions of the June 2008 Combined Code specified for our review; and certain elements of the Directors’ remuneration report.
Kari Hale (Senior Statutory Auditor) for and on behalf of Deloitte LLP Chartered Accountants and Statutory Auditor London, United Kingdom 23 February 2011 267RBS Group 2010
Financial statementsIndependent auditor’s report to the members of The Royal Bank of Scotland Group plc
Net interest income 1 14,209 13,388 15,482 Fees and commissions receivable 2 8,193 8,738 8,855 Fees and commissions payable 2 (2,211) (2,790) (2,444) Income/(loss) from trading activities 2 4,517 3,761 (9,025) Gain on redemption of own debt 2 553 3,790 — Other operating income (excluding insurance net premium income) 2 1,479 873 2,153 Insurance net premium income 26 5,128 5,266 5,709 Non-interest income 17,659 19,638 5,248 Total income 31,868 33,026 20,730 Staff costs - pension schemes curtailment gains — 2,148 — Premises and equipment (2,402) (2,594) (2,163) Other administrative expenses (3,995) (4,449) (4,716) Depreciation and amortisation (2,150) (2,166) (2,377) Write-down of goodwill and other intangible assets (10) (363) (16,911)
Operating loss before tax (399) (2,647) (25,691) Tax (charge)/credit 6 (634) 429 2,167 Loss from continuing operations (1,033) (2,218) (23,524) Loss from discontinued operations, net of tax 22 (633) (105) (11,018) Loss for the year (1,666) (2,323) (34,542)
Per ordinary and B share (2) Basic loss from continuing operations 10 (0.5p) (6.3p) (146.2p)
Notes: (1) The Dutch retail and other banking businesses transferred to the Dutch State on 1 April 2010 are recognised as discontinued operations. Comparative information has been changed accordingly. (2) B shares rank pari-passu with ordinary shares.
Loss for the year (1,666) (2,323) (34,542) Other comprehensive income/(loss) Available-for-sale financial assets (389) 2,016 (7,406) Cash flow hedges 1,454 684 (1,456) Currency translation 81 (3,300) 15,425 Actuarial gains/(losses) on defined benefit plans 4 158 (3,665) (2,287) Other comprehensive income/(loss) before tax 1,304 (4,265) 4,276 Tax (charge)/credit (309) 430 2,786 Other comprehensive income/(loss) after tax 995 (3,835) 7,062 Total comprehensive loss for the year (671) (6,158) (27,480)
Total comprehensive loss recognised in the statement of changes in equity is attributable as follows: Non-controlling interests (197) (1,346) (4,332) Preference shareholders 105 878 536 Paid-in equity holders 19 57 60 Ordinary and B shareholders (598) (5,747) (23,744) (671) (6,158) (27,480)
The accompanying notes on pages 287 to 385, the accounting policies on pages 275 to 286 and the audited sections of the Business review: Risk and balance sheet management on pages 119 to 224 form an integral part of these financial statements.
Liabilities Deposits by banks 11 98,790 142,144 258,044 — 93 1,802 Customer accounts 11 510,693 614,202 639,512 1,029 13,264 26 Debt securities in issue 11 218,372 267,568 300,289 8,742 11,788 14,179 Settlement balances 10,991 10,413 11,741 — — —
Subordinated liabilities 27 27,053 37,652 49,154 8,048 8,762 10,314 Liabilities of disposal groups 22 9,428 18,890 859 — — —
The accounts were approved by the Board of directors on 23 February 2011 and signed on its behalf by: Philip Hampton Chairman
Paid-in equity At 1 January 565 1,073 1,073 565 1,073 1,073 Securities redeemed (132) (308) — (132) (308) — Transfer to retained earnings (2) (200) — (2) (200) — At 31 December 431 565 1,073 431 565 1,073
Share premium account At 1 January 23,523 27,471 17,322 23,523 27,471 17,322 Ordinary shares issued in respect of placing and open offer, net of £95 million expenses — 1,047 — — 1,047 — Ordinary shares issued in respect of rights issue, net of £246 million expenses — — 10,469 — — 10,469 Ordinary shares issued in respect of capitalisation issue — — (101) — — (101) Expenses of placing and open offer — — (265) — — (265) Ordinary shares issued 281 — 46 281 — 46 Redemption of preference shares classified as debt 118 — — 118 — — Preference shares redeemed — (4,995) — — (4,995) — At 31 December 23,922 23,523 27,471 23,922 23,523 27,471
Foreign exchange reserve At 1 January 4,528 6,385 (426) — — — Retranslation of net assets 997 (2,322) 11,970 — — — Foreign currency (losses)/gains on hedges of net assets (458) 456 (5,801) — — — Tax 63 9 642 — — — Recycled to profit or loss on disposal of businesses 8 — — — — — At 31 December 5,138 4,528 6,385 — — —
Retained earnings At 1 January 12,134 7,542 21,072 13,262 5,550 3,787 Loss attributable to ordinary and B shareholders and other equity owners - continuing operations (973) (2,600) (23,624) (4,554) (1,503) (9,602)
- discontinued operations (28) (72) (86) — — — Ordinary dividends paid — — (2,312) — — (2,312)
Paid-in equity dividends paid, net of tax (19) (57) (60) (19) (57) (60) Transfer from paid-in equity - gross 2 200 — 2 200 — - tax (1) — — (1) — — Equity owners gain on withdrawal of non-controlling interests - gross 40 629 — — — —
Non-controlling interests At 1 January 16,895 21,619 38,388 — — — Currency translation adjustments and other movements (466) (1,434) 9,256 — — — Acquisition of ABN AMRO — — 356 — — — (Loss)/profit attributable to non-controlling interests - continuing operations (60) 382 100 — — — - discontinued operations (605) (33) (10,932) — — — Dividends paid (4,200) (313) (285) — — — Movements in available-for-sale securities - unrealised (losses)/gains (56) 299 (1,288) — — — - realised losses/(gains) 37 (466) (152) — — — - tax 5 (36) (7) — — — - recycled to profit or loss on disposal of discontinued operations, net of £2 million tax (7) — — — — — Movements in cash flow hedging reserve - amount recognised in equity (120) (209) (1,015) — — — - amount transferred from equity to earnings — — (36) — — — - tax 39 59 220 — — — - recycled to profit or loss on disposal of discontinued operations, net of £340 million tax 1,036 — — — — — Actuarial gains/(losses) recognised in retirement benefit schemes - gross — 91 (480) — — — - tax — 1 2 — — — Equity raised 559 9 1,071 — — — Equity withdrawn and disposals (11,298) (2,445) (13,579) — — — Transfer to retained earnings (40) (629) — — — — At 31 December 1,719 16,895 21,619 — — —
Total comprehensive loss recognised in the statement of changes in equity is attributable as follows: Non-controlling interests (197) (1,346) (4,332) — — — Preference shareholders 105 878 536 105 878 536 Paid-in equity holders 19 57 60 19 57 60 Ordinary and B shareholders (598) (5,747) (23,744) (4,677) (2,435) (10,197)
Sale and maturity of securities 47,604 76,492 53,390 — — — Purchase of securities (43,485) (73,593) (55,229) — — — Investment in subsidiaries — — — (1,884) (23,902) (10,349) Disposal of subsidiaries — — — 6 7,908 700 Sale of property, plant and equipment 2,011 1,948 2,228 — — — Purchase of property, plant and equipment (2,113) (4,898) (5,757) — — — Proceeds on disposal of discontinued activities — — 20,113 — — — Net investment in business interests and intangible assets 36 3,446 105 2,252 — — — Repayments from subsidiaries — — — — 274 — Transfer out of discontinued operations (4,112) — — — — — Net cash flows from investing activities 3,351 54 16,997 (1,878) (15,720) (9,649)
The Group has adopted the revised IFRS 3 ‘Business Combinations’ and related revisions to IAS 27 ‘Consolidated and Separate Financial Statements’ issued in January 2008 and also IFRIC 17 ‘Distributions of Non-cash Assets to Owners’ and the IASB’s consequential amendments to IFRS 5 ‘Non-Current Assets Held for Sale and Discontinued Operations’ issued in December 2008. They apply to transactions on or after 1 January 2010 and have not resulted in the restatement of previously published financial information. There have been no material acquisitions in the year. In accordance with IFRS 5, before and after the amendment, the Dutch retail and other banking businesses that were transferred to the Dutch State on 1 April 2010 have been recognised as discontinued operations with consequent changes to the presentation of comparative financial information.
The company is incorporated in the UK and registered in Scotland. The accounts are prepared on the historical cost basis except that the following assets and liabilities are stated at their fair value: derivative financial instruments, held-for-trading financial assets and financial liabilities, financial assets and financial liabilities that are designated as at fair value through profit or loss, available-for-sale financial assets and investment property. Recognised financial assets and financial liabilities in fair value hedges are adjusted for changes in fair value in respect of the risk that is hedged.
