M Why go online? www.rbs.com/annualreport2009 if you haven’t already tried it, visit our easy-to-use, fully interactive online Annual Report. Many shareholders are now benefiting from more accessible information and helping the environment too.
The essential value of RBS is intact. All our Core businesses are functioning normally, and our customer franchises are proving resilient.
We have set out the roadmap to recovery, with a clear strategy that is supported inside and outside RBS.
We now have the tools we need to do the job: the right leadership, appropriate levels of new capital and contingency protection.
• The Government will have sold or at least begun to sell its shares at a profit
Notes: (1) Before tax, amortisation of purchased intangible assets, write-down of goodwill, integration and restructuring costs, gain on redemption of own debt, strategic disposals, gains on pensions curtailment, bonus tax and RFS Holdings minority interest. Statutory operating loss before tax of £2.6 billion.
Economic backdrop – a deep recession, but signs of recovery Last year was a tumultuous one for the global economy. In our most important market, the UK, gross domestic product shrank by 4.8% in real terms. Significant contractions were also registered in the USA and, in particular, Ireland.
The recession hurt many of our customers, with unemployment rising sharply and corporate profitability coming under pressure, which in turn led to a marked deterioration in credit quality. In addition, lower interest rates squeezed margins on many of our savings products. Viewed in that context, there are resilient aspects of our performance in another disappointing year of overall losses.
External influences – a price worth paying The benefits to RBS of political involvement, in the widest possible sense, are significantly larger than the costs. Put simply, if RBS hadn’t received government support, it wouldn’t be here today. Moreover, the extent of the support it received means we are in a position to rebuild carefully on our strengths.
The Government’s Asset Protection Scheme (APS) comes with a high price tag, but is a worthwhile investment on two counts. First, it enables us to pass the Financial Services Authority’s stress tests. The insurance element of the scheme is the only way we could realistically achieve that. Second, it fills the hole in our capital ratios created by the losses we made in 2009, the further charges we expect to make in 2010, and the associated increase in risk-weighted assets from pro-cyclicality and regulatory change. We need the support of the APS if we are to accomplish our goals.
It is the Board’s view that the restructured terms of the APS, which were endorsed by independent shareholders in December 2009, represent a better outcome for shareholders than the outline agreement reached in February 2009, when market conditions were much more uncertain and difficult. It insures fewer assets and costs less. We do not expect to claim
Chairman’s statement losses under the APS, but it does provide valuable protection in the event of more challenging economic conditions. We have also agreed how, if we wish to do so, we can cancel the scheme at any stage. Finally, the fees have substantially reduced and we retain our deferred tax assets.
Remuneration reform – leading the way Throughout 2009, one of the biggest challenges we faced was balancing public and political concerns on bankers’ pay with the longterm interests of all our shareholders. We share the public’s concerns and we understand that it is impossible to defend some of the historic pay practices of the industry. Reform is needed. We said we would lead that reform and I believe we have: our policies on clawback and deferral of bonuses, announced in February 2009, went further than other banks and further than the subsequent G20 proposals.
On bonus payments for 2009, we were guided by a policy to pay the minimum necessary to retain and motivate staff who are critical to the recovery of RBS. The Board believes it would have undermined the profitable core of the business and damaged shareholder value had we recommended less. It is essential that talented people do not feel disadvantaged in working to restore value to RBS, compared with other banks. Nonetheless, the Board believes the position we have reached – developed by the Remuneration Committee, endorsed by the Board and accepted by UKFI, who for one year only held a legal right to consent – strikes an appropriate balance.
Governance – comprehensive change to Board and Executive Management We have made comprehensive changes to the Board and the Executive Management team. The Board is now the right size – smaller – and combines the skills and experience we need to rebuild the company. Sir Sandy Crombie, Bruce Van Saun, and Phillip Scott all joined in 2009, while Penny Hughes joined in 2010.
Finally, we are satisfied that we are fulfilling both the letter and the spirit of our lending commitments, which were to make an additional £9 billion available to the mortgage market and £16 billion to creditworthy businesses. On the former, we have beaten our target. On the latter, we have achieved £60 billion of gross new lending to businesses, including £39 billion to SMEs, but, in the current economic environment, many customers have been strongly focused on reducing their borrowings.
A new phase for RBS We are moving purposefully to a new phase for RBS. We have a focused team and a clear strategy. We have removed the main barriers that were in our way. If we do the right things for our customers we’ll be doing the right things for our shareholders. I hope that the Group’s results give you the clarity about our performance and direction that enables you to share the confidence I have in the brighter future for RBS.
Stephen Hester, Group Chief Executive d Watch or listen to Stephen Hester at www.rbs.com/annualreport2009
Everyone at RBS is conscious of the responsibilities that lie with us to ensure recovery of the support the Bank has received. In that context it is pleasing to be able to report some big steps on our recovery path, which I outline in this review.
Strategy Our strategy is simple and its concepts are well tested in this and other industries. Its implementation, however, constitutes one of the largest and most far-reaching company restructurings yet seen globally.
We aim to remake RBS as one of the world’s most admired, valuable and stable universal banks. Driven by market-leading businesses in large customer-driven markets, RBS targets 15%+ sustainable returns on equity from a stable AA category risk profile and balance sheet.
Results and progress 2009 saw pleasing progress toward our three main goals. On every published measure the Group is ahead of our Strategic Plan at this stage. However, the challenges of the starting point mean it will take until the end of our Plan period for overall profitability to meet our aspirations.
Risk We have also made substantial progress in restoring strength and improved risk management to RBS – both under our own steam and thanks to government support and improving markets. Our overall balance sheet is already £696 billion below its peak and the funded balance sheet is £351 billion lower, in constant currency terms; 70% of our targeted reduction is behind us. Our funding and liquidity resilience has dramatically improved. Our loan to deposit ratio is down from its 154%
In our Non-Core Division, rapid progress on divestments, asset run-off and sales reduced total third party assets by 36% in 2009, ahead of Plan, to £221 billion, including derivatives. Doing so crystallised losses, and further losses are likely to occur in coming years, albeit steadily declining. In the second half of 2009, Non-Core losses reduced 44% from the first half, providing encouragement about this trend. After some one-off gains, RBS Group had net attributable losses of £3.6 billion overall.
Outlook We see the outlook as cautiously encouraging for RBS and the economies we serve, although with clear risks. It looks as if loan impairments may have peaked in 2009 and our net interest margin, despite the continued squeeze on liability margins and higher liquidity costs, has now shown two quarters of improvement. Our progress in 2009 gives increased comfort in our ability to execute the restructuring challenges that remain.
Nonetheless, there are important areas of uncertainty today that should become clearer over the course of 2010. How these resolve will make the value case for RBS more certain.
• Firstly, much depends on the shape and pace of economic recovery and the way it feeds through to business activity, interest rates and credit impairments.
• Secondly, prospective regulatory change, about which more below, is likely to be significantly shaped in 2010 with the timing of implementation also clearer. This will affect customer activity and pricing as well as capital structure and shareholder returns.
• Finally, while the riskiest part of the recovery plan is behind us, 2010 will be a year of hard slog, with limited visibility of our end value. Though Non-Core impairments and write-downs are expected to improve, they are likely to remain high and will once again continue to weigh against our strong Core operating profits. Our plans carry execution risk, and there is a further risk of sheer change fatigue. We must make sure that we stay on top of these risks.
People There are several necessary ingredients on the journey from failed institution to recovery story, and in the end to market leader. Perhaps the most crucial of these ingredients is people.
• The decline in US GDP was mild by comparison (-2.4%), but that is still a deep recession by US historic standards. The unemployment rate more than doubled, giving rise to the weakest labour market conditions for almost 30 years.
As a result, most economists expect that the recovery in our core markets will be sluggish by historic standards. This suggests that inflation will remain low and that interest rates will be raised only gradually. Emerging markets, especially Asia, will likely outperform as they are less encumbered by balance sheet strains.
Finally, the financial services industry must do more on the issue of cultural change: reconnection with customers and communities; restoration of management excellence; reform of pay structures that have become hard to defend. The financial services industry is integral to our economic system. As such its weakening comes at considerable peril to society’s broader wealth creation and stability. But our more intangible licence to operate from society is at present rather battered. Our integral role requires that we restore it.
At the beginning of 2010 RBS is still a complex story. It will become simpler, clearer and more valuable as our strategy and actions show more results. We believe we can do this, to the benefit of all.
x What is your dividend policy going forward? In the light of our 2009 results, it would not be appropriate to pay any dividend on ordinary shares this year, nor, under the terms of the European Commission’s approval of the state aid we have received, will we be able to do so for a further two years. The Board is mindful that dividends form an extremely important part of shareholder return and income. It is our intention over time to resume the payment of a dividend as soon as it is prudent to do so, taking account of the Group’s capital position, retained earnings and prospects, as well as of the enhanced dividend rights attached to the B Shares held by the UK Government. There will be dividend payments on some preference shares this year but, thereafter, they will be subject to the same twoyear hiatus required by the EC.
x What is the timetable for the EU-required divestments? We have four years to make all our disposals and will determine the timing of each with reference to the following criteria: getting the best value for shareholders; minimising the disruption to our customers and employees; market conditions; and execution risk.
x How much of a problem has UK political interference been? The benefits to RBS of political involvement, in the widest possible sense, are significantly larger than the costs. Put simply, if RBS hadn’t received government support, it wouldn’t be here today. It is in every shareholder’s interest that RBS is run commercially and, on every item of strategic and operational substance, that has been the case.
x To what extent has the loss of high-performing employees affected performance? The loss of high-performing employees has been damaging but, to date, not destructive. Each year, we rate our employees on a scale of one to five, where four and five are the highest ratings. The bad news is that the percentage of people ranked four or five that left us in the second half of 2009 was roughly double the prevailing rate over the period 2005-07. The better news is that this number is rising from a relatively low base. We have also been able to hire talented people to help in the restructuring challenges ahead for the company.
x How would a UK sovereign credit downgrade affect the Group? We carry out contingency exercises on a range of possible outcomes. It is true that the RBS Group’s credit rating is, to a degree, supported by the UK sovereign rating, so a downgrade may have repercussions for the rating of RBS. We diligently employ liquidity oversight and contingency planning designed to mitigate the impact on the Group from a number of liquidity stresses, including credit rating downgrades, irrespective of the sovereign rating of the UK.
Philip Hampton (age 56) N (Chairman) Appointed to the Board on 19 January 2009 and as Chairman on 3 February 2009. Philip Hampton was previously chairman of J Sainsbury plc and group finance director of Lloyds TSB Group plc, BT Group plc, BG Group plc, British Gas and British Steel plc, an executive director of Lazards and a non-executive director of RMC Group plc. He is also former chairman of UK Financial Investments Limited, the company established to manage the UK Government's shareholding in banks subscribing to its recapitalisation fund, and is a non-executive director of Belgacom SA. Philip joined the Board of Anglo American plc as a non-executive director on 9 November 2009.
Bruce Van Saun (age 52) Group Finance Director Appointed to the Board on 1 October 2009, Bruce Van Saun has more than 25 years financial services experience. From 1997 to 2008 he held a number of senior positions with Bank of New York and later Bank of New York Mellon, most recently as vice chairman and chief financial officer and before that he was responsible for the Asset Management and Market Related businesses. Prior to that, he held senior positions with Deutsche Bank, Wasserstein Perella Group and Kidder Peabody & Co. He has served on several corporate boards as a nonexecutive director and has been active in numerous community organisations.
Colin Buchan* (age 55) A, N, R (Chairman), Ri Appointed to the Board in June 2002, Colin Buchan was educated in South Africa and spent the early part of his career in South Africa and the Far East. He has considerable international investment banking experience, as well as experience in very large risk management in the equities business. He was formerly a member of the group management board of UBS AG and head of equities of UBS Warburg, and was the former chairman of UBS Securities Canada Inc. He is chairman of Standard Life Investments Limited and a director of Standard Life plc and Black Rock World Mining Trust Plc. Colin is a fellow of the Chartered Institute of Bankers of Scotland.
Sandy Crombie* (age 61) Senior Independent Director N, R, Ri Appointed to the Board in June 2009, Sandy Crombie retired from his position as Group Chief Executive of Standard Life Plc on 31 December 2009. He has previously served as 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, as Vice Chairman of the Royal Scottish Academy of Music and Drama, and President of The Cockburn Association.
Penny Hughes* (age 50) N, R Penny Hughes joined the Board on 1 January 2010 and is currently a nonexecutive director of Home Retail Group plc and Cable & Wireless plc. Penny joined the board of Wm Morrisons Supermarkets plc on 1 January 2010. 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.
Joe MacHale* (age 58) A, N, Ri Appointed to the Board in September 2004, Joe MacHale is currently a non-executive director and chairman of the remuneration committee of Brit Insurance Holdings plc, and a trustee and treasurer of MacMillan Cancer Support. He held a number of senior executive positions with J P Morgan between 1979 and 2001 and was latterly chief executive of J P Morgan Europe, Middle East and Africa Region. He is a fellow of the Institute of Chartered Accountants and the Chairman of Prytania Holdings LLP.
John McFarlane* (age 62) 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.
Philip Scott* (age 55) A, N, Ri (Chairman) Appointed to the Board on 1 November 2009, Philip Scott has wide-ranging experience of financial services and risk management, including previous responsibility for Aviva's continental European and international life and long-term savings businesses. He has held a number of senior executive positions during his career at Aviva, including his role as Group Finance Director until January 2010. Philip is also an experienced non-executive director and is currently on the board of Diageo plc.
Key to pictures 1. Stephen Hester, Group Chief Executive 2. Bruce Van Saun, Group Finance Director 3. John Hourican, Chief Executive, Global Banking & Markets 4. Brian Hartzer, Chief Executive, UK Retail, Wealth and Ulster Bank 5. Chris Sullivan, Chief Executive, UK Corporate 6. Ellen Alemany, Chief Executive, Citizens and Head of Americas 7. Ron Teerlink, Chief Administrative Officer 8. Nathan Bostock, Head of Restructuring & Risk 9. Paul Geddes, Chief Executive, RBS Insurance 10. Alan Dickinson, Chairman, UK Corporate
The Executive Committee provides executive input to the Group Board, and monitors and reports to the Group Board on all operational and day to day activities in relation to the Group’s businesses.
Ron Teerlink (age 49) Chief Administrative Officer In April 2008, Ron Teerlink joined The RBS Group as Chief Executive of Business Services, becoming the Group Chief Administrative Officer in February 2009. At the same time he was re-appointed to the Managing Board of ABN AMRO to oversee the integration programme. Ron started his career with ABN Bank in 1986 as an IT/Systems analyst and held various functional positions before becoming Chief Operating Officer of the Wholesale Clients Business in 2002. He was appointed Chief Executive Officer of Group Shared Services in 2004 and joined ABN AMRO’s Managing Board in January 2006, where he was responsible for Services and Market Infrastructure. Ron holds a Masters degree in Economics from Amsterdam’s Vrije Universiteit.
Nathan Bostock (age 49) Head of Restructuring & Risk Nathan Bostock joined The RBS Group in June 2009 as Head of Restructuring and Risk with responsibility for the newly formed Non-Core Division & APS, the Global Restructuring Group and the control functions of Group Legal & Secretariat and Risk Management. Before joining RBS, Nathan spent eight years with Abbey National plc in several roles and was latterly the CFO and main Board Director responsible for Products & Marketing, HR, Insurance and Cards. Before joining Abbey in 2001, Nathan spent ten years with RBS in a number of roles, including Chief Operating Officer of Treasury and Capital Markets and Group Risk Director. A Chartered Accountant, Nathan worked with Coopers & Lybrand, before starting his career in banking. He spent seven years in Chase Manhattan Bank in a variety of areas and functions. He also holds a BSc (Hons) in Mathematics.
Alan Dickinson (age 59) Chairman, UK Corporate Alan Dickinson became Chairman, Corporate Banking on 1 August 2009 having been Chief Executive, Corporate Banking from March, following the Group’s restructure. The business looks after the Group’s SME and Corporate businesses in the UK and its Global Transaction Services Division. Alan is a member of the Bank’s Group Executive Committee. He joined The Royal Bank of Scotland Group in 1973. His career has covered working in the front line of Retail, Corporate and SME banking as well as in 1992 being Director of Credit covering the Bank’s personal, business, commercial and corporate customers in the UK.
It comprises members of the Executive Committee plus: Richard Hemsley, Chief Operating Officer, Business Services Jennifer Hill, Head of Strategy and Corporate Finance Marco Mazzucchelli, Deputy CEO of Global Banking & Markets Cormac McCarthy, Chief Executive, Ulster Bank John McCormick, CEO Asia Andrew McLaughlin, Head of Communications and Group Chief Economist Miller McLean, Group General Counsel and Group Secretary Peter Neilsen, Global Head of Markets Neil Roden, Head of Human Resources Brian Stevenson, Chief Executive, Global Transaction Services
We are concentrating RBS around the competitive strengths we enjoy in each of our Core businesses. We are focusing on what we are good at and making it better. At the same time we are reducing our balance sheet, risk and funding exposures through massive restructuring and are reducing both scale and scope in areas where we are not naturally strong. We are re-engineering cost structures and have embarked on overdue business investment. Management and cultural change has also been comprehensive.
RBS to deliver its strategy from a stable AA category risk profile and balance sheet
RBS management hallmarks to include an open, investor-friendly approach, discipline and proven execution effectiveness, strong risk management and central focus on the customer
Market-leading franchises Target and measure market positions and customer satisfaction in all core businesses
Rigorous capital and cost allocation Accurately deploy the Group’s capital and allocate appropriate costs to focus the Divisions on returns, as well as on profit growth
Focussed on retail and commercial banking Activity focussed on UK, US and Ireland and supported by significant business investment plans
Exit Non-Core business lines Expeditious run-off or sale of businesses and asset portfolios while maximising the value obtained for the Group
Strong risk management Introduce a new set of management disciplines to ensure that the RBS of tomorrow will be fundamentally different from the RBS of yesterday – notably in risk management
Achieve Non-Core run-off of £258 billion funded assets (2008) Additional reduction of £85 billion derivatives exposure is also targeted
Each of the Group’s Core businesses maintained or enhanced its market position in 2009. In the UK, RBS maintained its market leading franchises in retail (No.2), small business (No.1) and corporate and commercial banking (No.1).
Good progress has been made in the cost control initiatives across the Group, including major technology and back office restructuring. By the end of 2009 £1.3 billion of costs had been eliminated from RBS, notably in the areas of IT and property infrastructure, and through improved employee efficiency programmes. The Core bank cost:income ratio, net of claims, improved from 66.2% in 2008 to 53.5% in 2009.
Risk weighted assets, return on equity and fully allocated cost:income ratio targets set at Divisional as well as Group level.
At the end of 2009 the Group’s Core Tier 1 ratio was 11%. The Asset Protection Scheme, to which RBS acceded in December 2009, underpins our capital strength by providing protection in the event of severe market stress.
Non-Core Division reduced its portfolio of assets by £122 billion (36%) in 2009. The Group sold its 50% interest in the online Spanish motor insurer Linea Directa in 2009, as well as its 5% stake in Bank of China.
RBS also agreed to sell its retail and commercial banking businesses in Indonesia, Hong Kong, Singapore and Taiwan, and GBM/GTS operations in the Philippines, Taiwan and Vietnam. It remains committed to the sale of certain other parts of its Asian franchise. The Investment Strategies business of RBS Asset Management was sold to Aberdeen Asset Management in January 2010.
The non-US operations of RBS Sempra Commodities, the Group’s joint venture business with California-based Sempra Energy, were sold to J.P. Morgan in February 2010. Sale processes are proceeding in respect of the Global Merchant Services business of GTS and RBS branches in England and Wales, and NatWest branches in Scotland.
The Group’s new Board Risk Committee will regularly analyse the risk profile of the Group, identify any longer-term threats and make recommendations to the Board as appropriate. See page 19 for an overview of key risk developments in 2009, and the steps we took to mitigate them.
Wealth We offer banking and investment services to clients in the UK and around the world.
Citizens and Charter One brands in 12 states in the North East and
We provide a comprehensive range of financial services across the island of Ireland.
Target 2013 Leading franchise focused on re-building sustainable value for customers and the bank.
& Markets We offer a broad range of services enabling major corporations and institutions to achieve their financing objectives.
Services We offer global payments, cash and liquidity management, as well as trade finance, and commercial card products and services.
RBS Insurance We own some of the most well-known brands in the market.
And they help give our customers in the UK and Europe peace of mind.
When we drew-up our strategic plan, one of the tests we set was that each business is connected to the Group in ways that mean the whole is greater than the sum of the parts.
• GTS/Wealth provide a strong source of funding to complement our retail banking franchises. The businesses increased their deposit base in 2009 and contributed almost £1 in every £4 of deposits held by customers, highlighting the strength and depth of the customer relationships that exist in the Divisions. The low loan to deposit ratios (21% GTS and 38% Wealth) in each business help balance the funding profile of the Group.
• GBM helps Corporate Banking Division clients to raise finance from debt and equity markets. We participated in over 80% of equity issues by UK corporates in 2009 and led more UK corporate debt issues than any other bank.
• Insurance – In 2009, 500,000 insurance policies were sold via the branch networks of RBS and NatWest.
We want to put our balance sheet on a more secure footing, where loans are near fully funded by deposits.
We want to rebuild our liquidity buffers, to guard against unexpected funding difficulties.
(3) Amount of unsecured wholesale funding under 1 year. 2009 includes £109 billion of bank deposits and £141 billion of other wholesale funding. 2013 target is for <£65 billion of bank deposits, <£85 billion of other wholesale funding.
(5) Eligible assets held for contingent liquidity purposes including cash, government issued securities and other securities eligible with central banks.
(9) Indicative Core attributable profit taxed at 28% on attributable core spot tangible equity (circa 70% of Group tangible equity based on RWAs).
The risk of being unable to meet obligations as they fall due.
Pension risk is the risk that the Group may have to make additional contributions to its defined benefit pension schemes.
•Potential to disrupt the business model and stop normal functions of the Group
Unprecedented levels of structural change within the Group, the difficult economic environment and the rising level of external threats (e.g. fraud) all combined to expose the Group to a heightened level of operational risk.
The scale of regulatory change was maintained in key areas such as: systemically important firms; prudential and conduct issues; and treating customers fairly. In addition, we saw increased regulatory scrutiny and supervision around governance, capital, liquidity and remuneration.
The next formal valuation of the main UK pension scheme, due as at 31 March 2010, is expected to show a deficit. This may lead to an increase in contributions in 2010.
We have increased investment in specialised workout and collection functions. Enhancements to various elements of our Credit Risk framework, which has been embedded into key business processes, will ensure that the size and shape of the Group's portfolio is aligned to its strategic targets.
We have built up a significant liquidity reserve (£171 billion), increased average maturity of wholesale funding, and reduced our customer funding gap.
Our Core businesses have sustained their market positions, with customer numbers steady or growing across the Group’s major retail and corporate business lines, thereby confirming the essential health and value that underpins RBS’s businesses.
This is also a testimony to the efforts and endurance of our people. We can and must do better still, however. The new RBS will be known for its unswerving focus on customers.
We appreciate the support that the UK taxpayer continued to give RBS Group. In return, the Group agreed with the Government to support the mortgage market by lending, subject to demand, £9 billion – net – in the 12 months to the end of February 2010. The Group is on track to exceed this target on net lending by £3 billion. One result of our commitment to keep the mortgage market moving is that our share of gross mortgage lending nearly doubled, from 7% in 2008 to 12% in 2009.
As compensation for the state aid we received, we also reached an agreement with the European Commission to divest some businesses, including the RBS branches in England and Wales, and the NatWest branches in Scotland. A distinct management team is in place to manage the transition carefully. Their job is to look after the day-to-day needs of these branches and the support functions that back them up so that customers continue to receive the right standard of service.
We have worked hard to address the challenges we face. In July 2009, Brian Hartzer became Chief Executive of the UK Retail, Wealth and Ulster Bank Division. Brian joined from Australia and New Zealand Banking Group Ltd (ANZ) where he was Chief Executive Australia for all ANZ business lines.
£10.2 billion Our net mortgage lending in the UK was £10.2 billion
It’s also important that we provide a service that fits in with our customers’ lifestyles. Many of our customers want to visit a branch but can’t do so during the week. It’s important for them that they can come and talk to us on a Saturday and during the year we changed the opening hours of more than 600 branches so that we could better meet their needs.
To become more efficient we have invested in online banking and the number of active online banking customers increased by almost one quarter during the year. Our online customers have benefited from improved help facilities and we launched our online retirement planning tool for Private Banking customers, which will help them plan for the future.
We continued to take advantage of developments in technology to improve the service we provide our customers. During the year, we were the first UK bank to launch a mobile banking application for the iPhone. We were delighted by its popularity as we received 300% more customer registrations than we had originally targeted.
More changes are in the pipeline through our Retail Transformation Programme as we apply Lean thinking and techniques across the business. Already, our first pilots have delivered efficiency savings amongst our customer facing teams, and we expect these benefits to continue as we apply the lessons learned across the country.
We are committed to improving what we do to become the UK’s most Helpful and Sustainable bank and it’s encouraging that both RBS and NatWest retain a strong position for service in our customers’ eyes. We know we still have a long way to go and that 2010 will be a demanding year. However, we’re confident that with the changes we’re making we’ll build a successful business that will play a huge part in returning the Group to self-sufficiency.
In October, we launched the Business Hotline. Staffed by a team of experienced business bankers, from 8am to 8pm five days a week, Business Hotline offers small and medium-sized enterprises (SMEs) free advice and a second opinion in cases where their lending application has been turned down. Business Hotline is open to all SMEs, not just RBS or NatWest customers.
We offer two years’ free banking to start-ups and opened more than 100,000 start-up accounts in the nine months to September 2009.
start-up accounts in the nine months to September reduction in costs in the year
Our customers like what we’ve done. Their comments show that 91% were very satisfied with what the business branch offers and 86% were prepared to recommend the service. Our research showed that in December 2009, Relationship Directors in Branch Business Banking who have a dedicated business branch earned considerably higher customer satisfaction scores than their peers who don’t have that service. Four of the five branches received 100% scores in mystery shopping exercises.
In February 2009, we launched our SME Regional Funds. Worth an extra £3 billion, these are 12 funds of £250 million each, which we made available to all nine Regional Development Agency (RDA) areas in England, and in Scotland, Wales and Northern Ireland (provided by Ulster Bank).
Our strong support for the EFG, our SME Regional Funds and other initiatives demonstrate our determination to meet our Business Lending Commitments agreed with the Government. We set up a task force that is responsible for making sure we meet the Commitments. We have developed closer links with RDAs and other government bodies.
We continue to work with our customers in other ways too. In 2009, we played a lead role in helping UK corporate clients raise funding from bond markets more often than any other bank. And we participated in 80% of all equity fundraising from the stock market for UK corporates in 2009.
2009 was also the year we set about dealing with our past and making sure we can grow sustainably in future. The APS and EU divestment deals have been agreed. We completed our strategic review and we are implementing the plan. Our cost reduction actions have already saved substantial sums.
Bridging the gap between loans and deposits is an important part of our plan. Corporate Banking Division deposits increased by £6 billion yearon -year from their January 2009 levels, and a significant focus for us is to self-fund the loans on our books.
We operate a telephone service for clients, Coutts24, that handles calls 24 hours per day, seven days a week, in every week of the year. In 2009, we handled more than one million client calls.
We are conscious of our wider responsibilities and know that our clients often want to channel their money where it will make the greatest difference. We help them to do that. Our Wealth Institute works with clients who may run a family firm or have expressed a desire to increase their philanthropic giving. The Wealth Institute is building a portfolio of services that we believe will build trust in us among these clients. In 2009, Coutts launched a microfinance pilot fund, which provides small-scale financial support for people who have the means to earn their way out of poverty. We invited our clients to contribute to the fund, which supports projects in Cambodia, Malawi, South Africa, Nicaragua and Haiti.
increase in operating profit >1million calls handled in the year by Coutts24
During the year, we launched the Coutts Charitable Giving Account in response to client feedback. It helps clients to keep track of their donations to charities through our online and telephone banking services. We do not charge any administration fees for this account.
Our centuries-old heritage has seen Coutts progress as a sustainable and responsible business. We continued to promote this philosophy in 2009, when we launched a social enterprise initiative to inform clients about this rapidly growing and vibrant sector. Coutts CEO Michael Morley also ‘job swapped’ with The Big Issue’s Nigel Kershaw. Nigel spent time at Coutts, learning what we do and how we do it, before Michael visited the Vauxhall offices of the Big Issue. There he reviewed their Social Enterprise Investment Fund portfolio, followed by a live pitch to a potential investor.
Delivery of excellent customer service was at the forefront of RBS International’s activities. All of our staff supported National Customer Service Week in October. Among other things, that involved senior managers swapping places with their customers for a day. The UK National Customer Service Awards for Financial Services named our Isle of Man Peel branch the ‘Customer Service Team of the Year’. To win the accolade they successfully fended off competition from 52 other entrants. Our customers rated the service we provide at Peel at more than 96%, a score that places the branch on a par with the very best service firms in the world.
Adam & Company has been a keen supporter of the arts and we emphasised this by sponsoring the Scottish Ballet’s 40th anniversary tour.
After discovering high net worth women were turning away from financial institutions for advice, RBS Coutts launched a new private banking proposition with them specifically in mind. As part of the RBS Coutts Woman initiative, we sponsored the Women in Asia awards, which aim to promote, inspire and recognise the growing ranks of successful women in business.
We also took some hard financial decisions to support clients by investing in the business. One of The RBS Group’s biggest investments in 2009 was in Wealth Management, with multimillion pound funding to roll out a new technology platform across the business. It is part of the Wealth Management Platform Programme and will revolutionise how our private bankers support their clients. This will also be the first time Adam & Company, Coutts and RBS Coutts will be on a single global platform.
Our private bankers will have a single view of each client and the number of administrative tasks they have to undertake will diminish. This will make them more productive, reduce our costs and, we hope, enhance the service our clients receive. It will also give us much better management information and will support all of our major brands.
Our businesses performed well during 2009. We faced up to the major challenges from our past as well as those facing the investment banking industry. And we set out the strategy that we are confident will allow us to compete successfully in the future.
That brought a number of successes in 2009, including: • acting as joint financial advisor to BAA on its sale of Gatwick Airport; • providing Vattenfall with our full investment banking product suite in support of their acquisition of Nuon; and
In 2009, we participated in the five largest equity issues worldwide and six out of 10 of the biggest Debt Capital Market (DCM) transactions globally. Underlining the strength of our DCM offering, we participated in one in eight of all bonds issued by corporates and financial institutions in 2009. Anticipating trends during a turbulent period in the markets, we reopened the US dollar, euro, sterling and swiss franc corporate bond markets in early 2009.
Our Markets business had a strong year, capitalising on the volatile conditions that persisted during the first six months of 2009.
We consolidated our Top Five positions in the core fixed income securities business areas, bonds, rates and currencies, and made gains in important markets such as equities.
RBS participated in the five largest equity issues worldwide and six of the ten largest debt capital market issues
Throughout the year, our Sales teams built strong relationships with global clients, providing views on the market and working in partnership with researchers, strategists, structurers and traders to meet clients’ investment and risk-management objectives.
Risk and how we manage our exposures came under scrutiny after the events of 2008. We responded with a more thoughtful approach to risk management, putting new systems and processes in place. This included the successful design and implementation of enhancements to the business’s first line of defence, which incorporates The Risk and Control Committees, the Front Office Supervisory Policy and Counterparty Exposure Management. Becoming best in class in managing risk is an important feature of our investment programme.
Our Risk function was also instrumental in the creation of a culture for self-identification and the raising of risk issues throughout the division.
We would not have been able to meet the challenges we have faced during 2009, without our people.
The GBM People Programme developed in 2009, underpins our objective to be the partner of choice for our clients by having the right values and behaviours embedded in our organisation. It aligns employee objectives with business priorities and focuses on attracting and retaining the right people with the right skills, in the right places, motivated, engaged and performing. We have clearly set out our vision and values for the future.
Our strategic plan looks forward to 2013. During that time we aim to strengthen our penetration of the UK and Citizens markets and to gain even more benefits from our links to the rest of the Group by crossselling to existing RBS clients who could benefit from using our services. We will also sell our Global Merchant Services business as part of the agreement we reached with the European Commission.
One of the major tasks we faced during the year was to integrate ABN AMRO’s wholesale business with RBS. This was a challenge, not least because we were determined to maintain the best possible service for our customers and to avoid any disruption for them. We achieved that by implementing a first class client readiness programme. Six thousand clients have been notified of BIC/IBAN changes, which as a result will enable GTS to migrate more than 40,000 corporate accounts. We also concluded a Partner Bank Agreement between RBS NV and ABN AMRO II. This means that for the next three years RBS NV will continue to service the subsidiaries of ABN AMRO II parent companies that bank with the RBS network outside of the Netherlands.
We received a number of awards in 2009 which reflected both the quality and the diversity of our businesses in GTS.
Our UK domestic cash management business product was recognised in: • The Banker 2009 Best Innovation in Cash & Technology; • Best Transaction Banking Achievement at the Banking Technology Awards; and
• Best Payments Initiative and Most Effective Channel awards at the Financial Innovation Awards.
It’s great to win these awards and to receive the recognition of our peers, but the real test of our service is how our customers react.
Cormac McCarthy, Chief Executive, Ulster Bank 2009 was a year of further significant challenges for the economies of Northern Ireland and the Republic of Ireland, as well as for the banking industry across the island.
From the beginning of 2009 we prioritised the introduction of a number of initiatives designed to support our customers during these difficult times. The “Flex” initiative is a financial review designed to help those who are having trouble in meeting their full monthly debt repayments because of a change in their financial circumstances. We have provided specialist training to our staff which enables them to take our customers
€1billion Our island of Ireland SME Support Fund for SME businesses was worth €1 billion through a step by step budgeting process. Where a customer’s income falls short of their outgoings, we seek to find a solution such as extending the term of the loan or temporarily reducing payments. Since we introduced Flex in July 2009, we have assessed around 5,700 customer cases. In 87% of these cases, we approved new Flex arrangements, while for some customers no new arrangements were needed.
We have also extended dedicated support to our small and mediumsized enterprise (SME) customers with the launch of a €1 billion all-Ireland SME fund that provides businesses with access to working capital and development funding.
If we’re to become a top super-regional bank, we need to focus on our core businesses. That’s why we exited all activities in Indiana, selling 65 branches to Old National Bank. We also identified several business lines across the United States and designated them as non-core. They include our Marine/RV business, our Dealer Finance business and portions of our Auto Lending business. By isolating non-core activities that don’t fit with our long-term plans, we are able to focus our investments in infrastructure, technology and marketing to achieve leading positions in the markets in which we choose to compete.
increase in customer deposits in the year >3.7 million customers converted to upgraded online platform
These initiatives were part of the reason for our success in boosting customer deposits during the year by 4%.
Our Green$ense programme rewarded retail customers with more than $6.5 million during 2009 for helping the environment by choosing electronic transactions that cut down the amount of paper we use. The programme targets and rewards environmentally conscious customers who receive 10 cents for each electronic transaction they make, up to $120 per year. Green$ense includes automatic enrolment in e-Statements and free Online Banking with Bill Pay.
Our Wealth Management division created a new programme for massaffluent clients and began piloting Premier Banking from Citizens Bank in Massachusetts. This is an exclusive offering of products, services and creative solutions for select clients who are looking for a more efficient and convenient way to manage their funds and who prefer more dedicated relationship management. Premier Banking is designed to help us take advantage of a market that is large but which we have not penetrated much in the past. To help us make progress, we’ve assigned a dedicated team of relationship managers to target the mass-affluent market.
It is important to us and to our employees that we at Citizens are good citizens in our communities. In 2009, we launched Energy$ense. It is a multi-faceted initiative to help local non-profit organisations and Citizens Bank and Charter One customers address heat, utility and other energy costs. As part of the programme, Citizens provided more than $500,000 in energy assistance grants to homeless shelters and non-profit organisations that offer home weatherproofing and utility payment assistance to consumers. We also provide below market-rate loans to eligible consumers who want to make their homes more energy efficient, with a limited-time option to defer their first payment for 90 days. We also provide consumers with information about how they can stay warm and safe during the winter. Helpful tips include choosing electric heaters and extension cords that are UL rated, insulating pipes and water heaters, and installing carbon monoxide detectors and smoke alarms.
RBS Insurance sells and underwrites retail and SME insurance over the telephone and internet, as well as through brokers and partnerships. Its brands include Direct Line, Churchill and Privilege, which sell general insurance products direct to the customer, as well as Green Flag and NIG. Through its international division, RBS Insurance sells general insurance, mainly motor, in Germany and Italy. The Intermediary and Broker division sells general insurance products through independent brokers.
Direct Line was a pioneer of direct insurance in the UK more than two decades ago. That spirit of innovation is still strong in RBS Insurance because it is so important in giving us an edge with our customers. With several airlines going into liquidation in 2009, Direct Line was one of the few travel companies to introduce airline failure cover to its travel insurance products. The policy protects customers from financial loss if their airline goes out of business. It also covers the cost of a return flight if an airline collapses while customers are on holiday.
Green Flag launched its Rescue Me iPhone application in December. The app offers a range of motoring breakdown features, from free live streaming traffic updates to a click-to-call function, as well as providing iPhone users with direct call connection to Green Flag.
Our employees are also satisfied and motivated, despite the uncertainties they have faced in the last two years. Our annual survey of employees, conducted independently by Towers Perrin ISR, showed that we had improved or maintained our scores in 15 out of the 16 categories compared with 2008. The results were especially strong for Customer Focus, Cooperation and Working Relationships, and Respect and Diversity.