The results of discontinued operations are shown as a single amount on the face of the income statement comprising the post-tax profit or loss of discontinued operations and the post-tax gain or loss recognised either on measurement to fair value less costs to sell or on the disposal of the discontinued operation. A discontinued operation is a cash-generating unit or a group of cash-generating units that either has been disposed of, or is classified as held for sale, and (a) represents a separate major line of business or geographical area of operations, (b) is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations or (c) is a subsidiary acquired exclusively with a view to resale.
6. Intangible assets and goodwill Intangible assets that are acquired by the Group are stated at cost less accumulated amortisation and impairment losses. Amortisation is charged to profit or loss over the assets' estimated economic lives using methods that best reflect the pattern of economic benefits and is included in depreciation and amortisation. The estimated useful economic lives are as follows: Core deposit intangibles 6 to 10 years Other acquired intangibles 5 to 10 years Computer software 3 to 5 years
Acquired goodwill, being the excess of the cost of an acquisition over the Group's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities of the subsidiary, associate or joint venture acquired, is initially recognised at cost and subsequently at cost less any accumulated impairment losses. Goodwill arising on the acquisition of subsidiaries and joint ventures is included in the balance sheet category ‘Intangible assets’ and that on associates within their carrying amounts. The gain or loss on the disposal of a subsidiary, associate or joint venture includes the carrying value of any related goodwill.
10. Foreign currencies The Group's consolidated financial statements are presented in sterling which is the functional currency of the company.
12. Insurance General insurance General insurance comprises short-duration contracts. Due to the nature of the products sold - predominantly property, and motor - the insurance protection is provided on an even basis throughout the term of the policy. Consequently, written premiums are recognised on a straight-line basis over the period of the policy. Insurance premiums exclude insurance premium tax. Unearned premiums represent the proportion of the net premiums that relate to periods of insurance after the balance sheet date and are calculated over the period of exposure under the policy, on a daily basis, 24th's basis or allowing for the estimated incidence of exposure under policies which are longer than twelve months. Provision is made where necessary for the estimated amount of claims over and above unearned premiums including that in respect of future written business on discontinued lines under the run-off of delegated underwriting authority arrangements. The provision is designed to meet future claims and related expenses and is calculated across related classes of business on the basis of a separate carry forward of deferred acquisition expenses after making allowance for investment income.
Held-for-trading - a financial asset is classified as held-for-trading if it is acquired principally for sale in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial assets are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses on heldfor -trading financial assets are recognised in profit or loss as they arise.
In 2009 and 2008, financial assets designated as at fair value through profit or loss included policyholders' assets underpinning insurance and investment contracts issued by the Group's life assurance businesses. Fair value designation significantly reduces the measurement inconsistency that would arise if these assets were classified as available-for-sale.
Loans and receivables - non-derivative financial assets with fixed or determinable repayments that are not quoted in an active market are classified as loans and receivables, except those that are classified as available-for-sale or as held-for-trading, or designated as at fair value through profit or loss. Loans and receivables are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at amortised cost using the effective interest method (see Accounting policy 3) less any impairment losses.
Available-for-sale - financial assets that are not classified as held-tomaturity; held-for-trading; designated as at fair value through profit or loss; or loans and receivables, are classified as available-for-sale. Financial assets can be designated as available-for-sale on initial recognition. Available-for-sale financial assets are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at fair value. Unquoted equity investments whose fair value cannot be measured reliably are carried at cost and classified as available-for-sale financial assets. Impairment losses and exchange differences resulting from retranslating the amortised cost of foreign currency monetary available-for-sale financial assets are recognised in profit or loss together with interest calculated using the effective interest method (see Accounting policy 3). Other changes in the fair value of available-for-sale financial assets and any related tax are reported in a separate component of shareholders' equity until disposal, when the cumulative gain or loss is recognised in profit or loss.
17. Financial liabilities On initial recognition financial liabilities are classified into held-for-trading; designated as at fair value through profit or loss; or amortised cost.
Amortised cost - all other financial liabilities are measured at amortised cost using the effective interest method (see Accounting policy 3).
19. Loan commitments Provision is made for loan commitments, other than those classified as held-for-trading, if it is probable that the facility will be drawn and the resulting loan will be recognised at a value less than the cash advanced. Syndicated loan commitments in excess of the level of lending under the commitment approved for retention by the Group are classified as heldfor -trading and measured at fair value.
20. Derecognition A financial asset is derecognised when it has been transferred and the transfer qualifies for derecognition. A transfer requires that the Group either (a) transfers the contractual rights to receive the asset's cash flows; or (b) retains the right to the asset's cash flows but assumes a contractual obligation to pay those cash flows to a third party. After a transfer, the Group assesses the extent to which it has retained the risks and rewards of ownership of the transferred asset. If substantially all the risks and rewards have been retained, the asset remains on the balance sheet. If substantially all the risks and rewards have been transferred, the asset is derecognised. If substantially all the risks and rewards have been neither retained nor transferred, the Group assesses whether or not it has retained control of the asset. If it has not retained control, the asset is derecognised. Where the Group has retained control of the asset, it continues to recognise the asset to the extent of its continuing involvement.
22. Netting Financial assets and financial liabilities are offset and the net amount presented in the balance sheet when, and only when, the Group currently has a legally enforceable right to set off the recognised amounts; and it intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. The Group is party to a number of arrangements, including master netting agreements, that give it the right to offset financial assets and financial liabilities but where it does not intend to settle the amounts net or simultaneously and therefore the assets and liabilities concerned are presented gross.
23. Capital instruments The Group classifies a financial instrument that it issues as a financial asset, financial liability or an equity instrument in accordance with the substance of the contractual arrangement. An instrument is classified as a liability if it is a contractual obligation to deliver cash or another financial asset, or to exchange financial assets or financial liabilities on potentially unfavourable terms. An instrument is classified as equity if it evidences a residual interest in the assets of the Group after the deduction of liabilities. The components of a compound financial instrument issued by the Group are classified and accounted for separately as financial assets, financial liabilities or equity as appropriate.
Gains and losses arising from changes in the fair value of a derivative are recognised as they arise in profit or loss unless the derivative is the hedging instrument in a qualifying hedge. The Group enters into three types of hedge relationship: hedges of changes in the fair value of a recognised asset or liability or firm commitment (fair value hedges); hedges of the variability in cash flows from a recognised asset or liability or a highly probable forecast transaction (cash flow hedges); and hedges of the net investment in a foreign operation.
Cash flow hedge - in a cash flow hedge, the effective portion of the gain or loss on the hedging instrument is recognised directly in equity and the ineffective portion in profit or loss. When the forecast transaction results in the recognition of a financial asset or financial liability, the cumulative gain or loss is reclassified from equity in the same periods in which the asset or liability affects profit or loss. Otherwise the cumulative gain or loss is removed from equity and recognised in profit or loss at the same time as the hedged transaction. Hedge accounting is discontinued if the hedge no longer meets the criteria for hedge accounting; if the hedging instrument expires or is sold, terminated or exercised; if the forecast transaction is no longer expected to occur; or if hedge designation is revoked. On the discontinuance of hedge accounting (except where a forecast transaction is no longer expected to occur), the cumulative unrealised gain or loss in equity is recognised in profit or loss when the hedged cash flow occurs or, if the forecast transaction results in the recognition of a financial asset or financial liability, in the same periods during which the asset or liability affects profit or loss. Where a forecast transaction is no longer expected to occur, the cumulative unrealised gain or loss in equity is recognised in profit or loss immediately.
25. Share-based payments The Group awards shares and options over shares in The Royal Bank of Scotland Group plc to its employees. The expense for these transactions is measured based on the fair value on the date the awards are granted. The fair value of an option is estimated using valuation techniques which take into account its exercise price, its term, the risk-free interest rate and the expected volatility of the market price of The Royal Bank of Scotland Group plc's shares. Vesting conditions are not taken into account when measuring fair value, but are reflected by adjusting the proportion of awards that actually vest. The fair value is expensed on a straight-line basis over the vesting period. Following an amendment to IFRS 2 for accounting periods starting after 1 January 2009, the cancellation of an award with non-vesting conditions triggers immediate recognition of an expense in respect of any unrecognised element of the fair value of the award.
27. Shares in Group entities The company's investments in its subsidiaries are stated at cost less any impairment.
At 31 December 2010, gross loans and advances to customers totalled £573,315 million (2009 - £745,519 million; 2008 - £885,611 million) and customer loan impairment provisions amounted to £18,055 million (2009 - £17,126 million; 2008 - £10,889 million).
Pensions The Group operates a number of defined benefit pension schemes as described in Note 4 on the accounts. The assets of the schemes are measured at their fair value at the balance sheet date. Scheme liabilities are measured using the projected unit method, which takes account of projected earnings increases, using actuarial assumptions that give the best estimate of the future cash flows that will arise under the scheme liabilities. These cash flows are discounted at the interest rate applicable to high-quality corporate bonds of the same currency and term as the liabilities. Any recognisable surplus or deficit of scheme assets over liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit).
A pension asset of £105 million and a liability of £2,288 million were recognised in the balance sheet at 31 December 2010 (2009 - asset - £58 million, liability - £2,963 million; 2008 - asset - £36 million, liability - £2,032 million).