Last year might have been a rocky one because of the uncertainties surrounding RBS Insurance. But our people have delivered strongly once more, showing their commitment to serving customers. We have to sell RBS Insurance, but until then it remains in our good hands.
Business Services (formerly Group Manufacturing) supports the customerfacing businesses and provides operational technology, customer support in telephony, account management, lending and money transmission, global purchasing, property and other services. Business Services drives efficiencies and supports income growth across multiple brands and channels by using a single, scalable platform and common processes wherever possible. It also leverages the Group’s purchasing power and is the Group’s centre of excellence for managing large-scale and complex change.
Business Services also operates well-established and high quality transaction processing and technology hubs in India and Poland. The Indian operations hub is a shared service, which supports our major businesses in the UK, USA, Asia and Europe. Capabilities include investment banking, trade and payments, retail, corporate and mortgage back office operations, and technology development functions.
Centralising these capabilities, creating centres of expertise and deploying ‘Lean’ techniques allows us to increase the efficiency of the bank whilst at the same time improving the customer experience.
2009 was an intensive year of delivering real change globally in Business Services, creating new ways of working to improve the service to our customers. The focus on customers, delivery, collaboration, investment and empowering our people, gives us strong foundation stones on which to build.
The EPA framework is designed substantially to improve the quality of our Executive’s objectives and Personal Development Plans.
Group Communications Our Group Communications team manages our relationships with external stakeholders and makes sure we keep our employees informed about developments in the business. RBS wants to be more open to stakeholders than we were in the past and during the year Group Communications helped elected officials, commentators and others to gain a better understanding of our business and how we plan to return to self-sufficiency.
On the one hand, it is managing assets that are no longer core to our strategy and the continuing operations of RBS, and which we plan to sell or to run down. On the other, partly because Non-Core will reduce the asset side of our balance sheet, it will improve our funding position and make RBS a safer bank. Non-Core Division was created to facilitate the re-shaping of RBS on its journey to self-sufficiency and is responsible for one of the largest bank restructurings being undertaken globally and one of the largest in history.
The Asset Protection Scheme (APS) is also vital to our plans. It is a credit protection scheme. It gives us protection, similar to an insurance policy, against future losses in the event that the economy enters a further, severe and prolonged downturn.
We have structured Non-Core Division & APS into three key business areas.
• International Businesses & Portfolios manages assets and includes the retail and commercial businesses identified as non-core, the countries we are exiting to reduce our geographic footprint, and portfolios primarily transferred from our UK Corporate Banking Division, Ulster Bank and Citizens. It is the largest employer in the division with almost 13,000 employees globally.
During 2009, we made an encouraging start in reducing TPAs. RWAs remained broadly flat over the year. The downgrade in monolines and credit derivative product companies (CPDCs) and the impact of procyclicality – tougher economic conditions can increase the amount of capital we have to assign to a loan – partly offset our active management and runoff of RWAs.
Impairments increased relative to 2008 reflecting where we are in the economic cycle. However, we saw the level of impairments steadily decrease in three successive quarters to the end of 2009.
While our focus is on the successful run down of assets, close and responsible stewardship of these assets over the next four years will be key to maintaining their value, pending run-off or exit. This requires a high level of focus on business-as-usual challenges in a difficult economic and market environment that and against the background of a rapidly evolving regulatory environment.
The nature of the assets placed in Non-Core Division & APS creates a very high concentration of risk in one area of the group and managing the risk associated with this is a key priority. Our key risk is the credit risk resulting from the higher probability of default of the assets we are managing. We also have significant execution risk associated with the scale of the restructuring we are undertaking and the disposal of assets in the prevailing environment. Finally, we have to manage the high level of operational risk which naturally arises when businesses are being sold and staff face considerable uncertainty about their future.
Under the lighter touch terms agreed with the UK Government in November 2009, RBS would bear the first £60 billion of losses and the Treasury would bear 90% of losses thereafter. The fee for this insurance will be £700 million for the first three years and then £500 million annually. The new terms allow RBS to exit the APS at any time subject to meeting capital adequacy requirements and repaying the Treasury for any shortfall in fees due.
We have devoted a million person hours to agreeing APS and its rules, identifying and defining the four million assets covered, training and equipping our people, and setting up a robust infrastructure for the stewardship of these assets.
“Sustainability is not just about the many responsibilities and obligations that we have as a company, but about specific issues which we need to address to ensure that we have a healthy and respected business operating on a sustainable basis, in every sense of the word.”
We have always aimed to ensure that our business has a positive impact on society and that we support the communities in which we operate. Our difficulties in recent years now mean that it is more important than ever for us to demonstrate this. Given the public investment in RBS, there is considerable scrutiny – understandably – of how we manage issues such as treating customers fairly, support for enterprise, job losses, and our impact on the environment. Whilst we are able to build on many years of good work in areas such as financial education, we recognise that there is always more we can do, and that we need to work hard to rebuild trust in our business.
To increase the profile of sustainability across our business and enhance the governance of our strategy, we have established a new Group Corporate Sustainability Committee, which is chaired by Sandy Crombie, and has representation from our key business areas. It meets at least twice a year and oversees our approach to sustainability throughout the Group.
In some areas, however, we believe we should go beyond what we achieve in our business units. Alongside our day-to-day activities, we have established a number of dedicated programmes that we back up with additional resources – see page 47 for more details on our Community Investment programme.
Responsible lending practices Responsible lending continued to be a top priority for all stakeholders during 2009 and key issues were the availability and affordability of credit and support for customers in financial difficulty.
• We made a series of reductions to charges and fees for unarranged borrowing. The fee for returning a cheque, direct debit or standing order was reduced to £5. The fee for paying an item when overdrawn was cut by half to £15 per day.
Customer service We have listened to our customers’ views and we are making significant changes to ensure that customers are always put first.
The share of UK secondary schools where our MoneySense for Schools programme had a presence in 2009.
Financial education Understanding how financial products and services work is an important life skill for anybody – we want everyone to have the confidence to make the right financial decisions.
• We are working with the Government to deliver the Saving Gateway scheme in 2010, aimed at helping people on low incomes and benefits develop a savings habit.
• In November 2009, we launched a Customer Charter for small and medium-sized enterprises, which focused on four key areas: helping businesses to start and grow; providing access to finance; fairness and transparency on pricing; and transparency when making lending decisions.
• Through Coutts Wealth Management, we have one of the largest networks of successful entrepreneurs in the UK and, in 2009, Coutts launched a programme to support clients who would like to get more involved and make a significant impact in the social enterprise sector.
• In 2009, 46 RBS group employees provided direct support to young entrepreneurs across Scotland either as volunteer Panel Members or Aftercare Advisers with the Prince’s Scottish Youth Business Trust.
• Ensuring the safety, health and wellbeing of employees is core to our business. In 2009, we updated the Group’s Safety and Health policy standard to reflect our commitment to the safety and health of our people in every country in which we operate.
Global citizenship Global citizenship means taking responsibility for how we manage our wider economic, social and environmental impact on society. Environmental sustainability and responsible lending are key elements of this.
Environmental sustainability The transition to a low carbon society has already begun and we take seriously our role in supporting this transition. We set our environmental strategy through the Executive-led Environment Working Group, which has representation from all relevant Divisions and reports to the Group Sustainability Committee.
• We have developed a strong focus on providing financial services to clients and projects operating in the renewable power and energy efficiency sectors. In late 2009, we were confirmed as one of the three UK banks to take part in the European Investment Bank scheme to lend to onshore wind projects.
• In late 2009, we signed the Copenhagen Communiqué, a collective statement from businesses that called for an agreement between countries that would give them the confidence to invest in solutions to climate change.
• We continue our work to reduce the impacts of our own operations, covering energy consumption, CO2 emissions, travel, water and paper use. In the UK and Ireland, we procure 92% of our contracted electricity from renewable sources and our default office paper has 80% recycled content.
• We maintained strong performance in external indices that measure sustainability performance and in 2009 we scored 77% in the Carbon Disclosure Project and were included in the Dow Jones Sustainability Index with a score of 76%.
• To enhance online security for our customers, we launched a fraud prevention software package free of charge for anyone who banks online with RBS or NatWest. Since January 2009, Rapport has been downloaded by over 2.5 million customers.
• Customers can also subscribe for real time SMS alerts regarding customer deposits and credit card accounts, enabling customers to keep track of their debit and credit card transactions.
Community Investment Helping to rebuild our reputation The role of Community Investment is to deliver programmes that help to rebuild the reputation of the Group as a responsible business that has a sustainable impact upon the communities in which we operate. To ensure we make our community investments as effective as possible we focus our resources on a small number of substantial strategic programmes. These programmes centre around issues which are important to our businesses and important to our reputation. They complement the day-to-day activities of our businesses, but enable the Group to go further on key issues where we believe we have a role and responsibility to do so. By targeting additional resources through these programmes, we can make a greater difference to the communities in which we operate.
MoneySense Financial education is a key issue under our theme of Fair Banking. The aim of MoneySense is to increase financial capability and financial inclusion. A core part of this programme is MoneySense for Schools, where RBS employees deliver lessons in secondary schools designed to help young people to manage their money; we provide resources for teachers to do the same. In 2009, over 700 RBS employees delivered MoneySense lessons and over one-third of a million pupils were reached by the programme. MoneySense for Adults offers impartial guidance on money management through our MoneySense websites, which receive over 60,000 visitors every month. We also have a range of partnerships with third sector organisations where we can target support at vulnerable groups, for example, supporting single-parent families through Gingerbread.
Supporting enterprise and Microfinance We are currently building a new Community Investment programme under the theme of Supporting Enterprise that will significantly enhance our support for small businesses beyond our mainstream banking activities. For example, in the UK, we are a Platinum Patron of The Prince’s Trust. Our support is focused on the Trust’s Business Programme, which helps young people from disadvantaged backgrounds to explore their business ideas and provides access to advice, loan funding and the support of a business mentor, including our employees, when starting up an enterprise. The Business Programme has helped over 70,000 young people since its inception. In India, our RBS Foundation works in partnership with third-parties to provide technical assistance to emerging microfinance institutions in under-served areas and to promote new economic opportunities for vulnerable communities. Our 48 projects to date have helped more than 178,000 poor households across India.
50 Presentation of information 52 Forward-looking statements 53 Description of business 54 Competition 55 Risk factors 72 Key financials 73 Summary consolidated income statement 76 Analysis of results 86 Divisional performance 108 Consolidated balance sheet 111 Cash flow 112 Capital resources 113 Reconciliations of pro forma to statutory income statements and balance sheets 117 Risk, capital and liquidity management
In the Report and Accounts, and unless specified otherwise, the term ‘company’ means The Royal Bank of Scotland Group plc, ‘RBS’ or the ‘Group’ means the company and its subsidiaries, ‘the Royal Bank’ means The Royal Bank of Scotland plc and ‘NatWest’ means National Westminster Bank Plc.
The company publishes its financial statements in pounds sterling (‘£’ or ‘sterling’). The abbreviations ‘£m’ and ‘£bn’ represent millions and thousands of millions of pounds sterling, respectively, and references to ‘pence’ represent pence in the United Kingdom (‘UK’). Reference to ‘dollars’ or ‘$’ are to United States of America (‘US’) dollars. The abbreviations ‘$m’ and ‘$bn’ represent millions and thousands of millions of dollars, respectively, and references to ‘cents’ represent cents in the US. The abbreviation ‘€’ represents the ‘euro’, the European single currency, and the abbreviations ‘€m’ and ‘€bn’ represent millions and thousands of millions of euros, respectively.
The geographic analysis in the average balance sheet and interest rates, changes in net interest income and average interest rates, yields, spreads and margins in this report have been compiled on the basis of location of office – UK and overseas. Management believes that this presentation provides more useful information on the Group’s yields, spreads and margins of the Group’s activities than would be provided by presentation on the basis of the domestic and foreign activities analysis used elsewhere in this report as it more closely reflects the basis on which the Group is managed. ‘UK’ in this context includes domestic transactions and transactions conducted through the offices in the UK which service international banking transactions.
On 3 October 2008, the State of the Netherlands acquired Fortis Bank Nederland (Holding) N.V. including the Fortis participation in RFS Holdings that represents the acquired activities of ABN AMRO and their participation in Dutch insurance activities.
RFS Holdings is implementing an orderly separation of the business units of ABN AMRO with RBS retaining the following ABN AMRO business units: • Continuing businesses of Business Unit North America; • Business Unit Global Clients and wholesale clients in the Netherlands (including former Dutch wholesale clients) and Latin America (excluding Brazil); • Business Unit Asia (excluding Saudi Hollandi); and
Certain other assets will continue to be shared by the Consortium Members.
Glossary A glossary of terms is detailed on pages 383 to 387.
Certain sections in this document contain ‘forward-looking statements’ as that term is defined in the United States Private Securities Litigation Reform Act of 1995, such as statements that include the words ‘expect’, ‘estimate’, ‘project’, ‘anticipate’, ‘believes’, ‘should’, ‘intend’, ‘plan’, ‘probability’, ‘risk’, ‘Value-at-Risk (VaR)’, ‘target’, ‘goal’, ‘objective’, ‘will’, ‘endeavour’, ‘outlook’, ‘optimistic’, ‘prospects’ and similar expressions or variations on such expressions including, but not limited to, sections such as ‘Chairman’s statement’ and ‘Group Chief Executive’s review’.
In particular, this document includes forward-looking statements relating, but not limited to: the Group’s restructuring plans, capitalisation, portfolios, capital ratios, liquidity, risk weighted assets, return on equity, cost:income ratios, leverage and loan:deposit ratios, funding and risk profile; the Group’s future financial performance; the level and extent of future impairments and write-downs; the protection provided by the APS; and to the Group’s potential exposures to various types of market risks, such as interest rate risk, foreign exchange rate risk and commodity and equity price risk. Such statements are subject to risks and uncertainties. For example, certain of the market risk disclosures are dependent on choices about key model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and, as a result, actual future gains and losses could differ materially from those that have been estimated.
Following placing and open offers in December 2008 and in April 2009, HM Treasury currently own approximately 70.3% of the enlarged ordinary share capital of the company.
HM Treasury has agreed not to convert its B shares into ordinary shares to the extent that its holding of ordinary shares following the conversion would represent more than 75% of the company’s issued ordinary share capital.
Global Banking & Markets (GBM) is a leading banking partner to major corporations and financial institutions around the world, providing an extensive range of debt and equity financing, risk management and investment services to its customers. The division is organised along six principal business lines: money markets; rates flow trading; currencies and commodities; equities; credit markets and portfolio management & origination.
Global Transaction Services ranks among the top five global transaction services providers, offering global payments, cash and liquidity management, and trade finance and commercial card products and services. It includes the Group’s corporate money transmission activities in the United Kingdom and the United States as well as Global Merchant Services, the Group’s United Kingdom and international merchant acquiring business.
Business divestments To comply with EC state aid requirements the Group has agreed a series of restructuring measures to be implemented over a four year period. This will supplement the measures in the strategic plan previously announced by the Group. These include divesting fully RBS Insurance, Global Merchant Services and RBS Sempra Commodities, as well as divesting the RBS branch-based business in England & Wales and the NatWest branches in Scotland, along with the Direct SME customers across the UK.
In the United States, Citizens competes in the New England, MidAtlantic and Mid West retail and mid-corporate banking markets with local and regional banks and other financial institutions. The Group also competes in the US in large corporate lending and specialised finance markets, and in fixed-income trading and sales. Competition is principally with the large US commercial and investment banks and international banks active in the US.
If HM Treasury makes the decision to take the company into temporary public ownership, it may take various actions in relation to the company’s securities without the consent of holders of the securities, including (among other things): • transferring the securities free from any contractual or legislative restrictions on transfer; • transferring the securities free from any trust, liability or encumbrance; • extinguishing any rights to acquire securities; • delisting the securities; • converting the securities into another form or class (including, for example, into equity securities); or
• disapplying any termination or acceleration rights or events of default under the terms of the securities which would be triggered by the transfer.
If the company was taken into temporary public ownership and a partial transfer of its or any relevant entity’s business was effected, or if a relevant entity were made subject to the SRR and a partial transfer of its business to another entity was effected, the transfer may directly affect the company and/or its Group companies by creating, modifying or cancelling their contractual arrangements with a view to ensuring the provision of such services and facilities as are required to enable the bridge bank or private sector purchaser to operate the transferred business (or any part of it) effectively. For example, the transfer may (among other things) (i) require the company or Group companies to support and cooperate with the bridge bank or private sector purchaser, (ii) cancel or modify contracts or arrangements between the company or the transferred business and a Group company, or (iii) impose additional obligations on the company under new or existing contracts. There can be no assurance that the taking of any such actions would not adversely affect the ability of the company to satisfy its obligations under the issued securities or related contracts.
While the main provisions of the Banking (Special Provisions) Act 2008 were in force, which conferred certain transfer powers on HM Treasury, the UK Government took action under that Act in respect of a number of UK financial institutions, including, in extreme circumstances, full and part nationalisation. There have been concerns in the market in the past year regarding the risks of such nationalisation in relation to the company and other UK banks. If economic conditions in the United Kingdom or globally were to deteriorate, or the events described in the following risk factors occur to such an extent that they have a materially adverse impact on the financial condition, perceived or actual credit quality, results of operations or business of any of the relevant entities in the Group, the UK Government may decide to take similar action in relation to the company under the Banking Act. Given the extent of the Bank of England and HM Treasury’s powers under the Banking Act, it is difficult to predict what effect such actions might have on the Group and any securities issued by the company or Group companies. However, potential impacts may include full nationalisation of the company and the total loss of value in securities issued by the company and the inability of the company to perform its obligations under the securities.
The performance of the Group has been and will continue to be influenced by the economic conditions of the countries in which it operates, particularly the United Kingdom, the United States and other countries throughout Europe and Asia. The outlook for the global economy over the near to medium term remains challenging, particularly in the United Kingdom, the United States and other European economies. In addition, the global financial system has yet fully to overcome the difficulties which first manifested themselves in August 2007 and financial markets conditions have not yet fully normalised. These conditions led to severe dislocation of financial markets around the world and unprecedented levels of illiquidity in 2008 and 2009, resulting in the development of significant problems at a number of the world’s largest corporate institutions operating across a wide range of industry sectors, many of whom are the Group’s customers and counterparties in the ordinary course of its business. In response to this economic instability and illiquidity in the market, a number of governments, including the UK Government, the governments of the other EU member states and the US Government, have intervened in order to inject liquidity and capital into the financial system, and, in some cases, to prevent the failure of these institutions.
In addition, the Group will continue to be exposed to the risk of loss if major corporate borrowers or counterparty financial institutions fail or are otherwise unable to meet their obligations. The Group currently experiences certain business sector and country concentration risk, primarily focused in the United Kingdom and the rest of Europe and relating to personal and banking and financial institution exposures. The Group’s performance may also be affected by future recovery rates on assets and the historical assumptions underlying asset recovery rates, which (as has already occurred in certain instances) may no longer be accurate given the unprecedented market disruption and general economic instability. The precise nature of all the risks and uncertainties the Group faces as a result of current economic conditions cannot be predicted and many of these risks are outside the control of the Group.
The Group was required to obtain State aid approval, for the aid given to the Group by HM Treasury and for the Group’s State aid restructuring plan, from the European Commission (the “Commission”). The Group is subject to a variety of risks as a result of implementing the State aid restructuring plan. The State aid restructuring plan includes a prohibition on the making of discretionary dividend or coupon payments on existing hybrid capital instruments (including preference shares and B shares) for a two-year period commencing no later than 30 April 2010, which may impair the Group’s ability to raise new Tier 1 capital through the issuance of ordinary shares and other securities.
The Group is subject to a variety of risks as a result of implementing the State aid restructuring plan. There is no assurance that the price that the Group receives for any assets sold pursuant to the State aid restructuring plan will be at a level the Group considers adequate or which it could obtain in circumstances in which the Group was not required to sell such assets in order to implement the State aid restructuring plan or if such sale were not subject to the restrictions (including in relation to potential purchasers of the UK branch divestment) contained in the terms thereof. Further, should the Group fail to complete any of the required disposals within the agreed timeframes for such disposals, under the terms of the State aid clearance a divestiture trustee can be empowered to conduct the disposals, with the mandate to complete the disposal at no minimum price.
In implementing the State aid restructuring plan, the Group will lose existing customers, deposits and other assets (both directly through the sale and potentially through the impact on the rest of the Group’s business arising from implementing the State aid restructuring plan) and the potential for realising additional associated revenues and margins that it otherwise might have achieved in the absence of such disposals. Further, the loss of such revenues and related income may extend the time period over which the Group may pay any amounts owed to HM Treasury under the APS or otherwise. The implementation of the State aid restructuring plan may also result in disruption to the retained business and give rise to significant strain on management, employee, operational and financial resources, impacting customers and giving rise to separation costs which could be substantial.
Like many banking groups, the Group relies on customer deposits to meet a considerable portion of its funding. Furthermore, as part of its ongoing strategy to improve its liquidity position, the Group is actively seeking to increase the proportion of its funding represented by customer deposits. However, such deposits are subject to fluctuation due to certain factors outside the Group’s control, such as a loss of confidence, increasing competitive pressures or the encouraged or mandated repatriation of deposits by foreign wholesale or central bank depositors, which could result in a significant outflow of deposits within a short period of time. There is currently heavy competition among UK banks for retail customer deposits, which has increased the cost of procuring new deposits and impacted the Group’s ability to grow its deposit base. An inability to grow, or any material decrease in, the Group’s deposits could, particularly if accompanied by one of the other factors described above, have a negative impact on the Group’s ability to satisfy its liquidity needs unless corresponding actions were taken to improve the liquidity profile of other deposits or to reduce assets. In particular, the liquidity position of the Group may be negatively impacted if it is unable to achieve the run-off and sale of non-core and other assets as expected. Any significant delay in those plans may require the Group to consider disposal of other assets not previously identified for disposal to achieve its funded balance sheet target level.
There can be no assurance that these measures, alongside other available measures, will succeed in improving the funding and liquidity in the markets in which the Group operates, or that these measures, combined with any increased cost of any funding currently available in the market, will not lead to a further increase in the Group’s overall cost of funding, which could have an adverse impact on the Group’s financial condition and results of operations or result in a loss of value in its securities.
Governmental support schemes may be subject to cancellation, change or withdrawal or may fail to be renewed, which may have a negative impact on the availability of funding in the markets in which the Group operates.
Governmental support schemes may be subject to cancellation, change or withdrawal (on a general or individual basis, subject to relevant contracts) or may fail to be renewed, based on changing economic and political conditions in the jurisdiction of the relevant scheme. Furthermore, certain schemes which have been announced, may not yet have been fully implemented, or their terms have not yet been finalised.
The actual or perceived failure or worsening credit of the Group’s counterparties has adversely affected and could continue to adversely affect the Group.
Further information about the write-downs which the Group has incurred and the assets it has reclassified can be found in the Risk, capital and liquidity management section of the Business review.
Changes in interest rates, foreign exchange rates, credit spreads, bond, equity and commodity prices and other market factors have significantly affected and will continue to affect the Group’s business.
Some of the most significant market risks the Group faces are interest rate, foreign exchange, credit spread, bond, equity and commodity price risks. Changes in interest rate levels, yield curves and spreads may affect the interest rate margin realised between lending and borrowing costs, the effect of which may be heightened during periods of liquidity stress, such as those experienced in the past 18 months. Changes in currency rates, particularly in the sterling-US dollar and sterling-euro exchange rates, affect the value of assets, liabilities, income and expenses denominated in foreign currencies and the reported earnings of the company’s non-UK subsidiaries (principally Citizens and RBS Securities Inc.) and may affect income from foreign exchange dealing. The performance of financial markets may affect bond, equity and commodity prices and, therefore, cause changes in the value of the Group’s investment and trading portfolios. This has been the case during the period since August 2007, with market disruptions and volatility resulting in significant reductions in the value of such portfolios. While the Group has implemented risk management methods to mitigate and control these and other market risks to which it is exposed, it is difficult, particularly in the current environment, to predict with accuracy changes in economic or market conditions and to anticipate the effects that such changes could have on the Group’s financial performance and business operations.
The Group’s borrowing costs and its access to the debt capital markets depend significantly on its and the UK Government’s credit ratings. The company and other Group members have been subject to a number of downgrades in the recent past. Any future reductions in the long-term or short-term credit ratings of the company or one of its principal subsidiaries (particularly the Royal Bank) would further increase its borrowing costs, require the Group to replace funding lost due to the downgrade, which may include the loss of customer deposits, and may also limit the Group’s access to capital and money markets and trigger additional collateral requirements in derivatives contracts and other secured funding arrangements. Furthermore, given the extent of UK Government ownership and support provided to the Group through the Credit Guarantee Scheme, any downgrade in the UK Government’s credit ratings could adversely affect the Group’s own credit ratings and may have the effects noted above. All credit rating agencies have reaffirmed the UK Government’s AAA rating, although S&P changed its outlook to ‘negative’ on 21 May 2009. Fitch reaffirmed the UK Government’s stable outlook on 31 July 2009 and Moody’s reiterated the UK Government’s stable outlook on 26 October 2009. Credit ratings of the company, the Royal Bank, ABN AMRO, Ulster Bank and Citizens are also important to the Group when competing in certain markets, such as over-the-counter derivatives. As a result, any further reductions in the company’s long-term or short-term credit ratings or those of its principal subsidiaries could adversely affect the Group’s access to liquidity and competitive position, increase its funding costs and have a negative impact on the Group’s earnings and financial condition or result in a loss of value in its securities.
The Group’s business performance could be adversely affected if its capital is not managed effectively or if there are changes to capital adequacy and liquidity requirements.
Group’s Core Tier 1 capital ratio decline to below 5 per cent. at any time before 31 December 2014, or should the Group fall short of its funded balance sheet target level (after adjustments) for 31 December 2013 by £30 billion or more, the Group will be required to reduce its risk-weighted assets by a further £60 billion in excess of its plan through further disposals of identifiable businesses and their associated assets. The Group would also be subject to restrictions on payments on its hybrid capital instruments should its Core Tier 1 ratio fall below 6 per cent. or were it to fall below 6 per cent. as a result of such payment. As at 31 December 2009, the Group’s Tier 1 capital and Core Tier 1 capital ratios were 14.1 per cent. and 11.0 per cent. respectively, calculated in accordance with FSA definitions. Any change that limits the Group’s ability to manage effectively its balance sheet and capital resources going forward (including, for example, reductions in profits and retained earnings as a result of write-downs or otherwise, increases in riskweighted assets, delays in the disposal of certain assets or the inability to syndicate loans as a result of market conditions, a growth in unfunded pension exposures or otherwise) or to access funding sources, could have a material adverse impact on its financial condition and regulatory capital position or result in a loss of value in its securities.
Under IFRS, the Group recognises at fair value (i) financial instruments classified as ‘held-for-trading’ or ‘designated as at fair value through profit or loss’, (ii) financial assets classified as ‘available-for-sale’, and (iii) derivatives, each as further described in ‘Accounting Policies’ on page 252 of the financial statements. Generally, to establish the fair value of these instruments, the Group relies on quoted market prices or, where the market for a financial instrument is not sufficiently active, internal valuation models that utilise observable market data. In certain circumstances, the data for individual financial instruments or classes of financial instruments utilised by such valuation models may not be available or may become unavailable due to changes in market conditions, as has been the case during the recent financial crisis. In such circumstances, the Group’s internal valuation models require the Group to make assumptions, judgements and estimates to establish fair value. In common with other financial institutions, these internal valuation models are complex, and the assumptions, judgements and estimates the Group is required to make often relate to matters that are inherently uncertain, such as expected cash flows, the ability of borrowers to service debt, residential and commercial property price appreciation and depreciation, and relative levels of defaults and deficiencies. Such assumptions, judgements and estimates may need to be updated to reflect changing facts, trends and market conditions. The resulting change in the fair values of the financial instruments has had and could continue to have a material adverse effect on the Group’s earnings and financial condition. Also, recent market volatility and illiquidity have challenged the factual bases of certain underlying assumptions and have made it difficult to value certain of the Group’s financial instruments. Valuations in future periods, reflecting prevailing market conditions, may result in further significant changes in the fair values of these instruments, which could have a negative effect on the Group’s results of operations and financial condition or result in a loss of value in its securities.
Because the ability to dispose of assets and the price achieved for such disposals will be dependent on prevailing economic and market conditions, which may remain challenging, there is no assurance that the Group will be able to sell or run down (as applicable) those businesses it is seeking to exit either on favourable economic terms to the Group or at all. Furthermore, where transactions are entered into for the purpose of selling non-core assets and businesses, they may be subject to conditions precedent, including government and regulatory approvals and completion mechanics that in certain cases may entail consent from customers. There is no assurance that such conditions precedent will be satisfied, or consents and approvals obtained, in a timely manner or at all. There is consequently a risk that the Group may fail to complete such disposals by any agreed longstop date.
In addition, the Group may be liable for any deterioration in businesses being sold between the announcement of the disposal and its completion. In certain cases, the period between the announcement of a transaction and its completion may be lengthy and may span many months. Other risks that may arise out of the disposal of the Group’s assets include ongoing liabilities up to completion of the relevant transaction in respect of the assets and businesses disposed of, commercial and other risks associated with meeting covenants to the buyer during the period up to completion, the risk of employee and customer attrition in the period up to completion, substantive indemnity obligations in favour of the buyer, the risk of liability for breach of warranty, the need to continue to provide transitional service arrangements for potentially lengthy periods following completion of the relevant transaction to the businesses being transferred and redundancy and other transaction costs. Further, the Group may be required to enter into covenants agreeing not to compete in certain markets for specific periods of time. In addition, as a result of the disposals, the Group will lose existing customers, deposits and other assets (both directly through the sale and potentially through the impact on the rest of the Group’s business arising from implementing the restructuring plans) and the potential for realising additional associated revenues and margins that it otherwise might have achieved in the absence of such disposals.
Any of the above factors, either in the context of State aid-related or non-core or other asset disposals, could affect the Group’s ability to implement its strategic plan and have a material adverse effect on the Group’s business, results of operations, financial condition, capital ratios and liquidity and could result in a loss of value in its securities.
The extensive organisational restructuring may adversely affect the Group’s business, results of operations and financial condition. As part of its refocus on core strengths and its disposal programme, the company has undertaken and continues to undertake extensive organisational restructuring involving the allocation of assets identified as non-core assets to a separate Non-Core division, and the run-down and sale of those assets over a period of time. In addition, to comply with State aid clearance, the company has agreed to undertake a series of measures to be implemented over a four-year period, which include disposing of RBS Insurance (subject to potentially maintaining a minority interest until the end of 2014). The company will also divest by the end of 2013 Global Merchant Services, subject to the company retaining up to 20 per cent. of each business within Global Merchant Services if required by the purchaser, and its interest in RBS Sempra Commodities, as well as divesting the Royal Bank branch-based business in England and Wales and the NatWest branches in Scotland, along with the direct SME customers and certain mid-corporate customers across the United Kingdom. In order to implement these restructurings, various businesses and divisions within the Group will be re-organised, transferred or sold, or potentially merged with other businesses and divisions within the Group. As part of this process, personnel may be reallocated, where permissible, across the Group, new technology may be implemented, and new policies and procedures may be established in order to accommodate the new shape of the Group. As a result, the Group may experience a high degree of business interruption, significant restructuring charges, delays in implementation, and significant strain on management, employee, operational and financial resources. Any of the above factors could affect the Group’s ability to achieve its strategic objectives and have a material adverse effect on its business, results of operations and financial condition or could result in a loss of value in its securities.
As a condition to HM Treasury support, the company has agreed to certain undertakings which may serve to limit the Group’s operations and it may be required to agree to further restrictions in the future. Under the terms of the First Placing and Open Offer, the company provided certain undertakings aimed at ensuring that the subscription by HM Treasury of the relevant company ordinary shares and preference shares and the Group’s participation in the Credit Guarantee Scheme offered by HM Treasury as part of its support for the UK banking industry are compatible with the common market under EU law. These undertakings include (i) supporting certain initiatives in relation to mortgage lending and lending to SMEs until 2011, (ii) regulating management remuneration and (iii) regulating the rate of growth of the Group’s balance sheet. Under the terms of the Second Placing and Open Offer, the Group’s undertakings in relation to mortgage lending and lending to SMEs were extended to larger commercial and industrial companies in the United Kingdom. These undertakings may serve to limit the Group’s operations. In addition, pursuant to certain arrangements entered into between the company and certain UK Government departments, the company is subject to further undertakings, which supersede the lending commitments made to HM Treasury in October 2008 and January 2009 by agreeing to lend to creditworthy borrowers on commercial terms, £16 billion above the amount the company had budgeted to lend to UK businesses and £9 billion above the amount the company had budgeted to lend to UK homeowners in the year commencing 1 March 2009. There is also a commitment to lend at similar levels in the year commencing 1 March 2010, although this is subject to adjustment of the commitments by agreement with the UK Government to reflect circumstances at the start of the 2010 commitment period. Notwithstanding the Group’s willingness to lend to creditworthy customers and its clarity that the requisite funds are available, thereby fulfilling its commitments, indications remain that it is unlikely that the Group’s net business lending will increase by the £16 billion that it is making available, in the light of the subdued demand that the Group is currently experiencing. Failure to comply with these lending commitments may result in the withdrawal or restriction of the Group’s eligibility to extend its participation in the Credit Guarantee Scheme from three to five years, which could have a material adverse impact on the Group’s business, financial condition, results of operations and prospects.
The Group has also agreed to certain other commitments, which are material for the structure of the Group and its operations, under the State aid restructuring plan approved by the Commission in relation to State aid.
In addition, the Group, together with HM Treasury, has agreed with the Commission a prohibition on the making of discretionary dividends (including on preference shares and B shares) or coupon payments on existing hybrid capital instruments for a two-year period commencing no later than 30 April 2010. It is possible that the Group may, in future, be subject to further restrictions on payments on such hybrid capital instruments, whether as a result of undertakings given to regulatory bodies, changes to capital requirements such as the proposals published by the Basel Committee on 17 December 2009 or otherwise.
The Group has also agreed to certain other undertakings in the Acquisition and Contingent Capital Agreement.
The Group could fail to attract or retain senior management, which may include members of the Board, or other key employees, and it may suffer if it does not maintain good employee relations.
The Group’s ability to implement its strategy depends on the ability and experience of its senior management, which may include Directors, and other key employees. The loss of the services of certain key employees, particularly to competitors, could have a negative impact on the Group’s business. The Group’s future success will also depend on its ability to attract, retain and remunerate highly skilled and qualified personnel competitively with its peers. This cannot be guaranteed, particularly in light of heightened regulatory oversight of banks and heightened scrutiny of, and (in some cases) restrictions placed upon, management compensation arrangements, in particular those in receipt of government funding (such as the company). The Group has made a commitment to comply with the FSA Remuneration Code. These rules came into force on 1 January 2010 and are in line with the agreement reached by the G-20, setting global standards for the implementation of the Financial Stability Board’s remuneration principles. The Group agreed that it will be at the leading edge of implementing the G-20 principles and has granted UK Financial Investments Ltd (UKFI) consent rights over the shape and size of its aggregate bonus pool for the 2009 performance year. The level of the 2009 bonus pool and the deferral and clawback provisions implemented by the Group may impair the ability of the Group to attract and retain suitably qualified personnel in various parts of the Group’s businesses.
Each of the Group’s businesses is subject to substantial regulation and oversight. Any significant regulatory developments could have an effect on how the Group conducts its business and on its results of operations and financial condition.
Other areas where governmental policies and regulatory changes could have an adverse impact include, but are not limited to: • the monetary, interest rate, capital adequacy, liquidity, balance sheet leverage and other policies of central banks and regulatory authorities; • general changes in government or regulatory policy or changes in regulatory regimes that may significantly influence investor decisions in particular markets in which the Group operates or may increase the costs of doing business in those markets; • changes to financial reporting standards; • changes in regulatory requirements relating to capital, such as limitations on the use of deferred tax assets in calculating Core Tier 1 and/or Tier 1 capital, or prudential rules relating to the capital adequacy framework; • other general changes in the regulatory requirements, such as the imposition of onerous compliance obligations, restrictions on business growth or pricing and requirements to operate in a way that prioritises objectives other than shareholder value creation; • changes in competition and pricing environments; • further developments in financial reporting, corporate governance, conduct of business and employee compensation; • differentiation among financial institutions by governments with respect to the extension of guarantees to bank customer deposits and the terms attaching to such guarantees, including requirements for the entire Group to accept exposure to the risk of any individual member of the Group, or even third party participants in guarantee schemes, failing; • implementation of, or costs related to, local customer or depositor compensation or reimbursement schemes; • transferability and convertibility of currency risk; • expropriation, nationalisation and confiscation of assets; • changes in legislation relating to foreign ownership; and
The Group capitalises goodwill, which is calculated as the excess of the cost of an acquisition over the net fair value of the identifiable assets, liabilities and contingent liabilities acquired. Acquired goodwill is recognised initially at cost and subsequently at cost less any accumulated impairment losses. As required by IFRS, the Group tests goodwill for impairment annually or more frequently, at external reporting
dates, when events or circumstances indicate that it might be impaired. An impairment test involves comparing the recoverable amount (the higher of value in use and fair value less cost to sell) of an individual cash generating unit with its carrying value. The value in use and fair value of the Group’s cash generating units are affected by market conditions and the performance of the economies in which the Group operates. Where the Group is required to recognise a goodwill impairment, it is recorded in the Group’s income statement, although it has no effect on the Group’s regulatory capital position. For the year ended 31 December 2009, the Group recorded a £363 million accounting write down of goodwill and other intangibles relating to prior year acquisitions (see page 301).