Debt securities in issue (held-for-trading and designated as at fair value though profit or loss) - principally comprise medium term notes.
Short positions (held-for-trading) - arise in dealing and market making activities where debt securities and equity shares are sold which the Group does not currently possess.
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. Fair values are determined from quoted prices in active markets for identical financial assets or financial liabilities where these are available. Fair value for a net open position in a financial instrument in an active market is the number of units of the instrument held times the current bid price (for financial assets) or offer price (for financial liabilities). In determining the fair value of derivative financial instruments gross long and short positions measured at current mid market prices are adjusted by bid-offer reserves calculated on a portfolio basis. Credit valuation adjustments are made when valuing derivative financial assets to incorporate counterparty credit risk. Adjustments are also made when valuing financial liabilities to reflect the Group’s own credit standing. Where the market for a financial instrument is not active, fair value is established using a valuation technique. These valuation techniques involve a degree of estimation, the extent of which depends on the instrument’s complexity and the availability of market-based data. More details about the Group’s valuation methodologies and the sensitivity to reasonably possible alternative assumptions of the fair value of financial instruments valued using techniques where at least one significant input is unobservable are given in Note 12 on pages 310 to 324.
General insurance claims The Group makes provision for the full cost of settling outstanding claims arising from its general insurance business at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date and claims handling expenses. General insurance claims provisions amounted to £6,726 million at 31 December 2010 (2009 - £5,802 million; 2008 - £5,478 million).
Provisions are determined by management based on experience of claims settled and on statistical models which require certain assumptions to be made regarding the incidence, timing and amount of claims and any specific factors such as adverse weather conditions. In order to calculate the total provision required, the historical development of claims is analysed using statistical methodology to extrapolate, within acceptable probability parameters, the value of outstanding claims at the balance sheet date. Also included in the estimation of outstanding claims are other assumptions such as the inflationary factor used for bodily injury claims which is based on historical trends and, therefore, allows for some increase due to changes in common law and statute; and the incidence of periodical payment orders and the rate at which payments under them are discounted. Costs for both direct and indirect claims handling expenses are also included. Outward reinsurance recoveries are accounted for in the same accounting period as the direct claims to which they relate. The outstanding claims provision is based on information available to management and the eventual outcome may vary from the original assessment. Actual claims experience may differ from the historical pattern on which the estimate is based and the cost of settling individual claims may exceed that assumed.
Deferred tax The Group makes provision for deferred tax on short-term and other temporary differences where tax recognition occurs at a different time from accounting recognition. Deferred tax assets of £6,373 million were recognised as at 31 December 2010 (2009 - £7,039 million; 2008 - £7,082 million).
The Group has recognised deferred tax assets in respect of losses, principally in the UK, and short-term timing differences. Deferred tax assets are recognised in respect of unused tax losses to the extent that it is probable that there will be future taxable profits against which the losses can be utilised. Business projections prepared for impairment reviews (see Note 19) indicate that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within eight years (2009 - eight years). The Group's cumulative losses are principally attributable to the recent unparalleled market conditions. Deferred tax assets of £2,008 million (2009 - £2,163 million; 2008 - £1,748 million) have not been recognised in respect of tax losses carried forward in jurisdictions where doubt exists over the availability of future taxable profits.
The IASB issued IFRS 9 ‘Financial Instruments’ in November 2009 simplifying the classification and measurement requirements in IAS 39 ‘Financial Instruments: Recognition and Measurement’ in respect of financial assets. The standard reduces the measurement categories for financial assets to two: fair value and amortised cost. A financial asset is classified on the basis of the entity's business model for managing the financial asset and the contractual cash flow characteristics of the financial asset. Only assets with contractual terms that give rise to cash flows on specified dates that are solely payments of principal and interest on the principal amount outstanding and which are held within a business model whose objective is to hold assets in order to collect contractual cash flows are classified as amortised cost. All other financial assets are measured at fair value. Changes in the value of financial assets measured at fair value are generally taken to profit or loss.
The International Financial Reporting Interpretations Committee issued IFRIC 19 ‘Extinguishing Financial Liabilities with Equity Instruments’ in December 2009. The interpretation clarifies that the profit or loss on extinguishing liabilities by issuing equity instruments should be measured by reference to fair value, preferably of the equity instruments. The interpretation, effective for the Group for annual periods beginning on or after 1 January 2011, is not expected to have a material effect on the Group or the company.
Customer accounts: demand deposits 1,228 970 3,475 Customer accounts: savings deposits 1,148 1,245 2,261 Customer accounts: other time deposits 1,345 2,546 7,906 Deposits by banks 1,333 2,898 6,362 Debt securities in issue 3,277 4,482 8,919 Subordinated liabilities 417 1,291 1,959 Internal funding of trading businesses (181) (509) (4,174)
(2) In May 2010, the Group redeemed certain subordinated debt securities and equity preference shares in exchange for cash or senior debt. The exchanges involving instruments classified as liabilities all met the criteria in IFRS for treatment as the extinguishment of the original liability and the recognition of a new financial liability. Gains on these exchanges and on the redemption of securities classified as liabilities for cash, totalling £553 million were credited to profit or loss. No amounts have been recognised in profit or loss in relation to the redemption of securities classified as equity in the Group financial statements. The difference between the consideration and the carrying value for these securities amounting to £651 million has been recorded in equity. A similar series of exchange and tender offers completed in April 2009 and resulted in a gain of £3,790 million being credited to profit or loss and £829 million being recorded in equity.
Premises and equipment 2,402 2,594 2,163 Other administrative expenses 3,995 4,449 4,716
Property, plant and equipment (see Note 20) 1,428 1,427 1,406 Intangible assets (see Note 19) 722 739 971 Depreciation and amortisation 2,150 2,166 2,377
There were no persons employed in discontinued operations as at 31 December 2010 (2009 - 24,800; 2008 - 29,100).
Restricted share awards Senior employees Awards of conditional shares Continuing employment or leavers in certain circumstances and/or achievement of performance conditions
The market value of awards exercised in 2010 was less than £1 million (2009 - nil). There are vested options over 33 million shares exercisable up to 2020 (2009 - 33 million shares up to 2014).
Retirement Savings Plan, a defined contribution pension scheme. In 2009, pensionable salary increases in the Main scheme and certain other UK and Irish schemes were limited to 2% per annum or CPI inflation if lower.
Interim valuations of the Group’s schemes under IAS 19 ‘Employee Benefits’ were prepared to 31 December with the support of independent actuaries, using the following assumptions: Main scheme All schemes Principal actuarial assumptions at 31 December (weighted average) 2010 2009 2008 2010 2009 2008
Discount rate 5.5% 5.9% 6.5% 5.4% 5.7% 6.0% Expected return on plan assets 6.7% 6.8% 7.1% 6.3% 6.1% 6.3% Rate of increase in salaries 1.8% 1.8% 4.0% 2.0% 2.0% 3.4% Rate of increase in pensions in payment 3.3% 3.5% 2.7% 3.0% 3.0% 2.4% Inflation assumption 3.3% 3.5% 2.7% 3.2% 3.0% 2.4%
Major classes of plan assets as a percentage of total plan assets 2010 2009 2008 2010 2009 2008
Quoted equities 25.9% 38.9% 52.9% 28.2% 36.2% 38.0% Private equity 5.4% 5.1% 6.5% 4.5% 3.1% 3.7% Index-linked bonds 27.0% 23.7% 18.0% 24.1% 15.2% 11.4% Government fixed interest bonds — — 1.2% 1.9% 18.9% 23.2% Corporate and other bonds 26.2% 19.7% 18.5% 24.8% 14.7% 15.1% Hedge funds 3.2% 3.6% — 3.5% 3.1% 0.8% Property 3.4% 3.5% 3.7% 3.6% 3.6% 3.9% Derivatives 0.9% — (1.8%) 1.2% 0.8% 1.5% Cash and other assets 7.8% 5.3% 1.0% 8.1% 4.3% 2.4% Equity exposure of equity futures 25.6% 10.6% — 21.4% 6.3% — Cash exposure of equity futures (25.4%) (10.4%) — (21.3%) (6.2%) — 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Ordinary shares of the company with a fair value of £9 million (2009 - £4 million; 2008 - £15 million) are held by the Group's Main scheme which also holds other financial instruments issued by the Group with a value of £264 million (2009 - £192 million; 2008 - £421 million).
Equity exposure of equity futures 7.7% 8.0% — 7.7% 8.0% — Cash exposure of equity futures 4.0% 4.2% — 4.0% 4.2% —
Longevity at age 60 for future pensioners currently aged 40 (years) Males 29.3 29.2 28.1 293RBS Group 2010
At 1 January 2009 14,804 15,594 790 25,756 27,752 1,996 Currency translation and other adjustments — — — (699) (813) (114) Income statement
Interest cost 999 999 1,614 1,614 Current service cost 300 300 583 583 Past service cost 15 15 15 15 Gains on curtailments (1,947) (1,947) (2,148) (2,148)
Interest cost 1,091 1,091 1,402 1,402 Current service cost 345 345 499 499 Past service cost 76 76 67 67 Gains on curtailments — — (78) (78)
Curtailment gains of £78 million have been recognised in 2010 arising from changes to pension benefits in a subsidiary’s scheme. Curtailment gains of £2,148 million were recognised in 2009 arising from changes to pension benefits in the Main scheme and certain other subsidiaries’ schemes due to the capping of future salary increases that will count for pension purposes to the lower of 2% or the rate of CPI inflation in any year. The curtailment gains in 2009 were separately disclosed on the face of the income statement due to their size.
The Group expects to contribute £500 million to its defined benefit pension schemes in 2011 (Main scheme - £333 million). Of the net liabilities of schemes in deficit, £161 million (2009 - £198 million; 2008 - £201 million) relates to unfunded schemes.
The most recent funding valuation of the Main UK scheme was 31 March 2007. A funding valuation of the Main UK scheme at 31 March 2010 is currently in progress. The scheme trustees and the Group are in discussion on this valuation and the level of contributions to be paid by the Group and expect to reach agreement by 30 June 2011. The Group expects that in addition to estimated contributions of £300 - £350 million for future accrual of benefits, it will make additional contributions, as yet unquantified, in 2011 and subsequent years to improve the funding position of the scheme.
Cumulative net actuarial losses of £4,224 million (2009 - £4,382 million losses; 2008 - £717 million gains) have been recognised in the statement of comprehensive income, of which £3,252 million losses (2009 - £3,296 million losses; 2008 - £184 million gains) relate to the Main scheme.
Fair value of plan assets 19,110 16,603 14,804 18,575 17,374 22,816 27,925 25,756 27,662 18,959 Present value of defined benefit obligations 21,092 18,675 15,594 18,099 19,004 24,999 30,830 27,752 27,547 20,951 Net deficit/(surplus) 1,982 2,072 790 (476) 1,630 2,183 2,905 1,996 (115) 1,992
Experience (losses)/gains on plan liabilities (858) 135 (55) (256) (4) (882) 328 (65) (210) (19) Experience gains/(losses) on plan assets 1,718 993 (4,784) 163 552 1,797 1,344 (6,051) 19 587 Actual return/(loss) on pension schemes assets 2,832 2,022 (3,513) 1,345 1,574 3,225 2,897 (4,186) 1,413 1,660 Actual return/(loss) on pension schemes assets - % 17.2% 13.8% (19.0%) 7.8% 9.9% 15.6% 11.4% (14.5%) 6.9% 9.6%
in pension cost for year in obligation at 31 December in pension cost for year in obligation at 31 December 0.25% increase in the discount rate (17) (21) (37) (925) (790) (696) (42) (41) (53) (1,245) (1,261) (1,161) 0.25% increase in inflation 59 49 77 799 654 624 89 93 114 1,106 1,143 1,089 0.25% additional rate of increase in pensions in payment 37 33 41 527 442 383 43 47 63 599 596 695 0.25% additional rate of increase in deferred pensions 21 16 8 265 214 94 44 25 15 497 366 227 0.25% additional rate of increase in salaries 6 8 28 56 66 168 30 17 35 270 125 219 Longevity increase of 1 year 34 29 31 519 416 302 59 50 50 781 734 700 5 Auditor’s remuneration Amounts paid to the Group's auditors for statutory audit and other services are set out below. All audit related and other services are approved by the Audit Committee and are subject to strict controls to ensure the external auditor’s independence is unaffected by the provision of other services. The Audit Committee recognise that for certain assignments the auditors are best placed to perform the work economically; for other work the Group selects the supplier best placed to meet its requirements. The Group’s auditors are permitted to tender for such work in competition with other firms where the work is permissible under audit independence rules.
Fees payable for the audit of the Group's annual accounts 4.0 4.4 Fees payable to the auditor and its associates for other services to the Group pursuant to legislation - the audit of the company's subsidiaries (1) 26.0 36.9
Total audit and audit related services 33.2 44.6 Fees payable to the auditor and its associates for other services - services relating to tax 0.5 1.4 - services relating to corporate finance transactions, including securitisations, entered into by the Group (3) 0.8 2.5 All other services - accounting advice 0.1 0.6 - review of internal controls 0.9 1.1
Expected tax credit 112 741 7,322 Non-deductible goodwill impairment (3) (102) (3,826) Unrecognised timing differences 11 274 (274) Items not allowed for tax - losses on strategic disposals and write-downs (311) (152) (108)
Taxable foreign exchange movements 4 1 (80) Foreign profits taxed at other rates (517) (276) (509) UK tax rate change - deferred tax impact (82) — — Losses in year where no deferred tax asset recognised (450) (780) (942) Losses brought forward and utilised 2 94 11 Adjustments in respect of prior years (1) 355 (118) 352 Actual tax (charge)/credit (634) 429 2,167
7 Profit attributable to preference shareholders and paid-in equity holders Group 2010 £m
Preference shareholders Non-cumulative preference shares of US$0.01 105 342 293 Non-cumulative preference shares of €0.01 — 201 183 Non-cumulative preference shares of £1 - issued to UK Financial Investments Limited (1) — 274 —
Dividends received from banking subsidiary 60 2,523 4,639 Dividends received from other subsidiaries 24 408 163 Gain on redemption of own debt 53 238 — Total income 137 3,169 4,802 Interest receivable from subsidiaries 1,042 997 793 Interest payable to subsidiaries (263) (251) (495) Other net interest payable and operating expenses (263) (62) (796) Write-down of investments in subsidiaries (5,124) (5,139) (14,321) Operating loss before tax (4,471) (1,286) (10,017) Tax (charge)/credit (83) (217) 415 Loss for the year (4,554) (1,503) (9,602)
Loss for the year (4,554) (1,503) (9,602) Other comprehensive income Cash flow hedges 1 3 2 Tax on comprehensive income — — (1) Other comprehensive income for the year, net of tax 1 3 1 Total comprehensive loss for the year (4,553) (1,500) (9,601)
Earnings Loss attributable to ordinary and B shareholders (1,125) (3,607) (24,306) Loss from discontinued operations attributable to ordinary and B shareholders 28 72 86 Gain on redemption of preference shares and paid-in equity 610 200 — Loss from continuing operations attributable to ordinary and B shareholders (487) (3,335) (24,220)
Weighted average number of shares (millions) Ordinary shares in issue during the year 56,245 51,494 16,563 B shares in issue during the year 51,000 1,397 — Weighted average number of ordinary and B shares in issue during the year (1) 107,245 52,891 16,563
Note: (1) Following reconsideration of the terms of the B share subscription agreement with HM Treasury, it is no longer treated as dilutive. The comparative amount for the year ended 31 December 2009 has been restated.
liabilities Total 2010 £m £m £m £m £m £m £m £m £m Assets Cash and balances at central banks — — — 57,014 57,014 Loans and advances to banks - reverse repos 38,215 — — 4,392 42,607 - other (1) 26,082 — — 31,829 57,911 Loans and advances to customers - reverse repos 41,110 — — 11,402 52,512 - other (2) 19,903 1,100 — 471,308 10,437 502,748 Debt securities 98,869 402 111,130 7,079 217,480 Equity shares 19,186 1,013 1,999 — 22,198 Settlement balances — — — 11,605 11,605 Derivatives 421,648 5,429 — 427,077 Intangible assets 14,448 14,448 Property, plant and equipment 16,543 16,543 Deferred tax 6,373 6,373 Prepayments, accrued income and other assets — — — 1,306 11,270 12,576 Assets of disposal groups 12,484 12,484 665,013 2,515 5,429 113,129 595,935 10,437 61,118 1,453,576
Liabilities Deposits by banks - repos 20,585 — 12,154 32,739 - other (3) 28,216 — 37,835 66,051 Customer accounts - repos 53,031 — 29,063 82,094 - other (4) 14,357 4,824 409,418 428,599 Debt securities in issue (5,6) 7,730 43,488 167,154 218,372 Settlement balances — — 10,991 10,991 Short positions 43,118 — 43,118 Derivatives 419,103 4,864 423,967 Accruals, deferred income and other liabilities — — 1,793 458 20,838 23,089 Retirement benefit liabilities 2,288 2,288 Deferred tax 2,142 2,142 Insurance liabilities 6,794 6,794 Subordinated liabilities — 1,129 25,924 27,053 Liabilities of disposal groups 9,428 9,428 586,140 49,441 4,864 694,332 458 41,490 1,376,725 Equity 76,851
Assets Cash and balances at central banks — — — 52,261 52,261 Loans and advances to banks - reverse repos 26,886 — — 8,211 35,097
Accruals, deferred income and other liabilities — — 1,889 467 27,971 30,327 Retirement benefit liabilities 2,963 2,963 Deferred tax 2,811 2,811 Insurance liabilities 10,281 10,281
liabilities Total 2008 £m £m £m £m £m £m £m £m £m
Loans and advances to customers - reverse repos 22,539 — — 16,774 39,313
Settlement balances — — 11,741 11,741 Short positions 42,536 — 42,536
No amounts have been recognised in profit or loss for changes in credit risk associated with these liabilities as the changes are immaterial, measured as the change in fair value from movements in the period in the credit risk premium payable. The amounts include investment contracts with a carrying value of £41 million (2009 - £5,170 million; 2008 - £5,364 million).