The Group may be required to make further contributions to its pension schemes if the value of pension fund assets is not sufficient to cover potential obligations.
The Group maintains a number of defined benefit pension schemes for past and a number of current employees. Pensions risk is the risk that the liabilities of the Group’s various defined benefit pension schemes which are long term in nature will exceed the schemes’ assets, as a result of which the Group is required or chooses to make additional contributions to the schemes. The schemes’ assets comprise investment portfolios that are held to meet projected liabilities to the scheme members. Risk arises from the schemes because the value of these asset portfolios and returns from them may be less than expected and because there may be greater than expected increases in the estimated value of the schemes’ liabilities. In these circumstances, the Group could be obliged, or may choose, to make additional contributions to the schemes, and during recent periods, the Group has voluntarily made such contributions. Given the current economic and financial market difficulties and the prospects that they may continue over the near and medium term, the Group may experience increasing pension deficits or be required or elect to make further contributions to its pension schemes and such deficits and contributions could be significant and have a negative impact on the Group’s capital position, results of operations or financial condition or result in a loss of value in its securities. The next funding valuation of the Group’s major defined benefit pension plan, The Royal Bank of Scotland Group Pension Fund, will take place with an effective date of 31 March 2010.
The Group’s operations are diverse and complex, and it operates in legal and regulatory environments that expose it to potentially significant litigation, regulatory investigation and other regulatory risk. As a result, the Group is, and may in the future be, involved in various disputes, legal proceedings and regulatory investigations in the United Kingdom, the EU, the United States and other jurisdictions, including class action litigation and review by the European Commission under State aid rules. Furthermore, the Group, like many other financial institutions, has come under greater regulatory scrutiny over the last year and expects that environment to continue for the foreseeable future, particularly as it relates to compliance with new and existing corporate governance, employee compensation, conduct of business, anti-money laundering and anti-terrorism laws and regulations, as well as the provisions of applicable sanctions programmes. Disputes, legal proceedings and regulatory investigations are subject to many uncertainties, and their outcomes are often difficult to predict, particularly in the earlier stages of a case or investigation. Adverse regulatory action or adverse judgments in litigation could result in restrictions or limitations on the Group’s operations or result in a material adverse effect on the Group’s reputation or results of operations or result in a loss of value in the securities. For details about certain litigation and regulatory investigations in which the Group is involved, see Note 32 on the Financial statements.
The Group is exposed to the risk of changes in tax legislation and its interpretation and to increases in the rate of corporate and other taxes in the jurisdictions in which it operates.
The Group’s activities are subject to tax at various rates around the world computed in accordance with local legislation and practice. Action by governments to increase tax rates or to impose additional taxes or to restrict the tax reliefs currently available to the Group would reduce the Group’s profitability. Revisions to tax legislation or to its interpretation might also affect the Group’s results in the future.
HM Treasury (or UKFI on its behalf) may be able to exercise a significant degree of influence over the Group.
Future claims in the Group’s general and life assurance business may be higher than expected as a result of changing trends in claims experience resulting from catastrophic weather conditions, demographic developments, changes in the nature and seriousness of claims made, changes in mortality, changes in the legal and compensatory landscape and other causes outside the Group’s control. These trends could affect the profitability of current and future insurance products and services. The Group reinsures some of the risks it has assumed and is accordingly exposed to the risk of loss should its reinsurers become unable or unwilling to pay claims made by the Group against them.
In the United Kingdom and in other jurisdictions, the Group is responsible for contributing to compensation schemes in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers.
In addition, to the extent that other jurisdictions where the Group operates have introduced or plan to introduce similar compensation, contributory or reimbursement schemes (such as in the United States with the Federal Deposit Insurance Corporation), the Group may make further provisions and may incur additional costs and liabilities, which may negatively impact its financial condition and results of operations or result in a loss of value in its securities.
The restructuring plan in place for the integration and separation of ABN AMRO into and among the businesses and operations of the Consortium Members is complex, involving substantial reorganisation of ABN AMRO’s operations and legal structure. The restructuring plan is being implemented and significant elements have been completed within the planned timescales and the integration of the Group’s businesses continues. The Group may not realise the benefits of the acquisition or the restructuring when expected or to the extent projected. The occurrence of any of these events, including as a result of staff losses or performance issues, or as a result of further disposals or restructurings by the Group, may have a negative impact on the Group’s financial condition and results of operations. It is not expected that the Dutch State’s acquisition of Fortis Bank Nederland’s shares in RFS Holdings, will materially affect the integration benefits envisaged by the Group.
There is currently no restriction in respect of deferred tax assets recognised by the Group for regulatory purposes. Changes in regulatory rules may restrict the amount of deferred tax assets that can be recognised and such changes could lead to a reduction in the Group’s Core Tier 1 capital ratio. In particular, on 17 December 2009, the Basel Committee published a consultative document setting out certain proposed changes to capital requirements (see the risk factor headed “The Group’s business performance could be adversely affected if its capital is not managed effectively or if there are changes to capital adequacy and liquidity requirements” above). Those proposals included a requirement that deferred tax assets which rely on future profitability of the Group to be realised should be deducted from the common equity component of Tier 1 and therefore not count towards Tier 1 capital.
Risks relating to the Group’s participation in the APS Owing to the complexity, scale and unique nature of the APS and the uncertainty surrounding the duration and severity of the current economic recession, there may be unforeseen issues and risks that are relevant in the context of the Group’s participation in the APS and in the impact of the APS on the Group’s business, operations and financial condition. In addition, the assets or exposures to be covered by the APS may not be those with the greatest future losses or with the greatest need for protection.
There is no assurance that the Group’s participation in the APS and the issue of £25.5 billion of B shares and, if required, the £8 billion Contingent B shares will achieve the Group’s goals of improving and maintaining the Group’s capital ratios in the event of further losses. Accordingly, the Group’s participation in the APS and the issue of £25.5 billion of B shares and, if required, the £8 billion Contingent B shares may not improve market confidence in the Group and the Group may still face the risk of full nationalisation or other resolution procedures under the Banking Act.
In these circumstances, if the Group is unable to issue the £8 billion Contingent B shares, the Group will need to assess its strategic and operational position and will be required to find alternative methods for achieving the requisite capital ratios. Such methods could include an accelerated reduction in risk-weighted assets, disposals of certain businesses, increased issuance of Tier 1 capital securities, increased reliance on alternative government-supported liquidity schemes and other forms of government assistance. There can be no assurance that any of these alternative methods will be available or would be successful in increasing the Group’s capital ratios to the desired or requisite levels. If the Group is unable to issue the £8 billion Contingent B shares, the Group’s business, results of operations, financial condition and capital position and ratios will suffer, its credit ratings may drop, its ability to lend and access funding will be further limited and its cost of funding may increase. The occurrence of any or all of such events may cause the price of its securities to decline substantially and may result
Business review in intervention by the Authorities or other regulatory bodies in the other jurisdictions in which the company and its subsidiaries operate, which could include full nationalisation, other resolution procedures under the Banking Act or revocation of permits and licences necessary to conduct the Group’s businesses. Any compensation payable to holders of securities would be subject to the provisions of the Banking Act, and investors may receive no value for their securities (see the risk factor headed “the company and its UK bank subsidiaries may face the risk of full nationalisation or other resolution procedures under the Banking Act above).
The Group may have included Covered Assets that are ineligible (or that later become ineligible) for protection under the APS. Protection under the APS may be limited or may cease to be available where Covered Assets are not correctly or sufficiently logged or described, where a Covered Asset is disposed of (in whole or in part) prior to a Trigger, where the terms of the APS do not apply or are uncertain in their application, where the terms of the protection itself potentially give rise to legal uncertainty, where certain criminal conduct has or may have occurred or where a breach of bank secrecy, confidentiality, data protection or similar laws may occur. In addition, certain assets included in the APS do not satisfy the eligibility requirements of the Scheme Documents. In each case this would reduce the anticipated benefits to the Group of the APS.
During the life of the APS, certain or all of the Covered Assets may cease to be protected due to a failure to comply with continuing obligations under the APS, reducing the benefit of the APS to the Group. The Group is subject to limitations on actions it can take in respect of the Covered Assets and certain related assets and to extensive continuing obligations under the Scheme Conditions relating to governance, asset management, audit and reporting. The Group’s compliance with the Scheme Conditions is dependent on its ability to (i) implement efficiently and accurately new approval processes and reporting, governance and management systems in accordance with the Scheme Conditions and (ii) comply with applicable laws and regulations where it does business. The Group has complex and geographically diverse operations, and operational risk in the context of the APS may result from errors by employees or third-parties, failure to document transactions or procedures properly or to obtain proper authorisations in accordance with the Scheme Conditions, equipment failures or the inadequacy or failure of systems and controls. Although the Group has devoted substantial financial and operational resources, and intends to devote further substantial resources, to developing
HM Treasury may, following consultation with the company, modify or replace certain of the Scheme Conditions in such a manner as it considers necessary (acting reasonably) to: • remove or reduce (or remedy the effects of) any conflict between: (i) the operation, interpretation or application of certain Scheme Conditions; and (ii) any of the overarching principles governing the APS; • correct any manifest error contained in certain Scheme Conditions; or
HM Treasury can only effect a modification or replacement of a Scheme Condition if (i) it is consistent with each of the Scheme Principles, (ii) there has been no formal notification from the FSA that such modification would result in any protection provided to the Royal Bank under the APS ceasing to satisfy certain requirements for eligible credit risk mitigation and (iii) HM Treasury has considered in good faith and had regard to any submissions, communications or representations of or made by the Royal Bank regarding the anticipated impact of the proposed modification under any non-UK capital adequacy regime which is binding on the Royal Bank or a Covered Entity.
Business review capital ratios, this could cause the Group’s business, results of operations and financial condition to suffer, its credit rating to drop, its ability to lend and access to funding to be further limited and its cost of funding to increase. The occurrence of any or all of such events may cause the price of the securities to decline substantially and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act. Any compensation payable to holders of securities would be subject to the provisions of the Banking Act and investors may receive no value for their securities.
The costs of the Group’s participation in the APS may be greater than the amounts received thereunder.
The company may have to repay any net pay-outs made by HM Treasury under the APS in order to terminate its participation in the APS. During its participation in the APS, the Royal Bank will pay an annual participation fee to HM Treasury. The annual fee, which is payable in advance, is £700 million per annum for the first three years of the company’s participation in the APS and £500 million per annum thereafter until the earlier of (i) the date of termination of the APS and (ii) 31 December 2099. Pursuant to the Accession Agreement and the Tax Loss Waiver, subject to HM Treasury consent, all or part of the exit fee (but not the refund of the net payments the Royal Bank has received from HM Treasury under the APS) may be paid by the waiver of certain UK tax reliefs that are treated as deferred tax assets (pursuant to the Tax Loss Waiver). The Directors may, in the future, conclude that the cost of this annual fee, in combination with the other costs of the Group’s participation in the APS, outweighs the benefits of the Group’s continued participation and therefore that the Group’s participation in the APS should be terminated. However, in order to terminate the Group’s participation in the APS, the Group must have FSA approval and pay an exit fee which is an amount equal to (a) the larger of (i) the cumulative aggregate fee of £2.5 billion and (ii) 10 per cent. of the annual aggregate reduction in Pillar I capital requirements in respect of the assets covered by the APS up to the time of exit less (b) the aggregate of the annual fees paid up to the date of exit. In the event that the Group has received payments from HM Treasury under the APS in respect of losses on any Triggered Assets, it must either negotiate a satisfactory exit payment to exit the APS, or absent such agreement, refund to HM Treasury any net payments made by HM Treasury under the APS in respect of losses on the Triggered Assets.
The effect of the payment of the exit fee and potentially the refund of the net pay-outs it has received from HM Treasury under the APS may significantly reduce or even eliminate the anticipated further regulatory capital benefits to the Group of its participation in the APS or if FSA approval for the proposed termination is not obtained and could have an adverse impact on the Group’s financial condition and results of operation or result in a loss of value in its securities. Alternatively, if the Group is unable to repay to HM Treasury in full the exit fee and potentially the net pay-outs it has received under the APS and, therefore, unable to terminate its participation in the APS, the Group will be required under the Scheme Conditions to continue to pay the annual fee to HM Treasury until 31 December 2099, which could have an adverse impact on the Group’s financial condition and results of operation or result in a loss of value in its securities.
Under certain circumstances, the company cannot be assured that assets of ABN AMRO (and certain other entities) will continue to be covered under the APS, either as a result of a withdrawal of such assets or as a result of a breach of the relevant obligations.
If HM Treasury seeks to exercise its right to appoint one or more step-in managers in relation to the management and administration of Covered Assets held by ABN AMRO or its wholly owned subsidiaries, ABN AMRO will, in certain circumstances, need to seek consent from the Dutch Central Bank to allow it to comply with such step-in. If this consent is not obtained by the date (which will fall no less than 10 business days after the notice from HM Treasury) on which the stepin rights must be effective, and other options to effect compliance are not possible (at all or because the costs involved prove prohibitive), those assets would need to be withdrawn by the Royal Bank from the APS where permissible under the Scheme Conditions or, otherwise, with HM Treasury consent. If the Royal Bank cannot withdraw such Covered Assets from the APS, it would be likely to lose protection in respect of these assets under the APS and/or may be liable under its indemnity to HM Treasury. If the Royal Bank loses cover under the APS in respect of any Covered Asset held by ABN AMRO or its wholly owned subsidiaries, any losses incurred on such asset will continue to be borne fully by the company and may have a material adverse impact on its financial condition, profitability and capital ratios. Similar issues apply in certain other jurisdictions but the relevant Covered Assets are of a lower quantum.
Moreover, HM Treasury has the right under the Scheme Conditions to appoint one or more step-in managers (identified or agreed to by HM Treasury) to exercise certain step-in rights upon the occurrence of certain specified events. The step-in rights are extensive and include certain oversight, investigation, approval and other rights, the right to require the modification or replacement of any of the systems, controls, processes and practices of the Group and extensive rights in relation to the direct management and administration of the Covered Assets. If the Royal Bank does not comply with the instructions of the step-in manager, once appointed, the Royal Bank may lose protection under the APS in respect of all or some of the Covered Assets. The step-in manager may be a person identified by HM Treasury and not by the company.
Any conversion of the B shares, in combination with any future purchase by HM Treasury of ordinary shares, would increase HM Treasury’s ownership interest in the company, and could result in the delisting of the company’s securities.
On 22 December the company issued £25.5 billion of B shares to HM Treasury. The B shares are convertible, at the option of the holder at any time, into ordinary shares at an initial conversion price of £0.50 per ordinary share. Although HM Treasury has agreed not to convert any B shares it holds if, as a result of such conversion, it would hold more than 75 per cent. of the ordinary shares, if HM Treasury were to acquire additional ordinary shares otherwise than through the conversion of the B shares, such additional acquisitions could significantly increase HM Treasury’s ownership interest in the company to above 75 per cent. of the company’s ordinary issued share capital, which would put the company in breach of the Listing Rules requirement that at least 25 per cent. of its issued ordinary share capital must be in public hands. Although the company may apply to the UKLA for a waiver in such circumstances, there is no guarantee that such a waiver would be granted, the result of which could be the delisting of the company from the Official List and potentially other exchanges where its securities are currently listed and traded. In addition, HM Treasury will not be entitled to vote in respect of the B shares or in respect of the Dividend Access Share to the extent, but only to the extent, that votes cast on such B shares and/or on such Dividend Access Share, together with any
Any purchase of B shares by HM Treasury will, when taken together with its existing holding of ordinary shares, increase its economic interest in the company and will have a corresponding dilutive effect on other the company shareholders in respect of a winding up and the payment of dividends.
A significant proportion of senior management’s time and resources will have to be committed to the APS, which may have a material adverse effect on the rest of the Group’s business.
The Group expects that significant senior management and key employee time and resources will have to be committed to the ongoing operation of the APS, including governance, asset management and reporting and generally to ensure compliance with the Scheme Conditions. The time and resources required to be committed to the APS by the Group’s senior management and other key employees is likely to place significant additional demands on senior management in addition to the time and resources required to be dedicated to the rest of the Group’s business. In addition, and separately from the Group’s participation in the APS, significant headcount reductions are being introduced at all levels of management in the context of a restructuring of the Group. The Group’s ability to implement its overall strategy depends on the availability of its senior management and other key employees. If the Group is unable to dedicate sufficient senior management resources to the Group’s business outside the APS, its business, results of operations and financial condition will suffer.
The cost of the Tax Loss Waiver and related undertakings is uncertain and the Group may be subject to additional tax liabilities in connection with the APS.
Loss attributable to ordinary and B shareholders (3,607) (24,306) (3,607) (24,306)
Basic loss per ordinary and B share from continuing operations (pence) (6.3p) (146.2p) (6.3p) (146.2p) Adjusted loss per ordinary and B share from continuing operations (pence) (6) (13.2p) (43.1p) — —
Risk asset ratio – Core Tier 1 11.0% 5.9% 11.0% 6.6%
(3) Pro forma operating loss represents loss before tax, amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, gains on pensions curtailment and bonus tax.
(5) Pro forma cost:income ratio represents operating expenses excluding amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gains on pensions curtailment and bonus tax expressed as a percentage of total income excluding gain on redemption of own debt and strategic disposals.
(6) Adjusted loss per ordinary and B share is based on earnings from continuing operations adjusted for amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, gains on pensions curtailment and bonus tax.
Overview of results As discussed on page 51, the results of ABN AMRO are fully consolidated in the Group’s financial statements. Consequently, the statutory results of RBS for the year ended 31 December 2009 and 2008 include the results of ABN AMRO. The interests of the State of the Netherlands and Santander in RFS Holdings are included in minority interests.
Pro forma results have been prepared that include only those business units of ABN AMRO that will be retained by RBS. The financial review and divisional performance in the Business review focus on the pro forma results. The basis of preparation of the pro forma results is detailed on page 113.
Fees and commissions receivable 8,738 8,845 9,831 9,831 Fees and commissions payable (2,790) (2,411) (2,822) (2,386) Other non-interest income 4,644 (7,308) 9,633 (6,578) Insurance net premium income 5,266 5,709 5,544 6,326
Loss from continuing operations (1,589) (7,016) (2,224) (38,513) (Loss)/profit from discontinued operations, net of tax (72) (86) (99) 3,971 Loss for the year (1,661) (7,102) (2,323) (34,542)
Amortisation of purchased intangible assets 0.4p 2.1p Write-down of goodwill and other intangible assets 0.7p 97.8p Integration and restructuring costs 1.6p 5.9p Gain on redemption of own debt (6.8p) — Strategic disposals (0.2p) (2.7p) Gains on pensions curtailment (3.0p) — Bonus tax 0.4p — Adjusted loss per ordinary and B share from continuing operations (13.2p) (43.1p)
(2) Pro forma Group operating loss excludes amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, gains on pensions curtailment and bonus tax.