(6) The carrying amount is £751 million (2009 - £810 million; 2008 - £1,145 million) lower than the principal amount. (7) During 2009, the Group reclassified financial assets from the held-for-trading category into the loans and receivables category and in 2008 from the held-for-trading and available-for-sale categories into the loans and receivables category and from the held-for-trading category into the available-for-sale category (see pages 306 to 309).
Liabilities Deposits by banks (3) — 93 93 Customer accounts (4) — 13,264 13,264 Debt securities in issue — 11,788 11,788 Derivatives (4) 432 14 446 Accruals, deferred income and other liabilities — — 1,357 1,357 Subordinated liabilities — 8,762 8,762 432 14 33,907 1,357 35,710 Equity 65,582
11 Financial instruments - classification continued Reclassification of financial instruments The Group has reclassified financial assets from the held-for-trading (HFT) and available-for-sale (AFS) categories into the loans and receivables (LAR) category (as permitted by paragraph 50D of IAS 39 as amended) and from the held-for-trading category into the available-forsale category (as permitted by paragraph 50B of IAS 39 as amended).
The turbulence in the financial markets during the second half of 2008 was regarded by management as rare circumstances in the context of paragraph 50B of IAS 39 as amended.
The tables below show the carrying value, fair value and the effect on profit or loss of reclassifications undertaken by the Group in 2008 and 2009. There were no reclassifications in 2010.
Reclassified from HFT to LAR Loans - leveraged finance 1,100 963 88 59 317 170 - corporate and other loans 4,278 3,465 146 (205) 174 233 5,378 4,428 234 (146) 491 403 Debt securities - CDO 22 22 1 — 1 — - RMBS 983 787 24 (1) 139 116 - CMBS 844 732 — (13) 133 146 - CLOs 417 368 8 (3) 67 62 - other ABS 626 559 (6) — 3 9 - other 638 653 21 — 81 60 3,530 3,121 48 (17) 424 393 8,908 7,549 282 (163) 915 796 Reclassified from HFT to AFS (1) Debt securities - other 94 94 29 — 36 7 6,446 6,446 441 53 765 271 Equity securities 1 1 29 — 38 9 6,447 6,447 470 53 803 280 Reclassified from AFS to LAR (2) Debt securities 422 380 (31) (50) (81) — 15,777 14,376 721 (160) 1,637 1,076
Notes: (1) The amount taken to AFS reserves was £326 million. (2) The amount that would have been taken to AFS reserves if reclassification had not occurred is £98 million.
Reduction in profit or loss as result of reclassification 2009 £m £m £m £m £m £m Reclassified from HFT to LAR Loans - leveraged finance 2,574 2,257 109 (902) 482 1,275 - corporate and other loans 5,302 4,114 99 (361) (321) (59)
- CMBS 826 596 (44) — 24 68 - CLOs 647 536 (43) (16) 39 98 - other ABS 1,145 1,070 (13) — — 13 - other 886 882 34 — 254 220 5,057 4,273 (179) (16) 294 489 12,933 10,644 29 (1,279) 455 1,705 Reclassified from HFT to AFS (1) Debt securities - CDO 1,170 1,170 35 (226) 40 231 - RMBS 3,042 3,042 335 (84) 460 209 - CMBS 63 63 (2) — 11 13 - CLOs 2,676 2,676 57 — 704 647 - other ABS 508 508 20 — 44 24 - other 142 142 (3) (118) 34 155 7,601 7,601 442 (428) 1,293 1,279 Equity securities 28 28 (1) — — 1 7,629 7,629 441 (428) 1,293 1,280 Reclassified from AFS to LAR (2) Debt securities 869 745 21 — 21 — 21,431 19,018 491 (1,707) 1,769 2,985
Notes: (1) The amount taken to AFS reserves was £1,067 million. (2) The amount that would have been taken to AFS reserves if reclassification had not occurred is £(73) million.
Reclassified from HFT to LAR Loans - leveraged finance 510 13.37 1,075 — — — (70) (71) (141) — (76)
Reclassified from AFS to LAR: Debt securities (2) 694 1.38 760 1,016 956 (12) 6 — 6 — — 33,942 49,468 33,837 29,631 (2,894) (49) (446) (6,379) 5,884 (537)
Notes: (1) The amount taken to AFS reserves was £(2,193) million. (2) The amount that would have been in AFS reserves if reclassification had not occurred is £(39) million.
Monthly meetings are held between the business and the support functions to discuss the results of the IPV and reserves process in detail.
Valuation models are subject to a review process which requires different levels of model documentation, testing and review, depending on the complexity of the model and the size of the Group's exposure. A key element of the control environment over model use is a modelled product review committee, made up of valuations experts from several functions within the Group. This committee sets the policy for model documentation, testing and review, and prioritises models with significant exposure for review by the Group's Quantitative Research Centre (QuaRC). Potential valuation uncertainty is a key input in determining model review priorities at these meetings. The QuaRC team within Group Risk, which is independent of the trading businesses, assesses the appropriateness of the application of the model to the product, the mathematical robustness of the model, and (where appropriate), considers alternative modelling approaches.
The Group Executive Valuation Committee discusses the issues escalated by the Modelled Product Review Committee, GBM and NonCore senior management Valuations Control Committee and other relevant issues, including the APS credit derivative valuation. The committee covers key material and subjective valuation issues within the trading business. The committee will provide ratification to the appropriateness of areas with high levels of residual valuation uncertainty. Committee membership includes the Group Finance Director, the Group Chief Accountant, Global Head of Market and Insurance Risk, GBM Chief Financial Officer and Non-Core Chief Financial Officer, and representation from front office trading and finance.
New products The Group has formal review procedures to ensure that new products, asset classes and risk types are appropriately reviewed to ensure, amongst other things, that valuation is appropriate. Group Operational Risk owns the Group New Product Approval Process, the scope of which includes new business, markets, models, risks and structures.
Valuation hierarchy There is a process to review and control the classification of financial instruments into the three level hierarchy established by IFRS 7. Some instruments may not easily fall into a level of the fair value hierarchy per IFRS 7 (see pages 314 to 315) and judgment may be required as to which level the instrument is classified.
Initial classification of a financial instrument is carried out by the Business Unit Control (BUC) team following the principles in IFRS. BUC base their judgment on information gathered during the IPV process for instruments which include the sourcing of independent prices and model inputs. The quality and completeness of the information gathered in the IPV process gives an indication as to the liquidity and valuation uncertainty of an instrument.
These initial classifications are challenged by GPU and are subject to further review by local CFO, divisional CFO and the Group Chief Accountant. Particular attention is paid during the review processes upon instruments crossing from one level to another, new instrument classes or products, instruments that are generating significant profit and loss and instruments where valuation uncertainty is high.
12 Financial instruments - valuation continued Valuation reserves When valuing financial instruments in the trading book, adjustments are made to mid-market valuations to cover bid-offer spread, liquidity and credit risk.
Credit valuation adjustments Monoline insurers 2,443 3,796 5,988 Credit derivative product companies 490 499 1,311 Other counterparties 1,714 1,588 1,738 4,647 5,883 9,037 Bid-offer and liquidity reserves 2,797 2,814 3,260 7,444 8,697 12,297
Bid-offer adjustments for each risk factor are determined by aggregating similar risk exposures arising on different products. Additional basis bid/offer reserves are taken where these are charged in the market. Risk associated with non identical underlying exposures is not netted down unless there is evidence that the cost of closing the combined risk exposure is less than the cost of closing on an individual basis. For example: interest rate delta bid-offer methodology (when viewed in isolation) allows aggregation of risk across different tenor bases. Tenor basis bid-offer reserves are then applied to compensate for the netting within the (original) delta bid-offer calculation.
Netting is applied across risk buckets where there is market evidence to support this. For example, calendar netting and cross strike netting effects are taken into account where such trades occur regularly within the market. Netting will also apply where long and short risk in two different risk buckets can be closed out in a single market transaction at less cost than by way of two separate transactions (closing out the individual bucketed risk in isolation).
Where there is limited bid-offer information for a product, a conservative approach is adopted, taking into account pricing approach and risk management strategy.
Amounts deferred on initial recognition On initial recognition of financial assets and liabilities valued using valuation techniques incorporating information other than observable market data, any difference between the transaction price and that derived from the valuation technique is deferred. Such amounts are recognised in profit or loss over the life of the transaction; when market data becomes observable; or when the transaction matures or is closed out as appropriate. At 31 December 2010, net gains of £167 million (2009 - £204 million; 2008 - £102 million) were carried forward in the balance sheet. During the year net gains of £62 million (2009 - £127 million; 2008 - £89 million) were deferred and £99 million (2009 - £25 million; 2008 - £65 million) recognised in the income statement.
For issued debt and structured notes, this adjustment is based on independent quotes from market participants for the debt issuance spreads above average inter-bank rates, (at a range of tenors) which the market would demand when purchasing new senior or sub-debt issuances from the Group. Where necessary, these quotes are interpolated using a curve shape derived from credit default swap prices.
The fair value of the Group's derivative financial liabilities has also been adjusted to reflect the Group's own credit risk. The adjustment takes into account collateral posted by the Group and the effects of master netting agreements.
The own credit adjustment for fair value does not alter cash flows, is not used for performance management and is disregarded for regulatory capital reporting processes and will reverse over time as the liabilities mature.
12 Financial instruments - valuation continued Valuation hierarchy The following tables show financial instruments carried at fair value on the Group’s balance sheet by valuation hierarchy - level 1, level 2 and level 3. 2010 2009 2008 Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn Assets Loans and advances to banks Reverse repos — 38.2 — 38.2 — 26.9 — 26.9 — 26.1 — 26.1 Collateral — 25.1 — 25.1 — 18.4 — 18.4 — 29.7 — 29.7 Other — 0.6 0.4 1.0 — 0.1 — 0.1 — 0.4 — 0.4
Loans and advances to customers Reverse repos — 41.1 — 41.1 — 26.3 — 26.3 — 22.5 — 22.5 Collateral — 14.4 — 14.4 — 9.6 — 9.6 — 14.2 — 14.2 Other — 6.2 0.4 6.6 — 7.3 1.1 8.4 — 13.8 3.1 16.9
Derivatives Foreign exchange — 83.2 0.1 83.3 — 69.2 0.2 69.4 2.2 171.0 0.1 173.3 Interest rate 1.7 308.3 1.7 311.7 0.3 321.8 1.5 323.6 0.4 652.9 1.5 654.8 Credit - APS — — 0.6 0.6 — — 1.4 1.4 — — — — Credit - other — 23.2 3.1 26.3 0.1 37.2 3.0 40.3 0.8 133.6 8.0 142.4 Equities and commodities 0.1 4.9 0.2 5.2 0.4 6.1 0.3 6.8 0.5 20.9 0.7 22.1
— 48.8 — 48.8 — 53.6 — 53.6 — 81.1 — 81.1 Customer accounts Repos — 53.0 — 53.0 — 41.5 — 41.5 — 39.9 — 39.9 Collateral — 10.4 — 10.4 — 8.0 — 8.0 — 12.4 — 12.4 Other — 8.7 0.1 8.8 — 11.8 0.1 11.9 — 11.4 0.3 11.7
Assets Loans and advances 0.8 70 (60) 1.1 80 (40) Credit spreads, indices Debt securities MBS 0.7 120 (80) 0.6 60 (10) Prepayment rates, probability of default, loss severity and yield CDOs 2.4 180 (20) 1.0 130 (80) Implied collateral valuation, default rates, housing prices, correlation CLOs 2.1 180 (50) 0.8 80 (50) Credit spreads, recovery rates, correlation Other ABS 1.4 150 (80) 0.9 120 (40) Credit spreads Corporate 0.9 60 (60) 0.6 70 (20) Credit spreads Bank and building societies 0.7 60 (60) 0.2 10 (30) Credit spreads 8.2 750 (350) 4.1 470 (230) Equity shares 1.0 160 (160) 1.5 280 (220) Fund valuation Derivatives Foreign exchange 0.1 — — 0.2 10 — Volatility, correlation Interest rate 1.7 150 (140) 1.5 80 (100) Volatility, correlation Credit - APS 0.6 860 (940) 1.4 1,370 (1,540) Credit spreads, correlation, expected losses, discount rate recoveries, loss credits Credit - other 3.1 320 (170) 3.0 420 (360) Counterparty credit risk, correlation, volatility Equities and commodities 0.2 — — 0.3 20 (20) Correlation, dividends
Key points Level 3 assets of £15.7 billion represented 2.0% (2009 - £13.1 billion and 1.6%) of total assets carried at fair value, an increase of £2.6 billion, reflecting the movement of some lower quality AFS CDOs and CLOs in Non-Core in Q1 2010, where price discovery indicated uncertainty in observability. In addition, the use of more conservative internal recovery rates for the calculation of CVA for certain monolines resulted in these credit derivatives moving to level 3. This was partially offset by disposals in Q3 2010 and tighter credit spreads. The fair value of APS credit derivative decreased from £1,400 million to £550 million primarily due to the reduction in overall assets covered by the scheme.
Level 3 liabilities increased to £4.8 billion, mainly reflecting the impact of wider credit spreads on short positions.
12 Financial instruments - valuation continued Judgmental issues The diverse range of products traded by the Group results in a wide range of instruments that are classified into the three level hierarchy. Whilst the majority of these instruments naturally fall into a particular level, for some products an element of judgment is required. The majority of the Group’s financial instruments carried at fair value are classified as level 2: inputs are observable either directly (i.e. as a price) or indirectly (i.e. derived from prices).
As part of the Group’s IPV process, data is gathered at a trade level from market trading activity, trading systems, pricing services, consensus pricing providers, brokers and research material amongst other sources. The breadth and detail of this data allows a good assessment to be made of liquidity and pricing uncertainty, which assists with the process of allocation to an appropriate level. Where suitable independent pricing information is not readily available the instrument will be considered to be level 3.
12 Financial instruments - valuation continued Commercial mortgage backed securities CMBS are valued using an industry standard model and the inputs, where possible, are corroborated using observable market data.
For CLOs originated and still held by the Group, the fair value is determined using a correlation model based on a Monte Carlo simulation framework. The main model inputs are credit spreads and recovery rates of the underlying assets and their correlation. A credit curve is assigned to each underlying asset based on prices from third-party dealer quotes and cash flow profiles, sourced from an industry standard model. Losses are calculated taking into account the attachment and detachment point of the exposure. Where the correlation inputs to this model are not observable, CLOs are classified as level 3.
Derivatives Derivatives are priced using quoted prices for the same or similar instruments where these are available. However, the majority of derivatives are valued using pricing models. Inputs for these models are usually observed directly in the market, or derived from observed prices. However, it is not always possible to observe or corroborate all model inputs. Unobservable inputs used are based on estimates taking into account a range of available information including historic analysis, historic traded levels, market practice, comparison to other relevant benchmark observable data and consensus pricing data.
The model primarily uses the following inputs in relation to each individual asset: notional, maturity, probability of default and expected recovery rate given default. Other key inputs include: the correlation between the underlying assets; the range of possible recovery rates on the underlying assets (“alpha”); the size of the first loss; and the level of expected losses on covered assets that have been sold, that can be treated as losses for the purpose of the APS (“loss credits”).
As the inputs into the valuation model are not all observable the APS derivative is a level 3 asset. The fair value of the credit protection at 31 December 2010 was £0.55 billion (2009 - £1.40 billion).
Range of possible recovery rates on underlying assets (alpha): +/- 10% The level of alpha used in the valuation of the APS is in line with that used to value tranches traded by the exotic credit desk and assumes that the underlying assets have a wide range of potential recovery rates. As the APS protects a wider range of asset classes than is generally referenced by exotic credit trades, there is uncertainty in relation to this approach. A comparison of actual recoveries to expected recoveries supports the approach adopted and, in light of this, only changes of +/10 % in the assumed width of this range are considered reasonable.
Discount curve: +/- 1% Due to the long-dated contractual maturity of the APS, and the requirement to pay fixed levels of premiums each year, the valuation is sensitive to long-term interest rates. Valuation uncertainty arises due to the illiquidity of such interest rates. An interest rate range of +/- 1% is considered reasonable.
Using the above reasonably possible alternative assumptions, the fair value of the APS derivative could be higher by approximately £860 million or lower by approximately £940 million as detailed in the table below.
Individual sensitivities above have been aggregated and do not reflect the correlated effect of some of the assumptions as related sensitivities.
Interest rate and commodity derivatives Interest rate and commodity options provide a payout (or series of payouts) linked to the performance of one or more underlying, including interest rates, foreign exchange rates and commodities.
The carrying value of debt securities in issue is represented partly by underlying cash and partly through a derivative component. The classification of the amount in level 3 is driven by the derivative component and not by the cash element.
Other financial instruments In addition to the portfolios discussed above, there are other financial instruments which are held at fair value determined from data which are not market observable, or incorporating material adjustments to market observed data. These include subordinated liabilities and write downs relating to undrawn syndicated loan facilities.
Level 3 Reclassification Purchases and issuances Sales and settlements Foreign exchange
Liabilities Deposits 290 43 — (217) — 15 (23) (5) 103 — Debt securities in issue 4,362 57 — (1,682) — 493 (638) (247) 2,345 (41)
The assumptions and methodologies underlying the calculation of fair values of financial instruments at the balance sheet date are as follows: The fair value of financial instruments which are of short maturity (three months or less) approximates their carrying value. This mainly applies to cash and balances at central banks, items in the course of collection from other banks, settlement balances, items in the course of transmission to other banks and demand deposits.