Business review continued 2009 compared with 2008 – pro forma Operating loss Group operating loss, excluding amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, gains on pensions curtailment and bonus tax was £6,232 million, compared with a loss of £6,938 million in 2008. The reduction in the loss is primarily a result of a substantial increase in non-interest income partially offset by a significant increase in impairment losses and lower net interest income.
After amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, gains on pensions curtailment and bonus tax, the Group recorded a loss before tax of £2,291 million, compared with a loss before tax of £25,207 million in 2008.
Total income Total income, excluding the gain on redemption of own debt and strategic disposals, increased by 43% to £29,425 million, primarily reflecting a significant reduction in credit and other market losses. Increased market volatility and strong customer demand in a positive trading environment also contributed to this improvement. While income was down marginally in UK Corporate and held steady in Retail & Commercial Banking and RBS Insurance, a significant improvement occurred in Global Banking & Markets, reflecting the reduced credit and other market losses and a more buoyant trading market during the year compared to 2008.
Risk elements in lending and potential problem loans at 31 December 2009 represented 6.1% of loans and advances, excluding reverse repos, compared with 2.7% a year earlier. Provision coverage was 43%, compared with 50% at 31 December 2008 as a consequence of the growth in risk elements in lending being concentrated in secured, property-related loans. These loans require relatively lower provisions in view of their collateralised nature.
Other non-operating items Integration and restructuring costs decreased, primarily as ABN AMRO integration activity neared completion, partly offset by restructuring activity following the conclusion of the strategic review.
Taxation The Group recorded a tax credit of £339 million in 2009, compared with a tax credit of £1,280 million in 2008.
Loans and advances to customers were down £135.6 billion, 19%, at £595.7 billion. Within this, reverse repos increased by 4%, £1.8 billion to £41.0 billion. Excluding reverse repos, lending decreased by £137.3 billion to £554.7 billion or by £131.6 billion, 19%, before impairment provisions.
Net interest income Net interest income decreased by 12% to £16,504 million.
Balance Sheet Total assets of £1,696.5 billion at 31 December 2009 were down £705.2 billion, 29%, compared with 31 December 2008.
Loans and advances to customers were down £146.3 billion, 17%, at £728.4 billion. Within this, reverse repos increased by £1.7 billion, 4%, to £410 billion. Excluding reverse repos, lending decreased by £148.0 billion, 18%, to £687.4 billion or by £141.8 billion, 17%, before impairment provisions.
Capital Capital ratios at 31 December 2009 were 11.0% (Core Tier 1), 14.1% (Tier 1) and 16.1% (Total).
The Royal Bank of Scotland plc base rate (average) 0.64 4.67 0.64 4.67 London inter-bank three month offered rates (average): Notes: (1) Interest-earning assets and interest-bearing liabilities exclude the Retail bancassurance assets and liabilities attributable to policyholders, in view of their distinct nature. As a result, net interest income has been increased by £20 million (2008 – £84 million).
Total interest-earning assets – banking business (2, 3) 753,036 26,390 3.50 738,093 42,197 5.72
Customer accounts: savings deposits – UK 54,048 772 1.43 42,870 1,691 3.94
Customer accounts: other time deposits – UK 67,728 807 1.19 95,181 3,964 4.16
Debt securities in issue – UK 130,002 3,162 2.43 114,234 5,281 4.62
Internal funding of trading business – UK (60,284) (317) 0.53 (85,664) (3,445) 4.02
Assets Loans and advances to banks – UK 21,385 312 1.46 18,909 943 4.99
Total interest-earning assets – banking business (2, 3) 903,838 33,902 3.75 887,194 49,938 5.63
Total interest-earning assets 1,194,930 1,312,648 Non-interest-earning assets (2, 3) 828,550 728,037
Customer accounts: demand deposits – UK 110,294 569 0.52 99,852 2,829 2.83
Customer accounts: other time deposits – UK 69,687 932 1.34 95,181 4,011 4.21
Total interest-bearing liabilities 1,149,802 1,298,960 Non-interest-bearing liabilities: Demand deposits – UK 16,456 19,796
2009 over 2008 – pro forma 2009 over 2008 – statutory
Note: (1) The analysis into UK and Overseas has been compiled on the basis of location of office.
Fees and commissions receivable 8,738 8,845 9,831 9,831 Fees and commissions payable (2,790) (2,411) (2,822) (2,386) Income/(loss) from trading activities 3,806 (8,829) 3,881 (8,477) Gain on redemption of own debt — — 3,790 — Other operating income (excluding insurance net premium income) 838 1,521 1,962 1,899
2009 compared with 2008 – pro forma Net fees and commissions fell by £486 million primarily due to the withdrawal of the single premium payment protection insurance product and the restructuring of current account overdraft fees within UK Retail during the year, as well as to reduced fees received in Non-Core. This was partially offset by improved performance in GBM (£112 million) and US Retail & Commercial (£50 million).
Other operating income fell by £683 million. Adjusting for changes in the fair value of own debt and a gain of £600 million on the sale of Angel Trains in 2008, other operating income increased by £843 million. This improvement reflected a small gain in the fair value of securities and other assets and liabilities compared with a loss of £1.4 billion in 2008 partially offset by lower profits on sales of securities and properties and reduced dividend income.
2009 compared with 2008 – statutory Net fees and commissions fell by £436 million primarily due to the withdrawal of the single premium payment protection insurance product and the restructuring of current account overdraft fees within UK Retail during the year, as well as to reduced fees received in Non-Core. This was partially offset by improved performance in GBM (£112 million) and US Retail & Commercial (£50 million).
Income from trading activities rose substantially during the year by £12,358 million, principally due to lower credit market losses reflecting improved underlying asset prices compared with 2008. Increased market volatility and strong customer demand in a positive trading environment also contributed to this improvement.
2009 compared with 2008 – pro forma Staff costs were up £1,091 million with most of the movement relating to adverse movements in foreign exchange rates and some salary inflation. Changes in incentive compensation, primarily in Global Banking & Markets, represented most of the remaining change.
2009 compared with 2008 – statutory Staff costs, excluding pension schemes curtailment gains, were up £1,373 million with most of the movement relating to adverse movements in foreign exchange rates and some salary inflation. Changes in incentive compensation, primarily in Global Banking & Markets, represented most of the remaining change.
Pension curtailment gains of £2,148 million were recognised in 2009 arising from changes to prospective pension benefits in the defined benefit scheme and certain other subsidiary schemes.
Premises and equipment costs rose by £494 million primarily due to the impact of expanded Group premises in London and the US.
Write-down of goodwill and other intangible assets — — 363 32,581
Note: (1) Pro forma excludes amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gains on pensions curtailment and bonus tax.
Staff costs – redundancy — — 158 (158) — Staff costs – other 5 — 207 (212) —
Integration costs in 2009 were £859 million compared with £1,050 million in 2008. Integration and restructuring costs decreased primarily due to restructuring activity resulting from the strategic review undertaken earlier in the year. This was more than offset by lower ABN AMRO integration activity during the year.
Staff costs 328 251 Premises and equipment 48 15 Other administrative expenses 51 41
2009 compared with 2008 – statutory Impairment losses were £14,950 million compared with £8,072 million. Impairment losses in the Core divisions increased by £2,182 million, Non-Core losses increased by £4,285 million and RFS Holdings minority interest losses increased by £411 million.
Impairment losses Pro forma Statutory £m £m £m £m less: recoveries of amounts previously written-off (325) (261) (399) (319) Charge to income statement 13,899 7,432 14,950 8,072
• The increase in CVA resulting from the credit quality deterioration was partially offset by the decrease in CVA requirement following the reduction in gross exposure due to higher prices of underlying reference instruments. Consequently the net losses incurred in this regard were lower than in 2008 when there was both an increase in gross exposure and deterioration in credit quality.
• The credit quality of the CDPCs has continued to deteriorate and the level of CVA held against exposures to CDPC counterparties has increased from 27% to 39% during the year.
Losses relating to credit exotics were £558 million in 2009 compared with £947 million in 2008. These losses were reduced in 2009 as hedges were put in place to mitigate the risk.
The actual tax credit differs from the expected tax credit computed by applying the standard rate of UK corporation tax as follows: Pro forma Statutory £m £m £m £m
Taxable foreign exchange movements 1 (80) 1 (80) Foreign profits taxed at other rates (332) (271) (320) (203) Losses in year not recognised (715) (942) (780) (942) Losses brought forward and utilised 94 11 94 11 Adjustments in respect of prior periods (118) 352 (118) 352
Financial statements Critical accounting policies 256 Reclassification of financial instruments Financial statements Note 11 Financial instruments 275
Pro forma Group operating loss is before amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, gains on pensions curtailment and bonus tax.
Divisional performance The results of each division on a pro forma basis are set out below. The results are stated before amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, gains on pensions curtailment and bonus tax.
Treasury costs are allocated to operating divisions as follows: term funding costs are allocated or rewarded based on long term funding gap or surplus; liquidity buffer funding costs are allocated based on share of overall liquidity buffer derived from divisional stresses; and capital cost or benefit is allocated based on share of divisional riskadjusted RWAs.
Non-Core 171.3 170.9 Group before benefit of APS 565.8 577.8 Benefit of APS (127.6) —
• Customer deposits grew 11% on 2008 reflecting the strength of the UK Retail customer franchise, which outperformed the market in an increasingly competitive environment. Savings balances grew by £6 billion or 11% and account acquisition saw a 20% increase, with 2.2 million accounts opened. Personal current account balances increased by 12% on 2008 with a 3% growth in accounts to 12.8 million.
Net interest income increased significantly by 8% to £3,452 million, driven by strong balance sheet growth. Net interest margin was flat at 3.59%, with decreasing liability margins in the face of stiff competition for deposits offsetting wider asset margins. The growth in mortgages and the reduction in higher margin unsecured balances also had a negative impact on the blended net interest margin.
• Direct staff costs declined by 9%, as the division benefited from strong cost control, a focus on process re-engineering and a 10% reduction in headcount.
• RBS continues to progress towards a more convenient, lower cost operating model, with over 4 million active users of online banking and a record share of new sales achieved through direct channels. More than 5.5 million accounts have switched to paperless statements and 254 branches now utilise automated cash deposit machines.
Impairment losses increased 65% to £1,679 million reflecting the deterioration in the economic environment, and its impact on customer finances.
• The unsecured lending impairment charge was £1,555 million (2008 – £988 million) on a book of £19.8 billion. Industry benchmarks for cards arrears showed a slightly improving trend in the final quarter of 2009, which is consistent with the Group’s experience. RBS continues to perform better than the market on arrears.
Net interest income 2,292 2,448 Net fees and commissions 858 829 Other non-interest income 432 460 Non–interest income 1,290 1,289 Total income 3,582 3,737 Direct expenses
Operating profit before impairment losses 2,052 2,100 Impairment losses (927) (319) Operating profit 1,125 1,781
Analysis of income by business Corporate and commercial lending 2,401 2,166 Asset and invoice finance 232 241 Corporate deposits 985 1,266 Other (36) 64 Total income 3,582 3,737
Analysis of impairment by sector Banks and financial institutions 15 9 Hotels and restaurants 98 25 Housebuilding and construction 106 42 Manufacturing 51 14 Other 150 53 Private sector education, health, social work, recreational and community services 59 15 Property 259 24 Wholesale and retail trade, repairs 76 37 Asset and invoice finance 113 100 Total impairment 927 319
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector Banks and financial Institutions 0.29% 0.17% Hotels and restaurants 1.75% 0.41% Housebuilding and construction 3.12% 0.81%
Wholesale and retail trade, repairs 0.97% 0.41% Asset and invoice finance 1.33% 1.18%
Performance ratios Return on equity (1) 10.3% 18.0% Net interest margin 2.22% 2.40% Cost:income ratio 42.7% 43.8%
2009 compared with 2008 Operating profit of £1,125 million was £656 million lower than in 2008, largely due to an increase of £608 million in impairments.
Net interest margin levels were rebuilt during the second half as asset pricing was amended to reflect increased funding and credit costs. For the year as a whole net interest margin was 18 basis points lower than in 2008, reflecting higher funding costs and continued competitive pricing for deposits.
Gross new lending to customers remained resilient in 2009, with a noticeable acceleration of lending activity in the second half of the year. However, as customers have deleveraged and turned increasingly to capital markets, repayments have accelerated even more sharply. Loans and advances to customers, therefore, declined by 5% to £111.5 billion.
A reduction in costs of 7% was driven by lower staff expenses as a result of the Group’s restructuring programme, together with restraint on discretionary spending levels.
Impairment losses increased substantially reflecting both a rise in the number of corporate delinquencies requiring a specific impairment and a higher charge to recognise losses not yet specifically identified.
2009 compared with 2008 Wealth produced strong growth in operating profit, up 21% to £420 million, reflecting the increased value of the division’s healthy deposit base in an increasingly competitive market for funding. Deposit balances increased by 5% from 2008, though the deposit market remains highly competitive.
Total income was up 5% (1% in constant currency terms), with strong growth in net interest income, up 12% in constant currency terms reflecting the increased internal pricing applied to Wealth’s deposit base. This was offset by a marked decrease in investment income year on year as assets under management decreased by 8% at constant exchange rates during 2009, with investors turning to more liquid assets and away from longer term investments.
Net interest income 663 578 Net fees and commissions 363 405 Other non-interest income 83 76 Non-interest income 446 481 Total income 1,109 1,059 Direct expenses
Operating profit before impairment losses 453 364 Impairment losses (33) (16) Operating profit 420 348
Performance ratios Net interest margin 4.38% 4.51% Cost:income ratio 59.2% 65.6%
Net interest income from banking activities 2,243 2,440 Net fees and commissions receivable 1,335 1,223 Income from trading activities 7,763 (743) Other operating income (net of related funding costs) (332) (206) Non-interest income 8,766 274 Total income 11,009 2,714 Direct expenses
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) 0.59% 0.29%
Portfolio management and origination grew 39% as financial institutions and corporate clients refinanced through the debt capital markets. The refocused Credit Markets delivered a much improved result from greater liquidity and a more positive trading environment.
Despite quarterly movement in the Group’s credit spreads, overall spreads remained broadly flat over the year resulting in a small loss from movements in the fair value of own debt compared with a £357 million gain in 2008.
Risk-weighted assets decreased 19%, or 15% at constant exchange rates, reflecting the fall in third party assets and the Group’s continued focus on reducing its risk profile and balance sheet usage.
Cash and eligible bills 74.0 20.2 Other assets 31.1 38.0 Total third party assets (excluding derivatives mark to market) 412.2 498.7 Net derivative assets (after netting) 68.0 121.0 Customer deposits (excluding repos) 46.9 87.8 Risk elements in lending 1.8 0.9 Loan:deposit ratio 194% 192% Risk-weighted assets 123.7 151.8
Performance ratios Net interest margin 9.22% 8.25% Cost:income ratio 59.3% 56.6%
Capital and balance sheet Total third party assets 18.4 22.2 Loans and advances 12.7 14.8 Customer deposits 61.8 61.8 Risk elements in lending 0.2 0.1 Loan:deposit ratio 21% 25% Risk-weighted assets 19.1 17.4 2009 compared with 2008 Operating profit declined by 3%, or 6% at constant foreign exchange rates, largely reflecting pressure on deposit income. The attrition of deposit balances experienced in the first half was reversed in the second, but margins remain compressed due to both a very competitive deposit market as well as the low rate environment.
Customer deposit balances at £61.8 billion were flat on the previous year, with growth in the UK and international business offset by weaker US domestic balances. At constant exchange rates balances were up 3%. Loans and advances were down 14% (11% in constant currency terms) due to reduced overdraft utilisation and lower trade volumes.
Expenses were up 7% in headline terms but flat in constant currency terms, as cost savings and efficiencies helped to mitigate the impact of investment in infrastructure. Staff expenses were 2% lower in constant currency terms, with headcount down 5%. The cost:income ratio was 59.3%, a deterioration of 2.7 percentage points or 1.9 percentage points in constant currency terms.
Operating profit before impairment losses 281 324 Impairment losses (649) (106) Operating (loss)/profit (368) 218
Performance ratios Return on equity (1) (13.3%) 10.1% Net interest margin 1.87% 1.89% Cost:income ratio 72.8% 68.8%
Note: (1) Return on equity is based on divisional operating profit after tax, divided by divisional notional equity (based on 7% of divisional risk-weighted assets, adjusted for capital deductions).
Business review 2009 compared with 2008 Operating results were in line with expectations but deteriorated during 2009 as economic conditions across the island of Ireland worsened, with an operating loss for the year of £368 million.
Net interest income declined by 7% in constant currency terms, largely as a result of tightening deposit margins in an increasingly competitive market, partly offset by asset repricing initiatives. Net interest margin for the year at 1.87% remained broadly stable despite the challenging market conditions.
At constant exchange rates loans to customers decreased by 4% from the prior year as new business demand weakened. Customer deposits reduced by 5% in 2009 in constant currency terms, reflecting an increasingly competitive Irish deposit market and reductions in wholesale funding during the first quarter. During the second half of the year the market stabilised and the division recorded strong growth in customer balances resulting in an improved funding profile.
Non-interest income declined by 12% in constant currency terms due to lower fee income driven by reduced activity levels across all business lines.
Performance ratios Return on equity (1) (1.8%) 7.7% Net interest margin 2.37% 2.68% Cost:income ratio 78.3% 62.7%
Business review 2009 compared with 2008 The recessionary economic environment, historically low interest rates and deteriorating credit conditions resulted in an operating loss of $174 million. However, the business has now successfully refocused on its core customer franchises in New England, the Mid-Atlantic region and the Midwest.
Impairment losses increased to $1,099 million as charge-offs climbed to 0.90% of loans, an increase of 34bps compared with 2008.
Customer deposits increased 4% from the prior year. The deposit mix improved significantly, with strong growth in checking balances combined with migration away from higher priced term and time deposits as the division adjusted its pricing strategies. Over 58,000 consumer checking accounts were added over the course of the year, and more than 13,000 small business checking accounts. Consumer checking balances grew by 8% and small business balances by 12%.
(2) Based on total income and operating expenses above and after netting insurance claims against income.
Business review 2009 compared with 2008 Operating profit was severely affected by the rising costs of bodily injury claims, declining to £58 million. Significant price increases were implemented in the latter part of the year to mitigate the industry trend of rising claims costs.
In-force policies grew by 3%, driven by the success of own brands, up 11%. Churchill and Privilege have benefited from deployment on selected price comparison websites, with motor policy numbers up 19% and 3% respectively, and home policies up 32% and 109% respectively, compared with prior year. Direct Line motor and home policies grew by 4% and 2% respectively. The partnerships and broker segment declined by 10% in line with business strategy.