Debt securities Fair values are determined using quoted prices where available or by reference to quoted prices of similar instruments.
Deposits by banks and customer accounts The fair values of deposits are estimated using discounted cash flow valuation techniques.
Assets Cash and balances at central banks 56,997 17 57,014 52,229 32 52,261 12,364 36 12,400 Loans and advances to banks 98,789 1,729 100,518 89,622 2,131 91,753 133,565 4,632 138,197 Loans and advances to customers 199,626 355,634 555,260 227,745 500,648 728,393 338,751 535,971 874,722
More than 12 months Total £m £m £m £m £m £m £m £m £m Assets Loans and advances to banks 4,651 14,884 19,535 16,447 14,791 31,238 16,096 10,935 27,031 Loans and advances to customers 3,855 2,834 6,689 — 2,777 2,777 — — — Debt securities — 1,454 1,454 52 1,234 1,286 — — — Settlement balances — — — 11 — 11 — — — Derivatives 2 1,473 1,475 80 1,089 1,169 221 947 1,168
2009 Deposits by banks 65,966 15,541 3,934 2,301 632 12 Customer accounts 521,400 15,619 5,944 4,221 8,490 4,392 Debt securities in issue 100,220 49,300 56,869 25,915 27,326 3,819 Derivatives held for hedging 660 1,566 3,232 1,264 1,674 1,508 Subordinated liabilities 1,929 1,892 3,654 4,963 20,157 6,105 Settlement balances and other liabilities 12,048 100 139 104 239 83 702,223 84,018 73,772 38,768 58,518 15,919
Customer accounts 1,029 — — — — — Debt securities in issue 589 1,089 6,436 128 1,248 — Subordinated liabilities 317 310 1,357 1,873 1,998 3,482 1,935 1,399 7,793 2,001 3,246 3,482 2009 Deposits by banks 93 — — — — — Customer accounts 964 12,337 — — — — Debt securities in issue 3,132 2,080 2,732 3,615 1,255 — Derivatives held for hedging (5) (23) (19) 13 64 — Subordinated liabilities 106 406 1,146 2,010 2,634 3,923 4,290 14,800 3,859 5,638 3,953 3,923 2008 Deposits by banks 116 1,707 — — — — Debt securities in issue 4,448 3,105 1,334 6,105 — — Derivatives held for hedging 186 16 30 1 — — Subordinated liabilities 158 458 1,464 1,376 4,241 5,149 4,908 5,286 2,828 7,482 4,241 5,149
14 Financial assets - impairments The following table shows the movement in the provision for impairment losses on loans and advances.
At 1 January 8,953 5,254 3,076 17,283 11,016 6,452 Transfer to disposal groups (72) — — (72) (324) (767) Currency translation and other adjustments (15) 27 31 43 (530) 1,441 Disposal of subsidiaries (1,344) (526) (302) (2,172) (65) (178)
Loans and advances to customers 9,157 13,056 6,360 Loans and advances to banks (13) 34 118 9,144 13,090 6,478 Debt securities 81 601 858 Equity shares 31 208 103 112 809 961
The following tables show an analysis of impaired financial assets. Group 2010 2009 2008 Carrying Carrying Carrying
Value Value Value £m £m £m Available-for-sale securities Debt securities 580 758 618
The Group holds collateral in respect of certain loans and advances to banks and customers that are past due or impaired. Such collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower.
Loans that have been renegotiated in the past 12 months that would otherwise have been past due or impaired amounted to £5,758 million at 31 December 2010 (2009 - £2,698 million; 2008 - £2,637 million).
15 Derivatives Companies in the Group transact derivatives as principal either as a trading activity or to manage balance sheet foreign exchange, interest rate and credit risk.
For cash flow hedging relationships, the initial and ongoing prospective effectiveness is assessed by comparing movements in the fair value of the expected highly probable forecast interest cash flows with movements in the fair value of the expected changes in cash flows from the hedging interest rate swap or by comparing the respective changes in the price value of a basis point. Prospective effectiveness is measured on a cumulative basis i.e. over the entire life of the hedge relationship. The method of calculating hedge ineffectiveness is the hypothetical derivative method. Retrospective effectiveness is assessed by comparing the actual movements in the fair value of the cash flows and actual movements in the fair value of the hedged cash flows from the interest rate swap over the life to date of the hedging relationship.
For fair value hedge relationships of interest rate risk, the hedged items are typically large corporate fixed-rate loans, fixed rate finance leases, fixed rate medium-term notes or preference shares classified as debt. At 31 December 2010, fixed rate financial assets of £48.8 billion and fixed rate financial liabilities of £63.9 billion were hedged by interest rate swaps in fair value hedge relationships.
Interest rate contracts Interest rate swaps 29,792 251,312 243,807 30,956 265,528 253,793 37,901 548,040 532,180 Options purchased 2,619 57,359 — 3,180 55,976 — 5,673 99,192 — Options written 2,731 — 54,141 2,539 — 55,589 3,775 — 102,216 Futures and forwards 4,618 3,060 1,261 6,555 2,088 2,033 8,555 7,600 6,620
Included above are derivatives held for hedging purposes as follows: 2010 2009 2008 Assets Liabilities Assets Liabilities Assets Liabilities £m £m £m £m £m £m
Cash flow hedging Exchange rate contracts — — 2 7 2 90 Interest rate contracts 2,903 995 1,753 3,080 2,503 2,834 Commodity contracts — — — — 39 14
Hedge ineffectiveness recognised in other operating income comprised: Fair value hedging Gains/(losses) on the hedged items attributable to the hedged risk 343 512 (965) (Losses)/gains on the hedging instruments (405) (455) 884 Fair value ineffectiveness (62) 57 (81) Cash flow hedging ineffectiveness (37) 14 (16)
Hedged forecast cash flows expected to occur Forecast receivable cash flows 985 779 667 554 423 1,323 407 45 5,183 Forecast payable cash flows (1,732) (1,614) (1,390) (1,059) (890) (2,880) (1,397) (257) (11,219)
The following table shows the notional amounts and fair values of the company's derivatives.
Included above are derivatives held for hedging purposes as follows: Fair value hedging Assets £m Liabilities £m Assets £m Liabilities £m Assets £m Liabilities £m
Asset backed securities (1) Corporate Other (2) Total 2010 £m £m £m £m £m £m £m £m
Held-for-trading 5,097 15,956 43,224 5,778 21,988 6,590 236 98,869 Designated as at fair value 1 — 262 3 119 16 1 402 Available-for-sale 8,377 17,890 33,122 7,198 42,515 2,011 17 111,130 Loans and receivables 11 — — 15 6,203 848 2 7,079 13,486 33,846 76,608 12,994 70,825 9,465 256 217,480
Available-for-sale Gross unrealised gains 349 341 700 60 1,057 87 1 2,595 Gross unrealised losses (10) (1) (618) (32) (3,396) (37) (3) (4,097)
2008 Held-for-trading 5,372 9,859 37,519 11,021 39,879 11,057 1,573 116,280 Designated as at fair value 2,085 510 472 89 236 1,580 456 5,428 Available-for-sale 11,330 6,152 32,480 13,139 62,067 5,400 2,288 132,856 Loans and receivables — — — 114 8,961 3,749 161 12,985 18,787 16,521 70,471 24,363 111,143 21,786 4,478 267,549
Notes: (1) Includes securities issued by US federal agencies and government sponsored entities, and covered bonds. (2) Includes securities, other than asset-backed securities, issued by US federal agencies and government sponsored entities. (3) During 2009, the Group reclassified debt securities from the held-for-trading category into the loans and receivables category and in 2008 from the held-for-trading and available-for-sale categories into the loans and receivables category and from the held-for-trading category into the available-for-sale category (see pages 306 to 309).
The company holds debt securities issued by a Group undertaking of £1,454 million (2009 - £1,286 million; 2008 - nil) classified as loans and receivables.
Notes: (1) Includes securities issued by US federal agencies and government sponsored entities. (2) Includes securities, other than asset-backed securities, issued by US federal agencies and government sponsored entities.
Listed Unlisted Total Listed Unlisted Total Listed Unlisted Total £m £m £m £m £m £m £m £m £m
Gross gains of £83 million (2009 - £385 million; 2008 - £181 million) and gross losses of £63 million (2009 - £123 million; 2008 - £59 million) were realised on the sale of available-for-sale equity shares.
Unquoted equity investments whose fair value cannot be reliably measured are carried at cost and classified as available-for-sale financial assets. They include capital stock (redeemable at cost) in the Federal Home Loan Bank and the Federal Reserve Bank of £0.8 billion (2009 - £0.8 billion; 2008 - £0.9 billion) that the Group's banking subsidiaries in the US are required to hold; and a number of individually small shareholdings in unlisted companies.
Disposals in the year generated losses of £2 million (2009 - £21 million; 2008 - nil).