The UK combined operating ratio, including business services costs, was 105.9% compared with 93.6% in the previous year, with the impact of the increase in reserves for bodily injury claims and the bad weather experience only partially mitigated by commission and expense ratio improvement.
Items not allocated during the year amounted to a net credit of £292 million. The Group’s credit spreads have fluctuated over the course of the year, but ended the year slightly tighter, resulting in an increase in the carrying value of own debt. This was offset by a net credit on unallocated Group treasury items, including the impact of economic hedges that do not qualify for IFRS hedge accounting. 2008’s results included some significant disposal gains.
Operating loss before other operating charges and impairment losses (4,748) (5,715) Insurance net claims (588) (700) Impairment losses (9,221) (4,936) Operating loss (14,557) (11,351)
(2) Derivatives were £19.9 billion at 31 December 2009 (30 September 2009 – £30.9 billion; 31 December 2008 – £85.0 billion).
Gross customer loans and advances Banking & Portfolio 82.0 97.0 International Businesses & Portfolios 65.6 79.9
Notes: (1) Included in ‘Loss from trading activities’ on page 103.
Telecoms, media & technology 545 55 Banks & financials 567 870
Gross loans and advances to customers by donating division and sector (excluding reverse repurchase agreements) £bn £bn
UK Retail Mortgages 1.9 2.2 Personal 0.7 1.1 Total UK Retail 2.6 3.3
UK Corporate Manufacturing & infrastructure 0.3 0.3 Property & construction 10.8 11.3 Lombard 2.7 3.7 Invoice finance 0.4 0.7 Other 20.7 22.1 Total UK Corporate 34.9 38.1
Global Banking & Markets Manufacturing & infrastructure 17.5 Property & construction 25.7 Transport 5.8 Telecoms, media & technology 3.2 Banks & financials 16.0 Other 13.5 Total Global Banking & Markets 81.7 104.8
Ulster Bank Mortgages 6.0 6.5 Commercial investment & development 3.0 2.9 Residential investment & development 5.6 5.9 Other 1.1 1.1 Other EMEA 1.0 1.3 Total Ulster Bank 16.7 17.7
Global Transaction Services 0.8 1.4 RBS Insurance 0.2 0.2 Central items (3.2) —
Global Banking & Markets 16,800 16,500 Global Transaction Services 3,500 3,900 Ulster Bank 4,500 5,400 US Retail & Commercial 15,500 16,200 RBS Insurance 13,900 14,500 Central items 4,200 4,300
RFS Holdings minority interest 23,100 24,500 Group total 183,700 199,800 2009 compared with 2008 Losses from trading activities have declined significantly as underlying asset prices rallied. Mark to market values for exposures such as monolines, super senior high grade collateralised debt obligations, and many negative basis trade asset classes have risen over the course of 2009. However, the £1.6 billion gain recorded on banking book hedging in 2008 unwound over the course of the year to a loss of £1.6 billion in 2009, as spreads continued to tighten throughout the year, ending almost in line with origination levels.
Debt securities in issue 246,329 269,458 267,568 300,289 Settlement balances and short positions 50,875 54,264 50,876 54,277
Loans and advances to customers were down £135.6 billion, 19%, at £595.7 billion. Within this, reverse repos increased by 4%, £1.8 billion to £41.0 billion. Excluding reverse repos, lending decreased by £137.3 billion to £554.7 billion or by £131.6 billion, 19%, before impairment provisions. This reflected reductions in Global Banking & Markets of £71.4 billion, and planned reductions in Non-Core of £30.1 billion, including a £3.2 billion transfer to disposal groups in respect of RBS Sempra Commodities and the Asian and Latin American businesses. There were also reductions in US Retail & Commercial, £7.4 billion; UK Corporate & Commercial, £5.4 billion; Ulster Bank, £1.8 billion; and the effect of exchange rate movements, £22.8 billion, following the strengthening of sterling during the year, partially offset by growth in UK Retail of £9.2 billion, and in Wealth of £1.4 billion.
Debt securities decreased by £4.1 billion, 2%, to £249.1 billion and equity shares decreased by £6.2 billion, 28%, to £16.0 billion, principally due to the sale of the Bank of China investment and lower holdings in Global Banking & Markets and Non-Core, largely offset by growth in Group Treasury, in part reflecting an £18.0 billion increase in the gilt liquidity portfolio.
Deposits by banks declined by £109.0 billion, 41%, to £153.6 billion, due to a decrease in repurchase agreements and stock lending (‘repos’), down £45.7 billion, 55%, to £38.0 billion and reduced interbank deposits, down £63.3 billion, 35%, to £115.6 billion, principally in Global Banking & Markets reflecting reduced reliance on wholesale funding.
Commentary on consolidated balance sheet – statutory Total assets of £1,696.5 billion at 31 December 2009 were down £705.2 billion, 29%, compared with 31 December 2008, principally reflecting substantial repayments of customer loans and advances as corporate customer demand fell and corporates looked to deleverage their balance sheets. Lending to banks also fell in line with significantly reduced wholesale funding activity. There were also significant falls in the value of derivative assets, with a corresponding fall in derivative liabilities.
Loans and advances to customers were down £146.3 billion, 17%, at £728.4 billion. Within this, reverse repos increased by 4%, £1.7 billion to £41.0 billion. Excluding reverse repos, lending decreased by £148.0 billion, 18%, to £687.4 billion or by £141.8 billion, 17%, before impairment provisions. This reflected reductions in Global Banking & Markets of £71.4 billion, and planned reductions in Non-Core of £30.1 billion, including a £3.2 billion transfer to disposal groups in respect of RBS Sempra Commodities and the Asian and Latin American businesses. Reductions were also experienced in US Retail & Commercial, £7.4 billion; UK Corporate & Commercial, £5.4 billion; Ulster Bank, £1.8 billion; and the effect of exchange rate movements, £33.1 billion, following the strengthening of sterling during the year, partially offset by growth in UK Retail of £9.2 billion, and in Wealth of £1.4 billion.
Deposits by banks declined by £115.9 billion, 45%, to £142.1 billion due to a decrease in repurchase agreements and stock lending (‘repos’), down £45.7 billion, 55%, to £38.0 billion and reduced inter-bank deposits, down £70.2 billion, 40% to £104.1 billion principally in Global Banking & Markets, reflecting reduced reliance on wholesale funding, and in the RFS Holdings minority interest.
Debt securities in issue were down £32.7 billion, 11% to £267.6 billion mainly as a result of movements in exchange rates, together with reductions in Global Banking & Markets, Non-Core and the RFS Holdings minority interest.
Owners' equity increased by £18.9 billion, 32% to £77.7 billion. The issue of B shares to HM Treasury in December 2009 raised £25.1 billion, net of expenses, and was offset in part by the creation of a £1.2 billion reserve in respect of contingent capital B shares. The placing and open offer in April 2009 raised £5.3 billion to fund the redemption of the £5.0 billion preference shares issued to HM Treasury in December 2008. Actuarial losses, net of tax, of £2.7 billion; the attributable loss for the period, £2.7 billion; exchange rate movements of £1.9 billion; the payment of other owners dividends of £0.9 billion including £0.3 billion to HM Treasury on the redemption of preference shares, and partial redemption of paid-in equity £0.3 billion were partly offset by increases in available-for-sale reserves, £1.8 billion; cash flow hedging reserves, £0.6 billion; and the equity owners gain on withdrawal of minority interests, net of tax, of £0.5 billion arising from the redemption of trust preferred securities.
The major factors contributing to the net cash outflow from operating activities of £992 million were the net operating loss before tax of £2,696 million from continuing and discontinued operations, the decrease of £15,964 million in operating liabilities less operating assets, partly offset by the elimination of foreign exchange differences of £12,217 million and other items of £5,451 million.
Net cash flows from financing activities of £18,791 million primarily arose from the capital raised from the issue of B Shares of £25,101 million, the placing and open offer of £5,274 million and the issue of subordinated liabilities of £2,309 million. This was offset in part by the cash outflow on repayment of subordinated liabilities of £5,145 million, redemption of preference shares of £5,000 million, interest paid on subordinated liabilities of £1,746 million and dividends paid of £1,248 million.
Net cash flows from financing activities of £15,102 million primarily arose from the capital raised from the placing and open offer of £19,741 million and the rights issue of £12,000 million, the issue of subordinated liabilities of £2,413 million and proceeds of minority interests, £1,427 million. This was offset in part by the cash outflow on redemption of minority interests of £13,579 million, repayment of subordinated liabilities of £1,727 million, dividends paid of £3,193 million and interest paid on subordinated liabilities of £1,967 million.
Risk-weighted assets Credit risk 513,200 551,300 Counterparty risk 56,500 61,100 Market risk 65,000 46,500 Operational risk 33,900 36,900
Banking book: On-balance sheet 480,200 318,600 303,300 Off-balance sheet 84,600 59,400 51,500
Note: (1) The data for 2009 and 2008 are on a Basel II basis; prior periods are on a Basel I basis.
UK banking sector, comparing a bank’s capital resources with its riskweighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. At 31 December 2009, the Group’s total RAR was 16.1% (2008 – 14.1%) and the Tier 1 RAR was 14.1% (2008 – 10.0%).
Income statement for the year ended 31 December 2009 RFS Reallocation minority of one-off Pro forma interest items Statutory £m £m £m £m
Net interest income 13,567 2,937 — 16,504 Non-interest income (excluding insurance net premium income) 10,592 2,128 3,922 16,642 Insurance net premium income 5,266 278 — 5,544
Amortisation of purchased intangible assets (272) — 272 — Write-down of goodwill and other intangible assets (363) — 363 — Integration and restructuring costs (1,286) — 1,286 — Gain on redemption of own debt 3,790 — (3,790) — Strategic disposals 132 — (132) — Gains on pensions curtailment 2,148 — (2,148) — Bonus tax (208) — 208 — Operating loss before tax (2,291) (304) — (2,595)
Net interest income 15,764 2,911 — 18,675 Non-interest income (excluding insurance net premium income) (874) 1,299 442 867 Insurance net premium income 5,709 617 — 6,326
Assets Cash and balances at central banks 51,548 713 52,261 Net loans and advances to banks 48,777 7,879 56,656 Reverse repurchase agreements and stock borrowing 35,097 — 35,097 Loans and advances to banks 83,874 7,879 91,753 Net loans and advances to customers 554,654 132,699 687,353 Reverse repurchase agreements and stock borrowing 41,040 — 41,040 Loans and advances to customers 595,694 132,699 728,393
Repurchase agreements and stock lending 38,006 — 38,006 Deposits by banks 153,648 (11,504) 142,144
Repurchase agreements and stock lending 83,666 — 83,666 Deposits by banks 262,609 (4,565) 258,044
Note: (1) Businesses to be transferred to other consortium members in due course.
Risk, capital and liquidity management On pages 117 to 206 of the Business review certain information has been audited and is part of the Group’s financial statements as permitted by IFRS 7. Other disclosures are unaudited and labelled with an asterisk (*). Key points within this section generally relate to the Group before RFS Holdings minority interest.
Credit impairments in 2009 were materially higher than the previous year. As the year progressed, the level of impairments moderated, with the highest quarterly charge incurred in the second quarter. It is expected that the results for 2010 and 2011 will continue to be affected by a heightened level of credit impairments as exposures in the NonCore division are managed down and the economic environment continues to impact the Core business. The risk weightings applied to assets are also expected to increase due to procyclicality and as a result the amount of capital that banks generally are required to hold will increase. Future regulatory changes are also expected to increase the capital requirements of the banking sector. Against this background, the Non-Core portfolio is reducing and the Group has materially strengthened its capital base through the B share issuance in 117RBS Group Annual Report and Accounts 2009 * unaudited
Note: For key changes to the risk, capital and liquidity governance structure, refer to the table overleaf.
Group Audit Committee Financial reporting and the application of accounting Independent non-executive directors (GAC) policies as part of the internal control and risk assessment process. From a historical perspective, GAC monitors the identification, evaluation and management of all significant risks throughout the Group.
Board Risk Committee A new committee, formed to provide oversight and advice At least three independent non-executive (BRC) to the Group Board in relation to current and potential future directors, one of whom is the Chairman risk exposures of the Group and future risk strategy. Reports of the Group Audit Committee to the Group Board, identifying any matters within its remit in respect of which it considers an action or improvement is needed, and making recommendations as to the steps to be taken. Provides quantitative and qualitative advice to the Remuneration Committee upon the Group Remuneration Policy and the implications for risk management.
Chief Executive from each division Group Chief Accountant Group Treasurer and Deputy Group Treasurer Chief Financial Officer, ABN AMRO Director, Group Corporate Finance Director, Group Financial Planning & Analysis Head of Balance Sheet Management, Group Treasury
• Group Treasury: balance sheet, capital management, intra-group exposure, funding, liquidity and hedging policies.
Different techniques are used to ensure that the Group’s risk appetite is achieved. The Board Risk Committee considers and recommends for approval by the Group Board, the Group’s risk appetite framework and tolerance for current and future strategy, taking into account the Group’s capital adequacy and the external risk environment. The ERF is responsible for ensuring that the implementation of strategy and operations are in line with the risk appetite determined by the Board. This is reinforced through policy and limit frameworks ensuring that all staff within the Group make appropriate risk and reward trade-offs within pre-agreed boundaries.
The annual business planning and performance management processes and associated activities together ensure that the expression of risk appetite remains appropriate. Both GRC and GALCO support this work.
Remuneration responsibilities In August 2009, the Financial Services Authority (FSA) published its Code of Remuneration Practices (the Code). The Code requires the Group to establish, implement and maintain remuneration policies, procedures and practices that promote and are consistent with effective risk management.
During 2009 Risk Management provided formal independent 360° feedback for key individuals, reviewing their capability and performance in relation to managing risk. Individuals selected perform roles of significant influence and their activities have, or could have, a material impact on the Group’s risk profile.
The Group’s regulatory capital resources on a proportional consolidation basis at 31 December 2009 and in accordance with the FSA definitions were as follows: Composition of regulatory capital (proportional) £m £m
Tier 1 Ordinary and B shareholders' equity 69,890 45,525 Minority interests 2,227 5,436 Adjustments for: – Goodwill and other intangible assets – continuing (14,786) (16,386) – Goodwill and other intangible assets of discontinued businesses (238) — – Unrealised losses on available-for-sale debt securities 1,888 3,687 – Reserves arising on revaluation of property and unrealised gains on available-for-sale equities (207) (984) – Reallocation of preference shares and innovative securities (656) (1,813) – Other regulatory adjustments (950) 9
Less excess of expected losses over provisions net of tax (2,558) (770) Less securitisation positions (1,353) (663) Less APS first loss (5,106) — Core Tier 1 capital 48,151 34,041 Preference shares 11,265 16,655 Innovative Tier 1 securities 2,772 6,436 Tax on the excess of expected losses over provisions 1,020 308 Less deductions from Tier 1 capital (310) (316)
Risk weighted assets Credit risk 410,400 433,400 Counterparty risk 56,500 61,100 Market risk 65,000 46,500 Operational risk 33,900 36,800
The Group’s regulatory capital resources on a full consolidation basis at 31 December 2009 and in accordance with the FSA definitions were as follows: Composition of regulatory capital (statutory) £m £m
Asset Protection Scheme On 22 December 2009, the Group acceded to the Asset Protection Scheme (‘APS’ or ‘the Scheme’). The key commercial terms and details of the assets covered by the Scheme are set out on page 174.
On 19 January 2009, the FSA announced that it expects each bank participating in the UK Government’s recapitalisation scheme to have a minimum Core Tier 1 ratio of 4% on a stressed basis. As at 31 December 2009 the Group’s Core Tier 1 ratio was 11.0% (2008 – 6.6%). While the RWA relief from the APS enabled the Group to maintain robust capital ratios, it is clear that the next few years pose continuing challenges in respect of impairment levels, trading performance and the return to profitability, RWA volatility including procyclical effects, and increasing regulatory demands.
Regulatory capital impact of the APS Methodology The regulatory capital requirements for assets covered by the Scheme are calculated using the securitisation framework under the FSA prudential rules. The calculation is as follows (known as ‘the Uncapped Amount’): • First Loss – the residual first loss, after impairments and writedowns, to date, is deducted from the available capital – split equally between Core Tier 1 and Tier 2 capital; • HM Treasury share of covered losses – after the first loss piece has been deducted, the 90% of assets covered by HM Treasury are risk weighted at 0%; and
Impact at accession The Group expects initially to calculate its capital requirements in accordance with the Capped basis. Accordingly, the APS itself (viewed separately from the B share issuance) at accession had no impact on the Pillar 1 regulatory capital requirement in respect of the assets covered by the APS. It will, however, improve the total capital ratios, and the Core Tier 1 ratios, of the Group as a whole. It is also expected that the protection afforded by the APS will assist the Group in satisfying the forward looking stress testing framework applied by the FSA.
Using these approaches, the RWA requirements by division on a proportional basis are as follows: RWAs £bn £bn
UK Retail 51.3 45.7 UK Corporate 90.2 85.7 Wealth 11.2 10.8 Global Banking & Markets 123.7 151.8 Global Transaction Services 19.1 17.4 Ulster Bank 29.9 24.5 US Retail & Commercial 59.7 63.9 Other 9.4 7.1 Core 394.5 406.9 Non-Core 171.3 170.9 565.8 577.8 Benefit of APS (127.6) n/a
Future regulatory capital effects As impairments on the pool of assets arise, these will be required to be deducted in full from Core Tier 1 Capital in the normal way. The Group will be entitled to apply these impairments to reduce the First Loss deduction for the Scheme, potentially leading to a position where the capital requirement on the Uncapped Basis would no longer for the assets covered by the APS exceed the Non-APS Requirement and, as a result, the Group would expect to start reporting the regulatory capital treatment on the Uncapped Basis.
For further information on APS refer to pages 174 to 183.
Basel II The Group adopted Basel II on 1 January 2008. Pillar 1 focuses on the calculation of minimum capital required to support the credit, market and operational risks in the business. For credit risk, the majority of the Group uses the Advanced Internal Ratings Based Approach for calculating RWAs.
In addition to the calculation of minimum capital requirements for credit, market and operational risk, banks are required to undertake an Individual Capital Adequacy Assessment Process (ICAAP) for other risks. The Group’s ICAAP, in particular, focuses on pension fund risk, interest rate risk in the banking book together with stress tests to assess the adequacy of capital over one year and the economic cycle.
The Group publishes its Pillar 3 (Market disclosures) on its website, providing a range of additional information relating to Basel II and risk and capital management across the Group. The disclosures focus on Group level capital resources and adequacy, discuss a range of credit risk approaches and their associated RWAs under various Basel II approaches such as credit risk mitigation, counterparty credit risk and provisions. Detailed disclosures are also made on equity, securitisation, operational and market risk, as well as providing Interest Rate Risk in the Banking Book disclosures.
Stress and scenario testing Stress testing forms part of the Group’s risk and capital framework and an integral component of Basel II. As a key risk management tool, stress testing highlights to senior management potential adverse unexpected outcomes related to a mixture of risks and provides an indication of how much capital might be required to absorb losses, should adverse scenarios occur. Stress testing is used at both a divisional and Group level to assess risk concentrations, estimate the impact of stressed earnings, impairments and write-downs on capital. It determines the overall capital adequacy under a variety of adverse scenarios. The principal business benefits of the stress testing framework include: understanding the impact of recessionary scenarios; assessing material risk concentrations; forecasting the impact of market stress and scenarios on the Group’s balance sheet liquidity.
At Group level, a series of stress events are monitored on a regular basis to assess the potential impact of an extreme yet plausible event on the Group. There are four core elements of scenario stress testing: • Macroeconomic stress testing considers the impact on both earnings and capital for a range of scenarios. They entail multi-year systemic shocks to assess the Group’s ability to meet its capital requirements and liabilities as they fall due under a downturn in the business cycle and/or macroeconomic environment; • Enterprise wide stress testing considers scenarios that are not macroeconomic in nature but are sufficiently broad in nature to impact across multiple risks or divisions and are likely to impact earnings, capital and funding; • Cross-divisional stress testing includes scenarios which have impacts across divisions relating to sensitivity to a common risk factor(s). This would include sector based stress testing across corporate portfolios and sensitivity analysis to stress in market factors. These stress tests are discussed with senior divisional management and are reported to senior committees across the Group; and
Credit risk The risk arising from the possibility that the Group Loss characteristics vary materially across portfolios. (including country will incur losses owing to the failure of customers to and political risks) meet their financial obligations to the Group. Significant correlation between losses and the macroeconomic environment.
The risk arising from country events. Country risks correlated with macroeconomic developments.
Country vulnerabilities changing structurally in the aftermath of the financial crisis.
Market risk The risk that the value of an asset or liability may Potential for large, material losses. change as a result of a change in market risk factors.
Pension risk is the risk that the Group may have to Pension risk arises because of the uncertainty of make additional contributions to its defined benefit future investment returns and the projected value of pension schemes. schemes’ liabilities.
Principles for credit risk management The key principles for credit risk management in the Group are as follows: • A credit risk assessment of the customer and credit facilities is undertaken prior to approval of credit exposure. Typically, this includes both quantitative and qualitative elements including: the purpose of the credit and sources of repayment; compliance with affordability tests; repayment history; ability to repay; sensitivity to economic and market developments; and risk-adjusted return based on credit risk measures appropriate to the customer and facility type; • Credit risk authority is specifically granted in writing to individuals involved in the approval of credit extensions. In exercising credit authority, individuals are required to act independently of business considerations and must declare any conflicts of interest; • Credit exposures, once approved, are monitored, managed and reviewed periodically against approved limits. Lower quality exposures are subject to more frequent analysis and assessment; • Credit risk management works with business functions on the ongoing management of the credit portfolio, including decisions on mitigating actions taken against individual exposures or broader portfolios; • Customers with emerging credit problems are identified early and classified accordingly. Remedial actions are implemented promptly and are intended to restore the customer to a satisfactory status and minimise any potential loss to the Group; and
Credit risk organisation The credit risk function is organised within a divisionally aligned structure to ensure appropriate proximity to the businesses it covers and to develop and provide the specialisation required to manage the associated credit risk. The function comprises a number of activities: credit approval; transaction/customer assessment; policy formulation and development (in the context of the Group-wide policy framework); portfolio reporting; and quantitative portfolio analytics.
In addition to the activities undertaken within divisional functions, a Group-wide credit risk function sets the overall framework and highest level credit risk policy standards; produces Group-wide credit risk portfolio reporting and analysis; and approves credit transactions which exceed divisional credit authority.
The ongoing investment in collections and recoveries operations has continued in 2009. Investment has increased staffing levels in all collections and recoveries functions, enhanced staff training to improve efficiency and effectiveness as well as upgraded technology and infrastructure.
In the UK and Ireland, the Group has introduced new forbearance policies for customers in financial difficulty based on various government sponsored schemes, customer affordability and prospects. In the US there has been an increase in agreed loan modification programmes, including those sponsored by the US government.
Credit risk framework The approach taken to managing credit risk varies significantly between wholesale portfolios (loans, and other products giving rise to credit risk, to all but the smaller corporate customers, to financial institutions and to government entities) and retail portfolios (secured and unsecured loans and related products to individuals and small businesses).
The credit approval process has two stages, assessment and decision. Credit applications for corporate customers are prepared by relationship managers in the units originating the credit exposures or by the relationship management team with lead responsibility for a counterparty where a customer has relationships with different divisions and business units across the Group. This includes the assignment of risk parameter estimates (probability of default, loss given default and exposure at default) using approved models.
Credit approval authority is discharged by way of a framework of individual delegated authorities that requires at least two individuals to approve each credit decision, one from the business and one from the credit risk management function. Both parties must hold sufficient delegated authority under the Group-wide authority grid. The level of authority granted to an individual is dependent on their experience and expertise with only a small number of senior executives holding the highest authority provided under the framework.
As a minimum, credit relationships are reviewed and re-approved annually. The renewal process addresses: borrower performance, including reconfirmation or adjustment of risk parameter estimates; the adequacy of security; and compliance with terms and conditions.
Retail portfolios Retail business operations require a large volume of small scale credit decisions, typically involving an application for a new product or a change in facilities on an existing product. The majority of these decisions are based upon automated strategies utilising best practice credit and behaviour scoring techniques. Scores and strategies are typically segmented by product, brand and other significant drivers of credit risk. These data driven strategies utilise a wide range of credit information relating to a customer including, where appropriate, information across a customer’s holdings.
Credit risk measurement Credit risk models are used throughout the Group to support the quantitative risk assessment element of the credit approval process, ongoing credit risk management, monitoring and reporting and portfolio analytics. Credit risk models used by the Group may be divided into three categories.
• Wholesale businesses: each counterparty is assigned an internal credit grade which is in turn assigned to a default probability range. There are a number of different credit grading models in use across the Group, each of which considers risk characteristics particular to that type of customer. The credit grading models score a combination of quantitative inputs (for example, recent financial performance) and qualitative inputs, (for example, management performance or sector outlook). Scores are then mapped to grades within each model. Grades are calibrated centrally to default probabilities. Obligor grades can, under certain circumstances, be cascaded to other borrowing entities within the obligor group where there is sufficient dependence on the graded entity. The credit grades for sovereign and central bank entities are assigned by a specialist country risk analysis team using a sovereign grading model. This team is independent of the origination function and is comprised of economists. Certain grading models also cover customers or transactions categorised as specialised lending (for example certain types of investment property and asset finance such as shipping).
• Retail businesses: each customer account is separately scored using models based on the most material drivers of default. In general, scorecards are statistically derived using customer data. Customers are assigned a score which in turn, is mapped to a probability of default. The probability of default is used within the credit approval process and ongoing credit risk management, monitoring and reporting. The probabilities of default are used to group customers into risk pools. Pools are then assigned a weighted average probability of default using regulatory default definitions.
• Guarantees and similar instruments (for example, credit insurance) from related and third parties are used in the management of credit portfolios, typically to mitigate credit concentrations in relation to an individual obligor, a borrower group or a collection of related borrowers.
• Collateral management to ensure that credit risk mitigation is legally effective and enforceable.
Credit concentration risk The Group defines four key areas of concentration in credit risk that are monitored, reported and managed at both Group and divisional levels. These are single name, industry/sector, country and product/asset class. Frameworks to address single name, industry/sector and country concentrations are established and continue to be enhanced and embedded into business processes across the Group. Aspects of the product/asset class framework are in place whilst others will be developed during the course of 2010.
Under the Group’s credit approval framework, the required approval level is linked to the size of exposure with exposures above a certain level requiring the highest level of approval, held by a very small number of executives. In addition, the Group’s single name concentration framework includes specific approval requirements; additional reporting and monitoring; and the requirement to develop plans to address and reduce excess exposures.
Reviews conclude with specific sector caps and other portfolio strategies to align the Group’s exposure profile with its appetite.
The Group’s appetite for country risk is set by the ERF in the form of limits by country risk grade, with sub-limits on term exposure. Countries where exposures exceed this limit framework are approved by the ERF while authority is delegated to the Group Country Risk Committee (GCRC) to manage exposures within the framework. Specific limits are set for each country based on a risk assessment taking into account the Group’s franchise and business mix in that country. Additional limitations – on product types with higher loss potential, for example – are established to address specific vulnerabilities in the context of a country's outlook and/or the Group's business strategy in a particular country. A country watch list framework is in place to proactively monitor emerging issues and facilitate the development of mitigation strategies.
Risk, capital and liquidity management 131RBS Group Annual Report and Accounts 2009
• There has been a sustained focus on country exposures, both in terms of those countries that represent a larger concentration and those that, under the country watch list process, have been identified as exhibiting signs of actual or potential stress.
Most economies enter 2010 in a tentative recovery phase, attributed largely to official stimulus, resilient consumption and global restocking. International prospects vary and significant risks remain, particularly around exiting government support, advanced sovereign debt levels and rising inflationary pressures. Currently low yields may not last as these trends play out. Asia remains the best performing region, thanks to limited sovereign and corporate leverage. However, growth prospects remain linked to global trade flows. Middle East sovereigns are generally strong, but the private sector continues to feel the impact of weakness in real estate and construction. Latin America proved relatively insulated from the crisis, and policy gains look set to be sustained. Peripheral Euro zone sovereigns with heavy debt burdens face increased risks, with credible adjustment programmes needed. Eastern Europe has made some progress in addressing key weaknesses, but vulnerabilities in some countries remain and growth prospects are modest.
Asset quality by industry and geography Industry analysis plays an important part in assessing potential concentration risk in the loan portfolio. Particular attention is given to industry sectors where the Group believes there is a high degree of risk or potential for volatility in the future.
• Exposures have decreased materially across industry sectors and geographies, with the exception of the UK where exposure is only 2% lower at 31 December 2009 compared with a year earlier.
Single name concentrations During the first half of the year, the Group implemented an enhanced framework to address the risk arising from concentrations of exposure to related groups of borrowers. Despite market illiquidity that reduced the scope for exposure management strategies against certain assets, and negative credit migration, that created additional cases in excess of the framework’s parameters, some progress was made against exceptions arising from the framework. Overall there were 9% fewer exceptions at the end of the period than at the beginning. Plans have been developed and continue to be refined to deliver alignment with the framework over the course of the Group’s strategic plan.
Credit risk asset quality Using the PD models described above, customers are assigned credit grades and scores, which are used for internal management reporting across portfolios, including a Group level asset quality scale, as shown below.
Internal reporting and oversight of risk assets is principally differentiated by credit grades. Customers are assigned credit grades, based on various credit grading models that reflect the key drivers of default for the customer type. All credit grades across the Group map to both a Group level asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures used for internal management reporting across portfolios. Accordingly, measurement of risk is easily aggregated and can be reported at increasing levels of granularity depending on audience and business need.
Citizens: – Mortgages 26,534 34,394 – Auto and cards 6,917 9,126
(2) Personal exposures in other divisions, including Wealth, and RBS Insurance.
UK Retail Ulster Bank Citizens distribution by average LTV (1) (indexed) % % % % % %
Average LTV on new originations during the year 67.2 67.2 72.8 71.1 62.4 64.3
UK net new mortgage lending in 2009 was strong at £11 billion and the Group has exceeded its commitment to the UK Government on net mortgage lending. The average LTV for new business during 2009 was unchanged at 67.2%. The maximum LTV available to new customers remains at 90%.
The mortgage impairment charge was £129 million in 2009, compared with £33 million in 2008, attributable to declining house prices driving lower recoveries and an increase in defaults reflecting the difficult economic environment. Default rates remain sensitive to economic developments, notably unemployment rates. Provision as a proportion of balances at 31 December 2009 were 0.3% and 0.2% at 31 December 2008.
A number of initiatives aimed at increasing the levels of support to customers experiencing difficulties were implemented in 2008 and will continue in 2010. The Group does not initiate repossession proceedings for at least six months after arrears are evident and participates in various government-led initiatives such as the mortgage rescue scheme and homeowner mortgage support.
The arrears rate increased to 3.3% at 31 December 2009 from 1.6% at 31 December 2008. As a result, the impairment charge for 2009 was £115 million versus £23 million for 2008. Repossessions totalled 96 in 2009, compared with 37 in 2008 with the majority of these being voluntary.
During 2009 new business originations in the Republic of Ireland were very low across all segments. The bank introduced new products – Momentum and SecureStep – in both Northern Ireland and the Republic of Ireland which aim to support market activity for new build properties. In Northern Ireland, lending increased in the second half of 2009 as a degree of confidence returned to the property market.
Citizens has focused its origination efforts in the more mature and stable markets of New England and Mid Atlantic (Citizen’s ‘footprint states’), targeting low risk products and adopting conservative risk policies. Loan acceptance criteria were tightened during 2009 to address deteriorating economic and market conditions. At 31 December 2009, the portfolio consisted of $34 billion (80% of the total portfolio) in these footprint states.
Note: (1) UK Retail analysis covers the Royal Bank and NatWest brands and covers 77% of the UK Retail mortgage portfolio (the remainder operates under the same credit policies).
Notes: (1) The charge for UK Retail assets refers to impairment on assets in the year.
(2) The charge for Citizens assets refers to charge offs in the year, net of recoveries realised in the year.
The UK personal lending portfolio, of which 97% is in Core businesses, comprises credit cards, unsecured loans and overdrafts and totalled £20.3 billion at 31 December 2009, a decrease of 10% from 31 December 2008 (£22.5 billion) due to a general market trend of customers repaying debt on credit cards and loan balances and a reduction in new lending.
The Citizens credit card portfolio totalled US$2.3 billion, at 31 December 2009. Core assets comprised 58% of the portfolio.
The Citizens cards business adopts conservative risk strategies compared to the US market as illustrated by the business generally performing better than industry benchmarks (provided by VISA). The latest available metrics (December 2009) show the rate for 60+ days delinquency as a percentage of total outstandings at 4.4% (compared to an industry figure of 4.7%) and net contractual charge-offs as a percentage of total outstandings at 7.1% (compared to an industry figure of 7.4%).
For new customers, lending criteria have been tightened and initial credit lines reduced. Existing customers are regularly monitored for changes in asset quality and behaviour and, where appropriate, proactive measures are taken to limit or reduce credit exposure.
Citizens is a leading provider of retail auto financing to US consumers through a network of 3,500 auto dealers located in 23 US states. It maintains a conservative, prime indirect auto lending credit programme with loss rates that have historically been below national averages. Current outstanding retail auto loan balances totalled $8.8 billion as of 31 December 2009, when the 30-day delinquency rate stood at 2.6%. This compares to data reported by the American Bankers’ Association (latest available is at 30 September 2009) showing the nationwide indirect auto lending delinquency rate at 2.8%. Citizens recently shifted its focus on auto financing, moving from a nationwide emphasis to its regional lending footprint. This, together with enhanced collection activities, has resulted in better than expected loss results. Total portfolio losses fell from $129.6 million in 2008 to $120.6 million in 2009.
Risk, capital and liquidity management 137RBS Group Annual Report and Accounts 2009
Portfolios are subject to close monitoring within the originating division and a dedicated unit in the GRG focuses on commercial real estate to ensure that expertise is readily available to manage this portfolio actively on a coordinated basis globally.
Transport and storage The automotive, shipping and aviation portfolios form part of the transport and storage industry sector, which stood at £46.2 billion at 31 December 2009, down 22% during the year. The remainder of the portfolio largely comprises land-based freight, storage and logistics companies.
Core Non-Core Total Total Domicile of obligor £m £m £m % £m %
Central Eastern Europe, Middle East and Africa 373 152 525 6 872 7 * unaudited
The Group’s shipping portfolio is primarily focused on fully secured mortgage finance business in the dry bulk and tanker sectors, with a limited exposure to container vessels.
The Group has refined its strategy during the course of 2009 to define a core business focussed on a well established client base of owners in Europe and North America where the Group has long-standing relationships with companies that have a demonstrated ability to withstand cyclical downturns.
Note: (1) Operating lease assets, which are included in property, plant and equipment, represent the net investment in aircraft owned and on order. A smaller figure, £1 billion, is included within credit risk assets, representing the risk of customer default on lease agreements.
The aviation portfolio comprises a number of activities, but is primarily focused on the Dublin based Aviation Capital business, which has been designated as Non-Core.
The aviation sector has been under considerable pressure owing to the global downturn and compounded by the impact of the H1N1 virus (particularly in South America), overcapacity (notably in India and North America) and intense competition. Despite the publicised failure of several airlines, within the Group’s portfolio there have been very low incidences of payment defaults and exposures requiring restructuring.
The Group’s strategy is to focus on modern assets that are widely used across airlines and to maintain relationships with the strongest operators with the most flexible cost base. The majority of the portfolio is secured on modern aircraft and, although asset prices have weakened, exposures remain fully secured.
Aviation exposure on the Group’s watch list, where there is an increased level of management control and oversight, totalled £1.4 billion at 31 December 2009. Notwithstanding reduced passenger volumes, the leased fleet remains fully utilised. The young age and commodity nature of the assets and the quality of the lessees, result in a limited expectation of aircraft being returned.
Risk, capital and liquidity management 141RBS Group Annual Report and Accounts 2009
Economic weakness and reduced consumer confidence is affecting the sector, with the impact most severe for stores reliant on high discretionary spend and for smaller retailers. Food retailers generally fared well during the year, as did the ‘value’ end of the sector in the context of reduced household spending.
Central Eastern Europe, Middle East and Africa 394 74 468 3 589 3
• Provision coverage in Core business improved from 55% to 57%.
The analyses of risk elements in lending and impairments as discussed below, form a key part of the data provided to senior management on the credit performance of the Group’s portfolios.
REIL and PPL as a % of gross lending to customers
Notes: (1) For the analysis above, ‘Domestic’ consists of the United Kingdom domestic transactions of the Group. ‘Foreign’ comprises the Group’s transactions conducted through the offices outside the UK and those offices in the UK specifically organised to service international banking transactions.
• At 31 December 2009 REIL were 80% greater than at 31 December 2008. The majority of this growth was attributable to property assets, particularly in Non-Core which had a 107% increase in REIL.
• REIL and PPL represented 5.5% of gross lending to customers, up from 2.5% at the end of 2008.
Emergence periods are estimated at a portfolio level and reflect the portfolio product characteristics such as a coupon period and repayment terms, and the duration of the administrative process required to report and identify an impaired loan as such. Emergence periods vary across different portfolios from two to 225 days. They are based on actual experience within the particular portfolio and are reviewed regularly.
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, PDs and emergence periods. The wholesale calculation is based on similar principles but there is no segmentation into portfolios: PDs and LGDs are calculated on an individual basis.
Risk, capital and liquidity management 145RBS Group Annual Report and Accounts 2009