At 1 January 64,766 42,196 43,542 Currency translation and other adjustments (49) (566) 2,839 Additional investments in Group undertakings 1,884 36,202 10,323 Additions — — 26 Redemption of investments in Group undertakings (12,346) (7,908) — Disposals (6) (19) (213) Impairment of investments (5,124) (5,139) (14,321)
Net book value at 31 December 2010 12,528 150 636 1,134 14,448 2009 Cost At 1 January 2009 45,624 2,780 4,367 4,524 57,295 Transfers to disposal groups (238) — — — (238) Currency translation and other adjustments (2,743) (225) (281) (65) (3,314)
Accumulated amortisation and impairment At 1 January 2008 — 238 223 2,291 2,752 Transfer to disposal groups — — — (37) (37) Currency translation and other adjustments — 150 210 69 429 Disposals and write-off of fully amortised assets — (3) (1) (19) (23) Charge for the year - continuing operations — 89 301 581 971 Charge for the year - discontinued operations — 248 281 70 599 Write down of goodwill and other intangible assets - continuing operations 15,524 — 927 434 16,885 Write down of goodwill and other intangible assets - discontinued operations 14,538 685 428 19 15,670 At 31 December 2008 30,062 1,407 2,369 3,408 37,246
Impairment review The Group's goodwill acquired in business combinations is reviewed annually at 30 September for impairment by comparing the recoverable amount of each cash generating unit (CGU) to which goodwill has been allocated with its carrying value.
The recoverable amount of Global Transaction Services, based on a 3% (2009 - 3%) terminal growth rate and a 12.8% (2009 - 16.7%) pre tax discount rate, exceeded its carrying value by more than 100% (2009 - 100%) and was insensitive to a reasonably possible change in key assumptions.
Accumulated impairment, depreciation and amortisation At 1 January 2010 — 553 87 641 2,396 1,764 5,441 Currency translation and other adjustments — 62 1 75 199 17 354 Disposal of subsidiaries — (24) — (30) (197) (141) (392) Reclassifications — (17) 17 — — — — Write down of property, plant and equipment — 32 4 1 4 — 41 Disposals and write-off of fully depreciated assets — (10) (2) (48) (261) (435) (756) Charge for the year - continuing operations — 106 11 148 536 627 1,428 Charge for the year - discontinued operations — — — 6 23 17 46 At 31 December 2010 — 702 118 793 2,700 1,849 6,162
Net book value at 31 December 2010 4,170 2,236 173 1,039 1,539 7,386 16,543 2009 Cost or valuation At 1 January 2009 3,868 4,032 224 1,867 4,168 9,334 23,493 Transfers to disposal groups — (32) — (62) (80) — (174) Currency translation and other adjustments (85) (134) — (65) (131) (561) (976) Disposal of subsidiaries — (15) — — (19) — (34) Reclassifications 1 18 1 (34) 14 — — Additions 1,634 304 8 153 750 2,241 5,090 Expenditure on investment properties 8 — — — — — 8 Change in fair value of investment properties (117) — — — — — (117) Disposals and write-off of fully depreciated assets (426) (75) (19) (56) (420) (1,456) (2,452)
Net book value at 31 December 2009 4,883 3,545 127 1,162 1,886 7,794 19,397
Accumulated depreciation and amortisation At 1 January 2008 — 391 74 436 1,952 2,747 5,600 Transfers to disposal groups — (60) — (91) (243) — (394) Currency translation and other adjustments — (9) 1 9 148 202 351 Disposal of subsidiaries — — — (1) (39) (1,447) (1,487) Reclassifications — 17 (2) 1 (9) (7) — Write down of property, plant and equipment — 19 — — 7 — 26 Disposals and write-off of fully depreciated assets — (22) — (31) (539) (544) (1,136) Charge for the year - continuing operations — 86 6 139 534 641 1,406 Charge for the year - discontinued operations — — — 30 105 43 178 At 31 December 2008 — 422 79 492 1,916 1,635 4,544
Net book value at 31 December 2008 3,868 3,610 145 1,375 2,252 7,699 18,949
Investment properties are valued to reflect fair value, that is, the market value of the Group's interest at the reporting date excluding any special terms or circumstances relating to the use or financing of the property and transaction costs that would be incurred in making a sale. Observed market data such as rental yield, replacement cost and useful life, reflect relatively few transactions involving property that is not necessarily identical to property owned by the Group.
Valuations are carried out by qualified surveyors who are members of the Royal Institution of Chartered Surveyors, or an equivalent overseas body. The valuation as at 31 December 2010 for a significant majority of the Group's investment properties was undertaken with the support of external valuers.
The fair value of investment properties includes £248 million of depreciation since purchase (2009 - £84 million appreciation; 2008 - £172 million appreciation).
21 Prepayments, accrued income and other assets Group Company 2010 2009 2008 2010 2009 2008 £m £m £m £m £m £m
Discontinued operations Total income 1,433 5,664 7,709 Operating expenses (803) (4,061) (20,544) Insurance net claims (161) (500) (513)
Profit/(loss) before tax 427 52 (14,545) Gain on disposal before recycling of reserves 113 — 3,859 Recycled reserves (1,076) — — Operating (loss)/profit before tax (536) 52 (10,686) Tax on profit/(loss) (92) (58) (48) Tax on gain on disposal — — (33) Loss after tax (628) (6) (10,767)
Businesses acquired exclusively with a view to disposal Loss after tax (5) (99) (251) Loss from discontinued operations, net of tax (633) (105) (11,018)
Discontinued operations reflect the results of the State of the Netherlands and Santander in RFS Holdings B.V., following the legal separation of ABN AMRO Bank N.V. on 1 April 2010. Consortium partners’ results are classified as discontinued operations and prior years have been represented accordingly. Discontinued operations in 2008 also reflect the results of Banco Real sold to Santander on 24 July 2008.
Net cash flows from operating activities 2,528 (542) (7,497) Net cash flows from investing activities 400 (264) 7,654 Net cash flows from financing activities 129 1,020 3,333 Net increase/(decrease) in cash and cash equivalents 3,062 (402) 4,946
To comply with EC State Aid requirements, the Group has agreed to make a series of divestments within four years from December 2009. During 2010, the Group successfully completed the disposal of 80.01% of Global Merchant Services and substantially all of the RBS Sempra Commodities JV. Certain contracts of the RBS Sempra Commodities JV business were sold in risk transfer transactions prior to being novated to the purchaser and they comprise substantially all of its residual assets and liabilities. RBS Sempra Commodities JV was the only significant divestment that met the criteria for classification as a disposal group at 31 December 2010.
The other assets and liabilities classified as disposal groups include the project finance assets to be sold to The Bank of Tokyo-Mitsubishi UFJ, Ltd, and certain Non-Core interests in Latin America, Europe and the Middle East.
Note: (1) Other liabilities include £18 million (2009 - £10 million; 2008 - £1 million) in respect of share-based compensation.
At 1 January 2010 562 Currency translation and other movements (58) Disposal of subsidiaries (17) Transfer to disposal groups (33) Charge to income statement - continuing operations 453 Releases to income statement - continuing operations (72) Provisions utilised (211)
Notes: (1) Deferred tax assets are recognised, as set out above, that depend on the availability of future taxable profits in excess of profits arising from the reversal of other temporary differences. Business projections prepared for impairment reviews (see Note 19) indicate it is probable that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within eight years. UK losses do not expire and Netherlands losses expire after nine years. In jurisdictions where doubt exists over the availability of future taxable profits, deferred tax assets of £2,008 million (2009 - £2,163 million; 2008 - £1,748 million) have not been recognised in respect of tax losses carried forward of £9,689 million (2009 - £7,759 million; 2008 - £5,779 million). Of these losses, £41 million will expire within one year, £136 million within five years and £5,913 million thereafter. The balance of tax losses carried forward has no time limit.
(2) Deferred tax liabilities of £279 million (2009 - £279 million; 2008 - £980 million) have not been recognised in respect of retained earnings of overseas subsidiaries and held-over gains on the incorporation of overseas branches. Retained earnings of overseas subsidiaries are expected to be reinvested indefinitely or remitted to the UK free from further tax. No tax is expected to arise in the foreseeable future in respect of held-over gains. Changes to UK tax legislation largely exempts from UK tax, overseas dividends received on or after 1 July 2009.
General insurance business (i) Claims and loss adjustment expenses. Group Gross Reinsurance Net £m £m £m
Notified claims 4,052 (260) 3,792 Incurred but not reported 1,426 (27) 1,399 At 1 January 2009 5,478 (287) 5,191 Cash paid for claims settled in the year (3,812) 69 (3,743) Increase/(decrease) in liabilities - arising from current year claims 4,383 (23) 4,360 - arising from prior year claims (79) (53) (132) Disposal of subsidiary (124) 5 (119) Net exchange differences (44) 3 (41)
Notified claims 4,375 (305) 4,070 Incurred but not reported 2,351 (5) 2,346 At 31 December 2010 6,726 (310) 6,416
At 1 January 2009 2,711 (79) 2,632 Movement in the year (211) 12 (199) Exchange differences (10) — (10) At 1 January 2010 2,490 (67) 2,423 Increase in the year 2,191 (76) 2,115 Release in the year (2,393) 71 (2,322)